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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number
January 2, 1999 0-27422
ARTHROCARE CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3180312
(State or other jurisdiction of (I.R.S. employer identification number)
incorporation or organization)
595 North Pastoria Avenue, Sunnyvale, California 94086
(Address of principal executive offices and zip code)
(408) 736-0224
(Registrant's telephone number, including area code)
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Securities registered pursuant to 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.001 Par Value;
Preferred Share Purchase Rights
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Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 4, 1999, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $94,082,932 (based upon the closing sales
price of such stock as reported by The Nasdaq Stock Market on such date). Shares
of Common Stock held by each officer, director, and holder of 5% or more of the
outstanding Common Stock on that date have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of March 4, 1999, the number of outstanding shares of the Registrants' Common
Stock was 8,991,256.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference from the Registrant's proxy statement for the 1999
Annual Stockholders Meeting (the Proxy Statement) which will be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year ended January 2, 1999.
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PART I
ITEM 1. BUSINESS
This Report on Form 10-K contains certain forward-looking statements
regarding future events with respect to ArthroCare Corporation ("ArthroCare" or
"the company"). Actual events or results could differ materially due to a number
of factors, including those described herein and in the documents incorporated
herein by reference, and those factors described under "Additional Factors that
Might Affect Future Results".
OVERVIEW
ArthroCare develops, manufactures and markets surgical instruments based
on its novel Coblation(TM) technology. ArthroCare's tools enable surgeons to
ablate (remove) or shrink soft tissue and achieve hemostasis (sealing small
bleeding vessels). The company's Coblation-based tools are designed to allow
surgeons to operate on soft tissue with a high degree of precision and accuracy
and with minimal damage to surrounding tissues. The ArthroCare Soft-tissue
Surgery System replaces 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. In March 1995, the Company received
clearance of its 510(k) premarket notification to market the ArthroCare
Arthroscopic System for use in arthroscopic surgery of the knee, shoulder, ankle
and elbow. The company began shipping products for use in arthroscopic surgery
of the shoulder and knee in December 1995. The company has since received
clearance for use in the wrist and hip. In October 1996, it received clearance
of its 510(k) premarket notification for the System 2000 Arthroscopic
Soft-tissue Surgery System for use in arthroscopic surgery of the knee,
shoulder, elbow, ankle, wrist and hip. The company has received 510(k) clearance
for use of its technology in several other fields and has received approval of
an Investigational Device Exemption (IDE) to conduct a clinical study in one
such field which may result in the company submitting a 510(k) application to
the United States Food and Drug Administration (FDA).
During the year ended January 2, 1999, the company formed a new business
division, AngioCare(TM) for the purpose of commercializing the company's
technology in the cardiac and interventional cardiology markets. As part of
those efforts, in February 1998, the company entered into a license and OEM
agreement under which the SciMed division of Boston Scientific Corporation (BSC)
will develop and market products based on the company's Coblation technology for
myocardial revascularization procedures. In April 1998, the company announced
the creation of a new business division, Visage(TM), created for the purpose of
commercializing the company's Cosmetic Surgery System (CSS) for use in
dermatology and cosmetic surgery procedures. In May 1998, the company announced
the creation of a new business division, ENTec(TM), created for the purpose of
commercializing the company's ENT (ear, nose and throat) Surgery System (ESS)
for use in head and neck surgical procedures. With respect to CSS, the company
applied the CE mark for marketing of CSS in Europe for skin resurfacing and
wrinkle reduction procedures and has received 510(k) clearances for use of CSS
in general dermatology procedures in the United States. The company is pursuing
additional clearances that will allow CSS to be marketed in the United States
specifically for wrinkle reduction. With respect to ESS, the company intends to
apply the CE mark certification for marketing in Europe and has received 510(k)
clearances for use of ESS in general head, neck surgical procedures and
functional endoscopic sinus surgery in the United States. In addition, the
company may pursue clearance in other indications.
To date, the company's operations have consisted primarily of research and
development, product engineering, seeking patent approvals on novel technology,
obtaining FDA clearance of its Soft-tissue Surgery Systems, developing a network
of distributors in the United States and abroad to market the Soft-tissue
Surgery Systems, marketing and sales efforts and more than three years of
product sales. The company
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has realized increasing revenues from the sale of its products, but continues to
generate operating losses and anticipates becoming profitable during fiscal
1999. Whether the company can successfully manage the transition to a
larger-scale commercial enterprise will depend upon increasing sales of
disposables from its domestic and international distribution networks, obtaining
additional domestic and international regulatory approvals for the Soft-tissue
Surgery Systems, as well as potential future products and maintaining its
financial and management systems, procedures and controls.
COBLATION TECHNOLOGY
Coblation technology is ArthroCare's patented soft-tissue surgical
technology upon which all the company's products are based (arthroscopy,
cosmetic surgery, ear, nose and throat and cardiology). Coblation technology is
a novel use of radio frequency energy characterized by precision, accuracy, ease
of use and the capability of performing at a temperature lower than current
traditional surgical tools.
Traditional electrosurgical tools rely upon heat to essentially burn away
targeted tissue, which often results in collateral thermal damage to tissue
surrounding the surgical area. While excimer lasers are cooler than other types
of soft-tissue surgical tools, they lack tactile feedback, which make it
difficult for surgeons to control the depth of tissue penetration and can also
lead to collateral tissue damage. Coblation technology employs a lower
temperature process that minimizes the risk of thermal burn while increasing a
surgeon's control and precision.
Coblation technology works through a cool process similar to that of
excimer lasers. It uses the electrically conductive fluid typically employed in
surgeries in the gap between the electrode and tissue. When electrical current
is applied to this fluid, it creates a charged layer of particles, similar to a
plasma layer. Charged particles accelerate through the plasma and gain
sufficient energy to break the molecular bonds within cells as the plasma layer
comes into contact with the tissue. This literally causes the cells to
disintegrate molecule by molecule, so that tissue is volumetrically removed.
Because this effect is confined to the surface layer of the target tissue,
minimal damage occurs to surrounding tissue. An additional advantage is that,
unlike excimer lasers, Coblation can be performed in a continuous mode,
resulting in much more efficient tissue removal.
In addition to achieving more precise tissue removal (or shrinkage) and
less damage to collateral tissue, surgical tools based on Coblation technology
can achieve hemostasis (sealing of small bleeding vessels) near the surgical
site, which reduces bleeding at the site.
Coblation technology is applicable to soft-tissue surgery throughout the
body and the company is continually exploring possibilities for its use in other
non-arthroscopic indications.
The company commercially introduced the Arthroscopic System in December
1995 and by the year ended January 2, 1999, had reported 37 months of sales.
Since the Arthroscopic System accounts for substantially all of the company's
product sales, the company is highly dependent on its sales. The company's CSS
and ESS System have only recently been commercially available, and to date, the
company has sold only a small number of units. No assurance can be given that
the company will be able to manufacture CSS or ESS 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 on a timely basis, if at all, or that the potential
products will ever achieve commercial acceptance.
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THE ARTHROSCOPY MARKET
Historically, severe joint injuries have been treated using open surgery
involving large incisions, a hospital stay and a prolonged recovery period. In
contrast, arthroscopic surgery, which was introduced in the early 1980s, is
performed through several small incisions called portals and can be performed on
an outpatient basis. The company believes that arthroscopic surgery has gained
wide market acceptance because it promises shorter hospital stays and reduced
recovery time.
In 1998, approximately 2.3 million arthroscopic procedures were performed
in the United States. According to industry sources, the number of arthroscopic
procedures is growing due to patient demand for less invasive procedures as well
as the increasing incidence of joint injuries caused by a greater emphasis on
physical fitness and an aging population. Joints are susceptible to injuries
from blows, falls or twisting, as well as from natural deterioration and
stiffening associated with aging.
To perform arthroscopic surgery, a surgeon must use a tool to visualize
the site and other tools to perform the surgery. The tool used to visualize the
site, called an arthroscope, is a small fiber-optic viewing instrument made up
of a small lens, a light source and a video camera, which allows the surgeon to
view the surgical procedure on a video monitor. During the arthroscopic
procedure, an irrigant, such as saline or sterile water, is flushed through the
joint to permit clear visualization through the arthroscope and to create the
space within the joint for the surgical procedure. The surgeon inserts the
arthroscope into the joint through a portal measuring approximately six
millimeters (1/4 of an inch) in length. Other portals are used for the insertion
of surgical instruments to perform the surgery and to facilitate the flow of
irrigants. With small incision sites and direct access to most areas of the
joint, a surgeon can diagnose and correct an array of joint problems such as
cartilage tears, ligament tears and removal of loose and degenerative tissue.
The advantages of arthroscopic surgery over open surgery are often
significant. Due to the smaller incisions and reduced surgical trauma, the
patient might experience several benefits including reduced pain; treatment on
an out-patient basis; reduced or eliminated hospitalization times; immediate
joint mobility and less muscle atrophy; less surrounding tissue damage; lower
rate of complications; and generally quicker rehabilitation. In addition,
treatment on an outpatient basis and reduced operating time can significantly
lower hospital costs.
Knee
The knee is the most commonly injured joint. In 1998, it accounted for
approximately 1.5 million arthroscopic procedures in the United States. Damage
to a meniscus - a pad of cartilage that helps cushion the knee joint - is a
common form of knee injury. A meniscus can be torn by a twist of the leg when
the knee is flexed, displaced either inward toward the center of the tibia
(central shin bone) or outward beyond the surface of the femur (central
thighbone), or worn down by normal aging. The knee is also susceptible to
partial or complete tears of the ligaments and degeneration of the cartilage on
the underside of the patella (kneecap). In addition, the cartilage covering the
bony surfaces of the knee wears down with age and can become rough or tear loose
from the bone, causing pain and interfering with smooth joint movement.
Shoulder
The shoulder joint, because of its range of motion, is susceptible to a
number of injuries. In 1998, approximately 600,000 arthroscopic procedures in
the shoulder were performed in the United States. The company believes that
shoulder arthroscopy is the fastest-growing portion of the arthroscopy market.
With
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repetitive motion and lifting of the arm, such as that which occurs during a
tennis serve, the acromion (the "roof" of bone formed where the scapula, or
shoulder blade, extends over the humerus, the bone of the upper arm) may pinch
one of the shoulder muscles and cause persistent pain, known as a rotator cuff
injury. This condition can be treated by strengthening exercises and
physiotherapy; however, many rotator cuff injuries require surgical
intervention. The company believes that a significant percentage of the
population is born with an acromion that hooks over the humerus, making such
individuals more susceptible to rotator cuff injuries.
Elbow, Ankle, Wrist and Hip
The elbow, ankle, wrist and hip joints are also susceptible to certain
stress-related injuries and deterioration due to aging. In 1998, approximately
342,000 arthroscopic procedures were performed in the elbow, ankle and wrist, in
the United States. The company believes that the current number of surgical
procedures in the elbow, ankle, wrist and hip is relatively small due to the
limitations on conventional arthroscopic surgical equipment.
CONVENTIONAL TREATMENT METHODOLOGIES: THE PROBLEM
Most arthroscopic procedures require the surgeon to probe, cut, sculpt,
shape and cauterize (seal bleeding vessels) to achieve satisfactory results.
Surgeons frequently use a combination of instruments when performing an
arthroscopic procedure because each instrument is designed to perform a specific
function. Use of an assortment of tools requires the surgeon to insert and
remove each of the tools from the portals several times during the same
procedure.
Surgical procedures can employ one or more of four groups of surgical
instruments: (1) power or motorized instruments, such as cartilage and bone
shavers; (2) mechanical instruments, such as basket punches, graspers and
scissors; (3) electrosurgery systems (Bovie); or (4) laser systems.
Power instruments are generally used to smooth tissue and cartilage
defects on the surface of the bones of the joint. The damaged tissue is removed
from the joint using suction through a cannula surrounding the shaft of the
tool, which can become obstructed by bits of tissue and bone. Power shavers have
rotating cutters inside a tube and are not currently available in a wide variety
of tip angles or sizes for the precise shaving of tissue. This prevents power
shavers from being used in many areas of the joint.
Mechanical instruments are used primarily in meniscus removal by snipping
away the unwanted tissue. Because mechanical tools must open and shut to
operate, they cannot be used in small areas such as the back of the knee. In
addition, mechanical tools must be resharpened at regular intervals and
sterilized after each procedure.
Electrosurgery systems are primarily used to achieve hemostasis, which is
necessary to minimize bleeding and maximize the arthroscopic surgeon's
visibility of the procedure through the arthroscope. Bleeding occurs most
commonly in shoulder arthroscopies. Electrosurgical systems contain two
electrodes: the electrode tip held by the surgeon and a dispersive pad that
rests under the patient's body. The metal electrode tip of the instrument, which
resembles a pencil point, is placed on or near the bleeding vessel to be sealed.
A generator connected to the electrode delivers high-frequency voltage that arcs
between the electrode and the target tissue, sealing blood vessels in its
vicinity. After arcing, the current travels through the remaining tissue of the
patient, through the skin to the dispersive electrode pad, before being directed
back to the generator. A non-conductive media such as sterile water is used in
the surgical space so that the electricity is forced into the tissue instead of
into the surrounding fluid. As a result of its conductivity, saline - the
preferred irrigant - cannot be used during the procedure.
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Laser systems are used to ablate tissue while achieving simultaneous
hemostasis. Laser systems are not tactile tools, meaning that the surgeon cannot
feel how much tissue is being ablated. The surgeon must be extensively trained
to precisely position the laser to control the depth of tissue penetration to
minimize unintended tissue damage. In addition, the temperature of the laser
instrument is relatively high and can cause damage to surrounding tissue and
vascular areas. The American Academy of Orthopedic Surgeons (AAOS) has
recommended against the use of such devices in the knee. The company believes
that laser tools have not received wide acceptance because of high cost, lack of
tactile feedback for the surgeon, the required training and certification and
the recommendation of the AAOS.
THE ARTHROCARE ARTHROSCOPIC SYSTEM: A SOLUTION
The company's Arthroscopic System is a high frequency, surgical device
intended to perform tissue ablation and simultaneous hemostasis. The company
sells its Arthroscopic System for use in all six major joints: knee, shoulder,
elbow, ankle, wrist and hip. Tissues such as meniscus, synovium, cartilage and
ligaments can be ablated using the Arthroscopic System. In addition, the
company's capsular shrinkage (CAPS(TM)) wand is used to shrink collagen in
shoulder procedures.
The company's Arthroscopic System is comprised of an array of disposable
bipolar multielectrode and single electrode tools (disposables), a connecting
cable, foot pedal (or switch) and a radio frequency power controller. The System
2000 controller is used to deliver high-frequency power to the disposable. To
ablate different tissues or achieve hemostasis, the surgeon can control the
voltage level using the foot pedal or keys on the front panel of the controller.
The cable connects the System 2000 controller to the disposable. Power is
transmitted through the cable to the disposable by depressing a foot pedal,
thereby enabling surgeons to use the disposable as a conventional probe as well
as an instrument that ablates and achieves hemostasis (cauterizes).
Accordingly, a surgeon using the Arthroscopic System does not need to
remove and insert a variety of instruments to perform different tasks as is
required when using conventional arthroscopic instruments. The disposable is
approved for sale in tip sizes ranging from 1.5 mm to 4.5 mm, and in tip angles
ranging from 0 to 90 degrees. The company currently sells 19 models in various
tip sizes, angles and shapes, enabling the surgeon to ablate different volumes
of tissue and to reach treatment sites not readily accessible by existing
mechanical instruments and motorized cutting tools. In addition, the company
produces disposables such as the CoVac(TM), which combines suction and
Coblation, eliminating the necessity for a shaver in knee arthroscopies.
The company commercially introduced the Arthroscopic System in December
1995 and by the year ended January 2, 1999, had reported 37 months of sales. The
company is marketing and selling its arthroscopic system in the United States
through a network of independent orthopedic distributors and a small direct
sales force. The company has ramped up its manufacturing capabilities, and from
1997 to 1998, it doubled disposable volumes while maintaining yields.
Arthroscopy will account for a substantial portion of the company's
product sales for the near future. Accordingly, the company is highly dependent
on its Arthroscopic System. Additionally, the company's potential products for
non-arthroscopic indications are in various stages of development and
commercialization, and the company may be required to undertake time-consuming
and costly development activities and seek regulatory clearance of these
devices.
Currently, the majority of the company's sales are in the United States.
The company has established distribution capability in Europe, Australia, New
Zealand, Korea, Japan, Taiwan, Canada, Mexico, Caribbean, Russia, South Africa,
the Middle East , Northern Africa and South and Central America. Before
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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.
Physicians will not use the company's products unless they determine,
based on experience, clinical data and other factors, that these systems are an
attractive alternative to conventional means of tissue ablation. No independent
published clinical reports exist to support the company's marketing efforts for
its Arthroscopic Systems, which may have an adverse effect on its ability to
obtain physician acceptance. The company believes that continued recommendations
and endorsements by influential physicians are essential for market acceptance
of its Arthroscopic System. If the Arthroscopic System does not continue to
receive broad-based physician acceptance and endorsement by influential
physicians, the company's business, financial condition and results of
operations could be materially adversely affected.
THE OTORHINOLARYNGOLOGY MARKET
Otorhinolaryngology is the study and treatment of diseases of the ear,
nose, and throat (ENT). Historically, the ENT market relied upon general
surgical techniques to treat disorders. The company believes that the ENT market
is currently transitioning toward performing surgeries less invasively and ENT
surgeons are readily adopting new devices and instruments. To this end, great
strides have been made in the potential use of lasers, endoscopes, and
microsurgery.
According to industry sources, in 1998 approximately 1.4 million ENT
procedures were performed worldwide. Types of procedures performed include:
endoscopic sinus surgery; turbinectomies; tonsillectomy/adeniodectomy; surgical
removal of vocal cord polyps; surgical removal of acoustic neuromas; surgical
removal of facial tumors; and uvulopalatoplaties. The company is currently
evaluating the use of the ENTec Surgical System in these types of procedures.
THE ARTHROCARE ENT SURGERY SYSTEM
In May 1998, the company announced the creation of its new business
division, ENTec, for the purpose of commercializing the company's ENT Surgery
System for use in head and neck surgical procedures. The ENTec Surgery System
utilizes the same technology as the Arthroscopic System, which removes tissue
through a significantly cooler process than that of traditional electrosurgery
lasers. The company's ENTec Surgery System is a high frequency, electrosurgical
device intended to bring a new level of control and functionality to
Otorhinolaryngology. The ENTec Surgery System incorporates a disposable bipolar
device, a connecting cable and radio frequency power controller. The portable
controller is used to deliver high-frequency power to the disposable. The
disposable is intended for single use and utilizes multiple or single electrodes
to ablate tissue while simultaneously achieving hemostasis. The company believes
that its products contain the potential to produce excellent surgical results,
reduce pain and speed recovery when compared with existing techniques.
In June 1998, the company announced that it entered into an exclusive
worldwide marketing and distribution agreement with Xomed Surgical Products
(Xomed) for use in the ENT market. Under the terms of the agreement, ArthroCare
maintained responsibility for product development and manufacturing, while Xomed
assumed sales and marketing functions. The agreement included licensing and
milestone payments, original equipment manufacturer (OEM) sales, and royalties
on sales. The company terminated the agreement in February 1999. Xomed has filed
a claim against the company involving certain issues surrounding its
relationship with the company. See Part 1 Item 3 of this report for a
description of the litigation.
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The company has only recently commercialized its ENT products and will
continue these efforts on its own for the foreseeable future. There can be no
assurance that these products will generate sufficient or sustainable revenues
and may require significant investment in additional clinical evaluation,
regulatory and sales and marketing activities in order for the company to
further its commercialization efforts. Development and commercialization of
medical devices are subject to inherent risks.
THE COSMETIC SURGERY MARKET
Procedures to rejuvenate wrinkled skin and remove acne scaring and early
skin cancer became the most popular cosmetic surgical procedure in the United
States in 1996. These procedures are currently being performed with laser
technology including carbon dioxide and Erbium-YAG lasers. During the healing
process, new collagen is deposited in the skin and it becomes tighter and
smoother. This procedure is done on an outpatient basis with either local or
intravenous anesthesia. The American Academy of Cosmetic Surgeons estimates that
approximately 325,000 resurfacing procedures were performed in the United States
in 1998, with utilization growing at an annual rate of 15 percent over the next
several years.
The conventional continuous wave CO2, or carbon dioxide, laser has been
used successfully to resurface facial skin; however, the risk/benefit ratio is
extremely high and this procedure is not highly utilized. Excessive heat
diffusion into surrounding skin results in unwanted thermal necrosis and
unacceptable rates of scarring and impaired wound healing.
The new generation of pulsed lasers has proven to be an effective method
for the treatment of surface imperfections and irregularities, including
wrinkles, pigmented spots, and acne scars. The pulsed CO2 or carbon dioxide
laser permits precise ablation of tissue, 100 mm to 150 mm per pass, with
minimal accumulation and spread of heat so that minimal thermal damage and char
is seen. With laser resurfacing the target is the superficial portion of the
skin to the level of the upper- to mid-reticular dermis, although the ideal
depth has yet to be determined.
Erbium:YAG lasers are the newest lasers to enter the resurfacing market.
The Erbium:YAG laser system produces laser energy in the infrared spectrum. A
single pass with the Erbium:YAG yields an ablation depth of 20-25 microns.
Subsequent passes again yield approximately the same amount of ablation for each
pass. The reduced thermal injury by the Erbium:YAG permits a faster healing
process. Recent comparative studies indicated that healing time for the
Erbium:YAG treated area may be as much as one third that of the pulsed CO2, or
carbon dioxide, laser. The drawbacks to the Erbuim:YAG laser are the number of
passes required and the vascular bleeding that is associated with its usage.
THE ARTHROCARE COSMETIC SURGERY SYSTEM
In April 1998, the company announced the creation of its new business
division, Visage, for the purpose of commercializing the company's Cosmetic
Surgery System for use in dermatology and cosmetic surgery procedures. The
Cosmetic Surgery System utilizes the same technology as the Arthroscopic System,
which removes tissue through a significantly cooler process than traditional
electrosurgery or dermatologic lasers. The company's Cosmetic Surgery System is
a high frequency, electrosurgical device intended for use in cosmetic surgery to
perform skin resurfacing and other dermatologic and cosmetic procedures. The
Cosmetic Surgery System incorporates a disposable bipolar device, a connecting
resterilizable handpiece with cable and radio frequency power controller. The
controller delivers high-frequency power to the single-use, multi or single
electrode disposable. To enable the achievement of a variety of types of
procedures including skin resurfacing, the physician can adjust the voltage
level of the controller. The company believes its Cosmetic Surgery System will
enable the physician to achieve a similar reduction of wrinkles as the CO2
laser, but with a faster healing process and less pain for the patient.
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The company applied the CE mark for marketing the Cosmetic Surgery System
in Europe for skin resurfacing procedures and has received 510(k) clearance for
use of the system 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 wrinkle removal.
In January 1999, the company entered into an exclusive distribution
agreement (with modification in February 1999) with Collagen Aesthetics, Inc. to
license, market and distribute ArthroCare's Coblation-based products for
cosmetic, dermatologic and aesthetic surgical applications. Under the terms of
the agreement, Collagen is the exclusive worldwide distributor of ArthroCare's
Cosmetic Surgery System. This product has only recently been commercially
introduced and to date, the company has sold only a small number of units, which
have been utilized, by a limited number of doctors. No assurance can be given
that the company will be able to manufacture this system in commercial
quantities at acceptable costs, or that its products will be marketed
successfully.
ARTHROCARE'S PATENTED TECHNOLOGY
All of ArthroCare's Soft-Tissue Surgery Systems are based on the patented
Coblation core technology and are designed to achieve precise ablation of soft
tissue and simultaneous hemostasis while minimizing damage to the surrounding
healthy tissue. The company believes that its Coblation technology, and the
surgical tools the company has built based on this technology, offers several
advantages over other approaches to traditional surgery. The company believes
that Coblation technology enables surgeons to perform ablation, tissue shrinkage
and hemostasis with a single set of tools, with minimal collateral tissue
damage, with high degrees of accuracy and precision, with greater control and
reproducible results and at a lower cost than other surgical alternatives.
Further, the company believes that patients operated on using Coblation-based
surgical tools experience improved outcomes compared to conventional surgical
procedures, characterized by less pain, faster recovery and earlier resumption
of pre-injury activities.
The company's bipolar, multi-electrode and single electrode configurations
and power control systems allow high-frequency electrical energy to be precisely
focused on the surface of the tissue being treated. Using a bipolar probe
eliminates the need to deliver energy through the surgical site to a dispersive
electrode pad located outside the body, because the energy is directed from the
tip of the probe to a return electrode contained on its shaft. The electric
current travels a shorter distance from the active electrode to the target
tissue before returning to the electrode on the shaft, allowing the Soft-tissue
Surgical Systems to operate at lower voltages and at lower temperatures than
conventional monopolar electrosurgical systems.
The energy is concentrated only at the tip of the electrodes of the
disposable. This configuration allows the energy to be focused on the surface
layer of the tissue being ablated, thereby minimizing the risk of unwanted
damage to surrounding healthy tissue. The controller provides power individually
to each of the electrodes at the tip of the disposable, enabling only those
electrodes that come into contact with, or closely adjacent to, tissue to
deliver sufficient energy to ablate tissue. During use, the high frequency
current flows from the controller through each electrode to the tissue,
returning to the controller via the return electrode on the shaft of the
disposable.
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The company's patented Coblation technology, delivered in the form of
multi-electrode, bipolar, electrosurgical tools, offers a number of benefits
that the company believes may provide advantages over competing surgical methods
and devices. The principal benefits include:
o EASE OF USE. The Coblation-based Soft-tissue Surgery Systems perform many
of the functions of mechanical tools, power tools and electrosurgery
instruments, allowing the surgeon to use a single instrument. The
lightweight device is simple to use and complements the surgeon's existing
tactile skills without the need for extensive training.
o PRECISION. In contrast to conventional tools, the Coblation-based
Soft-tissue Surgery Systems permit surgeons to perform more precise tissue
ablation and sculpting. The company believes this may result in more rapid
patient rehabilitation.
o SAFETY. Coblation technology, unlike most electrosurgical tools, does not
work by heating tissue. The company believes that cooler operation can
lead to significant benefits for patients being treated with
Coblation-based surgical tools, in the form of little or no collateral
thermal burning of tissues near the surgical site. As a result, the
company believes that patients are likely to experience less trauma and
pain following surgery and might be able to recover more quickly.
o SIMULTANEOUS ABLATION AND HEMOSTASIS. The Coblation-based Soft-tissue
Surgery Systems efficiently seal small bleeding vessels while in the
hemostasis mode without changing tools.
o COST REDUCTION. The Coblation Soft-tissue Surgery Systems eliminate the
need to introduce multiple instruments to remove and sculpt tissue and
seal small bleeding vessels in arthroscopic procedures. The company
believes this may reduce operating time and thereby produce cost savings
for health care providers.
Despite the benefits of the Soft-tissue Surgery Systems, there can be no
assurance that doctors and surgical centers will buy the System. In order to
secure the benefits of the Soft-tissue Surgery Systems, however, a hospital or
surgical center must procure and use a specifically designed controller to power
the disposable. At hospital sites or surgical centers where several procedures
can be performed simultaneously, the procurement of multiple controllers is
required. To date, the company has placed its arthroscopic controllers at
substantial discounts in order to stimulate demand for its disposables. In
addition, motorized and mechanical instruments, lasers and electrosurgery
systems currently used by hospitals, surgical centers and private physicians
have become widely accepted. If physicians do not determine that the Soft-tissue
Surgery Systems are an attractive alternative to conventional means, the Systems
will not be acceptable, and the company's business, financial condition and
results of operations would be materially adversely affected.
ARTHROCARE STRATEGY
The company's objective is to use its patented Coblation technology to
design, develop, manufacture and sell innovative, clinically superior surgical
devices for the arthroscopic surgical treatment of joint injuries and for the
surgical treatment of other soft-tissue conditions throughout the body. The key
elements of the company's strategy to achieve this objective include:
o CONTINUE TO PENETRATE EXISTING ARTHROSCOPIC SURGICAL INSTRUMENT MARKET.
The company's initial sales efforts are focused on marketing the company's
products to orthopedic surgeons performing high-volume arthroscopy and to
opinion leaders in orthopedic surgery.
o EXPAND INTO NEW ARTHROSCOPIC SURGICAL MARKETS. The company encourages
surgeons to use its Arthroscopic System to treat joints that have been
historically treated by open surgery, such as
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the shoulder, elbow and ankle. Because of the small size, varying shapes
and tactile feel of the company's disposables, the company believes
surgeons will be able to arthroscopically access areas difficult to reach
by conventional arthroscopic surgical tools. In addition, the company has
introduced new products that expand the types of arthroscopic surgical
procedures to which its Coblation technology can be applied. During 1998,
the company introduced five arthroscopy disposable styles. The Eliminator,
Saber, and Covac disposables were designed to be used primarily in knee
procedures and are an example of this expansion. The company also
developed and introduced new disposables for small joint procedures and
for capsular shrinkage procedures.
o EXPAND INTO ADDITIONAL SURGICAL MARKETS. During this year, the company
commercialized its technology in markets other than arthroscopy, including
the ear, nose and throat and cosmetic and dermatologic markets.
o TARGET KEY INTERNATIONAL MARKETS. The company has begun to market its
Arthroscopic System in international markets. The company has signed
agreements with marketing partners to assist with regulatory requirements
and to market and distribute its products in Europe, Japan, Australia, New
Zealand, Korea, Japan, Taiwan, Canada, Mexico, Caribbean, Russia, the
Middle East, North Africa, South and Central America and South Africa.
o LEVERAGE BROADLY APPLICABLE PROPRIETARY TECHNOLOGY. The company plans to
continue to leverage its proprietary Coblation technology by developing
additional products for use in a variety of soft-tissue surgical
procedures.
o STRUCTURE TARGETED STRATEGIES TO COMMERCIALIZE THE PLATFORM TECHNOLOGY.
While the company will continue to focus on the arthroscopy, ENT and
cosmetic surgery fields, it will evaluate, and plans to pursue, additional
applications of its technology in other promising fields. On a
case-by-case basis, ArthroCare will determine the best strategy for
entering these additional markets. In some cases, the company might choose
to establish stable, long-term relationships with strong partners to
address specific fields outside of the ones mentioned above. In select
other areas, the company might bring products to market itself.
Despite the benefits of the company's 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. No independent published clinical reports
exist to support the company's marketing efforts for any of its products, which
may have an adverse effect on its ability to obtain physician acceptance. The
company believes that continued recommendations and endorsements by influential
physicians are essential for market acceptance of its products. If the
Arthroscopic System does not continue to receive broad-based physician
acceptance and endorsement by influential physicians, the company's business,
financial condition and results of operations could be materially adversely
affected. Similarly if the company's recently commercialized or future potential
products do not receive broad-based physicians acceptance and endorsement by
influential physicians, the company's business, financial condition and results
of operations would be materially adversely affected.
DEPENDENCE UPON COLLABORATIVE ARRANGEMENTS
In order to successfully develop and commercialize certain products, the
company may enter into collaborative or licensing arrangements with 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
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company has recently entered into collaborative arrangements with BSC, and
Collagen Aesthetics, Inc. (Collagen). See "Management's Discussion and Analysis
of Financial Condition and Results of Operations- Overview" for a discussion of
these arrangements.
The company's dependence on collaborative and licensing arrangements with
third parties subjects it 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 partners'
ability to meet its obligations under the arrangements. 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 commercialize successfully 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.
RESEARCH AND DEVELOPMENT
The company believes that its core Coblation technology is applicable to a
range of soft-tissue surgical applications that can use a system substantially
the same as its existing system. The company expects to continue to change the
disposable design to accommodate the specific requirements of the indications in
various surgical fields. However, the company believes that the design,
materials and manufacturing methods incorporated into its current products
should be applicable to subsequent products and indications.
The company has undertaken preliminary animal studies and development for
the use of its Coblation technology with its controller in several fields. The
company has received 510(k) clearance for use of its technology in certain of
these fields. The company has received approval of an Investigational Device
Exemption (IDE) to conduct a clinical study on a specific indication. Following
the completion of this study, the company may submit a 510(k) application to the
FDA.
Each of these potential products is in various stages of development, and
the company may be required to undertake time-consuming and costly development
activities and seek regulatory approval of these devices. There can be no
assurance that product development will ever be successfully completed, that
premarket applications (PMA) or 510(k) 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
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material adverse effect on the company's business, financial condition and
results of operations.
MANUFACTURING
The company's manufacturing operations consist of an in-house assembly
operation for the 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.
Manufacture 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 April 1998, the company started manufacturing its System 5000
controllers for cosmetic surgery 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 ENT and cosmetic
surgery applications. As a result, the company has limited experience
manufacturing its current products for ENT and cosmetic surgery 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 and
the connector housings at each end of the cable are supplied from a single
source. There can be no assurance that an alternate sterilizer or connector
housing supplier could be established if necessary or that available inventories
would be adequate to meet the company's production needs during any prolonged
interruption of supply. The company's inability to secure an alternative
sterilizer, if required, would limit its ability to manufacture the company's
Arthroscopic System and would have a material adverse effect on the company's
business, financial condition and results of operations.
Although the company believes that its subcontractors, and component
suppliers are in compliance with applicable regulations, there can be no
assurance that the FDA, or a state, local or international regulator, will not
take action against the subcontractor or a component supplier found to be
violating such regulations.
MARKETING AND SALES
Of the 18,500 orthopedic surgeons in the United States, approximately 80%
perform arthroscopy and approximately 40% consider arthroscopy to be their major
practice area. These 40% of orthopedic surgeons perform an estimated 70% of the
total arthroscopic procedures. In addition to marketing efforts aimed at these
surgeons, the company also recognizes that purchase decisions are greatly
influenced by health care administrators, who are subject to increasing
pressures to reduce costs. Health care administrators must determine that the
company's products are cost-effective alternatives to current means of tissue
ablation.
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The company had shipped more than 4,000 controller units and more than
325,000 disposables by the end of fiscal 1998. The company is marketing and
selling its Arthroscopic System in the United States through a network of
independent orthopedic distributors and a small direct sales force. The company
has more than 40 distributors representing more than 235 field sales
representatives. The distributors are supervised by 5 sales managers who are
employed by the company. The company expects that the network of distributors
will market directly to more than 7,500 orthopedic surgeons who primarily
perform arthroscopic surgery. As of the end of fiscal 1998, the company believes
it has achieved approximately 5% share of the addressable market for knee
procedures and approximately 20% share of the addressable market for shoulder
procedures.
The company's distributors sell orthopedic arthroscopy and ENT devices for
a number of other manufacturers. The company is currently marketing and selling
its ENT Soft-tissue Surgery System through a direct sales force both
domestically and internationally. Collagen is the exclusive, worldwide
distributor for CSS. There can be no assurance that the necessary resources to
effectively market and sell the company's Soft-tissue Surgery Systems, will be
committed and /or available or that efforts will be successful in closing sales
with doctors and hospitals. The company has offered its controller at
substantial discounts in the past and may be required to continue to offer such
discounts to generate demand for its various disposables. The inability to sell
sufficient quantities of disposables would have a material adverse effect on the
company's business, financial condition and results of operations.
If the company is successful in obtaining necessary regulatory approvals
in additional international markets, it expects to establish sales and marketing
capability in those markets. In these international markets, the company intends
to collaborate with one or more marketing partners to establish marketing and
distribution channels for its Soft-tissue Surgery System. However, regulatory
requirements vary by region, and compliance with such regulations may be costly
and time-consuming. Accordingly, the distribution, pricing and marketing
structure to be established by the company may vary from country to country.
No assurance can be given that the company will successfully sell its
product through its current international distributors, that the company will
secure marketing partners for other international markets, that all of its
international distributors and marketing partners will commit the necessary
resources to obtain additional necessary international regulatory approvals on
behalf of the company and successfully sell the Arthroscopic System in
international markets.
PATENTS AND PROPRIETARY RIGHTS
The company's ability to compete effectively depends in part on developing
and maintaining the proprietary aspects of its platform Coblation technology.
The company owns 18 issued United States patents, more than 45 pending United
States patent applications and international patent applications in Europe
(covering 16 separate countries), Japan, Canada, Australia and New Zealand
corresponding to eight of the United States filings relating to its Coblation
technology. The initial patent is currently set to expire in 2008, three issued
patents are currently expected to expire between 2008 and 2012 and the other 14
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 System, including both multielectrode and single-electrode
configurations of its wand tools, as well as the use of Coblation technology in
specific surgical procedures.
The issued patents cover, among other things, systems and methods for
applying radio frequency energy to tissue in the presence of electrically
conductive fluid such as isotonic saline and blood; probes having an electrode
array and a means to supply current independently to individual electrodes; and
systems and methods for employing radio frequency energy in urology, gynecology,
ENT, cosmetic surgery and cardiac procedures (e.g. transmyocardial
revascularization of the heart). The pending patent applications include
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coverage for the fundamental tissue ablation and cutting technology as well as
methods and apparatus for specific procedures.
There can be no assurance that the patents that have been issued to the
company or any patents which may be issued as a result of the company's United
States or international patent applications will provide any competitive
advantages for the company's products or that they will not be successfully
challenged, invalidated or circumvented in the future. In addition, there can be
no assurance that competitors, many of which have substantial resources and have
made substantial investments in competing technologies, will not seek to apply
for and obtain patents that will prevent, limit or interfere with the company's
ability to make, use and sell its products either in the United States or in
international markets.
A number of medical device and other companies, universities and research
institutions have filed patent applications or have issued patents relating to
monopolar and/or bipolar electrosurgical methods and apparatus. If third-party
patents or patent applications contain claims infringed by the company's
technology and such claims are ultimately determined to be valid, there can be
no assurance that the company would be able to obtain licenses to those patents
at a reasonable cost, if at all, or be able to develop or obtain alternative
technology, either of which would have a material adverse effect on the
company's business, financial condition and results of operations. There can be
no assurance that the company will not be obligated to defend itself in court
against allegations of infringement of third-party patents.
In addition to patents, the company relies on trade secrets and
proprietary know-how, which it seeks to protect, in part, through
confidentiality and proprietary information agreements. The company requires its
key employees and consultants to execute confidentiality agreements upon the
commencement of an employment or consulting relationship with the company. These
agreements generally provide that all confidential information, developed or
made known to the individual by the company during the course of the
individual's relationship with the company, is to be kept confidential and not
disclosed to third parties. These agreements also generally provide that
inventions conceived by the individual in the course of rendering services to
the company shall be the exclusive property of the company. There can be no
assurance that such agreements will not be breached, that the company would have
adequate remedies for any breach or that the company's trade secrets will not
otherwise become known to or be independently developed by competitors.
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that the company will not
become subject to patent infringement claims or litigation or interference
proceedings declared by the United States Patent and Trademark Office (USPTO) to
determine the priority of inventions. On February 13, 1998 the company filed a
lawsuit (the Lawsuit) against Ethicon, Inc. Mitek Surgical Products, a division
of Ethicon, Inc. and GyneCare, Inc. alleging among other things, infringement of
several of the company's patents. See Part I, Item 3 "Legal Proceedings" of this
Annual Report on Form 10-K. The defense and prosecution of the Lawsuit and
intellectual property suits generally, USPTO interference proceedings and
related legal and administrative proceedings are both costly and time-consuming.
The company believes that the Lawsuit is necessary and if others violate the
proprietary rights of the company, further litigation may be necessary to
enforce patents issued to the company, to protect trade secrets or know-how
owned by the company or to determine the enforceability, scope and validity of
the proprietary rights of others. Any litigation or interference proceedings
will result in substantial expense to the company and significant diversion of
effort by the company's technical and management personnel. An adverse
determination, 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
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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 replacing older tissue removal technology,
such as laser systems, conventional electrosurgical systems, manual instruments
and power shavers, in arthroscopic procedures. Consequently, the company
competes indirectly with the providers of such tissue removal systems because
the company must convert customers over 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 the face of such
competition. In addition, there can be no assurance that these or other
companies will not succeed in developing technologies and products that are more
effective than the company's or that would render the company's technology or
products obsolete or uncompetitive.
The company believes that its Arthroscopic System, comprising the
controller unit and disposables, presents a competitive pricing structure
compared to alternative tools being used in arthroscopic procedures. The list
price of the controller, including the cable, is approximately $7,000. The
disposable, which can be used by surgeons as a conventional probe as well as to
ablate soft tissue, collagen shrinkage and seal small bleeding vessels, have
list prices ranging from approximately $115-$195. Motorized cutting tools
consist of a power source with list prices of approximately $8,000 to $10,000
and disposable tips, with list prices of approximately $60 to $80. Reusable
mechanical tools have list prices of approximately $150 to $950 and it is not
unusual for 30 (thirty) different shaped tools to be resterilized for each
procedure. Neither motorized nor mechanical tools perform hemostasis, and
therefore additional tools may need to be purchased for that purpose.
Electrosurgical systems, used to stop the bleeding of small blood vessels during
surgery, consist of a power source with list prices of approximately $4,000 to
$9,000 plus a disposable tip with list prices of approximately $40 to $50,
including a single-use, dispersive electrode pad. Electrosurgical systems are
not generally used to cut or remove tissue. Laser systems, with list prices of
approximately $80,000 to $125,000, are used in conjunction with disposable or
reusable tips, with list prices of approximately $60 to $300, to ablate soft
tissue and simultaneously achieve hemostasis.
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 competes directly with the company's tissue ablation and shrinkage
technology 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 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
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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 market in arthroscopy, for the
company's products.
The ENT medical device industry is rapidly becoming more competitive. The
company recently cancelled their 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 11 of this Annual
Report on Form 10-K. However, other large companies, such as Smith & Nephew,
Stryker Corp. and Conmed Corporation each have shares of the market for manual
instruments, such as microdebriders for endoscopic sinus surgery. In addition,
the company faces competition with much larger laser companies, such as ESC
Medical Systems 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 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 and Ellman both
manufacture and sell a variety of medical devices that use conventional RF
technology for tissue desiccation, 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 CO2 or 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 company 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 rejuvenation 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.
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GOVERNMENT REGULATION
United States
The company's products are regulated in the United States as medical
devices by the FDA under the Federal Food, Drug, and Cosmetic Act (FDC Act) and
require premarket clearance or approval by the FDA prior to commercialization.
In addition, certain material changes or modifications to medical devices also
are subject to FDA review and clearance or approval. Pursuant to the FDC Act,
the FDA regulates the research, testing, manufacture, safety, labeling, storage,
record keeping, advertising, distribution and production of medical devices in
the United States. Noncompliance with applicable requirements can result in
warning letters, fines, injunctions, civil penalties, recall or seizure of
products, total or partial suspension of production, failure of the government
to grant premarket clearance or premarket approval for devices, and criminal
prosecution. Failure to comply with the regulatory requirements could have a
material adverse effect on the company's business, financial condition and
results of operations.
If human clinical trials of a device are required and if the device
presents a "significant risk," the manufacturer or the distributor of the device
is required to file an IDE application prior to commencing human clinical
trials. The IDE application must be supported by data, typically including the
results of animal and, possibly, mechanical testing. Sponsors of clinical trials
are permitted to sell investigational devices distributed in the course of the
study, provided such costs do not exceed recovery of the costs of manufacture,
research, development and handling. The clinical trials must be conducted under
the auspices of an independent Institutional Review Board (IRB) established
pursuant to FDA regulations, and with appropriate informed consent of the
patient.
Generally, before a new device can be introduced into the market in the
United States, the manufacturer or distributor must obtain FDA clearance of a
510(k) notification or approval of a PMA application. If a medical device
manufacturer or distributor can establish that a device is "substantially
equivalent" to a legally marketed Class I or Class II device, or to a Class III
device for which FDA has not called for PMAs, the manufacturer or distributor
may seek clearance from FDA to market the device by filing a 510(k)
notification. The 510(k) notification will need to be supported by appropriate
data establishing the claim of substantial equivalence to the satisfaction of
FDA. FDA recently has been requiring a more rigorous demonstration of
substantial equivalence.
Following submission of the 510(k) notification, the manufacturer or
distributor may not place the device into commercial distribution until an order
is issued by the FDA. No law or regulation specifies the time limit by which FDA
must respond to a 510(k) notification. At this time, the FDA typically responds
to the submission of a 510(k) notification within 90 to 120 days, but it may
take longer. An FDA order may declare that the device is substantially
equivalent to another legally marketed device and allow the proposed device to
be marketed in the United States. The FDA, however, may determine that the
proposed device is not substantially equivalent or require further information,
including clinical data, to make a determination regarding substantial
equivalence. Such determination or request for additional information could
delay market introduction of the products that are the subject of the 510(k)
notification.
The company has received clearance of 510(k) premarket notifications to
market its Arthroscopic System for surgery of the knee, shoulder, elbow, wrist,
hip and ankle joints. In addition, the company has received 510(k) premarket
notifications to market CSS in general dermatology procedures and is pursuing
additional clearances that will allow CSS to be marketed in the United States
specifically for wrinkle removal. With respect to ESS, the company has received
clearance of 510(k) premarket notifications to market ESS in general head and
neck surgical procedures, and has received regulatory clearance that will allow
ESS to be marketed in the United States for certain specific indications while
it is pursuing additional clearances for certain other indications. There can be
no assurance that the company will be able to obtain necessary
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clearances or approvals to market any other products on a timely basis, if at
all, and delays in receipt or failure to receive such clearances or approvals,
the loss of previously received clearances or approvals, or failure to comply
with existing or future regulatory requirements could have a material adverse
effect on the company's business, financial condition and results of operations.
If a manufacturer or distributor of medical devices cannot establish that
a proposed device is substantially equivalent to a legally marketed device, the
manufacturer or distributor must seek premarket approval of the proposed device
through submission of a PMA application. A PMA application must be supported by
extensive data, including, in many instances, preclinical and clinical trial
data, as well as extensive literature to prove the safety and effectiveness of
the device. Following receipt of a PMA application, if the FDA determines that
the application is sufficiently complete to permit a substantive review, the FDA
will "file" the application. Under the FDC Act, the FDA has 180 days to review a
PMA application, although the review of such an application more often occurs
over a protracted time period, and generally takes approximately two years or
more from the date of filing to complete.
The PMA application approval process can be expensive, uncertain and
lengthy. A number of devices for which premarket approval has been sought have
never been approved for marketing. The review time is often significantly
extended by the FDA, which may require more information or clarification of
information already provided in the submission. In addition, the FDA will
inspect the manufacturing facility to ensure compliance with the FDA's Good
Manufacturing Practice (GMP) or QS Regulations requirements prior to approval of
an application. If granted, the approval of the PMA application may include
significant limitations on the indicated uses for which a product may be
marketed.
If necessary, the company will file a PMA application with the FDA for
approval to sell its potential products commercially in the United States when
it has developed such products. There can be no assurance that the company will
be able to obtain necessary PMA application approvals to market such products on
a timely basis, if at all, and delays in receipt or failure to receive such
approvals, the loss of previously received approvals, or failure to comply with
existing or future regulatory requirements could have a material adverse effect
on the company's business, financial condition and results of operations.
The company is also required to register as a medical device manufacturer
with the FDA and state agencies, such as the California Department of Health
Services (CDHS) and to list its products with the FDA. As such, the company is
subject to inspections by both the FDA and the CDHS for compliance with the
FDA's 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 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.
19
<PAGE> 20
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 and Mexico, to market CSS in Europe and Canada and to market ESS
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.
THIRD-PARTY REIMBURSEMENT
In the United States, health care providers, such as 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
20
<PAGE> 21
systems in international markets vary significantly by country, and include both
government-sponsored health care and private insurance. The company intends to
seek international reimbursement approvals, although there can be no assurance
that any such approvals will be obtained in a timely manner, if at all.
UNCERTAINTY OF NEW PRODUCT DEVELOPMENT
The company has undertaken preliminary animal studies and development for
the use of its Coblation technology with its controller in several fields. The
company has received 510(k) clearance for use of its technology in certain of
these fields. The company has received approval of an Investigational Device
Exemption (IDE) to conduct a clinical study on a specific indication. Following
the completion of this study, the company may submit a 510(k) application to the
FDA.
Each of the company's potential products that may result from these
investigations are in 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 $7,000,000 per occurrence and $7,000,000
in the aggregate. There can be no assurance that such coverage limits are
adequate to protect the company from any liabilities it might incur in
connection with the development, manufacture and sale of its 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 CSS and ESS and has not
experienced any product liability claims to date. However, a successful product
liability claim or series of claims brought against the company in excess of its
insurance coverage could have a material adverse effect on the company's
business, financial condition and results of operations.
EMPLOYEES
As of January 2, 1999, the company had 217 employees of which 134 people
are engaged in manufacturing activities, 21 people are engaged in research and
development activities, 28 people are engaged in sales and marketing activities,
16 people are engaged in regulatory affairs and quality assurance and 18 people
are engaged in administration and accounting. No employees are covered by
collective bargaining agreements, and the company believes it maintains good
relations with its employees.
The company is dependent upon a number of key management and technical
personnel. The loss of the services of one or more key employees or consultants
could have a material adverse effect on the company. The company's success will
also depend on its ability to attract and retain additional highly qualified
management and technical personnel. The company faces intense competition for
qualified personnel, many of whom are often subject to competing employment
offers, and there can be no assurance that the company
21
<PAGE> 22
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.
ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS
HISTORY OF LOSSES; FLUCTUATIONS IN OPERATING RESULTS
The company has experienced significant operating losses since inception
and, as of January 2, 1999, had an accumulated deficit of $27.4 million. The
company anticipates becoming profitable during 1999. Results of operations may
fluctuate significantly from quarter to quarter due to the timing of operating
expenditures, absence of a backlog of orders, timing of the receipt of orders,
promotional discounts of the company's products, re-use of the company's
disposable products. The company's revenues and profitability will be critically
dependent on whether it can successfully continue to market its Arthroscopic
System. In addition, the company's gross margins may be adversely affected due
to the necessity to promote and sell its product at significantly reduced
prices. There can be no assurance that significant profitability will ever be
achieved.
CONTROL BY DIRECTORS, EXECUTIVE OFFICERS AND AFFILIATED ENTITIES
The company's directors, executive officers and entities affiliated with
them, in the aggregate, beneficially own approximately 38% of the company's
outstanding common stock. These stockholders, if acting together, will have
significant influence over all matters requiring approval by the stockholders of
the company, including the election of directors and the approval of mergers or
other business combination transactions.
POTENTIAL VOLATILITY OF STOCK PRICE
The stock markets have experienced price and volume fluctuations that have
particularly affected 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
22
<PAGE> 23
15 percent or more of the company's common stock, or announces commencement of a
tender offer, the consummation of which would result in ownership by the person
or group of 15 percent or more of the company's common stock. The company will
be entitled to redeem the Rights at $0.01 per Right at any time on or before the
tenth day following acquisition by a person or group of 15 percent or more of
the company's common stock.
The Stockholder Rights Plan and certain provisions of the company's
Certificate of Incorporation and Bylaws may have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire control of the company. This could limit the price that
certain investors might be willing to pay in the future for shares of the
company's common stock. Certain provisions of the company's Certificate of
Incorporation and Bylaws allow the company to issue preferred stock without any
vote or further action by the stockholders, eliminate the right of stockholders
to act by written consent without a meeting, specify procedures for director
nominations by stockholders and submission of other proposals for consideration
at stockholder meetings, and eliminate cumulative voting in the election of
directors. Certain provisions of Delaware law applicable to the company could
also delay or make more difficult a merger, tender offer or proxy contest
involving the company, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. The
Stockholder Rights Plan, the possible issuance of preferred stock, the
procedures required for director nominations and stockholder proposals and
Delaware law could have the effect of delaying, deferring or preventing a change
in control of the company, including without limitation, discouraging a proxy
contest or making more difficult the acquisition of a substantial block of the
company's common stock. These provisions could also limit the price that
investors might be willing to pay in the future for shares of the company's
common stock.
LACK OF DIVIDENDS
The company has not paid any dividends and does not anticipate paying any
dividends in the foreseeable future.
ITEM 2. PROPERTIES
The company leases approximately 32,000 square feet in two neighboring
buildings in Sunnyvale, California, which comprise the company's administrative
offices and manufacturing and warehousing space. The company's two leases for
these facilities extend through February 2002. The company believes that its
existing facilities will be sufficient for its operational purposes through
1999.
.
ITEM 3. LEGAL PROCEEDINGS
On February 13, 1998, the company filed a lawsuit against Ethicon, Inc.
Mitek Surgical Products, a division of Ethicon, Inc. and GyneCare, Inc. ("the
Defendants") in the United States District Court for the Northern District of
California. The lawsuit alleges, among other things, that the Defendants have
been and are currently infringing four patents issued to the company in December
1997. Specifically, the Defendants use, market and sell two separate
electrosurgical systems under the names of "VAPR" and "VersaPoint" which
infringe these patents. The company seeks: (1) a judgment that the Defendants
have infringed these patents; (2) to preliminarily and permanently restrain and
enjoin the Defendants from marketing and selling the VAPR and VersaPoint
systems; and (3) an award of damages (including attorneys' fees) to compensate
the company for lost profits, the damages to be trebled because of the
Defendants' willful infringement. In addition, the company filed a motion on
March 5, 1998 for preliminary injunction against the Defendants marketing and
selling of the VAPR system. The court denied this motion for preliminary
injunction in December 1998, stating that the defendants have raised questions
that should be more fully addressed by the
23
<PAGE> 24
parties, and then resolved by a jury at trial. The jury trial will begin on May
17, 1999 in San Francisco, California.
On February 4, 1999, Xomed Surgical Products 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 (see the description of this contract referenced elsewhere in
the 10K). This license and distribution agreement was terminated by the Company
on February 5, 1999. The Company believes that the suit is without merit, and
filed a Motion to Dismiss on February 24, 1999.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
EXECUTIVE OFFICERS
The executive officers of the company who are elected by and serve at the
discretion of the Board of Directors and their ages are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- -------------------------------------------------------------------------------------------------------
<S> <C> <C>
Michael A. Baker 40 President and Chief Executive Officer
Robert T. Hagan 53 Vice President, Manufacturing
Christine E. Hanni 38 Vice President, Finance and Chief Financial Officer
Bruce Prothro 37 Vice President, Regulatory Affairs and Quality
John R. Tighe 38 Vice President, Worldwide Sales and Marketing
</TABLE>
Michael A. Baker joined the company in July 1997 as President and Chief
Executive Officer and Director. From 1989 to 1997, Mr. Baker held several
positions in planning, corporate development and senior management at Medtronic,
Inc. a multi-billion dollar medical technology company specializing in
implantable and invasive therapies. His most recent position at Medtronic, Inc.,
was Vice President, General Manager of Medtronic's Coronary Vascular Division
based in San Diego, CA. From 1988 to 1989, Mr. Baker was a Management Consultant
at The Carroll Group. From 1986 to 1988, Mr. Baker was the Corporate Development
Officer at American National Bank & Trust Co. Prior to joining American National
Bank & Trust Co., Mr. Baker served in the United States Army from 1981 to 1986
were he rose to the rank of Captain. Mr. Baker holds a bachelor degree from the
United States Military Academy at West Point and an MBA from the University of
Chicago.
Robert T. Hagan joined the company in August 1995 as Vice President,
Manufacturing. From October 1992 to July 1995, Mr. Hagan was retired. From
October 1984 to September 1992, Mr. Hagan held several manufacturing oversight
positions with Haemonetics Corporation, a manufacturer of blood processing
equipment and sterile disposables. His most recent position at Haemonetics
Corporation was Director of Advanced Manufacturing Technologies. Mr. Hagan also
served as Vice President of Manufacturing for Haemonetics and Medical and
Scientific Designs, Incorporated a start-up reagent company. Mr. Hagan holds a
B.S. degree in Industrial Engineering from Tennessee Technology University.
Christine E. Hanni joined the company in January 1998 as Vice President,
Finance and Chief Financial Officer. From 1992 until 1997, Ms. Hanni first
served as Corporate Controller and then as Director of International Finance and
Sales Administration of Target Therapeutics, Inc. (Target), a leading
manufacturer of disposable medical devices for the treatment of various brain
diseases. Prior to joining Target, she held
24
<PAGE> 25
several finance and accounting positions with Tandem Computers, Inc. including
Marketing Accounting Manager. From 1983 to 1987 Ms. Hanni was an auditor for
Coopers & Lybrand in San Jose, California and Portland, Oregon. Ms. Hanni holds
a B.S. degree in Accounting from Southern Oregon University.
Bruce Prothro joined the company in October 1998 as Vice President,
Regulatory Affairs and Quality Assurance. From December 1982 to December 1994,
Mr. Prothro held various positions with KeraVision, where most recently he
served as the Director of Regulatory Affairs and Compliance. Prior to his tenure
at KeraVision, Mr. Prothro was Manager, Quality Engineering at Advanced
Cardiovascular Systems and Manufacturing Manager at Diamon Images, Inc. Mr.
Prothro holds a B.S. degree in Chemistry from the University of California,
Berkeley.
John R. Tighe joined the company in January 1995 as the Director of Sales.
He was appointed Vice President of Worldwide Sales and Marketing in January
1999. From December 1988 to December 1994, Mr. Tighe held various sales
positions with Acufex Microsurgical, Inc. (Acufex), a manufacturer of
arthroscopic instruments. His most recent position at Acufex was National Sales
Manager. Mr. Tighe holds a B.S. degree in Civil Engineering from the University
of Maryland.
DISCLOSURE WITH REGARD TO DELINQUENT FILINGS
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the company's directors and officers and persons who
own more than 10% of a registered class of the company's equity securities, to
file reports of ownership and reports of changes in the ownership with the
Securities and Exchange Commission (the SEC). Such persons are required by SEC
regulations to furnish the company with copies of all Section 16(a) forms they
file.
Based solely on its review of the copies of such forms submitted to it
during the year ended January 2, 1999, the company believes that, during the
Last Fiscal Year, its director and officers Robert T. Hagan, Christine Hanni and
Alan Weinstein each failed to timely file one Form 4 disclosing shares of the
company common stock acquired.
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<PAGE> 26
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The company's common stock trades publicly on The Nasdaq Stock Market
under the symbol ARTC. The following table sets forth for the periods indicated,
the quarterly high and low closing sales prices of the common stock on The
Nasdaq Stock Market.
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED
-------------------------------------------------------------------------------
1998 APRIL 4, 1998 JULY 4, 1998 OCTOBER 3, 1998 JANUARY 2, 1999
- ---- -------------- ------------ --------------- ---------------
<S> <C> <C> <C> <C>
High.................... $15.375 $18.625 $22.250 $21.750
Low..................... 10.375 13.750 12.000 11.250
</TABLE>
<TABLE>
<CAPTION>
THREE MONTH PERIOD ENDED
-------------------------------------------------------------------------------
1997 MARCH 29, 1997 JUNE 28, 1997 SEPTEMBER 27, 1997 JANUARY 3, 1998
- ---- -------------- ------------- ------------------ ---------------
<S> <C> <C> <C> <C>
High.................... $10.625 $9.500 $14.750 $13.563
Low..................... 5.500 5.500 8.625 9.500
</TABLE>
As of March 4, 1999, there were no outstanding shares of Preferred Stock
and 209 holders of record of 8,991,256 shares of outstanding Common Stock. The
company has not paid any dividends since its inception and does not intend to
pay any dividends on its Common Stock in the foreseeable future.
ITEM 6. SELECTED FINANCIAL DATA
The information set forth below is not necessarily indicative of the
results of future operations and should be read in conjunction with the audited
financial statements and notes thereto appearing in Item 8 of this Report.
<TABLE>
<CAPTION>
Year Ended
----------------------------------------------------------------------------------------
January 2, January 3, December 28, December 31, December 31,
1999 1998 1996 1995 1994
---------- ---------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(in thousands, except per share data)
Statements of Operations Data:
Product sales $24,624 $12,796 $ 6,022 $ 218 $ --
License fees 3,292 -- -- -- --
Total revenue 27,916 12,796 6,022 218 --
Gross profit 15,548 4,301 780 (229) --
Operating expenses 18,625 13,401 9,989 6,940 2,247
Net loss (2,141) (7,688) (7,705) (6,950) (2,121)
Basic and diluted net loss per common share $ (0.24) $ (0.87) $ (0.97) $ (1.82) $ (0.64)
</TABLE>
26
<PAGE> 27
ITEM 6. SELECTED FINANCIAL DATA CONTINUED:
<TABLE>
<CAPTION>
January 2, January 3, December 28, December 31, December 31,
1999 1998 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
(in thousands)
Balance Sheet Data:
Cash, cash equivalents
and available-for-sale
securities $ 8,058 $ 19,872 $ 29,281 $ 4,774 $ 2,599
Working capital 16,973 20,342 23,468 5,119 2,467
Total assets 27,760 26,675 33,297 7,800 2,917
Total stockholders' equity(1) 22,305 23,546 30,782 6,325 2,727
</TABLE>
(1) The company has not declared any cash dividends on its common stock since
its inception and does not anticipate paying cash dividends in the
foreseeable future.
27
<PAGE> 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Statements in this Management's Discussion and Analysis of Financial
Condition and Results of Operations which express that the company "believes",
"anticipates" or "plans to..." as well as other statements which are not
historical fact, are forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Actual events or results may
differ materially as a result of the risks and uncertainties described herein
and elsewhere including, in particular, those factors described under "Business"
and "Additional Factors That Might Affect Future Results" set forth in Part I of
this Report as well as other risks and uncertainties in the documents
incorporated herein by reference.
The company has primarily engaged in the design, development, clinical
testing, manufacturing and marketing of its Soft-tissue Surgery System since
commencing operations in April 1993. The Arthroscopic System uses the company's
novel Coblation(TM) technology, which allows surgeons to operate with increased
precision and accuracy with minimal damage to surrounding tissue. It is
currently being used in closed joint surgery including many types of knee and
shoulder procedures. The Arthroscopic System consists of a disposable,
multi-electrode, bipolar device, a radio frequency controller that powers the
disposable and a cable that connects the disposable to the controller. The
disposable ablates (removes) soft tissue with minimal damage to surrounding
healthy tissue and simultaneously achieves hemostasis (sealing of small bleeding
vessels).
During the year ended January 2, 1999, the company formed a new business
division, AngioCare(TM) for the purpose of commercializing the company's
technology in the cardiac and interventional cardiology markets. 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. In April 1998, the company announced that it had entered the
cosmetic surgery market, and that it had formed a new business unit called
Visage(TM) to commercialize its technology in this field.
In May 1998, the company announced that it had entered the
otorhinolaryngology (ear, nose and throat) market, and that it has formed a new
business unit called ENTec(TM) to commercialize the 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.
In January 1999, the company entered into an exclusive worldwide license
and OEM agreement with Collagen Aesthetics, Inc. (Collagen) to market and
distribute ArthroCare's Coblation-based product line for cosmetic, dermatologic
and aesthetic surgical applications. On February 8, 1999, the company announced
that Collagen had acquired expanded, exclusive, worldwide rights to market
ArthroCare's Cosmetic Surgery System to all physicians practicing dermatology,
and cosmetic and facial plastic surgery including ear, nose, and throat
physicians who perform such procedures.
The company received clearance of its 510(k) premarket notification from
the United States Food and Drug Administration (FDA) in March 1995 to market its
Arthroscopic Electrosurgery System in the United
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<PAGE> 29
States for use in arthroscopic surgery of the knee, shoulder, elbow and ankle.
The company has since received clearance for use in the wrist and hip. With
respect to Cosmetic Surgery System, the company applied the CE mark for
marketing in Europe for skin resurfacing and wrinkle reduction procedures and
has received 510(k) clearances for use in general dermatology procedures in the
United States. The company is pursing additional clearances that will allow the
system to be marketed in the United States specifically for wrinkle reduction.
With respect to ENTec Soft-tissue Surgery System, the company intends to apply
the CE mark certification for marketing in Europe and has received 510(k)
clearances for use in general head, neck surgical procedures and functional
endoscopic sinus surgery in the United States. In addition, the company may
pursue clearance in other indications.
The company first introduced commercially its Arthroscopic System through
a network of distributors in the United States, in December 1995. The company's
strategy includes placing with arthroscopic surgeons, controller units that are
intended to generate future disposable revenue. 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. The company has received 510(k)
clearance for use of its technology in several 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
The year and quarter ended January 2, 1999 was the company's third full
year of product shipments and the company's twelfth consecutive quarter of
increasing revenues, respectively.
ArthroCare Corporation Statements of Operations:
<TABLE>
<CAPTION>
Year Ended
-----------------------------------------------------------------
January 2, 1999 January 3, 1998 December 28, 1996
--------------- --------------- -----------------
<S> <C> <C> <C>
(in thousands)
Revenue:
Product sales $ 24,624 $ 12,796 $ 6,022
License fees 3,292 -- --
---------- ---------- ----------
Total revenue 27,916 12,796 6,022
Cost of product sales 12,368 8,495 5,242
---------- ---------- ----------
Gross profit 15,548 4,301 780
Operating expenses:
Research and development 4,355 4,026 3,772
Sales and marketing 10,495 6,263 3,635
General and administrative 3,775 3,112 2,582
---------- ---------- ----------
Total operating expenses 18,625 13,401 9,989
---------- ---------- ----------
Loss from operations (3,077) (9,100) (9,209)
Interest income and other, net 937 1,413 1,505
---------- ---------- ----------
Loss before income tax provision (2,140) (7,687) (7,704)
Income tax provision (1) (1) (1)
---------- ---------- ----------
Net loss $ (2,141) $ (7,688) $ (7,705)
========== ========== ==========
</TABLE>
29
<PAGE> 30
Revenues
Total revenue for the year ended January 2, 1999 was $27.9 million
compared to $12.8 million for the year ended January 3,1998 and $6.0 million for
the year ended December 28, 1996, increases year-over-year were due to higher
unit volume of disposable and controller unit sales resulting from promotional
controller programs and a larger installed base of controllers along with
revenues received from licensing arrangements with corporate partners.
The company's strategy in arthroscopy, has been and continues to be, to
increase future disposable sales by increasing the installed base of controllers
through promotional programs. Overall, disposables are consistently sold at or
near list price, except for sales to international distributors, which are
currently and are expected in the future to be sold at discounted prices.
Substantially all revenue was derived domestically during fiscal years 1998,
1997, and 1996. For the years ended January 2, 1999, January 3, 1998 and
December 28, 1996, disposable sales comprised substantially all of product
sales. The company attributes increased disposable sales to the company's
strategic plan to build market share in arthroscopy through continued
promotional programs of controllers. The company expects disposable sales to
remain the primary component of product sales in the near future.
The company believes that, in its three years of product shipments, it has
penetrated 25% to 30% of the hospitals that perform arthroscopic procedures in
the United States. The company believes that approximately 60 % of its
disposable revenue is being generated by the sale of disposables for use in
shoulder procedures. The company believes that shoulder procedures are the
fastest growing segment of the arthroscopic market and knee procedures represent
the largest segment of the arthroscopic market based on the estimated number of
procedures performed each year. In order to achieve increasing disposable sales
over time, the company believes it must continue to penetrate the market in knee
procedures, expand the education of physicians of the Coblation technology, and
continue working on articular cartilage applications and focus product
development efforts specifically for knee applications.
During the year ended January 2, 1999, the company introduced new
disposable styles that included Eliminator(TM), Saber(TM) and Covac(TM) which
are designed primarily to be used in arthroscopic knee procedures. Sales of
these disposables accounted for approximately 16% of total product sales for the
year ended January 2, 1999. The company also developed and introduced new
disposables for small joint and for capsular shrinkage procedures during the
year ended January 2, 1999.
During the year ended January 3, 1998, the company introduced its System
2000 controller designed for more aggressive ablation and hemostasis compared to
its predecessor unit. The company believes features found in the System 2000 as
well as the new disposables will increase disposable sales in the market for
knee and shoulder procedures. There can be no assurance that the use of these
new products will be adopted by physicians. In addition, the company has limited
sales and marketing experience and can make no assurance that the current trends
in sales and product acceptance will continue.
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
has paid license fees, a portion of which has been classified as prepaid
royalties, to the company upon achievement of designated milestones and
royalties on sales of resulting products, if any. The first nonrefundable
license payment of $3.0 million was received during the first quarter of 1998 of
which $2.6 million was recognized as license revenue during the year.
30
<PAGE> 31
In June 1998, the company entered into a license and distribution
agreement with Xomed whereby Xomed acquired exclusive, worldwide, marketing
rights for the company's patented Coblation technology in the ear, nose and
throat market. Under the terms of the agreement, Xomed paid license fees based
upon the achievement of certain milestones. During the year ended January 2,
1999, the company recognized $0.4 million of such payments as license revenue.
On February 8, 1999, the company terminated its license and OEM agreement with
Xomed, in turn Xomed filed a lawsuit against the company.
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 and cosmetic and
plastic surgery markets. Under the terms of the agreement, Collagen will pay
license fees based upon the achievement of certain milestones. During the year
ended January 2, 1999, the company recognized $0.3 million of such payments as
license 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 and achieve sufficient
commercial acceptance, so that the company may continue to receive licensing and
royalty revenues from its' business partners.
Cost of Sales
Cost of sales for the year-ended January 2, 1999 was $12.4 million or
50.2% of product sales, as compared with $8.5 million, or 66.4% of product
sales for the period ended January 3, 1998. During the year-ended December 28,
1996, cost of sales was $5.2 million, or 87.1% of product sales. The $3.9
million increase in cost of sales for the year ended January 2,1999 over the
year ended January 3, 1998 and the $7.2 million increase over the year ended
December 28, 1996 were due to increased shipments of both disposables and
controllers.
Cost of sales as a percentage of product sales decreased 16.2 percentage
points during the year ended January 2, 1999 as compared to the previous year
and 36.9 percentage points as compared to the year ended December 28, 1996. The
overall decrease in cost of sales as a percentage of product sales resulted from
fixed and semi-fixed costs being spread over higher manufacturing volumes,
improvements to the manufacturing process, new controller promotional programs
including one whereby the company maintains title to the controller, which
results in the cost being capitalized and amortized over future periods rather
than expensing one hundred percent of the cost at the time of placement and
improved efficiencies in manufacturing.
In 1997 the company made a strategic decision to manufacture its new
System 2000 controller in-house and introduced this new product in November
1997. Although shipments of the new controllers did not have a material impact
on controller cost or gross margin in 1997, the company believes that
manufacturing the System 2000 controllers in-house provided a positive impact to
gross margins during the year ended January 2, 1999. However, there can be no
assurance that the company will be able to continue to maintain additional
improvement to gross margin. The company believes future improvements to gross
margin will depend upon the mix of disposable sales versus controller sales
and/or placements and the distribution channels utilized to sell the company's
products in all commercialized fields. There can be no assurance that the
company will be successful in maintaining the mix of disposables to controllers
or in increasing demand for its disposables. In addition, production of future
new products may adversely impact gross margin due to the inefficiencies in
manufacturing new products as well as the distribution channels utilized to sell
those products.
31
<PAGE> 32
Operating Expenses
Research and development expense increased 8% to $4.4 million in 1998,
from $4.0 million in 1997, and increased 7% in 1997, from $3.8 million for the
year ended December 28, 1996. The $0.4 million and $0.2 million increases in
spending between 1998 and 1997 and between 1997 and 1996, respectively, are
attributed primarily to the development and introduction of new disposable
styles, the development of products for additional markets, patent filings and
increased clinical expenses. The increases were partially offset by a reduction
of quality assurance expenses related to research and development during the
year ended January 2, 1999, as quality activities now primarily relate to
manufacturing efforts rather than research and development efforts and
reimbursement of expenses by the company's business partners for certain
research and dual activities.
The company believes that continued investment in its platform technology
is essential if it is to maintain its competitive position. The company expects
to continue increasing research and development spending through substantial
expenditures on new product development, regulatory affairs, clinical studies
and patents. The company believes that its ability to attract and retain
qualified engineers in the future is critical to the continued success of the
company.
Sales and marketing expense increased to $10.5 million or 68% in 1998,
from $6.3 million in 1997, and increased 72% in 1997 from $3.6 million for the
year ended December 28, 1996. The $4.2 million and $2.6 million increases
between 1998 and 1997, and 1997 and 1996, were primarily due to higher dealer
commissions resulting from increased sales, higher staffing expenses including
the establishment of a European headquarters, and promotional and trade show
expenses reflecting an increased level of sales and marketing activity as the
company continues to increase its arthroscopy business as well as the expansion
into two additional fields.
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 its current products and commercialize future
products. There can be no assurance that the company will successfully develop
its own marketing and sales capabilities and experience or that its distributors
and marketing partners will commit the necessary resources to effectively market
and sell the company's current products and future products.
General and administrative expense increased to $3.8 million or 21% in
1998, from $3.1 million during 1997, and increased 21% in 1997, as compared to
$2.6 million for the year ended December 28, 1996. The $0.7 million increase for
the year ended January 2, 1999 over the year ended January 3, 1998 is primarily
due to expenses incurred by the company in association with its on-going patent
litigation brought by the company against certain competitors and increased
staffing, partially offset by the expense, in the prior year, of attracting,
recruiting and relocating a Chief Executive Officer. The $0.5 million increase
in 1997, over the year ended December 28, 1996 was mainly associated with
increased cost of general legal service, business development activities,
increased staffing, insurance and expenses necessary to expand the corporate
infrastructure. The company anticipates that general and administrative expenses
will continue to increase as a result of patent litigation and further business
development activities. See Part I Item 3 this report for a description of the
current patent litigation.
32
<PAGE> 33
Interest Income and Other, net
Interest income and other, net, decreased for the year ended January
2,1999 to $0.9 million from $1.4 million for the year ended January 3, 1998 and
from $1.5 million for the year ended December 28, 1996. The $0.5 million
decrease in the most recently completed period was attributable to the
conversion of investments to cash for use in business operations during the year
resulting in a lower balance of investment on which to earn interest income. At
the end of fiscal 1998, the company had $8.1 million in cash, cash equivalents,
and available-for-sale securities as compared to $19.9 million at the end of
fiscal 1997 and $29.3 million at the end of fiscal 1996. The company expects
that interest income will continue to decrease as the company reduces its
investments to meet the future cash needs of the business.
Net Loss
Net loss decreased significantly to $2.1 million for the year ended
January 2, 1999, from $7.7 million for each of the years ended January 3, 1998
and December 28, 1996. The overall decrease in net loss is primarily due to an
overall improvement in the operating position of the company. Specifically, the
company experienced a significant increase in sales with an improvement to gross
margin and reduced costs associated with research and development, sales and
marketing, and general and administrative expenses as a percentage of revenues.
Also contributing to the reduced net loss were license payments received from
the company's business partners. The company anticipates becoming profitable
during 1999, as sales increase faster than operating expenses and gross margin
continues to improve. However, there can be no assurance the company will be
successful in its efforts to increase sales and gross margin or control the
growth of operating expenses.
.
LIQUIDITY AND CAPITAL RESOURCES
At January 2, 1999 the company had $17.0 million in working capital
compared to $20.3 million at January 3, 1998 and its principal sources of
liquidity consisted of $8.1 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. The company's cash used in
operations was $8.8 million for the year-ended January 2, 1999 due to higher
inventory levels to support increased sales activity, increased controller
component inventory to support high volume, in-house manufacturing of the
controllers and higher accounts receivable balances resulting from higher sales.
This was partially offset by higher accrued compensation due to increased
staffing levels and higher accrued commissions due to increased sales.
Net accounts receivable increased to $6.0 million as of January 2, 1999
from $2.2 million as of January 3, 1998. The increase in accounts receivable was
due to significant sequentially increasing sales and the timing of sales and
collections during the year.
Inventories increased to $7.1 million as of January 2, 1999 compared to
$2.0 million as of January 3, 1998 due to higher product sales activity, higher
parts inventory to support in-house manufacturing, and an increasing number of
parts for two additional product markets. The company expects future inventory
levels to increase in absolute value.
Net property and equipment increased to $4.6 million as of January 2, 1999
compared to $1.4 million as of January 3, 1998. The increase in fiscal 1998 was
primarily due to purchases of computer equipment, manufacturing equipment and
machinery, furniture and fixtures and the capitalization of controllers for
which the company maintains ownership.
33
<PAGE> 34
The company plans to finance its operating and capital needs principally
with cash from product sales, cash, cash equivalents, and available-for-sale
securities and related interest, existing capital resources and licensing
arrangements which the company believes will be sufficient to fund its
operations at least through fiscal year 1999. The company currently has no
commitments for any credit facilities such as revolving credit agreements or
lines of credit that could provide additional working capital. The company's
future liquidity and capital requirements will depend on numerous factors
including the company's continued success of commercializing the Arthroscopic
System, development and commercialization of products in fields other than
arthroscopy, the ability of the company's suppliers to continue to meet the
demands of the company at current prices, the cost associated with the company's
ongoing patent litigation, obtaining and enforcing patents important to the
company's business, the status of regulatory approvals and competition. There
can be no assurance that the company will not be required to raise additional
capital or that such capital will be available on acceptable terms, if at all.
RECENT ACCOUNTING PRONOUNCEMENTS.
In June 1998, the Financial Accounting Standards Board (FASB) issued 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 2000. To date, the company does not
engage in hedging activities.
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 $250,000 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 June 30, 1999.
Any Year 2000 compliance problem with either the company, its suppliers,
its service providers or its customers could result in a materially 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.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ArthroCare 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Certain information required by this Item is included in Item 6 of Part II
of this Report and is incorporated herein by reference. All other information
required by this Item is included on pages 35 to 56 in Item 14 of Part IV of
this Report and is incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
34
<PAGE> 35
PART III
ITEM 10. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT
Information regarding the Directors of the company is incorporated by
reference from the information set forth under the caption "Proposal No. 1:
Election of Directors" in the Proxy Statement. Information regarding the
executive officers of the company is incorporated by reference from the
information set forth under the caption "Executive Officers of the Company" at
the end of Part I of this Report. Information with respect to Directors and
Officers of the Company required by Item 405 of Regulation S-K is set forth
under the caption "Disclosure with Regard to Delinquent Filings" at the end of
Part I of this Report
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Executive Compensation".
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Share Ownership of Directors,
Officers and Certain Beneficial Owners."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from
the discussion in the Proxy Statement captioned "Certain Transactions".
35
<PAGE> 36
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Report.
1. FINANCIAL STATEMENTS . The following financial statements of the company
and the Report of Independent Accountants, are included in Part IV of this
Report on the pages indicated.
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants................................................. 40
Balance Sheets as of January 2, 1999 and January 3, 1998.......................... 41
Statements of Operations for the years ended January 2, 1999,
January 3, 1998 and December 28, 1996............................................. 42
Statement of Stockholders' Equity for the years ended January 2, 1999,
January 3, 1998 and December 28, 1996............................................. 43
Statements of Cash Flows for the years ended January 2, 1999, January 3,
1998 and December 28, 1996........................................................ 44
Notes to Financial Statements..................................................... 45
</TABLE>
2. FINANCIAL STATEMENT SCHEDULE. The following financial statement schedule
of the company as of and for the years ended January 2, 1999, January 3, 1998
and December 28, 1996 is included in Part IV of this Report on the pages
indicated. This financial statement schedule should be read in conjunction with
the Financial Statements, and notes thereto, of the company.
<TABLE>
<CAPTION>
SCHEDULE TITLE PAGE
-------- ----- ----
<S> <C> <C>
II Valuation and Qualifying Accounts 57
</TABLE>
Schedules not listed above have been omitted because they are not applicable,
not required, or the information required to be set forth therein is included in
the Financial Statements or notes thereto.
3. EXHIBITS (in accordance with Item 601 of Regulation S-K).
(1)3.2 Certificate of Incorporation of the Registrant.
(1)3.3 Amended and Restated Bylaws of the Registrant.
(1)4.1 Specimen Common Stock Certificate.
(1)10.1 Form of Indemnification Agreement between the Registrant
and each of its directors and officers.
(1)10.2 Incentive Stock Plan and form of Stock Option Agreement
thereunder.
(1)10.3 Director Option Plan and form of Director Stock Option
Agreement thereunder.
(1)10.4 Employee Stock Purchase Plan and forms of agreements
thereunder.
36
<PAGE> 37
(1)10.5 Form of Exclusive Distribution Agreement.
(1)10.6 Form of Exclusive Sales Representative Agreement.
(1)10.7 Consulting Agreement, dated May 10, 1993, between the
Registrant and Philip E. Eggers, and amendment thereto.
(1)10.8 Consulting Agreement, dated May 20, 1993, between the
Registrant and Eggers & Associates, Inc., and amendment
thereto.
(1)10.9 Lease Agreement, dated September 15, 1994, between
Registrant and The Arrillaga Foundation and the Perry
Foundation for the Registrant's facility located at 595
North Pastoria Avenue, Sunnyvale, California 94086.
(1)10.10 Employment Letter Agreement, dated October 21, 1994,
between the Registrant and Allan Weinstein and amendment
thereto.
(1)10.11 Purchase Assistance Promissory Note, dated January 19,
1995, between Registrant and Allan Weinstein.
(1)10.12 Mortgage Assistance Promissory Note Agreement, dated
February 5, 1995, between the Registrant and Allan
Weinstein.
(1)10.13 Restricted Stock Purchase and Security Agreement, dated
February 5, 1995, between the Registrant and Allan
Weinstein.
(1)10.14 Employment Letter Agreement, dated July 18, 1995,
between the Registrant and Robert T. Hagan.
(1)10.15 Restricted Stock Purchase and Security Agreement, dated
August 1, 1995, between the Registrant and Robert T.
Hagan.
(1)10.16+ Radiation Services Agreement, dated September 13, 1995,
between the Registrant and SteriGenics International.
(1)10.17 Amended and Restated Stockholder Rights Agreement, dated
October 16, 1995, between the Registrant and certain
holders of the Registrant's securities.
(1)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.
(2)10.19 Preferred Stock Rights Agreement, dated November 14,
1996, between the Registrant and Norwest Bank Minnesota,
N.A.
(2)10.20 Amended Preferred Shares Rights Agreement, date October
2, 1998, between the Registrant and Norwest Bank
Minnesota, N.A.
(3)10.20+ Exclusive Distributor Agreement, dated April 15, 1997,
between the Registrant and Arthrex, GmbH.
37
<PAGE> 38
(4)10.21++ Employment Letter Agreement, dated June 20, 1997,
between the Registrant and Michael A. Baker.
(5)10.22+ Exclusive Distributor Agreement, dated August 21, 1997,
between the Registrant and Kobayashi Pharmaceutical
Company, Ltd.
(6)10.23++ License Agreement dated February 9, 1998, between the
Registrant and Boston Scientific Corporation.
(6)10.24++ Development and Supply Agreement dated February 9, 1998,
between the Registrant and Boston Scientific
Corporation.
(6)10.25 Lease Agreement date March 25, 1998 between the
Registrant and Aetna Life Insurance Company for the
Registrant's facility located at 840 Del Rey Avenue,
Sunnyvale, California 94086.
(7)10.26+ Term sheet for License and Distribution Agreement
between Xomed Surgical Products and the Registrant dated
June 25, 1998.
(8)10.27++ License Agreement dated February 9, 1999 between the
Registrant and Collagen Aesthetics
(8)10.28 Change of Control Agreement between the Registrant and
the CEO.
(8)10.29 The Form of "VP Continuity Agreement" between the
Registrant and its Vice Presidents.
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants.
24.1 Power of Attorney (see Page 34).
27.2 Financial Data Schedule.
(1) Incorporated herein by reference to the same-numbered exhibit previously
filed with the Registrant's Registration Statement on Form S-1
(Registration No. 33-80453).
(2) Incorporated here in by reference to exhibit 5 previously filed with the
Registrant's Registration Statement on Form 8-A (Registration No.
000-27422).
(3) Incorporated herein by reference to the same-numbered exhibit previously
filed with the Registrant's Quarterly Report on Form 10-Q for the period
ended April 4, 1998.
(4) Incorporated herein by reference to the same-numbered exhibit previously
filed with the Registrant's Quarterly Report on Form 10-Q for the period
ended July 4, 1998.
(5) Incorporated herein by reference to the same numbered exhibit previously
filed with the Registrant's Quarterly Report on Form 10-Q for the period
ended October 3, 1998.
(6) Incorporated herein by reference to the same numbered exhibit previously
filed with the
38
<PAGE> 39
Registrant's Annual Report on Form 10-K for the year ended January 2,
1999.
(7) Incorporated herein by reference to Exhibit 1 previously filed with the
Registrant's Registration statement on Form 8-A/A ( Registration No.
000-27422).
(8) Incorporated herein by reference to the same numbered exhibit previously
filed with the Registrant's Annual Report on Form 10-K for the year ended
January 2, 1999.
+ Confidential treatment granted. ++ Confidential treatment requested.
39
<PAGE> 40
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
ArthroCare Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
ArthroCare Corporation and its subsidiaries (the "company") at January 2, 1999,
and January 3, 1998, and the results of their operations and their cash flows
for each of the three years in the period ended January 2, 1999, in conformity
with generally accepted accounting principles. These consolidated financial
statements are the responsibility of the company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
San Jose, California
January 27, 1999
40
<PAGE> 41
ARTHROCARE CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
January 2, January 3,
1999 1998
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,826 $ 8,188
Available-for-sale securities 5,232 10,674
Accounts receivable, net of allowances
of $469 in 1998 and $594 in 1997 5,972 2,223
Inventories 7,069 2,019
Prepaid expenses and other current assets 1,038 210
--------- ---------
Total current assets 22,137 23,314
Available-for-sale securities -- 1,010
Property and equipment, net 4,560 1,412
Related party receivables 723 876
Other assets 340 63
--------- ---------
Total assets $ 27,760 $ 26,675
========= =========
LIABILITIES
Current liabilities:
Accounts payable $ 1,797 $ 968
Accrued liabilities 1,734 672
Accrued compensation 1,056 1,315
Deferred revenue 517 --
Capital lease obligation, current portion 60 17
--------- ---------
Total current liabilities 5,164 2,972
Capital lease obligation, less current portion 151 --
Deferred rent 140 157
--------- ---------
Total liabilities 5,455 3,129
--------- ---------
Commitments and contingencies (Note 5 and Note 14)
STOCKHOLDERS' EQUITY
Preferred stock, par value $0.001:
Authorized: 5,000 shares;
Issued and outstanding: 0 shares in 1998 and 1997 -- --
Common stock, par value $0.001:
Authorized: 20,000 shares;
Issued and outstanding: 8,972 shares in 1998 and 8,869 shares in 1997 9 9
Additional paid-in capital 49,901 49,153
Notes receivable from stockholders (51) (92)
Deferred compensation (68) (228)
Accumulated other comprehensive income (loss) (39) 10
Accumulated deficit (27,447) (25,306)
--------- ---------
Total stockholders' equity 22,305 23,546
--------- ---------
Total liabilities and stockholders' equity $ 27,760 $ 26,675
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
41
<PAGE> 42
ARTHROCARE CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
Year Ended
--------------------------------------------------
January 2, January 3, December 28,
1999 1998 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenue:
Product sales $ 24,624 $ 12,796 $ 6,022
License fees 3,292 -- --
------------ ------------ ------------
Total revenue 27,916 12,796 6,022
Cost of sales 12,368 8,495 5,242
------------ ------------ ------------
Gross profit 15,548 4,301 780
Operating expenses:
Research and development 4,355 4,026 3,772
Sales and marketing 10,495 6,263 3,635
General and administrative 3,775 3,112 2,582
------------ ------------ ------------
Total operating expenses 18,625 13,401 9,989
------------ ------------ ------------
Loss from operations (3,077) (9,100) (9,209)
Interest income and other, net 937 1,413 1,505
------------ ------------ ------------
Loss before income tax provision (2,140) (7,687) (7,704)
Income tax provision (1) (1) (1)
------------ ------------ ------------
Net loss $ (2,141) $ (7,688) $ (7,705)
============ ============ ============
Basic and diluted net loss per common share $ (0.24) $ (0.87) $ (0.97)
============ ============ ============
Shares used in computing basic and diluted net
loss per common share 8,926 8,813 7,936
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
42
<PAGE> 43
ARTHROCARE CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
(in thousands, except per share data)
<TABLE>
<CAPTION>
Preferred Stock Common Stock
--------------------------- --------------------------
Shares Amount Shares Amount
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1995 8,677,750 $ 9 1,792,725 $ 2
Issuance of common stock through:
Initial public offering at $ 14.00 per share
in February 1996, net of issuance costs
of $3,563 -- -- 2,530,000 3
Conversion of preferred stock in
connection with the initial public offering
in February 1996 (8,677,750) (9) 4,338,875 4
Exercise of options -- -- 106,643 --
Employee stock purchase plan -- -- 10,101 --
Deferred compensation related to issuance of
common stock and grants of stock options -- -- -- --
Amortization of deferred compensation -- -- -- --
Change in unrealized gain on available-for-sale
securities -- -- -- --
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, DECEMBER 28, 1996 -- -- 8,778,344 9
Issuance of common stock through:
Exercise of options -- -- 74,287 --
Employee stock purchase plan -- -- 16,865 --
Amortization of deferred compensation -- -- -- --
Change in unrealized gain on available-for-sale
securities -- -- -- --
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, JANUARY 3, 1998 -- -- 8,869,496 9
Issuance of common stock through:
Repayment of notes receivable from -- -- -- --
stockholder
Exercise of options -- -- 89,927 --
Employee stock purchase plan -- -- 13,545 --
Amortization of deferred compensation -- -- -- --
Change in unrealized gain on available-for-sale
securities -- -- -- --
Currency translation adjustment -- -- -- --
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, JANUARY 2, 1999 -- $ -- 8,972,968 $ 9
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Notes
Additional Receivable Accumulated Other
Paid-In from Deferred Comprehensive
Capital Stockholders Compensation Income/(loss)
---------- ------------ ------------ -----------------
<S> <C> <C> <C> <C>
BALANCES, DECEMBER 31, 1995 $ 16,869 $ (92) $ (550) $ --
Issuance of common stock through:
Initial public offering at $ 14.00 per share
in February 1996, net of issuance costs
of $ 3,563 31,854 -- -- --
Conversion of preferred stock in
connection with the initial public offering
in February 1996 5 -- -- --
Exercise of options 63 -- -- --
Employee stock purchase plan 66 -- -- --
Deferred compensation related to issuance of
common stock and grants of stock options 5 -- (5) --
Amortization of deferred compensation -- -- 167 --
Change in unrealized gain on available-for-sale
securities -- -- -- 9
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, DECEMBER 28, 1996 48,862 (92) (388) 9
Issuance of common stock through:
Exercise of options 201 -- -- --
Employee stock purchase plan 90 -- -- --
Amortization of deferred compensation -- -- 160 --
Change in unrealized gain on available-for-sale
securities -- -- -- 1
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, JANUARY 3, 1998 49,153 (92) (228) 10
Issuance of common stock through:
Repayment of notes receivable from -- 41 -- --
stockholder
Exercise of options 586 -- -- --
Employee stock purchase plan 162 -- -- --
Amortization of deferred compensation -- -- 160 --
Change in unrealized gain on available-for-sale
securities -- -- -- (10)
Currency translation adjustment -- -- -- (39)
Net loss -- -- -- --
---------- ---------- ---------- ----------
BALANCES, JANUARY 2, 1999 $ 49,901 $ (51) $ (68) $ (39)
========== ========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
Total
Accumulated Stockholders' Comprehensive
Deficit Equity Income/(loss)
----------- ------------- -------------
<S> <C> <C>
BALANCES, DECEMBER 31, 1995 $ (9,913) $ 6,325
Issuance of common stock through:
Initial public offering at $ 14.00 per share
in February 1996, net of issuance costs
of $3,563 -- 31,857
Conversion of preferred stock in
connection with the initial public offering
in February 1996 -- --
Exercise of options -- 63
Employee stock purchase plan -- 66
Deferred compensation related to issuance of
common stock and grants of stock options -- --
Amortization of deferred compensation -- 167
Change in unrealized gain on available-for-sale
securities -- 9 9
Net loss (7,705) (7,705) (7,705)
---------- ---------- ----------
BALANCES, DECEMBER 28, 1996 (17,618) 30,782 $ (7,696)
----------
Issuance of common stock through:
Exercise of options -- 201
Employee stock purchase plan -- 90
Amortization of deferred compensation -- 160
Change in unrealized gain on available-for-sale
securities -- 1 1
Net loss (7,688) (7,688) (7,688)
---------- ---------- ----------
BALANCES, JANUARY 3, 1998 (25,306) 23,546 $ (7,687)
----------
Issuance of common stock through:
Repayment of notes receivable from
stockholder 41
Exercise of options -- 586
Employee stock purchase plan -- 162
Amortization of deferred compensation -- 160
Change in unrealized gain on available-for-sale
securities -- (10) (10)
Currency translation adjustment -- (39) (39)
Net loss (2,141) (2,141) (2,141)
---------- ---------- ----------
BALANCES, JANUARY 2, 1999 $ (27,447) $ 22,305 $ (2,190)
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
43
<PAGE> 44
ARTHROCARE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Year Ended
----------------------------------------------------
January 2, January 3, December 28,
1999 1998 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (2,141) $ (7,688) $ (7,705)
Adjustments to reconcile net loss to net cash used in operating
activities:
Depreciation and amortization 958 615 370
Provision for doubtful accounts receivable
and product returns (125) 276 313
Forgiveness of notes receivable -- 11 --
Provision for excess and obsolete inventory (26) 249 50
Change in unrealized gain/loss on securities (10) -- --
Loss/(gain) on disposal of property and equipment (4) 19 309
Amortization of deferred compensation 160 160 167
Deferred rent (17) -- 9
Changes in operating assets and liabilities:
Accounts receivable (3,624) (1,248) (1,352)
Inventory (5,024) (1,509) (293)
Prepaid expenses and other current assets (828) (55) 736
Accounts payable 829 (87) 288
Accrued liabilities 803 742 772
Deferred revenue 517 -- --
Other assets (273) 6 (20)
------------ ------------ ------------
Net cash used in operating activities (8,805) (8,509) (6,356)
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment (3,893) (562) (1,028)
Purchases of available-for-sale securities (28,059) (20,656) (189,648)
Sales or maturities of available-for-sale securities 34,511 26,895 171,735
------------ ------------ ------------
Net cash provided by (used in) investing activities 2,559 5,677 (18,941)
------------ ------------ ------------
Cash flows from financing activities:
Issuance of notes receivable to related parties -- (686) (75)
Repayment of capital leases (14) (41) (29)
Repayment of notes receivable from related parties 148 97 --
Repayment of notes receivable from stockholder 41 -- --
Proceeds from issuance of common stock and preferred
stock, net of issuance costs 162 90 31,923
Proceeds from exercise of options to purchase common stock 586 201 63
------------ ------------ ------------
Net cash provided by (used in) financing activities 923 (339) 31,882
------------ ------------ ------------
Effect of exchange rate on changes in cash (39) -- --
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (5,362) (3,171) 6,585
Cash and cash equivalents, beginning of year 8,188 11,359 4,774
------------ ------------ ------------
Cash and cash equivalents, end of year $ 2,826 $ 8,188 $ 11,359
============ ============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
45
<PAGE> 45
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY:
ArthroCare Corporation (the company) was incorporated on April 29, 1993.
The company designs, develops, manufactures and markets medical devices for use
in soft-tissue surgery. The company's principal operations commenced in August
1995, at which time it emerged from the development stage.
On November 22, 1995, the company was reincorporated in the state of
Delaware with the associated exchange of shares of each class and series of
stock of the predecessor company for one share of each identical class and
series of stock of the Delaware successor company having a par value of $0.001
per share for both common stock and preferred stock.
The company sold 2,530,000 shares of common stock (including 330,000
shares from the exercise of the underwriter's over-allotment option) at $14.00
per share through an initial public offering in February 1996. Net proceeds
(after underwriter's commissions and fees along with other costs associated with
the offering) totaled $31,857,000. Upon completion of the offering, all
outstanding shares of preferred stock (a total of 8,678,000 shares) were
converted into shares of common stock on a two-for-one basis.
The company intends to finance its operations primarily through its cash,
cash equivalents and available-for-sale securities, together with future product
sales and licensing fees. There can be no assurance that the company will not
require additional funding or that such funding will be available on acceptable
terms, if at all.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation. The company maintains a fifty-two/fifty-three week
fiscal year cycle ending on a Saturday. To conform the company's fiscal year
ends, the company must add a fifty-third week to every fifth or sixth fiscal
year. Accordingly, fiscal 1998 and 1996 were fifty-two week years and fiscal
1997 was a fifty-three week year.
Use of Estimates. The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Principles of Consolidation. The consolidated financial statements include
the accounts of ArthroCare and all of its wholly owned subsidiaries. All
significant inter-company transactions and accounts have been eliminated.
46
<PAGE> 46
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED:
Cash and Cash Equivalents and Available-for-Sale Securities. The company
considers all highly liquid investments purchased with original maturities of
ninety days or less to be cash equivalents. Cash and cash equivalents include
money market funds and various deposit accounts.
The company has classified its investments as "available-for-sale." Such
investments are recorded at fair value and unrealized gains and losses, if
material, are recorded as a separate component of equity until realized.
Interest income is recorded using an effective interest rate, with the
associated premium or discount amortized to "interest income".
Inventories. Inventories are stated at the lower-of-cost-or-market, with
cost determined on a first-in, first-out basis.
Property and Equipment. Property and equipment, including equipment under
capital leases, is stated at cost and is depreciated on a straight-line basis
over the estimated useful lives of three to five years. The company places
controllers with customers in order to facilitate the sale of disposables.
Controllers placed with customers are capitalized at cost and amortized over a
three-year period. Leasehold improvements are amortized over the shorter of the
estimated useful lives or the lease term. Maintenance and repair costs are
charged to operations as incurred.
Revenue Recognition. The company recognizes revenue upon shipment of
product to the customer, upon fulfillment of acceptance terms, if any, and when
no significant contractual obligations remain. Revenue is reported net of a
provision for estimated product returns. The company recognizes revenue from its
business partners upon the completion of certain milestones. The company
recognized license fees of $3.2 million which were received from business
partners during 1998.
Reclassification. Certain amounts in the prior financial statements have
been reclassified to conform to the current year presentation. These
reclassifications did not impact previously reported total assets, liabilities,
stockholders' equity or net loss.
Research and Development. Research and development costs are charged to
operations as incurred.
Foreign Currency Translation. The functional currency of each foreign
subsidiary is its' local currency. Essentially all foreign assets and
liabilities are translated into U.S. dollars at year-end exchange rates, while
elements of the income statement are translated at average exchange rates in
effect during the year. Foreign currency transaction gains and losses are
included in the consolidated statement of operations. Adjustments arising from
the translation of net assets located outside the United States (gains and
losses) are recorded as a component of shareholders' equity.
Concentration of Risks and Uncertainties. Substantially all of the
company's cash and cash equivalents are maintained at financial institutions in
the United States. Deposits at these institutions may exceed the amount of
insurance provided on such deposits. The company has not experienced any losses
on its deposits of cash and cash equivalents.
47
<PAGE> 47
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED:
The company's Sunnyvale facility currently accounts for all of its product
manufacturing. Disruption of operations at the company's production facility
could cause delays in, or an interruption of, production and shipment of
products which could have a material adverse impact on the company's business,
operating results and financial condition.
The company purchases certain key components of its products, from sole,
single or limited source suppliers. For some of these components there are few
alternative sources. A reduction or stoppage in supply of sole-source components
would limit the company's ability to manufacture certain products. There can be
no assurance that an alternate supplier could be established if necessary or
that available inventories would be adequate to meet the company's production
needs during any prolonged interruption of supply.
The company's products require approval from the United States Food and
Drug Administration (FDA) and international regulatory agencies prior to the
commencement of commercial sales. There can be no assurance that the company's
products will receive any of these required approvals. If the company was denied
such approvals, or if such approvals were delayed, it would have a material
adverse impact on the company's business.
Sales to both international and domestic customers are generally made on
open credit terms. Management performs ongoing credit evaluations of the
company's customers and maintains an allowance for potential credit losses when
needed but historically has not experienced any significant losses related to
individual customers or a group of customers in any particular geographic area.
Fair Value of Financial Instruments. The carrying value of the
company's financial instruments approximate fair value.
Income Taxes. The company accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes," which prescribes the use of the liability method
whereby deferred tax asset or liability account balances are calculated at the
balance sheet date using current tax laws and rates in effect for the year in
which the differences are expected to affect taxable income. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amounts expected to be realized.
Computation of Net Loss per Common Share. Basic and diluted net loss per
common share are computed using the weighted average number of shares of common
stock outstanding. Common equivalent shares from stock options, warrants and
preferred stock of 535,000 shares have been excluded from the computation of net
loss per common share-assuming dilution as their effect is antidilutive. No
additional shares are considered to be outstanding for either computation under
the provisions of SAB No. 98.
Comprehensive Income (Loss). The company adopted the provision of the
Financial Accounting Standards Board (FASB) SFAS No. 130, "Reporting
Comprehensive Income" in 1998. This statement establishes requirements for
disclosure of comprehensive income with reclassification of earlier financial
statements for comparative purposes. Comprehensive income generally represents
all changes in stockholders' equity except those resulting from investments or
contributions by stockholders.
Segment Information. In 1998, the company adopted Statement of Financial
Accounting Standard (SFAS) No. 131, "Disclosures about Segments of an Enterprise
and Related Information". SFAS No. 131 supersedes SFAS No. 14, "Financial
Reporting for Segments of a Business Enterprise;, replacing the "industry
segment" approach with the
48
<PAGE> 48
ARTHROCARE CORPORATION
NOTES TO THE FINANCIAL STATEMENTS, Continued
"management" approach. The management approach designates the internal
organization that is used by management for making operating decisions and
assessing performance as the source of the company's reportable segments. SFAS
No. 131 also requires disclosures about products and services, geographic areas,
major customers. See Note 11 to the consolidated financial statements.
Recent Accounting Pronouncements. In June 1998, the Financial Accounting
Standards Board issued 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 2000. To date, the company does
not engage in hedging activities.
3. AVAILABLE-FOR-SALE SECURITIES:
The company's investments consist primarily of corporate notes and bonds
with contractual maturities of less than one year. Gains and losses were
immaterial for all periods presented. At January 2, 1999, the amortized cost of
the investment approximates fair value.
4. BALANCE SHEET DETAIL:
<TABLE>
<CAPTION>
(in thousands) January 2, 1999 January 3, 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Inventories:
Raw materials $ 3,127 $ 921
Work-in-process 1,852 165
Finished goods 2,090 933
---------- ----------
$ 7,069 $ 2,019
========== ==========
Prepaid expenses and other current assets:
Prepaid insurance $ 212 $ 125
Prepaid rent -- 28
Other 826 57
---------- ----------
$ 1,038 $ 210
========== ==========
Property and equipment:
Machinery and equipment $ 1,672 $ 1,123
Tooling and molds 343 216
Computer equipment 1,397 898
Controller placements 2,637 --
Furniture and fixtures 332 205
Leasehold improvements 271 148
---------- ----------
6,652 2,590
Less accumulated depreciation and amortization (2,092) (1,178)
---------- ----------
$ 4,560 $ 1,412
========== ==========
</TABLE>
<TABLE>
<CAPTION>
(in thousands) January 2, 1999 January 3, 1998
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Equipment acquired under capital leases included in property and equipment above:
Machinery and equipment $ 109 $ 109
Computer equipment 217 --
Less accumulated depreciation (99) (85)
---------- ----------
$ 227 $ 24
========== ==========
</TABLE>
49
<PAGE> 49
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
4. BALANCE SHEET DETAIL, CONTINUED:
<TABLE>
<CAPTION>
(in thousands) January 2, 1999 January 3, 1998
- ----------------------------------------------------------------------------------
<S> <C> <C>
Accrued liabilities:
Accrued professional fees $ 150 $ 164
Accrued warranty 302 316
Other 1,282 192
---------- ----------
$ 1,734 $ 672
========== ==========
</TABLE>
5. COMMITMENTS:
Capital Leases The company has entered into capital lease agreements to
lease certain computer and related equipment. At January 2, 1999, the total
future minimum payments under capital leases is $239,000 with $28,000
representing interest.
<TABLE>
<S> <C>
1999 $ 74
2000 74
2001 74
2002 17
</TABLE>
Operating Leases The company leases its facilities and certain equipment
under operating leases. The company recognizes rent expense on a straight-line
basis over the lease term. At January 2, 1999, total future minimum lease
payments are as follows (in thousands):
<TABLE>
<S> <C>
1999 $ 583
2000 631
2001 645
2002 110
</TABLE>
Rent expense for the years ended January 2, 1999, January 3, 1998 and
December 28, 1996 was $437,000, $349,000 and $345,000, respectively.
6. SUPPLEMENTAL CASH FLOW DISCLOSURES:
<TABLE>
<CAPTION>
Year Ended
- ------------------------------------------------------------------------------------------------------------------------
(in thousands) January 2, 1999 January 3, 1998 December 28, 1996
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Non-cash financing and investing activities:
Additions to property and equipment acquired
under capital lease $ 217 -- --
Cash paid during the period for:
Interest 1 $ 5 $ 9
Income Taxes 1 1 1
</TABLE>
50
<PAGE> 50
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. STOCKHOLDERS' EQUITY:
Preferred Stock Under the company's Articles of Incorporation, the company
is authorized to issue preferred stock. At January 2, 1999, 5,000,000 shares of
preferred stock were authorized and no preferred stock was issued and
outstanding as the previously outstanding preferred stock was converted into
common stock in connection with the company's initial public offering during
1996.
Stock Option Plans In May 1993, the company approved the 1993 Stock Plan
(1993 Plan) under which the Board of Directors of the company is authorized and
directed to enter into stock option agreements with selected individuals.
136,000 shares were authorized at the inception of the Plan with 250,000, and
1,150,025 additional shares authorized in 1994, and 1995, respectively. In May
1998, the stockholders of the company approved an increase in the number of
shares reserved for issuance under the Plan by an aggregate of 750,000 shares
for a total of 2,286,025. Options granted under the 1993 Plan generally become
exercisable over a 48-month period.
Activity under the 1993 Plan is as follows:
<TABLE>
<CAPTION>
Shares Outstanding Options
Available ----------------------------------
For Number Weighted-Average
Grant of Shares Exercise-Price
- ---------------------------------------------------------------------------------------------
<S> <C> <C> <C>
BALANCES, DECEMBER 31, 1995 1,020,925 491,350 $ 1.69
Options granted (217,575) 217,575 $ 13.18
Options exercised -- (106,735) $ 0.32
Options canceled 58,092 (58,092) $ 3.87
---------- ----------
BALANCES, DECEMBER 28, 1996 861,442 544,098 $ 6.32
Options granted (723,300) 723,300 $ 8.43
Options exercised -- (74,166) $ 2.71
Options canceled 162,203 (162,203) $ 5.43
---------- ----------
BALANCES, JANUARY 3, 1998 300,345 1,031,029 $ 8.20
Additional shares authorized 750,000 --
Options granted (601,950) 601,950 $ 15.17
Options exercised -- (89,927) $ 6.52
Options canceled 111,650 (111,650) $ 8.89
---------- ----------
BALANCES, JANUARY 2, 1999 560,045 1,431,402 $ 11.18
========== ==========
</TABLE>
At January 2, 1999 and January 3, 1998, there were 469,000 and 314,000
options, respectively, exercisable under the 1993 Plan.
In December 1995, the company adopted the Director Option Plan (Director
Plan) and reserved 100,000 shares of common stock for issuance to directors
under this plan. The plan allows for an initial grant and automatic annual
grants of options to outside directors of the company. As of January 2, 1999 and
January 3, 1998 outstanding options under the Director Plan were 33,000 and
24,000, respectively, with 25,875 options exercisable as of January 2, 1999.
In February 1995, pursuant to a restricted stock purchase agreement,
100,000 shares of common stock were purchased by an officer of the company at
$0.32 per share. The restricted stock purchase agreement contains provisions for
the repurchase of common stock by the company in the event of termination of
51
<PAGE> 51
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. STOCKHOLDERS' EQUITY CONTINUED:
employment during the four years following the date of the agreement. At January
2, 1999, 1,667 shares were subject to repurchase under this restricted stock
purchase agreement. Those shares were released from the purchase restriction in
January 1999.
In August 1995, 90,000 shares of common stock were purchased by an officer
of the company at $0.80 per share pursuant to a restricted stock purchase
agreement. The restricted stock purchase agreement contains provisions for the
repurchase of common stock by the company in the event of termination of
employment during the four years following the date of the agreement. At January
2, 1999, 10,938 shares were subject to repurchase under this restricted stock
purchase agreement. These shares will continue to be released ratably over the
remaining period.
Employee Stock Purchase Plan. In December 1995, the company approved the
Employee Stock Purchase Plan and reserved 150,000 shares of common stock for
issuance under this plan. For the years ended January 2, 1999 and January 3,
1998, 13,545 shares and 16,865 shares of common stock were sold under the
Employee Stock Purchase Plan, respectively.
Warrants In January 1998, the company issued a warrant to purchase 80,000
shares of common stock at a purchase price of $12.00 per share to certain
foreign employees. The warrant becomes exercisable over a four-year period.
Shareholders Rights Plan. In November 1996, the Board of Directors
approved a Shareholders Rights Plan declaring a dividend distribution of one
Preferred Share Purchase Right for each outstanding share of the company's
Common Stock. Each right will entitle stockholders to buy one-thousandth of one
share of the company's Series A Participating Preferred Stock at an exercise
price of $50.00. This Plan was designed to assure that the company's
stockholders receive fair and equal treatment in the event of any proposed
takeover of the company and to guard against partial tender offers and other
abusive tactics to gain control of the company without paying all stockholders
the fair value of their shares, including a "control premium".
Stock-Based Compensation. The company has adopted the disclosure-only
provisions of SFAS No. 123 "Accounting for Stock-Based Compensation" and
continues to account for options granted to employees under APB Opinion No. 25,
"Accounting for Stock Issued to Employees." Had compensation cost for the 1993
Plan, the Director Plan and the Employee Stock Purchase Plan been determined
based on the fair value at the grant date for awards in fiscal year 1998, 1997
and 1996 consistent with the provisions of SFAS No. 123, the company's net loss
per common share and per common share-assuming dilution for the years ended
January 2, 1999, January 3, 1998 and December 28, 1996 would have been increased
to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
Year Ended
---------------------------------------------------------------
(in thousands, except per share data) January 2, 1999 January 3, 1998 December 28, 1996
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net loss -- as reported $2,141 $7,688 $7,705
Net loss -- pro forma $3,650 $8,466 $7,962
Net loss per common share as reported $ 0.24 $ 0.87 $ 0.97
Net loss per common share pro forma $ 0.41 $ 0.96 $ 1.00
</TABLE>
52
<PAGE> 52
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
7. STOCKHOLDERS' EQUITY CONTINUED:
The effects of the pro forma disclosure of applying SFAS No. 123 are not likely
to be representative of the effects of the pro forma disclosures of future
years. Because SFAS No. 123 reflects only options granted after January 1, 1995,
the pro forma effect will not be fully reflected until 1999.
The fair value of each option grant is estimated on the date of grant using the
Black Scholes model with the following weighted average assumptions:
<TABLE>
<S> <C>
Risk-free interest rate 4.98% - 7.13%
Expected life 4 years
Expected dividends ---
Expected volatility 52%
</TABLE>
The options outstanding and currently exercisable by exercise price for both the
1993 Plan and the Director Plan at January 2, 1999 are as follows (in thousands,
except per share data and contractual life):
<TABLE>
<CAPTION>
Options Outstanding Options Currently Exercisable
- ------------------------------------------------------------------- -----------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 0.20 40,059 4.4 $ 0.20 40,059 $ 0.20
$ 0.32-$ 0.40 39,615 6.3 $ 0.39 35,777 $ 0.39
$ .80 7,725 6.5 $ 0.80 6,599 $ 0.80
$ 1.60 23,450 6.6 $ 1.60 20,242 $ 1.60
$ 3.00 2,750 6.7 $ 3.00 2,286 $ 3.00
$ 3.01-$ 7.38 141,664 7.5 $ 6.97 73,351 $ 6.96
$ 7.39-$11.88 707,035 8.2 $ 9.68 246,581 $ 9.44
$11.89-$19.75 474,454 9.2 $ 16.69 52,062 $ 16.79
$19.76-$24.25 27,650 7.4 $ 24.25 18,198 $ 24.25
--------- -------
1,464,402 8.3 $ 11.26 495,155 $ 8.53
========= =======
</TABLE>
7. STOCKHOLDERS' EQUITY CONTINUED:
Deferred compensation recognized as a result of stock options granted and
common stock issued subject to repurchase provisions as of January 2, 1999 is
$1,047,000. Deferred compensation is generally amortized over vesting periods of
one to four years, which resulted in compensation expense of $160,000, $160,000
and $167,000 recognized in the years ended January 2, 1999, January 3, 1998 and
December 28, 1996, respectively.
8. RELATED PARTIES:
In connection with the formation of the company, several of the founders
and a partnership of the founders entered into a licensing agreement to
facilitate patent transfers. As a result, the company acquired an exclusive
worldwide perpetual royalty-free license, with right of sublicense, to make, use
and sell products and use patent methods covered by the patent rights limited to
surgical orthopedic and arthroscopic applications.
Also in connection with its incorporation, the company entered into a
consulting agreement with a consulting and research firm, which is headed by one
of the company's founders. This consulting and research firm was contracted to
perform research related to the development of hand-held instruments used
53
<PAGE> 53
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
8. RELATED PARTIES CONTINUED:
in arthroscopic procedures. Research and development costs incurred on this
contract in fiscal 1998, 1997 and 1996 were approximately $392,000, $457,000 and
$456,000, respectively.
In January 1995, the company loaned to an officer $120,000 pursuant to a
provision in the officer's employment agreement. The resulting promissory note
bears interest at 6% per annum and is due on the earlier of January 31, 1999 or
termination of employment. In December 1998, the officer paid the note in full.
In February 1995, the company agreed to loan this officer up to an additional
$144,000 in monthly increments of $3,000 at 6% per annum. In December 1997, the
company amended this officer's employment agreement to terminate the increments
effective January 31, 1998 and forgive 10% of the principal and interest at the
end of each fiscal year in which the officer is employed by the company and in
which the company meets certain performance targets. During fiscal year 1997,
$11,000 of principal and interest was forgiven. At January 2, 1999, $99,000 of
principal and interest was outstanding on this note. Both aforementioned notes
are secured by shares of the company's common stock and a mortgage on the
officer's residence and as of February 1999 have been paid in full.
In December 1995, the company loaned an employee $62,000 pursuant to a
provision in the employee's employment agreement. The resulting promissory note
bears interest at the rate of 6% per annum and is due on the earlier of July 24,
2000 or the termination of employment. The note also permits the company to loan
this employee up to an additional $34,000 in $2,000 monthly increments. The
aforementioned notes are secured by a pledge of this employee's option for
50,000 shares of the company's common stock and any shares issued upon exercise
of such options. In May 1997, all principal and interest were repaid in full.
In June 1997, the company loaned an officer $500,000 pursuant to a
provision in the officer's employment agreement. The promissory note, which
bears no interest, is secured by a mortgage on the officer's residence and is
due and payable upon either the officer's termination of employment or the sale
of the officer's residence. If the officer is terminated by the company or the
company is acquired, the loan is due and payable within 12 months thereafter. As
of January 2, 1999, $500,000 of principal was outstanding on this note.
In November 1997, the company issued a relocation loan of $130,000 to an
employee. This loan is secured by the employee's residence and is due and
payable upon either the sale or transfer of the property or the termination of
the officer's employment with the company. As of January 2, 1999, $130,000 of
principal was outstanding on this loan.
9. INCOME TAXES:
At January 2, 1999, the company has approximately $18,700,000 and
$6,100,000 in federal and state net operating loss carryforwards, respectively,
which expire in the years 2004 through 2018 and 2000 through 2003, respectively.
The Tax Reform Act of 1986 substantially changed the rates relative to net
operating loss and tax credit carryforwards in the case of an "ownership change"
of a corporation. Any ownership changes, as defined, may restrict utilization of
carryforwards.
Temporary differences and carryforwards which gave rise to significant
portions of deferred tax assets and liabilities are as follows (in thousands):
54
<PAGE> 54
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
<TABLE>
<CAPTION>
January 2, 1999 January 3, 1998
--------------- ---------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 6,726 $ 5,612
Capitalized research and development costs 1,067 1,154
Capitalized start-up costs 323 499
Research and development credit 1,120 567
Allowances and reserves 2,093 1,806
------------ ------------
Deferred tax assets 11,329 9,638
Less: valuation allowance (11,329) (9,638)
------------ ------------
Net deferred tax assets $ -- $ --
============ ============
</TABLE>
In accordance with generally accepted accounting principles, a valuation
allowance must be established for a deferred tax asset if it is more likely than
not that a tax benefit may not be realized from the asset in the future. The
company has established a valuation allowance to the extent of its deferred tax
assets since it is more likely than not that a benefit can not be realized in
the future due to the company's recurring operating losses.
10. EMPLOYEE BENEFIT PLAN:
The company maintains a Retirement Savings and Investment Plan (401(k)
Plan) which covers substantially all employees. Eligible employees may defer
salary (before tax) up to a specified maximum. The company, at its discretion,
may make matching contributions on behalf of the participants in the 401(k)
Plan. To date, the company has not made any contributions to the 401(k) Plan.
11. SEGMENT INFORMATION:
The company is organized into four segments on the basis of product
markets, Arthroscopy, ENTec, Visage and AngioCare. To date, substantially all
the company's product revenue was related to the Arthroscopic segment. During
fiscal 1998, approximately $2.6 million of the company's license revenue was
attributable to the AngioCare segment, $0.4 million was attributable to the
ENTec segment and $0.3 million was attributable to the Visage segment. Export
sales were approximately $2.3 million during fiscal 1998 and $0.9 million for
fiscal 1997.
12. BUSINESS COLLABORATIONS
During the year ended January 2, 1999, the company formed a new business
division, AngioCare(TM) for the purpose of commercializing the company's
technology in the cardiac and interventional cardiology markets. 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(TM) technology for myocardial revascularization
procedures. Under the agreement, BSC has paid license fees to the company based
upon achievement of designated milestones and royalties on sales of resulting
products. The first nonrefundable license payment of $3.0 million was received
during 1998 of which $2.6 million was recognized as license revenue.
In May 1998, the company announced that it had entered the
otorhinolaryngology (ear, nose and throat) market, and that it has formed a new
business unit called ENTec(TM) to commercialize the 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(TM) products in the
otorhinolaryngology market. This agreement was terminated by the company in
February 1999.
55
<PAGE> 55
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
13. SUBSEQUENT EVENT:
In January 1999, the company entered into an exclusive worldwide license
and OEM agreement with Collagen to market and distribute ArthroCare's
Coblation-based product line for cosmetic, dermatologic and aesthetic surgical
applications. On February 8, 1999, the company announced that Collagen had
acquired expanded, exclusive, worldwide rights to market ArthroCare's Cosmetic
Surgery System to all physicians practicing dermatology, and cosmetic and facial
plastic surgery including ear, nose, and throat physicians who perform such
procedures.
14. EVENT SUBSEQUENT TO THE DATE OF THE INDEPENDENT ACCOUNTANT'S REPORT
(UNAUDITED)
On February 4, 1999, Xomed Surgical Products 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 Comed
and the Company (see the description of this contract referenced elsewhere in
the 10K). This license and distribution agreement was terminated by the Company
on February 5, 1999. The Company believes that the suit is without merit, and
filed a Motion to Dismiss on February 24, 1999.
56
<PAGE> 56
ARTHROCARE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS, Continued
SCHEDULE II
ARTHROCARE CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
<TABLE>
<CAPTION>
COLUMN A COLUMN COLUMN COLUMN COLUMN
B C D E
ADDITIONS
CHARGED
BALANCE AT TO COSTS BALANCE AT
BEGINNING OF AND END OF
PERIOD EXPENSES DEDUCTION PERIOD
------------ --------- --------- ----------
<S> <C> <C> <C> <C>
YEAR ENDED JANUARY 2, 1999 Deducted from asset accounts:
Allowance for doubtful accounts and product
returns $ 594 $(125) -- $ 469
Allowance for excess and obsolete inventory 349 (26) -- 323
YEAR ENDED JANUARY 3, 1998 Deducted from asset accounts:
Allowance for doubtful accounts and product
returns $ 318 $ 276 $-- $ 594
Allowance for excess and obsolete inventory 100 249 -- 349
YEAR ENDED DECEMBER 28, 1996 Deducted from asset accounts:
Allowance for doubtful accounts and product
returns $ 5 $ 313 $-- $ 318
Allowance for excess and obsolete inventory 50 50 -- 100
</TABLE>
57
<PAGE> 57
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized:
ARTHROCARE CORPORATION
a Delaware Corporation
By: /s/ MICHAEL A. BAKER
-----------------------------------
Michael A. Baker
President and Chief Executive Officer
Date: April 2, 1999
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints each of Michael A Baker and Christine E.
Hanni as his attorney-in-fact for him, in any and all capacities, to sign each
amendment to this Report on Form 10-K, and to file the same, with exhibits
thereto and other documents in connection therewith, with the Securities and
Exchange Commission, hereby ratifying and confirming all that said
attorney-in-fact or his substitute or substitutes may lawfully do or cause to be
done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated:
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ MICHAEL BAKER President, Chief Executive Officer and Director April 2, 1999
- -----------------------------------------
Michael Baker (Principal Executive Officer)
/s/ CHRISTINE E. HANNI Chief Financial Officer and Assistant Secretary April 2, 1999
- -----------------------------------------
Christine E. Hanni (Principal Financial and Accounting Officer)
/s/ HIRA V. THAPLIYAL Director April 2, 1999
- -----------------------------------------
Hira V. Thapliyal
/s/ ANNETTE J. CAMPBELL-WHITE Director April 2, 1999
- -----------------------------------------
Annette J. Campbell-White
/s/ PHILIP E. EGGERS Director April 2, 1999
- -----------------------------------------
Philip E. Eggers
/s/ C. RAYMOND LARKIN, Jr. Director April 2, 1999
- -----------------------------------------
C. Raymond Larkin, Jr.
/s/ JOHN S. LEWIS Director April 2, 1999
- -----------------------------------------
John S. Lewis
/s/ ROBERT R. MOMSEN Director April 2, 1999
- -----------------------------------------
Robert R. Momsen
</TABLE>
58
<PAGE> 58
ARTHROCARE CORPORATION
Report on Form 10-K for
the year ended January 2, 1999
INDEX TO EXHIBITS*
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT NAME
------- ------------
<S> <C>
10.27++ License Agreement dated February 9, 1998, between the
Registrant and Collagen Aesthetics Corporation.
10.28 Change of Control Agreement between the Registrant and
the CEO.
10.29 The Form of "VP Continuity Agreement" between the
Registrant and its Vice Presidents.
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants.
24.1 Power of Attorney (see page 53).
27.1 Financial Data Schedule.
</TABLE>
o Only exhibits actually filed are listed. Exhibits incorporated by
reference are set forth in the exhibit listing included in Item 14 of the
Report on Form 10-K.
59
<PAGE> 1
[ARTHROCARE LOGO]
LICENSE AND DISTRIBUTION AGREEMENT
This License and Distribution Agreement (the "Agreement") effective as
of January 27, 1999 (the "Effective Date") is entered into by and between
ArthroCare Corporation, on its own behalf and on behalf of its Affiliates
("ArthroCare"), a Delaware corporation having an address at 595 North Pastoria
Avenue, Sunnyvale, California 94086, and Collagen Aesthetics, Inc., on its own
behalf and on behalf of its Affiliates ("Collagen"), a Delaware corporation
having an address at 1850 Embarcadero Road, Palo Alto, California 94303.
BACKGROUND
A. ArthroCare owns certain Patent Rights (as defined in Article
1.21) relating to radio frequency ("RF") energy;
B. Collagen is a worldwide leader in marketing products for
dermatology, facial plastic surgery, cosmetic and aesthetic surgery;
C. Collagen desires to obtain a license under the Patent Rights
in order to commercialize Licensed Products in the Field, and ArthroCare desires
to grant such a license to Collagen, all on the terms and conditions set forth
herein; and
D. ArthroCare shall be Collagen's exclusive third party contract
manufacturer for certain Licensed Products and/or components of such Licensed
Products, all on the terms and conditions set forth herein.
NOW, THEREFORE, in consideration of the promises and the mutual
covenants contained herein, the parties agree as follows:
ARTICLE 1
DEFINITIONS
1.1
1.2 "Affiliate" means any corporation or other entity which is
directly or indirectly controlling, controlled by or under the common control
with a party hereto. For the purpose of
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<PAGE> 2
this Agreement, "control" shall mean the direct or indirect ownership of at
least 50% of the outstanding shares or other voting rights of the subject entity
to elect directors, or if not meeting the preceding definition, any entity owned
or controlled by or owning or controlling at the maximum control or ownership
right permitted in the country where such entity exists.
1.3
1.4
1.5
1.6 "Co-exclusive ENT License Rights" shall mean a co-exclusive,
non-transferable, worldwide license under the Patent Rights and the Trademark
Rights, with the right to use, market, sell and distribute Licensed Products in
the "ENT Field". The term "co-exclusive" shall mean that only Collagen and one
other party (which may include ArthroCare) shall have such rights.
1.7 "Competent Authority" shall mean an EU Member States' public
officer with jurisdiction to appoint a body to test or audit medical devices for
conformity to EU registration laws.
1.8 "Confidential Information" shall mean any: (i) information or
material in tangible form disclosed hereunder that is marked as "Confidential"
at the time it is delivered to the receiving party; or (ii) information
disclosed orally hereunder which is identified as confidential or proprietary
when disclosed.
1.9 "Controller(s)" shall mean an RF power supply.
1.10 "Disposable Wand(s)" shall mean medical instruments and
components of such medical instruments certain of which may have one or more
electrode(s) and electrical connection(s) for coupling the electrode(s) to a
Controller.
1.11 "ENT" shall mean ear, nose and throat.
1.12
1.13 "Exclusive ENT License Rights" shall mean an exclusive,
non-transferable, worldwide license under the Patent Rights and the Trademark
Rights, with the right to use, market, sell and distribute Licensed Products in
the ENT Field.
1.14 "FDA" shall mean the U.S. Food and Drug Administration.
1.15
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<PAGE> 3
1.16
1.17 "Marketing Authorizations" shall mean any regulatory approvals
or authorizations required by the FDA, Competent Authority or other regulatory
bodies to comply with the laws and regulations of any country or other
jurisdiction for sale, marketing and distribution of the Licensed Products.
1.18
1.19 "Net Sales" shall mean the invoice price of Licensed Products
sold by Collagen to unaffiliated third parties (including sales made in
connection with clinical trials), less, to the extent included in such invoice
price the total of: (1) ordinary and customary trade discounts actually allowed;
(2) credits, rebates and returns (including, but not limited to, wholesaler and
retailer returns); (3) freight, postage, insurance and duties paid for and
separately identified on the invoice or other documentation maintained in the
ordinary course of business, and (4) excise taxes, other consumption taxes,
customs duties and compulsory payments to governmental authorities actually paid
and separately identified on the invoice or other documentation maintained in
the ordinary course of business. Net Sales shall also include the fair market
value of all other consideration received by Collagen in respect of Licensed
Products, whether such consideration is in cash, payment in kind, exchange or
another form.
1.20 "Notified Body" shall mean that body appointed by a Competent
Authority to test or audit medical devices for conformity with EU registration
laws.
1.21 "Patent Rights" shall mean all patents and patent applications
in the Field owned by or licensed to ArthroCare, including, but not limited to,
the patent applications and patents listed on Exhibit A hereto; all priority
applications, divisionals, continuations, continuations-in-part, and
substitutions thereof; all patent applications and patents relating to
improvements thereof; all foreign patent applications corresponding to the
preceding applications; and all U.S. and foreign patents issuing on any of the
preceding applications, including extensions, reissues, and re-examinations. In
addition, the term "Patent Rights" includes any and all, inventions,
discoveries, know-how, trade secrets, data, information, technology, processes,
formulas, drawings, designs, computer programs, and licenses of ArthroCare which
are necessary or useful for designing, developing, manufacturing, using or
selling Licensed Products within the Field, and all amendments, modifications,
and improvements to any of the foregoing.
1.22
1.23 "RF" shall mean radiofrequency.
1.24 "Trademark Rights" shall mean all registered trademarks,
trademark applications, common law trademarks, domestic or foreign, to the marks
listed in Exhibit E, all foreign
-3-
<PAGE> 4
trademark applications or registrations corresponding to the preceding
applications, and all marks similar thereto.
1.25
ARTICLE 2
LICENSE
2.1 Exclusive License Grant. Subject to the terms and conditions
of this Agreement, ArthroCare and its Affiliates hereby grant to Collagen and
its Affiliates an exclusive, non-transferable, worldwide license under the
Patent Rights, to import, have imported, use, offer for sale and sell Licensed
Products in the Field. ArthroCare hereby grants to Collagen and its Affiliates
an exclusive, non-transferable, worldwide license under the Trademark Rights to
use marks and tradenames within the Trademark Rights in connection with the sale
of Licensed Products in the Field.
2.2 No Implied Rights. Only the licenses granted pursuant to the
express terms of this Agreement shall be of any legal force or effect. No other
license rights shall be granted or created by implication, estoppel or
otherwise.
2.3 Exclusive to ArthroCare. Under the exclusive license granted
by ArthroCare to Collagen in section 2.1, ArthroCare shall not have the right to
import, have imported, use, offer for sale or sell Licensed Products in the
Field during the Term of this Agreement and any renewals thereof;
2.4
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<PAGE> 5
ARTICLE 3
APPOINTMENT AND AUTHORITY OF COLLAGEN
3.1 Exclusive Distributor. Subject to the terms and conditions
herein, ArthroCare hereby appoints Collagen as ArthroCare's authorized exclusive
worldwide sales distributor for the Licensed Products in the Field, and Collagen
hereby accepts such appointment. Collagen's sole authority shall be to purchase
Licensed Products from ArthroCare and to promote, market and resell such
Licensed Products in the Field in accordance with the terms of this Agreement.
3.2
3.3 Reservation of Rights; No Rights Beyond Licensed Products.
Except as expressly provided in this Article 3, and by the license granted in
Article 2, no right, title, or interest is granted, whether express or implied,
by ArthroCare to Collagen, and nothing in this Agreement shall be deemed to
grant to Collagen rights in any Licensed Products or technology other than the
Licensed Products, nor shall any provision of this Agreement be deemed to
restrict ArthroCare's rights to exploit technology, know-how, patents or any
other intellectual property rights relating to the Licensed Products outside of
the Field.
3.4 Sale Conveys No Right to Manufacture or Copy. The Licensed
Products are offered for sale and are sold by ArthroCare subject in every case
to the condition that such sale does not convey any license, expressly or by
implication, to manufacture, duplicate or otherwise copy or reproduce any of the
Licensed Products.
3.5
3.6
ARTICLE 4
ENT RIGHTS
4.1 Exclusive ENT License Rights. In addition to the above rights
and licenses, if
-5-
<PAGE> 6
ArthroCare is able to, ArthroCare will offer the "Exclusive ENT License Rights"
to Collagen. In such event, Collagen will accept such rights
If ArthroCare offers and Collagen accepts the Exclusive ENT License Rights,
Collagen will have, in combination with the rights granted in section 2, an
exclusive, non-transferable, worldwide license under the Patent Rights and the
Trademark Rights, with the right to use, market, sell and distribute Licensed
Products to all physicians in the Field and the ENT Field.
In addition, if ArthroCare offers and Collagen accepts the Exclusive ENT License
Rights, Collagen's minimum annual royalty payments for Disposable Wands and
minimum purchase requirements for the Licensed Products will be increased
pursuant to sections 5.3(b) and 7.5(b), respectively.
4.2 Co-exclusive ENT License Rights. In addition to the above
rights and licenses, if ArthroCare is able to, ArthroCare will offer the
"Co-exclusive ENT License Rights" to Collagen. In such event, Collagen will
accept such rights.
In addition, if ArthroCare offers and Collagen accepts the Co-exclusive ENT
License Rights, Collagen's minimum annual royalty payments for Disposable Wands
and minimum purchase requirements for the Licensed Products will be increased
pursuant to sections 5.3(c) and 7.5(c), respectively.
-6-
<PAGE> 7
ARTICLE 5
CONSIDERATION
5.1 License Fee. In partial consideration for the license granted
herein, Collagen shall pay ArthroCare a license fee of in accordance with
the schedule set forth in Section 5.1(b).
(a) The parties hereto acknowledge and agree that
Collagen has paid and ArthroCare has accepted of such license fee.
(b) License Payment Schedule. Within three (3) days
following the Effective Date of this Agreement, Collagen shall make a payment to
ArthroCare of . In addition, within thirty (30) days following the
achievement by ArthroCare of each of the following milestones, Collagen shall
pay to ArthroCare the applicable payments below:
5.2 ROYALTIES. AS ADDITIONAL CONSIDERATION FOR THE RIGHTS AND
LICENSES GRANTED BY ARTHROCARE TO COLLAGEN HEREIN, COLLAGEN SHALL PAY TO
ARTHROCARE RUNNING ROYALTIES ON
(a)
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<PAGE> 8
5.3 Minimum Royalties.
(a) If ArthroCare does not offer to Collagen either the
Exclusive ENT License Rights or the Co-exclusive ENT License Rights pursuant to
sections 4.1 and 4.2, respectively, then, in addition to the license payments
made by Collagen pursuant to Section 5.1, Collagen's minimum annual royalty
payments for the Licensed Products
(b) If ArthroCare offers to Collagen, and Collagen
accepts, the Exclusive ENT License Rights pursuant to section 4.1, then, in
addition to the license payments made by Collagen pursuant to Section 5.1,
Collagen's minimum annual royalty payments for the Licensed Products
(c) If ArthroCare offers to Collagen, and Collagen
accepts, the Co-exclusive ENT License Rights pursuant to section 4.2, then, in
addition to the license payments made by Collagen pursuant to Section 5.1,
Collagen's minimum annual royalty payments for the Licensed Products
(d)
(e) In the event the Agreement is renewed pursuant to
Section 18.1, the minimum annual royalty for each renewal year will be mutually
agreed upon in writing by the parties. If the new minimums cannot be agreed upon
by the parties, an arbitrator will be appointed by the parties to determine the
new minimums according to Article 21.
(f)
-8-
<PAGE> 9
ARTICLE 6
-9-
<PAGE> 10
ARTICLE 7
MANUFACTURE; PURCHASE OF LICENSED PRODUCTS
7.1 Product Manufacture. ArthroCare shall manufacture and sell to
Collagen, and Collagen agrees to exclusively purchase from ArthroCare,
Collagen's requirements for Licensed Products in the Field. ArthroCare will
manufacture Licensed Products in accordance with ISO 9000 Standards, EN 46000
Standards, FDA Quality Systems Regulations (including Current Good Manufacturing
Practices), and requirements of the Medical Device Directives ("MDD") and the
then-current product specifications, as may be modified from time to time by the
mutual written consent of the parties hereto.
7.2 Product Development. During the Term of this Agreement,
ArthroCare, at its expense and initiative, will continue to pursue clinical
studies and product development efforts in collaboration with Collagen.
ArthroCare shall supply Collagen with any improvements and upgrades to the
Licensed Products developed by ArthroCare for use in the Field. ArthroCare
agrees that any substantial change to the Licensed Products during the Term
shall be subject to Collagen's prior written approval, which shall not be
unreasonably withheld.
ArthroCare agrees to supply Collagen documentation or information as
requested for such changes to the Licensed Products in meeting regulatory
compliances.
7.3 Terms and Conditions. All product purchases hereunder shall be
subject to the terms and conditions of this Agreement. Unless otherwise agreed
in writing, nothing contained in any purchase order or other document submitted
pursuant to this Agreement shall in any way modify or add to the terms and
conditions contained in this Agreement.
7.4 Order and Acceptance. All orders shall be by means of signed
written purchase orders, sent to ArthroCare at ArthroCare's address for notice
hereunder and requesting a delivery date that is consistent with the Forecasts
and not less than thirty (30) days after ArthroCare's receipt of such purchase
order. Orders may initially be placed by telephone or telecopy, provided that a
signed written confirming purchase order is received by ArthroCare within ten
(10) days after such telephonic or telegraphic order. ArthroCare shall use
reasonable best efforts to fulfill purchase orders submitted in accordance with
ArthroCare's lead times, it being understood that no purchase order shall be
binding upon ArthroCare until accepted by ArthroCare by telecopy or in writing,
and ArthroCare shall have no liability to Collagen with respect to purchase
orders that are not accepted. ArthroCare shall acknowledge each Order in writing
within 10 business days of receipt. By written notice given within such 10-day
period, ArthroCare may reject any Order, but only to the extent that the Order
exceeds the applicable, then-current Forecast, consistent with Section 8.1.
Notice of rejection must be given within 10 days to Collagen by telex or fax,
followed by notification in writing. Once an Order is accepted by ArthroCare,
Collagen may cancel or reschedule such Order only with approval of ArthroCare.
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<PAGE> 11
7.5 Minimum Purchase Requirements.
(a) If ArthroCare does not offer to Collagen either the
Exclusive ENT License Rights or the Co-exclusive ENT License Rights pursuant to
sections 4.1 and 4.2, respectively, then, in addition to the minimum royalty
payments made by Collagen pursuant to Section 5.3, Collagen's minimum annual
purchase requirements for the Licensed Products
(b) If ArthroCare offers to Collagen, and Collagen
accepts, the Exclusive ENT License Rights pursuant to section 4.1, then, in
addition to the minimum royalty payments made by Collagen pursuant to Section
5.3, Collagen's minimum annual purchase requirements for the Licensed Products
(c) If ArthroCare offers to Collagen, and Collagen
accepts, the Co-exclusive ENT License Rights pursuant to section 4.2, then, in
addition to the minimum royalty payments made by Collagen pursuant to Section
5.3, Collagen's minimum annual purchase requirements for the Licensed Products
(d)
(e) In the event the Agreement is renewed pursuant to
Section 18.1, the minimum annual purchase requirements for each renewal year
will be mutually agreed upon in writing by the parties. If the new minimums
cannot be agreed upon by the parties, an arbitrator will be appointed by the
parties to determine the new minimums according to Article 21.
(f)
7.6
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<PAGE> 12
ARTICLE 8
FORECASTS; NO BACKORDERS
8.1 Forecasts. Commencing no later than thirty (30) days after the
achievement by ArthroCare of milestone one (1) in section 5.1(b), Collagen shall
furnish ArthroCare a 6-month Forecast with estimated purchase dates and
quantities of Licensed Products, and shall deliver an updated forecast on a
rolling basis on the first day of each month. Such forecasts shall include
monthly delivery schedules. Based on the then current Forecast, ArthroCare will
maintain its production capability and adequate materials and labor to meet the
forecasted monthly delivery schedule for Licensed Products. ArthroCare shall
release Licensed Products in accordance with the delivery schedule set forth on
the then current Forecast;
8.2
ARTICLE 9
PAYMENTS
9.1 Prices. All prices shall be F.C.A. ArthroCare's facility
currently located at the address listed for ArthroCare at the beginning of this
Agreement ("F.C.A. Point"). ArthroCare may, upon thirty (30) days' notice to
Collagen, designate another facility as the F.C.A. Point. The difference between
Collagen's purchase price and Collagen's price to its Customers shall be
Collagen's sole remuneration for the sale of the Licensed Products. The initial
price to Collagen for each Licensed Product shall be as set forth in Exhibit B
attached hereto. Collagen's sales prices to its customers shall be subject to
Collagen's sole discretion.
-12-
<PAGE> 13
9.2 Taxes. Collagen's purchase price shall not include any
government taxes (including, without limitation, sales, use, excise,
withholding, and value-added taxes) or duties imposed by any governmental agency
that are applicable to the export, import, license or purchase of the Licensed
Products (other than taxes on the income of ArthroCare), and Collagen shall bear
all such taxes and duties. When ArthroCare has the legal obligation to collect
and/or pay such taxes, the appropriate amount shall be added to Collagen's
invoice and paid by Collagen, unless Collagen provides ArthroCare with a valid
tax exemption certificate authorized by the appropriate taxing authority.
9.3 Invoicing. ArthroCare shall submit an invoice to Collagen upon
shipment of each Licensed Product ordered by Collagen. Each such invoice shall
state Collagen's aggregate and unit purchase price for Licensed Products in a
given shipment, plus any freight, taxes or other costs incident to the purchase
or shipment initially paid by ArthroCare but to be borne by Collagen hereunder.
9.4 Payment and Terms. Collagen shall make payments to ArthroCare
under this Agreement by wire transfer or check in United States dollars in
immediately available funds to a bank designated by ArthroCare. Payment shall be
9.5 Shipping. All Licensed Products delivered pursuant to the
terms of this Agreement shall be suitably packed for shipment in ArthroCare's
standard shipping cartons, marked for shipment at Collagen's address set forth
above (unless otherwise agreed in writing by both parties), and delivered to
Collagen or its carrier agent at the F.C.A. Point, at which time risk of loss
shall pass to Collagen. The Licensed Products will be produced to the final
saleable form with Collagen's trade address, tradenames, and all language
compliant labeling, instructions for use and carton labeling affixed by
ArthroCare. Unless otherwise instructed in writing by Collagen, ArthroCare shall
select the carrier. Collagen agrees to undertake all import formalities required
to import the Licensed Products into the territory. All customs, freight,
insurance, and other shipping expenses, as well as any special packing expense,
shall be paid by Collagen. Collagen shall also bear all applicable taxes,
duties, and similar charges that may be assessed against the Licensed Products
after delivery to the carrier at the F.C.A. Point. All shipments and freight
charges shall be deemed correct unless ArthroCare receives from Collagen after
the shipping date of a given shipment, a written notice specifying the shipment,
the purchase order number, and the exact nature of the discrepancy between the
order and shipment or discrepancy in the freight cost, as applicable.
9.6 Records; Audit. Collagen shall keep complete, true and
accurate books of account and records for the purpose of determining the amounts
payable under Article 5 and Exhibit B. Such books and records shall be kept at
Collagen's principal place of business for at least three (3) years following
the end of the calendar quarter to which they pertain. Such records will be open
for inspection during such three (3)-year period by a representative or agent of
ArthroCare for the purpose of auditing sales and inventory records and for
verifying the amounts payable
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under Article 5. Upon prior written notice, Collagen shall provide reasonable
access to such records during normal business hours at Collagen's business
locations, no more than twice each calendar year.
9.7 Returns. Except as set forth in Section 10.3, Collagen may
return Licensed Products only with ArthroCare's prior written approval. Licensed
Products returned to ArthroCare other than under Section 10.3 shall be returned
F.C.A. the destination point designated by ArthroCare
ARTICLE 10
WARRANTY
10.1 Standard Limited Warranty. ArthroCare warrants to Collagen
that, subject to the exclusions set forth in Section 10.2 below, at the time of
shipment, the Licensed Products
Collagen's exclusive remedy and ArthroCare's sole liability for breach
of the foregoing warranty shall be the remedy set forth in Section 10.3. All
defective Licensed Products shall be returned to ArthroCare in accordance with
Section 10.3. Collagen shall not pass on to its Customers a warranty or
limitation of liability which is more protective of such Customers than the
warranty (including the limited remedy and exclusions) set forth in this Article
10 and the limitation of liability set forth in Article 19.
10.2 Warranty Limitations. The warranties in Section 10.1 are
contingent upon
10.3 Return of Defective Product. In the event that any Licensed
Product purchased by Collagen from ArthroCare fails to conform to the warranty
set forth in Section 10.1, ArthroCare's sole and exclusive liability and
Collagen's exclusive remedy shall be,
10.4 Exclusion of Other Warranties. Except for the limited warranty
provided in section 10.1 above, ArthroCare grants no other warranties or
conditions, express or implied, by statute, in any communication with Collagen
or the customer, or otherwise, regarding the Licensed Products, their fitness
for any purpose, their quality or their merchantability.
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ARTICLE 11
ADDITIONAL OBLIGATIONS OF COLLAGEN
11.1 Registrations, Licenses and Permits.
11.2 Product Complaints.
(a) Collagen will receive locally, and promptly
investigate and monitor, all Customer complaints and/or correspondence
concerning the use of the Licensed Products worldwide. Collagen will maintain
complaint files during the course of this Agreement, its extensions and for a
period of
(b) Collagen shall advise ArthroCare of all complaints
relating to the Licensed Products as promptly as possible but not more than
following the date Collagen receives such complaint. In addition, within
following the date Collagen receives such complaint, Collagen shall also provide
ArthroCare with a written or electronic report of such complaint. Upon
ArthroCare's request, Collagen shall either: (1) investigate and gather any
reasonable additional information regarding such complaints that is requested by
ArthroCare; or (2) provide ArthroCare with the relevant Customer names, phone
numbers and/or addresses so that ArthroCare may gather this information. Any
notice to ArthroCare under this Section 11.2 shall be sent via facsimile and
overnight delivery service to the attention of ArthroCare's Vice President of
Quality and Regulatory Affairs at (408) 736-0224 or to such other address or
person as ArthroCare may designate by notice. Collagen shall also provide to
ArthroCare a written quarterly listing of Customer and/or regulatory complaints
received by Collagen during the previous quarter.
(c)
11.3 Corrections, Withdrawals, and Alert Notices. In the event that
ArthroCare is required by any regulatory agency to recall the Licensed Products
or if ArthroCare voluntarily initiates a correction, withdrawal of alert notice
for the Licensed Products, Collagen shall, at ArthroCare's expense, cooperate
with and assist ArthroCare in locating and retrieving, if
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necessary, the recalled Licensed Products from the Customers. ArthroCare shall
give prompt notice to Collagen of any such correction, withdrawal or alert
notice, along with details of the concern and instructions for the recall.
Except as required by applicable law, Collagen shall not initiate any
correction, withdrawal or alert notice without the prior written consent of
ArthroCare.
11.4 Materials.
11.5 Product Packaging and Labeling.
In addition, except for the addition of information required by applicable laws
and regulations, Collagen shall not relabel Licensed Products supplied to
Collagen by ArthroCare hereunder without the prior written consent of
ArthroCare.
11.6 Proprietary Notices. Collagen shall not remove, alter, cover
or obfuscate any logo, trademark notice or other proprietary rights notices
placed or embedded by ArthroCare on or in any package or any of the items
contained therein.
11.7 Reporting Requirements. Pursuant to the FDA's medical device
reporting (MDR) Regulations, ArthroCare may be required to report to the FDA
information that reasonably suggests that a Licensed Product may have caused or
contributed to death or serious injury or has malfunctioned and that the device
would be likely to cause or contribute to a death or serious injury if the
malfunction were to recur. The parties hereto agree to supply to the other any
such information twenty-four (24) hours after becoming aware of it so that each
can comply with governmental reporting requirements. In the event that
ArthroCare is required by any regulatory agency to correct or withdraw the
Licensed Products or if ArthroCare voluntarily initiates such correction or
withdrawal, Collagen shall cooperate with and assist ArthroCare in locating and
retrieving if necessary, the recalled Products from Collagen's customers.
Collagen shall maintain all records of Licensed Products sales to customer by
lot number, and/or serial number in the event of a Licensed Product recall or
other quality related issue. Collagen shall only be required to make such sales
records available to ArthroCare in the event of a Product correction,
withdrawal, alert notice or other quality related issue.
ARTICLE 12
ADDITIONAL OBLIGATIONS OF ARTHROCARE
12.1 Promotional Materials. ArthroCare shall make available to
Collagen English
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language samples of promotional support materials, in quantities deemed
reasonable by ArthroCare, at ArthroCare's standard charges to distributors for
such items. Such materials shall include, without limitation, marketing and
technical information concerning the Licensed Products, brochures, advertising
literature, and other product data.
12.2 Telephone Marketing and Technical Support. ArthroCare shall
provide a reasonable level of telephone marketing and technical support to
employees of Collagen who have been trained by ArthroCare and/or customers of
Collagen to answer Collagen's questions related to Licensed Products.
12.3 Books and Records. ArthroCare agrees to keep documented
records of all repairs and servicing provided by ArthroCare by product number,
serial number, and description of each Licensed Product and to identify the type
of repair or service completed on the Licensed Product, inclusive of the name of
the individual servicing, the date of the service/repair, and test and
inspection data as required by 21 C.F.R. Section 820.200. During the Term
12.4 Registrations, Licenses and Permits.
(a) ArthroCare shall maintain all regulatory approvals in
ArthroCare's name for the marketing of the Licensed Products for the Term of
this Agreement
(b) ArthroCare will maintain the "Technical File"
required by MDD 93/42 EEC (Medical Device Directives), design history records,
device master records, and history records, and the quality system records for
the Licensed Products for the period of time required by the directives of its
Notified Body and other regulatory agencies requirements.
(c) ArthroCare will maintain for the period of this
Agreement and its extensions a certified quality system in compliance with and
maintain certifications with its Notified Body for valid standing to CE
conformity of its manufacturing facility and the Licensed Products. ArthroCare
shall use best efforts to supply to Collagen the information necessary to
fulfill any request by the EC Competent Authority or Notified Body to Collagen
for information contained in the records within the requested time period.
Changes in Specifications, manufacturing, including change of sterilization
process or provider, labeling, or packaging agreed to by Collagen and ArthroCare
may result in amendments to the Technical File. ArthroCare will provide to
Collagen a copy of any FDA or other regulatory agency correspondence within
seven (7) days of receipt that is directly relating to the Licensed Products
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which are reasonably necessary to Collagen's performance under this Agreement or
which could adversely affect Collagen or its Customers.
(d) ArthroCare understands that Collagen or any
government regulatory agency or third party observers may send representatives
to ArthroCare's facility to observe, inspect and audit the production facilities
related to the Licensed Products. ArthroCare will allow such representatives
reasonable access to all manufacturing facilities and records for the Licensed
Products so as to ensure applicable regulations are in compliance. Collagen will
provide at least ten (10) days advance notice of such observation and provide
the names, meeting agenda and provide proper identification of such
representatives. ArthroCare will use reasonable commercial efforts to correct
any material non-compliance brought to its attention as a result of such
inspections and audits. Collagen understands that ArthroCare or any government
regulatory agency or third party observers may send representatives to
Collagen's facility to observe, inspect and audit promotional, advertising and
educational materials and programs, and other literature relating to the sales
and marketing to the Licensed Products. Collagen will allow such representatives
reasonable access to all such promotional literature for the Licensed Products
so as to ensure applicable regulations are in compliance. ArthroCare will
provide at least ten (10) days advance notice of such observation and provide
the names, meeting agenda and provide proper identification of such
representatives. Collagen will use reasonable commercial efforts to correct any
material non-compliance brought to its attention as a result of such inspections
and audits.
ARTICLE 13
ADDITIONAL COVENANTS OF ARTHROCARE
13.1 Financial Statements. From time to time as requested by
Collagen (but not more frequently than once per calendar year), ArthroCare will
provide Collagen with copies of audited financial statements and such other
information reasonably requested by Collagen to demonstrate ArthroCare's
financial ability to perform under this Agreement. From time to time as
requested by ArthroCare (but not more frequently than once per calendar year),
Collagen will provide ArthroCare with copies of audited financial statements and
such other information reasonably requested by ArthroCare to demonstrate
Collagen's financial ability to perform under this Agreement. All information
provided to either party under this Section 13.1 will be treated confidentially,
unless such information is otherwise publicly available.
13.2 Exclusivity. Unless otherwise agreed by the parties, during
the term of this Agreement, ArthroCare shall not be involved with the design,
manufacture and/or sale, to or on behalf of any other person or entity, of any
Licensed Products intended for use in procedures in the Field.
13.3 ArthroCare's Assets. With the exception of standard financing
mechanisms, ArthroCare shall not sell, transfer, assign, pledge, grant a
security interest in, or otherwise
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encumber or allow any third party to obtain an interest in, any prints, designs,
tools, fixtures, raw materials, moldings or other equipment used or useful in
manufacturing and/or supplying the Products without giving Collagen at least
sixty (60) days prior written notice.
ARTICLE 14
INTELLECTUAL PROPERTY
14.1 Enforcement. In the event that any Patent Right necessary for
use and sale of a Licensed Product is infringed or misappropriated by a third
party in any country or is subject to a declaratory judgment action arising from
such infringement or misappropriation in such country, or is the subject of an
interference, re-examination, reissue or opposition proceeding, the party
becoming aware thereof shall promptly notify the other party hereto.
14.2
14.3 ArthroCare Trademarks. During the Term of this Agreement,
Collagen shall have the right to advertise and promote the Licensed Products
under ArthroCare's trademarks and tradenames initially identified in Exhibit E
("ArthroCare Marks"). ArthroCare reserves the right to modify the ArthroCare
Marks or substitute alternative marks for any or all of the ArthroCare Marks at
any time upon thirty (30) days prior written notice. Collagen shall have the
right to use any marketing materials in its possession to depletion. The rights
granted under this Section 14.3 shall automatically terminate on termination or
expiration of this Agreement.
14.4 Limitations. Except as set forth in this Agreement, nothing
contained in this Agreement shall grant to Collagen any right, title, or
interest in or to the ArthroCare Marks, whether or not specifically recognized
or perfected under applicable laws, and Collagen irrevocably assigns to
ArthroCare all such right, title, and interest, if any, in any ArthroCare
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Marks that are used in conjunction with the Licensed Products (other than
Collagen Marks). At no time during or after the Term of this Agreement shall
Collagen challenge or assist others to challenge ArthroCare Marks or the
registration thereof or attempt to register any trademarks, marks, or trade
names confusingly similar to ArthroCare Marks. All representations of ArthroCare
Marks that Collagen intends to use shall first be submitted to ArthroCare for
approval (which shall not be unreasonably withheld) of design, color, and other
details, or shall be exact copies of those used by ArthroCare. In addition,
Collagen shall fully comply with all reasonable guidelines, if any, communicated
by ArthroCare concerning the use of ArthroCare Marks.
14.5 Collagen Trademarks. During the Term of this Agreement,
subject to the limitations in section 14.3, (the "Collagen Marks"). Nothing in
this Agreement shall be deemed to grant to ArthroCare any right, title, or
interest in or to Collagen Marks. At no time during or after the Term of this
Agreement shall ArthroCare challenge or assist others to challenge Collagen
Marks or the registration thereof or attempt to register any trademarks, marks,
or tradenames confusingly similar to Collagen Marks.
14.6
14.7
ARTICLE 15
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ARTICLE 16
CONFIDENTIALITY
16.1 Confidential Information. Except as expressly provided herein,
the parties agree that, for the term of this Agreement and for five years
thereafter, the receiving party shall keep completely confidential and shall not
publish or otherwise disclose and shall not use for any purpose except for the
purposes contemplated by this Agreement any Confidential Information furnished
to it by the disclosing party hereto, except that to the extent that it can be
established by the receiving party by written proof that such Confidential
Information:
(i) was already known to the receiving party, other than under an
obligation of confidentiality, at the time of disclosure;
(ii) was available to the public or otherwise part of the public
domain at the time of its disclosure to the receiving party;
(iii) became available to the public or otherwise part of the public
domain after its disclosure and other than through any act or
omission of the receiving party in breach of this Agreement;
(iv) was subsequently lawfully disclosed to the receiving party by
a person other than a party hereto; or
(v) was independently developed by a person having no knowledge of
or access to any of the other party's Confidential
Information.
16.2 Permitted Use and Disclosures. Each party hereto may use or
disclose information disclosed to it by the other party to the extent such use
or disclosure is reasonably necessary in complying with applicable law or
governmental regulations, conducting clinical trials, or exercising its rights
hereunder to develop or commercialize Licensed Products, provided that if a
party is required to make any such disclosure of another party's confidential
information, other than pursuant to a confidentiality agreement, it will give
reasonable advance notice to the latter party of such disclosure and, will use
its best efforts to secure confidential treatment of such information prior to
its disclosure (whether through protective orders or otherwise).
16.3 Confidential Terms. Except as expressly provided herein, each
party agrees not to disclose any terms of this Agreement to any third party
without the consent of the other party; provided, disclosures may be made as
required by securities or other applicable laws, or to Affiliates, or to a
party's accountants, attorneys and other professional advisors provided that
such accountants, attorneys and other professional advisors are bound to retain
the terms of this Agreement as confidential. Disclosure to prospective corporate
partners or Affiliates is prohibited absent written consent from the
non-disclosing party. Neither party shall issue a press release or other public
announcement concerning this Agreement, the transactions contemplated
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herein or the relationship between Collagen and ArthroCare without the prior
written consent of an authorized representative of the other party.
ARTICLE 17
INDEMNIFICATION
17.1 Indemnification of Collagen.
(a) ArthroCare shall indemnify, defend, and hold harmless
Collagen, and its affiliates and their respective directors, officers,
employees, and agents, and the successors and assigns of any of the foregoing
(the "Collagen Indemnitees") from and against all claims, losses, costs, and
liabilities (including, without limitation, payment of reasonable attorneys'
fees and other expenses of litigation), and shall pay any damages (including
settlement amounts) finally awarded with respect to claims, suits, or
proceedings (any of the foregoing, a "Claim") brought by third parties against a
Collagen Indemnitee, caused by (i)
(b)
17.2 Indemnification of ArthroCare. Collagen shall indemnify,
defend, and hold harmless ArthroCare, and its Affiliates and their respective
directors, officers, employees and agents, and the successors, and assigns of
any of the foregoing (the "ArthroCare Indemnitees") from and against all claims,
losses, costs, and liabilities (including, without limitation, payment of
reasonable attorneys' fees and other expenses of litigation), and shall pay any
damages (including settlement amounts) finally awarded with respect to a Claim
brought by third parties against an ArthroCare Indemnitee, arising out of or
relating to
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17.3 Indemnification Procedures. A party (the "Indemnitee") that
intends to claim indemnification under this Article 17 shall promptly notify the
other party (the "Indemnitor") in writing of any claim in respect of which the
Indemnitee or any of its directors, officers, employees, agents, licensors,
successors, or assigns intends to claim such indemnification. The parties will
then determine whether complete or partial indemnification is appropriate in
such event. If the parties are unable to mutually agree on whether the
Indemnitee should be completely or partially indemnified by the Indemnitor, the
parties shall appoint an arbitrator to make a binding ruling on this issue. The
arbitrator will be appointed according to Section 21.
If the parties or the arbitrator determine that indemnification is appropriate,
the Indemnitor shall have sole control of the defense and/or settlement thereof,
provided that the indemnified party may participate in any such proceeding with
counsel of its choice at its own expense. The indemnity agreement in this
Article 17 shall not apply to amounts paid in settlement of any Claim if such
settlement is effected without the consent of the Indemnitor, which consent
shall not be withheld unreasonably. The failure to deliver written notice to the
Indemnitor within a reasonable time after the commencement of any such action,
if prejudicial to its ability to defend such action, shall relieve such
Indemnitor of any liability to the Indemnitee under this Article 17, but the
omission to so deliver written notice to the Indemnitor shall not relieve the
Indemnitor of any liability that it may otherwise have to any Indemnitee than
under this Article 17. The Indemnitee under this Article 17, its employees and
agents, shall cooperate fully with the Indemnitor and its legal representatives
and provide full information in the investigation of any Claim covered by this
indemnification. Notwithstanding anything to the contrary contained in this
Article 17, neither party shall be liable for any costs or expenses incurred
without its prior written authorization.
ARTICLE 18
TERM, CONVERSION AND TERMINATION
18.1 Term. The initial Term of this Agreement shall commence on the
Effective Date and continue in force until
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18.2 Termination for Cause. Either ArthroCare or Collagen may
terminate this Agreement by written notice stating each party's intent to
terminate in the event the other shall have breached or defaulted in the
performance of any of its material obligations hereunder, and such default shall
have continued for sixty (60) days after written notice thereof was provided to
the breaching party by the non-breaching party.
18.3 Termination for Bankruptcy. Either party may terminate this
Agreement effective upon written notice to the other party in the event the
other party declares bankruptcy or becomes the subject of any voluntary or
involuntary proceeding under the U.S. Bankruptcy Code or any state insolvency
proceeding, and such proceeding is not terminated within one hundred twenty
(120) days of its commencement.
18.4 Effect of Termination.
(a) Accrued Obligations. Termination shall not relieve
either party of obligations incurred prior to the effective date of such
termination.
(b) Return of Materials. All trademarks, marks, trade
names, patents, copyrights, designs, drawings, formulas or other data,
photographs, samples, literature, and sales and promotional aids of every kind
shall remain the property of ArthroCare. Within thirty (30) days after the
termination or expiration of this Agreement, Collagen shall destroy all tangible
items bearing, containing, or contained in, any of the foregoing, in its
possession or control and provide written certification of such destruction, or
prepare such tangible items for shipment to ArthroCare, as ArthroCare may
direct, at ArthroCare's expense. Collagen shall not make or retain any copies of
any confidential items or information which may have been entrusted to it.
Effective upon the termination of this Agreement, Collagen shall cease to use
all trademarks and trade names of ArthroCare and ArthroCare shall cease to use
all trademarks and trade names of Collagen with the limited exception of
repurchased Licensed Products pursuant to Section 18.4(c). During the Term and
after any termination or expiration of this Agreement, ArthroCare shall have the
right to continue to use and disclose for any purpose Customer lists, Customer
data and other Customer information and any and all clinical trial results and
other data relating to the Licensed Products and provided by Collagen to
ArthroCare during the Term.
(c) Limitation on Liability. In the event of termination
by either party in accordance with any of the provisions of this Agreement,
neither party shall be liable to the other, because of such termination, for
compensation, reimbursement or damages on account of the loss of prospective
profits or anticipated sales or on account of expenditures, investments, leases,
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inventory or commitments in connection with the business or goodwill of
ArthroCare or Collagen.
(d) Transition. Upon termination of this Agreement,
Collagen shall diligently cooperate with ArthroCare to effect a smooth and
orderly transition in the sale of the Licensed Products. From the time that a
notice of termination is received by either party until the effective
termination date, Collagen shall refer all Product inquiries to ArthroCare,
shall support ArthroCare's existing Customers (but shall not sell them new
Licensed Products), and shall cooperate fully with any newly appointed
distributors.
(f) Survival. The provisions of Sections 3.5, 9.4, 9.6,
9.7, 11.1, 11.2, 11.3, 12.3, 14.4, 14.5, 18.4 and 22.1 and Articles 10, 16, 17,
19 and 21 shall survive the expiration or termination of this Agreement for any
reason. All other rights and obligations of the parties shall cease upon
termination of this Agreement.
18.6
ARTICLE 19
LIMITED LIABILITY TO COLLAGEN AND OTHERS
WITH THE SOLE EXCEPTION OF ARTICLE 17 AND NOTWITHSTANDING ANY OTHER PROVISION OF
THIS AGREEMENT, ARTHROCARE'S LIABILITY ARISING OUT OF THIS AGREEMENT AND/OR SALE
OF THE LICENSED PRODUCTS SHALL BE LIMITED TO THE AMOUNT PAID BY COLLAGEN FOR THE
PRODUCT. IN NO EVENT SHALL ARTHROCARE BE LIABLE TO COLLAGEN OR ANY OTHER ENTITY
FOR COSTS OF PROCUREMENT OF SUBSTITUTE GOODS, LOST PROFITS, OR ANY OTHER
SPECIAL, CONSEQUENTIAL, OR INCIDENTAL DAMAGES, HOWEVER CAUSED AND ON ANY THEORY
OF LIABILITY ARISING OUT OF THIS AGREEMENT WHETHER BASED IN CONTRACT, TORT
(INCLUDING NEGLIGENCE), OR OTHERWISE. THESE LIMITATIONS SHALL APPLY WHETHER OR
NOT ARTHROCARE HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES AND
NOTWITHSTANDING ANY FAILURE OF ESSENTIAL PURPOSE OF ANY LIMITED REMEDY PROVIDED
HEREIN OR IN THE WARRANTY FOUND IN THE LICENSED PRODUCTS.
ARTICLE 20
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REPRESENTATIONS AND WARRANTIES
20.1 Representations and Warranties. ArthroCare represents and
warrants, to the best of its knowledge, that:
20.2 Disclaimer. Except as expressly provided in this Agreement,
nothing in this Agreement is or shall be construed as: (i) a warranty or
representation by ArthroCare as to the validity or scope of any claim or patent
within the Patent Rights; (ii) a warranty or representation that anything made,
used, sold, or otherwise disposed of under any license granted in this Agreement
is or will be free from infringement of any patent rights or other intellectual
property right of any third party; or (iii) granting by implication, estoppel,
or otherwise any licenses or rights under patents or other rights of ArthroCare
or third parties, regardless of whether such patents or other rights are
dominant or subordinate to any patent within the Patent Rights.
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ARTICLE 21
ARBITRATION
(a) If a dispute arises between the parties relating to
the interpretation or performances of this Agreement or the grounds for the
termination thereof, representatives of the parties with decision-making
authority shall meet to attempt in good faith to negotiate a resolution of the
dispute prior to pursuing other available remedies. If within sixty (60) days
after such meeting the parties have not succeeded in negotiating a resolution of
the dispute, such dispute shall be submitted to final and binding arbitration
under the then current Commercial Arbitration Rules of the American Arbitration
Association ("AAA"), by one (1) arbitrator in Santa Clara County, California;
provided, however, California Code of Civil Procedure Section 1283.05 shall
apply to any such proceeding. Such arbitrator shall be selected by the mutual
agreement of the parties or, failing such agreement, shall be selected according
to the AAA rules. The parties shall bear the costs of arbitration equally and
shall bear their own expenses, including professional fees. The decision of the
arbitrator shall be final and non-appealable and may be enforced in any court of
competent jurisdiction.
ARTICLE 22
MISCELLANEOUS PROVISIONS
22.1 Governing Law; Venue. This Agreement and any dispute,
including without limitation any arbitration, arising from the performance or
breach hereof shall be governed by and construed and enforced in accordance with
the laws of the state of California, without reference to conflicts of laws
principles.
22.2
22.3 Waiver. No waiver of any rights, shall be effective unless
consented to in writing by the party to be charged and the waiver of any breach
of default shall not constitute a waiver of any other right hereunder or any
subsequent breach or default.
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22.4 Severability. In the event that any provisions of this
Agreement are determined to be invalid or unenforceable by a court of competent
jurisdiction, the remainder of this Agreement shall remain in full force and
effect without said provision.
22.5 Notices. All notices, requests and other communications
hereunder shall be in writing and shall be personally delivered or sent by
telecopy or other electronic facsimile transmission or by certified mail-return
receipt requested, postage prepaid, or delivered by a nationally recognized
courier who guarantees next-day delivery in each case to the respective address
specified below, or such other address as may be specified in writing to the
other parties hereto:
Collagen: Collagen Aesthetics, Inc.
1850 Embarcadero Road
Palo Alto, California 94303
Attn: Gary S. Petersmeyer
Fax: (650) 354-4375
with a copy to:
Charlene A. Friedman, Esq.
Collagen Aesthetics, Inc.
1850 Embarcadero Road
Palo Alto, California 94303
Fax: (650) 354-4751
ArthroCare: 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
22.6 Independent Contractors. Both parties are independent
contractors under this
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Agreement. Nothing contained in this Agreement is intended nor is to be
construed so as to constitute ArthroCare or Collagen as partners or joint
venturers with respect to this Agreement. Neither party shall have any express
or implied right or authority to assume or create any obligations on behalf of
or in the name of the other party or to bind the other party to any other
contract, agreement, or undertaking with any third party.
22.7 Patent Marking. Collagen agrees to mark (or give directions to
ArthroCare to mark) all Licensed Products sold pursuant to this Agreement in
accordance with the applicable statute or regulations relating to patent marking
in the country or countries of manufacture and sale thereof.
22.8 Compliance with Laws. In performing their respective
obligations under this Agreement, the parties shall fully comply in all material
respects with the requirements of any and all applicable laws, regulations,
rules and orders of any governmental body having jurisdiction over the exercise
of rights under this Agreement.
22.9 Use of Name. Other than as expressly set forth in this
Agreement or the License Agreement, neither party shall use the name or
trademarks of the other party without the prior written consent of such other
party.
22.10 Entire Agreement; Amendment. This Agreement constitutes the
entire and exclusive Agreement between the parties with respect to the subject
matter hereof and supersedes and cancels all previous discussions, agreements,
commitments and writings in respect thereof except for the License Agreement. No
amendment or addition to this Agreement shall be effective unless reduced to
writing and executed by the authorized representatives of the parties.
22.11 Counterparts. This Agreement may be executed in any number of
counterparts and on separate signature pages by each party, each copy of which
shall for all purposes be deemed an original.
22.12 Force Majeure. Neither party shall be liable for any failure
to perform or delay in performance hereunder where such failure or delay is
occasioned by circumstances beyond the party's control, including, without
limitation, fire, explosion, storms, interruption of utility services, strikes
or labor disputes, water, acts of God, war, civil disturbances, acts of civil or
military authorities, inability to secure raw materials or transportation
facilities, fuel or energy shortages, acts or omissions of communications
carriers, or other causes beyond the party's control whether or not similar to
the foregoing.
-29-
<PAGE> 30
IN WITNESS WHEREOF, ArthroCare and Collagen have executed this
Agreement in duplicate originals by duly authorized officers.
ARTHROCARE CORPORATION COLLAGEN AESTHETICS INC.
By: _______________________________ By: __________________________________
Print Name: _______________________ Print Name: __________________________
Title: ____________________________ Title: _______________________________
-30-
<PAGE> 31
EXHIBIT B
PRODUCT PRICES
Licensed Product Price Per Unit
Disposable Wand Transfer Price:
TYPE OF DISPOSABLE PRICE
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
-31-
<PAGE> 32
EXHIBIT C
WARRANTY PERIODS
PRODUCT PERIOD
Controller
Cable/Handpiece
Disposable Wands
Adaptors
-32-
<PAGE> 1
EXHIBIT 10.28
CEO CONTINUITY AGREEMENT
This CEO Continuity Agreement (the "Agreement") is made and entered into
effective as of _____________, 1998, by and between Michael A. Baker (the
"Employee") and ArthroCare Corporation, a Delaware corporation (the "Company").
R E C I T A L S
A. It is expected that the Company from time to time will consider the
possibility of a Change of Control (as defined below). The Board of Directors of
the Company recognizes that such consideration can be a distraction to the
Employee and can cause the Employee to consider alternative employment
opportunities. The Board of Directors has determined that it is in the best
interests of the Company and its shareholders to assure that the Company will
have the continued dedication and objectivity of the Employee, notwithstanding
the possibility, threat or occurrence of a Change of Control.
B. The Board of Directors believes that it is in the best interests of
the Company and its shareholders to provide the Employee with an incentive to
continue his/her employment and to motivate the Employee to maximize the value
of the Company upon a Change of Control for the benefit of its shareholders.
C. The Board of Directors believes that it is imperative to provide the
Employee with certain benefits upon a Change of Control and, under certain
circumstances, upon termination of the Employee's employment, which benefits are
intended to provide the Employee with financial security and sufficient
incentive and encouragement to remain with the Company notwithstanding the
possibility of a Change of Control or a termination of employment.
D. Certain capitalized terms used in the Agreement are defined in
Section 7 below.
In consideration of the mutual covenants herein contained, and in
consideration of the continuing employment of Employee by the Company, the
parties agree as follows:
1. Duties and Scope of Employment. The Company shall continue to employ the
Employee in the position of President and Chief Executive Officer, as such
position was defined in terms of responsibilities and compensation as of the
effective date of this Agreement; provided, however, that the Board of Directors
shall have the right, subject to the other provisions of this Agreement, at any
time prior to the occurrence of a Change of Control, to revise such
responsibilities and compensation as the Board of Directors in its discretion
may deem necessary or appropriate. The Employee shall comply with and be bound
by the Company's operating policies, procedures and practices from time to time
in effect during his/her employment. During the term of the Employee's
employment with the Company, the Employee shall devote his/her full time, skill
and attention to his/her duties and responsibilities, and shall perform them
faithfully, diligently and competently, and the
<PAGE> 2
Employee shall use his/her best efforts to further the business of the Company
and its affiliated entities.
2. Base Compensation. The Company shall pay the Employee as compensation for
his/her services a base salary, along with such performance bonus amounts as the
Board of Directors shall authorize, in its discretion, from time to time. Such
salary shall be paid periodically in accordance with normal Company payroll
policies. The Employee's compensation (including bonus amounts) specified in
this Section 2, together with any increases in such compensation that the Board
of Directors may grant from time to time, is referred to in this Agreement as
the Employee's "Base Compensation."
3. Employee Benefits. The Employee shall be eligible to participate in the
employee benefit plans and compensation programs maintained by the Company and
applicable to other key employees of the Company, including (without limitation)
retirement plans, savings or profit-sharing plans, stock option, incentive or
other bonus plans, life, disability, health, accident and other insurance
programs, paid vacations, and similar plans or programs, subject in each case to
the generally applicable terms and conditions of the applicable plan or program
in question and to the determination of any committee administering such plan or
program.
4. At-Will Employment. The Company and the Employee acknowledge that the
Employee's employment is and shall continue to be at-will, as defined under
applicable law. If the Employee's employment terminates for any reason, the
Employee shall not be entitled to any payments, benefits, damages, awards or
compensation other than as provided by this Agreement, subject, however, to such
terms as stated in the offer of employment letter dated June 20, 1997, or as may
otherwise be available in accordance with the Company's established employee
plans and policies at the time of termination. The terms of this Agreement shall
terminate upon the earlier of (i) termination of the Employee's position as an
executive officer of the Company; (ii) the date that all obligations of the
parties hereunder have been satisfied or (iii) the date 24 months after a Change
of Control (the "Expiration Date"). A termination of the terms of this Agreement
pursuant to the preceding sentence shall be effective for all purposes, except
that such termination shall not affect the payment or provision of compensation
or benefits on account of a termination of employment occurring prior to the
termination of the terms of this Agreement.
5. Option Acceleration Upon a Change of Control. Upon a Change of Control, the
vesting and exercisability of each option granted to the Employee by the Company
(the "Options") shall be automatically accelerated as to 50% of the unvested
shares subject thereto at the time of the Change of Control; provided, however,
that if it is determined by the Company's independent public accountants that
such acceleration would preclude accounting for the Change of Control as a
pooling of interests for financial accounting purposes, and it is a condition to
the closing of the Change of Control that the transaction be accounted for as a
pooling of interests, then the vesting and exercisability of the Options shall
not accelerate pursuant to this Section 5.
2
<PAGE> 3
6. Option Acceleration Upon a Hostile Takeover. Upon a Hostile Takeover, the
vesting and exercisability of the Options shall be automatically accelerated as
to 100% of the shares subject thereto.
7. Termination Following a Change of Control. If the Employee's employment with
the Company terminates at any time within twenty four (24) months after a change
of control, then Employee shall be entitled to receive severance benefits as
follows:
(a) Involuntary Termination. If the Employee's employment with the
Company terminates in an Involuntary Termination, then the Employee shall be
entitled to receive severance benefits as follows:
(i) Severance Pay. During the Compensation Continuation
Period, the Company shall pay the Employee continuing payments of severance pay
in accordance with its normal payroll practices at a rate equal to the
Employee's Current Compensation. Such severance payments shall be paid monthly.
In addition, during the Compensation Continuation Period, the Company shall
continue to make available to the Employee and the Employee's spouse and
dependents any group health plans, life insurance plans and other benefit plans
and programs of the Company on the date of such termination of employment, to
the extent permitted by law and subject to the terms and conditions of the
relevant plan or program.
(ii) Medical Benefits. The Company shall reimburse the
Employee for the amount of his or her premium payment for group health coverage,
if any, elected by the Employee pursuant to the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended ("COBRA"); provided, however, that (A)
such reimbursement shall not exceed $650.00 per month, and (B) the Employee
shall be solely responsible for all matters relating to his or her continuation
of coverage pursuant to COBRA, including (without limitation) his or her
election of such coverage and his or her timely payment of premiums; provided,
further, that upon the earlier to occur of (C) the time that the Employee no
longer constitutes a Qualified Beneficiary (as such term is defined in Section
4980B(g)(1) of the Internal Revenue Code of 1986, as amended) and (D) the date
thirty-six (36) months following the Employee's termination, the Company's
obligations to reimburse the Employee under this subsection (ii) shall cease;
provided, finally, that if the Company's obligations under this subsection (ii)
cease pursuant to clause (C), the Company shall make a lump sum payment to the
Employee equal to the product of the last monthly reimbursement paid to the
Employee pursuant to this subsection (ii) multiplied by eighteen (18).
(iii) Outplacement Services. During the thirty-six (36) months
following termination of the Employee's employment, the Employee shall be
entitled to executive-level outplacement services at the Company's expense, not
to exceed $15,000. Such services shall be provided by a firm selected by the
Employee from a list compiled by the Company.
3
<PAGE> 4
(iv) Option Acceleration. The vesting and exercisability of
each option shall be automatically accelerated as to 100% of the unvested shares
subject thereto at the time of the Involuntary Termination; provided, however,
that it is determined by the Company's independent accountants that such
acceleration would preclude accounting for the Change of Control as a pooling of
interests for financial accounting purposes, and it is a condition to the
closing of the Change of Control that the transaction be accounted for as a
pooling of interests, then the vesting and exercisability of the Options should
not accelerate pursuant to this Section 7(a)(iv).
(b) Voluntary Resignation; Termination For Cause. If the Employee
voluntarily resigns from the Company (other than in an Involuntary Termination),
or if the Company terminates the Employee's employment for Cause, then the
Employee shall not be entitled to receive severance or other benefits under this
Section 7, but shall be eligible for those benefits (if any) as may then be
established under any other Section of this Agreement or the Company's
then-existing severance and benefits plans and policies at the time of such
termination.
(c) Disability; Death. If the Company terminates the Employee's
employment as a result of the Employee's Disability, or such Employee's
employment terminates due to the death of the Employee, either in connection
with or apart from a Change of Control, then the Employee shall not be entitled
to receive severance or other benefits under this Section 7, but shall be
eligible for those benefits (if any) as may then be established under any other
Section of this Agreement or the Company's then-existing severance and benefits
plans and policies at the time of such Disability or death.
8. Termination Apart from a Change of Control. If the Employee's employment with
the Company terminates at any time either prior to the occurrence of a Change of
Control or after the twenty-four month period following the effective date of a
Change of Control, then the Employee shall not be entitled to receive severance
or other benefits under this Agreement, but shall be eligible for those benefits
(if any) as may be established under the Company's then-existing severance and
benefits plans and policies at the time of such termination, or as may be
provided in the offer of employment letter dated June 20, 1997.
9. Definition of Terms. The following terms referred to in this Agreement shall
have the following meanings:
(a) Cause. "Cause" shall mean (i) any act of personal dishonesty taken
by the Employee in connection with his/her responsibilities as an employee and
intended to result in substantial personal enrichment of the Employee, (ii) the
Employee's commission of a felony or an act of fraud against the Company or its
affiliates, (iii) a willful act by the Employee that constitutes gross
misconduct and that is injurious to the Company, and (iv) continued violations
by the Employee of the Employee's obligations under Section 1 of this Agreement,
which are demonstrably willful and deliberate on the Employee's part after there
has been delivered to the Employee a written demand for performance from the
Company that describes the basis for the Company's belief that the Employee has
not substantially performed his/her duties along
4
<PAGE> 5
with an opportunity for the Employee to meet such demands, which the Employee
fails to accomplish within a reasonable period of time.
(b) Change of Control. "Change of Control" shall mean the occurrence of
any of the following events:
(i) Any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended) becomes the
"beneficial owner" (as defined in Rule 13d-3 under said Act), directly or
indirectly, of securities of the Company representing fifteen percent (15%) or
more of the total voting power represented by the Company's then outstanding
voting securities;
(ii) A merger or consolidation of the Company with any other
corporation, other than a merger or consolidation that would result in the
voting securities of the Company outstanding immediately prior thereto
continuing to represent (either by remaining outstanding or by being converted
into voting securities of the surviving entity) more than fifty percent (50%) of
the total voting power represented by the voting securities of the Company or
such surviving entity outstanding immediately after such merger or
consolidation;
(iii) The approval by the shareholders of the Company of a
plan of complete liquidation of the Company or an agreement for the sale or
disposition by the Company of all or substantially all of the Company's assets;
or
(iv) A change in the composition of the Board, as a result of
which fewer than a majority of the directors are Incumbent Directors. "Incumbent
Directors" shall mean directors who either (A) are directors of the Company as
of the date hereof, or (B) are elected, or nominated for election, to the Board
with the affirmative votes of at least a majority of those directors whose
election or nomination was not in connection with any transaction described in
subsections (i), (ii) or (iii) or in connection with an actual or threatened
proxy contest relating to the election of directors of the Company.
(c) Compensation Continuation Period. "Compensation Continuation Period"
shall mean the period of time commencing with termination of the Employee's
employment in an Involuntary Termination during the term of this Agreement and
ending with the expiration of thirty-six (36) months following the date of the
Employee's termination.
(d) Current Compensation. "Current Compensation" shall mean an amount
equal to the greater of (i) Employee's Base Compensation earned in the fiscal
year preceding the fiscal year of Employee's termination; or (ii) Employee's
Base Compensation for the fiscal year of Employee's termination, including 100%
of any bonus which the Employee could have earned during such fiscal year,
assuming the achievement of all relevant Employee and Company goals, milestones
and performance criteria.
5
<PAGE> 6
(e) Disability. "Disability" shall mean that the Employee has been
unable to perform his duties under this Agreement as the result of his
incapacity due to physical or mental illness, and such inability, at least 26
weeks after its commencement, is determined to be total and permanent by a
physician selected by the Company or its insurers and acceptable to the Employee
or the Employee's legal representative (such Agreement as to acceptability not
to be unreasonably withheld). Termination resulting from Disability may only be
effected after at least 30 days' written notice by the Company of its intention
to terminate the Employee's employment. In the event that the Employee resumes
the performance of substantially all of his/her duties hereunder before the
termination of his employment becomes effective, the notice of intent to
terminate shall automatically be deemed to have been revoked.
(f) Hostile Takeover. "Hostile Takeover" shall mean any "person" (as
such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of
1934, as amended) becoming the "beneficial owner" (as defined in Rule 13d-3
under said Act), directly or indirectly, of securities of the Company
representing fifty percent (50%) or more of the total voting power represented
by the Company's then outstanding voting securities, without the approval of the
Company's Board of Directors;
(g) Involuntary Termination. "Involuntary Termination" shall mean (i)
without the Employee's express written consent, the assignment to the Employee
of any duties or the significant reduction of the Employee's duties, either of
which is inconsistent with the Employee's position with the Company and his/her
responsibilities in effect immediately prior to such assignment, or the removal
of the Employee from such position and responsibilities; (ii) without the
Employee's express written consent, a substantial reduction, without good
business reasons, of the facilities and perquisites (including office space and
location) available to the Employee immediately prior to such reduction; (iii) a
reduction by the Company in the Base Compensation of the Employee as in effect
immediately prior to such reduction; (iv) a material reduction by the Company in
the kind or level of employee benefits to which the Employee is entitled
immediately prior to such reduction, with the result that the Employee's overall
benefits package is significantly reduced; (v) the relocation of the Employee to
a facility or a location more than 30 miles from the Employee's then present
location, without the Employee's express written consent; (vi) any purported
termination of the Employee by the Company that is not effected for Disability
or for Cause, or any purported termination for which the grounds relied upon are
not valid; or (vii) the failure of the Company to obtain the assumption of this
Agreement by any successors contemplated in Section 9 below; provided, however,
that no Involuntary Termination shall be deemed to have occurred if any such
successor substitutes an agreement for this Agreement providing comparable
severance benefits to those provided for in this Agreement.
10. Golden Parachute Excise Tax.
(a) Reimbursement. In the event that it shall be determined that any
payment or other benefit by the Company to or for the benefit of the Employee
under this Agreement, whether paid or payable, but determined without regard to
any additional payments required under this Section (the "Payments"), would be
subject to the excise tax imposed by
6
<PAGE> 7
Section 4999 of the Internal Revenue Code (the "Excise Tax"), then the Employee
shall be entitled to receive an additional payment from the Company (the "First
Reimbursement Payment") equal to one hundred percent (100%) of any Excise Tax
actually paid or payable by the Employee in connection with the Payments, plus
an additional payment from the Company in such amount that after payment of all
taxes (including, without limitation, any interest and penalties on such taxes
and the Excise Tax) on the Reimbursement Payment, the Employee retains an amount
equal to the Reimbursement Payment.
(b) Determination. Unless the Company and the Employee otherwise agree
in writing, any determination required under this Section shall be made in
writing by the Company's primary independent public accounting firm (the
"Accountants"), whose determination shall be conclusive and binding upon the
Employee and the Company for all purposes. For purposes of making the
calculations required by this Section, the Accountants may make reasonable
assumptions and approximations concerning applicable taxes and may rely on
reasonable, good faith interpretations concerning the application of Sections
280G and 4999 of the Code. The Company and the Employee shall furnish to the
Accountants such information and documents as the Accountants may reasonably
request in order to make their determination under this Section. The Company
shall bear all costs the Accountants may reasonably incur in connection with any
calculations contemplated by this Section.
11. Successors.
(a) Company's Successors. Any successor to the Company (whether direct
or indirect and whether by purchase, lease, merger, consolidation, liquidation
or otherwise) to all or substantially all of the Company's business and assets
shall assume the obligations under this Agreement and agree expressly to perform
the obligations under this Agreement in the same manner and to the same extent
as the Company would be required to perform such obligations in the absence of a
succession. For all purposes under this Agreement, the term "Company" shall
include any successor to the Company's business and assets that executes and
delivers the assumption agreement described in this subsection (a) or which
becomes bound by the terms of this Agreement by operation of law.
(b) Employee's Successors. The terms of this Agreement and all rights of
the Employee hereunder shall inure to the benefit of, and be enforceable by, the
Employee's personal or legal representatives, executors, administrators,
successors, heirs, devisees and legatees.
12. Notice.
(a) General. Notices and all other communications contemplated by this
Agreement shall be in writing and shall be deemed to have been duly given when
delivered personally, or by facsimile, or three business days after deposit in
the U.S. mail by registered or certified mail, return receipt requested and
postage prepaid. In the case of the Employee, mailed notices shall be addressed
to him/her at the home address which he/she most recently communicated to the
Company in writing. In the case of the Company, mailed notices shall be
7
<PAGE> 8
addressed to its corporate headquarters, and all notices shall be directed to
the attention of its Secretary.
(b) Notice of Termination. Any termination by the Company for Cause or
by the Employee as a result of an Involuntary Termination shall be communicated
by a notice of termination to the other party hereto given in accordance with
this Section. Such notice shall indicate the specific termination provision in
this Agreement relied upon, shall set forth in reasonable detail the facts and
circumstances claimed to provide a basis for termination under the provision so
indicated, and shall specify the termination date (which shall be not more than
15 days after the giving of such notice). The failure by the Employee to include
in the notice any fact or circumstance which contributes to a showing of
Involuntary Termination shall not waive any right of the Employee hereunder or
preclude the Employee from asserting such fact or circumstance in enforcing
his/her rights hereunder.
13. Confidentiality. The Parties hereto each agree to use their best efforts to
maintain in confidence the underlying facts leading up to this Agreement, the
existence of this Agreement, the contents and terms of this Agreement, and the
consideration for this Agreement. Each Party hereto agrees not to disclose or
use and to take every reasonable precaution to prevent disclosure or use of any
such information to or by third parties, and each agrees that there will be no
publicity, directly or indirectly, concerning any such information. The parties
hereto agree that breach of this Section shall constitute a material breach of
this Agreement that shall entitle the non-breaching party to all available legal
and equitable remedies including, but not limited to, recision of this
Agreement. The parties hereto further agree that all benefits to the Employee
under this Agreement shall be conditioned on his/her compliance with his/her
obligations under this Section.
14. Miscellaneous Provisions.
(a) No Duty to Mitigate. The Employee shall not be required to mitigate
the amount of any payment or benefit contemplated by this Agreement (whether by
seeking new employment or in any other manner), nor (except as otherwise
provided in this Agreement) shall any such payment or benefit be reduced by the
Employee obtaining new employment or by any earnings that the Employee may
receive from any other source.
(b) Waiver. No provision of this Agreement shall be modified, waived or
discharged unless the modification, waiver or discharge is agreed to in writing
and signed by the Employee and by an authorized officer of the Company (other
than the Employee). No waiver by either party of any breach of, or of compliance
with, any condition or provision of this Agreement by the other party shall be
considered a waiver of any other condition or provision or of the same condition
or provision at another time.
(c) Whole Agreement. No agreements, representations or understandings
(whether oral or written and whether express or implied) between the parties
with regard to severance or other benefits in connection with a Change of
Control that are not expressly set forth or referred to in this Agreement have
been made or entered into by either party.
8
<PAGE> 9
(d) Choice of Law. The validity and interpretation of this Agreement
shall be governed by the laws of the State of California without reference to
rules of conflicts of law. Employee hereby consents to the personal jurisdiction
of the state and federal courts located in California for any action or
proceeding arising from or relating to this Agreement or relating to any
arbitration in which the parties are participants.
(e) Severability. If any portion of this Agreement is held by an
arbitrator or a court of competent jurisdiction to conflict with any federal,
state or local law, or to be otherwise invalid or unenforceable, such portion of
this Agreement shall be of no force or effect and the remaining provisions of
this Agreement shall otherwise remain in full force and effect and be construed
as if such portion had not been included in this Agreement.
(f) Arbitration. Employee agrees that any dispute or controversy arising
out of, relating to, or in connection with this Agreement, or the
interpretation, validity, construction, performance, breach, or termination
thereof, shall be settled by binding arbitration to be held in Santa Clara
County, California in accordance with the rules of the American Arbitration
Association then in effect. The prevailing party shall be entitled to recover
its attorneys' fees. Judgment may be entered on the arbitrator's award in any
court having jurisdiction. Punitive damages shall not be awarded.
(g) No Assignment of Benefits. The rights of any person to payments or
benefits under this Agreement shall not be made subject to option or assignment,
either by voluntary or involuntary assignment or by operation of law, including
(without limitation) bankruptcy, garnishment, attachment or other creditor's
process, and any action in violation of this subsection (g) shall be void.
(h) Employment Taxes. All payments made pursuant to this Agreement will
be subject to withholding of applicable income and employment taxes.
(i) Assignment by Company. The Company may assign its rights under this
Agreement to an affiliate, and an affiliate may assign its rights under this
Agreement to another affiliate of the Company or to the Company; provided,
however, that no assignment shall be made if the net worth of the assignee is
less than the net worth of the Company at the time of assignment. In the case of
any such assignment, the term "Company" when used in a Section of this Agreement
shall mean the corporation that actually employs the Employee.
(j) Counterparts. This Agreement may be executed in counterparts, each
of which shall be deemed an original, but all of which together will constitute
one and the same instrument.
9
<PAGE> 10
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in
the case of the Company by its duly authorized officer, as of the day and year
first above written.
COMPANY:
ARTHROCARE CORPORATION
By:
-------------------------------------
Title:
-------------------------------------
EMPLOYEE:
-------------------------------------------
(Signature)
Michael A. Baker
-------------------------------------------
(Print Name)
Date:
-------------------------------------
10
<PAGE> 1
EXHIBIT 10.29
VP CONTINUITY AGREEMENT
This VP Continuity Agreement (the "Agreement") is made and entered into
effective as of _____________, by and between ___________ (the "Employee") and
ArthroCare Corporation, a Delaware corporation (the "Company").
R E C I T A L S
A. It is expected that the Company from time to time will consider the
possibility of a Change of Control (as defined below). The Board of Directors of
the Company recognizes that such consideration can be a distraction to the
Employee and can cause the Employee to consider alternative employment
opportunities. The Board of Directors has determined that it is in the best
interests of the Company and its shareholders to assure that the Company will
have the continued dedication and objectivity of the Employee, notwithstanding
the possibility, threat or occurrence of a Change of Control.
B. The Board of Directors believes that it is in the best interests of
the Company and its shareholders to provide the Employee with an incentive to
continue his/her employment and to motivate the Employee to maximize the value
of the Company upon a Change of Control for the benefit of its shareholders.
C. The Board of Directors believes that it is imperative to provide the
Employee with certain benefits upon a Change of Control and, under certain
circumstances, upon termination of the Employee's employment, which benefits are
intended to provide the Employee with financial security and sufficient
incentive and encouragement to remain with the Company notwithstanding the
possibility of a Change of Control or a termination of employment.
D. Certain capitalized terms used in the Agreement are defined in
Section 7 below.
In consideration of the mutual covenants herein contained, and in
consideration of the continuing employment of Employee by the Company, the
parties agree as follows:
1. Duties and Scope of Employment. The Company shall continue to employ the
Employee in the position of Vice President, ____________, as such position was
defined in terms of responsibilities and compensation as of the effective date
of this Agreement; provided, however, that the Board of Directors shall have the
right, subject to the other provisions of this Agreement, at any time prior to
the occurrence of a Change of Control, to revise such responsibilities and
compensation as the Board of Directors in its discretion may deem necessary or
appropriate. The Employee shall comply with and be bound by the Company's
operating policies, procedures and practices from time to time in effect during
his/her employment. During the term of the Employee's employment with the
Company, the Employee shall devote his/her full time, skill and attention to
his/her duties and responsibilities, and shall perform them faithfully,
diligently and competently, and the
<PAGE> 2
Employee shall use his/her best efforts to further the business of the Company
and its affiliated entities.
2. Base Compensation. The Company shall pay the Employee as compensation for
his/her services a base salary, along with such performance bonus amounts as the
Board of Directors shall authorize, in its discretion, from time to time. Such
salary shall be paid periodically in accordance with normal Company payroll
policies. The Employee's compensation (including bonus amounts) specified in
this Section 2, together with any increases in such compensation that the Board
of Directors may grant from time to time, is referred to in this Agreement as
the Employee's "Base Compensation."
3. Employee Benefits. The Employee shall be eligible to participate in the
employee benefit plans and compensation programs maintained by the Company and
applicable to other key employees of the Company, including (without limitation)
retirement plans, savings or profit-sharing plans, stock option, incentive or
other bonus plans, life, disability, health, accident and other insurance
programs, paid vacations, and similar plans or programs, subject in each case to
the generally applicable terms and conditions of the applicable plan or program
in question and to the determination of any committee administering such plan or
program.
4. At-Will Employment. The Company and the Employee acknowledge that the
Employee's employment is and shall continue to be at-will, as defined under
applicable law. If the Employee's employment terminates for any reason, the
Employee shall not be entitled to any payments, benefits, damages, awards or
compensation other than as provided by this Agreement, subject, however, to such
terms as stated in the offer of employment letter dated _______________, or as
may otherwise be available in accordance with the Company's established employee
plans and policies at the time of termination. The terms of this Agreement shall
terminate upon the earlier of (i) termination of the Employee's position as an
executive officer of the Company; (ii) the date that all obligations of the
parties hereunder have been satisfied or (iii) the date 24 months after a Change
of Control (the "Expiration Date"). A termination of the terms of this Agreement
pursuant to the preceding sentence shall be effective for all purposes, except
that such termination shall not affect the payment or provision of compensation
or benefits on account of a termination of employment occurring prior to the
termination of the terms of this Agreement.
5. Option Acceleration Upon a Change of Control. Upon a Change of Control, the
vesting and exercisability of each option granted to the Employee by the Company
(the "Options") shall be automatically accelerated as to 50% of the unvested
shares subject thereto at the time of the Change of Control; provided, however,
that if it is determined by the Company's independent public accountants that
such acceleration would preclude accounting for the Change of Control as a
pooling of interests for financial accounting purposes, and it is a condition to
the closing of the Change of Control that the transaction be accounted for as a
pooling of interests, then the vesting and exercisability of the Options shall
not accelerate pursuant to this Section 5.
2
<PAGE> 3
6. Option Acceleration Upon a Hostile Takeover. Upon a Hostile Takeover, the
vesting and exercisability of the Options shall be automatically accelerated as
to 100% of the shares subject thereto.
7. Termination Following a Change of Control. If the Employee's employment with
the Company terminates at any time within twenty four (24) months after a change
of control, then Employee shall be entitled to receive severance benefits as
follows:
(a) Involuntary Termination. If the Employee's employment with the
Company terminates in an Involuntary Termination, then the Employee shall be
entitled to receive severance benefits as follows:
(i) Severance Pay. During the Compensation Continuation
Period, the Company shall pay the Employee continuing payments of severance pay
in accordance with its normal payroll practices at a rate equal to the
Employee's Current Compensation. Such severance payments shall be paid monthly.
In addition, during the Compensation Continuation Period, the Company shall
continue to make available to the Employee and the Employee's spouse and
dependents any group health plans, life insurance plans and other benefits plans
and programs of the Company on the date of such termination of employment to the
extent permitted by law and subject to the terms and conditions of the relevant
plan or program.
(ii) Medical Benefits. The Company shall reimburse the
Employee for the amount of his or her premium payment for group health coverage,
if any, elected by the Employee pursuant to the Consolidated Omnibus Budget
Reconciliation Act of 1985, as amended ("COBRA"); provided, however, that (A)
such reimbursement shall not exceed $650.00 per month, and (B) the Employee
shall be solely responsible for all matters relating to his or her continuation
of coverage pursuant to COBRA, including (without limitation) his or her
election of such coverage and his or her timely payment of premiums; provided,
further, that upon the earlier to occur of (C) the time that the Employee no
longer constitutes a Qualified Beneficiary (as such term is defined in Section
4980B(g)(1) of the Internal Revenue Code of 1986, as amended) and (D) the date
twenty-four (24) months following the Employee's termination, the Company's
obligations to reimburse the Employee under this subsection (ii) shall cease;
provided, finally, that if the Company's obligations under this subsection (ii)
cease pursuant to clause (C), the Company shall make a lump sum payment to the
Employee equal to the product of the last monthly reimbursement paid to the
Employee pursuant to this subsection (ii) multiplied by six (6).
(iii) Outplacement Services. During the twenty-four (24)
months following termination of the Employee's employment, the Employee shall be
entitled to executive-level outplacement services at the Company's expense, not
to exceed $15,000. Such services shall be provided by a firm selected by the
Employee from a list compiled by the Company.
(iv) Option Acceleration. The vesting and exercisability of
each option shall be automatically accelerated as to 100% of the unvested shares
subject thereto at the time of the Involuntary Termination; provided, however,
that it is determined by the Company's
3
<PAGE> 4
independent accountants that such acceleration would preclude accounting for the
Change of Control as a pooling of interests for financial accounting purposes,
and it is a condition to the closing of the Change of Control that the
transaction be accounted for as a pooling of interests, then the vesting and
exercisability of the Options should not accelerate pursuant to this Section
7(a)(iv).
(b) Voluntary Resignation; Termination For Cause. If the Employee
voluntarily resigns from the Company (other than in an Involuntary Termination),
or if the Company terminates the Employee's employment for Cause, then the
Employee shall not be entitled to receive severance or other benefits under this
Section 7, but shall be eligible for those benefits (if any) as may then be
established under any other Section of this Agreement or the Company's
then-existing severance and benefits plans and policies at the time of such
termination.
(c) Disability; Death. If the Company terminates the Employee's
employment as a result of the Employee's Disability, or such Employee's
employment terminates due to the death of the Employee, either in connection
with or apart from a Change of Control, then the Employee shall not be entitled
to receive severance or other benefits under this Section 7, but shall be
eligible for those benefits (if any) as may then be established under any other
Section of this Agreement or the Company's then-existing severance and benefits
plans and policies at the time of such Disability or death.
8. Termination Apart from a Change of Control. If the Employee's employment with
the Company terminates at any time either prior to the occurrence of a Change of
Control or after the twenty-four month period following the effective date of a
Change of Control, then the Employee shall not be entitled to receive severance
or other benefits under this Agreement, but shall be eligible for those benefits
(if any) as may be established under the Company's then-existing severance and
benefits plans and policies at the time of such termination, or as may be
provided in the offer of employment letter dated _______________.
9. Definition of Terms. The following terms referred to in this Agreement shall
have the following meanings:
(a) Cause. "Cause" shall mean (i) any act of personal dishonesty taken
by the Employee in connection with his/her responsibilities as an employee and
intended to result in substantial personal enrichment of the Employee, (ii) the
Employee's commission of a felony or an act of fraud against the Company or its
affiliates, (iii) a willful act by the Employee that constitutes gross
misconduct and that is injurious to the Company, and (iv) continued violations
by the Employee of the Employee's obligations under Section 1 of this Agreement,
which are demonstrably willful and deliberate on the Employee's part after there
has been delivered to the Employee a written demand for performance from the
Company that describes the basis for the Company's belief that the Employee has
not substantially performed his/her duties along with an opportunity for the
Employee to meet such demands, which the Employee fails to accomplish within a
reasonable period of time.
4
<PAGE> 5
(b) Change of Control. "Change of Control" shall mean the occurrence of
any of the following events:
(i) Any "person" (as such term is used in Sections 13(d) and
14(d) of the Securities Exchange Act of 1934, as amended) becomes the
"beneficial owner" (as defined in Rule 13d-3 under said Act), directly or
indirectly, of securities of the Company representing fifteen percent (15%) or
more of the total voting power represented by the Company's then outstanding
voting securities;
(ii) A merger or consolidation of the Company with any other
corporation, other than a merger or consolidation that would result in the
voting securities of the Company outstanding immediately prior thereto
continuing to represent (either by remaining outstanding or by being converted
into voting securities of the surviving entity) more than fifty percent (50%) of
the total voting power represented by the voting securities of the Company or
such surviving entity outstanding immediately after such merger or
consolidation;
(iii) The approval by the shareholders of the Company of a
plan of complete liquidation of the Company or an agreement for the sale or
disposition by the Company of all or substantially all of the Company's assets;
or
(iv) A change in the composition of the Board, as a result of
which fewer than a majority of the directors are Incumbent Directors. "Incumbent
Directors" shall mean directors who either (A) are directors of the Company as
of the date hereof, or (B) are elected, or nominated for election, to the Board
with the affirmative votes of at least a majority of those directors whose
election or nomination was not in connection with any transaction described in
subsections (i), (ii) or (iii) or in connection with an actual or threatened
proxy contest relating to the election of directors of the Company.
(c) Compensation Continuation Period. "Compensation Continuation Period"
shall mean the period of time commencing with termination of the Employee's
employment in an Involuntary Termination during the term of this Agreement and
ending with the expiration of twenty-four (24) months following the date of the
Employee's termination.
(d) Current Compensation. "Current Compensation" shall mean an amount
equal to the greater of (i) Employee's Base Compensation earned in the fiscal
year preceding the fiscal year of Employee's termination; or (ii) Employee's
Base Compensation for the fiscal year of Employee's termination, including 100%
of any bonus which the Employee could have earned during such fiscal year,
assuming the achievement of all relevant Employee and Company goals, milestones
and performance criteria.
(e) Disability. "Disability" shall mean that the Employee has been
unable to perform his duties under this Agreement as the result of his
incapacity due to physical or mental illness, and such inability, at least 26
weeks after its commencement, is determined to be total and permanent by a
physician selected by the Company or its insurers and acceptable to the Employee
or the Employee's legal representative (such Agreement as to acceptability not
to be unreasonably withheld). Termination resulting from Disability may only be
effected after
5
<PAGE> 6
at least 30 days' written notice by the Company of its intention to terminate
the Employee's employment. In the event that the Employee resumes the
performance of substantially all of his/her duties hereunder before the
termination of his employment becomes effective, the notice of intent to
terminate shall automatically be deemed to have been revoked.
(f) Hostile Takeover. "Hostile Takeover" shall mean any "person" (as
such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of
1934, as amended) becoming the "beneficial owner" (as defined in Rule 13d-3
under said Act), directly or indirectly, of securities of the Company
representing fifty percent (50%) or more of the total voting power represented
by the Company's then outstanding voting securities, without the approval of the
Company's Board of Directors;
(g) Involuntary Termination. "Involuntary Termination" shall mean (i)
without the Employee's express written consent, the assignment to the Employee
of any duties or the significant reduction of the Employee's duties, either of
which is inconsistent with the Employee's position with the Company and his/her
responsibilities in effect immediately prior to such assignment, or the removal
of the Employee from such position and responsibilities; (ii) without the
Employee's express written consent, a substantial reduction, without good
business reasons, of the facilities and perquisites (including office space and
location) available to the Employee immediately prior to such reduction; (iii) a
reduction by the Company in the Base Compensation of the Employee as in effect
immediately prior to such reduction; (iv) a material reduction by the Company in
the kind or level of employee benefits to which the Employee is entitled
immediately prior to such reduction, with the result that the Employee's overall
benefits package is significantly reduced; (v) the relocation of the Employee to
a facility or a location more than 30 miles from the Employee's then present
location, without the Employee's express written consent; (vi) any purported
termination of the Employee by the Company that is not effected for Disability
or for Cause, or any purported termination for which the grounds relied upon are
not valid; or (vii) the failure of the Company to obtain the assumption of this
Agreement by any successors contemplated in Section 9 below; provided, however,
that no Involuntary Termination shall be deemed to have occurred if any such
successor substitutes an agreement for this Agreement providing comparable
severance benefits to those provided for in this Agreement.
10. Golden Parachute Excise Tax.
(a) Reimbursement. In the event that it shall be determined that any
payment or other benefit by the Company to or for the benefit of the Employee
under this Agreement, whether paid or payable, but determined without regard to
any additional payments required under this Section (the "Payments"), would be
subject to the excise tax imposed by Section 4999 of the Internal Revenue Code
(the "Excise Tax"), then the Employee shall be entitled to receive an additional
payment from the Company (the "First Reimbursement Payment") equal to one
hundred percent (100%) of any Excise Tax actually paid or payable by the
Employee in connection with the Payments, plus an additional payment from the
Company in such amount that after payment of all taxes (including, without
limitation, any interest and
6
<PAGE> 7
penalties on such taxes and the Excise Tax) on the Reimbursement Payment, the
Employee retains an amount equal to the Reimbursement Payment.
(b) Determination. Unless the Company and the Employee otherwise agree
in writing, any determination required under this Section shall be made in
writing by the Company's primary independent public accounting firm (the
"Accountants"), whose determination shall be conclusive and binding upon the
Employee and the Company for all purposes. For purposes of making the
calculations required by this Section, the Accountants may make reasonable
assumptions and approximations concerning applicable taxes and may rely on
reasonable, good faith interpretations concerning the application of Sections
280G and 4999 of the Code. The Company and the Employee shall furnish to the
Accountants such information and documents as the Accountants may reasonably
request in order to make their determination under this Section. The Company
shall bear all costs the Accountants may reasonably incur in connection with any
calculations contemplated by this Section.
11. Successors.
(a) Company's Successors. Any successor to the Company (whether direct
or indirect and whether by purchase, lease, merger, consolidation, liquidation
or otherwise) to all or substantially all of the Company's business and assets
shall assume the obligations under this Agreement and agree expressly to perform
the obligations under this Agreement in the same manner and to the same extent
as the Company would be required to perform such obligations in the absence of a
succession. For all purposes under this Agreement, the term "Company" shall
include any successor to the Company's business and assets that executes and
delivers the assumption agreement described in this subsection (a) or which
becomes bound by the terms of this Agreement by operation of law.
(b) Employee's Successors. The terms of this Agreement and all rights of
the Employee hereunder shall inure to the benefit of, and be enforceable by, the
Employee's personal or legal representatives, executors, administrators,
successors, heirs, devisees and legatees.
12. Notice.
(a) General. Notices and all other communications contemplated by this
Agreement shall be in writing and shall be deemed to have been duly given when
delivered personally, or by facsimile, or three business days after deposit in
the U.S. mail by registered or certified mail, return receipt requested and
postage prepaid. In the case of the Employee, mailed notices shall be addressed
to him/her at the home address which he/she most recently communicated to the
Company in writing. In the case of the Company, mailed notices shall be
addressed to its corporate headquarters, and all notices shall be directed to
the attention of its Secretary.
(b) Notice of Termination. Any termination by the Company for Cause or
by the Employee as a result of an Involuntary Termination shall be communicated
by a notice of termination to the other party hereto given in accordance with
this Section. Such notice shall
7
<PAGE> 8
indicate the specific termination provision in this Agreement relied upon, shall
set forth in reasonable detail the facts and circumstances claimed to provide a
basis for termination under the provision so indicated, and shall specify the
termination date (which shall be not more than 15 days after the giving of such
notice). The failure by the Employee to include in the notice any fact or
circumstance which contributes to a showing of Involuntary Termination shall not
waive any right of the Employee hereunder or preclude the Employee from
asserting such fact or circumstance in enforcing his/her rights hereunder.
13. Confidentiality. The Parties hereto each agree to use their best efforts to
maintain in confidence the underlying facts leading up to this Agreement, the
existence of this Agreement, the contents and terms of this Agreement, and the
consideration for this Agreement. Each Party hereto agrees not to disclose or
use and to take every reasonable precaution to prevent disclosure or use of any
such information to or by third parties, and each agrees that there will be no
publicity, directly or indirectly, concerning any such information. The parties
hereto agree that breach of this Section shall constitute a material breach of
this Agreement that shall entitle the non-breaching party to all available legal
and equitable remedies including, but not limited to, recision of this
Agreement. The parties hereto further agree that all benefits to the Employee
under this Agreement shall be conditioned on his/her compliance with his/her
obligations under this Section.
14. Miscellaneous Provisions.
(a) No Duty to Mitigate. The Employee shall not be required to mitigate
the amount of any payment or benefit contemplated by this Agreement (whether by
seeking new employment or in any other manner), nor (except as otherwise
provided in this Agreement) shall any such payment or benefit be reduced by the
Employee obtaining new employment or by any earnings that the Employee may
receive from any other source.
(b) Waiver. No provision of this Agreement shall be modified, waived or
discharged unless the modification, waiver or discharge is agreed to in writing
and signed by the Employee and by an authorized officer of the Company (other
than the Employee). No waiver by either party of any breach of, or of compliance
with, any condition or provision of this Agreement by the other party shall be
considered a waiver of any other condition or provision or of the same condition
or provision at another time.
(c) Whole Agreement. No agreements, representations or understandings
(whether oral or written and whether express or implied) between the parties
with regard to severance or other benefits in connection with a Change of
Control that are not expressly set forth or referred to in this Agreement have
been made or entered into by either party.
(d) Choice of Law. The validity and interpretation of this Agreement
shall be governed by the laws of the State of California without reference to
rules of conflicts of law. Employee hereby consents to the personal jurisdiction
of the state and federal courts located in California for any action or
proceeding arising from or relating to this Agreement or relating to any
arbitration in which the parties are participants.
8
<PAGE> 9
(e) Severability. If any portion of this Agreement is held by an
arbitrator or a court of competent jurisdiction to conflict with any federal,
state or local law, or to be otherwise invalid or unenforceable, such portion of
this Agreement shall be of no force or effect and the remaining provisions of
this Agreement shall otherwise remain in full force and effect and be construed
as if such portion had not been included in this Agreement.
(f) Arbitration. Employee agrees that any dispute or controversy arising
out of, relating to, or in connection with this Agreement, or the
interpretation, validity, construction, performance, breach, or termination
thereof, shall be settled by binding arbitration to be held in Santa Clara
County, California in accordance with the rules of the American Arbitration
Association then in effect. The prevailing party shall be entitled to recover
its attorneys' fees. Judgment may be entered on the arbitrator's award in any
court having jurisdiction. Punitive damages shall not be awarded.
(g) No Assignment of Benefits. The rights of any person to payments or
benefits under this Agreement shall not be made subject to option or assignment,
either by voluntary or involuntary assignment or by operation of law, including
(without limitation) bankruptcy, garnishment, attachment or other creditor's
process, and any action in violation of this subsection (g) shall be void.
(h) Employment Taxes. All payments made pursuant to this Agreement will
be subject to withholding of applicable income and employment taxes.
(i) Assignment by Company. The Company may assign its rights under this
Agreement to an affiliate, and an affiliate may assign its rights under this
Agreement to another affiliate of the Company or to the Company; provided,
however, that no assignment shall be made if the net worth of the assignee is
less than the net worth of the Company at the time of assignment. In the case of
any such assignment, the term "Company" when used in a Section of this Agreement
shall mean the corporation that actually employs the Employee.
(j) Counterparts. This Agreement may be executed in counterparts, each
of which shall be deemed an original, but all of which together will constitute
one and the same instrument.
9
<PAGE> 10
IN WITNESS WHEREOF, each of the parties has executed this Agreement, in
the case of the Company by its duly authorized officer, as of the day and year
first above written.
COMPANY:
ARTHROCARE CORPORATION
By:
-------------------------------------
Title:
-------------------------------------
EMPLOYEE:
--------------------------------------------
(Signature)
--------------------------------------------
(Print Name)
Date:
-------------------------------------
10
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 333-06297) of ArthroCare Corporation, of our report
dated January 27, 1999 appearing on page 40 of this Form 10-K. We also consent
to the application of such report to the Financial Statement Schedule for the
three years ended January 2, 1999 when such schedule is read in conjunction with
the financial statements referred to in our report. The audits referred to in
such report also include these schedules.
PricewaterhouseCoopers LLP
San Jose, California
April 2, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS RESTATED SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEET AND STATEMENT OF OPERATIONS INCLUDED IN THE COMPANY'S FORM 10-Q'S
FOR THE QUARTERS ENDED APRIL 4, JULY 4, AND OCTOBER 3, 1998 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
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<FISCAL-YEAR-END> JAN-02-1999 JAN-02-1999 JAN-02-1999 JAN-02-1999
<PERIOD-START> JAN-04-1998 JAN-04-1998 JAN-04-1998 JAN-04-1998
<PERIOD-END> JAN-02-1999 APR-04-1998 JUL-04-1998 OCT-03-1998
<CASH> 2826 12561 10299 6340
<SECURITIES> 5232 8752 4575 5732
<RECEIVABLES> 5972 2755 3806 4946
<ALLOWANCES> 0 0 0 0
<INVENTORY> 7069 2189 3744 5778
<CURRENT-ASSETS> 22137 24874 22968 21666
<PP&E> 4460 1351 2165 3410
<DEPRECIATION> 0 0 0 0
<TOTAL-ASSETS> 27760 28765 28730 27618
<CURRENT-LIABILITIES> 5164 4603 5266 5152
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0 0 0 0
0 0 0 0
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<OTHER-SE> 22296 23998 23293 22298
<TOTAL-LIABILITY-AND-EQUITY> 27760 28765 28730 27618
<SALES> 24624 4871 10544 17265
<TOTAL-REVENUES> 27916 4871 10544 17265
<CGS> 12368 2850 5995 9131
<TOTAL-COSTS> 12368 2850 5995 9131
<OTHER-EXPENSES> 18625 4312 8602 13693
<LOSS-PROVISION> 0 0 0 0
<INTEREST-EXPENSE> 0 0 0 0
<INCOME-PRETAX> (2140) 253 (841) (1921)
<INCOME-TAX> 1 0 0 0
<INCOME-CONTINUING> (2141) 253 (841) (1921)
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<EXTRAORDINARY> 0 0 0 0
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</TABLE>
