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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number
January 3, 1998 0-27422
ARTHROCARE CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3180312
(State or other jurisdiction of incorporation (I.R.S. employer
or organization) identification number)
595 North Pastoria Avenue, Sunnyvale, California 94086
(Address of principal executive offices and zip code)
(408) 736-0224
(Registrant's telephone number, including area code)
Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001
Par Value;
Preferred Share
Purchase Rights
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 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.
As of March 4, 1998, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $133,445,790 (based upon the closing sales
price of such stock as reported by The Nasdaq Stock Market on such date).
Shares of Common Stock held by each officer, director, and holder of 5% or more
of the outstanding Common Stock on that date have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination
As of March 4, 1998, the number of outstanding shares of the Registrants'
Common Stock was 8,896,386.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference from the Registrant's proxy statement for the 1998
Annual Stockholders Meeting (the Proxy Statement) which will be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year ended January 3, 1998.
PART I
ITEM 1. BUSINESS.
This Report on Form 10-K contains certain forward-looking statements regarding
future events with respect to the ArthroCare Corporation ("ArthroCare" or "the
company"). Actual events or results could differ materially due to a number of
factors, including those described herein and in the documents incorporated
herein by reference, and those factors described under "Additional Factors that
Might Affect Future Results"
OVERVIEW
ArthroCare develops, manufactures and markets surgical instruments based on
its novel Coblation (TM) technology. ArthroCare's tools enable surgeons to
ablate (remove) or shrink soft tissue and achieve hemostasis (sealing small
bleeding vessels). ArthroCare's Coblation-based tools are designed to allow
surgeons to operate on soft tissue with a high degree of precision and
accuracy, and with minimal damage to surrounding tissues. The ArthroCare
Arthroscopic System replaces the multiple surgical tools traditionally used in
arthroscopic procedures with one multi-purpose, surgical system that consists
of a controller unit and a series of disposable ArthroWand surgical tools
specialized for particular types of surgery. In March 1995, the company
received clearance of its 510(k) premarket notification to market the
ArthroCare Arthroscopic System for use in arthroscopic surgery of the knee,
shoulder, ankle and elbow. The company began shipping products for use in
arthroscopic surgery of the shoulder and knee in December 1995. In July 1996,
it received clearance of its 510(k) premarket notification to market its
Arthroscopic System for use in arthroscopic surgery of the wrist and hip.
To date, the company's operations have consisted primarily of research and
development, product engineering, seeking patent approvals on novel technology,
obtaining FDA clearance of its Arthroscopic System, developing a network of
distributors in the United States and abroad to market the Arthroscopic System,
marketing and sales efforts and more than two years of product sales. The
company has realized increasing revenues from the sale of its products, but
continues to generate operating losses and anticipates generating losses in
the future. Whether the company can successfully manage the transition to a
larger-scale commercial enterprise will depend upon increasing sales of
disposable ArthroWands from its domestic and international distribution
network, obtaining additional international regulatory approvals for the
Arthroscopic System, obtaining domestic and international regulatory approvals
for potential future products and maintaining its financial and management
systems, procedures and controls.
COBLATION TECHNOLOGY
Coblation technology is ArthroCare's patented soft-tissue surgical technology
upon which all the company's products are based. Coblation technology is a
novel use of radio frequency energy characterized by precision, accuracy, ease
of use and the capability of performing at a temperature lower than current
traditional surgical tools.
Traditional electrosurgical tools have relied upon heat to essentially burn
away targeted tissue, which often results in collateral thermal damage to
tissue surrounding the surgical area. Even excimer lasers, which are cooler
than other types of soft-tissue surgical tools, lack tactile feedback and
therefore make it difficult for surgeons to control the depth of tissue
penetration and also can lead to collateral tissue damage. Coblation
technology employs a lower temperature process that minimizes the risk of
thermal burn while increasing a surgeon's control and precision.
Coblation works through a cool process similar to that of excimer lasers. It
uses the electrically conductive fluid employed in arthroscopic surgeries in
the gap between the electrode and tissue. When electrical current is applied
to this fluid, it turns into a charged layer of particles, called a plasma
layer. Charged particles accelerate through the plasma and gain sufficient
energy to break the molecular bonds within cells. This literally causes the
cells to disintegrate molecule by molecule, so that tissue is volumetrically
removed. But, because this effect is confined to the surface layer of the
target tissue, there is minimal damage to surrounding tissue. An additional
advantage is that, unlike excimer lasers, Coblation can be performed in a
continuous mode. This results in much more efficient tissue removal.
In addition to achieving more precise tissue removal (or shrinkage) and less
damage to collateral tissue, surgical tools based on Coblation technology can
achieve hemostasis (sealing small bleeding vessels) near the surgical site,
which reduces bleeding at the site.
Coblation technology is applicable to soft tissue surgery thoughout the body
and the company is exploring its use in other non-arthroscopic indications.
The company commercially introduced the Arthroscopic System in December 1995
and by the year ended January 2, 1998, had reported 25 months of sales. The
Arthroscopic System is the company's only commercial product and will account
for substantially all of the company's revenue for the foreseeable future. As
such, the company is highly dependent on its Arthroscopic System.
Additionally, the company's potential products for non-arthroscopic
indications are in various stages of development, and the company may be
required to undertake time- consuming and costly development activities and
seek regulatory approval of these devices. There can be no assurance that
product development will ever be successfully completed, that regulatory
approval, if applied for, will be granted by the United States Food and Drug
Administration ("FDA") on a timely basis, if at all, or that the potential
products will ever achieve commercial acceptance.
THE ARTHROSCOPY MARKET
Historically, severe joint injuries have been treated using open surgery
involving large incisions, a hospital stay and a prolonged recovery period. In
contrast, arthroscopic surgery, which was introduced in the early 1980s, is
performed through several small incisions called portals and can be performed
on an outpatient basis. The company believes that arthroscopic surgery has
gained wide market acceptance because it promises shorter hospital stays and
reduced recovery time.
In 1996, approximately 2.2 million arthroscopic procedures were performed in
the United States. According to industry sources, the number of arthroscopic
procedures is growing due to patient demand for less invasive procedures as
well as the increasing incidence of joint injuries caused by a greater
emphasis on physical fitness and an aging population. Joints are susceptible
to injuries from blows, falls or twisting, as well as from natural
deterioration and stiffening associated with aging.
To perform arthroscopic surgery, a surgeon must use a tool to visualize the
site and a tool to perform the surgery. The tool used to visualize the site,
called an arthroscope, is a small fiber-optic viewing instrument made up of a
small lens, a light source and a video camera, which allows the surgeon to view
the surgical procedure on a video monitor. During the arthroscopic procedure,
an irrigant, such as saline or sterile water, is flushed through the joint to
permit clear visualization through the arthroscope and to create the space
within the joint for the surgical procedure. The surgeon inserts the
arthroscope into the joint through a portal measuring approximately six
millimeters (1/4 of an inch) in length. Other portals are used for the
insertion of surgical instruments to perform the surgery and to facilitate the
flow of irrigants. With small incision sites and direct access to most areas
of the joint, a surgeon can diagnose and correct an array of joint problems
such as cartilage tears, ligament tears and removal of loose and degenerative
tissue.
The advantages of arthroscopic surgery over open surgery are often
significant. Due to the smaller incisions and reduced surgical trauma, the
patient might experience several benefits including reduced pain; treatment on
an out-patient basis; reduced or eliminated hospitalization times; immediate
joint mobility and less muscle atrophy; less surrounding tissue damage; lower
rate of complications; and generally quicker rehabilitation. In addition,
treatment on an out-patient basis and reduced operating time can significantly
lower hospital costs.
Knee
The knee is the most commonly injured joint. In 1996, it accounted for
approximately 1.5 million arthroscopic procedures in the United States. Damage
to a meniscus - a pad of cartilage that helps cushion the knee joint - is a
common form of knee injury. A meniscus can be torn by a twist of the leg when
the knee is flexed, displaced either inward toward the center of the tibia
(central shin bone) or outward beyond the surface of the femur (central
thighbone), or worn down by normal aging. The knee is also susceptible to
partial or complete tears of the ligaments and degeneration of the cartilage
on the underside of the patella (knee cap). In addition, the cartilage
covering the bony surfaces of the knee wears down with age and can become
rough or tear loose from the bone, causing pain and interfering with smooth
joint movement.
Shoulder
The shoulder joint, because of its range of motion, is susceptible to a number
of injuries. In 1996, approximately 440,000 arthroscopic procedures in the
shoulder were performed in the United States. The company believes that
shoulder arthroscopy is the fastest-growing portion of the arthroscopy market.
With repetitive motion and lifting of the arm, such as that which occurs
during a tennis serve, the acromion (the "roof" of bone formed where the
scapula, or shoulder blade, extends over the humerus, the bone of the upper
arm) may pinch one of the shoulder muscles and cause persistent pain, known as
a rotator cuff injury. This condition can be treated by strengthening
exercises and physiotherapy; however, many rotator cuff injuries require
surgical intervention. The company believes that a significant percentage of
the population is born with an acromion that hooks over the humerus, making
such individuals more susceptible to rotator cuff injuries.
Elbow, Ankle, Wrist and Hip
The elbow, ankle, wrist and hip joints are also susceptible to certain stress-
related injuries and deterioration due to aging. In 1996, approximately 220,000
arthroscopic procedures were performed in the elbow, ankle and wrist, in the
United States. The company believes that the current number of surgical
procedures in the elbow, ankle, wrist and hip is relatively small due to the
limitations on conventional arthroscopic surgical equipment.
CONVENTIONAL TREATMENT METHODOLOGIES: THE PROBLEM
Most arthroscopic procedures require the surgeon to probe, cut, sculpt, shape
and cauterize (seal bleeding vessels) to achieve satisfactory results. Surgeons
frequently use a combination of instruments when performing an arthroscopic
procedure because each instrument is designed to perform a specific function.
Use of an assortment of tools requires the surgeon to insert and remove each
of the tools from the portals several times during the same procedure.
Surgical procedures can employ one or more of four groups of surgical
instruments: (1) power or motorized instruments, such as cartilage and bone
shavers; (2) mechanical instruments, such as basket punches, graspers and
scissors; (3) electrosurgery systems (Bovie); or (4) laser systems.
Power instruments are generally used to smooth tissue and cartilage defects on
the surface of the bones of the joint. The damaged tissue is removed from the
joint using suction through a cannula surrounding the shaft of the tool, which
can become obstructed by bits of tissue and bone. Power shavers have rotating
cutters inside a tube and are not currently available in a wide variety of tip
angles or sizes for the precise shaving of tissue. This prevents power shavers
from being used in many areas of the joint.
Mechanical instruments are used primarily in meniscus removal by snipping away
the unwanted tissue. Because mechanical tools must open and shut to operate,
they cannot be used in small areas such as the back of the knee. In addition,
mechanical tools must be resharpened at regular intervals and sterilized after
each procedure.
Electrosurgery systems are primarily used to achieve hemostasis, which is
necessary to minimize bleeding and maximize the arthroscopic surgeon's
visibility of the procedure through the arthroscope. Bleeding occurs most
commonly in shoulder arthroscopies. Electrosurgical systems contain two
electrodes: the electrode tip held by the surgeon and a dispersive pad that
rests under the patient's body. The metal electrode tip of the instrument,
which resembles a pencil point, is placed on or near the bleeding vessel to be
sealed. A generator connected to the electrode delivers high-frequency voltage
that arcs between the electrode and the target tissue, sealing blood vessels
in its vicinity. After arcing, the current travels through the remaining
tissue of the patient, through the skin to the dispersive electrode pad,
before being directed back to the generator. A non-conductive media such as
sterile water is used in the surgical space so that the electricity is forced
into the tissue instead of into the surrounding fluid. As a result of its
conductivity, saline - the preferred irrigant - cannot be used during the
procedure.
Laser systems are used to ablate tissue while achieving simultaneous
hemostasis. Laser systems are not tactile tools, meaning that the surgeon
cannot feel how much tissue is being ablated. The surgeon must be extensively
trained to precisely position the laser to control the depth of tissue
penetration to minimize unintended tissue damage. The company believes that
laser tools have not received wide acceptance because of high cost, lack of
tactile feedback for the surgeon and the required training and certification.
THE ARTHROCARE ARTHROSCOPIC SYSTEM
The company's Arthroscopic System is a high-frequency, surgical device
intended to perform tissue ablation and simultaneous hemostasis. The company
sells its Arthroscopic System for use in all six major joints: knee, shoulder,
elbow, ankle, wrist and hip. Tissues such as meniscus, synovium, cartilage and
ligaments can be ablated using the Arthroscopic System. In addition, the
company's capsular shrinkage (CAPS) wand is used to shrink collagen in shoulder
procedures.
The company's Arthroscopic System comprises an array of disposable bipolar
multielectrode tools (ArthroWands), a connecting cable, foot pedal (or switch)
and a radio frequency power controller. The System 2000 controller,
approximately 14 inches by 11 inches by five inches, is used to deliver
high-frequency power to the ArthroWands. To ablate different tissues or
achieve hemostasis, the surgeon can control the voltage level using the foot
pedal or keys on the front panel of the controller. The cable, which is
approximately 10 feet in length, connects the System 2000 controller to the
ArthroWand. Power is transmitted through the cable to the ArthroWand by
depressing a foot pedal, thereby enabling surgeons to use the ArthroWand as a
conventional probe as well as an instrument that ablates and achieves
hemostasis (cauterize).
Accordingly, the surgeon using the Arthroscopic System need not remove and
insert a variety of instruments to perform different tasks as is required when
using conventional arthroscopic instruments. The ArthroWand is approved for
sale in tip sizes 1.5 mm to 4.5 mm, and in tip angles ranging from 0 to 90
degrees. The company currently sells 14 models in various tip sizes, angles
and shapes which enable the surgeon to ablate different volumes of tissue and
to reach treatment sites not readily accessible by existing mechanical
instruments and motorized cutting tools.
The company commercially introduced the Arthroscopic System in December 1995
and by the year ended January 3, 1998, had reported 25 months of sales. By the
end of fiscal 1997, the company had shipped over 1,500 controller units. In
addition, the company has sold more than 140,000 ArthroWands. The company has
ramped up its manufacturing capabilities and from 1996 to 1997 it doubled
ArthroWand volumes while maintaining high yields. During fiscal 1997, the
company also began manufacturing the System 2000 controllers in-house, to
maintain process control, manage availability and leverage fixed costs.
The Arthroscopic System is the company's only commercial product and will
account for substantially all of the company's revenue for the foreseeable
future. As such, the company is highly dependent on its Arthroscopic System.
The company has established distribution capability in Europe, Australia,
Korea, Japan, Canada and parts of South and Central America. Before the
Arthroscopic System can be sold outside these regions, the company will have
to obtain additional international regulatory approvals and establish
additional distribution capability in other geographic regions. If such
regulatory approval is obtained, there can be no assurance that the company
will be able to establish a successful distribution capability.
Physicians will not use the company's products unless they determine, based on
experience, clinical data and other factors, that these systems are an
attractive alternative to conventional means of tissue ablation. No
independent published clinical reports exist to support the company's
marketing efforts for its Arthroscopic Systems, which may have an adverse
effect on its ability to obtain physician acceptance. The company believes
that continued recommendations and endorsements by influential physicians are
essential for market acceptance of its Arthroscopic System. If the
Arthroscopic System does not continue to receive broad-based physician
acceptance and endorsement by influential physicians, the company's business,
financial condition and results of operations would be materially adversely
affected.
ARTHROCARE'S PATENTED TECHNOLOGY
The ArthroCare Arthroscopic System is based on the patented Coblation core
technology and is designed to achieve precise ablation of soft tissue and
simultaneous hemostasis while minimizing damage to the surrounding healthy
tissue. The company believes that its Coblation technology, and the surgical
tools the company has built based on this technology, offer several advantages
over other approaches to arthroscopic surgery. The company believes that
Coblation technology enables surgeons to perform ablation, tissue shrinkage and
hemostasis with a single set of tools, with minimal collateral tissue damage,
with high degrees of accuracy and precision, with greater control and
reproducible results and at a lower cost than other surgical alternatives.
Further, the company believes that patients operated on using Coblation-based
surgical tools experience improved outcomes compared to conventional surgical
procedures, characterized by less pain, faster recovery and smoother resumption
of pre-injury activities.
The company's bipolar, multielectrode configuration and power control system
allow high-frequency electrical energy to be precisely focused on the surface
of the tissue being treated. Using a bipolar array of electrodes eliminates
the need to deliver energy through the surgical site to a dispersive electrode
pad located outside the body, because the energy is directed from the tip of
the probe to a return electrode contained on its shaft. The electric current
travels a shorter distance from the electrode array to the target tissue
before returning to the electrode on the shaft, allowing the Arthroscopic
System to operate at lower voltages and at a lower temperature than
conventional monopolar electrosurgical systems.
As illustrated below, the ArthroWand's energy is concentrated only at the tip
of the electrodes. This configuration allows the energy to be focused on the
surface layer of the tissue being ablated, thereby minimizing the risk of
unwanted damage to surrounding healthy tissue. The controller provides power
individually to each of the electrodes at the tip of the ArthroWand, enabling
only those electrodes that come into contact with tissue to deliver sufficient
energy to ablate tissue. During use, the high frequency current flows from the
controller through each electrode to the tissue, returning to the controller
via the return electrode on the shaft of the ArthroWand. The operation of a 90
degree ArthroWand is depicted below.
[Illustration depicting the operation of an ArthroWand on Tissue]
The company's patented Coblation technology, delivered in the form of
multielectrode, bipolar, electrosurgical tools, offers a number of benefits
that the company believes may provide advantages over competing surgical
methods and devices. The principal benefits include:
- Ease of Use. The Coblation-based Arthroscopic System performs many of the
functions of mechanical tools, power tools and electrosurgery instruments,
allowing the surgeon to use a single instrument. The lightweight probe is
simple to use and complements the surgeon's existing tactile skills
without the need for extensive training.
- Precision. In contrast to conventional tools, the Coblation-based
Arthroscopic System permits surgeons to perform more precise tissue
ablation and sculpting. The company believes this may result in more rapid
patient rehabilitation.
- Safety. Coblation technology, unlike most electrosurgical tools does not
work by heating tissue. The company believes that cooler operation can
lead to significant benefits for patients being treated with Coblation-
based surgical tools, in the form of little or no collateral thermal
burning of tissues near the surgical site. As a result, the company
believes that patients are likely to experience less trauma and pain
following surgery and might be able to recover more quickly to their pre-
injury activity levels.
- Simultaneous Ablation and Hemostasis. The Coblation-based Arthroscopic
System efficiently seals small bleeding vessels during the tissue ablation
process, which improves the surgeon's visibility of the operative site.
- Cost Reduction. The Coblation Arthroscopic System eliminates the need to
introduce multiple instruments to remove and sculpt tissue and seal small
bleeding vessels. The company believes this may reduce operating time and
thereby produce cost savings for health care providers.
Despite the benefits of the Arthroscopic System, there can be no assurance
that doctors and surgical centers will buy the Arthroscopic System. In order to
secure the benefits of the Arthroscopic Systems, however, a hospital or
surgical center must procure and use a specifically designed controller to
power the ArthroWand. At hospital sites or surgical centers where several
arthroscopic procedures can be performed simultaneously, the procurement of
multiple controllers is required. To date, the company has placed its
controllers at substantial discounts in order to stimulate demand for its
Arthroscopic System. In addition, motorized and mechanical instruments and
electrosurgery systems currently used by hospitals and surgical centers for
arthroscopic procedures have a history of success and have become widely
accepted by orthopedic surgeons. If physicians do not determine that the
Arthroscopic System is an attractive alternative to conventional means of
tissue ablation, the Arthroscopic System will not be acceptable, and the
company's business, financial condition and results of operations would be
materially adversely affected.
ARTHROCARE STRATEGY
The company's objective is to use its patented Coblation technology to design,
develop, manufacture and sell innovative, clinically superior surgical devices
for the arthroscopic surgical treatment of joint injuries and for the surgical
treatment of other soft-tissue conditions throughout the body. The key elements
of the company's strategy to achieve this objective include:
- Continue to Penetrate Existing Arthroscopic Surgical Instrument Market.
The company's initial sales efforts are focused on marketing the company's
products to orthopedic surgeons performing high-volume arthroscopy and to
opinion leaders in orthopedic surgery.
- Expand into New Arthroscopic Surgical Markets. The company encourages
surgeons to use its Arthroscopic System to treat joints that have been
primarily treated by open surgery, such as the shoulder, elbow and ankle.
Because of the small size, varying shapes and tactile feel of the
company's ArthroWand, the company believes surgeons will be able to
arthroscopically access areas difficult to reach by conventional
arthroscopic surgical tools. In addition, the company has introduced new
products that expand the types of arthroscopic surgical procedures to
which its Coblation technology can be applied. The CAPS wand to shrink
collagen in shoulder joints and the small joint wands are an example of
this expansion.
- Target Key International Markets. The company has begun to market its
Arthroscopic System in international markets. The company has signed
agreements with marketing partners to assist with regulatory requirements
and to market and distribute the Arthroscopic System in Europe, Japan and
Australia.
- Leverage Broadly Applicable Proprietary Technology. The company plans to
leverage its proprietary Coblation technology by developing additional
wands for use in a variety of non-arthroscopic soft tissue surgical
procedures.
- Structure Targeted Strategies to Commercialize the Platform Technology.
While the company will continue to focus on the arthroscopy field, it will
evaluate and plans to pursue additional applications of its technology in
other promising fields. On a case-by-case basis, ArthroCare will determine
the best strategy for entering these additional markets. In some cases,
the company might choose to establish stable, long-term relationships with
strong partners to address specific fields outside of arthroscopy. In
select other areas, the company might bring products to market itself.
RESEARCH AND DEVELOPMENT
The company believes that its core Coblation technology is applicable to a
range of soft-tissue surgical applications that can use a system substantially
the same as the Arthroscopic System. The company expects to change the wand
design to accommodate the specific requirements of the indications in various
surgical fields. However, the company believes that the design, materials and
manufacturing methods incorporated into the initial Arthroscopic System should
be applicable to subsequent products and indications.
The company has undertaken preliminary animal studies and development for the
use of its Coblation technology with its controller in several fields. The
company has received 510(k) clearance for use of its technology in certain of
these fields. The company has received approval of an investigational Device
Exemption (IDE) to conduct a clinical study on a specific indication.
Following the completion of this study, the company may submit a 510(k)
application to the FDA.
Each of these potential products is in various stages of development, and the
company may be required to undertake time-consuming and costly development
activities and seek regulatory approval of these devices. There can be no
assurance that product development will ever be successfully completed, that
premarket applications (PMA) or 510(k) application, if applied for, will be
granted by the FDA on a timely basis, if at all, or that the products will ever
achieve commercial acceptance. Failure by the company to develop, obtain
necessary regulatory approval for or to successfully market new products could
have a material adverse effect on the company's business, financial condition
and results of operations.
MANUFACTURING
The company's manufacturing operations consist of an in-house assembly
operation for the manufacturing of ArthroWands, and a separate in-house
operation for the manufacturing of the System 2000 controllers. The ArthroWand
is manufactured by the company from several components. In 1997, the company
ramped up its manufacturing capacity to double the production levels of
ArthroWands compared to the previous year. Manufacture of the System 2000
controller, of which an earlier version was manufactured by a third party, was
brought in-house in 1997 for the purposes of maintaining process control,
managing availability, and leveraging fixed costs.
The company has no previous controller manufacturing experience as its
previous controller model was manufactured under contract by another company.
In December 1997 the company started manufacture and sale of its System 2000
controllers. Only a small number of controllers have been manufactured and
sold. As a result, the company has limited experience manufacturing
controllers in the volumes necessary for the company to achieve additional
commercial sales, and there can be no assurance that reliable, high-volume
manufacturing can be achieved at commercially reasonable cost. In addition,
there can be no assurance that the company or its suppliers will not encounter
any manufacturing difficulties, including problems involving regulatory
compliance, product recalls, production yields, quality control and assurance,
supplies of components or shortages of qualified personnel.
The company and its component suppliers are required to operate in conformance
with Quality System Regulation (QS Regulations) requirements, in order to
produce products for sale in the United States, and ISO 9001 standards, in
order to produce products for sale in Europe. There can be no assurance that
the company or its component suppliers will remain in compliance with QS
Regulations or ISO 9001 standards. Any failure by the company or its
component suppliers to remain in compliance with QS Regulation or ISO 9001
standards could have a material adverse effect on the company's business,
financial condition and results of operations. In addition, the ArthroWand is
sterilized by a single subcontractor, and the connector housings at each end
of the cable are available only from a single source. There can be no
assurance that an alternate sterilizer or connector housing supplier could be
established if necessary or that available inventories would be adequate to
meet the company's product needs during any prolonged interruption of supply.
A reduction or stoppage in supply of the sole- source component, or the
company's inability to secure an alternative sterilizer, if required, would
limit its ability to manufacture the Arthroscopic System and would have a
material adverse effect on the company's business, financial condition and
results of operations.
Although the company believes that its subcontractor, and component suppliers
are in compliance with applicable regulations, there can be no assurance that
the FDA, or a state, local or international regulator, will not take action
against the subcontractor or a component supplier found to be violating such
regulations.
MARKETING AND SALES
Of the 18,500 orthopedic surgeons in the United States, approximately 80%
perform arthroscopy and approximately 40% consider arthroscopy to be their
major practice area. These 40% of orthopedic surgeons perform an estimated 70%
of the total arthroscopic procedures. In addition to marketing efforts aimed
at these surgeons, the company also recognizes that purchase decisions are
greatly influenced by health care administrators, who are subject to
increasing pressures to reduce costs. Health care administrators must
determine that the Arthroscopic System and the company's potential products
are cost-effective alternatives to current means of tissue ablation.
The company had shipped more than 1,500 Arthroscopic System controller units
and more than 140,000 ArthroWands by the end of fiscal 1997. The company is
marketing and selling its Arthroscopic System in the United States through a
network of independent orthopedic distributors. The company has more than 40
distributors representing more than 250 field sales representatives. The
distributors are supervised by 6 sales managers who are employed by the
company. The company expects that the network of distributors will market
directly to more than 7,500 orthopedic surgeons who primarily perform
arthroscopic surgery. As of the end of fiscal 1997, the company believes it
has achieved approximately 5% share of the market for knee procedures and 25%
share of .the market for shoulder procedures.
The company's distributors sell orthopedic arthroscopy devices for a number of
other manufacturers, and there can be no assurance that they will commit the
necessary resources to effectively market and sell the company's Arthroscopic
System, or that they will be successful in closing sales with doctors and
hospitals. The company has offered its controller to these independent
distributors at substantial discounts and may be required to continue to offer
such discounts on its controller to generate demand for its ArthroWands. The
inability to sell sufficient quantities of ArthroWands would have a material
adverse effect on the company's business, financial condition and results of
operations.
In October 1996, the company signed a distribution agreement with Advanced
Surgical Technologies Pty Ltd (AST), a large orthopedic distributor based in
Australia, to exclusively sell the company's Arthroscopic System in Australia.
In 1997, ArthroCare signed a distribution agreement with Arthrex, Inc., a
leading provider of arthroscopic equipment and training to surgeons and
hospitals worldwide, to distribute the company's products in Europe. Also in
1997, the company signed a distribution agreement with Kobayashi
Pharmaceutical Co., Ltd., a 110-year-old, $1.5 billion health-care company,
which will use its extensive medical device distribution operations to sell
the company's products in Japan. The company has also signed agreements with
regional distributors in Mexico, Brazil, Argentina and Korea.
If the company is successful in obtaining necessary regulatory approvals in
additional international markets, it expects to establish a sales and marketing
capability in those markets. In these international markets, the company
intends to collaborate with one or more marketing partners to establish
marketing and distribution channels for the Arthroscopic System. However,
regulatory requirements vary by region, and compliance with such regulations
may be costly and time-consuming. Accordingly, the distribution, pricing and
marketing structure to be established by the company may vary from country to
country.
No assurance can be given that the company will successfully sell its product
through its distributors in Europe, Australia, Mexico, Brazil, Argentina,
Canada, Japan or Korea, that the company will secure marketing partners for
other international markets, successfully sell its Arthroscopic System in
global markets or that any of its international distributors and marketing
partners will commit the necessary resources to obtain additional necessary
international regulatory approvals on behalf of the company and successfully
sell the Arthroscopic System in international markets.
PATENTS AND PROPRIETARY RIGHTS
The company's ability to compete effectively depends in part on developing and
maintaining the proprietary aspects of its platform Coblation technology. The
company owns ten issued United States patents, more than 30 pending United
States patent applications and international patent applications in Europe
(covering 16 separate countries), Japan, Canada, Australia and New Zealand
corresponding to eight of the United States filings relating to its Coblation
technology. The initial patent is currently set to expire in 2008, three
issued patents are currently expected to expire between 2008 and 2012 and the
other six patents are expected to expire between 2014 and 2016. The company
believes that the issued patents cover both the core technology used in the
company's Arthroscopic System, including both multielectrode and
single-electrode configurations of its wand tools, as well as the use of
Coblation technology in specific surgical procedures.
The issued patents cover, among other things, systems and methods for applying
radio frequency energy to tissue in the presence of electrically conductive
fluid such as isotonic saline and blood; probes having an electrode array and
a means to supply current independently to individual electrodes; and systems
and methods for employing radio frequency energy in urological and cardiac
procedures (e.g. transmyocardial revascularization of the heart). The pending
patent applications include coverage for the fundamental tissue ablation and
cutting technology as well as methods and apparatus for specific procedures.
There can be no assurance that the patents that have been issued to the
company or any patents which may be issued as a result of the company's United
States or international patent applications will provide any competitive
advantages for the company's products or that they will not be successfully
challenged, invalidated or circumvented in the future. In addition, there can
be no assurance that competitors, many of which have substantial resources and
have made substantial investments in competing technologies, will not seek to
apply for and obtain patents that will prevent, limit or interfere with the
company's ability to make, use and sell its products either in the United
States or in international markets.
A number of medical device and other companies, universities and research
institutions have filed patent applications or have issued patents relating to
monopolar and/or bipolar electrosurgical methods and apparatus. If third-party
patents or patent applications contain claims infringed by the company's
technology and such claims are ultimately determined to be valid, there can be
no assurance that the company would be able to obtain licenses to those
patents at a reasonable cost, if at all, or be able to develop or obtain
alternative technology, either of which would have a material adverse effect
on the company's business, financial condition and results of operations.
There can be no assurance that the company will not be obligated to defend
itself in court against allegations of infringement of third-party patents.
In addition to patents, the company relies on trade secrets and proprietary
know-how, which it seeks to protect, in part, through confidentiality and
proprietary information agreements. The company requires its key employees and
consultants to execute confidentiality agreements upon the commencement of an
employment or consulting relationship with the company. These agreements
generally provide that all confidential information, developed or made known to
the individual by the company during the course of the individual's
relationship with the company, is to be kept confidential and not disclosed to
third parties. These agreements also generally provide that inventions
conceived by the individual in the course of rendering services to the company
shall be the exclusive property of the company. There can be no assurance
that such agreements will not be breached, that the company would have
adequate remedies for any breach or that the company's trade secrets will not
otherwise become known to or be independently developed by competitors.
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain
a competitive advantage. There can be no assurance that the company will not
become subject to patent infringement claims or litigation or interference
proceedings declared by the United States Patent and Trademark Office ("USPTO")
to determine the priority of inventions. On February 13, 1998 the company
filed a lawsuit (the "Lawsuit") against Ethicon, Inc. Mitek Surgical
Products, a division of Ethicon, Inc. and GyneCare, Inc. alleging among other
things, infringement of several of the company's patents. See Part I, Item 3
"Legal Proceedings" of this Annual Report on Form 10-K. The defense and
prosecution of the Lawsuit and intellectual property suits generally, USPTO
interference proceedings and related legal and administrative proceedings are
both costly and time-consuming. The company believes that the Lawsuit is
necessary and if others violate the proprietary rights of the company, further
litigation may be necessary to enforce patents issued to the company, to
protect trade secrets or know-how owned by the company or to determine the
enforceability, scope and validity of the proprietary rights of others. Any
litigation or interference proceedings will result in substantial expense to
the company and significant diversion of effort by the company's technical and
management personnel. An adverse determination in the Lawsuit or other
litigation or interference proceedings to which the company may become a party
could subject the company to significant liabilities to third parties, require
disputed rights to be licensed from third parties or require the company to
cease using such technology. Although patent and intellectual property
disputes in the medical device area have often been settled through licensing
or similar arrangements, costs associated with such arrangements may be
substantial and could include ongoing royalties. Furthermore, there can be no
assurance that necessary licenses would be available to the company on
satisfactory terms, if at all. Adverse determinations in a judicial or
administrative proceeding or failure to obtain necessary licenses could
prevent the company from manufacturing and selling its products, which would
have a material adverse effect on the company's business, financial condition
and results of operations.
COMPETITION
The arthroscopic medical device industry is intensely competitive. The company
competes with providers of laser systems, electrosurgical systems, manual
instruments and power shavers. Many of these competitors have significantly
greater financial, manufacturing, marketing, distribution and technical
resources than the company. There can be no assurance that the company can
effectively compete against such competitors. In addition, there can be no
assurance that these or other companies will not succeed in developing
technologies and products that are more effective than the company's or that
would render the company's technology or products obsolete or uncompetitive.
The company believes that its Arthroscopic System, comprising the controller
unit and disposable ArthroWands, presents a competitive pricing structure
compared to alternative tools being used in arthroscopic procedures. The list
price of the controller, including the cable, is approximately $14,500. The
disposable ArthroWand, which can be used by surgeons as a conventional probe as
well as to ablate soft tissue, collagen shrinkage and seal small bleeding
vessels, have list prices ranging from of approximately $125-$195. Motorized
cutting tools consist of a power source with list prices of approximately
$8,000 to $10,000 and disposable tips, with list prices of approximately $60
to $80. Reusable mechanical tools have list prices of approximately $150 to
$950 and it is not unusual for 30 (thirty) different shaped tools to be
resterilized for each procedure. Neither motorized nor mechanical tools
perform hemostasis, and therefore additional tools may need to be purchased
for that purpose. Electrosurgical systems, used to stop the bleeding from
small blood vessels during surgery, consist of a power source with list prices
of approximately $4,000 to $9,000 plus a disposable tip with list prices of
approximately $40 to $50, including a single-use, dispersive electrode pad.
Electrosurgical systems are not generally used to cut or remove tissue. Laser
systems, with list prices of approximately $80,000 to $125,000, are used in
conjunction with disposable or reusable tips, with list prices of
approximately $60 to $300, to ablate soft tissue and simultaneously achieve
hemostasis.
Smith & Nephew Endoscopy, Inc. (which owns Acufex Microsurgical, Inc. and
Dyonics, Inc.), Conmed Corporation (including its Linvatec unit) and Stryker
Corp. each have large shares of the market for manual instruments, power
shavers and arthroscopes. These companies offer broad product lines, which
they may offer as a single package; have substantially greater resources and
name recognition than the company; and frequently offer significant discounts
as a competitive tactic. In addition, United States. Surgical, Corporation.
(including its Valley Labs unit) and Conmed Corporation each have large shares
of the market for electrosurgical systems, and Trimedyne, Inc. and Coherant.
each have large shares of the market for laser systems. The company expects
that competition from these and other well-established competitors will
increase as will competition from start-up and development stage medical
device companies such as Gyrus Medical Ltd., a company based in the United
Kingdom, and Orotec Interventions, Inc., a company based in Menlo Park,
California. The company is aware that Johnson & Johnson (including its Ethicon
unit) is marketing a bipolar electrosurgical tool developed by Gyrus Medical
Ltd. In order to successfully compete in the arthroscopic medical device
industry, the company anticipates that it may have to continue to offer
substantial discounts on its controller in order to increase demand for the
disposable ArthroWand, and that such competition could have a material
adverse effect on the company's business, financial condition and results of
operations.
The company believes that the primary competition factors in the market for
tissue ablation are precision, ease of use and price. The company further
believes that its tissue ablation instruments are easier to use than current
ablation instruments on the market while also providing the surgeon with a more
precise and efficient means of ablating tissue at lower cost. In addition, the
company's surgical system features a hemostasis mode and shrinks collagen. As a
result, the company believes that its products compete favorably with respect
to these factors, although no assurance can be given that they will be able to
continue to do so in the future, or that new instruments that perform more
favorably will not be introduced.
The company has received 510(k) premarket notifications for clearance to
market tissue ablation products to treat certain urological, periodontal,
dermatological, ear/nose/throat and general surgical conditions and has filed
510(k) premarket notification for clearance to market products for
gynecological conditions; the FDA has indicated that the 510(k) submission for
certain gynecological conditions must be supported by data from clinical
trials. These fields are intensely competitive and no assurance can be given
that these potential products, if approved, would be successfully marketed.
GOVERNMENT REGULATION
United States
The company's products are regulated in the United States as medical devices
by the FDA under the Federal Food, Drug, and Cosmetic Act ("FDC Act") and
require premarket clearance or approval by the FDA prior to commercialization.
In addition, certain material changes or modifications to medical devices also
are subject to FDA review and clearance or approval. Pursuant to the FDC Act,
the FDA regulates the research, testing, manufacture, safety, labeling,
storage, record keeping, advertising, distribution and production of medical
devices in the United States. Noncompliance with applicable requirements can
result in warning letters, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure of the
government to grant premarket clearance or premarket approval for devices, and
criminal prosecution. Failure to comply with the regulatory requirements could
have a material adverse effect on the company's business, financial condition
and results of operations.
If human clinical trials of a device are required and if the device presents a
"significant risk," the manufacturer or the distributor of the device is
required to file an IDE application prior to commencing human clinical trials.
The IDE application must be supported by data, typically including the results
of animal and, possibly, mechanical testing. If the FDA does not object to the
IDE application within 30 days from filing of the application, human clinical
trials may begin as defined in the IDE. Sponsors of clinical trials are
permitted to sell investigational devices distributed in the course of the
study, provided such costs do not exceed recovery of the costs of manufacture,
research, development and handling. The clinical trials must be conducted
under the auspices of an independent Institutional Review Board ("IRB")
established pursuant to FDA regulations, and with appropriate informed consent
of the patient.
Generally, before a new device can be introduced into the market in the United
States, the manufacturer or distributor must obtain FDA clearance of a 510(k)
notification or approval of a PMA application. If a medical device manufacturer
or distributor can establish that a device is "substantially equivalent" to a
legally marketed Class I or Class II device, or to a Class III device for which
FDA has not called for PMAs, the manufacturer or distributor may seek clearance
from FDA to market the device by filing a 510(k) notification. The 510(k)
notification will need to be supported by appropriate data establishing the
claim of substantial equivalence to the satisfaction of FDA. FDA recently has
been requiring a more rigorous demonstration of substantial equivalence.
Following submission of the 510(k) notification, the manufacturer or
distributor may not place the device into commercial distribution until an
order is issued by the FDA. No law or regulation specifies the time limit by
which FDA must respond to a 510(k) notification. At this time, the FDA
typically responds to the submission of a 510(k) notification within 90 to 120
days, but it may take longer. An FDA order may declare that the device is
substantially equivalent to another legally marketed device and allow the
proposed device to be marketed in the United States. The FDA, however, may
determine that the proposed device is not substantially equivalent or require
further information, including clinical data, to make a determination
regarding substantial equivalence. Such determination or request for
additional information could delay market introduction of the products that
are the subject of the 510(k) notification.
The company has received clearance of 510(k) premarket notifications to market
its Arthroscopic System for surgery of the knee, shoulder, elbow, wrist, hip
and ankle joints. In addition, the company received clearance of 510(k)
premarket notifications to market products based upon its proprietary core
technology to treat certain other soft tissue conditions. There can be no
assurance that the company will be able to obtain necessary clearances or
approvals to market any other products on a timely basis, if at all, and
delays in receipt or failure to receive such clearances or approvals, the loss
of previously received clearances or approvals, or failure to comply with
existing or future regulatory requirements could have a material adverse
effect on the company's business, financial condition and results of
operations.
If a manufacturer or distributor of medical devices cannot establish that a
proposed device is substantially equivalent to a legally marketed device, the
manufacturer or distributor must seek premarket approval of the proposed device
through submission of a PMA application. A PMA application must be supported by
extensive data, including, in many instances, preclinical and clinical trial
data, as well as extensive literature to prove the safety and effectiveness of
the device. Following receipt of a PMA application, if the FDA determines that
the application is sufficiently complete to permit a substantive review, the
FDA will "file" the application. Under the FDC Act, the FDA has 180 days to
review a PMA application, although the review of such an application more
often occurs over a protracted time period, and generally takes approximately
two years or more from the date of filing to complete.
The PMA application approval process can be expensive, uncertain and lengthy.
A number of devices for which premarket approval has been sought have never
been approved for marketing. The review time is often significantly extended
by the FDA, which may require more information or clarification of information
already provided in the submission. In addition, the FDA will inspect the
manufacturing facility to ensure compliance with the FDA's Good Manufacturing
Practice (GMP) or QS Regulations requirements prior to approval of an
application. If granted, the approval of the PMA application may include
significant limitations on the indicated uses for which a product may be
marketed.
If necessary, the company will file a PMA application with the FDA for
approval to sell its potential products commercially in the United States when
it has developed such products. There can be no assurance that the company
will be able to obtain necessary PMA application approvals to market such
products on a timely basis, if at all, and delays in receipt or failure to
receive such approvals, the loss of previously received approvals, or failure
to comply with existing or future regulatory requirements could have a
material adverse effect on the company's business, financial condition and
results of operations.
The company is also required to register as a medical device manufacturer with
the FDA and state agencies, such as the California Department of Health
Services ("CDHS") and to list its products with the FDA. As such, the company
is subject to inspections by both the FDA and the CDHS for compliance with the
FDA's GMP or QS Regulations and other applicable regulations. These
regulations require that the company maintain its documents in a prescribed
manner with respect to manufacturing, testing and control activities. Further,
the company and the third party manufacturers of its products are required to
comply with various FDA requirements for design, safety, advertising and
labeling. There can be no assurance that the company or its component
suppliers will not encounter any manufacturing difficulties, or that the
company any of its subcontractors or component suppliers will not experience
similar difficulties, including problems involving regulatory compliance,
product recalls, production yields, quality control and assurance, supplies of
components or shortages of qualified personnel.
Regulations regarding the manufacture and sale of the company's products are
subject to change. The company cannot predict the effect, if any, that such
changes might have on its business, financial condition or results of
operations.
International
International sales of the company's products are subject to the regulatory
agency product registration requirements of each country. The regulatory review
process varies from country to country. The company has obtained regulatory
clearance to market the Arthroscopic System in Australia and Europe but has not
obtained any other international regulatory approvals permitting sales of its
products outside of the United States. The company intends to seek regulatory
approvals in certain other international markets. There can be no assurance,
however, that such approvals will be obtained on a timely basis or at all.
For European distribution, the company has received ISO 9001 certification and
the CE mark. ISO 9001 certification standards for quality operations have been
developed to ensure that companies know, on a worldwide basis, the standards of
quality to which they will be held. The European Union has promulgated rules
requiring medical products to receive by mid-1998 the CE mark, an international
symbol of quality and compliance with applicable European medical device
directives. Failure to maintain the CE mark will prohibit the company from
selling its products in Europe. ISO 9001 certification in conjunction with
demonstrated performance to the medical device directive is one of the
alternatives available to meet the CE mark requirements. There can be no
assurance that the company will be successful in maintaining certification
requirements.
THIRD-PARTY REIMBURSEMENT
In the United States, health care providers, such as hospitals and physicians,
that purchase medical devices, such as the company's Arthroscopic System and
potential future products, generally rely on third-party payors, principally
federal Medicare, state Medicaid and private health insurance plans, to
reimburse all or part of the cost of the procedure in which the medical device
is being used. Reimbursement for arthroscopic procedures performed using
devices that have received FDA approval has generally been available in the
United States. In addition, certain health care providers are moving toward a
managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per person. Managed care providers are attempting
to control the cost of health care by authorizing fewer elective surgical
procedures, such as certain knee and shoulder, ankle, wrist, elbow and hip
arthroscopic procedures.
The company is unable to predict what changes will be made in the
reimbursement methods used by third-party health care payors. The company
anticipates that in a prospective payment system, such as the diagnosis related
group (DRG) system utilized by Medicare, and in many managed care systems used
by private health care payors, the cost of the company's products will be
incorporated into the overall cost of the procedure and that there will be no
separate, additional reimbursement for the company's products. The company
anticipates that hospital administrators and physicians will justify the use of
the company's products by the attendant cost savings and clinical benefits that
the company believes will be derived from the use of its products. However,
there can be no assurance that this will be the case. Furthermore, the company
could be adversely affected by changes in reimbursement policies of
governmental or private health care payors, particularly to the extent any
such changes affect reimbursement for procedures in which the company's
products are used. Failure by physicians, hospitals and other users of the
company's products to obtain sufficient reimbursement from health care payors
for procedures in which the company's products are used or adverse changes in
governmental and private third- party payors, policies toward reimbursement for
such procedures would have a material adverse effect on the company's
business, financial condition and results of operations.
If the company obtains the necessary international regulatory approvals ,
market acceptance of the company's products in international markets would be
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country, and include both
government- sponsored health care and private insurance. The company intends to
seek international reimbursement approvals, although there can be no assurance
that any such approvals will be obtained in a timely manner, if at all.
PRODUCT LIABILITY AND INSURANCE
The development, manufacture and sale of medical products entail significant
risks of product liability claims. The company's current product liability
insurance coverage limits are $5,000,000 per occurrence and $5,000,000 in the
aggregate. There can be no assurance that such coverage limits are adequate to
protect the company from any liabilities it might incur in connection with the
development, manufacture and sale of its Arthroscopic System and potential
future products. In addition, the company may require increased product
liability coverage if any potential future products are successfully
commercialized. Product liability insurance is expensive and in the future may
not be available to the company on acceptable terms, if at all. The company
has been selling its product since December 1995 and has not experienced any
product liability claims to date. However, a successful product liability
claim or series of claims brought against the company in excess of its
insurance coverage could have a material adverse effect on the company's
business, financial condition and results of operations.
EMPLOYEES
As of January 3, 1998, the company had 108 employees. 51 people are engaged in
manufacturing activities, 15 are engaged in research and development
activities, 19 people are engaged in sales and marketing activities, 12
persons are engaged in regulatory affairs and quality assurance and 11 people
are engaged in administration and accounting. No employees are covered by
collective bargaining agreements, and the company believes it maintains good
relations with its employees.
The company is dependent upon a number of key management and technical
personnel. The loss of the services of one or more key employees or consultants
could have a material adverse effect on the company. The company's success will
also depend on its ability to attract and retain additional highly qualified
management and technical personnel. The company faces intense competition for
qualified personnel, many of whom are often subject to competing employment
offers, and there can be no assurance that the company will be able to attract
and retain such personnel. Furthermore, the company's scientific advisory board
members all are otherwise employed on a full-time basis. As a result, the
scientific advisory board members are not available to devote their full time
or attention to the company's affairs.
FACILITIES
The company leases approximately 32,000 square feet in two neighboring
buildings in Sunnyvale, California, which comprise the company's administrative
offices and manufacturing and warehousing space. The company's lease for this
facility extends through February 2002. The company believes that its existing
facilities will be sufficient for its operational purposes through 1998.
ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS
History of Losses; Fluctuations in Operating Results; Losses Expected to
Continue
The company has experienced significant operating losses since inception and,
as of January 3, 1998, had an accumulated deficit of $25.3 million. The company
expects to generate additional losses due to increased operating expenditures
primarily attributable to the expansion of marketing and sales activities,
increased research and development, and activities to support regulatory
applications. Results of operations may fluctuate significantly from quarter
to quarter due to the timing of such expenditures, absence of a backlog of
orders, timing of the receipt of orders, promotional discounts of the
company's products, re-use of the company's disposable products, in addition
to those detailed above. The company's revenues and profitability will be
critically dependent on whether it can successfully continue to market its
Arthroscopic System. In addition, the company's gross margins may be
adversely affected due to the necessity to promote and sell its product at
significantly reduced prices. There can be no assurance that significant
profitability will ever be achieved.
Control by Directors, Executive Officers and Affiliated Entities
The company's directors, executive officers and entities affiliated with them,
in the aggregate, beneficially own approximately 40% of the company's
outstanding common stock. These stockholders, if acting together, will have
significant influence over all matters requiring approval by the stockholders
of the company, including the election of directors and the approval of
mergers or other business combination transactions.
Potential Volatility of Stock Price
The stock markets have experienced price and volume fluctuations that have
particularly affected medical technology companies, resulting in changes in the
market prices of the stocks of many companies that may not have been directly
related to the operating performance of those companies. Such broad market
fluctuations may adversely affect the market price of the company's common
stock. In addition, the market price of the company's common stock may be
highly volatile. Factors such as variations in the company's financial
results, comments by security analysts, announcements of technological
innovations or new products by the company or its competitors, changing
government regulations and developments with respect to FDA submissions,
patents, proprietary rights or litigation may have a significant adverse
effect on the market price of the common stock.
Anti-Takeover Effect of Stockholder Rights Plan and Certain Charter and Bylaw
Provisions
In November 1996, the company's Board of Directors adopted a Stockholder
Rights Plan. The Stockholder Rights Plan provides for a dividend distribution
of one Preferred Shares Purchase Right (a "Right") on each outstanding share
of the company's common stock. Each Right entitles shareholders to buy
1/1000th of a share of the company's Series A participating preferred stock at
an exercise price of $50.00. The Rights will become exercisable following the
tenth day after a person or group announces acquisition of 15 percent or more
of the company's common stock, or announces commencement of a tender offer,
the consummation of which would result in ownership by the person or group of
15 percent or more of the company's common stock. The company will be
entitled to redeem the Rights at $0.01 per Right at any time on or before the
tenth day following acquisition by a person or group of 15 percent or more of
the company's common stock.
The Stockholder Rights Plan and certain provisions of the company's
Certificate of Incorporation and Bylaws may have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire control of the company. This could limit the price that
certain investors might be willing to pay in the future for shares of the
company's common stock. Certain provisions of the company's Certificate of
Incorporation and Bylaws allow the company to issue preferred stock without any
vote or further action by the stockholders, eliminate the right of stockholders
to act by written consent without a meeting, specify procedures for director
nominations by stockholders and submission of other proposals for consideration
at stockholder meetings, and eliminate cumulative voting in the election of
directors. Certain provisions of Delaware law applicable to the company could
also delay or make more difficult a merger, tender offer or proxy contest
involving the company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. The
Stockholder Rights Plan, the possible issuance of preferred stock, the
procedures required for director nominations and stockholder proposals and
Delaware law could have the effect of delaying, deferring or preventing a
change in control of the company, including without limitation, discouraging a
proxy contest or making more difficult the acquisition of a substantial block
of the company's common stock. These provisions could also limit the price
that investors might be willing to pay in the future for shares of the
company's common stock.
Lack of Dividends
The company has not paid any dividends and does not anticipate paying any
dividends in the foreseeable future.
Item 2. PROPERTIES
The company leases approximately 32,000 square feet in two neighboring
buildings in Sunnyvale, California, which comprise the company's
administrative offices and manufacturing and warehousing space. The company's
two leases for these facilities extend through February 2002. The company
believes that its existing facilities will be sufficient for its operational
purposes through 1998.
Item 3. LEGAL PROCEEDINGS
On February 13, 1998, the company filed a lawsuit against Ethicon, Inc. Mitek
Surgical Products, a division of Ethicon, Inc. and GyneCare, Inc. ("the
Defendants") in the United States District Court for the Northern District of
California. The lawsuit alleges, among other things, that the Defendants have
been and are currently infringing four patents issued to the company in
December 1997. Specifically, the Defendants use, market and sell two separate
electrosurgical systems under the names of "VAPR" and "VersaPoint" which
infringe these patents. The company seeks: (1) a judgment that the Defendants
have infringed these patents; (2) to preliminarily and permanently restrain
and enjoin the Defendants from marketing and selling the VAPR and VersaPoint
systems; and (3) an award of damages (including attorneys' fees) to compensate
the company for lost profits, the damages to be trebled because of the
Defendants' willful infringement. In addition, the company filed a motion on
March 5, 1998 for preliminary injunction against the Defendants marketing and
selling of the VAPR system.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
EXECUTIVE OFFICERS
The executive officers of the company who are elected by and serve at the
discretion of the Board of Directors and their ages are as follows:
Name Age Position
- --------------------- ------ ------------------------------------
Michael A. Baker 39 President and Chief Executive Officer
Hira V. Thapliyal, Ph.D. 48 Chief Technical Officer
Robert T. Hagan 52 Vice President, Manufacturing
Christine E. Hanni 37 Vice President, Finance
and Chief Financial Officer
Allan Weinstein 44 Vice President, Sales and Marketing
Michael A. Baker joined the company in July 1997 as President and Chief
Executive Officer and Director, From 1989 to 1997, Mr. Baker held several
positions in planning, corporate development and senior management at
Medtronic, Inc. a $2.4 billion medical technology company specializing in
implantable and invasive therapies. His most recent position at Medtronic,
Inc., was Vice President, General Manager of Medtronic's Coronary Vascular
Division based in San Diego, CA. From 1988 to 1989, Mr. Baker was a
Management Consultant at The Carroll Group. From 1986 to 1988, Mr. Baker was
the Corporate Development Officer at American National Bank & Trust Co. Prior
to joining American National Bank & Trust Co., Mr. Baker served in the United
States Army from 1981 to 1986 were he rose to the rank of Captain. Mr. Baker
holds a bachelor degree from the United States Military Academy at West Point
and an MBA from the University of Chicago.
Hira V. Thapliyal, Ph.D., a founder of the company, has served as Chief
Technical Officer of the company since July 1997. Prior to July 1997, Dr.
Thapliyal was President, Chief Executive and Officer of the company since its
inception in April 1993. He has also been a Director of the company since April
1993. From 1989 to 1993, Dr. Thapliyal was President and Chief Executive
Officer of MicroBionics, Inc., a privately held company developing an in-vivo
continuous blood gas monitor. In 1986, Dr. Thapliyal founded Cardiovascular
Imaging Systems, Inc. (CVIS) and served as its President until 1988. CVIS
develops and markets catheters for ultrasonic intraluminal imaging of human
arteries. From 1984 to 1986, Dr. Thapliyal was Vice President, Engineering of
Devices for Vascular Interventions, Inc., a leader in marketing atherectomy
systems for treatment of atherosclerotic disease. Dr. Thapliyal holds an M.S.
degree in Electrical Engineering from University of Idaho and a Ph.D. in
Materials Science & Engineering from Cornell University.
Robert T. Hagan joined the company in August 1995 as Vice President,
Manufacturing. From October 1992 to July 1995, Mr. Hagan was retired. From
October 1984 to September 1992, Mr. Hagan held several manufacturing oversight
positions with Haemonetics Corporation, a manufacturer of blood processing
equipment and sterile disposables. His most recent position at Haemonetics
Corporation was Director of Advanced Manufacturing Technologies. Mr. Hagan
holds a B.S. degree in Industrial Engineering from Tennessee Technology
University.
Christine E. Hanni joined the company in January 1998 as Vice President,
Finance and Chief Financial Officer. From 1992 until 1997, Ms. Hanni first
served as Corporate Controller and then as Director of International Finance
and Sales Administration of Target Therapeutics, Inc. (Target), a leading
manufacturer of disposable medical devices for the treatment of various brain
diseases. Prior to joining Target, she held several finance and accounting
positions with Tandem Computers, Inc. including Marketing Accounting Manager.
From 1983 to 1987 Ms. Hanni was an auditor for Coopers & Lybrand in San Jose,
California and Portland, Oregon. Ms. Hanni holds a B.S. degree in Accounting
from Southern Oregon University.
Allan Weinstein joined the company in January 1995 as Vice President, Sales
and Marketing. From December 1982 to December 1994, Mr. Weinstein held various
marketing positions with Acufex Microsurgical, Inc. (Acufex), a manufacturer of
arthroscopic instruments. His most recent position at Acufex was Director of
Sales, North and South America. Mr. Weinstein holds a B.A. degree in
Communications from Seton Hall University.
DISCLOSURE WITH REGARD TO DELINQUENT FILINGS
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the company's directors and officers and persons who
own more than 10% of a registered class of the company's equity securities, to
file reports of ownership and reports of changes in the ownership with the
Securities and Exchange Commission (the "SEC"). Such persons are required by
SEC regulations to furnish the company with copies of all Section 16(a) forms
they file.
Based solely on its review of the copies of such forms submitted to it during
the year ended January 3, 1998, the company believes that, during the Last
Fiscal Year, its director and officer Michael A Baker failed to timely file
one Form 3 disclosing shares of the company common stock aquired by Mr. Baker
before he became a director and officer of the company.
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The company's common stock trades publicly on The Nasdaq Stock Market under
the symbol ARTC. The following table sets forth for the periods indicated, the
quarterly high and low closing sales prices of the common stock on The Nasdaq
Stock Market.
HIGH LOW
--------- ---------
Year Ended December 28, 1996
- --------------------------------------
Quarter Ended March 30, 1996 (1) $ 25.750 $ 16.875
Quarter Ended June 29, 1996 $ 24.750 $ 14.813
Quarter Ended September 28, 1996 $ 18.000 $ 8.750
Quarter Ended December 28, 1996 $ 11.000 $ 6.750
Year Ended January 3, 1998
- --------------------------------------
Quarter Ended March 29, 1997 $ 10.625 $ 5.500
Quarter Ended June 28, 1997 $ 9.500 $ 5.500
Quarter Ended September 27, 1997 $ 14.750 $ 8.625
Quarter Ended January 3, 1998 $ 13.563 $ 9.500
(1) Prior to February 5, 1996, there was no established public
trading market for the common stock. Market prices presented
for the quarter ended March 31, 1996 are for the period
commencing February 5, 1996 and ending March 31, 1996.
As of March 4, 1998, there were no outstanding shares of Preferred Stock and
231 holders of record of 8,896,386 shares of outstanding Common Stock. The
company has not paid any dividends since its inception and does not intend to
pay any dividends on its Common Stock in the foreseeable future.
Item 6. SELECTED FINANCIAL DATA
The following is a summary of the company's unaudited quarterly results for
the eight quarters in the period ended January 3, 1998, the audited annual
results for the years ended January 3, 1998, December 28, 1996, December 31,
1995 and 1994 and for the period from April 29, 1993 (date of inception) to
December 31, 1993. In management's opinion, the quarterly results have been
prepared on a basis consistent with the audited financial statements
contained elsewhere herein, and include all adjustments, consisting only of
normal recurring adjustments, necessary for a fair presentation of the
information for the periods presented. The information set forth below is not
necessarily indicative of the results of future operations and should be read
in conjunction with the audited financial statements and notes thereto
appearing on pages 21-38 of this report.
Three Month Period Ended
--------------------------------------------------
March 29, June 28, September 27, January 3,
1997 1997 1997 1998
----------- ----------- ----------- -----------
(in thousands, except per share data)
Statements of Operations Data:
Net sales $ 2,261 $ 2,832 $ 3,366 $ 4,337
Gross margin 582 838 1,165 1,716
Operating expenses 3,135 3,186 3,396 3,684
Net loss (2,167) (1,989) (1,900) (1,632)
Net loss per common share and
per common share-assuming
dilution(1) $ (0.25) $ (0.23) $ (0.22) $ (0.18)
Three Month Period Ended
--------------------------------------------------
March 30, June 29, September 28, December 28,
1996 1996 1996 1996
----------- ----------- ----------- -----------
(in thousands, except per share data)
Net sales $ 1,159 $ 1,406 $ 1,574 $ 1,883
Gross margin 94 170 209 307
Operating expenses 2,098 2,349 2,534 3,008
Net loss (1,743) (1,735) (1,932) (2,295)
Net loss per common share and
per common share-assuming
dilution(1) $ (0.30) $ (0.20) $ (0.22) $ (0.26)
(1) Per Share data has been restated to reflect the company's adoption of
Statement of Financial Accounting Standard No. 128 "Earnings Per Share" and
the Securities and Exchange Commission Staff Accounting Bulletin No. 98. See
Note 2 of the Financial Statements.
For The
Period From
April 29,
1993
(Date of
Year Ended Inception)
------------------------------------------------------ To
January 3, December 28, December 31, December 31, December 31,
1998 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(in thousands, except per share data)
Net sales $ 12,796 $ 6,022 $ 218 $ -- $ --
Gross margin 4,301 780 (229) -- --
Total operating expenses 13,401 9,989 6,940 2,247 857
Net loss (7,688) (7,705) (6,950) (2,121) (842)
Net loss per common share and per
common share-assuming dilution (1) (0.87) (0.97) (1.82) (0.64) (0.51)
January 3, December 28, December 31, December 31, December 31,
1998 1996 1995 1994 1993
------------ ------------ ------------ ------------ ------------
(in thousands)
Balance Sheet Data:
Cash and cash equivalents $ 8,188 $ 11,359 $ 4,774 $ 2,599 $ 993
Working capital 20,342 23,468 5,119 2,467 858
Total assets 26,675 33,297 7,800 2,917 1,048
Total stockholders' equity (2) 23,546 30,782 6,325 2,727 890
(1) Per Share data has been restated to reflect the company's adoption of
Statement of Financial Accounting Standard No. 128 "Earnings Per Share" and
the Securities and Exchange Commission Staff Accounting Bulletin No. 98. See
Note 2 of the Financial Statements.
(2) The company has not declared any cash dividends on its common stock since
its inception and does not anticipate paying cash dividends in the
foreseeable future.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
Statements in this Management's Discussion and Analysis of Financial Condition
and Results of Operations which express that the company "believes",
"anticipates" or "plans to..." as well as other statements which are not
historical fact, are forward looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Actual events or results may
differ materially as a result of the risks and uncertainties described herein
and elsewhere including, in particular, those factors described under
"Business" and "Additional Factors That Might Affect Future Results" set forth
in Part I of this Report as well as other risks and uncertainties in the
documents incorporated herein by reference.
Since commencing operations in April 1993, ArthroCare Corporation (the company)
has primarily engaged in the design, development, clinical testing,
manufacturing and marketing of its Arthroscopic System. The Arthroscopic
System uses the company's novel Coblation (TM) technology that allows surgeons
to operate with increased precision and accuracy with minimal damage to
surrounding tissue. It is currently being used in closed joint surgery
including many types of knee and shoulder procedures. The Arthroscopic System
consists of a disposable, bipolar ArthroWand, a radio frequency controller
that powers the ArthroWand and a cable that connects the ArthroWand to the
controller. The ArthroWand ablates (removes) soft tissue with minimal damage
to surrounding healthy tissue and simultaneously achieves hemostasis (sealing
of small bleeding vessels). After the close of the 1997 fiscal year, the
company entered into a license agreement under which Boston Scientific
Corporation will develop and market products based on the company's Coblation
(TM) technology for myocardial revascularization procedures.
The company received clearance of its 510(k) premarket notification from the
United States Food and Drug Administration (FDA) in March 1995 to market its
Arthroscopic System in the United States for use in arthroscopic surgery of the
knee, shoulder, elbow and ankle. The company has since received clearance for
use in the wrist and hip. In December 1995, the company commercially
introduced its Arthroscopic System through a network of distributors in the
United States. In light of the for going, the company has a limited history of
operations. The company's strategy includes placing with arthroscopic
surgeons, controllers that are intended to generate future wand revenues. The
company's long-term strategy includes applying its patented platform
technology to a range of other soft tissue surgical procedures. The company
has received 510(k) clearance for use of its technology in several fields and
has received approval of an investigational device exemption (IDE) to conduct
a clinical study which may result in the company submitting a 510(k)
application to the FDA. There can be no assurance that any of the company's
clinical studies will lead to 510(k) applications or that the applications
will be cleared by the FDA on a timely basis, if at all, or that the products,
if cleared for marketing, will ever achieve commercial acceptance.
RESULTS OF OPERATIONS
The year ended January 3, 1998 was the company's second full year of product
shipments. The company was in its development stage during the comparable year
ended December 31, 1995.
ArthroCare Corporation Statements of Operations
(in thousands)
For the Years Ended
------------------------------------------
January 3, December 28, December 31,
1998 1996 1995
------------ ------------ ------------
Net sales $ 12,796 $ 6,022 $ 218
Cost of sales 8,495 5,242 447
------------ ------------ ------------
Gross margin 4,301 780 (229)
------------ ------------ ------------
Operating expenses:
Research and development 4,026 3,772 4,009
Sales and marketing 6,263 3,635 1,351
General and administrative 3,112 2,582 1,320
Non-recurring charge for acquired technology -- -- 260
------------ ------------ ------------
Total operating expenses 13,401 9,989 6,940
------------ ------------ ------------
Loss from operations (9,100) (9,209) (7,169)
Interest and other expense, net 1,413 1,505 219
------------ ------------ ------------
Loss before income tax provision (7,687) (7,704) (6,950)
Income tax provision (1) (1) --
------------ ------------ ------------
Net loss $ (7,688) $ (7,705) $ (6,950)
============ ============ ============
Net Sales
Revenues for the year ended January 3, 1998 were $12.8 million compared to
$6.0 million for the year ended December 28, 1996. The $6.8 million increase
was due to higher unit volume wand and controller sales resulting from
controller promotional programs and a larger installed base of controllers.
The company was in its development stage during 1995 and shipped its first
Arthroscopic System in December 1995. Revenues for the year ended December 31,
1995 were $0.2 million.
The company's strategy has been and continues to be to increase future wand
sales by increasing the installed base of controllers through aggressive
promotional programs. This strategy has and will continue to have an adverse
impact on controller revenue and on gross margins, partially offsetting the
positive impact of increased wand sales.
Overall, wands were sold at or near list price during the years ended January
3, 1998 and December 28, 1996. The company expects to sell wands at discounted
prices to international dealers in the future.
For the years ended January 3, 1998 and December 28, 1996 wands sales
comprised the vast majority of revenues. The company believes increased wand
sales are a result of the company's strategic plan to build market share
through continued promotional programs of controllers. The company expects
wand sales to remain the primary component of revenues in the future.
The company believes that, in its second full year of product shipments, it
has penetrated 15% to 20% of hospitals that perform arthroscopic procedures in
the United States and that more than half of the company's wand revenue is
being generated by wands purchased for use in shoulder procedures. The company
believes that shoulder procedures are the fastest growing segment of the
arthroscopic market and knee procedures represent the largest segment of the
arthroscopic market. In order to achieve increasing wand sales over time, the
company believes it must further penetrate the market for knee procedures.
The company has introduced additional wand styles including its new Turbo Dome
wands designed to be used in both knee and shoulder arthroscopic procedures. In
November 1997, the company introduced its System 2000 controller designed for
more aggressive ablation and hemostasis. The company believes these features
will increase wand sales in the market for knee and shoulder procedures. In
addition, the company has introduced wand styles for small joint and for
capsular shrinkage procedures. The new wand styles and the new System 2000
controller are intended to increase the market for the company's products.
There can be no assurance that the use of these new products will be adopted
by doctors.
The company has limited sales and marketing experience and can make no
assurance that current trends in sales and product acceptance will continue.
Cost of Sales
Cost of sales for the year ended January 3, 1998 was $8.5 million, or 66% of
sales. During the year ended December 28, 1996, cost of sales was $5.2 million,
or 87% of sales. The company was in its development stage during 1995 and
shipped its first Arthroscopic System in December 1995. Cost of sales for the
year ended December 31, 1995 was $0.4 million. The $3.3 million increase in
cost of sales for the year ended January 3, 1998 over the year ended December
28, 1996 was due to increased shipments of both wands and controllers. Cost of
sales as a percentage of sales decreased 21 percentage points during the year
ended January 3, 1998 as compared to the year ended December 28, 1996
resulting from the fixed and semi-fixed costs being spread over higher
manufacturing volume. Improvements to the manufacturing process also reduced
costs by improving efficiency.
In 1997 the company made a strategic decision to manufacture its new System
2000 controller in-house and introduced this new product in November 1997.
While the shipments of System 2000 controllers did not have a material impact
on controller cost or gross margin in the year ended January 3, 1998, the
company believes it can reduce controller unit cost in the future by
manufacturing the new controller in-house. However, there can be no assurance
that the company will be able to achieve this objective.
The improvement in gross margin in 1997 includes the effect of the controller
promotional programs. The company believes that if its promotional programs
maintain the same or higher number of wands bundled with a discounted
controller, and if the demand for disposable wands increases over a growing
installed base of controllers, then the cost of sales will continue to
decrease as a percentage of sales and gross margins will continue to increase.
However, there can be no assurance the company will be successful in
maintaining the mix of wands to discounted controllers in its promotional
programs or in increasing demand for its disposable wands. Further, production
of future new products may adversely impact gross margin due to the
inefficiencies in manufacturing new products.
Operating Expenses
Research and development expense, which includes expenditures for regulatory
compliance and quality assurance, increased 7% to $4.0 million for the year
ended January 3, 1998 compared to $3.8 million for the year ended December 28,
1996. The $0.2 million increase is attributed to the development and
introduction of seven new wand styles and the System 2000 controller as well
as the development and investigation of products suitable for additional
markets. This increase was partially offset by reduced spending for outside
design and engineering services. Research and development expenses decreased 6
% or $0.2 million during the year ended December 28, 1996 as compared to $4.0
million for the year ended December 31, 1995. The decrease was due to the
inclusion of manufacturing startup costs in research and development in the
year ended December 31, 1995 when the company was in its development stage, as
well as a non-recurring charge of $260,000 in March 1995, for acquired
technology.
The company believes that continued investment in its platform technology is
essential if it is to maintain its competitive position. The company expects to
continue increasing research and development spending through substantial
expenditures on new product development, regulatory affairs, clinical studies
and patents, although not at the rate seen in the past year. The company
believes that its ability to attract and retain qualified engineers in the
future is critical to the continued success of the company.
Sales and marketing expense increased 72% to $6.3 million in the year ended
January 3, 1998 as compared to $3.6 million for the year ended December 28,
1996. The $2.7 million increase was primarily due to higher dealer commissions
resulting from increased sales, higher staffing, and promotional and trade show
expenses reflecting an increased level of sales and marketing activity. Sales
and marketing expenses increased 169% or $2.3 million during the year ended
December 28, 1996 as compared to $1.4 million in the year ended December 31,
1995 when the company was in its development stage. The increase was primarily
due to dealer commissions and promotional, demonstration and sample expenses.
The company anticipates that sales and marketing spending will continue to
increase due to higher dealer commissions from increased sales, the additional
cost of penetrating international markets for the company's products, higher
promotional, demonstration and sample expenses, and additional investments in
the sales, marketing and support staff necessary to market its current
products and commercialize future products.
General and administrative expense increased 21% to $3.1 million in the year
ended January 3, 1998 as compared to $2.6 million for the year ended December
28, 1996. The $0.5 million increase is primarily due to the expense of
attracting, recruiting and relocating a Chief Executive Officer and increased
staffing. Higher expenditures also include the cost of legal service, business
development activities, insurance and expenses necessary to expand the
corporate infrastructure. General and administrative expenses nearly doubled
to $2.6 million for the year ended December 28, 1996 from $1.3 million for the
year ended December 31, 1995 due to additional staffing including management
personnel, the increased cost of being a public company, business development
activities, consulting fees and expenses necessary to expand the corporate
infrastructure. The company expects that general and administrative expenses
will continue to increase as a result of a patent litigation claim against
certain competitors filed by the company after the close of the year, further
expansion of its staff, and business development activities. See Part I, Item
3 of this report for a description of the patent litigation.
Interest and Other Expense
Net interest income decreased slightly to $1.4 million for the year ended
January 3, 1998 as compared to $1.5 million for the year ended December 28,
1996. The $0.1 million decrease is attributable to the conversion of
investments to cash for use in business operations during the year. Interest
income increased $1.3 million in fiscal 1996 from $0.2 million for the year
ended December 31, 1995 due to interest received on investment of the proceeds
from the 1996 initial public offering of the company's common stock. At the
end of fiscal 1997, the company had $19.9 million in cash, cash equivalents,
and available-for-sale securities (which included long-term available-for-sale
securities) as compared to $29.3 million at the end of fiscal 1996 and $4.8
million at the end of fiscal 1995. The company expects that interest income
will decrease as the company reduces its investments to meet the future cash
needs of the business.
Net Loss
Net loss remained unchanged at $7.7 million for the years ended January 3,
1998 and December 28, 1996. During fiscal 1997, sales doubled, gross margin
grew four and a half times and operating expenses increased only 34%. The net
loss of $7.7 million for the year ended December 28, 1996 compares to $7.0
million in the year ended December 31, 1995. The increased loss is due to
higher operating expenses resulting from increased business activity including
product development, manufacturing ramp-up, higher dealer commissions, the
sales and marketing expenses necessary to promote products and the building of
corporate infrastructure. The higher operating expense was partially offset by
an increase in gross margin and higher interest income.
The company expects net losses to continue to decrease as sales increase
faster than operating expenses and gross margin continues to improve. However,
there can be no assurance the company will be successful in its efforts to
increase sales and gross margin or control the growth of operating expenses.
LIQUIDITY AND CAPITAL RESOURCES
At January 3, 1998 the company had $20.3 million in working capital and its
principal sources of liquidity consisted of $19.9 million in cash, cash
equivalents, and available-for-sale securities which include long-term
available- for-sale securities. The cash and cash equivalents are highly liquid
with original maturities of ninety days or less.
The company's cash used in operations increased to $8.5 million for the year
ended January 3, 1998 from $6.4 million for the year ended December 28, 1996
due to a higher inventory balance resulting from increased sales activity, the
build- up of controller component inventory in anticipation of volume, in-house
manufacturing of the new System 2000 controller and higher accounts receivable
balances resulting from higher sales. This was partially offset by higher
accrued compensation due to increased staffing levels and higher accrued
commissions due to increased sales. Cash used in operations during the year
ended December 28, 1996 decreased slightly to $6.4 million from $6.6 million
for the year ended December 31, 1995 reflecting higher accounts receivable,
net loss, and inventory at the end of fiscal year 1996, offset by higher
accrued compensation, accounts payable and financial reporting expenses, and
lower prepayments to a supplier of the company's inventory.
Net accounts receivable increased to $2.2 million as of January 3, 1998 from
$1.3 million as of December 28, 1996. Accounts receivable were $0.2 million as
of December 31, 1995. The increase in accounts receivable between the fiscal
years was due to sequentially increasing sales and the timing of sales within
the last few months of the year.
Inventories increased to $2.0 million as of January 3, 1998 compared to $0.8
million at December 28, 1996 due to higher product sales activity and higher
parts inventory in anticipation of volume, in-house manufacturing of the new
System 2000 controller. Inventories were $0.5 million at December 31, 1995. The
increase in fiscal year 1996 was due to the higher level of product sales
activity compared to the prior year during which the company began shipping
product in December. The company expects future inventory levels to grow both
in absolute value and as a percentage of total assets as sales volume
increases.
Net property and equipment decreased to $1.4 million as of January 3, 1998
compared to $1.5 million at December 28, 1996. The slight decrease in fiscal
1997 was due to an increase in accumulated depreciation partially offset by
the acquisition of capital equipment. Net property and equipment was $1.1
million as of December 31, 1995. The increase in fiscal 1996 was primarily due
to purchases of computer equipment, manufacturing equipment and machinery, and
furniture and fixtures. In 1998, the company has planned but not committed to
approximately $0.7 million in capital expenditures.
On February 11, 1998 the company and Boston Scientific Corporation (BSC)
announced an agreement in which BSC will develop and market the company's
proprietary Coblation (TM) technology for use in myocardial revascularization.
Under the agreement, BSC acquires exclusive licensing rights to the company's
intellectual property in this field. BSC will pay license fees, a portion of
which will be classified as prepaid royalties, to the company upon achievement
of designated milestones and royalties on sales of resulting products. There
can be no assurance the company and BSC will achieve the milestones required
for the company to receive the license fees or that a product will be
developed, cleared for marketing and achieve sufficient commercial acceptance
for the company to receive royalties.
The company relies on computers and computer software to run its business as
do its vendors, suppliers and customers. These computers and computer software
may not be able to properly recognize the dates commencing in the Year 2000.
The company has not completed an assessment of the impact this may have on its
business and does not have a reasonable basis to conclude whether the impact of
the year 2000 will or will not materially effect future financial results. To
date the company has not found any material impact which may result from the
failure of its computers and computer software or that of its vendors,
suppliers, and customers. However, the company plans to make an assessment of
this issue during 1998 and, if appropriate, develop an action plan to correct
it.
The company plans to finance its capital needs principally from cash from
product sales, cash, cash equivalents, and available-for-sale securities which
include long-term available-for-sale securities and related interest, existing
capital resources and licensing arrangements which the company believes will be
sufficient to fund its operations at least through fiscal year 1999. The
company currently has no commitments for any credit facilities such as
revolving credit agreements or lines of credit that could provide additional
working capital. The company's future liquidity and capital requirements will
depend on numerous factors including the company's success of commercializing
the Arthroscopic System, development and commercialization of products in
fields other than arthroscopy, the ability of the company's suppliers to
continue to meet the demands of the company at current prices, the cost
associated with the company's ongoing patent litigation, obtaining and
enforcing patents important to the company's business, the status of
regulatory approvals and competition. There can be no assurance that the
company will not be required to raise additional capital or that such capital
will be available on acceptable terms, if at all.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130 (SFAS 130), "Reporting Comprehensive
Income", and Statement of Financial Accounting Standards No. 131 (SFAS 131),
"Disclosure about Segments of an Enterprise and Related Information". SFAS 130
establishes requirements for disclosure of comprehensive income and becomes
effective for the company's fiscal year 1998 with reclassification of earlier
financial statements for comparative purposes. Comprehensive income generally
represents all changes in stockholders' equity except those resulting from
investments or contributions by stockholders. SFAS 131 establishes standards
for disclosure about operating segments in annual financial statements and
selected information in interim financial reports and standards for related
disclosures about products and services, geographic areas and major customers.
This statement supersedes Statement of Financial Accounting Standards No. 14,
"Financial Reporting for Segments of a Business Enterprise". The new standard
becomes effective for the company's fiscal year 1998, and requires that
comparative information from earlier years be restated to conform to
requirements of this standard. The company is evaluating the requirements of
SFAS 130 and SFAS 131 and the effects, if any, on the company's current
reporting and disclosures.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Certain information required by this Item is included in Item 6 of Part II of
this Report and is incorporated herein by reference. All other information
required by this Item is included on pages to in Item 14 of Part IV of
this Report and is incorporated herein by reference.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None
PART III
Item 10. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT
Information regarding the Directors of the Company is incorporated by
reference from the information set forth under the caption "Proposal No. 1:
Election of Directors" in the Proxy Statement. Information regarding the
executive officers of the Company is incorporated by reference from the
information set forth under the caption "Executive Officers of the Company" at
the end of Part I of this Report. Information with respect to Directors and
Officers of the Company required by Item 405 of Regulation S-K is set forth
under the captin "Disclosure with Regard to Delinquent Filings" at the end of
Part I of this Report
Item 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
discussion in the Proxy Statement captioned "Executive Compensation."
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
discussion in the Proxy Statement captioned "Share Ownership of Directors,
Officers and Certain Beneficial Owners."
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
discussion in the Proxy Statement captioned "Certain Transactions."
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM
8-K
(a) The following documents are filed as part of this Report.
1. Financial Statements. The following financial statements of the Company
and the Report of Independant Accountants, are included in Part IV of this
Report on the pages indicated.
Page
------
Report of Independent Accountants
Balance Sheets as of January 3, 1998 and December 28, 1996
Statements of Operations for the years ended January 3, 1998,
December 28, 1996, and December 31, 1995
Statement of Stockholders' Equity for the years ended
January 3, 1998, December 28, 1996 and December 31, 1995
Statements of Cash Flows for the years ended January 3,
1998, December 28, 1996 and December 31, 1995
Notes to Financial Statements
2. Financial Statement Schedule. The following financial statement schedule
of the Company as of and for the years ended January 3, 1998, December 28,
1996 and December 31, 1995, and the Report of Independent Accountants on
Financial Statements Schedule are included in Part IV of this Report on the
pages indicated. This financial statement schedule should be read in
conjunction with the Financial Statements, and notes thereto, of the Company.
Schedule Title Page
- -------- ------------------------------------ ------
II Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not applicable,
not required, or the information required to be set forth therein is included
in the Financial Statements or notes thereto.
3. Exhibits (in accordance with Item 601 of Regulation S-K).
(1) 3.2 Certificate of Incorporation of the Registrant.
(1) 3.3 Bylaws of the Registrant.
(1) 4.1 Specimen Common Stock Certificate.
(1) 10.1 Form of Indemnification Agreement between the Registrant
and each of its directors and officers.
(1) 10.2 Incentive Stock Plan and form of Stock Option Agreement
thereunder.
(1) 10.3 Director Option Plan and form of Director Stock Option
Agreement thereunder.
(1) 10.4 Employee Stock Purchase Plan and forms of agreements
thereunder.
(1) 10.5 Form of Exclusive Distribution Agreement.
(1) 10.6 Form of Exclusive Sales Representative Agreement.
(1) 10.7 Consulting Agreement, dated May 10, 1993, between the
Registrant and Philip E. Eggers, and amendment thereto.
(1) 10.8 Consulting Agreement, dated May 20, 1993, between the
Registrant and Eggers & Associates, Inc., and amendment
thereto.
(1) 10.9+ Development and Supply Agreement, dated March 1, 1994,
between the Registrant and SeaMed Corporation.
(1) 10.10 Lease Agreement, dated September 15, 1994, between
Registrant and The Arrillaga Foundation and the Perry
Foundation for the Registrant's facility located at 595
North Pastoria Avenue, Sunnyvale, California 94086.
(1) 10.11 Employment Letter Agreement, dated October 21, 1994,
between the Registrant and Allan Weinstein and amendment
thereto.
(1) 10.12 Purchase Assistance Promissory Note, dated January 19,
1995, between Registrant and Allan Weinstein.
(1) 10.13 Sublease Agreement, dated February 1, 1995, between
Registrant and Guided Medical Systems, Inc. for the
Registrant's former facility at 453 Ravendale Drive,
Mountain View, California 94043.
(1) 10.14 Mortgage Assistance Promissory Note Agreement, dated
February 5, 1995, between the Registrant and Allan
Weinstein.
(1) 10.15 Restricted Stock Purchase and Security Agreement, dated
February 5, 1995, between the Registrant and Allan
Weinstein.
(1) 10.16 Employment Letter Agreement, dated July 18, 1995, between
the Registrant and Robert T. Hagan.
(1) 10.17 Restricted Stock Purchase and Security Agreement, dated
August 1, 1995, between the Registrant and Robert T. Hagan.
(1) 10.18 Employment Letter Agreement, dated September 3, 1995,
between the Registrant and A. Larry Tannenbaum.
(1) 10.19+ Radiation Services Agreement, dated September 13, 1995,
between the Registrant and SteriGenics International.
(1) 10.20 Amended and Restated Stockholder Rights Agreement, dated
October 16, 1995, between the Registrant and certain
holders of the Registrant's securities.
(1) 10.21 Contribution Agreement, dated March 31, 1995, by and among
Philip E. Eggers, Robert S. Garvie, Anthony J. Manlove,
Hira V. Thapliyal and the Registrant.
(2) 10.22 Preferred Stock Rights Agreement, dated November 14, 1996,
between the Registrant and Norwest Bank Minnesota, N.A.
(3) 10.23+ Exclusive Distributor Agreement, dated April 15, 1997,
between the Registrant and Arthrex, Gmbh.
(4) 10.24++ Employment Letter Agreement, dated June 20, 1997, between
the Registrant and Michael A. Baker.
(5) 10.25+ Exclusive Distributor Agreement, dated August 21, 1997,
between the Registrant and Kobayashi Pharmaceutical
Company, Ltd.
10.26++ License Agreement dated February 9, 1998, between the
Registrant and Boston Scientific Corporation.
10.27++ Development and Supply Agreement Agreement dated February
9, 1998, between the Registrant and Boston Scientific
Corporation.
10.28 Lease Agreement date March 25, 1998 between the Registrant
and Aetna Life Insurance Company for the Registrant's
facility located at 840 Del Rey Avenue, Sunnyvale,
California 94086.
23.1 Consent of Coopers & Lybrand L.L.P., Independent
Accountants.
24.1 Power of Attorney (see Page 34).
27.1 Financial Data Schedule.
27.2 Restated Financial Data Schedule (1996).
27.3 Restated Financial Data Schedule (1997).
(1) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Registration Statement on Form
S- 1 (Registration No. 33-80453).
(2) Incorporated here in by reference to exhibit 5 previously filed with the
Registrant's Registration Statement on Form 8-A (Registration No. 000-
27422).
(3) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Quarterly Report on Form 10-Q
for the period ended March 29, 1997.
(4) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Quarterly Report on Form 10-Q
for the period ended June 28, 1997.
(5) Incorporated herein by reference to the same numbered exhibit
previously filed with the Registrant's Quarterly Report on Form 10-Q
for the period ended September 27, 1997.
+ Confidential treatment granted.
++ Confidential treatment requested.
REPORT OF INDEPENTANT ACCOUNTANTS
To the Board of Directors and Stockholders
ArthroCare Corporation:
We have audited the accompanying balance sheets of ArthroCare Corporation as of
January 3, 1998 and December 28, 1996, and the related statements of
operations, stockholders equity and cash flows for each of the three years in
the period ended January 3, 1998. These financial statements are the
responsibility of the companys management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of ArthroCare Corporation as of
January 3, 1998 and December 28, 1996, and the results of its operations and
its cash flows for each of the three years in the period ended January 3, 1998,
in conformity with generally accepted accounting principles.
/s/ COOPERS & LYBRAND L.L.P.
San Jose, California
January 27, 1998
except for Note 11 for which
the date is March 25, 1998
ARTHROCARE CORPORATION
BALANCE SHEETS
(in thousands, except per share data)
January 3, December 28,
1998 1996
----------- -----------
Assets
Current assets:
Cash and cash equivalents $ 8,188 $11,359
Available-for-sale securities 10,674 12,281
Accounts receivable, net of allowance for bad
debt of $115 in 1997 and $142 in 1996 2,223 1,251
Inventories 2,019 759
Prepaid expenses and other current assets 210 155
Total current assets 23,314 25,805
Available-for-sale securities 1,010 5,641
Property and equipment, net 1,412 1,484
Related party receivables 876 298
Other assets 63 69
----------- -----------
Total assets $26,675 $33,297
=========== ===========
Liabilities
Current liabilities:
Accounts payable:
Trade $ 950 $ 1,001
Related parties 18 54
Accrued liabilities 1,987 1,245
Capital lease obligation, current portion 17 37
----------- -----------
Total current liabilities 2,972 2,337
Capital lease obligation, less current portion -- 21
Deferred rent 157 157
----------- -----------
Total liabilities 3,129 2,515
----------- -----------
Commitments (Note 5 and Note 11)
Stockholders' Equity
Preferred stock, par value $0.001:
Authorized: 5,000 shares;
Issued and outstanding: 0 shares in 1997 and 1996 -- --
Common stock, par value $0.001:
Authorized: 20,000 shares;
Issued and outstanding: 8,869 shares in 1997
and 8,778 shares in 1996 9 9
Additional paid-in capital 49,153 48,862
Notes receivable from stockholders (92) (92)
Deferred compensation (228) (388)
Unrealized gain on available-for-sale securities 10 9
Accumulated deficit (25,306) (17,618)
----------- -----------
Total stockholders' equity 23,546 30,782
----------- -----------
Total liabilities and stockholders' equity $26,675 $33,297
=========== ===========
The accompanying notes are an integral part of these financial statements.
ARTHROCARE CORPORATION
STATEMENTS OF OPERATIONS
(in thousands, except per share data)
For the Years Ended
------------------------------------------
January 3, December 28, December 31,
1998 1996 1995
------------ ------------ ------------
Net sales $ 12,796 $ 6,022 $ 218
Cost of sales 8,495 5,242 447
------------ ------------ ------------
Gross margin 4,301 780 (229)
------------ ------------ ------------
Operating expenses:
Research and development 4,026 3,772 4,009
Sales and marketing 6,263 3,635 1,351
General and administrative 3,112 2,582 1,320
Non-recurring charge for acquired technology -- -- 260
------------ ------------ ------------
Total operating expenses 13,401 9,989 6,940
------------ ------------ ------------
Loss from operations (9,100) (9,209) (7,169)
Interest income 1,418 1,514 219
Other expense (5) (9) --
------------ ------------ ------------
Loss before income tax provision (7,687) (7,704) (6,950)
Income tax provision (1) (1) --
------------ ------------ ------------
Net loss $ (7,688) $ (7,705) $ (6,950)
============ ============ ============
Net loss per common share and per common
share-assuming dilution $ (0.87) $ (0.97) $ (1.82)
============ ============ ============
Shares used in computing net loss per common
share and per common share-assuming dilution 8,813 7,936 3,812
============ ============ ============
The accompanying notes are an integral part of these financial statements.
ARTHROCARE CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
for the years ended January 3, 1998, December 28, 1996, and December 31, 1995
(in thousands, except per share data)
Unreal-
ized
Notes Gain on
Receiv- Avail-
Addi- able able- Total
Preferred Stock Common Stock tional from Deferred for-Sale Accum- Stock-
--------------- ----------------- Paid-In Stock- Compensa- Secur- ulated holders'
Shares Amount Shares Amount Capital holders tion ities Deficit Equity
------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, December 31, 1994 4,356 $ 4 1,186 $ 1 $ 5,685 $ -- $ -- $ -- $ (2,963) $ 2,727
Issuance of Series C preferred
stock for cash at $2.00 per share
in March and June 1995, net of
issuance costs of $17 2,923 3 -- -- 5,825 -- -- -- -- 5,828
Issuance of notes receivable in
exchange for exercise of options
to purchase common stock at $0.32
per share in February 1995 and
$0.80 per share in August 1995 -- -- 190 -- 104 (104) -- -- -- --
Issuance of common stock through:
Exchange of intellectual
property rights at $0.40 per
share in March 1995 -- -- 400 1 160 -- -- -- -- 161
Exercise of options -- -- 16 -- 24 -- -- -- -- 24
Issuance of Series D preferred
stock for cash at $3.00 per
share in October 1995, net of
issuance cost of $7 1,399 2 -- -- 4,189 -- -- -- -- 4,191
Repayment of notes receivable
from stockholder in November 1995 -- -- -- -- -- 12 -- -- -- 12
Deferred compensation related to
grants of stock options -- -- -- -- 882 -- (882) -- -- --
Amortization of deferred
compensation -- -- -- -- -- -- 332 -- -- 332
Net Loss -- -- -- -- -- -- -- -- (6,950) (6,950)
------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, December 31, 1995 8,678 9 1,792 2 16,869 (92) (550) -- (9,913) 6,325
Issuance of common stock through:
Initial public offering at
$14.00 per share in February
1996, net of issuance costs of
$3,563 -- -- 2,530 3 31,854 -- -- -- -- 31,857
Conversion of preferred stock
in connection with the initial
public offering in February 1996 (8,678) (9) 4,339 4 5 -- -- -- -- --
Exercise of options -- -- 107 -- 63 -- -- -- -- 63
Employee stock purchase plan -- -- 10 -- 66 -- -- -- -- 66
Deferred compensation related to
issuance of common stock and
grants of stock options -- -- -- -- 5 -- (5) -- -- --
Amortization of deferred
compensation -- -- -- -- -- -- 167 -- -- 167
Change in unrealized gain on
available-for-sale securities -- -- -- -- -- -- -- 9 -- 9
Net Loss -- -- -- -- -- -- -- -- (7,705) (7,705)
------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, December 28, 1996 -- -- 8,778 9 48,862 (92) (388) 9 (17,618) 30,782
Issuance of common stock through:
Exercise of options -- -- 74 -- 201 -- -- -- -- 201
Employee stock purchase plan -- -- 17 -- 90 -- -- -- -- 90
Amortization of deferred
compensation -- -- -- -- -- -- 160 -- -- 160
Change in unrealized gain on
available-for-sale securities -- -- -- -- -- -- -- 1 -- 1
Net Loss -- -- -- -- -- -- -- -- (7,688) (7,688)
------- ------- -------- -------- -------- -------- --------- -------- --------- --------
Balances, January 3, 1998 -- $ -- 8,869 $ 9 $49,153 $ (92) $(228) $ 10 $(25,306) $23,546
======= ======= ======== ======== ======== ======== ========= ======== ========= ========
The accompanying notes are an integral part of these financial statements.
ARTHROCARE CORPORATION
STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended
--------------------------------------
January 3, December 28, December 31,
1998 1996 1995
------------ ------------ ------------
Cash flows from operating activities:
Net loss $ (7,688) $ (7,705) $ (6,950)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization 615 370 173
Provision for doubtful accounts
receivable and product returns 276 313 5
Forgiveness of notes receivable 11 -- --
Provision for excess and obsolete
inventory 249 50 50
Loss on disposal of property and
equipment 19 309 --
Amortization of deferred compensation 160 167 332
Deferred rent -- 9 137
Non-recurring charge for acquired
technology -- -- 260
Changes in operating assets and
liabilities:
Accounts receivable (1,248) (1,352) (217)
Inventory (1,509) (293) (566)
Prepaid expenses and other current
assets (55) 736 (860)
Accounts payable (87) 288 647
Accrued liabilities 742 772 437
Other assets 6 (20) (37)
------------ ------------ ------------
Net cash used in operating
activities (8,509) (6,356) (6,589)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (562) (1,028) (920)
Purchases of available-for-sale securities (113,117) (189,648) (2,500)
Sales or maturities of available-for-sale
securities 119,356 171,735 2,500
Purchase of intellectual property rights -- -- (100)
------------ ------------ ------------
Net cash provided by (used in)
investing activities 5,677 (18,941) (1,020)
------------ ------------ ------------
Cash flows from financing activities:
Issuance of notes receivable to related
parties (686) (75) (223)
Repayment of capital leases (41) (29) (47)
Repayment of notes receivable from
related parties 97 -- --
Repayment of notes receivable from
stockholder -- -- 12
Proceeds from issuance of common stock
and preferred stock, net of issuance
costs 90 31,923 10,018
Proceeds from exercise of options to
purchase common stock 201 63 24
------------ ------------ ------------
Net cash provided by (used in)
financing activities (339) 31,882 9,784
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents (3,171) 6,585 2,175
Cash and cash equivalents, beginning of period 11,359 4,774 2,599
------------ ------------ ------------
Cash and cash equivalents, end of period $ 8,188 $ 11,359 $ 4,774
============ ============ ============
The accompanying notes are an integral part of these financial statements.
ARTHROCARE CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
1. Formation and Business of the Company:
ArthroCare Corporation (the company) was incorporated on April 29, 1993. The
company designs, develops, manufactures and markets medical devices for use
in arthroscopic and orthopedic procedures. The company's principal operations
commenced in August 1995, at which time it emerged from the development stage.
On November 22, 1995, the company was reincorporated in the state of Delaware
with the associated exchange of shares of each class and series of stock of
the predecessor company for one share of each identical class and series of
stock of the Delaware successor company having a par value of $0.001 per share
for both common stock and preferred stock.
The company sold 2,530,000 shares of common stock (including 330,000 shares
from the exercise of the underwriter's overallotment option) at $14.00 per
share through an initial public offering in February 1996. Net proceeds
(after underwriter's commissions and fees along with other costs associated
with the offering) totaled $31,857,000. Upon completion of the offering, all
outstanding shares of preferred stock (a total of 8,678,000 shares) were
converted into shares of common stock on a two-for-one basis.
In the course of its development activities, the company has sustained
operating losses and expects such losses to continue through fiscal year
1998. The company intends to finance its operations primarily through its
cash, cash equivalents and available-for-sale securities, together with
future revenues and licensing fees. There can be no assurance that the
company will not require additional funding and should this prove necessary,
the company may sell additional shares of its common or preferred stock
through private placement or further public offerings. Such offerings could
cause additional dilution of the company's capital.
2. Summary of Significant Accounting Policies:
BASIS OF PRESENTATION
The company maintains a fifty-two/fifty-three week fiscal year cycle ending on
a Saturday. To conform the company's fiscal year ends, the company must add a
fifty- third week to every fifth or sixth fiscal year. Accordingly, fiscal
1997 was a fifty-three week fiscal year.
STOCK SPLIT
On December 12, 1995, the company effected a one-for-two reverse common stock
split and a corresponding change in the preferred stock conversion ratios. All
common stock data in the accompanying financial statements has been
retroactively adjusted to reflect the reverse stock split.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS AND AVAILABLE-FOR- SALE SECURITIES
The company considers all highly liquid investments purchased with original
maturities of ninety days or less to be cash equivalents. Cash and cash
equivalents include money market funds and various deposit accounts.
The company has classified its investments as "available-for-sale." Such
investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of equity until realized.
Interest income is recorded using an effective interest rate, with the
associated premium or discount amortized to "interest income". The cost of
securities sold is based upon the specific identification method.
INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in, first-
out basis) or market value.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and are depreciated on a
straight-line basis over their estimated useful lives of three to five years.
Leasehold improvements are amortized over the shorter of their estimated
useful lives or the lease term. Maintenance and repair costs are charged to
operations as incurred.
REVENUE RECOGNITION
The company recognizes revenue upon shipment of product to the customer, upon
fulfillment of acceptance terms, if any, and when no significant contractual
obligations remain. Revenue is reported net of a provision for estimated
product returns.
RESEARCH AND DEVELOPMENT
Research and development costs are charged to operations as incurred.
RECLASSIFICATIONS
Certain amounts in the financial statements have been reclassified to conform
with the current year presentation. These classifications and restatements did
not impact previously reported total assets, liabilities, stockholders'
equity or net loss.
CONCENTRATION OF RISKS AND UNCERTAINTIES
The company's cash and cash equivalents are maintained at five financial
institutions in the United States. Deposits at these institutions may exceed
the amount of insurance provided on such deposits. The company has not
experienced any losses on its deposits of cash and cash equivalents.
The company's Sunnyvale facility currently accounts for all of its product
manufacturing. Disruption of operations at the company's production facility
could cause delays in, or an interruption of, production and shipment of
products which could have a material adverse impact on the company's business,
operating results and financial condition.
The company's products require approval from the United States Food and Drug
Administration (FDA) and international regulatory agencies prior to the
commencement of commercial sales. There can be no assurance that the company's
products will receive any of these required approvals. If the company was
denied such approvals, or if such approvals were delayed, it would have a
materially adverse impact on the company's business.
Sales to both international and domestic customers are generally made on open
credit terms. Management performs ongoing credit evaluations of the company's
customers and maintains an allowance for potential credit losses when needed
but historically has not experienced any significant losses related to
individual customers or a group of customers in any particular geographic
area. Export sales totalled approximately $900,000 for 1997.
The company operates in an industry with rapid technological changes which may
render inventories maintained by the company obsolete.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The amounts for cash equivalents and accrued liabilities are a reasonable
estimate of their fair value due to their short-term nature. The estimated
fair value amounts of the company's financial instruments have been determined
by the company, using appropriate market information and valuation
methodologies. Considerable judgment is required to develop the estimates of
fair value, thus, the estimates provided herein are not necessarily
indicative of the amounts that could be realized in a current market exchange.
INCOME TAXES
The company accounts for income taxes under Statement of Financial Accounting
Standard (SFAS) No. 109, "Accounting for Income Taxes," which prescribes the
use of the liability method whereby deferred tax asset or liability account
balances are calculated at the balance sheet date using current tax laws and
rates in effect for the year in which the differences are expected to affect
taxable income. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts expected to be realized.
COMPUTATION OF NET LOSS PER COMMON SHARE AND PER COMMON SHARE-ASSUMING
DILUTION
The company adopted SFAS No. 128 "Earnings Per Share" and the Securities and
Exchange Commission Staff Accounting Bulletin No. 98 (SAB No. 98) effective
January 3, 1998; accordingly, all prior periods have been restated. Net loss
per common share and per common share-assuming dilution are computed using
the weighted average number of shares of common stock outstanding. Common
equivalent shares from stock options and preferred stock are excluded from
the computation of net loss per common share-assuming dilution as their effect
is antidilutive. No additional shares are considered to be outstanding for
either computation under the provisions of SAB No. 98.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No.
130, "Reporting Comprehensive Income". This statement establishes
requirements for disclosure of comprehensive income and becomes effective for
the company's fiscal year 1998, with reclassification of earlier financial
statements for comparative purposes. Comprehensive income generally
represents all changes in stockholders' equity except those resulting from
investments or contributions by stockholders. The company is evaluating
alternative formats for presenting this information but does not expect this
pronouncement to materially impact the company's reporting of results of
operations.
In June 1997, the FASB issued SFAS No. 131, "Disclosure about Segments of an
Enterprise and Related Information". This statement establishes standards for
disclosure about operating segments in annual financial statements and
selected information in interim financial reports. It also establishes
standards for related disclosures about products and services, geographic
areas and major customers. This statement supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise". The new standard becomes
effective for the company's fiscal year 1998 and requires that comparative
information from earlier years be restated to conform to requirements of this
standard. The company is evaluating the requirements of SFAS No. 131 and the
effects, if any, on the company's current reporting and disclosures.
3. Available-For-Sale Securities (in thousands):
The following summarizes the company's available-for-sale securities:
Gross Gross
Amortized Unrealized Unrealized Accrued Market
Cost Gains Losses Interest Value
---------- ---------- ---------- --------- ---------
January 3, 1998:
Corporate notes and bonds............. $ 11,550 $ 10 $ -- $ 124 $ 11,684
========== ========== ========== ========= =========
December 28, 1996:
U.S. government notes and bonds....... $ 1,588 $ 7 $ -- $ 42 $ 1,637
Corporate notes and bonds............. 13,040 12 (10) 336 13,378
Corporate equities.................... 2,900 -- -- 7 2,907
---------- ---------- ---------- --------- ---------
$ 17,528 $ 19 $ (10) $ 385 $ 17,922
========== ========== ========== ========= =========
Available-for-sale debt securities by contractual maturity at January 3, 1998
are shown below :
Amortized Market
Cost Value
---------- ----------
Less than one year.................... $ 10,550 $ 10,674
One to five years..................... 1,000 1,010
---------- ----------
$ 11,550 $ 11,684
========== ==========
4. Balance Sheet Detail (in thousands):
January 3, December 28,
1998 1996
---------- ----------
Inventories:
Raw materials...................... $ 921 $ 345
Work-in-process.................... 165 32
Finished goods..................... 933 382
---------- ----------
$ 2,019 $ 759
========== ==========
Prepaid expenses and other current assets:
Prepaid insurance.................. $ 125 $ 45
Prepaid rent....................... 28 34
Other.............................. 57 76
---------- ----------
$ 210 $ 155
========== ==========
Property and equipment:
Machinery and equipment............ $ 1,123 $ 877
Tooling and molds.................. 216 258
Computer equipment................. 898 732
Furniture and fixtures............. 205 165
Leasehold improvements............. 148 25
---------- ----------
2,590 2,057
Less accumulated depreciation and
amortization....................... (1,178) (573)
---------- ----------
$ 1,412 $ 1,484
========== ==========
Equipment acquired under capital leases included in property and equipment
above:
Machinery and equipment............ $ 109 $ 109
Less accumulated depreciation...... (85) (54)
---------- ----------
$ 24 $ 55
========== ==========
Accrued liabilities:
Accrued professional fees.......... $ 164 $ 163
Accrued compensation............... 1,314 777
Accrued warranty................... 316 123
Other.............................. 193 182
---------- ----------
$ 1,987 $ 1,245
========== ==========
5. Commitments:
CAPITAL LEASE
The company leases certain of its office and computer equipment from finance
companies under capital lease agreements which expire in November 1998. At
January 3, 1998, the total future minimum payments under capital leases for
1998 is $18,000 with $1,000 representing interest.
OPERATING LEASE
The company rents its office facility under an operating lease which expires
in February 2002. Under the terms of the lease, the company is responsible for
taxes, insurance and maintenance expenses. At January 3, 1998, total future
minimum lease payments are as follows (in thousands):
1998.................... $ 302
1999.................... 341
2000.................... 354
2001.................... 367
2002.................... 62
----------
$ 1,426
==========
Rent expense for the years ended January 3, 1998, December 28, 1996 and
December 31, 1995 was $349,000, $345,000 and $263,000, respectively.
6. Supplemental Cash Flow Disclosures (in thousands):
Year Ended
-----------------------------------------
January 3, December 28, December 31,
1998 1996 1995
---------- ---------- ----------
Non-cash financing and investing activities:
Additions to property and equipment
acquired under capital lease $ -- $ -- $ 113
Common stock issued for note
receivable $ -- $ -- $ 104
Common stock issued in exchange for
intellectual property rights $ -- $ -- $ 160
Conversion of preferred stock to
common stock in connection with the
company's initial public offering $ -- $ -- $15,750
Change in unrealized gain on
available-for-sale securities $ 1 $ 9 $ --
Cash paid during the period for:
Interest $ 5 $ 9 $ 7
Income Tax $ 1 $ 1 $ --
7. Stockholders' Equity:
PREFERRED STOCK
Under the company's Articles of Incorporation, the company is authorized to
issue preferred stock. At January 3, 1998, 5,000,000 shares of preferred stock
were authorized and no preferred stock was issued and outstanding as the
previously outstanding preferred stock was converted into common stock in
connection with the company's initial public offering effective February 5,
1996.
STOCK OPTION PLANS
In May 1993, the company approved the 1993 Stock Plan (1993 Plan) under which
the Board of Directors of the company is authorized and directed to enter into
stock option agreements with selected individuals. 136,000 shares were
authorized at the inception of the Plan with 250,000 and 1,150,000 additional
shares authorized in 1994 and 1995, respectively. Options granted under the
1993 Plan generally become exercisable over a 48- month period.
Activity under the 1993 Plan is as follows (in thousands, except per share
data):
Shares Outstanding Options
Available -------------------------------------
For Number Exercise Aggregate
Grant Of Shares Price Price
-------- -------- ---------------- ----------
Balances, December 31, 1994 225 153 $0.20-$ 0.32 $ 36
Additional shares authorized 1,150 -- -- --
Options granted (363) 363 $0.32-$ 9.00 826
Options exercised -- (16) $0.32-$ 1.60 (24)
Options canceled 9 (9) $0.32-$ 3.00 (5)
-------- -------- ----------
Balances, December 31, 1995 1,021 491 $0.20-$ 9.00 833
Options granted (218) 218 $9.50-$24.25 2,867
Options exercised -- (107) $0.20-$ 5.00 (34)
Options canceled 58 (58) $0.20-$24.25 (225)
-------- -------- ----------
Balances, December 28, 1996 861 544 $0.20-$24.25 3,441
Options granted (723) 723 $6.25-$11.88 6,147
Options exercised -- (74) $0.32-$11.00 (201)
Options canceled 162 (162) $0.40-$24.25 (881)
-------- -------- ----------
Balances, January 3, 1998 300 1,031 $0.20-$24.25 $ 8,506
======== ======== ==========
At January 3, 1998, 314,000 options were exercisable under the 1993 Plan.
In December 1995, the company adopted the Director Option Plan (Director Plan)
and reserved 100,000 shares of common stock for issuance to directors under
this plan. The plan allows for an initial grant and automatic annual grants
of options to outside directors of the company. As of January 3, 1998 and
December 28, 1996, outstanding options under the Director Plan were 24,000 and
12,000, respectively, with 13,000 options exercisable as of January 3, 1998.
In February 1995, pursuant to a restricted stock purchase agreement, 100,000
shares of common stock were purchased by an officer of the company at $0.32
per share. The restricted stock purchase agreement contains provisions for
the repurchase of common stock by the company in the event of termination of
employment during the four years following the date of the agreement. At
January 3, 1998, 21,667 shares were subject to repurchase under this
restricted stock purchase agreement. Those shares will be released ratably
over the following 13 months.
In August 1995, 90,000 shares of common stock were purchased by an officer of
the company at $0.80 per share pursuant to a restricted stock purchase
agreement. The restricted stock purchase agreement contains provisions for the
repurchase of common stock by the company in the event of termination of
employment during the four years following the date of the agreement. At
January 3, 1998, 29,688 shares were subject to repurchase under this
restricted stock purchase agreement. These shares will be released ratably
over the following 19 months.
EMPLOYEE STOCK PURCHASE PLAN
In December 1995, the company approved the Employee Stock Purchase Plan and
reserved 150,000 shares of common stock for issuance under this plan. For the
years ended January 3, 1998 and December 28, 1996, 16,865 shares and 10,101
shares of common stock were sold under the Employee Stock Purchase Plan,
respectively.
SHAREHOLDERS RIGHTS PLAN
In November 1996, the Board of Directors approved a Shareholders Rights Plan
declaring a dividend distribution of one Preferred Share Purchase Right for
each outstanding share of the company's Common Stock. Each right will entitle
stockholders to buy one-thousandth of one share of the company's Series A
Participating Preferred Stock at an exercise price of $50.00. This Plan was
designed to assure that the company's stockholders receive fair and equal
treatment in the event of any proposed takeover of the company and to guard
against partial tender offers and other abusive tactics to gain control of
the company without paying all stockholders the fair value of their shares,
including a "control premium."
STOCK-BASED COMPENSATION
The company has adopted the disclosure-only provisions of SFAS No. 123
"Accounting for Stock-Based Compensation." Had compensation cost for the 1993
Plan, the Director Plan and the Employee Stock Purchase Plan been determined
based on the fair value at the grant date for awards in fiscal year 1997,
1996 and 1995 consistent with the provisions of SFAS No. 123, the company's
net loss per common share and per common share- assuming dilution for the years
ended January 3, 1998, December 28, 1996 and December 31, 1995 would have
been increased to the pro forma amounts indicated below (in thousands, except
per share data):
Year Ended
-------------------------------------------
January 3, December 28, December 31,
1998 1996 1995
------------- ------------- -------------
Net loss as reported $ 7,688 $ 7,705 $ 6,950
Net loss pro forma $ 8,466 $ 7,962 $ 6,959
Net loss per common share and per common
share-assuming dilution as reported $ 0.87 $ 0.97 $ 1.82
Net loss per common share and per common
share-assuming dilution pro forma $ 0.96 $ 1.00 $ 1.83
The effects of the pro forma disclosure of applying SFAS No. 123 are not
likely to be representative of the effects of the pro forma disclosures of
future years. Because SFAS No. 123 reflects only options granted after January
1, 1995, the pro forma effect will not be fully reflected until 1999.
The fair value of each option grant is estimated on the date of grant using
the Black Scholes model with the following weighted average assumptions:
Risk-free interest rate 4.98%-7.13%
Expected life 4 years
Expected dividends --
Expected volatility 50%
The options outstanding and currently exercisable by exercise price for both
the 1993 Plan and the Director Plan at January 3, 1998 are as follows (in
thousands, except per share data and contractual life):
Options Outstanding Options Currently Exercisable
- ------------------------------------------------------ ------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- ----------------- ------------ ----------- ----------- ------------ -----------
$ 0.20 43 5.4 $ 0.20 43 $ 0.20
$ 0.32-$ 0.40 58 7.3 $ 0.39 38 $ 0.39
$ 0.80 9 7.5 $ 0.80 5 $ 0.80
$ 1.60 40 7.6 $ 1.60 23 $ 1.60
$ 3.00 5 7.7 $ 3.00 3 $ 3.00
$ 5.00-$ 7.38 204 9.0 $ 6.90 68 $ 6.77
$ 8.00-$11.88 627 9.2 $ 9.39 120 $ 9.64
$14.00-$19.75 36 8.3 $16.87 13 $16.62
$24.25 33 8.3 $24.25 14 $24.25
------------ ------------
1,055 8.8 $ 8.37 327 $ 6.82
============ ============
Deferred compensation recognized as a result of stock options granted and
common stock issued subject to repurchase provisions as of January 3, 1998
and December 28, 1996 is $887,000. Deferred compensation is generally
amortized over vesting periods of one to four years, which resulted in
compensation expense of $160,000, $167,000 and $332,000 recognized in the
years ended January 3, 1998, December 28, 1996 and December 31, 1995,
respectively. As of December 28, 1996, options to purchase 147,000 shares of
common stock were exercisable at a weighted average exercise price of $2.09
per share.
8. Related Parties:
In connection with the formation of the company, several of the founders and a
partnership of the founders entered into a licensing agreement to facilitate
patent transfers. As a result, the company acquired an exclusive worldwide
perpetual royalty-free license, with right of sublicense, to make, use and
sell products and use patent methods covered by the patent rights limited to
surgical orthopedic and arthroscopic applications.
Also in connection with its incorporation, the company entered into a
consulting agreement with a consulting and research firm, which is headed by
one of the company's founders. This consulting and research firm was
contracted to perform research related to the development of hand-held
instruments used in arthroscopic procedures. Research and development costs
incurred on this contract in fiscal 1997, 1996 and 1995 were approximately
$457,000, $456,000 and $481,000, respectively.
In January 1995, the company loaned to an officer $120,000 pursuant to a
provision in the officer's employment agreement. The resulting promissory
note bears interest at 6% per annum and is due on the earlier of January 31,
1999 or termination of employment. At January 3, 1998, $142,000 of principal
and interest was outstanding on this note. In February 1995, the company
agreed to loan this officer up to an additional $144,000 in monthly
increments of $3,000 at 6% per annum. In December 1997, the company amended
this officer's employment agreement to terminate the increments effective
January 31, 1998 and forgive 10% of the principal and interest at the end of
each fiscal year in which the officer is employed by the company and in which
the company meets certain performance targets. In fiscal 1997, $11,000 of
principal and interest was forgiven. At January 3, 1998, $103,000 of
principal and interest was outstanding on this note. Both aforementioned
notes are secured by shares of the company's common stock and a mortgage on
the officer's residence.
On March 31, 1995, the company issued 400,000 shares of common stock for $0.40
per share and $100,000 cash in exchange for certain intellectual property
rights of a related research firm headed by several of the company's
directors and co-founders. This transaction was accounted for as a non-
recurring charge to operating expense.
In December 1995, the company loaned an employee $62,000 pursuant to a
provision in the employee's employment agreement. The resulting promissory
note bears interest at the rate of 6% per annum and is due on the earlier of
July 24, 2000 or the termination of employment. The note also permits the
company to loan this employee up to an additional $34,000 in $2,000 monthly
increments. The aforementioned notes are secured by a pledge of this
employee's option for 50,000 shares of the company's common stock and any
shares issued upon exercise of such options. In May 1997, all principal and
interest were repaid in full.
In June 1997, the company loaned an officer $500,000 pursuant to a provision
in the officer's employment agreement. The promissory note, which bears no
interest, is secured by a mortgage on the officer's residence and is due and
payable upon either the officer's termination of employment or the sale of the
officer's residence. If the officer is terminated by the company or the
company is acquired, the loan is due and payable within 12 months thereafter.
As of January 3, 1998, $500,000 of principal was outstanding on this note.
In November 1997, the company issued a relocation loan of $130,000 to an
employee. This loan is secured by the employee's residence and is due and
payable upon either the sale or transfer of the property or the termination
of the officer's employment with the company. As of January 3, 1998, $130,000
of principal was outstanding on this loan.
9. Income Taxes:
At January 3, 1998, the company has approximately $16,000,000 and $4,500,000
in federal and state net operating loss carryforwards, respectively, which
expire in the years 2004 through 2013. The Tax Reform Act of 1986
substantially changed the rates relative to net operating loss and tax credit
carryforwards in the case of an "ownership change" of a corporation. Any
ownership changes, as defined, may restrict utilization of carryforwards.
Temporary differences and carryforwards which gave rise to significant
portions of deferred tax assets and liabilities are as follows (in thousands):
January 3, December 28,
1998 1996
---------- -----------
Deferred tax assets:
Net operating loss carryforwards $ 5,612 $ 2,167
Capitalized research and development costs 1,154 3,036
Capitalized start-up costs 499 710
Purchased patents -- 104
Research and development credit 567 446
Allowances and reserves 1,806 699
Other -- 130
Less: valuation allowance (9,638) (7,292)
---------- -----------
Net deferred tax assets $ -- $ --
========== ===========
In accordance with generally accepted accounting principles, a valuation
allowance must be established for a deferred tax asset if it is more likely
than not that a tax benefit may not be realized from the asset in the future.
The company has established a valuation allowance to the extent of its
deferred tax assets since it is more likely than not that a benefit can not be
realized in the future due to the company's recurring operating losses. The
company's valuation allowance increased from $7,292,000 at December 28, 1996
to $9,638,000 at January 3, 1998.
10. Employee Benefit Plan:
The company maintains a Retirement Savings and Investment Plan (401(k) Plan)
which covers substantially all employees. Eligible employees may defer salary
(before tax) up to a specified maximum. The company, at its discretion, may
make matching contributions on behalf of the participants in the 401(k) Plan.
To date, the company has not made any contributions to the 401(k) Plan.
11. Subsequent Events:
In February 1998, the company entered into a partnership agreement with Boston
Scientific Corporation (BSC) in which BSC will develop and market the
company's proprietary Coblation (TM) technology for use in myocardial
revascularization. Under the agreement, BSC acquires exclusive licensing
rights to the company's intellectual property in this field. BSC will pay a
licensing fee, a portion of which will be treated as prepaid royalties, to
the company upon achievement of certain milestones and pay royalties on sales
of any resulting product.
In March 1998 the company entered into a 47- month operating lease agreement
for an additional office and manufacturing facility in Sunnyvale. Under the
agreement, the company is responsible for taxes, insurance and maintenance
expenses. Total future minimum payments over the term of the lease is $963,000
which is subject to annual increases based on changes in the Consumer Price
Index.
SCHEDULE II
ARTHROCARE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
Additions
Balance at Charged to Balance
Beginning Statement of at end
of Year Operations Deductions of Year
----------- ------------- ----------- ---------
Year ended January 3, 1998
Deducted from asset accounts:
Allowance for doubtful
accounts and product returns $318 $276 $ -- $594
Allowance for excess and
obsolete inventory $100 $249 $ -- $349
Year ended December 28, 1996
Deducted from asset accounts:
Allowance for doubtful
accounts and product returns $5 $313 $ -- $318
Allowance for excess and
obsolete inventory $50 $50 $ -- $100
Year ended December 31, 1995
Deducted from asset accounts:
Allowance for doubtful
accounts and product returns $-- $5 $ -- $5
Allowance for excess and
obsolete inventory $-- $50 $ -- $50
REPORT OF INDEPENTANT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
In connection with our audit of the financial statements of ArthroCare
Corporation as of January 3, 1998 and December 28, 1996 and for each of the
three years in the period ended January 3, 1998 which financial statements are
included in this Annual Report on Form 10-K, we have also audited the
financial statement schedule listed in item 14 (a) herein.
In our opinion, the financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information required to be included therein.
COOPERS & LYBRAND L.L.P.
San Jose, California
January 27, 1998
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:
ARTHROCARE CORPORATION
a Delaware Corporation
/s/ MICHAEL A. BAKER
- -------------------------------
Michael A. Baker
President and Chief Executive Officer
Date: April 2, 1998
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints each of Michael A Baker and Christine E. Hanni
as his attorney-in-fact for him, in any and all capacities, to sign each
amendment to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that said
attorney-in-fact or his substitute or substitutes may lawfully do or cause to
be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
Signature Title Date
- ------------------------------- ---------------------------------- -------------
/s/ MICHAEL A. BAKER President, Chief Executive Officer April 2, 1998
- ------------------------------- and Director (Principal Executive
Michael A. Baker Officer)
/s/ CHRISTINE E. HANNI Chief Financial Officer and April 2, 1998
- ------------------------------- Assistant Secretary (Principal
Christine E. Hanni Financial and Accounting Officer)
/s/ HIRA V. THAPLIYAL Director April 2, 1998
- -------------------------------
Hira V. Thapliyal
/s/ ANNETTE J. CAMPBELL-WHITE Director April 2, 1998
- -------------------------------
Annette J. Campbell-White
/s/ PHILIP E. EGGERS Director April 2, 1998
- -------------------------------
Philip E. Eggers
/s/ C. RAYMOND LARKIN, Jr. Director April 2, 1998
- -------------------------------
C. Raymond Larkin, Jr.
/s/ JOHN S. LEWIS Director April 2, 1998
- -------------------------------
John S. Lewis
/s/ ROBERT R. MOMSEN Director April 2, 1998
- -------------------------------
Robert R. Momsen
ARTHROCARE CORPORATION
Report on Form 10-K for
the year ended January 3, 1998
INDEX TO EXHIBITS*
EXHIBIT
NUMBER EXHIBIT NAME
-------- -----------------------------------------------------------
10.26++ License Agreement dated February 9, 1998, between the
Registrant and Boston Scientific Corporation.
10.27++ Development and Supply Agreement Agreement dated February
9, 1998, between the Registrant and Boston Scientific
Corporation.
10.28 Lease Agreement date March 25, 1998 between the Registrant
and Aetna Life Insurance Company for the Registrant's
facility located at 840 Del Rey Avenue, Sunnyvale,
California 94086.
23.1 Consent of Coopers & Lybrand L.L.P., Independent Public
Accountants.
24.1 Power of Attorney (see Page 34).
27.1 Financial Data Schedule.
27.2 Restated Financial Data Schedule (1996).
27.3 Restated Financial Data Schedule (1997).
* Only exhibits actually filed are listed. Exhibits incorporated by
reference are set forth in the exhibit listing included in Item 14 of
the Report on Form 10-K.
++ Confidential treatment requested.