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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended Commission File Number
December 29, 2001 0-27422
ARTHROCARE CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3180312
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
680 Vaqueros Avenue, Sunnyvale, California 94085
(Address of principal executive offices and zip code)
(408) 736-0224
(Registrant's telephone number, including area code)
Securities registered pursuant
to 12(b) of the Act: None
Securities registered pursuant Common Stock, $0.001 Par Value;
to Section 12(g) of the Act: Preferred Share Purchase Rights
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
As of March 15, 2002, the aggregate market value of the voting stock held by
non-affiliates of the Registrant was $175,781,675 (based upon the closing sales
price of such stock as reported by The Nasdaq Stock Market on such date). Shares
of Common Stock held by each officer, director, and holder of 5% or more of the
outstanding Common Stock on that date have been excluded in that such persons
may be deemed to be affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.
As of March 15, 2002, the number of outstanding shares of the Registrant's
Common Stock was 21,836,267.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information required by Items 10, 11, 12 and 13 of Part III of Form 10-K
is incorporated by reference from the Registrant's proxy statement for the 2002
Annual Stockholders Meeting (the Proxy Statement) which will be filed with the
Securities and Exchange Commission within 120 days after the close of the
Registrant's fiscal year ended December 29, 2001.
PART I
ITEM 1. BUSINESS
This Report on Form 10-K contains certain forward-looking statements
regarding future events with respect to ArthroCare Corporation ("ArthroCare,"
"we," "us," and "our" refer to ArthroCare Corporation, a Delaware corporation
unless the context otherwise requires). Actual events or results could differ
materially due to a number of factors, including those described herein and in
the documents incorporated herein by reference, and those factors described
under "Additional Factors that Might Affect Future Results".
OVERVIEW
We are a medical device company that develops, manufactures and markets
products based on our patented Coblation(R) technology. Our products allow
surgeons to operate with a high level of precision and accuracy, limiting damage
to surrounding tissue thereby potentially reducing pain and speeding recovery
for the patient. Our products operate at lower temperatures than traditional
electrosurgical or laser surgery tools and enable surgeons to ablate, shrink,
sculpt, cut, aspirate and suction soft tissue, and to seal small bleeding
vessels. Ablation is the disintegration or removal of tissue. Our soft-tissue
surgery systems consist of a controller unit and an assortment of sterile,
single-use disposable devices that are specialized for specific types of
surgery. We believe our Coblation technology can replace the multiple surgical
tools traditionally used in soft-tissue surgery procedures with one
multi-purpose surgical system.
Coblation technology is applicable across many soft-tissue surgical
markets. Our systems are used to perform many types of surgical procedures. Our
strategy includes applying our patented Coblation technology to a broad range of
soft-tissue surgical markets, including arthroscopy, spinal surgery,
neurosurgery, cosmetic surgery, ear, nose and throat (ENT) surgery, gynecology,
urology, general surgery and various cardiology applications. We have formed the
following business units for commercialization of our technology in
non-orthopedic markets: ArthroCare Spine(TM), to commercialize our technology in
the spinal and neurosurgery markets; Visage(R), to commercialize our cosmetic
surgery products for use in various cosmetic surgery procedures; ENTec(R) to
commercialize our ENT surgery products for use in head and neck surgical
procedures; ArthroCare-ENDO(TM) to commercialize our Coblation-based products in
laparascopic and open surgical procedures for general surgery, gynecology and
urology applications; and AngioCare(TM), to commercialize our technology in
cardiology markets.
We have received 510(k) clearance from the United States Food and Drug
Administration, or FDA, to market our Arthroscopic Surgery System for use in
arthroscopic surgery of the knee, shoulder, ankle, elbow, wrist and hip, and our
Arthroscopic System is CE marked for use in arthroscopic surgery. The CE Mark is
a requirement to sell our products in most of Western Europe. Our Cosmetic
Surgery System has been cleared by the FDA and is CE marked for general
dermatologic procedures and skin resurfacing in connection with wrinkle
reduction procedures. Our ENT Surgery System is CE marked, and we have applied
the CE mark and received 510(k) clearances from the FDA for use of our ENT
Surgery System in general head, neck, oral and sinus surgery procedures,
including treatments for snoring, and turbinates and submucosal channelling
procedures. Our Spinal Surgery System is CE marked, and we have received 510(k)
clearances in the United States to market this system for spinal surgery and
neurosurgery. We have also applied the CE mark and received 510(k) clearance
from the FDA to market products based on Coblation technology for use in general
surgery, gynecology, urology, plastic and reconstructive surgery, and orthopedic
surgery.
We commercially introduced our Arthroscopic Surgery System in December
1995, and have derived a significant portion of our sales from this system. As
of December 29, 2001, we had shipped more than 13,700 controller units and more
than 1,500,000 disposable devices for a variety of indications. We are marketing
and selling our arthroscopic, ENT, cosmetic surgery and spinal surgery products
in the United States through a network of direct sales representatives and
independent distributors supported by regional managers. We have more than 70
distributors representing more than 400 field sales representatives in the
United States. We have also established distribution capability in Europe,
Australia, New Zealand, China, Korea, Japan, Taiwan, Canada, Mexico, the
Caribbean, Russia, South Africa, the Middle East, Northern Africa and South and
Central America. We have entered into a distribution agreement with Integra
NeuroSciences, a division of Integra LifeSciences Holding Corporation, for
Integra to be our exclusive sales and distribution partner in certain countries
for our products in the neurosurgical market. We have entered into a strategic
relationship with the GyneCare division of Ethicon, Inc. to commercialize
Coblation-based products for laparoscopic and open surgical procedures for
gynecological applications. We have also entered into a strategic relationship
with ACMI, under which ACMI will market and sell our products for urologic
indications, including transurethral resection of the prostate (TURP).
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The following is a list of our Coblation-based disposable devices as of December
29, 2001:
- -----------------------------------------------------------------------------------------------------------------------
Date of Current
Product Families Introduction # of models
---------------- ------------ -----------
Arthroscopy
Ablative Probes
90 degree August 1995 3
TurboDome(TM) July 1996 3
TurboBevel(TM) December 1996 3
Small Joint December 1997 2
Eliminator(TM) June 1998 1
Saber(TM) June 1998 1
LoPro(TM) April 1998 1
Microblator(TM) December 1999 1
Coblade(TM) May 2000 1
ACD50 April 2001 1
Suction Wands
CoVac(TM) June 1998 3
TurboVac(TM)/RazorVac/DiamondVac(TM) December 1998 3
MultiVac(TM) February 2000 3
Titan(TM) September 2000 1
Tristar(TM) September 2000 1
Shrinkage Wands
CAPSX(TM) April 1998 2
CAPSure(TM) June 1999 1
MicroCAP August 2000 1
Spinal and Neuro Surgery
ACCESS(TM)SpineWand(TM) September 1999 1
Aggressor(TM) June 2000 1
DisCoblator(TM) September 1999 2
Perc-D(TM) June 2000 1
Perc-DL(TM) June 2000 1
Perc-DLE(TM) March 2001
SpineVac(TM) June 2000 1
VersiTor(TM) May 2000 1
Cosmetic Surgery
Soft Touch(TM)Wand June 1998 2
MicroElectro Dissector December 1998 1
MicroTouch(TM)Wand December 1999 1
Plasma Scalpel September 1999 1
ENT Surgery
Hummingbird(TM) March 1999 1
Plasma Scalpel(TM) November 1998 3
Reflex(TM) June 1999 4
EVac(TM) February 2000 3
General Surgery
Plasma Scalpel GS September 1999 1
TurboVac GS November 1999 2
Versitor/Aggressor May 2000 2
Plasma Hook/Blade March 2001 3
Plasma Dissector December 2001 2
- -----------------------------------------------------------------------------------------------------------------------
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For information regarding the status of our regulatory approvals for our
products, see the information under the heading "Government Regulation."
ArthroCare Strategy
Our objective is to leverage our patented Coblation technology to design,
develop, manufacture and sell innovative, clinically superior surgical devices
for the surgical treatment of soft-tissue conditions throughout the body. The
key elements of our strategy include:
. EXPAND OUR PRODUCT OFFERING TO ADDRESS LARGE AND RAPIDLY GROWING MARKETS.
We are continuously expanding our portfolio of products and enhancing our
existing products to serve the needs of physicians. For example, we have
increased our penetration of arthroscopy procedures in the knee through the
addition of disposable devices with suction capability.
. REPLACE CURRENT TECHNOLOGY WITH COBLATION TECHNOLOGY. Coblation technology
offers a variety of options for physicians performing soft-tissue surgery.
Currently, our systems are being used to perform many types of
arthroscopic, cosmetic, ENT, spinal, neurosurgery and general surgery
procedures which were traditionally performed by mechanical, by
electrosurgical or laser surgery tools. In fact, soft tissue anywhere in
the body potentially can be treated with and benefit from our technology.
. FOCUS ON DISPOSABLE DEVICE SALES. We have utilized an aggressive
promotional product placement program in order for our controllers to
reside in hospitals throughout the world. Once a controller is placed
within an institution it may be utilized by a variety of physicians who
focus on different medical specialties. The same controller may be used to
perform arthroscopic, ENT, spinal, cosmetic, neurosurgery or general
surgery.
. LAYER GROWTH OPPORTUNITIES. We have established an extensive distributor
network, supported by our regional managers, in selected markets. We have
been executing a global distribution strategy in which we have been
expanding our direct sales presence in arthroscopy, spinal surgery and ENT
markets. We have signed agreements with several marketing partners to
assist with regulatory requirements and to market and distribute our
products internationally.
. ESTABLISH STRATEGIC PARTNERSHIPS TO COMMERCIALIZE OUR COBLATION TECHNOLOGY.
Our neurosurgery, gynecology and urology products are being commercialized
through strategic partnerships with Integra NeuroSciences, GyneCare and
ACMI, respectively.
COBLATION TECHNOLOGY
Our products are based on our patented soft-tissue surgical controlled
ablation technology, which we call Coblation technology. Coblation technology
involves an innovative use of radio frequency energy characterized by precision,
accuracy, ease of use and the capability of performing at temperatures lower
than traditional electrosurgical tools.
Traditional electrosurgical tools use heat to burn away targeted tissue,
which often results in thermal damage to tissue surrounding the surgical area.
Additionally, the lack of tactile feedback with these devices makes it difficult
for surgeons to control the depth of tissue penetration. Coblation technology
employs a lower temperature process that minimizes the risk of thermal burn to
surrounding tissue while increasing the surgeon's control and precision.
Coblation technology uses an electrically conductive fluid in the gap
between the electrode and tissue. When electrical current is applied to this
fluid, it creates a charged layer of particles. As the layer of charged
particles comes into contact with the targeted tissue, the molecular bonds
within the cells of the targeted tissue are broken. This process causes the
cells to disintegrate cell layer by cell layer, so that tissue is volumetrically
removed. Because this effect is confined to the surface layer of the targeted
tissue, minimal damage occurs to surrounding tissue, potentially resulting in
reduced pain and faster recovery for the patient. An additional advantage is
that Coblation can be performed in a continuous mode, resulting in efficient
tissue ablation thereby reducing the overall procedure time as compared to
conventional methods. In addition to achieving more precise tissue ablation or
shrinkage and less damage to surrounding tissue, surgical devices based on
Coblation technology can seal bleeding vessels near the surgical site.
We believe Coblation technology is applicable to soft-tissue surgery
throughout the body, and we have expanded its use into several non-arthroscopic
indications. In addition, we are exploring possibilities for the use of
Coblation technology in other markets.
We commercially introduced our soft-tissue surgery system in December 1995.
Since our arthroscopic soft-tissue surgery system accounts for a significant
portion of our product sales, we are highly dependent on its sales. Our spinal
surgery, neurosurgery, cosmetic surgery, and general surgery products, to date,
have sold only a relatively small number of units. We cannot assure you that we
will be able to continue to manufacture our products in commercial quantities at
acceptable costs, or that we will be able to continue to market such products
successfully.
To achieve increasing disposable device sales over time, we believe we
must continue to penetrate the market in knee procedures, expand physicians'
education with respect to Coblation technology and continue working on new
product development efforts specifically for
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knee applications. Furthermore, in order to maintain and increase current market
penetration we must be aggressive in increasing our installed base of
controllers to generate increased disposable device revenue. To date, we have
placed our controller units at substantial discounts in order to stimulate
demand for our disposable devices.
We believe that surgeons will not use our products unless they determine,
based on experience, clinical data and other factors, that these systems are an
attractive alternative to conventional means of tissue ablation. There are only
a few independently published clinical reports and limited long-term clinical
follow-up to support the marketing efforts for our Surgical Systems. We believe
that continued recommendations and endorsements by influential surgeons are
essential for market acceptance of our Surgical Systems. If our Coblation
technology does not continue to receive endorsement by influential surgeons or
long-term data does not support the effectiveness of our Surgical Systems, our
business, financial condition, results of operations and future growth prospects
will be materially adversely affected.
THE ARTHROSCOPY MARKET
In 2001, approximately 3.5 million arthroscopic procedures were performed
worldwide. Due to patient demand for less invasive procedures, we believe the
number of arthroscopic procedures is growing. In addition, a greater emphasis on
physical fitness and an aging population is increasing the incidence of joint
and soft tissue injuries. Joints are susceptible to injuries from blows, falls
or twisting, as well as from natural deterioration and stiffening associated
with aging.
Historically, joint injuries have been treated using open surgery involving
large incisions, a hospital stay and a prolonged recovery period. In contrast,
arthroscopic surgery, which was introduced in the early 1980's, is performed
through several small incisions called portals and can be performed on an
outpatient basis. We believe that arthroscopic surgery has gained wide market
acceptance because it offers shorter hospital stays and reduced recovery time,
resulting in reduced costs and improved medical outcomes. Arthroscopic surgery
performed on elite athletes often results in rapid returns to action. Publicity
concerning these athletes increases the demand for less invasive surgical
options by the general public.
To perform arthroscopic surgery, a surgeon uses a tool to view the site and
other tools to perform the surgery. The tool used to view the site, called an
arthroscope, is a small fiber-optic viewing instrument made up of a small lens,
a light source and a video camera. During the arthroscopic procedure, an
irrigant such as saline is flushed through the joint to permit clear
visualization through the arthroscope and to create the space within the joint
for the surgical procedure. The surgeon inserts the arthroscope into the joint
through a portal measuring approximately six millimeters, or 1/4 of an inch, in
length. Other portals are used for the insertion of surgical instruments to
perform the surgery and to facilitate the flow of irrigants. With small incision
sites and direct access to most areas of the joint, a surgeon can diagnose and
correct an array of joint problems such as cartilage and meniscus tears,
ligament tears and removal of loose and degenerative tissue.
The advantages of arthroscopic surgery over open surgery are often
significant. Due to the smaller incisions and reduced surgical trauma, the
patient might experience several benefits including reduced pain, treatment on
an outpatient basis, reduced hospitalization times, smaller scars, immediate
joint mobility and less muscle atrophy, less surrounding tissue damage, lower
rate of complications, and generally quicker rehabilitation. In addition,
treatment on an outpatient basis and reduced operating time can significantly
lower hospital costs.
Knee
The knee is the most commonly injured joint. In 2001, knee injuries
accounted for approximately 2 million arthroscopic procedures in the United
States. Damage to a meniscus, a disc of fibrous tissue that helps cushion the
knee joint, is the most common form of knee injury. A meniscus can be torn by a
twist of the leg when the knee is flexed, displaced either inward toward the
center of the shin bone or outward beyond the surface of the thighbone, or worn
down by normal aging. The knee is also susceptible to partial or complete tears
of the ligaments and degeneration of the cartilage on the underside of the
kneecap. In addition, the cartilage covering the bony surfaces of the knee can
become rough or tear loose from the bone as a result of age or injury, causing
pain and interfering with smooth joint movement.
Shoulder
The shoulder joint, because of its range of motion, is susceptible to a
number of injuries. In 2001, approximately 1.1 million arthroscopic procedures
in the shoulder were performed in the world. We believe that shoulder
arthroscopy is the fastest-growing portion of the arthroscopy market. With
repetitive motion and lifting of the arm, such as that which occurs during a
tennis serve, a bone formation of the upper arm may pinch one of the shoulder
muscles and cause persistent pain, known as a rotator cuff injury. Strengthening
exercises and physiotherapy can treat this condition; however, many rotator cuff
injuries require surgical intervention. We believe that a significant percentage
of the population is born with a susceptibility to rotator cuff injuries.
Elbow, Ankle, Wrist and Hip
The elbow, ankle, wrist and hip joints are also susceptible to certain
stress-related injuries and deterioration due to aging. In 2001, approximately
400,000 arthroscopic procedures were performed in the elbow, ankle, wrist or hip
in the world. We believe that the current number of surgical procedures in the
elbow, ankle, wrist and hip is relatively small due to the limitations of
conventional arthroscopic surgical equipment.
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Non-Traumatic Soft Tissue Injuries
It is estimated that nearly 15 million Americans suffer from injuries
called tendonopathies, or tendonosis, which is a chronic pain associated with
degeneration of tendons commonly used in everyday activity. Runners' knee,
tennis and golfers' elbow, jumpers' knee, and heel spurs are but a few of the
conditions limiting the lifestyles of normally active adults. Often the pain
associated with these injuries results in constant discomfort, difficulty
sleeping and the inability to perform normal daily activities without pain.
Currently, the few options for these chronic conditions include rest,
rehabilitation, bracing, and steroid injections. Surgical options have until now
been equally limited to surgical release procedures, grafts, and surgical
debridement, each with a significant recovery period.
CONVENTIONAL ARTHROSCOPIC TREATMENT METHODOLOGIES: THE PROBLEM
Most arthroscopic procedures require the surgeon to probe, cut, sculpt and
shape tissue and seal bleeding vessels to achieve satisfactory results. Surgeons
frequently use a combination of instruments when performing an arthroscopic
procedure because each instrument is designed to perform a specific function.
Use of an assortment of tools requires the surgeon to insert and remove each of
the tools from the portals several times during the same procedure.
Surgical procedures can employ one or more of four groups of surgical
instruments: (1) power or motorized instruments, such as cartilage and bone
shavers; (2) mechanical instruments, such as basket punches, graspers and
scissors; (3) electrosurgical systems; or (4) laser systems.
Power instruments are generally used to smooth tissue and cartilage
defects on the surface of the bones of the joint. The damaged tissue is removed
from the joint using suction through a tube surrounding the shaft of the tool,
which can become obstructed by bits of tissue and bone. Power shavers have
rotating cutters inside a tube and are available in a number of tip angles or
sizes for the precise shaving of tissue. Mechanical instruments must be
resharpened at regular intervals and sterilized after each procedure.
Conventional electrosurgical systems are used to seal blood vessels,
which is necessary to minimize bleeding and maximize the arthroscopic surgeon's
visibility of the procedure through the arthroscope. Conventional
electrosurgical systems contain two electrodes: the electrode tip held by the
surgeon and a dispersive pad that rests under the patient's body. The metal
electrode tip of the instrument, which resembles a pencil point, is placed on or
near the bleeding vessel to be sealed. A generator connected to the electrode
delivers high-frequency voltage that arcs between the electrode and the target
tissue, sealing blood vessels in its vicinity. After arcing, the current travels
through the remaining tissue of the patient's body, through the skin to the
dispersive electrode pad, before being directed back to the generator.
Laser systems are used to remove tissue while sealing bleeding vessels.
Because laser systems are not tactile tools, the surgeon cannot feel how much
tissue is being ablated. The surgeon must be extensively trained to precisely
position the laser to control the depth of tissue penetration to minimize
unintended tissue damage. In addition, the temperature of the laser instrument
is high and, as a result, can cause damage to surrounding tissue and vascular
areas. We believe that laser tools have not received wide acceptance because of
high capital cost and significant ongoing maintenance and operating expenses,
lack of tactile feedback for the surgeon, required training and certification,
and the concern about damage that may be caused by the significant heat
generated by these devices.
THE ARTHROCARE ARTHROSCOPIC SYSTEM: A SOLUTION
Our Arthroscopic System is a radio frequency surgical device intended to
perform tissue ablation, sculpting or shrinkage as well as sealing bleeding
vessels. Our Arthroscopic System is comprised of an assortment of disposable
bipolar multi-electrode and single electrode devices, a connecting cable, foot
pedal or handswitch and a radio frequency controller. We sell our Arthroscopic
System for use in all six major joints: knee, shoulder, elbow, ankle, wrist and
hip. Many types of tissue, including cartilage and ligaments, can be ablated
using our Arthroscopic System.
Our controller delivers radio frequency energy to the disposable device.
Surgeons can use the disposable device to ablate, sculpt and shrink tissue and
to seal bleeding vessels. The surgeon can control the mode of operation and
power setting with the foot pedal or keys on the front panel of the controller.
The incorporation of ablation, suction and fluid management into a single
disposable device potentially reduces operating time and expense.
A surgeon using the Arthroscopic System does not need to remove and insert
a variety of instruments to perform different tasks as is required when using
conventional arthroscopic instruments. Our disposable devices are approved for
sale in tip sizes ranging from 1.5 mm to 4.5 mm, and in tip angles ranging from
zero to 90 degrees. We currently sell 32 models for arthroscopy in various tip
sizes, angles and shapes, enabling the surgeon to ablate different volumes of
tissue and to reach treatment sites not readily accessible by existing
mechanical instruments and motorized cutting tools. In addition, some of our
disposable devices provide suction capability.
We commercially introduced the Arthroscopic System in December 1995. The
list price of the controller, including the cable, is approximately $7,500. The
disposable devices have list prices ranging from approximately $151 to $270, and
typically one disposable device is used per procedure. We are marketing and
selling our Arthroscopic System worldwide through a network of direct sales
representatives
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and independent orthopedic distributors supported by regional managers. We have
continually increased our manufacturing capabilities while maintaining yields.
THE SPINAL SURGERY MARKET
We believe spinal surgery had an estimated 2001 market size of more than
$1.5 billion, or 1.4 million procedures worldwide and is the most rapidly
growing segment of the orthopedic surgery market, increasing in excess of 20%
annually. Chronic back pain afflicts approximately five million people in the
U.S. and is the number one cause of healthcare expenditures. Chronic back pain
is estimated to cost the nation more than $50 billion per year in direct and
indirect medical expenses. Approximately one-half of those afflicted suffer from
disabling pain. Chronic back pain is the most common reason for disability for
persons under age 50 and is the second leading cause of workers' absenteeism.
The major causes of persistent, often disabling, back pain are disruption of a
portion of the disc, chronic inflammation of the disc, also known as herniation,
or relative instability of the vertebral bodies surrounding a given disc, such
as the instability that often occurs due to a degenerative disease.
Intervertebral discs mainly function to cushion and tether the vertebrae,
providing flexibility and stability to the patient's spine. As discs degenerate,
they lose their water content and height, bringing the adjoining vertebrae
closer together. This results in a weakening of the shock absorption properties
of the disc and a narrowing of the nerve openings in the sides of the spine
which may pinch these nerves. This disc degeneration can eventually cause back
and leg pain.
Often, inflammation from disc herniation can be treated successfully by
non-surgical means, such as rest, therapeutic exercise, or through the use of
anti-inflammatory medications. In some cases, the disc tissue is irreparably
damaged, thereby necessitating a discectomy, the removal of a portion of the
disc or the entire disc to eliminate the source of inflammation and pressure. In
more severe cases, the adjacent vertebral bodies must be stabilized following
excision of the disc material to avoid recurrence of the disabling back pain.
One approach to stabilizing the vertebrae, termed spinal fusion, is to insert an
interbody graft or implant into the space vacated by the degenerative disc. In
this procedure, a small amount of bone may be grafted from other portions of the
body, such as the hip, and packed into the implants. This allows the bone to
grow through and around the implant, fusing the vertebral bodies and alleviating
the pain.
Another surgical treatment for degenerative disc disease, termed
laminectomy, involves cutting away the lamina, the bony plate that connects the
bony ridges of the spine, known as pedicles. This allows the nerve tissue to
shift position to release pressure.
Until recently, spinal discectomy, laminectomy and fusion procedures
resulted in major operations and traumatic dissection of muscle and bone removal
or bone fusion. The open surgical procedures are invasive and typically require
a team of surgeons due to the length and complexity of the procedure. Recovery
time is also lengthy. To overcome the disadvantages of traditional traumatic
spinal surgery, minimally-invasive spinal surgery was developed. In
minimally-invasive spinal procedures, the spinal canal is not penetrated and
therefore bleeding with ensuing scarring is minimized or completely avoided. In
addition, the risk of instability from ligament and bone removal is generally
lower in minimally-invasive procedures than with open discectomy. Further, less
trauma during surgery often results in rapid rehabilitation and fast recovery.
CONVENTIONAL TREATMENT METHODOLOGIES FOR TREATMENT OF SPINE DISEASES AND
DISORDERS: THE PROBLEM
Techniques for the treatment of spinal diseases and disorders include laser
and mechanical techniques. These procedures can be "open" or minimally invasive
depending on the complexity, and generally require the surgeon to form a passage
or operating corridor from the skin of the patient to the spinal disc(s) for
passage of surgical instruments and implants. Typically, the formation of this
operating corridor requires the removal of soft tissue, muscle or other types of
tissue. This tissue is usually removed with mechanical or powered instruments,
such as graspers, cutters and drills. Multiple mechanical and powered
instruments must be used and are time-intensive. In addition, these instruments
sever blood vessels within this tissue, often causing profuse bleeding that
obstructs the surgeon's view of the target site.
Once the operating corridor is established, the nerve root is retracted and
a portion or all of the disc is removed with mechanical or powered instruments.
These instruments are typically slow and tedious, and can require up to 40
minutes to remove a single disc. In addition, these instruments, particularly
powered instruments, are not extremely precise, and it is often difficult during
the procedure to differentiate between the target disc tissue and other
structures within the spine, such as bone, cartilage, ligaments, nerves and
surrounding tissue. Thus, the surgeon must be extremely careful to minimize
damage to the cartilage and bone within the spine, and to avoid damaging nerves.
Both lasers and monopolar radio frequency devices have been used in spinal
surgery. We believe both have significant drawbacks. Lasers are expensive and
tedious to use. Another disadvantage of lasers is the difficulty in judging the
depth of tissue ablation. Because healthy tissue, bones, ligaments and nerves
often lie within close proximity of the spinal disc, it is essential to maintain
a minimum depth of tissue penetration. Monopolar radio frequency devices
increase the risk of unwanted electrical stimulation to portions of the
patient's body by utilizing electric current that disperses into the patient's
body.
THE ARTHROCARE SPINAL SURGERY SYSTEM: A SOLUTION
In September 1999, we announced our expansion into the spinal surgery
market. Our Spinal Surgery System is CE marked. We have received 510(k)
clearance for use of the system in spinal and neurosurgery procedures in the
United States. Our spinal surgery products,
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based on our Coblation technology, include multi-functional disposable devices
optimized for spinal surgery. The disposable products are compatible with the
controller that is used for arthroscopic, ENT and general surgery procedures.
Our controller is used to deliver radio frequency energy to the disposable
devices. The disposable devices are intended for single use and utilize multiple
or single electrodes to ablate tissue and seal bleeding vessels. In some cases,
our disposable devices may also include one or more tubes for the delivery of
electrically conductive fluid to the target site and/or for suction capability.
The incorporation of ablation, suction and fluid management into a single
disposable device potentially reduces operating time and expense. Although we
have had limited clinical experience with these products in spinal surgery
procedures, we believe physician and patient benefits experienced in
arthroscopic surgery, such as more rapid recovery time, reduced thermal injury
to tissue and reduced post-operative pain when compared to existing techniques,
could also apply to spinal surgery procedures.
Our disposable devices consist of the ACCESS SpineWand, VersiTor,
Aggressor, SpineVac, Perc-D, Perc-DL and the DisCoblator. The ACCESS SpineWand
is a bipolar electrosurgical device designed for controlled ablation of soft
tissue. We believe that the ACCESS SpineWand is an effective tool for creating
precise incisions through connective tissue to provide access to the disc in
discectomy, laminectomy and fusion procedures. In addition, we believe that the
ACCESS SpineWand may be effectively used to remove soft tissue from bones in
preparation for fusion procedures.
The DisCoblator is a bipolar electrosurgical device designed for aggressive
removal of large tissue volumes. The DisCoblator includes fluid delivery and
suction capabilities and incorporates an active screen electrode design to
inhibit clogging. We have marketed the DisCoblator to volumetrically remove a
portion or all of the disc during discectomy and fusion procedures. Although
there has been limited clinical experience with this product, we believe that
the DisCoblator is capable of removing a disc in less time than mechanical
instruments, such as graspers or cutters.
During fiscal year 2001, we introduced the Perc-DLE Convenience Pack for
volumetric tissue removal in the nucleus of the disc. Nucleoplasty(R), a
minimally invasive partial discectomy procedure utilizing our Coblation
technology, for the treatment of lower back pain through the process of ablation
and coagulation of soft tissue, combines both approaches for partial removal of
the nucleus of a disc. Coblation ablates tissue via a low-temperature, molecular
dissociation process to create small channels within the disc. On withdrawal,
the channels are thermally treated producing a zone of thermal-coagulation.
Although there has been limited clinical experience with the Perc-D product
line, we believe that this treatment may relieve pressure in the disc, and
contract collagen in the thermal zone, further shrinking and stiffening the
disc.
THE ARTHROCARE NEUROSURGERY MARKET
Approximately 250,000 surgical procedures are performed in the brain
each year, and more than 110,000 metastatic brain tumors are diagnosed annually
in the United States. According to the American Cancer Society, brain tumors are
the second fastest growing cause of cancer death among people over age 65 and
are one of the most common types of cancer found in children. In addition, brain
trauma affects another 1.5 million people each year in the United States.
CONVENTIONAL TREATMENT METHODOLOGIES FOR TREATMENT OF NEUROLOGICAL DISEASES: THE
PROBLEM
Surgery, radiation, and chemotherapy are the three most common
treatments used individually or in combination, for brain tumors. While surgery
is the preferred method of treatment, it is not always practical given difficult
or impossible access to the tumor. Coblation therapy can allow minimally
invasive access to the tumor and allow the physician to quickly remove solid
tissue with minimal thermal injury.
THE ARTHROCARE NEUROSURGERY SYSTEM: A SOLUTION
In February 2000, we announced that we were expanding our marketing efforts
for our Spinal Surgery System to specifically address selected applications in
neurosurgery. Our Spinal Surgery System is CE marked in Europe, and we have
received 510(k) clearance for the use of this system in neurosurgery procedures
in the United. Our spinal surgery and neurosurgery products, based on our
Coblation technology, include multi-functional disposable devices optimized for
spinal and neurosurgery. The disposable products are compatible with the
controller that is used for arthroscopic, ENT and general surgery procedures.
Our controller is used to deliver radio frequency energy to the disposable
devices. The disposable devices are intended for single use and utilize multiple
or single electrodes to ablate tissue and seal bleeding vessels. In some cases,
our disposable devices may also include one or more tubes for the delivery of
electrically conductive fluid to the target site and/or for suction capability.
The incorporation of ablation, suction and fluid management into a single
disposable device potentially reduces operating time and expense. Although we
have had limited clinical experience with these products in neurosurgery
procedures, we believe physician and patient benefits experienced in
arthroscopic surgery, such as more rapid recovery time, reduced thermal injury
to tissue and reduced post-operative pain when compared to existing techniques,
could also apply to neurosurgery procedures.
We have entered into a distribution agreement with Integra Lifescienses to
license, market and distribute our Coblation-based products for neurosurgical
procedures in North America and certain additional international markets.
8
THE EAR, NOSE AND THROAT (ENT) MARKET
We believe that in 2001, approximately 4 million ENT procedures were
performed worldwide. For example, surgical approaches for the treatment of
obstructive sleep apnea include the removal of excess tissue from the upper
airway or moving the lower jaw forward to widen the patient's airway. These
procedures are performed by highly specialized surgeons are, expensive, and
extremely painful for the patient and involve lengthy recovery periods.
Non-invasive treatment approaches include continuous positive airway pressure,
or CPAP, which requires the patient during sleep to wear a nasal mask connected
to an airflow generator that forces air through the nasal passages. The most
common procedures are placement of ear tubes and the removal of adenoids and
tonsils. Other procedures include obstructive sleep apnea, snoring and other
obstructions of the sinus and nasal passages.
Conventional treatment methodologies for ENT surgical procedures have been
performed by lasers, electrosurgical devices, endoscopes and microsurgical
tools. We believe our Coblation technology can be used in numerous types of ENT
procedures.
THE ARTHROCARE ENT SURGERY SYSTEM
Our ENT Surgery System uses the same technology as the Athroscopic System,
which removes soft tissue through a more precise and significantly cooler
process than that of traditional electrosurgery devices. Our controller is used
to deliver radio frequency energy to the disposable devices. The disposable
devices are intended for single use and utilize multiple or single electrodes.
We have three categories of wands to address the ENT Market. Suction wands
simultaneously ablate and remove tissue in applications such as tonsillectomy,
providing enhanced visibility. Channeling wands combine controlled ablation and
effective coagulative lesion formation in applications such as the soft palate
for the treatment of snoring. Excision wands provide precise dissection for
minimal damage to surrounding tissue. Although we have limited clinical
experience in ENT, we believe our products provide the same physician and
patient benefits experienced in arthroscopic surgery, such as reduced
post-operative pain, more rapid recovery, and reduced thermal injury to tissue
when compared to existing techniques.
Our ENT Surgery System is CE marked, and we have received 510(k) clearances
in the United States for use of the system in general head, neck and oral
surgical procedures, including sinus surgery, the treatment of snoring,
reduction of turbinate, adenoidectomy and tonsillectomy. We have been marketing
the ENT products through a network of direct sales representatives and
independent distributors supported by sales managers since February 1999.
THE COSMETIC SURGERY MARKET
The cosmetic surgery market primarily consists of three segments: invasive
surgical procedures that remove or alter body structures such as rhytidectomy
(face lift), rhinoplasty (nose restructuring), blepharoplasty (eye lift) and
liposuction; resurfacing procedures that reduce wrinkles and even out skin tone
such as laser resurfacing and chemical peels and non- or less-invasive cosmetic
procedures such as botulinum toxin, collagen injections, and microdermabrasion.
Of the approximately 9 million total cosmetic procedures performed in 2001 in
the United States, approximately 2 million were invasive surgical procedures,
approximately 2 million were resurfacing procedures and 5 million were non- or
less-invasive cosmetic procedures.
CONVENTIONAL TREATMENT TECHNIQUES FOR RESURFACING: THE PROBLEM
Conventional treatments for skin resurfacing include chemical peels,
dermabrasion and laser resurfacing. In chemical peels, an acid-based solution is
used to improve the texture of the skin and reduce wrinkles by removing its
damaged outer layers. Light chemical peels can improve texture but do not
address wrinkles. Deeper chemical peels can reduce wrinkles but often produce
uneven results and hypopigmentation (loss of color). In dermabrasion a
mechanical device is used to remove the damaged outer layers of the skin. While
dermabrasion has fallen out of favor in the majority of practices, laser
resurfacing remains the most popular resurfacing procedure for the treatment of
wrinkles. In particular, the carbon dioxide, or CO\2\, laser is considered the
gold standard for efficacy in the treatment of wrinkles. However, the excessive
heat diffusion into surrounding healthy skin cells during the procedure results
in an unacceptably long recovery period and a significant level of side effects
such as hypopigmentation and scarring.
THE VISAGE COBLATION COSMETIC SURGERY SYSTEM: A SOLUTION
Our Cosmetic Surgery System utilizes the same technology as the
Arthroscopic System and removes skin cells through a more precise and
significantly cooler process than traditional electrosurgery systems or
dermatologic lasers. Our Cosmetic Surgery System is a bipolar radiofrequency,
electrosurgical device used in skin resurfacing and other dermatologic and
cosmetic procedures. Our Cosmetic Surgery System incorporates a bipolar
disposable device, a connecting resterilizable handpiece with cable and a radio
frequency controller which differs from the controllers used in arthroscopy, ENT
surgery and spinal surgery. The controller delivers radio frequency energy to
multi-electrode or single electrode disposable devices. Our Cosmetic Surgery
System has been cleared by the FDA for the treatment of wrinkle reduction as
well as for general dermatologic procedures. We believe our Cosmetic Surgery
System, when used for skin resurfacing, results in more rapid recovery than seen
with CO\2\ laser systems.
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THE GENERAL SURGERY, UROLOGY AND GYNECOLOGY MARKETS
We have established a new division, ArhroCare-ENDO, to develop and market
products for the general surgery, gynecology and urology markets. In general
surgery, we have developed, and are developing, a set of Coblation-based
products for laparoscopic and open approaches to general surgery procedures.
These products are being distributed in selected regions worldwide by a small
network of distributors. In gynecology, we have entered into a strategic
relationship with the GyneCare, division of Ethicon, Inc., to commercialize
Coblation-based products for laparoscopic and open surgical procedures for
gynecological applications. In urology, we have entered into a strategic
relationship with ACMI under which ACMI will market and sell our products for
urologic indications, including transurethral resection of the prostate (TURP).
BENEFITS OF OUR COBLATION TECHNOLOGY
Our patented Coblation technology, delivered in the form of multi-electrode
and single electrode, bipolar disposable devices, offers a number of benefits
that we believe may provide advantages over competing surgical methods and
devices. The principal benefits include:
. EASE OF USE. Our Coblation-based soft-tissue surgery systems perform
many of the functions of mechanical tools, power tools and
electrosurgery instruments, allowing the surgeon to use a single
instrument. The lightweight device is simple to use and complements the
surgeon's existing tactile skills without the need for extensive
training.
. PRECISION. In contrast to conventional tools, our Coblation-based
soft-tissue surgery systems permit surgeons to perform more precise
tissue ablation and sculpting. We believe this may result in more rapid
patient rehabilitation.
. BENEFITS TO PATIENTS. Coblation technology operates at cooler
temperatures than traditional electrosurgical tools. This can lead to
significant benefits for patients treated with Coblation-based
disposable devices due to the minimal amount of thermal injury to
surrounding tissue. As a result, we believe that patients are likely to
experience less trauma and pain following surgery and may recover more
quickly.
. ABLATION AND SEALING OF BLEEDING VESSELS. Our Coblation-based
soft-tissue surgery systems allow for the efficient sealing of small
bleeding vessels without changing tools.
. COST REDUCTION. Our Coblation soft-tissue surgery systems eliminate the
need to introduce multiple instruments to remove and sculpt tissue and
seal bleeding vessels. We believe this may reduce operating time and
thereby produce cost savings for health care providers.
For information regarding product sales in certain market segments, see the
notes to the financial statements under the heading, "Segment Information."
DEPENDENCE UPON COLLABORATIVE ARRANGEMENTS
Integra Lifesciences. In July 2000, we entered into a license and
distribution agreement with Integra NeuroSciences, a division of Integra
Lifesciences Holding Corporation ("Integra"). Under this agreement Integra has
become our exclusive sales and distribution partner for the Coblation-based
surgical system for neurosurgery in the United States and certain additional
international markets. In addition, we will cooperate on strategic marketing and
product development initiatives.
GyneCare. We have entered into a strategic relationship with the GyneCare
division of Ethicon, Inc. to commercialize Coblation-based products for
laparoscopic and open surgical procedures for gynecological applications.
AMCI. We have also entered into a strategic relationship with AMCI, under
which AMCI will market and sell our products for urologic indications, including
transurethral resection of the prostate (TURP).
RESEARCH AND DEVELOPMENT
We have focused our research and development efforts in two areas. First,
in response to physician feedback, we are continually working on enhancements to
designs of our products to provide greater versatility in existing features and
functions. In addition, we continue to design new disposable devices that
incorporate added functionalities. Second, we are exploring new applications of
our Coblation technology in other soft-tissue surgical markets. We have
undertaken preliminary studies and development for the use of our technology in
several fields. Research and development expenses were $8.0 million in 2001,
$7.1 million in 2000 and $4.9 million in 1999.
MANUFACTURING
Our disposable devices and controllers are currently manufactured in a
portion of our 52,000 square foot facility in Sunnyvale, California. This
facility was acquired through a 5-year lease agreement in September 2001 and
became fully operational for our clean room manufacturing operations in January
2002. ArthroCare has also leased a 23,000 square foot facility in a tax-free
industrial park in Costa Rica for the purpose of manufacturing and packaging
additional disposable devices, which are currently made in Mexico and by two
contract manufacturers in Mexico. This facility has a five-year lease and is
expected to be in operation by June 2002. We believe that our Sunnyvale and
Costa Rican operations will provide adequate capacity for our manufacturing
needs through 2005.
Our products are manufactured from several components, most of which are
supplied to us from third parties. Most of the components that we use in the
manufacture of our products are available from more than one qualified supplier.
For some components, however, there
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are relatively few alternative sources of supply and the establishment of
additional or replacement suppliers may not be accomplished quickly. With
respect to a few components, we rely upon single source suppliers. For example,
two single source suppliers provide us with components used in substantially all
of our disposable devices. We also use a single subcontractor to sterilize our
disposable devices, but do not believe a major disruption is likely because the
supplier has multiple sterilization facilities throughout the United States as
well as internationally. See "ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE
RESULTS-We Have Limited Manufacturing Experience" for additional information
regarding the potential disruption in supply of our products and risks to our
operations resulting from our reliance upon single source suppliers.
We manufacture three different controller models for which the
manufacturing process is substantially the same.
We currently manufacture over 65 different versions of disposable devices.
Due to the various attributes of our disposable devices, which include, among
other functions, fluid management and suction, the manufacturing process is
varied. In order to improve yields and product cost, we operate under a
continuous improvement process.
We have established quality assurance systems in conformance with the FDA's
Quality System Regulation, or QSR. Our facility in Sunnyvale has received ISO
9001/EN46001 certification and is in conformance with the Medical Device
Directive, or MDD, for the sale of products in Europe.
The company has an agreement with a logistics company in Sweden that
provides for the warehousing, shipping and traceability of its products sold to
customers throughout Europe, Asia, the Middle East and South America.
MARKETING AND SALES
We have shipped more than 13,700 controller units and over 1,500,000
disposable devices, as of December 29, 2001 for a variety of indications. We use
a combination of distributors supported by regional sales managers, a direct
sales force and corporate partners to sell our products both domestically and
internationally.
We have more than 70 distributors representing more than 400 field sales
representatives in the United States. Integra NeuroSciences is our distributor
for neurosurgery in North and South America and certain additional international
markets. GyneCare, a division of Ethicon, Inc. is our worldwide distributor for
gynecology and ACMI is our worldwide distributor for urology.
We have established distribution capability in certain countries by means
of exclusive and non-exclusive distribution agreements with corporations,
including Kobayashi Pharmaceutical for the distribution of our arthroscopy,
spinal surgery and ENT surgery products in Japan. We have also established
distribution capability through relationships with distributors in arthroscopy
products in Europe, South Africa, South and Central America and Russia.
We believe the use of our products is generally intuitive to surgeons and
does not require extensive training. We frequently conduct training seminars and
demonstrations at regional training centers and trade shows. Our partners also
conduct training activities in their areas of responsibility.
At hospitals and surgical centers where several procedures can be performed
simultaneously, the procurement of multiple controllers is required. We have
offered our controllers at substantial discounts in the past and may be required
to continue to offer such discounts to generate demand for our disposable
devices. In addition, motorized and mechanical instruments, lasers and electro
surgery systems currently used by hospitals, surgical centers and private
physicians have become widely accepted. If physicians do not determine that our
soft-tissue surgery systems are an attractive alternative to conventional means,
our business would be materially adversely affected.
PATENTS AND PROPRIETARY RIGHTS
Our ability to compete effectively depends in part on developing and
maintaining the proprietary aspects of our Coblation technology. We own over 55
issued U.S. patents and over 20 issued international patents. In addition, we
have over 100 U.S. and international pending patent applications. We believe
that our issued patents are directed at the core technology used in our
soft-tissue surgery systems, including both multi-electrode and single electrode
configurations of our disposable devices, as well as the use of Coblation
technology in specific surgical procedures. The issued patents are directed at,
among other things, the following:
. systems and methods for applying radio frequency energy to tissue in
the presence of electrically conductive fluid such as isotonic saline;
. disposable devices having an electrode array and a system designed to
supply current independently to individual electrodes; and
. systems and methods for employing radio frequency energy in urology,
gynecology, ENT, spine surgery, cosmetic surgery, skin resurfacing,
neurosurgery and cardiac procedures.
11
The pending patent applications include coverage for the fundamental tissue
ablation and cutting technology as well as methods and apparatus for specific
procedures.
We cannot assure you that the patents we have obtained, or any patents that
we may obtain as a result of our U.S. or international patent applications, will
provide any competitive advantages for our products or that they will not be
successfully challenged, invalidated or circumvented in the future. In addition,
we cannot assure you that competitors, many of whom have substantial resources
and have made substantial investments in competing technologies, will not seek
to apply for and obtain patents that will prevent, limit or interfere with our
ability to make, use and sell our products either in the United States or in
international markets.
A number of other companies and universities and research institutions have
filed patent applications or have issued patents relating to monopolar and/or
bipolar electrosurgical methods and apparatus. In addition, we have become aware
of, and may become aware of in the future, patent applications and issued
patents that relate to our products and/or the surgical applications and issued
patents and, in some cases, have obtained internal and/or external opinions of
our counsel regarding the relevance of certain issued patents to our products.
We do not believe that our products currently infringe any valid and enforceable
claims of the issued patents that we have reviewed. However, if third-party
patents or patent applications contain claims infringed by our technology and
such claims are ultimately determined to be valid, we cannot assure you that we
would be able to obtain licenses to those patents at a reasonable cost, if at
all, or be able to develop or obtain alternative technology. The inability to do
either would have a material adverse effect on our business, financial
condition, results of operations and future growth prospects. We cannot assure
you that we will not have to defend ourselves in court against allegations of
infringement of third-party patents.
In addition to patents, we rely on trade secrets and proprietary know-how,
which we seek to protect, in part, through confidentiality and proprietary
information agreements. We require our employees and consultants to execute
confidentiality agreements upon the commencement of an employment or consulting
relationship with us. These agreements generally provide that all confidential
information developed or made known to the individual by us during the course of
the individual's relationship with us, is to be kept confidential and not
disclosed to third parties. These agreements also generally provide that
inventions conceived by the individual in the course of rendering services to us
shall be our exclusive property. We cannot assure you that employees will not
breach the agreements, that we would have adequate remedies for any breach or
that our trade secrets will not otherwise become known to or be independently
developed by competitors.
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. We cannot assure you that we will not become subject to
patent infringement claims or litigation or interference proceedings declared by
the United States Patent and Trademark Office, or USPTO, to determine the
priority of inventions. In February 1998, we filed a lawsuit against Ethicon,
Inc., Mitek Surgical Products, a division of Ethicon, Inc., and GyneCare, Inc.
alleging among other things, infringement of several of our patents. The lawsuit
has been settled. In June 2000, we filed a lawsuit against Stryker, alleging
infringement of several of our patents. The lawsuit has been settled. In July
2000, we filed a lawsuit against Smith & Nephews alleging infringement of
several of our patents. This lawsuit is pending. The defense and prosecution of
this lawsuit and intellectual property suits generally, USPTO interference
proceedings and related legal and administrative proceedings are both costly and
time-consuming. We believe that these lawsuits were necessary, and if others
violate our proprietary rights, further litigation may be necessary to enforce
our patents, to protect trade secrets or know-how owned by us or to determine
the enforceability, scope and validity of the proprietary rights of others. Any
litigation or interference proceedings will be costly and cause significant
diversion of effort by our technical and management personnel. An adverse
determination, other litigation or interference proceedings to which we may
become a party could subject us to significant liabilities to third parties,
require disputed rights to be licensed from third parties or require us to cease
using such technology. Although patent and intellectual property disputes in the
medical device area have often been settled through licensing or similar
arrangements, costs associated with such arrangements may be substantial and
could include ongoing royalties. Furthermore, we cannot be sure that we could
obtain necessary licenses on satisfactory terms, if at all. Adverse
determinations in a judicial or administrative proceeding or failure to obtain
necessary licenses could prevent us from manufacturing and selling our products,
which would have a material adverse effect on our business, financial condition,
results of operations, and future growth prospects.
COMPETITION
We believe that the principal competitive factors in soft-tissue surgery markets
include:
. acceptance by leading physicians;
. improved patient outcomes;
. superior product quality;
. the publication of peer-reviewed clinical studies;
. product innovation;
12
. sales and marketing capability; and
. strong intellectual property.
Arthroscopy
In arthroscopic procedures, we compete directly with the providers of
tissue removal systems, including conventional electrosurgical systems, manual
instruments, power shavers and laser systems. Smith & Nephew Endoscopy (which
owns Acufex Microsurgical, Inc. and Dyonics, Inc. and have recently announced
its planned acquisition of Oratec Interventions, Inc.), Conmed Corporation
(including its Linvatec unit), Medtronic, Inc. (which owns Sofamor Danek), and
Stryker Corporation each have large shares of the market for manual instruments,
power shavers and arthroscopes.
Johnson & Johnson, including Mitek, a division of its Ethicon, Inc. unit,
markets a bipolar electrosurgical system developed by Gyrus Medical Ltd., a
company based in the United Kingdom which competes with us. Stryker Corporation
and Smith & Nephew have recently introduced a bipolar electrosurgical system.
The bipolar electrosurgical systems marketed by Mitek, Stryker and Smith &
Nephew competes directly with our tissue ablation and shrinkage technology in
arthroscopy. In addition, the Linvatec unit of Conmed Corporation is marketing a
monopolar electrosurgical tool for tissue ablation in arthroscopy. Oratec
Interventions manufactures and sells a monopolar tissue ablation, shrinkage
system that competes directly with our arthroscopic products. The tissue
shrinkage market represents a small portion of the overall market in arthroscopy
for our products.
We believe that our Arthroscopic System, comprising the controller unit
and disposable devices, presents a competitive pricing structure compared to
alternative tools being used in arthroscopic procedures. While our disposable
devices perform many functions in one tool, most competitive disposable devices
only perform a single function. In such cases, multiple disposable or reusable
devices would be required. Laser systems have a significantly higher capital
cost than our controller and require significant ongoing maintenance and
operating expenses. We are also aware of additional competitors that may
commercialize products using technology similar to ours.
Spinal and Neurosurgery
We believe that Coblation technology will compete effectively against
conventional tissue removal technology used in spinal and neurosurgery
procedures, such as mechanical instruments, monopolar electrosurgical
instruments, ultrasonic and powered instruments. Mechanical instruments for
tissue removal in the spine are manufactured and sold by a large number of
small, diverse, specialty companies, and the substantial bulk of monopolar
electrosurgical instruments are manufactured by Valleylab and Linvatec (unit of
Conmed). We may indirectly compete with large companies in the spine fusion
market, such as Medtronic Sofamor Danek, Sulzer Spine-Tech, Surgical Dynamics
and DePuy Acromed. In addition, we are aware of several small companies offering
alternative treatments for back pain that may indirectly compete with our
products. For example, Oratec Interventions manufactures and sells a catheter
that uses resistive heating to reduce chronic low back pain caused by
degenerative disc disease and Radionics, a division of Tyco, manufactures and
sells monopolar electrosurgical instruments for treating low back pain. In
neurosurgery, we directly compete with a variety of tissue removal systems
designed for removing brain and cranial-based tumors, such as the CUSA(TM), an
ultrasonic tissue aspiration system manufactured by Valleylab.
Ear, Nose and Throat Surgery
There are large companies, such as Smith & Nephew, Inc., Stryker Corp.,
Medtronic, Incorporated (which owns Xomed Surgical Products, Inc.) and Conmed
Corporation, which have shares of the market for manual and powered instruments
for minimally-invasive sinus surgery. In addition, we face competition from
laser companies, such as ESC Medical Systems Ltd., which develops and markets
lasers for various ENT surgery applications. We expect that competition from
these and other well-established competitors will increase as will competition
from smaller medical device companies, such as Somnus Medical Technologies, Inc.
(owned by Gyros Medical Ltd.), Elmed Inc. and Ellman International, Inc. Somnus
Medical Technologies, Inc. manufactures and sells medical devices that utilize
radio frequency energy for the treatment of upper airway disorders, such as
snoring and obstructive sleep apnea. Elmed Inc. and Ellman International, Inc.
both manufacture and sell a variety of medical devices that use conventional
radio frequency energy for tissue removal, cutting and/or coagulation for the
treatment of snoring and other ENT surgery procedures.
Cosmetic Surgery
The cosmetic surgery industry includes a number of large and well
established companies that provide devices for rejuvenating skin, hair removal,
scar removal, the treatment of vascular and pigmented lesions and other
applications, including companies that manufacture and sell dermabrasion
equipment or chemical peels, and companies that manufacture and sell lasers. In
skin resurfacing, we directly compete with much larger companies that
manufacture lasers for medical use, such as Lumenis, Inc., a company that
resulted from the acquisition of Coherent Medical Group by ESC Medical Group.
The combined company develops and markets lasers for a broad range of cosmetic
applications, including the non-invasive treatment of varicose veins and other
benign vascular lesions, hair removal, skin rejuvenation and
others. In addition, other large companies manufacture and sell medical
devices that use radio frequency energy for certain applications in dermatology
and cosmetic surgery.
13
We cannot assure you that we can effectively convince surgeons and
physicians to adopt our Coblation technology in the face of competition. In
addition, we cannot be sure that these or other companies will not succeed in
developing technologies and products that are more effective than ours or that
would render our technology or products obsolete or uncompetitive. Many of these
competitors have significantly greater financial, manufacturing, marketing,
distribution and technical resources than us. We have received 510(k) clearances
to market tissue ablation products to treat disorders in other surgical fields
that we may enter. These fields are intensely competitive and we cannot assure
you that these potential products would be successfully marketed.
Third-Party Reimbursement
In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices, such as our products, generally rely
on third-party payors, principally federal Medicare, state Medicaid and private
health insurance plans, to reimburse all or part of the cost of the procedure in
which the medical device is being used. Reimbursement for arthroscopic, ENT
surgery, spinal and neuro surgery, gynecology, urology and general surgery
procedures performed using devices that have received FDA clearance has
generally been available in the United States. Generally, cosmetic procedures
are not reimbursed. In addition, some health care providers are moving toward a
managed care system in which providers contract to provide comprehensive health
care for a fixed cost per person. Managed care providers are attempting to
control the cost of health care by authorizing fewer elective surgical
procedures.
Government Regulation
United States
Our products are considered medical devices and are subject to extensive
regulation in the United States. We must obtain premarket clearance or approval
by the FDA for each of our products and indications before they can be
commercialized. FDA regulations are wide ranging and govern, among other things:
. product design and development;
. product 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:
. warning letters;
. fines, injunctions and civil penalties against us;
. recall or seizure of our products;
. operating restrictions, partial suspension or total shutdown of our
production;
. refusing our requests for premarket clearance or approval of new
products;
. withdrawing product approvals already granted; and
. criminal prosecution.
Unless an exemption applies, generally, before we can introduce a new
medical device into the United States market, we must obtain FDA clearance of a
510(k) premarket notification or approval of a premarket approval application,
or PMA application. If we can establish that our device is "substantially
equivalent" to a "predicate device," i.e., a legally marketed Class I or Class
II device or a preamendment Class III device (i.e., one that was in commercial
distribution before May 28, 1976) for which the FDA has not called for PMAs, we
may seek clearance from the FDA to market the device by submitting a 510(k)
premarket notification. The 510(k) premarket notification must be
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supported by appropriate data, including, in some cases, clinical data,
establishing the claim of substantial equivalence to the satisfaction of the
FDA.
We have received 510(k) clearance to market our Arthroscopic System for
surgery of the knee, shoulder, elbow, wrist, hip and ankle joints. We have
received clearance to market our Spinal Surgery System in the United States for
spinal and neuro surgery as well as the treatment of symptomatic patients with
contained herniated discs. In addition, we have received 510(k) clearance to
market our Cosmetic Surgery System in general dermatology and for skin
resurfacing for the purpose of wrinkle reduction. We have received 510(k)
clearance to market our ENT Surgery System in general head, neck and sinus
surgical procedures, as well as snoring, turbinate reduction, submucosal
channelling procedures and tonsillectomies. We cannot assure you that we will be
able to obtain necessary clearances or approvals to market any other products,
or existing products for new intended uses, on a timely basis, if at all. Delays
in receipt or failure to receive clearances or approvals, the loss of previously
received clearances or approvals, or failure to comply with existing or future
regulatory requirements could have a material adverse effect on our business,
financial condition, results of operations and future growth prospects.
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 the intended use of the device, technology, materials,
packaging, and certain manufacturing process may require a new 510(k) clearance.
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 submit a premarket notification
requesting 510(k) clearance. The FDA also can require the manufacturer to cease
marketing and/or recall the modified device until 510(k) clearance is obtained.
We have modified some of our marketed devices, but have determined that, in our
view, new 510(k) clearances are not required. No assurance can be given that the
FDA would agree with any of our decisions not to seek 510(k) clearance. If the
FDA requires us to seek 510(k) clearance for any modification, the FDA also may
require us to cease marketing and/or recall the modified device until we obtain
a new 510(k) clearance.
If we cannot establish that a proposed device is substantially equivalent
to a legally marketed device, we must seek premarket approval through submission
of a PMA application. A PMA application must be supported by extensive data,
including, in many instances, preclinical and clinical trial data, as well as
extensive literature to prove the safety and effectiveness of the device. If
necessary, we will file a PMA application for approval to sell our potential
products. The PMA process can be expensive, uncertain and lengthy. We cannot
assure you that we will be able to obtain PMA approvals on a timely basis, if at
all, and delays in receipt or failure to receive approvals, could have a
material adverse effect on our business, financial condition, results of
operations and future growth prospects.
We are also required to demonstrate and maintain compliance with the
Quality System Regulation, or QSR. The QSR incorporates the requirements of Good
Manufacturing Practice and relates to product design, testing, and manufacturing
quality assurance, as well as the maintenance of records and documentation. The
FDA enforces the QSR through inspections. We cannot assure you that we or our
key component suppliers are or will continue to be in compliance, will not
encounter any manufacturing difficulties, or that we or any of our
subcontractors or key component suppliers will be able to maintain compliance
with regulatory requirements. Failure to do so will have a material adverse
effect on our business, financial condition, results of operations and future
growth prospects.
We may not promote or advertise our products for uses not within the scope
of our clearances or approvals or make unsupported safety and effectiveness
claims. These determinations can be subjective. We cannot assure you that the
FDA would agree that all of our promotional claims are permissible or that the
FDA will not require us to revise our promotional claims or take enforcement
action against us based upon our labeling and promotional materials.
International
International sales of our products are subject to strict regulatory
requirements. The regulatory review process varies from country to country. We
have obtained regulatory clearance to market our Arthroscopic System in Europe,
Japan, Australia, Taiwan, Korea, Canada, China, Israel, Middle East, South
America and Mexico; to market our cosmetic surgery products in Europe,
Australia, Canada, Middle East, Taiwan, Korea, Australia, South America and
Israel; to market our ENT surgery products in Europe, Australia, Canada, China,
Israel, Japan, Middle East, Korea, Taiwan, Australia, and South America; to
market our spinal surgery products in Europe, Canada, Japan, South America,
Australia, Korea, Mexico, Middle East, Taiwan; to market our general surgery
products in Europe, Canada, Middle East, Korea, South America, and Taiwan; and
to market neurosurgery and urology products in Europe, but we have not obtained
any other international regulatory approvals in other international markets. We
cannot assure you that we will obtain such clearances and approvals on a timely
basis, or at all.
For European distribution, we have received ISO 9001/EN46001 certification
and the EC 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. During the years ended December 31, 2001
and December 31, 2000, approximately 17% and 14%, respectively, of our sales
were derived internationally.
Product Liability Risk and Insurance Coverage
15
The development, manufacture and sale of medical products entail
significant risk of product liability claims. Our current product liability
insurance coverage limits are $10,000,000 per occurrence and $10,000,000 in the
aggregate. We cannot assure you that such coverage limits are adequate to
protect us from any liabilities we might incur in connection with the
development, manufacture and sale of our products. In addition, we may require
increased product liability coverage as products are successfully commercialized
in additional applications. Product liability insurance is expensive and in the
future may not be available to us on acceptable terms, if at all. A successful
product liability claim or series of claims brought against us in excess of our
insurance coverage could have a material adverse effect on our business,
financial condition, results of operations and prospects.
Employees
As of December 29, 2001, we had 286 employees of which 120 people were
engaged in manufacturing activities, 27 people were engaged in research and
development activities, 90 people were engaged in sales and marketing
activities, 25 people were engaged in regulatory affairs and quality assurance
and 24 people were engaged in administration and finance. No employees are
covered by collective bargaining agreements, and we believe we maintain good
relations with our employees.
We are dependent upon a number of key management and technical personnel.
The loss of the services of one or more key employees or consultants could have
a material adverse effect on us. Our success also depends on our ability to
attract and retain additional highly qualified management and technical
personnel. We face intense competition for qualified personnel, many of whom
often receive competing employment offers. We cannot assure you that we will
continue to be able to attract and retain such personnel. Furthermore, our
scientific advisory board members are all otherwise employed on a full-time
basis. As a result, the scientific advisory board members are not available to
devote their full time or attention to our affairs.
Facilities
We lease an approximately 52,000 square foot facility in Sunnyvale,
California for administrative offices, research and development, general and
administrative purposes, manufacturing, warehousing, and distribution. Our lease
for the building will expire in September 2006.
We also leased approximately 32,000 square feet in two neighboring
buildings in Sunnyvale, California for the same purposes as above. Both these
leases expired in February 2002, and these buildings are no longer occupied by
our company.
We are leasing an approximately 23,000 square foot building in Costa Rica
for manufacturing and distribution. We believe that the two newly leased
facilities will be sufficient for operational purposes through 2005.
We also lease an approximately 3,300 square foot building in Stockholm,
Sweden for administrative and sales and marketing purposes.
ADDITIONAL FACTORS THAT MIGHT AFFECT FUTURE RESULTS
We Are Dependent Upon Our Arthroscopic System
We commercially introduced our Arthroscopic System in December 1995. Since
our Arthroscopic System accounted for 83% of our product sales in 2001 we are
highly dependent on its sales. We have only recently began to market our spinal
surgery, neurosurgery, cosmetic surgery, ENT surgery, and general surgery
products and to date, we have sold only a small number of units. We cannot
assure you that we will be able to continue to manufacture arthroscopy products
in commercial quantities at acceptable costs, or that we will be able to
continue to market such products successfully.
To achieve increasing disposable device sales over time, we believe we must
continue to penetrate the market in knee procedures, expand physicians'
education with respect to Coblation technology and continue working on new
product development efforts specifically for knee applications. Furthermore, in
order to maintain and increase current market penetration we must be aggressive
in increasing our installed base of controllers to generate increased disposable
device revenue. To date, we have priced our arthroscopic controllers at
substantial discounts in order to stimulate demand for our disposable devices.
We believe that surgeons will not use our products unless they determine,
based on experience, clinical data and other factors, that these systems are an
attractive alternative to conventional means of tissue ablation. There are only
a few independently published clinical reports and limited long-term clinical
follow-up to support the marketing efforts for our Arthroscopic System. We
believe that continued recommendations and endorsements by influential
arthroscopic surgeons are essential for market acceptance of our Arthroscopic
System. If our Coblation technology does not continue to receive endorsement by
influential surgeons or long-term data does not support our current claims of
efficacy, our business, financial condition, results of operations and future
growth prospects could be materially adversely affected.
Commercial Success of Our Non-Arthroscopic Products Is Uncertain
We have developed several applications for our Coblation technology in
spinal and neurosurgery, ENT surgery, cosmetic surgery, gynecology, urology, and
general surgery. Additionally we have established a program to explore the
application of our Coblation technology in various areas within cardiology. Our
products for these non-arthroscopic indications are in various stages of
commercialization and development, and we may be required to undertake
time-consuming and costly commercialization, development and additional
regulatory approval activities. If we do not receive future clearances we may be
unable to market these and other products for specific indications and
16
our business, financial condition, results of operations and future growth
prospects could be materially adversely affected. We cannot assure you that
product development will ever be successfully completed, that regulatory
clearances or approvals, if applied for, will be granted by the FDA or foreign
regulatory authorities on a timely basis, if at all, or that the products will
ever achieve commercial acceptance.
We may have to make a significant investment in additional preclinical and
clinical testing, regulatory, physician training and sales and marketing
activities to further develop and commercialize our spinal surgery,
neurosurgery, gynecology, urology, cosmetic surgery, ENT surgery, general
surgery and cardiology product lines. Although we believe that these products
offer certain advantages, we cannot assure you that these advantages will be
realized, or if realized, that these products will result in any meaningful
benefits to physicians or patients.
Development and commercialization of our current and future
non-arthroscopic products are subject to the risks of failure inherent in the
development of new medical devices. These risks include the following:
. such products may not be easy to use, will require extensive training
or may not be cost-effective;
. new products may experience delays in testing or marketing;
. there may be unplanned expenditures or in expenditures above those
anticipated by us;
. such products will not be proven safe or effective;
. third parties may develop and market superior or equivalent products;
. such products may not receive necessary regulatory clearances or
approvals;
. such products may be difficult or uneconomical to manufacture for
commercial sale; and
. proprietary rights of third parties may preclude us and our
collaborative partners from marketing such products.
In addition, the success of our non-arthroscopic products will depend on
their adoption as alternatives to conventional means of tissue ablation.
Clinical experience and follow-up data for our non-arthroscopic indications are
limited, and we have sold only a small number of units to date. We believe that
recommendations and endorsement of influential physicians are essential for
market acceptance of our products.
For information regarding the status of our regulatory approvals for our
products, see the information under the heading "Government Regulation."
We Have Limited Marketing and Sales Experience
We currently have limited experience in marketing and selling our products.
To the extent that we have established or will enter into distribution
arrangements for the sale of our products, we are and will be dependent upon the
efforts of third parties. We are marketing and selling our arthroscopic surgery,
spinal surgery, neurosurgery, ENT surgery, cosmetic surgery and general surgery
product lines in the United States through a network of independent distributors
supported by regional sales managers and a direct sales force. These
distributors sell arthroscopy, spinal surgery, neurosurgery, ENT surgery,
cosmetic surgery and general surgery devices for a number of other
manufacturers. We cannot assure you that these distributors will commit the
necessary resources to effectively market and sell our arthroscopic surgery,
spinal surgery, neurosurgery, ENT surgery, cosmetic surgery or general surgery
product lines, or that they will be successful in selling our products.
We have recently established a marketing presence in various countries and
we cannot assure you that these newly established operations will be successful.
In order to successfully market our products internationally, we will need to
address many issues with which we have little or no experience, including the
securing of necessary regulatory approvals in international markets and the
potential reuse of our disposable devices by our customers. Even if we are able
to successfully deal with these issues, we cannot assure you that we will be
able to establish successful distribution capabilities internationally or
receive favorable pricing for our products. In addition, we may face currency
exchange risks as part of our international expansion. To the extent our
marketing and sales efforts are unsuccessful, our business, financial condition,
results of operations and future growth prospects may be materially adversely
affected.
We Have Limited Manufacturing Experience
To be successful, we must manufacture our products in commercial
quantities in compliance with regulatory requirements at acceptable costs. At
the present time, we have limited manufacturing experience. Our manufacturing
operations consist of an in-house assembly operation for the manufacture of
disposable devices and controllers. We currently produce more than 66 models of
disposable devices utilizing different functionalities, including suction and
fluid management. As we increase the number of product designs for our
disposable devices, the complexity of our manufacturing processes will increase.
We manufacture several different controller models. Although the manufacturing
processes for the controllers designed to date are substantially the same, we
cannot be certain that we will be able to continue to manufacture these
controllers without additional expense and capabilities. We could also encounter
difficulties in manufacturing our
17
current or future products which could reduce yields, result in supply
disruptions and adversely affect our gross margins. If we have delays in
manufacturing, we will not have adequate finished inventory to meet our needs.
If our quality assurance programs do not continue to meet the demands of the
complexity and capacity of the products we manufacture, we may experience
product returns.
We Are Dependent on Key Suppliers
We depend on two sole source suppliers for many of our product components,
including two components that we include in substantially all of our disposable
devices. If the supply of materials from a sole source supplier were
interrupted, replacement or alternative sources might not be readily obtainable
due to the regulatory requirements applicable to our manufacturing operations.
In addition, a new or supplemental filing with applicable regulatory authorities
may require clearance prior to our marketing a product containing new material.
This clearance process may take a substantial period of time and we cannot
assure you that we would be able to obtain the necessary regulatory approval for
the new material to be used in our products on a timely basis, if at all. This
could create supply disruptions that would materially adversely affect our
business, financial condition, results of operations and future growth
prospects.
In addition, we use a single subcontractor, using two facilities, to
sterilize the disposable devices. We cannot assure you that we can identify and
qualify an alternate sterilizer. Our inability to secure an alternative
sterilizer, if required, would limit our ability to manufacture disposable
devices and could have a material adverse effect on our business, financial
condition, results of operations and future growth prospects.
We Face Intense Competition
The markets for our current and potential products are intensely
competitive. These markets include arthroscopy, spinal surgery, neurosurgery,
ENT surgery, cosmetic surgery, gynecology, urology, general surgery and
cardiology. We cannot assure you that other companies will not succeed in
developing technologies and products that are more effective than ours or that
would render our technology or products obsolete or uncompetitive in these
markets.
In arthroscopy, we compete against companies, such as Johnson &
Johnson, Smith & Nephew, Inc., Conmed Corporation, Stryker Corp. and Oratec
Interventions, Inc., which market products to remove or shrink tissue.
Specifically, Johnson & Johnson, Smith & Nephew and Stryker are currently
marketing worldwide bipolar electrosurgical systems for tissue ablation and
shrinkage based upon technology licensed by us. We are also aware of additional
competitors that may commercialize products using technology similar to ours. In
spinal surgery, we compete against companies which market products to remove
tissue and treat spinal disorders. In addition, Oratec is currently marketing a
percutaneous thermal heating product for treating certain types of disc pain. In
ENT surgery, we compete against companies that offer manual instruments, such as
Smith & Nephew, Inc., Stryker Corp., Conmed Corporation, and Xomed Surgical
Products, Inc., which was acquired by Medtronic, Inc. In addition, we compete
with companies that develop and market lasers for various ENT surgery
applications, including Lumenis. Smaller companies, including Somnus Medical
Technologies Inc., Elmed Inc. and Ellman International, Inc., also sell medical
devices for the treatment of various ENT disorders, including snoring and
obstructive sleep apnea. In cosmetic surgery, we compete against companies, such
as Lumenis, which markets lasers for use in this field. In addition, other large
companies manufacture and sell medical devices that use radio frequency energy
for certain applications in dermatology and cosmetic surgery. In cardiology, we
compete with companies which use lasers to treat cardiovascular disease. Other
approaches to alleviating cardiovascular disease, including drugs or other
surgical approaches, are also competitive with our products.
Many of our competitors have significantly greater financial,
manufacturing, marketing, distribution and technical resources than we do. Some
of these companies offer broad product lines that they may offer as a single
package and frequently offer significant discounts as a competitive tactic. For
example, in order to compete successfully, we anticipate that we may have to
continue to offer substantial discounts on our controllers in order to increase
demand for our disposable devices, and that this competition could have a
material adverse effect on our business, financial condition, results of
operations and future growth prospects. Furthermore, some of our competitors
utilize purchasing contracts that link discounts on the purchase of one product
to purchases of other products in their broad product lines. Many of the
hospitals in the United States have purchasing contracts with our competitors.
Accordingly, customers may be dissuaded from purchasing our products rather than
the products of these competitors to the extent the purchase would cause them to
lose discounts on products.
We Face Uncertainty Over Reimbursement
Failure by physicians, hospitals and other users of our products to obtain
sufficient reimbursement from health care payors for procedures in which our
products are used or adverse changes in governmental and private third-party
payors' policies toward reimbursement for such procedures would have a material
adverse effect on our business, financial condition, results of operations and
future growth prospects. Reimbursement for arthroscopic, spinal surgery,
neurosurgery, ENT surgery gynecology, urology and general surgery procedures
performed using devices that have received FDA clearance has generally been
available in the United States. Typically, cosmetic surgery procedures are not
reimbursed.
We are unable to predict what changes will be made in the reimbursement
methods used by third-party health care payors. In addition, some health care
providers are moving toward a managed care system in which providers contract to
provide comprehensive health care for a fixed cost per person. Managed care
providers are attempting to control the cost of health care by authorizing fewer
elective surgical
18
procedures. We anticipate that in a prospective payment system, such as the
diagnosis related group system utilized by Medicare, and in many managed care
systems used by private health care payors, the cost of our products will be
incorporated into the overall cost of the procedure and that there will be no
separate, additional reimbursement for our products.
If we obtain the necessary international regulatory approvals, market
acceptance of our products in international markets would be dependent, in part,
upon the availability of reimbursement within prevailing health care payment
systems. Reimbursement and health care payment systems in international markets
vary significantly by country and include both government-sponsored health care
and private insurance. We intend to seek international reimbursement approvals,
although we cannot assure you that any such approvals will be obtained in a
timely manner, if at all.
Our Business Depends on Attracting and Retaining Collaborators and Licensors
In order to successfully develop and commercialize certain products, we may
enter into collaborative or licensing arrangements with medical device companies
and other entities to fund and complete our research and development activities,
pre-clinical and clinical testing, manufacturing, regulatory approval activities
and to achieve successful commercialization of future products. In addition, we
have entered into a distribution agreement with Integra Neurosciences to market
and sell our Coblation-based products for neurosurgery and with GyneCare and
ACMI to market and sell our gynecology and urology products, respectively. See
the information under the heading "Collaborative Arrangements" for a discussion
of these arrangements.
Our participation in collaborative and licensing arrangements with third
parties subjects us to a number of risks. Collaborative partners typically have
significant discretion in electing whether to pursue any of the planned
activities. We cannot control the amount and timing of resources our
collaborative partners may devote to our products, and we cannot assure you that
our partners will perform their obligations as expected. Business combinations
or significant changes in a corporate partner's business strategy may adversely
affect that partner's ability to meet its obligations under the arrangements. If
a collaborative partner were to terminate or breach its agreement with us, or
otherwise fail to complete its obligations in a timely manner, our business,
financial condition, results of operations and prospects would be materially
adversely affected. To the extent that we are not able to establish further
collaborative arrangements or that any or all of our existing collaborative
arrangements are terminated, we would be required to seek new collaborative
arrangements or to undertake commercialization at our own expense, which could
significantly increase our capital requirements, place additional strain on our
human resource requirements and limit the number of products which we would be
able to develop and commercialize. In addition, we cannot assure you that our
existing and future collaborative partners will not pursue alternative
technologies or develop alternative products either on their own or in
collaboration with others, including our competitors.
We cannot assure you that disputes will not arise in the future with
respect to the ownership of rights to any technology or products developed with
any collaborative partner. Lengthy negotiations with potential new collaborative
partners or disagreements between established collaborative partners and us
could lead to delays in or termination of the research, development or
commercialization of certain products or result in litigation or arbitration
that would be time consuming and expensive. Failure by any collaborative partner
to commercialize successfully any product to which it has obtained rights from
us, or the decision by a collaborative partner to pursue alternative
technologies or commercialize or develop alternative products, either on its own
or in collaboration with others, could have a material adverse effect on our
business, financial condition, results of operations and future growth
prospects.
Our Operating Results Will Fluctuate
We achieved profitability in 1999 and, as of December 29, 2001, we had an
accumulated deficit of $0.3 million. Results of operations may fluctuate
significantly from quarter to quarter due to many factors, including the
following:
. the introduction of new product lines;
. increased penetration in existing applications;
. product returns;
. achievement of research and development milestones;
. the amount and timing of receipt and recognition of license fees;
. manufacturing or supply disruptions;
. timing of expenditures;
. absence of a backlog of orders;
. receipt of necessary regulatory approvals;
19
. the level of market acceptance for our products;
. timing of the receipt of orders and product shipments; and
. promotional programs for our products.
We cannot assure you that future quarterly fluctuations will not adversely
affect our business, financial condition, results of operations or future growth
prospects. Our revenues and profitability will be critically dependent on
whether or not we can successfully continue to market our Coblation-based
technology product lines. We cannot assure you that we will maintain or increase
our revenues or level of profitability.
We May Be Unable to Effectively Protect Our Intellectual Property
Our ability to compete effectively depends in part on developing and
maintaining the proprietary aspects of our Coblation technology. We believe that
our issued patents are directed at the core technology used in our soft-tissue
surgery systems, including both multi-electrode and single electrode
configurations of our disposable devices, as well as the use of Coblation
technology in specific surgical procedures.
We cannot assure you that the patents we have obtained, or any patents we
may obtain as a result of our pending U.S. or international patent applications,
will provide any competitive advantages for our products. We also cannot assure
you that those patents will not be successfully challenged, invalidated or
circumvented in the future. In addition, we cannot assure you that competitors,
many of which have substantial resources and have made substantial investments
in competing technologies, have not already applied for or obtained, or will not
seek to apply for and obtain, patents that will prevent, limit or interfere with
our ability to make, use and sell our products either in the United States or in
international markets. Patent applications are maintained in secrecy for a
period after filing. We may not be aware of all of the patents and patent
applications potentially adverse to our interests.
A number of medical device and other companies and universities and
research institutions have filed patent applications or have issued patents
relating to monopolar and/or bipolar electrosurgical methods and apparatus. We
have received, and we may receive in the future, notifications of potential
conflicts of existing patents, pending patent applications and challenges to the
validity of existing patents. In addition, we have become aware of, and may
become aware of in the future, patent applications and issued patents that
relate to our products and/or the surgical applications and issued patents and,
in some cases, have obtained internal and/or external opinions of counsel
regarding the relevance of certain issued patents to our products. We do not
believe that our products currently infringe any valid and enforceable claims of
the issued patents that we have reviewed. However, if third-party patents or
patent applications contain claims infringed by our technology and such claims
are ultimately determined to be valid, we may not be able to obtain licenses to
those patents at a reasonable cost, if at all, or be able to develop or obtain
alternative technology. Our inability to do either would have a material adverse
effect on our business, financial condition, results of operations and
prospects. We cannot assure you that we will not have to defend ourselves in
court against allegations of infringement of third-party patents, or that such
defense would be successful.
In addition to patents, we rely on trade secrets and proprietary know-how,
which we seek to protect, in part, through confidentiality and proprietary
information agreements. We require our key employees and consultants to execute
confidentiality agreements upon the commencement of an employment or consulting
relationship with us. These agreements generally provide that all confidential
information, developed or made known to the individual during the course of the
individual's relationship with us, is to be kept confidential and not disclosed
to third parties. These agreements also generally provide that inventions
conceived by the individual in the course of rendering services to us shall be
our exclusive property. We cannot assure you that employees will not breach such
agreements, that we would have adequate remedies for any breach or that our
trade secrets will not otherwise become known to or be independently developed
by competitors.
We May Become Subject to Patent Litigation
The medical device industry has been characterized by extensive litigation
regarding patents and other intellectual property rights, and companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. We cannot assure you that we will not become subject to
patent infringement claims or litigation or interference proceedings declared by
the United States Patent and Trademark Office, the USPTO, to determine the
priority of inventions. In February 1998, we filed a lawsuit against Ethicon,
Inc., Mitek Surgical Products, a division of Ethicon, Inc., and GyneCare, Inc.
alleging, among other things, infringement of several of our patents. The
parties subsequently settled this lawsuit. Under the terms of the settlement,
Ethicon, Inc. has licensed a portion of our U.S. patents for current products in
the arthroscopy and gynecology markets. The settlement agreement also
established a procedure for resolution of certain potential intellectual
property disputes in these two markets without litigation. Under this procedure,
the licenses granted in the Ethicon settlement have been extended to Australia,
Canada and Japan. In June 2000, we filed a lawsuit against Stryker, alleging
infringement of several of our patents. The lawsuit has been settled. In July
2000, we filed a lawsuit against Smith & Nephews alleging infringement of
several of our patents.
Defending and prosecuting intellectual property suits, USPTO interference
proceedings and related legal and administrative proceedings are costly and
time-consuming. Further litigation may be necessary to enforce our patents, to
protect our trade secrets or know-how or to determine the enforceability, scope
and validity of the proprietary rights of others. Any litigation or interference
proceedings will be costly and will result in significant diversion of effort by
technical and management personnel. An adverse determination in any of the
litigation or interference proceedings to which we may become a party could
subject us to significant liabilities to third parties, require us to license
disputed rights from third parties or require us to cease using such technology,
which would have a material adverse effect on our business, financial condition,
results of operations and future growth prospects. Patent and intellectual
property disputes in the medical device area
20
have often been settled through licensing or similar arrangements, and could
include ongoing royalties. We cannot assure you that we can obtain the necessary
licenses on satisfactory terms, if at all.
The Market Price of Our Stock May Be Highly Volatile
During the fiscal year ended December 29, 2001 our common stock has traded
between a range of $12.06 and $32.60 per share. The market price of our common
stock could continue to fluctuate substantially due to a variety of factors,
including:
. quarterly fluctuations in results of our operations;
. our ability to successfully commercialize our products;
. announcements regarding results of regulatory approval filings,
clinical studies or other testing, technological innovations or new
commercial products by us or our competitors;
. developments concerning government regulations, proprietary rights or
public concern as to the safety of technology;
. the execution of new collaborative agreements and material changes in
our relationships with our business partners;
. market reaction to acquisitions and trends in sales, marketing, and
research and development;
. changes in coverage or earnings estimates by analysts;
. sales of common stock by existing stockholders; and
. economic and political conditions.
The market price for our common stock may also be affected by our ability
to meet analysts' expectations. Any failure to meet such expectations, even
slightly, could have an adverse effect on the market price of our common stock.
In addition, the stock market is subject to extreme price and volume
fluctuations. This volatility has had a significant effect on the market prices
of securities issued by many companies for reasons unrelated to the operating
performance of these companies. In the past, following periods of volatility in
the market price of a company's securities, securities class action litigation
has often been instituted against the company. If similar litigation were
instituted against us, it could result in substantial costs and a diversion of
our management's attention and resources, which could have an adverse effect on
our business, results of operations and financial condition. See "Item 5. Market
for Registrant's Common Equity and Related Stockholder Matters."
Delaware Law, Provisions in Our Charter and Our Stockholder Rights Plan Could
Make the Acquisition of Our Company By Another Company More Difficult
Our stockholder rights plan and certain provisions of our certificate of
incorporation and bylaws may have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from attempting to
acquire, control of our company. This could limit the price that certain
investors might be willing to pay in the future for shares of our common stock.
Some provisions of our certificate of incorporation and bylaws allow us to issue
preferred stock without any vote or further action by the stockholders, to
eliminate the right of stockholders to act by written consent without a meeting,
to specify procedures for director nominations by stockholders and submission of
other proposals for consideration at stockholder meetings, and to eliminate
cumulative voting in the election of directors. Some provisions of Delaware law
applicable to us could also delay or make more difficult a merger, tender offer
or proxy contest involving us, including Section 203, which prohibits a Delaware
corporation from engaging in any business combination with any interested
stockholder for a period of three years unless certain conditions are met. Our
stockholder rights plan, the possible issuance of preferred stock, the
procedures required for director nominations and stockholder proposals and
Delaware law could have the effect of delaying, deferring or preventing a change
in control of ArthroCare, including without limitation, discouraging a proxy
contest or making more difficult the acquisition of a substantial block of our
common stock.
We Must Obtain Governmental Clearances Or Approvals Before We Can Sell Our
Products; We Must Continue To Comply With Applicable Laws and Regulations.
United States
Our products are considered medical devices and are subject to extensive
regulation in the United States. We must obtain premarket clearance or approval
by the FDA for each of our products and indications before they can be
commercialized. FDA regulations are wide ranging and govern, among other things:
21
. product design and development;
. product 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:
. warning letters;
. fines, injunctions and civil penalties against us;
. recall or seizure of our products;
. operating restrictions, partial suspension or total shutdown of our
production;
. refusal of our requests for premarket clearance or approval of new
products;
. withdrawal of product approvals already granted; and
. criminal prosecution.
Generally, before we can introduce a new medical device into the United
States market, we must obtain FDA clearance of a 510(k) premarket notification
or approval of a premarket approval application, or PMA application. If we can
establish that our device is "substantially equivalent" to a "predicate device,"
i.e., a legally marketed Class I or Class II device or a preamendment Class III
device (i.e., one that was in commercial distribution before May 28, 1976) for
which the FDA has not called for PMAs, we may seek clearance from the FDA to
market the device by submitting a 510(k) premarket notification. The 510(k)
premarket notification will need to be supported by appropriate data, including,
in some cases, clinical data, establishing the claim of substantial equivalence
to the satisfaction of the FDA.
We have received 510(k) clearance to market our Arthroscopic System for
surgery of the knee, shoulder, elbow, wrist, hip and ankle joints. We have
received 510(k) clearance in the United States to market our Spinal Surgery
System. In addition, we have received 510(k) clearance to market our Cosmetic
Surgery System in general dermatology procedures and for skin resurfacing for
the purpose of wrinkle reduction. We have received 510(k) clearance to market
our ENT Surgery System in general head, neck and sinus surgical procedures, as
well as the treatment of snoring, hypertrophic turbinates and submucosal
channelling. We cannot assure you that we will be able to obtain necessary
clearances or approvals to market any other products, or existing products for
new intended uses, on a timely basis, if at all. Delays in receipt or failure to
receive clearances or approvals, the loss of previously received clearances or
approvals, or failure to comply with existing or future regulatory requirements
could have a material adverse effect on our business, financial condition,
results of operations and future growth prospects.
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 the intended use of the device, requires a new 510(k) clearance.
The FDA requires each manufacturer to make this determination in