ITEM 1. BUSINESS
This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements are based on our current expectations about our business and industry. In some cases, these statements may be identified by terminology such as “may,” “will”, “should,” “expects,” “could,” “intends,” “might,” “plans,” “anticipates,” “targets,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. These statements involve known and unknown risks and uncertainties that may cause our results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed in this report in Item 1A
ITEM 1A. RISK FACTORS
Risks Related to Our Business
If we fail to obtain the necessary FDA clearance for our Magellan Robotic System, NorthStar Robotic Catheter and related accessories we will be unable to commercially distribute and market the system as planned.
Our Magellan Robotic System, NorthStar Robotic Catheter and related accessories designed, which we refer to as our Vascular System, have received CE mark approval for sale in the European Union. We will be not able to sell our Vascular System for clinical use outside of the European Union until we receive regulatory approval or clearance to do so. We submitted a 510(k) pre-market notification to the FDA on April 11, 2011 for our Vascular System. On September 7, 2011, we received a letter from the FDA responding to our application. The FDA’s initial response requested additional information but did not request additional clinical cases and did not raise questions regarding the 510(k) pathway for the device. On February 6, 2012, we responded to the FDA’s questions and provided the results of additional pre-clinical testing. The FDA or other regulatory authorities could ask us to supplement our submissions, collect more non-clinical data than requested to date, conduct clinical trials or engage in other time-consuming or costly actions, or it could simply deny our applications. Seeking new clearances or approvals could also result in the FDA or other regulatory authorities reviewing prior submissions and modifying or revoking prior clearances or approvals. In addition, clearance or approval could be revoked or other restrictions imposed if post-market data demonstrates safety issues or lack of effectiveness. While we believe that the FDA clearance for our Magellan Robotic System, NorthStar Robotic Catheter and related accessories can be expected in the second quarter of 2012, we cannot predict with certainty whether the data from our preclinical testing and other responses to the FDA will be sufficient to support clearance or how or when the FDA or other regulatory authorities will act with regard to our applications with respect to the Vascular System. If we are unable to obtain clearances for our proposed Vascular System on a timely basis, or at all, or on terms that are necessary for a successful product introduction, our financial condition and cash flow may be adversely affected, and our ability to grow may be limited.
Successful commercialization of our new Vascular System is subject to a manufacturing, marketing, sales and customer service risks.
We have not previously manufactured our Magellan Robotic System, NorthStar Robotic Catheter and related accessories in commercial quantities and we may encounter unexpected manufacturing problems when
scaling up the production of these new products. While we have experience marketing and selling the Sensei Robotic System following its initial regulatory approvals in 2007, the marketing and sales effort for our Vascular System will involve different customers, value propositions and purchasing processes. The time needed to obtain market acceptance of a new product such as the Vascular System is highly variable and as a result our commercialization plans may be prolonged. While we have prepared new training materials specifically for our Vascular System, these materials have not been used extensively and only a limited number of clinical cases have been performed with our Vascular System. As a result, with greater physician experience with our Vascular System, we may identify areas where further training is required. In addition, commercial introduction of new products sometimes results in the identification of latent or new product defects or quality issues that were not evident in the testing of the products. If we encounter any of these new product introduction issues with our Vascular System, our financial condition and results of operations could be adversely impacted.
We may not be able to further develop our Vascular System as planned.
We intend to further develop our Vascular System, consisting of our Magellan Robotic System, our NorthStar Robotic Catheter and related accessories. Due to the advanced electrical, mechanical, and software capabilities of this new robotic platform, we may encounter challenges in designing, engineering and manufacturing future enhancements to the platform, which may lead to compatibility obstacles with operating room and catheter laboratory layouts, equipment quality or performance issues, unmet customer expectations regarding features or functionality or other defects in future versions of the platform. Any such difficulties could result in delays in our submissions to regulatory agencies, delays in achieving or the failure to achieve additional regulatory approvals or clearances for enhancements to the system, lack of physician adoption of our system, higher than expected service claims, litigation and negative press coverage.
We have had material weaknesses in internal control over financial reporting in the past and cannot assure you that additional material weaknesses will not be identified or develop in the future. If our internal control over financial reporting or disclosure controls and procedures are not effective, there may be errors in our financial statements that could require a restatement or our filings may not be timely and investors may lose confidence in our reported financial information, which could lead to a decline in our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate the effectiveness of our internal control over financial reporting as of the end of each year, and to include a management report assessing the effectiveness of our internal control over financial reporting in each Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal control over financial reporting.
In assessing the results of an investigation conducted by the audit committee of our Board in 2009 as well as the internal review and recertification procedures performed for purposes of the preparation and certification of our restated consolidated financial statements in November 2009, our management identified material weaknesses as of December 31, 2008 and December 31, 2007 that resulted in errors in our financial reporting with regard to our accounting for revenue recognition with respect to the sale of our Sensei Robotic Catheter Systems. Such errors resulted in a restatement of our audited annual financial statements as of and for the years ended December 31, 2008 and December 31, 2007 and the unaudited interim financial statements as of and for the quarterly periods ended June 30, 2009, March 31, 2009, September 30, 2008, June 30, 2008 and March 31, 2008. Additionally, there were material weaknesses that resulted in audit adjustments in connection with the audit of our December 31, 2009 financial statements. Our evaluation of our disclosure controls and procedures in association with our assessment of the effectiveness of internal control over financial statements as of December 31, 2009 determined that we did not maintain effective controls because we did not maintain an effective control environment, we did not maintain effective information and communication, we did not maintain effective controls related to the process for ensuring completeness and accuracy of our accounting for revenue and did not maintain effective controls over the accounting for complex arrangements. We have adopted various remedial measures to improve our disclosure controls and procedures. A more detailed description of
these previously-reported material weaknesses and the remedial measures adopted is set forth in Part II Item 9A “Controls and Procedures” in our Annual Report on Form 10-K for the year ended December 31, 2010.
We evaluated our disclosure controls and procedures in association with our assessment of the effectiveness of internal control over financial reporting as of December 31, 2011 and determined that our internal control was effective as of that date. We cannot assure you, however, that significant deficiencies or material weaknesses in our internal control over financial reporting will not exist in the future. Any failure to maintain or implement new or improved controls, or any difficulties we encounter in their implementation, could result in significant deficiencies or material weaknesses, cause us to fail to timely meet our periodic reporting obligations, or result in material misstatements in our periodic reports, including the financial statements included in such reports. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding disclosure controls and the effectiveness of our internal control over financial reporting required under Section 404 of the Sarbanes-Oxley Act of 2002 and the rules promulgated thereunder. The existence of a significant deficiency or material weakness could result in errors in our financial statements that could result in a restatement of financial statements, cause us to fail to timely meet our reporting obligations and cause investors to lose confidence in our reported financial information, which in turn could lead to a decline in our stock price.
We are a defendant in a class action lawsuit and two shareholder derivative lawsuits that may adversely affect our financial condition, results of operations and cash flows.
We and certain of our current and former executive officers and directors, are defendants in a federal securities class action lawsuit, a Federal shareholder derivative lawsuit, and a State shareholder derivative lawsuit. These lawsuits are described in Part I Item 3 “Legal Proceedings” in this Annual Report on Form 10-K. Our attention may be diverted from our ordinary business operations by these lawsuits and we may incur significant expenses associated with the defense of these lawsuits (including substantial fees of lawyers and other professional advisors and potential obligations to indemnify officers and directors and our underwriters who may be or become parties to such action.) Depending on the outcome of these lawsuits, we may be required to pay material damages and fines, consent to injunctions on future conduct, or suffer other penalties, remedies or sanctions. The ultimate resolution of these matters could have a material adverse effect on our results of operations, financial condition, liquidity, our ability to meet our debt obligations and, consequently, negatively impact the trading price of our common stock. Prior to resolution of these matters, they will result in substantial expenses for legal, accounting, tax and other professional services, and will divert management’s attention from our business. In addition, there is the potential for additional stockholder litigation and governmental investigations, the possibility of governmental enforcement actions and the possibility that the restatement could impact our relationship with customers and our ability to generate revenue.
Continuing negative publicity may adversely affect our business.
As a result of our audit committee-led investigation in 2009, restatement of our financial statements for the years ended December 31, 2007 and 2008 and the quarterly periods ended March 31, 2008, June 30, 2008, September 30, 2008, March 31, 2009 and June 30, 2009 and related matters, we have been the subject of negative publicity. While we have settled the SEC’s investigation of our company, negative publicity associated with our company may continue as the SEC pursues claims against two of our former officers. This negative publicity may have an effect on the terms under which some customers, lenders, landlords and suppliers are willing to continue to do business with us and could affect our financial performance and condition. We also believe that this negative publicity could potentially damage our ability to recruit and retain employees. Should we continue to be the subject of negative publicity, it could have a material adverse effect on our business.
Potential indemnification obligations to our current and former directors and officers and contractual indemnification obligations to underwriters of our securities offerings could adversely affect us.
Several individuals who are current members of our Board of Directors and several former officers and former members of our Board of Directors are the defendants in pending lawsuits related to the restatement of our financial statements, two former officers are defendants in litigation commenced by the SEC, and other current or former officers, employees or directors may also be named as defendants in those or other lawsuits. Under Delaware law, our charter documents and certain indemnification agreements, we may have an obligation to indemnify our current and former officers and employees and directors in relation to these matters. In addition, we have contractual indemnification obligations to the underwriters of our April 2008, April 2009 and April 2010 public offerings of shares of our common stock. These indemnification obligations to directors, officers, employees and our underwriters are generally unlimited in nature and some of these indemnification obligations may not be covered by our directors’ and officers’ insurance policies. If we incur significant uninsured indemnity obligations, this could have a material adverse effect on our business, results of operations, financial condition and cash flows.
We are a company with a limited history of operations, which makes our future operating results difficult to predict.
We are a medical device company with a limited operating history and first recognized revenues in the second quarter of 2007. Prior to the second quarter of 2007, we were a development stage company. We have been engaged in research and product development since our inception in late 2002. Our Sensei Robotic Catheter System, or Sensei system, and our corresponding disposable Artisan catheter received FDA clearance in May 2007 for commercialization to facilitate manipulation, positioning and control of certain mapping catheters during electrophysiology procedures. We also received the CE Mark in Europe for our Sensei system in September 2006, for our Artisan catheter in May 2007, for our Lynx catheter in September 2010, for our Magellan Robotic System in July 2011 and for our NorthStar Robotic Catheter in September 2011. As of December 31, 2011, we have also received regulatory approvals related to our Sensei system in Russia, Thailand, Taiwan, Australia and India. The future success of our business will depend on our ability to design and obtain regulatory approval for new products, manufacture and assemble our current and future products in sufficient quantities in accordance with applicable regulatory requirements and at lower costs, increase product sales and successfully support and service our products, all of which we may be unable to do. We have a limited history of operations upon which you can evaluate our business and our operating expenses have increased significantly. Our lack of a significant operating history also limits your ability to make a comparative evaluation of us, our products and our prospects. If we are unable to successfully operate our business, our business and financial condition will be harmed.
We have incurred substantial losses since inception and anticipate that we will incur continued losses through at least the next year, we may not be able to raise additional financing to fund future losses and we may not be able to continue to operate as a going concern.
We have experienced substantial net losses since our inception in late 2002. As of December 31, 2011, we had an accumulated deficit of $274.8 million. We have funded our operations to date principally from the sale of our securities and through issuance of debt. In 2008, we both issued equity and entered into a new debt facility and, in 2009 and 2010, we issued additional equity. In 2011, we issued equity and entered in a new debt facility. In order to meet our anticipated cash requirements, we may seek to sell additional equity or debt securities, enter into additional collaborative, licensing or other arrangements or enter into debt or other credit facilities. If we seek additional funding in the future by selling additional equity or debt securities or entering into debt or credit facilities, such additional funding may result in substantial dilution to existing stockholders, may contain unfavorable terms or may not be available on any terms. Volatility in the global financial and credit markets may limit our ability to raise additional funds. We cannot guarantee that future equity or debt financing will be available in amounts or on terms acceptable to us, if at all. Further, even if financing is available, the cost to us
may be significantly higher than in the past. We will continue to face significant challenges if conditions in the financial markets do not improve or continue to worsen. In particular, our ability to access the capital markets and raise funds required for our operations may be severely restricted at a time when we would like, or need, to do so, which could have an adverse effect on our ability to meet our current and future funding requirements and on our flexibility to react to changing economic and business conditions. This could leave us without adequate financial resources to fund our operations as presently conducted or as we plan to conduct them in the future. If adequate funds are not available, we may be required to adopt additional cost-cutting measures, including additional reductions in its work force, reducing the scope of, delaying or eliminating some or all of our planned research, development and commercialization activities and/or reducing marketing, customer support or other resources devoted to our products. Also, we could be required to license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize ourselves or on terms that are less attractive than they might otherwise be. Any of these factors could materially harm our business and may negatively impact our ability to continue to operate as a going concern.
We expect to incur substantial additional net losses for at least the next year as we continue our development and commercialization efforts on our Magellan Robotic System and NorthStar Robotic Catheter, continue our manufacturing, marketing and sales operations to commercialize our products and seek additional regulatory clearances. We expect our reported research and development expenses to increase in 2012 as compared to 2011 levels as we will not receive reimbursements from Philips in 2012 as we did in 2011. Because we may not be successful in significantly increasing sales of our products, the extent of our future losses and the timing of achieving sustained profitability are highly uncertain, and we may never achieve sustained profitable operations. If we require more time than we expect to generate significant revenue and achieve sustained profitability, we may not be able to continue our operations. Even if we achieve significant revenues, we may never become profitable on a sustained basis or we may choose to pursue a strategy of increasing market penetration and presence at the expense of profitability.
If Philips is unable to develop or license new products or applications for the FOSSL technology, or such products are not commercially viable, we may not realize the full benefits of our agreements with Philips which would harm our results of operations and could delay and or impair our ability monetize that technology.
The realization of the full potential benefits of our agreements with Philips, including the receipt of any of the up to $78.0 million in future payments associated with the successful commercialization by Philips or its collaborators of products containing the FOSSL technology, requires the development of new products and applications of technology that are subject to design, engineering and manufacturing challenges, potential safety and regulatory issues that could delay, suspend or terminate clinical studies, regulatory approvals or sales, and our reliance on third parties to develop, obtain regulatory approval for, manufacture, market and sell products containing FOSSL technology. Approximately two-thirds of the up to $78.0 million of potential future payments could arise from Philips’ sublicensing the FOSSL technology, but Philips has no obligations to do so. Under certain circumstances, we have the right to reacquire certain of the rights licensed to Philips for an amount which in the aggregate would be greater than the upfront payment amounts received by us from Philips in connection with the agreements related to the FOSSL technology, however, there can be no assurance that we would have the capital resources to exercise such rights or that we could find another commercial partner or develop commercially such technologies. In addition, Philips’ sales of products containing the FOSSL technology could be sufficient to result in our not having any rights to reacquire any of the rights licensed to Philips, yet too low to result in any royalty payments to us. If any of these events occurred, we would be unable to realize the full financial benefits of our agreements with Philips and may be delayed or unable to monetize the FOSSL technology in other areas, harming our research and development efforts and adversely affecting our business.
We may be unable to complete our clinical trial for the treatment of atrial fibrillation or other future trials, or we may experience significant delays in completing our clinical trials, which could prevent or delay regulatory approval of our Sensei system for expanded uses and impair our financial position.
We have received IDE approval to investigate the use of our Artisan catheter in the treatment of atrial fibrillation in a clinical study designed to support the expansion of our current labeling in the U.S. beyond mapping. The study will involve approximately 300 patients and involves the treatment of atrial fibrillation. We enrolled our first patient in May 2010. We intend to complete enrollment by the end of 2013, but we may modify the timing of planned enrollment in the future to minimize expenditures. The study includes a seven-day follow-up for safety and a one-year follow-up for efficacy at intervals of 90, 180, and 365 days.
Enrollment of patients in the trial could be delayed for a variety of reasons, including:
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reaching agreement on acceptable terms with prospective clinical trial sites;
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obtaining additional institutional review board approval to conduct the trial at prospective sites; and
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obtaining sufficient patient enrollment, which is a function of many factors, including the size of the patient population, the nature of the protocol, the willingness of patients to randomize to manual catheter control or participate in a clinical trial, the proximity of patients to clinical sites and the eligibility criteria for the trial.
In addition, the completion of the trial, and any future clinical trials, could be delayed, suspended or terminated for several reasons, including:
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ongoing discussions with regulatory authorities regarding the scope or design of our preclinical results or clinical trial or requests for supplemental information with respect to our preclinical results or clinical trial results;
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our failure or inability to conduct the clinical trials in accordance with regulatory requirements;
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sites participating in the trial may drop out of the trial, which may require us to engage new sites or petition the FDA for an expansion of the number of sites that are permitted to be involved in the trial;
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patients may not enroll in, remain in or complete the clinical trial at the rates we expect;
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patients in either the control or test arm of the trial may experience serious adverse events or side effects during the trial, which, whether or not related to our products, could cause the FDA or other regulatory authorities to place the clinical trial on hold; and
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clinical investigators may not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices.
If our clinical trials are delayed it will take us longer to commercialize a product for the treatment of atrial fibrillation and generate revenues from such product. Moreover, our development costs will increase if we have material delays in our clinical trials or if we need to perform more or larger clinical trials than planned.
Even if we complete our trial for the treatment of atrial fibrillation or other clinical trials, these trials may not produce results that are sufficient to support approval of a PMA or 510(k) application.
We will consider our Sensei system to be effective if the trial for the treatment of atrial fibrillation demonstrates non-inferiority to manual control of the NaviStar Thermocool catheter, but there is a risk that, even if we achieve our trial endpoints, the FDA may not approve our Sensei system for use in the treatment of atrial fibrillation. In addition, there is a risk that the FDA may require us to conduct a larger or longer clinical trial, submit additional follow-up data, or engage in other costly and time consuming activities that may delay the FDA’s approval of the Sensei system for use in atrial fibrillation. Although we plan to file a 510(k) application based on data from our trial for the use of Sensei system in the treatment of atrial fibrillation, the FDA may
require a us to file a PMA, which is more time consuming and costly. If our clinical trials fail to produce sufficient data to support a PMA or 510(k) application, it will take us longer to ultimately commercialize a product for the treatment of atrial fibrillation, or any other intended treatment, and generate revenue or the delay could result in our being unable to do so. Moreover, our development costs will increase if we need to perform more or larger clinical trials than planned.
Even if we obtain the necessary regulatory approvals, our efforts to commercialize our systems for atrial fibrillation or vascular disease, we may not succeed or may encounter delays which could significantly harm our ability to generate revenue.
Even if we obtain U.S. regulatory approval to market our Sensei system for uses other than mapping electrophysiology procedures, such as for the treatment of atrial fibrillation, or our Magellan Robotic System for the treatment of vascular disease, our ability to generate revenue will depend upon the successful commercialization of our Sensei system and our Magellan Robotic System for such indications. Our efforts to commercialize our Sensei system or our Magellan Robotic System may not succeed for a number of reasons, including:
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our systems may not be accepted in the marketplace for other treatments by physicians;
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we may not be able to sell our systems and associated catheters at prices that allow us to meet the revenue targets necessary to generate revenue necessary to achieve profitability;
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we, or the investigators of our products, may not be able to have information on the outcome of the trials published in medical journals;
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the availability and perceived advantages and disadvantages of alternative treatments;
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any rapid technological change may make our products obsolete;
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we may not be able to have our systems or catheters manufactured in commercial quantities or at an acceptable cost;
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we may not have adequate financial or other resources to complete the development and commercialization of our systems; and
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we may be sued for infringement of intellectual property rights and could be enjoined from manufacturing or selling our products.
If we are not successful in the commercialization of our Sensei system for uses other than for mapping in electrophysiology procedures or the development and commercialization of our Magellan Robotic System, we may never achieve sustained profitability and may be forced to cease operations.
We have a debt facility with Oxford Finance LLC and Silicon Valley Bank that requires us to meet certain restrictive covenants that may limit our operating flexibility.
On December 8, 2011 we entered into a $30.0 million loan and security agreement with Oxford Finance LLC, or Oxford, Silicon Valley Bank and Oxford as the collateral agent, or Collateral Agent, with $20.0 million of the loan provided by Oxford and $10.0 million provided by Silicon Valley Bank. We are obligated to pay interest only on the loan through December 31, 2012, provided that the interest only period will be extended through June 30, 2013 if we receive approval from the U.S. Food and Drug Administration for our Magellan Robotic System prior to December 31, 2012. We will make payments on the loan through January 1, 2016. At our option, we may prepay all of the outstanding principal balance, subject to a pre-payment fee of (a) 3.00% of the principal amount of the loan then outstanding if our prepayment is made on before the second anniversary of funding the loan or (b) 1.50% of the principal amount of the loan then outstanding if our prepayment is made after the second anniversary of funding the loan. The loan is collateralized by substantially all of our assets now
owned or hereafter acquired, other than our intellectual property, and all proceeds and products thereof, and we agreed to a negative pledge on our intellectual property. Two of our wholly-owned subsidiaries, AorTx, Inc. and Hansen Medical International, Inc., entered into an Unconditional Guaranty and a Security Agreement with the Collateral Agent pursuant to which they guaranteed our obligations under the loan with a first priority security interest in their assets, excluding such subsidiaries’ intellectual property. We additionally agreed to pledge to Oxford and Silicon Valley Bank shares of each of our direct and indirect subsidiaries as collateral for the loan. We are also subject to certain affirmative and negative covenants, including a requirement to maintain a certain level of liquidity. The loan also limits our ability to do any of the following:
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undergo certain change of control events;
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convey, sell, lease, transfer, assign or otherwise dispose of certain of our assets;
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create, incur, assume, or be liable with respect to certain indebtedness;
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grant certain liens;
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pay dividends and make certain other restricted payments;
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make certain investments;
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make payments on any subordinated debt;
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enter into transactions with any of our affiliates outside of the ordinary course of business; or permit our subsidiaries to do the same.
In addition, subject to certain exceptions, we are required to maintain with SVB our primary deposit accounts, securities accounts and commodities, and to do the same for each of our domestic subsidiaries.
As of December 31, 2011, we were in compliance with all financial covenants. In the event we were to violate any covenants or if Oxford or Silicon Valley Bank believes that we have violated any covenants, and such violations are not cured pursuant to the terms of the loan and security agreement, we would be in default under the loan and security agreement, which would entitle Oxford or Silicon Valley Bank to exercise their remedies, including the right to accelerate the debt, upon which we may be required to repay all amounts then outstanding under the loan and security agreement. Complying with these covenants may make it more difficult for us to successfully execute our business strategy.
Credit, financial market and general economic conditions could delay or prevent potential customers from purchasing our products, which would adversely affect our sales, financial condition and results of operation.
The sale of our systems often represents a significant capital purchase for our customers and many customers finance their purchase of our systems through a credit facility or other financing. If prospective customers that need to finance their capital purchases are not able to access the credit or capital markets on terms that they consider acceptable, they may decide to postpone or cancel a potential purchase of one of our systems. Potential customers with limited capital budgets may decide to spend those dollars on other technologies rather than on our products. Also, even customers with sufficient financial resources to make such purchases without resorting to the credit and capital markets may be less likely to make capital purchases during periods when they view the overall economic conditions unfavorably or with uncertainty. Many potential customers have delayed making a decision to purchase a Sensei system, which has significantly impacted our sales, financial condition and results of operations. We believe that the macroeconomic environment and the deterioration in confidence and spending in the United States and, increasingly, in Europe, have impacted and will continue to impact potential customers and their decisions to purchase our products into the foreseeable future. We cannot predict the timing, strength or duration of any economic slowdown or subsequent recovery, whether worldwide, regional or specific to our industry, nor the extent of its potential impact on our future sales, financial condition and results of operations.
We have limited sales, marketing and distribution experience and capabilities, which could impair our ability to achieve sustained profitability.
In the second quarter of 2007, we received clearance to market, sell and distribute our Sensei system for use in the mapping of electrophysiology procedures in the United States and Europe. We had no prior experience as a company in undertaking these efforts. We received CE Mark to market, sell and distribute our Magellan Robotic System in Europe in the third quarter of 2011. In the United States, we market our Sensei system and Artisan catheter through a direct sales force of regional sales employees, supported by clinical sales representatives who provide training, clinical support and other services to our customers. Our direct sales force competes against the experienced and well-funded sales organizations of our competitors. Our revenues will depend largely on the effectiveness of our sales force. We face significant challenges and risks related to our direct sales force and the marketing of our current and future products, including, among others:
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the ability of sales personnel to obtain access to or persuade adequate numbers of hospitals to purchase our system and catheters or physicians to use our system and catheters;
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our ability to retain, properly motivate, recruit and train adequate numbers of qualified sales and marketing personnel;
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the costs associated with an independent sales and marketing organization, hiring, maintaining and expanding an independent sales and marketing organization; and
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our ability to promote our products effectively while maintaining compliance with government regulations and labeling restrictions with respect to the healthcare industry.
Outside the United States, primarily in the European Union, we are establishing a combination of a direct sales force and distributors to market, sell and support our current and future products. If we fail to select and maintain appropriate distributors, appropriately disengage from unsuccessful distributors or effectively use our distributors or sales personnel and coordinate our efforts for distribution of our systems and catheters in the European Union or if their and our sales and marketing strategies are not effective in generating sales of our system, our revenues would be adversely affected and we may never become profitable on a sustained basis.
We have limited experience in manufacturing and assembling our products and may encounter problems at our manufacturing facilities or otherwise experience manufacturing delays that could result in lost revenue or diminishing margins.
We do not have significant experience in manufacturing, assembling or testing our current products on a commercial scale. In addition, for our Sensei system and Magellan Robotic System, we subcontract the manufacturing of major components and complete the final assembly and testing of those components in-house. We face challenges in order to produce our Sensei system and disposable catheters effectively, to appropriately phase in new products such as the Magellan Robotic System and product designs, to efficiently utilize our manufacturing facility and to achieve planned manufacturing cost reductions. These challenges include equipment design and automation, material procurement, low or variable production yields on Artisan catheters and quality control and assurance. The costs resulting from these challenges and our relocation to a larger facility have had and will continue to have a significant impact on our gross margins and may result in significant fluctuations of gross margins from quarter to quarter. We may not successfully complete required manufacturing changes or planned improvements in manufacturing efficiency on a timely basis or at all. For example, as we were increasing our manufacturing capacity for Artisan catheters, we shipped a limited number in late 2007 and early 2008 that were later identified as having a potential leak. Although no patient is known or suspected to have experienced any consequences associated with this possible leak nor has it significantly impacted our business, these events were reported to the FDA in accordance with applicable regulations and we subsequently initiated a voluntary recall of the affected devices. This recall was closed in June 2008. Also, following the introduction of a new catheter in the fall of 2009, some of the new catheters experienced a leak in the flush assembly. Although no patient is known or suspected to have experienced any consequences associated with the new catheters, we
voluntarily recalled all of the catheters and reported the events to the FDA in accordance with applicable regulations. Subsequently, we returned to our prior design of the flush assembly. Any catheter redesign or other manufacturing issues may result in our being unable to meet the expected demand for our Artisan catheters or our Sensei system, maintain control over our expenses or otherwise successfully manage our manufacturing capabilities. If we are unable to satisfy demand for our Sensei system, Artisan catheters, Magellan Robotic System or NorthStar Robotic Catheter our ability to generate revenue could be impaired and hospitals may instead purchase, or physicians may use, our competitors’ products. Since our Sensei system and Magellan Robotic System require the use of disposable Artisan catheters and NorthStar Robotic Catheters, respectively, our failure to meet demand for catheters from hospitals that have purchased our systems could adversely affect the market acceptance of our products and damage our commercial reputation.
In addition, all of our operations are conducted at our facilities leased in Mountain View, California. We could encounter problems at these facilities, which could delay or prevent us from manufacturing, assembling or testing our products or maintaining our manufacturing capabilities or otherwise conducting operations.
Our reliance on third-party manufacturers and on suppliers, and in one case, a single-source supplier, could harm our ability to meet demand for our products in a timely manner or within budget, and could cause harm to our business and financial condition.
We depend on third-party manufacturers to produce most of the components of our Sensei system and other current products, and have not entered into formal agreements with several of these third parties. We also depend on various third-party suppliers for various components we use in our Sensei systems and for our catheters and sheaths. For example, Force Dimension Sàrl, a single-source supplier, manufactures customized motion controllers that are a part of our Sensei system and Magellan Robotic System. We also obtain the motors for our Sensei system and Magellan Robotic System from a single supplier, Maxon Motor AG, from whom we purchase on a purchase order basis, and we generally do not maintain large volumes of inventory. Additionally, in October 2007, we entered into a purchase agreement with Plexus Services Corp., or Plexus, under which Plexus will manufacture certain components for us in quantities determined by a non-binding forecast and by purchase orders.
Our reliance on third parties involves a number of risks, including, among other things, the risk that:
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suppliers may fail to comply with regulatory requirements or make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in or prevent shipments of our products;
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we may not be able to respond to unanticipated changes and increases in customer orders;
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we may be subject to price fluctuations due to a lack of long-term supply arrangements for key components with our suppliers;
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we may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of our systems and other products;
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our suppliers manufacture products for a range of customers, and fluctuations in demand for products these suppliers manufacture for others may affect their ability to deliver components to us in a timely manner;
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our suppliers may wish to discontinue supplying goods or services to us;
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we may not be able to find new or alternative components for our use or reconfigure our system and manufacturing processes in a timely manner if the components necessary for our system become unavailable; and
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our suppliers may encounter financial hardships unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements.
If any of these risks materialize, it could significantly increase our costs and impact our ability to meet demand for our products.
In addition, if these manufacturers or suppliers stop providing us with the components or services necessary for the operation of our business, we may not be able to identify alternative sources in a timely fashion. Any transition to alternative manufacturers or suppliers or a decision to discontinue our relationship with a current manufacturer or supplier could result in operational problems, increased expenses or write-down of capitalized assets that would adversely affect operating results and could delay the shipment of, or limit our ability to provide, our products. We cannot assure you that we would be able to enter into agreements with new manufacturers or suppliers on commercially reasonable terms on a timely basis or at all. Additionally, obtaining components from a new supplier may require qualification of a new supplier in the form of a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume purchasing components for inclusion in our products. Any disruptions in product supply may harm our ability to generate revenues, lead to customer dissatisfaction, damage our reputation and result in additional costs or cancellation of orders by our customers. We currently purchase a number of the components for our Sensei system in foreign jurisdictions. Any event causing a disruption of imports, including the imposition of import restrictions, could adversely affect our business and our financial condition.
If we fail to maintain necessary FDA clearances and CE marks for our medical device products, or if future clearances or approvals are delayed, we will be unable to commercially distribute and market our products.
The process of seeking regulatory clearance or approval to market a medical device is expensive and time-consuming and clearance or approval is never guaranteed and, even if granted, clearance or approval may be suspended or revoked. In May 2007, we received FDA clearance in the United States to commercialize our Sensei system and Artisan catheters only to facilitate manipulation, positioning and control, for collecting electrophysiological data within the heart atria with electro-anatomic mapping and recording systems. Because the FDA has determined that there is a reasonable likelihood that our products could be used by physicians for uses not encompassed by the scope of the present FDA clearance and that such uses may cause harm, we are required to label our products to state that their safety and effectiveness for use with cardiac ablation catheters in the treatment of cardiac arrhythmias including atrial fibrillation have not been established. Accordingly, the scope of the current label may be an obstacle to our ability to successfully market and sell our products in the United States to a broader group of potential customers. We will be required to seek a separate 510(k) clearance or PMA approval to market our Sensei system for uses other than those currently cleared by the FDA. We cannot assure you that the FDA would not impose a more burdensome level of premarket review on other intended uses or modifications to approved products. We plan to seek future approval of our Sensei system for other indications, including atrial fibrillation and other cardiac ablation procedures. We have received IDE approval to investigate the use of our Artisan catheter in the treatment of atrial fibrillation in a clinical study designed to support the expansion of our current labeling in the U.S. beyond mapping. The study will involve approximately 300 patients and involves the treatment of atrial fibrillation. We enrolled our first patient in May 2010. We intend to complete enrollment by the end of 2013, although we may modify the timing of planned enrollment in the future to minimize expenditures. The study will include a seven-day follow-up for safety and a one-year follow-up for efficacy at intervals of 90, 180, and 365 days. We cannot assure the timing or potential for success of those efforts.
As noted above, we submitted a 510(k) pre-market notification application with the FDA on April 11, 2011 for our Vascular System. On September 7, 2011, we received a letter from the FDA responding to our application. The FDA’s initial response requested additional information but did not request additional clinical cases and did not raise questions regarding the 510(k) pathway for the device. On February 6, 2012, we responded to the FDA’s questions which response included the results of additional pre-clinical testing.
With regard to our Sensei system, our Magellan Robot System, or other products, the FDA can delay, limit or deny clearance of a 510(k), or PMA approval, for many reasons, including:
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our inability to demonstrate safety or effectiveness to the FDA’s satisfaction;
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the data from our preclinical studies and clinical trials may be insufficient to support approval;
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the facilities of our third-party manufacturers or suppliers may not meet applicable requirements;
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our compliance with preclinical, clinical or other regulations;
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our inability to meet the FDA’s statistical requirements or changes in statistical tests or significance levels the FDA requires for approval of a medical device, including ours; and
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changes in the FDA approval policies, expectations with regard to the type or amount of scientific data required or adoption of new regulations may require additional data or additional clinical studies.
Furthermore, in order to market our products outside of the United States, we will need to establish and comply with the numerous and varying regulatory requirements of other countries regarding safety and efficacy. We received the CE Mark in Europe for our Sensei system in September 2006, for our Artisan catheters in May 2007, for our Lynx catheters in September 2010, for our Magellan Robotic System in July 2011 and for our NorthStar Robotic Catheter and related accessories designed for use with the Magellan System in September 2011, but may be required to seek separate clearances from the European Union in order to market our products for any additional uses. Regulatory approvals may be difficult and costly to achieve, or may not be granted at all. If we are unable to maintain our regulatory clearances and obtain future clearances for our products, our financial condition and cash flow may be adversely affected, and our ability to grow domestically and internationally may be limited.
If physicians and hospitals do not believe that our Sensei system and Artisan catheters are a viable alternative to existing mapping technologies used in atrial fibrillation and other cardiac ablation procedures, or if they do not believe that our Magellan Robotic System and NorthStar Robotic Catheter are a viable alternative for vascular diseases, they may choose not to use our products.
We believe that physicians will not use, and hospitals will not purchase, our systems unless they determine that they provide a safe and effective alternative to existing treatments. Since we have received FDA clearance to market our Sensei system and disposable Artisan catheters only for guiding catheters to map the heart anatomy, we will not be able to label or promote these products, or train physicians, for use in guiding catheters for cardiac ablation until such clearance or approval is obtained. Currently, there is only limited clinical data on our Sensei system with which to assess its safety and efficacy in any procedure, including atrial fibrillation and other cardiac ablation procedures. A number of recent studies have been published on the efficacy, safety and efficiency of our products, especially by comparison to manual techniques. While we believe many of those studies have demonstrated the benefits of our products, some of these studies have been cited by our competitors to portray our products in an unfavorable light. A number of additional studies are underway both in the United States and Europe assessing the clinical experience with our products and continuing to compare usability and success of treatment between procedures performed with our Sensei system and manual technique. If these studies, or other clinical studies performed by us or others, or clinical experience indicate that procedures with our Sensei system or the type of procedures that can be performed with the Sensei system are not effective or safe for such uses, physicians may choose not to use our Sensei system. For example, one study reported a statistically insignificant higher rate of major complications for patients treated with our system than those treated manually and one patient in the robotic arm of the study died. This study or other studies may create a perception that our system is not as effective and/or safe as manual technique. Reluctance by physicians to use our Sensei system or to perform procedures enabled by the Sensei system would harm sales. Furthermore, we are commencing the commercializing our Magellan Robotic System and NorthStar Robotic Catheter for the treatment of vascular diseases, but there is very little clinical data for the system’s safety and efficacy. Reluctance by physicians to use our Magellan Robotic System or to perform procedures enabled by the Magellan Robotic System would harm these sales. Further, unsatisfactory patient outcomes or patient injury in either of our major products could cause
negative publicity for our products, particularly in the early phases of product introduction. In addition, physicians may be slow to adopt our products if they perceive liability risks arising from the use of these new products. It is also possible that as our products become more widely used, latent or other defects could be identified, creating negative publicity and liability problems for us, thereby adversely affecting demand for our products. If physicians do not adopt the use of our products in their practices, we likely will not become profitable on a sustained basis and our business will be harmed.
In addition, our research and development efforts and our marketing strategy depend heavily on obtaining support and collaboration from highly regarded physicians at leading hospitals. If we are unable to gain or maintain such support and collaboration, our ability to market our Sensei system and Magellan Robotic System and, as a result, our business and results of operations, could be harmed.
Until other products are developed and receive regulatory approval and clinical acceptance, we expect to derive substantially all of our revenues from sales of our Sensei system and our catheters, in addition to our recently-introduced Magellan Robotic System and NorthStar Robotic Catheter. If hospitals do not purchase our system, we may not generate sufficient revenues to continue our operations.
Our initial commercial offering consisted primarily of two products, our Sensei system and our corresponding disposable Artisan catheters. The Sensei system has been supplemented by an optional CoHesion Module and, in the third quarter of 2010, we introduced our Lynx catheter in Europe. In order for us to achieve sales, hospitals must purchase our Sensei system and Artisan and Lynx catheters. We also received the CE Mark in Europe for our Magellan Robotic System in July 2011 and for the NorthStar Robotic Catheter and related accessories designed for use with the Magellan system in September 2011. Our products have been newly introduced to the market and hospitals are traditionally slow to adopt new products and treatment practices. In addition, our systems are an expensive capital equipment purchase, representing a significant portion of an electrophysiology or vascular laboratory’s annual budget, and the disposable catheters used with our systems are also expensive. In addition, because we have shipped only slightly more than 100 Sensei systems and our Magellan Robotic System has only recently been commercially introduced, our systems have limited product and brand recognition. Furthermore, particularly in this period of economic volatility and uncertainty, we do not believe hospitals will purchase our products unless the physicians at those hospitals express a strong desire to use our products and we cannot predict whether or not they will do so. If hospitals do not widely adopt our Sensei system or Magellan Robotic System, or if they decide that our systems are too expensive to purchase or operate, we may never achieve significant revenue or become profitable. Such a failure to adequately sell our Sensei system or Magellan Robotic System would have a materially detrimental impact on our business, results of operations and financial condition.
We may incur significant liability if it is determined that we are promoting off-label use of our products in violation of federal and state regulations in the United States or elsewhere.
We have received FDA clearance of our Sensei system and Artisan catheters only to facilitate manipulation, positioning and control for collecting electrophysiological data within the heart atria with two specified mapping catheters, which is a critical step in the identification of the heart tissue generating abnormal heart rhythms that may require ablation or other treatment. Because the FDA has determined that there is a reasonable likelihood that physicians may choose to use our products off-label, and that harm may result, we are required to label our products to state that their safety and effectiveness for use with cardiac ablation catheters in the treatment of cardiac arrhythmias including atrial fibrillation have not been established. We have commenced a clinical trial for the use of our Sensei system and Artisan catheter with an ablation catheter in the treatment of atrial fibrillation as part of our process to expand our current labeling in the U.S. beyond mapping. Thus, efforts are underway to eventually seek regulatory clearance for the use of our Sensei system in atrial fibrillation procedures. We may subsequently seek regulatory clearance for use of our Sensei system for use with other catheters. The future of our electrophysiology business will depend primarily on the use of our Sensei system in
the treatment of atrial fibrillation and other cardiovascular procedures, for which we do not yet, and may never, have FDA clearance or approval.
Unless and until we receive regulatory clearance or approval for use of our Sensei system with ablation catheters or in these procedures, uses in these procedures will be considered off-label uses of our Sensei system. Under the Federal Food, Drug, and Cosmetic Act and other similar laws, we are prohibited from labeling or promoting our products, or training physicians, for such off-label uses. This prohibition means that the FDA could deem it unlawful for us to make claims about the safety or effectiveness of our Sensei system for use with ablation catheters and in cardiac ablation procedures and that we may not proactively discuss or provide information or training on the use of our product in cardiac ablation procedures or use with unapproved catheters, with very limited exceptions. We presently believe that to date, substantially all of the procedures in which our products have been used in the United States have included off-label uses such as cardiac ablation, for which our Sensei system and Artisan catheters have not been cleared by the FDA.
The FDA and other regulatory agencies actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance or approval has not been obtained. Moreover, scrutiny of such practices by the FDA and other federal agencies has recently increased. Promotional activities for FDA regulated products of other companies have been the subject of enforcement action brought under healthcare reimbursement laws and consumer protection statutes. A company that is found to have improperly promoted off-label uses may be subject to significant liability, including civil and administrative remedies under the Federal False Claims Act and various other federal and state laws, as well as criminal sanctions.
Due to these legal constraints, our U.S. sales and marketing efforts focus on the general technical attributes and benefits of our Sensei system and the use of this device with the two mapping catheters that are identified in our FDA-cleared label. If we are perceived not to be in compliance with all of the restrictions limiting the promotion of our products for off-label use, we could be subject to various enforcement measures, including investigations, administrative proceedings and federal and state court litigation, which would likely be costly to defend and harmful to our business. If the FDA or another governmental authority ultimately concludes we are not in compliance with such restrictions, we could be subject to significant liability, including civil and administrative remedies, injunctions against sales for off-label uses, significant monetary and punitive penalties and criminal sanctions, any or all of which would be harmful to our business and in certain instances may cause us to have to cease operations.
The training required for physicians to use our Sensei system and Magellan Robotic System could reduce the market acceptance of our system and reduce our revenue.
It is critical to the success of our sales efforts to ensure that there are a sufficient number of physicians familiar with, trained on and proficient in the use of our Sensei system and Magellan Robotic System. Convincing physicians to dedicate the time and energy necessary for adequate training in the use of our systems is challenging, and we cannot assure you that we will be successful in these efforts.
It is our policy to train U.S. physicians to only insert, navigate, map and remove catheters using our Sensei system. Physicians must obtain training elsewhere to learn how to ablate cardiac tissue to treat atrial fibrillation, which is an off-label procedure with our Sensei system. This training may be provided in the U.S. by third parties, such as hospitals and universities and through independent peer-to-peer training among doctors. We cannot assure you that a sufficient number of U.S. physicians will become aware of training programs or that physicians will dedicate the time, funds and energy necessary for adequate training in the use of our system. Additionally, we will have no control over the quality of these training programs. If physicians are not properly trained, they may misuse or ineffectively use our products. This may result in unsatisfactory outcomes, patient injury, negative publicity or lawsuits against us, any of which could negatively affect our reputation and sales of our products. Furthermore, our inability to educate and train U.S. physicians to use our Sensei system for cardiac
ablation procedures may lead to inadequate demand for our products and have a material adverse impact on our business, financial condition and results of operation.
Training in the use of our products by U.S. physicians is regulated by the FDA. We monitor our training to ensure that off-label use is not promoted or enabled. However, from time to time, we may sponsor third party training. There is a risk that independent peer-to-peer interaction between physicians and other third party training may include discussion or observation of off-label procedures because most procedures performed to date using the Sensei system involve both mapping and cardiac ablation. If any such activities are attributed to us, the FDA or other governmental entities could conclude that we have engaged in off-label promotion of our products, which could subject us to significant liability.
Because our markets are highly competitive, customers may choose to purchase our competitors’ products, which would result in reduced revenue and harm our financial results.
Our Sensei system is still considered a new technology and must compete with established manual interventional methods and methods of our competitors, such as Stereotaxis, Inc., in remote navigation. Conventional manual methods are widely accepted in the medical community, have a long history of use and do not require the purchase of additional, expensive capital equipment. The Stereotaxis Niobe® system, which has been in the market since 2003, four years earlier than our Sensei system, has been adopted by a number of leading clinicians. Similarly, our Magellan Robotic System is a new technology and must compete with established manual interventional techniques. In addition, many of the medical conditions that can be treated using our products can also be treated with existing drugs or other medical devices and procedures. Many of these alternative treatments are widely accepted in the medical community and have a long history of use.
We also face competition from companies that are developing drugs or other medical devices or procedures to treat the conditions for which our products are intended. The medical device and pharmaceutical industries make significant investments in research and development and innovation is rapid and continuous. If new products or technologies emerge that provide the same or superior benefits as our products at equal or lesser cost, they could render our products obsolete or unmarketable. We cannot be certain that physicians will use our products to replace or supplement established treatments or that our products will be competitive with current or future products and technologies.
Most of our competitors enjoy several competitive advantages over us, including:
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significantly greater name recognition;
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longer operating histories;
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established relations with healthcare professionals, customers and third-party payors;
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established distribution networks;
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additional lines of products, and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage;
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greater experience in conducting research and development, manufacturing, clinical trials, obtaining regulatory clearance for products and marketing approved products; and
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greater financial and human resources for product development, sales and marketing, and patent litigation.
In addition, as the markets for medical devices develop, additional competitors could enter the market. As a result, we cannot assure you that we will be able to compete successfully against existing or new competitors. Our revenues would be reduced or eliminated if our competitors develop and market products that are more effective and less expensive than our products.
We expect to continue to experience extended and variable sales cycles, which could cause significant variability in our results of operations for any given quarter.
Our systems have a lengthy sales cycle because they involve a relatively expensive capital equipment purchase, which generally requires the approval of senior management at hospitals, inclusion in the hospitals’ budget process for capital expenditures and, in some instances, a certificate of need from the state or other regulatory clearance. We continue to estimate that this sales cycle may take between six and 18 months. Beginning with the fourth quarter of 2008 and continuing through 2011, in a period of economic uncertainty, we have seen sales cycles for many potential customers lengthen and purchase decisions postponed. Additionally, the majority of our revenue is shipped in the last weeks of a given quarter. Any disruption in our supply chain during those critical weeks or an inability to fulfill our deliverables during that compressed time frame could significantly impact the timing of our ability to recognize revenue on those items. These factors have contributed in the past and may contribute in the future to substantial fluctuations in our quarterly operating results, particularly in the near term and during any other periods in which our sales volume is relatively low. As a result, in future quarters our operating results could differ from our announcements of guidance regarding future operating or financial results or may fail to meet the expectations of securities analysts or investors, in which event our stock price would likely decrease. These fluctuations also mean that you will not be able to rely upon our operating results in any particular period as an indication of future performance. In addition, the introduction of new products such as our Magellan Robotic System and NorthStar Robotic Catheter could adversely impact our sales cycle, as customers take additional time to assess the benefits of new investments in capital products.
The use of our products could result in product liability claims that could be expensive, divert management’s attention and harm our reputation and business.
Our business exposes us to significant risks of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices. Moreover, the FDA has expressed concerns regarding the safety and efficacy of our Sensei system for ablation and other therapeutic indications, including for the treatment of atrial fibrillation and has specifically instructed that our products be labeled to inform our customers that the safety and effectiveness of our technology for use with cardiac ablation catheters in the treatment of cardiac arrhythmias, including for atrial fibrillation, have not been established. We presently believe that to date, all of the procedures in which our products have been used in the United States have included off-label uses such as cardiac ablation, for which our Sensei system and Artisan catheters have not been cleared by the FDA and which therefore could increase the risk of product liability claims. The medical device industry has historically been subject to extensive litigation over product liability claims. We may be subject to claims by consumers, healthcare providers, third-party payors or others selling our products if the use of our products were to cause, or merely appear to cause, injury or death. Any weakness in training and services associated with our products may also result in product liability lawsuits. Although we maintain clinical trial liability and product liability insurance, the coverage is subject to deductibles and limitations, and may not be adequate to cover future claims. Additionally, we may be unable to maintain our existing product liability insurance in the future at satisfactory rates or adequate amounts. A product liability claim, regardless of its merit or eventual outcome could result in:
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decreased demand for our products;
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injury to our reputation;
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diversion of management’s attention;
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withdrawal of clinical trial participants;
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significant costs of related litigation;
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payment of substantial monetary awards to patients;
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product recalls or market withdrawals;
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loss of revenue; and
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the inability to commercialize our products under development.
We may be unable to complete the development and commercialization of our existing and anticipated products without additional funding.
Our operations have consumed substantial amounts of cash since inception. We expect to continue to spend substantial amounts on research and development. We expect to spend significant additional amounts on the continuing commercialization of our products and the development and introduction of new products. In particular, we have recently begun commercialization in Europe of a new robotic system to be used in endovascular applications, are seeking U.S. regulatory approvals for the system and are continuing development of a next generation version of the system. We expect to spend considerable amounts in the development and commercialization of this device and in obtaining regulatory approval. In 2011, net cash used in operating activities was $36.4 million, which included $9.0 million received from Philips associated with the amended extended joint development agreement. We expect that our cash used in operations will be significant in each of the next several years, and we will need additional funds to continue the commercialization of both our Sensei system and our Magellan Robotic System in addition to ongoing product expansions.
Additional financing may not be available on a timely basis on terms acceptable to us, or at all. Furthermore, even if financing becomes available, the cost to us may be significantly higher than in the past. Any additional financing may be dilutive to stockholders or may require us to grant a lender a security interest in our intellectual property assets. The amount of funding we will need will depend on many factors, including:
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the success of our research and product development efforts;
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the expenses we incur in selling and marketing our products;
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the costs and timing of future regulatory clearances;
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the revenue generated by sales of our current and future products;
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the gross margins generated by our revenues and cost of sales;
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the rate of progress and cost of our clinical trials and other development activities;
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the emergence of competing or complementary technological developments;
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the cost of legal fees relating to shareholder lawsuits and government investigations;
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the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, or participating in litigation-related activities;
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the terms and timing of any collaborative, licensing or other arrangements that we may establish; and
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the acquisition of businesses, products and technologies.
If adequate funds are not available, we may have to delay development or commercialization of our products or license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. We also may have to reduce marketing, customer support or other resources devoted to our products. Any of these factors could harm our financial condition.
Our products and related technologies can be applied in different applications, and we may fail to focus on the most profitable areas or we may be unable to address successfully financial and technology risks associated with new applications, including applications for the vascular market.
The technology underlying our systems is designed to have the potential for applications beyond electrophysiology and vascular disease which require a control catheter to approach diseased tissue. We further believe that the technology underlying our system can provide multiple opportunities to improve the speed and
capability of many diagnostic and therapeutic procedures. We will be required to seek a separate 510(k) clearance or PMA approval from the FDA for these applications of our technology. However, we have limited financial and managerial resources and therefore may be required to focus on products in selected applications and to forego efforts with regard to other products and industries including expansion of our electrophysiology applications as well as the development of non-electrophysiology applications.
We are dedicating significant resources to the development and commercialization of our Magellan Robotic System, NorthStar Robotic Catheter and associated accessories. These efforts may not produce viable commercial products and may divert our limited resources from more profitable market opportunities. Moreover, we may devote resources to developing products in additional areas but may be unable to justify the value proposition or otherwise develop a commercial market for products we develop in these areas, if any. In that case, the return on investment in these additional areas may be limited, which could negatively affect our results of operations.
If we fail to maintain collaborative relationships with providers of imaging and visualization technology on terms favorable to us, or at all, our Sensei system may not be able to gain market acceptance and our business may be harmed.
Our success depends on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. We believe that integrating our Sensei system with key imaging and visualization technologies using an open architecture approach is a key element in establishing our Sensei system as important for complex interventional procedures. Our Sensei system currently utilizes a variety of imaging means to visualize and assist in navigating our catheters. These imaging systems include fluoroscopy, intravascular ultrasound and electro-anatomic mapping systems, as well as pre-operatively acquired three-dimensional computed tomography and magnetic resonance imaging. We believe that in the future, as imaging companies develop increasingly sophisticated three-dimensional imaging systems, we will need to integrate advanced imaging into our Sensei system in order to compete effectively. There can be no assurance that we can timely and effectively integrate these systems or components into our Sensei system in order to remain competitive. We expect to face competition from companies that are developing new approaches and products for use in interventional procedures and that have an established presence in the field of interventional cardiology, including the major imaging, capital equipment and disposables companies that are currently selling products in the electrophysiology laboratory. We may not be able to acquire or develop three-dimensional imaging and visualization technology for use with our Sensei system. In addition, developing or acquiring key imaging and visualization technologies could be expensive and time-consuming and may not integrate well with our Sensei system. If we are unable to timely acquire, develop or integrate imaging and visualization technologies, or any other changing technologies, effectively, our revenue may decline and our business will suffer.
In April 2007, we entered into agreements with St. Jude Medical, Inc., or St. Jude, to integrate our Sensei system with St. Jude’s Ensite system and to co-market the integrated product. We are not obligated to undertake any other development projects except for the integration of the Sensei system with the EnSite system. We are solely responsible for gaining regulatory approvals for, and all costs associated with, our portion of the integrated products developed under the arrangement. At the end of the second quarter of 2008, the FDA cleared for marketing in the United States our CoHesion Module, which provides an interface between our Sensei system and the EnSite system; however, there can be no assurance that we will successfully maintain necessary regulatory clearances or that we and St. Jude will maintain compatibility of our products under the collaboration or that the CoHesion Module will gain market acceptance. In August, 2010, we entered into an agreement with St. Jude permitting us to integrate St. Jude’s EnSite Velocity Cardiac Mapping System with our CoHesion Module to provide physicians the ability to visualize, locate and robotically control catheters within the heart to diagnose heart rhythm disorders.
Future acquisitions could disrupt our business and harm our financial condition and operating results.
Our success will depend, in part, on our ability to expand our offerings and markets and grow our business in response to changing technologies, customer demands and competitive pressures. In some circumstances, we may determine to do so through the acquisition of complementary businesses, solutions or technologies rather than through internal development. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be able to successfully complete identified acquisitions. Furthermore, even if we successfully complete an acquisition, we may not be able to successfully assimilate and integrate the business, technologies, solutions, personnel or operations of the company that we acquired, particularly if key personnel of an acquired company decide not to work for us. In addition, we may issue equity securities to complete an acquisition, which would dilute our stockholders’ ownership and could adversely affect the price of our common stock. Acquisitions may also involve the entry into geographic or business markets in which we have little or no prior experience. Consequently, we may not achieve anticipated benefits of the acquisitions which could harm our operating results.
Software defects may be discovered in our products.
Our systems incorporate sophisticated computer software. Complex software frequently contains errors, especially when first introduced. Because our products are designed to be used to perform complex interventional procedures, we expect that physicians and hospitals will have an increased sensitivity to the potential for software and other defects. We cannot assure you that our software will not experience errors or performance problems in the future. If we experience software errors or performance problems, we would likely also experience:
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loss of revenue;
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an increase in reportable adverse events to applicable authorities such as the FDA;
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delay in market acceptance of our products;
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damage to our reputation;
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additional regulatory filings;
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product recalls;
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increased service or warranty costs; and/or
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product liability claims relating to the software defects.
Our costs could substantially increase if we receive a significant number of service claims.
We typically provide post-contract customer service for each of our products against defects in materials and workmanship for a period of approximately 12 months from the delivery or acceptance of our product by a customer which is normally when the system is installed. The associated expenses are charged to cost of revenues as incurred. We have a very limited history of commercial placements from which to judge our rate of claims against our service contracts. Our obligation under these service contracts may be impacted by product failure rates, material usage and service costs. Unforeseen exposure under these post-contract customer service contracts could negatively impact our business, financial condition and results of operations.
Hospitals or physicians may be unable to obtain coverage or reimbursement from third-party payors for procedures using our Sensei system and Magellan Robotic System, which could affect the adoption or use of our systems and may cause our revenues to decline.
We anticipate that third-party payors will continue to reimburse hospitals and physicians under existing billing codes for the vast majority of the procedures involving our products. We expect that healthcare facilities
and physicians in the United States will continue to bill various third-party payors, such as Medicare, Medicaid, other governmental programs and private insurers, for services performed using our products. We believe that procedures targeted for use with our products are generally already reimbursable under government programs and most private plans. Accordingly, we believe providers in the United States will generally not be required to obtain new billing authorizations or codes in order to be compensated for performing medically necessary procedures using our products on insured patients.
There can be no assurance, however, that coverage, coding and reimbursement policies of third-party payors will not change in the future with respect to some or all of the procedures that would use our systems. Additionally, in the event that a physician uses our Sensei system or Magellan Robotic System for indications not approved by the FDA, there can be no assurance that the coverage or reimbursement policies of third-party payors will be comparable to FDA-approved uses. Future legislation, regulation or coverage, coding and reimbursement policies of third-party payors may adversely affect the demand for our products currently under development and limit our ability to profitably sell our products. For example, in prior years, certain recent regulatory changes were made to the methodology for calculating payments for inpatient procedures in certain hospitals, resulting in a decrease to Medicare payment rates for surgical and cardiac procedures, including those procedures for which our products are targeted. The majority of the procedures performed with our Sensei system and Artisan catheter are done on an in-patient basis and thus are paid under the Medicare-severity diagnosis related group, or MS-DRG system.
We believe that the majority of procedures performed using our Sensei technology fall under MS-DRG 251, percutaneous cardiovascular procedures without coronary artery stent or acute myocardial infarction without major cardiovascular complication. The Centers for Medicare & Medicaid Services update the MS-DRG payment rates annually effective October 1 through September 30 of the following year. Because hospital inpatient reimbursement is largely dependent on geographical location and other hospital-specific factors, an individual hospital’s revenues from ablation procedures to treat atrial fibrillation using our technology can vary significantly. At this time, although payments for these cardiac procedures have not undergone further reductions, we cannot predict the full impact any future rate changes, including rate reductions, will have on our revenues or business. We do not currently know which MS-DRG code or codes will be used for procedures performed with our Magellan Robotic System or whether reimbursement amounts will be considered favorable by hospitals.
Our success in international markets also depends upon the eligibility of our products for coverage and reimbursement by government-sponsored healthcare payment systems and third-party payors. Recent legislative proposals in the United States to reform healthcare and government insurance programs have included a focus on healthcare costs which could limit the coverage and reimbursement for procedures utilizing our products. In both the United States and foreign markets, healthcare cost-containment efforts are prevalent and are expected to continue and may increase. The failure of our customers to obtain sufficient reimbursement could have a material adverse impact on our financial condition and harm our business.
Legislative reforms to the United States healthcare system may adversely affect our revenues and business.
From time to time, legislative reform measures are proposed or adopted that would impact healthcare expenditures for medical services, including the medical devices used to provide those services. For example, in March 2010, U.S. President Barack Obama signed the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act, collectively referred to as the Affordable Care Act, which makes a number of substantial changes in the way health care is financed by both governmental and private insurers. Among other things, the Affordable Care Act requires certain medical device manufacturers and importers to pay an excise tax equal to 2.3% of the price for which such medical devices are sold, beginning January 1, 2013. We cannot assure you that the Affordable Care Act, as currently enacted or as amended in the future, will not adversely affect our business and financial results, and we cannot predict how future federal or state legislative or administrative changes relating to healthcare reform will affect our business.
Government and private sector initiatives to limit the growth of health care costs, including price regulation, competitive pricing, coverage and payment policies, comparative effectiveness of therapies, technology assessments, and managed-care arrangements, are continuing. Government programs, including Medicare and Medicaid, private health care insurance and managed-care plans have attempted to control costs by limiting the amount of reimbursement they will pay for particular procedures or treatments, tying reimbursement to outcomes, and other mechanisms designed to constrain utilization and contain costs. Hospitals are also seeking to reduce costs through a variety of mechanisms, which may increase price sensitivity among customers for our products, and adversely affect sales, pricing, and utilization of our products. Some third-party payors must also approve coverage for new or innovative devices or therapies before they will reimburse health care providers who use the medical devices or therapies. We cannot predict the potential impact of cost-containment trends on future operating results.
We have incurred substantial management and employee turnover and we may lose additional key personnel or fail to attract and retain additional personnel needed for us to operate our business effectively.
In January 2012, our Vice President of Marketing and Business Development resigned, in December 2011, our Vice President of Legal Affairs resigned, in May 2011, our Senior Vice President of Regulatory and Chief Technology Officer resigned, in January 2011, our Vice President of U.S. Commercial Operations resigned and in October 2010, our Senior Vice President of Operations resigned. We hired a new Vice President of Clinical Affairs and Training in October 2010, a new Vice President of Engineering in November 2010, a new Vice President of U.S. Commercial Operations in April 2011, a new Chief Financial Officer in June 2011 and a new Vice President and General Counsel in January 2012. If we are unable to recruit qualified individuals in a timely manner, our product development and commercialization efforts could be materially delayed or be unsuccessful. Additionally, in the third quarter of 2008 and the first and third quarters of 2009, we reduced our work force and we may undertake additional actions to reduce our work force in the future. These reductions in force may make it more difficult to retain and attract the qualified personnel required, placing a significant strain on our management. Accordingly, retaining such personnel and recruiting necessary new employees in the future will be critical to our success. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. If we fail to identify, attract, retain and motivate these highly skilled management and personnel, we may be unable to continue our development and commercialization activities and our business will be harmed.
We are highly dependent on the principal members of our management and scientific staff. We do not carry “key person” insurance covering any members of our senior management. Each of our officers and key employees may terminate his employment at any time without notice and without cause or good reason. The loss of any of these persons could prevent the implementation and completion of our objectives, including the development and introduction of our products, and could require the remaining management members to direct immediate and substantial attention to seeking a replacement.
If we do not effectively manage our growth, we may be unable to successfully develop, market and sell our products.
Our future revenue and operating results will depend on our ability to manage the possible future growth of our business. We have experienced periods of significant growth in the scope of our operations. This growth has placed significant demands on our management, as well as our financial and operations resources. In order to achieve our business objectives, however, we will need to continue to grow, which presents numerous challenges, including:
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implementing appropriate operational and financial systems and controls;
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expanding manufacturing capacity, increasing production and improving margins;
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developing our sales and marketing infrastructure and capabilities;
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identifying, attracting and retaining qualified personnel in our areas of activity; and
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training, managing and supervising our personnel worldwide.
Any failure to effectively manage our growth could impede our ability to successfully develop, market and sell our products and our business will be harmed.
We sell our systems internationally and are subject to various risks relating to such international activities which could adversely affect our international sales and operating performance.
A portion of our current and future revenues will come from international sales. To expand internationally, we will need to hire, train and retain additional qualified personnel. Engaging in international business inherently involves a number of difficulties and risks, including:
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required compliance with existing and changing foreign regulatory requirements and laws;
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export or import restrictions and controls relating to technology;
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pricing pressure;
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laws and business practices favoring local companies;
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longer payment cycles;
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shipping delays;
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difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;
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political and economic instability;
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potentially adverse tax consequences, tariffs and other trade barriers;
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international terrorism and anti-American sentiment;
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difficulties in penetrating markets in which our competitors’ products are more established;
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difficulties and costs of staffing and managing foreign operations; and
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difficulties in enforcing intellectual property rights.
If one or more of these risks are realized, it could require us to dedicate significant resources to remedy the situation, and if we are unsuccessful at finding a solution, our revenue may decline.
Our financial results are subject to currency fluctuations as a result of our international operations which could decrease our revenues.
In 2011, approximately 53% of our total revenues were generated outside the United States. While most of these revenues were denominated in U.S. dollars, approximately 20% of our total revenues were generated in other currencies. We translate results of transactions denominated in local currencies into U.S. dollars using market conversion rates applicable to the period in which the transaction is reported. As a result, changes in exchange rates during a period can unpredictably and adversely affect our consolidated operating results and our asset and liability balances, even if the underlying value of the item in its original currency has not changed. A hypothetical 10% increase in the United States dollar exchange rate used would have resulted in a decrease of approximately $452,000 in revenues for 2011.
Our business may be harmed by a natural disaster, terrorist attacks or other unanticipated problems.
Our manufacturing and office facilities are located in Mountain View, California. Despite precautions taken by us, a natural disaster such as fire or earthquake, a terrorist attack or other unanticipated problems at our facilities could interrupt our ability to manufacture our products or operate our business. These disasters or
problems may also destroy our product inventories. While we carry insurance for certain natural disasters and business interruption, any prolonged or repeated disruption or inability to manufacture our products or operate our business could result in losses that exceed the amount of coverage provided by this insurance, and in such event could harm our business.
We may be liable for contamination or other harm caused by materials that we handle, and changes in environmental regulations could cause us to incur additional expense.
Our research and development, manufacturing and clinical processes involve the handling of potentially harmful biological materials as well as other hazardous materials. We are subject to federal, state and local laws and regulations governing the use, handling, storage and disposal of hazardous and biological materials and we incur expenses relating to compliance with these laws and regulations. If violations of environmental, health and safety laws occur, we could be held liable for damages, penalties and costs of remedial actions. These expenses or this liability could have a significant negative impact on our financial condition. We may violate environmental, health and safety laws in the future as a result of human error, equipment failure or other causes. Environmental laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with violations. We are subject to potentially conflicting and changing regulatory agendas of political, business and environmental groups. Changes to or restrictions on permitting requirements or processes, hazardous or biological material storage or handling might require an unplanned capital investment or relocation. Failure to comply with new or existing laws or regulations could harm our business, financial condition and results of operations.
Changes to existing accounting pronouncements or taxation rules or practices may affect how we conduct our business and affect our reported results of operations.
Significant new accounting pronouncements and taxation rules or practices and updated interpretations of existing accounting pronouncements and taxation rules or practices have occurred in the past and may occur in the future. A change in accounting pronouncements or taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. In addition, a review of existing or prior accounting practices may result in a change in previously reported amounts. For example, the FASB has recently issued new accounting principles around revenue recognition and the SEC is considering adoption of international financial reporting standards. These changes to existing rules, future changes, if any, or the questioning of current practices may adversely affect our reported financial results or the way we conduct our business.
Risks Related to Our Intellectual Property
If we are unable to protect the intellectual property contained in our products from use by third parties, our ability to compete in the market will be harmed.
Our commercial success will depend in part on obtaining patent and other intellectual property protection for the technologies contained in our products, and on successfully defending our patents and other intellectual property against third party challenges. We expect to incur substantial costs in obtaining patents and, if necessary, defending our proprietary rights. The patent positions of medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions. We do not know whether we will be able to obtain the patent protection we seek, or whether the protection we do obtain will be found valid and enforceable if challenged. We also do not know whether we will be able to develop additional patentable proprietary technologies. If we fail to obtain adequate protection of our intellectual property, or if any protection we obtain is reduced or eliminated, others could use our intellectual property without compensating us, resulting in harm to our business. We may also determine that it is in our best interests to voluntarily challenge a third party’s products or patents in litigation or administrative proceedings, including patent interferences or reexaminations. In the event that we seek to enforce any of our owned or exclusively licensed patents against an infringing party, it is likely that the party
defending the claim will seek to invalidate the patents we assert, which, if successful could result in the loss of the entire patent or the relevant portion of our patent, which would not be limited to any particular party. Any litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Our competitors may independently develop similar or alternative technologies or products without infringing any of our patent or other intellectual property rights, or may design around our proprietary technologies.
We cannot assure you that we will obtain the patent protection we seek, that any protection we do obtain will be found valid and enforceable if challenged or that such patent protection will confer any significant commercial advantage. United States patents and patent applications may also be subject to interference proceedings and United States patents may be subject to reexamination proceedings and, starting in 2012, post grant and inter partes review in the United States Patent and Trademark Office, and foreign patents may be subject to opposition or comparable proceedings in the corresponding foreign patent offices, which proceedings could result in either loss of the patent or denial of the patent application, or loss or reduction in the scope of one or more of the claims of, the patent or patent application. In addition, such interference, reexamination, post grant review, inter partes review, and opposition proceedings may be costly. Some of our technology was, and continues to be, developed in conjunction with third parties, and thus there is a risk that such third parties may claim rights in our intellectual property. Thus, any patents that we own or license from others may provide limited or no protection against competitors. Our pending patent applications, those we may file in the future, or those we may license from third parties, may not result in patents being issued. If issued, they may not provide us with proprietary protection or competitive advantages against competitors with similar technology.
Non-payment or delay in payment of patent fees or annuities, whether intentional or unintentional, may result in loss of patents or patent rights important to our business. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as do the laws of the United States, particularly in the field of medical products and procedures.
Our trade secrets, nondisclosure agreements and other contractual provisions to protect unpatented technology provide only limited and possibly inadequate protection of our rights. As a result, third parties may be able to use our unpatented technology, and our ability to compete in the market would be reduced. In addition, employees, consultants and others who participate in developing our products or in commercial relationships with us may breach their agreements with us regarding our intellectual property, and we may not have adequate remedies for the breach.
Third parties may assert that we are infringing their intellectual property rights which may result in litigation.
Successfully commercializing our Sensei system, our Magellan Robotic System and any other products we may develop, will depend in part on our not infringing patents held by third parties. It is possible that one or more of our products, including those that we have developed in conjunction with third parties, infringes existing patents. From time to time, we have received, and likely will continue to receive, communications from third parties inviting us to license their patents or accusing us of infringement. There can be no assurance that a third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief, to bar the manufacture and sale of our Sensei system in the United States or elsewhere or the sale of our Magellan system in Europe. We may also choose to defend ourselves by initiating litigation or administrative proceedings to clarify or seek a declaration of our rights. As competition in our market grows, the possibility of a patent infringement claim against us or litigation we will initiate increases.
There may be existing patents which may be broad enough to cover aspects of our future technology. In addition, because patent applications in many countries such as the United States are maintained under conditions of confidentiality and can take many years to issue, there may be applications now pending of which we are unaware and which may later result in issued patents that our products infringe. We do not know whether any of these patents, if challenged, would be upheld as valid, enforceable and infringed by our products or technology. From time to time, we receive, and likely will continue to receive, letters from third parties accusing us of infringing their patents or inviting us to license their patents. We may be sued by, or become involved in an administrative proceeding with, one or more of these or other third parties. We cannot assure you that a court or administrative body would agree with any arguments or defenses we may present concerning the invalidity, unenforceability or noninfringement of any third-party patent. In addition to the issued patents of which we are aware, other parties may have filed, and in the future are likely to file, patent applications covering products that are similar or identical to ours. We cannot assure you that any patents issuing from applications will not cover our products or will not have priority over our own products and patent applications.
We may not be able to maintain or obtain all the licenses from third parties necessary or advisable for promoting, manufacturing and selling our Sensei system and our Magellan Robotic System, which may cause harm to our business, operations and financial condition.
We rely on technology that we license from others, including technology that is integral to our Sensei system and our Magellan Robotic System, such as patents and other intellectual property that we have co-exclusively licensed from Intuitive. Under our agreement with Intuitive, we received the right to apply Intuitive’s patent portfolio in the field of intravascular approaches for the diagnosis or treatment of cardiovascular, neurovascular and peripheral vascular diseases. To the extent that we develop or commercialize robotic capability outside the field of use covered by our license with Intuitive, which we may choose to do at some time in the future, we may not have the patent protection and the freedom to operate outside the field which is afforded by the license inside the field. Although we believe that there are opportunities for us to operate outside the licensed field of use without using Intuitive’s intellectual property, Intuitive from time to time has told us that it believes certain of our past activities that have fallen outside the licensed field have infringed its intellectual property rights. Although we disagree with Intuitive’s position, we presently remain focused within our licensed field and so have agreed to inform Intuitive before commencing any further outside clinical investigations for endoluminal applications or engaging in external technology exhibitions at non-intravascular conferences. There can be no assurance that Intuitive will not challenge any activities we engage in outside the intravascular space, and we cannot assure you that in the event of such a challenge we would be able to reach agreement with Intuitive on whether activities outside our licensed field may be conducted without the use of the Intuitive’s intellectual property. If Intuitive asserts that any of our activities outside the licensed field are infringing their patent or other intellectual property rights or commences litigation against us, we will incur significant costs defending against such claims or seeking an additional license from Intuitive, and we may be required to limit use of our systems or future products and technologies within our licensed intravascular field if any of our activities outside the licensed field are judged to infringe Intuitive’s intellectual property, any of which could cause substantial harm our business, operations and financial condition. Although Intuitive is restricted in how it can terminate our license, if Intuitive were ever to successfully do so, and if we are unable to obtain another license from Intuitive, we could be required to abandon use of our existing product technology completely and could have to undergo a substantial redesign and design-around effort, which we cannot assure you would be successful.
The medical device industry is characterized by patent litigation and we could become subject to litigation that could be costly, result in the diversion of management’s attention, require us to pay damages and discontinue selling our products.
The medical device industry is characterized by frequent and extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often difficult to predict, and the outcome may be
uncertain until the court has entered final judgment and all appeals are exhausted. Our competitors may assert, and have asserted in the past, that our products or the use of our products are covered by United States or foreign patents held by them. This risk is heightened due to the numerous issued and pending patents relating to the use of robotic and catheter-based procedures in the medical technology field. For example, we have received correspondence from a third party indicating it believes it holds a patent that our Sensei system may infringe. While we do not believe that the Sensei system infringes this patent, there can be no assurance that the third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief, to bar the manufacture and sale of our Sensei system in the United States.
If relevant patents are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our system unless we can obtain a license to use technology or ideas covered by such patent or are able to redesign our products to avoid infringement. A license may not be available at all or on commercially reasonable terms, and we may not be able to redesign our products to avoid infringement. Modification of our products or development of new products could require us to conduct additional clinical trials and to revise our filings with the FDA and other regulatory bodies, which would be time-consuming and expensive. If we are not successful in obtaining a license or redesigning our products, we may be unable to sell our products and our business could suffer. In addition, our patents may be subject to various invalidity attacks, such as those based upon earlier filed patent applications, patents, publications, products or processes, which might invalidate or limit the scope of the protection that our patents afford.
Infringement actions, validity challenges and other intellectual property claims and proceedings, whether with or without merit, may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our business and harm our reputation. We have incurred, and expect to continue to incur, substantial costs in obtaining patents and expect to incur substantial costs defending our proprietary rights. Incurring such costs could have a material adverse effect on our financial condition, results of operations and cash flow.
We cannot be certain that we will successfully defend our patents from infringement or claims of invalidity or unenforceability, or that we will successfully defend against allegations of infringement of third-party patents. In addition, any public announcements related to litigation or administrative proceedings initiated or threatened by us, or initiated or threatened against us, could cause our stock price to decline.
We may be subject to damages resulting from claims that our employees or we have wrongfully used or disclosed alleged trade secrets of their former employers.
Many of our employees were previously employed at universities or other medical device companies, including our competitors or potential competitors. We could in the future be subject to claims that these employees, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies or features that are important or essential to our products would have a material adverse effect on our business, and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial costs and be a distraction to management. Incurring such costs could have a material adverse effect on our financial condition, results of operations and cash flow.
Additional Risks Related to Regulatory Matters
If we fail to obtain regulatory clearances in other countries for existing products or products under development, we will not be able to commercialize these products in those countries.
In order to market our products outside of the United States, we must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA clearance. The regulatory approval process in other countries may include all of the risks detailed above regarding FDA clearance in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects described above regarding FDA clearance in the United States.
For example, the European Union requires that medical products receive the right to affix the CE mark. The CE mark is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. In order to obtain the right to affix the CE mark to our products, we will need to obtain certification that our processes meet European quality standards. These standards include certification that our product design and manufacturing facility complies with ISO 13485 quality standards. We received CE mark approval for our Artisan catheters in May 2007, our Lynx catheters in September 2010, our Magellan Robotic System in July 2011 and our NorthStar Robotic Catheter and related accessories designed for use with the Magellan system in September 2011. We cannot be certain that we will be successful in meeting European quality standards or other certification requirements.
We may fail to comply with continuing postmarket regulatory requirements of the FDA and other authorities and become subject to substantial penalties, or marketing experience may show that our device is unsafe, forcing us to recall or withdraw it permanently from the market.
We must comply with continuing regulation by the FDA and other authorities, including the FDA’s Quality System Regulation, or QSR, requirements, labeling and promotional requirements and medical device adverse event and other reporting requirements. If the adverse event reports we file with the FDA regarding death, serious injuries or malfunctions indicate or suggest that the device presents an unacceptable risk to patients, including when used off-label by physicians, we may be forced to recall the device and/or modify the device or its labeling, or withdraw it permanently from the market. The FDA has expressed concerns regarding the safety of the device when used with catheters and in procedures not specified in the indication we are seeking, such as ablation catheters and ablation procedures, and we have already filed Medical Device Reports reporting adverse events during procedures utilizing our technology. Physicians are using our device off-label with ablation catheters in ablation procedures, as well as in other electrophysiology procedures for which we have not collected safety data, and we therefore cannot assure you that clinical experience will demonstrate that the device is safe for these uses.
Any failure to comply, or any perception that we are not complying, with continuing regulation by the FDA or other authorities, including restrictions regarding off-label promotion, could result in enforcement action that may include suspension or withdrawal of regulatory clearances or approvals, recalling products, ceasing product marketing, seizure and detention of products, paying significant fines and penalties, criminal prosecution and similar actions that could limit product sales, delay product shipment and harm our profitability.
In many foreign countries in which we market our products, we are subject to regulations affecting, among other things, product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of these regulations are similar to those of the FDA. In addition, in many countries the national health or social security organizations require our products to be qualified before procedures performed using our products become eligible for coverage and reimbursement. Failure to receive, or
delays in the receipt of, relevant foreign qualifications could have a material adverse effect on our business, financial condition and results of operations. Due to the movement toward harmonization of standards in the European Union, we expect a changing regulatory environment in Europe characterized by a shift from a country-by-country regulatory system to a European Union-wide single regulatory system. The timing of this harmonization and its effect on us cannot currently be predicted. Adapting our business to changing regulatory systems could have a material adverse effect on our business, financial condition and results of operations. If we fail to comply with applicable foreign regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory clearances, product recalls, seizure of products, operating restrictions and criminal prosecution.
If we or our contract manufacturers fail to comply with the FDA’s Quality System Regulations or California Department of Health Services requirements, our manufacturing operations could be interrupted and our product sales and operating results could suffer.
Our manufacturing processes, and those of some of our contract manufacturers, are required to comply with the FDA’s Quality System Regulations, or QSR, which cover the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces the QSR through periodic inspections of manufacturing facilities. We and our contract manufacturers are subject to such inspections. If our manufacturing facilities or those of any of our contract manufacturers fail to take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take enforcement action, including any of the following sanctions, which could have a material impact on our operations:
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untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;
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unanticipated expenditures to address or defend such actions;
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customer notifications for repair, replacement, refunds;
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recall, detention or seizure of our products;
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operating restrictions or partial suspension or total shutdown of production;
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refusing or delaying our requests for 510(k) clearance or premarket approval of new products or modified products;
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operating restrictions;
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withdrawing 510(k) clearances or IDE/PMA approvals that have already been granted;
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refusal to grant export approval for our products; or
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criminal prosecution.
We underwent an FDA inspection, which employed QSIT, in July 2010 and received two inspectional observations. The agency has accepted our responses and the inspection has been closed.
We are subject to the licensing requirements of the California Department of Health Services, or CDHS. We have been inspected and licensed by the CDHS and remain subject to re-inspection at any time. Failure to maintain a license from the CDHS or to meet the inspection criteria of the CDHS would disrupt our manufacturing processes. If an inspection by the CDHS indicates that there are deficiencies in our manufacturing process, we could be required to take remedial actions at potentially significant expense, and our facility may be temporarily or permanently closed.
If our products cause or contribute to a death or a serious injury, or malfunction in certain ways, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions. An increased frequency of filing Medical Device Reports, or MDRs, concerning adverse events occurring during procedures performed with our technology could result in increased regulatory scrutiny of our products and could delay or prevent the adoption of our products.
Under the FDA medical device reporting regulations, medical device manufacturers are required to report to the FDA when the manufacturer becomes aware of information from any source that alleges that a device marketed by the manufacturer has or may have caused or contributed to a death or serious injury or has malfunctioned in a way that would likely cause or contribute to death or serious injury if the malfunction of the device or one of our similar devices were to recur. A manufacturer may determine that an event may not meet the FDA’s reporting criteria so that an MDR is not necessary. However, the FDA can review a manufacturer’s decision and may disagree. We have made decisions that certain types of events are not MDR reportable. There can be no assurance that the FDA will agree with our decisions. If we fail to report MDRs to the FDA within the required timeframes, or at all, or if the FDA disagrees with any of our determinations that events are not reportable, the FDA could take enforcement action against us. Any such adverse event involving our products also could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results.
We have filed Medical Device Reports, or MDRs, reporting adverse events during procedures utilizing our technology and have developed internal systems and processes that are designed to evaluate future events that may require adverse event reporting to the FDA. As the frequency of use of our technology in electrophysiology procedures increases, we are experiencing, and anticipate continuing to experience, it being necessary to file an increased number of MDRs. An increased frequency of filing MDRs or a failure to timely file MDRs may result in FDA requests for further information, which could delay other matters that we may have pending before the FDA, or result in additional regulatory action. An increased frequency of MDRs could also reduce confidence in the safety of our products and delay or prevent the acceptance of our products by physicians and hospitals, which would harm our business and cause our stock price to decline.
Our products may in the future be subject to product recalls that could harm our reputation, business and financial results.
The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture. In the case of the FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. For example, in May 2008, we initiated a voluntary recall of a limited number of our Artisan Control Catheters that were subject to potential leakage, and reported the recall to FDA in accordance with applicable regulations. No patient is known or suspected to have experienced any consequences associated with the recalled devices and the recall was closed in June 2008. Also, following the introduction of a new catheter in the fall of 2009, some of the new catheters experienced a leak in the flush assembly. Although no patient is known or suspected to have experienced any consequences associated with the new catheters, we voluntarily recalled all of the new catheters and reported the events to the FDA in accordance with applicable regulations. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations. The FDA requires that certain classifications of recalls be reported to FDA within 10 working days after the recall is initiated. Companies are required to maintain certain records of recalls, even if they are not
reportable to the FDA. We may initiate voluntary recalls involving our products in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, they could require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, the FDA could take enforcement action for failing to report the recalls when they were conducted.
Modifications to our products may, and in some instances, will, require new regulatory clearances or approvals and may require us to recall or cease marketing our products until clearances or approvals are obtained.
Modifications to our products may require new regulatory approvals or clearances, including 510(k) clearances or premarket approvals, or PMAs, and may require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. The FDA requires device manufacturers to initially make and document a determination of whether or not modifications require a new approval, supplement or clearance. A manufacturer of a 510(k) cleared product is required to obtain 510(k) clearance for device modifications that could significantly affect the safety or effectiveness of the device, or constitute a major change in the intended use of the subject device. Accordingly, a manufacturer may determine that a modification could not significantly affect safety or efficacy and does not represent a major change in its intended use so that no new 510(k) clearance is necessary. However, the FDA can review a manufacturer’s decision and may disagree. The FDA may also on its own initiative determine that a new clearance or approval is required.
We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. There can be no assurance that the FDA will agree with our approach in such matters or that, if required, subsequent requests for 510(k) clearance will be received in a timely fashion, if at all. The FDA may require us to recall and to stop marketing our products as modified or to disable features pending clearance or approval which would significantly harm our ability to sell our products and cause harm to our existing customer relationships and business. Even if we are not required to take such action, delays in obtaining clearances or approvals for features would adversely affect our ability to introduce enhanced products in a timely manner and would harm our revenue and operating results. The FDA could also take other enforcement action, including but not limited to, issuing a warning letter relating to our decision to implement features and other product modifications without submission of a new 510(k) notice.
Clinical trials necessary to support any future 510(k) or PMA application will be expensive and may require the enrollment of large numbers of clinical sites and patients, and suitable patients may be difficult to identify and recruit. Delays or failures in our clinical trials may prevent us from commercializing any modified or new products and will adversely affect our business, operating results and prospects.
Initiating and completing clinical trials necessary to support a 510(k) or PMA application for expanded indications for use of our existing products, will be time consuming and expensive and the outcome uncertain. Moreover, the results of early clinical trials are not necessarily predictive of future results, and any product we advance into clinical trials may not have favorable results in later clinical trials.
Conducting successful clinical studies may require the enrollment of large numbers of clinical sites and patients, and suitable patients may be difficult to identify and recruit. Patient enrollment in clinical trials and completion of patient participation and follow-up depends on many factors, including the size of the patient population, the nature of the trial protocol, the attractiveness of, or the discomforts and risks associated with, the treatments received by enrolled subjects, the availability of appropriate clinical trial investigators, support staff, and proximity of patients to clinical sites and able to comply with the eligibility and exclusion criteria for participation in the clinical trial and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures or follow-up to assess the safety and effectiveness of our products or if they determine that the treatments received under the trial protocols are not attractive or involve unacceptable risks or discomforts. Patients may
also not participate in our clinical trials if they choose to participate in contemporaneous clinical trials of competitive products. We have received IDE approval for an approximately 300 patient study for the treatment of atrial fibrillation and enrolled our first patient in May 2010. We intend to complete enrollment by the end of 2013. Additionally, we may modify the timing of planned enrollment in the future to minimize expenditures. The study includes a seven-day follow-up for safety and a one-year follow-up for efficacy at intervals of 90, 180, and 365 days.
Development of sufficient and appropriate clinical protocols to demonstrate safety and efficacy may be required and we may not adequately develop such protocols to support clearance or approval. Delays in patient enrollment or failure of patients to consent or continue to participate in a clinical trial may cause an increase in costs and delays in the approval and attempted commercialization of our products or result in the failure of the clinical trial. In addition, despite considerable time and expense invested in our clinical trials, FDA may not consider our data adequate to demonstrate safety and efficacy. Such increased costs and delays or failures could adversely affect our business, operating results and prospects.
If we fail to comply with healthcare laws and regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.
While we do not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, due to the breadth of many healthcare laws and regulations, we cannot assure you that they will not apply to our business. We could be subject to healthcare fraud and patient privacy regulation by both the federal government and the states in which we conduct our business. The regulations that may affect our ability to operate include:
•
the federal healthcare program Anti-Kickback Law, which prohibits, among other things, persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;
•
federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers or whose products are frequently used off-label;
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the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information;
•
federal self-referral laws, such as STARK, which prohibit a physician from making a referral to a provider of certain health services with which the physician or the physician’s family member has a financial interest, and prohibits submission of a claim for reimbursement pursuant to a prohibited referral; and
•
state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.
If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion of our products from reimbursement under Medicare and Medicaid programs and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations
could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, to achieve compliance with applicable federal and state privacy, security, and electronic transaction laws, we may be required to modify our operations with respect to the handling of patient information. Implementing these modifications may prove costly. At this time, we are not able to determine the full consequences to us, including the total cost of compliance, of these various federal and state laws.
Our International Operations expose us to liability under global anticorruption laws.
We are also subject to the U.S. Foreign Corrupt Practices Act, or “FCPA” and similar worldwide anti-bribery laws in non-U.S. jurisdictions which generally prohibit companies and their intermediaries from making improper payments to non-U.S. officials for the purpose of obtaining or retaining business. Because of the predominance of government-sponsored healthcare systems around the world, many of our customer relationships outside of the United States involve governmental entities and are therefore subject to such anti-bribery laws. Our policies mandate compliance with these anti-bribery laws. Despite our training and compliance programs, our internal control policies and procedures may not protect us from negligent, reckless or criminal acts committed by our employees or agents. Moreover, even a perceived or alleged violation could result in costly investigations or proceedings that could harm our financial position and reputation.
The application of state certificate of need regulations and compliance by providers with federal and state licensing requirements, as well as accreditation requirements, could substantially limit our ability to sell our products and grow our business.
Some states require healthcare providers to obtain a certificate of need or similar regulatory approval prior to the acquisition of high-cost capital items such as our Sensei system. In many cases, a limited number of these certificates are available and, as a result, hospitals and other healthcare providers may be unable to obtain a certificate of need for the purchase of our Sensei system. Further, our sales cycle for our system is typically longer in certificate of need states due to the time it takes our customers to obtain the required approvals. In addition, our customers must meet various federal and state regulatory and/or accreditation requirements in order to receive reimbursement from government-sponsored healthcare programs such as Medicare and Medicaid and other third-party payors. Any lapse by our customers in maintaining appropriate licensure, certification or accreditation, or the failure of our customers to satisfy the other necessary requirements under government-sponsored healthcare programs, could cause our sales to decline.
Risks Related to Ownership of Our Common Stock
The trading price of our common stock has been volatile and is likely to be volatile in the future.
The trading price of our common stock has been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in November 2006 through February 29, 2012, our stock price has fluctuated from a low of $1.24 to a high of $39.32. The market price for our common stock may be affected by a number of factors, including:
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the announcement of our operating results, including the number of systems sold during a period and our revenue for the period, and the comparison of these results to the expectations of analysts and investors;
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the receipt, denial or timing of regulatory clearances, approvals or actions of our products or competing products;
•
sales of common stock or other debt or equity securities by us or our stockholders in the future;
•
the success of any collaborations we may undertake with other companies;
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our ability to develop, introduce and market new or enhanced versions of our products on a timely basis;
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additions or departures of key scientific or management personnel;
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the pace of enrollment or results of our 300 patient clinical trial or any other clinical trials;
•
changes in policies affecting third-party coverage and reimbursement in the United States and other countries;
•
ability of our products to achieve market success;
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the performance of third-party contract manufacturers and component suppliers;
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our ability to develop sales and marketing capabilities;
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our ability to manufacture our products to meet commercial and regulatory standards;
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our ability to manage costs and improve margins;
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actual or anticipated variations in our results of operations or those of our competitors;
•
announcements of new products, technological innovations or product advancements by us or our competitors;
•
announcements of acquisitions or dispositions by us or our competitors;
•
developments with respect to patents and other intellectual property rights;
•
disputes or other developments relating to proprietary rights, including patents, litigation matters and our ability to obtain patent protection for our technologies;
•
trading volume of our common stock;
•
our announcements of guidance regarding future operating or financial results which fails to meet investor or analyst expectations or which differs from our previously-announced guidance;
•
changes in earnings estimates or recommendations by securities analysts, failure to obtain analyst coverage of our common stock or our failure to achieve analyst earnings estimates;
•
public statements by analysts or clinicians regarding their perceptions of the effectiveness of our products;
•
developments in our industry;
•
general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors; and
•
the impact of shareholder lawsuits and governmental investigations both on us and on our public perception.
The stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. Following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Additional class action securities litigation, if instituted against us, could result in substantial costs and a diversion of our management resources, which could significantly harm our business.
Securities analysts may not continue, or additional securities analysts may not initiate, coverage for our common stock or may issue negative reports, and this may have a negative impact on the market price of our common stock.
Currently, several securities analysts provide research coverage of our common stock. Several analysts have already published statements that do not portray our technology, products or procedures using our products in a
positive light and others may do so in the future. If we are unable to educate those who publicize such reports about the benefits we believe our technology provides, or if one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline rapidly. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about us or our business. If sufficient securities analysts do not cover our common stock, the lack of research coverage may adversely affect the market price of our common stock. It may be difficult for companies such as ours, with smaller market capitalizations, to attract and maintain sufficient independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.
Our principal stockholders, directors and management own a large percentage of our voting stock, which allows them to exercise significant influence over matters subject to stockholder approval.
Based on our review of publicly available filings as of February 29, 2012, our five largest stockholders collectively owned approximately 36.0 percent of our outstanding common stock. In addition, our executive officers and directors beneficially own or control approximately 10.9 percent of the outstanding shares of our common stock as of February 29, 2012. Accordingly, our principal stockholders and our executive officers and directors have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These stockholders may also delay or prevent a change of control or otherwise discourage a potential acquirer from attempting to obtain control of us, even if such a change of control would benefit our other stockholders. This significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.
We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our common stock.
We have never paid dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as our Board of Directors may consider relevant. If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if our stock price appreciates. Pursuant to our loan agreement with Oxford and Silicon Valley Bank, we must obtain Oxford’s and Silicon Valley Bank’s prior written consent in order to pay any dividends on our common stock.
Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions:
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permit our Board of Directors to issue up to 10,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate, including the right to approve an acquisition or other change in our control;
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provide that the authorized number of directors may be changed only by resolution of the Board of Directors;
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provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;
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divide our Board of Directors into three classes;
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require that any action to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and not be taken by written consent;
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provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide notice in writing in a timely manner, and also specify requirements as to the form and content of a stockholder’s notice;
•
do not provide for cumulative voting rights, therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose;
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provide that special meetings of our stockholders may be called only by the chairman of the Board, our chief executive officer or by the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors; and
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provide that stockholders will be permitted to amend our amended and restated bylaws only upon receiving at least 66 2/3 percent of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.
In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any broad range of business combinations with any stockholder who owns, or at any time in the last three years owned, 15 percent or more of our outstanding voting stock for a period of three years following the date on which the stockholder became an interested stockholder. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders.
Future sales of shares of our common stock, the announcement to undertake such sales, or the perception that they may occur, may depress the market price of our common stock.
Sales of our common stock or securities convertible into or exercisable for our common stock by us or by our stockholders, announcements of the proposed sales of our common stock or securities convertible into or exercisable for our common stock or the perception that sales may be made, could cause the market price of our common stock to decline. We may issue additional shares of our common stock in follow-on offerings to raise additional capital or in connection with acquisitions, corporate alliances or settlements with third parties and we plan to issue additional shares to our employees, directors or consultants in connection with their services to us. All of the currently outstanding shares of our common stock are freely tradable under federal and state securities laws, except for shares held by our directors, officers and certain greater than five percent stockholders, which may be subject to volume limitations. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. Such sales could reduce the market price of our common stock.
Our financial results may vary significantly from period to period, which may reduce our stock price.
Our financial results may fluctuate as a result of a number of factors, many of which are outside of our control, which may cause the market price of our common stock to fall. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our financial results may be negatively affected by any of the risk factors listed in this “Risk Factors” section.
We incur significant costs as a result of operating as a public company, and our management is required to devote substantial time to new compliance initiatives.
As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the United States Securities and Exchange Commission and the Nasdaq Global Market, have imposed various new requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these requirements. Moreover, these rules and regulations increase our legal and financial compliance costs and make some activities more time-consuming and costly.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
We lease approximately 63,000 square feet of manufacturing, laboratory and office space in Mountain View, California. The lease ends in November 2014, but we have an option to extend the lease until approximately November 30, 2019. We also lease approximately 3,300 square feet of office space in London, England. That lease ends in June 2020, but we have an option to exit the lease in 2015.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Following our October 19, 2009 announcement that we would restate certain of our financial statements, a securities class action lawsuit was filed on October 23, 2009 in the United States District Court for the Northern District of California, naming us and certain of our officers. Curry v. Hansen Medical, Inc. et al., Case No. 09-05094. The complaint asserts claims for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of purchasers of Hansen stock between May 1, 2008 and October 18, 2009, inclusive, and alleges, among other things, that defendants made false and/or misleading statements and/or failed to make disclosures regarding our financial results and compliance with GAAP while improperly recognizing revenue; that these misstatements and/or nondisclosures resulted in overstatement of our revenue and financial results and/or artificially inflated our stock price; and that following our October 19, 2009 announcement, the price of our stock declined. On November 4, 2009 and November 13, 2009, substantively identical complaints were filed in the Northern District of California by other purported Hansen stockholders asserting the same claims on behalf of the same putative class of Hansen stockholders. Livingstone v. Hansen Medical, Inc. et al., Case No. 09-05212 and Prenter v. Hansen Medical, Inc., et al., Case No. 09-05367. All three complaints seek certification as a class action and unspecified compensatory damages plus interest and attorneys fees. On December 22, 2009, two purported Hansen stockholders, Mina and Nader Farr, filed a joint application for appointment as lead plaintiffs and for consolidation of the three actions. On February 25, 2010, the Court issued an order granting Mina and Nader Farr’s application for appointment as lead plaintiffs and consolidating the three securities class actions. On July 15, 2010, the Court entered an order granting lead plaintiffs’ motion for leave to file a second amended complaint. Lead plaintiffs’ second amended complaint, in addition to alleging that shareholders suffered damages as a result of the decline in our stock price following the October 19, 2009 announcement, also alleges that shareholders suffered additional damages as the result of share price declines on July 28, 2009, July 31, 2009, January 8, 2009, July 6, 2009, and August 4, 2009, all of which lead plaintiffs allege were caused by the disclosure of what they claim was previously misrepresented information. The defendants filed their motion to dismiss the second amended complaint on October 13, 2010. The Court granted Defendants’ motion to dismiss with leave to amend on August 25, 2011. Plaintiffs’ third amended complaint was filed on October 18, 2011. Defendants filed their motion to dismiss on January 9, 2012. The hearing on Defendants’ motion to dismiss is set for April 19, 2012. We and the named officers intend to defend ourselves vigorously against these actions.
On November 12, 2009, Dawn Cates, a purported stockholder of Hansen, filed a shareholder derivative complaint in the Superior Court of the State of California, County of Santa Clara, against the current members of our Board of Directors and certain of our current and former officers (the “Individual Defendants”), as well as our former independent auditor, PricewaterhouseCoopers LLP (“PwC”). Cates v. Moll, et al., Case No 09cv157170 (the “Cates Action”). The Cates Action purports to be brought on behalf of Hansen. The complaint asserts claims for breach of fiduciary duties and waste of corporate assets against the Individual Defendants, and professional negligence against PwC. The complaint alleges that the Individual Defendants disseminated false and misleading information in our SEC filings, public statements and other disclosures, failed to maintain adequate internal controls and willfully ignored problems with accounting and internal control practices and procedures, mismanaged and failed appropriately to oversee our operations, and wasted corporate assets. The complaint further alleges that the director defendants breached their fiduciary duties by allowing defendant Christopher Sells to resign from Hansen. The complaint seeks unspecified damages, internal control and corporate governance reforms, restitution and an award of costs and fees incurred in bringing the action. A substantively identical complaint (although without any claims against PwC) was filed in Santa Clara Superior Court on November 19, 2009. Daneshmand v. Moll, et al., Case No. 09cv157592 (the “Daneshmand Action”). On December 22, 2009, the Santa Clara Superior Court entered an order consolidating the Cates and Daneshmand Actions and renaming the actions as In re Hansen Medical, Inc. Shareholder Derivative Litigation, Case No. 09cv157170. Plaintiffs designated their operative complaint on August 30, 2010. On November 3, 2010, Cates requested to be dismissed as a named plaintiff and subsequently sent a shareholder demand letter to the Company. The action continued with Daneshmand as the sole named plaintiff. We have reached a settlement of the Cates and Daneshmand Actions, as well as the Brown Action (see below) and the Cates shareholder demand (see below). On January 27, 2012, the Santa Clara Superior Court entered an order preliminarily approving that settlement. The hearing on final approval of the settlement is set for April 6, 2012.
On December 15, 2009, Michael Brown, a purported stockholder of Hansen, filed a shareholder derivative complaint in the United States District Court for the Northern District of California. Brown v. Moll, et al., Case No. 09-05881 (the “Brown Action”). The allegations of complaint in the Brown Action are substantively identical to the allegations of the Cates and Daneshmand Actions (the Brown Action does not name PwC as a defendant). On July 21, 2010, the Court in the Brown Action granted Defendants’ Motion to Dismiss on the ground that Plaintiff had not alleged facts sufficient to establish demand futility. The Court granted Plaintiff leave to amend. Plaintiffs filed their amended complaint on August 9, 2010. On November 12, 2010, the Court granted Defendants’ motion to dismiss, with prejudice. Plaintiff filed a Notice of Appeal on December 13, 2010. Briefing on the appeal is complete, although no hearing date has been set. Following the parties’ settlement agreement, the Ninth Circuit placed the appeal in its mediation program so as to monitor the status of the settlement. Plaintiff will dismiss the appeal upon final approval of the settlement by the Santa Clara Superior Court.
On December 1 and December 14, 2009, we received letters from counsel for purported Hansen stockholders Naoum Baladi and Robert Rogowski demanding that our Board of Directors take action to “remedy breaches of fiduciary duty by the directors and certain officers of Hansen and professional negligence by our outside auditor PricewaterhouseCoopers, LLP.” These letters recite essentially the same allegations as are contained in the Cates Action and demand that our Board take action against the officers and directors, and PwC, to recover damages incurred by us and to correct deficiencies in our internal controls. The letters state that if, within a reasonable time, our Board has not commenced the requested action or if our Board refuses to commence the requested action, the named stockholders will commence derivative actions. On July 9, 2010, we received a letter from counsel for purported Hansen stockholder Kathy Fox demanding that we investigate and bring legal action to remedy “possible breaches of fiduciary duty and other potential violations of law” by certain of our directors, officers and insiders. Our Board, with the assistance of an independent counsel, has completed its investigation regarding the allegations set forth by Baladi, Rogowski and Fox in their letters. Our Board has notified counsel for each of Baladi, Rogowski and Fox that it has determined, in the exercise of its business judgment, that any litigation would not be in our best interests and it affirmatively objects to the commencement of any litigation on our behalf. On January 11, 2011, we received a letter from counsel for purported Hansen
stockholder Dawn Cates demanding that our Board take action to remedy “possible breaches of fiduciary duty and other potential violations of law” by certain of our directors, officers and insiders, and PwC. On January 18, 2011 our Board responded to counsel for Cates, indicating that it has “determined, in the exercise of its business judgment, that any litigation would not be in our best interests, and it affirmatively objects to the commencement of any litigation on our behalf.” As discussed above, we have reached a tentative settlement of the Cates shareholder demand.
On October 6, 2011, the Securities and Exchange Commission (“Commission”) accepted our Offer of Settlement (“Offer”) to resolve a pending investigation by the Commission staff. Pursuant to the settlement, the Company consented to the entry of an administrative order (“Order”) directing us to cease and desist from committing or causing violations of the disclosure, periodic reporting, books and records and internal control provisions of the federal securities laws in Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 (“Securities Act”), Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 (“Exchange Act”) and under Rules 12b-20, 13a-1 and 13a-13 promulgated thereunder. We consented to the entry of the Order without admitting or denying the factual findings or legal conclusions contained in the Order. The Commission did not charge any of our directors or current officers or employees with any violations, and did not seek any penalty or other monetary relief against us. The entry of the Order fully resolves the SEC investigation of us relating to the issues surrounding the restatement.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II.
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market For Our Common Stock
Our common stock is traded on The Nasdaq Global Market under the symbol “HNSN.”
As of February 29, 2012, there were approximately 245 holders of record of our common stock and 60,537,240 shares of common stock outstanding. No dividends have been paid on our common stock to date, and we do not anticipate paying any dividends in the foreseeable future.
The following table lists the low and high sales prices for each period indicated:
The closing price for our common stock as reported by the Nasdaq Global market on February 29, 2012 was $3.19 per share.
Securities Authorized for Issuance Under Equity Compensation Plan
The following table provides certain information regarding our equity compensation plans in effect as of December 31, 2011:
Equity Compensation Plan Information
(1) Includes 4,766,904 shares issuable upon exercise of outstanding options.
(2) Does not take into account restricted stock units, which have no exercise price.
(3) On January 1st of each year, the number of authorized shares under (a) the 2006 Equity Incentive Plan automatically increases by a number of shares equal to the lesser of (i) 3,500,000 shares, (ii) 4% of the outstanding shares on December 31st of the preceding calendar year, and (iii) such other lesser number as
determined by the board of directors and (b) the 2006 Employee Stock Purchase Plan automatically increases by a number of shares equal to the lesser of (i) 2% of the outstanding shares on December 31st of the preceding calendar year, (ii) 750,000 shares of common stock, and (iii) such other lesser number as determined by the board of directors.
(4) Represents options issued to our current CEO and CFO upon the commencement of each of their employment with us. On June 9, 2010 we granted 1,700,000 options to our CEO at the then-current market price with a life of seven years. The shares vest over four years from the date of grant with 12.5% vesting six months from the option grant date and 1/42 of the remaining balance vesting each month thereafter. On June 20, 2011 we granted 360,000 options to our CFO at the then-current market price with a life of seven years. The shares vest over four years from the date of grant with 25% vesting one year from the option grant date and 1/36 of the remaining balance vesting each month thereafter
Recent Sales of Unregistered Securities
In November 2011, we entered into two definitive stock purchase agreements to sell an aggregate of 4,784,690 shares of our common stock for $2.09 per share in a private placement transaction. Pursuant to one purchase agreement, we sold an aggregate of 2,392,345 shares of common stock to Oracle Partners, LP, Oracle Institutional Partners, LP and Oracle Ten Fund Master, LP (collectively, the “Oracle entities”). Pursuant to the other purchase agreement, we sold 2,392,345 shares of common stock to Jack W. Schuler. The Oracle entities and Mr. Schuler were both existing stockholders. The securities were issued pursuant to the exemption from registration provided by Rule 506 of Regulation D, promulgated by the Securities and Exchange Commission (the “SEC”) and, as such, could not be offered or sold in the United States absent registration or an applicable exemption from registration requirements. However, pursuant to the terms of the agreements, we filed a registration statement on Form S-3 with the SEC covering resales of the securities on January 5, 2012.
On December 8, 2011 we entered into a $30.0 million loan and security agreement with Oxford Finance LLC, or Oxford, Silicon Valley Bank and Oxford as the collateral agent with $20.0 million of the loan provided by Oxford and $10.0 million provided by Silicon Valley Bank. As part of the financing, the lenders received warrants to purchase up to an aggregate of 660,793 fully paid and non-assessable shares of our common stock at an exercise price equal to $2.27 per share. These warrants may be exercised on a cashless net exercise basis and will expire seven years from the date of issuance.
Uses of Proceeds from Sale of Registered Securities
Not applicable
Issuer Purchases of Equity Securities
None
Performance Graph1
The following graph shows a comparison of cumulative total return for our common stock, the Nasdaq Composite Index, and the Nasdaq Medical Equipment Index. Such returns are based on historical results and are not intended to suggest future performance. The graph assumes $100 was invested in our common stock and in each of the indexes on December 31, 2006.
Data for the Nasdaq Composite Index and the Nasdaq Medical Equipment Index assume reinvestment of dividends. We have never paid dividends on our common stock and have no present plans to do so.
The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.
This Section is not “soliciting material,” is not deemed “filed” with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Hansen Medical under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain financial data with respect to our business. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-K are forward-looking statements that involve risks and uncertainties. The factors listed in Item 1A “Risk Factors,” as well as any cautionary language in this Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.
Overview
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes thereto included elsewhere in this annual report on Form 10-K.
We develop, manufacture and sell a new generation of medical robotics designed for accurate positioning, manipulation and stable control of catheters and catheter-based technologies. Our Sensei™ Robotic Catheter System, or Sensei system, is designed to allow physicians to instinctively navigate flexible catheters with greater stability and control in interventional procedures. Our Magellan™ Robotic System is designed to allow physicians to instinctively navigate flexible catheters in the vasculature. We believe our systems and the corresponding disposable catheters will enable physicians to perform procedures that historically have been too difficult or time consuming to accomplish routinely with manually-controlled, hand-held catheters and catheter-based technologies, or that we believe could be accomplished only by the most skilled physicians. We believe that our systems have the potential to benefit patients, physicians, hospitals and third-party payors by improving clinical outcomes and permitting more complex procedures to be performed interventionally.
We were formerly known as Autocath, Inc. and were incorporated in Delaware on September 23, 2002. In March 2007, we established Hansen Medical UK Ltd, a wholly-owned subsidiary located in the United Kingdom and, in May 2007, we established Hansen Medical Deutschland, GmbH, a wholly-owned subsidiary located in Germany. Since inception, we have devoted the majority of our resources to the development and commercialization of our Sensei system. Prior to the second quarter of 2007, we were a development stage company with a limited operating history. In the second quarter of 2007 we obtained the necessary regulatory approvals and recorded our initial product revenues. To date, we have incurred net losses in each year since our inception and, as of December 31, 2011, we had an accumulated deficit of $274.8 million. We expect our losses to continue through at least 2012 as we continue to expand the commercialization of our Sensei system, our Magellan Robotic System and our catheters and continue to develop new products. We have financed our operations primarily through the sale of public and private equity securities, the issuance of debt, partnering and the licensing of intellectual property.
We received CE Mark approval for our Sensei system in the fourth quarter of 2006 and made our first commercial shipments to the European Union in the first quarter of 2007. We deferred all revenue associated with those shipped systems as we had not yet received CE Mark approval for our Artisan catheters. In May 2007, we received CE Mark approval for our Artisan catheter and also received FDA clearance for the marketing of our Sensei system and Artisan catheter for manipulation, positioning and control of certain mapping catheters during electrophysiology procedures. As a result, we recorded our first revenues in the second quarter of 2007. We received CE Mark for our Lynx® catheter in September 2010. In July 2011, we received CE Mark for our Magellan Robotic System and received a CE Mark for the NorthStar™ Robotic Catheter and related accessories designed for use with the Magellan system in September 2011.
We market our products in the United States primarily through a direct sales force of regional sales employees, supported by clinical account managers who provide training, clinical support and other services to our customers. Outside the United States, primarily in the European Union, we use a combination of a direct sales force and distributors to market, sell and support our products.
In April 2007, we entered into development and marketing agreements with St. Jude Medical, Inc., or St. Jude. Pursuant to these agreements, we have introduced our CoHesionTM 3D Visualization Module, or CoHesion Module, which integrates our Sensei system with St. Jude’s Ensite® system. Under the agreements, we are solely responsible for obtaining regulatory approvals for, and all costs associated with, our portion of the integrated products developed under the arrangement. In addition, under the terms of the co-marketing agreement, we granted St. Jude the exclusive right to distribute products developed under the joint development agreement when ordered with St. Jude products worldwide, excluding certain specified countries, for the diagnosis and/or treatment of electrophysiologic cardiac conditions. In August, 2010, we entered into an agreement with St. Jude to commercialize new products based on the companies’ complementary technologies for treating patients suffering from heart rhythm disorders. The agreement permits us to integrate St. Jude’s EnSite Velocity Cardiac Mapping System with our CoHesion Module to provide physicians the ability to visualize, locate and robotically control catheters within the heart to diagnose heart rhythm disorders.
In November 2007, we acquired AorTx, Inc., or AorTx, an early stage company developing heart valves to be delivered in minimally invasive surgery by catheters through the skin and blood vessels. We have eliminated the research and development positions focused on developing the AorTx valve technology and in 2009, we entered into an agreement to license the acquired AorTx technologies back to an entity formed by the former AorTx stockholders.
In November 2009, we entered into agreements with Philips Medical Systems Nederland B.V., a Philips Healthcare company, or Philips, to co-develop integrated products that we expect will simplify complex cardiac procedures to diagnose and treat arrhythmias. The agreements are intended to lead to the creation of integrated product solutions by combining Philips’ Allura Xper X-Ray system with our Sensei system. The resulting innovations will seek to enable electrophysiologists to perform complex procedures with greater confidence and improved efficiency. We believe that closer integration between robotics and imaging systems will afford greater clinical capability in endovascular procedures.
Additionally, in December 2009, we entered into an extended joint development agreement with Philips. Under the terms of the extended joint development agreement, we have, with support and collaboration from Philips, developed a vascular robotics platform and associated catheters, or Vascular System. The Vascular System does not include our Sensei system or any system used for endoluminal, cardiac or other non-vascular procedures. Pursuant to the Agreement, Philips partially funded our development costs based upon our achievement of development milestones for the Vascular System and will receive royalties based on sales of the Vascular System subject to caps. In February 2011, we amended the extended joint development agreement. The amendment of the extended joint development agreement increased the amount of funding provided by Philips for the development of the Vascular System and extended and increased certain royalty fees to be paid to Philips based on sales of the Vascular System subject to caps. Funding received from Philips under this agreement including $8.0 million received from the original agreement and $6.0 million associated with the amendment in February 2011 was recognized as a reduction to research and development costs ratably as milestones were met through the end of the term of the agreement, which was in October 2011. We will pay Philips royalties based on the number of Magellan Robotic Systems and NorthStar Robotic Catheters that are sold, subject to caps, through October 2017
In February 2011, we entered, directly and through a wholly-owned subsidiary, into patent and technology license, sublicense and purchase agreements with Philips to allow them to develop and commercialize the non-robotic applications of our Fiber Optic Shape Sensing and Localization, or FOSSL, technology. Under the terms of the agreements, Philips has the exclusive right to develop and commercialize the FOSSL technology in the non-robotic vascular, endoluminal and orthopedic fields. Philips also receives non-exclusive rights in other non-robotic medical device fields, but not to any multi-degree of freedom robotic applications. If Philips does not meet certain specified commercialization obligations, we have the rights to re-acquire the licenses granted to Philips for pre-determined payments, which payments in the aggregate would be greater than the upfront payment amounts we received from Philips in connection with the agreements related to the FOSSL technology.
The agreement also contains customary representations, warranties and indemnification provisions by each party. Each party may terminate the agreements for material breach by the other party. Philips also has the right to terminate the agreement and its rights under the agreement if we are acquired by a competitor of the relevant business unit of Philips. In connection with the agreements, we received upfront payments of $23.0 million and will be eligible to receive up to an additional $78.0 million in future payments associated with the successful commercialization by Philips or its collaborators of products containing FOSSL technology. Approximately two-thirds of these potential future payments could arise from Philips’ sublicensing the FOSSL technology and approximately one-third of the potential future payments are based on Philips’ royalty obligations on its sales of products containing the FOSSL technology. We would receive less than half of Philips’ proceeds for its sublicensing FOSSL technology, if and following Philips entering into an applicable sublicensing transaction. Philips’ FOSSL-related royalty obligations are calculated on a consistent annual basis between 2014 and 2020 and arise in any year only to the extent that Philips achieves a substantial number of commercial placements of FOSSL-enabled products in the calendar year.
Critical Accounting Policies, Estimates and Judgments
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses, as well as related disclosures of contingent assets and liabilities. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. We base our estimates on our past experience and on other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.
While our significant accounting policies are fully described in Note 2 to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.
Revenue Recognition
Our revenues are primarily derived from the sale of the Sensei system and the associated catheters as well as the sale of post-contract customer service. Revenues also include and are expected to include sales of our Magellan Robotic System and NorthStar Robotic Catheter. Prior to January 1, 2011, as computer software was more than incidental to the functioning of those products, our revenue recognition policy was based on authoritative guidance regarding software revenue recognition. However, in October 2009, the Financial Accounting Standards Board issued authoritative guidance related to certain revenue arrangements that include software elements and revenue arrangements with multiple deliverables. This guidance became effective for us beginning January 1, 2011 and changes the way that we account for certain revenue arrangements that include multiple deliverables. In general, the new guidance allows certain elements to be recognized as revenue earlier than under the previous guidance. We adopted the revised guidance through prospective application, wherein all revenue arrangements entered into or materially modified after January 1, 2011 are accounted for under the revised guidance and any revenue arrangements which were entered into prior to January 1, 2011 and for which there is still unrecognized revenue will continue to be accounted for under the previous guidance.
Under our revenue recognition policy, revenues are recognized when persuasive evidence of an arrangement exists, delivery to the customer has occurred or the services have been fully rendered, the sales price is fixed or determinable and collectability is probable.
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Persuasive Evidence of an Arrangement. Persuasive evidence of an arrangement for sales of Sensei systems is generally determined by a sales contract signed and dated by both the customer and us, including approved terms and conditions and the receipt of an approved purchase order. Evidence of an
arrangement for the sale of disposable products is determined through an approved purchase order from the customer. Evidence of an arrangement for the sale of post-contract customer service is determined through either a signed sales contract or an approved purchase order from the customer.
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Delivery.
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Multiple-element Arrangements. Typically, all products and services sold to customers are itemized and priced separately. In arrangements that include multiple elements, we allocate revenue to the various elements based on vendor-specific objective evidence of fair value (“VSOE”) of the elements if VSOE exists. VSOE for each element is based on the price for which the item is sold separately, determined based on historical evidence of stand-alone sales of these elements or stated renewal rates for the element. If VSOE does not exist for an element, we allocate revenue based on third-party evidence (“TPE”) of selling price for the elements if TPE exists. TPE is the price of the our or any competitor’s largely interchangeable products or services in standalone sales to similarly situated customers. If neither VSOE nor TPE exist for a specific element, we allocate revenue to the various elements based on our best estimate of the selling price for that element or estimated selling price (“ESP”) using a top-down approach, which takes into account our target prices and overall pricing objectives. In situations where we have delivered certain elements but not delivered other elements, we, after we have allocated revenue to the various elements under the relative selling price method based on VSOE, TPE or ESP, defers revenue for the undelivered elements. Prior to January 1, 2011, we allocated revenue to the various elements based solely on VSOE of the elements. When contracts contained multiple elements wherein VSOE existed for all undelivered elements, the residual method prescribed by authoritative guidance regarding software revenue recognition was used to account for the delivered elements. Under the residual method, the full VSOE of the undelivered element was deferred until that element was delivered and any residual revenue was then recognized. When we could not reasonably determine the VSOE of an undelivered element, the entire arrangement fee was deferred until all elements were delivered. If we could not establish VSOE for an element of the arrangement and the only undelivered element was post-contract customer support (“PCS”), the arrangement fee was recognized ratably over the term of the PCS. If we could not establish VSOE except for PCS, revenue was recognized under the residual method when the only remaining undelivered element was PCS. For all periods presented through December 31, 2010, we did not have VSOE for training and installation services, but did have VSOE for PCS and recognized revenue once the only undelivered element was PCS.
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Systems. Typically, ownership of the Sensei system or Magellan Robotic System passes to customers upon shipment, at which time delivery is deemed to be complete. Substantially all of the sales contracts for systems include installation and training. Prior to January 1, 2011, as these services were not deemed to be perfunctory and we had not established VSOE for these elements, all such system revenue was deferred until training and installation were completed.
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Disposable Products. Ownership of the catheters and other disposable products typically passes to customers upon shipment, at which time delivery is deemed to be complete.
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Post-contract Customer Service Revenue. We recognize post-contract customer service revenue from the sale of product maintenance plans. Revenue from post-contract customer services, whether sold individually or as a separate unit of accounting in a multi-element arrangement, is deferred and amortized over the service period, which is typically one year.
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Sales Price Fixed or Determinable. We assess whether the sales price is fixed or determinable at the time of the transaction. Sales prices are documented in the executed sales contract or purchase order received prior to shipment. If a significant portion of the sales price is considered to have extended payment terms, the sales price is accounted for as not being fixed or determinable and revenue is recognized as payments become due. Our standard terms do not allow for contingencies, such as trial or evaluation periods, refundable orders, payments contingent upon the customer obtaining financing
or other contingencies which would impact the customer’s obligation. In situations where contingencies such as those identified are included, all related revenue is deferred until the contingency is resolved.
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Collectability. We assess whether collection is probable based on a number of factors, including the customer’s past transaction history and credit worthiness. If collection of the sales price is not deemed probable, the revenue is deferred and recognized at the time collection becomes probable, which is usually upon receipt of cash. Our sales contracts generally do not allow the customer the right of cancellation, refund or return, except as provided under our standard warranty. If such rights were allowed, all related revenues would be deferred until such rights expired.
Significant management judgments and estimates are made in connection with the determination of revenue to be recognized and the period in which it is recognized. If different judgments and estimates were utilized, the amount of revenue to be recognized and the period in which it is recognized could differ materially from the amounts reported.
Short-Term Investments
We determine the appropriate classification of investments at the time of purchase and evaluate such designation as of each balance sheet date. We classify all investments with maturities greater than three months at the time of purchase as short-term investments as they are subject to use within one year in current operations. We make investments based on specific guidelines approved by our board of directors with a view to liquidity and capital preservation and regularly review our investments for performance. As of December, 31, 2011, all our investments have been classified as available-for-sale and are carried on the balance sheet at fair value with unrealized gains and losses, if any, included in other comprehensive income within stockholders’ equity. Any unrealized losses which are determined to be other than temporary will be included in earnings. Realized gains and losses are recognized on the specific identification method.
We periodically evaluate our investments for impairment. In the event that the carrying value of an investment exceeds its fair value and the decline in fair value is determined to be other than temporary, an impairment charge is recorded and a new cost basis for the investment is established. In order to determine whether a decline in value is other than temporary, we evaluate many factors, including the following: the duration and extent to which the fair value has been less than the carrying value; our financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in the industry; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. During the third quarter of 2010, we determined that the impairment of our investment in Luna Innovations, Incorporated, common stock was other than temporary. As such, we permanently wrote down the value of that investment and recorded a loss of $1,926,000 in other expense on the consolidated statement of operations. In the fourth quarter of 2011, we further permanently wrote down the value of the Luna investment and recorded an additional loss of $337,000 in other expense on the consolidated statement of operations. Significant management judgment is required in determining whether an other-than-temporary decline in the fair value of an investment exists. Changes in our assessment of the valuation of our investments could materially impact our future operating results and financial position.
Inventories
We record inventory, which includes material, labor and overhead costs, at standard cost, which approximates actual cost, determined on a first-in, first-out basis, not in excess of market value. We record reserves, when necessary, to reduce the carrying value of excess or obsolete inventories to their net realizable value. These reserves are based on our best estimates after considering projected future demand. In the event that actual demand for our inventory differs from our best estimates or we fail to receive the necessary regulatory approvals, increases to inventory reserves may become necessary.
Impairment of Long-Lived Assets
We evaluate the recoverability of our long-lived assets in accordance with authoritative accounting guidance. When events or changes in circumstances indicate that the carrying value of long-lived assets may not be recoverable, we recognize such impairment if the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows attributable to the assets. In the second quarter of 2009, we recorded an impairment loss of $1.1 million of property and equipment related to the termination of our relationship with a subcontractor in Europe for the manufacture of catheters. As of December 31, 2011, we had $8.3 million of property and equipment, net. If estimates or the related assumptions change in the future, we may record impairment charges to reduce the carrying value of certain groups of these assets. Changes in the valuation of long-lived assets could materially impact our operating results and financial position.
Stock-Based Compensation
Under the fair value recognition provisions of authoritative guidance related to stock-based compensation, stock-based payment expense is estimated at the grant date based on the fair value of the award and is recognized as expense ratably over the requisite service period of the award. The recording of compensation expense related to stock-based awards is significant to our financial statements but does not result in the payment of cash by us. Determining the appropriate fair value model used to calculate the fair value of stock-based awards requires significant management judgment. Additionally, the calculation of the fair value of stock-based awards requires us to make significant estimates and judgments, including the expected volatility, the expected term of the award and the forfeiture rate. If we had chosen a different fair value model or made different estimates in the calculation of fair value, the amount or timing of stock-based compensation recorded could have differed materially from the amounts reported.
We have selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for our stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions in determining the fair value of stock-based awards, including the expected volatility of the underlying stock, the award’s expected term and the forfeiture rate.
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Expected Volatility. Our estimate of volatility is based on a blend of average historical volatilities of our stock price and the volatility of similar entities.
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Expected Term. We estimate the expected term based on our historical settlement experience related to vesting and contractual terms while giving consideration to awards that have life cycles less than the contractual terms and vesting schedules in accordance with authoritative guidance.
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Forfeiture Rate. We estimate our forfeiture rate based on our historical experience and revise these estimates in future periods if actual forfeitures differ from those estimates.
To the extent that future evidence regarding these variables is available and provides estimates that we determine are more indicative of actual trends, we may refine or change our approach to deriving these input estimates. These changes could significantly impact the stock-based compensation expense recorded in the future.
We account for compensation expense related to stock-based awards to non-employees in accordance with authoritative guidance. We record the expense of such services based on the estimated fair value of the award using the Black-Scholes pricing model. The value of the award is recognized as expense ratably over the requisite service period of the award.
Loss Contingencies
We evaluate potential loss contingencies as circumstances dictate. Should a specific loss contingency meet the definition of a liability under authoritative accounting guidance, we would record a loss and a liability. As of
December 31, 2011, we had not recorded any loss contingencies as liabilities. However, if estimates and assumptions change in the future, we may record charges to our financial statements. This could materially impact our operating results and financial position.
Net Operating Loss Carryforwards
We make certain judgments and estimates in determining and valuing deferred tax assets. These judgments arise from differences in timing of recognizing certain expenses for tax purposes and in the calculation of credit and net operating loss carryforwards.
At December 31, 2011, we had federal and state net operating loss carryforwards of approximately $179.1 million and $162.8 million, respectively. At December 31, 2010, we had federal and California net operating loss carryforwards of approximately $162.0 million and $147.7 million, respectively. These net operating loss carryforwards will expire in varying amounts from 2012 through 2031 if not utilized. We maintained a full valuation allowance against our deferred tax asset totaling $103.1 million and $97.4 million at December 31, 2011 and 2010, respectively. The determination to maintain an allowance is highly subjective. The factors we considered in making this determination include, but are not limited to (i) our historical cumulative net losses, after adjustment for permanent tax differences, over the previous five years through 2011; (ii) our dependence on continued high growth rates in achieving forecasted profitability; (iii) operation in an industry subject to rapid technological changes; and (iv) the unknown impact of current negative macroeconomic factors on our forecasted results of operations. Based on our consideration of these factors, we believe there is sufficient uncertainty regarding our ability to generate future taxable income. We will retain a full valuation allowance until such time that we determine it is more likely than not that we will recognize the benefit of the deferred tax assets. Throughout 2012, we will continually evaluate these, and other, factors, and the impact any changes in these factors has on our judgment regarding the realization of the deferred tax assets.
Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for annual limitations on the utilization of net operating loss and research and experimentation credit carryforwards if we were to undergo an ownership change, as defined in Section 382. As the result of the sale by us of 11,700,000 shares of common stock in April 2009, the sale by us of 16,100,000 shares of common stock in April 2010 and the sale by us of 4,785,000 shares of common stock in November 2011, such an ownership change may have occurred. Accordingly, our utilization of net operating loss and credit carryforwards which existed at that time could be limited.
Financial Overview
Revenues
We made our first commercial shipments to Europe in the first quarter of 2007 and recognized our first revenues in the second quarter of 2007 for both European and U.S. customers. 2008 represented our first full year of revenues. Our revenues primarily consist of sales of Sensei systems, catheters, other disposables and, beginning in 2008, post-contract customer service. In the fourth quarter of 2011 we made our first installation of our Magellan Robotic System and NorthStar Robotic Catheter. We anticipate that future revenues will be impacted by the sale of our Vascular System. We have experienced significant fluctuations in quarterly revenues, primarily attributable to still being in the early stages of our commercial launch and, especially beginning in the fourth quarter of 2008 and continuing through 2011, difficult general economic and capital market conditions, slower than expected macro-economic recovery and uncertainty created by new health care reform legislation that has impacted capital purchases by healthcare providers. We expect these fluctuations to continue throughout 2012. We do not anticipate that revenues in 2012 will be sufficient to eliminate losses.
Cost of Revenues
Cost of revenues consists primarily of materials, direct labor, depreciation, overhead costs associated with manufacturing, training and installation costs, royalties, provisions for inventory valuation, warranty expenses and the cost associated with our post-contract customer service. We expect that cost of revenues, both as a
percentage of revenues and on a dollar basis, will continue to vary from quarter to quarter in 2012 due, among other things, to fluctuations in shipments and revenue levels, average selling prices, the mix of products sold including the introduction of our Vascular System, manufacturing levels and manufacturing yields.
Research and Development Expenses
Our research and development expenses primarily consist of engineering, software development, product development, quality assurance and clinical and regulatory expenses, including costs to develop our Sensei system and disposable catheters. Research and development expenses include employee compensation, including stock-based compensation expense, consulting services, outside services, materials, supplies, depreciation and travel. We expense research and development costs as they are incurred. Prior to our first commercial shipments in the second quarter of 2007, research and development expenses also included manufacturing costs for commercial products, including start-up manufacturing costs. We expect research and development expenses in 2012 to decrease compared with 2011 levels net of the funding recognized in 2011 under our extended joint development agreement with Philips.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of compensation for executive, finance, sales, legal and administrative personnel, including sales commissions and stock-based compensation. Other significant expenses include costs associated with attending medical conferences, professional fees for legal services (including legal services associated with our efforts to obtain and maintain broad protection for the intellectual property related to our products) and accounting services, consulting fees and travel expenses. We expect our selling, general and administrative expenses in 2012, net of stock-based compensation charges, to decrease compared with 2011 levels as we continue to actively manage our general and administrative employee costs while maintaining our sales and clinical support groups which we believe are necessary for the continued commercialization of our electrophysiology products and the introduction of our Vascular System.
Gain on Settlement of Litigation
Gain on settlement of litigation in 2010 consists of the value of common stock, common stock warrants and a note receivable received in connection with the settlement of our litigation with Luna.
Gain on Sale of Intellectual Property
Gain on sale of intellectual property consists of amounts received in exchange for patent and technology license, sublicense and purchase agreements with Philips to allow them to develop and commercialize the non-robotic applications of the FOSSL technology in the non-robotic vascular, endoluminal and orthopedic fields.
Results of Operations
Comparison of the year ended December 31, 2011 to the year ended December 31, 2010
Revenues
The increase in revenue in 2011 compared with 2010 is due mainly to an increase in the number of systems and catheters sold. The increase in the number of systems sold is mainly due to the recognition of revenue on 12 systems that were previously in deferred revenue in addition to systems that we were able to recognize revenue on due to our adoption of new accounting guidance for 2011. Increases in catheter sales were due primarily to increases in our installed base. This was partially offset by decreases in our average selling prices on systems, due principally to sales to international distributors, which tend to generate lower average selling prices, in addition to greater discounting on system sales in 2011 as compared to 2010. Service revenue increased in 2011 as compared to 2010 due primarily to our increased installed base. We have experienced significant fluctuations in quarterly revenues, primarily due to the fact that we are still in the early stages of our commercial launch and, especially beginning in the fourth quarter of 2008 and continuing through 2011, difficult general economic and capital market conditions, slower than expected macro-economic recovery and uncertainty created by new healthcare reform legislation that has impacted capital purchases by health care providers. As discussed in our risk factors, these conditions can cause potential customers to delay purchases and can lengthen sales cycles and these factors have contributed to the variability of our results. We expect these fluctuations to continue. Future revenues will also be impacted by the sale of our Vascular System.
Cost of Revenues
Cost of revenues as a percentage of revenues for 2011 improved over 2010 levels primarily due to the increased level of sales. Cost of revenues for 2011 included stock-based compensation expense of $805,000 compared to $726,000 in 2010. We expect that cost of revenues both as a percentage of revenues and on a dollar basis will continue to vary significantly through 2012 due, among other things, to fluctuations in revenue levels, the timing of revenue recognition on shipped systems, average selling prices, the mix of products sold, including the introduction of our Vascular System, manufacturing levels and manufacturing yields.
Operating Expenses
Research and Development
The decrease in research and development expenses in 2011 compared to 2010 was primarily due to an increase of $7.1 million in the recognition of funded development costs under the Philips agreement in 2011 as compared to 2010, partly offset by a $0.4 million non-cash charge related to the issuance of common stock for the acquisition of technology and an increase in outside services, materials and overhead expenses, exclusive of Philips reimbursements, related primarily to costs associated with the development of vascular applications of our technology, and increases in employee-related expenses. Research and development expenses included $1.7 million of stock-based compensation in both 2011 and 2010. We expect research and development expenses in 2012 to decrease compared with 2011 levels excluding the impact of the funding recognized in 2011 under our extended joint development agreement with Philips.
Selling, General and Administrative
The increase in selling, general and administrative expenses in 2011 compared to 2010 was primarily due to an increase of $1.5 million in stock-based compensation expense, due primarily to the increased issuance of restricted stock units in 2011 as compared to 2010 and the vesting of the unvested portion of stock options held by our chairman as he transitioned to a non-employee status in addition to increases in overhead expenses and marketing expenses. The increase also reflected an increase in marketing expenses related to the introduction and promotion of our Vascular System and increases in supplies and overhead. Selling, general and administrative expenses in 2011 included $4.1 million of stock-based compensation expense compared to $2.6 million in 2010. We expect our selling, general and administrative expenses in 2012, net of stock-based compensation charges, to decrease compared with 2011 levels as we continue to actively manage our general and administrative employee costs while maintaining our sales and clinical support groups which we believe are necessary for the continued commercialization of our electrophysiology products and the introduction of our Vascular System.
Gain on Settlement of Litigation
Gain on settlement of litigation consists of the value of common stock, a warrant to purchase common stock and a secured promissory note received in connection with the settlement of our litigation with Luna in January 2010. The items were valued as follows (in thousands):
Common Stock
Upon execution of these agreements, Luna issued us approximately 1.2 million shares of common stock. These shares were not registered with the Securities and Exchange Commission but were expected to become salable six months after the date of issuance of the shares. The fair value of the shares recorded reflects the value that market participants would demand due to the value of the shares and the risk relating to the inability to access a public market for these securities for the specified period. The fair value of the unregistered shares was determined as of the market closing price on the dates the shares were issued less a 20% non-marketability discount, for a total value of $4.4 million.
We concluded that 20% was an appropriate discount based primarily on an analysis utilizing the Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the restricted stock over the expected period of non-marketability. This approach calculated the amount required to buy the right to sell the presently restricted stock at the then-current market price on the date the holder can count on the shares becoming salable on the public exchange. The assumptions input into the Black-Scholes option pricing model were based on the stock price on the date of the share issuance, an expected term of eight months, expected volatility of 59%, risk-free interest rate of 0.14% and no expected dividends.
This conclusion was corroborated by the Black-Scholes model by assessing that the discount was generally consistent with the ranges noted from published restricted stock studies and comparable to discounts on restricted stock transactions completed by other companies operating in similar industries as Luna.
Warrant to Purchase Common Stock
The warrant to purchase shares of common stock was valued based on an estimate of the number of shares which will be issued over the three-year life of the warrant. The number of shares were valued utilizing the Black-Scholes option pricing model based on the stock price on the date of the agreements, expected terms ranging from three months to three years, expected volatility ranging from 53% to 75%, risk-free interest rates ranging from 0.05% to 1.5% and no expected dividends. The total estimated fair value of the warrant was calculated at $583,000 at the date of issuance.
Secured Promissory Note
Luna issued us a secured promissory note in the principal amount of $5,000,000, with principal and interest payments to be made in 16 equal quarterly installments commencing April 2010. The outstanding principal amount under the note accrues interest at 8.5 percent per annum, payable quarterly in arrears. Luna may prepay, in whole or in part, the outstanding amount of the note without premium or penalty. Additionally, in connection with a Development and Supply Agreement between the parties, certain amounts billed for work performed by Luna in excess of quarterly limits are to be settled through a corresponding reduction in the principal of the $5,000,000 note. Through May 2011, the principal of the note had been reduced by approximately $358,000 in accordance with the Development and Supply Agreement. In May 2011, we reached an agreement with Luna whereby Luna paid off the remaining balance of the note at a discount. We recorded a loss of $190,000 in the second quarter of 2011 in conjunction with this transaction.
Gain on Sale of Intellectual Property
In February 2011, we entered, directly and through a wholly-owned subsidiary, into patent and technology license, sublicense and purchase agreements with Philips to allow them to develop and commercialize the non-robotic applications of the FOSSL technology. Under the terms of the agreements, Philips has the exclusive right to develop and commercialize the FOSSL technology in the non-robotic vascular, endoluminal and orthopedic fields. Philips also receives non-exclusive rights in other non-robotic medical device fields, but not to any multi-degree of freedom robotic applications. If Philips does not meet certain specified commercialization obligations, we have the rights to re-acquire the licenses granted to Philips for pre-determined payments. The agreement also contains customary representations, warranties and indemnification provisions by each party. Philips also has the right to terminate the agreement and its rights under the agreement if we are acquired by a competitor of the relevant business unit of Philips. Each party may terminate the agreements for material breach by the other party. In connection with the licensing of the technology, we received an upfront nonrefundable payment of $23.0 million which was recognized immediately in operating income. We will be eligible to receive up to an additional $78.0 million in future payments associated with the successful commercialization by Philips or its collaborators of products containing FOSSL technology.
Interest Income
Interest income from cash, cash equivalents and investments and from our note receivable from Luna decreased in 2011 compared to 2010 primarily due to the lower cash balances and the payoff of the note receivable by Luna. We expect interest income in 2012 to increase compared to 2011 levels due to our higher cash, cash equivalents and investments balances.
Interest Expense
Interest expense decreased in 2011 compared to 2010 primarily due to the decrease in the outstanding balance of our term equipment line. We expect interest expense to increase in 2012 over 2011 levels due to our new debt agreement.
Other Expense, net
Other expense, net decreased in 2011 compared to 2010 primarily due to the $1.9 million write down of our equity investment in Luna in the third quarter of 2010, partially offset by the $0.3 million write down of that same investment in the fourth quarter of 2011. The remaining variance is due to a decrease in unrealized losses on the valuation of the Luna Warrants and decreases in realized foreign exchange losses, partially offset by the loss on the settlement of the Luna note receivable.
Comparison of the year ended December 31, 2010 to the year ended December 31, 2009
Revenues
The decrease in revenue in 2010 as compared to 2009 was due mainly to a decrease in the number of systems shipped in addition to a decrease in our average selling prices. The decrease in our average selling prices of Sensei systems in 2010 as compared to 2009 was due primarily to the fact that, beginning in the third quarter of 2009, we began to include one year of post-contract customer service, or “PCS”, with the sale of our Sensei systems. PCS revenue is removed from the selling price of the Sensei system and is recognized ratably over the service period as a component of service revenue. PCS was not included in Sensei system sales for the first six months of 2009. The impact of the PCS was partially offset by sales in 2010 of our improved Sensei X model, which has a higher list price than our original Sensei model. Sales of catheters increased slightly in 2010 as compared to 2009 due principally to our increased installed base. Service revenue increased in 2010 as compared to 2009 due to our inclusion of one year of PCS with the sale of Sensei systems and as more existing customers transition from the first year of warranty to our service contracts.
Cost of Revenues
Cost of revenues for 2010 included stock-based compensation expense of $726,000 as compared to $787,000 in 2009. Cost of revenues as a percentage of revenues for 2010 were negatively impacted by the decreased level of sales.
Operating Expenses
Research and Development
The change in research and development expenses in 2010 compared to 2009 was primarily due to a decrease of $3.4 million due to the recognition in 2010 of funded development costs under the Philips agreement in addition to decreases in stock-based compensation expense and other employee-related expenses, partially offset by an increase of $1.9 million in costs of outside services provided by Luna and an increase of $1.0 million in outside services, materials and overhead expenses, exclusive of Luna services and Philips reimbursements related primarily to costs associated with the development of vascular applications of our technology. Total research and development expenses in 2010 included $1.7 million of stock-based compensation expense compared to $2.4 million in 2009.
Selling, General and Administrative
The change in selling, general and administrative expenses in 2010 compared to 2009 was primarily due to a decrease of $5.7 million in litigation costs associated with our 2009 trial against Luna, a decrease of $1.6 million in stock-based compensation expense, due primarily to the effects of our lower average stock price, a decrease of $1.1 million related to a charge in 2009 for the write-off of non-recoverable fixed assets related to our decision to terminate our relationship with our European subcontractor for the manufacture of catheters in addition to decreases in employee-related expenses. Selling, general and administrative expenses in 2010 included $2.6 million of stock-based compensation expense compared to $4.2 million in 2009.
Gain on Settlement of Litigation
Gain on settlement of litigation consists of the value of common stock, a warrant to purchase common stock and a secured promissory note received in connection with the settlement of our litigation with Luna in January 2010. The items were valued as follows (in thousands):
Common Stock
Upon execution of these agreements, Luna issued us approximately 1.2 million shares of common stock. These shares were not registered with the Securities and Exchange Commission but were expected to become salable six months after the date of issuance of the shares. We are in the process of removing the restriction from these shares. The fair value of the shares recorded reflects the value that market participants would demand due to the value of the shares and the risk relating to the inability to access a public market for these securities for the specified period. The fair value of the unregistered shares was determined as of the market closing price on the dates the shares were issued less a 20% non-marketability discount, for a total value of $4.4 million.
We concluded that 20% was an appropriate discount based primarily on an analysis utilizing the Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the restricted stock over the expected period of non-marketability. This approach calculated the amount required to buy the right to sell the presently restricted stock at the then-current market price on the date the holder can count on the shares becoming salable on the public exchange. The assumptions input into the Black-Scholes option pricing model were based on the stock price on the date of the share issuance, an expected term of eight months, expected volatility of 59%, risk-free interest rate of 0.14% and no expected dividends.
This conclusion was corroborated by the Black-Scholes model by assessing that the discount was generally consistent with the ranges noted from published restricted stock studies and comparable to discounts on restricted stock transactions completed by other companies operating in similar industries as Luna.
Warrant to Purchase Common Stock
The warrant to purchase shares of common stock was valued based on an estimate of the number of shares which will be issued over the three-year life of the warrant. The number of shares were valued utilizing the Black-Scholes option pricing model based on the stock price on the date of the agreements, expected terms ranging from three months to three years, expected volatility ranging from 53% to 75%, risk-free interest rates ranging from 0.05% to 1.5% and no expected dividends. The total estimated fair value of the warrant was calculated at $583,000 at the date of issuance.
Secured Promissory Note
Luna issued us a secured promissory note in the principal amount of $5,000,000, with principal and interest payments to be made in 16 equal quarterly installments commencing April 2010. The outstanding principal amount under the note accrues interest at 8.5 percent per annum, payable quarterly in arrears. Luna may prepay, in whole or in part, the outstanding amount of the note without premium or penalty. Additionally, in connection with a Development and Supply Agreement between the parties, certain amounts billed for work performed by Luna in excess of quarterly limits are to be settled through a corresponding reduction in the principal of the $5,000,000 note. Through May 2011, the principal of the note had been reduced by approximately $358,000 in accordance with the Development and Supply Agreement. In May 2011, we reached an agreement with Luna whereby Luna paid off the remaining balance of the note at a discount. We recorded a loss of $190,000 in the second quarter of 2011 in conjunction with this transaction.
Interest Income
Interest income from cash, cash equivalents and investments and from our note receivable from Luna increased in 2010 compared to 2009 primarily due to interest on the note receivable from Luna.
Interest Expense
Interest expense decreased in 2010 as compared to 2009 primarily due to the decrease in the outstanding balance of our term equipment line.
Other Expense, net
Other expense, net, for 2010 included the $1,926,000 write-down of our equity investment in Luna as the impairment of its value was considered other than temporary. The remaining increase in other expense, net in 2010 as compared to 2009 was mainly due to unrealized losses on the valuation of the Luna Warrants, partially offset by a decrease in net realized and unrealized foreign exchange losses.
Liquidity and Capital Resources
Cash, Cash Equivalents and Short-Term Investments
Our cash, cash equivalent and short-term investment balances are held in a variety of interest-bearing instruments, including United States government agency securities, corporate debt securities and money market funds in addition to corporate equity securities. Cash in excess of immediate requirements is invested in accordance with our investment policy primarily with a view towards liquidity and capital preservation.
Net Cash Used in Operating Activities
Net cash used in operating activities for the years presented primarily reflects the net loss for those periods adjusted for the gain on sale of intellectual property in 2011 and the gain on settlement of litigation in 2010, partially offset by non-cash charges such as depreciation and amortization, stock-based compensation, loss of disposal of fixed assets and net unrealized losses on investments. Additionally, net cash used in operations in 2011 was negatively impacted by increases in accounts receivable and inventory balances due to higher shipments at the end of 2011 and a slight build in inventory related to our Vascular System and by a decrease in deferred revenue. Net cash used in operating activities in 2010 was positively impacted by a decrease in accounts receivable and inventory balances due to the lower level of sales and an increase in deferred revenue, accounts payable and accrued liabilities balances. Net cash used in operating activities in 2009 was positively impacted by a decrease in average accounts receivable balances due to improved collections in 2009, and was negatively impacted by decreases in accounts payable and accrued liabilities resulting from our lower level of expenses in 2009.
Net Cash Provided by (Used in) Investing Activities
Net cash provided by investing activities in 2011 primarily relates to the proceeds from the sale of intellectual property and the collection of the note receivable from Luna, partially offset by net purchases of short-term investments as we manage our portfolio, including the cash raised during the year, to provide interest income and liquidity for our operations. Net cash provided by investing activities for 2010 primarily relates to the net proceeds from the sales and maturities of short-term investments. Net cash used in investing activities for 2009 primarily relates to the net purchases of investments. Investing activities were also negatively impacted by the purchase of property and equipment as we invested in the infrastructure of our company.
Net Cash Provided by Financing Activities
Net cash provided by financing activities in 2011 is primarily due to the proceeds from our new loan agreement, partially offset by the repayment of the existing loan balance. The remaining cash provided by financing activities in 2011 as well as in 2010 and 2009 was mainly due to the cash received from our equity offerings in addition to receipts from our employee stock purchase plan and from the exercises of stock options, partially offset by scheduled debt repayments.
Historical Financing Activities
We have incurred significant losses since our inception in September 2002 and, as of December 31, 2011 we had an accumulated deficit of $274.8 million. We have financed our operations to date principally through the sale of capital stock, debt financing, interest earned on investments and the sale of our products and, beginning in 2009 through partnering. Prior to our initial public offering of stock in November 2006, we had received net proceeds of $61.3 million from the issuance of common and preferred stock and $7.0 million in debt financing. Through our initial public offering in 2006 we received net proceeds of $78.3 million. In April 2008, we sold 3,000,000 shares of our common stock, resulting in approximately $39.5 million of net proceeds. In April 2009, we sold 11,692,000 shares of our common stock, resulting in approximately $35.3 million of net proceeds. In April 2010, we sold 16,100,000 shares of our common stock, resulting in approximately $29.8 million of net proceeds. In November 2011, we sold approximately 4,785,000 shares of our common stock, resulting in approximately $10.0 million of net proceeds.
In December 2011 we entered into a $30.0 million loan and security agreement with Oxford Finance LLC, or Oxford, Silicon Valley Bank and Oxford as the collateral agent, or Collateral Agent, with $20.0 million of the loan provided by Oxford and $10.0 million provided by Silicon Valley Bank. In connection with the loan and security agreement, we and Silicon Valley Bank terminated our previous loan agreement and we used approximately $3.4 million of the proceeds to pay off our existing obligations on that loan. We are obligated to
pay interest only on the loan through December 31, 2012, provided that the interest only period will be extended through June 30, 2013 if we receive approval from the U.S. Food and Drug Administration for our Magellan Robotic System prior to December 31, 2012. We will make payments on the loan through January 1, 2016. At our option, we may prepay all of the outstanding principal balance, subject to a pre-payment fee of (a) 3.00% of the principal amount of the loan then outstanding if our prepayment is made on before the second anniversary of funding the loan or (b) 1.50% of the principal amount of the loan then outstanding if our prepayment is made after the second anniversary of funding the loan. The loan is collateralized by substantially all of our assets now owned or hereafter acquired, other than our intellectual property, and all proceeds and products thereof, and we agreed to a negative pledge on our intellectual property. Two of our wholly-owned subsidiaries, AorTx, Inc. and Hansen Medical International, Inc., entered into an Unconditional Guaranty and a Security Agreement with the Collateral Agent pursuant to which they guaranteed our obligations under the loan with a first priority security interest in their assets, excluding such subsidiaries’ intellectual property. We additionally agreed to pledge to Oxford and Silicon Valley Bank shares of each of our direct and indirect subsidiaries as collateral for the loan. We are also subject to certain affirmative and negative covenants, including a requirement to maintain a certain level of liquidity. The loan also limits our ability to do any of the following:
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undergo certain change of control events;
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convey, sell, lease, transfer, assign or otherwise dispose of certain of our assets;
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create, incur, assume, or be liable with respect to certain indebtedness, not including, among other items, subordinated debt;
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grant certain liens;
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pay dividends and make certain other restricted payments;
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make certain investments;
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make payments on any subordinated debt;
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enter into transactions with any of our affiliates outside of the ordinary course of business; or permit our subsidiaries to do the same.
In addition, subject to certain exceptions, we are required to maintain with SVB our primary deposit accounts, securities accounts and commodities, and to do the same for each of our domestic subsidiaries.
In the event we were to violate any covenants or if Oxford or Silicon Valley Bank believes that we have violated any covenants and such violations are not cured pursuant to the terms of the loan and security agreement, we would be in default under the loan and security agreement, which would entitle Oxford or Silicon Valley Bank to exercise their remedies, including the right to accelerate the debt, upon which we may be required to repay all amounts then outstanding under the loan and security agreement. Complying with these covenants may make it more difficult for us to successfully execute our business strategy. As of December 31, 2011, we were in compliance with all financial covenants.
We consider the undistributed earnings of our foreign subsidiaries as of December 31, 2011, to be indefinitely reinvested and, accordingly, no U.S. income taxes have been provided thereon. As of December 31, 2011, the amount of cash associated with indefinitely reinvested foreign earnings was approximately $0.2 million. We have not, nor do we anticipate the need to, repatriate funds or accounting gains or losses to the United States to satisfy domestic liquidity needs arising in the ordinary course of business, including liquidity needs associated with our domestic debt service requirements.
Future Capital Requirements
We recognized our first revenues in 2007, have not achieved profitability and have not generated net income to date. We have experienced significant fluctuations in quarterly shipments and revenues and, beginning in the fourth quarter of 2008 and continuing through 2011, we saw many potential customers lengthen their sales cycles
and postpone purchase decisions. In an attempt to reduce our future spending, we reduced our work force in the third quarter of 2008 and again in the first and third quarters of 2009. We anticipate that we will continue to incur substantial net losses for at least the next year as we continue to commercialize our products, maintain and develop the corporate infrastructure required to manufacture and sell our products at sufficient levels and profit margins and operate as a publicly traded company as well as continue to develop new products and pursue additional applications for our technology platform including our Sensei system and Vascular System.
While we expect to continue to use cash in operations, we believe our existing cash, cash equivalents and short-term investment balances as of December 31, 2011 and the interest income we earn on these balances in addition to the amounts received through the sale of our products and services will be sufficient to meet our anticipated cash requirements for at least the next twelve months. However, we may decide to raise additional funding by selling equity or debt securities, licensing other core or non-core intellectual property assets, entering into future research and development funding arrangements or entering into a credit facility in order to meet our continuing cash needs beyond the next twelve months. If such financing, licensing or funding arrangements, which may occur at any time, do not meet our longer term needs or if our cash flows from operating activities are less than we expect, we may be required to adopt additional cost-cutting measures, including additional reductions in our work force, reducing the scope of, delaying or eliminating some or all of our planned research, development and commercialization activities and/or reducing marketing, customer support or other resources devoted to our products. Any of these factors could harm our financial condition. Failure to raise additional funding or manage our spending may adversely impact our ability to achieve our long term intended business objectives. We will continue to evaluate the extent of our implemented cost-saving measures based upon changing future economic conditions and the achievement of estimated revenue and will consider the implementation of additional cost reductions if and as circumstances warrant.
If we seek additional funding in the future by selling additional equity or debt securities or entering into a credit facility, such additional funding may result in substantial dilution to existing stockholders, may contain unfavorable terms or may not be available on any terms. If we are unable to obtain any needed additional funding, we may be required to reduce the scope of, delay, or eliminate some or all of, our planned research, development and commercialization activities or to license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize ourselves or on terms that are less attractive than they might otherwise be, any of which could materially harm our business. The timing and exact amounts of our capital requirements will depend on many factors, including but not limited to the following:
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our ability to maintain compliance with debt covenants;
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the cash collected from and the revenue and margins generated by sales of our current and future products;
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the terms and timing of any collaborative, licensing or other arrangements that we may establish;
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the success of our research and development efforts;
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our ability to generate revenue in a time of overall economic uncertainty;
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the expenses we incur in manufacturing, marketing and selling our products, developing new products and operating our company;
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our ability to achieve and maintain manufacturing cost reductions;
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our ability to achieve and maintain operating cost reductions;
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the rate of progress and cost of our clinical trials and other development activities;
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the cost and timing of future regulatory actions;
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the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property or other legal rights, or participating in litigation-related activities;
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the costs of defending against lawsuits brought against us or individuals indemnified by us;
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the emergence of competing or complementary technological developments; and
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the acquisition of businesses, products and technologies.
We cannot guarantee that future equity or debt financing or credit facilities will be available in amounts or on terms acceptable to us, if at all. This could leave us without adequate financial resources to fund our operations as presently conducted or as we plan to conduct them in the future.
Contractual Obligations
The following table summarizes our outstanding contractual obligations as of December 31, 2011 and the effect those obligations are expected to have on our liquidity and cash flows in future periods (in thousands):
The table above reflects only payment obligations that are fixed and determinable. Our commitments for operating leases relate principally to the lease for our corporate headquarters in Mountain View, California. Current future debt payments relate to principal and interest payments related to the $30.0 million we have borrowed under our loan agreement with Oxford and Silicon Valley Bank. Additionally, we have minimum royalty obligations of $100,000 per year under a license agreement with Mitsubishi Electric Research Laboratories, Inc. which reduces to $55,000 per year if the license becomes non-exclusive. The royalty obligation expires in 2018. We also have minimum royalty obligations of $200,000 per year under the terms of our cross license agreement with Intuitive. We also have royalty obligations under the amended joint development agreement with Philips which provides for the payment of royalties to Philips through October 2017. As of December 31, 2011, we had $1.7 million in uncertain tax positions. If it is determined in some future period that these amounts are not allowed to be deducted for tax purposes and if we do not have credits or carryforwards to cover these amounts, they could result in payments by us to taxing authorities.
Recent Accounting Pronouncements
There are a number of new accounting pronouncements and interpretations that will impact our financial statements and disclosures (see Note 2 to our consolidated financial statements under the caption “Recent Accounting Pronouncements”.) We do not expect that any of those pronouncements or interpretations upon adoption will have a material impact on our results of operations, financial position or cash flows.
Off-balance Sheet Arrangements
As of December 31, 2011, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the normal course of business, our financial position is subject to a variety of risks, including market risk associated with interest rate movements and foreign currency exchange risk. We regularly assess these risks and have established policies and business practices to protect against these and other exposures. As a result, we do not anticipate material potential losses in these areas.
The primary objective for our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term investments, consisting primarily of investment grade securities. As of December 31, 2011, the fair value of our cash, cash equivalents and short-term investments was approximately $52.2 million, the majority of which will mature in one year or less. A hypothetical 50 basis point increase in interest rates would not result in a material decrease or increase in our interest income nor in the fair value of our available-for-sale securities. We have no investments denominated in foreign country currencies and therefore our investments are not subject to foreign currency exchange risk.
A portion of our operations consist of sales activities outside of the United States and, as such, we have foreign currency exposure to non-United States dollar revenues and accounts receivable. Currently, we sell our products mainly in United States dollars, Euros and Great Britain Pounds although we may in the future transact business in other currencies. Future fluctuations in the exchange rates of these currencies may impact our revenues. In the past, we have not hedged our exposures to foreign currencies or entered into any other derivative instruments and we have no current plans to do so. For the year ended December 31, 2011, sales denominated in foreign currencies were approximately 20% of total revenue. A hypothetical 10% increase in the United States dollar exchange rate used would have resulted in a decrease of approximately $452,000 in revenues for 2011.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Hansen Medical, Inc.:
We have audited the accompanying consolidated balance sheets of Hansen Medical, Inc. and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the years then ended. We also have audited the Company’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As discussed in Note 2 to the consolidated financial statements, in the year ended December 31, 2011, the Company changed its method of recognizing revenue for multiple element arrangements in accordance with the Financial Accounting Standards Board’s Accounting Standards Update (ASU) 2009-13, Multiple-Deliverable Revenue Arrangements and ASU 2009-14, Certain Revenue Arrangements that include Software Elements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Hansen Medical, Inc. and subsidiaries as of December 31, 2011 and 2010, and the results
of their operations and their cash flows for each of the years then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ Deloitte & Touche LLP
San Francisco, California
March 15, 2012
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Hansen Medical, Inc.:
In our opinion, the accompanying consolidated statement of operations, consolidated statement of stockholders’ equity, and of the consolidated statement of cash flows present fairly, in all material respects, the financial position of Hansen Medical, Inc. and its subsidiaries at December 31, 2009, and the results of their operations and its cash flows for the year ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. 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 audit. We conducted our audit of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations and negative cash flows from operations since inception that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PricewaterhouseCoopers LLP
San Jose, California
March 15, 2010
HANSEN MEDICAL, INC.
Consolidated Balance Sheets
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
HANSEN MEDICAL, INC.
Consolidated Statements of Operations
(In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
HANSEN MEDICAL, INC.
Consolidated Statements of Stockholders’ Equity
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
HANSEN MEDICAL, INC.
Consolidated Statements of Cash Flows
(In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
HANSEN MEDICAL, INC.
Notes to Consolidated Financial Statements
1. Description of Business
Hansen Medical, Inc. (the “Company”) develops, manufactures and markets a new generation of medical robotics designed for accurate positioning, manipulation and stable control of catheters and catheter-based technologies. The Company was incorporated in the state of Delaware on September 23, 2002. The Company is headquartered in Mountain View, California. In March 2007, the Company established Hansen Medical UK Ltd., a wholly-owned subsidiary located in the United Kingdom and, in May 2007, the Company established Hansen Medical, GmbH, a wholly-owned subsidiary located in Germany. Both subsidiaries are engaged in marketing the Company’s products in Europe.
The Company’s products include the Sensei® Robotic Catheter System (the “Sensei system”) and its related Artisan® and Lynx® catheters and the newly developed robotic platform for use in the vasculature (the “Vascular System”) which consists of the Magellan™ Robotic System and the NorthStar™ Robotic Catheter. The Company received CE Mark approval for its Sensei system in the fourth quarter of 2006 and, in the second quarter of 2007, received CE Mark approval for its Artisan catheters and also received U.S. Food & Drug Administration (“FDA”) clearance for the marketing of its Sensei system and Artisan catheters for manipulation, positioning and control of certain mapping catheters during electrophysiology procedures. As a result of obtaining the necessary regulatory approvals, the Company recorded its initial product revenues in the second quarter of 2007, thus commencing its planned principal operations. The Company received CE Mark approval for the Lynx catheter in September 2010. The Company received CE Mark approval for its Magellan Robotic System in July 2011 and received CE Mark approval for the NorthStar Robotic Catheter and related accessories designed for use with the Magellan Robotic System in September 2011.
The Company completed its initial public offering of stock (“IPO”) on November 15, 2006. The IPO consisted of 7,187,500 shares of the Company’s common stock and produced net proceeds of $78.3 million, after expenses and underwriters’ discounts and commissions. On April 7, 2008, the Company sold an additional 3,000,000 shares of its common stock, resulting in net proceeds of approximately $39.5 million. On April 22, 2009, the Company sold 11,692,000 shares of its common stock, resulting in approximately $35.3 million of net proceeds, after underwriting discounts and commissions and offering expenses. On April 20, 2010, the Company sold 16,100,000 shares of its common stock, resulting in approximately $29.8 million of net proceeds, after underwriting discounts and commissions and offering expenses. On November 7, 2011, the Company sold 4,785,000 shares of its common stock, resulting in approximately $10.0 million in net proceeds after offering expenses. On December 8, 2011, the Company entered into a $30.0 million loan and security agreement with Oxford Finance LLC (“Oxford”) and Silicon Valley Bank (“SVB”), with $20.0 million of the loan provided by Oxford and $10.0 million provided by SVB. The Company is obligated to pay interest only on the loan through December 31, 2012, provided that the interest only period will be extended through June 30, 2013 if the Company receives approval from the U.S. Food and Drug Administration for its Magellan Robotic System prior to December 31, 2012. Payments on the loan will be made through January 1, 2016. See Note 8.
From inception to December 31, 2011, the Company has incurred losses totaling approximately $274.8 million and has not generated positive cash flows from operations. The Company expects such losses to continue through at least the year ended December 31, 2012 as it continues to commercialize its technologies and develop new applications and technologies. The Company also faces significant short-term uncertainty related to current economic and capital market conditions and the related impact of those conditions on the capital equipment market. The Company also faces uncertainty related to the development, approval and commercialization of its Vascular System. While the Company expects to continue to use cash in operations, the Company believes its existing cash, cash equivalents and short-term investment balances as of December 31, 2011 and the interest income it will earn on these balances in addition to the estimated amounts received through the sale of its products will be sufficient to meet its anticipated cash requirements for the next twelve months. However, the
Company may decide to raise additional funding in the future by selling equity or debt securities, licensing other non-core intellectual property assets, entering into future research and development funding arrangements or entering into a credit facility in order to meet its future cash needs. If such financing, licensing or funding arrangements, which may occur at any time, do not meet the Company’s longer term needs or if cash flows from operating activities are significantly less than expected, the Company may be required to adopt additional cost-cutting measures, including additional reductions in its work force, reducing the scope of, delaying or eliminating some or all of its planned research, development and commercialization activities and/or reducing marketing, customer support or other resources devoted to the Company’s products. Any of these factors could harm the Company’s financial condition. Failure to raise additional funding or manage spending may adversely impact the Company’s ability to achieve its long term intended business objectives. The Company will continue to evaluate the extent of its implemented cost-saving measures based upon changing future economic conditions and the achievement of estimated revenue and will consider the implementation of additional cost reductions if and as circumstances warrant.
2. Summary of Significant Accounting Policies
Basis of Presentation
The Company has prepared the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, or “GAAP”. The Company’s fiscal year ends on December 31. The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Significant estimates relate to the recognition of revenue, the evaluation of customer credit risk, the valuation of investments, inventory valuations, determination of impairment of assets, stock-based compensation, loss contingencies and the valuation of our deferred tax assets, among others. Actual results could differ from those estimates.
Revenue Recognition
The Company’s revenues are primarily derived from the sale of the Sensei system and the associated catheters as well as the sale of post-contract customer service. Revenues also include and are expected to include sales of its Magellan Robotic System and NorthStar Robotic Catheter. Prior to January 1, 2011, as computer software was more than incidental to the functioning of those products, the Company’s revenue recognition policy was based on authoritative guidance regarding software revenue recognition. However, in October 2009, the Financial Accounting Standards Board (the “FASB”) issued authoritative guidance related to certain revenue arrangements that include software elements and revenue arrangements with multiple deliverables. This guidance became effective for the Company beginning January 1, 2011 and changes the way that the Company accounts for certain revenue arrangements that include multiple deliverables. In general, the new guidance allows certain elements to be recognized as revenue earlier than under the previous guidance. The Company adopted the revised guidance through prospective application, wherein all revenue arrangements entered into or materially modified after January 1, 2011 are accounted for under the revised guidance and any revenue arrangements which were entered into prior to January 1, 2011 and for which there is still unrecognized revenue will continue to be accounted for under the previous guidance. Had the Company recognized revenue in 2011 consistent with the guidance used to recognize revenues in periods previous to January 1, 2011, product revenue for 2011 would have been $13,167,000 and deferred revenue at December 31, 2011 would have been $9,991,000.
Under the Company’s revenue recognition policy, revenues are recognized when persuasive evidence of an arrangement exists, delivery to the customer has occurred or the services have been fully rendered, the sales price is fixed or determinable and collectability is probable.
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Persuasive Evidence of an Arrangement. Persuasive evidence of an arrangement for sales of Sensei systems is generally determined by a sales contract signed and dated by both the customer and the Company, including approved terms and conditions and the receipt of an approved purchase order. Evidence of an arrangement for the sale of disposable products is determined through an approved purchase order from the customer. Evidence of an arrangement for the sale of post-contract customer service is determined through either a signed sales contract or an approved purchase order from the customer.
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Delivery.
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Multiple-element Arrangements. Typically, all products and services sold to customers are itemized and priced separately. In arrangements that include multiple elements, the Company allocates revenue to the various elements based on vendor-specific objective evidence of fair value (“VSOE”) of the elements if VSOE exists. VSOE for each element is based on the price for which the item is sold separately, determined based on historical evidence of stand-alone sales of these elements or stated renewal rates for the element. If VSOE does not exist for an element, the Company allocates revenue based on third-party evidence (“TPE”) of selling price for the elements if TPE exists. TPE is the price of the Company’s or any competitor’s largely interchangeable products or services in standalone sales to similarly situated customers. If neither VSOE nor TPE exist for a specific element, the Company allocates revenue to the various elements based on its best estimate of the selling price for that element or estimated selling price (“ESP”) using a top-down approach, which takes into account the Company’s target prices and overall pricing objectives. In situations where the Company has delivered certain elements but not delivered other elements, the Company, after it has allocated revenue to the various elements under the relative selling price method based on VSOE, TPE or ESP, defers revenue for the undelivered elements. Prior to January 1, 2011, the Company allocated revenue to the various elements based solely on VSOE of the elements. When contracts contained multiple elements wherein VSOE existed for all undelivered elements, the residual method prescribed by authoritative guidance regarding software revenue recognition was used to account for the delivered elements. Under the residual method, the full VSOE of the undelivered element was deferred until that element was delivered and any residual revenue was then recognized. When the Company could not reasonably determine the VSOE of an undelivered element, the entire arrangement fee was deferred until all elements were delivered. If the Company could not establish VSOE for an element of the arrangement and the only undelivered element was post-contract customer support (“PCS”), the arrangement fee was recognized ratably over the term of the PCS. If the Company could not establish VSOE except for PCS, revenue was recognized under the residual method when the only remaining undelivered element was PCS. For all periods presented through December 31, 2010, the Company did not have VSOE for training and installation services, but did have VSOE for PCS and recognized revenue once the only undelivered element was PCS.
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Systems. Typically, ownership of the Sensei system or Magellan Robotic System passes to customers upon shipment, at which time delivery is deemed to be complete. Substantially all of the sales contracts for systems include installation and training. Prior to January 1, 2011, as these services were not deemed to be perfunctory and the Company had not established VSOE for these elements, all such system revenue was deferred until training and installation were completed.
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Disposable Products. Ownership of the catheters and other disposable products typically passes to customers upon shipment, at which time delivery is deemed to be complete.
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Post-contract Customer Service Revenue. The Company recognizes post-contract customer service revenue from the sale of product maintenance plans. Revenue from post-contract customer services, whether sold individually or as a separate unit of accounting in a multi-element arrangement, is deferred and amortized over the service period, which is typically one year.
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Sales Price Fixed or Determinable. The Company assesses whether the sales price is fixed or determinable at the time of the transaction. Sales prices are documented in the executed sales contract or purchase order received prior to shipment. If a significant portion of the sales price is considered to have extended payment terms, the sales price is accounted for as not being fixed or determinable and revenue is recognized as payments become due. The Company’s standard terms do not allow for contingencies, such as trial or evaluation periods, refundable orders, payments contingent upon the customer obtaining financing or other contingencies which would impact the customer’s obligation. In situations where contingencies such as those identified are included, all related revenue is deferred until the contingency is resolved.
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Collectability. The Company assesses whether collection is probable based on a number of factors, including the customer’s past transaction history and credit worthiness. If collection of the sales price is not deemed probable, the revenue is deferred and recognized at the time collection becomes probable, which is usually upon receipt of cash. The Company’s sales contracts generally do not allow the customer the right of cancellation, refund or return, except as provided under the Company’s standard warranty. If such rights were allowed, all related revenues would be deferred until such rights expired.
Significant management judgments and estimates are made in connection with the determination of revenue to be recognized and the period in which it is recognized. If different judgments and estimates were utilized, the amount of revenue to be recognized and the period in which it is recognized could differ materially from the amounts reported.
Concentration of Credit Risk and Other Risks and Uncertainties
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable. Cash and cash equivalents are deposited in demand and money market accounts at two financial institutions. At times, such deposits may be in excess of insured limits. The Company has not experienced any losses on its deposits of cash and cash equivalents.
The Company had five customers who constituted 17%, 16%, 15%, 13% and 10%, respectively, of the Company’s net accounts receivable at December 31, 2011. The Company had three customers who constituted 15%, 15% and 13%, respectively, of the Company’s net accounts receivable at December 31, 2010. One customer accounted for 15% of revenues in 2011. No customer accounted for more than 10% of revenues in 2010 or 2009. The Company carefully monitors the creditworthiness of potential customers. As of December 31, 2011, the Company has not experienced any significant losses on its accounts receivable.
Most of the products developed by the Company require clearance from the FDA or corresponding foreign regulatory agencies prior to commercial sales. The Company received CE Mark approval to market its Sensei system in Europe in the fourth quarter of 2006 and received CE Mark approval to market its Artisan catheter in Europe in May 2007. The Company received FDA clearance for the marketing of its Sensei system and Artisan catheters for manipulation, positioning and control of certain mapping catheters during electrophysiology procedures in the United States in May 2007. The Company received CE Mark approval to market its Lynx catheter in Europe in September 2010. The Company received CE Mark approval for its Magellan Robotic System in July 2011 and received CE Mark approval for the NorthStar Robotic Catheter and related accessories designed for use with the Magellan Robotic System in September 2011. However, there can be no assurance that current products or any new products the Company develops in the future will receive the clearances necessary to allow the Company to market those products in certain desirable markets. If the Company is denied clearance or clearance is delayed, it could have a material adverse impact on the Company.
The medical device industry is characterized by frequent and extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often difficult to predict, and the outcome may be uncertain until the court has entered final judgment and all appeals are exhausted. The Company’s competitors may assert, and have asserted in the past, that its products or the use of the Company’s products are covered by United States or foreign patents held by them. This risk is heightened due to the numerous issued and pending patents relating to the use of catheter-based procedures in the medical technology field.
Fair Value of Financial Instruments
Carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued liabilities approximate fair value due to their short maturities.
Cash and Cash Equivalents
The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents. Cash and cash equivalents, include money market funds and various deposit accounts, which are readily convertible to cash and are stated at cost, which approximates market.
Short-Term Investments
The Company determines the appropriate classification of investments at the time of purchase and evaluates such classification as of each balance sheet date. The Company classifies all investments with maturities greater than three months at the time of purchase as short-term investments as they are subject to use within one year in current operations. The Company makes investments based upon specific guidelines approved by its board of directors with a view to liquidity and capital preservation and regularly reviews its investments for performance. As of December 31, 2011, all of the Company’s investments have been classified as available-for-sale and are carried on the balance sheet at fair value with the unrealized gains and losses, if any, included in other comprehensive income within stockholders’ equity. Any unrealized losses which are determined to be other than temporary are included in earnings. Realized gains and losses are recognized on the specific identification method.
The Company periodically evaluates its investments for impairment. In the event that the carrying value of an investment exceeds its fair value and the decline in fair value is determined to be other than temporary, an impairment charge is recorded and a new cost basis for the investment is established. In order to determine whether a decline in value is other than temporary, the Company evaluates many factors, including the following: the duration and extent to which the fair value has been less than the carrying value; the company’s financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in the industry; and the Company’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. During the third quarter of 2010, the Company determined that the impairment of its investment in Luna Innovations, Incorporated (together with its wholly-owned subsidiary, “Luna”) common stock was other than temporary. As such, the Company permanently wrote down the value of that investment and recorded a loss of $1,926,000 in other expense on the consolidated statement of operations. In the fourth quarter of 2011, the Company further permanently wrote down the value of the Luna investment and recorded an additional loss of $337,000 in other expense on the consolidated statement of operations. The carrying value of the Company’s initial Luna investment as of December 31, 2011 was $2,158,000. Significant management judgment is required in determining whether an other-than-temporary decline in the fair value of an investment exists. Changes in the Company’s assessment of the valuation of investments could materially impact future operating results and financial position.
Allowance for Doubtful Accounts
The Company establishes allowances for doubtful accounts based on a review of the credit profiles of customers, contractual terms and conditions, current economic trends and historical collection experience. The allowance for doubtful accounts is reassessed each period. If different judgments and estimates were utilized in establishing the allowance, the amount or timing of bad debt expense or revenue recognized could differ materially from the amounts reported. In the Company’s limited historical experience, actual losses and credits related to accounts receivable have been consistent with the recorded provisions. If, however, actual future receipts differ materially from the current assessments due, among other things, to unexpected events or significant changes in trends, additional provisions may be necessary and future cash flows and statements of operations could be materially negatively impacted. Provisions for doubtful accounts as a percentage of revenues have been immaterial for all periods presented.
Inventories
Inventory, which includes material, labor and overhead costs, is stated at standard cost, which approximates actual cost, determined on a first-in, first-out basis, not in excess of market value. The Company records reserves, when necessary, to reduce the carrying value of inventories to their net realizable value.
Property and Equipment, Net
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed using the straight-line method over their estimated useful lives of two to five years. Leasehold improvements are amortized on a straight-line basis over the lesser of their useful life or the term of the lease. Upon retirement or sale, the cost and related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is recognized. Maintenance and repairs are charged to operations as incurred.
Impairment of Long-Lived Assets
The Company evaluates the recoverability of its long-lived assets in accordance with authoritative accounting guidance. When events or changes in circumstances indicate that the carrying value of long-lived assets may not be recoverable, the Company recognizes such impairment if the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows attributable to the assets. In the second quarter of 2009, the Company recorded an impairment loss of $1.1 million of property and equipment related to the termination of its relationship with a subcontractor in Europe for the manufacture of catheters. As of December 31, 2011, the Company had $8.3 million of property and equipment, net. If estimates or the related assumptions change in the future, the Company may record impairment charges to reduce the carrying value of certain groups of these assets. Changes in the valuation of long-lived assets could materially impact the Company’s operating results and financial position.
Stock-Based Compensation
Under the fair value recognition provisions of authoritative guidance related to stock-based compensation, stock-based payment expense is estimated at the grant date based on the fair value of the award and is recognized as expense ratably over the requisite service period of the award. The recording of compensation expense related to stock-based awards is significant to the Company’s financial statements but does not result in the payment of cash by the Company. Determining the appropriate fair value model used to calculate the fair value of stock-based awards requires significant management judgment. Additionally, the calculation of the fair value of stock-based awards requires the Company to make significant estimates and judgments, including the expected
volatility, the expected term of the award and the forfeiture rate. If the Company had chosen a different fair value model or made different estimates in the calculation of fair value, the amount or timing of stock-based compensation recorded could have differed materially from the amounts reported.
The Company selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions in determining the fair value of stock-based awards, including the expected volatility of the underlying stock, the award’s expected term and the forfeiture rate.
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Expected Volatility. The Company’s estimate of volatility is based on a blend of average historical volatilities of its stock price and the volatility of similar entities.
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Expected Term. The Company estimates the expected term based on its historical settlement experience related to vesting and contractual terms while giving consideration to awards that have life cycles less than the contractual terms and vesting schedules in accordance with authoritative guidance.
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Forfeiture Rate. The Company estimates its forfeiture rate based on historical experience and revises these estimates in future periods if actual forfeitures differ from those estimates.
To the extent that future evidence regarding these variables is available and provides estimates that the Company determines are more indicative of actual trends, the Company may refine or change its approach to deriving these input estimates. These changes could significantly impact the stock-based compensation expense recorded in the future.
The Company accounts for compensation expense related to stock-based awards to non-employees in accordance with authoritative guidance and, as such, records the expense of such services based on the estimated fair value of the award using the Black-Scholes pricing model. The value of the award is recognized as expense ratably over the requisite service period of the award.
Research and Development
Research and development costs are charged to expense as incurred. Research and development costs include, but are not limited to, payroll and other personnel expenses, prototype materials, laboratory supplies, and consulting costs.
Income Taxes
The Company accounts for income taxes using the liability method whereby deferred tax asset and liability account balances are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established to reduce deferred tax assets when management estimates, based on available objective evidence, that it is more likely than not that the benefit will not be realized for the deferred tax assets. The Company accounts for uncertainty in income taxes using a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. The Company recognizes interest and penalties related to unrecognized tax benefits as a component of income tax expense.
Comprehensive Loss
Comprehensive loss is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investment owners and distributions to owners. The difference of comprehensive loss from reported net loss relates to net unrealized gains and losses on short-term investments and cumulative translation adjustments related to the Company’s foreign subsidiaries. The Company presents its comprehensive loss in its consolidated statement of stockholders’ equity.
Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is based on the weighted-average common shares outstanding during the period plus dilutive potential common shares. Such dilutive potential shares are excluded when the effect would be to reduce a net loss per share. The Company’s dilutive potential shares, which include outstanding common stock options, estimated shares to be issued under the Company’s employee stock purchase plan and unvested restricted stock, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive.
Recent Accounting Pronouncements
In June 2011, the FASB issued new authoritative accounting guidance related to the presentation of comprehensive income that increases comparability between GAAP and International Financial Reporting Standards. This guidance eliminates the current option to report other comprehensive income (loss) and its components in the consolidated statement of stockholders’ equity. In addition, in December 2011, the FASB issued an amendment to the update that defers indefinitely the requirement to present reclassification adjustments out of accumulated other comprehensive income (loss) on the face of the consolidated statements of operations. The guidance, other than the deferred portion, is effective for the Company’s interim and annual periods beginning January 1, 2012. The Company intends to adopt this guidance in the first quarter of 2012 and will report other comprehensive income (loss) in a separate statement.
In May 2011, the FASB issued new authoritative accounting guidance which amends the existing fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. The Company will adopt this standard in the first quarter of 2012 and the adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements and disclosures.
3. Investments and Fair Value Measurements
Investments
The amortized cost and fair value of investments, with gross unrealized gains and losses, were as follows (in thousands):
The Company periodically assesses whether significant facts and circumstance have arisen to indicate that an impairment, that is other than temporary, of the fair value of any underlying investment has occurred. In the third quarter of 2010, the Company determined that the impairment of its investment in Luna common stock was other than temporary. As such, during the third quarter of 2010, the Company permanently wrote down the value of that investment and recorded a loss of $1,926,000 in other expense on the consolidated statement of operations. In the fourth quarter of 2011, the Company further permanently wrote down the value of the Luna investment and recorded an additional loss of $337,000 in other expense on the consolidated statement of operations. The carrying value of the Company’s initial Luna investment as of December 31, 2011 was $2,158,000.
As of December 31, 2011, investments which are in an unrealized loss position are summarized as follows (in thousands):
None of the above fixed income securities have contractual maturities of more than one year and no investments have been in an unrealized loss position for longer than twelve months.
The gross unrealized losses on fixed income securities were due primarily to changes in interest rates and other market conditions as well as to changes in the credit conditions of the underlying securities. These investments are not considered other-than-temporarily impaired as the gross losses are minor and the Company
has the ability to hold these investments until maturity or until a recovery of fair value occurs. The warrants to purchase corporate equity securities are derivatives and, therefore, unrealized gains and losses are recorded in earnings, regardless of whether any impairment is other than temporary.
Fair Value Measurements
GAAP defines fair value as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, authoritative guidance establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
• Level 1 Inputs
Quoted prices (unadjusted) in active markets for identical assets or liabilities.
• Level 2 Inputs
Inputs other than quoted prices in active markets that are observable either directly or indirectly.
• Level 3 Inputs
Unobservable inputs in which there is little or no market data, which require us to develop our own assumptions.
This hierarchy requires the use of observable market data when available and to minimize the use of unobservable inputs when determining fair value. Investment instruments valued using Level 1 inputs include money market securities and certain of the corporate equity securities which were obtained by the Company as part of the Luna litigation settlement for which there is now not a significant non-marketability issue.
Investment instruments valued using Level 2 inputs include investment-grade corporate debts, such as bonds and commercial paper and U.S. governmental agency securities. The fair value of these investments is determined based on modeling techniques that include inputs such as the credit rating of the company issuing the debt and the observable market value of similarly-termed corporate debts with similar credit ratings.
The warrants to purchase corporate equity securities obtained as a part of the Luna litigation settlement and certain of the corporate equity securities obtained upon the exercise of certain of those warrants are valued using Level 3 inputs. The warrant to purchase corporate equity securities was valued based on an estimate of the number of shares which will be issued over the initial three-year life of the warrant, which were then valued utilizing the Black-Scholes option pricing model. The corporate equity securities obtained upon the exercise of certain of those warrants are initially unregistered and their valuation consists of the quoted stock price adjusted for the impact of the non-marketability during the period in which they are unregistered. The non-marketability discount was determined based primarily on an analysis utilizing the Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the restricted stock over the expected period of non-marketability, which was then corroborated by reviewing published restricted stock studies.
The fair value hierarchy of our cash equivalents and short-term investments is as follows (in thousands):
The following tables present a reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31, 2011 and 2010 (in thousands):
4. Balance Sheet Components
Inventories (in thousands)
Property and equipment, net (in thousands)
Accrued liabilities (in thousands)
5. Agreements with Philips
In February 2011, the Company entered, directly and through a wholly-owned subsidiary, into patent and technology license, sublicense and purchase agreements with Philips to allow them to develop and commercialize the non-robotic applications of the Company’s Fiber Optic Shape Sensing and Localization (“FOSSL”) technology. Under the terms of the agreements, Philips has the exclusive right to develop and commercialize the FOSSL technology in the non-robotic vascular, endoluminal and orthopedic fields. Philips also receives non-exclusive rights in other non-robotic medical device fields, but not to any multi-degree of freedom robotic applications. If Philips does not meet certain specified commercialization obligations, the Company has the rights to re-acquire the licenses granted to Philips for pre-determined payments, which payments in the aggregate would be greater than the upfront payment amounts received by the Company from Philips in connection with the agreements related to the FOSSL technology. The agreement also contains customary representations, warranties and indemnification provisions by each party. Each party may terminate the agreements for material breach by the other party. Philips also has the right to terminate the agreement and its rights under the agreement if the Company is acquired by a competitor of the relevant business unit of Philips. Also in February 2011, the Company amended its extended joint development agreement with Philips, increasing the amount of funding provided by Philips for the development of the Vascular System and potentially extending and increasing certain royalty fees to be paid to
Philips based on sales of the Vascular System, subject to caps based on the amounts Philips contributes to the development of the system. In connection with the agreements, the Company received upfront payments of $23.0 million with respect to the FOSSL technology and $6.0 million with respect to the amendment of the joint development agreement and will be eligible to receive up to an additional $78.0 million in future payments associated with the successful commercialization by Philips or its collaborators of products containing FOSSL technology. Approximately two-thirds of these potential future payments could arise from Philips’ sublicensing the FOSSL technology and approximately one-third of the potential future payments are based on Philips’ royalty obligations on its sales of products containing the FOSSL technology. The Company would receive less than half of Philips’ proceeds for its sublicensing FOSSL technology, if and following Philips entering into an applicable sublicensing transaction. Philips’ FOSSL-related royalty obligations are calculated on a consistent annual basis between 2014 and 2020 and arise in any year only to the extent that Philips achieves a substantial number of commercial placements of FOSSL-enabled products in the calendar year.
The Company allocated the arrangement consideration into two units of accounting based on their relative fair values; the licensing of intellectual property and the amendment of the extended joint development agreement. The two units were valued using discounted cash flows based on projections of potential income and associated costs. Based on these valuations, the Company allocated $23.0 million of the upfront payments to the sale of the intellectual property and $6.0 million to the extension of the extended joint development agreement. The $23.0 million associated with the sale of intellectual property was recognized immediately in net loss. The $6.0 million associated with the amendment of the extended joint development agreement was recognized as a reduction of research and development costs ratably as milestones were met through the end of the term of the agreement, which was October 2011, consistent with how the Company accounted for the previous funding received under the extended joint development agreement. In connection with the extended joint development agreement, the Company recognized reductions to its research and development expenses of $10,563,000 and $3,438,000 in 2011 and 2010, respectively. As of December 31, 2011, the Company had received and recognized all funds related to the amended extended joint development agreement.
6. Litigation Settlement
On January 12, 2010, the Company entered into a series of agreements with Luna Innovations Incorporated and its wholly-owned subsidiary which settled the outstanding litigation between the two companies. According to the terms of the agreements, Luna issued the following to the Company:
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1,247,330 shares of common stock, which at the time of the settlement gave the Company ownership of 9.9% of outstanding Luna common stock.
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A three-year warrant to purchase, from time to time, a number of shares of Luna common stock, at a purchase price of $0.01 per share, such that the total number of shares issuable under the warrant plus the 1,247,330 shares issued above will continue to equal 9.9% of Luna’s shares of common stock outstanding over that period. The warrant contains a “net exercise” provision and is exercisable for three years after January 12, 2010. Neither the warrant nor the shares issuable upon exercise of the warrant have been registered with the Securities and Exchange Commission. As of December 31, 2011, the Company had exercised warrants to purchase approximately 110,000 shares of Luna common stock.
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A secured promissory note in the principal amount of $5,000,000. Payment of principal and interest was to be made in 16 equal consecutive installments of principal and interest commencing April 13, 2010. Subsequent installments were payable on the last business day of each July, October, January and April of each calendar year thereafter, with the last such payment to be due and payable on January 31, 2014. The outstanding principal amount under the note accrued interest at 8.5 percent per annum, payable quarterly in arrears. Under the agreements, Luna could prepay, in whole or in part, the outstanding amount of the note without premium or penalty.
Additionally, Hansen and Luna entered into a Development and Supply Agreement, under which Luna will develop for the Company a localization and shape sensing solution for the Company’s medical robotics system in accordance with the agreed-upon development plan and development milestones, for which the Company will pay Luna for Luna’s development work based on certain agreed upon rates and budgets. The rates charged are equivalent to rates Luna charges for development work under government contracts. Luna will also manufacture and supply the Company with products developed under the agreement at certain agreed-upon pricing. Certain amounts billed under the Development and Supply Agreement in excess of a quarterly limit were settled by a corresponding reduction of the principal of the $5 million note. The principal of the note was reduced by approximately $358,000 in accordance with these terms. In May 2011, Hansen and Luna signed a revised agreement extending the length and scope of the Development and Supply Agreement and under which Luna paid off the remaining balance of the note at a discount. The Company recorded a loss of $190,000 to interest expense in the second quarter of 2011 in conjunction with the payoff of the note.
Under the agreements, Luna granted Hansen a co-exclusive (with Intuitive Surgical, Inc., (“Intuitive”)), royalty-free, fully paid, perpetual and irrevocable license to Luna’s fiber optic shape sensing and localization technology within the medical robotics field and a royalty-free, fully paid, perpetual and irrevocable license to Luna’s fiber optic shape sensing and localization technology for non-robotic medical devices. At the time of the settlement, the Company could not establish a stand-alone value for this technology at its then-current state of development and, as such, did not record a value associated with this technology.
Common Stock
Upon execution of these agreements, Luna issued approximately 1.2 million shares of common stock to the Company. These shares were not registered with the Securities and Exchange Commission and could not be resold except pursuant to an effective registration statement under the Securities Act or an available exemption from registration. These shares were restricted during the initial six months from the date of issuance. The fair value of the shares recorded should reflect the value that market participants would demand due to the value of the shares and the risk relating to the inability to access a public market for these securities for the specified period. The fair value of the unregistered shares was determined as of the market closing price on the dates the shares were issued less a 20% non-marketability discount, for a total value of $4.4 million.
The Company concluded that 20% was an appropriate discount based primarily on an analysis utilizing the Black-Scholes model to value a hypothetical put option to approximate the cost of hedging the restricted stock over the expected period of non-marketability. This approach calculated the amount required to buy the right to sell the presently restricted stock at the then-current market price on the date the holder can count on the shares becoming salable on the public exchange. The assumptions input into the Black-Scholes option pricing model were based on the stock price on the date of the share issuance, an expected term of eight months, expected volatility of 59%, risk-free interest rate of 0.14% and no expected dividends.
The Company corroborated the conclusion indicated by the Black-Scholes model by assessing that the discount was generally consistent with the ranges noted from published restricted stock studies and comparable to discounts on restricted stock transactions completed by other companies operating in similar industries as Luna. The valuation of the shares at December 31, 2011 no longer includes this 20% discount as the original six-month restriction period has ended.
The Company recorded the shares as a short-term available-for-sale security which is marked to market each reporting period with temporary unrealized gains and losses recorded in accumulated other comprehensive income/loss in the equity section of the balance sheet. In the third quarter of 2010, the recorded value of these shares was reduced by $1.9 million as the impairment of the market value of Luna stock was determined to be other than temporary. In the fourth quarter of 2011, the Company further permanently wrote down the value of the Luna investment and recorded an additional loss of $337,000 in other expense on the consolidated statement of operations. If a further reduction in the value of the shares occurs and is considered other than temporary, any such impairment will be recorded as a non-operating expense.
Warrant to Purchase Common Stock
The warrant to purchase shares of common stock was valued based on an estimate of the number of shares which will be issued over the three-year life of the warrant. The number of shares were valued utilizing the Black-Scholes option pricing model based on the stock price on the date of the agreements, expected terms ranging from three months to three years, expected volatility ranging from 53% to 75%, risk-free interest rates ranging from 0.05% to 1.5% and no expected dividends. Shares received upon exercise of warrants are not registered with the Securities and Exchange Commission and cannot be resold except pursuant to an effective registration statement under the Securities Act or an available exemption from registration. Shares received upon exercise of warrants are expected to become salable six months after the date of issuance of the shares. The value of the shares issued is reduced by a marketability discount to arrive at an estimated fair value until the end of the six month period. The total estimated fair value of the warrant was calculated at $583,000 at the date of issuance. As the warrant is a derivative instrument, it is be marked to market each reporting period with unrealized gains and losses recorded as non-operating income or expense.
Summary
Total amounts recorded in relation to the settlement of the litigation with Luna are as follows (in thousands):
7. Commitments and Contingencies
Operating Leases
The Company rents its office and laboratory facilities under operating leases which expire at various dates through June 2015. The Company has an option to extend the lease on its Mountain View, California facility until approximately November 30, 2019. Rent expense on a straight-line basis was as follows (in thousands):
At December 31, 2011, future minimum payments under the leases are as follows (in thousands):
Warranties
Prior to the third quarter of 2009, the Company generally provided a limited one-year warranty on its Sensei system and accrued the estimated cost of warranties at the time revenue was recognized. Beginning in the third quarter of 2009, the Company began providing one year of post-contract customer service on the sale of its
Sensei system. Post-contract customer service revenue is recognized ratably over the term of the service period and associated expenses are charged to cost of revenues as incurred. The Company continues to provide a limited warranty on the sale of catheters. The Company’s warranty obligation may be impacted by product failure rates, material usage and service costs associated with its warranty obligations. The Company periodically evaluates and adjusts the warranty reserve to the extent actual warranty expense differs from the original estimates. Movement in the warranty liability was as follows (in thousands):
License and Royalty Payments
In March 2003, the Company entered into a license agreement with Mitsubishi Electric Research Laboratories, Inc. (“Mitsubishi”) for the use of certain technology. Under the agreement, the Company is obligated to make royalty payments of $100,000 on the effective date of the agreement and on each anniversary thereafter while the license remains exclusive. If the license becomes nonexclusive, the royalty payment will be reduced to $55,000 per year. The license payments terminate upon the expiration of the technology patent in 2018. The Company also issued 9,375 shares of common stock to Mitsubishi in connection with this license agreement.
All amounts paid to Mitsubishi prior to the second quarter of 2007, when the Company commenced commercial operations, and the value of the common stock issued to Mitsubishi were expensed to research and development expense as technology feasibility had not been established and the technology had no alternative future use. Amounts paid to Mitsubishi subsequent to the commencement of commercial operations are expensed to cost of revenues.
In September 2005, the Company entered into a cross license agreement with Intuitive Surgical, Inc. (“Intuitive”). The agreement granted both the Company and Intuitive the right to use each other’s then-existing patents and related patent applications in certain fields of use. Under the terms of the agreement, Intuitive received 125,000 shares of Series B redeemable convertible preferred stock valued at $730,000. These shares were converted to common stock upon completion of the Company’s IPO. The Company also pays royalties to Intuitive on certain product sales, with an annual minimum royalty of $200,000.
The value of the Series B redeemable convertible preferred stock issued to Intuitive was expensed to research and development expense as technology feasibility had not been established for the Company’s underlying product that would potentially utilize the license and there was no alternative future use. Royalties paid to Intuitive subsequent to the commencement of commercial operations are expensed to cost of revenues.
In December 2009, the Company entered into an extended joint development agreement with Philips Medical Systems Nederland B.V., a Philips Healthcare company (“Philips”). The extended joint development agreement was amended in February 2011. Under the terms of the extended joint development agreement, the Company received an aggregate of $14 million from Philips to support the Company’s development of its Magellan Robotic System and NorthStar Robotic Catheter (together, the “Vascular System”). The Vascular System does not include the Company’s Sensei Robotic Catheter System or any system used for endoluminal, cardiac or other non-vascular procedures. Pursuant to the Agreement, Philips partially funded the Company’s development costs for the Vascular System based upon the achievement of development milestones. For up to six years after the initial commercial shipment of the Vascular System, the Company will pay Philips royalties based on the number of Magellan Robotic Systems and NorthStar Robotic Catheters that are sold, subject to caps based on the amounts Philips contributed to the development.
Indemnification
The Company has agreements with each member of its board of directors, its Chief Executive Officer and President and its Chief Financial Officer indemnifying them against liabilities arising from actions taken against the Company. To date, the Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the accompanying financial statements.
The Company has agreements with certain customers indemnifying them against liabilities arising from legal actions relating to the customer’s use of intellectual property owned by the Company. To date, the Company has not incurred any material costs as a result of such indemnifications and has not accrued any liabilities related to such obligations in the accompanying financial statements.
Legal Proceedings
Following the Company’s October 19, 2009 announcement that it would restate certain of its financial statements, a securities class action lawsuit was filed on October 23, 2009 in the United States District Court for the Northern District of California, naming the Company and certain of its officers. Curry v. Hansen Medical, Inc. et al., Case No. 09-05094. The complaint asserts claims for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 on behalf of a putative class of purchasers of Hansen stock between May 1, 2008 and October 18, 2009, inclusive, and alleges, among other things, that defendants made false and/or misleading statements and/or failed to make disclosures regarding the Company’s financial results and compliance with GAAP while improperly recognizing revenue; that these misstatements and/or nondisclosures resulted in overstatement of Company revenue and financial results and/or artificially inflated the Company’s stock price; and that following the Company’s October 19, 2009 announcement, the price of the Company’s stock declined. On November 4, 2009 and November 13, 2009, substantively identical complaints were filed in the Northern District of California by other purported Hansen stockholders asserting the same claims on behalf of the same putative class of Hansen stockholders. Livingstone v. Hansen Medical, Inc. et al., Case No. 09-05212 and Prenter v. Hansen Medical, Inc., et al., Case No. 09-05367. All three complaints seek certification as a class action and unspecified compensatory damages plus interest and attorneys fees. On December 22, 2009, two purported Hansen stockholders, Mina and Nader Farr, filed a joint application for appointment as lead plaintiffs and for consolidation of the three actions. On February 25, 2010, the Court issued an order granting Mina and Nader Farr’s application for appointment as lead plaintiffs and consolidating the three securities class actions. On July 15, 2010, the Court entered an order granting lead plaintiffs’ motion for leave to file a second amended complaint. Lead plaintiffs’ second amended complaint, in addition to alleging that shareholders suffered damages as a result of the decline in the Company’s stock price following the October 19, 2009 announcement, also alleges that shareholders suffered additional damages as the result of share price declines on July 28, 2009, July 31, 2009, January 8, 2009, July 6, 2009, and August 4, 2009, all of which lead plaintiffs allege were caused by the disclosure of what they claim was previously misrepresented information. The defendants’ filed their motion to dismiss the second amended complaint on October 13, 2010. The Court granted Defendants’ motion to dismiss with leave to amend on August 25, 2011. Plaintiffs’ third amended complaint was filed on October 18, 2011. Defendants filed their motion to dismiss on January 9, 2012. The hearing on Defendants’ motion to dismiss is set for April 19, 2012. The Company and the named officers intend to defend themselves vigorously against these actions.
On November 12, 2009, Dawn Cates, a purported stockholder of the Company, filed a shareholder derivative complaint in the Superior Court of the State of California, County of Santa Clara, against the current members of the Company’s board of directors and certain current and former officers of the Company (the “Individual Defendants”), as well as the Company’s former independent auditor, PricewaterhouseCoopers LLP (“PwC”). Cates v. Moll, et al., Case No 09cv157170 (the “Cates Action”). The Cates Action purports to be brought on behalf of the Company. The complaint asserts claims for breach of fiduciary duties and waste of corporate assets against the Individual Defendants, and professional negligence against PwC. The complaint alleges that the Individual Defendants disseminated false and misleading information in the Company’s SEC filings, public statements and other disclosures, failed to maintain adequate internal controls and willfully
ignored problems with accounting and internal control practices and procedures, mismanaged and failed appropriately to oversee the operations of the Company, and wasted corporate assets. The complaint further alleges that the director defendants breached their fiduciary duties by allowing defendant Christopher Sells to resign from the Company. The complaint seeks unspecified damages, internal control and corporate governance reforms, restitution and an award of costs and fees incurred in bringing the action. A substantively identical complaint (although without any claims against PwC) was filed in Santa Clara Superior Court on November 19, 2009. Daneshmand v. Moll, et al., Case No. 09cv157592 (the “Daneshmand Action”). On December 22, 2009, the Santa Clara Superior Court entered an order consolidating the Cates and Daneshmand Actions and renaming the actions as In re Hansen Medical, Inc. Shareholder Derivative Litigation, Case No. 09cv157170. Plaintiffs designated their operative complaint on August 30, 2010. On November 3, 2010, Cates requested to be dismissed as a named plaintiff and subsequently sent a shareholder demand letter to the Company. The action continued with Daneshmand as the sole named plaintiff. The Company has reached a settlement of the Cates and Daneshmand Actions, as well as the Brown Action (see below) and the Cates shareholder demand (see below), all of which will be covered by the Company’s insurance. On January 27, 2012, the Santa Clara Superior Court entered an order preliminarily approving that settlement. The hearing on final approval of the settlement is set for April 6, 2012.
On December 15, 2009, Michael Brown, a purported stockholder of the Company, filed a shareholder derivative complaint in the United States District Court for the Northern District of California. Brown v. Moll, et al., Case No. 09-05881 (the “Brown Action”). The allegations of complaint in the Brown Action are substantively identical to the allegations of the Cates and Daneshmand Actions (the Brown Action does not name PwC as a defendant). On July 21, 2010, the Court in the Brown Action granted Defendants’ Motion to Dismiss on the ground that Plaintiff had not alleged facts sufficient to establish demand futility. The Court granted Plaintiff leave to amend. Plaintiffs filed their amended complaint on August 9, 2010. On November 12, 2010, the Court granted Defendants’ motion to dismiss, with prejudice. Plaintiff filed a Notice of Appeal on December 13, 2010. Briefing on the appeal is complete, although no hearing date has been set. Following the parties’ settlement agreement, the Ninth Circuit placed the appeal in its mediation program so as to monitor the status of the settlement. Plaintiff will dismiss the appeal upon final approval of the settlement by the Santa Clara Superior Court.
On December 1 and December 14, 2009, the Company received letters from counsel for purported Hansen stockholders Naoum Baladi and Robert Rogowski demanding that the Company’s Board of Directors take action to “remedy breaches of fiduciary duty by the directors and certain officers of Hansen and professional negligence by the Company’s outside auditor PricewaterhouseCoopers, LLP.” These letters recite essentially the same allegations as are contained in the Cates Action and demand that the Board take action against the officers and directors, and PwC, to recover damages incurred by the Company and to correct deficiencies in the Company’s internal controls. The letters state that if, within a reasonable time, the Board has not commenced the requested action or if the Board refuses to commence the requested action, the named stockholders will commence derivative actions. On July 9, 2010, the Company received a letter from counsel for purported Hansen stockholder Kathy Fox demanding that the Company investigate and bring legal action to remedy “possible breaches of fiduciary duty and other potential violations of law” by certain directors, officers and insiders of the Company. The Board, with the assistance of an independent counsel, has completed its investigation regarding the allegations set forth by Baladi, Rogowski, and Fox in their letters. The Board has notified counsel for each of Baladi, Rogowski and Fox that it has determined, in the exercise of its business judgment, that any litigation would not be in the best interests of the Company, and it affirmatively objects to the commencement of any litigation on behalf of the Company. On January 11, 2011, the Company received a letter from counsel for purported Hansen stockholder Dawn Cates demanding the Board take action to remedy “possible breaches of fiduciary duty and other potential violations of law” by certain directors, officers and insiders of the Company, and PwC. On January 18, 2011 the Board responded to counsel for Cates, indicating that it has “determined, in the exercise of its business judgment, that any litigation would not be in the best interests of the Company, and it affirmatively objects to the commencement of any litigation on behalf of the Company.” As discussed above, the Company has reached a tentative settlement of the Cates shareholder demand.
On October 6, 2011, the Securities and Exchange Commission (“Commission”) accepted the Company’s Offer of Settlement (“Offer”) to resolve a pending investigation by the Commission staff. Pursuant to the settlement, the Company consented to the entry of an administrative order (“Order”) directing the Company to cease and desist from committing or causing violations of the disclosure, periodic reporting, books and records and internal control provisions of the federal securities laws in Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 (“Securities Act”), Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 (“Exchange Act”) and under Rules 12b-20, 13a-1 and 13a-13 promulgated thereunder. The Company consented to the entry of the Order without admitting or denying the factual findings or legal conclusions contained in the Order. The Commission did not charge any of the Company’s directors or current officers or employees with any violations, and did not seek any penalty or other monetary relief against the Company. The entry of the Order fully resolves the SEC investigation of the Company relating to the issues surrounding the restatement.
The Company cannot estimate whether any of the above actions will result in any significant expenses nor the amount of any such expenses. No amounts have been accrued for any of the preceding actions based on the uncertainly of the outcomes. However, depending on the outcome of these legal actions and investigations, we may be required to pay material damages and fines, consent to injunctions on future conduct, or suffer other penalties, remedies or sanctions. The ultimate resolution of these matters could have a material adverse effect on the Company’s results of operations, financial position and liquidity.
8. Long-term Debt
In December 2011, the Company entered into a $30.0 million loan and security agreement with Oxford Finance LLC (“Oxford”), Silicon Valley Bank (“SVB”) and Oxford as the collateral agent, or Collateral Agent, with $20.0 million of the loan provided by Oxford and $10.0 million provided by SVB. In connection with the loan and security agreement, the Company and SVB terminated their previous loan agreement and the Company used approximately $3.4 million of the proceeds to pay off their existing obligations on that loan. Under the agreement, the Company is obligated to pay interest only on the loan through December 31, 2012, provided that the interest only period will be extended through June 30, 2013 if the Company receives approval from the U.S. Food and Drug Administration for its Magellan Robotic System prior to December 31, 2012. The loan bears interest at a stated rate of 9.45% and includes a final interest payment of 3.95% of the original principal. Payments on the loan continue through January 1, 2016. At the Company’s option, it may prepay all of the outstanding principal balance, subject to a pre-payment fee of (a) 3.00% of the principal amount of the loan then outstanding if the prepayment is made on before the second anniversary of the funding of the loan or (b) 1.50% of the principal amount of the loan then outstanding if the prepayment is made after the second anniversary of the funding of the loan.
In connection with the execution of the loan and security agreement, the Company issued warrants to purchase 660,793 shares of common stock. The warrants have an exercise price of $2.27 per share and expire in December 2018. The fair value of the warrants was estimated at $868,000 using the Black-Scholes valuation model with the following assumptions: expected volatility of 58.0%, risk free interest rate of 1.41%, expected life of 7 years and no dividends. The fair value of the warrants was recorded as a discount to the loan and is being amortized to interest expense using the effective interest rate method over the term of the loan. A total of $15,000 was amortized to interest expense in 2011.
The loan is collateralized by substantially all of the Company’s assets then owned or thereafter acquired, other than its intellectual property, and all proceeds and products thereof, and the Company agreed to a negative pledge on its intellectual property. Two of the Company’s wholly-owned subsidiaries, AorTx, Inc. and Hansen Medical International, Inc., entered into an unconditional guaranty and a security agreement with the Collateral Agent pursuant to which they guaranteed the Company’s obligations under the loan with a first priority security interest in their assets, excluding such subsidiaries’ intellectual property. The Company additionally agreed to pledge to Oxford and SVB shares of each of its direct and indirect subsidiaries as collateral for the loan. The Company is also subject to certain affirmative and negative covenants, including a requirement to maintain a
certain level of liquidity. The loan also limits the Company’s ability to (a) undergo certain change of control events; (b) convey, sell, lease, transfer, assign or otherwise dispose of any of its assets; (c) create, incur, assume, or be liable with respect to certain indebtedness, not including, among other items, subordinated debt; (d) grant liens; (e) pay dividends and make certain other restricted payments; (f) make certain investments; (g) make payments on any subordinated debt; or (g) enter into transactions with any of its affiliates outside of the ordinary course of business, or permit its subsidiaries to do the same. In addition, subject to certain exceptions, the Company is required to maintain its primary deposit accounts, securities accounts and commodities with SVB and to do the same for each of its domestic subsidiaries. In the event the Company were to violate any covenants or if Oxford or SVB believes that the Company has violated any covenants including a significant adverse event clause, and such violations are not cured pursuant to the terms of the loan and security agreement, the Company would be in default under the loan and security agreement, which would entitle Oxford or SVB to exercise their remedies, including the right to accelerate the debt, upon which the Company may be required to repay all amounts then outstanding under the loan and security agreement. As of December 31, 2011, the Company was in compliance with all financial covenants.
Future annual payments due on the debt outstanding as of December 31, 2011 are as follows (in thousands):
The fair value of the Company’s long-term debt was estimated to be $29.1 million at December 31, 2011 based on the then-current rates available to the Company for debt of a similar term and remaining maturity. The Company determined the estimated fair value amount by using available market information and commonly accepted valuation methodologies which include significant unobservable inputs (Level 3.) However, considerable judgment is required in interpreting market data to develop estimates of fair value. Accordingly, the fair value estimate presented herein is not necessarily indicative of the amount that the Company or holders of the instruments could realize in a current market exchange. The use of different assumptions and/or estimation methodologies may have a material effect on the estimated fair value.
9. Employee Benefit Plan
The Company has a 401(k) income deferral plan (the “Plan”) for employees. According to the terms of the Plan, the Company may make discretionary matching contributions to the Plan. The Company made no discretionary contributions during the years ended December 31, 2011, 2010 and 2009.
10. Redeemable Convertible Preferred Stock
The Company’s Restated Certificate of Incorporation, as amended, currently authorizes 10,000,000 shares of $0.0001 par value redeemable convertible preferred stock (“preferred stock”). As of December 31, 2011 and 2010, there were no shares of preferred stock issued or outstanding as all shares of preferred stock converted to shares of common stock upon completion of the Company’s IPO.
11. Stockholders’ Equity
Common Stock
The Company’s Restated Certificate of Incorporation, as amended, authorizes the Company to issue 100,000,000 shares of $0.0001 par value common stock. The holder of each share of common stock is entitled to one vote. Common stockholders are entitled to dividends as and when declared by the board of directors, subject to the rights of holders of all classes of stock outstanding having priority rights as to dividends. There have been no dividends declared to date.
The Company has issued certain shares of common stock under restricted stock purchase agreements. For founders and employees of the Company these agreements contained provisions for the repurchase of unvested shares by the Company at the original issuance price for individuals who terminate their employment. The repurchase rights generally lapse over approximately three to four years. At December 31, 2011, there were no unvested shares issued under restricted stock purchase agreements.
Stock Option and Equity Incentive Plans
2002 Stock Option Plan
The Company’s 2002 Stock Option Plan (the “2002 Plan”) was created for the purpose of issuing stock options to employees, directors and consultants of the Company. Options granted under the 2002 Plan were either incentive stock options (“ISO”) or nonqualified stock options (“NSO”). ISOs may be granted only to Company employees (including officers and directors), whereas NSOs may be granted to Company employees and consultants. Options expire on terms as determined by the board of directors but not more than ten years after the date of grant. The Company reserved a total of 4,579,009 shares of its common stock for issuance under its 2002 Plan. Upon effectiveness of the Company’s IPO in November 2006, the Company ceased issuing stock options under the 2002 Plan. At that time, all shares remaining available for grant under the 2002 Plan became available for grant instead under the 2006 Equity Incentive Plan. However, cancelled shares under the 2002 Plan do not become available for grant under the 2006 Equity Incentive Plan. All outstanding options granted under the 2002 Plan continue to be administered under the 2002 Plan.
Stock options granted under the 2002 Plan provided employee option holders the right to elect to exercise unvested options in exchange for restricted common stock. Unvested shares were subject to a repurchase right held by the Company at the original issuance price in the event the optionees’ employment is terminated either voluntarily or involuntarily. For exercises of employee options, this right usually lapsed 25% on the first anniversary of the vesting start date and in 36 equal monthly amounts thereafter. These repurchase terms were considered to be a forfeiture provision and did not result in variable accounting. In accordance with authoritative accounting guidance, the cash received from employees for exercise of unvested options was treated as a refundable deposit shown as a liability in the Company’s financial statements. Total cash received for early exercise of options was $184,000. As of December 31, 2011, there were no unvested shares outstanding.
2006 Equity Incentive Plan
In August 2006, the Company’s board of directors approved the 2006 Equity Incentive Plan (the “2006 Plan”) to be effective on the date of the Company’s IPO. The 2006 Plan provides for the grant of ISOs, nonstatutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights, performance-based stock awards, and other forms of equity compensation, or collectively, stock awards, and performance-based cash awards, all of which may be granted to employees, including officers, non-employee directors and consultants. Options expire on terms as determined by the board of directors but not more than ten years after the date of grant.
The Company initially reserved a total of 2,000,000 shares for issuance under the 2006 Plan in addition to those shares which remained available for grant under the 2002 Plan. In addition, the number of shares of common stock reserved for issuance under the 2006 Plan automatically increases on January 1st each year by the
lowest of (a) 4% of the total number of shares of our common stock outstanding on December 31st of the preceding calendar year, (b) 3,500,000 shares, or (c) a number determined by the board of directors that is less than (a) or (b). At December 31, 2011, 1,254,000 shares were available for grant under the 2006 Plan.
Option activity under both the 2002 Plan and the 2006 Plan for 2011 is as follows:
The weighted-average grant-date fair value of options granted in 2011, 2010 and 2009 was $1.32, $1.00 and $1.72 per share, respectively. The total fair value of options that vested in 2011, 2010 and 2009 was $2,958,000, $4,201,000 and $6,796,000, respectively. As of December 31, 2011, total unamortized stock-based compensation related to unvested stock options was $3,683,000, with a weighted-average remaining recognition period of 2.52 years.
The intrinsic value of exercised stock options is calculated based on the difference between the exercise price and the quoted market price of the Company’s common stock as of the close of the exercise date. The total intrinsic value of stock options exercised in 2011, 2010 and 2009 was $510,000, $91,000 and $570,000, respectively.
The options outstanding, vested and currently exercisable by exercise price under both the 2002 Plan and the 2006 Plan at December 31, 2011 are as follows:
Restricted stock unit activity under the 2006 Plan is as follows:
The fair value of restricted stock units is the quoted market price of the Company’s common stock as of the close of the grant date. The total fair value of shares vested pursuant to restricted stock units in 2011, 2010 and 2009 was $907,000, $40,000 and $1,030,000, respectively. As of December 31, 2011, total unamortized stock-based compensation related to unvested restricted stock units was $428,000, with a weighted-average remaining recognition period of 1.73 years.
Stock-based Compensation Associated with Awards to Employees
Stock-based compensation expense charged to operations for options and restricted stock units granted to employees in 2011, 2010 and 2009 was $6,676,000, $4,955,000 and $7,397,000, respectively.
In 2011, the Company modified stock option agreements with an exiting employee. The modification consisted of acceleration of vesting. The modifications resulted in the recording of additional employee stock compensation expense of $634,000 in 2011.
The Company uses the Black-Scholes pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant is affected by our stock price as well as assumptions regarding a number of complex and subjective variables as follows:
Expected Volatility. As the Company has only been a public entity since November 2006, volatility is computed based on the Company’s volatility as well as on that of “guideline” companies. In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size.
Risk-Free Interest Rate. The risk-free rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.
Expected Term. Under the Company’s Plans, the expected term of options granted is determined using the average period the stock options are expected to remain outstanding and is based on the options vesting term, contractual terms and historical exercise and vesting information used to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior.
Expected Dividend Rate. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
Forfeitures. Authoritative accounting guidance also requires the Company to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards,
which are generally the vesting periods. If the Company’s actual forfeiture rate is materially different from its estimate, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.
The estimated grant date fair values of the employee stock options and restricted stock units were calculated using the following assumptions:
Stock-Based Compensation for Non-employees
Stock-based compensation expense related to stock options granted to non-employees is recognized on an accelerated basis as the stock options are earned. The final measurement occurs at the later of a performance commitment or when performance is complete. The Company believes that the fair value of the stock options is more reliably measurable than the fair value of the services received. The fair value of the stock options granted is calculated at each reporting date using the Black-Scholes option pricing model.
Stock-based compensation expense charged to operations for options granted to non-employees for the years ended December 31, 2011, 2010 and 2009 was $0, $49,000 and $(18,000), respectively. The estimated grant date fair values of the non-employee stock options were calculated using the following assumptions:
2006 Employee Stock Purchase Plan
In August 2006, the Company’s board of directors approved the 2006 Employee Stock Purchase Plan (the “Stock Purchase Plan”) which became effective upon the Company’s IPO. Commencing on January 1, 2007, the Stock Purchase Plan allows participating employees to contribute up to 15% of their earnings, up to a maximum of $25,000, to purchase shares of the Company’s stock at a price per share equal to the lower of (a) 85% of the fair market value of a share of our common stock on the first date of the offering period, or (b) 85% of the fair market value of a share of our common stock on the date of purchase. The Company’s board of directors may specify offerings with durations of not more than 27 months, and may specify shorter purchase periods within each offering. Each offering will have one or more purchase dates on which shares of the Company’s common stock will be purchased for employees participating in the offering.
The Company initially reserved a total of 625,000 shares of common stock for issuance under the Stock Purchase Plan. In addition, the plan provides for automatic increases on January 1st, from January 1, 2007 through January 1, 2016, by the lesser of (a) 2% of the total number of shares of common stock outstanding on December 31st of the preceding calendar year, (b) 750,000 shares of common stock or (c) a number determined by the board of directors that is less than (a) and (b).
The estimated fair values of the shares issued under the Stock Purchase Plan were calculated using the following assumptions:
Total Stock-based Compensation
Total stock-based compensation expense was allocated to cost of revenues, research and development and selling, general and administrative expense as follows (in thousands):
Fair Value Estimates
The Company’s determination of fair value of stock-based awards on the date of grant using the Black-Scholes pricing model is impacted by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. To the extent that future evidence regarding these variables is available and provides estimates that the Company determines are more indicative of actual trends, the Company may refine or change its approach to deriving these input estimates. These changes could significantly impact the stock-based compensation expense recorded in the future and materially impact future operating results.
12. Income Taxes
The Company’s pre-tax loss consists of the following:
Subsequent to the issuance of the December 31, 2010 consolidated financial statements, the Company identified an error in the computation of the effective tax rate for the years ended December 31, 2010 and 2009 and the deferred tax asset as of December 31, 2010. The Company has corrected the error in the tables below:
The correction had no net effect on the previously presented effective tax rate and net deferred tax asset.
The Company’s effective tax rate differs from the U.S. federal statutory rate as follows:
The tax effects of temporary differences and carryforwards that give rise to significant portions of the deferred tax assets are as follows (in thousands):
At December 31, 2011, the Company has federal and state net operating loss carryforwards of approximately $179,143,000 and $162,800,000, respectively, available to offset future taxable income. These net operating loss carryforwards will expire in varying amounts from 2012 through 2031 if not utilized. The Company has federal and California tax credit carryforwards of $6,991,000 and $5,857,000, respectively, available to offset future taxes payable. The federal credits begin to expire in 2022, while the state credits have no expiration.
The Company recognizes a tax benefit upon expensing certain stock-based awards associated with its stock-based compensation plans, including nonqualified stock options, restricted stock awards and restricted stock unit awards. The Company also establishes a deferred tax benefit on these types of stock-based awards. Under current accounting standards the Company cannot recognize tax benefits currently for stock-based compensation expenses associated with incentive stock options and employee stock purchase plan shares (qualified stock options). The Company also cannot establish a deferred tax benefit on costs associated with incentive stock options and employee stock purchase plan shares (qualified stock options). For qualified stock options the Company recognizes tax benefits only in the period when disqualifying dispositions of the underlying stock occur. Included in the Company’s net operating loss carryforwards are amounts which arose from the exercise of nonqualified stock options, and vesting of restricted stock awards and restricted stock unit awards, as well as disqualifying dispositions of qualified stock options. The excess, if any, of the tax benefits from such amounts over that recognized as an expense will be reflected as an increase to paid-in capital, when realized.
Due to uncertainty surrounding realization of the deferred tax assets in future periods, the Company has placed a 100% valuation allowance against its net deferred tax assets. The valuation allowance increased by $5,700,000, $15,333,000 and $18,652,000 during the years ended December 31, 2011, 2010 and 2009, respectively. At such time as it is determined that it is more likely than not that the deferred tax assets are realizable, the valuation allowance will be reduced. Sections 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for annual limitations on the utilization of net operating loss and research and experimentation credit carryforwards if the Company were to undergo an ownership change, as defined in Section 382. As the result of the sale by the Company of 11,700,000 shares of Common Stock in April 2009, the sale by the Company of 16,100,000 shares of common stock in April 2010 and the sale by the Company of 4,785,000 shares of common stock in November 2011, such an ownership change may have occurred. Accordingly, the Company’s utilization of net operating loss and credit carryforwards which existed at that time could be limited.
The Company has not provided for U.S. federal income and foreign withholding taxes on any undistributed earnings from non-U.S. operations because such earnings are intended to be reinvested indefinitely outside of the United States. If these earnings were distributed, foreign tax credits may become available under current law to reduce or eliminate the resulting U.S. income tax liability. As of December 31, 2011, there is $681,000 in cumulative foreign earnings upon which U.S. income taxes have not been provided.
A reconciliation of the beginning and ending balance of unrecognized tax benefits is as follows (in thousands):
If the Company is able to eventually recognize these uncertain tax positions, all of the unrecognized benefit would reduce the Company’s effective tax rate. The Company currently has a full valuation allowance against its net deferred tax asset which would impact the timing of the effective tax rate benefit should any of these uncertain tax positions be favorably settled in the future. While it is often difficult to predict the final outcome of
any particular uncertain tax position, management does not believe that it is reasonably possible that the estimates of unrecognized tax benefits will change significantly in the next twelve months.
As of December 31, 2011, the Company’s federal and state tax returns are open to examination for the years 2008 forward and 2007 forward, respectively. In addition, all of the net operating loss and research and development credit carryforwards that may be used in future years are still subject to adjustment. There are no tax examinations currently in progress.
13. Net Loss per Share
The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):
The following securities that could potentially dilute basic net loss per share are not included in the calculation of diluted net loss per share because to do so would be anti-dilutive as of the end of each period presented (in thousands):
14. Segment Information
The Company operates its business in one operating segment: the development and marketing of medical devices. The Company’s chief operating decision maker is its Chief Executive Officer who reviews the financial information presented on a consolidated basis for the purpose of making operating decisions and assessing financial performance.
The Company attributes revenues to different geographic areas on the basis of the location of the customer and attributes long-lived assets to different geographic areas based on the location of those assets. Information regarding geographic areas is as follows (in thousands):
15. Quarterly Data (unaudited)
The following table represents certain unaudited quarterly information for the eight quarters ended December 31, 2011. This data has been derived from unaudited consolidated financial statements that, in the opinion of the Company’s management, include all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of such information when read in conjunction with the Company’s annual audited consolidated financial statements and notes thereto appearing elsewhere in this report. These operating results are not necessarily indicative of results for any future period (in thousands, except per share data):
(1) Net income and basic and diluted net income per share for the first quarter of 2011 include the impact of the gain on sale of intellectual property of $23.0 million.
(2) Net loss and basic and diluted net loss per share for the first quarter of 2010 include the impact of the gain on the settlement of the litigation with Luna Innovations, Inc. of $10.0 million.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our senior management is responsible for establishing and maintaining a system of disclosure controls and procedures (as defined in Rule 13a-15e and 15d-15e under the Securities Exchange Act of 1934 (the “Exchange Act”)) designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including its principal executive officer or officers and principal financial officer or officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Management, including our Chief Executive Officer and Chief Financial Officer, performed an evaluation of our disclosure controls and procedures as defined under the Exchange Act as of December 31, 2011. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2011.
Management’s Report on Internal Control Over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP and includes those policies and procedures that:
i. Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of assets of the company
ii. Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Company; and
iii. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdowns resulting from human failures. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 31, 2011. In making its assessment of internal control over financial reporting, management used the criteria described in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our assessment under this framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2011.
The effectiveness of our internal control over financial reporting as of December 31, 2011 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in their report which appears in this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated our “internal control over financial reporting” as defined in Exchange Act Rule 13a-15(f) to determine whether any changes in our internal control over financial reporting occurred during the fourth quarter of 2011 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there were no changes in our internal control over financial reporting during the quarter ended December 31, 2011 that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.
Limitations of the Effectiveness of Controls
We are committed to continuing to improve our internal control processes and will continue to diligently review our financial reporting controls and procedures in order to ensure compliance with the requirements of the Sarbanes-Oxley Act and the related rules promulgated by the Securities and Exchange Commission. However, because of the inherent limitations in all control systems, any control system, regardless of how well designed, operated and evaluated, can provide only reasonable, not absolute, assurance that the control objectives will be met. The design of any system of controls is based, in part, on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this Item concerning our directors and executive officers is incorporated herein by reference to information contained in the sections of our Proxy Statement for our 2012 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of our fiscal year ended December 31, 2011 (the “2012 Proxy Statement”) entitled “Proposal 1 Election of Directors,” “Corporate Governance - Code of Business Conduct and Ethics,” “Corporate Governance - Audit Committee,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
Item 11.
Item 11. Executive Compensation.
The information required by this Item is incorporated herein by reference to the sections of our 2012 Proxy Statement entitled “Executive Compensation,” “Compensation Discussion and Analysis,” “Corporate Governance - Compensation Committee Interlocks and Insider Participation,” “Compensation Committee Report” and “Corporate Governance - 2011 Director Compensation Table.”
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this Item is incorporated herein by reference to the sections of our 2012 Proxy Statement entitled “Securities Authorized for Issuance under Equity compensation Plans,” “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation.”
Item 13.
Item 13. Certain Relationships and Related Transactions and Director Independence.
The information required by this Item is incorporated herein by reference to the section of our 2012 Proxy Statement entitled “Certain Relationships and Related Party Transactions.”
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this Item is incorporated herein by reference to the section of our 2012 Proxy Statement entitled “Ratification of Selection of Independent Registered Public Accounting Firm - Principal Accountant Fees and Services.”
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENTS and FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Schedules: Financial Statements for the three years ended December 31, 2011 are included in Part II, Item 8. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
(b) Exhibits: The list of exhibits on the Exhibit Index on pages 130 through 133 of this report is incorporated herein by reference.
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.
By:
/s/ Bruce J Barclay
Dated: March 15, 2012
President and Chief Executive Officer
(Principal Executive Officer)
POWERS OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Bruce J Barclay and Peter J. Mariani, and each of them, as his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them or their substitutes may lawfully do or cause to be done by virtue hereof.
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 and in the capacities and on the dates indicated.
EXHIBIT INDEX
(1) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on November 19, 2007 and incorporated herein by reference.
(2) Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K, filed on March 28, 2007 and incorporated herein by reference.
(3) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on February 16, 2007 and incorporated herein by reference.
(4) Previously filed as an exhibit to Registrant’s Registration Statement on Form S-1, as amended, originally filed on August 16, 2006 and incorporated herein by reference.
(5) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on August 14, 2007 and incorporated herein by reference.
(6) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on November 2, 2007 and incorporated herein by reference.
(7) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on April 9, 2008 and incorporated herein by reference.
(8) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on August 5, 2008 and incorporated herein by reference.
(9) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on August 27, 2008 and incorporated herein by reference.
(10) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on May 8, 2009 and incorporated herein by reference.
(11) Previously filed as an exhibit to Registrant’s Registration Statement on Form S-8, filed on May 8, 2009 and incorporated herein by reference.
(12) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on November 16, 2009 and incorporated herein by reference.
(13) Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K, filed on March 16, 2010 and incorporated herein by reference.
(14) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on May 10, 2010 and incorporated herein by reference.
(15) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on April 20, 2010 and incorporated herein by reference.
(16) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on August 6, 2010 and incorporated herein by reference.
(17) Previously filed as an exhibit to Registrant’s Annual Report on Form 10-K, filed on March 16, 2011 and incorporated herein by reference.
(18) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on May 10, 2011 and incorporated herein by reference.
(19) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on August 8, 2011 and incorporated herein by reference.
(20) Previously filed as an exhibit to Registrant’s Quarterly Report on Form 10-Q, filed on November 7, 2011 and incorporated herein by reference.
(21) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on November 7, 2011 and incorporated herein by reference.
(22) Previously filed as an exhibit to Registrant’s Current Report on Form 8-K, filed on December 9, 2011 and incorporated herein by reference.
+ Indicates management contract or compensatory plan.
* Confidential treatment has been granted with respect to certain portions of this exhibit.
*** The certifications attached hereto as Exhibits 32.1 and 32.2 accompany this Annual Report on Form 10-K are not deemed filed with the U.S. Securities and Exchange Commission and are not to be incorporated by reference into any filing of Hansen Medical, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-K, irrespective of any general incorporation language contained in such filing.