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 April 4, 1998
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: 0-27422
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
----- -----
The number of shares outstanding of the registrant's common stock as of
May 1, 1998 was 8,911,497.
<PAGE>
ARTHROCARE CORPORATION
INDEX
PART 1: Financial Information
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of April 4, 1998 and
January 3, 1998
Condensed Consolidated Statements of Operations for the three
months ended April 4, 1998 and March 29, 1997
Condensed Consolidated Statements of Cash Flows for the three
months ended April 4, 1998 and March 29, 1997
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
PART II: Other Information
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults upon Senior Securities
Item 4. Submission or Matters to Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURE
<PAGE>
Part 1. Financial Information
Item 1. Financial Statements
ARTHROCARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
April 4, January 3,
1998 1998
------------- -------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $12,561 $8,188
Available-for-sale securities 7,157 10,674
Accounts receivable, net 2,755 2,223
Inventory 2,189 2,019
Prepaid expenses and other current assets 212 210
------------- -------------
Total current assets 24,874 23,314
Available-for-sale securities 1,595 1,010
Property and equipment, net 1,351 1,412
Related party receivables 882 876
Other assets 63 63
------------- -------------
Total assets $28,765 $26,675
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $1,367 $950
Related party payables 35 18
Accrued liabilities 3,201 2,004
------------- -------------
Total current liabilities 4,603 2,972
Deferred rent 155 157
------------- -------------
Total liabilities 4,758 3,129
------------- -------------
Stockholders' equity:
Common stock 9 9
Additional paid in capital 49,326 49,153
Notes receivable from stockholders (92) (92)
Deferred compensation (188) (228)
Unrealized gain on available-for-sale securities 5 10
Accumulated deficit (25,053) (25,306)
------------- -------------
Total stockholders' equity 24,007 23,546
------------- -------------
Total liabilities and stockholders' equity $28,765 $26,675
============= =============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements
<PAGE>
ARTHROCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
---------------------------
April 4, March 29,
1998 1997
------------- -------------
<S> <C> <C>
Net sales $4,871 $2,261
Cost of sales 2,850 1,679
------------- -------------
Gross margin 2,021 582
------------- -------------
Operating expenses:
Research and development 985 880
Sales and marketing 2,116 1,365
General and administrative 1,211 891
------------- -------------
Total operating expenses 4,312 3,136
------------- -------------
Loss from operations (2,291) (2,554)
Interest and other income, net 2,544 387
------------- -------------
Net income (loss) $253 ($2,167)
============= =============
Net income (loss) per common share:
Basic $0.03 ($0.25)
============= =============
Diluted $0.03 ($0.25)
============= =============
Shares used in per share calculation:
Basic 8,889 8,785
============= =============
Diluted 9,244 8,785
============= =============
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements
<PAGE>
ARTHROCARE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three months ended
--------------------------
April 4, March 29,
1998 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $253 ($2,167)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 167 147
Amortization of deferred compensation 40 39
Provision for doubtful accounts receivable
and product returns 60 252
Provision for excess and obsolete inventory 100 183
Deferred rent (2) 5
Changes in operating assets and liabilities:
and product returns (592) (257)
Related party receivables (6) (12)
Inventory (270) (368)
Prepaid expenses and other current assets (2) 28
Accounts payable 434 (105)
Accrued liabilities 1,211 (150)
Other assets -- 6
------------ ------------
Net cash provided by (used in)
operating activities 1,393 (2,399)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (106) (129)
Purchases of available-for-sale securities (21,072) (18,487)
Sale or maturities of available-for-sale securities 23,999 27,499
------------ ------------
Net cash provided by investing activities 2,821 8,883
------------ ------------
Cash flows from financing activities:
Repayment of capital leases (14) (12)
Proceeds from exercise of options
to purchase common stock 173 20
------------ ------------
Net cash provided by financing activities 159 8
------------ ------------
Net increase in cash and cash equivalents 4,373 6,492
Cash and cash equivalents, beginning of period 8,188 11,359
------------ ------------
Cash and cash equivalents, end of period $12,561 $17,851
============ ============
Supplemental schedule of non-cash investing and
financing activities:
Net unrealized gain (loss) on
available-for-sale securities ($5) $6
</TABLE>
The accompanying notes are an integral part of these
condensed consolidated financial statements
<PAGE>
ARTHROCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS,
(Unaudited)
1. Basis of Presentation
In the opinion of management, the accompanying unaudited condensed
consolidated 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 Form 10-K for the
year ended January 3, 1998 should be read in conjunction with these
condensed consolidated financial statements. The balance sheet at
January 3, 1998 was derived from audited financial statements; however,
the financial statements in this report do not include all disclosures
required by generally accepted accounting principles.
2. Computation of Basic and Diluted Net Income (Loss) per Common Share
The company has adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 128, "Earnings Per Share" and the
Securities and Exchange Commission Staff Accounting Bulletin (SAB) No.
98, effective January 3, 1998, accordingly all prior periods have been
restated. SFAS No.128 requires the presentation of basic and diluted
net income/loss per common share. Basic net income/loss per common
share is computed using the weighted average number of common shares
outstanding during the period. Diluted net income/loss per common share
is computed giving effect to all dilutive potential common shares that
were outstanding during the period. Dilutive potential common
equivalent shares consist of the incremental common shares issuable upon
conversion of stock options.
In accordance with the disclosure requirements of SFAS No. 128, a
reconciliation of the numerator and denominator of basic and diluted net
income (loss) per common share is provided as follows (in thousands,
except per share amounts):
Three months ended
------------------------
April 4, March 29,
1998 1997
----------- -----------
Numerator - Basic and diluted net income (loss) per share
Net income (loss) $253 ($2,167)
=========== ===========
Denominator - Basic net income (loss) per share
Weighted average common shares outstanding 8,889,473 8,784,805
Basic net income (loss) per share $0.03 ($0.25)
=========== ===========
Denominator - Diluted net income (loss) per share
Weighted average common shares outstanding 8,889,473 8,784,805
=========== ===========
Effect of dilutive securities:
Common stock options 354,324 --
----------- -----------
Weighted average common and common equivalent
shares outstanding 9,243,797 8,784,805
=========== ===========
Diluted net income (loss) per share $0.03 ($0.25)
=========== ===========
Options to purchase 70,700 shares of common stock were outstanding
at April 4, 1998, but were not included in the calculation of diluted
earnings per share because the options' exercise price was greater than
the average market price of the common shares.
Stock options to purchase 743,217 shares of common stock at prices
ranging from $ 0.20 to $ 24.25 per share were outstanding at March 29,
1997, but were not included in
the computation of diluted net loss per common share because they were
antidilutive. The aforementioned stock options could potentially dilute
earnings per share in the future.
3. Interest and other income, net:
In February 1998, the company entered into a license agreement
under which Boston Scientific Corporation (BSC) will develop and market
products based on the company's Coblation (tm) technology for
myocardial revascularization procedures. Under the agreement, BSC
acquires exclusive licensing rights to the company's intellectual
property in this field. BSC will pay license fees, a portion of which
will be classified as prepaid royalties, to the company upon achievement
of designated milestones and royalties on sales of resulting products,
if any. Of this amount, the company received a license fee of $3.0
million in partial consideration for the license granted in the quarter
ended April 4, 1998. The company recognized $2.25 million as other
income. The remaining $0.75 million will be recognized as progress is
made toward the next milestone.
4. Balance sheet detail (in thousands):
<TABLE>
<CAPTION>
April 4, March 29,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
Inventory:
Raw materials $738 $921
Work-in-process 468 165
Finished goods 983 933
------------ ------------
Total $2,189 $2,019
============ ============
Other accrued liabilities:
Compensation $1,122 $1,314
Deferred license fee 750 --
Legal expense 594 38
Other 735 652
------------ ------------
Total $3,201 $2,004
============ ============
</TABLE>
5. Recent Accounting Pronouncements:
Effective April 4, 1998 the company has adopted SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards
for the reporting and display of comprehensive income and its components
in a full set of general purpose financial statements. Comprehensive
income is defined as the change in equity of a business enterprise
during a period, resulting from transactions and other events and
circumstances from non-owner sources. As the components of
comprehensive income for the company are not material, the additional
reporting and display of comprehensive income and its components have
not been reflected in the accompanying condensed consolidated financial
statements.
PART 1. FINANCIAL INFORMATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Statements in this Management's Discussion and Analysis of
Financial Condition and Results of Operations which express that the
company "believes", "anticipates" or "plans to." as well as other
statements which are not historical fact, are forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of
1995. Actual events or results may differ materially as a result of the
risks and uncertainties described herein and elsewhere including, in
particular, those factors described under "Business" set forth in Part I
of the company's Annual Report on Form 10-K for the year ended January
3, 1998 and "ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS".
Since commencing operations in April 1993, ArthroCare Corporation (the
company) has primarily engaged in the design, development, clinical
testing, manufacturing and marketing of its Arthroscopic System. The
Arthroscopic System uses the company's novel Coblation (tm) technology
that allows surgeons to operate with increased precision and accuracy
with minimal damage to surrounding tissue. It is currently being used in
closed-joint surgery including many types of knee and shoulder
procedures. The Arthroscopic System consists of a disposable, bipolar
ArthroWand, a radio frequency controller that powers the ArthroWand and
a cable that connects the ArthroWand to the controller. The ArthroWand
ablates (removes) soft tissue with minimal damage to surrounding healthy
tissue and simultaneously achieves hemostasis (sealing of small bleeding
vessels). In February 1998, the company entered into a license agreement
under which Boston Scientific Corporation (BSC) will develop and market
products based on the company's Coblation (tm) technology for myocardial
revascularization procedures. In April 1998 the company announced that
it is entering the cosmetic surgery market and that it has formed a new
business unit, called Visage (tm), to commercialize its technology in
this field. In May 1998, the company announced that it is entering the
otorhinolaryngology market and that it has formed a new business unit,
called ENTec (tm) to commercialize the technology in this field.
The company received clearance of its 510(k) premarket notification from
the United States Food and Drug Administration (FDA) in March 1995 to
market its Arthroscopic System in the United States for use in
arthroscopic surgery of the knee, shoulder, elbow and ankle. The company
has since received clearance for use in the wrist and hip. In December
1995, the company commercially introduced its Arthroscopic System
through a network of distributors in the United States. In light of the
foregoing, the company has a limited history of operations. The
company's strategy includes placing with arthroscopic surgeons,
controllers that are intended to generate future wand revenues. The
company's long-term strategy includes applying its patented platform
technology to a range of other soft-tissue surgical procedures. The
company has received 510(k) clearance for use of its technology in
several fields and has received approval of an investigational device
exemption (IDE) to conduct a clinical study which may result in the
company submitting a 510(k) application to the FDA. There can be no
assurance that any of the company's clinical studies will lead to 510(k)
applications or that the applications will be cleared by the FDA on a
timely basis, if at all, or that the products, if cleared for marketing,
will ever achieve commercial acceptance.
Results of Operations
Revenues
For the three-month period ended April 4, 1998, revenues were $4.9
million as compared to $2.3 million for the three-month period ended
March 29, 1997. The $2.6 million increase was primarily due to higher
unit volume wand sales resulting from a larger installed base of
controllers. Higher unit volume controller sales and higher average
selling price (ASP) of both wands and controllers also contributed to
the increase in sales.
The company's strategy has been and continues to be to increase
future wand sales by increasing the installed base of controllers
through aggressive promotional programs. This strategy has and will
continue to have an adverse impact on controller revenue and on gross
margins, partially offsetting the positive impact of increased wand
sales.
Overall, wands continue to be sold at or near list price. The wand
ASP was higher in the three-month period ended April 4, 1998 than in the
three-month period ended March 29, 1997 due to increased unit sales of
higher priced wands in the current year period and discounted sales to
stocking dealers in the prior year quarter. The company expects
international sales of wands at discounted prices to reduce wand ASP in
the future.
For the three-month period ended April 4, 1998 and March 29, 1997
wands sales comprised the vast majority of revenues. The company
believes increased wand sales are a result of the company's strategic
plan to build market share through continued promotional programs of
controllers. The company expects wand sales to remain the primary
component of revenues in the future.
The company believes that, in its first nine quarters of product
shipments, it has penetrated 15% to 20% of hospitals that perform
arthroscopic procedures in the United States. In addition, more than
half of the company's wand revenue is being generated by wands purchased
for use in shoulder procedures. The company believes that shoulder
procedures are the fastest growing segment of the arthroscopic market
and knee procedures represent the largest segment of the arthroscopic
market based on the number of procedures. In order to achieve increasing
wand sales over time, the company believes it must further penetrate the
market for knee procedures.
The company has introduced additional wand styles including its
new Turbo Dome and LoPro (tm) wands designed to be used in both knee and
shoulder arthroscopic procedures. In November 1997, the company
introduced its System 2000 controller designed for more aggressive
ablation and hemostasis. The company believes these features will
increase wand sales in the market for knee and shoulder procedures. In
addition, the company has introduced wand styles for small joint and for
capsular shrinkage procedures. There can be no assurance that the use of
these new products will be adopted by doctors.
The company has limited sales and marketing experience and can
make no assurance that current trends in sales and product acceptance
will continue.
Cost of Sales
Cost of sales was $2.9 million, or 59% of sales, for the three-
months ended April 4, 1998. During the three-month period ended March
29, 1997, cost of sales was $1.7 million, or 74% of sales. The dollar
increase in cost of sales in the current year period is due to the
increase of products shipped. As a percentage of sales, cost of sales
decreased compared with the previous year period as the fixed and semi-
fixed costs were spread over higher wand manufacturing volume and as the
unit cost of the company's new System 2000 controller decreased. The
first quarter of 1998 was Arthrocare's first full quarter of in-house
controller manufacture. Prior to introduction of its new controller the
company purchased its controllers from a subcontract manufacturer. In
1998, the company charges expenses related to quality control to cost of
sales since most of these activities relate to on-going manufacturing.
Previously these expenses were charged to research and development.
The improvement in gross margin in the first quarter of 1998
includes the effect of the promotional programs for controller. The
company believes that if its promotional programs maintain the same or
higher number of wands bundled with a discounted controller, and if the
demand for disposable wands increases over a growing installed base of
controllers, the cost of sales will continue to decrease as a percentage
of sales and gross margins will continue to improve. However, there can
be no assurance the company will be successful in maintaining the mix of
wands to discounted controllers in its promotional programs or in
increasing demand for its disposable wands. Further, production of
future new products may adversely impact gross margin due to the
inefficiencies in manufacturing new products.
Operating Expenses
Research and development expense increased to $1.0 million for the
three-month period ended April 4, 1998, a 12% increase compared to $0.9
million for the three-month period ended March 29, 1997. The $0.1
million increase is attributed to the development of new wand styles and
the launch of two new product business units which bring the company's
technology to the cosmetic surgery and ear, nose and throat surgical
markets. This increase was partially offset by the decreased allocation
of expenses related to quality control, which are charged to cost of
sales in 1998 since quality activities primarily relate to manufacturing
rather than research and development.
The company believes that continued investment in its platform
technology is essential if it is to maintain its competitive position.
The company expects to continue increasing research and development
spending through substantial expenditures on new product development,
regulatory affairs, clinical studies and patents, although not at the
rate seen in the past year. The company believes that its ability to
attract and retain qualified engineers in the future is critical to the
continued success of the company.
Sales and marketing expense increased to $2.1 million in the
three-month period ended April 4, 1998, a 55% increase as compared to
$1.4 million for the three-month period ended March 29, 1997. The $0.8
million increase was primarily due to higher dealer commissions
resulting from increased sales, higher staffing, and promotional and
trade show expenses reflecting an increased level of sales and marketing
activity.
The company anticipates that sales and marketing spending will
continue to increase due to higher dealer commissions from increased
sales, the additional cost of penetrating international markets and new
surgical markets for the company's products, higher promotional,
demonstration and sample expenses, and additional investments in the
sales, marketing and support staff necessary to market its current
products and commercialize future products.
General and administrative expense increased to $1.2 million in
the three-month period ended April 4, 1998 a 36% increase as compared to
$0.9 million for the three-month period ended March 29, 1997. The $0.3
million increase is primarily due to legal expense related to the
company's on-going patent litigation brought by the company against
certain competitors. See Part I, Item 3 of the company's Annual Report
on form 10-K for the year ended January 3, 1998 for a description of the
patent litigation. The increased legal expense includes the accrual of
approximately $0.5 million of anticipated and estimable legal expenses
related to such patent litigation and resulting from a number of motions
that are currently before the court. Bad debt and insurance expenses
were higher in the first quarter of 1997 than in the current year
quarter. The company expects that general and administrative expenses
will continue to increase as a result of the patent litigation, further
expansion of its staff, and business development activities.
Interest and Other Income, net
Net interest and other income increased to $2.5 million for the
three-month period ended April 4, 1998 from $0.4 million in the three-
month period ended March 29, 1997 due to a milestone payment received
from BSC pursuant to a technology licensing agreement. In February 1998,
the company entered into a license agreement under which BSC will
develop and market products based on the company's Coblation (tm)
technology for myocardial revascularization procedures. Under the
agreement, BSC acquired exclusive licensing rights to the company's
intellectual property in this field. BSC will pay license fees, a
portion of which will be classified as prepaid royalties, to the company
upon achievement of designated milestones and royalties on sales of
resulting products, if any. The first milestone payment of $3.0 million
was received in the first quarter of 1998. The company recognized $2.25
million of that payment as other income. The remaining $0.75 will be
recognized as progress is made toward the next milestone. Excluding this
milestone payment net interest and other income would have been $0.2
million, a decrease of $0.2 million from the three-month period ended
March 29, 1997. This $0.2 million decrease is attributable to the
conversion of investments to cash for use in business operations. The
company expects interest income to continue to decrease as investments
are reduced to meet the cash needs of the business.
Net Income (Loss)
Net income was $0.3 million for the three-month period ended April
4, 1998 compared to a loss of $2.2 million in the three-month period
ended March 29, 1997. The income is due to the milestone payment
received from BSC and recognized as other income. See Interest and Other
Income net discussion above. Excluding this payment and the accrual of
$0.5 million patent litigation expense detailed above, the company would
have reported a net loss of $1.5 million or $0.7 million less than in
the comparable three-month period ended March 29, 1997. This lower net
loss would have been primarily due to increased revenues, gross margin
improvement, and increases in operating expense at rates lower than the
increase in revenue.
The company expects net losses to continue in the future. However,
the company believes that nets losses will continue to decrease as sales
increase faster than operating expenses and gross margin continues to
improve. However, there can be no assurance the company will be
successful in its efforts to increase sales and gross margin or control
the growth of operating expenses.
Liquidity and Capital Resources
On April 4, 1998 the company had $20.3 million in working capital
and its principal sources of liquidity consisted of $21.3 million in
cash, cash equivalents, and available-for-sale securities which include
long-term available-for-sale securities. The cash and cash equivalents
are highly liquid with original maturities of ninety days or less.
The company's cash generated by operations was to $1.4 million for
the three-month period ended April 4, 1998. In the period ended March
29, 1997 the company used for operations $2.4 million of cash. The cash
positive position in the current year period is due primarily to the
milestone payment received from BSC in the current year period and the
reduction of operating loss excluding the legal accrual. See Interest
and Other Income, net and Operating Expenses, general and administrative
discussions above.
Net accounts receivable increased to $2.8 million as of April 4,
1998 from $2.2 million as of March 29, 1997. The increase in accounts
receivable is due to a corresponding increase in sales.
Inventories increased to $2.2 million as of April 4, 1998 compared
to $2.0 million at March 29, 1997 due to higher product sales activity.
The company expects future inventory levels to grow both in absolute
value and as a percentage of total assets as sales volume increases.
Net property and equipment of $1.4 million was the same at April
4, 1998 and March 29, 1997. In 1998, the company has planned but is not
committed to approximately $0.7 million in capital expenditures.
The company plans to finance its capital needs principally from
cash from product sales, cash, cash equivalents, and available-for-sale
securities which include long-term available-for-sale securities and
related interest, existing capital resources and licensing arrangements
which the company believes will be sufficient to fund its operations at
least through fiscal year 1999. The company currently has no commitments
for any credit facilities such as revolving credit agreements or lines
of credit that could provide additional working capital. The company's
future liquidity and capital requirements will depend on numerous
factors including the company's success of commercializing the
Arthroscopic System, development and commercialization of products in
fields other than arthroscopy, the ability of the company's suppliers to
continue to meet the demands of the company at current prices, the cost
associated with the company's ongoing patent litigation, obtaining and
enforcing patents important to the company's business, the status of
regulatory approvals and competition. There can be no assurance that the
company will not be required to raise additional capital or that such
capital will be available on acceptable terms, if at all.
The company relies on computers and computer software to run its
business as do its vendors, suppliers and customers. These computers and
computer software may not be able to properly recognize the dates
commencing in the year 2000. The company has not completed an
assessment of the impact this may have on its business and does not have
a reasonable basis to conclude whether the impact of the year 2000 will
or will not materially effect future financial results. To date the
company has not found any material impact which may result from the
failure of its computers and computer software or that of its vendors,
suppliers, and customers. However, the company plans to make an
assessment of this issue during 1998 and, if appropriate, develop an
action plan to correct it.
In June 1997, the Financial Accounting Standards Board issued SFAS
No. 131, Disclosure about Segments of an Enterprise and Related
Information. This statement establishes standards for disclosure about
operating segments in annual financial statements and selected
information in interim financial reports. It also establishes standards
for related disclosures about products and services, geographic areas
and major customers. This statement supersedes SFAS No. 14, Financial
Reporting for Segments of a Business Enterprise. The new standard
becomes effective for the year ended January 2, 1999 for the company and
requires that comparative information from earlier years be restated to
conform to requirements of this standard. The company is evaluating the
requirements of SFAS No. 131 and the effects, if any, on the company's
current reporting and disclosures.
ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS
ArthroCare became a public company in February 1996. Included
here are risk factors as updated from the company's Annual Report on
Form 10-K for the year ended January 3, 1998 filed April 3, 1998. The
following factors represent current challenges to the company that
create risk and uncertainty. Failure to adequately overcome any of the
following challenges, either singularly or in combination, could have a
material adverse effect on the company's results of operations,
business, or financial position.
Dependence Upon Arthroscopic System
The company commercially introduced the Arthroscopic System in
December 1995 and by the quarter ended April 4, 1998, had reported 28
months of sales. The Arthroscopic System is the company's only
commercial product and will account for a substantial portion of the
company's revenue for the foreseeable future. As such, the company is
highly dependent on its Arthroscopic System. Additionally, the company's
potential products for non-arthroscopic indications are in various
stages of development, and the company may be required to undertake
time-consuming and costly development activities and seek regulatory
approval of these devices. There can be no assurance that product
development will ever be successfully completed, that regulatory
approval, if applied for, will be granted by the United States Food and
Drug Administration (FDA) on a timely basis, if at all, or that the
potential products will ever achieve commercial acceptance. Failure by
the company to develop, obtain necessary regulatory approval for or to
successfully market new products could have a material adverse effect on
the company's business, financial condition and results of operations.
Currently, the majority of the company's sales come from the
United States. The company has established distribution capability in
Europe, Australia, Korea, Japan, Canada and parts of South and Central
America. Before the Arthroscopic System can be sold outside these
regions, the company will have to obtain additional international
regulatory approvals and establish additional distribution capability in
other geographic regions. If such regulatory approval is obtained,
there can be no assurance that the company will be able to establish a
successful distribution capability.
Uncertainty of 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 conventional means of
tissue ablation. The Arthroscopic System was introduced in December
1995 and no independent published clinical 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
continued recommendations and endorsements by influential physicians are
essential for market acceptance of its products. If the Arthroscopic
System does not continue to receive broad-based physician acceptance and
endorsement by influential physicians, the company's business, financial
condition and results of operations would be materially adversely
affected. Similarly, if the company's new products do not receive broad-
based physicians acceptance and endorsement by influential physicians,
the company's business, financial condition and results of operations
could be materially adversely affected.
Limited Operating History
The company's operations to date, have consisted of more than two
years of product sales. In addition the company has incurred expenses
related to research and development, product engineering, obtaining FDA
clearance of its Arthroscopic System, and developing a network of
distributors in the United States and internationally to market the
Arthroscopic System. The company continues to generate operating losses
and anticipates generating losses in the future. Whether the company
can successfully manage the transition to a larger-scale commercial
enterprise will depend upon increasing sales of disposable ArthroWands
from its distribution network, commercialization of the company's
technology in additional surgical markets, obtaining additional
international regulatory approvals for the company's Arthroscopic
System, obtaining domestic and international regulatory approvals for
potential new products and maintaining its financial and management
systems, procedures and controls.
Limited Domestic and International Marketing and Sales Experience
The company has shipped over 2,000 Arthroscopic System controller
units and more than 175,000 ArthroWands through the end of the first
quarter of 1998. The company is marketing and selling its Arthroscopic
System in the United States and internationally through a network of
independent orthopedic distributors. 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, or that
they will be successful in closing sales with doctors and hospitals.
The company has offered its controller to these independent distributors
at substantial discounts and may be required to continue to offer such
discounts on its controller to generate demand for its ArthroWands. The
inability to sell sufficient quantities of ArthroWands would have a
material adverse effect on the company's business, financial condition
and results of operations.
The company has signed distribution agreements with independent
distributors to sell and market the Arthroscopic Systems in Europe,
Australia, Mexico, Brazil, Argentina, Canada, Taiwan, South Africa,
Israel, Japan and Korea. In other international markets, the company
intends to collaborate with one or more marketing partners to establish
marketing and distribution channels for the Arthroscopic System and to
assist with regulatory requirements in such distributors' jurisdictions.
However, regulatory requirements vary by region, and compliance with
such regulations may be costly and time-consuming. Accordingly, the
distribution, pricing and marketing structure to be established by the
company may vary from country to country.
No assurance can be given that the company will successfully sell
its product through its distributors in Europe, Australia, Mexico,
Brazil, Argentina, Canada, Taiwan, South Africa, Israel, Japan or
Korea, that the company will secure marketing partners for other
international markets, successfully sell its Arthroscopic System in
international markets or that any of its international distributors and
marketing partners will commit the necessary resources to obtain
additional necessary international regulatory approvals on behalf of the
company and successfully sell the Arthroscopic System in international
markets.
Limited Manufacturing Experience
The company's manufacturing operations consist of an in-house
assembly operation for the manufacturing of ArthroWands, and a separate
in-house operation for the manufacturing of the System 2000 controllers.
The company's products are manufactured from several components some of
which are supplied to the company by third parties. Manufacture of the
System 2000 controller, of which an earlier version was manufactured by
a third party, was brought in-house in 1997 for the purposes of
maintaining process control, managing availability, and leveraging fixed
costs.
In December 1997 the company started manufacture and sale of its
System 2000 controllers and only a small number of this model of
controllers have been manufactured and sold. As a result, the company
has limited experience manufacturing controllers in the volumes
necessary for the company to achieve additional commercial sales, and
there can be no assurance that reliable, high-volume manufacturing can
be achieved at a commercially reasonable cost. In addition, there can
be no assurance that the company or its suppliers will not encounter any
manufacturing difficulties, including problems involving regulatory
compliance, product recalls, production yields, quality control and
assurance, supplies of components or shortages of qualified personnel.
The company and its component suppliers are required to operate in
conformance with Quality System Regulation (QS Regulations)
requirements, in order to produce products for sale in the United
States, and ISO 9001 standards, in order to produce products for sale in
Europe. There can be no assurance that the company or its component
suppliers will remain in compliance with QS Regulations or ISO 9001
standards. Any failure by the company or its component suppliers to
remain in compliance with QS Regulation or ISO 9001 standards could have
a material adverse effect on the company's business, financial condition
and results of operations. In addition, the ArthroWand is sterilized by
a single subcontractor and the connector housings at each end of the
cable are available only from a single source. There can be no
assurance that an alternate sterilizer or connector housing supplier
could be established if necessary or that available inventories would be
adequate to meet the company's product needs during any prolonged
interruption of supply. The company's inability to secure an
alternative sterilizer, if required, would limit its ability to
manufacture the company's Arthroscopic System and would have a material
adverse effect on the company's business, financial condition and
results of operations.
Although the company believes that its subcontractor, and
component suppliers are in compliance with applicable regulations, there
can be no assurance that the FDA, or a state, local or international
regulator, will not take action against the subcontractor or a component
supplier found to be violating such regulations.
History of Losses; Fluctuations in Operating Results; Losses
Expected to Continue
The company has experienced significant operating losses since
inception and, as of April 4, 1998, had an accumulated deficit of $25.1
million. The company expects to generate additional losses due to
increased operating expenditures primarily attributable to the expansion
of marketing and sales activities, the launch of additional product
lines, increased research and development, and activities to support
regulatory applications. Results of operations may fluctuate
significantly from quarter to quarter due to the timing of such
expenditures, absence of a backlog of orders, timing of the receipt of
orders, promotional programs for the company's products, in addition to
those detailed above. The company's revenues and profitability will be
critically dependent on whether it can successfully continue to market
its Arthroscopic System. In addition, the company's gross margins may be
adversely affected due to the necessity to promote and sell its products
at significantly reduced prices. There can be no assurance that
significant profitability will ever be achieved.
Patents and Proprietary Rights
The company's ability to compete effectively depends in part on
developing and maintaining the proprietary aspects of its platform
Coblation technology. The company owns ten issued United States patents,
more than 30 pending United States patent applications and international
patent applications in Europe (covering 16 separate countries), Japan,
Canada, Australia and New Zealand corresponding to eight of the United
States filings relating to its Coblation technology. The initial patent
is currently set to expire in 2008, three issued patents are currently
expected to expire between 2008 and 2012 and the other six patents are
expected to expire between 2014 and 2016. The company believes that the
issued patents cover both the core technology used in the company's
Arthroscopic System, including both multielectrode and single-electrode
configurations of its wand tools, as well as the use of Coblation
technology in specific surgical procedures.
There can be no assurance that the patents that have been issued to
the company or any patents which may be issued as a result of the
company's United States or international patent applications will
provide any competitive advantages for the company's products or that
they will not be successfully challenged, invalidated or circumvented in
the future. In addition, there can be no assurance that competitors,
many of which have substantial resources and have made substantial
investments in competing technologies, will not seek to apply for and
obtain patents that will prevent, limit or interfere with the company's
ability to make, use and sell its products either in the United States
or in international markets.
A number of medical device and other companies, universities and
research institutions have filed patent applications or have issued
patents relating to monopolar and/or bipolar electrosurgical methods and
apparatus. If third-party patents or patent applications contain claims
infringed by the company's technology and such claims are ultimately
determined to be valid, there can be no assurance that the company would
be able to obtain licenses to those patents at a reasonable cost, if at
all, or be able to develop or obtain alternative technology, either of
which would have a material adverse effect on the company's business,
financial condition and results of operations. There can be no
assurance that the company will not be obligated to defend itself in
court against allegations of infringement of third-party patents.
In addition to patents, the company relies on trade secrets and
proprietary know-how, which it seeks to protect, in part, through
confidentiality and proprietary information agreements. The company
requires its key employees and consultants to execute confidentiality
agreements upon the commencement of an employment or consulting
relationship with the company. These agreements generally provide that
all confidential information, developed or made known to the individual
by the company during the course of the individual's relationship with
the company, is to be kept confidential and not disclosed to third
parties. These agreements also generally provide that inventions
conceived by the individual in the course of rendering services to the
company shall be the exclusive property of the company. There can be no
assurance that such agreements will not be breached, that the company
would have adequate remedies for any breach or that the company's trade
secrets will not otherwise become known to or be independently developed
by competitors.
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. On February 13, 1998 the company filed a
lawsuit (the "Lawsuit") against Ethicon, Inc., Mitek Surgical Products,
a division of Ethicon, Inc. and GyneCare, Inc. alleging among other
things, infringement of several of the company's patents. See Part I,
Item 3 "Legal Proceedings" of the company's Annual Report on Form 10-K
for the year ended January 3, 1998. The defense and prosecution of the
Lawsuit and intellectual property suits generally, USPTO interference
proceedings and related legal and administrative proceedings are both
costly and time-consuming. The company believes that the Lawsuit is
necessary and if others violate the proprietary rights of the company,
further litigation may be necessary to enforce patents issued to the
company, to protect trade secrets or know-how owned by the company or to
determine the enforceability, scope and validity of the proprietary
rights of others. Any litigation or interference proceedings will
result in substantial expense to the company and significant diversion
of effort by the company's technical and management personnel. An
adverse determination in the Lawsuit or other litigation or interference
proceedings to which the company may become a party could subject the
company to significant liabilities to third parties, require disputed
rights to be licensed from third parties or require the company to cease
using such technology. Although patent and intellectual property
disputes in the medical device area have often been settled through
licensing or similar arrangements, costs associated with such
arrangements may be substantial and could include ongoing royalties.
Furthermore, there can be no assurance that necessary licenses would be
available to the company on satisfactory terms, if at all. Adverse
determinations in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the company from manufacturing
and selling its products, which would have a material adverse effect on
the company's business, financial condition and results of operations.
Competition
The arthroscopic medical device industry is intensely competitive.
The company competes with providers of laser systems, electrosurgical
systems, manual instruments and power shavers. Many of these competitors
have significantly greater financial, manufacturing, marketing,
distribution and technical resources than the company. There can be no
assurance that the company can effectively compete against such
competitors. In addition, there can be no assurance that these or other
companies will not succeed in developing technologies and products that
are more effective than the company's or that would render the company's
technology or products obsolete or uncompetitive.
Smith & Nephew Endoscopy, Inc. (which owns Acufex Microsurgical,
Inc. and Dyonics, Inc.), Conmed Corporation (including its Linvatec
unit) and Stryker Corp. each have large shares of the market for manual
instruments, power shavers and arthroscopes. These companies offer broad
product lines, which they may offer as a single package; have
substantially greater resources and name recognition than the company;
and frequently offer significant discounts as a competitive tactic. In
addition, United States Surgical Corporation (including its Valley Labs
unit) and Conmed Corporation each have large shares of the market for
electrosurgical systems, and Trimedyne, Inc. and Coherent, Inc. each
have large shares of the market for laser systems. The company expects
that competition from these and other well-established competitors will
increase as will competition from start-up and development stage medical
device companies such as Gyrus Medical Ltd., a company based in the
United Kingdom, and Orotec Interventions, Inc., a company based in Menlo
Park, California. The company is aware that Johnson & Johnson (including
its Ethicon unit) is marketing a bipolar electrosurgical tool developed
by Gyrus Medical Ltd. In order to successfully compete in the
arthroscopic medical device industry, the company anticipates that it
may have to continue to offer substantial discounts on its controller in
order to increase demand for the disposable ArthroWand, and that such
competition could have a material adverse effect on the company's
business, financial condition and results of operations.
The company has received 510(k) premarket notifications for clearance
to market tissue ablation products to treat certain urological,
periodontal, dermatological, ear/nose/throat and general surgical
conditions and has filed 510(k) premarket notification for clearance to
market products for gynecological conditions; the FDA has indicated that
the 510(k) submission for certain gynecological conditions must be
supported by data from clinical trials. These fields are intensely
competitive and no assurance can be given that these potential products,
if approved, would be successfully marketed.
Uncertainty of Approvals; Extensive Governmental Regulation
United States
The company's products are regulated in the United States as
medical devices by the FDA under the Federal Food, Drug, and Cosmetic
Act (FDC Act) and require premarket clearance or approval by the FDA
prior to commercialization. In addition, certain material changes or
modifications to medical devices also are subject to FDA review and
clearance or approval. Pursuant to the FDC Act, the FDA regulates the
research, testing, manufacture, safety, labeling, storage, record
keeping, advertising, distribution and production of medical devices in
the United States. Noncompliance with applicable requirements can result
in warning letters, fines, injunctions, civil penalties, recall or
seizure of products, total or partial suspension of production, failure
of the government to grant premarket clearance or premarket approval for
devices, and criminal prosecution. Failure to comply with the regulatory
requirements could have a material adverse effect on the company's
business, financial condition and results of operations.
Generally, before a new device can be introduced into the market
in the United States, the manufacturer or distributor must obtain FDA
clearance of a 510(k) notification or approval of a premarket approval
application (PMA). If a medical device manufacturer or distributor can
establish that a device is "substantially equivalent" to a legally
marketed Class I or Class II device, or to a Class III device for which
the FDA has not called for PMAs, the manufacturer or distributor may
seek clearance from the FDA to market the device by filing a 510(k)
notification. The 510(k) notification will need to be supported by
appropriate data establishing the claim of substantial equivalence to
the satisfaction of the FDA. The FDA recently has been requiring a more
rigorous demonstration of substantial equivalence.
Following submission of the 510(k) notification, the manufacturer
or distributor may not place the device into commercial distribution
until an order is issued by the FDA. No law or regulation specifies the
time limit by which the FDA must respond to a 510(k) notification. At
this time, the FDA typically responds to the submission of a 510(k)
notification within 90 to 120 days, but it may take longer. An FDA order
may declare that the device is substantially equivalent to another
legally marketed device and allow the proposed device to be marketed in
the United States. The FDA, however, may determine that the proposed
device is not substantially equivalent or require further information,
including clinical data, to make a determination regarding substantial
equivalence. Such determination or request for additional information
could be costly and delay market introduction of the products that are
the subject of the 510(k) notification.
The company has received clearance of 510(k) premarket notifications
to market its Arthroscopic System for surgery of the knee, shoulder,
elbow, wrist, hip and ankle joints. In addition, the company received
clearance of 510(k) premarket notifications to market products based
upon its proprietary core technology to treat certain other soft-tissue
conditions including general dermatology and ear, nose and throat
conditions. There can be no assurance that the company will be able to
obtain necessary clearances or approvals to market any other products on
a timely basis, if at all, and delays in receipt or failure to receive
such clearances or approvals, the loss of previously received clearances
or approvals, or failure to comply with existing or future regulatory
requirements could have a material adverse effect on the company's
business, financial condition and results of operations.
If a manufacturer or distributor of medical devices cannot
establish that a proposed device is substantially equivalent to a
legally marketed device, the manufacturer or distributor must seek
premarket approval of the proposed device through submission of a PMA
application. The PMA application approval process can be expensive,
uncertain and lengthy. A number of devices for which premarket approval
has been sought have never been approved for marketing. The review time
is often significantly extended by the FDA, which may require more
information or clarification of information already provided in the
submission. In addition, the FDA will inspect the manufacturing facility
to ensure compliance with the FDA's Good Manufacturing Practice (GMP) or
QS Regulations requirements prior to approval of an application. If
granted, the approval of the PMA application may include significant
limitations on the indicated uses for which a product may be marketed.
If necessary, the company may file a PMA application with the FDA
for approval to sell its potential products commercially in the United
States when it has developed such products. There can be no assurance
that the company will be able to obtain necessary PMA application
approvals to market such products on a timely basis, if at all, and
delays in receipt or failure to receive such approvals, the loss of
previously received approvals, or failure to comply with existing or
future regulatory requirements could have a material adverse effect on
the company's business, financial condition and results of operations.
The company is also required to register as a medical device
manufacturer with the FDA and state agencies, such as the California
Department of Health Services (CDHS) and to list its products with the
FDA. As such, the company is subject to inspections by both the FDA and
the CDHS for compliance with the FDA's GMP or QS Regulations and other
applicable regulations. These regulations require that the company
maintain its documents in a prescribed manner with respect to
manufacturing, testing and control activities. Further, the company, its
subcontractors and component suppliers are required to comply with
various FDA requirements for design, safety, advertising and labeling.
There can be no assurance that the company its subcontractors or
component suppliers will not encounter any manufacturing difficulties,
or that they will not experience difficulties, including problems
involving regulatory compliance, product recalls, production yields,
quality control and assurance, supplies of components or shortages of
qualified personnel.
Regulations regarding the manufacture and sale of the company's
products are subject to change. The company cannot predict the effect,
if any, that such changes might have on its business, financial
condition or results of operations.
International
International sales of the company's products are subject to the
regulatory agency product registration requirements of each country. The
regulatory review process varies from country to country. The company
has obtained regulatory clearance to market the Arthroscopic System in
Australia, Europe and Mexico, but has not obtained any other
international regulatory approvals permitting sales of its products
outside of the United States. The company is seeking and intends to seek
regulatory approvals in certain other international markets. There can
be no assurance, however, that such approvals will be obtained on a
timely basis or at all.
For European distribution, the company has received ISO 9001
certification and the CE mark. ISO 9001 certification standards for
quality operations have been developed to ensure that companies know, on
a worldwide basis, the standards of quality to which they will be held.
The European Union has promulgated rules requiring medical products to
receive by mid-1998 the CE mark, an international symbol of quality and
compliance with applicable European medical device directives. Failure
to maintain the CE mark will prohibit the company from selling its
products in Europe. ISO 9001 certification in conjunction with
demonstrated performance to the medical device directive is one of the
alternatives available to meet the CE mark requirements. There can be no
assurance that the company will be successful in maintaining
certification requirements.
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 future products, generally rely on
third-party payors, principally federal Medicare, state Medicaid and
private health insurance plans, to reimburse all or part of the cost of
the procedure in which the medical device is being used. Reimbursement
for arthroscopic procedures performed using devices that have received
FDA approval has generally been available in the United States. In
addition, certain health care providers are moving toward a managed care
system in which such providers contract to provide comprehensive health
care for a fixed cost per person. Managed care providers are attempting
to control the cost of health care by authorizing fewer elective
surgical procedures, such as certain knee and shoulder, ankle, wrist,
elbow and hip arthroscopic procedures.
The company is unable to predict what changes will be made in the
reimbursement methods used by third-party health care payors. The
company anticipates that in a prospective payment system, such as the
diagnosis related group (DRG) system utilized by Medicare, and in many
managed care systems used by private health care payors, the cost of the
company's products will be incorporated into the overall cost of the
procedure and that there will be no separate, additional reimbursement
for the company's products. The company anticipates that hospital
administrators and physicians will justify the use of the company's
products by the attendant cost savings and clinical benefits that the
company believes will be derived from the use of its products. However,
there can be no assurance that this will be the case. Furthermore, the
company could be adversely affected by changes in reimbursement policies
of governmental or private health care payors, particularly to the
extent any such changes affect reimbursement for procedures in which the
company's products are used. Failure by physicians, hospitals and other
users of the company's products to obtain sufficient reimbursement from
health care payors for procedures in which the company's products are
used or adverse changes in governmental and private third-party payors,
policies toward reimbursement for such procedures would have a material
adverse effect on the company's business, financial condition and
results of operations.
If the company obtains the necessary international regulatory
approvals , market acceptance of the company's products in international
markets would be dependent, in part, upon the availability of
reimbursement within prevailing health care payment systems.
Reimbursement and health care payment systems in international markets
vary significantly by country, and include both government-sponsored
health care and private insurance. The company intends to seek
international reimbursement approvals, although there can be no
assurance that any such approvals will be obtained in a timely manner,
if at all.
Uncertainty of New Product Development
The company has undertaken preliminary animal studies and
development for the use of its Coblation technology with its controller
in several fields. The company has received 510(k) clearance for use of
its technology in certain of these fields. The company has received
approval of an investigational Device Exemption (IDE) to conduct a
clinical study on a specific indication. Following the completion of
this study, the company may submit a 510(k) application to the FDA.
Each of the company's potential products that may result from
these investigations are in various stages of development, and the
company may be required to undertake time-consuming and costly
development activities and seek regulatory approval of these devices.
There can be no assurance that product development will ever be
successfully completed, that PMA or 510(k) application, if applied for,
will be granted by the FDA on a timely basis, if at all, or that the
products will ever achieve commercial acceptance. Failure by the
company to develop, obtain necessary regulatory approval for or to
successfully market new products could have a material adverse effect on
the company's business, financial condition and results of operations.
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 $7,000,000 per
occurrence and $7,000,000 in the aggregate. There can be no assurance
that such coverage limits are adequate to protect the company from any
liabilities it might incur in connection with the development,
manufacture and sale of its Arthroscopic System and potential 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. The company
has been selling its product since December 1995 and has not experienced
any product liability claims to date. However, a successful product
liability claim or series of claims brought against the company in
excess of its insurance coverage could have a material adverse effect on
the company's business, financial condition and results of operations.
Dependence on 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. Furthermore, the company's
scientific advisory board members all are otherwise employed on a full-
time basis. As a result, the scientific advisory board members are not
available to devote their full time or attention to the company's
affairs.
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
45% of the company's common stock. These stockholders, if acting
together, will have significant influence over all matters requiring
approval by the stockholders of the company, including the election of
directors and the approval of mergers or other business combination
transactions.
Potential Volatility of Stock Price
The stock markets have experienced price and volume fluctuations
that have particularly affected medical technology companies, resulting
in changes in the market prices of the stocks of many companies that may
not have been directly related to the operating performance of those
companies. Such broad market fluctuations may adversely affect the
market price of the company's common stock. In addition, the market
price of the company's common stock may be highly volatile. Factors
such as variations in the company's financial results, comments by
security analysts, announcements of technological innovations or new
products by the company or its competitors, changing government
regulations and developments with respect to FDA submissions, patents,
proprietary rights or litigation may have a significant adverse effect
on the market price of the common stock.
Anti-Takeover Effect of Stockholder Rights Plan and Certain Charter and
Bylaw Provisions
In November 1996, the company's Board of Directors adopted a
Stockholder Rights Plan. The Stockholder Rights Plan provides for a
dividend distribution of one Preferred Shares Purchase Right (a Right)
on each outstanding share of the company's common stock. Each Right
entitles shareholders to buy 1/1000th of a share of the company's Series
A participating preferred stock at an exercise price of $50.00. The
Rights will become exercisable following the tenth day after a person or
group announces acquisition of 15% or more of the company's common
stock, or announces commencement of a tender offer, the consummation of
which would result in ownership by the person or group of 15% or more of
the company's common stock. The company will be entitled to redeem the
Rights at $0.01 per Right at any time on or before the tenth day
following acquisition by a person or group of 15% or more of the
company's common stock.
The Stockholder Rights Plan and certain provisions of the
company's Certificate of Incorporation and Bylaws may have the effect of
making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire control of the
company. This could limit the price that certain investors might be
willing to pay in the future for shares of the company's common stock.
Certain provisions of the company's Certificate of Incorporation and
Bylaws allow the company to issue preferred stock without any vote or
further action by the stockholders, eliminate the right of stockholders
to act by written consent without a meeting, specify procedures for
director nominations by stockholders and submission of other proposals
for consideration at stockholder meetings, and eliminate cumulative
voting in the election of directors. Certain provisions of Delaware law
applicable to the company could also delay or make more difficult a
merger, tender offer or proxy contest involving the company, including
Section 203, which prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of
three years unless certain conditions are met. The Stockholder Rights
Plan, the possible issuance of preferred stock, the procedures required
for director nominations and stockholder proposals and Delaware law
could have the effect of delaying, deferring or preventing a change in
control of the company, including without limitation, discouraging a
proxy contest or making more difficult the acquisition of a substantial
block of the company's common stock. These provisions could also limit
the price that investors might be willing to pay in the future for
shares of the company's common stock.
Lack of Dividends
The company has not paid any dividends and does not anticipate
paying any dividends in the foreseeable future.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On February 13, 1998, the company filed a lawsuit against Ethicon, Inc.
Mitek Surgical Products, a division of Ethicon, Inc. and GyneCare, Inc.
("the Defendants") in the United States District Court for the Northern
District of California. The lawsuit alleges, among other things, that
the Defendants have been and are currently infringing four patents
issued to the company in December 1997. Specifically, the Defendants
use, market and sell two separate electrosurgical systems under the
names of "VAPR" and "VersaPoint" which infringe these patents. The
company seeks: (1) a judgment that the Defendants have infringed these
patents; (2) to preliminarily and permanently restrain and enjoin the
Defendants from marketing and selling the VAPR and VersaPoint systems;
and (3) an award of damages (including attorneys' fees) to compensate
the company for lost profits, the damages to be trebled because of the
Defendants' willful infringement. In addition, the company filed a
motion on March 5, 1998 for preliminary injunction against the
Defendants marketing and selling of the VAPR system.
Item 2. Changes in Securities
None
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 (1) Certificate of Incorporation of the
Registrant.
3.3 (1) Bylaws of the Registrant.
4.1 (1) Specimen Common Stock Certificate.
10.1 (1) Form of Indemnification Agreement between
the Registrant and each of its directors
and officers.
10.2 (1) Incentive Stock Plan and form of Stock
Option Agreement thereunder.
10.3 (1) Director Option Plan and form of Director
Stock Option Agreement thereunder.
10.4 (1) Employee Stock Purchase Plan and forms of
agreements thereunder.
10.5 (1) Form of Exclusive Distribution Agreement.
10.6 (1) Form of Exclusive Sales Representative
Agreement.
10.7 (1) Consulting Agreement, dated May 10, 1993,
between the Registrant and Philip E.
Eggers, and amendment thereto.
10.8 (1) Consulting Agreement, dated May 20, 1993,
between the Registrant and Eggers &
Associates, Inc., and amendment thereto.
10.9 (1) + Development and Supply Agreement, dated
March 1, 1994, between the Registrant and
SeaMed Corporation.
10.10 (1) Lease Agreement, dated September 15, 1994,
between Registrant and The Arrillaga
Foundation and the Perry Foundation for
the Registrant's facility located at 595
North Pastoria Avenue, Sunnyvale,
California 94086.
10.11 (1) Employment Letter Agreement, dated October
21, 1994, between the Registrant and Allan
Weinstein and amendment thereto.
10.12 (1) Purchase Assistance Promissory Note, dated
January 19, 1995, between Registrant and
Allan Weinstein.
10.13 (1) Sublease Agreement, dated February 1,
1995, between Registrant and Guided
Medical Systems, Inc. for the Registrant's
former facility at 453 Ravendale Drive,
Mountain View, California 94043.
10.14 (1) Mortgage Assistance Promissory Note
Agreement, dated February 5, 1995, between
the Registrant and Allan Weinstein.
10.15 (1) Restricted Stock Purchase and Security
Agreement, dated February 5, 1995, between
the Registrant and Allan Weinstein.
10.16 (1) Employment Letter Agreement, dated July
18, 1995, between the Registrant and
Robert T. Hagan.
10.17 (1) Restricted Stock Purchase and Security
Agreement, dated August 1, 1995, between
the Registrant and Robert T. Hagan.
10.18 (1) Employment Letter Agreement, dated
September 3, 1995, between the Registrant
and A. Larry Tannenbaum.
10.19 (1) + Radiation Services Agreement, dated
September 13, 1995, between the Registrant
and SteriGenics International.
10.20 (1) Amended and Restated Stockholder Rights
Agreement, dated October 16, 1995, between
the Registrant and certain holders of the
Registrant's securities.
10.21 (1) Contribution Agreement, dated March 31,
1995, by and among Philip E. Eggers,
Robert S. Garvie, Anthony J. Manlove, Hira
V. Thapliyal and the Registrant.
10.22 (2) Preferred Stock Rights Agreement, dated
November 14, 1996, between the Registrant
and Norwest Bank Minnesota, N.A.
10.23 (3) + Exclusive Distributor Agreement, dated
April 15, 1997, between the Registrant and
Arthrex, Gmbh.
10.24 (4) ++ Employment Letter Agreement, dated
June 20, 1997, between the Registrant and
Michael A. Baker.
10.25 (5) + Exclusive Distributor Agreement, dated
August 21, 1997, between the Registrant
and Kobayashi Pharmaceutical company, Ltd.
10.26 (6) ++ License Agreement dated February 9,
1998, between the Registrant and Boston
Scientific Corporation.
10.27 (6) ++ Development and Supply Agreement
dated February 9, 1998, between the
Registrant and Boston Scientific
Corporation.
10.28 (6) Lease Agreement dated March 25, 1998
between the Registrant and Aetna Life
Insurance company for the Registrant's
facility located at 840 Del Rey Avenue,
Sunnyvale, California 94086.
27.1 Financial Data Schedule.
(1) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Registration Statement on
Form S-1 (Registration No. 33-80453).
(2) Incorporated herein by reference to Exhibit 5 previously filed
with the
Registrant's Registration Statement on Form 8-A (Registration No.
000-27422).
(3) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Quarterly Report on Form
10-Q for the period ended March 29, 1997.
(4) Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Quarterly Report on Form
10-Q for the period ended June 28, 1997.
(5) Incorporated herein by reference to the same numbered exhibit
previously filed with the Registrant's Quarterly Report on Form
10-Q for the period ended September 27, 1997.
(6) Incorporated herein by reference to the same numbered exhibit
previously filed with the Registrant's Annual Report on Form 10-K
for the year ended January 3, 1998.
+ Confidential treatment granted.
++ Confidential treatment requested.
b) Reports on Form 8-K
None
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 19, 1998
/s/ CHRISTINE E. HANNI
Christine E. Hanni
Vice President of Finance,
Chief Financial Officer and
Assistant Secretary
(Principal Financial Officer
and Accounting Officer)
Date: May 19, 1998
/s/ MICHAEL A. BAKER
Michael A. Baker
President, Chief Executive
Officer and Director
(Principal Executive Officer)
EXHIBIT INDEX
Exhibit
Number Exhibit Description
27.1 Financial Data Schedule.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND> THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM THE ACCOMPANYING FINANCIAL STATEMENTS AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JAN-2-1999
<PERIOD-START> JAN-4-1998
<PERIOD-END> APR-4-1998
<CASH> 12,561
<SECURITIES> 8,752
<RECEIVABLES> 2,755
<ALLOWANCES> 0
<INVENTORY> 2,189
<CURRENT-ASSETS> 24,874
<PP&E> 1,351
<DEPRECIATION> 0
<TOTAL-ASSETS> 28,765
<CURRENT-LIABILITIES> 4,603
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 23,998
<TOTAL-LIABILITY-AND-EQUITY> 28,765
<SALES> 4,871
<TOTAL-REVENUES> 4,871
<CGS> 2,850
<TOTAL-COSTS> 2,850
<OTHER-EXPENSES> 4,312
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 253
<INCOME-TAX> 0
<INCOME-CONTINUING> 253
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 253
<EPS-PRIMARY> $0.03
<EPS-DILUTED> $0.03
</TABLE>
