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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB
[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 1-12471
INTEGRATED SURGICAL SYSTEMS, INC.
(NAME OF SMALL BUSINESS ISSUER IN ITS CHARTER)
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<S> <C>
DELAWARE 68-0232575
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
1850 RESEARCH PARK DRIVE, DAVIS, CA 95616-4884
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
(530) 792-2600
(ISSUER'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED UNDER SECTION 12(b) OF THE EXCHANGE ACT:
<TABLE>
<CAPTION>
NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS EACH CLASS IS REGISTERED
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<S> <C>
COMMON STOCK, $.01 PAR VALUE THE PACIFIC EXCHANGE INCORPORATED
COMMON STOCK PURCHASE WARRANTS THE PACIFIC EXCHANGE INCORPORATED
</TABLE>
SECURITIES REGISTERED UNDER SECTION 12(g) OF THE ACT:
NOT APPLICABLE
(TITLE OF CLASS)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 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 [ ]
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [X]
Revenues for the issuer's most recent fiscal year were $6,146,434.
The aggregate market value of the voting and non-voting common equity held
by non-affiliates computed by reference to the closing price of the common stock
on March 17, 1999 was $9,636,505.
ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS
DURING THE PAST FIVE YEARS
Check whether the issuer has filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by a court. Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE REGISTRANTS
As of March 17, 1999, the issuer had 5,744,037 shares of common stock, $.01
par value, outstanding.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive Proxy Statement for its 1999 Annual
Meeting of Stockholders are incorporated by reference into Part III of this Form
10-KSB in response to Items 9, 10, 11 and 12 of Part III.
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PART I
ITEM 1. DESCRIPTION OF BUSINESS.
Integrated Surgical Systems, Inc. (the "Company") develops, assembles,
markets and services image-directed, computer-controlled robotic products for
orthopaedic and neurosurgical applications. The Company was incorporated under
the laws of the State of Delaware on October 1, 1990.
ORTHOPAEDIC BUSINESS
The Company's principal orthopaedic product is the ROBODOC(R) Surgical
Assistant System, consisting of a computer-controlled surgical robot and the
Company's ORTHODOC(R) Presurgical Planner. The ROBODOC System has been used for
primary total hip replacement surgery on over 4,000 patients in Europe and the
United States. The Company believes its "active" robotic system is the only
available system that can accurately perform key segments of surgical procedures
semi-autonomously with precise tolerances generally not attainable by
traditional manual surgical techniques. The ROBODOC System also allows the
surgeon to prepare a preoperative plan specifically designed for the
characteristics of the individual patient's anatomy. The technology for the
ROBODOC System was initially developed at the University of California, Davis,
in collaboration with IBM.
The ORTHODOC is a computer workstation that uses the Company's proprietary
software for preoperative surgical planning. The ORTHODOC is a part of the
ROBODOC System, but the Company also markets it separately. The ORTHODOC
converts CT scan data of a patient's femur into three-dimensional images, and
through a graphical user interface, allows the surgeon to examine the bone more
thoroughly and to select the optimal implant for the patient using a built-in
library of available implants. A tape of the planned surgical procedure,
developed by the ORTHODOC, guides the surgical robot arm of the ROBODOC System
to accurately mill a cavity in the bone, thus allowing the surgeon to properly
orient and align the implant. Prior to the development of the DigiMatch(TM)
Single Surgery System, two titanium locator pins were placed in the patient's
femur in an outpatient procedure before the primary surgery. These locator pins
were used during the primary procedure to orient the ROBODOC System to the
ORTHODOC preoperative plan. With the development of the DigiMatch technology,
this pre-operative outpatient procedure has been eliminated. The orientation of
the patient is now accomplished using a proprietary, pinless registration
system. Non-clinical scientific data published by scientists from the Company
and IBM demonstrate that as a result of the precise milling of a cavity, the
ROBODOC System achieves over 95% bone-to-implant contact, as compared to an
average of 20% bone-to-implant contact when surgery is performed manually.
Total hip arthroplasty ("THA") surgery involves the insertion of an implant
into a cavity created in the patient's femur. The Company believes that precise
fit and correct alignment of the implant within the femoral cavity are key
factors in the long-term success of THA surgery. In conventional THA surgery, a
bone cavity is cut in the shape of the implant manually with metal tools, and
the surgical plan, including the selection of the size and shape of the implant,
is generally formulated based upon patient data obtained from two-dimensional
x-ray images of the patient's femur. Based upon clinical experience to date in
Europe with the ROBODOC System, patients generally have become weight-bearing in
a shorter period than generally experienced by patients who have had this
surgery performed manually. In addition, clinical data obtained from trials in
Europe and the United States indicates that intraoperative fractures have been
dramatically reduced in the THA surgeries performed with the ROBODOC System (to
the Company's knowledge, no intraoperative fractures have resulted from THA
surgeries performed with the ROBODOC System to date). The Company also believes
fewer hip revision surgeries (implant replacements) may be necessary for
patients who have had primary THA surgery performed with the ROBODOC System, as
compared to patients who have this surgery performed manually.
In the past, a majority of THA implants have been held in place with
acrylic cement, which fills the spaces between the implant and the bone, thereby
anchoring the implant to the femoral cavity ("cemented implants"). During the
1980s, implants that did not require cement ("cementless implants") were
developed with materials designed to stimulate bone ingrowth. The selection of a
cemented or cementless implant
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generally is based upon a patient's bone condition and structure, age and
activity level. Typically, cemented implants are used for older, less active
patients. Furthermore, most implants require replacement within five to 20 years
of the first operation. The software package developed by the Company in
collaboration with IBM and Johns Hopkins University eliminates the distortion of
the x-ray images of the patient's femur used in planning hip revision surgery
caused by the metal in the existing implant. A surgeon using this proprietary
hip revision software will have a clearer view of the remaining bone in planning
hip revision surgery and therefore will be better able to plan the surgery to
have the ROBODOC remove fragmented cement without removing any of the remaining
thin thigh bone.
The Company has developed and commenced marketing to its customers in
Europe the DigiMatch Single Surgery System, that, in most cases, eliminates the
need for an initial surgery to place registration pins in a patient's femur
before using the ROBODOC System in total hip replacement surgery. More than 200
patient surgeries have been successfully performed at the
Berufsgenossenschaftliche Unfallklinik ("BGU") in Frankfurt, Germany as well as
at other customer sites with the DigiMatch Single Surgery System.
The Company plans to amend its investigational device exemption under the
Food, Drug and Cosmetic Act, which allowed it to conduct clinical trials for the
ROBODOC System in the United States, to permit it to perform a relatively small
clinical study showing a correlation between the ROBODOC System using the
DigiMatch System technology and the three pin system that was used in its
initial clinical evaluations. The Company has deferred the filing of its
pre-market approval application to market the ROBODOC System in the United
States so that it may incorporate the DigiMatch Single Surgery System, and
possibly other technical developments, as part of its pre-market approval
application. The Company believes, based upon discussions with representatives
of the FDA, that the incorporation of the DigiMatch Single Surgery System will
enhance its prospects for obtaining FDA approval. However, there can be no
assurance as to when or if the FDA will approve the Company's pre-market
approval application to market the ROBODOC System or that such approval, if
obtained, will not include unfavorable limitations or restrictions.
NEUROSURGICAL BUSINESS
The Company entered the neurosurgical business through the acquisition of
Innovative Medical Machines International, S.A. ("IMMI") on September 5, 1997.
The Company's principal neurosurgical product is the NeuroMate System,
consisting of an image-guided, computer-controlled robotic arm, head stabilizer
and monitor. The Company also offers a workstation with presurgical planning
software through arrangements with original equipment manufacturers.
The NeuroMate System has been used to perform over 1,800 neurosurgical
procedures in France and Japan. The Company believes that the NeuroMate System,
which uses IMMI's proprietary robotic arm and control systems designed
specifically for use in the operating room, is the only image-guided, computer-
controlled robot currently in use to precisely position and hold critical tools
used in the performance of neurosurgical procedures.
Stereotactic neurosurgery is a minimally invasive approach to operating on
the brain. Because the brain is largely unexposed, it requires the surgeon to
work without direct visualization of the brain itself. This is overcome by a
thorough understanding of brain anatomy and by using a spatial coordinate system
that allows the surgeon to "navigate" within the brain without directly
visualizing it. Essentially, the coordinate space of the patient's brain is
correlated to the patient's own CT, magnetic resonance (MR) or other images by
using anatomical landmarks that are shared by the patient and the images. This
is known as "registration" of the patient's coordinate space to the coordinate
space of the images. Once this is accomplished, the patient's CT scan can be
used to guide the surgeon to specific sites within the brain through small holes
the surgeon has made in the cranium (i.e., not necessitating a craniotomy).
POTENTIAL ORTHOPAEDIC AND NEUROSURGICAL APPLICATIONS
The Company intends to offer separate software packages supporting each new
robotic application, when developed by the Company. Some of these developments
may be given to the Company's customers without charge. Customers may be
required to pay for other developments, such as alternative prosthesis software.
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Consequently, the Company's customers would be able to use the Systems as
platforms to perform a variety of surgical procedures without incurring
significant additional hardware costs. The Company plans to develop software
packages for the following orthopaedic surgical and neurosurgical procedures.
- POTENTIAL ORTHOPAEDIC APPLICATIONS
Total Knee Replacement. The Company plans to develop a software package
for total knee replacement ("TKR") surgery using the ROBODOC System. The
proposed application module is intended to enable the ROBODOC System to select
the optimal implant for the patient and make accurate cuts in the bone, thus
allowing the surgeon to properly orient and align the implant. The proposed
application module to be developed by the Company for TKR surgery performed with
the ROBODOC System, when developed, is intended to result in a precise and
accurate fit for implants that are properly sized and placed, regardless of bone
quality. Furthermore, the Company believes that if and when this application
module is developed, implant longevity and the prognosis for restored
biomechanics will be significantly improved as a result of TKR surgery performed
with the ROBODOC System.
Acetabulum Replacement and Revision. The Company plans to complement the
THA femoral replacement application with acetabular cup planning and bone
preparation for hip socket replacement surgery. Currently, surgeons estimate the
size of the cup-shaped cavity in hip socket surgery using x-rays, which are
subject to distortion. Working in a narrow space with a limited view, the
surgeon ultimately selects the final cup size through trial and error. Due to
the limitations of available surgical tools, the surgeon is obliged to use a
hemispheric reamer and cup, although the human acetabulum (hip socket) is an
irregular shape. The Company believes that the application module for this
application, when developed, would enable the computer-controlled robot to
prepare an accurate bed for the implant, based on its specifications, and could
prepare an irregularly shaped socket for a custom or anatomically-shaped
acetabular component. The three-dimensional capability of the ORTHODOC would
better enable it to determine and display the irregular shape of the acetabulum
and instruct the robot to prepare the proper socket. This procedure potentially
could solve the problem of leg-length discrepancies which often originate at the
acetabulum.
Osteotomies. Osteotomies are precise cuts in bone intended to reshape or
realign abnormal or deformed structures. The Company's engineers have generated
a detailed work plan to adapt the ROBODOC System for use in performing long-bone
osteotomies on femurs and tibias (i.e., shin bones). The proposed application
module for this application, when developed, is intended to enable the surgeon
using the views of the bone created by the ORTHODOC from CT scan data, to make
trial cuts, remove bone and manipulate the remaining fragments, and experiment
with the appropriate placement of plates and screws. The surgeon's final plan
would be saved on a tape that would instruct the robot where to make saw cuts.
The computer-controlled robot would then orient itself in space by using
topographical features of the operative bone. A fixator would secure the bone to
the robot. The computer-controlled robot would then pre-place screw holes to
facilitate the final realignment and make the actual cuts.
- POTENTIAL NEUROSURGICAL APPLICATIONS
Spine surgery. Surgical interventions in the spine generally involve tumor
biopsy/resection; vascular repair; implants of plates, rods, screws, or other
implantable devices or substances; and bone fusions of various types. The
Company believes that its image-directed, computer-controlled robotic technology
is applicable in most of these interventions and will significantly enhance
precision and accuracy in many of them. Spine surgery is a large segment of both
neurosurgery and orthopaedic surgery, as the nature of the abnormality may
involve the nervous system or the vertebral column, or both. A significant part
of this application involves the insertion of vertebral pedicle screws,
discussed below.
Vertebral Pedicle Screws. Pedicle screws are used to fuse vertebrae in
need of repair due to trauma or herniated disc disease. The procedure involves
the placement of screws straight down the center of an irregular section of a
fragile bone only twice the diameter of the screw itself. Precise placement of a
screw affects the outcome of the surgery. Misplacement of a screw can result in
failure of the repair, trauma to the adjacent spinal cord, or rupture of nearby
blood sinuses which can hemorrhage severely. The Company believes that when the
development of the proposed application module for this surgical procedure is
completed, the
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NeuroMate System will be capable of performing this surgical procedure more
safely and effectively than surgery performed manually since the
computer-controlled robot is better able to precisely orient its tool in a
manner compatible with what is required for screw placement.
MARKETING, SALES AND DISTRIBUTION
The ROBODOC System cannot be marketed in the United States until clearance
or approval is obtained from the FDA. The Company has received 510(k) clearance
from the FDA to sell the ORTHODOC in the United States. The NeuroMate System
also has received 510(k) clearance from the FDA for marketing in the United
States and from the Japanese Ministry of Health for marketing in Japan.
Presentations to potential customers focus on the clinical benefits obtained by
patients, and the potential financial and marketing benefits obtained by
hospitals and surgeons.
The Company has commenced marketing the ROBODOC System to orthopaedic and
trauma surgeons and hospitals in Europe through direct sales and arrangements
with implant manufacturers. To date, the Company's direct sales efforts have
been primarily in Germany and Austria. Over 1,600 THA surgeries have been
performed with the ROBODOC Systems at the BGU clinic in Frankfurt, Germany since
August 1994. As result of a significant increase in the number of THA surgeries
performed at the clinic with the ROBODOC System, the BGU clinic purchased a
second ROBODOC System in the second quarter of 1996. The Company has been
marketing the ORTHODOC to hospitals, orthopaedic surgeons and implant
manufacturers in the United States since early 1998.
The NeuroMate System is marketed in Europe through a direct sales force, in
Japan through a Japanese distributor, and in the United States through a direct
sales force and select distributors.
The Company promotes its products through presentations at trade shows and
advertisements in professional journals and technical and clinical publications,
as well as through direct mail campaigns.
MANUFACTURING
The Company's production process consists primarily of final assembly of
purchased components, testing of the products and packaging, and is conducted at
its facilities in Davis, California and Lyon, France. The Company purchases
substantially all the components for its systems from outside vendors, then
assembles these parts and installs its proprietary software.
The ROBODOC System consists of the robot, base and the control cabinet,
which are connected through four interface cables, and the ORTHODOC. The
NeuroMate System consists of a robot arm, electronics control and base. Sankyo
Seiki of Japan supplies the robot for the ROBODOC System customized to the
Company's specifications and Audemars-Piguet supplies the customized robot for
the NeuroMate System. Upon delivery of a robot, the Company performs a series of
tests to verify proper functioning. The customization and supply process for the
robots currently requires approximately four months lead time. While the robots
can be obtained from other suppliers with appropriate modifications and
engineering effort, there can be no assurance that delays resulting from the
required modifications or engineering effort to adopt alternative components
would not adversely affect the Company. Ancillary items required to perform
robotic surgeries, including devices for fixing the hip and attaching it to the
robot, numerous probes, cutter bearing sleeves and tool guides, are assembled
and tested separately.
Consumables, including sterile drapes, bone screws, cutters and pendants,
are also manufactured by outside vendors according to the Company's
specification and are inspected upon receipt to ensure that these specifications
are consistently met. The Company purchases these items in quantity and
distributes them on a per order basis. The Company also coordinates the
packaging and sterilization of certain items. The Company's policy is to procure
its consumables from vendors that it approves after ensuring that the goods
comply with the Company's sterilization requirements.
The ORTHODOC consists of a pentium-based computer workstation and
associated peripherals, and includes the Company's proprietary software. The
Company purchases and then tests the computer as a complete package. A computer
board is added to interface to CT/x-ray scanner input modules and, if
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required, the ROBODOC System's tape output drive. The hard drive is reformatted
to accept the operating system, and appropriate ORTHODOC software is installed.
The unit is configured for 110 or 220 AC volt operation.
The Company's production facilities are subject to periodic inspection by
the FDA for compliance with Good Manufacturing Practices ("GMP"). In addition,
the Company's products will be required to satisfy European manufacturing
standards for sale in Europe. The Company believes that it is in compliance with
GMP and it has obtained ISO-9001 certification, which is required for sales of
its products in Europe.
RESEARCH AND DEVELOPMENT
Since its inception, the Company's research and development activities have
focused on the development of innovative image-directed computer-controlled
robotic products for surgical applications and operating software for these
products. The Company incurred research and development expenses of
approximately $3,064,000 and $6,603,000 in connection with the development of
the ROBODOC System, the ORTHODOC and the NeuroMate System for the years ended
December 31, 1997 and December 31, 1998, respectively.
The Company offers its customers a software package for hip revision
surgery, which was developed in collaboration with IBM and Johns Hopkins
University and funded in part by a grant from the National Institute for
Standards and Technology (Advanced Technology Program) of the United States
Department of Commerce ("NIST"). Hip revision surgery generally is difficult,
time consuming and complex. The metal in the existing implant distorts x-ray
images used for planning the surgery, obstructing the remaining bone and, if a
cemented implant is to be replaced, the location of the cement mantle. The
removal of the cement mantle without removing any of the remaining thin bone
structure is a major challenge for the surgeon. The Company believes that its
hip revision application module improves surgical planning for hip revision
surgery and enables the robot to remove cement more precisely than if the hip
revision procedure were performed manually.
Under the terms of the NIST grant, the Company, IBM and Johns Hopkins
University are entitled to reimbursement for 49% of the expenses incurred in
connection with the project for a period of three years. The maximum amount of
expenses subject to reimbursement under the grant is approximately $4,000,000,
so that not more than $1,960,000 in expenses may be reimbursed in the aggregate
to the Company, IBM and Johns Hopkins University under the grant. The Company
has incurred research and development expenses of approximately $2,471,000 in
connection with the NIST project through December 31, 1998. As of December 31,
1998, the Company had received approximately $996,000 under the terms of the
grant.
The Company offers a number of lines of prostheses in its software library
of hip implants on its ORTHODOC. It is expanding the library to include multiple
implant lines, revision stems, and custom-made prostheses. In 1998, the Company
received orders from Howmedica (a division of Stryker Corporation), DePuy Inc.
(a subsidiary of Johnson & Johnson), Aesculap, AG & Co. KG, Zimmer Inc. (a
subsidiary of Bristol-Myers Squibb Company) and PLUS Endoprothetik A.G. to add
their respective hip prostheses to its existing software library. When
completed, the ROBODOC System will support 14 lines of popular prostheses from
seven of the largest orthopaedic companies in the world. The Company will
further expand the library of implants used at clinical sites to include
multiple implant lines, revision stems, and custom-made prostheses. The Company
has also commenced preliminary work with respect to the application of the base
technology for total knee replacement and acetabular cup replacement.
IMMI is the recipient of an interest-free loan from ANVAR (a national
agency in France established to aid research and development projects) in the
amount of approximately $143,200. This loan provides funding for the development
of the NeuroMate System for spine surgery. This project is currently in its
first phase of development in connection with a University hospital in Lille,
France. Under certain conditions (e.g., if at the completion of the project it
is not deemed a "success") there will be no requirement to repay the loan.
IMMI also is the recipient of a grant from ANVAR in the amount of
approximately $222,000, of which IMMI had received $174,000 as of December 31,
1998. This grant funds 50% of the cost to build and install
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NeuroMate Systems at two clinics in France as well as the costs to perform a
clinical study at these sites over a period of fifteen months commencing March
1997.
COMPETITION
The principal competition for the ROBODOC System is manual surgery
performed by orthopaedic surgeons, using surgical power tools and manual
devices. The providers of these instruments are the major orthopaedic companies,
which include Howmedica, Inc. (a division of Stryker Corporation), located in
New York; Zimmer, Inc. (a subsidiary of Bristol-Myers Squibb Company), located
in Indiana; Johnson & Johnson Orthopaedics, Inc. (a subsidiary of Johnson &
Johnson), located in New Jersey; DePuy, Inc. (a subsidiary of Johnson &
Johnson), located in Indiana; Biomet, Inc. located in Indiana; and Osteonics,
Inc. (a subsidiary of the Stryker Corporation), located in New Jersey. MAQUET, a
manufacturer of operating tables located in Germany, recently entered the market
with a device similar to ROBODOC. The principal competition for NeuroMate is
from manufacturers of frame-based and frameless stereotactic systems, some of
which are commonly called "navigators". Approximately twenty navigator models
have been introduced, including those by Radionics, Sofamor Danek, and Ohio
Medical Surgical Products, all located in the U.S.; Elekta, located in Sweden;
and, Fischer Leibingher and Brain Lab, both located in Germany. In addition,
there are companies in the medical products industry capable of developing and
marketing computer-controlled robotic systems for surgical applications, many of
whom have significantly greater financial, technical, manufacturing, marketing
and distribution resources than those of the Company, and have established
reputations in the medical device industry. However, the Company believes that
it enjoys a significant competitive advantage over such companies in view of the
time required to develop an image-directed, computer controlled robotic system
and to obtain the necessary regulatory approvals, including the sponsorship of
clinical trials. There can be no assurance that future competition will not have
a material adverse effect on the Company's business.
The Company's ROBODOC System represents a significant technological
advancement with respect to the manner in which THR surgery is performed. The
Company's image-directed, computer-controlled, robotic technology is intended to
complement, rather than replace, surgeons in performing THA and other
orthopaedic surgeries. Although there are companies which market technologically
advanced surgical tools used by surgeons in performing orthopaedic surgeries,
including passive robot systems that direct the surgeon in planning and
performing surgical procedures (e.g., aiming and holding devices), the Company
believes that the ROBODOC System is the most technologically advanced active
robotic system that performs a key segment of THA surgery (i.e., milling a bone
cavity) under the supervision of a surgeon.
The Company believes the NeuroMate System is the only robotic system
presently used for neurosurgery which provides superior accuracy and flexibility
as compared to other techniques.
WARRANTY AND SERVICE
The Company offers a full warranty, covering parts and labor, for the first
year following the purchase of its products, which warranty coverage can be
extended on an annual basis by purchasing a maintenance agreement at a price
negotiated on a customer by customer basis.
The Company trains its customers with its in-house technical staff and
services its customers with a direct service staff located in Europe. As needed,
technical support also is provided from the U.S. engineering organization.
PATENTS AND PROPRIETARY RIGHTS
The Company relies on a combination of patent, trade secret, copyright and
trademark laws and contractual restrictions to establish and protect proprietary
rights in its products and to maintain its competitive position.
The Company has been issued four U.S. patents and has filed seven patent
applications covering various aspects of its technology. In addition, IBM has
agreed not to assert infringement claims against the Company with respect to an
IBM patent relating to robotic medical technology, to the extent such technology
is used in
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the Company's products. Furthermore, significant portions of the ORTHODOC and
ROBODOC System software are protected by copyrights. IBM has granted the Company
a royalty-free license for the underlying software code for the ROBODOC System.
In addition, the Company has registered the marks ROBODOC and ORTHODOC.
GOVERNMENT REGULATION
The medical devices to be marketed and manufactured by the Company are
subject to extensive regulation by the FDA and, in some instances, by foreign
and state governments. Pursuant to the Federal Food, Drug, and Cosmetic Act of
1976, as amended, and the regulations promulgated thereunder (the "FDC Act"),
the FDA regulates the clinical testing, manufacturing, labeling, distribution,
and promotion of medical devices. Noncompliance with applicable requirements can
result in, among other things, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant pre-market clearance or pre-market approval for devices,
withdrawal of marketing clearances or approvals, and criminal prosecution. The
FDA also has the authority to request repair, replacement or refund of the cost
of any device manufactured or distributed by the Company.
Any products manufactured or distributed by the Company pursuant to the FDA
clearances or approvals are subject to pervasive and continuing regulation by
the FDA, including quality system requirements ("QSR"), documentation and
reporting of adverse experiences with the use of the device. Device
manufacturers are required to register their establishments and list their
devices with the FDA and with certain state agencies and are subject to periodic
compliance inspections by the FDA and certain state agencies.
Following a pre-filing meeting with representatives of the FDA in early
1998, the Company stated that it intended to file its pre-market approval
application to market the ROBODOC System with the FDA as part of the
pre-submission review process (which process is intended to expedite the FDA's
formal pre-market approval process). The Company has deferred the filing of its
pre-market approval application with the FDA so that it may incorporate the
DigiMatch Single Surgery System, and possibly other technical developments, as
part of its pre-market approval application. The Company believes, based upon
discussions with representatives of the FDA, that the incorporation of the
DigiMatch Single Surgery System will enhance its prospects for obtaining FDA
approval. There can be no assurance as to when or if the FDA will grant PMA
approval to the ROBODOC System or that such approval, if obtained, will not
include unfavorable limitations or restrictions.
After receipt of PMA approval, if any, the Company expects that the FDA
would consider new surgical applications for the ROBODOC System to be new
indications for use, which generally would require FDA approval of a PMA
supplement, 510(k) submission or, possibly a new PMA. The FDA is also likely to
require additional approvals before the agency will permit the Company to
incorporate new imaging modalities (such as ultrasound and MRI) or other
different technologies in the ROBODOC System. The FDA likely will require new
clinical data to support new indications and enhanced technological
characteristics.
In February 1996, the Company filed a 510(k) submission for the ORTHODOC as
a stand-alone device. This 510(k) was the first product submission filed by the
Company with the FDA. In January 1997, the ORTHODOC received clearance from the
FDA for marketing in the United States. The NeuroMate System received 510(k)
clearance from the FDA for marketing in the United States in May 1997. Medical
device companies may make regulatory decisions that non-significant
modifications to a 510(k) cleared product do not require additional regulatory
submissions or notifications.
Labeling and promotion activities are subject to scrutiny by the FDA and,
in certain instances, by the Federal Trade Commission. Current FDA enforcement
policy prohibits marketing approved medical devices for unapproved uses. The
Company and its products are also subject to a variety of state laws and
regulations in those states or localities where its products are or will be
marketed. Any applicable state or local regulations may hinder the Company's
ability to market its products in those states or localities. Manufacturers are
also subject to numerous federal, state and local laws relating to such matters
as safe working conditions, manufacturing practices, environmental protection,
fire hazard control and disposal of hazardous or potentially hazardous
substances. There can be no assurance that the Company will not be required to
incur significant
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<PAGE> 9
costs to comply with such laws and regulations now or in the future or that such
laws or regulations will not have a material adverse effect upon the Company's
business, financial condition or results of operations.
Exports of products subject to the 510(k) notification requirements, but
not yet cleared to market, are permitted without FDA export approval provided
certain requirements are met. Unapproved products subject to the PMA
requirements must receive prior FDA export approval unless they are approved for
use by any member country of the European Union and certain other countries,
including Australia, Canada, Israel, Japan, New Zealand, Switzerland and South
Africa, in which case they can be exported to any country without prior FDA
approval. To obtain FDA export approval, when it is required, certain
requirements must be met and information must be provided to the FDA, including
documentation demonstrating that the product is approved for import into the
country to which it is to be exported and, in some instances, safety data from
animal or human studies.
The introduction of the Company's products in foreign markets has subjected
and will continue to subject the Company to foreign regulatory clearances which
may impose additional substantive costs and burdens. International sales of
medical devices are subject to the regulatory requirements of each country. The
regulatory review process varies from country to country. Many countries also
impose product standards, packaging requirements, labeling requirements and
import restrictions on devices. In addition, each country has its own tariff
regulations, duties and tax requirements.
The ROBODOC System satisfies international electromedical standard IEC
601-1 and the protection requirements of the Electromagnetic Compatibility
Directive (89/336/EEC), thus allowing the Company to apply the CE Mark. This
conformity is evidenced by the grant of a GS-Mark by Technische Uebermachungs
Verein Rheinland ("TUV"), a testing body in Germany, under current German
regulations. The ROBODOC System also satisfies the relevant provisions of the
Medical Device Directive for a Class II b Medical Device.
The NeuroMate System satisfies the relevant provisions of the Medical
Device Directive for a Class IIb Medical Device, thus allowing the Company to
apply the CE Mark. In June 1997, the NeuroMate System received clearance from
the Japanese Ministry of Health for marketing in Japan.
PRODUCT LIABILITY
The manufacture and sale of medical products exposes the Company to the
risk of significant damages from product liability claims. The Company maintains
product liability insurance against product liability claims in the amount of $5
million per occurrence and $5 million in the aggregate. There can be no
assurance, however, that the coverage limits of the Company's insurance policies
will be adequate, that the Company will continue to be able to procure and
maintain such insurance coverage, or that such insurance can be maintained at
acceptable costs. Although the Company has not experienced any product liability
claims to date, a successful claim brought against the Company in excess of its
insurance coverage could have a materially adverse effect on the Company's
business, financial condition, and results of operations.
EMPLOYEES
As of March 5, 1999, the Company had 84 full time employees, including 44
in research and development, 7 in manufacturing, 8 in regulatory affairs and
quality assurance, 14 in sales and marketing and 11 in administration. Except
for the employees of IMMI, none of the Company's employees is covered by a
collective bargaining agreement. The Company believes its relationship with its
employees is satisfactory.
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's executive offices and principal production facilities,
comprising a total of approximately 30,500 square feet of space, are located in
Davis, California. The Company occupies the facilities in Davis pursuant to a
lease that expires in September 2004. The lease provides for rent of $29,229 per
month (plus real estate taxes and assessments, utilities and maintenance),
through May 31, 1999, subject to adjustment in subsequent years for cumulative
increases in the cost of living index, not to exceed 4% per year.
The Company leases its European facility under a non-cancelable operating
lease. The lease is for a term of eight years and expires in 2006. The lease
provides for rent of $7,197 per month.
8
<PAGE> 10
ITEM 3. LEGAL PROCEEDINGS.
The Company is not a party to any pending legal proceeding and its property
is not subject to such proceeding.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of security holders, through the
solicitations of proxies or otherwise, during the fourth quarter of the fiscal
year ended December 31, 1998.
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
(a) The Company's Common Stock and redeemable Common Stock Purchase
Warrants ("Warrants") are traded on the Nasdaq SmallCap Market under the symbols
"RDOC" and "RDOCW", respectively. The Company's Common Stock and Warrants also
are listed on the Pacific Exchange under the symbols "ROB" and "ROBWS",
respectively.* Since November 21, 1997, the Common Stock also has been traded on
EASDAQ under the symbol "RDOC."
Set forth below are the high and low closing sale prices for the Common
Stock and Warrants on the Nasdaq SmallCap Market for each quarter since January
1, 1997.
<TABLE>
<CAPTION>
COMMON STOCK WARRANTS
("RDOC") ("RDOCW")
------------ --------------
QUARTER ENDED HIGH LOW HIGH LOW
- ------------- ---- ---- ---- ----
<S> <C> <C> <C> <C>
March 31, 1997........................................ $6 1/4 $5 $1 1/2 $ 5/8
June 30, 1997......................................... $7 5/8 $5 $2 1/4 $ 7/16
September 30, 1997.................................... $9 1/2 $6 1/2 $3 3/8 $1 1/2
December 31, 1997..................................... $9 $3 7/8 $3 1/8 $1
March 31, 1998........................................ $5 7/8 $3 15/16 $1 13/16 $1 1/8
June 30, 1998......................................... $7 5/16 $4 7/8 $2 3/4 $1 1/4
September 30, 1998.................................... $5 $3 $1 9/16 $ 11/16
December 31, 1998..................................... $4 9/16 $2 9/16 $1 1/4 $ 7/16
</TABLE>
(b) As of March 17, 1999, there were 119 holders of record of the Common
Stock and 10 holders of record of the Warrants. The Company believes that as of
March 17, 1999 there were approximately 1,500 and 400 beneficial owners of
Common Stock and Warrants, respectively.
- ---------------
* No trading activity has been reported by the Pacific Exchange.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION.
The following discussion and analysis relates to the operations of
Integrated Surgical Systems, Inc. and does not include the operations of IMMI,
except for the results of its operations subsequent to its acquisition by the
Company on September 5, 1997, and should be read in conjunction with the
consolidated financial statements of Integrated Surgical Systems, Inc.,
including the notes thereto, appearing elsewhere in this report.
RESULTS OF OPERATIONS
Net Sales. Net Sales for the year ended December 31, 1998 increased by
approximately $1,212,000 or 25% to $6,146,000 compared to $4,934,000 for year
ended December 31, 1997. This increase in net sales is due to the increase in
the sale of ROBODOC Systems. During 1998, nine systems were sold and two were
leased compared to seven sold and one leased year during 1997.
Cost of Sales. Cost of sales for 1998 was $3,413,000 or 56% of net sales
as compared to $3,183,000 or 44% of net sales for the prior year. The higher
cost as a percent of sales for 1998 is due primarily to discounts
9
<PAGE> 11
granted to several customers who placed orders for multiple systems.
Selling, General and Administrative. Selling, general and administrative
expenses for 1998 were $6,216,000 compared to $3,701,000 for 1997. Selling,
general and administrative expenses increased by $2,515,000 as the Company
staffed its European sales organization with additional sales, administrative,
and training personnel. Additionally, sales expenses increased with the addition
of a sales staff to begin the marketing of the ORTHODOC and NeuroMate in the
United States. Finally, 1998 was the first full year in which the expenses
associated with IMMI were reflected in the consolidated results of the Company.
IMMI was acquired in September of 1997.
Research and Development. Expenses for research and development during
1998 increased by 115% to $6,603,000 from $3,064,000 during 1997. During 1998,
the Company elected to aggressively pursue the development of its DigiMatch
Single Surgery System proprietary pinless registration technology. This
technology eliminates the need for a preliminary surgical procedure to place
pins in the patient's femur prior to the implant surgery and at the time a CT
image is taken of the patient's bone. Historically this was done to effect an
accurate correlation of the patient's CT image to the patient's femur in the THA
surgical procedure. In addition, the Company determined that it was
competitively appropriate to expend more resources on the development implant
base, thus providing its customers with the largest offering of implants from
which to select.
During 1998, the Company amortized $839,000 of identified intangible assets
acquired in the IMMI transaction in 1997. This charge was $559,000 higher than
the amount recorded in 1997. Similarly, 1998 was the first full year in which
research and development costs of were recorded in connection with IMMI.
Stock Compensation. During 1998, amounts expensed for stock compensation
decreased to $131,000 from $155,000 during 1997. Amounts decreased since there
were fewer shares of options that vested in 1998. Deferred compensation for the
non-vested portion is being amortized into expense over the vesting period of
the stock options, which generally range from three to four years. As of
December 31, 1998, there remains an additional $86,000 subject to being expensed
in future years.
Interest Income and Expense. For 1998, interest income amounted to
$241,000 compared to $215,000 in 1997. The difference is the result of generally
higher average cash balances during the year. During the 1998 year, the Company
also made borrowings against a revolving line of credit, and had other interest
expenses which, in total, generated interest expense in the amount of $124,000.
Foreign Currency Gain (Loss). Gains incurred in connection with foreign
currency transactions amounted to $129,158 in 1998 as a result of exchange rates
that weakened the U.S. Dollar relative to European currencies. In 1997,
transaction losses were approximately $147,000.
Other Income and Expense. Other expense for 1998 amounted to $270,000
compared to other income of $32,000 for the same period in 1997. In June 1998
the Company and six other investors agreed to organize a Dutch company to be
known as Marbella High Care B.V. for the purpose of capitalizing a Spanish
company to be known as Marbella High Care S/A ("MBHC") to develop a surgical and
rehabilitation center in Marbella, Spain. As of December 31, 1998, the Company
owned 22% of the outstanding shares of MBHC and accounts for its investment
under the equity method. The Company's investment in MBHC, including loans was
approximately $563,000 in 1998. For the year ended December 31, 1998, the
Company recorded $317,000 of expense relating to its investment and advances in
MBHC for the period, which has been included in other income (expense).
Preferred Stock Accretion. During 1998, the Company entered into a private
placement agreement whereby the Company's Series A Preferred Stock was placed
with two private investors. The terms of the preferred stock include a
Beneficial Conversion Feature. The value assigned to the Beneficial Conversion
Feature, as determined using the quoted market price of the Company's common
stock on the date the Series A Preferred Stock was sold, amounted to $616,000,
which represents a discount to the value of the Series A Preferred Stock (the
"Discount"). The Discount is being accreted using the straight-line method
through March 9, 1999. Approximately $376,000 of the Discount was accreted in
1998.
10
<PAGE> 12
Net Loss. The net loss applicable to common stockholders for 1998
increased by 138% from $4,478,000 in 1997 to $10,644,000 in 1998. The increase
in the loss is due primarily to lower gross margins, higher operating expenses,
the write-off of the Company's pro-rata share of losses on its investment in
MBHC, and amounts attributable to the preferred stock accretion in connection
with the private placement in September of 1998.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's expenses have exceeded net sales. Operations
have been funded primarily from the issuance of debt and the sale of equity
securities aggregating approximately $36.6 million. In addition, the Company was
the beneficiary of proceeds from a $3 million key-man life insurance policy in
1993 upon the death of one of its executives.
The Company used cash from operating activities of approximately $4,438,000
and $8,846,000 in 1997 and 1998, respectively. Net cash used for operations in
each of these periods resulted primarily from the net loss. Cash used for
operations in 1997 reflected an increase in accounts receivable and inventories.
Cash used for operations in 1998 reflected an increase in accounts receivable
and inventories, partially offset by an increase in customer deposits. The
Company is eligible to receive reimbursement for 49% of its qualified
expenditures under the terms of a grant from the National Institute for
Standards & Technology ("NST"). The Company received reimbursements from this
program of approximately $317,000 and $514,000 for 1997 and 1998, respectively.
The Company used cash in investing activities of approximately $924,000 and
$4,259,000 in 1997 and 1998, respectively. The Company's investing activities
have consisted primarily of expenditures for property and equipment that totaled
approximately $377,000 and $1,746,000 in 1997 and 1998, respectively,
investments in sales-type leases of approximately $453,000 in 1997 and payments
of $119,000 in connection with the purchase of IMMI in 1997. In 1998, the
Company also invested $2,024,000 in marketable securities and $563,000 in MBHC.
Cash provided by financing activities from inception through 1998 is
comprised principally of the net cash proceeds from the sale of a convertible
note in the principal amount of $3,000,000, the sale of convertible preferred
stock and warrants for $14,676,000, the sale of Common Stock and warrants for
approximately $6,137,000 resulting from the Company's initial public offering in
November 1996, approximately $8,440,000 from the Company's European offering of
Common Stock in November 1997, and the sale of convertible preferred stock and
warrants for $3,300,400 in September 1998. As part of the recapitalization of
the Company in December 1995, the entire $3,000,000 principal amount of the
convertible note, together with accrued interest thereon of approximately
$1,224,000, was converted into a warrant to purchase Common Stock. A total of
$11,734,000 and $2,942,000 of preferred stock and warrants to purchase preferred
stock was converted into Common Stock and warrants to purchase Common Stock in
December 1995 and November 1996, respectively. In 1998, the Company also
established a $1.5 million revolving credit facility with a bank. At December
31, 1998, the outstanding amount of debt against the revolving line of credit
was approximately $678,000.
The Company expects to incur additional operating losses at least through
1999. These losses will be as a result of expenditures related to product
development projects and the establishment of marketing, sales, service and
training organizations. The timing and amounts of these expenditures will depend
on many factors, some of which are beyond the Company's control. Such factors
include the requirements for, and the time required to secure, FDA authorization
to market the ROBODOC System, the progress of the Company's product development
projects and market acceptance of the Company's products. Based on the Company's
1999 business plan the Company expects its current funding and cash flows from
operations to be sufficient to finance its operations through 1999. It is
likely, however, that the Company may require external financing in 1999 to
accomplish its product development and marketing objectives and to prepare for
entry into the Japanese market. Should the Company not be able to secure
external financing in 1999, it will likely be required to scale back its product
development objectives, thus increasing the time required to bring enhancements
to the ROBODOC System's functionality to market.
11
<PAGE> 13
YEAR 2000 COMPLIANCE
The Company has a wide variety of computers and computer software used in
the normal course of business. In predominant use throughout the Company are
commercially available hardware and software products that are year 2000
compliant.
The Company has potential exposure to the year 2000 computer bug in two
areas. First, the Company's accounting and manufacturing system, which are not
year 2000 compliant, could cause disruption of business, if it could not be
upgraded or replaced by the end of 1999. Secondly, products are computer
controlled, and might not function if affected by the year 2000 bug. Company
products are not highly date sensitive, which minimizes the impact of any year
2000 issues identified.
Potential exposure in other areas is minimal. Any year 2000 problems with
the Company's network or software used for research and development and
engineering could adversely affect research and development and engineering
costs, but would not immediately affect the ability to continue operations. Such
issues could also be resolved in short order with commercially available
products. Many of our major product components have relatively long lead times.
Temporary interruptions in our supplies caused by any year 2000 issues would not
significantly impact our manufacturing schedule, or our ability to service
customers. In general, the company has determined that there is a minimal
exposure to year 2000 problems through third parties.
The Company is in the process of selecting a solution for its accounting
and manufacturing computer system. We plan to complete the replacement or
upgrade by the beginning of the fourth quarter of 1999. The Company has
completed initial investigations of its products and concluded that there is
minimal risk of system failure due to the year 2000 problem. The Company will
complete all testing by the end of April 1999.
It is estimated that the Company will need to spend less than $100,000 to
become year 2000 compliant. The majority of this cost relates to upgrading or
replacing the Company's accounting and manufacturing system. Expenses include
the testing conducted by the Quality Department, Engineering Department
involvement in testing and de-bugging, and the Service Department upgrades to
customer equipment if any such service is required.
In the worst case scenarios, the Company believes that it would have
minimal business interruption due to any foreseeable year 2000 problems.
Management believes alternate vendors, and off the shelf solutions will be
available to solve any of the Company's undetected problems. In addition, the
Company is small enough to allow it to function with minimal operating
procedures for short periods of time.
Year 2000 project cost is based on management's best estimate and actual
results could differ from those anticipated. If the Company or its vendors are
unable to resolve the year 2000 issue in a timely manner, or if there are
significant undetected year 2000 issues, such matters could have a material
impact on the Company's results of operations. However, the Company believes the
necessary modifications and replacement of computer systems will be completed in
1999 and, as a result, the year 2000 issue is not expected to pose significant
operational or financial problems for the Company.
ITEM 7. FINANCIAL STATEMENTS.
The financial statements follow Item 13 of this report.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
The Company did not have any changes in or disagreements with its
accountants on accounting and financial disclosure.
12
<PAGE> 14
ITEM III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, AND PROMOTION AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.
The information called for by this Item is incorporated by reference to the
Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A.
ITEM 10. EXECUTIVE COMPENSATION.
The information called for by this Item is incorporated by reference to the
Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information called for by this Item is incorporated by reference to the
Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information called for by this Item is incorporated by reference to the
Company's definitive proxy statement for the 1999 Annual Meeting of Stockholders
to be filed pursuant to Regulation 14A.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S>
3.1 Form of Certificate of Incorporation of the Registrant, as
amended.
3.2 By-laws of the Registrant.*
4.1 Form of warrant issued to the underwriters for the
Registrant's initial public offering in November 1996.*
4.2 Form of Warrant Agreement relating to the Registrant's
Redeemable Common Stock Purchase Warrants.*
4.3 Specimen Common Stock Certificate.*
4.4 Specimen Warrant Certificate (included as Exhibit A to
Exhibit 4.2 herein).*
4.5 1998 Stock Option Plan.***
4.6 Employee Stock Purchase Plan.***
4.7 Common Stock Purchase Warrant issued by the Registrant to
International Business Machines Corporation ("IBM"), dated
February 6, 1991, as amended (included as Exhibit J to
Exhibit 10.5 herein).*
4.8 Stockholders' Agreement between the Founders of the
Registrant and IBM, dated February 6, 1991, as amended.*
4.9 Common Stock Purchase Warrant issued by the Registrant to
IBM, dated December 21, 1995 (included as Exhibit I to
Exhibit 10.5 herein).*
4.10 Series D Preferred Stock Purchase Warrant issued by the
Company to IBM, dated December 21, 1995 (included as Exhibit
H to Exhibit 10.5 herein).*
4.11 Warrant issued by the Registrant to Sutter Health, Sutter
Health Venture Partners ("Sutter Health VP") and Keystone
Financial Corporation ("Keystone"), dated December 21, 1995
(included as Exhibits K, L and M, respectively, to Exhibit
10.5 herein).*
4.12 Registration Rights Agreement among the Registrant, IBM,
John N. Kapoor Trust ("Kapoor"), EJ Financial Investments V,
L.P. ("EJ Financial"), Keystone, Sutter Health and Sutter
Health VP, dated as of December 21, 1995 (included as
Exhibit G to Exhibit 10.5 herein).*
</TABLE>
13
<PAGE> 15
<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S>
4.13 1995 Stock Option Plan, as amended.*
4.14 Series D Preferred Stock Purchase Warrant issued by the
Registrant to IBM, dated February 29, 1996 (together with
the warrant referred to in Exhibit 4.10, the "Series D
Warrants").*
4.15 Form of Lock-up Agreement.*
4.16 Letter Agreement between the Registrant and IBM dated
October 29, 1997, amending the Series D Warrants and the
Series D Preferred Stock and Warrant Purchase Agreement
among the Registrant, IBM and EJ Financial, dated December
21, 1995.**
4.17 Form of warrant issued to CA IB Investmentbank
Aktiengesellschaft and Value Management & Research GmbH.**
4.18 Preferred Stock Purchase Agreement, as amended.****
4.19 Certificate of Designations for Series A Convertible
Preferred Stock.****
4.20 Form of Warrant issued to purchasers of Series A Convertible
Preferred Stock.****
4.21 Form of Registration Rights Agreement for Series A
Convertible Preferred Stock financing.****
10.1 Loan and Warrant Purchase Agreement between the Registrant
and IBM, dated as of February 6, 1991.*
10.2 License Agreement between the Registrant and IBM, dated
February 4, 1991.*
10.3 Series B Preferred Stock Purchase Agreement among the
Registrant, Sutter Health and The John N. Kapoor Trust,
dated as of April 10, 1992.*
10.4 Series C Preferred Stock Purchase Agreement among the
Registrant, Sutter Health and Keystone, dated as of November
13, 1992, as amended December 13, 1995.*
10.5 Series D Preferred Stock and Warrant Purchase Agreement
among the Registrant, IBM and EJ Financial, dated December
21, 1995.*
10.6 Investors Agreement among the Registrant, IBM, Wendy
Shelton-Paul Trust, William Bargar, Brent Mittelstadt, Peter
Kazanzides, Kapoor, Sutter Health, Sutter Health VP and EJ
Financial, dated as of December 21, 1995 (included as
Exhibit F to Exhibit 10.5 herein).*
10.7 Employment Agreement between the Registrant and Ramesh
Trivedi, dated December 8, 1995.*
10.8 License Agreement between the Registrant and IBM, dated
February 4, 1991.*
10.9 Agreement for the Purchase and Use of Sankyo Industrial
Products between the Registrant and Sankyo Seiki (American)
Inc. dated November 1, 1992.*
10.10 Stock Purchase Agreement dated as of September 5, 1997
between the Registrant and the holders of the outstanding
capital stock of Innovative Medical Machines International,
S.A.**
10.11 Registration Rights Agreement dated September 5, 1997 by and
among the Registrant and the holders of the outstanding
capital stock of Innovative Medical Machines International,
S.A.**
23.1 Consent of Ernst & Young LLP, Independent Auditors.
27.1 Financial Data Schedule.
</TABLE>
- ---------------
* Incorporated by reference to the Company's Registration Statement on Form
SB-2 (Registration No. 3339207), declared effective on November 20, 1996.
** Incorporated by reference to the Company's Registration Statement on Form
SB-2 (Registration No. 333-31481), declared effective on November 14, 1997.
*** Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the fiscal year ended December 31, 1997.
**** Incorporated by reference to the Company's Registration Statement on Form
S-3 (Registration No. 333-66133), declared effective on January 14, 1999.
14
<PAGE> 16
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
INTEGRATED SURGICAL SYSTEMS, INC.
By: /s/ RAMESH C. TRIVEDI
------------------------------------
Ramesh C. Trivedi, President
(Principal Executive Officer)
By: /s/ MARK W. WINN
------------------------------------
Mark W. Winn, Chief Financial
Officer
(Principal Financial and Accounting
Officer)
Dated: March 25, 1999
In accordance with the Securities Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Registrant on March
25, 1999 in the capacities indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE
--------- -----
<S> <C>
/s/ RAMESH C. TRIVEDI Chief Executive Officer, President and a
- ----------------------------------------------------- Director (Principal Executive Officer)
Ramesh C. Trivedi
/s/ MARK W. WINN Chief Financial Officer (Principal Financial
- ----------------------------------------------------- and Accounting Officer)
Mark W. Winn
/s/ JAMES C. MCGRODDY Director
- -----------------------------------------------------
James C. McGroddy
/s/ JOHN N. KAPOOR Director
- -----------------------------------------------------
John N. Kapoor
/s/ PAUL A.H. PANKOW Director
- -----------------------------------------------------
Paul A.H. Pankow
Director
- -----------------------------------------------------
Gerald D. Knudson
/s/ PATRICK G. HAYS Director
- -----------------------------------------------------
Patrick G. Hays
</TABLE>
15
<PAGE> 17
INTEGRATED SURGICAL SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Ernst & Young LLP, Independent Auditors........... F-2
Consolidated Balance Sheet at December 31, 1998............. F-3
Consolidated Statements of Operations for the years ended
December 31, 1997 and 1998................................ F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997 and 1998.................... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997 and 1998................................ F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 18
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Integrated Surgical Systems, Inc.
We have audited the accompanying consolidated balance sheet of Integrated
Surgical Systems, Inc. as of December 31, 1998, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the years
ended December 31, 1997 and 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Integrated
Surgical Systems, Inc. at December 31, 1998, and the consolidated results of its
operations and its cash flows for the years ended December 31, 1997 and 1998 in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Sacramento, California
February 12, 1999
F-2
<PAGE> 19
INTEGRATED SURGICAL SYSTEMS, INC.
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 1998
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 223,581
Short-term investments.................................... 2,024,278
Accounts receivable....................................... 1,905,138
Inventory................................................. 3,005,658
Other current assets...................................... 464,421
------------
Total current assets........................................ 7,623,076
Net property and equipment.................................. 1,350,839
Leased equipment, net....................................... 641,411
Long-term net investment in sales-type leases............... 262,334
Intangible assets, net...................................... 3,014,978
Other assets................................................ 272,532
------------
$ 13,165,170
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 1,475,754
Value added taxes payable................................. 347,584
Accrued payroll and related expenses...................... 471,278
Customer deposits......................................... 896,276
Accrued product retrofit costs............................ 135,348
Current portion of bank loans............................. 897,021
Other current liabilities................................. 732,594
------------
Total current liabilities................................... 4,955,855
Bank loans, long term....................................... 7,505
Note payable................................................ 143,200
Commitments and contingencies (Notes 10 and 11)
Stockholders' equity:
Convertible preferred stock, $0.01 par value, 1,000,000
shares authorized, 3,520 shares issued and outstanding
($3,520,000 aggregate liquidation value)............... 35
Common stock, $0.01 par value, 15,000,000 shares
authorized; 5,650,400 shares issued and outstanding.... 56,504
Additional paid-in capital................................ 42,343,287
Deferred stock compensation............................... (85,638)
Preferred stock discount.................................. (239,736)
Accumulated other comprehensive income.................... 207,216
Accumulated deficit....................................... (34,223,058)
------------
Total stockholders' equity.................................. 8,058,610
------------
$ 13,165,170
============
</TABLE>
See accompanying notes.
F-3
<PAGE> 20
INTEGRATED SURGICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1997 1998
----------- ------------
<S> <C> <C>
Net sales................................................... $ 4,933,824 $ 6,146,434
Cost of sales............................................... 2,182,842 3,413,221
----------- ------------
2,750,982 2,733,213
Operating expenses:
Selling, general and administrative....................... 3,701,264 6,216,240
Research and development.................................. 3,063,925 6,602,550
Stock compensation........................................ 155,474 131,352
In-process research and development acquired.............. 331,668 --
----------- ------------
7,252,331 12,950,142
Other income (expense):
Interest income........................................... 214,913 240,959
Interest expense.......................................... (26,495) (124,095)
Foreign currency gain (loss).............................. (147,390) 129,158
Other, net................................................ 32,028 (269,737)
----------- ------------
Loss before provision for income taxes...................... (4,428,293) (10,240,644)
Provision for income taxes.................................. 49,811 27,235
----------- ------------
Net loss.................................................... (4,478,104) (10,267,879)
Preferred stock accretion................................... -- (376,264)
----------- ------------
Net loss applicable to common stockholders.................. $(4,478,104) $(10,644,143)
=========== ============
Basic and diluted net loss per share........................ $ (1.20) $ (1.91)
=========== ============
Shares used in computing basic net loss per share........... 3,737,318 5,584,639
=========== ============
</TABLE>
See accompanying notes.
F-4
<PAGE> 21
INTEGRATED SURGICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE ACCUMULATED
PREFERRED STOCK COMMON STOCK ADDITIONAL DEFERRED PREFERRED OTHER
--------------- ------------------- PAID-IN STOCK STOCK COMPREHENSIVE
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION DISCOUNT INCOME
------ ------ --------- ------- ----------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996... -- $-- 3,361,161 $33,611 $25,807,264 $(426,417) $ -- $ 8,657
Exercise of stock options.... -- -- 18,374 184 18,416 -- -- --
Issuance of stock options to
consultant................. -- -- -- -- 23,270 -- -- --
Issuance of warrants to
consultant................. -- -- -- -- 65,625 -- -- --
Acquisition of IMMI.......... -- -- 619,355 6,194 3,883,356 -- -- --
Issuance of common stock to
consultant................. -- -- 4,500 45 28,215 -- -- --
Sale of common stock, net of
offering expenses.......... -- -- 1,500,000 15,000 8,425,103 -- -- --
Stock compensation expense... -- -- -- -- (31,413) 186,887 -- --
Comprehensive loss:
Net loss................... -- -- -- -- -- -- -- --
Foreign currency
translation
adjustments.............. -- -- -- -- -- -- -- 17,615
Comprehensive loss........... -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------
Balance at December 31, 1997... -- -- 5,503,390 55,034 38,219,836 (239,530) -- 26,272
Exercise of stock options.... -- -- 142,010 1,420 14,313 -- -- --
Issuance of stock options to
consultant................. -- -- -- -- 208,386 -- -- --
Sale of common stock
warrants................... -- -- -- -- 6,930 -- -- --
Sale of convertible preferred
stock and warrants, net of
offering expenses.......... 3,520 35 5,000 50 3,300,362 -- -- --
Stock compensation expense... -- -- -- -- (22,540) 153,892 -- --
Preferred stock discount..... -- -- -- -- 616,000 -- (616,000) --
Preferred stock accretion.... -- -- -- -- -- -- 376,264
Comprehensive loss:
Net loss................... -- -- -- -- -- -- -- --
Unrealized gains of
securities............... -- -- -- -- -- -- -- 50,626
Foreign currency
translation
adjustments.............. -- -- -- -- -- -- -- 130,318
Comprehensive loss........... -- -- -- -- -- -- -- --
-----------------------------------------------------------------------------------------------
Balance at December 31, 1998... 3,520 $35 5,650,400 $56,504 $42,343,287 $ (85,638) $ (239,736) $207,216
===============================================================================================
<CAPTION>
TOTAL
ACCUMULATED STOCKHOLDERS
DEFICIT EQUITY
------------ ------------
<S> <C> <C>
Balance at December 31, 1996... $(19,100,811) $ 6,322,304
Exercise of stock options.... -- 18,600
Issuance of stock options to
consultant................. -- 23,270
Issuance of warrants to
consultant................. -- 65,625
Acquisition of IMMI.......... -- 3,889,550
Issuance of common stock to
consultant................. -- 28,260
Sale of common stock, net of
offering expenses.......... -- 8,440,103
Stock compensation expense... -- 155,474
Comprehensive loss:
Net loss................... (4,478,104) (4,478,104)
Foreign currency
translation
adjustments.............. -- 17,615
------------
Comprehensive loss........... -- (4,460,489)
------------
Balance at December 31, 1997... (23,578,915) 14,482,697
Exercise of stock options.... -- 15,733
Issuance of stock options to
consultant................. -- 208,386
Sale of common stock
warrants................... -- 6,930
Sale of convertible preferred
stock and warrants, net of
offering expenses.......... -- 3,300,447
Stock compensation expense... -- 131,352
Preferred stock discount..... -- --
Preferred stock accretion.... (376,264) --
Comprehensive loss:
Net loss................... (10,267,879) (10,267,879)
Unrealized gains of
securities............... -- 50,626
Foreign currency
translation
adjustments.............. -- 130,318
------------
Comprehensive loss........... -- (10,086,935)
------------
Balance at December 31, 1998... $(34,223,058) $ 8,058,610
</TABLE>
See accompanying notes.
F-5
<PAGE> 22
INTEGRATED SURGICAL SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------
1997 1998
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $(4,478,104) $(10,267,879)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation.............................................. 228,788 579,666
In-process research and development acquired.............. 331,678 --
Amortization of intangible assets......................... 279,680 839,040
Stock compensation........................................ 155,474 131,352
Issuance of stock options to consultant................... 23,270 208,386
Unrealized gain on short-term investments................. -- 50,626
Equity in net loss of Marbella High Care B.V. ............ -- 317,000
Changes in operating assets and liabilities:
Accounts receivable..................................... (809,338) (478,596)
Inventory............................................... (894,739) (1,110,320)
Other current assets.................................... (155,998) 9,188
Accounts payable........................................ 532,121 65,539
Value added taxes payable............................... 160,809 (91,098)
Accrued payroll and related expenses.................... 126,997 54,655
Customer deposits....................................... 13,672 757,604
Other current liabilities............................... 46,592 262,217
Note payable............................................ 778 (203)
----------- ------------
Net cash used in operating activities....................... (4,438,320) (8,672,823)
Cash flows from investing activities:
Purchase of short-term investments........................ -- (2,024,278)
Investment in Marbella High Care B.V. .................... -- (563,273)
Investment in sales-type lease............................ (453,250) --
Principal payments received on sales-type lease........... 19,967 88,425
Purchases of property and equipment....................... (376,573) (1,746,127)
Payments in connection with purchase of subsidiary, net of
cash acquired........................................... (118,880) --
Decrease (increase) in other assets....................... 4,446 (12,868)
----------- ------------
Net cash used in investing activities....................... (924,290) (4,258,121)
Cash flows from financing activities:
Proceeds from bank loans.................................. 71,422 678,447
Payments on bank loans.................................... (94,421) (69,138)
Proceeds from sale of preferred stock and warrants........ -- 3,300,447
Net proceeds from sale of common stock and warrants....... 8,440,103 6,930
Proceeds from exercise of stock options................... 18,600 15,733
----------- ------------
Net cash provided by financing activities................... 8,435,704 3,932,419
Effect of exchange rate changes on cash and cash
equivalents............................................... 17,615 130,318
----------- ------------
Net increase (decrease) in cash and cash equivalents........ 3,090,709 (8,868,207)
Cash and cash equivalents at beginning of year.............. 6,001,079 9,091,788
----------- ------------
Cash and cash equivalents at end of year.................... $ 9,091,788 $ 223,581
=========== ============
Supplemental disclosure of cash flow information:
Cash paid for interest...................................... $ 25,392 $ 118,925
</TABLE>
See accompanying notes.
F-6
<PAGE> 23
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. DESCRIPTION OF BUSINESS
Integrated Surgical Systems, Inc. (the "Company") was incorporated on
October 1, 1990 in Delaware. The Company develops, manufactures, markets and
services computer-controlled, image-directed robotic products for surgical
applications. The Company's principal product is the ROBODOC(R) Surgical
Assistant System (ROBODOC(R)), which is designed for orthopedic applications.
ROBODOC(R) is currently marketed in Europe.
On September 5, 1997, the Company acquired all of Innovative Medical
Machines International, S.A.'s ("IMMI") issued and outstanding capital stock,
stock warrants and convertible debt in a transaction accounted for as a purchase
(Note 3). IMMI develops, manufactures and markets image guided robotic devices
for surgical applications. Its principal product is the NeuroMate(R), a computer
controlled surgical robot supporting neurosurgical procedures.
On June 1, 1994, the Company acquired all shares of Gasfabriek Thijssen
Holding BV (later renamed Integrated Surgical Systems BV), a non-operating
Netherlands corporation, for approximately $4,000. The acquisition was accounted
for as a purchase. Integrated Surgical Systems BV purchases and licenses
products and technology from Integrated Surgical Systems, Inc. for distribution
in Europe and other markets.
2. SIGNIFICANT ACCOUNTING POLICIES
CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
FOREIGN CURRENCY TRANSLATION
The financial position and results of operations of IMMI and Integrated
Surgical Systems BV are measured using their respective local currencies. The
subsidiary balance sheet accounts are translated at the year-end exchange rate
and statement of operations amounts are translated at the average exchange rate
for the period. Translation adjustments are recorded as a separate component of
stockholders' equity. Foreign currency transaction gain (loss) was ($147,390)
and $129,158 during the years ended December 31, 1997 and December 31, 1998,
respectively.
REVENUE RECOGNITION
Revenues from sales without significant Company obligations beyond delivery
are recognized upon delivery of the products. Revenues pursuant to agreements
which include significant Company obligations beyond delivery are deferred until
the Company's remaining obligations are insignificant. Revenues are recognized
net of any deferrals for estimated future liabilities under contractual product
warranty provisions. Estimated future product retrofit costs for ROBODOC(R) sold
for clinical trials have been accrued in the accompanying financial statements.
Future retrofit costs are those expected to be required to update ROBODOC(R) to
the equivalent level of performance expected to be approved by the Food and Drug
Administration ("FDA").
RESEARCH AND DEVELOPMENT
Software development costs incurred subsequent to the determination of the
product's technological feasibility and prior to the product's general release
to customers are not material to the Company's financial position or results of
operations, and have been charged to research and development expense in the
F-7
<PAGE> 24
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accompanying consolidated statements of operations. Grants received from third
parties for research and development activities are recorded as reductions of
expense over the term of the agreement as the related activities are conducted.
Research and development costs are expensed as incurred.
CONCENTRATION OF CREDIT RISK
The Company sells its products to companies in the healthcare industry and
performs periodic credit evaluations of its customers and generally does not
require collateral. The Company believes that adequate provision for
uncollectible accounts receivable has been made in the accompanying financial
statements. The Company maintains substantially all of its cash at four
financial institutions.
FINANCIAL STATEMENT ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS
The Company invests its excess cash in various investment grade,
interest-bearing securities. As of December 31, 1998, cash equivalents and
short-term investments consisted of money market mutual funds, U.S. Treasury
Strips and a certificate of deposit. The Company has not experienced any losses
on such investments.
Management determines the appropriate classification of debt securities at
the time of purchase and re-evaluates such designation as of each balance sheet
date. At December 31, 1998, the Company's entire portfolio of investments is
classified as available-for-sale. These securities are stated at fair market
value, determined based on quoted market prices, with the unrealized gains and
losses reported in a separate component of stockholders' equity.
The amortized cost of debt securities classified as available-for-sale is
adjusted for amortization of premiums and accretion of discounts to maturity,
over the estimated life of the security. Such amortization is included in
interest income. Realized gains and losses were not material in any year
presented. The cost of securities sold is based on the specific identification
method.
For purposes of reporting cash flows, the Company considers highly liquid
investments with original maturities of three months or less as cash
equivalents.
FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying values of the bank loans approximate their fair values as of
December 31, 1998, based on current incremental borrowing rates for similar
types of borrowing arrangements.
Active markets for the Company's other financial instruments that are
subject to the fair value disclosure requirements of Statement of Financial
Accounting Standards No. 107, which consist of long-term lease receivables and
notes payable, do not exist and there are no quoted market prices for these
assets and liabilities. Accordingly, it is not practicable to estimate the fair
values of such financial instruments because of the limited information
available to the Company and because of the significance of the cost to obtain
independent appraisals for this purpose.
F-8
<PAGE> 25
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
INTANGIBLE ASSETS
The Company continually evaluates the value and future benefits of its
intangible assets. The Company assesses recoverability from future operations
using cash flows and income from operations of the related acquired business as
measures. Under this approach, the carrying value would be reduced if it becomes
probable that the Company's best estimate for expected future cash flows of the
related business would be less than the carrying amount of the related
intangible assets. There have been no adjustments to the carrying amounts of
intangible assets resulting from these evaluations as of December 31, 1998.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is calculated using
the straight-line method over estimated useful lives of 3 to 5 years, or the
lease term, whichever is shorter.
NET INVESTMENT IN SALES-TYPE LEASES
The net investment in sales-type leases consists of the following at
December 31, 1998:
<TABLE>
<S> <C>
Total minimum lease payments receivable..................... $388,904
Less unearned interest...................................... (38,828)
--------
Net investment in sales type leases......................... 350,076
Less current portion........................................ (87,742)
--------
Long-term net investment in sales-type leases............... $262,334
========
</TABLE>
The following represents future minimum lease payments to be received by
the Company under its net investment in sales-type leases as of December 31,
1998:
<TABLE>
<S> <C>
1999...................................................... $106,667
2000...................................................... 106,667
2001...................................................... 106,667
2002...................................................... 68,903
--------
$388,904
========
</TABLE>
OPERATING LEASES
The Company leases certain of its ROBODOC systems to customers under
cancelable operating leases. The typical lease period is 5 years and certain of
the leases contain purchase options. The cost of equipment under operating
leases as of December 31, 1998 was $733,781 and the related accumulated
amortization thereon was $92,370.
INVENTORY
Inventory is recorded at the lower of cost (first-in, first-out method) or
market and consists of materials and supplies used in the manufacture and
service support of the ROBODOC(R) and NeuroMate(TM) Systems. Inventory consists
of the following at December 31, 1998:
<TABLE>
<S> <C>
Raw materials............................................... $1,057,141
Work-in process............................................. 763,624
Finished goods.............................................. 1,184,893
----------
$3,005,658
==========
</TABLE>
F-9
<PAGE> 26
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
STOCK-BASED COMPENSATION
As permitted under the provisions of Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation" ("SFAS No. 123"),
the Company has elected to account for stock-based compensation using the
intrinsic value method prescribed by Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25"). Under the intrinsic
value method, compensation cost is the excess, if any, of the quoted market
price or fair value of the stock at the grant date or other measurement date
over the amount an employee must pay to acquire the stock.
INCOME TAXES
The liability method is used to account for income taxes. Under this
method, deferred income tax assets and liabilities are determined based on
differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that are
scheduled to be in effect when the differences are expected to reverse.
NET LOSS PER SHARE
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
No. 128, Earnings per Share. Statement 128 replaced the calculation of primary
and fully diluted earnings per share with basic and diluted earnings per share.
Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities. Diluted
earnings per share is very similar to the previously reported fully diluted
earnings per share. All earnings per share amounts have been presented on the
basis set forth in Statement 128 (Note 10).
SIGNIFICANT CUSTOMERS AND FOREIGN SALES
The Company recognized approximately 86% of its revenues from seven
customers, each representing at least 10% of the Company's total revenue, during
the year ended December 31, 1997 and 64% of its revenue from five customers each
representing at least 10% of the Company's total revenue, during the year ended
December 31, 1998. Foreign sales were approximately $4,919,000 and $6,005,000
for the years ended December 31, 1997 and December 31, 1998, respectively.
NEW ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Statement 130, Reporting
Comprehensive Income. Statement 130 establishes new rules for the reporting and
display of comprehensive income and its components. Statement 130 requires
unrealized gains or losses on the Company's available-for-sale securities and
the foreign currency translation adjustments, which prior to adoption were
reported separately in stockholders' equity, to be included in other
comprehensive income. Prior year financial statements have been reclassified to
conform to the requirements of Statement 130.
In June 1998, the Financial Accounting Standards Board issued Statement
133, Accounting for Derivative Instruments and Hedging Activities, which is
required to be adopted in years beginning after June 15, 1999. Management does
not anticipate that the adoption of the new Statement will have a significant
effect on earnings or the financial position of the Company.
RECLASSIFICATIONS
Certain amounts reported in prior years financial statements have been
reclassified to conform with the 1998 presentation.
F-10
<PAGE> 27
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITION OF IMMI
Effective September 5, 1997, ISS acquired all of IMMI's issued and
outstanding capital stock, stock warrants and convertible debt in a transaction
accounted for as a purchase. The purchase price included 619,355 shares of ISS
common stock with a fair market value of approximately $3.9 million and
liabilities assumed and acquisition costs of approximately $1.1 million. The
purchase agreement places certain restrictions on the future sale of the ISS
stock issued in connection with the purchase for a period of eighteen months.
The purchase price consists of the following:
<TABLE>
<S> <C>
619,355 shares of ISS common stock.......................... $3,889,549
Liabilities assumed......................................... 883,044
Acquisition costs........................................... 266,085
----------
$5,038,678
==========
</TABLE>
The Company retained independent valuation professionals to assist in the
values to be assigned to the individual assets acquired including the
intangibles and in-process research and development. A summary of the allocation
of purchase price is as follows:
<TABLE>
<S> <C>
Tangible assets acquired.................................... $ 573,302
Identified intangible assets................................ 4,133,698
In-process research and development......................... 331,678
----------
$5,038,678
==========
</TABLE>
Intangible assets consist primarily of developed technology relating to the
NeuroMate(R). Accumulated amortization on intangible assets was $1,118,720 as of
December 31, 1998. In the opinion of ISS and IMMI management, the developed
technology was completed and had alternative future uses. The estimated useful
lives are expected to range from 3 to 5 years. ISS management did not believe
that technological feasibility of the acquired in-process research and
development had been established. Further, ISS management believed the acquired
in-process research and development has no alternative future uses. Therefore,
the amount allocated to in-process research and development was required to be
immediately expensed under generally accepted accounting principles.
The following represents unaudited proforma statement of operations
information as if the acquisition of IMMI occurred on January 1, 1997.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
------------
(UNAUDITED)
<S> <C>
Revenue............................................... $ 5,554,000
===========
Net loss.............................................. $(5,394,000)
===========
Basic net loss per share.............................. $ (1.24)
===========
</TABLE>
The above proforma information is presented for illustrative purposes only
and may not be indicative of the results that would have been obtained had the
transaction actually occurred on January 1, 1997, nor is it necessarily
indicative of future combined results of operations.
F-11
<PAGE> 28
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
4. SHORT-TERM INVESTMENTS
Marketable debt securities are classified as available for sale and consist
of 1,849,000 shares of U.S. Treasury Strips. The shares have an original cost of
$1,767,773 on August 11, 1998 and a fair market value of $1,818,399 at December
31, 1998. The shares mature on May 15, 1999. The shares noted above have been
pledged as collateral for the line of credit with a bank (Note 7). The net
unrealized holding gain as of December 31, 1998 of $50,626 has been included as
a separate component of stockholders' equity.
Additionally, the Company purchased a 1-year certificate of deposit in June
1998 having an original cost of $200,000 and a fair market value of $205,879 on
December 31, 1998. The certificate of deposit is collateral under a letter of
credit to the benefit of the lessor of the Company's U.S. facility. The letter
of credit expires on June 30, 1999.
5. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31, 1998:
<TABLE>
<S> <C>
ROBODOC and NeuroMate System equipment...................... $ 1,039,261
Other equipment............................................. 1,677,695
Furniture and fixtures...................................... 291,798
Leasehold improvements...................................... 49,448
-----------
3,058,202
Less accumulated depreciation............................... (1,707,363)
-----------
$ 1,350,839
===========
</TABLE>
6. INVESTMENT IN MARBELLA HIGH CARE B.V.
Other assets consist primarily of the Company's investment in and advances
to Marbella High Care B.V. ("MBHC"). As of December 31, 1998, the Company owned
22% of the outstanding shares of MBHC and accounts for its investment under the
equity method. The Company's gross investment in MBHC, including loans, was
approximately $563,000 in 1998. For the year ended December 31, 1998, the
Company recorded $317,000 of expense relating to its investment and advances in
MBHC for the period, which has been included in other income (expense).
7. BANK LOANS AND NOTE PAYABLE
Bank loans consist of the following at December 31, 1998:
<TABLE>
<S> <C>
Revolving line of credit established in June 1998 with an
available amount of $1.5 million at December 31, 1998,
with interest accruing at prime plus .75% per annum
(aggregating 8.5% as of December 31, 1998) and expiring on
June 15, 1999............................................. $678,447
Revolving line of credit established in July 1996 for five
years with an available amount of $196,900 at December 31,
1998, with interest accruing at 7.15% per annum. The
amount available decreases quarterly by 5% of the original
amount beginning October 1996............................. 196,900
Bank term loan with monthly principal and interest payments
of approximately $1,762 over three years from May 1997,
with interest accruing at 5.75% per annum................. 29,179
--------
904,526
Less current portion........................................ 897,021
--------
Long-term bank loans........................................ $ 7,505
========
</TABLE>
F-12
<PAGE> 29
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The $1.5 million revolving line of credit is secured by a security interest
in the Company's marketable securities with a carrying value of $1,818,399 at
December 31, 1998. The Company is required to maintain sufficient collateral
equal to or greater than the credit limit, plus $100,000.
The bank term loan is secured by substantially all of IMMI's tangible
assets (with a net book value of approximately $1,804,000 at December 31, 1998)
and is guaranteed by the Company.
The Company received an interest free loan with a balance of $143,200 at
December 31, 1998 from a grant organization for the development of a new system.
In the case of failure of the project, the grant organization may decide to
forgive all or part of the repayments. If the Company sells either a license for
the related technology, the prototype developed, or articles manufactured
specifically for the research project, 50% of the revenue must be paid to the
grant organization in the subsequent year, up to the balance of the loan amount
outstanding. According to the contract, any such payments would be considered to
be an advance repayment of the loan. The Company has not made any sales of this
type through December 31, 1998.
8. STOCKHOLDERS' EQUITY
COMMON STOCK
As of December 31, 1998 the Company has reserved a total of 8,333,782
shares of common stock pursuant to Series A Convertible Preferred Stock,
warrants and options outstanding and reserved for future issuance.
INITIAL PUBLIC OFFERING
In November 1996, the Company sold in its initial public offering, a total
of 1,525,000 shares of common stock at $5.00 per share and 1,753,750 warrants at
$0.10 per warrant. In addition, the Company sold to its underwriter warrants to
purchase an additional 305,000 shares for total consideration of $10.00. The net
proceeds after underwriters' commissions and fees and other costs associated
with the offering were approximately $6,137,000.
Each warrant entitles the holder to purchase one share of common stock at
an exercise price of $6.00 per share, subject to adjustment in certain events,
at any time during the period commencing November 20, 1997, and thereafter for a
period of four years. The warrants are subject to redemption by the Company at
$0.10 per warrant at any time during the exercise period on not less than 30
days prior written notice to the holders of the warrants provided certain
criteria regarding the price performance of the Company's common stock are met.
EUROPEAN OFFERING
On November 20, 1997, the Company sold 1,500,000 shares of Common Stock at
approximately $7.00 per share in an offering to European investors (the
"European Offering"). In addition, the Company sold to its underwriters in the
European Offering warrants to purchase an additional 150,000 shares for nominal
consideration. The net proceeds of the European Offering were approximately
$8,440,000.
Each of the warrants issued to the European Offering underwriters entitles
the holder to purchase one share of common stock at an exercise price of $8.26
per share at any time during the period commencing November 21, 1998, and
thereafter for a period of four years.
CONVERTIBLE PREFERRED STOCK
As part of a Stock Purchase Agreement in December 1995 the Company sold a
warrant for $1,333,333 to purchase 1,386,390 shares of Series D Preferred Stock
at $0.01 per share, and in February 1996 sold a warrant for $666,667 to purchase
693,194 shares of Series D Preferred Stock at $0.01 per share. On October 29,
1997,
F-13
<PAGE> 30
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company and IBM executed an amendment to the Stock Purchase Agreement
pursuant to which the Company and IBM agreed that these combined warrants to
purchase 2,079,584 shares of Series D Preferred Stock would be exercisable only
for 2,079,584 shares of Common Stock at $0.01 per share. The warrants expire on
December 31, 2005 and have not been exercised as of December 31, 1998. Also on
October 29, 1997, the Company delivered to CA IB Investmentbank AG ("CA IB") an
agreement not to issue any shares of Common Stock, or any warrants, options or
other rights to subscribe for or purchase shares of Series D Preferred Stock, or
any other securities convertible into or exercisable or exchangeable for, Series
D Preferred Stock, without the consent of CA IB. In addition, the Company's
management caused the Board of Directors to present a resolution at the annual
meeting of the Company's stockholders to amend the Company's Restated
Certificate of Incorporation to eliminate the Series D Preferred Stock
therefrom. On April 28, 1998 elimination of Series D Preferred Stock was adopted
by the Company's stockholders.
In November 1996, the Board of Directors amended, and the stockholders
subsequently approved, the Company's Articles of Incorporation to authorize
1,000,000 shares of undesignated preferred stock. Preferred stock may be issued
from time to time in one or more series. The Board of Directors is authorized to
determine the rights, preferences, privileges and restrictions granted to and
imposed upon any wholly unissued series of preferred stock and designation of
any such series without any vote or action by the Company's stockholders.
In September 1998, the Company received net proceeds of $3,300,447 from the
sale of 3,520 shares of Series A Convertible Preferred Stock ("Series A
Preferred Stock") and warrants ("Warrants") to purchase 44,000 shares of common
stock ("Common Stock").
The Series A Preferred Stock is convertible into shares of Common Stock, at
the option of the holder, commencing December 9, 1998, subject to certain
limitations, discussed below. The number of shares of Common Stock issuable upon
conversion of the Series A Preferred Stock is equal to the quotient of (x) the
product of $1,000 (the stated value of each share of Series A Preferred Stock)
and the number of shares of Series A Preferred Stock to be converted and (y) 85%
of the lowest sale price of the Common Stock on the Nasdaq SmallCap Market
during the five trading days preceding the date of conversion (the "Market
Price"), but in no event more than $4.96 (the "Conversion Price"). As of
December 31, 1998, the number of common shares issuable upon conversion was
1,731,262.
Holders of Series A Preferred Stock may convert 25% of their shares
commencing December 9, 1998, 50% of their shares commencing January 8, 1999, 75%
of their shares commencing February 7, 1999 and 100% of their shares commencing
March 9, 1999. The Company may require holders to convert all (but not less than
all) of the Series A Preferred Stock at any time after August 24, 2001, or buy
out all outstanding shares, at the then Conversion Price.
The value assigned to the beneficial conversion feature, as associated with
the Market Price as determined using the quoted market price of the Company's
common stock on the date the Series A Preferred Stock was sold, amounted to
$616,000, which represents a discount to the value of the Series A Preferred
Stock (the "Discount"). The Discount is being accreted using the straight-line
method through March 9, 1999. Approximately $376,000 of the Discount was
accreted in 1998.
Holders of Series A Preferred Stock are not entitled to dividends and have
no voting rights, unless required by law or with respect to certain matters
relating to the Series A Preferred Stock.
The Company may redeem the Series A Preferred Stock upon written notice to
the holders of the Series A Preferred Stock at any time after the earlier of
January 10, 1999 and the closing of a registered firm underwritten secondary
offering of equity securities, at a redemption price equal to the greater of
$1,500 per share and the Market Price of the Shares of Common Stock into which
such Series A Preferred Stock could have been converted on the date of the
notice of redemption.
F-14
<PAGE> 31
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Warrants are exercisable at any time during the period commencing March
5, 1999 and ending March 5, 2002, at an exercise price of $4.31, subject to
adjustment. The Conversion Price and the number of shares of Common Stock
issuable upon conversion are subject to adjustment based upon certain future
events.
ISSUANCE OF STOCK AND STOCK WARRANTS
In September 1997, the Company issued 4,500 shares of Common Stock and
warrants to purchase 25,000 shares of Common Stock (with an aggregate estimated
fair value of $93,885) to Rickel & Associates, Inc. for services performed in
connection with the acquisition of IMMI. The warrants have an exercise price of
$7.50 per share and expire in September 2002.
In September 1998, the Company issued 5,000 shares of Common Stock (with an
aggregate estimated fair value of $20,625) to Trinity Capital Advisors, Inc. for
services performed in connection with the Series A Preferred Stock offering.
STOCK OPTION PLANS
The Company has elected to follow Accounting Principles Board Opinion No.
25 "Accounting for Stock Issued to Employees" and related Interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under FASB Statement No. 123,
"Accounting for Stock-Based Compensation," requires use of option valuation
models that were not developed for use in valuing employee stock options.
The Company established a stock option plan in 1991 (the "1991 Plan") and
on December 13, 1995, it established a new stock option plan (the "1995 Plan").
The Company adopted a third plan on April 28, 1998 (the "1998 Plan"). Certain
employees of the Company surrendered their options under the 1991 Plan in return
for new and additional options granted under the 1995 Plan. During the year
ended December 31, 1998, the Company reduced the exercise prices of certain
outstanding stock options with exercise prices ranging from $4.31 to $8.63
(377,752 options) to $3.00 per share which was the fair market value of common
stock as determined by the Company's Board of Directors on the date of
repricing. Officers, employees, directors and consultants to the Company may
participate in the Plans. Options granted under the Plans may be incentive stock
options or non-statutory stock options. 2,099,070 shares of the Company's common
stock have been reserved for issuance under the Plans. Options granted generally
have a term of ten years from the date of the grant. The exercise price of
incentive stock options granted under the Plans may not be less than 100% of the
fair market value of the Company's common stock on the date of the grant. The
exercise price of non-statutory stock options granted under the Plans may not be
less than 85% of the fair market value of the Company's common stock on the date
of the grant. For a person who, at the time of the grant, owns stock
representing 10% of the voting power of all classes of Company stock, the
exercise price of the incentive stock options or the non-statutory stock options
granted under the Plans may not be less than 110% of the fair market value of
the common stock on the date of the grant.
Pro forma information regarding net income (loss) and earnings (loss) per
share is required by SFAS No. 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions for 1997 and 1998, respectively: risk-free interest rates of 6.0%
and 5.0%; dividend yield of 0%; volatility factors of the expected market price
of the Company's common stock of 0.55 and 0.77; and an expected life of the
option of 4 years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the
F-15
<PAGE> 32
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options. For purposes of pro
forma disclosures, the estimated fair value of the options is amortized to
expense over the vesting period. The Company's pro forma information follows:
<TABLE>
<CAPTION>
1997 1998
----------- ------------
<S> <C> <C>
Pro forma net loss............................... $(4,624,429) $(10,997,076)
Pro forma basic net loss per share............... $ (1.24) $ (1.97)
</TABLE>
Because SFAS No. 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect will not be fully reflected until 1999.
The following summarizes activity under the Plans for the years ended
December 31, 1997 and 1998:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER OF AVERAGE
SHARES EXERCISE PRICE
--------- --------------
<S> <C> <C>
Outstanding at December 31, 1996 (at $0.07 to $7.84
per share)........................................ 947,184 $0.42
Granted (at $5.00 to $8.88 per share)............. 354,334 6.60
Canceled (at $.07 to $8.25 per share)............. (79,771) 4.38
Exercised (at $.07 to $3.33 per share)............ (18,374) 1.01
---------
Outstanding at December 31, 1997 (at $0.07 to $8.88
per share)........................................ 1,203,373 1.97
Granted (at $2.84 to $6.06 per share)............. 724,252 3.23
Canceled (at $.07 to $8.88 per share)............. (456,356) 5.33
Exercised (at $.07 to $2.07 per share)............ (142,010) 0.11
---------
Outstanding at December 31, 1998 (at $0.07 to $8.88
per share)........................................ 1,329,259 $1.93
=========
</TABLE>
All options granted in 1997 and 1998 were granted with option prices equal
to the fair market value of the Company's stock on the grant date. The weighted
average exercise price of options granted in 1997 was $6.60 and the weighted
average grant date fair value of these options was $3.16.
The weighted average exercise price of options granted in 1998 with option
prices equal to the fair market value of the Company's stock on the grant date
was $3.23 and the weighted average grant date fair value of these options was
$1.47.
F-16
<PAGE> 33
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes information related to options outstanding and
options exercisable at December 31, 1998:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
WEIGHTED REMAINING WEIGHTED
EXERCISE OPTIONS AVERAGE CONTRACTUAL LIFE OPTIONS AVERAGE
PRICE OUTSTANDING EXERCISE PRICE (IN YEARS) EXERCISABLE EXERCISE PRICE
- ------------------ ----------- -------------- ---------------- ----------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
$0.07 696,348 $0.07 7.1 598,475 $0.07
$2.07 6,760 $2.07 7.5 4,084 $2.07
$2.84 - $3.00 374,502 $3.00 9.7 28,477 $3.00
$3.13 - $3.94 50,750 $3.67 9.7 -- --
$4.00 - $4.88 40,500 $4.71 9.4 -- --
$5.00 - $6.13 106,399 $5.35 8.1 50,220 $5.29
$7.00 - $8.88 54,000 $7.98 8.8 17,024 $7.98
--------- ----- --- ------- -----
1,329,259 $1.93 8.2 698,280 $0.77
========= ===== === ======= =====
</TABLE>
Of the options outstanding at December 31, 1998, options to purchase
698,280 shares of common stock were immediately exercisable at a
weighted-average exercise price of $0.77 per share. A total of 197 shares were
still available for grant under the 1995 Plan at December 31, 1998. A total of
421,248 shares were still available for grant under the 1998 Plan at December
31, 1998.
During the year ended December 31, 1996, the Company recorded deferred
stock compensation of $783,666 relating to stock options granted during the
period with exercise prices less than the estimated fair value of the Company's
common stock, as determined by an independent valuation analysis, on the date of
grant. The deferred stock compensation is being amortized into expense over the
vesting period of the stock options which generally range from 3 to 5 years.
Deferred compensation relating to stock options which vested immediately was
expensed on the date of grant. The Company recorded a reduction of $31,413 and
$22,540 in deferred stock compensation relating to canceled options in 1997 and
1998, respectively. Compensation expense of $155,474 and $131,352 was recorded
during the years ended December 31, 1997 and 1998, respectively, relating to
these options. The remaining $85,638 will be amortized into expense in future
periods.
9. INCOME TAXES
The income tax provisions for the years ended December 31, 1997 and 1998
are comprised of currently payable state franchise taxes and currently payable
foreign income taxes.
F-17
<PAGE> 34
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred taxes result from temporary differences in the recognition of
certain revenue and expense items for income tax and financial reporting
purposes. The significant components of the Company's deferred taxes as of
December 31, 1997 and 1998 are as follows:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryover............................ $ 4,677,000 $ 5,842,000
Research and development................................ 223,000 285,000
Accrued product retrofit costs.......................... 21,000 54,000
Inventory............................................... 93,000 330,000
Depreciation............................................ 126,000 109,000
Stock compensation...................................... 220,000 256,000
Loss on investment...................................... -- 230,000
Deferred income......................................... -- 358,000
Other................................................... 158,000 248,000
----------- -----------
5,518,000 7,712,000
Less: Valuation allowance................................. (5,518,000) (7,712,000)
----------- -----------
Net deferred taxes........................................ $ -- $ --
=========== ===========
</TABLE>
The Company expects the carryforward amounts will not be utilized prior to
the expiration of the carryforward periods.
The principal reasons for the difference between the effective income tax
rate and the federal statutory income tax rate are as follows:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1997 1998
----------- -----------
<S> <C> <C>
Federal benefit expected at statutory rates............... $(1,506,000) $(3,481,777)
Net operating loss with no current benefit................ 1,506,000 3,481,777
Other taxes............................................... -- 14,000
Foreign income taxes...................................... 49,811 13,235
----------- -----------
$ 49,811 $ 27,235
=========== ===========
</TABLE>
As a result of stock sales a change of ownership (as defined in Section 382
of the Internal Revenue Code of 1986, as amended) has occurred. As a result of
this change, the Company's federal and state net operating loss carryforwards
generated through December 21, 1995 (approximately $14,300,000 and $2,600,000,
respectively) will be subject to a total annual limitation in the amount of
approximately $400,000.
The Company has at December 31, 1998 a net operating loss carryover of
approximately $16,200,000 for federal income tax purposes which expires between
2005 and 2013, a net operating loss carryforward of approximately $5,700,000 for
state income tax purposes which expires through 2003, and a net operating loss
carryforward of approximately $1,500,000 for foreign income tax purposes. The
Company has at December 31, 1998 research and development credit carryovers of
approximately $294,000 and $448,000 for federal and state income tax purposes,
respectively.
The Company paid $914 and $800 for income and franchise taxes during the
years ended December 31, 1997 and 1998, respectively.
F-18
<PAGE> 35
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. NET LOSS PER SHARE INFORMATION
As of December 31, 1998, outstanding options to purchase 1,329,259 shares
of common stock (with exercise prices ranging from $0.07 to $8.88), outstanding
warrants to purchase 4,551,816 shares of common stock (with exercise prices from
$0.07 to $8.26) and 1,731,262 shares of common stock issuable upon conversion of
Series A Preferred Stock could potentially dilute basic earnings per share in
the future and have not been included in the computation of diluted net loss per
share because to do so would have been antidilutive for the periods presented.
11. COMMITMENTS
The Company leases its U.S. facility under a non-cancelable operating
lease. The lease is for a term of seven years and expires on June 2, 2005. The
lease provides for rent of $29,229 per month during the first year of the lease
(plus real estate taxes and assessments, utilities and maintenance), subject to
adjustment in subsequent years for cumulative increases in the cost of living
index, not to exceed 4% per year.
The Company leases its European facility under a non-cancelable operating
lease. The lease is for a term of eight years and expires on 2006. The lease
provides for rent of $7,197 per month.
Future payments under non-cancelable facility operating leases are
approximately as follows:
<TABLE>
<S> <C>
1999................................................... $ 422,000
2000................................................... 440,000
2001................................................... 450,000
2002................................................... 457,000
2003................................................... 465,000
Thereafter............................................. 424,000
----------
$2,658,000
==========
</TABLE>
Aggregate rental expense under these leases amounted to $135,000 and
$309,000 during the years ended December 31, 1997 and 1998, respectively.
Future minimum payments under non-cancelable equipment operating leases are
approximately as follows:
<TABLE>
<S> <C>
1999..................................................... $48,000
2000..................................................... 33,000
2001..................................................... 4,000
2002..................................................... --
-------
$85,000
=======
</TABLE>
Rental expense for these non-cancelable equipment operating leases during
the years ended December 31, 1997 and 1998 was approximately $17,000 and
$41,000, respectively.
12. CONTINGENCIES
The Company has from time to time been notified of various claims
incidental to its business that are not the subject of pending litigation. While
the results of claims cannot be predicted with certainty, the Company believes
that the final outcome of all such matters will not have a materially adverse
effect on its consolidated financial position, results of operations or cash
flows.
F-19
<PAGE> 36
INTEGRATED SURGICAL SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. NIST GRANT
During 1994, the Company received notification it was awarded a $1,960,000
National Institute of Science and Technology ("NIST") grant from the U.S.
Department of Commerce ("USDC"). The grant is shared by the Company and two
strategic partners to fund approximately 49% of a $4 million joint development
project to adapt the ROBODOC System for use in hip revision surgery. The
development project and related NIST Grant began in 1995. The Company received
approximately $317,000 and $514,000 in proceeds under this grant during the
years ended December 31, 1997, and 1998, respectively.
14. ANVAR GRANT
During 1996, IMMI received notification it was awarded a $222,492 grant
from the French agency Agence Nationale de Valorisation de la Recherche
("ANVAR") which is a French national agency established to aid research and
development projects. The grant is to fund the clinical tests to be performed at
two university hospitals on the NeuroMate system over a period of fifteen months
commencing March 1997. IMMI received $173,595 in proceeds under this grant
during the year ended December 31, 1997. The grant income is being recognized
ratably over the project period.
15. EMPLOYEE STOCK PURCHASE PLAN
Shareholders approved and the Board of Directors adopted the Company's
Employee Stock Purchase Plan (the "Purchase Plan") at the annual Shareholders
meeting held April 28, 1998. The Purchase Plan provides all eligible employees
an opportunity to acquire a proprietary interest in the Company on a payroll
deduction or other compensation basis at a 15% discount. The Purchase Plan is
intended to qualify as an employee stock purchase plan under Section 423 of the
Code. The Purchase Plan covers an aggregate of 300,000 shares of the Company's
Common Stock. As of December 31, 1998, no offerings have been made to employees.
F-20
<PAGE> 1
RESTATED CERTIFICATE OF INCORPORATION
OF
INTEGRATED SURGICAL SYSTEMS, INC.
The undersigned, Ramesh Trivedi, being the President of Integrated
Surgical Systems, Inc., corporation organized and existing under the laws of the
State of Delaware (the "Corporation"), hereby certifies that:
1. The name of the corporation is Integrated Surgical Systems, Inc. The
Corporation was originally incorporated under the same name, and the original
Certificate of Incorporation was filed with the Secretary of State of the State
of Delaware on October 1, 1990.
2. This Certificate restates the provisions of the Corporation's
Certificate of Incorporation to read as set forth in Exhibit A attached to this
Certificate.
3. This restatement of the Corporation's Certificate of Incorporation has
been duly adopted by the Corporation's Board of Directors in accordance with
Sections 242 and 245 of the General Corporation Law of the State of Delaware.
IN WITNESS WHEREOF, the undersigned has hereunto caused this Certificate
of Restatement of the Certificate of Incorporation to be executed on behalf of
the Corporation this 26th day of November, 1996.
INTEGRATED SURGICAL SYSTEMS, INC.
By: s/ Ramesh C. Trivedi
---------------------------------
Ramesh C. Trivedi
President
<PAGE> 2
EXHIBIT A
RESTATED CERTIFICATE OF INCORPORATION
OF
INTEGRATED SURGICAL SYSTEMS, INC.
1. The name of the corporation is Integrated Surgical Systems, Inc. (the
"Corporation").
2. The address of the Corporation's registered office in the State of
Delaware is Corporation Trust Center, 1209 Orange Street, in the City of
Wilmington, County of New Castle, 19801. The name of the registered agent at
such address is The Corporation Trust Company.
3. The purpose of the Corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of Delaware.
4. The total number of shares of capital stock that the Corporation shall
have authority to issue is 16,000,000 shares, of which: 15,000,000 shares shall
be common stock, $0.01 par value per share (the "Common Stock"); and 1,000,000
shall be Preferred Stock, $0.01 par value per share (the "Preferred Stock").
Upon the filing of this Restated Certificate of Incorporation
(the "Restatement") with the Delaware Secretary of State, which is concurrent
with the closing of the Corporation's initial public offering, each currently
outstanding share of Series D Preferred Stock shall be converted into one share
of Common Stock, and the Series D Preferred Stock shall be cancelled, retired
and eliminated from the authorized capital stock of the Corporation. No
fractional shares shall be issued in connection with conversion, and the number
of shares issuable to each stockholder shall be determined by rounding upward to
the next whole number the total number of shares held by such stockholder
The relative rights, preferences, privileges and restrictions
granted to or imposed upon the respective classes of shares of capital stock or
holders thereof are as set forth below:
Preferred Stock:
The Preferred Stock may be issued in one or more series, from time to
time, with each such series to have such designation, powers, preferences, and
relative, participating, optional or other special rights, and qualifications,
limitations or restrictions thereof, as shall be stated and expressed in the
resolution or resolutions providing for the issue of such series adopted
2
<PAGE> 3
by the Board of Directors of the Corporation, subject to the limitations
prescribed by law and in accordance with the provisions hereof, the Board of
Directors being hereby expressly vested with authority to adopt any such
resolution or resolutions. The authority of the Board of Directors with respect
to each such series shall include, but not be limited to, the determination or
fixing of the following:
(a) The distinctive designation and number of shares comprising
such series, which number may (except where otherwise provided by the Board of
Directors in creating such series) be increased or decreased (but not below the
number of shares then outstanding) from time to time by like action of the Board
of Directors;
(b) The dividend rate of such series, the conditions and time
upon which such dividends shall be payable, the relation which such dividends
shall bear to the dividends payable on any other class or classes of stock or
series thereof, or any other series of the same class, and whether such
dividends shall be cumulative or non-cumulative;
(c) The conditions upon which the shares of such series shall be
subject to redemption by the Corporation and the times, prices and other terms
and provisions upon which the shares of the series may be redeemed;
(d) Whether or not the shares of the series shall be subject to
the operation of a retirement or sinking fund to be applied to the purchase or
redemption of such shares and, if such retirement or sinking fund be
established, the annual amount thereof and the terms and provisions relative to
the operation thereof;
(e) Whether or not the shares of the series shall be convertible
into or exchangeable for shares of any other class or classes, with or without
par value, or of any other series of the same class, and, if provision is made
for conversion or exchange, the times, prices, rates, adjustments, and other
terms and conditions of such conversion or exchange;
(f) Whether or not the shares of the series shall have voting
rights, in addition to the voting rights provided by law, and, if so, the terms
of such voting rights;
(g) The rights of the shares of the series in the event of
voluntary or involuntary liquidation, dissolution, or upon the distribution of
assets of the Corporation;
(h) Any other powers, preferences and relative participating,
optional or other special rights, and qualifications, limitations or
restrictions thereof, of the shares of such series, as the Board of Directors
may deem advisable and as shall not be inconsistent with the provisions of this
Certificate of Incorporation.
3
<PAGE> 4
The holders of shares of the Preferred Stock of each series shall be
entitled to receive, when and as declared by the Board of Directors, out of
funds legally available for the payment of dividends, dividends (if any) at the
rates fixed by the Board of Directors for such series, and no more, before any
cash dividends shall be declared and paid, or set apart for payment, on the
Common Stock with respect to the same dividend period.
The holders of shares of the Preferred Stock of each series shall be
entitled upon liquidation or dissolution or upon the distribution of the assets
of the Corporation to such preferences as provided in the resolution or
resolutions creating such series of Preferred Stock, and no more, before any
distribution of the assets of the Corporation shall be made to the holders of
shares of the Common Stock. Whenever the holders of shares of the Preferred
Stock shall have been paid the full amounts to which they shall be entitled, the
holders of shares of the Common Stock shall be entitled to share ratably in all
remaining assets of the Corporation."
4
<PAGE> 5
CERTIFICATE OF AMENDMENT
OF THE
RESTATED CERTIFICATE OF INCORPORATION
OF
INTEGRATED SURGICAL SYSTEMS, INC.
The undersigned, Ramesh Trivedi, being the Chief Executive Officer and
President of Integrated Surgical Systems, Inc., a corporation organized and
existing under the laws of the State of Delaware, hereby certifies that:
1. The name of the corporation is Integrated Surgical Systems, Inc.
(the "Corporation").
2. The Restated Certificate of Incorporation of the Corporation is
hereby amended by deleting Article 4 in its entirety and by
substituting the following new Article 4:
"4. The total number of shares of capital stock that the
Corporation shall have authority to issue is 16,000,000, of
which 1,000,000 shares shall be preferred stock, $0.01 par
value per share (the "Preferred Stock"), and 15,000,000 shares
shall be common stock, $0.01 par value per share (the "Common
Stock").
The Preferred Stock may be issued in one or more series, from
time to time, with each such series to have such designation,
powers, preferences, and relative, participating, optional or
other special rights, and qualifications, limitations or
restrictions thereof, as shall be stated and expressed in the
resolution or resolutions providing for the issue of such
series adopted by the Board of Directors of the Corporation,
subject to the limitations prescribed by law and in accordance
with the provisions hereof, the Board of Directors being
hereby expressly vested with authority to adopt any such
resolution or resolutions. The authority of the Board of
Directors with respect to each such series shall include, but
not be limited to, the determination of fixing of the
following:
(a) The distinctive designation and number of shares
comprising such series, which number may (except where
otherwise provided by the Board of Directors in creating
such series) be increased or decreased (but not below
the number of shares then outstanding) from time to time
by like action of the Board of Directors;
<PAGE> 6
(b) The dividend rate of such series, the conditions and
time upon which such dividends shall be payable, the
relation which such dividends shall bear to the
dividends payable on any other class or classes of stock
or series thereof, or any other series of the same
class, and whether such dividends shall be cumulative or
non-cumulative;
(c) The conditions upon which the shares of such series
shall be subject to redemption by the Corporation and
the times, prices and other terms and provisions upon
which the shares of the series may be redeemed;
(d) Whether or not the shares of the series shall be subject
to the operation of a retirement or sinking fund to be
applied to the purchase or redemption of such shares
and, if such retirement or sinking fund be established,
the annual amount thereof and the terms and provisions
relative to the operation thereof;
(e) Whether or not the shares of the series shall be
convertible into or exchangeable for shares of any other
class or classes, with or without par value, or of any
other series of the same class, and, if provision is
made for conversion or exchange, the times, prices,
rates, adjustments, and other terms and conditions of
such conversion or exchange;
(f) Whether or not the shares of the series shall have
voting rights, in addition to the voting rights provided
by law, and, if so, the terms of such voting rights;
(g) The rights of the shares of the series in the event of
voluntary or involuntary liquidation, dissolution, or
upon the distribution of assets of the Corporation; and
(h) Any other powers, preferences and relative
participating, optional or other special rights, and
qualifications, limitations or restrictions thereof, of
the shares of such series, as the Board of Directors may
deem advisable and as shall not be inconsistent with the
provisions of this Certificate of Incorporation.
The holders of shares of the Preferred Stock of each series
shall be entitled to receive, when and as declared by the
Board of Directors, out of funds legally available for the
payment of dividends, dividends (if any) at the rates fixed by
the Board of Directors for such series, and no more, before
any cash
2
<PAGE> 7
dividends shall be declared and paid, or set apart for
payment, on the Common Stock with respect to the same dividend
period.
The holders of shares of the Preferred Stock of each series
shall be entitled upon liquidation or dissolution or upon the
distribution of the assets of the Corporation to such
preferences as provided in the resolution or resolutions
creating such series of Preferred Stock, and no more, before
any distribution of the assets of the Corporation shall be
made to the holders of shares of the Common Stock. Whenever
the holders of shares of the Preferred Stock shall have been
paid the full amounts to which they shall be entitled, the
holders of shares of the Common Stock shall be entitled to
share ratably in all remaining assets of the Corporation."
3. This Amendment has been duly adopted in accordance with the
provisions of Section 242 of the General Corporation Law of the
State of Delaware.
IN WITNESS WHEREOF, I have hereunto set my hand and caused this
Amendment to be executed on behalf of the Corporation this 13th day of May,
1998.
Integrated Surgical Systems, Inc.
By: s/ Ramesh C.Trivedi
---------------------------------
Ramesh C. Trivedi
Chief Executive Officer
and President
3
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES
<TABLE>
<CAPTION>
Jurisdiction of
Name Incorporation Ownership
---- ------------- ---------
<S> <C> <C>
Integrated Surgical Systems BV Netherlands 100%
Innovative Medical Machines International, S.A. France 100%
Innovative Medical Machines International, Inc. Delaware 100%
Marbella High Care BV Netherlands 22%
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-3 Nos. 333-42051, 333-66133, 333-9207, 333-16539) of Integrated Surgical
Systems, Inc. and in the related Prospectuses of our report dated February 12,
1999, with respect to the consolidated financial statements of Integrated
Surgical Systems, Inc. included in this Annual Report (Form 10-KSB) for the year
ended December 31, 1998.
We also consent to the incorporation by reference in the Registration
Statements (Form S-8 Nos. 333-44093, 333-70779) pertaining to the 1995 Stock
Option Plan, As Amended, 1998 Stock Option Plan and Employee Stock Purchase Plan
of Integrated Surgical Systems, Inc. of our report dated February 12, 1999, with
respect to the consolidated financial statements of Integrated Surgical Systems,
Inc. included in this Annual Report (Form 10-KSB) for the year ended December
31, 1998.
ERNST & YOUNG LLP
Sacramento, California
March 23, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 223,581
<SECURITIES> 2,024,278
<RECEIVABLES> 1,905,138
<ALLOWANCES> 0
<INVENTORY> 3,005,658
<CURRENT-ASSETS> 7,623,076
<PP&E> 3,058,202
<DEPRECIATION> 1,707,363
<TOTAL-ASSETS> 13,165,170
<CURRENT-LIABILITIES> 4,955,855
<BONDS> 0
0
35
<COMMON> 56,504
<OTHER-SE> 8,002,071
<TOTAL-LIABILITY-AND-EQUITY> 13,165,170
<SALES> 6,146,434
<TOTAL-REVENUES> 6,146,434
<CGS> 3,413,221
<TOTAL-COSTS> 12,950,142
<OTHER-EXPENSES> (100,380)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 124,095
<INCOME-PRETAX> (10,240,644)
<INCOME-TAX> 27,235
<INCOME-CONTINUING> (10,267,879)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,267,879)
<EPS-PRIMARY> (1.91)
<EPS-DILUTED> (1.91)
</TABLE>
