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 SEPTEMBER 30, 1997.
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.)
10460 BUBB ROAD, CUPERTINO, CALIFORNIA 95014
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 863-2500
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 13,340,991 shares of Registrant's Common Stock
issued and outstanding as of November 1, 1997.
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1997
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated balance sheets at September 30, 1997
and June 30, 1997 ........................................ 3
Consolidated statements of operations for the three months
ended September 30, 1997 and September 30, 1996 .......... 4
Consolidated statements of cash flows for the three months
ended September 30, 1997 and September 30, 1996 .......... 5
Notes to consolidated financial statements ................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ............................... 8
PART II. OTHER INFORMATION
Item 1. Legal Proceedings ............................................ 20
Item 2. Changes in Securities and Use of Proceeds .................... 21
Item 3. Defaults Upon Senior Securities .............................. 21
Item 4. Submission of Matters to a Vote of Security Holders .......... 21
Item 5. Other Information ............................................ 21
Item 6. Exhibits and Reports on Form 8-K ............................. 22
2
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
September, 30 June, 30
1997 1997
------------- --------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents. . . . . . . . . . . . . . . . . . . . . . . . . . $ 4,753 $ 7,900
Available-for-sale securities. . . . . . . . . . . . . . . . . . . . . . . . 38,292 35,831
Accounts receivable, net of allowance for doubtful accounts of
$63 on September 30, 1997 and $47 on June 30, 1997. . . . . . . . . . . . 1,451 2,131
Inventories. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,489 1,717
Prepaid expenses and other current assets. . . . . . . . . . . . . . . . . . 1,161 971
-------- --------
Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,146 48,550
Property and equipment, net. . . . . . . . . . . . . . . . . . . . . . . . . . 2,346 2,251
Intangible and other assets, net . . . . . . . . . . . . . . . . . . . . . . . 245 261
-------- --------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 49,737 $ 51,062
-------- --------
-------- --------
LIABILITIES
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 609 $ 504
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 1,044
Bank borrowings. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 167 167
-------- --------
Total current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . 1,561 1,715
Bank borrowings, less current portion. . . . . . . . . . . . . . . . . . . . . 143 185
Other long-term liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . 196 175
-------- --------
Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,900 2,075
-------- --------
SHAREHOLDERS' EQUITY
Preferred stock, $.001 par value:
Authorized: 2,000,000 shares; issued and outstanding: none
Common stock, $.001 par value:
Authorized: 50,000,000 shares; issued and outstanding 13,340,133
on September 30, 1997 and 13,290,644 on June 30, 1997 . . . . . . . . . . . 13 13
Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . 65,114 65,089
Notes receivable from shareholders . . . . . . . . . . . . . . . . . . . . . . (87) (87)
Deferred compensation, net . . . . . . . . . . . . . . . . . . . . . . . . . . (263) (297)
Unrealized gain (loss) on available-for-sale securities. . . . . . . . . . . . 13 (38)
Accumulated deficit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (16,953) (15,693)
-------- --------
Total shareholders' equity . . . . . . . . . . . . . . . . . . . . . . . . . 47,837 48,987
-------- --------
Total liabilities and shareholders' equity . . . . . . . . . . . . . $ 49,737 $ 51,062
-------- --------
-------- --------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
3
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Three Months Ended
September 30,
----------------------
1997 1996
-------- --------
Sales. . . . . . . . . . . . . . . . . . . . . . $ 1,567 $ 2,470
Guaranteed payments. . . . . . . . . . . . . . . 775 -
-------- --------
Total revenue. . . . . . . . . . . . . . . . . . 2,342 2,470
Cost of sales. . . . . . . . . . . . . . . . . . 956 993
-------- --------
Gross profit. . . . . . . . . . . . . . . . 1,386 1,477
-------- --------
Operating Expenses:
Research and development . . . . . . . . . . . 765 462
Sales and marketing. . . . . . . . . . . . . . 1,126 1,108
General and administrative . . . . . . . . . . 1,346 723
-------- --------
Total operating expenses . . . . . . . . . . . 3,237 2,293
-------- --------
Operating loss . . . . . . . . . . . . . . . . (1,851) (816)
Interest income. . . . . . . . . . . . . . . . . 603 625
Interest expense . . . . . . . . . . . . . . . . (12) (12)
Other income (expense) . . . . . . . . . . . . . - (26)
-------- --------
Net loss . . . . . . . . . . . . . . . . . . . $ (1,260) $ (229)
-------- --------
-------- --------
Net loss per share . . . . . . . . . . . . . . . $ (0.09) $ (0.02)
-------- --------
-------- --------
Shares used in computing net loss per share. . . 13,314 13,147
-------- --------
-------- --------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED,
CONSOLIDATED FINANCIAL STATEMENTS.
4
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
Three Months Ended
September 30,
------------------------
1997 1996
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (1,260) $ (229)
Adjustments to reconcile net loss to net cash provided
by (used in) operating activities:
Amortization of deferred compensation. . . . . . . . . . . . . . . . . . . . 34 50
Depreciation and amortization. . . . . . . . . . . . . . . . . . . . . . . . 282 102
Provision for uncollectable accounts . . . . . . . . . . . . . . . . . . . . 16 (28)
Loss on write-off of fixed assets. . . . . . . . . . . . . . . . . . . . . . - 26
Provision for excess and obsolete inventory. . . . . . . . . . . . . . . . . (4) -
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . 664 223
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 232 (190)
Prepaid expenses and other current assets . . . . . . . . . . . . . . . (190) 209
Intangible and other assets . . . . . . . . . . . . . . . . . . . . . . (2) -
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 (137)
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . (273) 104
Deferred revenue. . . . . . . . . . . . . . . . . . . . . . . . . . . . - (33)
-------- --------
Net cash generated by (used in) operating activities . . . (396) 97
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities . . . . . . . . . . . . . . . . . . (6,060) (7,924)
Proceeds from sales and maturities of available-for-sale securities. . . . . . 3,542 -
Acquisition of property and equipment. . . . . . . . . . . . . . . . . . . . . (211) (78)
-------- --------
Net cash used in investing activities. . . . . . . . . . . (2,729) (8,002)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock . . . . . . . . . . . . . . . . . . . . 25 36
Payments on capital lease obligations. . . . . . . . . . . . . . . . . . . . . (5) -
Principal payments on bank borrowings. . . . . . . . . . . . . . . . . . . . . (42) (29)
-------- --------
Net cash generated by (used in) financing activities. . . . (22) 7
-------- --------
Net decrease in cash and cash equivalents. . . . . . . . . . . . . . . . . . . (3,147) (7,898)
Cash and cash equivalents, beginning of period . . . . . . . . . . . . . . . . 7,900 28,339
-------- --------
Cash and cash equivalents, end of period . . . . . . . . . . . . . . . . . . . $ 4,753 $ 20,441
-------- --------
-------- --------
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 12 $ 10
Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ - $ -
NONCASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock for notes receivable. . . . . . . . . . . . . . . . . $ - $ 11
Repurchase of common stock for notes receivable. . . . . . . . . . . . . . . . $ - $ -
Change in unrealized gain on available-for-sale securities . . . . . . . . . . $ 51 $ 2
Property acquired under capital leases . . . . . . . . . . . . . . . . . . . . $ 40 $ -
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
5
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements as of
September 30, 1997 of General Surgical Innovations, Inc. (the "Company") and
subsidiary 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 of normal recurring
adjustments, considered necessary for a fair presentation have been included.
Operating results for the three month period ended September 30, 1997 are not
necessarily indicative of the results that may be expected for the fiscal
year ended June 30, 1998, 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, 1997.
2. Reclassification:
Certain amounts in the financial statements have been reclassified
to conform with current year's presentation. These reclassifications had no
impact on previously reported working capital, operating income, or net
income.
3. Net Loss Per Share:
Net loss per share is computed using the weighted average number of
common shares outstanding. Common equivalent shares from stock options are
excluded from the computation as their effect is antidilutive.
4. Inventories:
Inventories comprise (IN THOUSANDS):
Sept. 30, June 30,
1997 1997
------ ------
(unaudited)
Raw materials ..................... $ 685 $ 706
Work in progress................... 144 43
Finished goods .................... 660 968
------ ------
$1,489 $1,717
------ ------
------ ------
6
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 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, 1997.
The Company desires to take advantage of the "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995. Specifically, the
Company wishes to alert readers that, 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, market demand for the Company's products,
the Company's ability to shift market focus successfully, fluctuations in
revenues among different product lines and markets, the timing and number of
orders and shipments, distribution efforts by Ethicon-Endo Surgery, Inc.
("EES"), a Johnson & Johnson company, EES's success in achieving certain
levels of sales growth, the performance of the Company's new corporate
partnering relationships, the Company's ability to establish and develop
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, 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,
have in the past affected, and 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;
ENDOSAPH-TM-, SAPHtrak-TM-, SPACEKEEPER-TM- 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 five 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 applications, such as hernia
repair, subfascial endoscopic perforator surgery and breast augmentation and
reconstruction surgery.
7
In March 1994, the Company entered into a distribution agreement with
U.S. Surgical Company ("USSC") providing 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
November 1996, the Company terminated its distribution agreement with USSC.
In December 1996, the Company entered into a five year OEM supply
agreement (the "Expanded EES Agreement") with EES, pursuant to which GSI
granted EES worldwide sales and marketing rights to sell the
SPACEMAKER-Registered Trademark- Balloon Dissection Systems in the
laparoscopic hernia repair and urinary stress incontinence ("USI") markets.
Under the Expanded EES Agreement, EES has begun selling GSI's dissector for
hernia repair. EES made guaranteed payments of $4.9 million in fiscal year
1997, and an additional payment in lieu of product purchases in the amount of
$775,000 in the first quarter of fiscal year 1998.
Additional sales in the United States (other than for hernia and USI
applications) are currently made through distributors and a small direct
sales force. The Company currently sells its products (other than for hernia
and USI applications) in international markets through a limited number of
distributors, which 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, almost all of the sales to distributors and 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
vascular, urinary stress incontinence, plastic surgery and orthopaedic
applications, sales of products for hernia repair are expected to provide a
majority of the Company's revenues at least through fiscal 1998.
The Company has acquired rights to a significant number of patents 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. 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. The payment of such royalty
amounts will have an adverse impact on the Company's gross profit and results
of operations.
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 June 30, 1998. 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 sales and marketing and research
and development (including marketing-related clinical evaluations). In
addition, the Company has experienced higher administration expenses since
its initial public offering resulting from its obligations as a public
reporting company and defense of its patents.
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 its distributors, its distributors'
ability to achieve certain levels of sales growth, the status of the
Company's relationship with EES and other partners, the Company's ability to
sell its line of cardiovascular products, 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
8
evaluations, sales of competitive products and the introduction of new
products from competitors (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 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 facility lease in
Cupertino, California and relocated its headquarters and manufacturing
operations to this new location in April 1997. The new facility's lease
comprises approximately 30,460 square feet, and the monthly rent is
approximately $47,000.
In October 1997, the Company received its CE mark certification,
pursuant to the Medical Devices Directive, which enables the Company to affix
CE marking on its products and continue selling its products within the
European Economic Area.
RESULTS OF OPERATIONS
REVENUE. Total revenue decreased by 5% to approximately $2.3 million
for the quarter ended September 30, 1997 from $2.5 million for the same
period in 1996. This decrease was due to slower-than-expected sales to EES
of the SPACEMAKER-Registered Trademark- I and II platforms for the hernia
market. The Company believes that its sales results will fluctuate from
quarter to quarter during at least the next several quarters.
COST OF SALES. Cost of sales decreased by 4% to approximately $956,000
for the quarter ended September 30, 1997 from $993,000 for the same period in
1996. This decrease in absolute dollars was related to lower unit sales in
the quarter ended September 30, 1997, as compared to the previous period.
Cost of sales increased as a percentage of sales to 61% for the quarter ended
September 30, 1997 from 40% for the quarter ended September 30, 1996. This
increase was primarily a result of under-utilized manufacturing capacity, the
cost of which was allocated among fewer unit sales.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses,
which include expenditures for marketing-related clinical evaluations and
regulatory expenses, increased by 66% to $765,000 in the quarter ended
September 30, 1997 from $462,000 for the same period in 1996 and increased as
a percentage of revenue to 33% in the quarter ended September 30, 1997 from
19% in the quarter ended September 30, 1996 as a result of increased spending
on new product development.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 35% to approximately $2.5 million for
the quarter ended September 30, 1997 from $1.8 million for the quarter ended
September 30, 1996 primarily due to increased legal expenses related to
intellectual property litigation.
9
INTEREST INCOME, INTEREST EXPENSE AND OTHER INCOME (EXPENSE). Interest
and other income (net of expense) increased to $591,000 for the quarter ended
September 30, 1997 from $587,000 for the quarter ended September 30, 1996.
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 approximately
$17.0 million at September 30, 1997. The Company has funded its operations
primarily through the sale of equity securities. From its inception through
September 30, 1997 the Company raised approximately $15.5 million through the
private placement of equity securities and approximately $46.9 million (net
of underwriting discounts and commissions) in an initial public offering.
As of September 30, 1997 the Company's principal source of liquidity
consists of cash, cash equivalents and available-for-sale securities of $43.0
million. In addition, the Company has a bank line of credit available for
$1,500,000. As of September 30, 1997, the Company has no amounts outstanding
under this line. The Company also has an equipment loan with an outstanding
balance of approximately $310,000.
The Company expects to incur substantial additional costs, including
costs related to patent litigation, 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. 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 at least calendar 1998. 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 sought, will be available on
satisfactory terms or at all.
RECENT PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128 (SFAS 128), EARNINGS PER
SHARE, which specifies the computation, presentation and disclosure
requirements for earnings per share. SFAS 128 supersedes Accounting
Principles Board Opinion No. 15 and is effective for financial statements
issued for periods ending after December 15, 1997. SFAS 128 requires
restatement of all prior-period earnings per share data presented after the
effective date. SFAS 128 is not expected to have a material impact on the
Company's financial position, results of operations or cash flows.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 (SFAS 130), REPORTING COMPREHENSIVE
INCOME. This statement establishes requirements for disclosure of
comprehensive income and becomes effective for the Company for fiscal years
beginning after December 15, 1997, with reclassification of earlier financial
statements for comparative purposes. Comprehensive income generally
represents all changes in shareholders' equity except those resulting from
investments or contributions by shareholders. The Company is evaluating
alternative formats for presenting this information, but does not expect this
pronouncement to materially impact the Company's results of operations.
10
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 (SFAS 131), DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. This statement
establishes standards for disclosure about operating segments in annual
financial statements and selected information in interim financial reports.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. This statement supersedes
Statement of Financial Accounting Standards No. 14, FINANCIAL REPORTING FOR
SEGMENTS OF A BUSINESS ENTERPRISE. The new standard becomes effective for
fiscal years beginning after December 15, 1997, and requires that comparative
information from earlier years be restated to conform to the requirements of
this standard. The Company is evaluating the requirements of SFAS 131 and
the effects, if any, on the Company's current reporting and disclosures.
LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company was
organized in April 1992 and began commercially shipping its first
SPACEMAKER-Registered Trademark- 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 September 30, 1997, the Company
had an accumulated deficit of $17.0 million. The Company's net operating
losses for the fiscal years ending June 30, 1995, 1996 and 1997 and for the
quarter ended September 30, 1997 were $4.1 million, $5.5 million, $1.9
million and $1.3 million, respectively. The Company expects to continue to
incur operating losses on a quarterly and annual basis through at least
fiscal year 1998. Due to the Company's limited operating history, there can
be no assurance of sales growth or profitability in the future. The Company
intends to increase 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 and successfully 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 market acceptance of and
demand for the Company's products and related procedures, the nature of the
technological advances inherent in the product designs, reduction 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, 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 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
11
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 DISTRIBUTORS. In December 1996, the Company
entered into a five year OEM supply agreement (the "Expanded EES Agreement")
with EES, pursuant to which GSI granted EES worldwide sales and marketing
rights to sell the SPACEMAKER-Registered Trademark- 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. Under the Expanded EES
Agreement, EES was obligated to make $4.9 million in guaranteed payments to
the Company during the year ended June 30, 1997, but is not obligated to make
any further guaranteed payments. There can be no assurance that EES's
manufacturing, marketing or distribution efforts will be successful. EES's
failure to achieve certain levels of sales growth or product orders 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 add additional distributors
to its distribution network in the United States could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company's products are currently sold internationally to general
surgeons and specialists through EES and independent distributors in Europe,
Asia, Latin America and the Middle East. In June 1997, GSI entered into an
exclusive agreement with Japan Lifeline to market and distribute in Japan
GSI's balloon dissection systems for use in vascular procedures. Japan
Lifeline is expected to begin distribution of the GSI balloon dissection
systems following receipt of the Japanese Ministry of Health and Welfare
approval, which the Company expects will occur in early 1998.
To date, substantially all of the Company's international sales for
hernia repair procedures have been made through Autosuture, a USSC affiliate,
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 EES has taken
over as the Company's international distributor, 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 to the hernia market and, to a lesser degree, to the
cardiovascular and cosmetic and reconstructive surgery markets. Establishing
marketing and sales capability sufficient to support sales in commercial
quantities for the cardiovascular market targeted by the Company will require
significant resources. There can be no assurance that the Company will be
able to recruit and retain additional qualified marketing or sales personnel,
or that future sales efforts of the Company will be successful. In markets
other than cardiovascular, 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 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."
12
UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE.
The Company's success is substantially dependent upon the success of its
SPACEMAKER-Registered Trademark- 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, clinical advantage 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-Registered Trademark- 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 failure 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. See "Management's Discussion
and Analysis of 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
numerous factors, including (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 and other
distributors, (iii) the rate of adoption by surgeons of balloon dissection
technology in markets targeted by the Company, (iv) the sales efforts of the
Company's distributors, (v) the mix of sales among distributors and the
Company's direct sales force, (vi) timing of patent and regulatory approvals,
if any, (vii) timing and growth of 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 worldwide sales and marketing rights to sell the SPACEMAKER-TM- Balloon
Dissection Systems in the laparoscopic hernia repair and urinary stress
incontinence 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. EES made approximately $4.9 million in guaranteed
payments to the Company in fiscal year 1997, which constituted 54% of
revenues for fiscal year 1997. EES is not obligated to make any such
guaranteed payments in future quarters. The Company anticipates that sales to
EES will fluctuate in the future. Failure
13
by EES to achieve certain levels of sales growth or purchases could adversely
affect the Company's operating results. In addition, announcements or
expected announcements by the Company, its competitors or its distributors 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.
In May 1996, the Guidant Corporation unit of Origin MedSystems, Inc.
("Origin"), a competitor of the Company, 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." In June, 1996, GSI filed an action against Origin 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. In addition, on September 26, 1997, the Company filed
another action against Origin alleging patent infringement of its patent for
a method of serial inflation of tissue dissectors. A decision against the
Company in any of these actions could have a material adverse effect on the
Company's business, financial condition or results of operations.
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. The Company believes
that the inventor named in its patent application 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 calendar year 1998. Failure of the Company to prevail in
such interference proceeding would 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
14
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 would have a material adverse effect
on the Company's business, financial condition and results of operations. As
discussed above, the Company is defending itself, and may in the future have
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.
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 under current challenges or
if subsequently challenged or that persons or entities in addition to Origin
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.
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. The Company has also
acquired patent rights under royalty-bearing agreements with respect to
certain surgical instruments. The payment of such royalty amounts will have
an adverse impact on the Company's gross profit and 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 has
relocated its headquarters and manufacturing operations in
15
April 1997 to this new facility. In addition, the Company has experienced
rapid growth in the number of its employees, the number of products under
development, the number and amount of products manufactured, and the
geographic scope of its sales. In order to augment its long-term competitive
position, the Company anticipates that it will be required to make
significant additional expenditures in research and development and sales and
marketing. 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 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
16
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 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 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-Registered
Trademark- 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
17
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 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, if obtained, 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-Registered Trademark- I platform, SPACEMAKER
II platform, SPACEMAKER Plastics platform, SPACEMAKER SAPHtrak 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 orthopaedic
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.
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 October 1997, the Company received its CE mark certification, pursuant
to the Medical Devices Directive, which enables the Company to affix CE
marking on its products and continue selling its products within the European
Economic Area.
18
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 (including, in the
event of low demand, over-capacity) 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.
In January 1997, the Company entered into a new facility lease in
Cupertino, California, and has relocated 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.
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
causes or 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. There were no international
sales in the first quarter of 1998. Sales outside of the United States
accounted for .5% and 4% of the Company's sales in fiscal 1997 and 1996,
respectively. The Company 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
19
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 Company's
common stock and the stock of many other publicly held medical device
companies have in the past been, and can in the future be expected to be,
especially volatile. Announcements regarding competitive developments,
product sales, 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 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." In June, 1996, GSI filed a claim
against Origin in the United States District Court for the Northern District
of California, alleging patent infringement of its patent for a method of
tissue plane dissection using balloon systems. In addition, on September 26,
1997, the Company filed another action against Origin alleging patent
infringement of its patent for a method of serial inflation of tissue
dissectors. A decision against the Company in any of these actions would have
a material adverse effect on the Company's business, financial condition or
results of operations.
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. The Company believes
that the inventor named in its patent application 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 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 would have a material adverse effect on the Company's business,
financial condition and results of operations.
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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, except for the patent interference
and infringement proceedings discussed herein.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with its initial public offering in 1996, the Company
filed a Registration Statement on Form S-1, SEC File No. 333-02774 (the
"REGISTRATION STATEMENT"), which was declared effective by the Commission on
May 9, 1996. Pursuant to the Registration Statement, the Company registered
and sold 3,450,000 shares of its Common Stock, $0.001 par value per share,
for its own account. The offering commenced on May 10, 1996 and terminated
when all of the registered shares had been sold. The aggregate offering
price of the registered shares was $51,750,000. The managing underwriters of
the offering were Cowen & Company and UBS Securities LLC.
From May 10, 1996 to September 30, 1997, the Company incurred the following
expenses in connection with the offering:
Underwriting discounts and commissions $3,622,500
Other expenses $1,187,025
----------
Total Expenses $4,809,525
All of such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after deducting the total
expenses above were $46,940,475. From May 10, 1996 to September 30, 1997,
the Company used such net offering proceeds, in direct or indirect payments
to others, as follows:
Construction of plant, building and facilities $ 1,164,154
Purchase and installment of machinery and equipment $ 1,071,416
Repayment of indebtedness $ 711,149
Working capital $19,630,578
-----------
Total $22,577,297
This use of proceeds does not represent a material change in the use of
proceeds described in the prospectus of the Registration Statement.
ITEM 3. DEFAULTS IN SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Description
------- ------------
3.4 Amended and Restated Bylaws
11.1 Statement of Computation of Earnings (Net Loss) Per Share
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended
September 30, 1997.
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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 Administration
Principal and Chief Financial Officer
Date: November 13, 1997
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