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ECLIPSE SURGICAL TECHNOLOGIES, INC.
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT of 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
Commission file number 0-28288
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ECLIPSE SURGICAL TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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CALIFORNIA 77-0223740
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(STATE OF INCORPORATION) (I.R.S. EMPLOYER
IDENTIFICATION NUMBER)
559 WEDDELL DRIVE
SUNNYVALE, CALIFORNIA 94089
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
(408) 747-0120
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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TITLE OF EACH CLASS NAME OF EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, NO PAR VALUE NASDAQ NATIONAL MARKET
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K.____
Indicate the number of shares outstanding of each of the issuer's
classes of common stock outstanding as of the last practicable date.
16,875,506 shares
As of February 27, 1998
DOCUMENTS INCORPORATED BY REFERENCE
PART OF FORM 10-K
ANNUAL REPORT IN WHICH
DOCUMENT DOCUMENT IS INCORPORATED
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Definitive Proxy Statement for the Registrant's Annual Meeting of Stockholders for the
fiscal year ended December 31, 1997, to be filed pursuant to Regulation 14A............. Part III
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INDEX TO FORM 10-K
PAGE
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PART I
Item 1. Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Item 2. Description of Property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . . . . . 14
PART II
Item 5. Market for Registrant's Shares and Related Shareholder Matters . . . . . . . . . . . . . . 15
Item 6. Selected Consolidated Financial Data . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . 17
Item 8. Consolidated Financial Statements and Supplementary Schedules. . . . . . . . . . . . . . . 29
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . 29
PART III
Item 10. Directors and Officers of Registrant . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 11. Executive Compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
Item 12. Security Ownership of Certain Beneficial Owners and Management . . . . . . . . . . . . . . 29
Item 13. Certain Relationships and Related Transactions . . . . . . . . . . . . . . . . . . . . . . 29
PART IV
Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K . . . . . . . . . . . . . . 30
Signatures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
PART I
ITEM 1. BUSINESS.
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS THAT
INVOLVE RISKS AND UNCERTAINTIES. THE STATEMENTS CONTAINED HEREIN THAT ARE
NOT PURELY HISTORICAL ARE FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF
SECTION 27A OF THE SECURITIES ACT AND SECTION 21E OF THE EXCHANGE ACT,
INCLUDING WITHOUT LIMITATION STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS,
BELIEFS, INTENTIONS OR STRATEGIES REGARDING THE FUTURE. ALL FORWARD-LOOKING
STATEMENTS INCLUDED IN THIS DOCUMENT OR INCORPORATED BY REFERENCE HEREIN ARE
BASED ON INFORMATION AVAILABLE TO THE COMPANY ON THE DATE HEREOF, AND THE
COMPANY ASSUMES NO OBLIGATION TO UPDATE ANY SUCH FORWARD-LOOKING STATEMENTS.
THE COMPANY'S ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF CERTAIN FACTORS, INCLUDING
THOSE ACT FORTH IN ITEM 7 AND ELSEWHERE.
GENERAL
The Company, incorporated in California in 1989, designs, develops,
manufactures and distributes laser-based surgical products and disposable
fiber-optic accessories for the treatment of advanced cardiovascular disease
through transmyocardial revascularization ("TMR") and percutaneous
transluminal myocardial revascularization ("PTMR"). TMR and PTMR are new
laser heart treatments in which millimeter channels are made in the heart
muscle. The pathways are intended to enable improved blood supply to the
myocardium. It is believed these procedures encourage new vessel formation,
or angiogenesis, and result in reduced angina pain. TMR is performed by a
cardiac surgeon through a small incision in the chest. PTMR is performed by
a cardiologist in a catheter based procedure under local anesthesia. Both
procedures can be performed as stand alone treatments or adjunctively with
coronary artery bypass graft ("CABG") or balloon angioplasty, respectively.
The Company has ongoing clinical trials in each of these areas. In the U.S.,
the Company currently offers its laser systems for sale in limited numbers
for investigational use only pursuant to Investigational Device Exemptions
("IDEs") from the U.S. Food and Drug Administration (the "FDA"). The
Company's initial clinical trial is completed and an application to the FDA
for preliminary marketing approval ("PMA") was submitted July 2, 1997.
BACKGROUND
Cardiovascular disease is the leading cause of death and disability in
the U.S., according to the American Heart Association (the "AHA"). Coronary
artery disease is the principal form of cardiovascular disease and is
characterized by a progressive narrowing of the coronary arteries, which
supply blood to the heart. This narrowing process is usually due to
atherosclerosis, the buildup of fatty deposits, or plaque, on the inner
lining of the arteries. Coronary artery disease reduces the available supply
of oxygenated blood to the heart muscle, potentially resulting in severe
chest pain known as angina, as well as damage to the heart. Typically, the
condition worsens over time and often leads to heart attack or death.
Based on standards promulgated by the Canadian Heart Association, angina
is typically classified into four classes, ranging from Class I, in which
anginal pain results only from strenuous exertion, to the most severe class,
Class IV, in which the patient is unable to conduct any physical activity
without angina and angina may be present even at rest. The AHA estimates that
more than six million Americans experience anginal symptoms.
The primary therapeutic options for treatment of coronary artery disease
are drug therapy, balloon angioplasty also known as percutaneous transluminal
coronary angioplasty or ("PTCA"), other interventional techniques which
augment or replace PTCA such as stent placement and atherectomy, and CABG.
The objective of each of these approaches is to increase blood flow through
the coronary arteries to the heart.
Drug therapy may be effective for mild cases of coronary artery disease
and angina either through medical effects on the arteries that improve blood
flow without reducing the plaque or by decreasing the rate of formation of
additional plaque (E.G., by reducing blood levels of cholesterol). Because of
the progressive nature of the disease, however, many patients with angina
ultimately undergo either PTCA or open heart bypass surgery.
1
PTCA is a less-invasive alternative to CABG introduced in the early 1980s
in which a balloon-tipped catheter is inserted into an artery, typically near
the groin, and guided to the areas of blockage in the coronary arteries. The
balloon is then inflated and deflated at each blockage site, thereby rupturing
the blockage and stretching the vessel. Although the procedure is usually
successful in widening the blocked channel, the artery often re-narrows within
six months of the procedure, a process called "restenosis," often
necessitating a repeat procedure. A variety of techniques for use in
conjunction with PTCA have been developed in an attempt to reduce the
frequency of restenosis, including stent placement and atherectomy. Stents are
small metal frames delivered to the area of blockage using a balloon catheter
and deployed or expanded within the coronary artery. The stent is a permanent
implant intended to keep the channel open. Atherectomy is a means of using
mechanical, laser or other techniques at the tip of a catheter to cut or grind
away plaque.
CABG is an open chest procedure developed in the 1960s in which conduit
vessels are taken from elsewhere in the body and grafted to the blocked
coronary arteries so that blood can bypass the blockage. CABG typically
requires use of a heart-lung bypass machine to render the heart inactive (to
allow the surgeon to operate on a still, relatively bloodless heart) and
involves prolonged hospitalization and patient recovery periods. Accordingly,
it is generally reserved for patients with severe cases of coronary artery
disease or those who have previously failed to receive adequate relief of
their symptoms from PTCA or related techniques. Unfortunately, most bypass
grafts fail within one to fifteen years following the procedure. Repeating the
surgery ("re-do bypass surgery") is possible, but is made more difficult
because of scar tissue and adhesions that typically form as a result of the
first operation. Moreover, for many patients CABG is inadvisable for various
reasons, such as the severity of the patient's overall condition, the extent
of coronary artery disease or the small size of the blocked arteries.
When these treatment options are exhausted, the patient is left with no
viable surgical alternative other than, in limited cases, heart
transplantation. Without a viable surgical alternative, the patient is
generally managed with drug therapy, often with significant lifestyle
limitations. TMR and PTMR, currently under clinical investigation by the
Company and certain other companies, offer potential relief to a large class
of patients with severe cardiovascular disease.
THE TMR AND PTMR PROCEDURE
TMR, or transmyocardial revascularization, is a surgical procedure
performed on the beating or non-beating heart, in which a laser device is
used to create pathways through the myocardium directly into the heart
chamber. The pathways are intended to enable improved perfusion, or supply, of
blood to the myocardium and reduce angina in the patient. TMR potentially can
be performed using any of several different surgical approaches, including
open chest surgery, minimally invasive surgery through a four inch incision
between the ribs, or videoscopically through small openings or ports in the
chest. TMR potentially offers end-stage cardiac patients who are not
candidates for PTCA or CABG a means to alleviate their symptoms and improve
their quality of life. TMR may also be effective when used in conjunction with
CABG to treat areas of the heart not treated after bypass surgery. The
Company has received IDEs from the FDA to conduct clinical trials which
include TMR using an open chest approach, TMR in conjunction with CABG, TMR in
a minimally invasive procedure, TMR with minimally invasive directed coronary
artery bypass ("MIDCAB"), and TMR via small ports in the chest.
PTMR, or percutaneous transluminal myocardial revascularization, is an
interventional procedure performed by a cardiologist. PTMR is based upon the
same principles as TMR, but the procedure is much less invasive. The patient
is under local anesthesia, and is treated through a catheter inserted in the
femoral artery at the top of the leg. A laser transmitting catheter is
threaded up into the heart chamber, where channels are created in the inner
portion of the myocardium (i.e. heart muscle). PTMR potentially offers angina
sufferers another treatment option before being referred to a surgeon for a
more invasive course of treatment. PTMR may also be effective when used in
conjunction with PTCA to treat areas of the heart not revascularized by a
balloon or stent. The Company has received IDEs to conduct clinical trials
studying PTMR, as well as PTMR in conjunction with PTCA.
The physiologic principles underlying TMR and PTMR as potential
treatments for cardiovascular disease were first identified in the 1930s. It
was observed then that, although the human myocardium depends on external
coronary
2
arteries for its blood supply, it displays elements of certain direct blood
pathways found in reptilian hearts. In reptiles, blood is supplied directly to
the myocardium through these pathways from the chambers of the heart. These
observations led to a belief that impaired vascularization in the human
myocardium could be treated by creating direct pathways through the myocardium
into the heart chamber. Successes in other treatment techniques such as PTCA
and CABG, however, as well as limitations in the technologies available to
perform TMR and PTMR, limited the focus on TMR and PTMR until recently.
Following numerous advancements in the use of laser technology in medical
applications, human trials of laser-based TMR commenced in the 1980s and of
PTMR in the 1990s. TMR and PTMR are now being offered as investigational
procedures as part of clinical studies to determine the safety and
effectiveness of such procedures.
BUSINESS STRATEGY
The Company's objective is to become the leading supplier in the TMR and
PTMR markets. The Company's strategies to achieve this goal are as follows:
DEMONSTRATE CLINICAL UTILITY OF TMR AND PTMR. The Company is seeking to
demonstrate the clinical safety and effectiveness of TMR and PTMR and achieve
FDA approval of the Company's products through clinical trials. The Company's
initial clinical trial commenced in November 1995 and is designed to assess
the safety and effectiveness of the Company's TMR procedure as compared with
drug therapy. The Company has commenced additional trials, including "TMR as
an Adjunct to Bypass Surgery," "TMR as an Adjunct to Minimally Invasive
Directed Coronary Artery Bypass," "TMR via Ports," "PTMR Compared to Drug
Therapy," and "PTMR as an Adjunct to PTCA."
DEVELOP COMPREHENSIVE PRODUCT LINES FOR TMR AND PTMR. The Company is
seeking to develop multiple surgical platforms and provide a comprehensive
suite of high quality products for TMR. The Company believes that its compact,
flexible, fiber-optic based system will enable it to offer effective TMR
solutions across the three principal TMR surgical approaches for TMR, open
chest surgery, minimally invasive surgery and percutaneous TMR. The Company is
also developing a broad range of disposable fiber-optic based surgical tools
designed to operate with the Company's laser base unit and intended to provide
physicians with a broad range of options for their individual tactile
preferences and solutions for the different geometry of each patient's heart
cavity.
LEVERAGE PROPRIETARY TECHNOLOGY. The Company believes that its
significant expertise in laser and catheter-based systems for cardiovascular
disease and the proprietary technologies it has developed are important
factors in its efforts to demonstrate the safety and effectiveness of its TMR
procedures. The Company is seeking to develop additional proprietary
technologies for TMR and related procedures. The Company has 30 patents or
allowed patent applications and 32 patent applications pending relating to
various aspects of TMR, PTMR and other cardiovascular therapies.
EXPAND MARKET FOR THE COMPANY'S PRODUCTS. The Company is seeking to
expand market awareness of the Company's products among opinion leaders in the
cardiovascular field, subject to appropriate regulatory guidelines. In
connection with the current clinical trials, the Company has focused its
initial efforts in the U.S. on the 200 hospitals that perform the greatest
number of cardiovascular procedures. The Company also sells its products
through its direct international sales organization and a network of
distributors and agents. In addition, the Company has assembled a board of
scientific advisors consisting of a number of influential cardiac surgeons and
cardiologists. The Company has also developed a comprehensive training program
to assist physicians in acquiring the expertise necessary to utilize the
Company's TMR or PTMR products and procedures. The Company is seeking to expand
the approved indications for TMR or PTMR through additional clinical studies.
RISK FACTORS
The Company's success will depend upon successful completion of clinical
trials, some of which are currently at an early stage; the receipt of FDA and
other governmental approvals, which may take considerable time, and may not be
granted at all; acceptance of TMR or PTMR, which are new surgical procedures,
among the medical community; the ability to protect its intellectual property
rights; the risks of claims of infringement of third party intellectual
Company's property rights; the ability of the Company to manage change and
growth in its business, particularly in light of the Company's limited history
of TMR operations and history of operating losses; the status of medical
reimbursement and
3
other regulatory matters; the ability of the Company to succeed in light of
significant competition; and other risks. See "Certain Factors Bearing on
Future Results" under Item 7.
PRODUCTS AND TECHNOLOGY
ECLIPSE TMR 2000 SYSTEM
The Eclipse TMR 2000 system consists of the Eclipse TMR 2000 laser base
unit and a line of fiber-optic, laser based surgical tools. Each surgical
tool utilizes optical fiber to deliver laser energy from the source laser
base unit to the distal tip of the surgical handpiece or PTMR catheter. The
compact base unit occupies a small amount of operating room floor space,
operates on a standard 208 or 220-volt power supply, features a
self-contained cooling system which eliminates the need for electrical or
plumbing modifications to the hospital operating room or catheterization
laboratory where it is typically used on patients, and is light enough to
move within the operating room or among operating rooms in order to use
operating room space efficiently. Moreover, the flexible, lightweight and
slender optical fiber used to deliver the laser energy to the patient enables
ready access to the patient and to various sites within the heart.
The Eclipse TMR 2000 system and related surgical procedures are designed
to be used without the requirement of the external systems utilized with
certain competitive TMR systems. For example, the Eclipse TMR 2000 does not
require electrocardiogram synchronization, which monitors the electrical
output of the heart and times the use of the laser to minimize electrical
disruption of the heart, or transesophageal echocardiography, which tests
each application of the laser to the myocardium during the TMR procedure to
determine if the pathway has penetrated through the myocardium into the heart
chamber.
ECLIPSE HOLMIUM LASER. The Eclipse TMR 2000 laser base unit generates
laser light of a 2-micron wavelength by photoelectric excitation of a solid
state holmium crystal. The holmium laser, because it uses a solid state
crystal as its source, is compact, reliable and requires low maintenance. The
Company has been using holmium lasers since its inception.
DISPOSABLE SURGICAL TOOLS. The Company offers to physicians a broad
range of surgical tool options for their individual tactile preferences and
solutions for the different geometry of each patient's heart cavity. These
products are designed to give the surgeon control of the procedure, access to
difficult to reach areas of the heart and clear visualization of the surgical
field. Each such tool is designed for disposal after use in a single surgical
procedure. The products include the following devices:
CRYSTALPOINT. The CrystalPoint fiber-optic handpiece system
utilizes a single, one millimeter diameter optical fiber to deliver the
energy from the Eclipse TMR 2000 laser base unit to the targeted
surgical sites within the body. The single strand design provides
maximum tactile feedback to the surgeon, as he or she monitors the
penetration of the laser into the myocardium. The fiber-optic design
provides flexibility and maneuverability for the surgeon, particularly
as compared to the articulated mechanical arms required in connection
with CO2 laser-based devices.
CRYSTALFLEX AND SOLO-GRIP. The CrystalFlex handpiece system is
comprised of multiple, fine fiber-optic strands in a one millimeter
diameter bundle. The CrystalFlex fiber delivers the same amount of
laser energy as the CrystalPoint, but the fiber bundle makes the
CrystalFlex more flexible than the CrystalPoint with its single solid
core. The CrystalFlex is used in conjunction with the Solo-Grip
handpiece to provide access to hard to reach sites within the heart
cavity while enabling single hand control.
PTMR CATHETER AND SLIMFLEX. The PTMR catheter is an over-the-wire,
steerable, disposable catheter system that features torque control,
deflection capability, infusion port, radioopaque markers for enhanced
visualization and depth control. After insertion into an artery of the
leg, the PTMR catheter is advanced over the aortic arch, across the
aortic valve and into the heart chamber. Visualization is achieved
using standard fluoroscopic or x-ray techniques common to all hospitals
doing cardiac catheterization.
4
The CrystalPoint, CrystalFlex and SlimFlex fiber-optic handpieces each
have an easy to install connector which screws into the laser base unit, and
each device is pre-calibrated in the factory so it requires no special
preparation.
REGULATORY STATUS
The Company has completed the final phase of a clinical study designed
to assess the safety and effectiveness of TMR performed in an open chest
procedure for the treatment of patients with Class IV angina as compared with
drug therapy. The Company originally received FDA clearance to commence this
clinical study in September 1995, and undertook Phase I of the study shortly
thereafter in November 1995. Phase I was intended to provide indications of
safety prior to undertaking expanded clinical trials, and was completed in
January 1996. In February 1996, the FDA reviewed the Phase I results and
authorized commencement of Phase II.
Phase II of the study involves a minimum of 126 patients and was
completed in November 1996. The Company began analyzing six month follow-up
data from this trial in April 1997, prior to submission of a PMA application
in July 1997. The Company was subsequently notified by the FDA that twelve
month follow-up data would be required. Twelve month data became available in
October 1997 and is being analyzed and prepared for submission as an
amendment to the original PMA application. The Company intends to submit this
additional data in the first quarter of 1998.
In February 1996, the Company obtained FDA clearance to undertake Phase
I of another clinical study of TMR intended to assess the safety and
effectiveness of "TMR Used in Conjunction with CABG" as compared with CABG
alone. In September 1996, the FDA provided the Company with clearance to
begin Phase II of this study which is currently in process. During 1996 the
Company was granted FDA clearance to begin Phase I of two additional clinical
trials. Both of these trials are currently in process.
In January 1997, the Company received an IDE to begin its first
minimally invasive clinical trial ,"TMR as an Adjunct to Minimally Invasive
Direct Coronary Artery Bypass Surgery".
In June 1997, the Company received an IDE from the FDA to begin its
first PTMR clinical trial, comparing patients treated with PTMR to patients
receiving only drug therapy. In November 1997, the FDA gave the Company
authorization to begin Phase II of this trial.
In December 1997, the Company received its most recent IDE from the FDA,
authorizing commencement of Phase I of another PTMR clinical trial. This
trial is studying PTMR in conjunction with PTCA or various other
interventional procedures, compared to people receiving only PTCA.
There can be no assurance that the results of the Company's studies will
be sufficient to obtain the PMA required to commercialize its TMR products.
Additionally, there can be no assurance that the Company will not be required
to conduct additional trials which may result in substantial costs and
delays.
SALES AND MARKETING
The Company is currently restricted to selling its TMR and PTMR products
for investigational use only. Due to a recent change in the Health Care
Financing Administration ("HCFA") policy regarding Medicare reimbursement for
TMR procedures, the Company expects revenues from sales of investigational
devices to decrease and expenses in support of clinical trials to increase
significantly over the short term and possibly thereafter. To the extent
permitted under FDA rules, the Company is seeking to promote market awareness
of the Company's products among opinion leaders in the cardiovascular field
and to recruit physicians and hospitals to participate in the Company's
clinical trials. To address this market area, the Company maintains a
domestic direct sales force consisting of nine sales people in the five sales
regions and utilizes a regional distributor of cardiovascular surgical
products to manage sales in the sixth designated U.S. sales region. In the
event the FDA approves a PMA application for the Company's TMR products, the
Company intends to expand its direct sales and support personnel.
5
The Company currently offers a laser base unit, at a current end user
list price of $295,000 per unit, and disposable surgical tools (at least one
of which must be used with each procedure) at an end user unit list price of
$1,895 for a TMR handpiece or $2,295 for a PTMR catheter. In order to assist
hospitals in making a substantial investment in the Company's laser system,
the Company intends to continue selling the systems to the hospital outright
or placing the system with the hospital, for a placement fee (currently
$25,000) plus an additional fee for each procedure performed. The Company
has also made contingency placements of its laser systems which are not taken
as revenue until a sale ensues only after FDA approval is received or HCFA
reimbursement becomes available.
The Company intends to continue to broaden its line of disposable
products as part of its strategy to develop multiple platforms for TMR. The
open chest, minimally invasive TMR procedures and percutaneous TMR procedures
are made possible by the use of the Company's flexible, lightweight and
slender fiber-optic based surgical tools. Open chest TMR procedures and
minimally invasive TMR surgical procedures are performed by cardiac surgeons.
In contrast, percutaneous TMR is performed by interventional cardiologists
using catheter-based products.
Internationally, the Company sells its products through a direct sales
and support organization of seven people and a network of distributors and
agents.
From September 1995 through December 31, 1997, the Company shipped 114
systems worldwide.
The Company has developed, in conjunction with several major hospitals
using the Company's TMR or PTMR products, a training program to assist
physicians in acquiring the expertise necessary to utilize the Company's
products and procedures. This program includes a comprehensive one-day course
including observation of live procedures, didactic training and hands-on
performance of TMR or PTMR in vivo.
The Company exhibits its products at major cardiovascular meetings and
recruits new investigators to buy the Company's products for investigational
use in their hospitals. Investigators of the Company's products have made
presentations at meetings around the world, describing their results.
Abstracts have been published and articles will be submitted to peer-reviewed
publications and industry journals to present the results of the ongoing
clinical trials.
SCIENTIFIC ADVISORY BOARD
The Company's Scientific Advisory Board meets with the Company on an
individual and group basis to discuss the Company's TMR products and
procedures, relevant developments in cardiology and the treatment of heart
disease, and strategic directions. In addition, the Company has worked with
the medical staffs of several major universities in developing the protocols
for the Company's TMR procedures and in clinical data monitoring and
statistical analysis.
The Scientific Advisory Board consists of a number of prominent members
of the medical and scientific communities, including the following persons:
Name Occupation/Title
- ---- ----------------
Eric Powers, M.D. Professor of Medicine and Director
Cardiac Cath Laboratory
University of Virginia
Vaughn Starnes, M.D. Professor of Surgery and Chief
Cardiothoracic Surgery
University of Southern California School of Medicine
Eric Topol, M.D. Chairman
Department of Cardiology
Cleveland Clinic Foundation
6
In addition, the Company meets several times each year, during
professional conferences and exhibitions, with the group of physicians who
serve as investigators in connection with the Company's clinical trials, in
order to discuss clinical procedures and results.
RESEARCH AND DEVELOPMENT
The Company's ongoing research and product development efforts are
focused on the development of new and enhanced lasers, fiber-optic handpieces
and TMR applications. In addition, the Company continues to develop new laser
handpieces in order to enhance the utility and quality of the Company's line
of disposable surgical tools and to expand the indications for use and
variety of procedures that can be performed with the Company's surgical
tools. Specifically, the Company is seeking to achieve continual improvements
in its TMR procedure, including greater surgical access and visualization of
the surgical field; greater precision in the placement of pathways; reduced
epicardial bleeding and bruising of heart muscle; greater margins of safety
with respect to underlying heart structures; and reduced likelihood of
induction of arrhythmia.
In furtherance of the Company's strategy to develop the three principal
surgical platforms for performance of TMR, current research efforts include
enhancements to open chest surgical TMR as well as complementary techniques
for minimally invasive surgical TMR and percutaneous TMR. In all these cases,
the Company anticipates new disposable products will be required to satisfy
market requirements.
The Company's research and development spending, including expenditures
related to clinical trials, was $12,007,000, $6,586,000 and $1,010,000,
respectively, in 1997, 1996 and 1995. The Company expects that research and
development expenses will continue to increase in connection with the
Company's clinical trials and ongoing development efforts. Additionally, due
to a May 1997 change in the HCFA policy regarding Medicare reimbursement for
TMR procedures in clinical trials, the Company expects expenses in support of
clinical trials to increase significantly at least over the short term and
possibly thereafter. See "Third Party Reimbursement".
All medical products of the types produced by the Company require a PMA
prior to commercial marketing in the U.S. There can be no assurance that the
Company will obtain a PMA from the FDA for the Company's TMR or PTMR
products.
MANUFACTURING AND QUALITY ASSURANCE
The Company manufactures and assembles its products from purchased
components and subassemblies, primarily at the Company's facility in
Sunnyvale, California.
Each laser is mobile and shock resistant, complies with Underwriters
Laboratory ("UL") standards and is equipped with safety interlocks and user
friendly controls and meters. Company production personnel assemble and test
each laser system in a process designed to test the integrity of the laser
system and to provide for accurate calibration of system components. Upon
completion of these tests, the laser is packaged for shipment. Company
personnel uncrate and install the laser at the hospital, and verify that the
system meets acceptance criteria, including all laser power output
specifications.
Laser handpieces are fabricated from tubing, connectors and optical
fibers, each of which is purchased from outside vendors. The individual
optical fibers are cut to the appropriate length, bundled and placed in the
extruded tubing and metal connectors, and the tip of the device is molded and
polished. Prior to packaging, each handpiece is tested on a laser system to
verify acceptable power output.
The Company's assembly and manufacturing activities to date have
consisted primarily of producing limited quantities of its laser units and
fiber-optic accessories for sale to clinical investigators. The Company's
future profitability will depend, in part, on its ability to achieve
manufacturing efficiencies as production volumes increase.
7
The core components of the Company's laser units and fiber-optic
handpieces are generally acquired from multiple sources. The Company
currently purchases certain laser and fiber-optic components and
subassemblies from single sources. Although the Company has identified
alternative vendors, the qualification of additional or replacement vendors
for certain components or services is a lengthy process. Any significant
supply interruption would have a material adverse effect on the Company's
ability to manufacture its products and, therefore, would materially and
adversely affect the Company's business, financial condition and results of
operations. The Company intends to continue to qualify multiple sources for
components that are presently single sourced and also to build an inventory
of these items for use in the event of supply interruptions.
In May 1997, the Company received ISO 9001 Certification for its
quality assurance process. The Company is committed to continuous quality
improvement in its manufacturing and assembly operations. Each subassembly
and product is thoroughly tested at multiple stages of production to ensure
proper operation and compliance with applicable regulatory standards.
Manufacturing quality is documented and monitored continually under ISO
guidelines.
The Company is required to register as a manufacturer of medical devices
with the FDA and state agencies such as the California Department of Health
Services. As a condition to receipt of a PMA, the Company's facilities,
procedures and practices will be subject to pre-approval GMP inspections and
thereafter to ongoing, periodic inspections by the FDA and such other
regulatory agencies.
The Company is also subject to certain federal, state and local
regulations regarding environmental protection and hazardous substance
controls, among others. Although the Company believes it currently complies
in all material respects with such regulations, failure to comply could
subject the Company to fines or other enforcement actions.
The Company provides to its customers in the U.S. and to its foreign
distributors a free one-year parts and service warranty for each laser unit.
The Company offers extended warranty coverage for one-year periods to
customers in the U.S. The Company also performs service on a fee basis on
laser units that are no longer covered by warranty. Annual service contracts
are generally priced at 10% of the purchase price of the laser unit.
Handpieces are sold without warranty.
COMPETITION
The Company expects that the market for TMR and PTMR, which is currently
in the early stages of development, will be intensely competitive.
Competitors include PLC Systems, Inc. ("PLC"), CardioGenesis Corporation
("CardioGenesis"), Johnson and Johnson ("J&J"), and U.S. Surgical
Corporation ("U.S. Surgical") which are currently selling TMR or PTMR
products for investigational use in the U.S. and abroad. Other competitors
may also enter the market, including large companies in the laser and cardiac
surgery markets. Many of these companies have or may have significantly
greater financial, research and development, marketing and other resources
than the Company.
PLC is a publicly traded corporation which uses a CO2 laser and an
articulated mechanical arm in its TMR products. PLC obtained an IDE to
undertake clinical trials in January 1990. PLC has conducted extensive trials
but has not yet received a PMA. PLC presented its results to an FDA advisory
panel in July 1997 and was instructed to gather more data. PLC has received
the CE Marking which allows sales of its products commercially in all
European Union countries. PLC has been issued patents for its apparatus and
methods for TMR.
CardioGenesis is a publicly held company which uses a holmium laser and
fiber optics in its TMR and PTMR products. CardioGenesis has been issued
patents for its methods of TMR and PTMR, is actively promoting its products
in Europe through a distribution agreement with Boston Scientific Corporation
and has begun clinical trials in the U.S. under an IDE.
J&J is a publicly traded company which uses a holmium laser and
fiber-optics in its PTMR products. J&J has acquired a ventricular mapping
company to further its PTMR product line and has begun U.S. trials under an
IDE.
8
U.S. Surgical is a publicly traded company which uses an excimer laser
and fiberoptics in its TMR products. U.S. Surgical is actively promoting its
products in Europe and has begun clinical trials in the U.S. under an IDE.
U.S. Surgical has acquired one laser company and rights to products from
another laser supplier.
The Company believes that the factors which will be critical to market
success include the timing of receipt of requisite regulatory approvals,
effectiveness and ease of use of the TMR products and procedures on both a
stand alone basis and in conjunction with other procedures such as CABG and
PTCA, breadth of product line, system reliability, brand name recognition and
effectiveness of distribution channels and cost of capital equipment and
disposable devices.
TMR also competes with other methods for the treatment of cardiovascular
disease, including drug therapy, PTCA and CABG. Although the Company is
seeking to demonstrate the safety and effectiveness of the Company's TMR and
PTMR procedures in patients for whom other cardiovascular treatments are not
likely to provide relief, and when used in conjunction with other treatments,
there can be no assurance that the Company's TMR or PTMR products will be
accepted. Moreover, technological advances in other therapies for
cardiovascular disease such as pharmaceuticals or future innovations in
cardiac surgery techniques could make such other therapies more effective or
lower in cost than the Company's TMR procedure and could render the Company's
technology obsolete. There can be no assurance that physicians will use the
Company's TMR procedure to replace or supplement established treatments, or
that the Company's TMR procedure will be competitive with current or future
technologies. Such competition could materially and adversely affect the
Company's business, financial condition and results of operations.
Any product developed by the Company that gains regulatory approval will
face competition for market acceptance and market share. An important factor
in such competition may be the timing of market introduction of competitive
products. Accordingly, the relative pace at which the Company can develop
products, complete clinical testing and regulatory approval processes, gain
reimbursement acceptance and supply commercial quantities of the product to
the market are expected to be important competitive factors. In the event a
competitor is able to obtain a PMA for its products prior to the Company, the
Company's ability to compete successfully could be materially and adversely
affected. There can be no assurance that the Company will be able to compete
successfully against current and future competitors. Failure to do so would
materially and adversely affect the Company's business, financial condition
and results of operations.
GOVERNMENT REGULATION
Laser-based surgical products and disposable fiber-optic accessories for
the treatment of advanced cardiovascular disease through TMR are considered
medical devices, and as such are subject to regulation in the U.S. by the FDA.
The Company has FDA clearance for the sale of the Eclipse laser system for
thoracic surgery. However, the Company has voluntarily submitted the device to
the more rigorous PMA process with the objective of gaining approval for more
specific labeling for the treatment of advanced cardiovascular disease.
To obtain a PMA for a medical device, the Company must file a PMA
application that includes clinical data and the results of pre-clinical and
other testing sufficient to show that there is a reasonable assurance of
safety and effectiveness of the product for its intended use. To begin a
clinical study, an IDE must be obtained and the study must be conducted in
accordance with FDA regulations. An IDE application must contain preclinical
test data demonstrating the safety of the product for human investigational
use, information on manufacturing processes and procedures, and proposed
clinical protocols. If the IDE application is cleared by the FDA, human
clinical trials may begin. The results obtained from these trials, if
satisfactory, are accumulated and submitted to the FDA in support of a PMA
application. Premarket approval from the FDA is required before commercial
distribution of devices similar to those under development by the Company is
permitted in the U.S. In addition to the results of clinical trials, the PMA
application must include other information relevant to the safety and
effectiveness of the device, a description of the facilities and controls used
in the manufacturing of the device, and proposed labeling. By law, the FDA has
180 days to review a PMA application. While the FDA has responded to PMA
applications within the allotted time frame, reviews more often occur over a
significantly longer period and may include requests for additional
information or extensive additional trials. There can be no assurance that the
Company will not be required to conduct additional trials which may result in
substantial
9
costs and delays, nor can there be any assurance that a PMA will be obtained
in a timely manner, if at all. In addition, changes in existing regulations or
the adoption of new regulations or policies could prevent or delay regulatory
approval of the Company's products. Furthermore, even if a PMA is granted,
subsequent modifications of the approved device for the manufacturing process
may require a supplemental PMA or the submission of a new PMA which could
require substantial additional clinicial efficacy data and FDA review. After
the FDA accepts a PMA application for filing, and after FDA review of the
application, a public meeting is frequently held before an FDA advisory panel
in which the PMA is reviewed and discussed. The panel then issues a favorable
or unfavorable recommendation to the FDA or recommends approval with
conditions. Although the FDA is not bound by the panel's recommendations, it
tends to give such recommendations significant weight.
Products manufactured or distributed by the Company pursuant to a PMA
will be subject to pervasive and continuing regulation by the FDA, including,
among other things, postmarket surveillance and adverse event reporting
requirements. Failure to comply with applicable regulatory requirements can
result in, among other things, warning letters, fines, suspensions or delays
of approvals, seizures or recalls of products, operating restrictions or
criminal prosecutions. The Federal Food, Drug and Cosmetic Act ("FD&C Act")
requires the Company to manufacture its products in registered establishments
and in accordance with GMP regulations and to list its devices with the FDA.
Furthermore, as a condition to receipt of a PMA, the Company's facilities,
procedures and practices will be subject to additional pre-approval GMP
inspections and thereafter to ongoing, periodic GMP inspections by the FDA.
These GMP regulations impose certain procedural and documentation requirements
upon the Company with respect to manufacturing and quality assurance
activities. Labeling and promotional activities are subject to scrutiny by the
FDA. Current FDA enforcement policy prohibits the marketing of approved
medical devices for unapproved uses. Changes in existing regulatory
requirements or adoption of new requirements could materially and adversely
affect the Company's business, financial condition and results of operations.
There can be no assurance that the Company will not be required to incur
significant costs to comply with laws and regulations in the future or that
current or future laws and regulations will not materially and adversely
affect the Company's business, financial condition and result of operations.
The Company is also regulated by the FDA under the Radiation Control for
Health and Safety Act, which requires laser products to comply with
performance standards, including design and operation requirements, and
manufacturers to certify in product labeling and in reports to the FDA that
their products comply with all such standards. The law also requires laser
manufacturers to file new product and annual reports, maintain manufacturing,
testing and sales records, and report product defects. Various warning labels
must be affixed and certain protective devices installed, depending on the
class of the product. In addition, the Company is subject to California
regulations governing the manufacture of medical devices, including an annual
licensing requirement. The Company's facilities are subject to ongoing,
periodic inspections by the FDA and California regulatory authorities.
Sales, manufacturing and further development of the Company's TMR and
PTMR systems also may be subject to additional federal regulations pertaining
to export controls and environmental and worker protection, as well as to
state and local health, safety and other regulations that by locality, which
may require obtaining additional permits. The impact of such regulations on
the Company's business, financial condition and results of operations cannot
be predicted.
Sales of medical devices outside of the U.S. are subject to foreign
regulatory requirements that vary widely by country. In addition, the FDA
must approve the export of devices to certain countries. To market in Europe,
a manufacturer must obtain the certifications necessary to affix to its
products the CE Marking. The CE Marking is an international symbol of
adherence to quality assurance standards and compliance with applicable
European medical device directives. In order to obtain a CE Marking, a
manufacturer must be in compliance with appropriate ISO 9001 standards and
obtain certification of its quality assurance systems by a recognized European
Union notified body. However, certain individual countries within Europe
require further approval by their national regulatory agencies. Failure to
receive the right to affix the CE Marking or other requisite approvals will
prohibit the Company from selling its TMR products in member countries of the
European Union or elsewhere, and there can be no assurance that the Company
will be successful in meeting the European certification requirements. In
December 1996, the Company obtained a CE Marking for its TMR laser system.
10
INTELLECTUAL PROPERTY MATTERS
The Company's success will depend, in part, on its ability to obtain
patent protection for its products, preserve its trade secrets, and operate
without infringing the proprietary rights of others. The Company's policy is
to seek to protect its proprietary position by, among other methods, filing
U.S. and foreign patent applications related to its technology, inventions and
improvements that are important to the development of its business. The
Company has 30 patents or allowed patent applications and 32 patent
applications pending relating to various aspects of TMR, PTMR and other
cardiovascular therapies. There can be no assurance that any of the Company's
patents or patent applications will not be challenged, invalidated or
circumvented in the future or that the rights granted thereunder will provide
a competitive advantage. The Company intends to vigorously protect and defend
its intellectual property. It is uncertain whether patent protection will
continue to be available for surgical methods in the future. Costly and
time-consuming litigation brought by the Company may be necessary to enforce
patents issued to the Company, to protect trade secrets or know-how owned by
the Company, or to determine the enforceability, scope and validity of the
proprietary rights of others.
The Company also relies upon trade secrets, technical know-how and
continuing technological innovation to develop and maintain its competitive
position. The Company typically requires its employees, consultants and
advisors to execute confidentiality and assignment of inventions agreements in
connection with their employment, consulting, or advisory relationships with
the Company. There can be no assurance, however, that these agreements will
not be breached or that the Company will have adequate remedies for any
breach. Furthermore, no assurance can be given that competitors will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's proprietary technology,
or that the Company can meaningfully protect its rights in unpatented
proprietary technology.
The medical device industry in general, and the industry segment that
includes products for the treatment of cardiovascular disease in particular,
have been characterized by substantial competition and litigation regarding
patent and other intellectual property rights. In this regard, competitors of
the Company have been issued a number of patents related to TMR and PTMR. In
September 1995 the Company received from a competitor a notice of potential
infringement of the competitor's patent regarding a method for TMR utilizing
synchronization of laser pulses to the electrical signals from the heart. In
January 1996, the Company received from a second competitor a notice of
potential infringement of the competitor's patents regarding methods to
perform TMR/PTMR using fiber optics. The Company had concluded in each case,
following discussion with its patent counsel, that it did not utilize the
process and/or apparatus which is the subject of the patent at issue, and had
responded to the respective competitor to such effect and has received no
further correspondence on either matter. There can be no assurance, however,
that further claims or proceedings will not be initiated by either competitor,
or that claims by other parties will not arise in the future. Any such claims
in the future, with or without merit, could be time-consuming and expensive to
respond to and could divert the attention of the Company's technical and
management personnel. The Company may be involved in litigation to defend
against claims of infringement by the Company, to enforce patents issued to
the Company, or to protect trade secrets of the Company. If any relevant
claims of third party patents are upheld as valid and enforceable in any
litigation or administrative proceeding, the Company could be prevented from
practicing the subject matter claimed in such patents, or would be required to
obtain licenses from the patent owners of each such patent or to redesign its
products or processes to avoid infringement.
Patent applications in the United States are maintained in secrecy until
patents issue, and patent applications in foreign countries are maintained in
secrecy for a period after filing. Publication of discoveries in the
scientific or patent literature tends to lag behind actual discoveries and the
filing of related patent applications. Accordingly, there can be no assurance
that current and potential competitors and other third parties have not filed
or in the future will not file applications for, or have not received or in
the future will not receive, patents or obtain additional proprietary rights
that will prevent, limit or interfere with the Company's ability to make, use
or sell its products either in the United States or internationally. In the
event the Company were to require licenses to patents issued to third parties,
there can be no assurance that such licenses would be available or, if
available, would be available on terms acceptable to the Company, nor can
there be any assurance that the Company would be successful in any attempt to
redesign its products or processes to avoid infringement or that any such
redesign could be accomplished in a cost-effective manner. Accordingly, an
11
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the Company from manufacturing and
selling its products, which would materially and adversely affect the
Company's business, financial condition and results of operations.
Unrelated to the products used in its TMR procedure, the Company has
received notices from three holders of patents requesting that the Company
become a licensee. Although the Company believes that either these patents are
subject to challenge as being invalid or are not infringed by the Company's
products, there can be no assurance that the Company would prevail in any such
action. In one case, the Company has taken a non-exclusive license to a patent
involving arthroscopy use. In a second case, the Company buys components only
from licensees of the patent holder, which the Company believes obviates the
need for a separate license. In addition, the Company has received notice of
interference of one of its patents involving products that the Company is not
actively pursuing. The Company has received a non-exclusive license to the
technology. Should the Company determine that it is necessary for it to obtain
a license to any patents or intellectual property, there can be no assurance
that any such license would be available on acceptable terms or at all, or
that the Company would be able to develop or otherwise obtain alternative
technology. Failure of the Company to obtain necessary licenses could prevent
the Company from manufacturing and selling its products, which would
materially and adversely affect the Company's business, financial condition
and results of operations.
THIRD PARTY REIMBURSEMENT
The Company expects that sales volumes and prices of the Company's
products will depend significantly on the availability of reimbursement for
surgical procedures using the Company's products from third party payors such
as governmental programs, private insurance and private health plans.
Reimbursement is a significant factor considered by hospitals in determining
whether to acquire new equipment. Reimbursement rates from third party payors
vary depending on the third party payor, the procedure performed and other
factors. Moreover, third party payors, including government programs, private
insurance and private health plans, have in recent years been instituting
increasing cost containment measures designed to limit payments made to
healthcare providers by, among other measures, reducing reimbursement rates,
limiting services covered, negotiating prospective or discounted contract
pricing and carefully reviewing and increasingly challenging the prices
charged for medical products and services.
Medicare reimburses hospitals on a prospectively determined fixed amount
for the costs associated with an in-patient hospitalization based on the
patient's discharge diagnosis, and reimburses physicians on a prospectively
determined fixed amount based on the procedure performed, regardless of the
actual costs incurred by the hospital or physician in furnishing the care and
unrelated to the specific devices used in that procedure. Medicare and other
third party payors are increasingly scrutinizing whether to cover new products
and the level of reimbursement for covered products. In addition, Medicare
traditionally has considered items or services involving devices that have not
been approved or cleared for marketing by the FDA to be precluded from
Medicare coverage. Under a HCFA policy effective November 1, 1995, Medicare
coverage will not be precluded for items and related services involving
devices that have been classified by the FDA as "non-experimental/
investigational" ("Category B") devices and that are furnished in accordance
with FDA-approved protocols governing clinical trials. Even with items or
services involving Category B devices, however, Medicare coverage may be
denied if other coverage requirements are not met, for example if the
treatment is not medically needed for the specific patient. In November 1995,
the Company received Category B designation for its TMR procedure from the
HCFA. Accordingly, the Company's procedures had received third party
reimbursement in many cases under HCFA's policy. As of May 19, 1997, although
Category B status is retained, under a recent HCFA ruling, there will not be
coverage for any manufacturer's TMR procedures at this time. There can be no
assurance that this coverage will be given in the future or that Medicare will
adequately reimburse the costs of the Company's TMR or PTMR procedures when
and if a PMA is granted. While the Company is unable to determine the
ultimate effect of this policy change on the business and operating results,
the Company anticipates that research and development expenses will increase
significantly due to increased expenses in support of clinical trials, and
revenues from sale of investigational products are likely to decrease, at
least over the short term and possibly thereafter.
The Company has limited experience to date with the acceptability of its
TMR procedures for reimbursement by private insurance and private health
plans. There can be no assurance that private insurance and private health
plans will approve reimbursement for TMR or PTMR.
12
In foreign markets, reimbursement is obtained from a variety of sources,
including governmental authorities, private health insurance plans and labor
unions. In most foreign countries, there are also private insurance systems
that may offer payments for alternative therapies. Although not as prevalent
as in the U.S., health maintenance organizations are emerging in certain
European countries. The Company may need to seek international reimbursement
approvals, and there can be no assurance that any such approvals will be
obtained in a timely manner, if at all. Failure to receive foreign
reimbursement approvals could have an adverse effect on market acceptance of
the Company's products in the foreign markets in which such approvals are
sought.
The Company believes that reimbursement in the future will be subject to
increased restrictions such as those described above, both in the U.S. and in
foreign markets. The Company believes that the escalating cost of medical
products and services has led to and will continue to lead to increased
pressures on the health care industry, both foreign and domestic, to reduce
the cost of products and services, including products offered by the Company.
There can be no assurance that third party reimbursement and coverage will be
available or adequate in U.S. or foreign markets, that current levels of
reimbursement will not be decreased in the future, or that future
legislation, regulation, or reimbursement policies of third party payors will
not otherwise adversely affect the demand for the Company's products or its
ability to sell its products on a profitable basis. Fundamental reforms in
the healthcare industry in the U.S. and Europe that could affect the
availability of third party reimbursement continue to be proposed, and the
Company cannot predict the timing or effect of any such proposal. If third
party payor coverage or reimbursement is unavailable or inadequate, the
Company's business, financial condition and results of operations could be
materially and adversely affected.
PRODUCT LIABILITY AND INSURANCE
The Company maintains insurance against product liability claims in the
amount of $3 million per occurrence and $3 million in the aggregate, and
expects to seek to increase such coverage if and when a PMA is obtained.
However, there can be no assurance that such coverage will continue to be
available in the amount desired or on terms acceptable to the Company, or
that such coverage will be adequate for liabilities actually incurred. Any
uninsured or underinsured claim brought against the Company, or any claim or
product recall that results in significant cost to or adverse publicity
against the Company, could materially and adversely affect the Company's
business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1997 the Company had 113 employees, including 39 in
research and development, 33 in manufacturing, 27 in sales and marketing and
14 in administration. All employees have entered into confidentiality
agreements with the Company but the Company does not otherwise have
employment agreements with any of its employees. None of the Company's
employees is covered by a collective bargaining agreement and the Company has
experienced no work stoppages to date.
13
ITEM 2. DESCRIPTION OF PROPERTY.
The Company's facilities are comprised of 36,990 square feet under five
separate leases. The facility contains a Class 10,000 clean room for laser
handpiece and catheter fabrication. The leases expire from December 1998
through December 2002. The Company's headquarters are located in Sunnyvale,
California. The Company believes its facilities are adequate to meet its
foreseeable requirements through at least 1998. There can be no assurance
that additional facilities will be available to the Company, if and when
needed, thereafter.
ITEM 3. LEGAL PROCEEDINGS.
There are no pending legal proceedings against the Company other than
ordinary litigation incidental to the Company's business, the outcome of
which, individually or in the aggregate, is not expected to have a material
adverse effect on the Company's business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
14
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock is traded on the Nasdaq National Market under
the symbol, ESTI, commencing May 31, 1996. For the periods indicated, the
following table presents the range of high and low sale prices for the Common
Stock as reported by the Nasdaq National Market.
1997 High Low
---- ---- ---
First Quarter. . . . . . . . . . . . . . . $ 9.75 $ 4.88
Second Quarter . . . . . . . . . . . . . . $ 8.50 $ 4.88
Third Quarter. . . . . . . . . . . . . . . $ 10.00 $ 6.75
Fourth Quarter . . . . . . . . . . . . . . $ 9.50 $ 5.50
1996 High Low
---- ---- ---
First Quarter. . . . . . . . . . . . . . . N/A N/A
Second Quarter . . . . . . . . . . . . . . $ 19.00 $ 12.25
Third Quarter. . . . . . . . . . . . . . . $ 14.00 $ 7.50
Fourth Quarter . . . . . . . . . . . . . . $ 14.00 $ 7.25
As of December 31, 1997, shares of the Company's Common Stock were held
by 156 registered shareholders.
The Company has never paid a cash dividend on its capital stock and does
not anticipate paying any cash dividends on the Common Stock in the
foreseeable future, as it intends to retain its earnings, if any, to generate
increased growth and for general corporate purposes.
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.
The following selected consolidated financial data with respect to the
Company for the five years ended December 31, 1997, are derived from the
consolidated financial statements of the Company which have been audited by
Coopers & Lybrand L.L.P. for the five fiscal years ended December 31, 1997.
The data should be read in conjunction with the financial statements, related
notes and other financial information included herein.
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1997 1996 1995 1994 1993
--------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net revenues . . . . . . . . . . . . . . . . . $ 5,499 $ 9,759 $ 2,707 $ 2,020 $ 2,105
Cost of revenues . . . . . . . . . . . . . . . 2,779 3,558 1,642 1,173 1,013
-------- ------- ------- ------- ------
Gross profit . . . . . . . . . . . . . . 2,720 6,201 1,065 847 1,092
-------- ------- ------- ------- ------
Operating Expenses:
Research and development . . . . . . . . . . 12,007 6,586 1,010 971 906
Sales and marketing. . . . . . . . . . . . . 7,345 3,327 879 392 794
General and administrative . . . . . . . . . 4,036 2,000 681 1,031 325
-------- ------- ------- ------- ------
Total operating expenses . . . . . . . . . . . 23,388 11,913 2,570 2,394 2,025
-------- ------- ------- ------- ------
Operating loss . . . . . . . . . . . . . (20,668) (5,712) (1,505) (1,547) (933)
Interest and other income (expense), net . . . 2,421 1,556 (921) (435) (3)
-------- ------- ------- ------- ------
Net loss . . . . . . . . . . . . . . . . $(18,247) $(4,156) $(2,426) $(1,982) $ (936)
-------- ------- ------- ------- ------
-------- ------- ------- ------- ------
Net loss per share - basic and diluted . $ (1.11) $ (0.30) $ (0.23) $ (0.19) $(0.10)
-------- ------- ------- ------- ------
-------- ------- ------- ------- ------
Shares used in per share calculation . . 16,404 14,078 10,470 10,231 9,381
-------- ------- ------- ------- ------
-------- ------- ------- ------- ------
1997 1996 1995 1994 1993
--------- -------- -------- -------- --------
BALANCE SHEET DATA:
Cash and cash equivalents. . . . . . . . . . . $ 16,997 $ 24,106 $ 123 $ 132 $ 131
Marketable securities. . . . . . . . . . . . . 18,197 27,957 - - -
Working capital (deficit). . . . . . . . . . . 36,434 47,861 (1,549) 657 834
Total Assets . . . . . . . . . . . . . . . . . 43,474 58,706 2,459 2,922 1,953
Long term debt less current portion. . . . . . 10 20 - 1,009 -
Accumulated deficit. . . . . . . . . . . . . . (28,418) (10,171) (6,015) (3,589) (1,607)
Total shareholders' equity (deficit) . . . . . 38,228 55,666 (1,429) (139) 1,011
16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
THIS MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS AND OTHER PARTS OF THIS REPORT ON FORM 10-K CONTAIN
FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES. THE
COMPANY'S ACTUAL RESULTS MAY DIFFER MATERIALLY FROM THE RESULTS DISCUSSED IN
SUCH FORWARD-LOOKING STATEMENTS. FACTORS THAT MAY CAUSE SUCH A DIFFERENCE
INCLUDE, BUT ARE NOT LIMITED TO, THOSE DISCUSSED IN "FACTORS AFFECTING FUTURE
RESULTS."
OVERVIEW
The Company was founded in 1989 as an outgrowth of certain research and
development efforts initially undertaken by the Company's founders in the
early 1980s related to the use of laser technology to treat cardiovascular
disease. From 1989 through September 1995, the Company engaged in research,
development and sale of surgical laser products principally for procedures
such as atherectomy and arthroscopy. In 1995, the Company determined that
there is a significant opportunity in the TMR market, and that the Company is
well-positioned to enter this market because of the Company's expertise with
laser-based surgical techniques and the treatment of cardiovascular disease.
Accordingly, in late 1995, the Company changed its strategic direction.
Prior to 1996, the Company had focused almost exclusively on research
and development activities relating to surgical laser products, substantially
contributing to annual operating losses since inception. Since 1996, the
Company has focused on TMR and PTMR activities, particularly research and
development activities and clinical trials. At December 31, 1997, the
Company had an accumulated deficit of $28,418,000. There are currently seven
clinical trials in progress in either TMR or PTMR. The Company has submitted
an application to the FDA for marketing clearance ("PMA" or Pre-Market
Approval) of its TMR products in the United States. The Company has
received the European Conforming Mark ("CE Mark") allowing the commercial
sale of its TMR laser system to the European Community.
The Company expects to continue to incur operating losses related to the
expansion of sales and marketing resources, research and development
activities, including clinical studies, and the continued development of
corporate infrastructure. The timing and amounts of the Company's
expenditures will depend upon a number of factors, including the progress of
the Company's clinical trials, the status and timing of regulatory approval,
the timing of market acceptance, if any, of the Company's products, and the
efforts required to develop the Company's sales and marketing organization.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
REVENUES
Net revenues of $5,499,000 for the year ended December 31, 1997
decreased $4,260,000 or 44% when compared to net revenues of $9,759,000 for
the year ended December 31, 1996. The decrease resulted primarily from a
change in the mix of lasers sold versus placed. This change was primarily
due to a Health Care Financing Administration ("HCFA") policy effective May
19, 1997 which restricts Medicare reimbursement for TMR equipment and
procedures. The Company's products had received third party reimbursement
under the preceding HCFA policy. Reimbursement is a significant factor
considered by hospitals in determining whether to acquire new equipment.
Future revenues could continue to be affected by restrictions on third
party reimbursement and the timing and manner of sale of a limited number of
units of TMR and PTMR laser systems. The Company intends to continue selling
the systems to the hospital outright (list price is $295,000) or placing the
system with the hospital for a placement fee (currently $25,000) plus an
additional fee for each procedure performed. The Company has also made
contingency placements which are not taken as revenue until a sale ensues
only after FDA approval is received or HCFA reimbursement becomes available.
As a result of the HCFA policy restricting Medicare reimbursement for TMR
equipment and procedures, the Company anticipates that these sales will
continue to be more difficult to obtain in the future than prior to the
effective date of the policy.
17
GROSS PROFIT
Gross profit decreased to $2,720,000 or 49% of net revenues for the
year ended December 31, 1997 as compared to $6,201,000 or 64% of net revenues
for the year ended December 31, 1996. The decrease resulted from a higher
level of manufacturing overhead associated with facility and infrastructure
expansion including increased headcount, as well as a lower average sales
price per laser in 1997 due to the higher mix of lasers placed versus sold in
1997 as compared to 1996.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenditures of $12,007,000 increased
$5,421,000 or 82% for the year ended December 31, 1997 when compared to
$6,586,000 for the year ended December 31, 1996. The increase in these
expenses reflects a higher level of costs related to the development of new
products, and increases in the number of clinical trials and the cost of
supporting clinical trials, and an increase in headcount to 39 from 25
research and development employees at December 31, 1997 as compared to
December 31, 1996.
The Company's products are currently in clinical trials and therefore
subject to limitations by the FDA. The Company believes that continued
investment in the development of new and improved products and procedures and
continued investment in the Company's clinical trials is critical to its
future success. As a result of the new HCFA policy restricting Medicare
reimbursement for TMR and PTMR equipment and procedures, the Company
reimbursed clinical sites for expenses incurred in conjunction with
performing clinical trials. The Company anticipates a significant increase
in future expenditures relating to hospital support of the Company's clinical
trials as the number of clinical trials increases. Accordingly, the Company
believes that research and development expenses may continue to increase over
the short term and possibly thereafter. There can be no assurance that the
Company's future revenues, if any, will be sufficient to offset the research
and development expenses required in connection with ongoing efforts
including current and future clinical trials.
SALES AND MARKETING
Sales and Marketing expenditures of $7,345,000 increased $4,018,000 or
121% for the year ended December 31, 1997 when compared to $3,327,000 for the
year ended December 31, 1996. The increase is due primarily to a headcount
increase to 27 in 1997 from nine in 1996. This resulted in significant
increases in salary, commission and travel expense. The additional headcount
has been utilized in the areas of international sales, service, training and
clinical support to the increasing number of clinical sites. The Company
expects that sales and marketing expenses will continue to increase as the
Company continues to focus resources on the development of the TMR and PTMR
market.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased to $4,036,000 in 1997 from
$2,000,000 in 1996. The increase in 1997 as compared to 1996 reflects an
increase in patent and patent related expenses. At December 31, 1997, the
Company had 30 patents or allowed patent applications and 32 patent
applications pending relating to various aspects of TMR , PTMR and other
cardiovascular therapies as compared to five and 29 at December 31, 1996.
The increase also reflects expenses related to being a publicly traded
company, including investor relations fees, legal, accounting and stock
administration expenses incurred throughout the year as compared to seven
months in 1996.
INTEREST INCOME AND EXPENSE, NET
Interest income of $2,446,000 increased $694,000 or 40% for the year
ended December 31, 1997 when compared to $1,752,000 for the year ended
December 31, 1996. This increase is due primarily to the investment of funds
received in connection with an initial public offering in May 1996 for twelve
months in 1997 as compared to seven months in 1996.
18
Interest expense of $25,000 decreased $171,000 or 87% for the year ended
December 31, 1997 when compared to $196,000 for the year ended December 31,
1996. This decrease reflects the use of funds from the initial public
offering to repay debt, resulting in a lower debt level in 1997 as compared
to 1996.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES
Revenues increased to $9,759,000 in 1996 from $2,707,000 in 1995. The
increase in 1996 as compared to 1995 was primarily due to the introduction
of the Company's TMR products at the end of 1995 resulting in increased sales
in the last quarter of 1995 and throughout 1996. The increase in revenues
also resulted in an increase in net accounts receivable to $2,483,000 at
December 31, 1996 from $532,000 at December 31, 1995. Since 1995, the
Company has focused on the TMR market. Sales of TMR related products
accounted for 98% and 32% of revenues in 1996 and 1995 respectively.
GROSS PROFIT
Gross profit increased to $6,201,000 in 1996 from $1,065,000 in 1995.
Gross margin increased to 64% in 1996, from a gross margin of 39% in 1995.
The increase in gross margin in 1996 from 1995 reflects increased sales of
TMR products which generally have a higher margin than non-TMR surgical
products.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses increased to $6,586,000 in 1996 from
$1,010,000 in 1995. The increase in these expenses in 1996 reflects a higher
level of research and development expenses relating to TMR including costs
related to the introduction of five new TMR products, filing 29 patent
applications, costs to introduce and support four clinical trials, and an
increase in headcount to 25 research and development employees at December
31, 1996 from six at December 31, 1995.
SALES AND MARKETING
Sales and marketing expenses increased to $3,327,000 in 1996 from
$879,000 in 1995. The increase in 1996 reflects expansion of the Company's
sales and marketing staff to nine in 1996 from six in 1995, increased travel
and trade show expenses, costs to develop the international market, and
increased commission expense related to increased sales, expenses associated
with the commencement of clinical trials for the Company's TMR products and
associated recruitment of participating physicians and hospitals.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased to $2,000,000 in 1996 from
$681,000 in 1995. The increase in 1996 as compared to 1995 reflects increased
headcount to 12 at December 31, 1996 from five in December 31, 1995, and
expenses related to being a publicly traded company, including investor
relations fees, legal, accounting and stock administration expenses.
INTEREST INCOME AND EXPENSE, NET
Interest income, net of interest expense, of $1,556,000 in 1996 reflects
investment income from the proceeds of the Company's public offering.
Interest expense, net of interest income, was $921,000 in 1995. The
outstanding debt at December 31,1995 was repaid from July 1996 through
February 1997 resulting in a decrease in interest expense.
19
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has satisfied its capital requirements
primarily through sales of its equity securities and, to a lesser extent,
loans from shareholders. In addition, the Company's operations have been
funded in part through sales of the Company's products. At December 31, 1997,
the Company had aggregate cash and marketable securities of $35,194,000 and
at December 31, 1996, the Company had cash and marketable securities of
$52,063,000. The Company used $17,374,000 and $6,173,000 for operating
activities in1997 and 1996, respectively. At December 31, 1997, the Company
had an accumulated deficit of $28,418,000.
The Company anticipates that its current cash and marketable securities,
together with sales of products for investigational use, will be sufficient
to meet the Company's capital requirements through at least calendar year
1998. There can be no assurance, however, that the Company will not require
additional sources of cash at an earlier date in the future, depending upon
the progress of expansion of the Company's clinical trials, any need for
additional clinical trials or other testing of the Company's products, and
the timing of other required expenditures as indicated above. If the Company
is required to obtain additional financing in the future, there can be no
assurance that capital will be available on terms acceptable to the Company,
if at all.
RECENTLY ISSUED ACCOUNTING STANDARDS
Management does not believe there are any recently issued accounting
standards not yet adopted by the Company, the future adoption of which will
have a material impact on the Company's financial position or results of
operations.
20
FACTORS AFFECTING FUTURE RESULTS
CERTAIN OF THE STATEMENTS ABOVE ARE FORWARD-LOOKING STATEMENTS. IN
ADDITION, THE COMPANY MAY FROM TIME TO TIME MAKE ORAL FORWARD-LOOKING
STATEMENTS. THE FOLLOWING ARE IMPORTANT FACTORS THAT COULD CAUSE ACTUAL
RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN ANY SUCH FORWARD-LOOKING
STATEMENTS.
EARLY STAGE OF CLINICAL TRIALS
The Company must obtain marketing clearance ("PMA") from the U.S. Food
and Drug Administration (the "FDA") before the Company will be able to offer
its products for TMR or PTMR on a commercial basis in the U.S. A necessary
prerequisite for submitting a PMA application is completion of clinical
testing to demonstrate the safety and effectiveness of the Company's TMR
products.
On July 2, 1997, the Company submitted a PMA application to the FDA
for use of the Eclipse laser system to treat patients with Class IV angina
(chest pain) caused by coronary artery disease using the TMR procedure. The
FDA review process can be lengthy and its results are uncertain. There can
be no assurance as to whether or when the FDA will approve this application.
On July 28, 1997 an FDA panel recommended non-approval of a PMA application
submitted by PLC Systems, Inc., a major competitor of the Company. The
Company believes that this decision may have a significant impact on the
FDA's review and approval of the Company's application. Subsequently, the FDA
requested twelve month follow up data on all TMR applications in addition to
the six month data previously provided. Although the Company has accumulated
this data and is currently preparing it for submission to the FDA, there can
be no assurance that the Company will not experience similar or other issues
with the FDA which could have a material adverse impact on its business and
operating results.
Completion of the Company's clinical studies on a timely basis will
depend, among other things, on the Company's ability to successfully
establish TMR and PTMR sites and continue to identify and enroll
participating patients in a timely fashion. In addition, the clinical studies
will require substantial financial and management resources. There can be no
assurance that the Company will have the resources necessary to complete such
clinical studies. Furthermore, there can be no assurance that the Company's
clinical studies will be completed within the currently anticipated time
frame or otherwise in a timely manner, nor that such clinical studies will
demonstrate the safety and effectiveness of the Company's products to the
extent necessary to obtain FDA and other regulatory approvals and establish a
commercial market for the Company's products. Moreover, results of the
initial clinical testing are not necessarily predictive of results to be
achieved in later clinical studies, if undertaken, or commercially, if a PMA
is obtained. Failure to complete the Company's clinical studies in a timely
manner or to demonstrate the safety and effectiveness of the Company's TMR or
PTMR products could delay or prevent regulatory approval and would materially
and adversely affect the Company's business, financial condition and
operating results.
NO ASSURANCE OF FDA OR OTHER REQUIRED GOVERNMENTAL APPROVALS
The Company's products are regulated in the U.S. as medical devices by
the FDA under the Federal Food, Drug, and Cosmetic Act ("FD&C Act") and, as
such, require FDA approval of a PMA application prior to commercial sale in
the U.S. The FDA approves PMA applications for specific indications only and
FDA regulation prohibits commercial marketing in the U.S. of devices for
indications that have not been approved by the FDA. The process of obtaining
required regulatory approvals from the FDA and other regulatory authorities
is lengthy, expensive and inherently uncertain, generally takes several years
or longer to complete, if approval is obtained at all, and requires the
submission of extensive clinical data and supporting information to the FDA.
On July 2, 1997, the Company submitted a PMA application to the FDA for
use of the Eclipse laser system to treat patients with Class IV angina (chest
pain) caused by coronary artery disease using the TMR procedure. There can be
no assurance that the FDA will approve this application in the foreseeable
future if at all. On July 28, 1997 an FDA panel recommended non-approval of
a PMA application submitted by PLC Systems, Inc. This decision may have an
impact on the FDA's review and approval of the Company's application.
Failure to obtain FDA approval on a timely
21
basis or for the indications sought by the Company would materially and
adversely affect the Company's business, financial condition and operating
results.
The Company will also be required to follow applicable Good
Manufacturing Practices ("GMP") regulations of the FDA, which include
testing, control and documentation requirements, as well as similar
requirements in other countries, including International Standards
Organization ("ISO") 9001 standards. Although the Company became 9001
certified in May 1997, failure to meet or to continue to satisfy these
requirements in the future would preclude the Company from marketing its
products on a commercial basis, and therefore would materially and adversely
affect the Company's business, financial condition and operating results.
Sales of medical devices outside of the U.S. are subject to foreign
regulatory requirements that vary widely by country. In addition, the FDA
must approve the export of devices that require a PMA but are not yet
approved domestically. Foreign and domestic regulatory approvals, if
granted, may include significant limitations on the indicated uses for which
the product may be marketed. In addition, to obtain such approvals, medical
device manufacturers must comply with numerous other requirements of the FDA
and certain foreign regulatory authorities. For example, the European
Conforming Mark (the "CE Mark") is required to sell products in European
Union countries. The Company received CE Marking for its TMR laser in
December 1996. However, product approvals can be withdrawn due to various
factors, including failure to comply with regulatory standards or unforeseen
problems following initial marketing.
RISKS ASSOCIATED WITH NEW SURGICAL PROCEDURES; NO ASSURANCE OF MARKET
ACCEPTANCE
The Company's ability to successfully commercialize its TMR and PTMR
products will depend upon its ability to achieve acceptance of its products
and procedures among cardiologists, cardiac surgeons and other members of the
medical community as well as prospective patients. The Company believes that
it will not achieve such acceptance until such time, if any, as the Company's
TMR or PTMR products can be demonstrated to be safe, efficacious and
cost-effective. Even if the clinical safety and effectiveness of the
Company's TMR products is established, cardiologists, cardiac surgeons and
other members of the medical community may elect not to recommend TMR or PTMR
for any number of other reasons. Broad use of the Company's products will
require training of numerous physicians, and the time required to complete
such training could adversely affect market acceptance. Moreover, even if TMR
and PTMR become generally accepted by the medical community, physicians
trained in competitive products may elect not to consider the Company's
products, or may elect instead to recommend a competitor's products. Failure
of the Company's products to achieve significant market acceptance would
materially and adversely affect the Company's business, financial condition
and operating results.
DEPENDENCE ON SINGLE PRODUCT LINE
The Company has elected to focus its resources on the continued
development and refinement of its TMR and PTMR products. If the Company is
unable to obtain requisite regulatory approvals or to achieve commercial
acceptance of these products, the Company's business, financial condition
and operating results would be materially and adversely affected, which could
result in cessation of the Company's business.
UNCERTAINTY REGARDING PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY; RISKS
OF FUTURE LITIGATION
The Company's success will depend, in part, on its ability to obtain
patent protection for its products, preserve its trade secrets, and operate
without infringing the proprietary rights of others. The Company's policy is
to seek to protect its proprietary position by, among other methods, filing
U.S. and foreign patent applications related to its technology, inventions
and improvements that are important to the development of its business.
Although the Company has a number of patents and patent applications pending
relating to various aspects of TMR, PTMR and other cardiovascular therapies,
there can be no assurance that any of the Company's patents or patent
applications will not be challenged, invalidated or circumvented in the
future or that the rights granted thereunder will provide a competitive
22
advantage. The Company intends to vigorously protect and defend its
intellectual property. It is uncertain whether patent protection will continue
to be available for surgical methods in the future. Costly and time-consuming
litigation brought by the Company may be necessary to enforce patents issued
to the Company, to protect trade secrets or know-how owned by the Company, or
to determine the enforceability, scope and validity of the proprietary rights
of others.
The Company also relies upon trade secrets, technical know-how and
continuing technological innovation to develop and maintain its competitive
position. The Company typically requires its employees, consultants and
advisors to execute confidentiality and assignment of inventions agreements in
connection with their employment, consulting or advisory relationships with
the Company. There can be no assurance, however, that these agreements will
not be breached or that the Company will have adequate remedies for any
breach. Furthermore, no assurance can be given that competitors will not
independently develop substantially equivalent proprietary information and
techniques or otherwise gain access to the Company's proprietary technology,
or that the Company can meaningfully protect its rights in unpatented
proprietary technology.
The medical device industry in general, and the industry segment that
includes products for the treatment of cardiovascular disease in particular,
have been characterized by substantial competition and litigation regarding
patent and other intellectual property rights. In this regard, competitors of
the Company have been issued a number of patents related to TMR. In September
1995, the Company received from a competitor a notice of potential
infringement of the competitor's patent regarding a method for TMR utilizing
synchronization of laser pulses to the electrical signals from the heart. In
January 1996, the Company received from a second competitor a notice of
potential infringement of the competitor's patent regarding a method to
perform TMR using fiber optics. The Company has concluded in each case,
following discussion with its patent counsel, that it does not utilize the
process and/or apparatus which is the subject of the patent at issue, and has
responded to the respective competitor to such effect. The Company has
received no further correspondence on either matter. There can be no
assurance, however, that further claims or proceedings will not be initiated
by either competitor, or that claims by other parties will not arise in the
future. Any such claims in the future, with or without merit, could be
time-consuming and expensive to respond to and could divert the attention of
the Company's technical and management personnel. The Company may be involved
in litigation to defend against claims of infringement by the Company, to
enforce patents issued to the Company, or to protect trade secrets of the
Company. If any relevant claims of third party patents are upheld as valid and
enforceable in any litigation or administrative proceeding, the Company could
be prevented from practicing the subject matter claimed in such patents, or
would be required to obtain licenses from the patent owners of each such
patent or to redesign its products or processes to avoid infringement.
Patent applications in the U.S. are maintained in secrecy until patents
issue, and patent applications in foreign countries are maintained in secrecy
for a period after filing. Publication of discoveries in the scientific or
patent literature tends to lag behind actual discoveries and the filing of
related patent applications. Accordingly, there can be no assurance that
current and potential competitors and other third parties have not filed or in
the future will not file applications for, or have not received or in the
future will not receive, patents or obtain additional proprietary rights that
will prevent, limit or interfere with the Company's ability to make, use or
sell its products either in the U.S. or internationally. In the event the
Company were to require licenses to patents issued to third parties, there can
be no assurance that such licenses would be available or, if available, would
be available on terms acceptable to the Company, or that the Company would be
successful in any attempt to redesign its products or processes to avoid
infringement. Accordingly, an adverse determination in a judicial or
administrative proceeding or failure to obtain necessary licenses could
prevent the Company from manufacturing and selling its products, which would
materially and adversely affect the Company's business, financial condition
and results of operations.
EXPECTATION OF INTENSE MARKET COMPETITION
The Company expects that the markets for TMR and PTMR, which are
currently in the early stages of development, will be intensely competitive.
Competitors are likely to include at least four laser companies: PLC Systems,
Inc. ("PLC"), CardioGenesis Corporation ("CardioGenesis"), U.S. Surgical
Corporation ("U.S. Surgical"), and Johnson & Johnson ("J & J") all four of
which are currently selling TMR and/or PTMR products for investigational use
23
in the U.S. and abroad. Other competitors may include additional companies
that elect to enter the market, including large companies in the laser,
cardiac devices and cardiac surgery markets. The Company believes that a
number of significant companies including Boston Scientific Corp., Baxter
International, Inc., and C.R. Bard, Inc. have distribution rights to current
or future products in TMR or PTMR. Many of these companies have significantly
greater financial, development, marketing and other resources than the
Company. In the event a competitor is able to obtain a PMA for its products
prior to the Company, the Company's ability to compete successfully could be
materially and adversely affected.
TMR and PTMR also compete with other more conventional or established
methods for the treatment of cardiovascular disease, including drug therapy,
PTCA and CABG. Although the Company is seeking to demonstrate the safety and
effectiveness of the Company's TMR and PTMR procedures in patients for whom
other cardiovascular treatments are not likely to provide relief, and in the
future intends to pursue the safety and effectiveness of TMR or PTMR when
used in conjunction with other treatments, there can be no assurance that the
Company's products will be accepted in these markets, nor can there be any
assurance that physicians will use the Company's procedures to replace or
supplement established treatments, or that the Company's procedures will be
competitive with current or future technologies. In such event, the Company's
business, financial condition and operating results could be materially and
adversely affected.
Any product developed by the Company that gains regulatory approval will
face competition for market acceptance and market share. An important factor
in such competition may be the timing of market introduction of competitive
products. Accordingly, the relative pace at which the Company is able to
develop products, complete clinical testing and regulatory approval
processes, gain third party reimbursement acceptance and supply commercial
quantities of the product to the market are expected to be important
competitive factors. There can be no assurance that the Company will be able
to compete successfully against current and future competitors. Failure to do
so would materially and adversely affect the Company's business, financial
condition and operating results.
HISTORY OF OPERATING LOSSES
From inception to December 31, 1997, the Company incurred cumulative net
losses of approximately $28.4 million. The Company's revenues and operating
income will continue to be constrained until such time, if ever, as FDA and
other regulatory approval is obtained for the Company's products, and for an
indefinite period of time after any such approval is obtained. Furthermore,
the Company expects its expenses in all categories to increase as its
clinical trial and other business activities expand. Hence, there can be no
assurance that the Company will achieve or sustain profitability in the
future. Failure to achieve significant commercial revenues or profitability
would materially and adversely affect the Company's business, financial
condition and results of operations.
RISKS OF TECHNOLOGICAL CHANGE
Significant resources are continually being expended to develop new and
improved treatment methodologies for coronary disease. Accordingly, the
market acceptance and commercial success of the Company's TMR and PTMR
products and procedures will depend not only on the safety and effectiveness
of the Company's TMR and PTMR products and procedures, but also the relative
safety and effectiveness of alternative treatment measures. Any such
alternatives could potentially include new treatments or improvements to
treatments which would materially and adversely affect the Company's
business, financial condition and results of operations.
POTENTIAL DIFFICULTIES IN MANAGING BUSINESS UNDERGOING RAPID CHANGE
The Company's future success will depend to a significant extent on the
ability of its current and future management personnel to operate
effectively, both independently and as a group. In this regard, a number of
members of the Company's senior management team have only recently joined the
Company. Moreover, certain members of such management team have limited
experience as a senior executive of a public corporation. There can be no
assurance that the management team will operate together effectively. To
compete successfully against current and future competitors,
24
complete clinical trials in progress, prepare additional products for clinical
trials and develop future products, the Company believes that it must continue
to expand its operations, particularly in the areas of research and
development, sales and marketing, training, and manufacturing. If the Company
were to experience significant growth in the future, such growth would likely
result in new and increased responsibilities for management personnel and
place significant strain upon the Company's management, operating and
financial systems and resources. To accommodate such growth and compete
effectively, the Company must continue to implement and improve information
systems, procedures and controls, and to expand, train, motivate and manage
its work force. There can be no assurance that the Company's personnel,
systems, procedures and controls will be adequate to support the Company's
future operations. Any failure to implement and improve the Company's
operational, financial and management systems or to expand, train, motivate or
manage employees could materially and adversely affect the Company's business,
financial condition and results of operations.
POTENTIAL FLUCTUATIONS IN OPERATING RESULTS
Results of operations are expected to fluctuate significantly from
quarter to quarter depending upon numerous factors, including the timing and
results of clinical trials; delays associated with the FDA and other
regulatory approval processes; health care reform and reimbursement policies;
demand for the Company's products; changes in pricing policies by the Company
or its competitors; the number, timing and significance of product
enhancements and new product announcements by the Company and its competitors;
the ability of the Company to develop, introduce and market new and enhanced
versions of the Company's products on a timely basis; customer order deferrals
in anticipation of new or enhanced products offered by the Company or its
competitors; product quality problems; personnel changes; changes in Company
strategy; and the level of international sales. Quarter to quarter operating
results could also be affected by the timing of the receipt of individual
customer orders, order fulfillment and revenue recognition with respect to
small numbers of individual laser base units, since each such product carries
a high price per unit.
UNCERTAINTY REGARDING THIRD PARTY REIMBURSEMENT
The Company expects that its ability to successfully commercialize its
products will depend significantly on the availability of reimbursement for
surgical procedures using the Company's products from third party payors such
as governmental programs, private insurance and private health plans.
Reimbursement is a significant factor considered by hospitals in determining
whether to acquire new equipment. Notwithstanding FDA approval, if granted,
third party payors may deny reimbursement if the payor determines that a
therapeutic medical device is unnecessary, inappropriate, not cost-effective
or experimental or is used for a non-approved indication.
Medicare reimburses hospitals on a prospectively determined fixed amount
for the costs associated with an in-patient hospitalization based on the
patient's discharge diagnosis, and reimburses physicians on a prospectively
determined fixed amount based on the procedure performed, regardless of the
actual costs incurred by the hospital or physician in furnishing the care and
unrelated to the specific devices used in that procedure. Medicare and other
third party payors are increasingly scrutinizing whether to cover new products
and the level of reimbursement for covered products. In addition, Medicare
traditionally has considered items or services involving devices that have not
been approved or cleared for marketing by the FDA to be precluded from
Medicare coverage. Under a HCFA policy effective November 1, 1995, Medicare
coverage will not be precluded for items and related services involving
devices that have been classified by the FDA as "non-experimental/
investigational" ("Category B") devices and that are furnished in accordance
with FDA-approved protocols governing clinical trials. Even with items or
services involving Category B devices, however, Medicare coverage may be
denied if other coverage requirements are not met, for example if the
treatment is not medically needed for the specific patient. In November 1995,
the Company received Category B designation for its TMR procedure from the
HCFA. Accordingly, the Company's procedures had received third party
reimbursement in many cases under HCFA's policy. As of May 19, 1997, although
Category B status is retained, under a recent HCFA ruling, there will not be
coverage for any manufacturer's TMR procedures at this time. There can be no
assurance that this coverage will be given in the future or that Medicare will
adequately reimburse the costs of the Company's TMR and PTMR procedures when
and if a PMA is granted. While the Company is unable to determine the
ultimate effect of this policy change on the business and operating results,
the Company anticipates that research
25
and development expenses will increase significantly due to increased
expenses in support of clinical trials, and revenues from sale of
investigational products are likely to decrease, at least over the short term
and possibly thereafter.
There can be no assurance as to whether third party payors will cover
TMR or PTMR procedures or as to the levels of reimbursement. There also can
be no assurance that levels of reimbursement, if any, will not be decreased
in the future, or that future legislation, regulation, or reimbursement
policies of third party payors will not otherwise adversely affect the demand
for the Company's products or its ability to sell its products on a
profitable basis. Fundamental reforms in the healthcare industry in the U.S.
and Europe that could affect the availability of third party reimbursement
continue to be proposed, and the Company cannot predict the timing or effect
of any such proposal. If third party payor coverage or reimbursement is
unavailable or inadequate, the Company's business, financial condition and
results of operations could be materially and adversely affected.
LIMITED SALES, MARKETING AND DISTRIBUTION SYSTEMS
The Company has made limited sales of its TMR products to date, for
investigational use only. Accordingly, the Company has maintained a limited
sales and marketing organization in the U.S. and abroad. The Company plans to
market its TMR and PTMR products, if approved, through a direct sales force
and through relationships with distributors or agents. Establishment of a
sales force capable of effectively commercializing the Company's TMR and PTMR
products will require substantial efforts and require significant management
and financial resources. There can be no assurance that the Company will be
able to establish such a sales capability on a timely basis, if at all.
Moreover, there can be no assurance that the Company's distributors will
devote sufficient resources to development of the markets for the Company's
products or that they will be successful in such commercialization efforts.
POTENTIAL NEED FOR ADDITIONAL CAPITAL
Although the Company anticipates that its current cash balances,
together with sales of products for investigational use, will be sufficient
to meet the Company's capital requirements through at least 1998, there can
be no assurance that the Company will not require additional sources of cash
at an earlier date. This will depend upon the progress of expansion of the
Company's clinical trials and any need for additional trials or other testing
of the Company's products, and the timing of required expenditures. If the
Company is required to obtain additional financing in the future, there can
be no assurance that capital will be available on terms acceptable to the
Company, if at all.
RISK OF PRODUCT LIABILITY
The Company faces an inherent and significant business risk of exposure
to product liability claims in the event that the use of its products results
in personal injury or death, and there can be no assurance that material
product liability claims will not be assessed against the Company in the
future. The Company maintains insurance against product liability claims in
the amount of $3 million per occurrence and $3 million in the aggregate.
However, there can be no assurance that such coverage will continue to be
available in the amount desired or on terms acceptable to the Company, or
that such coverage will be adequate for liabilities actually incurred. Also,
in the event that any of the Company's products prove to be defective, the
Company may be required to recall or redesign such products. Any uninsured or
underinsured claim brought against the Company or any claim or product recall
that results in significant cost to or adverse publicity against the Company
could materially and adversely affect the Company's business, financial
condition and results of operations.
LIMITED MANUFACTURING EXPERIENCE; DEPENDENCE ON KEY SUPPLIERS
The Company's success will depend in part on its ability to manufacture
its products in a timely, cost-effective manner and in compliance with GMP,
ISO 9001 and other regulatory requirements. The manufacture of the Company's
products is a labor-intensive, complex operation involving a number of
separate processes and components. The Company's manufacturing activities to
date have consisted primarily of manufacturing limited quantities of systems
for use in clinical trials. The Company does not have experience in
manufacturing its products in the commercial quantities
26
that might be required if the Company receives regulatory approval for its
TMR and PTMR products. Furthermore, as a condition to receipt of PMA
approval, the Company's facilities, procedures and practices will be subject
to pre-approval and ongoing GMP inspections by FDA.
Manufacturers often encounter difficulties in scaling up manufacturing of
new products, including problems involving product yields, quality control and
assurance, component and service availability, adequacy of control policies
and procedures, lack of qualified personnel, compliance with FDA regulations,
and the need for further FDA approval of new manufacturing processes and
facilities. There can be no assurance that manufacturing yields, costs or
quality will not be adversely affected as the Company seeks to increase
production, and any such adverse effect could materially and adversely affect
the Company's business, financial condition and results of operations.
The Company currently purchases certain laser and fiber-optic components
from single sources. Although the Company has identified alternative vendors,
the qualification of additional or replacement vendors for certain components
or services is a lengthy process. There can be no assurance that materials
obtained from outside suppliers will continue to be available in adequate
quantities or at the times required by the Company or that the Company will be
able to locate alternative suppliers on a timely basis. Any significant supply
interruption would have a material adverse effect on the Company's ability to
manufacture its products and, therefore, would materially and adversely affect
the Company's business, financial condition and results of operations. The
Company expects to manufacture its products based on forecasted product
orders, and intends to purchase subassemblies and components prior to receipt
of purchase orders from customers. Lead times for materials and components
ordered by the Company vary significantly, and depend on factors such as the
business practices of the specific supplier, contract terms and general demand
for a component at a given time. As a result, there is a risk of excess or
inadequate inventory if orders do not match forecasts.
DEPENDENCE ON KEY PERSONNEL
The Company's future business and operating results depend in significant
part aggregate or for each upon the continued contributions of its key
technical and senior management personnel, including Douglas Murphy-Chutorian,
M.D., the Company's Chief Executive Officer, and Richard L. Mueller, Jr., the
Company's President and Chief Operating Officer. The Company maintains key
person life insurance policies on both of these individuals in the amount of
$2 million. The Company's future business and operating results also depend in
significant part upon its ability to attract and retain qualified additional
management, manufacturing, technical, marketing and sales and support
personnel for its operations. Competition for such personnel is intense, and
there can be no assurance that the Company will be successful in attracting or
retaining such personnel. In this regard, the Chief Financial Officer and Vice
President of Quality Assurance, have agreed to remain with the Company until
suitable replacements have been hired. Although the Company has initiated a
search for these positions, there can be no assurance that suitable
replacements can be identified and successfully recruited in a timely fashion.
The loss of any key employee, the failure of any key employee to perform in
his or her current position, or the Company's inability to attract and retain
skilled employees, as needed, could materially and adversely affect the
Company's business, financial condition and results of operations.
TRADING MARKET FOR COMMON STOCK; VOLATILITY OF STOCK PRICE
The market price of the Common Stock has been, and is likely to continue
to be, highly volatile and may be significantly affected by factors such as
actual or anticipated fluctuations in the Company's operating results,
announcements of technological innovations, new products or new contracts by
the Company or its competitors, developments with respect to patents or
proprietary rights, conditions and trends in the medical device and other
technology industries, healthcare reform measures, adoption of new accounting
standards affecting the medical device industry, changes in financial
estimates by securities analysts, general market conditions and other factors.
In addition, the stock market has from time to time experienced significant
price and volume fluctuations that have particularly affected the market
prices for the common stocks of early stage companies. These broad market
fluctuations may materially and adversely affect the market price of the
Common Stock. In the past, following periods of volatility in the market price
of a particular company's securities, securities class action litigation has
often been brought against that company. Such litigation, if brought against
the Company, could result in substantial costs and a diversion of management's
attention and resources.
27
CONCENTRATION OF SHARE OWNERSHIP
The present directors and executive officers of the Company and their
affiliates beneficially own approximately 39% of the outstanding Common
Stock. As a result, these shareholders will be able to exercise significant
influence over matters requiring shareholder approval, including the election
of directors and approval of significant corporate transactions. Such
concentration of ownership may have the effect of delaying or preventing a
change in control of the Company.
28
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Item 14 below and the Index therein for a listing of the financial
statements and supplementary data filed as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information required by this item is incorporated by reference to
the information set forth under the caption "Board of Directors" contained in
the Proxy Statement to be used by the Company in connection with its 1998
Annual Meeting of Shareholders, to be filed with the Securities and Exchange
Commission on or prior to March 20, 1998.
ITEM 11. EXECUTIVE COMPENSATION.
The information required by this item is incorporated by reference to
the information set forth under the similarly titled caption contained in the
Proxy Statement to be used by the Company in connection with its 1998 Annual
Meeting of Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information required by this item is incorporated by reference to
the information set forth under the similarly titled caption contained in the
Proxy Statement to be used by the Company in connection with its 1998 Annual
Meeting of Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference to
the information set forth under the similarly titled caption contained in the
Proxy Statement to be used by the Company in connection with its 1998 Annual
Meeting of Shareholders.
29
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) (1) FINANCIAL STATEMENTS. The financial statements required to be filed
by Item 8 herewith are as follows:
Page
----
Report of Independent Accountants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
Consolidated Balance Sheets as of December 31, 1997 and 1996. . . . . . . . . . . . . . . . . . . . 33
Consolidated Statements of Operations for the years ended December 31, 1997, 1996 and 1995. . . . . 34
Consolidated Statements of Shareholders' Equity (Deficit) for the years ended December 31, 1997,
1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35
Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. . . . . 36
Notes to the Consolidated Financial Statements. . . . . . . . . . . . . . . . . . . . . . . . . . . 37
(2) FINANCIAL STATEMENT SCHEDULES. The following financial statement schedules are filed herewith.
Schedule II - Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . . . . . . . . . 47
Report of Independent Accountants on Financial Statement Schedule . . . . . . . . . . . . . . . . . 48
(3) EXHIBITS.
The exhibits listed under Item 14(c) are filed or incorporated by reference herein.
(b) REPORTS ON FORM 8-K.
None.
(c) EXHIBITS.
The exhibits below are filed or incorporated herein by reference.
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
3.1* Certificate of Amendment and Restated Articles of Incorporation of
Registrant.
3.2* Amended and Restated Bylaws of Registrant.
4.1* Form of Warrant issued in July 1993.
4.3* Form of Warrant issued in February 1994.
4.4* Form of Warrant issued in May 1994.
30
(c) EXHIBITS -- (CONTINUED)
4.5* Form of Warrant issued in October 1995.
4.6* Form of Warrant issued in March 1996.
10.1* Form of Director and Officer Indemnification Agreement.
10.2* Stock Option Plan.
10.3* Director Stock Option Plan.
10.4* 1996 Employee Stock Purchase Plan.
10.5* Facilities Lease for 1049 Kiel Court, Sunnyvale, California.
10.6* 401(k) Plan.
23.1 Consent of Coopers & Lybrand L.L.P.
27.1 Financial Data Schedule
- ---------------
* Incorporated herein by reference from the Company's Registration Statement
on Form S-1 (File No. 333-03770), as amended, filed on April 18, 1996.)
31
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Eclipse Surgical Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Eclipse
Surgical Technologies, Inc. and subsidiaries as of December 31, 1997 and
1996, and the related consolidated statements of operations, shareholders'
equity (deficit) and cash flows for each of the three years in the period
ended December 31, 1997. 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
Eclipse Surgical Technologies, Inc. and subsidiaries as of December 31, 1997
and 1996, and the consolidated results of their operations and their cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 30, 1998
32
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(IN THOUSANDS)
ASSETS
1997 1996
--------- ---------
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . $ 16,997 $ 24,106
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . 18,197 21,397
Accounts receivable, net of allowance for doubtful accounts of
$757 and $280 at December 31, 1997 and 1996, respectively . . . . 2,054 2,483
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,866 2,464
Prepaids and other current assets. . . . . . . . . . . . . . . . . . 556 431
--------- ---------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . 41,670 50,881
Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . 1,420 906
Marketable securities. . . . . . . . . . . . . . . . . . . . . . . . . - 6,560
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 384 359
--------- ---------
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 43,474 $ 58,706
--------- ---------
--------- ---------
LIABILITIES
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3,190 $ 2,043
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 965 908
Customer deposits. . . . . . . . . . . . . . . . . . . . . . . . . . 71 28
Note payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 -
Current portion of long-term debt. . . . . . . . . . . . . . . . . . 10 41
--------- ---------
Total current liabilities . . . . . . . . . . . . . . . . . . . . 5,236 3,020
Long-term debt, less current portion . . . . . . . . . . . . . . . . . 10 20
--------- ---------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . 5,246 3,040
--------- ---------
Commitments and contingencies (Note 9)
SHAREHOLDERS' EQUITY
Preferred stock, no par value:
Authorized: 5,000 shares;
Issued and outstanding: none
Common stock, no par value:
Authorized: 50,000 shares;
Issued and outstanding: 16,858 shares at December 31, 1997 and
16,172 shares at December 31, 1996. . . . . . . . . . . . . . . . 66,596 65,339
Unrealized gain on marketable securities . . . . . . . . . . . . . . . 50 498
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . (28,418) (10,171)
--------- ---------
Total shareholders' equity. . . . . . . . . . . . . . . . . . . . 38,228 55,666
--------- ---------
Total liabilities and shareholders' equity. . . . . . . . . . . . $ 43,474 $ 58,706
--------- ---------
--------- ---------
The accompanying notes are an integral part of these financial statements
33
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1997 1996 1995
-------- -------- --------
Net revenues . . . . . . . . . . . . . . . . . . . . . $ 5,499 $ 9,759 $ 2,707
Cost of revenues . . . . . . . . . . . . . . . . . . . 2,779 3,558 1,642
-------- -------- --------
Gross profit . . . . . . . . . . . . . . . . . . . . 2,720 6,201 1,065
-------- -------- --------
Operating expenses:
Research and development . . . . . . . . . . . . . . 12,007 6,586 1,010
Sales and marketing. . . . . . . . . . . . . . . . . 7,345 3,327 879
General and administrative . . . . . . . . . . . . . 4,036 2,000 681
-------- -------- --------
Total operating expenses. . . . . . . . . . . . . 23,388 11,913 2,570
-------- -------- --------
Operating loss. . . . . . . . . . . . . . . . . (20,668) (5,712) (1,505)
Interest expense . . . . . . . . . . . . . . . . . . . (25) (196) (923)
Interest and other income. . . . . . . . . . . . . . . 2,446 1,752 2
-------- -------- --------
Net loss. . . . . . . . . . . . . . . . . . . . $(18,247) $ (4,156) $ (2,426)
-------- -------- --------
-------- -------- --------
Net loss per share:
Basic earnings per share . . . . . . . . . . . . . . $ (1.11) $ (0.30) $ (0.23)
-------- -------- --------
-------- -------- --------
Diluted earnings per share . . . . . . . . . . . . . $ (1.11) $ (0.30) $ (0.23)
-------- -------- --------
-------- -------- --------
Weighted average shares outstanding. . . . . . . . . 16,404 14,078 10,470
-------- -------- --------
-------- -------- --------
The accompanying notes are an integral part of these financial statements
34
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS)
NOTES
RECEIVABLE UNREALIZED
COMMON STOCK FOR GAIN ON
-------------------- COMMON MARKETABLE ACCUMULATED
SHARES AMOUNT STOCK SECURITIES DEFICIT TOTAL
------ ------ ---------- ----------- ----------- --------
Balances, January 1, 1995 . . . . . . . 10,469 $ 3,450 $ (3,589) $ (139)
Issuance of common stock. . . . . . . 741 1,235 $ (104) - 1,131
Issuance of warrants. . . . . . . . . - 5 - 5
Net loss. . . . . . . . . . . . . . . - - - (2,426) (2,426)
------ --------- ------- --------- --------
Balances, December 31, 1995 . . . . . . 11,210 4,690 (104) (6,015) (1,429)
Issuance of common stock in
connection with initial
public offering. . . . . . . . . . 4,000 57,956 57,956
Issuance of common stock. . . . . . . 962 2,691 2,691
Payment on notes receivable . . . . . 104 104
Issuance of warrants. . . . . . . . . - 2 2
Unrealized gain on
marketable securities. . . . . . . $ 498 498
Net loss. . . . . . . . . . . . . . . - - - (4,156) (4,156)
------ --------- ------- ------- --------- --------
Balances, December 31, 1996 . . . . . . 16,172 65,339 - 498 (10,171) 55,666
Issuance of common stock. . . . . . . 552 956 956
Issuance of common stock
pursuant to exercise of
warrants . . . . . . . . . . . . . 134 301 301
Realized gain on
marketable securities. . . . . . . (448) (448)
Net loss. . . . . . . . . . . . . . . - - - (18,247) (18,247)
------ --------- ------- ------- --------- --------
Balances, December 31, 1997 . . . . . . 16,858 $ 66,596 $ - $ 50 $ (28,418) $ 38,228
------ --------- ------- ------- --------- --------
------ --------- ------- ------- --------- --------
The accompanying notes are an integral part of these financial statements
35
ECLIPSE SURGICAL TECHNOLOGIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995
(IN THOUSANDS)
1997 1996 1995
-------- -------- --------
Cash flows from operating activities:
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(18,247) $ (4,156) $ (2,426)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . 724 200 72
Amortization of discount and financing costs. . . . . . . . . . . - - 607
Provision for doubtful accounts . . . . . . . . . . . . . . . . . 477 378 40
Changes in operating assets and liabilities:
Increase in accounts receivable . . . . . . . . . . . . . . . . (48) (2,329) (191)
(Increase) decrease in inventories. . . . . . . . . . . . . . . (1,402) (794) 163
(Increase) decrease in prepaids and other current assets . . . (125) (417) 349
Increase in accounts payable. . . . . . . . . . . . . . . . . . 1,147 826 266
Increase (decrease) in customer deposits. . . . . . . . . . . . 43 (242) 46
Increase (decrease) in accrued liabilities. . . . . . . . . . . 57 361 (4)
-------- -------- --------
Net cash used in operating activities . . . . . . . . . . . . (17,374) (6,173) (1,078)
-------- -------- --------
Cash flows from investing activities:
Purchase of marketable securities. . . . . . . . . . . . . . . . . . - (27,459) -
Sale of marketable securities . . . . . . . . . . . . . . . . . . . 9,312 - -
Acquisition of property and equipment. . . . . . . . . . . . . . . . (1,238) (974) (62)
Increase in other assets . . . . . . . . . . . . . . . . . . . . . . (25) (337) -
-------- -------- --------
Net cash provided by (used) investing activities. . . . . . . 8,049 (28,770) (62)
-------- -------- --------
Cash flows from financing activities:
Payments on short-term borrowings. . . . . . . . . . . . . . . . . . - (45) (782)
Net proceeds from issuance of common stock and warrants. . . . . . . 1,257 60,649 1,136
Payments on notes receivable . . . . . . . . . . . . . . . . . . . . - 104 -
Proceeds from note payable . . . . . . . . . . . . . . . . . . . . . 1,000 - -
Proceeds from short-term borrowings. . . . . . . . . . . . . . . . . - - 827
Payments on long-term debt . . . . . . . . . . . . . . . . . . . . . (41) (1,782) (50)
-------- -------- --------
Net cash provided by financing activities . . . . . . . . . . 2,216 58,926 1,131
-------- -------- --------
Net increase (decrease) in cash and cash
equivalents . . . . . . . . . . . . . . . . . . . . . . . (7,109) 23,983 (9)
Cash and cash equivalents at beginning of period . . . . . . . . . . . 24,106 123 132
-------- -------- --------
Cash and cash equivalents at end of period . . . . . . . . . . . . . . $ 16,997 $ 24,106 $ 123
-------- -------- --------
-------- -------- --------
Supplemental schedule of cash flow information:
Interest paid. . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25 $ 281 $ 71
Taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - $ 1
Supplemental schedule of noncash investing and
financing activities:
Unrealized gain on marketable securities . . . . . . . . . . . . . . $ 50 $ 498 $ -
-------- -------- --------
-------- -------- --------
Issuance of common stock and warrants in exchange for
note receivable. . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ - $ 104
-------- -------- --------
-------- -------- --------
Acquisition of equipment under capital lease . . . . . . . . . . . . $ - $ 34 $ -
-------- -------- --------
-------- -------- --------
The accompanying notes are an integral part of these financial statements
36
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF OPERATIONS:
Eclipse Surgical Technologies, Inc. (the "Company") was founded in 1989 to
develop, manufacture and market surgical lasers and accessories for the
treatment of disease. Currently, the Company's emphasis is on development and
manufacture of products used for transmyocardial revascularization (TMR) and
percutaneous transluminal myocardial revascularization (PTMR), which are
cardiovascular procedures. The Company markets its products for sale primarily
in the U.S., Europe and Asia. In the U.S., the Company offers its laser systems
for sale in limited numbers for investigational use only pursuant to
Investigational Device Exemptions from the U.S. Food and Drug Administration.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries. All significant intercompany
transactions and balances have been eliminated.
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure 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 AND CASH EQUIVALENTS:
All highly liquid instruments purchased with an original maturity of three
months or less are considered cash equivalents, and are held primarily at one
commercial bank and one investment bank.
MARKETABLE SECURITIES:
Marketable securities are classified as available-for-sale and are
carried at fair value. Marketable securities classified as current assets
have scheduled maturities of less than one year, while marketable securities
classified as noncurrent assets have scheduled maturities of more than one
year. Unrealized holding gains on such securities are reported as a separate
component of shareholders' equity. Realized gains and losses on sales of all
such securities are reported in earnings and computed using the specific
identification cost method.
INVENTORIES:
Inventories are stated at the lower of cost (principally standard cost,
which approximates actual cost on a first-in, first-out basis) or market
value.
37
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):
FAIR VALUE OF FINANCIAL INSTRUMENTS:
Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts payable,
accrued liabilities and customer deposits approximate fair value due to their
short maturities. Based on borrowing rates currently available to the Company
for loans with similar terms, the carrying value of the long-term debt
obligations also approximates fair value.
CERTAIN RISKS AND CONCENTRATIONS:
The Company sells its products primarily to hospitals and other health care
providers in North America, Europe and Asia. The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. Although
the Company maintains allowances for potential credit losses that it believes to
be adequate, a payment default on a significant sale could materially and
adversely affect its operating results and financial condition. At December 31,
1997 and 1996, three customers accounted for 37% and four customers accounted
for 68% of accounts receivable, respectively.
The Company purchases certain laser and fiber-optic components and
subassemblies from single sources. Although the Company has identified
alternative vendors, the qualification of additional or replacement vendors for
certain components or services is a lengthy process. Any significant supply
interruption could affect the Company's ability to manufacture its products and
would, therefore, adversely affect operating results.
REVENUE RECOGNITION:
The Company typically recognizes revenue on product sales upon receipt of
purchase order and subsequent shipment of product. Where purchase orders allow
customers an acceptance period, revenue is recognized upon acceptance.
Revenues from service contracts, rentals, and per procedure fees are
recognized upon performance or over the terms of the contract as appropriate.
RESEARCH AND DEVELOPMENT:
Research and development expenses are charged to operations as incurred.
PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost and depreciated on a
straight-line basis over their estimated useful lives of three to five years.
Assets acquired under capital leases are amortized over the shorter of their
estimated useful lives or the term of the related lease (generally three to five
years). Amortization of leasehold improvements is based on the straight-line
method over the shorter of the estimated useful life or the lease term.
WARRANTIES:
The Company's laser products are generally warranted for one year. The
Company provides for estimated future costs of repair, replacement, or customer
accommodations which are reflected in the accompanying financial statements.
38
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):
INCOME TAXES:
The Company accounts for income taxes using the liability method under
which deferred tax assets or liabilities are calculated at the balance sheet
date using current tax laws and rates in effect for the year in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amounts
expected to be realized.
STOCK BASED COMPENSATION:
The Company accounts for its stock based compensation in accordance with
Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock
Issued to Employees." The Company has elected to adopt the disclosure only
provisions of Statement of Financial Accounting Standards No. 123 ("SFAS 123"),
"Accounting for Stock Based Compensation," which requires pro forma disclosures
in the financial statements as if the measurement provisions of SFAS 123 had
been adopted.
NET LOSS PER SHARE:
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 128, "Earnings Per Share," ("SFAS 128") effective December 31,
1997. SFAS 128 requires the presentation of basic and diluted earnings per
share (EPS). Basic EPS is computed by dividing loss available to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted EPS is computed giving effect to all dilutive potential common
shares that were outstanding during the period. Dilutive potential common
shares consist of incremental shares issuable upon the conversion of convertible
preferred stock (using the "if converted" method) and exercise of stock options
and warrants. All prior period earnings per share amounts have been restated
to comply with SFAS 128.
In accordance with the disclosure requirements of SFAS 128, a
reconciliation of the numerator and denominator of basic and diluted EPS is
provided as follows (in thousands, except per share amounts):
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---- ---- ----
Numerator - Basic and Diluted EPS
Loss available to common stockholders... $(18,247) $(4,156) $(2,426)
-------- ------- -------
-------- ------- -------
Denominator - Basic and Diluted EPS
Weighted average shares outstanding.... 16,404 14,078 10,470
-------- ------- -------
Basic earnings per share............... $ (1.11) $ (0.30) $ (0.23)
-------- ------- -------
-------- ------- -------
Diluted earnings per share............. $ (1.11) $ (0.30) $ (0.23)
-------- ------- -------
-------- ------- -------
Options to purchase 2,885,000, 2,785,000 and 2,540,000 shares of common
stock were outstanding at December 31, 1997, 1996 and 1995, respectively, but
were not included in the calculation of diluted EPS because their inclusion
would have been antidilutive.
39
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED):
RECENT PRONOUNCEMENTS:
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income." This statement establishes standards for reporting and display of
comprehensive income and its components (including revenues, expenses, gains
and losses) in a full set of general purpose financial statements. This
statement is effective for fiscal years beginning after December 15, 1997,
with earlier application permitted.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS 131"), which supersedes SFAS 14, "Financial Reporting for Segments of a
Business Enterprise." SFAS 131 changes current practice under SFAS 14 by
establishing a new framework on which to base segment reporting and also
requires interim reporting of segment information. SFAS 131 is effective for
fiscal years beginning after December 15, 1997 with earlier application
encouraged. The statement's interim reporting disclosures would not be
required until the first quarter immediately subsequent to the fiscal year in
which SFAS 131 is effective.
3. MARKETABLE SECURITIES:
At December 31, 1997, marketable securities consisted of fixed income
U.S. government securities held by an investment bank. These marketable
securities had a cost basis of approximately $18,147,000 and a fair value of
$18,197,000 and mature at various dates through 1998.
4. INVENTORIES:
Inventories consist of the following (IN THOUSANDS):
DECEMBER 31,
---------------
1997 1996
---- ----
Raw materials . . . . . . . . . . . . . . . . . . . . $1,446 $ 511
Work in process . . . . . . . . . . . . . . . . . . . - 99
Finished goods. . . . . . . . . . . . . . . . . . . . 2,420 1,854
------ ------
$3,866 $2,464
------ ------
------ ------
5. PROPERTY AND EQUIPMENT:
Property and equipment consists of the following (IN THOUSANDS):
DECEMBER 31,
----------------
1997 1996
-------- ------
Computers and equipment . . . . . . . . . . . . . . . $ 1,638 $ 879
Manufacturing and demonstration equipment . . . . . . 850 467
Leasehold improvements. . . . . . . . . . . . . . . . 124 28
-------- ------
2,612 1,374
-------- ------
Less accumulated depreciation and amortization. . . . (1,192) (468)
-------- ------
$ 1,420 $ 906
-------- ------
-------- ------
40
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company leases certain equipment under a capital lease which expires in
February 2000. Accordingly, capitalized costs of $34,000, net of accumulated
amortization of $11,900 and $5,100 at December 31, 1997 and 1996, respectively,
are included in property and equipment.
6. ACCRUED LIABILITIES:
Accrued liabilities consists of the following (IN THOUSANDS):
DECEMBER 31,
-------------------
1997 1996
------ -------
Accrued salaries and related. . . . . . . . . $ 483 $ 487
Accrued commissions . . . . . . . . . . . . . 127 156
Accrued warranty. . . . . . . . . . . . . . . 78 141
Accrued interest. . . . . . . . . . . . . . . - 6
Other . . . . . . . . . . . . . . . . . . . . 277 118
------ ------
$ 965 $ 908
------ ------
------ ------
7. SHORT-TERM BORROWINGS:
In October 1997, MicroHeart, a wholly-owned subsidiary of the Company,
entered into a note payable with an investor for $1,000,000 at 8% interest per
annum. Principal and interest are due October 31, 1998. Additionally, warrants
to purchase 400,000 shares of MicroHeart's common stock at $0.50 per share were
granted to the investor. The warrants are immediately exercisable and expire on
October 31, 2000.
8. LONG-TERM DEBT:
Long term debt consists of a capital lease which bears interest at 10.33%
and expires in February, 2000.
9. COMMITMENTS AND CONTINGENCIES:
The Company has entered into five operating leases for office facilities
with terms extending from December 1998 to December 2002. The minimum future
rental payments are (in thousands):
YEAR ENDED DECEMBER 31,
-----------------------
1998 . . . . . . . . . . . . . . . . . . . . $542
1999 . . . . . . . . . . . . . . . . . . . . 355
2000 . . . . . . . . . . . . . . . . . . . . 322
2001 . . . . . . . . . . . . . . . . . . . . 333
2002 . . . . . . . . . . . . . . . . . . . . 227
Rent expense was approximately $475,000, $172,000 and $139,000 for the
years ended December 31, 1997, 1996 and 1995, respectively.
The Company is engaged in certain legal and administrative proceedings
incidental to its normal business activities. While it is not possible to
determine the ultimate outcome of these actions at this time, management
believes that any liabilities resulting from such proceedings, or claims which
are pending or known to be threatened, will not have a material adverse effect
on the Company's financial position or results of operations.
41
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. SHAREHOLDERS' EQUITY:
WARRANTS:
At December 31, 1997, warrants were outstanding to purchase a total of
770,838 shares of common stock at exercise prices ranging from $1.67 to $4.17.
The warrants, which were issued in connection with various debt and equity
financings, are exercisable and terminate upon the earlier of; sixteen
months to five years from the effective grant date, a merger or sale of all or
substantially all of the Company's assets to a noncontrolling entity, or
certain other conditions. At December 31, 1997, the Company had reserved
770,838 shares of common stock for issuance upon exercise of these warrants.
During the year ended December 31, 1997 and 1996 133,743 and 267,057 warrants
were exercised generating proceeds of approximately $245,510 and $524,000,
respectively.
STOCK OPTION PLAN:
The Company maintains a Stock Option Plan, which includes the Employee
Program under which incentive and nonstatutory options may be granted to
employees and the Consultants Program, under which nonstatutory options may be
granted to consultants of the Company. As of December 31, 1997, the Company
had reserved for issuance under this plan a total of 4,000,000 shares of
common stock. Under the plan, options may be granted at not less than fair
market value (110% of fair market value for options granted to 10%
shareholders), as determined by the Board of Directors. Options generally vest
over a period of three years and expire ten years from date of grant (five
years for options granted to 10% shareholders). No shares of common stock
issued under the plan are subject to repurchase.
DIRECTORS' STOCK OPTION PLAN:
The Company maintains a Directors' Stock Option Plan which provides for
the grant of nonstatutory options to directors who are not officers or
employees of the Company. As of December 31, 1997, the Company had reserved
for issuance under this plan 200,000 shares of common stock. Under this plan,
options are granted at the trading price of the common stock at the date of
grant. Options generally vest over twelve to thirty-six months and expire ten
years from date of grant. No shares of common stock issued under the plan are
subject to repurchase.
STOCK BASED COMPENSATION:
The Company has adopted the disclosure only provision of SFAS No. 123,
"Accounting for Stock Based Compensation". The Company, however, continues to
apply APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations in accounting for its plans. Accordingly, no
compensation cost has been recognized for options granted under the Stock
Option Plan and Directors' Stock Option Plan. Had compensation cost for
these plans been determined based on the fair value of the options at the
grant date for awards in 1997, 1996 and 1995 consistent with the provisions of
SFAS No. 123, the Company's net loss and net loss per share would have
increased to the pro forma amounts indicated below (in thousands, except per
share amounts):
DECEMBER 31,
-------------------------------------
1997 1996 1995
--------- ------- --------
Net loss as reported . . . . . . . . . . . . . . . . . . . $(18,247) $(4,156) $(2,426)
-------- ------- -------
-------- ------- -------
Net loss - pro forma . . . . . . . . . . . . . . . . . . . $(20,951) $(5,794) $(2,636)
-------- ------- -------
-------- ------- -------
Basic net loss per share as reported . . . . . . . . . . . $ (1.11) $ (0.30) $ (0.23)
-------- ------- -------
-------- ------- -------
Basic net loss per share - pro forma . . . . . . . . . . . $ (1.28) $ (0.41) $ (0.25)
-------- ------- -------
-------- ------- -------
Diluted net loss per share as reported . . . . . . . . . . $ (1.11) $ (0.30) $ (0.23)
-------- ------- -------
-------- ------- -------
Diluted net loss per share - pro forma . . . . . . . . . . $ (1.28) $ (0.41) $ (0.25)
-------- ------- -------
-------- ------- -------
42
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. SHAREHOLDERS' EQUITY -- (CONTINUED):
As the provisions of SFAS No. 123 are only applied to stock options
granted after January 1, 1995 in the above pro forma amounts, the impact of
the pro forma stock compensation cost will likely continue to increase as the
vesting period for the Company's options and the period over which the stock
compensation is charged to expense is generally three years.
The fair value of each option grant is estimated on the date of grant
using a type of Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1997, 1996 and 1995.
DECEMBER 31,
------------------------------------
1997 1996 1995
------- ------- -------
Exercise price . . . . . . . . . . . . . . . . . . . . $ 4.04 $ 2.79 $ 1.40
Expected life of option. . . . . . . . . . . . . . . . 8 years 9 years 7 years
Risk-free interest rate. . . . . . . . . . . . . . . . 5.85% 6.36% 5.73%
Expected volatility. . . . . . . . . . . . . . . . . . 36% 45% 60%
Option activity under both plans is as follows (IN THOUSANDS, EXCEPT PER
SHARE AMOUNTS):
OUTSTANDING OPTIONS
SHARES ---------------------------------------
AVAILABLE NUMBER WEIGHTED
FOR OF AVERAGE
GRANT SHARES PRICE PER SHARE TOTAL
---------- -------- --------------- ------
Balance, January 1, 1995 . . . . . . . . . . . . . . . . . . 1,006 1,236 $1.09 $1,434
Additional shares reserved. . . . . . . . . . . . . . . 1,200
Options granted . . . . . . . . . . . . . . . . . . . . (1,308) 1,308 $1.67 2,180
Options canceled. . . . . . . . . . . . . . . . . . . . 4 (4) $1.45 (6)
------ ------ ----- -------
Balance, December 31, 1995 . . . . . . . . . . . . . . . . . 902 2,540 $1.38 3,608
Additional shares reserved. . . . . . . . . . . . . . . 750
Options granted . . . . . . . . . . . . . . . . . . . . (515) 515 $8.96 4,618
Options canceled. . . . . . . . . . . . . . . . . . . . 56 (56) $3.74 (208)
Options exercised . . . . . . . . . . . . . . . . . . . - (214) $0.91 (196)
------ ------ ----- --------
Balance, December 31, 1996 . . . . . . . . . . . . . . . . . 1,193 2,785 $2.77 $ 7,822
Options granted . . . . . . . . . . . . . . . . . . . . (775) 775 $7.52 5,823
Options canceled. . . . . . . . . . . . . . . . . . . . 174 (174) $6.70 (1,162)
Options exercised . . . . . . . . . . . . . . . . . . . - (501) $1.21 (604)
------ ------ ----- -------
Balance, December 31, 1997 . . . . . . . . . . . . . . . . . 592 2,885 $4.04 $11,879
------ ------ ----- -------
------ ------ ----- -------
At December 31, 1997, 1996 and 1995, options to purchase 1,720,531,
1,517,045 and 1,241,646 shares of common stock, respectively were exercisable at
weighted average fair values of $2.74, $1.38, and $0.96, respectively.
43
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. SHAREHOLDERS' EQUITY -- (CONTINUED):
OPTIONS CURRENTLY
OPTIONS OUTSTANDING EXERCISABLE
------------------------------ -------------------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE AVERAGE
EXERCISE SHARES CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OUTSTANDING LIFE IN YEARS PRICE EXERCISABLE PRICE
------- ------------ ------------- -------- ------------ ---------
(IN THOUSANDS) (IN THOUSANDS)
$ 0.03 - $ 1.43 400 3.66 $ 0.94 400 $ 0.94
$ 1.44 - $ 1.44 175 5.68 $ 1.44 175 $ 1.44
$ 1.67 - $ 1.67 1,191 7.90 $ 1.67 843 $ 1.67
$ 4.17 - $ 6.63 299 9.18 $ 5.74 23 $ 4.17
$ 6.75 - $ 8.50 531 9.14 $ 8.07 169 $ 8.08
$ 8.63 - $11.00 238 7.70 $ 10.19 91 $ 10.76
$ 11.50 - $16.00 51 8.79 $ 11.89 20 $ 11.90
EMPLOYEE STOCK PURCHASE PLAN:
The Company maintains an Employee Stock Purchase Plan, under which 250,000
shares of common stock have been reserved for issuance. Eligible employees are
permitted to purchase common stock at 85% of the fair market value through
payroll deductions of up to 15% of an employee's compensation, subject to
certain limitations. At December 31, 1997, 59,140 shares had been issued under
this plan.
11. EMPLOYEE RETIREMENT PLAN:
The Company maintains a 401(k) plan for its employees. The plan allows
eligible employees to defer up to 15% of their earnings, not to exceed the
statutory amount per year on a pretax basis through contributions to the plan.
The plan provides for employer contributions at the discretion of the Board of
Directors, however, no such contributions were made in 1997 or 1996.
12. INTEREST AND OTHER INCOME:
Interest and other income consist of the following (in thousands):
DECEMBER 31,
------------
1997 1996 1995
---- ---- ----
Interest Income . . . . . . . . . . . . . . . . . . . . . . $ 1,998 $ 1,752 $ 2
Gain on Sale of Marketable Securities . . . . . . . . . . . 448 - -
-------- -------- ----
$ 2,446 $ 1,752 $ 2
-------- -------- ----
-------- -------- ----
44
ECLIPSE SURGICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. INCOME TAXES:
The components of the net deferred tax asset are as follows (IN THOUSANDS):
DECEMBER 31,
------------------------
1997 1996
--------- --------
Net operating losses . . . . . . . . . . . . . . . . . . . . . . $ 10,212 $ 2,939
Research and development and other credits . . . . . . . . . . . 1,308 649
Reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . 959 301
Accrued Liabilities. . . . . . . . . . . . . . . . . . . . . . . 293 139
Other. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 829 37
--------- --------
Net deferred asset. . . . . . . . . . . . . . . . . . . . . 13,601 4,065
Less valuation allowance . . . . . . . . . . . . . . . . . . . . (13,601) (4,065)
--------- --------
$ - $ -
--------- --------
--------- --------
The Company has established a valuation allowance to the extent of its
deferred tax asset since it is not certain that a benefit can be realized in the
future due to the Company's recurring operating losses.
The change in the valuation allowance was $9,536,000, $1,998,000 and
$436,000 in 1997, 1996, and 1995, respectively.
The noncurrent portion of the deferred tax assets, which totaled
$12,521,000 and $3,290,000 at December 31, 1997 and 1996, respectively, is
included above.
At December 31, 1997, the Company had federal and state net operating loss
carryforwards of approximately $28,800,000 and $7,330,000, respectively,
available to offset future regular and alternative minimum taxable income. In
addition, the Company had federal and state credit carryforwards of
approximately $949,000 and $545,000 available to offset future tax liabilities.
The Company's net operating loss carryforwards, as well as credit carryforwards,
expire in 1998 through 2012, if not utilized.
The Tax Reform Act of 1986 limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. The Company believes that the sale of common stock in
its initial public offering resulted in an ownership change which could
restrict the utilization of the carryforwards.
14. MAJOR CUSTOMERS:
For the year ended December 31, 1997 two customers accounted for 35% of net
revenues. For the year ended December 31, 1996 one customer accounted for 11%
of net revenues. Two customers accounted for 10% each of net revenues for the
year ended December 31, 1995.
Export sales accounted for approximately 32%, 13% and 20% of net sales for
the years ended December 31, 1997, 1996 and 1995, respectively.
45
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
ECLIPSE SURGICAL TECHNOLOGIES, INC.
Registrant
Date: February 27, 1998 By: /s/ Douglas Murphy-Chutorian, M.D.
-------------------------------------------
DOUGLAS MURPHY-CHUTORIAN, M.D.
CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE
OFFICER
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT IN THE CAPACITIES AND ON THE DATE INDICATED.
Signature Title Date
--------- ------ -----
/s/ Douglas Murphy-Chutorian, M.D. Chairman and Chief Executive
- ------------------------------------------ Officer (Principal Executive Officer) February 27, 1998
Douglas Murphy-Chutorian, M.D.
/s/ Richard L. Mueller, Jr. President, Chief Operating Officer February 27, 1998
- ------------------------------------------ and Director
Richard L. Mueller, Jr.
/s/ Barbara A. Dreblow Chief Financial Officer February 27, 1998
- ------------------------------------------ (Principal Accounting and
Barbara A. Dreblow Financial Officer)
/s/ Iain M. Watson Director February 27, 1998
- ------------------------------------------
Iain M. Watson
/s/ Robert L. Mortensen Director February 27, 1998
- ------------------------------------------
Robert L. Mortensen
/s/ Alan L. Kaganov, Sc.D. Director February 27, 1998
- ------------------------------------------
Alan L. Kaganov, Sc.D.
46
SCHEDULE II
ECLIPSE SURGICAL TECHNOLOGIES, INC.
VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
BALANCE AT BALANCE
BEGINNING AT END
OF PERIOD ADDITIONS(1) DEDUCTIONS(2) OF PERIOD
--------- ------------ ------------ ----------
Year ended December 31, 1995
Allowance for doubtful accounts . . . . . . . . . . $ 60 $ 40 $ 71 $ 29
Year ended December 31, 1996 . . . . . . . . . . . . . $ 29 $ 258 $ 7 $ 280
Allowance for doubtful accounts
Year ended December 31, 1997
Allowance for doubtful accounts . . . . . . . . . . $ 280 $ 477 $ - $ 757
____________________________
(1) Charged to costs and expenses.
(2) Accounts written off against the reserve.
47
REPORT OF INDEPENDENT ACCOUNTANTS
ON FINANCIAL STATEMENT SCHEDULE
In connection with our audits of the consolidated financial statements of
Eclipse Surgical Technologies, Inc. as of December 31, 1997 and 1996, and for
each of the three years in the period ended December 31, 1997, which financial
statements are included in this Form 10-K, we have also audited the financial
statement schedule listed in Item 14a herein.
In our opinion, this financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 30, 1998
48