<PAGE>
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934 For the fiscal year ended October 31, 1996
or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act o 1934
For the transition period from ___ to ____
Commission file number: 0-13907
- --------------------------------------------------------------------------------
BIO-VASCULAR, INC.
(Exact name of Registrant as specified in its charter)
- --------------------------------------------------------------------------------
Minnesota 41-1526554
------------------ ------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
2575 UNIVERSITY AVENUE, ST. PAUL, MINNESOTA 55114-1024
(Address of principal executive offices)
TELEPHONE NUMBER: (612) 603-3700
--------------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common Stock Purchase Rights
--------------------------
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. [ ]
As of January 2, 1997, 9,486,270 shares of Common Stock of the Registrant were
outstanding, and the aggregate market value of the Common Stock of the
Registrant (based upon the last reported sale price of the Common Stock on that
date by the Nasdaq National Market), excluding shares owned beneficially by
executive officers and directors, was approximately $64,024,223.
Part III of this Annual Report on Form 10-K incorporates by reference
information (to the extent specific sections are referred to herein) from the
Registrant's Proxy Statement for its Annual Meeting of Shareholders to be held
March 19, 1997 (the "1997 Proxy Statement").
<PAGE>
Tissue-Guard(TM), Supple Tissue-Guard(TM), Peri-Strips(R), Dura-Guard(R), Vascu-
Guard(R), Supple Peri-Guard(R), Peri-Guard(R), Biograft(R), Flo-Rester(R), and
Bio-Vascular Probe(R), are trademarks of the Company. VoxelView(R),
VoxelGeo(R), Voxel Animator(TM), and Vitrea(TM) are trademarks of Vital Images
Incorporated ("Vital Images").
Forward-Looking Statements
- --------------------------
This Annual Report on Form 10-K contains certain forward-looking statements.
For this purpose, any statements contained in this Form 10-K that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the foregoing, words such as "may," "will," "expect,"
"believe," "anticipate," "estimate" or "continue" or the negative or other
variations thereof or comparable terminology are intended to identify forward-
looking statements. These statements by their nature involve substantial risks
and uncertainties, and actual results may differ materially depending on a
variety of factors, including those set forth in the section below entitled
"Important Factors."
PART I
ITEM 1 - Business
- -----------------
Bio-Vascular, Inc. ("Bio-Vascular" or "the Company") was incorporated in
Minnesota in July 1985. The Company's principal executive offices are located
at 2575 University Avenue, St. Paul, Minnesota 55114-1024, and its telephone
number is (612) 603-3700.
Discontinued Operations
- -----------------------
On October 28, 1996, the Bio-Vascular Board of Directors approved the spin-off
of its wholly owned subsidiary, Vital Images, to the Company's shareholders
through a pro rata distribution of all of the issued and outstanding shares of
capital stock. The spin-off is expected to occur around March 31, 1997,
following review of the appropriate filings by the Securities and Exchange
Commission, at which time Vital Images will trade as an independent public
company. The Company has attempted to structure the transaction as tax-free,
but since no advance ruling will be sought from the Internal Revenue Service, no
assurance can be made about the final tax treatment of the transaction. In
connection with the distribution, the Company will mail to shareholders, prior
to the distribution date, an Information Statement containing information
regarding Vital Images, its business and operations, and the distribution.
Vital Images is a leading developer of 3-D volume rendering software for medical
research, clinical diagnosis and screening, and surgical planning. Its
products, which are sold worldwide to hospitals, medical imaging centers,
surgery centers and oncology centers, are intended to reduce invasiveness,
enhance visual information and produce fast results.
In November 1996 Vital Images received clearance from the U.S. Food and Drug
Administration ("FDA") to market its new Vitrea(TM) 3-D medical visualization
system. The Vitrea system permits the user to visualize radiological images in
two or three dimensions, and navigate or "fly through" them interactively.
Vitrea will automatically set all visualization parameters using adaptive
clinical protocols. The Vitrea system, which consists of proprietary software
from Vital Images, operates on the new Silicon Graphics 0/2/(TM) computer and
will be marketed as an integrated visualization system. The Vitrea system
incorporates two features that make it easy to use: the built in clinical
workflow and the clinical protocols. The Vitrea workflow allows the user in five
minutes or less to: retrieve CT or MR data over the hospital's network; select a
starting image from a gallery of 2-D or 3-D views; "fly" through or around the
selected 3-D view; take a snapshot of selected images and create a multimedia
report; print the report to standard film or paper printers; and post the report
to an intranet server for instant secure access to the referring physician using
PC-based web browser technology.
Vital Images will market the Vitrea system through a direct sales channel in the
United States and through dealers in Europe and Asia, pending the appropriate
regulatory clearances in those countries. In addition, Vital Images is pursuing
development and sourcing relationships with major diagnostic imaging
manufacturers.
2
<PAGE>
Vital Images' offices are located at 2575 University Avenue, St. Paul, MN 55114-
1024 and at 505 North Fourth Street, Fairfield, Iowa 52556. Its telephone number
in St. Paul is (612) 603-3800 and in Fairfield is (515) 472-7726.
As a result of the plan to spin-off Vital Images, the Company's financial
statements and notes thereto contained elsewhere in this Annual Report on Form
10-K report the business of Vital Images as discontinued operations.
General Development of Business
- -------------------------------
Bio-Vascular, Inc. develops, manufactures and markets proprietary specialty
medical products for use in thoracic, cardiac, neuro and vascular surgery. The
Company's products include the Tissue-Guard product line and the Biograft
peripheral vascular graft. The Tissue-Guard product line includes Peri-Strips,
Dura-Guard, Vascu-Guard, Supple Peri-Guard, Peri-Guard, Tissue-Guard and Supple
Tissue-Guard. Tissue-Guard products are made from bovine pericardium (the thin
membrane surrounding the heart of cattle) processed using the Company's
proprietary tissue-fixation technologies. The Tissue-Guard products, made in
various configurations, are used in a wide variety of surgical procedures and
are designed to reinforce, reconstruct and repair tissue and prevent leaks of
air, blood and other body fluids. Biograft is used to bypass blocked blood
vessels and is produced from modified human umbilical veins. The Company also
markets and sells two surgical tools used in cardiac and vascular surgery, Flo-
Rester vessel occluders and the Bio-Vascular Probe, both of which are used in
bypass surgeries.
Peri-Strips was cleared to market by the Food and Drug Administration ("FDA") in
April of 1994. Peri-Strips are used primarily in lung volume reduction surgery
("LVRS") and other surgical procedures on the lung. LVRS is performed
principally on patients with late-stage emphysema who have significantly reduced
respiratory function. During a bilateral procedure, a portion of each diseased
lung is removed from the patient to provide relief from the symptoms of
emphysema. Peri-Strips are designed to prevent air leakage at the surgical
staple line which is essential to successful LVRS. While there is considerable
evidence that LVRS can significantly improve patients' breathing capacity,
exercise tolerance and quality of life, there does not presently exist, however,
a statistically significant body of clinical data from which to draw conclusions
concerning long-term outcomes associated with LVRS, as the procedure was first
performed less than four years ago.
Dura-Guard, which was cleared to market by the FDA in June of 1995, is a dural
patch used in cranial surgery designed to reduce post-surgical adhesions and
fluid leakage. Vascu-Guard, which was cleared to market by the FDA in June of
1995, is a vascular patch used primarily in carotid endarterectomy procedures
designed to improve tissue integration and reduce suture line bleeding. In
addition, the Company markets Supple Peri-Guard and Peri-Guard as a general
soft-tissue patching material for use in specialty surgical procedures.
The Company entered a period of significant growth in late 1994 and fiscal 1995.
Net revenue ("revenue") increased by 110%, fueled by sales of its Peri-Strips
product. Revenue from the sales of Peri-Strips was $685,000 in fiscal 1994 and
had increased to $5,550,000 in fiscal 1995. In January of 1996, the Healthcare
Financing Administration ("HCFA"), the agency of the federal government that
administers Medicare, made a national policy decision not to reimburse LVRS
("the HCFA decision"). These surgeries had been reimbursed nationwide on a
regional basis during fiscal 1994 and 1995. The Company estimates that
approximately 70% of the patients undergoing LVRS in fiscal 1995 were Medicare
patients. In April of 1996, the National Institute of Health ("NIH") announced a
collaborative study of LVRS with HCFA. The study, as it is currently structured,
is estimated to take seven years if it goes to completion and will include 2,580
Medicare patients, with a little more than half of those receiving LVRS done
bilaterally by open median sternotomy or thoracoscopic. This represents less
than 2% of those currently estimated to benefit from LVRS. The HCFA decision
materially and adversely affected the Company's financial results. In fiscal
1996 revenue from the sale of Peri-Strips decreased $1,214,000 to $4,336,000.
The Company understands that private insurance companies and managed care
organization are currently reimbursing LVRS based on their own evaluation of the
procedure and its outcomes. It is unknown whether these private payers will
change their reimbursement practices in the future. If these private payers
change their reimbursement practices, it could have an adverse impact on the
Company's business, financial condition and results of operations. (See
Business -Third Party Reimbursement and Cost Containment on Pages 15 and 16 of
this Report.)
3
<PAGE>
Members of Congress have been focusing their attention on the concerns raised by
HCFA's decision not to reimburse LVRS. The federal government's fiscal year
1997 appropriations bill, which was signed into law in the Fall of 1996,
included language requiring HCFA to review all available studies and research
data on the treatment of end-stage emphysema by LVRS and make a recommendation
to Congress as to the appropriateness of Medicare coverage by January 1, 1997.
The legislative history accompanying the law and interpreting this bill language
calls for HCFA's report to describe "a method and schedule for restoring
Medicare coverage of lung volume reduction surgery." As of January 24, 1997,
HCFA has not complied with this mandate and no information regarding the report
is available at this time. In addition, in late December 1996, a dozen members
of Congress submitted a written request to the House Ways and Means Committee
that it hold a hearing early in 1997 regarding LVRS because "such important
ethical and quality of care concerns have been raised." The hearing request
letter also states, "because many in the medical community believe LVRS is a
safe and effective treatment for certain patients with end-stage emphysema, we
are concerned that the decision not to extend Medicare coverage for the
procedure could negatively affect the lives of thousands of older Americans who
suffer from this disease." Despite the interest and action of Congress, no
assumptions can be made that any changes will occur to alter the study as it is
currently designed or to change the reimbursement decision before the study is
complete.
Financial Information About Industry Segments
- ---------------------------------------------
In connection with the spin-off of Vital Images and the Company's reporting of
the Vital Images business as discontinued operations in the financial statements
and notes thereto contained elsewhere in this Report, the Company's revenues,
operations and assets reported herein represent the Company's sole continuing
industry segment of developing, manufacturing and marketing proprietary
specialty medical products.
Narrative Description of Business
- ---------------------------------
Markets and Medical Need
While the trend in medicine is toward less invasive surgical procedures,
substantially all surgical procedures, whether invasive or not, involve the
cutting of tissue to access, repair or remove tissue at or from the surgical
site. Tissue which has been cut must either be repaired or replaced so that it
can heal properly. Proper repair of incised tissue is dependent upon a number
of variables, including whether (i) the repair must be leakproof, either for
air, blood or other body fluids, (ii) the incised tissue is under tension or
subject to shrinkage such that additional tissue is needed to bridge the two
tissue surfaces to be repaired, and (iii) the tissue subject to the repair must
be strengthened to accommodate the natural stresses of the human body. In
certain instances, suturing of two tissue surfaces will be effective. In other
instances, however, a patching material, whether autologous (from the body of
the patient), synthetic (from man-made materials) or tissue-based (from
processed tissue), may be needed. The Company's tissue-based products are
designed to fulfill the medical need for repairing human tissue and preventing
leaks at the surgical site in certain existing surgical procedures, as well as
offering a potential medium for techniques and procedures currently being
developed.
The Company's core competency is the development and manufacture of tissue-based
implantable medical products for use by surgeons in various surgical procedures
where reinforcing, reconstructing and repairing tissue and preventing leaks of
air, blood or other body fluids is necessary for the achievement of a favorable
outcome. Historically, surgeons primarily used autologous tissue in situations
where tissue repair was necessary. Harvesting the autologous material, which is
still performed in many circumstances, necessarily requires that the surgeon cut
into another part of the patient's body. The second surgical site increases the
cost of the procedure and lengthens the time the patient is under anesthesia,
thereby increasing the risk of complication and resulting in additional pain and
recovery time for the patient. To the extent a surgeon is confident that the
performance of a readily available medical product, whether tissue-based or
synthetic, is equal to or is better than the patient's own tissue, the Company
believes the surgeon will choose the tissue-based or synthetic product to avoid
a second surgical site as a means of reducing costs and improving outcomes.
Surgical procedures that are enabled or enhanced by the Company's tissue-based
products include lung volume reduction, craniotomy, carotid endarterectomy and
lower limb vascular reconstruction. Sales of the Company's products used in
these procedures accounted for 81% and 82% of the Company's net revenue in
fiscal 1996 and 1995,
4
<PAGE>
respectively.
Lung Volume Reduction Surgery ("LVRS"). Emphysema, most often caused by
cigarette smoking, is a progressive disease of the lungs characterized by air-
filled expansions or pocket-like blisters in the tissue of the lungs. Because
the air in the lungs cannot be fully expelled, the effort to inhale fresh air
becomes increasingly difficult, pushing the lung walls farther out and causing
the lungs to expand and lose their elasticity. The diaphragm, the major muscle
used for breathing, becomes flattened and loses its ability to function. As the
disease advances and patient health is progressively compromised, breathing
becomes more difficult. Persons with late-stage emphysema eventually become
incapable of even minor physical activity and often become dependent upon
continuous supplemental oxygen even when at rest. As a result, late-stage
emphysema can significantly reduce mobility, leaving individuals with late-stage
emphysema unable to care for themselves or engage in normal daily activities.
Because of the weakened respiratory condition of these patients, common
illnesses involving pulmonary functions can result in emergency room visits and
hospitalization.
Non-surgical therapies for patients suffering from emphysema include (i)
bronchodilators (pills and inhalers), to open up airways to temporarily relieve
wheezing or shortness of breath, (ii) steroids, to reduce inflammation in the
airways, (iii) pulmonary rehabilitation to increase endurance, and (iv) oxygen
supplements to help decrease the feeling of shortness of breath. Each of these
non-surgical therapies, however, offers only temporary relief and each becomes
less effective as the disease progresses. Data gathered by the Company
indicates that just the cost of medication and oxygen supplements for late-stage
emphysema patients can range from $5,000 to $8,000 annually. In addition,
visits to the doctor, in-home health care and equipment, and the need for
periodic emergency room care for persons suffering the effects of late-stage
emphysema, can increase costs substantially.
Lung transplantation is the only known cure for emphysema. A lung transplant
surgical procedure, however, costs up to $250,000 and is typically used only as
a last resort because of the high degree of risk associated with the procedure,
an inadequate supply of donor lungs, and the requirement that the patient
receive anti-rejection drugs for the remainder of his or her lifetime. Only 688
lung transplants were performed in the United States in 1994.
In the 1950's, a surgical procedure was developed to treat the symptoms of late-
stage emphysema by removing damaged lung tissue. Due to air leaks around the
suture lines, these experimental LVRS procedures resulted in a high mortality
rate and long, painful post-surgical recovery periods. As a result, the LVR
procedure was abandoned. In the late 1980's, various surgeons began to develop
specialized techniques for accessing and resecting the lung. The use of
surgical staples was introduced to perform LVRS more quickly, a particularly
important consideration in light of the debilitated condition of the patients
requiring the surgery. Despite many advances in LVRS, multiple small air leaks
caused by the staples in the lung continued to limit the effectiveness of the
procedure. In 1994, Dr. Joel Cooper, a pioneer in lung transplant surgery,
modified LVRS using strips of Supple Peri-Guard to reinforce the staple line to
prevent air leakage around the staples.
During LVRS, the surgeon collapses one lung, while allowing the patient to
continue breathing with the other lung with supplemental oxygen. Using a
stapling device, the surgeon removes sections of damaged tissue, typically 20%
to 30% of each lung. The Company's Peri-Strips are used to strengthen these
staple lines and prevent air leakage. By removing the most diseased tissue, the
remaining lung tissue has room to expand, improving breathing capacity by, among
other things, enabling the muscles used in breathing to regain their function
and allowing the rib cage and diaphragm to return to their normal size and
state. The Company estimates that the current cost of LVRS ranges from $25,000
to $45,000 per procedure.
The American Lung Association estimates that in 1992 there were approximately
1.9 million Americans suffering from emphysema. LVRS, however, is currently
only being performed on a small portion of these patients who have late-stage
emphysema and who meet certain criteria established by the attending surgeons.
Currently, most surgeons require that an LVRS candidate be less than 75 years
old, quit smoking at least six months prior to LVRS, have no documented history
of heart disease or previous lung surgery and have no other major diseases. In
addition, most surgeons performing LVRS require that candidates have documented
lung function testing and chest x-rays detailing the severity of the condition.
The Company believes that the patient selection criteria will continue to be
refined as surgeons become more familiar with LVRS and as long-term clinical
results become available.
5
<PAGE>
While LVRS is not a cure for emphysema, the results from the procedure to date
are encouraging based on information available to the Company. Generally, this
information suggests that patients undergoing the procedure have reduced
shortness of breath, improved exercise tolerance and improved quality of life.
However, LVRS was only re-introduced into the United States in late calendar
1993. While it is estimated that over 2,300 surgeons have been trained and over
4,500 procedures have been performed, not enough time has elapsed to provide a
statistically significant body of clinical data from which to draw conclusions
concerning the long-term efficacy and long-term outcomes associated with LVRS.
Craniotomy. Craniotomies (surgical operations involving the brain and skull)
are typically performed to treat various brain conditions, such as tumors,
aneurysms, blood clots, head injuries and abscesses. To access the brain, the
surgeon is required to cut through several of the protective layers surrounding
the brain. The dura, the fibrous protective layer below the skull, protects the
brain and spinal cord from bacterial infection and trauma and provides a fluid
tight seal. Once the surgeon has cut through the scalp and the skull, the dura
must be cut with a scalpel or scissors and resected to expose the brain.
After the specific brain condition has been treated by the surgeon, the dura
often must be closed to prevent cerebral spinal fluid leakage. While the dura
is often closed with direct suture, surgeons who consider the prevention of
fluid leakage to be critical to the success of the operation will use a dural
patch. The primary patching materials include autologous tissue, synthetic
patches, processed cadaver tissue or bovine pericardium. The Company's Dura-
Guard Dural Repair Patch is designed to be sewn to the dura to close the
incision by fusing to the native dura with little or no adhesion (an abnormal
union between two tissue surfaces not intended to be joined) to the underlying
brain cortex.
The Company estimates that in the United States approximately 125,000 cranial
operations were performed in 1995. Whether a dural patch is used in such
operations is subject to surgical conditions and surgeon discretion. Dural
patching is most often used when the dura shrinks after incision such that
sutures alone may not provide adequate closure.
Carotid Endarterectomy. Stroke is the third leading cause of death in the
United States with an estimated 500,000 new cases per year. The build-up of
atherosclerotic plaque (fat deposits with a proliferation of fibrous connective
cells along the artery walls) in the carotid arteries (the principal arteries
located in the neck that supply blood to the brain) increases the risk of
stroke. A substantial portion of strokes is caused by a fragment of
atherosclerotic plaque breaking away from the inner wall of the carotid artery
and becoming lodged in an artery in the brain.
Drug therapy is often prescribed to treat the early indications of
atherosclerotic plaque build-up. If the condition progresses to a point where
drug therapy is not effective, surgical intervention may be required. Carotid
endarterectomy is a surgical procedure used to remove atherosclerotic plaque
build-up in the carotid artery. The endarterectomy procedure begins with an
incision in the internal carotid artery. A temporary shunt may be inserted to
maintain blood flow to the brain during the surgery. Once the artery is opened,
the plaque and inner layer of the artery are carefully removed, and the incised
artery must be repaired. Although the artery often can be closed without a
patch, use of an autologous or prosthetic patch is often suggested to expand the
artery, encouraging greater blood flow. In addition, certain patients require
patching due to the small size of their carotid arteries, or in some patients
with a normal carotid artery diameter, a patch is used to decrease the incidence
of post-operative stenosis or occlusion.
While the Company estimates that in the United States approximately 110,000
carotid endarterectomy procedures were performed in 1995, the use of a patching
material in such procedures is subject to surgeon discretion. Once a surgeon
determines a vascular patch is necessary or desirable, the surgeon has
additional discretion in determining the type of patching material to use.
Characteristics of an effective vascular patch include the ability to imitate
human tissue, to exhibit good blood flow characteristics and to reapproximate
around sutures to prevent blood leaks. The primary patching materials include
autologous tissue, synthetic patches made out of polytetraflurothylene ("PTFE"),
silicone fabric or tissue-based patches made out of bovine pericardium, such as
Vascu-Guard.
Lower Limb Vascular Reconstruction. Certain diseases, such as diabetes, can
cause a restriction or occlusion in the arteries which provide blood to the
legs. If left untreated, insufficient blood flow can ultimately result in the
need for amputation. If drug therapy is not deemed an effective treatment based
upon the severity of the restriction or blockage, the use of a graft in
peripheral vascular reconstructive surgery may be needed. In this type of
surgical procedure, the
6
<PAGE>
surgeon can bypass the blocked artery to regain blood circulation, thereby
saving the affected limb. Diabetics, in particular, are often at risk for
amputation of a lower limb due to insufficient blood flow in the femoral artery
in the thigh. By implanting a graft from the upper portion of the femoral artery
to either the lower femoral artery or to the popliteal artery blow the knee, the
surgeon is able to increase blood flow below the site of the restriction or
blockage. Long-term patency (openness), and a thrombo-resistant surface that
provides smooth blood flow are essential qualities of an effective graft.
Saphenous veins (autologous veins from the leg) typically provide the most
effective grafting material. In many instances, however, a suitable saphenous
vein may be unavailable in sufficient quantity or quality, and a substitute
graft must be used. The primary alternative substitute grafts involve synthetic
grafts made from PTFE or bio-synthetic materials or tissue-based grafts, such as
Biograft. The Company estimates that in the United States approximately 55,000
lower limb vascular reconstructions were performed in 1995.
Products
- --------
The following table summarizes the Company's Surgical Business product lines and
primary products, the procedures in which such products are used and the type of
regulatory clearance obtained for such products:
<TABLE>
<CAPTION>
Regulatory
Product Application Representative Procedure Clearance
Product Line ------------ ------------------------- --------------------------- -----------
- ------------
<S> <C> <C> <C> <C>
Tissue-Guard
Peri-Strips Soft tissue stapling Lung volume reduction/lung
buttress resection 510(k)
Dura-Guard Dural repair patch Craniotomy 510(k)
Vascu-Guard Peripheral vascular patch Carotid Endarterectomy 510(k)
Supple Peri- General soft tissue patch Various surgical procedures 510(k)
Guard
Peri-Guard Pericardial patch Various cardiovascular 510(k)
procedures
Biograft
Biograft Peripheral vascular Lower limb vascular
bypass graft reconstruction PMA
Surgical
Productivity Tools
Bio-Vascular Locator of arterial Various surgical bypass
Probe blockages procedures 510(k)
Flo-Rester Internal vessel occluder Coronary artery bypass 510(k)
graft surgery
</TABLE>
7
<PAGE>
The following table summarizes the net revenue contributed by the Company's
primary Surgical Business products and various product lines for the periods
indicated:
<TABLE>
<CAPTION>
Years Ended October 31,
Product/ -----------------------
Product Line 1996 1995 1994
------------ ---- ---- ----
(In thousands)
<S> <C> <C> <C>
Peri-Strips...................... $4,336 $5,550 $ 685
Tissue-Guard Product (excluding
Peri-Strips).................... 2,944 1,845 990
Biograft......................... 938 1,198 1,525
Surgical Productivity Tools...... 1,902 1,825 1,700
</TABLE>
Tissue-Guard Product Line. The Company's Tissue-Guard products are all produced
- --------------------------
from bovine pericardium. Many of the product characteristics and competitive
advantages of this product line are derived from the collagen configuration of
the bovine pericardium. Collagen, which is a fibrous protein found in all multi-
cellular animals, makes the pericardium durable and provides superior fluid
interface properties, similar to autologous tissue. These characteristics
allow for effective host tissue incorporation. Host cells deposit a collagen
matrix on the surface of the pericardial product, which helps the Tissue-Guard
product integrate into the host tissue and which the Company believes enhances
the long-term tensile strength (the maximum stress a material subjected to a
stretching load can withstand without tearing) of all the products in the
Tissue-Guard product line.
The Company processes the bovine pericardium using proprietary and patented
tissue-fixation technologies. The tissue is treated with glutaraldehyde and
other proprietary chemical treatments to prevent degradation of the tissue and
to render it biologically compatible with the host tissue. In addition,
according to studies commissioned by the Company, the tissue-fixation
technologies used by the Company reduce the level of residual glutaraldehyde
remaining in the processed tissue to less than six parts per million, resulting
in a lower incidence of host tissue inflammatory response and promoting host
tissue incorporation similar to the body's natural healing process. Tissue-
Guard has a 15 year history of successful clinical performance as a surgical
patch in a wide variety of clinical applications.
Surgeons have indicated that different pericardial patch characteristics are
useful in different surgical procedures. Accordingly, depending on the
particular tissue-fixation technology used by the Company, the bovine
pericardium is processed into either Supple Peri-Guard or Peri-Guard. While the
raw material used is the same, Supple Peri-Guard has greater elasticity and
flexibility than Peri-Guard, which allows for greater conformity to the surgical
site. The Company's Peri-Guard and Supple Peri-Guard products are produced in
square or rectangular sheets of different sizes, ranging from 4 cm x 4 cm to 12
cm x 25 cm. Supple Peri-Guard is produced for use as a multi-purpose material
designed for reinforcing, reconstructing and repairing tissue and preventing
leaks of air, blood and other body fluids. Each of such products has received
510(k) clearance from the FDA as a general soft-tissue patch.
The products in the Tissue-Guard product line described below are special
configurations of Supple Peri-Guard designed to enable specific surgical
procedures.
Peri-Strips. Peri-Strips, soft tissue stapling buttress, are currently used
- -----------
primarily in LVRS but are also used for lobectomy (removal of a lobe),
excision/destruction of a lesion and segmental resection of the lung. The key
competitive features of Peri-Strips include the following:
8
<PAGE>
. Reapproximation. Due to the elastic-like nature of the collagen fibers in
the tissue, Peri-Strips reapproximate (close around) surgical staples to
prevent pulmonary air leaks at the staple site.
. Prevents Enlargement. The elasticity of Peri-Strips prevents staple holes
from enlarging, which could lead to additional air leaks and require
additional surgery.
. Reinforcement. The use of Peri-Strips strengthens the entire staple line,
which makes it more durable and less likely to tear. Also, Peri-Strips are
thin enough to allow for staple lines to be overlapped, which is often
required during LVRS.
. Sleeve Configuration. The sleeve configuration of Peri-Strips is customized
to fit disposable, reusable and endoscopic staplers of varying sizes and
produced by different manufacturers. The sleeve configuration allows for
greater ease of use and reduced surgical time resulting in lower costs.
The Company estimates its net revenue per LVRS to be approximately $1,500.
Dura-Guard. Dura-Guard, a dural repair patch, is primarily used in craniotomy
- ----------
procedures when the dura must be repaired and suturing without a patch is not
deemed sufficient. Dura-Guard offers advantages over competitive dural patches
produced from autologous or cadaver tissue. Harvesting autologous tissue
necessarily involves a second surgical site, thereby increasing costs and
recovery time. Cadaver tissue is subject to rigorous tissue bank regulations,
which could impact upon the availability of such tissue. Certain other
competitive advantages of Dura-Guard relate to the specific benefits produced by
the physical properties of Dura-Guard in connection with the craniotomy
procedure. Observations in the course of subsequent surgical procedures on
patients receiving Dura-Guard patches have shown that there is little or no
adhesion formation on the Dura-Guard surface that faces the cerebral cortex, a
complicating factor following any cranial surgery. In addition, Company
commissioned studies have shown that fibrous bone cells invade the Dura-Guard
surface facing the cranium, as they do the human dura, inviting good host tissue
incorporation. The collagen configuration of the processed bovine pericardium
in Dura-Guard reapproximates around the sutures used to affix the patch, thereby
providing a barrier between the skull and the tissue layers underlying the dura
and preventing the leakage of cerebrospinal fluid. Studies have shown synthetic
materials have been unable to perform as effective dura substitutes and have
been associated with late subdural hematoma formation (bleeding between the dura
and the brain).
Vascu-Guard. Vascu-Guard, a vascular repair patch, is primarily used in carotid
- -----------
endarterectomy procedures when the carotid artery must be repaired and closing
the vessel without a patch is not deemed sufficient. Vascu-Guard offers
advantages over competitive carotid artery repair patches produced from
autologous tissue or synthetics. The use of autologous tissue necessarily
involves a second surgical site and results in increased costs and additional
recovery time. Synthetic patches, which lack the collagen configuration of
tissue, do not reapproximate around sutures as does the Vascu-Guard product,
thereby increasing the risk of suture line bleeding and resulting in longer
operating times. In addition, unlike synthetic patches, the physical attributes
of Vascu-Guard imitate human tissue and certain characteristics associated with
human tissue. Specifically, Company commissioned studies have shown that, once
healed, Vascu-Guard supports endothelialization (growth of a cell layer normally
lining the interior of blood vessels) and its non-thrombogenic blood flow
surface imitates the blood flow characteristics of autologous vessels. In
addition, its pulsatility (ability to reflect movement signifying the rhythmic
pumping of the heart) allows the surgeon to readily verify normal blood flow
after implantation.
Biograft . Biograft, a peripheral vascular graft manufactured from human
- --------
umbilical veins, is indicated for use in lower limb vascular reconstructions
when a saphenous vein is not available. Biograft offers advantages over
competitive vein grafts produced from synthetics, like PTFE, due to its thrombo-
resistant surface which provides smooth blood flow and minimizes turbulence and
risk of occlusion. Other competitive advantages of Biograft include its long-
term patency and its similarity to an autologous blood vessel, minimizing
intimal hyperplasia (a build up of cells on the interior of the blood vessel
which results in restricted blood flow). In addition, a knitted and supportive
Dacron mesh is placed around the graft, which allows for easier handling and
promotes tissue integration for strength and stability.
9
<PAGE>
Surgical Productivity Tools. Flo-Rester and Bio-Vascular Probe. The Company's
- ---------------------------
Flo-Rester products are vessel occluders manufactured from medical grade
silicone. The Flo-Rester products are designed to interrupt blood flow in
arteries and to stent them (hold them open) during surgery, thereby facilitating
the suturing together of vessels. These products are primarily used during
coronary artery bypass graft surgeries in which blood is routed past the heart
through a heart-lung bypass machine in order to keep the heart free of blood
during surgery. During such procedures, incidental blood flow obstructs the
surgeon's view of the operative site and interferes with precise suturing. Flo-
Rester consists of a flexible shaft with small bulbs at each end that are
inserted into the blood vessel at the point where the artery bypass is sutured
to the artery to stop the blood flow. Competitive procedures involve external
occlusion through the use of clamps, snares or tapes. The Bio-Vascular Probe is
a flexible shaft with varying sizes of bulbous tips on either end. Surgeons use
the Bio-Vascular Probe to locate occlusions or blockages in arteries and to
ascertain the blood flow characteristics of arteries. The Bio-Vascular Probe is
inserted and fed into an artery. When the tip of the probe meets resistance,
the surgeon is able to identify the exact location of the occlusion. The Bio-
Vascular Probe is then extracted and a bypass is completed below the occlusion.
In addition, the Probe can be used to atraumatically lift the edge of the
incision to assist the surgeon in accurately placing sutures, which can improve
the functioning of bypass grafts.
Research and Development
The Company generally allocates its research and development resources among
three broad functions: research and development supports current products
through training of Company personnel and writing and publishing research papers
on existing products; they develop product line extensions by improving current
products or developing new applications for current products; and they develop
new products for surgical uses that utilize the Company's proprietary
technologies and core competencies in tissue processing and bio-materials.
As an integral part of both its research and development and sales and marketing
strategies, the Company strives to involve its surgeon-customers to a large
extent in its product development activities. The Company consults with selected
surgeons frequently as to market needs and assessments of products under
development. The Company believes that this practice allows it to receive
surgeon assessments of products in development at an early stage.
The Company's research and development staff currently consists of three
scientists and two technicians. The Company also expands its research and
development activities through the use of external consultants and research
staff and facilities at research centers and hospitals on an as-needed basis.
The Company spent approximately $909,000, $643,000 and $414,000 on research and
development in fiscal 1996, 1995 and 1994, respectively.
Marketing
The sales and marketing strategy of the Company includes developing and
maintaining a close working relationship with the hospitals and surgeons who
purchase and use the Company's products in order to assess and satisfy their
needs. For the past two years, the Company has focused marketing efforts toward
assisting in the education of surgeons in the use of Peri-Strips in LVRS through
sponsorship of workshops and training programs. These workshops and training
sessions have been conducted in the United States, Canada and certain European
and Far Eastern countries. The Company estimates that approximately 2,350
surgeons have been trained in LVRS as of the end of fiscal 1996. The Company
has also sponsored "focus group" meetings as a forum for discussion and the
exchange of information for surgeons performing LVRS. In addition, the Company
sponsors surgeon workshops and training programs in the use of Biograft.
The Company's sales and marketing strategy is also designed to ensure that the
Company has an innovative ''first in the mind of the customer'' focus that
results in timely and effective marketing programs and new product
introductions. These programs include surgical trade shows, support of the
presentation of clinical data and new product information by key physicians,
limited direct-mail campaigns and the development of strategic physician
alliances and utilization of the Company's scientific advisory boards. The
Company believes these efforts to be cost-effective in producing awareness of,
and loyalty to, the Company's products.
10
<PAGE>
The Company's products are sold to hospitals and surgeons worldwide. For the
fiscal years ended October 31, 1996, 1995 and 1994, approximately 22%, 17%, and
30% of the Company's revenue, respectively, were from sales in international
markets. The decrease in the percent of net revenue attributed to international
markets during fiscal 1995 was primarily due to increases of sales of Peri-
Strips in the United States. The majority of the Company's international sales
are in Europe.
In the United States, the Company sells its products through a combination of 12
distributors and independent sales representatives managed by regional sales
managers. To further strengthen the direct relationship between the Company and
the end users of its products, the Company requires distributors to provide the
Company with the names and addresses of such end users. The Company also ships
products directly to end users for a limited period of time when there is a new
product application. In addition to strengthening customer relationships, this
practice provides the Company with some protection in the event a distributor is
terminated and resists providing the Company with customer lists.
Internationally, the Company's products are sold through 35 distributors. In
some situations, sales in a country may occur through more than one distributor
due to distributors' varying market strengths and focus.
In fiscal 1996, three domestic distributors accounted for the following
percentages of the Company's gross revenue: Futuretech, Inc., (18%); Life
Systems, Inc., (15%); and Cardio Medical Products, (12%). In fiscal 1995, the
same three domestic distributors each accounted for more than 10% gross revenue,
while in fiscal 1994 Futuretech and Life Systems accounted for more than 10% of
gross revenue.
The Company currently has written agreements with 29 of its domestic and
international independent sales representatives and distributors. These
agreements generally impose limited geographic exclusivity and minimum purchase
obligations on the Company's independent sales representatives and distributors.
However, significant overlap occurs in many of the Company's international
distribution agreements. These agreements are typically terminable upon breach
of the agreement by the distributor, including breach of the minimum sales
obligations imposed by the agreement, as well as certain extraordinary events.
The Company's marketing and sales department and its national and international
distribution network is managed by the Vice President of Marketing and Sales.
The Company's marketing and sales department currently consists of 13 employees.
These employees include domestic and international sales managers, domestic
regional sales managers, product managers, administrative and customer service
personnel.
Competition
The Company competes primarily on the basis of product performance, service and
price. The Company believes that product performance is the single most
important factor in selling any of its products and develops and produces its
products accordingly. The surgical products market in which the Company
competes is characterized by intense competition. This market is dominated by
established manufacturers that have broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing,
research and development staffs and facilities than the Company. Many of these
competitors offer broader product lines within the Company's specific product
market, particularly in the Company's surgical tool product markets and/or in
the general field of medical devices and supplies. Broad product lines give
many of the Company's competitors the ability to negotiate exclusive, long-term
medical device supply contracts and, consequently, the ability to offer
comprehensive pricing for their products, including those that compete with the
Company's products. By offering a broader product line in the general field of
medical devices and supplies, competitors may also have a significant advantage
in marketing competing products to group purchasing organizations, health
maintenance organizations and other managed care organizations that increasingly
seek to reduce costs through centralization of purchasing functions.
In 1996 the FDA cleared for marketing a synthetic product made from PTFE,
configured for use with surgical staplers
11
<PAGE>
in LVRS, and intended to compete with Peri-Strips. Pictures taken with electron
microscopes indicate that PTFE , unlike Peri-Strips, does not fully
reapproximate around surgical staplers. Additionally, the Company is aware of
two tissue products that appear to intend to compete with Peri-Strips. The
Company, however, has three patents related to the use of Peri-Strips as a soft
tissue stapling buttress (see Intellectual Property on page 16) which the
Company intends to vigorously enforce. To the Company's knowledge, there are
dural patches currently available that compete with Dura-Guard. These are either
autologous tissue or processed cadaver tissue, including Tutoplast(TM), a
processed cadaver product manufactured by Biodynamics International, Inc., and
synthetic patches. In addition to specifically configured patches, there are
multi-purpose patches made from bovine and other types of animal tissue that
compete with the Company's Supple Peri-Guard, Peri-Guard, and Vascu-Guard
products, including bovine pericardium products produced by Medtronic, Inc. and
Baxter International Inc. The Company does not believe that these alternative
bovine pericardium products have specific FDA marketing clearance for use in the
lung, although such products are FDA cleared for pericardial closure and soft
tissue repair. In addition, synthetic multi-purpose patches made out of PTFE or
silicone fabric are currently available. W. L. Gore & Associates, Inc.,
manufacturer of Gore-Tex(R), is believed to have a prominent position in the
synthetic patch market. Synthetic patches are generally cheaper to produce and
to the extent that comparable synthetic patches are available and effective in
procedures, the Company faces significant price competition for its Tissue-Guard
products. The Company believes, however, that the collagen characteristics
exclusive to tissue, the special configuration of its Tissue-Guard products and
the proprietary tissue-fixation technology (Supple Peri-Guard, Peri-Strips,
Dura-Guard and Vascu-Guard) and patented (Peri-Guard) tissue-fixation technology
employed by the Company offer significant product performance advantages over
competing products.
Alternative treatments and competitive products to Biograft include drug
therapies and surgical procedures that use autologous or synthetic grafts. Once
the decision has been made to use surgical intervention, surgeons generally
prefer the patient's own vessels for lower limb vascular reconstruction. When
the patient's own vessels are not available in sufficient quality or quantity,
surgeons choose a prosthesis graft such as Biograft or synthetic grafts made
from expanded PTFE produced by W. L. Gore & Associates, Inc., IMPRA, Inc. or
other grafts made of bio-synthetic materials.
There can be no assurance that products which compete with the Company's
products will not achieve greater acceptance than the Company's products or that
future products developed by competitors will not offer similar or enhanced
performance advantages relative to the Company's product.
Manufacturing
The Company manufactures all of its products except the Bio-Vascular Probe at
its St. Paul, Minnesota facility. In late fiscal 1996, the Company acquired the
equipment and technology necessary to manufacture the Bio-Vascular Probe and
expects to begin the manufacture early in calendar 1997. Until that time, the
Bio-Vascular Probe will continue to be manufactured to the Company's
specifications by a contract manufacturer, with certain final cleaning,
packaging and sterilization testing procedures performed by the Company at its
St. Paul facility. Since July of 1995, the Company has occupied a 36,000 square
foot facility, which more than doubled its total space and nearly quadrupled its
manufacturing capacity.
The Company acquires bovine pericardium for use in the Tissue-Guard product line
from a private independent contractor who obtains the tissue from local United
States Department of Agriculture ("USDA") inspected meat packing facilities. The
Company acquires human umbilical cords for use in Biograft from various
hospitals throughout the United States. The Company has not experienced any
product shortages arising from interruptions in the supply of any raw materials
or components, and has identified alternative sources of supply for such raw
materials and components.
Governmental Regulation
The manufacture and sale of the Company's products are subject to regulation by
numerous governmental authorities, principally the FDA and corresponding foreign
agencies. In the United States, the FDA administers the Federal Food, Drug and
Cosmetics Act and amendments thereto. The Company is subject to the standards
and procedures respecting manufacture and marketing of medical devices contained
in the Federal Food, Drug and Cosmetics Act and the regulations promulgated
thereunder and is subject to inspection by the FDA for compliance with such
standards and
12
<PAGE>
procedures.
These regulations classify medical devices as either Class I, II or III devices,
which are subject to general controls, special controls or premarket approval
requirements, respectively. All Class I and II devices as well as some Class III
devices marketed prior to the effective date of the Medical Device Amendments of
1976 can be cleared for marketing pursuant to a 510(k) pre-market notification,
establishing that the device is "substantially equivalent" to a device that was
legally marketed prior to May 28, 1976, the date on which the Medical Device
Amendments of 1976 became effective. The 510(k) pre-market notification must be
supported by data establishing the claim of substantial equivalence to the
satisfaction of the FDA. The process of obtaining a 510(k) clearance typically
can take several months to a year or longer. If substantial equivalence cannot
be established, or if the FDA determines that the device or the particular
application for the device requires a more rigorous review, the FDA will require
that the manufacturer submit a PMA application that must be carefully reviewed
and approved by the FDA prior to sale and marketing of the device in the United
States. The PMA application must contain the results of clinical trials, the
results of all relevant prototype tests, laboratory and animal studies, a
complete description of the device and its components, and a detailed
description of the methods, facilities and controls used for manufacturing,
including the method of sterilization and its assurance. In addition, the
submission must include the proposed labeling, advertising literature and
training methods, if applicable. Most Class III devices are subject to the PMA
requirements rather than the 510(k) pre-market notification procedure. The
process of obtaining a PMA can be expensive, uncertain and lengthy, frequently
requiring anywhere from one to several years from the date of FDA submission, if
approval is obtained at all. Moreover, a PMA, if granted, may include
significant limitations on the indicated uses for which a product may be
marketed. FDA enforcement policy strictly prohibits the marketing of approved
medical devices for unapproved uses. In addition, product approvals can be
withdrawn for failure to comply with regulatory standards or the occurrence of
unforeseen problems following initial marketing.
Of the Company's current products, Biograft and Peri-Guard (when marketed as a
pericardial patch) are Class III devices. Biograft received marketing clearance
from the FDA pursuant to a PMA, while Peri-Guard received clearance for use as a
pericardial patch as the result of a 510(k) submission. Peri-Strips (as marketed
in both strip and sleeve configurations), Vascu-Guard, Dura-Guard, Peri-Guard
(when marketed as a patch for soft tissue deficiency), Supple Peri-Guard (when
marketed as a patch for soft tissue deficiency and as a pericardial patch) and
both the disposable and reusable Flo-Rester and the Bio-Vascular Probe have all
been classified as Class II medical devices and have received 510(k) marketing
clearance from the FDA.
Both the United States and Europe have recently focused attention on the safety
of tissue banks, spurred by incidents of the transmission of human disease
during tissue transplantation. In the United States, recent FDA draft
regulations have outlined requirements for tissue banks. The legislation has
specifically excluded medical devices subject to FDA review, including preserved
umbilical cord vein grafts such as Biograft. As a result, the Company does not
expect Biograft to be subject to tissue bank regulations in the United States,
including the expensive donor screening and donor testing procedures. In
response to the increased scrutiny of umbilical cord vein grafts, the Company
commissioned an independent virology laboratory to test Biograft for viral
inactivation. The results of the testing demonstrated that Biograft's chemical
manufacturing processes inactivate a variety of viruses, resulting in a sterile
product. The Company has informed the FDA of these test results and does not
anticipate that the FDA will impose additional regulatory requirements on
Biograft. There can be no assurance, however, that the FDA will not impose
additional regulatory requirements on Biograft at some later date or that
Biograft would be able to meet any such new requirements.
The Company is also subject to regulation in most of the foreign countries in
which it sells its products with regard to product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the Company's
products in such countries are similar to those of the FDA. The national health
or social security organizations of certain of such countries require the
Company's products to be qualified before they can be marketed in those
countries. In Japan, a potentially significant market for the Company's
products, clinical trials of certain of the Company's products are required
before such products can be cleared for sale in the Japanese market. To date,
this has delayed the Company's market entry in some cases, but has not
ultimately prevented sales in Japan of any of the Company's devices sold in the
United States. The Company relies on its independent distributors to comply with
the majority of the foreign regulatory requirements, including registration
13
<PAGE>
of the Company's products with the appropriate governmental authorities. To
date, the Company has been successful in complying with the regulatory
requirements in most foreign countries in which its products are marketed.
Bovine Spongiform Encephalopathy ("BSE") is endemic in cattle in the United
Kingdom (UK) and has received much publicity in Europe regarding beef for
dietary consumption. Under the direction of the USDA, the U.S. government has
had an active program of surveillance and import controls since the late 1980's,
designed to prevent the introduction of BSE into U.S. cattle. To date all
evidence indicates that U.S. cattle are free of BSE. The Company obtains all of
its raw pericardium from USDA slaughterhouses. To date BSE has not impeded sale
of the Company's products worldwide. The Company's Notified Body, the British
Standards Institute ("BSI"), and French authorities have specifically reviewed
Tissue-Guard sourcing and manufacturing processes and have then accepted the
Company's bovine pericardium products. The Company cannot predict whether or not
a case of BSE may someday be reported in the U.S. If a case of BSE were reported
in the U.S. cattle, it could have a material adverse effect on the Company's
business, financial condition and results of operations. Although the Company
does not anticipate that any countries will prohibit the sale of Tissue-Guard
products as a result of concerns related to BSE, such prohibition by certain
countries could have a material adverse effect on the Company's business,
financial condition and results of operation.
The Company is subject to periodic inspections by the FDA, whose primary purpose
is to audit the Company's compliance with good manufacturing practices ("GMP")
established by the FDA and other applicable government standards. Strict
regulatory action may be initiated in response to audit deficiencies or to
product performance problems. The Company believes that its manufacturing and
quality control procedures are in compliance with the requirements of the FDA
regulations.
The Company's new manufacturing facilities and processes were inspected and
audited by the BSI to verify the Company's compliance with the requirements of
the Medical Device Directive ("MDD") issued by the European Union ("EU"). They
have also verified that the Company's quality system conforms with the ISO 9001
international quality standard and that its products conform with the "essential
requirements" set forth by the MDD for the class of products produced by the
Company. In June of 1996, BSI certified the Company's conformity with both the
ISO 9001 standard and the MDD essential requirements, entitling the Company to
place the "CE" mark on the Company's Tissue-Guard products. The CE mark enables
the Company's products to be marketed, sold and used throughout the EU, subject
to limited "safeguard" powers of member states. Presently, the CE mark is not
required to be affixed to the Company's products (or those of its competitors)
sold in the EU, but may be affixed during a transition period currently in
effect and which began January 1, 1995. This transition period will end on June
15, 1998, when all of the Company's current products (and those of its
competitors) will be required to comply with the essential requirements in order
to be marketed in the EU.
The future regulatory environment for Biograft in Europe is unclear. The MDD
explicitly excludes from coverage medical devices derived from human tissue;
however, certain European medical device manufacturers are actively lobbying for
the re-inclusion of such devices in the MDD. If this effort is successful, the
earliest date for applying for CE mark approval for Biograft is expected to be
1998. In addition, if extensive donor screening and donor testing requirements
are imposed, such requirements could make it uneconomical to sell Biograft in
Europe even under the CE mark. As a result of significant problems with their
blood supply, France has passed national laws and regulations requiring
extensive donor screening and testing on products derived from human tissue.
Accordingly, Biograft is not being sold in France. It is not known whether a CE
mark for Biograft would override such national requirements or whether other
countries in the EU will adopt regulations similar to those of France. The
Company is seeking Biograft registration in Germany, but cannot predict when or
if it will achieve such registration. Biograft is not marketed generally in
Germany, but rather is prescribed by physicians on a prescription-by-
prescription basis only. If the CE mark is unavailable for Biograft or if the
requirements for obtaining a CE mark are too burdensome, the Company intends to
seek country-by-country registration of the product where such registration
requirements exist for as long as it continues to market the Biograft. The
Company cannot predict when or if it would obtain such registrations.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. The "fraud and
abuse" laws and regulations prohibit the
14
<PAGE>
knowing and willful offer, payment or receipt of anything of value to induce the
referral of Medicare or Medicaid patients for services or goods. In addition,
the physician anti-referral laws prohibit the referral of Medicare or Medicaid
patients for certain "Designated Health Services" to entities in which the
referring physician has an ownership or compensation interest. Violations of
these laws and regulations may result in civil and criminal penalties, including
substantial fines and imprisonment. In a number of states, the scope of fraud
and abuse or physician anti-referral laws and regulations, or both, have been
extended to include the provision of services or products to all patients,
regardless of the source of payment, although there is variation from state to
state as to the exact provisions of such laws or regulations. In other states,
and, on a national level, several health care reform initiatives have been
proposed which would have a similar impact. The Company believes that its
operations and its marketing, sales and distribution practices currently comply
in all respects with all current fraud and abuse and physician anti-referral
laws and regulations, to the extent they are applicable. Although the Company
does not believe that it will need to undertake any significant expense or
modification to its operations or its marketing, sales and distribution
practices to comply with federal and state fraud and abuse and physician anti-
referral regulations currently in effect or proposed, financial arrangements
between manufacturers of medical devices and other health care providers may be
subject to increasing regulation in the future. Compliance with such regulation
could adversely affect the Company's marketing, sales and distribution
practices, and may affect the Company in other respects not presently
foreseeable, but which could have an adverse impact on the Company's business,
financial condition and results of operations.
Third Party Reimbursement and Cost Containment
The Company's products are purchased primarily by hospitals and other users
which then bill various third-party payers for the services provided to the
patients. These payers, which include Medicare, Medicaid, private health
insurance plans and managed care organizations, reimburse part or all of the
costs and fees associated with the procedures utilizing the Company's products.
The availability and level of reimbursement from third-party payers is
significant to the Company's business. For Medicare carriers, HCFA may establish
a national coverage policy, including the amount to be reimbursed, for coverage
of claims submitted for reimbursement related to a specific procedure. Private
health insurance plans and managed care organizations make their own
determinations regarding coverage and reimbursement based either upon "usual and
customary" fees or, increasingly, upon a similar prospective payment system.
During the past several years, the major third party payers have substantially
revised their reimbursement methodologies in an attempt to contain their
healthcare reimbursement costs. Medicare and Medicaid reimbursement for
inpatient hospital services is based on a fixed amount per admission based on
the patient's specific diagnosis. As a result, any illness to be treated or
procedure to be performed will be reimbursed only at a prescribed rate set by
the government that is known in advance to the healthcare provider. If the
treatment costs less, the provider keeps the difference. If it costs more, the
provider cannot bill the patient for the rest. Frequently, reimbursement is
reduced to reflect the availability of a new procedure or technique, and as a
result hospitals are generally willing to implement new cost saving technologies
before these downward adjustments take effect. No separate payment is made in
most cases for products such as the Company's when they are furnished or used in
connection with inpatient care. Any amendments to existing rules and regulations
which restrict or terminate the reimbursement eligibility (or the extent or
amount of coverage) of medical procedures using the Company's products or the
eligibility (or the extent or amount of coverage) of the Company's products
could have an adverse impact on the Company's business, financial condition and
results of operations.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be proposals by legislators and regulators
and third-party payers to curb these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan,
and over 80% of hospitals participate in or have agreements with HMOs. It has
become a typical practice for hospitals to affiliate themselves with as many
managed care plans as possible. Higher managed care penetration typically drives
down the prices of health care procedures, which in turn places pressure on
medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
15
<PAGE>
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact these practices, the existing or proposed legislation, or such third-
party payor measures may have on its future business, financial condition or
results of operations.
Because the Company's surgical products are primarily used in thoracic, cardiac,
neuro and vascular surgeries, changes in reimbursement policies and practices of
third party payers with respect to these surgeries could have a substantial and
material impact on sales of the Company's products. The development or increased
use of more cost effective treatments for diseases requiring these surgeries
could cause such payers to decrease or deny reimbursement for such surgeries or
to favor these other treatments over surgical treatment.
In January of 1996, HCFA made a national policy decision not to reimburse LVRS
("the HCFA decision"), which had been reimbursed nationwide on a regional basis
during fiscal 1994 and 1995. The Company estimates that approximately 70% of the
patients undergoing LVRS in fiscal 1995 were Medicare patients. In April of
1996, the National Institute of Health ("NIH") announced a collaborative study
of LVRS with HCFA. The study, as it is currently structured, is estimated to
take seven years if it goes to completion and will include 2,580 Medicare
patients, with a little more than half of those receiving bilateral open median
sternotomy or thoracoscopic LVRS. This represents less than 2% of those
currently estimated to benefit from LVRS. The HCFA decision materially and
adversely affected the Company's financial results. In fiscal 1996 revenue from
the sale of Peri-Strips decreased $1,214,000 to $4,336,000. The Company
understands that some private insurance companies and managed care organizations
are currently reimbursing LVRS based on their own evaluation of the procedure
and its outcomes. It is unknown whether these private payers will change their
reimbursement practices in the future.
Intellectual Property
The Company's success will depend in large part on its ability to preserve its
trade secrets, to obtain patent protection for its products and to operate
without infringing the proprietary rights of third parties. While the Company
has obtained or acquired a license to certain patents and applied for additional
United States and foreign patents covering certain aspects of its products, no
assurance can be given that any additional patents will be issued, that the
scope of any patent protection will exclude competitors or that any of the
Company's rights under such patents will be held valid if subsequently
challenged. The validity and breadth of claims covered in medical technology
patents involve complex legal and factual questions and therefore may be highly
uncertain. Whether or not the Company's patent applications are granted, others
may receive patents which contain claims having a scope that covers products
developed by the Company.
The Company has been granted three United States patents relating to the use of
tissue on a removable backing which cover the sleeve configuration of Peri-
Strips, the combination of tissue with a surgical stapling gun, and methods of
performing a surgical procedure to remove diseased tissue. The Company holds no
patents and pays no royalties on Supple Peri-Guard or the configurations of
Supple Peri-Guard marketed as Dura-Guard or Vascu-Guard. In December 1994, the
Company entered into an agreement with Surgical Research, Inc., which obligates
the Company to pay royalties of five percent (5%) on revenue from sales of Peri-
Strips for the life of the patents. In December 1995, the Company purchased the
patent for Peri-Guard. Previously, the Company had an exclusive, worldwide,
perpetual license to make, use and sell its Peri-Guard product for use in
connection with the cardiovascular system. The Company also has an exclusive,
worldwide, perpetual license to make, use and sell its Flo-Rester product. The
last of the patents related to the Company's Biograft product expired in
November 1993.
The Company also relies on trade secrets and proprietary know-how which it seeks
to protect, in part, through confidentiality agreements with employees,
consultants and other parties. Supple Peri-Guard, which is used in the
manufacture of the majority of the Company's Tissue-Guard products, is protected
exclusively by trade secrets. There can be no assurance that these agreements
will not be breached, that the Company will have adequate remedies for any
breach, or that the Company's trade secrets will not otherwise become known to
or independently developed by competitors.
16
<PAGE>
The surgical products industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. The surgical products markets
are characterized by extensive patent and other intellectual property claims
that can create greater potential than in less developed markets for possible
allegations of infringement, particularly with respect to newly developed
technology. Intellectual property litigation is complex and expensive, and the
outcome of such litigation is difficult to predict. Any future litigation,
regardless of outcome, could result in substantial expense to the Company and
significant diversion of the efforts of the Company's technical and management
personnel. Litigation may also be necessary to enforce patents issued to and
licenses held by the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. It is the Company's intention to vigorously
enforce and defend these intellectual property rights. An adverse determination
in any such proceeding could subject the Company to significant liabilities to
third parties, or require the Company to seek licenses from third parties or pay
royalties that may be substantial. Furthermore, there can be no assurance that
necessary licenses would be available to the Company on satisfactory terms, if
at all. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent the Company
from manufacturing or selling certain of its products which in turn would have a
material adverse effect on the Company's business, financial condition or
results of operations.
The Company has registered United States trademarks, including Peri-Strips(R),
Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-Guard(R), Biograft(R),
Flo-Rester(R) and Bio-Vascular Probe(R).
Employees
At January 2, 1997, the Company's continuing operations employed 64 full-time
and two part-time individuals, including 5 in research and development, 26 in
manufacturing, 13 in sales and marketing, 19 in general and administrative
functions and three in regulatory affairs. The Company's employees are not
represented by a union, and the Company considers its relationship with its
employees to be good.
Financial Information About Foreign and Domestic Operations and Export Sales
- ----------------------------------------------------------------------------
For information with respect to the Company's revenue attributable to
international markets, see page 47 of this Annual Report on Form 10-K.
ITEM 1A - Important Factors
- ---------------------------
The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects.
Limitations on Third-Party Reimbursement
The Company's products are purchased primarily by hospitals and other users,
which bill various third-party payers, such as government health programs,
private health insurance plans, managed care organizations and other similar
programs, for the health care goods and services provided to their patients.
Payers may deny reimbursement if they determine that a product used in a
procedure was not used in accordance with established payor protocol regarding
cost-effective treatment methods or was used for an unapproved indication.
Third-party payers are also increasingly challenging the prices charged for
medical products and services and, in some instances, have put pressure on
medical device suppliers to lower their prices. The Company is unable to predict
what changes will be made in the reimbursement methods used by third-party
health care payers. There can be no assurance that the surgical procedures in
which the Company's products are used will continue to be considered cost-
effective by third-party payers, that reimbursement for such surgeries or
imaging services will be available or, if available will continue, or that
payers' reimbursement levels will not adversely affect the Company's ability to
sell its products on a
17
<PAGE>
profitable basis. The cost of health care has risen significantly over the past
decade, and there have been and may continue to be proposals by legislators,
regulators and third-party payers to curb these costs. Failure by hospitals and
other users of the Company's products to obtain reimbursement from third-party
payers, changes in third-party payers' policies towards reimbursement for
procedures using the Company's products or legislative action could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In January of 1996, HCFA made a national policy decision not to reimburse LVRS
("the HCFA decision"), which had been reimbursed nationwide on a regional basis
during fiscal 1994 and 1995. The Company estimates that approximately 70% of the
patients undergoing LVRS in fiscal 1995 were Medicare patients. In April of
1996, the National Institute of Health ("NIH") announced a collaborative study
of LVRS with HCFA. The study, as it is currently structured, is estimated to
take seven years if it goes to completion and will include 2,580 Medicare
patients, with a little more than half of those receiving bilateral open median
sternotomy or thoracoscopic LVRS. This represents less than 2% of those
currently estimated to benefit from LVRS. The HCFA decision materially and
adversely affected the Company's financial results. In fiscal 1996 revenue from
the sale of Peri-Strips decreased $1,214,000 to $4,336,000. The Company
understands that some private insurance companies and managed care organizations
are currently reimbursing LVRS based on their own evaluation of the procedure
and its outcomes. It is unknown whether these private payers will change their
reimbursement practices in the future.
Highly Competitive Industries and Risk of Technological Obsolescence
The Company faces intense competitions. The medical products industry is highly
competitive and characterized by rapid innovation and technological change. The
Company expects technology to continue to develop rapidly, and the Company's
success will depend to a large extent on its ability to maintain a competitive
position with its technology. There can be no assurance that the Company will be
able to compete effectively in the marketplace or that products developed by its
competitors will not render its products obsolete or non-competitive. Similarly,
there can be no assurance that the Company's competitors will not succeed in
developing or marketing products that are viewed by physicians as providing
superior clinical performance or are less expensive relative to the Company's
products currently marketed or to be developed. Several established companies
manufacture and sell surgical products which compete with all of the Company's
surgical products. The companies with which the Company competes have greater
distribution capabilities, substantially greater capital resources and larger
marketing, research and development staffs and facilities than the Company. In
addition, many of the Company's competitors offer broader product lines within
the Company's specific product markets. Broad product lines may give the
Company's competitors the ability to negotiate exclusive, long-term medical
product supply contracts and the ability to offer comprehensive pricing for
their products, including those that compete with the Company's products. By
offering a broader product line in the general field of medical products and
supplies, competitors may also have a significant advantage in marketing
competing products to group purchasing organizations and managed care
organizations that increasingly seek to reduce costs. There can be no assurance
that the Company will be able to compete effectively with such manufacturers.
Intellectual Property
The Company protects its technology through trade secrets and proprietary know-
how and through patents, both owned and licensed. The Company seeks to protect
its trade secrets and proprietary know-how through confidentiality agreements
with employees, consultants and other parties. Supple Peri-Guard, which is used
in the manufacture of the majority of the Company's Tissue-Guard products, is
protected exclusively by trade secrets. There can be no assurance that the
Company's trade secrets or confidentiality agreements will provide meaningful
protection of the Company's proprietary information or, in the event of a breach
of any confidentiality agreement, that the Company will have adequate remedies.
There can be no assurance that any pending or future patent applications will
result in issued patents, or that any current or future patent, regardless of
whether the Company is an owner or licensee of such patent, will not be
challenged, invalidated or circumvented or that the rights granted thereunder or
under its licensing agreements will provide a competitive advantage to the
Company. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology developed
by the Company or that the Company's technology does not or will not infringe
patents or other rights owned by others.
18
<PAGE>
The medical product industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. Intellectual property litigation
is complex and expensive, and the outcome of such litigation is difficult to
predict. Any future litigation, regardless of the outcome, could result in
substantial expense to the Company and significant diversion of the efforts of
the Company's technical and management personnel. Litigation may also be
necessary to enforce patents issued to the Company and license agreements
entered into by the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. An adverse determination in any such proceeding
could subject the Company to significant liabilities to third parties, or
require the Company to seek licenses from third parties or pay royalties that
may be substantial. Furthermore, there can be no assurance that necessary
licenses would be available to the Company on satisfactory terms, if at all.
Accordingly, an adverse determination in a judicial or administrative proceeding
or failure to obtain necessary licenses could prevent the Company from
manufacturing or selling certain of its products which in turn would have a
material adverse effect on the Company's business, financial condition and
results of operations. See "Intellectual Property" on page 16 of this Report.
Risks Associated with Human Tissue Products
Both the United States and Europe have recently focused attention on the safety
of tissue banks, spurred by incidents of the transmission of human disease
during tissue transplantation. In the United States, recent regulations drafted
by the FDA have outlined requirements for tissue banks. The regulations have
specifically excluded from regulation medical devices subject to FDA review,
including preserved umbilical cord vein grafts such as Biograft. As a result,
the Company does not expect Biograft to be subject to tissue bank regulations in
the United States and the related expensive donor screening and donor testing
procedures. There can be no assurance, however, that the FDA will not impose
additional regulatory requirements on Biograft at some later date or that
Biograft would be able to meet any such new requirements.
The future regulatory environment for Biograft in Europe is unclear. While the
MDD issued by the EU explicitly excludes medical devices derived from human
tissue from regulation, certain European medical device manufacturers are
actively lobbying for the re-inclusion of such devices in the MDD. If this
effort is successful, the earliest date for applying for CE mark approval for
Biograft is expected to be 1998. In addition, if extensive donor screening and
donor testing requirements are imposed, such requirements could make it
uneconomical to sell Biograft in Europe even under the CE mark. Biograft
accounted for 9% and 11% of the Company's net revenue and international net
revenue, respectively, for the year ended October 31, 1996.
Bovine Spongiform Encephalopathy ("BSE") is endemic in cattle in the United
Kingdom (UK) and has received much publicity in Europe regarding beef for
dietary consumption. Under the direction of the USDA, the U.S. government has
had an active program of surveillance and import controls since the late 1980's,
designed to prevent the introduction of BSE into U.S. cattle. To date all
evidence indicates that U.S. cattle are free of BSE. The Company obtains all of
its raw pericardium from USDA slaughterhouses. To date BSE has not impeded sale
of the Company's products worldwide. The Company's Notified Body, the British
Standards Institute ("BSI"), and French authorities have specifically reviewed
Tissue-Guard sourcing and manufacturing processes and have then accepted the
Company's bovine pericardium products. The Company cannot predict whether or
not a case of BSE may someday be reported in the U.S. If a case of BSE were
reported in the U.S. cattle, it could have a material adverse effect on the
Company's business, financial condition and results of operations. Although the
Company does not anticipate that any countries will prohibit the sale of Tissue-
Guard products as a result of concerns related to BSE, such prohibition by
certain countries could have a material adverse effect on the Company's
business, financial condition and results of operation.
Governmental Regulation
The Company's products, development activities and manufacturing processes are
subject to extensive and rigorous regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the FDA regulates the
introduction, manufacturing, labeling and record keeping procedures for medical.
The process of obtaining marketing clearance from the FDA for new products and
new applications for existing products can be time-consuming and expensive, and
there is no assurance that such clearances will be granted or that FDA review
will not involve delays that
19
<PAGE>
would adversely affect the Company's ability to commercialize additional
products or additional applications for existing products. In addition, certain
of the Company's products that are in the research and development stage may be
subject to a lengthy and expensive pre-market approval ("PMA") process with the
FDA. Even if regulatory approvals to market a product are obtained from the FDA,
these approvals may entail limitations on the indicated uses of the product.
Product approvals by the FDA can also be withdrawn due to failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
approval. The FDA could also limit or prevent the manufacture or distribution of
the Company's products and has the power to require the recall of such products.
FDA regulations depend heavily on administrative interpretation, and there can
be no assurance that future interpretations made by the FDA or other regulatory
bodies, with possible retroactive effect, will not adversely affect the Company.
The FDA, various state agencies and foreign regulatory agencies inspect the
Company and its facilities from time to time to determine whether the Company is
in compliance with various regulations relating to manufacturing practices,
validation, testing, quality control and product labeling. A determination that
the Company is in violation of such regulations could lead to imposition of
civil penalties, including fines, product recalls or product seizures and, in
extreme cases, criminal sanctions.
Approximately 22% of the Company's revenue in fiscal 1996 resulted from sales of
its products outside the United States through independent distributors.
International regulatory bodies have established varying regulations governing
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The Company
relies on independent distributors to comply with these foreign regulatory
requirements and communication between foreign regulatory agencies and the
Company is indirect and occurs through the foreign distributor. The inability
or failure of independent distributors to comply with the varying regulations or
the imposition of new regulations could restrict such distributors' ability to
sell the Company's products internationally and thereby adversely affect the
Company's business, financial condition and results of operations.
The new registration scheme in the EU requires that the Company's quality system
conform with the ISO 9001 international quality standard and that its products
conform with the "essential requirements" set forth by the MDD for the class of
products produced by the Company. Compliance with these requirements will allow
the Company to issue a "Declaration of Conformity" and apply the CE mark to
products, allowing free sale in the EU. While the Company has obtained the "CE"
mark for its Tissue-Guard products, there can be no assurance that the Company
will be able to maintain compliance with the regulations to retain the CE mark.
In addition, it is uncertain whether the Company will be successful in obtaining
the CE mark for its other products or new product introductions. Failure to
obtain the CE mark by 1998 would limit the Company's ability to sell its
products in Europe and would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Governmental
Regulation" on page 12 of this Report.
Exposure to Product Liability Claims; Risk of Product Recall
The medical product industry historically has been litigious, and the
manufacture and sale of the Company's products inherently entails a risk of
product liability claims. Since the Company's principal products are designed
to be permanently placed in the human body, production errors could result in an
unsafe product and injury to the patient. Although the Company maintains
product liability insurance in amounts believed to be adequate based upon the
nature and risks of its business in general and its actual experience to date,
there can be no assurance that one or more liability claims will not exceed the
coverage limits of such policies or that such insurance will continue to be
available on commercially reasonable terms, if at all. Furthermore, the Company
does not expect to be able to obtain insurance covering its costs and losses as
the result of any recall of its products due to alleged defects, whether such a
recall is instituted by the Company or required by a regulatory agency.
In September 1996 the Company voluntarily issued a Safety Alert regarding the
usage of its bovine pericardium as a urethral sling and removed "urethral sling"
from the "indications" statement in its instructions for use. The Company
issued the safety alert as a prudent course of action. The deletion of
"urethral sling" from the labeling caused the action to fall into the category
of a "field correction". In November 1996 the FDA acknowledged this field
correction and reported it in the "FDA Weekly Enforcement Report" of November
11, 1996 as a "recall", as the definition of a recall encompasses field
corrections. No product units were physically recalled and none were returned
to the Company.
20
<PAGE>
Although Peri-Guard and Supple Peri-Guard have included the urethral sling
indication in their labeling for several years, the products were rarely used in
this application until late 1995. At that time a handful of urological surgeons
began using the products in place of autologous fascia slings to treat female
urinary incontinence. Approximately 65 transvaginal implants were done,
resulting in 16 explants due to vaginal discharge, opening of the vaginal
incision, and localized inflammation without fever. These results were similar
to those which have been reported for synthetic urethral slings.
A product liability claim, recall or other claim with respect to uninsured
liabilities or in excess of insured liabilities could have a material adverse
effect on the business, financial condition and results of operations of the
Company.
Dependence on Distributor Sales
Sales to distributors constitute a significant portion of the Company's current
business. In the year ended October 31, 1996, three domestic distributors
accounted for an aggregate of 44% of gross revenue, with each of such
distributors accounting for in excess of 10% of the Company's gross revenue for
the period. There can be no assurance that the Company will be able to maintain
its relationships with these significant distributors, or, in the event of
termination of any of such relationships, that a new replacement distributor
will be found. The loss of a significant distributor could materially adversely
affect the Company's business, financial condition and results of operations if
a new distributor or other suitable sales organization could not be found on a
timely basis in the relevant geographic market. See Business - "Marketing" on
page 10 of this Report.
ITEM 2 - Properties
- -------------------
The Company leases approximately 36,000 square feet of office and manufacturing
space at 2575 University Avenue, St. Paul, Minnesota. The base rent of this
lease, which commenced August 1, 1995 and expires July 31, 2005, is
approximately $255,000 annually. The Company also pays apportioned real estate
taxes and common costs on this lease. The Company believes that its current
space is adequate for the foreseeable future.
ITEM 3 - Legal Proceedings
- --------------------------
During the first quarter of fiscal 1997, the Company received notice of a suit
brought against it in Tokyo District Court in Japan by Jostra, Japan, K.K., a
former Japanese distributor, claiming wrongful termination and economic damage
of $500,000. The Company believes the claim to be completely without merit and
intends to pursue this matter vigorously.
ITEM 4 - Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this Report.
ITEM 4A - Executive Officers of the Registrant
- ----------------------------------------------
The Company's executive officers, their ages, and their offices held as of
January 3, 1997 are as follows:
<TABLE>
<CAPTION>
Name Age Title
---- --- -----
<S> <C> <C>
John T. Karcanes...... 50 President, Chief Executive Officer and
Director
Andrew M. Weiss*...... 39 President, Vital Images, Incorporated
Vice President of Bio-Vascular, Inc.
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
Name Age Title
---- --- -----
<S> <C> <C>
Vincent Argiro, Ph.D*............. 40 Vice President of the Company, Executive
Vice President and Chief Technology Officer
of Vital Images, Incorporated and Director
M. Karen Gilles................... 54 Vice President of Finance, Chief Financial
Officer, and Corporate Secretary
Bruce A. MacFarlane,.............. 44 Vice President of Regulatory Affairs and
Ph.D. Quality Assurance
Robert P. Nelson.................. 51 Vice President of Operations
Kemal Schankereli................. 44 Vice President of Research and Development
Frank A. Stephenson............... 43 Vice President of Marketing and Sales
*Will cease to be an officer of Bio-Vascular concurrent with the spin-off
of Vital Images.
</TABLE>
John T. Karcanes. Mr. Karcanes has served as President, Chief Operating
Officer and a director of the Company since April 1994 and as Chief Executive
Officer of the Company since November 1994. From June 1992 to April 1994, Mr.
Karcanes acted as an independent consultant and an interim executive officer,
working primarily with early-stage technology companies. From 1987 to June 1992,
Mr. Karcanes served as President and Chief Executive Officer of Crosfield
Lightspeed, Inc., a technology company serving the publishing industry. Mr.
Karcanes served as President of Palladian Software, Inc., a software development
company, from 1984 to 1986, and from 1981 to 1984, he served in a number of
executive positions in international operations and sales and marketing with
Cullinet Software, Inc., a database and application software company, and
Computer Pictures Corporation, a software company specializing in executive
information systems.
Andrew M. Weiss. Mr. Weiss was appointed President of Vital Images and a Vice
President of the Company in October 1995. From July 1994 until October 1995,
Mr. Weiss served as Vice President of Sales and Marketing for Marquette
Electronics, a medical device manufacturer. From January 1986 through June
1994, Mr. Weiss was employed by General Electric Corporation, a multi-national
corporation with operations including medical device and medical imaging
equipment manufacturing, serving as Marketing Manager of GE Capital Vendor
Financial Services from January 1994 through June 1994, as Marketing Programs
Manager for GE Medical Systems - Americas from April 1992 through December 1993
and as Marketing Programs Manager for GE Medical Systems - Europe from January
1990 through March 1992.
Vincent Argiro. Dr. Argiro was appointed Executive Vice President and Chief
Technology Officer of Vital Images in October 1995 and serves as a Vice
President and Director of the Company. Dr. Argiro was elected a Vice President
and Director of the Company in May 1994 in connection with the acquisition of
Vital Images. Following the acquisition, Dr. Argiro served as President of
Vital Images from May 1994 to October 1995. Dr. Argiro, the founder of Vital
Images, served as Chairman of the Board of Vital Images from 1988 until May
1994. From 1988 to 1990 and from September 1991 to June 1992, Dr. Argiro also
served as President of Vital Images. In September 1991, Dr. Argiro became Chief
Executive Officer of Vital Images. From 1984 to June 1992, Dr. Argiro served as
an Associate Professor of Physiology at Maharishi International University where
he conducted research in neuroscience and cell biology.
M. Karen Gilles. Ms. Gilles has served as Chief Financial Officer of the
Company since December 1990, Vice President of Finance since 1989, and Secretary
of the Company since November 1991 after serving as the Director of Finance and
Administration from April 1989 to December 1989. From 1985 to 1989, Ms. Gilles
served as Controller
22
<PAGE>
for VEE Corporation, a production company, and Colin Companies, a related
concession company. From 1983 to 1985, Ms. Gilles was an accountant with
McGladrey & Pullen, a public accounting firm.
Bruce A. MacFarlane. Dr. MacFarlane has served as Vice President of
Regulatory Affairs and Quality Assurance since June 1995 after serving as
Director of Regulatory Affairs from November 1991 to June 1995. From 1985 to
October 1991, Dr. MacFarlane served as Director of New Product Development and
Regulatory Affairs at Medical Devices, Inc., a medical device company which
manufactures electromedical devices.
Robert P. Nelson. Mr. Nelson has served as Vice President of Operations since
September 1991. From 1988 until August 1991, Mr. Nelson served as Director of
Operations for Rexton, Inc., a hearing aid manufacturer. From 1977 through 1987,
he served as Director of Operations for heart valve manufacturing at Medtronic,
Inc., a medical device company.
Kemal Schankereli. Mr. Schankereli has served as Vice President of Research
and Development since December 1993 after serving as Director of Research and
Development from January 1993 to December 1993. From 1991 to December 1992, Mr.
Schankereli served as a private consultant to the bio-medical device industry.
From 1983 to 1991, Mr. Schankereli held the position of Manager of Vascular
Product Research at St. Jude Medical, Inc., a medical device company. From 1978
to 1983, Mr. Schankereli served as a Senior Research Scientist at Meadox
Medicals, Inc., a medical device company.
Frank A. Stephenson. Mr. Stephenson has served as Vice President of Marketing
and Sales since December 1994. From 1989 to August 1994, Mr. Stephenson served
as Vice President of Marketing and Sales for Spectranetics Corporation, a
medical laser company. From 1985 to 1989, Mr. Stephenson held a series of
marketing management positions with Boston Scientific, Inc., a manufacturer of
medical devices, and served as a senior sales representative and trainer from
1982 to 1985 with Codman & Shurtleff, a distributor of neurosurgical products,
which is a division of Johnson and Johnson, Inc.
PART II
ITEM 5 - Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
The Company's Common Stock is currently traded on the Nasdaq National Market
under the symbol "BVAS". Prior to September 21, 1995, the Company's common
stock was quoted on the Nasdaq SmallCap Market. The following table sets forth,
for each of the fiscal periods indicated, the range of high and low bid
quotations per share of Common Stock as reported on the Nasdaq SmallCap Market
through September 20, 1995, and the range of high and low closing sale prices
per share since September 21, 1995 as reported by the Nasdaq National Market.
These prices do not include adjustments for retail mark-ups, mark-downs or
commissions, and prior to September 21, 1995, represent inter-dealer quotations
and do not necessarily represent actual transactions).
<TABLE>
<CAPTION>
High Low
------- -------
<S> <C> <C>
Fiscal 1996
First Quarter............ $15.000 $ 7.500
Second Quarter........... 13.125 8.000
Third Quarter............ 9.875 6.125
Fourth Quarter........... 8.375 5.250
Fiscal 1995
First Quarter............ $ 5.750 $ 4.625
Second Quarter........... 7.375 5.250
Third Quarter.............. 14.650 6.875
Fourth Quarter............. 18.000 11.625
</TABLE>
23
<PAGE>
The Company has not declared or paid any cash dividends on its Common Stock
since its inception, and the Board of Directors presently intends to retain all
earnings for use in the business for the foreseeable future. As of January 2,
1997 there were approximately 6,900 beneficial owners of the Company's Common
Stock.
24
<PAGE>
ITEM 6 - Selected Financial Data
--------------------------------
<TABLE>
<CAPTION>
For the Year Ended October 31: 1996 1995 1994 1993 1992
===========================================================================================================
<S> <C> <C> <C> <C> <C>
Net revenue $10,124,709 $10,426,076 $ 4,951,743 $4,422,775 $4,185,110
Gross margin 6,681,611 6,964,259 3,027,708 2,586,354 2,519,324
Operating income (loss) 571,013 2,121,096 (255,951) 333,058 399,046
Income (loss) from continuing
operations 1,218,501 1,659,162 (697,025) 650,634 555,483
Discontinued operations,
net of taxes (2,396,142) 527,304 (1,182,497) (808,778) (714,201)
Net income (loss) $(1,177,641) $ 2,186,466 $(1,879,522) $ (158,144) $ (158,718)
--------------- ------------ ------------ ----------- -----------
Per share amounts:
Income (loss) from continuing .13 .20 (.10) .09 .08
operations
Net income (loss) per share $ (0.12) $ 0.27 $ (0.26) $ (.02) $ (.02)
Weighted average shares
outstanding 9,433,000 8,172,000 7,277,000 7,055,000 6,743,000
<CAPTION>
At October 31: 1996 1995 1994 1993 1992
==========================================================================================================
<S> <C> <C> <C> <C> <C>
Working capital /1/ 22,106,990 24,059,746 6,261,521 6,636,651 5,491,466
Total assets /1/ 37,881,279 37,303,375 7,431,793 8,807,445 7,974,050
Long-term debt -- -- -- 40,016 70,173
Shareholders' equity /2/ 35,220,535 35,355,336 6,785,539 8,476,742 7,643,046
</TABLE>
/1/ In connection with the spin-off of Vital Images Incorporated the Company
will eliminate Vital Images' intercompany debt and contribute $10,000,000 in
cash, cash equivalents and/or marketable securities effective November 1, 1996,
which Vital Images will use for working capital purposes from that date forward.
/2/ On the distribution date, Shareholders' Equity will be reduced by an amount
approximating the $10,000,000 working capital contribution, net of the losses of
Vital Images through the distribution date which are estimated to be $1,348,000.
25
<PAGE>
ITEM 7 - Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations
- -------------
Overview
On October 28, 1996, the Bio-Vascular Board of Directors approved the spin-off
of its wholly owned subsidiary, Vital Images, to the Company's shareholders
through a pro-rata distribution of all of the issued and outstanding shares of
capital stock. The spin-off is expected to occur around March 31, 1997,
following review of the appropriate filings by the Securities and Exchange
Commission, at which time Vital Images will trade as an independent public
company. The Company has attempted to structure the transaction as tax-free,
but since no advance ruling will be sought from the Internal Revenue Service, no
assurance can be made about the final tax treatment of the transaction.
It is expected that one share of Vital Images common stock will be distributed
in the spin-off for every two Bio-Vascular shares held. In connection with the
spin-off of Vital Images Incorporated, the Company will eliminate Vital Images'
intercompany debt and contribute $10,000,000 in cash, cash equivalents and/or
marketable securities effective November 1, 1996, which Vital Images will use
for working capital purposes from that date forward. On the distribution date,
Shareholders' Equity will be reduced by an amount approximating the $10,000,000
working capital contribution, net of the losses of Vital Images through the
distribution date which are estimated to be $1,348,000. Cash, cash equivalents
and marketable securities retained by Bio-Vascular will be approximately
$19,500,000.
The Company believes that strategically and financially, the timing and
circumstances are right to separate the Company's Surgical and Imaging
Businesses for the long-term benefit of the shareholders. Both organizations,
it is believed, will benefit from a tighter focus on their respective markets,
will be able to invest in research and development at levels appropriate to
their respective stages of development and will be able to evolve unique
organizational and marketing structures to better serve their substantially
different markets. Vital Images became a wholly-owned subsidiary of the Company
on May 24, 1994 in a business combination accounted for as a "pooling-of-
interests".
Vital Images, Incorporated, the new public company that results from the spin-
off, is a leading developer of 3-D volume rendering software for medical
research, clinical diagnosis and screening, and surgical planning. Its
products, which are sold worldwide, are intended to reduce invasiveness,
enhance visual information and produce fast results. As a result of the plan to
spin-off Vital Images, Bio-Vascular's discussion and analysis of financial
results, financial statements and notes to financial statements report Vital
Images as discontinued operations. (See Footnote 2 of Notes to the Financial
Statements on page 40 of this Report.) Prior years' consolidated financial
statements and notes have been restated accordingly. In addition, the Company
accrued the estimated losses of Vital Images through the anticipated date of
distribution, March 31, 1997. These estimated losses are reported as the loss
on disposal. All of the discussion which follows addresses the Company's
continuing operations.
The Company's continuing business develops, manufactures and markets proprietary
specialty medical products for use in thoracic, cardiac, neuro and vascular
surgery. The Company entered a period of significant growth in late 1994 and
during fiscal 1995. Net revenue ("revenue") increased by 110%, fueled by sales
of its Peri-Strips product. Peri-Strips are used in conjunction with lung
volume reduction surgery ("LVRS"), a surgical treatment for late-stage (also
referred to as end-stage) emphysema patients. Peri-Strips was cleared to
market by the Food and Drug Administration in April of 1994. Revenue from the
sales of Peri-Strips was $685,000 in fiscal 1994 and had increased to $5,550,000
in fiscal 1995. In January 1996, the Healthcare Financing Administration
("HCFA"), the agency of the federal government that administers Medicare, made a
national policy decision not to reimburse LVRS ("the HCFA decision"), these
surgeries had been reimbursed nationwide on a regional basis during fiscal 1994
and 1995. The Company estimates that approximately 70% of the patients
undergoing LVRS in fiscal 1995 were Medicare patients. In April of 1996, HICFA
announced a collaborative study of LVRS with the National Institute of Health
("NIH"). The study, as it is currently structured, is estimated to take seven
years if it goes to completion and will include 2,580 Medicare patients, with a
little more than half of those receiving bilateral open median sternotomy or
thoracoscopic LVRS. This represents less than 2% of those currently estimated
to benefit from LVRS. The HCFA decision materially and adversely affected the
26
<PAGE>
Company's financial results. In fiscal 1996, revenue from the sale of Peri-
Strips decreased $1,214,000 to $4,336,000. The Company understands that some
private insurance companies and managed care organizations are currently
reimbursing LVRS based on their own evaluation of the procedure and its
outcomes. It is unknown whether these private payers will change their
reimbursement practices in the future. If these private payers change their
reimbursement practices, it could have an adverse impact on the Company's
business, financial condition and results of operations. (See Business - Third
Party Reimbursement and Cost Containment on Pages 15 and 16 of this Report.)
Members of Congress have been focusing their attention on the concerns raised by
HCFA's decision not to reimburse LVRS. The federal government's fiscal year 1997
appropriations bill was signed into law in the Fall of 1996 which included
language requiring HCFA to review all available studies and research data on the
treatment of end-stage emphysema by LVRS and make a recommendation to Congress
as to the appropriateness of Medicare coverage by January 1, 1997. The
legislative history accompanying the law and interpreting this bill language
calls for HCFA's report to describe "a method and schedule for restoring
Medicare coverage of lung volume reduction surgery." As of January 24, 1997,
HCFA has not complied with this mandate and no information regarding the report
is available at this time. In addition, in late December 1996, a dozen members
of Congress submitted a written request to the House Ways and Means Committee
that it hold a hearing early in 1997 regarding LVRS because "such important
ethical and quality of care concerns have been raised." The hearing request
letter also states, "because many in the medical community believe LVRS is a
safe and effective treatment for certain patients with end-stage emphysema, we
are concerned that the decision not to extend Medicare coverage for the
procedure could negatively affect the lives of thousands of older Americans who
suffer from this disease." Despite the interest and action of Congress, no
assumptions can be made that any changes will occur to alter the study as it is
currently designed or to change the reimbursement decision before the study is
complete.
Results of Continuing Operations
Comparison of the Year Ended October 31, 1996 with the Year Ended October 31,
1995
Revenue decreased to $10,125,000 from $10,426,000, primarily due to the decrease
in Peri-Strips revenue resulting from the HCFA decision, offset substantially by
an increase in revenue from sales of other Tissue Guard products. Peri-Strips
revenue decreased $1,214,000 to $4,336,000 from $5,550,000. Revenue from sales
of other Tissue-Guard products, Dura-Guard, Vascu-Guard, Supple Peri-Guard and
Peri-Guard, increased by $1,099,000 to $2,944,000 from $1,845,000, primarily due
to the increase in revenue from Dura-Guard, which was cleared to market by the
FDA in June 1995. Pricing was not a factor in this revenue increase.
Revenue from sales of Biograft decreased to $938,000 from $1,198,000. The
Company believes that this pattern of year to year decreases is representative
of the later stages of this products' life cycle. Revenue from sales of surgical
productivity tools (Flo-Rester and the Bio-Vascular Probe) increased 4% to
$1,902,000 from $1,825,000. Revenue from these products has increased between 3%
and 7% in each of the last three years.
The gross margin percentage was 66% for 1996 and 67% for 1995. While the annual
gross margin percentages appear stable, they have not been on a quarter-to-
quarter basis during 1996. In 1995, the gross margin percentage was increasing,
primarily due to rapidly increasing production volume associated with rising
Peri-Strips sales, while in 1996, the gross margin percentages declined,
primarily due to decreases in the production volume in response to decreases in
expected demand for Peri-Strips as a result of the HCFA decision. During 1996,
the gross margin percentage was at a high of 72% in the first quarter and a low
of 62% by the fourth quarter (excluding the effect in the third quarter of an
addition of $228,000 to the reserve for potentially obsolete Peri-Strips
inventory). The Company expects the gross margin percentage for 1997 to be at or
near the 1996 fourth quarter level. This forward looking statement is influenced
primarily by the Company's current estimate of standard costs in periods where
the production volume of Peri-Strips has been materially reduced, and would be
impacted by significant increases or decreases in production volumes of the
Company's other products, by material changes in the Company's product mix and
by the accuracy of the Company's estimates of standard costs.
27
<PAGE>
Selling, general and administrative expense increased $1,002,000 or 24% between
1995 and 1996. Increases were generally across all functions and due in large
part to the presence during all of 1996 of a relatively complete basic corporate
infrastructure. This infrastructure was developed beginning in the last half of
1994 and throughout 1995 to support the Company's rapid growth. Although the
rapid growth, which was fueled by Peri-Strips was interrupted, the infra
structure that was built to support that growth is vital to managing the
situation that resulted and in moving the Company forward through the
acceleration and in pursuit of other opportunities. The increase in SG&A expense
also includes expense related to the development of a quality system under ISO
9001, which resulted in the Company obtaining the CE mark for its Tissue-Guard
product line in 1996; expenses related to business development and expenses
related to efforts to inform Congress and other interested parties of the
devastating effect of the HCFA decision on patients in the late-stages of
emphysema and to seek consideration of a modification or reversal of that
decision.
Research and development expense increased 41% between 1995 and 1996, with the
increase primarily due to the cost of moving projects forward in the research
and development pipeline and including an increase in animal studies. In
November of 1996, the Company announced several of the projects under
development. These include two long term projects, a small diameter graft and
the testing of the Company's tissue-processing techniques in inhibiting
mineralization of the tissue after implant, and several shorter-term projects
including a new version of Peri-Strips, and the evaluation of opportunities in
bladder, stomach and ophthalmic surgeries.
The increase in infrastructure, the increased level of business activities and
the acceleration and expansion of research and development efforts, resulted in
operating income of $571,000 compared to $2,121,000 for 1995.
An allocation of interest income between continuing and discontinued operations
has been made consistent with the allocation of cash, cash equivalents and
marketable securities. As a result, other income from continuing operations was
$1,161,000 in 1996, of which $1,050,000 was interest income and $105,000 was
capital gain received as part of an expected series of payments resulting from a
settlement agreement with plaintiffs in certain litigation relating to the Piper
Jaffray Institutional Government Investment Fund ("the Fund"). In 1995, other
income from continuing operations was $265,000, primarily interest income. A
secondary public offering which the Company completed in September of 1995
provided approximately $26,000,000 net of offering costs. This was the basis for
the increase in interest income between 1995 and 1996.
The Company also allocated its provision for income taxes to continuing and
discontinued operations based on their respective pretax income contribution and
tax attributes. As a result, continuing operations recorded a tax provision of
$514,000 for 1996 and $727,000 for 1995, representing an effective tax rate of
approximately 30% in both years. Continuing operations' effective tax rate in
1995 reflected the benefit of utilizing remaining net operating loss
carryforwards to offset 1995 income. Continuing operations' effective tax rate
for 1996 reflected the benefit of recognizing a deferred tax asset associated
with capital loss and research and experimentation credit carryforwards created
in prior years. The capital loss carryforward is expected to be utilized within
its carryforward period due to amounts being received from Piper Jaffray in
settlement of a class action claim on losses incurred in 1994 by an investment
in mutual fund shares. Research and experimentation credits are expected to be
utilized, after the spin-off of Vital Images, as continuing operations will
create taxable income. The Company has deferred tax assets at October 31, 1996,
of $1,096,500 related in part to the above capital loss and credit
carryforwards, but also for operating losses generated by discontinued
operations, which are expected to be fully utilized in the Company's final
consolidated tax return for fiscal 1997. In addition, the Company plans to
utilize the loss on disposal of Vital Images in its final consolidated tax
return for fiscal 1997.
Income from continuing operations was $1,219,000 or $0.13 per share compared to
$1,659,000 or $0.20 per share for 1995.
Comparison of the Year Ended October 31, 1995 with the Year Ended October 31,
1994
Revenue increased 111% to $10,426,000 in 1995 from $4,952,000 for 1994,
substantially due to increases in sales of
28
<PAGE>
Peri-Strips, which increased to $5,550,000 for 1995 from $685,000 for 1994 and
accounted for 53% and 14% of the revenue in 1995 and 1994, respectively. Revenue
from sales of other products of the Tissue-Guard product line, Dura-Guard,
Vascu-Guard, Supple Peri-Guard and Peri-Guard, increased by 86% to $1,845,000
for 1995 from $990,000 for 1994. Dura-Guard, which was cleared to market by the
FDA in June 1995, accounted for 42% of this increase. The Company believes that
heightened visibility in the surgical community created by Peri-Strips was the
other significant factor in the increase in revenues from sales of the other
Tissue-Guard products.
Revenue from sales of Biograft decreased by 21% to $1,198,000 for 1995 from
$1,525,000 for 1994. Revenue from the sales of Biograft has been decreasing
since late 1993, as new competitive treatments and choices reached the market.
Revenue from sales of surgical productivity tools (Flo-Rester and the Bio-
Vascular Probe) increased 7% for 1995 when compared to 1994.
The gross margin percentage increased to 67% for 1995 from 61% for 1994. The
vast majority of this gross margin percentage improvement was due to changes in
product mix resulting from the large volume of Peri-Strips sales and reduced per
product overhead from the increased volume of production. Improvement in
productivity related to the manufacture of Peri-Strips also contributed to the
increase.
Selling, general and administrative expense increased $1,678,000 or 67% between
1994 and 1995. The increase in expense was attributable to the building of a
corporate infra-structure and related overhead required to support the revenue
growth.
Research and development expense increased by 55% in 1995 when compared to 1994,
as the Company continued its plan of investing in the future through increased
research and development efforts.
Operating income was $2,121,000 for 1995 compared to an operating loss of
$256,000 for 1994 which included acquisition costs of $348,000 related to the
acquisition of Vital Images. The approximate $2,400,000 swing in operating
income is the result of Peri-Strips' revenue and gross margin contribution.
Other income was $265,000 in 1995. In 1994, a realized capital loss of $610,000
on an investment in mutual fund shares was the primary factor in net other
expense of $438,000. In 1996, the Company received $105,000 as a partial payment
related to the settlement of litigation on this mutual fund.
For 1995, the Company allocated its provision for income taxes to continuing and
discontinued operations based on their respective pretax income contribution and
tax attributes. As a result, continuing operations recorded a tax provision of
$727,000. In 1994, the Company recorded a tax provision of $3,000. Net operating
losses and credits created in 1994 were fully offset by a valuation allowance as
there was sufficient uncertainty as to their future realizability.
Income from continuing operations was $1,659,000 or $0.20 per share for 1995
compared to a loss of $697,000, or $0.10 per share in 1994.
Liquidity and Capital Resources
In September of 1995 the Company completed a secondary public offering,
resulting in the receipt of approximately $26,000,000, net of all related costs,
bringing its total cash, cash equivalents and marketable securities (short and
long-term) to $30,297,000 at October 31, 1995. One year later, at October 31,
1996, cash, cash equivalents and marketable securities (short and long-term)
totaled $29,671,000. In connection with the spin-off of Vital Images
Incorporated, the Company will eliminate Vital Images' intercompany debt and
contribute $10,000,000 in cash, cash equivalents and/or marketable securities
effective November 1, 1996, which Vital Images will use for working capital
purposes from that date forward. On the distribution date, Shareholders' Equity
will be reduced by an amount approximating the $10,000,000 working capital
contribution, net of the losses of Vital Images through the distribution date
which are estimated to be $1,348,000. Cash, cash equivalents and marketable
securities retained by Bio-Vascular will be
29
<PAGE>
approximately $19,500,000.
Operating activities of continuing operations provided cash of $338,000.
Investments in equipment and leasehold improvements of continuing operations for
1996 used $400,000 and included $186,000 for modification of the clean room for
manufacture of the Bio-Vascular Probe ("the Probe"). The Company has previously
relied on an outside vendor to manufacture the Probe; however, beginning in
early calendar 1997, the Company will assume the manufacture of this product. In
connection with the Probe manufacture, continuing operations used $240,000
primarily for the purchase of proprietary manufacturing technology for the
Probe, $220,000 of which was capitalized as goodwill and will be amortized over
ten years. Additionally, $500,000 was used for the purchase of the Peri-Guard
patent. Purchase of the Probe technology, the Peri-Guard patent and other patent
costs primarily related to Peri-Strips brought the total used by continuing
operations for intangible additions to $803,000. The Company's net investments
in marketable securities used $9,184,000. Financing activities, which provided
$808,000, included a tax benefit, booked to equity, of $682,000 related to the
exercise of stock options.
Historically, the cash needs of the Company have been met by cash generated from
operations and investments. The Company believes the approximate $19,500,000 of
cash, cash equivalents and marketable securities retained by continuing
operations will be sufficient to satisfy its cash requirements for the
foreseeable future.
Inflation
Management believes inflation has not had a material effect on the Company's
operations or on its financial condition.
Foreign Currency Transactions
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars. Fluctuations in currency exchange rates in other
countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of the countries
in which the products are sold.
New Accounting Standard
The Financial Accounting Standards Board (FASB) has issued Statement No. 123,
"Accounting for Stock-Based Compensation." In fiscal year 1997, the Company
intends to adopt the disclosure provisions of the Statement while continuing to
account for options and other employee stock-based compensation using the
intrinsic value based method.
ITEM 8 - Financial Statements and Supplementary Data
- ----------------------------------------------------
The Company's Consolidated Financial Statements and the reports of its
independent accountants are included herein on pages 34 through 49 of this
Annual Report on Form 10-K. The index to such items is included on page 31 of
this Report.
ITEM 9 - Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure
- --------------------
None.
PART III
ITEM 10 - Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
(a) Directors of the Registrant
---------------------------
30
<PAGE>
The information under the caption "Election of Directors" in the
Registrant's 1997 Proxy Statement is incorporated by reference herein.
(b) Executive Officers of the Registrant
------------------------------------
Information concerning Executive Officers of the Company is included in
this Report under Item 4A, "Executive Officers of the Registrant".
(c) Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------
The information under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance Reporting" in the Registrant's 1997 Proxy Statement is
incorporated by reference herein.
ITEM 11 - Executive Compensation
- --------------------------------
The information under the caption "Executive Compensation" and "Election of
Directors--Directors' Compensation" in the Registrant's 1997 Proxy Statement is
incorporated by reference herein.
ITEM 12 - Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------- ----------
The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in the Registrant's 1997 Proxy Statement is
incorporated by reference herein.
ITEM 13 - Certain Relationships and Related Transactions
- --------------------------------------------------------
None.
PART IV
ITEM 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K
- ---------------------------------------------------------------- --------
(a) List of documents filed as part of this Report
1) Financial Statements:
The following Financial Statements are included herein (page
numbers refer to pages in this Annual Report on Form 10-K):
<TABLE>
<CAPTION>
Page
----
<S> <C>
- Report of Independent Accountants 34
- Balance Sheets - as of October 31, 1996 and 1995 35
- Statements of Operations for the Years Ended October 31, 1996, 1995 and 1994 36
- Statements of Shareholders' Equity for the Years Ended October 31, 1996, 1995
and 1994 37
- Statements of Cash Flows for the Years Ended October 31, 1996, 1995 and 1994 38
- Notes to Financial Statements 39
</TABLE>
31
<PAGE>
2) Consolidated Financial Statement Schedules
The following financial statement schedules and independent
accountants' report thereon are included herein and should be
read in conjunction with the Financial Statements referred to
above (page numbers refer to pages in this Annual Report on Form
10-K):
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Accountants' on Financial Statement Schedule 49
Schedule II - Valuation and Qualifying Accounts 50
</TABLE>
All other financial statement schedules not listed have been
omitted because the required information is included in the
Consolidated Financial Statements or the Notes thereto, or is not
applicable.
3) Exhibits
The exhibits to this Annual Report on Form 10-K are listed in the
Exhibit Index hereinafter contained on pages E-1 through E-3 of
this Report.
The Company will furnish a copy of any exhibit to a shareholder
who requests a copy in writing upon payment to the Company of a
fee of $5.00 per exhibit. Requests should be sent to: M. Karen
Gilles, Chief Financial Officer, Vice President of Finance and
Secretary, Bio-Vascular, Inc., 2575 University Avenue, St. Paul,
Minnesota 55114-1024.
The following is a list of each management contract or
compensatory plan or arrangement required to be filed as an
exhibit to this Annual Report on Form 10-K pursuant to
Item 14(c):
A. The Company's 1988 Stock Option Plan (incorporated by
reference to Exhibit 10.21 to the Company's Annual Report on
Form 10-K for the year ended October 31, 1988 (File No. 0-
13907)).
B. Vital Images, Incorporated 1990 Management Incentive Stock
Option Plan (incorporated by reference to Exhibit 10.24 to the
Company's Annual Report on Form 10-K for the year ended
October 31, 1994 (File No. 0-13907)).
C. Vital Images, Incorporated 1992 Stock Option Plan
(incorporated by reference to Exhibit 10.25 to the Company's
Annual Report on Form 10-K for the year ended October 31, 1994
(File No. 0-13907)).
D. Employment letter agreement dated April 7, 1994 between the
Company and Mr. Karcanes (incorporated by reference to
Exhibit 10.26 to the Company's Annual Report on Form 10-K for
the year ended October 31, 1994 (File No. 0-13907)).
E. Employment agreement dated May 24, 1994 between the Company
and Dr. Argiro (incorporated by reference to Exhibit 10.27 to
the Company's Annual Report on Form 10-K for the year ended
October 31, 1994 (File No. 0-13907)).
F. Employment letter agreement dated November 28, 1994, as
amended January 2, 1995, between the Company and
Mr. Stephenson (incorporated by reference to Exhibit 10.20 to
the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No.
32
<PAGE>
0-13907)).
G. Employment letter agreement dated October 19, 1995 between
the Company and Mr. Weiss (incorporated by reference to
Exhibit 10.21 to the Company's Annual Report on Form 10-K for
the year ended October 31, 1995 (File No. 0-13907)).
H. Form of Change in Control Agreement dated November 16, 1994
entered into between the Company and each of Mr. Karcanes,
Ms. Gilles, Mr. Weiss, Mr. Nelson, Dr. MacFarlane, Mr.
Schankereli and Mr. Stephenson (incorporated by reference to
Exhibit 10.28 to the Company's Annual Report on Form 10-K for
the year ended October 31, 1994 (File No. 0-13907)).
I. Form of Change in Control Agreement dated November 16, 1994
entered into between the Company and Dr. Argiro (incorporated
by reference to Exhibit 10.29 to the Company's Annual
Report on Form 10-K for the year ended October 31, 1994 (File
No. 0-13907)).
J. 1995 Stock Incentive Plan (incorporated by reference to
Amendment No. 1 to the Company's Schedule 14-A/A Proxy
statement for the Company's 1996 annual meeting (File
No. 0-13907)).
K. Employee Stock Purchase Plan (incorporated by reference to
Amendment No. 1 to the Company's Schedule 14-A/A proxy
statement for the Company's 1996 annual meeting (File
No. 0-13907)).
b) Reports on Form 8-K
None.
(c) Exhibits:
The response to this portion of Item 14 is included as a separate section of
this Annual Report on Form 10-K.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is included as a separate section of
this Annual Report on Form 10-K.
33
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Bio-Vascular, Inc.:
We have audited the accompanying balance sheets of Bio-Vascular, Inc. as of
October 31, 1996 and 1995, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended October 31, 1996. 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 in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Bio-Vascular, Inc. as of
October 31, 1996 and 1995, and the results of its operations and its cash flows
for each of the three years in the period ended October 31, 1996, in conformity
with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
December 16, 1996
34
<PAGE>
BIO-VASCULAR, INC.
BALANCE SHEET
AS OF OCTOBER 31, 1996 AND 1995
- ------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
----------- -----------
Assets
- ------
<S> <C> <C>
Current assets:
Cash and cash equivalents............................................ $5,736,650 $15,424,969
Marketable securities, short-term.................................... 13,761,050 5,803,223
Accounts receivable, net of an allowance for doubtful accounts of....
$21,400 and 20,000 at October 31, 1996 and 1995.................... 1,465,809 2,170,226
Other receivables.................................................... 632,386 421,170
Inventories.......................................................... 1,972,728 1,968,226
Prepaid expenses..................................................... 284,811 219,971
Deferred income taxes................................................ 914,300 --
----------- -----------
Total current assets............................................. 24,767,734 26,007,785
Equipment and leasehold improvements, net................................ 1,370,256 1,264,698
Intangible assets, net................................................... 1,213,600 640,963
Marketable securities, long-term......................................... 10,173,086 9,069,286
Deferred income taxes.................................................... 182,200 --
Net assets of discontinued operations.................................... 174,403 320,643
----------- -----------
Total assets..................................................... $37,881,279 $37,303,375
=========== ===========
Liabilities and Shareholders' Equity
- ------------------------------------
Current liabilities:
Accounts payable..................................................... $ 306,376 $ 608,898
Accrued expenses..................................................... 554,368 914,271
Accrued loss on disposal of discontinued operations.................. 1,800,000 --
Accrued income taxes................................................. -- 424,870
----------- -----------
Total current liabilities........................................ 2,660,744 1,948,039
----------- -----------
Commitments and Contingency (Note 6)
Shareholders' equity:
Common stock: authorized 20,000,000 shares of $.01 par value;
issued and outstanding, 9,484,898 in 1996 and 9,379,768 shares
in 1995.............................................................. 94,849 93,798
Additional paid-in capital........................................... 39,500,239 38,352,660
Accumulated deficit.................................................. (3,838,537) (2,660,896)
Unrealized marketable securities holding loss........................ (51,107) --
Unearned compensation................................................ (484,909) (430,226)
----------- -----------
Total shareholders' equity........................................... 35,220,535 35,355,336
----------- -----------
Total liabilities and shareholders' equity....................... $37,881,279 $37,303,375
=========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
35
<PAGE>
BIO-VASCULAR, INC.
STATEMENT OF OPERATIONS
FOR THE YEARS ENDED OCTOBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Net revenue...................................... $10,124,709 $10,426,076 $ 4,951,743
Cost of revenue.................................. 3,443,098 3,461,817 1,924,035
----------- ----------- -----------
Gross margin............................... 6,681,611 6,964,259 3,027,708
Operating expenses:
Selling, general and administrative.............. 5,201,236 4,199,673 2,521,445
Research and development......................... 909,362 643,490 413,867
Acquisition costs................................ -- -- 348,347
----------- ----------- -----------
Operating income (loss)....................... 571,013 2,121,096 (255,951)
Other income (expense), net...................... 1,161,488 264,898 (437,996)
----------- ----------- -----------
Income (loss) from continuing operations before
income tax.................................... 1,732,501 2,385,994 (693,947)
Provision for income tax......................... 514,000 726,832 3,078
Income (loss) from continuing operations......... 1,218,501 1,659,162 (697,025)
Discontinued operations:
Income (loss) from operations of discontinued
business, net of income taxes................. (1,048,142) 527,304 (1,182,497)
Loss on disposal of discontinued business,
net of income tax benefit of $452,000......... (1,348,000) -- --
----------- ----------- -----------
Net income (loss)............................. $(1,177,641) $ 2,186,466 $(1,879,522)
=========== =========== ===========
Per share amounts:
Continuing operations......................... $ .13 $ .20 $ (.10)
Discontinued operations....................... (.25) .06 (.16)
----------- ----------- -----------
Net income (loss) per share...................... $ (.12) $ .27 $ (.26)
=========== =========== ===========
Weighted average shares outstanding.............. 9,433,000 8,172,000 7,277,000
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
36
<PAGE>
BIO-VASCULAR, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 1996, 1995 AND 1994
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Unrealized
Additional Marketable
Paid-in Unearned Securities Accumulated
Common Stock Capital Compensation Holding Loss Deficit
------------ ------- ------------ ------------ -------
Par
---
Shares Value
------ -----
<S> <C> <C> <C> <C> <C> <C>
Balances at October 31, 1993............ 7,232,823 $ 72,328 $11,485,997 $(113,743) -- $(2,967,840)
Stock option activity................ 36,115 361 48,387 18,495
Restricted stock activity............ 31,112 311 88,464 (53,495)
Compensation paid in stock........... 18,075 181 62,315 23,300
Net loss............................. (1,879,522)
---------- --------- ------------ ---------- ---------- ------------
Balances at October 31, 1994............ 7,318,125 73,181 11,685,163 (125,443) -- (4,847,362)
Stock option activity................ 197,400 1,974 424,819 4,250
Restricted stock activity............ 41,138 412 78,629 (269,908)
Compensation paid in stock........... 23,105 231 109,519 (39,125)
Issuance of stock, net of offering
costs of $2,277,460................ 1,800,000 18,000 26,054,530
Net income........................... 2,186,466
---------- --------- ------------ ---------- ---------- ------------
Balances at October 31, 1995............ 9,379,768 93,798 38,352,660 (430,226) -- (2,660,896)
Stock option activity, net of tax
benefit............................ 82,744 827 1,099,719 (150,387)
Warrant activity..................... 28,929 289 115,427
Employee Stock Purchase Plan
activity........................... 5,715 57 36,376
Restricted stock activity............ (12,258) (123) (16,616) 71,954
Compensation paid in stock........... 23,750
Offering costs....................... (87,327)
Unrealized marketable securities
holding loss....................... $ (51,107)
Net loss............................. (1,177,641)
---------- --------- ------------ ---------- ---------- ------------
Balances at October 31, 1996............ 9,484,898 $ 94,849 $39,500,239 $(484,909) $ (51,107) $(3,838,537)
========= ======== =========== ========= ========== ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
37
<PAGE>
BIO-VASCULAR, INC.
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31, 1996, 1995 AND 1994
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995 1994
------------ ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss).......................................... $ (1,177,641) $ 2,186,466 $(1,879,522)
Less (income) loss from discontinued operations............ 2,396,142 (527,304) 1,182,497
------------ ------------ -----------
Income (loss) from continuing operations................... 1,218,501 1,659,162 (697,025)
Adjustments to reconcile income from continuing operations
to net cash provided by (used in) operating activities:
Depreciation........................................... 296,732 229,241 179,567
Amortization........................................... 230,635 147,182 227,805
Provision for inventory obsolescence................... 354,822 176,568 45,145
Loss on disposal of assets............................. (4,852) 8,990 22,761
Non-cash compensation.................................. 286,018 232,839 120,670
Loss on sale of marketable securities.................. -- -- 609,653
Amortization of discounts and premiums on
marketable securities.................................. 64,043 -- --
Deferred income taxes.................................. (1,096,500) -- --
Changes in operating assets and liabilities:
Accounts receivable................................. 704,417 (1,142,845) (318,661)
Inventories......................................... (359,324) (1,012,125) (287,594)
Other assets........................................ (268,753) (527,547) (18,750)
Current liabilities................................. (1,087,297) 1,331,783 285,552
------------ ------------ -----------
Net cash provided by continuing operations............. 338,442 1,103,248 169,123
Net cash provided by (used in) discontinued operations. (1,870,046) 818,283 (928,955)
------------ ------------ -----------
Net cash provided by (used in) operating activities.... (1,531,604) 1,921,531 (759,832)
------------ ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements...................... (400,438) (1,045,612) (249,257)
Disposition of fixed assets................................. 3,000 1,085 --
Additions to intangibles.................................... (803,272) (42,799) (10,190)
Investments in marketable securities........................ (25,980,000) (14,872,509) (3,301,877)
Maturities of marketable marketable securities.............. 16,795,920 1,270,841 1,421,383
Discontinued operations, net................................ 1,420,145 (306,014) (255,465)
------------ ------------ -----------
Net cash (used in) investing activities................ (8,964,645) (14,995,008) (2,395,406)
------------ ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds related to the sale of common stock, net of expenses (87,327) 26,072,530 --
Proceeds related to stock options and restricted stock...... 895,257 77,962 44,349
Discontinued operations, net................................ -- -- (123,522)
------------ ------------ -----------
Net cash provided by (used in) financing activities.... 807,930 26,150,492 (79,173)
------------ ------------ -----------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS:.................................................. (9,688,319) 13,077,015 (3,234,411)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR................ 15,424,969 2,347,954 5,582,365
------------ ------------ -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR...................... $ 5,736,650 $ 15,424,969 $ 2,347,954
============ ============ ===========
</TABLE>
The accompanying notes are an integral part of the financial statements.
38
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
(1) BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business Description:
Bio-Vascular, Inc. ("the Company") develops, manufactures and markets
proprietary specialty medical products used in thoracic, cardiac, neuro and
vascular surgery. The Company markets its products through a worldwide network
of distributors and independent sales representatives.
Use of Estimates:
The preparation of financial statements in conformity with generally accepting
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 periods.
Actual results could differ from those estimates. The most significant areas
which require the use of management's estimates relate to the determination of
the allowance for obsolete inventory, the evaluation of realizability of
intangible and deferred tax assets, and the loss on disposal of discontinued
operations.
Cash and Cash Equivalents:
Cash and cash equivalents consist of cash and highly liquid investments
purchased with an original maturity of three months or less. Cash at
October 31, 1996 is primarily concentrated in one money market fund.
Marketable Securities:
Investments having original maturities in excess of three months are classified
as marketable securities and generally consist of U.S. Government or U.S.
Government-backed obligations. Investments are classified as short-term or
long-term in the balance sheet based on their maturity date.
At October 31, 1996 and 1995, all of the Company's marketable securities are
classified as available-for-sale and all mature in two years or less.
Available-for-sale investments are recorded at market value with unrealized
holding gains and losses included as a separate component of shareholders'
equity.
Inventories:
Inventories are valued at the lower of cost or market, with costs generally
determined on a first-in, first-out method.
Equipment and Leasehold Improvements:
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed using accelerated and straight-line methods over the
estimated useful lives (generally three to seven years) or lease life. Major
replacements and improvements are capitalized and maintenance and repairs which
do not improve or extend the useful lives of the respective assets are charged
to operations. The asset and related accumulated depreciation or amortization
accounts are adjusted for asset retirement or disposal with the resulting gain
or loss shown in non-operating income.
39
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- -------------------------------------------------------------------------------
Goodwill, Patents and Other Intangibles:
Goodwill, patents and other intangibles are recorded at cost and are being
amortized using the straight-line method over the estimated useful lives. The
Company evaluates the net realizability of goodwill and other intangibles on an
ongoing basis, based on current and anticipated undiscounted cash flows.
Revenue Recognition:
Revenue is recognized upon shipment of goods to customers.
Research and Development:
Research and development costs are expensed as incurred. Software development
costs of discontinued operations are expensed as incurred. Such costs are
required to be expensed until the point that technological feasibility and
proven marketability of the product are established. Costs otherwise
capitalized after such point are also expensed because they are insignificant.
Income Taxes:
The Company accounts for income taxes using the liability method. The liability
method provides that deferred tax assets and liabilities are recorded based on
the differences between the tax bases of assets and liabilities and their
carrying amounts for financial reporting purposes ("temporary differences").
Temporary differences relate primarily to operating and capital loss
carryforwards, research and experimentation tax credit carryforwards, and
obsolete inventory reserves.
Net Income (Loss) Per Common Share:
Net income (loss) per common share is computed by dividing net income (loss) by
the weighted average number of common and common equivalent shares outstanding.
Common equivalent shares relate to common stock options and warrants, when their
effect is not antidilutive.
(2) DISCONTINUED OPERATIONS:
On October 28, 1996, the Board of Directors approved a plan to separate the
Company's wholly owned subsidiary, Vital Images, Incorporated, as an
independent, publicly owned company. This transaction will be effected through
the distribution of shares of Vital Images to Bio-Vascular's shareholders. This
transaction is expected to be tax free to Bio-Vascular and the shareholders.
However, as the Company is not requesting an advance ruling on the taxability of
the transaction from the Internal Revenue Service, no assurance can be made
regarding the final tax treatment of the transaction. The distribution is
expected to occur around March 31, 1997. In connection with the spin-off, the
Company will eliminate Vital Images' intercompany debt and contribute
$10,000,000 in cash, cash equivalents and/or marketable securities effective
November 1, 1996, which Vital Images will use for working capital purposes from
that date forward. On the distribution date, Shareholders' Equity will be
reduced by an amount approximating the $10,000,000 working capital contribution,
net of the losses of Vital Images through the distribution date which are
estimated to be $1,348,000.
As a result of the plan to spin-off Vital Images, the Company's financial
statements and notes report Vital Images as discontinued operations. Prior
years' consolidated financial statements and notes have been restated
accordingly.
40
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- -------------------------------------------------------------------------------
The loss from operations of the discontinued business includes an allocation of
interest income (based on the ratio of net investment assets to be contributed
to the discontinued business over total investment assets) of $547,000 for the
year ended October 31, 1996. Interest income for the years ended October 31,
1995 and 1994 was determined to be attributable solely to income from continuing
operations. The loss on disposal of $1,348,000 includes the estimated future
operating losses of Vital Images through the estimated date of spin-off. In
addition to the estimate of future results of operations, major components of
the loss on disposal include $400,000 of transaction costs, interest income of
$200,000 and deferred income tax benefit of $452,000. Net cash used by
discontinued operations in 1996 differs from the loss from discontinued
operations principally due to the loss on disposal for which no cash had been
expended at October 31, 1996, deferred revenues and depreciation.
<TABLE>
<CAPTION>
DISCONTINUED OPERATIONS 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net revenue......................................... $ 882,126 $2,893,654 /1/ $ 1,679,775
Cost of revenue..................................... 162,286 405,174 /1/ 509,333
----------- -------------- -----------
Gross margin...................................... 719,840 2,488,480 1,170,442
Operating expenses:
Selling, general and administrative................ 1,617,415 813,697 1,019,137
Research and development........................... 1,459,490 1,356,578 1,254,946
Acquisition costs.................................. -- -- 71,573
----------- --------- ---------
Operating income (loss).......................... (2,357,065) 318,205 (1,175,214)
Other income (expense), net......................... 547,923 1,290 (11)
Provision for income tax (benefit).................. (761,000) (207,809) 7,272
----------- --------- ----------
Income (loss) from discontinued operations.......... (1,048,142) 527,304 (1,182,497)
Loss on disposal, net of income tax benefit of
$452,000............................................ (1,348,000) -- --
---------- ---------- -----------
Total discontinued operations,
net of income taxes................................ $(2,396,142) $ 527,304 $(1,182,497)
=========== ========== ===========
</TABLE>
/1/ A one-time license fee for VoxelGeo source code in the fourth quarter of
fiscal 1995 contributed $1,500,000 to net revenue and $1,322,000 to
operating income.
<TABLE>
<CAPTION>
NET ASSETS OF DISCONTINUED OPERATIONS 1996 1995
---- ----
<S> <C> <C>
Accounts receivable, net......................... $190,807 $234,032
Other assets..................................... 100,752 40,860
Equipment and leasehold improvements, net........ 651,351 464,602
Current liabilities.............................. (256,383) (285,339)
Deferred revenues................................ (512,124) (133,512)
-------- --------
Net assets of discontinued operations............ $174,403 $320,643
======== ========
</TABLE>
41
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
(3) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION:
<TABLE>
<CAPTION>
1996 1995
---- ----
<S> <C> <C>
Inventories:
Raw materials and supplies.................. $ 514,478 $ 440,377
Work-in-process............................. 541,483 374,495
Finished goods.............................. 916,767 1,153,354
---------- ----------
$1,972,728 $1,968,226
========== ==========
Equipment and leasehold improvements:
Furniture, fixtures and computer equipment.. $ 903,162 $ 853,428
Laboratory equipment........................ 168,463 147,365
Manufacturing equipment..................... 536,688 462,846
Leasehold improvements...................... 628,949 442,390
---------- ----------
Less accumulated depreciation and
amortization........................ (867,006) (641,331)
---------- ----------
$1,370,256 $1,264,698
========== ==========
Intangible assets:
Goodwill.................................... $1,538,374 $1,318,499
Less accumulated amortization........ (889,300) (746,234)
Patents and other intangibles............... 665,570 82,173
Less accumulated amortization........ (101,044) (13,475)
---------- ----------
$1,213,600 $ 640,963
========== ==========
Accrued expenses:
Payroll, other employee benefits and
related taxes...................... $ 263,423 $ 572,510
Royalties............................ 56,185 137,572
Other................................ 234,760 204,189
---------- ----------
$ 554,368 $ 914,271
========== ==========
</TABLE>
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Other income (expense), net:
<S> <C> <C> <C>
Interest income/1/....... $1,050,223 $272,025 $219,041
Capital (loss) gain on
sale of investment/2/... 104,980 -- (609,653)
Gain (loss) on disposal
of assets, net.......... 4,852 (8,990) (47,411)
Miscellaneous income
(expense)............... 1,433 1,863 27
---------- -------- ---------
$1,161,488 $264,898 $(437,996)
</TABLE> ========== ======== =========
/1/ Interest income for 1996 is net of $547,000 allocated to discontinued
operations. The allocation was based on the ratio of net investment assets
to be contributed to the discontinued business over total investment assets.
/2/ The 1994 capital loss amount relates entirely to the Company's investment in
mutual fund shares of the Piper Jaffray Institutional Government Income
Portfolio. The Company liquidated its investment in the fund as of October
31, 1994. The capital gain in 1996 relates to amounts received from Piper
Jaffray as a partial payment in settlement of a class action claim in
conjunction with the same investment.
42
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
(4) INCOME TAXES:
PROVISION (BENEFIT) FOR INCOME TAXES 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CONTINUING OPERATIONS:
Currently payable:
Federal...................... $834,720 $724,999 $2,778
State........................ 34,606 1,833 300
Deferred:
Federal....................... (345,518) -- --
State......................... (9,808) -- --
-------- -------- ------
$514,000 $726,832 $3,078
======== ======== ======
DISCONTINUED OPERATIONS:
Currently payable:
Federal...................... (473,327) (208,909) 5,472
State........................ 1,501 1,100 1,800
Deferred:
Federal....................... (275,241) -- --
State......................... (13,933) -- --
---------- --------- ------
$ (761,000) $(207,809) $7,272
========== ========= ======
</TABLE>
<TABLE>
<CAPTION>
COMPONENTS OF DEFERRED TAX ASSETS 1996 1995
---- ----
<S> <C> <C>
Operating and capital loss carryforwards......... $890,900 $187,500
Credit carryforwards............................. 128,300 83,600
Other............................................ 151,800 43,700
Less: valuation allowance........................ (74,500) (314,800)
------- --------
Total............................................ $1,096,500 $ 0
========== ========
</TABLE>
43
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
RECONCILIATION OF EFFECTIVE INCOME TAX
RATE 1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Income from continuing operations................ $1,732,501 $2,385,994 $(693,947)
========== ========== =========
Statutory federal rate........................... 606,375 835,098 (242,881)
Marginal rate.................................... (17,325) (23,860) 6,939
State taxes, net of federal benefit.............. 24,798 1,833 198
Permanent differences............................ 36,206 2,047 (33,437)
Increase (decrease) in valuation reserve......... (203,058) (239,316) 244,813
Other............................................ 67,004 151,030 27,446
---------- ---------- ---------
Total............................................ $ 514,000 $ 726,832 $ 3,078
========== ========== =========
</TABLE>
Income tax payments included in the Statement of Cash Flows totaled $410,769,
$77,152 and $17,490 for the years ended October 31, 1996, 1995 and 1994.
The operating loss carryforwards included as a component of deferred tax assets
were generated by discontinued operations and are expected to be fully utilized
in the Company's final consolidated tax return for fiscal 1997. Tax attributes
related to discontinued operations, primarily net operating losses and credits
limited by separate return year limitations (SRLY) and IRC (S) 382, not expected
to be utilized in the Company's final consolidated tax return have been
allocated to discontinued operations and offset by a full valuation allowance.
The Company also has recognized a deferred tax asset on the portion of its
capital loss carryforward which can be utilized against amounts received from
Piper Jaffray in settlement of a class action claim from the Company's
investment in mutual fund shares.
A tax benefit of $682,200 related to the exercise of stock options was allocated
to additional paid-in capital.
(5) SHAREHOLDERS' EQUITY:
Increase in Authorized Shares:
In March 1995, the shareholders approved an increase in authorized shares of
common stock from 10,000,000 shares to 20,000,000 shares.
Warrants:
During 1995, in connection with a stock offering and issuance of common shares,
the Company issued to the underwriter warrants to purchase 90,000 shares of
common stock, at an exercise price of $16.375 per share, commencing in September
1996. These warrants are exercisable until 1999.
44
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
Restricted Stock:
Under certain compensation agreements, an arrangement which provides for awards
of restricted common stock to key management was adopted in 1992. These awards
of restricted common stock are subject to forfeiture if employment terminates
prior to the end of the prescribed periods. Vesting periods range from three to
four years. The market value of the shares at the time of grant is recorded as
unearned restricted stock. The unearned amount is amortized to compensation
expense over the periods during which the restrictions lapse. As part of these
same compensation agreements, the Company agreed to buy back the number of
shares which would allow the employees to meet their income tax obligations
arising from the non-cash compensation related to the earned restricted shares.
Unearned restricted stock is summarized as follows:
<TABLE>
<CAPTION>
Unearned Restricted Stock Market Value
Balance Shares at Grant
------- ------ --------
<S> <C> <C> <C>
Balance October 31, 1993.................... $ 59,323 13,744 $3.3750----4.5000
Granted..................................... 199,062 50,410 3.2500----3.5000
Earned...................................... (58,174) (14,302) 3.4375----4.5000
Cancelled/Forfeited......................... (87,393) (14,648) 3.3750----4.5000
--------- -------
Balance October 31, 1994.................... 112,818 35,204 3.2500----3.4375
Granted..................................... 430,809 78,748 4.7500---14.5000
Earned...................................... (144,101) (33,887) 3.2500---14.5000
Cancelled/Forfeited......................... (16,800) (3,537) 4.7500
--------- -------
Balance October 31, 1995.................... 382,726 76,528 3.2500---14.5000
Granted..................................... 131,414 11,868 8.6250---14.0000
Earned...................................... (172,463) (35,061) 8.2500---14.5000
Cancelled/Forfeited......................... (30,905) (4,002) 4.7500---14.0000
--------- -------
Balance October 31, 1996.................... $ 310,772 49,333 $3.2500---14.5000
========= =======
</TABLE>
Stock Option Plans:
The Company has five stock option plans, the 1995 Stock Incentive Plan (the
"1995 Plan"), an Employee Incentive Stock Option Plan (the "1988 Plan"), a
Directors' Stock Option ("DSO") Plan, and two plans, the obligations of which
were assumed by the Company as a result of the 1994 acquisition of Vital Images:
the 1990 Management Incentive Stock Option Plan (the "1990 Plan"), and the
1992 Stock Option Plan (the "1992 Plan"). With the adoption of the 1995
Stock Incentive Plan all of the Company's other existing Stock Option Plans,
with the exception of the Director's Stock Option Plan, were terminated and no
additional options are to be granted thereunder, with remaining shares reserved
for issuance under these previous plans now being reserved for issuance under
the 1995 Plan.
As of October 31, 1996, 582,964 shares of common stock remain reserved for
issuance to directors, officers and employees at October 31, 1996. Options under
the plans are exercisable over periods of up to ten years from the date
45
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
of grant. The Company has reserved and granted 411,720 shares of common stock
for issuance in connection with non-plan options which have been granted to
consultants, an officer, and directors of the Company. The difference between
the estimated market value and the exercise price for certain option grants was
recorded as unearned compensation and is being amortized on a straight-line
basis over the vesting period of the related options. These options are
exercisable over periods of up to seven years from the date of grant. Option
activity is summarized as follows:
<TABLE>
<CAPTION>
Plans Non-Plan Price Per Share
--------- --------- -----------------
<S> <C> <C> <C>
Balances at October 31, 1993.. 594,175 106,390 $1.0000--$ 6.8750
Granted.................. 74,000 226,000 $2.0000--$ 3.4375
Exercised................ (7,725) (28,390) $1.0000--$ 2.3750
Canceled................. (45,600) (29,000) $1.0000--$ 5.3750
-------- --------
Balances at October 31, 1994.. 614,850 275,000 $1.0000--$ 6.8750
Granted.................. 346,297 139,000 $3.2500--$14.5000
Exercised................ (159,400) (38,000) $1.0000--$ 6.2500
Canceled................. (49,204) (114,280) $1.0000--$ 4.7500
-------- --------
Balances at October 31, 1995.. 752,543 261,720 $1.0000--$14.5000
Granted.................. 67,108 200,000 $6.3750--$14.0000
Exercised................ (53,744) (29,000) $1.0000--$ 5.3750
Canceled................. (28,863) (21,000) $2.0000--$14.0000
-------- --------
Balances at October 31, 1996.. 737,044 411,720
======== ========
</TABLE>
Options for the purchase of 692,623 shares of common stock at prices ranging
from $1.00 to $14.50 were exercisable at October 31, 1996. In connection with
the spin-off of Vital Images, the Company intends to restructure all outstanding
option agreements.
Rights Plan
In June 1996, the Company's Board of Directors declared a dividend distribution
of one Common Stock Purchase Right (Right) on each outstanding share of the
Company's common stock. With certain exceptions, the Right will become
exercisable only in the event that an acquiring party accumulates 15% or more of
the Company's common stock or a party announces an offer to acquire 15% or more
of the common stock. The Right will expire on June 11, 2006, if not previously
redeemed or exercised. Each Right will entitle the holder to purchase one-tenth
of a share of common stock at a price of $6.00. In addition, upon the
occurrence of certain events, holders of the Right will be entitled to purchase
for the exercise price, a number of common stock fractions having a then current
market value of twice the exercise price or a defined number of shares of an
acquiring entity's common stock at a then current market value of twice the
exercise price. The Company will generally be entitled to redeem the Right at
$.001 per Right at any time until the tenth day following the acquisition of 15%
or more of the Company's common stock or the Company's Board of Directors
determines that a person is an Adverse Person as defined by the Rights
Agreement.
New Accounting Standard
In October 1995, the Financial Accounting Standards Board issued Statement No.
123, Accounting for Stock-Based Compensation. In Fiscal 1997, the Company
intends to adopt the disclosure provisions of the statement while continuing to
account for options and other employee stock-based compensation using the
intrinsic value based method.
46
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
(6) COMMITMENTS AND CONTINGENCY
Operating Leases:
The Company has a noncancelable operating lease for rental of a combined office
and production facility which expires in July 2005. Total annual base rental
expense for this lease is $255,441. The Company also pays apportioned real
estate taxes and common costs on its leased facilities. Total rent expense was
$296,486, $154,622 and $94,738 for the years ended October 31, 1996, 1995 and
1994, respectively.
Future minimum payments at October 31, 1996 are payable as follows: 1997 through
2001--$255,441 each year and $957,921 thereafter.
Royalties:
In connection with the acquisition of product licenses and product manufacturing
rights, the Company is obligated for the payment of royalties as follows:
. 5% on net sales of Peri-Strips through December 2001, or if a patent is
issued, until the expiration of the patent.
. 2.5% or 3% of net sales of the Biograft through 1998 (2.5% if Biograft annual
sales are under $2,000,000; 3.0% if annual sales are over $2,000,000).
. 3% of net sales of the Bio-Vascular Probe through 2001.
Royalty expense was approximately $291,000, $393,000 and $169,000 for the years
ended October 31, 1996, 1995, and 1994, respectively, and is included in cost of
revenue.
Contingency:
Recently, the Company received notice of a suit brought against it in Japan by a
former Japanese distributor, claiming wrongful termination and economic damage
of $500,000. The Company believes the claim to be completely without merit and
intends to pursue this matter vigorously.
(7) EMPLOYEE BENEFIT PLANS:
Salary Reduction Plan:
The Company sponsors a salary reduction plan established on January 1, 1991,
which qualifies under Section 401(k) of the Internal Revenue Code. Employee
contributions are limited to 15% of their annual compensation, subject to yearly
limitations. At the discretion of the Board of Directors, the Company may make
matching contributions equal to a percentage of the salary reduction or other
discretionary amount. The Company has made no contributions to the plan since
its inception.
Employee Stock Purchase Plan:
In 1995, the Board of Directors approved and adopted an Employee Stock Purchase
Plan under which 300,000 shares of common stock were reserved for future
issuance. The Plan was established to enable employees of the Company to invest
in Company stock through payroll deduction. Shares of stock are granted
employees at 85 percent of market
47
<PAGE>
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- --------------------------------------------------------------------------------
value. There were 5,715 shares purchased during 1996 through the plan.
(8) MAJOR CUSTOMERS AND GEOGRAPHIC DATA:
<TABLE>
<CAPTION>
Significant Gross Percentage of Accounts
Customer Sales Gross Sales Receivable
-------- ----- ----------- ----------
<S> <C> <C> <C> <C>
Year ended October 31, 1996...... Futuretech $1,943,862 18% 21%
Life Systems 1,570,515 15% 16%
Cardio Medical 1,224,779 12% 14%
Year ended October 31, 1995...... Futuretech $2,153,750 19% 20%
Life Systems 1,791,055 16% 19%
Cardio Medical 1,274,126 11% 14%
Year ended October 31, 1994...... Futuretech $ 932,140 17%
Life Systems 793,928 15%
</TABLE>
Net export sales amounted to 22%, 17%, and 30% for 1996, 1995 and 1994,
respectively. Substantially all of the Company's export sales are negotiated,
invoiced and paid in U.S. dollars. Gross export sales by geographic area are
summarized as follows:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Europe and Middle East........... $1,371,867 $1,102,720 $1,069,467
Asia and Pacific Region.......... 623,884 521,642 320,619
Canada........................... 176,580 118,674 90,530
Latin America and Others......... 50,934 11,674 7,845
</TABLE>
48
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
Our report on the consolidated financial statements of Bio-Vascular, Inc. is
included on page 34 of this Form 10-K. In connection with our audits of such
financial statements, we have also audited the related financial statement
schedule listed in the index on page 31 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
December 16, 1996
49
<PAGE>
SCHEDULE II
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
BIO-VASCULAR, INC.
VALUATION AND QUALIFYING ACCOUNTS
- --------------------------------------------------------------------------------
Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Allowance for doubtful accounts:
Year ended October 31, 1996 $20,000 $36,592 $35,192 $21,400
Year ended October 31, 1995 $30,000 ($ 1,901) $ 8,099 $20,000
Year ended October 31, 1994 $20,000 $14,217 $ 4,217 $30,000
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Reserve for obsolete inventory:
Year ended October 31, 1996 $46,000 $354,822 $ 32,822 $368,000
Year ended October 31, 1995 $10,000 $176,568 $140,568 $ 46,000
Year ended October 31, 1994 $10,000 $ 45,145 $ 45,145 $ 10,000
</TABLE>
- --------------------------------------------------------------------------------
50
<PAGE>
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.
BIO-VASCULAR, INC.
By /s/ John T. Karcanes
-------------------------------------------------------
John T. Karcanes, President and Chief Executive Officer
Dated: January 27, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below on January 27, 1997 by the following persons on
behalf of the registrant and in the capacities indicated.
/s/ John T. Karcanes
------------------------------------------------------------------------------
John T. Karcanes, Chief Executive Officer (Principal Executive Officer and
Director)
/s/ M. Karen Gilles
------------------------------------------------------------------------------
M. Karen Gilles, Vice President of Finance and Chief Financial Officer
(Principal Financial Officer and Principal Accounting Officer)
/s/ James F. Lyons
------------------------------------------------------------------------------
James F. Lyons
Chairman of the Board of Directors
/s/ Richard W. Perkins
------------------------------------------------------------------------------
Richard W. Perkins, Director
/s/ Lawrence Perlman
------------------------------------------------------------------------------
Lawrence Perlman, Director
/s/ Edward E. Strickland
------------------------------------------------------------------------------
Edward E. Strickland, Director
51
<PAGE>
BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-K
For the Fiscal Year Ended October 31, 1996
3.1 Restated Articles of Incorporation of the Company (incorporated by
reference to Exhibit 3.2 to the Company's registration statement on Form
10 (File No. 0-13907)).
3.2 Amendment to Restated Articles of Incorporation of the Company dated June
21, 1995 (incorporated by reference to Exhibit 4.2 to the Company's
Registration Statement on Form S-3 (File No. 33-62199)).
3.3 Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement on Form S-4 (File
No.33-74750)).
4.1 Form of common stock Certificate of the Company (incorporated by reference
to Exhibit 4.1 to the Company's registration statement on Form 10 (File
No. 0-13907)).
4.2 Form of Rights Agreement, dated as of June 12, 1996, between Bio-Vascular,
Inc. and American Stock Transfer & Trust Company, which includes as
Exhibit A the form of Rights Certificate (incorporated by reference to
Exhibit 4.1 to the Company's Current Report on Form 8-K dated June 12,
1996 (File No. 0-13907)).
4.3 Restated Articles of Incorporation of the Company (see Exhibit 3.1).
4.4 Amendment to Restated Articles of Incorporation of the Company dated
June 21, 1995 (see Exhibit 3.2).
4.5 Amended and Restated Bylaws of the Company (see Exhibit 3.3).
10.1 Agreement dated as of July 31, 1985 among Genetic Laboratories, Inc.,
Vascular Services Diversified, Inc., and the Company, including first
amendment thereto, dated September 25, 1985 (incorporated by reference to
Exhibit 2.1 to the Company's registration statement on Form 10 (File
No. 0-13907)).
10.2 Amendment No. 2 to the Agreement referred to in Exhibit 10.1, effective
July 31, 1985 (incorporated by reference to Exhibit 19.1 to the Company's
Quarterly Report on Form 10-Q for the period ended April 30, 1986 (File
No. 0-13907)).
10.3 License Agreement dated September 25, 1985 between the Company
and Genetic Laboratories, Inc. (incorporated by reference to Exhibit 10.1
to the Company's registration statement on Form 10 (File No. 0-13907)).
10.4 Amendment to License Agreement dated June 13, 1986 between the
Company and Genetic Laboratories, Inc. (incorporated by reference to
Exhibit 10.4 to the Company's Current Report on Form 8-K dated June 15,
1986 (File No. 0-13907)).
10.5 Debt and Royalty Restatement Agreement dated June 16, 1986
among Genetic Laboratories, Inc., Vascular Services Diversified, Inc. and
the Company (incorporated by reference to Exhibit 19.3 to the Company's
Quarterly Report on Form 10-Q for the period ended April 30, 1986 (File
No. 0-13907)).
10.6 Purchase Agreement dated February 17, 1986, between the Company and
Genetic Laboratories, Inc. including Bill of Sale and Assignment
(incorporated by reference to Exhibit 19.4 to the Company's Quarterly
Report on Form 10-Q (File No. 0-13907)).
E-1
<PAGE>
10.7 Purchase and sale agreement dated October 30, 1989 and closed December 28,
1989 between the Company and Meadox Medicals, Inc. (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated
January 11, 1990 (File No. 0-13907)).
10.8 Assignment and Assumption Agreement dated July 31, 1985 between the
Company and Genetic Laboratories, Inc., including the Purchase Agreement
dated June 4, 1984 between Genetic Laboratories, Inc. and Xomed, Inc.
(incorporated by reference to Exhibit 19.5 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No. 0-
13907)).
10.9 Assignment dated June 13, 1986 by Genetic Laboratories, Inc. to the
Company (incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0-13907)).
10.10 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories, Inc.,
to the Company (incorporated by reference to Exhibit 10.2 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0-13907)).
10.11 Confirmatory Assignment dated June 13, 1986 by Genetic
Laboratories, Inc., to the Company (incorporated by reference to Exhibit
10.3 to the Company's Current Report on Form 8-K dated June 15, 1986 (File
No. 0-13907)).
10.12 Trademark Assignment Agreement dated June 19, 1986 between the
Company and Genetic Laboratories, Inc. (incorporated by reference to
Exhibit 19.10 to the Company's Quarterly Report on Form 10-Q for the
period ended April 30, 1986 (File No. 0-13907)).
10.13 Assignment dated June 26, 1986 between the Company and Genetic
Laboratories, Inc. (incorporated by reference to Exhibit 19.11 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).
10.14 1988 Stock Option Plan (incorporated by reference to Exhibit 10.21 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1988
(File No. 0-13907)).
10.15 Vital Images, Incorporated 1990 Management Incentive Stock
Option Plan (incorporated by reference to Exhibit 10.24 to the Company's
Annual Report on Form 10-K for the year ended October 31, 1994 (File No.
0-13907)).
10.16 Vital Images, Incorporated 1992 Stock Option Plan (incorporated by
reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for
the year ended October 31, 1994 (File No. 0-13907)).
10.17 Employment letter dated April 7, 1994 between the Company and
Mr. Karcanes (incorporated by reference to Exhibit 10.26 to the Company's
Annual Report on Form 10-K for the year ended October 31, 1994 (File No.
0-13907)).
10.18 Employment agreement dated May 24, 1994 between the Company
and Dr. Argiro (incorporated by reference to Exhibit 10.27 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1994
(File No. 0-13907)).
10.19 Employment letter dated November 28, 1994, as amended January 2, 1995,
between the Company and Mr. Stephenson (incorporated by reference to
Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
10.20 Employment letter dated October 19, 1995 between the Company and Mr. Weiss
(incorporated by reference to Exhibit 10.21 to the Company's Annual Report
on Form 10-K for the year ended October 31, 1995 (File No. 0-13907)).
E-2
<PAGE>
10.21 Change in Control Agreement dated November 16, 1994 between
the Company and Mr. Karcanes, which form of Change in Control Agreement
has been entered into between the Company and each of Ms. Gilles, Mr.
Weiss, Mr. Nelson, Dr. MacFarlane, Mr. Schankereli and Mr. Stephenson
(incorporated by reference to Exhibit 10.28 to the Company's Annual Report
on Form 10-K for the year ended October 31, 1994 (File No. 0-13907)).
10.22 Form of Change in Control Agreement dated November 16, 1994 entered into
between the Company and Dr. Argiro (incorporated by reference to Exhibit
10.29 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1994 (File No. 0-13907)).
10.23 Lease Agreement dated May 11, 1993 between the Company and Douglas Green
IRA Trust (incorporated by reference to Exhibit 10.24 to the Company's
Annual Report on Form 10-K for the year ended October 31, 1995 (File
No. 0-13907)).
10.24 Lease Agreement effective August 1, 1995 between the Company and CMS
Investors, Inc. (incorporated by reference to Exhibit 10.25 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.25 License Agreement dated August 25, 1995 between Vital Images Incorporated
and CogniSeis Development, Inc. (incorporated by reference to Exhibit
10.26 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No. 0-13907)).
10.26 Purchase and Sale Agreement dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to Exhibit
10.27 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No. 0-13907)).
10.27 License Agreement dated December 1, 1995 between the Company and
Uroplasty, Inc. (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.28 Assignment of U.S. Patent dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to Exhibit
10.29 to the Company's Annual Report on Form 10-K for the year ended
October 31, 1995 (File No. 0-13907)).
10.29 1995 Stock Incentive Plan (incorporated by reference to Amendment No. 1 to
the Company's Schedule 14-A/A Proxy statement for the Company's 1996
annual meeting (File No. 0-13907)).
10.30 Employee Stock Purchase Plan (incorporated by reference to Amendment No. 1
to the Company's Schedule 14-A/A proxy statement for the Company's 1996
annual meeting (File No. 0-13907)).
21.1 List of Subsidiaries of the Company (incorporated by reference
to Exhibit 21.1 to Amendment No. 1 to the Company's Annual Report on Form
10-K/A for the year ended October 31, 1994 (File No. 0-13907)).
23.1 Consent of Coopers & Lybrand L.L.P. Filed herewith electronically.
27.1 Financial Data Schedule for the year ended October 31, 1996. Filed
herewith electronically.
27.2 Restated Financial Data Schedule for the year ended October 31, 1995.
Filed herewith electronically
E-3
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTS
We consent to the incorporation by reference in the registration statement of
Bio-Vascular, Inc. on Form S-8 (File No. 33-85394), Form S-8 (File No. 33-
22302), Form S-8 (File No. 33-94588), Form S-8 (File No. 333-14093) and Form S-8
(File No. 333-14137) of our reports dated December 16, 1996, on our audits of
the financial statements and financial statement schedule of Bio-Vascular, Inc.
as of October 31, 1996 and 1995, and for each of the three years in the period
then ended, which reports are included in this Annual Report on Form 10-K. We
also consent to the reference to our firm under the captions "Experts" and
"Incorporation of Documents by Reference" in the Form S-8 (File No. 33-94588)
and under the caption "Incorporation of Documents by Reference in the Form S-8
(File No. 333-14093) and Form S-8 (File No. 333-14137).
/s/
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
January 27, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AND RELATED NOTES FOR THE YEAR ENDED OCTOBER 31, 1996 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1996
<PERIOD-START> NOV-01-1995
<PERIOD-END> OCT-31-1996
<CASH> 5,736,650
<SECURITIES> 23,934,136
<RECEIVABLES> 1,487,209
<ALLOWANCES> 21,400
<INVENTORY> 1,972,728
<CURRENT-ASSETS> 24,767,734
<PP&E> 2,237,262
<DEPRECIATION> 867,006
<TOTAL-ASSETS> 37,881,279
<CURRENT-LIABILITIES> 2,660,744
<BONDS> 0
0
0
<COMMON> 94,849
<OTHER-SE> 35,125,686
<TOTAL-LIABILITY-AND-EQUITY> 37,881,279
<SALES> 10,124,709
<TOTAL-REVENUES> 10,124,709
<CGS> 3,443,098
<TOTAL-COSTS> 6,110,598
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 1,732,501
<INCOME-TAX> 514,000
<INCOME-CONTINUING> 1,218,501
<DISCONTINUED> (2,396,142)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,177,641)
<EPS-PRIMARY> (.12)
<EPS-DILUTED> 0
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS AND RELATED NOTES FOR THE YEAR ENDED OCTOBER 31, 1996 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> OCT-31-1995
<PERIOD-START> NOV-01-1994
<PERIOD-END> OCT-31-1995
<CASH> 15,424,969
<SECURITIES> 14,872,509
<RECEIVABLES> 2,190,226
<ALLOWANCES> 20,000
<INVENTORY> 1,968,226
<CURRENT-ASSETS> 26,007,785
<PP&E> 1,906,029
<DEPRECIATION> 641,331
<TOTAL-ASSETS> 37,303,375
<CURRENT-LIABILITIES> 1,948,039
<BONDS> 0
0
0
<COMMON> 93,798
<OTHER-SE> 35,261,538
<TOTAL-LIABILITY-AND-EQUITY> 37,303,375
<SALES> 10,426,076
<TOTAL-REVENUES> 10,426,076
<CGS> 3,461,817
<TOTAL-COSTS> 4,843,163
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 2,385,994
<INCOME-TAX> 726,832
<INCOME-CONTINUING> 1,659,162
<DISCONTINUED> 527,304
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,186,466
<EPS-PRIMARY> .27
<EPS-DILUTED> .27
</TABLE>
