SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________
Form 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to ______________
Commission File Number 0-27212
ENDOCARE, INC.
(Exact name of registrant as specified in its charter)
Delaware 33-0618093
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
7 Studebaker, Irvine, California 92618
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (949) 595-4770
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)
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-10K. [X]
The number of shares of the registrant's common stock outstanding as of
February 29, 2000 was 11,297,531.
The aggregate market value of the registrant's common stock held by
non-affiliates of the registrant was $149,228,865 (computed using the average
bid and asked prices quoted on the Nasdaq Small Cap Market on February 29,
2000).
The information required to be included in Part III of this Form 10-K is
incorporated by reference to the definitive proxy statement for the
registrant's annual meeting of stockholders to be filed by the registrant no
later than 120 days after December 31, 1999, the close of its fiscal year.
ENDOCARE, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
ITEM NUMBER AND CAPTION
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PAGE
PART I NUMBER
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Item 1. Business 3
Item 2. Properties 14
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of Security Holders 14
PART II
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Item 5. Market for Registrant's Common Equity and Related Shareholder Matters 15
Item 6. Selected Financial Data 16
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 16
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 20
Item 8. Financial Statements and Supplementary Data 21
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 21
PART III
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Item 10. Directors and Executive Officers of the Registrant 21
Item 11. Executive Compensation 21
Item 12. Security Ownership of Certain Beneficial Owners and Management 21
Item 13. Certain Relationships and Related Transactions 21
PART IV
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Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 22
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<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Endocare, Inc., a Delaware corporation ("Endocare" or the "Company"),
develops, manufactures and markets an array of innovative, temperature-based
minimally invasive surgical devices and technologies to treat prostate disease.
The Company has focused its efforts on the continued clinical development of
surgical devices for the treatment of the two most common diseases of the
prostate, Prostate Cancer and Benign Prostate Hyperplasia ("BPH"). Prostate
cancer affects one in six men over the age of fifty, while BPH affects one in
two men over the age of fifty.
Endocare has developed and recently introduced an innovative, second
generation cryosurgical system for the treatment of prostate cancer. The
Cryocare System (TM) offers the advantage of controlled, targeted freezing of
the tumor with the benefit of faster patient recovery and minimal complications.
The system was launched in July 1999 following the initiation of national
Medicare coverage for cryosurgical procedures as a primary treatment alternative
for localized prostate cancer. The Company also operates a mobile cryosurgery
business in Florida which provides cryosurgical equipment for the treatment of
prostate and liver cancer on a per procedure basis.
Endocare has also developed new therapies for the improved treatment of
BPH. The Company's initial product development efforts for BPH involve the use
of stent technology to provide both immediate and long-term relief to BPH
patients. Endocare has implemented a two-part strategy for the commercialization
of its stent-based BPH therapies. The first stage is the development of the
Company's Horizon Prostatic Stent (TM). This nitinol-based stent has shape
memory characteristics for easy placement via a catheter following surgical
intervention of the prostate and convenient atraumatic removal of the stent
following the healing process. The Company believes that its Horizon Prostatic
Stent (TM) will address one of the major issues of BPH therapy, the immediate
relief of patients following thermotherapy and surgical resection. In 1999,
Endocare completed phase two of the Horizon Prostatic Stent (TM) FDA study and
received approval to expand the trial to the pivotal study. The Company expects
to complete the FDA study the second half of 2000. In addition, the Company is
exploring the use of the stent for long-term relief of BPH without the need for
thermotherapy in a subset of the patient population.
The second stage in developing the Company's stent technology will combine
a nitinol stent with a catheter system to deliver thermotherapy. The Company
believes that this ThermaStent (TM) will provide immediate and long-term therapy
in a one-step process. The Company believes that its ability to perform BPH
therapy in this manner could result in an increase in the number of BPH
sufferers who will seek curative surgical procedures.
Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International, Inc.
("Medstone"). Effective January 1, 1996, Endocare became an independent,
publicly-owned corporation upon being spun-out to existing Medstone
shareholders.
PROSTATE CANCER
MARKET BACKGROUND
The incidence of prostate cancer has risen steadily since 1980 to become
the second most common cause of cancer-related deaths among men. The dramatic
increase in prostate cancer cases has led to heightened awareness of the
disease, which has led to increased rates of testing and improved diagnostic
methods.
Therapeutic alternatives for patients with prostate cancer have been both
limited and unattractive. Current treatment options include radical surgery,
radiation therapy, hormone therapy, cryotherapy and "watchful waiting." These
options are evaluated using a number of criteria, including the patient's age,
physical condition and stage of the disease. However, due to the slow
progression of the disease, the decision for treatment typically is based upon
the severity of the condition and the resulting quality of life.
Radical prostatectomy is most often the therapy of choice due to the high
degree of confidence in surgically removing the cancerous tissue, particularly
for patients having more advanced stages of the disease and those who fail to
respond to less invasive alternatives. The procedure is dependent on the skill
of the surgeon and is highly morbid, often associated with high rates of
impotence, incontinence and operative mortality.
Radiation therapy for prostate cancer includes both external radiation beam
and interstitial radioactive seed therapies. External beam radiation therapy
emerged as one of the first alternatives to radical prostatectomy; however,
studies have shown that the success rate of this procedure is not comparable to
that of radical prostatectomy. Interstitial radioactive seed therapy, also
referred to as brachytherapy, is the permanent placement of radioactive seeds in
the prostate. Brachytherapy has been shown to be most effective for localized
tumors caught in the early stage of disease development.
Cryosurgery, freezing tissue to destroy tumor cells, was first developed in
the 1960's. During this period, the use of "cold probes," or cryoprobes, was
explored as a method to kill prostate tissue without having to use radical
surgery. Although effective in killing cancer cells, the lack of control as to
the amount of tissue frozen prevented broad use and development of cryotherapy
for prostate cancer.
In the late 1980's, progress in ultrasound imaging allowed for a revival in
the use of cryosurgery. Using ultrasound, the cryoprobe may be guided to the
targeted tissue from outside the body through a small incision. The physician
activates the cryoprobe and uses ultrasound to monitor the growth of ice in the
prostate as it is occurring. When the ice encompasses the entire prostate, the
probe is turned off. This feedback mechanism of watching the therapy as it is
administered allows the physician precise control during application. Recent
published studies suggest that cryosurgery may be able to deliver disease free
rates comparable to radical surgery, but with the benefit of lower rates of
incontinence and mortality.
CRYOCARE SYSTEM (TM)
Endocare has developed the Cryocare System (TM), a second-generation
cryosurgery system designed to overcome the limitations of existing systems and
to allow the urologist to treat prostate cancer in a minimally invasive manner
in an outpatient setting. The Cryocare System (TM) has been designed to freeze
tissue much faster and with more control than existing systems.
The Company believes the Cryocare System (TM) is significantly more
efficient than current competitive cryosurgical technology in creating the
lethal temperatures in the cryoprobe necessary to kill cancer cells. Current
cryosurgical technology employs a tank of liquid nitrogen, which is at -186
degrees Celcius (C), and pumps it through a tube to the cryoprobe. The challenge
for current liquid nitrogen technology is to not "leak" the cold prior to
delivering it to the tumor site. Liquid nitrogen technology starts out coldest
at the storage tank and can only get warmer and less effective by the time it
reaches the tumor site and attempts to freeze the tissue.
Endocare's Cryocare System (TM) utilizes a system that converts argon gas
to a liquid form at the tip of the probe. The gas itself is at room temperature
until reaching the tip, making it easier to handle and eliminating the need to
store liquid nitrogen. In addition, a temperature of -150 degrees C is achieved
at the tip of the Cryoprobe (TM), considerably colder than the -90 degrees C
achieved using liquid nitrogen systems, which results in substantially faster
tissue freezing rates.
The Cryocare System (TM) incorporates enhanced control mechanisms to
minimize the risk of unintended damage to tissue surrounding the prostate. Most
significantly, the Cryocare probes stop freezing instantly, whereas probes using
liquid nitrogen take up to one minute to stop freezing tissue. Use of four to
six temperature probes selectively placed in the prostate near the rectal
tissue, sphincter muscles (which control continence) and neurovascular bundles
(which control potency) enables the physician to monitor temperatures of tissue
adjacent to the prostate. Combining these control features allows the physician
to treat prostate cancer with a high degree of control and precision that was
not previously possible. The Cryocare System (TM) is approximately one quarter
of the size of currently available nitrogen systems and one tenth of the weight.
The Cryocare System (TM) has been cleared for marketing by the FDA and was
commercially launched in July 1999 following the initiation of national Medicare
coverage for cryosurgical procedures as a primary treatment alternative for
localized prostate cancer. Through direct sales of cryosurgical systems and its
cryosurgical system placement program, the Company has installed Cryocare
Systems (TM) primarily in North America, with over 1,000 patients treated to
date. Endocare's Cryocare System (TM) is the only temperature-monitored,
cryosurgical system specifically cleared by the FDA for the treatment of
prostate cancer.
The Company has received issued patents relating to the technology used to
create the freezing process and to precisely control the shape of the freeze
zone produced by the Cryoprobes (TM) and covering the Company's Cryoprobe (TM)
technology. The technology may also allow for expanded therapeutic applications
by tailoring the Cryoprobe (TM) performance to other anatomical targets, such as
liver cancer and gynecology applications.
BENIGN PROSTATE HYPERPLASIA
MARKET BACKGROUND
BPH, which affects a large number of adult men, is a non-cancerous
enlargement of the innermost part of the prostate. BPH frequently results in a
gradual squeezing of the part of the urethra which runs through the prostate.
This causes patients to experience a frequent urge to urinate because of the
incomplete emptying of the bladder and a burning sensation or similar discomfort
during urination. The obstruction of urinary flow can also lead to a general
lack of control over urination, including difficulty initiating urination when
desired as well as difficulty preventing urinary flow because of the residual
volume of urine in the bladder (a condition known as urinary incontinence). BPH
symptoms may disturb sleep by causing the BPH sufferer to awaken frequently to
urinate. Although symptoms occasionally stabilize or diminish without
intervention, they generally become more severe over the course of the disease.
Left untreated, the obstruction caused by BPH can lead to acute urinary
retention (complete inability to urinate), serious urinary tract infections and
permanent bladder and kidney damage.
Most males will eventually suffer from BPH. The incidence of BPH for men in
their fifties is approximately 50% and rises to approximately 80% by the age of
80. The general aging of the United States population, as well as increasing
life expectancies, is anticipated to contribute to the continued growth in the
number of BPH sufferers.
Patients diagnosed with BPH generally have four options for treatment: (i)
"watchful waiting," (ii) drug therapy; (iii) surgical intervention, including
transurethral resection of the prostate ("TURP") and laser assisted
prostatectomy; and (iv) new, less invasive thermal therapies. Currently the
number of patients who are actually treated by surgical approaches is
approximately 25% of patients with BPH. Treatment is generally reserved for
patients with intolerable symptoms or those with significant potential symptoms
if treatment were withheld. A large number delay discussing their symptoms or
elect "watchful waiting" to see if the condition remains tolerable. The Company
believes the development of less invasive procedures for treatment of BPH could
result in a substantial increase in the number of BPH patients who elect to
receive interventional therapy.
Drug Therapies: Some drugs are designed to shrink the prostate by
inhibiting or slowing the growth of prostate cells. Other drugs are designed to
relax the muscles in the prostate and bladder neck to relieve urethral
obstruction. Current drug therapy generally requires daily administration for
the duration of the patient's life.
Surgical Interventions: The most common surgical procedure, transurethral
resection of the prostate ("TURP"), involves the removal of the prostate's
innermost core in order to reduce pressure on the urethra. TURP is performed by
introducing an electrosurgical cutting loop through a cystoscope into the
urethra and "chipping out" both the prostatic urethra and surrounding prostate
tissue up to the surgical capsule, thereby completely clearing the obstruction.
The average TURP procedure requires a hospital stay of approximately four days.
Less Invasive Thermal Therapies: Other technologies developed or under
development are non-surgical, catheter-based therapies that use thermal energy
to preferentially heat diseased areas of the prostate to a temperature
sufficient to cause cell death. Thermal energy forms being utilized include
microwave, radio frequency ("RF") and ultrasound energy. The procedures are
typically performed in an outpatient setting under local anesthesia. Both
microwave and RF therapy systems are currently being marketed worldwide,
including the United States, where the first FDA clearances were obtained in May
and October 1996, for microwave and RF, respectively.
HORIZON PROSTATIC STENT
Endocare has developed a new urological stent which has been designed to provide
immediate relief for BPH patients who undergo thermotherapy. The Company's
Horizon Prostatic Stent (TM) is made of nitinol, a new titanium metal alloy that
employs a feature called shape memory. This shape memory feature allows the
Horizon Prostatic Stent (TM) to be soft and flexible in its relaxed state,
allowing the device to be introduced in a relatively pain-free manner using a
catheter. When the device is heated to its transition temperature, the device
self-expands to a pre-determined shape. In the case of the Horizon Prostatic
Stent (TM), the predetermined shape is that of a rigid tube, or stent. The
catheter is inserted using a local anesthetic and positioned in the prostatic
urethra under direct vision. The stent is activated by body heat, causing the
shape memory to open to its tube-like position. After approximately 30 days, the
stent is removed by the physician by flushing cool water through an endoscope,
causing the stent to return to its soft, relaxed state. The stent is removed by
retrieving it through the working channel of the endoscope.
Endocare has completed the early stage FDA clinical trials for the Horizon
Prostatic Stent (TM) and has received approval to expand the trial to the
pivotal study, which is the final study before clearance can be obtained for
broader use. Because the stent will be removed from the patients within 30 to
60 days, the Company expects that the trials can be completed quickly and that
the regulatory process may be expedited. However, there can be no assurance that
the FDA will not require more time consuming and extensive clinical studies.
THERMASTENT
Endocare's ThermaStent (TM) is expected to be the second product developed for
the Company's office-based therapy product line. The ThermaStent (TM) is being
designed to combine thermotherapy with the Company's nitinol stent. The
ThermaStent is currently in development and in pre-clinical studies. The
Company secured a patent position on the ThermaStent (TM) device whereby in
April 1996, Endocare licensed from the Brigham and Women's Hospital ("BW") an
issued patent covering urological applications of the delivery of thermal energy
by a stent.
LEVERAGING CORE TECHNOLOGIES
The Company views its cryosurgical technology as a core technology that can
be applied in the treatment of other types of cancers. In 1999, the Company
entered into an alliance with Sanarus Medical, Inc., a women's healthcare
company, to develop market applications in breast cancer, benign breast tumors
and gynecological diseases. The Company is also exploring clinical applications
in cryoablation of kidney and liver tumors.
PRODUCTS
Endocare has developed the following products:
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COMMERCIAL
PRODUCT NAME TARGETED INDICATION STATUS LAUNCH DATE
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Cryocare-4 Probe System General Surgery Marketing May 1996
Cryocare-8 Probe System Prostate Cancer Marketing July 1999
Horizon Prostatic Stent Acute Urinary Retention FDA Trials ------
ThermaStent BPH Pre-Clinical ------
Studies
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PATENTS AND INTELLECTUAL PROPERTY
The Company's policy is to secure and protect intellectual property rights
relating to its technology. While Endocare believes that the protection of
patents and licenses is important to its business, it also relies on trade
secrets, know-how and continuing technological innovation to maintain its
competitive position. The Company has received two issued patents from the U.S.
Patent and Trademark Office covering the Company's Cryoprobe (TM) technology.
The Company entered into worldwide licensing agreements relating to urological
applications of a patent from BW for the ThermaStent (TM) product and a method
patent covering treatment of obstructive portions of urinary passageways from
Beth Israel Deaconess Medical Center ("BI") for the Horizon Prostatic Stent (TM)
product. The BW patent covers the concept of a variety of methods to heat
occluded body passageways by use of a stent. The BI issued patent covers a
method for the treatment of an obstructive portion of a urinary passageway via
the placement of a temperature-activated nitinol stent. The Company has also
received a patent which focuses on the use of a combination therapy of a stent
for short-term relief of the occlusion and thermotherapy for long-term relief
and licensed a patent covering the delivery mechanism of a nitinol stent for
hollow body conduits. Patent applications for some of the new products described
above under "Products" have been filed or are in the process of being filed.
The Company has a patent portfolio consisting of 13 issued patents and patents
under license and 8 patent applications pending issuance from the U.S. Patent
and Trademark Office.
No assurance can be given that Endocare's processes or products will not
infringe patents or proprietary rights of others or that any license required
would be made available under any such patents or proprietary rights, on terms
acceptable to Endocare or at all. From time to time, the Company has received
correspondence alleging infringement of proprietary rights of third parties. No
assurance can be given that any relevant claims of third parties would not be
upheld as valid and enforceable, and therefore the Company could be prevented
from practicing the subject matter claimed or would be required to obtain
licenses from the owners of any such proprietary rights to avoid infringement.
The Company seeks to preserve the confidentiality of its technology by
entering into confidentiality agreements with its employees, consultants,
customers and key vendors and by other means. No assurance can be given,
however, that these measures will prevent the unauthorized disclosure or use of
such technology.
SALES AND MARKETING
The Company derives a majority of its revenues from the sales of Cryocare
Systems (TM), which includes the sales of associated disposable Cryoprobes (TM),
and from the sale of disposable Cryoprobes (TM) to sites where the Company has
placed cryosurgical systems. The Company expects that sales of these products
will continue to constitute the majority of net sales for the foreseeable
future. Accordingly, any factor adversely affecting the sales of Cryocare
Systems (TM) and Cryoprobes (TM) would have a material adverse effect on the
Company's business, financial condition and results of its operations. The
Company also operates a regional mobile cryosurgery business in Florida which
provides cryosurgical equipment for the treatment of prostate and liver cancer
on a procedural basis. In July 1999, HCFA implemented national Medicare
coverage for cryosurgical ablation of the prostate, one of the approved uses of
the Company's eight probe Cryocare System (TM). Although HCFA's decision has
been implemented, reimbursement codes and corresponding rates are in the process
of being established. No assurance can be given that health care professionals
will adopt the technology or that reimbursement will be sufficient enough to
induce the physicians to perform the procedure.
In March 1999, the Company exercised an option to terminate its
distribution agreement with Boston Scientific Corporation ("Boston Scientific")
under which Boston Scientific had exclusive worldwide distribution rights to
market the Cryocare System (TM) for urology except in Canada where it is
distributed under a distribution agreement with Mentor Medical Systems Canada.
As a result of the termination of the Boston Scientific agreement, future sales
of the Cryocare System (TM) and Cryoprobes (TM), will largely be dependent upon
the marketing efforts of the Company and/or new distributorship relationships
which the Company may enter into.
Until March 1999, Endocare's Cryocare System (TM) for urological
applications was distributed worldwide by Boston Scientific (other than in
Canada). For the years ended December 31, 1997, 1998, and 1999, Boston
Scientific accounted for 59%, 41%, and 0%, respectively, of the Company's
consolidated revenues. The Company is evaluating additional international
distribution partners for its Cryocare System (TM) for urological applications
as an alternative to establishing an international sales force to sell the
product. The Company currently sells its products domestically through its
direct sales force which consists of a senior vice president of sales, seven
regional sales managers and three clinical application specialists.
Internationally, products are sold primarily through independent distributors.
Overall, international sales for urological applications were insignificant in
1997 and 1998 and represented approximately 12% of consolidated revenue in 1999.
The Company's distributor agreements typically provide the distributor with
exclusive selling rights to certain products in a particular territory, and are
terminable by either party generally on 60 days notice. Each party bears its own
expenses in performing under the agreement. The Company's ability to distribute
its products depends substantially on the capabilities of its distributors.
There can be no assurance that the Company will be able to maintain or expand
its relationships with its distributors or to replace a distributor in the event
any such relationships were terminated. In the event that the Company's
relationships with any of its distributors were terminated and the Company was
unable to replace the distribution capability, the Company's ability to
distribute its products could be materially adversely affected, which could have
a material adverse effect on the Company's business, financial condition and
results of operations. In addition, in such event, the Company's current sales
and marketing personnel and financial resources might not be sufficient to
enable the Company to establish its own distribution capability to market and
sell its products.
BACKLOG
As of December 31, 1999, the Company maintained minimal backlog. Endocare's
policy is to stock enough inventory to be able to ship most orders within a few
days of receipt of order. Historically, most of the Company's orders have been
for shipment within 30 days of the placement of the order. Therefore, backlog
information as of the end of a particular period is not necessarily indicative
of future levels of the Company's revenue.
MANUFACTURING
The Company uses internal manufacturing capacity in its manufacturing
efforts. Most of the Company's purchased components and processes are available
from more than one vendor. However, certain components and processes are
currently available from or performed by a single vendor. The ability of third
party manufacturing sources to deliver components or finished goods will affect
the Company's ability to commercialize its products, and the Company's
dependence on third party sources may adversely affect the Company's profit
margins. Further, although the Company continuously evaluates alternative
vendors, the qualification of additional or replacement vendors for certain
components or services is a lengthy process. Any supply interruption from a
single source vendor would have a material adverse effect on the Company's
ability to manufacture its products until a new source of supply was qualified
and, as a result, could have a material adverse effect on the Company's
business, financial condition and results of operations.
Additionally, the Company's success will depend in part upon its ability to
manufacture its products in compliance with the FDA's current Good Manufacturing
Practices ("GMP") regulations and other regulatory requirements, in sufficient
quantities and on a timely basis, while maintaining product quality and
acceptable manufacturing costs. Failure to increase production volumes in a
timely or cost effective manner or to maintain compliance with current GMP or
other regulatory requirements could have a material adverse effect on the
Company's business, financial condition and results of operations. Endocare also
has obtained from the California Department of Health Services a license to
manufacture medical devices and is subject to periodic inspections and other
regulation by that agency.
Manufacturers often encounter difficulties in scaling up production of new
products, including problems involving production yields, quality control and
assurance, component supply and shortages of qualified personnel. The Company's
failure to overcome these manufacturing problems could have a material adverse
effect on the Company's business, financial condition and results of operations.
GOVERNMENT REGULATION
Governmental regulation in the United States and other countries is a
significant factor affecting the research and development, manufacture and
marketing of the Company's products. In the United States, the FDA has broad
authority under the Federal Food, Drug and Cosmetic Act and the Public Health
Service Act to regulate the distribution, manufacture and sale of medical
devices. Foreign sales of medical devices are subject to foreign governmental
regulation and restrictions which vary from country to country.
Medical devices intended for human use in the United States are classified into
one of three categories, depending upon the degree of regulatory control to
which they will be subject. Such devices are classified by regulation into
either class I (general controls), class II (performance standards) or class III
(pre-market approval) depending upon the level of regulatory control required to
provide reasonable assurance of the safety and effectiveness of the device. Good
Manufacturing Practices, labeling, maintenance of records and filings with the
FDA also apply to medical devices.
A subset of medical devices categorized as class I or II devices that were
commercially distributed before March 28, 1976 or are substantially equivalent
to a device that was in commercial distribution before that date may be marketed
after the acceptance of the pre-market notification under a 510(k) exemption.
Section 510(k) of the Federal Food, Drug and Cosmetic Act allows an exemption
from the requirement of pre-market notification. Generally, devices that have an
existing history or track record are included in this category.
The process of obtaining FDA and other required regulatory clearances or
approvals is lengthy and expensive. There can be no assurance that Endocare will
be able to obtain necessary clearances or approvals for clinical testing or for
manufacturing or marketing of its products. Failure to comply with applicable
regulatory approvals can, among other things, result in warning letters, fines,
suspensions of regulatory approvals, product recalls, operating restrictions and
criminal prosecution. In addition, governmental regulation may be established
which could prevent, delay, modify or rescind regulatory clearance or approval
of Endocare's products.
Regulatory clearances or approvals, if granted, may include significant
limitations on the indicated uses for which the Company's products may be
marketed. In addition, to obtain such clearances or approvals, the FDA and
foreign regulatory authorities may impose numerous other requirements on the
Company. FDA enforcement policy strictly prohibits the marketing of approved
medical devices for unapproved uses. In addition, product approvals can be
withdrawn for failure to comply with regulatory standards or the occurrence of
unforeseen problems following initial marketing. There can be no assurance that
the Company will be able to obtain regulatory clearances or approvals for its
products on a timely basis or at all, and delays in receipt of or failure to
receive such approvals, the loss of previously obtained approvals, or failure to
comply with existing or future regulatory requirements would have a material
adverse effect on the Company's business, financial condition and results of
operations.
Endocare's Cryocare System (TM) has received FDA clearance for sale in the
United States for approved urological and general surgery, gynecology and
oncology uses. Endocare's manufacturing facility was subject to an FDA audit in
September 1999, and the Company received no notice that it did not comply with
the FDA's current GMP regulations. In addition, Endocare has obtained from the
California Department of Health Services a license to manufacture medical
devices, subject to periodic inspections and other regulation by that agency.
COMPETITION
Currently, the Company markets cryosurgical systems and other urological
products. Significant competitors in the area of prostate cancer therapies
include Cryomedical Sciences, Inc., Galil Medical, Ltd., Theragenics Corporation
and North American Scientific, Inc. Significant competitors in the area of BPH
therapies include Urologix, Inc., VidaMed, Inc., EDAP/TMS, S.A., C.R. Bard, Inc.
and ACMI/Circon Corporation.
Many of the Company's competitors are significantly larger than the Company
and have greater financial, technical, research, marketing, sales, distribution
and other resources than the Company. Additionally, the Company believes there
will be intense price competition for products developed in the Company's
market. There can be no assurance that the Company's competitors will not
succeed in developing or marketing technologies and products that are more
effective or commercially attractive than any that are being developed or
marketed by the Company, or that such competitors will not succeed in obtaining
regulatory approval, introducing or commercializing any such products prior to
the Company. Such developments could have a material adverse effect on the
Company's business, financial condition and results of operations. Further,
there can be no assurance that, even if the Company is able to compete
successfully, that it would do so in a profitable manner.
EMPLOYEES
As of December 31, 1999, Endocare had a total of 56 employees. Of the 56
employees, 8 are engaged directly in research and development activities, 5 in
regulatory affairs/quality assurance, 14 in manufacturing, 20 in sales and
marketing, and 9 in general and administrative positions. The Company expects to
increase employment in conjunction with the commercial launch of the Cryocare
System (TM)and expanded research, development and clinical activities related to
the Horizon Prostatic Stent (TM) and ThermaStent (TM) programs. The Company has
never experienced a work stoppage, none of its employees are represented by a
labor organization, and the Company considers its employee relations to be good.
Although Endocare conducts most of its research and development using its
own employees, the Company occasionally has funded and plans to continue to fund
research using consultants. Consultants provide services under written
agreements and are paid based on the amount of time spent on Company matters.
Under their consulting agreements, such consultants are required to disclose and
assign to the Company any ideas, discoveries and inventions developed by them in
the course of providing consulting services.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND TRADING PRICE OF COMMON STOCK
This report for the year ended December 31, 1999 contains forward-looking
statements that involve risks and uncertainties including those discussed below
and in the Management's Discussion and Analysis of Financial Condition and
Results of Operations section and Notes to Consolidated Financial Statements.
The actual results that the Company achieves may differ materially from any
forward-looking statements due to such risks and uncertainties. All such
factors should be considered by investors in the Company.
WE HAVE A LIMITED OPERATING HISTORY AND A HISTORY OF LOSSES
We have a limited history of operations as an independent entity. Since
our inception, we have engaged primarily in research and development and have
minimal experience in manufacturing, marketing and selling our products in
commercial quantities. We have incurred annual operating losses since
inception, and expect to continue to incur operating losses because new products
will require substantial development, clinical, regulatory, manufacturing,
marketing and other expenditures. For the fiscal years ended December 31,
1997, 1998 and 1999, we had net losses of approximately $4.0 million, $4.9
million and $9.3 million, respectively. As of December 31, 1999, our
accumulated deficit was approximately $19.8 million. We may not be able to
successfully develop or commercialize our current or future products, achieve
significant revenues from sales or procedures, or achieve or sustain
profitability. Successful completion of our development program and its
transition to attaining profitable operations is dependent upon achieving a
level of revenues adequate to support our cost structure and obtaining
additional financing adequate to fulfill our research and development activities
to continue refining our existing products and developing and commercializing
new products.
<PAGE>
OUR NEW PRODUCTS MAY NOT BE ACCEPTED IN THE MARKET AND INSURANCE REIMBURSEMENT
MAY NOT BE SUFFICIENT
Certain of our products, including our Cryocare Systems (TM), are in the
early stages of development or market introduction. Our products may not be
accepted by potential customers. Our ability to successfully market our
Cryocare System (TM) is dependent upon acceptance of cryosurgical procedures in
the United States and certain international markets. Cryosurgery has existed
for many years, but has not been widely accepted due to cost, competing products
and limited reimbursement by third party payers. Effective July 1, 1999, the
Health Care Financing Administration implemented approved uses of our eight
probe Cryocare System (TM), however, reimbursement rates are in the process of
being established. Certain private health insurance companies pay for
procedures in which our products are used in certain areas of the United States,
but private insurance reimbursement may not be adopted nationally or by
additional insurers. Reimbursement from Medicare or private insurers may not be
sufficient to induce physicians to perform, and patients to elect, our
procedure. The acceptance of cryosurgery by the general population may be
negatively affected by its price, concerns relating to its safety and efficacy,
the accepted effectiveness of alternative methods of correcting urological
disorders, and the level of reimbursement from private insurers. Any future
reported adverse events or other unfavorable publicity involving patient
outcomes from the use of cryosurgery, whether from our products or the products
of our competitors, could also adversely affect acceptance and reimbursement for
cryosurgery. Emerging new technologies and procedures to treat cancer, prostate
enlargement and other prostate disorders also may negatively affect the market
acceptance of cryosurgery. Our Cryocare Systems (TM) may not gain any
significant degree of market acceptance among physicians, patients and health
care payers.
THE DEVELOPMENT OF OUR PRODUCTS IS UNCERTAIN
Our growth depends in large part on continued ability to successfully
develop, commercialize and market new products. Several of our products are in
varying stages of development. We may not be successful in developing and
commercializing new products that achieve market acceptance. We may experience
difficulties that could delay or prevent the successful development,
introduction and marketing of new products. Our products in development may not
prove safe and effective in clinical trials under regulatory guidelines.
Clinical trials may identify significant technical or other obstacles that must
be overcome prior to obtaining necessary regulatory or reimbursement approvals.
Even if our products overcome these obstacles, they will not be used unless they
present an attractive alternative to other treatments and the clinical benefits
to the patient and cost savings achieved through their use outweigh the cost of
the products. We believe that recommendations and endorsements of physicians
and patients and sufficient reimbursement by health care payers will be
essential for market acceptance of our products, and recommendations,
endorsements or sufficient reimbursement may not be obtained. Our failure to
successfully develop, commercialize and market new products or to achieve
significant market acceptance would have a significant negative effect on our
financial condition.
WE HAVE LIMITED SALES AND MARKETING EXPERIENCE
We have limited experience marketing and selling our products, and do not
have experience marketing and selling our products in commercial quantities. In
March 1999, we exercised our right to terminate our exclusive worldwide
distribution agreement with Boston Scientific pursuant to which Boston
Scientific had agreed to market and distribute our Cryocare Systems (TM) for
urology worldwide, except Canada. As a result, future sales of the Cryocare
System (TM) and Cryoprobes (TM), will be dependent on our marketing efforts. We
derive a majority of our revenues from the sales of Cryocare Systems (TM), which
includes the sales of associated disposable Cryoprobes (TM), and expect that
sales of Cryocare Systems (TM) and Cryprobes (TM) will continue to constitute
the majority of sales for the foreseeable future. Any factor negatively
impacting the sales or usage of Cryocare Systems (TM) and Cryoprobes (TM) would
have a significant effect on our business.
We believe that to become and remain competitive, we will need to continue
to develop third party international distribution channels and a direct sales
force for our products. Establishing marketing and sales capabilities
sufficient to support sales in commercial quantities will require significant
resources. We may not be able to recruit and retain direct sales personnel,
succeed in establishing and maintaining any third party distribution channels,
or succeed in our future sales and marketing efforts.
WE WILL NEED ADDITIONAL LONG TERM FINANCING
We believe that our existing cash resources and anticipated cash flow from
future operations and our exercise of the put options discussed below, will
provide sufficient resources to meet present and reasonably foreseeable working
capital requirements and other cash needs for the next twelve months. In June
1999 and July 1999, we received $5,000,000 and $3,000,000, respectively, from
the sale of 7% convertible debentures due three years from their respective sale
dates. Under the corresponding financing arrangements, the purchasers of the
convertible debentures have options to purchase additional debentures for the
aggregate principal amounts of $5,000,000 and $3,000,000 and, under certain
circumstances, we may require the purchasers to exercise these purchase options.
We entered into a line of credit in July 1999, which provides for a non-formula
revolving line of credit of $2,000,000 and up to an additional $1,000,000 based
on our eligible accounts receivable. The line of credit expires and all amounts
thereunder must be repaid in July 2001. If we undertake or accelerate
significant research and development projects for new products or pursue
corporate acquisitions, it may require additional outside financing. We expect
that to meet our long-term needs we will need to raise substantial additional
funds through the sale of our equity securities, the incurrence of additional
debt or through collaborative arrangements. Any additional equity financing may
be dilutive to shareholders, and debt financing, if available, may involve
restrictive covenants. Collaborative arrangements, if necessary to raise
additional funds, may require us to relinquish rights to certain of our
technologies, products or marketing territories. Our failure to raise capital
when needed could have a significant negative effect on our financial condition.
WE ARE FACED WITH INTENSE COMPETITION AND RAPID TECHNOLOGICAL AND INDUSTRY
CHANGE
There is intense competition in our field of surgical device manufacturers.
Many of our competitors are significantly larger than us and have greater
financial, technical, research, marketing, sales, distribution and other
resources than us. We believe there will be intense price competition for
products developed in our markets. Our competitors may develop or market
technologies and products, including drug-based treatments, that are more
effective or commercially attractive than any that we are developing or
marketing. Our competitors may succeed in obtaining regulatory approval, and
introducing or commercializing products before we do. Such developments could
have a significant negative effect on our financial condition. Even if we are
able to compete successfully, we may not be able to do so in a profitable
manner. The medical device industry generally, and the urological disease
treatment market in particular, are characterized by rapid technological change,
changing customer needs, and frequent new product introductions. Our future
success will depend upon our ability to develop and introduce new cost-effective
products in a timely manner. Our products may be rendered obsolete as a result
of future innovations.
WE HAVE LIMITED MANUFACTURING EXPERIENCE
We have limited experience in producing our products in commercial
quantities. Manufacturers often encounter difficulties in scaling up production
of new products, including problems involving production yields, quality control
and assurance, component supply and shortages of qualified personnel. Our
failure to overcome these manufacturing problems could negatively impact our
business and financial condition. We use internal manufacturing capacity in our
manufacturing efforts. Most of our purchased components and processes are
available from more than one vendor. However, certain components and processes
are currently available from or performed by a single vendor. Any supply
interruption from a single source vendor would have a significant negative
effect on our ability to manufacture our products until a new source of supply
is qualified and, as a result, could have a significant negative effect on our
business and financial condition. Further, the ability of third party
manufacturing sources to deliver components will affect our ability to
commercialize our products, and our dependence on third party sources may have a
negative effect on our profit margins. Our success will depend in part upon our
ability to manufacture our products in compliance with the FDA's Good
Manufacturing Practices regulations and other regulatory requirements in
sufficient quantities and on a timely basis, while maintaining product quality
and acceptable manufacturing costs. Failure to increase production volumes in a
timely or cost-effective manner or to maintain compliance with the FDA's Good
Manufacturing Practices or other regulatory requirements could have a
significant negative effect on our financial condition.
WE ARE DEPENDENT ON KEY PERSONNEL
Our future success depends to a significant degree upon the continued
service of key technical and senior management personnel, including Paul W.
Mikus, the President of Endocare, none of whom are bound by an employment
agreement or covered by an insurance policy of which we are the beneficiary.
Our future success also depends on our continuing ability to attract, retain and
motivate highly qualified technical, managerial and sales personnel. The
inability to retain or attract qualified personnel could have a significant
negative effect upon our financial condition.
GOVERNMENT REGULATION CAN HAVE A SIGNIFICANT IMPACT ON OUR BUSINESS
Government regulation in the United States and other countries is a
significant factor affecting the research and development, manufacture and
marketing of our products. In the United States, the FDA has broad authority
under the Federal Food, Drug and Cosmetic Act and the Public Health Service Act
to regulate the distribution, manufacture and sale of medical devices. Foreign
sales of drugs and medical devices are subject to foreign governmental
regulation and restrictions which vary from country to country. The process of
obtaining FDA and other required regulatory approvals is lengthy and expensive.
We may not be able to obtain necessary approvals for clinical testing or for the
manufacturing or marketing of our products. Failure to comply with applicable
regulatory approvals can, among other things, result in fines, suspension of
regulatory approvals, product recalls, operating restrictions, and criminal
prosecution. In addition, governmental regulations may be established which
could prevent, delay, modify or rescind regulatory approval of our products.
Any such position by the FDA, or change of position by the FDA, may adversely
impact our business and financial condition. Regulatory approvals, if granted,
may include significant limitations on the indicated uses for which our products
may be marketed. In addition, to obtain such approvals, the FDA and foreign
regulatory authorities may impose numerous other requirements on us. FDA
enforcement policy strictly prohibits the marketing of approved medical devices
for unapproved uses. In addition, product approvals can be withdrawn for
failure to comply with regulatory standards or the occurrence of unforeseen
problems following initial marketing. We may not be able to obtain regulatory
approvals for our products on a timely basis, or at all, and delays in receipt
of or failure to receive such approvals, the loss of previously obtained
approvals, or failure to comply with existing or future regulatory requirements
would have a significant negative effect on our financial condition.
THERE IS UNCERTAINTY RELATING TO THIRD PARTY REIMBURSEMENT WHICH IS CRITICAL TO
MARKET ACCEPTANCE OF OUR PRODUCTS
In the United States, health care providers, such as hospitals and
physicians, that purchase our products generally rely on third party payers,
principally Federal Medicare, state Medicaid and private health insurance plans,
to reimburse all or part of the cost of medical procedures involving our
products. Effective July 1, 1999, the Health Care Financing Administration
implemented national Medicare coverage for cryosurgical ablation of the
prostate, one of the approved uses of our eight probe Cryocare System (TM),
however, reimbursement rates are in the process of being established. Certain
private health insurance companies pay for the procedures in which our products
are used in certain areas of the United States, but private insurance
reimbursement may not be adopted nationally or by additional insurers. We
anticipate that under the prospective payment system used by private health care
payers, the cost of our products will be incorporated into the overall cost of
the procedure and that there will be no separate, additional reimbursement for
our products. Separate reimbursement for our products is not expected to be
available in the United States although reimbursement for our products may be
available in international markets under either governmental or private
reimbursement systems. This may discourage the use of our products.
Furthermore, we could be negatively affected by changes in reimbursement
policies of government or private health care payers, particularly to the extent
any such changes affect reimbursement for procedures in which our products are
used. Failure by physicians, hospitals and other users of our products to
obtain sufficient reimbursement from health care payers for procedures involving
our policies toward reimbursement for such procedures, could have a significant
negative effect on our financial condition.
OUR BUSINESS IS EXPOSED TO RISKS RELATED TO ACQUISITIONS / MERGERS
As part of our strategy to develop and market our products, we may acquire
a business or businesses that we believe might enhance and speed up the
development of our products through clinical trials, such as a surgical center
or related company that would use our products in clinical applications. In
June 1999, we merged with Advanced Medical Procedures, LLC, a regional mobile
cryosurgery service company that trains surgeons and others in the use of our
products and supplies our products to them. We may not be able to effectively
integrate our business with Advanced Medical Procedures or any other business we
may acquire or merge with, or effectively utilize the business acquired to
develop and market our products. The failure to integrate an acquired company
into our operations may cause a drain on our financial and managerial resources,
and thereby have a significant negative effect on our business and financial
results.
WE MAY BE NEGATIVELY IMPACTED BY PRODUCT LIABILITY AND PRODUCT RECALL
The manufacture and sale of medical products entails significant risk of
product liability claims or product recalls. Our existing insurance coverage
limits may not be adequate to protect us from any liabilities we might incur in
connection with the clinical trials or sales of our products. We may require
increased product liability coverage as our products are commercialized.
Insurance is expensive and may not be available on acceptable terms, if at all.
A successful product liability claim or series of claims brought against us in
excess of our insurance coverage, or a recall of our products, could have a
significant negative effect on our business and financial condition.
WE ARE EXPOSED TO RISKS RELATED TO HEALTH CARE REFORM
Political, economic and regulatory influences are subjecting the health
care industry in the United States to fundamental change. We anticipate the
Congress, state legislatures and the private sector will continue to review and
assess alternative health care delivery and payment systems. Potential
approaches that have been considered include mandated basic health care
benefits, controls on health care spending through limitations on the growth of
private purchasing groups, price controls, and other fundamental changes to the
health care delivery system. Legislative debate is expected to continue in the
future, and market forces are expected to demand reduced costs. We cannot
predict what impact the adoption of any Federal or state health care reform
measures, future private sector reform or market forces may have on our
business.
WE ARE DEPENDENT ON ADEQUATE PROTECTION OF OUR PATENT AND PROPRIETARY RIGHTS
Our success will depend in part on our ability to secure and protect
intellectual property rights relating to our technology. While we believe that
the protection of patents or licenses is important to our business, we also rely
on trade secrets, know-how and continuing technological innovation to maintain
our competitive position. We face the following risks: our patent applications
may not be approved, we may not be able to develop any additional proprietary
products that are patentable, issued patents may not provide us with a
competitive edge or may be challenged by third parties, and/or our processes or
products may infringe patents or proprietary rights of others, and we may not be
able to obtain licenses to use such patents or proprietary rights, on terms
acceptable to us or at all. From time to time, we have received correspondence
alleging infringement of proprietary rights of third parties. Certain claims of
third parties may be upheld as valid and enforceable, and therefore we may be
prevented from practicing the subject matter claimed or would be required to
obtain licenses from the owners of any such proprietary rights to avoid
infringement. We try to preserve the confidentiality of our technology by
entering into confidentiality agreements with our employees, consultants,
customers, and key vendors and by other means. These measures may not, however,
prevent the unauthorized disclosure or use of such technology.
OUR COMMON STOCK HAS A LIMITED MARKET AND TRADING HISTORY
Our common stock began trading on the Nasdaq Small Cap Market on February
28, 1997 and has a limited trading history. From February 20, 1996 to February
28, 1997, trading was conducted in the over-the-counter market on the Nasdaq
Electronic Bulletin Board. If we are unable to maintain the standards for
quotation on the Nasdaq Small Cap Market, the ability of our investors to resell
their shares may be limited. In addition, our securities may be subjected to
"penny stock" rules that impose additional sales practice and market making
requirements on broker-dealers who sell or make a market in such securities.
This could affect the ability or willingness of broker-dealers to sell or make a
market in our securities and the ability of holders of our securities to sell
their securities in the secondary market. The market prices for securities of
emerging companies have historically been highly volatile. The following future
announcements concerning us or our competitors may have a significant impact on
the market price of our common stock: our operating results, technological
innovations or new commercial products, corporate collaborations, government
regulations, developments concerning proprietary rights, litigation or public
concern as to safety of our products, investor perception of us and our
industry, and general economic and market conditions. In addition, the stock
market is subject to price and volume fluctuations that affect the market prices
for companies in general and small-capitalization, high-technology companies in
particular, which are often unrelated to their operating performance.
FUTURE SALES OF OUR COMMON STOCK MAY HAVE DILUTIVE EFFECTS
Future sales of our common stock (including shares issued upon the exercise
of outstanding options and warrants and the conversion of convertible
debentures) could have a significant negative effect on the market price of our
common stock. Such sales also might make it more difficult for us to sell
equity securities or equity-related securities in the future at a time and price
that we would deem appropriate. As of February 29, 2000, we had 11,297,531
shares of common stock outstanding, substantially all of which may be freely
traded (unless held by an affiliate of ours). In addition, as of February 29,
2000, 1,253,814 shares could be issued upon the conversion of the principal
amount and payment of a portion of the interest on convertible debentures,
warrants to purchase 482,753 shares of common stock were outstanding, and stock
options to purchase 3,140,226 shares of common stock were outstanding under our
stock option plans, subject to various vesting schedules. Stock options to
purchase an additional 308,533 shares of common stock may be issued by us from
time to time under such option plans and up to 250,000 shares of common stock
may be purchased under our Employee Stock Purchase Plan. In addition, under our
1995 Stock Option Plan, there is an automatic annual increase in the number of
shares reserved for issuance under the plan of 3% of the total number of shares
outstanding on the last trading day of the immediately preceding calendar year,
up to a maximum increase of 500,000 shares per year. Additionally, 300,000
shares of common stock may be issued under our 1995 Director Option Plan.
Exercise of options or warrants to purchase our common stock and the issuance of
common stock upon the conversion of convertible debentures may result in
substantial dilution to investors.
ANTI-TAKEOVER PROVISION IN OUR CHARTER MAY HAVE A POSSIBLE NEGATIVE EFFECT ON
OUR STOCK PRICE
Certain provisions of our 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 us. In March
1999, our board of directors adopted a stockholder rights plan in which
preferred stock purchase rights were distributed as a dividend. The rights are
designed to guard against partial tender offers and other abusive and coercive
tactics that may be used in an attempt to gain control of us. Such provisions
could limit the price that certain investors might be willing to pay in the
future for shares of our common stock. These provisions may make it more
difficult for stockholders to take certain corporate actions and may have the
effect of delaying or preventing a change in control.
WE FACE "YEAR 2000" RISKS
The Year 2000 problem refers to the potential for information systems to be
unable to correctly recognize and process calendar dates and date-sensitive
information involving dates on or after January 1, 2000. We did not experience
any material Year 2000 problems as the date changed and through the date of this
report. We attribute this to our Year 2000 readiness efforts. As of December
31, 1999, systems remediation and integration testing and development of our
contingency plans had been completed. Supplier management is an ongoing
process, and no material impact has been felt from lack of supplier readiness.
Although we did not experience any material problems related to the Year 2000
issue, there can be no assurances that problems relating to the Year 2000 issue
will not manifest themselves in the future. Historical amounts spent on the
Year 2000 project have not been material to the results of operations. In
addition, we do not believe that we will incur material costs in the future
because of date related problems.
ITEM 2 PROPERTIES
The Company currently occupies approximately 16,000 square feet of office,
manufacturing, engineering, warehouse, and research and development space in
Irvine, California. The property is leased through February 2002. The Company
had subleased its previously occupied facility and the original lease and
sublease expired in August 1998.
ITEM 3. LEGAL PROCEEDINGS
The Company, in the normal course of business, is subject to various legal
matters. While the results of litigation and claims cannot be predicted with
certainty, the Company believes that the final outcome of these matters will not
have a material adverse effect on the Company's results of operations or
financial condition.
From time to time, the Company has received correspondence alleging infringement
of proprietary rights of third parties. No assurance can be given that any
relevant claims of third parties would not be upheld as valid and enforceable,
and therefore the Company could be prevented from practicing the subject matter
claimed or would be required to obtain licenses from the owners of any such
proprietary rights to avoid infringement. Management does not expect any
material adverse effect on financial condition or the results of operations
because of such actions.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders of the Company
during the fourth quarter of 1999, as required to be disclosed in this item.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
Endocare's common stock began trading on the Nasdaq SmallCap Market on
February 28, 1997. Between February 20, 1996 and February 27, 1997, trading was
conducted in the over-the-counter market on the Nasdaq Electronic Bulletin Board
under the symbol "ENDO." The following table sets forth the high and low bid
prices for Endocare's common stock during the periods indicated as quoted on the
Nasdaq SmallCap Market or Nasdaq Electronic Bulletin Board:
<TABLE>
<CAPTION>
FISCAL YEAR ENDED DECEMBER 31,
-------------------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
HIGH LOW HIGH LOW HIGH LOW
------ ----- ----- ----- ----- -----
Fourth quarter. $6.63 $3.50 $3.25 $1.63 $9.12 $5.12
Third quarter . 3.88 3.69 $3.63 $1.81 $8.19 $4.62
Second quarter 3.88 3.69 $4.13 $2.75 $6.00 $2.87
First quarter . 4.63 3.94 $3.94 $2.75 $6.87 $1.94
</TABLE>
Endocare's common stock first traded publicly on February 20, 1996, at a
price of $0.375 per share. As of February 29, 2000, the closing price of the
Company's common stock was $18.063. Also, as of that date, Endocare had
approximately 329 stockholders of record. On February 29, 2000 there were
11,297,531 shares of Endocare common stock issued and outstanding.
In March 1999, the Company's Board of Directors adopted a Stockholder Rights
Plan ("Plan") in which preferred stock purchase rights ("Rights") were
distributed as a dividend at the rate of one Right for each share of Common
Stock held as of the close of business on April 15, 1999. The Rights are
designed to guard against partial tender offers and other coercive tactics that
might be used in an attempt to gain control of the Company or to deprive
stockholders of their interest in the long-term value of the Company. The
Rights will be exercisable only if a person or group acquires 15% or more of the
Company's Common Stock (subject to certain exceptions stated in the Plan) or
announces a tender offer, the consummation of which would result in ownership by
a person or a group of 15% or more of the Company's Common Stock. Each Right
will entitle stockholders to buy one one-thousandth of a share of a new series
of junior participating preferred stock at an exercise price of $25 upon certain
events. If a person or group acquires 15% or more of the Company's outstanding
Common Stock (subject to certain exceptions stated in the Plan), or a holder of
15% or more of the Company's Common Stock engages in certain self-dealing
transactions or a merger transaction in which the Company is the surviving
corporation and its Common Stock remains outstanding, then each Right not owned
by such person or group or certain related parties will entitle its holder to
purchase, at the Right's then-current exercise price, units of the Company's
Series A Preferred Stock (or, in certain circumstances, Company Common Stock,
cash, property or other securities of the Company) having a market value equal
to twice the then-current exercise price. In addition, if, after the Rights
become exercisable, Endocare is acquired in a merger or other business
combination transaction, or sells 50% or more of its assets or earnings power,
each Right will entitle its holder to purchase, at the Right's then-current
price, a number of the acquiring company's common shares having a market value
at the time of twice the Right's exercise price. At any time on or prior to the
close of business on the first date of a public announcement that a person or
group has acquired beneficial ownership of 15% or more of the Company's Common
Stock (subject to certain exceptions stated in the Plan), the Rights are
redeemable for one cent per Right at the option of the Board of Directors. The
Rights are intended to enable all stockholders to realize the long-term value of
their investment in the Company. The Rights will not prevent a takeover
attempt, but should encourage anyone seeking to acquire the Company to negotiate
with the Board prior to attempting to a takeover. The dividend distribution was
made on April 15, 1999 to the stockholders of record on that date. The Rights
will expire on April 15, 2009.
Endocare has not paid any cash dividends on its common stock and does not
intend to pay any cash dividends in the foreseeable future.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data of Endocare for the
years ended December 31, 1996, 1997, 1998 and 1999 and for its predecessor,
Endocare Division of Medstone, for the year ended December 31, 1995. Prior to
1996, Endocare was not an independent company with publicly traded shares.
Hence, no earnings per share data is presented for 1995.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1996 1997 1998 1999
------ ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues:
Net product sales . . . . . . . . . . . $ 951 $ 1,878 $ 1,918 $ 1,363 $ 2,329
Mobile cryosurgical procedures. . . . . -- 148 347 490 1,133
Revenue from collaborative agreements . -- 250 83 642 --
Research revenue from related party . . 377 1 -- -- --
-------- ---------- ----------- ----------- ----------
Total revenues. . . . . . . . . . . . . 1,328 2,277 2,348 2,495 3,462
-------- ---------- ----------- ----------- ----------
Costs and expenses:
Cost of product sales . . . . . . . . . 380 994 1,271 974 1,255
Cost of mobile cryosurgical procedures. -- 59 151 209 429
Research and development. . . . . . . . 852 1,023 1,596 1,920 2,574
Selling, general and administrative . . 673 1,410 3,553 4,653 7,992
Impairment loss on long-lived assets. . -- 325 -- -- --
-------- ---------- ----------- ---------- -----------
Total costs and expenses. . . . . . 1,905 3,811 6,571 7,756 12,250
-------- ---------- ----------- ----------- ----------
Loss from operations. . . . . . . . . . (577) (1,534) (4,223) (5,261) (8,788)
Interest income (expense), net. . . . . -- (29) 201 336 (476)
--------- ---------- ----------- ----------- ----------
Net loss. . . . . . . . . . . . . . . . $ (577) $ (1,563) $ (4,022) $ (4,925) $ (9,264)
========= ========== =========== ============ ==========
Net loss per share. . . . . . . . . . . $ (.27) $ (.48) $ (.49) $ (.86)
========= ========== =========== ============ ==========
Weighted average shares outstanding . . 5,895,000 8,307,000 10,062,000 10,838,000
========= ========== =========== ============ ==========
</TABLE>
<TABLE>
<CAPTION>
BALANCES AT DECEMBER 31,
------------------------
1995 1996 1997 1998 1999
------- ------- -------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
- ------------------
Working capital . . . . . . . $ 328 $ 595 $3,718 $5,544 $ 6,445
Total assets. . . . . . . . . 806 1,952 5,691 7,992 12,996
Long-term debt. . . . . . . . -- 771 44 201 10,153
Total shareholders'/division
equity (deficiency) . . . . . 803 (17) 3,960 6,011 (480)
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
Endocare, Inc. ("Endocare" or the "Company") develops, manufactures and
markets an array of innovative, temperature-based minimally invasive surgical
devices and technologies to treat prostate disease. The Company has focused its
efforts on the continued clinical development of surgical devices for the
treatment of the two most common diseases of the prostate, Prostate Cancer and
Benign Prostate Hyperplasia ("BPH"). Prostate cancer affects one in six men
over the age of fifty, while BPH affects one in two men over the age of fifty.
Endocare has developed and recently introduced an innovative, second generation
cryosurgical system for the treatment of prostate cancer. The Cryocare System
(TM) offers the advantage of controlled, targeted freezing of the tumor with the
benefit of faster patient recovery and minimal complications. The system was
launched in July 1999 following the initiation of national Medicare coverage for
cryosurgical procedures as a primary treatment alternative for localized
prostate cancer.
The Company derives revenues primarily from the sale of its Cryocare
Systems (TM), related disposable Cryoprobes (TM) and revenue from mobile
cryosurgical procedures. Revenue is recognized upon the shipment of products,
or in the case of mobile cryosurgical procedures, upon the completion of
procedures. Under the Company's cryosurgical system placement program, a system
is placed at a customer site for use with the Company's disposable Cryoprobes
(TM). The cost of the system is depreciated into product cost of sales over an
estimated useful life of three years.
The Company has incurred losses since its inception. As of December 31, 1999,
the Company has an accumulated deficit of $19.8 million. These losses and
accumulated deficit have resulted from significant costs incurred in the
development of the cryosurgery and stent technology platforms, clinical studies
and establishing the Company's infrastructure to launch its products. The
Company intends to continue to invest heavily in research, development, clinical
studies, sales and marketing, and general administrative infrastructure. As a
result, the Company does not expect to be profitable in the near future.
Although the Company has experienced revenue growth in recent periods, operating
results for future periods are subject to numerous uncertainties. In view of the
rapidly evolving nature of the business and the Company's limited operating
history, period-to-period comparisons of operating results are not necessarily
meaningful and should not be relied upon as an indication of future performance.
There can be no assurance that the Company will be able to achieve or sustain
profitability.
On June 30, 1999, the Company acquired all the outstanding units of Advanced
Medical Procedures, LLC, a Florida limited liability company ("AMP"). AMP
operates a mobile cryosurgery business which provides cryosurgical equipment for
the treatment of prostate and liver cancer on a per procedure basis. The merger
was accounted for as a pooling-of-interests for financial reporting purposes.
The historical financial statements for the periods prior to the merger are
restated as though the companies had been combined. The AMP unitholders
received an aggregate of 260,000 shares of the Company's common stock in
exchange for all of their AMP units.
Since its formation in 1990, Endocare operated first as a research and
development department, then later as a division of Medstone International, Inc.
In this form, Endocare shared facilities and certain personnel with its parent.
Effective January 1, 1996, Endocare began operating as an independent
corporation.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain financial
data as a percentage of total revenues.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1997 1998 1999
------ ------ ------
<S> <C> <C> <C>
Revenues:
Net product sales. . . . . . . . . . . 82% 55% 67%
Mobile cryosurgical procedures . . . . 15 20 33
Revenue from collaborative agreements. 3 25 --
------ ------ ------
Total revenues . . . . . . . . . . . . 100% 100% 100%
------ ------ ------
Costs and expenses:
Cost of product sales. . . . . . . . . 54% 39% 36%
Cost of mobile cryosurgical procedures 7 8 13
Research and development . . . . . . . 68 77 74
Selling, general and administrative. . 151 187 231
Total costs and expenses . . . . . . . 280 311 354
------ ------ ------
Loss from operations . . . . . . . . . (180) (211) (254)
Interest income (expense), net . . . . 9 14 (14)
------ ------ ------
Net loss . . . . . . . . . . . . . . . (171)% (197)% (268)%
====== ====== ======
</TABLE>
Year Ended December 31, 1999 Compared to Year Ended December 31, 1998
Product revenue for the year ended December 31, 1999 increased 71% to
$2,329,000 compared to $1,363,000 in 1998. The increase was attributable to
the third quarter 1999 launch of the Company's cryosurgical technology in
conjunction with Medicare's July 1, 1999 implementation of national coverage for
this treatment protocol for localized prostate cancer.
Revenue from mobile cryosurgical procedures for the year ended December 31,
1999 increased 131% to $1,133,000 compared to $490,000 in 1998. The increase
corresponds to a greater number of procedures performed in 1999 as a result of
increased sales and marketing efforts.
Revenue from collaborative agreements for the year ended December 31, 1999
was zero compared to $642,000 in 1998. The 1998 amount represented a licensing
fee and the respective quarters' amortization of a lump-sum payment from Boston
Scientific Corporation ("Boston Scientific") based upon a previous distribution
agreement entered into in November 1996. The distribution agreement with Boston
Scientific was terminated by Endocare in March 1999.
Gross margins on product sales were 46% for the year ended December 31,
1999 compared to 29% in 1998. The increase is due to a mix of higher margin
cryosurgical probe and system sales in 1999 coupled with a reduction in product
costs due to increased manufacturing efficiencies.
Gross margin on mobile cryosurgical procedures was 62% for the year ended
December 31, 1999 compared to 57% in 1998. The change in margins is
attributable to procedure mix and higher surgery rental rates in 1998.
Research and development expense increased 34% to $2,574,000 for the year
ended December 31, 1999 compared to $1,920,000 in 1998. The increase reflects
the investment the Company has made in the form of additional personnel and
related infrastructure to support general product improvement, new product
development efforts and clinical costs associated with the Horizon Prostatic
Stent (TM).
Selling, general and administrative expense increased 72% to $7,992,000 for
the year ended December 31, 1999 compared to $4,653,000 in 1998. This increase
reflects increased sales and marketing costs associated with the launch of
Endocare's cryosurgical product for prostate cancer and an almost doubling of
Endocare's direct sales and marketing personnel between periods.
Interest income (expense), net was ($476,000) for the year ended December
31, 1999 compared to $337,000 in 1998. The change was due to interest expense
associated with the issuance of convertible debentures and a note payable in
1999, including corresponding amortization of deferred financing costs, offset
by interest income.
Endocare's net loss for the year ended December 31, 1999 was $9,264,000, or
86 cents per share on 10,838,000 weighted average shares outstanding, compared
to a net loss of $4,925,000, or 49 cents per share on 10,062,000 weighted
average shares outstanding for the same period in 1998. The increase in net loss
resulted from higher research and development costs, higher selling, general and
administrative expenses and increased interest expense partially offset by
increased revenues and lower cost of sales as a percentage of sales.
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Product revenue for the year ended December 31, 1998 decreased 29% to
$1,363,000 compared to $1,918,000 in 1997. The decline in 1998 product sales
was attributed primarily to reduced purchases of Cryocare surgical systems for
urological applications by Boston Scientific in exchange for higher licensing
payments. The majority of product sales in 1998 resulted from direct sales by
the Company.
Revenue from mobile cryosurgical procedures for the year ended December 31, 1998
increased 41% to $490,000 compared to $347,000 in 1997. The increase
corresponds to a greater number of procedures performed in 1998.
Revenue from collaborative agreements for the year ended December 31, 1998 was
$642,000 compared to $83,000 in 1997. The increase in 1998 revenue from
collaborative agreements reflects $475,000 in non-refundable Boston Scientific
licensing payments and recognition of the remaining deferred revenue associated
with a Boston Scientific milestone payment upon fulfilling corresponding
obligations. The 1997 revenue from collaborative agreements represents one
year's amortization of the lump-sum milestone payment from Boston Scientific to
Endocare associated with a former distribution agreement which gave Boston
Scientific exclusive worldwide marketing rights for the Cryocare System (TM) in
urological applications.
Gross margins on product sales were 29% for the year ended December 31,
1998 compared to 34% in 1997. This difference was due to a change in Endocare's
product revenue mix along with additional infrastructure and personnel costs
associated with the Company's new manufacturing facility.
Gross margin on mobile cryosurgical procedures was 57% for both years ended
December 31, 1998 and 1997.
Research and development expense increased 20% to $1,920,000 for the year ended
December 31, 1998 compared to $1,596,000 in 1997. The increase was primarily a
result of additional personnel and costs to support the further development of
the Cryocare System (TM), including one and four probe platforms, and
development of the Horizon Prostatic Stent (TM) and other new products.
Selling, general and administrative expense increased 31% to $4,653,000 for the
year ended December 31, 1998 compared to $3,553,000 in 1997. This increase
reflects the increased sales and marketing effort associated with the Company's
Cryocare products, in addition to the increases in personnel and operating costs
as the Company continued to build its infrastructure to support its product
lines.
Interest income (expense), net was $336,000 for the year ended December 31, 1998
compared to $201,000 in 1997. The increase in 1998 was due to increased
interest income on a higher balance of cash and cash equivalents.
Endocare's net loss for the year ended December 31, 1998 was $4,925,000 or
49 cents per share on 10,062,000 weighted average shares outstanding, compared
to a net loss of $4,022,000 or 48 cents per share on 8,307,000 weighted average
shares outstanding for the same period in 1997. This increase was primarily due
to lower gross margins and the increase in research and development costs and
selling, general and administrative expenses described above.
LIQUIDITY AND CAPITAL RESOURCES
Endocare has funded its operations since inception primarily through
private placements of equity securities, loans that were subsequently converted
into equity securities, convertible debentures, sales to customers, licensing
fees from a former distributor, a credit facility, interest on investments, and
the proceeds from the exercise of outstanding options and warrants.
At December 31, 1999, Endocare's cash and cash equivalents balance was
$7,365,000, compared to $6,286,000 at December 31, 1998. This increase was
provided primarily by the 1999 financing transactions discussed below offset by
cash used in operating activities. At December 31, 1999, net working capital
was $6,445,000, and the ratio of current assets to current liabilities was 2.9
to 1.
For the year ended December 31, 1999, net cash used by operating activities
was approximately $8.4 million compared to $4.3 million and $3.6 million for
years ended December 31, 1998 and 1997, respectively. Working capital has been
used as Endocare's operations have increased in 1999. Net accounts receivable
increased to $958,000 at December 31, 1999, compared to $408,000 at December 31,
1998. The increase resulted primarily from a corresponding increase in product
sales and revenue from mobile cryosurgical procedures. In conjunction with the
commercial launch of the Company's cryosurgical technology for prostate cancer
in 1999, inventories increased to $1,279,000 at December 31, 1999 compared to
$543,000 at December 31, 1998. Property and equipment additions during 1999
were approximately $339,000 as compared to $351,000 and $218,000 in 1998 and
1997, respectively. Additionally, $490,000 of inventory was transferred to
property and equipment during 1999 under the Company's cryosurgical system
placement program. Working capital was provided as accounts payable and other
current liabilities grew to approximately $3,324,000 compared to $1,779,000 at
December 31, 1998 due to an increase in operating activities. In 1999, the
Company invested $300,000 in Sanarus Medical Inc., a women's healthcare company.
In June and July 1999, Endocare received a total of $8,000,000 from the
sale to institutional investors of 7% convertible debentures which are due in
three years. Under the financing arrangements, the purchasers of the
convertible debentures have options to purchase additional debentures for the
aggregate principal amounts of $5,000,000 and $3,000,000 prior to June 7, 2002
and July 29, 2002, respectively. The additional debentures will mature three
years from the date they are issued, will bear interest at 7% per annum and will
be convertible in whole or in part at a conversion price of $6.75 per share
(subject to certain anti-dilution adjustments). The Company has a put option to
require the purchasers to buy the $5,000,000 principal amount of additional
debentures if the closing bid price for the common stock as listed for quotation
is more that $10.00 per share for the twenty (20) trading days in a consecutive
thirty (30) trading day period and on the date the Company elects to exercise
the put option, and if certain other conditions are met. The Company also has a
put option to require the purchasers to buy the $3,000,000 principal amount of
additional debentures if the closing bid price for the common stock as listed
for quotation is more that $9.00 per share for twenty (20) trading days in a
consecutive thirty (30) trading day period and on the date the Company elects to
exercise the put option, and if certain other conditions are met. In addition,
in July 1999, the Company entered into a Loan and Security Agreement which
provides for a revolving credit line in the amount of $2,000,000 plus up to an
additional $1,000,000 based on eligible accounts receivable for the Company (the
"Loan"). As of December 31, 1999, $2,000,000 of the Loan is outstanding. The
Loan matures and all amounts must be repaid on July 31, 2001. The Loan bears
interest at the highest prime or equivalent rate announced by certain designated
banks, plus 2% or 3.5%. The Loan is secured by a first priority lien on all of
the assets of the Company, except for intellectual property, is fully guaranteed
by the Company's subsidiary, and contains certain restrictive covenants.
The Company believes that its existing cash resources, credit facility and
access to additional working capital under the financing arrangements discussed
above will provide sufficient resources to meet present and reasonably
foreseeable working capital requirements and other cash needs for the next year.
If the Company elects to undertake or accelerate significant research and
development projects for new products or pursue corporate acquisitions, it may
require additional outside financing prior to such time. The Company expects
that to meet its long-term needs it will need to raise substantial additional
funds through the sale of its equity securities, the incurrence of indebtedness
or through funds derived through entering into collaborative agreements with
third parties.
This document contains forward-looking statements. The Company's business and
results of operations are subject to risks and uncertainties including, but not
limited to, those discussed under the caption "Factors That May Affect Future
Results and Trading Price of Common Stock" included elsewhere in this report,
and in risk factors contained in other periodic reports filed with the
Securities and Exchange Commission. Such risk factors include, but are not
limited to, limited operating history of the Company with a history of losses;
fluctuations in the Company's order levels; uncertainty regarding market
acceptance of the Company's new products; uncertainty of product development and
the associated risks related to clinical trials; the rapid pace of technological
change in the Company's industry; the Company's limited sales, marketing and
manufacturing experience; uncertainty regarding the impact Year 2000 system
failures may have if experienced by the Company, its suppliers and customers;
the ability to convince health care professionals and third party payers of the
medical and economic benefits of the Company's Cryocare System (TM), and
uncertainty as to whether payers will reimburse health care providers who
perform prostate cancer cryosurgical procedures and whether reimbursement, if
provided, will be adequate. The actual results that the Company achieves may
differ materially from any forward-looking statements due to such risks and
uncertainties.
OTHER MATTERS
ACCOUNTING PRINCIPLES
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"). The Statement establishes accounting
and reporting standards for derivative financial instruments and hedging
activities related to those instruments as well as other hedging activities. It
requires an entity to recognize all derivatives as either assets or liabilities
in the statement of financial position and measures those instruments at fair
value. In June 1999, the FASB issued Statement of Financial Accounting
Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of the Effective Date of FASB Statement No. 133 - an
amendment of FASB Statement No. 133" ("SFAS No. 137"). SFAS No. 137 delays the
effective date of SFAS No. 133 to fiscal quarters and fiscal years beginning
after June 15, 2000. The Company does not typically enter into arrangements
that would fall under the scope of Statement No. 133 and thus, management
believes that Statement No. 133 will not significantly affect its consolidated
financial condition and results of operations.
YEAR 2000
The Year 2000 problem refers to the potential for information systems to be
unable to correctly recognize and process calendar dates and date-sensitive
information involving dates on or after January 1, 2000. The Company did not
experience any material Year 2000 problems as the date changed and through the
date of this report. The Company attributes this to our Year 2000 readiness
efforts. As of December 31, 1999, systems remediation and integration testing
and development of the Company's contingency plans had been completed. Supplier
management is an ongoing process, and no material impact has been felt from lack
of supplier readiness. Although the Company did not experience any material
problems related to the Year 2000 issue, there can be no assurances that
problems relating to the Year 2000 issue will not manifest themselves in the
future. Historical amounts spent on the Year 2000 project have not been
material to the results of operations. In addition, the Company does not
believe that it will incur material costs in the future because of date related
problems.
OTHER
The Company is not aware of any issues related to environmental concerns that
have or are expected to materially effect its business.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's financial instruments include cash, cash equivalents, and
notes receivable. At December 31, 1999, the carrying values of the Company's
financial instruments approximated their fair values.
It is the Company's policy not to enter into derivative financial
instruments. The Company does not have any significant foreign currency
exposure since it does not transact business in foreign currencies. Therefore,
the Company does not have significant overall currency exposure. In addition,
the Company does not enter into any futures or forward contracts and therefore
does not have significant market risk exposure with respect to commodity prices.
The Company maintains a $3,000,000 credit facility bearing interest at the
highest prime rate or equivalent rate announced by certain designated banks,
plus 2% or 3.5%. The current rate of interest on the credit facility is
approximately 12%. This is the only debt of the Company which does not have a
fixed-rate of interest. A significant change in interest rates would not
materially impact the Company's consolidated financial statements. The credit
facility expires in July 2001.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Item 14, "Exhibits, Financial Statement Schedules, and Reports on Form
8-K."
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL
DISCLOSURE
Not applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT *
ITEM 11. EXECUTIVE COMPENSATION *
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT *
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS *
_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _
*The information called for by items 10, 11, 12 and 13 is omitted from this
Report and is incorporated by reference to the definitive Proxy Statement to be
filed by the Company no later than 120 days after December 31, 1999, the close
of its fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) DOCUMENTS FILED AS A PART OF THIS REPORT
(1) Index to Financial Statements
Independent Auditors' Report
Consolidated Statements of Operations for the years ended
December 31, 1997, 1998 and 1999
Consolidated Balance Sheets at December 31, 1998 and 1999
Consolidated Statements of Shareholders' Equity (Deficiency)
for the years ended December 31, 1997, 1998 and 1999
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1998 and 1999
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
Schedule II--Valuation and Qualifying Accounts -for the years ended
December 31, 1997, 1998 and 1999
(All other schedules are omitted because they are not applicable or the
required information is included in the financial statements or notes
thereto)
(3) Exhibits
2.1 Distribution Agreement between the Registrant and Medstone
International, Inc., dated October 31, 1995(1)
3.1 Certificate of Incorporation of the Company(2)
3.2 Amended and Restated Bylaws of the Company(3)
4.1 Specimen Certificate of the Company's Common Stock(4)
10.1 Form of Indemnification Agreement(2)
10.2 1995 Stock Plan(1)
10.3 1995 Director Option Plan(1)
10.4 Patent License Agreement between the Company and Brigham and Women's
Hospital Inc. dated April 17, 1996(5)
10.5 Form of Warrant to purchase an aggregate of 150,000 shares of common
stock, dated August 26, 1996(6)
10.6 Common Stock Purchase Agreement by and among the Company and the
persons listed on the Schedule of Investors attached thereto as Exhibit
A, dated January 21, 1997(7)
10.7 Facility Lease dated January 31, 1997 for 7 Studebaker(8)
10.8 Common Stock Purchase Agreements by and among the Company and the
persons indicated therein, dated April 15 and April 11, 1998(3)
10.9 Rights Agreement, dated as of March 31, 1999, between the Company and
U.S. Stock Transfer Corporation, which includes the form of
Certificate of Designation for the Series A Junior Participating
Preferred Stock as Exhibit A, the form of Rights Certificate as
Exhibit B and the Summary of Rights to Purchase Series A Preferred
Shares as Exhibit C (filed as Exhibit 4 to Form 8-K filed on June 3,
1999) (9)
10.10 Debenture dated June 7, 1999 between the Company and Brown Simpson
Strategic Growth Fund, Ltd. (filed as Exhibit 4.1 to Form 8-K filed on
June 14, 1999) (10)
10.11 Debenture dated June 7, 1999 between the Company and Brown Simpson
Strategic Growth Fund, L.P. (filed as Exhibit 4.2 to Form 8-K filed on
June 14 1999) (10)
10.12 Securities Purchase Agreement dated June 7, 1999 among the Company and
the Purchasers. (filed as Exhibit 10.1 to Form 8-K filed on June 14,
1999) (10)
10.13 Registration Rights Agreement dated June 7, 1999 among the Company and
the Purchasers. (filed as Exhibit 10.2 to Form 8-K filed on June 14,
1999) (10)
10.14 Debenture dated July 29, 1999 between the Company and Brown Simpson
Strategic Growth Fund, Ltd. (filed as Exhibit 4.1 to Form 8-K filed on
August 6, 1999) (11)
10.15 Debenture dated July 29, 1999 between the Company and Brown
Simpson Strategic Growth Fund, L.P. (filed as Exhibit 4.2 to Form
8-K filed on August 6, 1999) (11)
10.16 Securities Purchase Agreement dated July 29, 1999 among the
Company and the Purchasers. (filed as Exhibit 10.1 to Form 8-K
filed on August 6, 1999) (11)
10.17 Registration Rights Agreement dated July 29, 1999 among the
Company and the Purchasers. (filed as Exhibit 10.2 to Form 8-K
filed on August 6, 1999) (11)
10.18 Loan and Security Agreement dated July 29, 1999 between the
Company and TBCC. (filed as Exhibit 10.3 to Form 8-K filed
on August 6, 1999) (11)
10.19 Streamlined Facility Agreement dated July 29, 1999 between the Company
and TBCC. (filed as Exhibit 10.3 to Form 8-K filed on August 6,
1999) (11)
10.20 Continuing Guaranty dated July 29, 1999 by the AMP in favor of TBCC.
(filed as Exhibit 10.3 to Form 8-K filed on August 6,
1999) (11)
10.21 Security Agreement dated July 29, 1999 between AMP and TBCC. (filed
as Exhibit 10.3 to Form 8-K filed on August 6, 1999) (11)
23.1 Consent of KPMG LLP*
27.1 Financial Data Schedule*
__________
(1) Previously filed with the Company's Application for Registration on Form
10-SB under the Securities Exchange Act of 1934, filed on November 14, 1995, and
incorporated herein by reference. Each such exhibit had the same exhibit number
in that filing, except that the 1995 Stock Plan was exhibit number 10.6 and the
1995 Director Option Plan was exhibit 10.7.
(2) Previously filed with Amendment number 1 to Company's Application for
Registration on Form 10-SB, filed on December 21, 1995, and incorporated herein
by reference.
(3) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on April 23, 1998, and incorporated
herein by reference.
(4) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1995, and incorporated herein by reference.
(5) Previously filed with the Company's Current Report on Form 8-K, as
amended, as filed with the Securities and Exchange Commission on April 26, 1996,
and incorporated herein by reference.
(6) Previously filed with the Company's Current Report on Form 8-K as filed
with the Securities and Exchange Commission on September 10, 1996, and
incorporated herein by reference.
(7) Previously filed with the Company's Current Report on Form 8-K as filed
with the Securities and Exchange Commission on January 31, 1997, and
incorporated herein by reference.
(8) Previously filed with the Company's Annual Report on Form 10-K/A
(Amendment No. 3) for the year ended December 31, 1996, and incorporated herein
by reference.
(9) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on June 3, 1999, and incorporated
herein by reference.
(10) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on June 14, 1999, and incorporated
herein by reference.
(11) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on August 6, 1999, and incorporated
herein by reference.
* Filed herewith.
(b) REPORTS ON FORM 8-K
None
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors
Endocare, Inc.:
We have audited the accompanying consolidated financial statements of Endocare,
Inc. (the Company) and subsidiary as listed in the accompanying index. In
connection with our audits of the financial statements, we also have audited the
financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Endocare, Inc. and
subsidiary as of December 31, 1998 and 1999, and the results of their operations
and their cash flows for each of the years in the three year period ended
December 31, 1999, in conformity with generally accepted accounting principles.
Also in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly,
in all material respects, the information set forth therein.
KPMG LLP
Orange County, California
February 10, 2000
<PAGE>
ENDOCARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1997 1998 1999
------------ ------------- -------------
<S> <C> <C> <C>
Revenues:
Net product sales. . . . . . . . . . . $ 1,917,707 $ 1,363,112 $ 2,328,973
Mobile cryosurgical procedures . . . . 346,758 490,066 1,132,901
Revenue from collaborative agreements. 83,328 641,672 --
------------ ------------- -------------
Total revenues . . . . . . . . . . . 2,347,793 2,494,850 3,461,874
------------ ------------- -------------
Costs and expenses:
Cost of product sales. . . . . . . . . 1,270,838 974,308 1,254,917
Cost of mobile cryosurgical procedures 151,442 208,685 429,751
Research and development . . . . . . . 1,596,242 1,919,527 2,573,518
Selling, general and administrative. . 3,552,329 4,653,487 7,991,885
------------ ------------- -------------
Total costs and expenses . . . . . . . 6,570,851 7,756,007 12,250,071
------------ ------------- -------------
Loss from operations . . . . . . . . . (4,223,058) (5,261,157) (8,788,197)
Interest income (expense), net . . . . 201,317 336,593 (475,978)
------------ ------------- -------------
Net loss . . . . . . . . . . . . . . . $(4,021,741) $ (4,924,564) $ (9,264,175)
============ ============= =============
Net loss per share of common stock -
basic and diluted. . . . . . . . . . . $ (.48) $ (.49) $ (.86)
============ ============= =============
Weighted average shares of
common stock outstanding . . . . . . . 8,307,000 10,062,000 10,838,000
============ ============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
ENDOCARE, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
-------------
1998 1999
------------- -------------
<S> <C> <C>
ASSETS
--------
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . $ 6,285,799 $ 7,364,951
Accounts receivable, less allowances of $86,000
and $270,000 at December 31, 1998 and 1999,
respectively. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 407,602 958,145
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 542,610 1,278,785
Prepaid expenses and other current assets . . . . . . . . . . . . . . . . 87,397 166,969
------------- -------------
Total current assets. . . . . . . . . . . . . . . . . . . . . . . . . . 7,323,408 9,768,850
Property and equipment, net . . . . . . . . . . . . . . . . . . . . . . . . 498,240 962,720
Deferred financing costs and other assets, net of accumulated amortization
of $0 and $413,394 at December 31, 1998 and 1999, respectively. . . . . 170,206 2,264,803
------------- -------------
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . . . .. $ 7,991,854 $ 12,996,373
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
-------------------------------------------------
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 653,548 $ 1,517,470
Accrued compensation. . . . . . . . . . . . . . . . . . . . . . . . . . . 604,628 910,103
Other accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . 521,204 896,210
------------- -------------
Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . 1,779,380 3,323,783
Convertible debentures. . . . . . . . . . . . . . . . . . . . . . . . . . . -- 8,000,000
Note payable and other liabilities. . . . . . . . . . . . . . . . . . . . . 201,274 2,153,082
------------- -------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,980,654 13,476,865
Shareholders' equity (deficiency):
Preferred stock, $.001 par value; 1,000,000 shares
authorized; none issued and outstanding . . . . . . . . . . . . . . . . . -- --
Common stock, $.001 par value; 20,000,000 shares
authorized; 10,698,354 and 11,248,323 issued and
outstanding at December 31, 1998 and 1999, respectively . . . . . . . . . 10,698 11,248
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . . . . . 16,509,952 20,310,010
Note receivable from stock sale . . . . . . . . . . . . . . . . . . . . . -- (1,028,125)
Accumulated deficit . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,509,450) (19,773,625)
------------- -------------
Total shareholders' equity (deficiency) . . . . . . . . . . . . . . . . 6,011,200 (480,492)
------------- -------------
Commitments and contingencies
Total liabilities and shareholders' equity (deficiency) . . . . . . . . $ 7,991,854 $ 12,996,373
============= =============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
ENDOCARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIENCY
<TABLE>
<CAPTION>
NOTE TOTAL
ADDITIONAL RECEIVABLE SHAREHOLDERS'/
COMMON STOCK PAID-IN FROM ACCUMULATED EQUITY
SHARES CAPITAL AMOUNT STOCK SALE DEFICIT (DEFICIENCY)
---------- -------- ----------- -------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1996 . . . . 5,905,139 $ 5,905 $ 1,540,344 $ -- $ (1,563,145) $ (16,896)
Common stock issued in
private placement
and note conversion, net . . . . . . 2,550,714 2,551 7,885,100 -- -- 7,887,651
Stock options exercised. . . . . . . 182,501 182 32,668 -- -- 32,850
Equity provided by
warrant amortization . . . . . . . . -- -- 78,235 -- -- 78,235
Net loss . . . . . . . . . . . . . . -- -- -- -- (4,021,741) (4,021,741)
---------- -------- ----------- -------------- ------------- -------------
BALANCE AT DECEMBER 31, 1997 . . . . 8,638,354 8,638 9,536,347 -- (5,584,886) 3,960,099
Common stock issued in
private placement, net . . . . . . . 2,000,000 2,000 6,883,820 -- -- 6,885,820
Stock options exercised. . . . . . . 60,000 60 10,741 -- -- 10,801
Equity provided by
warrant amortization . . . . . . . . -- -- 79,044 -- -- 79,044
Net loss . . . . . . . . . . . . . . -- -- -- -- (4,924,564) (4,924,564)
---------- -------- ----------- -------------- ------------- -------------
BALANCE AT DECEMBER 31, 1998 . . . . 10,698,354 10,698 16,509,952 -- $(10,509,450) $ 6,011,200
Common stock issued. . . . . . . . . 210,988 211 1,316,535 (1,028,125) -- 288,621
Stock options and warrants exercised 338,981 339 750,023 -- -- 750,362
Equity provided by
warrant amortization . . . . . . . . -- -- 133,500 -- -- 133,500
Fair value of convertible debenture
purchase options . . . . . . . . . . -- -- 1,600,000 -- -- 1,600,000
Net loss . . . . . . . . . . . . . . -- -- -- -- (9,264,175) (9,264,175)
---------- -------- ----------- -------------- ------------- -------------
BALANCE AT DECEMBER 31, 1999 . . . . 11,248,323 $ 11,248 $20,310,010 $ (1,028,125) $(19,773,625) $ (480,492)
========== ======== =========== ============== ============= =============
</TABLE>
ENDOCARE, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1998 1999
------------ ------------- ------------
<S> <C> <C> <C>
Cash flows from operating activities:
- ---------------------------------------------
Net loss. . . . . . . . . . . . . . . . . . $(4,021,741) $ (4,924,564) $(9,264,175)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation and amortization . . . . . . . . 175,319 164,629 365,925
Amortization of warrant value . . . . . . . . 78,235 79,044 133,500
Amortization of deferred financing costs. . . -- -- 378,695
Common stock issued for interest payable. . . -- -- 288,621
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . 168,304 12,039 (550,543)
Inventories . . . . . . . . . . . . . . . . . (528,867) 382,982 (1,226,412)
Prepaid expenses and other current
assets. . . . . . . . . . . . . . . . . . . (29,450) (23,160) (79,572)
Other assets. . . . . . . . . . . . . . . . . 28,445 (112,922) 26,778
Accounts payable. . . . . . . . . . . . . . . 131,402 (169,015) 863,922
Accrued compensation. . . . . . . . . . . . . 212,637 370,798 305,475
Other accrued liabilities . . . . . . . . . . 287,519 90,286 373,656
Deferred revenue. . . . . . . . . . . . . . . (118,328) (166,672) --
------------ ------------- ------------
Net cash used in operating activities . . . . (3,616,525) ( 4,296,555) (8,384,130)
------------ ------------- ------------
Cash flows from investing activities:
- ---------------------------------------------
Purchases of property and equipment . . . . . (217,727) (350,645) (338,818)
Investment in Sanarus . . . . . . . . . . . . -- -- (300,061)
------------ ------------- ------------
Net cash used in investing activities . . . . (217,727) (350,645) (638,879)
------------ ------------- ------------
Cash flows from financing activities:
- ---------------------------------------------
Issuance of convertible debentures
and other debt. . . . . . . . . . . . . . . -- -- 10,000,000
Issuance of common stock, other . . . . . . . 7,170,501 6,896,621 750,362
Financing costs and other . . . . . . . . . . -- 124,000 (648,201)
------------ ------------- ------------
Net cash provided by financing activities . . 7,170,501 7,020,621 10,102,161
------------ ------------- ------------
Net increase in cash and cash equivalents . . 3,336,249 2,373,421 1,079,152
Cash and cash equivalents, beginning of year. 576,129 3,912,378 6,285,799
------------ ------------- ------------
Cash and cash equivalents, end of year. . . . $ 3,912,378 $ 6,285,799 $ 7,364,951
============ ============= ============
Non-cash activities:
- ---------------------------------------------
Conversion of note payable and accrued
interest to common stock, net of
origination fees paid by issuance
of common stock . . . . . . . . . . . . . .$ 820,250 $ -- $ --
Fair value of convertible debenture
purchase options credited to additional
paid-in-capital . . . . . . . . . . . . . . . -- -- 1,600,000
Note receivable from stock sale . . . . . . . -- -- 1,028,125
Transfer of inventory to property
and equipment for placement at customer sites -- -- 490,237
------------ ------------- ------------
Total non-cash activities . . . . . . . $ 820,250 $ -- $ 3,118,362
============ ============= ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
ENDOCARE, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF THE COMPANY
Endocare, Inc. (the "Company") designs, manufactures, and markets an array of
innovative, temperature-based surgical devices and technologies primarily to
treat prostate diseases, including prostate cancer and prostate enlargement.
The Company also operates a mobile cryosurgery business. Since its formation in
1990, Endocare operated first as a research and development department, then
later as a division of Medstone International, Inc. ("Medstone"). Effective
January 1, 1996, Endocare became a totally independent, publicly-owned
corporation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of Endocare, Inc. and its wholly-owned subsidiary Advanced Medical
Procedures, Inc. All intercompany balances and transactions have been
eliminated.
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 at
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: All highly liquid investments purchased with an
original maturity of three months or less are considered to be cash equivalents.
Inventories: Inventories are stated at the lower of actual cost (first-in,
first-out) or net realizable value.
Property and Equipment: Property and equipment are stated at cost and are
depreciated on a straight-line basis over the estimated useful lives of the
respective assets, which range from two to five years. Leasehold improvements
are amortized over the shorter of the estimated useful lives of the assets or
the related lease term. Cryosurgical equipment placed at customer sites for use
with the Company's disposable Cryoprobes (TM) is depreciated into product cost
of sales over an estimated useful life of three years.
Long-Lived Assets: The Company reviews property, equipment, and intangible
assets for possible impairment whenever events or circumstances indicate that
the carrying amounts may not be recoverable. If the sum of the expected future
undiscounted cash flows is less than the carrying amount of an asset, an
impairment loss is recognized as the excess of the carrying value of the asset
over its fair value.
Deferred Financing Costs: Deferred financing costs are amortized to interest
expense over the lives of the respective assets.
Revenue Recognition: The Company recognizes product revenue upon the shipment of
its products, including the shipment of disposable products to customer sites
where the Company has placed cryosurgical systems. Revenue from mobile
cryosurgical procedures is recognized upon completion of procedures. Revenue
from collaborative agreements are recognized as the related activities are
performed or milestones are met. Realizability of accounts receivable is
determined based upon an understanding of the financial condition of, and prior
history with, the buyer and overall historical experience.
Warranty Costs: Certain of the Company's products are covered by warranties
against defects in material and workmanship for periods of up to twelve months.
The estimated warranty cost is recorded at the time of sale and is adjusted
periodically to reflect actual experience.
Research and Development: Research and development costs relate to both present
and future products and are expensed as incurred.
Net Loss Per Share: The Company has adopted Statement of Financial Accounting
Standards No. 128, "Earnings Per Share" ("SFAS 128"). Under SFAS 128, basic EPS
is calculated by dividing net earnings (loss) by the weighted-average common
shares outstanding during the period. Diluted EPS reflects the potential
dilution to basic EPS that could occur upon conversion or exercise of
securities, options, convertible debentures, or other such items, to common
shares using the treasury stock method based upon the weighted-average fair
value of the Company's common shares during the period. In accordance with SFAS
128, the consolidated loss (numerator), shares (denominator) and per-share
amount for fiscal 1997 are $(4,021,741), 8,307,000 and $(0.48), respectively.
The consolidated loss (numerator), shares (denominator) and per-share amount for
fiscal 1998 are $(4,924,564), 10,062,000 and $(0.49), respectively, and the
consolidated loss (numerator), shares (denominator) and per-share amount for
fiscal 1999 are $(9,264,175), 10,838,000 and $(0.86), respectively. As the
Company has been in a net loss position for the fiscal years 1997, 1998, and
1999, the potential dilution from the conversion of options, warrants and
convertible debentures to common stock of 1,715,000, 2,549,000 and 3,953,000 in
fiscal years 1997, 1998 and 1999, respectively, were not used to compute diluted
loss per share as the effect was antidilutive. Consequently, diluted EPS equals
basic EPS for all periods presented.
Fair Value of Financial Instruments: The carrying amount of cash and cash
equivalents approximates fair value for all periods presented because of the
short-term maturity of these financial instruments. The carrying amounts of all
other financial instruments on the consolidated balance sheets approximate their
fair values.
Comprehensive Income: The Company has adopted SFAS NO. 130 ("SFAS 130"),
"Reporting Comprehensive Income." This statement establishes rules for the
reporting of comprehensive income and its components. The adoption of SFAS 130
did not impact the Company's consolidated financial statements or related
disclosures as the Company does not have any components of other comprehensive
income. Therefore, comprehensive income (loss) equaled net income (loss) for
all periods presented.
Segment Disclosures: The Company has adopted SFAS No. 131 ("SFAS 131"),
"Disclosure about Segments of an Enterprise and Related Information." SFAS 131
establishes standards for reporting information about operating segments. The
Company operates in one industry segment - the design, manufacture and marketing
of surgical devices and related procedures to treat prostate diseases.
3. MERGER
On June 30, 1999, Endocare acquired all the outstanding units of Advanced
Medical Procedures, LLC, a Florida limited liability company ("AMP"). AMP
operates a mobile cryosurgery business which provides cryosurgical equipment for
the treatment of prostate and liver cancer on a procedural basis. The
acquisition was consummated pursuant to a Plan of Merger (the "AMP Merger
Agreement") by and among AMP, Endocare, and Advanced Medical Procedures, Inc.
("AMPI"), a Delaware corporation and wholly-owned subsidiary of Endocare.
Pursuant to the Merger Agreement, AMP was merged with and into AMPI, with AMPI
surviving as a wholly-owned subsidiary of Endocare. The AMP unitholders
received an aggregate of 260,000 shares of Endocare Common Stock in exchange for
all of their AMP units. The acquisition was accounted for as a
pooling-of-interests for financial reporting purposes. The pooling-of-interests
method of accounting is intended to present as a single interest two or more
common stockholders' interests which were previously independent; accordingly,
the historical financial statements for the periods prior to the merger have
been restated as though the companies had been combined. Fees and expenses
related to the merger were expensed as incurred and amounted to approximately
$50,000.
The results of operations previously reported by the separate companies and the
combined amounts presented in the accompanying consolidated financial statements
are summarized below:
<TABLE>
<CAPTION>
Six Months
Years Ended Ended
December 31, June 30,
-------------
1997 1998 1999
------------ --------------- ------------
<S> <C> <C> <C>
Net Revenue:
Endocare
Net product sales. . . . . . . . . . . . . . . . $ 1,917,707 $ 1,476,112 $ 741,903
Revenue from collaborative agreements. . . . . . 83,328 641,672 --
AMP. . . . . . . . . . . . . . . . . . . . . . .
Procedures . . . . . . . . . . . . . . . . . . . 346,758 490,066 573,638
Adjustments - elimination of intercompany activities -- (113,000) (51,910)
------------ --------------- ------------
Combined . . . . . . . . . . . . . . . . . . . . . $ 2,347,793 $ 2,494,850 $ 1,263,631
============ =============== ============
Net Loss:
Endocare . . . . . . . . . . . . . . . . . . . . . $(3,899,860) . $(4,837,346) $(4,405,759)
AMP. . . . . . . . . . . . . . . . . . . . . . . . (121,881) (49,218) 36,956
Adjustments - elimination of intercompany activities -- (38,000) (51,910)
------------ --------------- ------------
Combined . . . . . . . . . . . . . . . . . . . . . $(4,021,741) $ (4,924,564) $(4,420,713)
============ =============== ============
</TABLE>
Adjustments have been made to eliminate the impact of intercompany sales from
Endocare to AMP. Additionally, a previously existing note payable from AMP to
Endocare of $135,000 at December 31, 1998, has been eliminated in the
accompanying consolidated balance sheets. There were no other significant
transactions between Endocare and AMP prior to the combination.
4. SUPPLEMENTAL FINANCIAL STATEMENT DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1997 1998 1999
----------- ----------- ----------
<S> <C> <C> <C>
Interest income (expense), net
Interest income . . . . . . . . . . . . . . . . . . . . $ 204,675 $ 338,710 $ 315,864
Interest Expense. . . . . . . . . . . . . . . . . . . . (3,358) (2,117) (791,842)
----------- ----------- ----------
Interest income (expense), net. . . . . . . . . . . . $ 201,317 $ 336,593 $(475,978)
=========== =========== ==========
Cash paid for interest. . . . . . . . . . . . . . . . . $ 3,358 $ 2,117 $ 17,580
=========== =========== ==========
Inventories:
Raw materials . . . . . . . . . . . . . . . . . . . . . $ 260,222 $ 481,141
Work in process . . . . . . . . . . . . . . . . . . . . 86,375 310,651
Finished goods. . . . . . . . . . . . . . . . . . . . . 196,013 486,993
----------- -----------
Total inventories . . . . . . . . . . . . . . . . . . $ 542,610 $1,278,785
=========== ===========
Property and Equipment:
Equipment . . . . . . . . . . . . . . . . . . . . . . . $ 554,516 $ 488,000
Equipment -cryosurgical systems placed at customer sites -- 490,237
Furniture and fixtures. . . . . . . . . . . . . . . . . 275,371 442,531
Leasehold improvements. . . . . . . . . . . . . . . . . 82,740 86,440
Assets held for disposal (net of reserves) (see note 5) 167,947 --
----------- -----------
Total property and equipment, at cost . . . . . . . . 1,080,574 1,507,208
Accumulated depreciation and amortization . . . . . . . (582,334) (544,488)
----------- -----------
Net property and equipment. . . . . . . . . . . . . . $ 498,240 $ 962,720
=========== ===========
</TABLE>
5. LONG-LIVED ASSETS
In 1996, the Company reduced the value of certain property and equipment to
their estimated fair market values. The identification and measurement of these
impaired assets was primarily a result of the post spin-out business operations
of the Company, and the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" were utilized in determining the amount of
the impairment charge. The majority of the property and equipment adjustment
pertained to laser machines which were no longer generating sales of the
Company's laser catheters. Prior to 1998, the net book value of these assets
were fully reserved and in 1999 the assets were disposed of.
6. DEBT
Convertible Debentures
On June 7, 1999 and July 30, 1999, the Company received $5,000,000 and
$3,000,000, respectively, from the sale of its 7% convertible debentures due in
three years (the "Debentures"). Interest is payable annually in cash or, at the
Company's option, in common stock at a price per share based on recent bid
prices prior to the date interest is paid. Under the financing arrangements,
the purchasers have options to purchase additional debentures for the aggregate
principal amounts of $5,000,000 and $3,000,000. Under the circumstances
described below, the Company may require the purchasers to exercise these
purchase options. The $5,000,000 principal amount of the Debentures must be
repaid in full in cash on June 7, 2002, but may be converted into the Company's
common stock in whole or in part at the purchasers' option at any time on or
prior to June 7, 2002 at a conversion price of $5.125 per share. The $3,000,000
principal amount of the debentures must be repaid in full in cash on July 29,
2002, but may be converted into the Company's common stock in whole or in part
at the purchasers' option at any time, subject to certain restrictions, on or
prior to July 29, 2002 at a conversion price of $6.00 per share. The conversion
prices are subject to certain anti-dilution adjustments.
In addition to the purchasers' option to convert the $5,000,000 principal
amount of the Debentures, the Company may require that the purchasers convert
the debentures into common stock at a conversion price of $5.125 per share
(subject to certain anti-dilution adjustments) if the bid price for the common
stock as listed for quotation is above $8.00 per share for twenty (20) trading
days during a consecutive thirty (30) trading day period, and certain other
conditions are met. Subject to certain restrictions, the Company may also
require that the purchasers convert the $3,000,000 principal amount of the
debentures into common stock at a conversion price of $6.00 per share (subject
to certain anti-dilution adjustments) if the bid price for the common stock as
listed for quotation is above $9.00 per share for twenty (20) trading days
during a consecutive thirty (30) trading day period, and certain other
conditions are met. Subsequent to December 31, 1999, the share price conditions
have been met.
Under a securities purchase agreement, the purchasers have a call option
exercisable at any time prior to June 7, 2002 to require that the Company sell
to the purchasers an additional $5,000,000 principal amount of debentures. The
additional debentures will mature three years from the date they are issued,
will bear interest at 7% per annum and will be convertible in whole or in part
at a conversion price of $6.75 per share (subject to certain anti-dilution
adjustments). The Company has a put option to require the purchasers to buy the
$5,000,000 principal amount of additional debentures if the closing bid price
for the common stock as listed for quotation is more that $10.00 per share for
the twenty (20) trading days in a consecutive thirty (30) trading day period and
on the date the Company elects to exercise the put option, and if certain other
conditions are met. The purchasers also have a call option exercisable at any
time prior to July 29, 2002 to require that the Company sell to the purchasers
an additional $3,000,000 principal amount of debentures. The additional
debentures will mature three years from the date they are issued, will bear
interest at 7% per annum and will be convertible in whole or in part at the
option of the purchasers at any time prior to maturity into common stock at a
conversion price of $6.75 per share (subject to certain anti-dilution
adjustments). The Company has a put option to require the purchasers to buy the
$3,000,000 principal amount of additional debentures if the closing bid price
for the common stock as listed for quotation is more that $9.00 per share for
twenty (20) trading days in a consecutive thirty (30) trading day period and on
the date the Company elects to exercise the put option, and certain other
conditions are met. Subsequent to December 31, 1999, the share price conditions
for both put options have been met.
The fair value of the purchasers' two call options described above totaling
$1,600,000, has been estimated using the Black-Scholes pricing model and is
reflected in deferred financing costs and other assets in the accompanying
consolidated balance sheet as of December 31, 1999. This amount is being
amortized to interest expense over the lives of the call options. As of
December 31, 1999, the Company issued 35,988 shares of its common stock to the
purchasers for payment of $289,000 in accrued Debenture interest through
December 31, 1999.
Convertible Loan Payable
In August 1996, Endocare obtained a two-year $1,500,000 borrowing facility from
four partnerships (the "Partnerships") managed by Technology Funding Inc., a
venture capital firm. Peter F. Bernardoni is an officer of Technology Funding
Inc. and has served as a member of Endocare's Board of Directors since November
1995. At December 31, 1996, $750,000 was outstanding under this loan.
In connection with entering into this loan, Endocare issued to the four
partnerships 10,000 shares of common stock as an origination fee and warrants to
purchase an aggregate of up to 150,000 shares of Endocare common stock. The
warrants are exercisable at any time between August 26, 1996 and August 26,
2001, at an exercise price of $3.00 per share, subject to adjustment.
The loan accrued interest at the rate of 16% per year, which was due and payable
in arrears on the maturity date. The outstanding principal and interest under
the loan was convertible into common stock of Endocare at a conversion price of
$2.50 per share, subject to certain conditions. All of the obligations under the
loan were secured by a security interest in all present and after acquired
personal property of Endocare.
On January 27, 1997, the Partnerships converted their $750,000 principal amount
and accrued interest of $50,000 into 320,000 shares of common stock. Also,
12,000 additional shares of common stock were issued to the partnerships as an
inducement to convert at that time which were valued at fair value of $50,250.
The Convertible Loan, which provided an additional $750,000 in borrowing
capacity, was cancelled as of the conversion. In conjunction with the
conversion, approximately $30,000 in unamortized note origination fees were
reclassified against additional paid-in capital.
Credit Facility
On July 29, 1999, the Company entered into a Loan and Security agreement
with a lender which provides for a revolving credit line in the amount of
$2,000,000 plus up to an additional $1,000,000 based on eligible accounts
receivable of the Company (the "Loan"). As of December 31, 1999, $2,000,000 of
the loan is outstanding. The Loan matures and all amounts must be repaid on
July 31, 2001. The Loan bears interest at the highest prime or equivalent rate
announced by certain designated banks, plus 2% for the portion of the loan based
on eligible account receivables or 3.5%. The Loan is secured by a first
priority lien on all of the assets of the Company, except for intellectual
property, is fully guaranteed by the Company's subsidiary, and contains certain
restrictive covenants. The Company is in compliance with the restrictive
covenants of the agreement as of December 31, 1999.
Aggregate maturities of long-term debt are zero, $2,000,000 and $8,000,000 for
the years ending December 31, 2000, 2001 and 2002, respectively. Long-term debt
is comprised of the credit facility's note payable and convertible debentures as
of December 31, 1999. The balance of the long-term liabilities of approximately
$153,000 as of December 31, 1999 consists primarily of a capital lease
obligation and equipment loan.
7. PRIVATE PLACEMENTS
In January 1997, the Company sold 2,218,714 common stock at a price of $3.50
per share in a private placement, with Oppenheimer & Co., Inc. ("Oppenheimer")
acting as placement agent. After expenses, the net contribution to the Company's
capital was approximately $7,067,000. Expenses deducted from the proceeds
include a commission to Oppenheimer of approximately $540,000 and legal,
accounting, and other professional expenses of approximately $155,000. In
addition, Oppenheimer received a warrant to purchase 177,497 shares of Endocare
common stock for a period of five years at a price of $4.20 per share. The
warrants are exercisable at any time through January 27, 2002.
In April 1998, the Company sold 2,000,000 shares of common stock at a price of
$3.50 per share in a direct private placement. After legal, accounting, filing
fees and other associated expenses of approximately $150,000, the net
contribution to the Company's capital was approximately $6,886,000.
8. STOCK OPTIONS AND WARRANTS
At December 31, 1999, Endocare had two stock-based compensation plans, as
described below. Per FASB Statement No. 123, the Company has elected to apply
APB Opinion No. 25 and related Interpretations in accounting for its plans.
Accordingly, no compensation expense has been recognized for these plans in the
Consolidated Statements of Operations.
The 1995 Stock Plan authorizes the Board or one or more committees which the
Board may appoint from among its members (the "Committee") to grant options and
rights to purchase common stock to employees and certain consultants and
distributors. Options granted under the 1995 Stock Plan may be either "incentive
stock options" as defined in Section 422 of the Internal Revenue Code of 1986,
as amended, or nonstatutory stock options, as determined by the Board or the
Committee. The exercise price of options granted under the 1995 Stock Plan is
equal to the fair market value of Endocare common stock on the date of grant.
Options generally vest 25% on the one year anniversary date, with the remaining
75% vesting monthly over the following three years. Options are exercisable for
ten years. A total of 3,312,000 shares of common stock have been reserved for
issuance under the 1995 Stock Plan, subject to an automatic annual share
increase to which the number of shares available for issuance under the plan
will automatically increase on the first trading day of each calendar year by 3%
of the total number of shares of the Company's common stock outstanding at the
end of the preceding calendar year, to a maximum of 500,000 shares each year. As
of December 31, 1999, options to purchase a total of 3,299,416 shares of the
Company's common stock have been granted under the 1995 Stock Plan.
The 1995 Director Option Plan (the "Director Plan") was adopted by the Board of
Directors (the "Board") in October 1995 and approved by the shareholders in
November 1995. It provides automatic, nondiscretionary grants of options to
Endocare's non-employee directors ("Outside Directors"). The Director Plan
provides that each Outside Director is granted an option to purchase 20,000
shares of Endocare common stock vested over a two-year period upon his or her
initial election or appointment as an Outside Director. Subsequently, each
Outside Director who has served for at least six months will be granted an
additional option to purchase 5,000 shares of Endocare common stock, on January
1 of each year, or the first trading day thereafter, so long as he or she
remains an Outside Director. The exercise price of options granted to Outside
Directors must be the fair market value of Endocare common stock on the date of
grant. Options granted to Outside Directors have ten-year terms, subject to an
Outside Director's continued service as a director. The Subsequent Options
granted to the Outside Directors become fully exercisable on the first
anniversary of the date of grant. A total of 300,000 shares of common stock has
been reserved for issuance under the Director Plan. As of December 31, 1999,
options to purchase a total of 105,000 shares of the Company's common stock have
been granted under the Director Plan.
<PAGE>
The following tables summarize Endocare's option activity under both plans:
<TABLE>
<CAPTION>
1997 1998 1999
----- ----- -----
WEIGHTED AVG. WEIGHTED AVG.
WEIGHTED AVG. EXERCISE EXERCISE
NUMBER OF EXERCISE PRICE NUMBER OF PRICE NUMBER OF PRICE
OPTIONS PER OPTION OPTIONS PER OPTION OPTIONS PER OPTION
---------- ----------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 1,506,000 $ 0.84 1,499,916 $ 1.36 2,657,553 $ 1.96
Granted during year. . . . . . 363,500 $ 3.25 1,463,000 $ 2.70 749,500 $ 3.31
Cancelled during year. . . . . (187,083) $ 2.05 (245,363) $ 2.84 (245,138) $ 3.04
Exercised. . . . . . . . . . . (182,501) $ 0.18 (60,000) $ 0.18 (202,731) $ 1.60
---------- ----------- ---------- ----------- ---------- -----------
Outstanding, end of year . . . 1,499,916 $ 1.36 2,657,553 $ 1.96 2,959,184 $ 2.24
========== =========== ========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------- --------------------
NUMBER NUMBER
OUTSTANDING WEIGHTED-AVG. EXERCISABLE
RANGE OF AT REMAINING WEIGHTED-AVG. AT WEIGHTED-AVG.
EXERCISE PRICES DECEMBER 31, 1999 CONTRACTUAL LIFE EXERCISE PRICE DECEMBER 31, 1999 EXERCISE PRICE
- ---------------- ------------------- -------------------- --------------- ------------------ ---------------
<S> <C> <C> <C> <C> <C>
$ 0.18 779,186 5.9 years $ 0.18 775,022 $ 0.18
$1.88 - 2.31 . 698,083 8.9 years $ 2.03 236,479 $ 2.05
$2.50 - 4.00 . 1,188,415 8.0 years $ 2.98 596,019 $ 3.09
$4.25 - 5.06 . 233,500 9.6 years $ 4.93 1,625 $ 4.50
$6.19 - 7.44 . 60,000 9.8 years $ 6.23 -- $ --
------------------- -------------------- --------------- ------------------ ---------------
$0.18 to 7.44 2,959,184 7.8 years $ 2.24 1,609,145 $ 1.54
=============== ================== ===============
</TABLE>
The following table presents consolidated pro forma information as if the
Company recorded compensation cost using the fair value of the issued stock
options using the Black-Scholes valuation model:
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ -------------
<S> <C> <C> <C>
Net loss:
- ---------
As reported . . . . . . . . . . . . . . $(4,021,741) $(4,924,564) $ (9,264,175)
Assumed stock compensation cost . . . . (157,000) (363,000) (896,000)
------------ ------------ -------------
Pro forma, adjusted . . . . . . . . . . $(4,178,741) $(5,287,564) $(10,160,175)
============ ============ =============
Net loss per share - basic and diluted:
- ---------------------------------------
As reported . . . . . . . . . . . . . . $ (0.48) $ (0.49) $ (0.86)
Pro forma, adjusted . . . . . . . . . . $ (0.50) $ (0.53) $ (0.94)
</TABLE>
The weighted average fair value of the Company's options at the grant date was
approximately $1.01 in 1997, and $1.35 in 1998, and $1.90 in 1999. The fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model, with the following assumptions:
<TABLE>
<CAPTION>
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Stock volatility. . . . .1 .1 .5
Risk-free interest rate 6.00% 6.00% 6.00%
Option term in years. . 10 years 10 years 10 years
Stock dividend yield. . -- -- --
</TABLE>
The Company issued warrants to purchase 222,497, 5,000, and 176,506 shares of
the Company's common stock in 1997, 1998, and 1999, respectively (see notes 6
and 7). Warrants generally vest over a one to four year period and have been
provided in conjunction with financing transactions, patent licenses and service
contracts. As of December 31, 1999, the Company had 427,753 warrants
outstanding, of which 352,000 are exercisable. Warrant exercise prices range
from $2.31 to $5.13 per share. During 1999, 136,250 warrants were exercised,
and no warrants had been exercised in prior years. The Company amortizes the
fair values of these warrants, as determined using the Black-Scholes option
pricing method, to expense over the service period of the related warrants.
9. STOCKHOLDER RIGHTS PLAN
On March 5, 1999, the Company's Board of Directors adopted a Stockholder Rights
Plan ("Plan") in which preferred stock purchase rights will be distributed as a
dividend at the rate of one Right for each share of Common Stock held as of the
close of business on April 15, 1999. Each Right will entitle Stockholders to
buy one one-thousandth of a share of Series A Preferred Stock of the Company at
an Exercise Price of $25. The Rights are designed to guard against partial
tender offers and other coercive tactics that might be used in an attempt to
gain control of the Company or to deprive Stockholders of their interests in the
long-term value of the Company. The Rights will be exercisable only if a person
or group acquires 15% or more of the Company's Common Stock (subject to certain
exceptions stated in the Plan) or announces a tender offer, the consummation of
which would result in ownership by a person or group of 15% or more of the
Company's Common Stock. Each Right will entitle stockholders to buy one
one-thousandth of a share of new series of junior participating preferred stock
at an exercise price of $25 upon certain events. If a person or group acquires
15% or more of the Company's outstanding Common Stock (subject to certain
exceptions stated in the Plan), or a holder of 15% or more of the Company's
Common Stock engages in certain self-dealing transactions or a merger
transaction in which the Company is the surviving corporation and its Common
Stock remains outstanding, then each Right not owned by such person or certain
related parties will entitle its holder to purchase, at the Right's then-current
exercise price, units of the Company's Series A Preferred Stock (or, in certain
circumstances, Company Common Stock, cash, property or other securities of the
Company) having a market value equal to twice the then-current exercise price.
In addition, if, after the Rights become exercisable, Endocare, Inc. is acquired
in a merger or other business combination transaction, or sells 50% or more of
its assets or earnings power, each Right will entitle its holder to purchase, at
the Right's then-current price, a number of the acquiring company's common
shares having a market value at the time of twice the Right's exercise price.
At any time on or prior to the close of business on the first date of a public
announcement that a person or group has acquired beneficial ownership of 15% or
more of the Company's Common Stock (subject to certain exceptions stated in the
Plan), the Rights are redeemable for one cent per Right at the option of the
Board of Directors. The Rights are intended to enable all stockholders to
realize the long-term value of their investment in the Company. The Rights will
not prevent a takeover attempt, but should encourage anyone seeking to acquire
the Company to negotiate with the Board prior to attempting to a takeover. The
dividend distribution was made on April 15, 1999 payable to stockholders of
record on that date. The Rights will expire on April 15, 2009.
10. INCOME TAXES
Income tax expense consisted of:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------
1998 1999
------ -----
<S> <C> <C>
Current: Federal $ -- $ --
State and local 3,400 3,600
Deferred: Federal -- --
State and local -- --
-------- ------
Total . . . $ 3,400 $3,600
======== ======
</TABLE>
The following table summarizes the tax effects of temporary differences which
give rise to significant portions of the deferred tax assets at December 31:
<TABLE>
<CAPTION>
1998 1999
------------- ------------
<S> <C> <C>
Deferred tax assets:
Product and other reserves
established for book purposes. $ 19,000 $ 42,000
Property and equipment reserve . 84,000 96,000
Inventory obsolescence reserve . 80,000 52,000
Accounts receivable reserve. . . 16,000 107,000
Recognition of deferred revenue. -- 15,000
Net operating loss carryforwards 3,738,000 7,373,000
Other. . . . . . . . . . . . . . 203,000 267,000
------------- -------------
Gross deferred tax assets. . . 4,140,000 7,952,000
Valuation allowance. . . . . . . ( 4,140,000) ( 7,952,000)
------------- -------------
Net deferred tax assets. . . . . $ -- $ --
============= =============
</TABLE>
The valuation allowance increased by $1,992,000 and $3,812,000 during the years
ended December 31, 1998 and 1999, respectively.
Actual income tax expense differs from amounts computed by applying the U.S.
federal income tax rate of 34% to pretax loss as a result of the following:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
Computed expected tax benefit . . . . . . $(1,326,000) $(1,644,000) $(3,150,000)
State income taxes net of federal benefit (214,000) (282,000) (541,000)
Nondeductible expenses. . . . . . . . . . 6,000 13,000 19,400
Change in valuation allowance . . . . . . 1,797,000 1,992,000 3,812,000
Change in tax rate with respect to
net operating loss. . . . . . . . . . . (259,000) -- --
Provision to return adjustment. . . . . . -- -- (114,000)
Other . . . . . . . . . . . . . . . . . . 1,000 (75,600) (22,800)
------------ ------------ ------------
Actual tax expense. . . . . . . . . . $ 5,000 $ 3,400 $ 3,600
============ ============ ============
</TABLE>
As of December 31, 1999, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $18,524,000 which are available to
offset future federal taxable income, if any, through the year 2019. For state
income tax purposes, the Company has net operating losses of approximately
$8,640,000 which are available to offset future state taxable income, if any,
through the year 2004.
In accordance with Internal Revenue Code Section 382, the annual utilization of
net operating loss carryforwards and credits existing prior to a change in
control may be limited.
11. COLLABORATIVE AGREEMENTS
Boston Scientific: In March 1999, Endocare exercised its right, at no cost to
the Company, to terminate a distribution agreement with Boston Scientific, which
was originally entered into in November 1996. This agreement granted Boston
Scientific exclusive worldwide marketing rights for Endocare's Cryocare System
(TM) for urology and a purchase right on the technology. Under the original
distribution agreement, Boston Scientific guaranteed Endocare certain minimum
purchases of Cryocare Systems (TM) over a five-year period, subject to certain
conditions and renegotiations. In addition, Boston Scientific committed to pay
Endocare four payments of $250,000 each, based upon meeting certain specified
milestones. The first milestone payment, based upon contract signing, was
received in November 1996, and revenue was recognized in the fourth quarter of
1996. Due to continuing obligations of the Company to Boston Scientific, cash
related to the second milestone of $250,000 was received in December 1996 and
was being recognized as earned. The remaining obligations relating to this
second milestone were fulfilled in 1998 and the remaining deferred revenue of
$166,672 recognized. In 1998, Boston Scientific paid additional nonrefundable
licensing payments of $475,000 to Endocare.
Sanarus Medical, Inc.: In October 1999, the Company entered into a strategic
alliance with Sanarus Medical, Inc. ("Sanarus") to commercialize Endocare's
proprietary cryosurgical technology in the treatment of breast tumors and
gynecological diseases. The terms of the related agreements included an equity
investment by Endocare in Sanarus totaling $300,000 and a warrant received by
Endocare to acquire approximately 57% of Sanarus common stock in consideration
for entering into a manufacturing supply and license agreement. In the event
Endocare were to exercise the warrant, the Company would then own a majority
equity position in Sanarus. As of December 31, 1999, the Company owns less than
5% of the outstanding shares in Sanarus and the investment is reflected at cost,
which approximates fair market value, as it does not have significant influence
over the operations of Sanarus. The investment is included in other assets in
the accompanying consolidated balance sheet as of December 31, 1999.
12. COMMITMENTS AND CONTINGENCIES
Commitments
In September 1995, the Company moved from Medstone's facility to its own
facility in Irvine, California. Gross rent expense was $40,872 in 1997. This
facility lease, and a related sublease, expired on August 31, 1998. In February
1997, the Company signed a new five-year lease for a larger 16,100 square foot
facility in Irvine, California. Rent expense on this lease was $119,383 in 1997,
$153,860 in 1998 and $157,727 in 1999. Future minimum commitments on this
operating lease are $161,593 in 2000, $165,460 in 2001, and $34,639 in 2001.
The Company also leases various office equipment under operating leases, with
lease commitments totaling $17,658 in 2000 and $3,075 in 2001.
As of December 31, 1999, the Company has no other facility leases, capital
leases, or other long-term commitments.
Contingencies
The Company, in the normal course of business, is subject to various legal
matters. While the results of litigation and claims cannot be predicted with
certainty, the Company believes that the final outcome of these matters will not
have a material adverse effect on the Company's consolidated results of
operations or financial condition.
From time to time, the Company has received correspondence alleging infringement
of proprietary rights of third parties. No assurance can be given that any
relevant claims of third parties would not be upheld as valid and enforceable,
and therefore that the Company could be prevented from practicing the subject
matter claimed or would be required to obtain licenses from the owners of any
such proprietary rights to avoid infringement. Management does not expect any
material adverse effect on its consolidated financial condition or the
consolidated results of operations because of such actions.
13. MAJOR CUSTOMERS AND CONCENTRATION OF CREDIT RISK
The Company currently operates in one industry segment - the design, manufacture
and marketing of surgical devices and related procedures to treat prostate
diseases. The Company markets and sells its devices worldwide to distributors of
medical devices and directly to hospitals and other medical professional
organizations. Until the Company exercised its right to terminate the
distribution agreement with Boston Scientific in March 1999 (see Note 11), the
Company's Cryocare System (TM) was distributed exclusively by Boston Scientific
for urological applications.
Customer credit may be extended based upon evaluation of the customer's
financial condition. The Company maintains reserves for credit losses, and
Company management considers such reserves to be adequate based upon historical
experience. International shipments are billed and collected by the Company in
U.S. dollars.
During the year ended December 31, 1999, no customer accounted for more than 10%
of the Company's total revenues. As of December 31, 1999, one customer accounted
for approximately 11% of net accounts receivable. The Company derived 12% of
its total revenues from foreign customers during the year ended December 31,
1999. By significant geographic area, approximately 9%, 3% and 88% of revenues
were from Asia, other foreign countries and the United States, respectively.
During the year ended December 31, 1998, 9 customers accounted for 40% of the
Company's total revenues. During the year ended December 31, 1998, Boston
Scientific accounted for 41% of the Company's revenues. As of December 31,
1998, four customers accounted for approximately 98% of net accounts receivable.
The Company derived 8% of its total revenues from foreign customers during the
year ended December 31, 1998.
During the year ended December 31, 1997, Boston Scientific accounted for 59% of
total revenues. As of December 31, 1997, one customer and Boston Scientific
accounted for approximately 44% and 48%, respectively, of net accounts
receivable. The Company derived approximately 5% of its total revenues from
foreign customers during the year ended December 31, 1997.
14. RELATED PARTY TRANSACTIONS
Relationship with AMP
As of December 31, 1998, the Company had a $135,000 note payable from AMP. The
loan bore interest at prime plus 1% and was originally repayable beginning
September 30, 2000 in equal monthly installments of principal and interest over
a twelve month period. The loan was secured by the assets of AMP and Robert F.
Byrnes, a former member of AMP and a member of Endocare's Board of Directors.
In June 1999, Endocare acquired all of the outstanding units of interest in AMP
in exchange for 260,000 shares of common stock. Mr. Byrnes received 102,413
shares of common stock for his ownership interest in AMP.
Loan to Officers
In November 1999, the Company received a full recourse promissory note for
$1,028,125 in connection with the sale of 175,000 shares of its common stock to
Jerry W. Anderson, the Company's Senior Vice President, Sales and Marketing.
The note bears interest at 5.99% per annum, payable annually, and the principal
is payable in September 2003. The stock was sold at the fair market value of
the common stock on the date of sale. As of December 31, 1998 and 1999, the
Company had loans and related accrued interest due from various other officers
totaling $104,228 and $93,725, respectively, which is included in other assets
in the accompanying consolidated balance sheet. The loans accrue interest at
5.41% and all interest and principal are payable on August 25, 2000.
<PAGE>
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
TOTAL NET LOSS
REVENUE NET LOSS PER SHARE
---------- ------------ -----------
<S> <C> <C> <C>
Quarter Ended:
December 31, 1999. $1,169,023 $(2,332,833) $ (0.21)
September 30, 1999 1,029,220 (2,510,629) (0.23)
June 30, 1999. . . 606,510 (2,577,036) (0.24)
March 31, 1999 . . 657,121 (1,843,677) (0.17)
December 31, 1998. $ 601,788 $(1,463,302) $ (0.14)
September 30, 1998 538,666 (1,191,229) (0.11)
June 30, 1998. . . 821,306 (1,221,940) (0.12)
March 31, 1998 . . 533,090 (1,048,093) (0.12)
December 31,1997 . $ 595,157 $(1,013,902) $ (0.12)
September 30, 1997 606,164 (1,131,074) (0.13)
June 30, 1997. . . 466,804 (1,137,311) (0.13)
March 31, 1997 . . 679,668 (739,454) (0.10)
</TABLE>
<PAGE>
ENDOCARE, INC. AND SUBSIDIARY
SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ALLOWANCE FOR RESERVE FOR
DOUBTFUL RECEIVABLES INVENTORY OBSOLESCENCE
AND SALES RETURNS AND NET REALIZABLE VALUE
------------------- --------------------------
<S> <C> <C>
Balance at December 31, 1996 $ 58,139 $ 77,236
Charges to operations. . . 249,983 62,764
Deductions . . . . . . . . (116,122) --
Other. . . . . . . . . . . -- --
------------------- --------------------------
Balance at December 31, 1997 192,000 140,000
Charges to operations. . . 34,736 87,000
Deductions . . . . . . . . (140,736) (25,000)
Other. . . . . . . . . . . -- --
------------------- --------------------------
Balance at December 31, 1998 86,000 202,000
Charges to operations. . . 254,238 109,059
Deductions . . . . . . . . (70,238) (181,059)
Other. . . . . . . . . . . -- --
------------------- --------------------------
Balance at December 31, 1999 $ 270,000 $ 130,000
=================== ==========================
</TABLE>
<PAGE>
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.
ENDOCARE, INC.
By: /s/ PAUL W. MIKUS
--- ---------------
Paul W. Mikus
Chief Executive Officer and
President
Dated: March 28, 2000
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 indicated on March 28, 2000.
<TABLE>
<CAPTION>
SIGNATURE TITLE
- ---------- -----
<S> <C>
/s/ PAUL W. MIKUS . . . . . . Chief Executive Officer, President,
- -------------------------------
Paul W. Mikus . . . . . . . . . and Chairman of the Board
/s/ WILLIAM R. HUGHES . . . . Senior Vice President and
- -------------------------------
William R. Hughes . . . . . Chief Financial Officer
(Principal Financial and
Accounting Officer)
/s/ PETER F. BERNARDONI
- -------------------------------
Peter F. Bernardoni . . . . . . Director
/s/ ROBERT F. BYRNES
- -------------------------------
Robert F. Byrnes. . . . . . . . Director
/s/ BENJAMIN GERSON, M.D.
- -------------------------------
Benjamin Gerson, M.D. . . . . . Director
/s/ ALAN L. KAGANOV, SC.D
- -------------------------------
Alan L. Kaganov, Sc.D . . . . . Director
/s/ MICHAEL J. STRAUSS, M.D.
- -------------------------------
Michael J. Strauss, M.D.. . . . Director
</TABLE>
<PAGE>
ENDOCARE, INC.
INDEX TO EXHIBITS
2.1 Distribution Agreement between the Registrant and Medstone
International, Inc., dated October 31, 1995(1)
3.1 Certificate of Incorporation of the Company(2)
3.2 Amended and Restated Bylaws of the Company(3)
4.1 Specimen Certificate of the Company's Common Stock(4)
10.1 Form of Indemnification Agreement(2)
10.2 1995 Stock Plan(1)
10.3 1995 Director Option Plan(1)
10.4 Patent License Agreement between the Company and Brigham and Women's
Hospital, Inc., dated April 17, 1996(5)
10.5 Form of Warrant to purchase an aggregate of 150,000 shares of common
stock, dated August 26, 1996(6)
10.6 Common Stock Purchase Agreement by and among the Company and the
persons listed on the Schedule of Investors attached thereto as Exhibit
A, dated January 21, 1997(7)
10.7 Facility Lease dated January 31, 1997 for 7 Studebaker(8)
10.8 Common Stock Purchase Agreements by and among the Company and the
persons indicated therein, dated April 15 and April 11, 1998(3)
10.9 Rights Agreement, dated as of March 31, 1999, between the Company and
U.S. Stock Transfer Corporation, which includes the form of Certificate of
Designation for the Series A Junior Participating Preferred Stock as Exhibit A,
the form of Rights Certificate as Exhibit B and the Summary of Rights to
Purchase Series A Preferred Shares as Exhibit C. (filed as Exhibit 4 to Form
8-K filed on June 3, 1999) (9)
10.10 Debenture dated June 7, 1999 between the Company and Brown Simpson
Strategic Growth Fund, Ltd. (filed as Exhibit 4.1 to Form 8-K filed on June 14,
1999) (10)
10.11 Debenture dated June 7, 1999 between the Company and Brown Simpson
Strategic Growth Fund, L.P. (filed as Exhibit 4.2 to Form 8-K filed on June 14,
1999) (10)
10.12 Securities Purchase Agreement dated June 7, 1999 among the Company and
the Purchasers. (filed as Exhibit 10.1 to Form 8-K filed on June 14, 1999) (10)
10.13 Registration Rights Agreement dated June 7, 1999 among the Company and
the Purchasers. (filed as Exhibit 10.2 to Form 8-K filed on June 14, 1999) (10)
10.14 Debenture dated July 29, 1999 between the Company and Brown Simpson
Strategic Growth Fund, Ltd., (filed as Exhibit 4.1 to Form 8-K filed on August
6, 1999) (11)
10.15 Debenture dated July 29, 1999 between the Company and Brown Simpson
Strategic Growth Fund, Ltd. (filed as Exhibit 4.1 to Form 8-K filed on August
6, 1999) (11)
10.16 Securities Purchase Agreement dated July 29, 1999 among the Company
and the Purchasers. (filed as Exhibit 10.1 to Form 8-K filed on August 6, 1999)
(11)
10.17 Registration Rights Agreement dated July 29, 1999 among the Company
and the Purchasers. (filed as Exhibit 10.2 to Form 8-K filed on August 6, 1999)
(11)
10.18 Loan and Security Agreement dated July 29, 1999 between the Company
and TBCC. (filed as Exhibit 10.3 to Form 8-K filed on August 6, 1999) (11)
10.15 Streamlined Facility Agreement dated July 29, 1999 between the Company
and TBCC. (filed as Exhibit 10.3 to Form 8-K filed on August 6, 1999) (11)
10.16 Continuing Guaranty dated July 29, 1999 by the AMP in favor of TBCC.
(filed as Exhibit 10.3 to Form 8-K filed on August 6, 1999) (11)
10.17 Security Agreement dated July 29, 1999 between AMP and TBCC. (filed
as Exhibit 10.3 to Form 8-K filed on August 6, 1999) (11)
23.1 Consent of KPMG LLP*
27.1 Financial Data Schedule*
__________
(1) Previously filed with the Company's Application for Registration on Form
10-SB under the Securities Exchange Act of 1934, filed on November 14, 1995, and
incorporated herein by reference. Each such exhibit had the same exhibit number
in that filing, except that the 1995 Stock Plan was exhibit number 10.6 and the
1995 Director Option Plan was exhibit 10.7.
(2) Previously filed with Amendment number 1 to Company's Application for
Registration on Form 10-SB, filed on December 21, 1995, and incorporated herein
by reference.
(3) Previously filed with the Company's current report on Form 8-K dated
April 15, 1998 as filed with the Securities and Exchange Commission on April 23,
1998, and incorporated herein by reference.
(4) Previously filed with the Company's Annual Report on Form 10-K for the
year ended December 31, 1995, and incorporated herein by reference.
(5) Previously filed with the Company's Current Report on Form 8-K, as
amended, as filed with the Securities and Exchange Commission on April 26, 1996,
and incorporated herein by reference.
(6) Previously filed with the Company's Current Report on Form 8-K dated as
filed with the Securities and Exchange Commission on September 10, 1996, and
incorporated herein by reference.
(7) Previously filed with the Company's Current Report on Form 8-K as filed
with the Securities and Exchange Commission on January 31, 1997, and
incorporated herein by reference.
(8) Previously filed with the Company's Annual Report on Form 10-K/A
(Amendment No. 3) for the year ended December 31, 1996, and incorporated herein
by reference.
(9) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on June 3, 1999, and incorporated
herein by reference.
(10) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on June 14, 1999, and incorporated
herein by reference.
(11) Previously filed with the Company's current report on Form 8-K as filed
with the Securities and Exchange Commission on August 6, 1999, and incorporated
herein by reference.
* Filed herewith.
(b) REPORTS ON FORM 8-K
None
<PAGE>
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