<PAGE>
As filed with the Securities and Exchange Commission on April 4, 2000
Registration No. 333-95815
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------
AMENDMENT NO. 5
TO
FORM S-1
REGISTRATION STATEMENT
Under
The Securities Act of 1933
--------------
ORATEC INTERVENTIONS, INC.
(Exact Name of Registrant as Specified in Its Charter)
--------------
Delaware 3845 94-3180773
(State or Other (Primary Standard (I.R.S. Employer
Jurisdiction of Industrial Classification Identification Number)
Incorporation or Code Number)
Organization)
3700 Haven Court
Menlo Park, California 94025
(650) 369-9904
(Address, Including Zip Code, and Telephone Number, Including Area
Code, of Registrant's Principal Executive Offices)
--------------
Kenneth W. Anstey
Chief Executive Officer
ORATEC Interventions, Inc.
3700 Haven Court
Menlo Park, California 94025
(650) 369-9904
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
--------------
Copies to:
Mark B. Weeks Patrick T. Seaver
Laurel Finch Charles K. Ruck
Brooke Campbell Shayne Kennedy
VENTURE LAW GROUP LATHAM & WATKINS
A Professional Corporation 650 Town Center Drive
2800 Sand Hill Road Costa Mesa, CA 92626
Menlo Park, California 94025
--------------
Approximate date of commencement of proposed sale to the public:
As soon as practicable after the effective date of this Registration
Statement.
--------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
--------------
CALCULATION OF REGISTRATION FEE
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Proposed
Proposed Maximum
Title of each Class of Amount Maximum Aggregate Amount of
Securities to be To be Offering Price Offering Registration
Registered Registered(1) Per Share(2) Price(2) Fee(3)
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock, $.001 par
value................. 4,600,000 $15.00 $69,000,000 $18,216.00(3)
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
(1) Includes 600,000 shares of Common Stock issuable upon exercise of the
Underwriters' over-allotment option.
(2) Estimated solely for the purpose of computing the amount of the
registration fee pursuant to Rule 457(a) under the Securities Act.
(3) The additional fee has been remitted.
--------------
The Registrant hereby amends this registration statement on such date or
dates as may be necessary to delay its effective date until the registrant
shall file a further amendment which specifically states that this
registration statement shall thereafter become effective in accordance with
Section 8(a) of the Securities Act of 1933 or until this registration
statement shall become effective on such date as the Commission, acting
pursuant to said Section 8(a), may determine.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+The information in this prospectus is not complete and may be changed. We may +
+not sell these securities until the registration statement filed with the +
+Securities and Exchange Commission is effective. This preliminary prospectus +
+is not an offer to sell these securities and is not soliciting an offer to +
+buy these securities in any state where the offer or sale is not permitted. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
Subject to Completion
Preliminary Prospectus dated April 4, 2000
PROSPECTUS
- -----------
4,000,000 Shares
[ORATEC LOGO APPEARS HERE]
Common Stock
------------
This is ORATEC's initial public offering of common stock. All the shares of
common stock are being sold by ORATEC.
We expect the initial public offering price to be between $13.00 and $15.00.
Currently, no public market exists for the shares. We have applied to list our
common stock on the Nasdaq National Market under the symbol "OTEC."
Investing in our common stock involves risks which are described in the "Risk
Factors" section beginning on page 5 of this Prospectus.
------------
<TABLE>
<CAPTION>
Per Share Total
--------- -----
<S> <C> <C>
Public offering price.................................. $ $
Underwriting discount.................................. $ $
Proceeds, before expenses, to ORATEC................... $ $
</TABLE>
The underwriters may also purchase up to an additional 600,000 shares of
common stock from us at the public offering price, less the underwriting
discount, within 30 days from the date of this prospectus to cover over-
allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
The shares of common stock will be ready for delivery on or about , 2000.
------------
Merrill Lynch & Co.
J.P. Morgan & Co.
U.S. Bancorp Piper Jaffray
------------
The date of this prospectus is , 2000.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary of the Prospectus................................................ 3
Risk Factors............................................................. 5
Special Note Regarding Forward-Looking Statements........................ 11
Use of Proceeds.......................................................... 12
Our Policy Regarding Dividends........................................... 12
Capitalization........................................................... 13
Dilution................................................................. 14
Selected Financial Data.................................................. 15
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 16
Business................................................................. 22
Management............................................................... 38
Transactions with Directors, Executive Officers and 5% Stockholders...... 48
Principal Stockholders................................................... 50
Description of Capital Stock............................................. 52
Shares Eligible for Future Sale.......................................... 55
Underwriting............................................................. 57
Legal Matters............................................................ 59
Experts.................................................................. 59
Where You Can Find More Information...................................... 60
Index to Financial Statements............................................ F-1
</TABLE>
----------------
You should rely only on the information contained in this prospectus. We
have not and the underwriters have not authorized any other person to provide
you with information different from that contained in this prospectus. We are
offering to sell, and seeking offers to buy, shares of common stock only in
jurisdictions where offers and sales are permitted. The information contained
in this prospectus is accurate only as of the date of this prospectus,
regardless of the time of delivery of this prospectus or of any sale of the
common stock.
Until , 2000 (25 days after the date of this prospectus), all dealers
that effect transactions in these securities, whether or not participating in
this offering, may be required to deliver a prospectus. This is in addition to
the dealers' obligation to deliver a prospectus when acting as underwriters
and with respect to their unsold allotments or subscriptions.
----------------
We own or have rights to trademarks or tradenames that we use in conjunction
with the sale of our products. The term "ORATEC" and our logo are registered
trademarks owned by us. We have also filed for trademark protection for the
use of the terms SpineCATH, IDET, ElectroThermal and Vulcan which are used in
conjunction with the sale of our products. This prospectus also makes
reference to trademarks of other companies.
Our principal offices are located at 3700 Haven Court, Menlo Park, CA 94025
and our telephone number is (650) 369-9904. We were incorporated in May 1993
as Dorsamed Incorporated, and we changed our name to ORATEC Interventions,
Inc. in October 1995.
i
<PAGE>
SUMMARY OF THE PROSPECTUS
This summary highlights information contained elsewhere in this prospectus.
You should read this entire prospectus carefully, including the "Risk Factors"
section and the financial statements and the notes to those statements.
ORATEC Interventions, Inc.
ORATEC Interventions develops and markets innovative medical devices that use
controlled thermal energy to treat spine and joint disorders. We currently
market two minimally invasive systems, the SpineCATH IntraDiscal ElectroThermal
Therapy, or IDET, system and the ElectroThermal Arthroscopy System. Our
proprietary systems use heat to modify, cut or remove damaged or stretched soft
tissue. We market our products to orthopedic surgeons, neurosurgeons and pain
management specialists.
Our SpineCATH IDET system offers a minimally invasive outpatient alternative
to patients suffering from chronic low back pain caused by degenerative disc
disease. The IDET system enables physicians to navigate to the location of
damaged tissue within a spinal disc using a self-guiding single use catheter.
Physicians can then apply heat directly to the disc wall, causing the tissue to
contract and thicken. We believe that the application of heat desensitizes
nerve fibers and over time results in a stiffening of the disc wall. Treatment
with the IDET system is indicated for degenerative disc disease, including
contained herniations, which are small bulges in the disc wall. IDET is not
recommended for the treatment of completely ruptured discs. Following the IDET
procedure, many patients have experienced significant pain reduction and
improved overall quality of life, and have reduced or eliminated pain
medication. The procedure does not require general anesthesia or extended
hospitalization and does not subject the patient to the post-operative
complications often associated with spine surgery. The IDET system was formally
launched in October 1998, and we estimate that, as of December 31, 1999, over
640 physicians had performed the IDET procedure on approximately 11,000
patients.
Back pain costs the U.S. economy over $50 billion annually and represents the
second most common reason for doctor visits. Conditions related to back pain
account for more hospitalizations annually than any other orthopedic condition.
It is estimated that, at any given time, five million individuals in the U.S.
suffer from low back pain. The vast majority of these cases are resolved within
three months using non-operative therapies ranging from physical therapy to
spinal injections. However, many of these individuals fail to improve with
non-operative therapies, suffer from degenerative disc disease and yet do not
have the level of disc degeneration necessary to warrant a spinal fusion. We
believe these individuals are candidates for our IDET procedure.
In addition to our spine products, we offer a proprietary ElectroThermal
Arthroscopy System, which treats joint disorders through the application of
controlled heat by modifying, cutting or removing soft tissue. The system
provides a minimally invasive outpatient treatment option for patients who
suffer from joint disorders caused by loose or stretched ligaments and whose
most viable option is often open surgery. In addition, we believe our system
can improve on existing arthroscopic procedures through tissue modification in
combination with tissue anchoring, cutting and removal, or ablation. The
ElectroThermal Arthroscopy System was launched in March 1997. In November 1999,
we introduced the new Vulcan ElectroThermal Arthroscopy System (EAS) which
combines the benefits of rapid tissue cutting and ablation capabilities with
the ability to modify tissue using our temperature control technology. We
estimate that, as of December 31, 1999, over 1,500 physicians had used our
arthroscopy products in approximately 100,000 procedures.
Approximately 2.2 million arthroscopic procedures were performed in the U.S.
in 1998. However, many joint injuries and disorders are still treated using
open surgery because, for many of these conditions, arthroscopic techniques are
not available, not effective or are difficult to perform. Our products expand
arthroscopic treatment options for surgeons treating joint disorders.
We have a separate sales and marketing team for each of the spine and
arthroscopy markets in order to address the different physician groups in these
growing areas. Our sales organizations include direct sales employees
complemented by select sales agencies. We have entered into an exclusive
distribution agreement with DePuy AcroMed, a division of Johnson & Johnson, for
the international marketing and sales of our spine products. The marketing
platform for both spine and arthroscopy is built on scientific and clinical
data and extensive physician training programs. The products we currently
market have either received the necessary 510(k) pre-market clearance from the
FDA or are exempt from this requirement. As of December 31, 1999 we had 12
issued patents, four notices of allowance and 45 U.S. and foreign patent
applications pending.
3
<PAGE>
The Offering
<TABLE>
<S> <C>
Common stock offered by ORATEC....... 4,000,000 shares
Common stock to be outstanding after
the offering........................ 20,491,149 shares
Use of proceeds...................... Expanded sales and marketing activities,
future product development, repayment of
debt and general corporate purposes. See
"Use of Proceeds."
Proposed Nasdaq National Market sym-
bol................................. "OTEC"
</TABLE>
The share data in the table above is based on shares outstanding as of
December 31, 1999 and excludes: (a) 3,374,037 shares that were subject to
outstanding options at a weighted average exercise price of $3.26 as of
December 31, 1999; (b) 212,908 shares that were issuable upon exercise of
outstanding warrants at a weighted average exercise price of $3.29 per share as
of December 31, 1999; and (c) an aggregate of 1,618,700 shares that were
available for future issuance under our 1999 stock plan, our 1999 directors'
plan and our 1999 employee stock purchase plan as of December 31, 1999.
Summary Financial Data
(in thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended December
31,
-------------------------
1997 1998 1999
------ -------- -------
<S> <C> <C> <C>
Statement of Operations Data:
Sales............................................. $2,600 $ 11,129 $31,365
Gross profit...................................... 859 4,563 18,335
Total operating expenses.......................... 7,857 15,748 27,293
Net loss.......................................... (6,832) (11,342) (9,669)
Net loss per common share, basic and diluted...... $(1.75) $ (2.83) $ (2.30)
Shares used in computing net loss per common
share, basic and diluted......................... 3,912 4,006 4,201
Pro forma net loss per share, basic and diluted
(unaudited)...................................... $ (0.59)
Shares used in computing pro forma net loss per
share, basic and diluted (unaudited)............. 16,276
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
---------------------
Actual As Adjusted
-------- -----------
(unaudited)
<S> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short term investments...... $ 8,874 $60,154
Total assets........................................... 23,841 75,121
Long term obligations, net of current portion.......... 4,348 4,348
Redeemable convertible preferred stock................. 35,816 --
Common stock, additional paid-in capital, deferred
stock compensation, receivable from stockholder and
accumulated deficit................................... (29,385) 57,711
</TABLE>
The as adjusted numbers in the table above reflect receipt of the net
proceeds from the sale of shares of common stock offered by us at an assumed
offering price of $14.00 per share, after deducting the estimated underwriting
discount and commissions and estimated offering expenses payable by us. See
also "Use of Proceeds," "Capitalization" and "Underwriting."
Except as otherwise indicated, all information in this prospectus is based on
the following assumptions: (a) the conversion of each outstanding share of
redeemable preferred stock into one share of common stock upon the completion
of this offering, (b) no exercise of the underwriters' overallotment option and
(c) the filing of our amended and restated certificate of incorporation
immediately following the closing of the offering.
4
<PAGE>
RISK FACTORS
If you purchase our common stock and become an ORATEC stockholder, you will
be subject to risks inherent in our business. Our stock price will fluctuate
for many reasons, including how our business performs relative to, among other
things, competition, market conditions and general economic and industry
conditions. You should carefully consider the following risk factors as well as
other information in this prospectus before purchasing our common stock. The
risks and uncertainties described below are intended to be the material risks
that are specific to us, to our industry or to companies going public. There
may be other risks which we do not currently believe are material which may
impair our business.
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 never become profitable.
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. See
"Business--Third-Party Reimbursement."
Because we lack sufficient long term data regarding the safety and 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 data may not be reproduced in wider
patient populations. In addition, we are aware of studies related to our
arthroscopy products that have produced bench data that is inconsistent with
our scientific findings. If we are unable to produce clinical data that is
supported by the independent efforts of other clinicians, our business could
suffer.
Because we expect operating expenses to increase substantially in the
forseeable future and cannot be certain that revenues will continue to
increase, we may never become profitable.
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. If
sales do not continue to grow, we may not be able to achieve or maintain
profitability in the future. We have incurred net losses each year since
inception. In particular, we incurred losses of $11.3 million in 1998 and $9.7
million in 1999. As of December 31, 1999, we had an accumulated deficit of
approximately $30.7 million.
5
<PAGE>
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 never become profitable.
You may have a difficult time evaluating an investment in our stock because we
have a limited operating history.
You can only evaluate our business based on a limited operating history
because we began selling arthroscopy products in 1997 and spine products in
1998. This short history may not be adequate to enable you to fully assess our
ability to successfully develop our products, achieve market acceptance of our
products and respond to competition.
Because we 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;
. products that 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. See "Business--Competition."
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.
6
<PAGE>
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 may be subject to product liability lawsuits. In particular,
the market for spine products has a history of product liability litigation. We
have reported to the FDA instances in which burns were reported in connection
with the use of our arthroscopy products and one instance 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 after the procedure 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 has passed outside the disc wall causing mild
motor 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
7
<PAGE>
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. A
lawsuit has been filed in state court in New Jersey by a patient who claims
that he was injured during treatment with the SpineCATH catheter. We are
currently investigating the claims set forth in the complaint. See "--
Complying with FDA and other regulations is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties."
Any failure to build and manage our sales organization may negatively affect
our market share and revenues.
We currently have two separate sales forces, one for each of our spine and
arthroscopy product lines, and we rely on a combination of direct sales
employees and sales agents to sell each product line in the U.S. We need to
expand both the spine and arthroscopy sales teams over the next 12 months to
achieve our market share and revenue growth goals. There are significant risks
involved in building and managing our spine and arthroscopy sales forces,
including:
. failure to manage the development and growth of two distinct sales
forces;
. failure to adequately train both our employees and our outside sales
agents in the use and benefits of our products; and
. dependence on outside agencies, over which we have limited or no control.
See "--If we fail to support our anticipated growth in operations, our
business could suffer." See also "Business--Sales and Marketing."
Any failure in our physician training efforts could significantly reduce
product sales.
It is critical to the success of our sales effort to train a sufficient
number of physicians and to provide them adequate instruction in the use of
our products. We rely on physicians to spend their time and money to attend
our training sessions. If physicians are not properly trained, they may misuse
or ineffectively use our products. This may result in unsatisfactory patient
outcomes, patient injury, negative publicity or lawsuits against us, any of
which could have an adverse effect on our product sales.
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
8
<PAGE>
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. See "Business--Competition."
Complying with FDA and other regulations is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties.
We are subject to a host of federal, state, local and international
regulations regarding the 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. See
"Business--Government Regulation."
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 marketed 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. See "Business--
Government Regulation."
Our stock price, like that of many early stage medical technology companies,
may be volatile.
If our future quarterly operating results are below the expectations of
securities analysts or investors, the price of our common stock would likely
decline. Stock price fluctuations may be exaggerated if the trading volume of
our common stock is low.
9
<PAGE>
In the past, securities class action litigation has often been brought
against a company after a period of volatility in the market price of its
stock. Any securities litigation claims brought against us could result in
substantial expense and the diversion of management's attention from our core
business. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Quarterly Results of Operations."
We may need to raise additional capital in the future and may be unable to do
so on acceptable terms.
We may need to raise additional funds for operations and to execute our
business strategy. The sale of additional equity or convertible debt securities
could result in additional dilution to our stockholders. If additional funds
are raised through the issuance of debt securities, these securities could have
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.
Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval after this offering.
Immediately after this offering, our executive officers and directors, and
their respective affiliates, will continue to own approximately 27.2% of our
outstanding common stock. Accordingly, these stockholders may, as a practical
matter, be able to exert significant influence over matters requiring approval
by our stockholders, including the election of directors and the approval of
mergers or other business combinations. This concentration could have the
effect of delaying or preventing a change in control.
Our certificate of incorporation, our bylaws and Delaware law contain
provisions that could discourage a takeover.
Provisions of our certificate of incorporation, bylaws and Delaware law may
discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. See "Management--Board Composition" and "Description of
Capital Stock--Delaware Anti-Takeover Law and Provisions of our Certificate of
Incorporation and Bylaws."
10
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
There are statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus which are forward-
looking, such as "may," "plans," "expects" or "continue" and other similar
words. These statements relate to future events or our future financial
performance, and involve known and unknown risks, uncertainties and other
factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any
future results, levels of activity, performance or achievements expressed or
implied by these forward-looking statements. Such factors include those listed
under "Risk Factors" in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We are under no duty to update any of
the forward-looking statements after the date of this prospectus or to conform
such statements to actual results.
11
<PAGE>
USE OF PROCEEDS
Our net proceeds from the sale of the 4,000,000 shares of common stock we are
offering are estimated to be $51,280,000 ($59,092,000 if the underwriters'
over-allotment option is exercised in full), assuming an offering price of
$14.00 per share, after deducting the estimated underwriting discount and
commissions and the estimated offering expenses.
We currently intend to use the net proceeds from this offering for expansion
of sales, marketing and reimbursement activities, future development of our
product lines and approximately $9.0 million to repay debt with interest rates
ranging from 7% to 13% and maturities ranging from month to month to August
2002. We currently intend to use the remaining proceeds for general corporate
purposes. The debt being repaid was used primarily for purchasing generators
and funding the increased costs of operations as ORATEC's sales activities
increased. We have not yet determined our expected use of the remaining
proceeds, but we currently estimate that we will incur at least $18 million in
sales, marketing, reimbursement and product development expenses and $5 million
in capital expenditures over the next 18 months. We may use a portion of the
net proceeds to fund, acquire or invest in complementary businesses or
technologies, although we have no present commitments with respect to any
acquisition or investment. The amount of cash that we actually expend for any
of the described purposes will vary significantly depending on a number of
factors, including future sales growth, if any, and the amount of cash we
generate from operations. Thus, management will have significant discretion in
applying the net proceeds of this offering. Pending the uses described above,
we will invest the net proceeds in short term, investment grade, interest
bearing securities.
OUR POLICY REGARDING DIVIDENDS
We have never paid dividends on our common stock or redeemable preferred
stock. We currently intend to retain any future earnings to fund the
development of our business. In addition, there is a covenant in one of our
loan agreements restricting our ability to pay dividends. Therefore, we do not
currently anticipate paying any cash dividends in the foreseeable future.
12
<PAGE>
CAPITALIZATION
The following table sets forth the following information:
. the actual capitalization of ORATEC as of December 31, 1999;
. the pro forma capitalization of ORATEC, after giving effect to the
automatic conversion of all outstanding shares of preferred stock into
12,079,948 shares of common stock; and
. the as adjusted capitalization, after giving effect to the sale of shares
of common stock at an assumed initial public offering price of $14.00 per
share in this offering, after deducting the estimated underwriting
discount and commissions and estimated offering expenses that ORATEC
expects to pay in connection with this offering.
This table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Financial
Statements and Notes to the Financial Statements included elsewhere in this
prospectus.
<TABLE>
<CAPTION>
December 31, 1999
-------------------------------------------
Actual Pro Forma As Adjusted
------------ ------------ --------------
(in thousands, except per share data)
(unaudited)
<S> <C> <C> <C>
Current portion of long term
obligations...................... $ 3,130 $ 3,130 $ 3,130
============ ============ ============
Long term obligations............. $ 4,348 $ 4,348 $ 4,348
Redeemable convertible preferred
stock, par value $0.001 per
share; 12,400,000 shares
authorized, actual; 12,079,948
shares issued and outstanding,
actual; 5,000,000 shares
authorized, none issued or
outstanding, pro forma and as
adjusted......................... 35,816 -- --
Common stock, par value $0.001 per
share, 19,900,000 shares
authorized, actual; 4,411,201
shares issued and outstanding,
actual; 75,000,000 shares
authorized, pro forma; 16,491,149
issued and outstanding, pro
forma; 75,000,000 shares
authorized, as adjusted;
20,491,149 shares issued and
outstanding, as adjusted......... 4 16 20
Additional paid-in capital........ 1,625 37,429 88,705
Deferred stock compensation....... (320) (320) (320)
Receivable from stockholder....... (9) (9) (9)
Accumulated deficit............... (30,685) (30,685) (30,685)
------------ ------------ ------------
Total capitalization.............. $ 10,779 $ 10,779 $ 62,059
============ ============ ============
</TABLE>
- --------
This table excludes the following shares (in thousands, except per share data):
. 3,374,037 shares issuable upon exercise of outstanding options at a
weighted average exercise price of $3.26 per share as of December 31,
1999;
. 212,908 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $3.29 per share as of December 31,
1999; and
. an aggregate of 1,618,700 shares available for future issuance under our
1999 stock plan, our 1999 directors' plan and our 1999 employee stock
purchase plan as of December 31, 1999. See "Management--Stock Plans" and
Note 11 of Notes to Financial Statements.
13
<PAGE>
DILUTION
The pro forma net tangible book value of our common stock on December 31,
1999 was $6,431,000 or $0.39 per share. Pro forma net tangible book value per
share represents the amount of our total tangible assets less total
liabilities, divided by the number of shares of common stock outstanding,
assuming the conversion of all outstanding shares of preferred stock into
shares of common stock. Dilution in net tangible book value per share
represents the difference between the amount per share paid by purchasers of
shares of our common stock in this offering and the net tangible book value per
share of our common stock immediately following this offering. After giving
effect to our sale of shares of common stock in this offering and after
deducting the estimated underwriting discount and commissions and our estimated
offering expenses, our pro forma net tangible book value as of December 31,
1999 would have been $57,711,000 or $2.82 per share of common stock. This
represents an immediate increase in net tangible book value of $2.43 per share
to existing stockholders and an immediate dilution of $11.18 per share to new
investors. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $14.00
Pro forma net tangible book value per share as of December 31,
1999........................................................... $0.39
Increase per share attributable to new investors................ 2.43
-----
Pro forma net tangible book value per share after the offering.. 2.82
------
Dilution per share to new investors............................. $11.18
======
</TABLE>
The following table summarizes, on a pro forma basis, as of December 31,
1999, the differences between the existing stockholders and new investors with
respect to the number of shares of stock purchased from us, the total
consideration paid to us, and the average price per share paid.
<TABLE>
<CAPTION>
Shares
Purchased Total Consideration
------------------ ------------------- Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 16,491,149 80.5% $36,883,000 39.7% $ 2.24
New investors.............. 4,000,000 19.5 56,000,000 60.3 14.00
---------- ----- ----------- -----
Total.................... 20,491,149 100.0% $92,883,000 100.0%
========== ===== =========== =====
</TABLE>
This table excludes the following shares:
. 3,374,037 shares issuable upon exercise of outstanding options at a
weighted average exercise price of $3.26 per share as of December 31,
1999;
. 212,908 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $3.29 per share as of December 31,
1999; and
. an aggregate of 1,618,700 shares available for future issuance under
our 1999 stock plan, our 1999 directors' plan and our 1999 employee
stock purchase plan as of December 31, 1999. See "Management--Stock
Plans" and Note 11 of Notes to Financial Statements.
If the underwriters' over-allotment option is exercised in full, the
following will occur:
. the percentage of shares of common stock held by existing
stockholders will decrease to approximately 78.2% of the total number
of shares of our common stock outstanding after this offering; and
. the number of shares held by new investors will be increased to
4,600,000 or approximately 21.8% of the total number of shares of our
common stock outstanding after this offering.
14
<PAGE>
SELECTED FINANCIAL DATA
(In thousands, except per share data)
The following selected financial data should be read in conjunction with the
Financial Statements and Notes and with "Management's Discussion and Analysis
of Financial Condition and Results of Operations," which are included elsewhere
in this prospectus. The statement of operations data for the years ended
December 31, 1997, 1998 and 1999, and the balance sheet data at December 31,
1998 and 1999, are derived from audited financial statements included elsewhere
in this prospectus. The statement of operations data for the years ended
December 31, 1995 and 1996, and the balance sheet data as of December 31, 1995,
1996 and 1997, are derived from audited financial statements not included in
this prospectus.
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------
1995 1996 1997 1998 1999
------ ------- ------- -------- -------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Sales............................. $ -- $ -- $ 2,600 $ 11,129 $31,365
Cost of sales..................... -- -- 1,741 6,566 13,030
------ ------- ------- -------- -------
Gross profit...................... -- -- 859 4,563 18,335
Operating expenses:
Research and development........ 156 878 2,147 4,056 4,709
Sales and marketing............. -- 561 2,622 8,318 17,541
General and administrative...... 187 945 3,088 3,374 5,043
------ ------- ------- -------- -------
Total operating expenses...... 343 2,384 7,857 15,748 27,293
------ ------- ------- -------- -------
Loss from operations.............. (343) (2,384) (6,998) (11,185) (8,958)
Interest income (expense), net.... 3 82 166 (157) (711)
------ ------- ------- -------- -------
Net loss.......................... $ (340) $(2,302) $(6,832) $(11,342) $(9,669)
====== ======= ======= ======== =======
Net loss per common share, basic
and diluted...................... $(0.10) $ (0.60) $ (1.75) $ (2.83) $ (2.30)
====== ======= ======= ======== =======
Shares used in computing net loss
per common share, basic and
diluted.......................... 3,246 3,841 3,912 4,006 4,201
Pro forma net loss per share,
basic and diluted (unaudited).... $ (0.59)
=======
Shares used in computing pro forma
net loss per share, basic and
diluted (unaudited).............. 16,276
</TABLE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------
1995 1996 1997 1998 1999
----- ------- ------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and short
term investments................. $ 64 $ 1,778 $ 9,185 $ 15,581 $ 8,874
Working capital................... (97) 1,545 8,717 13,997 6,370
Total assets...................... 97 2,593 13,418 24,195 23,841
Long term obligations, net of
current portion.................. 35 221 404 2,702 4,348
Redeemable convertible preferred
stock............................ 474 4,792 20,324 35,816 35,816
Common stock, additional paid-in
capital, deferred stock
compensation, receivable from
stockholder and accumulated
deficit.......................... (582) (2,838) (9,771) (20,746) (29,385)
</TABLE>
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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 (EAS).
All of our revenues are generated from the sales of our spine and arthroscopy
products. For the year ended December 31, 1999, 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. We incurred net losses of
approximately $11.3 million in 1998 and $9.7 million in 1999. As of December
31, 1999, we had an accumulated deficit of $30.7 million.
For the year ended December 31, 1999, approximately 67% of our U.S. sales was
generated by our direct sales employees and the remainder of our sales was
generated by independent sales agencies. These sales agencies do not purchase
our products, but are paid a commission at the time they generate a product
sale. We intend to continue building our direct sales force and expect that in
the future an increasing percentage of U.S. sales will be generated by our
direct sales employees.
In the year ended December 31, 1999, 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 less 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 and we may become a party to product
liability or patent proceedings. The costs of such lawsuits may be material and
could affect our earnings and financial position. 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.
16
<PAGE>
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.
Results of Operations
Years Ended December 31, 1999, 1998 and 1997
Sales
Sales increased 182% to $31.4 million in 1999 from $11.1 million in 1998, and
increased 328% in 1998 from sales of $2.6 million in 1997. We began selling our
arthroscopy products early in 1997, and those products comprised all of our
sales for that year. During 1998, we experienced growth in the unit sales of
our arthroscopy products. In the fourth quarter of 1998, we formally launched
our spine products, sales of which comprised 11% of our revenues for that year.
During 1999, revenue growth was led by sales of our spine products, which
increased from $1.2 million in 1998 to $16.2 million in 1999. Sales of
arthroscopy products increased by 54% to $15.2 million in 1999 from sales of
$9.9 million in 1998. This increase in overall sales was due to higher unit
shipments. These higher unit shipments resulted from an increased number of
physicians trained in the use of our products, the expansion of our spine sales
force, the increasing effectiveness of the arthroscopy direct sales force
during 1998 and 1999 and the enhancement of our product line through
modifications to the probe tips and sizes of our existing products.
Cost of sales
Cost of sales increased 98% to $13.0 million in 1999 from $6.6 million in
1998, and increased 277% in 1998 from cost of sales of $1.7 million in 1997.
The growth in cost of sales was attributable primarily to the significant
expansion of our manufacturing operations, higher material, labor and overhead
costs associated with increased unit shipments and higher depreciation costs on
the increased number of generators placed with customers. 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 $18.3 million, or 58% of sales, in 1999 from $4.6
million, or 41% of sales, in 1998, and increased in 1998 from $900,000, or 33%
of sales, in 1997. The increase in gross profit as a percentage of sales was
due to sales growing at a faster pace than manufacturing and depreciation
costs.
Research and development expenses
Research and development expenses increased 16% to $4.7 million in 1999 from
$4.1 million in 1998, and increased 89% in 1998 from research and development
expenses of $2.1 million in 1997. Each of these expense increases was
attributable primarily to additional personnel and increased numbers of
clinical studies. During 1999, expenses related to the development of the
Vulcan arthroscopy system represented the largest component of research and
development spending. During 1998, expense increases were driven by spine
product and generator development. Research and development expenses in 1997
were largely focused on the enhancement of probes for the arthroscopy system.
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 111% to $17.5 million in 1999 from
$8.3 million in 1998, and increased 217% in 1998 from sales and marketing
expenses of $2.6 million in 1997. Each of these expense
17
<PAGE>
increases reflected increased personnel expense as we developed a field sales
force for each of the spine and arthroscopy markets, added personnel in our
reimbursement group, increased spending on physician training and medical
conference participation and paid higher commissions on an increased volume of
sales. Sales and marketing expenses consist primarily of costs for sales,
marketing and reimbursement staff, sales commissions, medical conference
participation and physician training programs. We anticipate that sales and
marketing expenses will increase as we continue to develop our sales and
reimbursement support staffs and expand our physician training programs.
General and administrative expenses
General and administrative expenses increased 49% to $5.0 million in 1999
from $3.4 million in 1998, primarily due to the write-off of $1.0 million in
expenses related to our initial public offering, which was postponed in
September 1999. General and administrative expenses increased 9% in 1998 from
general and administrative expenses of $3.1 million in 1997. Increases in
general and administrative expenses resulted from increased personnel expenses
related to our growth in operations. In 1998, this increase in general and
administrative expenses was partially offset by the relatively high expense of
hiring and relocating executive officers in 1997. 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.
Interest and other income (expense), net
Net interest and other expense increased 353% to $(711,000) in 1999 from
$(157,000) in 1998. Net interest and other income was $166,000 in 1997. The
higher interest expense in 1999 was related to debt funding obtained to support
our growth in working capital and equipment purchases. Other year-to-year
changes resulted from changes in earnings on short term investment balances,
which varied as a result of the timing of our private placement financings, and
increasing interest expense resulting from our drawdown of debt. Net interest
and other income (expense) is comprised primarily of interest earned on short
term investments, offset by interest expense on equipment and debt obligations.
Income Taxes
As of December 31, 1999, we had net operating loss carryforwards of
approximately $24.1 million for federal and $4.5 million for California and
Delaware 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.
See Note 12 of Notes to Financial Statements.
18
<PAGE>
Quarterly Results of Operations
The following table sets forth our operating results for each of the eight
quarters in the period ended December 31, 1999. This data has been derived from
unaudited financial statements that, in the opinion of our management, include
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of such information when read in conjunction with our
annual audited financial statements and notes thereto appearing elsewhere in
this prospectus. These operating results are not necessarily indicative of
results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
------------------------------------------------------------------------------
Mar. 31, June 30, Sept. 30, Dec. 31, Mar. 31, June 30, Sept. 30, Dec. 31,
1998 1998 1998 1998 1999 1999 1999 1999
-------- -------- --------- -------- -------- -------- --------- --------
(in thousands, unaudited)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales................... $ 1,572 $ 2,535 $ 2,782 $ 4,240 $ 5,196 $ 7,703 $ 8,839 $ 9,627
Cost of sales........... 987 1,368 1,867 2,344 2,828 3,433 3,328 3,441
------- ------- ------- ------- ------- ------- ------- -------
Gross profit............ 585 1,167 915 1,896 2,368 4,270 5,511 6,186
Gross margin
percentage............. 37% 46% 33% 45% 46% 55% 62% 64%
Operating expenses:
Research and
development.......... 800 947 1,053 1,255 1,044 1,225 1,337 1,103
Sales and marketing... 1,512 1,879 2,284 2,643 3,254 4,240 4,675 5,372
General and
administrative....... 678 860 1,006 831 997 823 2,241 982
------- ------- ------- ------- ------- ------- ------- -------
Total operating
expenses............ 2,990 3,686 4,343 4,729 5,295 6,288 8,253 7,457
------- ------- ------- ------- ------- ------- ------- -------
Loss from operations.... (2,405) (2,519) (3,428) (2,833) (2,927) (2,018) (2,742) (1,271)
Interest and other
income (expense), net.. 56 68 (43) (238) (106) (233) (118) (254)
------- ------- ------- ------- ------- ------- ------- -------
Net loss................ $(2,349) $(2,451) $(3,471) $(3,071) $(3,033) $(2,251) $(2,860) $(1,525)
======= ======= ======= ======= ======= ======= ======= =======
</TABLE>
We have historically experienced seasonal fluctuations in our sales of
arthroscopy products. Sales of our arthroscopy products tend to flatten or
decrease during the summer months because people often defer elective surgeries
until the fall. In addition, sales of arthroscopy products have tended to
increase in the last quarter of the year as individuals seek to use health plan
coverage before the end of the insurance year.
For the quarter ended December 31, 1998, our revenues increased 52% to $4.2
million from $2.8 million for the quarter ended September 30, 1998 as a result
of the commercial launch of our spine products and the seasonal strength of
arthroscopy sales in the fourth quarter. This growth continued during the next
two quarters, with a quarter-to-quarter increase of 23% in revenues during the
quarter ended March 31, 1999 and a further increase of 48% during the quarter
ended June 30, 1999 as a result of increased sales of our spine products.
Quarter-to-quarter sales increased by 15% during the quarter ended September
30, 1999 and 9% during the quarter ended December 31, 1999. During the quarter
ended December 31, 1999, sales growth slowed due to deferred purchases of
arthroscopy products by new customers as a result of the pending introduction
of our Vulcan arthroscopy system and our failure to obtain pre-authorization
for insurance reimbursement for our spine products from some payors. Overall,
spine sales as a percentage of total sales grew from 33% in the first quarter
of 1999 to 55% in the fourth quarter of 1999.
Gross margin percentage tended to increase over the eight quarter period
ending December 31, 1999 as a result of the formal launch of new products and
the leveraging of these sales over our manufacturing cost base. We expect gross
margin to flatten or decline along with any leveling or decline in sales
growth. There was a decline in gross margin percentage in the quarter ended
September 30, 1998 due to a major investment in manufacturing infrastructure
and personnel to accommodate an expected increase in product demand.
The total number of our employees grew from 59 at December 31, 1997 to 213 at
December 31, 1999. As a result of the growth in the number of employees
throughout the organization, all of the operational expenses have generally
tended to increase on a quarter-to-quarter basis. Additionally, the increased
product sales on a quarter-to-
19
<PAGE>
quarter basis have caused commission expenses paid to both employees and sales
agencies to increase. We have also increased spending on clinical studies,
physician training, medical conferences and outside development costs during
this eight quarter period.
We believe that period-to-period comparisons of our operating results are not
necessarily meaningful. You should not rely on them to predict future
performance. The amount and timing of our operating expenses may fluctuate
significantly in the future as a result of a variety of factors. We face a
number of risks and uncertainties encountered by early stage companies,
particularly those in rapidly evolving markets such as the medical device
industry. In addition, although we have experienced revenue growth recently,
such revenue growth may not continue, and we may not achieve or maintain
profitability in the future.
Our quarterly revenues and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter due to a number of factors,
some of which are outside of our control. These factors include, but are not
limited to:
. the timing of training physicians in the use of our products;
. the timing of publication of supporting clinical data;
. delays in obtaining pre-authorization for insurance reimbursement from
payors;
. the introduction of new products by us or our competitors;
. possible intellectual property litigation;
. changes in our pricing policies or those of our competitors or customers;
. delays in introducing new products; and
. timing of regulatory approvals or other FDA action.
Most of our expenses, such as employee compensation and lease payments for
facilities and equipment, are relatively fixed. In addition, our expense levels
are based, in part, on our expectations regarding future sales. As a result,
any shortfall in sales relative to our expectations could cause significant
changes in our operating results from quarter-to-quarter.
Liquidity and Capital Resources
From inception through December 31, 1999, we financed our operations
primarily through private sales, net of expenses, of $35.8 million of
redeemable convertible preferred stock. To a lesser extent, we also financed
our operations through equipment financing and other loans, which totaled $10.9
million in principal outstanding at December 31, 1999. As of December 31, 1999,
we had $5.9 million of cash and cash equivalents, $2.9 million of short term
investments and $6.4 million of working capital.
Net cash used for operating activities was $9.3 million in 1999, $9.2 million
in 1998 and $6.2 million in 1997. Cash used for operating activities was
attributable primarily to net losses after adjustment for non-cash depreciation
and amortization charges on generators and equipment and increases in accounts
receivable and inventories, resulting from higher revenues on increasing unit
shipments in all periods. These increases in use of cash for operating
activities were offset in part by increases in accounts payable, accrued
compensation and other accrued liabilities also resulting from the upward trend
in business activities in all periods.
Net cash used in investing activities was $2.7 million in 1999, compared to
$4.0 million in 1998 and $5.3 million in 1997. For each of these periods, cash
used in investing activities reflected purchases of property, generators and
equipment and net purchases or sales of short term investments.
Net cash provided by financing activities was $6.4 million in 1999,
$19.3 million in 1998 and $15.8 million in 1997. Cash provided during these
periods was attributable to proceeds from the issuance of stock and debt
obligations.
20
<PAGE>
As of December 31, 1999, our principal debt and other commitments consisted
of $3.5 million outstanding under our equipment loans, $3.4 million under our
accounts receivable credit line, $4.0 million under our subordinated debt
facility and amounts payable under various operating leases. We expect to
increase capital expenditures consistent with our anticipated growth in
manufacturing, infrastructure and personnel. We also may increase our capital
expenditures as we expand our product lines or invest to address new markets.
As of December 31, 1999, we had available debt facilities totaling
approximately $600,000 under our asset-based line of credit. Our loan
agreements with Transamerica Business Credit Corporation and one loan agreement
with Silicon Valley Bank require the lenders' consent before we can incur
additional debt. One of our loan agreements contains financial covenants
including a maximum debt to tangible net worth ratio of 3:1. During the third
quarter of 1998, we were not in compliance with these financial covenants,
including a profitability covenant and the maximum debt to tangible net worth
ratio, due to expenditures associated with the growth of our spine business and
the timing of our Series E equity financing which was completed in December
1998. We received a waiver from the lender for our non-compliance. Since
December 1998, we have been in compliance with all financial covenants.
We believe that the net proceeds from this offering, together with our
current cash and investment balances and cash generated from operations, will
be sufficient to meet our anticipated cash needs for working capital and
capital expenditures for at least the next 18 months. If existing cash and cash
generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or debt securities or
obtain an additional credit facility. The sale of additional equity or
convertible debt securities could result in dilution to our stockholders. If
additional funds are raised through the issuance of debt securities, these
securities could have rights senior to holders of common stock, and could
contain covenants that would restrict our operations. Any additional financing
may not be available in amounts or on terms acceptable to us, if at all. If we
are unable to obtain this additional financing, we may be required to reduce
the scope of our planned product development and marketing efforts, which could
harm our results of operations and financial condition.
Quantitative and Qualitative Disclosures About Market Risk
Our exposure to interest rate risk at December 31, 1999 related to our
investment portfolio and our borrowings. Fixed rate investments and borrowings
may have their fair market value adversely impacted from changes in interest
rates. Floating rate investments may produce less income than expected if
interest rates fall, and floating rate borrowings will lead to additional
interest expense if interest rates increase. Due in part to these factors, our
future investment income may fall short of expectations, and our interest
expense may be above our expectations due to changes in U.S. interest rates.
Further, we may suffer losses in investment principal if we are forced to sell
securities which have declined in market value due to changes in interest
rates.
We invest our excess cash in debt instruments of the U.S. government and its
agencies, and in high quality corporate issuers. The average contractual
duration of all of our investments in 1999 was approximately two months. Due to
the short term nature of these investments, we have assessed that there is no
material exposure to interest rate risk arising from our investments.
We enter into loan arrangements with banks and financial institutions when
available on favorable terms. At December 31, 1999, we had bank borrowings of
$3.4 million outstanding, which bear interest at 1% above the prime rate, and
notes payable of $4 million outstanding,which bear interest at 13.1% per annum.
We have determined that there is no material exposure to interest rate risk
arising from these borrowings.
21
<PAGE>
BUSINESS
Overview
ORATEC Interventions develops and markets innovative medical devices that use
controlled thermal energy to treat spine and joint disorders. We currently
market two minimally invasive systems, the SpineCATH IntraDiscal ElectroThermal
Therapy, or IDET, system and the ElectroThermal Arthroscopy System. These
proprietary systems deliver heat to modify, cut or remove damaged or stretched
tissue.
Our SpineCATH IDET system is a minimally invasive treatment for low back pain
caused by degenerative disc disease. The SpineCATH IDET system enables
physicians to navigate a self-guiding catheter within a spinal disc to the
location of damaged tissue and apply heat to, over time, tighten and stiffen
the disc wall. Treatment with the IDET system is indicated for degenerative
disc disease, including contained herniations, which are small bulges in the
disc wall. IDET is not recommended for the treatment of completely ruptured
discs. We believe IDET is a new and effective solution for many patients facing
few options to treat their chronic discogenic pain.
Our ElectroThermal Arthroscopy System is a minimally invasive treatment for
joint disorders. Our proprietary tissue temperature control technology enables
physicians to treat damaged tissue in joints by modifying, cutting or removing
tissue. We believe that this minimally invasive treatment not only complements
existing arthroscopic procedures, but is a viable alternative to many open
surgical procedures.
As of December 31, 1999 we had 12 issued patents, four notices of allowance
and 45 U.S. and foreign patent applications.
In 2000, we plan to continue to devote substantial resources to physician
training programs, to our sales and marketing efforts, to the continued
establishment of clinical and scientific support of our products and to our
research and development efforts. Our goal is to establish and maintain
technology leadership by meeting the needs of the spine and arthroscopy
markets, two growing segments of the medical device industry.
Spine Market Opportunity
Back pain costs the U.S. economy over $50 billion annually and represents the
second most common reason for doctor visits. Conditions related to back pain
account for more hospitalizations annually than any other orthopedic condition.
It is estimated that, at any given time, five million individuals in the U.S.
suffer from pain in the lumbar region, commonly known as low back pain. The
prescribed treatment for low back pain depends on the severity and duration of
the pain and the success or failure of non-operative therapies. Non-operative
therapies include bed rest, medication, lifestyle modification, exercise,
physical therapy, chiropractic care and steroid injections. While the vast
majority of patients respond to these treatments, many fail to improve with
non-operative therapies, suffer from degenerative disc disease and yet do not
have the level of disc degeneration necessary to warrant a spinal fusion. We
believe these individuals are candidates for our IDET procedure.
Spinal Anatomy and Back Pain
The spinal column is segmented into 24 separate bones called vertebrae that
are connected together to permit a normal range of motion, including forward,
backward, lateral and twisting movement. The spinal cord, the body's central
nerve column, is enclosed within the spinal column.
Between each vertebra of the spine is a disc which allows for flexible
movement between the vertebra. Discs act as shock absorbers that protect the
spinal column during normal activities. Each disc consists of a "jelly-like"
internal mass, known as the nucleus. The layered fibrous wall, known as the
annulus, which surrounds the nucleus is composed primarily of collagen. In a
healthy spine, the nucleus is elastic and is surrounded by a strong disc wall
which allows the vertebra to be well supported and move normally.
22
<PAGE>
Everyday motion of our backs causes repeated stress on the spine. Over time,
and after repeated stress, the wall of the disc may weaken and develop cracks
and fissures. This condition is known as degenerative disc disease. The cracks
and fissures may allow the nucleus to seep into the disc wall, which can
sensitize nerve fibers and cause severe back pain. In addition, small blood
vessels and tiny nerve fibers grow into the fissures, causing ongoing pain. The
weakened disc wall may also bulge or rupture under the pressure of the seeping
nucleus, resulting in a disc herniation. This bulging or rupturing of the disc
can injure the spinal nerve roots causing leg and hip pain, also known as
sciatica.
Existing Surgical Procedures
Spine surgery is highly invasive and complex due to the proximity of major
muscle groups, nerves, blood vessels and organs. The spinal cord, branching
nerves and major muscle groups surround the rear portion of the spine, while
blood vessels, nerves and organs surround the front portion of the spine.
Discectomies, which involve the removal of a portion of the affected disc
tissue, are the most commonly performed surgical treatment to treat severe leg
pain caused by disc herniation. However, for patients suffering from chronic
back pain caused by degenerative disc disease, spinal fusion is the most viable
surgical treatment option.
Spinal fusion involves the fusing together of adjoining vertebrae in cases
where the patient has advanced disc degeneration or spine instability. This
invasive procedure involves a surgical incision in the patient's back or
abdomen. Fusions frequently require the removal of the affected disc material
and the surgical attachment of a metal implant or a spinal fusion cage to join
the two surrounding vertebrae. In addition, this procedure often involves a
second incision to remove bone from the patient's hip for implantation as a
bone graft for insertion into the disc space.
The operating time for low back spinal fusion surgeries utilizing metal
implants and spine cages averages over three hours with a post-operative
hospital stay for the patient which averages over four days. The patient also
generally requires significant post-operative pain medication. While the cost
of these procedures varies widely, we estimate that the total cost of most
spinal fusion surgeries is approximately $45,000.
We estimate that approximately 100,000 low back pain sufferers in the U.S.
undergo spinal fusion surgery annually. Only a small percentage of patients
with chronic low back pain actually undergo spinal fusion because it is
permanent, highly invasive and generally limited to the treatment of severe
conditions which could not be treated with a minimally invasive procedure. In
addition, clinical data has indicated that spinal fusion often causes further
deterioration of the discs on either side of the fusion site and only reduces
pain in approximately 60% of patients treated. Further, there are spine
disorders for which spinal fusion is not the medically indicated treatment. We
believe that the overall invasiveness of available therapies, as well as the
uncertainty of the alleviation of pain, leads many patients to defer surgery
until surgery is their only option, and continue to live with their chronic
pain.
The ORATEC Catheter-Based Spine Solution
Our SpineCATH IntraDiscal ElectroThermal Therapy, or IDET, system offers a
minimally invasive outpatient alternative to patients suffering from chronic
low back pain caused by degenerative disc disease.
The Procedure
The SpineCATH IDET system uses thermal energy technology to treat the
degenerated disc wall in a minimally invasive manner. The procedure begins with
the insertion of our proprietary single use SpineCATH catheter through an
introducer needle into the center of the disc. As the surgeon inserts the
catheter into the spine, the catheter guides itself along the disc wall. The
position of the catheter is confirmed by the physician using real time X-rays.
The physician begins to treat the disc by applying controlled levels of heat to
the disc wall. In response to the application of heat, the collagen in the disc
shrinks, causing the wall to contract and thicken. We believe that the
application of heat during the procedure desensitizes nerve fibers and that
23
<PAGE>
following the procedure the contracted collagen acts as a scaffold which
supports the growth of new collagen, stiffening and repairing the disc wall. In
contrast to spine surgery, our procedure does not remove disc tissue.
IDET is performed in an outpatient setting using local anesthesia. ORATEC's
protocol calls for the patient to be responsive during the procedure to enable
the physician to closely monitor his or her condition. Depending on the
condition of the disc, the procedure may require the insertion of more than one
catheter for more complete treatment of the affected area of the disc wall.
Multiple discs may be treated in a single IDET procedure. Once the therapy is
completed, the catheter and needle are removed and an antibiotic is injected
into the disc to prevent infection. The patient is sent home with a bandaid
over the needle insertion site. The procedure costs approximately $8,000.
During the three to four month healing period following the procedure,
patients must exercise caution in the amount of stress the treated disc
endures. Patients are often advised by the physician to wear back support for
the first six weeks and to adhere to activity and physical rehabilitation
guidelines. While there are a few patients who have reported increased pain in
their backs and numbness in their legs following the IDET procedure, most
patients report significant relief from their back pain and few post-procedure
complications. Clinical data has indicated that 60%-85% of patients treated
with IDET report a significant reduction in pain and a significant improvement
in physical function, as measured by the Visual Analog Scale, or VAS, pain
score system and the SF-36 patient outcomes questionnaire. The breadth of this
range is due to the numerous variables which affect physician results
including, among others, patient selection criteria and each physician's
experience using the SpineCATH catheter.
Because we only have two years of patient follow-up data for our spine
products, we do not have sufficient data to determine if the pain relief
provided by the IDET procedure is permanent, but we believe the procedure can
be repeated if longer-term patient follow up indicates that patients experience
a recurrence in pain.
Benefits of IDET
Clinical and scientific experience to date has indicated that IDET has the
following benefits:
. Minimally invasive treatment option: With the IDET procedure, patients
suffering from chronic low back pain have a new, minimally invasive
alternative if non-operative therapies have failed. IDET treats the
affected area of a specific disc in the lower back without the removal of
tissue or the permanent alteration of spinal anatomy associated with
conventional surgical treatments. We believe our procedure can be
repeated and does not preclude physicians from subsequently prescribing
more invasive surgical alternatives in the future.
. IDET may be reparative: Clinical results indicate that the IDET enables
physicians to apply controlled levels of heat to the disc wall causing
the collagen in the disc wall to contract and thicken. We believe the
contracted collagen, heated during the IDET procedure, acts as a scaffold
for the growth of new collagen, and over time stiffens and repairs the
disc wall. Scientific studies are currently underway to investigate the
healing process following the IDET therapy.
. Significant reduction in reported patient pain levels and improvement in
overall quality of life: Clinical data has indicated that 60%-85% of
patients treated with IDET report a significant reduction in pain and a
significant improvement in physical function. In many cases, IDET
benefits also include increased sitting tolerance and ability to return
to work. Over 70% of patients report that they reduced or eliminated
their intake of pain medication following the IDET procedure.
. Significant decrease in overall time and cost: IDET takes approximately
one hour to perform in an outpatient setting under local anesthesia.
Spinal fusions are inpatient procedures performed under general
anesthesia, are costly and require a prolonged hospital stay.
24
<PAGE>
Arthroscopy Market Opportunity
Arthroscopy is the minimally invasive treatment of joint tissue assisted with
a miniaturized camera, or arthroscope. Approximately 2.2 million arthroscopic
procedures were performed in the U.S. in 1998. We believe the number of
arthroscopic procedures is growing due to technological advancements, physician
and patient demand for less invasive procedures, the increasing incidence of
joint injuries caused by a greater emphasis on physical fitness, and an aging
population.
While we believe that shoulder arthroscopy is the fastest-growing portion of
the market, with 450,000 procedures performed in 1998, knee arthroscopy
continues to represent the greatest number of arthroscopic procedures,
accounting for approximately 1.5 million of arthroscopic procedures performed.
In addition, there were approximately 250,000 elbow, ankle, wrist and hip joint
arthroscopic procedures performed in 1998.
Joint Anatomy and Soft Tissue Disorders
Human joints are formed at the juncture of two or more bones and permit
motion of the otherwise rigid human skeleton. The bones of the joints are
joined by ligaments and separated by cartilage. The cartilage in the joints
acts as a cushion and the ligaments work to stabilize the joints when they are
stressed. As a result of injury or repetitive motion, soft tissue of the
ligaments and cartilage can be damaged, become worn and begin to stretch,
loosen or tear. This tissue damage can result in a wide range of joint
disorders from joint instability to severe ligament tears.
Existing Surgical Alternatives
Many joint injuries and disorders, including loose shoulder ligaments, severe
ankle sprains and torn and stretched knee ligaments, are treated using open
surgery. Open surgery involves large incisions, a prolonged hospital stay,
extensive rehabilitation over an extended recovery period and high overall
costs. Many of these conditions are not treated arthroscopically either because
arthroscopic techniques are not available, are not effective, or are too
difficult to perform.
Arthroscopic surgery allows surgeons direct access to and a magnified view of
most areas of the joint through several small incisions. Using existing
electrosurgical tools, surgeons are able to cut and ablate damaged tissue.
However, research indicates that for conditions that involve stretched or loose
tissue, the ability to modify tissue by using heat to shrink the collagen
within the tissue could produce better patient outcomes. Existing
electrosurgical tools are capable of cutting and removing, or ablating, soft
tissue because feedback on tissue temperature is not required for these
procedures. We believe that for tissue modification, physicians must be able to
monitor tissue temperature within an optimal temperature range. The
invasiveness of open surgery and the lack of effective arthroscopic procedures
to modify tissue has led many patients to elect to live with their condition
until pain or loss of motion becomes unmanageable.
The ORATEC Temperature Control Arthroscopy Solution
Our ElectroThermal Arthroscopy System for tissue modification, cutting and
ablation offers a minimally invasive solution to patients whose alternatives
are open surgery or a less effective arthroscopic procedure.
The Procedures
Our ElectroThermal Arthroscopy System utilizes the TAC probe, a single use
device which applies heat to soft tissue in the joints utilizing our
proprietary temperature control system. The procedure begins with the insertion
of several small tubes into the joint. An irrigant is then flushed through the
joint to permit clear visualization through the arthroscope and expand the
space in the joint for the surgical procedure. The surgeon inserts the TAC
probe into the joint and begins to paint the surface of the tissue with the tip
of the probe, controlling the energy level and monitoring tissue temperature.
In response to the application of heat, the collagen in the tissue of the
joints shrinks and tightens.
25
<PAGE>
In November 1999, we introduced the new Vulcan ElectroThermal Arthroscopy
System, or EAS. This system is designed to allow physicians to set the
generator at higher temperature levels to rapidly cut and ablate soft tissue
and to utilize our proprietary temperature control technology to effectively
modify damaged tissue.
Our procedure is usually performed under general anesthesia, and the patient
is sent home the same day with the joint immobilized by a brace or a sling. The
post-operative healing period can extend to four months.
Benefits of the ElectroThermal Arthroscopy System
Clinical and scientific experience to date has indicated that our
ElectroThermal Arthroscopy System has the following benefits:
. Single comprehensive system: Existing arthroscopic systems do not allow
physicians to effectively monitor the temperature of the treated tissue
during modification procedures and to cut and ablate tissue using the
same system. Our Vulcan EAS provides physicians a single system for all
three treatment approaches, and includes our proprietary temperature
control capability, which is designed to keep the temperature of treated
tissue within an optimal temperature range.
. Minimally invasive solution: The ElectroThermal Arthroscopy System
offers physicians a minimally invasive alternative for patients who might
otherwise avoid or delay open surgery. Clinical data indicates that
patients treated with our products typically require significantly less
post-operative pain medication, experience a decreased risk of post-
operative recovery complications and require less extensive
rehabilitation compared to patients who undergo open procedures. Open
surgical treatments require large incisions and often result in a loss of
range of motion and reduced athletic function.
. Improvement of existing arthroscopic procedures: By combining our
temperature control technology with other arthroscopic tools, physicians
can more completely treat joint disorders. For example, in connection
with the arthroscopic repair of a torn ligament, the application of our
temperature control technology can be useful to tighten the joint tissue
after the tear is repaired.
. Significant decrease in overall cost and time: For physicians, our
products offer less technically demanding procedures that significantly
reduce operating times. For patients, our procedures cost significantly
less than comparable open surgical procedures and typically allow them to
leave the hospital within two hours of the procedure as compared to open
surgery which requires hospitalization.
Business Strategy
Our strategy is to be the leading provider of minimally invasive devices for
the treatment of chronic back pain and joint injuries and disorders. The key
elements of our strategy include:
Target Large and Growing Markets. We target the spine and arthroscopy
markets, two growing segments of the medical device industry.
Provide Proprietary Minimally Invasive Techniques to Meet Unmet Medical
Needs. We focus on providing proprietary minimally invasive products to
overcome the limitations of existing treatment options, which can be highly
invasive and expensive and can result in sub-optimal patient outcomes.
Maintain Technology Leadership in Target Markets. We have an aggressive
product development program designed to enhance our current products and
develop new products for our target markets. Our ongoing focus will be to
design products that improve patient outcomes, simplify techniques, shorten
procedure and rehabilitation time and reduce costs.
Expand Clinical Leadership to Promote Use of Our Products. We will continue
to make substantial investments in the development of scientific and clinical
research to support market acceptance of our
26
<PAGE>
innovative minimally invasive therapies. We have established strong
relationships with leading physicians and have developed an extensive physician
training and education program.
Establish Sales Leadership. We are investing in, and marketing our products
through, separate spine and arthroscopy sales forces. In the U.S. market, we
have direct sales employees in most major markets and sales agents elsewhere.
We also provide reimbursement support for our customers. Internationally, we
use distributors to market our arthroscopy products and have an exclusive
distribution agreement with DePuy Acromed for the sale of our spine products.
Technology
Our proprietary SpineCATH IDET system and ElectroThermal Arthroscopy System
apply temperature-controlled thermal energy to achieve controlled modification
of soft tissue. Collagen, the fibrous tissue that composes all human ligaments,
tendons and connective tissue, reacts to heat by shrinking. At optimal
temperatures, collagen fibers shrink, yet the mechanical and structural
integrity of the treated collagen allows new collagen to grow back in a
reparative way, as opposed to charring or forming scar tissue. Heating the
tissue above this range damages the collagen, making it weak and preventing
optimal growth of new collagen. Our SpineCATH IDET system utilizes our
proprietary technology to control the temperature of the catheter allowing
physicians to effectively modify, or shrink, the collagen in the disc. Our
ElectroThermal Arthroscopy System includes the only products in the market that
monitor tissue temperature to facilitate effective modification while also
permitting a physician to cut and ablate damaged tissue. We believe our systems
result in more effective treatments than competing technologies.
Technology--SpineCATH IDET
Our IDET system is based on the application of resistive heat, which is
thermal energy generated by an electric heating coil. This resistive heat is
delivered through a proprietary self-guiding spine catheter to achieve
controlled contraction of collagen in the affected areas of the spinal disc.
The thermal delivery system is a five-centimeter heating tip at the end of the
catheter. The tip of the catheter contains a thermal monitoring mechanism,
which continually measures and relays catheter temperature back to the energy
source, the generator. Our research indicates that the optimal heating protocol
for many procedures requires an incremental increase in the temperature of the
treated tissue to a therapeutic temperature range. The most common treatment
protocol requires a 149(degrees)F initial catheter temperature, which then
rises periodically by 2(degrees)F until the temperature of the catheter reaches
194(degrees)F. The temperature is then maintained at that level for the
remainder of the prescribed treatment period. Our temperature feedback
mechanism enables the generator to continually adjust heat to achieve catheter
temperatures consistent with these predetermined heating protocols.
Technology--ElectroThermal Arthroscopy System
Physicians use our patented electrothermal arthroscopy products to perform a
number of electrosurgical functions, including cutting, ablation, coagulation
and electrothermal modification of tissue. Radiofrequency, or RF, energy is a
portion of the electromagnetic spectrum, in which the alternating current flow
produces molecular friction and thus heat in soft tissue. All electrosurgical
systems contain two electrodes for directing energy: an active electrode and a
return electrode. In monopolar electrosurgery, the active electrode is located
at the tip of a hand-held probe and the return electrode is a dispersive pad,
which rests on the patient's body. In bipolar electrosurgery, both active and
return electrodes are located at the tip of the probe. Consequently, in bipolar
systems, the current travels through only a shallow portion of target tissue
before traveling back through the probe. We have based our arthroscopic system
on monopolar technology because we believe that monopolar technology allows for
more effective and consistent temperature control as well as deeper penetration
of target tissue, permitting modification as well as effective cutting and
ablation of soft tissue. The tip of our temperature control probe contains a
thermocouple which records tissue temperature and relays it back to the
generator, enabling the generator to adjust energy output up to 50 times per
second to maintain optimal tissue temperatures in modification procedures.
27
<PAGE>
Products
We currently manufacture and sell the SpineCATH IntraDiscal ElectroThermal
Therapy system for the treatment of spinal disc disorders and the
ElectroThermal Arthroscopy System for the treatment of joint injuries and
disorders. Each of these systems utilizes controlled thermal energy to enable
physicians to perform minimally invasive treatments of these disorders.
SpineCATH IDET System
Our SpineCATH IDET system provides a non-surgical alternative for patients
suffering from degenerative disc disease in the lower back. Our SpineCATH IDET
received 510(k) premarket clearance from the FDA in March 1998 and was formally
launched in October 1998.
<TABLE>
<CAPTION>
SpineCATH IDET System Description Features
- -------------------------------------------------------------------------------
<C> <C> <S>
. SpineCATH IntraDiscal . Disposable 1.0 mm . Enters the disc through a
Catheter flexible, self-guiding 17 gauge introducer
catheter designed to needle
deliver resistive . Catheter temperature
thermal energy sensing and control
system
. Pre-curved navigation
tip, designed to
automatically follow the
curvature of the human
disc
. Radiopaque indicators,
which enable physicians
to verify optimal
catheter placement
through the use of real
time X-rays
. List price: $795
(Approximately 1.5
catheters used per
procedure)
- -------------------------------------------------------------------------------
. ORA-50 S . The source of the . Software that causes the
Electrothermal energy used to heat catheter temperature to
Generator the SpineCATH catheter automatically increase
according to the pre-
determined heating
protocols
. Proprietary temperature
feedback and control
system, which monitors
temperature in the tip of
the catheter
. Easy-to-read graphic
display, which enables
the physician to monitor
catheter temperatures,
delivered power and total
treatment time
. List price: $12,995
</TABLE>
In addition, we offer the ORAflex electrothermal disposable spine probe for
the treatment of herniated discs. The list price of the ORAflex probe is $595.
28
<PAGE>
ElectroThermal Arthroscopy System
Our ElectroThermal Arthroscopy System provides a minimally invasive
alternative for patients suffering from joint injuries. Our first TAC probe
received 510(k) premarket clearance from the FDA in December 1995, and the
first arthroscopy generator received clearance in December 1996. This system
was launched in March 1997. We received 510(k) premarket clearance from the FDA
for our ligament chisels in February 1997, and began marketing these products
in September 1997. In November 1999, following 510(k) premarket clearance in
October 1999, we introduced the Vulcan ElectroThermal Arthroscopy System (EAS)
and a line of ablation probes for the rapid removal of soft tissue.
<TABLE>
<CAPTION>
Electrothermal Arthroscopy System Description Features
- -------------------------------------------------------------------------------------
<C> <C> <S>
. Temperature Control . Disposable temperature . Malleable shaft, for
(TAC) Probes control probes improved access and
maneuverability in
difficult-to-reach
areas
. Designed to treat a . Thermocouple in the
variety of joint probe tip, which
disorders using low measures and monitors
energy for soft tissue tissue temperature
modification . Variety of probe
shapes and sizes for
optimal tissue access
. List price: $295
- -------------------------------------------------------------------------------------
. Ligament Chisel Family . Disposable . Malleable shaft for
of Electrosurgical electrosurgical improved access and
Probes cutting probes maneuverability in
difficult-to-reach
joint areas
. Cuts soft tissue while . Four different tip
simultaneously designs to allow
cauterizing bleeding precise matching of
vessels energy delivery to
specific anatomy and
procedures
. Tip design that
enhances tactile
feedback for optimal
control and access
. List price: $95-$120
- -------------------------------------------------------------------------------------
. Vulcan Family of . Disposable . Low tip profile for
Surgical Ablation electrosurgical improved joint access
Probes ablation probes and mobility within
designed for rapid the joint
tissue removal . Improved visualization
. Ablate tissue using . Monopolar probe tips
higher energy levels which allow direct
while simultaneously contact with tissue to
cauterizing bleeding enhance tactile
vessels feedback to the
physician
. Variety of probe
angles for optimal
tissue access
. List price: $125
- -------------------------------------------------------------------------------------
. Eflex Family of Probes . Specialized versions . Deflectable tips which
of the temperature can move up to
control and cutting 90(degrees) through a
probes mechanism built into
the device handles
. Improved access to
stretched or damaged
joint tissue (for
example, the hip
joint)
. List price: $345-$495
- -------------------------------------------------------------------------------------
. Vulcan EAS Generator . 200 watt generator . Improved temperature
control technology for
faster tissue response
and shorter treatment
times
. Combines our . Auto-Probe recognition
proprietary that automatically
temperature control selects the
technology with appropriate power,
enhanced cutting and temperature and mode
ablation capabilities settings for each
probe attachment
. List price: $13,495
</TABLE>
In addition, we have historically marketed the ORA-50 ElectroThermal
Generator, a 50 watt dual mode generator. The list price of the ORA-50
Generator is $8,995. We intend to discontinue sales of the ORA-50 Generator
because it was replaced by the Vulcan EAS Generator.
29
<PAGE>
Sales and Marketing
We market our products in the U.S. directly to physicians who perform spine
and arthroscopic procedures. For our spine products, these physicians include
orthopedic spine surgeons, neurosurgeons and pain management specialists. For
our arthroscopy products, these physicians are orthopedic surgeons, including
sports medicine specialists. We estimate that there are approximately 8,500
spine specialists in the U.S. and 7,000 orthopedic surgeons who consider
arthroscopy to be their major practice area.
We have a separate sales and marketing team for each of the spine and
arthroscopy markets in order to address the different physician groups in each
of these two areas. Each of these two sales organizations includes sales
employees covering most major markets, complemented by select sales agencies.
We believe that a direct sales force is better able to attain in-depth
expertise on the clinical benefits of our products. Sales agents typically
support the direct sales strategy by covering more rural areas. Agents
representing our product lines concurrently handle other related products and
have been selected based on their stature and performance in their respective
markets.
The marketing platform for both spine and arthroscopy is built on scientific
and clinical data and extensive surgeon training programs. As of December 31,
1999, we have trained over 1,675 physicians in the use of the IDET procedure.
Course faculty is comprised of physicians with extensive procedure experience
using our products. We expect to have scientific data presented at over 30
specialty meetings during 2000.
Our spine products are marketed domestically by 19 direct sales employees,
one national director, two regional sales managers, one marketing manager and
10 independent sales agencies. Our arthroscopy products are marketed
domestically by 21 direct sales employees, one national training director, four
regional managers, one national manager, one marketing manager and 28 sales
agencies. We plan to increase both of our sales forces during 2000.
We have focused our resources on the rapid development of the U.S. market for
our products. International sales have not been significant to date. Our
arthroscopy products are distributed in select countries by exclusive
distributors in those countries. With the market introduction of the SpineCATH
product, we have entered into an exclusive distribution agreement with DePuy
AcroMed for the marketing and sales of our spine products internationally. The
initial term of the agreement is five years and is automatically renewable
unless terminated by ORATEC or DePuy AcroMed. We have the right to terminate
the agreement if DePuy AcroMed fails to meet negotiated minimum purchase
requirements commencing in the year 2001. This 2001 deadline was informally
extended from the original deadline of 2000 because the parties agreed that
additional time was needed to establish an international market for the
SpineCATH product.
Reimbursement
Establishing reimbursement for any new technology is a challenge in the
current environment of cost containment and managed care. The cost reduction
orientation of the payor community makes it exceedingly difficult for new
medical technologies and surgical techniques to be covered for reimbursement.
We have a dedicated reimbursement group which:
. assists physicians and surgery centers with obtaining pre-authorization
of procedures;
. screens each case to determine that the procedure is appropriate for the
patient's condition;
. assists physicians and providers in claim collections; and
. provides payors with outcome data on their insured patients.
We have been working with various medical associations responsible for
determining reimbursement coding to develop our coding and reimbursement
strategy. The codes define reimbursement levels and are used for billing
purposes by health care providers. We have also introduced a new service for
physicians: based on physician authorization, we obtain payment pre-
authorization for the IDET procedure by contacting payors on
30
<PAGE>
behalf of the physician practice and facility. The service is free to
physicians and facilities. Our reimbursement staff of 13 individuals educates
the payor community, from the local case managers to the national policy
makers, on the IDET procedure. To date, we have had a 75% reimbursement success
rate for the IDET procedure. However, several large insurance plans have yet to
approve payment for the procedure. While we have experienced a decline in our
reimbursement rates over the past six months, as more physicians are trained to
perform the IDET procedure and pre-authorization requests are submitted to new
payors, we believe that published clinical data in peer reviewed journals will
facilitate further acceptance by payors. See "Risk Factors--If health care
providers cannot get reimbursed for the procedures which use our products, our
sales may decline."
Arthroscopy procedure costs, including the cost of our products, have been
covered under the customary payment policies of most payors. Reimbursement for
the incremental cost of our temperature control probes has been an issue for
ambulatory surgical centers. We have assisted these facilities in understanding
how to receive reimbursement for the incremental cost.
Competition
The medical device industry is subject to intense competition. Accordingly,
our future success will depend on our ability to meet the clinical needs of
physicians, improve patient outcomes and remain cost-effective for payors.
There are a number of medical treatments for low back pain ranging from
medication and physical therapy to spinal injections and interbody spine
fusion. We believe these types of treatments are not directly competitive with
our IDET procedure. IDET is typically offered to a patient after medications,
injections and physical therapy have failed, usually after six months of
unresolved symptoms. We are aware that Radionics offers kits that are designed
to lesion and denervate tissue in the spine. The lesioning product has gained
acceptance in the spinal denervation market. The kits are not, however,
designed to shrink collagen in disc tissue. There are also products which are
currently under development, including the prosthetic nucleus, which are not
currently supported by clinical data, are not currently FDA cleared and are not
currently available on the market. At some point, these products may offer
competitive treatments for low back pain caused by degenerative disc disease.
The spinal fusion market is highly competitive. Spinal fusion is not
considered directly competitive with our product because it treats severe disc
degeneration, which the IDET procedure is not designed to treat. However, spine
implant companies including Sofamor Danek, Sulzer Spine-Tech, Surgical
Dynamics, DePuy AcroMed and SYNTHES-STRATEC may consider us to be a competitor
because physicians may use spinal fusion to treat patients with degenerative
disc disease in an overlapping patient population. The cost of our IDET
procedure is approximately $8,000. The cost of spinal fusion is approximately
$45,000.
Several larger companies sell competitive products to our ElectroThermal
Arthroscopy System. These competitors, ArthroCare, Mitek and CONMED, are
focused on the tissue ablation market and offer directly competitive cutting
and ablating products. ArthroCare and Mitek also have low energy tissue
coagulation products which compete directly with our temperature control
products and, we believe, currently represent a combined 15% of the tissue
modification market.
We believe that the principal competitive factors in the markets for the
treatment of spine and joint disorders include:
. improved patient outcomes;
. the publication of peer reviewed clinical studies;
. acceptance by leading physicians;
. ease of use for physicians;
. sales and marketing capability;
. timing and acceptance of product innovation;
31
<PAGE>
. patent protection;
. product quality; and
. cost effectiveness.
Patents and Proprietary Technology
We believe that in order to have a competitive advantage we must develop and
maintain the proprietary aspects of our technologies. To this end, we file
patent applications to protect technology, inventions and improvements that we
believe are significant to the growth of our business. As of December 31, 1999,
we had 11 issued U.S. patents, one issued foreign patent, four notices of
allowance, 21 pending U.S. patent applications and 24 pending foreign patent
applications. The issued and allowed patents cover, among other things, method
and apparatus claims for directing energy to and sealing fissures in the spinal
discs, including navigation within a disc and devices with a functional element
at the tip, and the controlled contraction of tissue in all joints and spinal
discs. Our patents also cover our temperature feedback system, probe tip
technology, ligament shrinkage and controlled depth ablation.
We require our employees, consultants and advisors to execute confidentiality
agreements in connection with their employment, consulting or advisory
relationships with us. We also require our employees, consultants and advisors
who we expect to work on our products to agree to disclose and assign to us all
inventions conceived during the ORATEC work day, using our property or which
relate to our business. Despite any measures taken to protect our intellectual
property, unauthorized parties may attempt to copy aspects of our products or
to obtain and use information that we regard as proprietary. Finally, our
competitors may independently develop similar technologies. See "Risk Factors--
Because of the importance of our patent portfolio to our business, we may lose
market share to our competitors if we fail to protect our intellectual property
rights."
The medical device industry is characterized by the existence of a large
number of patents and frequent litigation based on allegations of patent
infringement. As the number of entrants into our market increases, the
possibility of an infringement claim against us grows. 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, our
competitors may assert that future products we may market infringe their
patents. See "Risk Factors--Because the medical device industry is litigious,
we are susceptible to an intellectual property suit."
Research and Development
We have an aggressive product development program to develop and enhance
products for the spine and arthroscopy markets. The ongoing focus of our
research and development group is to design products that improve patient
outcomes, simplify techniques, shorten procedure and rehabilitation time and
reduce costs. As of December 31, 1999, we employed 24 people in our research
and development organization. Our probe and generator development group
consisted of 18 people. We also had six people responsible for clinical and
regulatory affairs.
New Product Development
We are committed to leveraging our existing technologies into new orthopedic
applications and responding to the clinical needs of physicians and patients in
cost effective ways. We have a number of new projects and product enhancements
under development by the research and development group. Some of our planned
product line extensions include:
. the development of a spine catheter for the upper spine;
. the expansion of our ablation probe line;
32
<PAGE>
. enhanced electrosurgical capabilities in our arthroscopy generators;
. product enhancements for the SpineCATH IDET system; and
. advanced devices for knee and small joint arthroscopy procedures.
Clinical Research
The clinical research department supports our development efforts by
conducting in-house cadaveric and bench testing for the development and
evaluation of products and managing the numerous scientific and clinical
studies conducted by investigators and institutions studying the effects of our
technologies. In addition to administrative support and funding, the department
assists investigators in writing protocols and collecting data, when necessary,
as well as by providing site monitoring and research support.
As of December 31, 1999, there had been 14 published reports in peer reviewed
journals discussing the effects of our arthroscopic technology. An additional
five manuscripts related to our spine technology are pending publication, and
35 abstracts have been presented at medical conferences by both physicians
affiliated with us as clinical and scientific advisors and unaffiliated
physicians.
Manufacturing
Our manufacturing operations are focused on the manufacture of disposable
products and generators. The manufacturing process includes the inspection,
assembly, testing, packaging and sterilization of components that have been
manufactured by us or to our specifications by outside contractors. We inspect
each lot of components and finished products to determine compliance with our
specifications.
Our quality assurance systems are required to be in conformance with the
Quality System Regulation, or QSR, as mandated by the FDA. Our Menlo Park,
California facility received ISO 9001/EN 46001 certification in March 1998 and
is in conformance with the Medical Device Directive, or MDD, for sale of
products in Europe. We inspect incoming components, and inspect and test
products both during and after the manufacturing process. We also inspect
packaged products and test the sterilization process to produce quality
products.
In October 1999, we began to assemble our generators at our facility in Menlo
Park, California. We continue to subcontract the manufacture of a small number
of generators from a third party supplier. We made this transition in order to
reduce the risk of having a single source supplier, to directly control the
quality and availability of the product and to leverage fixed costs. See "Risk
Factors--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."
Most purchased components and services are available from more than one
supplier. For the components and services for which there are relatively few
alternate sources of supply, establishment of additional or replacement
suppliers for such components and services could not be accomplished quickly.
There are no contractual obligations by suppliers to continue to supply to us
nor are we contractually obligated to purchase from a particular supplier.
We utilize a gas plasma sterilization system that has been used extensively
in hospital settings but only recently for industrial applications. A contract
sterilizer provides gas plasma sterilization services as a backup to our
system. We also utilize a contract sterilizer that provides gamma sterilization
services for those products that cannot be sterilized with gas plasma.
Sterilization indicators for all products sterilized at our facilities are
processed at an outside certified laboratory to verify the effectiveness of the
sterilization process prior to the release of the product for distribution.
Government Regulation
Our products are regulated in the U.S. as medical devices by the FDA under
the Federal Food, Drug, and Cosmetic Act and require clearance of a premarket
notification under Section 510(k) of the FDC Act or approval
33
<PAGE>
of a PMA under Section 515 of the FDC Act by the FDA prior to
commercialization. Material changes or modifications to medical devices are
also subject to FDA review and clearance or approval. The FDA regulates the
research, clinical testing, manufacturing, safety, labeling, storage, record
keeping, reporting of adverse events and corrective actions, advertising,
distribution, sale and promotion of medical devices in the U.S. Non-compliance
with applicable requirements can result in, among other actions, warning
letters, fines, injunctions, civil and criminal penalties against us, our
officers, and our employees, recall or seizure of products, total or partial
suspension of production, failure of the government to grant premarket
clearance or premarket approval for devices, withdrawal of marketing approvals
and recommendation that we not be permitted to enter into government contracts.
All of our products have the necessary 510(k) clearances required for
marketing or are exempt from this requirement. It generally takes three to 12
months from the date of the submission to obtain clearance of a 510(k)
submission, but may take longer. Recently, the FDA has begun requiring a more
rigorous demonstration of substantial equivalence, including clinical trials
for devices which represent either new technologies, new intended uses or new
materials with no previous history of use in medical applications. While we
have been successful to date in obtaining regulatory clearance of our products
through the 510(k) notification process, our future products may not meet the
requirements for 510(k) clearance. If the FDA concludes that any product does
not meet the requirements for 510(k) clearance, then a PMA would be required
and the time required for obtaining regulatory approval would be significantly
lengthened.
Once 510(k) clearance has been received, any products that we manufacture or
distribute are subject to extensive and continuing regulation by the FDA.
Modifications to devices cleared via the 510(k) process may require a new
510(k) submission. We have made modifications to our products which we believe
do not require the submission of new 510(k) notifications. If the FDA disagrees
with us and requires us to submit a new 510(k) notification for any prior
device modification, we may be prohibited from marketing the modified device
until the new 510(k) is cleared by the FDA.
We have been an FDA registered medical device facility since 1996 and
obtained our manufacturing license from the California Department of Health
Services, or CDHS, in 1997. We are subject to periodic inspection by both the
FDA and CDHS for compliance with GMP, QSR and other applicable regulations. Our
manufacturing processes are required to comply with GMP and QSR regulations,
which cover the methods and documentation of the design, testing, production,
control, quality assurance, labeling, packaging and shipping of our products.
We are also required to comply with Medical Device Reporting regulations that
require us to report to the FDA any incident in which our product may have
caused or contributed to a death or serious injury, or in which our product
malfunctioned and, if the malfunction were to recur, it would be likely to
cause or contribute to a death or serious injury. As of December 31, 1999, we
had filed 25 Medical Device Reports, or MDRs, with the FDA. In June 1999, we
sent a letter to our physician customers informing them about the close
association between catheter kinking and catheter breakage, but we do not
believe that these instances were the result of a design flaw. In September
1999, we sent a safety alert to our physician customers which emphasizes the
importance of following the correct protocol during the IDET procedure,
including constant monitoring of the patient's condition and the electrical
resistance reading on the ORA 50 S generator. See "Risk Factors--If we are sued
in a product liability action, we could be forced to pay substantial
penalties."
456 TAC probes were returned to us as a result of a March 1999 voluntary
recall for a faulty part supplied to us by an outside vendor, however no
patient complaints or claims were received. We informed the FDA about this
voluntary recall, and no further notification was required. In April 1999, we
received a warning letter from the FDA regarding information on our website
which the FDA believed extended beyond our cleared label indications. This
means that the FDA believed that there was information on our website which led
readers to believe that our products could be used for indications that have
not been cleared by the FDA. We removed the information that we agreed was
outside our FDA-cleared label indications and responded that we believed the
remaining information was within our FDA-cleared label indications. In October
1999 we received a response from the FDA supporting our position.
34
<PAGE>
We are also subject to regulations and product registration requirements in
many of the foreign countries in which we sell our products, in the areas of
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The time
required to obtain clearance required by foreign countries may be longer or
shorter than that required for FDA clearance, and requirements for licensing a
product in a foreign country may differ significantly from FDA requirements.
Either we or our distributors have received registrations and approvals to
market the ORA-50 ElectroThermal Generator and arthroscopy probes and
accessories in Australia, Belgium, Canada, Italy, the Netherlands, Spain,
Taiwan and the United Kingdom. Registration for market approval for our spine
products is in process in several international markets. We are seeking or
intend to seek regulatory approvals in other international markets. We may not
obtain these foreign approvals on a timely basis, or at all.
The European Union has promulgated rules, under the MDD 93/42/EEC, which
require medical devices to bear the "CE mark" by June 1998. The CE mark is an
international symbol of adherence to quality assurance standards. Our ISO
9001/EN 46001 registration and conformance with the MDD have allowed us to
affix the CE mark to our devices and export our devices to any EC-member
country.
Employees
As of December 31, 1999, we had 213 employees, including 24 in research and
development, 96 in manufacturing, 75 in sales and marketing and 18 in general
and administrative functions. From time to time, we also employ independent
contractors to support our engineering, marketing, sales and support and
administrative organizations.
Insurance
We have general and product liability insurance coverage which is consistent
with the level of coverage held by other companies in the medical device
industry. We believe our level of liability insurance coverage provides us with
adequate protection against the risks associated with general and product
liability claims.
Facilities
We are headquartered in Menlo Park, California, where we lease three
buildings with approximately 30,000 square feet of office, research and
development and manufacturing space under leases expiring between September
2000 and March 2005. We have entered into one additional agreement to lease
approximately 6,000 square feet of space for manufacturing and distribution. We
will occupy that space during the second quarter of 2000. We also maintain an
office for our reimbursement function in Dallas, Texas. We believe that our
existing facilities are adequate to meet our current and foreseeable
requirements for the next 12 months or that suitable additional or substitute
space will be available as needed.
Legal Proceedings
From time to time we are a party to various legal proceedings arising in the
ordinary course of our business. We are not currently subject to any material
legal proceedings.
35
<PAGE>
Scientific and Clinical Advisory Boards
Our scientific and clinical advisory boards work collaboratively with ORATEC
to provide advice, assistance and consultation in the spine and arthroscopy
fields. We consider our advisory board members to be opinion leaders in their
fields, and they offer us advice regarding the applicability of our products to
procedures and feedback on both existing products and products under
development. Our advisory boards meet as a group approximately annually to
provide ORATEC with feedback on their clinical needs, new product development
and their experience using our products. In addition, we consult with
individual advisors on a regular basis to obtain interim product feedback,
advice regarding new product applications and updates on the spine and
arthroscopy markets. Upon commencement of their services, advisors are granted
options to purchase ORATEC common stock.
The following individuals sit on our advisory boards for spine.
Scientific Advisory Board
<TABLE>
<CAPTION>
Name Position and Affiliation
---- ------------------------
<C> <S>
Howard An, M.D. ........ Professor of Orthopedic Surgery, Rush Presbyterian
St. Luke's Medical Center, Chicago, IL
Gunnar Anderson, M.D. .. Orthopedic Spine Surgeon, Rush Presbyterian St.
Luke's Medical Center, Chicago, IL
Charles Aprill, M.D. ... Radiologist and Medical Director, Magnolia
Diagnostics, New Orleans, LA
David Casper, M.D. ..... Clinician of Orthopedic and Spine Surgery, Oklahoma
Sports Science and Orthopedics, Oklahoma City, OK
Richard Derby, M.D. .... Medical Director, Spinal Diagnostics & Treatment
Center, Daly City, CA
Neil Kahanovitz, M.D. .. Orthopedic Surgeon, Anderson Orthopedic Clinic,
Arlington, VA
Jeffrey Saal, M.D. ..... Associate Clinical Professor, Stanford University
School of Medicine, Palo Alto, CA
Joel Saal, M.D. ........ Assistant Clinical Professor, Stanford University
School of Medicine, Palo Alto, CA
Robert Watkins, M.D. ... Orthopedic Spine Surgeon, Center for Orthopedic
Spinal Surgery, Los Angeles, CA
Hansen Yuan, M.D. ...... Professor of Orthopedic and Neurological Surgery,
State University of New York, Syracuse, NY
</TABLE>
Clinical Advisory Board
<TABLE>
<CAPTION>
Name Position and Affiliation
---- ------------------------
<C> <S>
Steve Garfin, M.D. .......... Orthopedic Surgeon, Spine; Professor and Chair
in the Department of Orthopedics, University of
California, San Diego, CA
Steve Hochschuler, M.D. ..... Chairman, Texas Back Institute, Plano, TX
Dennis Karasek, M.D. ........ Physician, Northwest Spine Group, Eugene, OR
Michael Karasek, M.D. ....... President, Northwest Spine Group, Eugene, OR
Casey Lee, M.D. ............. Clinical Professor, Department of Orthopedics,
New Jersey Medical School, Newark, NJ
Sam Maywood, MD.............. Medical Director, Coast Surgery and Pain
Management Center, San Diego, CA
John Peloza, M.D............. Clinical Assistant Professor, University of
Texas, Southwestern Medical School, Department
of Orthopaedic Surgery, Dallas, TX; Spine
Surgeon, Center for Spine Care, Dallas, TX
Ralph Rashbaum, M.D. ........ Clinical Medical Director, Texas Back Institute,
Plano, TX
John Regan, M.D. ............ Associate, Texas Back Institute, Plano, TX
Daniel A. Sapir, MD.......... Medical Director, Indiana Pain Institute,
Lafayette, IN
James Walt Simmons, Jr., MD.. Clinical Professor, Department of Orthopedics
and Rehabilitation, University of Texas Medical
Branch, Galveston, TX
Kerry Thompson, M.D. ........ Neuroradiologist, Anne Arundel General Hospital,
Annapolis, MD
Michael Wall, M.D. .......... Orthopedic Surgeon, S.O.A.R., Menlo Park, CA
F. Todd Wetzel, M.D. ........ Associate Professor of Surgery, Section of
Orthopedic Surgery and Rehabilitation,
University of Chicago, Chicago, IL
Robert E. Wright, MD......... Medical Director, Denver Pain Management,
Denver, CO
</TABLE>
36
<PAGE>
The following individuals sit on our advisory boards for arthroscopy.
Scientific Advisory Board
<TABLE>
<CAPTION>
Name Position and Affiliation
---- ------------------------
<S> <C>
David Drez, M.D. ....... Clinical Professor of Orthopedics, Louisiana State University
School of Medicine, Lake Charles, LA
Lawrence Lemak, M.D. ... Orthopedic Surgeon, Alabama Sports Medicine Orthopedic Center,
Birmingham, AL
Mark Markel, M.D. ...... Chair, Department of Medical Sciences, University of Wisconsin,
Madison, WI
Gary Poehling, M.D. .... Chairman of Orthopedics, Wake Forest School of Medicine, Winston-
Salem, NC
Felix Savoie, M.D. ..... Director, Upper Extreme Service, Mississippi Sports Medicine,
Jackson, MS
James Tibone, M.D. ..... Orthopedic Surgeon, Kerlan-Jobe Orthopedic Clinic, Inglewood, CA
Michael Wall, M.D ...... Orthopedic Surgeon, S.O.A.R., Menlo Park, CA
Russell Warren, M.D. ... Surgeon in Chief, Hospital for Special Surgery, New York, NY
Clinical Advisory Board
<CAPTION>
Name Position and Affiliation
---- ------------------------
<S> <C>
Jeffrey Abrams, M.D. ... Associate Medical Director, Princeton Orthopedic and
Rehabilitation Associates, Princeton, NJ
James Andrews, M.D. .... Medical Director, American Sports Medicine Institute, Birmingham,
AL
James R. Bocell, Jr.,
M.D. .................. Clinical Professor, Dept. of Orthopedics, Baylor College of
Medicine, Houston, TX
James Bradley, M.D. .... Director, Pittsburgh Center for Sports Medicine, Shadyside
Hospital, Pittsburgh, PA
Christopher D.
Casscells, M.D......... Attending Staff, Christian Care Health Systems
Brian Cole, M.D. ....... Assistant Professor of Orthopedics, Sports Medicine, Rush
Presbyterian St. Luke's Medical Center, Chicago, IL
Stevens D. Coupens,
M.D. .................. Orthopedic Surgeon, Oklahoma Sports Science & Orthopedics
Philip A. Davidson,
M.D. .................. Tampa Bay Orthopedic Specialists; Assistant Professor, Clinical-
Orthopedic Surgery, University of South Florida
Michael Dillingham,
M.D. ................. Partner, Sports Orthopedic and Rehabilitation, of S.O.A.R.,
Medicine Associates, Menlo Park, CA
Neal S. ElAttrache,
M.D. .................. Orthopedic Surgeon, Kerlan-Jobe Orthopedic Clinic, Los Angeles, CA
Robert Eppley, M.D. .... Orthopedic Consultant, University of California, Berkeley, CA
Gary Fanton, M.D. ...... Assistant Clinical Professor, Stanford University School of
Medicine, Palo Alto, CA
Gary Gartsman, M.D...... Orthopedic Surgeon, Fondren Orthopedic Group, Houston, TX
Jeffrey Halbrecht,
M.D. .................. Medical Director, Women's Professional Ski Tour; California
Pacific Medical Center, San Francisco, CA
Richard Hawkins, M.D. .. Orthopedic Surgeon, Steadman Hawkins Clinic, Vail, CO
Robert F. Hines, M.D. .. Orthopedic Surgeon, Oklahoma Sports Science & Orthopedics,
Clinical Instructor, University of Oklahoma, Department of
Orthopedics, Oklahoma City, OK
Darryl Kan, M.D. ....... Orthopedic Team Physician, University of Hawaii, Honolulu, HI
Michael Krinsky, M.D. .. Chief of Staff, Health Surgery Center of Castro Valley, CA
Craig Levitz, M.D. ..... Attending Physician, Long Island Jewish Hospital; Director, OCOA
Cartilage Repair and Sports Medicine Center, Long Island, NY
Walter Lowe, M.D. ...... Associate Clinical Professor, Baylor College of Medicine,
Department of Orthopaedic Surgery, Houston, TX
Steven C. Mirabello,
M.D. .................. Orthopedic Surgeon, Florida Sports & Orthopedic Medicine
Dev Mishra, M.D. ....... Orthopedic Consultant, Team Physician, University of California,
Berkeley, CA
Bruce Moseley, M.D. .... Clinical Associate Professor, Baylor College of Medicine, Houston,
TX
Stephen J. Nicholas,
M.D. .................. Orthopedic Surgeon, Director of the Nicholas Institute of Sports
Medicine and Athletic Trauma
Lawrence
Oloff, D.P.M. ......... D.P.M. Surgeon, S.O.A.R., Menlo Park, CA
Marc J. Philippon,
M.D. .................. Orthopedic Surgeon, Holy Cross Hospital, Fort Lauderdale, FL
Pierce Scranton, M.D. .. Orthopedic Surgeon, Orthopedics International LTD P.S., Seattle,
WA
Eric Stahl, M.D. ....... Orthopedic Surgeon, Lakewood Orthopedic Clinic, Lakewood, CO
George Thabit, M.D. .... Orthopedic Surgeon, S.O.A.R., Menlo Park, CA
Eric Verploeg, M.D. .... Orthopaedics Surgeon, Orthopaedics of Steamboat Springs, CO
Kenneth Zaslov, M.D. ... Clinical Assistant Professor of Orthopaedic Surgery, Virginia
Commonwealth University; Director of Sports Medicine, Advanced
Orthopaedic Centers, Richmond, VA
</TABLE>
37
<PAGE>
MANAGEMENT
Executive Officers and Directors
The following table sets forth specific information regarding our executive
officers and directors as of December 31, 1999:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Kenneth W. Anstey....... 53 President, Chief Executive Officer and Director
Hugh R. Sharkey......... 49 Executive Vice President, Chief Technical Officer and Director
Nancy V. Westcott....... 46 Chief Financial Officer, Vice President, Administration and Secretary
Roger H. Lipton......... 42 Vice President, Sales and Marketing
Calvin K. Lee........... 45 Vice President, Operations
Theresa M. Mitchell..... 50 Vice President, Regulatory and Clinical Affairs and Quality Assurance
Richard M. Ferrari
(1)(2)................. 46 Chairman of the Board
Stephen Brackett (1).... 36 Director
Gary S. Fanton, M.D.
(2).................... 48 Director
Patrick F. Latterell
(1).................... 41 Director
Jeffrey A. Saal, M.D.
(2).................... 49 Director
</TABLE>
- --------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Kenneth W. Anstey joined ORATEC in April 1996 as a director and has served as
President and Chief Executive Officer of ORATEC since July 1997. From December
1995 to March 1997, Mr. Anstey was the Chief Executive Officer of Biofield
Corporation, a cancer diagnostic company. From August 1991 to December 1995, he
served as President and Chief Executive Officer of Mitek Surgical Products, an
orthopedic implant company, which was subsequently acquired by Johnson &
Johnson. He currently serves as a director of Vision Sciences, a medical device
company. Mr. Anstey holds a B.A. degree in Advertising and an M.B.A. degree
from Michigan State University.
Hugh R. Sharkey co-founded ORATEC and has served as a director since
inception. From July 1995 until July 1997, he served as Chief Executive
Officer, President and Chief Financial Officer, and in June 1997 he became
Executive Vice President and Chief Technical Officer. In March 1994, Mr.
Sharkey co-founded ZoMed International (now RITA Medical Systems), a
radiofrequency ablation company. In 1992, Mr. Sharkey co-founded VIDAMed, a
urology company, and in 1987, he co-founded Danforth Biomedical, a medical
device company. From May 1988 to May 1989, he served as Vice President and
General Manager of EP Technologies, a cardiac electrode company, which was
acquired by Boston Scientific, a minimally invasive medical device company. Mr.
Sharkey is listed as an inventor on over 53 patents for medical devices. He
holds an A.A. degree in Nursing and a B.S. degree in Business Administration
from the University of Phoenix.
Nancy V. Westcott joined ORATEC as its Chief Financial Officer and Vice
President, Administration in November 1997 and was elected to the office of
Secretary in August 1999. From November 1992, she served as Vice President of
Corporate Communications for Caremark International, a health care services
company, until its acquisition in September 1996. From June 1978 to November
1992, she held a number of management positions with Baxter International in
pension management and international and domestic treasury. Ms. Westcott holds
a B.A. degree in German from the University of Idaho and a Masters of
International Management degree from the American Graduate School of
International Management (Thunderbird). She earned her Professional Accounting
Certificate at the J.L. Kellogg Graduate School of Management at Northwestern
University.
Roger H. Lipton joined ORATEC in January 1996 as Vice President, Sales and
Marketing. From January 1989 to November 1995, Mr. Lipton held management
positions in marketing and business development at AME
38
<PAGE>
Orthofix, an orthopedic and spine implant company. Prior to working at AME
Orthofix, he served as a principal of Martek, a marketing consulting firm, and
as Director of Sales and Marketing of Medmax, a start-up cardiovascular
company. Mr. Lipton holds a B.S. degree in Business Administration from the
University of Hartford.
Calvin K. Lee joined ORATEC as Vice President, Manufacturing in October 1996,
and was promoted to Vice President, Operations in June 1999. From November 1987
to September 1996, Mr. Lee was employed by Cardiometrics, a manufacturer of
blood-flow monitors, most recently as Vice President of Manufacturing. Prior to
working at Cardiometrics, Mr. Lee held several manufacturing management
positions with Advanced Cardiovascular Systems, a cardiovascular device
company. Mr. Lee holds a B.S. degree in Business Administration from California
State University at San Jose.
Theresa M. Mitchell joined ORATEC in December 1999 as Vice President,
Regulatory and Clinical Affairs and Quality Assurance. From June 1999 to
December 1999, Ms. Mitchell was a regulatory consultant to APX, Inc. and
Circulation, Inc., cardiovascular medical device companies. From December 1997
to June 1999, she served as co-CEO and Senior Vice President, Business
Development and Marketing of Fidus Medical Technology, Inc., a medical
technology company. From October 1995 to October 1997, Ms. Mitchell served as
Vice President, Business Development, Regulatory and Clinical Affairs and
Quality Assurance of Intella Interventional, Inc., a cardiovascular medical
device company. From January 1995 to September 1995, Ms. Mitchell was a
consultant to Sunrise Medical, an opthalmic lasers company. Ms. Mitchell holds
M.A. and B.A. degrees in Experimental Psychology/Biostatistics from the
California State University, San Francisco.
Richard M. Ferrari has served as a director of ORATEC since May 1996 and was
elected Chairman of the Board in January 1997. Since June 1995, Mr. Ferrari has
served as Chief Executive Officer of CardioThoracic Systems, a minimally
invasive coronary bypass company, which was recently acquired by Guidant
Corporation. From January 1991 to September 1995, Mr. Ferrari was President and
Chief Executive Officer of CVIS, a cardiovascular medical device company, which
was recently acquired by Boston Scientific. From April 1990 to January 1991, he
served as President and Acting Chief Executive Officer of Medstone
International, a shockwave therapy company, and from January 1986 to April
1990, he was an Executive Vice President and General Manager with ADAC
Laboratories, a nuclear medical imaging and healthcare information systems
company. Mr. Ferrari also serves as a director and advisor for several start-up
companies in the medical device industry. Mr. Ferrari holds a B.S. degree in
Health and Education from Ashland University and an M.B.A. from the University
of South Florida.
Stephen Brackett has served as a director of ORATEC since December 1998. Mr.
Brackett founded MF Private Capital, Inc., a merchant bank and registered
broker-dealer, in 1998 and currently serves as a managing director. From
February 1995 to December 1997, Mr. Brackett managed the Corporate Advisory and
Investment Banking services for The Bank of Tokyo-Mitsubishi Capital
Corporation. From March 1994 to February 1995 Mr. Brackett was President and
Chief Operating Officer of State Street Business Group, an investment banking
firm. Mr. Brackett also serves on the board of directors of several private
companies. Mr. Brackett holds a B.A. degree in Political Science from Bates
College.
Gary S. Fanton, M.D. is a co-founder of ORATEC and has served as a director
since August 1995. Since, 1983, Dr. Fanton has been conducting his medical
practice with Sports Orthopedic and Rehabilitation, or S.O.A.R., Medicine
Associates. In addition, Dr. Fanton has been an Assistant Clinical Professor at
Stanford University since 1983, the head orthopedic surgeon for the Stanford
University football team since 1992 and the associate team physician for the
San Francisco 49ers since 1984. Dr. Fanton founded the International
Musculoskeletal Laser Society and has done extensive research on the effects of
thermal energy on soft tissue. He is a member of the Orthopedic Research
Society and the American Orthopedic Society for Sports Medicine. Dr. Fanton
holds a B.S. degree in Zoology from the University of Michigan and an M.D.
degree from the Medical College of Wisconsin, and completed his orthopedic
residency training at the Cleveland Clinic and his fellowship training in
sports medicine at the Kerlan-Jobe Orthopedic Clinic. Dr. Fanton is board
certified in Orthopedic Surgery.
39
<PAGE>
Patrick F. Latterell has served as a director of ORATEC since October 1997,
and previously served as a director and Chairman of the Board from August 1996
to January 1997. Mr. Latterell has been a general partner at Venrock
Associates, a venture capital firm, since April 1989. Mr. Latterell also serves
as a director of Vical, a gene-based pharmaceutical company, as well as several
private companies. He holds S.B. degrees in both Biology and Economics from the
Massachusetts Institute of Technology and an M.B.A degree from the Stanford
University Graduate School of Business.
Jeffrey A. Saal, M.D. is a co-founder of ORATEC and has been a director since
August 1995. Since 1981, Dr. Saal has been conducting his medical practice with
the S.O.A.R. Physiatry Medical Group. Since 1992, he has been an Associate
Clinical Professor at Stanford University, and since 1981 he has served as team
physician to various college sports teams. Dr. Saal is on the editorial boards
of several peer review journals, including Spine. Dr. Saal holds several
positions with professional societies, including Founding Chairman of PASSOR,
the Physiatric Association of Spine Sports and Occupational Rehabilitation. He
was also a former President of the North American Spine Society, or NASS. Dr.
Saal holds a B.A. degree in Biology from the State University of New York,
Oneonta and an M.D. degree from Tulane Medical School. He completed his
residency training at the Boston VA Hospital and Stanford University. Dr. Saal
is board certified in Physical Medicine, Internal Medicine and
Electrodiagnostic Medicine.
Board Composition
Our bylaws currently provide for a board of directors consisting of seven
members. Following the offering and beginning at the first annual meeting of
stockholders after the date on which we shall have had at least 800
stockholders, the board of directors will be divided into three classes, each
serving staggered three year terms: Class I, which is anticipated to consist of
directors Fanton and Ferrari, whose term will expire at the first annual
meeting of stockholders after the date on which we have 800 stockholders; Class
II, which is anticipated to consist of directors Latterell, Saal and Sharkey,
whose term will expire at the second annual meeting of stockholders after the
date on which we have 800 stockholders; and Class III, which is anticipated to
consist of directors Anstey and Brackett, whose term will expire at the third
annual meeting of stockholders after the date on which we have 800
stockholders. As a result, only one class of directors will be elected at each
annual meeting of stockholders of ORATEC, with the other classes continuing for
the remainder of their terms. Messrs. Latterell and Brackett were elected to
the board of directors pursuant to voting agreements between us and our Series
D and Series E Preferred Stock investors, respectively. These voting agreements
will terminate upon completion of this offering. Our officers are appointed by
the board of directors and serve at the discretion of the board of directors.
Board of Directors Compensation
Our directors do not currently receive compensation for their services as
members of the board of directors. Employee directors are eligible to
participate in our 1999 Stock Plan and will be eligible to participate in our
1999 Employee Stock Purchase Plan. Nonemployee directors are eligible to
participate in our 1999 Stock Plan and will be eligible to participate in our
1999 Directors' Stock Option Plan. See "--Stock Plans."
Board Committees
The compensation committee currently consists of Gary Fanton, M.D., Richard
Ferrari and Jeffrey Saal, M.D. The compensation committee:
. reviews and approves the compensation and benefits for our executive
officers and grants stock options under our stock option plan; and
. makes recommendations to the board of directors regarding such matters.
The audit committee consists of Stephen Brackett, Richard Ferrari and Patrick
Latterell. The audit committee:
. makes recommendations to the board of directors regarding the selection
of independent auditors;
40
<PAGE>
. reviews the results and scope of the audit and other services provided by
our independent auditors; and
. reviews and evaluates our audit and control functions.
Compensation Committee Interlocks and Insider Participation
The members of the compensation committee of the board of directors are
currently Gary Fanton, M.D., Richard Ferrari and Jeffrey Saal, M.D., none of
whom has ever been an officer or employee of ORATEC.
Executive Compensation
Summary Compensation. The following table sets forth the compensation
received for services rendered to us during 1998 and 1999 by our Chief
Executive Officer and our named executive officers, the four other most highly
compensated executive officers who earned more than $100,000 during 1998 and
1999.
Summary Compensation Table
<TABLE>
<CAPTION>
Annual Compensation Long Term Compensation
--------------------------------- ------------------------
All Other Restricted Securities
Compensation Stock Underlying
Name and Principal Position Year Salary ($) Bonus ($) ($) Awards($) Options (#)
- --------------------------- ---- ---------- --------- ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Kenneth W. Anstey,....... 1999 220,000 118,000 $ 55,439(1) -- 100,000
President and Chief
Executive Officer 1998 200,000 38,000 $101,629(2) $40,001(3) --
Hugh R. Sharkey,......... 1999 160,000 35,000 $ 6,000(4) -- --
Executive Vice President 1998 150,000 37,500 $ 6,000(4) -- --
and Chief Technical
Officer
Nancy V. Westcott,....... 1999 160,000 40,000 -- -- --
Chief Financial Officer, 1998 150,000 50,000 $103,738(5) -- --
Vice President,
Administration and
Secretary
Roger H. Lipton,......... 1999 165,000 65,000 $ 50,480(6) -- --
Vice President, Sales
and Marketing 1998 150,000 45,000 $ 3,600(4) -- 5,000
Calvin K. Lee,........... 1999 153,000 30,000 -- -- --
Vice President,
Operations 1998 135,000 10,000 -- -- 10,000
</TABLE>
- --------
(1) Consists of $49,670 in perquisite (including reimbursement of taxes) and
$5,769 car allowance.
(2) Consists of $95,629 in payments for moving and relocation costs and $6,000
car allowance.
(3) Represents 9,412 shares of common stock valued at the fair market value on
October 27, 1998, the issuance date, of $4.25 per share. The fair market
value of these shares was also $4.25 per share on December 31, 1998. These
shares were fully vested on the date of grant. No dividends will be paid on
these shares.
(4) Consists of car allowance.
(5) Consists of $63,366 in payments for moving and relocation costs and $40,372
in tax reimbursement in connection with relocation.
(6) Consists of $46,880 in perquisite (including reimbursement of taxes) and
$3,600 car allowance.
41
<PAGE>
Option Grants. The following table shows information regarding stock options
granted to our named executive officers during 1998 and 1999. No stock
appreciation rights were granted to these individuals during the year.
Option Grants in 1998 and 1999
<TABLE>
<CAPTION>
Potential Realizable
Value at Assumed
Annual Rates
Number of of Stock Price
Shares Percentage of Appreciation for
Underlying Total Options Option Term(2)
Options Granted to Exercise Price Expiration ---------------------
Name Year Granted(1) Employees per Share Date 5% 10%
---- ---- ---------- ------------- -------------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Kenneth W. Anstey....... 1999 100,000 8.6% $4.25 2/25/09 $1,855,452 $3,206,239
Roger H. Lipton......... 1998 5,000 0.7% $1.75 1/18/08 $ 105,273 $ 172,812
Calvin K. Lee........... 1998 10,000 1.4% $1.75 1/18/08 $ 210,545 $ 345,624
</TABLE>
- --------
(1) These stock options, which were granted under our 1995 plan, become
exercisable at the rate of 1/48th of the total number of shares on the
monthly anniversary of the date of grant, as long as the optionee remains
an employee with, consultant to, or director of ORATEC.
(2) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by the Securities and Exchange Commission and are based on the
assumption that the assumed initial public offering price of $14.00 was the
fair market value of the common stock on the date of grant. There is no
assurance provided to any executive officer or any other holder of our
securities that the actual stock price appreciation over the 10-year option
term will be at the assumed 5% and 10% levels or at any other defined
level. Unless the market price of the common stock appreciates over the
option term, no value will be realized from the option grants made to the
executive officers.
Aggregate Option Exercises and Holdings. The following table provides summary
information concerning option exercises and the shares of common stock
represented by outstanding stock options held by each of our named executive
officers as of December 31, 1999. No named executive officer exercised options
during 1998.
Fiscal Year-End Option Values
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money Options
Number of Options at at December 31, 1999
Shares Value December 31, 1999 (#) ($)(2)
Acquired on Realized ------------------------- -------------------------
Name Exercise (#) ($)(1) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ -------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Kenneth W. Anstey....... -- -- 354,584 245,416 $4,677,319 $2,974,681
Hugh R. Sharkey......... 40,000 $166,000 -- -- -- --
Nancy V. Westcott....... 59,375 $163,281 18,750 71,875 $ 234,375 $ 898,438
Roger H. Lipton......... -- -- 114,479 8,021 $1,588,745 $ 107,422
Calvin K. Lee........... -- -- 83,959 26,041 $1,107,665 $ 339,835
</TABLE>
- --------
(1) The amount set forth represents the difference between the fair market
value of the shares on the date of exercise as determined by the Board of
Directors and the exercise price of the option.
(2) The amount set forth represents the difference between the fair market
value of the underlying common stock at December 31, 1999, using an assumed
initial public offering price of $14.00 per share as the fair market value,
and the exercise price of the option.
Employment Agreements. We have entered into employment agreements with the
executive officers set forth below, which provide for the payment of severance
or the acceleration of unvested stock, options and warrants in some
circumstances. In addition, effective upon the closing of this offering our
stock plans provide for accelerated vesting of some employee options and shares
if the employee is involuntarily terminated without cause by ORATEC or a
successor company within two years after a change of control transaction. To
42
<PAGE>
the extent that the acceleration provisions in our stock plans provide for a
greater acceleration benefit than an executive officer would otherwise receive
based on that officer's agreement, then the stock plan acceleration provisions
would govern the acceleration of that officer's stock and options.
Mr. Anstey's agreement provides that if he is involuntarily terminated
without cause, including his constructive termination, he will receive a
severance payment, paid in two installments, equal to 12 months of his base
salary and target bonus earned, as well as acceleration of vesting on 50% of
his unvested options. If, as a result of a change of control of ORATEC, Mr.
Anstey is involuntarily terminated other than for cause, any unvested options
and stock granted under this agreement shall vest immediately.
Mr. Sharkey's agreement provides that if we terminate him without cause, he
will receive continued payment of his base salary and a pro rata amount of his
prior year's annual bonus for a period of six months after his termination
date.
Ms. Westcott's agreement provides that if we terminate her without cause, she
will receive continued payment of base salary on a monthly basis for (a) six
months, or (b) 12 months, if she is involuntarily terminated, including her
constructive termination, in connection with a change of control. In addition,
if Ms. Westcott is involuntarily terminated, including her constructive
termination, within 12 months after a change of control of ORATEC, 100% of her
unvested options will vest immediately.
Mr. Lipton's agreement provides that, upon a change of control of ORATEC,
100% of his unvested options will vest immediately.
Stock Plans
1995 Stock Plan, as amended. The 1995 plan was originally adopted by our
board of directors in July 1995 and approved by our stockholders in September
1995. Our board of directors approved amendments to the 1995 plan to increase
the number of shares reserved under the 1995 plan in April 1996, July 1997,
November 1998 and July 1999, and our stockholders approved these amendments to
the 1995 plan in May 1996, July 1997, November 1998 and August 1999. A total of
4,990,000 shares were authorized for issuance under this plan. In October 1999,
the board of directors approved an amendment to the 1995 plan effective upon
the closing of this offering which, under the circumstances described in detail
in the 1995 plan, provides for acceleration of vesting if we consummate a
change of control transaction.
In connection with our reincorporation in Delaware in December 1999, the
board of directors determined that no future grants will be made out of the
1995 plan and no annual increases in shares will be made under the existing
provision regarding automatic annual increases in authorized shares.
As of December 31, 1999, options to purchase 3,168,737 shares of common stock
were outstanding under the 1995 plan at a weighted average exercise price of
$2.85 per share, 656,201 shares had been issued upon exercise of outstanding
options or pursuant to restricted stock purchase agreements, 1,165,062 shares
had been retired and no shares remained available for future grant.
The terms of awards issued under our 1995 plan are generally the same as
those that may be issued under our 1999 plan described below.
1999 Stock Plan. Our 1999 plan provides for the grant of incentive stock
options to employees, including employee directors, and of nonstatutory stock
options and stock purchase rights to employees, directors, including employee
and non-employee directors, and consultants. The purposes of the 1999 plan are
to attract and retain the best available personnel, to provide additional
incentives to our employees and consultants and to promote the success of our
business. The 1999 plan was adopted by our board of directors in November 1999
and will be submitted to our stockholders for their approval prior to the date
of this offering. A total of 1,149,000 shares of common stock has been reserved
for issuance under the 1999 plan. The number of shares reserved for issuance
under the 1999 plan will be subject to an automatic annual increase on the
first day
43
<PAGE>
of each of our fiscal years beginning in 2000, 2001 and 2002 equal to the
lesser of 1,250,000 shares, 4% of our outstanding common stock on the last day
of the immediately preceding fiscal year, or a lesser number of shares as the
board of directors determines. The 1999 plan will terminate in 2009 unless the
board of directors terminates it earlier.
As of December 31, 1999, options to purchase 205,300 shares of common stock
were outstanding under the 1999 plan at a weighted average exercise price of
$9.60 per share, no shares had been issued upon exercise of outstanding options
or pursuant to restricted stock purchase agreements and 943,700 shares remained
available for future grant.
The 1999 plan may be administered by the board of directors or a committee of
the board, each known as the administrator. The administrator determines the
terms of options and stock purchase rights granted under the 1999 plan,
including the number of shares subject to the award, the exercise or purchase
price, the vesting and/or exercisability of the award and any other conditions
to which the award is subject. Stock options are generally subject to vesting,
which means the optionee earns the right to exercise an increasing number of
the shares underlying the option over a specific period of time only if he or
she continues to provide services to ORATEC over that period. However, in no
event may an employee receive awards for more than 1,000,000 shares under the
1999 plan in any fiscal year. Incentive stock options granted under the 1999
plan must have an exercise price of at least 100% of the fair market value of
the common stock on the date of grant, and not less than 110% of the fair
market value in the case of incentive stock options granted to an employee who
holds more than 10% of the total voting power of all classes of our stock or
any parent or subsidiary's stock. Prior to this offering, nonstatutory stock
options and stock purchase rights granted under the 1999 plan were required to
have an exercise or purchase price of at least 85% of the fair market value of
the common stock on the date of grant, and grants vested at the rate of at
least 20% per year. After the date of this offering, the exercise price of
nonstatutory stock options and the purchase price of stock purchase rights will
no longer be subject to these restrictions, although nonstatutory stock options
and stock purchase rights granted to our chief executive officer and our four
other most highly compensated officers will generally equal at least 100% of
the fair market value on the grant date if we intend that awards to those
individuals will qualify as performance-based compensation under applicable tax
law. Payment of the exercise or purchase price may be made in cash or other
consideration as determined by the administrator.
With respect to options granted under the 1999 plan, the administrator
determines the term of options, which may not exceed 10 years, or five years in
the case of an incentive stock option granted to an employee who holds more
that 10% of the total voting power of all classes of our stock or a parent or
subsidiary's stock. Generally, an option granted under the 1999 plan is
nontransferable other than by will or the laws of descent and distribution, and
may be exercised during the lifetime of the optionee only by such optionee.
However, the administrator may in its discretion provide for the limited
transferability of nonstatutory stock options granted under the 1999 plan as
provided in the 1999 plan. Stock issued pursuant to stock purchase rights
granted under the 1999 plan is generally subject to a repurchase right at the
purchaser's original purchase price exercisable by ORATEC upon the termination
of the holder's employment or consulting relationship with us for any reason,
including death or disability. This repurchase right will lapse in accordance
with the terms of the stock purchase right determined by the administrator at
the time of grant.
If we sell all or substantially all of our assets or if we are acquired by
another corporation, each outstanding option and stock purchase right may be
assumed or an equivalent award substituted by the acquiror or purchaser.
However, if the acquiror does not agree to this assumption or substitution, all
outstanding options and stock purchase rights will terminate. Upon the closing
of this offering, the 1999 plan provides, under the circumstances described in
detail in the 1999 plan, for the accelerated vesting of outstanding options and
repurchase rights if an optionee is involuntarily terminated without cause by
ORATEC or a successor corporation within two years after a change of control
transaction. If an acquiror does not agree to assume or substitute outstanding
ORATEC options and repurchase rights with an equivalent award at the time of
the transaction, the acceleration of vesting described above shall be effective
on the date immediately prior to the effective date of the transaction. If a
44
<PAGE>
change of control transaction is consummated, all unvested shares held by
consultants shall automatically become vested immediately prior to the
effective date of the change of control transaction.
Outstanding awards will be adjusted in the event of a stock split, stock
dividend or other similar change in our capital. The board of directors has the
power to amend or terminate the 1999 plan as long as this action does not
adversely affect any outstanding option and we obtain stockholder approval for
any amendment to the extent required by applicable law.
1999 Employee Stock Purchase Plan. Our 1999 employee stock purchase plan was
adopted by the board of directors in July 1999 and was approved by our
stockholders in August 1999. A total of 425,000 shares of common stock has been
reserved for issuance under the 1999 purchase plan, none of which have been
issued as of the date of this offering. The number of shares reserved for
issuance under the 1999 purchase plan will be subject to an automatic annual
increase on the first day of each of our fiscal years beginning in 2001, 2002
and 2003 equal to the lesser of 425,000 shares, 2% of our outstanding common
stock on the last day of the immediately preceding fiscal year, or a lesser
number of shares as the board of directors determines. The 1999 purchase plan
becomes effective upon the date of this offering. Unless terminated earlier by
the board of directors, the 1999 purchase plan shall terminate in 2009.
The 1999 purchase plan, which is intended to qualify under Section 423 of the
Internal Revenue Code, will be implemented by a series of offering periods of
approximately six months' duration, with new offering periods, other than the
first offering period, commencing generally on May 1 and November 1 of each
year. At the end of each offering period an automatic purchase will be made for
participants. The initial offering period is expected to commence on the date
of this offering and end on October 31, 2000. The 1999 purchase plan will be
administered by the board of directors or by a committee appointed by the
board. Employees, including officers and employee directors of ORATEC or of any
majority-owned subsidiary designated by the board, are eligible to participate
in the 1999 purchase plan if they are employed by us or any subsidiary for at
least 20 hours per week and more than five months per year. The 1999 purchase
plan permits eligible employees to purchase common stock through payroll
deductions, which may not exceed 15% of an employee's compensation. The
purchase price is equal to the lower of 85% of the fair market value of the
common stock at the beginning of each offering period or at the end of each
offering period. Employees may end their participation in the 1999 purchase
plan at any time during an offering period, and participation ends
automatically on termination of employment.
An employee is not eligible to participate in the 1999 purchase plan if
immediately after the grant of an option to purchase stock under the 1999
purchase plan the employee would own stock and/or hold outstanding options to
purchase stock equaling 5% or more of the total voting power or value of all
classes of our stock or stock of our subsidiaries, or if the option would
permit an employee's rights to purchase stock under the 1999 purchase plan to
accrue at a rate that exceeds $25,000 of the fair market value of the stock for
each year in which the option is outstanding. In addition, no employee may
purchase more than 3,000 shares of common stock under the 1999 purchase plan in
any one offering period.
If we merge or consolidate with or into another corporation or sell all or
substantially all of our assets, each right to purchase stock under the 1999
purchase plan will be assumed or an equivalent right substituted by the
successor corporation. However, the board of directors will shorten any ongoing
offering period so that an employee's rights to purchase stock under the 1999
purchase plan are able to be exercised prior to the transaction if the
successor corporation refuses to assume each purchase right or to substitute an
equivalent right. Outstanding options will be adjusted if we effect a stock
split, stock dividend or other similar change in our capital. The board of
directors has the power to amend or terminate the 1999 purchase plan and to
change or terminate an offering period as long as this action does not
adversely affect any outstanding rights to purchase stock. However, the board
of directors may amend or terminate the 1999 purchase plan or an offering
period even if it would adversely affect outstanding options in order to avoid
our incurring adverse accounting charges.
45
<PAGE>
1999 Directors' Stock Option Plan. The 1999 directors' stock option plan was
adopted by the board of directors in July 1999 and was approved by our
stockholders in August 1999. It will become effective upon the date of this
offering. A total of 250,000 shares of common stock has been reserved for
issuance under the 1999 directors' plan, all of which remains available for
future grants. The directors' plan provides for the grant of nonstatutory stock
options to our nonemployee directors. The directors' plan is designed to work
automatically without administration; however, to the extent administration is
necessary, it will be performed by the board of directors. To the extent a
conflict of interest arises, it will be addressed by abstention of any
interested director from both deliberations and voting regarding matters in
which the director has a personal interest. Unless terminated earlier, the
directors' plan will terminate 10 years after the date of this offering.
The directors' plan provides that each person who becomes a nonemployee
director after the completion of this offering will be granted a nonstatutory
stock option to purchase 20,000 shares of common stock on the date on which the
individual first becomes a member of our board of directors. This initial grant
will vest monthly over three years. Thereafter, on the date of each annual
shareholder meeting, each nonemployee director will be granted a nonstatutory
stock option to purchase 5,000 shares of common stock, if on the date of that
meeting, the nonemployee director has been a member of the board of directors
for at least six months. Each of these subsequent grants will vest monthly over
one year.
All options granted under the directors' plan will have a term of 10 years
and an exercise price equal to the fair market value of the common stock on the
date of grant and will generally be nontransferable. If a nonemployee director
ceases to serve as a director for any reason other than death or disability, he
or she may, but only within 60 days after the date he or she ceases to be a
director, exercise options granted under the directors' plan. If he or she does
not exercise the option within this 60-day period, the option shall terminate.
If a director's service terminates as a result of his or her disability or
death, or if a director dies within three months following termination for any
reason, the director or his or her estate will have 12 months after the date of
termination or death, as applicable, to exercise options that were vested as of
the date of termination.
If we are acquired by another corporation, each option outstanding under the
directors' plan will be assumed by the acquiror or equivalent options
substituted, unless our acquiror does not agree to such assumption or
substitution, in which case the options will terminate upon consummation of the
acquisition to the extent not previously exercised. Outstanding options will be
adjusted if we effect a stock split, stock dividend or other similar change in
our capital. Our board of directors may amend or terminate the directors' plan
as long as such action does not adversely affect any outstanding option and we
obtain stockholder approval for any amendment to the extent required by
applicable law.
Limitation of Liability and Indemnification Matters
Our certificate of incorporation limits the liability of directors to the
maximum extent permitted by Delaware law. Delaware law provides that directors
of a corporation will not be personally liable for monetary damages for breach
of their fiduciary duties as directors, except liability for:
. any breach of their duty of loyalty to the corporation or its
stockholders;
. acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
. any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission. Our certificate of
incorporation and bylaws provide that we shall indemnify our directors and
executive officers and may indemnify our other officers and employees and other
agents to the fullest extent permitted by law. We believe that indemnification
under our bylaws covers at least negligence and gross negligence on the part of
46
<PAGE>
indemnified parties. Our bylaws also permit us to secure insurance on behalf of
any officer, director, employee or other agent for any liability arising out of
his or her actions in this capacity, regardless of whether Delaware law would
permit indemnification.
We have entered into agreements to indemnify our directors and executive
officers in addition to indemnification provided for in our bylaws. These
agreements provide, among other things, for indemnification of our directors
and executive officers for expenses specified in the agreements, including
attorneys' fees, judgments, fines and settlement amounts incurred by any
director or officer in any action or proceeding arising out of his or her
services as a director or executive officer of ORATEC, any subsidiary of ORATEC
or any other entity to which the person provides services at our request. In
addition, we maintain directors' and officers' insurance. We believe that these
provisions and agreements are necessary to attract and retain qualified persons
as directors and executive officers.
At present, we are not aware of any pending or threatened litigation or
proceeding involving a director, officer, employee or agent in which
indemnification would be required or permitted. We are not aware of any
threatened litigation or proceeding that might result in a claim for
indemnification.
47
<PAGE>
TRANSACTIONS WITH DIRECTORS, EXECUTIVE OFFICERS AND 5% STOCKHOLDERS
From December 31, 1996 through February 29, 2000, we issued shares of
preferred stock in private placement transactions as follows:
. an aggregate of 1,442,542 shares of Series C preferred stock at $3.00 per
share in March 1997 through December 1997;
. an aggregate of 3,228,571 shares of Series D preferred stock at $3.50 per
share in November 1997 and December 1997; and
. an aggregate of 3,757,807 shares of Series E preferred stock at $4.25 per
share in December 1998.
The following table summarizes the shares of preferred stock purchased since
December 31, 1996 and held as of February 29, 2000 by our executive officers,
directors, holders of more than 5% of our outstanding stock and their
affiliates:
<TABLE>
<CAPTION>
Series C Series D Series E
Name Preferred Preferred Preferred
---- --------- --------- ---------
<S> <C> <C> <C>
Entities affiliated with Venrock Associates(1).. 571,429 176,471
Entities affiliated with Delphi Ventures........ 428,571
Entities affiliated with Pequot Private Equity
Fund, L.P...................................... 1,142,857 235,300
Gerlach & Co. as nominee for The Manufacturers
Life Insurance Company (U.S.A.)(2)............. 941,176
Kenneth W. Anstey............................... 16,666
Gary S. Fanton, M.D............................. 15,000
Richard M. Ferrari.............................. 25,000 85,000
Calvin K. Lee................................... 10,000 12,000
Jeffrey A. Saal, M.D............................ 10,000
Hugh R. Sharkey................................. 10,000
</TABLE>
- --------
(1) Patrick Latterell, a general partner of Venrock Associates, is a director
of ORATEC.
(2) Stephen Brackett, a managing director of MF Private Capital, an affiliate
of The Manufacturers Life Insurance Company, is a director of ORATEC.
Shares held by affiliated persons and entities have been aggregated. See
"Principal Stockholders."
On February 26, 1999, Roger H. Lipton, one of our executive officers,
purchased 34,117 shares of Series B preferred stock by exercising a warrant.
See "Management--Executive Compensation" for description of employment
agreements with the named executive officers, which provide for the payment of
severance or the acceleration of unvested stock and options. In addition,
Theresa Mitchell, one of our executive officers, has an agreement, which
provides that if she is terminated other than for cause or constructively
terminated in connection with a change of control of ORATEC, 100% of the shares
underlying her option shall vest on her termination.
We have entered into indemnification agreements with our officers and
directors containing provisions which may require us, among other things, to
indemnify our officers and directors against the liabilities described in the
indemnification agreements that may arise by reason of their status or service
as officers or directors, other than liabilities arising from willful
misconduct of a culpable nature, and to advance their expenses incurred as a
result of any proceeding against them as to which they could be indemnified.
48
<PAGE>
The following table summarizes the options granted to, and the shares of
common stock purchased since December 31, 1996 and held as of February 29, 2000
by, our executive officers, directors, holders of more than 5% of our
outstanding stock and their affiliates:
<TABLE>
<CAPTION>
Common Issuance Vesting
Name Stock Options Price Date Schedule
---- ------ ------- ------ ---------- --------
<S> <C> <C> <C> <C> <C>
Kenneth W. Anstey.................. 9,412(1) $ 4.25 Aug. 1998
420,000 $ 0.75 July 1997 (2)
100,000 $ 4.25 Feb. 1999 (3)
Gary S. Fanton, M.D................ 10,000 $ 1.75 Feb. 1998 (4)
10,000 $ 4.25 Mar. 1999 (4)
Richard M. Ferrari................. 10,000 $ 4.25 Mar. 1999 (4)
Calvin K. Lee...................... 10,000 $ 1.75 Jan. 1998 (3)
20,000 $10.50 Jan. 2000 (3)
Roger H. Lipton.................... 27,500(5) $0.001 Jan. 1997
10,000 $ 0.75 June 1997 (4)
5,000 $ 1.75 Jan. 1998 (3)
20,000 $10.50 Jan. 2000 (3)
Theresa M. Mitchell................ 120,000 $ 9.60 Nov. 1999 (6)
Jeffrey A. Saal, M.D............... 10,000 $ 1.75 Feb. 1998 (4)
10,000 $ 4.25 Mar. 1999 (4)
Hugh R. Sharkey.................... 34,000(5) $ 0.10 April 1999
20,000 $10.50 Jan. 2000 (3)
Nancy V. Westcott.................. 46,875(5) $ 1.50 Feb. 1999
12,500(5) $ 1.50 June 1999
90,625 $ 1.50 Nov. 1997 (6)
20,000 $10.50 Jan. 2000 (3)
</TABLE>
- --------
(1) Shares were issued as a bonus to Mr. Anstey.
(2) Shares vest at the rate of 6/48ths six months after the vesting
commencement date and 1/48th per month thereafter.
(3) Shares vest at the rate of 1/48th per month after the vesting commencement
date.
(4) Shares vest at the rate of 1/24th per month after the vesting commencement
date.
(5) Shares were purchased with cash pursuant to an option exercise.
(6) Shares vest as follows: 1/4th of the total shares vest on the one year
anniversary of the vesting commencement date and 1/48th of the total shares
vest on the monthly anniversary of the vesting commencement date
thereafter.
49
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table sets forth information known to us with respect to
beneficial ownership of our common stock as of December 31, 1999, as adjusted
to reflect the sale of common stock offered hereby, by:
. each person, or group of affiliated persons, known by us to own
beneficially more than 5% of our outstanding common stock,
. each director,
. our chief executive officer and our four other most highly
compensated executive officers, and
. all directors and officers as a group.
<TABLE>
<CAPTION>
Percent Beneficially
Owned(2)
--------------------
Number of Before After
Name Shares Offering Offering(1)
---- --------- -------- -----------
<S> <C> <C> <C>
Patrick F. Latterell(3)........................ 1,678,825 10.2% 8.2%
Entities Associated with Venrock
Associates(4)................................. 1,673,825 10.1% 8.2%
30 Rockefeller Plaza, Suite 5508
New York, NY 10112
Entities Associated with Pequot Private Equity
Fund, L.P.(5)................................. 1,378,157 8.4% 6.7%
500 Nayala Farm Road
Westport, CT 06880
Entities Associated with Delphi Ventures(6).... 1,354,496 8.2% 6.6%
3000 Sand Hill Road
Building 1, Suite 135
Menlo Park, CA 94025
Stephen Brackett(7)............................ 941,176 5.7% 4.6%
Gerlach & Co. as nominee for The Manufacturers
Life Insurance Company (U.S.A.)............... 941,176 5.7% 4.6%
45 Milk Street, Suite 600
Boston, MA 02109-5105
Hugh R. Sharkey(8)............................. 916,429 5.6% 4.5%
Gary S. Fanton, M.D.(9)........................ 658,749 4.0% 3.2%
Jeffrey A. Saal, M.D.(10)...................... 619,860 3.7% 3.0%
Kenneth W. Anstey(11).......................... 402,328 2.4% 1.9%
Richard M. Ferrari(12)......................... 194,583 1.2% *
Roger H. Lipton(13)............................ 180,053 1.1% *
Calvin K. Lee(14).............................. 110,957 * *
Nancy V. Westcott(15).......................... 84,791 * *
All directors and officers as a group (ten
persons)(16).................................. 5,787,751 33.5% 27.2%
</TABLE>
- --------
* Less than 1% of the outstanding shares of common stock.
(1) Assumes no exercise of the underwriters' over-allotment option. Except
under applicable community property laws or as indicated in the footnotes
to this table, to our knowledge, each stockholder identified in the table
possesses sole voting and investment power with respect to all shares of
common stock shown as beneficially owned by that stockholder.
(2) Options vested as of February 29, 2000 are included as shares beneficially
owned. For the purposes of calculating percent ownership, as of December
31, 1999, 16,491,149 shares were issued and outstanding, and, for any
individual who beneficially owns shares represented by options vested as
of February 29, 2000, these shares are treated as if
50
<PAGE>
outstanding for that person, but not for any other person. Unless otherwise
indicated, the address of each of the individuals named below is: c/o
ORATEC Interventions, Inc., 3700 Haven Court, Menlo Park, CA 94025.
(3) Includes 1,673,825 shares held by entities associated with Venrock
Associates, of which Mr. Latterell is a general partner. Mr. Latterell
disclaims beneficial ownership of the shares held by the entities except
to the extent of his pecuniary interest therein.
(4) Consists of 795,296 shares held by Venrock Associates II, L.P. and
878,529 shares held by Venrock Associates. The general partners of these
funds who share voting and dispositive power over these shares are
Anthony B. Evnin, Ted H. McCourtney and Anthony Sun.
(5) Consists of 1,223,276 shares held by Pequot Private Equity Fund, L.P. and
154,881 shares held by Pequot Offshore Private Equity Fund, Inc. The
beneficial owner of these shares is Pequot Capital Management, Inc. The
investment committee of Pequot Capital Management consists of Mark
Broach, Lawrence Lenihan, Gerald A. Poch and Arthur J. Samberg, all of
whom share voting and dispositive power over these shares.
(6) Consists of 1,330,542 shares held by Delphi Ventures III, L.P. and 23,954
shares held by Delphi Bioinvestments III, L.P. The general partner of
these funds is Delphi Management Partners III, L.L.C., and the managing
members of Delphi Management Partners, all of whom share voting and
dispositive power over these shares, are James J. Bochnowski, David L.
Douglass and Donald J. Lothrop. Each of these managing members disclaims
beneficial ownership of the shares held by these funds except to the
extent of each of their pecuniary interests in the partnerships.
(7) Consists of 941,176 shares held by Gerlach & Co. as nominee for The
Manufacturers Life Insurance Company (U.S.A.), of which Mr. Brackett is a
managing director. Mr. Brackett disclaims beneficial ownership of these
shares except to the extent of his pecuniary interest therein. The other
managing directors of MF Private Capital, Inc., with whom Mr. Brackett
shares voting and dispositive power over these shares, are David Alpert,
Raymond Britt, Myles Gilbert and William Sheehan. In addition, Richard
Coles, an Executive Vice President of The Manufacturers Life Insurance
Company, also shares voting and dispositive power over these shares.
(8) Includes 107,531 shares held in trust for or on behalf of Mr. Sharkey's
children, 616,394 shares held by the Sharkey-Daly Family Trust, 33,000
shares held by Kathleen Daly, Mr. Sharkey's spouse and 416 shares
issuable upon exercise of options vested as of February 29, 2000.
(9) Includes 54,583 shares issuable upon exercise of options vested as of
February 29, 2000.
(10) Includes 54,583 shares issuable upon exercise of options vested as of
February 29, 2000 and 116,000 shares held in trust for Dr. Saal's
children.
(11) Includes 376,250 shares issuable upon exercise of options vested as of
February 29, 2000 and 16,666 shares held by Mary Jo Anstey, Mr. Anstey's
spouse.
(12) Consists of 84,583 shares issuable upon exercise of options vested as of
February 29, 2000, 85,000 shares held by Saratoga Ventures, a limited
partnership of which Mr. Ferrari is the general partner, and 25,000
shares held by Ferrari Partners, a limited partnership of which Mr.
Ferrari is a limited partner. Mr. Ferrari disclaims beneficial ownership
of the shares held by Ferrari Partners except to the extent of his
pecuniary interest in the partnership.
(13) Includes 118,436 issuable upon exercise of options vested as of February
29, 2000.
(14) Includes 88,957 shares issuable upon exercise of options vested as of
February 29, 2000.
(15) Includes 25,416 shares issuable upon exercise of options vested as of
February 29, 2000.
(16) Includes 802,392 shares issuable upon exercise of options vested as of
February 29, 2000 held by all directors and officers.
51
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, we will be authorized to issue
75,000,000 shares of common stock, $0.001 par value, and 5,000,000 shares of
undesignated preferred stock, $0.001 par value.
Common Stock
As of December 31, 1999, there were 16,491,149 shares of common stock
outstanding, held of record by approximately 349 stockholders, which reflects
the conversion of all outstanding shares of preferred stock into common stock.
In addition, as of December 31, 1999, there were 3,374,037 shares of common
stock subject to outstanding options and 212,908 shares of common stock subject
to outstanding warrants. Upon completion of this offering, there will be
20,491,149 shares of common stock outstanding, assuming no exercise of the
underwriters' overallotment option or additional exercise of outstanding
options under our stock option plan and warrants.
The holders of common stock are entitled to one vote per share on all matters
to be voted upon by stockholders. Subject to preferences that may be applicable
to any outstanding preferred stock, holders of common stock are entitled to
receive ratably dividends as may be declared by the board of directors out of
funds legally available for that purpose. See "Our Policy Regarding Dividends."
In the event of our liquidation, dissolution or winding up, the holders of
common stock are entitled to share ratably in all assets remaining after
payment of liabilities and the liquidation preference of any outstanding
preferred stock. The common stock has no preemptive or conversion rights, other
subscription rights, or redemption or sinking fund provisions. All outstanding
shares of common stock are fully paid and non-assessable, and the shares of
common stock to be issued upon completion of this offering will be fully paid
and non-assessable.
Preferred Stock
Immediately before the closing of the offering, all outstanding shares of
preferred stock will be converted into 12,079,948 shares of common stock and
will be automatically retired. Thereafter, the board of directors will have the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of preferred stock in one or more series and to designate the rights,
preferences, privileges and restrictions of each such series. The issuance of
preferred stock could have the effect of restricting dividends on the common
stock, diluting the voting power of the common stock, impairing the liquidation
rights of the common stock or delaying or preventing our change in control
without further action by the stockholders. We have no present plans to issue
any shares of preferred stock.
Warrants
As of December 31, 1999 there were the following warrants outstanding:
. a warrant to purchase 55,555 shares of Series B preferred stock with an
exercise price of $1.35, which expires on March 20, 2001;
. warrants to purchase an aggregate of 35,000 shares of Series C preferred
stock with an exercise price of $3.00, which expire five years after the
closing of this initial public offering; and
. a warrant to purchase 122,353 shares of Series E preferred stock with an
exercise price of $4.25 which expires two years after the closing of this
initial public offering.
All of these warrants become exercisable for shares of common stock upon the
closing of this initial public offering.
Registration Rights
The holders of 11,805,857 shares of common stock, the "registrable
securities," are entitled to have their shares registered by us under the
Securities Act under the terms of an agreement between us and the
52
<PAGE>
holders of the registrable securities. Subject to limitations specified in the
agreement, these registration rights include the following:
. The holders of at least 40% of the registrable securities may require, on
two occasions beginning six months after the date of this prospectus,
that we use our best efforts to register the registrable securities for
public resale, provided that the aggregate offering price for such
registrable securities is more than $5,000,000. This right is subject to
the ability of the underwriters to limit the number of shares included in
the offering in view of market conditions.
. If we register any common stock, either for our own account or for the
account of other security holders, the holders of registrable securities
are entitled to include their registrable securities in such
registration. This right is subject to the ability of the underwriters to
limit the number of shares included in the offering in view of market
conditions.
. The holders of at least 30% of the then outstanding registrable
securities may require us to register all or a portion of their
registrable securities on Form S-3 when use of such form becomes
available to us, provided that the proposed aggregate offering price is
more than $1,000,000. The holders of registrable securities may only
exercise these Form S-3 registration rights twice, and may not exercise
this right within six months after the effective date of a previous
registration.
Holders of warrants exercisable for a total of 212,908 shares of common stock
have the right to include these shares in a piggyback or Form S-3 registration.
We will bear all registration expenses other than underwriting discounts and
commissions, except that we shall only pay registration expenses for one Form
S-3 registration in any twelve month period. All registration rights terminate
on the date five years after the closing of this offering, or, with respect to
each holder of registrable securities, at such time as the holder owns less
than 1% of the voting stock, or can sell all of his or her shares in any three
month period under Rule 144 of the Securities Act.
Delaware Anti-Takeover Law and Provisions of our Certificate of Incorporation
and Bylaws
Provisions of Delaware law and our certificate of incorporation and bylaws
could make more difficult our acquisition by a third-party and the removal of
our incumbent officers and directors. These provisions, summarized below, are
expected to discourage coercive takeover practices and inadequate takeover bids
and to encourage persons seeking to acquire control of ORATEC to first
negotiate with us. We believe that the benefits of increased protection of our
ability to negotiate with the proponent of an unfriendly or unsolicited
acquisition proposal outweigh the disadvantages of discouraging such proposals
because, among other things, negotiation could result in an improvement of
their terms.
We are subject to Section 203 of the Delaware General Corporation Law, which
regulates corporate acquisitions. In general, Section 203 prohibits a publicly
held Delaware corporation from engaging in a business combination with an
interested stockholder for a period of three years following the date the
person became an interested stockholder, unless:
. the board of directors approved the transaction in which such stockholder
became an interested stockholder prior to the date the interested
stockholder attained such status;
. upon consummation of the transaction that resulted in the stockholder's
becoming an interested stockholder, he or she owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced, excluding shares owned by persons who are directors and also
officers; or
. on or subsequent to such date the business combination is approved by the
board of directors and authorized at an annual or special meeting of
stockholders.
A business combination generally includes a merger, asset or stock sale, or
other transaction resulting in a financial benefit to the interested
stockholder. In general, an interested stockholder is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status, did own, 15% or more of a
corporation's voting stock.
53
<PAGE>
Our certificate of incorporation and bylaws do not provide for the right of
stockholders to act by written consent without a meeting or for cumulative
voting in the election of directors. Our certificate of incorporation permits
the board of directors to issue preferred stock with voting or other rights
without any stockholder action. Our bylaws provide that, upon our stock being
listed on the Nasdaq National Market and upon our having at least 800
shareholders of record at an annual meeting, shareholders will no longer be
able to call special shareholder meetings. Our certificate of incorporation
provides that at our first annual meeting of stockholders following the date on
which we have at least 800 stockholders, the board of directors shall be
divided into three classes, with staggered three year terms. As a result, only
one class of directors will be elected at each annual meeting of stockholders.
The other classes of directors will continue to serve for the remainder of
their three year terms. These provisions, which require the vote of
stockholders holding at least 66 2/3% of the outstanding common stock to amend,
may have the effect of deterring hostile takeovers or delaying changes in our
management. In addition, a director may be removed from office:
. for cause, by a vote of the holders of a majority of the outstanding
shares, and
. without cause, by a vote of the holders of at least 66 2/3% of the
outstanding shares.
Transfer Agent and Registrar
The transfer agent and registrar for the common stock is American Stock
Transfer and Trust Company, and its address and telephone number are 40 Wall
Street, New York, NY 10005 (tel.) (212) 936-5100.
54
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering, there has been no market for our common stock. Future
sales of substantial amounts of common stock in the public market could
adversely affect prevailing market prices. As described below, only 41,000
shares currently outstanding will be available for sale immediately after this
offering because of contractual restrictions on resale. Sales of substantial
amounts of our common stock in the public market after the restrictions lapse
could adversely affect the prevailing market price and impair our ability to
raise equity capital in the future.
Upon completion of the offering, we will have 20,491,149 outstanding shares
of common stock. Of these shares, the 4,000,000 shares sold in the offering,
plus any shares issued upon exercise of the underwriters' overallotment option,
will be freely tradable without restriction under the Securities Act, unless
purchased by our affiliates as that term is defined in Rule 144 under the
Securities Act. In general, affiliates include officers, directors and 10%
stockholders.
The remaining 16,491,149 shares outstanding are "restricted securities"
within the meaning of Rule 144. Restricted securities may be sold in the public
market only if they are registered or if they qualify for an exemption from
registration under Rules 144, 144(k) or 701 promulgated under the Securities
Act, which are summarized below. Sales of the restricted securities in the
public market, or the availability of such shares for sale, could adversely
affect the market price of the common stock.
Our directors, officers and security holders have entered into lock-up
agreements in connection with this offering generally providing that they will
not offer, sell, contract to sell or grant any option to purchase or otherwise
dispose of our common stock or any securities exercisable for or convertible
into our common stock owned by them for a period of 180 days after the date of
this prospectus without the prior written consent of Merrill Lynch & Co.
Notwithstanding possible earlier eligibility for sale under the provisions of
Rules 144, 144(k) and 701, shares subject to lock-up agreements will not be
salable until such agreements expire or are waived by each of Merrill Lynch &
Co. and ORATEC. Taking into account the lock-up agreements, and assuming
Merrill Lynch & Co. and we do not release stockholders from these agreements,
the following shares will be eligible for sale in the public market at the
following times:
. Beginning on the effective date of this prospectus, the 4,000,000 shares
sold in the offering and 41,000 additional shares will be immediately
available for sale in the public market.
. Beginning 180 days after the effective date, approximately 13,790,081
shares will be eligible for sale, 5,020,119 of which will be subject to
volume, manner of sale and other limitations under Rule 144.
. The remaining 2,660,068 shares will be eligible for sale pursuant to Rule
144 upon the expiration of various one-year holding periods during the
six months following 180 days after the effective date.
In general, under Rule 144 as currently in effect, after the expiration of
the lock-up agreements, a person who has beneficially owned restricted
securities for at least one year would be entitled to sell within any three-
month period a number of shares that does not exceed the greater of:
. one percent of the number of shares of common stock then outstanding
which will equal approximately shares immediately after the offering;
or
. the average weekly trading volume of the common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to requirements with respect to manner
of sale, notice and the availability of current public information about us.
Under Rule 144(k), a person who is not deemed to have been our affiliate at
anytime during the three months preceding a sale, and who has beneficially
owned the shares proposed to be sold for at least two years, is entitled to
sell such shares without complying with the manner of sale, public information,
volume limitation or notice provisions of Rule 144.
55
<PAGE>
Rule 701, as currently in effect, permits our employees, officers, directors
or consultants who purchased shares pursuant to a written compensatory plan or
contract to resell such shares in reliance upon Rule 144 but without compliance
with specific restrictions. Rule 701 provides that affiliates may sell their
Rule 701 shares under Rule 144 without complying with the holding period
requirement and that non-affiliates may sell such shares in reliance on Rule
144 without complying with the holding period, public information, volume
limitation or notice provisions of Rule 144.
In addition, we intend to file registration statements under the Securities
Act as promptly as possible after the effective date to register shares to be
issued pursuant to our employee benefit plans. As a result, any options or
rights exercised under the 1995 plan, the 1999 plan, the 1999 employee stock
purchase plan, the 1999 directors' stock option plan or any other benefit plan
after the effectiveness of the registration statements will also be freely
tradable in the public market. However, shares held by affiliates will still be
subject to the volume limitation, manner of sale, notice and public information
requirements of Rule 144 unless otherwise resalable under Rule 701. As of
December 31, 1999 there were outstanding options for the purchase of 3,374,037
shares of common stock, of which options to purchase 1,526,050 shares were
exercisable.
56
<PAGE>
UNDERWRITING
Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities
Inc. and U.S. Bancorp Piper Jaffray Inc. are acting as representatives of each
of the underwriters named below. Subject to the terms and conditions described
in a purchase agreement between us and the underwriters, we have agreed to sell
to the underwriters, and each of the underwriters severally and not jointly has
agreed to purchase from us, the number of shares of common stock listed
opposite its name below.
<TABLE>
<CAPTION>
Number of
Underwriter Shares
----------- ---------
<S> <C>
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...........................................
J.P. Morgan Securities Inc......................................
U.S. Bancorp Piper Jaffray Inc..................................
---------
Total...................................................... 4,000,000
=========
</TABLE>
In the purchase agreement, the several underwriters have agreed, subject to
the terms and conditions described in the purchase agreement, to purchase all
of the shares of common stock being sold pursuant to this agreement if any of
the shares of common stock being sold pursuant to the agreement are purchased.
In the event of a default by an underwriter, the purchase agreement provides
that the purchase commitments of the nondefaulting underwriters may be
increased or the purchase agreement may be terminated.
We have agreed to indemnify the underwriters against the liabilities
described in the underwriting agreement, including liabilities under the
Securities Act as provided in the underwriting agreement, or to contribute to
payments the underwriters may be required to make.
Commissions and Discounts
The representatives have advised us that the underwriters propose initially
to offer the shares of common stock to the public at the initial public
offering price described on the cover page of this prospectus, and to dealers
at that price less a concession not in excess of $ per share. The
underwriters may allow, and those dealers may reallow, a discount not in excess
of $ per share to other dealers. After the initial public offering, the
public offering price, concession and discount may be changed.
The following table shows the per share and total public offering price, the
underwriting discount we will pay to the underwriters and the proceeds we will
receive before expenses. This information is presented assuming either no
exercise or full exercise by the underwriters of their over-allotment options.
<TABLE>
<CAPTION>
Per Without With
Share Option Option
----- ------- ------
<S> <C> <C> <C>
Public offering price...................................... $ $ $
Underwriting discount...................................... $ $ $
Proceeds, before expenses, to ORATEC....................... $ $ $
</TABLE>
The expenses of the offering, not including the underwriting discount, are
estimated at $ million and are payable by us.
The shares of common stock are being offered by the underwriters, subject to
prior sale, when, as and if issued to and accepted by them, subject to approval
of legal matters by counsel for the underwriters and other conditions. The
underwriters reserve the right to withdraw, cancel or modify their offer and to
reject orders in whole or in part.
57
<PAGE>
Over-allotment Option
We have granted an option to the underwriters, exercisable for 30 days after
the date of this prospectus, to purchase up to an aggregate of 600,000
additional shares of common stock at the public offering price described on the
cover page of this prospectus, less the underwriting discount. The underwriters
may exercise this option solely to cover over-allotments, if any, made on the
sale of the common stock. To the extent that the underwriters exercise this
option, each underwriter will be obligated, subject to the conditions described
in the underwriting agreement, to purchase a number of additional shares of
common stock proportionate to that underwriter's initial amount reflected in
the above table.
Reserved Shares
At our request, the underwriters have reserved for sale, at the initial
public offering price, up to 5% of the shares to be sold to directors,
officers, employees, business associates and related persons of ORATEC. The
number of shares of common stock available for sale to the general public will
be reduced to the extent those persons purchase reserved shares. Any reserved
shares which are not orally confirmed for purchase within one day of the
pricing of the offering will be offered by the underwriters to the general
public on the same terms as the other shares offered hereby. Reserved shares
will be sold at the initial public offering price.
No Sales of Similar Securities
We and our executive officers and directors and almost all of existing
stockholders have agreed, not to directly or indirectly, for a period of 180
days after the date of this prospectus:
. offer, sell, contract to sell, grant any option or warrant for the sale
of, register, or otherwise transfer, dispose of, loan, pledge or grant
any rights with respect to any shares of capital stock of ORATEC or
securities convertible into or exchangeable or exercisable for, or any
rights to purchase or acquire, shares of capital stock of ORATEC,
including, without limitation, common stock which may be deemed to be
beneficially owned by the stockholder in accordance with the rules and
regulations of the SEC.
The foregoing restriction is expressly agreed to preclude stockholders from
engaging in any hedging or other transaction which is designed to result in a
disposition of securities during the 180-day lock-up period, even if such
securities would be disposed of by someone other than the stockholder.
Initial Public Offering Price
Prior to the offering, there has been no public market for our common stock.
The initial public offering price will be determined through negotiations
between us and the representatives. The factors considered in determining the
initial public offering price, in addition to prevailing market conditions, are
. price-earnings ratios of publicly traded companies that the
representatives believe to be comparable to ORATEC;
. financial information about us and the industry in which we compete; and
. an assessment of our management, our past and present operations, our
prospects for, and timing of, future revenue, and the present state of
our development.
If the underwriters create a short position in the common stock in connection
with the offering, i.e., if they sell more shares of common stock than are set
forth on the cover page of this prospectus, the representatives may reduce that
short position by purchasing common stock in the open market. The
representatives may also elect to reduce any short position by exercising all
or part of the over-allotment options described above.
The representatives may also impose a penalty bid on other underwriters and
selling group members, which means that if the representatives purchase shares
of common stock in the open market to reduce the underwriters' short position
or to stabilize the price of the common stock, they may reclaim the amount of
the selling concession from the underwriters and selling group members who sold
those shares as part of the offering.
58
<PAGE>
An active trading market for our common stock may not develop and the price
at which our stock trades after the offering may be below the initial public
offering price.
Price Stabilization, Short Positions and Penalty Bids
Until the distribution of the common stock is completed, the rules of the
Securities and Exchange Commission may limit the ability of the underwriters
and selling group members to bid for and purchase the common stock. As an
exception to these rules, the representatives are permitted to engage in
transactions that stabilize the price of the common stock. These transactions
consist of bids or purchases for the purpose of pegging, fixing or maintaining
the price of the common stock.
In general, purchases of a security for the purpose of stabilization or to
reduce a short position could cause the price of the security to be higher than
it might be in the absence of those purchases. The imposition of a penalty bid
might also have an effect on the price of the common stock to the extent that
it discourages resales of the common stock.
Neither we nor any of the underwriters makes any representation or prediction
as to the direction or magnitude of any effect that the transactions described
above may have on the price of the common stock. In addition, neither we nor
any of the underwriters makes any representation that the representatives will
engage in any stabilizing transactions or that these transactions, once
commenced, will not be discontinued without notice.
Merrill Lynch will be facilitating Internet distribution for this offering to
certain of its internet subscription customers. Merrill Lynch intends to
allocate a limited number of shares for sale to its online brokerage customers.
An electronic prospectus is available on the website maintained by Merrill
Lynch. Other than the prospectus in electronic format, the information on the
Merrill Lynch website relating to this offering is not a part of this
prospectus.
LEGAL MATTERS
The validity of our common stock offered hereby will be passed upon for
ORATEC by Venture Law Group, A Professional Corporation, 2800 Sand Hill Road,
Menlo Park, California 94025. Mark Weeks, a director of Venture Law Group, is
the Assistant Secretary of ORATEC. Legal matters with respect to information
contained in this prospectus under the captions "Risk Factors--Because the
medical device industry is litigious, we are susceptible to an intellectual
property suit," "--If we are sued for patent infringement, we could be
prevented from selling our products and our business could suffer," and "--
Because of the importance of our patent portfolio to our business, we may lose
market share to our competitors if we fail to protect our intellectual property
rights" and "Business--Patents and Proprietary Technology" will be passed upon
for ORATEC by Wilson Sonsini Goodrich & Rosati, a Professional Corporation,
patent counsel to ORATEC. Legal matters in connection with this offering will
be passed upon for the underwriters by Latham & Watkins, 650 Town Center Drive,
20th floor, Costa Mesa, CA 95626. As of the date of this prospectus, an
investment partnership controlled by Venture Law Group beneficially owns 31,333
shares of ORATEC'S common stock. As of the date of this prospectus, partners of
Wilson Sonsini Goodrich & Rosati, a Professional Corporation, beneficially own
45,000 shares of ORATEC's common stock.
EXPERTS
Ernst & Young LLP, independent auditors, have audited our financial
statements at December 31, 1998 and 1999, and for each of the three years ended
December 31, 1999, as set forth in their report. We have included our financial
statements in the prospectus and elsewhere in the registration statement in
reliance on Ernst & Young LLP's report, given on their authority as experts in
accounting and auditing.
59
<PAGE>
The statements set forth in this prospectus under the captions "Risk
Factors--Because the medical device industry is litigious, we are susceptible
to an intellectual property suit," "--If we are sued for patent infringement,
we could be prevented from selling our products and our business could suffer,"
and "--Because of the importance of our patent portfolio to our business, we
may lose market share to our competitors if we fail to protect our intellectual
property rights" and "Business--Patents and Proprietary Technology" have been
reviewed and approved by Wilson Sonsini Goodrich & Rosati, a Professional
Corporation, patent counsel to ORATEC, as experts in such matters, and are
included herein in reliance upon its review and approval.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement, which includes any amendments to the registration statement, on Form
S-1 under the Securities Act with respect to the common stock offered by this
prospectus. This prospectus, which constitutes a part of the registration
statement, does not contain all of the information set forth in the
registration statement. There are items contained in exhibits to the
registration statement as permitted by the rules and regulations of the
Securities and Exchange Commission. For further information with respect to
ORATEC and the common stock offered by this prospectus, reference is made to
the registration statement and its exhibits, and the financial statements and
notes filed as a part of the registration statement. Statements made in this
prospectus concerning the contents of any document are not necessarily
complete. With respect to each document filed with the Securities and Exchange
Commission as an exhibit to the registration statement, reference is made to
the exhibit for a more complete description of the matter involved. The
registration statement, including the exhibits, financial statements and notes
filed as a part of the registration statement, as well as reports and other
information filed with the Securities and Exchange Commission, may be inspected
without charge at the public reference facilities maintained by the Securities
and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and
at the regional offices of the Securities and Exchange Commission located at
Seven World Trade Center, 13th Floor, New York, New York, 10048, and the
Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661.
Copies of all or any part thereof may be obtained from the Securities and
Exchange Commission upon payment of fees prescribed by the Securities and
Exchange Commission. These reports and other information may also be inspected
without charge at a website maintained by the Securities and Exchange
Commission. The address of the SEC site is http://www.sec.gov.
60
<PAGE>
ORATEC INTERVENTIONS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors......................... F-2
Balance Sheets............................................................ F-3
Statements of Operations.................................................. F-4
Statement of Redeemable Convertible Preferred Stock and Stockholders'
Equity................................................................... F-5
Statements of Cash Flows.................................................. F-6
Notes to Financial Statements............................................. F-7
</TABLE>
F-1
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
ORATEC Interventions, Inc.
We have audited the accompanying balance sheets of ORATEC Interventions,
Inc. as of December 31, 1998 and 1999, and the related statements of
operations, cash flows, and statement of redeemable convertible preferred
stock and stockholders' equity for each of the three years in the period ended
December 31, 1999. These financial statements are the responsibility of
ORATEC's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of ORATEC Interventions, Inc.
at December 31, 1998 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1999, in
conformity with accounting principles generally accepted in the United States.
/s/ Ernst & Young LLP
Palo Alto, California
January 17, 2000
F-2
<PAGE>
ORATEC INTERVENTIONS, INC.
BALANCE SHEETS
(In thousands, except share and per share data)
<TABLE>
<CAPTION>
December 31, Pro Forma
------------------ at December 31,
1998 1999 1999
-------- -------- ---------------
(unaudited)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents............... $ 11,583 $ 5,943
Short term investments.................. 3,998 2,931
Accounts receivable, less allowance for
doubtful accounts of $216 in 1998 and
$528 in 1999........................... 2,905 6,306
Inventories............................. 1,421 3,248
Prepaid expenses and other current
assets................................. 513 1,004
-------- --------
Total current assets.................. 20,420 19,432
Property and equipment, net............... 3,775 4,409
-------- --------
$ 24,195 $ 23,841
======== ========
Liabilities and stockholders' equity
Current liabilities:
Bank borrowings......................... $ 1,178 $ 3,427
Accounts payable........................ 1,672 1,735
Accrued compensation and benefits....... 1,327 2,953
Other accrued liabilities............... 1,637 1,817
Current portion of notes payable........ -- 1,705
Current portion of equipment financing
obligations............................ 609 1,425
-------- --------
Total current liabilities............. 6,423 13,062
Long term notes payable................... -- 2,295
Long term equipment financing
obligations.............................. 2,702 2,053
Commitments
Redeemable convertible preferred stock,
$0.001 par value, issuable in series;
12,400,000 shares authorized in 1998 and
1999 (5,000,000 shares pro forma);
12,045,831 and 12,079,948 shares issued
and outstanding in 1998 and 1999, respec-
tively (none pro forma); aggregate re-
demption value of $36,380 at December 31,
1998 and $36,426 at December 31,
1999 (none pro forma).................... 35,816 35,816 $ --
Common stock, $0.001 par value; 19,900,000
shares authorized in 1998 and 1999
(75,000,000 shares pro forma); 4,026,341
and 4,411,201 shares issued and outstand-
ing in 1998 and 1999, respectively
(16,491,149 shares pro forma)............ 4 4 16
Additional paid-in capital................ 266 1,625 37,429
Deferred stock compensation............... -- (320) (320)
Receivable from stockholder............... -- (9) (9)
Accumulated deficit....................... (21,016) (30,685) (30,685)
-------- --------
$ 24,195 $ 23,841
======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
ORATEC INTERVENTIONS, INC.
STATEMENTS OF OPERATIONS
(In thousands, except per share data)
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------
1997 1998 1999
------- -------- -------
<S> <C> <C> <C>
Sales............................................. $ 2,600 $ 11,129 $31,365
Cost of sales..................................... 1,741 6,566 13,030
------- -------- -------
Gross profit...................................... 859 4,563 18,335
Operating expenses:
Research and development........................ 2,147 4,056 4,709
Sales and marketing............................. 2,622 8,318 17,541
General and administrative...................... 3,088 3,374 5,043
------- -------- -------
Total operating expenses.......................... 7,857 15,748 27,293
------- -------- -------
Loss from operations.............................. (6,998) (11,185) (8,958)
Interest and other income......................... 196 265 646
Interest and other expense........................ (30) (422) (1,357)
------- -------- -------
Net loss.......................................... $(6,832) $(11,342) $(9,669)
======= ======== =======
Net loss per common share, basic and diluted...... $ (1.75) $ (2.83) $ (2.30)
======= ======== =======
Shares used in computing net loss per common
share, basic and diluted......................... 3,912 4,006 4,201
Pro forma net loss per share, basic and diluted
(unaudited)...................................... $ (0.59)
=======
Shares used in computing net loss per share, basic
and diluted (unaudited).......................... 16,276
</TABLE>
See accompanying notes.
F-4
<PAGE>
ORATEC INTERVENTIONS, INC.
STATEMENT OF REDEEMABLE CONVERTIBLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY
(In thousands, except share data)
<TABLE>
<CAPTION>
Redeemable
Convertible
Preferred Stock Common Stock Additional Deferred
------------------ ---------------- Paid-In Stock Receivable from Accumulated
Shares Amount Shares Amount Capital Compensation Stockholder Deficit
---------- ------- --------- ------ ---------- ------------ --------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1996................... 3,616,911 $ 4,792 3,865,750 $ 4 $ 1 $ -- $ -- $ (2,842)
Issuance of Series C
redeemable convertible
preferred stock........ 1,442,542 4,328 -- -- -- -- -- --
Issuance of Series D
redeemable convertible
preferred stock (net of
issuance costs of
$96)................... 3,228,571 11,204 -- -- -- -- (124) --
Issuance of common stock
upon exercise of stock
options................ -- -- 85,304 -- 23 -- -- --
Net and comprehensive
loss................... -- -- -- -- -- -- -- (6,832)
---------- ------- --------- ---- ------ ----- ----- --------
Balances at December 31,
1997................... 8,288,024 20,324 3,951,054 4 24 -- (124) (9,674)
Warrants to purchase
122,353 shares of
Series E preferred
stock for loan
arrangement............ -- 146 -- -- -- -- -- --
Compensation expense for
non-employee options... -- -- -- -- 102 -- -- --
Issuance of common stock
upon exercise of
options, net........... -- -- 65,875 -- 100 -- -- --
Grant of common stock in
lieu of compensation... -- -- 9,412 -- 40 -- -- --
Cash payments on
receivable from
stockholders........... -- -- -- -- -- -- 124 --
Issuance of Series E
preferred stock (net of
issuance costs of
$625).................. 3,757,807 15,346 -- -- -- -- -- --
Net and comprehensive
loss................... -- -- -- -- -- -- -- (11,342)
---------- ------- --------- ---- ------ ----- ----- --------
Balances at December 31,
1998................... 12,045,831 35,816 4,026,341 4 266 -- -- (21,016)
Issuance of common stock
upon exercise of
options ............... -- -- 379,860 -- 375 -- (9) --
Exercise of warrants for
Series B redeemable
convertible preferred
stock ................. 34,117 -- -- -- -- -- -- --
Compensation expense for
non-employee options .. -- -- -- -- 584 -- -- --
Grant of common stock in
lieu of compensation .. -- -- 5,000 -- 40 -- -- --
Deferred stock
compensation related to
options granted to
employees and
consultants............ -- -- -- -- 360 (360) -- --
Amortization of deferred
stock compensation..... -- -- -- -- -- 40 -- --
Net and comprehensive
loss .................. -- -- -- -- -- -- -- (9,669)
---------- ------- --------- ---- ------ ----- ----- --------
Balances at December 31,
1999 .................. 12,079,948 $35,816 4,411,201 $ 4 $1,625 $(320) $ (9) $(30,685)
========== ======= ========= ==== ====== ===== ===== ========
</TABLE>
See accompanying notes.
F-5
<PAGE>
ORATEC INTERVENTIONS, INC.
STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(In thousands)
<TABLE>
<CAPTION>
Years ended December 31,
--------------------------
1997 1998 1999
------- -------- -------
<S> <C> <C> <C>
Operating activities
Net loss.......................................... $(6,832) $(11,342) $(9,669)
Adjustments to reconcile net loss to net cash used
in operating activities:
Depreciation and amortization................... 573 2,097 3,208
Compensation expense for options granted to non-
employees...................................... -- 102 584
Issuance of equity for non-cash benefits........ -- 186 40
Non-cash interest expense....................... -- 108 350
Changes in operating assets and liabilities:
Accounts receivable........................... (897) (2,008) (3,401)
Inventories................................... (419) (919) (1,827)
Prepaid expenses and other current assets..... (491) 80 (491)
Accounts payable.............................. 1,654 203 63
Accrued compensation and benefits............. 228 1,051 1,626
Other accrued liabilities..................... -- 1,205 180
------- -------- -------
Net cash used in operating activities............. (6,184) (9,237) (9,337)
------- -------- -------
Investing activities
Purchases of short term investments............... (3,500) (3,998) (7,154)
Sales of short term investments................... 411 3,650 8,221
Capital expenditures.............................. (2,183) (3,631) (3,802)
------- -------- -------
Net cash used in investing activities............. (5,272) (3,979) (2,735)
------- -------- -------
Financing activities
Proceeds from issuance of preferred stock......... 15,408 15,346 --
Proceeds from issuance of common stock............ 23 100 366
Receipts from stockholder receivables............. -- 124 --
Proceeds from bank borrowings..................... -- 1,178 2,249
Proceeds from notes payable....................... -- -- 4,000
Proceeds from equipment financing obligations..... 506 3,000 633
Repayment of equipment financing obligations...... (163) (484) (816)
------- -------- -------
Net cash provided by financing activities......... 15,774 19,264 6,432
------- -------- -------
Net increase (decrease) in cash and cash
equivalents...................................... 4,318 6,048 (5,640)
Cash and cash equivalents at beginning of period.. 1,217 5,535 11,583
------- -------- -------
Cash and cash equivalents at end of period........ $ 5,535 $ 11,583 $ 5,943
======= ======== =======
Supplemental schedule of noncash investing and
financing activities
Issuance of stock to stockholders for
receivables...................................... $ 124 $ -- $ 9
======= ======== =======
Deferred stock compensation....................... $ -- $ -- $ 360
======= ======== =======
Supplemental disclosure of cash flow information
Cash payments for interest........................ $ 30 $ 272 $ 1,008
======= ======== =======
</TABLE>
See accompanying notes.
F-6
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS
December 31, 1999
1. Organization and Summary of Significant Accounting Policies
The Company
ORATEC Interventions, Inc. was incorporated in the State of California on May
26, 1993 to develop medical devices which use controlled thermal energy to
treat spine and joint disorders. ORATEC's products use heat to modify, cut or
remove damaged or stretched soft tissue. In August 1999, ORATEC's stockholders
authorized the reincorporation of ORATEC in the state of Delaware. The
accompanying financial statements have been adjusted retroactively to reflect
the reincorporation.
Basis Of Presentation
Certain amounts in 1997 and 1998 have been restated to conform to the current
period presentation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from these estimates.
Unaudited Pro Forma Redeemable Convertible Preferred Stock and Stockholders'
Equity
If ORATEC's initial public offering as described in Note 14 is consummated,
all of the redeemable convertible preferred stock outstanding will
automatically be converted into common stock. The unaudited pro forma
redeemable convertible preferred stock and stockholders' equity at December 31,
1999 has been adjusted for the assumed conversion of redeemable convertible
preferred stock based on the shares of redeemable convertible preferred stock
outstanding at December 31, 1999.
Cash Equivalents and Short Term Investments
ORATEC considers all highly liquid investments purchased with original
maturities of three months or less at the date of purchase to be cash
equivalents.
In accordance with the Financial Accounting Standards Board's Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," ORATEC classifies its debt securities as
"available-for-sale" securities for use in its current operations. Such debt
securities are carried at amortized cost which approximates fair value. The
cost of the securities sold is based on specific identification.
Fair Value of Financial Instruments
The fair values of marketable securities, as described in Note 5, are based
on quoted market prices and are not necessarily indicative of the amounts that
ORATEC could realize in a current market exchange. The carrying value of those
securities approximates their fair value.
The fair value of notes payable, as described in Note 10, are estimated by
discounting the future cash flows using the current interest rates at which
similar loans would be made to borrowers with similar credit ratings and for
the same remaining maturities. The carrying values of these obligations
approximate their respective fair values.
F-7
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
The fair value of short term and long term equipment financing obligations
and bank borrowings, as described in Notes 8 and 9, are estimated based on
current interest rates available to ORATEC for debt instruments with similar
terms, degrees of risk and remaining maturities. The carrying values of these
obligations approximate their respective fair values.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided using the straight line method over the estimated
useful lives of the respective assets, generally two to seven years. The cost
of generators in service is depreciated into cost of sales over an estimated
useful lives ranging from two to three years.
Impairment of Long-Lived Assets
In accordance with the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of" ("SFAS 121"), ORATEC reviews long-lived
assets, including property and equipment, for impairment whenever events or
changes in business circumstances indicate that the carrying amount of the
assets may not be fully recoverable. Under SFAS 121, an impairment loss would
be recognized when estimated undiscounted future cash flows expected to result
from the use of the asset and its eventual disposition is less than its
carrying amount. Impairment, if any, is assessed using discounted cash flows.
Through December 31, 1999 there have been no such losses.
Revenue Recognition
ORATEC recognizes revenue upon shipment of products to customers or when
inventory provided to customers by ORATEC employees or sales agencies has been
used at their facility as evidenced by receipt of a purchase order. If title
to the products does not pass until receipt by the customer, revenue is
deferred until proof of receipt is obtained. ORATEC's return policy allows
customers to return new products up to 90 days after a sale. To date, returns
have been insignificant. Title has been retained to the majority of
arthroscopy generators, which have been placed with customers for their use
with ORATEC's disposable arthroscopy probes. ORATEC is selling its spine
generators following placement with customers for a demonstration period.
Revenue is recognized upon customer acceptance evidenced by the issuance of a
customer purchase order.
Advertising Costs
Advertising costs are expensed as incurred. Advertising costs were not
material in 1997, 1998, or 1999.
Product Liability and Patent Litigation Risks
The medical device market is litigious and ORATEC may become a party to
product liabilty or patent proceedings. The costs of such lawsuits may be
material and could effect our earnings and financial position.
Stock-Based Compensation
ORATEC accounts for grants of stock options and common stock purchase rights
in accordance with Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees and Related Interpretations." Information regarding
pro forma adjustments to net loss, as required by Financial Accounting
Standards Board Statement No. 123, "Accounting for Stock-Based Compensation"
("SFAS 123"), is included in Note 11.
F-8
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
Comprehensive Income (Loss)
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" ("SFAS 130") requires unrealized gains or losses on ORATEC's available-
for-sale investments to be included in other comprehensive income. For the
years ended December 31, 1997, 1998 and 1999, comprehensive loss approximated
net loss as other comprehensive income was not material.
Net Loss Per Share
Basic earnings per share is calculated based on the weighted-average number
of common shares outstanding during the period. Diluted earnings per share
gives effect to the dilutive effect of common stock equivalents consisting of
stock options and warrants (calculated using the treasury stock method).
The computation of pro forma net loss per share includes shares issuable upon
the conversion of outstanding shares of convertible preferred stock (using the
as-if converted method) from the original date of issuance.
A reconciliation of shares used in the calculations is as follows (in
thousands):
<TABLE>
<CAPTION>
Years ended
December 31,
------------------
1997 1998 1999
----- ----- ------
<S> <C> <C> <C>
Basic and diluted unaudited:
Weighted-average shares of common stock outstanding.... 3,912 4,006 4,201
===== ===== ======
Pro forma basic and diluted (unaudited):
Shares used above...................................... 4,201
Pro forma adjustment to reflect weighted-average effect
of assumed conversion of redeemable convertible
preferred stock....................................... 12,075
------
16,276
======
</TABLE>
The following outstanding options, warrants, and redeemable convertible
preferred stock (on an as converted basis) were excluded from the computation
of diluted net loss per share as they had an antidilutive effect (in
thousands):
<TABLE>
<CAPTION>
December 31,
-------------------
1997 1998 1999
----- ------ ------
<S> <C> <C> <C>
Options and warrants..................................... 2,369 2,985 3,582
Redeemable convertible preferred stock................... 8,288 12,046 12,080
</TABLE>
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Financial
Instruments and for Hedging Activities" ("SFAS 133") which provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities. SFAS 133 is effective for fiscal years
beginning after June 15, 1999 and is not anticipated to have an impact on
ORATEC's results of operations or financial condition when adopted as ORATEC
holds no derivative financial instruments and does not currently engage in
hedging activities.
F-9
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
2. Accounts Receivable
Accounts receivable is stated net of allowance for doubtful accounts. A
summary of movement in the allowance is as follows (in thousands):
<TABLE>
<CAPTION>
Years ended
December 31,
----------------
1997 1998 1999
----- ---- ----
<S> <C> <C> <C>
Balance at beginning of period............................. $ -- $106 $216
Additions charged to costs and expenses.................... 106 151 363
Write-off of uncollectible accounts........................ -- (41) (51)
----- ---- ----
Balance at end of period................................... $ 106 $216 $528
===== ==== ====
</TABLE>
3. Inventories
Inventories are stated at the lower of standard cost or market. Standard
costs approximate average actual costs. Inventories are summarized below (in
thousands):
<TABLE>
<CAPTION>
December 31,
-------------
1998 1999
------ ------
<S> <C> <C>
Raw materials................................................. $ 432 $1,087
Work-in-process............................................... 41 284
Finished goods................................................ 370 790
Electrothermal generators held for sale....................... 578 1,087
------ ------
$1,421 $3,248
====== ======
</TABLE>
4. Property and Equipment
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
----------------
1998 1999
------- -------
<S> <C> <C>
Electrothermal generators.................................. $ 4,692 $ 7,581
Computers, machinery and equipment......................... 1,148 1,993
Furniture and fixtures..................................... 459 451
Leasehold improvements..................................... 218 294
------- -------
6,517 10,319
Less accumulated depreciation and amortization............. (2,742) (5,910)
------- -------
Property and equipment, net................................ $ 3,775 $ 4,409
======= =======
</TABLE>
F-10
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
5. Cash Equivalents and Short Term Investments
Cash equivalents and short term investments include the following (in
thousands):
<TABLE>
<CAPTION>
Amortized Cost and
Fair Value at
December 31,
------------------
1998 1999
------------------
<S> <C> <C>
Certificates of deposit.................................. $ 1,000 $ --
Corporate commercial paper............................... 2,998 3,781
Asset-backed auction rate securities..................... 4,500 2,004
-------- ---------
$ 8,498 $ 5,785
======== =========
Reported as:
Cash equivalents....................................... $ 4,500 $ 2,854
Short term investments................................. 3,998 2,931
-------- ---------
$ 8,498 $ 5,785
======== =========
</TABLE>
At December 31, 1998 and 1999, the average maturity of the investments was
approximately two months.
There were no material gross realized gains or losses from sales of
securities in the periods presented. Unrealized gains and losses on investments
were not material at December 31, 1998 or 1999.
6. Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
-------------
1998 1999
------ ------
<S> <C> <C>
Professional fees............................................. $ 529 $ 581
Dealer commissions............................................ 138 299
Clinical and development costs................................ 452 189
Other......................................................... 518 748
------ ------
$1,637 $1,817
====== ======
</TABLE>
7. Operating Lease Commitments
ORATEC leases its facilities under various agreements expiring through March
2005. Rent expense was approximately $230,000, $320,000 and $525,000 for the
years ended December 31, 1997, 1998 and 1999. ORATEC has the option to extend
the term of the majority of its operating leases for three additional years. At
December 31, 1999, minimum future rental payments under operating leases are as
follows (in thousands):
<TABLE>
<S> <C>
Year ended December 31,
2000................................................................. $ 699
2001................................................................. 536
2002................................................................. 531
2003................................................................. 351
2004................................................................. 148
Thereafter........................................................... 37
------
$2,302
======
</TABLE>
F-11
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
8. Equipment Financing Obligations
In March 1996, a financial institution made available to ORATEC equipment
loans of up to $500,000 on which interest accrues at a rate of 8% per annum.
Final drawdown of all amounts available under this line was made in September
1997.
In October 1997, two financial institutions made available to ORATEC
equipment loans of up to an aggregate $1,000,000 on which interest is fixed at
the time of each drawdown. At December 31, 1999, approximately $924,000 had
been drawn down under three promissory notes with interest ranging between 7%
and 8%. Principal and interest under the notes must be repaid according to the
terms of each promissory note issued. In accordance with the loan agreements,
ORATEC granted the lenders perfected security interests in some specified
computer, manufacturing, laboratory and office equipment and furniture.
In August 1998, a financial institution made available to ORATEC an equipment
loan on which the interest is fixed at the time of each drawdown. The loan is
secured by a security interest in the equipment financed and a junior interest
in the other assets of ORATEC. At December 31, 1999, ORATEC had drawn down the
total loan of $2,562,415 with interest rates of 12% to 13%.
Future minimum payments under equipment financing obligations are as follows
at December 31, 1999 (in thousands):
<TABLE>
<S> <C>
Year ended December 31,
2000.............................................................. $ 1,758
2001.............................................................. 1,744
2002.............................................................. 223
-------
Total minimum payments.............................................. 3,725
Less amount representing interest................................... (247)
-------
Present value of minimum payments................................... 3,478
Less current portion................................................ (1,425)
-------
Long term portion................................................... $ 2,053
=======
</TABLE>
9. Bank Borrowings
In June 1998, ORATEC entered into a loan and security agreement for a
revolving line of credit of up to $2,500,000. In October 1999 the line of
credit was increased to $4,000,000. The line of credit bears interest at 1%
above the prime rate and has a first priority security interest over the assets
of ORATEC. The loan agreement requires the lender's consent before ORATEC can
incur additional debt. ORATEC is subject to covenants under the terms of the
agreement including a maximum debt to tangible net worth ratio of 3:1. During
the third quarter of 1998, ORATEC was not in compliance with these financial
covenants, including a profitability covenant and the maximum debt to tangible
net worth ratio. ORATEC received a waiver from the lender for its non-
compliance. At December 31, 1999, ORATEC was in compliance with all financial
covenants. At December 31, 1999, the balance outstanding under this agreement
was $3,427,449 and the unused line of credit was $572,551. The weighted-average
interest rate for 1999 was 9.0%.
10. Notes Payable
In December 1998, a financial institution made available to ORATEC a loan
facility of up to $4,000,000 which bears interest at 13.5% per annum, subject
to changes in the three year treasury rates. The loan is covered by a
subordinated security interest in the assets of ORATEC. In connection with the
set up of the loan arrangement, ORATEC agreed to issue to the financial
institution a warrant to purchase 122,353 shares of
F-12
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
ORATEC's Series E preferred stock at $4.25 per share. For accounting purposes,
the warrant was valued at $145,821 and was fully expensed in 1998. ORATEC drew
down the full $4,000,000 in January 1999.
At December 31, 1999, the total loan of $4,000,000 was outstanding in the
form of two notes payable of $2,000,000 each bearing interest at 13.1% per
annum. The notes are repayable over three years after an initial twelve months
of interest-only payments. The annual maturities of the notes at December 31,
1999 were as follows: $1,705,000, $2,107,000 and $188,000 for the years ended
December 31, 2000, 2001 and 2002, respectively.
11. Redeemable Convertible Preferred Stock and Common Stock
Redeemable Convertible Preferred Stock
A summary of redeemable convertible preferred stock ("preferred stock") is as
follows:
<TABLE>
<CAPTION>
December 31,
---------------------------------------------------------------------
1998 1999
---------------------------------- ----------------------------------
Redemption/ Redemption/
Issued and Liquidation Issued and Liquidation
Authorized Outstanding Value Authorized Outstanding Value
---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Series A................ 260,416 260,416 $ 250,000 260,416 260,416 $ 250,000
Series B................ 3,462,050 3,356,495 4,531,268 3,462,050 3,390,612 4,577,326
Series C................ 1,477,542 1,442,542 4,327,638 1,477,542 1,442,542 4,327,638
Series D................ 3,228,571 3,228,571 11,299,998 3,228,571 3,228,571 11,299,998
Series E................ 3,971,421 3,757,807 15,970,680 3,971,421 3,757,807 15,970,680
---------- ---------- ----------- ---------- ---------- -----------
12,400,000 12,045,831 $36,379,584 12,400,000 12,079,948 $36,425,642
========== ========== =========== ========== ========== ===========
</TABLE>
Each share of Series A, B, C, D, and E preferred stock is convertible, at the
option of the holder, into one share of common stock, subject to adjustments
for antidilution. Upon the approval of the holders of a majority of the
outstanding shares of the Series A, B, C, D, or E preferred stock, voting as a
single class, and a majority of the Series D and E preferred stock, together
voting as a single class, the Series A, B, C, D, or E preferred stock are
convertible to one share of common stock, subject to adjustments for
antidilution. Additionally, the preferred stock will automatically convert into
common stock concurrent with the closing of an underwritten public offering of
common stock under the Securities Act of 1933 in which ORATEC receives at least
$20,000,000 in gross proceeds and the price per share is at least $7.00
(subject to adjustment for a recapitalization, stock splits, or stock
dividends).
Series A, B, C, D, and E preferred stockholders are entitled to annual
noncumulative dividends at a rate of $0.08, $0.11, $0.24, $0.29, and $0.34 per
share, before and in preference to any dividends paid on common stock, when and
as declared by the board of directors. No dividends have been declared as of
December 31, 1999.
The Series A, B, C, D, and E preferred stockholders are entitled to receive,
upon liquidation or certain merger transactions, a distribution of $0.96,
$1.35, $3.00, $3.50, and $4.25 per share, (subject to adjustment for a
recapitalization) plus all declared but unpaid dividends. Thereafter, the
remaining assets and funds, if any, shall be distributed among the holders of
the Series D and E preferred stock and the common stock pro rata based on the
number of shares held by each until the Series D and E preferred stockholders
have received an aggregate of $10.50 per share. Thereafter, the remaining
assets and funds, if any, shall be distributed ratably on a per share basis
among the common stockholders.
If, upon liquidation, dissolution, or winding up of ORATEC, the assets and
funds distributed among the preferred stockholders are insufficient to permit
the payment to which they are entitled as set forth above, the
F-13
<PAGE>
ORATEC INTERVENTION, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
entire assets and funds of ORATEC legally available for distribution shall be
distributed ratably among the holders of Series A, B, C, D, and E preferred
stock in proportion to the aggregate preferential amounts owed to each such
holder.
The Series A, B, C, D, and E preferred stockholders have voting rights
substantially equal to the common shares they would own upon conversion, with
additional protective provisions requiring a separate class vote of the
preferred stock.
As long as at least 1,000,000 shares of Series D preferred stock remains
outstanding, the Series D preferred stockholders shall have the right to elect
one member of the board of directors of the corporation. As long as at least
1,000,000 shares of Series E preferred stock remains outstanding, the Series E
preferred stockholders shall have the right to elect one member of the board of
directors of the corporation. All other members of the board of directors shall
be elected by the Series A, B, C, D, and E and common stockholders, voting as a
single class on an as-converted basis.
In accordance with the amended and restated Investor Rights Agreement that
ORATEC entered into in December 1998, holders of at least 40% of the common
stock issued or issuable upon conversion of the Series A, B, C, D, and E
preferred stock may request ORATEC to file a registration statement covering
the registration of those securities outstanding, if the aggregate offering
price to the public exceeds $5,000,000 after the earlier of December 31, 2000
or six months after the effective date of the first registration statement for
a public offering of ORATEC's securities. The Investor Rights Agreement also
contains additional registration and information rights for the benefit of the
holders of the Series A, B, C, D, and E preferred stock.
Stock Option Plans
In July 1995, ORATEC adopted the 1995 Stock Plan (the "95 Plan") and, in
November 1999, ORATEC adopted the 1999 Stock Plan (the "99 Plan") in
conjunction with ORATEC's reincorporation in Delaware. These plans provide for
the issuance of common stock options and common stock purchase rights to
employees and consultants of ORATEC. The plans permit ORATEC to (i) grant
incentive stock options to employees at no less than 100% of fair value at date
of grant as determined by the board of directors; (ii) grant nonstatutory stock
options at no less than 85% of fair value; and (iii) sell common stock at no
less than 85% of fair value subject to stock purchase agreements. At December
31, 1999, ORATEC had issued 19,412 shares of common stock under 95 Plan stock
purchase rights. No stock purchase rights have been issued under the 99 Plan.
Incentive stock options become exercisable ratably generally over four years
from the date of grant. Nonstatutory stock options granted prior to May 1999
become exercisable ratably generally over two years from the date of grant.
Nonstatutory stock options beginning in May 1999 were granted as fully vested.
The term of the plans is 10 years. In August 1999, the ORATEC stockholders
approved an amendment to the 95 Plan to increase the number of shares reserved
for issuance by 1,250,000 shares. ORATEC's board of directors determined that
no grants will be made from the 95 Plan subsequent to October 1999 and the
1,165,062 shares available for grant under the 95 Plan at December 31, 1999
were retired. The number of shares initially reserved for issuance under the 99
Plan was 1,149,000. The number of shares reserved for issuance under the 99
Plan is subject to an automatic annual increase on January 1, 2000, 2001 and
2002 equal to the lesser of (i) 1,250,000 shares, (ii) 4% of the shares of
common stock outstanding on the last day of the immediately preceding fiscal
year or, (iii) such lesser number of shares as the board of directors
determines. At December 31, 1999, ORATEC had 943,700 options available for
future grant under the 99 Plan.
In August 1999, ORATEC stockholders approved the 1999 Directors' Option Plan
(the "Directors' Plan"), which provides for the grant of nonqualified stock
options to nonemployee directors of ORATEC. A total of 250,000 shares of common
stock have been reserved for issuance under the Directors' Plan. No options had
been granted under this plan as of December 31, 1999.
F-14
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
A summary of option activity under ORATEC's stock option plans is as follows:
<TABLE>
<CAPTION>
Years ended December 31,
---------------------------------------------------------------
1997 1998 1999
-------------------- --------------------- --------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------- --------- ---------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year....... 1,211,750 $0.35 2,228,420 $0.67 2,721,829 $1.46
Granted................. 1,224,600 $0.99 823,688 $3.46 1,281,000 $6.54
Canceled................ (121,304) $0.28 (190,654) $1.88 (248,932) $3.84
Exercised............... (86,626) $0.23 (139,625) $0.76 (379,860) $0.99
--------- ---------- ---------
Outstanding at
end of year............. 2,228,420 $0.67 2,721,829 $1.46 3,374,037 $3.26
========= ========== =========
Weighted-average
fair value of options
granted during the year.. $ 0.15 $ 0.58 $ 1.13
========= ========== =========
</TABLE>
<TABLE>
<CAPTION>
December 31, 1999
---------------------------------------------------
Options Outstanding Options Exercisable
------------------------------- -------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Number of Contractual Exercise Number of Exercise
Range of Exercise Prices Options Life Price Options Price
- ------------------------ --------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
$0.001 - $0.10 436,165 7.22 $ 0.08 423,195 $ 0.08
$0.75 - $2.50 1,353,911 8.84 $ 1.05 866,456 $ 0.99
$3.50 - $5.00 989,661 9.03 $ 4.33 203,830 $ 4.37
$7.50 - $9.60 594,300 9.71 $ 8.88 32,569 $ 8.16
--------- ---------
$0.001 - $9.60 3,374,037 8.84 $ 3.26 1,526,050 $ 1.34
========= =========
</TABLE>
Options exercisable at December 31, 1998 was 1,220,102.
On March 18 and May 14, 1999, ORATEC granted options to purchase 371,000
shares of common stock at $4.25 per share. On May 24, 1999, ORATEC granted
options to purchase 26,500 shares of common stock at $7.50 per share. On July 1
and July 22, 1999, ORATEC granted options to purchase 207,000 shares of common
stock at $7.50 to $8.00 per share. Deferred compensation of $360,000 has been
recorded in 1999 for these option grants based on the deemed fair value of the
common stock. The deferred compensation will be amortized to expense over the
four year average vesting period of the options.
Pro forma information regarding net loss is required by SFAS 123, and has
been determined as if ORATEC had accounted for its employee stock options
issued under the fair value method of that Statement. The fair value of these
options was estimated at the date of grant using the minimum value method and
assumptions for 1997, 1998 and 1999 as follows: risk-free interest rates of 6%,
4.5% and 4.5%; weighted-average expected life of the options was approximately
48 months and no dividends. The effect of applying SFAS 123 to ORATEC's stock
option awards would have resulted in a net loss of $11,487,121 ($2.87 per
common share) and $10,036,084 ($2.39 per common share) for the years ended
December 31, 1998 and 1999, respectively. The pro forma effect for the year
ended December 31, 1997 was not materially different from the actual net losses
reported. The pro forma net loss is not necessarily indicative of potential pro
forma effects on results for future years.
F-15
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
ORATEC has granted 87,303 and 82,750 options to nonemployees in 1998 and
1999, respectively, which resulted in compensation expense of $102,000 and
$584,000 in 1998 and 1999, respectively. The options vest primarily over a two-
year period and, therefore, ORATEC will record additional expense related to
these options in 2000 and 2001.
Stock Purchase Plan
In August 1999, the ORATEC stockholders approved the adoption of the 1999
Employee Stock Purchase Plan (the "1999 Purchase Plan"). A total of 425,000
shares of common stock have been reserved for issuance under the 1999 Purchase
Plan. The number of shares reserved for issuance is subject to an automatic
annual increase on January 1, 2001, 2002 and 2003 equal to the lesser of (i)
425,000 shares, (ii) 2% of the outstanding common stock on the last day of the
immediately preceding fiscal year, or (iii) such lesser number of shares as the
board of directors determines. The 1999 Purchase Plan permits eligible
employees to acquire shares of ORATEC's common stock through periodic payroll
deductions of up to 15% of total compensation. An employee may purchase no more
than 2,000 shares during any given offering period. Each offering period will
have a maximum duration of approximately six months. The price at which the
common stock may be purchased is 85% of the lesser of the fair market value of
ORATEC's common stock at the beginning or the end of each offering period . The
initial offering period will commence on the effectiveness of ORATEC's initial
public offering.
Warrants
In February 1996, ORATEC issued to an employee a warrant to purchase 50,000
shares of Series B preferred stock at a purchase price of $1.35 per share. In
the year ended December 31, 1999, these warrants were exercised or cancelled.
In March 1996, ORATEC issued a warrant to purchase 55,555 shares of Series B
preferred stock at a purchase price of $1.35 per share in conjunction with
obtaining equipment financing from a lender. The warrant expires in five years
from the issuance date.
In October 1997, ORATEC issued warrants to purchase 35,000 shares of Series C
preferred stock at $3.00 per share in conjunction with obtaining an equipment
financing facility. The warrants expire at the later of ten years from the
issuance date or five years after the closing of ORATEC's initial public
offering.
In December 1998, ORATEC entered into negotiations with a lender to obtain
debt financing (see Note 10). As an inducement to conduct negotiations, ORATEC
agreed to issue a warrant to purchase 122,353 shares of Series E preferred
stock at a purchase price of $4.25 per share. The warrant expires on the
earlier of (i) January 2004 or (ii) the earlier of the second anniversary of
either ORATEC's initial public offering or an acquisition of ORATEC by a
publicly traded company.
As of December 31, 1999, warrants to purchase a total of 55,555 shares of
Series B preferred stock, 35,000 shares of Series C preferred stock and 122,353
shares of Series E preferred stock were outstanding.
Reserved Stock
As of December 31, 1999, ORATEC has reserved shares of common stock for
future issuance as follows:
<TABLE>
<S> <C>
Stock plans....................................................... 4,992,737
Redeemable convertible preferred stock and warrants............... 12,292,856
----------
17,285,593
==========
</TABLE>
F-16
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
In addition, ORATEC has reserved the following shares of preferred stock for
issuance upon exercise of stock warrants:
<TABLE>
<S> <C>
Series B preferred stock............................................. 55,555
Series C preferred stock............................................. 35,000
Series E preferred stock............................................. 122,353
</TABLE>
12. Income Taxes
As of December 31, 1999, ORATEC had federal and state net operating loss
carryforwards of approximately $24,100,000 and $4,500,000. ORATEC also had
federal research and development tax credit carryforwards of approximately
$400,000. The net operating loss and credit 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 provided
by the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses before utilization.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
and the amounts used for income tax purposes. Significant components of
ORATEC's deferred tax assets and liabilities for federal and state income taxes
are as follows:
<TABLE>
<CAPTION>
December 31,
-------------------------
1998 1999
----------- ------------
<S> <C> <C>
Net operating loss carryforwards.................. $ 7,200,000 $ 8,500,000
Research credit carryforwards..................... 400,000 600,000
Capitalized research & development................ 300,000 500,000
Inventory reserves ............................... -- 1,100,000
Accrued liabilities .............................. -- 1,700,000
Other-net......................................... 100,000 (500,000)
----------- ------------
Net deferred tax assets........................... 8,000,000 11,900,000
Valuation allowance............................... (8,000,000) (11,900,000)
----------- ------------
TOTAL $ -- $ --
=========== ============
</TABLE>
Because of ORATEC's lack of earnings history, the deferred tax assets have
been fully offset by a valuation allowance. The valuation allowance increased
by $2,500,000, $4,300,000 and $3,900,000 during the years ended December 31,
1997, 1998 and 1999.
13. Segment Reporting
In 1998, ORATEC adopted Statement of Financial Accounting Standards No. 131,
"Disclosure about Segments of an Enterprise and Related Information" ("SFAS
131"). SFAS 131 establishes standards for the reporting of selected financial
information about a company's operating segments and disclosures about a
company's products, geographical areas and major customers.
Since inception, ORATEC has been primarily engaged in one reportable
operating segment, providing medical devices which use controlled thermal
energy to treat spine and joint disorders. At the present time, ORATEC is
organized and managed along functional lines. ORATEC's President and Chief
Executive Officer evaluates performance and allocates resources based on the
operating results of the whole company. Revenues
F-17
<PAGE>
ORATEC INTERVENTIONS, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
December 31, 1999
are tracked per product line (spine and arthroscopy) but operating expenses are
not allocated to individual product lines so that no measure of profit or loss
for any individual product line is available. ORATEC attributes revenues from
customers to individual countries based on the location of the customer.
Substantially all of ORATEC's revenues to date have been derived from sales to
customers in the U.S. Further, all of ORATEC's assets have been located in the
U.S. for all periods presented. ORATEC's current products consist of two
minimally invasive systems for the treatment of spine and joint disorders.
ORATEC's spine and arthroscopy product sales are as follows (in thousands):
<TABLE>
<CAPTION>
Years ended
December 31,
----------------------
1997 1998 1999
------ ------- -------
<S> <C> <C> <C>
Spine................................................. $ -- $ 1,246 $16,163
Arthroscopy........................................... 2,600 9,883 15,202
------ ------- -------
$2,600 $11,129 $31,365
====== ======= =======
</TABLE>
14. Initial Public Offering
In January 2000, ORATEC's board of directors authorized management to file a
registration statement with the Securities and Exchange Commission to permit
ORATEC to sell 4 million shares of its common stock to the public at an assumed
offering price of $13-$15 per share. Upon completion of ORATEC's initial public
offering as described in the registration statement, all outstanding redeemable
convertible preferred stock will be converted into 12,079,948 shares of common
stock.
F-18
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
4,000,000 Shares
[LOGO OF ORATEC(R)]
Common Stock
------------
PROSPECTUS
------------
Merrill Lynch & Co.
J.P. Morgan & Co.
U.S. Bancorp Piper Jaffray
, 2000
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 13. Other Expenses of Issuance and Distribution
The following table sets forth the costs and expenses, other than the
underwriting discount and commissions, payable by ORATEC in connection with
the sale of common stock being registered. All amounts are estimates except
the Securities and Exchange Commission registration fee, the NASD filing fee
and the Nasdaq National Market listing fee.
<TABLE>
<CAPTION>
Amount to
be Paid
---------
<S> <C>
Securities and Exchange Commission registration fee............. $ 15,787
NASD filing fee................................................. 6,480
Nasdaq National Market listing fee.............................. 95,000
Printing and engraving expenses................................. 200,000
Legal fees and expenses......................................... 250,000
Accounting fees and expenses.................................... 200,000
Blue Sky qualification fees and expenses........................ 5,000
Transfer Agent and Registrar fees............................... 15,000
Miscellaneous fees and expenses................................. 12,733
--------
Total......................................................... $800,000(1)
========
</TABLE>
- --------
(1) Excludes approximately $1 million in initial public offering expenses,
which were written off in 1999 as a result of the postponement of the
offering.
Item 14. Indemnification of Directors and Officers
Section 145 of the Delaware General Corporation Law authorizes a court to
award, or a corporation's board of directors to grant, indemnity to directors
and officers in terms sufficiently broad to permit such indemnification under
the circumstances described in Section 145 of the Delaware General Corporation
Law, for liabilities, including reimbursement for expenses incurred, arising
under the Securities Act of 1933, as amended. Article XII of ORATEC's
certificate of incorporation (Exhibit 3.2) and Article VI of ORATEC's bylaws
(Exhibit 3.4) provide for indemnification of ORATEC's directors, officers,
employees and other agents to the maximum extent permitted by Delaware Law. In
addition, ORATEC has entered into indemnification agreements (Exhibit 10.16)
with its officers and directors. The underwriting agreement (Exhibit 1.1) also
provides for cross-indemnification among ORATEC and the underwriters with
respect to the matters described in the underwriting agreement including
matters arising under the Securities Act.
Item 15. Recent Sales of Unregistered Securities
Since December 31, 1996, ORATEC has sold and issued the following
securities:
(1) In March through December 1997, we issued and sold shares of Series C
preferred stock convertible into an aggregate of 1,442,542 shares of common
stock to a total of 120 investors for an aggregate purchase price of
$4,327,626.
(2) In October 1997, we issued warrants to purchase shares of Series C
preferred stock convertible into an aggregate of 35,000 shares of common
stock to two lenders.
(3) In November and December 1997, we issued and sold shares of Series D
preferred stock convertible into an aggregate of 3,228,571 shares of common
stock to a total of 60 investors for an aggregate purchase price of
$11,299,999.
(4) In December 1998, we issued and sold shares of Series E preferred
stock convertible into an aggregate of 3,757,807 shares of common stock to
a total of 59 investors for an aggregate purchase price of $15,970,680.
II-1
<PAGE>
(5) In January 1999, we issued a warrant to purchase Series E preferred
stock convertible into an aggregate of 122,353 shares of common stock to
one lender.
(6) In February 1999, we issued and sold 34,117 shares of Series B
preferred stock to an executive officer upon his exercise of a warrant.
(7) From December 31, 1996 through December 31, 1999, under our 1995
stock plan, 606,039 shares of common stock had been issued upon exercise of
options, 14,412 shares of common stock had been issued pursuant to
restricted stock purchase agreements and, as of December 31, 1999,
3,168,737 shares of common stock were issuable upon exercise of outstanding
options.
(8) From December 31, 1996 through December 31, 1999, under our 1999
stock plan, no shares of common stock had been issued upon exercise of
options or pursuant to restricted stock purchase agreements and, as of
December 31, 1999, 205,300 shares of common stock were issuable upon
exercise of outstanding options.
The issuances of the above securities were deemed to be exempt from
registration under the Securities Act in reliance on Section 4(2) of the
Securities Act as transactions by an issuer not involving any public offering.
In addition, the issuances described in Item 7 and Item 8 were deemed exempt
from registration under the Securities Act in reliance upon Rule 701
promulgated under the Securities Act. The recipients of securities in each
transaction represented their intentions to acquire the securities for
investment only and not with a view to or for sale in connection with any
distribution and appropriate legends were affixed to the share certificates
and warrants issued in the transactions. All recipients had adequate access,
through their relationships with us, to information about us.
Item 16. Exhibits and Financial Statement Schedules
(a) Exhibits
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
1.1+ Form of Underwriting Agreement (subject to negotiation).
3.1+ Certificate of Incorporation.
3.2+ Amended and Restated Certificate of Incorporation, post-IPO.
3.3+ Bylaws, as amended.
3.4+ Amended and Restated Bylaws, post-IPO.
4.1+ Specimen Stock Certificate.
5.1 Opinion of Venture Law Group regarding the legality of the common
stock being registered.
10.1+ Amended and Restated Investors' Rights Agreement dated December 7,
1998 among ORATEC and certain investors.
10.2+ Employment Letter Agreement dated October 29, 1997 between ORATEC
and Nancy V. Westcott.
10.3+ Employment Agreement dated July 14, 1997 between ORATEC and Kenneth
W. Anstey.
10.4+ Employment Agreement dated August 21, 1996 and First Amendment to
Employment Agreement dated July 14, 1997 between ORATEC and Hugh
Sharkey.
10.5+ Change of Control Letter Agreement dated 1996 between ORATEC and
Roger Lipton.
10.6+ Offer letter dated November 29, 1999 between ORATEC and Theresa
Mitchell.
10.7+ 1995 Stock Plan, as amended, and form of option agreement.
10.8+ 1995 Stock Plan, as amended (post-IPO).
10.9+ 1999 Stock Plan and form of option agreement.
10.10+ 1999 Stock Plan and form of option agreement (post-IPO).
10.11+ 1999 Directors' Stock Option Plan and form of option agreement.
10.12+ 1999 Employee Stock Purchase Plan and form of subscription
agreement.
10.13+ Lease dated May 7, 1998 between ORATEC and White Properties Joint
Venture (as amended).
10.14+ Lease dated August 2, 1996 between ORATEC and Huettig &
Schromm/Heaton & Keyser.
10.15+ Lease dated August 25, 1999 between ORATEC and White Properties
Joint Venture.
</TABLE>
II-2
<PAGE>
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
10.16+ Form of Indemnification Agreement between ORATEC and directors
and officers.
10.17**+ International Distribution Agreement dated March 30, 1999 between
ORATEC and DePuy Acromed, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Venture Law Group, A Professional Corporation (See
Exhibit 5.1).
23.3+ Consent of Wilson Sonsini Goodrich & Rosati, a Professional
Corporation.
23.4+ Power of Attorney (See page II-4).
27.1+ Financial Data Schedule.
</TABLE>
- --------
+ Previously filed.
** Confidential treatment has been requested with respect to portions of this
exhibit. Portions of this exhibit have been omitted.
(b) Financial Statement Schedules
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or is shown in the
financial statements or notes thereto.
Item 17. Undertakings
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement certificates in the
denominations and registered in the names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act, and is,
therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the
registrant in the successful defense of any action, suit or proceeding) is
asserted by such director, officer or controlling person in connection with
the securities being registered, the registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by
the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new registration statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this amendment to its registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized, in the city of Menlo
Park, State of California, on April 4, 2000
ORATEC INTERVENTIONS, INC.
*
By: _________________________________
Kenneth W. Anstey
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this amendment
to its Registration Statement has been signed by the following persons in the
capacities and on the dates indicated:
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
* President, Chief Executive April 4, 2000
______________________________________ Officer and Director
Kenneth W. Anstey (Principal Executive
Officer)
/s/ Nancy V. Westcott Chief Financial Officer April 4, 2000
______________________________________ (Principal Financial and
Nancy V. Westcott Accounting Officer)
* Director April 4, 2000
______________________________________
Stephen Brackett
* Director April 4, 2000
______________________________________
Gary S. Fanton, M.D.
* Director April 4, 2000
______________________________________
Richard M. Ferrari
* Director April 4, 2000
______________________________________
Patrick F. Latterell
* Director April 4, 2000
______________________________________
Jeffrey A. Saal, M.D.
* Director April 4, 2000
______________________________________
Hugh R. Sharkey
</TABLE>
/s/ Nancy V. Westcott
*By:_____________________________
(Attorney-in-fact)
II-4
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Number Description
------ -----------
<C> <S>
1.1+ Form of Underwriting Agreement (subject to negotiation).
3.1+ Certificate of Incorporation.
3.2+ Amended and Restated Certificate of Incorporation, post-IPO.
3.3+ Bylaws, as amended.
3.4+ Amended and Restated Bylaws, post-IPO.
4.1+ Specimen Stock Certificate.
5.1 Opinion of Venture Law Group regarding the legality of the common
stock being registered.
10.1+ Amended and Restated Investors' Rights Agreement dated December 7,
1998 among ORATEC and certain investors.
10.2+ Employment Letter Agreement dated October 29, 1997 between ORATEC and
Nancy V. Westcott.
10.3+ Employment Agreement dated July 14, 1997 between ORATEC and Kenneth
W. Anstey.
10.4+ Employment Agreement dated August 21, 1996 and First Amendment to
Employment Agreement dated July 14, 1997 between ORATEC and Hugh
Sharkey.
10.5+ Change of Control Letter Agreement dated 1996 between ORATEC and
Roger Lipton.
10.6+ Offer letter dated November 29, 1999 between ORATEC and Theresa
Mitchell.
10.7+ 1995 Stock Plan, as amended, and form of option agreement.
10.8+ 1995 Stock Plan, as amended (post-IPO)
10.9+ 1999 Stock Plan and form of option agreement.
10.10+ 1999 Stock Plan and form of option agreement (post-IPO)
10.11+ 1999 Directors' Stock Option Plan and form of option agreement.
10.12+ 1999 Employee Stock Purchase Plan and form of subscription agreement.
10.13+ Lease dated May 7, 1998 between ORATEC and White Properties Joint
Venture (as amended).
10.14+ Lease dated August 2, 1996 between ORATEC and Huettig &
Schromm/Heaton & Keyser.
10.15+ Lease dated August 25, 1999 between ORATEC and White Properties Joint
Venture.
10.16+ Form of Indemnification Agreement between ORATEC and officers and
directors.
10.17**+ International Distribution Agreement dated March 30, 1999 between
ORATEC and DePuy Acromed, Inc.
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Venture Law Group, A Professional Corporation (See Exhibit
5.1).
23.3+ Consent of Wilson Sonsini Goodrich & Rosati, a Professional
Corporation.
23.4+ Power of Attorney (See page II-4).
27.1+ Financial Data Schedule.
</TABLE>
- --------
+ Previously filed.
** Confidential treatment has been requested with respect to portions of this
exhibit. Portions of this exhibit have been omitted.
<PAGE>
EXHIBIT 5.1
April 4, 2000
ORATEC Interventions, Inc.
3700 Haven Court
Menlo Park, CA 94025
Registration Statement on Form S-1 (File No. 333-95815)
Ladies and Gentlemen:
We have examined the Registration Statement on Form S-1 (File No. 333-95815)
(the "Registration Statement") filed by you, ORATEC Interventions, Inc., with
the Securities and Exchange Commission on January 31, 2000, and as amended by
Amendment No. 1 filed on March 2, 2000, Amendment No. 2 filed on March 10,
2000, Amendment No. 3 filed on March 28, 2000 Amendment No. 4 filed on April 3,
2000, in connection with the registration under the Securities Act of 1933 and
Amendment No. 5 filed on April 4, 2000, as amended, of shares of your Common
Stock (the "Shares"). As your counsel in connection with this transaction, we
have examined the proceedings taken and we are familiar with the proceedings
proposed to be taken by you in connection with the sale and issuance of the
Shares.
It is our opinion that, assuming effectiveness of the Registration Statement,
the Shares when issued and sold in the manner described in the Registration
Statement will be legally and validly issued, fully paid and nonassessable.
We are admitted to practice law only in the State of California, and,
accordingly, we express no opinion as to any matter relating to the laws of any
jurisdiction other than the laws of California, the General Corporation Law of
the State of Delaware, and the federal securities laws of the United States. We
consent to the use of this opinion as an exhibit to the Registration Statement
and further consent to the use of our name wherever appearing in the
Registration Statement, including the Prospectus constituting a part thereof,
and in any amendment thereto.
Very truly yours,
Venture Law Group
A Professional Corporation
/s/ Venture Law Group
<PAGE>
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated January 17, 2000, in Amendment No. 5 to the
Registration Statement (Form S-1 No. 333-95815) and related Prospectus of
ORATEC Interventions, Inc. for the registration of 4,600,000 shares of its
common stock.
/s/ Ernst & Young LLP
Palo Alto, California
April 3, 2000
