ArthroCare Corporation



680 Vaqueros Avenue
Sunnyvale, California 94085-3523
U.S.A.
Telephone: (408) 736-0224
Toll Free: (800) 348-8929
Fax: (408) 736-0226
Web site: http://www.arthrocare.com

Public Company
Incorporated: 1993
Employees: 643
Sales: $147.8 million (2004)
Stock Exchanges: NASDAQ
Ticker Symbol: ARTC
NAIC: 334510 Navigational, Measuring, Electromedical, and Control Instruments Manufacturing

Based in Sunnyvale, California, ArthroCare Corporation is a medical device company, relying mostly on its patented Coblation technology. Coblation-based products use radiofrequency energy to dissolve soft tissue without burning, unlike other radiofrequency-based products, like lasers, that are heat-driven. ArthroCare organizes its business around four medical specialties. The ArthroCare Sports Medicine unit is devoted to products used in arthroscopic joint surgery, the company's first application for Coblation. It has found a ready market among surgeons using single-use ArthroWands repairing the knees and shoulders of athletes. The division also treats chronic tendon pain through the TOPAZ procedure. The ArthroCare Spine unit uses the company's minimally invasive DISC Nucleoplasty procedure to treat back conditions such as herniated discs. In addition, vertebral compression fractures and spinal tumors can be treated with the CAVITY SpineWand. The ArthroCare ENT business unit leverages Coblation technology to perform tonsillectomies as well as procedures to address disorders such as chronic stuffy noses and problem snoring. The unit also represents the company's cosmetic surgery product line, which offers a wrinkle-reducing procedure that rivals laser techniques. Finally, the Coblation business unit looks to develop new devices for laparoscopic and general surgical procedures. In addition to Sunnyvale, the company also maintains a campus in Austin, Texas, a manufacturing plant in Costa Rica, and an international office in Stockholm, Sweden. ArthroCare is a public company listed on the NASDAQ.

Company Founding in the Early 1990s

ArthroCare was founded in 1993 by Hira V. Thapliyal and Philip E. Eggers. Born in India, Thapliyal received his higher education in the United States, earning a B.S. in electrical engineering from Washington State University, followed by an M.S. in electrical engineering from the University of Idaho and a Ph.D. in materials science and engineering from Cornell University. Before teaming up with Eggers, Thapliyal gained experience in the medical device field while working for Vascular Interventions, maker of atherectomy systems. In 1986 he cofounded Cardiovascular Imaging Systems, Inc., a company that developed catheters for the ultrasonic intraluminal imaging of human arteries. Three years later he became CEO of Micro-Bionics, Inc. Eggers came to the medical devices industry from a different direction, earning an M.S. in physics and an M.B.A. from Ohio State University. He then went to work at Battelle Columbus Laboratories, where he spent a dozen years involved in both the nuclear and medical fields.

When Thapliyal and Eggers began working together their goal was to find a way to use electrosurgical energy to unblock coronary arteries. Hence, the original name of their company was Angiocare. But an accidental discovery changed the direction their start-up company would take. Typical electrosurgical tools drove energy through tissue, which was then burned away, but Thapliyal and Eggers, working with conductive fluid, became puzzled by the results they were getting. Although tissue was clearly being removed, they could find no evidence of burned edges. After some investigation they realized that the radiofrequency energy they were using had ionized the electrolytes in the conductive fluid, and these ions in turn possessed enough energy to break down the molecules of the soft tissue, essentially dissolving the tissue without generating enough heat to burn surrounding areas. It was apparent that this phenomenon held great promise, since it offered surgeons greater precision than could be found with traditional electrosurgical instruments, lasers, or even scalpels.

Although the partners were excited by the Coblation technology they had stumbled upon (it could be used to clear a clogged artery without causing harm to surrounding tissue) they began having second thoughts about trying to enter the highly competitive cardiac product field, requiring a great deal of seed money and years to gain FDA approval. Instead they decided to look for surgical applications in which precision was a major selling point and settled on arthroscopic joint surgery. Arthroscopy's $600 million market may have been dwarfed by cardiology's $10 billion market, but it was a field that had not seen a new development in quite a few years and regulatory approval could be gained in a few months. Thus when Thapliyal and Eggers incorporated their new company in April 1993 they called it ArthroCare Corporation, originally based in Sunnyvale, California. Thapliyal served as the company's initial president and chief executive officer.

In 1995 ArthroCare had completed the development of a commercial product using Coblation technology. The company hired a number of doctors as consultants and they began spreading the word throughout the arthroscopy field that an exciting new product was on the horizon. As a result, when ArthroCare unveiled its first Coblation wands at an arthroscopy trade show in 1996 a crowd of surgeons circled the company's booth. In short order the company had the foundation of a sales and distribution network in place and began selling its product. The initial marketing approach was simple yet effective: Surgeons were given a chance to use the product for free on surgeries they already had scheduled. Once they tried the wands, they were convinced of the product's efficacy and asked their hospitals to buy the controlling devices and supply the single-use wands. Sports medicine was one of the early users of the product, since athletes undergoing arthroscopic surgery could reduce their recovery times and be back in action much quicker and with less pain.

Going Public in the Mid-1990s

In the fall of 1995 the company began the process of going public, reincorporating in Delaware, and then in December filing with the Securities and Exchange Commission (SEC). The initial public offering of stock, managed by San Francisco investment banks Robertson, Stephens & Co. LLC and Volpe, Welty & Co., was conducted in early February 1996, selling more than 2.5 million shares of common stock at $14 per share and netting nearly $32 million. After sales of just $200,000 in 1995, ArthroCare began making significant inroads into the arthroscopic market during its first full year in operation. By the end of 1996 it had a 2 percent market share, resulting in sales of $6 million. Close to 600 controllers were installed and more than 40,000 disposable wands were shipped. Already the Coblation device was being used in more than 10 percent of all arthroscopic rotator cuff procedures done on shoulders in the United States.

ArthroCare received a patent on its Coblation technology in 1997. Sales continued to mount and new markets were beginning to open up, but to achieve the kind of growth its founders envisioned it was time to bring in a more seasoned executive to take the business to the next stage in its development. In July 1997 Michael A. Baker replaced Thapliyal as president and CEO. A graduate of West Point with an M.B.A. from the University of Chicago, Baker had managed the coronary angioplasty unit at giant Medtronic, Inc., where he spent eight years and played a key role in the development and commercialization of a number of medical products. After Baker joined ArthroCare, Thapliyal stayed on as chief technology officer (CTO) and Eggers remained involved on a consulting basis. Fourteen months later Thapliyal retired as CTO, turning his attention to other projects.

Baker continued the strategy of identifying new medical applications for the Coblation technology, focusing on areas in which precision was at a premium and the elimination of collateral damage important. The company decided to revisit cardiology. About six months after Baker took over, ArthroCare forged a partnership with Boston Scientific to develop a Coblation system suitable for cardiac surgery. Several months later the two partners began to look for ways to apply the technology to ear, nose, and throat surgery. ArthroCare then formed an alliance with medical device company Inamed Corp. to become involved in cosmetic surgery. In early 2000 ArthroCare received FDA approval for its method of facial resurfacing, that is, wrinkle reducing. Also in 2000, the company introduced DISC Nucleoplasty to treat herniated back discs by inserting a Coblation needle into the center of a bulging disc and removing some of the tissue, with the goal of returning the disc to its normal size and reducing the pressure on nerves that often caused patients severe leg pain. The procedure required local anesthesia only and could be done in less than an hour.

Although ArthroCare enjoyed rapid growth during the late 1990s and into the 2000s, it also faced challenges on a myriad of fronts. It had to turn to the court system to protect the patent on its technology. In 1998 it sued Ethicon Inc., a Johnson & Johnson medical device maker involved in fields such as sports medicine. The two sides settled in July 1999 with Ethicon agreeing to license some of ArthroCare's technology. In addition to Johnson & Johnson, ArthroCare had to contend with other well-funded companies such as the United Kingdom's Smith & Nephew and Oratec Interventions. In the cosmetic surgery field the company faced a market saturated with alternative procedures, leaving little revenue potential despite the effectiveness of ArthroCare's method.

Company Perspectives:

Millions of people undergo tissue surgery worldwide each year. Our Coblation technology offers an alternative to standard surgical techniques for removing and treating tissue.

Accounting Concerns in the Late 1990s

Although the company had branched into a variety of fields, arthroscopic surgery continued to supply the bulk of sales. Revenues essentially doubled each year, improving to $12.8 million in 1997, $24.6 million in 1998, and $44.2 million in 1999, before tapering off in 2000 when the company posted sales of $64 million. But questions were being raised about ArthroCare possibly inflating its numbers, due to the company's policy of booking all licensing and royalty fees from multiyear contracts at the time of signing. As a result, ArthroCare in 1999 showed a profit for the first time. According to an October 2000 Forbes article, the company's "stock, which had been dragging along at around $6 per share, took off. After it hit its high of $62 in late February, Chief Executive Michael Baker began unloading shares, reaping $10.6 million." ArthroCare was not the only company that accounted for licensing in the way it did, prompting the SEC to crack down on the practice, implementing a new accounting rule that called for licensing fees, and royalties (if applicable), to be recognized over the life of the contract. The company announced that it would begin to spread out revenues starting with the first quarter of 2000, but what Forbes called the "day of reckoning" kept getting pushed back later into the year. The SEC mandated that the accounting change begin no later than the fourth quarter.

In 2001 ArthroCare received approval to use Coblation technology to remove tonsils, opening up yet another source of revenues. But the company had now reached a crossroads in its history; management had to determine the best way to take the company to the next level, whether to sell the business to a giant rival or commit the necessary funds to augment the company's infrastructure to support continued growth. In the end, the decision was to remain independent. With almost $100 million in cash at its disposal, the company began making a number of long-term investments that resulted in a short-term drag on profits, which management hoped would hit $13 million in 2002 after reaching $10 million the prior year. Instead, net income totaled just $1.1 million on sales of $85 million. Primary reasons for the shortfall was the hiring of a sales force to free the company from its dependence on U.S. and European distributors to become more involved in direct sales, and the cost of building a new manufacturing plant in Costa Rica. Previously, ArthroCare relied on suppliers who did subassembly in Mexico. In addition, the company vacated its headquarters-manufacturing facility for a new Sunnyvale campus offering twice as much space. Unfortunately, the transition was costly and took longer than expected. The balance sheet also was adversely impacted by the unexpected write-off of inventory. Once the company worked through this transitional phase, profits improved, approaching $7.5 million in 2003 on revenues of nearly $115 million.

ArthroCare continued to build research partnerships with other companies. It worked with Johnson & Johnson to develop gynecology products and teamed up with Lawrence Berkeley Laboratories and a pair of Russian institutes, the High Current Electronics Institute and the Russian States Research Center Troitsk Institute for Innovation and Fusion Research, to find more applications for Coblation. ArthroCare also became active on the acquisitions front in the early 2000s. To build on its direct sales efforts in the sports medicine field, it acquired Atlantech Medical Devices, Ltd. and its sister companies in Germany and Australia, which had distributed Arthrocare's products in the United Kingdom, Germany, and Austria. In 2004 ArthroCare completed a pair of significant acquisitions. First it bought Medical Device Alliance along with subsidiary Parallax Medical, Inc., which brought with it the back treatment method of percutaneous injections of bone cement and bone augmentation. In addition, ArthroCare gained the distribution rights to a line of medical screws used in arthroscopy, thus helping the company to round out its product line in the United States. Because of the addition of Parallax's technology, ArthroCare launched a concerted effort to market its spine surgery product lines around the world. In November 2004 ArthroCare acquired Opus Medical in a $130 million cash and stock deal, adding an anchoring system, AutoCuff, to help surgeons more easily use ArthroCare wands while performing arthroscopic rotator cuff surgery.

Sales approached $150 million in 2004, but it was very likely that ArthroCare was just beginning to realize its potential as its Coblation technology continued to find new applications.

Principal Subsidiaries

AngioCare Corporation; ArthroCare Costa Rica S.R.L.; Atlantech Medical Devices Ltd.; Medical Device Alliance Inc.; Parallax Medical, Inc.

Principal Competitors

Smith & Nephew PLC; Tyco Healthcare Group; United States Surgical Corporation.

Key Dates:

1993:
The company is founded.
1995:
The company's first sales are recorded.
1996:
Arthrocare completes its initial public offering of stock.
1997:
Michael Baker is named president and CEO.
2004:
Significant acquisitions include those of Medical Device Alliance, along with its subsidiary Parallax Medical, Inc., and Opus Medical.

Further Reading

Austin, Deborah, "New Medical Technology Builds ArthroCare's Revenues," Industry Week Midmarket , March 3, 2000.

Chandler, Michele, "Sunnyvale, Calif., Scalpel Seller Maps High-Stakes Strategy of Independence," San Jose Mercury News , November 12, 2003.

Keeney, Jennifer, and Andrew Rafalaf, "Ready to Run," Fortune Small Business , May 2002, p. 32.

MacDonald, Elizabeth, "Jam Today or Jam Tomorrow," Forbes , October 30, 2000, p. 64.

Moore, Brenda L., "ArthroCare's Wrinkle Treatment Draws Fans to Its Sagging Shares," Wall Street Journal , April 19, 2000, p. CA2.

Reeves, Amy, "ArthroCare Corp. Sunnyvale, California; Medical Tech Firm Is Focused on Staying a Step Ahead," Investor's Business Daily , October 9, 2003, p. A08.

—Ed Dinger



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