<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number 000-26745
================================================================================
ORATEC INTERVENTIONS, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
Delaware 94-3180773
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
</TABLE>
3700 Haven Court
Menlo Park, California 94025
(Address of principal executive offices, including zip code)
650-369-9904
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
As of October 31, 2000, there were 22,222,895 shares of the registrant's
Common Stock outstanding.
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INDEX
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<CAPTION>
Page
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited).
Condensed Balance Sheets - September 30, 2000 and 3
December 31, 1999
Condensed Statements of Operations - Three months and nine months 4
ended September 30, 2000 and 1999
Condensed Statements of Cash Flows - Nine months 5
ended September 30, 2000 and 1999
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition and 8
Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 16
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. 16
Item 2. Changes in Securities and Use of Proceeds. 16
Item 3. Defaults Upon Senior Securities. 16
Item 4. Submission of Matters to a Vote of Security Holders. 16
Item 5. Other Information. 16
Item 6. Exhibits and Reports on Form 8-K. 16
SIGNATURES 17
</TABLE>
2
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
ORATEC INTERVENTIONS, INC.
CONDENSED BALANCE SHEETS
(In thousands, except per share data)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------- --------
(unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents........................................................... $ 51,260 $ 5,943
Short term investments.............................................................. -- 2,931
Accounts receivable, net............................................................ 7,674 6,306
Inventories......................................................................... 6,151 3,248
Prepaid expenses and other current assets........................................... 2,233 1,004
---------- ---------
Total current assets............................................................... 67,318 19,432
Property and equipment, net........................................................... 8,901 4,409
---------- ---------
$ 76,219 $ 23,841
========== =========
Liabilities and stockholders' equity
Current liabilities:
Bank borrowings..................................................................... $ -- $ 3,427
Accounts payable.................................................................... 1,586 1,735
Accrued compensation and benefits................................................... 3,570 2,953
Other accrued liabilities........................................................... 1,859 1,817
Current portion of notes payable.................................................... -- 1,705
Current portion of equipment financing obligations.................................. 35 1,425
---------- ---------
Total current liabilities............................................................. 7,050 13,062
Long term notes payable............................................................... -- 2,295
Long term equipment financing obligations............................................. 5 2,053
Redeemable convertible preferred stock, $0.001 par value.............................. -- 35,816
Common stock, $0.001 par value........................................................ 22 4
Additional paid-in capital............................................................ 98,946 1,625
Deferred stock compensation........................................................... (252) (320)
Receivable from stockholder........................................................... -- (9)
Accumulated deficit................................................................... (29,552) (30,685)
---------- ---------
$ 76,219 $ 23,841
========== =========
</TABLE>
See accompanying notes.
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ORATEC INTERVENTIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share data, unaudited)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------------------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Sales...................................................................... $ 11,528 $ 8,839 $ 37,754 $ 21,738
Cost of sales.............................................................. 3,954 3,328 11,382 9,589
-------- ------- -------- --------
Gross profit............................................................... 7,574 5,511 26,372 12,149
Operating expenses:
Research and development................................................. 1,489 1,099 4,293 3,121
Sales and marketing...................................................... 4,979 4,675 17,210 12,169
General and administrative............................................... 1,294 2,241 3,568 4,061
Stock compensation (1)................................................... 182 238 1,102 485
-------- ------- -------- --------
Total operating expenses................................................... 7,944 8,253 26,173 19,836
-------- ------- -------- --------
Income (loss) from operations.............................................. (370) (2,742) 199 (7,687)
Interest and other income.................................................. 804 164 1,744 505
Interest and other expense................................................. (125) (282) (750) (962)
-------- ------- -------- --------
Income (loss) before income taxes.......................................... 309 (2,860) 1,193 (8,144)
Provision for income taxes................................................. 15 -- 60 --
-------- ------- -------- --------
Net income (loss).......................................................... $ 294 $(2,860) $ 1,133 $ (8,144)
======== ======= ======== ========
Basic net income (loss) per share.......................................... $ 0.01 $ (0.67) $ 0.07 $ (1.97)
======== ======= ======== ========
Diluted net income (loss) per share........................................ $ 0.01 $ (0.67) $ 0.05 $ (1.97)
======== ======= ======== ========
Pro forma diluted net income (loss) per share.............................. $ 0.01 $ (0.18) $ 0.05 $ (0.50)
======== ======= ======== ========
Shares used in computing basic net income (loss) per share................. 22,140 4,248 15,944 4,141
Shares used in computing diluted net income (loss) per share............... 24,776 4,248 22,737 4,141
Shares used in computing pro forma diluted net income (loss) per share..... 24,776 16,328 22,737 16,214
</TABLE>
(1) Stock compensation expense relates to research and development expenses.
See accompanying notes.
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ORATEC INTERVENTIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
Increase (decrease) in cash and cash equivalents
(In thousands, unaudited)
<TABLE>
<CAPTION>
Nine months ended
September 30,
2000 1999
------- -------
<S> <C> <C>
Operating activities
Net income (loss)........................................................................ $ 1,133 $(8,144)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization........................................................... 2,608 2,548
Stock compensation expense.............................................................. 1,102 449
Issuance of equity for non-cash benefits................................................ 120 36
Changes in operating assets and liabilities:
Accounts receivable.................................................................... (1,368) (2,835)
Inventories............................................................................ (2,903) (1,478)
Prepaid expenses and other current assets.............................................. (1,229) (651)
Accounts payable....................................................................... (149) 58
Accrued compensation and benefits...................................................... 617 1,007
Other accrued liabilities.............................................................. 42 457
------- -------
Net cash used in operating activities.................................................... (27) (8,553)
------- -------
Investing activities:
Purchases of short term investments...................................................... -- (6,173)
Maturities of short term investments..................................................... 2,931 6,996
Capital expenditures..................................................................... (7,100) (1,665)
------- -------
Net cash used in investing activities.................................................... (4,169) (842)
------- -------
Financing activities:
Proceeds from issuance of common stock................................................... 60,369 341
Proceeds from repayment of shareholder receivable........................................ 9 --
Proceeds from notes payable.............................................................. -- 4,000
Repayment of bank borrowings............................................................. (3,427) --
Repayment of notes payable............................................................... (4,000) --
Proceeds from equipment financing obligations............................................ -- 633
Repayment of equipment financing obligations............................................. (3,438) (457)
------- -------
Net cash provided by financing activities................................................ 49,513 4,517
------- -------
Net increase (decrease) in cash and cash equivalents..................................... 45,317 (4,878)
Cash and cash equivalents at beginning of period......................................... 5,943 11,583
------- -------
Cash and cash equivalents at end of period............................................... $51,260 $ 6,705
======= =======
</TABLE>
See accompanying notes.
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ORATEC INTERVENTIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation:
In the opinion of management, the accompanying unaudited condensed financial
statements contain all adjustments (all of which are normal and recurring in
nature) necessary to present fairly the financial position, results of
operations and cash flows of ORATEC Interventions, Inc. for the periods
indicated. Interim results of operations are not necessarily indicative of the
results to be expected for the full year or any other interim periods. These
condensed financial statements should be read in conjunction with financial
statements for the year ended December 31, 1999 contained in our Registration
Statement on Form S-1 (No. 333-95815). The balance sheet at December 31, 1999
was derived from audited financial statements; however, the financial statements
in this report are condensed and do not include all disclosures required by
generally accepted accounting principles.
2. Computation of Net Income (Loss) Per Share:
Basic net income (loss) per share is computed using the weighted-average number
of shares of stock outstanding. Diluted net income (loss) per common share is
computed using the weighted average number of common shares, redeemable
convertible preferred shares (on an as-if-converted basis) and common equivalent
shares outstanding during the period. Common equivalent shares are computed
using the treasury stock method and consist of shares outstanding related to
stock options and warrants. Common stock equivalents and redeemable convertible
preferred stock are excluded from the computation of diluted earnings per share
if their effect is anti-dilutive. Redeemable convertible preferred shares have
been treated as converted from the date of issuance in the pro forma
calculations of net income (loss) per share.
The following is a reconciliation of the computation for basic, diluted and pro
forma diluted net income (loss) per share (in thousands, except per share data):
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------- ------------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income (loss)................................................. $ 294 $(2,860) $ 1,133 $(8,144)
======= ======= ======= =======
Shares used in the calculation:
Weighted-average common shares outstanding
used to compute basic net income (loss) per share............... 22,140 4,248 15,944 4,141
Weighted-average effect of dilutive securities:
Options......................................................... 2,444 -- 2,444 --
Warrants........................................................ 192 -- 192 --
------- ------- ------- -------
Weighted-average shares used to compute
diluted net income (loss) per share............................. 24,776 4,248 18,580 4,141
Pro forma adjustment to reflect weighted-
average effect of assumed conversion of
redeemable convertible preferred shares........................... -- 12,080 4,157 12,073
------- ------- ------- -------
Weighted-average shares used to compute pro forma
diluted net income (loss) per share............................... 24,776 16,328 22,737 16,214
======= ======= ======= =======
Net income (loss) per share:
Basic............................................................. $ 0.01 $ (0.67) $ 0.07 $ (1.97)
======= ======= ======= =======
Diluted........................................................... $ 0.01 $ (0.67) $ 0.05 $ (1.97)
======= ======= ======= =======
Pro forma diluted................................................. $ 0.01 $ (0.18) $ 0.05 $ (0.50)
======= ======= ======= =======
</TABLE>
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The Company issued 4,600,000 shares of common stock at the close of its initial
public offering on April 10th, 2000. At that time, all outstanding convertible
preferred stock converted to common stock.
3. Comprehensive Income (Loss):
Comprehensive income (loss) is comprised of net income (loss) and other
comprehensive income (loss) such as foreign currency translation gain/loss and
unrealized gains or losses on available-for-sale marketable securities. For the
three and nine month periods ended September 30, 2000 and September 30, 1999,
reported net income (loss) approximated comprehensive net income (loss).
4. Balance Sheet Detail (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
-------------------------------------
2000 1999
------ ------
<S> <C> <C>
Inventory:
Raw materials........................................ $2,407 $1,087
Work-in-process...................................... 301 284
Finished goods....................................... 2,730 790
Generators held for sale............................. 714 1,087
------ ------
Total................................................. $6,151 $3,248
====== ======
Other accrued liabilities:
Accrued professional fees............................ $ 604 $ 581
Dealer commissions................................... 303 299
Clinical and development costs....................... 300 189
Other................................................ 652 748
------ ------
Total................................................. $1,859 $1,817
====== ======
</TABLE>
5. Recent Accounting Pronouncements:
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in
Financial Statements." SAB 101 summarizes certain of the SEC's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. In June 2000, the SEC issued SAB No. 101B, which
defers the effective date of SAB 101 until no later than the fourth quarter
of 2000. ORATEC believes that the adoption of SAB 101 will not have a
material impact on its operations, historical financial statements or
financial position.
In June 1998, the Financial Accounting Standards Board ("FASB") 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. In June 1999, FASB
issued Financial Accounting Standards No. 137, which deferred the effective
date of SFAS 133 to fiscal years beginning after June 15, 2000. The adoption
of SFAS 133 is not anticipated to have a material impact on ORATEC's
operations, historical financial statements or financial position.
In March 2000, the FASB issued No. 44 ("FIN 44"), "Accounting for Certain
Transactions Involving Stock Compensation - an Interpretation of APB 25."
This Interpretation clarifies (a) the definition of employee for purposes of
applying Opinion 25, (b) the criteria for determining whether a plan
qualifies as a noncompensatory plan, (c) the accounting consequence of
various modifications to the terms of a previously fixed stock option or
award, and (d) the accounting for an exchange of stock compensation awards
in a business combination. This Interpretation is effective July 1, 2000,
but certain conclusions in the Interpretation cover specific events that
occur after either December 15, 1998, or January 12, 2000. To the extent
that this Interpretation covers events occurring during the period after
December 15, 1998, or January 12, 2000, but before the effective date of
July 1, 2000, the effects of applying this Interpretation are recognized on
a prospective basis from July 1, 2000. The adoption of FIN 44 does not have
a material impact on ORATEC's financial statements.
-7-
<PAGE>
6. Segment Information:
ORATEC's spine and arthroscopy product sales are as follows (in thousands):
<TABLE>
<CAPTION>
Three months ended Nine months ended
---------------------------------------------------------------
September 30, September 30,
------------------------------- -----------------------------
2000 1999 2000 1999
---------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Spine..................................... $ 5,724 $ 5,231 $ 19,766 $ 10,845
Arthroscopy............................... 5,804 3,608 17,988 10,893
--------- -------- ---------- -----------
$ 11,528 $ 8,839 $ 37,754 $ 21,738
========= ======== ========== ===========
</TABLE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and
Results of Operations and other parts of this Form 10-Q contain forward-looking
statements that involve risks and uncertainties. Words such as "anticipates,"
"expects," "intends," "plans," "believes," "seeks," "estimates," and similar
expressions identify such forward-looking statements. These statements are not
guarantees of future performance and are subject to risks and uncertainties,
which could cause actual results to differ materially from those expressed or
forecasted. Factors that might cause such a difference include, but are not
limited to, those discussed in the section entitled "Factors That May Affect
Future Results" and those appearing elsewhere in this Form 10-Q. Readers are
cautioned not to place undue reliance on these forward-looking statements, which
reflect management's analysis only as of the date hereof. The Company assumes no
obligation to update these forward-looking statements to reflect actual results
or changes in factors or assumptions affecting such forward-looking statements.
Overview
ORATEC Interventions develops and markets innovative medical devices that
use controlled thermal energy to treat spine and joint disorders. From inception
in 1993 until February 1997, our operations consisted primarily of various
start-up activities, including development of technologies central to our
business, recruiting personnel and raising capital. In December 1995 we gained
FDA 510(k) clearance for our first product, our TAC probe for the treatment of
joint disorders. In March 1997, after 18 months of funding scientific and
clinical studies, we formally launched this product at the American Academy of
Orthopedic Surgeons convention. We received FDA 510(k) clearance for our
SpineCATH product in March 1998 and formally launched this product at the North
American Spine Society, or NASS, conference in October 1998. In November 1999,
we introduced the new Vulcan ElectroThermal Arthroscopy System.
All of our revenues are generated from sales of our spine and arthroscopy
products. For the nine months ended September 30, 2000, 92% of our total sales
was derived from our disposable spine catheters and arthroscopy probes and 8%
was derived from sales of generators and accessories. During the nine months
ended September 30, 2000, our results of operations produced a profit of $1.1
million. Our profitability continues to be attributable to increased sales of
our spine and arthroscopy products. At September 30, 2000 we had an accumulated
deficit of $29.6 million.
In the nine months ended September 30, 2000, only 2% of our sales was
derived from markets outside the U.S., and we do not expect international sales
to increase significantly in the near future. In international markets, we
expect to rely exclusively on third-party distributors. Our gross margins on
sales through international third-party distributors are 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.
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<PAGE>
The medical device market is litigious. Although we are involved in product
liability actions, we do not believe that any of these are material to our
business or financial condition. In addition, we may become subject to patent
proceedings. The costs of such lawsuits may be material and could affect our
earnings and financial position. An adverse outcome in a patent lawsuit could
require us to cease sales of affected products or to pay royalties, which could
harm our results of operations.
Our future growth depends on expanding our current markets and finding new
high growth markets in which we can leverage our core technologies of applying
thermal energy to treat soft tissue disorders. Additionally, our growth rate may
be affected by the timing of the release of clinical results data that certain
managed care organizations await before making reimbursement decisions related
to our IDET procedure. 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
Sales
Sales increased 30% to $11.5 million for the three months ended September
30, 2000 from $8.8 million for the three months ended September 30, 1999. Sales
increased 74% to $37.8 million for the nine months ended September 30, 2000 from
$21.7 million for the nine months ended September 30, 1999. The sales increase
was led by continued market adoption of our SpineCATH IntraDiscal Electrothermal
Therapy (IDET) system, for which sales have increased from $10.8 million to
$19.8 million, or 82%, between the first nine months of 1999 and the first nine
months of 2000. Our arthroscopy business increased from $10.9 million to $18.0
million, or 65%, between the first nine months of 1999 and the first nine months
of 2000, as the introduction of our Vulcan arthroscopy system led to greater
account penetration and probe utilization rates. The increased sales in both
product lines is attributable to new product introductions, increased numbers of
physicians trained in the use of our products, the increasing effectiveness of
our spine and arthroscopy sales forces and the numbers of generators placed in
hospitals and clinics.
Cost of sales
Cost of sales increased to $4.0 million for the three months ended
September 30, 2000, a 19% increase from $3.3 million for the three months ended
September 30, 1999. Cost of sales increased to $11.4 million for the nine months
ended September 30, 2000, a 19% increase from $9.6 million for the nine months
ended September 30, 1999. The increase in overall cost of goods sold between
1999 and 2000 was driven by higher unit shipments and costs of increased
manufacturing capacity. Cost of sales consists of material, labor and overhead
costs, as well as depreciation on generators placed with customers for their use
with our disposable products.
Gross profit
Gross profit increased to $7.6 million, or 66% of sales, for the three
months ended September 30, 2000 from $5.5 million, or 62% of sales, for the
three months ended September 30, 1999. Gross profit increased to $26.4 million,
or 70% of sales, for the nine months ended September 30, 2000 from $12.1
million, or 56% of sales, for the nine months ended September 30, 1999. The
increases in overall gross profit are attributable to sales growing at a faster
pace than manufacturing and depreciation costs and overall increases in
manufacturing efficiency.
Research and development expenses
Research and development expenses increased 36% to $1.5 million for the
three months ended September 30, 2000 from $1.1 million for the three months
ended September 30, 1999. Research and development expenses increased 38% to
$4.3 million for the first nine months of 2000 from $3.1 million for the first
nine months of 1999. The increases are related to the addition of headcount and
office space for increased development efforts on next-generation spine devices
and advanced arthroscopy probes. Research and development expenses consist of
costs related to our research and development, regulatory and clinical affairs
functions, as well as costs associated with scientific and clinical studies. We
expect to continue to make substantial investments in research and development
and anticipate that research and development expenses will continue to increase
in the future.
Sales and marketing expenses
Sales and marketing expenses increased 7% to $5.0 million for the three
months ended September 30, 2000 from $4.7 million for the three months ended
September 30, 1999. Sales and marketing expenses increased 41% to $17.2 million
in the
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<PAGE>
first nine months of 2000 from $12.2 million for the first nine months of 1999.
Increased expenses were primarily due to greater overall sales and marketing
headcount, higher commission expenses, increased marketing and training costs
and expenses associated with our reimbursement function. Sales and marketing
expenses consist primarily of costs for sales, marketing and reimbursement
staff, sales commissions, medical conference participation and physician
training programs. We anticipate that sales and marketing expenses will increase
as we continue to develop our sales and reimbursement support staffs and expand
our physician training programs.
General and administrative expenses
General and administrative expenses were $1.3 million for the three months
ended September 30, 2000, a 42% decrease from $2.2 million for the three months
ended September 30, 1999. General and administrative expenses were $3.6 million
for the nine months ended September 30, 2000, a 12% decrease from $4.1 million
for the first nine months ended September 30, 1999. General and administrative
costs for the third quarter of 1999 included $1.0 million related to the
company's efforts to complete a public offering that was cancelled during that
quarter. Increased expense activity levels during the nine months ended
September 30, 2000 were primarily from costs associated with increased
headcount, patent legal costs, along with expenses related to being a public
company. General and administrative expenses consist primarily of personnel
costs, professional service fees, expenses related to intellectual property
rights and general corporate expenses. We expect general and administrative
expenses to increase in the future as we add personnel, continue to expand our
patent portfolio and incur reporting and investor-related expenses as a public
company.
Stock compensation expense
Stock compensation expense was $182,000 and $238,000 for the three months
ended September 30, 2000 and September 30, 1999, respectively. Stock
compensation expense was $1.1 million and $485,000 for the nine month periods
ended September 30, 2000 and September 30, 1999, respectively. Stock
compensation expense relates principally to options granted to consultants for
services rendered. Stock compensation expense for consultant options is
calculated using the Black-Scholes option pricing model, in which the stock
price is one of the key variables. The stock compensation expense for the nine
months ended September 30, 2000 was based on the average monthly stock prices
for each month of 2000. To the extent that our average stock price for the
remaining months of 2000 is higher, this charge could increase significantly.
Interest and other income (expense), net
Net interest and other income was $679,000 for the three months ended
September 30, 2000, a change from net interest and other expense of $(118,000)
for the three months ended September 30, 1999. Net interest and other income
was $994,000 for the nine months ended September 30, 2000, a change from net
interest and other expense of $(457,000) for the nine months ended September 30,
1999. Net interest and other income (expense) is comprised primarily of
interest earned on cash balances and short term investments, offset by interest
expense on equipment and debt obligations. In 2000, interest income exceeded
interest expense due to proceeds received from the company's initial purchase
offering in the second quarter of 2000. During the three months ended September
30, 2000, the company paid down substantially all of its debt balances,
decreasing future interest expenses.
Provision for income taxes
The income tax provision for the three and nine months ended September 30,
2000 is based on an estimated effective annual tax rate of 5%. The income tax
provision represents primarily current state and federal minimum income taxes
after utilization of net operating loss carryforwards.
As of December 31, 1999, we had net operating loss carryforwards of
approximately $24.1 million for federal and $4.5 million for California 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, however, the Company
believes that there is no material limitation on utilization as a result. The
annual limitation may result in the expiration of the net operating losses
before utilization.
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<PAGE>
Net cash used in operating activities was $27,000 for the nine months ended
September 30, 2000, compared to net cash used of $8.6 million for the nine
months ended September 30, 1999. The decrease related mainly to our
profitability in the first nine months of 2000, offset by increased working
capital requirements.
Net cash used in investing activities was $4.2 million for the nine months
ended September 30, 2000, compared to $842,000 for the nine months ended
September 30, 1999. The increase was related to higher capital expenditures for
generators and facilities in the first nine months of 2000, partially offset by
the timing of maturities of our short term investments.
Net cash provided by financing activities was $49.5 million for the nine
months ended September 30, 2000, compared to net cash provided by financing
activities of $4.5 million for the nine months ended September 30, 1999. The
increase is due mainly to proceeds from our initial public offering and the
exercise of stock options and was partially offset by the repayment of debt
balances. During the nine months ended September 30, 1999, we drew down a
subordinated debt facility for $4.0 million, which accounted for substantially
all of the financing activity for that period.
As of September 30, 2000, our principal debt and other commitments
consisted of $40,000 outstanding under various capital leases and financing
agreements. We expect to increase our capital expenditures consistent with our
anticipated growth in manufacturing, infrastructure and personnel. We also may
increase our capital expenditures as we expand our product lines or invest to
address new markets. As of September 30, 2000, we had no active or available
debt facilities.
Our principal source of liquidity at September 30, 2000 consisted of $51.3
million of cash and cash equivalents, primarily from our initial public offering
which was completed on April 10, 2000. Our offering raised net proceeds of
approximately $58.8 million. We believe that our current cash position, along
with cash generated from the future sales of products, will be sufficient to
meet our operating and capital requirements for 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
a credit facility. If additional funds are raised through the issuance of debt
securities, these securities could have rights senior to holders of common
stock, and could contain covenants that restrict our operations. Any additional
funding, if required, may not be available in amounts or on terms acceptable to
us, if at all. If we are unable to obtain this additional funding, if needed, we
may be required to reduce the scope of our planned product development and
marketing efforts, which could harm our results of operations and financial
condition.
Factors That May Affect Future Results
In addition to the other information in this report, the following factors
should be considered carefully in evaluating our business and prospects.
If physicians do not support the use of our products, we may not achieve future
sales growth.
Our product sales have mainly been to a group of early adopting physicians
who are receptive to minimally invasive techniques. Other physicians may not
purchase our products until there is long term clinical evidence to convince
them to alter their existing treatment methods and recommendations from
prominent physicians that our products are effective in treating spine and joint
disorders. In addition, physicians tend to be slow to change their medical
treatment practices because of perceived liability risks arising from the use of
new products and the uncertainty of third party reimbursement. If we fail to
gain further physician support for our products, we may not achieve expected
revenues and may not sustain profitability.
Because several large insurance companies have refused to reimburse health care
providers for our procedures, physicians, hospitals and other health care
providers may be reluctant to use our products and sales may decline.
Physicians, hospitals and other health care providers are unlikely to
purchase our products if they do not receive reimbursement from payors for the
cost of the procedures using our products. There are payors, including a number
of managed care organizations, that have refused to reimburse for the cost of
procedures using our products until long term 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 based on individual criteria.
The advent of contracted rates per procedure has also made it difficult to
receive reimbursement for disposable products, even if the use of these products
improves clinical outcomes.
Because we lack sufficient long term outcomes data regarding the efficacy of our
products, we could find that our long term data does not support our current
clinical results.
Because our spine products are supported by only two years of patient
follow up and our arthroscopy products are supported by only three years of
patient follow up, we could discover that our current clinical results cannot be
supported. If longer term patient studies or clinical experience indicate that
treatments with our products do not provide patients with sustained
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benefits, our sales could decline. If longer term patient studies or clinical
experience indicate that our procedures cause tissue damage, motor impairment or
other negative effects, we could be subject to significant liability. Further,
because some of our data has been produced in studies that are not randomized
and involve small patient groups, our results may not be reproduced in wider
patient populations. In addition, we are aware of pre-clinical studies related
to our arthroscopy products that have produced data 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.
Our stock price, like that of many early stage medical technology companies, may
be volatile.
If our future quarterly sales or operating results are below the
expectations of securities analysts or investors, the price of our common stock
would likely decline. Stock price fluctuations may be exaggerated if the trading
volume of our common stock is low.
In the past, securities class action litigation has often been brought
against a company after a period of volatility in the market price of its stock.
Any securities litigation claims brought against us could result in substantial
expense and the diversion of management's attention from our core business.
Because we expect operating expenses to increase substantially in the forseeable
future and cannot be certain that revenues will continue to increase, we may not
sustain profitability.
We anticipate that our operating expenses will increase substantially in
absolute dollars for the foreseeable future as we expand our sales and
marketing, manufacturing, product development and administrative staff. Although
we attained profitability during the first three quarters of 2000, if sales do
not continue to grow, we may not be able to maintain profitability in the
future. In particular, we incurred losses of $11.3 million in 1998 and $9.7
million in 1999. As of September 30, 2000, we had an accumulated deficit of
approximately $29.6 million.
Because we are introducing new products and technology into the spine and
arthroscopy markets, we may fail to gain market acceptance for our products and
our business could suffer.
We have developed products for spine and joint disorders that we believe
are not effectively addressed by existing medical devices. Because we are
introducing novel technology into these markets, we face the challenge of
gaining widespread acceptance of our products. If we fail at this task, we may
not achieve expected revenues and may not sustain profitability.
You may have a difficult time evaluating our company because we have a limited
operating history.
You can only evaluate our business based on a limited operating history
because we began selling arthroscopy products in 1997 and spine products in
1998. This short history may not be adequate to enable you to fully assess our
ability to successfully develop our products, achieve market acceptance of our
products and respond to competition.
Because we face significant competition from companies with greater resources
than we have, we may be unable to compete effectively.
The market for our products is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We compete with many larger companies that
enjoy several competitive advantages, including:
. established distribution networks;
. products that are supported by long term clinical data;
. 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. For example, Stryker Corporation entered into an agreement with
Arthrocare Corporation and announced and began marketing a competing line of
arthroscopy products during the second quarter of 2000.
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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.
Because the medical device industry is litigious, we are susceptible to an
intellectual property suit.
There is a substantial amount of litigation over patent and other
intellectual property rights in the medical device industry generally, and in
the spine and arthroscopy market segments particularly. Whether a product
infringes a patent involves complex legal and factual issues, the determination
of which is often uncertain. While we attempt to ensure that our products do not
infringe other parties' patents and proprietary rights, our competitors may
assert that our products and the methods they employ may be covered by U.S.
patents held by them. In consultation with our experts, we have made a careful
analysis of patents covering related technology, and, based on this analysis, we
believe that either those patents or claims are invalid, or if valid, that we do
not infringe. In addition, because patent applications can take many years to
issue, there may be applications now pending of which we are unaware, which may
later result in issued patents which our products may infringe. There could also
be existing patents that one or more of our products may inadvertently be
infringing of which we are unaware. As the number of competitors in the markets
for minimally invasive treatment of spine and joint disorders grows, the
possibility of a patent infringement claim against us increases. Infringement
and other intellectual property claims, with or without merit, can be expensive
and time consuming to litigate and divert management's attention from our core
business.
If we are sued for patent infringement, we could be prevented from selling our
products and our business could suffer.
We are aware of the existence of patents held by competitors in the spine
and arthroscopy markets which could result in a patent lawsuit against us.
However, following a review of those patents with outside experts, we believe
they are invalid or that if valid, we do not infringe. In the event that we are
subject to a patent infringement lawsuit and if the relevant patent claims are
upheld as valid and enforceable, we believe we have defenses based on
noninfringement. If our products are found to infringe a valid patent, we could
be prevented from selling them unless we can obtain a license or are able to
redesign the product to avoid infringement. A license may not be available or if
available may be on terms unacceptable to us, or we may not be successful in any
attempt to redesign our products to avoid any infringement. Modification of our
products or development of new products could require us to conduct additional
clinical trials for these new or modified products and to revise our filings
with the FDA, which is time consuming and expensive. If we are not successful in
obtaining a license or redesigning our products, we may be unable to sell our
products and our business could suffer.
Product liability claims brought against us could result in payment of
substantial damages to plaintiffs.
We manufacture medical devices that are used on patients in surgical
procedures, and we are thus subject to product liability lawsuits as part of our
ordinary course of business. Although we are involved in product liability
actions, we do not believe any of these are material to our business or
financial condition. We have reported to the FDA instances in which burns and
probe breakage were reported in connection with the use of our arthroscopy
products and instances of nerve inflammation caused by an arthroscopic procedure
performed on the shoulder. We have also reported instances in which a portion of
the SpineCATH catheter broke off in the patient's body 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 caused motor and nerve impairment. We do not believe that any of
these instances were the result of design flaws. During 1999, we sent a letter
to our physician customers
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informing them of the close association between catheter kinking and breakage
and a safety alert emphasizing the importance of following the correct protocol
during the IDET procedure.
Any product liability claim brought against us, with or without merit,
could result in the increase of our product liability insurance rates or the
inability to secure coverage in the future. In addition, we would have to pay
any amount awarded by a court in excess of policy limits. Our insurance policies
have various exclusions, and thus we may be subject to a product liability claim
for which we have no insurance coverage, in which case we may have to pay the
entire amount of any award. Even in the absence of a claim, our insurance rates
may rise in the future to a point where we decide not to carry this insurance.
Finally, even a meritless or unsuccessful product liability claim would be time
consuming and expensive to defend and could result in the diversion of
management's attention from our core business.
Any failure to build and manage our sales organization may negatively affect our
market share and revenues.
We currently have two separate sales forces, one for each of our spine and
arthroscopy product lines, and we rely on a combination of direct sales
employees and sales agents to sell each product line in the U.S. We need to
expand both the spine and arthroscopy sales teams during this fiscal year to
achieve our market share and revenue growth goals. There are significant risks
involved in building and managing our spine and arthroscopy sales forces,
including:
. failure to manage the development and growth of two distinct sales
forces;
. failure to adequately train both our employees and our outside sales
agents in the use and benefits of our products; and
. dependence on outside agencies, over which we have limited or no
control.
Any failure in our physician training efforts could significantly reduce product
sales.
It is critical to the success of our sales effort to train a sufficient
number of physicians and to provide them adequate instruction in the use of our
products. We rely on physicians to spend their time and money to attend our
training sessions. If physicians are not properly trained, they may misuse or
ineffectively use our products. This may result in unsatisfactory patient
outcomes, patient injury, negative publicity or lawsuits against us, any of
which could have an adverse effect on our product sales.
If we fail to support our anticipated growth in operations, our business could
suffer.
To succeed in the implementation of our business strategy, our management
team must rapidly execute our sales strategy and further develop products, while
managing anticipated growth by implementing effective planning and operating
processes. To manage anticipated growth in operations, we must increase our
manufacturing and quality assurance staff, expand our sales teams and expand our
manufacturing facility. Our systems, procedures and controls may not be adequate
to support our expected growth in operations.
Because we have limited control over third party distributors, we may be unable
to sell our products in international markets.
We intend to rely on third-party distributors, over whom we have limited
control, to sell our products in international markets. We have entered into an
exclusive agreement with, and are dependent upon, DePuy AcroMed for the
marketing and sales of our spine products internationally. We also have
exclusive distributor relationships for the sale of our arthroscopy products in
foreign countries, including Australia, Belgium, Canada, Italy, the Netherlands,
Spain, Taiwan and the United Kingdom.
Because we compete with Mitek, an Ethicon division of Johnson & Johnson, in the
arthroscopy market, a conflict with them could negatively affect our
international spine sales efforts which are conducted exclusively by DePuy
AcroMed, another division of Johnson & Johnson.
Because our exclusive international spine product distributor is affiliated
with competitors in both the spine and arthroscopy markets, they may devote
insufficient resources to sales of our products or a conflict may arise which
could disrupt international sales. If DePuy AcroMed fails to devote adequate
resources to our products, we could fail to achieve expected international
sales. If a conflict arises which we could not readily resolve, there could be a
period of declining international sales
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as we search for an alternative means of international product
distribution. Complying with FDA and other regulations is an expensive and time
consuming process, and any failure to comply could result in substantial
penalties.
We are subject to a host of federal, state, local and international
regulations regarding the testing, manufacture, distribution, marketing,
promotion, record keeping and reporting of our products. In particular, our
failure to comply with FDA regulations could result in, among other things,
recalls of our products, substantial fines and/or criminal charges against us
and our employees.
Product sales, introductions or modifications may be delayed or canceled as a
result of the FDA regulatory process, which could cause our sales to decline.
Before we can sell a new medical device in the U.S., we must obtain FDA
clearance, which can be a lengthy and time consuming process. The products we
market have obtained the necessary clearances from the FDA through premarket
notification under Section 510(k) of the Federal Food, Drug, and Cosmetic Act or
were exempt from the 510(k) clearance process. We have modified some of our
products, but we do not believe these modifications require us to submit new
510(k) notifications. However, if the FDA disagrees with us and requires us to
submit a new 510(k) notification for modifications to our existing products, we
may be required to stop marketing the products while the FDA reviews the 510(k)
notification, or if the FDA requires us to go through a lengthier, more rigorous
examination than we had expected, our product introductions or modifications
could be delayed or canceled, which could cause our sales to decline. In
addition, the FDA may determine that future products will require the more
costly, lengthy and uncertain premarket approval, or PMA, process.
Off label use of our products could result in substantial penalties.
510(k) clearance only permits us to promote our products for the uses
indicated on the labels cleared by the FDA. We may request additional label
indications for our current products, and the FDA may deny those requests
outright, require additional expensive clinical data to support any additional
indications or impose limitations on the intended use of any cleared product as
a condition of clearance. If the FDA determines that we have promoted our
products for off label use, we could be subject to fines, injunctions or other
penalties.
Our disposable probes have been cleared by the FDA for single use, but we
are aware that from time to time physicians reuse our disposable products. We
have strongly advised physicians against reuse of our products.
We may need to raise additional capital in the future and may be unable to do so
on acceptable terms.
We may need to raise additional funds for operations and to execute our
business strategy. The sale of additional equity or convertible debt securities
could result in additional dilution to our stockholders. If additional funds are
raised through the issuance of debt securities, these securities could have
rights senior to holders of common stock, and could contain covenants that would
restrict our operations. Any additional financing may not be available in
amounts or on terms acceptable to us, if at all.
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Our executive officers and directors own a large percentage of our voting stock
and could exert significant influence over matters requiring stockholder
approval.
Our executive officers and directors, and their respective affiliates, own
a substantial percentage of our outstanding common stock. Accordingly, these
stockholders may, as a practical matter, be able to exert significant influence
over matters requiring approval by our stockholders, including the election of
directors and the approval of mergers or other business combinations. This
concentration could have the effect of delaying or preventing a change in
control.
Our certificate of incorporation, our bylaws and Delaware law contain provisions
that could discourage a takeover.
Provisions of our certificate of incorporation, bylaws and Delaware law may
discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk disclosures have not changed significantly from those set
forth in Management's Discussion and Analysis of Financial Condition and Results
of Operations in our Form S-1 filing dated April 4, 2000 for the year ended
December 31, 1999.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings. From time to time we are a party to various legal
proceedings arising in the ordinary course of our business. We are not currently
subject to any material legal proceedings.
Item 2. Changes in Securities and Use of Proceeds.
(d) On April 4, 2000, in connection with our initial public offering, a
Registration Statement on Form S-1 (No. 333-95815) was declared effective by the
Securities and Exchange Commission, pursuant to which 4,600,000 shares of our
Common Stock were sold on April 10, 2000 for the account of the Company at a
price of $14.00 per share, generating aggregate gross proceeds of $64.4 million
before payment of underwriting discounts and commissions and transaction
expenses. The managing underwriters were Merrill Lynch & Co., J.P. Morgan & Co.
and U.S. Bancorp Piper Jaffray. After deducting approximately $4.5 million in
underwriting discounts and commissions and $1,100,000 in other transaction
expenses, the net proceeds of the offering were approximately $58.8 million.
None of the payments for underwriting discounts and commissions and other
transaction expenses represented direct or indirect payments to directors,
officers or other affiliates of the Company. The net proceeds of the offering
have been invested in short term, investment grade, interest bearing securities.
As of September 30, 2000, we had used approximately $10.9 million of the
proceeds of the offering to repay debt balances. We intend to use the proceeds
from the offering to expand sales, marketing and reimbursement activities, to
develop the Company's product lines, to fund acquisitions or investments and to
fund general corporate purposes, including working capital.
Item 3. Defaults Upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders. Not applicable.
Item 5. Other Information. Not Applicable
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits:
10.11++ 1999 Directors' Stock Option Plan
27.1 Financial Data Schedule
____________________________
++ Supersedes previously filed exhibit
(b) Reports on Form 8-K: Not Applicable.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ORATEC INTERVENTIONS, INC.
By: /s/ Nancy V. Westcott
-------------------------
Nancy V. Westcott
Chief Financial Officer and Vice
President of Administration
Date: November 14, 2000
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EXHIBIT INDEX
-------------
10.11++ 1999 Directors' Stock Option Plan and Form Option Agreement.
27.1 Financial Data Schedule.
____________________________
++ Supersedes previously filed exhibit
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