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, 1998.
Commission file number: 0-28448
GENERAL SURGICAL INNOVATIONS, INC.
(Exact name of Registrant as specified in its charter)
CALIFORNIA 94-3160456
(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 13,478,910 shares of Registrant's Common Stock
issued and outstanding as of January 31, 1999.
GENERAL SURGICAL INNOVATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Financial Statements (Unaudited)
Condensed balance sheets at December 31, 1998
and June 30, 1998............................................... 3
Condensed statements of operations and comprehensive loss
for the three and six months ended December 31, 1998 and
December 31, 1997............................................... 4
Condensed statements of cash flows for the six months ended
December 31, 1998 and December 31, 1997 ........................ 5
Notes to condensed financial statements......................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ...................................... 7
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..... 20
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 ............................... 22
Item 4. Submission of Matters to a Vote of Security Holders............. 22
Item 5. Other Information .............................................. 22
Item 6. Exhibits and Reports on Form 8-K ............................... 22
2
GENERAL SURGICAL INNOVATIONS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
December 31, June 30,
1998 1998
-------------------- -------------------
ASSETS
Current assets:
Cash and cash equivalents..................................... $ 14,501 $ 17,954
Available-for-sale securities................................. 8,323 10,743
Accounts receivable, net...................................... 991 1,043
Inventories................................................... 2,836 1,284
Prepaid expenses and other current assets..................... 671 733
---------- ----------
Total current assets............................... 27,322 31,757
Available-for-sale securities, non-current......................... 6,768 8,772
Property and equipment, net........................................ 2,434 2,101
Other assets....................................................... 375 194
---------- ----------
Total assets....................................... $ 36,899 $ 42,824
---------- ----------
---------- ----------
LIABILITIES
Current liabilities:
Accounts payable.............................................. $ 2,015 $ 910
Accrued liabilities........................................... 1,320 1,316
Capital leases................................................ 14 14
Bank borrowings............................................... 82 103
---------- ----------
Total current liabilities.......................... 3,431 2,343
Other long-term liabilities........................................ 75 149
Capital leases, less current portion............................... 5 12
Bank borrowings, less current portion.............................. 41 82
---------- ----------
Total liabilities.................................. 3,552 2,586
---------- ----------
Contingencies (Note 4)
SHAREHOLDERS' EQUITY
Preferred stock, $.001 par value................................... - -
Common stock, $.001 par value...................................... 13 13
Additional paid-in capital......................................... 65,369 65,290
Notes receivable from shareholders................................. (84) (87)
Deferred compensation, net......................................... (91) (159)
Accumulated other comprehensive income............................. 50 16
Accumulated deficit................................................ (31,910) (24,835)
---------- ----------
Total shareholders' equity......................... 33,347 40,238
---------- ----------
Total liabilities and shareholders' equity....... $ 36,899 $ 42,824
---------- ----------
---------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED FINANCIAL STATEMENTS.
3
GENERAL SURGICAL INNOVATIONS, INC.
CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
-------------------------- ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
Sales................................................................... $ 926 $ 1,408 $ 2,947 $ 2,975
Guaranteed payments..................................................... - 860 - 1,635
---------- ---------- ---------- ----------
Total revenue........................................................... 926 2,268 2,947 4,610
Cost of sales........................................................... 731 1,186 1,815 2,142
---------- ---------- ---------- ----------
Gross profit..................................................... 195 1,082 1,132 2,468
---------- ---------- ---------- ----------
Operating expenses:
Research and development............................................ 934 658 1,678 1,423
Sales and marketing................................................. 1,836 1,168 3,154 2,294
General and administrative.......................................... 2,359 1,738 4,310 3,084
---------- ---------- ---------- ----------
Total operating expenses.......................................... 5,129 3,564 9,142 6,801
---------- ---------- ---------- ----------
Operating loss................................................... (4,934) (2,482) (8,010) (4,333)
Interest income......................................................... 450 594 953 1,197
Interest expense........................................................ (4) (9) (10) (21)
Other expense, net...................................................... (8) - (8) -
---------- ---------- ---------- ----------
Net loss......................................................... (4,496) (1,897) (7,075) (3,157)
Other comprehensive income (loss):
Change in unrealized gain or loss on available-for-sale securities (34) (18) 34 33
---------- ---------- ---------- ----------
Comprehensive loss............................................... $ (4,530) $ (1,915) $ (7,041) $ (3,124)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Net loss per common share and per common share-assuming
dilution............................................................ $ (0.33) $ (0.14) $ (0.53) $ (0.23)
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
Shares used in computing net loss per common share and per
common share-assuming dilution...................................... 13,446 13,355 13,442 13,334
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED FINANCIAL STATEMENTS.
4
GENERAL SURGICAL INNOVATIONS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Six Months Ended
December 31,
-----------------------------------
1998 1997
---------------- ----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss............................................................................. $ (7,075) $ (3,157)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization of deferred compensation........................................... 68 69
Depreciation and amortization................................................... 412 567
Provision for uncollectible accounts............................................ 61 7
Provision for excess and obsolete inventory..................................... 50 (4)
Changes in operating assets and liabilities:
Accounts receivable........................................................ (9) (91)
Inventories................................................................ (1,602) 705
Prepaid expenses and other current assets.................................. 62 (153)
Other assets............................................................... (217) (2)
Accounts payable........................................................... 1,105 75
Accrued liabilities........................................................ (70) (267)
--------- ----------
Net cash used in operating activities............................ (7,215) (2,251)
--------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities........................................... (2,795) (15,800)
Proceeds from sales and maturities of available-for-sale securities.................. 7,200 17,792
Acquisition of property and equipment................................................ (656) (304)
--------- ----------
Net cash provided by investing activities........................ 3,749 1,688
--------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock............................................... 79 130
Proceeds from payment on notes receivable from shareholders.......................... 3 -
Payments on capital lease obligations................................................ (7) (9)
Principal payments on bank borrowings................................................ (62) (84)
--------- ----------
Net cash provided by financing activities......................... 13 37
--------- ----------
Net decrease in cash and cash equivalents............................................ (3,453) (526)
Cash and cash equivalents, beginning of period....................................... 17,954 7,900
--------- ----------
Cash and cash equivalents, end of period............................................. $ 14,501 $ 7,374
--------- ----------
--------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONDENSED FINANCIAL STATEMENTS.
5
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited condensed financial statements as of December
31, 1998 of General Surgical Innovations, Inc. (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
of normal recurring adjustments, considered necessary for a fair presentation
have been included. Operating results for the three and six month periods ended
December 31, 1998 are not necessarily indicative of the results that may be
expected for the fiscal year ending June 30, 1999, 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, 1998.
2. Computation of Net Loss per Common Share and per Common Share-Assuming
Dilution:
Effective December 15, 1997, the Company adopted Financial Accounting
Standards Board ("FASB") No. 128 "Earnings Per Share", and the provisions of the
Securities and Exchange Commission Staff Accounting Bulletin ("SAB 98"), and
accordingly all prior periods have been restated. Net loss per common share and
per common share-assuming dilution are computed using the weighted average
number of shares of common stock outstanding. Common equivalent shares from
stock options are excluded from the computation of net loss per common
share-assuming dilution as their effect is antidilutive. The Company has
determined that no incremental shares should be included in the computations in
accordance with SAB 98.
Stock options to purchase 1,858,034 and 1,285,732 shares of common stock
at prices ranging from $0.09 to $9.75 per share were outstanding at December 31,
1998 and December 31 1997, respectively, but were not included in the
computation of net loss per common share-assuming dilution because they were
antidilutive. The aforementioned stock options could potentially dilute earnings
per share in the future.
3. Inventories:
Inventories comprise (IN THOUSANDS):
Dec. 31, June 30,
-------- --------
1998 1998
---- ----
(unaudited)
Raw materials................................... $ 1,323 $ 910
Work in progress................................ 38 -
Finished goods.................................. 1,475 374
--------------- ---------------
$ 2,836 $ 1,284
--------------- ---------------
--------------- ---------------
6
4. Contingencies:
In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant
Corporation, filed suit against GSI for infringement of U.S. Patent No.
5,520,609 in the United States District Court for the Northern District of
California. That suit was resolved in GSI's favor by judgment entered on
May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that
judgment is pending and is expected to be decided in 1999. The District
Court has also awarded $990,000 in attorneys' fees to GSI and Origin has
appealed that ruling as well.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that use of Origin's
products infringes GSI's U.S. Patent 5,514,153. The court agreed with this
allegation in a summary judgment ruling in GSI's favor. On February 8, 1999,
a jury found the patent to be valid, that infringement was willful, and
granted GSI approximately $12.9 million in damages. GSI is seeking an
injunction against further infringements.
A second action was filed similarly in September 1997, alleging that
use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery
is near completion in this case.
GSI is also involved in an interference proceeding in the U.S. Patent
Office to determine whether certain subject matter was first invented by
GSI's inventor. The priority portion of this interference has been decided in
GSI's favor by an arbitrator to whom this issue was referred. The
patentability portion of this interference was decided in GSI's favor by the
United States Patent and Trademark Office ("PTO"). Origin is expected to
appeal the PTO's decision, but GSI believes that the arbitrator's priority
decision is not appealable.
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
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, 1998.
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. The following General Surgical
Innovations, Inc. trademarks are mentioned in this Quarterly Report:
ENDOSAPH-Registered Trademark-, SPACEMAKER-Registered Trademark-,
SAPHtrak-Registered Trademark-, registered trademarks of the Company;
SPACEKEEPER-TM-, and Total Solution-TM-, trademarks 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 seven 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, Europe, Asia and South America for selected
7
applications, such as hernia repair, subfascial endoscopic perforator surgery,
saphenous vein harvesting and breast augmentation and reconstruction surgery.
In December 1996, the Company entered into a five year OEM supply
agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery, Inc.
("EES"), pursuant to which GSI granted EES worldwide sales and marketing
rights to sell the SPACEMAKER-Registered Trademark- surgical balloon
dissectors in the laparoscopic hernia repair and stress urinary incontinence
("SUI") markets. In February 1998, the Company and EES signed a non-exclusive
distribution agreement for the laparoscopic hernia repair and SUI markets.
This agreement supersedes the December 1996 Expanded EES Agreement.
During the first six months of fiscal 1999, the Company added eight
direct sales personnel and realigned its regional distribution in the United
States from one consisting primarily of third-party distributors to a
combination of distributors and a GSI direct sales force. The Company plans to
continue its direct sales force expansion, which the Company believes will
create a more balanced approach to distribution, throughout the remainder of the
fiscal year. Any increase in the Company's direct sales force will require
significant expenditures and additional management resources.
In September 1998, the Company signed two non-exclusive, three-year
agreements with United States Surgical Corporation ("USSC"). Under the terms
of the first agreement, USSC has obtained non-exclusive rights to market and
distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors
worldwide for use in hernia repair and incontinence procedures. Under the
terms of the second agreement, GSI has secured non-exclusive worldwide rights
to market and distribute several products, including USSC's 5mm mesh fixation
device, the ProTack(TM), which is offered with GSI's balloon dissectors in a
Total Solution-TM- hernia repair kit.
In October 1998, GSI entered into non-exclusive agreements with seven
leading surgical suppliers to distribute its SPACEMAKER-Registered Trademark-
surgical balloon dissector kits used for hernia repair in the United States.
Currently, domestic distribution of GSI's products is made through ten
independent distributors covering 45 states for Subfascial Endoscopic
Perforator Surgery ("SEPS") and saphenous vein harvest products, and nine
independent distributors covering 41 states for hernia and SUI products. The
Company currently has a direct sales force distributing products in the
remaining portion of the United States as well as managing distributor
relationships.
In addition, the Company has agreements with USSC and EES to
distribute hernia repair and SUI products worldwide. GSI also sells its
products (other than for hernia and SUI applications) in international
markets through other distributors, which resell to surgeons and hospitals.
At present, the Company has exclusive distribution agreements with eight
international distributors, including Baxter International, to distribute
GSI's cardiovascular products in Europe and the Company has employees located
in Europe to manage those distributors.
To date, the majority of the sales to distributors and by the
Company's direct sales force have been of products for use in hernia repair
procedures. The Company's initial market focus was the application of its
SPACEMAKER-Registered Trademark- balloon dissection technology for hernia
repair. Subsequent to this, the Company has developed additional products for
use in general surgery, as well as products for plastic surgery and
cardiovascular applications. The Company has completed marketing-related
clinical evaluations of, and has introduced products for, saphenous vein
harvesting, SEPS, breast augmentation and reconstruction procedures and SUI.
The Company is currently conducting additional marketing-related clinical
evaluations for products for use in tissue dissection/expansion.
8
While the Company has developed or is developing balloon dissection
systems for stress urinary incontinence, vascular and plastic surgery, sales of
products for hernia repair are expected to provide a majority of the Company's
revenues at least through calendar 1999.
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 between one and four percent
of sales of such products, which payments are expected to exceed certain minimum
royalty payments due under the agreements with such parties. The payment of such
royalty amounts will have an adverse impact on the Company's gross profit and
results of operations.
The Company has experienced significant operating losses since
inception. The Company expects such operating losses to continue at least
through fiscal 1999. The Company's sales to date have consisted primarily of
surgical balloon dissectors 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 surgical balloon dissectors for other
applications, the Company anticipates that it will be required to make
significant additional expenditures in sales and marketing, and in research
and development (including marketing-related clinical evaluations).
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.
RESULTS OF OPERATIONS
REVENUE. Total revenue, including product sales and guaranteed payments,
decreased by 59% to $926,000 for the quarter ended December 31, 1998 from $2.3
million for the same period in 1997. Revenue for the six months ended December
31, 1998 decreased 36% to approximately $2.9 million from $4.6 million for the
six months ended December 31, 1997. Revenues in fiscal 1999 consisted entirely
of product sales, while revenues for the three and six months ended December 31,
1997 consisted of $860,000 and $1.6 million, respectively, in guaranteed
payments from EES. 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 38% to $731,000 for the quarter
ended December 31, 1998 from approximately $1.2 million for the same period in
1997. This decrease in absolute dollars was due to a decrease in product sales
over this same period. As a percentage of product sales, cost of sales decreased
from 84% in the second quarter of fiscal 1998 to 79% in the second quarter of
fiscal 1999. Cost of sales for the six months ended December 31, 1998 decreased
as a percent of sales to 62%, or approximately $1.8 million, as compared to 72%
of sales, or approximately $2.1 million, for the six months ended December 31,
1997.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses,
which include expenditures for marketing-related clinical evaluations and
regulatory expenses, increased 42% to $934,000 in the quarter ended December 31,
1998 from $658,00 for the same period in 1997. R&D expenses for the six months
ended December 31, 1998 were approximately $1.7 million as compared to $1.4
million for the same period of the prior fiscal year, which represented an 18%
increase. Increases are due to new general and vascular surgical product
development expenditures.
9
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 44% to approximately $4.2 million for
the quarter ended December 31, 1998 from $2.9 million for the quarter ended
December 31, 1997. For the six months ended December 31, 1998, SG&A expenses
were $7.5 million compared to $5.4 million for the same period in 1997. These
increases are primarily due to increased legal expenses related to
intellectual property litigation, as well as increased labor and labor
related expenses as the Company expands its sales and marketing
infrastructure.
INTEREST INCOME, INTEREST EXPENSE, AND OTHER EXPENSE. Interest and other
income (net of expense) decreased to $438,000 for the quarter ended December 31,
1998 from $585,000 for the quarter ended December 31, 1997. For the six months
ended December 31, 1998, interest and other income (net of expense) decreased to
$935,000 from $1.2 million for the same period in 1997. Decreases are due mainly
to lower 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 approximately $31.9
million at December 31, 1998. The Company has funded its operations primarily
through the sale of equity securities. From its inception through December 31,
1998 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 December 31, 1998 the Company's principal source of liquidity
consists of cash, cash equivalents and available-for-sale securities of $29.6
million. In addition, the Company has a bank line of credit available for $5.0
million. As of December 31, 1998, the Company has no amounts outstanding under
this line. The Company also has an equipment loan with an outstanding balance of
approximately $123,000.
The Company expects to continue to incur costs over the next fiscal year,
including costs related to increased sales and marketing activities, increased
research and development, additional marketing-related clinical evaluations, and
costs to defend its patent positions. 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 year 2000. 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.
YEAR 2000 COMPLIANCE
The Year 2000 ("Y2K") issue arises from computer programs using two
digits rather than four to define the applicable year. Such software may
recognize a date using "00" as the year 1900 rather than the year 2000. This
could result in system failures or miscalculations leading to disruptions or
delays in the Company's activities and operations. If the Company, its key
customers or suppliers fail to make necessary modifications to their information
technology or non-information technology systems on a timely basis, the
10
Y2K issue could have a material adverse effect on Company operations.
However, the impact cannot be quantified at this time.
In January 1998, the Company began to evaluate and assess the
Company's information technology and non-information technology systems for
compliance with the Y2K issue. The Company is in the process of fixing or
replacing noncompliant software and systems and intends to have this process
completed by June 30, 1999, but there can be no assurance that such fixes or
replacements will occur by such date. The Company is currently conducting
testing and remediation activities on its systems, and intends to survey
major customers and suppliers to assess their systems' compliance as well as
their systems' compatibility with the Company's existing or projected
compliant systems. There can be no assurance that there will not be an
adverse material effect on the Company's business, financial condition or
results of operations if the Company or its suppliers or customers do not
convert or replace their systems in a timely manner to comply with the Y2K
issue.
The Company's costs related to the Y2K issue are funded through
operating cash flows. Through December 31, 1998, the Company expended
approximately $15,000 in evaluating and planning. The Company estimates total
costs to be between $50,000 and $100,000 for fixing and replacing
noncompliant systems, including the cost of new software and modifying the
applicable code of existing software. The Company currently believes that the
total cost of achieving Y2K compliant systems will not be material to its
business, financial condition or results of operations. In the event that the
Company will be unable to achieve Y2K compliance in a timely manner with
existing personnel, as a contingency the Company expects to hire outside Y2K
solution providers to assist in achieving such compliance.
Time and cost estimates are based on currently available information.
Factors that could affect these estimates include, but are not limited to, the
availability and cost of trained personnel to evaluate and implement the
changes, the ability to locate and correct all noncompliant systems, and the
ability of the Company's customers and suppliers to successfully implement Y2K
compliant systems or fixes.
FACTORS AFFECTING FUTURE RESULTS
The following discussion should be read in conjunction with the condensed
financial statements and notes thereto included herein.
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 timing of orders
and shipments, the timely development and market acceptance of new products and
surgical procedures, the impact of performance of the Company's distributors,
the Company's ability to further expand into international markets, public
policy relating to health care reform in the United States and other countries,
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 periods to differ
materially from those expressed in any forward-looking statements contained in
the following discussion.
11
HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES. The Company has
experienced significant operating losses since inception and as of
December 31, 1998, the Company had an accumulated deficit of $31.9 million.
The Company's net operating losses for the quarters ended December 31, 1998
and September 30, 1998 were $4.5 million and $2.6 million, respectively. The
Company expects to continue to incur operating losses on a quarterly and
annual basis through at least calendar year 1999. The Company's limited
operating history makes accurate prediction of future operating results
difficult or impossible. There can be no assurance that the Company will ever
generate substantial revenue or achieve profitability. Failure by the Company
to generate substantial revenue would have a material adverse effect on the
Company's business, financial condition and results of operations.
DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL
OBSOLESCENCE. Nearly 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. 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, 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 surgical balloon dissectors 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.
DEPENDENCE ON KEY DISTRIBUTORS. In February 1998, the Company replaced
its five-year OEM supply agreement with EES with a non-exclusive distribution
agreement which granted EES worldwide sales and marketing rights to sell the
SPACEMAKER-Registered Trademark- surgical balloon dissectors in the
laparoscopic hernia repair and stress urinary incontinence ("SUI") markets.
Unlike the prior EES OEM Agreement, this new EES non-exclusive agreement does
not provide for any minimum payments from EES to the Company. In December
1997, the Company entered into a four-year distribution agreement with
Genzyme Surgical Products Corporation ("Genzyme"). Under the agreement,
Genzyme has exclusive rights to market and distribute GSI's surgical balloon
dissectors worldwide for use in reconstructive and cosmetic plastic surgery
procedures. In September 1998, the Company signed a non-exclusive, three-year
agreement with United States Surgical Corporation ("USSC"). Under the terms
of the agreement, USSC has obtained non-exclusive rights to market and
distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors
worldwide for use in hernia repair and incontinence procedures.
12
LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has 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 vascular surgery
markets. The Company intends to establish relationships with additional
distribution partners, and there can be no assurance that the Company will be
successful in establishing such 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.
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
adoption of laparoscopic techniques generally and the conversion of
non-balloon dissection surgical techniques and treatments to balloon
dissection techniques specifically. To date, the Company has limited
long-term outcomes data regarding successful balloon dissection procedures.
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 dissection 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.
The Company introduced its surgical balloon dissectors in late 1993.
To the extent that laparoscopic techniques are adopted slowly, that surgical
balloon dissectors are not incorporated into laparoscopic techniques or that
surgeons are unwilling or unable to develop the skills necessary to utilize
surgical 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) fluctuations in purchases of the Company's
products by its distributors, (ii) the ability of the Company's distributors
to effectively promote and sell the Company's products, (iii) the rate of
adoption by surgeons of balloon dissection technology in markets targeted by
the Company, (iv) the mix of sales among distributors and the Company's
direct sales force, (v) new product introductions by the Company and its
competitors, (vi) fluctuations in revenues among different product lines and
markets, (vii) timing of patent and regulatory approvals, if any,
(viii) intellectual property litigation, (ix) timing and growth of operating
expenses and (x) general market conditions.
13
In December 1996, the Company entered into the Expanded Ethicon
Agreement, pursuant to which 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 and payments by mutual consent of $775,000 in the first
quarter of fiscal year 1998 and $860,000 in the second quarter of fiscal 1998.
The Company and EES entered into a nonexclusive distribution agreement for the
laparoscopic hernia repair and stress urinary incontinence markets in February
1998, which supersedes the Expanded Ethicon Agreement and which does not include
a provision for minimum quarterly payments. The Company anticipates that sales
to EES may decrease in the future. Failure by EES to achieve certain levels of
sales growth or purchases could adversely affect the Company's operating
results. In September 1998, the Company signed two non-exclusive, three-year
agreements with United States Surgical Corporation. Failure by the Company or
USSC 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
purchased from 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.
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, Origin Medsystems, Inc. ("Origin"), a unit of Guidant
Corporation, filed suit against GSI for infringement of U.S. Patent No.
5,520,609 in the United States District Court for the Northern District of
California. That suit was resolved in GSI's favor by judgment entered on
May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that
judgment is pending and is expected to be decided in 1999. The District
Court has also awarded $990,000 in attorneys' fees to GSI and Origin has
appealed that ruling as well.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that use of Origin's
products infringes GSI's U.S. Patent 5,514,153. The court agreed with this
allegation in a summary judgment ruling in GSI's favor. On February 8, 1999,
a jury found the patent to be valid, that infringement was willful, and
granted GSI approximately $12.9 million in damages. GSI is seeking an
injunction against further infringements.
A second action was filed similarly in September 1997, alleging that
use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery
is near completion in this case.
GSI is also involved in an interference proceeding in the U.S. Patent
Office to determine whether certain subject matter was first invented by
GSI's inventor. The priority portion of this interference has been decided in
GSI's favor by an arbitrator to whom this issue was referred. The
patentability portion of this interference was decided in GSI's favor by the
United States Patent and Trademark Office ("PTO"). Origin is expected to
appeal the PTO's decision, but GSI believes that the arbitrator's priority
decision is not appealable.
14
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 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.
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 rights to patents
from third parties, including rights that apply to the Company's current
surgical balloon dissectors. The Company has historically paid and is obligated
to pay in the future to such third parties royalties equal to between one and
four percent of sales of such products, which payments are expected to exceed
minimum royalty payments due under agreements with such parties. 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.
15
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 surgical 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 surgical balloon dissectors 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 surgical 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 surgical balloon
dissectors, 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 some 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 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
16
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
surgical balloon dissectors 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 surgical 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-
surgical balloon dissectors 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 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.
17
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-Registered Trademark- II platform, SPACEMAKER-Registered
Trademark- Plastics platform, SPACEMAKER-Registered Trademark-
SAPHtrak-Registered Trademark- platform and KnotMakerTM- product each have
received 510(k) clearance for use during general, endoscopic, laparoscopic or
cosmetic and reconstructive surgery, and certain vascular surgery (including
saphenous vein procedures) when tissue dissection is required. The Company
has promoted these products for surgical applications (E.G., hernia repair,
subfascial endoscopic perforator surgery, breast augmentation and
reconstruction, treatment of stress urinary incontinence and saphenous vein
harvesting), and may in the future promote these products for the dissection
required for additional selected applications (E.G. tissue
dissection/expansion and a variety of orthopedic procedures such as anterior
spinal fusion and long-bone plating). 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.
LIMITED COMMERCIAL MANUFACTURING EXPERIENCE. The Company has only limited
experience in manufacturing its products in commercial quantities. Manufacturers
often encounter difficulties in scaling up for commercial 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.
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
contracts with such suppliers. There can be no assurance that the component
materials obtained from single source suppliers will continue to be available in
adequate quantities or, if required, that
18
the Company will be able to locate alternative sources of such component
materials on a timely basis to market its products, if at all. 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 attempts to identify and certify 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
cause or are 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.
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.
YEAR 2000 COMPLIANCE. The Year 2000 ("Y2K") issue arises from computer
programs using two digits rather than four to define the applicable year. Such
software may recognize a date using "00" as the year 1900 rather than the year
2000. This could result in system failures or miscalculations leading to
disruptions or delays in the Company's activities and operations. If the
Company, its key customers or suppliers fail to make necessary modifications to
their information technology or non-information technology systems on a timely
basis, the Y2K issue could have a material adverse effect on Company operations.
However, the impact cannot be quantified at this time.
19
In January 1998 the Company began to evaluate and assess the Company's
information technology and non-information technology systems for compliance
with the Y2K issue. The Company is in the process of fixing or replacing
noncompliant software and systems and intends to have this process completed
by June 30, 1999, but there can be no assurance that such fixes or
replacements will occur by such date. The Company is currently conducting
testing and remediation activities on its systems, and intends to survey
major customers and suppliers to assess their systems' compliance as well as
their systems' compatibility with the Company's existing or projected
compliant systems. There can be no assurance that there will not be an
adverse material effect on the Company's business, financial condition or
results of operations if the Company or its suppliers or customers do not
convert or replace their systems in a timely manner to comply with the Y2K
issue. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Year 2000 Compliance."
RECENT PRONOUNCEMENTS
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company had no holdings of derivative financial or commodity
instruments at December 31, 1998. A review of the Company's other financial
instruments and risk exposures at that date revealed that the Company had
exposure to interest rate risk. At December 31, 1998 the Company performed
sensitivity analyses to assess the potential effect of this risk and concluded
that near-term changes in interest rates should not materially adversely affect
the Company's financial position, results of operations or cash flows.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant
Corporation, filed suit against GSI for infringement of U.S. Patent No.
5,520,609 in the United States District Court for the Northern District of
California. That suit was resolved in GSI's favor by judgment entered on
May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that
judgment is pending and is expected to be decided in 1999. The District
Court has also awarded $990,000 in attorneys' fees to GSI and Origin has
appealed that ruling as well.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that use of Origin's
products infringes GSI's U.S. Patent 5,514,153. The court agreed with this
allegation in a summary judgment ruling in GSI's favor. On February 8, 1999,
a jury found the patent to be valid, that infringement was willful, and
granted GSI approximately $12.9 million in damages. GSI is seeking an
injunction against further infringements.
A second action was filed similarly in September 1997, alleging that
use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery
is near completion in this case.
GSI is also involved in an interference proceeding in the U.S. Patent
Office to determine whether certain subject matter was first invented by
GSI's inventor. The priority portion of this interference has been decided in
GSI's favor by an arbitrator to whom this issue was referred. The
patentability portion of this interference was decided in GSI's favor by the
United States Patent and Trademark Office ("PTO"). Origin is expected to
appeal the PTO's decision, but GSI believes that the arbitrator's priority
decision is not appealable.
20
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. 333-2774 (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 December 31, 1998, 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 December 31, 1998, the
Company used such net offering proceeds, in direct or indirect payments to
others, as follows:
Construction of plant, building and facilities $ 1,227,065
Purchase and installment of machinery and equipment $ 1,937,420
Repayment of indebtedness $ 898,811
Working capital $30,502,324
-----------
Total $34,565,620
21
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
On November 19, 1998 at the Company's Annual Meeting of Shareholders for
the Fiscal Year Ending June 30, 1998 the following matters were submitted and
voted on by securityholders and were adopted:
A. The election of Class I directors to serve until the Annual Meeting
of the shareholders for fiscal year 2000 or until their successors
are elected and qualified.
The results of the vote are as follows:
Yes Abstain
---------- -------
Gregory D. Casciaro 12,725,913 50,907
Thomas J. Fogarty 12,694,090 82,730
Roderick A. Young 12,723,990 52,830
The terms of office for the following individuals, who are Class II
directors, will continue until the Annual Meeting of Shareholders for fiscal
year 1999: David Chonette, Paul Goeld, James Sulat, and Mark Wan.
B. The approval of an amendment to the 1992 Stock Option Plan (i) to
increase the number of shares of Common Stock reserved for issuance
thereunder on the date of each annual meeting of the shareholders
during the period beginning on and including November 19, 1998 and
ending on September 14, 2002 by an amount equal to the lesser of:
(x) four percent (4%) of the total number of shares of the Company's
Common Stock issued and outstanding as of the last business day
immediately preceding the date of the annual meeting of the
shareholders each fiscal year, or (y) 600,000 shares, and (ii) to
increase the total maximum number of shares subject to options that
may be issued to any one employee during a fiscal year to 1,000,000
effective as of July 1, 1998.
The results of the vote are as follows:
Yes No Abstain Broker Non-Vote
--------- ------- ------- ---------------
7,292,379 642,631 906,723 3,935,087
C. The ratification of PricewaterhouseCoopers, LLP as the Company's
independent accountants for the fiscal year ended June 30, 1999.
The results of the vote are as follows:
Yes No Abstain
---------- ------ -------
12,750,326 18,236 8,258
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit Description
------- -----------
10.2 1992 Stock Option Plan, as amended November 1997
and November 1998.
10.27 Written Compensation Agreement Dated April 6, 1998.
22
27.1 Financial Data Schedule.
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1998.
23
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: February 16, 1999
24