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Hansen Medical 10-K 2009
Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Form 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2008

Commission file number: 001-33151

HANSEN MEDICAL, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   14-1850535
(State of Incorporation)   (I.R.S. Employer Identification No.)

800 East Middlefield Road, Mountain View, CA 94043

(Address of Principal Executive Offices)

(650) 404-5800

(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Act:

 

Title of Class

 

Name of Exchange On Which Registered

Common stock, $0.0001 par value per share

  The NASDAQ Global Market

Securities registered under Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Exchange Act”) during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ¨    Accelerated filer x    Non-accelerated filer ¨    Smaller reporting company ¨
      (Do not check if a smaller
reporting company)
  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes  ¨    No  x

At June 30, 2008, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock as reported by the Nasdaq Global Market on that date was $267,974,550.

As of February 27, 2009, the registrant had outstanding 25,296,966 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Specified portions of the registrant’s Definitive Proxy Statement (the “Proxy Statement”), which is expected to be filed with the Commission pursuant to Regulation 14A not later than 120 days after the registrant’s fiscal year ended December 31, 2008 in connection with the registrant’s 2009 Annual Meeting of Stockholders, are incorporated by reference into Part III of this report. Except with respect to information specifically incorporated by reference in this report, the Proxy Statement is not deemed to be filed as a part hereof.

 

 

 


Table of Contents
Part I
Item 1   Business    1

Item 1A

  Risk Factors    30
Item 1B  

Unresolved Staff Comments

   56
Item 2  

Properties

   56
Item 3  

Legal Proceedings

   56
Item 4  

Submission of Matters to a Vote of Security Holders

   56
Part II
Item 5  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   57
Item 6  

Selected Financial Data

   60
Item 7  

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

   60
Item 7A  

Quantitative and Qualitative Disclosure about Market Risk

   76
Item 8  

Financial Statements and Supplementary Data

   76
Item 9  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   103
Item 9A  

Controls and Procedures

   103
Item 9B  

Other Information

   104
Part III
Item 10  

Directors, Executive Officers and Corporate Governance

   105
Item 11  

Executive Compensation

   105
Item 12  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   105
Item 13  

Certain Relationships and Related Transactions, and Director Independence

   105
Item 14  

Principal Accountant Fees and Services

   105
Part IV
Item 15  

Exhibits and Financial Statement Schedules

   106
 

Signatures

   107

We have applied for trademark registration of, and claim trademark rights in, “Artisan,” “Artisan eXtend,” “Hansen Artisan,” “Instinctive Motion,” “Fine Force Technology,” and “CoolSense.” We have obtained trademark registration in the United States for, and claim trademark rights in “Hansen Medical,” “Hansen Medical (with Heart Design),” “Heart Design (Logo),” “Sensei,” and “IntelliSense.” This report also includes other trademarks, service marks and trade names of other companies.


Table of Contents

PART I

 

ITEM 1. BUSINESS

This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements are based on our current expectations about our business and industry. In some cases, these statements may be identified by terminology such as “may,” “will”, “should,” “expects,” “could,” “intends,” “might,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. These statements involve known and unknown risks and uncertainties that may cause our results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed in this report in Item 1A “Risk Factors.” Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

We develop, manufacture and sell a new generation of medical robotics designed for accurate positioning, manipulation and stable control of catheters and catheter-based technologies. While earlier generations of medical robotics were designed primarily for manipulating rigid surgical instruments, our Sensei® Robotic Catheter System, or Sensei system, is designed to allow physicians to instinctively navigate flexible catheters with greater stability and control in interventional procedures. Instinctive navigation refers to the ability of our Sensei system to enable physicians to direct the movements of our Artisan Control Catheter, or Artisan catheter, to a desired anatomical location in a way that is natural and inherently simple. We believe our Sensei system and its corresponding disposable Artisan catheter enable physicians to perform procedures that historically have been too difficult or time consuming to accomplish routinely with existing catheters and catheter-based technologies, or that we believe could be accomplished only by the most skilled physicians. We believe that our Sensei system has the potential to benefit patients, physicians, hospitals and third-party payors by improving clinical outcomes and permitting more complex procedures to be performed interventionally.

We received CE Mark approval for our Sensei system in the fourth quarter of 2006 and made our first commercial shipments to the European Union in the first quarter of 2007. In May 2007, we received CE Mark approval for our Artisan catheter and also received U.S. Food & Drug Administration, or FDA, clearance to market and promote our Sensei system and Artisan catheter in the United States for manipulation, positioning and control of certain mapping catheters during electrophysiology, or EP, procedures. To better define the scope of our initial mapping clearance, the FDA also required that we label our products with language stating that their safety and effectiveness for use with ablation catheters have not been established in the treatment of cardiac arrhythmias including atrial fibrillation. We recognized revenue on our first system in May 2007 and, through December 31, 2008, we had shipped and recognized revenue on 55 Sensei systems worldwide, consisting of 36 in the United States and 19 in Europe. Our customers for these systems range from large university medical centers to community hospitals.

For the most part, catheters and catheter-based technologies have used blood vessels and other tubular anatomic structures as “highways” to constrain and guide their movement to specific parts of the body. However, we believe that physicians have limited ability to accurately control the working tips of these manually-controlled, hand-held instruments, which may hinder the physician’s ability to perform complex procedures that require precise navigation and stability of catheters in tortuous vessels. These issues are magnified in larger open spaces such as the atria and ventricles of the heart where the navigation of the tip of the catheter is no longer aided by vessel walls.

Our current focus is on EP procedures for the diagnosis and treatment of patients who suffer from abnormal heart rhythms, or arrhythmias, such as atrial fibrillation. Most of the procedures completed to date using our Sensei system involved mapping and ablation of cardiac tissue to treat atrial fibrillation. The use of the Sensei

 

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system and Artisan catheter in the United States for ablation procedures has been done on an off-label basis. We are currently evaluating different strategies to address this situation, including seeking FDA clearance for labeling that includes certain ablation procedures, although this may prove prohibitively costly and time-consuming. Without such clearance, this use (and any use other than manipulation, positioning and control of certain mapping catheters during EP procedures) is considered an off-label use of our products, and we are prohibited from labeling or promoting our products, or training physicians for such off-label use. Off-label use is possible because physicians are not precluded from using an FDA-cleared product in the practice of medicine beyond the scope of its cleared indications. We believe that our Sensei system will improve a physician’s ability to map the hearts of patients with cardiac arrhythmias—and to perform ablation procedures on such patients in the European Union—because of its ability to provide accurate and stable robotic control of the working tip of catheters and flexible instruments. Based on our experience with previous catheter and catheter-based procedures, the results of the procedures performed with our Sensei system and feedback from the physicians that have used our Sensei system, we believe that our Sensei system offers significant benefits over conventional catheter-based technologies.

In April 2007, we entered into a Joint Development Agreement and a Co-Marketing Agreement with the Atrial Fibrillation Division of St. Jude Medical, Inc., or St. Jude. Pursuant to this joint development agreement, we have introduced our CoHesionTM 3D Visualization Module, or CoHesion Module, which integrates our Sensei system with St. Jude’s EnSite® System. The EnSite system provides visualization and localization or detection of EP catheters in 3D space within the heart chamber. The CoHesion Module became commercially available in the European Union and in the United States in 2008. We believe that the integrated system helps physicians navigate more instinctively within the 3D cardiac space because the system combines visualization in 3D and catheter movement in 3D, which may lead to greater accuracy of movement during catheter-based EP procedures. As of December 31, 2008, 30 of the 55 systems we have shipped and recognized revenue on are configured with the CoHesion Module.

We believe our Sensei system and Artisan catheter, which are labeled and marketed for manipulation, positioning and control of certain mapping catheters during EP procedures, a critical step in the identification of the heart tissue generating abnormal heart rhythms that may require ablation or other treatment, will improve the efficacy, consistency of results and ease of performing many catheter-based interventional procedures and will enable other procedures that are not currently performed with catheter-based technologies. Our initial focus is on EP procedures for the diagnosis and treatment of patients who suffer from abnormal heart rhythms, or arrhythmias. Atrial fibrillation, which is the most common form of arrhythmia, results from abnormal electrical impulses that cause a rapid, irregular heartbeat within the upper chambers of the heart, leading to ineffective pumping of the blood through the heart, as well as complications that include a significantly increased risk of stroke. According to industry estimates, approximately five million people in the United States and the European Union alone suffer from atrial fibrillation. The vast majority of patients with atrial fibrillation require some form of treatment.

Many patients with atrial fibrillation are initially treated with drug therapies, which may cause significant side effects. Patients who are either not responsive to drug therapy or are unhappy with its side effects are candidates for catheter-based ablation treatments. However, non-robotic catheter-based approaches have significant drawbacks that we believe directly relate to the difficulty of manually controlling the catheters. These drawbacks include success rates of only approximately 75 percent and risks such as lengthy procedure times, which can lead to extensive radiation exposure for the physician and the patient. We believe that, primarily due to the limitations of non-robotic techniques, only approximately 40,000 of these procedures were performed in the United States in 2008. We believe that many of the electrophysiologists in the United States do not regularly perform these catheter-based procedures because of the difficulty of manual technique, lack of clinical data and the complexity and time-consuming nature of treating atrial fibrillation.

In addition to our development efforts in the treatment of complex atrial arrhythmias, we are also investigating other EP applications such as Ventricular tachycardia and left atrial appendage occlusion. We also

 

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believe that robotic control of flexible instruments has application to a broad range of interventional procedures. As a result, we plan to expand the uses for our technology beyond EP procedures to additional interventional applications in cardiovascular and peripheral vascular diseases. Consistent with this strategy, we have investigated the application of robotic delivery techniques to percutaneous aortic valve replacement and other structural heart applications.

Background

Over the past thirty years, one of the most significant medical trends has been the development of less traumatic or minimally invasive methods of diagnosing and treating disease. These less traumatic methods have largely fallen into two groups:

 

   

Minimally invasive surgery, which reduces the size of incisions in body walls, generally results in fewer complications, shorter hospitalization and recovery times and substantially reduced pain and suffering. These procedures generally use rigid instruments.

 

   

Interventional procedures, which minimize trauma by using blood vessels and other tubular anatomic structures such as the nose, mouth, urethra, rectum and cervix as “highways” to guide flexible instruments such as catheters to the area of treatment.

Minimally invasive surgery reduces the trauma of open surgery, and interventional procedures cause even less trauma and can reach many areas of the body that rigid-instrument robotic surgery cannot. Each year, catheter-based technologies are used for millions of interventional diagnostic and therapeutic medical procedures worldwide. However, manually-controlled hand-held catheter delivery devices, even in the hands of the most skilled specialists, have inherent instrument control limitations. In traditional interventional procedures, devices are manually manipulated by physicians, who twist and push the external ends of the instrument in an iterative process that attempts to thread the internal end of the instrument through tubular anatomic structures to a specific treatment site. Manual control of the working tip of the catheter becomes increasingly difficult as more turns are required to navigate the instrument to the treatment site. These control problems are significant in constrained tubular spaces such as blood vessels and become even more difficult in unconstrained spaces such as the atria and ventricles of the heart. In addition, while sophisticated imaging, mapping and location-sensing systems have provided visualization for interventional procedures and allowed physicians to treat more complex conditions using flexible instruments, the substantial lack of integration of these information systems requires the physician to mentally integrate and process large quantities of information from different sources in real time during an interventional procedure. These systems display data differently, requiring physicians to continuously reorient themselves to the different formats and displays as they shift their focus from one data source to the next while at the same time manually controlling an inherently difficult-to-control catheter.

In recent years, another company has attempted to address these challenges with a remote guidance system that steers catheters using large magnets. However, we believe this magnetic system has a number of limitations, including the overall cost of the very large equipment; the need to modify and magnetically shield procedure rooms at significant expense prior to installation; the need to dedicate a room to the magnetic system; potential magnetic interference with other equipment and implanted devices; the inability to apply variable force at the working tip of the catheter, narrowing the range of potential procedural applications for the system; and the inherent limitations associated with only having one magnetically moveable surgical instrument at a time inside the patient’s body. In addition, this magnetically based system lacks an open architecture for third-party catheters, necessitating the development, regulatory clearance and utilization of proprietary therapeutic magnetically based catheters made by the system manufacturer or its business partners.

The Hansen Medical Solution

Our Sensei system principally consists of two portable modules: a physician control console and a patient-side module that can be easily connected to most procedure tables. Physicians sit at the control console and use

 

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their hands to instinctively control the motion of our disposable Artisan catheter, which is attached to the patient-side module. The Artisan catheter is designed to accurately navigate third-party catheters and catheter-based technologies to specific sites. Our Sensei system is designed to use advanced robotics to enable physicians to vary the force at the working tip of these flexible devices in a broad range of procedures.

We believe our Sensei system, combined with our disposable Artisan catheters, overcomes the limitations of both hand-held catheters and magnetic navigation systems. We designed our Sensei system to have the following attributes:

 

   

Instinctive control. Our Sensei system utilizes computer-controlled robotics to directly translate the motions of the physician’s hands from our control console into corresponding accurate manipulations of the catheters and catheter-based technologies inside the body. We believe the instinctive robotic control of the catheters will be easier to use than manual catheter approaches and therefore have the potential to reduce the variability of procedure times, improve efficacy and enable new or additional procedures to be performed. In addition, we believe this instinctive control will enable physicians to be trained in the use of our Sensei system in a relatively short period of time and also increase the number of physicians who are capable of performing these catheter-based procedures.

 

   

Stability. We believe our Sensei system provides the accuracy and control required for treating a number of cardiac conditions in which the stable and repeated placement of a catheter is necessary for an effective outcome, such as against a specific location on the inner wall of a beating heart.

 

 

 

Variable force at the catheter tip. To effectively perform a broad range of catheter-based procedures, physicians must have the ability to apply variable force at the working tip of the catheters and other catheter-based technologies. We designed our disposable Artisan catheter products to provide variable support while maintaining the flexibility required to navigate the catheter. In addition, we have developed our proprietary IntelliSense® force-sensing technology to measure and display the amount of force being applied by a catheter throughout the procedure.

 

   

Compatibility with third-party devices. Our Artisan catheter does not require physicians to use a set of proprietary therapeutic catheters made by a specific manufacturer. Although we have received clearance for use of our Sensei system with only two specified mapping catheters, our Artisan catheter incorporates a center lumen that is designed to be compatible with most currently approved third-party catheters without modification. This enables us to potentially achieve clearance for a broader range of devices for use with our Sensei system than we have achieved thus far.

 

   

Movability. Our Sensei system primarily consists of two portable modules: a physician control console and a patient-side module that can be connected to most procedure tables. In addition, the system includes a portable electronics rack. These modules can be wheeled between procedure rooms and reinstalled by a Hansen service technician, and do not require a dedicated space, any special facility modification or magnetic shielding to prevent interference for their use. As a result, we expect our Sensei system to be much more convenient and significantly less expensive to install than a magnetic system.

Although our clinical trial data is still limited, we believe that our robotic solution may offer the potential for substantial benefits to patients, physicians, hospitals and third-party payors including:

 

   

improving patient outcomes through greater control, consistency and stability in catheter-based procedures;

 

   

permitting access to more complex existing cases and enabling broader use of catheter-based treatments for diseases where catheters are rarely used today, if at all;

 

   

enabling more physicians to perform complex interventional procedures through greater ease of use and reduced training time;

 

   

reducing x-ray radiation exposure to the primary physician by permitting the physician to conduct procedures away from the radiation field or in an adjacent room; and

 

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reducing physician fatigue and the risk of physician back and neck problems from heavy lead protective clothing by allowing physicians to sit comfortably at our control console during a procedure instead of standing at table-side. Reduced fatigue to primary physician may allow for additional cases to be performed in one day, thus increasing hospital efficiency.

Our Products

Sensei system

Our Sensei system is principally comprised of two portable modules: a physician control console and a patient-side module that can be connected to most procedure tables. The control console can be located inside the EP lab and close to the patient or outside the EP lab in a separate location shielded from radiation. The control console features an instinctive motion controller, which robotically controls the patient-side module to accurately move the catheter within the patient anatomy. Our robotics technology uses sophisticated software and system control algorithms to command the motion of our Artisan catheter. Having navigated the catheter to the treatment site, the physician uses instinctive controls to accurately place the working tip of the control catheters where the desired treatment is to be performed.

Our patient-side module is a robotic manipulator actuated by motors that control pull-wires in our Artisan catheter. The manipulator is mounted on an articulating, or pivoting, arm that is in turn mounted to the procedure table in the EP lab or other treatment room. The manipulator may be directed over the patient during a procedure and thus positioned optimally for that procedure.

We received CE Mark approval for our Sensei system in the fourth quarter of 2006 and in May 2007 we received FDA clearance for the marketing of our Sensei system for manipulation, positioning and control of certain mapping catheters during EP procedures. When the FDA cleared our technology for commercialization in the U.S., it concluded that there is a reasonable likelihood that our products will be used for an intended use not identified in the proposed labeling and that such uses could cause harm. The FDA therefore required that we label our products with language spelling out that the safety and effectiveness of our products for use with cardiac ablation catheters, in the treatment of cardiac arrhythmias including atrial fibrillation, have not been established. Our Sensei system and our Artisan catheter have been used in the United States for ablation procedures in an off-label basis.

To assist physicians in applying the appropriate force with the catheter tip, we have developed our proprietary IntelliSense Fine Force TechnologyTM to measure and display the amount of force in grams transmitted along the shaft of the catheter as a result of catheter tissue contact. We obtained premarket notification, or 510(k) clearance, from the FDA for this feature in 2008.

Artisan catheter

Our disposable Artisan catheter and guide catheter assembly consists of a telescoping set of control catheters that are integrated to provide the desired motion of the tip of a diagnostic or therapeutic catheter that is inserted through the center lumen of the Artisan catheter. In this manner, the Artisan assembly is designed to accurately control the movement of an existing mapping catheter chosen by the physician. As a result, physicians are not limited to using particular proprietary catheters as is the case with the magnetic-based remote system. In addition, the center lumen of the Artisan catheter allows physicians to adapt and expand the procedures they can perform as other manufacturers invent new therapeutic or diagnostic catheters. Each Artisan catheter is designed to be used only once and then discarded.

Our disposable Artisan catheter and guide are designed to move together or independently, and can move with multiple degrees of freedom when attached to the robotically-controlled motors of our Sensei system. In addition, our Artisan catheter has a programmable chip that prevents use of an Artisan catheter that has been previously used and that restricts other control catheters from being plugged into our Sensei system patient-side

 

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module. In May 2007, we received CE Mark approval for our Artisan catheter and also received FDA clearance for the marketing of our Artisan catheter for manipulation, positioning and control of certain mapping catheters during electrophysiology procedures.

CoHesionTM 3D Visualization Module

Our CoHesion 3D Visualization Module, or CoHesion Module, is a software interface between our Sensei system and the St. Jude Medical EnSiteTM System for EP procedures. It is designed to provide physicians with 3D visualization to augment their ability to move a catheter throughout the heart, as well as increase control over placement of the catheter in specific locations. The CoHesion Module expands the utility of the EnSite and Sensei systems to provide physicians with a comprehensive and easy-to-use remote navigation and mapping system for EP procedures. Key features of the CoHesion Module include:

 

   

importation of EnSite 3D geometry into the Sensei system’s main navigation window;

 

   

localization of the percutaneous catheter tip within the EnSite 3D geometry; and

 

   

instinctive navigation of the localized catheter tip by the Artisan catheter.

Based on early, unpublished data, we believe that the use of the CoHesion Module results in the reduction of radiation exposure to the patient compared to conventional procedures. The CoHesion Module became commercially available in the European Union in the first quarter of 2008 and we obtained FDA clearance for the CoHesion Module in the United States at the end of the second quarter of 2008.

Our Strategy

Our goal is to establish our technology as the leading robotic platform for complex interventional catheter-based procedures for cardiovascular and peripheral vascular diseases. We believe our Sensei system will accomplish this objective by improving patient outcomes, reducing physician fatigue which may allow for additional cases to be performed in one day, reducing radiation exposure for primary physicians and reducing overall procedure costs and hospital expenditures. We also believe that we will be able to increase the number of procedures treated with catheter-based approaches and enable more doctors to perform such procedures. We market our products in the United States through a direct sales force of regional sales employees, supported by clinical account managers who provide training, clinical support and other services to our customers. Outside the United States, primarily in the European Union, we use a combination of a direct sales force and distributors to market, sell and support our products.

Elements of our strategy include:

 

   

Focus on key institutions and thought leaders to encourage adoption of our Sensei system. We are currently focusing our marketing efforts on the academic and community hospitals where the majority of EP procedures are performed. We believe these efforts will benefit those hospitals which adopt our technology by reinforcing their reputations as centers of excellence in their local markets in the specialties that benefit from procedures performed with our Sensei system. Through December 31, 2008, we have shipped and recognized revenue on a total of 55 Sensei systems worldwide, consisting of 36 in the United States and 19 in Europe. The installation sites range from large university medical centers to community hospitals.

 

   

Increase use of our Sensei systems and Artisan catheter. Following the initial placement within a given hospital, we will endeavor to expand the number of physicians who use our Sensei system. Our goal is to increase usage per system, leading to higher volume sales of our disposable Artisan catheter and sales of additional Sensei systems at each hospital.

 

   

Expand potential applications for our Sensei system. We intend to conduct post-marketing studies to provide evidence for the benefits which we believe our technology brings to the clinician, which should help to drive adoption of our technology. We also intend to develop relationships and pursue clinical

 

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research with leading cardiologists in order to develop and expand the range of clinical applications for our Sensei system in the fields of EP and interventional cardiology, and to capitalize on such relationships to apply our Sensei system to areas of unmet need within cardiovascular disease. Studies are currently under way in Europe comparing the safety, usability and success of the treatment of atrial fibrillation with our Sensei system to manual techniques.

 

   

Leverage the open architecture of our Sensei platform. We believe that our broad compatibility with key imaging and visualization technologies will facilitate adoption of our system in the marketplace. We also believe that adoption of our system will be enhanced because physicians will be able to use existing approved catheters in the lumen of our Artisan catheter. We plan to collaborate with manufacturers of disposable interventional products and imaging equipment to optimize compatibility with future enhancements of our Sensei system. Further, our open architecture allows us to benefit from third-party development efforts that advance current catheter and imaging technologies.

 

   

Continue ongoing research and development efforts to broaden our technology platform and extend our leadership. We intend to enhance and maintain our technology leadership with focused research and development efforts. Specifically, we are continuing to investigate the application of robotic delivery techniques to percutaneous aortic valve replacement and other structural heart applications. We are also developing a smaller Artisan catheter assembly for complex vascular applications in conjunction with developing the capabilities of our Sensei system to control this new assembly.

We only received FDA clearance of our Sensei system and Artisan catheter to map the heart anatomy using two particular mapping catheters. Our business and future growth, however, will depend on the use of our Sensei system in the treatment of atrial fibrillation and other cardiovascular procedures, for which we plan to seek future clearances or approvals for labeling that includes certain ablation procedures, depending upon regulatory requirements and our understanding of the needs of the physician community. Without such clearance or approval, each of these uses is considered an off-label use of our Sensei system, and we are prohibited from labeling or promoting our Sensei system, or training physicians, for such off-label use. Due to these legal constraints, our sales and marketing efforts focus on the general technical attributes and benefits of our Sensei system and its use to map the heart anatomy. As a result of promotional limits based on our labeling and the competitive nature of the market, some hospitals or physicians may not adopt our Sensei system or use our products unless and until we are able to broaden the scope of FDA clearance for our products. In addition, if the FDA determines that we have engaged in off-label promotion, we could be subject to significant liability.

Clinical Focus

Electrophysiology

Electrophysiology, or EP, is the study of electrical impulses through the heart. EP is focused primarily on diagnosing and treating arrhythmias, which are conditions in which electrical impulses within the heart vary from the normal rate or rhythm of a heartbeat. Such conditions may be associated with significant risks. Drug therapies have traditionally been used as initial treatments but they often fail to adequately control the arrhythmia and may have significant side effects. As a result, a significant unmet medical need for long-term solutions persists.

Severe heart rhythm disturbances were historically treated by highly invasive open chest heart surgery and are therefore typically only performed in conjunction with other procedures unrelated to the arrhythmia such as coronary artery bypass surgery or valve replacement and, as such, the total procedure can be very expensive. While generally very effective, these procedures are extremely traumatic for the patient, and usually require long hospital stays followed by a significant period of convalescence. Minimally invasive surgical procedures for the treatment of severe heart rhythm disturbances, including some which are robotically controlled, were devised to add visualization and instrument control using an endoscope in order to reduce the trauma for the patient. While these minimally invasive surgical techniques have been used for a number of anti-arrhythmic procedures, we believe the results have been mixed and the trauma to the patient and procedure cost remain high.

 

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Interventional electrophysiology further advanced these surgical procedures in EP labs through visualization provided by real-time x-ray imaging, often enhanced by electro-anatomic mapping and intracardiac ultrasound. These advances enable physicians to insert and navigate catheters into the vasculature or open chambers of the heart to deliver diagnostic and therapeutic technologies.

In EP mapping and ablation procedures, physicians have traditionally used specialized hand-held catheters. These catheters are manually navigated using a system of mechanical control cables to first map the electrical signals within the patient’s heart and then to ablate the heart tissue to eliminate arrhythmias. Generally, ablation is accomplished by applying radio frequency energy or electrical energy, or freezing the diseased tissue giving rise to the arrhythmia, usually through a catheter which creates a small scar that is incapable of generating or conducting heart arrhythmias. EP procedures have proven highly effective at treating arrhythmias at sites accessible through the vasculature. According to Millennium Research Group, there were approximately 164,000 EP procedures for diagnosis and treatment of arrhythmia conducted in the United States in 2007 and approximately 200,000 such procedures in Europe in 2006.

Control of the hand-held devices used in these EP procedures requires significant skill, because navigation in the blood vessels and the chambers of the heart can be difficult. The path that the interventional device must follow to arrive at the treatment site can be complex and tortuous and can include crossing the septum. Existing hand-held devices are limited in their ability to accurately navigate the tip of the mapping and ablation catheter to the treatment site on the heart wall, maintain adequate tissue contact within a beating heart to effect treatment and perform complex ablations within the left atrium of the heart. Physicians using manually-controlled, hand-held devices often utilize a range of different catheters and sheaths in an attempt to find the right device or devices for the procedure being performed. Our Sensei system has been designed to address the challenges associated with the use of current hand-held devices in performing many EP procedures.

We believe the instinctive robotic control of our Sensei system may provide greater accuracy, stability and control, reduce the variability of procedure times and improve the efficacy of EP procedures, including:

 

   

General mapping and ablation. A physician typically performs a diagnostic procedure in which the electrical signal patterns of the heart wall are mapped to identify the heart tissue generating the aberrant electrical signals. Mapping allows the physician to measure the timing and strength of the electrical activity. Following the mapping procedure, the physician may then use an ablation catheter to disable the aberrant signal or signal path, restoring the heart to its normal rhythm. In cases where an ablation is anticipated, physicians generally choose an ablation catheter and perform both the mapping and ablation with the same catheter.

 

   

Atrial fibrillation. The most common arrhythmia is atrial fibrillation, which is characterized by rapid, disorganized contractions of the heart’s upper chambers, the atria. Atrial fibrillation leads to ineffective pumping of the blood through the heart and significantly increases the risk of stroke. According to Millennium Research Group, over 3.1 million people in the United States currently suffer from atrial fibrillation. Despite wide-spread use of catheters by interventional cardiologists, interventional radiologists and vascular surgeons for the past 10 years, there were approximately 40,000 ablation treatments of atrial fibrillation performed in the United States in 2008. We believe that the number of atrial fibrillation procedures has the potential to grow rapidly if quicker, effective and easier to accomplish interventional treatments are available. We believe that due primarily to the difficulties of accurately controlling the catheter, the efficacy of ablation to treat atrial fibrillation is believed to be only approximately 75% and the procedure has significant risks, including stroke. As a result, atrial fibrillation ablations are generally only performed by very experienced physicians. We believe that many of the electrophysiologists in the United States do not regularly perform these catheter-based procedures because of their complexity and time-consuming nature and lack of clinical data. These procedures often last three to seven hours because of their complexity. The length of these procedures exposes the physician and staff to extensive radiation, requiring them to wear heavy lead vests for many hours at a time. In addition, there is only one catheter approved by the FDA for the treatment of a

 

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particular sub-set of patients with atrial fibrillation. In February 2009, Biosense Webster, a Johnson & Johnson company, obtained FDA approval of a premarket approval, or PMA, for the NAVISTAR® THERMOCOOL® Catheter for the treatment of drug refractory recurrent symptomatic paroxysmal atrial fibrillation, when used with compatible three-dimensional electroanatomic mapping systems. As noted above, our Sensei System has not been cleared or approved for use with ablation catheters or for the treatment of atrial fibrillation. We are required by the FDA to label our products with language specifying that the safety and effectiveness of our products for use with cardiac ablation catheters, in the treatment of cardiac arrhythmias including atrial fibrillation, has not been established.

The following table summarizes arrhythmias we believe could benefit from use of our Sensei system. All data regarding prevalence and incidence is for 2007:

 

Form of Arrhythmia

  

Definition

  

U.S. Prevalence/Incidence

  

Location and Success Rate of
Ablation Therapy

Atrial Fibrillation (AF)    Rapid, disorganized beating of the upper chambers or atria of the heart. The ventricle or lower chamber of the heart cannot respond to the increased pace, so blood pools in the atria leading to a three to five times increased risk of stroke. Heart failure will eventually occur if AF is left untreated. This arrhythmia may occur intermittently, or it may be permanent.    3.1 million/160,000    In this arrhythmia, the ablation therapy is performed in the left atrium. Since this arrhythmia can arise from multiple electrical sites, the goal is to electrically isolate those sites from the rest of the left atrium, thereby forcing the heart’s normal conduction pathway to take over. Success rates vary from approximately 50% to 75%.
Atrial Flutter    Rapid, but organized and predictable pattern of beating of the atria. As with AF, the ventricles cannot respond to all of the atrial beats, so blood pools in the atria, increasing the risk of stroke.    unknown/200,000    Unlike AF, atrial flutter arises from a single electrical wave that circulates rapidly throughout the right side of the heart. Ablation is used to interrupt this circuit and is successful in approximately 90% of cases.
Atrioventricular Nodal Reentrant Tachycardia (AVNRT)    In AVNRT the abnormal signal begins in the atria and transfers to the atrioventricular node, or AV node. Instead of conducting down to the ventricle, the signal is returned to the atria.    570,000/89,000    In AVNRT, the ablation therapy is performed in the right atrium. Treatment success rate is approximately 95%.

 

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Form of Arrhythmia

  

Definition

  

U.S. Prevalence/Incidence

  

Location and Success Rate of
Ablation Therapy

Ventricular Tachycardia (VT)    Ventricular tachycardia arises from the lower chambers of the heart. It is characterized by heart rates over 100 beats per minute, but heart rates often approach 200 beats per minute. At this rate, very little blood is pumped out of the heart to the brain and other organs. Extremely fast VT can be fatal.    uncertain due to overlap with ventricular fibrillation    Lesions are placed in either the left or right ventricle depending on where the arrhythmia arises. Treatment success rate is approximately 75%.
Wolff-Parkinson-White    An arrhythmia caused by an abnormal bridge of tissue that connects the atria and ventricles of the heart. This accessory pathway allows electrical signals to go back and forth between the atria and the ventricles without passing through the AV node. If the signal travels back and forth, very fast heart rates and life threatening arrhythmias can develop.    up to 3% of the general population/200,000    Lesions for this arrhythmia are placed in the right side of the heart. Ablation is the accepted form of curative therapy for symptomatic patients with success rates from approximately 88% to 99%.

Other potential applications in interventional cardiology

Vascular Market. Hansen believes that its Sensei system has the potential to add significant value to a number of procedures that can generally be grouped into the category of endovascular therapies. These are catheter based procedures done in the arterial vasculature and include procedures such as abdominal and thoracic aortic grafting as well as access and stenting of branches of the aorta and arterial system including the carotid arteries and the iliac, femoral, popleteal, renal and mesenteric vessels. We believe that robotic control of the tip of the catheter can make navigation to the anatomical area of interest inside an artery both easier and safer, as well as facilitate the proper placement of a graft or stent. In particularly diseased or tortuous arteries, facilitation of steering of the catheter and providing the precision to avoid point contact with atheromatous disease present in the vessel wall may facilitate procedures that are now difficult to do and could positively impact outcomes by avoiding the dislodgement of embolic debris inside the vessel which can lead to stroke.

Carotid Artery Stenting. In patients with hardening of the arteries, plaque, made up of cholesterol, calcium and fibrous tissue, builds up in the walls of the arteries. As more plaque builds up, the arteries can narrow and stiffen. Eventually, enough plaque may build up to reduce blood flow through the arteries or to cause pieces of the plaque to break free and to block the arteries in the brain. Carotid endardarectomy is a surgical procedure that is the standard of care for this type of carotid disease. This procedure involves removing the plaque via a surgical approach which leaves the patient with a three to four inch exposed scar along the neckline. Carotid artery stenting is a procedure in which the surgeon inserts a slender, metal-mesh tube, called a stent, which expands

 

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inside the carotid artery to increase blood flow in areas blocked by plaque. Traditional stents are relatively inflexible and difficult to maneuver. We believe our technology may be able to perform carotid artery stenting with minimized risks.

Percutaneous Aortic Valve Replacement. Percutaneous valve replacement represents an emerging alternative therapy for high-risk and inoperable patients with severe valve disease, and may offer advantages over open heart surgery. For example, non-surgical heart valve replacement may minimize complications associated with general anesthesia, opening the chest wall and the use of heart-lung bypass machines. Percutaneous aortic valve replacement using a catheter-based approach may enable surgeons to perform procedures under local anesthesia in a cardiac catheterization lab. This may be a preferred alternative for high-risk valve disease patients who otherwise have no choice but open heart surgery, and more importantly, for those patients with life-threatening valve disease who cannot undergo surgery. We believe that the controlled and precise access and deployment that robotics can provide in an endovascular aortic valve replacement has the potential for enabling current surgical valve candidates to be treated less invasively.

Valve Repair. Heart valve disease is a common disorder which affects millions of patients and is characterized by a progressive deterioration of one or more of the heart’s valvular mechanisms. Repair of heart valves has historically been accomplished by open heart surgery. Although often very successful in improving valve function, surgery of heart valves is associated with a risk of death and even if successful requires a long post-operative recovery. As a result, cardiologists tend to wait as long as possible before resorting to surgery in patients with deteriorating valve function. There is increasing interest in treating valve disease with less invasive means in order to enable treatment earlier in the disease and potentially slow or stop the progression of heart failure. In recent years, catheter-based procedures have been developed to repair valves in a surgical manner. We believe that as these procedures develop, physicians will require a new generation of catheters that can be used like surgical tools and which can be precisely controlled. As a result, we believe that we can participate in the development of a new generation of procedures in cardiac valve intervention as an alternative to conventional cardiac surgery, potentially offering a safer and more cost-effective approach to the early treatment of heart valve disease.

Patent Foramen Ovale. A patent foramen ovale, or PFO, is an abnormal opening in the atrial septum which results in shunting of blood between the atrial chambers. PFOs are believed to be present in as many as 20% of the adult population and there is strong evidence that PFOs are responsible for the occurrence of a type of stroke, known as cryptogenic stroke, which occurs as a result of a blood clot in an otherwise healthy individual. Additionally, there is increasing evidence that the presence of a PFO is in some way related to the occurrence of migraine headache with aura in certain patients. Migraine headaches affect more than 28 million people in the United States alone, according to the Mayo Clinic.

Historically, closing PFOs has required open heart surgery, a traumatic procedure, requiring significant post-operative recovery. More recently, PFOs have been closed successfully with prosthetic patches that are delivered via catheter-based procedures. These procedures offer a minimally invasive approach, but require that the clinician leave a prosthesis inside the heart to cover and occlude the PFO defect. The presence of foreign material inside the heart can lead to significant complications including infection, thrombus formation leading to stroke, development of cardiac arrhythmias, and dislodgment or migration necessitating surgical removal of the device. In the future, we believe that our Sensei system, because of the increased control of the catheter tip, may give the clinician the ability to close a PFO without the use of patches or prosthetic material.

Left Atrial Appendage Occlusion. One of the significant clinical risks associated with atrial rhythm abnormalities is the development of blood clots in the atrial chamber which can result in stroke. The anatomic portion of the left atrium, referred to as the left atrial appendage, or LAA, is particularly susceptible to clot formation. One approach to elimination of the risk of clot formation in the LAA is the use of catheter-based devices that block blood flow and pooling of blood in the LAA, and thereby reduce clotting risk in the atrium. These devices are believed to work well if they are properly positioned and oriented at the opening of the LAA,

 

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however, placement can be exceedingly challenging with conventional catheter techniques. We believe that our Sensei system may simplify the process of delivering these devices, enabling their widespread use.

Biventricular Lead Placement. Pacemakers have been used in cardiology for many years to treat rhythm abnormalities and improve cardiac function. More recently, many physicians have concluded that pacing of both ventricles of the heart in synchrony is, in many patients, more effective than pacing one ventricular location. This technique requires that one of the pacing leads be positioned at an optimal location in the wall of the left ventricle. In order to deliver the left ventricular lead, cardiologists often use a catheter based approach that delivers the pacing lead by introducing a cannula or tube into the coronary sinus, a vein that runs along the outside of the heart. Navigating this coronary sinus vein requires significant catheter manipulation, and also requires stability of the catheter tip when the proper anatomic location is reached. We believe that our Sensei system may be able to simplify the placement of biventricular leads in their optimal location, particularly for physicians with limited experience with this technique.

Chronic Total Occlusion. Chronic total occlusions, or CTOs, refer to lesions of the coronary vasculature system that completely block the lumen of a coronary artery, and prevent blood from passing by the lesion’s location. Cardiologists encounter CTO lesions in approximately 10% to 20% of their interventional cases for coronary disease. These occlusions create inadequate blood flow to the region of the heart that derives its blood from the occluded artery, and forces the affected region to survive based on collateral circulation from other vessels. Unlike partial occlusions, CTOs are difficult to pass a catheter or guide wire through because of the lack of any central lumen in the artery. As a result, conventional therapy of balloon dilation and stent placement is often impossible to perform, and the arterial lesion may be left untreated. Many specialized devices have been developed to try to cannulate through the center of a CTO lesion. However, procedures using these devices are often lengthy and are associated with significant complications and unsuccessful outcomes due to calcification of the lesion or inability to navigate the catheter tip through the center of the artery. We believe that our Sensei system, because of the ability to accurately control and stabilize the tip of the catheter as it is advanced, may be able to simplify the crossing of CTOs, eventually lowering procedure times and improving outcomes in these procedures.

Ventricular Injection Therapy. Many chronic heart conditions lead to progressive deterioration in heart function, often resulting in a debilitating and eventually fatal disease referred to as congestive heart failure, or CHF. In CHF, the heart muscle becomes less efficient, the chambers of the heart begin to dilate and cardiac function tends to deteriorate. As the heart muscle becomes weaker, the heart has to work harder to pump an adequate amount of blood. The harder the heart works, the more damage is done to its structure and function. Clinicians treat CHF with a variety of drugs that decrease blood volume and increase contractility of the heart muscle. However, there is increasing investigation into techniques which attempt to repair the muscle cells that have been damaged through the direct injection of growth factors or healthy cells into injured muscle. These techniques have shown some ability to replace damaged muscle but often demand the precise control of a needle injector inside the heart. We believe that our Sensei system may be able to provide a very efficient means for more easily performing ventricular injection at the specific locations where clinicians desire to deliver drug and cell therapies.

Although the FDA has granted 510(k) clearance for the use of the Sensei system in mapping heart anatomy, we will not be able to label or promote the Sensei system or train physicians in its use for any of the above applications unless separate 510(k) clearance or premarket application, or PMA, approval from the FDA is obtained for each such application.

Collaboration with St. Jude

On April 30, 2007, we entered into a Joint Development Agreement and a Co-Marketing Agreement with the Atrial Fibrillation Division of St. Jude Medical, Inc., or St. Jude. Pursuant to the joint development agreement we will work together with St. Jude to develop certain mutually agreed-upon products. The first product developed under the joint development agreement is our CoHesion Module, a newly-integrated EP solution that

 

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offers physicians a software interface between our Sensei system and the St. Jude Medical EnSite System. The EnSite system provides visualization and localization or detection of EP catheters in 3D space within the heart chamber. The integrated CoHesion Module is designed to allow physicians to remotely manipulate catheters with more accuracy because it provides 3D information regarding the actual position of catheters inside a patient’s heart. The CoHesion Module expands the utility of the EnSite and Sensei systems with the goal of providing physicians with a more comprehensive and easy-to-use remote navigation and mapping system for EP procedures. The CoHesion Module became commercially available in the European Union in the first quarter of 2008 and we obtained FDA approval for the CoHesion Module in the United States at the end of the second quarter of 2008. As of December 31, 2008, 30 of the 55 systems we have shipped and recognized revenue on are configured with the CoHesion Module.

The EnSite system is a computer-based technology marketed worldwide that facilitates EP procedures by creating real-time 3D graphical displays or maps of cardiac structures and arrhythmias. These maps are designed to provide the visual guidance necessary to navigate catheters used during EP procedures. Two-dimensional technologies such as fluoroscopy or ultrasound can also be used to assist physicians with guiding catheters inside the heart, but provide limited information regarding the three-dimensional space inside the heart. Combining the Sensei and EnSite technologies provides physicians with 3D visualization that augments their ability to confidently move a catheter throughout the heart, as well as increase control over placement of the catheter in specific locations. The EnSite System is used by EP clinicians during EP procedures to create 3D models of their patients’ cardiac anatomy and then to visualize catheters used in those procedures as they are navigated to critical anatomical targets. The system collects and organizes activation and voltage data from the inner surface of the heart, which allows physicians to visualize arrhythmias on the 3D model and more easily determine a treatment strategy. Localization of our Artisan catheter within the EnSite System’s 3D map gives physicians the ability to move the catheter deliberately and accurately while seeing specifically, in three dimensions, the location of the catheter inside the heart. We believe this integrated functionality enables clinicians of varying skill levels to more effectively and safely treat complex cardiac arrhythmias.

Other than the integration of the Sensei system with the EnSite technology, we are not obligated to undertake any other development projects under the joint development agreement with St. Jude, although we and St. Jude may decide to do so. Under the joint development agreement, we will be required to maintain compatibility of our Sensei system with St. Jude’s EnSite system for a defined period of time after our agreements with St. Jude expire. Under the joint development agreement, we retain the right to maintain compatibility with catheters from any other manufacturers. We are solely responsible for gaining regulatory approvals for and all costs associated with our portion of products developed under the joint development agreement. The joint development agreement continues in effect until the completion of all development work contemplated by any agreed development plan prior to termination of the joint development agreement. Either party may terminate the joint development agreement without cause upon not less than 90 days prior written notice to the other party. The joint development agreement also terminates upon written notice to the other party if our co-marketing agreement with St. Jude terminates due to uncured material breach or if the products under the program are subject to significant regulatory limitations.

Under the terms of our co-marketing agreement, we granted St. Jude the exclusive right to distribute products developed under the joint development agreement when ordered with St. Jude products worldwide, excluding certain specified countries, for the diagnosis and/or treatment of electrophysiologic cardiac conditions. Pursuant to a separate agreement, St. Jude is the exclusive distributor for our Sensei system in France. We maintain the right to sell the integrated system and retain additional exclusive rights in specified countries outside of the U.S. In addition, we retain the unrestricted right to market our Sensei system and Artisan catheter without St. Jude products. The initial term of the co-marketing agreement is until December 31, 2009.

Collaboration with Philips

We have also entered into agreements with Royal Philips Electronics, or Philips, to co-develop integrated products that we hope will simplify complex cardiac procedures to diagnose and treat arrhythmias. The

 

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agreements are intended to lead to the creation of integrated product solutions by combining Philips’ Allura Xper X-Ray system with our Sensei system. The resulting innovations will seek to enable electrophysiologists to perform complex procedures with greater confidence and improved efficiency. We believe that closer integration between robotics and imaging systems will afford greater clinical capability in endovascular procedures.

Advanced Cardiac Therapeutics

In 2009, we made an equity investment in Advanced Cardiac Therapeutics, Inc., or ACT, and secured exclusive rights to certain ACT intellectual property for certain robotic applications. ACT, a privately held company located in Laguna Beach, Calif., is developing a novel technology that is designed to accurately measure the temperature in a lesion during cardiac ablation procedures. ACT’s patented Microwave Radiometry System has the potential to be incorporated into standard and irrigated cardiac catheters. A catheter with ACT’s technology would have the potential to assist electrophysiologists by providing real-time feedback about effective energy delivery by the catheter. ACT’s technology has not been clinically tested and has not received regulatory approval.

Research and Development

As of December 31, 2008, our research and development team, excluding those who are now involved primarily in regulatory and quality functions, consisted of 60 people. We have assembled an experienced team with recognized expertise in robotics, mechanical and electrical engineering, software, control algorithms, systems integration and disposable device design, as well as significant clinical knowledge and expertise.

Our research and development efforts are focused in four major areas:

 

   

continuing to enhance the capabilities of our existing Sensei system and Artisan catheter through ongoing product and software development;

 

   

developing new capabilities for our Sensei system;

 

   

designing new proprietary disposable interventional devices for use with our system; and

 

   

developing new applications for our technology and related additions to our Sensei system, new control catheters, or integration with other imaging technologies or other modalities.

Our research and development team works independently and with other manufactures of EP lab equipment to integrate our open architecture platform with key imaging, location sensing and information systems in the EP labs. We also collaborate with a number of highly regarded electrophysiologists and cardiologists in key clinical areas in search of new applications for our technology.

We have historically spent a significant portion of our capital resources on research and development. Our research and development expenses were $25.6 million, $19.0 million and $16.6 million in 2008, 2007 and 2006, respectively.

Sales and Marketing

We market, sell and support our products in the United States through a direct sales force of regional sales employees, supported by clinical account managers who provide training, clinical support and other services to our customers. Outside the United States, primarily in the European Union, we use a combination of a direct sales force and distributors to market, sell and support our products. We have established sales subsidiaries in the United Kingdom and Germany and have hired sales representatives in the UK and Germany. We currently have distribution agreements in Canada, Czech Republic, France, Italy, Portugal, Russia and Spain.

We are still gaining experience as a company in the marketing, sale and distribution of our products. As of December 31, 2008, we had a direct sales force, clinical support team and marketing team of 36 employees, but we intend to continue to grow this team, which can be expensive and time consuming.

 

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Our sales and marketing process consists of two important steps: selling systems directly to the customer, and leveraging our installed base of systems to drive recurring sales of disposable interventional devices, software and services.

Through December 31, 2008, our customers fall into three broad categories:

 

   

leading academic institutions with physician thought leaders who are interested in performing complex new procedures enabled by our system;

 

   

high-volume non-academic regional centers interested in the benefits of our system; and

 

   

medium and low volume community hospitals that are competing intensely for patients, attempting to minimize referrals of complex cases to other centers and focusing on gaining market share in their regional markets.

Many hospitals are part of an integrated delivery network, or IDN, and/or a group purchasing organization, or GPO. When possible, we focus on leveraging opportunities in which we believe a sale to one member of an IDN or GPO creates interest and drives competition within that group. We also focus sales and marketing development activities where strategic synergies or competition exist between our current installed base and other area hospitals.

Following the initial sale of a system to a given hospital, we endeavor to expand the number of physicians who use our Sensei system. We believe these efforts will benefit early-adopting hospitals by increasing their market share in the procedures and specialties that benefit from procedures performed with our Sensei system. We expect these efforts to increase demand for our disposable products among hospitals, physicians and referring physicians.

Sales of medical capital equipment generally follow a staged sales process that includes the following:

 

   

generating initial customer interest;

 

   

gaining commitment from the customer, which often involves a formal written proposal;

 

   

helping the customer secure formal budget approval for the system purchase;

 

   

receiving a formal purchase order from the customer after its approval process is complete and after sales terms have been agreed upon; and

 

   

installation of the system at the customer’s site and providing physician and staff training so it is used properly.

Our system utilizes proprietary control catheters, as well as software tailored to specific clinical applications. After a system is installed and initial training has been completed, we provide ongoing support in order to increase customers’ familiarity with system features and benefits, with the goal of increasing usage of the system. More frequent usage will result in increased consumption of our disposable Artisan catheter. A basic one-year warranty is included with each system. We believe that service contracts providing for enhanced levels of support and service beyond the basic warranty could become an important additional source of revenue in the future.

We expect that our relationships with physician thought leaders in the field of electrophysiology will continue to be an important element of our selling efforts. These relationships are often built around research collaborations that enable us to better understand and articulate the most useful features and benefits of our system as well as to develop new solutions to long-standing challenges in interventional electrophysiology. We plan to continue to provide support for and collaborate with highly regarded physicians in order to accelerate market awareness and adoption of our systems.

 

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Customer Service and Support

We are building an infrastructure for customer service and support activities to address the needs of our growing installed base. As of December, 31, 2008, we had a customer service and support team of 13 employees. These employees form a call center, a network of field service engineers and a service parts logistics repair and delivery system. We also outsource the after-hours portion of our call center, including weekends and holidays, to an answering service. This infrastructure provides a single point of contact for our customers in the United States and the European Union via telephone and email and enables us to provide online, telephone and on-site technical support services 24 hours a day, seven days a week. In addition, we now offer post-warranty maintenance plans for our customers to manage their on-going support needs. We plan to expand our technical training and support capabilities as our installed base continues to grow.

Manufacturing

At December 31, 2008, we had a manufacturing team of 56 employees. We manufacture our Sensei systems and Artisan catheters using a combination of in-house manufacturing and third-party contract manufacturers. Some of the components for our Sensei system are single sourced. We may not be able to quickly establish additional or replacement suppliers for our single-source components, in part because of FDA requirements and because of the custom nature of the parts we utilize. Any supply interruption for any of these components or interruptions at our contract manufacturers could limit our ability to manufacture our products, which could have a material adverse effect on our business.

We are still gaining experience in manufacturing, assembling and testing our products on a commercial scale. In 2008, we moved into a new facility, thus increasing our ability to produce Sensei systems and Artisan catheters in quantities sufficient to meet our anticipated market demand. However, we still face technical challenges in our manufacturing processes, including manufacturing cost reductions, equipment design and automation, material procurement, problems with production yields and quality control and assurance. Developing our current manufacturing capacity has required the investment of substantial funds and additional changes in the future to reduce manufacturing costs or to adapt our capacity to market fluctuations may require the investment of substantial additional funds and the hiring and retaining of management and technical personnel who have the necessary manufacturing experience. We may not successfully complete any future required change in manufacturing ability on a timely basis or at all.

Lead times for materials and components ordered by us and our contract manufacturers vary and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. We and our contract manufacturers acquire materials, complete standard subassemblies and assemble fully configured systems based on sales forecasts. If orders do not match forecasts, we and our contract manufacturers may have excess or inadequate inventory of materials and components.

The Sensei system

Our Sensei system incorporates a number of custom parts and components that we have designed and which are manufactured to our specifications by third parties. Our manufacturing strategy for our Sensei system is to assemble some critical subsystems in-house while outsourcing less critical subsystems, and to complete the final assembly and testing of those components in-house in order to control quality.

Artisan catheter and guide catheter assembly

Our Artisan catheter consists almost entirely of custom parts which we have designed and are manufactured either by us or by contract manufacturers to our specifications. We currently assemble Artisan catheters in-house and have made agreements with a contract manufacturer to manufacture additional catheters in order to increase capacity for expected future demands. We outsource the manufacture of certain other disposable products, including sterile drapes used with our system in EP procedures. We also manufacture prototype disposables to facilitate future product development.

 

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Software

We develop the software components of our Sensei system, including control and application software, both internally and with integrated modules which we purchase or license from third parties. We perform final testing of software products in-house prior to commercial release.

Regulatory framework

Our manufacturing facilities operate under processes designed to meet the FDA’s requirements under the Quality System Regulation. We underwent an FDA inspection, which employed the Quality System Inspection Technique, or QSIT, from November 29, 2007 through December 4, 2007. This was the first FDA inspection of our company. The inspection has closed and the FDA did not identify any deficiencies in our quality systems or operations as a result of that inspection. Our existing quality management system passed European Notified Body audits in 2006, 2007 and 2008, and it was determined that we are in compliance with the requirements of ISO 13485. If we fail to comply with the FDA requirements or maintain ISO 13485 standards in the future, we may be subject to FDA enforcement action or required to cease all or part of our manufacturing operations for some period of time until we can demonstrate that appropriate steps have been taken to comply with such standards.

Our manufacturing facility also has been inspected and licensed by the California Department of Health Services, or CDHS, and remains subject to re-inspection at any time. Failure to maintain a license from the CDHS or to meet the inspection criteria of the CDHS would disrupt our manufacturing processes. If an inspection by the CDHS were to indicate that there are deficiencies in our manufacturing process, we could be required to take remedial actions at potentially significant expense, and our facility may be temporarily or permanently closed.

Force Dimension Development and Supply Agreement

On November 9, 2004, we entered into a Development and Supply Agreement with Force Dimension Sàrl, a Swiss limited liability company. Pursuant to the terms of the agreement, Force Dimension manufactures and supplies to us specially-configured motion controllers in accordance with a predefined pricing matrix. We may terminate the agreement for any reason upon 30 days notice to Force Dimension, provided that we will remain obligated to purchase all delivered and ordered master input devices at the time of such termination. Either party may terminate the agreement for a material breach by the other party if the material breach is not cured within 90 days of notice of the material breach. Force Dimension is a single-source supplier for the motion controllers in our Sensei system.

Plexus Purchase Agreement

In October 2007, we entered into a purchase agreement with Plexus Services Corp., or Plexus, under which Plexus manufactures certain items for us. Under the agreement, Plexus manufactures products for us in quantities determined by a non-binding forecast and by purchase orders. The agreement contains no minimum purchase quantities; however, we may be liable for certain components purchased by Plexus in the event that such items become obsolete or exceed demand as a result of an engineering change or demand cancellation from us. The agreement remains in effect through September 2009 unless terminated sooner according to provisions in the agreement. The agreement may be extended upon mutual agreement by both Plexus and us. If we are unable to extend this agreement we may not be able to identify alternative sources in a timely fashion and the resulting transition to alternative manufacturers would likely result in operational problems and increased expenses and could delay the shipment of, or limit our ability to provide, our products.

Reimbursement

We expect that healthcare facilities and physicians in the United States will continue to bill various third-party payors, such as Medicare, Medicaid, other governmental programs and private insurers, for services performed using our products. We believe that procedures targeted for use with our products are generally already reimbursable under governmental programs and most private plans, and we anticipate that third-party

 

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payors will continue to cover and reimburse hospitals and physicians under existing coverage and reimbursement policies for the vast majority of procedures that would use our products. In addition, claims for services using our products are reimbursed under existing billing codes. These billing codes differ based on the place of service. For hospital inpatient departments, the billing codes generally are reported using the International Classification of Disease, Ninth Revision, Clinical Modification, or ICD-9-CM, procedure codes. The coding classification for hospital outpatient services and physician professional services is based on the coding system established by the American Medical Association under the Current Procedural Terminology, or CPT. Currently there are ICD-9-CM codes for cardiac mapping, a CPT code for mapping arrhythmias and a separate CPT code for combination mapping/ablation procedures. Accordingly, we believe hospitals and physicians in the United States will generally not require new billing authorizations or codes in order to be compensated for performing medically necessary procedures using our products on insured patients. We cannot be certain, however, that current coverage, coding and reimbursement policies of third-party payors will continue or the extent to which future changes to coverage, coding and reimbursement policies will affect some or all of the procedures that would use the Sensei system.

We are aware that physicians may elect to use products we sell for off-label indications, including, for example, for procedures to treat atrial fibrillation. Currently there is only one catheter which is approved by the FDA for the treatment of a particular sub-set of patients with atrial fibrillation. In February 2009, Biosense Webster, a Johnson & Johnson company, was granted marketing approval to the NAVISTAR® THERMOCOOL® Catheter for the treatment of drug refractory recurrent symptomatic paroxysmal atrial fibrillation, when used with compatible three-dimensional electroanatomic mapping systems. We believe that both physicians and hospitals are currently reimbursed for these and certain other procedures even when the procedures are performed off-label using other manufacturers’ products. We cannot be certain, however, that third-party payors will continue to provide coverage and/or reimbursement to physicians and hospitals for off-label use of products to treat atrial fibrillation or any other procedures. In addition, we cannot be certain that third-party payors will not require extensive clinical support showing the efficacy and cost effectiveness of off-label uses of our products before providing coverage and reimbursement for such procedures. If such support is required, we may not be able to satisfy such requests within the limitations of our FDA cleared labeling.

Future legislation, regulation or coverage and reimbursement policies of third-party payors may adversely affect the demand for our products currently under development and limit our ability to profitably sell our products. For example, under recent regulatory changes to the methodology for calculating payments for current inpatient procedures in certain hospitals, Medicare payment rates for surgical and cardiac procedures have been decreased, including those procedures targeted for use of our products. The reductions are to be transitioned over three years, beginning in fiscal year 2007. Further, physicians are paid for their professional services to Medicare beneficiaries under the Medicare Physician Fee Schedule, which is updated on an annual basis. Under the Medicare statutory formula, payments under the fee schedule would have decreased for the past several years if Congress failed to intervene. For example, for 2008, the fee schedule rates were to be reduced by approximately 10.1 percent. Section 101 of the Medicare, Medicaid and SCHIP Extension Act of 2007 eliminated the 10.1 percent reduction for 2008 and increased the annual payment rate update by 0.5 percent. This increase to the annual Medicare Physician Fee Schedule was effective only for Medicare claims with dates of service between January 1, 2008 and June 30, 2008. Beginning July 1, 2008, under the Medicare Improvement for Patients and Providers Act of 2008, or MIPPA, the 0.5 percent increase was continued for the rest of 2008.

Also with respect to the Medicare Physician Fee Schedule, MIPPA established a 1.1 percent increase to the update factor for 2009. MIPPA also modified the methodology by which the budget neutrality formula was applied to the 2009 physician fee schedule payment rates, however, resulting in an overall reduction in payment rates for services performed by some specialties, including an estimated 2% reduction for cardiology but a 2% increase in cardiac surgery.

In addition, the Centers for Medicare & Medicaid Services, or CMS, responsible for administering the Medicare program, also implemented revised reimbursement codes that better reflect the severity of patients’ conditions in the hospital inpatient prospective payment system for fiscal year 2008. These changes took effect

 

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on October 1, 2007. The majority of the procedures performed with our Sensei system and Artisan catheter are done on an in-patient basis and thus are paid under the revised Medicare-severity diagnosis related group, or MS-DRG system. We believe that the majority of procedures performed using our technology fall under MS-DRG 251, percutaneous cardiovascular procedures without coronary artery stent or acute myocardial infarction without major cardiovascular complication, with an average reimbursement of $9,260 for fiscal year 2008. The Center for Medicare and Medicaid services updates the MSDRG annually effective October 1 through September 30th of the following year. The proposed rule stating anticipated changes will be published June 2009 with a period for comments and the final rule becoming effective October 1, 2010. Because hospital inpatient reimbursement is largely dependent on geographical location and other hospital-specific factors, an individual hospital’s revenues from ablation procedures to treat atrial fibrillation using our technology can vary significantly.

Although currently procedures using our products are performed in the hospital inpatient setting, as discussed above, CPT codes describing procedures using our products in the outpatient setting exist. In September 2007, the Company consulted with the American Hospital Association’s, or AHA’s, Central Office on how hospitals should code for using the Sensei system with the Artisan catheter. In its response, the AHA advised that it appears that “the Hansen Medical Catheter Control System, Accessories, and Steerable Guide and Sheath are considered as one device and would be appropriately reported with the Healthcare Common Procedure Coding System “C” codes developed for new devices and used for Medicare claims for hospital outpatient service reporting HCPCS code C1766, introducer/sheath, guiding, intracardiac electrophysiological, steerable, other than peel away. This code identifies the entire system and is reported in addition to the procedure described by the appropriate CPT code. While this code does not correspond to a specific payment for our products, it does allow for hospitals to report the use of the products and may result in more accurate reimbursement once claims data has been developed.

Intellectual Property

Since our inception, our strategy has been to patent the technology, inventions and improvements that we consider important to the development of our business and technology. Our intellectual property portfolio, including patents and patent applications that we own or license, covers key aspects of our Sensei system and Artisan catheter products, as well as other technology 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 technology, including our robotic technology, navigational methods, procedures, systems, disposable interventional devices and our three dimensional integration technology. As of December 31, 2008, we owned 18 issued U.S. patents and approximately 100 pending U.S. patent applications, 7 granted foreign patents and approximately 40 pending foreign applications. We also share the rights to approximately 230 issued U.S. patents, approximately 70 pending U.S. patent applications and over 140 pending or granted foreign applications under the cross license agreement with Intuitive Surgical, Inc., or Intuitive, which in turn shares rights to our patents pursuant to the cross-license agreement. We also have a number of invention disclosures under consideration and several new patent applications that are being prepared for filing, and we continue to gain the benefit of certain new patent applications and patents by virtue of the cross license agreement with Intuitive. Accordingly, we anticipate that the number of pending patent applications and patents in our portfolio will increase.

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 robotic design and robotic instrument control which we maintain as trade secrets or copyrighted software.

Further successful commercializing of our Sensei system, and any other products we may develop, will depend in part on our not infringing patents held by third parties. It is possible that one or more of our products, including those that we have developed in conjunction with third parties, infringes existing patents. From time to time, we receive letters from one or more third parties alleging that certain aspects of our Sensei system infringe issued patent(s) or asking us to consider licensing their patent rights. While we do not believe that the Sensei

 

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system infringes any valid and enforceable patent of any third party, there can be no assurance that any third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief, to bar the manufacture and sale of our Sensei system in the United States or elsewhere. There also can be no assurance that we will not seek to take the initiative in defending ourselves by instituting litigation against such third party challenges.

We have applied for trademark registration of, and claim trademark rights in, “Artisan,” “Artisan eXtend,: “Hansen Artisan,” “Instinctive Motion,” “Fine Force Technology” and “CoolSense,” We have obtained trademark registration in the United States for, and claim trademark right in “Hansen Medical,” “Hansen Medical (with Heart Design),” “Heart Design (Logo),” “Sensei,” and “IntelliSense.”

Cross License Agreement with Intuitive Surgical

On September 1, 2005, we entered into a cross license agreement with Intuitive. Pursuant to this agreement, Intuitive granted us a co-exclusive, worldwide license in the field of intravascular approaches for the diagnosis and treatment of cardiovascular, neurovascular and peripheral vascular diseases. In return, we granted Intuitive a co-exclusive, worldwide license in the fields of endoscopic, laparoscopic, thoracoscopic or open diagnosis and/or surgical procedures, including endoluminal applications in gastrointestinal, respiratory, ear, nose and throat, urologic and gynecologic surgery. These licenses cover our and Intuitive’s patents and patent applications that were filed on or prior to the date of the agreement, as well as later filed divisionals, continuations and continuations in part with respect to the matters that were part of the original patents and patent applications as of the date of the agreement, but not any other later-filed patents and patent applications. In addition, these licenses cover all trade secrets and other know-how that we and Intuitive disclosed to each other prior to the date of the agreement. Each party retained full rights to practice its own technology for all purposes. As consideration for the licenses granted by Intuitive, we issued 125,000 shares of our Series B preferred stock to Intuitive in 2005 (which converted into 125,000 shares of our common stock at the time of our initial public offering) and we will owe royalties to Intuitive on certain future product sales. We may also be required to pay Intuitive annual minimum royalties. We will not receive any royalties or other compensation from Intuitive under the agreement.

Each party has agreed not to engage in activities outside its licensed field that, to its knowledge, would infringe the other party’s licensed patents. Although we believe that there are opportunities for us to operate outside the licensed field of use without the use of the Intuitive intellectual property, Intuitive, from time to time has told us that it believes certain of our past activities that have fallen outside the licensed field have infringed its intellectual property rights. Although we disagree with Intuitive’s position, we presently remain focused within our licensed field and so have agreed to inform Intuitive before commencing any further outside clinical investigations for endoluminal applications or engaging in external technology exhibitions at non-intravascular conferences. There can be no assurance that Intuitive will not challenge any activities we engage in outside the intravascular space and we cannot be sure that in the event of such a challenge we would be able to reach agreement with Intuitive on whether activities outside our licensed field may be conducted without the use of Intuitive’s intellectual property. Any disputes regarding a party’s potential infringement of the other party’s licensed patents that cannot be resolved through discussions between the parties will be settled by litigation. If such litigation results in a judgment of infringement that cannot be appealed and the infringing party fails to cease such infringement within a specified cure period, the non-infringing party will have the right to terminate the agreement. The parties have also agreed on a procedure under which either party may, but is not obligated to, ask an arbitration panel to make a binding determination as to whether or not a new product being developed by such party would, if commercialized outside such party’s licensed field, infringe any issued patents of the other party.

The agreement may be terminated by either party for bankruptcy of the other party. We also have the right to terminate the agreement at any time on or after March 1, 2018, and if we exercise this termination right, the licenses granted to us by Intuitive will terminate, but the licenses granted by us to Intuitive will survive. Neither party is permitted to terminate the agreement based on a breach by the other party, except in the event of the other party’s failure to cease infringing activity as described above or to remedy a significant payment default

 

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that has been established through a court judgment that cannot be appealed. If a party terminates the agreement for one of these types of breaches, the licenses granted by this party will terminate, but the licenses granted to this party will survive. In the absence of any early termination, the agreement will expire upon the expiration of the last to expire of the patents licensed under the agreement.

License Agreement with Mitsubishi Electric Research Laboratories

On March 7, 2003, we entered into a License Agreement with Mitsubishi Electric Research Laboratories, Inc., or Mitsubishi. Pursuant to this agreement, we obtained an exclusive, worldwide license to certain Mitsubishi patents and related know-how for use in the field of therapeutic or diagnostic vascular or endoluminal intervention involving robotics, automation or telemanipulation. In consideration for such license, we issued 9,375 shares of our common stock to Mitsubishi, and paid commercialization milestones and we will continue to owe minimum royalties and royalties on certain future product sales, subject to an annual royalty cap. Under the agreement, we are obligated to use reasonable commercial efforts to commercialize royalty-bearing products. The agreement may be terminated by Mitsubishi in the event of an uncured material breach by us. In addition, we can terminate the agreement for any reason with advanced written notice to Mitsubishi.

Competition

The markets for medical devices are intensely competitive and are characterized by rapid technological advances, frequent new product introductions, evolving industry standards and price erosion.

We believe that the principal competitive factors in our market include:

 

   

safety, efficacy and high-quality performance of products;

 

   

integration with a three-dimensional visualization methodology;

 

   

ease of use and comfort for the physician;

 

   

cost of capital equipment and disposable products, including the cost of installation and maintenance;

 

   

eligibility for coverage and reimbursement;

 

   

procedure times and improved clinical outcomes for patients;

 

   

effective sales, marketing and distribution;

 

   

brand awareness and strong acceptance by healthcare professionals and patients;

 

   

training, service and support and comprehensive education for patients and physicians; and

 

   

intellectual property leadership and superiority.

We consider our primary competition in EP, our first market, to be in the following areas:

 

   

Drug therapies. Drug therapy is currently considered the first line treatment for electrophysiological conditions such as atrial fibrillation. As a result, physicians typically attempt to treat these conditions with drugs designed to control heart rate and heart rhythm before indicating interventional procedures. Among atrial fibrillation patients, approximately 40 percent respond to drug therapies and, as a result, are not considered candidates for interventional treatment. Therefore, we face competition with the companies who currently market or are developing drugs or gene therapies to treat electrophysiological conditions such as atrial fibrillation. We are not currently aware of drug therapies under development that have the potential to improve the success rate of drug treatment for electrophysiological conditions such as atrial fibrillation. However, to the extent that more effective drug therapies are developed and approved for use in treating these conditions, we will face increased competition.

 

   

Manual catheter-based interventional techniques. The vast majority of interventional EP procedures performed today are performed with several types of hand-held catheters. These products evolve rapidly, and their manufacturers are constantly attempting to make them easier to use or more efficacious in performing procedures.

 

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Minimally invasive surgical procedures. A number of manufacturers are marketing devices that access the heart through an endoscopic surgical technique called thoracoscopy to treat atrial fibrillation. While less invasive than open surgery, these still require a surgical incision and general anesthesia, and therefore are more traumatic to the patient than an interventional EP procedure.

 

   

Magnetic guidance systems for steering catheters. Stereotaxis, Inc. markets a system that has been on the market in the United States and in Europe since 2003 and that uses magnets to control the working tip of catheters and other control catheters during interventional EP and other procedures. Because the system was introduced prior to our Sensei system and has a significant installed base, we believe it currently leads the market for guidance systems for controlling the working tip of catheters and catheter-based technologies.

 

   

New approaches. We expect to face competition from companies that are developing new approaches and products for use in interventional procedures. Some of these companies may attempt to use robotic techniques to compete directly with us, such as Corindus, Inc. and Catheter Robotics, Inc. Many potential competitors also have an established presence in the field of interventional cardiology, including the major imaging, capital equipment and disposables companies that are currently selling products in the EP lab.

For applications outside of EP, we expect to face similarly intense competition. The use of catheters and catheter-based technologies is common for a broad range of interventional procedures in cardiology and in other medical specialties. Other companies may market guidance systems for use outside of EP. In addition, we believe that Intuitive is developing a system to guide flexible medical devices in fields such as urology, gynecology, gastrointestinal disease, and other medical fields outside of cardiology. While they may not use our patents in EP and cardiology procedures, Intuitive may attempt to compete directly with us in EP and cardiology, and will likely compete with us if we decide to offer products outside of our licensed field of treating cardiovascular, neurovascular and peripheral vascular diseases. We also face competition from large medical device companies that have significantly greater financial and human resources for product development, sales and marketing, and patent litigation. Large medical device companies such as Johnson & Johnson, St. Jude Medical, Boston Scientific and others, as well as a variety of smaller innovative companies, are also expected to be targeting the EP and cardiology markets for guiding flexible medical devices.

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 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. In addition, because our products are used off label, we believe we are subject to increased risk of prosecution under these laws and by these entities even if we believe we are acting appropriately. We discuss below the statutes and regulations that are most relevant to our business and most frequently cited in enforcement actions.

 

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U.S. Food and Drug Administration Regulation

The FDA strictly 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, recalls, and advertising and promotion.

Our medical devices are categorized under the statutory framework described in the FFDCA. This framework is a risk-based system that classifies medical devices into three classes from lowest risk (Class I) to highest risk (Class III). In general, Class I devices are subject to only general controls (e.g., labeling, medical devices reporting, and prohibitions against adulteration and misbranding) and, in some cases, to the 510(k) premarket clearance requirements. Class II devices generally require 510(k) premarket clearance before they may be commercially marketed in the United States. Class II devices also may be subject to special controls such as performance standards and FDA guidelines that are not applied to Class I devices. Class III devices require FDA approval of a premarket application, or PMA, prior to commercial distribution. Class III devices are those deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously cleared 510(k) device. Both premarket clearance and PMA applications are subject to the payment of user fees paid at the time of submission for FDA review. The current use of our Sensei/Artisan is classified in Class II, but future applications for ablation in treatment of specific arrhythmias could be Class III.

The 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 previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of premarket approval applications, referred to as 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 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 guaranteed. In reviewing a premarket notification, the FDA may request additional information, including clinical data. 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.

In May 2007, the FDA provided 510(k) clearance of our Sensei system and Artisan catheter for use in mapping the heart anatomy with two specified mapping catheters. When the FDA cleared our technology for promotion in the U.S., it concluded that there is a reasonable likelihood that our products will be used for an intended use not identified in the proposed labeling and that such uses could cause harm. The FDA therefore required that we label our products with language spelling out that the safety and effectiveness of our products for use with cardiac ablation catheters, in the treatment of cardiac arrhythmias including atrial fibrillation, have not been established. Although this is not a formal contraindication, the FDA, with supporting data (for example, based on observed trends in postmarket adverse event reports,) could later choose to require a specific contraindication for use in cardiac ablation procedures. We plan to seek FDA clearance for labeling that includes ablation procedures.

We cannot assure you that the FDA will grant 510(k) clearance to our Sensei system and disposable Artisan catheter for other uses including for ablation procedures, or what data the FDA will require us to submit data as part of the 510(k) process for other uses. The FDA could even deny 510(k) clearance for other uses and require us to seek PMA approval.

 

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The PMA Approval Process. A PMA must be submitted if the device cannot be cleared through the 510(k) process. The PMA process is generally more costly and time consuming than the 510(k) process. A premarket approval application must be supported by extensive data including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. After a premarket approval application is sufficiently complete, the FDA will accept the application and begin an in-depth review of the submitted information. By statute, the FDA has 180 days to review the “accepted application”, although, generally, review of the application can take between one and three years and it may take significantly longer. During this review period, the FDA may request additional information or clarification of information already provided. Typically, the FDA will convene an advisory panel meeting to seek review of the data presented in the PMA for novel devices. The panel’s recommendation is given great weight, but is not dispositive of the agency’s decision. Prior to approving the PMA, the FDA will conduct an inspection of the manufacturing facilities and a number of the clinical sites where the supporting study was conducted. The facility inspection evaluates the company’s compliance with the Quality System Regulation, or QSR, which impose elaborate testing, control, documentation and other quality assurance procedures in the manufacturing process. The FDA may approve the PMA with postapproval conditions intended to ensure the safety and effectiveness of the device including, among other things, restrictions on labeling, promotion, sale and distribution. 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.

Clinical Trials. Clinical trials are generally required to support a PMA application and are sometimes required for 510(k) clearance. Such trials, if conducted in the United States, generally require an investigational device exemption application, or IDE, approved in advance by the FDA for a specified number of patients and study sites, unless the product is deemed an nonsignificant risk device eligible for more abbreviated IDE requirements. Clinical trials are subject to extensive monitoring, recordkeeping and reporting requirements. Clinical trials must be conducted under the oversight of an institutional review board, or IRB, for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices. To conduct a clinical trial, we also are required to obtain the patients’ informed consent that complies with FDA requirements, state and federal privacy regulations and human subject protection regulations. We, the FDA or the IRB could suspend a clinical trial at any time for various reasons, including a belief that the risks to study subjects outweigh the anticipated benefits. Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and efficacy of the device or may otherwise not be sufficient to obtain FDA clearance or approval to market the product in the U.S. Following completion of a study, we would need to collect, analyze and present the data in an appropriate submission to the FDA, either a 510(k) premarket notification or a PMA. Even if a study is completed and submitted to the FDA, the results of our clinical testing may not demonstrate the safety and efficacy of the device, or may be equivocal or otherwise not be sufficient to obtain approval of our product.

Pervasive and Continuing Regulation. After a device is placed on the market, numerous regulatory requirements apply. These include:

 

   

product listing and establishment registration, which helps facilitate FDA inspections and other regulatory action;

 

   

Quality System Regulation, or QSR, which requires manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all aspects of the manufacturing process;

 

   

labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label use or indication;

 

   

clearance of product modifications that could significantly affect safety or efficacy or that would constitute a major change in intended use of cleared devices;

 

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approval of product modifications that affect the safety or effectiveness of approved devices;

 

   

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

 

   

post-approval restrictions or conditions, including post-approval study commitments;

 

   

post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device;

 

   

the FDA’s recall authority, whereby it can ask, or under certain conditions order, device manufacturers to recall from the market a product that is in violation of governing laws and regulations;

 

   

regulations pertaining to voluntary recalls; and

 

   

notices of corrections or removals.

Advertising and promotion of medical devices, in addition to being regulated by the FDA, are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. Recently, promotional activities for FDA-regulated products of other companies have been the subject of enforcement action brought under healthcare reimbursement laws and consumer protection statutes. In addition, under the federal Lanham Act and similar state laws, competitors and others can initiate litigation relating to advertising claims. Accordingly, we may not market or promote our Sensei system for any off-label use. For example, we are not permitted to promote our system for use with any other mapping catheter other than the two specified in our 510(k) clearance, use with any ablation catheters, or in any other procedure such as ablation procedures. The FDA has specifically indicated that the commercial distribution of these devices for use in ablation procedures will require us to obtain a new 510(k) clearance or PMA approval with significant clinical data. Nonetheless, physicians are using our devices off-label for these indications within their practice of medicine. If the FDA determines that our promotional materials or training constitutes promotion of an unapproved use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of the products would be impaired.

Furthermore, our products could be subject to voluntary recall if we or the FDA determine, for any reason, that our products pose a risk of injury or are otherwise defective. Moreover, the FDA can order a mandatory recall if there is a reasonable probability that our device would cause serious adverse health consequences or death.

The Medical Device Reporting regulation (21 CFR 803), or MDR regulation, requires device manufacturers and U.S.-designated agents of foreign manufacturers to report to the FDA whenever they receive or become aware of information that reasonably suggests that a device marketed by the manufacturer “may have caused or contributed to a death or serious injury” or has malfunctioned and, if the malfunction were to recur, likely would cause or contribute to a death or serious injury (21 CFR 803.50(a)). Adverse event reporting, under the MDR regulation, is subject to two different time frames and report types, depending on the nature of the event. Once reportable events have been identified, we must decide which individual adverse event report to file: a five-day report or a 30-day report. For events involving deaths, serious injuries or malfunctions that require remedial action to prevent an unreasonable risk of substantial harm to the public health, a five-day report must be filed. If remedial action is not necessary, a 30-day report must be filed. MDRs are disclosed to the public via the Manufacturer and User Facility Device Experience (MAUDE) database, which is maintained by the FDA. All of the procedures performed using our technology have involved a combination of mapping and ablation of one sort or another. As of December 31, 2008, we have submitted 16 MDRs based on events observed during these cases.

 

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The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA to determine our compliance with the QSR and other regulations, and these inspections may include the manufacturing facilities of some of our subcontractors. We underwent an FDA inspection, which employed QSIT, from November 29, 2007 through December 4, 2007. This was the first FDA inspection of our company. The inspection has closed and the FDA did not identify any deficiencies in our operations. Later discovery of previously unknown problems with our Sensei system, including 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, or observations found during a future inspection, could result in enforcement action by the FDA or other regulatory authorities, which may result in sanctions including, but not limited to:

 

   

untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;

 

   

unanticipated expenditures to address or defend such actions;

 

   

customer notifications for repair, replacement, refunds;

 

   

recall, detention 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 modified products;

 

   

operating restrictions;

 

   

withdrawing 510(k) clearances on PMA approvals that have already been granted;

 

   

refusal to grant export approval for our products; or

 

   

criminal prosecution.

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 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 currently consists of 27 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.

In September 2006, we received the CE mark for the sale of our Sensei system, and in May 2007 we received the CE mark for our Artisan catheter which allows us to market our system for ablation procedures in Europe. If we modify existing products or develop new products in the future, including new devices, we will need to apply for permission to affix the CE mark to such products. We will be subject to regulatory audits, currently conducted biannually, in order to maintain any CE mark permissions we have already obtained. We cannot be certain that we will be able to obtain permission to affix the CE mark for new or modified products or that we will continue to meet the quality and safety standards required to maintain the permissions we have

 

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already received. If we are unable to maintain permission to affix the CE mark to our products, we will no longer be able to sell our products in member countries of the European Union. We will evaluate regulatory approval in other foreign countries on an opportunistic basis.

Anti-Kickback Statutes and Federal False Claims Act

In the United States, there are federal and state anti-kickback laws that generally prohibit the payment or receipt of kickbacks, bribes or other remuneration in exchange for the referral of patients or other health-related business. For example, the federal healthcare program Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs. The definition of “remuneration” has been broadly interpreted to include anything of value, including for example gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash and waivers of payments. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, 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 Anti-Kickback Statute is broad and prohibits many arrangements and practices that are 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, Congress authorized the OIG to issue a series of regulations, known as the “safe harbors” which it did, beginning in July of 1991. These safe harbors set forth provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the Anti-Kickback Statute. The failure of a transaction or arrangement to fit precisely within 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 applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG.

Many states have adopted laws similar to the 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.

Another trend affecting the healthcare industry is the increased use of the False Claims Act and, in particular, actions under the False Claims Act’s “whistleblower” or “qui tam” provisions. Those provisions allow a private individual to bring actions on behalf of the government alleging that the defendant has defrauded the federal government. In recent years, the number of suits brought against healthcare providers by private individuals has increased dramatically. In addition, various states have enacted laws modeled after the False Claims Act and some states’ laws may apply to claims for items or services reimbursed under Medicare, Medicaid and/or commercial insurance.

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. Sanctions under false claims laws may also include exclusion of a manufacturer’s products from reimbursement under government programs and imprisonment. 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, improper referrals, and improper use of Medicare numbers when detailing the provider of services, in addition to the more predictable allegations as to misrepresentations with respect to the services rendered and promotion of products for off-label uses. We are unable to predict whether we could be subject to actions under the False Claims Act or any comparable state laws, or the impact of such

 

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actions. However, the costs of defending claims under the False Claims Act or any comparable state laws, as well as sanctions imposed under the Act, could significantly affect our financial performance.

Our 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.

Government officials have focused their enforcement efforts on marketing of healthcare services and products, among other activities, and recently have brought cases against 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 and practices to assure compliance with these federal and state laws, and will inform employees and marketing representatives of the Anti-Kickback Statute and their obligations thereunder. However, we cannot rule out the possibility that the government or other third parties could interpret these laws differently and challenge our practices under one or more of these laws. If our past or present operations are found to be in violation of any of these laws, we could be subject to civil and criminal penalties, which could hurt our business, results of operations and financial condition.

Health Insurance Portability and Accountability Act of 1996

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 healthcare fraud statute prohibits knowingly and willfully executing 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 or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement 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 or imprisonment.

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

The American Recovery and Reinvestment Act of 2009, or ARRA, commonly referred to as the economic stimulus package, includes sweeping changes to HIPAA that expand HIPPA privacy and security standards and will likely lead to increased federal and state enforcement standards. The legislation, which was signed into law on February 17, 2009, includes the Health Information Technology for Economic and Clinical Health Act. Among other things, the new law makes HIPAA’s privacy and security standards directly applicable to covered entities’ “business associates”—independent contractors of those covered covered entities that receive or obtain protected health information in connection with providing a service on their behalf. Accordingly, this new legislation effectively expands HIPAA as a vehicle to regulate anyone servicing the healthcare industry that has access to protected health information. ARRA also increases the civil and criminal penalties that may be imposed and gives state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney fees and costs associated with pursuing federal civil actions.

 

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Although we believe we are not a covered entity and therefore do not need to comply with these standards at this time, we expect that our customers generally will be covered entities and may obligate us to contractually 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, we may be subject to liability for violation of related contractual obligations we have with our customers. When the provisions of ARRA extending direct liability under HIPAA to business associates become effective February 17, 2010, we will be subject to HIPAA security and privacy standards as if we were a covered entity. Our compliance with these standards may entail significant costs for us and we cannot predict the effect of increased enforcement efforts in this area.

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.

Certificate of Need Laws

In approximately two-thirds of the states, a certificate of need or similar regulatory approval is required prior to the acquisition of high-cost capital items or various types of advanced medical equipment, such as our system. At present, many of the states in which we expect to sell our system have laws that require institutions located in those states to obtain a certificate of need in connection with the purchase of our system, and we anticipate that some of our purchase orders may be conditioned upon our customer’s receipt of necessary certificate of need approval. Certificate of need laws were enacted to contain rising healthcare costs, prevent the unnecessary duplication of health resources, and increase patient access for health services. In practice, certificate of need laws have prevented hospitals and other providers who have been unable to obtain a certificate of need from acquiring new equipment or offering new services. A further increase in the number of states regulating our business through certificate of need or similar programs could adversely affect us. Moreover, some states may have additional requirements. For example, we understand that California’s certificate of need law also incorporates seismic safety requirements which must be met before a hospital can acquire our system.

Employees

As of December 31, 2008, we had 208 employees, 60 of whom were engaged directly in research and development, 69 in manufacturing and service, 28 in general administrative and accounting activities, 15 in regulatory, clinical affairs and quality activities and 36 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.

Additional Information

Hansen Medical, Inc. was incorporated in Delaware in 2002 under the name AutoCath, Inc. We file reports and other information with the Securities and Exchange Commission, or SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy or information statements. Those reports and statements as well as all amendments to those documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, (1) are available at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549, (2) are available at the SEC’s internet site (www.sec.gov), which contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC and (3) are available free of charge through our website as soon as reasonably practicable after electronic filing with, or furnishing to, the SEC. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

Our website address is www.hansenmedical.com. Information on our website is not incorporated by reference nor otherwise included in this report. Our principal executive offices are located at 800 East Middlefield Road, Mountain View, California 94043 and our telephone number is (650) 404-5800.

 

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ITEM 1A. RISK FACTORS

Risks Related to Our Business

We are a company with a limited history of operations, which makes our future operating results difficult to predict.

We are a medical device company with a limited operating history and first recognized revenues in the second quarter of 2007. Prior to the second quarter of 2007, we were a development stage company. We have been engaged in research and product development since our inception in late 2002. Our Sensei Robotic Catheter System, or Sensei system, and our corresponding disposable Artisan catheter received FDA clearance in May 2007 for commercialization to facilitate manipulation, positioning and control of certain mapping catheters during electrophysiology procedures. We also received the CE Mark in Europe for our Sensei system in September 2006 and for our Artisan catheter in May 2007. The future success of our business will depend on our ability to manufacture and assemble our products in sufficient quantities in accordance with applicable regulatory requirements and at lower costs, increase product sales and successfully introduce new products, all of which we may be unable to do. We have a limited history of operations upon which you can evaluate our business and our operating expenses have increased significantly. Our lack of a significant operating history also limits your ability to make a comparative evaluation of us, our products and our prospects. If we are unable to successfully operate our business, our business and financial condition will be harmed.

Credit, financial market and general economic conditions could delay or prevent potential customers from purchasing our products, which would adversely affect our sales, financial condition and results of operation.

The sale of a Sensei system often represents a significant capital purchase for our customers and many customers finance their purchase of a Sensei system through a credit facility or other financing. If prospective customers that need to finance their capital purchases are not able to access the credit or capital markets on terms that they consider acceptable, they may decide to postpone or cancel a potential purchase of a Sensei system. Also, even customers with sufficient financial resources to make such purchases without resorting to the credit and capital markets may be less likely to make capital purchases during periods when they view the overall economic conditions unfavorably or with uncertainty. Financial market conditions in the U.S. and the European Union during the fourth quarter of 2008, including especially the credit and capital markets, were extremely volatile and uncertain. As a result, many potential customers delayed making a decision to purchase a Sensei system during the quarter, which significantly impacted our sales, financial condition and results of operations. Financial market conditions are likely to continue to be volatile into the near future. We believe that the macroeconomic environment and the deterioration in confidence and spending have impacted and will continue to impact potential customers and their decisions to purchase our products into the foreseeable future. We cannot predict the timing, strength or duration of any economic slowdown or subsequent recovery, whether worldwide, regional or specific to our industry, nor the extent of its potential impact on our future sales, financial condition and results of operations.

We have limited sales, marketing and distribution experience and capabilities, which could impair our ability to achieve profitability.

In the second quarter of 2007, we received clearance to market, sell and distribute our products in the United States and Europe. We had no prior experience as a company in undertaking these efforts. In the United States, we market our products through a direct sales force of regional sales employees, supported by clinical account managers who provide training, clinical support and other services to our customers. Our direct sales force competes against the experienced and well-funded sales organizations of our competitors. Our revenues will depend largely on the effectiveness of our sales force. We face significant challenges and risks related to our direct sales force and the marketing of our products, including, among others:

 

   

the ability of sales personnel to obtain access to or persuade adequate numbers of hospitals to purchase our products or physicians to use our products;

 

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our ability to retain, properly motivate, recruit and train adequate numbers of qualified sales and marketing personnel;

 

   

the costs associated with an independent sales and marketing organization, hiring, maintaining and expanding an independent sales and marketing organization; and

 

   

assuring compliance with government scrutiny and labeling restrictions with respect to promotional activities in the healthcare industry.

Outside the United States, primarily in the European Union, we are establishing a combination of a direct sales force and distributors to market, sell and support our products. If we fail to select appropriate distributors or effectively use our distributors or sales personnel and coordinate our efforts for distribution of our products in the European Union or if their and our sales and marketing strategies are not effective in generating sales of our products, our revenues would be adversely affected and we may never become profitable.

We have limited experience in manufacturing and assembling our products and may encounter problems at our manufacturing facilities or otherwise experience manufacturing delays that could result in lost revenue or diminishing margins.

We do not have significant experience in manufacturing, assembling or testing our products on a commercial scale. In addition, for our Sensei system, we subcontract the manufacturing of major components and complete the final assembly and testing of those components in-house. We face challenges in order to produce our Sensei system and disposable Artisan catheters in quantities sufficient to meet anticipated market demand, to efficiently utilize our new manufacturing facility and to achieve planned manufacturing cost reductions. These challenges include equipment design and automation, material procurement, low or variable production yields on Artisan catheters and quality control and assurance. The costs resulting from these challenges and our relocation to a larger facility have had and will continue to have a significant impact on our gross margins and may result in significant fluctuations of gross margins from quarter to quarter. We may not successfully complete required increases in manufacturing capacity or planned improvements in manufacturing efficiency on a timely basis or at all. For example, as we were increasing our manufacturing capacity for Artisan catheters, we shipped a limited number in late 2007 and early 2008 that were later identified as having a potential leak. Although no patient is known or suspected to have experienced any consequences associated with this possible leak nor has it significantly impacted our business, these events were reported to the FDA in accordance with applicable regulations and we subsequently initiated a voluntary recall of the affected devices. The recall was closed in June 2008. We may encounter other manufacturing issues that result in our being unable to meet the expected demand for our Sensei system or Artisan catheters, maintain control over our expenses or otherwise successfully increase our manufacturing capabilities. If we are unable to satisfy demand for our Sensei system or Artisan catheters, our ability to generate revenue could be impaired and hospitals may instead purchase, or physicians may use, our competitors’ products. Since our Sensei system requires the use of disposable Artisan catheters, our failure to meet demand for Artisan catheters from hospitals that have purchased our Sensei system could adversely affect the market acceptance of our products and damage our commercial reputation.

In addition, all of our operations are conducted at our facilities leased in Mountain View, California. We could encounter problems at these facilities, which could delay or prevent us from manufacturing, assembling or testing our products or maintaining our manufacturing capabilities or otherwise conducting operations.

Our reliance on third-party manufacturers and on suppliers, and in one case, a single-source supplier, could harm our ability to meet demand for our products in a timely manner or within budget, and could cause harm to our business and financial condition.

We depend on third-party manufacturers to produce most of the components of our Sensei system and other products, and have not entered into formal agreements with several of these third parties. We also depend on various third-party suppliers for various components we use in our Sensei systems and for our Artisan catheters and sheaths. For example, Force Dimension Sàrl, a single-source supplier, manufactures customized motion

 

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controllers that are a part of our Sensei system. We also obtain the motors for our Sensei system from a single supplier, Maxon Motor AG, from whom we purchase on a purchase order basis, and we generally do not maintain large volumes of inventory. Additionally, in October 2007, we entered into a purchase agreement with Plexus Services Corp., or Plexus, under which Plexus will manufacture certain components for us in quantities determined by a non-binding forecast and by purchase orders.

Our reliance on third parties involves a number of risks, including, among other things, the risk that:

 

   

suppliers may fail to comply with regulatory requirements or make errors in manufacturing components that could negatively affect the efficacy or safety of our products or cause delays in or prevent shipments of our products;

 

   

we may not be able to respond to unanticipated changes and increases in customer orders;

 

   

we may be subject to price fluctuations due to a lack of long-term supply arrangements for key components with our suppliers;

 

   

we may lose access to critical services and components, resulting in an interruption in the manufacture, assembly and shipment of our systems and other products;

 

   

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

 

   

our suppliers may wish to discontinue supplying goods or services to us;

 

   

we may not be able to find new or alternative components for our use or reconfigure our system and manufacturing processes in a timely manner if the components necessary for our system become unavailable; and

 

   

our suppliers may encounter financial hardships unrelated to our demand for components, which could inhibit their ability to fulfill our orders and meet our requirements.

If any of these risks materialize, it could significantly increase our costs and impact our ability to meet demand for our products.

In addition, if these manufacturers or suppliers stop providing us with the components or services necessary for the operation of our business, we may not be able to identify alternative sources in a timely fashion. Any transition to alternative manufacturers or suppliers would likely result in operational problems and increased expenses and could delay the shipment of, or limit our ability to provide, our products. We cannot assure you that we would be able to enter into agreements with new manufacturers or suppliers on commercially reasonable terms or at all. Additionally, obtaining components from a new supplier may require qualification of a new supplier in the form of a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume product sales. Any disruptions in product supply may harm our ability to generate revenues, lead to customer dissatisfaction, damage our reputation and result in additional costs or cancellation of orders by our customers. We currently purchase a number of the components for our Sensei system in foreign jurisdictions. Any event causing a disruption of imports, including the imposition of import restrictions, could adversely affect our business and our financial condition.

If we fail to maintain necessary FDA clearances and CE marks for our medical device products, or if future clearances are delayed, we will be unable to commercially distribute and market our products.

The process of seeking regulatory clearance or approval to market a medical device is expensive and time-consuming and clearance or approval is never guaranteed and, even if granted, clearance or approval may be suspended or revoked. In May 2007, we received FDA clearance in the United States to commercialize our Sensei system and Artisan catheters only to facilitate manipulation, positioning and control, for collecting electrophysiological data within the heart atria with electro-anatomic mapping and recording systems. Because the FDA has determined that there is a reasonable likelihood that our products could be used by physicians for

 

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uses not encompassed by the scope of the present FDA clearance and that such uses may cause harm, we are required to label our products to state that their safety and effectiveness for use with cardiac ablation catheters in the treatment of cardiac arrhythmias including atrial fibrillation have not been established. Accordingly, the scope of the current label may be an obstacle to our ability to successfully market and sell our products in the United States to a broader group of potential customers. We will be required to seek a separate 510(k) clearance or PMA to market our Sensei system for uses other than those currently cleared by the FDA. We cannot assure you that the FDA would not impose a more burdensome level of premarket review on other intended uses or modifications to approved products. We may seek future clearances or approvals of our Sensei system for other indications, including atrial fibrillation or other cardiac ablation procedures but there can be no assurance as to the timing or potential for success of those efforts if undertaken. We received the CE Mark in Europe for our Sensei system in September 2006 and for our Artisan catheters in May 2007, but we may be required to seek separate clearances from the European Union in order to market our Sensei system for any additional uses. Such approval may be difficult and costly to achieve, or may not be granted at all.

Seeking to obtain future clearances or approvals from the FDA and other regulatory authorities could result in unexpected and significant costs for us and consume management’s time and other resources. The FDA or other regulatory authorities could ask us to supplement our submissions, collect non-clinical data, conduct clinical trials or engage in other time-consuming or costly actions, or it could simply deny our applications. Seeking new approvals could also result in the FDA or other regulatory authorities reviewing prior submissions and modifying or revoking prior approvals. In addition, clearance or approval could be revoked or other restrictions imposed if post-market data demonstrates safety issues or lack of effectiveness. We cannot predict with certainty how, or when, the FDA or other regulatory authorities will act. If we are unable to maintain our regulatory clearances and obtain future clearance, our financial condition and cash flow may be adversely affected, and our ability to grow domestically and internationally may be limited.

If physicians and hospitals do not believe that our products are a safe and effective alternative to existing technologies used in atrial fibrillation and other cardiac ablation procedures, they may choose not to use our Sensei system.

We believe that physicians will not use, and hospitals will not purchase, our products unless they determine that our Sensei system provides a safe and effective alternative to existing treatments. Since we have received FDA clearance to market our Sensei system and disposable Artisan catheters only for guiding catheters to map the heart anatomy, we will not be able to label or promote these products, or train physicians, for use in guiding catheters for cardiac ablation procedures until such clearance or approval is obtained. Currently, there is only limited clinical data on our Sensei system with which to assess its safety and efficacy in any procedure, including atrial fibrillation and other cardiac ablation procedures. Studies are currently under way outside the United States comparing the safety, usability and success of the treatment of atrial fibrillation with our Sensei system to manual techniques. If these studies, or other clinical studies performed by us or others, or clinical experience indicate that procedures with our Sensei system or the type of procedures that can be performed with the Sensei system are not effective or safe for such uses, physicians may choose not to use our Sensei system. Reluctance by physicians to use our Sensei system or to perform procedures enabled by the Sensei system would harm sales. Further, unsatisfactory patient outcomes or patient injury could cause negative publicity for our products, particularly in the early phases of product introduction. In addition, physicians may be slow to adopt our products if they perceive liability risks arising from the use of these new products. It is also possible that as our products become more widely used, latent or other defects could be identified, creating negative publicity and liability problems for us, thereby adversely affecting demand for our products. If physicians do not use our products in cardiac ablation procedures, we likely will not become profitable and our business will be harmed.

In addition, our research and development efforts and our marketing strategy depend heavily on obtaining support and collaboration from highly regarded physicians at leading hospitals. If we are unable to gain or maintain such support and collaboration, our ability to market our Sensei system and, as a result, our business and results of operations, could be harmed.

 

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We expect to derive substantially all of our revenues from sales of our Sensei system and Artisan catheters. If hospitals do not purchase our system, we may not generate sufficient revenues to continue our operations.

Our initial commercial offering consists primarily of two products, our Sensei system and our corresponding disposable Artisan catheters. The Sensei system has recently been supplemented by an optional CoHesion Module. In order for us to achieve sales, hospitals must purchase our Sensei system and Artisan catheters. Our Sensei system is a novel device, and hospitals are traditionally slow to adopt new products and treatment practices. In addition, our Sensei system is an expensive capital equipment purchase, representing a significant portion of an electrophysiology laboratory’s annual budget. In addition, because it has only recently been commercially introduced, our Sensei system has limited product and brand recognition. Furthermore, particularly in this period of economic volatility and uncertainty, we do not believe hospitals will purchase our products unless the physicians at those hospitals express a strong desire to use our products and we cannot predict whether or not they will do so. If hospitals do not widely adopt our Sensei system, or if they decide that it is too expensive, we may never achieve significant revenue or become profitable. Such a failure to adequately sell our Sensei system would have a materially detrimental impact on our business, results of operations and financial condition.

We have incurred substantial losses since inception and anticipate that we will incur continued losses for the foreseeable future and we may not be able to raise additional financing to fund future losses.

We have experienced substantial net losses since our inception in late 2002. At December 31, 2008, we had an accumulated deficit of $162.9 million. We have funded our operations to date principally from the sale of our securities and through issuance of debt. In 2008, we both issued equity and entered into a new debt facility; however, we may at any time sell additional securities resulting in further dilution to existing stockholders and we may at any time incur additional indebtedness. Also, the recent turmoil in the global financial and credit markets may limit our ability to raise additional funds. We cannot guarantee that future equity or debt financing will be available in amounts or on terms acceptable to us, if at all. Further, even if financing becomes available, the cost to us may be significantly higher than in the past. We will continue to face significant challenges if conditions in the financial markets do not improve or continue to worsen. In particular, our ability to access the capital markets and raise funds required for our operations may be severely restricted at a time when we would like, or need, to do so, which could have an adverse effect on our ability to meet our current and future funding requirements and on our flexibility to react to changing economic and business conditions. This could leave us without adequate financial resources to fund our operations as presently conducted or as we plan to conduct them in the future.

We expect to incur substantial additional net losses for at least the next year as we continue our manufacturing, marketing and sales operations to commercialize our products and seek additional regulatory clearances. We expect our research and development and general and administrative expenses to decrease in 2009 from 2008 levels, but to remain significant as we maintain the infrastructure necessary to support operating as a public company, develop our intellectual property portfolio and incur other intellectual property related legal expenses, including litigation expenses. Because we may not be successful in significantly increasing sales of our products, the extent of our future losses and the timing of profitability are highly uncertain, and we may never achieve profitable operations. If we require more time than we expect to generate significant revenue and achieve profitability, we may not be able to continue our operations. Even if we achieve significant revenues, we may never become profitable or we may choose to pursue a strategy of increasing market penetration and presence at the expense of profitability.

We may incur significant liability if it is determined that we are promoting off-label use of our products in violation of federal and state regulations in the United States or elsewhere.

We have received FDA clearance of our Sensei system and Artisan catheters only to facilitate manipulation, positioning and control for collecting electrophysiological data within the heart atria with electro-anatomic mapping and recording systems, which is a critical step in the identification of the heart tissue generating

 

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abnormal heart rhythms that may require ablation or other treatment. Because the FDA has determined that there is a reasonable likelihood that physicians may choose to use our products off-label, and that harm may result, we are required to label our products to state that their safety and effectiveness for use with cardiac ablation catheters in the treatment of cardiac arrhythmias including atrial fibrillation have not been established. We may subsequently seek regulatory clearance for use of our Sensei system for use with other catheters, including ablation catheters, or for a variety of other interventional procedures in electrophysiology, including atrial fibrillation and other cardiovascular procedures. Our business and future growth will depend primarily on the use of our Sensei system in the treatment of atrial fibrillation and other cardiovascular procedures, for which we do not yet, and may never, have FDA clearance or approval.

Unless and until we receive regulatory clearance or approval for use of our Sensei system with ablation catheters or in these procedures, uses in these procedures will be considered off-label uses of our Sensei system. Under the Federal Food, Drug, and Cosmetic Act and other similar laws, we are prohibited from labeling or promoting our products, or training physicians, for such off-label uses. This prohibition means that the FDA could deem it unlawful for us to make claims about the safety or effectiveness of our Sensei system for use with ablation catheters and in cardiac ablation procedures and that we may not proactively discuss or provide information or training on the use of our product in cardiac ablation procedures or use with unapproved catheters, with very limited exceptions. We presently believe that to date, all of the procedures in which our products have been used in the United States have included off-label uses such as cardiac ablation, for which our Sensei system and Artisan catheters have not been cleared by the FDA.

The FDA and other regulatory agencies actively enforce regulations prohibiting promotion of off-label uses and the promotion of products for which marketing clearance or approval has not been obtained. Moreover, scrutiny of such practices by the FDA and other federal agencies has recently increased. Promotional activities for FDA regulated products of other companies have been the subject of enforcement action brought under healthcare reimbursement laws and consumer protection statutes. A company that is found to have improperly promoted off-label uses may be subject to significant liability, including civil and administrative remedies under the Federal False Claims Act and various other federal and state laws, as well as criminal sanctions.

Due to these legal constraints, our sales and marketing efforts focus on the general technical attributes and benefits of our Sensei system and the use of this device to guide two specific catheters for heart mapping. If we are perceived not to be in compliance with all of the restrictions limiting the promotion of our products for off-label use, we could be subject to various enforcement measures, including investigations, administrative proceedings and federal and state court litigation, which would likely be costly to defend and harmful to our business. If the FDA or another governmental authority ultimately concludes we are not in compliance with such restrictions, we could be subject to significant liability, including civil and administrative remedies, injunctions against sales for off-label uses, significant monetary and punitive penalties and criminal sanctions, any or all of which would be harmful to our business and in certain instances may cause us to have to cease operations.

The training required for physicians to use our Sensei system could reduce the market acceptance of our system and reduce our revenue.

It is critical to the success of our sales efforts to ensure that there are a sufficient number of physicians familiar with, trained on and proficient in the use of our Sensei system. Convincing physicians to dedicate the time and energy necessary for adequate training in the use of our system is challenging, and we cannot assure you that we will be successful in these efforts.

It is our policy to only train physicians to insert, navigate, map and remove catheters using our Sensei system. Physicians must obtain training elsewhere to learn how to ablate cardiac tissue to treat atrial fibrillation, which is an off-label procedure. This training may be provided by third parties, such as hospitals and universities and through independent peer-to-peer training among doctors. We cannot assure you that a sufficient number of physicians will become aware of training programs or that physicians will dedicate the time, funds and energy necessary for adequate training in the use of our system. Additionally, we will have no control over the quality of

 

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these training programs. If physicians are not properly trained, they may misuse or ineffectively use our products. This may result in unsatisfactory outcomes, patient injury, negative publicity or lawsuits against us, any of which could negatively affect our reputation and sales of our products. Furthermore, our inability to educate and train physicians to use our Sensei system for atrial fibrillation or other cardiac ablation procedures may lead to inadequate demand for our products and have a material adverse impact on our business, financial condition and results of operation.

Training in the use of our products is regulated by the FDA. Our physician training and the training provided by third parties typically includes facilitating an observation of a Sensei case by the trainee physician. We monitor our training to ensure that off-label use is not promoted or enabled. However, from time to time, we may sponsor third party training. There is a risk that independent peer-to-peer interaction between physicians and other third party training may include discussion or observation of off-label procedures because most procedures performed to date using the Sensei system involve both mapping and cardiac ablation. If any such activities are attributed to us, the FDA or other governmental entities could conclude that we have engaged in off-label promotion of our products, which could subject us to significant liability.

Because our markets are highly competitive, customers may choose to purchase our competitors’ products, which would result in reduced revenue and harm our financial results.

Our Sensei system is a new technology and must compete with established manual interventional methods and methods of our competitors, such as Stereotaxis, Inc., in remote navigation. Conventional manual methods are widely accepted in the medical community, have a long history of use and do not require the purchase of additional, expensive capital equipment. The Stereotaxis Niobe® system, which has been in the market since 2003, four years earlier than our Sensei system, has been adopted by a number of leading clinicians. In addition, many of the medical conditions that can be treated using our products can also be treated with existing drugs or other medical devices and procedures. Many of these alternative treatments are widely accepted in the medical community and have a long history of use.

We also face competition from companies that are developing drugs or other medical devices or procedures to treat the conditions for which our products are intended. The medical device and pharmaceutical industries make significant investments in research and development and innovation is rapid and continuous. If new products or technologies emerge that provide the same or superior benefits as our products at equal or lesser cost, they could render our products obsolete or unmarketable. We cannot be certain that physicians will use our products to replace or supplement established treatments or that our products will be competitive with current or future products and technologies.

Most of our competitors enjoy several competitive advantages over us, including:

 

   

significantly greater name recognition;

 

   

longer operating histories;

 

   

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

 

   

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 clearance for products and marketing approved products; and

 

   

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

In addition, as the markets for medical devices develop, additional competitors could enter the market. As a result, we cannot assure you that we will be able to compete successfully against existing or new competitors. Our revenues would be reduced or eliminated if our competitors develop and market products that are more effective and less expensive than our products.

 

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We expect to continue to experience extended and variable sales cycles, which could cause significant variability in our results of operations for any given quarter.

Our Sensei system has a lengthy sales cycle because it involves a relatively expensive capital equipment purchase, which generally requires the approval of senior management at hospitals, inclusion in the hospitals’ electrophysiology laboratory budget process for capital expenditures and, in some instances, a certificate of need from the state or other regulatory clearance. We continue to estimate that this sales cycle may take between six and 18 months. During the fourth quarter of 2008, in a period of economic uncertainty, we saw sales cycles for many potential customers lengthen and purchase decisions postponed. These factors have contributed in the past and may contribute in the future to substantial fluctuations in our quarterly operating results, particularly in the near term and during any other periods in which our sales volume is relatively low. As a result, in future quarters our operating results could differ from our announcements of guidance regarding future operating or financial results or may fail to meet the expectations of securities analysts or investors, in which event our stock price would likely decrease. These fluctuations also mean that you will not be able to rely upon our operating results in any particular period as an indication of future performance. In addition, the introduction of new products could adversely impact our sales cycle, as customers take additional time to assess the benefits and investments on capital products.

The use of our products could result in product liability claims that could be expensive, divert management’s attention and harm our reputation and business.

Our business exposes us to significant risks of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices. Moreover, the FDA has expressed concerns regarding the safety and efficacy of our Sensei system for ablation and other therapeutic indications, including for the treatment of atrial fibrillation and has specifically instructed that our products be labeled to inform our customers that the safety and effectiveness of our technology for use with cardiac ablation catheters in the treatment of cardiac arrhythmias, including for atrial fibrillation, have not been established. We presently believe that to date, all of the procedures in which our products have been used in the United States have included off-label uses such as cardiac ablation, for which our Sensei system and Artisan catheters have not been cleared by the FDA and which therefore could increase the risk of product liability claims. The medical device industry has historically been subject to extensive litigation over product liability claims. We may be subject to claims by consumers, healthcare providers, third-party payors or others selling our products if the use of our products were to cause, or merely appear to cause, injury or death. Any weakness in training and services associated with our products may also result in product liability lawsuits. Although we maintain clinical trial liability and product liability insurance, the coverage is subject to deductibles and limitations, and may not be adequate to cover future claims. Additionally, we may be unable to maintain our existing product liability insurance in the future at satisfactory rates or adequate amounts. A product liability claim, regardless of its merit or eventual outcome could result in:

 

   

decreased demand for our products;

 

   

injury to our reputation;

 

   

diversion of management’s attention;

 

   

withdrawal of clinical trial participants;

 

   

significant costs of related litigation;

 

   

payment of substantial monetary awards to patients;

 

   

product recalls or market withdrawals;

 

   

loss of revenue; and

 

   

the inability to commercialize our products under development.

 

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We may be unable to complete the development and commercialization of our existing and anticipated products without additional funding.

Our operations have consumed substantial amounts of cash since inception. We expect to continue to spend substantial amounts on research and development. We expect to spend significant additional amounts on the continuing commercialization of our products and the development and introduction of new products. In 2008, net cash used in operating activities was $45.3 million. We expect that our cash used by operations will be significant in each of the next several years, and we will need additional funds to continue the commercialization of our Sensei system. Additional financing may not be available on a timely basis on terms acceptable to us, or at all. Furthermore, even if financing becomes available, the cost to us may be significantly higher than in the past. Any additional financing may be dilutive to stockholders or may require us to grant a lender a security interest in our intellectual property assets. The amount of funding we will need will depend on many factors, including:

 

   

the success of our research and product development efforts;

 

   

the expenses we incur in selling and marketing our products;

 

   

the costs and timing of future regulatory clearances;

 

   

the revenue generated by sales of our current and future products;

 

   

the costs to scale-up manufacturing capacity;

 

   

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

 

   

the emergence of competing or complementary technological developments;

 

   

the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, or participating in litigation-related activities;

 

   

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

 

   

the acquisition of businesses, products and technologies.

If adequate funds are not available, we may have to delay development or commercialization of our products or license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. We also may have to reduce marketing, customer support or other resources devoted to our products. Any of these factors could harm our financial condition.

Our products and related technologies can be applied in different applications, and we may fail to focus on the most profitable areas.

Our Sensei system is designed to have the potential for applications beyond electrophysiology, including in a variety of endoscopic procedures which require a control catheter to approach diseased tissue. We further believe that our Sensei system can provide multiple opportunities to improve the speed and capability of many diagnostic and therapeutic procedures. We will be required to seek a separate 510(k) clearance or PMA approval from the FDA for these applications of our Sensei system. However, we have limited financial and managerial resources and therefore may be required to focus on products in selected applications and to forego efforts with regard to other products and industries. Our decisions may not produce viable commercial products and may divert our resources from more profitable market opportunities. Moreover, we may devote resources to developing products in these additional areas but may be unable to justify the value proposition or otherwise develop a commercial market for products we develop in these areas, if any. In that case, the return on investment in these additional areas may be limited, which could negatively affect our results of operations.

If we fail to obtain or acquire imaging and visualization technology, or successfully collaborate with a strategic partner to provide such technology on terms favorable to us, or at all, our Sensei system may not be able to gain market acceptance and our business may be harmed.

Our success depends on our ability to continually enhance and broaden our product offerings in response to changing technologies, customer demands and competitive pressures. We believe that integrating our Sensei

 

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system with key imaging and visualization technologies using an open architecture approach is a key element in establishing our Sensei system as important for complex interventional procedures. Our Sensei system currently utilizes a variety of imaging means to visualize and assist in navigating our Artisan catheters. These imaging systems include fluoroscopy, intravascular ultrasound and electro-anatomic mapping systems, as well as pre-operatively acquired three-dimensional computed tomography and magnetic resonance imaging. We believe that in the future, as imaging companies develop increasingly sophisticated three-dimensional imaging systems, we will need to integrate advanced imaging into our Sensei system in order to compete effectively. There can be no assurance that we can timely and effectively integrate these systems or components into our Sensei system in order to remain competitive. We expect to face competition from companies that are developing new approaches and products for use in interventional procedures and that have an established presence in the field of interventional cardiology, including the major imaging, capital equipment and disposables companies that are currently selling products in the electrophysiology laboratory. We may not be able to acquire or develop three-dimensional imaging and visualization technology for use with our Sensei system. In addition, developing or acquiring key imaging and visualization technologies could be expensive and time-consuming and may not integrate well with our Sensei system. If we are unable to timely acquire, develop or integrate imaging and visualization technologies, or any other changing technologies, effectively, our revenue may decline and our business will suffer.

In April 2007, we entered into agreements with St. Jude Medical, Inc., or St. Jude, to integrate our Sensei system with St. Jude’s Ensite system and to co-market the integrated product. We are not obligated to undertake any other development projects except for the integration of the Sensei system with the EnSite system. We are solely responsible for gaining regulatory approvals for, and all costs associated with, our portion of the integrated products developed under the arrangement. At the end of the second quarter of 2008, the FDA cleared for marketing in the United States our CoHesion Module, which provides an interface between our Sensei system and the EnSite system; however, there can be no assurance that we will successfully maintain necessary regulatory clearances or compatibility of our products under the collaboration or that the CoHesion Module will gain market acceptance.

In addition, under the terms of the co-marketing agreement, we granted St. Jude the exclusive right to distribute products developed under the joint development agreement when ordered with St. Jude products worldwide, excluding certain specified countries, for the diagnosis and/or treatment of certain cardiac conditions. There can be no assurance that we will successfully collaborate or that St. Jude will generate significant sales under this arrangement. If we are not able to successfully collaborate with St. Jude or are unable to successfully integrate our systems, we may not be able to effectively compete with new technologies and our business may be harmed.

Our acquisition of AorTx, Inc. and future acquisitions are subject to a number of risks.

Our acquisition of AorTx, Inc., or AorTx, in November 2007 and the proposed completion of any future acquisitions will be subject to a number of risks, including:

 

   

with respect to future acquisitions, the possibility that an announced acquisition does not close;

 

   

the diversion of management’s time and resources;

 

   

the difficulty of assimilating the operations and personnel of the acquired companies;

 

   

the potential disruption of our ongoing business;

 

   

the difficulty and cost of completing the development of and regulatory approval for technologies acquired at a development stage;

 

   

the difficulty of incorporating acquired technology and rights into our products and services;

 

   

unanticipated expenses related to integration of the acquired companies;

 

   

difficulties in implementing and maintaining uniform standards, controls, procedures and policies; and

 

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potential unknown liabilities associated with acquired businesses, including additional risks of third parties asserting claims that acquired intellectual property infringes on the rights of such third parties.

We acquired AorTx with the expectation that the acquisition will result in various benefits including, among other things, leveraging our Sensei system into the developing market for percutaneous aortic heart valve replacement; however, we have decided to pursue this market opportunity independently from the development of AorTx’s technology. We have eliminated the research and development positions focused on developing the AorTx valve technology and while we continue to pursue the application of robotics to structural heart procedures, we do not expect that the technologies acquired from AorTx will form a material, or any, part of that strategy. Under the terms of the AorTx acquisition, we must decide by May 15, 2009 whether to make a $5 million payment to the former AorTx stockholders or license the acquired AorTx technologies back to an entity formed by the former AorTx stockholders. If we decide to license the technologies back, rather than make the payment, or if other risks associated with acquisitions materialize, our stock price could be adversely affected.

Software defects may be discovered in our products.

Our Sensei system incorporates sophisticated computer software. Complex software frequently contains errors, especially when first introduced. Because our products are designed to be used to perform complex interventional procedures, we expect that physicians and hospitals will have an increased sensitivity to the potential for software and other defects. We cannot assure you that our software will not experience errors or performance problems in the future. If we experience software errors or performance problems, we would likely also experience:

 

   

loss of revenue;

 

   

an increase in reportable adverse events to applicable authorities such as the FDA;

 

   

delay in market acceptance of our products;

 

   

damage to our reputation;

 

   

additional regulatory filings;

 

   

product recalls;

 

   

increased service or warranty costs; and/or

 

   

product liability claims relating to the software defects.

Our costs could substantially increase if we receive a significant number of warranty claims.

We warrant each of our products against defects in materials and workmanship for a period of approximately 12 months from the delivery or acceptance of our product by a customer which is normally when the system is installed. We accrue the estimated cost of warranties at the time revenue is recognized; however, we have a very limited history of commercial placements from which to judge our rate of warranty claims. Our warranty obligation may be impacted by product failure rates, material usage and warranty service costs. We periodically evaluate and adjust the warranty reserve to the extent actual warranty expense differs from the original estimates, and, if warranty claims are significant or differ significantly from estimates, we could incur additional expenditures for parts and service and our reputation and goodwill in the electrophysiology lab market could be damaged. Unforeseen warranty exposure in excess of our reserves could negatively impact our business, financial condition and results of operations.

Hospitals or physicians may be unable to obtain coverage or reimbursement from third-party payors for procedures using our Sensei system, which could affect the adoption or use of our Sensei system and may cause our revenues to decline.

We anticipate that third-party payors will continue to reimburse hospitals and physicians under existing billing codes for the vast majority of the procedures involving our products. We expect that healthcare facilities

 

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and physicians in the United States will continue to bill various third-party payors, such as Medicare, Medicaid, other governmental programs and private insurers, for services performed using our products. We believe that procedures targeted for use with our products are generally already reimbursable under government programs and most private plans. Accordingly, we believe providers in the United States will generally not be required to obtain new billing authorizations or codes in order to be compensated for performing medically necessary procedures using our products on insured patients.

There can be no assurance, however, that coverage, coding and reimbursement policies of third-party payors will not change in the future with respect to some or all of the procedures that would use our Sensei system. Additionally, in the event that a physician uses our Sensei system for indications not approved by the FDA, there can be no assurance that the coverage or reimbursement policies of third-party payors will be comparable to FDA-approved uses. Future legislation, regulation or coverage, coding and reimbursement policies of third-party payors may adversely affect the demand for our products currently under development and limit our ability to profitably sell our products. For example, under recent regulatory changes to the methodology for calculating payments for current inpatient procedures in certain hospitals, Medicare payment rates for surgical and cardiac procedures have been decreased, including those procedures for which our products are targeted. The majority of the procedures performed with our Sensei system and Artisan catheter are done on an in-patient basis and thus are paid under the Medicare-severity diagnosis related group, or MS-DRG system. We believe that the majority of procedures performed using our technology fall under MS-DRG 251, percutaneous cardiovascular procedures without coronary artery stent or acute myocardial infarction without major cardiovascular complication, with an average reimbursement of $9,260 for fiscal 2008. The Center for Medicare and Medicaid services updates the MSDRG annually effective October 1 through September 30th of the following year. The proposed rule stating anticipated changes will be published June 2009 with a period for comments and the final rule becoming effective October 1, 2010. Because hospital inpatient reimbursement is largely dependent on geographical location and other hospital-specific factors, an individual hospital’s revenues from ablation procedures to treat atrial fibrillation using our technology can vary significantly. At this time, we cannot predict the full impact any rate reductions will have on our future revenues or business.

Our success in international markets also depends upon the eligibility of our products for coverage and reimbursement by government-sponsored healthcare payment systems and third-party payors. In both the United States and foreign markets, healthcare cost-containment efforts are prevalent and are expected to continue. The failure of our customers to obtain sufficient reimbursement could have a material adverse impact on our financial condition and harm our business.

We may lose our key personnel or fail to attract and retain additional personnel.

We are highly dependent on the principal members of our management and scientific staff, in particular Frederic Moll, M.D., our Founder and Chief Executive Officer and one of our directors. Dr. Moll has extensive experience in the medical device industry, and we believe his expertise in the robotic device field may enable us to have proposals reviewed by key hospital decision-makers earlier in the sales process than may otherwise be the case. We do not carry “key person” insurance covering any members of our senior management. Each of our officers and key employees may terminate his employment at any time without notice and without cause or good reason. The loss of any of these persons could prevent the implementation and completion of our objectives, including the development and introduction of our products, and could require the remaining management members to direct immediate and substantial attention to seeking a replacement.

Additionally, in the third quarter of 2008 and the first quarter of 2009, we reduced our work force. This may make it more difficult to retain and attract the qualified personnel required, placing a significant strain on our management. Accordingly, retaining such personnel and recruiting necessary new employees in the future will be critical to our success. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. If we fail to identify, attract, retain and motivate these highly skilled personnel, we may be unable to continue our development and commercialization activities.

 

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If we do not effectively manage our growth, we may be unable to successfully develop, market and sell our products.

Our future revenue and operating results will depend on our ability to manage the anticipated growth of our business. We have experienced significant growth in the scope of our operations since our inception. This growth has placed significant demands on our management, as well as our financial and operations resources. In order to achieve our business objectives, however, we will need to continue to grow, which presents numerous challenges, including:

 

   

implementing appropriate operational and financial systems and controls;

 

   

expanding manufacturing capacity, increasing production and improving margins;

 

   

developing 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.

We commenced sales of our Sensei system internationally and are subject to various risks relating to such international activities which could adversely affect our international sales and operating performance.

A portion of our current and future revenues will come from international sales. To expand internationally, we will need to hire, train and retain additional qualified personnel. Engaging in international business inherently involves a number of difficulties and risks, including:

 

   

required compliance with existing and changing foreign regulatory requirements and laws;

 

   

export or import restrictions and controls relating to technology;

 

   

pricing pressure;

 

   

laws and business practices favoring local companies;

 

   

longer payment cycles;

 

   

the effects of fluctuations in foreign currency exchange rates;

 

   

shipping delays;

 

   

difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;

 

   

political and economic instability;

 

   

potentially adverse tax consequences, tariffs and other trade barriers;

 

   

international terrorism and anti-American sentiment;

 

   

difficulties in penetrating markets in which our competitors’ products are more established;

 

   

difficulties and costs of staffing and managing foreign operations; and

 

   

difficulties in enforcing intellectual property rights.

If one or more of these risks are realized, it could require us to dedicate significant resources to remedy the situation, and if we are unsuccessful at finding a solution, our revenue may decline.

Our business may be harmed by a natural disaster, terrorist attacks or other unanticipated problems.

Our manufacturing and office facilities are located in Mountain View, California. Despite precautions taken by us, a natural disaster such as fire or earthquake, a terrorist attack or other unanticipated problems at our facilities could interrupt our ability to manufacture our products or operate our business. These disasters or

 

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problems may also destroy our product inventories. While we carry insurance for certain natural disasters and business interruption, any prolonged or repeated disruption or inability to manufacture our products or operate our business could result in losses that exceed the amount of coverage provided by this insurance, and in such event could harm our business.

We may be liable for contamination or other harm caused by materials that we handle, and changes in environmental regulations could cause us to incur additional expense.

Our research and development, manufacturing and clinical processes involve the handling of potentially harmful biological materials as well as other hazardous materials. We are subject to federal, state and local laws and regulations governing the use, handling, storage and disposal of hazardous and biological materials and we incur expenses relating to compliance with these laws and regulations. If violations of environmental, health and safety laws occur, we could be held liable for damages, penalties and costs of remedial actions. These expenses or this liability could have a significant negative impact on our financial condition. We may violate environmental, health and safety laws in the future as a result of human error, equipment failure or other causes. Environmental laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with violations. We are subject to potentially conflicting and changing regulatory agendas of political, business and environmental groups. Changes to or restrictions on permitting requirements or processes, hazardous or biological material storage or handling might require an unplanned capital investment or relocation. Failure to comply with new or existing laws or regulations could harm our business, financial condition and results of operations.

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

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 the Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 123 (revised 2004), or SFAS No. 123(R), Share-Based Payment, which replaced Statement of Financial Accounting Standards No. 123, or SFAS 123, Accounting for Stock-Based Compensation and superseded APB Opinion No. 25, Accounting for Stock Issued to Employees. Adoption of this statement has had a significant impact on our financial statements since 2006 and is expected to 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 employee stock purchase plan rather than disclose the impact on our net loss within our footnotes. 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 a debt facility with Silicon Valley Bank that requires us to meet certain restrictive covenants that may limit our operating flexibility.

In August 2008, we entered into a $25 million loan and security agreement with Silicon Valley Bank, consisting of a $15 million term equipment loan and a one-year $10 million revolving credit line. At December 31, 2008, we had drawn down approximately $12.5 million on this facility. At the time of the drawdown, we paid in full our then-existing debt. The facility is collateralized by substantially all of our assets, excluding intellectual property, and is subject to certain covenants, including maintaining the required liquidity, achieving the specified EBITDA amounts and fulfilling certain reporting requirements. The liquidity covenants require us to maintain at the end of each month either liquid assets in the amount of 1.5 times the outstanding loan balance or sufficient liquidity to fund at least six months of projected operations, whichever is greater. We will become subject to quarterly EBITDA covenants beginning with the quarter ending March 31, 2009. Silicon Valley Bank has yet to determine the quarterly EBITDA amounts with us. As of December 31, 2008, we were in compliance with all financial covenants. If we fail to comply with any of the loan covenants, we could be deemed

 

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to have an event of default. In the case of an event of default, we could be required to immediately remit all outstanding funds then due under the facility; or prepare our collateral for sale to satisfy the amount of outstanding funds owed to Silicon Valley Bank. Moreover, the agreement limits our ability to take the following corporate actions without prior consent from Silicon Valley Bank:

 

   

transfer all or any part of our business or properties, other than transfers made in the ordinary course of business;

 

   

engage in any business other than the business in which we are currently engaged;

 

   

merge or consolidate with any other person, or acquire, all or substantially all of the capital stock or property of another person, subject to certain exceptions;

 

   

create, incur, assume, or be liable for any indebtedness, other than certain permitted indebtedness;

 

   

pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock, subject to certain exceptions;

 

   

create, incur, allow or suffer any lien on any of our property, including without limitation intellectual property, assign or convey any right to receive income;

 

   

directly or indirectly enter into or permit to exist any material transaction with any of our affiliates, subject to certain exceptions; and

 

   

make or permit any payment on any subordinated debt.

Complying with these covenants may make it more difficult for us to successfully execute our business strategy.

Risks Related to Our Intellectual Property

If we are unable to protect the intellectual property contained in our products from use by third parties, our ability to compete in the market will be harmed.

Our commercial success will depend in part on obtaining patent and other intellectual property protection for the technologies contained in our products, and on successfully defending our patents and other intellectual property against third party challenges. We expect to incur substantial costs in obtaining patents and, if necessary, defending our proprietary rights. The patent positions of medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions. We do not know whether we will be able to obtain the patent protection we seek, or whether the protection we do obtain will be found valid and enforceable if challenged. We also do not know whether we will be able to develop additional patentable proprietary technologies. If we fail to obtain adequate protection of our intellectual property, or if any protection we obtain is reduced or eliminated, others could use our intellectual property without compensating us, resulting in harm to our business. We may also determine that it is in our best interests to voluntarily challenge a third party’s products or patents in litigation or administrative proceedings, including patent interferences or reexaminations. In the event that we seek to enforce any of our owned or exclusively licensed patents against an infringing party, it is likely that the party defending the claim will seek to invalidate the patents we assert, which, if successful could result in the loss of the entire patent or the relevant portion of our patent, which would not be limited to any particular party. Any litigation to enforce or defend our patent rights, even if we were to prevail, could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Our competitors may independently develop similar or alternative technologies or products without infringing any of our patent or other intellectual property rights, or may design around our proprietary technologies.

We cannot assure you that we will obtain the patent protection we seek, that any protection we do obtain will be found valid and enforceable if challenged or that such patent protection will confer any significant commercial advantage. United States patents and patent applications may also be subject to interference proceedings and United States patents may be subject to reexamination proceedings in the United States Patent and Trademark Office, and foreign patents may be subject to opposition or comparable proceedings in the

 

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corresponding foreign patent offices, which proceedings could result in either loss of the patent or denial of the patent application, or loss or reduction in the scope of one or more of the claims of, the patent or patent application. In addition, such interference, reexamination and opposition proceedings may be costly. Some of our technology was, and continues to be, developed in conjunction with third parties, and thus there is a risk that such third parties may claim rights in our intellectual property. Thus, any patents that we own or license from others may provide limited or no protection against competitors. Our pending patent applications, those we may file in the future, or those we may license from third parties, may not result in patents being issued. If issued, they may not provide us with proprietary protection or competitive advantages against competitors with similar technology.

Non-payment or delay in payment of patent fees or annuities, whether intentional or unintentional, may result in loss of patents or patent rights important to our business. Many countries, including certain countries in Europe, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, the patent owner may have limited remedies, which could materially diminish the value of the patent. In addition, the laws of some foreign countries do not protect intellectual property rights to the same extent as do the laws of the United States, particularly in the field of medical products and procedures.

Our trade secrets, nondisclosure agreements and other contractual provisions to protect unpatented technology provide only limited and possibly inadequate protection of our rights. As a result, third parties may be able to use our unpatented technology, and our ability to compete in the market would be reduced. In addition, employees, consultants and others who participate in developing our products or in commercial relationships with us may breach their agreements with us regarding our intellectual property, and we may not have adequate remedies for the breach.

Third parties may assert that we are infringing their intellectual property rights which may result in litigation.

Successfully commercializing our Sensei system, and any other products we may develop, will depend in part on our not infringing patents held by third parties. It is possible that one or more of our products, including those that we have developed in conjunction with third parties, infringes existing patents. From time to time, we have received, and likely will continue to receive, communications from third parties inviting us to license their patents or accusing us of infringement. There can be no assurance that a third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief, to bar the manufacture and sale of our Sensei system in the United States or elsewhere. We may also choose to defend ourselves by initiating litigation or administrative proceedings to clarify or seek a declaration of our rights. As competition in our market grows, the possibility of a patent infringement claim against us or litigation we will initiate increases.

There may be existing patents which may be broad enough to cover aspects of our future technology. In addition, because patent applications in many countries such as the United States are maintained under conditions of confidentiality and can take many years to issue, there may be applications now pending of which we are unaware and which may later result in issued patents that our products infringe. We do not know whether any of these patents, if challenged, would be upheld as valid, enforceable and infringed by our products or technology. From time to time, we receive, and likely will continue to receive, letters from third parties accusing us of infringing their patents or inviting us to license their patents. We may be sued by, or become involved in an administrative proceeding with, one or more of these or other third parties. We cannot assure you that a court or administrative body would agree with any arguments or defenses we may present concerning the invalidity, unenforceability or noninfringement of any third-party patent. In addition to the issued patents of which we are aware, other parties may have filed, and in the future are likely to file, patent applications covering products that are similar or identical to ours. We cannot assure you that any patents issuing from applications will not cover our products or will not have priority over our own products and patent applications.

 

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We may not be able to maintain or obtain all the licenses from third parties necessary or advisable for promoting, manufacturing and selling our Sensei system, which may cause harm to our business, operations and financial condition.

We rely on technology that we license from others, including technology that is integral to our Sensei system, such as patents and other intellectual property that we have co-exclusively licensed from Intuitive. Under our agreement with Intuitive, we received the right to apply Intuitive’s patent portfolio in the field of intravascular approaches for the diagnosis or treatment of cardiovascular, neurovascular and peripheral vascular diseases. To the extent that we develop or commercialize robotic capability outside the field of use covered by our license with Intuitive, which we may choose to do at some time in the future, we may not have the patent protection and the freedom to operate outside the field which is afforded by the license inside the field. Although we believe that there are opportunities for us to operate outside the licensed field of use without using Intuitive’s intellectual property, Intuitive from time to time has told us that it believes certain of our past activities that have fallen outside the licensed field have infringed its intellectual property rights. Although we disagree with Intuitive’s position, we presently remain focused within our licensed field and so have agreed to inform Intuitive before commencing any further outside clinical investigations for endoluminal applications or engaging in external technology exhibitions at non-intravascular conferences. There can be no assurance that Intuitive will not challenge any activities we engage in outside the intravascular space, and we cannot assure you that in the event of such a challenge we would be able to reach agreement with Intuitive on whether activities outside our licensed field may be conducted without the use of the Intuitive’s intellectual property. If Intuitive asserts that any of our activities outside the licensed field are infringing their patent or other intellectual property rights or commences litigation against us, we will incur significant costs defending against such claims or seeking an additional license from Intuitive, and we may be required to limit use of our Sensei system or future products and technologies within our licensed intravascular field if any of our activities outside the licensed field are judged to infringe Intuitive’s intellectual property, any of which could cause substantial harm our business, operations and financial condition. Although Intuitive is restricted in how it can terminate our license, if Intuitive were ever to successfully do so, and if we are unable to obtain another license from Intuitive, we could be required to abandon use of our existing Sensei technology completely and could have to undergo a substantial redesign and design-around effort, which we cannot assure you would be successful.

The medical device industry is characterized by patent litigation and we could become subject to litigation that could be costly, result in the diversion of management’s attention, require us to pay damages and discontinue selling our products.

The medical device industry is characterized by frequent and extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often difficult to predict, and the outcome may be uncertain until the court has entered final judgment and all appeals are exhausted. Our competitors may assert, and have asserted in the past, that our products or the use of our products are covered by United States or foreign patents held by them. This risk is heightened due to the numerous issued and pending patents relating to the use of robotic and catheter-based procedures in the medical technology field. For example, we have received correspondence from a third party indicating it believes it holds a patent that our Sensei system may infringe. While we do not believe that the Sensei system infringes this patent, there can be no assurance that the third party will not take further action, such as filing a patent infringement lawsuit, including a request for injunctive relief, to bar the manufacture and sale of our Sensei system in the United States.

If relevant patents are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our system unless we can obtain a license to use technology or ideas covered by such patent or are able to redesign our Sensei system 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

 

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our products and our business could suffer. In addition, our patents may be subject to various invalidity attacks, such as those based upon earlier filed patent applications, patents, publications, products or processes, which might invalidate or limit the scope of the protection that our patents afford.

Infringement actions, validity challenges and other intellectual property claims and proceedings, whether with or without merit, may cause us to incur substantial costs and could place a significant strain on our financial resources, divert the attention of management from our business and harm our reputation. We have incurred, and expect to continue to incur, substantial costs in obtaining patents and expect to incur substantial costs defending our proprietary rights. Incurring such costs could have a material adverse effect on our financial condition, results of operations and cash flow.

We cannot be certain that we will successfully defend our patents from infringement or claims of invalidity or unenforceability, or that we will successfully defend against allegations of infringement of third-party patents. In addition, any public announcements related to litigation or administrative proceedings initiated or threatened by us, or initiated or threatened against us, could cause our stock price to decline.

If we are unsuccessful in our litigation with Luna Innovations, Inc., our business may be materially harmed.

In June 2007, we filed suit against Luna Innovations, Inc., or Luna, alleging that Luna has, among other things, breached a 2006-2007 development and intellectual property agreement between us and Luna that we believe establishes our ownership of all intellectual property in medical robotics developed by the parties during performance of the agreement, misappropriated our trade secrets and has revealed our confidential information to other companies who might improperly benefit from it. Luna’s Cross-Complaint against us asserts various claims including misappropriation of trade secrets and breach of the parties’ agreements and challenging the inventorship and our ownership of several patent applications which we filed during that same time period. The parties engaged in a nonbinding arbitration process earlier in 2008. Discovery in the case is almost completed and trial has been set for late March 2009. We are vigorously prosecuting our own claims and defending against Luna’s counterclaims. This litigation will require substantial resources, both financial and managerial and there can be no assurance that we will be the prevailing party on all or any of the issues being litigated. If we do not succeed in prosecuting our rights against Luna or if Luna prevails on one or more of its counterclaims, other companies, including companies who may attempt to compete with our flexible robotic technology, may benefit from work we performed with Luna without compensation to us. In addition, if Luna is successful, we may have to pay substantial damages and may lose rights to the patent applications in question that pertain to certain aspects of flexible robotics that we do not presently use but which may limit certain development paths for our technology unless we can design around the intellectual property in question or obtain a license which, if available at all, may require us to pay substantial royalties, any or all of which could materially harm our business.

We may be subject to damages resulting from claims that our employees or we have wrongfully used or disclosed alleged trade secrets of their former employers.

Many of our employees were previously employed at universities or other medical device companies, including our competitors or potential competitors. We could in the future be subject to claims that these employees, or we, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. If we fail in defending against such claims, a court could order us to pay substantial damages and prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies or features that are important or essential to our products would have a material adverse effect on our business, and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our ability to commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, such litigation could result in substantial

 

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costs and be a distraction to management. Incurring such costs could have a material adverse effect on our financial condition, results of operations and cash flow.

Additional Risks Related to Regulatory Matters

If we fail to obtain regulatory clearances in other countries for products under development, we will not be able to commercialize these products in those countries.

In order to market our products outside of the United States, we must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods. The time required to obtain approval in other countries might differ from that required to obtain FDA clearance. The regulatory approval process in other countries may include all of the risks detailed above regarding FDA clearance in the United States. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others. Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects described above regarding FDA clearance in the United States.

For example, the European Union requires that medical products receive the right to affix the CE mark. The CE mark is an international symbol of adherence to quality assurance standards and compliance with applicable European medical device directives. In order to obtain the right to affix the CE mark to our products, we will need to obtain certification that our processes meet European quality standards. These standards include certification that our product design and manufacturing facility complies with ISO 13485 quality standards. We received CE mark approval for our Artisan catheters in May 2007. However, future regulatory approvals may be needed. We cannot be certain that we will be successful in meeting European quality standards or other certification requirements.

We may fail to comply with continuing postmarket regulatory requirements of the FDA and other authorities and become subject to substantial penalties, or marketing experience may show that our device is unsafe, forcing us to recall or withdraw it permanently from the market.

We must comply with continuing regulation by the FDA and other authorities, including the FDA’s Quality System Regulation, or QSR, requirements, labeling and promotional requirements and medical device adverse event and other reporting requirements. If the adverse event reports we file with the FDA regarding death, serious injuries or malfunctions indicate or suggest that the device presents an unacceptable risk to patients, including when used off-label by physicians, we may be forced to recall the device and/or modify the device or its labeling, or withdraw it permanently from the market. The FDA has expressed concerns regarding the safety of the device when used with catheters and in procedures not specified in the indication we are seeking, such as ablation catheters and ablation procedures, and we have already filed Medical Device Reports reporting adverse events during procedures utilizing our technology. Physicians are using our device off-label with ablation catheters in ablation procedures, as well as in other electrophysiology procedures for which we have not collected safety data, and we therefore cannot assure you that clinical experience will demonstrate that the device is safe for these uses.

Any failure to comply, or any perception that we are not complying, with continuing regulation by the FDA or other authorities, including restrictions regarding off-label promotion, could result in enforcement action that may include suspension or withdrawal of regulatory clearances or approvals, recalling products, ceasing product marketing, seizure and detention of products, paying significant fines and penalties, criminal prosecution and similar actions that could limit product sales, delay product shipment and harm our profitability.

In many foreign countries in which we market our products, we are subject to regulations affecting, among other things, product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of these regulations are similar to those of the FDA. In addition, in many countries the national health or social security organizations require our products to be qualified before

 

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procedures performed using our products become eligible for coverage and reimbursement. Failure to receive, or delays in the receipt of, relevant foreign qualifications could have a material adverse effect on our business, financial condition and results of operations. Due to the movement toward harmonization of standards in the European Union, we expect a changing regulatory environment in Europe characterized by a shift from a country-by-country regulatory system to a European Union-wide single regulatory system. The timing of this harmonization and its effect on us cannot currently be predicted. Adapting our business to changing regulatory systems could have a material adverse effect on our business, financial condition and results of operations. If we fail to comply with applicable foreign regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory clearances, product recalls, seizure of products, operating restrictions and criminal prosecution.

If we or our contract manufacturers fail to comply with the FDA’s Quality System Regulations or California Department of Health Services requirements, our manufacturing operations could be interrupted and our product sales and operating results could suffer.

Our manufacturing processes, and those of some of our contract manufacturers, are required to comply with the FDA’s Quality System Regulations, or QSR, which cover the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces the QSR through periodic inspections of manufacturing facilities. We and our contract manufacturers are subject to such inspections. If our manufacturing facilities or those of any of our contract manufacturers fail to take satisfactory corrective action in response to an adverse QSR inspection, the FDA could take enforcement action, including any of the following sanctions, which could have a material impact on our operations:

 

   

untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;

 

   

unanticipated expenditures to address or defend such actions

 

   

customer notifications for repair, replacement, refunds;

 

   

recall, detention 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 modified products;

 

   

operating restrictions;

 

   

withdrawing 510(k) clearances on PMA approvals that have already been granted;

 

   

refusal to grant export approval for our products; or

 

   

criminal prosecution.

We are subject to the licensing requirements of the California Department of Health Services, or CDHS. We have been inspected and licensed by the CDHS and remain subject to re-inspection at any time. Failure to maintain a license from the CDHS or to meet the inspection criteria of the CDHS would disrupt our manufacturing processes. If an inspection by the CDHS indicates that there are deficiencies in our manufacturing process, we could be required to take remedial actions at potentially significant expense, and our facility may be temporarily or permanently closed.

If our products cause or contribute to a death or a serious injury, or malfunction in certain ways, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions. An increased frequency of filing Medical Device Reports concerning adverse events occurring during procedures performed with our technology could result in increased regulatory scrutiny of our products and could delay or prevent the adoption of our products.

Under the FDA medical device reporting regulations, medical device manufacturers are required to report to the FDA information that a device has or may have caused or contributed to a death or serious injury or has

 

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malfunctioned in a way that would likely cause or contribute to death or serious injury if the malfunction of the device or one of our similar devices were to recur. If we fail to report these events to the FDA within the required timeframes, or at all, FDA could take enforcement action against us. Any such adverse event involving our products also could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results.

We have filed Medical Device Reports, or MDRs, reporting adverse events during procedures utilizing our technology and have developed internal systems and processes that are designed to evaluate future events that may require adverse event reporting to the FDA. As the frequency of use of our technology in electrophysiology procedures increases, we are experiencing, and anticipate continuing to experience, it being necessary to file an increased number of MDRs. An increased frequency of filing MDRs or a failure to timely file MDRs may result in FDA requests for further information, which could delay other matters that we may have pending before the FDA, or result in additional regulatory action. An increased frequency of MDRs could also reduce confidence in the safety of our products and delay or prevent the acceptance of our products by physicians and hospitals, which would harm our business and cause our stock price to decline.

Our products may in the future be subject to product recalls that could harm our reputation, business and financial results.

The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture. In the case of the FDA, the authority to require a recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. For example, in May 2008, we initiated a voluntary recall of a limited number of our Artisan Control Catheters that were subject to potential leakage, and reported the recall to FDA in accordance with applicable regulations. No patient is known or suspected to have experienced any consequences associated with the recalled devices and the recall was closed in June 2008. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations. The FDA requires that certain classifications of recalls be reported to FDA within 10 working days after the recall is initiated. Companies are required to maintain certain records of recalls, even if they are not reportable to the FDA. We may initiate voluntary recalls involving our products in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, they could require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, the FDA could take enforcement action for failing to report the recalls when they were conducted.

Modifications to our products may, and in some instances, will, require new regulatory clearances or approvals and may require us to recall or cease marketing our products until clearances or approvals are obtained.

Modifications to our products may require new regulatory approvals or clearances, including 510(k) clearances or premarket approvals, or PMAs, and may require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. The FDA requires device manufacturers to initially make and document in a “letter to file” a determination of whether or not a modification requires a new approval, supplement or clearance. A manufacturer of a 510(k) cleared product may determine that a modification could not significantly affect safety or efficacy and does not represent a major change in its intended use so that no new 510(k) clearance is necessary. However, the FDA can review a manufacturer’s decision and may disagree. The FDA may also on its own initiative determine that a new clearance or approval is required.

 

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We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals because we believe they can be made on a letter-to-file approach. There can be no assurance that the FDA will agree with our approach in such matters or that, if required, subsequent requests for 510(k) clearance will be received in a timely fashion, if at all. The FDA may require us to recall and to stop marketing our products as modified or to disable features pending clearance or approval which would significantly harm our ability to sell our products and cause harm to our existing customer relationships and business. Even if we are not required to take such action, delays in obtaining clearances or approvals for features would adversely affect our ability to introduce enhanced products in a timely manner and would harm our revenue and operating results. The FDA could also take other enforcement action, including but not limited to, issuing a warning letter relating to our decision to implement features and other product modifications via a letter to file rather than submission of a new 510(k) notice.

Clinical trials necessary to support any future510(k) or PMA application will be expensive and may require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Delays or failures in our clinical trials may prevent us from commercializing any modified or new products and will adversely affect our business, operating results and prospects.

If required by the FDA to do so, initiating and completing clinical trials necessary to support a 510(k) or PMA application for expanded indications for use of our existing products, will be time consuming and expensive and the outcome uncertain. Moreover, the results of early clinical trials are not necessarily predictive of future results, and any product we advance into clinical trials may not have favorable results in later clinical trials.

Conducting successful clinical studies may require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Patient enrollment in clinical trials and completion of patient participation and follow-up depends on many factors, including the size of the patient population, the nature of the trial protocol, the attractiveness of, or the discomforts and risks associated with, the treatments received by enrolled subjects, the availability of appropriate clinical trial investigators, support staff, and proximity of patients to clinical sites and able to comply with the eligibility and exclusion criteria for participation in the clinical trial and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures or follow-up to assess the safety and effectiveness of our products or if they determine that the treatments received under the trial protocols are not attractive or involve unacceptable risks or discomforts. Patients may also not participate in our clinical trials if they choose to participate in contemporaneous clinical trials of competitive products.

Development of sufficient and appropriate clinical protocols to demonstrate safety and efficacy may be required and we may not adequately develop such protocols to support clearance or approval. Delays in patient enrollment or failure of patients to continue to participate in a clinical trial may cause an increase in costs and delays in the approval and attempted commercialization of our products or result in the failure of the clinical trial. In addition, despite considerable time and expense invested in our clinical trials, FDA may not consider our data adequate to demonstrate safety and efficacy. Such increased costs and delays or failures could adversely affect our business, operating results and prospects.

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

While we do not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payors, due to the breadth of many healthcare laws and regulations, we cannot assure you that they will not apply to our business. We could be subject to healthcare fraud and patient privacy regulation by both the federal government and the states in which we conduct our business. The regulations that may affect our ability to operate include:

 

   

the federal healthcare program Anti-Kickback Law, which prohibits, among other things, persons from soliciting, receiving or providing remuneration, directly or indirectly, to induce either the referral of an individual, for an item or service or the purchasing or ordering of a good or service, for which payment may be made under federal healthcare programs such as the Medicare and Medicaid programs;

 

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federal false claims laws which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third- party payors that are false or fraudulent, and which may apply to entities like us which provide coding and billing advice to customers or whose products are frequently used off-label;

 

   

the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which prohibits executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information;

 

   

federal self-referral laws, such as STARK, which prohibit a physician from making a referral to a provider of certain health services with which the physician or the physician’s family member has a financial interest, and prohibits submission of a claim for reimbursement pursuant to a prohibited referral; and

 

   

state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

If our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion of our products from reimbursement under Medicare and Medicaid programs and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, to achieve compliance with applicable federal and state privacy, security, and electronic transaction laws, we may be required to modify our operations with respect to the handling of patient information. Implementing these modifications may prove costly. At this time, we are not able to determine the full consequences to us, including the total cost of compliance, of these various federal and state laws.

The application of state certificate of need regulations and compliance with federal and state licensing requirements could substantially limit our ability to sell our products and grow our business.

Some states require healthcare providers to obtain a certificate of need or similar regulatory approval prior to the acquisition of high-cost capital items such as our Sensei system. In many cases, a limited number of these certificates are available and, as a result, hospitals and other healthcare providers may be unable to obtain a certificate of need for the purchase of our Sensei system. Further, our sales cycle for our system is typically longer in certificate of need states due to the time it takes our customers to obtain the required approvals. In addition, our customers must meet various federal and state regulatory and/or accreditation requirements in order to receive reimbursement from government-sponsored healthcare programs such as Medicare and Medicaid and other third-party payors. Any lapse by our customers in maintaining appropriate licensure, certification or accreditation, or the failure of our customers to satisfy the other necessary requirements under government-sponsored healthcare programs, could cause our sales to decline.

 

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Risks Related to Ownership of Our Common Stock

The trading price of our common stock has been volatile and is likely to be volatile in the future.

The trading price of our common stock has been highly volatile. Further, our common stock has a limited trading history. Since our initial public offering in November 2006 through February 27, 2009, our stock price has fluctuated from a low of $3.80 to a high of $39.32. The market price for our common stock may be affected by a number of factors, including:

 

   

the announcement of our operating results, including the number of our Sensei systems sold during a period and our resulting revenue for the period, and the comparison of these results to the expectations of analysts and investors;

 

   

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

 

   

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

 

   

ability of our products to achieve market success;

 

   

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

 

   

our ability to develop sales and marketing capabilities;

 

   

our ability to manufacture our products to meet commercial and regulatory standards;

 

   

our ability to manage costs and improve margins;

 

   

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;

 

   

announcements of acquisitions or dispositions by us or our competitors;

 

   

developments with respect to patents and other intellectual property rights;

 

   

sales of common stock or other debt or equity 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;

 

   

our announcements of guidance regarding future operating or financial results which fails to meet investor or analyst expectations or which differs from our previously-announced guidance;

 

   

changes in earnings estimates or recommendations by securities analysts, failure to obtain analyst coverage of our common stock or our failure to achieve analyst earnings estimates;

 

   

public statements by analysts or clinicians regarding their perceptions of the effectiveness of our products;

 

   

developments in our industry; and

 

   

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

 

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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 continue, or additional securities analysts may not initiate, coverage for our common stock or may issue negative reports, and this may have a negative impact on the market price of our common stock.

Currently, several securities analysts provide research coverage of our common stock. Several analysts have already published statements that do not portray our technology, products or procedures using our products in a positive light and others may do so in the future. If we are unable to educate those who publicize such reports about the benefits we believe our technology provides, or if one or more of the analysts who elects to cover us downgrades our stock, our stock price would likely decline rapidly. If one or more of these analysts ceases coverage of our company, we could lose visibility in the market, which in turn could cause our stock price to decline. The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about us or our business. If sufficient securities analysts do not cover our common stock, the lack of research coverage may adversely affect the market price of our common stock. It may be difficult for companies such as ours, with smaller market capitalizations, to attract and maintain sufficient independent financial analysts that will cover our common stock. This could have a negative effect on the market price of our stock.

Our principal stockholders, directors and management own a large percentage of our voting stock, which allows them to exercise significant influence over matters subject to stockholder approval.

Our executive officers, directors and stockholders holding 5 percent or more of our outstanding common stock beneficially own or control approximately 33.4 percent of the outstanding shares of our common stock as of February 27, 2009. Accordingly, these executive officers, directors and principal stockholders, acting as a group, have substantial influence over the outcome of corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transaction. These stockholders may also delay or prevent a change of control or otherwise discourage a potential acquirer from attempting to obtain control of us, even if such a change of control would benefit our other stockholders. This significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

We have not paid dividends in the past and do not expect to pay dividends in the future, and any return on investment may be limited to the value of our common stock.

We have never paid dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future. The payment of dividends on our common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as our board of directors may consider relevant. If we do not pay dividends, our common stock may be less valuable because a return on your investment will only occur if our stock price appreciates. Pursuant to our agreement with Silicon Valley Bank, we must obtain Silicon Valley Bank’s prior written consent in order to pay any dividends on our common stock.

Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders.

Provisions in our amended and restated certificate of incorporation and amended and restated bylaws, as well as provisions of Delaware law, could make it more difficult for a third party to acquire us, even if doing so would benefit our stockholders. These provisions:

 

   

permit our board of directors to issue up to 10,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate, including the right to approve an acquisition or other change in our control;

 

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provide that the authorized number of directors may be changed only by resolution of the board of directors;

 

   

provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;

 

   

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;

 

   

provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide notice in writing in a timely manner, and also specify requirements as to the form and content of a stockholder’s notice;

 

   

do not provide for cumulative voting rights, therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose;

 

   

provide that special meetings of our stockholders may be called only by the chairman of the board, our chief executive officer or by the board of directors pursuant to a resolution adopted by a majority of the total number of authorized directors; and

 

 

 

provide that stockholders will be permitted to amend our amended and restated bylaws only upon receiving at least 66 2/3 percent of the votes entitled to be cast by holders of all outstanding shares then entitled to vote generally in the election of directors, voting together as a single class.

In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any broad range of business combinations with any stockholder who owns, or at any time in the last three years owned, 15 percent or more of our outstanding voting stock for a period of three years following the date on which the stockholder became an interested stockholder. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders.

Future sales of a substantial number of shares of our common stock in the public market, the announcement to undertake such sales, or the perception that they may occur, may depress the market price of our common stock.

Sales of substantial amounts of our common stock by us or by our stockholders, announcements of the proposed sales of substantial amounts of our common stock or the perception that substantial sales may be made, could cause the market price of our common stock to decline. We may issue additional shares of our common stock in follow-on offerings to raise additional capital or in connection with acquisitions or corporate alliances and we plan to issue additional shares to our employees, directors or consultants in connection with their services to us. All of the currently outstanding shares of our common stock are freely tradable under federal and state securities laws, except for shares held by our directors, officers and certain greater than 5 percent stockholders, which may be subject to volume limitations. Due to these factors, sales of a substantial number of shares of our common stock in the public market could occur at any time. Such sales could reduce the market price of our common stock.

Our financial results may vary significantly from period to period, which may reduce our stock price.

Our financial results may fluctuate as a result of a number of factors, many of which are outside of our control, which may cause the market price of our common stock to fall. For these reasons, comparing our operating results on a period-to-period basis may not be meaningful, and you should not rely on our past results as an indication of our future performance. Our financial results may be negatively affected by any of the risk factors listed in this “Risk Factors” section.

 

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

As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company. In addition, the Sarbanes-Oxley Act, as well as rules subsequently implemented by the United States Securities and Exchange Commission and the Nasdaq Global Market, have imposed various new requirements on public companies, including requiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these requirements. Moreover, these rules and regulations increase our legal and financial compliance costs and make some activities more time-consuming and costly. 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 of 2002, or Sarbanes-Oxley Act, requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls and procedures. In particular, commencing in fiscal 2007, we were required to perform a system and process evaluation and testing of our internal controls over financial reporting to allow management and our independent registered public accounting firm to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. As a result of our compliance with Section 404, we have incurred and will continue to incur substantial accounting expense and expend significant management efforts and we may need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge to ensure continuing compliance.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable

 

ITEM 2. PROPERTIES

We lease approximately 63,000 square feet of manufacturing, laboratory and office space in Mountain View, California. The lease ends in November 2014, but the Company has an option to extend the lease until approximately November 30, 2019.

 

ITEM 3. LEGAL PROCEEDINGS

In June 2007, we filed suit against Luna Innovations, Inc., or Luna, alleging that Luna has, among other things, breached a 2006-2007 development and intellectual property agreement between us and Luna that we believe establishes our ownership of all intellectual property in medical robotics developed by the parties during performance of the agreement, misappropriated our trade secrets and has revealed our confidential information to other companies who might improperly benefit from it. Luna’s Cross-Complaint against us asserts various claims including misappropriation of trade secrets and breach of the parties’ agreements and challenging the inventorship and our ownership of several patent applications which we filed during that same time period. The parties engaged in a nonbinding arbitration process earlier in 2008. Discovery in the case is almost completed and trial has been set for late March 2009.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

 

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PART II.

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market For Our Common Stock

Our common stock is traded on The Nasdaq Global Market under the symbol “HNSN.”

As of February 27, 2009, there were approximately 302 holders of record of our common stock and 25,296,966 shares of common stock outstanding. No dividends have been paid on our common stock to date, and we do not anticipate paying any dividends in the foreseeable future.

The following table lists the low and high sales prices for each period indicated:

 

     2008    2007
         Low            High            Low            High    

First quarter

   $ 13.48    $ 30.93    $ 11.66    $ 22.67

Second quarter

     13.66      19.97      17.60      26.69

Third quarter

     11.72      20.20      17.97      29.15

Fourth quarter

     6.00      13.77      24.62      39.32

The closing price for our common stock as reported by the Nasdaq Global market on February 27, 2009 was $3.86 per share.

Securities Authorized for Issuance Under Equity Compensation Plan

The following table provides certain information regarding our equity compensation plans in effect as of December 31, 2008:

Equity Compensation Plan Information

 

Plan Category

   Number of Securities to
be Issued Upon Exercise
of Outstanding Options,
Warrants and Rights
    Weighted-Average
Exercise Price of
Outstanding Options,
Warrants and Rights
    Number of Securities
Remaining Available for
Issuance Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (a))
 
     (a)     (b)     (c)  

Equity compensation plans approved by security holders

   4,242,510 (1)   $ 12.33 (2)   863,644 (3)

Equity compensation plans not approved by security holders

   —         —       —    
                    

Total

   4,242,510     $ 12.33     863,644  
                    

 

(1) Includes 4,202,510 shares issuable upon exercise of outstanding options and 40,000 shares issuable upon settlement of unvested restricted stock units.
(2) Does not take into account restricted stock units, which have no exercise price.

(3)

On January 1st of each year, the number of authorized shares under (a) the 2006 Equity Incentive Plan automatically increases by a number of shares equal to the lesser of (i) 3,500,000 shares, (ii) 4% of the outstanding shares on December 31 st of the preceding calendar year, and (iii) such other number as determined by the board of directors and (b) the 2006 Employee Stock Purchase Plan automatically increases by a number of shares equal to the lesser of (i) 2% of the outstanding shares on December 31st of the preceding calendar year, and (ii) such other number as determined by the board of directors.

 

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Recent Sales of Unregistered Securities

Not applicable

Uses of Proceeds from Sale of Registered Securities

Not applicable

Issuer Purchases of Equity Securities

None

Performance Graph1

The following graph shows a comparison of cumulative total return for the Company’s common stock, the Nasdaq Composite Index, and the Nasdaq Medical Equipment Index. Such returns are based on historical results and are not intended to suggest future performance. The graph assumes $100 was invested in the Company’s common stock and in each of the indexes on November 16, 2006 (the date the Company’s common stock commenced trading on The Nasdaq Global Market).

Data for the Nasdaq Composite Index and the Nasdaq Medical Equipment Index assume reinvestment of dividends. The Company has never paid dividends on its common stock and has no present plans to do so.

The stockholder return shown on the graph below is not necessarily indicative of future performance, and we do not make or endorse any predictions as to future stockholder returns.

 

 

1

This Section is not “soliciting material,” is not deemed “filed” with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Hansen Medical under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

 

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LOGO

 

     November 16,
2006
   December 31,
2006
   December 31,
2007
   December 31,
2008

Hansen Medical, Inc

   $ 100.00    $ 94.59    $ 245.41    $ 59.18

Nasdaq Composite

     100.00      102.56      111.98      65.24

Nasdaq Medical Equipment

     100.00      101.56      129.57      71.36

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth certain financial data with respect to our business. The information set forth below is not necessarily indicative of results of future operations and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 and the financial statements and related notes thereto in Item 8.

 

     2008(1)     2007(1)(2)     2006(1)     2005(3)     2004  
     (In thousands, except per share data)  

Operations:

          

Revenues

   $ 30,233     $ 10,085     $ —       $ —       $ —    

Loss from operations

     (53,989 )     (53,602 )     (26,683 )     (21,664 )     (7,294 )

Net loss

     (53,444 )     (50,421 )     (26,004 )     (21,403 )     (7,089 )

Basic and diluted net loss per share

     (2.21 )     (2.33 )     (7.09 )     (19.14 )     (9.15 )

Shares used to compute basic and diluted net loss per share

     24,232       21,603       3,670       1,118       775  

Financial Position:

          

Cash and cash equivalents

     17,377       30,404       88,911       15,561       1,604  

Short-term investments

     17,846       18,148       989       20,341       13,836  

Working capital

     40,549       47,569       86,393       33,175       15,364  

Total assets

     72,018       59,901       92,790       37,641       16,863  

Long-term debt

     10,025       1,208       3,309       4,917       —    

Redeemable convertible preferred stock

     —         —         —         61,316       27,700  

Accumulated deficit

     (162,879 )     (109,435 )     (59,014 )     (33,010 )     (11,607 )

Stockholders’ equity (deficit)

     47,705       49,064       84,772       (32,343 )     (11,568 )

 

(1) Loss from operations, net loss and basic and diluted net loss per share for 2008, 2007 and 2006 include the impact of SFAS 123(R) stock-based compensation charges, which were not present in prior years. Refer to Notes 2 and 10 of our Notes to the Financial Statements.
(2) Loss from operations, net loss and basic and diluted net loss per share for 2007 include the impact of the write-off of acquired in-process research and development related to the acquisition of AorTx of $11.4 million.
(3) Loss from operations, net loss and basic and diluted net loss per share for 2005 include the impact of the write-off of acquired in-process research and development related to the acquisition of the assets of endoVia of $4.7 million.

 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-K are forward-looking statements that involve risks and uncertainties. The factors listed in Item 1A “Risk Factors,” as well as any cautionary language in this Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

We develop, manufacture and sell a new generation of medical robotics designed for accurate positioning, manipulation and stable control of catheters and catheter-based technologies. Our Sensei™ Robotic Catheter System, or Sensei system, is designed to allow physicians to instinctively navigate flexible catheters with greater stability and control in interventional procedures. We believe our Sensei system and its corresponding disposable Artisan catheter will enable physicians to perform procedures that historically have been too difficult or time

 

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consuming to accomplish routinely with manually-controlled, hand-held catheters and catheter-based technologies, or that we believe could be accomplished only by the most skilled physicians. We believe that our Sensei system has the potential to benefit patients, physicians, hospitals and third-party payors by improving clinical outcomes and permitting more complex procedures to be performed interventionally.

We were formerly known as Autocath, Inc. and were incorporated in Delaware on September 23, 2002. In March 2007, we established Hansen Medical UK Ltd, a wholly-owned subsidiary located in the United Kingdom and, in May 2007, we established Hansen Medical Deutschland, GmbH, a wholly-owned subsidiary located in Germany. Since inception, we have devoted the majority of our resources to the development and commercialization of our Sensei system. Prior to the second quarter of 2007, we were a development stage company with a limited operating history. In the second quarter of 2007 we obtained the necessary regulatory approvals and recorded our initial product revenues. To date, we have incurred net losses in each year since our inception and, as of December 31, 2008, we had an accumulated deficit of $162.9 million. We expect our losses to continue through at least 2009 as we continue to expand the commercialization of our Sensei system and Artisan catheter and continue to develop new products. We have financed our operations primarily through the sale of public and private equity securities and the issuance of debt.

We received CE Mark approval for our Sensei system in the fourth quarter of 2006 and made our first commercial shipments to the European Union in the first quarter of 2007. We deferred all revenue associated with those shipped systems as we had not yet received CE Mark approval for our Artisan catheters. In May 2007, we received CE Mark approval for our Artisan catheter and also received FDA clearance for the marketing of our Sensei system and Artisan catheter for manipulation, positioning and control of certain mapping catheters during electrophysiology procedures. As a result, we recorded our first revenues in the second quarter of 2007.

We market our products in the United States primarily through a direct sales force of regional sales employees, supported by clinical account managers who provide training, clinical support and other services to our customers. Outside the United States, primarily in the European Union, we use a combination of a direct sales force and distributors to market, sell and support our products. We have increased our manufacturing capacity to enable production of commercial quantities of our Sensei system and Artisan catheter.

In April 2007, we entered into development and marketing agreements with St. Jude Medical, Inc., or St. Jude. Pursuant to these agreements, we have introduced our CoHesionTM 3D Visualization Module, or CoHesion Module, which integrates our Sensei system with St. Jude’s Ensite® system. Under the agreements, we are solely responsible for obtaining regulatory approvals for, and all costs associated with, our portion of the integrated products developed under the arrangement. In addition, under the terms of the co-marketing agreement, we granted St. Jude the exclusive right to distribute products developed under the joint development agreement when ordered with St. Jude products worldwide, excluding certain specified countries, for the diagnosis and/or treatment of electrophysiologic cardiac conditions.

In November 2007, we acquired AorTx, Inc., or AorTx, an early stage company developing heart valves to be delivered in minimally invasive surgery by catheters through the skin and blood vessels, which is known as “percutaneous” delivery. Under the terms of our agreement with AorTx, we acquired all of the outstanding equity interests of AorTx in exchange for 140,048 shares of Hansen common stock plus cash consideration of approximately $4.5 million and forgiveness of approximately $143,000 of notes payable plus possible future milestone payments of up to $30.0 million upon achievement of regulatory clearances and revenue and partnering milestones. Such future payments are to be made 50% in cash and 50% in shares of our common stock. We have eliminated the research and development positions focused on developing the AorTx valve technology and while we continue to pursue the application of robotics to structural heart procedures, we do not expect that the technologies acquired from AorTx will form a material, or any, part of that strategy. Under the terms of the AorTx acquisition, we must decide by May 15, 2009 whether to make a $5 million payment to the former AorTx stockholders or license the acquired AorTx technologies back to an entity formed by the former AorTx stockholders.

 

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Critical Accounting Policies, Estimates and Judgments

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States. In doing so, we have to make estimates and assumptions that affect our reported amounts of assets, liabilities, revenues and expenses, as well as related disclosures of contingent assets and liabilities. In many cases, we could reasonably have used different accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. We base our estimates on our past experience and on other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected.

While our significant accounting policies are fully described in Note 2 to our Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form 10-K, we believe that the following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.

Revenue Recognition

Our revenues are primarily derived from the sale of our Sensei system and the associated Artisan catheters. As computer software is more than incidental to the functioning of those products, our revenue recognition policy is based on American Institute of Certified Public Accountants, or AICPA, Statement of Position 97-2, Software Revenue Recognition, or SOP 97-2. Under our policy, revenues are recognized when persuasive evidence of an arrangement exists, delivery to the customer has occurred or the services have been fully rendered, the sales price is fixed or determinable and collectibility is probable.

 

   

Persuasive Evidence of an Arrangement. Persuasive evidence of an arrangement for sales of Sensei systems is determined by a sales contract signed and dated by both the customer and us, including approved terms and conditions. Evidence of an arrangement for the sale of disposable products is determined through an approved purchase order from the customer.

 

   

Delivery.

 

   

Multiple-element Arrangements. Typically, all products and services sold to customers are itemized and priced separately. In arrangements that include multiple elements, we allocate revenue based on vendor-specific objective evidence of fair value, or VSOE, and defer revenue for undelivered items. VSOE for each element is based on the price for which the item is sold separately, determined based on historical evidence of stand-alone sales of these elements or stated renewal rates for the element. When contracts contain multiple elements wherein VSOE exists for all undelivered elements, we account for the delivered elements in accordance with the residual method prescribed by AICPA Statement of Position 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions. Under the residual method, the full VSOE of the undelivered element is deferred until that element is delivered and any residual revenue is recognized. When we are not able to reasonably determine the VSOE of an undelivered element, we defer the entire arrangement fee until all elements are delivered. If we cannot establish VSOE for an element of the arrangement and the only undelivered element is post-contract customer support, or PCS, the arrangement fee is recognized ratably over the term of the PCS.

 

   

Systems. Typically, ownership of our Sensei systems passes to our customers upon shipment. When no further obligations exist subsequent to the shipment of the system, we recognize system revenues upon shipment. However, a large percentage of the sales contracts for our systems include installation and training. These services are not as yet offered on a stand-alone basis and we are not currently able to reliably estimate the fair value of these services based on VSOE. Therefore, we currently defer all such system revenues until training and installation are completed.

 

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Disposable Products. Ownership of our Artisan catheters and other disposable products typically passes to our customers upon shipment, at which time delivery is deemed to be complete.

 

   

Service Revenue. We recognize service revenue from the sale of product maintenance plans. Revenue from services, whether sold individually or as a separate unit of accounting in a multi-element arrangement, is deferred and amortized over the service period, which is typically one year.

 

   

Sales Price Fixed and Determinable. Sales prices are documented in the executed sales contract or purchase order received prior to shipment. Our standard terms do not allow for contingencies, such as trial or evaluation periods, refundable orders, payments contingent upon the customer obtaining financing or other contingencies which would impact the customer’s obligation. In situations where contingencies such as those identified are included, we defer all related revenue until the contingency is resolved.

 

   

Collectibility. Our sales contracts generally do not allow the customer the right of cancellation, refund or return, except as provided under our standard warranty. If such rights were allowed, we would defer all related revenues until such rights expired.

Significant management judgments and estimates are made in connection with the determination of revenue to be recognized and the period in which it is recognized. If we were to make different judgments or utilize different estimates, the amount of revenue to be recognized and the period in which it is recognized could differ materially from the amounts reported.

Short-Term Investments

We determine the appropriate classification of investments at the time of purchase and evaluate such designation as of each balance sheet date. We classify all investments with maturities greater than three months at the time of purchase as short-term investments as they are subject to use within one year in current operations. We make investments based on specific guidelines approved by our board of directors with a view to liquidity and capital preservation and regularly review our investments for performance. As of December, 31, 2008, all our investments have been classified as available-for-sale and are carried on the balance sheet at fair value with unrealized gains and losses, if any, included in other comprehensive income within stockholders’ equity. Any unrealized losses which are determined to be other than temporary will be included in earnings. Realized gains and losses are recognized on the specific identification method.

We periodically evaluate our investments for impairment. In the event that the carrying value of an investment exceeds its fair value and the decline in fair value is determined to be other than temporary, an impairment charge is recorded and a new cost basis for the investment is established. In order to determine whether a decline in value is other than temporary, we evaluate many factors, including the following: the duration and extent to which the fair value has been less than the carrying value; our financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in the industry; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. As of December 31, 2008, we had not experienced other-than-temporary declines in value in any of our investments. Significant management judgment is required in determining whether an other-than-temporary decline in the value of an investment exists. Changes in our assessment of the valuation of our investments could materially impact our future operating results and financial position.

Allowance for Doubtful Accounts

We establish allowances for doubtful accounts based on our review of the credit profiles of our customers, contractual terms and conditions, current economic trends and historical collection experience. We reassess the allowance for doubtful accounts for each period. If we were to make different judgments or utilize different

 

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estimates, the amount or timing of bad debt expense or revenue recognized could differ materially from the amounts reported. In our limited historical experience, our actual losses and credits related to our accounts receivable have been consistent with the recorded provisions. If, however, our actual future receipts differ materially from our current assessments due, among other things, to unexpected events or significant changes in trends, additional provisions may be necessary and our future cash flows and statements of operations could be materially negatively impacted. Our allowances for doubtful accounts as a percentage of revenues have been immaterial.

Inventories, Net

We record inventory, which includes material, labor and overhead costs, at standard cost, which approximates actual cost, determined on a first-in, first-out basis, not in excess of market value. We record reserves, when necessary, to reduce the carrying value of excess or obsolete inventories to their net realizable value. These reserves are based on our best estimates after considering projected future demand. In the event that actual demand for our inventory differs from our best estimates or we fail to receive the necessary regulatory approvals, increases to inventory reserves might become necessary.

Impairment of Long-Lived Assets

We evaluate the recoverability of our long-lived assets in accordance with Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 144 (as amended), Accounting for the Impairment or Disposal of Long-Lived Assets. When events or changes in circumstances indicate that the carrying value of long-lived assets may not be recoverable, we recognize such impairment if the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows attributable to the assets. We have not recorded any impairment losses to date. As of December 31, 2008, we had $18.2 million of property and equipment, net. If estimates or the related assumptions change in the future, we may record impairment charges to reduce the carrying value of certain groups of these assets. Changes in the valuation of long-lived assets could materially impact our operating results and financial position.

Stock-Based Compensation

We account for compensation expense related to stock-based awards in accordance with FASB SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS 123(R). Under the fair value recognition provisions of SFAS 123(R), stock-based payment expense is estimated at the grant date based on the fair value of the award and is recognized as expense ratably over the requisite service period of the award. The recording of compensation expense related to stock-based awards is significant to our financial statements but does not result in the payment of cash by us. Determining the appropriate fair value model used to calculate the fair value of stock-based awards requires significant management judgment. Additionally, the calculation of the fair value of stock-based awards requires us to make significant estimates and judgments, including the expected volatility, the expected term of the award and the forfeiture rate. If we had chosen a different fair value model or made different estimates in the calculation of fair value, the amount or timing of stock-based compensation recorded could have differed materially from the amounts reported.

Upon the adoption of SFAS 123(R) on January 1, 2006, we selected the Black-Scholes option pricing model as the most appropriate method for determining the estimated fair value for our stock-based awards. The Black-Scholes model requires the use of highly subjective and complex assumptions in determining the fair value of stock-based awards, including the expected volatility of the underlying stock, the award’s expected term and the forfeiture rate.

 

   

Expected Volatility. Our current estimate of volatility is based on a blend of average historical volatilites of our stock price and the volatility of similar entities.

 

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Expected Term. We estimate the expected term based on our historical settlement experience related to vesting and contractual terms while giving consideration to awards that have life cycles less than the contractual terms and vesting schedules in accordance with SFAS 123(R) and Securities and Exchange Commission Staff Accounting Bulletin No. 107.

 

   

Forfeiture Rate. We estimate our forfeiture rate based on our historical experience and revise these estimates in future periods if actual forfeitures differ from those estimates.

To the extent that future evidence regarding these variables is available and provides estimates that we determine are more indicative of actual trends, we may refine or change our approach to deriving these input estimates. These changes could significantly impact the stock-based compensation expense recorded in the future.

We account for compensation expense related to stock-based awards to non-employees in accordance with Emerging Issues Task Force Issue No. 96.18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. We record the expense of such services based on the estimated fair value of the award using the Black-Scholes pricing model. The value of the award is recognized as expense ratably over the requisite service period of the award.

Net Operating Loss Carryforwards

At December 31, 2008, we had federal and California net operating loss carryforwards of approximately $125.1 million and $109.5 million, respectively. At December 31, 2007, we had federal and California net operating loss carryforwards of approximately $84.6 million and $73.4 million, respectively. These net operating loss carryforwards will expire in varying amounts from 2015 through 2029 if not utilized. Based on the weight of the available evidence, we have provided a full valuation allowance against the deferred tax asset for those net operating losses totaling $48.9 million and $33.1 million at December 31, 2008 and 2007, respectively.

Section 382 and 383 of the Internal Revenue Code of 1986, as amended, provide for limitations on the utilization of net operating loss and research and experimentation credit carryforwards if the Company were to undergo an ownership change, as defined in Section 382. The Company’s initial public offering in November 2006 resulted in such an ownership change. Accordingly, the annual utilization of net operating loss and credit carryforwards which existed at the time of the offering will be limited to $7.6 million.

Financial Overview

Revenues

We made our first commercial shipments to Europe in the first quarter of 2007 and recognized our first revenues in the second quarter of 2007 for both European and U.S. customers. 2008 represents our first full year of revenues. Our revenues consist of sales of Sensei systems, Artisan catheters, other disposables and, beginning in 2008, service revenues. We have experienced significant fluctuations in quarterly revenues, primarily due to still being in the early stages of our commercial launch and, especially in the fourth quarter of 2008, general economic and capital market conditions. We expect these fluctuations to continue in 2009, even as we plan to experience overall revenue growth as compared to 2008 levels. We do not anticipate that revenues in 2009 will be sufficient to eliminate losses.

Cost of Goods Sold

Cost of goods sold consists primarily of materials, direct labor, depreciation, overhead costs associated with manufacturing, training and installation costs, royalties, provisions for inventory valuation and warranty expenses. We expect that cost of goods sold both as a percentage of revenue and on a dollar basis will continue to vary from quarter to quarter in 2009 due, among other things, to fluctuations in revenue levels, average selling prices, the mix of products sold, manufacturing levels and manufacturing yields.

 

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Research and Development Expenses

Our research and development expenses primarily consist of engineering, software development, product development, quality assurance and clinical and regulatory expenses, including costs to develop our Sensei system and disposable Artisan catheters. Research and development expenses include employee compensation, including stock-based compensation expense, consulting services, outside services, materials, supplies, depreciation and travel. We expense research and development costs as they are incurred. Prior to our first commercial shipments in the second quarter of 2007, research and development expenses also included manufacturing costs for commercial products, including start-up manufacturing costs. We expect research and development expenses in 2009 to decrease as compared to 2008 levels as we reduce our employee costs and carefully manage expenses related to our development activities for the electrophysiology market and exploring certain other potential future applications of our technology.

Selling, General and Administrative Expenses

Our selling, general and administrative expenses consist primarily of compensation for executive, finance, sales, legal and administrative personnel, including sales commissions and stock-based compensation. Other significant expenses include costs associated with attending medical conferences, professional fees for legal services (including legal services associated with our efforts to obtain and maintain broad protection for the intellectual property related to our products) and accounting services, consulting fees and travel expenses. We expect our selling, general and administrative expenses in 2009 to decrease as compared to 2008 levels as we reduce general and administrative employee costs while we continue to maintain our sales and clinical support groups and prepare for a March 2009 trial in our litigation against Luna Innovations, Inc.

Acquired In-process Research and Development

Acquired in-process research and development consists of in-process research and development acquired in our acquisition of AorTx in November 2007. As the research and development acquired in the AorTx acquisition had not reached the stage of technological feasibility and had no alternative future use, the amounts were immediately written off.

Results of Operations

Comparison of the year ended December 31, 2008 to the year ended December 31, 2007

Revenues

 

     Year Ended
December 31,
   Change  
     2008    2007    $        %      
     (Dollars in thousands)  

Revenues

   $ 30,233    $ 10,085    $ 20,148    200 %

Revenues for 2008 primarily related to the sale of 27 Sensei systems in the United States and 13 Sensei systems in Europe at an average selling price of approximately $658,000 per unit and the sale of approximately 1,600 Artisan catheters at an average selling price of approximately $1,700 per unit. Revenues for 2007 primarily related to the sale of nine Sensei systems in the United States and six Sensei systems in Europe at an average selling price of $625,000 per unit and the sale of approximately 380 Artisan catheters at an average selling price of approximately $1,900. Average selling prices of Sensei systems in 2008 were positively impacted by sales of Sensei systems with CoHesion Modules and the sale of one system with an additional robotic arm. We have experienced significant fluctuations in quarterly revenues, primarily due to our still being in the early stages of our commercial launch and, especially in the fourth quarter of 2008, general economic and capital market conditions. During the fourth quarter of 2008, in a period of economic uncertainty, we saw many potential customers lengthen their sales cycles and postpone purchase decisions. We expect these fluctuations to continue in 2009, even as we plan to experience overall revenue growth as compared to 2008 levels.

 

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Cost of Goods Sold

 

     Year Ended
December 31,
    Change  
     2008     2007     $        %      
     (Dollars in thousands)  

Cost of goods sold

   $ 21,528     $ 9,138     $ 12,390    136 %

As a percentage of revenues

     71.2 %     90.6 %     

Cost of goods sold for 2008 included stock-based compensation expense of $0.7 million as compared to $0.4 million for 2007. During the second half of 2008, we experienced an increase in the overhead applied to our inventory, primarily due to our move into a new facility. During 2007 we sold certain inventory which had previously been written down to zero as a result of the uncertainty of receiving FDA clearance and CE Mark approval. As a result, cost of goods sold for 2007 did not include all of the cost for those sales, which resulted in a benefit of approximately $0.7 million. Cost of goods sold for 2007 also included a $0.4 million non-recurring milestone royalty charge. Overall, cost of goods sold for 2008 benefited as compared to 2007 from an increase in the level of production necessary for the increase in the sales and from manufacturing efficiencies as we have reduced the cost of producing our products. We expect that cost of goods sold both as a percentage of revenue and on a dollar basis will continue to vary from quarter to quarter during 2009 due, among other things, to fluctuations in revenues, average selling prices, the mix of products sold, manufacturing levels and manufacturing yields.

Operating Expenses

Research and Development

 

     Year Ended
December 31,
   Change  
     2008    2007    $        %      
     (Dollars in thousands)  

Research and development

   $ 25,582    $ 19,020    $ 6,562    35 %

In the first quarter of 2007, as a development-stage company, all manufacturing expenses were included in research and development expenses. Beginning in the second quarter of 2007, as we received the necessary regulatory approvals, commenced our commercial operations and exited the development stage, manufacturing expenses were included in cost of goods sold. Research and development expenses for 2007 included development-stage manufacturing expenses of $1.0 million, all of which were incurred during the first quarter of 2007. The remaining change in research and development expenses in 2008 compared to 2007 of approximately $7.6 million was primarily due to the following:

 

   

An increase of $3.9 million in research and development materials, outside services and overhead expenses;

 

   

An increase of $3.4 million in employee-related expenses related to an increase of 18 in average research and development headcount; and

 

   

An increase of $0.3 million in stock-based compensation expenses due to our larger employee base, partially offset by the effects of our lower average stock price.

Research and development expenses in 2008 included $2.7 million of non-cash stock-based compensation expenses compared to $2.4 million in 2007. We expect research and development expenses in 2009 to decrease as compared to 2008 levels as we reduce our employee costs and carefully manage expenses related to our development activities for the electrophysiology market and exploring certain other potential future applications of our technology.

 

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Selling, General and Administrative

 

     Year Ended
December 31,
   Change  
     2008    2007    $        %      
     (Dollars in thousands)  

Selling, general and administrative

   $ 37,112    $ 24,179    $ 12,933    53 %

Selling, general and administrative expenses increased in 2008 compared to 2007 primarily due to the following:

 

   

An increase of $6.0 million in employee-related expenses, including sales commissions and traveling expenses, associated with an increase in average sales and marketing headcount of 18 and an increase in average general and administrative headcount of 5;

 

   

An increase of $2.5 million in stock-based compensation expenses due to our larger employee base and the effects of stock option modifications for exiting employees;

 

   

An increase of $2.2 million in professional service fees, primarily consisting of legal fees necessary for the development of our intellectual property portfolio, Luna litigation costs and other intellectual property related legal expenses;

 

   

An increase of $1.3 million in supplies, equipment and overhead expenses;

 

   

An increase of $1.1 million in lease costs for our new facility, all of which were being charged to selling, general and administrative expenses prior to its occupancy in July 2008; and

 

   

A decrease of $0.2 million in non-compensation marketing expenses.

Selling, general and administrative expenses in 2008 included $7.8 million of non-cash stock-based compensation expenses compared to $5.3 million in 2007. We expect our selling, general and administrative expenses in 2009 to decrease as compared to 2008 levels as we reduce general and administrative employee costs while we continue to maintain our sales and clinical support groups and prepare for a March 2009 trial in our litigation against Luna Innovations, Inc.

Acquired In-process Research and Development

 

     Year Ended
December 31,
   Change  
     2008    2007    $         %      
     (Dollars in thousands)  

Acquired in-process research and development

   $ —      $ 11,350    $ (11,350 )   (100 )%

Acquired in-process research and development for 2007 consists of in-process research and development acquired in our acquisition of AorTx. Under the terms of our agreement with AorTx, we acquired all of the outstanding equity interests of AorTx in exchange for 140,048 shares of our common stock plus cash consideration of approximately $4.5 million and forgiveness of approximately $143,000 of notes payable plus possible future milestone payments of up to $30.0 million upon achievement of regulatory clearances and revenue and partnering milestones.

Interest Income

 

     Year Ended
December 31,
   Change  
     2008    2007    $         %      
     (Dollars in thousands)  

Interest income

   $ 1,393    $ 3,672    $ (2,279 )   (62 )%

 

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Interest income decreased in 2008 compared to 2007 primarily due to decreased average cash, cash equivalents and short-term investments balances in 2008 as compared to 2007, due primarily to the use of cash in operations and for the acquisition of AorTx, partially offset by the cash received from our equity offering in April 2008. We expect interest income to continue to decrease in 2009 as our average cash, cash equivalents and short-term investments balances continue to decrease.

Interest Expense

 

     Year Ended
December 31,
    Change  
     2008     2007     $         %      
     (Dollars in thousands)  

Interest expense

   $ (630 )   $ (482 )   $ (148 )   31 %

Interest expense increased in 2008 as compared to 2007 primarily due to the interest on our new term equipment line with Silicon Valley Bank. We expect our interest expense to increase in 2009 compared to 2008 based on a full year of interest related to the term equipment line.

Other Expense

 

     Year Ended
December 31,
    Change  
     2008     2007     $         %      
     (Dollars in thousands)  

Other expense

   $ (218 )   $ (9 )   $ (209 )   2322 %

Other expense consisted mainly of realized foreign exchange losses in both 2008 and 2007.

Comparison of the year ended December 31, 2007 to the year ended December 31, 2006

Revenues

 

     Year Ended
December 31,
   Change
     2007    2006    $        %    
     (Dollars in thousands)

Revenues

   $ 10,085    $ —      $ 10,085    N/A

In the second quarter of 2007, we received FDA clearance for commercialization of our Sensei system and Artisan catheter in the United States. This was followed by receipt of CE Mark approval in the European Union, enabling us to begin marketing our products in Europe for use during electrophysiology procedures. As a result, we recorded our initial product revenues in the second quarter of 2007. In 2007, our revenues related to the sale of six Sensei systems to Europe and nine Sensei systems to the United States at an average selling price of $625,000 per unit. Revenues also include the sales of disposable products for use with the Sensei system.

Cost of Goods Sold

 

     Year Ended
December 31,
   Change
     2007     2006    $        %    
     (Dollars in thousands)

Cost of goods sold

   $ 9,138     $ —      $ 9,138    N/A

As a percentage of revenues

     90.6 %     N/A      

 

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In conjunction with our first revenues, we recorded our first cost of goods sold in the second quarter of 2007. Cost of goods sold for 2007 included a non-recurring milestone royalty charge of $0.4 million. During 2007 the Company sold certain inventory which had previously been written down to zero as a result of the uncertainty of receiving FDA clearance and CE Mark approval. As a result, cost of goods sold for 2007 did not include all of the cost for those sales, which resulted in a benefit of approximately $0.7 million. Cost of goods sold for 2007 also included non-cash stock-based compensation expense of $379,000.

Operating Expenses

Research and Development

 

     Year Ended
December 31,
   Change  
     2007    2006    $        %      
     (Dollars in thousands)  

Research and development

   $ 19,020    $ 16,561    $ 2,459    15 %

Prior to the second quarter of 2007, as a development-stage company, all manufacturing expenses, including provisions for inventory valuation required as a result of the uncertainty of receiving the necessary regulatory approvals, were included in research and development expenses. Beginning in the second quarter of 2007, as we received the necessary regulatory approvals, commenced our commercial operations and exited the development stage, manufacturing expenses were included in cost of goods sold. Research and development expenses for 2007 included development-stage manufacturing expenses of $1.0 million, all of which were incurred during the first quarter of 2007. Research and development expenses for 2006 included development-stage manufacturing expenses of $2.5 million and provisions for inventory valuation of $1.3 million. The remaining change in research and development expenses for 2007 compared to 2006 was primarily due to the following:

 

   

An increase of $2.3 million in employee-related expenses related to an increase of 21 in research and development headcount;

 

   

An increase of $1.5 million in stock-based compensation expenses due to our larger employee base, the effect of our prospective adoption of SFAS No. 123(R), the effect of increases in the price of our common stock and the start of our 2006 Employee Stock Purchase Plan, or ESPP;

 

   

An increase of $2.0 million in outside services, materials and overhead expenses; and

 

   

A decrease of $0.4 million in the cost of licensed technology.

Research and development expenses in 2007 included $2.4 million of non-cash stock-based compensation expenses compared to $0.9 million in 2006.

Selling, General and Administrative

 

     Year Ended
December 31,
   Change  
     2007    2006    $        %      
     (Dollars in thousands)  

Selling, general and administrative

   $ 24,179    $ 10,122    $ 14,057    139 %

Selling, general and administrative expenses increased in 2007 compared to 2006 primarily due to the following:

 

   

An increase of $5.8 million in employee-related expenses, including sales commissions and traveling expenses, associated with an increase in sales and marketing headcount of 23 and an increase in general and administrative headcount of 9;

 

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An increase of $3.2 million in professional service fees, primarily consisting of legal fees necessary for the development of our intellectual property portfolio and other intellectual property related legal expenses and accounting and legal fees necessary to operate as a public company;

 

   

An increase of $3.5 million in stock-based compensation expenses due to our larger employee base, the effect of our prospective adoption of SFAS No. 123(R), the effect of increases in the price of our common stock and the start of our ESPP;

 

   

An increase of $1.0 million in supplies, equipment and overhead expenses; and

 

   

An increase of $0.6 million in non-compensation marketing expenses.

Selling, general and administrative expenses in 2007 included $5.3 million of non-cash stock-based compensation expenses compared to $1.8 million in 2006.

Acquired In-process Research and Development

 

     Year Ended
December 31,
   Change
     2007    2006    $        %    
     (Dollars in thousands)

Acquired in-process research and development

   $ 11,350    $ —      $ 11,350    N/A

Acquired in-process research and development for 2007 consists of in-process research and development acquired in our acquisition of AorTx. Under the terms of our agreement with AorTx, we acquired all of the outstanding equity interests of AorTx in exchange for 140,048 shares of Hansen common stock plus cash consideration of approximately $4.5 million and forgiveness of approximately $143,000 of notes payable plus possible future milestone payments of up to $30.0 million upon achievement of regulatory clearances and revenue and partnering milestones.

Interest Income

 

     Year Ended
December 31,
   Change  
     2007    2006    $        %      
     (Dollars in thousands)  

Interest income

   $ 3,672    $ 1,631    $ 2,041    125 %

Interest income increased for 2007 compared to 2006 primarily due to increased cash, cash equivalents and short-term investments balances in 2007 as compared to 2006, due primarily to the net $78.3 million raised in our initial public offering in November 2006.

Interest Expense

 

     Year Ended
December 31,
    Change  
     2007     2006     $        %      
     (Dollars in thousands)  

Interest expense

   $ (482 )   $ (647 )   $ 165    (26 )%

Interest expense decreased for 2007 as compared to 2006 primarily due to the lowering of the debt balances as we pay down our long-term loan.

 

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Other Expense

 

     Year Ended
December 31,
    Change  
     2007     2006     $        %      
     (Dollars in thousands)  

Other expense

   $ (9 )   $ (305 )   $ 296    (97 )%

Other expense consisted of realized foreign exchange losses in 2007. Other expense in 2006 consisted of the change in the carrying value of warrants to purchase redeemable convertible preferred stock.

Liquidity and Capital Resources

 

     2008     2007     2006  

Cash and cash equivalents

   $ 17,377     $ 30,404     $ 88,911  

Short-term investments

     17,846       18,148       989  
                        

Total cash, cash equivalents and short-term investments

   $ 35,223     $ 48,552     $ 89,900  
                        

Cash used in operating activities

   $ (45,251 )   $ (33,108 )   $ (21,970 )

Cash provided by (used in) investing activities

     (17,735 )     (24,380 )     17,776  

Cash provided by (used in) financing activities

     49,959       (1,019 )     77,544  
                        

Net increase (decrease) in cash and cash equivalents

   $ (13,027 )   $ (58,507 )   $ 73,350  
                        

Cash, Cash Equivalents and Short-Term Investments

Our cash and investment balances are held in a variety of interest-bearing instruments, including United States government agency securities, corporate debt securities and money market funds. Cash in excess of immediate requirements is invested in accordance with our investment policy primarily with a view towards liquidity and capital preservation.

Net Cash Used in Operating Activities

Net cash used in operating activities for the years presented primarily reflects the net loss for those periods excluding the acquired in-process research and development expenses in 2007, partially offset by non-cash charges such as depreciation and amortization and stock-based compensation. Additionally, net cash used in operating activities in 2008 and 2007 was negatively impacted by the increase in accounts receivable and inventory balances necessitated by the continuing growth of commercial sales of our Sensei system and Artisan catheter, and was positively impacted by the increase in our accounts payable and accrued liability accounts as our increased operations require higher levels of purchasing.

Net Cash Provided by (Used in) Investing Activities

Net cash provided by (used in) investing activities for the years presented primarily relates to the proceeds and purchases of investments as we manage our investment portfolio to provide interest income and liquidity. Investing activities were also negatively impacted by the purchase of property and equipment as we invested in the infrastructure of our growing company, especially in 2008 as we invested in the build-out of our new facility. Investing activities in 2007 included the acquisition of AorTx.

Net Cash Provided by (Used in) Financing Activities

Net cash provided by financing activities in 2008 was mainly due to the cash received from our equity offering in April 2008 and the proceeds from our new term equipment line, in addition to receipts from our

 

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employee stock purchase plan and from the net exercises of stock options, partially offset by repayments of our long-term debt. Net cash used in financing activities in 2007 was mainly attributable to repayments of long-term debt and the payments for remaining costs associated with our initial public offering in November 2006, partially offset by receipts from stock option exercises and our employee stock purchase plan. Net cash provided by financing activities in 2006 was mainly attributable to the issuance of common shares in our initial public offering.

Historical Financing Activities

We have incurred losses since our inception in September 2002 and, as of December 31, 2008 we had an accumulated deficit of $162.9 million. We have financed our operations to date principally through the sale of capital stock, debt financing, interest earned on investments and the sales of our products. Prior to our initial public offering of stock in November 2006, we had received net proceeds of $61.3 million from the issuance of common and preferred stock and $7.0 million in debt financing. Through our initial public offering in 2006 we received net proceeds of $78.3 million. On April 7, 2008, we sold 3,000,000 shares of our common stock, resulting in approximately $39.5 million of net proceeds.

On August 25, 2008, we entered into a $25 million loan and security agreement with Silicon Valley Bank, consisting of a $15 million term equipment line and a one-year $10 million revolving credit line. As of December 31, 2008, we had drawn down approximately $12.5 million against the equipment line under this agreement, leaving $2.5 million available under the equipment line which we may continue to draw against until March 31, 2009 and $10 million available under the revolving credit line which expires in August 2009. At the time of the drawdown, we paid in full our then-existing debt. Our current debt with Silicon Valley bank is collateralized by substantially all of our assets, excluding intellectual property, and is subject to certain covenants, including maintaining the required liquidity, achieving specified EBITDA amounts and fulfilling certain reporting requirements. The liquidity covenants require us to maintain at the end of each month either liquid assets in the amount of 1.5 times the outstanding loan balance or sufficient liquidity to fund at least six months of projected operations, whichever is greater. We will become subject to quarterly EBITDA covenants beginning with the quarter ending March 31, 2009. Silicon Valley Bank has yet to determine the quarterly EBITDA amounts with us. As of December 31, 2008, we were in compliance with all financial covenants. Additionally, the agreement limits our ability to take the following corporate actions without prior consent from Silicon Valley Bank:

 

   

transfer all or any part of our business or properties, other than transfers made in the ordinary course of business;

 

   

engage in any business other than the business in which we are currently engaged;

 

   

merge or consolidate with any other person, or acquire, all or substantially all of the capital stock or property of another person, subject to certain exceptions;

 

   

create, incur, assume, or be liable for any indebtedness, other than certain permitted indebtedness;

 

   

pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock, subject to certain exceptions;

 

   

create, incur, allow or suffer any lien on any of our property, including without limitation intellectual property, assign or convey any right to receive income;

 

   

directly or indirectly enter into or permit to exist any material transaction with any of our affiliates, subject to certain exceptions; and

 

   

make or permit any payment on any subordinated debt.

In the event we were to violate any covenants or if Silicon Valley Bank deems there to have been a material adverse change, including (1) a material impairment in the perfection or priority of Silicon Valley Bank’s lien in

 

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the collateral or in the value of such collateral, (2) a material adverse change in our business, operations or condition (financial or otherwise), or (3) a material impairment of the prospect of repayment of any portion of our obligations, we would seek to obtain a waiver from Silicon Valley Bank. If we were unable to obtain a waiver, we would be in default under the loan and security agreement, which would preclude us from accessing any available borrowings under the loan and security agreement. This would also entitle Silicon Valley Bank to exercise their remedies, including the right to accelerate the debt, upon which we may be required to repay all amounts then outstanding under the loan and security agreement.

Future Capital Requirements

We are still in the early stages of commercializing our Sensei system and Artisan catheter and we have not achieved profitability. We recognized our first revenues in 2007 and have not generated net income to date. We have experienced significant fluctuations in quarterly revenues and, especially in the fourth quarter of 2008, we saw many potential customers lengthen their sales cycles and postpone purchase decisions due in large part to general economic and capital market conditions. In an attempt to reduce our future spending, we reduced our work force in the third quarter of 2008 and again in the first quarter of 2009. We anticipate that we will continue to incur substantial net losses for at least the next year as we continue to commercialize our products, maintain and develop the corporate infrastructure required to manufacture and sell our products at sufficient levels and profit margins and operate as a publicly traded company as well as continue to develop new products and pursue additional applications for our technology platform.

We believe our existing cash, cash equivalents and short-term investment balances and the interest income we earn on these balances in addition to the amounts available under our term equipment line and revolving credit line and amounts received through the sale of our products will be sufficient to meet our anticipated cash requirements through at least 2009. As discussed herein, the loan and security agreement with Silicon Valley Bank requires us to be in compliance with certain covenants beginning with the quarter ended March 31, 2009, including a liquidity covenant and a quarterly EBITDA covenant. The quarterly EBITDA covenant amount has yet to be determined and we are currently working with Silicon Valley Bank to establish the EBITDA amounts based on financial projections provided by us to Silicon Valley Bank. We expect to have sufficient margin in the EBITDA amounts, when finalized, so that the covenant will not be triggered in any quarter in 2009, however, there can be no assurances that this will be the case. In order to maintain compliance with the financial covenants during 2009, we will need to achieve certain revenue targets and also achieve certain cost reductions to our operating expenses. We have considered the impact of the cost reductions to our business and believe these measures are temporary in nature, and will not have a significant adverse impact on our operations during the next twelve months. We believe that the actions we have taken to date, together with actions we may take in 2009, will continue to provide sufficient liquidity to finance our business requirements for at least the next twelve months. However, if our cash flows from operating activities during 2009 are significantly less than we expect, we may be required to adopt additional cost-cutting measures, including additional reductions in our work force, reducing the scope of, delaying or eliminating some or all of our planned research, development and commercialization activities or to license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to commercialize and we may require additional capital. In any event, we believe that, by the first half of 2010, we will require additional capital and at any time prior to that we may seek to sell additional equity or debt securities or enter into an additional credit facility. 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 or to license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize, any of which could materially harm our business.

The timing and exact amounts of our future capital requirements will depend on many factors, including but not limited to the following:

 

   

the revenue and margins generated by sales of our current and future products;

 

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our ability to generate revenue in a time of overall economic and capital market uncertainty;

 

   

the expenses we incur in manufacturing, marketing and selling our products, developing new products and operating our company;

 

   

our ability to achieve manufacturing cost reductions as we scale the production of our products;

 

   

our ability to achieve and maintain operating cost reductions;

 

   

the success of our research and development efforts;

 

   

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

 

   

the cost and timing of future regulatory actions;

 

   

our ability to maintain compliance with debt covenants;

 

   

the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property or other legal rights, or participating in litigation-related activities, including the March 2009 trial in our litigation against Luna Innovations, Inc.;

 

   

the emergence of competing or complementary technological developments;

 

   

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

 

   

the acquisition of businesses, products and technologies.

We cannot guarantee that future equity or debt financing or credit facilities will be available in amounts or on terms acceptable to us, if at all. This could leave us without adequate financial resources to fund our operations as presently conducted or as we plan to conduct them in the future.

Contractual Obligations

The following table summarizes our outstanding contractual obligations as of December 31, 2008 and the effect those obligations are expected to have on our liquidity and cash flows in future periods (in thousands):

 

     Payments Due by Period

Contractual Obligations

   Total    Less than
1 Year
   1-3
Years
   3-5
years
   More than
5 Years

Operating lease—real estate

   $ 10,852    $ 1,811    $ 3,527    $ 3,731    $ 1,783

Debt, including interest

     14,833      3,167      7,940      3,726      —  
                                  

Total

   $ 25,685    $ 4,978    $ 11,467    $ 7,457    $ 1,783
                                  

The table above reflects only payment obligations that are fixed and determinable. Our commitments for operating leases relate principally to the lease for our corporate headquarters in Mountain View, California. Current future debt payments relate to principal and interest payments related to the $12.5 million we have borrowed under our term equipment line with Silicon Valley Bank. Additionally, we have minimum royalty obligations of $100,000 per year under a license agreement with Mitsubishi Electric Research Laboratories, Inc. which reduces to $55,000 per year if the license becomes non-exclusive. The royalty obligation expires in 2018. We may also have minimum royalty obligations under the terms of our cross license agreement with Intuitive Surgical, Inc. Our agreement to acquire AorTx includes possible future payments of up to $30.0 million payable upon achievement of regulatory clearances and revenue and partnering milestones. Such future payments are to be made 50% in cash and 50% in shares of our common stock. Under the terms of the AorTx acquisition, we must decide by May 15, 2009 whether to make a $5 million payment to the former AorTx stockholders or license the acquired AorTx technologies back to an entity formed by the former AorTx stockholders.

 

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Recent Accounting Pronouncements

There are a number of new accounting pronouncements and interpretations that will impact our financial statements and disclosures (see Note 2 to our consolidated financial statements under the caption “Recent Accounting Pronouncements”.) We do not expect that any of those pronouncements or interpretations upon adoption will have a material impact on our results of operations, financial position or cash flows.

Off-balance Sheet Arrangements

As of December 31, 2008, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

In the normal course of business, our financial position is subject to a variety of risks, including market risk associated with interest rate movements and foreign currency exchange risk. We regularly assess these risks and have established policies and business practices to protect against these and other exposures. As a result, we do not anticipate material potential losses in these areas.

The primary objective for our investment activities is to preserve principal while maximizing yields without significantly increasing risk. This is accomplished by investing in widely diversified short-term investments, consisting primarily of investment grade securities. As of December 31, 2008, the fair value of our cash, cash equivalents and short-term investments was approximately $35.2 million, the majority of which will mature in one year or less. A hypothetical 50 basis point increase in interest rates would not result in a material decrease or increase in the fair value of our available-for-sale securities. We have no investments denominated in foreign country currencies and therefore our investments are not subject to foreign currency exchange risk.

A portion of our operations consist of sales activities outside of the United States and, as such, we have foreign currency exposure to non-United States dollar revenues and accounts receivable. Currently, we sell our products mainly in United States dollars, Euros and Great Britain Pounds although we may in the future transact business in other currencies. Future fluctuations in the exchange rates of these currencies may impact our revenues. In the past, we have not hedged our exposures to foreign currencies or entered into any other derivative instruments and we have no current plans to do so. For the year ended December 31, 2008, sales denominated in foreign currencies were approximately 32% of total revenue. A hypothetical 10% increase in the United States dollar exchange rate used would have resulted in a decrease of approximately $959,000 in revenues for 2008.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Financial Statements

 

     Page

Report of Independent Registered Public Accounting Firm

   77

Consolidated Balance Sheets

   78

Consolidated Statements of Operations

   79

Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

   80

Consolidated Statements of Cash Flows

   81

Notes to Consolidated Financial Statements

   82

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of

Hansen Medical, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, consolidated statements of redeemable convertible preferred stock and stockholders’ equity (deficit) and consolidated statements of cash flows present fairly, in all material respects, the financial position of Hansen Medical, Inc. and its subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Annual Report on Internal Control Over Financial Reporting included in section 9A of this Annual Report on Form 10-K. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits, which were integrated audits in 2008 and 2007. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

San Jose, California

March 13, 2009

 

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HANSEN MEDICAL, INC.

Consolidated Balance Sheets

(In thousands, except share and per share data)

 

     December 31,  
     2008     2007  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 17,377     $ 30,404  

Short-term investments

     17,846       18,148  

Accounts receivable, net of allowance of $— and $26 at December 31, 2008 and 2007, respectively

     9,506       4,003  

Inventories

     6,674       2,982  

Prepaids and other current assets

     2,136       1,397  
                

Total current assets

     53,539       56,934  

Property and equipment, net

     18,195       2,672  

Restricted cash

     110       105  

Other assets

     174       190  
                

Total assets

   $ 72,018     $ 59,901  
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 3,081     $ 2,956  

Accrued liabilities

     6,072       4,083  

Current portion of deferred revenue

     1,386       225  

Current portion of long-term debt

     2,451       2,101  
                

Total current liabilities

     12,990       9,365  

Deferred rent, net of current portion

     860       13  

Deferred revenue, net of current portion

     189       143  

Long-term debt, net of current portion

     10,025       1,208  

Other long-term liabilities

     249       108  
                

Total liabilities

     24,313       10,837  
                

Commitments and contingencies (Note 6)

    

Stockholders’ equity:

    

Preferred stock, par value $0.0001:

    

Authorized: 10,000,000 shares

    

Issued and outstanding: none

     —         —    

Common stock, par value $0.0001:

    

Authorized: 100,000,000 shares

    

Issued and outstanding: 25,273,623 and 21,961,811 shares at December 31, 2008 and 2007, respectively

     3       2  

Additional paid-in capital

     210,548       158,607  

Deferred stock-based compensation

     (44 )     (167 )

Accumulated other comprehensive income

     77       57  

Accumulated deficit

     (162,879 )     (109,435 )
                

Total stockholders’ equity

     47,705       49,064  
                

Total liabilities and stockholders’ equity

   $ 72,018     $ 59,901  
                

The accompanying notes are an integral part of these consolidated financial statements.

 

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HANSEN MEDICAL, INC.

Consolidated Statements of Operations

(In thousands, except per share data)

 

     Years ended December 31,  
     2008     2007     2006  

Revenues

   $ 30,233     $ 10,085     $ —    

Cost of goods sold

     21,528       9,138       —    
                        

Gross profit

     8,705       947       —    
                        

Operating expenses:

      

Research and development

     25,582       19,020       16,561  

Selling, general and administrative

     37,112       24,179       10,122  

Acquired in-process research and development

     —         11,350       —    
                        

Total operating expenses

     62,694       54,549       26,683  
                        

Loss from operations

     (53,989 )     (53,602 )     (26,683 )

Interest income

     1,393       3,672       1,631  

Interest expense

     (630 )     (482 )     (647 )

Other expense, net

     (218 )     (9 )     (305 )
                        

Net loss

   $ (53,444 )   $ (50,421 )   $ (26,004 )
                        

Basic and diluted net loss per share

   $ (2.21 )   $ (2.33 )   $ (7.09 )
                        

Shares used to compute basic and diluted net loss per share

     24,232       21,603       3,670  
                        

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

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HANSEN MEDICAL, INC.

Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(In thousands, except share data)

 

    Redeemable
Convertible
Preferred Stock
    Common Stock   Additional
Paid-In
Capital
    Deferred
Stock-based
Employee
Compensation
    Accumulated
Other
Comprehensive
Income (Loss)
    Accumulated
Deficit
    Total
Stockholders’
Equity
(Deficit)
 
    Shares     Amount     Shares   Amount          

Balances, December 31, 2005

  12,354,742     $ 61,316     1,595,388   $ —     $ 2,852     $ (2,170 )   $ (15 )   $ (33,010 )   $ (32,343 )

Vesting of restricted common stock

  —         —       —       —       175       —         —         —         175  

Reclassification of amounts due to shareholders for fractional shares upon reverse stock split

  —         —       —       —       (1 )     —         —         —         (1 )

Exercise of stock options

  —         —       367,933     —       153       —         —         —         153  

Issuance of common stock in initial public offering (“IPO”), net of discounts, commissions and issuance costs of $7,997

  —         —       7,187,500     1     78,252       —         —         —         78,253  

Conversion of preferred stock to common stock in connection with the IPO

  (12,354,742 )     (61,316 )   12,354,742     1     61,315       —         —         —         61,316  

Reclassification of liability for Series B preferred stock warrants upon IPO

  —         —       —       —       549       —         —         —         549  

Amortization of deferred stock-based employee compensation

  —         —       —       —       —         600       —         —         600  

Reversal of deferred stock-based compensation due to cancellations

  —         —       —       —       (1,224 )     1,224       —         —         —    

Nonemployee stock-based compensation

  —         —       —       —       414       —         —         —         414  

Employee share-based compensation expense, net of cancellations

  —         —       —       —       1,645       —         —         —         1,645  

Comprehensive loss:

                 

Net loss

  —         —       —       —       —         —         —         (26,004 )     (26,004 )

Change in unrealized loss on investments

  —         —       —       —       —         —         15       —         15  
                       

Total comprehensive loss

                    (25,989 )
                                                               

Balances, December 31, 2006

  —         —       21,505,563     2     144,130       (346 )     —         (59,014 )     84,772  

Exercise of stock options

  —         —       199,564     —       367       —         —         —         367  

Issuance of common stock pursuant to the employee stock purchase plan

  —         —       74,345     —       929       —         —         —         929  

Net exercise of warrants to purchase common stock

  —         —       42,291     —       —         —         —         —         —    

Issuance of common stock pursuant to acquisition of AorTx, Inc.

  —         —       140,048     —       5,224       —         —         —         5,224  

Change in estimated IPO costs

  —         —       —       —       127       —         —         —         127  

Amortization of deferred stock-based employee compensation

  —         —       —       —       —         118       —         —         118  

Reversal of deferred stock-based compensation due to cancellations

  —         —       —       —       (61 )     61       —         —         —    

Nonemployee stock-based compensation

  —         —       —       —       1,637       —         —         —         1,637  

Employee share-based compensation expense, net of cancellations

  —         —       —       —       6,254       —         —         —         6,254  

Comprehensive loss:

                 

Net loss

  —         —       —       —       —         —         —         (50,421 )     (50,421 )

Change in unrealized loss on investments

  —         —       —       —       —         —         41       —         41  

Translation adjustment

  —         —       —       —       —         —         16       —         16  
                       

Total comprehensive loss

                    (50,364 )
                                                               

Balances, December 31, 2007

  —         —       21,961,811     2     158,607       (167 )     57       (109,435 )     49,064  

Exercise of stock options

  —         —       219,872     —       281       —         —         —         281  

Issuance of common stock pursuant to the employee stock purchase plan

  —         —       91,940     —       1,077       —         —         —         1,077  

Issuance of common stock pursuant to secondary public offering

  —         —       3,000,000     1     39,491       —         —         —         39,492  

Amortization of deferred stock-based employee compensation

  —         —       —       —       —         104       —         —         104  

Reversal of deferred stock-based compensation due to cancellations

  —         —       —       —       (19 )     19       —         —         —    

Non-employee stock-based compensation

  —         —       —       —       63       —         —         —         63  

Employee share-based compensation expense, net of cancellations

  —         —       —       —       11,048       —         —         —         11,048  

Comprehensive loss:

                 

Net loss

  —         —       —       —       —         —         —         (53,444 )     (53,444 )

Change in unrealized loss on investments

  —         —       —       —       —         —         92       —         92  

Translation adjustment

  —         —       —       —       —         —         (72 )     —         (72 )
                       

Total comprehensive loss

                    (53,424 )
                                                               

Balances, December 31, 2008

  —       $ —       25,273,623   $ 3   $ 210,548     $ (44 )   $ 77     $ (162,879 )   $ 47,705  
                                                               

The accompanying notes are an integral part of these consolidated financial statements.

 

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HANSEN MEDICAL, INC.

Consolidated Statements of Cash Flows

(In thousands)

 

     Years Ended December 31,  
     2008     2007     2006  

Cash flows from operating activities

      

Net loss

   $ (53,444 )   $ (50,421 )   $ (26,004 )

Adjustments to reconcile net loss to net cash used in operating activities:

      

Acquired in-process research and development

     —         11,350       —    

Depreciation and amortization

     2,822       1,337       851  

Stock-based compensation

     11,215       8,010       2,659  

Loss on disposal of fixed assets

     99       —         —    

Amortization of preferred stock warrants

     74       58       62  

Provision for doubtful accounts

     (26 )     26       —    

Change in carrying value of warrant liability

     —         —         305  

Common stock issued and vested for intellectual property and license agreement

     —         —         175  

Changes in operating assets and liabilities:

      

Accounts receivable

     (5,477 )     (4,009 )     —    

Inventories

     (3,692 )     (2,692 )     (290 )

Prepaids and other current assets

     (837 )     (725 )     (154 )

Other long-term assets

     —         (161 )     —    

Accounts payable

     125       1,153       118  

Accrued liabilities

     1,927       2,626       334  

Deferred revenue

     1,207       368       —    

Deferred rent

     795       (74 )     (71 )

Other long-term liabilities

     (39 )     46       45  
                        

Net cash used in operating activities

     (45,251 )     (33,108 )     (21,970 )
                        

Cash flows from investing activities

      

Purchase of property and equipment, net

     (18,117 )     (2,264 )     (1,581 )

Payment for purchase of AorTx, Inc., net of cash acquired

     —         (5,089 )     —    

Proceeds from sales and maturities of short-term investments

     15,467       12,100       21,856  

Purchase of short-term investments

     (15,080 )     (29,112 )     (2,489 )

Restricted cash

     (5 )     (15 )     (10 )
                        

Net cash provided by (used in) investing activities

     (17,735 )     (24,380 )     17,776  
                        

Cash flows from financing activities

      

Proceeds from loans payable

     12,476       —         380  

Repayments of loans payable

     (3,334 )     (1,939 )     (1,727 )

Proceeds from issuance of common stock, net of issuance costs

     39,492       (317 )     78,695  

Proceeds from exercise of common stock options

     250       321       211  

Proceeds from employee stock purchase plan

     1,077       929       —    

Repurchase of unvested shares

     (2 )     (13 )     (15 )
                        

Net cash provided by (used in) financing activities

     49,959       (1,019 )     77,544  
                        

Net increase (decrease) in cash and cash equivalents

     (13,027 )     (58,507 )     73,350  

Cash and cash equivalents at beginning of year

     30,404       88,911       15,561  
                        

Cash and cash equivalents at end of year

   $ 17,377     $ 30,404     $ 88,911  
                        

Supplemental disclosures of cash flow informati