Table of Contents

As filed with the Securities and Exchange Commission on March 19, 2007

Registration No. 333-140115

 


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Amendment No. 1

to

Form S-1

REGISTRATION STATEMENT

Under

THE SECURITIES ACT OF 1933


CARDIOMEMS, INC.

(Exact name of registrant as specified in its charter)


 

Delaware   3841   58-2621266

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)


75 Fifth Street, N.W., Suite 440

Atlanta, GA 30308

(404) 920-6700

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)


Jay S. Yadav, M.D.

Chairman of the Board and Chief Executive Officer

75 Fifth Street, N.W., Suite 440

Atlanta, GA 30308

(404) 920-6700

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 


Copies to:

 

Frank F. Rahmani, Esq.

John T. McKenna, Esq.

Cooley Godward Kronish LLP

Five Palo Alto Square

3000 El Camino Real

Palo Alto, CA 94306-2155

(650) 843-5000

 

Charles K. Ruck, Esq.

B. Shayne Kennedy, Esq.

Latham & Watkins LLP

650 Town Center Drive, 20th Floor

Costa Mesa, CA 92626-1925

(714) 540-1235

 


Approximate date of commencement of proposed sale to the public:     As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ¨


The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment that specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 



Table of Contents

The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and is not soliciting offers to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MARCH 19, 2007

Prospectus

                     Shares

LOGO

Common Stock

 


CardioMEMS, Inc. is offering              shares of common stock. This is our initial public offering, and no public market currently exists for our shares. We anticipate that the initial public offering price will be between $         and $         per share. After the offering, the market price for our shares may be outside this range.

 


We have applied to list our common stock on the NASDAQ Global Market under the symbol “SENS.”

 


Investing in our common stock involves a high degree of risk. See “ Risk Factors ” beginning on page 8.

 


         Per Share      Total    

Offering Price

     $                  $            

Discounts and commissions to underwriters

     $                  $            

Offering proceeds to CardioMEMS, before expenses

     $                  $            

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense.

We have granted the underwriters the right to purchase up to              additional shares of common stock to cover any over-allotments. The underwriters can exercise this right at any time within 30 days after the offering. The underwriters expect to deliver the shares on or about                 , 2007.

 

Banc of America Securities LLC

 


CIBC World Markets

 


 

Jefferies & Company   Pacific Growth Equities, LLC

                , 2007


Table of Contents

LOGO

 

Cardiomems

CAUTION: Investigational device. Limited by Federal law to investigational use and not cleared or approved for commercial sale by any regulatory agency.


Table of Contents

LOGO

 

WIRELESS SENSING DESIGNED FOR PROACTIVE MANAGEMENT OF HEART FAILURE PATIENTS*

For patients with heart failure, a miniature wireless sensor is inserted into the pulmonary artery through a minimally invasive procedure.

An external electronics module and a flat, flexible antennae allows for collection and transmission of patient data to our secure database.

The patient’s physician is able to access this data via the Internet, enabling proactive patient management.

*CAUTION: Investigational device. Limited by Federal law to investigational use and not cleared or approved for commercial sale by any regulatory agency.


Table of Contents

LOGO

CARDIOMEMS WIRELESS PRESSURE SENSORS*

Implanted in Pulmonary Artery

Heart Failure

Pulmonary Hypertension

Implanted in Aorta

(Cleared for use in the U.S.)

Abdominal Aortic Aneurysm

Thoracic Aortic Aneurysm

Implanted in Radial Artery

Hypertension

Small, portable external electronics module.

*CAUTION: Investigational devices. Limited by Federal law to investigational use and not cleared or approved for commercial sale by any regulatory agency.


Table of Contents

You should rely only on the information contained in this prospectus and any free-writing prospectus that we authorize to be distributed to you. We have not, and the underwriters have not, authorized anyone to provide you with information different from or in addition to that contained in this prospectus or any related free-writing prospectus. If anyone provides you with different or inconsistent information, you should not rely on it. We are offering to sell, and are seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of the common stock. Our business, financial conditions, results of operations and prospects may have changed since that date.

We have a registered trademark in the United States and the United Kingdom in “CardioMEMS” and have applied for additional trademark registrations of, or claim trademark rights in, such name in the United States and in several international jurisdictions. We have also applied for trademark registrations of, or claim trademark rights in, “EndoSure” as well as the CardioMEMS logo. All other trademarks, trade names and service marks appearing in this prospectus are the property of their respective owners.

 


TABLE OF CONTENTS

 

       Page

Summary

   1

Risk Factors

   8

Forward-Looking Statements

   31

Use of Proceeds

   32

Dividend Policy

   32

Capitalization

   33

Dilution

   35

Selected Financial Data

   38

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   40

Business

   53

Management

   81

Compensation Discussion and Analysis

   86

Certain Relationships and Related Party Transactions

   104

Principal Stockholders

   108

Description of Capital Stock

   110

Shares Eligible for Future Sale

   114

Certain Material U.S. Tax Consequences for Non-U.S. Holders of Common Stock

   116

Underwriting

   119

Legal Matters

   124

Experts

   124

Where You Can Find Additional Information

   124

Index to Financial Statements

   F-1

 


 

i


Table of Contents

SUMMARY

The following summary is qualified in its entirety by, and should be read together with, the more detailed information and financial statements and related notes thereto appearing elsewhere in this prospectus. Before you decide to invest in our common stock, you should read the entire prospectus carefully, including the “Risk Factors” section and the financial statements and related notes included in this prospectus.

Our Business

Overview

We are a medical device company that has developed and is commercializing a proprietary wireless sensing and communication technology for the human body. Our technology platform is designed to improve the management of severe chronic cardiovascular diseases such as heart failure, aneurysms and hypertension. Our miniature wireless sensors can be implanted using minimally invasive techniques and transmit cardiac output, blood pressure and heart rate data that are critical to the management of patients. Due to their small size, durability, and lack of wires and batteries, our sensors are designed to be permanently implanted into the cardiovascular system. Using radiofrequency, or RF, energy, our sensors transmit real-time data to our external electronics modules, which then communicate this information to the patient’s physician. We believe frequent, on-demand, real-time monitoring of vital information enables proactive patient management, which holds the promise of reducing hospitalizations, improving a patient’s quality of life and delivering more efficient and cost effective health care.

Our first commercial device, the EndoSure Wireless AAA Pressure Measurement System, or EndoSure system, is comprised of an implanted sensor and an external electronics module. The EndoSure Wireless AAA Pressure Sensor, or EndoSure sensor, is inserted during the minimally invasive cardiovascular repair of an abdominal aortic aneurysm via a catheter into a patient’s aneurysm sac and measures and communicates pressure information to an external electronics module from inside the sac. Since a goal of the endovascular repair procedure of abdominal aortic aneurysms is to eliminate or minimize pressure on the walls of the aneurysm sac, our EndoSure sensor is a valuable tool in helping a physician to determine during the procedure if the abdominal aortic aneurysm has been adequately repaired. The EndoSure system was cleared by the U.S. Food and Drug Administration, or FDA, in October 2005, for measuring intrasac pressure during endovascular repair of abdominal aortic aneurysms and is used alongside traditional angiography. In March 2007, our EndoSure system was cleared by the FDA for measuring intrasac pressure during thoracic aortic aneurysm repair. Our FDA clearance does not allow us to promote the EndoSure system as a replacement for traditional angiography or for measuring pressure after the procedure. We plan on conducting clinical trials to seek FDA clearance for measuring pressure after a procedure. Our EndoSure sensor has been placed in more than 1,500 patients since receiving FDA clearance.

We have a pipeline of cardiovascular products that leverage our core wireless sensing technology. We are adapting our EndoSure system for use in patients with heart failure and in patients with hypertension. Our heart failure and hypertension sensors are further miniaturized versions of our EndoSure sensor that use the same materials, manufacturing methods and operational concepts as our EndoSure sensor.

 

   

Heart Failure. We have developed a sensor that we believe can help heart failure patients avoid hospitalizations by providing early detection of a worsening in their condition by measuring pressure inside the heart. We initiated our heart failure feasibility studies in South America in February 2006, in Europe in October 2006 and in the United States in December 2006. These feasibility studies are designed to preliminarily assess the sensor’s safety and ability to help heart failure patients avoid hospitalizations by detecting an increase in pressure inside the heart, an early warning sign of a worsening of their condition. As of February 28, 2007, we have implanted sensors in 32 patients as part of these feasibility studies. We expect our pivotal U.S. heart failure trial to start in 2007 and we expect to file an application for premarket approval with the FDA for our heart failure system in 2008.

 

1


Table of Contents
   

Hypertension. We are developing a hypertension sensor that we expect will be able to provide frequent long-term monitoring of a patient’s blood pressure. We initiated human implants of our hypertension sensor as part of feasibility studies commenced in March 2007. Initially, we plan to target severely hypertensive patients and then expand our indications to the broader hypertensive population.

Market Opportunity

Cardiovascular disease is the leading cause of death in the United States. It encompasses a wide range of conditions and pathologies including aneurysms, heart failure, hypertension, strokes and heart attacks. Recent advances in drug and device technologies have significantly reduced mortality rates from cardiovascular diseases, and, therefore, cardiovascular patients are now living longer. As a result, there is a significant unmet need for ongoing patient management of chronic cardiovascular disease.

Aortic Aneurysms. Aortic aneurysms affect approximately 2.7 million Americans and are the 13th leading cause of death in the United States. We believe aneurysm procedures are steadily increasing due to recently approved Medicare reimbursement for screening, greater patient awareness and the adoption of less invasive repair techniques. Increased pressure inside the aortic aneurysm is the primary cause of aneurysm enlargement and rupture.

Heart Failure. Heart failure afflicts more than five million Americans, is the leading cause of hospitalizations with over one million hospitalizations per year and kills over 200,000 people each year. The estimated direct and indirect cost of heart failure in the United States for 2006 was approximately $30 billion. In Europe, heart failure afflicts more than 14 million people with over 3.6 million hospitalizations per year. By 2020, the number of people with heart failure in Europe is projected to increase to 30 million with nine million deaths attributed to the disease. Careful regulation of pressure inside the heart is important in keeping heart failure patients out of the hospital.

Hypertension. Hypertension is one of most common diseases in the world and affects 65 million people in the United States alone. The estimated direct and indirect cost of hypertension in the United States for 2006 was approximately $64 billion. Worldwide, the hypertensive population is estimated at one billion with as many as seven million deaths per year attributable to the disease. The prevalence of hypertension is increasing due to an aging population, increases in obesity, sedentary behavior and dietary factors. Careful management of blood pressure can reduce the development of more serious conditions including heart disease, stroke and kidney failure. Frequent blood pressure monitoring allows physicians to optimize the impact of anti-hypertensive drugs.

Pressure: Critical Variable in Cardiovascular Disease

The cardiovascular system is a pressurized network of blood vessels powered by the heart, akin to a network of pipes powered by a pump. Measuring pressure inside the heart and blood vessels is crucial to the management of patients with heart failure, aneurysms and hypertension. Pressure levels that are either too high or too low can result in serious complications such as aneurysm rupture, stroke or kidney failure. As a result, regular measurement of pressure is a critical tool for predicting a patient’s condition and managing therapy. However, the current techniques for measuring pressure in the heart and blood vessels can be invasive, in-hospital procedures with potentially serious complications.

Limitations of Current Pressure Measurement Technologies

While there are several methods currently used to measure pressure in the heart and blood vessels, these methods have significant limitations, including:

 

   

Multiple Procedures. Monitoring using current pressure measurement methods for aortic aneurysms and heart failure require a procedure to be performed for each set of measurements, resulting in multiple procedures over the life of the patient. These procedures involve some level of invasiveness and are often accompanied by significant risk and adverse events.

 

2


Table of Contents
   

Short-Term Solutions. Current pressure measurement technologies are short-term in nature and fail to provide physicians long-term management tools, such as frequent pressure measurement, for effective patient management.

 

   

Adverse Events. Surveillance and monitoring of aortic aneurysm repair patients generally involves the use of medical imaging technology, such as computed tomography, or CT scans, which are associated with radiation and intravenous contrast toxicity, which can lead to kidney damage. Heart failure pressure measurement procedures are associated with life-threatening complications, such as development of an irregular heartbeat, rupture of the pulmonary artery, development of blood clots, collapsed lungs, infection and internal bleeding.

 

   

Inadequate Data. Current non-invasive pressure measurement technologies for aortic aneurysms and hypertension lack the ability to provide physicians and patients with consistently accurate and timely data.

 

   

Inconvenience. Heart failure pressure measurement generally involves a catheter remaining in place for several days and the heart failure patient is required to be in the intensive care unit for pressure monitoring. A CT scan typically requires a half a day to a full day of an aortic aneurysm patient’s time and is, therefore, inefficient for both the patient and the physician.

 

   

Patient Discomfort . The invasive nature of heart failure and aortic aneurysm pressure measurement methods result in significant patient discomfort and anxiety. Frequent blood pressure cuff inflations that occur during ambulatory blood pressure measurement are uncomfortable for the hypertensive patient and can interfere with the patient’s sleep.

Our Solution

We believe that our wireless sensing and communication technology overcomes many of the limitations of existing pressure measurement technologies in the following ways:

 

   

Single Minimally Invasive Procedure . We have designed our miniature wireless sensors to be implanted inside the body using a single minimally invasive procedure. Once implanted, our wireless sensors are designed to take pressure measurements non-invasively over the life of the patient.

 

   

Long-Term Solution . Our sensors are composed of materials selected for their durability, robustness, bio-compatibility, and insensitivity to changes in body chemistry or biology. In addition, our sensors are powered by RF energy transmitted from our external electronics modules and possess no battery or internal power source of their own. As a result, we believe our sensors can last for, and transmit data over, the lifetime of the patient without requiring repeat procedures.

 

   

No Observed Adverse Events . We have not received any reports of adverse events after implantation attributed to our commercialized EndoSure system to date, nor have we observed any adverse events in our aortic aneurysm or heart failure clinical trials attributed to our sensors.

 

   

Real-Time Data . Our technology is designed to enable frequent, on-demand, real-time monitoring of vital information, enabling proactive patient management.

 

   

Convenience and Ease of Use . Our sensors have been carefully designed to be implantable in a variety of settings outside of the operating room, including the cardiac catheterization lab as well as the intensive care unit. Our sensors are designed to be implanted and monitored by a wide variety of physicians including cardiologists, radiologists, electrophysiologists, surgeons, anesthesiologists and intensivists.

 

   

Patient Comfort . Once implanted, our sensors are designed to remain at the implant site for the patient’s life and to eliminate the need for additional procedures required to monitor pressure. Communication with our external electronics modules does not require wires and can be performed with the patient lying down, sitting or standing.

 

3


Table of Contents

Our Strategy

Our goal is to be the leading provider of wireless sensing and communication technology for the improved management of severe chronic cardiovascular diseases such as aneurysms, heart failure and hypertension. To achieve this goal, we are pursuing the following strategies:

 

   

Leverage our EndoSure system to pursue the regulatory approval and commercialization of our heart failure and hypertension sensors;

 

   

Accelerate the market adoption of our EndoSure system;

 

   

Continue to strengthen our direct sales and marketing infrastructure and customer service capabilities;

 

   

Continue ongoing research and development investment to improve and broaden our product portfolio; and

 

   

Leverage our technology platform and IP position into other medical and industrial applications through selective partnering and licensing arrangements.

In November 2005, we entered into a license and development agreement with Medtronic, Inc., or Medtronic, as well as a related supply agreement, to adapt our sensor technology for use as a wired pressure sensor system capable of working with Medtronic’s implantable devices to address impaired cardiac function, hypertension, or both. Medtronic is funding our efforts under this joint development program through a series of milestone payments totaling $3.0 million. We are also entitled to receive royalties on sales of Medtronic devices incorporating our technology, subject to the terms of the license agreement including a cumulative royalty cap of $25.0 million. Upon reaching this royalty cap, the license becomes non-exclusive.

Risks Associated with Our Business

Our business is subject to numerous risks, as discussed more fully in the section entitled “Risk Factors” immediately following this prospectus summary. We have a limited operating history, which limits our ability to accurately predict our future performance. From our inception through December 31, 2006, we recognized total revenue of $3.5 million. As of December 31, 2006, we had an accumulated deficit of $132.1 million and we may never achieve profitability. Compared to some potential competitors, we have less brand recognition, as well as less experience and resources in manufacturing, sales and marketing, and research and development. Our success depends on the growth in demand and continued adoption of our EndoSure system, and the continued design, development, regulatory approval and commercialization of our future products, including our heart failure and hypertension sensors.

Corporate Information

We were incorporated in Delaware in November 2000. The address of our principal executive office is 75 Fifth Street, N.W., Suite 440, Atlanta, GA 30308, and our telephone number is (404) 920-6700. Our website address is www.cardiomems.com. We do not incorporate the information on our website into this prospectus, and you should not consider it part of this prospectus. As used in this prospectus, references to “CardioMEMS,” “our,” “us” and “we” refer to CardioMEMS, Inc. unless the context requires otherwise.

Market Data

This prospectus contains market data and industry forecasts that were obtained from industry publications. We have not independently verified any of this information.

 

4


Table of Contents

SUMMARY OF THE OFFERING

 

Common stock offered by us

             shares

 

Common stock to be outstanding after this offering

             shares

 

Use of proceeds

To support research and product development activities; to support sales and marketing activities; and to fund working capital and other general corporate purposes.

 

Proposed NASDAQ Global Market symbol

SENS

The number of shares of common stock that will be outstanding immediately after this offering is based on 50,073,991 shares of common stock outstanding as of December 31, 2006 and excludes:

 

   

5,562,338 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.27 per share;

 

   

17,578 shares of common stock issuable upon the exercise of an outstanding warrant, with an exercise price of $0.96 per share;

 

   

1,184,095 shares of common stock reserved for future issuance under our 2001 Equity Incentive Plan; and

 

   

3,400,000 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan and 2006 Employee Stock Purchase Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under these benefit plans.

Except as otherwise indicated, all information in this prospectus assumes:

 

   

a     -for-     reverse stock split of our common stock and preferred stock to be effected prior to the effectiveness of this offering;

 

   

the conversion of all our outstanding shares of preferred stock into 40,446,099 shares of common stock upon the closing of this offering;

 

   

the filing of our amended and restated certificate of incorporation, which will occur immediately prior to the closing of this offering; and

 

   

no exercise of the underwriters’ option to purchase additional shares of common stock to cover any over-allotments.

 

5


Table of Contents

SUMMARY FINANCIAL DATA

The following table summarizes our financial data. We have derived the following summary of our statements of operations data for the years ended December 31, 2004, 2005 and 2006 from our audited financial statements appearing elsewhere in this prospectus. The balance sheet data as of December 31, 2006 has been derived from our audited financial statements appearing elsewhere in this prospectus. Our historic results are not necessarily indicative of the results that may be expected in the future. The summary of our financial data set forth below should be read together with our financial statements and the related notes to those statements, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” appearing elsewhere in this prospectus.

 

    Years Ended December 31,  
        2004             2005             2006      
    ($ in thousands, except per share data)  

Statements of Operations Data:

     

Revenue

  $     $ 95     $ 3,413  

Cost of revenue

          54       1,913  
                       

Gross profit

          41       1,500  

Operating expenses:

     

Research and development

    3,716       4,752       8,517  

Selling, general and administrative

    1,486       4,198       14,032  
                       

Total operating expenses

    5,202       8,950       22,549  
                       

Operating loss

    (5,202 )     (8,909 )     (21,049 )

Interest and other income (expense), net

    84       62       331  
                       

Net loss

    (5,118 )     (8,847 )     (20,718 )

Accretion of redeemable convertible preferred stock

    (3,224 )     (4,437 )     (85,186 )
                       

Net loss attributable to common stockholders

  $ (8,342 )   $ (13,284 )   $ (105,904 )
                       

Net loss per share:

     

Basic and diluted(1)

  $ (0.89 )   $ (1.42 )   $ (11.17 )
                       

Weighted average number of shares used in computation

    9,359,325       9,370,346       9,484,745  

Pro forma net loss per share:

     

Basic and diluted(1)

      $ (0.49 )
           

Weighted-average number of shares used in pro forma per share calculations

        41,900,455  

 

     As of December 31, 2006
     Actual     As Adjusted(2)
           (unaudited)
     ($ in thousands)

Balance Sheet Data:

    

Cash and cash equivalents

   $ 14,354    

Working capital

     14,557    

Total assets

     18,770    

Long-term debt, net of current portion

        

Redeemable convertible preferred stock

     147,540    

Total stockholders’ equity (deficit)

     (132,064 )  

 

6


Table of Contents

(1)   Please see Note 3 to the notes to our audited financial statements for an explanation of the method used to calculate basic and diluted net loss per common share and pro forma basic and diluted net loss per common share.

 

(2)   On an as adjusted basis to give effect to the automatic conversion of all outstanding shares of redeemable convertible preferred stock into common stock upon the closing of this offering, and to reflect the sale of shares of our common stock in this offering at an assumed initial public offering price of $             per share, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $             per share, the mid-point of the range reflected on the cover page on this prospectus, would increase (decrease) each of cash, cash equivalents and short-term investments, working capital, total assets and total stockholders’ equity by approximately $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase of 1.0 million shares in the number of shares offered by us, together with a concomitant $1.00 increase in the assumed initial public offering price of $             per share, would increase each of cash, cash equivalents and short-term investments, working capital, total assets and total stockholders’ equity by approximately $             million. Similarly, each decrease of 1.0 million shares in the number of shares offered by us, together with a concomitant $1.00 decrease in the assumed initial public offering price of $             per share, would decrease each of cash, cash equivalents and short-term investments, working capital, total assets and total stockholders’ equity by approximately $             million. The pro forma information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

 

7


Table of Contents

RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the following risks, as well as all of the other information contained in this prospectus, before investing in our common stock. If any of the following possible events actually occur, our business, business prospects, cash flow, results of operations or financial condition could be harmed. In this case, the trading price of our common stock could decline, and you might lose all or part of your investment in our common stock. In assessing these risks, you should also refer to the other information contained in this prospectus, including our financial statements and related notes. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our operations.

Risks Related to Our Business

We have a limited history of operations and a history of net losses, and we may not be able to achieve profitability even if we are able to generate significant revenue.

We were incorporated in November 2000 and have a limited operating history upon which you can evaluate our business. We commercialized our first product, the EndoSure Wireless AAA Pressure Measurement System, or EndoSure system, in 2005. We incurred net losses in each year since our inception, including net losses of $3.3 million in 2003, $5.1 million in 2004, $8.8 million in 2005 and $20.7 million in 2006. As of December 31, 2006, we had an accumulated deficit of approximately $132.1 million. We have financed our operations primarily through private placements of our equity securities and have devoted substantially all of our resources to research and development of our proprietary wireless sensing and communication technology and the commercialization of our initial product, the EndoSure system. We expect our operating expenses to continue to increase as we expand our direct sales force and manufacturing capabilities to meet anticipated increased demand for our EndoSure system. We also expect research and development expenses to increase in connection with our clinical trials and other development activities related to our products under development, including our heart failure and hypertension sensors. If we receive approval from the U.S. Food and Drug Administration, or the FDA, to market our heart failure and hypertension sensors, we expect to incur significant additional sales and marketing expenses and manufacturing expenses as we commence the commercial launch of those products. Additionally, if we complete this initial public offering, we expect that our general and administrative expenses will increase due to additional operational and regulatory burdens associated with being a public company. As a result, we expect to continue to incur significant operating losses for the foreseeable future, and we cannot assure you that we will be able to achieve or sustain profitability even if we are able to generate significant revenue.

We currently rely on a single product, our EndoSure system, for all of our revenue. If we are unable to obtain regulatory approval for our heart failure and hypertension sensors or other products under development, our ability to generate significant revenue will be limited, our business will be harmed and we may never become profitable.

All of our current revenue comes from sales of our sole product offering, our EndoSure system. We have leveraged the technology in our EndoSure system to develop other products, including wireless sensors that are designed to enable the treatment of heart failure patients and hypertensive patients. We anticipate that our ability to generate significant revenue will depend on the successful development, regulatory approval and commercialization of our heart failure and hypertension sensors. We do not have the necessary regulatory approval to market our heart failure or hypertension sensors or any of our other products in development in the United States or any foreign market. The regulatory approval processes for our heart failure and hypertension sensors involve, among other things, successfully completing clinical trials and obtaining premarket approvals from the FDA. The premarket approval process requires us to demonstrate the safety and efficacy of our heart failure and hypertension sensors to the FDA’s satisfaction. This process can be expensive and uncertain, requires detailed and comprehensive scientific and human clinical data, generally takes one to three years after a

 

8


Table of Contents

premarket approval application is filed and may never result in the FDA granting such an application. The FDA can delay, limit or deny approval of our premarket approval applications for many reasons, including:

 

   

we may not be able to provide reasonable assurance that our heart failure and hypertension sensors are safe and effective to the FDA’s satisfaction;

 

   

the data from our pre-clinical studies and clinical trials may be insufficient to support approval;

 

   

the manufacturing process or facilities that we use may not meet applicable requirements; and

 

   

changes in FDA approval policies or adoption of new regulations may require additional data.

In addition, even if we receive FDA approval of our heart failure or hypertension sensors, the FDA may not approve our sensors for the indications that are necessary or desirable for commercialization of our heart failure or hypertension systems. We may not obtain regulatory approval to market our heart failure and hypertension sensors in the United States or anywhere else. Any delay in, or failure to receive or maintain, approval of our heart failure or hypertension sensors could prevent us from generating significant revenue or achieving profitability.

Our EndoSure system and, if approved, our heart failure and hypertension sensors, may never achieve market acceptance.

Our EndoSure system and, if they receive regulatory approval, our heart failure and hypertension sensors or any other wireless sensor that we may develop, may not gain market acceptance among physicians, patients, healthcare payors and the medical community. The degree of market acceptance of any of our wireless sensors will depend on a number of factors, including:

 

   

the perceived effectiveness and reliability of our wireless sensors;

 

   

the prevalence and severity of any adverse events;

 

   

the results of any long-term clinical studies relating to our EndoSure system or heart failure or hypertension sensors and other products under development;

 

   

the availability and perceived advantages and disadvantages of alternative technologies;

 

   

the strength of our marketing and distribution infrastructure;

 

   

the level of education and awareness among physicians and hospitals concerning our EndoSure system or heart failure or hypertension sensors and other products under development; and

 

   

the availability of sufficient third-party coverage or reimbursement for our EndoSure system or heart failure or hypertension sensors and other products under development.

Currently there is only limited clinical data on our products with which to assess their safety and efficacy in any procedure, including the treatment of patients with aortic abdominal aneurysms, or AAA, or with heart failure or hypertension. If longer-term or more extensive clinical studies performed by us or others indicate that procedures using our products are not safe and effective, physicians may choose not to use our products. Furthermore, unsatisfactory outcomes or patient injury could cause negative publicity for our products. 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 defects could be identified, creating negative publicity and liability problems for us, thereby adversely affecting demand for our products. If our EndoSure system and our heart failure and hypertension sensors, to the extent they receive regulatory approval, do not achieve an adequate level of acceptance by physicians, we may not generate sufficient revenue and may never become profitable.

 

9


Table of Contents

The medical device industry is highly competitive, and if our competitors are able to develop and market products that are safer and more effective than any products that we may develop, our commercial opportunity will be reduced or eliminated.

The medical device industry is highly competitive and subject to rapid and profound technological change. We face potential competition from established medical device companies, academic institutions, government agencies and private and public research institutions in the United States and abroad. Most of our principal competitors have significantly greater financial resources and expertise in research and development, manufacturing, pre-clinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. For example, Medtronic, Inc., or Medtronic, a company with significantly greater financial and marketing resources than we possess, is developing a competing wired sensor monitoring system for patients with heart failure named Chronicle which may be further ahead in the FDA regulatory clearance process than our competing heart failure sensor. Other companies such as St. Jude Medical, Inc., Proteus Biomedical, Inc. and Remon Medical Technologies, Inc., or Remon Medical, are also developing new approaches and products for the heart failure patient monitoring market. Our heart failure sensor will also face competition from existing products and monitoring techniques, including the Swan-Ganz catheter. We are aware that Remon Medical is also developing a wireless sensing technology for use in AAA patients that, if commercialized, will compete with our EndoSure system. In addition, we expect to face significant competition for our hypertension sensor from well-established alternative products and techniques, including relatively inexpensive blood pressure monitoring systems developed by companies such as Roche Diagnostics, a division of F. Hoffmann-La Roche Ltd., and LifeScan, Inc., a division of Johnson & Johnson, and various other manufacturers worldwide. If we are unable to compete successfully with these companies on the basis of cost or effectiveness, our revenue will suffer. Our competitors may:

 

   

develop and patent processes or products earlier than us;

 

   

obtain regulatory approvals for competing products more rapidly than us; and

 

   

develop more effective or less expensive products or technologies that render our technology or products obsolete or non-competitive.

The industry in which we operate has undergone, and is expected to continue to undergo, rapid and significant technological change, and we expect competition to intensify as technical advances are made. Our competitors may develop and commercialize sensor monitoring systems that are safer or more effective, have fewer side effects or are less expensive than any products that we develop. We also compete with our competitors in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business. Because our products often have long development and regulatory approval cycles, we must anticipate changes in the marketplace and the direction of technological innovation and customer demands.

If we fail to obtain and maintain necessary FDA clearances or approvals for our products and indications or if clearances or approvals for future products and indications are delayed or not issued, our business will be harmed.

Our products are classified as medical devices and are subject to extensive regulation in the United States by the FDA and other federal, state and local authorities. These regulations relate to the design, development, testing, manufacturing, labeling, sale, promotion, distribution, importing and exporting and shipping of our products. In the United States, before we can market a new medical device, or a new use of, or claim for, or significant modification to, an existing product, we must first receive either 510(k) clearance or approval of a premarket approval application from the FDA, unless an exemption applies. In the 510(k) clearance process, the FDA must determine that the proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. The premarket approval pathway requires an applicant to demonstrate the safety and effectiveness of the device

 

10


Table of Contents

based, in part, on data obtained in clinical trials. Both of these processes can be expensive and lengthy and entail significant user fees, unless exempt. The FDA’s 510(k) clearance process usually takes from three to 12 months, but it can last longer. The premarket approval pathway is much more costly and uncertain than the 510(k) clearance process. It generally takes from one to three years, or even longer, from the time the premarket approval application is submitted to the FDA until an approval is obtained.

Our products when indicated for heart failure and hypertension will be required to obtain a premarket approval. Such approvals may not be obtained in a timely fashion or at all. We will request a humanitarian use designation for our heart failure sensor when indicated for pulmonary hypertension, which if granted would allow us to seek approval of a humanitarian designation exemption. A humanitarian designation exemption is a somewhat abbreviated premarket approval that allows a manufacturer to market a humanitarian use designation without collecting the effectiveness data necessary to support a premarket approval. The FDA may not grant a humanitarian use designation or approve a humanitarian designation exemption application in a timely fashion or at all.

Although we believe the FDA will allow the less burdensome 510(k) pathway for pressure measurement after the AAA repair procedure and cardiac surgery indications for heart failure, the FDA may ultimately impose the burdensome premarket approval process on these and other indications for which we may seek clearance or approval. An indication for pressure measurement after the AAA repair procedure is likely to require a significant clinical study. We have a 510(k) pending for our next generation EndoSure system for pressure measurement during the AAA repair procedure. There is no assurance that any or all of the required clearances and approvals can be obtained in a timely fashion or at all.

Our current and planned clinical trials may not begin on time, or at all, and may not be completed on schedule, or at all.

In order to obtain premarket approval and, in some cases, a 510(k) clearance, a product sponsor must conduct well controlled clinical trials designed to test the safety and effectiveness of the product. Conducting clinical trials generally entails a long, expensive and uncertain process that is subject to delays and failure at any stage. The data obtained from clinical trials may be inadequate to support approval or clearance of a submission. In addition, the occurrence of unexpected findings in connection with clinical trials may prevent or delay obtaining approval or clearance.

The FDA is requiring our products to undergo clinical study. We rely on clinical investigators and clinical sites to enroll subjects in our clinical trials and other third parties to manage the trial and to perform related data collection and analysis. However, we may not be able to control the amount and timing of resources that clinical sites may devote to our clinical trials. If these clinical investigators and clinical sites fail to enroll a sufficient number of subjects in our clinical trials or fail to ensure compliance by subjects with clinical protocols, we will be unable to complete these trials or may obtain invalid or inadequate data, which could prevent us from obtaining regulatory clearances and approvals for our products. Our agreements with clinical investigators and clinical sites for clinical testing place substantial responsibilities on these parties and, if these parties fail to perform as expected, our trials could be delayed or terminated. If these clinical investigators, clinical sites or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to the FDA’s good clinical practice regulations or our clinical protocols or for other reasons, our clinical trials may be extended, delayed or terminated, and we may be unable to obtain regulatory clearances and approvals for, or successfully commercialize, our future products.

The commencement or completion of any of our clinical trials may be delayed or halted for numerous reasons, including, but not limited to, the following:

 

   

the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;

 

11


Table of Contents
   

subjects do not enroll in clinical trials at the rate we expect;

 

   

subjects are not followed-up at the rate we expect;

 

   

subjects experience adverse events related to our products;

 

   

subjects die during a clinical trial for a variety of reasons, including the advanced stage of their disease and medical problems, which may not be related to our product;

 

   

third-party clinical investigators do not perform our clinical trials on our anticipated schedule or consistent with the clinical trial protocol and good clinical practices, or other third-party organizations do not perform data collection and analysis in a timely or accurate manner;

 

   

regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials if investigators find us not to be in compliance with regulatory requirements;

 

   

third-party suppliers fail to provide us with critical components, including microelectromechanical systems, or MEMS, wafers, which conform to design and performance specifications;

 

   

the failure of our manufacturing process to produce finished products that conform to design and performance specifications;

 

   

changes in governmental regulations or administrative actions;

 

   

the interim results of any of our clinical trials are inconclusive or negative; or

 

   

our trial design, although approved, is inadequate to demonstrate safety and/or efficacy.

The results of pre-clinical studies do not necessarily predict future clinical trial results, and predecessor clinical trial results may not be repeated in subsequent clinical trials. Additionally, the FDA may disagree with our interpretation of the data from our pre-clinical studies and clinical trials, or may find the clinical trial design, conduct or results inadequate to prove safety or efficacy, and may require us to pursue additional pre-clinical studies or clinical trials, which could further delay the clearance or approval of our products. If we are unable to demonstrate the safety and efficacy of our products in our clinical trials, we will be unable to obtain regulatory approval to market our products. The data we collect from our current clinical trials, our pre-clinical studies and other clinical trials may not be sufficient to support FDA approval. If we are unsuccessful in either filing a premarket approval application or receiving premarket approval for our heart failure or hypertension sensors, our business strategy may have to be altered to rely solely on our EndoSure system.

We may fail to obtain timely FDA approval to conduct our planned U.S. pivotal clinical trial for our heart failure sensor, which could significantly increase our development costs and lengthen the time to possible approval.

Before we can commence our planned U.S. pivotal clinical trial for our heart failure sensor, an investigational device exemption application must be approved by the FDA. Although we have received approval of our investigational device exemption application for our heart failure sensor from the FDA, the FDA’s approval of our investigational device exemption application allows us to begin only a pilot study with limited enrollment in our pilot study for the heart failure sensor. We are required to provide data from the pilot study to the FDA, which the FDA will review to determine whether to grant approval of our pivotal trial. We cannot assure you that the FDA will view the results of our pilot study as sufficiently favorable to allow us to proceed with a pivotal clinical trial on a timely basis or at all.

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. Adverse events during a clinical trial could cause us to repeat a trial, terminate a trial or cancel our entire heart failure program. The FDA or the Institutional Review Board with authority over a clinical trial may also terminate the trial at any time if it believes continuation of the trial presents an unreasonable risk to the study subjects. The FDA’s grant of permission to proceed with the trials does

 

12


Table of Contents

not constitute a binding commitment that the FDA will consider the trial design adequate to support approval. There can be no assurance that the data generated during the pivotal trials will meet the safety and effectiveness endpoints we ultimately choose or otherwise produce results that will lead the FDA to grant marketing approval.

If we fail to obtain an adequate level of coverage and reimbursement by third-party payors for our EndoSure system or other products under development, the markets for our products may be much smaller than expected.

The availability and levels of reimbursement by governmental and other third-party payors directly affect the market for our EndoSure system and other products under development. The ability of our hospital customers and physicians to obtain adequate coverage and reimbursement from third-party payors therefore impacts the success of our products. In addition, third-party payors continue to scrutinize the prices of products and services for which payments are made, particularly for new products and services. Therefore, the efficacy, safety, performance and cost-effectiveness of our products and of any competing products will determine the availability and level of reimbursement. Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government sponsored healthcare and private insurance. To obtain reimbursement or pricing approval in some countries, we may be required to produce clinical data, which may involve one or more clinical trials, that compares the cost-effectiveness of our products to other available therapies. We may not obtain reimbursement or pricing approvals in a timely manner, if at all. Our failure to receive reimbursement or pricing approvals would negatively impact market acceptance of our EndoSure system and our other products under development in the United States and in the international markets in which those approvals are sought.

Under current Medicare policies, hospitals implanting our EndoSure sensor generally are reimbursed for the device and for the endovascular abdominal aortic aneurysm repair surgery during which our devices are implanted under a single payment, typically based on a diagnosis-related group for major cardiovascular procedures. The diagnosis-related group payment rates include all devices and services that are provided during the repair surgery, regardless of the actual costs of such services. Separate payments currently are not made for the EndoSure sensor.

Physicians may receive a separate payment for their professional services performed in connection with the EndoSure sensor. Physicians submit bills for these services under the following Category III Current Procedural Terminology, or CPT, billing codes. One of these CPT codes relates to monitoring after a sensor is implanted. Since the monitoring is not part of an FDA clearance for the EndoSure system, we may not promote this use, although that does not prevent physicians from making their own determination to provide and bill for the monitoring service. We are pursuing this monitoring indication with the FDA, but we may not be able to obtain the indication needed to allow us to market the use of the EndoSure system for subsequent monitoring.

The applicable Category III codes do not have established national payment levels, and local Medicare contractors make independent determinations of payment levels for these codes for their specific geographic areas. This has resulted in wide variances in physician payment levels, and some local Medicare contractors have determined not to cover physician services billed under the pertinent CPT codes 0153T and 0154T, asserting that the technology at issue is investigational or experimental in nature. We are unaware of the extent of the volume of denials based upon these non-coverage decisions. The inability for physicians to receive adequate reimbursement for these codes could negatively impact market acceptance of our EndoSure system.

Applications have been made with the American Medical Association for Category I CPT codes that would describe physician services performed in connection with the implantation and monitoring of the EndoSure system and would replace the current Category III codes. If the applications are approved, we expect that physicians would begin to bill for their services using these Category I codes and that the Medicare program would develop federal reimbursement rates for these Category I codes for January 2008. In the event Category I

 

13


Table of Contents

codes are implemented, it is uncertain whether reimbursement under such codes could be adequate or set at lower levels than what physicians are currently receiving under the Category III CPT codes. However, the availability of national payment levels may simplify the process of submitting claims for payment. As of now, it is not possible to assess the full impact of new Category I codes on our business or results of operations. If such new codes were adopted, and the levels of reimbursement for physicians were considered to be inadequate, our business and results of operations may be harmed and our stock price could decline.

We also plan on pursuing coverage and reimbursement for services performed in connection with the implantation and monitoring of our heart failure and hypertension sensors. We expect to seek coverage and reimbursement and new codes for hospital services, including the hospital outpatient setting, and for physician professional services for these indications. Generally, any coverage and payment policies for a new procedure does not occur until after FDA approval of the product used in the surgery. It is possible that we may not prevail in our applications or that the extent of coverage or the reimbursement rates established for any new codes may be limited in scope or amount or otherwise insufficient to permit broad acceptance of our products by physicians and hospitals.

If we are unable to expand our sales and marketing capabilities, enter into and maintain arrangements with third parties to continue the commercialization of our EndoSure system or sell and market any other products that may be approved for sale, our business may be harmed.

We have limited experience as a company in the sale, marketing and distribution of our EndoSure system and any other products we may sell in the future. As of December 31, 2006, we had 37 employees engaged in sales and marketing activities. If our heart failure or hypertension sensors are approved for marketing, we will need to expand our sales force significantly to reach our target markets. Developing a sales force is expensive and time consuming and could delay or limit the success of any product launch. Thus, we may not be able to expand our sales and marketing capabilities on a timely basis or at all. If we are unable to establish these capabilities, we will need to contract with third parties to market and sell our EndoSure system or heart failure or hypertension sensors and any other product that we may develop. To the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services on our behalf in the United States or internationally, our product revenues could be lower than if we directly marketed and sold our EndoSure system or heart failure or hypertension sensors and any other products that we may develop. Furthermore, to the extent that we enter into co-promotion or other marketing and sales arrangements with other companies, any revenues received will depend on the skills and efforts of others, and we do not know whether these efforts will be successful. Some of our distributors may have current products or products under development that compete with ours, and they may have an incentive not to devote sufficient efforts to marketing our products.

If we are unable to manufacture our products efficiently in significant volumes, we may continue to incur losses.

We are currently manufacturing our EndoSure system in commercial quantities. However, we have limited resources, facilities and experience in commercially manufacturing our products. If we receive regulatory approval of our heart failure or hypertension sensors, we will need to increase our manufacturing capacity by a significant factor over current levels. We have no experience manufacturing our products in the volume that we anticipate will be required if we receive regulatory approval for our heart failure or hypertension sensors. To date, we have focused primarily on research and development and very low volume manufacturing of our EndoSure system. As a result, we may not be able to develop and implement efficient, low-cost manufacturing capabilities and processes that will enable us to manufacture our EndoSure system or heart failure or hypertension sensors and other products that we may develop in significant volumes, while meeting the legal, regulatory, quality, price, durability, engineering, design and production standards required to market our products successfully. If we fail to develop and implement these manufacturing capabilities and processes, we may be unable to sell our EndoSure system and any future products at a profit because the per unit cost of our products is highly dependent upon production volumes and the level of automation in our manufacturing processes. There are technical challenges to

 

14


Table of Contents

increasing manufacturing capacity, including equipment design and automation, material procurement, problems with production yields, and quality control and assurance. Developing commercial-scale manufacturing facilities will require the investment of substantial additional funds and the hiring and retaining of additional management and technical personnel who have the necessary manufacturing experience. We may not successfully complete any required increase in manufacturing capacity in a timely manner or at all. Even if our heart failure or hypertension sensors receive regulatory approval, if we are unable to manufacture a sufficient supply of sensors, maintain control over expenses or otherwise adapt to anticipated growth, or if we underestimate growth, we may not have the capability to satisfy market demand and our business will suffer.

Our manufacturing operations are dependent upon third-party suppliers, including single source suppliers, making us vulnerable to supply problems and price fluctuations, which could cause us to fail to meet the demands of our customers and adversely affect our ability to commercialize our EndoSure system or heart failure or hypertension sensors and any other products that we may develop.

We rely on single source suppliers to provide certain components of our wireless sensors and substantially all of the components that are used to manufacture our external electronics modules. We purchase these components on a purchase order basis. If we overestimate our component requirements, we could have excess inventory, which would increase our costs and result in write-downs harming our operating results. If we underestimate our requirements, we may not have an adequate supply, which could interrupt manufacturing of our EndoSure system or heart failure or hypertension sensors and any other products that we may develop and result in delays in shipments and revenue. We are dependent on these suppliers to provide us with materials in a timely manner that meet our quality, quantity and cost requirements. Our suppliers may encounter problems during manufacturing due to a variety of reasons, including failure to follow specific protocols and procedures, failure to comply with applicable regulations, equipment malfunction and environmental factors, any of which could delay or impede their ability to meet our demand. Our reliance on these outside suppliers also subjects us to other risks that could harm our business, including:

 

   

suppliers may make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in shipment of our products;

 

   

we may not be able to obtain adequate supply in a timely manner or on commercially reasonable terms;

 

   

we may have difficulty locating and qualifying alternative suppliers for our sole-source supplies;

 

   

switching components may require product redesign and submission to the FDA of a new 510(k), premarket approval supplement or possibly a separate premarket approval application, any of which could significantly delay production;

 

   

our suppliers manufacture products for a range of customers, and fluctuations in demand for the products these suppliers manufacture for others may affect their ability to deliver components to us in a timely manner; and

 

   

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.

We currently do not have long-term supply contracts with our component suppliers, and they are not required to supply us with products for any specified periods, in any specified quantities or at any set price, except as may be specified in a particular purchase order. We have no reason to believe any of our current suppliers is the sole source for the components they supply us. However, if we lost one of these suppliers and were unable to obtain an alternate source on a timely basis or on terms acceptable to us, our production schedules could be delayed and we could fail to meet our customers’ demands. Our customers rely upon our ability to meet committed delivery dates, and any disruption in the supply of key components would adversely affect our ability to meet these dates and could result in legal action by our customers, cause loss of customers or harm our ability to attract new customers, any of which could decrease our revenue and negatively impact our growth. In addition, to the extent that our suppliers use technology or manufacturing processes that are proprietary, we may be unable to obtain comparable materials or components from alternative sources.

 

15


Table of Contents

We may be subject to fines, penalties or injunctions if we are determined to be promoting the use of our products for unapproved, or off-label, uses.

Our EndoSure system is currently approved for measuring intrasac pressure during an endovascular AAA repair. With this clearance, we are not allowed to market our EndoSure system for use by physicians after the procedure. We believe, however, that physicians might use the EndoSure system in this manner. Although we believe our promotional materials and training methods regarding physicians are conducted in compliance with regulations of the FDA and other applicable regulations, if the FDA determines that our promotional materials or training constitutes promotion of off-label use, it could request that we modify our training or promotional materials or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider promotional or training materials to constitute promotion of an off-label use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement.

We face the risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to a risk of product liability claims that is inherent in the testing, manufacturing and marketing of medical devices. We may be subject to product liability claims if our EndoSure sensor or heart failure or hypertension sensors or any other products we develop or sell, causes, or appears to have caused, an injury. Claims may be made by consumers, healthcare providers, third-party strategic collaborators or others selling our products. We currently have $10.0 million of product liability insurance, which covers the sale of our EndoSure system and the use of our other products in development in clinical trials, which amount we believe is appropriate. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, the coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost and on acceptable terms for an adequate coverage amount or otherwise to protect against potential product liability claims, we could be exposed to significant liabilities, which may harm our business. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could harm our business. These liabilities could prevent or interfere with our product sale and commercialization efforts. Defending a suit, regardless of merit, could be costly, could divert management attention and might result in adverse publicity, which could result in the withdrawal of, or inability to recruit, clinical trial volunteers or result in reduced acceptance of our EndoSure system, or any other products we sell, in the market.

The medical device industry has historically been subject to extensive litigation over product liability claims. We may be subject to product liability claims even if it appears that the claimed injury is due to the actions of others. For example, we rely on the expertise of surgeons, other physicians, therapists and other associated medical personnel to perform the medical procedure to implant our EndoSure sensor and to conduct related patient monitoring sessions where our EndoSure system is used. If these medical personnel are not properly trained or are negligent, any and all positive effects of our EndoSure system, or any other products we sell, may be diminished or the patient may suffer critical injury, which may subject us to liability. In addition, an injury that is caused by the negligence of one of our suppliers in supplying us with a defective component that injures a patient could be the basis for a claim against us. A product liability claim, regardless of its merit or eventual outcome could result in:

 

   

decreased demand for our products;

 

   

injury to our reputation;

 

   

diversion of management’s attention;

 

   

withdrawal of clinical trial participants;

 

   

significant costs of related litigation;

 

   

substantial monetary awards to patients;

 

16


Table of Contents
   

product recalls or market withdrawals;

 

   

loss of revenue; and

 

   

the inability to commercialize our products under development.

Software defects may be discovered in our products, which could harm our reputation and reduce our revenue.

Our external electronics modules incorporate computer software which can contain errors, especially when first introduced. Because our products are designed to be used to perform complex calculations and measurements, we expect that physicians and hospitals will have an increased sensitivity to the potential for software 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:

 

   

loss of revenue;

 

   

delay in market acceptance of our products;

 

   

damage to our reputation;

 

   

additional regulatory filings;

 

   

product recalls;

 

   

increased service costs; and/or

 

   

product liability claims relating to the software defects.

We may be unable to complete the development and commercialization of our EndoSure system and our heart failure and hypertension sensors and other products under development 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, including conducting clinical trials for our heart failure and hypertension sensors. In 2005, our net cash used in operating activities was $8.2 million and was $18.9 million in 2006. We expect that our cash used by operations will increase significantly in each of the next several years, and we may need additional funds to continue to commercialize our recently-introduced EndoSure system, and to complete the development and commercialization of our heart failure and hypertension sensors and our other products under development. Additional financing may not be available on a timely basis on terms acceptable to us, or at all. Any additional financing may be dilutive to stockholders or may require us to grant a lender a security interest in our assets. The amount of funding we will need will depend on many factors, including:

 

   

the rate of progress and cost of our clinical trials and other development activities for our future products;

 

   

the success of our research and development efforts;

 

   

the costs and timing of regulatory approval;

 

   

the expenses we incur in developing, selling and marketing our products;

 

   

the revenue generated by sales of our future products;

 

   

the emergence of competing or complementary technological developments;

 

   

the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual product rights;

 

   

the terms and timing of any collaborative, licensing or other arrangements that we may establish; and

 

   

the acquisition of businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

 

17


Table of Contents

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.

We depend on clinical investigators and clinical sites to enroll patients in our clinical trials and on other third parties to manage the trials and to perform related data collection and analysis, and, as a result, we may face costs and delays that are outside of our control.

We rely on clinical investigators and clinical sites to enroll patients in our clinical trials and other third parties to manage the trial and to perform related data collection and analysis. However, we may not be able to control the amount and timing of resources that clinical sites may devote to our clinical trials. If these clinical investigators and clinical sites fail to enroll a sufficient number of patients in our clinical trials or fail to ensure compliance by patients with clinical protocols, we will be unable to complete these trials, which could prevent us from obtaining regulatory approvals for our products. Our agreements with clinical investigators and clinical sites for clinical testing place substantial responsibilities on these parties and, if these parties fail to perform as expected, our trials could be delayed or terminated. If these clinical investigators, clinical sites or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols, the FDA’s good clinical practice regulations or for other reasons, our clinical trials may be extended, delayed or terminated, and we may be unable to obtain regulatory approval for, or successfully commercialize, our future products.

The loss of any of our executive officers or the failure to attract or retain specialized technical and management personnel could impair our ability to grow our business.

We are highly dependent on our senior management, especially Jay S. Yadav, M.D., our Chairman and Chief Executive Officer. Our success will depend on our ability to retain our current management and to attract and retain qualified personnel in the future, including scientists, clinicians, engineers and other highly skilled personnel. Competition for senior management personnel, as well as scientists, clinicians and engineers, is intense and we may not be able to retain our personnel. The loss of the services of members of our senior management, scientists, clinicians or engineers could negatively impact the implementation and completion of our objectives, including the development and introduction of our products. The loss of a member of our senior management or our professional staff would require the remaining executive officers to divert immediate and substantial attention to seeking a replacement. Each of our officers may terminate their employment at any time without notice and without cause or good reason. We do not carry “key person” insurance covering any members of our senior management.

Our future success will depend, in part, on our ability to attract and retain qualified management and technical personnel, many of whom must be relocated from other regions in the United States or other countries. We may not be successful in hiring or retaining qualified personnel. Our inability to hire qualified personnel on a timely basis, or the departure of key employees, could harm our business.

We may have difficulty managing the growth, if any, of our operations, which could harm our business.

We continue to undergo rapid change in the scope and breadth of our operations as we seek to grow our business. Our potential growth will place a significant strain on our senior management team and other resources. We will be required to make significant investments in our engineering, logistics, financial and management information systems. We expect to relocate our manufacturing, research and development and administrative offices to a new location in the greater Atlanta area in 2007. Continued growth presents numerous additional challenges, including:

 

   

implementing appropriate operational and financial systems and controls;

 

18


Table of Contents
   

expanding manufacturing capacity and increasing production;

 

   

expanding our sales and marketing infrastructure and capabilities;

 

   

identifying, attracting and retaining qualified personnel in our areas of activity; and

 

   

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.

If we fail to maintain effective internal control over financial reporting in the future, the accuracy and timing of our financial reporting may be adversely affected.

In connection with the audit of our financial statements for the year ended December 31, 2005 our independent registered public accounting firm identified material weaknesses in our internal control over financial reporting. A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our management and independent registered public accounting firm did not perform an evaluation of our internal control over financial reporting during any period in accordance with the provisions of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley Act. Had we and our independent registered public accounting firm performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act, additional control deficiencies may have been identified by management or our independent registered public accounting firm, and those control deficiencies could have also represented one or more material weaknesses.

Our independent registered public accounting firm identified material weaknesses related to a lack of appropriate financial management and reporting infrastructure to accurately and properly record and provide comprehensive financial information in accordance with U.S. generally accepted accounting principles. As a result, audit adjustments to our financial statements were identified during the course of the audit. In an effort to remediate these weaknesses, we retained a new chief financial officer in August 2006 and retained a new controller and assistant controller in November 2006. We also promoted our former controller to the position of director, finance. We intend to further develop and document our accounting policies and financial reporting procedures prior to the closing of this offering. These actions were taken in part to address our material weaknesses, and there were no material weaknesses noted in connection with the audit of our financial statements for the year ended December 31, 2006. However, we cannot assure you that we have identified all or that we will not in the future have additional material weaknesses.

The standards required for a Section 404 assessment under the Sarbanes-Oxley Act will require us to implement additional corporate governance practices and adhere to a variety of reporting requirements and complex accounting rules. These stringent standards require that our audit committee be advised and regularly updated on management’s review of internal controls. Our management may not be able to effectively and timely implement controls and procedures that adequately respond to the increased regulatory compliance and reporting requirements that will be applicable to us as a public company. If we fail to staff our accounting and finance function adequately or maintain internal controls adequate to meet the demands that will be placed upon us as a public company, including the requirements of the Sarbanes-Oxley Act, we may be unable to report our financial results accurately or in a timely manner and our business and stock price may suffer.

 

19


Table of Contents

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 obtain the patent protection we seek, or that 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 or we could be stopped from preventing other parties from developing products like ours, in either case, 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 is very uncertain. Moreover, even if we were to prevail, such litigation 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 it will confer any significant commercial advantage. U.S. patents and patent applications may also be subject to interference proceedings and U.S. patents may be subject to reexamination proceedings in the U.S. 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 a patent or denial of a patent application, or loss or reduction in the scope of one or more of the claims of, a patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Some of our technology was, and continues to be, developed in conjunction with certain 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. Additionally, we are aware of a company in Germany with a registered trademark on the name “CardioMEM.” We believe this may prevent us from doing business in Germany, and possibly throughout the European Union, using our current name. As a result, we may have to change our company name or market our products in Germany, and possibly throughout the EU, under a different name, either of which could result in loss of brand recognition and significant expense.

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 a 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.

 

20


Table of Contents

Our trade secrets, nondisclosure agreements and other contractual provisions to protect unpatented technology provide only limited and possibly inadequate protection of our rights. Our trade secrets may not be upheld and our nondisclosure agreements and other contractual provisions may not be enforced. 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.

Because the medical device industry is characterized by competing intellectual property, we may be sued for violating the intellectual property rights of others.

Successfully commercializing our implantable sensor systems, 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. As competition in our market grows, the possibility of a patent infringement claim against us 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 may 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 non-infringement 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 for the use of our implantable sensor systems, which may cause our revenue to decline.

We rely on technology that we license from others, including technology that is integral to our implantable sensor systems, such as patents that we have exclusively licensed from Georgia Tech Research Corporation, or GTRC, an entity that owns all intellectual property arising from research conducted at the Georgia Institute of Technology, and the Massachusetts Institute of Technology, or MIT. We received the right to apply GTRC’s relevant patent in the field of medical diagnostic equipment, implants and prostheses, surgical and medical equipment, medical services and applications and medical therapeutic equipment. We received the right to apply MIT’s relevant patent in the field of any medical device, medical instrumentation or other medical product or medical process for which commercial sale in the United States is regulated under the jurisdiction of the FDA. To the extent that we develop capability outside the field of use covered by our respective licenses with GTRC and MIT, we would no longer have the patent protection and the freedom to operate which may be afforded by these licenses. If either GTRC or MIT asserts that we are infringing their patent rights, we may incur significant costs defending against such claims or seeking an additional license from GTRC or MIT, as the case may be, or be required to limit use of our recently-introduced EndoSure system or future products and technologies within our licensed field, any of which could harm our business. Moreover, if either GTRC or MIT asserts that we have breached the terms of our license and successfully terminates our license, and if we are unable to obtain another license from GTRC or MIT, as the case may be, we may be required to abandon use of our implantable sensor systems completely.

If we also fail to reach specified sales targets during the initial years following the launch of our EndoSure system as specified in our respective licenses with GTRC and MIT, our licenses may be converted into

 

21


Table of Contents

non-exclusive licenses. To the extent we do not generate significant revenue from our EndoSure system and do not receive marketing approval for our other products under development, we risk losing our exclusivity rights with respect to the licenses we have from GTRC and MIT. If we lose our exclusivity rights with respect to these licenses, our ability to maintain our competitive position and grow our business would be adversely affected.

In addition, as we develop additional features for, and interventional devices for use with, our implantable sensor systems, we may find it advisable or necessary to seek additional licenses from third parties who hold patents covering technology used in specific indications we are targeting. If we cannot obtain those licenses or if we fail to maintain our current licenses, we could be forced to design around those patents at additional cost or abandon our implantable sensor systems altogether, which could adversely affect our revenue, results of operations and cash flow. If we have to abandon any product, our ability to develop and grow our business in new directions and markets would be adversely affected.

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 and 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 that our products or the use of our products are covered by U.S. or foreign patents held by them. If such relevant patents are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our implantable sensors unless we can obtain a license to use technology or ideas covered by such patents 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 implantable sensor systems 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 assert our patents against infringers, defend our patents from claims of invalidity or unenforceability, or 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

 

22


Table of Contents

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 comply with the extensive government regulations relating to our business, we may be subject to fines, injunctions and other penalties that could harm our business.

Our products and operations are subject to extensive regulation by the FDA and various other federal, state and foreign governmental authorities. Government regulations and foreign requirements specific to medical devices are wide ranging and govern, among other things:

 

   

design, development and manufacturing;

 

   

testing, labeling and storage;

 

   

clinical trials;

 

   

product safety;

 

   

marketing, sales and distribution;

 

   

premarket clearance and approval;

 

   

record keeping procedures;

 

   

advertising and promotions;

 

   

recalls and field corrective actions;

 

   

post-market surveillance, including reporting of deaths or serious injuries and malfunctions that, if they were to recur, could lead to death or serious injury; and

 

   

product import and export.

The FDA, state, foreign and other governmental authorities have broad enforcement powers. Our failure to comply with applicable regulatory requirements could result in governmental agencies or a court taking action, including any of the following:

 

   

issuing public warning letters to us;

 

   

imposing fines and penalties on us;

 

   

obtaining an injunction preventing us from manufacturing or selling our products;

 

   

bringing civil or criminal charges against us;

 

   

delaying the introduction of our products into the market;

 

   

delaying pending requests for clearance or approval of new uses or modifications to our existing products;

 

   

recalling, detaining or seizing our products; or

 

   

withdrawing or denying approvals or clearances for our products.

 

23


Table of Contents

If we fail to obtain regulatory clearances in other countries for our EndoSure system and heart failure and hypertension sensors and other 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. If we do not receive the right to affix the CE mark, we will be prohibited from selling our products in member countries of the European Union. 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 post-market regulatory requirements of the FDA and other authorities and become subject to substantial penalties, or marketing experience may show that our EndoSure system or any subsequently approved product, if any, is unsafe, forcing us to recall or withdraw our products permanently from the market.

Even after product clearance or approval, we and our contract manufacturers must comply with continuing regulation by the FDA and other authorities, including the FDA’s Quality System Regulation requirements, which obligate manufacturers, including third-party contract manufacturers, to adhere to stringent design, testing, control, documentation and other quality assurance procedures during the design and manufacture of a device. We are subject to medical device reporting regulations, which require us to report to the FDA if our products may have caused or contributed to a death or serious injury or malfunction in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur. We must report corrections and removals to the FDA where the correction or removal was initiated to reduce a risk to health posed by the device or to remedy a violation of the federal Food, Drug, and Cosmetic Act caused by the device that may present a risk to health, and we must maintain records of other corrections or removals. The FDA closely regulates promotion and advertising and our promotional and advertising activities could come under scrutiny.

There have been implant procedures where there was no signal from our EndoSure sensor or the signal was weak or difficult to obtain. We responded with corrections to products in the field to improve signal reliability. Through our quality system, we are continuing to investigate and make product modifications to address this issue. Our Endosure system may experience future signal reliability issues and the FDA may not agree that we have appropriately established and maintained procedures for implementing corrective and preventive action as required under the FDA’s Quality System Regulation requirements. We have determined that these signal reliability issues and field corrections are not reportable to the FDA, because the signal reliability issues have not caused injuries and do not pose a risk to health. The FDA may not agree with our determination that such reports are not required. If the adverse event reports we file with the FDA regarding death, serious injuries or malfunctions indicate or suggest that our EndoSure system or any subsequently cleared or approved product, if any, presents an unacceptable risk to patients, including when used off-label by physicians, we may be forced to recall our product or withdraw it permanently from the market.

 

24


Table of Contents

Any failure to comply with continuing regulation by the FDA or other authorities 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 intend to market our products, we will be 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 modify any product for which we receive FDA clearance, the FDA could retroactively determine that the modifications required clearance or approval and require us to stop marketing and recall the modified products.

Any modification to an FDA-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance or a premarket approval from the FDA. We may be required to submit extensive preclinical and clinical data depending on the nature of the changes. The FDA requires each manufacturer to make this determination in the first instance, but the FDA may review any such decision. If the FDA disagrees with the manufacturer’s decision not to seek a new 510(k) clearance or premarket approval, the FDA may retroactively require the manufacturer to seek such clearance or approval, and may require the manufacturer to cease marketing and/or recall the modified device until clearance or approval is obtained. When required, we may not be able to obtain additional 510(k) clearances or premarket approvals from the FDA for modifications to, or additional indications for, our existing products in a timely fashion, or at all. Delays in obtaining future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our revenue and operating results. We have made modifications to EndoSure system in the past, and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. For example, we made changes to the EndoSure system that were intended to improve signal reliability. We believe that these changes do not require the submission of a new 510(k) notice. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified EndoSure system, which could harm our operating results and require us to redesign our products.

If we fail to comply with healthcare regulations, we could face substantial penalties and our business, operations and financial condition could be adversely affected.

While we do not provide health care services, control the referral of patients for healthcare services, or directly bill Medicare and Medicaid, 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 abuse as well as patient privacy regulation and enforcement by both the federal government and the states in which we conduct our business. The laws that may affect our ability to operate include:

 

   

the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or providing remuneration, directly or indirectly, in cash or in

 

25


Table of Contents
 

kind, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs such as Medicare and Medicaid;

 

   

federal False Claims Act which prohibits, among other things, individuals or entities from knowingly presenting, or causing to be presented to the federal government, claims for payment that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers;

 

   

the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which created federal criminal laws that prohibit 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;

 

   

the federal physician self-referral law, known as the Stark Law, which prohibits a physician from making a referral to an entity for certain designated health services reimbursed by Medicare or Medicaid if the physician (or a member of the physician’s family) has a financial relationship with the entity, and which also prohibits the submission of any claim for reimbursement for designated health services furnished pursuant to a prohibited referral; and

 

   

the 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 past or present 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 from federal healthcare programs and/or the curtailment or restructuring of our operations. Similarly, if the physicians or other providers or entities with whom we do business are found to be non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. 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, divert our management’s attention from the operation of our business and damage our reputation. 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.

Risks Related to this Offering and Ownership of Our Common Stock

Our common stock has not been publicly traded, and we expect that the price of our common stock will fluctuate substantially, possibly resulting in class action securities litigation.

Before this offering, there has been no public market for shares of our common stock. An active public trading market may not develop after the closing of this offering or, if developed, may not be sustained. The price of the shares of common stock sold in this offering will not necessarily reflect the market price of the common stock after this offering. The market price for the common stock after this offering will be affected by a number of factors, including:

 

   

the receipt, denial or timing of regulatory clearances or approvals of our products or competing products;

 

   

changes in policies affecting third-party coverage and reimbursement in the United States and other countries;

 

26


Table of Contents
   

ability of our approved EndoSure system and our heart failure and hypertension sensors or other products that we may develop, if they receive regulatory clearance, to achieve market acceptance;

 

   

the performance of third-party contract manufacturers and component suppliers;

 

   

our ability to expand our sales and marketing capabilities;

 

   

our ability to manufacture our products to commercial standards;

 

   

the success of any collaborations we may undertake with other companies;

 

   

our ability to develop, introduce and market new or enhanced versions of our products on a timely basis;

 

   

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;

 

   

developments with respect to patents and other intellectual property rights;

 

   

sales of common stock or other securities by us or our stockholders in the future;

 

   

additions or departures of key scientific or management personnel;

 

   

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;

 

   

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;

 

   

developments in our industry; and

 

   

general market conditions and other factors unrelated to our operating performance or the operating performance of our competitors or potential competitors.

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. 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 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.

Securities analysts may elect not to provide research coverage of our common stock after the closing of this offering. If securities analysts do not cover our common stock after the closing of this offering, the lack of research coverage may adversely affect the market price of our common stock. 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 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. In addition, recently-adopted rules mandated by the Sarbanes-Oxley Act and a global settlement reached in 2003 between the Securities and Exchange Commission, or SEC, other regulatory agencies and a number of investment banks have led to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many investment banking firms will be required to contract with independent financial analysts for their stock research. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.

 

27


Table of Contents

Our principal stockholders, directors and management will continue to own a large percentage of our voting stock after this offering, which will allow them to exercise significant influence over matters subject to stockholder approval.

Our executive officers, directors and stockholders holding 5% or more of our outstanding common stock will beneficially own or control approximately         % of the outstanding shares of our common stock, after giving effect to the conversion of all outstanding preferred stock and the exercise of all outstanding options and the exercise of an outstanding warrant, following the closing of this offering. Accordingly, these executive officers, directors and principal stockholders, acting as a group, will 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.

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:

 

   

permit our board of directors to issue up to 15,000,000 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;

 

   

divide our board of directors into three classes;

 

   

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; and

 

   

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.

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% 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.

Sales of a substantial number of shares of our common stock in the public market after this offering, or the perception that they may occur, may depress the market price of our common stock.

Sales of substantial amounts of our common stock in the public market following this offering, or the perception that substantial sales may be made, could cause the market price of our common stock to decline. These sales might also make it more difficult for us to sell equity securities at a time and price that we deem

 

28


Table of Contents

appropriate. The lock-up agreements delivered by our executive officers, directors and substantially all of our stockholders and option holders provide that Banc of America Securities LLC, on behalf of the underwriters, in its sole discretion, may release those parties, at any time or from time to time and without notice, from their obligation not to dispose of shares of common stock for a period of 180 days after the date of this prospectus, which period may be extended in certain limited circumstances. Banc of America Securities LLC does not have any pre-established conditions to waiving the terms of the lock-up agreements, and any decision by it to waive those conditions would depend on a number of factors, which may include market conditions, the performance of the common stock in the market and our financial condition at that time.

Based on the number of shares of common stock outstanding as of December 31, 2006, upon the closing of this offering,              shares of our common stock will be outstanding, assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of options or our outstanding warrant. All of the shares sold in this offering will be freely tradable unless held by an affiliate of ours. Except as set forth below, the remaining 50,073,991 shares of common stock outstanding after this offering will be restricted as a result of securities laws or lock-up agreements. These remaining shares will generally become available for sale in the public market as follows:

 

   

             shares of common stock will be eligible for immediate sale upon the closing of this offering;

 

 

   

             shares of common stock will be eligible for sale under Rule 144 or Rule 701 upon expiration of lock-up agreements 180 days after the date of this prospectus, unless the option is otherwise extended; and

 

   

             shares of common stock will be eligible for sale from time to time thereafter upon expiration of their respective one-year holding periods, but could be sold earlier if the holders exercise any available registration rights.

As restrictions on resale end, the market price could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them.

We intend to file a registration statement on Form S-8 to register the shares subject to outstanding options or reserved for issuance under our various stock option plans. The registration statement will become effective when filed, and, subject to applicable lock-up agreements, these shares may be resold without restriction in the public marketplace.

New investors in our common stock will experience immediate and substantial dilution after this offering.

The initial public offering price of our common stock will be substantially higher than the pro forma net tangible book value per share of the outstanding common stock immediately after the offering. Based on an assumed initial public offering price of $             per share and our net tangible book value as of December 31, 2006, if you purchase our common stock in this offering you will pay more for your shares than the amounts paid by certain existing stockholders for their shares, and you will suffer immediate dilution of approximately $             per share in pro forma net tangible book value. In the past, we have issued options and a warrant to acquire common stock at prices significantly below the initial public offering price. As of December 31, 2006, 5,562,338 shares of our common stock were issuable upon exercise of currently outstanding stock options, at a weighted average exercise price of $0.27 per share, 17,578 shares of our common stock were issuable upon the exercise of an outstanding warrant, at an exercise price of $0.96 per common share, and up to 1,184,095 shares of our common stock were reserved for future issuance under our 2001 Equity Incentive Plan. In addition, 3,400,000 shares are reserved for issuance under our 2006 Equity Incentive Plan and our 2006 Employee Stock Purchase Plan, which will become effective immediately upon the signing of the underwriting agreement for this offering. Our 2006 Equity Incentive Plan also provides for annual increases in the number of shares that may be granted under that plan. If all currently outstanding stock options and our outstanding warrant were exercised, you would suffer additional dilution and pro forma as adjusted net tangible book value after this offering would be decreased to $             per share. As a result of this dilution, investors purchasing common stock in this offering may receive significantly less than the full purchase price that they paid for the shares purchased in this offering in the event of a liquidation.

 

29


Table of Contents

We will incur significant increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the SEC 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 will need to devote a substantial amount of time to these new compliance initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly. For example, we expect these rules and regulations to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to incur substantial costs to maintain the same or similar coverage.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal control over financial reporting and disclosure controls and procedures. As a result of our compliance with Section 404, we will incur substantial accounting expense and expend significant management efforts and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge to ensure such compliance.

Changes to existing accounting pronouncements or taxation rules or practices may affect how we conduct our business and affect our reported results of operations.

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. During the first quarter of fiscal 2006, we adopted the provisions of, and account for stock-based compensation in accordance with, the Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment , or SFAS No. 123(R), which revises Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation , or SFAS 123, and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. Under the fair value recognition provisions of SFAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period. The effective date of this new standard for our financial statements was January 1, 2006. Adoption of this statement could have a significant impact on our future financial statements, as we are now required to expense the fair value of our stock option grants and stock purchases under our equity benefit plans rather than disclose the impact on our net loss within our footnotes. The impact of SFAS No. 123(R) on our financial statements and related disclosures are expected to be material to our future results of operations. Our actual stock-based compensation expense in 2006 and in the future will be dependent on a number of factors, including the amount of awards granted and the fair value of those awards at the time of grant, as well as any changes in underlying assumptions used to determine fair value under our pricing model. Other new accounting pronouncements or taxation rules and varying interpretations of accounting pronouncements or taxation practice have occurred and may occur in the future. 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.

We have broad discretion in the use of the net proceeds from this offering, and we may not use these proceeds effectively.

We have not determined the specific allocation of the net proceeds of this offering. Our management will have broad discretion in the application of the net proceeds from this offering and could spend the proceeds in ways that do not necessarily improve our results of operations or enhance the value of our common stock. The failure by our management to apply these funds effectively could result in financial losses that could have a material adverse effect on our business or financial condition, cause the price of our common stock to decline and delay product development.

 

30


Table of Contents

FORWARD-LOOKING STATEMENTS

Some of the statements under the sections of this prospectus entitled “Prospectus Summary,” “Risk Factors,” “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this prospectus contain forward-looking statements. In some cases, you can identify forward-looking statements by the following words: “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would,” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Although we believe that we have a reasonable basis for each forward-looking statement contained in this prospectus, we caution you that these statements are based on a combination of facts and factors currently known by us and our projections of the future, about which we cannot be certain. Many important factors affect our ability to achieve our objectives, including:

 

   

our ability to obtain and maintain regulatory clearance or approval of our products;

 

   

our plans to develop and commercialize our products;

 

   

the successful development of our sales and marketing capabilities;

 

   

our use of the proceeds from this offering; and

 

   

our ability to obtain and maintain intellectual property protection for our products.

In addition, you should refer to the section of this prospectus entitled “Risk Factors” for a discussion of other important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. As a result of these factors, we cannot assure you that the forward-looking statements in this prospectus will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all.

 

31


Table of Contents

USE OF PROCEEDS

We estimate that the net proceeds from the sale of the shares of our common stock in this offering will be approximately $              million, or approximately $              million if the underwriters exercise their right to purchase additional shares of common stock to cover any over-allotments in full, based upon an assumed initial public offering price of $              per share, the mid-point of the range reflected on the cover page of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses. Each $              increase (decrease) in the assumed initial public offering price of $              per share would increase (decrease) the net proceeds to us from this offering by approximately $              million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. Each increase of              million shares in the number of shares offered by us, together with a concomitant $              increase in the assumed initial public offering price of $              per share, would increase the net proceeds to us from this offering by approximately $              million. Similarly, each decrease of              million shares in the number of shares offered by us, together with a concomitant $              decrease in the assumed initial public offering price of $              per share, would decrease the net proceeds to us from this offering by approximately $              million. We do not expect that a change in the offering price or the number of shares by these amounts would have a material effect on our uses of the proceeds from this offering, although it may impact the amount of time prior to which we will need to seek additional capital.

We currently expect to use our net proceeds from this offering as follows:

 

   

approximately $              million for research and product development activities;

 

   

approximately $              million for sales and marketing activities; and

 

   

the remainder to fund working capital and other general corporate purposes.

We may also use a portion of the proceeds for the potential acquisition of, or investment in, other products that we may develop, intellectual property rights or companies that complement our business, although we have no current understandings, commitments or agreements to do so.

The expected use of net proceeds of this offering represents our current intentions based upon our present plans and business conditions. The amounts we actually expend in these areas may vary significantly from our current intentions and will depend upon a number of factors, including FDA approval of our products, future sales growth, success of research and product development efforts, cash generated from future operations and actual expenses to operate our business. As of the date of this prospectus, we cannot specify with certainty all of the particular uses for the net proceeds to be received upon the closing of this offering. Accordingly, our management will have broad discretion in the application of the net proceeds, and investors will be relying on the judgment of our management regarding the application of the proceeds of this offering.

The amount and timing of our expenditures will depend on several factors, including the progress of our research and development efforts and the amount of cash used by our operations. Pending their uses, we plan to invest the net proceeds of this offering in short- and intermediate-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings to support our operations and finance the growth and development of our business. We do not intend to pay cash dividends on our common stock for the foreseeable future. Any future determination related to dividend policy will be made at the discretion of our board of directors.

 

32


Table of Contents

CAPITALIZATION

The following table sets forth our capitalization as of December 31, 2006:

 

   

on an actual basis;

 

   

on an as adjusted basis to reflect:

 

   

the conversion of all of our outstanding shares of preferred stock into 40,446,099 shares of common stock immediately prior to the closing of this offering; and

 

   

the sale of              shares of common stock in this offering at an assumed initial offering price of $             per share, the mid-point of the range reflected on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses.

You should read the information in this table together with our financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus.

 

     As of December 31, 2006
     Actual     As Adjusted(1)
     ($ in thousands,
except share data)

Long-term debt, net of current portion

   $     $
              

Redeemable convertible preferred stock, $0.001 par value, issuable in series, 41,500,000 shares authorized, 40,446,099 shares issued and outstanding, actual; no shares authorized, issued and outstanding, as adjusted

     147,540      

Stockholders’ equity (deficit):

    

Preferred stock, $0.001 par value; no shares authorized, issued and outstanding, actual; $0.0001 par value, 15,000,000 shares authorized, no shares issued and outstanding, as adjusted

          

Common stock, $0.001 par value, 76,500,000 shares authorized, 9,627,892 shares issued and outstanding, actual; $0.0001 par value, 150,000,000 shares authorized,              shares issued and outstanding, as adjusted

     10    

Additional paid-in capital

        

Accumulated deficit

     (132,074 )  
              

Total stockholders’ equity (deficit)

     (132,064 )  
              

Total capitalization

   $ 15,476     $             
              

(1)   Each $              increase (decrease) in the assumed public offering price of $              per share, the mid-point of the range reflected on the cover page of this prospectus, would increase (decrease) each of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $              million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase of million shares in the number of shares offered by us, together with a concomitant $              increase in the assumed initial public offering price of $              per share, would increase each of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $              million. Similarly, each decrease of              million shares in the number of shares offered by us, together with a concomitant $              decrease in the assumed initial public offering price of $              per share, would decrease each of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $              million. The as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

 

33


Table of Contents

The outstanding share information in the table above excludes as of December 31, 2006:

 

   

5,562,338 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.27 per share;

 

   

17,578 shares of common stock issuable upon the exercise of an outstanding warrant, with an exercise price of $0.96 per share;

 

   

1,184,095 shares of common stock reserved for future issuance under our 2001 Equity Incentive Plan; and

 

   

3,400,000 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan and 2006 Employee Stock Purchase Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under these benefit plans.

 

34


Table of Contents

DILUTION

If you invest in our common stock in this offering, your ownership interest will be diluted to the extent of the difference between the initial public offering price per share and the pro forma net tangible book value per share of our common stock after this offering. Net tangible book value per share is determined by dividing the number of outstanding shares of our common stock into our total tangible assets (total assets less intangible assets) less total liabilities and redeemable convertible preferred stock. As of December 31, 2006, we had a historical net tangible book value (deficit) of our common stock of $(132.1) million, or approximately $(13.78) per share, not taking into account the conversion of our outstanding redeemable convertible preferred stock. The pro forma net tangible book value of our common stock as of December 31, 2006 was approximately $14.9 million, or approximately $0.30 per share, based on the number of shares outstanding as of December 31, 2006, after giving effect to the conversion of all outstanding redeemable convertible preferred stock into shares of common stock upon the closing of this offering.

Investors participating in this offering will incur immediate, substantial dilution. After giving effect to the sale of common stock offered in this offering at an assumed initial public offering price of $         per share, the mid-point of the range reflected on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, our pro forma as adjusted net tangible book value as of December 31, 2006 would have been approximately $         million, or approximately $         per share of common stock. This represents an immediate increase in pro forma as adjusted net tangible book value of $         per share to existing stockholders, and an immediate dilution of $         per share to investors participating in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

     $  

Historical net tangible book value per share as of December 31, 2006

   $ (13.78 )  

Pro forma increase in net tangible book value per share attributable to conversion of redeemable convertible preferred stock

     14.08    
          

Pro forma net tangible book value per share before this offering

   $ 0.30    
          

Pro forma increase in net tangible book value per share attributable to investors participating in this offering

    
          

Pro forma as adjusted net tangible book value per share after this offering

    
        

Pro forma dilution per share to investors participating in this offering

     $             
        

Each $         increase (decrease) in the assumed public offering price of $         per share would increase (decrease) our pro forma as adjusted net tangible book value by approximately $         million, or approximately $         per share, and the pro forma dilution per share to investors in this offering by approximately $         per share, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. An increase of          million shares in the number of shares offered by us, together with a concomitant $         increase in the assumed initial public offering price of $         per share, would result in an as pro forma adjusted net tangible book value of approximately $         million, or $         per share, and the pro forma dilution per share to investors in this offering would be $         per share. Similarly, a decrease of          million shares in the number of shares offered by us, together with a concomitant $         decrease in the assumed initial public offering price of $         per share, would result in an pro forma as adjusted net tangible book value of approximately $         million, or $         per share, and the pro forma dilution per share to investors in this offering would be $         per share. The pro forma as adjusted information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

If the underwriters exercise their option in full to purchase          additional shares of common stock in this offering, the pro forma as adjusted net tangible book value per share after the offering would be $         per share,

 

35


Table of Contents

the increase in the pro forma net tangible book value per share to existing stockholders would be $         per share and the pro forma dilution to new investors purchasing common stock in this offering would be $         per share.

The following table summarizes, on a pro forma basis as of December 31, 2006, the differences between the number of shares of common stock purchased from us, the total consideration and the weighted average price per share paid by existing stockholders and by investors participating in this offering at an assumed initial public offering price of $         per share, before deducting underwriting discounts and commissions and estimated offering expenses:

 

     Shares Purchased    Total
Consideration
  

Weighted
Average Price

Per Share

     Number    Percent    Amount    Percent   

Existing stockholders before this offering

              %    $                     %    $         

Investors participating in this offering

              
                            

Total

              %    $              %    $  
                            

The above discussion and tables also assume no exercise of any outstanding stock options or a warrant except as set forth above. As of December 31, 2006, there were:

 

   

5,562,338 shares of common stock issuable upon the exercise of outstanding options with a weighted average exercise price of $0.27 per share;

 

   

17,578 shares of common stock issuable upon the exercise of an outstanding warrant, with an exercise price of $0.96 per share;

 

   

1,184,095 shares of common stock reserved for future issuance under our 2001 Equity Incentive Plan; and

 

   

3,400,000 shares of common stock reserved for future issuance under our 2006 Equity Incentive Plan and 2006 Employee Stock Purchase Plan, as well as any automatic increases in the number of shares of our common stock reserved for future issuance under these benefit plans.

The following table summarizes, on a pro forma basis as of December 31, 2006, after giving effect to the exercise of all stock options and a warrant outstanding as of December 31, 2006, the differences between the number of shares of common stock purchased from us, the total consideration and the weighted average price per share paid by existing stockholders and by investors participating in this offering at an assumed initial public offering price of $         per share, before deducting underwriting discounts and commissions and estimated offering expenses:

 

     Shares Purchased    Total
Consideration
  

Weighted
Average Price

Per Share

     Number    Percent    Amount    Percent   

Existing stockholders before this offering

              %    $                     %    $         

Investors participating in this offering

              
                            

Total

              %    $              %    $  
                            

The number of shares of common stock outstanding in the table above is based on the pro forma number of shares outstanding as of December 31, 2006 and assumes no exercise of the underwriters’ option to purchase additional shares. If the underwriters’ option to purchase additional shares is exercised in full, the number of shares of common stock held by existing stockholders will be reduced         % of the total number of shares of common stock to be outstanding after this offering, and the number of shares of common stock held by investors participating in this offering will be increased to          shares or     % of the total number of shares of common stock to be outstanding after this offering.

 

36


Table of Contents

Effective upon the closing of this offering, an aggregate of 4,584,095 shares of our common stock will be reserved for future issuance under our equity benefit plans, and these share reserves will also be subject to automatic annual increases in accordance with the terms of the plans. To the extent that any of these options or the warrant are exercised, new options are issued under our equity benefit plans or we issue additional shares of common stock in the future, there will be further dilution to investors participating in this offering.

 

37


Table of Contents

SELECTED FINANCIAL DATA

The following selected financial data should be read together with our financial statements and accompanying notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this prospectus. The selected financial data in this section is not intended to replace our financial statements and the accompanying notes. Our historical results are not necessarily indicative of our future results.

We derived the statements of operations data for the years ended December 31, 2004, 2005 and 2006 and the balance sheet data as of December 31, 2005 and 2006 from our audited financial statements appearing elsewhere in this prospectus. The statement of operations data for the year ended December 31, 2003 and the balance sheet data as of December 31, 2003 and 2004 are derived from our audited financial statements, which are not included in this prospectus. The statement of operations data for the year ended December 31, 2002 and the balance sheet data as of December 31, 2002 are derived from our unaudited financial statements, which are not included in this prospectus.

 

    Years Ended December 31,  
    2002     2003     2004     2005         2006      
    ($ in thousands, except share and per share data)  

Statements of Operations Data:

         

Revenue

  $     $     $     $ 95     $ 3,413  

Cost of revenue

                      54       1,913  
                                       

Gross profit

                      41       1,500  

Operating expenses:

         

Research and development

    1,272       1,601       3,716       4,752       8,517  

Selling, general and administrative

    1,016       1,645       1,486       4,198       14,032  
                                       

Total operating expenses

    2,288       3,246       5,202       8,950       22,549  
                                       

Operating loss

    (2,288 )     (3,246 )     (5,202 )     (8,909 )     (21,049 )

Interest income (expense), net

    7       (76 )     87       72       394  

Other income (expenses), net

          16       (3 )     (10 )     (63 )
                                       

Net loss

    (2,281 )     (3,306 )     (5,118 )     (8,847 )     (20,718 )
                                       

Accretion of redeemable convertible preferred stock

          (280 )     (3,224 )     (4,437 )     (85,186 )
                                       

Net loss attributable to common stockholders

  $ (2,281 )   $ (3,586 )   $ (8,342 )   $ (13,284 )   $ (105,904 )
                                       

Net loss per share:

         

Basic and diluted(1)

  $ (0.25 )   $ (0.38 )   $ (0.89 )   $ (1.42 )   $ (11.17 )
                                       

Weighted average number of shares used in computation:

    9,281,654       9,359,325       9,359,325       9,370,346       9,484,745  

Pro forma net loss per share:

         

Basic and diluted(1)

          $ (0.49 )
               

Weighted average number of shares used in computation:

            41,900,455  

(1)   Please see Note 3 to the notes to our audited financial statements for an explanation of the method used to calculate basic and diluted net loss per share attributable to common stockholders, the pro forma basic and diluted net loss per share and the number of shares used in the computation of the per share amounts.

 

38


Table of Contents
    

As of December 31,

 
   2002     2003     2004     2005     2006  
     ($ in thousands)        

Balance Sheet Data:

          

Cash and cash equivalents

   $ 732     $ 10,086     $ 2,506     $ 12,694     $ 14,354  

Working capital

     589       9,870       5,013       11,579       14,557  

Total assets

     765       10,217       5,892       14,095       18,770  

Long-term debt, net of current portion

     1,013       19       397       177        

Redeemable convertible preferred stock

     2,514       16,249       19,473       39,781       147,540  

Total stockholders’ deficit

     (2,686 )     (6,267 )     (14,586 )     (27,839 )     (132,064 )

 

39


Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read together with our financial statements and related notes appearing elsewhere in this prospectus. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. You should review the “Risk Factors” section of this prospectus for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements described in the following discussion and analysis.

Overview

We are a medical device company that has developed and is commercializing a proprietary wireless sensing and communication technology for the human body. Our technology platform is designed to enable the improved management of patients with severe chronic cardiovascular diseases such as heart failure, aneurysms and hypertension. In October 2005, we received approval from the U.S. Food and Drug Administration, or FDA, for our EndoSure Wireless AAA Pressure Measurement System, or EndoSure system. We commenced initial commercial shipments of our EndoSure system in December 2005.

To support the launch of our EndoSure system, we have built a direct sales force in the United States to market the EndoSure system to physicians who treat AAA, including vascular surgeons, radiologists and cardiologists. Our sales and marketing initiatives include continuing medical education programs and involvement in industry trade shows. In addition, we use clinical studies, cost-benefit data and case studies in our selling process. Our clinical specialists provide technical and implantation support for our EndoSure system to physicians and their hospital staff. We believe that this combination of sales managers, clinical specialists and technical support staff provides an appropriate balance of professional selling skills and ongoing customer education and support.

We currently sell our EndoSure sensors in the United States to medical facilities through a direct sales force that is supported by our internal marketing organization. Our external electronics modules are generally provided at no cost to medical facilities that purchase our sensors.

We currently produce commercial quantities of the EndoSure system for AAA patients. We outsource the majority of the wireless sensor manufacturing processes to external manufacturers and conduct the remaining manufacturing processes at our facility. Our external electronics modules are manufactured entirely by a third-party electronics contract manufacturer to our specifications.

We have a pipeline of cardiovascular products that leverage our core wireless sensing technology. We are adapting our EndoSure system for use in patients with heart failure and in patients with hypertension. We initiated our heart failure clinical studies in South America in February 2006, in Europe in October 2006 and in the United States in December 2006. These feasibility studies are designed to assess the sensor’s ability to help heart failure patients avoid hospitalizations by providing early detection of a worsening of their condition. We are currently engaged in pre-clinical testing to determine the feasibility of our sensor for hypertensive patients.

We were incorporated in Delaware in November 2000 and since inception, we have devoted substantially all of our resources to start-up activities, raising capital and research and development, including product design, testing, manufacturing and clinical trials. We expect to spend considerable resources to further the commercialization of our EndoSure system as well as the continued clinical development of our technology platform. We have incurred losses since our inception and, as of December 31, 2006, we had an accumulated deficit of $132.1 million.

 

40


Table of Contents

Results of Operations

Year Ended December 31, 2005 Compared to Year Ended December 31, 2006

Revenue. Our revenue in 2005 and 2006 was derived from the sale of our EndoSure sensors. The increase in revenue from 2005 to 2006 was due to 12 months of sales in 2006 compared to one month in 2005.

 

     Year Ended
December 31,
   Change  
         2005            2006               $                 %        
     ($ in thousands)  

Revenue

   $ 95    $ 3,413    $ 3,318    3,492.6 %

Cost of Revenue. Cost of revenue consists of material, labor, freight and the associated overhead costs related to the processes employed in the production of our EndoSure sensors. The total costs of producing and distributing our external electronics modules are also included in cost of revenue. We do not sell our external electronics modules, rather, we provide them to medical facilities at no cost. Our cost of revenue is affected by a variety of factors, including supplier pricing, production volumes, yield and scrap and manufacturing efficiencies.

Cost of revenue for 2005 and 2006 was as follows:

 

     Year Ended
December 31,
   Change  
         2005            2006               $                 %        
     ($ in thousands)  

Cost of revenue

   $ 54    $ 1,913    $ 1,859    3,442.6 %

The increase in cost of revenue is the result of commencing sales of our EndoSure sensors and the cost of providing our external electronics modules. We expect that as production processes mature and our sensor revenue volumes increase, our cost of revenue as a percentage of revenue will decrease. Cost of revenue was 56.1% of revenue for 2006 compared to 56.8% of revenue for 2005.

Research and Development Expenses. Research and development expenses consist of engineering, product development and clinical and regulatory expenses, including salary, benefits and stock-based compensation. Research and development expenses also include consulting fees, and the cost of materials, supplies and clinical trials, including trial design, clinical site reimbursement, data management and associated travel expenses.

Research and development expenses for 2005 and 2006 were as follows:

 

     Year Ended
December 31,
   Change  
         2005            2006               $                 %        
     ($ in thousands)  

Research and development

   $ 4,752    $ 8,517    $ 3,765    79.2 %

The increase in research and development expenses from 2005 to 2006 was primarily due to a $1.6 million increase in salary and benefit expense associated with increased headcount, a $777,000 increase in product development costs including materials and supplies and a $641,000 increase in clinical trial expense. There was no stock-based compensation recorded in research and development for 2005. Research and development expenses for 2006 included $167,000 of stock-based compensation expense, which is primarily attributable to the adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment , or SFAS No. 123(R), on January 1, 2006. We expect our research and development expenses to continue to increase as we improve and broaden our product portfolio.

 

41


Table of Contents

Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries and other related costs for personnel in the executive, financial, sales, marketing, legal and administrative functions. Other expenses include costs associated with attending medical conferences and trade shows, professional fees for legal, consulting and accounting services, marketing fees, depreciation, travel expenses and stock-based compensation.

Selling, general and administrative expenses for 2005 and 2006 were as follows:

 

     Year Ended
December 31,
   Change  
         2005            2006               $                 %        
     ($ in thousands)  

Selling, general and administrative

   $ 4,198    $ 14,032    $ 9,834    234.3 %

The increase in selling, general and administrative expenses from 2005 to 2006 was primarily due to a $5.9 million increase in salary and benefit expense associated with increased headcount, a $1.5 million increase in sales and marketing related costs, a $707,000 increase in facility, administrative and depreciation expenses and a $527,000 increase in legal and professional fees. Selling, general and administrative expenses for 2005 included $27,000 of stock-based compensation expense related to stock options granted during this period. Selling, general and administrative expenses for 2006 included $1.1 million of stock-based compensation, which is primarily attributable to the adoption of SFAS No. 123(R) on January 1, 2006. We expect our selling, general and administrative expenses to increase as we expand our sales and marketing functions.

Interest Income, Net. Interest income, net for 2005 and 2006 was as follows:

 

     Year Ended
December 31,
   Change  
         2005            2006               $                 %        
     ($ in thousands)  

Interest income, net

   $ 72    $ 394    $ 322    447.2 %

The increase in interest income, net from 2005 to 2006 was due primarily to higher cash and cash equivalent balances following the closing of the Series C preferred stock financing in November 2005 and the Series D preferred stock financing in September and October 2006, higher average interest rates in 2006 and a reduction of the balance of our equipment financing note.

Year Ended December 31, 2004 Compared to Year Ended December 31, 2005

Revenue . Revenue for 2004 and 2005 was as follows:

 

     Year Ended
December 31,
   Change  
         2004            2005               $                 %        
     ($ in thousands)  

Revenue

   $    $ 95    $ 95    %

The increase in revenue from 2004 to 2005 was the result of the sale of our EndoSure sensors.

Cost of Revenue. Cost of revenue for 2004 and 2005 was as follows:

 

     Year Ended
December 31,
   Change  
         2004            2005               $                 %        
     ($ in thousands)  

Cost of revenue

   $    $ 54    $ 54          — %

 

42


Table of Contents

The increase in cost of revenue from 2004 to 2005 was the result of the initial sales of our EndoSure sensors and the cost of providing our external electronics modules. Cost of revenue was 56.8% of revenue for 2005.

Research and Development Expenses. Research and development expenses for 2004 and 2005 were as follows:

 

     Year Ended
December 31,
   Change  
         2004            2005               $                 %        
     ($ in thousands)  

Research and development

   $ 3,716    $ 4,752    $ 1,036        27.9 %

The increase in research and development expenses from 2004 to 2005 was primarily due to a $774,000 increase in salary and benefit expense associated with an increase in headcount, a $155,000 increase in product development costs including materials and supplies and a $89,000 increase in clinical trial expense.

Selling, General and Administrative Expenses. Selling, general and administrative expenses from 2004 and 2005 were as follows:

 

     Year Ended
December 31,
   Change  
         2004            2005               $                 %        
     ($ in thousands)  

Selling, general and administrative

   $ 1,486    $ 4,198    $ 2,712    182.5 %

The increase in selling, general and administrative expenses from 2004 to 2005 was primarily due to a $1.2 million increase in salary and benefit expense associated with an increase in headcount, a $604,000 increase in sales and marketing related costs, a $408,000 increase in facility, administrative and depreciation expenses and a $371,000 increase in legal and professional fees related to patent filings and general corporate matters. Included in our selling, general and administrative expense for 2005 is $27,000 of stock-based compensation due to the grant of stock options compared to $14,000 for 2004.

Interest Income, Net. Interest income, net for 2004 and 2005 was as follows:

 

     Year Ended
December 31,
   Change  
         2004            2005               $                 %        
     ($ in thousands)  

Interest income, net

   $ 87    $ 72    $ (15)    (17.2) %

The decrease in interest income, net from 2004 to 2005 was due primarily to higher interest-bearing average debt balances during 2004.

Liquidity and Capital Resources

We have incurred losses since our inception in November 2000 and, as of December 31, 2006 we had an accumulated deficit of $132.1 million. We have financed our operations to date principally through the sale of preferred stock, debt financing and interest earned on investments. Through December 31, 2006, we have received net proceeds of $54.5 million from the issuance of common and preferred stock. Working capital as of December 31, 2006 was $14.6 million. From inception through December 31, 2006, we recognized revenue of $3.5 million from the sales of our EndoSure sensors. Our cash and investment balances are held in a variety of interest bearing instruments, including corporate bonds, commercial paper and money market funds. Cash in excess of immediate requirements is invested in accordance with our investment policy primarily with a view to liquidity and capital preservation.

 

43


Table of Contents

Cash Flows

The following table summarizes our cash flows for 2004, 2005 and 2006:

 

     Year Ended
December 31,
 
     2004     2005     2006  
     ($ in thousands)  

Cash flow (used in) provided by:

      

Operating activities

   $ (4,940 )   $ (8,178 )   $ (18,882 )

Investing activities

     (3,240 )     2,705       (2,183 )

Financing activities

     600       15,661       22,725  
                        

Increase (decrease) in cash and cash equivalents

   $ (7,580 )   $ 10,188     $ 1,660  
                        

Operating Activities. Net cash used in operating activities primarily represents our net loss for the periods presented. The increase of $10.7 million in cash used in operating activities for 2005 compared to 2006 was primarily due to an increase in net loss of $11.9 million, offset by a net $1.3 million increase in stock-based compensation.

Net cash used in operating activities increased $3.2 million from 2004 to 2005 due to a $3.7 million increase in net loss, together with a $585,000 increase in inventory and a $146,000 increase in net accounts receivable, offset by a $1.2 million increase in accounts payable and accrued expenses.

Investing Activities. Net cash used in investing activities for 2006 was related to investments of $2.8 million in short-term investments, a $427,000 investment in patent and trademark development and $179,000 in property and equipment purchases, offset by $1.2 million in proceeds from the sale of short-term investments.

Net cash provided by investing activities in 2005 was due to proceeds of $3.0 million from the sale of short-term investments, offset by $194,000 in investments in patent and trademark development and purchases of $134,000 in property and equipment.

Net cash used in investing activities in 2004 was due to investments of $4.2 million in short-term investments and $230,000 in property and equipment purchases, offset by $1.2 million in proceeds from the sale of short-term investments.

Financing Activities. Net cash flows provided by financing activities for 2004, 2005 and 2006 consisted of the following:

 

   

cash of $653,000 from borrowings of long term debt in April 2004;

 

   

sale of our Series C preferred stock in November 2005, with net proceeds of $15.9 million; and

 

   

sale of our Series D preferred stock in September and October 2006, with net proceeds of $22.6 million.

Operating Capital and Capital Expenditure Requirements

To date, we have only commercialized one of our products and we have not achieved profitability. We anticipate that we will continue to incur substantial net losses for the next several years as we develop our products, prepare for the potential commercial launch of our heart failure and hypertension sensors, develop the corporate infrastructure required to manufacture and sell our products and operate as a publicly traded company as well as pursue additional applications for our technology platform.

 

44


Table of Contents

We believe the net proceeds from this offering, together with our forecasted revenue, cash, cash equivalents and investment balances and interest income we earn on these balances will be sufficient to meet our anticipated cash requirements through at least the next 24 months. If our available cash, cash equivalents and investment balances and net proceeds from this offering are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or enter into a credit facility. The sale of additional equity and debt securities may result in dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay, or eliminate some or all of, our planned research, development and commercialization activities, which could materially harm our business.

Our forecast of the period of time through which our financial resources will be adequate to support our operations, the costs to complete development of products and the cost to commercialize our future products are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in the “Risk Factors” section of this prospectus. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.

Because of the numerous risks and uncertainties associated with the development of medical devices, such as our wireless sensor systems, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to complete the development of our future products and successfully deliver any such products to the market. Our future capital requirements will depend on many factors, including but not limited to the following:

 

   

the rate of progress and cost of our clinical trials and other development activities for our future products;

 

   

the success of our research and development efforts;

 

   

the costs and timing of regulatory approval;

 

   

the expenses we incur in developing, selling and marketing our products;

 

   

the revenue generated by sales of our future products;

 

   

the emergence of competing or complementary technological developments;

 

   

the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual product rights;

 

   

the terms and timing of any collaborative, licensing or other arrangements that we may establish; and

 

   

the acquisition of businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

Working capital as of December 31, 2006 was $14.6 million, consisting of $17.8 million in current assets and $3.2 million in current liabilities. Working capital as of December 31, 2005 was $11.6 million, consisting of $13.6 million in current assets and $2.0 million in current liabilities.

 

45


Table of Contents

Contractual Obligations

The following table summarizes our outstanding contractual obligations as of December 31, 2006 and the effect those obligations are expected to have on our liquidity and cash flows in future periods:

 

     Payment Due by Period

Contractual Obligations

   Total   

Less than

1 Year

   1-3
Years
   3-5
Years
   More than
5 Years
     ($ in thousands)

Capital leases

   $ 2    $ 2    $    $    $

Long-term debt

     182      182               

Purchase commitments

     553      553               
                                  

Total

   $ 737    $ 737    $    $    $
                                  

The table above reflects only payment obligations that are fixed and determinable. Our purchase commitments represent our agreement, dated March 2005, with Sparton Medical Systems, Inc. to manufacture our external electronics modules and to purchase excess materials related to the manufacturing of our external electronics modules. Long-term debt includes $5,000 of interest due, calculated based on the individual advances.

Credit Facilities

Loan and Security Agreement. In April 2004, we entered into a loan and security agreement with Silicon Valley Bank. The loan and security agreement provides that we may borrow up to $1.0 million at an interest rate equal to the greater of (i) the prime rate plus 0.75% (ii) or 4.75%. The proceeds of the loan may be used for the purchase of equipment and other development costs. Payments are required to be made on a monthly basis over a 36 month repayment period for each equipment advance. The outstanding balance is collateralized by the equipment purchased with the proceeds from each equipment advance. As of December 31, 2006, the outstanding balance on the loan was $177,000 and the last payment is due in December 2007.

Line of Credit. In November 2005, we entered into a line of credit, or the credit facility, with Medtronic, Inc., which matures on November 18, 2011. The credit facility allows us to borrow up to $5.0 million. The credit facility carries a fixed interest rate equal to 9%, with interest payable in arrears on the maturity date. The credit facility is collateralized by all our assets. No amounts were outstanding under the credit facility as of December 31, 2006. In March 2007, we provided Medtronic with notice of our termination of the credit facility effective immediately upon the closing of this offering.

Off-Balance Sheet Arrangements

During 2004, 2005 and 2006, we did not engage in any off-balance sheet arrangements.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported expenses during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ materially from these estimates under different assumptions or conditions.

 

46


Table of Contents

Revenue Recognition

We generate revenue from the sale of our EndoSure sensors to medical facilities. The elements of a typical revenue arrangement can include the EndoSure sensor, a wireless sensor which is a single-procedure product, an external electronics module, and an initial training session. Revenue is recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements , or SAB No. 104, which requires that persuasive evidence of a sales arrangement exists, delivery of goods occurs through transfer of title and risk and rewards of ownership, the selling price is fixed or determinable and collectibility is reasonably assured. Initial training of hospital personnel is considered to be essential to the functionality of the EndoSure system. Revenue is generally recognized when delivery of all EndoSure system components is confirmed for a given customer and the aforementioned criteria under SAB No. 104 are met. Initial training and delivery of our external electronics modules are only required on the initial sale of an EndoSure sensor. Subsequent sales of our EndoSure sensors do not require training or delivery of external electronics modules in order to be recognized as revenue.

Our EndoSure sensors require the external electronics module in order to be functional. Accordingly, the initial purchase of EndoSure sensors is not considered delivered until a customer has taken delivery of the external electronics module. Generally, we do not charge our customers for an external electronics module. The external electronics module costs are charged as a direct cost and included in cost of revenue. We apply Emerging Issues Task Force, Revenue Arrangements with Multiple Deliverables , or EITF No. 00-21, when accounting for the EndoSure system. EITF No. 00-21 requires that we assess whether the different elements qualify for separate accounting. Since we do not have objective evidence of the fair value of the undelivered elements, generally an external electronics module and training, it was determined that the arrangement should be accounted for as a single unit of accounting.

Our external electronics modules are operated by our proprietary embedded software application. We considered paragraph two of the American Institute of Certified Public Accountants, or AICPA, Statement of Position No. 97-2, Software Revenue Recognition , and determined that the embedded software is incidental to the functionality of our external electronics modules. Therefore, Statement of Position No. 97-2 is not applicable.

We maintain sensor inventory at various medical facilities under the custody of the medical facility personnel for use in emergency procedures. We recognize revenue on sales to these customers when the revenue criteria have been met, which occurs when the medical facility customer informs us that a sensor has been removed from inventory and used in a procedure.

Allowance for Doubtful Accounts

We perform ongoing evaluations of our customers and continuously monitor collections and payments and estimate an allowance for doubtful accounts based on the aging of the underlying receivables, our experience to date and any specific collection issues we have identified. We believe appropriate reserves have been established, but may not adequately predict future credit losses. If the financial condition of our customers were to deteriorate and result in an impairment of their ability to make payments, additional allowances may be required which would result in additional selling, general and administrative expense in the period such determination is made.

Inventories

Inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. Inventories include raw materials, work in progress and finished goods. Inventory amounts include the expense to manufacture the item, such as the expense of raw materials, labor and other applied direct and indirect expenses. We continuously review our inventory for obsolescence and marketability. If the estimated market value, which is based upon assumptions about future demand and market conditions, falls below cost, the inventory value is reduced to market value. If technology rapidly changes or actual market conditions are less favorable than those estimated by management, inventory write-downs may be required.

 

47


Table of Contents

Stock-Based Compensation

Through December 31, 2005, we accounted for stock-based employee compensation arrangements using the intrinsic value method in accordance with the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , or APB No. 25, and complied with the disclosure-only provisions required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation , or SFAS No. 123. We applied the intrinsic value method of accounting prescribed by APB No. 25 and related interpretations. Under this method, if the exercise price of the award equaled or exceeded the fair market value of the underlying stock on the measurement date, no compensation expense was recognized. The measurement date was the date on which the final number of shares and exercise price were known and was the grant date for awards to employees and directors. If the exercise price of the award was below the fair market value of the underlying stock on the measurement date, then compensation cost was recorded, using the intrinsic value method, and was recognized in the statements of operations over the vesting period of the award.

We account for stock-based compensation arrangements with non-employees in accordance with Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services , using a fair value approach. For stock options granted to non-employees, we record the expense of such services based on the estimated fair value of the equity instrument using the Black-Scholes option pricing model. The value of the equity instrument is recognized in the statements of operations over the requisite service period of the award.

As of December 31, 2005, we recorded total deferred stock-based compensation within stockholders’ deficit of $191,000. Upon adoption of SFAS No. 123(R) on January 1, 2006, this deferred stock-based compensation was reclassified to additional paid-in capital.

Adoption of SFAS No. 123(R)

Effective January 1, 2006, we adopted SFAS No. 123(R) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees, non-employee directors and consultants based on fair value. SFAS No. 123(R) supersedes our previous accounting under APB No. 25 and SFAS No. 123 for periods beginning in fiscal 2006. We adopted SFAS No. 123(R) using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006, the first day of our fiscal year 2006. Under this method, compensation expense recognized for 2006 included: (a) expense for all stock-based awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation expense for all stock-based awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS No. 123(R). In accordance with the modified prospective transition method, our statements of operations for prior periods have not been restated to reflect, and do not include, the impact of SFAS No. 123(R).

Determining the appropriate fair value model and calculating the fair value of stock-based awards require the input of highly subjective assumptions. We use the Black-Scholes option pricing model to value our stock option awards. Stock-based compensation expense is significant to our financial statements and is calculated using our best estimates which involve inherent uncertainties and the application of management’s judgment. Significant estimates include our expected term, stock price volatility and forfeiture rates.

The expected term represents the weighted-average period that our stock options are expected to be outstanding. The expected term is based on the observed and expected time to post-vesting exercise of options by employees and considers the impact of post-vesting award cancellations. As we have been operating as a private company since inception with no active market for our stock or traded options, it is not possible to use actual price volatility data. Therefore, we estimate the volatility of our common stock based on volatility of similar entities. We base the risk-free interest rate that we use in the option pricing model on U.S. Treasury zero-coupon

 

48


Table of Contents

issues with terms equal to the expected term on the options. We have never and do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option pricing model. In order to properly attribute compensation expense, we are required to estimate pre-vesting forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting forfeitures and record stock-based compensation expense only for those awards that are expected to vest. If the actual forfeiture rate is materially different from the estimate, stock-based compensation expense could be significantly different from what has been recorded in the current period. We allocate expense on a straight-line basis over the requisite service period.

There are significant differences among option valuation models, and this may result in a lack of comparability with other companies that use different models, methods and assumptions. If factors change and we employ different assumptions in the application of SFAS No. 123(R) in future periods, or if we decide to use a different valuation model, the stock-based compensation expense that we record in the future under SFAS No. 123(R) may differ significantly from what we have recorded in the current period and could materially affect our operating results.

In the absence of a public trading market for our common stock, our board of directors determined the fair market value of our common stock in good faith based upon consideration of a number of objective and subjective factors, including the factors described below:

 

   

our stock option grants involved illiquid securities in a private company;

 

   

the shares of our common stock acquired upon exercise of stock options are subject to vesting;

 

   

prices of our Series A, Series B, Series C and Series D preferred stock issued primarily to outside investors in arms-length transactions, and the rights, preferences and privileges of our preferred stock relative to those of our common stock;

 

   

our results of operations, financial status and the status of our research and product development efforts;

 

   

our stage of development and business strategy;

 

   

the composition of and changes to our management team; and

 

   

the likelihood of achieving a liquidity event for the shares of our common stock underlying stock options, such as an initial public offering of our common stock or our sale to a third-party, given prevailing market conditions.

In November 2005, in response to Section 409A of the Internal Revenue Code of 1986, as amended, or Section 409A, and the proposed regulations issued by the U.S. Internal Revenue Service thereunder, we performed a valuation analysis to determine the fair market value of our common stock as of November 30, 2005, which resulted in an estimated fair market value per share at that date of $0.28. We performed a subsequent valuation analysis to determine the fair market value of our common stock as of September 18, 2006 in accordance with Section 409A, which resulted in an estimated fair market value per share at that date of $0.41. All equity awards to our employees, including executive officers, and to our directors in 2006 were granted at no less than the fair market value of our common stock as determined in good faith by our board of directors on the date of grant.

In connection with the preparation of the financial statements necessary for the filing of this registration statement, we retrospectively analyzed the fair value of our common stock at option grant dates from January 1, 2006 to December 31, 2006. As part of our retrospective analysis, we considered the status and progress of a number of company-specific business and financial conditions and milestones during 2006, including our results of operations, research and development activities, regulatory milestones, product and operational milestones, the lack of liquidity in our common stock, the increasing likelihood we would pursue an initial public offering, preliminary pricing indications in connection with this offering and industry trends in the market for medical device issuers. In accordance with the fair market value concepts within the AICPA’s Practice Aid titled “ Valuation of Privately-Held Company Equity Securities Issued as Compensation, ” we also considered arms-

 

49


Table of Contents

length cash transactions with unrelated parties for issuances of our equity securities as an indicator of an observable market price, namely, the established per share fair market value of our Series D preferred stock issuances of $2.07 per share in September 2006 and October 2006. We also considered the rights and preferences of our preferred stock in relation to our common stock. Our retrospective analysis was completed without the use of an independent valuation specialist. With the benefit of hindsight and actual knowledge of how the various factors noted above had progressed over time and uncertainties existing at the time of option grants were resolved, we reassessed the deemed fair value of our common stock for financial reporting purposes for all stock options granted since January 1, 2006.

The definition of grant date pursuant to SFAS No. 123(R) includes criteria for determining that a stock option has been granted for financial reporting purposes. One of the criteria is a mutual understanding by the employer and employee of the key terms and conditions of the stock option. As the documentation underlying the stock options granted in 2006 were not delivered to the optionees until some time after the date of grant, we determined that, for financial reporting purposes, the reassessed fair value should be as of the date the option grant documentation was delivered to the optionee, or the deemed grant date. The following table shows the retrospective analysis of stock options granted during the period from January 1, 2006 to December 31, 2006:

 

Date Action

Taken (1)

 

Deemed Date

of Grant

 

Number of

Stock
Options

Granted

  Exercise
Price
 

Reassessed

Fair Value

per Share

March and May 2006   July 2006   1,742,458   $ 0.28   $ 1.76
July 2006   October 2006   55,000     0.28     1.86
October 2006   December 2006   2,060,665     0.41     3.60

(1)   Represents the date on which our board of directors took all corporate action necessary to grant the stock option.

During 2006, we recorded $1.3 million of stock-based compensation expense. We expect to expense $8.2 million from the first quarter of 2007 through 2010 for unvested stock options as of December 31, 2006 as follows:

 

2007

 

2008

 

2009

 

2010

  Total
$2,390,000   $ 2,357,000   $ 2,284,000   $ 1,201,000   $ 8,232,000

Although it is reasonable to expect that the completion of our initial public offering may add value to our common stock as a result of increased liquidity and marketability, the amount of additional value cannot be measured with precision or certainty. Determining the reassessed fair value of our common stock required our board of directors and management to make complex and subjective judgments, assumptions and estimates, which involved inherent uncertainty. Had our board of directors and management used different assumptions and estimates, the resulting fair value of our common stock and the resulting stock-based compensation expense could have been different.

Net Operating Losses and Tax Credit Carryforwards

As of December 31, 2006, we had federal net operating loss carryforwards of approximately $38.0 million and $1.0 million of research and development tax credits. These net operating loss carryforwards, if not utilized, will begin to expire in 2021. A valuation allowance has been established to reserve the potential benefits of these carryforwards in our financial statements to reflect the uncertainty of future taxable income required to utilize available tax loss carryforwards and other deferred tax assets. Under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, substantial changes in our ownership, including due to this offering, may limit the amount of net operating loss carryforwards that can be utilized annually in the future to offset taxable income. If a change in our ownership is deemed to have occurred or occurs in the future, our ability to use our net operating loss carryforwards in any fiscal year may be limited.

 

50


Table of Contents

Recent Accounting Pronouncements

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 , or FIN No. 48, which clarifies the accounting for uncertainty in tax positions. FIN No. 48 requires that we recognize in our financial statements the impact of a tax position if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN No. 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect, if any, of the change in accounting principle recorded as an adjustment to opening retained earnings. We believe that FIN No. 48 will not have a material impact on our financial statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements , or SAB No. 108. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements. Traditionally, there have been two widely-recognized methods for quantifying the effects of financial statement misstatements: the “roll-over” method and the “iron curtain” method. The roll-over method focuses primarily on the impact of a misstatement on the income statement — including the reversing effect of prior year misstatements — but its use can lead to the accumulation of misstatements in the balance sheet. The iron curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. In SAB No. 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it requires quantification of errors under both the iron curtain and the roll-over methods. There are no unadjusted differences or financial statement misstatements noted in our financial statements and related disclosures.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, or SFAS No. 157. This statement defines fair value as used in numerous accounting pronouncements, establishes a framework for measuring fair value in GAAP and expands disclosure related to the use of fair value measures in financial statements. SFAS No. 157 does not expand the use of fair value measures in financial statements, but standardizes its definition and guidance in GAAP. The statement emphasizes that fair value is a market-based measurement and not an entity-specific measurement based on an exchange transaction in which the entity sells an asset or transfers a liability (exit price). SFAS No. 157 establishes a fair value hierarchy from observable market data as the highest level to fair value based on an entity’s own fair value assumptions as the lowest level. SFAS No. 157 is to be effective for our financial statements issued in 2008; however, earlier application is encouraged. We have not yet determined the impact that the adoption of SFAS No. 157 will have on our financial statements.

Quantitative and Qualitative Disclosure of Market Risks

Our exposure to market risk is limited to our cash, cash equivalents and short-term investments which have maturities of less than one year. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk. To achieve our goals, we maintain a portfolio of cash equivalents and investments in a variety of securities of high credit quality. The securities in our investment portfolio are not leveraged, are classified as available for sale and are, due to their very short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our investments, we do not believe that an increase in market rates would have any material negative impact on the value of our investment portfolio.

Controls and Procedures

In connection with the audit of our financial statements for the year ended December 31, 2005, our independent registered public accounting firm identified material weaknesses in our internal control over

 

51


Table of Contents

financial reporting. A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our management and independent registered public accounting firm did not perform an evaluation of our internal control over financial reporting during any period in accordance with the provisions of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act. Had we and our independent registered public accounting firm performed an evaluation of our internal control over financial reporting in accordance with the provisions of the Sarbanes-Oxley Act, additional control deficiencies may have been identified by management or our independent registered public accounting firm, and those control deficiencies could have also represented one or more material weaknesses.

Our independent registered public accounting firm communicated to our management and Audit Committee of the board of directors the following deficiencies in our internal control over financial reporting, which constitute material weaknesses:

 

   

we had inadequate accounting personnel resources to properly identify and apply GAAP on a consistent and timely basis; and

 

   

we had inadequate documentation of accounting policies, procedures and controls.

These material weaknesses existed as of December 31, 2005 and due to the incorrect application of GAAP, resulted in adjustments to our financial statements for the year ended December 31, 2005, affecting our inventory and cost of revenue accounts. These adjustments related to allocating indirect costs and overhead to inventory, and reclassifying certain costs from selling, general and administrative to costs of revenue. These control deficiencies could result in a misstatement of financial statement amounts and required disclosures that would result in a material misstatement to our interim or annual consolidated financial statements that would not be prevented or detected.

Since August 2006, we have hired three additional finance personnel, including our current chief financial officer and a corporate controller, whom have previous experience in financial reporting for publicly-traded companies. We have also implemented new accounting procedures and controls and documentation standards, including analysis and accounting interpretation of material contracts, inventory valuation procedures, review of account reconciliations and timeliness of reporting. These actions were taken in part to address our material weaknesses, and there were no material weaknesses noted in connection with the audit of our financial statements for the year ended December 31, 2006. However, we cannot assure you that we have identified all, or that we will not in the future have additional material weaknesses. The existence of one or more material weaknesses precludes a conclusion that we maintain effective internal control over financial reporting. Such conclusion would be required to be disclosed in our future Annual Reports on Form 10-K and may impact the accuracy and timing of our financial reporting and the reliability of our internal control over financial reporting.

 

52


Table of Contents

BUSINESS

Overview

We are a medical device company that has developed and is commercializing a proprietary wireless sensing and communication technology for the human body. Our technology platform is designed to improve the management of severe chronic cardiovascular diseases such as heart failure, aneurysms and hypertension. Our miniature wireless sensors can be implanted using minimally invasive techniques and transmit cardiac output, blood pressure and heart rate data that are critical to the management of patients. Due to their small size, durability, and lack of wires and batteries, our sensors are designed to be permanently implanted into the cardiovascular system. Using radiofrequency, or RF, energy, our sensors transmit real-time data to our external electronics modules, which then communicate this information to the patient’s physician. We believe frequent, on-demand, real-time monitoring of vital information enables proactive patient management, which holds the promise of reducing hospitalizations, improving a patient’s quality of life and delivering more efficient and cost effective health care.

Measuring pressure inside the heart and blood vessels is crucial to the management of patients with heart failure, aneurysms and hypertension. Pressure levels that are either too high or too low can result in serious complications such as aneurysm rupture, stroke or kidney failure. As a result, regular measurement of pressure is a critical tool for predicting a patient’s condition and managing therapy. However, the current techniques for measuring pressure in the heart and blood vessels can be invasive, in-hospital procedures with potentially serious complications.

Our first commercial device, the EndoSure Wireless AAA Pressure Measurement System, or EndoSure system, is comprised of an implanted sensor and an external electronics module. The EndoSure Wireless AAA Pressure Sensor, or EndoSure sensor, is inserted during the minimally invasive repair of an abdominal aortic aneurysm, or AAA, via a catheter into a patient’s aneurysm sac and communicates pressure information to an external electronics module from inside the sac. Since a goal of endovascular AAA repair is to eliminate or minimize pressure on the walls of the sac, our sensor is a valuable tool in helping a physician to determine during the procedure if the AAA has been adequately repaired. The EndoSure system received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, in October 2005, for measuring intrasac pressure during endovascular AAA repair and is used alongside traditional angiography. Angiography is used during AAA repair to detect leaks in the aneurysm sac. Angiography involves injecting a special dye via a catheter into the bloodstream that highlights the aneurysm sac and associated blood vessels for easier viewing through electronic imaging. We believe our EndoSure sensor augments angiography by providing objective evidence that pressure inside the aneurysm sac has decreased after the AAA repair. In March 2007, our EndoSure system was cleared by the FDA for measuring intrasac pressure during thoracic aortic aneurysm, or TAA, repair. Our FDA clearance does not allow us to promote the EndoSure system as a replacement for traditional angiography or for measuring pressure after a procedure. We plan on conducting clinical trials to seek FDA clearance for measuring pressure after the procedure. Our EndoSure sensor has been placed in more than 1,500 patients since receiving FDA clearance.

We have a pipeline of cardiovascular products that leverage our core wireless sensing technology. We are adapting our EndoSure system for use in patients with heart failure and in patients with hypertension. We initiated our heart failure feasibility studies in South America in February 2006, in Europe in October 2006 and in the United States in December 2006. These feasibility studies are designed to preliminarily assess the sensor’s safety and ability to help heart failure patients avoid hospitalizations by providing early detection of a worsening in their condition by measuring pressure inside the heart. As of February 28, 2007, we have implanted sensors in 32 patients as part of these feasibility studies. We expect our pivotal U.S. heart failure trial to start in 2007 and we expect to file an application for premarket approval, or PMA, with the FDA for our heart failure sensor in 2008. We are developing a hypertension sensor that will be able to provide frequent long-term monitoring of a patient’s blood pressure. We initiated human implants of our hypertension sensor as part of feasibility studies commenced in March 2007. Initially, we plan to target severely hypertensive patients and then expand our indications to the broader hypertensive population.

 

53


Table of Contents

Market Opportunity

Cardiovascular disease is the leading cause of death in the United States. It encompasses a wide range of conditions and pathologies including aneurysms, heart failure, hypertension, strokes and heart attacks. Recent advances in drug and device technologies have significantly reduced mortality rates from cardiovascular diseases, and, therefore, cardiovascular patients are now living longer. As a result, there is a significant unmet need for ongoing patient management of chronic cardiovascular disease.

Aortic Aneurysms

An aortic aneurysm is the weakening and enlargement of the aortic wall, which if left untreated can lead to rupture and death. There are two types of aortic aneurysms: thoracic and abdominal. Aortic aneurysms affect approximately 2.7 million Americans and are the 13th leading cause of death in the United States. Early diagnosis and preventive repair are vital since only one out of two patients with an AAA rupture will survive. We believe aneurysm procedures are steadily increasing due to recently approved Medicare reimbursement for screening, greater patient awareness and the adoption of less invasive repair techniques.

Heart Failure

Heart failure is the progressive weakening of the heart muscle that can occur from a variety of causes, particularly heart attacks and hypertension. Heart failure is characterized by high mortality, frequent hospitalizations and poor quality of life. As the ability to keep people from dying from heart attacks has improved, the number of patients living with heart failure has significantly increased over the last 25 years. Despite the dramatic improvements in medical care, heart failure afflicts more than five million Americans, is the leading cause of hospitalizations with over one million hospitalizations per year and kills over 200,000 people each year. The estimated direct and indirect cost of heart failure in the United States for 2006 was approximately $30 billion. In Europe, heart failure afflicts more than 14 million people with over 3.6 million hospitalizations per year. By 2020, the number of people with heart failure in Europe is projected to increase to 30 million with nine million deaths attributed to the disease.

Hypertension

Hypertension is a disease characterized by a chronic increase in blood pressure and is a major cause of heart failure, stroke and kidney failure. Hypertension is one of the most common diseases in the world and affects 65 million people in the United States alone. The estimated direct and indirect cost of hypertension in the United States for 2006 was approximately $64 billion. The prevalence of hypertension in Europe is estimated to occur in over 44% of the population with only 8% of hypertensive individuals having their condition controlled. The World Health Organization reports that hypertension is the underlying cause of 62% of strokes and 49% of heart attacks. Hypertension is the number one attributable risk for death throughout the world. The prevalence of hypertension is increasing due to an aging population, increases in obesity, sedentary behavior and dietary factors.

Pressure: Critical Variable in Cardiovascular Disease

The cardiovascular system is a pressurized network of blood vessels powered by the heart, akin to a network of pipes powered by a pump. As such, maintenance of the pressure inside the heart and blood vessels within a narrow range is critical to overall patient health.

In heart failure patients, the heart has been damaged by any number of causes, including heart attacks and hypertension. The damaged heart enlarges and the pressure inside the heart increases. High pressure can lead to fluid in the lungs, a condition known as pulmonary edema, which can be fatal and often requires the patient being placed on a ventilator in the intensive care unit, or ICU. The pressure must be carefully managed by the patient’s physician through the administration of drugs that are intended to lower the pressure inside the heart. However, pressure that is too low can lead to fatigue, loss of consciousness and kidney failure. Just as tight regulation of

 

54


Table of Contents

blood glucose is essential to preventing complications from diabetes, careful regulation of pressure inside the heart is important in keeping heart failure patients out of the hospital. Unlike current glucose measuring techniques, which involve a simple fingerstick device used by the patient, the current techniques for measuring pressure inside the heart are generally invasive, in-hospital procedures with potentially serious complications.

Increased pressure inside the aortic aneurysm is the primary cause of aneurysm enlargement and rupture. In hypertension, careful management of blood pressure can reduce the development of more serious conditions including heart disease, stroke and kidney failure. Frequent blood pressure monitoring allows physicians to optimize the impact of anti-hypertensive drugs.

Current Pressure Management Technologies

Aortic Aneurysms

Aortic aneurysms are frequently treated with minimally invasive endovascular stent grafts which are believed to be less traumatic to the patient than standard open surgical repair. While aortic stent grafting has improved patient care, future leaks from the stent graft can lead to aortic aneurysm rupture. As a result, frequent and sustained surveillance to detect leaks and assess the status of the aortic aneurysm repair is needed for safe management of patients.

In 2003, the FDA recommended that aortic aneurysm repair patients undergo periodic medical imaging examinations, such as x-rays or computed tomography, or CT scans, to detect leaks and assess the status of the aortic aneurysm repair. CT scanning is a test that uses intravenous contrast material, x-rays and computers to create detailed images of the internal structures of the body. The contrast material contains some harmful elements, and repeated exposure to this material presents a significant risk of kidney damage and allergic reaction. Further, some patients cannot tolerate the contrast material and, therefore, a CT scan cannot be used for these patients. Because CT scanning is an x-ray test, it sends radiation through the patient which can damage cells over time. CT scans have significant limitations, including their inability to detect all leaks and to measure intrasac pressure of the aneurysm, which is a key measurement for determining the stability of a repaired aortic aneurysm. In addition, although the CT scan itself is a rapid procedure, the preparatory and ancillary activities associated with it consume a half a day to a full day of the patient’s time.

Measuring sac pressure and monitoring a trend in reduced sac pressure can provide direct evidence of both repair success and long-term stent graft stability. Until the introduction of our EndoSure system, the only available procedure to measure intra-sac pressure was a trans-lumbar aortic puncture through the back, directly into the aortic aneurysm. This is an invasive surgical procedure that is usually performed when leaks are suspected, carries significant risk and provides only a single measurement. This procedure is performed in the hospital under local or general anesthesia.

Heart Failure

Today’s current standard of care for measuring pressure inside the heart is a right heart catheterization procedure using a Swan-Ganz catheter. The Swan-Ganz is a specialized balloon tipped catheter that is used to access the pulmonary artery. It can provide direct and simultaneous measurement of pressures in the right atrium, right ventricle, pulmonary artery, as well as the filling pressure of the left atrium. In a right heart catheterization, the Swan-Ganz catheter is introduced through a large vein in the neck, groin or chest. The balloon at the tip of the catheter is inflated and the catheter is guided through the veins into the right atrium, followed by the right ventricle of the heart, and ultimately into the pulmonary artery. After placement of the catheter tip into the pulmonary artery, pressure and cardiac output measurements are taken. To obtain cardiac output, nurses perform a complex series of measurements requiring injection of cold saline into the patient typically once or twice a day.

The right heart catheterization procedure is invasive and carries several patient risks, including development of an irregular heartbeat, rupture of the pulmonary artery, collapsed lungs, infection and internal bleeding. In addition, the procedure must be performed in the ICU or cardiac catheterization lab and requires a hospital stay

 

55


Table of Contents

of at least one day, making it costly as well as inconvenient and uncomfortable for the patient. The procedure takes approximately one hour, and the catheter can only remain in place for a few days before needing to be replaced due to a risk of infection.

Hypertension

Regular blood pressure monitoring is an important factor in the treatment of patients with hypertension and allows physicians to optimize the impact of anti-hypertensive drugs. Home pressure monitoring has become increasingly popular with the availability of low-cost devices that can be used by the patient in the home. These home monitoring devices allow patients to have greater control over managing their own health and also provide additional information for physicians regarding treatment effectiveness. Recent evidence indicates that even small but persistent increases in blood pressure can be clinically significant and may lead to adverse outcomes. As a result, it is important to identify these changes as soon as possible so that drug regimens, diet and other treatment protocols can be adjusted to bring about better control. Blood pressure varies significantly throughout the day and an estimated 71% of patients with hypertension in the United States and 92% of the patients in Europe are not adequately treated. There are many low cost devices available for use by a patient for blood pressure measurements away from the physician office, including manual, digital and wrist monitors and cuffs. However, such devices can be complicated to use, and may provide inaccurate readings if used improperly. The accuracy and effectiveness of these devices also vary based on degree of patient training and compliance.

Limitations of Current Pressure Measurement Technologies

While there are several methods currently used to measure pressure in the heart and blood vessels, these methods have significant limitations, including:

 

   

Multiple Procedures . Monitoring using current pressure measurement methods for aortic aneurysms and heart failure require a procedure to be performed for each set of measurements resulting in multiple procedures over the life of the patient. These procedures involve some level of invasiveness and are often accompanied by significant risk and adverse events.

 

   

Short-Term Solutions . Current pressure measurement technologies are short-term in nature and fail to provide physicians long-term management tools, such as frequent pressure measurement, for effective patient management. For aortic aneurysm patients, the trans-lumbar puncture procedure provides a maximum of one to two hours of measurement for each procedure. For heart failure patients, a Swan-Ganz catheter should be removed within several days due to the risk of infection. As a result, neither procedure provides for long-term frequent pressure measurement.

 

   

Adverse Events . Surveillance and monitoring of aortic aneurysm repair patients must be performed for the life of the patient and generally involves the use of medical imaging technology, such as CT scans, which are associated with radiation and intravenous contrast toxicity that can lead to kidney damage. Life threatening complications associated with the Swan-Ganz catheter and the catheterization procedure include development of an irregular heartbeat, rupture of the pulmonary artery, development of blood clots, collapsed lungs, infection and internal bleeding.

 

   

Inadequate Data . Current non-invasive pressure measurement technologies for aortic aneurysms and hypertension lack the ability to provide physicians and patients with consistently accurate and timely data. CT scans of aortic aneurysm repairs are not able to measure intrasac pressure and are unable to detect all leaks associated with aortic aneurysm repair. The devices available to hypertension patients are unable to take direct measurements of pressure inside the blood vessel and often provide inaccurate measurements.

 

   

Inconvenience . For heart failure patients, the Swan-Ganz catheter is generally in place for several days and the heart failure patient is required to be in the ICU for monitoring. The associated hospital stay is costly and ICUs generally have limited bed availability. A CT scan typically requires a half a day to a full day of an aortic aneurysm patient’s time and is inefficient for both the patient and the physician. If

 

56


Table of Contents
 

required, a trans-lumbar puncture procedure generally involves an additional overnight stay in the hospital.

 

   

Patient Discomfort . The invasive nature of right heart catheterization for heart failure patients and trans-lumbar puncture procedure for aortic aneurysm patients results in significant patient discomfort and anxiety. The prolonged insertion of the Swan-Ganz catheter can be particularly uncomfortable and also limits patient mobility. Frequent blood pressure cuff inflations that occur during ambulatory blood pressure measurement are uncomfortable for the hypertensive patient and can interfere with the patient’s sleep.

Our Solution

We have developed and are commercializing a proprietary wireless sensing and communication technology for the human body. Our technology consists of a wireless sensor and an external electronics module. Our wireless sensors can be implanted through a minimally invasive procedure and communicate vital patient data to the external electronics module.

We believe that our technology overcomes many of the limitations of existing pressure measurement technologies in the following ways:

 

   

Single Minimally Invasive Procedure . We have designed our miniature wireless sensors to be implanted inside the body using a single minimally invasive procedure. Once implanted, our wireless sensors are designed to take pressure measurements non-invasively over the life of the patient.

 

   

Long-Term Solution . Our sensors are composed of materials selected for their durability, robustness, bio-compatibility, and insensitivity to changes in body chemistry or biology. We believe we have established the long-term stability of our sensors through numerous bench tests and animal tests, including accelerated fatigue testing simulating operation over ten years. In addition, our sensors are powered by RF energy transmitted from an external electronics module and possess no battery or internal power source of their own. As a result, we believe our sensors can last for, and transmit data over, the lifetime of the patient without requiring repeated procedures.

 

   

No Observed Adverse Events . We have not received any reports of any reported adverse events after implantation attributed to our commercialized EndoSure system to date nor have we observed any adverse events in our aortic aneurysm or heart failure clinical trials attributed to our sensors.

 

   

Real-Time Data . Our technology is designed to enable frequent, on-demand, real-time monitoring of vital information, enabling proactive patient management. Our sensors transmit real-time data using RF energy to our external electronic modules which then communicate this information to our secure database where it can be accessed by the patient’s physician via the Internet.

 

   

Convenience and Ease of Use . Our sensors have been carefully designed to be implantable in a variety of settings outside of the operating room, including the cardiac catheterization lab as well as the ICU. However, our sensors can also be implanted during open surgery giving maximum flexibility to the physician. Our sensors are designed to be implanted and monitored by a wide variety of physicians, including cardiologists, radiologists, electrophysiologists, surgeons, anesthesiologists and intensivists. In addition, we believe our external electronics modules are simple and easy to use by healthcare personnel and eventually by patients at home.

 

   

Patient Comfort . Once implanted, our sensors are designed to eliminate the need for additional procedures required to monitor pressure. Unlike a right heart catheterization which may require the Swan-Ganz catheter to remain in the pulmonary artery for several days each time one is used, our sensors are designed to remain at the implant site for the patient’s lifetime. Communication with our external electronics modules does not require wires and can be performed with the patient lying down, sitting or standing. In addition, we are developing our heart failure system with a home monitoring external electronics module that will enable patients to monitor their pressure in the convenience of their own homes.

 

57


Table of Contents

We have developed wireless sensors for measuring pressure in AAA and in patients with heart failure and hypertension. Our existing FDA-cleared product, the EndoSure system, is currently being commercialized for measuring pressure during endovascular AAA repair procedures. Our heart failure sensor is in feasibility studies for use in heart failure or pulmonary hypertension patients. It can be implanted percutaneously through a puncture or small incision or during open cardiac surgery and can be placed either inside or outside the pulmonary artery. Our heart failure sensor’s cross-sectional area is much smaller than the pulmonary artery’s cross-sectional area and, as a result, has been designed to prevent any blood flow blockage. Our sensor is held in place in the pulmonary artery by the wire loops made from a nickel titanium alloy, called nitinol, that are attached to the sensor and designed to push against the arterial wall to stabilize the sensor. Although our heart failure sensor is designed not to move, we believe some movement would not alter the sensor’s ability to measure pressure since pressure is known to be uniform within the pulmonary artery.

Our hypertension sensor is in pre-clinical trials for use in hypertension. It can be implanted percutaneously or during minimally invasive surgery and can be placed either inside or outside the radial artery in the wrist. In addition, we have developed and are commercializing our external electronics module that communicates with our sensors using RF energy and presents vital patient information.

While we believe our wireless sensing technology offers the advantages described above, physicians may not perceive some or all of these advantages and may be unwilling to change their current treatment regimes. Currently, there is only limited clinical data regarding the safety and efficacy of our products and if long-term data does not support our current data, physicians may choose not to use our products. Readings from our EndoSure sensors are not always readily obtainable and may require adjustments to the antenna placement and the external electronics module. In addition, in a small number of sensor implants amounting to less than 2% of implants to date, no pressure signal was obtained during the endovascular AAA repair procedure. We believe that this lack of signal acquisition is attributable to one or more factors, including, but not limited to, excessive distance between the sensor and the antenna, suboptimal orientation of the sensor during implantation, or unusual patient anatomy. In all such cases, there was no patient injury. We continue to work on improving the reliability of the EndoSure system’s signal; however, we may not be successful in achieving a level of reliability satisfactory to physicians who might use our products. Additionally, while we believe our sensors, once implanted, can improve patient comfort in pressure monitoring procedures, we expect that our heart failure sensor will have to be calibrated during implantation using a Swan-Ganz catheter.

Our Strategy

Our goal is to be the leading provider of sensing and communication technology for the improved management of severe chronic cardiovascular diseases such as aneurysms, heart failure and hypertension. To achieve this goal, we are pursuing the following strategies:

 

   

Leverage our EndoSure system to pursue the regulatory approval and commercialization of our heart failure and hypertension sensors . Our commercialized EndoSure system is the foundation for our heart failure and hypertension products. We believe this reduces technological risk as we pursue commercialization for these additional applications. We have commenced a broad clinical trial program to further demonstrate the effectiveness and safety of these products that we believe will enable us to successfully enter these large markets. We expect to increase our sales and marketing efforts in anticipation of these product launches.

 

   

Accelerate the market adoption of our EndoSure system . Following FDA clearance of our EndoSure system, one of our major strategic initiatives has been to drive adoption and increase revenue of this product through increased physician usage and broadening of our customer base. To further drive adoption, we are developing the next generation of our EndoSure system to improve implantation through the use of a smaller size sensor and enhanced delivery system. In addition, we are continuing our clinical programs to provide additional data on the benefits of our system and to broaden our current indication to include chronic use.

 

58


Table of Contents
   

Continue to strengthen our direct sales and marketing infrastructure and customer service capabilities . We have assembled a sales force of experienced professionals to introduce and educate the market on the characteristics and benefits of our technology and products. To complement our sales efforts, we employ clinical support managers who provide technical and implantation support to physicians. Our initial focus is on commercializing our products in the United States and we expect to expand into select international markets. We support our sales and marketing efforts with a customer service program that includes implantation expertise, customer training and support. We provide direct technical support by telephone and internet access 24 hours a day to physicians and other medical support personnel to promote safe and successful use of our products.

 

   

Continue ongoing research and development investment to improve and broaden our product portfolio . We intend to enhance and maintain our technology leadership with focused research and development efforts. We are continually seeking to reduce the size of our sensors and improve our system’s performance levels. We are also focused on improving our manufacturing efficiency and reducing the cost of our products.

 

   

Leverage our technology platform and IP position into other medical and industrial applications through selective partnering and licensing arrangements. We believe our sensor and communication technology has broad application for the transmission of vital data from inside the human body. Specifically, we believe our technology will have application in the fields of neurology, incontinence, obesity, ophthalmology and orthopedics. We are currently exploring licensing and collaboration opportunities for medical, as well as industrial, applications. Our first collaboration is with Medtronic, Inc., or Medtronic, for the development and commercialization of our sensor technology as a wired sensor to be used as part of Medtronic’s implantable devices to address impaired cardiac function or hypertension, or both.

Our Technology Platform

We have developed and are commercializing a proprietary wireless sensing and communication technology platform for the human body. Our monitoring technology is composed of two components: a miniaturized, wireless implantable sensor and an external electronics module. The external electronics module wirelessly communicates with our sensors to deliver vital patient data. Our wireless sensors are powered by RF energy transmitted from an external electronics module and transmit real-time data without batteries.

Sensor Technology

Our sensors are designed and manufactured using microelectromechanical systems, or MEMS, technology, which enables the fabrication of millimeter-scale devices with internal features in the nanometer to micrometer range. MEMS technology allows the creation of sensors with measurement stability and energy efficiency. We believe our sensors are the first commercially available implantable medical devices using MEMS technology.

Our sensors do not require batteries because they function by passive resonance. Using passive resonance, our sensors are designed to efficiently absorb RF energy transmitted from the external electronics module and to resonate at a frequency which is proportional to the pressure on the sensor. Since the pressure inside the body is continually changing, during a heartbeat for example, this resonant frequency detection method is repeated approximately two thousand times per second. The information is processed in real time and displayed as a pressure waveform on the external electronics module. Our sensors are designed to measure vital medical parameters such as mean pressure, systolic pressure, diastolic pressure, heart rate and cardiac output.

All of our sensor components are made of materials that have been chosen for their durability, robustness, biocompatibility, and insensitivity to changes in body chemistry or biology. We believe we have established the long-term stability of our sensors through numerous bench tests and animal tests, including accelerated fatigue testing to 10 years. Simulated use testing has also shown our sensors’ pressure measurements to remain accurate for up to 10 years. This testing has shown the life span of our sensors to be at least consistent with the life span of

 

59


Table of Contents

other permanent implants such as cardiovascular stents. Patients have had our sensors implanted for up to two years without any reported adverse events after implantation. Our sensors also incorporate radio-opaque features to enable fluoroscopic visualization during placement within the body.

We have designed our first and next generation EndoSure sensors to be implanted inside the aortic aneurysm sac. Nitinol wires are attached to the sensor and provide an anchoring mechanism for the sensor inside the aneurysm sac. We use nitinol wires in our EndoSure sensors because nitinol is a highly flexible metal and has favorable shape retention and fatigue resistance properties. Nitinol is also generally known to be non-toxic for use in the human body and is commonly used in cardiovascular and peripheral vascular stents.

Electronics Technology

Our external electronics modules consists of three parts: the internal signal processing electronics, or main unit, the antenna used to wirelessly communicate with the sensor, and the graphical user interface that displays the patient information.

The main unit generates and processes the RF signal. This unit is comprised of custom RF processing circuitry, microprocessors, the software, a smart card reader and multiple input and output ports. The custom circuitry generates the bursts of RF energy that power the sensor, processes the return signal from the sensor and transmits pressure information to the microprocessors. This circuitry also contains a barometric pressure sensor that provides information to compensate for altitude and atmospheric pressure variations. The microprocessors provide the processing and storage for the graphical user interface. The smart card reader is a part of the graphical user interface and is used to obtain sensor calibration data. In the absence of the smart card, the physician can manually enter the calibration data. The input and output ports allow patient data to be transferred and stored electronically. An optional printer provides a two-inch wide printout of data from the readout for the physician unit only.

During a reading, the antenna is placed near the implant site and communicates with the sensor. There are two models of the antenna: a handheld rigid version and a flat flexible version which is designed to allow the patient to lie flat on the antenna. Either model is designed to be used during the implant procedure, as well as during long-term monitoring.

The graphical user interface allows for system operation and data entry and displays information generated from the sensor. This information includes a pressure waveform and readings, such as mean pressure, systolic pressure, diastolic pressure, heart rate and cardiac output.

We have a commercially available external electronics module that is used with our EndoSure sensor in a hospital setting. Our next generation external electronics module is smaller, portable and designed to be utilized in the hospital setting and the patient’s home. The two models are designed to be functionally equivalent.

 

60


Table of Contents

Our Products

Leveraging our core wireless sensor and communication technology, we are developing and commercializing a family of products that target select cardiovascular markets where we believe wireless pressure monitoring can have a significant impact on patient treatment. The following table summarizes the applications for our current product and products under development.

 

Application

 

Approximate
Sensor Size

 

Implant

location

 

Anticipated
Regulatory
Pathway

 

Current

Status

AAA/during procedure

(abdominal aortic aneurysms)

  30 mm sensor   AAA sac   U.S. 510(k) clearance in October 2005   Commercialized as the EndoSure system in the U.S.

TAA

(thoracic aortic aneurysms)

  30 mm sensor   TAA sac   U.S. 510(k) clearance in March 2007  

Commercialized as the EndoSure system in the U.S.

AAA/after procedure

  18 mm sensor   AAA sac   U.S. 510(k) expected to be required   U.S. clinical trial commencement expected in 2007
Heart failure   18 mm sensor   Inside pulmonary artery   U.S. PMA and European CE Mark   Ongoing clinical trials in the U.S., Europe and South America
Heart failure – pulmonary hypertension   18 mm sensor   Inside pulmonary artery   U.S. HUD/HDE   Request for HUD expected to be submitted in 2007
Heart failure–cardiac surgery   18 mm sensor   Outside pulmonary artery   U.S. 510(k) expected to be required   Multi-center U.S. clinical trial protocol being prepared. U.S. 510(k) expected to be submitted in 2007
Hypertension   5 mm sensor   Brachial/radial artery (arm/wrist)   U.S. PMA and European CE Mark   Ongoing preclinical testing

EndoSure System

Our initial commercial product, the EndoSure system, is cleared in the United States for measuring intrasac pressure during endovascular AAA repair and thereby serving as an adjunctive tool in the detection of intraoperative leaks of the stent graft. The EndoSure system is also cleared in the United States for measuring intrasac pressure during TAA repair. The EndoSure system includes two components, a wireless sensor and an external electronics module. The sensor comes pre-loaded in a one-piece 14 French delivery system that enables the physician to insert the EndoSure sensor during the same procedure as the stent graft. Radiopaque markers assist the physician in delivery of the EndoSure sensor by clearly defining the sensor location within the aneurysm sac between the stent graft and aortic wall. The EndoSure sensor is intended to be a permanent implant in the aneurysm sac.

By comparing pressure waveforms before and after deployment of the stent graft, the EndoSure system assists the physician in confirming the traditional angiographic findings of successful stent graft placement. In addition, the EndoSure system is designed to allow the physician to rapidly measure intrasac pressure during a

 

61


Table of Contents

patient’s routine follow-up visits, potentially reducing the need for more costly, potentially less accurate and possibly harmful CT scans with intravenous contrast. This use has not been cleared by the FDA. We intend to commence a clinical trial to support a 510(k) clearance for this post-operative use in 2007. We expect this trial may require approximately 1,200 patients with a two year follow-up to support clearance.

We commercially introduced our EndoSure system in December 2005 following clearance by the FDA in October 2005. The first patients who received the EndoSure sensor in our initial clinical study have passed their two year follow-up milestone with no adverse events, and we expect to have three year follow-up data beginning in March 2007. As of February 28, 2007, over 1,500 EndoSure sensors have been implanted at more than 140 sites across the United States.

We expect to introduce our next generation EndoSure system in 2007. The next generation EndoSure sensor is smaller, approximately 18 millimeters versus 30 millimeters, and, is therefore, easier to deliver. The next generation external electronics module has also been reduced in size and has an improved graphic user interface. The next generation external electronics module also includes a flat antenna that is thinner and more flexible and can be placed on the back of a chair or bed located in the hospital or the patient’s home. The next generation external electronics module also allows patient data to be stored and immediately transmitted to a secure, online database where the patient’s physician can access the data. These technical improvements have been completed and are designed to enhance the EndoSure system’s ease of use. We are currently seeking 510(k) clearance of these modifications from the FDA.

Heart Failure Program

Leveraging our EndoSure system, we are commercializing wireless sensors to enable more effective treatment of heart failure patients. Our wireless heart failure sensors have been designed for three applications: heart failure, cardiac surgery and pulmonary hypertension. The core technology of our heart failure sensors is identical to our EndoSure sensor and can be percutaneously implanted in a patient’s pulmonary artery for heart failure and pulmonary hypertension patients or surgically placed just outside the pulmonary artery during cardiac surgery procedures. Our heart failure sensor includes nitinol wires, similar to those used in the EndoSure sensor, designed for permanent placement inside the pulmonary artery. Our cardiac surgery sensor does not have nitinol wires and has holes that allow surgeons to attach the sensor to the outside of the pulmonary artery with sutures. Our heart failure systems have been designed to monitor patients both in the hospital as well as at the patient’s home using our next generation external electronics module.

Heart Failure: Heart Failure Indication

Feasibility Study — Outside of the U.S. Our heart failure feasibility study was designed to confirm the safety and accuracy of our heart failure sensor. Our heart failure sensor implants commenced in February 2006 in Santiago, Chile. We have also performed clinical implants in Brazil. In addition to the South American sites, we initiated heart failure sensor implants in Europe in October 2006. As part of this ongoing feasibility study, additional European implants are planned to support CE Mark certification and to facilitate reimbursement within select European healthcare markets. As of February 28, 2007, 32 successful implants have been performed in heart failure patients as part of our feasibility study.

Following the successful human implants in South America and Europe, comparative measurements were made between our heart failure sensor and a Swan-Ganz catheter to confirm appropriate correlation between these independent methods of pulmonary artery pressure measurement. In comparing the data, three clinical values were measured: systolic pressure, diastolic pressure and mean pressure. The three charts below illustrate the correlation between data from our heart failure sensor and data from the Swan-Ganz catheter for these clinical values. For each of the data points shown on the charts, the horizontal axis represents the Swan-Ganz catheter measurement and the vertical axis represents the corresponding measurement from our heart failure

 

62


Table of Contents

sensor. Based on data from the first nine patients through 90 days of follow-up, excellent correlation (R 2 >= 0.89) was seen between our heart failure sensor and the Swan-Ganz catheter. There was one complication reported, which occurred during the first implant procedure, involving the femoral vein access site, that was successfully treated. As of the date of this prospectus, there have been no other reported complications during our heart failure study.

 

LOGO  

 

 

 

 

 

When compared with systolic pressure measurements taken from each patient’s Swan-Ganz catheter, or SG, our heart failure sensor showed excellent correlation (R 2  = 0.9297).

 

LOGO  

 

 

 

 

When compared with diastolic pressure measurements taken from each patient’s Swan-Ganz catheter, our heart failure system showed excellent correlation (R 2  = 0.8947).

 

LOGO  

 

 

 

 

When compared with mean pressure measurements taken from each patient’s Swan-Ganz catheter, our heart failure system showed excellent correlation (R 2  = 0.9788).

Feasibility Study – U.S. We met with the FDA to discuss the preclinical and clinical plan for a U.S. feasibility study prior to filing the IDE in September 2006. We received FDA approval to implant our heart failure sensor in up to 15 subjects at a maximum of eight sites. This pilot study has been completed and we believe it demonstrated that our device can be safely implanted and that pressure measurements are accurate when compared to Swan- Ganz catheter measurements at 60 days. We also evaluated, as a safety endpoint, adverse events through 90 days. Conditional approval was granted in October 2006 and full approval of the IDE was granted by the FDA in December 2006. The first U.S. implant occurred in December 2006. Once 10 subjects have reached the 90 day milestone, we intend to file an IDE supplement requesting FDA approval to begin a separate pivotal clinical study.

 

63


Table of Contents

Pivotal Study – U.S. Prior to designing our pivotal study, we reviewed the clinical data from Medtronic’s COMPASS-HF (Chronicle Offers Management to Patients with Advanced Signs and Symptoms of Heart Failure) trial using its Chronicle device. The Medtronic Chronicle is a cardiac device that consists of a metal case that contains electronics and a battery, connected to insulated wires, or a lead, that contain a pressure sensor. The device is surgically implanted underneath the collarbone and the lead is implanted in the right ventricle of the heart to measure pressure and other related variables. COMPASS-HF was a randomized, single-blinded 274 subject trial that included Class III and Class IV patients. Class III refers to patients exhibiting moderate symptoms and Class IV refers to patients exhibiting the most severe symptoms for heart failure, in each case under the New York Heart Association’s functional classification scale. The primary endpoint of the COMPASS-HF trial was a composite of heart failure-related hospitalizations, emergency room visits and urgent care visits. While Medtronic reported a 21% improvement in the primary endpoint of the trial, the results did not demonstrate statistical significance (p=0.33) and the study failed to meet its primary endpoint. In March 2007, a FDA advisory panel voted against recommending that the FDA approve Medtronic’s Chronicle device. We believe the failure of the COMPASS-HF trial to meet the primary endpoint contributed to the advisory panel’s decision. We believe factors that contributed to the failure of the Chronicle device to meet its primary endpoint included:

 

   

a small sample patient size in the study that lead to an underpowered study with a statistical power of 68%;

 

   

inclusion of very ill Class IV patients in the study for whom there was a lack of benefit from the Chronicle device; and

 

   

inclusion in the primary endpoint of the study urgent care and emergency room visits which were not reduced in the treatment arm.

Medtronic reported that a secondary analysis of hospitalizations alone, without emergency room or urgent care visits, showed a statistically significant 36% (p=0.03) reduction in the treatment arm. Excluding the Class IV patient subgroup, results for the Class III subgroup demonstrated a reduction in heart failure-related hospitalizations and emergency room and urgent care visits of 36% (p=0.06), which was just above statistical significance (p=0.05).

We believe that the COMPASS-HF study demonstrates that heart failure management based on measuring pressure inside the heart in Class III patients is a promising way to reduce their hospitalizations.

We plan to request the FDA’s permission to conduct a randomized, prospective, multi-center study of approximately 450 subjects enrolled at approximately 35 sites. We expect this sample size will be sufficient to give our study a statistical power of 90%. The subjects will be limited to Class III patients and we anticipate the primary endpoint to be the number of heart failure hospitalizations. The study hypothesis is expected to be that the number of hospitalizations will be significantly reduced for the six-month period in the study group as compared to the control group. All subjects will receive the heart failure sensor and both groups will take their own pressure readings at home each day. Data will be transmitted to a secure database. While the control group will transmit pressure readings daily, the investigator will not see the readings or use the data to manage patient care. Pressure measurements from the study group will be used by the investigator to manage the patient’s care. If favorable, we intend to use this data to support our request for PMA approval. We expect the FDA to require us to follow the study subjects for five years following the implant of our sensor, although we will propose that the FDA’s approval, if any, be based on the six-month data from our pivotal study. We anticipate a PMA filing for our heart failure sensor in 2008.

Heart Failure: Cardiac Surgery Indication

In May 2006, we initiated enrollment into our feasibility study to confirm the safety and accuracy of our surgically-implanted heart failure sensor in patients undergoing cardiac surgery. Our heart failure sensor is designed to enable physicians to monitor pressure inside the heart without using a Swan-Ganz catheter.

We initiated our feasibility study in Santiago, Chile and as of February 28, 2007, have implanted 20 sensors into 15 patients. The sensors were implanted in different areas of the heart, all outside of blood vessels, and each

 

64


Table of Contents

sensor implant generally took a few minutes. There have been no reported adverse events related to the sensor to date. Clinical data collected from this study to date has demonstrated that our heart failure sensor can effectively measure pressure inside the heart from outside of the pulmonary artery, a location that is readily accessible to surgeons during cardiac surgery and that the covering on the pulmonary artery is a suitable location for sensor placement. To date, the study has also demonstrated the heart failure system’s ability to measure right heart, left heart and pulmonary artery pressures using multiple sensors, allowing flexibility for a physician to dictate both the location and number of sensors required based on the patient’s condition.

We anticipate using the data generated from the feasibility study to support the design and submission of our 510(k) study to the FDA in 2007. In addition, we have initiated several animal studies, and we expect six-month follow-up data from our animal studies will be used to supplement the clinical data supporting our FDA 510(k) submission. Initial 30-day follow-up data from our animal study has demonstrated safety and sensor accuracy, both immediately after implantation and during the follow-up period.

Heart Failure: Pulmonary Hypertension Indication

We intend to seek FDA’s designation of our percutaneous sensor for use in World Health Organization, or WHO, Category I pulmonary arterial hypertension, or WHO Category I PAH, patients as a Humanitarian Use Device, or HUD. This designation would, among other things, require the FDA’s concurrence with our belief that the number of newly diagnosed WHO Category I PAH patients in the U.S. is less than 4,000 per year. WHO Category I PAH is the most severe category of pulmonary hypertension. These patients have a very poor prognosis and have the most urgent need for pressure monitoring. If all pulmonary hypertension patients are considered, the numbers are greater than 4,000 per year. We cannot assure you that the FDA will agree that WHO Category I PAH is a medically plausible subset. If the FDA grants HUD status, then we will seek approval to conduct a 35 subject study to support a request for a Humanitarian Device Exemption, or HDE, for our percutaneous sensor in WHO Category I PAH patients. We expect our HDE application to be similar in both form and content to a PMA application, but exempt from the effectiveness requirements of a PMA.

Our anticipated WHO Category I PAH HDE study would be required to demonstrate the safety and probable benefit of the wireless monitoring of pulmonary artery pressure measurements and hemodynamic monitoring of WHO Category I PAH patients. This study would use our heart failure sensor, which is implanted percutaneously into the pulmonary artery. The study would evaluate the ability of surgeons to position the sensor in the right or left pulmonary artery, as well as the correlation of pressure measurements taken using our heart failure sensor with Swan-Ganz catheter measurements.

If HUD status is granted, we will ask the FDA for permission to conduct this prospective, non-blinded, non-randomized, multi-center clinical study at approximately eight sites in the United States, enrolling approximately 35 subjects. Implants would occur during a patient’s right heart catheterization procedure, which is the current standard of care for WHO Category I PAH. Pulmonary artery pressure measurements would be used to evaluate the subjects’ response to pharmacologic therapy during the procedure and 90 days following implantation of the sensor.

Hypertension Program

We have developed an approximately 5 mm sensor that is small enough to be inserted on or into the brachial or radial artery in the arm of hypertensive patients. Our hypertension sensor uses the same materials, manufacturing methods and operational concepts as our EndoSure sensor. We are developing a wristwatch-sized electronics module that can be comfortably worn by the hypertensive patient to continuously monitor blood pressure and provide appropriate alerts to the patient should certain pre-set limits be exceeded. The brachial and radial artery’s close proximity to the surface of the body enables us to significantly simplify our signal detection equipment and further miniaturize the antenna and electronics module. The hypertension sensor is designed to communicate wirelessly with our wristwatch-sized external electronics module, thereby allowing the patient’s

 

65


Table of Contents

blood pressure data to be transmitted directly to our secure database where it can be accessed by a patient’s physician over the Internet.

Prototypes of both the hypertension sensor and our wristwatch-sized external electronics module have been developed and successfully tested in the laboratory and in animal studies. We initiated a feasibility study involving our hypertension sensor outside the United States in March 2007. We anticipate that the first indication for this sensor that we will pursue will be in poorly controlled hypertensive individuals, such as dialysis patients.

Sales and Marketing

We currently market our first approved product, the EndoSure system, in the United States through a direct sales force to physicians who treat AAA, including vascular surgeons, radiologists and cardiologists. As of December 31, 2006, we had a total of 37 employees in our sales and marketing group. We have focused our sales and marketing hiring initiatives on professionals with prior experience in the cardiovascular medical device industry. We expect to continue to increase the number of sales and marketing personnel as we expand our business and anticipate the expansion of our sales and marketing capabilities upon FDA approval and commercialization of our heart failure and hypertension sensors. However, we believe we can leverage much of our existing sales and marketing infrastructure to initially address the expected marketing of our products under development for cardiovascular applications.

Our sales and marketing strategy involves the use of a combination of regional and territory sales managers, clinical specialists and technical support staff. Sales managers are responsible for selling our EndoSure system through the use of marketing materials and initiatives that educate physicians on the benefits of our wireless sensing and communication technology, while promoting our brand and developing customer relationships. Our internally developed marketing material describes the features and benefits of our EndoSure system, as well as the clinical value of our wireless sensing and communication technology. Our sales and marketing initiatives include continuing medical education programs and involvement in industry trade shows. In addition, we use clinical studies, cost-benefit data and case studies in our selling process. Peer-to-peer selling such as medical grand rounds is also an element of our strategy. Our clinical specialists provide technical and implantation support for our EndoSure system to physicians and their hospital staff. We believe that this combination of sales managers, clinical specialists and technical support staff provides an appropriate balance of professional selling skills and ongoing customer education and support.

International sales do not currently account for any portion of our revenue. We expect to market our products in select international markets using a combination of distributors and direct sales and support personnel. We do not expect to derive significant international revenue before 2008.

Collaboration with Medtronic

In November 2005, we entered into a license and development agreement with Medtronic as well as a related supply agreement. The license and development agreement provides for a joint development program in which we and Medtronic are working on adapting our sensor technology for use as a wired pressure sensor system capable of working with Medtronic’s implantable devices to address impaired cardiac function or hypertension, or both. Medtronic agreed to fund our efforts under the joint development program through a series of milestone payments totaling $3.0 million. Medtronic will have overall control and responsibility for the clinical and regulatory development of any implantable leads and devices incorporating our sensor technology, and Medtronic will bear the costs associated with such clinical and regulatory development work.

Under the license and development agreement, we granted Medtronic a royalty-bearing, worldwide license to develop and commercialize devices incorporating our technology for certain diagnostic and/or therapeutic applications. Wireless sensing applications are expressly excluded from the licensed field. In return for this license grant, Medtronic will pay us quarterly royalties on sales of the licensed devices, subject to a cumulative royalty cap of $25.0 million. Upon reaching this royalty cap, the license becomes non-exclusive.

 

66


Table of Contents

The license granted to Medtronic will initially be exclusive, but will convert to either a non-exclusive or co-exclusive license upon the occurrence of certain events. First, the license will convert to non-exclusive either if Medtronic fails to meet certain diligence obligations with respect to seeking and obtaining regulatory approval for the sale of licensed devices within a defined period, or upon reaching the cumulative royalty cap described above. Medtronic may receive a one-time extension of the diligence deadlines by paying us an agreed-upon fee. Second, we may elect to convert the license from exclusive to co-exclusive under certain conditions following regulatory approval or regulatory clearance of a licensed device. Under such a co-exclusive license, we and Medtronic would each be permitted to practice the licensed intellectual property in the licensed field, but neither of us would be permitted to sublicense such intellectual property in the licensed field to third parties. If the license converts from an exclusive to either a non-exclusive or co-exclusive license for any of the reasons set forth above, Medtronic will no longer owe us any royalties.

We may terminate the joint development program upon advance written notice to Medtronic, and Medtronic may terminate the joint development program for our uncured material breach of the license and development agreement. In addition, either party may terminate the development program if we undergo a change of control. If either party terminates the joint development program, Medtronic may elect to continue development of the wired sensor system, and Medtronic will no longer owe us future milestone payments. However, Medtronic will continue to owe royalty payments on sales of licensed devices, subject to reductions in the royalty cap in certain circumstances. In addition, either party may terminate the license and development agreement for an uncured breach of other party, and Medtronic may terminate the license and development agreement in its entirety, including all licenses, at any time with advance written notice to us.

Pursuant to the supply agreement, we will supply Medtronic’s commercial and clinical requirements for the wired sensor developed under the joint development program. Medtronic will only be permitted to use such wired sensors as part of licensed devices and will have no rights to sell such wired sensors on a standalone basis. Medtronic will exclusively purchase from us, and we will exclusively supply to Medtronic, such wired sensors for so long as the license granted under the license and development agreement remains exclusive. Medtronic will pay us a transfer price for the wired sensors that is, at a minimum, equal to our manufacturing costs.

We may terminate the supply agreement at any time on advance written notice to Medtronic, at which point Medtronic will receive a license to enable it to manufacture sensors itself or through a third-party. Medtronic may terminate the supply agreement on advance written notice to us, but only after the license granted under the license and development agreement has become non-exclusive or co-exclusive. Either party may terminate the supply agreement for an uncured breach of other party or if we undergo a change of control. The supply agreement will also automatically terminate upon termination of the joint development program or the license and development agreement.

Competition

The medical device industry is subject to intense and increasing competition, rapidly evolving technologies, evolving industry standards and price erosion. Because our products often have long development and regulatory approval cycles, we must anticipate changes in the marketplace and the direction of technological innovation and customer demands. To compete successfully, we will need to continue to demonstrate the advantages of our products and technologies over established and other competing alternative procedures, products and technologies, and convince physicians and other healthcare decision makers of the advantages of our products and technologies.

We believe there are no competing wireless pressure monitoring products to our EndoSure system currently in the market. We are aware that Remon Medical Technologies, Inc., or Remon Medical, is developing a wireless sensing technology using ultrasound for use in AAA patients. Our EndoSure system also faces competition from alternative techniques, products and technologies that could affect the demand for our EndoSure system, such as the trans-lumbar puncture procedure and any improvements to this and any other alternative procedures. Our

 

67


Table of Contents

success in the AAA market depends in part on convincing physicians, hospitals and patients of the benefits of our wireless monitoring technology to existing techniques, products and technologies.

We may face competition for our heart failure sensor from companies that are developing new approaches and products for the heart failure patient monitoring market, including Medtronic, St. Jude Medical, Inc., Proteus Biomedical, Inc. and Remon Medical. Medtronic has an established presence in the field of patient monitoring, has very significant financial and operational resources and is developing a competing wired sensor monitoring system for patients with heart failure named Chronicle. Chronicle is a cardiac device that consists of a metal case that contains electronics and a battery, connected to insulated wires, or a lead, that contain a pressure sensor. Patient data from the Chronicle is continuously recorded and transmitted wirelessly approximately once a week to an external electronics system. Remon Medical is developing a wireless sensing technology for heart failure using ultrasound and has conducted clinical implants outside the United States. Our heart failure sensor will also face competition from existing products and monitoring techniques, including the Swan-Ganz catheter and any improvements to this and any other alternative technologies.

We do not believe there are any competing wireless implantable blood pressure monitoring devices in clinical development or for sale. However, we may face significant competition for our hypertension sensor from well-established alternative products and techniques, including relatively inexpensive blood pressure monitoring systems developed by companies such as Roche Diagnostics, a division of F. Hoffmann-La Roche Ltd., and LifeScan, Inc., a division of Johnson & Johnson, and various other manufacturers worldwide.

Due to the sheer size of the potential markets for heart failure and hypertension patient monitoring, we expect to face competitors and potential competitors for our products targeting these markets. These competitors may enjoy several competitive advantages, including:

 

   

significantly greater name recognition;

 

   

established relations with healthcare professionals, customers and third-party payors;

 

   

established direct sales forces;

 

   

established distribution networks;

 

   

additional lines of products, and the ability to offer rebates or bundle products to offer higher discounts or incentives to gain a competitive advantage;

 

   

greater experience in conducting research and development, manufacturing, clinical trials, obtaining regulatory approval for products and marketing approved products; and

 

   

greater financial and human resources for product development, sales and marketing, and patent litigation.

As a result, we cannot assure you that we will be able to compete effectively against these companies or their products.

Our future success will also depend in large part on our ability to establish and maintain a competitive position in current and future technologies. Rapid technological development may render our wireless monitoring technology obsolete. Many of our competitors have or may have greater corporate, financial, operational, sales and marketing resources, and more experience in research and development than we have. We cannot assure you that our competitors will not succeed in developing or marketing technologies or products that are more effective or commercially attractive than our products or that would render our technologies and products obsolete. We may not have the financial resources, technical expertise, marketing, distribution or support capabilities to compete successfully in the future.

 

68


Table of Contents

Manufacturing

We currently produce commercial quantities of the EndoSure system for AAA patients. We outsource the majority of the wireless sensor manufacturing processes to external manufacturers and conduct the remaining manufacturing processes at our facility. Our external electronics modules are manufactured entirely by a third-party electronics contract manufacturer to our specifications.

The manufacturing processes for our heart failure and hypertension sensors, as well as their respective external electronics modules, are similar to those of our EndoSure system and are manufactured by our current external manufacturing suppliers.

Our Sensors

Our sensors are manufactured using MEMS technology by external MEMS foundries that perform the initial sensor fabrication steps. We perform laser cutting and packaging of the sensors in their housings using proprietary techniques. Final testing and calibration of our sensors is also performed internally using proprietary test systems.

The delivery system for our sensors incorporates a number of custom parts and components that we have designed and that are manufactured to our specifications by third-party manufacturers using standard manufacturing technologies. Final assembly of our sensors with the delivery system, packaging of the product, and sterilization is performed by a medical device contract manufacturer. This contract manufacturer also provides us with warehousing and distribution services for order fulfillment.

External Electronics

The external electronics module was custom designed by us and leverages existing electronics manufacturing expertise. In addition, because the components used to produce our external electronics module are highly standardized, they can be obtained from multiple suppliers if necessary. The external electronics module is manufactured and assembled by an electronics contract manufacturer. This manufacturer manages the entire manufacturing process, including the sourcing of the key components from suppliers, the assembly of the final external electronics modules, and their warehousing and distribution.

Software

The external electronics module is operated by our proprietary software application. This software application consists of internally developed software modules along with some integrated modules that we purchase or license from third parties, as well as off-the-shelf software. We performed final testing and validation of the software at our facility prior to its commercial release.

Regulatory Framework

Our medical device and electronics contract manufacturers are ISO 13485 certified. Our internal manufacturing facilities operate under processes designed to comply with the FDA’s Quality System Regulation, or QSR. We are pursuing ISO 13485 certification, the scope of which will cover design and development and internal manufacturing. We also follow Occupational Safety and Health Administration, or OSHA, guidelines for workplace safety.

Intellectual Property

Overview

Protection of our intellectual property is a strategic priority for our business. We rely on a combination of patent, copyright, trademark and other intellectual property laws, trade secrets, nondisclosure agreements and other

 

69


Table of Contents

measures to protect our proprietary rights. Our intellectual property portfolio, including patents and patent applications that we own or license, covers key aspects of our sensors, wireless monitoring technologies, and interventional devices for use with our sensors, as well as other technologies that we have under development. As a result, we believe that we are building an extensive intellectual property portfolio to protect the fundamental scope of our technologies. As of December 31, 2006, we had two issued U.S. patents and 27 pending U.S. patent applications. We believe it will take up to two years, and possibly longer, for our pending U.S. patent applications to result in issued patents, if at all. Our issued U.S. patents expire in 2019. We have also filed seven foreign patent applications seeking rights corresponding to aspects of our issued U.S. patents and pending U.S. patent applications.

We also have a number of invention disclosures under consideration and several new patent applications that are being prepared for filing. Accordingly, we anticipate that the number of pending patent applications and patents in our portfolio will increase.

We also have exclusive medical licenses to three issued U.S. patents pursuant to agreements entered into with the Georgia Tech Research Corporation, or GTRC, and Massachusetts Institute of Technology, or MIT. GTRC is an entity that owns all intellectual property arising from research conducted at the Georgia Institute of Technology, or Georgia Tech, and MIT. Two of these licensed patents cover portions of the MEMS technologies that are used in the development of our wireless sensors, and the other patent covers key aspects of our current technology along with certain alternative MEMS technologies that we may use in the development of future sensor products. Our rights to use these technologies and employ the inventions claimed in the licensed patents are subject to our abiding by the terms of our licenses with GTRC and MIT.

Together, our patents, patent applications and exclusive licenses of patents cover aspects of our sensors, wireless monitoring technologies, and technologies for delivering and securing our sensors within the human body, and we have filed patent applications covering additional product concepts using our sensor technology. We believe that our issued patents, patent applications, if issued, and license positions will provide us with sufficient rights to protect our existing and currently proposed commercial products. In addition to our existing patent coverage that we expect to build upon, we believe it would be technically difficult and costly to reverse engineer our products and technology. Further, we have developed substantial know-how in sensor and wireless monitoring technologies which we maintain as trade secrets or copyrighted software.

Georgia Tech License Agreement

In March 2001, we entered into a license agreement with GTRC pursuant to which we were granted an exclusive license under certain GTRC inventions, patents, and know-how to make, have made, sell, offer for sale, use, and import medical equipment, services, and applications that incorporate the licensed technology. If we fail to sell at least $1.0 million worth of licensed products by October 28, 2010, or if we cease selling all licensed products at any time after this date, GTRC may convert our license to a non-exclusive license. We also have a right of first offer in the event that GTRC desires to grant a license to a third-party under the licensed technology outside the licensed field.

In consideration for our license rights, we paid an upfront fee and agreed to pay GTRC an annual maintenance fee. In addition, we issued GTRC 105,000 shares of our common stock. We do not owe any milestone or royalty payments under the license agreement and are current in our annual maintenance fee obligation.

Our license agreement with the GTRC extends until the expiration of the last licensed patent, which will occur in 2019. Each party has the right to terminate the agreement in the event that the other party commits an uncured material breach of the agreement.

In January 2007, this agreement was amended to expand the license field to include certain industrial applications of the licensed technology. In connection with this amendment, we issued GTRC 40,000 shares of our common stock.

 

70


Table of Contents

MIT License Agreement

On August 1, 2001, we entered into a license agreement with MIT pursuant to which we were granted an exclusive license under certain MIT patents to develop, make, have made, use, sell, offer for sale, lease, and import certain medical products or processes falling within the scope of such patents. If we fail to sell at least $5.0 million worth of licensed products by October 28, 2010, MIT may convert our license to a non-exclusive license.

In consideration for our license rights, we paid an upfront fee and issued MIT 149,325 shares of our common stock. We do not owe any milestone or royalty payments under the license agreement.

Our license agreement with MIT extends until the expiration of the last licensed patent, which will occur in 2017. MIT has the right to terminate the license agreement if we fail to pay any amounts due to MIT and fail to remedy such nonpayment after receiving notice from MIT, or if we cease to carry on our business for an extended time period. In addition, each party has the right to terminate the agreement in the event that the other party commits an uncured material breach of the agreement.

Government Regulation

The healthcare industry, and thus our business, is subject to extensive federal, state, local and foreign regulation. Some of the pertinent laws have not been definitively interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of subjective interpretations. In addition, these laws and their interpretations are subject to change.

Both federal and state governmental agencies continue to subject the healthcare industry to intense regulatory scrutiny, including heightened civil and criminal enforcement efforts. As indicated by work plans and reports issued by these agencies, the federal government will continue to scrutinize, among other things, the billing practices of healthcare providers and the marketing of healthcare products. The federal government also has increased funding in recent years to fight healthcare fraud, and various agencies, such as the U.S. Department of Justice, the Office of Inspector General of the Department of Health and Human Services, or OIG, and state Medicaid fraud control units, are coordinating their enforcement efforts.

We believe that we have structured our business operations and relationships with our customers to comply with all applicable legal requirements. However, it is possible that governmental entities or other third parties could interpret these laws differently and assert otherwise. We discuss below the statutes and regulations that are most relevant to our business and most frequently cited in enforcement actions.

U.S. Food and Drug Administration Regulation

The FDA extensively regulates medical devices under the authority of the federal Food, Drug, and Cosmetic Act, or FFDCA, and the regulations promulgated under the FFDCA. The FFDCA and the implementing regulations govern, among other things, the following activities relating to our medical devices: preclinical and clinical testing, design, manufacture, safety, efficacy, labeling, storage, record keeping, sales and distribution, postmarket adverse event reporting, import/export and advertising and promotion.

The FDA classifies medical devices into one of three classes. Devices deemed to pose lower risk are placed in either class I or II, which requires the manufacturer to submit to the FDA a premarket notification requesting permission for commercial distribution. This process is known as 510(k) clearance. Some low risk devices are exempt from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, a device deemed to be not substantially equivalent to a previously cleared 510(k) device or a “preamendment” class III device (in commercial distribution before May 28, 1976) for which premarket applications have not been called, are placed in class III. In general, a class III device cannot be marketed in the United States unless the FDA approves the device after submission of a premarket approval, or

 

71


Table of Contents

PMA, application. The FDA can also impose restrictions on the sale, distribution or use of devices at the time of their clearance or approval, or subsequent to marketing.

510(k) Clearance Process . In the 510(k) process, the FDA reviews a premarket notification and determines whether or not a proposed device is “substantially equivalent” to a “predicate device.” In making this determination, the FDA compares the proposed device to the predicate device. If the two devices are comparable in intended use, technology, and safety and effectiveness, the device may be cleared for marketing. The FDA’s 510(k) clearance pathway usually takes from four to 12 months, but it can last longer and clearance is never assured. Although many 510(k) premarket notifications are cleared without clinical data, in some cases, the FDA requires significant clinical data to support substantial equivalence. In reviewing a premarket notification, the FDA may request additional information, including clinical data, which may significant prolong the review process. After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance or could require PMA approval. The FDA requires each manufacturer to make this determination in the first instance, but the agency can review any such decision. If the FDA disagrees with a manufacturer’s decision not to seek a new 510(k) clearance, the agency may retroactively require the manufacturer to seek 510(k) clearance or PMA approval. The FDA also can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA approval is obtained. Also, the manufacturer may be subject to significant regulatory fines or penalties.

Request for Evaluation of Automatic Class III Designation . A procedure for obtaining clearance was added by the Food and Drug Administration Modernization Act of 1997. This procedure is intended for novel but low risk devices. If the FDA denies 510(k) clearance of a device because it is novel and an adequate predicate device does not exist, the “de novo classification” procedure can be invoked to request that the FDA place the device in class I or II despite the absence of a predicate device, based upon reasonable assurance that the device is safe and effective for its intended use. The de novo process requires that the 510(k) be filed with FDA and that a letter denying clearance be sent to the manufacturer. Upon formal denial, a request for de novo classification can be submitted to FDA. This pathway to market approximates the level of scrutiny in the 510(k) process but generally adds several months to the clearance process, because denial of 510(k) clearance is the first step. If the FDA grants the de novo request, the device is permitted to enter commercial distribution in the same manner as if 510(k) clearance had been granted, and the device becomes a potential predicate device for any future device of that type for which 510(k) clearance is sought. Our EndoSure system was cleared through the de novo classification procedure for measuring intrasac pressure during endovascular AAA repair. We expect that this product when intended for AAA intrasac pressure measurement after the procedure and implantation outside the pulmonary artery will also be permitted to undergo the 510(k) clearance pathway, though the FDA will likely require significant supporting clinical data. We believe that it will not be necessary to undergo the de novo classification procedure again. We cannot assure you, however, that the FDA will not require a separate de novo classification for these other indications or even impose the more burdensome PMA approval process.

Premarket Application Approval Process . The PMA approval pathway requires proof of the safety and effectiveness of the device to the FDA’s satisfaction. The PMA approval pathway is much more costly, lengthy and uncertain. In the PMA process, the FDA examines detailed data relating to the safety and effectiveness of the device. This information includes design, development, manufacture, labeling, advertising, preclinical testing and clinical study data. Prior to approving the PMA, the FDA will conduct an inspection of the manufacturing facilities and the clinical sites where the supporting study was conducted. The facility inspection evaluates the company’s compliance with the QSR requirements, which impose elaborate design development, testing, control, documentation and other quality assurance procedures in the design and manufacturing process. An inspection of clinical sites evaluates compliance with the IDE requirements described below. Frequently, the FDA will convene an advisory panel of experts from outside the FDA to review and evaluate the PMA and provide recommendations to the FDA as to the approvability of the device. The panel’s recommendation is given great weight, but is not dispositive of the agency’s decision. If the FDA’s evaluation is favorable, the PMA is approved, and the device may be marketed in the United States. The FDA may approve the PMA with postapproval conditions intended to ensure the safety and effectiveness of the device including, among other

 

72


Table of Contents

things, restrictions on labeling, promotion, sale and distribution, and collection of long-term follow-up data from patients in the clinical study that supported PMA approval. Failure to comply with the conditions of approval can result in material adverse enforcement action, including the loss or withdrawal of the approval. Even after approval of a PMA, a new PMA or PMA supplement is required in the event of a modification to the device, its labeling or its manufacturing process. Supplements to a PMA often require the submission of the same type of information required for an original PMA, except that the supplement is generally limited to that information needed to support the proposed change from the product covered by the original PMA. At a minimum, we anticipate that our pressure measurement system for heart failure and heart failure/pulmonary hypertension (both inside the pulmonary artery) and hypertension (brachial/radial artery) use will each require PMA approval. We also anticipate requirements to collect long-term follow-up data following approval.

Humanitarian Use Exemption . The Humanitarian Device Exemption, or HDE, process is a somewhat abbreviated version of the PMA regulatory pathway to market. In order to obtain marketing approval for a product via this regulatory pathway, two steps are necessary. First, the product must be designated as a humanitarian use device, or HUD, based upon a demonstration to the FDA that the device is designed to treat the disease or condition that occurs in fewer than 4,000 people in the U.S. per year. In some cases, the disease or condition may be a subset of a more widely occurring disease or condition, but only if the FDA deems the subset medically plausible. Second, the HDE application itself must demonstrates that there is no comparable device available and that the probable benefit to health from the proposed HDE device outweighs the risk of injury or illness from its use, taking into account alternative treatments that are available for the condition or disease. An approved HDE must be labeled with a disclaimer stating that the effectiveness of the device has not been established. Prior to HUD use at any facility, the HDE holder is required to ensure that use of the HUD has been approved by from the facility’s Institutional Review Board, or IRB. We intend to seek an HUD designation for our product for use in Category I PAH. Although PAH cases collectively exceed the 4,000 per year threshold for an HUD designation, we believe Category I PAH is a medical plausible subset that is below the threshold. There can be no assurance that the FDA will agree our analysis. If the HUD designation is granted, we will seek HDE approval.

Clinical Studies . Clinical testing is sometimes required to support a 510(k) premarket notification, including some of our expected 510(k) notifications, and one or more clinical trials are almost always required to support a PMA application. All clinical studies of investigational devices must be conducted in compliance with the FDA’s requirements for such studies. If an investigational device could pose a significant risk to patients, the FDA must approve an Investigational Device Exemption, or IDE, application prior to initiation of a clinical study. An IDE application must be supported by appropriate data, such as animal and laboratory test results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The FDA typically grants IDE approval for a specified number of study centers and patients. There can be no assurance that submission of an IDE will result in the ability to commence clinical trials. Additionally, after a trial begins, the FDA may place it on hold or terminate it if, among other reasons, it concludes that clinical subjects are exposed to an unacceptable health risk. The FDA’s grant of permission to proceed with clinical testing does not constitute a binding commitment that the FDA will consider the study design adequate to support clearance or approval. In addition, there can be no assurance that the data generated during a clinical study will meet chosen safety and effectiveness endpoints or otherwise produce results that will lead the FDA to grant marketing clearance or approval.

If U.S. clinical data is required to support one of our other marketing applications, an investigational device exemption, or IDE, will in most cases need to be assembled and submitted to the FDA. The FDA reviews and must approve an IDE before a study may begin in the United States. In addition, the study must be approved by an Institutional Review Board, or IRB, for each clinical site. When all approvals are obtained, the study may be initiated to evaluate the device. The FDA, and the IRB at each institution at which a clinical trial is being performed, may suspend a clinical trial at any time for various reasons, including a belief that the subjects are being exposed to an unacceptable health risk. All clinical studies of investigational devices must be conducted in compliance with FDA’s extensive requirements. During a study, we would be required to comply with the FDA’s IDE requirements for investigator selection, trial monitoring, reporting, record keeping and prohibitions on the promotion of investigational devices or making safety or efficacy claims for them. The investigators must obtain

 

73


Table of Contents

patient informed consent, rigorously follow the investigational plan and study protocol, control the disposition of investigational devices, and comply with all reporting and record keeping requirements. Following completion of a study, we would need to collect, analyze and present the data to the FDA in a 510(k) premarket notification or a PMA, as appropriate. The results of clinical testing may not be sufficient to obtain clearance or approval of the product.

Postmarket Regulation. After a device is placed on the market, regardless of the classification or premarket pathway, significant regulatory requirements apply. These include:

 

   

establishing registration and device listings with the FDA;

 

   

QSR requirements, which obligate manufacturers, including third-party or contract manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all aspects of design and manufacturing;

 

   

labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label uses, and other requirements related to promotional activities;

 

   

medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur; and

 

   

corrections and removal reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FFDCA that may present a risk to health.

We are subject to inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements. Furthermore, later discovery of previously unknown problems with our EndoSure system or any of our future products, including design defects, unanticipated adverse events or adverse events of increasing severity or frequency, whether resulting from the use of the device within the scope of its clearance or off-label by a physician in the practice of medicine, could result in restrictions on the device, including withdrawal of the product from the market or voluntary or mandatory recalls.

The FDA enforces these requirements by inspection and market surveillance. If the FDA finds a violation, it can institute a wide variety of enforcement actions, ranging from a published warning letter to more severe sanctions such as:

 

   

fines, injunctions, and civil penalties;

 

   

recall, detention or seizure of products;

 

   

operating restrictions, partial suspension or total shutdown of production;

 

   

refusing requests for 510(k) clearance or PMA approval of new products;

 

   

withdrawing 510(k) clearance or PMA approvals already granted; and

 

   

criminal prosecution.

The FDA also has the authority to request repair, replacement or refund of the cost of any device manufactured or distributed by us. In the event that one of our suppliers fails to maintain compliance with our quality requirements, we may have to qualify a new supplier and could experience manufacturing bottlenecks or delays as a result.

Foreign Regulation

In order for us to market our products in other countries, we must obtain regulatory approvals and comply with extensive safety and quality regulations in other countries. These regulations, including the requirements for

 

74


Table of Contents

approvals or clearance and the time required for regulatory review, vary from country to country. Failure to obtain regulatory approval in any foreign country in which we plan to market our products may harm our ability to generate revenue and harm our business.

The primary regulatory environment in Europe is that of the European Union, which consists of 25 countries encompassing most of the major countries in Europe. The European Union requires that manufacturers of medical products obtain the right to affix the CE mark to their products before selling them in member countries of the European Union. 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 products, a manufacturer must obtain certification that its processes meet certain European quality standards. Compliance with the Medical Device Directive, as certified by a recognized European Notified Body, permits the manufacturer to affix the CE mark on its products and commercially distribute those products throughout the European Union.

We are pursuing ISO 13485 certification and were audited by TUV Rheinland in December 2006. We expect to complete a design dossier for our EndoSure system in the third quarter of 2007 and will subsequently request the CE mark approval for our EndoSure system with the European Notified Body.

Anti-Kickback Statutes and False Claims Act

The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the furnishing, recommending or arranging for any good or service for which payment may be made under a federal healthcare program, such as Medicare and Medicaid. The term “remuneration” has been broadly interpreted to include anything of value, including, for example, gifts, discounts, the furnishing of free supplies or equipment, commercially unreasonable credit arrangements, payments of cash, waivers of payments or providing anything at less than its fair market value. Several courts have interpreted the Anti-Kickback Statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of business reimbursable by a federal healthcare program, the statute has been violated. Penalties for violations include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. In addition, some kickback allegations have been claimed to violate the federal False Claims Act, discussed in more detail below.

The federal Anti-Kickback Statute is broad and prohibits many arrangements and practices that may be lawful in businesses outside of the healthcare industry. Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements, the U.S. Department of Health and Human Services, or HHS, as authorized by Congress, has issued a series of regulations, known as safe harbors, that deem certain arrangements meeting specified requirements to comply with the federal Anti-Kickback Statute. We seek to comply with such safe harbors. The failure of a transaction or arrangement to meet all requirements of one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy each requirement of an applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the HHS office of Inspector General.

Many states have adopted anti-kickback laws similar to the federal Anti-Kickback Statute. Some of these state prohibitions apply to referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs and do not have exceptions identical to those under federal law.

Government officials have focused their enforcement efforts on marketing of healthcare services and products, among other activities, and have initiated investigations and enforcement actions against companies and their sales personnel who allegedly offered unlawful inducements to potential or existing customers in an attempt to procure their business. As part of our compliance program, we plan to review our sales contracts and marketing materials to assure compliance with the Anti-Kickback Statute and similar state laws, and will educate

 

75


Table of Contents

our employees and marketing representatives about the Anti-Kickback Statute and their obligations thereunder. However, we cannot rule out the possibility that the government enforcement agencies or other third parties could interpret these laws differently and assert otherwise.

Another development affecting the healthcare industry is the increased use of the False Claims Act and, in particular, actions brought pursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. The False Claims Act imposes liability on any person or entity who, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal healthcare program. The qui tam provisions of the False Claims Act allow a private individual to bring actions on behalf of the federal government alleging that the defendant has defrauded the federal government by submitting a false claim to the federal government and permit such individuals to share in any amounts paid by the entity to the government in fines or settlement. In recent years, the number of suits brought against healthcare providers by private individuals has increased dramatically. In addition, various states have enacted false claim laws analogous to the federal False Claims Act, although many of these state laws apply where a claim is submitted to any third-party payor and not merely a federal healthcare program.

When an entity is determined to have violated the False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 to $11,000 for each separate false claim. There are many potential bases for liability under the False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. The False Claims Act has been used to assert liability on the basis of inadequate care and improper use of Medicare numbers when detailing the provider of services, in addition to the more predictable allegations regarding misrepresentations with respect to nature of the services rendered. In addition, manufacturers, like us, can be held liable under the False Claims Act, even if they do not submit claims to the government, where they are found to have caused submission of false claims by, among other things, providing incorrect coding or billing advice about their products to customers that file claims, or by engaging in kickback arrangements with customers that file claims. We are unable to predict whether we could be subject to actions under the False Claims Act, or the impact of such actions. However, the costs of defending claims under the False Claims Act, as well as sanctions imposed under the Act, could significantly affect our financial performance.

Our future activities relating to the reporting of wholesale or estimated retail prices for our products, the reporting of discount and rebate information and other information affecting federal, state and third-party reimbursement of our products, and the sale and marketing of our products, may be subject to scrutiny under these laws. In addition, companies have been prosecuted under the False Claims Act in connection with alleged off-label promotion of products.

Health Insurance Portability and Accountability Act of 1996

Among other things, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The HIPAA healthcare fraud statute prohibits, among other things, knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment and/or exclusion from government-sponsored programs. The HIPAA false statements statute prohibits, among other things, knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines and/or imprisonment.

In addition to creating the two new federal healthcare crimes, HIPAA also establishes uniform standards governing the conduct of certain electronic healthcare transactions and protecting the security and privacy of individually identifiable health information maintained or transmitted by healthcare providers, health plans and healthcare clearinghouses. Three standards have been promulgated under HIPAA: the Standards for Privacy of

 

76


Table of Contents

Individually Identifiable Health Information, which restrict the use and disclosure of certain individually identifiable health information, the Standards for Electronic Transactions, which establish standards for common healthcare transactions, such as claims information, plan eligibility, payment information and the use of electronic signatures, and the Security Standards, which require covered entities to implement and maintain certain security measures to safeguard certain electronic health information. Although we believe we are not a covered entity and therefore do not need to comply with these standards, we expect that our customers generally will be covered entities and may ask us to comply with certain aspects of these standards. While the government intended this legislation to reduce administrative expenses and burdens for the healthcare industry, our compliance with certain provisions of these standards may entail significant costs for us. If we fail to comply with these standards, it is possible that we could be subject to criminal penalties.

In addition to federal regulations issued under HIPAA, some states have enacted privacy and security statutes or regulations that, in some cases, are more stringent than those issued under HIPAA. In those cases, it may be necessary to modify our planned operations and procedures to comply with the more stringent state laws. If we fail to comply with applicable state laws and regulations, we could be subject to additional sanctions.

Third-Party Reimbursement and Pricing

General

In the United States and elsewhere, health care providers that purchase medical devices generally rely on third-party payors, including the Medicare and Medicaid programs and private payors, to reimburse all or part of the cost of the products. Consequently, sales of medical devices are dependent in part on the availability of reimbursement to customers from third-party payors, such as government healthcare programs and private insurance plans. The manner in which reimbursement is sought and obtained varies based upon the type of payor involved and the setting in which the product is furnished and utilized. In determining payment rates, third-party payors are increasingly scrutinizing the prices charged for medical products and services. Our products, and the procedures in which our products are used, may not be reimbursed by these third party payors at rates sufficient to allow us to sell our products on a competitive and profitable basis.

In addition, in many foreign markets, including the countries in the European Union, pricing of medical devices is subject to governmental control. Failure to obtain approvals for coverage or a lengthy process may adversely impact our sales. To date, we have not sold any products in foreign markets and have no experience with such countries applicable pricing regulations.

In the United States, there have been, and we expect that there will continue to be, a number of federal and state legislative and regulatory proposals to limit payments by governmental payors for medical devices, and the procedures in which medical devices are used. While we cannot predict whether such legislative or regulatory proposals will be adopted, the adoption of proposals limiting coverage and/or payment could have a material adverse effect on our business, financial condition and profitability.

Medicare and Medicaid

The Medicare program is a federal health benefit program administered by the Centers for Medicare and Medicaid Services, or CMS, and covers certain medical care items and services for eligible elderly, blind, and disabled individuals, and individuals with end stage renal disease. Coverage under Part A of the Medicare program includes items and services provided in the hospital inpatient setting and other institutional services, while coverage under Part B of Medicare includes physician services, among other items. Because we expect that a significant percentage of patients who receive our EndoSure system will be Medicare beneficiaries, and because some private insurers may follow the coverage and payment policies for Medicare, Medicare’s coverage and payment policies are significant to our business.

 

77


Table of Contents

Medicare coverage for endovascular repair procedures during which our EndoSure sensors are implanted currently exists in the hospital inpatient setting. In general, Medicare reimburses hospitals for procedures performed in the inpatient setting based upon prospectively determined amounts, using a prospective payment system, or PPS. For inpatient stays in acute care hospitals, the prospective payment is determined by the patient’s condition and other patient data and procedures performed during the inpatient stay, using a classification system known as diagnosis-related groups, or DRGs. Each DRG has an index-like relative weight that represents the average resources required to care for cases grouped in that particular DRG relative to the average resources used to treat cases in all DRGs. The DRG payments include all devices and services that are provided during that stay regardless of the actual costs of such services, with limited exceptions. In certain cases, hospitals may receive additional payments for certain exceptionally costly stays, known as outliers, or for costly new technology meeting certain qualifying criteria.

Current Medicare payments to hospitals providing endovascular abdominal aortic aneurysm repair surgery are based typically on DRG 110- Major Cardiovascular Procedures with Complication/Comorbidity and DRG 111- Major Cardiovascular Procedures without Complication/Comorbidity . As to hospital inpatient billing, procedures are referenced by international classifications of diseases, clinical modification, or ICD-9-CM, volume 3 procedure codes. Currently, endovascular repair procedures during which our EndoSure sensors are implanted are coded under ICD-9-CM procedure code 39.71- Endovascular Implantation of Graft Abdominal Aorta .

Under the DRG payment system, hospitals performing inpatient procedures during which the EndoSure sensor is implanted do not receive separate Medicare reimbursement for the specific costs of purchasing or implanting our device. Rather, reimbursement for these costs is bundled with the DRG-based payments made to hospitals for the endovascular repair procedure during which our devices are implanted. Because such payments are based on predetermined rates and may be less than a hospital’s actual costs in furnishing care, hospitals have incentives to lower their inpatient operating costs by utilizing products, devices and supplies that will reduce the length of inpatient stays, decrease labor or otherwise lower their costs.

Physicians performing endovascular repair procedures during which the EndoSure sensor is implanted may receive separate Medicare reimbursement for their professional services during the implantation of the sensor. Physicians may also receive payment for subsequent monitoring of the device, although we are not able to promote this use of the EndoSure system because subsequent monitoring is not part of the FDA approved indication for the system. Physicians generally bill for such services using a coding system known as Current Procedural Terminology, a system established and maintained by the American Medical Association, or AMA. Physician services performed in connection with the implantation and monitoring of our EndoSure system are currently billed under two Category III CPT codes: 0153T- Transcatheter Placement of Wireless Physiologic Sensor in Aneurismal Sac during Endovascular Repair, Including Radiological Supervision and Interpretation and Instrument Calibration and 0154T- Noninvasive Physiologic Study of Implanted Wireless Pressure Sensor in Aneurismal sac following Endovascular Repair, Complete Study including Recording, Analysis of Pressure and Waveform Tracings, Interpretation and Report . Category III codes are temporary codes for emerging technology and services.

Generally, payment levels for physician services are developed by CMS annually under the Medicare Physician Fee Schedule. CMS has not developed a federal payment rate for use of the EndoSure sensors. Instead, for 2007, the Medicare contractors processing physician claims have the discretion to set a payment level specific to the contractor’s locality. This has resulted in significant variability in the physician payment rate. Further, some local Medicare contractors have determined not to cover physician services billed to CPT codes 0153T and 0154T, asserting that the technology at issue is investigational or experimental in nature.

Applications have been submitted with the AMA’s CPT Editorial Panel for Category I CPT codes—permanent codes that would describe physician services performed in connection with the implantation and monitoring of our EndoSure system and would replace the current Category III CPT codes. If approved, we expect that physicians would begin to bill for their services using these Category I codes effective by January

 

78


Table of Contents

2008. At this time, we cannot predict the payment levels under Category I codes or the extent to which payment levels under the permanent codes would differ from current levels under Category III codes.

We also plan on pursuing coverage and reimbursement for services performed in connection with the implantation and monitoring of our heart failure and hypertension sensors. We expect to seek unique coverage and reimbursement for hospital services, including the hospital outpatient setting, and for physician professional services for these indications. Generally, coverage and payment policies and the designation of a new procedure code for a new procedure using a new product does not occur until after FDA approval of the product used in the surgery. It is possible that we may not prevail in our applications or that the extent of coverage or the reimbursement levels established for any new codes may be limited in scope or amount or otherwise insufficient to permit broad acceptance of our products by physicians and hospitals.

Commercial Insurers

In addition to the Medicare program, many private payors look to CMS policies as a guideline in setting their coverage policies and payment amounts. The current coverage policies of these private payors may differ from the Medicare program, and the payment rates they make may be higher, lower, or the same as the Medicare program. If CMS decreases or limits reimbursement payments for physicians and/or hospitals, this may affect coverage and reimbursement determinations by many private payors. Additionally, some private payors do not follow the Medicare guidelines, and those payors may reimburse only a portion of the costs associated with the use of our products, or not at all.

Research and Development

As of December 31, 2006, our research and development team consisted of 26 people, representing an experienced team of engineers and scientists with expertise in MEMS design, biomedical engineering, software authoring and both digital and analog electronics. The majority of our research and development team have advanced technical degrees, including seven who have doctorates, and have significant industry experience. Our research and development initiatives are focused on developing next generation versions of our proprietary products while also creating entirely new sensor and wireless monitoring products.

Since our inception, we have devoted a significant amount of resources to develop our technology platform. During 2004, 2005 and 2006, we recorded $3.7 million, $4.8 million and $8.5 million, respectively, in research and development expenses. We plan to continue to increase our investment in research and development in future periods.

Employees

As of December 31, 2006, we had 106 employees, 26 of whom were engaged directly in research and development, 16 in manufacturing and service, 14 in general administrative and accounting activities, 13 in regulatory, clinical affairs and quality activities and 37 in sales and marketing activities. None of our employees is covered by a collective bargaining agreement, and we consider our relationship with our employees to be good.

Facilities

We maintain our headquarters in Atlanta, Georgia in leased facilities consisting of approximately 12,000 square feet in the aggregate, which includes our laboratory, research and development, manufacturing and general administration functions. Our Atlanta facilities are leased from Georgia Advanced Technology Ventures on a month-to-month term. We, or our landlord, may terminate the lease at any time upon 90 days notice. We believe that our existing facilities are adequate to meet our needs through mid-2007. However, we expect to relocate our headquarters to a new facility in 2007 to meet our future needs and believe that suitable space will be available on commercially reasonable terms.

 

79


Table of Contents

Legal Proceedings

We are not currently involved in any material litigation. However, litigation is common in the medical device industry, and we may become involved in material litigation in the future.

Scientific and Medical Advisory Board

We have established a Scientific and Medical Advisory Board, or advisory board, composed of international leaders in cardiology, cardiac surgery, vascular surgery and interventional radiology who have demonstrated excellence in research and in clinical medicine. Members of our advisory board meet formally and informally with us. We have advisory board members with specialties in each of our targeted indications.

Several members of our advisory board are employed by academic institutions and may have commitments to, or agreements with, other entities that may limit their availability to us. Members of our advisory board may also serve as consultants to other medical product companies, including those that may be competitive with ours.

We have entered into a written agreement with each member of our advisory board pursuant to which the advisory board member is obligated to provide consulting services relating to the research, design, development and/or marketing of our products. The agreements may be terminated by us or by the advisory board member upon 30 days notice. We own the rights to any inventions or ideas made or conceived by each advisory board member during performance of the consulting services.

We generally compensate the members of our advisory board through payment of consulting fee ranging between $1,500 and $2,500 per day for any time commitments in excess of four days per year. Travel and other expenses are also reimbursed, to the extent we approve of these expenses in advance. In addition, we have granted some of our advisory board members options to purchase our common stock.

We do not expect or require our advisory board members to utilize or promote our products.

 

80


Table of Contents

MANAGEMENT

Executive Officers and Directors

Our executive officers and directors and their respective ages and positions as of December 31, 2006 are as follows:

 

Name

   Age   

Position

Jay S. Yadav, M.D.(1)(2)

   47    Chairman of the Board and Chief Executive Officer

Harold W. Ingalls

   59    Chief Financial Officer

Sandeep S. Yadav(1)

   37    Chief Operating Officer

Mark G. Allen, Ph.D.

   44    Chief Technical Officer and Director

David R. Stern

   46    Senior Vice President, Research and Development and Director

Matthew Borenzweig

   47    Senior Vice President, Sales and Marketing

Patrick J. Fortune, Ph.D.(2)(3)

   59    Director

John J. Huntz, Jr.(3)(4)

   56    Director

Muhit U. Rahman(4)

   50    Director

Marvin L. Woodall(2)(4)

   69    Director

Lee R. Wrubel, M.D.(3)

   42    Director

(1)   Dr. Yadav and Mr. Yadav are natural brothers.

 

(2)   Member of the nominating and corporate governance committee.

 

(3)   Member of the compensation committee.

 

(4)   Member of the audit committee.

Executive Officers

Jay S. Yadav , M . D. , is a co-founder and has served as Chairman of our board of directors since our inception in November 2000. From our inception to October 2006, Dr. Yadav served as one of our consultants. In May 2006, Dr. Yadav was appointed as our Acting Chief Executive Officer and became an employee and our Chief Executive Officer in October 2006. From 1998 to August 2006, Dr. Yadav held various staff positions at the Cleveland Clinic Foundation, or CCF, including the Ferchill Distinguished Chair, Chairman of the Center for Medical Innovation as well as Director of Vascular Intervention. On August 17, 2006, Dr. Yadav was notified by the CCF that he would not be reappointed as a staff member of the CCF upon the expiration of his contract on September 30, 2006. The CCF has publicly stated that its decision not to reappoint Dr. Yadav was due to the CCF’s determination that Dr. Yadav did not meet the standards for disclosure under the CCF’s conflict of interest policies. From 1997 to 1999, Dr. Yadav was the founder and Chairman of the Board of Directors of AngioGuard, Inc., developer of the first filter for emboli prevention during interventional and surgical procedures, which was acquired by Johnson & Johnson in 1998. Dr. Yadav serves on the board of directors of several private medical device and technology companies. Dr. Yadav holds a B.S. from Yale University and an M.D. from West Virginia University Medical School. Dr. Yadav’s post-graduate medical training was performed at Duke University and The University of Alabama at Birmingham.

Harold W. Ingalls has served as our Chief Financial Officer since August 2006. From October 2001 to July 2006, Mr. Ingalls served as Vice President and Chief Financial Officer of Serologicals Corporation, a life sciences company, which was acquired by Millipore Corporation in July 2006. Mr. Ingalls holds a B.B.A in Accounting from the University of Wisconsin and is a member of the American Institute of Certified Public Accountants.

Sandeep S . Yadav has served as our Chief Operating Officer since May 2006. From July 2002 to August 2006, Mr. Yadav was our Chief Financial Officer. From September 1998 to January 2002, Mr. Yadav was an associate at Deutsche Bank AG. Mr. Yadav holds a B.S. in Finance from Auburn University and an M.B.A. from Emory University.

 

81


Table of Contents

Mark G. Allen , Ph . D . , is a co-founder and has served as our Chief Technology Officer and a member of our board of directors since our inception in November 2000. Prior to co-founding CardioMEMS in 1999, Dr. Allen was the co-founder of Redeon, Inc., which was one of the earliest companies to successfully develop micro-needle technology and was subsequently acquired by Biovalve Technologies, Inc. in 2001. Since 1989, Dr. Allen has been employed at the Georgia Institute of Technology, or Georgia Tech. Dr. Allen is the Joseph M. Pettit Professor of Electrical and Computer Engineering at Georgia Tech and directs the university’s MEMS research program. In light of his employment obligations to Georgia Tech and consulting work for several private companies, Dr. Allen does not devote his full time to CardioMEMS. Dr. Allen holds a B.A. in Chemistry, a B.S.E. in Chemical Engineering and a B.S.E. in Electrical Engineering from the University of Pennsylvania and an M.S. and Ph.D. in Chemical Engineering from the Massachusetts Institute of Technology.

David R . Stern has served as our Senior Vice President, Research and Development since May 2006 and as a member of our board of directors since April 2002. From December 2001 to April 2002, Mr. Stern served as our Vice President, Research and Development and most recently as our Chief Executive Officer from April 2002 to May 2006. From July 2000 to April 2001, Mr. Stern served as Vice President and Business Unit Manager of the Peripheral Technologies Division of C.R. Bard, Inc. where he was responsible for directing marketing, research and development and business development activities. Mr. Stern holds a B.S. in Biomedical Engineering from Rensselaer Polytechnic Institute and a M.E. in Biomedical Engineering from Worcester Polytechnic Institute.

Matthew Borenzweig has served as our Senior Vice President, Sales and Marketing since May 2006 and has been our employee since January 2006. From 2000 to January 2006, Mr. Borenzweig served as Vice President of U.S. Endovascular sales at Medtronic Vascular, Inc. Prior to 2000, Mr. Borenzweig held sales and management positions at AVE/Medtronic, Boston Scientific Corp., C.R. Bard, Inc. and Upjohn Pharmaceuticals, Inc. He also serves as a member of the board of directors of MicroMed Cardiovascular, Inc., a medical device company. Mr. Borenzweig holds a B.S. in Biological Sciences from the University of Southern California.

Directors

Patrick J. Fortune, Ph.D. , has served as a member of our board of directors since May 2005. Since 2001, Dr. Fortune has been a Partner of Boston Millennia Partners, a venture capital investment firm. From 1999 to 2001, Dr. Fortune was President and Chief Operating Officer of New Era of Networks, Inc. He serves on the board of directors of Parexel International Corporation, CombinatoRx, Inc., EPIX Pharmaceuticals, Inc. and several private companies. He has also served on the engineering and scientific advisory boards of the University of Wisconsin, the University of Illinois and the University of Chicago. Dr. Fortune holds a B.S. in chemistry from the University of Wisconsin, an M.B.A. from Northwestern University and a Ph.D. in physical chemistry from the University of Wisconsin.

John J. Huntz, Jr. , has served as a member of our board of directors since September 2006. Since October 2005, Mr. Huntz has served as the Executive Director, Head of Venture Capital, of Arcapita Inc., a private equity investment firm. From May 1998 to 2005, Mr. Huntz served as Managing Director of Fuqua Ventures, LLC, a private equity investment firm. Mr. Huntz serves as Chairman of the board of directors of Manhattan Associates, Inc., a leading supply chain solutions provider, and is a member of the board of directors of several private technology companies. Mr. Huntz founded and serves as President of the Atlanta Venture Forum, a risk capital network, and has previously served as a member of the board of directors of the National Venture Capital Association. He is also a member of the Securities and Exchange Commission Executive Committee on Small Business Capital Formation. Mr. Huntz holds a B.B.A. from Niagra University and holds an M.B.A. from Sacred Heart University.

Muhit U. Rahman has served as a member of our board of directors since July 2001. Mr. Rahman is a co-founder and has been a Managing Member of Arcade Partners LLC, a private equity investment firm, since November 2003. Since January 2004, he has been a Managing Director of Washington & Congress Managers, an

 

82


Table of Contents

investment management firm. From November 1993 to December 2003, Mr. Rahman was a Managing Director of Triumph Capital Group, a private equity investment firm. Mr. Rahman is a director of KapStone Paper and Packaging Corporation (formerly Stone Arcade Acquisition Corp.), a paper and packaging company. Mr. Rahman holds a B.S. from Yale University and an M.B.A. from the Anderson School of Management at the University of California at Los Angeles.

Marvin L. Woodall has served as a member of our board of directors since April 2004. Since August 2006, Mr. Woodall has served as Chief Executive Officer of the Cardiovascular Research Foundation, a non-profit research foundation. From 2001 to 2005, Mr. Woodall served as Chairman of the Board of the Lehigh Valley Hospitals and Health Network. From 1988 to 1996, Mr. Woodall was the President of Johnson & Johnson Interventional Systems, a medical device company. He serves as an advisor or a member of the board of directors to several medical and healthcare private companies and hospitals. Mr. Woodall holds a degree in Management and Finance from the University of Oklahoma.

Lee R. Wrubel, M.D. , has served as a member of our board of directors since November 2003. Since 2000, Dr. Wrubel has been a General Partner of Foundation Medical Partners, L.P., a venture capital investment firm. Dr. Wrubel serves on the board of directors of AtriCure, Inc., a medical device company and several private companies. He serves on the Translational Research Advisory Committee of the Muscular Dystrophy Association. Dr. Wrubel holds a B.A. from Lafayette College, an M.D. and M.S. in Public Health from Tufts University and an M.B.A. from Columbia University.

Board Composition

Our board of directors currently consists of eight members. Effective upon the closing of this offering, we will divide our board of directors into three classes, as follows:

 

   

Class I, which will consist of Mr. Stern and Dr. Wrubel, and whose term will expire at our annual meeting of stockholders to be held in 2008;

 

   

Class II, which will consist of Messrs. Rahman and Huntz and Dr. Allen, and whose term will expire at our annual meeting of stockholders to be held in 2009; and

 

   

Class III, which will consist of Drs. Yadav and Fortune and Mr. Woodall, and whose term will expire at our annual meeting of stockholders to be held in 2010.

At each annual meeting of stockholders to be held after the initial classification, the successors to directors whose terms then expire will serve until the third annual meeting following their election and until their successors are duly elected and qualified. The authorized number of directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed between the three classes so that, as nearly as possible, each class will consist of one-third of the directors. This classification of the board of directors may have the effect of delaying or preventing changes in our control or management. Under Delaware law, our directors may be removed for cause by the affirmative vote of the holders of a majority of our voting stock.

Board Committees

Our board of directors has an audit committee, a compensation committee and a nominating and corporate governance committee.

Audit Committee

Our audit committee consists of Messrs. Rahman, Huntz and Woodall. Mr. Rahman serves as the chair of our audit committee. The functions of this committee include, among other things:

 

   

reviewing and pre-approving the engagement of our independent auditors to perform audit services and any permissible non-audit services;

 

83


Table of Contents
   

evaluating the performance of our independent auditors and deciding whether to retain their services;

 

   

reviewing our annual and quarterly financial statements and reports and discussing the statements and reports with our independent auditors and management;

 

   

reviewing and approving all related-party transactions;

 

   

reviewing with our independent auditors and management significant issues that may arise regarding accounting principles and financial statement presentation, as well as matters concerning the scope, adequacy and effectiveness of our financial controls; and

 

   

establishing procedures for the receipt, retention and treatment of complaints received by us regarding financial controls, accounting or auditing matters.

Our board of directors has determined that Mr. Huntz qualifies as an audit committee financial expert within the meaning of the regulations of the Securities and Exchange Commission and the NASDAQ listing standards. In making this determination, our board of directors has considered the nature and scope of experience Mr. Huntz has previously had with reporting companies. Mr. Huntz meets the independence requirements of Rule 10A-3 of the Exchange Act. Both our independent registered public accounting firm and management periodically meet privately with our audit committee.

Compensation Committee

Our compensation committee consists of Mr. Huntz and Drs. Fortune and Wrubel. Mr. Huntz serves as the chair of our compensation committee. The functions of this committee include, among other things:

 

   

determining the compensation and other terms of employment of our executive officers and senior management and reviewing and approving corporate performance goals and objectives relevant to such compensation;

 

   

evaluating and recommending to our board of directors the equity incentive plans, compensation plans and similar programs advisable for us, as well as modification or termination of existing plans and programs;

 

   

reviewing and approving appropriate insurance coverage for our officers and directors; and

 

   

reviewing and approving the terms of any employment agreements, severance arrangements, change-in-control protections and any other compensatory arrangements for our executive officers.

Each member of our compensation committee is a non-employee director, as defined in Rule 16b-3 promulgated under the Securities Exchange Act of 1934, as amended, an outside director, as defined pursuant to Section 162(m) of the Internal Revenue Code of 1986, as amended, and satisfies the NASDAQ independence requirements.

Nominating and Corporate Governance Committee

Our nominating and corporate governance committee consists of Mr. Woodall and Drs. Yadav and Fortune. We believe that each of Mr. Woodall and Dr. Fortune satisfies the NASDAQ independence requirements, but Dr. Yadav does not meet these requirements. In accordance with NASDAQ Rule 4350, Dr. Yadav will cease serving as a member of our nominating and corporate governance committee upon the one year anniversary of this offering. Mr. Woodall serves as the chair of our nominating and corporate governance committee. The functions of this committee include, among other things:

 

   

developing and maintaining a current list of the functional needs and qualifications of members of our board of directors;

 

   

evaluating director performance on our board of directors and its applicable committees and determining whether continued service on our board of directors is appropriate for such director;

 

84


Table of Contents
   

interviewing, evaluating, nominating and recommending individuals for membership on our board of directors;

 

   

reviewing and recommending to our board of directors the compensation arrangements for our non-employee directors;

 

   

evaluating nominations by stockholders of candidates for election to our board of directors;

 

   

reviewing and reporting annually to our board of directors an assessment of the board’s performance;

 

   

reviewing and recommending to our board of directors any amendments to our corporate governance documents; and

 

   

reviewing and recommending to our board of directors changes with respect to corporate governance issues, issues of broad social significance and our overall conduct as a responsible corporate citizen.

 

85


Table of Contents

COMPENSATION DISCUSSION AND ANALYSIS

The primary goals of the compensation committee of our board of directors with respect to executive compensation are to attract and retain the most talented and dedicated executives possible, to tie annual and long-term cash and stock incentives to achievement of specified performance objectives, and to align executives’ incentives with stockholder value creation. To achieve these goals, our compensation committee recommends executive compensation packages to our board of directors that are generally based on a mix of salary, discretionary bonus and equity awards. Although our compensation committee has not adopted any formal guidelines for allocating total compensation between equity compensation and cash compensation, we intend to implement and maintain compensation plans that tie a substantial portion of our executives’ overall compensation to achievement of corporate goals and value-creating milestones. We believe that performance and equity-based compensation are important components of the total executive compensation package for maximizing stockholder value while, at the same time, attracting, motivating and retaining high-quality executives.

Benchmarking of Cash and Equity Compensation

We have not retained a compensation consultant to review our policies and procedures with respect to executive compensation. We conduct an annual benchmark review of the aggregate level of our executive compensation, as well as the mix of elements used to compensate our executive officers. This review is based on a survey of executive compensation paid by peer companies in the medical devices industry conducted by third-party providers. In addition, our compensation committee has historically taken into account input from other independent members of our board of directors and publicly available data relating to the compensation practices and policies of other companies within and outside our industry. We benchmark our executive compensation against the median updated compensation paid by these peer companies. While benchmarking may not always be appropriate as a stand-alone tool for setting compensation due to the aspects of our business and objectives that may be unique to us, we generally believe that gathering this information is an important part of our compensation-related decision-making process.

Our compensation committee intends to retain the services of third-party executive compensation specialists from time to time, as it sees fit, in connection with the establishment of cash and equity compensation and related policies.

Elements of Compensation

Our compensation committee evaluates individual executive performance with a goal of setting compensation at levels the committee believes are comparable with executives in other companies of similar size and stage of development operating in the medical device industry while taking into account our relative performance and our own strategic goals. The compensation received by our executive officers consists of the following elements:

Base Salary. Base salaries for our executives are established based on the scope of their responsibilities and individual experience, taking into account competitive market compensation paid by other companies for similar positions within the medical device industry. Base salaries are reviewed annually, and adjusted from time to time to realign salaries with market levels after taking into account individual responsibilities, performance and experience. Three of our executive officers were appointed in 2006. Our current senior vice president, sales and marketing, was hired in January 2006 at an annual base salary of $250,000. In September 2006, we hired our current chief financial officer at a base salary of $250,000. In October 2006, our co-founder and chairman became a full-time employee and was appointed as our chief executive officer. He had previously served as a consultant and our executive chairman at a base consulting fee of $14,583 per month. Our board of directors, upon the recommendation of the compensation committee, established a base salary of $350,000 for our chairman and chief executive officer. Our current chief operating officer was appointed in May 2006. He had

 

86


Table of Contents

previously served as our chief financial officer. Our compensation committee believes that these base salary levels are commensurate with the general salary levels for similar positions in medical device companies of similar size and stage of development and operations. Our compensation committee undertook this review for the 2007 annual base salaries for our executive officers in the fourth quarter of 2006.

Discretionary Annual Bonus. In addition to base salaries, our compensation committee has the authority to award discretionary annual bonuses to our executive officers. The annual incentive bonuses are intended to compensate officers for achieving corporate goals and for achieving what the committee believes to be value-creating milestones. Our annual bonus is paid in cash in an amount reviewed and approved by our compensation committee and ordinarily is paid in a single installment in the first quarter following the completion of a given fiscal year. Each executive officer is eligible for a discretionary annual bonus up to an amount equal to a specified percentage of such executive officer’s salary. The target percentages are set at levels that, upon achievement of the target percentage, are likely to result in bonus payments that our compensation committee believes to be at or near the median for target bonus amounts for comparable companies in the medical device industry. However, our compensation committee may increase the annual bonus paid to our executive officers.

At the end of each year, our board of directors, upon the recommendation of the compensation committee, determines the level of achievement for each corporate goal and value-creating milestone and awards credit for the achievement of these corporate goals or milestones as a percentage of the target bonus. Final determinations as to bonus levels are then based in part on the achievement of these corporate goals or milestones, as well as our assessment as to the overall success of our company and the development of our business. These corporate goals and milestones, and the proportional emphasis placed on each goal and milestone may vary, from time to time, depending on our overall strategic objectives, but relate generally to factors such as development and progression of existing products under development, achievement of clinical and regulatory milestones, establishment of new collaborative arrangements, sales and marketing targets, and to financial factors such as raising or preserving capital and improving our results of operations.

Our compensation committee established bonus amounts to be paid in 2007 for performance in 2006 at up to 30% of base salary for each of our executive officers, excluding our chairman and chief executive officer, and for our chairman and chief executive officer, up to 40% of his base salary. The actual amount of bonuses for 2006 was determined in December 2006 following a review of the achievement of overall corporate goals and milestones and each executive officer’s individual performance and contribution. Our compensation committee has not yet determined the strategic milestones or corporate goals that it will apply in determining executives’ bonuses for 2007.

Long-Term Incentive Program. We believe that long-term performance is achieved through an ownership culture that encourages such performance by our executive officers through the use of stock and stock-based awards. Our equity benefit plans have been established to provide certain of our employees, including our executive officers, with incentives to help align those employees’ interests with the interests of our stockholders. Our compensation committee believes that the use of equity and equity-based awards offers the best approach to achieving our compensation goals. We have not adopted stock ownership guidelines, and, other than for our co-founders, our equity benefit plans have provided the principal method for our executive officers to acquire equity or equity-linked interests in our company.

Prior to this offering, we have granted equity awards primarily through our 2001 Equity Incentive Plan, which was adopted by our board of directors and stockholders to permit the grant of stock options, stock appreciation rights, restricted stock and other stock-based awards to our officers, directors, scientific advisory board members, employees and consultants. In 2006, certain named executive officers were awarded stock options under our 2001 Equity Incentive Plan in the amounts indicated in the section below entitled “Grants of Plan Based Awards.” These equity awards included the grant of a stock option for 994,665 shares of common stock to our chairman and chief executive officer in connection with the commencement of his full-time employment and appointment as our chief executive officer.

 

87


Table of Contents

In the absence of a public trading market for our common stock, our board of directors determined the fair market value of our common stock in good faith based upon consideration of a number of relevant factors including the status of our development and commercialization efforts, results of operations, financial status and market conditions. In November 2005, in response to Section 409A of the Internal Revenue Code of 1986, as amended, or Section 409A, and the proposed regulations issued by the U.S. Internal Revenue Service thereunder, we performed a valuation analysis to determine the fair market value of our common stock as of November 30, 2005, which resulted in an estimated fair market rate per share at that date of $0.28. We performed a subsequent valuation analysis to determine the fair market value of our common stock as of September 18, 2006 in accordance with Section 409A, which resulted in an estimated fair market value per share at that date of $0.41. All equity awards to our employees, including executive officers, and to our directors in 2006 were granted at no less than the fair market value of our common stock as determined in good faith by our board of directors on the date of grant. We do not have any program, plan or obligation that requires us to grant equity compensation on specified dates and, because we have not been a public company, we have not made equity grants in connection with the release or withholding of material non-public information. Authority to make equity grants to executive officers rests with our compensation committee, although, our compensation committee does consider the recommendations of our chairman and chief executive officer for officers other than himself. Prior to November 2005, we did not obtain contemporaneous valuations by valuation specialists and our board of directors determined the value of our common stock based solely on an internal assessment of our business progress, development and results of operations, discussion with management, management’s recommendation, and other relevant factors.

In connection with this offering, our board of directors has adopted new equity benefit plans described under “—Equity Benefit Plans” below. The 2006 Equity Incentive Plan will replace our existing 2001 Equity Incentive Plan immediately following this offering and, as described below, will afford our compensation committee much greater flexibility in making a wide variety of equity awards. Participation in our 2006 Employee Stock Purchase Plan that we have adopted and will become effective after this offering will also be available to all executive officers following this offering on the same basis as our other employees.

Stock Appreciation Rights. Our 2006 Equity Incentive Plan authorizes us to grant stock appreciation rights, or SARs, which are more fully described below under “—Equity Benefit Plans.” To date, no SARs have been awarded to any of our executive officers. However, our compensation committee, in its discretion, may in the future elect to make such grants to our executive officers if it deems it advisable.

Severance and Change-in-Control Benefits. Our named executive officers, whom are designated below under “—Summary Compensation Table,” are entitled to certain severance and change of control benefits, the terms of which are described below under “—Severance and Change-in-Control Arrangements.” We believe these severance and change-in-control benefits are an essential element of our executive compensation package and assist us in recruiting and retaining talented individuals.

Restricted Stock Grants or Awards. Our compensation committee did not authorize the grant of restricted stock or restricted stock awards pursuant to our equity benefit plans to any of our executive officers in the year ended December 31, 2006. However, our compensation committee, in its discretion, may in the future elect to make such grants to our executive officers if it deems it advisable.

Other Compensation. Our executive officers who were parties to employment agreements prior to this offering will continue, following this offering, to be parties to such employment agreements in their current form until such time as our compensation committee determines in its discretion that revisions to such employment agreements are advisable. In addition, consistent with our compensation philosophy, we intend to continue to maintain the current benefits and perquisites for our executive officers; however, our compensation committee, in its discretion, may in the future revise, amend or add to the benefits and perquisites of any executive officer if it deems it advisable. The material terms of our employment agreements with our named executive officers are described below under “—Employment Agreements.”

 

88


Table of Contents

Equity Benefit Plans

2001 Equity Incentive Plan

Our board of directors adopted and our stockholders approved the 2001 Equity Incentive Plan, or 2001 Incentive Plan, in March 2001. As of December 31, 2006, 265,651 shares of common stock had been issued upon the exercise of options granted under the 2001 Incentive Plan, options to purchase 5,562,338 shares of common stock were outstanding at a weighted average exercise price of $0.27 per share and 1,184,095 shares remained available for future grant. Upon the effective date of this offering, no further option grants will be made under the 2001 Incentive Plan and any shares then remaining available for future grant will be allocated to our 2006 Equity Incentive Plan.

Administration. Our board of directors administers the 2001 Incentive Plan. Our board of directors, however, may delegate this authority to a committee of one or more board members. Our board has delegated such authority nonexclusively to our compensation committee. The board of directors or a committee of the board has the authority to construe, interpret, amend and modify the 2001 Incentive Plan as well as to determine the terms of an option. Our board of directors may amend or modify the 2001 Incentive Plan at any time. However, no amendment or modification shall adversely affect the rights and obligations with respect to outstanding options unless the holder consents to that amendment or modification.

Eligibility. The 2001 Incentive Plan permits us to grant stock options to our employees, directors and consultants. A stock option may be an incentive stock option within the meaning of Section 422 of the Internal Revenue Code or a nonstatutory stock option.

Stock Option Provisions Generally. In general, the duration of a stock option granted under the 2001 Incentive Plan cannot exceed ten years. The exercise price of an incentive stock option cannot be less than 100% of the fair market value of the common stock on the date of grant. The exercise price of a nonstatutory stock option cannot be less than 100% of the fair market value of the common stock on the date of grant. An incentive stock option may be transferred only on death, but a nonstatutory stock option may be transferred as permitted in an individual stock option agreement. Stock option agreements may provide that the stock options may be early exercised subject to our right of repurchase of unvested shares. In addition, our board of directors may reprice any outstanding option or, with the permission of the optionholder, may cancel any outstanding option and grant a substitute option.

Incentive stock options may be granted only to our employees. The aggregate fair market value, determined at the time of grant, of shares of our common stock with respect to which incentive stock options are exercisable for the first time by an optionholder during any calendar year under all of our stock plans may not exceed $100,000. An incentive stock option granted to a person who at the time of grant owns or is deemed to own more than 10% of the total combined voting power of all classes of our outstanding stock or any of our affiliates must have a term of no more than five years and an exercise price that is at least 110% of fair market value at the time of grant.

Effect on Stock Options of Certain Corporate Transactions. If we dissolve or liquidate, then outstanding stock options under the 2001 Incentive Plan will terminate immediately prior to such dissolution or liquidation. However, we treat outstanding stock options differently in the following situations:

 

   

a sale of all or substantially all of our assets;

 

   

a merger or consolidation in which we are not the surviving corporation; or

 

   

a reverse merger in which we are the surviving corporation but the shares of our common stock outstanding immediately preceding the merger are converted by virtue of the merger into other property.

 

89


Table of Contents

In the event any of the above situations occurs, if the surviving entity determines not to assume or substitute for these stock options, the vesting of stock options held by persons whose service with us or our affiliates has not already terminated will accelerate in full prior to such corporate transaction.

Other Provisions. If there is a transaction or event which changes our stock that does not involve our receipt of consideration, such as a merger, consolidation, reorganization, stock dividend or stock split, our board of directors will appropriately adjust the class and the maximum number of shares subject to the 2001 Incentive Plan.

2006 Equity Incentive Plan

Our board of directors adopted the 2006 Equity Incentive Plan, or 2006 Incentive Plan, in December 2006 and our stockholders approved the 2006 Incentive Plan in March 2007. The 2006 Incentive Plan will become effective immediately upon the signing of the underwriting agreement for this offering. The 2006 Incentive Plan will terminate on December 19, 2016, unless sooner terminated by our board of directors.

Stock Awards. The 2006 Incentive Plan provides for the grant of incentive stock options, 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, all of which may be granted to employees, including officers, non-employee directors and consultants.

Share Reserve. Following this offering, the aggregate number of shares of our common stock that may be issued initially pursuant to stock awards under the 2006 Incentive Plan is 3,000,000 shares. The number of shares of our common stock reserved for issuance will automatically increase on January 1st, from January 1, 2008 through January 1, 2016, by the least of (a) 4% of the total number of shares of our common stock outstanding on December 31st of the preceding calendar year, (b) 8,500,000 shares, or (c) a number determined by our board of directors that is less than (a) or (b). The maximum number of shares that may be issued pursuant to the exercise of incentive stock options under the 2006 Incentive Plan is equal to 6,000,000 shares, as increased from time to time pursuant to annual increases.

No person may be granted stock awards covering more than 2,500,000 shares of our common stock under the 2006 Incentive Plan during any calendar year pursuant to stock options or stock appreciation rights. Such limitation is designed to help assure that any deductions to which we would otherwise be entitled upon the exercise of a stock option or stock appreciation right or upon the subsequent sale of shares purchased under such stock awards, will not be subject to the $1.0 million limitation on the income tax deductibility of compensation paid per covered executive officer imposed by Section 162(m) of the Internal Revenue Code.

If a stock award granted under the 2006 Incentive Plan expires or otherwise terminates without being exercised in full, or is settled in cash, the shares of our common stock not acquired pursuant to the stock award again become available for subsequent issuance under the 2006 Incentive Plan. In addition, the following types of shares under the 2006 Incentive Plan may become available for the grant of new stock awards under the 2006 Incentive Plan: (a) shares that are forfeited to or repurchased by us prior to becoming fully vested; (b) shares withheld to satisfy income or employment withholding taxes; (c) shares used to pay the exercise price of an option in a net exercise arrangement; and (d) shares tendered to us to pay the exercise price of an option. Shares issued under the 2006 Incentive Plan may be previously unissued shares or reacquired shares bought on the open market. As of the date hereof, no shares of our common stock have been issued under the 2006 Incentive Plan.

Administration. Our board of directors has delegated its authority to administer the 2006 Incentive Plan (except with respect to non-discretionary grants made to non-employee directors, as discussed below) to our compensation committee. Subject to the terms of the 2006 Incentive Plan, our board of directors or an authorized committee, referred to as the plan administrator, determines recipients, dates of grant, the numbers and types of stock awards to be granted and the terms and conditions of the stock awards, including the period of their

 

90


Table of Contents

exercisability and vesting. Subject to the limitations set forth below, the plan administrator will also determine the exercise price of options granted, the consideration to be paid for restricted stock awards and the strike price of stock appreciation rights.

The plan administrator does not have the authority to reprice any outstanding stock award under the 2006 Incentive Plan, unless our stockholders have approved such an action within a 12-month period preceding or following such an event. However, the plan administrator may cancel and re-grant any outstanding stock award with the consent of any affected participant.

Stock Options. Incentive and nonstatutory stock options are granted pursuant to incentive and nonstatutory stock option agreements adopted by the plan administrator. The plan administrator determines the exercise price for a stock option, within the terms and conditions of the 2006 Incentive Plan, provided that the exercise price of a stock option cannot be less than 100% of the fair market value of our common stock on the date of grant. Options granted under the 2006 Incentive Plan vest at the rate specified by the plan administrator.

The plan administrator determines the term of stock options granted under the 2006 Incentive Plan, up to a maximum of ten years, except in the case of certain incentive stock options, as described below. Unless the terms of an optionee’s stock option agreement provide otherwise, if an optionee’s relationship with us, or any of our affiliates, ceases for any reason other than disability or death, the optionee may exercise any vested options for a period of three months following the cessation of service. If an optionee’s service relationship with us, or any of our affiliates, ceases due to disability or death, or an optionee dies within a certain period following cessation of service, the optionee or a beneficiary may exercise any vested options for a period of 12 months in the event of disability and 18 months in the event of death. The option term may be extended in the event that exercise of the option following termination of service is prohibited by applicable securities laws. In no event, however, may an option be exercised beyond the expiration of its term.

Acceptable consideration for the purchase of common stock issued upon the exercise of a stock option will be determined by the plan administrator and may include (a) cash, check, bank draft or money order, (b) a broker-assisted cashless exercise, (c) the tender of common stock previously owned by the optionee, (d) a net exercise of the option and (e) other legal consideration approved by the plan administrator.

Unless the plan administrator provides otherwise, options generally are not transferable except by will, the laws of descent and distribution, or pursuant to a domestic relations order. An optionee may designate a beneficiary, however, who may exercise the option following the optionee’s death.

Tax Limitations on Incentive Stock Options. Incentive stock options may be granted only to our employees. The aggregate fair market value, determined at the time of grant, of shares of our common stock with respect to incentive stock options that are exercisable for the first time by an optionee during any calendar year under all of our stock plans may not exceed $100,000. No incentive stock option may be granted to any person who, at the time of the grant, owns or is deemed to own stock possessing more than 10% of our total combined voting power or that of any of our affiliates unless (a) the option exercise price is at least 110% of the fair market value of the stock subject to the option on the date of grant, and (b) the term of the incentive stock option does not exceed five years from the date of grant.

Restricted Stock Awards. Restricted stock awards are granted pursuant to restricted stock award agreements adopted by the plan administrator. Restricted stock awards may be granted in consideration for (a) cash, check, bank draft or money order, (b) past or future services rendered to us or our affiliates, or (c) any other form of legal consideration. Shares of common stock acquired under a restricted stock award may, but need not, be subject to a share repurchase option in our favor in accordance with a vesting schedule to be determined by the plan administrator. Rights to acquire shares under a restricted stock award may be transferred only upon such terms and conditions as set by the plan administrator.

 

91


Table of Contents

Restricted Stock Unit Awards. Restricted stock unit awards are granted pursuant to restricted stock unit award agreements adopted by the plan administrator. Restricted stock unit awards may be granted in consideration for any form of legal consideration. A restricted stock unit award may be settled by cash, delivery of stock, a combination of cash and stock as deemed appropriate by the plan administrator, or in any other form of consideration set forth in the restricted stock unit award agreement. Additionally, dividend equivalents may be credited in respect of shares covered by a restricted stock unit award. Except as otherwise provided in the applicable award agreement, restricted stock units that have not vested will be forfeited upon the participant’s cessation of continuous service for any reason.

Stock Appreciation Rights. Stock appreciation rights are granted pursuant to stock appreciation rights agreements adopted by the plan administrator. The plan administrator determines the strike price for a stock appreciation right which cannot be less than 100% of the fair market value of our common stock on the date of grant. Upon the exercise of a stock appreciation right, we will pay the participant an amount equal to the product of (a) the excess of the per share fair market value of our common stock on the date of exercise over the strike price, multiplied by (b) the number of shares of common stock with respect to which the stock appreciation right is exercised. A stock appreciation right granted under the 2006 Incentive Plan vests at the rate specified in the stock appreciation right agreement as determined by the plan administrator.

The plan administrator determines the term of stock appreciation rights granted under the 2006 Incentive Plan, up to a maximum of ten years. If a participant’s service relationship with us, or any of our affiliates, ceases, then the participant, or the participant’s beneficiary, may exercise any vested stock appreciation right for three months (or such longer or shorter period specified in the stock appreciation right agreement) after the date such service relationship ends. In no event, however, may a stock appreciation right be exercised beyond the expiration of its term.

Performance Stock Awards. The 2006 Incentive Plan permits the grant of performance-based stock and cash awards that may qualify as performance-based compensation that is not subject to the $1.0 million limitation on the income tax deductibility of compensation paid per covered executive officer imposed by Section 162(m) of the Internal Revenue Code. To assure that the compensation attributable to performance-based stock awards will so qualify, our compensation committee can structure such awards so that stock will be issued or paid pursuant to such award only upon the achievement of certain pre-established performance goals during a designated performance period. The maximum benefit to be received by a participant in any calendar year attributable to performance stock awards may not exceed 2,000,000 shares of common stock.

Other Stock Awards. The plan administrator may grant other awards based in whole or in part by reference to our common stock. The plan administrator will set the number of shares under the award and all other terms and conditions of such awards.

Non-Discretionary Grants to Non-Employee Directors. Under the 2006 Incentive Plan, our non-employee directors will automatically receive a series of nonstatutory stock options over their period of service on our board:

 

 

   

Initial Awards. Each individual who first becomes a non-employee director after this offering will automatically be granted an option to purchase 90,000 shares of our common stock. All of the shares subject to each such initial award vest in a series of 36 successive equal monthly installments measured from the date of grant.

 

   

Annual Awards. Each individual who is serving as a non-employee director on the date of an annual meeting of our stockholders, commencing with the annual meeting in 2008, will automatically be granted an option to purchase 36,000 shares of our common stock on such date. The shares subject to each such annual award vest in a series of 36 successive equal monthly installments measured from the date of grant.

 

   

Terms for Initial and Annual Awards. The exercise price of each option granted as an initial or annual award for a non-employee director is 100% of the fair market value of our common stock on the date of

 

92


Table of Contents
 

grant. The maximum term of such options is ten years. If a non-employee director’s service relationship with us, or any of our affiliates, whether as a non-employee director or subsequently as an employee, director or consultant of ours or an affiliate, ceases for any reason other than disability, death, or following a change in control, the optionee may exercise any vested options for a period of three months following the cessation of service. If such an optionee’s service relationship with us, or any of our affiliates, ceases due to disability or death, or an optionee dies within a certain period following cessation of service, the optionee or a beneficiary, if applicable, may exercise the option for a period of 12 months in the event of disability and 18 months in the event of death. If such an optionee’s service terminates within 12 months following a specified change in control transaction, the optionee may exercise the option for a period of 12 months following the effective date of such a transaction. The option term may be extended in the event that exercise of the option following termination of service is prohibited by applicable securities laws. In no event, however, may an option be exercised beyond the expiration of its term. If a non-employee director is required to resign his or her position as a condition of a change of control transaction or is removed as a director in connection with a change of control transaction, the unvested portion of the option award shall vest in full.

Changes to Capital Structure. In the event that there is a specified type of change in our capital structure, such as a stock split, appropriate adjustments will be made to (a) the number of shares reserved under the 2006 Incentive Plan, (b) the maximum number of shares by which the share reserve may increase automatically each year, (c) the maximum number of options, stock appreciation rights and performance-based stock and cash awards that can be granted in a calendar year, (d) the number of shares for which options are subsequently to be made as initial and annual grants to new and continuing non-employee directors and (e) the number of shares and exercise price or strike price, if applicable, of all outstanding stock awards.

Corporate Transactions. In the event of certain significant corporate transactions, awards under the 2006 Incentive Plan may be assumed, continued or substituted for by any surviving or acquiring entity or its parent company. If the surviving or acquiring entity or its parent company elects not to assume, continue or substitute for such stock awards, then (a) with respect to any such stock awards that are held by individuals whose service with us or our affiliates has not terminated prior to the effective date of the corporate transaction, the vesting and exercisability provisions of such stock awards will be accelerated in full and such awards will be terminated if not exercised prior to the effective date of the corporate transaction, and (b) all other outstanding stock awards will terminate if not exercised prior to the effective date of the corporate transaction. Our board of directors has the discretion to:

 

   

arrange for the assumption, continuation, or substitution of a stock award by a surviving or acquiring entity or parent company;

 

   

accelerate the vesting of a stock award and provide for its termination prior to the effective time of the corporate transaction; or

 

   

provide for the surrender of a stock award in exchange for a payment equal to the excess of (a) the value of the property that the optionee would have received upon exercise of the stock award over (b) the exercise price otherwise payable in connection with the stock award.

Changes in Control. Our board of directors has the discretion to provide that a stock award under the 2006 Incentive Plan will immediately vest as to all or any portion of the shares subject to the stock award (a) immediately upon the occurrence of certain specified change in control transactions, whether or not such stock award is assumed, continued or substituted by a surviving or acquiring entity in the transaction or (b) in the event a participant’s service with us or a successor entity is terminated actually or constructively within a designated period following the occurrence of certain specified change in control transactions. Except as described above with respect to the non-discretionary initial and annual awards made to our non-employee directors, stock awards held by participants under the 2006 Incentive Plan will not vest automatically on such an accelerated basis unless specifically provided by the participant’s applicable award agreement.

 

93


Table of Contents

2006 Employee Stock Purchase Plan

Our board of directors adopted our 2006 Employee Stock Purchase Plan, or 2006 Purchase Plan, in December 2006 and our stockholders approved the 2006 Purchase Plan in March 2007. The 2006 Purchase Plan will become effective immediately upon the signing of the underwriting agreement for this offering.

Share Reserve. Following this offering, the 2006 Purchase Plan authorizes the issuance of 400,000 shares of our common stock pursuant to purchase rights granted to our employees or to employees of any of our designated affiliates. The number of shares of our common stock reserved for issuance will automatically increase on January 1st, from January 1, 2008 through January 1, 2016, by the least of (a) 1.5% of the total number of shares of our common stock outstanding on December 31st of the preceding calendar year, (b) 2,500,000 shares, or (c) a number determined by our board of directors that is less than (a) or (b). The 2006 Purchase Plan is intended to qualify as an “employee stock purchase plan” within the meaning of Section 423 of the Internal Revenue Code. As of the date hereof, no shares of our common stock have been purchased under the 2006 Purchase Plan.

Administration. Our board of directors has delegated its authority to administer the 2006 Purchase Plan to our compensation committee. The 2006 Purchase Plan is implemented through a series of offerings of purchase rights to eligible employees. Under the 2006 Purchase Plan, we may specify offerings with a duration 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 our common stock will be purchased for employees participating in the offering. An offering may be terminated under certain circumstances.

Payroll Deductions. Generally, all regular employees, including executive officers, employed by us or by any of our designated affiliates, may participate in the 2006 Purchase Plan and may contribute, normally through payroll deductions, up to 15% of their earnings for the purchase of our common stock under the 2006 Purchase Plan. Unless otherwise determined by our board of directors, common stock will be purchased for accounts of employees participating in the 2006 Purchase Plan 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 an offering or (b) 85% of the fair market value of a share of our common stock on the date of purchase.

Limitations. Employees may have to satisfy one or more of the following service requirements before participating in the 2006 Purchase Plan, as determined by our board of directors: (a) customarily employed for more than 20 hours per week, (b) customarily employed for more than five months per calendar year or (c) continuous employment with us or one of our affiliates for a period of time not to exceed two years. No employee may purchase shares under the 2006 Purchase Plan at a rate in excess of $25,000 worth of our common stock based on the fair market value per share of our common stock at the beginning of an offering for each year such a purchase right is outstanding. Finally, no employee will be eligible for the grant of any purchase rights under the 2006 Purchase Plan if immediately after such rights are granted, such employee has voting power over 5% or more of our outstanding capital stock measured by vote or value.

Changes to Capital Structure. In the event that there is a specified type of change in our capital structure, such as a stock split, appropriate adjustments will be made to (a) the number of shares reserved under the 2006 Purchase Plan, (b) the maximum number of shares by which the share reserve may increase automatically each year and (c) the number of shares and purchase price of all outstanding purchase rights.

Corporate Transactions. In the event of certain significant corporate transactions, any then-outstanding rights to purchase our stock under the 2006 Purchase Plan will be assumed, continued or substituted for by any surviving or acquiring entity (or its parent company). If the surviving or acquiring entity (or its parent company) elects not to assume, continue or substitute for such purchase rights, then the participants’ accumulated contributions will be used to purchase shares of our common stock within ten business days prior to such corporate transaction, and such purchase rights will terminate immediately thereafter.

 

94


Table of Contents

401(k) Plan

We maintain a defined contribution employee retirement plan, or 401(k) plan, for our employees. Our executive officers are also eligible to participate in the 401(k) plan on the same basis as our other employees. The 401(k) plan is intended to qualify as a tax-qualified plan under Section 401(k) of the Internal Revenue Code. The plan provides that each participant may contribute up to 15% of his or her pre-tax compensation, up to the statutory limit, which is $15,500 for calendar year 2007. Participants that are 50 years or older can also make “catch-up” contributions, which in calendar year 2007 may be up to an additional $5,000 above the statutory limit. Under the 401(k) plan, each participant is fully vested in his or her deferred salary contributions, including any matching contributions by us, when contributed. Participant contributions are held and invested by the plan’s trustee. The plan also permits us to make discretionary contributions and matching contributions, subject to established limits and a vesting schedule. In 2006, we matched 100% of participant contributions up to the first three percent of eligible compensation and 50% of participant contributions up to the next two percent of eligible compensation. We intend to match participant contributions at the same levels in 2007.

Summary Compensation Table

The following table provides information regarding the compensation earned during the year ended December 31, 2006 by our chief executive officer, our four other most highly compensated executive officers and our former chief executive officer at December 31, 2006 whose combined salary and bonus exceeded $100,000 during that 2006. We refer to our Chief Executive Officer and these other executive officers as our “named executive officers” elsewhere in this prospectus.

 

Name and Principal Position

  

Salary

  

Bonus

  

Option
Awards(1)

   All Other
Compensation
  

Total

Jay S. Yadav, M.D.(2)

    Chairman and Chief Executive Officer

   $ 226,042    $ 43,750    $ 529,508    $ 11,912(3)    $ 811,212

Harold W. Ingalls

    Chief Financial Officer

     94,697      25,000      158,696      —          278,393

Sandeep S. Yadav

    Chief Operating Officer

     228,333      34,500      93,672      7,244(4)      329,757

Matthew Borenzweig

    Senior Vice President, Sales and Marketing

     242,364      50,000      115,753      —          408,117

David R. Stern(5)

    Senior Vice President, Research and Development and Director

     197,885      30,375      15,474      8,600(4)      250,724

Mark G. Allen, Ph.D.(6)

    Chief Technical Officer and Director

     80,625      11,063      34,431      —          126,119

(1)   The dollar amounts in this column represent the compensation cost for the year ended December 31, 2006 of option awards granted in and prior to 2006. See Note 12 of “Notes to Financial Statements—Stock-Based Compensation Associated with Awards to Employees” for a discussion of assumptions made in determining the grant date fair value and compensation expense of our option awards.

 

(2)   Dr. Yadav served as a consultant until October 2006, when he became an employee and our chief executive officer.

 

(3)   Represents commuting expenses paid by us to such named executive officer.

 

(4)   Represents matching contributions made by us under our 401(k) plan to such named executive officer.

 

(5)   Mr. Stern served as our chief executive officer until May 2006.

 

(6)   All compensation earned in 2006 was for consulting services rendered to us pursuant to our consulting agreement with Dr. Allen. See “—Consulting Agreement with Mark G. Allen, Ph.D.” below.

 

95


Table of Contents

Grants of Plan-Based Awards

All stock options granted to our named executive officers are incentive stock options, to the extent permissible under the Internal Revenue Code of 1986, as amended. The exercise price per share of each stock option granted to our named executive officers was equal to the fair market value of our common stock as determined in good faith by our board of directors on the date of the grant. All stock options were granted under our 2001 Incentive Plan.

We omitted columns related to non-equity and equity incentive plan awards as none of our named executive officers earned any such awards during 2006. The following table sets forth certain information regarding grants of plan-based awards to our named executive officers for 2006:

 

Name

 

Date
Action
Taken (1)

 

Grant
Date (2)

  All Other
Option
Awards:
Number of
Securities
Underlying
Options
  Exercise or
Base Price of
Option
Awards (3)
  Grant
Date Fair
Value of
Option
Awards (4)
         

Jay S. Yadav, M.D.

  03/17/06
10/10/06
  07/10/06
12/28/06
  413,958
994,665
  $
 
0.28
0.41
  $
 
726,648
3,302,288

Harold W. Ingalls

  10/10/06   12/28/06   506,000     0.41     1,679,920

Sandeep S. Yadav

  03/17/06
10/10/06
  07/10/06
12/28/06
  90,000
260,000
   
 
0.28
0.41
   
 
142,200
863,200

Matthew Borenzweig

  03/17/06   07/10/06   300,000     0.28     474,000

David R. Stern

  03/17/06   07/10/06   45,000     0.28     71,100

Mark G. Allen, Ph.D.

  10/10/06   12/28/06   150,000     0.41     498,000

(1)   Represents the date on which our board of directors took all corporate action necessary to grant the option award.

 

(2)   Represents the date of grant for financial reporting purposes pursuant to SFAS No. 123(R). Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Adoption of SFAS No. 123(R).”

 

(3)   Represents the per share fair market value of our common stock, as determined in good faith by our board of directors on the grant date.

 

(4)   The dollar amounts in this column represent the grant date fair value of such option award. See Note 12 of “Notes to Financial Statements—Stock-Based Compensation Associated with Awards to Employees” for a discussion of assumptions made in determining the grant date fair value of our option awards.

 

96


Table of Contents

Outstanding Equity Awards At December 31, 2006

The following table sets forth certain information regarding equity awards granted to our named executive officers outstanding as of December 31, 2006:

 

           Option Awards

Name

        

Number of

Securities
Underlying
Unexercised
Options

Exercisable

  

Number of
Securities
Underlying
Unexercised
Options

Unexercisable

   Option
Exercise
Price(1)
   Option
Expiration
Date

Jay S. Yadav, M.D.

   (2 )   101,537    312,421    $ 0.28    03/16/2016
   (2 )   62,166    932,499      0.41    10/09/2016

Harold W. Ingalls

   (3 )      506,000      0.41    10/09/2016

Sandeep S. Yadav

   (3 )   50,000         0.10    07/29/2012
   (3 )   37,500    12,500      0.15    12/18/2013
   (2 )   25,000    25,000      0.15    12/16/2014
   (2 )   16,875    73,125      0.28    03/16/2016
   (2 )   16,250    243,750      0.41    10/09/2016

Matthew Borenzweig

   (3 )      300,000      0.28    03/16/2016

David R. Stern

   (3 )   298,650         0.02    06/19/2011
   (2 )   200,000         0.10    07/29/2012
   (2 )   8,437    36,563      0.28    03/16/2016

Mark G. Allen, Ph.D.

   (2 )   9,375    140,625      0.41    10/09/2016

(1)   Represents the per share fair market value of our common stock, as determined in good faith by our board of directors on the grant date.

 

(2)   1/48th of the shares subject to the option award vest monthly over four years.

 

(3)   1/4th of the shares subject to the option award vest on the first anniversary of the vesting commencement date and 1/48th of the shares subject to the option award vest monthly thereafter.

Option Exercises and Stock Vested

Our named executive officers did not exercise any stock options or have any stock awards subject to vesting during the year ended December 31, 2006.

Pension Benefits

Our named executive officers did not participate in, or otherwise receive any benefits under, any pension or retirement plan sponsored by us during the year ended December 31, 2006.

Nonqualified Deferred Compensation

Our named executive officers did not earn any nonqualified compensation benefits from us during the year ended December 31, 2006.

Employment Agreements

Jay S. Yadav, M.D.

In January 2007, we entered into an employment agreement with Dr. Yadav, our Chairman and Chief Executive Officer. The agreement provides that Dr. Yadav will receive an annual base salary of $350,000 and

 

97


Table of Contents

will be eligible to receive an annual performance bonus of up to 40% of his annual base salary. Dr. Yadav is also eligible to participate in our general employee benefit plans in accordance with the terms and conditions of such plans. The agreement provides that Dr. Yadav is employed “at-will,” and his employment may be terminated at any time by us or Dr. Yadav. The agreement also provides Dr. Yadav with certain severance and change of control benefits. See “ — Severance and Change of Control Arrangements” below.

Harold W. Ingalls

In August 2006, we entered into an employment agreement with Mr. Ingalls, our Chief Financial Officer. The agreement provides that Mr. Ingalls will receive an annual base salary of $250,000 and a guaranteed $25,000 bonus for 2006. Mr. Ingalls is also eligible to participate in our general employee benefit plans in accordance with the terms and conditions of such plans. The agreement provides that Mr. Ingalls is employed “at-will,” and his employment may be terminated at any time by us or Mr. Ingalls. The agreement was amended in January 2007 to provide Mr. Ingalls with certain severance and change of control benefits that superseded any similar pre-existing benefits under the agreement. See “ — Severance and Change of Control Arrangements” below.

Matthew Borenzweig

In December 2005, we entered into an employment agreement with Mr. Borenzweig, our Senior Vice President, Sales and Marketing. The agreement provides that Mr. Borenzweig will receive an annual base salary of $250,000 and will be eligible to receive an annual performance bonus. Mr. Borenzweig is also eligible to participate in our general employee benefit plans in accordance with the terms and conditions of such plans. The agreement also provides that Mr. Borenzweig is employed “at-will,” and his employment may be terminated at any time by us or Mr. Borenzweig. The agreement was amended effective January 2007 to provide Mr. Borenzweig with certain severance and change of control benefits that superseded any similar pre-existing benefits under the agreement. See “ — Severance and Change of Control Arrangements” below.

Sandeep S. Yadav

In January 2007, we entered into an employment agreement with Mr. Yadav, our Chief Operating Officer, which superseded and replaced Mr. Yadav’s previous offer letter entered into in June 2002. The agreement provides that Mr. Yadav will receive an annual base salary of $275,000 and will be eligible to receive an annual performance bonus of up to 30% of his annual base salary. Mr. Yadav is also eligible to participate in our general employee benefit plans in accordance with the terms and conditions of such plans. The agreement provides that Mr. Yadav is employed “at-will,” and his employment may be terminated for any reason at any time by us or Mr. Yadav. The agreement also provides Mr. Yadav with certain severance and change-in-control benefits. See “— Severance and Change of Control Arrangements” below.

David R. Stern

In January 2007, we entered into an employment agreement with Mr. Stern, our Senior Vice President, Research and Development and a member of our board of directors, which superseded and replaced Mr. Stern’s previous offer letter entered into in April 2001. The agreement provides that Mr. Stern will receive an annual base salary of $215,000 and will be eligible to receive an annual performance bonus of up to 30% of his annual base salary. Mr. Stern is also eligible to participate in our general employee benefit plans in accordance with the terms and conditions of such plans. The agreement provides that Mr. Stern is employed “at-will,” and his employment may be terminated for any reason at any time by us or Mr. Stern. The agreement also provides Mr. Stern with certain severance and change-in-control benefits. See “— Severance and Change of Control Arrangements” below.

 

98


Table of Contents

Consulting Agreement with Mark G. Allen, Ph.D.

In May 2001, we entered into a consulting agreement with Dr. Allen, our Chief Technology Officer and a member of our board of directors, which was amended in November 2003 and January 2007. The agreement, as amended, provides that Dr. Allen will receive an annual consulting fee of $115,000 and reimbursement of certain expenses incurred in connection with rendering services to us. The agreement may be terminated for any reason at any time by us or Dr. Allen upon 30 days written notice. The agreement also provides Dr. Allen with certain severance and change of control benefits. See “— Severance and Change of Control Arrangements” below.

Severance and Change of Control Arrangements

Jay S. Yadav, M.D.

Our employment agreement with Dr. Yadav, our Chairman and Chief Executive Officer, provides that in the event of a change of control of our company pursuant to which Dr. Yadav remains an employee as of the consummation of such change of control, 25% of his then-unvested stock options will become immediately vested. Dr. Yadav’s remaining unvested stock options will become immediately vested upon the earlier of the one year anniversary of our change of control or upon Dr. Yadav’s termination by us without good cause or if he resigns for good reason due to a material decrease in his compensation or duties or a substantial relocation of his place of work. If we terminate Dr. Yadav’s employment within 30 days prior to the consummation of a change of control of our company, all of Dr. Yadav’s then-unvested stock options will become immediately vested. In addition, in the event we terminate Dr. Yadav’s employment at any time, before or after our change of control, without good cause or if he resigns for good reason due to a material decrease in his compensation or duties or a substantial relocation of his place of work, he will also be entitled to receive severance pay equal to 12 months of his then-current base salary plus up to 12 months reimbursement for the cost of the continuation of his then-current group heath insurance benefits.

The following table describes the potential payments to Dr. Yadav upon his termination without good cause, or resignation for good reason, if applicable, both in connection with a change of control and not in connection with a change of control:

 

       Change of Control    No Change of Control

Name

   Salary(1)    Equity
Acceleration(2)
   Benefits(3)    Salary(1)    Equity
Acceleration
   Benefits(3)

Jay S. Yadav, M.D.

   $ 350,000    $                         $ 10,763    $ 350,000    $                 —    $ 10,763

(1)   Represents 12 months of continued salary.

 

(2)   Calculated based on a change of control taking place as of December 31, 2006 and assuming a price per share of $             , which is the mid-point of the range reflected on the cover page of this prospectus. Represents the full acceleration of unvested stock options held by Dr. Yadav. All of Dr. Yadav’s unvested stock options will become immediately vested upon the earlier of (i) the one year anniversary of our change of control, provided that Dr. Yadav continues to be employed with us as of such date, or (ii) his termination without good cause or resignation for good reason.

 

(3)   Represents 12 months of COBRA health benefits.

Mark G. Allen, Ph.D.

Our consulting agreement with Dr. Allen, our Chief Technology Officer and a member of our board of directors, provides that if Dr. Allen’s consulting agreement is terminated without cause or Dr. Allen terminates the consulting agreement for good reason because he suffers a material decrease in his compensation or duties or a substantial relocation of his place of work during the period beginning 30 days prior to the consummation of a change of control of our company and ending on the one year anniversary of such change of control, Dr. Allen will be eligible for continued payment of his then-current consulting fee for a period of 12 months from the

 

99


Table of Contents

termination date of the consulting agreement, paid on a semi-monthly basis or, at our discretion, paid in a lump sum. In addition, all of Dr. Allen’s then-unvested stock options will become immediately vested. In the event we terminate Dr. Allen’s consulting agreement at any time without good cause and such termination is not related to a change of control in which Dr. Allen in eligible for the above change of control benefits, then Dr. Allen will be entitled to his then-current consulting fee for a period of six months from the termination date of the consulting agreement, paid on a semi-monthly basis or, at our discretion, paid in a lump sum.

The following table describes the potential payments to Dr. Allen upon the termination of the consulting agreement without good cause, or by Dr. Allen for good reason, if applicable, both in connection with a change of control and not in connection with a change of control:

     Change of Control    No Change of Control

Name

   Salary(1)    Equity
Acceleration(2)
   Salary(3)    Equity
Acceleration

Mark G. Allen, Ph.D.

   $ 115,000    $                             $ 57,500    $

(1)   Represents payment of consulting fee for a period of 12 months.
(2)   Calculated based on a change of control taking place as of December 31, 2006 and assuming a price per share of $            , which is the mid-point of the range reflected on the cover page of this prospectus. Represents the full acceleration of unvested stock options held by Dr. Allen.

 

(3)   Represents payment of consulting fees for a period of six months.

Other Named Executive Officers

Our employment agreements, as amended, with Harold W. Ingalls, our Chief Financial Officer, Sandeep S. Yadav, our Chief Operating Officer, Matthew Borenzweig, our Senior Vice President, Sales and Marketing, and David R. Stern, our Senior Vice President, Research and Development, and a member of our board of directors, provide that in the event we terminate the employment of any such executive without good cause or if such executive resigns for good reason due to a material decrease in his compensation or duties or a substantial relocation of his place of work during the period beginning 30 days prior to the consummation of a change of control of our company and ending on the one year anniversary of such change of control, then all of such executive’s then-unvested stock options will become immediately vested, and he will be eligible to receive severance pay equal to 12 months of his then-current base salary plus up to 12 months reimbursement for the cost of continuation of his then-current group heath insurance benefits. In the event we terminate any such executive without good cause and such termination is not related to a change of control in which the executive is eligible for the above change of control severance benefits, then such executive will be eligible to receive severance pay equal to six months of his then-current base salary.

The following table describes the potential payments to the listed named executive officers upon such executives’ termination without good cause, or resignation for good reason, if applicable, both in connection with a change of control and not in connection with a change of control:

 

 

       Change of Control    No Change of Control

Name

   Salary(1)   

Equity
Acceleration(2)

  

Benefits(3)

   Salary(4)   

Equity
Acceleration

  

Benefits

Harold W. Ingalls

   $ 250,000    $                             $ 7,429    $ 125,000    $    $

Sandeep S. Yadav

     275,000         9,229      137,500          

Matthew Borenzweig

     250,000         10,763      125,000          

David R. Stern

     215,000         9,229      107,500          

(1)   Represents 12 months of continued salary.

 

100


Table of Contents
(2)   Calculated based on a change of control taking place as of December 31, 2006 and assuming a price per share of $            , which is the mid-point of the range reflected on the cover page of this prospectus. Represents the full acceleration of unvested stock options held by such named executive officer.

 

(3)   Represents 12 months of continued COBRA health benefits.

 

(4)   Represents six months of continued salary.

Non-Employee Director Compensation

The non-employee members of our board of directors are reimbursed for travel, lodging and other reasonable expenses incurred in attending board or committee meetings. Members of our board of directors do not currently receive cash compensation for attending board meetings. In March 2007, our board of directors adopted a new cash compensation program for non-employee directors to be effective upon the closing of this offering. Pursuant to this program, each member of our board of directors who is not our employee will receive the following cash compensation for board services, as applicable:

 

   

$20,000 per year for service as a board member;

 

   

$7,500 per year for service as chairman of the audit committee;

 

   

$5,000 per year for service as chairman of the compensation committee;

 

   

$5,000 per year for service as chairman of the nominating and corporate governance committee;

 

   

$1,500 per year for service as a non-chairman member of the audit committee;

 

   

$1,500 per year for service as a non-chairman member of the compensation committee;

 

   

$1,500 per year for service as a non-chairman member of the nominating and corporate governance committee;

 

   

$1,500 for each board meeting attended in person ($500 for meetings attended by video or telephone conference); and

 

   

$1,500 for each committee meeting attended in person ($500 for meetings attended by video or telephone conference).

We will continue to reimburse our non-employee directors for their reasonable expenses incurred in attending meetings of our board of directors and committees of the board of directors.

Additionally, members of our board of directors who are not our employees will receive non-statutory stock options under our 2006 Equity Incentive Plan, which will become effective immediately upon the signing of the underwriting agreement for this offering. Each non-employee director joining our board of directors after the closing of this offering will automatically be granted a non-statutory stock option to purchase 90,000 shares of common stock with an exercise price equal to the then fair market value of our common stock. On the date of each annual meeting of our stockholders beginning in 2008, each non-employee director will automatically be granted a non-statutory stock option to purchase 36,000 shares of our common stock on that date with an exercise price equal to the then fair market value of our common stock. Both the initial grants and annual grants will vest monthly over three years. All stock options granted under our 2006 Equity Incentive Plan will have a term of ten years.

 

101


Table of Contents

The following table provides compensation information for all our non-employee directors during 2006:

 

Name

   Fees
Earned
or Paid
in Cash
  

Option

Awards(1)(2)(3)

  

Non-Equity

Incentive Plan

Compensation

  

All Other

Compensation

  

Total

Patrick J. Fortune, Ph.D.

   $  —         $  —    $  —    $  —

John J. Huntz, Jr.

                        

Muhit U. Rahman(4)

        $ 6,264               

Marvin L. Woodall(4)

          8,558               

Lee R. Wrubel, M.D.

                        

(1)   The dollar amounts in this column represent the compensation cost for the year ended in December 31, 2006 of option awards granted in and prior to 2006. See Note 12 of “Notes to Financial Statements — Stock-Based Compensation Associated with Awards to Employees” for a discussion of assumptions made in determining the grant date fair value and compensation expense of our option awards.

 

(2)   The aggregate number of shares subject to outstanding option awards held by each of the directors listed in the table above as of December 31, 2006 was as follows: Mr. Rahman 20,000 shares and Mr. Woodall 45,000 shares.

 

(3)   The grant date fair value of the option awards granted during the year ended December 31, 2006 for each of the directors listed in the table was as follows: Mr. Rahman $31,600 and Mr. Woodall $31,600.

 

(4)   1/48th of the shares subject to each option award vest monthly over four years.

Compensation Committee Interlocks and Insider Participation

Prior to the closing of this offering, Jay S. Yadav, M.D., our Chairman and Chief Executive Officer, was a member of our compensation committee. Other than Dr. Yadav, no member of our compensation committee has ever been an executive officer or employee of ours. None of our executive officers currently serves, or has served during the last completed fiscal year, on the compensation committee or board of directors of any other entity that has one or more executive officers serving as a member of our board of directors or compensation committee. We have had a compensation committee for four years. Prior to establishing the compensation committee, our full board of directors made decisions relating to compensation of our executive officers.

Limitation of Liability and Indemnification

Our amended and restated certificate of incorporation, which will become effective upon the closing of this offering, limits the liability of our directors to the fullest extent permitted by Delaware law. Delaware law provides that directors of a corporation will not be personally liable for monetary damages for breach of their fiduciary duties as directors, except for liability for any:

 

   

breach of their duty of loyalty to us or our stockholders;

 

   

act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;

 

   

unlawful payment of dividends or redemption of shares as provided in Section 174 of the Delaware General Corporation Law; or

 

   

transaction from which the directors derived an improper personal benefit.

These limitations of liability do not apply to liabilities arising under federal securities laws and do not affect the availability of equitable remedies such as injunctive relief or rescission.

Our amended and restated bylaws, which will become effective upon the closing of this offering, provide that we will indemnify our directors and executive officers, and may indemnify other officers, employees and other agents, to the fullest extent permitted by law. Our amended and restated bylaws also permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in connection with their services to us, regardless of whether our amended and restated bylaws permit such indemnification. We have obtained such a directors’ and officers’ liability insurance policy.

 

102


Table of Contents

We have entered, and intend to continue to enter, into separate indemnification agreements with our directors and executive officers, in addition to the indemnification provided for in our amended and restated bylaws. These agreements, among other things, require us to indemnify our directors and executive officers for certain expenses, including attorneys’ fees, judgments, fines and settlement amounts incurred by a director or executive officer in any action or proceeding arising out of their services as one of our directors or executive officers, or any of our subsidiaries or any other company or enterprise to which the person provides services at our request.

At present, there is no pending litigation or proceeding involving any of our directors or executive officers as to which indemnification is required or permitted, and we are not aware of any threatened litigation or proceeding that may result in a claim for indemnification.

Insofar as indemnification for liabilities arising under the Securities Act may be permitted to directors, executive officers or persons controlling us, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

 

103


Table of Contents

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

The following is a summary of transactions since our inception to which we have been a party in which the amount involved exceeded $120,000 and in which any of our executive officers, directors or beneficial holders of more than 5% of our capital stock had or will have a direct or indirect material interest, other than compensation arrangements which are described under the section of this prospectus entitled “Compensation Discussion and Analysis.”

Policies and Procedures for Related Party Transactions

Pursuant to our code of business conduct and ethics, or Code of Conduct, our executive officers, directors, and principal stockholders, including their immediate family members and affiliates, are not permitted to enter into a related party transaction with us without the prior consent of our audit committee, or other independent committee of our board of directors in the case it is inappropriate for our audit committee to review such transaction due to a conflict of interest. Any request for us to enter into a transaction with an executive officer, director, principal stockholder, or any of such persons’ immediate family members or affiliates, in which the amount involved exceeds $120,000 must first be presented to our audit committee for review, consideration and approval. All of our directors, executive officers and employees are required to report to our audit committee any such related party transaction. In approving or rejecting the proposed agreement, our audit committee shall consider the relevant facts and circumstances available and deemed relevant to the audit committee, including, but not limited to the risks, costs and benefits to us, the terms of the transaction, the availability of other sources for comparable services or products, and, if applicable, the impact on a director’s independence. Our audit committee shall approve only those agreements that, in light of known circumstances, are in, or are not inconsistent with, our best interests, as our audit committee determines in the good faith exercise of its discretion. All of the transactions described below were entered into prior to the adoption of our Code of Conduct and were approved by our board of directors.

Sales of Securities

The shares of common stock set forth in the table below were purchased in March and May 2001 at a price of $0.01 and $0.02 per share, respectively. During the period from August 2001 through February 2002, we issued and sold an aggregate of 4,189,852 shares of our Series A preferred stock at a per share price of $0.60 for aggregate consideration of $2.5 million. In November 2003, we issued and sold an aggregate of 14,014,909 shares of our Series B preferred stock at a per share price of $0.96 for aggregate consideration of $13.5 million. In November 2005, we issued and sold an aggregate of 11,336,661 shares of our Series C preferred stock at a per share price of $1.40 for aggregate consideration of $15.9 million. In September and October 2006, we issued and sold an aggregate of 10,904,677 shares of our Series D preferred stock at a per share price of $2.07 for aggregate consideration of $22.6 million. All outstanding shares of our preferred stock will convert automatically into shares of our common stock on a one-for-one basis upon the closing of this offering. We believe the terms obtained or consideration that we paid or received, as applicable, in connection with the transactions described below were comparable to terms available or the amounts that would be paid or received, as applicable, in arm’s-length transactions.

 

104


Table of Contents

Purchaser

   Common
Stock
   Series A
Preferred
Stock
   Series B
Preferred
Stock
   Series C
Preferred
Stock
   Series D
Preferred
Stock

Executive Officers and Directors

              

Jay S. Yadav, M.D.

   5,700,000            

Mark G. Allen, Ph.D.

   2,850,000            

Sandeep S. Yadav

   200,000            

David R. Stern

      37,500         

5% Stockholders

              

Medtronic, Inc.

            6,336,661    1,227,193

Boston Millennia Partners II L.P. and affiliated entities(1)

         4,075,259    1,750,266    1,128,204

Arcapita Ventures I Limited(2)

               5,458,937

Foundation Medical Partners L.P.(3)

         3,056,444    1,400,855    483,092

(1)   Consists of shares held by Boston Millennia Partners II L.P., Boston Millennia Partners GmbH & Co. KG, Boston Millennia Partners II-A L.P., Boston Millennia Associates II L.P. and Strategic Advisors Fund L.P. Patrick J. Fortune, Ph.D., a member of our board of directors, is a partner of Boston Millennia Partners, the sponsor of these investment funds.

 

(2)   John J. Huntz, Jr., a member of our board of directors, is an executive director of Arcapita Ventures I Limited.

 

(3)   Lee R. Wrubel, M.D., a member of our board of directors, is a managing member of Foundation Medical Managers, LLC, the general partner of Foundation Medical Partners L.P.

Amended and Restated Investor Rights Agreement

We have entered into an investor rights agreement with the purchasers of our outstanding preferred stock and a warrant to purchase our preferred stock, including entities with which certain of our directors are affiliated. As of December 31, 2006, the holders of 40,446,099 shares of our common stock, including the shares of common stock issuable upon the automatic conversion of our preferred stock, and a warrant to purchase up to 17,578 shares of our common stock are entitled to rights with respect to the registration of their shares following this offering under the Securities Act. For a description of these registration rights, see “Description of Capital Stock — Registration Rights.”

Voting Agreement

The election of the members of our board of directors is governed by a voting agreement that we entered into with certain holders of our common stock and holders of our preferred stock and related provisions of our amended and restated certificate of incorporation. The holders of a majority of our common stock have designated Jay S. Yadav, M.D., David R. Stern and Mark G. Allen, Ph.D., for election to our board of directors. The holders of a majority of our Series A preferred stock have designated Muhit U. Rahman for election to our board of directors. The holders of a majority of our Series B preferred stock have designated Patrick J. Fortune, Ph.D., and Lee R. Wrubel, M.D., for election to our board of directors. The holders of a majority of our Series D preferred stock have designated John J. Huntz, Jr., for election to our board of directors. The holders of a majority of our common stock and preferred stock, voting together as a single class, have designated Marvin L. Woodall for election to our board of directors. Upon the closing of this offering, the voting agreement will terminate in its entirety and none of our stockholders will have any special rights regarding the election or designation of members of our board of directors.

Employment Agreements

We have entered into employment agreements with our executive officers. For more information regarding these agreements, see “Compensation Discussion and Analysis — Employment Agreements.”

 

105


Table of Contents

Severance and Change of Control Arrangements

Some of our executive officers are entitled to certain severance and change of control benefits. For information regarding these arrangements, see “Compensation Discussion and Analysis — Severance and Change of Control Arrangements.”

Stock Options Granted to Executive Officers and Directors

We have granted stock options to our executive officers and directors. For more information regarding these stock options, see “Compensation Discussion and Analysis.”

Relationship Between our Executive Officers

Jay S. Yadav, M.D., our Chairman and Chief Executive Officer, and Sandeep S. Yadav, our Chief Operating Officer, are natural brothers.

Relationship and Transactions with the Cleveland Clinic Foundation

In January 2002, we entered into a consulting services and technology transfer agreement with Jay S. Yadav, M.D. and the Cleveland Clinic Foundation, or CCF, as subsequently amended. From 1998 to August 2006, Dr. Yadav held various staff positions at CCF, including the Ferchill Distinguished Chair, Chairman of the Center for Medical Innovation as well as Director of Vascular Intervention. In conjunction with the agreement, we issued the CCF 105,000 shares of our common stock as consideration for CCF agreeing to allow Dr. Yadav to provide consulting services to us under the agreement.

Relationship and Transactions with Georgia Tech

In March 2001, we entered into a license agreement with Georgia Tech Research Corporation, or GTRC, pursuant to which we were granted an exclusive license under certain GTRC intellectual property for medical applications. In January 2007, this agreement was amended to expand the license field to include certain industrial applications of the licensed technology. Mark G. Allen, Ph.D. our Chief Technical Officer and a member or our board of directors, is the Joseph M. Pettit Professor of Electrical and Computer Engineering at the Georgia Institute of Technology, or Georgia Tech. The general manager of GTRC reports to the Office of the Vice Provost for Research at Georgia Tech. In conjunction with the license agreement and the amendment, we issued GTRC an aggregate of 145,000 shares of our common stock.

Relationship and Transactions with Medtronic

In November 2005, we entered into a license and development agreement as well as a related supply agreement with Medtronic, Inc., or Medtronic, one of our principal stockholders. The license and development agreement provides for a joint development program in which we and Medtronic are working on adapting our sensor technology for use as a wired pressure sensor system capable of working with Medtronic’s implantable devices to address impaired cardiac function or hypertension, or both. Pursuant to the supply agreement, we will supply Medtronic’s commercial and clinical requirements for the wired sensor developed under the joint development program. For more detailed information regarding our development program with Medtronic, see “Business — Collaboration with Medtronic.”

In November 2005, we also entered into a Credit Agreement and related ancillary agreements with Medtronic, pursuant to which we were provided with a $5.0 million credit facility by Medtronic to fund our working capital needs. In connection with this credit facility, we executed a promissory note in favor of Medtronic that is secured by all of our tangible and intellectual property assets. We have not drawn any amounts under this credit facility and have no balance owing to Medtronic as of the date of this prospectus. In March 2007, we provided Medtronic with notice of our termination of the credit facility effective immediately upon the closing of this offering. For more detailed information regarding our credit facility with Medtronic, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”

 

106


Table of Contents

Relationship and Transactions with Maya

In November 2003, we formed a subsidiary, Maya Interventional LLC, or Maya, and assigned Maya our patents and intellectual property that did not relate to sensing or measurement technology. Our board of directors believed that this transaction would maximize the value of our technology for the benefit of our stockholders by focusing our limited resources on the development of our sensing and measurement technology while allowing Maya to focus on further development and exploitation of technology unrelated to the sensing or measurement areas. The technology assigned to Maya consisted primarily of patents and intellectual property related to stents, stent delivery systems and electrodes for neurological applications. No sensing or measurement related intellectual property was included in the technology assigned to Maya. We also granted Maya a non-exclusive royalty-free license to our intellectual property for applications other than sensing or measurement. Maya granted us a non-exclusive royalty-free license to its intellectual property, including any intellectual property that we assigned or licensed to Maya, for use by us for sensing or measurement applications. In connection with this assignment and license of intellectual property to Maya, we were granted a preference in the amount of $375,000 on any subsequent distributions by Maya to its members and we retained an approximately 2% beneficial interest in Maya’s total outstanding equity, or capital units. The remaining 98% beneficial interest in Maya’s capital units were distributed to holders of our common stock and Series A preferred stock. The holders of our common stock and Series A preferred stock were issued one capital unit of Maya for each 1,000 shares of our common stock and Series A preferred stock held by them at the time of the distribution. Jay S. Yadav, M.D., and Mark G. Allen, Ph.D., serve as members of the board of directors of Maya and together beneficially hold over 60% of Maya’s capital units.

Indemnification Agreements with Executive Officers and Directors

Effective upon the closing of this offering, we will have entered into an indemnification agreement with each of our directors and executive officers. These indemnification agreements and our amended and restated certificate of incorporation and amended and restated bylaws will indemnify each of our directors and officers to the fullest extent permitted by the Delaware General Corporation Law. See “Management — Limitation of Liability and Indemnification.”

Relationship with Underwriters

An affiliate of CIBC World Markets Corp., one of the underwriters in this offering, owns a limited partnership interest in Boston Millennia Partners II L.P., one of our principal stockholders which also has a right to name a member of our board of directors. This indirect interest in our company represents less than 1% of our outstanding common stock.

 

107


Table of Contents

PRINCIPAL STOCKHOLDERS

The following table sets forth information regarding the beneficial ownership of our common stock as of December 31, 2006 and as adjusted to reflect the sale of the common stock in this offering for:

 

   

each person, or group of affiliated persons, known by us to beneficially own more than 5% of our common stock;

 

   

each of our named executive officers;

 

   

each of our directors; and

 

   

all of our executive officers and directors as a group.

The percentage ownership information shown in the table is based upon 50,073,991 shares of common stock outstanding as of December 31, 2006, assuming the conversion of all outstanding shares of our preferred stock as of December 31, 2006 and the issuance of          shares of common stock in this offering. The percentage ownership information assumes no exercise of the underwriters’ over-allotment option.

Information with respect to beneficial ownership has been furnished by each director, officer or beneficial owner of more than 5% of our common stock. We have determined beneficial ownership in accordance with the rules of the Securities and Exchange Commission. These rules generally attribute beneficial ownership of securities to persons who possess sole or shared voting power or investment power with respect to those securities. In addition, the rules include shares of common stock issuable pursuant to the exercise of stock options or a warrant that are either immediately exercisable or exercisable on or before March 1, 2007, which is 60 days after December 31, 2006. These shares are deemed to be outstanding and beneficially owned by the person holding those options or a warrant for the purpose of computing the percentage ownership of that person, but they are not treated as outstanding for the purpose of computing the percentage ownership of any other person. Unless otherwise indicated, the persons or entities identified in this table have sole voting and investment power with respect to all shares shown as beneficially owned by them, subject to applicable community property laws.

Except as otherwise noted below, the address for each person or entity listed in the table is c/o CardioMEMS, Inc., 75 Fifth Street, N.W., Suite 440, Atlanta, GA 30308.

 

108


Table of Contents

Name and Address of Beneficial Owner

   Shares That May
be Acquired within
60 days of
December 31, 2006
   Number of Shares
Beneficially Owned
   Percentage of Shares
Beneficially Owned
         Before
Closing
    After
Closing

5% Stockholders

          

Medtronic, Inc.(1)

   —      7,563,854    15.1 %  

Entities affiliated with Boston Millennia Partners(2)

   —      6,953,729    13.9