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CRDC > SEC Filings for CRDC > Form 10-K on 25-Sep-2013All Recent SEC Filings

Show all filings for CARDICA INC

Form 10-K for CARDICA INC


25-Sep-2013

Annual Report


Item 7. 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 in conjunction with our financial statements and the related notes to those statements included elsewhere in this report. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results and timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under "Risk Factors" and elsewhere in this Report.


Overview

Historically, our business focused on the design, manufacture and marketing of proprietary automated anastomotic systems used by cardiac surgeons to perform coronary bypass surgery. We have expanded and refocused our business by emphasizing the development of a laparoscopic microcutter product line intended for use by thoracic, bariatric, colorectal and general surgeons.

We are developing our microcutter product line based on our proprietary "staple-on-a-strip" technology, which expands our commercial opportunity into additional surgical markets. Our planned microcutter product line consists of the MicroCutter XCHANGE™ 30, a cartridge based microcutter device with a 5 millimeter shaft diameter and a 30 millimeter staple line, the MicroCutter XCHANGE™ 45, a planned cartridge based microcutter device with a 8 millimeter shaft and a 45 millimeter staple line, the MicroCutter XPRESS™ 30, a true multi-fire endolinear stapling device, the MicroCutter FLEXCHANGE™ 30, a planned cartridge based microcutter device with a flexible shaft to facilitate endoscopic procedures requiring cutting and stapling, the MicroCutter XPRESS™ 45, a planned multi-fire endolinear microcutter device with a 45 millimeter staple line, and the MicroCutter XPRESS™ 60, a planned cutting and stapling device specifically designed for the bariatric and thoracic surgery markets. We estimate these planned devices expand our commercial opportunity to approximately 1.4 million additional procedures annually in the United States, involving, we estimate, over 4 million staple cartridge deployments, 3 million of which we believe are deployed in laparoscopic procedures.

In March 2012, we completed the design verification for and applied Conformité Européenne, or the CE Mark, to the MicroCutter XCHANGE™ 30. We believe that the MicroCutter XCHANGE 30 is and will be differentiated in the market compared to currently marketed staplers due to its significantly reduced size and ability to articulate up to 80 degrees. We intend to expand our microcutter product line with the development of the MicroCutter XCHANGE 45, but, in light of our limited financial resources, we have limited the development of other potential products in our planned microcutter product line.

We initiated first-in-man use of the MicroCutter XCHANGE 30, with the CE Mark, in Europe in March 2012, and began enrollment in a clinical trial of our MicroCutter XCHANGE 30 in July 2012. We completed enrollment with 160 patients in May 2013, with a 30 day follow up as outlined in the clinical trial protocol. As part of our controlled commercial launch, on December 26, 2012, we made our first shipment to our distributor in Europe.

To date, we generated revenues almost exclusively from the sale of automated anastomotic systems, and have generated minimal revenues from the commercial sales of the MicroCutter XCHANGE 30, as it was only introduced to the European market in December 2012.

We were advised by the U.S. Food and Drug Administration, or FDA, that the FDA will require clinical data related to the staple design used as part of a 510(k) submission for clearance of the products in our planned microcutter product line for marketing and sale in the United States. We submitted a 510(k) with clinical data of the MicroCutter XCHANGE 30 to the FDA on August 16, 2013, and received an acceptance review notification from the FDA on September 3, 2013, which indicated that the 510(k) submission contains all of the necessary elements and information needed to proceed with the substantive review. While we cannot predict when or if the FDA will clear our 510(k) submission of the MicroCutter XCHANGE 30 or what the scope of that clearance will cover, we anticipate that the earliest that any such clearance could be obtained would be in the first half of calendar 2014. In addition, our exclusive distributor in Japan, Century Medical, Inc., or Century, recently filed for regulatory approval of our MicroCutter XCHANGE 30 cartridge with the Pharmaceuticals and Medical Devices Agency in Japan and anticipates launching our MicroCutter XCHANGE 30 in Japan during 2014.

Our C-Port® Distal Anastomosis Systems, or C-Port systems, are sold in the United States and Europe. The C-Port systems are used to perform a distal anastomosis, which is the connection between a bypass graft vessel and the target coronary artery. As of June 30, 2013, more than 13,800 C-Port systems had been sold in the United States and Europe. We also currently sell our PAS-Port® Proximal Anastomosis System, or PAS-Port system, in the United States, Europe and Japan. The PAS-Port system is used to perform a proximal anastomosis, which is the connection of a bypass graft vessel to the aorta or other source of blood. As of June 30, 2013, more than 32,600 PAS-Port systems had been sold in the United States, Europe and Japan.

We use independent distributors and manufacturers' representatives to augment a small core direct sales team for our C-Port systems and PAS-Port system in the United States to contain sales costs while continuing to serve our customers and potential customers for our automated anastomosis product line.

We manufacture our cardiac and microcutter products with parts we manufacture and components supplied by vendors, which we then assemble, test and package.

Since our inception, we have incurred significant net losses, and we expect to continue to incur net losses for the foreseeable future. We have not generated significant revenues from sales of any of the microcutter products that we are developing. For the fiscal year ended June 30, 2013, we generated net revenue of $3.5 million, including $0.2 million from commercial sales of the MicroCutter XCHANGE 30, $0.3 million of license and development revenue, and incurred a net loss of $16.1 million. To date, our C-Port and PAS-Port systems have had limited commercial adoption, and sales have not met the levels that we had anticipated. Revenues from product sales and milestone payments were not sufficient to support the operation of our business as we had planned. If we fail to obtain broader commercial adoption of our systems or achieve commercial adoption of our microcutter products, we may be required to delay, further reduce the scope of or eliminate our commercialization efforts with respect to one or more of our products or one or more of our research and development programs.


On March 20, 2013, we completed the sale of 14,251,368 shares of our common stock at a price to the public of $1.05 per share. Net proceeds from the financing to us were $14.0 million. As of June 30, 2013, we had approximately $12.4 million of cash, cash equivalents and short-term investments and $4.0 million of debt principal outstanding. We believe that our existing cash, cash equivalents and short-term investments, together with the cash that we expect to generate from sales, will be sufficient to meet our anticipated cash needs to enable us to conduct our business substantially as currently conducted through February 28, 2014, excluding the repayment of $4.0 million debt principal outstanding. We would be able to extend this time period to the extent that we decreased our planned expenditures, or raise additional capital. Our independent registered public accounting firm has indicated in their audit report on our fiscal 2013 financial statements that our recurring losses from operations raise substantial doubt about our ability to continue as a going concern. We have based our estimate as to the sufficiency of our cash resources on assumptions that may prove to be wrong, including assumptions with respect to the level of revenue from product sales and the cost of product development, and we could exhaust our available financial resources sooner than we currently expect. The sufficiency of our current cash resources and our need for additional capital, and the timing thereof, will depend on many factors, including the extent of our ongoing research and development programs and related costs, including costs related to the continued development of the MicroCutter XCHANGE 30, the MicroCutter XCHANGE 45 and additional products in our planned microcutter product line, our ability to enter into additional license, development and/or collaboration agreements with respect to our technology, and the terms thereof, market acceptance and adoption of our current products or future products that we may commercialize, our level of revenues, costs associated with our sales and marketing initiatives and manufacturing activities, costs and timing of obtaining and maintaining FDA, and other regulatory clearances or approvals for our products and potential additional products, securing, maintaining and enforcing intellectual property rights and the costs thereof, and the effects of competing technological and market developments.

We may seek to sell additional equity or debt securities, obtain a credit facility, enter into product development, license or distribution agreements with third parties or divest one or more of our commercialized products or products in development. The sale of additional equity or convertible debt securities could result in significant dilution to our stockholders, particularly in light of the prices at which our common stock has been recently trading. In addition, if we raise additional funds through the sale of equity securities, new investors could have rights superior to our existing stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any product development, licensing, distribution or sale agreements that we enter into may require us to relinquish valuable rights, including with respect to commercialized products or products in development that we would otherwise seek to commercialize or develop ourselves. We may not be able to obtain sufficient additional financing or enter into a strategic transaction in a timely manner. Our need to raise capital may require us to accept terms that may harm our business or be disadvantageous to our current stockholders.

Agreement with Century

On September 2, 2011, we signed a distribution agreement, or the Distribution Agreement, with Century with respect to distribution of our planned microcutter products in Japan. Under the terms of a secured note purchase agreement, Century agreed to loan us an aggregate of up to $4.0 million, with principal due on September 30, 2016, under the agreement, subject to certain conditions. Under this facility, we received $2.0 million on September 30, 2011, and the remaining $2.0 million on December 27, 2011. The note bears 5% annual interest which is payable quarterly in arrears on the last business day of March, June, September and December of each year through September 30, 2016, the maturity date when the total $4.0 million of principal becomes due . In return for the loan commitment, we granted Century distribution rights to our planned microcutter product line in Japan, and a right of first negotiation for distribution rights in Japan to future products. Century will be responsible for securing regulatory approval from the Ministry of Health in Japan for the microcutter product line. After approval for marketing in Japan, we would sell microcutter units to Century, who would then sell the microcutter devices to their customers in Japan. Century recently filed for regulatory approval of our MicroCutter XCHANGE 30 cartridge with the Pharmaceuticals and Medical Devices Agency in Japan and anticipates launching our MicroCutter XCHANGE 30 in Japan during 2014.

Proceeds from the note and granting the distribution rights were allocated to the note based on their aggregate fair value of $2.4 million at the dates of receipt. This fair value was determined by discounting cash flows using a discount rate of 18%, which we estimated was a market rate of borrowing that could be obtained by companies with credit risk similar to ours. The remainder of the proceeds of $1.6 million was recognized as debt issuance discount and was allocated to the value of the distribution rights granted to Century under the Distribution Agreement and is included in deferred revenue. The deferred revenue will be recognized on a straight-line basis over the term of the Distribution Agreement, beginning upon the first sale by Century of microcutter products in Japan.


Agreements with Intuitive Surgical

On August 16, 2010, we entered into a license agreement, or License Agreement, with Intuitive Surgical Operations, Inc., or Intuitive Surgical, pursuant to which we granted to Intuitive Surgical a worldwide, sublicenseable, exclusive license to use our intellectual property in the robotics field in diagnostic or therapeutic medical procedures, but excluding vascular anastomosis applications, for an upfront license fee of $9.0 million. We are also eligible to receive a contingent payment if sales of any products incorporating our patent rights achieve a specified level of net sales within a specified period after the date of the License Agreement, as well as single-digit royalties on sales by Intuitive Surgical, its affiliates or its sublicensees of specified stapler and clip applier products covered by our patent rights as well as on sales of certain other products covered by our patent rights that may be developed in the future, if any. Each party has the right to terminate the License Agreement in the event of the other party's uncured material breach or bankruptcy. Following any termination of the License Agreement, the licenses granted to Intuitive Surgical will continue, and, except in the case of termination for our uncured material breach or insolvency, Intuitive Surgical's payment obligations will continue as well. Under the License Agreement, Intuitive Surgical has rights to improvements in our technology and intellectual property over a specified period of time.

In addition, on the same date, we entered into a stock purchase agreement with Intuitive Surgical pursuant to which Intuitive Surgical paid $3.0 million to purchase from us an aggregate of 1,249,541 shares of our common stock, or the Stock Issuance. The net proceeds recorded to stockholders' equity based upon the fair value of our common stock on August 16, 2010, were approximately $2.0 million after offering expenses. From the premium paid of $1.0 million and the upfront license fee payment of $9.0 million, $0.3 million have been recorded as license and development revenue for the fiscal years ended June 30, 2013 and 2012, and $41,000 has been recorded as deferred revenue as of June 30, 2013. There were no underwriters or placement agents involved with the Stock Issuance, and no underwriting discounts or commissions or similar fees were payable in connection with the Stock Issuance.

Agreement with Aspire Capital

Subject to the terms and conditions of the Purchase Agreement with Aspire Capital, we had a right to sell to Aspire Capital pursuant to the Purchase Agreement up to $10.0 million of our common stock at a maximum of 300,000 shares per day based on the trading price of our common stock. In consideration for entering into the Purchase Agreement, concurrently with the execution of the Purchase Agreement, we issued to Aspire Capital 295,567 shares of our common stock as a commitment fee, or the Commitment Shares. The Purchase Agreement terminated on February 10, 2013, and 166,759 shares of the our common stock issued pursuant to the Purchase Agreement were returned to us as the maximum numbers of shares available under the Purchase Agreement were not sold to Aspire. Based on the quoted price, the shares were valued at $1.38 per share, or $0.2 million. We are no longer entitled to sell any further shares of our common stock to Aspire Capital under the Purchase Agreement. Through the termination date, a total of 1,478,808 shares of common stock (including the 128,808 Commitment Shares) had been issued to Aspire Capital pursuant to the Purchase Agreement and $4.4 million of capital had been raised through the sale of 1,350,000 shares of common stock at an average price of $3.23 per share. During the fiscal year ended June 30, 2013, we did not issue any shares under the Purchase Agreement.

Agreement with MLV

Subject to the terms and conditions of the ATM Agreement, we may issue and sell up to $10.0 million of our common stock through MLV as our sales agent. The extent to which we rely on sales of common stock under the ATM Agreement as a source of funding will depend on a number of factors, including the prevailing market price of our common stock and the extent to which we are able to secure working capital from other sources. The ATM Agreement provides that the offering of shares of our common stock pursuant to the ATM Agreement will terminate upon the earlier of (1) the sale of all common stock subject to the ATM Agreement,
(2) August 2, 2014, and (3) termination of the ATM Agreement. As of June 30, 2013, we received net proceeds of $0.8 million from the sale of an aggregate of 445,593 shares of common stock through MLV. We are subject to limitations on the amount that we may sell under our shelf registration statement, and therefore that we may sell pursuant to the ATM Agreement.

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, or GAAP. The preparation of our financial statements requires management to make estimates and assumptions that affect the amounts reported in our financial statements and accompanying notes. Actual results could differ materially from those estimates.

We believe that the following critical accounting policies are the most critical to an understanding of our financial statements because they require us to make significant judgments and estimates that are used in the preparation of our financial statements.


Revenue Recognition. We recognize revenue when four basic criteria are met: (1) persuasive evidence of an arrangement exists; (2) title has transferred; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. We generally use contracts and customer purchase orders to determine the existence of an arrangement. We use shipping documents and third-party proof of delivery to verify that title has transferred. We assess whether the fee is fixed or determinable based upon the terms of the agreement associated with the transaction. To determine whether collection is probable, we assess a number of factors, including past transaction history with the customer and the creditworthiness of the customer. If we determine that collection is not reasonably assured, then the recognition of revenue is deferred until collection becomes reasonably assured, which is generally upon receipt of payment.

We record product sales net of estimated product returns and discounts from the list prices for our products. The amounts of product returns and the discount amounts have not been material to date.

Payments that are contingent upon the achievement of a substantive milestone are recognized in their entirety in the period in which the milestone is achieved subject to satisfaction of all revenue recognition criteria at that time. Revenue generated from license fees and performing development services are recognized when they are earned and non-refundable upon receipt, over the period of performance, or upon incurrence of the related development expenses in accordance with contractual terms, based on the actual costs incurred to date plus overhead costs for certain project activities. Amounts paid but not yet earned on the project are recorded as deferred revenue until such time as performance is rendered or the related development expenses are incurred.

When a sale combines multiple elements upon performance of multiple services, we allocate revenue for transactions that include multiple elements to each unit of accounting based on its relative selling price, and recognizes revenue for each unit of accounting when the revenue recognition criteria have been met. We follow the selling price hierarchy as outlined in the guidance Revenue Recognition (ASC Topic 605) - Multiple-Deliverable Revenue Arrangements. The guidance provides a hierarchy to determine the selling price to be used for allocating revenue to deliverables: (i) vendor-specific objective evidence ("VSOE"), (ii) third-party evidence ("TPE") if available and when VSOE is not available, and (iii) best estimate of the selling price ("BESP") if neither VSOE nor TPE is available. We use BESP to determine the standalone selling price for such deliverables. We have an established process for developing BESP, which incorporates, pricing practices, historical selling prices, the effect of market conditions as well as entity-specific factors. Estimated selling price is monitored and evaluated on a regular basis to ensure that changes in circumstances are accounted for in a timely manner.

Inventory. We state our inventories at the lower of cost or market value on a first-in, first-out basis. Inventory write-downs are established when conditions indicate that the net realizable value is less than cost due to physical deterioration, usage, obsolescence, reductions in estimated future demand or reductions in selling prices. Inventory write-downs are measured as the difference between the cost of inventory and estimated net realizable value. Inventory write-downs are charged to cost of product sales and establish a lower cost basis for the inventory. We balance the need to maintain strategic inventory levels with the risk of obsolescence due to changing technology and the risk of lower customer demand levels. While we believe the current value of inventories represents all known and estimated changes in demand, we have experienced reduced demand for our C-Port systems and further unfavorable changes in market conditions may result in a need for additional inventory write-downs that could adversely impact our financial results.

Stock-Based Compensation. We account for employee and director share-based compensation plans, including stock options and restricted stock units, or RSUs, pursuant to Accounting Standards Codification, or ASC, 718 "Compensation - Stock Compensation". Stock-based compensation cost is measured on the grant date, based on fair value-based measurement of the award, and is recognized as an expense over the requisite service period.

We selected the Black-Scholes option pricing model for determining the estimated fair value-based measurements of share-based awards. The use of the Black-Scholes model requires the use of assumptions including expected term, expected volatility, risk-free interest rate and expected dividends. The expected term of options granted is determined using the "simplified" method. Under this approach, the expected term is presumed to be the mid-point between the vesting date and the end of the contractual term. The expected volatility is based on the our historical stock price. Prior to the third quarter of fiscal year 2011, since we had limited historical data on volatility of our stock, the expected volatility was based on the volatility of similar entities (referred to as "guideline" companies). In evaluating similarity, we considered factors such as industry, stage of life cycle, size, and financial leverage. The risk-free interest rate for the expected term of each option is based on a risk-free zero-coupon spot interest rate at the time of grant. We have never declared or paid any cash dividends and do not plan to pay cash dividends in the foreseeable future. Subsequent to the third quarter of fiscal year 2011, the volatility is based on our historical stock price. We estimate forfeitures in calculating the expense related to stock-based compensation. We recognize stock-based compensation expense for options and restricted stock awards using the accelerated method over the requisite service period of the award, which generally equals the vesting period of each grant. We recorded fair value-based stock-based compensation expense of $0.9 million, or $0.02 per share, $0.7 million, or $0.02 per share, and $0.6 million, or $0.02 per share, for the fiscal years ended June 30, 2013, 2012 and 2011, respectively.


Results of Operations

Comparison of Fiscal Years ended June 30, 2013 and 2012

Net Revenue. Net revenue decreased $0.2 million, or 5%, to $3.5 million in fiscal year 2013 compared to $3.7 million in fiscal year 2012.

Net product sales decreased $0.2 million, or 6%, to $3.1 million in fiscal year 2013 compared to $3.3 million in fiscal year 2012. The decrease of product sales for the fiscal year ended June 30, 2013, was primarily attributable to both lower PAS-Port and C-Port systems sales in the United States, offset in part by our MicroCutter XCHANGE 30 commercial sales of $0.2 million.

For fiscal years 2013 and 2012, sales to Century, our distributor in Japan, accounted for approximately 33% and 32%, respectively, of our total product sales.

License and development revenue was $0.3 million in both fiscal years 2013 and 2012. The license and development revenue in both years resulted from the amortization of the $1.0 million of premium from the Stock Purchase Agreement with Intuitive Surgical that we entered into in August 2010.

Cost of Product Sales. Cost of product sales consists primarily of material, labor and overhead costs. Cost of product sales decreased by $34,000, or 1%, from fiscal 2012 to fiscal 2013.

The decrease in cost of product sales in fiscal year 2013 compared to fiscal year 2012 is primarily driven by lower product revenue offset in part by higher product cost related to the introduction of the microcutter products in fiscal 2013.

Our cost of product sales was 117% and 111% of our net product sales in fiscal years 2013 and 2012, respectively, due largely to higher fixed overhead costs per unit sold in the current year due to building an infrastructure in anticipating of the foreseeable future growth and higher product cost related to the new microcutter products. We expect higher costs relative to product sales for the foreseeable future due to the planned commercialization of our microcutter product line.

Research and Development Expenses. Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical groups and the costs of clinical trials. Research and development expenses increased by $1.9 million, or 27%, to $9.1 million in fiscal year 2013 compared to $7.2 million in fiscal year 2012.

The increase in research and development expenses in fiscal year 2013 compared to fiscal year 2012 was attributable to higher salaries and benefits of $0.4 million due primarily to an increase in the number of personnel and higher bonus percentage payout based on milestone achievements, increased prototype project materials of $0.3 million, increased facility related and depreciation expenses of $0.6 million, increased in travel expenses of $0.2 million, and increased clinical trial expenses of $0.5 million all related to microcutter activities.

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