UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934 [NO FEE REQUIRED]
For the Fiscal Year Ended June 30, 1999, or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the Transition period from ___ to ___.
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)
http://www.gsii.com
(Web site address)
Registrant's telephone number, including area code: (408) 863-2500
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
--- ---
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to
the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the voting stock held by non-affiliates of the
Registrant was approximately $64,956,519 as of August 31, 1999, based upon
the closing sale price on the NASDAQ National Market System reported for such
date. Shares of Common Stock held by each officer and director and by each
person who owns 5 percent of more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This
determination of affiliate status is not necessarily a conclusive
determination for other purposes.
There were 13,847,025 shares of Registrant's Common Stock issued and
outstanding as of August 31, 1999.
--------------------------------
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement of the Registrant for the 1999 Annual Meeting
of Shareholders are incorporated by reference in Part III of this Form 10-K.
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INTRODUCTORY STATEMENT
Except for the historical information contained in this Annual
Report on Form 10-K, 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, 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.
References made in this Annual Report on Form 10-K 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 Annual Report:
SPACEMAKER-Registered Trademark-, SAPHtrak-Registered Trademark-,
GSI-Registered Trademark-, ENDOSAPH-Registered Trademark-, registered
trademarks of the Company; SPACEMAKER-Registered Trademark- Total
Solution-TM-, SPACEKEEPER DIRECT-TM-, SpaceSEAL-TM- and SPACEKEEPER-TM-,
trademarks of the Company.
PART I
ITEM 1. BUSINESS
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 eight 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, South America
and Australia for selected applications, such as hernia repair, subfascial
endoscopic perforator surgery ("SEPS"), saphenous vein harvesting and breast
reconstruction and augmentation surgery, and laparoscopic bladder neck
suspension.
Sales of the Company's products in the United States and
internationally are currently made through both distributors and the
Company's direct sales force. Distribution in the hernia and SUI markets is
currently through non-exclusive relationships with Ethicon Endo-Surgery
("EES"), United States Surgical Corporation ("USSC"), Dexterity Surgical,
Inc. ("Dexterity") and other distributors. The Company has two non-exclusive
agreements with USSC, a wholly owned subsidiary of Tyco International Ltd.
("Tyco"). Under the terms of the first agreement, USSC has non-exclusive
rights to market and distribute GSI's SPACEMAKER-Register Trademark- surgical
balloon dissectors worldwide for use in hernia repair and stress urinary
incontinence ("SUI") procedures. Under the terms of the second agreement,
GSI has non-exclusive rights to market several products, including USSC's 5mm
mesh fixation device, the ProTack, which is offered as part of GSI's
SPACEMAKER-Registered Trademark- Total Solution-TM- hernia repair kit.
Additionally, the Company has an exclusive agreement with Genzyme Surgical
Products Corporation ("Genzyme") to market and distribute GSI's surgical
balloon dissection systems for use in plastic surgery (reconstructive and
aesthetic) procedures. Sales of devices for cardiac/vascular applications are
made through non-exclusive agreements with distributors and through the
Company's direct sales force.
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During fiscal year 2000, the Company plans to extend its domestic
and international distribution networks, as well as its direct sales force.
Any increase in the Company's direct sales force will require significant
expenditures and additional management resources.
To date, the majority of the sales of the Company's products 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
surgical balloon dissectors for SUI, vascular and plastic surgery, sales of
products for hernia repair are expected to provide a majority of the
Company's revenues at least through fiscal year 2000.
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. Total amounts paid for royalties for the years ended June
30, 1999, 1998 and 1997 were $187,497, $289,255 and $356,831, respectively.
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 2000. 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 studies).
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.
RECENT DEVELOPMENTS
In August 1999, the Company and Tyco entered into a definitive
agreement pursuant to which Tyco will acquire GSI. GSI shareholders will
receive a fraction of a Tyco common share valued at $7.50 per common share
for each common share of GSI. The transaction is valued at approximately $100
million. The closing of this deal is contingent upon shareholder approval of
the Company, as well as certain regulatory approvals.
INDUSTRY BACKGROUND
Open surgery is an invasive procedure that generally requires large
incisions and significant tissue manipulation in order to provide the surgeon
with direct access to the intended surgical site. Much of the trauma suffered
in connection with open surgery is a result of gaining access to the surgical
site and is not caused by the surgical repair itself. For example, the
surgeon often must make large incisions through layers of muscle and tissue,
which may cause muscle or nerve damage, bleeding, scarring and other
complications such as infection, temporary or permanent debilitation and
pain. As a result, many open surgical procedures require extended operating
times, expose the patient to the risks of general anesthesia and involve
lengthy hospitalization and patient recovery times. In addition, because of
the severe trauma often associated with open surgical procedures, a
significant population of patients, including the elderly and weak, are not
considered good candidates for these surgical procedures and are thus
deprived of treatment.
In order to reduce the complications associated with open surgery,
surgical techniques referred to as minimally invasive surgery ("MIS") have
been developed. These techniques allow surgeons to access the surgical site
through the body's natural openings (E.G. mouth, urethra or rectum) or by
making small incisions to access body cavities such as the abdominal cavity
(the peritoneal cavity). The performance of MIS generally involves five basic
steps. First, a small incision (approximately 1 cm) is made for insertion of
a trocar, a valved tube with a blunt or sharp insertion device. Next,
additional trocars are introduced to gain increased access to the surgical
site and permit the introduction of surgical instruments. Third, the surgeon
creates a working space through the use of dissection tools or by
insufflating a natural body cavity (such as the abdominal cavity) with air or
gas. Fourth, the surgeon utilizes a device such as an endoscope or
laparoscope to visualize the surgical field. Finally, the surgeon utilizes
specialized MIS instruments to perform the surgical procedure.
Studies published in the NEW ENGLAND JOURNAL OF MEDICINE and THE
JOURNAL OF VASCULAR SURGERY support the benefits of MIS as compared to open
surgery, which generally include reduced patient trauma (including less
muscle, nerve and other tissue damage), reduced blood loss, reduced
post-operative infection, reduced scarring at the site of the incision (which
in turn reduces reintervention requirements), shorter patient recovery time
and ultimately lower medical costs.
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Despite the documented benefits of MIS, its adoption to date has
been limited to a select number of surgical procedures, and, in the
aggregate, represented only an estimated 15 percent of all surgical
procedures performed in the United States in 1997. The most widely adopted
MIS procedure, laparoscopic cholecystectomy (removal of the gall bladder),
has been successfully adopted and is used in an estimated 90 percent of such
cases largely because the target surgical site lies within the abdominal
cavity, the only natural body cavity that provides a working space when
insufflated. Application of MIS techniques to other surgical procedures and
the ability to exploit the clinical benefits of MIS have been limited by the
lack of a natural body cavity proximate to the surgical site and the
inability of the surgeon to easily and atraumatically access the surgical
site or establish a surgical working space where no natural body cavity
exists. MIS conducted outside of a natural body cavity requires the surgeon
to tunnel through tissue to reach the target surgical site and to dissect a
working space. If conventional dissection techniques are utilized, the
resulting working space is often relatively bloody and affords only poor
visualization.
As a result of these limitations, many common types of surgical
repairs cannot be effectively performed using traditional blunt dissection
MIS techniques, including hernia repairs, and procedures performed on organs
such as the bladder, kidney, spine, aorta or other sites that lie outside the
abdominal cavity. For other procedures, although MIS techniques may exist for
the performance of the repair itself, gaining access to the target surgical
site is invasive, thereby reducing many of the clinical benefits of MIS. For
example, currently utilized MIS for spinal fusion requires making small
incisions at the midline of the patient's abdomen, entering the peritoneum,
retracting bowel and other organs to one side, exiting the back of the
peritoneum and continuing down to the front of the spine to access the
surgical site.
The Company believes that a significant opportunity exists for
technologies and surgical instruments that can effectively address the
limitations of MIS and facilitate the adoption of MIS for a wider range of
surgical procedures.
GSI SOLUTION
GSI's proprietary surgical balloon dissectors allow a surgeon to
rapidly access and relatively atraumatically create a working space at a
target surgical site where none previously existed. The body is largely made
up of tissue layers (skin, fat, and muscle, for example) with distinct planes
between layers. The Company's surgical balloon dissectors allow the surgeon
to exploit this anatomy using minimally invasive techniques. By following
such a plane with a deflated and rolled balloon, and then inflating the
balloon to dissect and separate the two adjacent layers, a new working space
is created. Because MIS techniques are employed, there is little damage
compared to that likely encountered with open surgery and its related long
incisions and collateral trauma to tissues and nerves.
GSI provides a wide range of surgical balloon dissectors, each
having different attributes or combinations of attributes. Generally, by
selecting one of these dissectors for the purpose at hand, the surgeon may
quickly and easily create an accurate and predictable working space, giving
consideration to both size and shape and with the desired proximity to the
chosen surgical site.
The Company believes that its SPACEMAKER-Registered Trademark-
products can be deployed anywhere in the body where a natural tissue plane
exists. For example, by creating a working space in the pre-peritoneal area
(the space in front of the peritoneum) the Company's technology enables the
use of MIS for hernia repair or treatment of SUI. Similarly, by creating a
working space in the retroperitoneal area (the space behind the peritoneum)
the Company's technology enables the use of MIS for exposure to the anterior
spine and other structures accessible in this area. In addition, the ability
of the Company's line of SPACEMAKER-Registered Trademark- products to create
working spaces at different tissue levels (including subcutaneous,
subfascial, submuscular and subglandular) enables the use of MIS for
saphenous vein harvesting, SEPS, breast augmentation and reconstruction,
tissue flap harvesting for reconstruction, long-bone plating and a variety of
other medical procedures.
COMPANY STRATEGY
The Company's objective is to become the leading provider of
surgical balloon dissectors and specialty surgical instruments for MIS. The
key elements of the Company's strategy are as follows:
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INCREASE MARKET ACCEPTANCE OF BALLOON DISSECTION TECHNIQUES. The
Company intends to increase market acceptance for its SPACEMAKER-Registered
Trademark- products primarily by developing and maintaining relationships
worldwide with leading general surgeons and specialists in the surgical
fields of cardiac/vascular surgery, obstetrics, gynecology, urology, general
and cosmetic and reconstructive surgery. The Company supports these efforts
through surgeon training programs designed to increase surgeon familiarity
with the advantages and applications of the Company's products. In addition,
the Company is conducting marketing-related clinical studies to increase
exposure of surgeons to the Company's products. The Company uses data
collected from marketing-related clinical studies to demonstrate the
anticipated clinical and cost advantages of the Company's products to
patients, surgeons, hospital administrators and third-party health care
payers.
CAPITALIZE ON EXISTING PROPRIETARY POSITION. GSI has established an
extensive patent portfolio, and plans to capitalize on its proprietary
position to establish and maintain a leadership position in the balloon
dissection market. As of June 30, 1999, GSI had 57 United States patents
issued, and had applied for an additional 52 United States patents, 12 of
which had been allowed. In addition, as of June 30, 1999, GSI had 10 foreign
patents issued, and 46 in prosecution covering GSI's technology, including
tissue dissection with balloons. In May 1996, the Company was issued a United
States patent that contains broad claims regarding use of balloons to dissect
along tissue planes. The Company believes that the scope of these claims
could provide a competitive advantage for many of the Company's balloon
dissection products, however, there can be no assurance that the Company's
intellectual property position will yield a long-term competitive advantage.
DEVELOP NEW BALLOON DISSECTOR PRODUCTS. The Company intends to
develop additional surgical balloon dissection products and enhancements to
its products. GSI's SPACEMAKER-Registered Trademark- surgical balloon
dissectors have received FDA 510(k) clearance for tissue plane dissection
during general, endoscopic, laparoscopic or cosmetic and reconstructive
surgery and certain vascular surgeries, using a broad range of balloon sizes
and shapes. Accordingly, the Company believes it is well positioned to offer
a portfolio of products for additional surgical procedures without
significant additional United States regulatory pre-market clearance
compliance requirements. The Company has developed or is planning to develop
surgical balloon dissectors to facilitate access for a number of procedures
for which MIS, without these products, is currently suboptimal, including
chronic venous insufficiency, SUI and anterior spinal fusion and long-bone
plating for certain fractures.
DEVELOP NEW SURGICAL INSTRUMENTS FOR MIS. As part of its MIS product
strategy, the Company will continue to develop and/or seek to acquire or
license surgical instruments tailored for use in the working spaces created
by the Company's surgical balloon dissectors. To date, the Company has
developed several instruments including its GSI Hook & Fork Dissectors and
SPACEKEEPER-TM- retractor products and reusable clip applier with 5mm shaft
for saphenous vein harvesting. To complete its hernia and laparoscopic
bladder neck suspension surgical procedure offerings, GSI has developed and
is currently selling its SpaceSEAL-TM- BTC and EPS balloon tip cannulae. The
SpaceSEAL-TM- BTC is designed to provide a secure seal at port sites to
prevent leakage of CO(2) during an endoscopic procedure. The SpaceSEAL-TM-
EPS is a balloon-tip cannula specifically designed for preperitoneal surgery.
The Company will continue to develop and/or seek to acquire or license
specialized surgical instruments that facilitate the broader adoption of MIS
and balloon dissection products for surgical procedures.
DEVELOP AND LAUNCH COMPLETE PROCEDURAL KITS. The Company now offers
procedural kits that are configured according to customer preference. Each
kit includes one or more surgical balloon dissectors and complementary
ancillary instruments, such as the balloon tip cannulae. Each component is
individually sealed to minimize waste, and for the convenience of the
customer. In product development, the Company evaluates on a case by case
basis whether a proposed new kit component should be developed in-house or
purchased as an OEM product.
MARKET PRODUCTS THROUGH A DIRECT SALES FORCE AND DISTRIBUTORS.
Domestically GSI sells products through a direct sales force that it
continues to build, as well as various distributors. In addition to their
sales efforts, the GSI direct sales force supports the efforts of
distributors' sales representatives in their geographical areas. For
international sales of its products the Company has, and intends to continue
to build, relationships with medical device companies both in the United
States and internationally that can provide the Company access to an
established distribution network in GSI's target markets. As of the end of
the fiscal year 1999,
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the Company had agreements with 22 distributors domestically and
internationally. Additionally, the Company has an exclusive agreement with
Genzyme Surgical Products Corporation to market and distribute GSI's surgical
balloon dissectors for use in plastic surgery (reconstructive and aesthetic)
procedures.
BALLOON DISSECTION SYSTEMS
GSI's SPACEMAKER-Registered Trademark- tissue dissection systems,
based on the Company's patented balloon technology, rapidly and gently create
surgical working spaces in the body by separating natural tissue planes
without resorting to blunt dissection used in conventional open surgery or
minimally invasive surgery conducted outside of a natural body cavity. In
procedures using SPACEMAKER-Registered Trademark- balloon dissectors, a
surgeon creates a small incision through which the balloon is inserted and
placed between naturally occurring tissue layers such as muscle, fat, and
skin. Subsequently, the balloon is filled to a specific volume with air or
saline, causing the desired dissection of the tissue planes. The system is
then deflated and removed and the dissected space can be insufflated with gas
to create a surgical operating space.
The Company's surgical balloon dissectors incorporate several
proprietary technologies to increase the reliability, effectiveness and ease
of use in creating working spaces during MIS. Each balloon is composed of
nonelastomeric polyurethane material and is welded using a proprietary
technique that allows the balloon to be inflated to a predetermined size and
predictable shape with minimal risk of rupture. Each of the Company's
balloons is designed to be deployed in a predictable manner that maximizes
effectiveness and accuracy in creating the surgical working space and is
designed to minimize unnecessary tissue trauma because of the specific and
predictable manner in which the balloon unfurls. The Company has designed its
dissection balloons in a variety of shapes and sizes that are tailored for
specific procedures. For example, the Company's kidney shaped balloon is
designed for use in hernia repair to maximize working space and visibility of
the surgical site while minimizing the disruption of other anatomy at the
surgical site.
The Company currently offers its surgical balloon dissectors in five
distinct access and deployment platforms, the SPACEMAKER-Registered
Trademark- I platform with integral cannula, the SPACEMAKER-Registered
Trademark- II platform with optional visualization, the SPACEMAKER-Registered
Trademark- Plastics platform, the SAPHtrak-Registered Trademark- platform,
and the ENDOSAPH-Registered Trademark- platform, along with several different
balloon shapes and sizes, designed for various surgical techniques, procedure
types and market segments. Each balloon dissection system, except the
ENDOSAPH-Registered Trademark- system, contains three primary components: a
guide rod and blunt tip to access the surgical site; a single use, disposable
balloon dissector (which includes a tubing and valve apparatus to fill the
balloon) to create a working space at the surgical site; and a balloon cover
to protect the balloon dissector and maintain the balloon in its furled state
prior to inflation. ENDOSAPH-Registered Trademark- dissectors contain the
first two components. The end-user price for the Company's single surgical
balloon dissector is approximately $250 per unit, and procedural kits range
from approximately $350 to $850 per kit, depending upon the type of balloon
dissector platform purchased and the ancillary instruments chosen by the
customer to complete the procedural kit.
The key attributes of the Company's five major product platforms are
described below:
SPACEMAKER-Registered Trademark- I (WITH INTEGRAL CANNULA) PLATFORM.
The SPACEMAKER-Registered Trademark- I platform is composed of a stainless
steel rod with a blunt tip which is used both as the guide rod for the
balloon and as the insertion rod for a pre-loaded integral cannula. This
enables the surgeon to insert the cannula quickly and accurately into the
dissected space once the balloon is removed. In addition, the balloon cover
used with the SPACEMAKER-Registered Trademark- I platform is a strong sheath
that maximizes its tunneling capability.
SPACEMAKER-Registered Trademark- II PLATFORM. The
SPACEMAKER-Registered Trademark- II platform has a blunt-tipped, polymeric
guide rod for insertion of the balloon. This platform is designed to allow
endoscopic visualization of the dissected space. Visualization enables the
surgeon to identify anatomical features and access the dissected surgical
site. The SPACEMAKER-Registered Trademark- II platform includes an integral
balloon cover, which releases automatically upon inflation of the balloon,
thus simplifying the procedure for the surgeon.
SPACEMAKER-Registered Trademark- PLASTICS PLATFORM. The
SPACEMAKER-Registered Trademark- Plastics platform consists of a combined
blunt-tipped guide rod and handle, used for insertion, and a balloon. An
integral cover over the balloon provides protection to the balloon during
insertion. This platform is used primarily for plastic and reconstructive
surgery of the breast.
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SPACEMAKER-Registered Trademark- SAPHTRAK-Registered Trademark-
PLATFORM. The SPACEMAKER-Registered Trademark- SAPHtrak platform consists of
a malleable steel rod with a blunt tip, an eight inch balloon and a handle.
The malleable feature of the guide rod allows the surgeon to adjust the
curvature of the device to maneuver around challenging patient anatomy. The
150cc capacity balloon is not removable from the guide so that it is
redeployable at multiple sites along the course of the vein. This platform is
used primarily for saphenous vein harvesting.
ENDOSAPH-Registered Trademark- PLATFORM. The SPACEMAKER-Registered
Trademark- ENDOSAPH-Registered Trademark- platform consists of two disposable
devices - the SAPHfinder-TM- balloon dissector and the SPACEKEEPER-TM-
retractor. The SAPHfinder-TM- balloon dissector consists of an open-ended tip
on a hollow guide rod, an eight inch balloon, and a handle. The device is
designed to accommodate a standard-length 5mm endoscope for viewing from the
tip. The 150cc capacity balloon is not removable from the guide rod so that
it is re-deployable at multiple sites along the course of the vein. The
SPACEKEEPER-TM- retractor is a single-piece, polycarbonate construction
consisting of a distal retractor, 5mm endoscope channel and handle. The
retractor is used to hold the operating space open after removal of the
balloon and is also designed to accommodate a standard-length 5mm endoscope.
This platform is used primarily for saphenous vein harvesting.
APPLICATIONS OF BALLOON DISSECTION TECHNOLOGIES
The Company's initial market focus has been the application of its
SPACEMAKER-Registered Trademark- balloon dissection technology for hernia
repair. More recently, the Company has begun to increase its emphasis on
cardiac/vascular applications. The Company has completed marketing-related
clinical studies of, and has introduced products for, saphenous vein
harvesting, SEPS, breast augmentation and reconstruction procedures and SUI
applications. The Company believes that its current FDA clearances provide
coverage for many surgical applications that the Company may pursue. The
Company has commenced commercial sales of its products in the United States,
Europe, Australia and South America for selected applications including
hernia repair, saphenous vein harvesting, SEPS and breast augmentation and
reconstruction surgery.
HERNIA REPAIR
A hernia, a condition that commonly occurs in the groin, is a
protrusion of normal abdominal contents through a muscle defect, usually in
the tissue layers overlying the abdomen. The peritoneum and/or bowel often
project into this defect, causing pain and potential major complications. In
1997 over 650,000 people in the United States and approximately 1.3 million
people worldwide underwent surgery for hernia repair.
The open surgical procedure for hernia repair is a herniorrhaphy,
which involves making a 10 to 15 cm open incision in the groin over the
muscle defect to be repaired. As in most invasive surgical procedures,
recovery periods tend to be long, typically extending between three and six
weeks.
Over the last few years, in an effort to reduce post-operative pain
and recovery times, several laparoscopic techniques have been developed to
repair hernias. Despite these advances, there is not yet a consensus on the
optimal method for MIS hernia repair. For example, in certain MIS hernia
repair procedures, a surgeon first makes an incision in the abdominal wall to
gain access to the abdominal cavity. She then makes an additional incision in
the peritoneum in order to reach the surgical site and create the working
space required to conduct the surgical repair. The Company believes that its
balloon dissection technology can significantly improve the outcome of this
laparoscopic hernia repair procedure by eliminating the need for an incision
in the abdominal wall.
Utilizing the Company's SPACEMAKER-Registered Trademark- products,
the surgeon tunnels the device through a small incision at the umbilicus and
then inflates the balloon to create a large and relatively bloodless space at
the site of the hernia, but outside the abdominal cavity. As a result, the
surgeon is able to access the target surgical site and complete the hernia
repair. In addition, because the surgeon never enters the peritoneum, this
procedure reduces the risk of organ damage, adhesion formation and morbidity,
and eliminates the requirement for general anesthesia. In a study published
in May 1997 by the NEW ENGLAND JOURNAL OF MEDICINE, MIS hernia repair
procedures utilizing balloon dissection resulted in fewer recurrences and
faster recovery times as compared to traditional open surgical hernia repair
procedures.
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The Company believes that its SPACEMAKER-Registered Trademark-
products provide a platform for increasing the conversion of open hernia
repair procedures to laparoscopic procedures. According to Medical Data
International, Inc., laparoscopic hernia repair procedures represented
approximately 104,000 or 16 percent of total hernia repair procedures in the
United States in 1997.
The Company commenced commercial sales of its hernia repair balloon
dissection products in the United States in late 1993 and in Europe in 1994
and currently sells two versions: the SPACEMAKER-Registered Trademark- I
platform, which was introduced in September 1993 and the
SPACEMAKER-Registered Trademark- II platform, which was introduced in October
1995. The Company sells these products both in the United States and certain
foreign markets, including Europe, Australia and South America, through its
direct sales force and distributors.
SUBFASCIAL ENDOSCOPIC PERFORATOR SURGERY (SEPS)
Chronic venous insufficiency, which results in insufficient blood
flow from the extremities, is a common and debilitating disease. A frequent
manifestation of venous insufficiency is venous stasis ulceration (chronic
skin ulcers), which currently affects approximately 1.25 million people in
the United States.
The Company believes that current treatment options for venous
stasis ulceration and venous insufficiency are suboptimal. Compression
stockings (elastic stockings that put pressure on the leg to force blood
flow), the most common treatment, often temporarily heal the ulcers but do
not treat the underlying venous incompetence. Compression stockings as
treatments are also ineffective because patients often do not wear the
stockings, the associated healing process is slow and the recurrence rate for
the ulcers is high. Treating the incompetent vein through an open surgical
procedure allows treatment of the underlying condition, but requires an
incision through the ulcer wound, which is composed of diseased tissue and is
often incapable of healing. Alternatively, a minimally invasive ligation
procedure known as SEPS allows the surgeon to access the incompetent vein
from an incision remote from the ulcer wound using traditional dissection
instruments. However, because this access to the surgical site causes
bleeding and significant tissue trauma, the procedure is difficult and time
consuming for the surgeon to perform because of poor visualization.
The Company's SPACEMAKER-Registered Trademark- surgical balloon
dissectors allow the surgeon to perform SEPS to ligate incompetent veins
endoscopically in a relatively atraumatic, bloodless manner. By utilizing the
Company's SPACEMAKER-Registered Trademark- technology, the surgeon is able to
deploy an elongated balloon down the length of the patient's leg to create an
operating space for access to one or more incompetent veins. Because the
incisions needed for this procedure are very small (approximately one cm) and
are remote from the area of ulcerated skin, the Company believes that wounds
will heal more rapidly and that there will be fewer complications compared to
open surgery at or near the ulcer site. In addition, the relatively bloodless
working space created by the Company's balloon provides the surgeon with
improved visualization of the veins requiring ligation, making the procedure
easier and faster for the surgeon.
The Company launched its initial product to treat venous stasis
ulceration and venous insufficiency in January 1996. Additional outcome
studies have been completed, including the study reported in the June 1997
JOURNAL OF VASCULAR SURGERY that supported the Company's belief that balloon
assisted SEPS tends to produce faster healing rates, fewer complications and
lower recurrence rates as compared to compression stockings or open surgical
ligation. By the end of 1998, the Company's SPACEMAKER-Registered Trademark-
I balloon dissection products had been used to treat over 1,100 patients
suffering from venous stasis ulcers or venous insufficiency in over 250
centers across the United States, with results indicating generally
successful outcomes.
SAPHENOUS VEIN HARVESTING
In recent years, advanced coronary artery disease has been
increasingly treated by coronary artery bypass graft (CABG) procedures, which
usually involve grafting a portion of a patient's vein, taken from a
different part of the body, around an arterial blockage. An estimated 665,000
CABG procedures were performed worldwide in 1998. About 80 percent of these
procedures in the United States utilize the patient's saphenous vein for
bypass grafting.
Traditional saphenous vein harvesting procedures require a
continuous incision above the vein segment to be harvested, often from the
ankle to the upper thigh of the patient's leg. The saphenous vein is then
dissected and removed, and the wound is sutured closed. A study published in
the Annals of Thoracic Surgery in 1998 involving over 112 patients indicates
that the open surgical procedure for saphenous vein harvesting results in
wound healing impairment in approximately 19 percent of patients. The length
and
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invasiveness of the leg incision also causes significant postoperative
patient pain and discomfort. Surgeons indicate that after the CABG procedure
patients more frequently complain about the pain caused by leg incisions than
other aspects of the procedure.
The Company launched its ENDOSAPH-Registered Trademark- Vein harvest
system, utilizing balloon dissection technology and ancillary instruments, in
January 1998. By utilizing the Company's ENDOSAPH-Registered Trademark-
balloon dissection system and hook and fork dissection tools in the saphenous
vein harvest procedure, the surgeon can reduce the leg incisions to a total
length of three or four centimeters, and can minimize damage to the muscles
and nerve endings surrounding the saphenous vein. Results from clinical usage
of the ENDOSAPH-Registered Trademark-vein harvest system indicate generally
successful outcomes from the procedure including less postoperative pain,
faster healing and less scarring than with traditional open procedures.
STRESS URINARY INCONTINENCE SURGERY (SUI)
SUI is the uncontrollable loss of urine due to a displacement of the
bladder neck. Depending on the severity of incontinence, there are a number
of treatment options for SUI, including collagen injections, drugs,
biofeedback exercises and absorbent pads. The standard treatment for severe
SUI is a highly invasive, open surgical procedure involving suture suspension
of the bladder neck. This method can create significant complications for the
patient, including enterocele (a hernia within the vaginal wall) and genital
prolapse (a descending of the uterus due to a weakness of the pelvic floor).
Furthermore, after surgery patients may require up to six weeks or more to
resume their preoperative lifestyle. Because of the risk, expense and
complexity of open suture suspension, this surgical procedure is often
performed only in conjunction with other open abdominal procedures such as
hysterectomy.
The Journal of Urology September 1997 issue reported the findings
of The American Urological Association Female Stress Urinary Incontinence
Clinical Guidelines Panel, which concluded from long-term outcomes that
"surgical treatment of stress urinary incontinence is effective, offering a
long-term cure in a significant percentage of women."
Several MIS alternatives to open surgical procedures for the
treatment of SUI have recently been developed to suspend the bladder neck.
These less invasive procedures have been increasingly accepted as stand-alone
procedures and are typically less expensive and less likely to cause adverse
side effects. Outcome studies are now becoming available which indicate
satisfactory outcomes for MIS procedures when compared to open bladder neck
suspension procedures in successfully treating incontinence. As in hernia
repair, some MIS techniques involve accessing the surgical site by entering,
traversing and then exiting the abdominal cavity. While these procedures
offer improvements over open surgery and afford the benefits of MIS, they
still involve the morbidity risks and difficulties associated with violating
the peritoneum.
Utilizing the Company's surgical balloon dissector, the surgeon can
suspend the bladder neck laparoscopically without entering the peritoneum,
and can do so under visualization. As in the hernia repair procedure, GSI's
SPACEMAKER-Registered Trademark- dissection products can be deployed near the
umbilicus to provide direct access to the bladder and bladder neck. The
surgeon can then use conventional laparoscopic instruments to complete the
procedure. A study published in THE JOURNAL OF THE AMERICAN ASSOCIATION OF
GYNECOLOGIC LAPAROSCOPISTS in November 1996 shows that the SUI repair
procedure utilizing balloon dissection can usually be performed in less than
one hour on an outpatient basis.
GSI offers a SPACEMAKER-Registered Trademark- II dissector and
SPACEMAKER-Registered Trademark- Total Solution-TM- Laparoscopic Bladder Neck
Suspension kit to specifically to address the extraperitoneal treatment of
SUI, which the Company believes optimizes the working space for the procedure.
BREAST AUGMENTATION AND RECONSTRUCTIVE SURGERY
In 1997, approximately 150,000 women in the United States had breast
reconstruction and augmentation surgery. Traditional surgical methods for
such procedures require making a three to five cm incision in the skin,
finding the required tissue plane, and then using a combination of blunt and
sharp dissection tools to create a pocket for the implant. The procedure can
cause substantial bleeding, can sever both sensory nerves and perforating
vessels and can leave the patient with substantial, noticeable scars.
In contrast to traditional breast augmentation and reconstruction
procedures, the Company's SPACEMAKER-Registered Trademark- products require
only small incisions, create a relatively bloodless pocket, minimize
disruption of sensory nerves and perforating vessels and minimize scarring
and loss of mobility or sensation. In addition, because the
SPACEMAKER-Registered Trademark- product allows the surgeon to introduce the
balloon dissector from a crease in the axilla (armpit), from the inframammary
fold (below the breast), or in the periareolar (nipple) area, the surgeon can
minimize the appearance of
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any marks or scars. The Company believes that its SPACEMAKER-Registered
Trademark- dissection products for breast augmentation and reconstruction
procedures enable the surgeon to create uniform, symmetrical pockets in less
time and with much less bleeding than is possible with traditional blunt or
sharp dissection tools.
The Company's balloon dissection products for breast augmentation
and reconstruction were first introduced commercially in the United States in
January 1995. The SPACEMAKER-Registered Trademark- Plastic platform is used
for these procedures.
OTHER COSMETIC AND RECONSTRUCTIVE SURGERY
In addition to the market opportunities for breast augmentation and
reconstruction, the Company has designed and developed balloon dissection
technology for combined tissue dissection and expansion for general cosmetic
and reconstructive surgery procedures. The Company believes that its balloon
dissection technology is well-suited for such procedures, including limb
reconstruction, correction of congenital deformities and scar revision.
SPINE SURGERY
The Company believes that its products can be used to provide
exposure in several orthopedic spinal procedures to both reduce the costs of
the procedure and enhance patient benefits. Foremost among these procedures
is spinal fusion, which was performed approximately 200,000 times in the
United States in 1994. Spinal fusion is usually performed to remove a
ruptured vertebral disc that is causing significant patient discomfort, and
subsequently to promote fusion between the then exposed and adjacent
vertebrae. This fusion procedure can be performed by using any of several
prosthetic systems, by traditional bone prostheses, or by a combination of
the two.
Most traditional open spinal fusion procedures have approached the
spine from the back. Several newer procedures, some currently under clinical
investigation, approach the spine through the abdomen, which appears to
yield better results. The open abdominal approach is highly invasive,
however, and has led researchers to try to develop a minimally invasive,
transperitoneal laparoscopic approach. This approach still subjects the
patient to the same risks associated with the open abdominal approach.
The Company's surgical balloon dissectors have been used in several
cadaver studies in which an extraperitoneal laparoscopic approach to the
spine has been successfully performed. In this procedure, the balloon is
deployed in the retroperitoneal area under the rib cage and is inflated in
order to dissect the peritoneum away from muscle layers in the back and side
of the patient. By doing so, the surgeon can create a large working space to
access the spine without entering the peritoneum. The Company believes the
spinal fusion procedure is a natural extension of the aortic reconstruction
application for balloon dissection technology because the required dissected
space is essentially the same. The Company intends to conduct additional
marketing-related clinical evaluations to evaluate physician preference and
utility of the Company's SPACEMAKER-Registered Trademark- surgical balloon
dissectors for the orthopedic spine surgery market.
ADDITIONAL PRODUCTS UNDER DEVELOPMENT
As part of its competitive strategy, GSI continually seeks to
leverage its core technology to develop surgical balloon dissectors for new
surgical procedures, as well as to develop new surgical instruments for MIS.
The Company has made a significant investment in developing its proprietary
balloon dissection technology and believes its research and development
commitment in this area is critical to its competitive position. Research and
development expenses for fiscal 1999, 1998 and 1997 were approximately $3.7
million, $2.8 million and $2.2 million, respectively. As of June 30, 1999,
the Company employed 14 persons engaged in research and development
activities.
The Company is continuing to exploit its expertise in MIS to develop
a range of instruments to maximize the surgeon's ability to perform MIS once
an operative working space is created by the Company's surgical balloon
dissectors. Product research and development will require substantial
expenditures, and there can be no assurance that the Company will be
successful in identifying products for which demand exists, in developing
products that have the characteristics necessary to treat target indications,
or that any new product introduced will receive regulatory approval or be
commercially successful.
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MARKETING, SALES AND DISTRIBUTION
The Company markets its products, both domestically and
internationally, to general surgeons, urologists, gynecologists, vascular
surgeons, orthopedic surgeons and cosmetic and reconstructive surgeons. Sales
in the United States and internationally in the hernia and SUI markets are
currently made through non-exclusive relationships with EES, USSC, Dexterity
and other distributors, as well as through a direct sales force.
Additionally, the Company has an exclusive agreement with Genzyme to market
and distribute GSI's surgical balloon dissection systems for use in plastic
surgery (reconstructive and aesthetic) procedures. Sales of devices for
cardiac/vascular applications are made through non-exclusive agreements with
distributors and through the Company's direct sales force.
MARKETING PROGRAMS. The Company's marketing strategy for its
surgical balloon dissector products and procedural kits is designed to target
surgeons who are leaders in their respective surgical specialties, and to
promote visibility of the Company's products and awareness of the clinical
efficacy and cost effectiveness of surgical techniques that employ the
Company's products. For product sales in the cardiac/vascular, hernia, and
SUI markets, the Company is using a combination of a direct sales force and
distributors. The Company has entered into or is seeking to enter into
agreements with independent distributors that have well-established
distribution networks across wide geographic areas and training programs.
The Company disseminates clinical and technical information
worldwide to educate surgeons about the benefits of, and to encourage
surgeons to perform procedures utilizing, the Company's products. In support
of this program, the Company has produced and distributed to surgeons
SPACEMAKER-Registered Trademark- dissector procedure demonstration and
educational videos for hernia repair, bladder neck suspension, vascular
surgery and cosmetic and reconstructive surgery. In addition, the Company has
developed relationships with several leading surgeons in each of the
Company's targeted major surgical specialty areas, and other surgical
specialty areas, who provide input on clinical and product development. The
Company has recently initiated a residency training program to give didactic,
computer-aided and cadaver training to chief residents from several selected
residency programs in hernia repair using GSI products. In addition, the
Company is actively sponsoring two marketing-related clinical studies
designed to demonstrate the utility and ease of use of the Company's products.
SALES IN THE UNITED STATES. GSI maintains a small direct sales
organization in the United States to market its products to general surgeons
and specialists, and to support its distributors' sales efforts. As of June
30, 1999, the Company's direct sales force in the United States consisted of
ten persons. As of the end of the fiscal year 1999, the Company had
agreements with nine U.S. distributors and intends to establish additional
distributorships in the United States. There can be no assurance that such
efforts will be successful.
INTERNATIONAL SALES. The Company's products are currently sold
internationally to general surgeons and specialists through EES, Genzyme,
United States Surgical Corporation and independent distributors in Europe,
Australia and South America. The Company generally operates under written
agreements with its international distributors, which agreements typically
grant distributors the right to sell the Company's products within a defined
territory and permit the distributors to sell other non-competing medical
products. In addition, the agreements often include requirements regarding
minimum purchases, participation in trade shows and marketing efforts on
behalf of GSI, and training programs for end-users. The Company's
distributors typically purchase the Company's products at discounts that vary
by product and market.
Substantially all of the Company's revenues to date have been
derived from hernia repair products sold to distributors. Although certain
contractually guaranteed payments from EES accounted for 24 percent of total
revenues in fiscal year 1998, and 54 percent of GSI's total revenues in
fiscal year 1997, there were no guaranteed payments from EES in fiscal year
1999. Product sales to distributors accounted for approximately 90 percent of
the Company's total product sales for the year ended June 30, 1999 and 89
percent for the year ended June 30, 1998. Product sales outside of the United
States accounted for eight, three and one-half percent of the Company's total
sales in fiscal years 1999, 1998 and 1997, respectively. The Company expects
that international sales will represent an increasing portion of revenue in
the future.
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MANUFACTURING
The Company manufactures its products in a controlled environment in
its facility in Cupertino, California. The Company has implemented quality
control systems as part of its manufacturing process and achieved ISO 9001
certification status in August 1997. The FDA conducted a routine inspection
of the Company's Cupertino facility in February 1999. The FDA reported that
the areas inspected appeared to be in substantial compliance with the
applicable requirements of the Federal Food, Drug and Cosmetic Act and
implementing regulations. The Company has also been inspected in prior years
by the California Department of Health Services ("CDHS"), on behalf of the
CDHS and the FDA, and is registered with the State of California to
manufacture its medical devices. Additionally, the Company successfully
completed the first year ISO annual assessment, maintaining a valid
certificate. The Company believes that it is in compliance with all FDA
requirements including FDA Good Manufacturing Practices ("GMP") and Quality
Systems Regulations for medical devices. There can be no assurance, however,
that the Company will remain in compliance with GMP, and failure to do so
could have a material adverse effect on the Company's business, operating
results or financial condition.
Raw materials used in the production of the Company's surgical
balloon dissectors are purchased from various qualified suppliers, subjected
to stringent quality specifications and assembled by the Company. Quality
audits of suppliers are conducted, and the Company has adopted a supplier
qualification program. The Company currently obtains certain products from
single source suppliers. The Company believes that alternative suppliers are
available for its raw materials and other product components and plans to
qualify additional suppliers when sales volumes warrant. 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 of GSI's single source suppliers to provide adequate
supplies of high quality products, or the loss of any of the Company's single
source suppliers, could cause a delay in GSI's ability to fill orders while
the Company attempts to identify and certify a replacement supplier, if any,
and could have a material adverse effect upon the Company's business,
financial condition and results of operations. See "Factors Affecting Future
Results -- Limited Manufacturing Experience."
COMPETITION
Competition in the market for medical devices and tissue dissection
products is intense and is expected to increase. The Company competes
primarily with other producers of MIS tissue dissection products. Origin,
which was a subsidiary of Guidant Corporation and has recently been purchased
by Tyco, was previously, and will continue through November 15, 1999 (pending
the outcome of current litigation), to be the Company's primary direct
competition in the field of balloon dissection products. Other companies
currently compete against the Company in the development, production and
marketing of MIS tissue dissection instruments and technology, such as blunt
dissectors, insufflation dissection and aqua irrigation with blunt
dissection. To the extent that surgeons elect to use open surgical procedures
rather than MIS, the Company also competes with manufacturers of tissue
dissection products 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
products and technology for open surgical procedures. In addition, the
Company competes indirectly with producers of therapeutic drugs, when such
drugs are used as an alternative to surgery. Many of the Company's
competitors and potential competitors have substantially greater name
recognition and capital resources than the Company and also have greater
resources and expertise in the areas of research and development, the
obtaining of regulatory approvals, and in manufacturing and marketing.
The Company believes that the primary competitive factors in the
market for tissue dissection products include safety, efficacy, ease of use,
quality, reliability and cost effectiveness. In addition, the length of time
required for products to be developed and to receive regulatory approval is
an important competitive factor. The Company believes that it competes
favorably with respect to these factors, although there can be no assurance
that it will continue to do so.
The market for tissue dissection products is characterized by rapid
technical innovation. Product development involves a high degree of risk, and
there can be no assurance that the Company's competitors and potential
competitors will not succeed in developing and marketing technologies and
products that are more effective than those developed and marketed by the
Company or that would render the Company's technology and products obsolete
or noncompetitive. The medical applications for which the Company's MIS
tissue dissection products are used can also be addressed by other medical
devices in either MIS or open surgical procedures, many of which are widely
accepted in the medical community. There can be no assurance that a procedure
using MIS balloon dissection technology will be able to
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replace such established products and procedures. Additionally, new surgical
products or procedures could be developed that replace or reduce the
importance of current procedures that use the Company's products.
PATENTS AND PROPRIETARY RIGHTS
The Company's success will depend on its ability to obtain patent
protection for its products and processes, to preserve its trade secrets and
proprietary technology and to operate without infringing upon the patents or
proprietary rights of third parties. As of June 30, 1999, GSI had 57 United
States patents issued, and had applied for an additional 52 United States
patents, 12 of which had been allowed. In addition, as of June 30, 1999, GSI
had 10 foreign patents issued, and 46 in prosecution covering GSI's
technology, including tissue dissection with balloons. In May 1996, the
Company was issued a United States patent that contains broad claims
regarding use of balloons to dissect along tissue planes.
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 (C96-20424JW). In April 1998, GSI obtained a summary judgment
that the patent in suit, Moll et al Patent No. 5,520,609, was unenforceable
because it had been obtained by misleading the Patent & Trademark Office
("PTO"), and an award of attorney's fees of $990,000. The appellate court
subsequently vacated this decision because, in its view, there are factual
issues which must be resolved in a trial on whether Origin misled the PTO. In
July 1999, the case was returned to the district court for further
proceedings.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that the use of
Origin's products infringes GSI's U.S. Patent No. 5,514,153 (C96-20447JW).
The case was decided in favor of GSI partly by summary judgment and partly by
jury verdict, both during fiscal 1999. Patent 5,514,153 ("the '153 patent")
was found to be valid, and Origin's infringement was found to be willful.
Lost profits of approximately $12.9 million were awarded to GSI by the jury.
Origin is appealing the infringement and willfulness findings (but not patent
validity nor the amount of infringement damages), and GSI is appealing for
enhanced damages, attorneys' fees and the failure to find infringement of
additional claims. Resolution is expected in calendar year 2000. Following
these findings, the Court has entered an injunction prohibiting sale in the
United States of all of Origin's balloon dissection products, to become fully
effective on November 15, 1999, and an immediate injunction against sales of
all of Origin's balloon dissection products to any new customers in the
United States.
In September 1997, the Company filed an action against Origin
alleging that the use of Origin's products infringes GSI's U.S. Patent No.
5,667,520 (C97-20944JW). Discovery is nearly complete in this case and the
complaint has now been amended to add a claim of infringement of GSI's patent
number 5,860,997. This case is now stayed pending the outcome of appeals in
the '153 case.
GSI is also involved in an interference proceeding in the U.S. Patent
Office against Origin to determine whether certain subject matter was first
invented by GSI and whether the disputed matter is patentable. In November
1998, binding arbitration determined that GSI was first to invent the
disputed subject matter and therefore is the only party entitled to any
patent. Additionally, the Patent Office Appeals Board found the subject
matter to be patentable. This latter finding is being appealed by Origin to
the Court of Appeals for the Federal Circuit. Resolution is expected in
calendar year 2000.
On April 9, 1999, a suit was filed against GSI in the United States
District Court for the Southern District of Illinois. This suit, brought by
Dr. Peter M. Bonutti and by Bonutti Research, Inc., seeks a 50 percent share
of the $12.9 million damages judgment GSI obtained in its suit against Origin
and seeks rescission of the 1995 agreement by which GSI obtained assignment
of certain Bonutti technology. From this assigned technology, GSI prosecuted
patent applications which became the '153 and other patents, which credit Dr.
Bonutti as sole inventor. This case is in the discovery phase.
While the Company believes it will be successful in these
proceedings, there can be no assurance of such success. Failure of the
Company to prevail in such proceedings would have a material adverse effect
on the Company's business, financial condition and results of operations.
Patent interference or infringement proceedings involve complex legal
and factual issues and are highly uncertain, and there can be no assurance
that any conclusion reached by the Company regarding patent interference or
infringement
-13-
will be consistent with the resolution of such issues 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. Because 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 outside the U.S. 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.
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, 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-Registered Trademark- II platform, SPACEMAKER-Registered
Trademark- Plastics platform and SPACEMAKER-Registered Trademark-
SAPHtrak-Registered Trademark- platform each have received 510(k) clearance
for use during general, endoscopic, laparoscopic and plastic and
reconstructive surgery (including aesthetic), and certain vascular surgery
(including saphenous vein procedures) when tissue dissection is required.
Additionally, the Company has received clearance to market these products for
thoracoscopic procedures involving exposure and dissection of structures
external to the parietal pleura and procedures in the extraperitoneal space.
The Company has also received clearance to market combined tissue
dissection/expansion products. The Company has promoted these products for
surgical applications (E.G., hernia repair, subfascial endoscopic perforator
surgery, breast augmentation and reconstruction, SEPS, treatment of SUI 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 procedures
-14-
which require exposure to the anterior spine or for 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.
In order to continue selling its products within the European
Economic Area, in August 1997 the Company achieved compliance with the
requirements of the Medical Devices Directive. The Company affixes CE marking
on its products to attest to such compliance.
THIRD-PARTY REIMBURSEMENT
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.
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"). However, 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 in the United States 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. Failure to obtain such approvals for reimbursement in
international markets could have a material adverse effect on the Company's
business, financial condition and results of operations.
-15-
Regardless of the type of reimbursement system, the Company believes
that surgeon advocacy of its products will be required to obtain
reimbursement. 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.
PRODUCT LIABILITY AND INSURANCE
The Company's business involves an inherent risk of exposure to
product liability claims. Although the Company has not experienced any
product liability claims to date, there can be no assurance that the Company
will be able to avoid significant product liability claims and potential
related adverse publicity. The Company maintains product liability insurance
with coverage limits of $5,000,000 per occurrence and an annual aggregate
maximum of $5,000,000, which the Company believes is comparable to that
maintained by other companies of similar size serving similar markets.
However, there can be no assurance that product liability claims will not
exceed such insurance coverage limits, which could have a material adverse
effect on the Company, or that such insurance will continue to be available
on commercially reasonable terms, or at all.
ENVIRONMENTAL MATTERS
The Company is subject to federal, state and local laws, rules,
regulations and policies governing the use, generation, manufacture, storage,
air emission, effluent discharge, handling and disposal of certain hazardous
and potentially hazardous substances used in connection with the Company's
operations. Although the Company believes that it has complied with these
laws and regulations in all material respects and to date has not been
required to take any action to correct any noncompliance, there can be no
assurance that the Company will not be required to incur significant costs to
comply with environmental regulations in the future.
EMPLOYEES
As of June 30, 1999, GSI employed 93 individuals, 29 of whom were
engaged in research, development, operations, regulatory affairs and quality
assurance, 26 in manufacturing, 22 in marketing and sales and 16 in finance,
customer service and administration. The Company also contracts with outside
consultants. None of the Company's employees is covered by a collective
bargaining agreement. GSI believes that it maintains good relations with its
employees.
EXECUTIVE OFFICERS OF THE COMPANY
The executive officers of the Company and their ages as of August 5,
1999 are as follows:
NAME AGE POSITION
---- --- --------
Gregory D. Casciaro 42 President, Chief Executive Officer and Director
James E. Jervis 63 Vice President of Research and Development
Stephen J. Bonelli 37 Chief Financial Officer, Vice President of Finance
& Administration & Treasurer
Ferolyn T. Powell 37 Vice President of Operations
The officers of the Company are appointed by the Board of Directors
and serve at the discretion of the Board. There are no family relationships
among the directors or officers of GSI.
GREGORY D. CASCIARO joined GSI in February 1995 as Vice President of
Sales and Marketing, was promoted to Senior Vice President in November 1996,
President, Chief Operating Officer and Director of the Company in August 1997
and has served as President, Chief Executive Officer and Director of the
Company since April 1998. Prior to joining GSI, Mr. Casciaro held various
positions at Devices for Vascular Intervention, Inc., a medical device
manufacturer, including Vice President of Sales from June 1991 to February
1995. Previously, Mr. Casciaro held
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various sales positions at North American Instrument Corporation, a medical
device company, from March 1983 to May 1991. Mr. Casciaro received a B.S.
degree in Business Administration at Marquette University.
JAMES E. JERVIS joined GSI in March 1994, and serves as Vice
President of Research and Development. Prior to joining GSI, Mr. Jervis had
30 years of engineering design, development and operations experience at
Raychem Corporation ("Raychem"). At Raychem, Mr. Jervis held various
executive positions, including Director of New Business Development, General
Manager - Medical Products Group and Operations Manager. Mr. Jervis holds 19
patents and is named as inventor in over 50 other patents. Mr. Jervis holds a
B.S. in Mechanical Engineering and an MBA from Stanford University.
STEPHEN J. BONELLI joined GSI in September 1994, and serves as Chief
Financial Officer, Vice President of Finance and Administration and
Treasurer. Prior to joining GSI, Mr. Bonelli held financial management
positions at Coactive Computing Corporation, a computer networking company,
from November 1993 to August 1994, and Ready Systems Corporation, a software
company, from May 1990 to October 1993. Previous to those positions, Mr.
Bonelli held a management position with Ernst & Young. Mr. Bonelli received a
B.S. degree in Business Administration from California Polytechnic State
University, San Luis Obispo. Mr. Bonelli is a Certified Public Accountant.
FEROLYN T. POWELL joined GSI in October 1995, and has served as Vice
President of Operations since November 1996. Prior to joining GSI, Ms. Powell
served as Director of Research and Development at Adjacent Surgical, Inc.
from June 1995 to October 1995, and as Senior Engineer, Project Manager and
Director at Devices for Vascular Interventions, Inc. from September 1992 to
June 1995. Previous to those positions, Ms. Powell held technical management
positions at Frantz Medical Development Ltd. and Life Systems, Inc. Ms.
Powell received her M.S. degree in Engineering from the University of Akron
and her B.S. degree in Chemical Engineering from Cleveland State University.
ITEM 2. PROPERTIES
The Company occupies a facility of approximately 30,400 square feet
in Cupertino, California, which houses the Company's headquarters,
administrative offices, research laboratories and manufacturing facilities.
ITEM 3. 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 (C96-20424JW). In April 1998, GSI obtained a summary judgment that
the patent in suit, Moll et al Patent No. 5,520,609, was unenforceable
because it had been obtained by misleading the PTO, and an award of
attorney's fees of $990,000. The appellate court subsequently vacated this
decision because, in its view, there are factual issues which must be
resolved in a trial on whether Origin misled the PTO. In July 1999, the case
was returned to the district court for further proceedings.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that the use of
Origin's products infringes GSI's U.S. Patent No. 5,514,153 (C96-20447JW).
The case was decided in favor of GSI partly by summary judgment and partly by
jury verdict, both during fiscal 1999. Patent 5,514,153 ("the '153 patent")
was found to be valid, and Origin's infringement was found to be willful.
Lost profits of approximately $12.9 million were awarded to GSI by the jury.
Origin is appealing the infringement and willfulness findings (but not patent
validity nor the amount of infringement damages), and GSI is appealing for
enhanced damages, attorneys' fees and the failure to find infringement of
additional claims. Resolution is expected in calendar year 2000. Following
these findings, the Court has entered an injunction prohibiting sale in the
United States of all of Origin's balloon dissection products, to become fully
effective on November 15, 1999, and an immediate injunction against sales of
all of Origin's balloon dissection products to any new customers in the
United States.
In September 1997, the Company filed an action against Origin
alleging that the use of Origin's products infringes GSI's U.S. Patent No.
5,667,520 (C97-20944JW). Discovery is nearly complete in this case and the
complaint has now been amended to add a claim of infringement of GSI's patent
number 5,860,997. This case is now stayed pending the outcome of appeals in
the '153 case.
-17-
GSI is also involved in an interference proceeding in the U.S. Patent
Office against Origin to determine whether certain subject matter was first
invented by GSI and whether the disputed matter is patentable. In November
1998, binding arbitration determined that GSI was first to invent the
disputed subject matter and therefore is the only party entitled to any
patent. Additionally, the Patent Office Appeals Board found the subject
matter to be patentable. This latter finding is being appealed by Origin to
the Court of Appeals for the Federal Circuit. Resolution is expected in
calendar year 2000.
On April 9, 1999, a suit was filed against GSI in the United States
District Court for the Southern District of Illinois. This suit, brought by
Dr. Peter M. Bonutti and by Bonutti Research, Inc., seeks a 50 percent share
of the $12.9 million damages judgment GSI obtained in its suit against Origin
and seeks rescission of the 1995 agreement by which GSI obtained assignment
of certain Bonutti technology. From this assigned technology, GSI prosecuted
patent applications which became the '153 and other patents, which credit Dr.
Bonutti as sole inventor. This case is in the discovery phase.
While the Company believes it will be successful in these
proceedings, there can be no assurance of such success. Failure of the
Company to prevail in such proceedings would have a material adverse effect
on the Company's business, financial condition and results of operations.
From time to time the Company may be exposed to litigation arising
out of its products or operations. The Company is not engaged in any legal
proceedings that are expected, individually or in the aggregate, to have a
material adverse effect on the Company, except for the patent interference
and infringement proceedings discussed herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
-18-
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
MARKET INFORMATION
The Company completed its initial public offering on May 15, 1996,
and the Company's common stock is traded on the NASDAQ National Market under
the symbol GSII. As of August 31, 1999 the Company had approximately 129
shareholders of record, including several holders who are nominees for an
undetermined number of beneficial owners. On August 31, 1999, the closing
price of the Company's common stock was $7.03.
The following table shows the Company's high and low selling prices
for the periods indicated as reported by NASDAQ:
Quarters Ended High Low
June 30, 1999................................. $ 4.31 $ 2.84
March 31, 1999............................... $ 5.00 $ 3.50
December 31, 1998........................... $ 3.75 $ 1.44
September 30, 1998........................... $ 4.56 $ 1.88
June 30, 1998................................. $ 4.62 $ 3.50
March 31, 1998............................... $ 6.00 $ 3.87
December 31, 1997........................... $ 6.00 $ 3.37
September 30, 1997........................... $ 5.81 $ 3.31
DIVIDEND POLICY
The Company has not paid dividends on its common stock and has no
present plans to do so. Provisions of the Company's bank line of credit
prohibit the payment of dividends without the bank's permission.
ITEM 6. SELECTED FINANCIAL DATA
STATEMENT OF OPERATIONS DATA:
YEARS ENDED JUNE 30,
----------------------------------------------------------------------
1999 1998 1997 1996 1995
------------ ----------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Sales $ 6,876 $ 5,193 $ 4,090 $ 6,165 $ 2,437
Guaranteed payments - 1,635 4,896 - -
------------ ----------- ---------- ---------- ----------
Total revenue 6,876 6,828 8,986 6,165 2,437
Cost of sales 5,212 3,565 2,385 2,772 1,262
------------ ----------- ---------- ---------- ----------
Gross profit 1,664 3,263 6,601 3,393 1,175
------------ ----------- ---------- ---------- ----------
Operating expenses:
Research and development 3,695 2,825 2,231 1,306 975
Selling, general and administrative 15,581 11,843 8,784 5,204 4,258
Write-off of acquired in-process
research and development - - - 2,791 -
------------ ----------- ---------- ---------- ----------
Total operating expenses 19,276 14,668 11,015 9,301 5,233
------------ ----------- ---------- ---------- ----------
Operating loss (17,612) (11,405) (4,414) (5,908) (4,058)
Interest and other income, net 1,541 2,263 2,538 443 7
------------ ----------- ---------- ---------- ----------
Net loss $(16,071) $ (9,142) $(1,876) $(5,465) $(4,051)
------------ ----------- ---------- ---------- ----------
------------ ----------- ---------- ---------- ----------
Net loss per common share and per
common share-assuming dilution $ (1.19) $ (0.68) $ (0.14) $ (0.74) $ (0.62)
------------ ----------- ---------- ---------- ----------
------------ ----------- ---------- ---------- ----------
Shares used in computing net loss per
common share and per common
share-assuming dilution 13,461 13,373 13,197 7,411 6,496
------------ ----------- ---------- ---------- ----------
------------ ----------- ---------- ---------- ----------
-19-
BALANCE SHEET DATA:
JUNE 30,
----------------------------------------------------------------------
1999 1998 1997 1996 1995
----------- ----------- ------------ ---------- ----------
(IN THOUSANDS)
Cash, cash equivalents and
available-for-sale securities
(including non-current portion)........ $ 19,298 $ 37,469 $ 43,731 $49,790 $ 4,541
Working capital............................ 20,105 29,414 46,835 50,068 4,457
Total assets............................... 28,237 42,824 51,062 52,767 6,245
Convertible redeemable preferred stock..... - - - - 13,225
Accumulated deficit........................ (40,906) (24,835) (15,693) (13,817) (8,352)
Shareholders' equity (deficit)............. $ 24,435 $ 40,238 $ 48,987 $50,474 $(8,316)
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 eight 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, South America
and Australia for selected applications, such as hernia repair, subfascial
endoscopic perforator surgery, saphenous vein harvesting and breast
reconstruction and augmentation surgery, and laparoscopic bladder neck
suspension.
Sales of the Company's products in the United States and
internationally are currently made through both distributors and the
Company's direct sales force. Distribution in the hernia and SUI markets is
currently through non-exclusive relationships with Ethicon Endo-Surgery
("EES"), United States Surgical Corporation ("USSC"), Dexterity Surgical,
Inc. ("Dexterity") and other distributors. The Company has two non-exclusive
agreements with USSC, a wholly owned subsidiary of Tyco International Ltd.
("Tyco"). Under the terms of the first agreement, USSC has non-exclusive
rights to market and distribute GSI's SPACEMAKER-Registered Trademark-
surgical balloon dissectors worldwide for use in hernia repair and stress
urinary incontinence ("SUI") procedures. Under the terms of the second
agreement, GSI has non-exclusive rights to market several products, including
USSC's 5mm mesh fixation device, the ProTack, which is offered as part of
GSI's SPACEMAKER-Registered Trademark- Total Solution-TM- hernia repair kit.
Additionally, the Company has an exclusive agreement with Genzyme Surgical
Products Corporation ("Genzyme") to market and distribute GSI's surgical
balloon dissection systems for use in plastic surgery (reconstructive and
aesthetic) procedures. Sales of devices for cardiac/vascular applications are
made through non-exclusive agreements with distributors and through the
Company's direct sales force.
During fiscal year 2000, the Company plans to extend its domestic and
international distribution networks, as well as its direct sales force. Any
increase in the Company's direct sales force will require significant
expenditures and additional management resources.
To date, the majority of the sales of the Company's products 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
surgical balloon dissectors 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 fiscal year 2000.
-20-
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. Total amounts paid for royalties for the years ended June
30, 1999, 1998 and 1997 were $187,497, $289,255 and $356,831, respectively.
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 2000. 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 studies).
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.
RECENT DEVELOPMENTS
In August 1999, the Company and Tyco entered into a definitive
agreement pursuant to which Tyco will acquire GSI. GSI shareholders will
receive a fraction of a Tyco common share valued at $7.50 per common share
for each common share of GSI. The transaction is valued at approximately $100
million. The closing of this deal is contingent upon shareholder approval of
the Company, as well certain regulatory approvals.
RESULTS OF OPERATIONS
The following table sets forth certain data from the Company's
statements of operations, expressed as a percentage of total revenue:
AS A PERCENTAGE OF TOTAL REVENUE:
YEARS ENDED JUNE 30,
---------------------------------------
1999 1998 1997
---- ---- ----
Sales......................................................... 100.0% 76.1% 45.5%
Guaranteed payments........................................... - 23.9 54.5
------------- ------------- -------------
Total revenue................................................. 100.0% 100.0% 100.0%
Cost of sales................................................. 75.8 52.2 26.5
------------- ------------- -------------
Gross profit........................................... 24.2 47.8 73.5
------------- ------------- -------------
Operating expenses:
Research and development.................................... 53.7 41.4 24.8
Selling, general and administrative......................... 226.6 173.4 97.8
------------- ------------- -------------
Total operating expenses.................................. 280.3 214.8 122.6
------------- ------------- -------------
Operating loss......................................... (256.1) (167.0) (49.1)
Interest and other income, net................................ 22.4 33.1 28.2
------------- ------------- -------------
Net loss............................................... (233.7)% (133.9)% (20.9)%
------------- ------------- -------------
------------- ------------- -------------
YEARS ENDED JUNE 30, 1999 AND 1998
REVENUE. Revenue totaled $6.9 million in fiscal 1999, an increase of
$0.1 million or one percent over revenue of $6.8 million in fiscal 1998.
During fiscal 1999, no guaranteed payments were received from EES versus $1.6
million during fiscal 1998. Product sales accounted for all of the fiscal
1999 revenue, which represents a 32 percent increase over fiscal 1998 product
sales. The increase in product sales is due to an increase in product demand,
primarily for SPACEMAKER-Registered Trademark- Total Solution-TM- hernia
kits, as well as expanded product distribution in the fourth quarter.
COST OF SALES. Cost of sales at $5.2 million in 1999 increased 46%
as compared to $3.6 million in 1998 due to increased product sales and
production capacity ramp-up. Direct product costs were 76 percent of total
product sales in fiscal 1999, an increase of seven percent from fiscal 1998,
as a result of increasing costs related to ramping up production capacity in
anticipation of the court injunction against Origin Medsystems, Inc.
("Origin"). In addition, the
-21-
Company's product costs have increased relative to sales dollars as
additional OEM products are offered as part of the SPACEMAKER-Registered
Trademark- Total Solution-TM- hernia and laparoscopic bladder neck suspension
kits. The Company expects cost of sales as a percentage of product sales to
decrease as the Company's sales volume increases.
RESEARCH AND DEVELOPMENT EXPENSES. Research and Development ("R&D")
expenses for fiscal 1999 increased 31 percent to $3.7 million versus $2.8
million for the year ended June 30, 1998. Increases over the prior year are
mainly due to increased expenditures on new general surgery product design
work in conjunction with expanding SPACEMAKER-Registered Trademark- Total
Solution-TM- hernia and laparoscopic bladder neck suspension kit offerings,
as well as an increase in the number of employees in R&D. The Company expects
to continue to increase R&D expenses as it pursues additional market
opportunities.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, General and
Administrative ("SG&A") expenses were $15.6 million in fiscal year 1999, an
increase of 32 percent as compared to $11.8 million in fiscal 1998. This
increase is primarily related to litigation expenses related to the Origin
matters and are expected to decrease in the future. In addition,
sales and marketing expenses increased as the Company devoted more resources
to physician training programs as well as increased exposure at relevant
industry trade shows. GSI expects increases in SG&A expenses as the
Company's level of sales increases and the Company continues to
administratively support growth, and expects SG&A to be impacted by its
ongoing litigation matters.
INTEREST AND OTHER INCOME AND EXPENSE (NET). Interest and other
income and expense (net) totaled $1.5 million in fiscal 1999 compared to $2.3
million in fiscal 1998, and consisted mainly of interest income, primarily
from interest earned on available-for-sale securities. Interest income
decreased 32% from $2.3 million in 1998 to $1.6 million in 1999, due to
overall lower cash balances in connection with funding ongoing operating
activities.
NET LOSS. The Company had a net loss of approximately $16.1 million
in fiscal 1999 compared to a $9.1 million net loss in fiscal 1998, primarily
due to the increased operating expenses as the Company prepared for
anticipated sales growth and aggressively defended its patent positions.
YEARS ENDED JUNE 30, 1998 AND 1997
SALES AND GUARANTEED PAYMENTS. Sales and guaranteed payments totaled
$6.8 million in fiscal 1998, a decrease of $2.2 million or 24 percent from
sales and guaranteed payments of $9.0 million in fiscal 1997. This decrease
in revenue is in connection with the conversion of EES to a non-exclusive
distributor, which eliminated future guarante ed payments. During fiscal
1998, $1.6 million in guaranteed payments was received from EES versus $4.9
million during fiscal 1997. Product sales accounted for $5.2 million of total
revenue in fiscal 1998, which represents a 27 percent increase over fiscal
1997. This increase was a result of rapid growth in sales of the Company's
vascular surgery products and plastic surgery products.
COST OF SALES. Direct product costs were 69 percent of total product
sales in fiscal 1998, an increase of 11 percent from fiscal 1997, as a result
of underutilized manufacturing capacity in fiscal 1998.
RESEARCH AND DEVELOPMENT EXPENSES. R&D expenses for fiscal 1998
increased 27 percent to $2.8 million versus $2.2 million for the year ended
June 30, 1997, as the Company continued to develop products for its vascular
and hernia markets. The Company expects to continue to increase R&D expenses
as it pursues additional market opportunities.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. SG&A expenses were
$11.8 million in fiscal year 1998, an increase of 35 percent as compared to
$8.8 million in fiscal 1997. This increase is primarily related to increased
litigation expenses related to the Origin infringement case.
INTEREST AND OTHER INCOME AND EXPENSE (NET). Interest and other
income and expense (net) totaled $2.3 million in fiscal 1998 compared to $2.5
million in fiscal 1997, and consisted mainly of interest income, primarily
from interest earned on available-for-sale securities. Interest income
decreased 10% from $2.6 million in 1997 to $2.3 million in 1998, due to
overall lower cash balances in connection with funding ongoing operating
activities.
NET LOSS. The Company had a net loss of approximately $9.1 million
in fiscal 1998 compared to a $1.9 million net loss in fiscal 1997, primarily
due to the decrease in guaranteed payments from EES and increased operating
expenses as the Company prepared for anticipated sales growth and
aggressively defended its patent positions.
-22-
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's cash expenditures have significantly
exceeded its sales, resulting in an accumulated deficit of $40.9 million at
June 30, 1999. The Company has funded its operations primarily through the
sale of equity securities. From its inception through June 30, 1999, 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.
Net cash used in operating activities in 1999 was approximately
$16.1 million which consisted mainly of the Company's net loss for the year
of $16.1 million offset slightly by increases in gross accounts receivable
and inventory of $3.3 million. Net cash provided by investing activities totaled
approximately $8.0 million. Proceeds from sales and maturities of
available-for-sale securities of $13.5 million was somewhat offset by
purchases of available-for-sale securities of $3.8 million and acquisition of
property and equipment of $1.7 million. Net cash used in financing
activities was approximately $258,000, which consisted of $157,000 in proceeds
from the issuance of common stock, offset by a $300,000 outflow for a related
party loan, as well as $117,000 in payments on capital lease obligations and
bank borrowings.
As of June 30, 1999, the Company's principal source of liquidity
consists of cash, cash equivalents and investments of $19.3 million. The
Company has an equipment loan outstanding with a balance of approximately
$82,000. The Company expects to spend approximately $2.1 million on capital
equipment purchases in fiscal year 2000.
The Company expects to incur additional costs over the next fiscal
year, including costs related to increased sales and marketing activities,
increased research and development, additional marketing-related clinical
studies, and litigation costs. 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.
MANAGEMENT INFORMATION SYSTEMS
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 year 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 intends to fix or replace
noncompliant software and systems by November 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.
-23-
The Company's costs related to the Y2K issue are funded through
operating cash flows. Through fiscal 1999, the Company expended approximately
$20,000 in evaluating and planning and fixing and replacing noncompliant
systems, including the cost of new software and modifying the applicable code
of existing software. The Company estimates total costs to be approximately
$25,000 to achieve Y2K compliance. 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. We have not yet
developed a complete contingency plan for dealing with the most likely
worst-case scenario, as this scenario has not yet been clearly identified. We
currently plan to complete such contingency planning by November 30, 1999.
There can be no assurance that such contingency plan will adequately address
the Company's Y2K compliance issues.
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.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activities," which establishes
accounting and reporting standards for derivative instruments and hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure
those instruments at fair value. To date, the Company has not engaged in
derivative and hedging activities. SFAS 133 will be effective for fiscal
years beginning after June 15, 2000.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the
Company's financial position, operating results or cash flows due to changes
in financial and commodity market prices and rates. The Company's exposure to
market risk for changes in United States interest rates relates primarily to
its investment portfolio and bank borrowings. The Company does not use
derivative financial instruments in its investment portfolio, and its
investment portfolio only includes highly liquid instruments with original
maturity dates ranging between September 24, 1999 and October 30, 2000. The
Company has primarily entered into debt obligations for capital expenditures.
The Company is subject to fluctuating interest rates that may
impact, adversely or otherwise, its results of operations or cash flows for
our variable rate bank borrowings, available-for -sale securities and cash
and cash equivalents.
The table below presents principal amounts and related weighted
average interest rates by period of maturity for our investment portfolio and
debt obligations:
Twelve Months Twelve Months
Ending Ending
June 30, 2000 June 30, 2001 Total
------------------ ------------------- -------
Assets
Cash and cash equivalents $ 9,600 - $ 9,600
Average interest rate 4.86% - 4.86%
Available-for-sale securities $ 8,699 $ 999 $ 9,698
Average interest rate 6.05% 5.46% 5.99%
Liabilities
Bank borrowings $ 82 - $ 82
Average interest rate 9.00% - 9.00%
Capital leases $ 12 - $ 12
Average interest rate 8.00% - 8.00%
FACTORS AFFECTING FUTURE RESULTS
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto included herein.
-24-
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 Annual Report on Form 10-K, 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, outcomes in litigation
proceedings, 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 and direct sales force, 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 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.
HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES. The Company has
experienced significant operating losses since inception. As of June 30,
1999, the Company had an accumulated deficit of $40.9 million. The Company's
net operating losses for the fiscal years ending June 30, 1999, 1998 and 1997
were $16.1 million, $9.1 million and $1.9 million, respectively. The Company
expects to continue to incur operating losses on a quarterly and annual basis
through at least fiscal 2000. There can be no assurance that the Company will
ever generate substantial revenue or achieve profitability. Failure by the
Company to generate substantial revenues would have material adverse effect
on the Company's business, financial conditions and results of operations.
See "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and "Business -- Company Strategy."
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 clinical studies results will be
favorable, that surgeons will continue to adopt MIS procedures, that
recently-introduced products or future products of the Company or procedures
using the Company's products 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. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business -- Applications of Balloon
Dissection Technology," and "- Additional Products Under Development."
DEPENDENCE ON KEY DISTRIBUTORS. In February 1998, the Company
entered into a non-exclusive distribution agreement with EES. Unlike the
prior EES OEM Agreement, this new agreement does not provide for any minimum
payments from EES to the Company. In December 1997, the Company entered into
a distribution agreement with Genzyme. Under the agreement, Genzyme has
exclusive rights to market and distribute GSI's surgical balloon dissectors
worldwide for use in plastic surgery (reconstructive and aesthetic)
procedures. In September 1998, the Company signed a non-exclusive, three-year
agreement with USSC, a wholly-owned subsidiary of Tyco. 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.
In May 1999, the Company signed a distribution agreement with
Dexterity Surgical, Inc. ("Dexterity"). The terms of the agreement give
Dexterity rights to market and distribute GSI's SPACEMAKER-Registered
Trademark- balloon dissector products for hernia repair and laparoscopic
bladder neck suspension repair procedures in all or parts of 28 states.
-25-
In June 1997, GSI entered into an exclusive agreement with Japan
Lifeline to market and distribute in Japan GSI's surgical balloon dissectors
for use in vascular procedures. Distribution of the GSI surgical balloon
dissectors is expected to begin following final receipt of the Japanese
Ministry of Health and Welfare approval, which the Company expects to occur
in fiscal year 2000.
Although the Company intends to continue to establish additional
distributorships in the United States and internationally, there can be no
assurance that its distributors will be successful, or that efforts to
establish additional distributors will be successful. Failure of current
distributors to succeed, or failure to add additional distributors to its
distribution network, could have a material adverse effect on the Company's
business, financial condition and results of operations.
LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only
limited experience marketing and selling its products through its direct
sales force. 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 to hire and retain
qualified and effective direct 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,"
and "Business --Marketing, Sales and Distribution."
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 techniques 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) or 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. See "Business -Marketing, Sales and Distribution."
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 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 "Business -Third-Party
Reimbursement."
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 and direct sales force, (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) litigation, (ix) timing and growth
of operating expenses and (x) general market conditions.
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. 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.
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 (C96-20424JW). In April 1998, GSI had obtained a summary judgment
that the patent in suit, Moll et al Patent No. 5,520,609, was unenforceable
because it had been obtained by misleading the Patent & Trademark Office, and
an award of attorney's fees of $990,000. The appellate court subsequently
vacated this decision because, in its view, there are factual issues which
must be resolved in a trial on whether Origin misled the PTO. In July 1999,
the case was returned to the district court for further proceedings.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that the use of
Origin's products infringes GSI's U.S. Patent No. 5,514,153 (C96-20447JW).
The case was decided in favor of GSI partly by summary judgment and partly by
jury verdict, both during fiscal 1999. Patent 5,514,153 ("the '153 patent")
was found to be valid, and Origin's infringement was found to be willful.
Lost profits of approximately $12.9 million were awarded to GSI by the jury.
Origin is appealing the infringement and willfulness findings (but not patent
validity nor the amount of infringement damages), and GSI is appealing for
enhanced damages, attorneys' fees and the failure to find infringement of
additional claims. Resolution is expected in calendar year 2000. Following
these findings, the Court has entered an injunction prohibiting sale in the
United States of all of Origin's balloon dissection products, to become fully
effective on November 15, 1999, and an immediate injunction against sales of
all of Origin's balloon dissection products to any new customers in the
United States.
In September 1997, the Company filed an action against Origin
alleging that the use of Origin's products infringes GSI's U.S. Patent No.
5,667,520 (C97-20944JW). Discovery is nearly complete in this case and the
complaint has now been amended to add a claim of infringement of GSI's patent
number 5,860,997. This case is now stayed pending the outcome of appeals in
the '153 case.
GSI is also involved in an interference proceeding in the U.S. Patent
Office against Origin to determine whether certain subject matter was first
invented by GSI and whether the disputed matter is patentable. In November
1998, binding arbitration determined that GSI was first to invent the
disputed subject matter and therefore is the only party entitled to any
patent. Additionally, the Patent Office Appeals Board found the subject
matter to be patentable. This latter finding is being appealed by Origin to
the Court of Appeals for the Federal Circuit. Resolution is expected in
calendar year 2000.
On April 9, 1999, a suit was filed against GSI in the United States
District Court for the Southern District of Illinois. This suit, brought by
Dr. Peter M. Bonutti and by Bonutti Research, Inc., seeks a 50 percent share
of the $12.9 million damages judgment GSI obtained in its suit against Origin
and seeks rescission of the 1995 agreement by which GSI obtained assignment
of certain Bonutti technology. From this assigned technology, GSI prosecuted
patent applications which became the '153 and other patents, which credit Dr.
Bonutti as sole inventor. This case is in the discovery phase.
-27-
Patent interference or infringement proceedings involve complex legal
and factual issues and are 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.
While the Company believes it will be successful in these
proceedings, there can be no assurance of such success. Failure of the
Company to prevail in such proceedings would have a material adverse effect
on the Company's business, financial condition and results of operations.
The validity and breadth of claims in medical technology patents
involve complex legal and factual questions and, therefore, may be highly
uncertain. No assurance can be given that any patents based on pending patent
applications or any future patent applications will be issued, that the scope
of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents or patents to
which it has licensed rights will be held valid 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.
COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in the
market for medical devices and tissue dissection products is intense and is
expected to increase. The Company competes primarily with other producers of
MIS tissue dissection products. Origin, which was a subsidiary of Guidant
Corporation and has recently been purchased by Tyco, was previously, and will
continue through November 15, 1999 (pending the outcome of current
litigation), to be the Company's primary direct competition in the field of
balloon dissection products. Other companies currently compete against the
Company in the development, production and marketing of MIS tissue dissection
instruments and technology, such as blunt dissectors, insufflation dissection
and aqua irrigation with blunt dissection. To the extent that surgeons elect
to use open surgical procedures rather than MIS, the Company also competes
with producers of tissue dissection products 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 products and technology for open surgical
procedures. In addition, the Company competes indirectly with producers of
therapeutic drugs, when such drugs are used as an alternative to surgery.
Many of the Company's competitors and potential competitors have substantially
-28-
greater name recognition and capital resources than the Company and also have
greater resources and expertise in the areas of research and development, the
obtaining of regulatory approvals, and in manufacturing and marketing.
The Company believes that the primary competitive factors in the
market for tissue dissection products include safety, efficacy, ease of use,
quality, reliability and cost effectiveness. In addition, the length of time
required for products to be developed and to receive regulatory approval is
an important competitive factor. The Company believes that it competes
favorably with respect to these factors, although there can be no assurance
that it will continue to do so.
The market for tissue dissection products is characterized by rapid
technical innovation. Product development involves a high degree of risk, and
there can be no assurance that the Company's competitors and potential
competitors will not succeed in developing and marketing technologies and
products that are more effective than those developed and marketed by the
Company or that would render the Company's technology and products obsolete
or noncompetitive. The medical applications for which the Company's MIS
tissue dissection products are used can also be addressed by other medical
devices in either MIS or open surgical procedures, many of which are widely
accepted in the medical community. There can be no assurance that a procedure
using MIS balloon dissection technology will be able to replace such
established products and procedures. Additionally, new surgical products or
procedures could be developed that replace or reduce the importance of
current procedures that use the Company's products.
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"). However, 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 in the United States 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. Failure to obtain such approvals for reimbursement in
international markets 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. 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. See "Business -- Third-Party
Reimbursement."
GOVERNMENT REGULATION. The Company's 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
-29-
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-Registered Trademark- II platform, SPACEMAKER-Registered
Trademark- Plastics platform and SPACEMAKER-Registered Trademark-
SAPHtrak-Registered Trademark- platform each have received 510(k) clearance
for use during general, endoscopic, laparoscopic and plastic and
reconstructive surgery (including aesthetic), and certain vascular surgery
(including saphenous vein procedures) when tissue dissection is required.
Additionally, the Company has received clearance to market these products for
thoracoscopic procedures involving exposure and dissection of structures
external to the parietal pleura and procedures in the extraperitoneal space.
The Company has also received clearance to market combined tissue
dissection/expansion products. The Company has promoted these products for
surgical applications (E.G., hernia repair, SEPS, breast augmentation and
reconstruction, treatment of SUI 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
procedures which require exposure to the anterior spine or for 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 MANUFACTURING EXPERIENCE. The Company has only limited
experience in manufacturing its products in commercial quantities.
Manufacturers often encounter difficulties in scaling up production of new
products, including problems involving production yields, quality control and
assurance, component supply and shortages of qualified personnel.
Difficulties experienced by the Company in manufacturing scale-up and
manufacturing difficulties could have a material adverse effect on its
business, financial condition and results of operations. There can be no
assurance that the Company will be successful in scaling up or that it will
not experience manufacturing difficulties or product recalls in the future.
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 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 and
could have a material adverse effect on the Company's business, financial
condition and results of operations. See "Business --Manufacturing."
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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. See "Business -- Product
Liability and Insurance."
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.
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 intends to fix or replace
noncompliant software and systems by November 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".
-31-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's financial statements as of June 30, 1999 and 1998 and
for each of the three years ending June 30, 1999, June 30, 1998 and June 30,
1997 are included in this Form 10-K starting at page 39.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANT ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
-32-
PART III
Certain information required by Part III is omitted from this report
because the Company will file a definitive Proxy Statement within 120 days
after the end of its fiscal year pursuant to Regulation 14A (the "Proxy
Statement") for its Annual Meeting of Shareholders to be held December 16,
1999, and the information included therein is incorporated herein by
reference to the extent detailed below.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information regarding the Company's directors will be set forth
under the caption "Election of Directors -- Nominees" in the Company's proxy
statement and is incorporated herein by reference. The Proxy Statement will
be filed with the Securities and Exchange Commission within 120 days after
the end of the Company's fiscal year.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference
into this Form 10-K from the information set forth under the caption
"Compensation of Executive Officers" in the Company's Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference
into this Form 10-K from the information set forth under the caption "Common
Stock Ownership of Certain Beneficial Owners and Management" in the Company's
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information required by this item is incorporated by reference into
this Form 10-K from the information set forth under the caption "Certain
Relationships and Related Transactions" in the Company's Proxy Statement.
-33-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULE AND
REPORTS ON FORM 8-K
Page
----
(a) (1) Financial Statements:
Report of Independent Accountants.................................................. 38
Balance Sheets..................................................................... 39
Statements of Operations and Comprehensive Loss.................................... 40
Statements of Shareholders' Equity ................................................ 41
Statements of Cash Flows........................................................... 42
Notes to Financial Statements...................................................... 43
(2) Financial Statement Schedule:
Independent Accountants' Report on Schedule........................................ S1
Schedule II-Valuation and Qualifying Accounts...................................... S2
All other schedules are omitted because they are not applicable or the
required information is shown in the financial statements or notes
thereto.
(3) Exhibits included herein (numbered in accordance with Item 601
of Regulation S-K)
Exhibit
Number Description
- --------- ------------
3.2 (1) Amended and Restated Articles of Incorporation of Company.
3.4 (1) By-laws of Company, as amended.
4.2 (2) Shareholder Rights Plan.
10.1 (1) Form of Indemnification Agreement.
10.2 (1) 1992 Stock Option Plan and form of Agreement.
10.3 (1) 1996 Employee Stock Purchase Plan and form of Subscription
Agreement.
10.4 (1) 1995 Directors' Stock Option Plan and form of Option Agreement.
10.5 (1) Third Amended and Restated Registration Rights Agreement among
the Company and certain security holders of the Company dated as
of March 21, 1996.
10.6 (1) Commercial Security Agreement and Promissory Note dated as of
December 15, 1994 between Silicon Valley Bank and the Company.
10.7 (1) Sublease dated July 13, 1994, Sublease Amendment dated
November 4, 1995 and Sublease Second Amendment dated March 15,
1996 between the Company and CV Therapeutics, Inc.
10.8 (1)(3) Agreement and Plan of Reorganization dated as of October 1,
1995, by and among the Company, General Surgical Acquisition
Corporation and Adjacent Surgical, Inc.
10.9 (1) Merger Agreement dated February 12, 1996 by and among Adjacent
Surgical, Inc., Thomas J. Fogarty, Fogarty Engineering and the
Company.
10.10 (1)(3) Exclusive License Agreement dated as of February 12, 1996 by and
among Adjacent Surgical, Inc., Thomas J. Fogarty, Fogarty
Engineering and the Company.
-34-
10.11 (1)(3) Assignment Agreement dated as of March 9, 1995 between Apogee
Medical Products, Inc., and the Company.
Exhibit
Number Description
10.12 (1)(3) Hernia Repair Device Agreement dated as of April 29, 1992 by and
among Maciej Kieturakis, Thomas J. Fogarty and the Registrant,
as amended on April 18, 1995.
10.14 (1) Professional Services Agreement dated June 16, 1992 between the
Company and Thomas J. Fogarty.
10.15 (1) Professional Services Agreement dated June 16, 1992 between the
Company and Mark A. Wan.
10.16 (1) Bill of Sale and Instrument of Assignment and Grantback License
Agreement dated June 16, 1992 between the Company and Thomas J.
Fogarty.
10.17 (1) Bill of Sale and Instrument of Assignment dated June 16, 1992,
between the Company and Mark Wan.
10.18 (1) Loan Modification Agreement dated as of March 25, 1996, by and
between the Company and Silicon Valley Bank.
10.20 (4) OEM Supply Agreement (Expanded Field) dated December 20, 1996
between Ethicon Endo-Surgery, Inc. and the Company.
10.21 (4) Modification and Termination Agreement and Mutual Release dated
November 12, 1996, between United States Surgical Corporation
and the Company.
10.22 (4) Real Estate Lease between Berg & Berg Developers and the
Company.
10.23 (5) Form of change of Control Agreement between the Company and
Executive Officers dated January 20, 1998.
10.24 (5) Termination, Release and Distribution Agreement between the
Company and Ethicon Endo-Surgery, Inc. dated February 23, 1998.
10.25 (6) Consulting Agreement between the Company and Roderick A. Young
dated Nov. 1, 1998.
10.26 (6) Promissory Note and Bonus Agreement between the Company and
Greg Casciaro dated September 3, 1998.
10.27 (7) Written Compensation Agreement dated April 6, 1998.
10.28 Distribution Agreement between the Company and Dexterity
Surgical, Inc. dated May 6, 1999.
10.29 Second Amendment to Full Recourse Promissory Note between the
Company and James Jervis dated May 3, 1999.
10.30 Amendment to Full Recourse Promissory Note between the Company
and Gregory Casciaro dated May 3, 1999.
23.1 Consent of PricewaterhouseCoopers LLP, Independent Accountants.
25.1 Power of Attorney (see p. 54).
27.1 Financial Data Schedule.
- --------------------------------------------------------------------------------
-35-
(1) Incorporated by reference to identically numbered exhibits filed in
response to Item 16(a), "Exhibits," of the Company's Registration
Statement on Form S-1 and Amendments thereto (File No. 333-2774), which
became effective on May 10, 1996.
(2) Incorporated by reference to identically numbered exhibits filed in
response to item 2, "Exhibits," of the Company's Registration Statement
on Form 8-A (File No. 000-28448), filed with the Commission on May 13,
1997.
(3) Confidential treatment has been granted with regard to certain portions
of this exhibit.
(4) Incorporated by reference to identically numbered exhibits filed in
response to Item 6(a), "Exhibits," of the Company's Quarterly Report on
Form 10-Q, filed with the Commission on February 14, 1997 (File no.
000-28448).
(5) Incorporated by reference to identically numbered exhibits filed in
response to Item 6(a), "Exhibits," of the Company's Quarterly Report on
Form 10-Q, filed with the Commission on May 14, 1998 (File no.
000-28448).
(6) Incorporated by reference to identically numbered exhibits filed in
response to Item 6 (a), "Exhibits", of the Company's Quarterly Report on
Form 10-Q, Filed with the Commission on November 16, 1998 (file no.
000-28448).
(7) Incorporated by reference to identically numbered exhibits filed in
response to Item 6 (a), "Exhibits", of the Company's Quarterly Report
on Form 10-Q, filed with the Commission on November 16, 1998 (File no.
000-28448).
(b) REPORTS ON FORM 8-K: The Company filed no reports on form 8-K during the
quarter ended June 30, 1999.
-36-
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
General Surgical Innovations, Inc.:
In our opinion, the accompanying balance sheets and the related
statements of operations and comprehensive loss, of shareholders' equity and
of cash flows present fairly, in all material respects, the financial
position of General Surgical Innovations, Inc. at June 30, 1999 and 1998, and
the results of its operations and its cash flows for each of the three years
in the period ended June 30, 1999, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on
these financial statements based on our audits. We conducted our audits of
these statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
San Jose, California
July 23, 1999
-37-
GENERAL SURGICAL INNOVATIONS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
JUNE 30,
-------------------------
1999 1998
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents ............................................ $ 9,600 $ 17,954
Available-for-sale securities ....................................... 8,699 10,743
Accounts receivable, net of allowances of $350 in 1999 and $72 in 1998 2,550 1,043
Inventories .......................................................... 2,532 1,284
Prepaid expenses and other current assets ............................ 489 733
----------- -----------
Total current assets .............................................. 23,870 31,757
Available-for-sale securities, non-current .......................... 999 8,772
Property and equipment, net .......................................... 3,052 2,101
Intangible and other assets, net ..................................... 316 194
----------- -----------
Total assets ...................................................... $ 28,237 $ 42,824
----------- -----------
----------- -----------
LIABILITIES
Current liabilities:
Accounts payable ..................................................... $ 2,231 $ 910
Accrued liabilities .................................................. 1,440 1,316
Capital leases ....................................................... 12 14
Bank borrowings ...................................................... 82 103
----------- -----------
Total current liabilities ......................................... 3,765 2,343
Other long-term liabilities ............................................... 37 149
Capital leases, less current portion ...................................... -- 12
Bank borrowings, less current portion ..................................... -- 82
----------- -----------
Total liabilities ............................................ 3,802 2,586
----------- -----------
Commitments and Contingencies (Note 5)
SHAREHOLDERS' EQUITY
Preferred stock, $.001 par value:
Authorized: 2,000 shares; issued and outstanding: none ............... -- --
Common stock, $.001 par value:
Authorized: 50,000 shares; issued and outstanding:
13,504 on June 30, 1999, and 13,435 on June 30, 1998 .............. 14 13
Additional paid-in capital ................................................ 65,446 65,290
Notes receivable from shareholders ........................................ (85) (87)
Deferred compensation, net ................................................ (22) (159)
Accumulated other comprehensive income (loss) ............................. (12) 16
Accumulated deficit ....................................................... (40,906) (24,835)
----------- -----------
Total shareholders' equity ........................................... 24,435 40,238
----------- -----------
Total liabilities and shareholders' equity ........................ $ 28,237 $ 42,824
----------- -----------
----------- -----------
The accompanying notes are an integral part of
these financial statements.
-38-
GENERAL SURGICAL INNOVATIONS, INC.
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEARS ENDED JUNE 30,
---------------------------------------------
1999 1998 1997
------------ ------------- ------------
Sales.................................................................... $ 6,876 $ 5,193 $ 4,090
Guaranteed payments...................................................... - 1,635 4,896
------------ ------------- ------------
Total revenue............................................................ 6,876 6,828 8,986
Cost of sales............................................................ 5,212 3,565 2,385
------------ ------------- ------------
Gross profit.................................................. 1,664 3,263 6,601
------------ ------------- ------------
Operating expenses:
Research and development.......................................... 3,695 2,825 2,231
Sales and marketing............................................... 6,523 4,911 4,906
General and administrative........................................ 9,058 6,932 3,878
------------ ------------- ------------
Total operating expenses....................................... 19,276 14,668 11,015
------------ ------------- ------------
Operating loss................................................ (17,612) (11,405) (4,414)
------------ ------------- ------------
Interest income.......................................................... 1,574 2,308 2,572
Interest expense......................................................... (19) (38) (47)
Other income (expense), net.............................................. (14) (7) 13
------------ ------------- ------------
Net loss...................................................... (16,071) (9,142) (1,876)
Other comprehensive income (loss):
Change in unrealized gain or loss on available-for-sale securities (28) 54 (39)
------------ ------------- ------------
Comprehensive loss............................................. $ (16,099) $ (9,088) $ (1,915)
------------ ------------- ------------
------------ ------------- ------------
Net loss per common share and per common share-assuming
dilution.......................................................... $ (1.19) $ (0.68) $ (0.14)
------------ ------------- ------------
------------ ------------- ------------
Shares used in computing net loss per common share and per
common share-assuming dilution.................................... 13,461 13,373 13,197
------------ ------------- ------------
------------ ------------- ------------
The accompanying notes are an integral part of these financial statements.
-39-
GENERAL SURGICAL INNOVATIONS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
Notes
Additional Receivable
Common Stock Paid-in From Deferred
Shares Amount Capital Shareholders Compensation
-------- -------- -------- -------- --------
Balances, June 30, 1996....................... 13,133 $ 13 $ 64,885 $ (112) $ (496)
Exercise of stock options.................. 148 -- 67 -- --
Exercise of stock options with notes
receivable............................. 23 -- 11 (11) --
Issuance of common stock in connection
with employee stock purchase plan...... 18 -- 135 -- --
Repurchase of common stock................. (31) -- (9) 9 --
Amortization of deferred compensation -- -- -- -- 199
Change in unrealized loss on available-
for-sale securities.................... -- -- -- -- --
Payment of shareholders' notes receivable.. -- -- -- 27 --
Net loss................................... -- -- -- -- --
-------- -------- -------- -------- --------
Balances, June 30, 1997....................... 13,291 13 65,089 (87) (297)
Exercise of stock options.................. 128 -- 129 -- --
Issuance of common stock in connection
with employee stock purchase plan...... 16 -- 72 -- --
Amortization of deferred compensation...... -- -- -- -- 138
Change in unrealized gain on available-for-
sale securities........................ -- -- -- -- --
Net loss................................... -- -- -- -- --
-------- -------- -------- -------- --------
Balances, June 30, 1998....................... 13,435 13 65,290 (87) (159)
Exercise of stock options.................. 33 -- 42 -- --
Issuance of common stock in connection
with employee stock purchase plan...... 36 1 114 -- --
Amortization of deferred compensation...... -- -- -- -- 137
Payment on shareholder notes receivable.... 2
Change in unrealized gain on available-for-
sale securities ....................... -- -- -- -- --
Net loss .................................. -- -- -- -- --
-------- -------- -------- -------- --------
Balances, June 30, 1999 ...................... 13,504 $ 14 $ 65,446 $ (85) $ (22)
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Accumulated
Other
Comprehensive
Income Accumulated
(Loss) Deficit Total
------------ ----------- -------
Balances, June 30, 1996....................... $ 1 $(13,817) $50,474
Exercise of stock options.................. -- -- 67
Exercise of stock options with notes
receivable............................. -- -- --
Issuance of common stock in connection
with employee stock purchase plan...... -- -- 135
Repurchase of common stock................. -- -- --
Amortization of deferred compensation -- -- 199
Change in unrealized loss on available-
for-sale securities.................... (39) -- (39)
Payment of shareholders' notes receivable.. -- -- 27
Net loss................................... -- (1,876) (1,876)
----- -------- --------
Balances, June 30, 1997....................... (38) (15,693) 48,987
Exercise of stock options.................. -- -- 129
Issuance of common stock in connection
with employee stock purchase plan...... -- -- 72
Amortization of deferred compensation...... -- -- 138
Change in unrealized gain on available-for-
sale securities........................ 54 -- 54
Net loss................................... -- (9,142) (9,142)
----- -------- --------
Balances, June 30, 1998....................... 16 (24,835) 40,238
Exercise of stock options.................. -- -- 42
Issuance of common stock in connection
with employee stock purchase plan...... -- -- 115
Amortization of deferred compensation...... -- -- 137
Payment on shareholder notes receivable.... 2
Change in unrealized gain on available-for-
sale securities ....................... (28) -- (28)
Net loss .................................. -- (16,071) (16,071)
----- -------- --------
Balances, June 30, 1999 ...................... $ (12) $(40,906) $ 24,435
----- -------- --------
----- -------- --------
The accompanying notes are an integral part of these financial statements.
-40-
GENERAL SURGICAL INNOVATIONS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEARS ENDED JUNE 30,
---------------------------------------------
1999 1998 1997
------------ ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.............................................................. $ (16,071) $ (9,142) $ (1,876)
Adjustments to reconcile net loss to net cash used in operating
activities:
Amortization of deferred compensation.......................... 137 138 199
Depreciation and amortization.................................. 880 1,049 889
Provision for uncollectable accounts and sales returns......... 659 25 (31)
Loss on write-off of fixed assets.............................. 20 7 38
Provision for excess and obsolete inventory.................... 417 43 57
Forgiveness of related party note receivable................... 107 - -
Changes in operating assets and liabilities:
Accounts receivable........................................ (2,166) 1,064 (1,227)
Inventory.................................................. (1,665) 390 (1,074)
Prepaid expenses and other current assets.................. 244 238 (533)
Intangible and other assets................................ (1) (5) (69)
Accounts payable........................................... 1,321 406 (110)
Accrued and other liabilities.............................. 12 246 127
Deferred revenue........................................... - - (100)
------------ ------------- ------------
Net cash used in operating activities................. (16,106) (5,541) (3,710)
------------ ------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available-for-sale securities........................... (3,811) (22,766) (54,335)
Proceeds from sales and maturities of available-for-sale securities... 13,500 38,792 39,467
Acquisition of property and equipment................................. (1,679) (450) (2,018)
Disposal of fixed assets.............................................. - - 63
------------ ------------- ------------
Net cash provided by (used in) investing activities... 8,010 15,576 (16,823)
------------ ------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock, net of issuance costs......... 157 201 202
Proceeds from payment on shareholders' notes receivable............... 2 - 27
Payments on capital lease obligations................................. (14) (15) -
Principal payments on bank borrowings................................. (103) (167) (135)
Related party note receivable......................................... (300) - -
------------ ------------- ------------
Net cash provided by(used in) financing activities.... (258) 19 94
------------ ------------- ------------
Net increase (decrease) in cash and cash equivalents.................. (8,354) 10,054 (20,439)
Cash and cash equivalents, beginning of year.......................... 17,954 7,900 28,339
------------ ------------- ------------
Cash and cash equivalents, end of year................................ $ 9,600 $ 17,954 $ 7,900
------------ ------------- ------------
------------ ------------- ------------
Cash paid during the period for:
Interest....................................................... $ 19 $ 38 $ 51
Taxes.......................................................... $ - $ - $ 1
NONCASH INVESTING AND FINANCING ACTIVITIES:
Issuance of common stock for notes receivable......................... $ - $ - $ 11
Repurchase of common stock for notes receivable....................... $ - $ - $ 9
Change in unrealized gain or loss in available-for-sale securities... $ (28) $ 54 $ 39
Property acquired under capital leases................................ $ - $ 40 $ -
The accompanying notes are an integral part of these financial statements.
-41-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS
1. FORMATION AND BUSINESS OF THE COMPANY:
General Surgical Innovations, Inc. ("the Company") was incorporated
on April 13, 1992, to engage in the development, manufacturing and marketing
of medical device surgical balloon dissectors which create new working spaces
between natural tissue planes in the human body. The Company sells products
in the United States, Europe, Australia and South America, through its direct
sales force and key distributors. While the Company has developed or is
developing surgical balloon dissectors 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
fiscal 2000.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
USE OF ESTIMATES:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS:
The Company considers investments with an original maturity of 90 days
or less as of the date of purchase to be cash equivalents.
AVAILABLE-FOR SALE SECURITIES:
The Company has classified its investments as "available-for-sale."
Such investments are recorded at fair value, and unrealized holding gains and
losses are recorded net of related taxes as a separate component of
shareholders' equity. Interest income is recorded using an effective interest
rate, with associated premium or discount amortized to "investment income."
Realized gains and losses on sales of all such securities are reported in
earnings and computed using the specific identification cost method. All
investments with maturity dates greater than 365 days are classified as
non-current.
INVENTORIES:
Inventories are stated at the lower of cost or market. Cost is based on
actual costs computed on a first-in, first-out basis.
PROPERTY AND EQUIPMENT:
Property and equipment are stated at cost, net of accumulated
depreciation and amortization. Furniture, fixtures, equipment and tooling are
depreciated on a straight-line basis over their estimated useful lives of three
to five years. Leasehold improvements are amortized over the lesser of their
estimated useful lives or the term of the lease.
INTANGIBLE ASSETS:
Intangible assets include patents which are being amortized on a
straight-line basis over five years. The Company periodically assesses the
recoverability of intangible assets by determining whether amortization of the
asset
-42-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
balance over the remaining life can be recovered through undiscounted future
operating cash flows of the acquired operation. The amount of impairment, if
any, is measured based on projected discounted future operating cash flows and
is recognized as a write down of the asset to net realizable value.
EMPLOYEE STOCK PLANS:
The Company accounts for its stock option plans and its employee stock
purchase plan in accordance with the provisions of the Accounting Principles
Board's Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees."
In 1995, the Financial Accounting Standards Board issued Statement of Financial
Accounting Standards No. 123 ("SFAS 123"), "Accounting for Stock-Based
Compensation." SFAS 123 establishes a fair value based method of accounting for
stock-based plans and is effective for fiscal years beginning after December 15,
1995. The Company is continuing to account for its employee stock plans in
accordance with the provisions of APB 25, and has provided pro forma disclosure
in Note 6 as if the measurement provisions of SFAS 123 had been adopted.
REVENUE RECOGNITION:
The Company recognizes revenue from product sales upon shipment of
product and when title passes to its customer. Allowances are provided for
estimated returns. Revenue from guaranteed payments is recognized in the period
received according to the terms and conditions of a distributor agreement.
RESEARCH AND DEVELOPMENT:
Research and development expenses are charged to operations as
incurred.
BUSINESS RISKS AND CREDIT CONCENTRATION:
A substantial portion of the Company's sales have been derived from
sales of its surgical balloon dissectors for hernia repair procedures. Failure
of the Company to successfully develop and commercialize surgical balloon
dissector products for applications other than hernia repair could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In March 1994, the Company entered into a distribution agreement
with United States Surgical Corporation ("USSC") providing USSC with limited
exclusive rights to distribute the Company's surgical balloon dissectors in
the hernia repair market in both the United States and certain other
countries. In fiscal 1997 and 1996, sales to USSC, which include sales to
Autosuture, Inc., a subsidiary of USSC, represented approximately 27 percent
and 92 percent, respectively, of the Company's sales. In November 1996, the
Company terminated its distribution agreement with USSC; there were no sales
to USSC in fiscal 1998. In September 1998, the Company signed two
non-exclusive, three-year agreements with USSC. Under the terms of the first
agreement, USSC has obtained non-exclusive rights to market and distribute
GSI's SPACEMAKER(R) surgical balloon dissectors worldwide for use in hernia
repair and stress urinary incontinence ("SUI") procedures. Under the terms of
the second agreement, GSI has non-exclusive rights to market and distribute
several products, including USSC's 5 mm mesh fixation device, the
ProTack(TM), which is offered with GSI's balloon dissectors in the
SPACEMAKER(R)Total Solution(TM) hernia repair kit. Sales to USSC in fiscal
1999 represented approximately three percent of the Company's total sales.
In December 1996, the Company entered into a five year OEM supply
agreement (the "EES Agreement") with Ethicon Endo-Surgery ("EES"), pursuant
to which GSI granted EES exclusive worldwide sales and marketing rights to
sell the SPACEMAKER(R) surgical balloon dissectors in the laparoscopic hernia
repair and stress urinary incontinence ("SUI") markets. EES made guaranteed
payments pursuant to the EES Agreement of $4.9 million in fiscal year 1997,
and additional payments in lieu of product purchases pursuant to a mutual
agreement in the amount of $1.6 million in fiscal year 1998. In February
1998, the Company and EES replaced the exclusive EES Agreement
-43-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
with a non-exclusive distribution agreement for the laparoscopic hernia repair
and SUI markets. In fiscal year 1999, EES made no guaranteed payments or
payments in lieu of product purchases. Sales and guaranteed payments from EES
represented approximately 21 percent, 74 percent and 65 percent of the Company's
1999, 1998 and 1997 revenues, respectively.
In May 1999, the Company signed a distribution agreement with Dexterity
Surgical, Inc. ("Dexterity"). The terms of the agreement gave Dexterity rights
to market and distribute GSI's SPACEMAKER(R) balloon dissector products for
hernia repair and laparoscopic bladder neck suspension repair procedures in all
or parts of 28 states. In fiscal year 1999, sales to Dexterity represented
approximately 23 percent of total company sales.
The Company maintains its cash balances in demand accounts primarily
with one financial institution. For its accounts receivable, management of the
Company performs ongoing credit evaluations of its customers and maintains
allowances for doubtful accounts. Historically the Company has not experienced
significant losses related to individual customers or groups of customers in any
particular geographic area. At June 30, 1998 and 1997, one distributor accounted
for approximately 46 percent and 93 percent, respectively, of accounts
receivable. At June 30, 1999, another distributor accounted for approximately 46
percent of accounts receivable.
FAIR VALUE OF FINANCIAL INSTRUMENTS:
Carrying amounts of the Company's financial instruments including
cash and cash equivalents, accounts receivable and accounts payable
approximate fair values due to their short maturities. Based on the borrowing
rates currently available to the Company for loans with similar terms, the
carrying values of the equipment loan and line of credit approximate fair
values. Estimated fair values for available-for-sale securities, which are
separately disclosed elsewhere, are based on quoted market prices for the
same or similar instruments.
INCOME TAXES:
The Company accounts for income taxes under the liability method. Under
the liability method, deferred tax assets and liabilities are determined based
on differences between financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that will be
in effect when the differences are expected to reverse. The Company is required
to adjust deferred tax liabilities in the period when tax rates or the
provisions of the income tax laws change. Valuation allowances are established
when necessary to reduce deferred tax assets to the amounts expected to be
realized.
COMPREHENSIVE INCOME:
The Company has adopted the provisions of Statement of Financial
Accounting Standards No. 130 ("SFAS 130"), "Comprehensive Income." SFAS 130
establishes standards for reporting and display of comprehensive income and its
components for general-purpose financial statements. Comprehensive income is
defined as net income plus all revenues, expenses, gains and losses from
non-owner sources that are excluded from net income in accordance with generally
accepted accounting principles.
COMPUTATION OF NET LOSS PER COMMON SHARE AND PER COMMON SHARE-ASSUMING
DILUTION:
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.
-44-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Stock options to purchase 2,245,655, 1,816,906 and 1,363,447 shares
of common stock at prices ranging from $0.09 to $9.75 per share were
outstanding at June 30, 1999, 1998 and 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.
RECENT PRONOUNCEMENTS:
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting
for Derivative Instruments and Hedging Activities," which establishes
accounting and reporting standards for derivative instruments and hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure
those instruments at fair value. To date, the Company has not engaged in
derivative and hedging activities. SFAS 133 will be effective for fiscal
years beginning after June 15, 2000.
3. BALANCE SHEET DETAIL:
AVAILABLE-FOR-SALE SECURITIES:
As of June 30, 1999, available-for-sale securities consisted of the
following (IN THOUSANDS):
AMORTIZED UNREALIZED ESTIMATED MATURITY
COST GAINS (LOSSES) FAIR VALUE DATES
----------- -------------- ----------- ----------
Obligations of federal government agencies,
short-term................................. $ 8,698 $ 1 $ 8,699 7/99-6/00
Corporate obligations, principally commercial
paper and corporate notes, long-term....... 1,012 (13) 999 7/00-4/01
----------- ----------- -----------
$ 9,710 $ (12) $ 9,698
----------- ----------- -----------
----------- ----------- -----------
-45-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. BALANCE SHEET DETAIL: (CONTINUED)
As of June 30, 1998, available-for-sale securities consisted of the
following (IN THOUSANDS):
AMORTIZED UNREALIZED ESTIMATED
COST GAINS FAIR VALUE
-------------- --------------- ---------------
Corporate obligations, principally commercial
paper and corporate notes, short-term....... $ 10,729 $ 14 $ 10,743
Corporate obligations, principally commercial
paper and corporate notes, long-term........ 8,770 2 8,772
-------------- --------------- ---------------
$ 19,499 $ 16 $ 19,515
-------------- --------------- ---------------
-------------- --------------- ---------------
During 1999 and 1998, there were no realized gains or losses on the
disposal of available-for-sale securities.
PROPERTY AND EQUIPMENT:
Property and equipment comprise (IN THOUSANDS):
JUNE 30,
-----------------------------------
1999 1998
--------------- ----------------
Equipment....................................................... $ 1,612 $ 1,238
Furniture and fixtures.......................................... 380 437
Tooling......................................................... 1,546 457
Leasehold improvements.......................................... 1,233 1,192
--------------- ----------------
4,771 3,324
Less accumulated depreciation and amortization.................. (1,719) (1,223)
--------------- ----------------
$ 3,052 $ 2,101
--------------- ----------------
--------------- ----------------
INVENTORIES:
Inventories comprise (IN THOUSANDS):
JUNE 30,
-----------------------------------
1999 1998
--------------- ----------------
Raw materials................................................... $ 1,358 $ 910
Work in progress................................................ 78 -
Finished goods.................................................. 1,096 374
--------------- ----------------
$ 2,532 $ 1,284
--------------- ----------------
--------------- ----------------
INTANGIBLE AND OTHER ASSETS:
Intangible and other assets comprise (IN THOUSANDS):
JUNE 30,
-----------------------------------
1999 1998
--------------- ----------------
Patents......................................................... $ 360 $ 360
Related party note receivable................................... 193 -
Other........................................................... 81 80
--------------- ----------------
634 440
Less accumulated amortization................................... (318) (246)
--------------- ----------------
$ 316 $ 194
--------------- ----------------
--------------- ----------------
-46-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
3. BALANCE SHEET DETAIL: (CONTINUED)
ACCRUED LIABILITIES:
Accrued liabilities comprise (IN THOUSANDS):
JUNE 30,
-----------------------------------
1999 1998
--------------- ----------------
Accrued payroll and related expenses............................ $ 463 $ 391
Accrued legal expenses.......................................... 536 660
Accrued other................................................... 421 265
--------------- ----------------
$ 1,440 $ 1,316
--------------- ----------------
--------------- ----------------
4. BANK BORROWINGS:
On March 25, 1996, the Company entered into a loan agreement with a
financial institution which provides for an equipment loan of $700,000 with
interest at the bank's prime rate plus 1.25 percent (9.00 percent at June 30,
1999). The note matures on June 30, 2000. Future minimum payments under the
loan are $82,000 in the fiscal year ending June 30, 2000.
The bank borrowings are collateralized by substantially all of the
Company's assets. In addition, the Company is required to maintain certain
restrictive financial covenants including minimum tangible net worth and a
minimum quick ratio.
5. COMMITMENTS AND CONTINGENCIES:
OPERATING LEASE AGREEMENTS:
The Company leases its facilities under a non-cancelable operating
lease that expires on April 1, 2004. The lease contains two options to extend
the lease term, with each extended term to be for a period of five years. The
Company is responsible for certain taxes, maintenance costs and insurance under
the lease. Future minimum rental payments under the lease are as follows (IN
THOUSANDS):
YEAR ENDING JUNE 30,
2000..................................... 740
2001..................................... 997
2002..................................... 1,024
2003..................................... 1,052
2004..................................... 805
----------
$ 4,618
----------
----------
Rent expense for the years ended June 30, 1999, 1998 and 1997 was
$635,244, $625,488, and $600,645, respectively.
-47-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
CAPITAL LEASE AGREEMENTS:
The Company has two capital lease agreements for office equipment.
Amounts financed under these leases total approximately $41,000, with
associated accumulated depreciation of $29,000. Future minimum lease payments
under these capital leases are $12,000 in the fiscal year ending June 30,
2000.
OTHER COMMITMENTS:
The Company has entered into certain royalty agreements to obtain
technology which provide for royalties ranging from one to four percent of the
sales price for products which utilize this technology. Amounts charged to
operations for the years ended June 30, 1999, 1998 and 1997 were $187,497,
$289,255 and $356,831, respectively.
Also, in 1994 in conjunction with obtaining technology, the Company
entered into a royalty agreement that provides for royalties of four percent of
net sales for products which utilize this technology through 2001. Minimum
royalties under the agreement are $75,000, $87,500 and $50,000 for the years
ending June 30, 2000, 2001 and 2002, respectively.
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 (C96-20424JW). In April 1998, GSI obtained a summary judgment that
the patent in suit, Moll et al Patent No. 5,520,609, was unenforceable
because it had been obtained by misleading the Patent & Trademark Office, and
an award of attorney's fees of $990,000. The appellate court subsequently
vacated this decision because, in its view, there are factual issues which
must be resolved in a trial on whether Origin misled the PTO. In July 1999,
the case was returned to the district court for further proceedings.
In June 1996, GSI filed an action against Origin in the U.S. District
Court for the Northern District of California alleging that the use of
Origin's products infringes GSI's U.S. Patent No. 5,514,153 (C96-20447JW).
The case was decided in favor of GSI partly by summary judgment and partly by
jury verdict, both during fiscal 1999. Patent 5,514,153 ("the '153 patent")
was found to be valid, and Origin's infringement was found to be willful.
Lost profits of approximately $12.9 million were awarded to GSI by the jury.
Origin is appealing the infringement and willfulness findings (but not patent
validity nor the amount of infringement damages), and GSI is appealing for
enhanced damages, attorneys' fees and the failure to find infringement of
additional claims. The Company has not recorded a receivable for this gain
contingency. Resolution is expected in calendar year 2000. Following these
findings, the Court has entered an injunction prohibiting sale in the United
States of all of Origin's balloon dissection products, to become fully
effective on November 15, 1999, and an immediate injunction against sales to
any new customers.
In September 1997, the Company filed an action against Origin alleging
that the use of Origin's products infringes GSI's U.S. Patent No. 5,667,520
(C97-20944JW). Discovery is nearly complete in this case and the complaint has
now been amended to add a claim of infringement of GSI's patent number
5,860,997. This case is now stayed pending the outcome of appeals in the '153
case.
-48-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
5. COMMITMENTS AND CONTINGENCIES: (CONTINUED)
GSI is also involved in an interference proceeding in the U.S. Patent
Office against Origin to determine whether certain subject matter was first
invented by GSI and whether the disputed matter is patentable. In November
1998, binding arbitration determined that GSI was first to invent the
disputed subject matter and therefore is the only party entitled to any
patent. Additionally, the Patent Office Appeals Board found the subject
matter to be patentable. This latter finding is being appealed by Origin to
the Court of Appeals for the Federal Circuit. Resolution is expected in
calendar year 2000.
On April 9, 1999, a suit was filed against GSI in the United States
District Court for the Southern District of Illinois. This suit, brought by
Dr. Peter M. Bonutti and by Bonutti Research, Inc., seeks a 50 percent share
of the $12.9 million damages judgment GSI obtained in its suit against Origin
and seeks rescission of the 1995 agreement by which GSI obtained assignment
of certain Bonutti technology. From this assigned technology, GSI prosecuted
patent applications which became the '153 and other patents, which credit Dr.
Bonutti as sole inventor. This case is in the discovery phase.
While the Company believes it will be successful in these
proceedings, there can be no assurance of such success. Failure of the
Company to prevail in such proceedings would have a material adverse effect
on the Company's business, financial condition and results of operations.
6. SHAREHOLDERS' EQUITY:
PREFERRED STOCK:
Under the Company's Articles of Incorporation, the Company's preferred
stock is issuable in series and the Company's Board of Directors is authorized
to determine the rights, preferences and terms of each series.
During 1996, the Company amended its Articles of Incorporation to
authorize 2,000,000 shares of undesignated preferred stock. Preferred stock may
be issued from time to time in one or more series. As of June 30, 1999, the
Company had no shares issued and outstanding.
COMMON STOCK:
The Company has issued through June 30, 1999, shares of its common
stock to the founders and key employees of the Company under stock purchase
agreements. Certain stock purchase agreements (the "Agreements") contain
provisions for the repurchase of common stock by the Company in the event of
termination of employment during the vesting period following the date of
employment. Generally, 25 percent of the shares of common stock purchased under
the Agreements are released from the Company's repurchase option at the end of
twelve months from a participant's hiring date with the remaining shares being
released from repurchase ratably over the next 36 months. At June 30, 1999,
14,897 shares are subject to repurchase under the Agreements. Each share of
common stock has the right to one vote. The holders of common stock are also
entitled to receive dividends whenever funds are legally available and when
declared by the Board of Directors, subject to the prior rights of holders of
any class of outstanding stock having priority rights as to dividends.
STOCK OPTION PLANS:
1992 Stock Option Plan
The Company has an Incentive Stock Option Plan (the "Plan") under
which 1,715,895 shares of common stock were originally reserved for issuance.
An additional 500,000 and 400,000 shares were reserved in November 1997 and
November 1996, respectively, bringing the aggregate number of shares of
common stock reserved for issuance to 2,615,895 as of June 30, 1998. In
November 1998, the Plan was amended to: (i) 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 September 14, 2002 (the date the 1992 Plan
terminates) by an amount equal to the lesser of (x) four percent (four
percent) 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
such annual meeting, or (y) 600,000 shares, and (ii) 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
-49-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. SHAREHOLDERS' EQUITY: (CONTINUED)
(effective as of July 1, 1998). The maximum aggregate number of shares of common
stock that may be issued under the 1992 Plan is 5,015,895. At this time, an
additional 438,773 shares were reserved, bringing the aggregate number of shares
of common stock reserved for issuance to 3,054,668 as of June 30, 1999.
Under the Plan, incentive options may be granted at prices not lower
than fair market value at the date of grant or 110 percent of the fair market
value if the optionee, immediately prior to the grant, owns stock representing
10 percent or more of the voting power or value of all securities. Nonstatutory
options may be granted at prices not lower than 85 percent of fair market value
at the date of grant as determined by the Board of Directors. Options granted
under the Plan are exercisable and vest at such times and under such conditions
as determined by the Board. The options generally expire from five years to ten
years from date of grant.
1995 Directors' Stock Option Plan
In November 1995, the Company adopted the Directors' Stock Option Plan
("the Directors' Plan"), under which 164,726 shares of common stock have been
reserved for issuance. The Directors' Plan provides for the grant of
nonstatutory stock options to non-employee directors of the Company. The
Directors' Plan provides an initial option to purchase 27,454 shares of common
stock, which vests annually over four years, and beginning with the 1997 annual
meeting, provides an additional annual option to purchase 6,864 shares of common
stock.
The exercise price of all stock options granted under the Directors'
Plan shall be equal to the fair market value of the Company's common stock on
the date of grant of the option. Options granted under the Directors' Plan have
a term of ten years.
An additional 25,000 shares have been granted outside of the above
stock options plans.
Stock option activity is set forth below (IN THOUSANDS, EXCEPT PER
SHARE DATA):
OUTSTANDING OPTIONS
---------------------------------------------------------
WEIGHTED
SHARES AVERAGE AGGREGATE
AVAILABLE NUMBER OF PRICE PER PRICE IN
FOR GRANT SHARES SHARE DOLLARS
----------- ----------- ----------- -----------
Balances, June 30, 1996........................... 696 1,096 $ 1.21 $ 1,322
Increase in shares reserved.................. 400 - - -
Options granted.............................. (497) 497 8.65 4,299
Options exercised............................ - (172) .45 (78)
Options terminated........................... 58 (58) 2.21 (128)
----------- ----------- -----------
Balances, June 30, 1997........................... 657 1,363 3.97 5,415
Increase in shares reserved.................. 525 - - -
Options granted.............................. (1,153) 1,153 4.47 5,159
Options exercised............................ - (128) 1.00 (129)
Options terminated........................... 571 (571) 6.40 (3,655)
----------- ----------- -----------
Balances, June 30, 1998........................... 600 1,817 3.74 6,790
Increase in shares reserved.................. 439 - - -
Options granted.............................. (1,757) 1,757 2.29 4,031
Options exercised............................ - (33) 1.26 (42)
Options terminated........................... 1,295 (1,295) 4.69 (6,077)
----------- ----------- ----------- -----------
Balances, June 30, 1999........................... 577 2,246 $ 2.09 $ 4,702
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
-50-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. SHAREHOLDERS' EQUITY: (CONTINUED)
At June 30, 1999, stock options outstanding are as follows (IN
THOUSANDS, EXCEPT PER SHARE DATA):
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE PRICES OF SHARES CONTRACTUAL LIFE EXERCISE PRICE OF SHARES EXERCISE PRICE
$ 0.0874 - $ 1.5600 584 5.8 $0.94 550 $0.92
$ 1.5601 - $ 4.0000 1,552 8.7 $2.25 73 $2.39
$ 4.0001 - $ 9.7500 110 8.6 $5.96 22 $8.02
-------- ---
2,246 7.9 $2.09 645 $1.33
-------- ---
-------- ---
At June 30, 1998 and 1997, options to purchase 679,327 and 434,609
shares were exercisable at a weighted average exercise price of $2.49 and $1.60
per share, respectively.
Compensation of approximately $600,000 has been attributed to stock
options granted after May 1995 and prior to the sale of the Company's common
stock in an initial public offering. The deferred compensation is being
recognized as a charge to income over the period for which the related stock
options become exercisable, which is generally four years. Amortization of the
deferred compensation was approximately $137,000, $138,000 and $199,000 during
the years ended June 30, 1999, 1998 and 1997, respectively.
On August 5, 1997, the Company repriced 357,034 options, ranging in
price from $5.63 to $22.25 per share, to the fair market value on that date
of $4.38 per share.
The Company implemented a stock option exchange program effective
October 6, 1998, pursuant to which all holders of options issued under the
1992 Plan may surrender for cancellation all options granted after May 10,
1996 (the date of the Company's initial public offering) with a price above
$1.5601, the fair market value on the effective date. The Company cancelled
1,127,876 options, ranging in price from $2.00 to $9.75, and reissued the
same number of new options for an exercise price of $1.5601. The new options
were subject to a nine month restriction on exercise (until July 6, 1999),
subject to certain exceptions. All executive officers of the Company were
eligible to participate in the option exchange program.
PRO FORMA INFORMATION:
Had compensation costs for options awarded in fiscal 1999, 1998 and
1997 been determined based on the fair value at the grant date consistent with
the provisions of SFAS 123, the Company's net loss and net loss per share would
have resulted in the pro forma amounts indicated in the following (IN THOUSANDS,
EXCEPT PER SHARE data):
JUNE 30,
-----------------------------------------------
1999 1998 1997
------------ ------------- ------------
Actual net loss $(16,071) $ (9,142) $ (1,876)
Pro forma net loss $(18,819) $ (10,511) $ (2,661)
Actual net loss per share $ (1.19) $ (.68) $ (.14)
Pro forma net loss per share $ (1.40) $ (.79) $ (.20)
The above pro forma disclosures are not necessarily representative of
the effects on reported net income (loss) in future years.
In fiscal 1999, 1998 and 1997, the weighted-average fair value of options
granted during the year was $1.74, $2.61 and $5.12, respectively. The fair value
of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions used for
grants:
-51-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
6. SHAREHOLDERS' EQUITY: (CONTINUED)
June 30,
------------------------------------------
1999 1998 1997
------- ------- -------
Dividend yield 0.00% 0.00% 0.00%
Expected volatility 97.00% 62.00% 62.00%
Risk-free interest rate 5.58% 5.93% 6.69%
Expected term 5 Years 5 Years 5 Years
EMPLOYEE STOCK PURCHASE PLAN:
In March 1996, the Board of Directors adopted the 1996 Employee Stock
Purchase Plan (the "ESPP") and reserved 274,543 shares of common stock for
issuance. The purpose of the ESPP is to provide eligible employees of the
Company with a means of acquiring common stock of the Company through payroll
deductions. The purchase price of such stock under the ESPP cannot be less than
85 percent of the lower of the fair market value on the specified purchase date
or at the beginning of the offering period. At June 30, 1999, 69,670 shares had
been issued under the ESPP.
COMMON STOCK PURCHASE RIGHTS:
In May 1997, the Company distributed a dividend to shareholders
comprised of a right to purchase one share of common stock (a "Right") for each
outstanding share of common stock of the Company they hold. These Rights do not
become exercisable or transferable apart from the common stock until the
Distribution Date which is the tenth day after a person or group either (a)
acquires beneficial ownership of 15 percent or more of the Company's common
stock or (b) announces a tender or exchange offer, the consummation of which
would result in ownership by a person or group of 15 percent or more of the
Company's common stock. After the Distribution Date, each Right will entitle the
holder to purchase from the Company one share of common stock at a price of $35
per share.
If the Company is acquired in a merger or other business combination
transaction, or if 50 percent or more of its assets or earnings power is sold,
each Right will entitle the holder to purchase at the exercise price that number
of shares of the acquiring company having a then current market value of two
times the exercise price of the Right. In the event that the Company is the
surviving corporation in a merger and the Company's common stock remains
outstanding, or in the event that an acquiring party engages in certain
self-dealing transactions, each Right not owned by the acquiring party will
entitle the holder to purchase at the exercise price that number of shares of
the Company's common stock having a then current market value of two times the
exercise price of the Right.
The Rights are redeemable at the Company's option for $.01 per Right
prior to becoming exercisable, may be amended at the Company's option on or
prior to the Distribution Date and expire on May 8, 2007.
7. EMPLOYEE BENEFIT PLAN:
The Company has a qualified 401(k) plan available to substantially all
employees over the age of 21. Participants may contribute up to 20 percent of
their annual compensation to the plan, limited to a maximum amount set by the
Internal Revenue Service. The Company may make contributions to the 401(k) plan
at the discretion of the Board of Directors. No Company contributions have been
made to the plan since inception.
8. INCOME TAXES:
At June 30, 1999, the Company had federal and state net operating loss
carryforwards of $37.3 million and $11.5 million, respectively, which expire in
the years 1999 - 2019.
As a result of a change in ownership, as defined, federal and state net
operating loss carryforwards are subject to an annual limitation of $400,000.
-52-
GENERAL SURGICAL INNOVATIONS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES: (CONTINUED)
Temporary differences and carryforwards that gave rise to significant
portions of deferred tax assets and liabilities are as follows (IN THOUSANDS):
JUNE 30,
-----------------------------
1999 1998
------------- ------------
Deferred tax assets:
Net operating loss carryforwards................... $ 13,364 $ 7,657
Capitalized research expenses...................... 433 370
Research and development credit carryforward....... 665 421
Accrued liabilities and other...................... 335 240
Valuation allowance................................ (14,797) (8,688)
------------- ------------
$ --- $ ---
------------- ------------
------------- ------------
In accordance with generally accepted accounting principles, a valuation
allowance must be established for a deferred tax asset if it is more likely
than not that a tax benefit will not be realized from the asset in the
future. The Company has established a valuation allowance to the extent of
its deferred tax assets since it is more likely than not that a benefit will
not be realized in the future due to the Company's recurring operating losses.
The Company's effective tax rate differs from the statutory federal
income tax rate as shown in the following schedule:
JUNE 30,
----------------------------------------------
1999 1998 1997
------------- ------------ ------------
Income tax benefit at statutory rate...................... (34)% (34)% (34)%
Net operating loss not benefited.......................... 34 34 34
------------- ------------ ------------
Effective tax rate........................................ --- % --- % --- %
------------- ------------ ------------
------------- ------------ ------------
9. RELATED PARTY TRANSACTIONS:
The Company entered into certain product development arrangements and
royalty agreements with a sole proprietorship which is owned by a director of
the Company. Under these agreements, the Company pays royalties of one to
four percent of the sales price for products which utilize the technology
obtained. The Company has paid this sole proprietorship $88,030, $111,536 and
$190,485 in fiscal years 1999, 1998 and 1997, respectively.
The Company has a note receivable for $300,000 from an officer of the
Company. The note accrues interest at 5.42% per annum. The principal and
accrued interest will be forgiven monthly in the form of bonus payments of
$68,750 on September 3, 1998 and monthly over a 53 month period thereafter
provided the officer is an employee of the Company. In the event of termination
of the officer's employment with the Company without cause, the aggregate amount
of all bonus payments that would have been otherwise received will be paid by
the Company in one bonus payment. At June 30, 1999, the note receivable from
related party was $193,405.
10. SEGMENT INFORMATION:
The Company, which operates in a single industry segment, designs,
manufactures and markets balloon dissection systems and related minimally
invasive surgical instruments and sells its products globally. The following
is a summary of the Company's geographic operations (IN THOUSANDS):
1999 1998 1997
------ ------ ------
Domestic........... $6,328 $6,618 $8,944
International...... 548 210 42
------ ------ ------
Total revenue $6,876 $6,828 $8,986
------ ------ ------
------ ------ ------
The Company's assets are located in the United States. The Company does
not segregate information related to operating income generated by its export
sales.
11. SUBSEQUENT EVENTS (Unaudited):
TYCO MERGER:
In August 1999, the Company and Tyco International Ltd. ("Tyco")
entered into a definitive agreement pursuant to which TYCO will acquire GSI.
GSI shareholders will receive a fraction of a TYCO common share valued at
$7.50 per common share for each common share of GSI. The transaction is
valued at approximately $100 million. The closing of this deal is contingent
upon shareholder approval of the Company, as well as certain regulatory
approvals.
-53-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
Date: September 16, 1999 By: /s/ Gregory D. Casciaro
------------------------
Gregory D. Casciaro
President, Chief Executive Officer and Director
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENT, that each person whose signature
appears below constitutes and appoints Gregory D. Casciaro and Stephen J.
Bonelli his attorneys-in-fact, each with the power of substitution, for him in
any and all capacities, to sign any amendments to this Report on Form 10-K, and
to file the same, with exhibits thereto and other documents in connection
therewith with the Securities and Exchange Commission, hereby ratifying and
confirming all that each of said attorneys-in-fact, or his substitute or
substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons in the capacities and
on the dates indicated.
Signature Title Date
- ------------------------------------------------------------------------------------------------------------------
/s/ Roderick A. Young Chairman of the Board of Directors September 16, 1999
- ---------------------
(Roderick A. Young)
/s/ Gregory D. Casciaro President, September 16, 1999
- ----------------------- Chief Executive Officer and Director
(Gregory D. Casciaro)
/s/ Stephen J. Bonelli Chief Financial Officer, September 16, 1999
- ----------------------- Vice President of Finance and Treasurer
(Stephen J. Bonelli)
Director
- ---------------------
(David W. Chonette)
/s/ Thomas A. Fogarty Director September 16, 1999
- ---------------------
(Thomas A. Fogarty)
/s/ Paul Goeld Director September 16, 1999
(Paul Goeld)
/s/ James Sulat Director September 16, 1999
(James Sulat)
/s/ Mark A. Wan Director September 16, 1999
- ----------------
(Mark A. Wan)
-54-