<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___________ TO ___________
Commission file number: 0-24663
---------------------------
ASPECT MEDICAL SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 04-2985553
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
141 NEEDHAM STREET, NEWTON, MASSACHUSETTS 02464-1505
(Address of Principal Executive Offices) (Zip Code)
(617) 559-7000
Registrant's Telephone Number, Including Area Code
TWO VISION DRIVE, NATICK, MASSACHUSETTS 01760
Former Address
---------------------------
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 [ ]
The Registrant had 17,359,691 shares of Common Stock, $0.01 par value per share,
outstanding as of November 7, 2000.
<PAGE> 2
ASPECT MEDICAL SYSTEMS, INC.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION 1
Item 1. Financial Statements (Unaudited) 1
Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999 1
Consolidated Statements of Operations for the Three and Nine Months Ended
September 30, 2000 and October 2, 1999 2
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2000 and October 2, 1999 3
Notes to Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19
PART II. OTHER INFORMATION 20
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 21
SIGNATURE 22
</TABLE>
<PAGE> 3
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 26,337,945 $ 13,535,364
Marketable securities 34,537,161 1,000,000
Accounts receivable, net of allowance of $472,000 at
September 30, 2000 and $407,000 at December 31, 1999 4,532,885 4,300,235
Current portion of investment in sales-type leases 1,714,173 1,689,585
Inventory 5,202,851 1,514,702
Other current assets 1,220,053 1,006,023
------------- -------------
Total current assets 73,545,068 23,045,909
Property and equipment, net 6,375,025 3,449,252
Long-term investment in sales-type leases 2,690,681 2,906,447
------------- -------------
Total assets $ 82,610,774 $ 29,401,608
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 2,585,130 $ 2,125,526
Accounts payable 1,946,180 1,569,093
Accrued liabilities 5,860,177 5,937,554
Deferred revenue 807,898 1,135,225
------------- -------------
Total current liabilities 11,199,385 10,767,398
------------- -------------
Deferred revenue 1,192,926 1,682,509
Long-term debt 3,165,089 3,872,484
------------- -------------
Commitments and contingencies
Stockholders' equity:
Preferred Stock, $.01 par value; 5,000,000 shares
authorized, no shares issued or outstanding -- --
Convertible Preferred Stock, $.01 par value; 22,363,224 shares
authorized, 11,067,238 shares issued and
outstanding at December 31, 1999 -- 67,560,365
Common Stock, $.01 par value; 60,000,000 and 17,030,000
shares authorized, 17,346,003 and 1,815,840 shares
issued and outstanding at September 30, 2000 and
December 31, 1999, respectively 173,460 18,158
Additional paid-in capital 124,737,294 1,273,725
Warrants 121,684 146,606
Notes receivable from employees and directors (513,587) (305,324)
Deferred compensation (117,205) (225,111)
Accumulated other comprehensive income 40,682 --
Accumulated deficit (57,388,954) (55,389,202)
------------- -------------
Total stockholders' equity 67,053,374 13,079,217
------------- -------------
Total liabilities and stockholders' equity $ 82,610,774 $ 29,401,608
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE> 4
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------- ---------------------------------
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- ---------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Revenue $ 7,231,033 $ 7,125,464 $ 27,956,577 $ 18,837,661
Costs and expenses:
Costs of revenue 2,097,716 2,325,555 8,563,151 6,561,492
Research and development 1,304,227 1,220,778 4,106,976 3,566,758
Sales and marketing 5,484,308 4,294,291 15,410,937 11,860,062
General and administrative 1,738,341 1,258,180 4,732,854 3,551,242
------------ ------------ ------------ ------------
Total costs and expenses 10,624,592 9,098,804 32,813,918 25,539,554
------------ ------------ ------------ ------------
Loss from operations (3,393,559) (1,973,340) (4,857,341) (6,701,893)
Interest income 1,173,066 392,623 3,427,797 1,132,597
Interest expense (198,065) (49,273) (570,208) (145,160)
------------ ------------ ------------ ------------
Net loss $ (2,418,558) $ (1,629,990) $ (1,999,752) $ (5,714,456)
============ ============ ============ ============
Net loss per share:
Basic and diluted $ (0.14) $ (1.03) $ (0.13) $ (3.81)
Shares used in computing net loss per share:
Basic and diluted 17,199,671 1,579,535 15,229,417 1,501,240
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 5
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended
-----------------------------------
September 30, October 2,
2000 1999
------------- ----------
(Unaudited) (Unaudited)
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (1,999,752) $ (5,714,456)
Adjustments to reconcile net loss to net cash used for
operating activities -
Depreciation and amortization 1,200,920 972,685
Provision for doubtful accounts 65,000 152,100
Compensation expense related to stock options 446,963 268,924
Changes in assets and liabilities -
Increase in accounts receivable (297,650) (2,242,151)
Increase in inventory (3,688,149) (976,233)
Increase in other current assets (214,030) (198,877)
Decrease (increase) in investment in sales-type leases 191,178 (1,911,754)
Increase in accounts payable 377,087 1,031,258
(Decrease) increase in accrued liabilities (77,377) 1,149,740
Decrease in deferred revenue (816,910) (203,282)
------------ ------------
Net cash used for operating activities (4,812,720) (7,672,046)
------------ ------------
Cash flows from investing activities:
Acquisition of property and equipment (4,126,693) (1,837,933)
Purchases of marketable securities (54,246,480) (1,810,895)
Proceeds from sales and maturities of marketable securities 20,750,000 4,770,481
------------ ------------
Net cash (used for) provided by investing activities (37,623,173) 1,121,653
------------ ------------
Cash flows from financing activities:
Principal payments on capital lease obligations -- (96,044)
Proceeds from working capital line of credit -- 2,059,616
Principal payments on equipment loan (540,502) (540,502)
Principal payments on term loan (706,847) --
Proceeds from sale of investment in sales-type leases 1,514,084 1,447,130
Principal payments on debt related to investment in sales-type
leases (514,526) (8,768)
Proceeds from issuance of common stock 55,460,108 10,840
Payments received on notes receivable from employees and
directors 26,157 859
------------ ------------
Net cash provided by financing activities 55,238,474 2,873,131
------------ ------------
Net increase (decrease) in cash and cash equivalents 12,802,581 (3,677,262)
Cash and cash equivalents, beginning of period 13,535,364 17,122,993
------------ ------------
Cash and cash equivalents, end of period $ 26,337,945 $ 13,445,731
============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 585,744 $ 145,160
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 6
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(1) Basis of Presentation
The accompanying unaudited consolidated financial statements of Aspect
Medical Systems, Inc. (the "Company") have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, all normal, recurring adjustments considered necessary for a fair
presentation have been included. The financial statements should be read in
conjunction with the audited financial statements for the year ended December
31, 1999 included in the Registration Statement on Form S-1 of Aspect Medical
Systems, Inc., as amended, filed with the Securities and Exchange Commission
(File No. 333-86295). Interim results of operations are not necessarily
indicative of the results to be expected for the full year or any other interim
periods.
(2) Computation of Net Loss Per Share
In accordance with Statement of Financial Accounting Standards No. 128,
Earnings Per Share (SFAS No. 128), basic and diluted loss per share for the
three and nine months ended September 30, 2000 and October 2, 1999, were
computed by dividing net loss by the weighted average common shares outstanding
during the periods presented. The effect of stock options and warrants is
antidilutive and accordingly is excluded for diluted earnings per share.
(3) Revenue Recognition
Revenue from equipment sales, disposable product sales and sales-type
leases is recognized at the time of shipment. Payments received prior to
shipment are recorded as deferred revenue. The Company has entered into certain
licensing and distribution agreements for which payments received in advance are
recorded as deferred revenue. Revenue is recognized as earned per the terms of
the respective agreements. The Company provides for the cost of warranty at the
time of product shipment.
(4) Comprehensive Income
Statement of Financial Accounting Standards No. 130 (SFAS No. 130),
Reporting Comprehensive Income, requires disclosure of all components of
comprehensive income on an annual and interim basis. Comprehensive income is
defined as the change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources. The
Company's total comprehensive income is as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------- ----------------------------------
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- -----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Net loss $(2,418,558) $(1,629,990) $(1,999,752) $(5,714,456)
Other comprehensive income (loss):
Unrealized gain (loss) on
marketable securities 123,287 -- 40,682 (4,408)
----------- ----------- ----------- -----------
Comprehensive net loss $(2,295,271) $(1,629,990) $(1,959,070) $(5,718,864)
=========== =========== =========== ===========
</TABLE>
4
<PAGE> 7
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(5) Investment in Sales-Type Leases
The Company leases equipment to customers under sales-type leases. The
components of the Company's net investment in sales-type leases are as follows:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
Total minimum lease payments receivable $5,745,517 $5,737,674
Less-- unearned interest 1,340,663 1,141,642
---------- ----------
Net investment in sales-type leases 4,404,854 4,596,032
Less-- current portion 1,714,173 1,689,585
---------- ----------
$2,690,681 $2,906,447
========== ==========
</TABLE>
(6) Inventory
Inventory consists of the following:
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
(Unaudited)
<S> <C> <C>
Raw material $1,496,381 $ 421,117
Work-in-progress 8,925 100,586
Finished goods 3,697,545 992,999
---------- ----------
$5,202,851 $1,514,702
========== ==========
</TABLE>
(7) Segment Information and Enterprise Reporting
The Company operates in one reportable segment as it has one family of
anesthesia monitoring systems. The Company does not disaggregate financial
information by product or geographically, other than export sales by region and
sales by product, for management purposes. Substantially all of the Company's
assets are located within the United States. All of the Company's products are
manufactured in the United States.
5
<PAGE> 8
ASPECT MEDICAL SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Revenue by geographic destination and as a percentage of total revenue is
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------- ---------------------------------
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Geographic Area by Destination
Domestic $ 5,743,043 $ 6,498,882 $23,346,078 $17,135,698
International 1,487,990 626,582 4,610,499 1,701,963
----------- ----------- ----------- -----------
$ 7,231,033 $ 7,125,464 $27,956,577 $18,837,661
=========== =========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------- ---------------------------------
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- ----------
(Unaudited) (Unaudited) (Unaudited) (Unaudited)
<S> <C> <C> <C> <C>
Geographic Area by Destination
Domestic 79% 91% 84% 91%
International 21 9 16 9
--- --- --- ---
100% 100% 100% 100%
=== === === ===
</TABLE>
(8) Initial Public Offering
On February 2, 2000, the Company completed the initial public offering of
its common stock. Upon the closing of the initial public offering, the Company
issued 3,500,000 shares of its common stock at an offering price of $15.00 per
share and all of the Company's convertible preferred stock automatically
converted into 11,067,238 shares of common stock. On February 4, 2000, the
underwriters exercised in full their over-allotment option to purchase an
additional 525,000 shares at $15.00 per share. Cash proceeds from the sale of
the 4,025,000 shares of common stock, net of the underwriters' discount and
offering expenses, totaled approximately $54.6 million. Also upon closing of the
Company's initial public offering, the authorized capital stock of the Company
consisted of 60,000,000 shares of common stock and 5,000,000 shares of preferred
stock. No shares of preferred stock are outstanding and the terms of the
preferred stock have not been designated.
6
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Quarterly Report on Form 10-Q contains, in addition to historical
information, forward-looking statements within the meaning of Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
involve risks and uncertainties and are not guarantees of future performance.
Our actual results could differ significantly from the results discussed in such
forward-looking statements. See "Factors Affecting Future Operating Results"
below.
OVERVIEW
We develop, manufacture and market an anesthesia monitoring system that we call
the BIS system. The BIS system enables anesthesia providers to assess and manage
a patient's level of consciousness during surgery. Our proprietary BIS system
includes our BIS monitor or BIS Module Kit and our disposable BIS Sensors. The
BIS system is based on our patented core technology, the Bispectral Index, which
we refer to as the BIS index. Our latest generation monitor, the A-2000 BIS
Monitor, was cleared for marketing by the FDA in February 1998. Our other
monitor products are the A-1000 Monitor, the A-1050 EEG Monitor with BIS and the
BIS Module Kit. After the introduction of the A-2000 BIS Monitor, we ceased
active marketing of the A-1050 EEG Monitor domestically. In addition to the
disposable BIS Sensor, we offer the Zipprep EEG Electrode.
We follow a system of fiscal months as opposed to calendar months. Under this
system, the first eleven months of each fiscal year end on the Saturday closest
to the end of the calendar month and the last month of the fiscal year always
ends on December 31.
We offer customers the option either to purchase BIS monitors outright or to
acquire BIS monitors pursuant to a sales-type lease agreement whereby the
customer contractually commits to purchase a minimum number of BIS Sensors per
BIS monitor per year. Under this agreement, customers purchase BIS Sensors and
the BIS monitor for the purchase price of the BIS Sensors plus an additional
charge per BIS Sensor to pay for the purchase price of the BIS monitor and
related financing costs over the term of the agreement. The customer is granted
an option to purchase the BIS monitor at the end of the term of the agreement,
which is typically three to five years. Revenue related to BIS monitors sold
pursuant to sales-type leases is recognized at the time of shipment of the BIS
monitors. Sales-type leases accounted for approximately 3% and 14% of revenue in
the three months and 7% and 19% of revenue in the nine months ended September
30, 2000 and October 2, 1999, respectively.
In the three months ended September 30, 2000, revenue from the sale of monitors
decreased by 58% and revenue from the sale of disposable sensors decreased by
14% as compared to the three months ended July 1, 2000. In the fourth quarter,
we expect to introduce a variety of sales and marketing programs to address the
factors which we believe contributed to these decreases. These factors include
increased competition in the domestic level of consciousness monitoring market
as a result of recent FDA approval of a new monitoring system, the transition to
a new vice president of sales and our underestimating the amount of clinical
education necessary to bring our installed base up to expected sensor
utilization levels. These sales and marketing programs will include new sales
programs to facilitate monitor placements. We also intend to increase
investments in clinical education in an effort to return to higher and more
consistent sensor utilization rates. Even with the introduction of new sales and
marketing programs and increased investment in clinical education, we believe
that the factors that adversely affected our revenue for the quarter ended
September 30, 2000 will continue to influence our revenue for the fourth quarter
of 2000 and next year.
We derive our revenue primarily from sales of monitors, including related
accessories and BIS Module Kits, and sales of disposable sensors. In the three
months ended September 30, 2000 and October 2, 1999, revenue from the sale of
monitors represented approximately 31% and 51%, respectively, of our revenue,
and revenue from the sale of disposable sensors represented approximately 69%
and 49%, respectively, of our revenue. In the nine months ended September 30,
2000 and October 2, 1999, revenue from the sale of monitors represented
approximately 43% and 54%, respectively, of our revenue, and revenue from the
sale of disposable sensors represented approximately 57% and 46%, respectively,
of our revenue. In the three months ended September 30, 2000, revenue from the
sale of monitors, as a percentage of total revenue, decreased to 31% from 48% in
the three months ended July 1, 2000 and revenue from the sale of disposable
sensors, as a percentage of total revenue, increased to 69% from 52% in the
three months ended July 1, 2000.
7
<PAGE> 10
Revenue from domestic sales in the three months ended September 30, 2000 and
October 2, 1999 was approximately $5.7 million and $6.5 million, respectively,
which represented approximately 79% and 91%, respectively, of our revenue.
Revenue from domestic sales in the nine months ended September 30, 2000 and
October 2, 1999 was approximately $23.3 million and $17.1 million, respectively,
which represented approximately 84% and 91%, respectively, of our revenue.
Revenue from international sales in the three months ended September 30, 2000
and October 2, 1999 was approximately $1.5 million and $627,000, respectively,
which represented approximately 21% and 9%, respectively, of our revenue.
Revenue from international sales in the nine months ended September 30, 2000 and
October 2, 1999 was approximately $4.6 million and $1.7 million, respectively,
which represented approximately 16% and 9%, respectively, of our revenue. In
December 1998 and March 1999, we established subsidiaries in The Netherlands and
the United Kingdom, respectively, to facilitate our entry into the international
market. We are developing our international sales and distribution program
through a combination of distributors and marketing partners, including
companies with which we have entered into original equipment manufacturer
relationships. We expect to enhance our international third-party distribution
program through direct sales efforts and to support our customers with clinical
specialists. In January 1998, we entered into a three-year distribution
agreement with Nihon Kohden Corporation to distribute BIS monitors in Japan. In
March 2000, the Japanese Ministry of Health and Welfare approved our A-1050 EEG
Monitor with BIS for marketing in Japan. Sales to Nihon Kohden represented
approximately 33% and 2% of revenue from international sales for the three
months ended September 30, 2000 and October 2, 1999, respectively. Sales to
Nihon Kohden represented approximately 47% and 4% of international revenue for
the nine months ended September 30, 2000 and October 2, 1999, respectively. We
believe that Japan's Ministry of Health and Welfare approval for the A-2000 BIS
Monitor will occur late in the fourth quarter of 2000 or the first quarter of
2001. As a result, we believe that monitor shipments to Nihon Kohden will be
delayed until Japan's Ministry of Health and Welfare's approval is received and
therefore revenue from international sales may decrease in the fourth quarter of
2000 as compared to the three months ended September 30, 2000.
RESULTS OF OPERATIONS
The following table presents, for the periods indicated, information expressed
as a percentage of revenue. This information has been derived from our
consolidated statements of operations included elsewhere in this Quarterly
Report on Form 10-Q. You should not draw any conclusions about our future
results from the results of operations for any period.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
--------------------------------- ---------------------------------
September 30, October 2, September 30, October 2,
2000 1999 2000 1999
------------- ---------- ------------- ----------
<S> <C> <C> <C> <C>
Revenue 100% 100% 100% 100%
Costs and expenses:
Costs of revenue 29 33 31 35
Research and development 18 17 14 19
Sales and marketing 76 60 55 63
General and administrative 24 18 17 19
---- ---- ---- ----
Total costs and expenses 147 128 117 136
---- ---- ---- ----
Loss from operations (47) (28) (17) (36)
Interest income, net 14 5 10 6
---- ---- ---- ----
Net loss (33)% (23)% (7)% (30)%
==== ==== ==== ====
</TABLE>
8
<PAGE> 11
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE AND NINE MONTHS
ENDED OCTOBER 2, 1999
Revenue. Our revenue increased slightly to approximately $7.2 million in the
three months ended September 30, 2000 from approximately $7.1 million in the
three months ended October 2, 1999. Our revenue increased to approximately $28.0
million in the nine months ended September 30, 2000 from approximately $18.8
million in the nine months ended October 2, 1999, an increase of approximately
48%. Revenue from the sale of monitors decreased to approximately $2.2 million
in the three months ended September 30, 2000 from approximately $3.6 million in
the three months ended October 2, 1999, a decrease of approximately 39%. Revenue
from the sale of monitors increased to approximately $11.9 million in the nine
months ended September 30, 2000 from approximately $10.2 million in the nine
months ended October 2, 1999, an increase of approximately 16%. The decrease in
revenue from the sale of monitors in the three months ended September 30, 2000
as compared to the comparable period in the prior year was primarily
attributable to a decrease of approximately 34% in the number of monitors sold.
The growth in revenue from the sale of monitors in the nine months ended
September 30, 2000 as compared to the comparable period in the prior year was
primarily attributable to an increase of approximately 28% in the number of
monitors sold. There were two primary factors that contributed to the decrease
in monitor sales in the three months ended September 30, 2000 as compared to the
three months ended October 2, 1999. First, as a result of the recent FDA
approval of a competitive monitoring product, more customers than we expected
have elected to delay purchase decisions until they have had an opportunity to
evaluate the competitive product. Second, we hired a new vice president of sales
during the third quarter and we underestimated the impact that this transition
would have on our sales effort. The increase in the sales of monitors in the
nine months ended September 30, 2000 as compared to the comparable period in the
prior year resulted from the efforts of our direct sales force, the development
of our domestic distributor network and the contribution of our international
organization.
Revenue from the sale of disposable sensors increased to approximately $5.0
million in the three months ended September 30, 2000 from approximately $3.5
million in the three months ended October 2, 1999, an increase of approximately
43%. Revenue from the sale of disposable sensors increased to approximately
$16.1 million in the nine months ended September 30, 2000 from approximately
$8.6 million in the nine months ended October 2, 1999, an increase of
approximately 86%. The increase in revenue from the sale of disposable sensors
was primarily attributable to an increase in the number of disposable sensors
sold as a result of growth in the installed base of monitors. The number of
disposable sensors sold increased approximately 43% and 87% in the three and
nine months ended September 30, 2000 as compared to the three and nine months
ended October 2, 1999, respectively.
Our gross profit was approximately 71% of revenue in the three months ended
September 30, 2000 as compared to a gross profit of approximately 67% of revenue
in the three months ended October 2, 1999. Our gross profit was approximately
69% of revenue in the nine months ended September 30, 2000 as compared to a
gross profit of approximately 65% of revenue in the nine months ended October 2,
1999. The increase in the gross profit percentage in the three and nine months
ended September 30, 2000 as compared to the three and nine months ended October
2, 1999 was primarily attributable to an increase in sales of disposable sensors
as a percentage of revenue. Disposable sensors have a higher profit margin than
monitors and contributed nearly all of the increase in gross profit in the three
months ended September 30, 2000 as compared to the three months ended October 2,
1999 and 87% of the increase in gross profit in the nine months ended September
30, 2000 as compared to the nine months ended October 2, 1999. We expect that
sales of higher-margin disposable sensors, as a percentage of revenue, will
continue to represent the majority of our sales as the installed base of
monitors continues to grow and we increase our investments in clinical education
in an effort to maintain higher and more consistent sensor utilization rates.
Research and Development. Research and development expenses increased to
approximately $1.3 million in the three months ended September 30, 2000 from
approximately $1.2 million in the three months ended October 2, 1999, an
increase of approximately 7%. Research and development expenses increased to
approximately $4.1 million in the nine months ended September 30, 2000 from
approximately $3.6 million in the nine months ended October 2, 1999, an increase
of approximately 15%. Research and development expenses increased as a
percentage of revenue in the three months ended September 30, 2000 as compared
to the three months ended October 2, 1999 and decreased as a percentage of
revenue for the nine months ended September 30, 2000 as compared to the nine
months ended October 2, 1999. The increase in research and development expenses
for
9
<PAGE> 12
the three and nine months ended September 30, 2000 as compared to the three and
nine months ended October 2, 1999, was primarily attributable to an increase in
research and development personnel and related payroll and other expenses. These
expenses were incurred in connection with the continued product development
efforts related to the A-2000 BIS Monitor, BIS Sensor and BIS Module Kit and the
development of products for use outside the operating room in the intensive care
unit and for procedural sedation. We expect research and development expenses to
increase as we continue to invest in the development of product improvements,
product extensions and new applications for our technology.
Sales and Marketing. Sales and marketing expenses increased to approximately
$5.5 million in the three months ended September 30, 2000 from approximately
$4.3 million in the three months ended October 2, 1999, an increase of
approximately 28%. Sales and marketing expenses increased to approximately $15.4
million in the nine months ended September 30, 2000 from approximately $11.9
million in the nine months ended October 2, 1999, an increase of approximately
30%. Sales and marketing expenses increased as a percentage of revenue for the
three months ended September 30, 2000 as compared to the three months ended
October 2, 1999 and decreased as a percentage of revenue for the nine months
ended September 30, 2000 as compared to the nine months ended October 2, 1999.
The increase in sales and marketing expenses in the three and nine months ended
September 30, 2000 as compared to the three and nine months ended October 2,
1999 was primarily attributable to an increase in sales and marketing personnel
and related payroll and other expenses, which represented approximately 66% and
61%, respectively, of the increase in each period, and the increased operations
of our international subsidiaries, which represented approximately 9% and 20%,
respectively, of the increase. We expect sales and marketing expenses to
increase as we continue to expand our international operations, enter into
agreements with group purchasing organizations, increase our direct sales force
and clinical specialists in the United States, increase our sales and marketing
programs and engage in activities to further educate and promote the use of the
BIS system by our customers.
General and Administrative. General and administrative expenses increased to
approximately $1.7 million in the three months ended September 30, 2000 from
approximately $1.3 million in the three months ended October 2, 1999, an
increase of approximately 38%. General and administrative expenses increased to
approximately $4.7 million in the nine months ended September 30, 2000 from
approximately $3.6 million in the nine months ended October 2, 1999, an increase
of approximately 33%. General and administrative expenses increased as a
percentage of revenue for the three months ended September 30, 2000 as compared
to the three months ended October 2, 1999 and decreased as a percentage of
revenue for the nine months ended September 30, 2000 as compared to the
comparable period in the prior year. The increase in general and administrative
expenses in the three and nine months ended September 30, 2000 as compared to
the three and nine months ended October 2, 1999 was primarily attributable to an
increase in general and administrative personnel to support our growth and
related payroll and other expenses, which represented approximately 34% and 69%,
respectively, of the increase. The increase in payroll and other expenses
included compensation expense related to stock options, which decreased
approximately 70% in the three months ended September 30, 2000 as compared to
the comparable period in the prior year and increased approximately 171% in the
nine months ended September 30, 2000 as compared to the comparable period in the
prior year. The increase also included incremental expenses related to being a
public company, such as expenses related to enhancements of our investor
relations capabilities and insurance expenses, which represented approximately
21% and 24%, respectively, of the increase. We expect general and administrative
expenses to increase as we increase the number of personnel and related
resources required to support our growth.
Interest Income, Net. Interest income, net, increased to approximately $975,000
in the three months ended September 30, 2000 from approximately $343,000 in the
three months ended October 2, 1999, an increase of approximately 184%. Interest
income, net, increased to approximately $2.9 million in the nine months ended
September 30, 2000 from approximately $988,000 in the nine months ended October
2, 1999, an increase of approximately 189%. Interest income increased to
approximately $1.2 million in the three months ended September 30, 2000 from
approximately $393,000 in the three months ended October 2, 1999, an increase of
approximately 199%. Interest income increased to approximately $3.4 million in
the nine months ended September 30, 2000 from approximately $1.1 million in the
nine months ended October 2, 1999, an increase of approximately 203%. The
increase in interest income was primarily attributable to a higher average
balance of cash and investments resulting from our initial public offering of
common stock in February 2000 and the proceeds from the sale of a portion of our
investment in sales-type leases. Interest expense increased to approximately
$198,000 in the three months ended September 30, 2000 from approximately $49,000
in the three months ended October 2, 1999, an increase of approximately 302%.
Interest expense increased to approximately $570,000 in the nine months ended
September 30, 2000 from approximately $145,000 in the nine
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months ended October 2, 1999, an increase of approximately 293%. The increase in
interest expense in the three and nine months ended September 30, 2000 was a
result of higher average outstanding debt obligations resulting from borrowings
under a term loan we entered into in December 1999 and debt obligations related
to the sale of a portion of our investments in sales-type leases in the second
half of 1999 and the first nine months of 2000. We expect interest income to
increase in the fourth quarter of 2000 as compared to the interest income in the
fourth quarter of 1999 as a result of the higher cash and investments balances
that exist as a result of our initial public offering in February 2000.
Net Loss. As a result of the factors discussed above, in the three and nine
months ended September 30, 2000, we had a net loss of approximately $2.4 million
and $2.0 million, respectively, as compared to a net loss of approximately $1.6
million and $5.7 million in the three and nine months ended October 2, 1999,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
From our inception through January 2000, we financed our operations primarily
from the sale of our convertible preferred stock. Through September 30, 2000, we
raised approximately $67.6 million from private equity financings and have
received approximately $3.4 million in equipment financing and approximately
$3.4 million of financing related to our investments in sales-type leases. We
received approximately $2.8 million of financing under a term loan in December
1999. In February 2000, we closed our initial public offering of an aggregate of
4,025,000 shares of common stock and received net proceeds of approximately
$54.6 million. At September 30, 2000, we had approximately $190,000 committed
primarily to the purchase of equipment related to improvements in our monitor
and disposable sensor production lines.
Working capital at September 30, 2000 was approximately $62.3 million compared
to approximately $12.3 million at December 31, 1999. The increase in working
capital from December 31, 1999 to September 30, 2000 was primarily attributable
to the proceeds from our initial public offering.
We used approximately $4.8 million of cash for operations in the nine months
ended September 30, 2000 as compared to approximately $7.7 million in the nine
months ended October 2, 1999. Cash used for operations during the nine months
ended September 30, 2000 was primarily driven by operating losses, increases in
net accounts receivable, inventory and other current assets and decreases in
accrued liabilities and deferred revenue which were offset by a decrease in
investment in sales-type leases and an increase in accounts payable.
We used approximately $37.6 million of cash for investing activities in the nine
months ended September 30, 2000 as compared to receiving approximately $1.1
million in the nine months ended October 2, 1999. The cash used for investing
activities in the nine months ended September 30, 2000 was primarily the result
of the investment of the proceeds we received from our February 2000 initial
public offering of common stock. Capital expenditures were approximately $4.1
million in the nine months ended September 30, 2000, primarily for manufacturing
equipment and leasehold improvements for our new facility, as compared to
approximately $1.8 million in the nine months ended October 2, 1999.
We received approximately $55.2 million of cash from financing activities in the
nine months ended September 30, 2000 as compared to approximately $2.9 million
in the nine months ended October 2, 1999. The cash received from financing
activities in the nine months ended September 30, 2000 was primarily a result of
the closing of our initial public offering of common stock. Cash from financing
activities during the nine months ended October 2, 1999 resulted primarily from
borrowings under a working capital line of credit and proceeds from the sale of
a portion of our investment in sales-type leases.
In December 1999, we renegotiated our loan agreement with Imperial Bank.
Borrowings outstanding at September 30, 2000 of approximately $901,000 under the
equipment portion of the new loan agreement are payable in monthly installments
of approximately $60,000 plus interest through December 31, 2001. The working
capital portion of the original loan agreement was replaced with a term loan
portion. Borrowings under the term loan portion outstanding at September 30,
2000 of approximately $2.1 million are payable in 36 monthly installments of
approximately $79,000 plus interest which commenced in January 2000. Interest on
both the equipment portion and the term loan portion of the new loan agreement
accrued at the prime rate plus 1.0% through the closing date of our initial
public offering of common stock. Since the closing date of our initial public
offering, the interest rate has been the prime rate plus 0.5%. The new loan
agreement contains restrictive covenants that require us to maintain liquidity
and borrowing base ratios and restrict us from declaring and paying
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cash dividends. The new loan agreement is secured by substantially all of our
assets. No additional amounts may be borrowed under the equipment portion or
term loan portion of the new loan agreement. Approximately $1.5 million is
available under the standby letter of credit portion of the new loan agreement.
In July 1999, we entered into an agreement under which we can sell a portion of
our existing and future investments in sales-type leases to AmeriCorp Financial,
Inc. Through September 30, 2000, we sold approximately $3.4 million of our
investments in sales-type leases. In accordance with Statement of Financial
Accounting Standards No. 125, Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities, the proceeds from these
sales are classified as debt. Payments on the outstanding principal under this
debt match the timing of the payments due on the underlying investments in
sales-type leases.
We anticipate that the level of capital expenditures will decrease as a result
of the completion of the leasehold improvements to our Newton, Massachusetts
facility.
We believe that the financial resources available to us, including our current
working capital, together with the proceeds from selling our investments in
sales-type leases, will be sufficient to finance our planned operations and
capital expenditures at least through 2001. However, our future liquidity and
capital requirements will depend upon numerous factors, including the resources
required to further develop our marketing and sales organization domestically
and internationally, to expand manufacturing capacity, to finance our sales-type
lease program and to meet market demand for our products.
INCOME TAXES
We have net operating loss and research and development tax credit carryforwards
for federal income tax purposes that will expire commencing in the year 2002
through the year 2019 if not utilized.
The net operating loss and research and development tax credit carryforwards are
subject to review by the Internal Revenue Service. Ownership changes, as defined
in the Internal Revenue Code, may limit the amount of these tax attributes that
can be utilized annually to offset future taxable income or tax liabilities. The
amount of the annual limitation is determined based on our value immediately
prior to the ownership change. Subsequent ownership changes may further affect
the limitation in future years.
CONVERSION TO EURO
Eleven of the 15 members of the European Union have agreed to adopt the Euro as
their legal currency. Our current information systems allow us to process
Euro-denominated transactions. We are also assessing the business implications
of the conversion to the Euro, including long-term competitive implications and
the effect of market risk with respect to financial instruments. Substantially
all of our international sales are denominated in United States dollars. We do
not believe the Euro will have a significant effect on our business, financial
condition or results of operations. We will continue to assess the impact of
Euro conversion issues as the applicable accounting, tax, legal and regulatory
guidance evolves.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 133 (SFAS No. 133), Accounting
for Derivatives and Hedging Activities, which establishes accounting and
reporting standards of derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities. In June
1999, the FASB issued Statement of Financial Accounting Standards No. 137,
Accounting for Derivatives and Hedging Activities -- Deferral of the Effective
Date of FASB Statement No. 133, which defers the effective date of SFAS No. 133
to be effective for all fiscal quarters beginning after June 15, 2000. The
adoption of SFAS No. 133, as amended, is not expected to have a material effect
on our financial condition and results of operations as we do not currently hold
any derivative instruments or engage in hedging activities.
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FACTORS AFFECTING FUTURE OPERATING RESULTS
This Quarterly Report on Form 10-Q includes forward looking statements,
including information relating to our ability to achieve profitability,
information with respect to market acceptance of our BIS system, continued
growth in sales of our BIS monitors and BIS Sensors, our dependence on the BIS
system, our ability to remain competitive and achieve future growth, information
with respect to other plans and strategies for our business and factors that may
influence our revenue for the fourth quarter of 2000. The following factors
represent current challenges to us that create risk and uncertainty. Failure to
adequately overcome any of the following challenges, singularly or in
combination, could have a material adverse effect on our results of operations,
business or financial condition.
WE WILL NOT BE PROFITABLE IF HOSPITALS AND ANESTHESIA PROVIDERS DO NOT BUY AND
USE OUR BIS SYSTEM IN SUFFICIENT QUANTITIES.
Customers may determine that the cost of the BIS system exceeds cost savings in
drugs, personnel and post-anesthesia care recovery resulting from use of the BIS
system. In addition, hospitals and anesthesia providers may not accept the BIS
system as an accurate means of assessing a patient's level of consciousness
during surgery if patients regain consciousness during surgery while being
monitored with the BIS system. If extensive or frequent malfunctions occur,
these providers may also conclude that the BIS system is unreliable. If
hospitals and anesthesia providers do not accept the BIS system as
cost-effective, accurate or reliable, they will not buy and use the BIS system
in sufficient quantities to enable us to be profitable.
WE DEPEND ON OUR BIS SYSTEM FOR SUBSTANTIALLY ALL OF OUR REVENUE, AND IF THE BIS
SYSTEM DOES NOT GAIN WIDESPREAD MARKET ACCEPTANCE, THEN OUR REVENUE WILL NOT
GROW.
We began selling our current BIS system in early 1998. To date, we have not
achieved widespread market acceptance of the BIS system. Because we depend on
our BIS system for substantially all of our revenue and we have no other
significant products, if we fail to achieve widespread market acceptance we will
not be able to sustain or grow our product revenue.
CASES OF SURGICAL AWARENESS DURING MONITORING WITH THE BIS SYSTEM COULD LIMIT
MARKET ACCEPTANCE OF BIS SYSTEMS AND COULD EXPOSE US TO PRODUCT LIABILITY
CLAIMS.
Clinicians have reported to us a total of 58 cases of possible surgical
awareness during surgical procedures monitored with the BIS system as of
September 30, 2000. Not all cases of surgical awareness during surgical
procedures monitored with the BIS system may be reported to us, and we have not
systematically solicited reports of surgical awareness. Anesthesia providers and
hospitals may elect not to purchase and use BIS systems if there is adverse
publicity resulting from the report of cases of surgical awareness that were not
detected during procedures monitored with the BIS system. If anesthesia
providers and hospitals do not purchase and use the BIS system, then we may not
sustain or grow our product revenue. Although we do not claim that patient
monitoring with the BIS system will reduce the incidence of surgical awareness,
we may be subject to product liability claims for cases of surgical awareness
during surgical procedures monitored with the BIS system. These claims could
require us to spend significant time and money in litigation or to pay
significant damages.
WE MAY NOT BE ABLE TO COMPETE WITH NEW PRODUCTS OR ALTERNATIVE TECHNIQUES
DEVELOPED BY OTHERS, WHICH COULD IMPAIR OUR ABILITY TO REMAIN COMPETITIVE AND
ACHIEVE FUTURE GROWTH.
The medical industry in which we market our products is characterized by rapid
product development and technological advances. Our revenue in the quarter ended
September 30, 2000 was adversely affected by recent FDA approval of a
competitive anesthesia monitoring product. If we do not compete effectively with
this new monitoring product, our revenue will be adversely affected. Our current
or planned products are at risk of obsolescence from:
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- other new monitoring products, based on new or improved technologies,
- new products or technologies used on patients or in the operating room
during surgery in lieu of monitoring devices,
- electrical or mechanical interference from new or existing products or
technologies,
- alternative techniques for evaluating the effects of anesthesia,
- significant changes in the methods of delivering anesthesia, and
- the development of new anesthetic agents.
We may not be able to improve our products or develop new products or
technologies quickly enough to maintain a competitive position in our markets
and continue to grow our business.
IF WE DO NOT SUCCESSFULLY DEVELOP AND INTRODUCE ENHANCED OR NEW PRODUCTS WE
COULD LOSE REVENUE OPPORTUNITIES AND CUSTOMERS.
As the market for our BIS system matures, we need to develop and introduce new
products for anesthesia monitoring or other applications. We face at least the
following risks:
- we may not successfully adapt the BIS system to function properly in the
intensive care unit, for procedural sedation, when used with anesthetics we
have not tested or with patient populations we have not studied, such as
infants and young children, and
- our technology is complex, and we may not be able to develop it further for
applications outside anesthesia monitoring.
If we do not successfully adapt the BIS system for new products and applications
both within and outside the field of anesthesia monitoring, then we could lose
revenue opportunities and customers.
IF WE DO NOT DEVELOP AND IMPLEMENT A SUCCESSFUL SALES AND MARKETING STRATEGY, WE
WILL NOT EXPAND OUR BUSINESS.
We recently hired a new vice president of sales and we have underestimated the
impact that this transition would have on our sales efforts. Until we succeed in
effecting this transition, our sales efforts will be adversely affected. In
addition, our current sales and marketing operation is not sufficient to achieve
the level of market awareness and sales we need to expand our business. We have
only limited sales and marketing experience both in the United States and
internationally and may not be successful in developing and implementing our
strategy. We need to:
- provide or assure that distributors and original equipment manufacturers
provide the technical and educational support customers need to use the BIS
system successfully,
- promote frequent use of the BIS system so that sales of our disposable BIS
Sensors increase,
- encourage our customers to purchase our products prior to availability of
products that are made by original equipment manufacturers incorporating
our technology,
- manage geographically dispersed operations, and
- modify our products for foreign markets.
IN ORDER TO REACH THE LEVEL OF SALES WE NEED TO ACHIEVE PROFITABILITY, WE NEED
TO FURTHER DEVELOP OUR DIRECT AND INDIRECT SALES CHANNELS.
In order to increase our sales, we need to add domestic and international
distributors, original equipment manufacturers and other sales channels and
increase sales through these channels. In addition, we need to hire and train
more sales persons and clinical specialists. We are also implementing new sales
and marketing programs and clinical education programs to promote the use of our
BIS system by our customers. If we do not further develop our direct and
indirect sales channels and successfully implement new sales and marketing
programs and clinical education programs, we will not reach the level of sales
necessary to achieve profitability.
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OUR THIRD-PARTY DISTRIBUTION AND ORIGINAL EQUIPMENT MANUFACTURER RELATIONSHIPS
COULD NEGATIVELY AFFECT OUR PROFITABILITY, CAUSE SALES OF OUR PRODUCTS TO
DECLINE AND BE DIFFICULT TO TERMINATE IF WE ARE DISSATISFIED.
Sales through distributors could be less profitable than direct sales. Sales of
our products through multiple channels could also confuse customers and cause
the sale of our products to decline. We do not control our original equipment
manufacturers and distribution partners. Our partners could sell competing
products and may devote insufficient sales efforts to our products. Our partners
are generally not required to purchase minimum quantities. As a result, even if
we are dissatisfied with the performance of our partners, we may be unable to
terminate our agreements with these partners or enter into alternative
arrangements.
WE MAY NOT BE ABLE TO GENERATE ENOUGH ADDITIONAL REVENUE FROM OUR PLANNED
INTERNATIONAL EXPANSION TO OFFSET THE COSTS ASSOCIATED WITH ESTABLISHING AND
MAINTAINING FOREIGN OPERATIONS.
A component of our growth strategy is to expand our presence in foreign markets.
We conduct international business primarily in Europe and Japan and we are
attempting to increase the number of countries in which we do business. It will
be costly to establish international facilities and operations and to promote
the BIS system in international markets. In addition, we have little experience
in marketing and distributing products for these markets. Revenue from
international activities may not offset the expense of establishing and
maintaining these foreign operations.
WE MAY NOT BE ABLE TO MEET THE UNIQUE OPERATIONAL, LEGAL AND FINANCIAL
CHALLENGES THAT WE WILL ENCOUNTER IN OUR INTERNATIONAL OPERATIONS, WHICH MAY
LIMIT THE GROWTH OF OUR BUSINESS.
We are increasingly subject to a number of challenges which specifically relate
to our international business activities. These challenges include:
- failure of local laws to provide the same degree of protection against
infringement of our intellectual property,
- protectionist laws and business practices that favor local competitors,
which could slow our growth in international markets,
- less acceptance by foreign anesthesia providers of the use of disposable
products similar to the BIS Sensor,
- longer sales cycles to sell products like the BIS system to hospitals and
outpatient surgical centers, which could slow our revenue growth from
international sales, and
- longer accounts receivable payment cycles and difficulties in collecting
accounts receivable.
If we are unable to meet and overcome these challenges, our international
operations may not be successful which would limit the growth of our business.
WE MAY EXPERIENCE CUSTOMER DISSATISFACTION AND OUR REPUTATION COULD SUFFER IF WE
FAIL TO MANUFACTURE ENOUGH PRODUCTS TO MEET OUR CUSTOMERS' DEMANDS.
We rely on third-party manufacturers to assemble and manufacture the components
of our BIS monitors and a portion of our BIS Sensors. We manufacture
substantially all BIS Sensors in our own manufacturing facility. We have only
one manufacturing facility. If we fail to produce enough products at our own
manufacturing facility or at a third-party manufacturing facility or experience
a termination or modification of any manufacturing arrangement with a third
party, we may be unable to deliver products to our customers on a timely basis.
Our failure to deliver products on a timely basis could lead to customer
dissatisfaction and damage our reputation.
OUR RELIANCE ON SOLE SUPPLIERS COULD ADVERSELY AFFECT OUR ABILITY TO MEET OUR
CUSTOMERS' DEMANDS FOR OUR PRODUCTS IN A TIMELY MANNER OR WITHIN BUDGET.
Some of the components that are necessary for the assembly of our BIS system,
including some of the components used in the BIS Sensor, are currently provided
to us by separate sole suppliers or a limited group of suppliers. We purchase
components through purchase orders rather than long-term supply agreements and
generally do not maintain large volumes of inventory. We have experienced
shortages and delays in obtaining some of the components of our BIS systems in
the past, and we may experience similar delays or shortages in the future. The
disruption or termination of the supply of components could cause a significant
increase in the
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costs of these components, which could affect our profitability. A disruption or
termination in the supply of components could also result in our inability to
meet demand for our products, which could lead to customer dissatisfaction and
damage our reputation. Furthermore, if we are required to change the
manufacturer of a key component of the BIS system, we may be required to verify
that the new manufacturer maintains facilities and procedures that comply with
quality standards and with all applicable regulations and guidelines. The delays
associated with the verification of a new manufacturer could delay our ability
to manufacture BIS systems in a timely manner or within budget.
WE MAY BE REQUIRED TO BRING LITIGATION TO ENFORCE OUR INTELLECTUAL PROPERTY
RIGHTS, WHICH MAY RESULT IN SUBSTANTIAL EXPENSE AND MAY DIVERT OUR ATTENTION
FROM THE IMPLEMENTATION OF OUR BUSINESS STRATEGY.
We believe that the success of our business depends, in part, on obtaining
patent protection for our products, defending our patents once obtained and
preserving our trade secrets. We rely on a combination of contractual
provisions, confidentiality procedures and patent, trademark and trade secret
laws to protect the proprietary aspects of our technology. These legal measures
afford only limited protection and competitors may gain access to our
intellectual property and proprietary information. Litigation may be necessary
to enforce our intellectual property rights, to protect our trade secrets and to
determine the validity and scope of our proprietary rights. Any litigation could
result in substantial expense and diversion of our attention from the growth of
the business and may not be adequate to protect our intellectual property
rights.
WE DO NOT OWN THE TRADEMARK "ASPECT" AND ANY COMPETITIVE ADVANTAGE WE DERIVE
FROM THE NAME MAY BE IMPAIRED BY THIRD-PARTY USE.
We are a party to a license agreement with a third party under which we have
obtained the nonexclusive right to make, use or sell products under the name
"Aspect." The licensor of the Aspect name markets products for use in the health
care industry. There may be confusion in the market between the licensor and us
and this confusion could compromise the competitive advantage, if any, we derive
from our name.
WE MAY BE SUED BY THIRD PARTIES WHICH CLAIM THAT OUR PRODUCTS INFRINGE ON THEIR
INTELLECTUAL PROPERTY RIGHTS, PARTICULARLY BECAUSE THERE IS SUBSTANTIAL
UNCERTAINTY ABOUT THE VALIDITY AND BREADTH OF MEDICAL DEVICE PATENTS.
We may be exposed to litigation by third parties based on claims that our
products infringe the intellectual property rights of others. This risk is
exacerbated by the fact that the validity and breadth of claims covered in
medical technology patents involve complex legal and factual questions for which
important legal principles are unresolved. Any litigation or claims against us,
whether or not valid, could result in substantial costs, could place a
significant strain on our financial resources and could harm our reputation. In
addition, intellectual property litigation or claims could force us to do one or
more of the following:
- cease selling, incorporating or using any of our products that incorporate
the challenged intellectual property, which would adversely affect our
revenue,
- obtain a license from the holder of the infringed intellectual property
right, which license may not be available on reasonable terms, if at all,
and
- redesign our products, which would be costly and time-consuming.
WE COULD BE EXPOSED TO SIGNIFICANT PRODUCT LIABILITY CLAIMS WHICH COULD DIVERT
MANAGEMENT ATTENTION AND ADVERSELY AFFECT OUR CASH BALANCES, OUR ABILITY TO
OBTAIN AND MAINTAIN INSURANCE COVERAGE AT SATISFACTORY RATES OR IN ADEQUATE
AMOUNTS AND OUR REPUTATION.
The manufacture and sale of our products expose us to product liability claims
and product recalls, including those which may arise from misuse or malfunction
of, or design flaws in, our products or use of our products with components or
systems not manufactured or sold by us. Product liability claims or product
recalls, regardless of their ultimate outcome, could require us to spend
significant time and money in litigation or to pay significant damages. We
currently maintain insurance; however, it might not cover the costs of any
product liability claims made against us. Furthermore, we may not be able to
obtain insurance in the future at satisfactory rates or in adequate amounts. In
addition, publicity pertaining to the misuse or malfunction of, or design flaws
in, our products could impair our ability to successfully market and sell our
products.
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FLUCTUATIONS IN OUR QUARTERLY OPERATING RESULTS COULD CAUSE OUR STOCK PRICE TO
DECREASE.
Our operating results have fluctuated significantly from quarter to quarter in
the past and are likely to vary in the future. These fluctuations are due to
several factors relating to the sale of our products, including the timing and
volume of customer orders for our BIS system, use of and demand for our BIS
Sensors, customer cancellations, introduction of competitive products, changes
in management, reductions in orders by our distribution partners and the timing
and amount of our expenses. Because of these fluctuations, our operating results
for the quarter ended September 30, 2000 fell below the expectations of
securities analysts or investors, and it is likely that in some future quarter
or quarters our operating results could again fall below the expectations of
securities analysts or investors. Following the public announcement of our
results of operations for the quarter ended September 30, 2000, the market price
of our stock declined. If our quarterly operating results are below expectations
in the future the market price of our stock would also be likely to decrease. In
addition, because we do not have a significant backlog of customer orders for
our BIS system, revenue in any quarter depends on orders received in that
quarter. Our quarterly results may also be adversely affected because some
customers may have inadequate financial resources to purchase our products or
may fail to pay for our products after receiving them. In particular, hospitals
are increasingly experiencing financial constraints, consolidations and
reorganizations as a result of cost containment measures and declining
third-party reimbursement for services, which may result in decreased product
orders or an increase in bad debts in any quarter.
VARIOUS MARKET FACTORS MAY ADVERSELY AFFECT OUR QUARTERLY OPERATING RESULTS FOR
THE FOURTH FISCAL QUARTER OF 2000.
Various factors may adversely affect our quarterly operating results for the
fourth fiscal quarter of 2000. We are facing increased competition in the
domestic level of consciousness monitoring market as a result of recent FDA
approval of a new monitoring system. Second, we transitioned to a new vice
president of sales. This may adversely impact our revenue for the fourth fiscal
quarter of 2000, depending in part on the successful implementation of the
transition. Third, we underestimated the amount of clinical education necessary
to bring our installed base up to expected sensor utilization levels.
WE MAY NOT RESERVE AMOUNTS ADEQUATE TO COVER PRODUCT OBSOLESCENCE, CLAIMS AND
RETURNS, WHICH COULD RESULT IN UNANTICIPATED EXPENSES AND FLUCTUATIONS IN
OPERATING RESULTS.
Depending on factors such as the timing of our introduction of new products
which utilize our BIS technology, as well as warranty claims and product
returns, we may need to reserve amounts in excess of those currently reserved
for product obsolescence, excess inventory, warranty claims and product returns.
These reserves may not be adequate to cover all costs associated with these
items. If these reserves are inadequate, we would be required to incur
unanticipated expenses which could result in unexpected fluctuations in
quarterly operating results.
WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY, WHICH COULD RESULT IN PRICE
REDUCTIONS AND DECREASED DEMAND FOR OUR PRODUCTS.
We are facing increased competition in the domestic level of consciousness
monitoring market as a result of recent FDA approval of a new monitoring
product. This recently approved product is marketed by a well-established
medical products company with significant resources. We may not be able to
compete effectively with these potential competitors. We may also face
substantial competition from companies developing sensor products that compete
with our proprietary BIS Sensors for use with our BIS monitors or with
third-party monitoring systems or anesthesia delivery systems that incorporate
the BIS index. We also expect to face competition from companies currently
marketing conventional electroencephalogram, or EEG, monitors using standard and
novel signal-processing techniques. Other companies may develop
anesthesia-monitoring systems that perform better than the BIS system and/or
sell for less. In addition, one or more of our competitors may develop products
that are substantially equivalent to our FDA-approved products, in which case
they may be able to use our products as predicate devices to more quickly obtain
FDA approval of their competing products. Medical device companies developing
these and other competitive products may have greater financial, technical,
marketing and other resources than we do. Competition in the sale of
anesthesia-monitoring systems could result in price reductions, fewer orders,
reduced gross margins and loss of market share.
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OUR ABILITY TO MARKET AND SELL OUR PRODUCTS AND GENERATE REVENUE DEPENDS UPON
RECEIPT OF DOMESTIC AND FOREIGN REGULATORY APPROVAL OF OUR PRODUCTS AND
MANUFACTURING OPERATIONS.
Before we can market new products in the United States we must obtain clearance
from the United States Food and Drug Administration, or FDA. If the FDA
concludes that any of our products do not meet the requirements to obtain
clearance of a premarket notification under Section 510(k) of the Food, Drug and
Cosmetic Act, then we would be required to file a premarket approval
application. The approval process for a premarket approval application is
lengthy, expensive and typically requires extensive preclinical and clinical
trial data. We may not obtain clearance of a 510(k) notification or approval of
a premarket approval application with respect to any of our products on a timely
basis, if at all. If we fail to obtain timely clearance or approval for our
products, we will not be able to market and sell our products, which will limit
our ability to generate revenue. We may also be required to obtain clearance of
a 510(k) notification from the FDA before we can market certain previously
marketed products which we modify after they have been cleared. We have made
certain enhancements to our currently marketed products which we have determined
do not necessitate the filing of a new 510(k) notification. However, if the FDA
does not agree with our determination, it will require us to file a new 510(k)
notification for the modification and we may be prohibited from marketing the
modified device until we obtain FDA clearance.
The FDA also requires us to adhere to current Good Manufacturing Practices
regulations, which include production design controls, testing, quality control,
storage and documentation procedures. The FDA may at any time inspect our
facilities to determine whether adequate compliance has been achieved.
Compliance with current Good Manufacturing Practices regulations for medical
devices is difficult and costly. In addition, we may not continue to be
compliant as a result of future changes in, or interpretations of, regulations
by the FDA or other regulatory agencies. If we do not achieve continued
compliance, the FDA may withdraw marketing clearance or require product recall.
When any change or modification is made to a device or its intended use, the
manufacturer may be required to reassess compliance with current Good
Manufacturing Practices regulations, which may cause interruptions or delays in
the marketing and sale of our products.
Sales of our products outside the United States are subject to foreign
regulatory requirements that vary from country to country. The time required to
obtain approvals from foreign countries may be longer than that required for FDA
approval, and requirements for foreign licensing may differ from FDA
requirements.
The federal, state and foreign laws and regulations regarding the manufacture
and sale of our products are subject to future changes, as are administrative
interpretations of regulatory agencies. If we fail to comply with applicable
federal, state or foreign laws or regulations, we could be subject to
enforcement actions, including product seizures, recalls, withdrawal of
clearances or approvals and civil and criminal penalties.
IF WE DO NOT RETAIN OUR SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES, WE MAY NOT BE
ABLE TO SUCCESSFULLY IMPLEMENT OUR BUSINESS STRATEGY.
Our president and chief executive officer, Nassib Chamoun, joined us at our
inception in 1987. Our chairman, J. Breckenridge Eagle, began serving as a
director in 1988. Many other members of our management and key employees have
extensive experience with us and other companies in the medical device industry.
Our success is substantially dependent on the ability, experience and
performance of these members of our senior management and other key employees.
Because of their ability and experience, if we lose one or more of the members
of our senior management or other key employees, our ability to successfully
implement our business strategy could be seriously harmed.
IF WE DO NOT ATTRACT AND RETAIN SKILLED PERSONNEL, WE WILL NOT BE ABLE TO EXPAND
OUR BUSINESS.
Our products are based on complex signal-processing technology. Accordingly, we
require skilled personnel to develop, manufacture, sell and support our
products. Our future success will depend largely on our ability to continue to
hire, train, retain and motivate additional skilled personnel, particularly
sales representatives and clinical specialists who are responsible for customer
education and training and post-installation customer support. We continue to
experience difficulty in recruiting and retaining skilled personnel because the
pool of experienced persons is small and we compete for personnel with other
companies, many of which have greater resources than we do. Consequently, if we
are not able to attract and retain skilled personnel, we will not be able to
expand our business.
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FAILURE OF USERS OF THE BIS SYSTEM TO OBTAIN ADEQUATE REIMBURSEMENT FROM
THIRD-PARTY PAYORS COULD LIMIT MARKET ACCEPTANCE OF THE BIS SYSTEM, WHICH COULD
PREVENT US FROM ACHIEVING PROFITABILITY.
Anesthesia providers are generally not reimbursed separately for patient
monitoring activities utilizing the BIS system. For hospitals and outpatient
surgical centers, when reimbursement is based on charges or costs, patient
monitoring with the BIS system may reduce reimbursements for surgical
procedures, because charges or costs may decline as a result of monitoring with
the BIS system. Failure by hospitals and other users of the BIS system to obtain
adequate reimbursement from third-party payors, or any reduction in the
reimbursement by third-party payors to hospitals and other users as a result of
using the BIS system could limit market acceptance of the BIS system, which
could prevent us from achieving profitability.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to financial market risks, including changes in foreign currency
exchange rates and interest rates. Most of our revenue, expenses and capital
spending are transacted in U.S. dollars. However, the expenses and capital
spending of our international subsidiaries are transacted in local currency. As
a result, changes in foreign currency exchange rates or weak economic conditions
in foreign markets could affect our financial results. We do not use derivative
instruments to hedge our foreign exchange risk. Our exposure to market risk for
changes in interest rates relates primarily to our cash and cash equivalent
balances, marketable securities, investment in sales-type leases and our
commercial loan agreement with Imperial Bank. The majority of our investments
are in short-term instruments and subject to fluctuations in U.S. interest
rates. Due to the nature of our short-term investments, we believe that there is
no material risk exposure.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Initial Public Offering
On February 2, 2000, we sold 3,500,000 shares of our common
stock, at an initial public offering price of $15.00 per share,
pursuant to a Registration Statement on Form S-1 (Registration No.
333-86295), which was declared effective by the Securities and
Exchange Commission on January 27, 2000. On February 4, 2000, the
underwriters exercised in full their over-allotment option to purchase
an additional 525,000 shares of our common stock at $15.00 per share.
The managing underwriters of our initial public offering were Morgan
Stanley & Co. Incorporated, Deutsche Bank Securities Inc. and U.S.
Bancorp Piper Jaffray Inc.
The aggregate gross proceeds raised in the offering were
approximately $60.4 million. Our total expenses in connection with the
offering were approximately $5.7 million, of which $4.2 million was
for underwriting discounts and commissions and, based on our
reasonable estimate, approximately $1.5 million was for other
expenses. Our net proceeds from the offering were approximately $54.6
million. From January 27, 2000 through September 30, 2000, we used
approximately $4.1 million of the net proceeds for the acquisition of
machinery and equipment and for leasehold improvements to our new
facility in Newton, Massachusetts. In addition, from January 27, 2000
through September 30, 2000, we used approximately $5.1 million of the
net proceeds for general corporate purposes, including working
capital, product development, increasing our sales and marketing
capabilities and expanding our international operations. As of
September 30, 2000, we had approximately $45.4 million of proceeds
remaining from the offering, and pending use of the proceeds, we have
invested these funds in short-term, interest-bearing, investment-grade
securities.
(b) Warrant Exercises
On July 18, August 2 and August 7, 2000, we issued 12,100, 4,037
and 6,163 shares of our common stock, respectively, to three of our
stockholders pursuant to the exercise of warrants issued by us in
December 1998 in connection with our Series E preferred stock
financing. The exercise price of the warrants was $12.50 per share of
our common stock; however, two of the warrants were exercised pursuant
to a cashless exercise provision contained in the warrants. As a
result, we received no consideration upon the exercise of those two
warrants and approximately $151,250 of consideration for the third
warrant. The shares of our common stock issued upon exercise of the
warrants were issued in reliance upon the exemptions from registration
under Section 4(2) of the Securities Act of 1933, as amended, or
Regulation D promulgated thereunder, relative to sales by an issuer
not involving any public offering.
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ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule for the Nine Months Ended September 30,
2000
10.1 Promissory Note, dated July 13, 2000, made in favor of the
Registrant by Nassib Chamoun, together with Pledge Agreement,
dated as of July 13, 2000, by and between the Registrant and
Nassib Chamoun.
(b) Reports on Form 8-K
We did not file any reports on Form 8-K during the quarter ended
September 30, 2000.
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SIGNATURE
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.
ASPECT MEDICAL SYSTEMS, INC.
Date: November 13, 2000 By: /s/ J. Neal Armstrong
------------------------------------
J. Neal Armstrong
Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
EXHIBIT
NUMBER EXHIBIT
------- -------
27 Financial Data Schedule for the Nine Months Ended
September 30, 2000
10.1 Promissory Note, dated July 13, 2000, made in favor of the
Registrant by Nassib Chamoun, together with Pledge Agreement,
dated as of July 13, 2000, by and between the Registrant and
Nassib Chamoun.
23
