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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended March 30, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number: 0-27422
ARTHROCARE CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 94-3180312
(State of incorporation) (I.R.S. Employer
Identification No.)
595 North Pastoria Avenue
Sunnyvale, California 94086
(Address of principal executive offices)
(408) 736-0224
(Registrant's telephone number, including area code)
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
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The number of shares outstanding of the registrant's common stock as of April
30, 1996 was 8,670,725.
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ARTHROCARE CORPORATION
INDEX
Page
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PART 1: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Balance Sheets as of March 30,1996 and 3
December 31, 1995.
Condensed Statements of Operations for the three months
ended March 30, 1996 and March 31, 1995. 4
Condensed Statements of Cash Flows for the three months
ended March 30, 1996 and March 31, 1995. 5
Notes to the Condensed Financial Statements 6
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 7-18
PART II: OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES 19
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 19-21
SIGNATURE 22
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PART I - FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ARTHROCARE CORPORATION
Condensed Balance Sheets
(In thousands)
<TABLE>
<CAPTION>
March 30, December 31,
ASSETS 1996 1995
----------- ------------
(Unaudited)
<S> <C> <C>
Current assets
Cash and cash equivalents $ 24,801 $ 4,774
Available-for-sale securities 8,240 -
Accounts receivable, net 863 212
Inventory 1,143 516
Prepaid expenses and other
current assets 355 891
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Total current assets 35,402 6,393
Property and equipment, net 1,090 1,135
Related party receivables 241 223
Available-for-sale securities 1,586 -
Other assets 69 49
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Total assets $ 38,388 $ 7,800
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LIABILITIES
Current liabilities
Accounts payable $ 1,051 $ 733
Related party payables 36 35
Accrued liabilities 577 472
Capital lease obligation,
current 35 34
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Total current liabilities 1,699 1,274
Capital lease obligation, net of
current portion 44 53
Deferred rent 163 148
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Total liabilities 1,906 1,475
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STOCKHOLDERS' EQUITY
Convertible Preferred Stock - 9
Common Stock 9 2
Additional paid in capital 48,767 16,869
Notes receivable from stockholders (92) (92)
Deferred compensation (509) (550)
Accumulated deficit (11,656) (9,913)
Unrealized loss on investment (37) -
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Total stockholders' equity 36,482 6,325
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Total liabilities and
stockholders' equity $ 38,388 $ 7,800
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</TABLE>
The accompanying notes are an integral part of the financial statements
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ARTHROCARE CORPORATION
Condensed Statements of Operations
(In thousands, except share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 30, March 31,
1996 1995
------------ ------------
<S> <C> <C>
Net sales $ 1,159 $ -
Cost of sales 1,065 -
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Gross margin 94 -
Operating expenses:
Research and development 864 644
Sales and marketing 658 188
General and administrative 576 135
Non-recurring charge for
acquired technology - 260
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Total operating expenses 2,098 1,227
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Loss from operations (2,004) (1,227)
Interest and other income, net 263 21
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Loss before provision for income
taxes (1,741) (1,206)
Income taxes 2 -
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Net loss $ (1,743) $ (1,206)
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Net loss per share $ (0.25) $ (0.27)
------------ ------------
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Shares used in per share
calculation 6,856,086 4,420,370
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</TABLE>
The accompanying notes are an integral part of the financial statements
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ARTHROCARE CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended:
March 30, March 31,
1996 1995
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss ($1,743) ($1,206)
Adjustments to reconcile net loss to net cash used in
operating activities:
Non-recurring charge for acquired technology - 260
Depreciation and amortization 77 19
Write-off of property and equipment 187 -
Amortization of deferred compensation 41 -
Provision for doubtful accounts 19 -
Provision for excess and obsolete inventory 5 -
Deferred rent 15 18
Changes in operating assets and liabilities:
Accounts receivable (670) -
Related party receivables (18) -
Inventory (632) -
Prepaid expenses and other current assets 536 (31)
Accounts payable 319 (14)
Accrued liabilities 105 16
Other assets (20) (52)
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Net cash used in operating activities (1,779) (990)
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Cash flows from investing activities:
Purchases of property and equipment (219) 3
Purchase of available-for-sale securities (9,863) -
Purchase of intellectual property rights - (100)
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Net cash used in investing activities (10,082) (97)
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Cash flows from financing activities:
Issuance of notes receivable to related parties - (124)
Repayment of capital leases (8) (2)
Proceeds from issuance of Common Stock 31,896 2
Proceeds from issuance of Preferred Stock - 4,748
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Net cash provided by financing activities 31,888 4,624
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Net increase in cash and cash equivalents 20,027 3,537
Cash and cash equivalents, beginning of period 4,774 2,599
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Cash and cash equivalents, end of period $24,801 $6,136
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Supplemental schedule of non-cash investing and financing
activities:
Issuance of Common Stock on conversion of Preferred Stock $15,704 $ -
Unrealized loss on avaliable for sale securities $ 37 $ -
Common stock issued for intellectual property rights $ - $ 160
</TABLE>
The accompanying notes are an integral part of the financial statements
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ARTHROCARE CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
In the opinion of management, the accompanying unaudited condensed
financial statements contain all adjustments (all of which are normal and
recurring in nature) necessary to present fairly the financial position, results
of operations and cash flows of ArthroCare Corporation ("the Company"). Interim
results of operations are not necessarily indicative of the results to be
expected for the full year. The notes to the financial statements contained in
the Registration Statement on Form S-1 (the "Registration Statement") declared
effective by the Securities and Exchange Commission on February 5, 1996 should
be read in conjunction with these condensed financial statements. The balance
sheet at December 31, 1995 was derived from audited financial statements;
however, it does not include all disclosures required by generally accepted
accounting principles.
2. COMPUTATION OF NET LOSS PER SHARE
The net loss per share is based upon the weighted average number of common
and common equivalent shares outstanding. Common equivalent shares from stock
options, warrants and preferred stock are excluded from the computation as their
effect is anti-dilutive, except that, pursuant to the Securities and Exchange
Commission Staff Accounting Bulletin No. 83, common and common equivalent shares
issued by the Company during the twelve months preceding the initial offering
date have been included in the calculations as if they were outstanding for all
of the periods presented (using the treasury stock method and the public
offering price per share).
3. INITIAL PUBLIC OFFERING
In February 1996, the Company completed its initial public offering of
common stock. A total of 2.5 million shares of Common Stock was sold for net
proceeds to the Company of approximately $32 million, after deducting
underwriters' discounts and commissions. Upon completion of the offering, all
outstanding shares of Preferred Stock (a total of 8.7 million shares) were
converted into 4.3 million shares of Common Stock on a one-for-two basis.
4. COMPONENTS OF INVENTORY:
March 31, 1996 Dec. 31, 1995
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Inventory: (in thousands)
Raw materials $ 579 $ 418
Work-in-process 174 2
Finished goods 390 96
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$1,143 $ 516
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PART 1. FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATION
OVERVIEW
Since commencing operations in April 1993, ArthroCare Corporation has
primarily engaged in the design, development, clinical testing and manufacturing
of its Arthroscopic System. The Company has a limited history of operations
that, to date, has consisted primarily of research and development, product
engineering, obtaining FDA clearance of its Arthroscopic System and efforts to
develop a network of distributors in the United States to market the
Arthroscopic System. The Company received clearance of its 510(k) premarket
notification from the FDA in March 1995 to market its Arthroscopic System in
the United States for arthroscopic surgery of the knee, shoulder, elbow and
ankle. Although the Company shipped a small number of sample units in August
1995, it did not commercially introduce the Arthroscopic System until December
1995.
The Company's Arthroscopic System incorporates an electrosurgical system
consisting of a disposable, bipolar ArthroWand, a connecting cable and a
radio frequency power controller. The ArthroWand ablates soft tissue with
minimal damage to surrounding healthy tissue, and simultaneously achieves
hemostasis. The Company's long term strategy includes applying its
proprietary technology to a range of other soft tissue surgical procedures in
the fields of urology, gynecology, dermatology, and plastic, oral, and
general surgery.
Forward-looking statements in this report are made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that such forward-looking statements involve risks
and uncertainties, including, without limitation, risks disclosed under the
caption "Additional Factors That Might Affect Future Results" beginning on
page 9 of this report, and other risks detailed from time to time in the
Company's filings with the Securities and Exchange Commission. The Company's
actual results may differ materially from the results discussed in the
forward-looking statements.
RESULTS OF OPERATIONS
The three month period ended March 30, 1996 is the Company's first full
quarter of shipments. The company was in its development stage during the
comparable three month period ended March 31, 1995.
REVENUES
Revenues for the three month period ended March 30, 1996 were $1.2 million.
There were no revenues in the quarter ended March 31, 1995, as the Company was
in its development stage. Approximately 75% of the sales for the quarter can be
attributed to initial stocking orders from the approximately 30 (thirty) dealer
distributors in the United States. The promotional controllers and wands
purchased this quarter by dealer distributors were at or near cost. These
dealer distributors have now purchased enough controllers and initial inventory
of wands to support the approximately 165 sales representatives' demonstrations
and evaluations of the ArthroCare System to doctors and hospitals. By the end
of the first quarter approximately 50 (fifty) ArthroCare Systems have been
placed with doctors or hospitals primarily as the result of the demonstration
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and evaluations performed by the sales representatives. For the quarter, the
sales mix of controllers and disposable wands were approximately even.
Management believes that the revenue mix in the first quarter of shipments is
not indicative of future revenues, but rather an indication of dealer product
acceptance.
COST OF SALES
Cost of sales were $1.1 million, or 92% of revenues for the three months
ended March 30, 1996. There is no comparison to the three months ended March
31, 1995, as the Company was in its development stage. In spite of
controller sales to dealers at near cost, higher manufacturing volume
absorbed more overhead costs than planned resulting in a positive gross
margin. The Company believes that if revenues increase, gross margin could
improve in future quarters.
OPERATING EXPENSE:
RESEARCH AND DEVELOPMENT expense, which includes expenditures for
regulatory compliance and quality assurance, increased 34% to $864K in three
months ended March 30, 1996 from $644K in the same quarter of the prior
year. The increase was due primarily to costs associated with additional
product research, prototype development, patent preparation and filing,
supplemental facility requirements, and additional costs associated with the
Company's increase in regulatory and clinical personnel.
In March 1995, the Company acquired Thapliyal & Eggers Partners resulting
in a non-recurring charge for acquired technology of $260,000.
The Company believes that its investment in product development and
engineering and manufacturing processes are essential to enable it to maintain
its competitive position. The Company expects to continue to make substantial
expenditures on new product development and currently anticipates increases in
research and development spending to continue.
SALES AND MARKETING expense increased substantially to $658K in the
quarter ended March 30, 1996 from $188K in the quarter ended March 31, 1995
when the Company was in its development stage. The increase is due primarily
to the hiring of additional personnel, demonstration and sample expenses and
dealer commissions.
The Company currently anticipates that sales and marketing spending will
continue to increase driven primarily by dealer commissions, and investment in
additional sales, marketing and support staff necessary to market its product.
GENERAL AND ADMINISTRATIVE expense increased substantially to $576K in
the three months ended March 30, 1996 from $135K in the three months ended
March 31, 1995 due to additional staffing, including management personnel,
the increased cost of being a public company, consulting fees, and
information systems services necessary to expand the corporate infrastructure.
The Company expects that general and administrative expenses will increase
as the Company expands its staffing and other support operations required to
grow the business.
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INTEREST AND OTHER INCOME
Net interest income increased to $263K for the quarter ended March 30, 1996
from $21K in the prior year quarter. The increase is attributable to interest
received on the investment of the proceeds of the initial pubic offering during
the current quarter.
NET LOSS
Net loss was $1.7 million for the quarter ended March 30, 1996 compared to
$1.2 million in the same quarter of 1995, when the Company was in its
development stage. The increase is due primarily to higher operating expense
from increased business activity including product development, manufacturing
start-up, building a sales and marketing organization, bringing the ArthroCare
Arthroscopic System to market and building the corporate infrastructure.
LIQUIDITY AND CAPITAL RESOURCES
At March 30, 1996 the Company had approximately $33.7 million in working
capital and its principal sources of liquidity consisted of $34.6 million in
cash, cash equivalents, and available-for-sale securities. The cash and cash
equivalents are highly liquid with original maturities of ninety days or less.
The available-for-sale securities consist mainly of bank notes, commercial paper
rated Aa or better and US government securities. The Company has $44K of long
term capital lease obligations.
Net cash provided by financing activities reflect the Company's completion
of its initial public offering of common stock during February 1996. A total of
2,530,000 shares of Common Stock were sold for net proceeds to the Company of
$31.9 million. Proceeds from the sale of common stock were used to purchase
available-for-sale securities.
The Company believes that the net proceeds from the sale of common stock,
together with its current cash balances will be sufficient to meet its working
capital and capital expenditure requirements for at least the next twelve
months.
ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS
Since the first quarter of 1996 was ArthroCare's first quarter as a
public company, included here are risk factors as updated from the Company's
Prospectus dated February 5, 1996. The following factors represent current
challenges to the Company which create risk and uncertainty. Failure to
adequately overcome any of the following challenges, either singly or in
combination, could have a materially adverse effect on the Company's results of
operations, business, or financial position.
DEPENDENCE UPON ARTHROSCOPIC SYSTEM
The Arthroscopic System is the Company's only commercial product and will
account for substantially all of the Company's revenue for the foreseeable
future. The Company commercially introduced the Arthroscopic System in December
1995 and by the end of the first quarter of 1996, had reported only four months
of sales. To date, the Company has only sold a limited number of units and
these have been utilized by a limited number of doctors primarily for
arthroscopic procedures in the knee and shoulder.
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UNCERTAINTY OF MARKET ACCEPTANCE
The Company's Arthroscopic System and potential products are based upon a
new method of tissue ablation, and there can be no assurance that any of these
products will gain market acceptance. Physicians will not use the Company's
products unless they determine, based on experience, clinical data, and other
factors, that these systems are an attractive alternative to current means of
tissue ablation. To date, the Arthroscopic System has only been used to treat a
limited number of patients, and no published reports exist to support the
Company's marketing efforts, which may have an adverse effect on its ability to
obtain physician acceptance. The Company believes that recommendations and
endorsements by influential physicians will be essential for market acceptance
of its products. In addition, purchase decisions are greatly influenced by
health care administrators who are subject to increasing pressures to reduce
costs. Health care administrators must determine that the Arthroscopic System
and the Company's potential products are cost-effective alternatives to current
means of tissue ablation. The Company may be required to, among other things,
offer substantial discounts on its controller to stimulate demand for its
Arthroscopic System. Whether the Company can place sufficient quantities of
controllers to obtain physician acceptance of its products and sell disposable
ArthroWands is uncertain.
LIMITED OPERATING HISTORY
The Company has a limited history of operations that, to date, has
consisted primarily of research and development, product engineering,
obtaining FDA clearance of its Arthroscopic System and developing a network
of distributors in the United States to market the Arthroscopic System. The
Company has generated limited revenues from the sale of its products, and
there can be no assurance that it will ever achieve significant revenues on
an ongoing basis. Whether the Company can successfully manage the transition
to a larger-scale commercial enterprise will depend upon increasing sales
from its domestic distribution network, the successful development of its
manufacturing capability, obtaining foreign regulatory approvals for the
Arthroscopic System, obtaining domestic and foreign regulatory approvals
for potential products and strengthening its financial and management
systems, procedures and controls.
LIMITED DOMESTIC AND INTERNATIONAL MARKETING AND SALES EXPERIENCE
The Company has only sold a few of its Arthroscopic Systems and has limited
experience marketing and selling such product in commercial quantities. The
Company markets and sells its Arthroscopic System in the United States through a
network of independent orthopedic distributors. While dealer distributors have
purchased controllers at greatly reduced prices to be used for doctor
evaluations and demonstrations, there can be no assurance that sales
representatives will be successful in closing sales with doctors and hospitals.
These distributors sell orthopedic arthroscopy devices for a number of other
manufacturers, and there can be no assurance that they will commit the necessary
resources to effectively market and sell the Company's Arthroscopic System. The
Company may be required to, among other things, offer substantial discounts on
its controller to stimulate demand for its Arthroscopic System. The inability
to place sufficient quantities of controllers would have a material adverse
effect the Company's ability to sell ArthroWands.
The Company has not obtained the necessary regulatory approvals to market
and sell its Arthroscopic System in any foreign market. If the Company is
successful in obtaining the necessary regulatory approvals in foreign markets,
it expects to establish a sales and marketing capability in those markets.
However, regulatory requirements vary
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by region, and compliance with such regulations may be costly and time-
consuming. Accordingly, the distribution, pricing and marketing structure to be
established by the Company may vary from country to country. In Europe, the
Company intends to establish a network of distributors to market and distribute
its Arthroscopic System. In Japan, the Company intends to collaborate with one
or more marketing partners to assist with regulatory requirements and to market
and distribute its Arthroscopic System. No assurance can be given that the
Company will obtain any necessary foreign regulatory approvals, that the Company
will establish a network of distributors and successfully sell its product in
Europe, that the Company will secure a marketing partner and successfully sell
its Arthroscopic System in Japan or that any foreign distributors and marketing
partners will commit the necessary resources and successfully sell the
Arthroscopic System in foreign markets.
LIMITED MANUFACTURING EXPERIENCE
The Company has only limited experience in manufacturing the Arthroscopic
System. As a result, the Company has limited experience manufacturing its
product in the volumes necessary for the Company to achieve significant
commercial sales, and there can be no assurance that reliable, high-volume
manufacturing can be achieved at a commercially reasonable cost. In September
1995, the State of California required the Company to cease shipping products
until a manufacturing license was obtained, and the FDA, following a Good
Manufacturing Practices ("GMP") audit, instructed the Company to correct certain
record keeping practices and enter into a written contract with the third party
that sterilizes the ArthroWand. There can be no assurance that the Company will
not encounter any further manufacturing difficulties, or any of its contract
manufacturers will not experience similar difficulties, including problems
involving production yields, quality control and assurance, supplies of
components or shortages of qualified personnel.
RISK OF FURTHER PRODUCT RECALLS OR REQUIRED REDESIGN
In October 1995, the Company discovered that the ArthroWand packaging
was subject to cracking due to a flawed design of the packaging tray and
undertook a voluntary product recall of the 61 ArthroWands affected. The
Company has completed execution of its corrective action and has received
written confirmation from the FDA that the recall has been closed. There can
be no assurances that there will be no further product recalls or required
redesign of the company's packaging or products.
HISTORY OF LOSSES: FLUCTUATIONS IN OPERATING RESULTS, SUBSTANTIAL LOSSES
EXPECTED TO CONTINUE
The Company has experienced significant operating losses since inception
and, as of March 30, 1996, had an accumulated deficit of $11.7 million. The
Company expects to generate substantial additional losses due to increased
operating expenditures primarily attributable to the expansion of marketing and
sales activities, scale-up of manufacturing capabilities, increased research and
development and activities to support regulatory and reimbursement applications.
Results of operations may fluctuate significantly from quarter to quarter due to
the timing of such expenditures, absence of a backlog of orders, timing of the
receipt of orders, promotional discounts of the Company's products, re-use of
the Company's disposable products, availability of third-party reimbursement,
timing of regulatory actions, introduction of new products by competitors of the
company, pricing of competitive products and the cost and effect of promotional
and marketing programs. The Company's revenues and profitability will be
critically dependent on whether it can
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successfully market its Arthroscopic System. In addition, the Company's gross
margins may be adversely affected due to the necessity to sell its product at
significantly reduced prices. There can be no assurance that significant
revenue or profitability will ever be achieved.
RELIANCE ON PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY
The Company's ability to compete effectively will depend in part on its
ability to develop and maintain proprietary aspects of its technology. The
Company owns four issued United States patents, six pending United States patent
applications and international patent applications in Europe (covering 16
separate countries), Japan, Canada, Australia and New Zealand corresponding to
three of the United States filings relating to its multi-electrode technology.
The initial patent is set to expire in 2008, and the other three issued patents
are currently expected to expire between 2008 and 2012. None of the issued
patents have specific arthroscopic claims. There can be no assurance that the
patents that have been issued to the Company or any patents which may be issued
as a result of the Company's United States or international patent applications
will provide any competitive advantages for the Company's products or that they
will not be successfully challenged, invalidated or circumvented in the future.
In addition, there can be no assurance that competitors, many of which have
substantial resources and have made substantial investments in competing
technologies, will not seek to apply for and obtain patents that will prevent,
limit or interfere with the Company's ability to make, use and sell its products
either in the United States or in international markets.
A number of medical device and other companies, universities and research
institutions have filed patent applications or have issued patents relating to
monopolar and/or bipolar electrosurgical methods and apparatus. If third-party
patents or patent applications contain claims infringed by the Company's
technology and such claims are ultimately determined to be valid, there can be
no assurance that the Company would be able to obtain licenses to these patents
at a reasonable cost, if at all, or be able to develop or obtain alternative
technology. There can be no assurance that the Company will not be obliged to
defend itself in court against allegations of infringement of third-party
patents.
In addition to patents, the Company relies on trade secrets and proprietary
know-how, which it seeks to protect, in part, through confidentiality and
proprietary information agreements. There can be no assurance that such
confidential or proprietary information agreements will not be breached, that
the Company would have adequate remedies for any breach, or that the Company's
trade secrets will not otherwise become known to or be independently developed
by competitors.
PATENT LITIGATION
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that the Company will not
become subject to patent infringement claims or litigation or interference
proceedings declared by the United States Patent and Trademark Office ("USPTO")
to determine the priority of inventions. The defense and prosecution of
intellectual property suits, USPTO interference proceedings and related legal
and administrative proceedings are both costly and time-consuming. Litigation
may be necessary to enforce patents issued to the Company, to protect trade
secrets or know-how owned by the Company or to determine the enforceability,
scope and validity of the proprietary rights of others. Any litigation or
interference proceedings will result in substantial expense to the Company and
significant diversion of effort by the Company's
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technical and management personnel. An adverse determination in litigation or
interference proceedings to which the Company may become a party could subject
the Company to significant liabilities to third parties, require dispute rights
to be licensed from third parties or require the Company to cease using such
technology. Although patent and intellectual property disputes regarding
medical devices have often been settled through licensing or similar
arrangements, costs associated with such arrangements may be substantial and
could include ongoing royalties. Furthermore, there can be no assurance that
necessary licenses would be available to the Company on satisfactory terms, if
at all.
INTENSE COMPETITION
The arthroscopic medical device industry is intensely competitive. The
Company competes with providers of laser systems, electrosurgical systems,
manual instruments and power shavers. Many of these competitors have
significantly greater financial, manufacturing, marketing, distribution and
technical resources than the Company. There can be no assurance that the
Company can effectively compete against such competitors. In addition, there
can be no assurance that these or other companies will not succeed in developing
technologies and products that are more effective than the Company's or that
would render the Company's technology or products obsolete or uncompetitive.
Smith & Nephew Endoscopy, Inc. (which owns Acufex Microsurgical, Inc.,
and Dyonics, Inc.), Bristol-Meyers Squibb Company (including its Linvatec
division) and Stryker Corp. each have large shares of the market for manual
instruments, power shavers and arthroscopes. These companies offer broad
product lines, which they may offer as a single package, have substantially
greater resources and name recognition than the Company and frequently offer
significant discounts as a competitive tactic. In addition, Pfizer Inc.
(including its Valley Labs division) and Bristol-Meyers Squibb Company each
have large shares of the market for electrosurgical systems, and Trimedyne,
Inc. and Coherent, Inc. each have large shares of the market for laser
systems. The Company expects that competition from these well established
competitors will increase, and the Company anticipates that it may have to
offer substantial discounts on its controller in order to stimulate demand
for the disposable ArthroWand.
UNCERTAINTY OF DOMESTIC AND FOREIGN REGULATORY APPROVALS; EXTENSIVE DOMESTIC AND
FOREIGN GOVERNMENT REGULATION
The manufacturing, labeling, distribution and marketing of the Company's
products are subject to extensive and rigorous government regulation in the
United States and certain other countries where the process of obtaining and
maintaining required regulatory approvals is lengthy, expensive and uncertain.
In order for the Company to market its products for clinical use in the United
States, the Company must obtain clearance from the FDA of a 510(k) premarket
notification or approval of a more extensive submission known as premarket
approval ("PMA"). The Company has obtained clearance of a 510(k) premarket
notification for use of its Arthroscopic System in the knee, shoulder, elbow and
ankle. Although the Company is strictly limited to marketing its product only
for the indications for which it was cleared, physicians are not prohibited by
the FDA from using the products for indications other than those cleared by the
FDA. There can be no assurance that the Company will not become subject to FDA
actions resulting from physician use of its Arthroscopic System that is outside
of its approved indications.
In December 1995, the Company filed 510(k) submissions for clearance to
market tissue ablation products to treat certain urological and gynecological
conditions. In March 1996, the Company received a 510(k) premarket notification
for a tissue ablation product to treat certain urological conditions. The FDA
may require clinical studies in support of the
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gynecological submission. The Company has made certain modifications to the
Arthroscopic System that the Company believes do not require the submission of
new 510(k) notifications. There can be no assurance, however, that the FDA
would agree with the Company's determination not to submit a new 510(k)
premarket notification for the changes, or can there by any assurance that the
FDA would not require the Company to submit a new 510(k) premarket notification
for the changes made to the device. If the FDA requires the Company to submit a
new 510(k) premarket notification for any device modification, the Company may
be prohibited from marketing the modified device until 510(k) clearance is
obtained. The Company may be prohibited from marketing the modified device
until 510(k) clearance is obtained. The Company may also be required to make
additional 510(k) submission for additional potential products. There can be no
assurance that the FDA will act favorably or quickly in its review of the
Company's 510(k) submissions, or that significant difficulties and costs will
not be encountered by the Company in its efforts to obtain FDA clearance, all of
which could delay or preclude the Company from selling products in the United
States. Furthermore, there can be no assurance that the FDA will not request
additional data, require that the Company conduct clinical studies in support of
a 510(k) submission or require a PMA, any of which would cause the Company to
incur further cost and delay. If the FDA determines that a PMA is required for
any of the company's potential products, the application would require extensive
clinical studies, manufacturing information and likely a review by a panel of
experts outside the FDA. Clinical studies would need to be conducted in
accordance with FDA requirements. Failure to comply with FDA requirements could
result in the FDA's refusal to accept the clinical data or the imposition of
regulatory sanctions. FDA review of a PMA application takes significantly
longer than that for a 510(k) premarket notification. There can be no assurance
that the Company will be able to meet the requirements to obtain PMA approval or
that any necessary approvals will be received from the FDA. In addition, there
can be no assurance that the FDA will not place significant limitations upon the
intended use of the Company's products as a condition of 510(k) clearance or PMA
approval.
The Company has not obtained any foreign regulatory approval permitting
sales outside of the United States. International regulatory bodies often
establish varying regulations governing product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. In order to commence sale in Europe, the Company
will be required to obtain ISO 9001 certification and receive "CE" mark
certification, which is an international symbol of quality and compliance with
applicable European medical device directives. After mid-1998, the Company will
be prohibited from selling its products in Europe until such times as the
Company receives CE mark certification. There can be no assurance that the
Company will be successful in meeting such certification requirements. If the
Company obtains foreign regulatory approvals to sell the Arthroscopic System or
potential products, it may rely on independent distributors or distribution
partners to comply with the majority of the foreign regulatory requirements.
There can be no assurance that such third parties will comply with the varying
regulations or the imposition of new regulations.
The Company and its contract manufacturers will be required to adhere to
applicable FDA regulations regarding GMP and similar regulations in other
countries, which include testing, control, and documentation requirements.
Ongoing compliance with GMP and other applicable regulatory requirements will be
monitored through periodic inspections by state and federal agencies, including
the FDA, and by comparable agencies in other countries. Failure to comply with
applicable regulatory requirements could result in,
14 of 24
<PAGE>
among other things, warning letters, fines, injunctions, civil penalties, recall
or seizure of products, total or partial suspension of production, refusal of
the government to grant premarket clearance or premarket approval for devices,
withdrawal of approvals and criminal prosecution.
UNCERTAINTY RELATING TO THIRD-PARTY REIMBURSEMENT
In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices such as the Company's Arthroscopic
System and potential 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 the procedure in which the medical device
is being used. In addition, certain health care providers are moving towards a
managed care system in which such providers contract to provide comprehensive
health care for a fixed cost per person. Managed care providers are attempting
to control the cost of health care by authorizing fewer elective surgical
procedures, such as certain knee and shoulder arthroscopies. The Company is
unable to predict what changes will be made in the reimbursement methods
utilized by third-party health care payers. Furthermore, the Company could be
adversely affected by changes in reimbursement policies of governmental or
private health care payers, particularly to the extent any such changes affect
reimbursement for procedures in which the Company's products are used.
If the Company obtains the necessary foreign regulatory approvals, market
acceptance of the Company's products in international markets would be
dependent, in part, upon the availability of reimbursement within prevailing
health care payment systems. Reimbursement and health care payment systems in
international markets vary significantly by country, and include both government
sponsored health care and private insurance. The Company intends to seek
international reimbursement approvals, although there can be no assurance that
any such approvals will be obtained in a timely manner, if at all.
DEPENDENCE ON SINGLE CONTRACT MANUFACTURERS AND SOLE SOURCE SUPPLIERS
The controller for the Company's Arthroscopic System is assembled by a
single contract manufacturer. The agreement between the Company and the
contract manufacturer requires the Company to purchase all of its controllers
from the contract manufacturer through July 1998. The contract manufacturer is
required to operate in conformance with GMP requirements in order to produce
products for sale in the United States, and ISO 9001 standards, in order to
produce products for sale in Europe. There can be no assurance that the
contract manufacturer will remain in compliance with GMP or ISO 9001 standards.
In addition, the ArthroWand is sterilized by a single subcontractor, and the
connector housings at each end of the cable are only available from a single
source. There can be no assurance that an alternate contract manufacturer,
sterilizer or connector housings supplier would be established if necessary or
that available inventories would be adequate to meet the Company's product needs
during any prolonged interruption of supply. A reduction or stoppage in supply
of the sole source component, or the Company's inability to secure an
alternative contract manufacturer or sterilizer, if required, would limit its
ability to manufacture the Arthroscopic System.
The Company believes that its contract manufacturer, subcontractor and
suppliers are in compliance with applicable regulations However, there can be
no assurance that the FDA, or a state, local or foreign regulator will not take
action against a contract manufacturer, subcontractor or supplier found to be
violating such regulations.
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<PAGE>
UNCERTAINTY OF NEW PRODUCT DEVELOPMENT
In December 1995, the Company filed 510(k) submissions for clearance to
market tissue ablation products to treat certain urological and gynecological
conditions. In March 1996, the Company received a 510(k) premarket notification
for the tissue ablation product to treat certain urological conditions. The FDA
may require clinical studies in support of the gynecological submission. The
Company has under development certain additional potential products utilizing
the Company's proprietary technology. Each of these products is at an early
stage of development, and the Company will be required to undertake time-
consuming and costly development activities and seek regulatory approval for
these devices. There can be no assurance that product development will ever be
successfully completed, that PMAs or 510(k)s, if applied for, will be granted by
the FDA on a timely basis, if at all, or that the products will ever achieve
commercial acceptance.
PRODUCT LIABILITY RISK: LIMITED INSURANCE COVERAGE
The development, manufacture and sale of medical products entail
significant risk of product liability claims. The Company's current product
liability insurance coverage limits are $5,000,000 per occurrence and $5,000,00
in the aggregate, and there can be no assurance that such coverage limits are
adequate to protect the Company from any liabilities it might incur in
connection with the development manufacture and sale of its Arthroscopic System
and potential products. In addition, the Company may require increased product
liability coverage if any potential products are successfully commercialized.
Product liability insurance is expensive and in the future may not be available
to the Company on acceptable terms, if at all. There can be no assurance that
successful product liability claim or series of claims will not be brought
against the Company in excess of its insurance coverage.
DEPENDENCE UPON KEY PERSONNEL AND KEY CONSULTANTS
The Company is dependent upon a number of key management and technical
personnel. The loss of the services of one or more key employees or consultants
could have a material adverse effect on the Company. The Company's success will
also depend on its ability to attract and retain additional highly qualified
management and technical personnel. The Company faces intense competition for
qualified personnel, many of whom are often subject to competing employment
offers, and there can be no assurance that the Company will be able to attract
and retain such personnel. The Company has two key consulting agreements, one
with Philip E. Eggers, who is also a director of the Company, and one with
Eggers & Associates, Inc. ("E&A"). a corporation wholly owned by Mr. Eggers.
Pursuant to these agreements, Mr. Eggers performs a significant amount of the
Company's research and development and prepares materials for and attend as
meetings as requested by the Company. Mr. Eggers is not employed by the Company
on a full-time basis and, as a result, is not available to devote his full time
or attention to the Company's affairs.
CONTROL BY DIRECTORS, EXECUTIVE OFFICERS AND AFFILIATED ENTITIES
The Company's directors, executive officers and entities affiliated with
them, in the aggregate, beneficially own approximately 48% of the Company's
outstanding Common Stock. These stockholders, if acting together, would be
able to control substantially all matters requiring approval by the
stockholders of the Company, including the election of directors and the
approval of mergers or other business combination transactions.
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<PAGE>
POTENTIAL VOLATILITY OF STOCK PRICE
The stock markets have experienced price and volume fluctuations that have
particularly affected medical technology companies, resulting in changes in the
market prices of the stocks of many companies that may not have been directly
related to the operating performance of those companies. Such broad market
fluctuations may adversely affect the market price of the Common Stock following
this offering. In addition, the market price of the Company's Common Stock may
be highly volatile. Factors such as variations in the Company's financial
results, comments by security analysts, announcements of technological
innovations or new products by the Company or its competitors, changing
government regulations and developments with respect to FDA submissions,
patents, proprietary rights or litigation may have a significant adverse effect
on the market price of the Common Stock.
POTENTIAL ADVERSE EFFECT ON PRICE OF COMMON STOCK AND THE COMPANY'S ABILITY TO
RAISE CAPITAL
Sales of a substantial number of shares of the Company's Common Stock in
the public market could adversely affect the market price of the Company's
Common Stock. The holders of approximately 4,300,000 shares of Common Stock are
entitled to certain demand and piggyback rights with respect to registration of
such shares under the Securities Act of 1933 as amended (the "Securities Act").
If such holders, by exercising their demand registration rights, cause a large
number of securities to be registered and sold in the public market, such sales
could have an adverse effect on the market price for the Company's Common Stock.
If the Company were to initiate a registration and include shares held by such
holders pursuant to the exercise of their piggyback registration rights, such
sales may have an adverse effect on the Company's ability to raise capital.
POTENTIAL ADVERSE EFFECT OF UNDERWRITERS' RELEASE OF LOCK-UP RESTRICTIONS
The number of shares of Common Stock available for sale in the public
market is currently limited by lock-up agreements under which all directors,
executive officers and certain other stockholders of the Company that
beneficially own or have dispositive power over substantially all of the shares
of Common Stock outstanding prior to this offering, including Common Stock to be
issued upon the closing of this offering upon conversion of the Company's
Preferred Stock, have agreed not to sell or otherwise dispose of any of their
shares prior to August 5, 1995 without the prior written consent of Robertson,
Stephens & Company. However, Robertson, Stephens & Company may, in its sole
discretion, release all or any portion of the securities subject to such lock-up
agreements. 3,726,503 shares of Common Stock would be eligible for sale in
compliance with certain limitations set forth in the Securities Act if
Robertson, Stephens & Company were to release the lock-up restrictions. Release
of lock-up restrictions and the subsequent sale of the shares subject thereto
may have an adverse effect on the ability of the Company to raise capital and
could adversely affect the market price of Company's Common Stock.
ANTI-TAKEOVER EFFECT OF CERTAIN CHARTER AND BYLAW PROVISIONS ON PRICE OF COMMON
STOCK
Certain provisions of the Company's Certificate of Incorporation and bylaws
may have the effect of making it more difficult for a third party to acquire, or
of discouraging a third party from attempting to acquire, control of the
Company. Such provisions could limit the price that certain investors might be
willing to pay in the future for shares of the Company's Common Stock. Certain
of these provisions allow the company to issue Preferred Stock without any vote
or further action by the stockholders, eliminate the right
17 of 24
<PAGE>
of stockholders to act by written consent without a meeting, specify procedures
for director nominations by stockholders and submission of other proposals for
consideration at stockholder meetings, and eliminate cumulative voting in the
election of directors. Certain provisions of Delaware law applicable to the
Company could also delay or make more difficult a merger, tender offer or proxy
contest involving the Company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. The
possible issuance of Preferred Stock, the procedures required for director
nominations and stockholder proposals and Delaware law could have the effect of
delaying, deferring or preventing a change in control of the Company, including
without limitation, discouraging a proxy contest or making more difficult the
acquisition of a substantial block of the Company's common stock. These
Provisions could also limit the price that investors might be willing to pay in
the future for shares of the Company's Common Stock.
LACK OF DIVIDENDS
The Company has not paid any dividends and does not anticipate paying any
dividends in the foreseeable future.
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<PAGE>
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEDINGS
None
ITEM 2. CHANGES IN SECURITIES
Upon the closing of the Company's initial public offering in
February 1996, all outstanding shares of preferred stock were
automatically converted into 4,338,874 shares of common stock.
Promptly following such closing, the Company filed a Restated
Certificate of Incorporation which eliminated the previously
authorized preferred stock, authorized 5,000,000 shares of
undesignated preferred stock and increased the authorized common stock
to 20,000,000 shares.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8 - K.
a) Exhibits
3.2 Certificate of Incorporation of Company.
3.3 Bylaws of the Company.
4.1* Specimen Common Stock Certificate.
10.1* Form of Indemnification Agreement between the Company
and each of its directors and officers.
10.2* Incentive Stock Plan and form of Stock Option
Agreement thereunder.
10.3* Director Option Plan and form of Director Stock Option
Agreement thereunder.
10.4* Employee Stock Purchase Plan and forms of agreements
thereunder.
10.5* Form of Exclusive Distribution Agreement.
10.6* Form of Exclusive Sales Representative Agreement
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<PAGE>
10.7* Consulting Agreement, dated May 10, 1993, between the
Company and Philip E. Eggers, and amendment thereto.
10.8* Consulting Agreement, dated May 20, 1993, between the
Company and Eggers & Associates, Inc., and amendment
thereto.
10.9* Development and Supply Agreement, dated March 1, 1994,
between the Company and SeaMED Corporation.
10.10* Lease Agreement, dated September 15, 1994, between
Company and The Arrillaga Foundation and the Peery
Foundation for the Company's facility located at 595
North Pastoria Avenue, Sunnyvale, California, 94086.
10.11* Employment Letter Agreement, dated October 21, 1994,
between the Company and Allan Weinstein and amendment
thereto.
10.12* Purchase Assistance Promissory Note, dated January 19,
1995, between Company and Allan Weinstein.
10.13* Sublease Agreement, dated February 1, 1995, between
Company and Guided Medical Systems, Inc. for the
Company's former facility at 453 Ravendale Drive,
Mountain View, California, 94043.
10.14* Mortgage Assistance Promissory Note Agreement, dated
February 5, 1995, between the Company and Allan
Weinstein.
10.15* Restricted Stock Purchase and Security Agreement,
dated February 5, 1995, between the Company and Allan
Weinstein.
10.16* Employment Letter Agreement, dated July 18, 1995,
between the Company and Robert T. Hagan.
10.17* Restricted Stock Purchase and Security Agreement,
dated August 1, 1995, between the Company and
Robert T. Hagan.
10.18* Employment Letter Agreement, dated September 3, 1995,
between the Company and A. Larry Tannenbaum.
10.19* Radiation Services Agreement, dated September 13,
1995, between the Company and SteriGenics
International.
10.20* Amended and Restated Stockholder Rights Agreement,
dated October 16, 1995, between the Company and
certain holders of the Company's securities.
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<PAGE>
10.21* Contribution Agreement, dated March 31, 1995, by and
among Philip E. Eggers, Robert S. Garvie, Anthony J.
Manlove, Hira V. Thapliyal and the Company.
11.1 Calculation of net loss per share.
23.1* Consent of Coopers & Lybrand L.L.P., Independent
Accountants.
23.2* Consent of Counsel.
23.3* Consent of Townsend and Townsend and Crew, patent
counsel for the Company.
23.4* Report of Independent Accountants on Financial
Statement Schedule.
27.1 Financial Data Schedule.
* Incorporated herein by reference to the same-numbered exhibit previously
filed with the Company's Registration Statement on Form S-1 (Registration
No. 33-80453).
b) Reports on Form 8-K
None
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
ARTHROCARE CORPORATION
a Delaware corporation
Date: May 10, 1996
/s/ A. LARRY TANNENBAUM
------------------------
A. Larry Tannenbaum
Vice President, Finance & Administration,
Chief Financial Officer and Assistant
Secretary
(Principal Financial Officer and Duly
Authorized Officer)
22 of 24
<PAGE>
EXHIBIT INDEX
Exhibit Page
Number Exhibit Description Number
- ------- ----------------------------- ------
11.1 Calculation of net loss per share. 24
27.1 Financial Data Schedule. 25
23 of 24
<PAGE>
ARTHROCARE CORPORATION
EXHIBIT 11.1
COMPUTATION OF NET LOSS PER SHARE
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended:
March 30, March 31,
1996 1995
--------- ----------
<S> <C> <C>
Weighted average common shares outstanding 3,739 1,303
for the period
Common equivalent shares pursuant to Staff
Accounting Bulletin No. 83 3,117 3,117
--------- ---------
Shares used in per share calculation 6,856 4,420
--------- ---------
--------- ---------
Net loss $ (1,743) $ (1,206)
--------- ---------
--------- ---------
Net loss per share $ (0.25) $ (0.27)
--------- ---------
--------- ---------
</TABLE>
24 of 24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
ArthroCare Corporation Financial Statements for the three month period ended
March 30, 1996 as shown in the 100 filing
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> MAR-30-1996
<CASH> 24,801
<SECURITIES> 8,240
<RECEIVABLES> 863
<ALLOWANCES> 0
<INVENTORY> 1,143
<CURRENT-ASSETS> 35,402
<PP&E> 1,090
<DEPRECIATION> 0
<TOTAL-ASSETS> 38,388
<CURRENT-LIABILITIES> 1,699
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 36,473
<TOTAL-LIABILITY-AND-EQUITY> 38,388
<SALES> 1,159
<TOTAL-REVENUES> 1,159
<CGS> 1,065
<TOTAL-COSTS> 1,065
<OTHER-EXPENSES> 2,098
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1,741)
<INCOME-TAX> 2
<INCOME-CONTINUING> (1,743)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,743)
<EPS-PRIMARY> ($0.25)
<EPS-DILUTED> ($0.25)
</TABLE>
