Note 7 of Notes to Financial Statements included in Item 8 of this Report.
The foregoing factors, among others, raise substantial doubt about the
Company's ability to continue as a going concern. The financial statements do
not include any adjustments relating to the recoverability and classification
of asset carrying amounts or the amount and classification of liabilities that
might be necessary should the Company be unable to continue as a going concern.
Personnel
The Company reduced its workforce from 54 employees to 30 as of January 1994.
The Company had 16 employees as of May 31, 1996 and has hired 21 additional
employees and four consultants through January 17, 1997. The Company expects
to hire two additional employees in Sales and Marketing before the end of the
first fiscal quarter of 1997 and expects to hire 11 additional employees in
fiscal 1997 (one in Management, two in Administration, four more in Sales and
Marketing, one in Medical Affairs, one in Quality Control, one in
Manufacturing, and one in Service). The Company expects to incur these
expenses before
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receiving substantially increased proceeds from sales of its
products, and such expenses will continue even if revenues do not increase.
Therefore, in the short-run, they are expected to increase the Company's net
losses. As of January 17, 1997, the Company had 37 employees and four
consultants.
Effective November 4, 1996, Gary D. Lewis resigned as a director of the
Company. The size of the Board was reduced to four members, and Bruce J.
Barrett was changed from a Class II director to a Class III director to make
the number of directors in each class as nearly equal as possible. Mr. Barrett
will now serve until the 1998 Annual Meeting of Shareholders and until his
successor is duly elected and qualified, or until his earlier death,
resignation or removal. On November 6, 1996, Gary D. Lewis paid the Company
$175,000 (the outstanding principal amount of the loan at the time) in full
satisfaction of all of his obligations under the loan made by the Company to
him on February 1, 1993, and the Company discharged the second mortgage and
released the security interests securing the loan and wrote off approximately
$29,750 of accrued interest with respect to that loan.
Effective December 26, 1995, Larry Layman II resigned as the Company's Vice
President, Sales and Marketing. Effective December 1, 1996, the Board of
Directors approved an increase in Raymond W. Gunn's base salary to $110,250,
and the extension of Mr. Gunn's employment agreement through November 30, 1997.
In light of the lack of 1995 bonuses, lack of increases in 1996 salaries and
lack of a 1996 bonus plan, and to facilitate the retention of the Company's
employees and to align their interests with the interests of the Company's
shareholders, in December 1995, in exchange for the cancellation of certain
outstanding stock options, most of which were granted subject to shareholder
approval, the Company granted stock options to purchase an aggregate of 689,000
Common Shares (most of which were granted independent of the Company's stock
option plans and none of which was granted subject to shareholder approval) to
each then current employee of the Company and two advisors to the Company,
including options to purchase 165,000, 150,000 and 50,000 Common Shares granted
to Messrs. Barrett, Gunn and Layman, respectively, the Company's then current
President and Chief Executive Officer, Executive Vice President and Chief
Financial Officer, and Vice President, Sales and Marketing, respectively.
Except for the options granted to officers, the new options cover the same
number of shares and are subject to substantially the same terms and conditions
as the options previously granted to such persons under the 1991 Incentive
Stock Option Plan (the "Plan"), except that (i) the exercise price of the new
options is the fair market value of the Company's Common Shares as of the date
of grant ($0.50 a share), (ii) the new options become exercisable in one-fourth
cumulative annual increments beginning December 22, 1996 and expire December
22, 2005, and (iii) the new options are not subject to shareholder approval.
The new options granted to officers are the same as those granted to other
persons, except that (i) the exercise price of the new options granted to
officers is the same as the exercise price of their cancelled options ($1.3125
a share), and (ii) the new options granted to the officers become exercisable
at the same times as the cancelled options: one-fourth cumulative annual
increments beginning March 13, 1996.
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In addition, in December 1995 and January 1996, the Company granted options to
purchase an additional 624,850 Common Shares (most of which were granted
independent of the Company's stock option plans) to officers and employees of,
and advisors to, the Company, including options to purchase 267,000 and 141,000
Common Shares granted to Messrs. Barrett and Gunn, respectively.
Pursuant to an amended agreement with Rauscher Pierce & Clark, Inc. and
Rauscher Pierce & Clark Limited (collectively, the "Placement Agent") in
connection with the April 2, 1996 Regulation S offering, the Company agreed to
permit a person designated by the Placement Agent to attend meetings of the
Company's Board of Directors until the 1998 Annual Meeting of Shareholders and
to participate in discussions at such meetings. The Placement Agent designated
Mr. Alan Nash as the designee.
Facilities
The Company leases approximately 23,000 square feet of office, assembly and
warehouse space in a stand-alone building in Troy, Michigan. On July 22, 1994,
the Company extended the lease on its office, assembly and warehouse space
through December 1997. The minimum lease payments as of November 30, 1996
through the end of the extended lease, including the option period, is
$199,000, excluding other occupancy costs. The Company believes that,
depending on sales of the Cerebral Oximeter, its current facility is more than
suitable and adequate for its current needs, including assembly of the Cerebral
Oximeter by the Company and conducting Company operations in compliance with
prescribed FDA/GMP guidelines, and will allow for substantial expansion of the
Company's business and number of employees. The Company is subleasing a
portion of its warehouse space on a month-to-month basis for $2,700 per month.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company's business consists of a single industry segment.
NARRATIVE DESCRIPTION OF BUSINESS
INVOS TECHNOLOGY:
Optical Spectroscopy
The Company's technology relies primarily on the physics of optical
spectroscopy, which is the interpretation of the interaction between matter and
light. Spectrometers and spectrophotometers function primarily by shining
light through matter and measuring the extent to which such light is
transmitted through, or scattered or absorbed by, matter. Doctors and
scientists can use spectrophotometers to determine the concentrations, or
relative concentrations, of substances. These devices measure the relative
intensities of predetermined wavelengths of light received by light sensors in
the device after being transmitted into a substance (using a sufficient number
of wavelengths).
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The atoms in a molecule in a particular substance vibrate at unique
frequencies. Only light waves that match a particular molecule's vibrational
frequency are absorbed by the molecule, and such absorption occurs in
characteristic and predictable ways. Devices using spectrophotometers can
measure the reaction of light to vibrating molecules and allow doctors to draw
specific conclusions based on the measured reaction. The absorption,
transmission and scattering data become much more difficult to evaluate with
human tissue containing numerous molecules. Analysis of human tissue,
therefore, requires more sophisticated empirical methods.
Doctors have been able to examine human blood and tissue using optical
spectroscopy. Although most human tissue is opaque to ordinary light, certain
wavelengths penetrate tissue more easily than others. Therefore, by shining
light of appropriate wavelengths into the body and measuring its transmission,
scattering and absorption, or a combination, doctors can obtain information
about the molecules existing within the matter under scrutiny. Optical
spectroscopy was first used clinically in the 1940s at the Sloan-Kettering
Institute for cancer research. Currently, the pulse oximeter, for example, a
commercially available device, uses optical spectroscopy to determine the
oxygen saturation of the blood in the arteries in peripheral tissue, such as in
a finger or an earlobe. By identifying the hemoglobin molecules and the
oxygenated hemoglobin molecules and measuring the relative amount of such
molecules, oxygen saturation of hemoglobin can be measured.
INVOS Technology
INVOS technology also measures the composition of substances by detecting the
effect they have on particular wavelengths of light. INVOS transmits
low-intensity visible and near infrared light through a portion of the body and
detects the manner in which the molecules of the exposed substance interact
with light at specific wavelengths. INVOS detects this interaction by
measuring the intensity of the various wavelengths of light received by light
sensors.
The use of optical spectroscopy in vivo (in the body) has not generally been
useful when the substances to be measured were surrounded by, were behind, or
were near bones, muscle or other tissue, because the transmission, scattering
and absorption of the transmitted light produces extraneous data that
interferes with analysis of the data from the area being examined. Differences
in skin pigment also affect results. The Company has developed a method of
reducing the effect on the measurements of extraneous spectroscopic data caused
by surrounding bone, muscle and other tissue. This method allows data to be
gathered from areas of the body which could not previously be analyzed using
spectroscopy. The Company and independent researchers have demonstrated that
visible and near infrared light are able to penetrate brain tissue. The INVOS
technology has been shown to measure the presence of certain substances in the
brain. Now that the Company has FDA 510(k) clearance, the Company expects to
focus its efforts on developing extensions of the Cerebral Oximeter for use on
children and newborns and enhancements to the Cerebral Oximeter. The Company
also intends to explore other applications of its INVOS technology and related
technologies. As described above under the caption "RECENT DEVELOPMENTS -
PRODUCTS AND MARKETING", the
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Company has entered into a Consulting Order with NeuroPhysics
Corporation pursuant to which the Company is supporting NeuroPhysics' research
into the feasibility and development of prototypes of four new products.
The Company believes that this INVOS technology will enable it to develop
products which safely provide primary information about the patient's
physiology and metabolism without invading the patient's body, without
ionization (which occurs when x-rays are used and may be dangerous in some
instances) and without the often expensive and time-consuming delays involved
in laboratory analysis.
CEREBRAL OXIMETER:
INVOS Cerebral Oximeter Technology
Hypoxia (insufficiency of oxygen delivery) is a common mechanism for the
eventual adverse outcome for many surgical procedures. Additional patients
experience permanent brain damage. Studies suggest that insufficiency of
oxygen delivery to the brain is a frequent cause of these problems.
In major complex surgical procedures, especially major neurological, cardiac
and vascular repairs, low blood flow or pressure may be induced or may occur,
which can have detrimental effects on blood oxygen saturation in the brain.
Immediate information concerning brain oxygen saturation changes would help the
anesthesiologist and surgeons take appropriate corrective action through the
introduction of medications, anesthetic agents or mechanical intervention.
However, because of the unconscious state of the patient, an anesthesiologist
is unable to observe ordinary physical responses to make a determination.
Because of the short period of time that the brain is able to survive without
sufficient oxygen, immediate, accurate information is of vital importance to
the anesthesiologist. Currently, several different diagnostic methods are used
to detect blood oxygen levels or inadequate oxygen delivery.
The brain is the human organ least tolerant of oxygen deprivation. Without
oxygen, brain cells die within a few minutes and are not replaced, potentially
resulting in paralysis, severe and complex disabilities or death. Within
minutes of oxygen deprivation, irreversible brain damage may occur.
Oxygen molecules are carried to the brain by hemoglobin molecules contained in
the blood. Hemoglobin, passing through the lungs, bonds with oxygen and is
pumped by the heart through arteries and capillaries to the brain. Brain cells
extract the oxygen and the blood carries away carbon dioxide through the
capillaries and veins back to the lungs. Oxygen saturation is the term that
describes the percentage of hemoglobin molecules contained in a given amount of
blood which are bound to oxygen molecules. By measuring the effect on specific
wavelengths of light caused by oxygenated hemoglobin contained in blood in the
region of the brain being monitored, the Cerebral Oximeter can monitor changes
in the approximate oxygen saturation of the hemoglobin in the area of the brain
being monitored.
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The light from the Cerebral Oximeter's sensor is able to penetrate the
patient's brain, and monitor changes in the approximate oxygen saturation of
the hemoglobin contained in the blood vessels inside the brain in the region
under examination. The information received from the sensor is transmitted to
the Cerebral Oximeter's computer which, through a series of calculations, is
able to reduce the influence on the light caused by extraneous tissue, such as
the skin, muscle and skull of the patient.
The Cerebral Oximeter monitors changes in the approximate oxygen
saturation in all blood vessels in the region being monitored. Under normal
circumstances, in the head, these blood vessels consist of approximately (by
volume) 75% of veins, 20% of arteries and 5% of capillaries. Thus, the
Cerebral Oximeter's measurement is dominated by the blood in the veins.
Regional oxygen saturation of the predominantly venous blood in the blood
vessels in and supplying the brain is most helpful because such information is
a direct indicator of insufficient blood or oxygen supply or high brain oxygen
consumption. Devices such as pulse oximeters only determine the oxygen
saturation of blood in the arteries in a particular portion of the body, not
necessarily the adequacy of oxygen delivery to the brain or other portions of
the body.
The Cerebral Oximeter
The Cerebral Oximeter is a compact, portable monitor measuring 12 inches wide,
6 inches high and 13 inches deep and weighing approximately 15 pounds. It
consists of a small disposable sensor which transmits and receives light,
connected to a computer which analyzes the data and a monitor to display and
print the results. The Cerebral Oximeter can be placed at a patient's bedside
in the operating room, recovery room, emergency room or intensive care units.
After being adhered to a patient's forehead, the sensor continuously sends
predetermined wavelengths of low-intensity near infrared and visible light into
the patient's head through the scalp, muscle and bone into the brain tissue.
The Cerebral Oximeter then measures and analyzes the intensity of the light
scattered by the blood and tissue in the area being monitored and received by
the sensor. After analysis by the Cerebral Oximeter's internal computer, a
digital display provides a continuous reading of the changes in the approximate
regional brain oxygen saturation in the area being monitored.
The Cerebral Oximeter may be used by physicians on patients who have a risk of
inadequate oxygen delivery to the brain and who are located in any critical
care areas of the hospital, including the emergency room or intensive care
units on patients with head injuries or strokes. In the operating room, the
Cerebral Oximeter may be used on patients having brain and other surgeries
involving risk of inadequate oxygen delivery or decreases in blood flow, such
as any heart surgery, transplant surgery or surgeries involving major blood
vessels, such as a carotid endarterectomy, which is the removal of blockage in
the carotid artery.
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Existing Diagnostic Methods
The neurological exam is the generally used method for evaluating the brain.
The patient is tested for signs of brain damage by testing limb strength, limb
sensation, patient orientation, speech, response to commands, and the
functioning of eyes and pupils. The neurological exam measures only
manifestations of injuries and cannot be performed on unconscious patients.
Skin color is also a commonly used method for determining whether sufficient
oxygen is reaching various body parts.
Pulse oximetry is currently the standard method used by
anesthesiologists during surgery to monitor arterial hemoglobin oxygen
saturation. The pulse oximeter uses near infrared spectroscopy, similar to
that used by the Cerebral Oximeter, to measure the oxygen saturation in the
arteries in peripheral tissue, typically a finger or an earlobe. The technique
distinguishes between blood and other extraneous tissue such as bone and muscle
by using the pulsation of arterial blood. The effectiveness of pulse oximetry
is dependent upon the strong pulse of the patient. In addition, the technique
measures the oxygen saturation of blood in the arteries in a particular portion
of the body, not necessarily the adequacy of oxygen delivery to other portions
of the body.
With Invasive Jugular Bulb Catheter Monitoring, blood is drawn from a patient's
jugular vein, and the oxygen content, acidity and other blood gases are
analyzed directly from the removed blood. By analyzing venous blood, this
method provides information about the adequacy of oxygen delivery to the brain.
However, the procedure is able to provide information only for the point in
time at which the blood is removed from the vein and it is invasive, in that
blood must be removed from a vein in the neck near the base of the brain. It
measures global saturation of the venous blood in the brain, not regional
saturation.
Transcranial doppler (TCD) is a relatively new modality for measuring cranial
hemodynamics during carotid surgery. One or two transducers are placed
temporally, just in front of the ear and focused on the middle cerebral artery.
Doppler ultrasound bounces high frequency sound waves off the blood flowing
toward the transducer giving a relative read-out of "flow-velocity". Assuming
the artery does not change diameter and the transducer is not moved during the
case, relative changes in hemodynamics can be detected as well as emboli moving
down the vessel. TCD cannot be used in 5-10% of the population where the
temporal bone is too thick; additionally, TCD is technically difficult during
carotid surgery.
Surgeons may also monitor brain function, typically during procedures in which
oxygen delivery to the brain is threatened, by using an Electroencephalogram
("EEG"). It measures neural activity directly, which can be affected by
anesthetic agents or by decreased oxygen supply. However, EEG may be
ineffective in any procedure involving suppressed neural activity, such as
operations involving deep anesthesia or induced hypothermia (lowered body
temperature), such as organ transplants.
Several different imaging techniques, such as CAT scan, Magnetic Resonance
Imaging, Positron Emission Tomography and Single Photon Emission Computerized
Tomography, may also be used to measure brain condition or activity. However,
these are generally expensive procedures which may only be performed in
dedicated facilities. They are generally used as
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diagnostic tests to detect anatomical abnormalities, such as tumors or
blood clots, or cellular metabolism or blood flow. They would not currently
appear to be practical for generating continuous measurements or for use in an
operating room or for patient monitoring.
Less frequently, physicians may use Intracranial Pressure monitoring to monitor
the pressure inside the patient's skull. This invasive monitor involves the
placement of a sensor in the intracranial space through a drilled hole. There,
it measures the pressure on the brain which may increase as a secondary effect
of certain brain damage or head injuries.
Measurement of carbon dioxide in the expired gas of patients under anesthesia
can provide an early indication of a ventilation problem, which may result in
an oxygen delivery problem. However, a low blood oxygen level, including a low
blood oxygen level in the brain, may not be associated with an abnormal carbon
dioxide level.
The Cerebral Oximeter is noninvasive, generates no ionizing radiation and
produces no known hazardous effects. The Company believes that it can provide
physicians with continuous information concerning changes in the approximate
oxygen saturation of the hemoglobin in the blood in specific regions of the
brain. It is portable and it should be an inexpensive alternative to the above
diagnostic methods. Unlike pulse oximetry, a standard of care in anesthesia
which derives its measurement from pulsating arterial blood, the Cerebral
Oximeter is not dependent on a pulsatile flow to function. The measurement
provided by the Cerebral Oximeter is a combination of arterial, venous and
capillary oxygenation.
The Cerebral Oximeter is intended to provide surgeons, anesthesiologists, and
other medical professionals with a patient safety monitor to identify
immediately adult brain oxygen imbalances and to further serve as a tool to
guide therapeutic interventions, which could affect brain oxygen supply and
demand.
The data from the Cerebral Oximeter, however, may be adversely affected by the
following: (i) major changes in the ratio of arterial to venous blood vessel
volume, (ii) major changes in blood volume or hematocrit (the ratio of volume
of red blood cells to volume of whole blood), (iii) excessive ambient light,
(iv) electrical interference, (v) the presence of dyshemoglobins (hemoglobin
molecules that do not release their oxygen), (vi) dyes in the blood, and (vii)
placing the SomaSensor over sinus cavities, tumors, swelling containing blood
or other anomalies.
Development of the Cerebral Oximeter
In 1982, the Company commenced research and development efforts with respect to
INVOS technology in connection with the development of a spectroscopic
instrument for the measurement of breast tissue abnormalities. The Somanetics
INVOS 2100 System (the "INVOS 2100") used the same INVOS technology as the
Cerebral Oximeter. By transmitting low-intensity visible and near-infrared
light through a woman's breast and measuring the effects the breast tissue had
on the light, the INVOS 2100 could be used to analyze certain compositional and
physiological properties of the breast. The measurements were analyzed to
estimate the risk of a patient developing breast cancer. The INVOS 2100
gathered information
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concerning glandular, fibrous and fatty tissue as well as hemoglobin
and extracellular water. Subsequently, the Company commenced investigations
with respect to the application of INVOS technology to the measurement of
changes in cellular metabolism in the brain. The INVOS 2100 drew conclusions
concerning a condition or risk based upon measurements of several elements.
The Cerebral Oximeter monitors changes in one element, oxyhemoglobin, or brain
oxygen saturation, directly. Accordingly, the Company believed that it could
demonstrate more easily the effectiveness of the Cerebral Oximeter to potential
customers. Early studies conducted in conjunction with the Henry Ford
Neurosurgical Institute, Detroit, Michigan, demonstrated the ability of the
Company's INVOS technology to make certain measurements which were highly
correlated to controlled changes in animal brain cell metabolism.
In 1988, the Company began clinical studies of the Cerebral Oximeter on
human patients in operating rooms, emergency rooms and intensive care units at
Henry Ford Hospital, Detroit, and later at Bowman Gray School of Medicine,
North Carolina, and Mount Sinai Medical Center, New York. On June 6, 1996, the
Company received clearance from the FDA to market the Cerebral Oximeter in the
United States. The Company continues to sponsor clinical research for
marketing purposes. The research consists primarily of comparing the
measurements obtained from the Cerebral Oximeter to the data obtained from
existing diagnostic methods, including EEG, Transcranial Doppler and Invasive
Jugular Bulb Catheter Monitoring. There can be no assurance that hospitals
will buy it in sufficient quantities to support the Company's operations.
MARKETING
The Company sells the Cerebral Oximeter through its sales and marketing
employees and independent specialty distributors to hospitals for use on
patients with head trauma or cerebral vascular disease, or at risk of brain
hypoxia (insufficiency of oxygen delivery) or ischemia (tissue oxygen
starvation due to the obstruction of the inflow of arterial blood), in any
critical care areas of the hospital, including the operating room, recovery
room, intensive care units and emergency care room. Purchasers of the Cerebral
Oximeter will also be required to purchase disposable sensors on a regular
basis. The sensor may only be used once because its effectiveness is not
warranted by the Company after one use and because the sensor may become
contaminated after one use.
The Company did not have any backlog of firm orders as of January 17, 1997.
The Company has been able to fill its firm orders within days of their receipt.
The Company does not believe that its current backlog is necessarily
indicative of trends in its business, especially because the Company is in the
development stage and did not regain its FDA 510(k) clearance until June 1996.
For a description of the current status of the Company's marketing efforts, see
"Recent Developments - Products and Marketing".
The Company has engaged distributors for some new markets cleared for
distribution and replaced some distributors that terminated their distribution
agreements. On March 15, 1995,
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the Company announced the engagement of Baxter Limited as its exclusive
distributor in Japan. On April 10, 1995, the Company received its license from
the Japanese Ministry of Health and Welfare to market its product in Japan. In
September 1996, the Company entered into a Master Distributor Agreement with
MedLink Europe, an operational services company located in Amsterdam, with
offices in other parts of Europe. MedLink helps U.S.-based companies execute
their marketing activities throughout Europe, and is expected to provide the
Company with sales and marketing support as well as distribution, customer
service and technical product advice. In January 1994, the sales and marketing
staff was reduced from 12 to 5 as a result of the FDA's rescission of the
Company's 510(k). As of January 17, 1997, there were 18 employees and one
consultant in the sales and marketing department, with two more budgeted to be
hired in the first fiscal quarter of 1997 and four more budgeted to be hired
during the remainder of fiscal 1997.
As of January 17, 1997, the Company had entered into distribution
agreements with 26 international specialty medical dealers, covering 74
countries outside the United States. Seven of these countries require the
Company to comply with additional regulatory requirements prior to sale.
During fiscal 1996, the Company sold its products to 14 of its international
distributors. The Company has granted extended payment terms to some of its
international distributors.
For a description of the restructuring of the Company's United States
distribution, see "Recent Developments - Products and Marketing."
The Company's distributors also distribute other products, some of which may
compete with the Company's products or may provide greater revenues to the
distributor than are provided by the Company. There can be no assurance that
the Company will be able to replace distributors desiring to terminate their
distribution agreements, engage distributors in additional territories, or
retain its existing distributors, or that existing distributors will not incur
conflicting obligations before, and will remain motivated until, the Company
begins commercial shipments in the territories served by such distributors.
With the June 1996 FDA 510(k) clearance, the Company intends to devote its
sales efforts equally between the United States and foreign markets.
The Company sells the Cerebral Oximeter primarily to neuro anesthesiologists,
cardiothoracic and vascular surgeons, anesthesiologists and neurosurgeons in
hospitals. The Company believes that neuro anesthesiologists, cardiothoracic
and vascular surgeons, anesthesiologists and neurosurgeons are the most
sensitive to cerebral vascular disease and the prevention of ischemic and
hypoxic events. The Company's strategy is to attempt to establish the efficacy
of the Cerebral Oximeter and related disposable SomaSensor through publication
of peer reviewed papers and through its clinical research program. In
addition, the Company's independent distributors and direct sales personnel are
expected to contact leading neuro anesthesiologists, cardiothoracic and
vascular surgeons, anesthesiologists, neurosurgeons, critical care physicians
and others who might use the product at teaching institutions and private
hospitals. The Company and its distributors have initially concentrated on
sales to the major teaching hospitals in selected foreign markets in which the
Company has commenced commercial sales and the 2,000 largest United States
hospitals and on the use of the Cerebral Oximeter in operating rooms at
teaching hospitals, departments of the hospitals, universities,
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clinics and leading health institutions. Later, marketing efforts are
expected to expand to (i) major teaching hospitals in other foreign markets,
and (ii) smaller hospitals and the use of the Cerebral Oximeter in the recovery
room or post anesthesia care unit ("PACU"), intensive care unit ("ICU"), and
emergency room ("ER").
The Company has also attended and plans to attend market specific trade
shows in order to introduce and promote its Cerebral Oximeter and to meet
persons with an interest in submitting peer reviewed papers to appropriate
anesthesia and neurological publications and to major national meetings. A
total of 30 presentations concerning the Cerebral Oximeter were presented to 20
meetings in fiscal year 1996, and 13 peer-reviewed articles mentioning the
Cerebral Oximeter were published. While the Company believes favorable peer
review is a key element to a product's success in the medical equipment
industry, there can be no assurance that additional papers will be submitted or
that any such papers will accomplish the Company's objectives. While the other
publications in fiscal 1996 have been generally favorable, some researchers
have published adverse results after using the product beyond its indicated
use. There can be no assurance that these publications, the Company's financial
condition and the FDA's rescission of the Company's 510(k) clearance for the
Cerebral Oximeter will not adversely affect the Company's reputation or its
ability to market and sell its device.
The Company also intends to use its clinical trial relationships to help
identify and develop additional products. Now that the Company has FDA 510(k)
clearance, the Company expects to focus its efforts on developing extensions of
the Cerebral Oximeter for use on children and newborns and enhancements to the
Cerebral Oximeter. The Company also intends to explore other applications of
its INVOS technology and related technologies. As described above under the
caption "RECENT DEVELOPMENTS - PRODUCTS AND MARKETING", the Company has entered
into a Consulting Order with NeuroPhysics Corporation pursuant to which the
Company is supporting NeuroPhysics' research into the feasibility and
development of prototypes of four new products.
Because the medical community is often skeptical of new companies and new
technologies, the Company might be unable to gain access to potential customers
to attempt to demonstrate the operation and efficacy of the Cerebral Oximeter.
Even if the Company gains access to potential customers, no assurance can be
given that members of the medical community will perceive a need for or accept
the Cerebral Oximeter. In fiscal year 1996, the Company continued to support
clinical research programs with third party clinicians and researchers intended
to demonstrate the need for, and efficacy of, the Cerebral Oximeter with the
specific objective of publishing the results in peer reviewed journals. The
Company expects such programs to continue in 1997. In addition, although the
Company believes its current distributors to be knowledgeable and although the
Company has a training program for new distributors concerning the Company's
technology and the Cerebral Oximeter, independent distributors might not have
sufficient knowledge about, or familiarity with, the Company's technology or
the Cerebral Oximeter to demonstrate adequately its operation and efficacy.
In addition, hospital capital equipment purchasing decisions are often made by
hospital committees that might not include the user of the device. If so, the
Company will also have to convince such committees to purchase the Company's
device. Even if the Company is
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successful in convincing doctors, hospitals, clinics and other
potential users of the Cerebral Oximeter of their need for the Cerebral
Oximeter, they might be unwilling or unable to commit funds to the purchase of
the Cerebral Oximeter due to institutional budgetary constraints or decreases
in capital expenditures. The Company has designed a leasing program, including
a no-capital leasing program, to lower the capital initially required to obtain
the Cerebral Oximeter. The Company intends to test market its program
domestically before expanding it worldwide. Some purchasers might also be
reluctant to purchase the device from the Company for fear that it will be
unable to satisfy warranty obligations in connection with, supply replacement
parts for, and supply disposable sensors for, the Cerebral Oximeter or to
continue in existence in the future.
The Company provides a one-year warranty on the Cerebral Oximeter, which the
Company will satisfy by repairing or exchanging those in need of repair. The
Company also expects to offer maintenance agreements and service for the
Cerebral Oximeter for a fee after the warranty expires. The Company's service
department currently consists of one person. The Company intends to increase
its service personnel commensurate with product service demand.
The Company has not had significant prior experience in the marketing of
medical capital equipment. Consequently, there can be no assurance that the
marketing efforts of the Company will be successful on a scale necessary to
enable the Company to attain profitability.
The Cerebral Oximeter has not had extensive use in commercial setting and has
not been evaluated for every medical procedure in which it might be used.
There can be no assurance that further research or use of the device will not
reveal unexpected problems with its operation or performance, especially in
connection with medical procedures for which the device has not yet been
evaluated. Although the Company's testing of the Cerebral Oximeter to date
indicates clinical utility, subsequent performance problems could result in
unanticipated expense and could adversely affect future sales of the device.
The following table shows the approximate percentage of net sales for major
product classifications for the past three years:
Years Ended November 30,
----------------------------
Product 1996 1995 1994
- ------- -------- -------- --------
Refurbished Cerebral Oximeters 14% 10% 0%
Commercial Cerebral Oximeters 63% 74% 84%
SomaSensors 23% 16% 16%
------- ------- -------
Total 100% 100% 100%
======= ======= =======
The following table shows the approximate percentage of United States and
export net sales for the past three years:
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Years Ended November 30,
----------------------------
Type of Sale 1996 1995 1994
- ------------ -------- -------- --------
United States 4% 0% 0%
Export 96% 100% 100%
------- ------- -------
Total 100% 100% 100%
======= ======= =======
Two international distributors accounted for approximately 62% and 15% of total
revenues for fiscal 1996, approximately 53% and 13% of total revenues for
fiscal 1995 and approximately 43% and 10% of total revenues in fiscal year
1994. The Company's distributor in Japan, has been the Company's largest
customer in each of fiscal 1996, 1995 and 1994. The Company is dependent on
its sales to Baxter Limited, and the loss of Baxter Limited as a customer would
have a material adverse effect on the Company's business.
MANUFACTURING
The Company is currently assembling the Cerebral Oximeter in its
facilities in Troy, Michigan, from components purchased from outside suppliers.
The Company believes that each component is generally available from several
potential suppliers, although loss of any particular supplier could have an
adverse effect on the Company's ability to assemble the Company's products
timely. The disposable sensor, the printed circuit boards, other mechanical
components, and the cabinet are the primary components that must be
manufactured according to specifications provided by the Company. Although the
Company is currently dependent on one manufacturer of the SomaSensor, the
Company believes that several potential suppliers are available to manufacture
these components. The Company would, however, require approximately three to
four months to change SomaSensor suppliers.
The Company does not currently intend to manufacture on a commercial scale the
disposable sensor or the components of the Cerebral Oximeter. The Company
expects that it will be dependent to a significant extent on other entities for
commercial scale manufacturing of the disposable sensor and of components for
its products, and on their ability to manufacture and deliver, on a timely
basis, sufficient quantities of the disposable sensor and of components for its
products in compliance with the Company's own quality standards and in required
cases in compliance with FDA Good Manufacturing Practice regulations. The
Company is also dependent on its own ability to inspect adequately and
accurately such third parties' work and on its ability and capacity to assemble
Cerebral Oximeters on a commercial scale.
RESEARCH AND DEVELOPMENT
During fiscal 1996, additional efforts were made to improve the disposable
SomaSensor and considerable work was performed evaluating the results of the
clinical trials that supported the 510(k) submission and defending the 510(k)
application. The Company focused its efforts after FDA 510(k) clearance on
product-line extensions of the Cerebral Oximeter for use on children and
newborns in operating rooms and intensive care units and enhancements to the
Cerebral Oximeter. The Company also intends to explore other applications of
its INVOS technology and related technologies. As described above under the
caption "RECENT DEVELOPMENTS - PRODUCTS AND MARKETING", the Company has entered
into a Consulting Order with NeuroPhysics Corporation pursuant to which the
Company is supporting NeuroPhysics' research into the feasibility and
development of prototypes of four new products.
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The Company's research and development strategy relating to a proposed new
product is to identify and work with leaders in the field at teaching
hospitals, departments of the hospitals, universities, clinics or leading
health institutions (the "Hospital"). After obtaining clearance or approval
for clinical studies from the FDA or the Hospital's Institutional Review Board
(whichever is appropriate), the Company would provide a prototype of the
product to the Hospital, and the Hospital would provide the space, staff and
clinical testing of the prototype product. A prototype of the Cerebral
Oximeter for use on children and newborns was being developed; however, in
November 1993 when the FDA rescinded the Company's 510(k), research and
development of new products was suspended. The Company is expected to begin
clinical trials for pediatric use after completing development of a prototype.
The Company has become affiliated with a sponsoring hospital in connection with
human testing of the proposed Cerebral Oximeter for use on children and
newborns. No other clinical trials of new products have been performed.
The Company's proposed marketing strategy for new products is to
attempt to establish relationships with physicians and researchers in
particular market segments to determine market needs, to obtain experimentation
support and to properly define the required clinical trials. New products
require extensive testing and regulatory clearance before they can be marketed,
and substantial customer education concerning product use, advantages and
effectiveness. In addition, the Company's products might meet market
resistance in their primary markets because of price resistance to major
capital equipment and fixed reimbursement amounts from medical insurers for the
procedures in which the Company's products might be used. There can be no
assurance that the Company will be able to successfully apply the INVOS
technology in the development of commercially viable products or that
competitors will not develop and market similar products before the Company
does.
During fiscal years 1996, 1995 and 1994 the Company spent $235,354, $285,893
and $549,737, respectively, on research, development and engineering.
COMPETITION
The Company competes indirectly with numerous others in the development,
manufacture and marketing of medical equipment that is used in existing
diagnostic techniques for surgical and critical care patient diagnosis and
monitoring (see "Cerebral Oximeter - Existing Diagnostic Methods"), many of
which are large medical companies with longer histories in the medical
equipment industry than the Company, well established reputations, customer
relationships and marketing, distribution and service networks, larger product
lines than the Company and greater management, financial and technical
resources. The Company also competes with suppliers of capital equipment of
various types for limited hospital capital equipment budgets. In addition, the
large installed base of pulse oximeters poses a significant marketing challenge
to the introduction of new oximetry equipment such as the Company's. A number
of other companies market products which use optical spectroscopy for in vivo
patient examination, including measurement of blood oxygen levels, or have
announced intentions to enter markets which the Company is considering
entering. In addition, numerous patents have been issued to others involving
optical spectroscopy and the interaction of light with tissue and many of these
could have relevance to or even cover technology used by the Company; further,
some of
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these relate to the use of optical spectroscopy in vivo in the area of
cranial metabolism monitoring, the primary use of the Cerebral Oximeter. No
patent infringement claims have been made against the Company, but it has not
obtained an opinion from its patent counsel that the Cerebral Oximeter does not
infringe any of the numerous patents issued to others. The Company is not
aware of any commercial product developed from the patented technology of
others relating to cranial metabolism monitoring, although such devices have
been sold for research or evaluation.
There can be no assurance that these potential competitors will not
duplicate the Company's technological achievements in the future or will not
develop products which directly compete with the Company's products in existing
or intended markets. The Company's technology primarily represents
improvements or adaptations of known optical spectroscopy technology, which
might be duplicated or discovered through its patents, reverse engineering or
both. The Company believes that a manufacturer's reputation for producing
accurate, reliable and technically advanced products, references from users,
features (speed, safety, ease of use, patient convenience and range of
applicability), product effectiveness and price are the principal competitive
factors in the medical equipment industry. There can be no assurance that the
publication by one group of researchers of adverse results from tests of the
Cerebral Oximeter in situations beyond its indicated use, the Company's
financial condition and the FDA's rescission of the Company's 510(k) clearance
will not adversely affect the Company's reputation or its ability to market and
sell its device.
PROPRIETARY INFORMATION
The Company's initial United States patent, covering the in vivo tissue
examination technology developed in conjunction with the INVOS 2100 and its
predecessor the SOMA 100, was allowed and issued in 1986 and will expire on
October 14, 2003. The corresponding Canadian patent was issued in 1987. In
addition, the corresponding European Community patent was granted in 1990, and
the corresponding patent in Japan was granted in 1991.
The Company has filed other patent applications in the United States and
foreign countries with respect to other aspects of its technology relating to
the interaction of light with tissue, and eleven of these additional
applications have now been issued as patents in the United States while others
remain pending. The eleven additional United States patents expire on February
16, 2005, February 18, 2006, April 4, 2006, August 18, 2009, August 25, 2009,
June 6, 2011, July 8, 2013, July 11, 2014, December 26, 2012, August 29, 2014,
and December 15, 2014, respectively. Although the Company believes and asserts
that one or more of its issued patents cover some of the underlying technology
used in the Cerebral Oximeter, there can be no assurance that any such
assertion would be successful, and only seven of the issued patents expressly
refer to examination of the brain or developments involving the Cerebral
Oximeter. If the Company files additional applications, there can be no
assurance that any such applications will be allowed or that any issued patents
would be upheld or afford meaningful protection against competition.
Furthermore, many patents have previously been issued to others involving
optical spectroscopy and the interaction of light with tissue, some of which
relate to the use of optical
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spectroscopy in the area of cranial metabolism monitoring, the primary
use of the Cerebral Oximeter. No patent infringement claims have been asserted
against the Company, but it has not obtained an opinion from its patent counsel
that the Cerebral Oximeter does not infringe any of the numerous patents
already issued. If it were determined that the Company's products infringed
any claims of an issued patent, the Company could be enjoined from making or
selling such products or forced to obtain a license in order to continue the
manufacture or sale of the product involved, requiring payment of a licensing
fee or royalties of unknown magnitude on sales of the product. In addition,
the Company could be liable for substantial damages, and even the defense of
patent litigation can be extremely expensive. There can be no assurance that
if any such license were required, it would be available, or available on terms
acceptable to the Company. There can be no assurance that claims for
infringement will not be asserted against the Company. Any inability to obtain
required licenses on favorable terms, or at all, would adversely affect the
Company's business.
The Company's patents are basically directed to methods and apparatus for
introducing light into a body part and receiving, measuring and analyzing the
resulting light. The patented methods also involve determining and analyzing
the light transmissivity of various body parts of a single subject, as well as
of body parts of different subjects, which provides a standard against which a
single subject can be compared. Certain of these and other developments of the
Company enable the Cerebral Oximeter to monitor oxygen saturation changes and
reduce extraneous information from bone, muscle and other tissue in the region
being measured.
In addition to its patent rights, the Company has obtained U.S. Trademark
Registrations for its trademarks "SOMANETICS," "SOMAGRAM," "INVOS,"
"SOMASENSOR" and "WINDOW TO THE BRAIN," and has also obtained registrations of
its basic mark, "SOMANETICS," in thirteen foreign countries.
The Company also relies on trade secret, copyright and other laws to protect
its technology, but believes that neither its patents nor other legal rights
will necessarily prevent others from developing or from using similar or
related technology to compete against the Company's products. Moreover, the
Cerebral Oximeter might be susceptible to reverse engineering, allowing
competitors to obtain the Company's proprietary technology. The Company is
aware that a number of companies are interested and may have patents in similar
or related technological areas involving interaction of light with tissue.
There can be no assurance that any issued patents will provide the Company with
significant competitive advantages, or that challenges will not be instituted
against the validity or enforceability of any patents owned by the Company or,
if instituted, that such challenges will not be successful. The cost of
litigation to uphold the validity of a patent and prevent infringement can be
very substantial and could be beyond the Company's means even if the Company
could otherwise prevail. Furthermore, there can be no assurance that others
will not independently develop similar technologies, duplicate the Company's
technology or design around the patented aspects of the Company's technology or
that the Company will not infringe patents or other rights owned by others.
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REGULATION
Because the Company distributes "medical devices" as defined under the Federal
Food, Drug, and Cosmetic Act ("FD&C Act"), the Company and its products are
subject to regulation by the FDA and the corresponding agencies of the states
and foreign countries in which the Company sells its products. Accordingly,
the Company is required to comply with FDA regulations governing the
manufacture, distribution and labeling of its products. This includes certain
Good Manufacturing Practice ("GMP") regulations in the processing or
manufacture of the devices. States and foreign countries could have similar
requirements. In addition, the Company is subject to periodic inspections by
the FDA, and may be subject to inspections by state and foreign agencies. If
the FDA believes that its legal requirements have not been fulfilled, it has
extensive enforcement powers, including the ability to bar products from the
market, to prohibit the operation of manufacturing facilities and to require
recalls of devices from customer locations.
Before being distributed commercially, the Company's medical devices must
undergo FDA review of a pre-market notification ("510(k)"). A 510(k) is
submitted in instances where the manufacturer claims that the device in
question is "substantially equivalent" to a legally marketed device. A
manufacturer must file a 510(k) with the FDA at least 90 days before it
proposes to distribute the device commercially. The FDA can determine whether
the device is or is not equivalent to a legally marketed device within this
90-day period, although this process generally takes longer than 90 days. A
device requiring a 510(k) may not be marketed in the United States until FDA
clearance has been obtained.
In a Notice of Adverse Findings letter dated February 22, 1988, the FDA
notified the Company that certain of its GMP's with regard to the processing
and assembly of the INVOS 2100 were deficient. The Company also underwent an
FDA GMP audit in 1992. The Company believes it corrected any noted
deficiencies to the FDA's satisfaction.
During 1985, the Company applied for and received 510(k) clearance to market
its SOMA 100 device as an adjunctive technique for the evaluation of the
breast. The SOMA 100 was considered by the FDA to be substantially equivalent
to other legally marketed transillumination devices. The Company was not
required to perform clinical trials to obtain 510(k) clearance of its SOMA 100
device. The INVOS 2100 was an update of the SOMA 100. The Company did not
submit a new 510(k) pre-market notification to the FDA because the Company
believed the changes made in the INVOS 2100 version were not significant and
did not affect the safety or effectiveness of the device.
In 1988, the FDA advised the Company of its belief that the claims in the
Company's advertising and packaging for the INVOS 2100 with regard to the
system's ability to determine or assess the risk of breast cancer were not
covered by the FDA 510(k) clearance for the device. The Company received a
letter dated August 3, 1994, from the FDA warning manufacturers of breast
transillumination devices that these devices are in violation of the Federal
Food Drug and Cosmetic Act in that their labeling is false or misleading and
fails to bear adequate directions for use. The FDA requested the Company to
inform FDA of steps taken with regard to future production and distribution and
with regard to previously distributed devices. The Company responded to the
FDA by explaining the INVOS 2100 had
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not been available for sale by the Company commercially or otherwise
since January, 1989. The Company had not received any correspondence or
inquiries regarding the INVOS 2100 since fiscal 1991 (other than the August 3,
1994 letter from the FDA) and believes the devices currently in the domestic
marketplace are no longer used, based on the manner in which the unit is to be
used and the instructions in the user manual. The Company believes no further
action is required.
For a history and a description of the current FDA clearance to market the
Cerebral Oximeter in the United States, see "Recent Developments - Products and
Marketing".
There can be no assurance that the Cerebral Oximeter will be successfully or
profitably marketed by the Company. There can be no assurance that if and when
any additional products are developed by the Company, they will receive FDA
clearance. If any clearances are denied or rescinded, sales of the Company's
products in the United States would be prohibited during the period the Company
does not have such clearances. In such cases the Company would consider
shipping its products internationally and/or assembling them overseas if
permissible, and if the Company determines its product to be ready for
commercial shipment. The FDA's current policy is that a medical device not in
commercial distribution in the United States, but which needs a 510(k)
substantially equivalent determination to be entered into domestic commercial
distribution, can be exported without the submission of an export request and
prior FDA clearance provided that (i) a Company believes the device can be
found to be substantially equivalent through a 510(k) submission; (ii) the
device is intended for export; (iii) the device is in accord with the
specifications of the foreign purchaser, and (iv) other conditions of the
export provisions of the Food, Drug and Cosmetic Act have been met.
INSURANCE
Because the Cerebral Oximeter is intended to be used in critical care hospital
units with patients who may be seriously ill or may be undergoing dangerous
procedures, the Company may be exposed to serious potential product liability
claims. From time to time, patients on whom the Cerebral Oximeter is being
used will sustain injury or death relating to his or her medical treatment or
condition. If litigation is initiated because of such injury, the Company may
be sued, and regardless of whether it is ultimately determined to be liable,
the Company may incur significant legal expenses. In addition, product
liability litigation could damage the Company's reputation and therefore impair
its marketing ability. Such litigation could also impair the Company's ability
to retain products liability insurance or make such insurance more expensive.
The Company has obtained products liability insurance along with an umbrella
policy. The Company also maintains coverage for property damage or loss,
general liability, business interruption, travel-accident, directors' and
officers' liability and workers' compensation. Such insurance is costly and
even though it has been obtained, there can be no assurance that the amount of
insurance carried by the Company will be sufficient to protect it fully in the
event of a major defect in the Cerebral Oximeter.
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EMPLOYEES
At January 17, 1997, the Company had 37 employees and four consultants. The
Company expects to increase its workforce in 1997 as it resumes sales and
marketing activities in the United States, including two additional sales and
marketing employees expected to be hired in the first fiscal quarter of 1997,
and 11 additional employees in fiscal 1997 (one in Management, two in
Administration, four more in Sales and Marketing, one in Medical Affairs, one
in Quality Control, one in Manufacturing, and one in Service). The Company
believes that its future success is dependent, in large part, on its ability to
attract and retain highly qualified management, marketing, technical and
administrative personnel. The Company's ability to retain existing employees
and attract new employees may be adversely affected by its current financial
situation.
The Company's employees are not represented by a union or subject to a
collective bargaining agreement. The Company believes that its relations with
its current employees are good.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
The Company is located in Troy, Michigan and has no other locations. The
Company's export sales for the fiscal years ended November 30, 1996, 1995 and
1994 were approximately $745,000, $1,336,000 and $938,500, respectively.
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