<PAGE>
FILED PURSUANT TO RULE 424(b)(3)
REGISTRATION NO. 333-37866
PROSPECTUS
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5,000,000 Shares
[CURON MEDICAL LOGO]
Common Stock
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This is our initial public offering of shares of our common stock. No public
market currently exists for our common stock.
The Nasdaq National Market has approved our common stock for quotation under
the symbol "CURN."
Before buying any shares you should read the discussion of material risks of
investing in our common stock in "Risk factors" beginning on page 7.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or passed upon the
accuracy or adequacy of this prospectus. Any representation to the contrary is
a criminal offense.
<TABLE>
<CAPTION>
Per Share Total
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<S> <C> <C>
Public offering price $11.00 $55,000,000
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Underwriting discounts and commissions $ 0.77 $ 3,850,000
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Proceeds, before expenses, to us $10.23 $51,150,000
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</TABLE>
The underwriters may also purchase up to 750,000 shares of common stock from us
at the public offering price, less the underwriting discounts and commissions,
within 30 days from the date of this prospectus. The underwriters may exercise
this option only to cover over-allotments, if any. If the underwriters exercise
the option in full, the total underwriting discounts and commissions will be
$4,427,500, and our total proceeds, before expenses, will be $58,822,500.
The underwriters are offering the common stock as set forth under
"Underwriting." Delivery of the shares will be made on or about September 26,
2000.
UBS Warburg LLC
CIBC World Markets
SG Cowen
The date of this prospectus is September 21, 2000
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[Stretta Logo]
The Stretta Procedure
The Stretta procedure, developed by Curon Medical, provides an alternative to
medication or surgery for patients with gastroesophageal reflux disease.
Gastroesophageal reflux disease is caused by a malfunctioning lower esophageal
sphincter, the muscle responsible for preventing the backward flow, or reflux,
of stomach contents into the esophagus. The Stretta procedure is designed to
correct the function of the lower esophageal sphincter to reduce reflux events
and eliminate or reduce patients' ongoing need for prescription medications.
[Three step-by-step Images of the Stretta Procedure]
<TABLE>
<S> <C> <C>
With the patient sedated The physician repeats this Over the next several weeks,
but awake, the Stretta sequence multiple times to the lesions are reabsorbed
Catheter is inserted create an array of thermal and the tissue contracts,
through the mouth into lesions along the length of improving the function of
the lower esophageal the lower esophageal the lower esophageal
sphincter. The balloon sphincter. sphincter.
is inflated, electrodes
are deployed into the
tissue, and
radiofrequency energy is
delivered to create
well-defined thermal
lesions in the tissue.
</TABLE>
The Stretta System
<TABLE>
<S> <C>
[Image of Curon Control Module] The Curon Control Module is a four-channel
generator that delivers controlled
radiofrequency energy to achieve precise
treatment temperatures during the Stretta
procedure.
The Stretta Catheter is a flexible handheld [Image of the Stretta Catheter]
disposable device that is used in
conjunction with the Curon Control Module
to deliver radiofrequency energy to the
lower esophageal sphincter.
</TABLE>
[Curon Logo]
<PAGE>
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Through and including October 16, 2000 (the 25th day after commencement of this
offering), federal securities law may require all dealers selling shares of our
common stock, whether or not participating in this offering, to deliver a
prospectus. This delivery requirement is in addition to the obligation of
dealers to deliver a prospectus when acting as underwriters and with respect to
their unsold allotments or subscriptions.
TABLE OF CONTENTS
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<TABLE>
<S> <C>
Prospectus summary................... 3
The offering......................... 5
Summary financial and operating
data............................... 6
Risk factors......................... 7
Forward-looking information.......... 16
Use of proceeds...................... 17
Dividend policy...................... 17
Capitalization....................... 18
Dilution............................. 19
Selected financial data.............. 21
Management's discussion and analysis
of financial condition and results
of operations...................... 22
</TABLE>
<TABLE>
<S> <C>
Business......................... 28
Scientific Advisory Board........ 45
Management....................... 46
Certain transactions............. 57
Principal stockholders........... 59
Description of capital stock..... 61
Shares eligible for future sale.. 65
Underwriting..................... 67
Legal matters.................... 70
Experts.......................... 70
Where you can find more
information.................... 70
Index to financial statements.... F-1
</TABLE>
Curon(TM), Stretta(TM) and Secca(TM) are our trademarks. This prospectus also
refers to trademarks and trade names of other organizations.
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Prospectus summary
This summary highlights information contained elsewhere in this prospectus. You
should read the entire prospectus carefully, especially the risks of investing
in our common stock which we discuss under "Risk factors." Except as otherwise
indicated, information in this prospectus assumes the conversion of each
outstanding share of convertible preferred stock into one share of common stock
and assumes no exercise of the underwriters' over-allotment option. Information
contained in this prospectus reflects a 0.57-for-one reverse stock split, which
will occur before the closing of this offering.
OUR BUSINESS
We develop, manufacture and market innovative proprietary products for the
treatment of gastrointestinal disorders. Our products consist of radiofrequency
generators and single-use disposable devices. Our first product, the Stretta
System, received United States Food and Drug Administration clearance in April
2000 for the treatment of gastroesophageal reflux disease, commonly referred to
as GERD, which affects approximately 14 million U.S. adults on a daily basis.
Unlike medication, which temporarily suppresses GERD symptoms, our Stretta
System is designed to apply radiofrequency energy to treat the causes of GERD.
In a multi-center clinical trial used to support our FDA clearance, 47 patients
who required daily anti-acid medications were treated with the Stretta System.
After six months, the need for all anti-acid medication was eliminated in 70%
of the 44 patients available for follow-up, and the need for the most potent
prescription GERD medication was eliminated in 87% of those patients that
required such medication before treatment. We commercially launched the Stretta
System in May 2000 at a major gastroenterology conference and have only limited
revenues to date. As of August 1, 2000, approximately 200 patients have been
treated with the Stretta procedure. Our second product, the Secca System, is
currently under development for the treatment of fecal incontinence. In July
2000, we began a U.S. clinical trial of the Secca System.
GERD: THE PROBLEM AND CONVENTIONAL TREATMENT OPTIONS
GERD is the frequent backward flow, or reflux, of stomach contents into the
esophagus. In the lower part of the esophagus, there is an area of thickened
muscle known as the lower esophageal sphincter which, when functioning
properly, acts as a one-way valve that allows food to pass down from the
esophagus into the stomach but prevents reflux. In GERD patients, the lower
esophageal sphincter functions improperly and allows chronic reflux to occur.
Stomach acid, enzymes and bile irritate the esophagus and cause a wide range of
symptoms and complications, most commonly persistent, severe heartburn and
chest pain. In some GERD sufferers, the pain is acute enough to require an
emergency room visit. People with GERD often have difficulty sleeping due to
increased reflux and heartburn when they lie down. Also, damage to the
esophagus caused by reflux may result in more serious complications, such as
erosion or ulceration of the esophagus, build-up of scar tissue that can narrow
and obstruct the esophagus, and Barrett's epithelium, a condition that
increases the risk of esophageal cancer.
Prescription medication is the primary treatment option used by people with
GERD. There are many widely prescribed medications, including Prilosec, with
worldwide sales of approximately $6 billion in 1999, Prevacid, Tagamet, Pepcid
and Zantac. Although these medications temporarily ease heartburn symptoms by
reducing stomach acid, they do not prevent reflux or treat the underlying
causes of GERD. Side effects may include diarrhea, headaches, dizziness and
nausea. Taken regularly, these medications are expensive, costing an estimated
average of $2,300 per year based solely on retail prices
3
<PAGE>
for medication requirements of the patients in our clinical trial. Many GERD
patients do not want to be dependent on medications and have difficulty
complying with prescribed lifestyle modifications which require ongoing
fundamental changes in eating, drinking and sleeping behavior.
The most common corrective treatment for GERD is fundoplication surgery. This
inpatient surgical procedure costs approximately $11,700, involves a prolonged
recovery period, and exposes the patient to a significant risk of serious side
effects. Consequently, physicians are reluctant to refer otherwise healthy
patients for the surgery. An estimated 70,000 patients underwent fundoplication
surgery in the United States in 1999.
OUR SOLUTION: THE STRETTA SYSTEM
Our proprietary Stretta System provides physicians with the tools to perform a
minimally invasive, outpatient and cost-effective procedure for the treatment
of GERD. Unlike medication, the Stretta procedure is designed to treat GERD,
rather than simply manage symptoms. Unlike fundoplication surgery, the Stretta
procedure is an outpatient procedure with minimal side effects. The Stretta
procedure, which we believe will cost an average of $2,000, is designed to take
less than an hour utilizing techniques commonly used by gastroenterologists.
Most treated patients have been able to return to normal activities within one
day of treatment and reduce or eliminate medication use shortly thereafter. We
believe that the Stretta procedure's effectiveness and relatively low cost,
combined with the absence of significant discomfort and side effects, makes it
a clinically and economically attractive GERD treatment compared to either
medication or fundoplication surgery.
The Stretta System consists of the Stretta Catheter, which is a disposable
flexible catheter with needle electrodes, and the Curon Control Module, which
is a radiofrequency energy generator. Using these devices, the physician
delivers precisely controlled radiofrequency energy to create thermal lesions
in the muscle of the lower esophageal sphincter. These lesions reabsorb over
several weeks and cause tissue contraction, which increases the ability of the
lower esophageal sphincter to act as a barrier to reflux.
THE SECCA SYSTEM: TREATMENT OF FECAL INCONTINENCE
We are applying our experience with the Stretta System to the development of
the Secca System, which is designed to treat fecal incontinence, a condition
that affects up to 16 million U.S. adults. Fecal incontinence is caused by
damage to the anal sphincter from childbirth or surgery, neurologic disease,
injury or age. It is a life-altering condition that, like GERD, lacks minimally
invasive corrective treatment alternatives. The most common treatment options
control, but do not correct, the condition, and include the use of protective
undergarments, diet modification and over-the-counter dietary supplements.
Current corrective treatment options include highly invasive surgery and are
rarely utilized.
The Secca System is designed to provide a minimally invasive, outpatient, and
cost-effective procedure for the treatment of fecal incontinence. The Secca
procedure utilizes the same technology and treatment concepts as the Stretta
System. Using our Curon Control Module and our handheld disposable device
called the Secca Handpiece, physicians deliver radiofrequency energy into the
muscle of the anal sphincter to improve its barrier function. We began a U.S.
clinical trial of the Secca System in July 2000 and, if successful, we intend
to submit the results to the FDA in mid-2001.
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The offering
The following information assumes that the underwriters do not exercise their
over-allotment option to purchase additional shares in the offering.
<TABLE>
<C> <S>
Common stock we are offering............... 5,000,000 shares
Common stock to be outstanding after the
offering................................. 18,661,000 shares
Nasdaq National Market symbol.............. CURN
Use of proceeds............................ For research and development,
continued development,
manufacturing and
commercialization of existing and
future products, support of
clinical trials and reimbursement
efforts, sales and marketing
initiatives and for general
corporate purposes. See "Use of
proceeds."
Risk factors............................... Investing in our common stock
involves significant risks. See
"Risk factors."
</TABLE>
Unless we indicate otherwise, when analyzing the information in this
prospectus, you should assume that all outstanding shares of our preferred
stock convert into 9,597,000 shares of our common stock upon the closing of
this offering.
At July 15, 2000, we were obligated to issue shares of common stock upon
exercise of options and warrants as follows:
.1,179,000 shares of common stock issuable upon exercise of options under our
1997 Stock Option Plan at a weighted average exercise price of $1.50 per
share; and
.722,000 shares of common stock issuable upon the exercise of warrants at a
weighted average exercise price of $3.69 per share of which 569,000 shares of
common stock are issuable upon exercise of warrants issued in connection with
convertible notes (see Note 13 of the notes to the financial statements) at an
exercise price of $4.39 per share.
In addition, we have agreed to issue an additional 750,000 shares if the
underwriters exercise their over-allotment option in full, which we describe in
"Underwriting." If the underwriters exercise this option in full, 19,411,000
shares of common stock will be outstanding after this offering.
We base our calculation of the number of shares of common stock outstanding
after the offering on shares outstanding as of July 15, 2000. See
"Capitalization."
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We were incorporated in Delaware in May 1997 as Conway-Stuart Medical, Inc. and
changed our name to Curon Medical, Inc. in March 2000. Our principal executive
offices are located at 735 Palomar Avenue, Sunnyvale, California 94085. Our
telephone number is (408) 733-9910. Our web site is
http://www.curonmedical.com. We do not intend information contained on our web
site to be a part of this prospectus.
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Summary financial and operating data
The following table summarizes the financial data for our business, a company
in the development stage, during the periods indicated. See note 10 of the
notes to financial statements for an explanation of the determination of the
number of shares used in computing per share data. The pro forma net loss per
share and shares used in computing pro forma net loss per share are calculated
as if all of our convertible preferred stock was converted into shares of our
common stock on the date of their issuance. See "Use of proceeds" and
"Capitalization."
<TABLE>
<CAPTION>
Cumulative
Period from
May 1, 1997
Six Months Ended (Date of
Year Ended December 31, June 30, Inception) to
1998 1999 1999 2000 June 30, 2000
(unaudited) (unaudited)
Statement of operations
data: (In thousands, except per share data)
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<S> <C> <C> <C> <C> <C>
Revenues................ $ -- $ -- $ -- $ 170 $ 170
Cost of goods sold...... -- -- -- 281 281
----------- ----------- --------- ---------- --------
Gross profit............ -- -- -- (111) (111)
Operating expenses:
Research and
development......... 1,581 8,961 2,343 3,091 13,661
Clinical and
regulatory.......... 335 2,012 790 912 3,259
Sales and marketing.... -- 940 410 1,095 2,035
General and
administrative...... 959 2,345 784 2,079 5,396
----------- ----------- --------- ---------- --------
Operating loss.......... (2,875) (14,258) (4,327) (7,288) (24,462)
Interest income......... 8 258 56 260 526
Interest expense (see
Note 13 of the notes
to the financial
statements).......... (86) (89) (34) (1,052) (1,227)
----------- ----------- --------- ---------- --------
Net loss................ $(2,953) $(14,089) $(4,305) $(8,080) $(25,163)
=========== =========== ========= ========== ========
Net loss per share,
basic and diluted.... $ (2.01) $ (6.94) $ (2.04) $ (3.27)
=========== =========== ========= ==========
Shares used in computing
net loss per share,
basic and diluted.... 1,472,000 2,030,000 2,115,000 2,472,000
Pro forma net loss per
share, basic and
diluted.............. $ (1.79) $ (0.67)
=========== ==========
Shares used in computing
pro forma net loss
per share, basic and
diluted.............. 7,890,000 12,069,000
</TABLE>
The following table sets forth balance sheet data as of June 30, 2000:
.On a pro forma basis to give effect to the automatic conversion of all
outstanding shares of preferred stock into 9,597,000 shares of common stock
upon closing of this offering, and
.On a pro forma as adjusted basis to reflect the net proceeds from the sale of
5,000,000 shares of our common stock in this offering at a public offering
price of $11.00 per share, after deducting the underwriting discounts and
commissions and estimated offering expenses. This also assumes the repayment
of convertible notes payable and interest and elimination of the beneficial
conversion feature and related discount on the warrants (see Note 13 of the
notes to the financial statements.)
<TABLE>
<CAPTION>
As of June 30, 2000
Pro Forma
Actual Pro Forma As Adjusted
Balance sheet data: (In thousands)
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<S> <C> <C> <C>
Cash, cash equivalents and marketable
securities.................................. $14,799 $14,799 $53,585
Working capital................................ 13,439 13,439 52,299
Total assets................................... 18,660 18,660 57,446
Long-term obligations.......................... 116 116 116
Convertible preferred stock and warrants....... 23,908 -- --
Stockholders' equity (deficit)................. $(7,900) $16,008 $55,792
</TABLE>
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Risk factors
If you purchase our common stock, your investment will be subject to risks
inherent in our business. You should carefully consider the risks described
below before participating in this offering. The risks and uncertainties
described below are, in our opinion, the material risks that are specific to
us, our industry and companies going public. If any of the following risks
actually occur, our business could be materially harmed. As a result, the
trading price of our common stock could decline and you could lose all or part
of your investment.
We may never achieve or maintain profitability.
We have only a limited operating history upon which you can evaluate our
business. We have incurred losses every year since we began operations. In
particular, we incurred net losses of $3.0 million in 1998 and $14.1 million in
1999. As of June 30, 2000, we had an accumulated deficit of approximately $25.2
million. We have generated limited revenues from the sale of our products, and
it is possible that we will never generate significant revenues from product
sales in the future. Even if we do achieve significant revenues from our
product sales, we expect to incur significant net losses over the next several
years and these losses may increase. It is possible that we will never achieve
profitable operations.
The Stretta System is our only marketed product. If physicians do not adopt our
Stretta System, we will not achieve future sales growth.
We commercially introduced our Stretta System, which consists of a
radiofrequency generator and a disposable handheld device, in May 2000. We are
highly dependent on Stretta System sales because we anticipate that the Stretta
System will account for substantially all our revenue through at least 2001. To
achieve increasing sales, our product must gain recognition and adoption by
physicians who treat gastrointestinal disorders. The Stretta System represents
a significant departure from conventional GERD treatment methods. We believe
that physicians will not use our Stretta System unless they determine, based on
published peer-reviewed journal articles, long-term clinical data and their
professional experience, that the Stretta System provides an effective and
attractive alternative to conventional means of treatment for GERD. Currently,
there are only limited peer-reviewed clinical reports and short-term clinical
follow-up data on our Stretta System. Physicians are traditionally slow to
adopt new products and treatment practices, partly because of perceived
liability risks and uncertainty of third-party reimbursement. If physicians do
not adopt our Stretta System, we may never achieve significant revenues or
profitability.
If the effectiveness and safety of our products are not supported by long-term
data, our sales could decline and we could be subject to liability.
If we do not produce clinical data supported by the independent efforts of
clinicians, our products may never be accepted. We received clearance from the
FDA for the use of the Stretta System to treat GERD based upon the study of 47
patients. Safety and efficacy data presented to the FDA for the Stretta System
was based on six month follow-up studies on 44 of these patients. We may find
that data from longer-term patient follow-up studies is inconsistent with those
indicated by our relatively short-term data. If longer-term patient studies or
clinical experience indicate that treatment with the Stretta System does not
provide patients with sustained benefits or that treatment with our product is
less effective or less safe than our current data suggests, our sales could
decline and we could be subject to significant liability. Further, we may find
that our data is not substantiated in studies involving more patients, in which
case we may never achieve significant revenues or profitability.
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Risk factors
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Our clinical studies of the Secca System are in the early stages. The Secca
System has undergone a 10-patient pilot study and the FDA approved our
application to conduct a U.S. multi-center clinical study, which we began in
July 2000. You should not draw any conclusion about the safety or efficacy of
the Secca System based upon data from the pilot study because this study
involved only a small patient group. If patient studies or clinical experience
do not meet our expectations regarding the benefits of the Secca System, we may
not obtain regulatory clearance or approval to sell the product and our
expected revenues from this product may never materialize.
Any failure in our physician education efforts could significantly reduce
product sales.
It is important to the success of our sales efforts to educate physicians in
the techniques of using the Stretta System. We rely on physicians to spend
their time and money to attend our pre-sale educational sessions. Positive
results using the Stretta System are highly dependent upon proper physician
technique. If physicians use the Stretta System improperly, they may have
unsatisfactory patient outcomes or cause patient injury, which may give rise to
negative publicity or lawsuits against us, any of which could have a material
adverse effect on our sales and profitability.
If health care providers are not adequately reimbursed for the procedures which
use our products, or for the products themselves, we may never achieve
significant revenues.
Physicians, hospitals and other health care providers are unlikely to purchase
our products if they are not adequately reimbursed for the Stretta procedure or
the products. To date, only a limited number of private third-party payors have
agreed to reimburse for the cost of the Stretta procedure or products. Until a
sufficient amount of positive peer-reviewed clinical data has been published,
insurance companies and other payors may refuse to provide reimbursement for
the cost of the Stretta procedure or may reimburse at levels that are not
acceptable to providers. Some payors may refuse adequate reimbursement even
upon publication of peer-reviewed data. The advent of contracted rates per
procedure has also made it difficult to receive reimbursement for disposable
products, even if the use of these products improves clinical outcomes. If
users of our products cannot obtain sufficient reimbursement from health care
payors for the Stretta procedure or the Stretta System disposables, then it is
unlikely that our product will ever achieve significant market acceptance. See
"Business--Reimbursement."
Reimbursement from third-party health care payors is uncertain due to factors
beyond our control.
Even if third-party payors provide adequate reimbursement for the Stretta
procedure, adverse changes in third-party payors' policies generally toward
reimbursement could preclude market acceptance for our products and have a
material adverse effect on our sales and revenue growth. We are unable to
predict what changes will be made in the reimbursement methods used by third-
party health care payors.
For example, some health care payors are moving toward a managed care system in
which providers contract to provide comprehensive health care for a fixed cost
per person. We cannot assure you that in a prospective payment system, which is
used in many managed care systems, the cost of our products will be
incorporated into the overall payment for the procedure or that there will be
adequate reimbursement for our products separate from reimbursement for the
procedure.
Internationally, market acceptance of our products will be dependent upon the
availability of adequate reimbursement within prevailing health care payment
systems. Reimbursement and health care payment systems in international markets
vary significantly by country and include both government-sponsored health care
and private insurance. Although we intend to seek international reimbursement
approvals, we cannot assure you that any such approvals will be obtained in a
timely manner or at all. If foreign third-party payors do not adequately
reimburse providers for the Stretta procedure and the products used with it,
then our sales and revenue growth may be limited.
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Risk factors
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We face competition from more established treatments and from competitors with
greater resources, which will make it difficult for us to achieve significant
market penetration.
The market for the treatment of GERD is dominated by companies that have well-
established products, reputations and resources. We primarily compete with
large pharmaceutical companies such as AstraZeneca, Takeda Abbott
Pharmaceuticals and Merck, which collectively generate over $6 billion in
annual U.S. revenues from sales of medication for the treatment of GERD
symptoms. We also compete with large medical device companies such as Johnson &
Johnson/Ethicon, which makes instrumentation for fundoplication surgery, and
C.R. Bard, which has recently received FDA clearance for an endoscopic suturing
device for the treatment of GERD.
These larger companies enjoy several competitive advantages over us, including:
.existing widely-adopted medications and procedures for the treatment of GERD;
.established reputations within the medical community;
.established distribution networks that permit these companies to introduce new
products and have such products accepted by the medical community promptly;
.established relationships with health care providers and payors that can be
used to facilitate reimbursement for new treatments; and
.greater resources for product development and sales and marketing.
At any time, these competitors or other companies may develop new competitive
products that are more effective or less expensive than ours. For example,
AstraZeneca's patent for Prilosec, the leading prescription medication for the
treatment of GERD, expires in 2001, after which time companies may manufacture
less expensive generic versions of the drug. If we cannot compete effectively
in this highly competitive market, we may not be able to achieve our expected
revenue growth. See "Business--Competition."
We have limited sales and marketing experience, and our failure to build and
manage our sales force or to market and distribute our products effectively
will hurt our revenues and profits.
We have limited sales and marketing experience. As of August 1, 2000, we relied
on six direct sales employees to sell our Stretta System in the United States.
We must expand this sales team over the next 24 months to achieve our market
share and revenue growth goals. Since we have only recently launched the
Stretta System, our sales force has little experience marketing the product,
and we cannot predict how successful they will be in selling the product. There
are significant risks involved in building and managing our sales force and
marketing our products, including our:
.Inability to hire a sufficient number of qualified sales people with the
skills and understanding to sell the Stretta System effectively;
.Failure to adequately train our sales force in the use and benefits of our
products, making them less effective promoters; and
.Failure to accurately price our products as attractive alternatives to
conventional treatments.
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9
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Risk factors
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Internationally, we intend to use third-party distributors to sell our
products, and we cannot assure you that these distributors will commit the
necessary resources to effectively market and sell our products or that they
will be successful in selling our products.
If we fail to adequately build and manage our domestic and foreign sales force,
or to effectively market and distribute our products domestically and
internationally, then our revenues and our profitability will be materially and
negatively impacted.
We have no experience manufacturing our products in commercial quantities,
which could adversely impact the rate at which we grow.
We may encounter difficulties manufacturing our products for the following
reasons:
.We do not have experience manufacturing our products in commercial quantities;
.We do not have extensive experience manufacturing our products in compliance
with the FDA's Quality System Regulation;
.To increase our manufacturing output significantly, we will have to attract
and retain qualified employees, who are in short supply, for the assembly and
testing operations; and
.Some of the components and materials necessary for manufacturing our products
are currently provided by a single supplier.
In addition, although we believe that our current manufacturing facility will
be adequate to support our commercial manufacturing activities for the
foreseeable future, we may be required to expand our manufacturing facilities
to begin large-scale manufacturing. If we are unable to provide customers with
high-quality products in a timely manner, we may not be able to achieve market
acceptance for our Stretta System. Our inability to successfully manufacture or
commercialize our devices could have a material adverse effect on our product
sales.
If we lose our relationship with any individual suppliers of product
components, we will face regulatory requirements with regard to replacement
suppliers that could delay the manufacture of our products.
Third-party suppliers provide materials and components used in our products. If
these suppliers become unwilling or unable to supply us with our requirements,
replacement or alternative sources might not be readily obtainable due to
regulatory requirements applicable to our manufacturing operations. Obtaining
components from a new supplier may require a new or supplemental filing with
applicable regulatory authorities and clearance or approval of the filing
before we could resume product sales. This process may take a substantial
period of time, and we cannot assure you that we would be able to obtain the
necessary regulatory clearance or approval. This could create supply
disruptions that would reduce our product sales and revenue. See "Business--
Government Regulation."
If we or our suppliers fail to comply with the FDA quality system regulation,
manufacturing operations could be delayed and our business could be harmed.
Our manufacturing processes are required to comply with the quality system
regulation, or QSR, which covers the methods and documentation of the design,
testing, production, control, quality assurance, labeling, packaging and
shipping of our products. The United States Food and Drug Administration
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10
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Risk factors
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enforces the QSR through inspections. We have never been through a QSR
inspection, and we cannot assure you that we would pass. If we failed a QSR
inspection, our operations could be disrupted and our manufacturing delayed.
Failure to take corrective action in response to a QSR inspection could force a
shut-down of our manufacturing operations and a recall of our products, which
would have a material adverse effect on our product sales, revenues, and
expected revenues and profitability. Furthermore, we cannot assure you that our
key component suppliers are or will continue to be in compliance with
applicable regulatory requirements, will not encounter any manufacturing
difficulties, or will be able to maintain compliance with regulatory
requirements. Any such event could have a material adverse effect on our
available inventory and product sales. See "Business--Government Regulation."
Our failure to obtain or maintain necessary FDA clearances or approvals could
hurt our ability to commercially distribute and market our products in the
United States.
Our products are considered medical devices and are subject to extensive
regulation in the United States and in foreign countries where we intend to do
business. Unless an exemption applies, each medical device that we wish to
market in the United States must first receive either 510(k) clearance or
premarket approval from the FDA. Either process can be lengthy and expensive.
The FDA's 510(k) clearance process usually takes from four to twelve months,
but may take longer. The premarket application, or PMA, approval process is
much more costly, lengthy and uncertain. It generally takes from one to three
years or even longer. Delays in obtaining regulatory clearance or approval will
adversely affect our revenues and profitability.
Although we have obtained 510(k) clearance for the Stretta System for use in
treating GERD, our clearance can be revoked if postmarketing data demonstrates
safety issues or lack of effectiveness. Moreover, we will need to obtain 510(k)
clearance or premarket approval to market the Secca System for fecal
incontinence and for any other new products we wish to market. If the FDA
concludes that the Secca System does not meet the requirements to obtain 510(k)
clearance, then we would have to seek PMA approval. We cannot assure you that
the FDA will not impose the more burdensome PMA approval process upon this
technology in the future. More generally, we cannot assure you that the FDA
will ever grant 510(k) clearance or premarket approval for any product we
propose to market. If the FDA withdraws or refuses to grant approvals, we will
be unable to market such products in the United States. See "Business--
Government Regulation."
If we market our products for uses that the FDA has not approved, we could be
subject to FDA enforcement action.
Our Stretta System is cleared by the FDA for the treatment of GERD. FDA
regulations prohibit us from promoting or advertising the Stretta System, or
any future cleared or approved devices, for uses not within the scope of our
clearances or approvals or making unsupported safety and effectiveness claims.
These determinations can be subjective, and the FDA may disagree with our
promotional claims. If the FDA requires us to revise our promotional claims or
takes enforcement action against us based upon our labeling and promotional
materials, our sales could be delayed, our profitability could be harmed and we
could be required to pay significant fines or penalties.
Modifications to our marketed devices may require new 510(k) clearances or PMA
approvals or require us to cease marketing or recall the modified devices until
such clearances are obtained.
Any modification to an FDA 510(k)-cleared device that could significantly
affect its safety or effectiveness, or that would constitute a major change in
its intended use, requires a new FDA 510(k)
--------------------------------------------------------------------------------
11
<PAGE>
Risk factors
--------------------------------------------------------------------------------
clearance or, possibly, premarket approval, or PMA approval. The FDA requires
every manufacturer to make this determination in the first instance, but the
FDA can review any such decision. We have modified aspects of our Stretta
System, but we believe that new 510(k) clearances are not required. We may
modify future products after they have received clearance or approval, and, in
appropriate circumstances, we may determine that new clearance or approval is
unnecessary. We cannot assure you that the FDA would agree with any of our
decisions not to seek new clearance or approval. If the FDA requires us to seek
510(k) clearance or PMA approval for any modification to a previously cleared
product, we also may be required to cease marketing or recall the modified
device until we obtain such clearance or approval. Also, in such circumstances,
we may be subject to significant regulatory fines or penalties.
Complying with FDA and other regulations is an expensive and time-consuming
process, and any failure to comply could result in substantial penalties.
Our products are medical devices that are subject to extensive regulation. FDA
regulations are wide-ranging and govern, among other things:
.product design, development, manufacture and testing;
.product labeling;
.product storage;
.premarket clearance or approval;
.advertising and promotion; and
.product sales and distribution.
Noncompliance with applicable regulatory requirements can result in enforcement
action which may include recalling products, ceasing product marketing, paying
significant fines and penalties, and similar FDA actions which could limit
product sales, delay product shipment, and adversely affect our profitability.
See "Business--Government Regulation."
We face risks related to our international operations, including the need to
obtain necessary foreign regulatory approvals.
To date, we have not begun selling our products in international markets and we
do not anticipate doing so before 2001 at the earliest. To successfully market
our products internationally, we must address many issues with which we have
little or no experience. We have obtained regulatory clearance to market the
Stretta System in the European Union and Australia, but we have not obtained
any other international regulatory approvals for other markets or products. We
cannot assure you that we will be able to obtain or maintain such approvals.
Furthermore, international sales may be made in currencies other than the U.S.
dollar. As a result, currency fluctuations may impact the demand for our
products in foreign countries where the U.S. dollar has increased compared to
the local currency. Engaging in international business involves the following
additional risks:
.export restrictions, tariff and trade regulations, and foreign tax laws;
.customs duties, export quotas or other trade restrictions;
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12
<PAGE>
Risk factors
--------------------------------------------------------------------------------
.economic or political instability;
.shipping delays; and
.longer payment cycles.
In addition, contracts may be difficult to enforce and receivables difficult to
collect through a foreign country's legal system, and the protection of
intellectual property in foreign countries may be more difficult to enforce.
Once we begin selling our products internationally, any of these factors could
cause our international sales to decline, which would impact our expected sales
and growth rates.
Product liability suits against us could result in expensive and time-consuming
litigation, payment of substantial damages and an increase in our insurance
rates.
The development, manufacture and sale of medical products involve a significant
risk of product liability claims. The use of any of our products may expose us
to liability claims, which could divert management's attention from our core
business, be expensive to defend, and result in sizable damage awards against
us. We cannot assure you that our product liability insurance would protect us
from product liability claims. Any product liability claims brought against us,
with or without merit, could increase our product liability insurance rates or
prevent us from securing any coverage in the future. Even in the absence of a
claim, our insurance rates may rise in the future to a point where we decide
not to carry any insurance.
We have limited protection for our intellectual property. If our intellectual
property does not sufficiently protect our products, third parties will be able
to compete against us more directly and more effectively.
As of July 15, 2000, we had 11 issued or allowed U.S. patents and 22 pending
U.S. patent applications. We also had 12 issued U.S. patents and 21 pending
U.S. patent applications licensed in from third-parties. We rely on patent,
copyright, trade secret and trademark laws to protect our products, including
our Stretta Catheter and our Curon Control Module, from being duplicated by
competitors. However, these laws afford only limited protection. Our patent
applications and the notices of allowance we have received may not issue as
patents or, if issued, may not issue in a form that will be advantageous to us.
Patents we have obtained and may obtain in the future may be challenged,
invalidated or legally circumvented by third parties. We may not be able to
prevent the unauthorized disclosure or use of our technical knowledge or other
trade secrets by consultants, vendors, former employees or current employees,
despite the existence of nondisclosure and confidentiality agreements and other
contractual restrictions. Furthermore, the laws of foreign countries may not
protect our intellectual property rights to the same extent as the laws of the
United States. If our intellectual property rights do not adequately protect
our commercial products, our competitors could develop new products or enhance
existing products to compete more directly and effectively with us and harm our
product sales and market position. See "Business-- Patents and Proprietary
Technology."
Because of our reliance on unique technology to develop and manufacture
innovative products, we depend on our ability to operate without infringing or
misappropriating the proprietary rights of others.
There is a substantial amount of litigation over patent and other intellectual
property rights in the medical device industry generally. Because we rely on
unique technology to develop and manufacture innovative products, we are
especially sensitive to the risk of infringing intellectual property rights.
While we attempt to ensure that our products do not infringe other parties'
patents and proprietary
--------------------------------------------------------------------------------
13
<PAGE>
Risk factors
--------------------------------------------------------------------------------
rights, our competitors may assert that our products and the methods they
employ may be covered by patents held by them or invented by them before they
were invented by us. Although we may seek to obtain a license or other
agreement under a third party's intellectual property rights to bring an end to
certain claims or actions asserted against us, we may not be able to obtain
such an agreement on reasonable terms or at all. If we were not successful in
obtaining a license or redesigning our products, our product sales and
profitability could suffer, and we could be subject to litigation and
potentially sizable damage awards.
Also, one or more of our products may now be infringing inadvertently on
existing patents. As the number of competitors in our markets grows, the
possibility of a patent infringement claim against us increases. Whether a
product infringes a patent involves complex legal and factual issues, the
determination of which is often uncertain. Infringement and other intellectual
property claims, with or without merit, can be expensive and time-consuming to
litigate and divert management's attention from our core business. If we lose
in this kind of litigation, a court could require us to pay substantial damages
or grant royalties, and prohibit us from using technologies essential to our
products. This kind of litigation is expensive to all parties and consumes
large amounts of management's time and attention. In addition, because patent
applications can take many years to issue, there may be applications now
pending of which we are unaware and which may later result in issued patents
that our products may infringe. See "Business--Patents and Proprietary
Technology."
If we are unable to attract and retain qualified personnel, we will be unable
to expand our business.
We believe our future success will depend upon our ability to successfully
manage our growth, including attracting and retaining engineers and other
highly skilled personnel. Our employees are at-will employees and, with the
exception of certain executive officers, are not subject to employment
contracts. The loss of services of one or more key employees could materially
adversely affect our growth. In addition, hiring qualified management and
technical personnel will be difficult due to the intense competition for
qualified professionals within the medical device industry. In the past, we
have experienced difficulty in recruiting qualified personnel. Failure to
attract and retain personnel, particularly management and technical personnel,
would materially harm our ability to grow our business rapidly and effectively.
Our directors, executive officers and principal stockholders have significant
voting power and may take actions that may not be in the best interests of our
other stockholders.
After this offering, our officers, directors and principal stockholders holding
more than 5% of our common stock together will control approximately 59.1% of
our outstanding common stock. As a result, these stockholders, if they act
together, will be able to control the management and affairs of our company and
all matters requiring stockholder approval, including the election of directors
and approval of significant corporate transactions. This concentration of
ownership may have the effect of delaying or preventing a change in control and
might adversely affect the market price of our common stock. This concentration
of ownership may not be in the best interest of our other stockholders.
Our certificate of incorporation and bylaws and Delaware law contain provisions
that could discourage a takeover.
Our basic corporate documents and Delaware law contain provisions that might
enable our management to resist a takeover. These provisions might discourage,
delay or prevent a change in the control of our company or a change in our
management. The existence of these provisions could
--------------------------------------------------------------------------------
14
<PAGE>
Risk factors
--------------------------------------------------------------------------------
adversely affect the voting power of holders of common stock and limit the
price that investors might be willing to pay in the future for shares of our
common stock. See "Description of capital stock."
Our common stock has not been publicly traded, and we expect that the price of
our common stock will fluctuate substantially.
Before this offering, there has been no public market for shares of our common
stock. An active public trading market may not develop after completion of this
offering or, if developed, may not be sustained. The price of the shares of
common stock sold in this offering will not necessarily reflect the market
price of the common stock after this offering. The market price for the common
stock after this offering will be affected by a number of factors, including:
.the announcement of new products or product enhancements by us or our
competitors;
.quarterly variations in our or our competitors' results of operations;
.changes in earnings estimates or recommendations by securities analysts, or
our failure to achieve analyst earnings estimates;
.developments in our industry; and
.general market conditions and other factors, including factors unrelated to
our operating performance or the operating performance of our competitors.
In addition, the stock prices of many companies in the medical device industry
have experienced wide fluctuations that have often been unrelated to the
operating performance of such companies. Such factors and fluctuations may
materially and adversely affect the market price of our common stock, which, in
turn, may negatively affect our ability to raise capital and to acquire
technologies in the future.
A sale of a substantial number of shares of our common stock may cause the
price of our common stock to decline.
If our stockholders sell substantial amounts of our common stock in the public
market after this offering, including shares issued upon the exercise of
outstanding options, the market price of our common stock could fall. Such
sales also might make it more difficult for us to sell equity or equity-related
securities in the future at a time and price that we deem reasonable or
appropriate. See "Shares eligible for future sale."
New investors in our common stock will experience immediate and substantial
dilution after this offering.
If you purchase shares of our common stock in this offering, you will incur
immediate and substantial dilution in pro forma net tangible book value. If the
holders of outstanding options exercise those options, you will incur further
dilution. See "Dilution."
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15
<PAGE>
--------------------------------------------------------------------------------
Forward-looking information
Some of the statements under "Prospectus summary," "Risk factors,"
"Management's discussion and analysis of financial condition and results of
operations," "Business" and elsewhere in this prospectus constitute forward-
looking statements. These statements relate to future events or our future
financial performance and involve known and unknown risks, uncertainties and
other factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any
future results, levels of activity, performance, or achievements expressed or
implied by such forward-looking statements. Such factors include, among other
things, those listed under "Risk factors" and elsewhere in this prospectus. In
some cases, you can identify forward-looking statements by terminology such as
"may," "will," "should," "could," "expects," "plans," "intends," "anticipates,"
"believes," "estimates," "predicts," "potential" or "continue" or the negative
of such terms and other comparable terminology. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. These statements are only predictions.
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16
<PAGE>
--------------------------------------------------------------------------------
Use of proceeds
We estimate that the net proceeds from the sale of the shares of common stock
we are offering will be approximately $50.0 million. If the underwriters fully
exercise the over-allotment option, the net proceeds will be approximately
$57.6 million. "Net proceeds" are what we expect to receive after we pay the
underwriting discount and other estimated expenses for this offering.
Of the net proceeds that we will receive from the offering, we expect to use
$11.0 million for research and development, $6.0 million for continued
development, manufacturing and commercialization of existing and future
products, $5.0 million in support of clinical trials and reimbursement efforts
and $2.0 million for sales and marketing initiatives to support the
commercialization of the Stretta System. We intend to use approximately $12.0
million of the net proceeds to repay our debt and accrued interest, including
the May 2000 borrowing of $11.1 million (see note 13 of the notes to the
financial statements). The May 2000 borrowing bears interest at 8% and must be
repaid on or before May 2005. We intend to use the remainder of the net
proceeds for general corporate purposes, which may include the purchase of
equipment, the expansion of facilities and the further expansion of our sales
and marketing efforts. From time to time, we have discussed potential strategic
acquisitions and investments with third parties. Currently, we have no
agreements or commitments to complete any such transactions. Pending our uses
of the proceeds, we intend to invest the net proceeds of this offering
primarily in short-term, interest-bearing instruments.
The timing and amount of our actual expenditures will be based on many factors,
including cash flows from operations and the growth of our business.
Dividend policy
We have never declared or paid any dividends on our capital stock. We
anticipate that we will retain any earnings to support operations and to
finance the growth and development of our business. Therefore, we do not expect
to pay cash dividends in the foreseeable future. Any future determination
relating to our dividend policy will be made at the discretion of our board of
directors and will depend on a number of factors, including future earnings,
capital requirements, financial conditions, future prospects and other factors
that the board of directors may deem relevant.
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17
<PAGE>
--------------------------------------------------------------------------------
Capitalization
The following table sets forth our actual capitalization as of June 30, 2000.
It also sets forth our capitalization on a pro forma basis giving effect to:
.the automatic conversion upon completion of this offering of all outstanding
shares of our preferred stock into 9,597,000 shares of common stock;
and our capitalization on a pro forma as adjusted basis giving effect to:
.the sale of 5,000,000 shares of common stock at a public offering price of
$11.00 per share, less underwriting discounts and commissions and estimated
offering expenses; and
.the repayment of $11,090,000 of convertible notes payable plus accrued
interest. At June 30, 2000, the convertible notes were recorded net of a
discount of $10,166,000 related to both warrants issued with the notes and a
beneficial conversion feature. As a result of the assumed repayment of the
notes, we have recorded an extraordinary loss of $1,925,000 on the unamortized
discount associated with the warrants and an extraordinary gain of $749,000
associated with the elimination of the beneficial conversion feature. The
original amount recorded as the beneficial conversion feature, $8,990,000 in
additional paid-in capital, was also reversed (see Note 13 of the notes to the
financial statements). The long term obligations in the table below include
$924,000 classified as current.
<TABLE>
<CAPTION>
June 30, 2000
Pro Forma
Actual Pro Forma as adjusted
(in thousands, except per
share amounts)
-------------------------------------------------------------------------------
<S> <C> <C> <C>
Long-term obligations, excluding current
portion................................... $ 116 $ 116 $ 116
-------- -------- --------
Convertible preferred stock, $0.001 par
value; 10,500,000 shares authorized;
9,597,000 shares issued and outstanding,
actual; no shares issued and outstanding,
as adjusted and pro forma as adjusted..... 21,688 -- --
-------- -------- --------
Preferred stock warrants..................... 2,220 -- --
-------- -------- --------
Stockholders' equity (deficit):
Common stock, $0.001 par value; 30,000,000
shares authorized; 4,064,000 shares
issued and outstanding, actual;
13,661,000 and 18,661,000 issued and
outstanding, as adjusted and pro forma
as adjusted, respectively............... 4 14 19
Additional paid-in capital................. 21,409 45,307 86,262
Deferred stock compensation................ (4,150) (4,150) (4,150)
Deficit accumulated during the development
stage................................... (25,163) (25,163) (26,339)
-------- -------- --------
Total stockholders' equity (deficit)...... (7,900) 16,008 55,792
-------- -------- --------
Total capitalization................... $ 16,124 $ 16,124 $ 55,908
======== ======== ========
</TABLE>
The table above does not include:
.1,179,000 shares of common stock issuable upon exercise of options under our
1997 Stock Option Plan outstanding as of July 15, 2000 at a weighted average
exercise price of $1.50 per share;
.722,000 shares of common stock issuable upon the exercise of warrants
outstanding as of July 15, 2000 at a weighted average exercise price of $3.69
per share;
.2,000,000 shares of common stock reserved for issuance under our 2000 Stock
Plan; and
.400,000 shares available for issuance under our 2000 Employee Stock Purchase
Plan.
See "Use of proceeds," "Capitalization," "Management--Employee Benefit Plans"
and "Description of capital stock."
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18
<PAGE>
--------------------------------------------------------------------------------
Dilution
If you invest in our common stock, your interest will be diluted immediately to
the extent of the difference between the public offering price per share of our
common stock and the pro forma as adjusted net tangible book value per share of
our common stock after this offering. Net tangible book value dilution per
share represents the difference between the amount per share paid by purchasers
of shares of common stock in this offering and the pro forma net tangible book
value per share of common stock immediately after completion of this offering.
The net tangible book value of our common stock as of June 30, 2000, was
approximately $15,197,000 or $1.11 per share. Net tangible book value per share
represents the amount of our total tangible assets reduced by the amount of our
total liabilities and divided by the total number of shares of common stock
outstanding after giving effect to the conversion of all outstanding shares of
preferred stock into common stock. This analysis has been prepared assuming no
conversion of the convertible notes into 2,107,000 shares of common stock as
our intention is to repay the notes with proceeds from this initial public
offering (see Note 13 of the notes to the financial statements). Dilution in
net tangible book value per share represents the difference between the amount
per share paid by purchasers of shares of our common stock in this offering and
the net tangible book value per share of our common stock immediately
afterwards. After giving effect to our sale of 5,000,000 shares of common stock
offered by this prospectus at a public offering price of $11.00 per share and
after deducting the underwriting discount, estimated offering expenses payable
by us, and repayment of $11,164,000 of convertible notes and accrued interest,
our pro forma net tangible book value will be $54,981,000, or approximately
$2.95 per share. This represents an immediate increase in pro forma net
tangible book value of $2.38 per share to existing stockholders and an
immediate dilution in pro forma net tangible book value of $8.05 per share to
new investors.
Pro forma net tangible book value before the repayment of the notes is
$65,147,000, or $3.49 per share. After repayment of the principal balance on
the notes of $11,090,000, net of the carrying amount of $924,000, total pro
forma net tangible book value is reduced to $54,981,000, or $8.05 per share.
<TABLE>
<S> <C> <C>
Public offering price per share.................................. $11.00
Net tangible book value per share as of June 30, 2000........... $1.11
Increase per share attributable to new investors................ 2.38
-----
Pro forma net tangible book value per share after the offering
and before repayment of notes................................. 3.49
------
Dilution per share to new investors before repayment of notes.... 7.51
Additional dilution in pro forma net tangible book value per
share due to repayment of notes............................... 0.54
------
Pro forma dilution per share to new investors.................... $ 8.05
======
</TABLE>
The table above assumes no exercise of the underwriters' over-allotment option
and excludes exercises of options after June 30, 2000. The number of shares
outstanding as of June 30, 2000 excludes 1,179,000 shares of common stock
issuable upon exercise of options outstanding as of June 30, 2000, having a
weighted average exercise price of $1.50 per share and 722,000 shares of stock
issuable upon exercise of warrants outstanding at June 30, 2000, having a
weighted average exercise price of $3.69 per share. The exercise of outstanding
options and warrants having an exercise price less than the offering price
would increase the dilutive effect to new investors.
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19
<PAGE>
Dilution
--------------------------------------------------------------------------------
Assuming complete conversion of all of our outstanding stock options and
warrants totaling 1,901,000 additional shares and approximately $4,433,000 in
exercise proceeds, the pro forma net tangible book value would be reduced and
further dilute new investors an additional $0.06 per share, to $8.11 per share.
The following table sets forth, as of June 30, 2000, the differences between
the number of shares of common stock purchased from us, the total consideration
paid and average price per share paid by existing stockholders and by the new
investors, before deducting expenses payable by us.
<TABLE>
<CAPTION>
Shares Purchased Total Consideration Average Price
Number Percent Amount Percent Per Share
---------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders...... 13,661,000 73.2% $23,512,000 29.9% $ 1.72
New investors.............. 5,000,000 26.8 55,000,000 70.1 $11.00
---------- ----- ----------- -----
Total...................... 18,661,000 100.0% $78,512,000 100.0%
========== ===== =========== =====
</TABLE>
If the underwriters' over-allotment option is exercised in full, the following
will occur:
.the number of shares of common stock held by existing stockholders will
decrease to approximately 70.4% of the total number of shares of common stock
outstanding; and
.the number of shares held by new public investors will be increased to
5,750,000 or approximately 29.6% of the total number of shares of our common
stock outstanding after this offering.
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20
<PAGE>
--------------------------------------------------------------------------------
Selected financial data
The selected financial data set forth below should be read in conjunction with
our financial statements and the related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," included in this
prospectus. The statement of operations data for the period from May 1, 1997
(date of inception) to December 31, 1997, for the years ended December 31, 1998
and 1999, and the balance sheet data as of December 31, 1998 and 1999, are
derived from our audited financial statements included elsewhere in this
prospectus. The balance sheet data as of December 31, 1997 is derived from our
audited financial statements that are not included in this prospectus. The
statement of operations data for the six months ended June 30, 1999 and 2000
and the balance sheet data as of June 30, 2000 are derived from our unaudited
financial statements included elsewhere in this prospectus. In the opinion of
management, the unaudited financial statements include all adjustments,
consisting principally of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations for the
period. The historical results are not necessarily indicative of the operating
results to be expected in the future and the results of interim periods are not
necessarily indicative of the results for a full year.
See the notes to the financial statements for an explanation of the method used
to determine the numbers of shares used in computing basic and diluted and pro
forma basic and diluted net loss per share.
<TABLE>
<CAPTION>
Period from
May 1, 1997
(Inception)
to Year Ended Six Months
December 31, December 31, Ended June 30,
1997 1998 1999 1999 2000
(unaudited)
Statement of operations
data: (In thousands, except per share data)
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ -- $ -- $ -- $ 170
Cost of goods sold...... -- -- -- -- 281
------ ------- -------- ------- -------
Gross profit............ -- -- -- -- (111)
Operating expenses:
Research and
development........... 28 1,581 8,961 2,343 3,091
Clinical and
regulatory............ -- 335 2,012 790 912
Sales and marketing.... -- -- 940 410 1,095
General and
administrative........ 13 959 2,345 784 2,079
------ ------- -------- ------- -------
Operating loss.......... (41) (2,875) (14,258) (4,327) (7,288)
Interest income......... -- 8 258 56 260
Interest expense........ -- (86) (89) (34) (1,052)
------ ------- -------- ------- -------
Net loss................ $(41) $(2,953) $(14,089) $(4,305) $(8,080)
====== ======= ======== ======= =======
Net loss per share,
basic and diluted...... $(0.04) $ (2.01) $ (6.94) $ (2.04) $ (3.27)
====== ======= ======== ======= =======
Shares used in computing
net loss per share,
basic and diluted...... 1,103 1,472 2,030 2,115 2,472
Pro forma net loss per
share, basic and
diluted................ $ (1.79) $ (0.67)
======== =======
Shares used in computing
pro forma net loss per
share, basic and
diluted................ 7,890 12,069
</TABLE>
<TABLE>
<CAPTION>
As of December 31, June 30,
1997 1998 1999 2000
Balance sheet data: (In thousands)
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash, cash equivalents and marketable
securities................................. $ 1 $ 4,502 $ 9,498 $14,799
Working capital............................. (96) 4,223 8,176 13,439
Total assets................................ 56 5,842 11,686 18,660
Long-term obligations....................... -- 459 227 116
Convertible preferred stock and warrants.... -- 7,713 21,808 23,908
Total stockholders' deficit................. (41) (2,877) (12,099) (7,900)
</TABLE>
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21
<PAGE>
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Management's discussion and analysis of financial condition and results of
operations
The following discussion of our financial condition and results of operations
should be read in conjunction with the financial statements and the notes to
those statements included elsewhere in this prospectus. This discussion may
contain forward-looking statements that involve risks and uncertainties. As a
result of the factors set forth under "Risk factors," our actual results may
differ materially from those anticipated in these forward-looking statements.
OVERVIEW
We were incorporated in May 1997. Business activities before January 1998 were
negligible. In 1998, our primary activity was developing the Curon Control
Module and Stretta Catheter for the treatment of GERD. We are still in the
development stage and since our inception, have devoted substantially all of
our efforts to developing our products, raising capital and have recently
commenced marketing efforts.
In early 1999, we began a multi-center clinical trial of the Stretta System in
the United States. We also developed our manufacturing capability to support
the production of Stretta Catheters and Curon Control Modules for the clinical
trial. Based on the data acquired in the trial, we submitted a 510(k)
notification to the FDA in January 2000 for clearance to market the Stretta
System for treatment of GERD. We received 510(k) clearance in April 2000. In
May 2000, we launched the Stretta System commercially at Digestive Disease
Week, a large gastroenterology professional conference. Also, in May 2000, we
initiated a randomized controlled trial of the Stretta System, which we
anticipate will be completed in the second half of 2001.
In April 1999, we began developing the Secca System for the treatment of fecal
incontinence. In November 1999, we conducted a 10-patient human clinical pilot
study outside the United States and, in July 2000, we began a U.S. multi-center
clinical trial of the Secca System under an Investigational Device Exemption.
Assuming successful results of this trial, we intend to submit a 510(k)
supported by these results to the FDA in mid-2001 or, if required by the FDA, a
PMA supported by these results.
We recognize revenue upon shipment of products to customers. To date, we have
generated limited revenues. Our revenues will be derived from the sale of
radiofrequency generators and our disposable devices, such as the Stretta
Catheter. We intend that disposables will form the basis of a recurring revenue
stream and intend to price catheters, at high volumes, to generate greater
margins than generators. We expect the percentage of revenue from disposables
to increase over time as our installed base of generators grows.
Initially, we will focus our sales efforts in the United States through a
direct sales force. We do not expect to generate international sales before
2001. In international markets, we expect to rely primarily on third-party
distributors. Our gross margins on sales through international third-party
distributors will be lower than our gross margins on U.S. sales as a result of
distributor discounts.
Our costs of revenues represent the cost of producing generators and disposable
devices. We also license a technology used in the generators that we sell. In
addition to the up-front payment to license the technology, we are required to
pay licensing fees based on the sales price of the units. There are no
additional expected costs to be incurred as part of the licensing agreement. We
believe that there are alternative technologies that could be utilized should
we choose to do so. Research and development expenses consist primarily of
amortization of stock-based compensation, personnel costs, professional
services, patent application costs, materials, supplies and equipment. Clinical
and regulatory expenses consist primarily of expenses associated with the costs
of clinical trials, clinical support personnel, the collection and analysis of
the results of these trials, and the costs of submission of the results to the
FDA. Sales and marketing expenses consist of personnel costs, advertising,
public relations and
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attendance at selected medical conferences. General and administrative expenses
consist primarily of amortization of stock-based compensation, the cost of
corporate operations and personnel, legal, accounting and other general
operating expenses of our company.
Through June 30, 2000, we recorded limited product sales while incurring
cumulative net losses of $25.2 million. We intend to use $2.0 million of the
net proceeds of the offering to increase spending on sales and marketing
initiatives to support commercial sales and market penetration of the Stretta
System, which was launched in May 2000. We will also increase spending on
administrative infrastructure as sales increase. In addition to increasing
expenditures related to market launch of the Stretta System, we anticipate that
our expenses will increase as we continue to develop new products, conduct
clinical trials, commercialize our products and acquire additional technologies
as the opportunities arise. As a result, we expect our operating expenses and
net losses to increase.
We grant stock options to hire, motivate and retain employees and non-employee
consultants. With respect to these stock options, we may record deferred stock
compensation. For stock options granted to employees the difference between the
exercise price of the stock options and the fair value of our stock at the date
of grant is recorded as deferred compensation on the date of grant. For stock
options granted to non-employees, the fair value of the options, estimated
using the Black-Scholes valuation model is initially recorded on the date of
grant. As the non-employee options become exercisable, we revalue the remaining
unvested options, with the change in fair value from period to period
represented as change in the deferred compensation charge.
We are amortizing these amounts in accordance with Financial Accounting
Standards Board (FASB) Interpretation No. 28, "Accounting for Stock
Appreciation Rights and Other Variable Stock Option or Award Plans" (FIN 28).
As a result of stock options granted through June 30, 2000, we recorded
$11.1 million in deferred stock compensation, including $3.1 million related to
the modification of stock repurchase rights resulting from a mutual agreement
to terminate our employment relationship with our former president and CEO
extending the repurchase right 18 months to April 2001 (see Note 6 of the notes
to the financial statements). Unamortized stock based compensation of
approximately $4.2 million remained as of June 30, 2000.
RESULTS OF OPERATIONS
Six months ended June 30, 1999 and 2000
Revenue
In the six months ended June 30, 2000, we generated $170,000 in revenues from
the sale of generators and catheters to customers in the United States.
Commercial shipments began in June 2000.
Cost of goods sold
In the six months ended June 30, 2000, the cost of goods sold was $281,000 and
was significant in relation to revenues as we began commercial manufacturing
operations.
Research and development expenses
Research and development expenses were $2.3 million in the six months ended
June 30, 1999 and $3.1 million in the six months ended June 30, 2000.
Amortization of stock-based compensation accounted for $358,000 in the six
months ended June 30, 1999 and $867,000 in the six months ended June 30, 2000.
The remaining increase in spending over the first six months of 1999 was
primarily due to preparing the Stretta Catheter for commercial manufacturing
and increased development activity for the Secca Handpiece.
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Clinical and regulatory expenses
Clinical and regulatory expenses were $790,000 in the six months ended June 30,
1999 and $912,000 in the six months ended June 30, 2000. Amortization of stock-
based compensation accounted for $24,000 in the six months ended June 30, 1999
and $92,000 in the six months ended June 30, 2000. The remaining increase in
spending in 2000 over 1999 was primarily due to hiring clinical and regulatory
personnel and the costs involved in preparation for filing the Stretta System
510(k) submission with the FDA.
Sales and marketing expenses
Sales and marketing expenses were $410,000 in the six months ended June 30,
1999 and $1,095,000 in the six months ended June 30, 2000. Amortization of
stock-based compensation accounted for $41,000 in the six months ended June 30,
1999 and $170,000 in the six months ended June 30, 2000. The remaining increase
in spending in 2000 over 1999 was primarily due to an increase in expenditures
for personnel, public relations designed to heighten awareness for our product
within the physician community, and activities to promote reimbursement for our
products.
General and administrative expenses
General and administrative expenses were $784,000 in the six months ended June
30, 1999 and $2,079,000 in the six months ended June 30, 2000. Amortization of
stock-based compensation accounted for $138,000 in the six months ended June
30, 1999 and $789,000 in the six months ended June 30, 2000. The remaining
increase in spending in 2000 over 1999 was primarily due to increased personnel
costs as our company expanded and a stock-based settlement valued at $230,000.
Interest Income and Expense
During the six months ended June 30, 1999 compared to the six months ended June
30, 2000, interest income increased by $204,000 primarily as a result of
increased earnings on interest bearing marketable securities.
Interest expense for the six months ended June 30, 1999 and June 30, 2000
increased by $1.0 million due to increased average interest bearing debt
outstanding in 2000, $250,000 of amortization of the discount on warrants, and
$674,000 of amortization of an associated beneficial conversion feature (see
Note 13 of the notes to financial statements).
Income taxes
As a result of our net losses, we did not incur any income tax obligations in
either the six months ended June 30, 1999 or the six months ended June 30,
2000.
Years ended December 31, 1998 and 1999
Although we were incorporated in May 1997, there was little activity in 1997.
Financial statements for 1997 included only $41,000 in total expenses.
Revenues; cost of revenues
We generated no revenues and incurred no cost of revenues in either 1998 or
1999.
Research and development expenses
Research and development expenses were $1.6 million in 1998 and $9.0 million in
1999. Amortization of stock-based compensation accounted for $71,000 in 1998
and $4.1 million in 1999. The remaining year-to-year increases resulted
primarily from costs associated with the development and refinement of
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engineering prototypes for commercialization of the Stretta System. We also
started developing our Secca System in May 1999.
Clinical and regulatory expenses
Clinical and regulatory expenses were $335,000 in 1998 and $2.0 million in
1999. Amortization of stock-based compensation accounted for $7,000 in 1998 and
$96,000 in 1999. The remaining increase in 1999 resulted primarily from costs
associated with the open-label Stretta System clinical trial, which started in
February 1999, and the Secca System pilot clinical trial, which started in
November 1999.
Sales and marketing expenses
Sales and marketing expenses were $0 in 1998 and $940,000 in 1999. Amortization
of stock-based compensation accounted for $0 in 1998 and $85,000 in 1999. The
remaining spending in 1999 resulted primarily from personnel, public relations,
market research, reimbursement related activities and attendance at medical
conferences.
General and administrative expenses
General and administrative expenses were $959,000 in 1998 and $2.3 million in
1999. Amortization of stock-based compensation accounted for $19,000 in 1998
and $554,000 in 1999. The remaining year-to-year increases resulted primarily
from increased personnel costs as we expanded our general and administrative
organization.
Income taxes
As a result of our net losses, we have not incurred any income tax obligations.
At December 31, 1999, we had estimated net operating loss carryforwards of $7.4
million which will expire at various dates through 2019. The principal
differences between losses for financial and tax reporting purposes are the
result of the capitalization of research and development and start-up expenses
for tax purposes and the amounts recorded as stock-based compensation expense.
Federal and state tax laws contain provisions that may limit the net operating
loss carryforwards that can be used in any given year, should certain changes
in the beneficial ownership of our shares occur. Such events could limit the
future utilization of our net operating loss carryforwards.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have funded our operations and capital investments from the
private sale of equity securities totaling $23.2 million, the issuance of
convertible notes totaling $11.8 million and from bank equipment line financing
totaling $781,000, of which $339,000 was remaining at June 30, 2000. This debt
is being paid off under a term debt agreement maturing in February 2002 and
collateralized by certain assets of the Company. Interest is payable monthly at
prime plus 2%. At June 30, 2000, we had $13.4 million in working capital and
our primary source of liquidity was $14.8 million in cash and cash equivalents
and marketable securities. In May 2000, we issued $11.1 million in convertible
notes that bear interest at 8%, with principal and interest both due and
payable in May 2005. In connection therewith, we issued warrants exercisable at
$4.39 per share into 569,000 shares of preferred Series C stock. The
convertible notes may be converted, if not earlier prepaid, into 2,107,000
shares of common stock beginning in May 2001.
Six months ended June 30, 1999 and 2000
Cash used in operating activities was $3.4 million in the six months ended June
30, 1999 and $5.6 million in the six months ended June 30, 2000. The increase
in cash used reflects the increased net
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loss incurred primarily as a result of higher research and development
expenses of $239,000 and higher sales and marketing expenses of $556,000,
excluding charges related for stock-based compensation.
Cash used in investing activities amounted to $610,000 in the six months ended
June 30, 1999 related to the purchase of property and equipment. Cash used in
investing activities was $2.9 million in the six months ended June 30, 2000
due to the purchase of marketable securities of approximately $2.6 million and
purchases of property and computer-related equipment of $330,000. As of June
30, 2000, we had no material commitments for capital expenditures.
Cash used in financing activities was $33,000 in the six months ended June 30,
1999 and cash provided by financing activities in the six months ended June
30, 2000 was $11.2 million, of which $276,000 was received from the exercise
of stock options and $11,045,000 from convertible debt financing partially
offset by $111,000 of principal payments on notes payable.
Years ended December 31, 1998 and 1999
Cash used in operating activities was $2.2 million in 1998 and $8.1 million in
1999. The increase in cash used reflects the increased net loss incurred
primarily as a result of higher research and development expenses of $3.3
million and clinical and regulatory expenditures expenses of $1.6 million
excluding charges related to stock based compensation. These expenses are
partially offset by increases in accounts payable and accrued liabilities of
$824,000.
Cash used in investing activities amounted to $867,000 in 1998 and $2.5
million in 1999, primarily for the purchase of equipment and building
expansion costs, $1.0 million to support our clinical and development
programs, and $1.5 million to purchase marketable securities.
Cash provided by financing activities was $7.6 million in 1998 and $14.1
million in 1999, both years resulting primarily from the sale of preferred
equity securities of $7.4 million in 1998 and $13.3 million in 1999.
We will expend substantial funds in the future for research and development,
pre-clinical and clinical testing, capital expenditures, and the
manufacturing, marketing, and sale of our products. We cannot accurately
predict the timing and amount of spending of such capital resources, which
will depend on several factors, including:
.the results of the Stretta System market launch;
.the progress of our research and development efforts;
.the timing of our clinical trials for the Secca System and any other clinical
activities;
.competing technological and market developments;
.the time and costs of obtaining regulatory approvals;
.the time and costs involved in filing, prosecuting and enforcing patent
claims;
.the progress and cost of commercialization of products currently under
development; and
.market acceptance and demand for our products if approved for marketing.
While we believe that the net proceeds of this offering together with our
existing capital resources and projected interest income will be sufficient to
fund our operations and capital investments for at least the next 24 months,
we cannot assure you that we will not require additional financing before that
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time. We cannot assure you that such additional financing will be available on
a timely basis on terms acceptable to us or at all, or that such financing will
not be dilutive to our stockholders. If adequate funds are not available to us,
we could be required to delay development or commercialization of our products,
to license to third parties the rights to commercialize products or
technologies that we would otherwise seek to commercialize ourselves or to
reduce the marketing, customer support or other resources devoted to our
products, any of which could have a material adverse effect our business,
financial condition and results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK
We invest our excess cash primarily in U.S. government securities and
marketable debt securities of financial institutions and corporations with
strong credit ratings. These instruments have maturities of three months or
less when acquired. We do not utilize derivative financial instruments,
derivative commodity instruments or other market risk sensitive instruments,
positions or transactions in any material fashion. Accordingly, we believe that
while the instruments we hold are subject to changes in the financial standing
of the issuer of such securities, we are not subject to any material risks
arising from changes in interest rates, foreign currency exchange rates,
commodity prices, equity prices or other market changes that affect market risk
sensitive instruments.
Recent accounting pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, Accounting for Derivative Instruments
and Hedging Activities, which establishes accounting and reporting standards
for derivative instruments and 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. SFAS No. 133 as
amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities--Deferral of the Effective Date of FASB Statement No. 133, an
amendment of FASB Statement No. 133, is effective for fiscal years beginning
after June 15, 2000. We are evaluating the impact, if any, that SFAS No. 133
may have on our financial statements. To date, we have not engaged in
derivative and hedging activities.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin 101, Revenue Recognition, which provides guidance on the
recognition, presentation and disclosure on revenue in financial statements
filed with the SEC. SAB 101 outlines the basic criteria that must be met to
recognize revenue and provides guidance for disclosure related to revenue
recognition policies. We believe that our current revenue recognition policy is
in compliance with SAB 101.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44, Accounting for Certain Transactions Involving Stock Compensation an
Interpretation of APB 25, which clarifies (a) the definition of an employee for
purposes of applying opinion 25 (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan (c) the accounting consequence of various
modifications to the terms of a previously fixed stock option or award, and
(d) the accounting for an exchange of stock compensation awards in a business
combination. This interpretation is effective July 1, 2000, with certain
provisions effective earlier. We do not expect FIN 44 to have a significant
impact on our financial statements.
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Business
OVERVIEW
We develop, manufacture and market innovative proprietary products for the
treatment of gastrointestinal disorders. Our products consist of radiofrequency
generators and single-use disposable devices. Our first product, the Stretta
System, received U.S. Food and Drug Administration clearance in April 2000 for
the treatment of gastroesophageal reflux disease, or GERD, which affects
approximately 14 million U.S. adults on a daily basis. GERD is the backward
flow, or reflux, of stomach contents into the esophagus, which leads to
heartburn, chest pain and other symptoms. The Stretta System applies
radiofrequency energy to treat GERD. The system is used in an outpatient
procedure and is designed to eliminate or reduce the need to manage GERD
symptoms over an extended period of time with medication. In a multi-center
clinical trial used to support FDA clearance, 47 patients who required daily
GERD medications were treated with the Stretta System. Three weeks after the
procedure, these patients were taken off all GERD medication. After six months,
the need for all anti-acid medication was eliminated in 70% of the 44 patients
available for follow-up. Of the 41 patients who needed the most potent
prescription GERD medication, known as proton pump inhibitors, before
treatment, only five still required proton pump inhibitors after treatment. As
of August 1, 2000, approximately 200 patients have been treated with the
Stretta procedure.
We believe that the Stretta System represents a fundamental advance in the
treatment of GERD, most commonly recognized as a condition that causes chronic,
severe heartburn. In the United States, approximately $8 billion is spent
annually on anti-acid medications, including Prilosec, Prevacid, Tagamet,
Pepcid and Zantac. These medications temporarily reduce the acidity of the
stomach, which eases heartburn symptoms, but may have unwelcome side effects
and do not treat the causes of GERD. Currently, fundoplication surgery is the
most common procedure to treat the actual causes of GERD. In 1999, only an
estimated 70,000 U.S. GERD patients opted for this surgical treatment, which
involves an inpatient hospital stay, significant potential for side effects, a
long recovery period, and a cost of approximately $11,700 per procedure. We
believe that the Stretta System is an attractive alternative for patients
seeking to discontinue lifetime medication treatment and to avoid surgery. The
Stretta System is used in a procedure which, unlike medication, is designed to
address the underlying causes of GERD and, unlike surgery, is an outpatient
procedure with reduced side effects. The Stretta procedure, which we believe
will cost an average of $2,000, enables most patients to return to normal
activities within a day and has enabled most patients in our 47-patient
clinical trial to reduce or discontinue medication use while achieving control
of heartburn. We are devoting substantial resources to the commercial launch of
this product, which was introduced in May 2000.
We are also developing a product called the Secca System, which is designed to
use radiofrequency energy to treat fecal incontinence, a condition that affects
up to 16 million U.S. adults, or 8% of the adult U.S. population. Only limited
treatment options currently exist to manage fecal incontinence. Most patients
control the disorder by using protective undergarments and typically avoid
travel and activities away from home. Very few patients undergo costly surgical
treatment, which involves a lengthy inpatient hospital stay, significant side
effects and a long recovery period. By contrast, the Secca System is intended
to be a lower cost outpatient procedure to improve continence with minimal
interruption in patients' everyday lives and with few side effects. Six-month
follow-up results in our 10-patient pilot study have shown that the patients
experienced significant improvement in fecal incontinence symptoms,
incontinence-related quality of life, and general quality of life as measured
by validated questionnaires. We began a U.S. clinical trial of the Secca System
in July 2000 and, assuming successful results, we intend to seek permission
from the FDA in mid-2001 to market the system.
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INDUSTRY
Gastrointestinal disorders
Gastrointestinal disorders affect broad segments of the United States and
worldwide population, but many conditions lack corrective treatments. Common
current therapies for gastrointestinal disorders, such as acid suppressive
medication for GERD and protective undergarments for fecal incontinence, are
designed not to correct the disorder, but to manage symptoms. We believe that
there is a significant opportunity for technologies aimed at resolution of the
underlying causes of these disorders, rather than just symptom management.
GASTROESOPHAGEAL REFLUX DISEASE
Overview of the disease
GERD is the backward flow, or reflux, of stomach contents into the esophagus,
the muscular tube that connects the mouth to the stomach. In the lower part of
the esophagus, there is an area of thickened muscle, known as the lower
esophageal sphincter, which, when functioning properly, acts as a one-way
valve, allowing food to pass down from the esophagus into the stomach, but
preventing reflux. In GERD patients, the lower esophageal sphincter does not
function properly due to low sphincter pressure or inappropriate nerve impulses
leading to frequent sphincter relaxations. This lack of proper sphincter
function allows stomach contents to reflux into the esophagus. While the
stomach lining provides a natural protective barrier to stomach acid, enzymes,
and bile, the esophagus lacks such protection. Frequent reflux of stomach
contents causes chronic irritation of the esophagus, which can result in a wide
range of symptoms and complications.
Symptoms and complications
Most commonly, GERD patients feel persistent, severe heartburn, which is caused
by stomach acid, enzymes, and bile entering and irritating the esophagus. In
some patients, the chest pain caused by this heartburn may be severe enough to
require an emergency room visit. Patients often have difficulty sleeping due to
increased reflux and heartburn when they lie down. Other common symptoms
include regurgitation of stomach contents into the back of the throat, chronic
cough and sore throat, laryngitis and difficulty swallowing.
Irritation of the esophagus caused by reflux may also result in more serious
complications. Approximately 30% to 40% of GERD patients examined by endoscopy
have evidence of damage to the esophagus in the form of a break in the
esophageal lining. The following complications may be experienced by these
patients:
.Erosion or Ulceration: Damage to the esophageal lining may lead to scar tissue
formation and eventual development of a stricture.
.Stricture: Build-up of scar tissue caused by repeated injury from reflux can
narrow and obstruct the esophagus.
.Barrett's Epithelium: Intestinal cells may develop in the esophagus, which
increases the patient's risk of esophageal cancer.
.Esophageal Cancer: Esophageal cancer may occur with or without Barrett's
epithelium. In a March 1999 New England Journal of Medicine study,
investigators found that patients who experienced heartburn or regurgitation
at least once per week were eight times more likely to develop esophageal
cancer than the general population.
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Market size
Approximately 7% of American adults, or 14 million Americans, experience daily
GERD symptoms. International studies show similar prevalence rates around the
world. GERD incidence increases significantly in individuals over the age of
40, with individuals over 65 accounting for approximately 36% of GERD-related
physician visits. The disease affects men and women equally. Acid-suppressive
medication accounts for over $8 billion in annual U.S. medication expenditures,
the majority of which is used to control GERD symptoms.
Traditional treatment options
Initially, people manage GERD symptoms with a combination of lifestyle
modification and over-the-counter antacids. Generally, people avoid fatty or
spicy foods, chocolate, coffee and alcohol, all of which can aggravate GERD
symptoms. In addition, some people elevate the head of their beds while
sleeping to avoid reflux.
When lifestyle modifications and over-the-counter medications fail to
satisfactorily relieve GERD symptoms, people may seek a physician's help.
Gastroenterologists are the primary physician contact for patients seeking
treatment for GERD. Treatment options for GERD include prescription medication
and inpatient surgery.
.Prescription Medications. Most patients are prescribed anti-acid medication to
manage GERD symptoms, including Prilosec, Prevacid, Pepcid, Zantac and
Tagamet. Prilosec is the single largest selling prescription medication, with
worldwide sales of $6 billion in 1999. These medications reduce the amount of
acid produced by the stomach, which alleviates the symptomatic pain associated
with reflux and enables esophageal inflammation to heal. While medications may
be effective in reducing symptoms, they do not prevent reflux or correct the
condition that causes GERD.
.Surgery. The most common surgical procedure used to correct the condition is
fundoplication surgery, in which the upper stomach is wrapped around the lower
esophageal sphincter to provide support. Fundoplication surgery is an
inpatient laparoscopic procedure performed by general surgeons and requires
one to four days in the hospital and up to five weeks recovery. In 1999,
approximately 70,000 fundoplications were performed in the United States.
Drawbacks of current treatment options
The currently available GERD treatments have significant drawbacks including:
.Failure to treat the underlying causes of GERD. Medications help patients
manage GERD symptoms. However, they do not address the causes of the disease.
Consequently, these medications are required for the patient"s lifetime and
some symptoms, such as regurgitation, persist.
.Discomfort and other side effects. Side effects of medications include
diarrhea, headaches, dizziness and nausea. Side effects of fundoplication
surgery include difficulty swallowing, the inability to belch or vomit,
excessive flatulence, nausea and diarrhea.
.Patient compliance. Patients often have difficulty complying with lifestyle
modifications which require continuous and fundamental changes in eating,
drinking and sleeping behavior. For patients who must take medication on a
long-term basis, compliance can be a problem due to the side effects, cost, or
forgetting to take the medication.
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.Significant costs to health care system. To be effective, prescription
medications are taken regularly throughout a patient's lifetime, costing an
estimated average of $2,300 per year based solely on retail prices of the
medication requirements of the patients in our clinical trial whose conditions
ranged from mild to severe. Fundoplication surgery costs approximately
$11,700.
.Risk of complications. Complications of fundoplication surgery include damage
to the nerves which control stomach function, injury to the pancreas, spleen,
colon, or other organs, postoperative breakdown of the surgical repair,
gastric ulceration, and, in rare cases, death. Because of these complications,
many physicians are reluctant to refer an otherwise healthy patient for
surgery.
As a result of these drawbacks with traditional GERD treatment options, we
think there is a significant need for a new GERD treatment.
THE CURON SOLUTION: THE STRETTA SYSTEM
Our proprietary Stretta System, which we commercially launched in May 2000 and
which has been the subject of limited clinical testing, is designed to provide
GERD patients with a minimally invasive, outpatient and cost-effective
alternative to existing treatments. The Stretta System consists of the Stretta
Catheter, which is a disposable flexible catheter with needle electrodes, and
the Curon Control Module, which is a radiofrequency energy generator. Using
this system, physicians deliver precisely controlled radiofrequency energy to
create thermal lesions in the muscle of the lower esophageal sphincter.
The Stretta System treats GERD by improving the barrier function of the lower
esophageal sphincter. The Stretta procedure is designed to take less than an
hour, utilizing techniques commonly used by gastroenterologists. The procedure
is performed on an outpatient basis under conscious sedation. Patients return
home the same day and are typically able to resume normal activities the next
day. We believe that the Stretta System's efficacy and relative cost, combined
with the absence of significant discomfort and side effects, makes it a
clinically and economically attractive GERD treatment. Based upon our clinical
trial results to date, we believe that the Stretta procedure has benefits over
both medication and surgery:
BENEFITS OVER MEDICATION
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.Reduction in reflux, not just symptom control
.No patient compliance issues
.No observed persistent side effects
.One time estimated $2,000 cost, as compared to an estimated average annual
medication cost of $2,300 based solely on the retail prices of the medication
requirements of the patients in our clinical trial whose conditions ranged
from mild to severe
BENEFITS OVER FUNDOPLICATION SURGERY
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.One-hour procedure under conscious sedation, as compared to a three-hour
surgical procedure performed under general anesthesia
.Less invasive: performed endoscopically, through the mouth, compared to
laparoscopically, through small incisions in the abdomen
.Outpatient procedure, as compared to a one to four day inpatient
hospitalization
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.Resumption of normal activities within a day, as compared to up to five weeks
after surgery
.No observed persistent side effects
.Minimal risk of complications
.Costs an estimated $2,000, as compared to approximately $11,700 per surgical
procedure
.Performed by gastroenterologists who otherwise would refer patients to general
surgeons
The Stretta procedure
With the patient sedated but awake, the physician first inserts an endoscope
into the esophagus to examine the lower esophageal sphincter and measure the
distance to the areas to be treated. The physician then removes the endoscope
and inserts the Stretta Catheter through the esophagus to the treatment area.
The physician inflates a balloon on the end of the Stretta Catheter and deploys
the needle electrodes into the tissue of the lower esophageal sphincter. Using
the Curon Control Module, the physician then delivers radiofrequency energy
through the needles to create well-defined thermal lesions in the tissue.
Cooled water is delivered through ports in the catheter to the lining of the
esophagus while the deeper tissue is treated. The temperature of the treated
tissue and the surface tissue are constantly monitored as a safety precaution.
The physician repeats this sequence multiple times along the length of the
lower esophageal sphincter. The lesions reabsorb over several weeks and cause
tissue contraction, which increases the barrier function of the lower
esophageal sphincter. In addition, we believe that radiofrequency energy
interrupts nerve pathways responsible for inappropriately frequent sphincter
relaxations.
THE SECCA SYSTEM: TREATMENT OF FECAL INCONTINENCE
Overview and drawbacks of current treatment options
Fecal incontinence is the involuntary leakage of stool, typically caused by
physical damage to the anal sphincter from childbirth or surgery, neurologic
disease, injury or age. Fecal incontinence is a life-altering condition that
affects up to 8% of U.S. adults and has similar prevalence rates around the
world. This condition is the second leading cause of nursing home placement of
elderly people. Nearly 50% of elderly people in nursing homes suffer from fecal
incontinence. In addition, approximately 3% of women report fecal incontinence
as a result of natural childbirth. Two-thirds of the people with fecal
incontinence do not seek medical attention.
People with fecal incontinence lack adequate minimally invasive treatment
alternatives that treat the cause of the problem, rather than the symptoms.
Current treatment options include:
.Use of protective undergarments. Most patients wear protective undergarments
as the sole response to incontinence. Protective undergarments do not
alleviate the symptoms of the disorder and do not diminish embarrassment or
lifestyle limitations.
.Diet modification and supplements. People are often advised by their
physicians to alter dietary habits, use dietary bulking products like
Metamucil, or take anti-diarrheal agents. These treatments are limited in
effectiveness and require lifetime use.
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.Biofeedback. Biofeedback is a procedure utilizing an electronic device to aid
patients in consciously retraining and strengthening sphincter muscles.
Biofeedback"s effectiveness is limited unless the patient is highly motivated,
is mentally capable and has the ability to consciously contract the sphincter.
In addition, biofeedback training requires multiple sessions with a therapist
and can be costly.
.Surgery. Otherwise healthy patients with severe incontinence may opt for
highly invasive surgical treatment. Surgical procedures take several hours,
require hospitalization for up to ten days, and have long recovery periods.
Surgical risks include failure to improve continence, urinary tract infection,
hemorrhage and hematoma, infection and, in rare cases, death.
The Curon Solution: The Secca System
The Secca System is designed to provide a simple, minimally invasive and cost-
effective treatment option for patients. The Secca procedure utilizes the same
technology and treatment concept as the Stretta System. Using our proprietary
radiofrequency generator, the Curon Control Module, and our proprietary
handheld disposable delivery device, known as the Secca Handpiece, a physician
delivers precisely controlled radiofrequency energy to create thermal lesions
in the muscle of the anal canal. We believe that reabsorption of these lesions
over the next several weeks and months will cause tissue contraction and
increase the barrier function of the anal sphincter. In a limited 10-patient
pilot study conducted outside the United States, the Secca procedure
demonstrated encouraging six-month follow-up results in patients with fecal
incontinence. Specifically, these patients had significant improvements in
fecal incontinence symptoms, incontinence-related quality of life, and general
quality of life as measured by validated questionnaires.
We began a U.S. multi-center clinical trial in July 2000 to study the safety
and efficacy of the Secca System for treatment of fecal incontinence. If we
achieve successful results, we intend to submit these results to the FDA in
mid-2001. See "Government Regulation."
STRATEGY
Our strategy is to be the leading provider of minimally-invasive and cost-
effective treatments for gastrointestinal disorders. The key elements of our
strategy are to:
.Provide innovative medical devices for the treatment of inadequately-addressed
gastrointestinal disorders. Our Stretta System and Secca System target GERD
and fecal incontinence, markets in which we believe there is a significant
demand for new treatment options. These systems are designed to address
drawbacks of current therapies, such as lifestyle modification, medication and
surgery, as well as underlying causes of the conditions, instead of simply
managing the symptoms.
.Increase awareness and market penetration of our products through education
and aggressive sales effort. We intend to generate demand for our products by
increasing market awareness of our new treatment alternatives and their
corresponding benefits relative to current therapies. To this end, we are
focusing our initial sales and marketing efforts for the Stretta System on the
8,000 practicing U.S. gastroenterologists who would perform the Stretta
procedure and the hospital endoscopy suites where the procedure may be
performed. Because these physicians typically practice in group and hospital
settings, we believe that we will be able to access our potential customer
base efficiently and expeditiously by using a direct sales effort focused on
both group practices and endoscopy suites of hospitals. We participate in
professional conferences typically attended by gastroenterologists, including
Digestive Disease Week, where we launched our Stretta System in May 2000. We
also intend to sponsor education courses at our 14 clinical investigation
centers around the United States.
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Because the Stretta System incorporates existing gastroenterologist skill sets
and techniques, we do not believe that training will impede physician
adoption. We intend to focus initially on the U.S. market and longer-term on
selling our products internationally through a distributor network supported
by our employees.
.Generate a recurring revenue stream through disposable product sales. To
perform the Stretta procedure, physicians must be equipped with our Curon
Control Module and our disposable Stretta Catheter. Each Stretta Catheter is
designed for single-use and incorporates reuse prevention features to prevent
multiple uses by a physician. We intend that disposables will form the basis
of a recurring revenue stream and that disposables, as a percentage of
revenue, will increase over time as our installed base of generators grows. We
will seek to expand our recurring revenue stream through the introduction of
new proprietary disposable devices and accessories for new gastrointestinal
disorders.
.Provide reimbursement support to physicians and payors. Securing reimbursement
for our existing and future products is critical to our success. The Health
Care Financing Administration, or HCFA, the governmental agency responsible
for reimbursement policy, has approved the use of an existing Medicare
reimbursement code in conjunction with the use of our Stretta System. We
intend to assist our physician customers in securing reimbursement for the
Stretta System through a dedicated reimbursement group. This group will
provide payors with copies of the HCFA coding decision, published literature
and clinical data designed to facilitate reimbursement. In addition, our
reimbursement group will call on third-party payors to educate them about the
economic benefits of the Stretta System, as compared to currently reimbursed
treatments. We also intend to sponsor post-clearance clinical studies to
generate additional data to support reimbursement.
.Acquire and license complementary technologies and products. We intend to
acquire and license complementary technologies and products for use in the
gastroenterology marketplace. We believe that this will allow us to broaden
our product line, leverage our gastroenterology distribution network, and
expand and accelerate the marketing of our existing products.
PRODUCTS
We have developed a suite of products incorporating proprietary design features
for use in the Stretta and Secca procedures. These products consist of a
disposable catheter and a disposable handpiece for delivery of controlled
radiofrequency energy to tissue and a radiofrequency generator, known as the
Curon Control Module. Both our current products and products under development
utilize proprietary software to interface with our Curon Control Module.
Single-use disposable devices
Both the Stretta Catheter and the Secca Handpiece are disposable products
incorporating innovative designs that enable a physician to easily access the
treatment site and accurately deliver radiofrequency energy into the tissue.
Features include:
.Four electrode needles, which are deployed into the tissue at the treatment
site for delivery of radiofrequency energy;
.Irrigation ports located at the base of each electrode, which deliver water to
the surface tissue during treatment;
.Thermocouples located at each needle tip and base, which provide continuous
temperature readings to the Curon Control Module, enabling precise temperature
control;
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.A balloon in the Stretta Catheter, which is inflated once the Stretta Catheter
reaches the lower esophageal sphincter to maintain catheter positioning; and
.An illuminated clear window in the Secca Handpiece that enables the physician
to view the treatment site.
Curon Control Module
The Stretta System and the Secca System both incorporate our radiofrequency
energy generator, the Curon Control Module. The Curon Control Module has four
channels, which allow for independent control of each of the four needle
electrodes on the Stretta Catheter and Secca Handpiece. The generator uses
continuous data feedback to achieve precise tissue temperatures at the
treatment site. The generator tracks surface tissue temperatures from each
electrode, and if temperatures at either the treatment site or surface tissue
exceed pre-set safe levels, the generator automatically stops delivering energy
to that electrode. An integrated pump delivers water to surface tissue during
the procedure. The Stretta System and the Secca System each utilize proprietary
software installed onto the Curon Control Module. The software provides a
distinct graphical user interface and the functions and parameters that are
required for the particular procedure.
Radiofrequency energy
Our products are based on radiofrequency energy delivery, which has a long
history of use in medical applications. Radiofrequency energy has been cleared
by the FDA for many therapies involving tissue heating, tissue remodeling and
nerve pathway interruption, including:
.shrinking prostatic tissue to treat enlarged prostates;
.interrupting nerve pathways in the heart to treat irregular heartbeats;
.shrinking tissue in the shoulder joint to prevent repeated shoulder
dislocation; and
.shrinking tissue in the base of the tongue to alleviate obstructive sleep
apnea.
We intend to develop additional innovative products that utilize
radiofrequency, as well as expand beyond radiofrequency for treatment of
additional gastrointestinal disorders.
CLINICAL STUDIES
Stretta clinical studies
To evaluate the Stretta System, we conducted an open label multi-center U.S.
clinical trial with leading investigators at 14 institutions, in which 131
patients were treated. We measured how well the procedure eliminated the need
for heartburn medication, improved symptoms, improved quality of life, and
reduced the amount of acid detected in the esophagus. Results from the initial
47 patients treated were submitted to the FDA. Six-month data was available for
44 of the 47 treated patients because three patients did not participate in the
voluntary follow-up testing. The follow-up data indicated that the Stretta
procedure led to significant improvement in both objective and subjective
measurements. A subset of this data was presented at the Digestive Disease Week
and published in abstract form in GI Endoscopy. The six-month data shows:
.Reduced need for medication. As of six months after treatment with the Stretta
System, the need for all anti-acid medication was eliminated in 70% of the 44
patients available for follow-up, and the need for the most potent
prescription GERD medication was eliminated in 87% of those patients that
required this medication before treatment.
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.Fewer GERD symptoms. GERD symptom scores improved 73% as defined by a
standardized GERD symptom measurement test.
.Reduced heartburn. Heartburn symptom scores improved 75% as defined by a
heartburn symptom measurement test.
.Decreased regurgitation. Regurgitation was eliminated in 59% of patients.
.Improved quality of life scores. Quality of life scores, as measured using a
validated scoring questionnaire, improved significantly.
.Reduced esophageal acid exposure. After treatment with the Stretta procedure,
patients experienced a 60% reduction in esophageal acid exposure.
Patients in our trials experienced no persistent side effects or other
significant complications during the treatment and follow-up period. Most
patients resumed normal levels of activity on the day after treatment. A few
patients reported difficulty swallowing, increased flatulence or mild abdominal
discomfort for a period of days. These symptoms were significantly milder and
shorter in duration than those typically experienced after surgical
fundoplication.
We believe that the lower esophageal sphincter is more resistant to reflux
after radiofrequency treatment. We believe that this increased resistance is
due to the collagen contraction that occurs after the creation of the lesions,
as well as interruption of nerve pathways that are responsible for
inappropriate relaxations of the lower esophageal sphincter. These neural
pathways are similar to those in the heart muscle, which may cause irregular
heartbeats shown in electrophysiology procedures to respond favorably to
radiofrequency energy treatment. Two scientific papers were presented at the
annual major meeting of the American Gastroenterological Association in May
2000 reporting on the ability of the Stretta procedure to disrupt nerve
pathways in animals and humans.
In May 2000, we began an eight-center, randomized controlled trial of the
Stretta System in the United States. In this trial, patients will receive
either the Stretta procedure or a placebo procedure, and the results will be
compared. We intend to use the data generated for future peer-reviewed
publications and for presentations at national scientific meetings and that
this data will influence physician adoption rates, facilitate reimbursement
approvals and enhance marketing activity.
Secca clinical studies
In November 1999, we conducted a pilot study at a leading medical institution
in Mexico City. Ten patients with fecal incontinence were treated with the
Secca System. Six months following the procedure, patients showed significant
improvements in fecal incontinence symptoms, incontinence-related quality of
life and general quality of life, each as measured by validated questionnaires.
We have received no reports of persistent complications or persistent side
effects. Based on these encouraging preliminary results, we are further
evaluating the Secca System in a multi-center U.S. clinical study involving six
sites and 50 patients, which began in July 2000. Assuming success of the study,
we intend to compile and submit data from this study to the FDA for 510(k)
clearance, or for premarket application approval if required by the FDA, to
market the Secca System for treatment of fecal incontinence. We intend to
target the Secca System, if and when commercialized, primarily to colorectal
surgeons, 1,000 of whom practice in the United States. Secondarily, we intend
to target gastroenterologists, particularly those who are familiar with the
Stretta System.
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SALES AND MARKETING
Our strategy to achieve market penetration in the United States with the
Stretta System is to initially market directly to high volume practicing
gastroenterologists, gastroenterology practice groups and endoscopy suite
facilities. Secondarily, we intend to target lower volume gastroenterology
practices and general surgeons. In the United States, there are approximately
8,000 practicing gastroenterologists, approximately 4,000 hospital endoscopy
suites and approximately 4,000 ambulatory treatment centers that perform
procedures similar to those required in the Stretta procedure. We believe that
the Stretta System represents a significant opportunity for gastroenterologists
because it enables them to keep patients within their practices and perform
revenue generating procedures instead of referring these patients to surgeons.
In addition to providing an incentive for gastroenterologists, the procedure
represents an opportunity for endoscopy suites to expand their business by
increasing the number of procedures done at the facility.
We intend to sell, market and distribute the Stretta System in the United
States through a direct sales force supported by a team of clinical training
and support specialists. Currently, we have six sales representatives and one
support specialist. By the end of 2000, we plan to have ten sales
representatives in regions across the country supported by three clinical
specialists. Sales representatives will call on gastroenterologists and
endoscopy suites. The clinical specialists will be responsible for initial
training of physicians as well as ongoing clinical field support. We intend to
expand this sales and clinical support organization to facilitate product
introduction and physician adoption. In 2001, we intend to introduce the
Stretta System internationally in select countries through distributors
supported by our local employees. Initially, we intend to target countries
within Europe that have demonstrated favorable acceptance and reimbursement of
new technologies and then target similar countries in the Pacific Rim.
The techniques employed in the Stretta procedure build upon skills used in
typical procedures performed by gastroenterologists, which reduces the need for
us to provide training. Our customer support strategy is to provide physician
education in the techniques of the Stretta System by providing physician-
moderated seminars. We offer additional education consisting of an on-site
visit by one of our clinical application specialists, who can attend the
physician's first Stretta procedure. We also offer web-site-based education,
videos, and written training materials. We intend to sponsor educational
courses around our 14 clinical investigation centers and have a significant
presence at national and regional gastroenterology events including the major
conferences held by the American Gastroenterological Association and the
American College of Gastroenterology.
REIMBURSEMENT
In the United States, health care providers generally rely on third-party
payors, principally private health insurance plans, Medicare and Medicaid, to
reimburse all or part of the cost of procedures in which medical devices are
used. The Health Care Financing Administration, or HCFA, the governmental
agency responsible for Medicare reimbursement policy, has approved the use of
an existing Medicare reimbursement code, which includes the ablation of nerves
in the lower esophageal sphincter, for billing costs associated with the
Stretta procedure by physicians and facilities. In appropriate cases, we
believe that physicians and facilities can use this code for billing costs
associated with the Stretta Catheter and the Stretta procedure. However, we
cannot assure you that the procedure will be reimbursed or that the amounts
reimbursed under this code will be adequate. While these organizations
frequently follow HCFA coding decisions, we cannot assure you that these payors
will reimburse the procedure or accept the Medicare established code.
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The current cost reduction orientation of the third-party payor community makes
it exceedingly difficult for new medical devices and surgical procedures to
obtain reimbursement. Often, it is necessary to convince these payors that the
new devices or procedures will establish an overall cost savings compared to
currently reimbursed devices and procedures. We believe that the Stretta System
may offer an opportunity for payors to reduce the cost of treating GERD
patients by possibly eliminating or reducing the costs of medication or
fundoplication surgery. While we believe that the Stretta System possesses
economic advantages that will be attractive to payors, we cannot assure you
that they will make reimbursement decisions based upon these advantages.
Reimbursement by third-party payors is often positively influenced by the
existence of peer-reviewed publications of long-term safety and efficacy data.
We have collected and published data on six-month results after treatment with
the Stretta System. Additional clinical abstracts and papers have been accepted
for publication in 2000. We cannot assure you that our products will be
reimbursed without publications of longer-term data. We are actively
encouraging ongoing research studies to evaluate and publish the long-term
safety and efficacy of the Stretta System. In addition, many third-party payors
require that randomized studies be conducted to determine the effect of the
procedure versus placebo or another standard of care. Currently, we are
conducting a randomized, controlled, multi-center study to generate this data.
We cannot assure you that the Stretta System will have compelling results in
this study, that the results will be published in a timely manner or at all, or
that such publication will benefit our reimbursement efforts.
To facilitate reimbursement for the Stretta System, we have hired a director of
reimbursement and are establishing a dedicated reimbursement group to assist
physicians and facilities in obtaining reimbursement for the Stretta System.
This group will assist in pre-approving patients for the Stretta procedure, and
will provide payors with copies of the Health Care Financing Administration's
coding decision, published literature and clinical data. In addition, this
group will educate third-party payors about the economic benefits of the
Stretta System and seek to influence them to reimburse for the Stretta System
and to incorporate the Stretta System into their standards of care for GERD.
Reimbursement systems in international markets vary significantly by country
and, within some countries, by region. Reimbursement approvals must be obtained
on a country-by-country basis or a region-by-region basis. In addition,
reimbursement systems in international markets may include both private and
government sponsored insurance. We have not obtained any international
reimbursement approvals. We cannot assure you that we will obtain any such
approvals in a timely manner, if at all. If we fail to receive international
reimbursement approvals at all or in acceptable amounts, market acceptance of
our products would be adversely affected.
MANUFACTURING
Our manufacturing strategy is to conduct a significant portion of the
manufacturing process in-house to control quality and manufacturing efficiency.
Over time, we intend to move some labor-intensive operations to less-costly
manufacturing locations within the United States and, eventually, outside the
United States to manufacturers meeting our quality standards in order to reduce
costs and to add additional capacity.
We manufacture, assemble and test each Stretta Catheter in-house. The
manufacturing process consists primarily of assembling internally manufactured
and externally purchased components and sub-assemblies in an environmentally
controlled area. After assembly, each Stretta Catheter is internally inspected
and then sent out for sterilization by a sub-contractor. We manufacture the
Curon Control Module primarily by in-house assembly and testing of components
ordered from outside manufacturers.
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We have no experience manufacturing our products in the volumes that will be
necessary for us to achieve significant commercial sales, and we cannot assure
you that we can establish high volume manufacturing or, if established, that we
will be able to manufacture our products in high volumes with commercially
acceptable yields. To achieve our business plan, we expect to hire additional
personnel to assemble our catheters. There is a shortage of such personnel in
our area and we cannot be sure that we will be able to recruit and retain them.
We will also need to achieve some enhancements to our manufacturing operations
to increase our capacity. We cannot be sure about achieving this objective.
We purchase various materials and components from qualified suppliers that are
subject to stringent quality specifications and inspections. We conduct quality
audits of our key suppliers, several of which are experienced in the supply of
components to manufacturers of medical devices. Most purchased components and
services are available from more than one supplier. For the few components for
which relatively few alternate supply sources exist, we have identified back-up
suppliers. The qualification of these back-up suppliers may require regulatory
approval, which may or may not be available on a timely basis or at all.
Currently, only one supply source exists for the peristaltic pump and the
computer chip used in our Curon Control Module. For these two components, we
believe we have accumulated enough product to allow time to research
alternatives without harming our business. The peristaltic pump integrated into
the Control Module is manufactured by our supplier in accordance with our
specifications. We have contracted with the supplier for ongoing supply, and we
have secured inventory that we believe is sufficient to allow us time to locate
and qualify a new pump supplier should our current supplier fail to fulfill our
needs. If a new pump is incorporated into the Control Module, then the Control
Module may require regulatory clearance under the FDA's 510(k) process, which
could take several months or more. Also, a computer chip in the Control Module
is no longer manufactured. This chip is currently available from multiple
suppliers, but we cannot assure you that it will be available in the future. We
have purchased an inventory of these chips sufficient to meet our projected
manufacturing needs for at least the next 18 months and we are currently
working on developing a new generator that will use newer chip technology. As
with the pump, we cannot incorporate a new chip into the generator without
regulatory clearance under the FDA's 510(k) process, which could take several
months or more.
Our manufacturing facility is subject to periodic inspection by regulatory
authorities. Our quality assurance systems are subject to FDA regulations.
These regulations require that we conduct our product design, testing,
manufacturing, and control activities in conformance with these regulations and
that we maintain our documentation of these activities in a prescribed manner.
Our manufacturing facility is licensed by the California Department of Health
Services, Food and Drug Branch. In addition, our facility has received ISO
9001/EN46001 certification and the European Union Certificate pursuant to the
European Union Medical Device Directive 93/42/EEC, allowing us to CE mark our
products after assembling appropriate documentation. ISO 9001/EN46001
certification standards for quality operations have been developed to ensure
that companies know the standards of quality on a worldwide basis. Failure to
maintain the CE mark will preclude us from selling our products in Europe. We
cannot assure you that we will be successful in maintaining certification
requirements in Europe or elsewhere.
RESEARCH & DEVELOPMENT
Our research and development activities are conducted internally by a research
and development staff consisting of ten employees. Our research and development
efforts are focused on development of
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additional products for new gastrointestinal indications as well as evaluation
of existing product alternatives. We intend to develop products that leverage
our existing radiofrequency energy platform, and we also plan to explore
options utilizing technology not associated with this platform. We have a
number of new projects and products under development, including several
projects related to development of a new generator as well as development of
additional products for treatment of GERD.
In addition to working on new products, our research and development
organization is developing products and fixtures that are designed to reduce
the time to manufacture, improve quality or reduce cost of products. Our
research and development expenditures were $1.6 million in 1998 and
$9.0 million in 1999.
PATENTS AND PROPRIETARY TECHNOLOGY
We have an aggressive program to obtain or license intellectual property in the
United States, Europe and Asia for our medical advances. We are building a
portfolio of apparatus and method patents covering aspects of our current and
future technology.
As of July 15, 2000, we had 11 issued or allowed U.S. patents and 22 pending
U.S. patent applications. We intend to continue to file for patents for our
technologies to strengthen our position.
We require our employees, consultants and advisors to execute confidentiality
agreements in connection with their employment, consulting or advisory
relationships with us. We also require employees, consultants and advisors who
are expected to work on our products to agree to disclose and assign to us all
inventions conceived during the work day, using our property or which relate to
our business. Despite any measures taken to protect our intellectual property,
unauthorized parties may attempt to copy aspects of our products or to obtain
and use information that we regard as proprietary.
Certain aspects of our products incorporate technology subject to patents that
we have licensed from others. As of July 15, 2000, we have licensed in 12
issued U.S. patents and 21 pending U.S. patent applications. In December 1998,
we entered into an agreement with Somnus Medical Technologies, Inc. for the
license of the technology related to Somnus' radiofrequency generator. The non-
exclusive license gives us the right to manufacture, have manufactured, use,
offer to sell, sell and import Somnus' radiofrequency generator technology for
use in the treatment of GERD and other medical disorders of the digestive
tract. The license expires on December 10, 2013. During the term of the
license, we are obligated to pay a royalty to Somnus for our sale of generators
that incorporate the licensed technology. We have also licensed patented
technology from the University of Kansas Medical Research Institute relating to
applying radiofrequency energy to tissue. This is an exclusive, worldwide and
royalty-bearing license allowing us to incorporate the patented technology in
our products to treat medical disorders throughout the gastrointestinal tract.
The license expires on September 17, 2013 and may be terminated earlier for
breach. We have also licensed other patents that we believe may apply to our
current business or that we may incorporate into future products. We intend to
continue to license technologies to strengthen our competitive position.
The medical device industry is characterized by the existence of a large number
of patents and frequent litigation based on allegations of patent infringement.
As the number of entrants into our market increases, the possibility of an
infringement claim against us grows. While we attempt to ensure that our
products do not infringe other parties' patents and proprietary rights, our
competitors may assert that our products and the methods they employ may be
covered by U.S. patents held by them. In addition, our competitors may assert
that future products we may market infringe their patents. In August 2000, we
received a third-party request for our position regarding infringement of a
patent. After discussion with our patent counsel, we do not believe that we
infringe the patent.
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COMPETITION
The medical device industry is subject to intense competition. To be
successful, we must establish our products, and the procedures in which our
products are used, as attractive alternatives to currently available
treatments.
Our primary competitors in the GERD market are manufacturers and marketers of
existing pharmaceutical and surgical treatments for GERD, and manufacturers
focused on innovative outpatient treatments. We compete with manufacturers of
medications, such as Zantac, Tagamet, Pepcid and Prilosec. These manufacturers
and manufacturers of generic medication equivalents have significantly greater
resources than we do. These companies may market products more aggressively,
gain influence among opinion leaders, or lower their prices, all of which may
affect the adoption of and the market for our products. We also compete with
manufacturers of devices and equipment used in laparoscopic fundoplication.
Increased publicity regarding these procedures or advantageous pricing may
adversely affect the market for our products. Both medication treatment and
fundoplication are established GERD therapies with well-defined reimbursement
profiles.
We also compete with a number of companies that are working on GERD treatments
that eliminate or reduce the need for medication but are less invasive than
surgery. For example, C.R. Bard has developed an endoscopic suturing system
that enables patients to undergo a fundoplication-like surgery in the endoscopy
suite as an outpatient procedure. The device used in this procedure received
FDA marketing clearance in March 2000. We compete with several companies that
are developing bulking agents to be injected into the muscle of the lower
esophageal sphincter. There may also be other companies developing innovative
therapies of which were are not aware.
In the fecal incontinence market, we consider our primary competitors to be
American Medical Systems and Medtronic, both of which are developing
implantable devices for treatment of severe incontinence. Both of these
competitors have significantly greater resources than we do, and we cannot
assure you that we will be able to compete effectively with these companies.
GOVERNMENT REGULATION
Our products are medical devices subject to extensive regulation by the FDA and
other regulatory bodies. FDA regulations govern, among other things, the
following activities that we will perform:
.Product development;
.Product testing;
.Product labeling;
.Product storage;
.Premarket clearance or approval;
.Advertising and promotion;
.Product sales and distribution.
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FDA's premarket clearance and approval requirements
Each medical device that we wish to commercially distribute in the United
States will likely require either prior 510(k) clearance or prior PMA approval
from the U.S. Food and Drug Administration under the Federal Food, Drug, and
Cosmetic Act. Devices deemed to pose relatively minimal risk are placed in
either class I or II, which requires the manufacturer to submit a premarket
notification requesting permission for commercial distribution; this is known
as 510(k) clearance. Some low risk devices are exempted from this requirement.
Devices deemed by the FDA to pose the greatest risk, such as life-sustaining,
life-supporting or implantable devices, or devices deemed not substantially
equivalent to a previously 510(k) cleared device or a preamendment class III
device for which PMA applications have not been called, are placed in class
III, requiring PMA approval.
510(k) Clearance Pathway. To obtain 510(k) clearance for one of our products,
we must submit a premarket notification demonstrating that the proposed device
is substantially equivalent in intended use and in safety and effectiveness to
a previously 510(k) cleared device or a device that was in commercial
distribution before May 28, 1976 for which the FDA has not yet called for
submission of PMA applications. The FDA's 510(k) clearance pathway usually
takes from four to 12 months, but it can last longer.
After a device receives 510(k) clearance, any modification that could
significantly affect its safety or effectiveness, or that would constitute a
major change in its intended use, requires a new 510(k) clearance or could
require a PMA approval. The FDA requires each manufacturer to make this
determination in the first instance, but the FDA can review any such decision.
If the FDA disagrees with a manufacturer's decision not to seek a new 510(k)
clearance, the agency may retroactively require the manufacturer to seek 510(k)
clearance or PMA approval. The FDA also can require the manufacturer to cease
marketing and/or recall the modified device until 510(k) clearance or PMA
approval is obtained.
PMA Approval Pathway. If the FDA denies 510(k) clearance for one of our
products, the product must follow the PMA approval pathway, which requires
proof of the safety and effectiveness of the device to the FDA's satisfaction.
A PMA application must provide extensive preclinical and clinical trial data
and also information about the device and its components regarding, among other
things, device design, manufacturing and labeling. After approval of a PMA, a
new PMA or PMA supplement is required in the event of a modification to the
device, its labeling or its manufacturing process. The PMA approval pathway is
much more costly, lengthy and uncertain than 510(k) clearance. It generally
takes from one to three years or even longer.
Clinical Trials. A clinical trial is almost always required to support a PMA
application and is sometimes required for a 510(k) premarket notification. Such
trials generally require submission of an application for an Investigational
Device Exemption, or IDE. The IDE application must be supported by appropriate
data, such as animal and laboratory testing results, showing that it is safe to
test the device in humans and that the testing protocol is scientifically
sound. The IDE must be approved in advance by the FDA for a specified number of
patients unless the product is deemed a nonsignificant risk device eligible for
more abbreviated IDE requirements. Clinical trials may begin once the IDE
application is approved by the FDA and the appropriate institutional review
boards at the clinical trial sites. In June 2000, we received IDE approval
allowing us to commence a multicenter clinical trial of the Secca System. We
began the trial in July 2000.
In April 2000, we received 510(k) premarket clearance from the FDA for the
Stretta System when used to treat GERD. Based on preliminary discussions with
the FDA staff, we believe that the Secca System
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<PAGE>
Business
--------------------------------------------------------------------------------
may be permitted to follow the 510(k) clearance pathway. However, we cannot
assure you that FDA will not deem the Secca System, or one or more of our
future products, to be a class III device subject to the more burdensome PMA
approval process.
Pervasive and continuing FDA regulation
After a device is placed on the market, numerous regulatory requirements apply.
These include: the quality system regulation, or QSR, which requires
manufacturers to follow elaborate design, testing, control, documentation and
other quality assurance procedures during the manufacturing process; labeling
regulations; the FDA's general prohibition against promoting products for
unapproved or "off-label" uses; and the Medical Device Reporting regulation,
which requires that manufacturers report to the FDA if their device may have
caused or contributed to a death or serious injury or malfunctioned in a way
that would likely cause or contribute to a death or serious injury if it were
to recur. Class II devices also can have special controls such as performance
standards, postmarket surveillance, patient registries, and FDA guidelines that
do not apply to class I devices. Unanticipated changes in existing regulatory
requirements or adoption of new requirements could hurt our business, financial
condition and results or operations.
We are subject to inspection and marketing surveillance by the FDA to determine
our compliance with regulatory requirements. If the FDA finds that we have
failed to comply, the Agency can institute a wide variety of enforcement
actions against us, ranging from a public Warning Letter to more severe
sanctions such as:
.Fines, injunctions, and civil penalties;
.Recall or seizure of our products;
.Operating restrictions, partial suspension or total shutdown or production;
.Refusing our requests for 510(k) clearance or PMA approval of new products;
.Withdrawing 510(k) clearance or PMA approvals already granted; and
.Criminal prosecution.
The FDA also has the authority to require repair, replacement or refund of the
cost of any medical device manufactured or distributed by us. Our failure to
comply with applicable requirements could lead to an enforcement action that
may have an adverse effect on our financial condition and results of
operations.
We have been an FDA registered medical device facility since January 1999 and
we obtained our manufacturing license from the California Department of Health
Services, or CDHS, in September 1999. We are subject to inspection by both the
FDA and CDHS for compliance with the quality systems regulations and other
applicable regulations.
Other U.S. regulation
We also must comply with numerous federal, state and local laws relating to
such matters as safe working conditions, manufacturing practices, environmental
protection, fire hazard control and hazardous substance disposal. We may be
required to incur significant costs to comply with such laws and regulations in
the future and such laws and regulations may hurt our business, financial
condition and results of operations.
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Business
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Foreign regulation
Our products are also regulated outside the United States as medical devices by
government agencies and are subject to registration requirements in many of the
foreign countries in which we plan to sell our products. Our Stretta System
carries a CE Mark, which is required for European product sales, and a
Therapeutic Goods Administration, which is required for product sales in
Australia. Our facility has been audited and certified to be ISO9001/EN46001
compliant, which allows us to sell our products in Europe. Our facility is
subject to inspection by TUV/Essen. We plan to seek approval to sell the
Stretta System in additional foreign countries. The time and cost required to
obtain clearance required by foreign countries may be longer or shorter than
that required for FDA clearance, and requirements for licensing a product in a
foreign country may differ significantly from FDA requirements.
EMPLOYEES
As of July 15, 2000, we had 62 employees, with 19 employees in operations, 10
employees in research and development, 13 employees in sales and marketing, 11
employees in general and administrative, and 9 employees in clinical and
regulatory affairs. We believe that our future success will depend in part on
our continued ability to attract, hire and retain qualified personnel. None of
our employees is represented by a labor union, and we believe our employee
relations are good.
FACILITIES
We are headquartered in Sunnyvale, California, where we lease one building with
approximately 20,000 square feet of office, research and development, and
manufacturing space under leases expiring September 30, 2003. We believe our
current facilities are adequate to meet our current and foreseeable
requirements through the end of 2001 and that suitable additional or substitute
space will be available as needed.
LITIGATION
We are not a party to any pending litigation.
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Scientific Advisory Board
The members of our Scientific Advisory Board, none of whom are our managers or
employees, consult with us to provide advice, assistance and consultation in
the field of gastrointestinal disorders. We consider our advisory board members
to be opinion leaders in their fields, and they offer us advice regarding the
following:
.pre-clinical and clinical study design;
.clinical and marketing feedback on existing products;
.design and clinical feedback on new products;
.methods of gaining physician acceptance; and
.physician training.
Scientific Advisory Board members
<TABLE>
<CAPTION>
Name Position and Affiliation
-------------------------------------------------------------------------------
<S> <C>
Donald O. Castell, M.D... Professor and Chairman, Department of Medicine,
Graduate Hospital, Philadelphia, Pennsylvania;
Professor of Medicine, MCP/Hahnemann University,
Philadelphia, Pennsylvania; Past President, American
Gastroenterological Association
John Dent, M.D........... Clinical Professor of Medicine, University of
Adelaide, Australia; Director, Department of
Gastroenterology, Hepatology and General Medicine,
Royal Adelaide Hospital, Adelaide, Australia
Richard H. Holloway, Clinical Associate Professor, University of
M.D. ................. Adelaide, Australia; Senior Consultant, Department
of Gastrointestinal Medicine, Royal Adelaide
Hospital, Adelaide, Australia
Michael A. Kamm, M.D..... Professor of Gastroenterology, St. Mark's
University, London; Director, Physiology Unit and
Chairman of Medicine, St. Mark's Hospital, London
Joel E. Richter, M.D. ... Chairman, Gastroenterology Department, The Cleveland
Clinic Foundation, Cleveland, Ohio; Professor of
Medicine, The Cleveland Clinic Health Science
Center, Ohio State University; Past President,
American College of Gastroenterology
George Triadafilopoulos, Professor of Medicine, Stanford University School of
M.D................... Medicine; Chief, Section of Gastroenterology, Palo
Alto Veterans Affairs Health Care System, Palo Alto,
California
Mark Vierra, M.D......... Assistant Professor of Surgery, Division of
Gastrointestinal Surgery, Stanford University School
of Medicine, Palo Alto, California
Arnold Wald, M.D......... Professor of Medicine, University of Pittsburgh;
Associate Chief, Division of Gastroenterology and
Hepatology, University of Pittsburgh Medical Center,
Pittsburgh, Pennsylvania
</TABLE>
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Management
EXECUTIVE OFFICERS AND DIRECTORS
Set forth below is the name, age, position and a brief account of the business
experience of each of our executive officers and directors.
<TABLE>
<CAPTION>
Name Age Position(s)
-------------------------------------------------------------------------------
<S> <C> <C>
John W. Morgan............. 40 President, Chief Executive Officer and Director
Alistair F. McLaren........ 60 Chief Financial Officer and Vice President of
Finance and Administration
David S. Utley, M.D........ 36 Chief Medical Officer
Carol A. Chludzinski....... 46 Vice President of Sales and Marketing
John W. Gaiser............. 42 Vice President of Engineering, Research and
Development
Viorica Filimon............ 42 Vice President of Quality Affairs
Michael Berman............. 43 Director
Fred L. Brown.............. 59 Director
David I. Fann.............. 36 Director
Alan L. Kaganov............ 61 Director
Robert F. Kuhling, Jr. .... 51 Director
</TABLE>
Messrs. Berman, Fann, and Kaganov are members of the audit committee of our
board of directors. Messrs. Kaganov and Kuhling are members of the compensation
committee of our board of directors.
John W. Morgan Mr. Morgan has served as our President and Chief Executive
Officer and as a member of our board of directors since November 1999. From
October 1997 to October 1999, Mr. Morgan worked as Chief Executive Officer at
Epitope Inc., a manufacturer of medical devices and diagnostic products
utilizing oral fluid technologies. From October 1996 to October 1997, Mr.
Morgan was President of Regent Medical Products Group for London International
Group, PLC, a manufacturer of latex medical products. From April 1983 to
October 1996, Mr. Morgan worked at Baxter International, a large medical supply
and distribution company, in various management positions including President
of the MidAmerican Regional Company. He holds a B.S. degree in Public
Administration and Economics from the University of Arizona.
Alistair F. McLaren Mr. McLaren has served as our Chief Financial Officer and
Vice President of Finance and Administration since January 1998. From April
1994 to May 1998, Mr. McLaren was Co-President of NeoCon Associates, Inc., an
interim management services company. During his tenure with NeoCon Associates,
Inc., Mr. McLaren served at various times as General Manager of Advanced
Closure Systems, Inc., a medical device company, Chief Financial Officer and
Director of Operations of RITA Medical Systems, Inc., a manufacturer of
radiofrequency devices, and President and Chief Operating Officer of Southern
Pump and Tank, a construction company and SPATCO Environmental, Inc. Mr.
McLaren is a member of the Institute of Chartered Accountants of Scotland.
David S. Utley, M.D. Dr. Utley is a co-founder of the company. He has served as
our Chief Medical Officer since July 1998. From October 1997 to July 1998, Dr.
Utley was Medical Director of Somnus Medical Technologies, Inc., a manufacturer
of medical devices for treatment of ear, nose and throat disorders. From June
1997 through June 1998, he was a fellow in plastic and reconstructive surgery
at Stanford University Medical Center. From June 1992 through June 1997, Dr.
Utley was a resident of surgery at Stanford University Medical Center. Dr.
Utley currently holds faculty positions at Stanford University Medical Center
and the VA Palo Alto Health Care System. He received his M.D. from Harvard
Medical School and holds a B.A. in Science/Arts from Pennsylvania State
University.
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Management
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Carol A. Chludzinski Ms. Chludzinski has served as our Vice President of Sales
& Marketing since February 1999. From August 1995 to January 1999, Ms.
Chludzinski was employed by VidaMed, Inc., a manufacturer of devices for
treatment of urologic disorders, where she first served as Vice President of
North American Sales and Worldwide Marketing and later as Senior Vice
President, where she was responsible for reimbursement activities. From January
1995 to July 1995, Ms. Chludzinski was Director of Sales for Cybex, Inc., a
manufacturer of products sold to hospitals and clinics. Ms. Chludzinski holds a
B.A. in Liberal Arts from Chestnut Hill College.
John W. Gaiser Mr. Gaiser has served as our Vice President of Engineering,
Research and Development since May 1998. From August 1991 to January 1998, Mr.
Gaiser was Vice President of Research and Development for Medtronic
Cardiorhythm Inc., a developer of devices for treatment of cardiac disorders.
From May 1986 to July 1991, he was project group leader for Advanced
Cardiovascular System Inc., a cardiovascular device company. From February 1981
until May 1986, Mr. Gaiser held senior engineering positions at Baxter
International. Mr. Gaiser holds a B.S. in Mechanical Engineering from Purdue
University.
Viorica Filimon Ms. Filimon has served as our Vice President of Quality Affairs
since March 2000 and served as our Director of Quality Affairs from May 1999 to
March 2000. From April 1998 to May 1999, Ms. Filimon was Director of Quality
Assurance for EndoTex Interventional Systems Inc., an endovascular company.
From September 1995 to January 1998, Ms. Filimon served as Quality Engineering
Manager for Boston Scientific-Target Therapeutics Inc., a developer and
manufacturer of cardiovascular devices. From January 1995 to September 1995,
she served as a senior engineer for Toshiba America MRI, a medical imaging
company. Ms. Filimon holds an M.S. in Electrical Engineering from Bucharest
Polytechnic Institute and is certified by the American Society of Quality as a
Certified Reliability Engineer, a Certified Quality Engineer, and a Certified
Quality Auditor.
Michael Berman Mr. Berman has served as a director since July 2000. Since
February 2000, Mr. Berman has been Senior Vice President of Boston
Scientific/Scimed. From June 1995 until February 2000, Mr. Berman was President
and from January to June 1995 he was Vice President of Sales and Marketing of
Boston Scientific/Scimed. He serves as a director of several private companies.
Mr. Berman holds both an M.B.A. and a B.S. in Industrial and Labor Relations
from Cornell University.
Fred L. Brown Mr. Brown has served as a director since May 2000. Since June
1993, Mr. Brown has been employed at BJC Health System, a health system
comprising over 200 hospitals and healthcare delivery centers, where he first
served as President and Chief Executive Officer and, since January 1999, as
Vice Chairman. In addition, Mr. Brown is immediate past chairman of the
American Hospital Association. He also serves as a director of the Citation
Computer Systems Inc., a publicly traded health care information systems
company; Morrison Management Specialists, Inc., a publicly traded food services
contractor for healthcare facilities; XCare.net, a publicly traded provider of
consulting and web development services; and Commerce Bancshares Inc., a
publicly traded bank holding company; and several private companies. Mr. Brown
holds an M.B.A. from George Washington University and a B.A. in Psychology from
Northwestern University.
David I. Fann Mr. Fann has served as a director since September 1999. Since
March 1997, he has been President and Chief Executive Officer of Excelsior
Private Equity Fund II, Inc., a business development company, and, since
September 1994, he has also served as President and Chief Executive Officer of
UST Private Equity Investors Fund, Inc., a business development company. Since
April 1994, Mr. Fann also has been a managing director of U.S. Trust Company of
New York. Mr. Fann holds a B.A.S. in Industrial Engineering and Economics from
Stanford University.
Alan L. Kaganov Mr. Kaganov has served as a director since December 1998. Since
July 1996, he has been associated with U.S. Venture Partners, a Menlo Park
based venture capital firm, as a venture partner. From March 1993 to June 1996,
Mr. Kaganov served as Vice President of Business
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Management
--------------------------------------------------------------------------------
Development and Strategic Planning for Boston Scientific, a large medical
device manufacturer. Mr. Kaganov holds Sc.D. and M.S. degrees in Biomedical
Engineering from Columbia University, an M.B.A. from New York University, and a
B.S. in Mechanical Engineering from Duke University. He also serves as a
director of Eclipse Surgical and ENDOcare, Inc., both publicly-traded medical
device companies, as well as several private companies.
Robert F. Kuhling, Jr. Mr. Kuhling has served as a director since December
1999. Since February 1987, Mr. Kuhling has been a general partner or managing
director of several venture capital partnerships managed by ONSET Ventures. He
also serves as a director of Euphonix, Inc., a publicly- traded professional
audio products company, Gadzoox Networks, Inc., a publicly-traded computer
networking company, and several private companies. Mr. Kuhling holds an M.B.A.
from Harvard Business School and an A.B. in Economics from Hamilton College.
EXECUTIVE OFFICERS
Our executive officers are elected by, and serve at the discretion of, our
board of directors. There are no family relationships among our directors and
officers.
BOARD OF DIRECTORS
Currently, we have authorized a range of four to seven directors. Our board of
directors consists of Messrs. Berman, Brown, Fann, Kaganov, Kuhling and Morgan.
All our directors hold office until the next annual meeting of stockholders or
until their successors are duly qualified. Our amended and restated certificate
of incorporation to be effective upon completion of this offering provides
that, as of the first annual meeting of stockholders, our board of directors
will be divided into three classes, each with staggered three-year terms. As a
result, only one class of directors will be elected at each annual meeting of
our stockholders, with the other classes continuing for the remainder of their
respective three-year terms. Messrs. Fann and Morgan have been designated as
Class I directors, and their terms expire at the 2001 annual meeting of
stockholders; Messrs. Kaganov and Kuhling have been designated as Class II
directors, and their terms expire at the 2002 annual meeting of stockholders;
and Messrs. Berman and Brown have been designated as Class III directors, and
their terms expire at the 2003 annual meeting of stockholders.
BOARD COMMITTEES
Our board of directors has an audit committee and a compensation committee.
The audit committee was formed in October 1999 and currently consists of
Messrs. Berman, Fann, and Kaganov. The audit committee reviews the results and
scope of the annual audit and other services provided by our independent
accountants, reviews and evaluates our internal audit and control functions,
and monitors transactions between us and our employees, officers and directors.
The compensation committee was formed in January 1999 and currently consists of
Messrs. Kaganov and Kuhling. The compensation committee administers the 1997
Stock Option Plan, the 2000 Stock Option Plan and the 2000 Employee Stock
Purchase Plan, and reviews the compensation and benefits for our executive
officers.
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Management
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COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Before establishing the compensation committee, the board of directors as a
whole performed the functions delegated to the compensation committee. None of
our compensation committee members and none of our executive officers have a
relationship that would constitute an interlocking relationship with executive
officers or directors of another entity.
DIRECTOR COMPENSATION
Our non-employee directors are reimbursed for their out-of-pocket expenses
incurred in connection with attending board and committee meetings, but they
are not compensated for their services as board members. In the past, we have
granted directors options to purchase our common stock pursuant to the terms of
our 1997 Stock Option Plan. See "--Employee Benefit Plans."
EXECUTIVE COMPENSATION
The following table sets forth certain information concerning the compensation
of our chief executive officer and each of the next four most highly
compensated current executive officers whose aggregate cash compensation
exceeded $100,000 during the year ended December 31, 1999. We refer to these
persons as the "named executive officers" elsewhere in this prospectus. The
amounts listed under the column captioned "All Other Compensation" represent
car allowances for the named executive officers, unless otherwise indicated.
Summary compensation
<TABLE>
-------------------------------------------------------------------------------
<CAPTION>
Long-Term
Compensation
Securities
1999 Compensation Underlying All Other
Name and Principal Position Salary Bonus Options Compensation
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John W. Morgan (1)............. $ 41,667 $ -- 555,750 $125,000(2)
President and Chief Executive
Officer
Stuart D. Edwards (3).......... 179,538 -- -- 25,463(4)
Former President and Chief
Executive Officer
Alistair F. McLaren............ 165,000 -- 114,000 5,400
Chief Financial Officer and
Vice President of Finance
and Administration
David S. Utley, M.D............ 157,500 -- 199,500 3,600
Chief Medical Officer
Carol A. Chludzinski (5)....... 131,250 -- 57,000 3,150
Vice President of Sales and
Marketing
John W. Gaiser................. 160,000 -- 171,000 3,600
Vice President of Engineering,
Research and Development
</TABLE>
--------
(1) Mr. Morgan joined our company in November 1999 as President and Chief
Executive Officer and as a member of our board of directors, at an annual
salary of $250,000.
(2) In 1999, Mr. Morgan accrued the right to $50,000 attributable to a signing
bonus and $75,000 attributable to relocation expenses. These expenses were
paid in 2000.
(3) Mr. Edwards served as President and Chief Executive Officer through October
1999. As of December 31, 1999, Mr. Edwards held 628,000 shares of
restricted stock subject to vesting valued at $399,400.
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<PAGE>
Management
--------------------------------------------------------------------------------
(4) Mr. Edwards received $21,463 in consulting fees following his termination
as President and Chief Executive Officer.
(5) Ms. Chludzinski joined our company in February 1999 as Vice President of
Sales and Marketing, at an annual salary of $150,000.
Options
The following table sets forth certain information with respect to stock
options granted to each of our named executive officers during the fiscal year
ended December 31, 1999.
Option grants in fiscal year 1999
<TABLE>
---------------------------------------------------------------------------------------------------------
<CAPTION>
Individual Grants
Potential Realizable
Number of Percent of Value At Assumed
Securities Total Grant Date Annual Rates Of
Underlying Net Options Exercise Market Stock Price Appreciation
Options Granted to Price Per Expiration Value For Option Term
Name Granted Employees Share (1) Date 0% 5% 10%
---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
John W. Morgan.......... 555,750 38.5 $0.26 10/27/09 $2,293,493 $ 3,793,085 $ 6,074,176
Alistair F. McLaren..... 57,000 3.9 $0.19 4/1/09 81,340 134,008 211,983
David S. Utley, M.D..... 57,000 3.9 $0.19 4/1/09 81,340 134,008 211,983
David S. Utley, M.D..... 85,500 5.9 $0.26 10/27/09 352,845 583,552 934,489
Carol A. Chludzinski.... 57,000 3.9 $0.19 2/19/09 63,100 104,741 166,071
John W. Gaiser.......... 57,000 3.9 $0.19 4/1/09 81,340 134,008 211,983
</TABLE>
--------
(1) We recorded deferred compensation with respect to the option grants for the
difference between the exercise price and the deemed fair value of these
options. See Note 9 of the Notes to Financial Statements.
In 1999, we granted options to purchase an aggregate of 1,587,000 shares.
798,000 options are fully exercisable, subject to our lapsing right to
repurchase any unvested shares at the original exercise price in the event of
the optionee's termination. Shares generally vest at the rate of 25.0% after
one year of service from the date of grant, and monthly thereafter, generally
over 36 additional months. Options have a term of ten years but may terminate
before their expiration dates if the optionee's status as an employee is
terminated or upon the optionee's death or disability.
With respect to the amounts disclosed in the column captioned "Potential
Realizable Value At Assumed Annual Rates Of Stock Price Appreciation For Option
Term," the 5% and 10% assumed annual rates of compounded stock price
appreciation are mandated by rules of the Securities and Exchange Commission
and do not represent our estimate or projection of our future common stock
prices. The potential realizable values are calculated by assuming the market
price of the underlying security at the grant date appreciates at the indicated
rate for the entire term of the option, and that the option is exercised at the
exercise price and sold on the last day of the option term at the appreciated
price. Actual gains, if any, on stock option exercises are dependent on the
future performance of our common stock and overall stock market conditions. The
amounts reflected in the table may not necessarily be achieved.
Aggregate option exercises in last fiscal year and year-end option values
The following table sets forth certain information concerning exercises of
stock options during the fiscal year ended December 31, 1999 by the named
executive officers and the number and value of unexercised options held by each
of the named executive officers on December 31, 1999. No options were exercised
by the named executive officers in 1999.
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<PAGE>
Management
--------------------------------------------------------------------------------
All options are fully exercisable, subject to our lapsing right to repurchase
any unvested shares at the original exercise price in the event of the
optionee's termination.
The value of "in-the-money" stock options represents the positive spread
between the exercise price of stock options and the fair market value of the
options, based upon the public offering price minus the exercise price per
share.
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
Number of
Securities Underlying Value of Unexercised
Unexercised Options In-the-Money Options
At December 31, 1999 At December 31, 1999
Name Exercisable Unexercisable Exercisable Unexercisable
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
John W. Morgan.............. 370,500 185,250 3,978,000 1,989,000
Alistair F. McLaren......... 78,375 35,625 847,688 385,313
David S. Utley, M.D. ....... 162,687 36,813 1,754,084 396,916
Carol A. Chludzinski........ 57,000 -- 616,000 --
John W. Gaiser.............. 111,964 59,036 1,211,306 638,694
</TABLE>
LIMITATIONS ON LIABILITY AND INDEMNIFICATION
Our bylaws provide that we will indemnify our directors and executive officers,
and may indemnify our other officers, employees and other agents, to the
fullest extent permitted by the General Corporation Law of the State of
Delaware. Under our bylaws, we also are empowered to enter into indemnification
agreements with our directors and officers and to purchase insurance on behalf
of any person whom we are required or permitted to indemnify. We intend to
purchase a directors' and officers' liability insurance policy that insures
such persons against the costs of defense, settlement or payment of a judgment
under certain circumstances.
We intend to enter into indemnification agreements with our directors and
executive officers. Under these agreements, we would be required to indemnify
them against all expenses, judgments, fines, settlements and other amounts
actually and reasonably incurred, in connection with any actual, or any
threatened, proceeding if any of them may be made a party because he or she is
or was one of our directors or officers. We are obligated to pay these amounts
only if the officer or director acted in good faith and in a manner that he or
she reasonably believed to be in or not opposed to our best interests. With
respect to any criminal proceeding, we are obligated to pay these amounts only
if the officer or director had no reasonable cause to believe that his or her
conduct was unlawful. The indemnification agreements also set forth procedures
that will apply in the event of a claim for indemnification thereunder.
In addition, our amended and restated certificate of incorporation filed in
connection with this offering provides that the liability of our directors for
monetary damages shall be eliminated to the fullest extent permissible under
the General Corporation Law of the State of Delaware. This provision in our
amended and restated certificate of incorporation does not eliminate a
director's duty of care, and, in appropriate circumstances, equitable remedies
such as an injunction or other forms of non-monetary relief would remain
available. Each director will continue to be subject to liability for any
breach of the director's duty of loyalty to us, for acts or omissions not in
good faith or involving intentional misconduct or knowing violations of law,
for acts or omissions that the director believes to be contrary to our best
interests or our stockholders, for any transaction from which the director
derived an improper personal benefit, for improper transactions between the
director and us, and for improper distributions to stockholders and loans to
directors and officers. This provision also does not affect a
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Management
--------------------------------------------------------------------------------
director's responsibilities under any other laws, such as the federal
securities laws or state or federal environmental laws.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, or otherwise, we have been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act of 1933, as amended, and is,
therefore, unenforceable.
There is no pending litigation or proceeding involving any of our directors or
officers as to which indemnification is being sought, nor are we aware of any
pending or threatened litigation that may result in claims for indemnification
by any director or officer.
EMPLOYMENT AGREEMENTS
In September 1999, we entered into an at-will employment agreement with John W.
Morgan whereby we have agreed to provide Mr. Morgan with a lump sum severance
payment equal to six months current monthly salary and six months accelerated
vesting on any unvested options upon termination of his employment other than
for cause. The agreement also provides that, upon Mr. Morgan's termination
other than for cause within 12 months following an acquisition, merger or sale
of a majority of the company's assets, Mr. Morgan's outstanding stock options
will fully and immediately vest. The agreement also provides for mortgage
assistance in the amount of $8,500 per month for four years and an annual
salary of $250,000. See also "Certain transactions."
Each of our other named executive officers signed an offer letter before
commencing their employment with us. The offer letters set forth each
officer's:
.position and title,
.salary and other compensation,
.health benefits,
.option grant and vesting schedule, and
.obligation to abide by confidentiality provisions.
Additionally, each offer letter states that employment with us is at-will and
may be terminated by either party at any time with or without notice or cause.
EMPLOYEE BENEFIT PLANS
1997 Stock Option Plan
On May 1, 1997, our sole director at the time adopted our 1997 Stock Option
Plan, referred to as the 1997 Plan, and the stockholders approved our 1997 Plan
in March 1998. Our board of directors has decided not to grant any additional
awards under the 1997 Plan as of the effective date of this offering. However,
the 1997 Plan will continue to govern the terms and conditions of the
outstanding awards granted under the 1997 Plan.
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52
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Management
--------------------------------------------------------------------------------
A total of 2,679,000 shares of our common stock are authorized for issuance
under the 1997 Plan. As of July 15, 2000, options and stock purchase rights to
acquire a total of 1,179,000 shares of our common stock were issued and
outstanding, and a total of 1,143,000 shares of our common stock had been
issued upon the exercise of options and stock purchase rights granted under the
1997 Plan.
Our board of directors or a committee of our board administers the 1997 Plan.
The administrator of the 1997 Plan has the authority to determine the terms and
conditions of the options and stock purchase rights granted under the 1997
Plan.
Our 1997 Plan provides for the grant of options and stock purchase rights.
Stock purchase rights and nonstatutory stock options may be granted to our
employees, directors and consultants, and incentive stock options within the
meaning of Section 422 of the Internal Revenue Code may be granted to our
employees.
The exercise price of options granted under our 1997 Plan may not be less than
85% of fair market value of our common stock on the date of grant, or 100% of
fair market value in the case of an incentive stock option and the term of an
option may not exceed 10 years. An outstanding option may terminate before the
end of its 10 year term if an optionee ceases to be a service provider.
Stock purchase rights provide an eligible service provider the right to
purchase shares of our common stock. The shares under a stock purchase right
may or may not be fully vested on the date of grant. If the shares are
initially unvested, the shares will vest over the individual's period of
continued service with us. We will have the right to repurchase any unvested
shares upon the individual's termination of service with us.
Our 1997 Plan provides that in the event of our merger with or into another
corporation or a sale of substantially all of our assets, the successor
corporation will assume or substitute each option. If the outstanding options
are not assumed or substituted, the options will terminate. However, the
administrator of the 1997 Plan has the discretionary authority to provide that
each option that is not assumed or substituted in a merger or asset sale will
accelerate and become fully exercisable before termination.
2000 Stock Plan
Our board of directors adopted the 2000 Stock Plan, referred to as the 2000
Plan, in June 2000 and the stockholders approved our 2000 Plan in August 2000,
subject to the closing of the offering. Our 2000 Plan is the successor equity
incentive plan to our 1997 Plan.
The 2000 Plan is designed to allow us to retain and attract employees,
directors and consultants who are essential to our future growth and success by
providing such individuals with an opportunity to acquire shares of our common
stock. Our 2000 Plan provides for the grant of nonstatutory stock options to
our employees, directors and consultants, and for the grant of incentive stock
options, within the meaning of Section 422 of the Internal Revenue Code, to our
employees and employees of our corporations.
Number of shares of common stock available under the 2000 Plan
A total of 2,000,000 shares of our common stock are authorized for issuance
under the 2000 Plan. On the first day of each fiscal year during the term of
the 2000 Plan, beginning with our fiscal year 2001, the number of shares
available for issuance under our 2000 Plan will increase by an amount of shares
equal to the lesser of 5% of the outstanding shares of our common stock on the
last day of our immediately preceding fiscal year, 500,000 shares, or such
lesser number of shares as our board may determine.
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53
<PAGE>
Management
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Administration of the 2000 Plan
Our board of directors or a committee of our board administers the 2000 Plan.
In the case of options intended to qualify as "performance-based compensation"
within the meaning of Section 162(m) of the Internal Revenue Code, the
committee will consist of two or more "outside directors" within the meaning of
Section 162(m) of the Internal Revenue Code. The administrator has the power to
determine the terms of the options granted, including the exercise price, the
number of shares subject to each option, the exercisability of the options, and
the form of consideration payable upon exercise.
Options
The administrator determines the exercise price of options granted under the
2000 Plan, but with respect to nonstatutory stock options intended to qualify
as "performance-based compensation" within the meaning of Section 162(m) of the
Internal Revenue Code and all incentive stock options, the exercise price must
at least be equal to the fair market value of our common stock on the date of
grant. The term of an incentive stock option may not exceed 10 years, except
that with respect to any participant who owns 10% of the voting power of all
classes of our outstanding capital stock, the term must not exceed five years
and the exercise price must equal at least 110% of the fair market value on the
grant date. The administrator determines the term of all other options.
No optionee may be granted an option to purchase more than 1,000,000 shares in
any fiscal year. In connection with his or her initial service, an optionee may
be granted options to purchase up to an additional 2,000,000 shares.
After termination of one of our employees, directors or consultants, he or she
may exercise his or her option for the period of time stated in the option
agreement. Generally, if termination is due to death or disability, the option
will remain exercisable for 12 months. In all other cases, the option will
generally remain exercisable for three months. However, an option may never be
exercised later than the expiration of its term.
Automatic grants to nonemployee directors
Our 2000 Plan provides for the periodic automatic grant of options to our
nonemployee directors. Each option granted under this automatic grant provision
will have an exercise price per share equal to 100% of the fair market value
per share of our common stock on the date of grant, and will have a term of 10
years, unless terminated earlier upon the optionee's termination of service as
a director. Following is a brief description of the options that will
automatically be granted to nonemployee directors under the 2000 Plan:
.Initial Grant. A nonemployee director will automatically be granted an option
to purchase shares of our common stock on the later of the effective date
of the 2000 Plan, or the date the individual first becomes a nonemployee
director, whether by appointment by our board or election by our stockholders.
An employee director who ceases to be an employee will not be eligible to
receive this initial grant. Each initial 30,000-share option grant will become
vested and exercisable with respect to the shares in four successive equal
annual installments measured from the option grant date.
.Annual Grants. Each nonemployee director will automatically be granted an
option to purchase 10,000 shares of our common stock following each annual
meeting of stockholders, provided the individual has been a nonemployee
director for at least six months on the date of grant. Each annual 10,000-
share option grant will become vested and exercisable in four yearly
installments on each anniversary of the option grant date.
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54
<PAGE>
Management
--------------------------------------------------------------------------------
The other terms and conditions of the options automatically granted to
nonemployee directors under the 2000 Plan will be governed by the terms of our
2000 Plan.
Transferability of options
Our 2000 Plan generally does not allow for the transfer of options and only the
optionee may exercise an option during his or her lifetime. The administrator
may, however, allow options to be transferable.
Adjustments upon merger or asset sale
Our 2000 Plan provides that in the event of our merger with or into another
corporation or a sale of substantially all of our assets, the successor
corporation will assume or substitute each option. If the outstanding options
are not assumed or substituted, the administrator will provide notice to the
optionee that he or she has the right to exercise the option as to all of the
shares subject to the option, including shares which would not otherwise be
exercisable, for a period of 15 days from the date of the notice. The option
will terminate upon the expiration of the 15-day period.
Amendment and termination of our 2000 Plan
Our 2000 Plan will automatically terminate in 2010, unless we terminate it
sooner. In addition, our board of directors has the authority to amend, suspend
or terminate the 2000 Plan provided it does not adversely affect any option
previously granted under our 2000 Plan.
2000 Employee Stock Purchase Plan
Our board of directors adopted the 2000 Employee Stock Purchase Plan, referred
to as the Purchase Plan, in June 2000 and the stockholders approved our
Purchase Plan in August 2000, subject to the closing of the offering. Our
Purchase Plan provides eligible employees the opportunity to purchase shares of
our common stock at a discount through payroll deductions.
Number of shares of common stock available under the Purchase Plan
A total of 400,000 shares of our common stock are authorized for issuance under
the Purchase Plan. In addition, the number of shares authorized for issuance
under the Purchase Plan will increase annually on the first day of each fiscal
year, beginning with our fiscal year 2001, equal to the lesser of 1.5% of the
outstanding shares of our common stock on the last day of the immediately
preceding fiscal year, 500,000 shares, or such lesser number of shares as may
be determined by our board of directors.
Administration of the Purchase Plan
Our board of directors or a committee of our board administers the Purchase
Plan. Our board of directors or its committee has full and exclusive authority
to interpret the terms of the Purchase Plan and determine eligibility.
Eligibility to participate
All of our employees are eligible to participate if they are customarily
employed by us for at least 20 hours per week and more than five months in any
calendar year. However, an employee may not be granted an option to purchase
stock under the Purchase Plan if such employee:
.immediately after grant owns stock possessing 5% or more of the total combined
voting power or value of all classes of our capital stock; or
.whose rights to purchase stock under all of our employee stock purchase plans
accrues at a rate that exceeds $25,000 worth of stock for each calendar year.
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55
<PAGE>
Management
--------------------------------------------------------------------------------
Offering periods and contributions
Our Purchase Plan is intended to qualify under Section 423 of the Internal
Revenue Code and contains consecutive, overlapping 24-month offering periods.
Each offering period includes four six-month purchase periods. The offering
periods generally start on the first trading day on or after May 1st and
November 1st of each year, except for the first such offering period which will
begin on the first trading day on or after the effective date of this offering
and will end on the first trading day on or after November 1, 2002.
Our Purchase Plan permits participants to purchase common stock through payroll
deductions of up to 15% of their eligible compensation which includes a
participant's base straight time gross earnings and commissions. A participant
may purchase a maximum of 5,000 shares during a six-month purchase period.
Purchase of shares
Amounts deducted from a participant's eligible compensation and accumulated
during a six-month purchase period are used to purchase shares of our common
stock at the end of the six-month purchase period. The price is 85% of the
lower of the fair market value of our common stock at the beginning of an
offering period or at the end of a purchase period. If the fair market value at
the end of a purchase period is less than the fair market value at the
beginning of the offering period, participants will be withdrawn from the
current offering period after their purchase of shares on the purchase date and
will be automatically re-enrolled in a new offering period. Participants may
end their participation at any time during an offering period, and will be paid
their payroll deductions to date. Participation ends automatically upon
termination of employment with us.
Transferability of rights
A participant may not transfer rights granted under the Purchase Plan other
than by will, the laws of descent and distribution or as otherwise provided
under the Purchase Plan.
Adjustments upon merger or change of control
In the event of our merger or change of control, a successor corporation may
assume or substitute each outstanding option. If the successor corporation
refuses to assume or substitute for the outstanding options, the offering
period then in progress will be shortened, and a new exercise date will be set.
Amendment and termination of the Purchase Plan
Our Purchase Plan will terminate in 2010. However, our board of directors has
the authority to amend or terminate our Purchase Plan, except that, subject to
certain exceptions described in the Purchase Plan, no such action may adversely
affect any outstanding rights to purchase stock under our Purchase Plan.
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56
<PAGE>
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Certain transactions
In January and February 1998, we issued and sold an aggregate of 2,855,700
shares of common stock to a total of 29 investors at a purchase price of
$0.0018 per share. The officers, directors and five percent stockholders who
purchased shares of common stock were (i) Stuart D. Edwards, 1,784,100 shares,
(ii) Alistair F. McLaren, 57,000 shares and (iii) David S. Utley, 114,000
shares.
In December 1998, we sold shares of our Series B preferred stock, which is
convertible into an aggregate of 2,925,664 shares of common stock, at a price
per common equivalent share of $1.98. We sold the shares pursuant to a
preferred stock purchase agreement and a registration rights agreement under
which we made standard representations, warranties and covenants, and provided
the purchasers with registration rights and information rights. The
registration rights are the only rights that survive beyond this offering. See
"Description of capital stock."
In August 1999, we sold shares of our Series C preferred stock convertible into
an aggregate of 5,605,000 shares of common stock at a price per common
equivalent share of $2.63. We sold the shares pursuant to a preferred stock
purchase agreement and a registration rights agreement under which we made
standard representations, warranties and covenants, and provided the purchasers
with registration rights and information rights. The registration rights are
the only rights that survive beyond this offering. See "Description of capital
stock."
The purchasers of the Series B and Series C preferred stock included, among
others, the following principal stockholders, directors and affiliates:
<TABLE>
<CAPTION>
Series B Series C
Stockholders, directors and affiliates Preferred Preferred
--------------------------------------------------------------------------------
<S> <C> <C>
U.S. Venture Partners....................................... 1,450,221 1,520,000
ONSET Ventures.............................................. 1,450,221 950,000
Excelsior Private Equity Fund II............................ 2,280,000
Travelers Insurance Co...................................... 760,000
Alan L. Kaganov............................................. 25,221 19,000
</TABLE>
In May 2000, we issued promissory notes in the aggregate principal amount of
$11,090,000, all of which is currently outstanding. The notes bear interest at
8%. If not prepaid, the notes are convertible into approximately 2,107,000
shares of common stock beginning in May 2001 and are due in May 2005. Notes
were issued to affiliates ONSET Ventures in the amount of $7,500,000, U.S.
Venture Partners in the amount of $2,000,000, and Excelsior Private Equity Fund
in the amount of $1,500,000. In connection with the issuance of the notes, each
holder received warrants to purchase the number of shares of common stock equal
to nine percent of the face value of each note, exercisable at a price of $4.39
per share.
On December 10, 1998, we extended a loan to Mr. Edwards in the aggregate
principal amount of $250,000, all of which is currently outstanding. This loan
bears interest at the rate of 6% per annum, matures on December 10, 2000 and is
secured by 892,050 shares of our common stock.
Robert F. Kuhling is a general partner of ONSET Ventures and beneficially owns
2,400,222 shares of our stock. Mr. Kuhling disclaims beneficial ownership of
the shares held by such entity except to his proportionate ownership interest
therein. Mr. Morgan has invested $200,000, Mr. Gaiser has invested $200,000 and
Dr. Utley has invested $100,000 in a fund managed by ONSET Ventures.
In March 2000, John W. Morgan exercised his option for 370,500 shares of common
stock; Alistair F. McLaren exercised his options for 81,938 shares of common
stock; David S. Utley exercised his
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57
<PAGE>
Certain transactions
--------------------------------------------------------------------------------
options for 166,250 shares of common stock; Carol Chludzinski exercised her
options for 85,500 shares of common stock; John W. Gaiser exercised his options
for 144,535 shares of common stock; and Alan L. Kaganov exercised his option
for 57,000 shares of common stock. The shares issued or issuable upon exercise
are subject to repurchase by us, with such repurchase right lapsing with
respect to various amounts depending on the date of grant and vesting schedule.
Our right of repurchase lapses in full in the event of our merger with or into
another corporation, or the sale of all or substantially all of our assets, in
which our stockholders before the transaction own less than 50% of the voting
securities of the surviving corporation or its parent following the
transaction.
We provide Mr. Morgan with mortgage assistance in the amount of $8,500 per
month for four years following the commencement of his employment. The loan
will be forgiven upon termination of his employment other than for cause or
upon death or disability. The loan is due and payable immediately, if he
voluntarily terminates employment, within 24 months of an initial public
offering, or within 6 months of a change in control, unless the acquiring
entity assumes the loan.
We have entered into a termination agreement with Stuart D. Edwards providing
for his resignation as President and Chief Executive Officer, effective October
29, 1999. The agreement provides for continuation of services as a consultant
until April 1, 2001 at a fee of $17,167 per month. The Company has no plans on
utilizing these consulting services. In addition, the agreement provides that
his remaining restricted stock will continue to lapse through the consulting
period. If Mr. Edwards dies during the consulting period, his spouse will
continue to receive consulting payments.
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58
<PAGE>
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Principal stockholders
The following table sets forth certain information known to us with respect to
beneficial ownership of our common stock as of July 15, 2000, and as adjusted
to reflect the sale of the shares offered, by:
.each person known by us to own beneficially more than 5% of our outstanding
stock;
.each of our directors;
.each named executive officer; and
.all current executive officers and directors as a group.
Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that person,
shares of common stock subject to options held by that person that are
currently exercisable or exercisable within 60 days of July 15, 2000 are deemed
outstanding. Percentage of beneficial ownership is based upon 13,661,000 shares
of common stock outstanding before this offering and 18,661,000 shares of
common stock outstanding after this offering, based on the number of shares
outstanding as of July 15, 2000. To our knowledge, except as set forth in the
footnotes to this table and subject to applicable community property laws, each
person named in the table has sole voting and investment power with respect to
the shares set forth opposite such person's name. Except as otherwise
indicated, the address of each of the persons in this table is as follows:
c/o Curon Medical, Inc., 735 Palomar Ave., Sunnyvale, California 94085.
<TABLE>
<CAPTION>
Number of
shares Percent Percent
Number of underlying owned owned
shares options or before this after this
Name of beneficial owner outstanding warrants offering offering
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Entities affiliated with U.S.
Venture Partners (1)........ 2,970,222 102,600 22.49 16.47
2180 Sand Hill Road, Suite 300
Menlo Park, CA 94025
Entities affiliated with ONSET
Ventures (2)................ 2,400,222 384,750 20.39 14.92
Robert F. Kuhling, Jr.
2400 Sand Hill Road
Menlo Park, CA 94025
Excelsior Private Equity Fund
II.......................... 2,280,000 76,950 17.25 12.63
David I. Fann
114 W. 47th Street
New York, NY 10036-1532
Alan L. Kaganov (3)............ 101,221 17,100 * *
2180 Sand Hill Road, Suite 300
Menlo Park, CA 94025
Robert F. Kuhling, Jr. (4)..... 2,400,222 384,750 20.39 14.92
David I. Fann (5).............. 2,280,000 76,950 17.25 12.63
Stuart D. Edwards.............. 1,482,276 -- 10.85 7.94
658 Westridge Drive
Portola Valley, CA 94028
</TABLE>
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59
<PAGE>
Principal stockholders
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Number of
shares Percent Percent
Number of underlying owned owned
shares options or before this after this
Name of beneficial owner outstanding warrants offering offering
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Travelers Insurance Co.......... 760,000 -- 5.56 4.07
One Tower Square
Nine Plaza Building
Hartford, CT 06183
John W. Morgan.................. 370,500 185,250 4.07 2.98
David S. Utley, M.D............. 280,250 33,250 2.29 1.68
John W. Gaiser.................. 150,642 48,858 1.46 1.07
Alistair F. McLaren............. 138,938 32,063 1.25 0.92
Carol Chludzinski............... 85,500 -- 0.63 0.46
All executive officers and
directors as a group
(9 persons).................. 8,058,099 1,353,208
</TABLE>
--------
* Less than 1% of the outstanding common stock.
(1) Includes 2,673,200 shares held by U.S. Venture Partners V, L.P., 148,511
shares held by USVP V International, L.P., 83,166 shares held by 2180
Associates Fund V, L.P., and 65,345 shares held by USVP V Entrepreneur
Partners, L.P. (collectively "USVP")
(2) Included 2,400,222 shares held by ONSET Enterprise Associates III, L.P.
(3) Excludes 2,970,222 shares and 102,600 warrants held by USVP with whom
Mr. Kaganov is associated as a venture partner. However, Mr. Kaganov
neither exercises nor shares voting or dispositive power over the shares
held by USVP. Further, Mr. Kaganov disclaims beneficial ownership of the
shares held by USVP except to the extent of his pecuniary interest therein
arising from his venture partner relationship with USVP.
(4) Includes 2,400,222 shares and 384,750 warrants held by ONSET Enterprise
Associates III, L.P. Mr. Kuhling is a general partner of ONSET Enterprise
Associates, III L.P. and disclaims beneficial ownership of the shares held
by ONSET Enterprise Associates III, L.P. except to the extent of his
proportionate partnership interest therein.
(5) Includes 2,280,000 shares and 76,950 warrants held by Excelsior Private
Equity Fund II, Inc. Mr. Fann is President and Chief Executive Officer of
Excelsior Private Equity Fund II, Inc. and disclaims beneficial ownership
of the shares held by Excelsior Private Equity Fund II, Inc. except to the
extent of his proportionate investment interest therein.
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60
<PAGE>
-------------------------------------------------------------------------------
Description of capital stock
The following information describes our common stock and preferred stock, as
well as options to purchase our common stock, and provisions of our
certificate of incorporation and our bylaws. This description is only a
summary. You should also refer to the certificate and bylaws which have been
filed with the Securities and Exchange Commission as exhibits to our
registration statement, of which this prospectus forms a part.
Upon the completion of this offering, we will be authorized to issue up to
55,000,000 shares of capital stock, $0.001 par value, to be divided into two
classes to be designated, respectively, "common stock" and "preferred stock."
Of such shares authorized, 50,000,000 shares shall be designated as common
stock, and 5,000,000 shares shall be designated as preferred stock.
COMMON STOCK
As of July 15, 2000, there were 13,661,000 shares of common stock outstanding
that were held of record by approximately 122 stockholders, assuming
conversion of all shares of preferred stock outstanding as of July 15, 2000
into 9,597,000 shares of common stock. There will be 18,661,000 shares of
common stock outstanding, assuming no exercise of the underwriters' over-
allotment option and no exercise of outstanding options, after giving effect
to the sale of common stock offered in this offering. As of July 15, 2000,
there are outstanding options to purchase a total of 1,179,000 shares of our
common stock under our stock plans.
The holders of common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. Our
stockholders do not have cumulative voting rights in the election of
directors. Accordingly, holders of a majority of the shares voting are able to
elect all of the directors. Subject to preferences that may be granted to any
then outstanding preferred stock, holders of common stock are entitled to
receive ratably only those dividends as may be declared by the board of
directors out of funds legally available therefor, as well as any
distributions to the stockholders. See "Dividend policy." In the event of our
liquidation, dissolution or winding up, holders of common stock are entitled
to share ratably in all of our assets remaining after we pay our liabilities
and distribute the liquidation preference of any then outstanding preferred
stock. Holders of common stock have no preemptive or other subscription or
conversion rights. There are no redemption or sinking fund provisions
applicable to the common stock.
WARRANTS
As of July 15, 2000, there were warrants outstanding to purchase 722,000
shares of common stock at a weighted average exercise price of $3.69 per
share, assuming conversion of series A and C convertible preferred stock to
common. As of July 15, 2000, there were warrants outstanding to purchase
124,000 shares of series A convertible preferred stock at a weighted average
exercise price of $1.15 per share, which upon completion of this offering will
be exercisable into 124,000 shares of common stock. We issued all of the
warrants to Venture Banking Group, a division of Cupertino National Bank, in
connection with a line of credit. Warrants to purchase 29,000 shares of common
stock are exercisable at any time prior to the earlier of January 8, 2008, or
five years after the effective date of this offering. Warrants for 4,000,
34,000 and 86,000 shares of series A preferred stock are exercisable at any
time prior to the earlier of February, August and October, 2008, respectively,
or five years after the effective date of this offering. In addition, on May
19, 2000 we issued warrants to purchase 569,000 shares of series C convertible
preferred stock at an exercise price of $4.39 per share in connection with a
convertible note financing.
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61
<PAGE>
Description of capital stock
--------------------------------------------------------------------------------
PREFERRED STOCK
Upon completion of this offering, our board of directors will have the
authority, without further action by the stockholders, to issue up to 5,000,000
shares of preferred stock in one or more series and to fix the rights,
preferences, privileges and restrictions thereof. These rights, preferences and
privileges include dividend rights, conversion rights, voting rights, terms of
redemption, liquidation preferences, sinking fund terms and the number of
shares constituting any series or the designation of such series, any or all of
which may be greater than the rights of common stock. The issuance of preferred
stock could adversely affect the voting power of holders of common stock and
the likelihood that such holders will receive dividend payments and payments
upon liquidation. In addition, the issuance of preferred stock could have the
effect of delaying, deferring or preventing a change in control of Curon
Medical. We have no present plan to issue any shares of preferred stock.
REGISTRATION RIGHTS
After the closing of this offering, the holders of approximately 9,597,000
shares of our common stock will be entitled to certain rights with respect to
the registration of such shares under the Securities Act. In the event that we
propose to register any of our securities under the Securities Act, either for
our own account or for the account of other security holders, these holders are
entitled to notice of such registration and are entitled to include their
common stock in such registration, subject to certain marketing and other
limitations. Beginning six months after the closing of this offering, the
holders of at least 40% of these securities have the right to require us, on
not more than three occasions, to file a registration statement under the
Securities Act in order to register shares of their common stock. We may, in
certain circumstances, defer such registrations and the underwriters have the
right, subject to certain limitations, to limit the number of shares included
in such registrations. Further, these holders may require us to register all or
a portion of their shares on Form S-3, subject to certain conditions and
limitations.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF THE CERTIFICATE OF INCORPORATION, BYLAWS
AND DELAWARE LAW
Our bylaws provide for our board of directors to be divided into three classes,
with staggered three-year terms. When this division is effective, only one
class of directors will be elected at each annual meeting of our stockholders,
with the other classes continuing for the remainder of their respective three-
year terms. However, until this classification of our board of directors is
effective, and because our stockholders have no cumulative voting rights, our
stockholders representing a majority of the shares of common stock outstanding
will be able to elect all of the directors. Our bylaws also provide that all
stockholder action must be effected at a duly called meeting of stockholders
and not by a consent in writing, and that only our board of directors, chairman
of the board and president may call a special meeting of stockholders.
The combination of the classification of our board of directors, when
effective, and the lack of cumulative voting will make it more difficult for
our existing stockholders to replace our board of directors as well as for
another party to obtain control of Curon Medical by replacing our board of
directors. Since the board of directors has the power to retain and discharge
our officers, these provisions could also make it more difficult for existing
stockholders or another party to effect a change in management. In addition,
the authorization of undesignated preferred stock makes it possible for the
board of directors to issue preferred stock with voting or other rights or
preferences that could impede the success of any attempt to change control of
Curon Medical.
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62
<PAGE>
Description of capital stock
--------------------------------------------------------------------------------
These provisions may have the effect of deterring hostile takeovers or delaying
changes in control or management of Curon Medical. These provisions are
intended to enhance the likelihood of continued stability in the composition of
our board of directors and in the policies furnished them and to discourage
certain types of transactions that may involve an actual or threatened change
of control of Curon Medical. These provisions are designed to reduce our
vulnerability to an unsolicited acquisition proposal. The provisions also are
intended to discourage certain tactics that may be used in proxy fights.
However, such provisions could have the effect of discouraging others from
making tender offers for our shares and, as a consequence, they also may
inhibit fluctuations in the market price of our shares that could result from
actual or rumored takeover attempts. Such provisions may also have the effect
of preventing changes in our management.
SECTION 203 OF THE GENERAL CORPORATION LAW OF THE STATE OF DELAWARE
We are subject to Section 203 of the General Corporation Law of the State of
Delaware, which prohibits a Delaware corporation from engaging in any business
combination with any interested stockholder for a period of three years after
the date that such stockholder became an interested stockholder, with the
following exceptions:
.before such date, the board of directors of the corporation approved either
the business combination or the transaction that resulted in the stockholder
becoming an interested holder;
.upon consummation of the transaction that resulted in the stockholder becoming
an interested stockholder, the interested stockholder owned at least 85% of
the voting stock of the corporation outstanding at the time the transaction
began, excluding for purposes of determining the number of shares outstanding
those shares owned by persons who are directors and also officers and by
employee stock plans in which employee participants do not have the right to
determine confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer; or
.on or after such date, the business combination is approved by the board of
directors and authorized at an annual or special meeting of the stockholders,
and not by written consent, by the affirmative vote of at least 66 2/3% of the
outstanding voting stock that is not owned by the interested stockholder.
Section 203 defines business combination to include the following:
.any merger or consolidation involving the corporation and the interested
stockholder;
.any sale, transfer, pledge or other disposition of 10% or more of the assets
of the corporation involving the interested stockholder;
.subject to certain exceptions, any transaction that results in the issuance or
transfer by the corporation of any stock of the corporation to the interested
stockholder;
.any transaction involving the corporation that has the effect of increasing
the proportionate share of the stock or any class or series of the corporation
beneficially owned by the interested stockholder; or
.the receipt by the interested stockholder of the benefit of any loss,
advances, guarantees, pledges or other financial benefits by or through the
corporation.
--------------------------------------------------------------------------------
63
<PAGE>
Description of capital stock
--------------------------------------------------------------------------------
In general, Section 203 defines interested stockholder as an entity or person
beneficially owning 15% or more of the outstanding voting stock of the
corporation or any entity or person affiliated with or controlling or
controlled by such entity or person.
NASDAQ NATIONAL MARKET LISTING
The Nasdaq National Market has approved our common stock for quotation under
the symbol "CURN."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services L.L.C. Its address is 400 South Hope St., 4th Floor, Los
Angeles, California 90071, and its telephone number is (213) 553-9730.
--------------------------------------------------------------------------------
64
<PAGE>
--------------------------------------------------------------------------------
Shares eligible for future sale
Upon completion of this offering, we will have 18,661,000 shares of common
stock outstanding based on shares outstanding as of July 15, 2000. Of these
shares, the 5,000,000 shares sold in this offering will be freely transferable
without restriction under the Securities Act, unless they are held by our
"affiliates" as that term is used under the Securities Act and the regulations
promulgated thereunder.
Of these shares, the remaining 13,661,000 shares were sold by us in reliance on
exemptions from the registration requirements of the Securities Act, are
restricted securities within the meaning of Rule 144 under the Securities Act
and become eligible for sale in the public market as follows:
.beginning 90 days after the effective date, 189,050 shares will become
eligible for sale subject to the provisions of Rules 144 and 701; and
.beginning 180 days after the date of this prospectus, 13,471,950 additional
shares will become eligible for sale, subject to the provisions of Rule 144,
Rule 144(k) or Rule 701, upon the expiration of agreements not to sell such
shares entered into between the underwriters and such stockholders;
Beginning 180 days after the date of this prospectus, 189,486 additional shares
subject to vested options as of the date of completion of this offering will be
available for sale subject to compliance with Rule 701 and upon the expiration
of agreements not to sell such shares entered into between the underwriters and
such stockholders. Any shares subject to lock-up agreements may be released at
any time without notice by the underwriters.
In general, under Rule 144 as currently in effect, a person, or persons whose
shares are aggregated, including an affiliate, who has beneficially owned
restricted shares for at least one year is entitled to sell, within any three-
month period commencing 90 days after the date of completion of this offering,
a number of shares that does not exceed the greater of 1% of the then
outstanding shares of common stock, approximately 186,610 shares immediately
after this offering, or the average weekly trading volume in the common stock
during the four calendar weeks preceding such sale, subject to the filing of a
Form 144 with respect to such sale and certain other limitations and
restrictions. In addition, a person who is not deemed to have been an affiliate
of our company at any time during the 90 days preceding a sale and who has
beneficially owned the shares proposed to be sold for at least two years, would
be entitled to sell such shares under Rule 144(k) without regard to the
requirements described above.
Any of our employees, officers, directors or consultants who purchased his or
her shares before the date of completion of this offering or who holds vested
options as of that date pursuant to a written compensatory plan or contract is
entitled to rely on the resale provisions of Rule 701, which permits non-
affiliates to sell their Rule 701 shares without having to comply with the
public-information, holding-period, volume-limitation or notice provisions of
Rule 144 and permits affiliates to sell their Rule 701 shares without having to
comply with Rule 144's holding-period restrictions, in each case commencing 90
days after the date of completion of this offering. However, we and certain
officers, directors and other stockholders have agreed not to sell or otherwise
dispose of any shares of our common stock for the 180-day period after the date
of this prospectus without the prior written consent of the underwriters. See
"Underwriting."
--------------------------------------------------------------------------------
65
<PAGE>
Shares eligible for future sale
--------------------------------------------------------------------------------
Upon the closing of this offering, we intend to file a registration statement
on Form S-8 under the Securities Act to register shares of common stock
reserved for issuance under the 1997 Plan, the 2000 Plan and the Purchase Plan,
thus permitting the resale of such shares by non-affiliates in the public
market without restriction under the Securities Act. Such registration
statements will become effective immediately upon filing.
Before this offering, there has been no public market for our common stock, and
any sale of substantial amounts in the open market may adversely affect the
market price of our common stock offered hereby.
--------------------------------------------------------------------------------
66
<PAGE>
--------------------------------------------------------------------------------
Underwriting
Curon Medical and the underwriters for the offering named below have entered
into an underwriting agreement concerning the shares being offered. Subject to
conditions, each underwriter has severally agreed to purchase the number of
shares indicated in the following table. UBS Warburg LLC, CIBC World Markets
Corp. and SG Cowen Securities Corporation are the representatives of the
underwriters.
<TABLE>
<CAPTION>
Number of
Underwriters Shares
--------------------------------------------------------------------------------
<S> <C>
UBS Warburg LLC...................................................... 2,097,000
CIBC World Markets Corp. ............................................ 1,049,000
SG Cowen Securities Corporation...................................... 1,049,000
Donaldson, Lufkin & Jenrette Securities Corporation.................. 70,000
A.G. Edwards & Sons, Inc............................................. 70,000
ING Barings LLC...................................................... 70,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated................... 70,000
Morgan Stanley & Co. Incorporated.................................... 70,000
PaineWebber Incorporated............................................. 70,000
Prudential Securities Incorporated................................... 70,000
Robertson Stephens, Inc.............................................. 70,000
U.S. Bancorp Piper Jaffray Inc....................................... 70,000
Advest, Inc.......................................................... 35,000
Robert W. Baird & Co. Incorporated................................... 35,000
Pacific Growth Equities, Inc......................................... 35,000
Pennsylvania Merchant Group.......................................... 35,000
Tucker Anthony Incorporated.......................................... 35,000
---------
Total.............................................................. 5,000,000
=========
</TABLE>
If the underwriters sell more shares than the total number set forth in the
table above, the underwriters have a 30-day option to buy from us up to an
additional 750,000 shares at the initial public offering price less the
underwriting discounts and commissions to cover these sales. If any shares are
purchased under this option, the underwriters will severally purchase shares in
approximately the same proportion as set forth in the table above.
The following table shows the per share and total underwriting discounts and
commissions we will pay to the underwriters. These amounts are shown assuming
both no exercise and full exercise of the underwriters' option to purchase up
to an additional 750,000 shares.
<TABLE>
<CAPTION>
No exercise Full exercise
--------------------------------------------------------------------------------
<S> <C> <C>
Per share............................................ $ 0.77 $ 0.77
Total.............................................. $3,850,000 $4,427,500
</TABLE>
We estimate that the total expenses of the offering payable by us, excluding
underwriting discounts and commissions, will be approximately $1,200,000.
Shares sold by the underwriters to the public will initially be offered at the
initial public offering price set forth on the cover of this prospectus. Any
shares sold by the underwriters to securities dealers may be sold at a discount
of up to $0.46 per share from the initial public offering price. Any of these
securities dealers may resell any shares purchased from the underwriters to
other brokers or dealers at
--------------------------------------------------------------------------------
67
<PAGE>
Underwriting
-------------------------------------------------------------------------------
a discount of up to $0.10 per share from the initial public offering price. If
all the shares are not sold at the initial public offering price, the
representatives may change the offering price and the other selling terms.
The underwriters have informed us that they do not expect discretionary sales
to exceed 5% of the shares of common stock to be offered.
Curon Medical, its directors, officers and substantially all of its
stockholders, option holders and warrant holders have agreed with the
underwriters, pursuant to lock-up agreements, not to offer, sell, contract to
sell, hedge or otherwise dispose of, directly or indirectly, or file with the
SEC a registration statement under the Securities Act relating to, any of its
common stock or securities convertible into or exchangeable for shares of
common stock during the period from the date of this prospectus continuing
through the date 180 days after the date of this prospectus, without the prior
written consent of UBS Warburg LLC.
The underwriters have reserved for sale, at the initial public offering price,
up to 250,000 shares of our common stock being offered for sale to our
customers and business partners. At the discretion of our management, other
parties, including our employees, may participate in the reserve shares
program. The number of shares available for sale to the general public in the
offering will be reduced to the extent these persons purchase reserved shares.
Any reserved shares not so purchased will be offered by the underwriters to
the general public on the same terms as the other shares in this offering.
Shares purchased in this program by persons who have otherwise entered into
lock-up agreements with the underwriters, as described above, generally may
not be sold for 180 days after the date of this prospectus. In some cases, the
rules of National Association of Securities Dealers, Inc. may require
purchasers in this offering, including participants in this program, to enter
into agreements not to sell their shares for a specified period.
Before this offering, there has been no public market for our common stock.
The initial public offering price was negotiated by us and the
representatives. The principal factors considered in determining the initial
public offering price include:
.the information set forth in this prospectus and otherwise available to the
representatives;
.the history and the prospects for the industry in which we compete;
.the ability of our management;
.our prospects for future earnings, the present state of our development, and
our current financial position;
.the general condition of the securities markets at the time of this offering;
and
.the recent market prices of, and the demand for, publicly traded common stock
of generally comparable companies.
In connection with the offering, the underwriters may purchase and sell shares
of common stock in the open market. These transactions may include stabilizing
transactions. Stabilizing transactions consist of bids or purchases made for
the purpose of preventing or retarding a decline in the market price of the
common stock while the offering is in progress. These transactions may also
include short sales and
-------------------------------------------------------------------------------
68
<PAGE>
Underwriting
--------------------------------------------------------------------------------
purchases to cover positions created by short sales. Short sales involve the
sale by the underwriters of a greater number of shares than they are required
to purchase in the offering. Short sales may be either "covered short sales" or
"naked short sales." Covered short sales are sales made in an amount not
greater than the underwriters' over-allotment option to purchase additional
shares in the offering. The underwriters may close out any covered short
position by either exercising their over-allotment option or purchasing shares
in the open market. In determining the source of shares to close out the
covered short position, the underwriters will consider, among other things, the
price of shares available for purchase in the open market as compared to the
price at which they may purchase shares through the over-allotment option.
Naked short sales are sales in excess of the over-allotment option. The
underwriters must close out any naked short position by purchasing shares in
the open market. A naked short position is more likely to be created if the
underwriters are concerned that there may be downward pressure on the price of
the shares in the open market after pricing that could adversely affect
investors who purchase in the offering.
The underwriters also may impose a penalty bid. This occurs when a particular
underwriter repays to the underwriters a portion of the underwriting discount
received by it because the representatives have repurchased shares sold by or
for the account of that underwriter in stabilizing or short covering
transactions.
These activities by the underwriters may stabilize, maintain or otherwise
affect the market price of the common stock. As a result, the price of the
common stock may be higher than the price that otherwise might exist in the
open market. If these activities are commenced, they may be discontinued by the
underwriters at any time. These transactions may be effected on the Nasdaq
National Market, in the over-the-counter market or otherwise.
We have agreed to indemnify the several underwriters against some liabilities,
including liabilities under the Securities Act of 1933 and to contribute to
payments that the underwriters may be required to make in respect thereof.
--------------------------------------------------------------------------------
69
<PAGE>
--------------------------------------------------------------------------------
Legal matters
The validity of the shares of common stock offered hereby will be passed upon
for Curon Medical, Inc. by Wilson Sonsini Goodrich & Rosati, Palo Alto,
California. Partners and associates of Wilson Sonsini Goodrich & Rosati, Palo
Alto, California maintain beneficial ownership of 91,200 shares of our common
stock. Dewey Ballantine LLP, New York, New York, is acting as counsel for the
underwriters in connection with various legal matters relating to the shares of
common stock offered by this prospectus.
Experts
The financial statements as of December 31, 1998 and 1999 and for the period
from May 1, 1997 (date of inception) to December 31, 1997, for each of the two
years in the period ended December 31, 1999 and for the cumulative period from
May 1, 1997 (date of inception) to December 31, 1999, included in this
prospectus, have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
Where you can find more information
We have filed with the SEC a registration statement on Form S-1 (including
exhibits, schedules and amendments) under the Securities Act with respect to
the shares of common stock to be sold in this offering. This prospectus does
not contain all the information set forth in the registration statement. For
further information with respect to us and the shares of common stock to be
sold in this offering, reference is made to the registration statement.
Statements contained in this prospectus as to the contents of any contract,
agreement or other document referred to are not necessarily complete. Whenever
a reference is made in this prospectus to any contract or other document of
ours, the reference may not be complete, and you should refer to the exhibits
that are apart of the registration statement for a copy of the contract or
document.
You may read and copy all or any portion of the registration statement or any
other information that Curon Medical, Inc. files at the SEC's public reference
room at 450 Fifth Street, N.W., Washington, D.C. 20549. You can request copies
of these documents, upon payment of a duplicating fee, by writing to the SEC.
Please call the SEC at 1-800-SEC-0330 for further information on the operation
of the public reference rooms. Our SEC filings, including the registration
statement, are also available to you on the SEC's web site
(http://www.sec.gov).
As a result of this offering, we will become subject to the information and
reporting requirements of the Securities Exchange Act, and, in accordance with
those requirements, will file periodic reports, proxy statements and other
information with the SEC.
This prospectus includes statistical data that were obtained from industry
publications. These industry publications generally indicate that the authors
of these publications have obtained information from sources believed to be
reliable, but do not guarantee the accuracy and completeness of their
information. While we believe these industry publications to be reliable, we
have not independently verified their data.
--------------------------------------------------------------------------------
70
<PAGE>
Curon Medical, Inc. (a company in the development stage)
--------------------------------------------------------------------------------
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
--------------------------------------------------------------------------------
<S> <C>
Report of Independent Accountants.......................................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Deficit........................................ F-5
Statements of Cash Flows................................................... F-6
Notes to Financial Statements.............................................. F-7
</TABLE>
--------------------------------------------------------------------------------
F-1
<PAGE>
--------------------------------------------------------------------------------
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Curon Medical, Inc.
(a company in the development stage)
In our opinion, the accompanying balance sheets and the related statements of
operations, of stockholders' deficit and of cash flows present fairly, in all
material respects, the financial position of Curon Medical, Inc. (a company in
the development stage) at December 31, 1998 and December 31, 1999, and the
results of its operations and its cash flows for the period from May 1, 1997
(date of inception) to December 31, 1997 and for each of the two years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. These 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 financial statements in accordance with auditing standards
generally accepted in the United States, 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
May 3, 2000, except for Note 13
for which the date is August 23, 2000
--------------------------------------------------------------------------------
F-2
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
BALANCE SHEETS
<TABLE>
<CAPTION>
Pro forma
Stockholders'
December 31, June 30, Equity at
1998 1999 2000 June 30, 2000
-------------------------------------------------------------------------------
(unaudited)
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash
equivalents............. $4,502,000 $7,988,000 $10,729,000
Marketable securities.... -- 1,510,000 4,070,000
Accounts receivable...... -- -- 112,000
Related party
receivables............. 262,000 -- --
Prepaid expenses and
other current assets.... 6,000 88,000 509,000
Inventories.............. -- 321,000 510,000
---------- ----------- -----------
Total current assets...... 4,770,000 9,907,000 15,930,000
Related party note
receivable............... 250,000 250,000 250,000
Property and equipment,
net...................... 767,000 1,458,000 1,534,000
Intangible assets......... -- -- 811,000
Other assets.............. 55,000 71,000 135,000
---------- ----------- -----------
Total assets.............. $5,842,000 $11,686,000 $18,660,000
========== =========== ===========
Liabilities, Convertible
Preferred Stock and
Warrants and
Stockholders' Equity
(Deficit)
Current liabilities:
Accounts payable......... $183,000 $586,000 $277,000
Accrued liabilities...... 207,000 922,000 1,067,000
Current portion of long-
term debt............... 157,000 223,000 223,000
Convertible notes
payable, net............ -- -- 924,000
---------- ----------- -----------
Total current
liabilities.............. 547,000 1,731,000 2,491,000
Long-term debt, net of
current portion.......... 459,000 227,000 116,000
Other liabilities......... -- 19,000 45,000
---------- ----------- -----------
Total liabilities......... 1,006,000 1,977,000 2,652,000
---------- ----------- -----------
Convertible preferred
stock: $0.001 par value;
Authorized: 10,500,000
shares
Issued and outstanding:
3,992,000 shares at
December 31, 1998,
9,597,000 shares at
December 31, 1999, and
June 30, 2000
(unaudited) and none
pro forma (unaudited)
(Liquidation value:
$22,421,000 at December
31, 1999) .............. 7,593,000 21,688,000 21,688,000 $ --
---------- ----------- ----------- ------------
Preferred stock
warrants................ 120,000 120,000 2,220,000 --
---------- ----------- ----------- ------------
Commitments and
Contingencies (Note 6)
Stockholders' equity
(deficit):
Common Stock: $.001 par
value;
Authorized: 30,000,000
shares
Issued and outstanding:
2,833,000 shares at
December 31, 1998,
2,819,000 shares at
December 31, 1999,
4,064,000 shares at June
30, 2000 (unaudited) and
13,661,000 shares pro
forma (unaudited)....... 3,000 3,000 4,000 14,000
Additional paid-in
capital................. 290,000 8,644,000 21,409,000 45,307,000
Deferred stock
compensation............ (176,000) (3,663,000) (4,150,000) (4,150,000)
Deficit accumulated
during the development
stage................... (2,994,000) (17,083,000) (25,163,000) (25,163,000)
---------- ----------- ----------- ------------
Total stockholders'
equity (deficit)........ (2,877,000) (12,099,000) (7,900,000) $ 16,008,000
---------- ----------- ----------- ============
Total liabilities,
convertible preferred
stock and warrants and
stockholders' equity
(deficit)................ $5,842,000 $11,686,000 $18,660,000
========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
F-3
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Period from Cumulative
May 1, 1997 Period from
(Date of May 1, 1997
Inception) (Date of
to Six Months Ended Inception)
December 31, Years Ended December 31, June 30, to June 30,
1997 1998 1999 1999 2000 2000
<S> <C> <C> <C> <C> <C> <C> <C>
--------- ------------------------- ------------------------ ------------
<CAPTION>
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ -- $ -- $ -- $ -- $ 170,000 $ 170,000
Cost of goods sold...... -- -- -- -- 281,000 281,000
--------- ----------- ------------ ----------- ----------- ------------
Gross profit............ -- -- -- -- (111,000) (111,000)
Operating expenses:
Research and
development......... 28,000 1,581,000 8,961,000 2,343,000 3,091,000 13,661,000
Clinical and
regulatory.......... -- 335,000 2,012,000 790,000 912,000 3,259,000
Sales and marketing.... -- -- 940,000 410,000 1,095,000 2,035,000
General and
administrative...... 13,000 959,000 2,345,000 784,000 2,079,000 5,396,000
--------- ----------- ------------ ----------- ----------- ------------
Operating loss.......... (41,000) (2,875,000) (14,258,000) (4,327,000) (7,288,000) (24,462,000)
Interest income......... -- 8,000 258,000 56,000 260,000 526,000
Interest expense........ -- (86,000) (89,000) (34,000) (1,052,000) (1,227,000)
--------- ----------- ------------ ----------- ----------- ------------
Net loss................ $(41,000) $(2,953,000) $(14,089,000) $(4,305,000) $(8,080,000) $(25,163,000)
========= =========== ============ =========== =========== ============
Net loss per share,
basic and diluted.... $ (0.04) $ (2.01) $ (6.94) $ (2.04) $ (3.27)
========= =========== ============ =========== ===========
Shares used in computing
net loss per share,
basic and diluted.... 1,103,000 1,472,000 2,030,000 2,115,000 2,472,000
========= =========== ============ =========== ===========
Pro forma net loss per
share, basic and
diluted.............. $ (1.79) $ (0.67)
============ ===========
Shares used in computing
pro forma net loss
per share, basic and
diluted.............. 7,890,000 12,069,000
============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
F-4
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
STATEMENTS OF STOCKHOLDERS' DEFICIT
Period from May 1, 1997 (Date of Inception) to June 30, 2000
<TABLE>
<CAPTION>
Deficit
Accumulated
Additional Deferred during the Total
Common Stock Paid-In Stock Development Stockholders'
Shares Amount Capital Compensation Stage Deficit
--------- ------ ----------- ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
May 1, 1997 (date of
inception).............
Net loss................ -- $-- $-- $-- $(41,000) $(41,000)
--------- ------ ----------- ----------- ------------ -----------
Balance at December 31,
1997................... -- -- -- -- (41,000) (41,000)
Issuance of common
stock in February and
March 1998 at $0.002
per share ............ 2,856,000 3,000 2,000 -- -- 5,000
Repurchase of common
stock in June, October
and November 1998 at
$0.002 per share...... (108,000) -- -- -- -- --
Issuance of common
stock in July 1998 in
exchange for services
received valued at
$0.175 per share...... 85,000 -- 15,000 -- -- 15,000
Deferred stock
compensation.......... -- -- 273,000 (273,000) -- --
Amortization of
deferred stock
compensation.......... -- -- -- 97,000 -- 97,000
Net loss............... -- -- -- -- (2,953,000) (2,953,000)
--------- ------ ----------- ----------- ------------ -----------
Balance at December 31,
1998................... 2,833,000 3,000 290,000 (176,000) (2,994,000) (2,877,000)
Common shares forfeited
against unpaid
employee loan in March
1999.................. (14,000) -- -- -- -- --
Deferred stock
compensation.......... -- -- 8,354,000 (8,354,000) -- --
Amortization of
deferred stock
compensation.......... -- -- -- 4,867,000 -- 4,867,000
Net loss............... -- -- -- -- (14,089,000) (14,089,000)
--------- ------ ----------- ----------- ------------ -----------
Balance at December 31,
1999................... 2,819,000 3,000 8,644,000 (3,663,000) (17,083,000) (12,099,000)
Issuance of common
stock in February 2000
at $8.65 per share in
exchange for patent
license agreement..... 57,000 -- 493,000 -- -- 493,000
Issuance of common
stock in January,
March and May upon
exercise of stock
options at an average
exercise price of
$0.24 per share ...... 916,000 1,000 275,000 -- -- 276,000
Issuance of 12,000
stock options in June
in exchange for
services.............. 40,000 -- -- 40,000
Issuance of 29,000
shares in June 2000 at
$11.84 per share in
exchange for patent
license agreement..... 29,000 338,000 -- -- 338,000
Issuance of 17,000
shares in June at
$11.84 per share in
exchange for
consulting services
received.............. 17,000 203,000 -- -- 203,000
Beneficial conversion
feature on notes
payable............... 8,990,000 8,990,000
Deferred stock
compensation.......... -- -- 2,426,000 (2,426,000) -- --
Amortization of
deferred stock
compensation.......... -- -- -- 1,939,000 -- 1,939,000
Net loss............... -- -- -- -- (8,080,000) (8,080,000)
--------- ------ ----------- ----------- ------------ -----------
Balance at June 30, 2000
(unaudited)............ 4,064,000 $4,000 $21,409,000 $(4,150,000) $(25,163,000) $(7,900,000)
========= ====== =========== =========== ============ ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
F-5
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Period from Cumulative
May 1, 1997 Period from
(Date of May 1, 1997
Inception) (Date of
to Six Months Ended Inception) to
December 31, Year Ended December 31, June 30, June 30, 2000
1997 1998 1999 1999 2000
------------ ----------- ------------ ----------- ------------ -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss............... $(41,000) $(2,953,000) $(14,089,000) $(4,307,000) $(8,080,000) $(25,163,000)
Adjustments to
reconcile net loss to
net cash provided by
(used in) operating
activities:
Depreciation and
amortization......... -- 151,000 325,000 123,000 274,000 750,000
Note payable issued in
exchange for services
received............. -- -- -- -- 45,000 45,000
Write-off of related
party receivables.... -- -- 73,000 -- -- 73,000
Amortization of stock-
based compensation... -- 97,000 4,867,000 561,000 1,939,000 6,903,000
Amortization of
discount on notes
payable.............. -- 69,000 22,000 5,000 924,000 1,015,000
Common stock issued in
exchange for services
received............. -- 18,000 -- -- 203,000 221,000
Preferred stock issued
in exchange for
intellectual property
and services
received............. -- 175,000 3,000 -- -- 178,000
Stock options issued
in exchange for
services rendered -- -- -- -- 40,000 40,000
Changes in current
assets and
liabilities:
Accounts receivable
trade................ -- -- -- -- (112,000) (112,000)
Inventories........... -- -- (321,000) (264,000) (189,000) (510,000)
Prepaid expenses and
other current
assets............... -- (6,000) (82,000) (69,000) (421,000) (509,000)
Other assets.......... (4,000) (51,000) (16,000) (23,000) (64,000) (135,000)
Accounts payable...... 96,000 87,000 403,000 591,000 (309,000 277,000
Accrued liabilities... -- 207,000 715,000 1,000 145,000 1,067,000
Other long-term
liabilities........... -- -- 19,000 -- 26,000 45,000
-------- ----------- ------------ ----------- ------------ -------------
Net cash provided by
(used in) operating
activities.......... 51,000 (2,206,000) (8,081,000) (3,382,000) (5,579,000) (15,815,000)
-------- ----------- ------------ ----------- ------------ -------------
Cash flows from
investing activities:
Purchase of property
and equipment........ (51,000) (867,000) (1,016,000) (610,000) (330,000) (2,264,000)
Purchase of marketable
securities........... -- -- (1,510,000) -- (2,560,000) (4,070,000)
-------- ----------- ------------ ----------- ------------ -------------
Net cash used in
investing
activities.......... (51,000) (867,000) (2,526,000) (610,000) (2,890,000) (6,334,000)
-------- ----------- ------------ ----------- ------------ -------------
Cash flows from
financing activities:
Proceeds from issuance
of notes payable..... 1,000 780,000 -- -- -- 781,000
Proceeds from issuance
of convertible notes
payable.............. -- -- 800,000 -- 11,045,000 11,845,000
Principal payments on
notes payable........ -- (114,000) (188,000) (83,000) (111,000) (413,000)
(Payments to) proceeds
from related
parties.............. -- (262,000) 189,000 50,000 -- (73,000)
Related party note
receivable........... -- (250,000) -- -- -- (250,000)
Proceeds from issuance
of convertible
preferred stock, net
of issuance costs.... -- 7,418,000 13,292,000 -- -- 20,710,000
Proceeds from issuance
of common stock...... -- 2,000 -- -- 2,000
Proceeds from exercise
of stock options..... -- -- -- -- 276,000 276,000
-------- ----------- ------------ ----------- ------------ -------------
Net cash provided by
financing
activities.......... 1,000 7,574,000 14,093,000 (33,000) 11,210,000 32,878,000
-------- ----------- ------------ ----------- ------------ -------------
Net increase (decrease)
in cash and cash
equivalents........... 1,000 4,501,000 3,486,000 (4,025) 2,741,000 10,729,000
Cash and cash
equivalents at
beginning of period... -- 1,000 4,502,000 4,502 7,988,000 12,491,000
-------- ----------- ------------ ----------- ------------ -------------
Cash and cash
equivalents at end of
period................ $ 1,000 $4,502,000 $ 7,988,000 $ 477 $10,729,000 $23,220,000
======== =========== ============ =========== ============ =============
Supplemental disclosure
of cash flow
information:
Cash paid for
interest............. $ -- $ 16,000 $ 67,000 $ 30,000 $ 29,000 $ 83,000
Cash paid for taxes... $ -- $ 3,000 $ 1,000 -- $ -- $ 4,000
Supplemental disclosure
of non-cash investing
and financing
information:
Conversion of notes
payable and accrued
interest to preferred
stock................ $ -- $ -- $ 803,000 $ -- $ -- $ 803,000
Deferred stock based
compensation......... $ -- $ 273,000 $ 8,354,000 $ 2,160,000 $ 2,426,000 $ 11,053,000
Issuance of warrants
with debt............ $ -- $ 120,000 $ -- $ -- $ 2,100,000 $ 2,220,000
Issuance of common
stock in exchange for
intangible assets.... $ -- $ -- $ -- $ -- $ 831,000 $ 831,000
Beneficial conversion
feature of
convertible notes.... $ 8,990,000 $ 8,990,000
</TABLE>
The accompanying notes are an integral part of these financial statements.
--------------------------------------------------------------------------------
F-6
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS
NOTE 1--FORMATION AND BUSINESS OF THE COMPANY:
Curon Medical, Inc., formerly Conway Stuart Medical, Inc., (the "Company") was
incorporated in the state of Delaware on May 1, 1997. The Company develops,
manufactures, and markets proprietary products for the treatment of
gastrointestinal disorders. The Company is in the development stage and since
inception has devoted substantially all of its efforts to developing its
products and raising capital.
In the course of its development activities, the Company has sustained
operating losses and expects such losses to continue over the next several
years. The Company intends to finance its operations primarily through its cash
and cash equivalents, marketable securities, future financing and future
revenues. However, there can be no assurance that such efforts will succeed or
that sufficient funds will be made available.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Unaudited interim financial information
The interim financial statements for the six months ended June 30, 1999 and
June 30, 2000 are unaudited and have been prepared on the same basis as the
annual financial statements. In the opinion of management, all adjustments,
consisting of normal recurring adjustments necessary for the fair presentation
of the financial statements have been included. The results of operations of
any interim period are not necessarily indicative of the results of operations
for the full year.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Initial public offering
In April 2000, the Board of Directors authorized management of the Company to
file a registration statement with the Securities and Exchange Commission
permitting the Company to sell shares of its common stock to the public. If the
initial public offering is closed under the terms presently anticipated, all of
the outstanding preferred stock and warrants to purchase preferred stock as of
December 31, 1999, will automatically convert into 9,597,000 shares of common
stock. Unaudited pro forma stockholders' equity, as adjusted for the assumed
conversion of the preferred stock, is set forth on the balance sheet.
Cash and cash equivalents
The Company considers all highly liquid investments purchased with remaining
maturities of three months or less at the date of purchase to be cash
equivalents. The Company's cash and cash equivalents include deposit funds,
money market funds and commercial paper.
Marketable securities
Marketable securities consist primarily of marketable corporate bonds and
commercial paper with a remaining maturity at the date of purchase of greater
than three months. These investments are classified as available-for-sale
securities and are stated at market value (which approximates cost), with any
temporary differences between an investment's amortized cost and its market
value recorded as a
--------------------------------------------------------------------------------
F-7
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
separate component of stockholders' equity (deficit) until such gains or losses
are realized. Gains or losses on the sales of securities are determined on a
specific identification basis. At December 31, 1999, marketable securities were
invested in corporate bonds and commercial paper which mature in 2000.
Concentration of credit risk and other risks and uncertainties
The Company's cash and cash equivalents are maintained at one financial
institution. Deposits in this institution may exceed the amount of insurance
provided on such deposits.
The majority of products developed by the Company may require clearance from
the Food and Drug Administration ("FDA") or other international regulatory
agencies prior to commercial sales. There can be no assurance the Company's
products will receive the necessary clearance. If the Company was denied
clearance or clearance was delayed, it may have a material adverse impact on
the Company.
The Company's products and services are concentrated in rapidly changing,
highly competitive markets which are characterized by rapid technological
advances, changes in customer requirements and evolving regulatory requirements
and industry standards. Any failure by the Company to anticipate or to respond
adequately to technological developments in its industry, changes in customer
requirements or changes in regulatory requirements or industry standards, or
any significant delays in the development or introduction of products or
services, could have a material adverse effect on the Company's business and
operating results.
Inventories
Inventories are stated at the lower of cost (determined on a first-in, first-
out basis) or market.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is computed using the straight-line method over the
estimated useful lives of the assets. Fixed assets are depreciated over a life
of 3-5 years. Leasehold improvements are amortized using the straight-line
method over the estimated useful life of the improvement, or the lease term if
shorter. Upon retirement or sale, the cost and related accumulated depreciation
are removed from the balance sheet and the resulting gain or loss is reflected
in operations. Maintenance and repairs are charged to operations as incurred.
Intangible assets
Intangible assets consist of a technology license which is being amortized on a
straight-line basis over its estimated useful life of five years.
Impairment of long-lived assets
Long-lived assets and intangible assets are reviewed for impairment when events
or changes in circumstances indicate the carrying amount of an asset may not be
recoverable. Recoverability is measured by comparison of the asset's carrying
amount to future net undiscounted cash flows the assets are expected to
generate. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the projected discounted future net cash flows arising from the asset.
Revenue Recognition
Revenue from product sales is recognized on product shipment against a valid
purchase order provided no significant obligations remain and collection of the
receivables is deemed probable for both sales of
--------------------------------------------------------------------------------
F-8
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
control modules and catheters. Revenues for extended warranty contracts are
recognized over the extended warranty period. To date, post-sale customer
support and training has not been significant.
The Company may sell products under a purchase commitment, generally delivered
over a period of six months. Revenue for the control module is deferred and is
recognized ratably over the shipment of catheters under the contract.
Research and development
Research and development costs are expensed as incurred.
Advertising costs
Advertising costs are expensed as incurred. Advertising costs were not material
in 1997, 1998 or 1999.
Income taxes
The Company accounts for income taxes under 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.
Accounting for stock-based compensation
The Company accounts for stock-based employee compensation arrangements in
accordance with provisions of Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB No. 25") and complies with the
disclosure provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" ("SFAS No. 123"). Under APB No. 25,
unearned stock compensation is based on the difference, if any, on the date of
grant, between the fair value of the Company's common stock and the exercise
price.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other
Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." The equity instruments are valued using the Black-Scholes model.
All deferred stock compensation is amortized and expensed in accordance with
FASB Interpretation No. 28, an accelerated vesting model.
Net loss per share
Basic net loss per share is calculated based on the weighted-average number of
common shares outstanding during the period excluding those shares that are
subject to repurchase. Diluted net loss per share would give effect to the
dilutive effect of common stock equivalents consisting of preferred stock,
stock options, warrants, and common stock subject to repurchase (calculated
using the treasury stock method). Potentially dilutive securities have been
excluded from the diluted net loss per share computations as they have an
antidilutive effect due to the Company's net loss.
Pro forma net loss per share (unaudited)
Pro forma net loss per share for the year ended December 31, 1999 and the six
months ended June 30, 2000 is computed using the weighted average number of
common shares outstanding, including the
--------------------------------------------------------------------------------
F-9
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
pro forma effects of the automatic conversion of the Company's preferred stock
into shares of common stock effective upon the closing of the offering, as if
such conversion occurred on January 1, 1999 and January 1, 2000 or at the date
of the original issuance, if later. The resulting pro forma adjustment includes
an increase in the weighted average shares used to compute basic and diluted
net loss per share of 5,860,000 shares and 9,597,000 shares for the year ended
December 31, 1999 and for the six months ended June 30, 2000, respectively.
Comprehensive income
The Company has adopted the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "Comprehensive Income." SFAS 130 establishes
standards for reporting and display of comprehensive income and its components
for general purpose financial statements. For all periods presented, there were
no differences between net loss and comprehensive loss.
Fair value of financial instruments
The carrying value of the Company's financial instruments, including cash and
cash equivalents, related party receivables, and accounts payable approximate
fair value. Based on borrowing rates currently available to the Company for
loans with similar terms, the carrying value of obligations approximates fair
value.
Segments
The Company operates in one segment, using one measurement of profitability to
manage its business. All long-lived assets are maintained in the United States.
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") which establishes accounting and reporting standards for derivative
instruments and 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. SFAS No. 133 as amended
by SFAS No. 137 "Accounting for Derivative Instruments and Hedging Activities--
Deferral of the Effective Date of FASB Statement No. 133, an amendment of FASB
Statement No. 133" is effective for fiscal years beginning after June 15, 2000.
The Company is evaluating the impact, if any, that SFAS No. 133 may have on its
financial statements. The Company, to date, has not engaged in derivative and
hedging activities.
In December 1999, the Securities and Exchange commission ("SEC") issued Staff
Accounting Bulletin ("SAB") 101, Revenue Recognition, which provides guidance
on the recognition, presentation and disclosure on revenue in financial
statements filed with the SEC. SAB 101 outlines the basic criteria that must be
met to recognize revenue and provides guidance for disclosure related to
revenue recognition policies. The Company believes that its current revenue
recognition policy is in compliance with SAB 101.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions
Involving Stock Compensation an Interpretation of APB 25," which clarifies (a)
the definition of an employee for purposes of applying opinion 25 (b) the
criteria for determining whether a plan qualifies as a non-compensatory plan
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. This interpretation is
effective July 1, 2000, with certain provisions effective earlier. The Company
does not expect FIN 44 to have a significant impact on its financial
statements.
--------------------------------------------------------------------------------
F-10
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
NOTE 3--INVENTORIES:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1999
-------------------------------------------------------------------------------
<S> <C> <C>
Raw materials...................................... $ -- $ 209,000
Finished goods..................................... -- 112,000
--------- ----------
$ -- $ 321,000
========= ==========
NOTE 4--PROPERTY AND EQUIPMENT:
<CAPTION>
December 31, December 31,
1998 1999
-------------------------------------------------------------------------------
<S> <C> <C>
Computer and office equipment...................... $ 178,000 $ 336,000
Equipment.......................................... 614,000 1,072,000
Furniture and fixtures............................. 7,000 85,000
Leasehold improvements............................. 83,000 283,000
Software........................................... 36,000 158,000
--------- ----------
918,000 1,934,000
Less: Accumulated depreciation and amortization.... (151,000) (476,000)
--------- ----------
$ 767,000 $1,458,000
========= ==========
</TABLE>
Depreciation and amortization expense on property and equipment, for the years
ended December 31, 1998 and 1999 was $151,000 and $325,000, respectively.
NOTE 5--LONG-TERM DEBT:
Long-term borrowings
The Company entered into an equipment line of credit in 1998. On February 18,
1999, the Company converted its equipment line of credit into a term debt
agreement which is collateralized by the equipment purchased under the original
line of credit and under substantially the same terms as the original
agreement. No gain or loss resulted on this conversion. At December 31, 1999,
the Company had $430,000 outstanding on this debt. Monthly payments began on
March 18, 1999 and will continue through February 2002. The term debt bears
interest at a rate of prime plus 2% per annum (10.5% at December 31, 1999).
Under the agreement, the Company is required to comply with certain financial
covenants.
The Company has a term loan with an outstanding balance at December 31, 1999 of
$49,000. The note is collateralized by the Company's assets. Monthly payments
of principal and interest will continue through December 18, 2001. Interest on
this note is set at the prime rate plus 2% per annum (10.5% at December 31,
1999).
On July 29, 1999, the Company issued 6% convertible promissory notes totaling
$800,000 in exchange for cash. The notes were due on August 31, 1999. On August
31, 1999, the notes and accrued interest of $3,000 were converted into 535,698
shares of Series C Preferred Stock based on a conversion price of $1.50 per
preferred share.
--------------------------------------------------------------------------------
F-11
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
Principal payments on notes payable are as follows:
<TABLE>
<CAPTION>
Year Ending December 31,
--------------------------------------------------------------------------------
<S> <C>
2000................................................................. $ 223,000
2001................................................................. 223,000
2002................................................................. 33,000
2003 and thereafter.................................................. --
---------
479,000
Less:
Unamortized discount related to stock warrants....................... (29,000)
Current portion...................................................... (223,000)
---------
$ 227,000
=========
</TABLE>
NOTE 6--COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases office space under noncancelable operating leases expiring
in September 2003. Rent expense for the period May 1, 1997 through December 31,
1997, the years ended December 31, 1998, 1999 and for the cumulative period
from May 1, 1997 (date of inception) to December 31, 1999 was $0, $144,000,
$406,000 and $550,000, respectively.
At December 31, 1999, future minimum facility lease payments, are as follows:
<TABLE>
<S> <C>
2000................................................................. $ 508,000
2001................................................................. 525,000
2002................................................................. 543,000
2003................................................................. 414,000
----------
$1,990,000
==========
</TABLE>
In October 1999, the Company entered into a mutual agreement to terminate an
employment relationship with the former president and CEO. At the time of the
agreement, the former president and CEO of the Company had approximately
706,000 common shares that were subject to repurchase by the Company. The
agreement modified the repurchase rights to reduce the lapsing period. The
706,000 shares subject to repurchase were valued at $4.39 per share, with no
future services expected to be performed. The Company also agreed to pay
$310,000 over a period of 18 months. As a result, the Company has recorded a
total of $3.4 million in charges in 1999 related to this agreement.
Contingencies
The Company is involved in routine legal and administrative proceedings that
arise from the normal conduct of business. Management believes that the
ultimate disposition of these matters will not have a material adverse effect
on the financial results or condition of the Company.
Development and technology license agreements
In December 1998, the Company entered into a technology license agreement with
Somnus Medical Technologies, Inc. granting the Company a license to
manufacture, use or sell products based on
--------------------------------------------------------------------------------
F-12
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
licensed technology in exchange for 57,000 shares of the Company's Series A
Preferred Stock valued at $175,000 and a one-time license fee. At the time of
the licensing agreement, the Company believed that any knowledge gained would
be useful in developing its new product, however, there were no alternative
future uses (in other research and development projects or otherwise) as its
product was still undergoing significant testing and development. Therefore,
all amounts paid, including the value of the preferred shares, were included as
a component of research and development expense in 1998. Additionally, the
Company is obligated to make royalty payments tied to the Company's average
selling price on licensed products. At the time of the agreement, the Company
paid to Somnus document fees upon receipt of the design and manufacturing
documents.
The technology agreement allows the Company to use the technology in a licensed
field, as defined in the technology agreement, and gives the Company an
irrevocable license to manufacture, have manufactured, use, offer to sell, sell
and import Radio Frequency generators based on the licensed technology in the
licensed field. The term of the agreement will be until the earlier of (i) the
expiration of the term of the last patent within the licensed technology owned
by Somnus or (ii) fifteen years if no patents within the licensed technology
are issued.
NOTE 7--CONVERTIBLE PREFERRED STOCK:
At December 31, 1999, the amounts, terms and liquidation values of Series A,
Series B and Series C convertible preferred stock are as follows:
<TABLE>
<CAPTION>
Shares of
Common
Stock
Shares Amount Net Reserved Aggregate
Shares Issued and Issue of Issuance for Liquidation
Designated Outstanding Date of Issuance Price Costs Conversion Preference
----------------------------------------------------------------------------------------------------
<C> <C> <C> <S> <C> <C> <C> <C>
March, May,
Series A.. 1,197,000 1,066,000 June and December 1998 $1.75 $ 1,850,000 1,197,000 $ 1,871,000
Series B.. 2,964,000 2,926,000 December 1998 $1.98 5,743,000 2,964,000 5,800,000
Series C.. 5,985,000 5,605,000 August 1999 $2.63 14,095,000 5,985,000 14,750,000
---------- --------- ----------- ---------- -----------
10,146,000 9,597,000 $21,688,000 10,146,000 $22,421,000
========== ========= =========== ========== ===========
</TABLE>
Voting
Each share of Series A, Series B and Series C convertible preferred stock has
voting rights equal to an equivalent number of shares of common stock into
which it is convertible.
As long as any shares of Series C convertible preferred stock remains
outstanding, the Company must obtain the approval from the holders of a
majority of the outstanding Series C convertible preferred stock in order to
make any change to the liquidation preference of the Series C convertible
preferred stock.
As long as any shares of Series A, Series B and Series C convertible preferred
stock remain outstanding, the Company must obtain approval from the holders of
at least two-thirds of the outstanding Series A, Series B and Series C
convertible preferred stock voting together as a single class in order to alter
the
--------------------------------------------------------------------------------
F-13
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
certificate of incorporation as related to convertible preferred stock, change
the authorized number of shares of convertible preferred stock or common stock,
repurchase any shares of common stock other than shares from employees or
consultants to the Company or pursuant to the Company's right of first refusal,
change the authorized number of Directors, create a new class of stock or
effect a merger or sale of all or substantially all of the assets of the
Company.
Dividends
Holders of Series A, Series B and Series C convertible preferred stock are
entitled to receive noncumulative dividends at the per annum rate of $0.12,
$0.14 and $0.184 per share, respectively, when and if declared by the Board of
Directors. The holders of Series A, Series B and Series C convertible preferred
stock will also be entitled to participate in dividends on common stock, when
and if declared by the Board of Directors, based on the number of shares of
common stock held on an as-if converted basis. No dividends on convertible
preferred stock or common stock have been declared by the Board from inception
through December 31, 1999.
Liquidation
In the event of any liquidation, sale, dissolution or winding up of the
Company, the holders of Series C preferred stock shall be entitled to receive
an amount of $2.63 per share plus any declared but unpaid dividends prior to
and in preference to any distribution to the holders of Series A and Series B
convertible preferred stock and common stock. After payments have been made to
the holders of Series C convertible preferred stock, the holders of Series A
and Series B convertible preferred stock are entitled to receive an amount of
$1.75 and $1.98 per share, respectively, plus any declared but unpaid dividends
prior to and in preference to any distribution to the holders of common stock.
After payment has been made to the holders of Series A, Series B and Series C
convertible preferred stock, each share of Series A, Series B and Series C
convertible preferred stock and common stock shall receive pro rata payment on
an as-if-converted to common stock basis until the holders of Series A, Series
B and Series C convertible preferred stock have received an aggregate of $5.26,
$5.95 and $7.89 per share, respectively, after which all remaining assets or
surplus funds of the Company shall be distributed to the holders of common
stock.
Should the Company's legally available assets distributed among the holders of
the Series C convertible preferred stock, be insufficient to satisfy the
liquidation preferences, the entire assets and funds of the Company legally
available for distribution shall be distributed among the holders of Series C
convertible preferred stock in proportion to the respective amounts which would
be payable on the shares held by them if the preferential amounts were paid in
full.
Should the Company's legally available assets, distributed among the holders of
the Series A and Series B Convertible Preferred Stock, be insufficient to
satisfy the liquidation preferences, the entire assets and funds of the Company
legally available for distribution shall be distributed among the holders of
Series A and Series B convertible preferred stock in proportion to the
respective amounts which would be payable on the shares held by them if the
preferential amounts were paid in full.
Due to the liquidation preferences described above, the Company has classified
its preferred stock and preferred stock warrants outside of stockholders'
equity in the balance sheet.
Conversion
Each share of Series A, Series B and Series C convertible preferred stock is
convertible, at the option of the holder, according to a conversion ratio,
subject to adjustment for dilution. Each share of Series A, Series B and Series
C convertible preferred stock automatically converts into the number of shares
of common stock into which such shares are convertible at the then effective
conversion ratio upon: (1) the closing of an initial public offering of common
stock under the Securities Act of 1933 at a per share price of at least $8.77
per share with gross proceeds of at least $15,000,000, or (2) the closing of
--------------------------------------------------------------------------------
F-14
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
a firm commitment public offering of common stock at a price per share of less
than $8.77 but not less than $7.02 and an aggregate offering price of not less
than $15,000,000 provided that the holders of a majority of the holders of
outstanding preferred stock voting as a single class, or (3) upon the Company's
receipt of the written consent of the holders of a majority of the outstanding
shares of the Series B and C convertible preferred stock, voting separately.
Warrants for Convertible Preferred Stock
In February and August 1998, the Company issued warrants to purchase 4,000 and
34,000 shares of Series A convertible preferred stock for $1.75 per share in
connection with a line of credit arrangement (Note 5). Should the Company
complete an initial public offering, the warrants would provide for the
purchase of common stock based on the conversion ratio of the common to
preferred on the closing date. Such warrants are outstanding at December 31,
1999 and expire the later of 2008 or five years after the closing of an initial
public offering of the Company's common stock. The value of these warrants,
determined by using a Black-Scholes model, was not material.
In connection with a line of credit agreement (Note 5), the Company issued a
warrant to purchase 86,000 shares of series A preferred stock for $0.88 per
share. Should the Company complete an initial public offering, the warrants
would provide for the purchase of common stock based on the conversion ratio of
the common to preferred on the closing date. The warrant expires the later of
October 2008 or five years after the closing of an initial public offering of
the Company's common stock. The aggregate value of these warrants of $120,000,
determined using a Black-Scholes valuation model, has been recorded as a
discount to notes payable and is being accreted as interest expense over the
life of the line.
NOTE 8--COMMON STOCK:
The Company's Certificate of Incorporation, as amended, authorizes the Company
to issue 30,000,000 shares of $0.001 par value common stock. Certain of the
shares issued are subject to a right of repurchase by the Company subject to
vesting, which is generally over a three or four year period from the issuance
date until vesting is complete. At December 31, 1998 and 1999, there were
1,619,000 and 1,353,000 shares subject to repurchase, respectively.
Warrants for Common Stock
During January 1998, the Company issued a warrant to purchase 29,000 shares of
common stock, for $0.88 per share in connection with a line of credit. The
warrant was outstanding at December 31, 1999 and expires the later of January
2008, or five years after the closing of an initial public offering of the
Company's common stock. The value of the warrant, determined using a Black-
Scholes valuation model, was not material.
NOTE 9--STOCK OPTION PLANS AND OTHER EMPLOYEE BENEFITS:
During 1997, the Company adopted the 1997 Stock Plan (the "Plan"). The Plan
provides for the granting of stock options to employees and consultants of the
Company. Options granted under the Plan may be either incentive stock options
or nonstatutory stock options. Incentive stock options ("ISO") may be granted
only to Company employees (including officers and directors who are also
employees). Nonstatutory stock options ("NSO") may be granted to Company
employees, officers, directors, and consultants. The Company has reserved
2,679,000 shares of Common Stock for issuance under the Plan. The first options
were issued in 1998.
--------------------------------------------------------------------------------
F-15
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
Options under the Plan may be granted for periods of up to ten years and at
prices no less than 85% of the estimated fair value of the shares on the date
of grant as determined by the Board of Directors, provided, however, that (i)
the exercise price of an ISO and NSO shall not be less than 100% and 85% of the
estimated fair value of the shares on the date of grant, respectively, and (ii)
the exercise price of an ISO and NSO granted to a 10% shareholder shall not be
less than 110% of the estimated fair value of the shares on the date of grant,
respectively. Options generally vest 25% one year from the vest start date and
ratably over the next 36 months and expire 10 years from the date of grant.
Deferred stock compensation
During the years ended December 31, 1998 and 1999 and the six months ended June
30, 2000, the Company issued stock options under the Plan at exercise prices,
deemed by the Board of Directors at the date of grant to be equal to the fair
value of the common stock. In anticipation of the Company's initial public
offering, the Company has subsequently determined that, for financial statement
purposes, the estimated value of its common stock was in excess of the exercise
prices. Accordingly, the Company has recorded deferred stock compensation for
stock options issued to both employees and non-employees.
For stock options granted to employees (390,000 and 1,472,000 in 1998 and 1999,
respectively, and 467,000 in the six months ended June 30, 2000), the
difference between the exercise price of the stock options and the fair value
of the Company's stock at the date of grant is recorded as deferred
compensation on the date of grant. For stock options granted to non-employees,
generally for future services (148,000 and 115,000 in 1998 and 1999,
respectively, and 36,000 in the six months ended June 30, 2000), the fair value
of the options, estimated using the Black-Scholes valuation model, is initially
recorded as deferred stock compensation on the date of grant. As the non-
employee fulfils the terms of the option grants, all relating to continued
service to the Company, the Company revalues the remaining unvested options,
with the change in fair value from period to period represented as additional
deferred compensation.
All deferred compensation charges are amortized over the service period,
generally four years, using an accelerated model (FIN 28). During 1998 and
1999, and the six months ended June 30, 2000, the Company recorded deferred
stock compensation related to these options of $273,000, $8,354,000 (including
$3.1 million related to the modification of certain stock repurchase rights
(Note 6)) and $2,426,000 respectively, of which $97,000, $4,867,000 and
$1,939,000 has been amortized to expense during the years then ended,
respectively. Amortization of deferred stock compensation is as follows:
<TABLE>
<CAPTION>
Period from
May 1, 1997 Cumulative
(date of period from
inception) May 1, 1997
to Years ended Six months (date of
December 31, December 31, ended June 30, inception) to
1997 1998 1999 1999 2000 June 30, 2000
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Amortization of stock-
based compensation:
Cost of product sold.. -- -- -- -- $ 21,000 $ 21,000
Research and
development........ -- $71,000 $4,132,000 $358,000 867,000 5,070,000
Clinical and
regulatory......... -- 7,000 96,000 24,000 92,000 195,000
Sales and marketing... -- -- 85,000 41,000 170,000 255,000
General and
administrative..... -- 19,000 554,000 138,000 789,000 1,362,000
------- ------- ---------- -------- ---------- ----------
$ -- $97,000 $4,867,000 $561,000 $1,939,000 $6,903,000
======= ======= ========== ======== ========== ==========
</TABLE>
--------------------------------------------------------------------------------
F-16
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
Included in the 1999 research and development stock-based compensation is $3.1
million related to the modification of repurchase rights for 706,000 shares of
common stock (Note 6). During 1999, the Company granted to certain employees
and non-employees, options which were immediately exercisable into common
stock, subject to repurchase by the Company based on the same remaining vesting
schedule as the related option. Shares are subject to repurchase at the option
exercise price.
<TABLE>
<CAPTION>
1998 1999
-------------------------------------------------------------------------------
Weighted Weighted
Shares average Shares average
under exercise under exercise
options price options price
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Beginning balance outstanding............. -- $ -- 538,000 $0.18
Granted.................................. 538,000 $0.18 1,587,000 $0.23
Exercised................................ -- $ -- -- $ --
Forfeited................................ -- $ -- (143,000) $0.19
------- ----- --------- -----
Ending balance outstanding................ 538,000 $0.18 1,982,000 $0.21
======= ===== ========= =====
Exercisable at end of year................ 39,000 $0.18 1,074,000 $0.23
======= ===== ========= =====
</TABLE>
The weighted average grant-date fair value of stock options granted in 1998 and
1999 are $0.61 per share and $2.75 per share, respectively.
The options outstanding and currently exercisable by exercise price at December
31, 1999 are as follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
---------------------------------------------------------- --------------------------
Weighted Average
Exercise Number Remaining Contractual Number
Price Outstanding Life (Years) Exercise Price Exercisable Exercise Price
-------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.18 481,000 8.56 $0.18 205,000 $0.18
0.19 840,000 9.28 0.19 413,000 0.19
0.26 648,000 9.82 0.26 456,000 0.26
0.61 13,000 9.92 0.61 -- 0.61
--------- ---------
1,982,000 9.28 $0.21 1,074,000 $0.23
========= =========
</TABLE>
Fair value disclosures
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model using the following weighted average
assumptions:
<TABLE>
<CAPTION>
1998 1999
--------------------------------------------------------------------------------
<S> <C> <C>
Risk-free interest rate......................................... 5.3% 5.6%
Expected life................................................... 4 years 4 years
Expected volatility............................................. 75% 75%
</TABLE>
As discussed in Note 2, the Company accounts for its stock-based compensation
using the method prescribed by APB No. 25. Had the Company determined its
stock-based compensation cost based on
--------------------------------------------------------------------------------
F-17
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
the fair value at the grant dates for the awards under a method prescribed by
SFAS No. 123, the Company's net loss would have been increased to the FAS 123
adjusted amounts indicated below:
<TABLE>
<CAPTION>
Year Ended December 31,
1997 1998 1999
-------------------------------------------------------------------------------
<S> <C> <C> <C>
Net loss.................................. $(41,000) $(2,953,000) $(14,089,000)
-------- ----------- ------------
Net loss--FAS 123 adjusted................ $(41,000) $(2,956,000) $(14,108,000)
-------- ----------- ------------
Net loss per share--as reported
Basic and diluted......................... $ (0.04) $ (2.01) $ (6.94)
-------- ----------- ------------
Net loss per share--FAS 123 adjusted
Basic and diluted......................... $ (0.04) $ (2.01) $ (6.95)
-------- ----------- ------------
</TABLE>
401(k) Savings Plan
In October, 1999, the Company began a 401(k) savings plan (the "401(k) Plan").
The 401(k) Plan is a defined contribution plan intended to qualify under
Section 401(a) and 401(k) of the Internal Revenue Code. All full-time employees
of the Company are eligible to participate in the 401(k) Plan pursuant to the
terms of the Plan. Contributions by the Company are discretionary and no
contributions have been made by the Company for the year ended December 31,
1999 and for the six months ended June 30, 2000.
NOTE 10--NET LOSS PER SHARE:
Net loss per share is calculated as follows:
<TABLE>
<CAPTION>
Period Ended
December 31, Year Ended December 31,
1997 1998 1999
------------------------------------------------------------------------------
<S> <C> <C> <C>
Basic and diluted:
Net loss.............................. $(41,000) $(2,953,000) $(14,089000)
--------- ----------- -----------
Weighted average shares used in basic
and diluted net loss per share........ 1,103,000 1,472,000 2,030,000
--------- ----------- -----------
Net loss per share..................... $ (0.04) $(2.01) $(6.94)
--------- ----------- -----------
</TABLE>
The Company has issued shares to employees that are subject to repurchase
should an employee terminate employment with the Company. The shares vest
monthly and the vesting periods range from 36 months to 48 months. Shares
subject to repurchase are excluded from the average shares used in the
calculation of basic and diluted net loss per share.
--------------------------------------------------------------------------------
F-18
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
Equity instruments that could dilute basic earnings per share in the future
that were not included in the computation of diluted earnings per share as
their effect is antidilutive are as follows:
<TABLE>
<CAPTION>
1997 1998 1999
------------------------------------------------------------------------------
<S> <C> <C> <C>
Unvested common shares (shares subject to
repurchase)........................................ -- 923,000 771,000
Shares issuable upon exercise of stock options...... -- 538,000 1,982,000
Conversion of convertible preferred stock........... -- 3,992,000 9,597,000
Shares issuable upon exercise of warrants........... -- 153,000 153,000
--- --------- ----------
Total............................................... -- 5,606,000 12,503,000
--- ========= ==========
</TABLE>
NOTE 11--INCOME TAXES:
At December 31, 1999, the Company has approximately $7,360,000 in federal and
state net operating loss carryforwards to reduce future taxable income. These
carryforwards will expire by the year 2019 for federal and 2006 for state, if
not utilized.
The Tax Reform Act of 1986 limits the use of 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 are as follows:
<TABLE>
<CAPTION>
December 31, December 31,
1998 1999
--------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................... $1,106,000 $2,932,000
Research and development tax credit................ 88,000 280,000
Depreciation and amortization...................... 81,000 162,000
Capitalized start-up costs......................... -- 1,542,000
Other.............................................. 9,000 180,000
---------- ----------
1,284,000 5,096,000
Less: Valuation allowance.......................... (1,284,000) (5,096,000)
---------- ----------
$ -- $ --
========== ==========
</TABLE>
Due to the uncertainty surrounding the realization of the favorable tax
attributes in future tax returns, the Company has placed a valuation allowance
against its deferred tax assets. The change in the valuation allowance was
$1,284,000 and $3,812,000 for the years ended December 31, 1998 and 1999,
respectively.
NOTE 12--RELATED PARTY TRANSACTIONS:
During the period from May 1, 1997 (date of inception) to December 9, 1998, the
Company paid for various operating expenses for two privately held companies in
which the founder of the Company is a shareholder. Amounts due to the Company
at December 31, 1998 and 1999, net of allowance for doubtful accounts are
reported as related party receivables and equal $262,000 and $0, respectively.
--------------------------------------------------------------------------------
F-19
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
During December 1998, the Company entered into a promissory note agreement with
the Company's founder, whereby the founder borrowed $250,000 from the Company
to be due upon the earlier of December 10, 2000 or the date of any breach by
the founder of either proprietary information and technology agreements or his
nonsolicitation agreement with the Company. Interest accrues at a rate of 6%
per year and is payable no later than the maturity date.
NOTE 13--SUBSEQUENT EVENTS
Technology license agreement
In February and April, 2000, the Company entered into two separate licensing
agreements for the use of proprietary radiofrequency technologies used in
certain of the Company's products.
The Company issued 86,000 shares of its common stock, valued at $831,000 on the
date of the agreements, in exchange for the right to use the technologies. As
part of the agreements, the Company is also required to pay a royalty on all
revenues collected when the related licensed technology is part of the sold
item. The cost of the technologies is included in intangible assets and is to
be amortized over its remaining estimated useful life of five years using the
straight-line method.
Convertible Note and Warrant Agreement
In May 2000, the Company entered into a Convertible Note (Notes) and Warrant
Purchase Agreement (Warrants) with existing preferred shareholders. The Company
received $11.045 million in cash and services valued at $45,000 in exchange for
Notes bearing interest at 8% per annum and warrants to purchase 569,000 Series
C convertible preferred shares (or an equal number of shares of common stock if
converted after a qualifying public offering) for a purchase price of $4.39 per
share. Notes are convertible into approximately 2,107,000 shares of common
stock (if not earlier repaid) and mature in May 2005. The difference between
the conversion price and the fair value of the common stock on the transaction
date resulted in a beneficial conversion feature in the amount of $13.9
million. The warrant had a fair value of $5.8 million, estimated using the
Black-Scholes valuation model. The fair values of both the beneficial
conversion feature and the warrant were allocated to the outstanding debt based
on the relative fair values of the debt and warrants and reflected as a
discount on the Notes. Both the beneficial conversion feature (recorded at $9.0
million) and the warrant (recorded at $2.1 million) are being accreted to
interest expense over a one year period which is the debt instrument's earliest
conversion date.
Notes
The principal and interest on the Notes is due and payable on May 19, 2005
unless previously converted. The Notes may be prepaid anytime without penalty
following the closing of an initial public offering of the Company's common
stock.
The outstanding principal balance of and any accrued but unpaid interest on the
Notes shall be automatically converted into series D preferred stock priced at
$5.26 per share upon an equity financing of the Company involving the receipt
of at least $10,000,000, at least 50% of which is received from venture capital
or other financial investors at a price of at least $5.26 per share.
If not automatically converted, upon the demand of the holders of 70% of
amounts underlying the Notes, the principal and accrued interest of all Notes
shall be converted into convertible preferred Series D convertible preferred
shares at a price of $5.26 per share. This demand conversion right may
--------------------------------------------------------------------------------
F-20
<PAGE>
CURON MEDICAL, INC. (a company in the development stage)
--------------------------------------------------------------------------------
NOTES TO FINANCIAL STATEMENTS (continued)
only be exercised after the one year anniversary of the issuance of the Notes.
The series D convertible preferred stock will have substantially the same
rights and privileges as the series C convertible preferred stock.
In the event of a change in control as defined in the agreement, all
outstanding and unpaid accrued interest due on this Note shall be due and
payable upon the closing of a change in control transaction.
Warrants
The warrants are exercisable immediately and through May 19, 2007 or five years
following the conversion or repayment of the Notes. The value of the warrants
was determined using the Black-Scholes valuation model and allocated based on
its fair value relative to the fair value of the debt, and has been included in
the $11.1 million discount on the Notes.
Stock split
On July 26, 2000, the Company's Board of Directors approved a 0.57 for 1
reverse stock split. Stockholders' approval of the reverse stock split was
obtained on August 23, 2000. All common and preferred share and per share
amounts for all periods presented in the accompanying financial statements have
been restated to reflect the effect of this reverse stock split.
--------------------------------------------------------------------------------
F-21
<PAGE>
[Image of face]
STRETTA IS CHANGING THE FACE OF GERD
WHILE OTHERS ARE TREATING THE SYMPTOMS, STRETTA IS TREATING THE DISEASE
The Stretta System delivers radiofrequency energy to the lower esophageal
sphincter in a procedure designed to treat gastroesophageal reflux disease, or
GERD. In our clinical study most patients returned to normal activity the day
following treatment and eliminated or reduced anti-acid medication shortly
thereafter.
[Stretta Logo]
<PAGE>
[LOGO OF CURON MEDICAL]
