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 July 3, 1999.
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to _______
Commission File Number: 0-27422
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
August 6, 1999 was 9,080,153.
<PAGE>
ARTHROCARE CORPORATION
INDEX
PART 1: Financial Information
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets as of July 3, 1999
and January 2, 1999
Condensed Consolidated Statements of Operations for the
three and six months ended July 3, 1999 and July 4, 1998
Condensed Consolidated Statements of Cash Flows
for the six months ended July 3, 1999 and July 4, 1998
Notes to Condensed Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
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
SIGNATURES
Part 1. Financial Information
Item 1. Financial Statements
ARTHROCARE CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
July 3, January 2,
1999 1999
------------- -------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $2,831 $2,826
Available-for-sale securities 4,316 5,232
Accounts receivables, net of allowance for bad de 7,380 5,972
Inventory 7,632 7,069
Prepaid expenses and other current assets 405 1,038
------------- -------------
Total current assets 22,564 22,137
Property and equipment, net 5,723 4,560
Related party receivables 1,205 723
Other assets 272 340
------------- -------------
Total assets $29,764 $27,760
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable 1,326 $1,797
Accrued liabilities 1,201 1,734
Accrued compensation 1,892 1,056
Deferred revenue 458 517
Capital lease obligation, current portion 59 60
------------- -------------
Total current liabilities 4,936 5,164
Capital lease obligation, less current portion 117 151
Deferred rent 135 140
------------- -------------
Total liabilities 5,188 5,455
------------- -------------
Contingencies (Note 6)
Stockholders' equity:
Common stock 9 9
Additional paid in capital 50,553 49,901
Notes receivable from stockholders -- (51)
Deferred compensation -- (68)
Accumulated other comprehensive income (loss) (80) (39)
Accumulated deficit (25,906) (27,447)
------------- -------------
Total stockholders' equity 24,576 22,305
------------- -------------
Total liabilities and stockholders' equity $29,764 $27,760
============= =============
</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 Six Months Ended
------------------- -------------------
July 3, July 4, July 3, July 4,
1999 1998 1999 1998
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Product sales $10,100 $5,673 $19,177 $10,544
License fees and royalty revenue 2,125 375 2,750 2,625
--------- --------- --------- ---------
Total revenue: 12,225 6,048 21,927 13,169
Cost of product sales 4,310 3,145 8,186 5,995
--------- --------- --------- ---------
Gross profit 7,915 2,903 13,741 7,174
--------- --------- --------- ---------
Operating expenses: 1,152 1,155 2,176 2,140
Research and development 3,810 2,422 7,146 4,538
Sales and marketing 1,679 713 3,028 1,924
General and administrative --------- --------- --------- ---------
Total operating expenses 6,641 4,290 12,350 8,602
--------- --------- --------- ---------
Net Income (loss)from operations 1,274 (1,387) 1,391 (1,428)
Interest and other income, net 81 293 215 587
--------- --------- --------- ---------
Income before taxes 1,355 (1,094) 1,606 (841)
Income tax provision 54 -- 65 --
--------- --------- --------- ---------
Net income (loss)
$1,301 ($1,094) $1,541 ($841)
========= ========= ========= =========
Basic net income (loss) per common share
$0.14 ($0.12) $0.17 ($0.09)
Diluted net income (loss) per common share ========= ========= ========= =========
$0.14 ($0.12) $0.16 ($0.09)
========= ========= ========= =========
Shares used in computing basic
net income (loss) per common share
9,036 8,914 8,973 8,902
Shares used in computing diluted ========= ========= ========= =========
net income(loss) per common share 9,609 8,914 9,547 8,902
========= ========= ========= =========
</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>
SIx months ended
--------------------------
July 3, July 4,
1999 1999
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $1,541 ($841)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Depreciation and amortization 1,057 282
Amortization of deferred compensation 68 80
Provision for doubtful accounts receivable
and product returns 131 50
Provision for excess and obsolete inventory 595 186
Deferred rent (5) (7)
Changes in operating assets and liabilities:
Accounts receivable (1,539) (1,633)
Inventory (1,158) (1,911)
Prepaid expenses and other current assets 633 (334)
Accounts payable (471) 774
Accrued liabilities 302 660
Deferred revenue (59) 875
Other assets 68 (13)
------------ ------------
Net cash provided by operating activities 1,163 (1,832)
------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (2,220) (1,035)
Purchases of available-for-sale securities (85) (22,093)
Sale or maturities of available-for-sale securities 1,001 26,550
------------ ------------
Net cash provided by (used in) investing activities (1,304) 3,422
------------ ------------
Cash flows from financing activities:
Issuance of notes receivable to related parties (575) (10)
Repayment of capital leases (34) (15)
Repayment of notes receivable from related parties 144 9
Proceeds from exercise of options
to purchase common stock 652 537
------------ ------------
Net cash provided by financing activities 187 521
------------ ------------
Effect of exchange rate on cash and cash equivalents (41) --
------------ ------------
Net increase in cash and cash equivalents 5 2,111
Cash and cash equivalents, beginning of period 2,826 8,188
------------ ------------
Cash and cash equivalents, end of period $2,831 $10,299
============ ============
</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" or "ArthroCare") for the periods
indicated. Interim results of operations are not necessarily indicative
of the results to be expected for the full year or any other interim
periods. The notes to the financial statements contained in the Form
10-K for the year ended January 2, 1999 should be read in conjunction
with these condensed consolidated financial statements. The balance
sheet at January 2, 1999 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 Net Income (Loss) Per Share:
Basic net income (loss) per share is computed using the weighted
average number of shares of common stock. Diluted net income (loss) per
share is computed using the weighted average number of shares of common
stock and common equivalent shares outstanding during the period.
Common equivalent shares consist of stock options. Common equivalent
shares are excluded from the computation if their effect is anti-
dilutive.
The following is a reconciliation of the computation for basic and
diluted net income (loss) per share (in thousands, except per share
data):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
------------------------ ---------------------
July 3, July 4, July 3, July 4,
1999 1998 1999 1998
----------- ----------- ----------- ---------
<S> <C> <C> <C> <C>
Net income (loss) $1,301 ($1,094) $1,541 ($841)
=========== =========== =========== =========
Shares calculation:
Weighted average basic shares outstanding 9,036 8,914 8,973 8,902
Options 573 -- 574 --
----------- ----------- ----------- ---------
Total shares used to compute
diluted net income (loss) per share 9,609 8,914 9,547 8,902
=========== =========== =========== =========
Net income (loss) per basic share $0.14 ($0.12) $0.17 ($0.09)
=========== =========== =========== =========
Net income (loss) per diluted share $0.14 ($0.12) $0.16 ($0.09)
=========== =========== =========== =========
</TABLE>
Options to purchase 62,631 shares of common stock at prices
ranging from $18.25-$24.25 per share were outstanding during the periods
ended July 4, 1998, but were not included in the computation of diluted
net loss per share because inclusion of such options would have been
anti-dilutive. Options to purchase 93,700 and 331,681 shares of common
stock at prices ranging from $17.625-$24.25 per share were outstanding
during the three and six-month periods ending July 3, 1999,
respectively, but were not included in the computation of diluted net
loss per share because inclusion of such options would have been anti-
dilutive.
3. Comprehensive Income (Loss):
Comprehensive income (loss) is comprised of net income and other
comprehensive income (loss) such as foreign currency translation
gain/loss and unrealized gains or losses on available-for-sale
marketable securities. The company's unrealized gains and losses on
available for sale marketable securities have been insignificant for all
periods presented. ArthroCare's total comprehensive income (loss) was
as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------- --------------------
July 3, July 4, July 3, July 4,
1999 1998 1999 1998
--------- --------- --------- ---------
'<S> <C> <C> <C> <C>
Net income (loss) $1,301 ($1,094) $1,541 ($841)
Other comprehensive income (loss):
Unrealized gain and losses on
available for sale marketable
securities -- (7) -- (7)
Foreign translation adjustment (4) -- (41) --
--------- --------- --------- ---------
Comprehensive net income (loss) 1,297 (1,087) 1,500 (834)
========= ========= ========= =========
</TABLE>
4. Balance sheet detail (in thousands):
<TABLE>
<CAPTION>
July 3, January 2,
1999 1999
------------ ------------
(Unaudited)
<S> <C> <C>
Inventory:
Raw materials $3,292 $3,127
Work-in-process 1,546 1,852
Finished goods 2,794 2,090
------------ ------------
Total $7,632 $7,069
============ ============
Other accrued liabilities:
Accrued professional fees $188 $150
Accrued warranty 302 302
Other 711 1,282
------------ ------------
Total $1,201 $1,734
============ ============
</TABLE>
ARTHROCARE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
5. Line of Credit:
In June 1999, the company entered into a $7.0 million revolving
line of credit that expires in June 2000. Borrowings under the line of
credit bear interest at the bank's prime rate plus one-quarter of one
percentage point. Borrowings under this line are secured by certain of
the company's assets and are subject to certain covenants related to
financial ratios and profits. At July 3, 1999 the company was in
compliance with these covenants. No borrowings were outstanding as of
July 3, 1999.
6. Litigation:
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 alleged, 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(R) and VersaPoint(R) which the company believes
infringe these patents. The Company settled this patent litigation with
the Defendants on June 24, 1999. Under the terms of the settlement,
Ethicon, Inc. has licensed the company's United States patents in the
arthroscopy and gynecology markets and ArthroCare has dismissed the
legal action. Both companies will remain active in the marketplace.
Ethicon, Inc. has paid ArthroCare a license fee and will pay ongoing
royalties on sales in the United States of certain arthroscopy and
gynecology products. The settlement agreement also establishes a
procedure for resolution of certain potential future intellectual
property disputes in these two markets without litigation.
On February 4, 1999, Xomed Surgical Products ("Xomed") of
Jacksonville, Florida filed a complaint against the company in the
Fourth Judicial Circuit, Duval County, Florida, alleging breach of
contract by the company. In the complaint, Xomed has demanded a full
refund of the amounts paid for certain products bought by Xomed from the
company, and for a portion of an exclusive license fee paid by Xomed
pursuant to an exclusive license and distribution agreement between
Xomed and the company. This license and distribution agreement was
terminated by the company on February 5, 1999. The company believes the
suit is without merit, and filed a Motion to Dismiss and Answer to the
Complaint on May 3, 1999. In addition, the company filed two
counterclaims against Xomed for damages caused by Xomed's failure to
perform under the contract and for a certain milestone payment owed to
ArthroCare by Xomed.
On March 24, 1999, a former employee of the company filed a complaint
of action for sexual harassment in violation of the Fair Employment and
Housing Act and retaliation in violation of the Fair Employment and Housing
Act. The company filed a response to the complaint on June 23, 1999, and
had a case management conference July 27 at which the parties stipulated
mediation. According to the complaint, the demand exceeds $25,000.
7. Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No.
133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments, embedded in other
contracts, and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. The company must adopt this standard no later than fiscal year
2001. To date, the company does not engage in hedging activities.
8. Segment Information:
The company is organized into four business units based on product
markets: arthroscopy, ear nose and throat, cosmetic surgery and
cardiology. To date, substantially all the company's product sales were
related to the Arthroscopy segment. Licensing fees are primarily
attributable to the Arthroscopy segment. However, during the three- and
six- month periods ended July 3, 1999, approximately $0.1 million and
$0.3 million, respectively, of the company's license revenue was
attributable to the AngioCare(TM) segment and $0.5 million and $1.0
million, respectively, was attributable to the Visage segment. During
the three-and six-month periods ended July 4, 1998, approximately $0.2
million and $2.3 million, respectively, of the company's license revenue
was attributable to the AngioCare segment.
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
ArthroCare Corporation (the "company" or "ArthroCare") "believes",
"anticipates", "expects" 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 2, 1999
and "ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS" set forth below.
ArthroCare has developed a broad technology platform for operating
on soft tissue. The technology is based on a patented method of tissue
removal, called Coblation(TM) technology, that is designed to improve the
effectiveness and safety of standard surgical methods. Coblation (TM)
technology uses radio frequency ("RF") energy to remove tissue through
a significantly cooler process than is possible with traditional electro
or laser-surgery. Coblation-assisted surgery has the potential to
improve operative precision and efficiency compared with many standard
surgical techniques and thereby reduce pain and speed recovery.
ArthroCare's Coblation Systems replace the multiple surgical tools
traditionally used in soft-tissue surgery procedures with one multi-
purpose, surgical system that consists of a controller unit and a series
of disposable surgical tools that are specialized for particular types
of surgery. The disposable surgical tool ablates (removes) soft tissue
with minimal damage to surrounding healthy tissue and simultaneously
achieves hemostasis (sealing of small bleeding vessels). Although the
company's Coblation technology is most commonly used in arthroscopic
procedures, ArthroCare has developed Coblation technology for use in
cosmetic surgery, ear, nose and throat ("ENT") surgery, and
cardiology. The company's long-term strategy includes applying its
patented technology to other soft-tissue surgery fields.
During the year ended January 2, 1999, the company formed a
business unit, AngioCare(TM), for the purpose of commercializing the
company's technology in the cardiac medicine market.
As part of those efforts, in February 1998, the company entered
into a license and OEM agreement under which Boston Scientific
Corporation ("BSC") will provide input into the development of, obtain
regulatory approval for and market products based on the company's
Coblation technology for myocardial revascularization procedures. The
company believes that there may be additional applications within
cardiology for which the company's technology could be utilized.
In April 1998, the company announced that it had entered the
cosmetic surgery market, and that it had formed a business unit called
Visage(R) to commercialize Coblation technology in this field. In January
1999, the company entered into a license and distribution agreement with
Collagen Aesthetics ("Collagen"), which was expanded in February 1999.
Under this agreement, Collagen acquired exclusive, worldwide marketing
rights for the company's Visage line of products for the dermatology and
cosmetic surgery markets. In August 1999, a tender offer was made for
Collagen. The company anticipates that there will be no significant
changes to the agreement based upon the acquisition.
In May 1998, the company announced that it had entered the
otorhinolaryngology (ear, nose and throat) market, and that it had
formed a business unit called ENTec(TM) to commercialize Coblation
technology in this field. In June 1998, the company entered into a
license and OEM agreement with Xomed Surgical Products ("Xomed") to
market the Coblation products in the otorhinolaryngology market. This
agreement was terminated by the company in February 1999, following
which the company has been pursuing direct marketing and distribution of
the ENTec product line. Xomed has filed suit against the company alleging
brach of contract and seeking monetary damages.
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 Electrosurgery System
in the United States for use in arthroscopic surgery of the knee,
shoulder, elbow and ankle. The company has since received FDA clearance
for use of this system in the wrist and hip. In May 1999, the company
received notification of approval by the Japanese Ministry of Health and
Welfare to market the company's Coblation-based arthroscopy products in
Japan. The company applied the CE mark for marketing the Visage System
in Europe for general dermatology, cosmetic surgery, skin resurfacing
and wrinkle reduction procedures and has received 510(k) clearance for
use in general dermatology procedures in the United States. The company
is pursuing additional clearances that will allow the system to be
marketed in the United States specifically for skin resurfacing and
wrinkle reduction. The company applied the CE mark for marketing the
ENTec System in Europe and has received 510(k) clearances for use in
general head and neck surgical procedures and functional endoscopic
sinus surgery in the United States. In addition, the company may pursue
FDA clearance for the use of Coblation technology in other indications.
In December 1995, the company first commercially introduced its
Arthroscopic System through a network of distributors in the United
States. The company's strategy includes placing controller units that
are intended to generate future disposable revenue with arthroscopic
surgeons. The company's long-term strategy includes applying its
patented platform technology to a range of other soft-tissue surgical
procedures including the newly introduced products in the fields of
cosmetic surgery and ear, nose and throat surgery. The company has
received 510(k) clearance for use of its technology in several other
fields. 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:
Product sales for the three months ended July 3, 1999 were $10.1
million, an increase of $4.4 million or 78% from $5.7 million for the
prior year period. For the six months ended July 3, 1999 product sales
were $19.2 million, representing an 82% increase, from $10.5 million for
the same period of the prior year. The increase in product sales was
primarily due to an increase in the number of sales of both controllers
and disposable units. The higher unit volume of sales resulted
primarily from increased activity for newly introduced styles of
disposables for arthroscopy, and sales of disposables for new product
lines. Another factor contributing to the increase in products sales was
the increase in international product sales during 1999.
International product sales for the three months ended July 3,
1999 increased to 16% of total product sales when compared to 9% of
product sales for the same period of the prior year. International
product sales for the six months ended July 3, 1999 increased to 11%
compared to 9% of product sales for the same period in 1998. The
increase in international sales are primarily attributable to increasing
sales in the Pacific Rim since the company received approval by the
Japanese Ministry of Health and Welfare to market arthroscopic products
in Japan and increased sales in Europe.
The company believes that, to date, it has penetrated 30% of
hospitals and surgical centers that perform arthroscopic procedures in
the United States. The company's strategy in arthroscopy has been, and
continues to be, to increase future disposables sales by increasing the
installed base of controllers through promotional programs. Disposables
are consistently sold at or near list price except for sales to
international distributors and marketing partners, which are currently,
and are expected in the future to be, sold at discounted prices.
Based on the estimated number of procedures performed each year,
the company believes that knee procedures represent the largest segment
of the arthroscopic market. In order to achieve increasing disposable
sales over time, the company believes it must continue to penetrate the
market in knee procedures, expand physicians' education with respect to
Coblation technology, continue working on articular cartilage
applications and focus product development efforts specifically on knee
applications. During the second half of fiscal year 1998, the company
introduced new disposable styles, including the Saber(TM) and Covac(TM), that
are designed primarily to be used in arthroscopic knee procedures.
Sales of these disposables specifically designed for use in the knee
accounted for approximately 16% of the arthroscopy disposables sold.
License fees and royalty revenue increased to $2.1 million for the
three months ended July 3, 1999 from $0.4 million for the three months
ended July 4, 1998 and increased to $2.8 million for the six months
ended July 3, 1999 from $2.6 million for the six months ended July
4,1998. The increases are primarily due to the timing of licensing
payments received as the result of settlement of a patent infringement
suit initiated by the company, offset by the timing of licensing fees
received from its business partners. In February 1998, the company
entered into a license agreement under which BSC was granted an
exclusive right to develop and market products based on the company's
Coblation technology for myocardial revascularization procedures. BSC
pays 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. Licensing fees are
primarily attributable to the Arthroscopy segment, however, during the
three- and six-month periods ending July 3, 1999 the company recognized
$0.1 million and $0.3 million, respectively, of such payments as license
fees and royalty revenue. The company received a license payment from
BSC of $3.0 million in February of 1998, of which $0.2 million and $2.3
million was recognized as revenue during the three- and six-month
periods ended July 4, 1998, respectively.
In January 1999, the company entered into a license and
distribution agreement with Collagen, which was broadened by mutual
agreement in February 1999, whereby Collagen acquired exclusive,
worldwide, marketing rights for the company's patented Coblation
technology in the dermatology, cosmetic and plastic surgery markets.
Under the terms of the agreement, Collagen pays license fees based upon
the achievement of certain milestones and royalties on sales of product
to end-users. During the three-and six-month periods ended July 3, 1999,
the company recognized $0.5 million and $1.0 million, respectively, of
such payments as license fees and royalty revenue.
There can be no assurance that the company will be able to
continue to achieve the milestones required to recognize future license
fees, or that products will be developed, cleared for marketing by
various regulatory agencies or achieve sufficient commercial acceptance
so that the company may continue to receive licensing and royalty
revenues from its business partners.
Cost of Product Sales
Cost of product sales for the three months ended July 3, 1999 was
$4.3 million or 43% of product sales, as compared with $3.2 million or
56% of product sales for the three months ended July 4, 1998. For the
six months ended July 3, 1999, cost of product sales was $8.2 million or
43% of product sales, as compared with $6.0 million or 57% of product
sales for the comparable period of the prior year. The absolute dollar
increase in cost of product sales for the three-and six-month periods
ended July 3, 1999 compared to the same period of the prior year is
attributable to increasing unit sales of both controllers and
disposables. The decrease in absolute dollars in cost of product sales
and as a percentage of sales for the six months ended July 3, 1999 as
compared to the prior year period ended July 4, 1998 is attributable to
increased manufacturing efficiency and increased production volume along
with additional controller placement programs whereby the company
maintains ownership of the controller.
There can be no assurance that cost of product sales as a percentage
of product sales will remain at current levels or show improvement in
the future due to the distribution channels utilized, product mix, and
fluctuation in manufacturing production levels due to new product
introductions.
Operating Expenses
Research and development expense was $1.2 million, for the three
months ended July 3, 1999 and July 4, 1998. For the six months ended
July 3, 1999, and July 4, 1998, research and development expense was
$2.2 million and $2.1 million, respectively. In general, overall
spending in research and development increased slightly as the company
continues to develop new products in its currently commercialized market
as well as development effort for potential additional products.
Increases in research and development expense have been partially offset
by funding received from business partners for continued product
development. The company believes that investment in its platform
technology is essential for the company to maintain its competitive
position. The company expects to increase the dollar amount of research
and development spending through continued expenditures on new product
development, regulatory affairs, clinical studies and patents, but
anticipates expenses to continue to decrease as an overall percentage of
product sales.
Sales and marketing expense increased to $3.8 million or 38% of
product sales during the three months ended July 3, 1999, as compared to
$2.4 million or 43% of product sales during the same period of the
previous fiscal year. For the six months ended July 3, 1999, and July 4,
1999 sales and marketing expense increased to $7.1 million or 37% of
product sales from $4.5 million or 43% of product sales, respectively.
The increase in spending in absolute dollars for the three-and six-month
periods was primarily due to higher dealer commissions resulting from
increased sales, increased staffing and increased trade-show related
expense. Additional sales and marketing expenses were incurred during
the current-year periods as the company expanded operations in Europe.
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, higher
promotional, demonstration and sample expenses, and additional
investments in the sales, marketing and support staff necessary to
market the company's current products and commercialize future products.
General and administrative expense increased to $1.7 million or
17% of product sales during the three months ended July 3, 1999, as
compared to $0.7 million or 13% of product sales during the same period
of the previous fiscal year. For the six months ended July 3, 1999, and
July 4, 1999 general and administrative expense increased to $3.0
million or 16% of product sales from $1.9 million or 18% of product
sales, respectively. Overall, the most significant increase was
attributable to legal expenses related to the patent infringement claims
brought by the company against certain competitors. The company expects
that general and administrative expenses will decrease as a result of
the recent settlement of this litigation, offset partially by an
increase in additional business development activities.
Interest and Other Income, net
Interest and other income, net decreased to $0.1 million during
the three months ended July 3, 1999 from $0.3 million for the three
months ended July 4, 1998. For the six months ended July 3, 1999, and
July 4, 1999 interest and other income, net decreased to $0.2 million
from $0.6 million, respectively. The decreases were primarily due to a
decrease in interest income from investments due to the declining
balance of cash and investments.
Income Tax Provision
The provision for income taxes was $54,000 and $65,000 for the
three-and six- month periods ended July 3, 1999, respectively. The
company's tax rate is below the statutory rate due to the utilization of
net operating loss carryforwards incurred in prior years. The company
has federal net operating loss carryforwards which expire in the years 2004
through 2018, and state net operating loss carryforwards which expire in the
years 2000 through 2003. The company is subject to certain alternative
minimum tax requirements for which an estimate is made based on the
anticipated effective tax rate at the end of the fiscal year.
Net Income (Loss)
Net income was $1.3 million for the three months ended July 3, 1999
compared to a loss of $1.1 million for the period ended July 4,
1998. For the six months ended July 3, 1999, net income increased to
$1.5 million from a net loss of $0.8 million for the same period of the
prior year. Net income for the current periods reflect an increase in
product sales, license fees and gross margin primarily offset by
increased spending in sales and marketing and legal expenses. Although
the company has experienced substantial revenue growth since its
inception, and has been profitable on a quarterly basis since the
quarter ended April 3, 1999, due to its short operating history, no
assurance can be given that revenue growth or profitability will be
sustained.
Liquidity and Capital Resources
On July 3, 1999, the company had $22.6 million in working capital.
Principal sources of liquidity consisted of $7.1 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. In addition, the company had $7.0 million available under a line
of credit. Available borrowings under this line of credit are contingent
upon and secured by certain of the company's asset balances. Borrowings
under the line of credit bear interest at the Bank's prime rate plus
one-quarter of one percentage point. Borrowings under this line are
secured by certain of the company's assets and are subject to certain
covenants related to financial ratios and profits. At July 3, 1999 the
company was in compliance with these covenants. No borrowings were
outstanding as of July 3, 1999.
Net cash provided by operating activities for the six months ended
July 3, 1999 was $1.2 million. Cash used in operating activities for the
six months ended July 4, 1998 was $1.8 million. The increase in cash
provided by operating activities year-over-year was primarily due to the
net income of $1.5 million for 1999 compared to a net loss in 1998 of
$0.8 million and a increase in the depreciation amounts year-over-year.
Net accounts receivable increased to $7.4 million as of July 3,
1999 from $6.0 million as of January 2, 1999. The increase in accounts
receivable is mainly attributable to the corresponding increase in
product sales offset in part by a decrease in the overall number of days
sales outstanding.
Inventories increased slightly to $7.6 million as of July 3, 1999
from $7.1 million at January 2, 1999, due to higher product sales
activity along with the anticipated ramp-up of new product markets. The
company expects future inventory levels to grow as sales volume
increases.
Net property and equipment increased to $5.7 million as of July 3,
1999 from $4.6 million on January 2, 1999. The increase is primarily
attributable to the capitalization of controllers placed under various
promotional programs along with an increase of computer software and
equipment.
The company plans to finance its capital needs principally from
cash from product sales, license fees and royalty income, and existing
cash and cash equivalents and related interest. The company believes
this will be sufficient to fund its operations through fiscal year 1999.
The company has obtained a $7.0 million line of credit that could
provide additional working capital. As of July 3, 1999, the company had
committed to capital expenditures of approximately $0.3 million. The
company's future liquidity and capital requirements will depend on
numerous factors, including the company's success in commercializing its
products, 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, obtaining and
enforcing patents important to the company's business, the status of
regulatory approvals and competition.
Year 2000
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 assigned a Task Force to
handle the significant uncertainty that exists concerning the potential
effects associated with Year-2000 compliance. The Task Force has
formulated and begun to implement a plan to address Year-2000
compliance, including the formulation of contingency plans. To date, the
company has not found a material impact that may result from the failure
of its computers and computer software, or that of its vendors,
suppliers, and customers, to recognize dates. The company has completed
an upgrade of its information technology system, including its financial
system, order processing, manufacturing and inventory system, which
included Year-2000 compliance. To date the company has spent
approximately $900,000 upgrading its computer system and related
technology. The company has not yet undertaken the steps to quantify the
effects of noncompliance of its customers, suppliers and/or its service
providers. The company's goal is to complete all phases of its review
and be Year-2000 compliant by December 1999.
Any Year-2000 compliance problems with either the company, its
suppliers, its service providers or its customers could result in a
material adverse effect on the company's financial condition and
operating results. There can be no assurance that further assessment of
the company's suppliers, data processing systems or contingency plans
will address all issues of Year-2000 compliance.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS
No. 133 establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments, embedded in other
contracts, and for hedging activities. It requires that an entity
recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair
value. The company must adopt this standard no later than fiscal year
2001. To date, the company does not engage in hedging activities.
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, filed April 2, 1999 for the year ended January 2, 1999. 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.
Early Stage of Commercialization of Non-Arthroscopic Products;
Uncertainties Associated with Non-Arthroscopic Products.
During the year ended January 2, 1999, the company formed a
business unit, AngioCare(R), for the purpose of commercializing the
company's technology in the cardiac and interventional cardiology
markets. In April 1998, the company announced the creation of its new
business unit, Visage, created for the purpose of commercializing the
company's Coblation technology for use in dermatology and cosmetic
surgery procedures. In May 1998, the company announced the creation of
its new business unit, ENTec, created for the purpose of commercializing
the company's Coblation technology for use in head and neck surgical
procedures. During 1998, the company entered into a license and OEM
agreement under which Boston Scientific Corporation ("BSC") will
provide input into the development of, obtain regulatory approval for
and market products based on the company's Coblation technology for
myocardial revascularization procedures. In addition, the company may
pursue additional clearances for certain other indications. The company
applied the CE mark for marketing of the Visage product line in Europe
for general dermatology, cosmetic surgery, skin resurfacing and wrinkle
reduction procedures and has received 510(k) clearances for use of
Visage products in general dermatology procedures in the United States.
The company is pursuing additional clearances that will allow the Visage
product line to be marketed in the United States specifically for skin
resurfacing and wrinkle reduction. During 1999, the company entered into
a license and distribution agreement with Collagen Aesthetics
("Collagen"). Under this agreement, Collagen acquired exclusive,
worldwide, marketing rights for the company's Visage line of products
for the dermatology and cosmetic surgery markets. The company has
applied the CE mark certification for marketing the ENTec line of
Coblation-based products in Europe and has received 510(k) clearances
for use of this system in general head and neck surgical procedures, as
well as endoscopic sinus surgery, in the United States. Both the ENTec
and Visage product lines have only recently been commercially introduced
and, to date, the company has sold only a limited number of units, which
have been utilized by a limited number of doctors. No assurance can be
given that the company or its partners will be able to market the
Visage, ENTec or AngioCare product lines successfully.
A significant investment in additional preclinical and clinical
testing, regulatory and sales and marketing activities may be necessary
in order for the company to commercialize the Visage, ENTec and
AngioCare product lines. There can be no assurance that the Visage,
ENTec or AngioCare product lines will generate sufficient or sustainable
revenues to enable the company to profitable. Furthermore, although the
company believes that these products offer certain advantages, there can
be no assurance that these advantages will be realized, or if realized,
that these products will result in any meaningful benefits to current or
future collaborative partners or patients.
Development and commercialization of the Visage, ENTec and
AngioCare product lines are subject to the risks of failure inherent in
the development of new medical devices. These risks include the
possibility that the company will experience delays in testing or
marketing, that such testing or marketing will result in unplanned
expenditures or in expenditures above those anticipated by the company,
that the Visage, ENTec and AngioCare product lines will not be proven
safe or effective, that such products will not be easy to use or cost-
effective, that third parties will develop and market superior or
equivalent products, that such products will fail to receive necessary
regulatory approvals, that such products will be difficult or
uneconomical to manufacture on a commercial scale, that proprietary
rights of third parties will preclude the company or its collaborative
partners from marketing such products and that such products will not
achieve market acceptance. As a result of these risks, there can be no
assurance that research and development efforts conducted by the
company or its collaborative partners will result in any commercially
viable products. If required regulatory approvals are not obtained for
the Visage, ENTec and AngioCare product lines or any approved products
are not commercially successful, there may be a material adverse effect
on the company's business, financial condition and results of
operations.
Dependence Upon Arthroscopic System
The company commercially introduced the Arthroscopic System in
December 1995. Since the Arthroscopic System accounts for substantially
all of the company's product sales, the company is highly dependent on
it. No assurance can be given that the company will be able to
manufacture the Visage, ENTec and AngioCare product lines in commercial
quantities at acceptable costs, or that it will be able to market such
products successfully. 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 FDA or foreign regulatory authorities on a timely
basis, if at all, or that the potential products will ever achieve
commercial acceptance.
Currently, a large portion of the company's sales are from its
Arthroscopic System in the United States. The company has established
distribution capability in Europe, Australia, New Zealand, Korea, Japan,
Taiwan, Canada, Mexico, the Caribbean, Russia, South Africa, the Middle
East, Northern Africa and South and Central America. Before the
Arthroscopic System can be sold in some of these regions, the company
will have to obtain additional international regulatory approvals. If
such regulatory approval is obtained, there can be no assurance that the
company will be able to establish a successful distribution capability
in these or in other geographic regions, or for other than the
arthroscopic product line.
Dependence Upon Collaborative Arrangements
In order to successfully develop and commercialize certain
products, the company may enter into collaborative or licensing
arrangements with other medical device companies and other entities to
fund and complete its research and development activities, pre-clinical
and clinical testing and manufacturing, to seek and obtain regulatory
approval and to achieve successful commercialization of future products.
The company has entered into collaborative arrangements with BSC and
Collagen. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview" for a discussion of
these arrangements.
Participation in collaborative and licensing arrangements with
third parties subjects the company to a number of risks. Agreements with
collaborative partners typically allow such partners significant
discretion in electing whether to pursue any of the planned activities.
The company cannot control the amount and timing of resources its
collaborative partners may devote to the products and there can be no
assurance that such partners will perform their obligations as expected.
Business combinations or significant changes in a corporate partner's
business strategy may adversely affect such partner's ability to meet
its obligations under the arrangements. For example, a third party has
recently made a tender offer for Collagen stock. Although, the company
does not believe that the new partner will have an adverse, if any collaborative
partner were to terminate or breach its agreement with the company, or otherwise
fail to complete its obligations in a timely manner, such conduct could
have a material adverse effect on the company's business, financial
condition and results of operations. To the extent that the company is
not able to establish further collaborative arrangements or that any or
all of the company's existing collaborative arrangements are terminated,
the company would be required to seek new collaborative arrangements or
to undertake commercialization at its own expense, which could
significantly increase the company's capital requirements, place
additional strain on its human resource requirements and limit the
number of products which the company would be able to develop and
commercialize. In addition, there can be no assurance that existing and
future collaborative partners will not pursue alternative technologies
or develop alternative products either on their own or in collaboration
with others, including the company's competitors.
There can also be no assurance that disputes will not arise in the
future with respect to the ownership of rights to any technology or
products developed with any collaborative partner. Lengthy negotiations
with potential new collaborative partners or disagreements between
established collaborative partners and the company could lead to delays
or termination in the research, development or commercialization of
certain products or result in litigation or arbitration, which would be
time consuming and expensive. Failure by any collaborative partner to
successfully commercialize any product candidate to which it has
obtained rights from the company, or the decision by a collaborative
partner to pursue alternative technologies or commercialize or develop
alternative products, either on their own or in collaboration with
others, could have a material adverse effect on the company's business,
financial condition and results of operations.
Uncertainty of Market Acceptance
Despite the benefits of the company's Coblation technology,
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.
Only a few, independently published clinical reports exist to support
the company's marketing efforts for its products and technology. The
company believes that continued recommendations and endorsements by
influential physicians are essential for market acceptance of its
products and technology. If Coblation technology does not continue to
receive broad-based physician acceptance and endorsement by influential
physicians, the company's business, financial condition and results of
operations could be materially adversely affected.
Limited Domestic and International Marketing and Sales Experience
The company has shipped over 5,000 controller units and more than
450,000 disposables through the quarter ended July 3, 1999. The company
is marketing and selling its Arthroscopic and ENTec product lines in the
United States and internationally through a network of independent
distributors and its subsidiary, ArthroCare Europe AB. These
distributors sell orthopedic arthroscopy and ENTec devices for a number
of other manufacturers. In addition, there can be no assurance that
these distributors will commit the necessary resources to effectively
market and sell the company's Arthroscopic or ENTec product lines, or
that they will be successful in closing sales with doctors and
hospitals. Collagen is the exclusive and worldwide distributor for the
Visage product line. The inability to sell sufficient quantities of the
cosmetic surgery products could have a material adverse effect on the
company's business, financial condition and results of operations.
The company has established distribution capability in Europe,
Australia, New Zealand, Korea, Japan, Taiwan, Canada, Mexico, the
Caribbean, Russia, South Africa, the Middle East, Northern Africa and
South and Central America. Before the Arthroscopic System can be sold in
some of these regions, the company will have to obtain additional
international regulatory approvals. If such regulatory approval is
obtained, there can be no assurance that the company will be able to
establish a successful distribution capability in these or in other
geographic regions. In January 1999, the company entered into a license
agreement with Collagen, whereby Collagen has the exclusive worldwide
distribution rights for Visage. For a description of additional risks
and uncertainties relating to Collagen's exclusive worldwide
distribution rights for Visage, see "Additional Factors That Might
Affect Future Results - Dependence on Collaborative Arrangements" on
page 20 of this Quarterly Report on Form 10-Q.
No assurance can be given that the company will successfully
market its products directly, or through its distributors or its
business partners, that the company will secure marketing partners for
other international markets, and successfully sell its products 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 its products in international markets.
Limited Manufacturing Experience
The company's manufacturing operations consist of an in-house
assembly operation for the manufacture of disposables, and a separate
in-house operation for the manufacture of controllers. The company's
products are manufactured from several components, some of which are
supplied to the company by third parties. Manufacturing of the
controllers, of which an earlier version was manufactured by a third
party, was brought in-house in late 1997 for purposes of maintaining
process control, managing availability, and leveraging fixed costs.
In early 1998, the company started manufacturing its System 5000
controllers for its Visage product line and only a small number of this
model of controllers have been manufactured and sold. In the same time
period, the company began to manufacture limited numbers of disposables
for the ENTec and Visage product lines. As a result, the company has
limited experience manufacturing ENTec and Visage product lines in
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 FDA Quality System Regulation ("QSR") 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. In addition,
the company must conform to the Medical Device Directive ("MDD") for
sale in Europe. There can be no assurance that the company or its
component suppliers will remain in compliance with the QSR, ISO 9001 or
MDD standards. Any failure by the company or its component suppliers to
remain in compliance with the QSR, ISO 9001 or MDD standards could have
a material adverse effect on the company's business, financial condition
and results of operations.
In addition, the disposables are sterilized by a single
subcontractor. There can be no assurance that an alternate sterilizer
can be identified and qualified for sterilizing the disposables. The
company's inability to secure an alternative sterilizer, if required,
would limit its ability to manufacture the company's disposables and
could have a material adverse effect on the company's business,
financial condition and results of operations.
History of Losses; Fluctuations in Operating Results
The company has experienced significant operating losses since
inception and, as of July 3, 1999, had an accumulated deficit of $25.9
million. Results of operations may fluctuate significantly from quarter
to quarter due to the timing of expenditures, receipt of license fees
and/or milestone payments, absence of a backlog of orders, timing of the
receipt of orders, and promotional programs for the company's products.
The company's revenues and profitability will be critically dependent on
whether or not it can successfully continue to market its Coblation-
based technology product lines. 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 19 issued United States
("U.S.") patents, more than 60 pending U.S. patent applications, 10
issued international patents and over 40 international patent
applications corresponding to 20 of the U.S. filings. The initial U.S.
patent is currently set to expire in 2008, three issued U.S. patents are
currently expected to expire between 2008 and 2012 and the other 15 U.S.
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 Soft-tissue Surgery Systems, including both multi-
electrode and single-electrode configurations of its disposable tools,
as well as the use of Coblation technology in specific surgical
procedures.
The issued patents cover, among other things, systems and methods
for applying radio frequency energy to tissue in the presence of
electrically conductive fluid such as isotonic saline; disposables
having an electrode array and a means to supply current independently to
individual electrodes; and systems and methods for employing radio
frequency energy in arthroscopy, urology, gynecology, ENT, cosmetic
surgery and cardiac procedures (e.g. transmyocardial revascularization
of the heart). The pending patent applications include coverage for the
fundamental tissue ablation and cutting technology as well as methods
and apparatus for specific procedures.
There can be no assurance that the patents that have been issued
to the company or any patents that 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 in in the United States or
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.
This lawsuit has been settled. See Part II, Item I of this Quarterly
Report on Form 10-Q. The defense and prosecution of the Lawsuit and
intellectual property suits, generally, USPTO interference proceedings
and related legal and administrative proceedings are all costly and
time-consuming. The company believes that the Lawsuit was 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 such further litigation or interference proceedings may
result in substantial expense to the company and significant diversion
of effort by the company's technical and management personnel. An
adverse determination, 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's Coblation technology is beginning to replace older tissue
removal technology, such as laser systems, conventional electrosurgical
systems, manual instruments and power shavers in certain arthroscopic
procedures. Consequently, the company competes indirectly with the
providers of such tissue removal systems because the company must
convert customers to its Coblation technology. Many of these competitors
have significantly greater financial, manufacturing, marketing,
distribution and technical resources than the company. Smith & Nephew
Endoscopy (which owns Acufex Microsurgical, Inc. and Dyonics, Inc.),
Conmed Corporation (including its Linvatec unit) and Stryker Corporation
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. There can be no assurance
that the company can effectively convince surgeons and physicians to
adopt the company's Coblation technology. 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.
Johnson & Johnson (including Mitek, a division of its Ethicon unit)
is marketing a bipolar electrosurgical tool developed by Gyrus Medical
Ltd., a company based in the United Kingdom. The bipolar
electrosurgical tool marketed by Mitek & Linvatec competes directly with the
company's tissue ablation and shrinkage technology in arthroscopy. In addition,
the Linvatec unit of Conmed is marketing a monopolar electrosurgical tool
for tissue ablation in arthroscopy. In order to successfully compete
against Mitek, the company anticipates that it may have to continue
to offer substantial discounts on its controller in order to increase
demand for the disposables, and that such competition could have a material
adverse effect on the company's business, financial condition and
results of operation. Furthermore, certain of the company's competitors
including Ethicon, utilize purchasing contracts that link discounts
on the purchase of one product to purchases of other products in
to their broad product lines. Many of the hospitals in the United States
have purchasing contracts with such competitors of the company.
Accordingly, customers may be dissuaded from purchasing the
company's products rather than the products of such competitors to the extent
the purchase would cause them to lose discounts on products
that they regularly purchase from such competitors.
Oratec Interventions Inc., a company based in Menlo Park, California,
manufactures and sells a monopolar tissue shrinkage system that competes
directly with the company's tissue shrinkage products. The tissue
shrinkage market represents a small portion of the overall potential
market for the company's products in arthroscopy.
The ear, nose and throat ("ENT") medical device industry is
rapidly becoming more competitive. The company recently cancelled its
exclusive license and distribution agreement with Xomed Surgical
Products, which is currently the largest company focused solely on the
ENT market. (see "Additional Factors That Might Affect Future Results -
Dependence on Collaborative Arrangements" on page 20 of this Quarterly
Report on Form 10-Q). However, other large companies, such as Smith &
Nephew, Stryker Corporation and Conmed Corporation, each have shares of
the market for manual instruments, such as microdebriders for endoscopic
sinus surgery. In ENT, the company faces competition from large laser
companies, such as ESC Medical Systems ("ESC") of Tel Aviv, Israel,
which develops and markets lasers for certain ENT applications, such as
laser-assisted uvuloplasty ("LAUP"). The company expects that
competition from these and other well-established competitors will
increase as will competition from start-up and small cap medical device
companies, such as Somnus Medical Technologies, a company based in
Sunnyvale, California, Elmed Inc. of Addison, Illinois and Ellman
International, Inc. of Hewlett, New York. Somnus Medical Technologies
manufactures and sells medical devices that utilize RF technology for
the treatment of upper airway disorders, such as snoring, enlarged
turbinates, and obstructive sleep apnea. Elmed Inc. and Ellman
International, Inc. both manufacture and sell a variety of medical
devices that use conventional RF technology for tissue dissection,
cutting and/or coagulation in turbinate surgery, the treatment of
snoring and other ENT procedures.
The company has entered into an exclusive license and distribution
agreement with Collagen, which is currently one of the largest company's
focused on the cosmetic surgery market. The cosmetic surgery industry
includes a number of large and well established companies that provide
devices for rejuvenating skin, hair removal, scar removal, the treatment
of vascular and pigmented lesions and other applications, including
companies that manufacture and sell dermabrasion equipment or chemical
peels, and companies that manufacture and sell carbon dioxide and Er:YAG
lasers. In skin resurfacing, the company will directly compete with much
larger companies that manufacture lasers for medical use, such as
Coherent Medical Group of Santa Clara, California and ESC Medical
Systems of Tel Aviv, Israel. ESC recently merged with Laser Industries,
Ltd., already one of the largest medical laser manufacturers in the
world. The combined entity develops and markets lasers for a broad range
of cosmetic applications including the non-invasive treatment of
varicose veins and other benign vascular lesions, hair removal, skin
resurfacing and others. In addition, other large companies manufacture
and sell medical devices that use RF energy for certain applications in
dermatology and cosmetic surgery. One such company is Conmed
Corporation, which currently sells medical devices for
electrodessication, fulguration and coagulation in office-based
dermatology procedures.
The company has received 510(k) premarket notifications for
clearance to market tissue ablation products to treat other surgical
fields that the company may enter. 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 by the
Food and Drug Administration ("FDA") as medical devices under the
Federal Food, Drug, and Cosmetic Act ("FDC Act") and require premarket
clearance or approval by the FDA prior to commercialization. In
addition, certain material changes or modifications to medical devices
also are subject to FDA review and clearance or approval. Pursuant to
the FDC Act, the FDA regulates the research, testing, manufacture,
safety, labeling, storage, record keeping, advertising, distribution and
production of medical devices in the United States. Noncompliance with
applicable requirements can result in warning letters, fines,
injunctions, civil penalties, recall or seizure of products, total or
partial suspension of production, failure of the government to grant
premarket clearance or premarket approval for devices, and criminal
prosecution. Failure to comply with the regulatory requirements could
have a material adverse effect on the company's business, financial
condition and results of operations.
If human clinical trials of a device are required and if the
device presents a "significant risk," the manufacturer or the
distributor of the device is required to file an Investigational Device
Exemption ("IDE") application prior to commencing human clinical
trials. The IDE application must be supported by data, typically
including the results of animal and, possibly, mechanical testing.
Sponsors of clinical trials are permitted to sell investigational
devices distributed in the course of the study, provided such costs do
not exceed recovery of the costs of manufacture, research, development
and handling. The clinical trials must be conducted under the auspices
of an independent Institutional Review Board ("IRB") established
pursuant to FDA regulations, and with appropriate informed consent of
the patient.
Generally, before a new device can be introduced into the market
in the United States, the manufacturer or distributor must obtain FDA
clearance of a 510(k) notification or approval of a Pre-Market
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 FDA. The FDA has recently been requiring a more
rigorous demonstration of substantial equivalence.
Following submission of the 510(k) notification, the manufacturer
or distributor may not place the device into commercial distribution
until an order is issued by the FDA. No law or regulation specifies the
time limit by which FDA must respond to a 510(k) notification. At this
time, the FDA typically responds to the submission of a 510(k)
notification within 90 to 120 days, but it may take longer. An FDA order
may declare that the device is substantially equivalent to another
legally marketed device and allow the proposed device to be marketed in
the United States. The FDA, however, may determine that the proposed
device is not substantially equivalent or require further information,
including clinical data, to make a determination regarding substantial
equivalence. Such determination or request for additional information
could delay market introduction of the products that are the subject of
the 510(k) notification.
The company has received clearance of 510(k) premarket
notifications to market its Arthroscopic System for surgery of the knee,
shoulder, elbow, wrist, hip and ankle joints. In addition, the company
has received 510(k) premarket notifications to market Visage in general
dermatology procedures and is pursuing additional clearances that will
allow Visage to be marketed in the United States specifically for skin
resurfacing and wrinkle reduction. With respect to ENTec, the company
has received clearance of 510(k) premarket notifications to market the
ENTec product line in general head and neck surgical procedures, as well
as endoscopic sinus surgery. There can be no assurance that the company
will be able to obtain necessary clearances or approvals to market any
other products on a timely basis, if at all, and delays in receipt or
failure to receive such clearances or approvals, the loss of previously
received clearances or approvals, or failure to comply with existing or
future regulatory requirements could have a material adverse effect on
the company's business, financial condition and results of operations.
If a manufacturer or distributor of medical devices cannot
establish that a proposed device is substantially equivalent to a
legally marketed device, the manufacturer or distributor must seek
premarket approval of the proposed device through submission of a PMA
application. A PMA application must be supported by extensive data,
including, in many instances, preclinical and clinical trial data, as
well as extensive literature to prove the safety and effectiveness of
the device. Following receipt of a PMA application, if the FDA
determines that the application is sufficiently complete to permit a
substantive review, the FDA will "file" the application. Under the FDC
Act, the FDA has 180 days to review a PMA application, although the
review of such an application more often occurs over a protracted time
period, and generally takes approximately two years or more from the
date of filing to complete.
The PMA application approval process can be expensive, uncertain
and lengthy. A number of devices for which premarket approval has been
sought have never been approved for marketing. The review time is often
significantly extended by the FDA, which may require more information or
clarification of information already provided in the submission. In
addition, the FDA will inspect the manufacturing facility to ensure
compliance with the FDA's Good Manufacturing Practice ("GMP") or QS
Regulations ("QSR") requirements prior to approval of an application.
If granted, the approval of the PMA application may include significant
limitations on the indicated uses for which a product may be marketed.
If necessary, the company will file a PMA application with the FDA
for approval to sell its potential products commercially in the United
States when it has developed such products. There can be no assurance
that the company will be able to obtain necessary PMA application
approvals to market such products on a timely basis, if at all, and
delays in receipt or failure to receive such approvals, the loss of
previously received approvals, or failure to comply with existing or
future regulatory requirements could have a material adverse effect on
the company's business, financial condition and results of operations.
The company is also required to register as a medical device
manufacturer with the FDA and state agencies, such as the California
Department of Health Services ("CDHS") and to list its products with
the FDA. As such, the company is subject to inspections by both the FDA
and the CDHS for compliance with the FDA's QSR requirements and other
applicable regulations. These regulations require that the company
maintain its documents in a prescribed manner with respect to
manufacturing, testing and control activities. Further, the company and
the third party manufacturers of its products are required to comply
with various FDA requirements for design, safety, advertising and
labeling. There can be no assurance that the company or its component
suppliers will not encounter any manufacturing difficulties, or that the
company and any of its subcontractors or component suppliers will not
experience similar difficulties, including problems involving regulatory
compliance, product recalls, production yields, quality control and
assurance, supplies of components or shortages of qualified personnel.
Regulations regarding the manufacture and sale of the company's
products are subject to change. The company cannot predict the effect,
if any, that such changes might have on its business, financial
condition or results of operations.
International
International sales of the company's products are subject to the
regulatory agency product registration requirements of each country. The
regulatory review process varies from country to country. The company
has obtained regulatory clearance to market the Arthroscopic System in
Australia, Europe, Canada, Japan and Mexico; to market Visage in Europe,
Australia and Canada and to market ENTec in Europe, 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/EN46001 certification and the CE mark. ISO 9001/EN46001
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 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/EN46001
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 day-surgery
facilities, hospitals and physicians, that purchase medical devices,
such as the company's 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 and ENT procedures performed using devices that have
received FDA approval has generally been available in the United States.
Generally, cosmetic procedures are not reimbursed. 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.
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 apparent 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 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 is in the early 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) applications, 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 $7.0 million per
occurrence and $7.0 million 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 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
Arthroscopic System since December 1995 and recently commenced sales of
the Visage and ENTec, product lines 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.
Year 2000
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 assigned a Task Force to
handle the significant uncertainty that exists concerning the potential
effects associated with Year-2000 compliance. The Task Force has
formulated and begun to implement a plan to address Year-2000 compliance
including the formulation of contingency plans. To date, the company has
not found a material impact that may result from the failure of its
computers and computer software or that of its vendors, suppliers, and
customers, to recognize dates. The company has completed an upgrade of
its information technology system including its financial system, order
processing, manufacturing and inventory system which included Year-2000
compliance. To date the company has spent approximately $900,000
upgrading its computer technology. The company has not yet undertaken
the steps to quantify the effects of noncompliance of its customers,
suppliers and/or its service providers. The company's goal is to
complete all phases of its review and be Year-2000 compliant by December
1999.
Any Year-2000 compliance problem with either the company, its
suppliers, its service providers or its customers could result in a
material adverse effect on the company's financial condition and
operating results. There can be no assurance that further assessment of
the company's suppliers, data processing systems or contingency plans
will address all issues of Year-2000 compliance.
Significant Influence by Directors, Executive Officers and Affiliated
Entities
As of July 3, 1999, the company's directors, executive officers
and entities affiliated with them, in the aggregate, beneficially own
approximately 15% of the company's outstanding common stock. These
stockholders, if acting together, may have significant influence over
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 small-cap medical device companies
resulting in changes in the market prices of the stocks of many
companies that may not have been directly related to the operating
performance of those companies. Such broad market fluctuations may
adversely affect the market price of the company's common stock. In
addition, the market price of the company's common stock may be highly
volatile. Factors, such as variations in the company's financial
results, comments by security analysts, announcements of technological
innovations or new products by the company or its competitors, changing
government regulations and developments with respect to FDA submissions,
patents, proprietary rights or litigation may have a significant adverse
effect on the market price of the common stock.
Anti-Takeover Effect of Stockholder Rights Plan and Certain Charter and
Bylaw Provisions
In November 1996, the company's Board of Directors adopted a
Stockholder Rights Plan. The Stockholder Rights Plan provides for a
dividend distribution of one Preferred Shares Purchase Right (a "Right")
on each outstanding share of the company's common stock. Each Right
entitles shareholders to buy 1/1000th of a share of the company's Series
A participating preferred stock at an exercise price of $50.00. The
Rights will become exercisable following the tenth day after a person or
group announces acquisition of 15 percent or more of the company's
common stock, or announces commencement of a tender offer, the
consummation of which would result in ownership by the person or group
of 15 percent or more of the company's common stock. The company will be
entitled to redeem the Rights at $0.01 per Right at any time on or
before the tenth day following acquisition by a person or group of 15
percent or more of the company's common stock.
The Stockholder Rights Plan and certain provisions of the
company's Certificate of Incorporation and Bylaws may have the effect of
making it more difficult for a third party to acquire, or of
discouraging a third party from attempting to acquire control of the
company. This could limit the price that certain investors might be
willing to pay in the future for shares of the company's common stock.
Certain provisions of the company's Certificate of Incorporation and
Bylaws allow the company to issue preferred stock without any vote or
further action by the stockholders, eliminate the right of stockholders
to act by written consent without a meeting, specify procedures for
director nominations by stockholders and submission of other proposals
for consideration at stockholder meetings and eliminate cumulative
voting in the election of directors. Certain provisions of Delaware law
applicable to the company could also delay or make more difficult a
merger, tender offer or proxy contest involving the company, including
Section 203, which prohibits a Delaware corporation from engaging in any
business combination with any interested stockholder for a period of
three years unless certain conditions are met. The Stockholder Rights
Plan, the possible issuance of preferred stock, the procedures required
for director nominations and stockholder proposals and Delaware law
could have the effect of delaying, deferring or preventing a change in
control of the company, including without limitation, discouraging a
proxy contest or making more difficult the acquisition of a substantial
block of the company's common stock. These provisions could also limit
the price that investors might be willing to pay in the future for
shares of the company's common stock.
Lack of Dividends
The company has not paid any dividends and does not anticipate
paying any dividends in the foreseeable future.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
The company has an investment portfolio of fixed income
securities that are classified as "available-for-sale securities."
These securities, like all fixed income instruments, are subject to
interest rate risk and will fall in value if market interest rates
increase. ArthroCare attempts to limit this exposure by investing
primarily in short-term securities.
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 Company settled this patent litigation with
Ethicon on June 24, 1999. Under the terms of the settlement, Ethicon
has licensed the Company's United States patents in the arthroscopy and
gynecology markets and ArthroCare has dismissed the legal action. Both
companies will remain active in the marketplace. Ethicon has paid
ArthroCare a license fee and will pay ArthroCare ongoing royalties on
sales in the United States of certain arthroscopy and gynecology
products. The settlement agreement also establishes a procedure for
resolution of certain potential intellectual property disputes in these
two markets without litigation.
On February 4, 1999, Xomed Surgical Products ("Xomed") of
Jacksonville, Florida filed a complaint against the company in the
Fourth Judicial Circuit, Duval County, Florida, alleging breach of
contract by the company. In the complaint, Xomed has demanded a full
refund of the amounts paid for certain products bought by Xomed from the
company, and for a portion of an exclusive license fee paid by Xomed
pursuant to an exclusive license and distribution agreement between
Xomed and the company. This license and distribution agreement was
terminated by the company on February 5, 1999. The company believes the
suit is without merit, and filed a Motion to Dismiss and Answer to the
Complaint on May 3, 1999. In addition, the company filed two
counterclaims against Xomed for damages caused by Xomed's failure to
perform under the contract and for a certain milestone payment owed to
ArthroCare by Xomed.
On March 24, 1999, a former employee of the company filed a complaint
of action for sexual harassment in violation of the Fair Employment and
Housing Act and retaliation in violation of the Fair Employment and Housing
Act. The company filed a response to the complaint on June 23, 1999, and
had a case management conference July 27 at which the parties stipulated
mediation. According to the complaint, the demand exceeds $25,000.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
With respect to stockholder proposals not included in the
company's proxy statement for the 1999 Annual Meeting of Stockholders,
the persons named in management's proxy for the 1999 Annual Meeting of
Stockholders will be entitled to exercise the discretionary voting power
conferred by such proxy under the circumstances` specified in Rule 14a-
4(c) under the Securities Exchange Act of 1934, as amended, including
with respect to proposals received by the Company within forty-five (45)
days of the date of mailing of the proxy statement for the 1999 Annual
Meeting of Stockholders.
The annual meeting of stockholders was held May 21, 1999.
Matters voted on at that meeting were (I) the election of six directors,
(ii) the ratification of the appointment of PricewaterhouseCoopers
L.L.P. as the company's independent auditors for the fiscal year ending
January 1, 2000. Tabulation for each proposal and individual directors
were as follows:
PROPOSAL I. ELECTION OF DIRECTORS
VOTES
NOMINEE VOTES WITHHELD
- ---------------------------- ---------- ---------
Michael A. Baker 5,513,010 427,049
Hira V. Thapliyal 5,513,310 426,749
Philip E. Eggers 5,513,310 426,749
Annette J. Campbell-White 5,513,310 426,749
C. Raymond Larkin Jr. 5,512,510 427,549
John S. Lewis 5,513,310 426,749
Robert R. Momsen 5,513,310 426,749
PROPOSAL II. RATIFICATION OF APPOINTMENT OF PRICEWATERHOUSECOOPERS LLP
VOTES
---------
FOR 6,115,130
AGAINST 4,100
BROKER NON-VOTE 60
Item 5. Other Information
none
a) Exhibits
3.2 Restated Certificate of Incorporation of the Registrant.
(Incorporated herein by reference to the Exhibit filed
previously with the Registrant's Registration Statement on Form 8-A
(Registration No.000-27422))
3.3 Amended Restated Bylaws of the Registrant. ( Incorporated herein
by reference to the same-numbered exhibit filed previously with the
Registrant's Quarterly Report on Form 10-Q for the period ended
October 3, 1998).
4.1 Specimen Common Stock Certificate. (Incorporated herein
by reference to the Exhibit filed previously with the
Registrant's Registration Statement on Form 8-A (Registration No.
000-27422))
10.1 Form of Indemnification Agreement between the Registrant and each of
its directors and officers. (Incorporated herein
by reference to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.2 Incentive Stock Plan and form of Stock Option Agreement thereunder.
(Incorporated herein by reference to the same-numbered exhibit filed
previously with the Registrant's Registration Statement on Form S-1
(Registration No.33.80453 ))
10.3 Director Option Plan and form of Director Stock Option Agreement
thereunder. (Incorporated herein by reference
to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.4 Employee Stock Purchase Plan and forms of agreements thereunder.
(Incorporated herein by reference to the same-numbered exhibit filed
previously with the Registrant's Registration Statement on Form S-1
(Registration No.33.80453))
10.5 Form of Exclusive Distribution Agreement. (Incorporated herein
by reference to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.6 Form of Exclusive Sales Representative Agreement. (Incorporated herein
by reference to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.7 Consulting Agreement, dated May 10, 1993, between the Registrant and
Philip E. Eggers, and amendment thereto. (Incorporated herein by
reference to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.8 Consulting Agreement, dated May 20, 1993, between the Registrant and
Eggers & Associates, Inc., and amendment thereto. (Incorporated herein
reference to the same-numbered exhibit filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.9 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. (Incorporated herein by reference to exhibit 10.10
filed previously with the Registrant's Registration Statement on
Form S-1(Registration No. 33.80453))
10.14 Employment Letter Agreement, dated July 18, 1995, between the
Registrant and Robert T. Hagan. (Incorporated herein by reference to
Exhibit 10.16 filed previously with the Registrant's
Registration Statement on Form S-1(Registration No. 33.80453))
10.15 Restricted Stock Purchase and Security Agreement, dated August 1,
1995, between the Registrant and Robert T. Hagan. (Incorporated
herein as exhibit numbered 10.17 filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.16 + Radiation Services Agreement, dated September 13, 1995, between
the Registrant and SteriGenics International. (Incorporated
herein by reference to Exhibit 10.19 filed previously with the
Registrant's Registration Statement on Form S-1 (Registration No.
33.80453))
10.17 Amended and Restated Stockholder Rights Agreement, dated October 16,
1995, between the Registrant and certain holders of the Registrant's
securities.(Incorporated herein by reference to as Exhibit 10.20 filed
previously with the Registrant's Registration Statement on Form S-1
(Registration No. 000-27422.))
10.18 Contribution Agreement, dated March 31, 1995, by and among Philip E.
Eggers, Robert S. Garvie, Anthony J. Manlove, Hira V. Thapliyal and
the Registrant.(Incorporated herein by reference to Exhibit 10.21 filed
previously with the Registrant's Registration Statement on Form S-1
(Registration No. 33.80453))
10.20 Amended Rights Agreement, dated October 2, 1998, between the
the Registrant and Norwest Bank Minnesota, N.A.
(Incorporated herein by reference to Exhibit 1 previously filed with
the Registrant's Registration Statement on Form 8-A
filed October 21, 1998 (Registration number 000-27422).
10.21 + Amended Distribution Agreement, between the
Registrant and Arthrex, GmbH. effective October 2, 1998.
(Incorporated herein by reference to Exhibit
10.20 previously filed with the Registrant's Quarterly
Report on Form 10-Q for the period ended April 3, 1999.
10.22 + Employment Letter Agreement, dated June 20, 1997, between the
Registrant and Michael A. Baker. (Incorporated herein by reference to
Exhibit 10.24 previously filed with Amendment No. 1 to
the Registrant's Quarterly Report on Form 10-Q for the period
ended June 28, 1997.
10.23 + Exclusive Distributor Agreement, dated August 21, 1997, between the
Registrant and Kobayashi Pharmaceutical Company, Ltd. (Incorporated
herein by reference to Exhibit 10.25 previously filed
with the Registrant's Quarterly Report on Form 10-Q for the period
ended September 27, 1997).
10.24 + License Agreement dated February 9, 1998, between the Registrant
and Boston Scientific Corporation. (Incorporated
herein by reference to Exhibit 10.26 previously filed
with the Registrant's Annual Report on Form 10-K for the period
ended January 3, 1998).
10.25 + Development and Supply Agreement dated February 9, 1998, between
the Registrant and Boston Scientific Corporation. (Incorporated
herein by reference to Exhibit 10.26 previously filed
with the Registrant's Annual Report on Form 10-K for the period
ended January 3, 1998).
10.26 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. (Incorporated
herein by reference to Exhibit 10.28 previously filed
with the Registrant's Annual Report on Form 10-K for the period
ended January 3, 1998).
10.28 + Term sheet for License and Distribution Agreement between Xomed
Surgical Products and the Registrant dated June 25, 1998.
(Incorporated herein by reference to Exhibit 10.29 previously filed
with the Registrant's Quarterly Report on Form 10-Q for the period
ended July 4, 1998).
10.27 ++ License Agreement dated February 9, 1999 between the
Registrant and Collagen Aesthetics. (Incorporated
herein by reference to the same-numbered exhibit previously filed
with the Registrant's Annual Report on Form 10-K for the period
ended January 2, 1999).
10.28 Change of Control Agreement between the Registrant and the CEO.
(Incorporated herein by reference to the same-numbered exhibit
previously filed with the Registrant's Annual Report on Form 10-K
for the period ended January 2, 1999).
10.29 The form of "VP Continuity Agreement" between the Registrant
and its Vice presidents. (Incorporated herein
by reference to the same-numbered exhibit previously filed
with the Registrant's Annual Report on Form 10-K
for the period ended January 2, 1999).
10.30 Letter Agreement, between the Registrant and
Collagen Aesthetics dated February 9, 1999. (Incorporated herein
by reference to the same-numbered exhibit previously filed
with the Registrant's Annual Report on Form 10-K /A
for the period ended January 2, 1999).
10.31 Employment Letter Agreement, between the Registrant
and John R. Tighe dated January 26, 1999. (Incorporated herein
by reference to Exhibit 10.30 previously filed
with the Registrant's Quarterly Report on Form 10-Q for the period
ended April 3, 1999).
10.32 Employment Letter Agreement, between the Registrant
and Christine E. Hanni dated May 12, 1999. (Incorporated herein
by reference to the same-numbered Exhibit 10.31 previously filed
with the Registrant's Quarterly Report on Form 10-Q for the period
ended April 3, 1999).
10.33 Employment Letter Agreement, between the Registrant
and Bruce Prothro amended May 19, 1999. (Incorporated herein
by reference to Exhibit 10.32 previously filed
with the Registrant's Quarterly Report on Form 10-Q for the period
ended April 3, 1999).
10.33 ++ Litigation Settlement Agreement, between the Registrant and
ETHICON, Inc. dated June 24, 1999 filed herewith.
10.34 Relocation Loan Agreement, between the Registrant and John R.
Tighe dated May 1,1999 filed herewith.
10.35 Line of Credit Agreement with Silicon Valley Bank dated
June 11, 1999 filed herewith.
27.1 Financial Data Schedule.
+ Confidential treatment granted.
++ Confidential treatment requested.
b) Reports on Form 8-K
None
<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: August 13, 1999
/s/ CHRISTINE E. HANNI
Christine E. Hanni
Vice President of Finance,
Chief Financial Officer and
Assistant Secretary
(Principal Financial Officer
and Accounting Officer)
Date: August 13, 1999
/s/ MICHAEL A. BAKER
Michael A. Baker
President, Chief Executive
Officer and Director
(Principal Executive Officer)
<PAGE>
EXHIBIT INDEX
Exhibit
Number Exhibit Description
10.33 ++ Litigation Settlement Agreement, between the Registant and
Ethicon, Inc dated June 24, 1999.
10.34 Relocation Agreement, between the Registrant
and John R. Tighe dated May 1, 1999.
10.35 ++ Line of Credit Agreement, between the Registant and
Silicon Valley Bank dated June 11, 1999.
24.1 Power of Attorney.
27.1 Financial Data Schedule.
SETTLEMENT AGREEMENT
This is an agreement (hereinafter referred to as "Agreement")
dated and effective as of this 28th day of June, 1999 ("Effective
Date"), by and between the following parties:
a) Ethicon Inc., a corporation organized under the laws of the
State of New Jersey, having its principal office at U.S.
Route 22, Somerville, NJ 08876; Mitek Surgical Products, a
division of Ethicon, having its principal office at 60
Glacier Drive, Westwood, MA 02090; Gynecare, a division of
Ethicon, having its principal office at 235 Constitution
Drive, Menlo Park, CA 94025; and Gynecare, Inc., a
corporation organized under the laws of the State of
California, having its principal office at 235 Constitution
Drive, Menlo Park, CA 94025 (collectively "Ethicon");
b) Gyrus Medical, Ltd., a corporation organized under the laws
of the United Kingdom, having a principal office at Fortran
Road, St. Mellons, Cardiff CF3 OLT, UK ("Gyrus"); and
c) ArthroCare Corporation, a corporation organized under the
laws of the State of Delaware having its principal office at
595 North Pastoria Ave., Sunnyvale, CA 94086
("ArthroCare").
ARTICLE 1 - BACKGROUND
1.1 Ethicon and ArthroCare are presently parties to a pending
patent litigation (further defined below), that involves alleged
infringement arising from the manufacture and sale of Ethicon's VAPR(R)
and VersaPoint(R) electrosurgical products. ArthroCare and Ethicon wish to
fully settle this litigation through licenses and grants of immunity
from suit upon the terms and conditions set forth below.
1.2 Ethicon and ArthroCare further wish to establish and utilize
procedures for binding arbitration to resolve certain future patent-
related disputes between the parties.
NOW, THEREFORE, in consideration of the mutual promises contained
in this Agreement, the parties agree as follows:
ARTICLE 2 - DEFINITIONS
The following terms, when used with initial capital letters, shall
have the meanings set forth below.
2.1 "Affiliate" is any entity that directly or indirectly
controls, is controlled by, or is under common control with a Party, and
for such purpose "control" shall mean the possession, direct or
indirect, of the power to direct or cause the direction of the
management and policies of the entity, whether through the ownership of
voting securities, by contract or otherwise.
2.2 "ArthroCare Patents and Applications" includes U.S.
patents and applications that contain claims or pending claims [***] and
are further defined by the following:
a. U.S. patents issued, and U.S. patent applications
pending in the United States Patent and Trademark Office ("PTO"), [***]; and
b. U.S. patent applications that are filed in the PTO after
the Effective Date that claim priority to any issued
patent or pending patent application identified in
clause (a) above, including any patents issuing from
such patent applications; and
c. U.S. patents issuing after the Effective Date that issue
from or claim priority to any issued patent or pending
patent application identified in clauses (a) or (b) 'above; and
d. Any reissues, renewals, substitutions, re-examinations
and extensions of any of the foregoing in clauses (a),
(b), or (c), above.
A list of the patents and patent applications in existence as of the
Effective Date that fall under the definition of "ArthroCare Patents
and Applications" is attached as Schedule A hereto.
2.3 "Arthroscopy Field of Use" means the use of radio
frequency (between 10 Kilohertz ("Khz") and 20 Megahertz ("Mhz")) in
arthroscopy [***].
2.4 "Asserted Claims" means the following patent claims: [***]
2.5 "Calendar Quarter" is the usual and customary Ethicon
calendar quarter, used for
internal accounting purposes, of approximately three (3) months, in
which each of the first two months consist of four weeks and the third
month consists of five weeks.
2.6 "Controller(s)" shall mean a radio frequency power supply
that operates at any frequency between 10Khz and 20Mhz.
2.7 "Disposable Product(s)" shall mean medical instruments and
components of such medical instruments which may have one or more
electrode(s) and electrical connection(s) for coupling the electrode(s)
to a Controller(s).
2.8 "Established Current Net Selling Price" shall mean the
average selling price
("ASP") of a Licensed Product in the Territory in the applicable Field
of Use for the immediately preceding three (3) month period.
2.9 "Ethicon Patents and Applications" includes U.S. patents
and applications that contain claims or pending claims [***] and are
further defined by the following:
a. U.S. patents issued, and U.S. patent applications
pending in the United States Patent Office "PTO"), [***]; and
b. U.S. patent applications that are filed in the PTO
after the Effective Date that claim priority to any
issued patent or pending patent application identified
in clause (a) above, including any patents issuing
from such patent applications; and
c. U.S. patents issuing after the Effective Date that
issue from or claim
priority to any issued patent or pending patent
application identified in clauses (a) or (b) above;
and
d. Any reissues, renewals, substitutions, re-examinations
and extensions of any of the foregoing in clauses (a), (b), or (c),
above.
A list of the patents and patent applications in existence as of the
Effective Date that fall under the definition of "Ethicon Patents and
Applications," including but not limited to those Ethicon Patents and
Applications [***] is attached as Schedule B hereto.
2.10 "Ethicon Issued Patent" means an issued patent listed on
Schedule B, or a patent which issues from an application listed on
Schedule B, or a patent which issues from an application which claims
priority to a patent or application listed on Schedule B.
2.11 [***]
2.12 "Fields of Use" shall mean, collectively, the Arthroscopy
Field of Use and the
Gynecology Field of Use.
2.13 "Foreign Counterpart" means counterparts to the ArthroCare
Patents and Applications or counterparts to the Ethicon Patents and
Applications filed outside of the United States. Attached as Schedule D
hereto is a list of the currently pending Foreign Counterparts to the
ArthroCare Patents and Applications filed as of the Effective Date.
Attached as Schedule E hereto is a list of the currently pending Foreign
Counterparts to the Ethicon Patents and Applications filed as of the
Effective Date.
2.14 "Gynecology Field of Use" means the use of radio frequency
(between 10 Khz and 20 Mhz) in hysteroscopic [***]
2.15 "Licensed Product" includes [***]
2.16 "Litigation" shall mean ArthroCare Corporation v. Ethicon,
Inc., et al., U.S. District Court for the Northern District of California
Civil Action No. C98-00609 WHO.
2.17 "Material Change" shall be [***] The following examples
are only intended to assist the Parties and any appointed arbitrator(s)
under this Agreement in assessing whether a change is a Material Change.
The examples are not intended to act as a limitation on the stated
definition of "Material Change."
a. By way of example only and not limitation, [***]
b. In contrast, and by way of further example and not
limitation, [***]
2.18 "Net Sales" is [***] less the following amounts: [***]
2.19 "The Parties" to this Agreement are ArthroCare, Ethicon
and Gyrus.
2.20 "Surgical Kit" shall mean a plurality of products or
devices sold together with a single invoice price. Such products or
devices do not necessarily have to be used together in a surgical
procedure, or used in a surgical procedure at all, to be considered part
of the Surgical Kit.
2.21 "Technology" means radio frequency (between 10 Khz and 20
Mhz) medical devices for use in arthroscopy or hysteroscopic gynecology
[***].
2.22 "Territory" shall mean the United States of America,
including its territories and possessions.
2.23 "Valid Claim" is an unexpired issued claim of a patent
that has not been held invalid or unenforceable by a final decision of a court
or other governmental agency of competent jurisdiction, which final
decision is not appealable or appealed within the time allowed for
appeal, or by a decision from the arbitrator(s) as provided under
Article 14, herein, and which has not been admitted to be invalid or
unenforceable by the patent owner or its successors or assigns through
reissue or disclaimer.
ARTICLE 3 - DISMISSAL OF THE LITIGATION
3.1 Subject to the terms and conditions of this Agreement,
Ethicon and ArthroCare agree to promptly dismiss with prejudice all
claims and counterclaims in the Litigation, each side bearing its own
costs of suit and attorney fees. To effectuate this provision, those
Parties will sign the Stipulated Notice of Dismissal with Prejudice that
is attached hereto as Schedule F within 2 court days of the Effective
Date. Ethicon and ArthroCare shall, immediately upon execution thereof,
[***]
ARTICLE 4 - ARTHROCARE LICENSE GRANT AND RELEASE
4.1 Subject to the terms and conditions of this Agreement,
ArthroCare grants to Ethicon a [***] license [***] under the ArthroCare
Patents and Applications to make, have made, use, import, sell, have
sold, and offer for sale Licensed Products solely in the Arthroscopy
Field of Use solely within the Territory.
4.2 Subject to the terms and conditions of this Agreement,
ArthroCare grants to Ethicon a [***] license [***] under the ArthroCare Patents
and Applications to make, have made, use, import, sell, have sold, and offer
for sale Licensed Products solely in the Gynecology Field of Use solely
within the Territory.
4.3 Ethicon shall have the right to extend the licenses granted
herein to any of Ethicon's Affiliates, upon the terms and conditions of
this Agreement, provided that Ethicon provides ArthroCare with notice of
any such extension within sixty (60) days thereof and further provided
that Ethicon agrees in writing to be responsible for the performance by
such Affiliates of all of Ethicon's obligations hereunder, [***]
4.4 Subject to the terms and conditions of this Agreement,
ArthroCare forever releases and discharges Ethicon and Gyrus, and their
Affiliates, directors, officers, employees, suppliers and customers (the
"Released Parties") from and against all patent claims, liabilities,
damages, royalties and other expenses whatsoever [***]
4.5
(a) [***]
(b) [***]
(c) [***]
(d) [***]
(e) [***]
(f) [***]
(g) [***]
(h) [***]
(i) [***]
ARTICLE 5 - PAYMENTS
5.1 License Fee. Within two (2) business days of the Effective
Date, Ethicon will pay ArthroCare [***] as a license fee [***] This
license fee shall [***]
5.2 Royalty Payments. In further consideration for the licenses
and release granted to
Ethicon under Article 4 herein, Ethicon shall pay ArthroCare on a
quarterly basis pursuant to Article 6.1, below, royalties for the term
of the licenses granted in Article 4 as follows:
a. Ethicon shall pay ArthroCare a royalty of [***] on Net
Sales of the Licensed Products in the Arthroscopy
Field of Use in the Territory [***]
b. Ethicon shall pay ArthroCare a royalty of [***] on Net
Sales of the Licensed Products in the Gynecology Field
of Use in the Territory commencing on the Effective
Date.
c. Notwithstanding anything to the contrary in Articles
5.2(a) and (b), Ethicon shall pay ArthroCare a royalty
of [***]
d. [***]
No multiple royalties shall be payable because [***]
5.3 [***]
5.4 Surgical Kit Sales. In the event that a Licensed Product is
sold as part of a Surgical Kit and if, as such part, such Licensed
Product does not have a separate invoiced selling price, then for the
purposes of computing earned royalties, the following guidelines shall
apply:
a. Net Sales of such Licensed Product shall be
[***]
5.5 Payment in U.S. Dollars. Royalties and the license fee shall
be paid in United States Dollars. In the event Ethicon receives payment
for Licensed Products in a currency other than U.S. dollars, the payment
payable by Ethicon to ArthroCare shall be computed using the official
rate of exchange of the currency as quoted by the Wall Street Journal,
New York Edition, on the last business day of the calendar quarter for
which the royalties are payable.
5.6 Place for Payment. The payment of royalties and the license
fee shall be made
payable to ArthroCare Corporation, and sent to the following address:
ArthroCare Corporation, Attn. Christine Hanni, Vice President, Finance
and CFO, 595 North Pastoria Ave., Sunnyvale, CA 94086 or such address or
individual as ArthroCare provides Ethicon in writing under Article 15.4
below. The payment of the license fee shall be made by wire transfer to
the following account number:
[***]
5.7 [***]
ARTICLE 6 - ETHICON RECORD KEEPING AND REPORTS
6.1 Ethicon shall keep accurate books and records of the Net
Sales of the Licensed Product, and of all payments due ArthroCare
hereunder. Ethicon shall deliver to ArthroCare
written reports of Net Sales of the Licensed Products (including number
of units sold and revenue received) during the preceding Calendar
Quarter on or before the [***] day following the end of each Calendar
Quarter. Such report shall include a summary of the units sold and
revenue received for the relevant time period on a product-by-product
basis and, subject to the provisions of Article 5.8, shall be
accompanied by the monies due.
6.2 ArthroCare shall have the right at its own expense, after
[***] days advance written notice to Ethicon to nominate an independent
accountant acceptable to and approved by Ethicon (which approval shall
not be unreasonably withheld or delayed.) The independent accountant
shall have access to Ethicon's books and records during reasonable
business hours for the sole purposes of auditing the royalty reports
(and supporting books and records) and verifying the royalties payable
as provided for in this Agreement for the three preceding calendar
years. This right may not be exercised more than once in any calendar
year. During the inspection, ArthroCare shall solicit or receive only
information relating solely to the accuracy of the royalty report and
the royalty payments made according to this Agreement. Ethicon shall be
entitled to withhold approval of said accountant unless the accountant
shall agree to sign a reasonable confidentiality agreement with Ethicon
which shall obligate such accountant to hold the information it receives
from Ethicon in confidence except for information necessary for
disclosure to ArthroCare to establish the accuracy of the royalty
reports and payments. Although the fees and expenses of such
inspection/audit shall initially be borne by ArthroCare, if an
underpayment in royalties of more than [***] of the total royalties due
to ArthroCare hereunder for any Calendar Quarter is discovered, then
such fees and expenses shall be borne by Ethicon, and Ethicon shall
promptly pay ArthroCare any such delinquent royalty amounts with
interest thereon at the prime rate reported by the Bank of America, San
Francisco, plus [***], computed from the date such royalty amounts were
due until the date Ethicon pays such royalty amounts.
ARTICLE 7 - IMMUNITY FROM SUIT
7.1 Subject to the terms and conditions of this Agreement,
Ethicon and Gyrus hereby grant to ArthroCare and its directors,
officers, employees, distributors, sales agents, suppliers, and
customers ("the Immune Parties") in the Fields of Use in the Territory
immunity from suit for infringement (whether direct, contributory or
induced) under the Ethicon Patents and Applications, such immunity
extending [***]
7.2 (a) If any ArthroCare product incorporating, using, or made
using any of the Technology (other than those products identified in
Article 7.1) infringes a Valid Claim of an Ethicon Issued Patent,
ArthroCare shall be entitled to a [***] license in the Territory, [***]
in and to the infringed Ethicon Issued Patents in the Fields of Use, and
at a royalty rate to be determined by agreement or through mediation or
binding arbitration as set forth in Article 14, below. If Ethicon or
Gyrus grants such a [***] license to ArthroCare in the Territory for any
[***]
(b) At the time any license is granted under this Article
7.2, Gyrus and/or Ethicon (as appropriate) will enter into a separate
license agreement with ArthroCare reflecting its scope, terms and
provisions, which shall be negotiated by the Parties in good faith. The
[***] license(s) granted under this Article 7.2 will provide ArthroCare
with the right to make, have made, use, import, sell, have sold, and
offer for sale the licensed products in the Fields of Use within the
Territory.
(c) In the event that [***] under this paragraph shall be
limited to the U.S. patent applications and U.S. patents identified in
Article 2.7 of this Agreement that are owned by or assigned to [***] as
of the date of such transfer. In that event, ArthroCare's royalty
payments under such licenses will be made to [***]
(d) [***]
7.3 If ArthroCare receives a license as provided for under
Article 7.2, the following provision shall apply: In the event Ethicon
has granted or shall grant to any third party any license, release or
other right, including, but not limited to, a waiver of suit or
settlement of litigation under any Ethicon Issued Patents in the Fields
of Use for any period of time and such license, release or other right
includes a royalty based on sales of products covered by the Ethicon
Issued Patents in the Fields of Use (hereinafter "Third Party Grant,')
Ethicon shall, within [***] days of either the date of the license to
ArthroCare under Article 7.2 or the Third Party Grant, whichever is
earlier, provide written notice of the Third Party Grant to ArthroCare,
[***]
ARTICLE 8 - THIRD PARTY INFRINGEMENT
8.1 In the event that there is infringement on a Substantial
Commercial Scale by a third party of any Valid Claim of an ArthroCare
Patent covering a Licensed Product and licensed to Ethicon hereunder in
the Fields of Use in the Territory, Ethicon shall notify ArthroCare in
writing to that effect, including with said written notice evidence
establishing a prima facie case of infringement by one or more
Infringing Product(s) of one or more Valid Claim(s) by such third party.
For the purposes of Article 8, Substantial Commercial Scale shall mean
[***] If, prior to the expiration of [***] from the date of said
notice, ArthroCare obtains a discontinuance of such infringement or
brings suit against the third party infringer, and diligently prosecutes
such suit thereafter, then [*** ] Ethicon will cooperate with ArthroCare
in any such suit and shall have the right to consult with ArthroCare and
be represented by its own counsel at its own expense. ArthroCare and
Ethicon shall both have the right to arbitrate, under the provisions of
Article 14, any disagreement between the Parties under Article 8,
including, but not limited to, any disagreement over [***] From the
date one party notifies the other it wishes to commence an arbitration
proceeding or mediation under Article 14, until such time as the matter
has been finally settled, the running of any time period referred to in
Article 8 shall be suspended.
8.2 In the event that the Parties enter into arbitration
regarding [***] and in the event that Ethicon should prevail in any such
arbitration, ArthroCare [***] However, in the event that the arbitration
decision issues within the [***] set forth in Article 8.1 (as suspended
during the pendency of the arbitration), ArthroCare [***]
8.3 Notwithstanding anything to the contrary in the Agreement,
if in ArthroCare's reasonable judgement it is necessary [***] then
ArthroCare shall notify Ethicon and ArthroCare shall [***]
8.4 After the expiration of said [***] from the date of said
notice, if Ethicon and ArthroCare have agreed, or an arbitrator has
ruled pursuant to Article 14, that [***]
8.5 Notwithstanding any other provision in this Agreement,
ArthroCare shall not be required to [***]
ARTICLE 9 - WARRANTIES AND REPRESENTATIONS
9.1 ArthroCare expressly warrants and represents that
a. It owns all of the right, title and interest in and to
the ArthroCare Patents and Applications and/or is
empowered to grant the licenses and release granted
herein;
b. It has no outstanding encumbrances or agreements,
including any agreements with academic institutions,
universities, or other third parties, whether written,
oral or implied, which would be inconsistent with the
licenses and release granted herein;
c. Schedule A includes to the best of ArthroCare's
knowledge all of the patents and patent applications
filed as of the Effective Date that fall under the
definition of ArthroCare Patents and Applications; and
d. Schedule C includes to the best of ArthroCare's
knowledge [***]
9.2 ArthroCare shall indemnify and hold Ethicon and its
Affiliates, officers, directors, employees, and agents, as well as Gyrus
and its Affiliates, officers, directors, employees, and agents, harmless
from all liabilities, demands, damages, expenses (including reasonable
attorney fees) and losses arising out of or relating to:
a. The breach of any of the warranties and
representations set forth in Article 9.1 above; and
b. The possession, manufacture, use, sale or other
disposition by or on behalf of ArthroCare of any
ArthroCare product (including without limitation
Existing Products) whether based on breach of
warranty, negligence, product liability or otherwise,
and
c. ArthroCare's exercise of any right granted to
ArthroCare pursuant to this Agreement.
9.3 Ethicon expressly warrants and represents that
a. Ethicon is empowered to grant the immunities from suit
granted in Article 7.1, and is empowered to grant the
licenses described in Article 7.2.
b. Ethicon has no outstanding encumbrances or agreements,
including any agreements with academic institutions,
universities, or other third parties, whether written,
oral or implied, which would be inconsistent with the
licenses and immunities from suit granted herein;
c. Schedule B includes to the best of Ethicon's knowledge
all of the patents and patent applications in
existence as of the Effective Date that fall under the
definition of Ethicon Patents and Applications; and
d. [***]
9.4 Gyrus expressly warrants and represents that
a. Gyrus is empowered to grant the immunities from suit
granted in Article 7.1, and is empowered to grant the
licenses described in Article 7.2, to the extent that
such immunities and licenses relate to Ethicon Patents
and Applications owned by, or assigned to, Gyrus;
b. Gyrus has no outstanding encumbrances or agreements,
including any agreements with academic institutions,
universities, or other third parties, whether written,
oral or implied, which would be inconsistent with the
licenses and immunities from suit granted herein;
c. Schedule B includes to the best of Gyrus'knowledge
all of the patents and patent applications in
existence as of the Effective Date that fall under the
definition of Ethicon Patents and Applications; and
d. [***]
9.5 Ethicon shall indemnify and hold ArthroCare and its
Affiliates and its officers, directors, employees, and agents harmless
from all liabilities, demands, damages, expenses (including reasonable
attorney fees) and losses arising out of or relating to:
a. The breach by Ethicon of any of the warranties and
representations set forth in Article 9.3 above; and
b. The possession, manufacture, use, sale or other
disposition by or on behalf of Ethicon of any Licensed
Product whether based on breach of warranty,
negligence, product liability or otherwise, and
c. Ethicon's exercise of any right granted to Ethicon
pursuant to this Agreement.
9.6 Gyrus shall indemnify and hold ArthroCare and its Affiliates
and its officers, directors, employees, and agents harmless from all
liabilities, demands, damages, expenses (including reasonable attorney
fees) and losses arising out of or relating to:
a. The breach by Gyrus of any of the warranties and
representations set forth in Article 9.4 above; and
b. The possession, manufacture, use, sale or other
disposition by or on behalf of Gyrus of any Licensed
Product whether based on breach of warranty,
negligence, product liability or otherwise, and
c. Gyrus' exercise of any right granted to Gyrus pursuant
to this Agreement.
9.7 Notwithstanding anything to the contrary herein, the
indemnification provisions of this Article shall not extend to any
consequential damages that a Party may suffer as a result of a breach of
this Agreement.
9.8 Notwithstanding anything to the contrary herein, the parties
agree that a breach of Sections 9.1c. and d. and 9.3 c. and d. shall not
be deemed to be a material breach. Upon knowledge of any such breach by
one party, the non-breaching party shall notify the breaching party of
the breach. The breaching party shall have a period of ninety (90) days
from the date of receipt of the notice to correct the breach, at which
point the breach shall be deemed material. Should either party decide
to submit the matter to arbitration pursuant to Article 14 herein, then
the ninety-day period shall be tolled pending the outcome of the
arbitration.
ARTICLE 10 - DISCLAIMER OF CERTAIN WARRANTIES
10.1 Nothing in this Agreement is or shall be construed as:
a. A warranty or representation by ArthroCare as to the
validity or scope of any patent claim or patent under ArthroCare Patents
and Applications; or
b. A warranty or representation by Ethicon or Gyrus as to
the validity or scope of any patent claim or patent
under Ethicon Patents and Applications; or
c. A warranty or representation by ArthroCare that
anything made, used,
imported, sold, or offered for sale under the licenses
granted by ArthroCare to Ethicon or Gyrus hereunder is
or will be free from infringement of any patent
rights, foreign or domestic, or other intellectual
property right of any third party and/or not covered
by this Agreement; or
d. A warranty or representation by Ethicon or Gyrus that
anything made, used, imported, sold, or offered for sale under the
licenses or immunities from suit granted by Ethicon
and/or Gyrus to ArthroCare hereunder is or will be
free from infringement of any patent rights, foreign
or domestic, or other intellectual property right of
any third party and/or not covered by this Agreement;
or
e. Except as provided in Article 8 of this Agreement, an
obligation of ArthroCare to bring or prosecute actions
or suits against third parties for infringement of the
ArthroCare Patents and Applications; or
f. An obligation of Ethicon or Gyrus to bring or
prosecute actions or suits against third parties for infringement of the Ethicon
Patents and Applications; or
g. Granting, by implication, estoppel, or otherwise, any
licenses or rights to Ethicon under patents or other rights of ArthroCare
or third parties other than as expressly provided
herein, regardless of whether such patents or other
rights are dominant or subordinate to any ArthroCare
Patents and Applications; or
h. Granting, by implication, estoppel, or otherwise, any
licenses or rights to ArthroCare under patents or other rights of
Ethicon, Gyrus or third parties other than as
expressly provided herein, regardless of whether such
patents or other rights are dominant or subordinate to
any Ethicon Patents and Applications.
10.2 ARTHROCARE MAKES NO WARRANTIES WITH RESPECT TO THE
ARTHROCARE PATENTS AND APPLICATIONS, FOREIGN COUNTERPARTS, ANY NON-U.S.
PATENTS, OR THE LICENSED PRODUCTS, WHETHER EXPRESS OR IMPLIED, EITHER IN
FACT OR BY OPERATION OF LAW, BY STATUTE OR OTHERWISE. WITHOUT LIMITING
THE GENERALITY OF THE FOREGOING, ARTHROCARE SPECIFICALLY DISCLAIMS ANY
IMPLIED WARRANTIES OF QUALITY, MERCHANTABILITY. FITNESS FOR A
PARTICULAR PURPOSE AND NONINFRINGEMENT.
10.3 ETHICON AND GYRUS MAKE NO WARRANTIES WITH RESPECT TO THE
ETHICON PATENTS AND APPLICATIONS, FOREIGN COUNTERPARTS, ANY NON-U.S.
PATENTS, OR ANY PRODUCTS THAT MAY BE LICENSED THEREUNDER, WHETHER
EXPRESS OR IMPLIED, EITHER IN FACT OR BY OPERATION OF LAW, BY STATUTE OR
OTHERWISE. WITHOUT LIMITING THE GENERALITY OF THE FOREGOING, ETHICON
AND GYRUS SPECIFICALLY DISCLAIM ANY IMPLIED WARRANTIES OF QUALITY,
MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE AND NON-INFRINGEMENT.
ARTICLE 11 - LIMITATION OF LIABILITY
11.1 NO PARTY WILL BE LIABLE TO ANY OTHER PARTY WITH RESPECT TO
ANY SUBJECT MATTER OF THIS AGREEMENT UNDER ANY CONTRACT, NEGLIGENCE,
STRICT LIABILITY OR OTHER LEGAL OR EQUITABLE THEORY FOR (A) ANY
INCIDENTAL, SPECIAL, OR CONSEQUENTIAL DAMAGES, (B) ANY LOST PROFITS OR
LOST BUSINESS OR (C) COST OF PROCUREMENT OF SUBSTITUTE GOODS, TECHNOLOGY
OR SERVICES; EVEN IF THE REMEDIES PROVIDED FOR IN THIS AGREEMENT FAIL OF
THEIR ESSENTIAL PURPOSE AND EVEN IF EITHER PARTY HAS BEEN ADVISED OF
THE POSSIBILITY OR PROBABILITY OF SUCH DAMAGES.
ARTICLE 12 - TERMINATION
12.1 The licenses granted under Article 4, and the payment
obligations under Article 5, shall remain in effect until [***]
12.2 Any licenses granted under Article 7 shall remain in effect
until [***] The immunity granted in Article 7.1 shall remain in effect
until [***]
12.3 Ethicon or ArthroCare [***] may terminate this Agreement
upon ninety (90) days prior written notice for any material breach or
default of the other Party of any material provision of this Agreement.
Such written notice shall be sent to all Parties. Subject to the
provisions of Article 14 below, such termination shall become effective
at the end of the ninety (90) day period unless during such period the
party in breach or default cures such breach or default, or in the event
of a material breach by Ethicon, [***] From the date one Party notifies
the other it wishes to commence an arbitration proceeding or a mediation
under Article 14, until such time as the matter has been finally settled
through mediation or by arbitration, the running of the time period
referred to herein, as to which a party must cure a breach, shall be
suspended as to the subject matter of the dispute. This Agreement will
remain in full force and effect during any ninety (90) day cure period
and/or during any such mediation or arbitration.
ARTICLE 13 - MATTERS SUBMITTED TO BINDING ARBITRATION
13.1 The following matters shall be submitted to binding
arbitration in accordance with Article 14.
a. Disputes which may arise under Articles 4, 5, or 6,
above, including but not limited to the following:
i. [***]
b. Disputes which may arise under Article 7, above,
including but not limited to the following:
i. [***]
c. [***]
d. Any other disputes that arise between the Parties
concerning or relating to the Agreement.
ARTICLE 14 - BINDING ARBITRATION
14.1 Any dispute, claim or controversy arising from or related in
any way to this Agreement or to the interpretation, application, breach,
termination or validity thereof, including any claim of inducement of
this Agreement by fraud or otherwise, will be submitted for resolution
to arbitration pursuant to the commercial arbitration rules then
pertaining to the CPR Institute for Dispute Resolution, or successor
("CPR"). In the event, however, that the rules of the CPR conflict
with the express provisions herein the provisions of this Article 14
control. If ArthroCare submits a claim or controversy to arbitration
pursuant to this Article the arbitration will be held in New Brunswick,
New Jersey. If Ethicon or Gyrus submit a claim or controversy to
arbitration pursuant to this Article the arbitration will be held in
Santa Clara County, California. Any cross-claims, counterclaims or
other claims arising out of or related to this Agreement or the original
arbitration shall be arbitrated in the same location as the original
arbitration proceeding.
14.2 The panel of arbitrators shall consist of three arbitrators
chosen from the CPR
Panels of Distinguished Neutrals. Each arbitrator chosen from the CPR
Panels of Distinguished Neutrals under this Article shall be either a
lawyer who has specialized in business litigation with at least 15 years
experience with a law firm of over 25 lawyers or has served as a judge
of a court of general jurisdiction. Furthermore, if at least one of the
issues to be resolved by the arbitrators is described in Articles
13.1(a)(i), 13.1(b)(i), 13.1(b)(ii), or 13.l(c), then at least one of
the arbitrators shall, in addition to the qualifications listed above,
be an attorney with at least 10 years experience litigating or preparing
and prosecuting patent applications. In the event that the aggregate
damages sought by the claimant are stated to be less than [***] and the
aggregate damages sought by the counterclaimant are stated to be less
than [***] the Parties shall select a single arbitrator having the same
qualifications and experience specified above. The arbitrator(s) shall
be neutral, independent, disinterested, impartial, and shall abide by
the Canons of Ethics of the American Bar Association for neutral,
independent arbitrators.
14.3 The Parties agree to cooperate in good faith to set up the
logistics and procedures of the arbitration. In particular, the Parties
agree to cooperate: (a) to obtain selection of the arbitrator(s) within
45 days of initiation of the arbitration, (b) to meet with the
arbitrator(s) within 45 days of their selection, and (c) to agree at that
meeting or before upon procedures for discovery and as to the conduct of
the arbitration hearing. There shall be no ex parte communications with
an arbitrator either before or during the arbitration relating to the
dispute, the issues involved in the dispute, or the arbitrator's views
on any such issues.
14.4 The Parties further agree that the procedures for discovery
and the conduct of the arbitration hearing will result in the hearing
being concluded within no more than 9 months after selection of the
arbitrator(s). The Parties further agree that arbitrator(s) shall
render the judgment and award within 9 months of the conclusion of the
hearing(s), or of any post-hearing briefing, which must be completed by
both sides with 30 days after the conclusion of the hearing. The Parties
further agree that during discovery any expert witness(es) retained to
testify in the arbitration must submit an expert report which complies
with the provisions of Federal Rule of Civil Procedure 26(a)(2).
14.5 In the event that the Parties are unable to reach agreement
on the procedures for
discovery and the conduct of the arbitration hearing as set forth in
clause 14.3 -- 14.4 above, the CPR will select the arbitrator(s). In so
doing, the CPR will allow three peremptory challenges for each side and
appropriate strikes for reasons of conflict or other cause. The
arbitrator(s) shall then set a date for the hearing and commit to the
rendering of the award within the time periods specified in clause 14.4
above. The arbitrators shall also provide for discovery according to
the time limits set forth in clause 14.4. In so doing the arbitrators
shall recognize the understanding of The Parties that they contemplate
reasonable discovery, including document demands and depositions, but
that such discovery be limited so that The Parties may meet the time
limits of clause 14.4 without undue difficulty. Neither side may obtain
more than a total of [***] of deposition testimony from all witnesses,
including both fact and expert witnesses. Furthermore, neither side may
serve more than [***] individual requests for documents, including
subparts, or [***] individual requests for admission or interrogatories,
including subparts. Notwithstanding the above limits on deposition time
and written discovery, if the arbitration includes a large number of
patents, named inventors and/or products in dispute, either Party may
show good cause to expand the hours of deposition testimony allowed from
the witnesses, and the arbitrator(s) will have the discretion to grant
such request, so long as such grant of additional discovery is
consistent with the limitations and the spirit of this Agreement to have
substantially less discovery conducted than is conducted in typical
patent litigation, and notwithstanding the above, in no event shall such
additional discovery allow any increase in the time periods described in
Article 4.4. In the event multiple hearing days are required, they will
be scheduled consecutively to the greatest extent possible.
14.6 The arbitrator(s) shall render their award following the
substantive law of the state where the arbitration is conducted pursuant
to clause 14.1, as well as the law set forth in the Patent Code (35
U.S.C.1 et seq.), except that the interpretation and enforcement of
these arbitration provisions shall be governed by the Federal
Arbitration Act. The arbitrator(s) are not free to apply "amiable
compositeur," or to apply their own or another's view of "natural
justice and equity." The arbitrator(s) shall have the power to exclude
evidence on the grounds that the prejudicial effect of such evidence
exceeds its probative value, that the evidence is cumulative, or that
the evidence is irrelevant. The arbitrator(s) shall issue a written
opinion setting forth findings of fact, conclusions of law, and the
reasons therefor. A transcript of the evidence adduced at the hearing
shall be made and shall be made available to either Party on request at
the requesting Party's expense.
14.7 The Parties agree that the arbitration hearings, the award,
and the written opinion will be kept confidential. The arbitrator(s)
shall issue appropriate protective orders to safeguard The Parties'
confidential information.
14.8 Each Party to this Agreement hereby knowingly and
voluntarily waives its right to trial by jury of any dispute, claim or
controversy arising from or related in any way to this
Agreement or to the interpretation, application, breach,
termination or validity thereof, including any claim of inducement of
this Agreement by fraud or otherwise.
14.9 Each Party to this Agreement hereby knowingly and
voluntarily waives any claim to punitive or exemplary damages from
another Party as part of any dispute, claim or controversy arising from
or related in any way to this Agreement or to the interpretation,
application, breach, termination or validity thereof, including any
claim of inducement of this Agreement by fraud or otherwise. This
waiver includes any claim to increased damages premised on an allegation
of willful patent infringement. Each Party to this Agreement is hereby
precluded from requesting or receiving such damages in any arbitration
proceeding under this Article.
14.10 Each Party to this Agreement hereby knowingly and
voluntarily waives any right to seek or receive injunctive relief as
part of any dispute, claim or controversy arising from or related in any
way to this Agreement or to the interpretation, application, breach,
termination or validity thereof, including any claim of inducement of
this Agreement by fraud or otherwise. Each Party to this Agreement is
hereby precluded from requesting or receiving injunctive relief in any
arbitration proceeding under this Article.
14.11 The Parties agree that there is no right of appeal from the
final decision of the arbitrator(s). Each Party to this Agreement
acknowledges that the final decision of the arbitrator(s) shall be
binding upon The Parties, and hereby knowingly and voluntarily waives
any right to appeal the decision of the arbitrator(s) to the federal or
state courts. The decision of the arbitrator(s) may be vacated,
modified or corrected only upon the grounds specified in the Federal
Arbitration Act.
14.12 The United States District Court for the jurisdiction in
which the arbitration is held may enter judgment upon any award rendered
under this Article to ensure that the award is enforceable against The
Parties. The Parties consent to the jurisdiction of that United States
District Court for the enforcement of this Agreement and for the entry
of judgment on any award. In the event that such Court lacks
jurisdiction, then any court having jurisdiction of this matter may
enforce this Article and enter judgment upon any award rendered under
this Article.
14.13 The Parties agree that [***] The written opinion rendered
by the arbitrator(s) under clause 14.6 will include a determination as
to which Party (if any) is to be considered the "prevailing Party" for
the purposes of this Article. [***]
14.14 The arbitrator(s) shall be bound by the express terms of
this Agreement, and may not amend or modify such terms in any manner.
Any award rendered by the arbitrator(s) shall be consistent with the
terms of this Agreement, and such terms herein shall control the rights
and obligations of the parties.
14.15 Any dispute controversy or claim arising out of or related
to this agreement, or the interpretation, application, breach,
termination or validity thereof, including any claim of inducement by
fraud or otherwise, which claim would, but for this provision, be
submitted to arbitration shall, before submission to arbitration, first
be mediated through non-binding mediation in accordance with the Model
Procedures for the Mediation of Business Disputes promulgated by the CPR
Institute for Dispute Resolution, or successor ("CPR") then in effect,
except where those rules conflict with these provisions, in which case
these provisions control. The Parties shall agree upon the place of the
Mediation once the mediator is selected. The Mediation shall be
attended by a senior executive with authority to resolve the dispute
from each of the operating companies that are Parties.
14.16 The mediator shall be neutral, independent, disinterested
and shall abide by the Canons of Ethics of the American Bar Association
for neutral, independent arbitrators and will be selected from a
professional mediation firm such as ADR Associates or JAMS/ENDISPUTE or
CPR.
14.17 The Parties shall promptly confer in an effort to select a
mediator by mutual agreement. In the absence of such an agreement, the
mediator shall be selected from a list generated by CPR with each party
having the right to exercise challenges for cause and two peremptory
challenges within 72 hours of receiving the CPR list.
14.18 The mediator shall confer with the Parties to design
procedures to conclude the mediation within no more than 45 days after
initiation. Under no circumstances shall the commencement of
arbitration under Article 14.1, above, be delayed more than 45 days by the
mediation process specified herein absent contrary agreement.
14.19 Each Party agrees to toll all applicable statutes of
limitation during the mediation process and not to use the period or
pendancy of the mediation to disadvantage the other Party procedurally
or otherwise. No statements made by either Party during the mediation
may be used by the other Party during any subsequent arbitration or
other proceeding.
14.20 From the date one party notifies the other it wishes to
commence an arbitration proceeding or a mediation, until such time as
the matter has been finally settled through mediation or by arbitration
the running of the time period referred to in Article 12.3 above, as to
which a party must cure a breach shall be suspended as to the subject
matter of the dispute.
ARTICLE 15 - MISCELLANEOUS
15.1 Marketing Obligations. ArthroCare acknowledges that Ethicon
and Gyrus have no affirmative obligation to sell the Licensed Products,
and therefore shall not be obligated to use its best efforts or any
other efforts in marketing the Licensed Products. All business
decisions, including without limitation the design, manufacture, sale,
price and promotion of the Licensed Products, shall be within the sole
discretion of Ethicon and/or Gyrus.
15.2 Disputes as to Asserted Claims. Subject to the terms and
conditions of this Agreement, [***]
15.3 Confidentiality and Publicity. No Party shall disclose the
terms of this Agreement to an unaffiliated third party, except for
legal, financial, accounting or other similar advisors who agree to keep
the terms of this Agreement confidential, without the prior written
approval of the other party, or as required by law or regulation. No
Party shall use the fact of the agreement or any of its terms as a
competitive tool. Furthermore, except as required by law or regulation,
and except for information that has already been made public in the
press release attached in Schedule G or otherwise agreed to by the
parties, no party will originate any publicity, news release, or other
public announcement, written or oral, whether to the public press, to
stockholders, or otherwise, relating to this Agreement, to any amendment
hereto or to performance hereunder or the existence of an arrangement
between the parties without the prior written approval of the other
parties. To effectuate these provisions, within 15 days of the
Effective Date, ArthroCare will issue the press release attached hereto
as Schedule G, Ethicon and ArthroCare will generate an approved
statement containing the portions of this agreement that may be
disseminated to the public, and Ethicon and ArthroCare will also
distribute this approved statement to their respective sales forces.
Notwithstanding anything to the contrary herein, the Parties agree that
an unintentional breach of Section 15.3 shall not be deemed to be a
material breach so long as the breaching Party uses reasonable efforts
to remedy or mitigate any such breach within a reasonable time after
being notified of such breach. Furthermore, the Parties agree that
Gyrus shall be permitted to issue the press release attached hereto as
Schedule I.
15.4 Notices. All notices hereunder shall be in writing and
shall be deemed to have been duly given if delivered personally, one day
after delivery to a nationally recognized overnight delivery service,
charges prepaid, three days after sent by registered or certified mail,
postage prepaid, or when receipt is confirmed if by, facsimile or other
telegraphic means:
In the case of ArthroCare Corporation:
ArthroCare Corporation
595 North Pastoria Avenue
Sunnyvale, California 94086
Attn: Michael A. Baker
Fax: (408) 732-2752
with a copy to:
John T. Raffle, Esq.
ArthroCare Corporation
595 North Pastoria Avenue
Sunnyvale, California 94086
Fax: (408) 530-9143
In the case of Ethicon:
Ethicon, Inc.
U.S. Route 22
Somerville, New Jersey 08976
Attn: Vice-President, New Business Development
With a copy to:
Chief Patent Counsel
Johnson & Johnson
One Johnson & Johnson Plaza
New Brunswick, New Jersey 08933
In the case of Gyrus:
Gyrus Medical Ltd.
Fortran Road
St. Mellons, Cardiff
CF3 OLT, United Kingdom
Attn: Managing Director
Fax: 44-1222-777-282
With a copy to:
Robert A. Molan, Esq.
Nixon & Vanderhye, P.C.
1100 North Glebe Road, 8th Floor
Arlington, Virginia 77201-4714
Fax: (703) 816-4100
Such addresses may be altered by written notice given in accordance with
this Article 15.4.
15.5 Assignment. [***]
15.6 Force Majeure. Any delays in or failures of performance by
any Party under this Agreement shall not be considered a breach of this
Agreement if and to the extent caused by occurrences beyond the
reasonable control of the party affected, including but not limited to:
acts of God; acts, regulations or laws of any government; strikes or
other concerted acts of workers; fires; floats; explosions; riots; wars;
rebellions; and sabotage; and any time for performance hereunder shall
be extended by the actual time of delay caused by such occurrence.
15.7 Relationship of Parties. The Parties hereto are entering
into this Agreement as independent contractors, and nothing herein is
intended or shall be construed to create between the Parties a
relationship of principal and agent, partners, joint venturers or
employer and employee. No Party shall hold itself out to others or seek
to bind or commit the other Parties in any manner inconsistent with the
foregoing provisions of this Article.
15.8 [***]
15.9 Integration. This Agreement constitutes the entire
agreement and understanding between the Parties with respect to the
matters contained herein, and there are no prior oral or written
promises, representations, conditions, provisions or terms related
thereto other than those set forth in this Agreement. The Parties may
from time to time during the term of this Agreement modify any of its
provisions by mutual agreement in writing.
15.10 Other Disputes. (a) Issues or disputes pertaining to
patents, products or processes not specifically included within the
terms and provisions of this Agreement are outside the scope of this
Agreement. By way of example only and not limitation, issues concerning
[***]
(b) The Parties agree that in the case of any action or
proceeding brought in any court or tribunal in any
country concerning the patents, products, or processes
that [***]
15.11 Headings. The inclusion of headings in this Agreement is
for convenience only and shall not affect the construction or
interpretation hereof.
15.12 Construction. The Parties agree and acknowledge that this
Agreement is the product of both parties and shall not be construed
against either party.
15.13 Governing Law. Except as provided in Article 14 above, the
validity and interpretation of this Agreement and the legal relations of
the parties to it shall be governed by the internal laws of the State of
Delaware.
15.14 Patent Applications. The Parties will have access to
confidential information regarding the ArthroCare and Ethicon Patents
and Applications, such as the serial numbers of U.S. patent
applications. All Parties agree to maintain the confidentiality of this
information, and not to use this information against the other party in
any confidential patent office proceeding that is not open to the
public.
15.15 Execution of Agreement in Counterparts. This Agreement may
be executed in any number of counterparts, and execution by each of the
Parties of any one of such counterparts will constitute due execution of
this Agreement. Each such counterpart hereof shall be deemed to be an
original instrument, and all such counterparts together shall constitute
but one agreement.
This Agreement is signed as indicated below by duly authorized
representatives of
ArthroCare, Ethicon, and Gyrus, respectively.
ARTHROCARE CORPORATION
Date: _____________________ By: _____________________________
Michael A. Baker
President and CEO
ETHICON, INC.
MITEK SURGICAL PRODUCTS
GYNECARE
GYNECARE, INC.
Date: _____________________ By: _____________________________
Howard I. Zauberman
Vice-President,
Growth Technologies &
New Business Development
GYRUS MEDICAL LTD.
Date: _____________________ By: _____________________________
Mark Goble, M.D.
Managing Director
SCHEDULE A
[***]
SCHEDULE B
[***]
SCHEDULE C
[***]
SCHEDULE D
[***]
SCHEDULE E
[***]
SCHEDULE F
[Counsel listed on last page.]
UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF CALIFORNIA
ARTHROCARE CORP. No. C-98-00609 WHO
Plaintiff,
vs. STIPULATED NOTICE OF DISMISSAL
WITH
ETHICON, INC. et al. PREJUDICE
Defendants
DATE: June 29, 1999
TIME: 12:00pm
CTRM: 7
Hon. William H. Orrick, Jr.
______________________________________
Pursuant to Federal Rule of Civil Procedure 41(A)(1), the Parties to the
above-captioned litigation agree to the dismissal with prejudice of the
litigation and all claims, counterclaims, and defenses therein.
Accordingly, the Parties hereby stipulate and agree that all claims,
counterclaims, and defenses therein the above-captioned litigation SHALL
BE, and HEREBY ARE, dismissed with prejudice, with all parties to bear
their own costs and attorney's fees.
DATED: June ___, 1999 Respectfully Submitted,
___________________________ ______________________________
MATTHEW D. POWERS (Bar No. 104795) MARTIN D. BERN (State Bar No.
153203)
JARED BOBROW (Bar No. 133712) KELLY M. KLAUS (State Bar No. 16190
1)
BRADFORD SCHMIDT (Bar No. 174440) 33 New Montgomery Tower
WEIL, GOTSHAL & MANGES LLP Nineteenth Floor
Silicon Valley Office San Francisco, CA 94105-
9781
2882 Sand Hill Road, Suite 280 (415) 512-4000
Menlo Park, CA 94025-7022
(650) 926-6200
Attorneys for Plaintiff GEORGE F. PAPPAS
ArthroCare Corporation VICKI MARGOLIS (State Bar No.
194029)
CHELLIS E. NEAL
VENABLE, BAETJER, HOWARD &
CIVILETTI LLP
1201 New York Avenue, N.W.
Suite 1000
Washington, D.C. 20005-3917
Phone (202) 962-4800
Attorneys for Defendants
Ethicon, Inc., Mitek Surgical
Products,
and Gynecare, Inc.
SCHEDULE G
ARTHROCARE AND ETHICON TO SETTLE LITIGATION
ETHICON LICENSES ARTHROCARE'S PATENTS IN TWO FIELDS
SUNNYVALE, CA--JUNE 24, 1999-- ArthroCare Corporation (NASDAQ:ARTC)
today announced that ETHICON, Inc. and ArthroCare have agreed to
settle a patent infringement claim brought by ArthroCare in February
1998 against ETHICON and the MITEK and GYNECARE divisions. Under the
terms of the settlement, ETHICON will license ArthroCare's United
States patents in the arthroscopy and gynecology markets and
ArthroCare will dismiss the legal action.
Both companies will continue to be active in the marketplace.
ETHICON, Inc. will pay ArthroCare a license fee and ongoing royalties
on sales in the United States of certain arthroscopy and gynecology
products. ArthroCare anticipates these payments will have a positive
material impact on results for the quarter ending July 3, 1999. The
settlement agreement also establishes a procedure for resolution of
certain potential intellectual property disputes in these two markets
without litigation. Additional terms of the settlement agreement
were not disclosed.
ArthroCare has developed a broad technology platform for operating on
soft tissue. The technology is based on a patented method of tissue
removal, called Coblation(TM) technology, that is designed to improve
the effectiveness and safety of standard surgical methods. Coblation
technology uses radio frequency (RF) energy to remove tissue through
a significantly cooler process than is possible with traditional
electro- or laser-surgery. Coblation-assisted surgery has the
potential to improve operative precision and efficiency compared with
many standard surgical techniques and thereby reduce pain and speed
recovery.
Except for historical information, this press release includes forward-
looking statements that involve risks and uncertainties, including, but
not limited to, the value of intellectual property, the establishment of
brand identity, and risks as detailed from time to time in the company's
Securities and Exchange Commission filings, including ArthroCare's Form
10-K for the year ended January 3, 1999 and form 10-Q for the quarter
ended April 3, 1999. Actual results may differ materially from
management expectations.
ArthroCare Corporation is a medical device company redefining the
standard in soft tissue surgery by developing, manufacturing, and
marketing patented Coblation technology that allows surgeons to
operate with increased precision and accuracy, with minimal damage to
surrounding tissue. The company's systems are being used to perform
many types of closed joint surgery, and have been introduced for use
in cosmetic surgery and ear, nose and throat (ENT) surgery.
ArthroCare's long-term strategy includes applying its patented
platform technology to a broad range of other soft tissue surgical
markets including various cardiology applications and the fields of
urology, gynecology, and oral and general surgery. ArthroCare's web
site can be found at www.arthrocare.com.
ETHICON, INC. is a Johnson & Johnson company marketing surgical
devices in the areas of wound management, women's health, and
surgical sports medicine. ETHICON's worldwide web address is
www.ethiconinc.com.
# # #
SCHEDULE H
[***]
SCHEDULE I
M E M O R A N D U M
TO: Peter Hawley
FROM: Mark Goble
SUBJECT: Draft Press Release on Arthrocare Settlement
DATE: --- June 1999
Gyrus, the "PlasmaKinetic" endosurgical device company, announces the
settlement of the US litigation brought by Arthrocare in February 1998
against Ethicon Inc relating to their importation, sale and distribution
of Gyrus's VAPR(R) arthroscopic and VersaPoint(R) hysteroscopic systems in
the US market. The VAPR(R) and VersaPoint(R) systems are manufactured by
Gyrus and licensed to Ethicon Inc, a division of Johnson & Johnson.
Under the terms of the settlement, Ethicon has licensed Arthrocare's US
patents in the arthroscopic and hysteroscopic gynaecology markets and
Arthrocare has dismissed the legal action.
Both Ethicon and ArthroCare will continue to be active in developing the
arthroscopic market. Ethicon will pay Arthrocare a license fee and
ongoing royalties on sales in the United States of certain arthroscopic
and gynaecological products. The settlement agreement also establishes
a procedure for resolution of any future intellectual property disputes
in these two markets worldwide without resorting to litigation.
Additional terms of the settlement agreement were not disclosed.
In a separate agreement, Gyrus and Ethicon will share the costs of
settlement including ongoing royalties on a proportional basis,
comparable to their respective sharing of sales revenue. Gyrus will
make a one-off charge of approximately 1M against the costs related to
settling the litigation in the current financial year ending 30th June,
1999. Other aspects of the agreement include an extension of Gyrus's
manufacturing exclusivity for the US market. Gyrus and Ethicon are also
negotiating terms to support a more aggressive product development
program for both the VAPR(R) and VersaPoint(R) product lines.
In the first half of the current financial year, Gyrus was able to
report a 135% leap in product sales (4 million from 1.7 million),
along with a sharp drop in pre-tax losses (0.9 million from 1.9
million). The settlement of the US litigation has now removed what
could have been a significant risk to the future growth of the business
and has simultaneously provided a much stronger barrier to other
competitors seeking to enter the market. This has not been without its
costs, not least in deflecting the focus of senior management from
developing other aspects of the business. With resolution of this
issue, Gyrus can now confidently move forward in developing additional
markets and alliances.
Gyrus employ 190 people at their headquarters and manufacturing plant
near Cardiff, Wales. Their factory includes a 3,000sq. ft. Class 10,000
Clean Room where the single use disposables for use with PlasmaKinetic
systems are produced. Plans to develop an adjacent site which will
increase production capacity significantly from January 2000 have been
approved and the company is now moving into its next rapid scale up
phase.
Gyrus Group PLC has its UK headquarters at Gyrus Group PLC., Fortran
Road, St Mellons, Cardiff, Wales CF3 0LT. Tel: (01222) 300100, fax:
(01222) 300101. You can also visit the company on the web at:
www.gyrus.co.uk
With Compliments,
Jean Garon PR
Tel: (01628) 483040
Fax: (01628) 486796
E-Mail: [email protected]
1
DC2/146182v7
FINAL
ArthroCare, Corporation
DO NOT DESTROY THIS NOTE: When paid, this note, with Deed of Trust
securing same, must be surrendered to Trustee before reconveyance will
be made.
NOTE SECURED BY DEED OF TRUST
STRAIGHT NOTE
$350,000
Sunnyvale, California
May 1, 1999
For value received, John Tighe and Susie Tighe, husband and wife
(payor/trustor) and promises to pay to ArthroCare Corporation, a
Delaware corporation (payee/beneficiary), or order, at place designated
by payee, the principal sum of three hundred fifty thousand dollars
($350,000), together with interest from N/A on the unpaid principal
hereof from the date hereof at the rate of zero percent (0%) per annum,
payable upon the earlier of (1) following a sale or transfer of the
property securing this note or any interest therein (2) twelve months
following the termination by ArthroCare Corporation of John Tighe's
employment with ArthroCare (3) twelve months following the sale of
ArthroCare Corporation by merger, reorganization or sale of
substantially all assets or (4) upon the termination by John Tighe of
his employment with ArthroCare.
Principal, interest, and all other sums which may become due in
connection with this note and the deed of trust security same, shall be
payable in lawful money of the United States of America. Should default
be made in any payment when due, the whole sum of principal and interest
shall become immediately due at the option of the holder of this note.
If action be instituted on this note, I promise to pay such sum as the
Court may fix as attorney's fees.
The Deed of Trust securing this note contains the following provision:
In the event the herein described property or any part hereof, or any
interest therein is sold agreed to be sold, conveyed or alienated by the
Trustor, or by the operation of law or otherwise, all obligations
secured by this instrument, irrespective of the maturity dates expressed
therein, at the option of the holder hereof and without demand or notice
shall immediately become due and payable. This note is secured by a
DEED OF TRUST to ArthroCare Corporation, a Delaware corporation as
Trustee.
_______________________________
John Tighe
_______________________________
Susie Tighe
ARTHROCARE CORPORATION
LOAN AND SECURITY AGREEMENT
This LOAN AND SECURITY AGREEMENT is entered into as of June 11, 1999,
by and between SILICON VALLEY BANK ("Bank") and ARTHROCARE CORPORATION
("Borrower").
RECITALS
Borrower wishes to obtain credit from time to time from Bank, and
Bank desires to extend such credit to Borrower. This Agreement sets
forth the terms on which Bank will advance credit to Borrower, and
Borrower will repay that credit owing to Bank.
AGREEMENT
The parties agree as follows:
1. DEFINITIONS AND CONSTRUCTION
1.1 Definitions. As used in this Agreement, the
following terms shall have the following definitions:
"Accounts" means all presently existing and
hereafter arising accounts, contract rights, and all other forms of
obligations owing to Borrower arising out of the sale or lease of goods
(including, without limitation, the licensing of software and other
technology) or the rendering of services by Borrower, whether or not
earned by performance, and any and all credit insurance, guaranties,
and other security therefor, as well as all merchandise returned to or
reclaimed by Borrower and Borrower's Books relating to any of the
foregoing.
"Advance' or "Advances' means a cash advance under
the Revolving Facility.
"Affiliate" means, with respect to any Person, any
Person that owns or controls directly or indirectly such Person, any
Person that controls or is controlled by or is under common control
with such Person, and each of such Person's senior executive officers,
directors, and partners.
"Bank Expenses"means all: reasonable costs or
expenses (including reasonable attorneys' fees and expenses) incurred
in connection with the preparation, negotiation, administration, and
enforcement of the Loan Documents; reasonable Collateral audit fees;
and Bank's reasonable attorneys' fees and expenses incurred in
amending, enforcing or defending the Loan Documents (including fees and
expenses of appeal), incurred before, during and after an Insolvency
Proceeding, whether or not suit is brought.
"Borrower's Books" means all of Borrower's books and
records including: ledgers; records concerning Borrower's assets or
liabilities, the Collateral, business operations or financial
condition; and all computer programs, or tape files, and the equipment,
containing such information.
"Borrowing Base" means an amount equal to eighty
percent (80%) of Eligible Accounts, as determined by Bank with
reference to the most recent Borrowing Base Certificate delivered by
Borrower.
'Business Day" means any day that is not a Saturday,
Sunday, or other day on which banks in the States of California or
Colorado are authorized or required to close.
"Closing Date" means the date of this Agreement.
"Code" means the California Uniform Commercial Code.
"Collateral" means the property described on
Exhibit A attached hereto.
"Committed Revolving Line" means Seven Million
Dollars ($7,000,000).
"Contingent Obligation" means, as applied to any
Person, any direct or indirect liability, contingent or otherwise, of
that Person with respect to (i) any indebtedness, lease, dividend,
letter of credit or other obligation of another, including, without
limitation, any such obligation directly or indirectly guaranteed,
endorsed, co-made or discounted or sold with recourse by that Person,
or in respect of which that Person is otherwise directly or indirectly
liable; (ii) any obligations with respect to undrawn letters of credit
issued for the account of that Person; and (iii) all obligations
arising under any interest rate, currency or commodity swap agreement,
interest rate cap agreement, interest rate collar agreement, or other
agreement or arrangement designated to protect a Person against
fluctuation in interest rates, currency exchange rates or commodity
prices; provided, however, that the term "Contingent Obligation" shall
not include endorsements for collection or deposit in the ordinary
course of business. The amount of any Contingent Obligation shall be
deemed to be an amount equal to the stated or determined amount of the
primary obligation in respect of which such Contingent Obligation is
made or, if not stated or determinable, the maximum reasonably
anticipated liability in respect thereof as determined by such Person
in good faith; provided, however, that such amount shall not in any
event exceed the maximum amount of the obligations under the guarantee
or other support arrangement.
"Copyrights" means any and all copyright rights,
copyright applications, copyright registrations and like protections in
each work or authorship and derivative work thereof, whether published
or unpublished and whether or not the same also constitutes a trade
secret, now or hereafter existing, created, acquired or held.
"Credit Extension" means each Advance or any other
extension of credit by Bank for the benefit of Borrower hereunder.
"Current Liabilities" means, as of any applicable
date, all amounts that should, in accordance with GAAP, be included as
current liabilities on the consolidated balance sheet of Borrower and
its Subsidiaries, as at such date, plus, to the extent not already
included therein, all outstanding Advances made under this Agreement,
including all Indebtedness that is payable upon demand or within one
year from the date of determination thereof unless such Indebtedness is
renewable or extendible at the option of Borrower or any Subsidiary to
a date more than one year from the date of determination.
"Daily Balance" means the amount of the Obligations
owed at the end of a given day.
"Eligible Accounts" means those Accounts that arise
in the ordinary course of Borrower's business that comply with all of
Borrower's representations and warranties to Bank set forth in
Section 5.4; provided, that standards of eligibility may be fixed and
revised from time to time by Bank as a consequence of any Collateral
audits done pursuant to Section 6.3 in Bank's reasonable judgment and
upon notification thereof to Borrower in accordance with the provisions
hereof. Unless otherwise agreed to by Bank, Eligible Accounts shall
not include the following:
(a) Accounts that the account debtor has failed to
pay within ninety (90) days of invoice date or account debtors who have
been granted extended payment terms unless approved by Bank on a case
by case basis;
(b) Accounts with respect to an account debtor,
fifty percent (50%) of whose Accounts the account debtor has failed to
pay within ninety (90) days of invoice date;
(c) Accounts with respect to which the account
debtor is an officer, employee, or agent of Borrower;
(d) Accounts with respect to which goods are placed
on consignment, guaranteed sale, sale or return, sale on approval, bill
and hold, or other terms by reason of which the payment by the account
debtor may be conditional;
(e) Accounts with respect to which the account
debtor is an Affiliate of Borrower;
(f) Accounts with respect to which the account
debtor does not have its principal place of business in the United
States, except for Eligible Foreign Accounts;
(g) Accounts with respect to which the account
debtor is the United States or any department, agency, or
instrumentality of the United States;
(h) Accounts with respect to which Borrower is
liable to the account debtor for goods sold or services rendered by the
account debtor to Borrower, but only to the extent of any amounts owing
to the account debtor against amounts owed to Borrower;
(i) Accounts with respect to an account debtor,
including Subsidiaries and Affiliates, whose total obligations to
Borrower exceed twenty-five percent (25%) of all Accounts, to the
extent such obligations exceed the aforementioned percentage, except as
approved in writing by Bank;
(j) Accounts with respect to which the account
debtor disputes liability or makes any claim with respect thereto as to
which Bank believes, in its sole discretion, that there may be a basis
for dispute (but only to the extent of the amount subject to such
dispute or claim), or is subject to any Insolvency Proceeding, or
becomes insolvent, or goes out of business; and
(k) Accounts the collection of which Bank
reasonably determines to be doubtful.
"Eligible Foreign Accounts" means Accounts with
respect to which the account debtor does not have its principal place
of business in the United States and that are: (1) covered by credit
insurance in form and amount, and by an insurer satisfactory to Bank
less the amount of any deductible(s) which may be or become owing
thereon; or (2) supported by one or more letters of credit in favor of
Bank as beneficiary, in an amount and of a tenor, and issued by a
financial institution, acceptable to Bank; or (3) that Bank approves on
a case-by-case basis.
"Equipment" means all present and future machinery,
equipment, tenant improvements, furniture, fixtures, vehicles, tools,
parts and attachments in which Borrower has any interest.
"ERISA" means the Employee Retirement Income
Security Act of 1974, as amended, and the regulations thereunder.
"Event of Default" has the meaning assigned in
Article 8.
"GAAP" means generally accepted accounting
principles as in effect from time to time.
"Indebtedness" means (a) all indebtedness for
borrowed money or the deferred purchase price of property or services,
including without limitation reimbursement and other obligations with
respect to surety bonds and letters of credit, (b) all obligations
evidenced by notes, bonds, debentures or similar instruments, (c) all
capital lease obligations and (d) all Contingent Obligations.
"Insolvency Proceeding" means any proceeding
commenced by or against any person or entity under any provision of the
United States Bankruptcy Code, as amended, or under any other
bankruptcy or insolvency law, including assignments for the benefit of
creditors, formal or informal moratoria, compositions, extension
generally with its creditors, or proceedings seeking reorganization,
arrangement, or other relief.
"Intellectual Property" means all of Borrower's
right, title and interest in the following
(a) Copyrights, Trademarks and Patents;
(b) Any and all trade secrets, and any and all
intellectual property rights in computer software and computer software
products now or hereafter existing, created, acquired or held;
(c) Any and all design rights which may be
available to Borrower now or hereafter existing, created, acquired or
held;
(d) Any and all claims for damages by way of past,
present and future infringement of any of the rights included above,
with the right, but not the obligation, to sue for and collect such
damages for said use or infringement of the intellectual property
rights identified above;
(e) All licenses or other rights to use any of the
Copyrights, Patents or Trademarks, and all license fees and royalties
arising from such use to the extent permitted by such license or
rights;
(f) All amendments, renewals and extensions of any
of the Copyrights, Trademarks or Patents; and
(g) All proceeds and products of the foregoing,
including without limitation all payments under insurance or any
indemnity or warranty payable in respect of any of the foregoing.
"Inventory" means all present and future inventory
in which Borrower has any interest, including merchandise, raw
materials, parts, supplies, packing and shipping materials, work in
process and finished products intended for sale or lease or to be
furnished under a contract of service, of every kind and description
now or at any time hereafter owned by or in the custody or possession,
actual or constructive, of Borrower, including such inventory as is
temporarily out of its custody or possession or in transit and
including any returns upon any accounts or other proceeds, including
insurance proceeds, resulting from the sale or disposition of any of
the foregoing and any documents of title representing any of the above,
and Borrower's Books relating to any of the foregoing.
"Investment" means any beneficial ownership of
(including stock, partnership interest or other securities) any Person,
or any loan, advance or capital contribution to any Person.
"IRC" means the Internal Revenue Code of 1986, as
amended, and the regulations thereunder.
"Lien" means any mortgage, lien, deed of trust,
charge, pledge, security interest or other encumbrance.
"Loan Documents" means, collectively, this
Agreement, any note or notes executed by Borrower, and any other
agreement entered into between Borrower and Bank in connection with
this Agreement, all as amended or extended from time to time.
"Material Adverse Effect" means a material adverse
effect on (i) the business operations or condition (financial or
otherwise) of Borrower and its Subsidiaries taken as a whole or
(ii) the ability of Borrower to repay the Obligations or otherwise
perform its obligations under the Loan Documents.
"Negotiable Collateral" means all of Borrower's
present and future letters of credit of which it is a beneficiary,
notes, drafts, instruments, securities, documents of title, and chattel
paper, and Borrower's Books relating to any of the foregoing.
"Obligations" means all debt, principal, interest,
Bank Expenses and other amounts owed to Bank by Borrower pursuant to
this Agreement or any other agreement, whether absolute or contingent,
due or to become due, now existing or hereafter arising, including any
interest that accrues after the commencement of an Insolvency
Proceeding and including any debt, liability, or obligation owing from
Borrower to others that Bank may have obtained by assignment or
otherwise.
"Patents" means all patents, patent applications and
like protections including without limitation improvements, divisions,
continuations, renewals, reissues, extensions and continuations-in-part
of the same.
"Periodic Payments" means all installments or
similar recurring payments that Borrower may now or hereafter become
obligated to pay to Bank pursuant to the terms and provisions of any
instrument, or agreement now or hereafter in existence between Borrower
and Bank.
"Permitted Indebtedness" means:
(a) Indebtedness of Borrower in favor of Bank
arising under this Agreement or any other Loan Document;
(b) Indebtedness existing on the Closing Date and
disclosed in the Schedule;
(c) Indebtedness secured by a lien described in
clause (c) of the defined term "Permitted Liens," provided such
Indebtedness does not exceed the lesser of the cost or fair market
value of the equipment financed with such Indebtedness;
(d) Subordinated Debt; and
(e) Indebtedness to trade creditors incurred in the
ordinary course of business.
"Permitted Investment" means
(a) Investments existing on the Closing Date
disclosed in the Schedule; and
marketable direct obligations issued or
unconditionally guaranteed by the United States of America or any
agency or any State thereof maturing within one (1) year from the date
of acquisition thereof, (ii) commercial paper maturing no more than
one (1) year from the date of creation thereof and currently having
rating of at least A-2 or P-2 from either Standard & Poor's Corporation
or Moody's Investors Service, (iii) certificates of deposit maturing no
more than one (1) year from the date of investment therein issued by
Bank and (iv) Bank's money market accounts, and (v) investments in
accordance with the investment policy approved by Borrower's Board of
Directors and a copy of which has been provided to Bank
"Permitted Liens" means the following
(a) Any Liens existing on the Closing Date and
disclosed in the Schedule or arising under this Agreement or the other
Loan Documents;
(b) Liens for taxes, fees, assessments or other
governmental charges or levies, either not delinquent or being
contested in good faith by appropriate proceedings, provided the same
have no priority over any of Bank's security interests;
(c) Liens (i) upon or in any equipment acquired or
held by Borrower or any of its Subsidiaries to secure the purchase
price of such equipment or indebtedness incurred solely for the purpose
of financing the acquisition of such equipment, or (ii) existing on
such equipment at the time of its acquisition, provided that the Lien
is confined solely to the property so acquired and improvements
thereon, and the proceeds of such equipment;
(d) Liens incurred in connection with the
extension, renewal or refinancing of the indebtedness secured by Liens
of the type described in clauses (a) through (c) above, provided that
any extension, renewal or replacement Lien shall be limited to the
property encumbered by the existing Lien and the principal amount of
the indebtedness being extended, renewed or refinanced does not
increase.
"Person" means any individual, sole proprietorship,
partnership, limited liability company, joint venture, trust,
unincorporated organization, association, corporation, institution,
public benefit corporation, firm, joint stock company, estate, entity
or governmental agency.
"Prime Rate" means the variable rate of interest,
per annum, most recently announced by Bank, as its "prime rate"
whether or not such announced rate is the lowest rate available from
Bank.
"Quick Assets" means, at any date as of which the
amount thereof shall be determined, Borrower's unrestricted cash and
cash-equivalents; accounts receivable; and investments with maturities
not to exceed 90 days; in each case determined in accordance with GAAP.
"Responsible Officer" means each of the President,
Chief Executive Officer, the Chief Financial Officer and the Controller
of Borrower.
"Revolving Facility" means the facility under which
Borrower may request Bank to issue Advances, as specified in
Section 2.1 hereof.
"Revolving Maturity Date" means June 10, 2000.
"Schedule" means the schedule of exceptions attached
hereto, if any.
"Subordinated Debt" means any debt incurred by
Borrower that is subordinated to the debt owing by Borrower to Bank on
terms reasonably acceptable to Bank (and identified as being such by
Borrower and Bank).
"Subsidiary" means any corporation or partnership in
which (i) any general partnership interest or (ii) more than 50% of the
stock of which by the terms thereof ordinary voting power to elect the
Board of Directors, managers or trustees of the entity shall, at the
time as of which any determination is being made, is owned by Borrower,
either directly or through an Affiliate.
"Tangible Net Worth" means at any date as of which
the amount thereof shall be determined, the sum of the capital stock
and additional paid-in capital plus retained earnings (or minus
accumulated deficit) of Borrower and its Subsidiaries minus intangible
assets, plus Subordinated Debt, on a consolidated basis determined in
accordance with GAAP.
"Total Liabilities" means at any date as of which
the amount thereof shall be determined, all obligations that should, in
accordance with GAAP be classified as liabilities on the consolidated
balance sheet of Borrower, including in any event all Indebtedness.
"Trademarks" means any trademark and servicemark
rights, whether registered or not, applications to register and
registrations of the same and like protections, and the entire goodwill
of the business of Borrower connected with and symbolized by such
trademarks.
1.2 Accounting Terms. All accounting terms not
specifically defined herein shall be construed in accordance with GAAP
and all calculations made hereunder shall be made in accordance with
GAAP consistently applied in the books and records of Borrower. When
used herein, the terms "financial statements" shall include the notes
and schedules thereto. This Agreement shall be construed to impart
upon Bank a duty to act reasonably at all times.
2. LOAN AND TERMS OF PAYMENT
2.1 Credit Extensions.
Borrower promises to pay to the order of Bank, in
lawful money of the United States of America, the aggregate unpaid
principal amount of all Credit Extensions made by Bank to Borrower
hereunder. Borrower shall also pay interest on the unpaid principal
amount of such Credit Extensions at rates in accordance with the terms
hereof.
2.1.1 Revolving Advances.
(a) Subject to and upon the terms and conditions of
this Agreement, Borrower may request and Bank shall make Advances in an
aggregate outstanding amount not to exceed the lesser of (i) the
Committed Revolving Line, or (ii) the Borrowing Base. Subject to the
terms and conditions of this Agreement, amounts borrowed pursuant to
this Section 2.1.1 may be repaid and reborrowed at any time prior to
the Revolving Maturity Date, at which time all Advances under this
Section 2.1.1 shall be immediately due and payable. Borrower may
prepay any Advances without penalty or premium.
(b) Whenever Borrower desires an Advance, Borrower
will notify Bank by facsimile transmission or telephone no later than
3:00 p.m. Pacific time, on the Business Day that the Advance is to be
made. Each such notification shall be promptly confirmed by a
Payment/Advance Form in substantially the form of Exhibit B hereto.
Bank is authorized to make Advances under this Agreement, based upon
instructions received from a Responsible Officer or a designee of a
Responsible Officer or without instructions if in Bank's discretion
such Advances are necessary to meet Obligations which have become due
and remain unpaid. Bank shall be entitled to rely on any telephonic
notice given by a person who Bank reasonably believes to be a
Responsible Officer or a designee thereof, and Borrower shall indemnify
and hold Bank harmless for any damages or loss suffered by Bank as a
result of such reliance. Bank will credit the amount of Advances made
under this Section 2.1.1 to Borrower's deposit account.
2.2 Overadvances. If, at any time or for any reason, the
outstanding Advances under the Revolving Facility exceed the lesser of
(i) the Committed Revolving Line or (ii) the Borrowing Base, Borrower
shall immediately pay to Bank, in cash, the amount of such excess.
2.3 Interest Rates, Payments, and Calculations.
(a) Interest Rate. Except as set forth in
Section 2.3(b), any Advances shall bear interest, on the average Daily
Balance, at a rate equal to one-quarter of one (0.25) percentage point
above the Prime Rate.
(b) Default Rate. All Obligations shall bear
interest, from and after the occurrence and during the continuance of
an Event of Default, at a rate equal to five (5) percentage points
above the interest rate applicable immediately prior to the occurrence
of the Event of Default.
(c) Payments. Interest hereunder shall be due and
payable on the tenth (10th) calendar day of each month during the term
hereof. For Obligations due and unpaid, Borrower authorizes Bank to,
at Bank's option, automatically debit Borrower's account with Bank (if
applicable) or charge such interest, all Bank Expenses, and all
Periodic Payments against any of Borrower's deposit accounts or against
the Committed Revolving Line, in which case those amounts shall
thereafter accrue interest at the rate then applicable hereunder. Any
interest not paid when due shall be compounded by becoming a part of
the Obligations, and such interest shall thereafter accrue interest at
the rate then applicable hereunder.
(d) Computation. In the event the Prime Rate is
changed from time to time hereafter, the applicable rate of interest
hereunder shall be increased or decreased effective as of 12:01 a.m. on
the day the Prime Rate is changed, by an amount equal to such change in
the Prime Rate. Bank shall notify Borrower of the change in the
ordinary course of business. All interest chargeable under the Loan
Documents shall be computed on the basis of a three hundred sixty (360)
day year for the actual number of days elapsed.
2.4 Crediting Payments. Prior to the occurrence of an
Event of Default, Bank shall credit a wire transfer of funds, check or
other item of payment to such deposit account or Obligation as Borrower
specifies. After the occurrence of an Event of Default, the receipt by
Bank of any wire transfer of funds, check, or other item of payment
shall be immediately applied to conditionally reduce Obligations, but
shall not be considered a payment on account unless such payment is of
immediately available federal funds or unless and until such check or
other item of payment is honored when presented for payment.
Notwithstanding anything to the contrary contained herein, any wire
transfer or payment received by Bank after 12:00 noon Pacific time
shall be deemed to have been received by Bank as of the opening of
business on the immediately following Business Day. Whenever any
payment to Bank under the Loan Documents would otherwise be due (except
by reason of acceleration) on a date that is not a Business Day, such
payment shall instead be due on the next Business Day, and additional
fees or interest, as the case may be, shall accrue and be payable for
the period of such extension, provided however, that no late fee shall
accrue because the relevant date is not a Business Day.
2.5 Fees. Borrower shall pay to Bank the following:
(a) Facility Fee. On the Closing Date, a Facility
Fee equal to Seventeen Thousand Five Hundred Dollars ($17,500) which
shall be nonrefundable;
(b) Non-Utilization Fee. On the last day of each
fiscal quarter, an amount equal to one-quarter of one percent (0.25%)
on an annualized basis, of the remainder of the Committed Revolving
Line minus the aggregate amount of Advances made by Bank to Borrower on
a daily basis during such fiscal quarter, which shall be nonrefundable;
(c) Bank Expenses. On the Closing Date, all Bank
Expenses incurred through the Closing Date, including reasonable
attorneys' fees and expenses (provided, however that Bank shall pay
fifty percent (50%) of any attorney's fees and expenses that exceed
Five Thousand Dollars ($5,000)) and, after the Closing Date, all Bank
Expenses, including reasonable attorneys' fees and expenses, as and
when they become due.
2.6 Additional Costs. In case any change in any law,
regulation, treaty or official directive or the interpretation or
application thereof by any court or any governmental authority charged
with the administration thereof or the compliance with any guideline or
request of any central bank or other governmental authority (whether or
not having the force of law), in each case after the date of this
Agreement:
(a) subjects Bank to any tax with respect to
payments of principal or interest or any other amounts payable
hereunder by Borrower or otherwise with respect to the transactions
contemplated hereby (except for taxes on the overall net income of Bank
imposed by the United States of America or any political subdivision
thereof);
(b) imposes, modifies or deems applicable any
deposit insurance, reserve, special deposit or similar requirement
against assets held by, or deposits in or for the account of, or loans
by, Bank; or
(c) imposes upon Bank any other condition with
respect to its performance under this Agreement,
and the result of any of the foregoing is to increase the cost to Bank,
reduce the income receivable by Bank or impose any additional expense
upon Bank with respect to any loans, Bank shall notify Borrower
thereof. Borrower agrees to pay to Bank the amount of such increase in
cost, reduction in income or additional expense as and when such cost,
reduction or expense is incurred or determined, upon presentation by
Bank of a statement of the amount and setting forth Bank's calculation
thereof, all in reasonable detail, which statement shall be deemed true
and correct absent manifest error. Bank agrees that it will allocate
all such increased costs among the outstanding Advances and its
customers similarly affected in good faith and in a manner consistent
with Bank's customary practice.
2.7 Term. This Agreement shall become effective on the
Closing Date, and subject to Section 12.7, shall continue in full force
and effect for a term ending on the Revolving Maturity Date.
Notwithstanding the foregoing, Bank shall have the right to terminate
its obligation to make Advances under this Agreement during the
continuance of an Event of Default. Notwithstanding termination,
Bank's Lien on the Collateral shall remain in effect for so long as any
Obligations are outstanding.
3. CONDITIONS OF LOANS
3.1 Conditions Precedent to Initial Advance. The
obligation of Bank to make the initial Advance is subject to the
condition precedent that Bank shall have received, in form and
substance reasonably satisfactory to Bank, the following:
(a) this Agreement;
(b) a certificate of the Secretary of Borrower with
respect to incumbency and resolutions authorizing the execution and
delivery of this Agreement;
(c) a financing statement (Form UCC-1);
(d) an audit of Borrower's Accounts;
(e) a Y2K survey of Borrower;
(f) an insurance certificate;
(g) payment of the fees and Bank Expenses then due
specified in Section 2.5 hereof; and
(h) such other documents, and completion of such
other matters, as Bank may reasonably deem necessary or appropriate.
3.2 Conditions Precedent to all Advances. The obligation
of Bank to make each Advance, including the initial Advance, is further
subject to the following conditions:
(a) timely receipt by Bank of the Payment/Advance
Form as provided in Section 2.1; and
(b) the representations and warranties contained in
Section 5 shall be true and correct in all material respects on and as
of the date of such Payment/Advance Form and on the effective date of
each Advance as though made at and as of each such date, and no Event
of Default shall have occurred and be continuing, or would result from
such Advance. The making of each Advance shall be deemed to be a
representation and warranty by Borrower on the date of such Advance as
to the accuracy of the facts referred to in this Section 3.3(b).
4. CREATION OF SECURITY INTEREST
4.1 Grant of Security Interest. Borrower grants and
pledges to Bank a continuing security interest in all presently
existing and hereafter acquired or arising Collateral in order to
secure prompt repayment of any and all Obligations and in order to
secure prompt performance by Borrower of each of its covenants and
duties under the Loan Documents. Except as set forth in the Schedule,
such security interest constitutes a valid, first priority security
interest in the presently existing Collateral, subject to Permitted
Liens, and will constitute a valid, first priority security interest in
Collateral acquired after the date hereof, subject to Permitted Liens.
4.2 Delivery of Additional Documentation Required.
Borrower shall from time to time execute and deliver to Bank, at the
request of Bank, all Negotiable Collateral, all financing statements
and other documents that Bank may reasonably request, in form
satisfactory to Bank, to perfect and continue perfected Bank's security
interests in the Collateral and in order to fully consummate all of the
transactions contemplated under the Loan Documents.
4.3 Right to Inspect. Bank (through any of its officers,
employees, or agents) shall have the right, upon reasonable prior
notice and without causing undue disruption to the conduct of
Borrower's business, from time to time during Borrower's usual business
hours, to inspect Borrower's Books and to make copies thereof and to
check, test, and appraise the Collateral in order to verify Borrower's
financial condition or the amount, condition of, or any other matter
relating to, the Collateral.
5. REPRESENTATIONS AND WARRANTIES
Borrower represents and warrants as follows:
5.1 Due Organization and Qualification. Borrower and
each Subsidiary is a corporation duly existing and in good standing
under the laws of its state or country of incorporation and qualified
and licensed to do business in, and is in good standing in, any state
in which the conduct of its business or its ownership of property
requires that it be so qualified.
5.2 Due Authorization; No Conflict. The execution,
delivery, and performance of the Loan Documents are within Borrower's
powers, have been duly authorized, and are not in conflict with nor
constitute a breach of any material provision contained in Borrower's
Articles of Incorporation or Bylaws, nor will they constitute an event
of default under any material agreement to which Borrower is a party or
by which Borrower is bound except to the extent that certain
intellectual property agreements prohibit the assignment of the rights
thereunder to a third party without the Borrower's or other party's
consent. Borrower is not in default under any agreement to which it is
a party or by which it is bound, which default could have a Material
Adverse Effect.
5.3 No Prior Encumbrances. Borrower has good and
indefeasible title to the Collateral, free and clear of Liens, except
for Permitted Liens.
5.4 Bona Fide Eligible Accounts. The Eligible Accounts
are bona fide existing obligations. The property giving rise to such
Eligible Accounts has been delivered to the account debtor or to the
account debtor's agent for immediate shipment to and unconditional
acceptance by the account debtor. Borrower has not received notice of
actual or imminent Insolvency Proceeding of any account debtor that is
included in any Borrowing Base Certificate as an Eligible Account.
5.5 Merchantable Inventory. All Inventory is in all
material respects of good and marketable quality, free from all
material defects, normal wear and tear excepted.
5.6 Intellectual Property. Borrower is the sole owner of
the Intellectual Property, except for non-exclusive licenses granted by
Borrower to its customers in the ordinary course of business, and as
provided in the Schedule. Each of the Patents is valid and
enforceable, and no part of the Intellectual Property has been judged
invalid or unenforceable, in whole or in part, and no claim has been
made that any part of the Intellectual Property violates the rights of
any third party.
5.7 Name; Location of Chief Executive Office. Except as
disclosed in the Schedule, Borrower has not done business under any
name other than that specified on the signature page hereof. The chief
executive office of Borrower is located at the address indicated in
Section 10 hereof.
5.8 Litigation. Except as set forth in the Schedule,
there are no actions or proceedings pending by or against Borrower or
any Subsidiary before any court or administrative agency in which an
adverse decision could have a Material Adverse Effect or a material
adverse effect on Borrower's interest or Bank's security interest in
the Collateral. Borrower does not have knowledge of any such pending
or threatened actions or proceedings.
5.9 No Material Adverse Change in Financial Statements.
Consolidated financial statements related to Borrower and any
Subsidiary that have been delivered by Borrower to Bank fairly present
in all material respects Borrower's consolidated financial condition as
of the date thereof and Borrower's consolidated results of operations
for the period then ended. There has not been a material adverse
change in the consolidated financial condition of Borrower since the
date of the most recent of such financial statements submitted to Bank.
5.10 Solvency. Borrower is solvent and is able to pay its
debts (including trade debts) as they mature.
5.11 Regulatory Compliance. Borrower and each Subsidiary
have met the minimum funding requirements of ERISA with respect to any
employee benefit plans subject to ERISA. No event has occurred
resulting from Borrower's failure to comply with ERISA that is
reasonably likely to result in Borrower's incurring any liability that
could have a Material Adverse Effect. Borrower is not an "investment
company" or a company "controlled" by an "investment company"
within the meaning of the Investment Company Act of 1940. Borrower is
not engaged principally, or as one of the important activities, in the
business of extending credit for the purpose of purchasing or carrying
margin stock (within the meaning of Regulations T and U of the Board of
Governors of the Federal Reserve System). Borrower has complied with
all the provisions of the Federal Fair Labor Standards Act. Borrower
has not violated any statutes, laws, ordinances or rules applicable to
it, the violation of which could have a Material Adverse Effect.
5.12 Environmental Condition. Except as disclosed in the
Schedule, none of Borrower's or any Subsidiary's properties or assets
has ever been used by Borrower or any Subsidiary or, to the best of
Borrower's knowledge, by previous owners or operators, in the disposal
of, or to produce, store, handle, treat, release, or transport, any
hazardous waste or hazardous substance other than in accordance with
applicable law; to the best of Borrower's knowledge, none of Borrower's
properties or assets has ever been designated or identified in any
manner pursuant to any environmental protection statute as a hazardous
waste or hazardous substance disposal site, or a candidate for closure
pursuant to any environmental protection statute; no lien arising under
any environmental protection statute has attached to any revenues or to
any real or personal property owned by Borrower or any Subsidiary; and
neither Borrower nor any Subsidiary has received a summons, citation,
notice, or directive from the Environmental Protection Agency or any
other federal, state or other governmental agency concerning any action
or omission by Borrower or any Subsidiary resulting in the releasing,
or otherwise disposing of hazardous waste or hazardous substances into
the environment.
5.13 Taxes. Borrower and each Subsidiary has filed or
caused to be filed all tax returns required to be filed, and has paid,
or has made adequate provision for the payment of, all taxes reflected
therein.
5.14 Subsidiaries. Borrower does not own any stock,
partnership interest or other equity securities of any Person, except
for Permitted Investments and has no Subsidiaries other than as
disclosed in the Schedule.
5.15 Government Consents. Borrower and each Subsidiary
has obtained all consents, approvals and authorizations of, made all
declarations or filings with, and given all notices to, all
governmental authorities that are necessary for the continued operation
of Borrower's business as currently conducted, except to the extent
that any failure to do so would not have a Material Adverse Effect;
provided that neither Borrower nor any subsidiary makes any
representation or warranty as to the likelihood or ability of Borrower
obtaining any consent, approval or authorization from the United States
Food and Drug Administration.
5.16 Full Disclosure. No representation, warranty or
other statement made by Borrower in any certificate or written
statement furnished to Bank contains any untrue statement of a material
fact or omits to state a material fact necessary in order to make the
statements contained in such certificates or statements not misleading.
6. AFFIRMATIVE COVENANTS
Borrower covenants and agrees that, until payment in full
of all outstanding Obligations, and for so long as Bank may have any
commitment to make an Advance hereunder, Borrower shall do all of the
following:
6.1 Good Standing. Borrower shall maintain its and each
of its Subsidiaries' corporate existence and good standing in its
jurisdiction of incorporation and maintain qualification in each
jurisdiction in which the failure to so qualify could have a Material
Adverse Effect. Borrower shall maintain, and shall cause each of its
Subsidiaries to maintain in force all licenses, approvals and
agreements, the loss of which could have a Material Adverse Effect.
6.2 Government Compliance. Borrower shall meet, and
shall cause each Subsidiary to meet, the minimum funding requirements
of ERISA with respect to any employee benefit plans subject to ERISA.
Borrower shall comply, and shall cause each Subsidiary to comply, with
all statutes, laws, ordinances and government rules and regulations to
which it is subject, noncompliance with which could have a Material
Adverse Effect or a material adverse effect on the Collateral or the
priority of Bank's Lien on the Collateral.
6.3 Financial Statements, Reports, Certificates.
Borrower shall deliver to Bank: (a) as soon as available, but in any
event within thirty (30) days after the end of each calendar month, a
company prepared consolidated balance sheet and income statement
covering Borrower's consolidated operations during such period, in a
form acceptable to Bank and certified by a Responsible Officer; (b) as
soon as available, but in any event within ninety (90) days after the
end of Borrower's fiscal year, audited consolidated financial
statements of Borrower prepared in accordance with GAAP, consistently
applied, together with an unqualified opinion on such financial
statements of an independent certified public accounting firm
reasonably acceptable to Bank; (c) copies of all statements, reports
and notices sent or made available generally by Borrower to its
security holders or to any holders of Subordinated Debt and all reports
on Form 10-K and 10-Q filed with the Securities and Exchange
Commission, within five days of filing; (d) promptly upon receipt of
notice thereof, a report of any legal actions pending or threatened
against Borrower or any Subsidiary that could result in damages or
costs to Borrower or any Subsidiary of Fifty Thousand Dollars ($50,000)
or more; (e) prompt notice of any material change in the composition of
the Intellectual Property, including, but not limited to, any
subsequent ownership right of the Borrower in or to any Copyright,
Patent or Trademark or knowledge of an event that materially adversely
effects the value of the Intellectual Property; and (f) such budgets,
sales projections, operating plans or other financial information as
Bank may reasonably request from time to time.
Within thirty (30) days after the last day of each month,
Borrower shall deliver to Bank a Borrowing Base Certificate signed by a
Responsible Officer in substantially the form of Exhibit C hereto,
together with aged listings by invoice date of accounts receivable and
accounts payable.
Borrower shall deliver to Bank with the monthly financial
statements a Compliance Certificate signed by a Responsible Officer in
substantially the form of Exhibit D hereto.
Bank shall have a right from time to time hereafter to audit
Borrower's Accounts and appraise Collateral and to incur reasonable
audit and appraisal fees to be paid for by Borrower in connection
therewith, provided that such audits will be conducted no more often
than every six (6) months unless an Event of Default has occurred and
is continuing.
6.4 Inventory; Returns. Borrower shall keep all
Inventory in good and marketable condition, free from all material
defects, subject to normal wear and tear. Returns and allowances, if
any, as between Borrower and its account debtors shall be on the same
basis and in accordance with the usual customary practices of Borrower,
as they exist at the time of the execution and delivery of this
Agreement. Borrower shall promptly notify Bank of all returns and
recoveries and of all disputes and claims, where the return, recovery,
dispute or claim involves more than One Hundred Thousand Dollars
($100,000).
6.5 Taxes. Borrower shall make, and shall cause each
Subsidiary to make, due and timely payment or deposit of all material
federal, state, and local taxes, assessments, or contributions required
of it by law, and will execute and deliver to Bank, on demand,
appropriate certificates attesting to the payment or deposit thereof;
and Borrower will make, and will cause each Subsidiary to make, timely
payment or deposit of all material tax payments and withholding taxes
required of it by applicable laws, including, but not limited to, those
laws concerning F.I.C.A., F.U.T.A., state disability, and local, state,
and federal income taxes, and will, upon request, furnish Bank with
proof satisfactory to Bank indicating that Borrower or a Subsidiary has
made such payments or deposits; provided that Borrower or a Subsidiary
need not make any payment if the amount or validity of such payment is
contested in good faith by appropriate proceedings and is reserved
against (to the extent required by GAAP) by Borrower.
6.6 Insurance.
(a) Borrower, at its expense, shall keep the
Collateral insured against loss or damage by fire, theft, explosion or
sprinklers, using a standard commercial all-risk form that excludes
from coverage damage from earthquakes and floods and in such amounts,
as ordinarily insured against by other owners in similar businesses
conducted in the locations where Borrower's business is conducted on
the date hereof. Borrower shall also maintain insurance relating to
Borrower's ownership and use of the Collateral in amounts and of a type
that are customary to businesses similar to Borrower's, including, but
not limited to, products liability insurance.
(b) All such policies of insurance shall be in such
form, with such companies, and in such amounts as reasonably
satisfactory to Bank. All such policies of property insurance shall
contain a lender's loss payable endorsement, in a form reasonably
satisfactory to Bank, showing Bank as an additional loss payee thereof
and all liability insurance policies shall show the Bank as an
additional insured, and shall specify that the insurer must give at
least twenty (20) days notice to Bank before canceling its policy for
any reason. Upon Bank's request, Borrower shall deliver to Bank
certified copies of such policies of insurance and evidence of the
payments of all premiums therefor. After the occurrence of an Event of
Default, all proceeds payable under any such policy shall, at the
option of Bank, be payable to Bank to be applied on account of the
Obligations.
6.7 Principal Depository. Borrower shall maintain its
principal depository and operating accounts with Bank.
6.8 Quick Ratio. Borrower shall maintain, as of the last
day of each calendar month, a ratio of Quick Assets to Current
Liabilities of at least 1.00 to 1.00.
6.9 Tangible Net Worth. Borrower shall maintain, as of
the last day of each fiscal quarter, a Tangible Net Worth of not less
than Twenty Million Dollars ($20,000,000).
6.10 Profitability. Borrower shall not suffer losses in
excess of Five Hundred Thousand Dollars ($500,000) for the fiscal
quarter ending July 3, 1999. Thereafter, Borrower shall achieve, as of
the last day of each fiscal quarter, profitability of at least One
Dollar ($1.00). Borrower shall achieve annual profitability of at
least One Dollar ($1.00).
6.11 Total Liabilities-Tangible Net Worth. Borrower shall
maintain, as of the last day of each fiscal quarter, a ratio of Total
Liabilities to Tangible Net Worth of not more than 0.75 to 1.00.
6.12 Further Assurances. At any time and from time to
time Borrower shall execute and deliver such further instruments and
take such further action as may reasonably be requested by Bank to
effect the purposes of this Agreement.
7. NEGATIVE COVENANTS
Borrower covenants and agrees that, so long as any credit
hereunder shall be available and until payment in full of the
outstanding Obligations or for so long as Bank may have any commitment
to make any Advances, Borrower will not do any of the following:
(a) Dispositions. Convey, sell, lease, transfer or
otherwise dispose of (collectively, a "Transfer"), or permit any of
its Subsidiaries to Transfer, all or any part of its business or
property, including the Intellectual Property, other than:
(i) Transfers of Inventory in the ordinary course of business;
(ii) Transfers of non-exclusive licenses for the use of the property of
Borrower or its Subsidiaries; (iii) Transfers of exclusive licenses for
(a) the use of property of Borrower or its Subsidiaries related to
applications of Borrower's Intellectual Property outside the scope of
arthroscopic applications, and (b) the distribution rights for any
applications of Borrower's Intellectual Property outside of the United
States; or (iv) Transfers of worn-out or obsolete equipment (in which
case Bank will, upon Borrower's request, execute a partial release of
lien with respect thereto).
7.2 Change in Business. Engage in any business, or
permit any of its Subsidiaries to engage in any business, other than
the businesses currently engaged in by Borrower and any business
substantially similar or related thereto (or incidental thereto), or
suffer a material change in Borrower's ownership in any single or
related series of transactions of more than 25%. Borrower will not,
without thirty (30) days prior written notification to Bank, relocate
its chief executive office.
7.3 Mergers or Acquisitions. Merge or consolidate, or
permit any of its Subsidiaries to merge or consolidate, with or into
any other business organization, or acquire, or permit any of its
Subsidiaries to acquire, all or substantially all of the capital stock
or property of another Person.
7.4 Indebtedness. Create, incur, assume or be or remain
liable with respect to any Indebtedness, or permit any Subsidiary so to
do, other than Permitted Indebtedness.
7.5 Encumbrances. Create, incur, assume or suffer to
exist any Lien with respect to any of its property, or assign or
otherwise convey any right to receive income, including the sale of any
Accounts, or permit any of its Subsidiaries so to do, except for
Permitted Liens.
7.6 Distributions. Pay any dividends or make any other
distribution or payment on account of or in redemption, retirement or
purchase of any capital stock, except Borrower may at any time when an
Event of Default is not continuing (or would not exist after giving
effect thereto), repurchase from an officer, director or employee
shares of equity securities of Borrower held by them upon such Person's
termination of employment or rendering of service to Borrower or
pursuant to agreements to which Borrower may be a party.
7.7 Investments. Directly or indirectly acquire or own,
or make any Investment in or to any Person, or permit any of its
Subsidiaries so to do, other than Permitted Investments.
7.8 Transactions with Affiliates. Directly or indirectly
enter into or permit to exist any material transaction with any
Affiliate of Borrower except for transactions that are in the ordinary
course of Borrower's business, upon fair and reasonable terms that are
no less favorable to Borrower than would be obtained in an arm's length
transaction with a nonaffiliated Person.
7.9 Intellectual Property Agreements. Enter into any
agreement with a third party which allows for the creation of a
security interest in Borrower's rights and interests in any
intellectual property or the proceeds for the benefit of a third party.
7.10 Subordinated Debt. Make any payment in respect of
any Subordinated Debt, or permit any of its Subsidiaries to make any
such payment, except in compliance with the terms of such Subordinated
Debt, or amend any provision contained in any documentation relating to
the Subordinated Debt without Bank's prior written consent.
7.11 Inventory. Store the Inventory with a bailee,
warehouseman, or similar party unless Bank has received a pledge of the
warehouse receipt covering such Inventory. Except for Inventory sold
in the ordinary course of business and except for such other locations
as Bank may approve in writing, Borrower shall keep the Inventory only
at the location set forth in Section 10 hereof or on the Schedule, and
such other locations of which Borrower gives Bank prior written notice
and as to which Borrower signs and files a financing statement where
needed to perfect Bank's security interest.
7.12 Compliance. Become an "investment company" or be
controlled by an "investment company," within the meaning of the
Investment Company Act of 1940, or become principally engaged in, or
undertake as one of its important activities, the business of extending
credit for the purpose of purchasing or carrying margin stock, or use
the proceeds of any Advance for such purpose. Fail to meet the minimum
funding requirements of ERISA, permit a Reportable Event or Prohibited
Transaction, as defined in ERISA, to occur, fail to comply in a
material respect with the Federal Fair Labor Standards Act or violate
any law or regulation, which violation could have a Material Adverse
Effect or a material adverse effect on the Collateral or the priority
of Bank's Lien on the Collateral, or permit any of its Subsidiaries to
do any of the foregoing.
8. EVENTS OF DEFAULT
Any one or more of the following events shall constitute an
Event of Default by Borrower under this Agreement:
8.1 Payment Default. If Borrower fails to pay when due,
any of the Obligations;
8.2 Covenant Default. If Borrower fails to perform any
obligation under Article 6 or violates any of the covenants contained
in Article 7 of this Agreement, or fails or neglects to perform, keep,
or observe any other material term, provision, condition, covenant, or
agreement contained in this Agreement, in any of the Loan Documents, or
in any other present or future agreement between Borrower and Bank and
as to any default under such other term, provision, condition, covenant
or agreement that can be cured, has failed to cure such default within
ten (10) days after Borrower receives notice thereof or any officer of
Borrower becomes aware thereof; provided, however, that if the default
cannot by its nature be cured within the ten (10) day period or cannot
after diligent attempts by Borrower be cured within such ten (10) day
period, and such default is likely to be cured within a reasonable
time, then Borrower shall have an additional reasonable period (which
shall not in any case exceed thirty (30) days) to attempt to cure such
default, and within such reasonable time period the failure to have
cured such default shall not be deemed an Event of Default (provided
that no Advances will be required to be made during such cure period);
8.3 Material Adverse Change. If there occurs a material
adverse change in Borrower's business or financial condition, or if
there is a material impairment of the prospect of repayment of any
portion of the Obligations or a material impairment of the value or
priority of Bank's security interests in the Collateral;
8.4 Attachment. If any material portion of Borrower's
assets is attached, seized, subjected to a writ or distress warrant, or
is levied upon, or comes into the possession of any trustee, receiver
or person acting in a similar capacity and such attachment, seizure,
writ or distress warrant or levy has not been removed, discharged or
rescinded within twenty (20) days, or if Borrower is enjoined,
restrained, or in any way prevented by court order from continuing to
conduct all or any material part of its business affairs, or if a
judgment or other claim becomes a lien or encumbrance upon any material
portion of Borrower's assets, or if a notice of lien, levy, or
assessment is filed of record with respect to any of Borrower's assets
by the United States Government, or any department, agency, or
instrumentality thereof, or by any state, county, municipal, or
governmental agency, and the same is not paid within twenty (20) days
after Borrower receives notice thereof, provided that none of the
foregoing shall constitute an Event of Default where such action or
event is stayed or an adequate bond has been posted pending a good
faith contest by Borrower (provided that no Advances will be required
to be made during such cure period);
8.5 Insolvency. If Borrower becomes insolvent, or if an
Insolvency Proceeding is commenced by Borrower, or if an Insolvency
Proceeding is commenced against Borrower and is not dismissed or stayed
within thirty (30) days (provided that no Advances will be made prior
to the dismissal of such Insolvency Proceeding);
8.6 Other Agreements. If there is a default in any
agreement to which Borrower is a party with a third party or parties
resulting in a right by such third party or parties, whether or not
exercised, to accelerate the maturity of any Indebtedness in an amount
in excess of One Hundred Thousand Dollars ($100,000) or that could
reasonably be expected to have a Material Adverse Effect;
8.7 Subordinated Debt. If Borrower makes any payment on
account of Subordinated Debt, except to the extent such payment is
allowed under any subordination agreement entered into with Bank;
8.8 Judgments. If a judgment or judgments for the
payment of money in an amount, individually or in the aggregate, of (i)
more than One Million Dollars ($1,000,000) whether or not covered by
Borrower's insurance company, or (ii) less than One Million Dollars
($1,000,000) but not covered or contested by Borrower's insurance
company, shall be rendered against Borrower and shall remain
unsatisfied and unstayed for a period of twenty (20) days (provided
that no Advances will be made prior to the satisfaction or stay of such
judgment). Notwithstanding the foregoing, it shall not be an Event of
Default under this Section 8.8 if Borrower suffers one (but no more
than one) adverse judgment in a products liability action provided
Borrower's insurance company confirms that all damages arising out of
such judgment will be promptly paid without contest by such insurance
company; or
8.9 Misrepresentations. If any material written
misrepresentation or material written misstatement exists now or
hereafter in any warranty or representation set forth herein or in any
certificate delivered to Bank by any Responsible Officer pursuant to
this Agreement or to induce Bank to enter into this Agreement or any
other Loan Document.
9. Bank's RIGHTS AND REMEDIES
9.1 Rights and Remedies. Upon the occurrence and during
the continuance of an Event of Default, Bank may, at its election,
without notice of its election and without demand, do any one or more
of the following, all of which are authorized by Borrower:
(a) Declare all Obligations, whether evidenced by
this Agreement, by any of the other Loan Documents, or otherwise,
immediately due and payable (provided that upon the occurrence of an
Event of Default described in Section 8.5 all Obligations shall become
immediately due and payable without any action by Bank);
(b) Cease advancing money or extending credit to or
for the benefit of Borrower under this Agreement or under any other
agreement between Borrower and Bank;
(c) Settle or adjust disputes and claims directly
with account debtors for amounts, upon terms and in whatever order that
Bank reasonably considers advisable;
(d) Make such payments and do such acts as Bank
considers necessary or reasonable to protect its security interest in
the Collateral. Borrower agrees to assemble the Collateral if Bank so
requires, and to make the Collateral available to Bank as Bank may
designate. Borrower authorizes Bank to enter the premises where the
Collateral is located, to take and maintain possession of the
Collateral, or any part of it, and to pay, purchase, contest, or
compromise any encumbrance, charge, or lien which in Bank's
determination appears to be prior or superior to its security interest
and to pay all expenses incurred in connection therewith. With respect
to any of Borrower's owned premises, Borrower hereby grants Bank a
license to enter into possession of such premises and to occupy the
same, without charge, in order to exercise any of Bank's rights or
remedies provided herein, at law, in equity, or otherwise;
(e) Set off and apply to the Obligations any and
all (i) balances and deposits of Borrower held by Bank, or
(ii) indebtedness at any time owing to or for the credit or the account
of Borrower held by Bank;
(f) Ship, reclaim, recover, store, finish,
maintain, repair, prepare for sale, advertise for sale, and sell (in
the manner provided for herein) the Collateral. Bank is hereby granted
a license or other right, solely pursuant to the provisions of this
Section 9.1, to use, without charge, Borrower's labels, patents,
copyrights, rights of use of any name, trade secrets, trade names,
trademarks, service marks, and advertising matter, or any property of a
similar nature, as it pertains to the Collateral, in completing
production of, advertising for sale, and selling any Collateral and, in
connection with Bank's exercise of its rights under this Section 9.1,
Borrower's rights under all licenses and all franchise agreements shall
inure to Bank's benefit;
(g) Sell the Collateral at either a public or
private sale, or both, by way of one or more contracts or transactions,
for cash or on terms, in such manner and at such places (including
Borrower's premises) as is commercially reasonable, and apply any
proceeds to the Obligations in whatever manner or order Bank deems
appropriate;
(h) Bank may credit bid and purchase at any public
sale; and
(i) Any deficiency that exists after disposition of
the Collateral as provided above will be paid immediately by Borrower.
9.2 Power of Attorney. Effective only upon the
occurrence and during the continuance of an Event of Default, Borrower
hereby irrevocably appoints Bank (and any of Bank's designated
officers, or employees) as Borrower's true and lawful attorney to:
(a) send requests for verification of Accounts or notify account
debtors of Bank's security interest in the Accounts; (b) endorse
Borrower's name on any checks or other forms of payment or security
that may come into Bank's possession; (c) sign Borrower's name on any
invoice or bill of lading relating to any Account, drafts against
account debtors, schedules and assignments of Accounts, verifications
of Accounts, and notices to account debtors; (d) make, settle, and
adjust all claims under and decisions with respect to Borrower's
policies of insurance; (e) settle and adjust disputes and claims
respecting the accounts directly with account debtors, for amounts and
upon terms which Bank determines to be reasonable; (f) to dispose of
the Collateral; (g) to file, in its sole discretion, one or more
financing or continuation statements and amendments thereto, relative
to any of the Collateral without the signature of Borrower where
permitted by law; and (h) to transfer the Intellectual Property into
the name of Bank or a third party to the extent permitted under the
California Uniform Commercial Code; provided Bank may exercise such
power of attorney to sign the name of Borrower on any of the documents
described in Section 4.2 regardless of whether an Event of Default has
occurred. The appointment of Bank as Borrower's attorney in fact, and
each and every one of Bank's rights and powers, being coupled with an
interest, is irrevocable until all of the Obligations have been fully
repaid and performed and Bank's obligation to provide advances
hereunder is terminated.
9.3 Accounts Collection. Upon the occurrence and during
the continuance of an Event of Default, Bank may notify any Person
owing funds to Borrower of Bank's security interest in such funds and
verify the amount of such Account. Borrower shall collect all amounts
owing to Borrower for Bank, receive in trust all payments as Bank's
trustee, and immediately deliver such payments to Bank in their
original form as received from the account debtor, with proper
endorsements for deposit.
9.4 Bank Expenses. If Borrower fails to pay any amounts
or furnish any required proof of payment due to third persons or
entities, as required under the terms of this Agreement, then Bank may
do any or all of the following: (a) make payment of the same or any
part thereof; (b) set up such reserves under the Revolving Facility as
Bank deems necessary to protect Bank from the exposure created by such
failure; or (c) obtain and maintain insurance policies of the type
discussed in Section 6.6 of this Agreement, and take any action with
respect to such policies as Bank reasonably deems prudent. Any amounts
so paid or deposited by Bank shall constitute Bank Expenses, shall be
immediately due and payable, and shall bear interest at the then
applicable rate hereinabove provided, and shall be secured by the
Collateral. Any payments made by Bank shall not constitute an
agreement by Bank to make similar payments in the future or a waiver by
Bank of any Event of Default under this Agreement. Bank shall have a
non-exclusive, royalty-free license to use the Intellectual Property to
the extent reasonably necessary to permit Bank to exercise its rights
and remedies upon the occurrence of an Event of Default.
9.5 Bank's Liability for Collateral. So long as Bank
complies with reasonable banking practices, Bank shall not in any way
or manner be liable or responsible for: (a) the safekeeping of the
Collateral; (b) any loss or damage thereto occurring or arising in any
manner or fashion from any cause; (c) any diminution in the value
thereof; or (d) any act or default of any carrier, warehouseman,
bailee, forwarding agency, or other person whomsoever. All risk of
loss, damage or destruction of the Collateral shall be borne by
Borrower.
9.6 Remedies Cumulative. Bank's rights and remedies
under this Agreement, the Loan Documents, and all other agreements
shall be cumulative. Bank shall have all other rights and remedies not
inconsistent herewith as provided under the Code, by law, or in equity.
No exercise by Bank of one right or remedy shall be deemed an election,
and no waiver by Bank of any Event of Default on Borrower's part shall
be deemed a continuing waiver. No delay by Bank shall constitute a
waiver, election, or acquiescence by it. No waiver by Bank shall be
effective unless made in a written document signed on behalf of Bank
and then shall be effective only in the specific instance and for the
specific purpose for which it was given.
9.7 Demand; Protest. Borrower waives demand, protest,
notice of protest, notice of default or dishonor, notice of payment and
nonpayment, notice of any default, nonpayment at maturity, release,
compromise, settlement, extension, or renewal of accounts, documents,
instruments, chattel paper, and guarantees at any time held by Bank on
which Borrower may in any way be liable.
10. NOTICES
Unless otherwise provided in this Agreement, all notices or
demands by any party relating to this Agreement or any other agreement
entered into in connection herewith shall be in writing and (except for
financial statements and other informational documents which may be
sent by first-class mail, postage prepaid) shall be personally
delivered or sent by a recognized overnight delivery service, certified
mail, postage prepaid, return receipt requested, or by telefacsimile to
Borrower or to Bank, as the case may be, at its addresses set forth
below:
If to Borrower:
ARTHROCARE CORPORATION
595 North Pastoria Avenue
Sunnyvale, CA 94086
Attn: Christine Hanni
FAX: (408) 530-9143
with a copy to:
Latham & Watkins
505 Montgomery Street, Suite 1900
San Francisco, CA 94111-2562
Attn: Warren Lilien
FAX: (415) 395-8095
If to Bank:
Silicon Valley Bank
3003 Tasman Drive
Santa Clara, CA 95054
Attn: Lois Fisher
FAX: (408) 654-1045
Any notice delivered or sent to Borrower shall be effective
notwithstanding a failure to deliver or send a copy of such notice to
Borrower's counsel or any other person. The parties hereto may change
the address at which they are to receive notices hereunder, by notice
in writing in the foregoing manner given to the other.
11. CHOICE OF LAW AND VENUE; JURY TRIAL WAIVER
The Loan Documents shall be governed by, and construed in
accordance with, the internal laws of the State of California, without
regard to principles of conflicts of law. Each of Borrower and Bank
hereby submits to the exclusive jurisdiction of the state and Federal
courts located in the County of Santa Clara, State of California.
BORROWER AND BANK EACH HEREBY WAIVE THEIR RESPECTIVE RIGHTS TO A JURY
TRIAL OF ANY CLAIM OR CAUSE OF ACTION BASED UPON OR ARISING OUT OF ANY
OF THE LOAN DOCUMENTS OR ANY OF THE TRANSACTIONS CONTEMPLATED THEREIN,
INCLUDING CONTRACT CLAIMS, TORT CLAIMS, BREACH OF DUTY CLAIMS, AND ALL
OTHER COMMON LAW OR STATUTORY CLAIMS. EACH PARTY RECOGNIZES AND AGREES
THAT THE FOREGOING WAIVER CONSTITUTES A MATERIAL INDUCEMENT FOR IT TO
ENTER INTO THIS AGREEMENT. EACH PARTY REPRESENTS AND WARRANTS THAT IT
HAS REVIEWED THIS WAIVER WITH ITS LEGAL COUNSEL AND THAT IT KNOWINGLY
AND VOLUNTARILY WAIVES ITS JURY TRIAL RIGHTS FOLLOWING CONSULTATION
WITH LEGAL COUNSEL.
12. GENERAL PROVISIONS
12.1 Successors and Assigns. This Agreement shall bind
and inure to the benefit of the respective successors and permitted
assigns of each of the parties; provided, however, that neither this
Agreement nor any rights hereunder may be assigned by Borrower without
Bank's prior written consent, which consent may be granted or withheld
in Bank's sole discretion. Bank shall have the right without the
consent of or notice to Borrower to sell, transfer, negotiate, or grant
participation in all or any part of, or any interest in, Bank's
obligations, rights and benefits hereunder to any commercial lender or
financial institution.
12.2 Indemnification. Borrower shall defend, indemnify
and hold harmless Bank and its officers, employees, and agents against:
(a) all obligations, demands, claims, and liabilities claimed or
asserted by any other party in connection with the transactions
contemplated by the Loan Documents; and (b) all losses or Bank Expenses
in any way suffered, incurred, or paid by Bank as a result of or in any
way arising out of, following, or consequential to transactions between
Bank and Borrower whether under the Loan Documents, or otherwise
(including without limitation reasonable attorneys fees and expenses),
except for losses caused by Bank's gross negligence or willful
misconduct.
12.3 Time of Essence. Time is of the essence for the
performance of all obligations set forth in this Agreement.
12.4 Severability of Provisions. Each provision of this
Agreement shall be severable from every other provision of this
Agreement for the purpose of determining the legal enforceability of
any specific provision.
12.5 Amendments in Writing, Integration. This Agreement
cannot be amended or terminated orally. All prior agreements,
understandings, representations, warranties, and negotiations between
the parties hereto with respect to the subject matter of this
Agreement, if any, are merged into this Agreement and the Loan
Documents.
12.6 Counterparts. This Agreement may be executed in any
number of counterparts and by different parties on separate
counterparts, each of which, when executed and delivered, shall be
deemed to be an original, and all of which, when taken together, shall
constitute but one and the same Agreement.
12.7 Survival. All covenants, representations and
warranties made in this Agreement shall continue in full force and
effect so long as any Obligations remain outstanding. The obligations
of Borrower to indemnify Bank with respect to the expenses, damages,
losses, costs and liabilities described in Section 12.2 shall survive
until all applicable statute of limitations periods with respect to
actions that may be brought against Bank have run.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement
to be executed as of the date first above written.
ARTHROCARE CORPORATION
By:
Title:
SILICON VALLEY BANK
By:
Title:
EXHIBIT A
The Collateral shall consist of all right, title and interest of
Borrower in and to the following:
(a) All goods and equipment now owned or hereafter acquired,
including, without limitation, all machinery, fixtures, vehicles
(including motor vehicles and trailers), and any interest in any of the
foregoing, and all attachments, accessories, accessions, replacements,
substitutions, additions, and improvements to any of the foregoing,
wherever located;
(b) All inventory, now owned or hereafter acquired, including,
without limitation, all merchandise, raw materials, parts, supplies,
packing and shipping materials, work in process and finished products
including such inventory as is temporarily out of Borrower's custody or
possession or in transit and including any returns upon any accounts or
other proceeds, including insurance proceeds, resulting from the sale
or disposition of any of the foregoing and any documents of title
representing any of the above, and Borrower's Books relating to any of
the foregoing;
(c) All contract rights and general intangibles now owned or
hereafter acquired, including, without limitation, goodwill, leases,
license agreements, franchise agreements, blueprints, drawings,
purchase orders, customer lists, route lists, infringements, claims,
computer programs, computer discs, computer tapes, literature, reports,
catalogs, design rights, income tax refunds, payments of insurance and
rights to payment of any kind;
(d) All now existing and hereafter arising accounts, contract
rights, royalties, license rights and all other forms of obligations
owing to Borrower arising out of the sale or lease of goods, the
licensing of technology or the rendering of services by Borrower,
whether or not earned by performance, and any and all credit insurance,
guaranties, and other security therefor, as well as all merchandise
returned to or reclaimed by Borrower and Borrower's Books relating to
any of the foregoing;
(e) All documents, cash, deposit accounts, securities, letters
of credit, certificates of deposit, instruments and chattel paper now
owned or hereafter acquired and Borrower's Books relating to the
foregoing; and
(f) Any and all claims, rights and interests in any of the
above and all substitutions for, additions and accessions to and
proceeds thereof.
Notwithstanding the foregoing, the Collateral shall not be deemed to
include any copyright rights, copyright applications, copyright
registrations and like protections in each work of authorship and
derivative work thereof, whether published or unpublished, now owned or
hereafter acquired; any patents, patent applications and like
protections including without limitation improvements, divisions,
continuations, renewals, reissues, extensions and continuations-in-part
of the same, trademarks, servicemarks and applications therefor,
whether registered or not, and the goodwill of the business of Borrower
connected with and symbolized by such trademarks, any trade secret
rights, including any rights to unpatented inventions, know-how,
operating manuals, license rights and agreements and confidential
information, now owned or hereafter acquired; or any claims for damages
by way of any past, present and future infringement of any of the
foregoing (collectively, the "Intellectual Property"), except that the
Collateral shall include the proceeds of all the Intellectual Property
that are accounts, i.e. accounts receivable, of Borrower; and, to the
extent that the Company is in default of this Agreement, if a judicial
authority (including a U.S. Bankruptcy Court) holds that a security
interest in the underlying Intellectual Property is necessary to have a
security interest in such accounts of Borrower that are proceeds of the
Intellectual Property, then the Collateral shall include the
Intellectual Property solely to the extent necessary to permit
perfection of Bank's security interest in such accounts of Borrower
that are proceeds of the Intellectual Property.
EXHIBIT B
LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM
DEADLINE FOR SAME DAY PROCESSING IS 3:00 P.M., P.S.T.
TO: CENTRAL CLIENT SERVICE DIVISION DATE:
FAX#: (408) 496-2426 TIME:
FROM:
CLIENT NAME (BORROWER)
REQUESTED BY:
AUTHORIZED SIGNER'S NAME
AUTHORIZED SIGNATURE:
PHONE NUMBER:
FROM ACCOUNT # TO ACCOUNT #
REQUESTED TRANSACTION TYPE REQUEST DOLLAR AMOUNT
PRINCIPAL INCREASE (ADVANCE) $
PRINCIPAL PAYMENT (ONLY) $
INTEREST PAYMENT (ONLY) $
PRINCIPAL AND INTEREST (PAYMENT) $
OTHER INSTRUCTIONS:
All representations and warranties of Borrower stated in the Loan and
Security Agreement are true, correct and complete in all material respects
as of the date of the telephone request for and Advance confirmed by this
Borrowing Certificate; provided, however, that those representations and
warranties expressly referring to another date shall be true, correct and
complete in all material respects as of such date.
BANK USE ONLY
TELEPHONE REQUEST:
The following person is authorized to request the loan payment transfer
/loan advance on the advance designated account and is known to me.
Authorized Requester
Received By (Bank)
Authorized Signature (Bank)
EXHIBIT C
BORROWING BASE CERTIFICATE
Borrower: ARTHROCARE CORPORATION Lender: SILICON VALLEY BANK
Commitment Amount: $7,000,000
ACCOUNTS RECEIVABLE
1. Accounts Receivable Book Value as of $
2. Additions (please explain on reverse) $
3. TOTAL ACCOUNTS RECEIVABLE $
ACCOUNTS RECEIVABLE DEDUCTIONS (without duplication)
4. Amounts over 90 days due
5. Balance of 50% over 90 day accounts
6. Concentration Limits
(account balances>25% of Total Accounts Receivable) $
7. Foreign Accounts
8. Governmental Accounts
9. Contra Accounts
10. Demo Accounts
11. Intercompany/Employee Accounts
12. Other (please explain on reverse)
13. TOTAL ACCOUNTS RECEIVABLE DEDUCTIONS $
14. Eligible Accounts (#3 minus #13) $
15. LOAN VALUE OF ACCOUNTS (80% of #14) $
BALANCES
16. Maximum Loan Amount $7,000,000
17. Total Funds Available [Lesser of #15 or #16] $
18. Present balance owing on Line of Credit $
19. Outstanding under Sublimits (if any) $
20. RESERVE POSITION (#17 minus #18 and #19) $
The undersigned represents and warrants that the foregoing is true,
complete and correct, and that the information reflected in this
Borrowing Base Certificate complies with the representations and
warranties set forth in the Loan and Security Agreement between the
undersigned and Silicon Valley Bank.
COMMENTS:
ARTHROCARE CORPORATION
By:
Authorized Signer
EXHIBIT D
COMPLIANCE CERTIFICATE
TO: SILICON VALLEY BANK
FROM: ARTHROCARE CORPORATION
The undersigned authorized officer of ARTHROCARE CORPORATION
hereby certifies that in accordance with the terms and conditions of
the Loan and Security Agreement between Borrower and Bank (the
"Agreement"), (i) Borrower is in complete compliance for the period
ending _______________ with all required covenants except as noted
below and (ii) all representations and warranties of Borrower stated in
the Agreement are true and correct in all material respects as of the
date hereof. Attached herewith are the required documents supporting
the above certification. The Officer further certifies that these are
prepared in accordance with Generally Accepted Accounting Principles
(GAAP) and are consistently applied from one period to the next except
as explained in an accompanying letter or footnotes.
Please indicate compliance status by circling Yes/No under "Complies"
column.
Reporting Covenant Required Complies
Monthly financial statements and Compliance Monthly
within 30 days Yes No
Certificate
Annual (CPA Audited) FYE within 90 days Yes No
A/R & A/P Agings Monthly within 30 days Yes No
A/R Audit Semi-Annually Yes No
10Q & 10K Within 5 days after filing Yes No
Financial Covenant Required Actual Complies
Quarterly unless stated otherwise:
Minimum Quick Ratio (monthly) 1.00:1.00 _____:1.0 Yes No
Tangible Net Worth $20,000,000 $_____ Yes No
Profitability $1.00 $_____: Yes No
Maximum Debt-TNW 0.75:1.00 _____:1.0 Yes No
BANK USE ONLY
Received by:
AUTHORIZED SIGNER
Date:
Verified:
AUTHORIZED SIGNER
Date:
Compliance Status: Yes No
Comments Regarding Exceptions: See Attached.
Sincerely,
SIGNATURE
TITLE
DAT
DISBURSEMENT REQUEST AND AUTHORIZATION
Borrower: ARTHROCARE CORPORATION
Bank: Silicon Valley Bank
LOAN TYPE. This is a Variable Rate revolving line of credit up to
$7,000,000.
PRIMARY PURPOSE OF LOAN. The primary purpose of this loan is for
business.
SPECIFIC PURPOSE. The specific purpose of this loan is: Short Term
Working Capital.
DISBURSEMENT INSTRUCTIONS. Borrower understands that no loan proceeds
will be disbursed until all of Bank's conditions for making the loan
have been satisfied. Please disburse the loan proceeds as follows:
Revolver
Amount paid to Borrower directly:
$
Undisbursed Funds
$
Principal
$7,000,000
CHARGES PAID IN CASH. Borrower has paid or will pay in cash as agreed
the following charges:
Charges Paid in Cash:
$17,500 Loan Fee
$TBD Outside Counsel Fees and Expenses
Total Charges Paid in Cash:
$___________
AUTOMATIC PAYMENTS. Borrower hereby authorizes Bank automatically to
deduct from Borrower's account numbered _____________ the amount of any
loan payment. If the funds in the account are insufficient to cover
any payment, Bank shall not be obligated to advance funds to cover the
payment.
FINANCIAL CONDITION. BY SIGNING THIS AUTHORIZATION, BORROWER
REPRESENTS AND WARRANTS TO BANK THAT THE INFORMATION PROVIDED ABOVE IS
TRUE AND CORRECT AND THAT THERE HAS BEEN NO ADVERSE CHANGE IN
Borrower's FINANCIAL CONDITION AS DISCLOSED IN Borrower's MOST RECENT
FINANCIAL STATEMENT TO BANK. THIS AUTHORIZATION IS DATED AS OF JUNE
11, 1999.
BORROWER:
ARTHROCARE CORPORATION
Authorized Officer
AGREEMENT TO PROVIDE INSURANCE
Grantor: ARTHROCARE CORPORATION Bank: Silicon Valley
Bank
INSURANCE REQUIREMENTS. ARTHROCARE CORPORATION ("Grantor")
understands that insurance coverage is required in connection with the
extending of a loan or the providing of other financial accommodations
to Grantor by Bank. These requirements are set forth in the Loan
Documents. The following minimum insurance coverages must be provided
on the following described collateral (the "Collateral"):
Collateral: All Inventory, Equipment and Fixtures.
Type: All risks, including fire, theft and liability.
Amount: Full insurable value.
Basis: Replacement value.
Endorsements: Loss payable clause to Bank with
stipulation that coverage will not be cancelled
or diminished without a minimum of twenty (20)
days' prior written notice to Bank.
INSURANCE COMPANY. Grantor may obtain insurance from any
insurance company Grantor may choose that is reasonably acceptable to
Bank. Grantor understands that credit may not be denied solely because
insurance was not purchased through Bank.
FAILURE TO PROVIDE INSURANCE. Grantor agrees to deliver to Bank,
on or before closing, evidence of the required insurance as provided
above, with an effective date of June 11, 1999, or earlier. Grantor
acknowledges and agrees that if Grantor fails to provide any required
insurance or fails to continue such insurance in force, Bank may do so
at Grantor's expense as provided in the Loan and Security Agreement.
The cost of such insurance, at the option of Bank, shall be payable on
demand or shall be added to the indebtedness as provided in the
security document. GRANTOR ACKNOWLEDGES THAT IF BANK SO PURCHASES ANY
SUCH INSURANCE, THE INSURANCE WILL PROVIDE LIMITED PROTECTION AGAINST
PHYSICAL DAMAGE TO THE COLLATERAL, UP TO THE BALANCE OF THE LOAN;
HOWEVER, GRANTOR'S EQUITY IN THE COLLATERAL MAY NOT BE INSURED. IN
ADDITION, THE INSURANCE MAY NOT PROVIDE ANY PUBLIC LIABILITY OR
PROPERTY DAMAGE INDEMNIFICATION AND MAY NOT MEET THE REQUIREMENTS OF
ANY FINANCIAL RESPONSIBILITY LAWS.
AUTHORIZATION. For purposes of insurance coverage on the
Collateral, Grantor authorizes Bank to provide to any person (including
any insurance agent or company) all information Bank deems appropriate,
whether regarding the Collateral, the loan or other financial
accommodations, or both.
GRANTOR ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS
AGREEMENT TO PROVIDE INSURANCE AND AGREES TO ITS TERMS. THIS AGREEMENT
IS DATED JUNE 11, 1999.
GRANTOR:
ARTHROCARE CORPORATION
x
Authorized Officer
FOR BANK USE ONLY
INSURANCE VERIFICATION
DATE: PHONE:
AGENT'S NAME:
INSURANCE COMPANY:
POLICY NUMBER:
EFFECTIVE DATES:
COMMENTS:
CORPORATE RESOLUTIONS TO BORROW
Borrower: ARTHROCARE CORPORATION
I, the undersigned Secretary or Assistant Secretary of ARTHROCARE
CORPORATION (the "Corporation"), HEREBY CERTIFY that the Corporation
is organized and existing under and by virtue of the laws of the State
of Delaware.
I FURTHER CERTIFY that attached hereto as Attachments 1 and 2 are
true and complete copies of the Certificate of Incorporation and Bylaws
of the Corporation, each of which is in full force and effect on the
date hereof.
I FURTHER CERTIFY that at a meeting of the Directors of the
Corporation, duly called and held, at which a quorum was present and
voting (or by other duly authorized corporate action in lieu of a
meeting), the following resolutions were adopted.
BE IT RESOLVED, that any one (1) of the following named officers,
employees, or agents of this Corporation, whose actual signatures are
shown below:
NAMES
POSITIONS
ACTUAL SIGNATURES
acting for an on behalf of this Corporation and as its act and deed be,
and they hereby are, authorized and empowered:
Borrow Money. To borrow from time to time from Silicon Valley
Bank ("Bank"), on such terms as may be agreed upon between the
officers, employees, or agents and Bank, such sum or sums of money as
in their judgment should be borrowed, without limitation, including
such sums as are specified in that certain Loan and Security Agreement
dated as of June 11, 1999, as amended from time to time (the "Loan
Agreement").
Execute Notes. To execute and deliver to Bank the promissory
note or notes of the Corporation, on Lender's forms, at such rates of
interest and on such terms as may be agreed upon, evidencing the sums
of money so borrowed or any indebtedness of the Corporation to Bank,
and also to execute and deliver to Lender one or more renewals,
extensions, modifications, refinancings, consolidations, or
substitutions for one or more of the notes, or any portion of the
notes.
Grant Security. To grant a security interest to Bank in the
Collateral described in the Loan Agreement, which security interest
shall secure all of the Corporation's Obligations, as described in the
Loan Agreement.
Negotiate Items. To draw, endorse, and discount with Bank all
drafts, trade acceptances, promissory notes, or other evidences of
indebtedness payable to or belonging to the Corporation or in which the
Corporation may have an interest, and either to receive cash for the
same or to cause such proceeds to be credited to the account of the
Corporation with Bank, or to cause such other disposition of the
proceeds derived therefrom as they may deem advisable.
Letters of Credit; Foreign Exchange. To execute letters of
credit applications, foreign exchange agreements and other related
documents pertaining to Bank's issuance of letters of credit and
foreign exchange contracts.
Cash Management Services. To enter into that certain Cash
Management Services Agreement by and between Borrower and Bank
authorizing Bank to perform Cash Management Services as defined
therein.
Further Acts. In the case of lines of credit, to designate
additional or alternate individuals as being authorized to request
advances thereunder, and in all cases, to do and perform such other
acts and things, to pay any and all fees and costs, and to execute and
deliver such other documents and agreements as they may in their
discretion deem reasonably necessary or proper in order to carry into
effect the provisions of these Resolutions.
BE IT FURTHER RESOLVED, that any and all acts authorized pursuant
to these resolutions and performed prior to the passage of these
resolutions are hereby ratified and approved, that these Resolutions
shall remain in full force and effect and Bank may rely on these
Resolutions until written notice of their revocation shall have been
delivered to and received by Bank. Any such notice shall not affect
any of the Corporation's agreements or commitments in effect at the
time notice is given.
I FURTHER CERTIFY that the officers, employees, and agents named
above are duly elected, appointed, or employed by or for the
Corporation, as the case may be, and occupy the positions set forth
opposite their respective names; that the foregoing Resolutions now
stand of record on the books of the Corporation; and that the
Resolutions are in full force and effect and have not been modified or
revoked in any manner whatsoever.
IN WITNESS WHEREOF, I have hereunto set my hand on
_______________, 19___ and attest that the signatures set opposite the
names listed above are their genuine signatures.
CERTIFIED TO AND ATTESTED BY:
X
Debtor: ARTHROCARE CORPORATION
Secured Party: Silicon Valley Bank
NEGATIVE PLEDGE AGREEMENT
This Negative Pledge Agreement is made as of June 11, 1999, by
and between ARTHROCARE CORPORATION ("Borrower") and SILICON VALLEY
BANK ("Bank").
In connection with the Loan Documents being concurrently executed
between Borrower and Bank, Borrower agrees as follows:
1. Except as permitted in the Loan Documents and subject to
Permitted Liens, Borrower shall not sell, transfer, assign, mortgage,
pledge, lease, grant a security interest in, or encumber any of
Borrower's intellectual property, including, without limitation, the
following:
a. Any and all copyright rights, copyright applications,
copyright registrations and like protection in each work or authorship
and derivative work thereof, whether published or unpublished and
whether or not the same also constitutes a trade secret, now or
hereafter existing, created, acquired or held (collectively, the
"Copyrights");
b. Any and all trade secrets, and any and all
intellectual property rights in computer software and computer software
products now or hereafter existing, created, acquired or held;
c. Any and all design rights which may be available to
Borrower now or hereafter existing, created, acquired or held;
d. All patents, patent applications and like
protections, including, without limitation, improvements, divisions,
continuations, renewals, reissues, extensions and continuations-in-part
of the same, including, without limitation, the patents and patent
applications (collectively, the "Patents");
e. Any trademark and servicemark rights, whether
registered or not, applications to register and registrations of the
same and like protections, and the entire goodwill of the business of
Borrower connected with and symbolized by such trademarks
(collectively, the "Trademarks");
f. Any and all claims for damages by way of past,
present and future infringements of any of the rights included above,
with the right, but not the obligation, to sue for and collect such
damages for said use or infringement of the intellectual property
rights identified above;
g. All licenses or other rights to use any of the
Copyrights, Patents or Trademarks and all license fees and royalties
arising from such use to the extent permitted by such license or
rights;
h. All amendments, extensions, renewals and extensions
of any of the Copyrights, Patents or Trademarks; and
i. All proceeds and products of the foregoing,
including, without limitation, all payments under insurance or any
indemnity or warranty payable in respect of any of the foregoing.
2. It shall be an Event of Default under the Loan Documents
between Borrower and Bank if there is a breach of any term of this
Negative Pledge Agreement.
3. Capitalized items used herein without definition shall have
the same meanings as set forth in the Loan and Security Agreement of
even date herewith.
ARTHROCARE CORPORATION
By:
Title:
SILICON VALLEY BANK
By:
Title:
<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> 6-MOS
<FISCAL-YEAR-END> JAN-01-2000
<PERIOD-START> JAN-03-1999
<PERIOD-END> JUL-03-1999
<CASH> 2,831
<SECURITIES> 4,316
<RECEIVABLES> 7,380
<ALLOWANCES> 0
<INVENTORY> 7,632
<CURRENT-ASSETS> 22,564
<PP&E> 5,723
<DEPRECIATION> 0
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<CURRENT-LIABILITIES> 4,936
<BONDS> 0
0
0
<COMMON> 9
<OTHER-SE> 24,567
<TOTAL-LIABILITY-AND-EQUITY> 29,764
<SALES> 10,100
<TOTAL-REVENUES> 12,225
<CGS> 4,310
<TOTAL-COSTS> 4,310
<OTHER-EXPENSES> 6,641
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,301
<INCOME-TAX> 54
<INCOME-CONTINUING> 1,301
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,301
<EPS-BASIC> $0.14
<EPS-DILUTED> $0.14
</TABLE>
