| SOMANETICS CORP ITEM 1A RISK FACTORS An investment in our common shares involves a high degree of risk |
| You should carefully consider the specific factors described below, together with the cautionary statement under the caption “Forward — Looking Statements” in Item 7 of this Report and the other information included in this report, before purchasing our common shares |
| The risks described below are not the only ones that we face |
| Additional risks that are not yet known to us or that we currently think are immaterial could also impair our business, financial condition or results of operations |
| If any of the following risks actually occurs, our business, financial condition or results of operations could be adversely affected |
| In such case, the trading price of our common shares could decline, and you may lose all or part of your investment |
| Risks Relating to Our Business Our future growth depends on increased market acceptance of our INVOS System in existing market segments and market acceptance in new market segments |
| Since sales of the INVOS System, including SomaSensors, currently account for substantially all of our revenues, our future growth will depend on the degree to which our INVOS System is accepted by hospitals and clinicians in our existing market segments and in new market segments, such as the neonatal ICU, major surgeries involving diabetic and elderly patients and other applications |
| There are numerous factors that could adversely impact market acceptance of our INVOS System |
| We depend on favorable peer-reviewed publication and successful clinical use of our products for our success |
| The INVOS System has not had extensive clinical use in the new market segments |
| We cannot assure you that additional research papers will be published or that any such papers will conclude that the INVOS System provides information that is clinically important |
| In addition, researchers might publish results that do not support the clinical importance of the information provided by the INVOS System or that conclude that another product provides better or more important information |
| Performance problems or adverse research results could prevent acceptance of the product in existing and new market segments, adversely affect our reputation in the medical community, result in unexpected expense and adversely affect future sales |
| In addition, we compete with numerous medical equipment companies for the portions of hospital budgets allocated to capital equipment and for the limited amount of forehead space on patients to place sensors for all types of monitoring |
| Sales of our INVOS System might be limited or delayed because of resistance to major capital equipment expenditures by hospital purchasing committees |
| Even if we are successful in convincing physicians, other medical professionals and hospital purchasing committees that the INVOS System provides valuable benefits, they might be unwilling or unable to commit funds to the purchase of the INVOS System due to budgetary constraints |
| Moreover, even if one or two units are sold to a hospital, we believe that it will take additional time and experience with the INVOS System before additional medical professionals in the hospital might be interested in using the INVOS System in other procedures or other areas of the hospital |
| Sales of all of our products might be limited because hospitals might fear that the cost of a new device or product will lower their profits because medical insurers generally fix reimbursement amounts for the procedures in which our products might be used |
| Moreover, medical professionals may be reluctant to use our INVOS System in some new market segments, particularly those involving diagnostic applications, unless they receive reimbursement from medical insurers for using the system |
| Our INVOS System is not currently cleared by the FDA for use in the diagnosis of disease states |
| Additionally, the INVOS System is not currently approved for separate reimbursement, and we might not be able to obtain reimbursement for these uses of our INVOS System |
| If the INVOS System fails to achieve market acceptance in existing or new market segments or if these market segments fail to develop as rapidly as expected, our business, financial condition and results of operations could be adversely affected and our plan to increase our investments in our direct sales team, additional clinical trials and our research and development team might not produce favorable results |
| 20 _________________________________________________________________ [50]Table of Contents We are dependent on our distributors and our independent sales representative firms for a substantial portion of our sales, and their failure to sell our products adequately would adversely affect our business |
| We are dependent on our distributors to generate all of our international sales, and on our independent sales representative firms for a substantial portion of our sales in the United States |
| Independent distributors or independent sales representative firms might fail to commit the necessary resources to market and sell our products to the level of our expectations, especially as significant customer education and long lead times are typically required to market and sell our products successfully |
| If our distributors or independent sales representative firms fail to market, promote and sell our products adequately, our business, financial condition and results of operations would be adversely affected |
| We might not be able to engage additional distributors on a timely basis, enter into other third-party marketing arrangements or retain or replace our existing distributors, when required |
| If we are unable to engage, replace or retain distributors, our ability to market and sell our products internationally could be adversely affected |
| In addition, if any of our distributor arrangements is terminated or discontinued, we will likely be faced with increased costs as we attempt to replace these arrangements |
| Even if we are able to engage new distributors or retain existing ones, they might incur conflicting obligations to sell other companies’ products or they might distribute other products that provide greater revenues to them than are provided by our products |
| Tyco Healthcare, part of Tyco International Ltd, our international distributor in Europe, the Middle East, Africa and Canada for our INVOS System, accounted for 11 percent and 12 percent of our net revenues for fiscal 2005 and for fiscal 2003, respectively |
| Edwards Lifesciences Ltd, formerly Baxter Limited, our international distributor in Japan for our INVOS System, was our largest customer for fiscal 2004, although it accounted for less than 10 percent of our net revenues for fiscal 2004 |
| The loss of either of these distributors could have an adverse effect on our business, financial condition and results of operations |
| We plan to increase the number of our direct sales team personnel in the United States and reduce our dependence on our independent sales representative firms |
| As a result, we might terminate some of our existing independent sales representatives, which could result in claims by terminated sales representative firms |
| If we are required to pay any significant amounts to terminated sales representatives, our results of operations and financial condition would be adversely affected |
| We currently depend on single-source suppliers for key components of the INVOS System, and the loss of any of these suppliers could harm our ability to manufacture and sell our products, increase the cost of our components or delay our clinical trials |
| We are dependent on various suppliers for manufacturing the components for our INVOS System |
| Although we believe that most components are generally available from several potential suppliers, we depend on one supplier for one of our components |
| We are not aware of any validated alternative supplier for this component, although we are currently in the process of validating in accordance with FDA requirements a second source of supply |
| Moreover, we typically use one supplier for custom-designed components, including the unit enclosure, the printed circuit boards, other mechanical components and the SomaSensor |
| SomaSensors represented 75 percent of our net revenues in fiscal 2005 |
| Engaging additional or replacing existing suppliers of custom-designed components is costly and time consuming |
| We estimate that it would require approximately four to five months to change SomaSensor suppliers |
| We do not intend to maintain significant inventories of components, other than an approximate six-month supply of the one component for which we currently have no alternative supplier |
| If we fail to obtain custom-designed components from our sole suppliers, if we lose any of our present suppliers and cannot replace them on a timely basis when necessary, if there is an interruption of production at one or more of our suppliers, or if any supplier is otherwise unable or unwilling to meet our requirements at current prices or at all, our ability to manufacture and sell our products would be impaired or we might have to pay higher prices for our components or our clinical trials could be delayed |
| In addition, because we do not have long-term agreements with our suppliers, we might be subject to unexpected price increases which might adversely affect our profit margins |
| In addition, we do not have direct control over the activities of our suppliers and are dependent on them for quality control, capacity, processing technologies and, in required cases, compliance with FDA Quality System Regulation requirements |
| If we are unsuccessful in managing our suppliers, our business could be adversely affected |
| 21 _________________________________________________________________ [51]Table of Contents We may become subject to competition which may adversely affect us |
| We believe that the markets for cerebral and somatic oximetry products may become highly competitive |
| In the United States, we believe there is currently only one other company with FDA clearance to sell a cerebral oximeter |
| In December 2005, CAS Medical Systems, Inc |
| announced that it received 510(k) clearance to market a cerebral oximeter for the adult market, with plans to launch the product in late 2006 |
| Outside the United States, several Japanese manufacturers offer competitive products for sale in that country and primarily for research in other parts of the world, but, to our knowledge, as of yet, none has pursued FDA clearance to market its product in the United States |
| We are aware that several companies and individuals are engaged in the research and development of non-invasive cerebral oximeters, and we believe that there are several other potential entrants into the market |
| Other companies have FDA clearance to market somatic oximeters in the United States |
| Competition might cause our sales cycle to lengthen to the extent that customers take longer to make purchasing decisions |
| Competition might also reduce our gross margins and market share and prevent us from achieving further market penetration |
| Competitors might be more successful than we are in obtaining FDA clearance with broader claims in their labeling or more successful than we are in manufacturing and marketing their products and may be able to take advantage of the significant time and effort we have invested to gain medical acceptance of cerebral oximetry |
| We also compete with companies that have longer operating histories, more established products and greater resources than we do for, among other things, forehead monitoring space, limited hospital capital budgets and alternative products |
| The medical products industry is characterized by extensive research and development and intense competition in an increasingly cost-conscious environment |
| Some of these potential competitors have well-established reputations, customer relationships and marketing, distribution and service networks |
| Some of them have substantially longer histories in the medical products industry, larger product lines and greater financial, technical, manufacturing, research and development and management resources than we do |
| Many of these potential competitors have long-term product supply relationships with our potential customers |
| These potential competitors might be able to use their resources, reputations and ability to leverage existing customer relationships to give them a competitive advantage over us, including in securing forehead sensor space for their products and dollars from hospital capital equipment budgets to purchase their products |
| They might also succeed in developing products that are at least as reliable and effective as our products, that make additional measurements, that are less costly than our products or that provide alternatives to our products |
| If we fail to manage our growth effectively, our business and operating results could be harmed |
| If we experience growth in our business, our growth could place a significant strain on our management, customer service, operations, sales and administrative personnel and other resources |
| To serve the needs of our existing and future customers, we will be required to train, motivate and manage qualified employees |
| We have incurred and will continue to incur significant costs to retain qualified management, sales and marketing, engineering, production, manufacturing and administrative personnel, as well as expenses for marketing and promotional activities |
| Our ability to manage our planned growth depends upon our success in expanding our operating, management and information and financial systems, which might significantly increase our operating expenses |
| We expect to continue to invest substantial resources to develop a smaller SomaSensor for use with newborns, product-line extension of the INVOS System for monitoring non-brain tissues and other advances to the design and performance features of the INVOS System, including the disposable SomaSensor |
| New products require extensive testing and regulatory clearance before they can be marketed, and substantial customer education concerning the product’s use, advantages and effectiveness |
| We might not be able to develop commercially viable products |
| We might not be able to manage effectively our future growth, and if we fail to do so, our business, financial condition and results of operations would be adversely affected |
| 22 _________________________________________________________________ [52]Table of Contents Patients might assert product liability claims against us |
| Because we test, market and sell a patient monitoring device and a heart patch, patients might assert product liability claims against us |
| The INVOS System is used in operating rooms and other critical care hospital units with patients who might be seriously ill or might be undergoing dangerous procedures |
| The CorRestore Patch is used on seriously ill patients undergoing a dangerous procedure |
| On occasion, patients on whom the INVOS System is being used, or in whom a CorRestore Patch is implanted, may be injured or die as a result of their medical treatment or condition |
| We might be sued because of such injury or death, and regardless of whether we are ultimately determined to be liable or our products are determined to be defective and a contributing factor in such injury or death, we might incur significant legal expenses not covered by insurance |
| In addition, product liability litigation could damage our reputation and impair our ability to market our products, regardless of the outcome |
| Litigation could also impair our ability to retain product liability insurance or make our insurance more expensive |
| We have product liability insurance with a liability limit of dlra5cmam000cmam000 |
| This insurance is costly and even though it has been obtained, we might not be able to retain it |
| Even if we are able to retain this insurance, it might not be sufficient to protect us in the event of a major defect in the INVOS System or the CorRestore Patch |
| If we are subject to an uninsured or inadequately insured product liability claim based on the performance of the INVOS System or the CorRestore Patch, our business, financial condition and results of operations could be adversely affected |
| If we fail to obtain and maintain necessary US Food and Drug Administration clearances for our products and indications or if clearances for future products and indications are delayed or not issued, our business would 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 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, an existing product such as the INVOS System, we must first receive either 510(k) clearance or premarket approval from the FDA, unless an exemption applies |
| The FDA’s 510(k) clearance process usually takes from three to six months, but it can last longer |
| The process of obtaining premarket approval 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 |
| 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 |
| If we conduct clinical trials, they may be delayed or halted, or be inadequate to support approval or clearance |
| Medical devices may be marketed only for the indications for which they are approved or cleared |
| The FDA may fail to approve or clear indications that are necessary or desirable for successful commercialization |
| Indeed, the FDA may refuse our requests for 510(k) clearance or premarket approval of new products, new intended uses or modifications to existing products |
| Our clearances can be revoked if safety or effectiveness problems develop |
| The FDA might require us to obtain a new clearance to label or promote more actively the INVOS System for specific patient subgroups, such as diabetics; if we fail to obtain such clearances, our sales and revenues may be adversely affected |
| Our INVOS System 510(k) clearance states that the prospective clinical value of the INVOS System has not been demonstrated in patients with specific disease states |
| If we wish to label or promote more actively the INVOS System for specific types of patients, such as diabetics, the FDA may require us to obtain a new 510(k) clearance and would likely carefully scrutinize the data support for any such claim |
| The FDA may also determine that our current promotion of the INVOS System as suitable for use in diabetics constitutes promotion for an unapproved use and 23 _________________________________________________________________ [53]Table of Contents may take regulatory action against us and require us to cease and desist from such promotion until a new clearance or approval is obtained |
| We cannot assure you that the FDA would grant additional 510(k) clearances in a timely fashion, or at all, or that the FDA would not require us to undertake the more burdensome premarket approval process as a prerequisite for marketing the INVOS System with this type of claim |
| Any of the above could delay our ability to market and sell new products or to promote the INVOS System for specific patient subgroups such as diabetics and would thereby have an adverse effect on our business, financial condition and results of operations |
| After clearance or approval of our products, we are subject to continuing regulation by the FDA, and if we fail to comply with FDA regulations, our business could suffer |
| Even after clearance or approval of a product, we are subject to continuing regulation by the FDA, including the requirements that our facility be registered and our devices listed with the agency |
| 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 maintain records of other corrections or removals |
| The FDA closely regulates promotion and advertising, and our promotional and advertising activities could come under scrutiny |
| If the FDA objects to our promotional and advertising activities or finds that we failed to submit reports under the Medical Device Reporting regulations, for example, the FDA may allege our activities resulted in violations |
| The FDA and state authorities have broad enforcement powers |
| Our failure to comply with applicable regulatory requirements could result in enforcement action by the FDA or state agencies, which may include any of the following sanctions: • untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties; • repair, replacement, refunds, recall or seizure of our products; • operating restrictions or partial suspension or total shutdown of production; • refusing or delaying our requests for 510(k) clearance or premarket approval of new products or new intended uses; • withdrawing 510(k) clearance or premarket approvals that have already been granted; and • criminal prosecution |
| If any of these events were to occur, they could harm our business |
| We have modified some of our products without FDA clearance |
| The FDA could retroactively determine that the modifications were improper and require us to stop marketing and recall the modified products |
| Any modifications to one of our FDA-cleared devices 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 |
| We may be required to submit extensive pre-clinical and clinical data depending on the nature of the changes |
| We may not be able to obtain additional 510(k) clearances or premarket approvals 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 our devices in the past, such as changes to the SomaSensor, and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals |
| 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 devices, which could harm our operating results and require us to redesign our products |
| 24 _________________________________________________________________ [54]Table of Contents If we fail to comply with the FDA’s Quality System Regulation, our manufacturing operations could be halted, and our business would suffer |
| We are currently required to demonstrate and maintain compliance with the FDA’s Quality System Regulation, or QSR The QSR is a complex regulatory scheme that covers the methods and documentation of the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products |
| The FDA enforces the QSR through periodic unannounced inspections |
| We have been, and anticipate in the future being, subject to such inspections |
| Our failure to comply with the QSR or to take satisfactory corrective action in response to an adverse QSR inspection could result in enforcement actions, including a public warning letter, a shutdown of or restrictions on our manufacturing operations, delays in approving or clearing a product, refusal to permit the import or export of our products, a recall or seizure of our products, fines, injunctions, civil or criminal penalties, or other sanctions, any of which could cause our business and operating results to suffer |
| Failure to obtain or maintain regulatory approval in foreign jurisdictions would prevent us from marketing our products abroad |
| We market our products through distributors in foreign markets |
| In order to market our products in the European Community and many other foreign jurisdictions, we must obtain separate regulatory approvals |
| We depend on our distributors to obtain and maintain certain of these regulatory approvals |
| The approval procedure varies among countries and can involve additional requirements and testing, and the time required to obtain approval may differ from that required to obtain FDA clearance |
| The foreign regulatory approval process may include all of the risks associated with obtaining FDA clearance in addition to other risks |
| Our distributors might not be able to obtain or maintain foreign approvals on a timely basis or at all |
| Clearance by the FDA does not ensure approval by regulatory authorities in other countries, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or approval or clearance by the FDA Failure to obtain or maintain regulatory approval in foreign jurisdictions would prevent us from marketing our products abroad |
| Federal regulatory reforms may adversely affect our ability to sell our products profitably |
| From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing clearance or approval, manufacture and marketing of a device |
| In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products |
| We cannot predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be |
| Changes in our actual or estimated future taxable income could change the value of our deferred tax asset, potentially resulting in a decrease in net income, which could adversely affect the price of our common shares |
| We have recognized deferred tax assets relating to the expected future benefits of our net operating loss carryforwards |
| Our assessment of our deferred tax assets, and the reversal of part of our valuation allowance relating to those assets in fiscal 2005 and 2004, included assuming that our net revenues and pre-tax income will grow in future years consistent with the growth guidance given for fiscal 2006 and making allowance for the uncertainties surrounding, among things, our future rate of growth in net revenues, the rate of adoption of our products in the marketplace, and the potential for competition to enter the marketplace |
| Given the assumptions inherent in our financial plans, it is possible to calculate a different value for our deferred tax assets by changing one or more of the variables in our assessment |
| In addition, changes in our actual or estimated future taxable income could change the value of our deferred tax asset, potentially resulting in a decrease in net income, which could adversely affect the price of our common shares |
| New stock option accounting rules will increase our reported expenses, which could adversely affect the price of our common shares |
| Effective December 1, 2005, we became subject to new stock option accounting rules that require that compensation costs related to share-based payment transactions, including stock options, stock appreciation rights 25 _________________________________________________________________ [55]Table of Contents and restricted stock, be recognized in our financial statements |
| Previously, we accounted for stock-based compensation of employees using the intrinsic value method, which resulted in no compensation expense charged against income for stock option grants to employees for fiscal 2005, 2004 or 2003 |
| In addition, in November 2005, we accelerated the vesting of all unvested stock options to eliminate compensation expense that we would otherwise have recognized in our results of operations after the adoption of the new stock option accounting rules when those options would have otherwise vested |
| Future grants of options, however, will require us to recognize compensation expense in our income statement, increasing our reported expenses for the same activities, which could adversely affect the price of our common shares |
| The lengthy sales cycle for the INVOS System could cause variability in our operating results |
| The decision-making process for our INVOS System customers is often complex and time-consuming |
| We believe the period between initial discussions with a potential customer and a sale of even one unit is typically approximately six to nine months |
| The process can be delayed as a result of hospital capital budgeting procedures |
| These delays could have an adverse effect on our business, financial condition and results of operations and cause variability in our operating results from quarter to quarter, which could cause fluctuations in the trading price of our common shares |
| If we are unable to obtain or maintain intellectual property rights relating to our technology and products, the commercial value of our technology and products will be adversely affected and our competitive position could be harmed |
| Our success and ability to compete depends in part upon our ability to obtain protection in the United States and other countries for our products by establishing and maintaining intellectual property rights relating to or incorporated into our technology and products |
| We own or license a variety of patents and patent applications in the United States and corresponding patents and patent applications in certain foreign jurisdictions |
| Pending and future patent applications owned or licensed by us may not issue as patents or, if issued, may not issue in a form that will be commercially advantageous to us |
| Even if issued, patents may be challenged, narrowed, invalidated or circumvented, which could limit our ability to stop competitors from marketing similar products or limit the length of term of patent protection we may have for our products |
| In addition, already issued patents owned or licensed by us may not be valid or enforceable |
| Further, even if valid and enforceable, these already issued patents may not be sufficiently broad to prevent others from marketing competitive products, despite our patent rights |
| Changes in either patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection |
| For example, one of our significant patents is the subject of a reissue proceeding in the US Patent and Trademark Office |
| Our reissue application was filed for the sole purpose of seeking to broaden certain claims |
| We cannot predict the outcome of this proceeding, which may result in some or all of the claims being broadened, narrowed or rejected |
| Another of our patents may be expired for ultimately claiming priority to a patent that was filed more than 20 years ago |
| We believe that this patent does not have a claim of priority that extends back for more than 20 years, and that the patent is still extant and will expire on March 29, 2009 |
| However, there is a risk that a court might find that the earliest effective filing date for this patent is more than 20 years ago, and rule that this patent is expired and unenforceable |
| The validity of our patent claims depends, in part, on whether prior art references disclosed or rendered obvious our inventions as of the filing date of our patent applications |
| We may not have identified all prior art, such as US and foreign patents or published applications or published scientific literature, that could adversely affect the validity of our issued patents or the patentability of our pending patent applications |
| For example, patent applications in the United States are maintained in confidence for up to 18 months after their filing |
| In some cases, however, patent applications remain confidential in the US Patent and Trademark Office for the entire time prior to issuance as a US patent |
| Patent applications filed in countries outside the United States are also not typically published until at least 18 months from their first filing date |
| Similarly, publication of discoveries in the scientific or patent literature often lags behind actual discoveries |
| 26 _________________________________________________________________ [56]Table of Contents We may initiate litigation to enforce our patent rights, which may prompt our adversaries in such litigation to challenge the validity, scope or enforceability of our patents |
| If a court decides that our patents are not valid, not enforceable or of a limited scope, we will not have the right to stop others from using our inventions |
| The outcome of litigation to enforce our patent rights is subject to substantial uncertainties, especially in medical device-related patent cases that may, for example, turn on the interpretation of patent claim language by the court which may not be to our advantage, and also the testimony of experts as to technical facts upon which experts may reasonably disagree |
| Our involvement in such intellectual property litigation could result in significant expense |
| We also cannot be certain that we were the first to invent, or the first to file patent applications relating to, our cerebral oximeter technologies |
| In the event that a third party has also filed a US patent application covering our cerebral oximeter devices, the sensors used with these devices, or a similar invention, we may have to participate in an adversarial proceeding known as an interference, which is declared by the US Patent and Trademark Office to determine priority of invention in the United States |
| It is possible that we may be unsuccessful in the interference, resulting in a loss of some or all of our US patent claims |
| We may also face similar proceedings outside the United States, including oppositions, to determine priority of invention or patentability |
| Even if we are successful in these proceedings, we may incur substantial costs, and the time and attention of our management and scientific personnel will be diverted in pursuit of these proceedings |
| Moreover, the laws of some foreign jurisdictions may not protect intellectual property rights to the same extent as in the United States, and many companies have encountered significant difficulties in protecting and defending such rights in foreign jurisdictions |
| If we encounter such difficulties or we are otherwise precluded from effectively protecting our intellectual property rights in foreign jurisdictions, we may incur substantial costs and our business prospects could be substantially harmed |
| We rely on trade secret and copyright protection to protect our interests in proprietary information and know-how, and for processes for which patents are undesirable to obtain or are difficult to obtain or enforce |
| We may not be able to protect our trade secrets or copyrights adequately |
| For example, none of our copyrights have been registered with the US Copyright Office, which limits our ability to sue for and collect damages from third party infringers |
| In addition, we rely on non-disclosure and confidentiality agreements with employees, consultants and other parties to protect, in part, trade secrets and other proprietary technology |
| These agreements may be breached, and we may not have adequate remedies for any breach |
| Moreover, others may independently develop equivalent proprietary information, and third parties may otherwise gain access to our trade secrets and proprietary knowledge |
| Any disclosure of confidential data into the public domain or to third parties could allow our competitors to learn our trade secrets and use the information in competition against us |
| If we are found to infringe or are alleged to infringe any third party intellectual property rights, then our business may be adversely affected |
| There are numerous US and foreign issued patents and pending patent applications owned by third parties with patent claims in the field of tissue or organic matter oximetry, including cerebral oximetry and areas that are the focus of our product development efforts |
| We are aware of patents owned by third parties, to which we do not have licenses, that relate to, among other things, optical spectroscopy and the interaction of light with tissue and optical spectroscopy in the area of brain metabolism |
| For example, possible competitors own patents that are directed to the non-invasive determination of blood oxygen saturation levels with a near infra-red spectrophotometric sensor and to an apparatus for measuring oxygen saturation in blood using two different wavelengths of light |
| There may be other patents in addition to those of which we are aware that relate to aspects of our technology and that may materially and adversely affect our business |
| Moreover, because patent applications can take many years to issue, there may be currently pending applications, unknown to us, which may later result in issued patents that pose a material risk to us |
| We may pose a threat to companies who own or control patents relating to cerebral oximetry systems or their components, or to the manufacture and use of such systems, and one or more third parties may file a lawsuit asserting a patent infringement claim against the manufacture, use or sale of the INVOS System based on one or more of these patents |
| We are not aware of any infringement of the claims of any issued patents by our products, and no charge of patent infringement has been asserted against us |
| However, potential competitors would have more 27 _________________________________________________________________ [57]Table of Contents incentive to assert infringement claims or challenge our patents if a more significant market for the INVOS System develops |
| Whether the manufacture, sale or use of the INVOS System, or whether any products under development would, upon commercialization, infringe any patent claim will not be known with certainty unless and until a court interprets the patent claim in the context of litigation |
| If an infringement allegation is made against us, we may seek to invalidate the asserted patent claim and/or to allege non-infringement of the asserted patent claim |
| In order for us to invalidate a US patent claim, we would need to rebut the presumption of validity afforded to issued patents in the United States with clear and convincing evidence of invalidity, which is a high burden of proof |
| The outcome of infringement litigation is subject to substantial uncertainties, especially in medical device-related patent cases that may, for example, turn on the interpretation of patent claim language by the court which may not be to our advantage, and also the testimony of experts as to technical facts upon which experts may reasonably disagree |
| Our defense of an infringement litigation lawsuit could result in significant expense |
| Regardless of the outcome, infringement litigation could significantly disrupt our marketing, development and commercialization efforts, divert our management’s attention and quickly consume our financial resources |
| In the event that we are found to infringe any valid claim in a patent held by a third party, we may, among other things, be required to: • pay damages, including up to treble damages and the other party’s attorneys’ fees, which may be substantial; • cease the development, manufacture, importation, use and sale of products that infringe the patent rights of others, including our INVOS System, through a court-imposed sanction called an injunction; • expend significant resources to redesign our technology so that it does not infringe others’ patent rights, or to develop or acquire non-infringing intellectual property, which may not be possible; • discontinue manufacturing or other processes incorporating infringing technology; and/or • obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all |
| Any development or acquisition of non-infringing products or technology or licenses could require the expenditure of substantial time and other resources and could have a material adverse effect on our business and financial results |
| If we are required to, but cannot, obtain a license to valid patent rights held by a third party, we would likely be prevented from commercializing the relevant product, or from further manufacture, sale or use of the relevant product |
| If we need to redesign products to avoid third-party patents, we may suffer significant regulatory delays associated with conducting additional studies or submitting technical, manufacturing or other information related to the redesigned product and, ultimately, in obtaining approval |
| While our products are in clinical trials, and prior to commercialization, we believe our activities in the United States related to the submission of data to the FDA fall within the scope of the exemptions that cover activities related to developing information for submission to the FDA and fall under general investigational use or similar laws in other countries |
| However, the US exemptions would not cover the manufacturing, sale or use of products which are no longer in clinical trials, or other activities in the United States that support overseas clinical trials if those activities are not also reasonably related to developing information for submission to the FDA In any event, the fact that no third party has asserted a patent infringement claim against us to date should not be taken as an indication, or a level of comfort, that a patent infringement claim will not be asserted against us prior to or upon commercialization |
| Some of our agreements, including our distribution and sales representative agreements require us to indemnify the other party in certain circumstances where our products have been found to infringe a patent or other proprietary rights of others |
| An indemnification claim against us may require us to pay substantial sums to the indemnified party, including its attorneys’ fees |
| 28 _________________________________________________________________ [58]Table of Contents Our success depends on our ability to attract and retain key personnel |
| Our future performance depends in significant part on the continued service of our senior management, including Bruce J Barrett, our President and Chief Executive Officer, and various scientific, technical and manufacturing personnel |
| Our loss of any of these key personnel could have an adverse effect on us |
| We do not maintain key-man life insurance on any of our key personnel, and our employment agreement with Mr |
| In addition, competition for qualified employees is intense, and if we are unable to attract, retain and motivate additional, highly-skilled employees required for the expansion of our operations, our business, financial condition and results of operations could be adversely affected |
| We cannot assure you that we will be able to retain our existing personnel or attract additional, qualified persons when required and on acceptable terms |
| Any acquisitions that we make could disrupt our business and harm our financial condition |
| From time to time, we evaluate potential strategic acquisitions of complementary businesses, products or technologies, as well as consider joint ventures and other collaborative projects |
| We may not be able to identify appropriate acquisition candidates or strategic partners, or successfully negotiate, finance or integrate any businesses, products or technologies that we acquire |
| We do not have any experience with acquiring companies or products, other than the CorRestore System |
| Any acquisition we pursue could diminish our cash otherwise available to us for other uses or be dilutive to our shareholders, and could divert management’s time and resources from our core operations |
| We have had limited success in marketing the CorRestore System, which could result in claims against us |
| Since we acquired rights in the CorRestore System in 2000, we have had limited success in marketing the system |
| The CorRestore system competes against existing patches also used for cardiac reconstruction and repair that are significantly less expensive and at least one study indicates are effective |
| We also compete against alternative methods of treating congestive heart failure |
| Surgical Ventricular Restoration, or SVR, is in the early stages of its development and will likely require significant clinical studies before it is widely accepted |
| There are many larger companies in this industry that have significantly larger research and development budgets than ours |
| Competitors may be able to develop additional or better treatments for congestive heart failure and may be able to take advantage of the significant time and effort we have invested to gain medical acceptance of SVR surgeries |
| We are dependent on a third party to manufacture the CorRestore System |
| Our license agreement limits the parties that we may engage |
| The ultimate success of our CorRestore business is dependent on our ability to manage the manufacturer of the CorRestore System |
| If we are unsuccessful in managing the manufacturer of the CorRestore System, our business could be adversely affected |
| We entered into a license agreement with respect to the CorRestore System in 2002 |
| Although we believe we have complied with our obligations under the license agreement, our limited success in marketing the CorRestore System could result in claims against us |
| As part of the compensation for the acquisition of our CorRestore licenses, we issued five-year warrants to purchase an aggregate of 2cmam100cmam000 common shares at dlra3dtta00 per share, exercisable based on our cumulative net sales of the CorRestore System products |
| We do not expect the sales requirements for exercise of these warrants to be met before the November 2006 expiration date of these warrants |
| Expiration of these warrants before they become exercisable could cause the holders of these warrants to make claims against us under the license agreement |
| If we are required to pay any significant amounts to defend or as a result of any such claims, our results of operations would be adversely affected |
| Risks Relating to Our Common Shares If we were to complete a public offering, we would have broad discretion to determine how to allocate the net proceeds of that offering and may not use them effectively |
| If we were to complete a public offering of common shares, we would intend to use the net proceeds of that offering primarily to expand our direct sales team and other sales and marketing activities, sponsor additional clinical trials and expand our 29 _________________________________________________________________ [59]Table of Contents research and development efforts and for working capital and general corporate purposes |
| A significant portion of the net proceeds of any such offering would be allocated to working capital and general corporate purposes |
| We would be raising money for these purposes to strengthen our balance sheet and provide us with greater flexibility in implementing our business plans and responding to future business conditions and opportunities |
| We would retain broad discretion to determine how to allocate the net proceeds of our proposed public offering of common shares and the timing of the payments |
| If we fail to apply these funds effectively, the failure could result in financial losses that could have a material adverse effect on our business and cause the price of our common shares to decline |
| Pending the application of such potential proceeds, we intend to keep sufficient net proceeds of sales of common shares in cash and bank accounts to avoid becoming an inadvertent investment company subject to regulation under the Investment Company Act of 1940 |
| The remaining proceeds would be expected to be invested in short-term, US government or other investment grade, interest-bearing investments |
| These restrictions on our investments might limit the income otherwise available from investing these funds, lowering our income and potentially decreasing our earnings and the price of our common shares |
| Provisions of our corporate charter documents and Michigan law may delay or prevent attempts by our shareholders to change our management and hinder efforts to acquire a controlling interest in us |
| Our board of directors has the authority, without further approval of our shareholders, to issue preferred shares having such rights, preferences and privileges as the board may determine |
| Any such issuance of preferred shares could, under some circumstances, have the effect of delaying or preventing a change in control of us and might adversely affect the rights of holders of common shares |
| In addition, we are subject to Michigan statutes regulating business combinations, takeovers and control share acquisitions, which might also hinder or delay a change in control of our company |
| Anti-takeover provisions that could be included in the preferred shares when issued and the Michigan statutes regulating business combinations, takeovers and control share acquisitions can depress the market price of our securities and can limit the shareholders’ ability to receive a premium on their shares by discouraging takeover and tender offer bids, even if such events could be viewed as beneficial by our shareholders |
| Our directors serve staggered three-year terms, and directors may be removed only for cause by a vote of the holders of a majority of the shares entitled to vote at an election of directors |
| Our Restated Articles of Incorporation also set the minimum number of directors constituting the entire board at three and the maximum at fifteen, and they require approval of holders of 90 percent of our voting shares to amend these provisions |
| Our bylaws contain procedures, including notice requirements, for nominating persons for election to our board of directors |
| These provisions could have an anti-takeover effect by making it more difficult to acquire our company by means of a tender offer, a proxy contest or otherwise or by removing incumbent officers and directors |
| These provisions could delay, deter or prevent a tender offer or takeover attempt that a shareholder might consider in his or her best interests, including those attempts that might result in a premium over the market price for the common shares held by our shareholders |
| The market price of our common shares has been volatile and may continue to remain so |
| The market price of our common shares has been highly volatile |
| The following could cause the market price of the common shares to continue to fluctuate substantially: • changes in our quarterly financial condition or operating results; • changes in general conditions in the economy; • changes in the financial markets; • changes in the medical equipment industry; • changes in financial estimates by securities analysts or differences between those estimates and our actual results; • the liquidity of the market for the common shares; • developments with respect to patents and proprietary rights; • publication of clinical research results regarding our products; 30 _________________________________________________________________ [60]Table of Contents • changes in health care policies in the United States or foreign countries; • grants or exercises of stock options or warrants; • news announcements; • litigation involving us; • actions by governmental agencies, including the FDA, or changes in regulations; and • other developments affecting us or our competitors |
| In particular, the stock market might experience significant price and volume fluctuations that might affect the market price of the common shares for reasons that are unrelated to our operating performance and that are beyond our control |
| We have never paid cash dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future |
| We have never paid cash dividends on our common shares and do not expect to pay dividends in the foreseeable future |
| We currently intend to retain any future earnings for use in our business |
| The payment of any future dividends will be determined by the board in light of the conditions then existing, including our financial condition and requirements, future prospects, restrictions in financing agreements, business conditions and other factors deemed relevant by the board |
| As a result, capital appreciation, if any, of our common shares will be your sole source of gain for the foreseeable future |
| The market price of the common shares might be lower because of shares eligible for future sale and shares reserved for future issuance upon the exercise of options and warrants we have granted |
| Future sales of substantial amounts of common shares in the public market or the perception that such sales could occur could adversely affect the market price of the common shares |
| Any substantial sale of common shares or even the possibility of such sales occurring may have an adverse effect on the market price of the common shares |
| We have outstanding options and warrants to purchase an aggregate of 4cmam014cmam232 common shares |
| We have also reserved up to an additional 505cmam785 common shares for issuance upon exercises of options or awards of restricted stock or restricted stock units which have not yet been granted or awarded under our stock incentive plans |
| We have effective registration statements for the shares underlying these options and stock awards |
| Therefore, except for volume limitations imposed by Securities and Exchange Commission Rule 144, these shares are freely tradeable |
| The market price of our common shares could fall if the holders of these shares sell them or are perceived by the market as intending to sell them |
| Forward-Looking Statements Some of the statements in this report are forward-looking statements |
| These forward-looking statements include statements relating to our performance in the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” and elsewhere in this report |
| Forward-looking statements include statements regarding the intent, belief or current expectations of us or our management, including statements preceded by, followed by or including forward-looking terminology such as “may,” “will,” “should,” “believe,” “expect,” “anticipate,” “plan,” “intend,” “propose,” “estimate,” “continue,” “predict” or similar expressions, with respect to various matters |
| These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements |
| We discuss 31 _________________________________________________________________ [61]Table of Contents many of these risks, uncertainties and other factors in this report in greater detail under the heading “Risk Factors |
| ” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements |
| Also, these forward-looking statements represent our estimates and assumptions only as of the date of this report |
| You should read this report and the documents that we have filed as exhibits and incorporated by reference to this report completely and with the understanding that our actual future results may be materially different from what we expect |
| We hereby qualify all of our forward-looking statements by these cautionary statements |
| All forward-looking statements in this report are based on information available to us on the date of this report |