UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996.
Commission file number: 0-28448
GENERAL SURGICAL INNOVATIONS, INC.
(Exact name of Registrant as specified in its charter)
CALIFORNIA 97-3170244
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3172A PORTER DRIVE, PALO ALTO, CALIFORNIA 94304
(Address of principal executive offices)
Registrant's telephone number, including area code: (415) 812-9730
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
There were approximately 13,199,353 shares of Registrant's Common Stock issued
and outstanding as of December 31, 1996.
-------------------------------------
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED DECEMBER 31, 1996
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed, consolidated balance sheets at December 31, 1996 and
June 30, 1996......................................................... 3
Condensed, consolidated statements of operations for the three months
ended December 31, 1996 and 1995 and for the six months ended
December 31, 1996 and 1995............................................ 4
Condensed, consolidated statements of cash flows for the six months
ended December 31, 1996 and 1995...................................... 5
Notes to condensed, consolidated financial statements................. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 8
PART II. OTHER INFORMATION
2
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
December 31, June 30,
1996 1996
------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 11,483 $ 28,339
Available-for-sale securities 36,412 21,451
Accounts receivable, net 1,714 873
Inventories 1,379 700
Prepaid expenses and other current assets 160 438
--------- ---------
TOTAL CURRENT ASSETS 51,148 51,801
Property and equipment, net 632 702
Intangible and other assets, net 247 264
--------- ---------
Total assets $ 52,027 $ 52,767
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 545 $ 614
Accrued liabilities 644 892
Bank borrowings 167 127
Deferred revenue - 100
--------- ---------
TOTAL CURRENT LIABILITIES 1,356 1,733
Bank borrowings, less current portion 269 360
Other long-term liabilities 200 200
--------- ---------
Total liabilities 1,825 2,293
Shareholders' equity:
Preferred stock, $.001 par value:
Authorized: 2,000,000 shares; none issued and outstanding
Common stock, $.001 par value:
Authorized: 50,000,000 shares; issued and outstanding 13,199,353 13 13
on Dec. 31, 1996 and 13,132,903 on June 30, 1996
Additional paid in capital 65,002 64,885
Notes receivable from shareholders (105) (112)
Deferred compensation, net (396) (496)
Unrealized gain/(loss) on available-for-sale securities (29) 1
Accumulated deficit (14,283) (13,817)
--------- ---------
Total shareholders' equity 50,202 50,474
--------- ---------
Total liabilities and shareholders' equity $ 52,027 $ 52,767
--------- ---------
--------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS.
3
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Six Months Ended
December 31, December 31,
-------------------------- ------------------------
1996 1995 1996 1995
-------- -------- -------- --------
Sales $ 361 $ 1,217 $ 2,831 $ 1,708
Guaranteed payments 1,500 - 1,500 -
---------- --------- ---------- ---------
Gross Sales 1,861 1,217 4,331 1,708
Cost of Sales 359 586 1,352 920
---------- --------- ---------- ---------
Gross Profit 1,502 631 2,979 788
---------- --------- ---------- ---------
Operating Expenses:
Research and development 484 278 946 480
Sales and marketing 1,095 998 2,203 1,753
General and administrative 830 395 1,553 706
---------- --------- ---------- ---------
Total operating expenses 2,409 1,671 4,702 2,939
---------- --------- ---------- ---------
Operating loss (907) (1,040) (1,723) (2,151)
Interest and other income 670 25 1,257 88
---------- --------- ---------- ---------
Net loss $ (237) $ (1,015) $ (466) $ (2,063)
---------- --------- ---------- ---------
---------- --------- ---------- ---------
Net loss per share $ (0.02) $ (0.15) $ (0.04) $ (0.31)
---------- --------- ---------- ---------
---------- --------- ---------- ---------
Shares used in computing net loss per share 13,183,440 6,555,770 13,165,128 6,554,626
---------- --------- ---------- ---------
---------- --------- ---------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS.
4
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Six Months Ended
December 31,
------------------------------
1996 1995
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used in operating activities (2,000) (2,434)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities (37,305) -
Maturities of available-for-sale securities 22,500 -
Acquisition of property and equipment (124) (161)
Proceeds from payments on shareholder notes receivable 18 -
------------ ------------
Net cash used in investing activities (14,911) (161)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on obligations under capital leases and
capital loans (51) (43)
Proceeds from issuance of common stock, net of
issuance costs 106 1
------------ ------------
Net cash provided by (used in) financing
activities 55 (42)
------------ ------------
Net decrease in cash and cash equivalents (16,856) (2,637)
Cash and cash equivalents, beginning of period 28,339 4,541
------------ ------------
Cash and cash equivalents, end of period $ 11,483 $ 1,904
------------ ------------
------------ ------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS.
5
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited condensed, consolidated financial
statements as of December 31, 1996 and for the three and six month periods
ended December 31, 1996 and 1995 of General Surgical Innovations, Inc. and
subsidiary (the "Company") have been prepared in accordance with generally
accepted accounting principles for interim financial information and pursuant
to the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments, consisting only of
normal recurring adjustments, considered necessary for a fair presentation
have been included. Operating results for the three month and six month
periods ended December 31, 1996 are not necessarily indicative of the results
that may be expected for the fiscal year ended June 30, 1997, or any future
interim period.
These financial statements and notes should be read in conjunction
with the Company's audited financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
June 30, 1996.
2. RECENT PRONOUNCEMENTS:
In October 1995, the Financial Accounting Standards Board issued
Statement No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION (SFAS No. 123),
which establishes a fair value based method of accounting for stock-based
compensation plans and requires additional disclosures for those companies
that elect not to adopt the new method of accounting. While the Company
studies the impact of the pronouncement, it continues to
6
account for employees' stock options under APB Opinion No. 25, "Accounting
for Stock Issued to Employees." SFAS No. 123 will be effective for the
Company's 1997 fiscal year.
3. Inventories:
Inventories comprise:
Dec 31, Jun 30,
-------------------
1996 1995
---- ----
(in thousands)
Raw Materials................ $ 767 $ 387
Work in progress............. 93 153
Finished goods............... 519 160
------ ------
$1,379 $ 700
------ ------
------ ------
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
unaudited condensed, consolidated financial statements and notes thereto
included in part I, Item I of this Quarterly Report and with Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K for the year ended
June 30, 1996.
Except for the historical information contained in this Quarterly
Report on Form 10-Q, the matters discussed herein are forward-looking
statements that are subject to certain risks and uncertainties that could
cause the actual results to differ materially from those projected. Factors
that could cause actual results to differ materially include, but are not
limited to, fluctuations in revenues among different product lines and
markets, the timing of orders and shipments, the ramp-up of distribution
efforts by Ethicon-Endo Surgery, Inc. ("EES"), EES's success in achieving
certain levels of sales growth, the Company's ability to manage growth and
the transition to EES and possible other new corporate partnering
relationships, the timely development and market acceptance of new products
and surgical procedures, the impact of competitive products and pricing,
results of ongoing litigation, the Company's ability to further expand into
international markets, approval of its products by government agencies such
as the United States Food and Drug Administration, the termination of the
Company's distributorship agreement with United States Surgical Corporation
("USSC"), and other risks detailed below and included from time to time in
the Company's other SEC reports and press releases, copies of which are
available from the Company upon request. The Company assumes no obligation to
update any forward-looking statements contained herein. The factors listed
below under "Factors Affecting Future Results," as well as other factors,
could in the future affect the Company's actual results and could cause the
Company's results for future quarters to differ materially from those
expressed in any forward-looking statements contained in the following
discussion.
References made in this Quarterly Report on Form 10-Q to "General
Surgical Innovations, Inc.," the "Company" or the "Registrant" refer to General
Surgical Innovations, Inc. and its subsidiary. The following General Surgical
Innovations, Inc. trademarks are mentioned in this Quarterly Report: Spacemaker
- -Registered Trademark-, registered trademark of the Company; and Knotmaker -TM-,
trademark of the Company.
Overview
Since its inception in April 1992, GSI has been engaged in the
development, manufacturing and marketing of balloon dissection systems and
related minimally invasive surgical instruments. The Company began commercial
sales of its balloon dissection systems for hernia repair in September 1993.
To date, the Company has received from the FDA four 510(k) clearances for use
of the Company's technology to perform dissection of tissue planes anywhere
in the body using a broad range of balloon sizes and shapes. The Company
currently sells products in the United States and certain other countries in
Europe, Asia and South America for selected
8
applications, such as hernia repair, subfascial endoscopic perforator surgery
and breast augmentation and reconstruction surgery.
In November 1996, the Company terminated its distribution agreement
with USSC which provided USSC with limited exclusive rights to distribute the
Company's balloon dissection systems in the hernia repair market in both the
United States and certain international countries.
In December 1996, the Company entered into a five year OEM supply
agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery,Inc.
("EES"), a Johnson & Johnson company ("JNJ") pursuant to which GSI granted
EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM-
Balloon Dissection Systems in the laparoscopic hernia repair and urinary
stress incontinence ("USI") markets. The Expanded EES Agreement supersedes
the June 1996 licensing agreement between the Company and EES pursuant to
which GSI granted EES the right to market its new balloon dissection product.
Under the Expanded EES Agreement, GSI will manufacture certain products and
EES will market and distribute these products in the hernia and USI markets.
In addition to the development of balloon dissection systems, the companies
will collaborate on development of additional products for these markets. EES
made an initial guaranteed payment of $1.5 million under the Expanded EES
Agreement. In addition, the Expanded EES Agreement provides that EES will
either purchase products, or make payments in lieu of such purchases, to
ensure that GSI maintains a gross margin of $1.6 million and $1.7 million in
the third and fourth quarters of fiscal 1997, respectively (ie through June
30, 1997). Following this initial ramp-up period, EES is required to make
certain minimum quarterly product purchases.
Additional sales in the United States are currently made through a
small direct sales force. The Company currently sells its products (other
than for hernia and SUI applications) in international markets through a
limited number of distributors who resell to surgeons and hospitals. The
Company plans to increase its direct sales force in the United States and may
seek to establish a direct sales force in one or more other countries in the
future. Any increase in the Company's direct sales force will require
significant expenditures and additional management resources.
To date, all of the sales made through distributors and almost all
of the sales by the Company's direct sales force have been for use in hernia
repair procedures. While the Company has developed or is developing balloon
dissection systems for urinary stress incontinence, vascular, plastic surgery
and orthopedics applications, sales of products for hernia repair are
expected to provide a substantial majority of the Company's revenues at least
through fiscal 1997.
The Company has acquired significant patent rights from third
parties, including rights that apply to the Company's current balloon
dissection systems. The Company has historically paid and is obligated to pay
in the future to such third parties royalties equal to 4% of sales of such
products, which payments are expected to exceed certain minimum royalty
payments due under agreements with such parties. The Company has also
acquired patent rights under royalty-bearing agreements with respect to
certain surgical instruments, including the KnotMaker product and the balloon
valve trocar currently under development.
In February 1996, the Company acquired Adjacent Surgical, Inc., a
company engaged in the development of balloon dissection systems for use in
vascular applications. The transaction resulted in a one-time expense related
to in-process research and development of approximately $2.8 million, in the
quarter ended March 31, 1996. From time to time, the Company has had
discussions with third parties regarding various strategic relationships,
although the Company currently has no commitments with respect to any such
relationships. The Company plans
9
to continue to investigate potential strategic relationships in the future.
The Company has a limited history of operations and has experienced
significant operating losses since inception. The Company expects such
operating losses to continue at least through calendar year 1997. The
increase in the Company's sales to date has been due to demand for the
Company's balloon dissector systems principally for hernia repair. In order
to support increased levels of sales in the future and to augment its
long-term competitive position, including the development of balloon
dissection systems for other applications, the Company anticipates that it
will be required to make significant additional expenditures in
manufacturing, research and development (including marketing-related clinical
evaluations), sales and marketing and administration. In addition, the
Company anticipates higher administration expenses resulting from its
obligations as a public reporting company.
The Company anticipates that its results of operations may fluctuate
for the foreseeable future due to several factors, including fluctuations in
purchases of the Company's products by EES, EES's ability to achieve certain
levels of sales growth, the status of the Company's relationship with EES or
other partners, fluctuations in revenues among different product lines and
markets, the mix of sales among the distributors and the Company's direct
sales force, timing of new product introductions or transitions to new
products, the margins recognized from products for various surgical
procedures, the progress of marketing-related clinical evaluations, the
introduction of competitive products (including pricing pressures),
activities related to patents and patent approvals (including litigation) and
regulatory and third-party reimbursement matters, and the timing of research
and development expenses (including marketing-related clinical evaluations).
In addition, the Company's results of operations could be affected by the
timing of orders from distributors, expansion of the Company's distributor
network, the ability of the Company's distributors to effectively promote the
Company's products and the ability of the Company to quickly and cost
effectively increase its direct domestic sales force. The Company's limited
operating history makes accurate prediction of future operating results
difficult or impossible.
The Company currently manufactures and ships product shortly after
the receipt of orders, and anticipates that it will do so in the future.
Accordingly, the Company has not developed a significant backlog and does not
anticipate that it will develop a material backlog in the future.
In January 1997, the Company entered into a new local facility lease and
is planning to relocate its headquarters and manufacturing operations to this
new location during April 1997. The new facility's lease comprises
approximately 30,460 square feet and the monthly rent is approximately
$47,000.
RESULTS OF OPERATIONS
REVENUE. Revenue increased by 53% to approximately $1.9 million for
the quarter ended December 31, 1996 from $1.2 million for the same period in
1995. Revenue for the six months ended December 31, 1996 increased 154% to
approximately $4.3 million from $1.7 million for the six months ended
December 31, 1995. This increase was due to growth in direct unit sales of
the Spacemaker I and II platforms for the hernia market and an initial
guaranteed payment of $1.5 million from EES pursuant to the Expanded EES
Agreement. The Expanded EES Agreement provides that EES will purchase
products, or make payments in lieu of such purchases, to ensure that GSI
maintains a gross margin of $1.6 million and $1.7 million in the third and
fourth quarters of fiscal 1997, respectively (ie through June 30, 1997). As
the Company begins its transition to EES, the Company believes that its sales
results will fluctuate from quarter to quarter during at least the next
several quarters.
10
COST OF SALES. Cost of sales decreased by 39% to approximately
$359,000 for the quarter ended December 31, 1996 from $586,000 for the same
period in 1995, and increased as a percentage of sales to 99% for the quarter
ended December 31, 1996 from 48% for the quarter ended December 31, 1995.
This increase in cost of sales as a percentage of sales was primarily a
result of under-utilized manufacturing capacity as the Company had lower
sales during its transition to EES as its new major distributor. Cost of
sales for the six months ended December 31, 1996 decreased as a percent of
sales to 48% or approximately $1.4 million as compared to 54% of sales or
approximately $920,000 for the six months ended December 31, 1995.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development
expenses, which include expenditures for marketing-related clinical
evaluations and regulatory expenses, increased by 74% to $484,000 in the
quarter ended December 31, 1996 from $278,000 for the same period in 1995 due
to increased funding of new product development. Research and development
expenses for the six months ended December 31, 1996 were approximately
$946,000 compared to $480,000 for the six months ended December 31, 1995. The
Company expects research and development expenses to increase in absolute
dollars as the Company pursues development of new products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative (SG&A) expenses increased by 38% to $1.9 million for the quarter
ended December 31, 1996 from $1.4 million for the quarter ended December 31,
1995. For the six months ended December 31, 1996 SG&A expenses were $3.8
million compared to $2.5 million for the six months ended December 31, 1995.
This increase was primarily due to the growth of a direct sales force in the
United States and the growth in marketing and other personnel associated with
the Company's higher levels of operations. The Company expects selling,
general and administrative expenses to continue to increase in absolute
dollars as the Company's sales and manufacturing infrastructure (including
additional sales personnel) increases and as the Company increases its
finance and administrative expenditures to meet its obligations as a public
reporting company.
INTEREST AND OTHER INCOME. Interest and other
income increased to $670,000 for the quarter ended December 31,
1996 from $25,000 for the quarter ended December 31, 1995. For the six
months ended December 31, 1996 interest and other income increased
to $1.3 million from $88,000 for the same period in 1995 due to higher
average cash, cash equivalents and available-for-sale securities balances.
Interest earned in the future will depend on the Company's funding cycles and
prevailing interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's cash expenditures have significantly
exceeded its sales, resulting in an accumulated deficit of $14.3 million at
December 31, 1996. The Company has funded its operations primarily through
the sale of equity securities. From its inception through December 31, 1996
the Company raised approximately $15.2 million through the private placement
of equity securities and approximately $46.9 million (net of underwriting
discounts and commissions) in an initial public offering.
11
As of December 31, 1996 the Company's principal source of liquidity
consists of cash, cash equivalents and short-term investments of $47.9
million, as compared to approximately $49.8 million at June 30, 1996. This
decrease reflects approximately $2 million used to fund operations.
The Company expects to incur substantial additional costs, including
costs related to increased sales and marketing activities, increased research
and development, expenditures in connection with seeking regulatory approvals
and conducting additional marketing-related clinical evaluations, capital
equipment and other costs associated with expansion of the Company's
manufacturing capabilities and higher administration costs resulting from its
obligations as a reporting company. While the Company believes that its
current cash balances and short-term investments along with cash generated
from the future sales of products will be sufficient to meet the Company's
operating and capital requirements through calendar 1997, there can be no
assurance that the Company will not require additional financing within this
time frame. The Company may seek additional equity or debt financing to
address its working capital needs or to provide funding for capital
expenditures. There can be no assurance that additional financing, if
required, will be available on satisfactory terms or at all.
FACTORS AFFECTING FUTURE RESULTS
LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company
was organized in April 1992 and began commercially shipping its first
Spacemaker products in September 1993. Accordingly, the Company has only a
limited operating history upon which an evaluation of the Company and its
prospects can be based. As of December 31, 1996, the Company had an
accumulated deficit of $14.3 million. The Company's net operating losses for
the fiscal years ending June 30, 1994, 1995 and 1996 and for the quarter
ended December 31, 1996 were, $3.1 million, $4.1 million, $5.5 million,
and $237,000 respectively. The Company expects to continue to incur operating
losses on a quarterly and annual basis through at least calendar year 1997.
Due to the Company's limited operating history, and the recent transition to
EES as its major distributor, there can be no assurance of sales growth or
profitability in the future. The Company intends to increase significantly
its investments in research and development, sales and marketing,
marketing-related clinical evaluations and related infrastructure. Due to the
anticipated increases in the Company's operating expenses, the Company's
operating results will be adversely affected if sales do not increase. The
Company's prospects must be considered in light of the risks, expenses and
difficulties frequently encountered by companies in their early stage of
development, particularly companies in rapidly evolving markets. To address
these risks, the Company must respond to competitive developments, continue
to attract, retain and motivate qualified persons and successfully
commercialize products incorporating advanced technologies. There can be no
assurance that the Company will be successful in addressing such risks.
DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL
OBSOLESCENCE. All of the Company's sales since inception have been derived
from sales of its balloon dissection products, with a substantial portion
derived from sales for hernia repair procedures. Failure of the Company to
develop successfully and commercialize balloon dissection products for
applications other than hernia repair could have a material adverse effect on
the Company's business, financial condition and results of operations. The
success of the Company's products depends on the nature of the technological
advances inherent in the product designs, reductions in patient trauma or
other benefits provided by such products, results of marketing-related
clinical evaluations, continued adoption of minimally invasive surgery
("MIS") procedures by surgeons, market acceptance of the Company's products
and related procedures, reimbursement for the Company's products by health
care payors and the Company's receipt of regulatory approvals. There can be
no assurance that the Company's products will have the required technical
characteristics, that the Company's products will provide adequate patient
benefits, that marketing-related clinical evaluations results will be
favorable, that surgeons will continue to adopt MIS procedures, that
recently-introduced products or future products of the Company or related
procedures will gain market acceptance, or that required regulatory approvals
12
will be obtained. The failure to achieve any of the foregoing could have a
material adverse effect on the Company's business, financial condition and
results of operations. To the extent demand for the Company's balloon
dissection systems for hernia repair declines and the Company's
newly-introduced products are not commercially accepted or its existing
products are not developed for new procedures, there could be a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
DEPENDENCE ON KEY DISTRIBUTOR. In December 1996, the Company entered
into a five year OEM supply agreement (the "Expanded EES Agreement") with
Ethicon Endo-Surgery,Inc. ("EES"), a Johnson & Johnson company ("JNJ")
pursuant to which GSI granted EES exclusive worldwide sales and marketing
rights to sell the Spacemaker-TM- Balloon Dissection Systems in the
laparoscopic hernia repair and urinary stress incontinence ("USI") markets.
The Expanded EES Agreement supersedes the June 1996 licensing agreement
between the Company and EES pursuant to which GSI granted EES the right to
market its new balloon dissection product. Under the Expanded EES agreement,
GSI will manufacture certain products and EES will market and distribute
these products in the hernia and USI markets. The parties expect to jointly
develop and begin marketing this dissector for SUI repair in early calendar
1997. In addition to the development of balloon dissection systems, the
companies will collaborate on development of additional products for these
markets. EES made an initial payment of $1.5 million under the Expanded EES
Agreement. In addition, the Expanded EES Agreement provides that EES will
either purchase products, or make payments in lieu of such purchases, to
ensure that GSI maintains a gross margin of $1.6 million and $1.7 million in
the third and fourth quarter of fiscal 1997, respectively (ie through June
30, 1997). Following this initial ramp-up period, EES is required to make
certain minimum quarterly product purchases. No manufacture or distribution
of products has occurred to date pursuant to the Expanded EES Agreement, and
there can be no assurance that such manufacturing, marketing or distribution
efforts will be successful. EES's failure to achieve certain levels of sales
growth or a reduction in orders from EES could have a material adverse effect
on the Company's business, financial condition and results of operations.
Although the Company intends to establish additional distributorships in the
United States for products in areas other than hernia repair and urinary
stress incontinence, there can be no assurance that such efforts will be
successful. Failure to diversify its distribution network in the United
States could have a material adverse effect on the Company's business,
financial condition and results of operations.
To date, substantially all of the Company's international sales for
hernia repair procedures have been made through Autosuture under the same
terms and conditions as the Company's agreement with USSC, which was
terminated in November 1996. Thus, the Company does not anticipate that it
will have future sales through Autosuture. Although the Company has replaced
this international distributor network through its agreement with Ethicon
Endo-Surgery, there can be no assurance that EES's efforts in international
distribution will be successful.
LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only
limited experience marketing and selling its products through its direct
sales force, and has sold its products in commercial quantities through its
direct sales force only to the hernia market and, to a lesser degree, to the
cosmetic and reconstructive surgery market. Establishing marketing and sales
capability sufficient to support sales in commercial quantities for the other
markets targeted by the Company, including additional hernia, vascular,
urology, obstetrics, gynecology and orthopedic surgery markets, will require
significant resources, and there can be no assurance that the Company will be
able to recruit and retain additional qualified marketing personnel or direct
sales personnel or that future sales efforts of the Company will be
successful. In markets where there is a large potential customer base, the
Company intends to establish partnership relationships with additional
distribution partners, and there can be no assurance that the Company will be
successful in establishing such partnership relationships on commercially
reasonable terms, if at all. The failure to establish and maintain an
effective distribution channel for the Company's products, or establish and
retain qualified and effective sales personnel to support commercial
13
sales of the Company's products, could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL
ADVANTAGE. The Company's success is substantially dependent upon the success
of its Spacemaker balloon dissection products. The Company believes that
market acceptance of the Company's products will depend on the Company's
ability to provide evidence to the medical community of the safety, efficacy
and cost-effectiveness of its products and the procedures in which these
products are intended to be used. Market acceptance is also dependent on the
adoption of laparoscopic techniques generally and the conversion of
non-balloon dissection techniques to balloon dissection techniques
specifically. To date, the Company's products have only been used to treat a
limited number of patients and the Company has limited long-term outcomes
data. If the Company is not able to demonstrate consistent clinical benefits
resulting from the use of its products (including reduced procedure time,
reduced patient trauma and lower costs), the Company's business, financial
condition and results of operations could be materially and adversely
affected.
The Company further believes that the ability of health care
providers to obtain adequate reimbursement for procedures using the Company's
Spacemaker balloon dissector products and related instruments will be
critical to market acceptance of the Company's products. Although the Company
believes that procedures using its balloon dissection products currently may
be reimbursed in the United States under certain existing procedure codes,
there can be no assurance that such procedure codes will remain available or
that reimbursement under these codes will be adequate. The Company has
limited experience in obtaining third-party reimbursement, and the inability
to obtain reimbursement for some or all of its products could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company introduced its balloon dissectors in late 1993 and to
date there has been relatively little education among surgeons about the
benefits of balloon dissection technology. Further, due to the novelty of
balloon dissection procedures, many surgeons and surgeons' assistants have
not developed the requisite skills to perform balloon dissection procedures.
To the extent that laparoscopic techniques are adopted slowly, that balloon
dissectors are incorporated into laparoscopic techniques less often or that
surgeons are unwilling or unable to develop the skills necessary to utilize
balloon dissectors, the Company's business, financial condition and results
of operations could be materially adversely affected.
FLUCTUATIONS IN QUARTERLY RESULTS. Results of the Company's
operations may fluctuate significantly from quarter to quarter and will
depend on (i) new product introductions by the Company and its competitors
and fluctuations in revenues among different product lines and markets, (ii)
purchases of the Company's products by EES, (iii) the rate of adoption by
surgeons of balloon dissection technology in markets targeted by the Company,
(iv) the sales efforts of EES, (v) the mix of sales among distributor and the
Company's direct sales force, (vi) timing of patent and regulatory approvals,
if any, (vii) timing and growth in operating expenditures, (viii) timing of
research and development expenses, including marketing-related clinical
evaluation expenditures, (ix) intellectual property litigation and (x)
general market conditions. In the past, the Company's sales were highly
dependent upon the marketing efforts and success of United States Surgical
Corporation, which was the Company's major distributor until the relationship
was mutually terminated in November 1996. In December 1996 the Company
entered into the Expanded Ethicon Agreement, pursuant to which GSI granted
EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM-
Balloon Dissection Systems in the laparoscopic hernia repair and urinary
stress incontinence (USI) markets. The Company's sales in any period will be
highly dependent upon the marketing efforts and success of EES, which are not
within the control of the Company. The Company anticipates that sales to EES
will fluctuate in the future. Failure by EES to achieve
14
certain levels of sales growth or a decline in purchases by EES could result
in a decline in sales and adversely affect the Company's operating results.
No manufacture or distribution of products has occurred to date pursuant to
the EES Agreement, and there can be no assurance that efforts to do so will
be effective. In addition, announcements or expected announcements by the
Company, its competitors or its distributor of new products, new technologies
or pricing changes could cause existing or potential customers of the Company
to defer purchases of the Company's existing products and could alter the mix
of products sold by the Company, which could have a material adverse effect
on the Company's business, financial condition and results of operations.
There can be no assurance that future products or product enhancements will
be successfully introduced or that such introductions will not adversely
affect the demand for existing products. As a result of these and other
factors, the Company's quarterly operating results have fluctuated in the
past, and the Company expects that such results may fluctuate in the future.
Due to such quarterly fluctuations in operating results, quarter-to-quarter
comparisons of the Company's operating results are not necessarily meaningful
and should not be relied upon as indicators of likely future performance or
annual operating results. In addition, the Company's limited operating
history makes accurate prediction of future operating results difficult or
impossible to make. There can be no assurance that in the future the Company
will achieve sales growth or become profitable on a quarterly or annual
basis, if at all, or that its growth, if any, will be consistent with
predictions by securities analysts and investors. In such event, the price of
the Company's Common Stock would likely be materially and adversely affected.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations."
RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's
success will depend on its ability to obtain patent protection for its
products and processes, to preserve its trade secrets and proprietary
technology and to operate without infringing upon the patents or proprietary
rights of third parties. As of December 31, 1996, GSI had 17 United States
patents issued, and had applied for an additional 48 United States patents,
11 of which had been allowed. In addition, GSI had two foreign patents
issued, and 20 in prosecution as of such date. In May 1996, the Company was
issued a United States patent that contains claims regarding the use of
balloons to dissect tissue planes anywhere in the body.
In May 1996, the Guidant Corporation unit of Origin MedSystems, Inc.
filed an action against GSI in the U.S. District Court for the Northern
District of California, alleging patent infringement of its patent entitled
"Apparatus and Method for Peritoneal Retraction". GSI subsequently filed an
action against Origin Medsystems, Inc. in the U.S. District Court for the
Northern District of California alleging patent infringement of its patent
for a method of tissue plane dissection using balloon systems. A decision
against the Company in either of these actions could have a material adverse
effect on the Company's business, financial condition or results of
operations. The validity and breadth of claims in medical technology patents
involve complex legal and factual questions and, therefore, may be highly
uncertain. No assurance can be given that any patents based on pending patent
applications or any future patent applications will be issued, that the scope
of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents or patents to
which it has licensed rights will be held valid if subsequently challenged or
that others will not claim rights in or ownership of the patents and other
proprietary rights held or licensed by the Company or that the Company's
existing patents will cover the Company's future products. Furthermore, there
can be no assurance that others have not developed or will not develop
similar products, duplicate any of the Company's products or design around
any patents issued to or licensed by the Company or that may be issued in the
future to the Company. Since patent applications in the United States are
maintained in secrecy until patents issue, the Company also cannot be certain
that others did not first file applications for inventions covered by the
Company's pending patent applications, nor can the Company be certain that it
will not infringe any patents that may issue to others on such applications.
One of the patent applications filed by the Company, which is
directed to a surgical method using balloon dissection technology, has been
placed in interference with a patent application filed by Origin Medsystems,
Inc. ("Origin"), a competitor of the Company. The Company believes that the
inventor named in its patent application
15
was the first to invent this subject matter, and has asserted that the Origin
patent application was filed after a disclosure made by such inventor to
employees of Origin. Origin takes a contrary position. This interference is
presently pending in the United States Patent and Trademark Office ("USPTO")
and, as permitted by the rules of the USPTO, has been referred to an
arbitrator for completion of the interference proceeding. A decision is not
expected in this interference proceeding until 1998. Failure of the Company
to prevail in such interference proceeding could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Patent interference or infringement involves complex legal and
factual issues and is highly uncertain, and there can be no assurance that
any conclusion reached by the Company regarding patent interference or
infringement will be consistent with the resolution of such issue by a court.
In the event the Company's products are found to infringe patents held by
competitors, there can be no assurance that the Company will be able to
modify successfully its products to avoid infringement, or that any modified
products will be commercially successful. Failure in such event to either
develop a commercially successful alternative or obtain a license to such
patent on commercially reasonable terms could have a material adverse effect
on the Company's business, financial condition and results of operations. In
any event, there can be no assurance that the Company will not be required to
defend itself in court against allegations of infringement of third-party
patents. Patent litigation is expensive, requires extensive management time,
and could subject the Company to significant liabilities, require disputed
rights to be licensed from third parties or require the Company to cease
selling its products.
Legislation has recently been enacted in Congress, the effect of
which is to immunize physicians and their employers from liability for patent
infringement for alleged infringement of patent claims directed to medical
procedures.
The patent laws of European and certain other foreign countries
generally do not allow for the issuance of patents for methods of surgery on
the human body. Accordingly, the ability of the Company to gain patent
protection for its methods of tissue dissection will be significantly
limited. As a result, there can be no assurance that the Company will be able
to develop a patent portfolio in Europe or that the scope of any patent
protection will provide competitive advantages to the Company.
ROYALTY PAYMENT OBLIGATIONS. The Company has acquired a significant
number of patent rights from third parties, including rights that apply to
the Company's current balloon dissection systems. The Company has
historically paid and is obligated to pay in the future to such third parties
royalties equal to 4% of sales of such products, which payments are expected
to exceed minimum royalty payments due under agreements with such parties.
The Company also has acquired patent rights under royalty-bearing agreements
with respect to certain surgical instruments, including the KnotMaker product
and the balloon valve trocar currently under development. The payment of such
royalty amounts will have an adverse impact on the Company's gross profit and
other results of operations. There can be no assurance that the Company will
be able to continue to satisfy such royalty payment obligations in the
future, and a failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.
EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF
ABILITY TO MANAGE GROWTH. The Company began commercial sales of its balloon
dissection products in September 1993 and, as a result, has limited
experience in manufacturing, marketing and selling its products commercially.
In January 1997 the Company entered into a real estate lease and will be
relocating its headquarters and manufacturing operations in April 1997 to
this new facility. In addition, the Company experienced rapid growth in the
number of its employees, the number of products under development, the number
and amount of products manufactured and sold, and the geographic scope of its
sales. In order to augment its long-term competitive
16
position, the Company anticipates that it will be required to make
significant additional expenditures in manufacturing, research and
development, sales and marketing, and administration. The Company's inability
to manage its growth effectively could have a material adverse effect on the
Company's business, financial condition and results of operations.
COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in
the market for medical devices used in tissue dissection surgical procedures
is intense and is expected to increase. The Company competes primarily with
other producers of MIS tissue dissection instruments. Origin, a subsidiary of
Guidant Corporation, and others, currently compete against the Company in the
development, production and marketing of MIS tissue dissection instruments
and tissue dissection technology. To the extent that surgeons elect to use
open surgical procedures rather than MIS, the Company also competes with
producers of tissue dissection instruments used in open surgical procedures,
such as blunt dissectors or graspers. A number of companies currently compete
against the Company in the development, production and marketing of tissue
dissection instruments and technology for open surgical procedures. In
addition, the Company indirectly competes with producers of therapeutic
drugs, when such drugs are used as an alternative to surgery. Many of the
Company's competitors have substantially greater capital resources, name
recognition, expertise in research and development, manufacturing and
marketing and obtaining regulatory approvals. There can be no assurance that
the Company's competitors will not succeed in developing balloon dissectors
or competing technologies that are more effective than products marketed by
the Company or that render the Company's technology obsolete. Additionally,
even if the Company's products provide performance comparable to competing
products or procedures, there can be no assurance that the Company will be
able to obtain necessary regulatory approvals or compete against competitors
in terms of price, manufacturing, marketing and sales.
Many of the alternative treatments for medical indications that can
be treated by balloon dissection products and laparoscopic surgery are widely
accepted in the medical community and have a long history of use. In
addition, technological advances with other therapies could make such other
therapies more effective or cost-effective than balloon dissectors and
minimally invasive surgery, and could render the Company's technology
non-competitive or obsolete. There can be no assurance that surgeons will use
MIS to replace or supplement established treatments or that MIS will remain
competitive with current or future treatments. The failure of surgeons to
adopt MIS could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition to the Company's focus on the development of its balloon
dissection systems, the Company has also developed surgical instruments for
use in MIS. There can be no assurance that the Company's surgical instruments
will successfully compete with those manufactured by other producers of such
surgical instruments. The failure to achieve commercial market acceptance of
such surgical instruments could have a material adverse effect on the
Company's business, financial condition and results of operations.
UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT. The Company's
success will depend upon the ability of surgeons to obtain satisfactory
reimbursement from healthcare payors for the Company's products. In the
United States, hospitals, physicians and other healthcare providers that
purchase medical devices generally rely on third-party payors, such as
private health insurance plans, to reimburse all or part of the costs
associated with the treatment of patients. Reimbursement in the United States
for the Company's balloon dissection products is currently available from
most third-party payors, including most major private health care insurance
plans and Medicaid, under existing surgical procedure codes. The Company does
not expect that third-party reimbursement in the United States will be
available for use of its other products unless and until clearance or
approval is received from the federal Food and Drug Administration (the
"FDA"). If FDA clearance or approval is received, third-party reimbursement
for these products will depend upon decisions by individual
17
health maintenance organizations, private insurers and other payors. Many
payors, including the federal Medicare program, pay a preset amount for the
surgical facility component of a surgical procedure. This amount typically
includes medical devices such as the Company's. Thus, the surgical facility
or surgeon may not recover the added cost of the Company's products. In
addition, managed care payors often limit coverage to surgical devices on a
preapproved list or obtained from an exclusive source. If the Company's
products are not on the list or are not available from the exclusive source,
the facility or surgeon will need to obtain an exception from the payor or
the patient will be required to pay for some or all of the cost of the
Company's product. The Company believes that procedures using its balloon
dissection products currently may be reimbursed in the United States under
certain existing procedure codes. However, there can be no assurance that
such procedure codes will remain available or that the reimbursement under
these codes will be adequate. Given the efforts to control and decrease
health care costs in recent years, there can be no assurance that any
reimbursement will be sufficient to permit the Company to increase revenues
or achieve or maintain profitability. The unavailability of third-party or
other adequate reimbursement could have a material adverse effect on the
Company's business, financial condition and results of operations.
Reimbursement systems in international markets vary significantly by
country, and by region within some countries, and reimbursement approvals
must be obtained on a country-by-country basis. Many international markets
have government-managed health care systems that govern reimbursement for new
devices and procedures. In most markets, there are private insurance systems
as well as government-managed systems. Large-scale market acceptance of the
Company's balloon dissection systems and other products will depend on the
availability and level of reimbursement in international markets targeted by
the Company. Currently, the Company has been informed by its international
distributors that the balloon dissectors have been approved for reimbursement
in many of the countries in which the Company markets its products. Obtaining
reimbursement approvals can require 12 to 18 months or longer. There can be
no assurance that the Company will obtain reimbursement in any country within
a particular time, for a particular amount, or at all. Failure to obtain such
approvals could have a material adverse effect on the Company's business,
financial condition and results of operations.
Regardless of the type of reimbursement system, the Company believes
that surgeon advocacy of its products will be required to obtain
reimbursement. Availability of reimbursement will depend on the clinical
efficacy of the procedure and the utility and cost of the Company's products.
There can be no assurance that reimbursement for the Company's products will
be available in the United States or in international markets under either
government or private reimbursement systems, or that surgeons will support
and advocate reimbursement for use of the Company's systems for all
applications intended by the Company. Failure by surgeons, hospitals and
other users of the Company's products to obtain sufficient reimbursement from
health care payors or adverse changes in government and private third-party
payors' policies toward reimbursement for procedures employing the Company's
products could have a material adverse effect on the Company's business,
financial condition and results of operations.
GOVERNMENT REGULATION. The Company's Spacemaker balloon dissection
systems and other products are subject to extensive and rigorous regulation
by the FDA and, to varying degrees, by state and foreign regulatory agencies.
Under the federal Food, Drug, and Cosmetic Act, the FDA regulates the
clinical testing, manufacture, labeling, packaging, marketing, distribution
and record keeping for medical devices, in order to ensure that medical
devices distributed in the United States are safe and effective for their
intended use. Prior to commercialization, a medical device generally must
receive FDA and foreign regulatory clearance or approval, which can be an
expensive, lengthy and uncertain process. The Company is also subject to
routine inspection by the FDA and state agencies, such as the California
Department of Health Services ("CDHS"), for compliance with Good
Manufacturing Practice requirements, Medical Device Reporting requirements
and other applicable regulations. Noncompliance with applicable requirements
can result in warning letters, import detentions, fines, civil penalties,
injunctions, suspensions or losses of regulatory approvals, recall or seizure
of products, operating
18
restrictions, refusal of the government to approve product export
applications or allow the Company to enter into supply contracts, and
criminal prosecution. Delays in receipt of, or failure to obtain, regulatory
clearances and approvals, or any failure to comply with regulatory
requirements could have a material adverse effect on the Company's business,
financial condition and results of operations.
Labeling and promotional activities are subject to scrutiny by the
FDA and, in certain circumstances, by the Federal Trade Commission. Current
FDA enforcement policy prohibits the marketing of approved medical devices
for unapproved uses. The Spacemaker I platform, Spacemaker II platform,
Spacemaker Resposable platform, and KnotMaker product each have received
510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic
and reconstructive surgery, either when tissue dissection is required or,
with respect to the KnotMaker product, when a surgical knot for suturing is
required. The Company has promoted these products for surgical applications
(e.g., hernia repair, subfascial endoscopic perforator surgery and breast
augmentation and reconstruction), and may in the future promote these
products for the dissection or knotmaking required for additional selected
applications (e.g., treatment of stress urinary incontinence, saphenous vein
harvesting and a variety of orthopedic procedures such as anterior spinal
fusion). For any medical device cleared through the 510(k) process,
modifications or enhancements that could significantly affect the safety or
effectiveness of the device or that constitute a major change to the intended
use of the device will require a new 510(k) submission. The Company has made
modifications to its products which the Company believes do not affect the
safety or effectiveness of the device or constitute a major change to the
intended use and therefore do not require the submission of new 510(k)
notices. There can be no assurance, however, that the FDA will agree with any
of the Company's determinations not to submit a new 510(k) notice for any of
these changes or will not require the Company to submit a new 510(k) notice
for any of the changes made to the product. If such additional 510(k)
clearances are required, there can be no assurance that the Company will
obtain them on a timely basis, if at all, and delays in receipt of or failure
to receive such approvals could have a material adverse effect on the
Company's business, financial condition and results of operations. If the FDA
requires the Company to submit a new 510(k) notice for any product
modification, the Company may be prohibited from marketing the modified
product until the 510(k) notice is cleared by the FDA. The Company plans to
file a 510(k) submission for its specialized trocar with a balloon valve,
which is intended to provide a seal to maintain insufflation of the surgical
space during MIS. There can be no assurance that the FDA will grant 510(k)
clearance for the Company's specialized trocar on a timely basis, if at all.
Sales of medical devices outside of the United States are subject to
foreign regulatory requirements that vary widely from country to country. The
Company currently relies on its international distributors for the receipt of
premarket approvals and compliance with clinical trial requirements in those
countries that require them, and it expects to continue to rely on
distributors in those countries where the Company continues to use
distributors. In the event that the Company's international distributors fail
to obtain or maintain premarket approvals or compliance in foreign countries
where such approvals or compliance are required, the Company may be required
to cause the applicable distributor to file revised governmental
notifications, cease commercial sales of its products in the applicable
countries or otherwise act so as to stop any ongoing noncompliance in such
countries. Any enforcement action by regulatory authorities with respect to
past or any future regulatory noncompliance could have a material adverse
effect on the Company's business, financial condition and results of
operations.
In order to continue selling its products within the European
Economic Area following June 14, 1998, the Company will be required to
achieve compliance with the requirements of the Medical Devices Directive
(the "MDD") and to affix CE marking on its products to attest such
compliance. Failure by the Company to comply with CE marking requirements by
June 1998 would prohibit the Company from selling its products in the
European Economic Area unless and until compliance was achieved, which could
have a material adverse effect upon the Company's business, financial
condition and results of operations.
19
LIMITED MANUFACTURING EXPERIENCE; UNCERTAINTY REGARDING FUTURE
FACILITIES. The Company has only limited experience in manufacturing its
products in commercial quantities. The Company intends to scale up its
production of new products and to increase its manufacturing capacity for
existing and new products. However, manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply
and shortages of qualified personnel. Difficulties experienced by the Company
in manufacturing scale-up and manufacturing difficulties could have a
material adverse effect on its business, financial condition and results of
operations. There can be no assurance that the Company will be successful in
scaling up or that it will not experience manufacturing difficulties or
product recalls in the future.
The Company currently occupies a single facility in Palo Alto,
California that houses its headquarters, administrative offices, research
laboratories and manufacturing facilities. In January 1997, the Company
entered into a new facility lease for premises in Cupertino, California, and
is planning to relocate its headquarters and manufacturing operations to this
new location during April 1997. The new facilities lease comprises
approximately 30,460 square feet and the monthly rent is approximately
$47,000. There can be no guarantee that the Company will be able to establish
and certify adequate manufacturing capacity in a timely manner, or at all, in
the new space. Failure to establish and certify adequate manufacturing
capacity in a timely manner could have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL
ARRANGEMENTS. The Company currently relies upon single source suppliers for
several components of its balloon dissection products, and in most cases
there are no formal supply contracts. There can be no assurance that the
component materials obtained from single source suppliers will continue to be
available in adequate quantities, if at all, or, if required, that the
Company will be able to locate alternative sources of such component
materials on a timely basis, if at all, to market its products. In addition,
there can be no assurance that the single source suppliers will meet the
Company's future requirements for timely delivery of products of sufficient
quality and quantity. The failure to obtain sufficient quantities and
qualities of such component materials, or the loss of any of the Company's
single source suppliers, could cause a delay in GSI's ability to fulfill
orders while it identifies and certifies a replacement supplier, if any, and
could have a material adverse effect on the Company's business, financial
condition and results of operations.
PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE
COVERAGE. The Company's business exposes it to potential product liability
risks or product recalls that are inherent in the design, development,
manufacture and marketing of medical devices, in the event the use of the
Company's products is alleged to have caused adverse effects on a patient or
such products are believed to be defective. The Company's products are
designed to be used in certain procedures where there is a high risk of
serious injury or death. Such risks will exist even with respect to those
products that have received, or may in the future receive, regulatory
clearance for commercial sale. As a result, there can be no assurance that
the Company's product liability insurance is adequate or that such insurance
coverage will continue to be available on commercially reasonable terms or at
all. Particularly given the lack of data regarding the long-term results of
the use of balloon dissection products, there can be no assurance the Company
will avoid significant product liability claims. Consequently, a product
liability claim or other claim with respect to uninsured or underinsured
liabilities could have a material adverse effect on the Company's business,
financial condition and results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL SALES. Sales outside of the
United States accounted for approximately 3% and 4% of the Company's sales in
fiscal 1995 and 1996, respectively, and the Company
20
expects that international sales will represent an increasing portion of
revenue in the future. The Company intends to continue to expand its sales
outside of the United States and to enter additional international markets,
which will require significant management attention and financial resources
and subject the Company further to the risks of selling internationally.
These risks include unexpected changes in regulatory requirements, tariffs
and other barriers and restrictions, reduced protection for intellectual
property rights, and the burdens of complying with a variety of foreign laws.
In addition, because all of the Company's sales are denominated in U.S.
dollars, fluctuations in the U.S. dollar could increase the price in local
currencies of the Company's products in foreign markets and make the
Company's products relatively more expensive than competitors' products that
are denominated in local currencies. There can be no assurance that
regulatory, currency and other factors will not adversely impact the
Company's operations in the future or require the Company to modify its
current business practices.
DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL. The Company is
dependent upon a limited number of key management and technical personnel.
The loss of the services of one or more of such key employees could have a
material adverse effect on the Company's business, financial condition, and
results of operations. In addition, the Company's success will be dependent
upon its ability to attract and retain additional highly qualified sales,
management, manufacturing and research and development personnel. The Company
faces intense competition in its recruiting activities and there can be no
assurance that the Company will be able to attract and/or retain qualified
personnel.
POTENTIAL VOLATILITY OF STOCK PRICE. The market prices of the
common stock of many publicly held medical device companies have in the past
been, and can in the future be expected to be, especially volatile.
Announcements of technological innovations or new products by the Company or
its competitors, clinical marketing trial results, release of reports by
securities analysts, developments or disputes concerning patents or
proprietary rights, regulatory developments, changes in regulatory or medical
reimbursement policies, economic and other external factors, as well as
period-to-period fluctuations in the Company's financial results, may have a
significant impact on the market price of the Common Stock. In addition, the
securities markets have from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May, 1996, the Guidant Corporation unit of Origin MedSystems, Inc.
filed an action against GSI in the United States District Court for the
Northern District of California, alleging patent infringement of its patent
entitled "Apparatus and Methods for Peritoneal Retraction." GSI subsequently
filed a claim against Origin Medsystems, Inc. in the United States District
Court for the Northern District of California, alleging that the use of
Origin's balloon dissection products infringe its patent for a method of
tissue plane dissection using balloon systems. In addition, one of the patent
applications filed by the Company, which is directed to a surgical method
using balloon dissection technology, has been placed in interference with a
patent application filed by Origin, a competitor of the Company. The Company
believes that the inventor named in its patent application was the first to
invent this subject matter, and the Company has asserted that the Origin
patent application was filed after a disclosure made by such inventor to
employees of Origin. Origin takes a contrary position. This interference is
presently pending in the United States Patent and Trademark Office ("USPTO")
and, as permitted by the rules of the USPTO, has been referred to an
arbitrator for completion of the interference proceeding. A decision is not
expected in the interference proceeding until calendar year 1998, and, while
the Company believes it will be successful in this interference proceeding
there can be no assurance of such success. Failure of the Company to prevail
in such interference proceeding could have a material adverse effect on the
Company business, financial
21
condition or results of operation. A decision against the Company in either
of these actions could have a material adverse effect on the Company's
business, financial condition or results of operations.
From time to time the Company may be exposed to litigation arising out of its
products or operations. The Company is not engaged in any legal proceedings that
are expected, individually or in the aggregate, to have a material adverse
effect on the Company, expect for the patent interference proceedings discussed
herein.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS IN SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
Holders
On November 19, 1996, the Company held its annual meeting of shareholders.
At the annual meeting, the Company's shareholders approved the following matters
by the following votes:
1. Election of the following directors of the Company:
NOMINEE FOR ABSTAIN
- -------------------------- ----------- --------------
Roderick A. Young 7,473,233 1,300
----------- --------------
Thomas J. Fogarty 7,454,233 20,300
----------- --------------
David W. Chonette 7,473,233 1,300
----------- --------------
Paul Goeld 7,454,233 20,300
----------- --------------
Mark A. Wan 7,472,933 1,600
----------- --------------
2. Amendments to the Company's 1992 Stock Option Plan to increase the number
of shares of Common Stock reserved for issuance thereunder by 400,000 shares to
an aggregate of 2,115,882 shares.
FOR 7,388,727 AGAINST 84,406 ABSTAIN 1,400
--------- ------ -----
3. Ratification of the appointment of Coopers & Lybrand L.L.P. as independent
accountants for the Company for the fiscal year ending June 30, 1997.
FOR 7,472,033 AGAINST 1,200 ABSTAIN 1,300
--------- ----- -----
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit Description
------- -----------
10.20 (1)(2) OEM Supply Agreement (Expanded Field) dated
December 20, 1996, between Ethicon
Endo-Surgery, Inc. and the Company
("Expanded EES Agreement").
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10.21(2) Modification and Termination Agreement and
Mutual Release dated November 12, 1996,
between United States Surgical Corporation and the
Company.
10.22 Real Estate Lease between Berg & Berg Developers
and the Company.
11.1 Statement of Computation of Earnings (Net Loss)
Per Share
27.1 Financial Data Schedule
(1) This exhibit supercedes Exhibit 10.19.
(2) Confidential treatment has been requested with regard to
certain portions of this exhibit.
(b) REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1996.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GENERAL SURGICAL INNOVATIONS, INC.
By:/s/ STEPHEN J. BONELLI
------------------------
Stephen J. Bonelli
Vice President, Finance
and Chief Financial Officer
Date: February , 1997
24