ATH MicroTechnologies, Inc.

Instructions:
This case describes the evolution of an innovative, entrepreneurial firm in the medical technology industry. The successes—and difficulties—of the business are due in large part to management’s attempts to design and use formal control systems to achieve profit and performance goals The case is structured in five chronological sections that will be discussed in class. To prepare for the initial discussion, please answer the questions at the end of this case.

Founding
In 1997, Dr. Charles Casper and John Frost founded ATH MicroTechnologies Inc. to develop, manufacture, and sell a new medical imaging product. Dr. Casper (47), a radiologist, had trained at Johns Hopkins medical school and, after a research fellowship at Harvard Medical School, joined a private practice in Florida. Casper specialized in the use of imaging systems for the medical practice. Over time, he had experimented with different procedures, such as ultrasounds and x-ray, until he became interested in a new technology based on sending electronic impulses through electrodes attached to the skin and observing how these impulses changed as they went through the body. Together with John Frost—an engineer who specialized in digital imaging for medical applications— Casper perfected the technology, reducing its cost and improving its resolution. Both founders anticipated a significant market potential for their product.

Relatively low cost combined with improved image quality made it a very attractive alternative for applications where other imaging systems were prohibitively expensive to use. With these expectations, they convinced a group of doctors to invest in the venture. The company started with $3.6 million in paid-in capital. In 1998, ATH MicroTechnologies received regulatory approval to market its first product—an imaging system to work in conjunction with minimally invasive surgical procedures. Building on this initial success and after a detailed sales and profit projection over a five year period, a deal was struck with Alumni Capital Partners, a venture capital firm, which agreed to invest $8.7 million to support the launch of the new product. The business plan anticipated the introduction of new products with increased image resolution and a broader range of applications to pull the company into profitability by the end of 2001. During this period, all the cash of the business would be invested in product development, production tooling, and marketing.

Professor Robert Simons and Doctoral Candidate Antonio Dávila prepared the original version of this case, “ATH Technologies, Inc. (A): Making the Numbers,” HBS No. 100-016, which is being replaced by this version prepared by Professor Robert Simons. Certain details have been disguised. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2008, 2009 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-5457685, write Harvard Business School Publishing, Boston, MA 02163, or go to www.hbsp.harvard.edu/educators. This publication may not be digitized, photocopied, or otherwise reproduced, posted, or transmitted, without the permission of Harvard Business School.

The product was launched in December 1998 and gained a toehold in the marketplace. Additional managers, scientists, and marketing personnel were hired. Some were given equity positions in the company in lieu of fully competitive salaries. As expected, the investment in product development and manufacturing processes absorbed all the cash that the business generated. In 1999, the venture capital firm organized another round of financing, bringing other venture capital firms into the company which invested $8.0 million. At this point, the board was comprised 60% inside directors and 40% outsiders.

During 2000, the company improved the product and a new generation was developed. That same year, the founders received an offer to sell the company to Scepter Pharmaceutical, Inc. (a pseudonym), a $10 billion pharmaceutical and medical products company that wished to increase its presence in this market segment. The offer seemed attractive to all the parties involved. The venture capital firms would be able to cash out profitably, Scepter would add a new and successful product to its product line, and ATH would have access to cash to finance faster growth. The business could add more people, expand facilities, and buy new equipment to take advantage of the market opportunity for its product.

ATH was acquired by Scepter in early 2001 for an initial payment of $90 million to existing shareholders. In addition, there was an “earn-out” clause whereby Scepter would pay, on a pro rata basis, an additional $30 million if the new products currently under development were approved by the FDA; $35 million if an independent study proved that the ATH’s technology was superior to other existing technologies; and $120 million over a three-year period starting in December 2003 if sales growth and earnings goals were met (Table A describes the earn-out structure). ATH’s 10 equity-holding managers who chose to stay with Scepter could receive between $1.5 million and $7.5 million as additional payout from the sale of the company. Table A

Structure of Earn-out Payments
Sales Goals

2003 results
2004 results
2005 results

Table B

Bonus

$63 million
$114 million
$165 million

Earnings Goals

$15 million
$20 million
$25 million

$8 million
$26 million
$36 million

Bonus
$15 million
$20 million
$25 million

Financial Performance, 1997-2000

Net sales
Gross margin
Marketing and sales
Research and development
Net income (loss)
Cash and short-term investments
Other current assets
Net fixed assets
Total assets
Long-term debt
Common stock
Retained earnings
Headcount (year-end)

1997

1998

1999

2000

7,290
(211,571)
28,968
775,941
(1,200,441)

272,582
(529,131)
296,874
1,320,329
(3,076,724)

1,295,271
(882,978)
1,226,747
2,174,553
(5,428,640)

4,136,258
259,842
2,280,464
3,295,041
(6,791,526)

1,000,101
128,139
471,878
1,865,468

5,879,451
645,177
1,306,449
8,121,039

8,122,898
1,207,577
1,653,102
11,414,744

1,801,023
1,753,899
1,940,523
5,965,154

3,649,677
(1,976,913)

12,369,788
(5,053,637)

20,379,063
(10,482,276)

20,379,063
(17,273,802)

This document is authorized for use only in Strategic Cost and Profitability Management by Dr. Bala V Balachandran from January 2012 to July 2012.

ATH MicroTechnologies, Inc. (A): Making the Numbers

108-092

Questions:

Does the earn-out structure focus on the right performance goals?

(a) Should Scepter Pharmaceutical put additional controls on this entrepreneurial firm?

If you were president of ATH MicroTechnologies, how would you communicate and motivate employees to achieve profit and performance goals?

(a) What are the appropriate performance goals for employees to focus on?

(b) How would you communicate and control events and employee actions that could put business objectives at risk?

What are the best financial measures to assess ATH MicroTechnologies’