Circon Corporation

1969–1995

Circon Corporation is the largest producer of laparoscopic scopes, medical video systems, and endoscopic suction irrigation devices in the United States. With the acquisition of Cabot Medical Corporation in 1995, it also became the largest producer of ureteral stents and gynecological sterilization products. A pioneer in the field of medical video technology, Circon designs, manufactures, and markets the complete endoscopic optical-video chain for use in minimally invasive surgery (MIS). The system incorporates all of the elements generating the optical image, including advanced endoscopes, the video camera system, adapter optics, and light source. Circon's product line also includes other electronic equipment as well as electrosurgical and manual instruments for use by surgeons in diagnosing, taking biopsies, performing surgery, removing kidney and gall stones, performing cauterization, and excising benign tumors.

MIS instrumentation extends the eyes and ears of the surgeon through the optical-video chain. MIS procedures can be accomplished by means of endoscopes without a major incision or other traumatization of the patient. Endoscopes are small tubular optical instruments that enter the body through either a natural orifice or a small incision. Endoscopy grew in the 1980s and 1990s because it provides several medical advantages as well as cost savings over traditional open surgery. Since the patient has a much faster recovery with substantially lower costs, government reimbursement programs as well as private insurance and prepaid health plans have encouraged the use of MIS endoscopic procedures over traditional open surgery.

Richard A. Auhll Joined Circon as President, 1969

When Richard A. Auhll joined Circon as president in 1969, it had eight employees with $200,000 in sales. For approximately 12 years, it had been making circuit board components. Approximately two-thirds of the company's products were nearly obsolete, including the gold-plated eyelets it made for printed circuit board repair. Since Circon had a positive cash flow, however, Auhll saw it as a potential source of financing for the start-up of a new company.

Auhll brought to Circon two engineering degrees, a Harvard MBA, and five years experience as a rocket engineer. What most interested him about Circon were the industrial microtools it was manufacturing. These included knives and other tools that Circon was making on the tips of needles for use in hybrid circuit repair under the microscope. Auhll discovered that a few surgeons at Johns Hopkins University were buying them because they were the smallest microsurgical instruments in the world. For medical use, the company's aluminum, brass, and carbon steel designs were manufactured out of stainless steel.

Introduced First Commercially Successful Color Medical Video System, 1972

Under Auhll's leadership, Circon began selling television microscope systems for industrial inspection in 1970. Then, in 1972, the company introduced the world's first commercially successful color medical video system. Used primarily for teaching, the system incorporated a fiberoptic image guide to transfer a microscope image to an 18-pound, three-tube color video camera. These cameras, designed for television broadcast, were too heavy for direct attachment to endoscopes.

In the early 1970s, the medical video market was a classic niche market. Sales were low, but there was little competition. Circon began seeking out surgeons to become "product champions" for the concept. Gradually, surgeon "product champions" became more vocal and sales increased. Major medical instrument companies began approaching Circon to private-label products for them to sell through their sales forces.

Although Circon did not really want to private-label products (fearing the other companies would eventually replace Circon as a source of video products), the economics of the situation proved compelling. Even with a 40 percent wholesale discount to distributors, a dramatically increased sales volume would result in an even faster rising net income for Circon. Therefore, over a 12-year period (1973-1985) Circon provided private-label video systems for many of the major medical suppliers.

Circon took two precautions in its private label endeavors. First, it insisted on dual branding, with both Circon and the "distributor-manufacturer" names and logos on the product. Second, Circon continued to build its own brand name through exhibits and product champions.

In 1973 Auhll developed his vision of the future of medical video technology. He felt that the ideal medical video system would have zero size, zero weight, and zero controls, so as not to compromise the resolution of the optics, encumber the doctor, or confuse the staff with complex equipment. He also believed that sooner or later virtually all surgery would be performed using endoscopic optical video chains.

Hence, in 1973 Circon introduced the MV-9265 camera, weighing 3.8 pounds and measuring 3.25″ × 4.6″ × 9″. For the first time, a video camera could be attached directly to a microscope or endoscope, eliminating the fiberoptic image guide. The camera contained a single one-inch tube with a special filter and electronics to generate a full color picture. It was a dramatic advance in medical television, but the camera was still somewhat heavy and bulky.

The initial public offering (IPO) took place on July 7, 1983, with the sale of $30 million of stock.

1973–1993

Over the next 20 years (1973-1993), the technology and design of Circon medical video cameras progressed, with significant advancements occurring about every two years. Improvements were systematically made to such characteristics as size, weight, color fidelity, light sensitivity, resolution, push button controls, and dynamic range, among others. By 1993, virtually every field of surgery was using medical video.

Auhll Executed a Leveraged Buyout from Prior Owners, 1977

In 1977 Auhll executed a leveraged buyout of Circon from the prior owners for $1.1 million, with equity put up by Auhll and three venture investors. Auhl retained 55 percent ownership by guaranteeing a Small Business Administration loan and the commitment of all his net worth. The leveraged buyout meant that the prior owners held the debt and any failure to make repayments would have had all of the company's assets go to the bank and all of the stock go to the original owners.

In 1980 Circon began experiencing an explosive growth in video sales, primarily through its private-labeling for larger companies. In 1982 it was able to wipe out its debt through a $7 million private stock placement in the United Kingdom after making a return to the original investors.

Became a Public Corporation with Initial Public Offering, 1983

In 1983 Circon became a publicly traded corporation on the NASDAQ exchange. The initial public offering (IPO) took place on July 7, 1983, with the sale of $30 million of stock. Going public gave the company a diversified investor base, access to additional capital, and a way to lock in key managers with stock options.

Since Circon had demonstrated dramatic growth in sales and earnings, it became a darling of Wall Street. In July 1983, the value of the company rose to $128 million with only $9 million in sales and $1 million in net income. That worked out to a price-earnings ratio of 128-to-one.

Around 1984 a number of problems came to a head. The explosive growth in video sales began tapering off. Distributors were pressing for even deeper discounts, indicating they would find alternative sources if greater discounts were not offered. The company was unhappy about its lack of control or influence over its private-label customers' sales forces, and it found itself severely limited in its ability to expand its product lines. It could not introduce other elements of the optical video chain, such as endoscopes, light sources, and other accessories, because they were already the major products manufactured by Circon's private-label customers. With investors expecting major growth in sales and profits and the medical video market slowing, Circon was in a box. At this point, Circon decided it had to take control of its channels of distribution.

At the end of 1985, Circon terminated all of its OEM and distributor-manufacturer customers and proceeded to hire, train, and field its own direct sales force. This was a major strategic gamble. Existing marketing management was able to train the sales force. The sales force was able to capitalize on Circon's stellar reputation and brand name, which the company had been building and promoting since the time it had invented color medical video systems. Now Circon could enjoy higher margins by selling at retail rather than wholesale, but the significant issue was how many salespeople the company could field.

At this point, Circon began actively seeking products, divisions, or companies to purchase. Circon's strengths were its technology and marketing expertise. It sought ways to employ these strengths in new medical markets through acquisitions. Circon was looking for products with a compatible operating room technology to use in conjunction with its medical video products. Ideally, it was looking for an optical endoscope product line to acquire.

The acquisition program had several objectives. These included: 1) field a much larger sales force; 2) improve margins by eliminating the discounts to distributors, which were as high as 50 percent, and replacing them with sales force commissions, which averaged 15 percent; 3) improve control with respect to geographical and market segment success; 4) offer a broader product line; 5) improve customer contact, which would provide valuable feedback regarding new products, competition, and so forth; 6) obtain footholds in new markets through the existing market share of an acquired company; and 7) find an acquisition that would offer synergies in marketing and administration to provide a greater sales overhead spread.

Acquired ACMI Division of American Hospital Supply Corporation, 1986

1902–1997

The successful acquisition of the ACMI Division of American Hospital Supply Corporation (AHS) was completed on August 6, 1986. Four times larger than Circon, ACMI was much larger than any other candidate Circon had considered. After studying ACMI, Circon decided there was an excellent match in terms of technology, marketing, and management. With respect to technology, Circon video and ACMI optics were used together in many of the same endoscopic products in the video-optical chain. In terms of the relative strengths and weaknesses of the two companies, they appeared to be complementary rather than duplicative. Circon's strength of being a first-class electronic and video designer and manufacturer offset ACMI's relatively weak electro-mechanical manufacturing abilities. Some of ACMI's products were being manufactured by outside vendors, and these could be manufactured by Circon after the acquisition. On the other hand, Circon had little capability of manufacturing or designing specialized optics, a field in which ACMI excelled. With the acquisition of ACMI, Circon could develop new optical products and improve existing ones.

ACMI and Circon also had compatible marketing programs. Circon had a small direct sales force that could be folded into ACMI's much larger 44-member team and be managed by ACMI's sales management group. The sales force would also have a much broader product line to offer, an important consideration for customers who preferred to buy a complete system from a single source rather than buy subsystems from several different vendors.

Having decided that it definitely wanted to purchase ACMI, the next big question was how to finance the acquisition. The final purchase price was $28.5 million. Circon had a $14 million cash balance and good relations with the financial community. The acquisition was paid for with $21.5 million in cash (including a $2 million loan from Auhll), a $5 million short-term promissory note, and $2 million worth of Circon common stock. Of the $28.5 million, about half was borrowed, adding approximately $2.5 million annually in interest charges to ACMI's existing losses. Circon had planned to replace all of that debt with equity through a stock offering, but the market turned sour. Convertible debentures in the amount of $9 million were issued, saddling Circon with heavy interest costs.

ACMI had been founded in 1902. After three generations of family ownership, it had lost the focus, somewhat, of its main business. In 1980 it was acquired by AHS, who installed its own management team. It went through a period of turmoil, with ACMI's sales and marketing teams being dismantled, then reassembled. More turmoil resulted from the hostile takeover of AHS in 1985 by Baxter Travenol.

Thus, at the time ACMI was acquired by Circon, it was a troubled company with a history of major losses. Circon was faced with a major turnaround situation. It needed to add $9 million to ACMI's bottom line each year for ACMI to break even. Since ACMI was four times the size of Circon, the turnaround would take time. A strategic plan was put in place to yield progressive improvement in profitability. The plan had seven major objectives. They included increasing gross profit, cutting costs, adding high margin products, creating a more effective organization, increasing market penetration, expanding sales into new markets, and expanding product lines.

By the second half of 1988, a positive operating profit was realized. By 1989, Circon generated 20 percent internal sales growth and made a profit. By 1991, the Circon-ACMI merger was a success. The company's stock price had risen from a low of $2.50 per share to around $11 per share, so there was a favorable market for the sale of equity. Management wanted to be debt-free and implemented a two-stage strategy. First, a medium-sized stock offering was made to eliminate all debt. A subsequent second offering would build a reserve for acquisitions and other activities. In June 1991, Circon sold one million shares at the market price of $16. Subsequently, the stock price rose, and in December 1991, Circon sold 1.1 million shares at $25 per share. These two stock offerings netted the company $43 million over a six-month period. Within a month of the December offering, the stock price doubled to $50, then settled into the $40 range.

In 1992 Circon set sales and profit records, but the stock price dropped to $23 by year end and reached a low of $11 in 1993. Many of Circon's problems were shared by the entire medical equipment industry. Following the election of Bill Clinton, the specter of health care reform and the congressional battles over reform kept the health care markets in a state of near paralysis. It was difficult, if not impossible, to make capital commitments. By 1995, federal health care reform efforts were dead and the medical equipment markets began growing again.

Acquired Cabot Medical Corporation, 1995

In August 1995 Circon completed a merger with Cabot Medical Corporation, which it acquired for approximately $75 million in stock. The merger made Circon the largest producer of minimally invasive surgery products specializing in urology and gynecology. Cabot's key market was gynecology endoscopy and it was a leader in disposable products, which provided the company with a growing market in an aging but underserved female population. By merging with Cabot, Circon substantially broadened its product lines and gained a major presence in the gynecology and laparoscopy growth markets. Its U.S. sales force doubled in size as a result of the merger. Other benefits included proprietary technology and a larger "critical mass" to compete in the health care market.

The combined Circon-Cabot sales force was the largest sales force in endoscopy. After combining the two sales forces, each sales representative had half as much geographic territory and half as many accounts, but twice as many products to sell. With only about 40 percent of doctors buying products from both companies, significant cross-selling opportunities existed with the remaining 60 percent of customers. The larger sales force, combined with the broadened product offering, enabled Circon to better serve larger hospitals and buyer groups.

Recognizing that it had to solve Cabot's operational problems of overstaffing and redundant facilities, Circon closed Cabot's Langhorne, Pennsylvania facility in October 1996. Although Circon incurred $2.6 million in closure expenses, it expected to achieve up to $4 million in savings in 1997 and each subsequent year.

U.S. Surgical Corporation Began Hostile Takeover Attempt, 1996

1995–1997

On August 2, 1996, U.S. Surgical Corporation made an unsolicited tender offer, through its subsidiary U.S. Surgical Acquisition Corporation, of $18 per share for all of Circon's outstanding stock. In late July, shares of Circon were trading at $9, but the stock price jumped to around $19 after the tender offer was announced. With the tender offer set to expire August 29, the takeover bid was valued at $230 million.

Within two weeks, Circon's board of directors recommended that Circon stockholders reject the tender offer, calling it inadequate and saying the company was not for sale. At the same time, the company announced it had adopted a stockholders rights plan, essentially a defense against a hostile takeover. Under the plan, the company declared a dividend distribution of preferred shares purchase rights to stockholders of record. The rights would become exercisable under certain circumstances if someone tendered for or acquired 15 percent or more of Circon's common stock. With respect to the tender offer by U.S. Surgical, the rights were not currently exercisable, but could become exercisable at a date to be determined by the board of directors. If the 15 percent threshold were crossed, then the rights would entitle stockholders to purchase Circon common stock at a discount to market prices. This plan would make it prohibitively expensive for anyone to acquire 15 percent or more of the company.

Another defense, adopted in July 1995 but not effective until July 16, 1996, was a new provision in the company's charter that prevented investors from acting by written consent or from calling a special meeting, two ploys sometimes used in a hostile takeover situation. That meant, for example, that a group of investors intent on a hostile takeover could not submit a new slate of directors to oust the existing board, nor could they call a special shareholder meeting to attempt a hostile takeover.

At the end of August, U.S. Surgical extended its tender offer to the end of September. At this time U.S. Surgical had not purchased any of the shares tendered and only owned approximately one million shares of Circon's common stock. Circon had approximately 12.5 million shares outstanding.

Putting up yet another defense, Circon announced an Employee Retention Plan, which would be triggered in the event of any change in control of the company. The plan called for certain benefits to be paid to certain key employees, either for remaining with the company for a certain period of time, or upon an involuntary termination of employment following a change in control of the company.

On September 18, 1996, U.S. Surgical filed suit against Circon to block its shareholder rights plan. Two weeks later it made a second extension of its tender offer, and Circon again urged its shareholders not to tender and those who had already tendered to withdraw.

On December 17, 1996, U.S. Surgical lowered its tender offer from $18 per share to $17 per share. Circon called this offer, like its predecessor, inadequate. U.S. Surgical later stated that more than 7.7 million shares were tendered that month, however.

On February 14, 1997, U.S. Surgical made a fourth extension of its tender offer. Then on June 17, 1997, U.S. Surgical lowered its bid to $14.50 per share in making a tender offer for 973,174 shares of Circon common stock. This offer was successfully completed on July 14, 1997, giving U.S. Surgical ownership of the approximate maximum amount of shares before Circon's shareholder rights plan would be triggered. According to statements released by U.S. Surgical, this offer was oversubscribed by 400 percent, with some 4.5 million shares tendered.

On August 5, 1997, U.S. Surgical made a new cash tender offer for all of the outstanding common shares of Circon for $16.50 per share. In making the announcement, U.S. Surgical noted that Circon had turned down every request for a meeting at which to negotiate a friendly merger. The company pointed out that Circon's financial performance had deteriorated since the original tender offer of August 1996. Operating income for six months ending June 30 was down 22 percent, and the operating margin for the same period dropped from six percent to four percent. Second quarter operating income fell more than 25 percent from the first quarter, and earnings per share dropped 50 percent.

U.S Surgical's offer, set to expire September 25, 1997, was conditional on several factors. U.S. Surgical would have to acquire at least two-thirds of Circon's shares, Circon's shareholder rights plan would have to be inapplicable, and the proposed merger with Circon would have to occur. At this time, U.S. Surgical owned 14.8 percent of Circon's outstanding shares. If it acquired more, Circon's shareholder rights plan would take effect.

On August 13, 1997, U.S. Surgical filed suit against Circon to force it to hold its 1997 annual meeting of shareholders. Under Delaware law (Circon is incorporated in Delaware), shareholders can call an annual meeting if a company fails to do so within 13 months of its previous meeting. Circon's last annual meeting was held July 12, 1996. In a related action, U.S. Surgical also reinstated its lawsuit seeking to compel Circon to provide it with information so that it could communicate directly to Circon's stockholders concerning its tender offer and proxy contest to elect directors to Circon's board.

On August 14, 1997, the day after U.S. Surgical filed suit, Richard Auhll announced that Circon's board of directors had set October 6, 1997, as the date of the annual meeting of stockholders. It was likely that the success or failure of U.S. Surgical's hostile takeover bid would hinge on this meeting.