Item 1. Business
Company Overview
Curon Medical, Inc was incorporated in Delaware in May 1997. We develop, manufacture and market innovative proprietary products for the treatment of gastrointestinal disorders. Our products consist of radiofrequency generators and single-use disposable devices.
Our first product, the Stretta® System, received United States Food and Drug Administration (“FDA”) clearance in April 2000 for the treatment of gastroesophageal reflux disease, or GERD, which affects approximately 15 million U.S. adults on a daily basis. In patients with GERD, acidic stomach contents reflux backward from the stomach into the esophagus, causing a wide range of symptoms and complications, including, most commonly, persistent heartburn and chest pain. Unlike medication, which addresses GERD symptoms, our Stretta System applies radiofrequency energy to treat the causes of GERD. The Stretta System consists of a disposable catheter with needle electrodes and our control module, which is a radiofrequency energy generator. Using the Stretta System, the physician delivers temperature-controlled radiofrequency energy to the muscle of the lower esophageal sphincter and upper portion of the stomach. The delivery of this energy creates heat, causing tissue contraction and creating thermal lesions that resorb over time, resulting in improved sphincter function. Clinical studies show a significant reduction in GERD symptom scores, esophageal acid exposure, and use of anti-secretory medications.
We commercially launched the Stretta System in May 2000. As of December 31, 2004, we have sold 358 control modules and approximate that to date more than 7,000 patients have been treated with the Stretta Procedure.
Our second product, the Secca® System, is a radiofrequency energy-based system for the treatment of bowel incontinence (formerly and clinically referred to as “Fecal incontinence”). Bowel incontinence is caused by damage to the anal sphincter from childbirth, surgery, neurological disease, injury or age, and affects up to 16 million adults in the United States. Using the Secca System, physicians deliver radiofrequency energy to the anal sphincter muscle in the anal canal. Clinical studies have shown a reduction in bowel incontinence symptoms and improvement in general quality of life. In March 2002, we received 510(k) clearance from the FDA to market the
Secca System for the treatment of fecal incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback and who are not candidates for or amenable to surgery. We undertook a limited test launch of Secca in June 2002, and fully launched the product commercially in May 2003.
We have a direct sales force to market and sell our products in the United States. We market the Stretta System, as an alternative to anti-reflux surgery, primarily to high volume general surgeons and gastroenterologists. In the United States, we estimate that there are approximately 4,500 general surgeons and 7,000 gastroenterologists who actively perform endoscopy. We market the Secca System primarily to colon and rectal surgeons and to those general surgeons who perform colorectal surgery. We estimate that there are approximately 1,200 colon and rectal surgeons and up to 3,000 general surgeons that routinely perform colorectal surgery in the United States.
Our Stretta System has also received European, Australian and Canadian regulatory approval, and our Secca System has also received regulatory approval in Europe. We incorporated a subsidiary company in Belgium in November 2000 to manage distribution of our products in Europe, the Middle East and Africa. In March 2003, we entered into distribution agreements for the Stretta System in Switzerland, Austria, and the Netherlands, and have international distribution agreements with a distributor for the Far East, giving us representation in the countries of the Peoples Republic of China, Taiwan, Hong Kong, South Korea, Singapore, Malaysia, Indonesia, Vietnam, Thailand and India. To date, we have international distribution agreements for our products in 11 European and Middle Eastern countries and in South Africa. The Secca System is also sold through distributors in Europe. The first European Secca Procedures were performed in Germany, Denmark and Italy in March 2002, as part of our clinical trials. The first international commercial Secca procedure was performed in March 2003. We are organized into a single reportable segment consisting of the development, manufacture, and marketing of proprietary products for the treatment of gastrointestinal disorders. We use one measurement of profitability and do not disaggregate our business for internal reporting.
The American Medical Association recently issued a Category I CPT code for the Stretta procedure that became effective January 1, 2005, which will make it easier for physicians to code for the procedure from this date.
Business Strategy
Our strategy is to establish our Stretta and Secca Systems as standard treatment options for patients with GERD and bowel incontinence, respectively. We believe that our products offer substantial improvements over the current treatment options in the care of patients with these disorders.
The typical Stretta patient has not achieved adequate symptom control on, or is intolerant of, escalated medical therapy, or does not wish to continue indefinite anti-secretory medication use. Until recently, the only option for these patients has been a surgical anti-reflux procedure. We believe that the Stretta System offers several significant benefits over anti-reflux surgery, including that it is most commonly an outpatient procedure rather than inpatient surgery, that it is typically performed under conscious sedation rather than general anesthesia, and that it has a lower incidence of side effects and complications. Patients also return to normal activities faster after the Stretta procedure than after anti-reflux surgery. Due to these features, the Stretta procedure is significantly less expensive than anti-reflux surgery, and thus insurance companies may benefit through cost savings.
The Secca procedure offers a treatment option for patients with bowel incontinence who have failed more conservative therapies such as diet modification and biofeedback. Currently, bowel incontinence patients have few treatment options. These options include fiber therapy, anti-diarrheal medications, biofeedback therapy, and major surgery, which may involve reconstruction of the sphincter muscle or implantation of a continence device. These therapies have only modest effectiveness, and we believe that there is a need for a minimally invasive treatment option that may be offered to patients as an alternative to major surgery. We believe that the Secca
procedure has several significant benefits over surgery, including that it is most commonly an outpatient procedure rather than inpatient surgery, that it is typically performed under conscious sedation rather than general anesthesia, and that it has a lower incidence of side effects and complications. Recovery after incontinence surgery may take several months, whereas patients who have the Secca procedure may usually return to their normal daily activities the following day.
We have established both a direct and indirect sales and distribution network in the United States to target the approximately 4,000 hospital endoscopy suites and approximately 4,000 ambulatory treatment centers. We currently have fourteen direct sales territories, a sales vice president, a marketing vice president, two regional direct sales managers, and two clinical applications specialists. In addition, we have an indirect sales channel comprised of 6 Manufacturer Representative firms, with 15 salespeople to sell and market our products, on a part time basis, across the United States. In Europe and other selected areas, we have distributors covering 26 countries. We may hire additional salespeople or enter new distributor relationships to increase market penetration of our products.
We have acquired and may continue to acquire complementary technologies. We have a license agreement with Gyrus Group PLC (formerly Somnus Medical Technologies, Inc) for the use of technology related to Gyrus’ radiofrequency generator. We also have entered into license agreements with the University of Kansas Medical Institute and with Messrs. Shadduck and Baker relating to applying radiofrequency energy to tissue. We may enter into license agreements with other persons or companies covering technology relating to gastrointestinal tract diseases.
GERD: The problem and conventional treatment options
GERD is the frequent backward flow, or reflux, of stomach contents into the esophagus, the muscular tube that connects the mouth to the stomach. In the lower part of the esophagus, there is an area of thickened muscle known as the lower esophageal sphincter which, when functioning properly, acts as a one-way valve, allowing food to pass down from the esophagus into the stomach, but preventing reflux. In GERD patients, the lower esophageal sphincter does not function properly and allows chronic reflux to occur. Stomach acid, enzymes and bile irritate the esophagus and cause a wide range of symptoms and complications, most commonly persistent severe heartburn and chest pain. In some GERD sufferers, the pain is acute enough to require an emergency room visit. People with GERD often have difficulty sleeping due to increased reflux and heartburn when they lie down. Also, damage to the esophagus caused by reflux may result in more serious complications, such as erosion or ulceration of the esophagus, build-up of scar tissue that can narrow and obstruct the esophagus, and Barrett’s epithelium, a condition that is associated with an elevated risk of esophageal cancer.
Prescription medication is the primary treatment option for patients with GERD. The most widely prescribed medications from the proton pump inhibitor drug class, such as Prilosec or Nexium, have annual U.S. sales of approximately $10 billion. Although these medications temporarily ease heartburn symptoms by reducing stomach acid, they do not prevent reflux or treat the underlying causes of GERD. Side effects may include diarrhea, headaches, dizziness and nausea. Taken regularly, these medications are expensive, costing an estimated average of $2,300 per year, based solely on retail prices for medication requirements of the patients in our clinical trial. Many GERD patients do not want to be dependent on medications and have difficulty complying with prescribed lifestyle modifications that require ongoing fundamental changes in eating, drinking and sleeping behavior.
The most common corrective treatment for GERD is an anti-reflux surgical procedure generally known as a laparoscopic Nissen fundoplication where the fundus of the stomach is wrapped around the lower esophageal sphincter and sutured in position to provide a mechanical barrier to reflux. This inpatient surgical procedure costs between $11,000 and $15,000, involves a hospital stay of several days and a prolonged recovery period, and has a significant morbidity risk. We believe that approximately 250,000 patients are referred for this procedure annually, of which up to 100,000 actually undergo the anti-reflux surgery. The remainder of those referred who do not undergo the procedure are either contra-indicated or choose not to proceed after learning the details of the surgery.
The Stretta System: Treatment of GERD
Our proprietary Stretta System provides physicians with the tools to perform a minimally invasive, outpatient, and cost-effective procedure for the treatment of GERD. Unlike medication, the Stretta procedure treats GERD, rather than simply managing the symptoms by neutralizing or inhibiting acid secretion in the stomach. Unlike anti-reflux surgery, the Stretta procedure is most commonly an outpatient procedure with minimal side effects. The Stretta Procedure, which typically costs between $3,000 and $5,000, takes less than an hour, and utilizes techniques commonly used by general surgeons and gastroenterologists who perform endoscopy. Most treated patients have been able to return to normal activities within one day of treatment and reduce or eliminate medication use shortly thereafter. We believe that the Stretta Procedure’s effectiveness and relatively low cost, combined with the absence of significant discomfort and side effects, makes it a clinically and economically attractive GERD treatment for those patients with unsatisfactory symptom control on drugs, who are considering an anti-reflux surgical procedure.
The Stretta System consists of the Stretta Catheter, which is a disposable flexible catheter with needle electrodes, and the Curon Control Module, which is a radiofrequency energy generator. Using these devices, the physician delivers temperature-controlled radiofrequency energy to create thermal lesions in the muscle of the lower esophageal sphincter and upper stomach. These lesions reabsorb over several weeks and cause tissue contraction, which increases the ability of the lower esophageal sphincter to act as a barrier to reflux.
The Secca System: Treatment of Bowel Incontinence
The Secca System is designed to treat bowel incontinence, a condition that affects up to 16 million U.S. adults. Bowel incontinence is caused by damage to the anal sphincter from childbirth, surgery, neurological disease, injury or age. It is a life-altering condition that, unlike GERD, lacks effective corrective treatment alternatives. The most common treatment options control, but do not correct, the condition, and include the use of protective undergarments, diet modification and over-the-counter dietary supplements. Current corrective treatment options include major surgery, limited to those patients with a specific anatomic sphincter defect, and are rarely utilized.
The Secca System provides a minimally invasive, outpatient, and cost-effective procedure for the treatment of bowel incontinence. The Secca procedure utilizes the same radiofrequency technology and treatment concepts as the Stretta System. Using our Curon Control Module and our handheld disposable device called the Secca Handpiece, physicians deliver radiofrequency energy into the muscle of the anal sphincter to improve its barrier function. We completed a U.S. clinical trial of the Secca System in April 2001, and submitted the results to the FDA in December 2001. In March 2002, we received 510(k) clearance from the FDA to market the Secca System for the treatment of bowel incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback.
Product Description
We have developed a suite of products incorporating proprietary design features for use in the Stretta and Secca procedures. These products consist of a disposable catheter and a disposable handpiece for delivery of controlled radiofrequency energy to tissue, and a radiofrequency generator, known as the Curon Control Module. Both our current products and products under development utilize proprietary software to interface with our Curon Control Module.
Single-use disposable devices
Both the Stretta Catheter and the Secca Handpiece are disposable products incorporating innovative designs that enable a physician to easily access the treatment site and accurately deliver radiofrequency energy into the tissue. Features include:
•
A balloon in the Stretta Catheter, which is inflated once the Stretta Catheter reaches the lower esophageal sphincter to maintain catheter positioning;
•
Four electrode needles, which are deployed into the tissue at the treatment site for delivery of radiofrequency energy;
•
Thermocouples located at each needle tip and base, which provide continuous temperature readings to the Curon Control Module, enabling precise temperature control;
•
Irrigation ports located at the base of each electrode, which deliver water to the surface tissue during treatment; and
•
An illuminated clear window in the Secca Handpiece that enables the physician to view the treatment area.
Curon Control Module
The Stretta System and the Secca System both incorporate our radiofrequency energy generator, the Curon Control Module. The Curon Control Module has four channels, each of which independently control the four needle electrodes on the Stretta Catheter and Secca Handpiece. The generator uses continuous data feedback to achieve precise tissue temperatures at the treatment site. The generator tracks surface tissue temperatures from each electrode, and if temperatures at either the treatment site or surface tissue exceed pre-set levels, the generator automatically stops delivering energy to that electrode. An integrated pump delivers water to surface tissue during the procedure. The Stretta System and the Secca System each utilize proprietary software installed onto the Curon Control Module. The software provides a distinct graphical user interface and the functions and parameters that are required for the particular procedure.
Radiofrequency energy
Our products are based on radiofrequency energy delivery, which has a long history of use in medical applications. Radiofrequency energy has been cleared by the FDA for many therapies involving tissue heating, tissue remodeling and nerve pathway interruption, including:
•
Shrinking prostatic tissue to treat enlarged prostates;
•
Interrupting nerve pathways in the heart to treat irregular heartbeats;
•
Shrinking tissue in the shoulder joint to prevent repeated shoulder dislocation; and
•
Shrinking tissue in the base of the tongue to alleviate obstructive sleep apnea.
Clinical and Regulatory Status
Stretta clinical studies
In April 2000, we received 510(k) clearance from the FDA to market the Stretta System for the treatment of GERD. To evaluate the Stretta System, we conducted an open label multi-center U.S. clinical trial with leading investigators at 14 institutions, in which 131 patients were treated. We measured how well the procedure eliminated the need for heartburn medication, improved symptoms, improved quality of life, and reduced the amount of acid detected in the esophagus. Results from the initial 47 patients treated were submitted to the FDA. Six-month data was available for 44 of the 47 treated patients. The follow-up data indicated that the Stretta procedure led to significant improvement in both objective and subjective measurements. Six and twelve-month data for 118 of the 131 patients was published in Gastrointestinal Endoscopy in 2002.
Patients in our trials experienced no persistent side effects or other significant complications during the treatment and follow-up period. Most patients resumed normal levels of activity on the day after treatment. A few patients reported difficulty swallowing, increased flatulence or mild abdominal discomfort for a period of days. These symptoms were significantly milder and shorter in duration than those typically experienced after anti-reflux surgery.
We have conducted an eight-center, clinical trial of the Stretta System in the United States, treating 64 patients. Results of this trial were published in Gastroenterology in September 2003. This trial demonstrated significant improvements in GERD symptom scores and satisfaction that were not present in the sham (control) group. Further, there were significant improvements in acid exposure in the Stretta treated group at 12 months versus baseline.
To date, twenty-seven peer- reviewed clinical articles and meeting presentations have been published, augmenting the knowledgebase associated with the Stretta procedure, symptom response, and long-term results, and supporting the use of the Stretta system for patients with GERD. We expect that this data will influence physician adoption rates, facilitate reimbursement approvals, and enhance marketing activity.
Secca clinical studies
In November 1999, we conducted a pilot study at a leading medical institution in Mexico City. Ten patients with bowel incontinence were treated with the Secca System. Six months and two years following the procedure, most patients showed significant improvements in bowel incontinence symptoms, incontinence-related quality of life and general quality of life, each as measured by validated questionnaires, without persistent complications or side effects. The six-month data demonstrating improved incontinence scores was published in Diseases of the Colon & Rectum in July 2002. The two-year data demonstrating durability of the effect of Secca procedure on improving bowel incontinence symptoms was presented at the 2002 Meeting of the American Society of Colon and Rectal Surgeons, and was published in Diseases of the Colon & Rectum in March 2003.
Based on these encouraging preliminary results, we further evaluated the Secca System in a multi-center U.S. clinical study involving six sites and 50 patients. The data from this study was compiled and submitted to the FDA, and in March 2002 we received 510(k) clearance to market the Secca System for the treatment of bowel incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback. The results of this clinical trial were published in Diseases of the Colon and Rectum in December 2003. The study demonstrated that the Secca procedure resulted in significant improvements in bowel incontinences scores, bowel incontinence related quality of life, and general quality of life. In June 2002, we started a limited commercial release of the Secca System and in June 2003, we launched the Secca System on a full commercial basis.
Research and Development
Our research and development activities are conducted internally by a research and development staff and are focused on continuing improvements to design changes of existing product alternatives and product accessories. In addition to working on new products, our research and development organization is improving products and developing fixtures that are designed to reduce the time to manufacture, improve quality and reduce cost of products. Our research and development expenditures were $1.7 million in 2004, $1.8 million in 2003 and $2.7 million in 2002. Pilot manufacturing costs included in research and development were $235,000 in 2002 for the Secca System. No pilot manufacturing was performed in either 2003 or 2004.
Manufacturing
We manufacture, assemble and test our products in-house. The manufacturing process consists primarily of assembling internally manufactured and externally purchased components and sub-assemblies in an environmentally controlled area. After assembly, each Stretta Catheter and Secca Handpiece is inspected and then sent to a sub-contractor for sterilization. Final assembly and test of Curon Control Module is performed in-house.
We purchase various materials and components from qualified suppliers that are subject to stringent quality specifications and inspections. We conduct quality audits of our key suppliers, several of which are experienced
in the supply of components to manufacturers of medical devices. Most purchased components and services are available from more than one supplier. For the few components for which relatively few alternate supply sources exist, we have identified back-up suppliers. The qualification of these back-up suppliers may require regulatory approval, which may or may not be available on a timely basis or at all.
Currently, only one supply source exists for the peristaltic pump. Our supplier in accordance with our specifications manufactures this pump. We have contracted with this supplier for ongoing supply, but we would need additional time to locate and qualify a new pump supplier should our current supplier fail to fulfill our needs. If a new pump is incorporated into the Control Module, then the Control Module may require regulatory clearance under the FDA’s 510(k) process, which could take several months or more. Also, a computer chip in the Control Module is no longer manufactured. We have purchased an inventory of these chips sufficient to meet our projected manufacturing needs for at least the next 12 months and have developed a revision to our current generator that has incorporated an updated version of this chip.
Our manufacturing facility is subject to periodic inspection by regulatory authorities. Our quality assurance systems are subject to FDA regulations. These regulations require that we conduct our product design, testing, manufacturing, and control activities in conformance with these regulations and that we maintain our documentation of these activities in a prescribed manner. Our manufacturing facility is licensed by the California Department of Health Services, Food and Drug Branch. In addition, our facility has received ISO 9001/EN46001/ISO13485 certification and the European Union Certificate pursuant to the European Union Medical Device Directive 93/42/EEC, allowing us to CE mark our products after assembling appropriate documentation. ISO 9001/EN46001/ISO13485 certification standards for quality operations have been developed to ensure that companies know the standards of quality on a worldwide basis. Failure to maintain the CE mark will preclude us from selling our products in Europe. We cannot assure you that we will be successful in maintaining certification requirements in Europe or elsewhere.
Due to the necessity of continuous compliance with the above regulatory regimes and other support activities we have a high fixed manufacturing cost. To generate positive gross profit, we will need to increase our sales to $1.5 million per quarter, or thereby, to absorb fully these necessary fixed costs.
Patents and Proprietary Technology
We have an aggressive program to obtain or license intellectual property in the United States, Europe and Asia for our medical advances. We are building a portfolio of apparatus and method patents covering aspects of our current and future technology.
As of December 31, 2004, we had 35 issued or allowed U.S. patents and 24 pending U.S. patent applications. We intend to continue to file for patents for our technologies to strengthen our position. We require our employees, consultants and advisors to execute confidentiality agreements in connection with their employment, consulting or advisory relationships with us. We also require employees, consultants and advisors who work on our products to agree to disclose and assign to us all inventions conceived during the work day, using our property or which relate to our business. Despite any measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary.
Certain aspects of our products incorporate technology subject to patents that we have licensed from others. As of December 31, 2004, we had licensed in 23 issued and allowed U.S. patents and 16 pending U.S. patent applications. We have a license with Gyrus Group PLC (formerly, Somnus Medical Technologies, Inc.) for their generator technology. The non-exclusive license gives us the right to manufacture, have manufactured, use, offer to sell, sell and import Gyrus’ radiofrequency generator technology for use in the treatment of GERD and other medical disorders of the digestive tract. The license expires on October 6, 2017. During the term of the license, we are obligated to pay a royalty to Gyrus for our sale of generators that incorporate the licensed technology. We
have also licensed patented technology from the University of Kansas Medical Research Institute relating to applying radiofrequency energy to tissue. This is an exclusive, worldwide and royalty-bearing license allowing us to incorporate the patented technology in our products to treat medical disorders throughout the gastrointestinal tract. The license expires on September 17, 2013 and may be terminated earlier for breach. We have also licensed other patents that we believe may apply to our current business or that we may incorporate into future products. We intend to continue to license technologies to strengthen our competitive position.
The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As the number of entrants into our market increases, the possibility of an infringement claim against us grows. While we attempt to ensure that our products do not infringe other parties’ patents and proprietary rights, our competitors may assert that our products and the methods they employ may be covered by U.S. patents held by them. In addition, our competitors may assert that future products we may market infringe their patents.
Competition
Companies that have well-established products, reputations and resources dominate the market for the treatment of GERD. Our primary competitors are large medical device manufacturers such as Ethicon Endo Surgery and United States Surgical, manufacturers of instrumentation for anti-reflux surgery, C.R. Bard, Wilson Cook and NDO Surgical, each of which manufactures an endoscopic sewing device for treating GERD and Boston Scientific, which manufactures an injectable product for the treatment of GERD. In addition, Medtronic is currently in clinical trials with an implantable product for treating GERD that may, in the future, provide competition for the Stretta procedure. Other competitive devices may be developed.
Most of these competitors are larger companies that enjoy several competitive advantages over us, which may include:
•
Existing anti-reflux surgical procedures and devices for the treatment of GERD;
•
Established reputations within the surgical and gastroenterological community;
•
Established distribution networks that permit these companies to introduce new products and have such products accepted by the physician community promptly;
•
Established relationships with health care providers and payers that can be used to facilitate reimbursement for new treatments; and
•
Greater resources for product development and sales and marketing.
We do not feel that we compete with large pharmaceutical companies, such as AstraZeneca, Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate patients for Stretta are intolerant to drug therapy or have failed, or only partially responded to, drug therapy. However, these companies have an established relationship with the gastroenterology community and generate over $10 billion in annual U.S. revenues from the proton pump inhibitor drug class. We could be adversely affected if one or more pharmaceutical companies elects to market aggressively against our product, or if a new, more effective, pharmaceutical product is developed. Further, less expensive generic drugs have been introduced to treat GERD as AstraZeneca’s patent for Prilosec, the leading prescription medication for the treatment of GERD, expired in 2001. Prilosec, formerly a prescription medication, is now available over the counter.
In the bowel incontinence market, we consider our primary competitors to be American Medical Systems, who received FDA clearance in December 2001 to market its implanted Artificial Bowel Sphincter for the treatment of severe bowel incontinence, and Medtronic, which is developing an implantable sacral nerve stimulation device for treatment of incontinence. There are also a small number of companies pursuing injectable therapies for bowel incontinence including Boston Scientific and Uroplasty.
Government Regulation
Our products are medical devices subject to extensive regulation by the FDA and other regulatory bodies. FDA regulations govern, among other things, the following activities that we will perform:
•
Product development;
•
Product testing;
•
Product labeling;
•
Product storage;
•
Premarket clearance or approval;
•
Advertising and promotion; and
•
Product sales and distribution.
FDA’s premarket clearance and approval requirements
Each medical device that we wish to commercially distribute in the United States will likely require either prior 510(k) clearance or prior PMA approval from the U.S. Food and Drug Administration under the Federal Food, Drug, and Cosmetic Act. Devices deemed to pose relatively minimal risk are placed in either Class I or II, which requires the manufacturer to submit a premarket notification requesting permission for commercial distribution; this is known as 510(k) clearance. Some low risk devices are exempted from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a previously 510(k) cleared device or a preamendment Class III device for which PMA applications have not been called, are placed in Class III, requiring PMA approval.
510(k) Clearance Pathway: To obtain 510(k) clearance for one of our products, we must submit a premarket notification demonstrating that the proposed device is substantially equivalent in intended use and in safety and effectiveness to a previously 510(k) cleared device or a device that was in commercial distribution before May 28, 1976, for which the FDA has not yet called for submission of PMA applications. The FDA’s 510(k) clearance pathway usually takes from four to 12 months, but it can last longer.
After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new 510(k) clearance or could require a PMA approval. The FDA requires each manufacturer to make this determination in the first instance, but the FDA can review any such decision. If the FDA disagrees with a manufacturer’s decision not to seek a new 510(k) clearance, the agency may retroactively require the manufacturer to seek 510(k) clearance or PMA approval. The FDA also can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or PMA approval is obtained.
PMA Approval Pathway: If the FDA denies 510(k) clearance for one of our products, the product must follow the PMA approval pathway, which requires proof of the safety and effectiveness of the device to the FDA’s satisfaction. A PMA application must provide extensive preclinical and clinical trial data and also information about the device and its components regarding, among other things, device design, manufacturing and labeling. After approval of a PMA, a new PMA or PMA supplement is required in the event of a modification to the device, its labeling or its manufacturing process. The PMA approval pathway is much more costly, lengthy and uncertain than 510(k) clearance. It generally takes from one to three years or even longer.
Clinical Trials: A clinical trial is almost always required to support a PMA application and is sometimes required for a 510(k) premarket notification. Such trials generally require submission of an application for an Investigational Device Exemption, or IDE. The IDE application must be supported by appropriate data, such as
animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The FDA must approve the IDE in advance for a specified number of patients unless the product is deemed a non-significant risk device eligible for more abbreviated IDE requirements. Clinical trials may begin once the IDE application is approved by the FDA and the appropriate institutional review boards at the clinical trial sites. In June 2000, we received IDE approval allowing us to commence a multicenter clinical trial of the Secca System. We began the trial in July 2000. In April 2001, we completed this trial and the results were submitted to the FDA in December 2001.
In April 2000, we received 510(k) premarket clearance from the FDA for the Stretta System for the treatment of GERD, and in March 2002 we received 510(k) premarket clearance from the FDA for the Secca System for the treatment of bowel incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback. We cannot assure you that the FDA will not deem one or more of our future products to be a class III device subject to the more burdensome PMA approval process.
Pervasive and continuing FDA regulation
After a device is placed on the market, numerous regulatory requirements apply. These include: the quality system regulation, or QSR, which requires manufacturers to follow elaborate design, testing, control, documentation and other quality assurance procedures during the manufacturing process; labeling regulations; the FDA’s general prohibition against promoting products for unapproved or off-label uses; and the Medical Device Reporting regulation, which requires that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur. Class II devices also can have special controls such as performance standards, postmarket surveillance, patient registries, and FDA guidelines that do not apply to Class I devices. Unanticipated changes in existing regulatory requirements or adoption of new requirements could hurt our business, financial condition and results of operations.
We are subject to inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements. If the FDA finds that we have failed to comply, the Agency can institute a wide variety of enforcement actions against us, ranging from a public Warning Letter to more severe sanctions such as:
•
Fines, injunctions, and civil penalties;
•
Recall or seizure of our products;
•
Operating restrictions, partial suspension or total shutdown of production;
•
Refusing our requests for 510(k) clearance or PMA approval of new products;
•
Withdrawing 510(k) clearance or PMA approvals already granted; and
•
Criminal prosecution.
The FDA also has the authority to require repair, replacement or refund of the cost of any medical device manufactured or distributed by us. Our failure to comply with applicable requirements could lead to an enforcement action that may have an adverse effect on our financial condition and results of operations.
We have been an FDA registered medical device facility since January 1999 and we obtained our manufacturing license from the California Department of Health Services, or CDHS, in September 1999. We are subject to inspection by both the FDA and CDHS for compliance with the quality systems regulations and other applicable regulations.
Other U.S. regulation
We also must comply with numerous federal, state and local laws relating to such matters as safe working conditions, manufacturing practices, environmental protection, fire hazard control and hazardous substance
disposal. We may be required to incur significant costs to comply with such laws and regulations in the future and such laws and regulations may hurt our business, financial condition and results of operations. We are subject to quarterly audits performed by Underwriters Laboratories to ensure that our Control Module products continue to comply with the applicable requirements. Failure to comply could result in production delays, and potential product recall.
Foreign regulation
Our products are also regulated as medical devices outside the United States by government agencies and are subject to registration requirements in many of the foreign countries in which we plan to sell our products. Our Stretta and Secca Systems carry a CE Mark, which is required for European product sales. The Stretta System carries a Therapeutic Goods Administration license, which is required for product sales in Australia, and a license issued by Health Canada, which allows commercialization in Canada. Our facility is subject to inspection by RWTUV for compliance with the quality system and other applicable regulations. Our facility has been audited and certified to be ISO9001/EN46001/ISO13485 compliant, which allows us to sell our products in Europe. We plan to seek approval to sell the Stretta and Secca Systems in additional foreign countries. The time and cost required to obtain clearance required by foreign countries may be longer or shorter than that required for FDA clearance, and requirements for licensing a product in a foreign country may differ significantly from FDA requirements.
Third Party Reimbursement
In the United States, health care providers generally rely on third-party payers, principally private health insurance plans, Medicare and Medicaid, to reimburse all or part of the cost of procedures in which medical devices are used. Medicare reimburses hospital outpatient clinics on a prospectively determined fixed amount for the costs associated with an outpatient procedure. Individual outpatient procedures are assigned Ambulatory Payment Classification (APC) codes. Effective October 1, 2001, the Center for Medicare and Medicaid Services, CMS (formerly HCFA), designated a code for the Stretta System, which pays the hospital component of the procedure cost, including the cost of the disposable device. In 2003, CMS reassigned the Stretta procedure to a new APC, which maintained essentially the same payment rate of $1,850. In 2004, CMS announced a revision downwards of the APC value from $1,850 to $1,264.79. CMS published its April 2005 Hospital Outpatient Prospective Payment System update on March 18, 2005, in which they indicated that the previously published APC reimbursement rate for the Stretta procedure was incorrect. In its Addendum A published subsequently, the new national payment rate for the Stretta procedure is set at $1,335.65 retroactive to January 1, 2005. This translates to a range of actual reimbursement amounts, depending on the geographic adjustments, of between $977.43 and $2,583.55.
Effective January 1, 2004 the American Medical Association issued a Category III CPT code for the Stretta procedure. Effective January 1, 2005, the Stretta procedure was awarded a Level I CPT code by the AMA with an associated national average payment of $305.45. CPT codes are used to specify the physician component of the procedure cost.
Effective July 1, 2004, CMS designated an APC code for the Secca System, which pays the hospital component of the procedure $1,750 including the cost of the disposable device. For each of the procedures, private insurers will set their own reimbursement levels that are typically higher than the Medicare level.
The current cost reduction orientation of the third-party payer community makes it exceedingly difficult for new medical devices and surgical procedures to obtain reimbursement. Often, it is necessary to convince these payers that the new devices or procedures will establish an overall cost savings compared to currently reimbursed devices and procedures. We believe that the Stretta System may offer an opportunity for payers to reduce the cost of treating GERD patients by possibly eliminating or reducing the costs of medication or anti-reflux surgery.
While we believe that the Stretta System possesses economic advantages that will be attractive to payers, we cannot assure you that they will make reimbursement decisions based upon these advantages.
Reimbursement by third-party payers is often positively influenced by the existence of peer-reviewed publications of long-term safety and efficacy data. We have collected data on six-month results after treatment with the Stretta System, and this information was published in a peer-reviewed journal in 2001. We have collected and published data on twelve-month results, and this information was published in a peer-reviewed journal in 2002. Follow-up data in the form of a Stretta Registry, supporting the durability of the procedure for up to 33 months, was published in a peer-reviewed journal in December 2002. Subsequently, data has been presented at physician society medical meetings demonstrating positive durability of the Stretta procedure to four years. While we cannot assure you that our products will be reimbursed without publications of longer-term data, we are actively encouraging ongoing research studies to evaluate and publish the long-term safety and efficacy of the Stretta System. In addition, many third-party payers require that randomized studies be conducted to determine the effect of the procedure versus placebo or another standard of care. We have completed a double-blinded, randomized, sham-controlled, multi-center study to generate this data, and these results were published in September 2003.
To facilitate reimbursement for the Stretta and Secca Systems, we continue to maintain a dedicated reimbursement department. The department assists physicians with case-by-case pre-determination for coverage and appeals of denied claims, and actively pursues local coverage decisions. For the Stretta procedure, Curon Medical has established numerous Medicare coverage policies, as well as individual case-by-case Medicare coverage in various states. In addition, an increasing number of private payors have issued policies or are covering procedures on an individual basis.
We believe that achieving appropriate reimbursement for the Stretta procedure removes the major impediments to growth in sales. We believe that we are making progress toward wider reimbursement of the procedure. However, while we are actively pursuing reimbursement through case-by-case approvals and by pursuing coverage decisions by local carriers, we cannot guarantee the speed or the scale to which payers will approve reimbursement of the Stretta Procedure. While the Secca procedure has been on the market a shorter amount of time, we anticipate similar challenges in achieving reimbursement for this product.
Reimbursement systems in international markets vary significantly by country and, within some countries, by region. Reimbursement approvals must be obtained on a country-by-country basis or a region-by-region basis. In addition, reimbursement systems in international markets may include both private and government sponsored insurance. We have so far obtained limited international reimbursement approvals. We cannot assure you that we will obtain any further approvals in a timely manner, if at all. If we fail to receive international reimbursement approvals at all, or in acceptable amounts, market acceptance of our products would be adversely affected.
Employees
As of December 31, 2004, we employed 68 people worldwide, of which 2 are in Europe and 66 are in the U.S. which includes 30 employees in operations, two employees in research and development, 22 employees in sales and marketing, 10 employees in general and administrative, two employees in reimbursement and two employees in clinical and regulatory affairs. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel. None of our employees are represented by a labor union, and we believe our employee relations are good.
Available Information
Our Web Site is http://www.curonmedical.com. We make available free of charge, on or through our Web Site, our annual, quarterly and current reports, as well as any amendments to these reports, as soon as reasonably practicable after electronically filing these reports with the Securities and Exchange Commission (“SEC”).
Information contained on our Web Site is not a part of this report. We have adopted a code of ethics applicable to our principal executive, financial and accounting officers. We make available free of charge, on or through our Web Site’s investor relations page, our code of ethics.
The SEC maintains an Internet site at http://www.sec.gov that contains reports, proxy and information statements of the Company. All reports that the Company files with the SEC may be read and copied at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.
Additional Risk Factors
We have limited capital resources and expect that we will need to raise additional funds if we want to continue our current level of operations, which we may not be able to do.
As of December 31, 2004, we had cash and cash equivalents on hand of $5.9 million and working capital of $6.6 million. We intend to finance our operations primarily through our cash and cash equivalents, marketable securities, future financing and future revenues. Although we recognize the need to raise funds in the near future, there can be no assurance that we will be successful in consummating any such transaction, or, if we did consummate such a transaction, that the terms and conditions of such financing will be favorable to us. We believe that our cash balances will not be sufficient to fund planned expenditures in the third quarter of 2005. This raises substantial doubt about our ability to continue as a going concern. Even if we can raise funds, this may not be at a level that will allow for the continuance of operations.
We may never achieve or maintain significant revenues or profitability.
We have only a limited operating history upon which you can evaluate our business. We have incurred losses every year since we began operations. In particular, we incurred net losses of $15.3 million in 2004, $15.6 million in 2003, and $15.4 million in 2002. As of December 31, 2004, we had an accumulated deficit of approximately $94.6 million. Our revenues are, and will be, derived from the sale of radiofrequency generators and our disposable devices, such as the Stretta Catheter and Secca Handpiece. We have generated limited revenues, and it is possible that we will never generate significant revenue from product sales. Even if we do achieve significant revenues from our product sales, we expect to incur significant net losses over the next several years and these losses may increase. It is possible that we will never achieve profitable operations.
Our internal controls may not be sufficient to ensure timely and reliable financial information.
We restated our financial results for the quarter ended March 31, 2004 to reflect adjustments to our previously reported financial information. The restatements arose, in part, out of an internal investigation by the Audit Committee. As a result of the investigation, management and the Audit Committee determined that certain sales employees had improperly offered rights of return and exchange in violation of our revenue recognition policy, and a manufacturer’s representative had not actually made sales that it had reported to the Company. As a result of this investigation, we were also unable to timely file the Form 10-Q for the quarter ended June 30, 2004. In connection with the restatement of our financial results for the quarter ended March 31, 2004, our independent registered public accounting firm identified material weaknesses in our internal controls and procedures.
Our Audit Committee, with the assistance of independent legal and accounting advisors, evaluated the effectiveness of our disclosure controls and procedures. As a result of this evaluation, our Board of Directors has directed management to implement and management has implemented additional measures designed to ensure that information required to be disclosed in our periodic reports is recorded, processed, summarized and reported accurately. These measures include the adoption of a Disclosure Committee Charter, the adoption of a written revenue recognition policy, further controls on shipment of products for revenue transactions, and additional training of our sales and marketing staff to minimize the risk of revenue recognition errors. Given the additional
measures adopted by the company, we believe that our disclosure controls and procedures are now effectively designed to ensure that information we are required to disclose in reports that we file or submit to the SEC is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. However, the effectiveness of our controls and procedures are still limited by a variety of factors including:
•
Faulty human judgment and simple errors, omissions or mistakes;
•
Fraudulent action of an individual or collusion of two or more people;
•
Inappropriate management override of procedures; and
•
The possibility that our enhanced controls and procedures may still not be adequate to assure timely and accurate financial information.
If we fail to have effective internal control over financial reporting in place, we could be unable to provide timely and accurate financial information and be subject to delisting, and civil or criminal sanctions.
We may be delisted from the Nasdaq SmallCap Market immediately if we fail to timely file our periodic reports. This may adversely affect trading in our stock and our ability to raise capital.
Due to our inability to timely file our Form 10-Q for the quarter ended June 30, 2004, we became subject to delisting from the Nasdaq SmallCap Market. Subsequent to an appeal proceeding, the Nasdaq Listing Qualifications Panel determined to continue our listing on the Nasdaq SmallCap Market, conditioned upon the timely filing of all periodic reports with the Securities and Exchange Commission and Nasdaq for all reporting periods beginning with September 30, 2004 and ending on September 30, 2005. Should we fail to make any filing in accordance with this condition, we will not be entitled to a new hearing with Nasdaq and our securities may be immediately delisted from the Nasdaq SmallCap Market.
There are no assurances that we will timely make our filings in accordance with the terms of Nasdaq’s conditional continued listing determination. If we are delisted, trading in our common stock could be subject to the so-called “penny stock” rules that impose additional sales practice and market making requirements on broker-dealers who sell and/or make a market in those securities. Consequently, removal from the Nasdaq SmallCap Market, if it were to occur, could affect the ability or willingness of broker-dealers to sell and/or make a market on our common stock and the ability of purchasers of our common stock to sell their securities in the secondary market. These rules could further limit the market liquidity of our common stock and the ability of investors to sell our common stock in the secondary market. If we are delisted from the Nasdaq SmallCap Market, our stock price is likely to decline significantly.
If health care providers are not adequately reimbursed for the procedures, which use our products, or for the products themselves, we may never achieve significant revenues.
Our physician customers continue to encounter difficulties in readily obtaining reimbursement for the Stretta procedure on a case-by-case basis, and this continues to impact our ability to significantly increase revenues. We may not be successful at addressing these difficulties with our strategies of pursuing state-by-state and also selected national reimbursement coverage, focusing on promoting repeat catheter sales and incorporating technical improvements to our systems to reduce treatment times.
Curon has been actively seeking positive coverage decisions from Medicare and private payers to reimburse physicians, hospitals and other health care providers for procedures using our products. While the American Medical Association has issued a Level I CPT code for the Stretta procedure effective January 1, 2005, there is no assurance that local Medicare or private payers will choose to pay for this procedure. Physicians, hospitals and other health care providers are unlikely to purchase our products if they are not adequately reimbursed for the Stretta procedure or the products. In 2004, CMS announced a revision downwards of the APC value from
$1,850 to $1,264.79. CMS published its April 2005 Hospital Outpatient Prospective Payment System update on March 18, 2005, in which they indicated that the previously published APC reimbursement rate for the Stretta procedure was incorrect. In its Addendum A published subsequently, the new national payment rate for the Stretta procedure is set at $1,335.65 retroactive to January 1, 2005. This translates to a range of actual reimbursement amounts, depending on the geographic adjustments, of between $977.43 and $2,583.55. Even with the revised amount it may still be difficult to convince hospitals and other health care providers to offer the Stretta procedure to their patients. While coverage policies and case-by-case payments are increasing, some payers may refuse adequate reimbursement even though significant peer-reviewed data has been published. If users of our products cannot obtain sufficient reimbursement from health care payers for the Stretta procedure or the Stretta System disposables, then it is unlikely that our products will ever achieve increased market acceptance.
Although the Secca procedure has been awarded an APC code by the CMS, it has not received a CPT code and there is little data yet regarding the willingness of third-party health care payers to reimburse the costs of the procedure. We cannot assure you that the procedure will ever be reimbursed. Failure to achieve reimbursement may have a serious negative effect on our ability to grow our revenues.
Reimbursement from third-party health care payers is uncertain due to factors beyond our control and changes in third-party health care payers’ policies could adversely affect our sales growth.
Even if third-party payers provide adequate reimbursement for the Stretta procedure, adverse changes in third-party payers’ policies toward reimbursement could preclude market acceptance for our products and have a material adverse effect on our sales and revenue growth. We are unable to predict what changes will be made in the reimbursement methods used by third-party health care payers.
For example, some health care payers are moving toward a managed care system in which providers contract to provide comprehensive health care for a fixed cost per person. We cannot assure you that in a prospective payment system, which is used in many managed care systems, the cost of our products will be incorporated into the overall payment for the procedure or that there will be adequate reimbursement for our products separate from reimbursement for the procedure.
Internationally, market acceptance of our products will be dependent upon the availability of adequate reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country and include both government-sponsored health care and private insurance. Although we are seeking international reimbursement approvals, we cannot assure you that any such approvals will be obtained in a timely manner or at all. If foreign third-party payers do not adequately reimburse providers for the Stretta procedure and the products used with it, then our sales and revenue growth may be limited.
If we fail to take adequate action to remedy problems that have adversely affected our sales and marketing efforts our future performance may be harmed.
In the past, we became aware of some issues that negatively impacted our earnings. For example, we learned that it is time consuming to obtain purchase commitments for our products because of the number of individuals at hospitals who need to approve the purchase. As a result, we changed our sales and marketing models to more effectively address this issue. We also became aware of misinformation in the marketplace regarding past adverse events associated with our procedure. In response, we dedicated resources to educating physicians regarding the use of our products to combat this misinformation. Our efforts to rectify these situations may not be sufficient to materially improve our earnings. In addition, the cost of our efforts in addressing these matters diverts resources that could be allocated towards other efforts at increasing revenues. In the future, we may experience similar problems and if we are unable to take appropriate action, our results of operations and our financial performance will be harmed.
If physicians do not adopt our products, we will not achieve future sales growth.
To achieve increasing sales, our products must continue to gain recognition and adoption by physicians who treat gastrointestinal disorders. Our products represent a significant departure from conventional treatment methods. We believe that physicians will not increase rates of adoption of our systems unless they determine, based on published peer-reviewed journal articles, long-term clinical data and their professional experience, that our systems provide an effective and attractive alternative to conventional means of treatment. Currently, there are over 27 peer-reviewed journal articles on the Stretta procedure, including the results of our Stretta randomized trial, and three peer-reviewed journal articles on the Secca procedure. Some physicians may be slow to adopt new products and treatment practices, partly because of perceived liability risks and uncertainty of third-party reimbursement. Future adverse events or recalls could also impact future acceptance rates. Additionally, some of our customers and potential customers also find the 30-45 minutes necessary to perform a Stretta procedure to be a limiting issue, as their endoscopy unit schedule is typically dominated by short diagnostic procedures. If we cannot achieve increasing physician adoption rates of our products, we may never achieve significant revenues or profitability.
If the effectiveness and safety of our products are not supported by long-term data, our sales could decline and we could be subject to liability.
We received clearance from the FDA for the use of the Secca System to treat bowel incontinence, for patients who have failed more conservative treatments such as diet modification or biofeedback. This clearance was based upon the study of 50 patients. Safety and efficacy data presented to the FDA for the Secca System was based on six-month follow-up studies on these patients. However, if longer-term patient studies or clinical experience indicate that treatment with the Secca System does not provide patients with sustained benefits or that treatment with our product is less effective or less safe than our current data suggests, our sales could decline and we could be subject to significant liability. Further, we may find that our data is not substantiated in studies involving more patients, in which case we may never achieve significant revenues or profitability. If patient studies or clinical experience do not meet our expectations regarding the benefits of the Secca System, our expected revenues from this product may never materialize.
Failure in our physician education efforts could significantly reduce product sales.
It is important to the success of our sales efforts to educate physicians in the techniques of using our products. We rely on physicians to spend their time and money to attend pre-sale educational sessions. Positive results using the Stretta and Secca Systems are highly dependent upon proper physician technique. If physicians use either system improperly, they may have unsatisfactory patient outcomes or cause patient injury, which may give rise to negative publicity or lawsuits against us, any of which could have a material adverse effect on our sales and profitability.
We face competition from more established GERD treatments and from competitors with greater resources, which will make it difficult for us to achieve significant market penetration.
Companies that have well-established products, reputations and resources dominate the market for the treatment of GERD. Our primary competitors are large medical device manufacturers such as Ethicon Endo Surgery and United States Surgical, manufacturers of instrumentation for anti-reflux surgery, C.R. Bard, Wilson Cook and NDO Surgical, each of which manufactures an endoscopic sewing device for treating GERD, and Boston Scientific, which manufactures an injectable product for the treatment of GERD. In addition, Medtronic is currently in clinical trials with an implantable product for treating GERD that may, in the future, provide competition for the Stretta procedure. Other competitive devices may be developed.
Most of these competitors are larger companies that enjoy several competitive advantages over us, which may include:
•
Existing anti-reflux surgical procedures and devices for the treatment of GERD;
•
Established reputations within the surgical and gastroenterological community;
•
Established distribution networks that permit these companies to introduce new products and have such products accepted by the physician community promptly;
•
Established relationships with health care providers and payers that can be used to facilitate reimbursement for new treatments; and
•
Greater resources for product development and sales and marketing.
We do not feel that we compete with large pharmaceutical companies, such as AstraZeneca, Takeda Abbott Pharmaceutical, Wyeth Laboratories and Eisai, because candidate patients for Stretta are intolerant to drug therapy or have failed, or only partially responded to, drug therapy. However, these companies have an established relationship with the gastroenterology community and generate over $12 billion in annual U.S. revenues from the proton pump inhibitor drug class. We could be adversely affected if one or more pharmaceutical companies elects to market aggressively against our product, or if a new, more effective, pharmaceutical product is developed. Further, less expensive generic drugs have been introduced to treat GERD as AstraZeneca’s patent for Prilosec, the leading prescription medication for the treatment of GERD, expired in 2001. Prilosec, formerly a prescription medication is now available over the counter.
We have limited sales and marketing experience, and failure to build and manage our sales force or to market and distribute our products effectively will hurt our revenues and profits.
We have limited sales and marketing experience. As of December 31, 2004, we relied on fourteen direct sales territories for the sale of our Stretta System in the United States. We also deploy an indirect sales channel of 6 Manufacturers Representative firms, which adds 15 salespeople available to sell and market our products across the United States. The success of this sales channel will depend upon a number of factors, many of which are beyond our control, including the willingness of such distributors to prioritize the sale of our products, and their effectiveness in such sales efforts.
Since we have relatively limited marketing experience since the launch of the Secca System, our sales force has limited experience marketing the product, and we cannot predict how successful they will be in selling the product. There are significant risks involved in building and managing our sales force and marketing our products, including our:
•
Inability to hire a sufficient number of qualified sales people with the skills and understanding to sell the Stretta and Secca Systems effectively;
•
Failure to adequately train our sales force in the use and benefits of our products, making them less effective promoters; and
•
Failure to accurately price our products as attractive alternatives to conventional treatments.
Our failure to adequately address these risks will harm our ability to sell our products.
Internationally, we rely on third-party distributors to sell our products, and we cannot assure you that these distributors will commit the necessary resources to effectively market and sell our products.
Internationally, we rely on a network of distributors to sell our products. We depend on these distributors in such markets and we will need to attract additional distributors to grow our business and expand the territories into which we sell our products. Distributors may not commit the necessary resources to market and sell our products to the level of our expectations. If current or future distributors do not perform adequately, we may not realize expected international revenue growth.
We depend on the suppliers who provide the materials and components used in our products, and if we lose our relationship with any individual suppliers, we will face regulatory requirements with regard to replacement suppliers that could delay the manufacture of our products.
Third-party suppliers provide materials and components used in our products, some of which are the single and/or sole source for the components they provide. If any of our suppliers become unwilling or unable to supply us with our requirements, replacement or alternative sources might not be readily obtainable due to regulatory requirements applicable to our manufacturing operations. Obtaining components from a new supplier may require a new or supplemental filing with applicable regulatory authorities and clearance or approval of the filing before we could resume product sales. This process may take a substantial period of time, and we cannot assure you that we would be able to obtain the necessary regulatory clearance or approval. This could create supply disruptions that would reduce our product sales and revenue.
If we, or our suppliers, fail to comply with the FDA Quality System Regulation, manufacturing operations could be delayed and our business could be harmed.
Our manufacturing processes are required to comply with the Quality System Regulation, or QSR, which covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging and shipping of our products. The FDA enforces the QSR through inspections. Our first QSR inspection was in March 2001, and we were also inspected in July 2003. There were no significant findings from either inspection. If we fail any future QSR inspections, our operations could be disrupted and our manufacturing delayed. Failure to take appropriate corrective action in response to a QSR inspection could force a shut-down of our manufacturing operations, a recall of our products, and potentially a revocation of the FDA 510(k) clearance of our products, which would have a material adverse effect on our product sales, revenues, expected revenues and profitability. Furthermore, we cannot assure you that our key component suppliers are, or will continue to be, in compliance with applicable regulatory requirements, will not encounter any manufacturing difficulties, or will be able to maintain compliance with regulatory requirements. Any such event could have a material adverse effect on our available inventory and product sales.
Our failure to obtain or maintain necessary FDA clearances or approvals could hurt our ability to commercially distribute and market our products in the United States.
Our products are medical devices and are therefore subject to extensive regulation in the United States and in foreign countries where we intend to do business. Unless an exemption applies, each new Class II or III medical device that we wish to market in the United States must first receive either 510(k) clearance or premarket approval from the FDA. Either process can be lengthy and expensive. The FDA’s 510(k) clearance process usually takes from four to twelve months, but may take longer. The premarket application, or PMA, approval process is much more costly, lengthy and uncertain. It generally takes from one to three years or even longer. Delays in obtaining regulatory clearance or approval will adversely affect our ability to generate revenues and profitability from new products. We cannot assure you that the FDA will ever grant 510(k) clearance or premarket approval for any new product we propose to market. If the FDA withdraws or refuses to grant approvals, we will be unable to market such products in the United States.
If we market our products for uses that the FDA has not approved, we could be subject to FDA enforcement action.
Our Stretta and Secca Systems are cleared by the FDA, the Stretta System for the treatment of GERD and the Secca System for the treatment of bowel incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback. FDA regulations prohibit us from promoting or advertising either system, or any future cleared or approved devices, for uses not within the scope of our clearances or approvals. These determinations can be subjective, and the FDA may disagree with our promotional claims. If the FDA requires us to revise our promotional claims or takes enforcement action against us based upon our labeling and promotional materials, our sales could be delayed, our profitability could be harmed and we could be required to pay significant fines or penalties.
Modifications to our marketed devices may require new 510(k) clearances or PMA approvals or require us to cease marketing or recall the modified devices until such clearances are obtained.
Any modification to an FDA 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, requires a new FDA 510(k) clearance or, possibly, PMA approval. The FDA requires every manufacturer to make this determination in the first instance, but the FDA can review any such decision. We have modified aspects of our products, but we believe that new 510(k) clearances are not required. We may modify future products after they have received clearance or approval, and, in appropriate circumstances, we may determine that new clearance or approval is unnecessary. Though we believe these changes fall within the acceptable scope of changes allowed for Class II devices, we cannot assure you that the FDA would agree with any of our decisions not to seek new clearance or approval. If the FDA requires us to seek 510(k) clearance or PMA approval for any modification to a previously cleared product, we also may be required to cease marketing or recall the modified device until we obtain such clearance or approval. Also, in such circumstances, we may be subject to significant regulatory fines or penalties.
We face risks related to our international operations, including the need to obtain necessary foreign regulatory approvals.
To date we have international distribution agreements for Europe, Asia, and South Africa. We have obtained regulatory clearance to market the Stretta System in the European Union, Australia and Canada and to market the Secca System in the European Union, but we have not obtained any other international regulatory approvals for other markets or products. We cannot assure you that we will be able to obtain or maintain such approvals. Furthermore, although contracts already signed with European distributors specify payment in U.S. dollars, future international sales may be made in currencies other than the U.S. dollar. As a result, currency fluctuations may impact the demand for our products in countries where the U.S. dollar has increased compared to the local currency. Engaging in international business involves the following additional risks:
•
Export restrictions, tariff and trade regulations, and foreign tax laws;
•
Customs duties, export quotas or other trade restrictions;
•
Economic or political instability;
•
Shipping delays; and
•
Longer payment cycles.
In addition, contracts may be difficult to enforce and receivables difficult to collect through a foreign country’s legal system, and the protection of intellectual property in foreign countries may be more difficult to enforce. Any of these factors could cause our international sales to decline, which would impact our expected sales and growth rates.
Product liability suits against us may result in expensive and time-consuming litigation, payment of substantial damages and an increase in our insurance rates.
The development, manufacture and sale of medical products involves a significant risk of product liability claims. The use of any of our products may expose us to liability claims, which could divert management’s attention from our core business, could be expensive to defend, and could result in substantial damage awards against us. For example, we are currently a party to a product liability lawsuit where there are allegations that our products are defectively designed and that we were negligent in manufacturing our products.
We maintain product liability insurance at coverage levels we believe to be commercially acceptable, and we re-evaluate annually whether we need to obtain additional product liability insurance. However there can be no assurance that product liability or other claims will not exceed such insurance coverage limits or that such insurance will continue to be available on the same or substantially similar terms, or at all. Our former product
liability insurance carrier has filed a civil action against us asking for rescission of coverage as it relates to the lawsuit we recently settled for $1.25 million. An action for declaratory judgment filed by the carrier was recently granted and we are considering whether to file an appeal. Should we not file an appeal we shall initiate settlement negotiations with the carrier. If the carrier’s suit is successful, we will not recover any of the settlement amount paid, or any amounts in settlement of any future product liability action arising in the coverage period relating to this specific carrier. Any product liabilities claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing any coverage in the future. There have been no product liability suits relating to the period May 22, 2002 to May 21, 2003 filed against us.
We have limited protection for our intellectual property. If our intellectual property does not sufficiently protect our products, third parties will be able to compete against us more directly and more effectively.
We rely on patent, copyright, trade secret and trademark laws to protect our products, including our Stretta Catheter, our Secca Handpiece and our Curon Control Module, from being duplicated by competitors. However, these laws afford only limited protection. Our patent applications and the notices of allowance we have received may not issue as patents or, if issued, may not issue in a form that will be advantageous to us. Patents we have obtained and may obtain in the future may be challenged, invalidated or legally circumvented by third parties. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors, former employees or current employees, despite the existence of nondisclosure and confidentiality agreements and other contractual restrictions. Furthermore, the laws of foreign countries may not protect our intellectual property rights to the same extent as the laws of the United States. If our intellectual property rights do not adequately protect our commercial products, our competitors could develop new products or enhance existing products to compete more directly and effectively with us and harm our product sales and market position.
Because, in the United States, patent applications are secret unless and until issued as patents, or corresponding applications are published in other countries, and because publication of discoveries in the scientific or patent literature often lags behind actual discoveries, we cannot be certain that we were the first to file patent applications for such inventions. Litigation or regulatory proceedings, which could result in substantial cost and uncertainty, may also be necessary to enforce patent or other intellectual property rights or to determine the scope and validity of other parties’ proprietary rights. There can be no assurance that we will have the financial resources to defend our patents from infringement or claims of invalidity.
Because of our reliance on unique technology to develop and manufacture innovative products, we depend on our ability to operate without infringing or misappropriating the proprietary rights of others.
There is a substantial amount of litigation over patent and other intellectual property rights in the medical device industry. Because we rely on unique technology to develop and manufacture innovative products, we are especially sensitive to the risk of infringing intellectual property rights. While we attempt to ensure that our products do not infringe other parties’ patents and proprietary rights, our competitors may assert that our products and the methods they employ may be covered by patents held by them or invented by them before they were invented by us. Although we may seek to obtain a license or other agreement under a third party’s intellectual property rights to bring an end to certain claims or actions asserted against us, we may not be able to obtain such an agreement on reasonable terms or at all. If we were not successful in obtaining a license or redesigning our products, our product sales and profitability could suffer, and we could be subject to litigation and potentially substantial damage awards.
Also, one or more of our products may now be infringing inadvertently on existing patents. As the number of competitors in our markets grows, the possibility of a patent infringement claim against us increases. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate and divert management’s attention from our core business. If we lose in this kind of
litigation, a court could require us to pay substantial damages or grant royalties, and prohibit us from using technologies essential to our products. This kind of litigation is expensive to all parties and consumes large amounts of management’s time and attention. In addition, because patent applications can take many years to issue, there may be applications now pending of which we are unaware and which may later result in issued patents that our products may infringe.
If we lose our rights to intellectual property that we have licensed we may be forced to develop new technology and we may not be able to develop that technology or may experience delays in manufacturing as a result.
Our license with Gyrus Group PLC, a public company incorporated and existing under the laws of England and Wales, allows us to manufacture and sell our products using their radiofrequency generator technology. In addition, the University of Kansas license allows us to apply radiofrequency energy to tissue. To the extent these license interests become jeopardized through termination or material breach of the license agreements, our operations may be harmed. We may have to develop new technology or license other technology. We cannot provide any assurance that we will be able to develop such technology or that other technology will be available for license. Even if such technology is available, we may experience delays in our manufacturing as we transition to a different technology.
If we are unable to attract and retain qualified personnel, we will be unable to expand our business.
We believe our future success will depend upon our ability to successfully manage our employees, which includes attracting and retaining engineers and other highly skilled personnel. Our employees are at-will employees and are not subject to employment contracts. The loss of services of one or more key employees could materially adversely affect our growth. In addition, our stock price is depressed and the results of our operations have been less successful than anticipated. This history of performance may make it difficult to attract and retain qualified personnel. Failure to attract and retain personnel, particularly management and technical personnel, would materially harm our ability to grow our business rapidly and effectively.
Our directors, executive officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.
Our officers, directors and principal stockholders holding more than 5% of our common stock together control over 50% of our outstanding common stock. As a result, these stockholders, if they act together, will be able to control the management and affairs of our company and all matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interest of our other stockholders.
Our stockholder rights plan, certificate of incorporation, bylaws and Delaware law contain provisions that could discourage a takeover.
In November 2001, we adopted a stockholder rights plan. The purpose of the plan is to assure fair value in the event of a future unsolicited business combination or similar transaction involving Curon. If an individual or entity accumulates 15% of our stock, or 20% in the case of certain existing stockholders, the rights become exercisable for additional shares of our common stock or, if followed by a merger or other business combination where Curon does not survive, additional shares of the acquirer’s common stock. The intent of these rights is to force a potential acquirer to negotiate with the Board to increase the consideration paid for our stock. The existence of this plan, however, may deter a potential acquirer, which could negatively impact shareholder value.
In addition, our basic corporate documents and Delaware law contain provisions that might enable our management to resist a takeover. Any of the above provisions might discourage, delay or prevent a change in the control of our company or a change in our management. The existence of these provisions could adversely affect the voting power of holders of common stock and limit the price that investors might be willing to pay in the future for shares of our common stock.
Item 2.
Item 2. Properties
We are headquartered in Fremont, California, where we lease one building with approximately 35,000 square feet of office, research and development, and manufacturing space under leases expiring October 31, 2006. We believe that the facility is suitable and adequate for our current and future needs for the foreseeable future. We are currently utilizing approximately 65% of the facility’s total space.
Item 3.
Item 3. Legal Proceedings
In June 2001, a civil action was filed against us in the United States District Court, Western District of Kentucky, Louisville Division, alleging that the plaintiff sustained injury when undergoing a procedure utilizing the Stretta System, caused by defects in design and manufacture. This matter was amicably resolved in February 2005 without material financial impact on us.
In June 2002, a civil action was filed against a number of defendants, including Curon, in the Court of Common Pleas, Philadelphia County, in the State of Pennsylvania, alleging that the plaintiff sustained injury during a Secca procedure caused by the device being defective and/or in an unreasonably dangerous condition. We have settled this case resulting in a payment in March 2004 of $1.25 million that was reserved in the year ending December 31, 2003.
In April 2003, a civil action was filed against us in United States District Court for the Northern District of California by Federal Insurance Corporation, our insurance carrier, for rescission, reformation, and restitution in connection with the our liability insurance policy. This policy covers, among other things, product liability claims made against us by people treated with our product. In October 2004, the Plaintiff’s summary judgment motion was granted. Consequently, there will be no coverage in the Pennsylvania suit described above and the payment of the $1.25 million will be the limit of our liability in that case. We have decided not to appeal the result of the summary judgment and are engaged with settlement discussions with Federal Insurance Corporation. We believe that the resolution of this matter will not have a material effect, if any, on our business, financial position, and results of operations and cash flows.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of security holders during the quarter ended December 31, 2004.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Common Stock trades under the symbol CURN. As of December 9, 2002, our Common Stock has been quoted on the NASDAQ SmallCap Market. Until that date, our Common Stock had been quoted on the NASDAQ National Market since our initial public offering on September 22, 2000. The following table shows the high and low sales prices for the Company’s Common Stock for the periods indicated, as reported on the NASDAQ SmallCap or National Markets.
As of March 14, 2005, the last reported sales price of our Common Stock on the NASDAQ SmallCap Market was $1.17 per share, and the number of beneficial common stockholders was approximately 1,600. We currently intend to retain any earnings for use in our business and do not anticipate paying any cash dividends in the foreseeable future.
On September 26, 2000, we completed the sale of 5,000,000 shares of our common stock at a per share price of $11.00 in a firm commitment underwritten public offering. The offering was effected pursuant to a Registration Statement on Form S-1 (Registration No. 333-378666), which the United States Securities and Exchange Commission declared effective on September 21, 2000. On October 24, 2000, we completed the sale of an additional 475,000 shares of our common stock at a per share price of $11.00 pursuant to the exercise of the over-allotment option by the underwriters. All shares sold were shares of our common stock, $0.001 par value per share. UBS Warburg LLC, CIBC World Markets, and SG Cowen were the managing underwriters of the IPO. Aggregate gross proceeds to us from the IPO (prior to deduction of underwriting discounts and commissions and expenses of the offering) were $60.2 million. There were no selling stockholders in the IPO. We paid underwriting discounts and commissions of approximately $4.2 million and other expenses of approximately $1.2 million in connection with the IPO. The total expenses paid by us in the IPO were approximately $5.5 million and the net proceeds to us in the IPO were approximately $54.8 million.
On February 6, 2004, the Company raised approximately $13.5 million in gross proceeds from the private placement of common stock and warrants to several institutional investors. Net proceeds to the Company after estimated offering costs and expenses were approximately $12.6 million. The transaction involved the sale of 4,025,000 newly issued shares of the Company’s common stock at a price of $3.36 per share and warrants to purchase an aggregate of 905,625 shares of common stock an exercise price of $4.71 per share. The common stock warrants have a five-year term and became exercisable on August 6, 2004. In addition, on or after August 6, 2007, should the company’s stock price close at or above 175% of the exercise price on any 15 out of 30 consecutive trading days, and other certain conditions are met as defined in the warrant agreement, the company has the right, on one occasion, to require the holders of the common stock warrants to exercise such common stock warrants. The warrant agreement contains a provision (Section 9(c)) providing that if the
Company enters into a fundamental transaction, as defined further in the agreement (i.e. merger/consolidation, sale of substantially all of its assets, tender offer, reclassification common stock) that is consummated after the second anniversary of the date of the warrant and the cash consideration to be received by the holder is not greater than or equal to 30% over the exercise price, then at the request of the holder, the Company shall cash settle the warrants, purchasing such warrants for cash equal to the Black-Scholes value (assuming a 55% volatility) of the remaining unexercised portion of the warrant. As a result, the aggregate fair value of the warrants of $1.7 million was recorded as a liability with the remaining net proceeds of $10.9 million recorded as equity in the accompanying condensed consolidated balance sheet. The warrants were valued on February 6, 2004, using the Black-Scholes model with the following assumptions: 5 year expected life, risk free interest rate of 3.23 %, dividend yield of zero, volatility of 73%.
The fair value of the warrants and the corresponding liability is re-measured at the end of each reporting period with any change in fair value being recorded as a non-operating item in the statement of operations. The aggregate fair value of the warrant decreased from $1.7 million upon issuance on February 6, 2004, to $469,000 at December 31, 2004 using the Black-Scholes model with the following assumptions: 4.08 year expected life, risk free interest rate of 3.6%, dividend rate of zero and volatility of 67%.
The Board of Directors approved a stock repurchase program in July 2002 pursuant to which up to 1,000,000 shares of our outstanding common stock may be repurchased from time to time. The duration of the repurchase program is open-ended. Under the program, we may purchase shares of common stock through open market transactions at prices deemed appropriate by management. The timing and amount of repurchase transactions under this program will depend on market conditions and corporate and regulatory considerations. The purchases will be funded from available working capital. No repurchases were made in either 2003 or 2004, and as of December 31, 2004, we hold approximately 325,300 shares pursuant to this repurchase program.
Item 6.
Item 6. Selected Financial Data
The following tables reflect selected summary financial data for each of the last five fiscal years. This data should be read in conjunction with the financial statements and notes thereto, and with Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition in this Annual Report on Form 10-K. The information provided below is in thousands, except for per share data.
(1) The per share data have been restated for all periods presented to reflect the 0.57 to 1 reverse stock split effective September 22, 2000.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth below contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The following discussion should be read in conjunction with the financial statements and notes thereto for the fiscal years ended December 31, 2004, 2003, and 2002.
Overview
We were incorporated in May 1997. Business activities before January 1998 were negligible. Prior to December 31, 2000 we were in the development stage and until that time, we had devoted substantially all of our efforts to raising capital and developing, marketing and selling our products.
In 1998, our primary activity was developing the Curon Control Module and Stretta Catheter for the treatment of gastroesophageal reflux disease, or GERD. In October 1999, we received CE Mark approval of the Stretta System, indicating that the Stretta System meets MDD standards allowing us to market it within the European Union. We received 510(k) clearance from the FDA in April 2000 and commercially launched in the United States in May 2000.
In April 1999, we began developing our second set of products, the Secca System, for the treatment of fecal incontinence, otherwise known as bowel incontinence. In November 1999, we conducted a 10-patient human clinical pilot study outside the United States and, in July 2000, we began a U.S. multi-center clinical trial of the Secca System under an Investigational Device Exemption. In September 2001, we received CE Mark approval of the Secca System, indicating that the Secca System meets European medical device standards, allowing us to market it within the European Union. Our multi-center clinical trial was completed, and the results were used to support a 510(k) submission to the FDA in December 2001. We received 510(k) clearance from the FDA in March 2002 to market the system for the treatment of bowel incontinence in patients who have failed more conservative therapies such as diet modification and biofeedback. We made our first sales of the Secca System in June 2002.
We market the Stretta System, as a complement to anti-reflux surgery, primarily to high volume gastroenterologists and general surgeons who actively perform endoscopy. In the United States, we estimate that there are approximately 4,500 general surgeons and 7,000 gastroenterologists who actively perform endoscopy. We market the Secca System primarily to colon and rectal surgeons and to those general surgeons who perform colorectal surgery. We estimate that there are approximately 1,200 colon and rectal surgeons and approximately 3,000 general surgeons who perform colorectal surgery in the United States.
We are focusing our sales efforts in the United States through a direct sales force, supplemented by selected independent manufacturing representatives. In international markets, we rely primarily on third-party distributors. In November 2000, we incorporated a subsidiary company in Belgium to support European distributors’ sales, marketing and clinical efforts. As of December 31, 2004, this subsidiary had two employees. To date, we have international distribution agreements in 26 countries, of which 11 are in the European Union. Our gross margins on sales through international third-party distributors will be lower than our gross margins on U.S. sales as a result of distributor discounts.
To date, we have generated limited revenues. Our revenues are, and will be, derived from the sale of radiofrequency generators and our disposable devices, such as the Stretta Catheter and Secca Handpiece. We expect that disposable sales will continue to form the basis of a recurring revenue stream. However, domestic disposable sales continue to grow more slowly than expected primarily due to difficulties encountered by our physician customers in easily obtaining reimbursement for the Stretta procedure on a case-by-case basis. Some of our customers also find the 45 minutes necessary to perform a Stretta procedure to be a limiting issue, as their endoscopy unit schedule is typically dominated by short diagnostic procedures. Although disposable sales from outside the United States are increasing, they are not yet sufficient to offset the current domestic situation. Our strategies of pursuing state and national reimbursement coverage, focusing on entrenching the therapy to promote repeat catheter sales and incorporating technical improvements to our systems to reduce treatment times are designed to address these issues and we expect that our revenue from disposables will increase on implementation.
Through December 31, 2004, we recorded limited product sales while incurring cumulative net losses of $94.6 million. In addition to increasing expenditures related to continuing selling activities of the Stretta and
Secca Systems, we anticipate that our expenses will increase as we continue to develop new products, conduct clinical trials, commercialize our products and acquire additional technologies as opportunities arise. As a result, we expect our operating expenses and cumulative net losses to increase.
Critical Accounting Polices and Estimates
Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.
We believe the following critical accounting policies, among others, affect its more significant judgments and estimates in the preparation of its consolidated financial statements:
•
Revenue Recognition and Accounts Receivable-We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition in Financial Statements” (SAB 104), as amended. SAB 104 requires that four criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or service rendered; (3) the fee is fixed or determinable; and (4) collectibility is reasonably assured. Revenue from product sales is recognized on product shipment against a signed purchase order or sales quote provided no significant obligations remain and collection of the receivables is deemed probable for both sales of control modules and disposables. We also provide customers with training and assistance in obtaining reimbursement, and to the extent that these remaining obligations are not considered inconsequential or perfunctory to the sales arrangement, we will defer the recognition of the revenue related to these services until fulfillment of the obligation. Any change in our selling process or post-sale training and customer support could result in deferred revenue.
We assess collection based on historical experience and the credit-worthiness of the customer. Based on management’s on-going analysis of accounts receivable balances, and after the initial recognition of the revenue, if an event occurs which adversely affects the ultimate collectibility of the related receivable, management will record an allowance for bad debts. To date, bad debts have not had a significant impact on our financial position, results of operations and cash flows.
Revenues for extended warranty contracts are deferred and recognized over the extended warranty period. To date, post-sale customer support and training have not been significant.
•
Inventories-Inventories are stated at the lower of standard cost (which approximates average cost) or market. We record adjustments to the value of the inventory based on sales forecasts, physical condition, and potential obsolescence due to technological advancements in its products. These adjustments are estimates that could be materially different from actual results if future market conditions as they relate to our products differ from our expectations.
•
Accounting for Income Taxes-Our income tax policy records the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the accompanying consolidated balance sheets, as well as operating loss and tax credit carryforwards. We have recorded a full valuation allowance to reduce the deferred tax asset, as based on available objective evidence, it is more likely than not that the deferred tax asset will not be realized. While we have considered potential future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the full valuation allowance, in the event that we were to determine that we would be able to realize our deferred tax assets in the future, an adjustment to the deferred tax asset would increase income in the period such determination was made.
•
Stock-Based Compensation-We have various stock option, stock purchase and incentive plans to reward employees and key executive officers of the Company. We continue to use the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and apply the disclosure provisions of Statements of Financial Accounting Standards No. 123 (“SFAS 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure”. Under APB No. 25 stock compensation is measured as the difference, if any, on the date of grant between the fair value of our common stock and the exercise price. Under SFAS 123 stock compensation is based on the fair value of the stock award measured using option valuation models. Though we do disclose in the notes to the financial statements the pro-forma impact of applying the provision of SFAS 123 to our stock awards, if we were to change our accounting policy to fully adopt the fair value measurement provisions of SFAS 123, it could have a material impact on our financial position and results of operations.
•
Accounting for Common Stock Warrants-We consider EITF 00-19 “Accounting for derivative financial instruments indexed to, and potentially settled in a Company’s own stock” and SFAF No.150 “Accounting for certain financial instruments with characteristics of both liabilities and equity” to properly classify and value issued financial instruments. On February 6, 2004, we issued warrants to several institutional investors in connection with the private placement of common stock. The common stock warrants have a five-year term and became exercisable on August 6, 2004. The aggregate fair value of the warrants were recorded as a liability. The warrants were valued on February 6, 2004, using the Black-Scholes model. The fair value of the warrants and the corresponding liability is re-measured at the end of each reporting period utilizing current inputs to the Black-Scholes model, with any change in fair value being recorded as a non-operating item in the statement of operations.
•
Legal Proceedings and Loss Contingencies-We are involved in routine legal and administrative matters that arise from the normal conduct of business. Other matters contain allegations that are not routine and involve compensatory, punitive, and treble damages. The outcome of these proceedings which are not within our control, are often difficult to predict and often are resolved over long periods of time. We also maintain product liability insurance with third parties to mitigate any loss that is related to product liability claims. We record loss contingencies as liabilities in the financial statements when it is determined that we have incurred a loss that is probable and the amount of the loss is reasonably estimable, in accordance with SFAS 5 “Accounting for Contingencies”.
Restatement of Financial Statements-We have restated our financial results for the quarter ended March 31, 2004 to reflect adjustments to our previously reported financial information. The restatements arose, in part, out of an internal investigation by the Audit Committee. As a result of the investigation, the Audit Committee determined that certain sales employees had improperly offered rights of return and exchange in violation of our revenue recognition policy, and a manufacturer’s representative had not actually made sales that it had reported to the Company. As a result of this investigation, we were also unable to timely file our Form 10-Q and to timely announce our financial results for the quarter ended June 30, 2004.
Internal Accounting Review-We announced on August 17, 2004 that the Audit Committee of our Board of Directors had initiated an Internal Accounting Review of our accounting and reporting practices, including the appropriateness and timing of the revenue recognition. The improper recognition of revenue did have an impact on Quarterly revenue for fiscal year 2003. Management and the Audit Committee performed an SAB 99 analysis on the impact of the improper revenue recognition, examining both quantitative and qualitative factors. From a quantitative standpoint, none of the quarters (or the 12 month impact) was deemed individually significant enough to warrant restatement without regard to qualitative factors. Upon assessment of the ten qualitative factors, management and the Audit Committee concluded that the impact of the improper revenue recognition did not warrant restating the 2003 audited financial statements nor any quarters in 2003. As a result of this evaluation, our Board of Directors directed management to implement and management has implemented additional measures designed to ensure that
information required to be disclosed in our periodic reports is recorded, processed, summarized and reported accurately. These measures include the adoption of a Disclosure Committee Charter, the adoption of a written revenue recognition policy, further controls on shipment of products for revenue transactions, and additional training of our sales and marketing staff to minimize the risk of revenue recognition errors. Given the additional measures adopted by the company, we believe that our disclosure controls and procedures are now effectively designed to ensure that information we are required to disclose in reports that we file or submit to the SEC is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
RESULTS OF OPERATIONS
Revenue
Total revenues for the year ended December 31, 2004 were $3,709,000, an increase of $288,000 or 8% over total revenues of $3,421,000 for the year ended December 31, 2003. This increase was due primarily to increased sales of Secca product, which accounted for $505,000 of the increase. Total revenues for the year ended December 31, 2003 were $3,421,000, an increase of $18,000 or essentially flat growth over total revenues of $3,403,000 for the year ended December 31, 2002. Sales have been lower than anticipated, primarily due to the sales and marketing efforts involved in repositioning the Stretta System as an alternative to anti-reflux surgery, requiring us, mid-2002, to refocus our sales force to target surgeons as opposed to gastroenterologists. We now see our lower sales to gastroenterologists being replaced by higher sales to surgeons, a trend that we expect to continue. In all three years, our revenues have been impacted by our ongoing challenges in receiving favorable coverage decisions from both public and private carriers on a state-by-state basis for the Stretta procedures. Stretta System products accounted for 74% and Secca System products accounted for 24% of the revenues for the year ended December 31, 2004, as compared to 87% and 11%, respectively, for the same period in 2003 and 96% and 3% respectively in 2002. The Stretta Control Module and Catheter accounted for 38% and 58%, respectively, of the Stretta product line sales for the year ended December 31, 2004, compared to 43% and 54%, respectively, for the same period in 2003, and 52% and 46%, respectively, in 2002. The Secca Control Module and Handpieces accounted for 32% and 64%, respectively, of the Secca product line sales for the year ended December 31, 2004, compared to 52% and 41%, respectively, for the same period in 2003, and 54% and 40%, respectively, in 2002. International sales accounted for $179,000 for the year ended December 31, 2004, compared to $226,000 for the same period in 2003, and $423,000 in 2002. International sales were higher in 2002 due to the sale of capital equipment to new distributors during that year. With the expansion and subsequent training of our sales organization complete, we expect to realize steady growth in new sales of both control modules and disposable components. In addition, we expect that increased patient awareness and subsequent demand for these two minimally invasive options will fuel further revenue growth in product usage with both existing and new customers.
Cost of goods sold
Our costs of goods sold represent the cost of producing generators and disposable devices. We also license a technology used in the generators that we sell. We are required to pay licensing fees based on the sales price of the units. We believe that there are alternative technologies that could be utilized should we choose to do so. Cost of goods sold was $4,358,000, $4,322,000 and $4,080,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. As sales volume increases, we expect gross profit to become positive and increase accordingly. Our sales have not yet reached a level that would absorb our manufacturing capacity to the extent that we would experience positive gross profit. For the twelve months ended December 31, 2002, $235,000 of excess manufacturing capacity was used to support Secca Pilot manufacturing, prior to product commercialization in June 2002. This manufacturing capacity was therefore charged to research and development, as compared to the same period in 2004 and 2003, and no pilot manufacturing activities were done in 2004 or 2003.
Research and development expenses
Research and development expenses consist primarily of personnel costs, professional services, patent application and maintenance costs, materials, supplies and equipment. Research and development expenses were $1,736,000, $1,823,000, and $2,668,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. The decrease in expenses in 2004 compared to 2003 was due to the scaling back of disposables development activities. The decrease in expenses in 2003 compared to 2002 was due to cost reduction strategies as well as the completion of Secca pilot manufacturing activities in the second quarter of 2002, when commercialization occurred. Amortization of stock-based compensation accounted for $1,000, $27,000, and $66,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. During the quarter ended September 30, 2002, we reduced the number of research and development personnel from ten to seven. Costs associated with terminating these individuals were $83,000. In September 2004, we reduced the level of research activities and reduced headcount by 5 employees. Costs associated with terminating these individuals were $138,000. As a result of this action we expect spending for research and development expenses in 2005 to be lower than 2004.
Clinical and regulatory expenses
Clinical and regulatory expenses consist primarily of expenses associated with the costs of clinical trials, clinical support personnel, the collection and analysis of the results of these trials, and the costs of submission of the results to the FDA. Clinical and regulatory expenses were $1,096,000, $1,497,000, and $1,784,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. Spending decreased in 2004 as compared to 2003 and 2002. Our clinical and regulatory costs fluctuate depending on the number of clinical trial patients treated in any period. Spending during 2004 and 2003 has been further reduced compared to 2002 due to decreased headcount. Clinical trial costs include payments to hospitals, and the related travel expense for Curon employees. Amortization of stock-based compensation accounted for $29,000, $142,000, and $51,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. The increase in stock-based compensation during 2003 was due to a consultant option. During the quarter ended September 30, 2002, we reduced the number of clinical personnel from four to three. Costs associated with terminating these individuals were $13,000. We expect spending for clinical and regulatory expenses in 2005 to be comparable to 2004.
Sales and marketing expenses
Sales and marketing expenses consist of personnel related costs, advertising, public relations and attendance at selected medical conferences. Sales and marketing expenses were $8,083,000, $6,825,000, and $7,065,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. Spending increased in the twelve months ended December 2004 as compared to the same period in 2003 as we positioned our sales, marketing and reimbursement teams for projected increased sales volumes. Implementation of cost reduction strategies realized lower spending for the twelve months ended December 31, 2003 as compared to the same period in 2002. Amortization of stock-based compensation accounted for $12,000, $14,000, and $47,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. During the quarter ended September 30, 2002, we reduced the number of sales and marketing personnel from 28 to 26. Costs associated with terminating these individuals were $147,000. We expect spending for sales and marketing in 2005 to be comparable to 2004.
General and administrative expenses
General and administrative expenses consist primarily of the cost of corporate operations and personnel, legal, accounting and other general operating expenses of our company. General and administrative expenses were $5,073,000, $3,505,000, and $4,023,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. The primary reason for the increase for the twelve months ended December 31, 2004 compared to 2003, was due to the cost associated with the investigation related to our revenue recognition policy in 2004, amounting to $1.2 million. Apart from the Audit Committee investigation, higher spending is related to an
increase in insurance rates, legal spending and investor relations. After eliminating the stock-based compensation and termination costs noted below, spending in 2003 is slightly higher in comparison to 2002, due to the relocation costs for our new CEO in the amount of $225,000. Amortization of stock-based compensation accounted for $9,000 and $186,000 in the twelve months ended December 31, 2003 and 2002, respectively. During the quarter ended September 30, 2002, we reduced the number of general and administrative personnel from nine to seven. Costs associated with terminating these individuals were $555,000, which included loan forgiveness in the amount of $272,000, which occurred in July 2002. We expect spending for general and administrative in 2005 to be lower than to 2004.
Litigation charge
This is a non-recurring litigation charge related to a settlement of $1,250,000 related to the settlement of litigation against the company, in which the Plaintiff alleges injury during a Secca procedure caused by the device being defective and/or in an unreasonably dangerous condition. The Plaintiff was a subject in a clinical trial. This is related to the lawsuit in the state of Pennsylvania, and also to the Chubb insurance suit.
Interest income and expense
Interest income was $132,000, $234,000, and $751,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. Interest income has decreased in 2004 as compared to 2003 and 2002, due to a declining balance of marketable securities. Average cash and investment balances in 2004 were $8.0 million, compared to the 2003 average of $16.8 million and $30.8 million in 2002. Earnings have also been affected by declining interest rates through 2002, 2003 and 2004.
Interest expense was $6,000, $5,000, and $8,000 in the twelve months ended December 31, 2004, 2003, and 2002, respectively. In all three years, interest expense is related to notes payable related to insurance policies.
Decrease in warrant liability
Our sale of 4,025,000 newly issued shares on February 6, 2004, included warrants to purchase an additional 905,625 shares of common stock. These warrants provide for cash redemption by the holders upon the occurrence of certain events outside our control. As a result, the aggregate fair value of the warrants of $1,669,000, determined using the Black-Scholes model, was recorded as a liability at the time of sale with subsequent changes to the fair value of the warrants being recorded as a non-operating item through the statement of operations. As at December 31, 2004, the fair value of the warrants decreased from $1,669,000 on February 6, 2004, to $469,000 at December 31, 2004, resulting in us recording a benefit of $1,200,000 in the twelve months ended December 31, 2004.
Income taxes
As a result of our net losses, we did not incur any income tax obligations in each of the twelve-month periods ended December 31, 2004, 2003 and 2002.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, we have funded our operations and capital investments from gross proceeds from our initial public offering completed in September 2000 totaling $55.0 million, from the partial exercise of the underwriter’s over-allotment provision totaling $5.2 million, from the private sale of equity securities totaling $35.5 million, from the issuance of convertible notes totaling $11.8 million and from bank equipment line financing totaling $780,000. As of December 31, 2004, we had cash and cash equivalents on hand of $5.9 million and working capital of $6.6 million. We intend to finance our operations primarily through our cash and cash equivalents, marketable securities, future financing and future revenues. Although we recognize the need to raise
funds in the near future, there can be no assurance that we will be successful in consummating any such transaction, or, if we did consummate such a transaction, that the terms and conditions of such financing will be favorable to us. We believe that our cash balances will not be sufficient to fund planned expenditures in the third quarter of 2005. This raises substantial doubt about our ability to continue as a going concern. Even if we can raise funds, this may not be at a level that will allow for the continuance of operations.
Cash used in operating activities was $16.7 million in the twelve months ended December 31, 2004, compared to $12.5 million and $14.4 million for the same period in 2003 and 2002 respectively. Cash used in operating activities for fiscal 2004 of $16.7 million, primarily comprised net loss, net of non-cash related expenses. The increased in cash used in operating activities in 2004 was due to the $1.25 million cash paid for the settlement of a lawsuit and the costs of the Audit Committee investigation totaling $1.2 million. Working capital sources of cash were a decrease in accounts receivable and inventory.
Cash used in investing activities was $941,000 in the twelve months ended December 31, 2004, which consists of net maturities of marketable securities of $757,000 used to fund operations. Cash provided by investing activities was $ 8.7 million and $15.6 million for the same period in 2003 and 2002, respectively, which consisted of $9.3 and $15.8 million in net maturities of marketable securities to fund operations. Our investment balances have decreased over the past twelve months, and therefore the related volume of investment purchases and maturities is lower for the years ended December 31, 2004 and 2003, as compared to the same period in 2002.
Cash provided by financing activities was $13.1 million in the twelve months ended December 31, 2004, related to the private placement of common stock to a group of institutional investors in the net amount of $12.6 million, in addition to $433,000 from exercise of stock options and the Employee Stock Purchase Plan, and net cash provided by financing of business insurance in the amount net amount of $57,000. Cash provided by financing activities was $72,000 for the twelve months ended December 31, 2003, primarily related to sales of common stock and proceeds from notes payable to finance insurance policies, offset by payments on those notes payable. Cash used by financing activities was $76,000 for the twelve months ended December 31, 2002, primarily due to payments on the notes payable used to finance insurance policies. During 2002, sales of stock through employee stock plans were offset by purchases of treasury stock.
Contractual Obligations
The following table sets forth our contractual obligations as of December 31, 2004 and the years in which such obligations are expected to be settled.
Recent Accounting Pronouncements
At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115 and investments accounted for under the cost method or the equity method. The recognition and measurement guidance for which the consensus was reached in the March 2004 meeting is to be applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. We do not believe that this consensus on the recognition and measurement guidance will have an impact on our results of operations.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. This statement requires that these items be expensed as incurred and not included in overhead. In addition, SFAS 151 requires that allocation of fixed production overhead to conversion costs should be based on normal capacity of the production facilities. This Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 is not expected to have a material impact on our financial position and results of operations.
In December 2004, the FASB issued Statement No. 123(R) (“SFAS 123(R)”), “Share-Based Payment”. This statement replaces Statement of Financial Accounting Standards No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. We are currently in the process of evaluating the impact from this standard on our results of operations and financial position.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. That means that a change in prevailing interest rates may cause the fair value of the principal amount of an investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing rate rises, the fair value of the principal amount of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments has generally been less than eighteen months. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments.
Our exposure to market risk for changes in interest rates relates primarily to the increase or decrease in the amount of interest income we can earn on our available funds for investment. We do not plan to use derivative financial instruments in our investment portfolio. We plan to ensure the safety and preservation of our invested principal funds by limiting default risks, market risk and reinvestment risk. We plan to mitigate default risk by investing in high-credit quality securities.
All of our revenue is realized in U.S. dollars. Therefore, we do not believe that we currently have any significant direct foreign currency exchange rate risk.
Item 8.
Item 8. Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Curon Medical, Inc:
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Curon Medical, Inc. (the Company) and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a) (2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and the financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company has suffered recurring losses and negative cash flows from operations that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
March 28, 2005
CURON MEDICAL, INC.
Consolidated Balance Sheets
(in thousands, except share amounts)
See accompanying notes to consolidated financial statements
CURON MEDICAL, INC.
Consolidated Statements of Operations
(in thousands, except per share amounts)
See accompanying notes to consolidated financial statements
CURON MEDICAL, INC.
Consolidated Statements of Stockholders’ Equity And Comprehensive Income (Loss)
For the Years Ended December 31, 2004, 2003, and 2002
(in thousands)
See accompanying notes to the consolidated financial statements
CURON MEDICAL, INC.
Consolidated Statements of Cash Flows
(in thousands)
See accompanying notes to the consolidated financial statements
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in thousands, except share and per share amounts)
NOTE 1-FORMATION AND BUSINESS OF THE COMPANY:
Curon Medical, Inc. (the Company) was incorporated in the State of Delaware on May 1, 1997. The Company develops, manufactures and markets proprietary products for the treatment of gastrointestinal disorders.
Going Concern
In the course of its operations, the Company has sustained operating losses and negative cash flows from operations and expects such losses to continue in the foreseeable future. As of December 31, 2004 the Company had cash and cash equivalents on hand of $5.9 million, working capital of $6.6 million, and an accumulated deficit of approximately $94.6 million. The Company intends to finance its operations primarily through its cash and cash equivalents, marketable securities, future financing and future revenues. Although the Company recognizes the need to raise funds in the near future, there can be no assurance that it will be successful in consummating any such transaction, or, if it did consummate such a transaction, that the terms and conditions of such financing will be favorable to the Company. The Company believes that its cash balances will not be sufficient to fund planned expenditures in the third quarter of 2005. This raises substantial doubt about the Company’s ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.
NOTE 2-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in preparation of the consolidated financial statements.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Certain Risks and Uncertainties
The Company’s products and services are currently concentrated in a single segment of the gastrointestinal treatment field, which is characterized by increasing technological advances and changes in customer requirements. The success of the Company depends on management’s ability to anticipate or to respond quickly and adequately to technological developments in its industry, changes in customer requirements or industry standards. Failure to obtain or maintain necessary FDA clearances or approvals could hurt the Company’s ability to commercially distribute and market its products in the United States. Any significant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business and operating results. The Company has two products that it is currently marketing: radio-frequency generators and single use disposable devices. A single supplier currently provides some components and materials necessary for manufacturing of products. Any technical or quality problems in the manufacturing of
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
these components, changes to the product specifications, changes in rights to currently licensed intellectual property, or lack of essential equipment by suppliers, could have a significant impact on the Company’s financial condition and results of operations.
Cash and Cash Equivalents
The Company considers all highly liquid investments purchased with remaining maturities of three months or less at the date of purchase to be cash equivalents. The Company’s cash and cash equivalents include deposit funds, money market funds and commercial paper.
Marketable Securities
Investments consist primarily of marketable corporate bonds and commercial paper with a remaining maturity at the date of purchase of greater than three months. Investments with maturities beyond 2004 are classified as long-term investments and those maturing during 2004 are shown as current marketable securities. These investments are classified as available-for-sale securities and are stated at market value, with any temporary differences between an investment’s amortized cost and its market value recorded as a separate component of stockholders’ equity until such gains or losses are realized. Gains or losses on the sales of securities are determined on a specific identification basis. The following is a summary of investments at December 31, 2004 and 2003, respectively:
Inventories
Inventories are stated at the lower of standard cost (which approximates average cost) or market.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the estimated useful life of the improvement, or the lease term, if shorter. Useful lives by principal classifications are as follows:
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Upon retirement or sale, the cost and related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance and repairs are charged to operations as incurred.
Impairment of Long-Lived Assets
Long-lived assets to be held and used are reviewed for impairment when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable, or its estimated useful life has changed significantly. When an asset’s expected future undiscounted cash flows are less than its carrying value, an impairment loss is recognized and the asset is written down to its estimated fair value. Long-lived assets and certain identifiable intangible assets to be disposed of are reported at the lower of the carrying amount or fair value less cost to dispose. There have been no impairment charges recorded to date.
Revenue Recognition
The Company recognizes revenue in accordance with SEC SAB 104, as amended. Revenue from product sales is recognized on product shipment against a signed purchase order or sales quote provided no significant obligations remain and collection of the receivables is deemed probable for both sales of control modules and catheters. Revenues for extended warranty contracts are recognized over the extended warranty period. To date, post-sale customer support and training have not been significant.
The Company may sell products under a purchase commitment, with delivery of the control module at inception of the contract and catheters generally delivered over a period of six months. Revenue for the control module is deferred and recognized ratably over shipment of catheters under contract. Revenue on the catheters is recognized upon shipment at an amount representing their fair value based on verifiable objective evidence of such.
Shipping and handling costs charged to customers are recognized as revenue and the associated costs incurred by the Company are expensed under cost of goods sold.
Product Warranty
The Company generally warrants its products against defects for a period of one year and records a liability for such product warranty obligations at the time of sale based upon historical experience. The Company also sells separately priced extended warranties to provide additional warranty coverage and recognizes the related revenue on a straight-line basis over the extended warranty period, which are generally one to four years. Costs associated with services performed under the extended warranty obligation are expensed as incurred.
Changes in product warranty obligations, including separately priced extended warranty obligations, for the years ended December 31, 2004 and 2003 is as follows:
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Research and Development
Research and development costs are expensed as incurred. Legal expenses related to patent development costs are expensed as incurred.
Advertising Costs
Advertising costs are expensed as incurred and were $380,000 in 2004 and $327,000 in 2003, and $348,000 in 2002.
Income Taxes
The Company accounts for income taxes under the liability method whereby deferred tax asset or liability account balances are calculated at the balance sheet date using current tax laws and rates in effect for the year in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
Accounting for Stock-Based Compensation
The Company accounts for stock-based employee compensation arrangements in accordance with provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25) and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure.” Under APB No. 25, unearned stock compensation is based on the difference, if any, on the date of grant, between the fair value of the Company’s common stock and the exercise price. Had the Company determined its stock-based compensation based on the fair value at the grant dates for the awards under a method prescribed by SFAS No. 123, the Company’s net loss would have been increased to the FAS 123 adjusted amounts indicated below, as amended by SFAS No. 148:
The Company accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services. The equity instruments are valued using the Black-Scholes Model. All unvested shares are marked to market until such options vest.
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Net Loss per Share
Basic net loss per share is calculated based on the weighted-average number of common shares outstanding during the period excluding those shares that are subject to repurchase. Diluted net loss per share would give effect to the dilutive effect of common stock equivalents consisting of stock options, warrants, and common stock subject to repurchase (calculated using the treasury stock method). Potentially dilutive securities have been excluded from the diluted net loss per share computations as they have an antidilutive effect due to the Company’s net loss.
Fair Value of Financial Instruments
The carrying value of the Company’s financial instruments, including cash and cash equivalents, trade accounts receivable, and accounts payable approximate fair value. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of obligations approximates fair value.
Segments
The Company operates in one reportable segment, using one measurement of profitability to manage its business. All long-lived assets are maintained in the United States.
Recent accounting pronouncements
At its March 2004 meeting, the EITF reached a consensus on recognition and measurement guidance previously discussed under EITF 03-01. The consensus clarifies the meaning of other-than-temporary impairment and its application to investments classified as either available-for-sale or held-to-maturity under SFAS No. 115 and investments accounted for under the cost method or the equity method. The recognition and measurement guidance for which the consensus was reached in the March 2004 meeting is to be applied to other-than-temporary impairment evaluations in reporting periods beginning after June 15, 2004. The Company does not believe that this consensus on the recognition and measurement guidance will have an impact on its results of operations.
In November 2004, the FASB issued SFAS No. 151, “Inventory Costs”. SFAS 151 amends the guidance in ARB No. 43, Chapter 4, Inventory Pricing, to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and spoilage. This statement requires that these items be expensed as incurred and not included in overhead. In addition, SFAS 151 requires that allocation of fixed production overhead to conversion costs should be based on normal capacity of the production facilities. This Statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The Company’s adoption of SFAS No. 151 is not expected to have a material impact on the Company’s financial position and results of operations.
In December 2004, the FASB issued Statement No. 123(R), “Share-Based Payment”. This statement replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”. SFAS 123(R) will require compensation costs related to share-based payment transactions to be recognized in the financial statements (with limited exceptions). The amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. This statement is effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company is currently evaluating the impact from this standard on its results of operations and financial position.
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
NOTE 3-BALANCE SHEET COMPONENTS:
Depreciation and amortization expense of property and equipment totaled $329,000, $517,000 and $702,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
NOTE 4-NOTES PAYABLE:
The Company had short-term notes payable at December 31, 2004 in the amount of $57,000. The note bears interest at 3.99% with the final payment due in January 2005 and is related to the financing of corporate insurance policies in the amount of $454,000. During 2003, a note payable in the amount of $309,000, bearing interest at 3.99% was used to finance the corporate liability insurance policy renewal. This note was paid in full in December 2003.
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
NOTE 5-COMMITMENTS AND CONTINGENCIES:
Leases
The Company leases office space under a noncancelable operating leases expiring through August 2007. Rent expense for the years December 31, 2004, 2003, and 2002 was $348,000, $576,000 and $528,000 respectively.
At December 31, 2004, future minimum facility lease payments are as follows:
Purchase commitments
The Company had noncancelable commitments to purchase raw material and finished goods inventory totaling $243,000 in aggregate at December 31, 2004. These purchase commitments represent outstanding purchase orders submitted to the Company’s third party suppliers for goods to be delivered to the Company in 2005.
Contingencies
The Company is involved in routine legal and administrative proceedings that arise from the normal conduct of business. Management believes that the ultimate disposition of these matters will not have a material adverse effect on the financial results or condition of the Company.
In June 2001, a civil action was filed against the Company in the United States District Court, Western District of Kentucky, Louisville Division, alleging that the plaintiff sustained injury when undergoing a procedure utilizing the Stretta System, caused by defects in design and manufacture. This matter was amicably resolved in February 2005 without material financial impact on the Company.
In June 2002, a civil action was filed against a number of defendants, including the Company, in the Court of Common Pleas, Philadelphia County, in the State of Pennsylvania, alleging that the Plaintiff sustained injury during a Secca procedure caused by the device being defective and/or in an unreasonably dangerous condition. The Company has settled the case, resulting in a payment to Plaintiff in March 2004 of $1.25 million. This amount had been reserved at December 31, 2003.
In April 2003, a civil action was filed against the Company in United States District Court for the Northern District of California by Federal Insurance Corporation, the Company’s insurance carrier, for rescission, reformation, and restitution in connection with the Company’s liability insurance policy. This policy covers, among other things, product liability claims made against the Company by people treated with the Company’s product. In October 2004, the Plaintiff’s summary judgment motion was granted. Consequently, there will be no coverage in the Pennsylvania suit described above and the payment of the $1.25 million will be the limit of the Company’s liability in that case. The Company has decided not to appeal the result of the summary judgment and is engaged with settlement discussions with Federal Insurance Corporation. The Company believes that the resolution of this matter will not have a material effect, if any, on its business, financial position, and results of operations and cash flows.
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Development and Technology License Agreements
The Company licenses certain radiofrequency technology through an agreement that gives the Company an irrevocable license to manufacture, have manufactured, use, offer to sell, sell and import radiofrequency generators based on the licensed technology in the licensed field. The agreement expires on October 6, 2017. Royalties are accrued at the time of sale, based on the revenues recognized when the related licensed technology is part of the sold item and were $60,000 in 2004, $66,000 in 2003 and $75,000 in 2002.
In February and April 2000, the Company entered into two separate licensing agreements for the use of proprietary radiofrequency technologies used in certain of the Company’s products. The Company issued 86,000 shares of its common stock, valued at $831,000 on the date of the agreements, in exchange for the right to use the technologies. In addition, $73,000 was paid in conjunction with the licensed technology. As part of the February agreement, the Company is also required to pay a royalty on all revenues collected when the related licensed technology is part of the sold item.
NOTE 6-STOCKHOLDERS’ EQUITY:
The Company’s Certificate of Incorporation, as amended, authorizes the Company to issue 50,000,000 shares of $.001 par value common stock. Certain of the shares issued are subject to a right of repurchase by the Company, which lapses over a three or four-year period from the issuance dates. At December 31, 2004, there were no shares subject to repurchase. At December 31, 2003 and 2002 there were 1,000 and 34,000 shares subject to repurchase, respectively.
Issuance of Common Stock
On February 6, 2004, the Company completed a private placement of 4,025,000 shares of common stock for aggregate gross proceeds of approximately $13.5 million to a group of institutional investors. The shares were purchased at a price of at a price of $3.36 per share. Net proceeds after offering costs and expenses were approximately $12.6 million. Investors received warrants with a term of five years to purchase an aggregate of 905,625 common shares at an exercise price of $4.71 per share.
Common Stock Warrants
In May 2000, the company issued warrants to purchase 568,917 shares of common stock in connection with convertible notes payable. These warrants are exercisable immediately and expire in 2005. The value of the warrants, $2.1 million, was determined using the Black-Scholes option-pricing model and was amortized to interest expense in 2000. These warrants are outstanding at December 31, 2004.
On February 6, 2004, the Company issued warrants to purchase an aggregate of 905,625 shares of common stock an exercise price of $4.71 per share to several institutional investors in connection with the private placement of common stock. The common stock warrants have a five-year term and became exercisable on August 6, 2004. In addition, on or after August 6, 2007, should the company’s stock price close at or above 175% of the exercise price on any 15 out of 30 consecutive trading days, and other certain conditions are met as defined in the warrant agreement, the company has the right, on one occasion, to require the holders of the common stock warrants to exercise such common stock warrants. The warrant agreement contains a provision (Section 9(c)) providing that if the Company enters into a fundamental transaction, as defined further in the agreement (i.e. merger/consolidation, sale of substantially all of its assets, tender offer, reclassification common stock) that is
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
consummated after the second anniversary of the date of the warrant and the cash consideration to be received by the holder is not greater than or equal to 30% over the exercise price, then at the request of the holder, the Company shall cash settle the warrants, purchasing such warrants for cash equal to the Black-Scholes value (assuming a 55% volatility) of the remaining unexercised portion of the warrant. As a result, the aggregate fair value of the warrants of $1,669,000 was recorded as a liability. The warrants were valued on February 6, 2004, using the Black-Scholes model with the following assumptions: 5 year expected life, risk free interest rate of 3.23%, dividend yield of zero, volatility of 73%.
The fair value of the warrants and the corresponding liability is re-measured at the end of each reporting period utilizing current inputs to the Black-Scholes model, with any change in fair value being recorded as a non-operating item in the statement of operations. The aggregate fair value of the warrant decreased from $1669,000 upon issuance on February 6, 2004, to $469,000 at December 31, 2004. The warrants were valued on December 31, 2004, using the Black-Scholes model with the following assumptions: 4.1 year expected life, risk free interest rate of 3.6%, dividend rate of zero and volatility of 67%.
Stockholder Rights Plan
In October 2001, the Company adopted a Preferred Stock Rights Agreement. Under this agreement, the Company will issue a dividend of one Preferred Share Purchase Right (a “Right”) for each share of common stock held by stockholders of record as of the close of business on November 20, 2001. Each Right entitles the registered stockholder to purchase from the Company one one-thousandth of a share of the Company’s Series A Participating Preferred Stock (“Preferred Stock”) at an exercise price of $30.00. The agreement is designed to assure stockholders fair value in the event of a future unsolicited business combination or similar transaction.
The Rights do not have any voting rights, and will expire upon the earlier of redemption or November 20, 2011. If the Rights are exercised, each stockholder receives one one-thousandth of a share of Preferred Stock, which entitles the holder to one additional vote and dividends and liquidation rights equal to that paid on common stock.
NOTE 7-STOCK OPTION PLANS AND OTHER EMPLOYEE BENEFITS:
Stock Option Plans
During 1997, the Company adopted the 1997 Stock Plan (the “1997 Plan”). The 1997 Plan provides for the granting of stock options to employees and consultants of the Company. Options granted under the 1997 Plan may be either incentive stock options or non statutory stock options. Incentive stock options (ISO) may be granted only to Company employees (including officers and directors who are also employees). Non statutory stock options (NSO) may be granted to Company employees, officers, directors, and consultants. The Company reserved 2,679,000 of common stock for issuance under the 1997 Plan. The first options were issued in 1998. No further options will be granted under the 1997 Plan. The remaining shares reserved for issuance under this plan are being used for grant under the 2000 Stock Plan.
During 2000, the 2000 Stock Plan (the “2000 Plan”) was adopted by the Board of Directors and became effective on September 21, 2000. The terms of this plan are generally the same as under the 1997 Plan. At December 31, 2004, there were 5,950,091 shares authorized for issuance under this plan.
Under both plans, options are granted for a period of up to ten years and at prices no less than 85% of the estimated fair value of the shares on the date of grant, provided, however, that (i) the exercise price of an ISO and
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
NSO shall not be less than 100% and 85% of the estimated fair value of the shares on the date of grant, respectively, and (ii) the exercise price of an ISO and NSO granted to a 10% shareholder shall not be less than 110% of the fair market value of the shares on the date of grant. Options generally vest 25% one year from the vest start date and ratably over the next 36 months and expire 10 years from the date of grant.
With effect from June 16th 2004, the 2000 Stock Option Plan was amended to include each non-employee director elected to the Board of Directors for the first time following the Annual Meeting will receive upon election an initial grant of options to purchase 15,000 shares of common stock at fair market value on the date of grant as well as an annual grant of options to purchase 15,000 shares for each year during the director’s term. All of the foregoing options have a ten-year term. The initial option grants as well as the annual grants are fully vested and immediately exercisable on the day of grant. All grants issued to outside Board members will be exercisable for up to a year from the date of such Board member’s termination of service with the Company.
Deferred Stock Compensation
Prior to its IPO in September 2000, the Company issued stock options under the 1997 Plan at exercise prices, deemed by the Board of Directors at the date of grant to be equal to the fair value of the common stock. In anticipation of the Company’s initial public offering, the Company subsequently determined that, for financial statement purposes, the estimated value of its common stock was in excess of the exercise prices. Accordingly, the Company has recorded deferred stock compensation for stock options issued to both employees and non-employees.
For stock options granted to employees (1,155,320 in 2004, 1,661,000 in 2003 and 1,098,000 in 2002), the difference, if any, between the exercise price of the stock options and the fair value of the Company’s stock at the date of grant is recorded as deferred compensation on the date of grant.
For stock options granted to non-employees, generally for future services (10,000 in 2004, 10,000 in 2003, and none in 2002), the fair value of the options, was determined using the Black-Scholes valuation model. The Company records stock as the non-employee fulfills the terms of the option grants, with changes in fair value of the unvested options from period to period recorded as an adjustment to compensation expense.
Stock compensation expense is classified as follows:
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Activity under stock option plans is as follows:
The options outstanding and currently exercisable by exercise price at December 31, 2004 are as follows:
Fair Value Disclosures
The fair value of options granted is estimated on the date of grant using the Black-Scholes option pricing model, using the following assumptions:
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
401(k) Savings Plan
In October 1999, the Company began a 401(k) savings plan (the “401(k) Plan”). The 401(k) Plan is a defined contribution plan intended to qualify under Section 401(a) and 401(k) of the Internal Revenue Code. All full-time employees of the Company are eligible to participate in the 401(k) Plan pursuant to the terms of the Plan. Contributions by the Company are discretionary and the Company has made no contributions for the years ended December 31, 2004, 2003, or 2002.
Employee Stock Purchase Plan
Effective September 21, 2000, the Company adopted the 2000 Employee Stock Purchase Plan (ESPP). A total of 400,000 shares of common stock were initially reserved for issuance under this plan. In addition, subject to the Board of Directors’ discretion, on January 1, 2001 and on each anniversary thereafter, the aggregate number of shares reserved for issuances under the ESPP will be increased automatically by the lesser of: 500,000 shares, 1.5% of the outstanding shares of the Company’s Common Stock, or a lesser amount determined by the Board of Directors. During 2004, 2003 and 2002, the shares reserved for issuance under the ESPP were increased by 303,000, 300,000 and 295,000 shares, respectively.
Under the ESPP, eligible employees may have up to 15% of their earnings withheld, subject to certain limitations, to be used to purchase shares of the Company’s common stock. Unless the Board of Directors shall determine otherwise, each offering period provides for consecutive 24-month periods commencing on each May 1 and November 1. Each offering period is comprised of four 6-month purchase periods. The price at which common stock may be purchased under the ESPP is equal to 85% of the lower of the fair market value of common stock on the commencement date of each offering period or the fair market value on the last day of the purchase period. During 2004, the shares purchased under the ESPP were 103,000 and 72,000 on May 1 and November 1, respectively.
NOTE 8-NET LOSS PER SHARE:
Basic and diluted net loss per share is calculated as follows:
The Company has issued shares to employees and non-employees that are subject to repurchase should an employee terminate employment with the Company. The shares vest monthly and the vesting periods range from 36 months to 48 months. Shares subject to repurchase are excluded from the average shares used in the calculation of basic and diluted net loss per share.
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Equity instruments that could dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share as their effect is antidilutive are as follows:
NOTE 9-GEOGRAPHIC SEGMENT INFORMATION
The Company has determined that it has a single reportable segment consisting of the development, manufacture, and marketing of proprietary products for the treatment of gastrointestinal disorders. Management uses one measurement of profitability and does not disaggregate its business for internal reporting. Operations outside the United States primarily consist of a sales office in Belgium that is responsible for promoting sales activities to foreign customers who are invoiced by the Company’s headquarters in the United States, and a subsidiary in Australia that was used to coordinate Australian clinical trials in the past, and currently is inactive. The foreign subsidiaries do not carry any significant long-lived assets, and income and assets of the Company’s foreign subsidiaries were not significant.
Revenue from external customers by geographic area for each of the three years in the period ended December 31, 2004, were as follows:
NOTE 10-INCOME TAXES:
The components of net deferred tax assets and liabilities as of December 31, 2004 and 2003 are as follows:
CURON MEDICAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
(Tabular amounts in thousands, except share and per share amounts)
Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. The valuation allowance is increased by $6,652,000 and $5,548,000 for the period ended December 31, 2004 and 2003 respectively.
As of December 31, 2004, the Company has a net operating loss carry forward for federal purposes of approximately $81.8 million, which expire beginning in the year 2018. The Company also has California net operating loss carry forward of approximately $58.5 million which expire beginning in the year 2008.
The Company has research and development credit carry forwards of approximately $715,000 and $574,000 for federal and state income tax purposes, respectively. If not utilized, the federal carry forward will expire in various amounts beginning in 2018. The California credit can be carried forward indefinitely.
The Tax Reform Act of 1986 limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. In the event the Company has had a change in ownership, utilization of the carryforwards could be restricted.
NOTE 11-QUARTERLY FINANCIAL DATA (UNAUDITED):
The following table presents certain unaudited consolidated quarterly financial information for each of the eight quarters ended December 31, 2004. In our opinion, this quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting only of normal recurring adjustments, except for the litigation charge in the fourth quarter of 2003) necessary to present fairly the information for the periods presented. The results of operations for any quarter are not necessarily indicative of results for the full year or for any future period.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
Not applicable.
Item 9a.
Item 9a. Controls and Procedures
We restated our financial results for the quarter ended March 31, 2004 to reflect adjustments to our previously reported financial information. As a result of the investigation, management and the Audit Committee determined that certain sales employees had improperly offered rights of return and exchange in violation of our revenue recognition policy, and a manufacturer’s representative had not actually made sales that it had reported to the Company. As a result of this investigation, we were also unable to timely file the Form 10-Q for the quarter ended June 30, 2004. In connection with the financial results for the quarter ended March 31, 2004, our independent registered public accounting firm identified material weaknesses in our internal controls and procedures.
Our Audit Committee, with the assistance of independent legal and accounting advisors, recently evaluated the effectiveness of our disclosure controls and procedures. As a result of this evaluation, our Board of Directors has directed management to implement and management has implemented additional measures designed to ensure that information required to be disclosed in our periodic reports is recorded, processed, summarized and reported accurately. These measures include the adoption of a Disclosure Committee Charter, the adoption of a written revenue recognition policy, further controls on shipment of products for revenue transactions, and additional training of our sales and marketing staff to minimize the risk of revenue recognition errors. Given the additional measures adopted by the company, we believe that our disclosure controls and procedures are now effectively designed to ensure that information we are required to disclose in reports that we file or submit to the SEC is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.
With the participation of management, our President and Chief Executive Officer and our Vice President of Finance and Chief Financial Officer evaluated our disclosure controls and procedures as of December 31, 2004. Based upon this evaluation, our President and Chief Executive Officer and our Vice President of Finance and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
There were no changes in our internal controls or, to the knowledge of our management, in other factors, during the fourth quarter of fiscal 2004.
Item 9b.
Item 9b. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Certain of the information required by this item relating to directors is incorporated by reference to the information under the caption Proposal No. 1-Election of Directors in the Proxy Statement and under the caption Executive Officers.
Item 11.
Item 11. Executive Compensation
The information required by this item is incorporated by reference to the information under the caption Executive Compensation in the Proxy Statement.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is incorporated by reference to the information under the caption Record Date and Stock Ownership in the Proxy Statement.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information required by this item is incorporated by reference to the information under the caption Certain Transactions in the Proxy Statement.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item is incorporated by reference to the section entitled “Proposal Number 2-Selection of Auditors,” beginning with the section entitled “Audit and Other Fees,” but only up to and not including the section entitled “Recommendation and Vote Required of the Company’s Proxy Statement for the 2004 Annual Meeting of Stockholders.”
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(A)
1. Financial Statements
The following documents are filed as part of this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm.
Consolidated Balance Sheets at December 31, 2004 and 2003.
Consolidated Statements of Operations, for the years ended December 31, 2004, 2003, and 2002.
Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss) for the years ended December 31, 2004, 2003, and 2002.
Consolidated Statements of Cash Flows, for the years ended December 31, 2004, 2003, and 2002.
Notes to Consolidated Financial Statements.
Quarterly Financial Data (unaudited).
2. Financial Statement Schedules
The following financial statement schedule is filed as part of this Annual Report on Form 10-K:
Schedule II-Valuation and Qualifying Accounts and Reserves
All other schedules have been omitted as they are not required, not applicable, or the required information is otherwise included.
3. Exhibits
* Confidential treatment has been requested for certain portions of this Exhibit.
(1) Filed as an Exhibit to Curon’s Registration Statement on Form S-1 (File No. 333-37866) and incorporated herein by reference.
(2) Filed as an Exhibit to Curon’s 8-A12G filing on November 9, 2001, and incorporated by reference.
(3) Filed as an Exhibit to Curon’s report on 8-K filing on February 6, 2004, and incorporated herein by reference.
(4) Filed as an Exhibit to Curon’s report on 10-K for the year ending December 31, 2003, and incorporated herein by reference.
(5) Filed as an Exhibit to Curon’s report on 10-Q for the quarter ending September 30, 2003, and incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Larry C. Heaton II and Alistair F. McLaren, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the U.S. Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact, or his or their substitute or substitutes, may do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Act of 1934, this report signed below by the following person on behalf of the registrant and in the capacities and on the date indicated:
CURON MEDICAL, INC.
Schedule II
VALUATION AND QUALIFYING ACCOUNTS
Years ended December 31, 2004, 2003, and 2002
(In thousands)