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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
/X/ Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the Fiscal Year Ended December 31, 1996
or
/ / Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the Transition Period From _______________ to ________________.
Commission file number 0-26116
SPINE-TECH, INC.
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(Exact name of registrant as specified in its charter)
Minnesota 06-1258314
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(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
7375 Bush Lake Road
Minneapolis, Minnesota 55439
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(Address of principal executive offices) (Zip code)
(612) 832-5600
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(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
par value $.01 per share
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the Common Stock held by non-affiliates of
the registrant as of March 18, 1997 was $275,467,702, based on the closing sale
price for the Company's Common Stock on that date. For purposes of determining
this number, all officers and directors of the registrant are considered to be
affiliates of the registrant. This number is provided only for the purpose of
this report on Form 10-K and does not represent an admission by either the
registrant or any such person as to the status of such person.
As of March 18, 1997 the registrant had 10,068,812 shares of Common Stock
issued and outstanding.
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DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's Annual Report to Shareholders for the fiscal
year ended December 31, 1996 are incorporated by reference in Part II. Portions
of the registrant's Proxy Statement dated March 28, 1997 for the annual meeting
of shareholders to be held May 8, 1997 are incorporated by reference in Part
III.
FORWARD-LOOKING STATEMENTS
The information presented in this Annual Report on Form 10-K under the
headings "Item 1. Business," "Item 2. Properties" and "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of Operations"
contains forward-looking statements within the meaning of the safe harbor
provisions of Section 21E of the Securities Exchange Act of 1934, as amended.
Such statements are subject to risks and uncertainties, including those
discussed under "Forward Looking Statements" in Item 7 and "Risk Factors" on
pages 11-16 of this Annual Report on Form 10-K, that could cause actual results
to differ materially from those projected. Because actual results may differ,
readers are cautioned not to place undue reliance on these forward-looking
statements. Certain forward-looking statements are indicated below by an
asterisk.
ITEM 1. BUSINESS
THE COMPANY
Spine-Tech, Inc. (the "Company") was incorporated in Minnesota in 1988, and
began full-time operations in 1991. The Company designs, manufacturers and
markets an innovative series of spinal implants, instruments and procedures
based on the Company's BAK-TM- technology for the treatment of degenerative
conditions of the human spine. The Company's spinal implants are designed to
facilitate fusion of spinal vertebrae in order to reduce spinal instability that
can cause chronic, disabling back pain.
The Company conducted a clinical trial of the BAK/L-TM-, for use in the
lumbar region of the spine, starting in April 1992. Based upon data from the
clinical trial, the Company submitted a Pre-Market Approval Application ("PMA")
to the United States Food and Drug Administration (the "FDA"), which included
data on 942 patients. On May 23, 1996, the Orthopaedic and Rehabilitation
Devices Advisory Panel reviewed the Company's PMA and voted to recommend
approval of the BAK/L. On September 23, 1996, the FDA approved the BAK/L for
marketing in the United States.
The BAK system consists of the BAK spinal implants and customized surgical
instruments and techniques that facilitate the surgical placement of the
implants between the vertebrae. The BAK implants are hollow, threaded cylinders
made of a titanium alloy that are implanted in the disc space between two or
more vertebrae. The implants are packed with bone graft to facilitate growth of
the vertebrae bones through holes in the walls of the implants. Fusion is
achieved when adjoining vertebrae grow together. In most procedures performed
in the lumbar spine, two BAK devices are implanted, side by side. The BAK
devices may be implanted between two adjoining vertebrae (one-level) or between
three consecutive vertebrae (two-level). Implantation of the BAK device can be
performed using an open surgical technique from an anterior (front) or posterior
(back) approach.
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As part of the multi-center clinical trial of the BAK/L, certain surgeons
perfected the techniques and instruments necessary to implant the BAK/L using a
minimally invasive laparoscopic technique through the abdomen. In December
1996, the Company assembled the data from this portion of the multi-center
clinical trial and submitted it to the FDA in a Supplemental Pre-Market Approval
Application. As of December 2, 1996, the cut-off date for data analyses, a
total of 240 patients had been enrolled in the laparoscopic BAK study and had
complete history and hospitalization data forms. The series is comprised of a
total of 215 one-level and 25 two-level patients. The laparoscopic study was
performed at 10 centers. The laparoscopic surgical approach for implantation of
the BAK/L for the treatment of one-level degenerative disc disease showed
comparable rates of operative and post-operative complications, as well as
secondary surgery rates, as those documented in the FDA approved BAK/L open
anterior one-level series.
OTHER PRODUCTS
In addition to the BAK/L, the Company has developed the BAK/C-TM-, based
upon the BAK technology to treat degenerative disc disease in the cervical
(neck) area of the spine. The BAK/C system is a series of implantable devices
and customized instruments specifically designed and sized to facilitate fusion
of vertebrae in the cervical spine. Either one or two BAK/C devices are
implanted anteriorally in the disc space between two or three vertebrae. The
implants provide stability for fusion to occur through and around the implants,
similar to the BAK/L implants. In November 1994, the FDA granted approval for
the BAK/C Investigational Device Exemption ("IDE") clinical study. The study is
a randomized study comparing BAK/C implants to non-instrumental cervical fusion
procedures. The Company is currently enrolling patients in the study and as of
December 1, 1996, approximately 250 procedures had been performed. There can be
no assurance that the Company will achieve results in this study sufficient to
obtain required marketing clearance or physician acceptance in the United States
or internationally, which could have a material adverse effect on the Company's
future operating results.
The Company also developed its BAK/T-TM- implants and instruments,
specifically designed for use in the thoracic region of the spine. Fusion
procedures to treat degenerative disc disease and other spinal conditions in the
thoracic spine have rarely been attempted due to the difficulty of surgical
access to the disc site through the chest cavity due to the highly invasive
nature of the procedure. Instead of making a large incision in the front of the
patient's chest, spreading the patient's ribs and moving the patient's organs,
the surgeon makes four small punctures in the patient's side and inserts the
instruments in between the patient's ribs using a small television camera called
a thoracoscope for visualization on a monitor. The surgeon can visualize and
access the patient's spine from the side (laterally) and implant the BAK/T
implants through a trocar inserted through one of the punctures. The Company
believes that the BAK/T may enable surgeons to treat degenerative disc disease
in the thoracic spine with reduced trauma and recovery time as compared to
current open surgical alternatives.* On September 27, 1995, the FDA granted
conditional approval to begin Phase I of the BAK/T IDE clinical study. The
Company is currently enrolling patients in the study and as of December 1, 1996,
approximately 12 procedures had been performed. There can be no assurance that
the Company will achieve results in this study sufficient to obtain required
marketing clearance or physician acceptance in the United States or
internationally, which could have a material adverse effect on the Company's
future operating results.
In addition to products based on the BAK technology, the Company has
developed the following products:
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CERVI-LOK SPINAL STABILIZATION SYSTEM. The Company's Cervi-Lok-Registered
Trademark- system is a line of implantable metal plates and screws for
stabilizing vertebrae in the cervical spine. The Cervi-Lok system utilizes a
unique screw-to-plate locking mechanism that locks the screw to the plate to
provide stability and helps to prevent loosening of the screw. The system also
includes surgical instruments that are used to implant the devices.
MINIMALLY INVASIVE DISCECTOMY INSTRUMENTS. The Company markets a line of
surgical instruments for use in minimally invasive endoscopic discectomy and
fusion procedures.
BONE HARVESTER. The Bone Harvester is a surgical instrument that provides
a less invasive technique and more convenient method for gathering autologous
bone. This autologous bone may be used to fill the inner chambers of the BAK
implants for spinal fusion. In addition, the autologous bone may be used in
other surgical techniques which require bone for creating fusion or filling
boney defects. The Bone Harvester is sold as a disposable sterile kit for
one-time use. The main components within the kit are a clear plastic T-handle
and a cutting head. The cutting head is designed to morselize and gather bone
into the T-handle.
MARKETING AND DISTRIBUTION
The Company's sales and marketing strategy is to focus its efforts on
orthopaedic and neurological spine surgeons through a combination of direct
marketing, comprehensive training and on-going surgical support. The Company
markets its products domestically through a network of 25 direct sales
representatives, all with successful experience selling medical/surgical
specialty devices, four regional sales managers and seven independent agent
groups. The Company believes there are more than 4,000 orthopaedic and
neurological spine surgeons in the United States, the majority of which are
located in major metropolitan areas. Through September 23, 1996, the Company
sold its principal products in the United States primarily in conjunction with
its clinical trials. Beginning in June 1996 the Company began hiring the sales
and marketing personnel necessary to begin to launch the BAK domestically.
In September 1993, the Company entered into an exclusive agreement with
Smith & Nephew Richards, Inc. ("Smith & Nephew"), a leading medical products
company headquartered in the United Kingdom, for marketing and distribution of
the BAK/L outside the United States for a period of up to eight years if certain
quarterly minimum purchases were made. In February 1996, the Company terminated
its exclusive agreement with Smith & Nephew because the required minimum
purchases were not made. Through February 1997, Smith & Nephew retained limited
non-exclusive rights to sell the BAK/L outside the United States. These
non-exclusive rights have terminated.
Since March 1996, the Company has been establishing a network of
independent distributors on a country-by-country basis to market and distribute
all of its products outside of the United States. Currently, the Company has
distribution agreements with 19 different independent distributors who cover 28
different foreign markets. Most of these independent distributors have ordered
and received product shipments and are selling products or working on mandatory
registration requirements.
MANUFACTURING AND QUALITY CONTROL
The Company's manufacturing and quality control operations consist
primarily of testing and inspection of products manufactured to the Company's
specifications by outside contractors. The Company inspects each lot of
implants and instruments to ensure that it complies with the Company's
specifications.
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The quality of finished products is controlled in accordance with the Company's
procedures, those of the FDA's Good Manufacturing Practices ("GMP")
requirements, and the requirements of foreign regulatory agencies, including ISO
9001 certification. Products requiring sterilization are sent to a certified
laboratory where they are sterilized before being shipped to customers.
Currently, the Company is dependent on one contract sterilizer. In the event
that this relationship is terminated, the Company will have to locate a new
contract sterilizer, which could result in increased cost and turn around time
for sterilization of the Company's products.
During much of 1995 and the first half of 1996, the Company established the
systems, procedures and documentation necessary to comply with ISO 9001 Quality
System Certification. This effort resulted in the Company receiving ISO 9001
Certification and CE Mark Certification. CE Mark Certification signifies that
the Company conforms with the European Community Medical Device Directive
requirements for the design, manufacturing, servicing and installation of its
products.
The Company does not conduct manufacturing operations and is dependent upon
several contract manufacturers for the production of its products and expects to
continue to be dependent upon such manufacturers for the foreseeable future.
The Company is dependent upon these manufacturers for timely and cost-effective
manufacturing services. In the event that the Company is unable to obtain
contract manufacturing, or obtain such manufacturing on commercially reasonable
terms, it may not be able to manufacture its products on a timely and
competitive basis, or at all.
PRODUCT DEVELOPMENT
The Company's objective is to continue to develop innovative products for
the spinal implant market. The Company's research and development department
consists of six engineers with substantial design experience in the orthopaedic
industry. In addition to the engineers, the department has two individuals with
Ph.D. degrees in biomedical engineering and biophysics.
The research and development department is continually engaged in assessing
new spinal devices, materials and surgical techniques that are applicable to the
Company's business strategies. The Company evaluates new technologies using
sound biomechanical principles in the Company's own laboratory or at university-
based research centers. The Company spent $1.2 million, $1.6 million and $1.8
million on research and development in fiscal years 1994, 1995 and 1996,
respectively.
The Company is investigating both genetic and biologic bone substitutes
that may be used instead of harvested bone to fill the Company's BAK products.
In addition, the Company is evaluating the efficacy of new implant structures,
designs and procedures for use in spinal fusions, and advanced design and
technique enhancements to the Company's BAK products.
Furthermore, the research and development department is evaluating
proprietary metallic and non-metallic implant designs to improve fusion success
rates. The Company is also investigating the application of its minimally
invasive technologies to discectomy procedures.
THIRD-PARTY REIMBURSEMENT
Spinal implants are generally purchased by hospitals upon the
recommendation of spinal surgeons on staff. These hospitals bill various third-
party payors for the services provided to patients. Spinal fusion procedures
are considered elective surgeries and therefore most require preapproval by the
payor. In
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the United States, these payors include private insurance companies, managed
care organizations, workers' compensation insurers and occasionally Medicare.
Most private payors pay for the costs of the surgery and rehabilitation, and
procedures that are deemed cost-effective will generally receive reimbursement
by private payors.* Workers' compensation insurers are responsible for both
surgical costs and patient disability costs, including lost wages. Since back
pain claims represent the largest category of workers' compensation claims paid,
workers' compensation insurers are motivated to reimburse for surgical
procedures that reduce surgical costs and reduce or eliminate long-term
disability costs. Cost-effective procedures with positive surgical outcomes
enabling workers to return to work more rapidly are generally supported by
workers' compensation insurers. However, no assurance can be given that the
Company's products will be recommended for purchase by surgeons at prices
comparable to those charged by the Company in the past, if at all, or that
third-party payors will reimburse hospitals, in whole or in part, if such
purchases are made.
Reimbursement for BAK products may also be affected by the increasing
prevalence of cost-containment measures of managed care systems. In a managed
care system, a health care provider typically contracts with an employer or
organization to provide comprehensive health care to covered persons for a fixed
fee per person. A provider in a managed care system, generally a family
practice physician, will attempt to control the costs of health care for each
individual. While such cost control efforts may result in an emphasis on more
cost-effective procedures and may result in fewer elective surgical procedures,
the Company believes that it may benefit from this emphasis due to the cost-
effective nature of its products as compared to other products in the spinal
implant market.* However, there can be no assurance that these benefits will be
realized by the Company.
The Company must register its products in each foreign country where it
intends to sell its products. In many countries the Company must also receive
reimbursement approval from the foreign government authorities. The Company has
received reimbursement approval in several foreign countries, and is seeking
reimbursement approval in all countries where its products are sold. Lack of
reimbursement approval may restrict the Company's ability to sell its products
in certain foreign markets and there can be no assurance that it will receive
reimbursement approval in other foreign markets.
LICENSE AGREEMENTS
In May 1992, the Company entered into a license agreement with Dr. Gary
Michelson ("Dr. Michelson") and an affiliated company, Karlin Technology, Inc.
("Karlin"), as the owners of certain patents and patent applications relating to
threaded cylindrical spinal implants, the technology which is the basis of the
Company's BAK implant (the "Karlin Technology"). Pursuant to the license
agreement, the Company has a co-exclusive worldwide license during the life of
the patents to make, use or sell products covered by the Karlin Technology. One
other party may license and develop the Karlin Technology subject to the terms
and conditions of the license agreement. Sofamor Danek Inc. ("Danek"), a
competitor of the Company, is the other co-licensee of the Karlin Technology.
The Company also has rights to certain future instruments or methods developed
by Dr. Michelson during the life of the agreement. The license agreement
provides for a cross-license of certain patented technology of the Company and
obligates the Company to pay Karlin a royalty based upon a percentage of the net
sales price for sales of its products utilizing the Karlin Technology. Karlin
is currently involved in litigation with Surgical Dynamics, Inc., a subsidiary
of U.S. Surgical Corporation ("Surgical Dynamics"), regarding the patent which
covers the Karlin Technology. Surgical Dynamics has filed a complaint for
declaratory judgment of patent invalidity, unenforceability and non-infringement
against Karlin and Danek regarding the Karlin Technology. Karlin and Danek have
counterclaimed against Surgical Dynamics claiming patent infringement. The
outcome of the litigation is
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uncertain. However, under its license agreement with Dr. Michelson, if the
patent is declared invalid, the Company's royalty obligations will be reduced.
Furthermore, if no subsequent patent is issued to Dr. Michelson related to
technology that would be utilized in the Company's products within the four
quarters after the patent is declared invalid, the Company's royalty obligations
will expire. See "Item 3. Legal Proceedings" for a discussion of certain claims
that have been made against the Company by Dr. Michelson and Karlin in
connection with the license agreement and the Karlin Technology and for more
information regarding the Surgical Dynamics litigation.
In January 1995, the Company entered into a license agreement with Dr. Ted
Obenchain, the owner of certain patents and patent applications relating to
tools and methods used in minimally invasive discectomy surgery. Pursuant to
the license agreement, the Company has an exclusive worldwide right during the
life of the patents to make, use or sell instruments and methods developed by
Dr. Obenchain. The license agreement obligates the Company to pay Dr. Obenchain
a royalty based upon a percentage of the net sales of its products utilizing the
licensed technology.
PATENTS AND PROPRIETARY TECHNOLOGY
The Company relies heavily on proprietary technology, which it protects
primarily through licensing arrangements, patents and trade secrets. In
addition, the Company files patent applications to protect technology,
inventions and improvements that are significant to the development of its
business. The Company currently holds ten issued United States patents and has
licensed three issued United States patents and one foreign patent and has
pending seven United States and five foreign patent applications relating to
spinal implants, instruments and surgical methods. Dr. Michelson claims to be
the true inventor of the innovations claimed in one of these patents. On
February 6, 1996, the Company filed a declaratory action asserting that Dr.
Michelson has no rights in that patent. There can be no assurance that any
pending or future patent applications will be granted or that any current or
future patent, regardless of whether the Company is an owner or a licensee of
such patent, will not be challenged, rendered unenforceable, invalidated or
circumvented or that the rights granted thereunder or under its licensing
agreements will provide competitive advantages to the Company. The Surgical
Dynamics litigation is challenging the validity and enforceability of the patent
that covers key aspects of the design of the Company's BAK products. The
outcome of the litigation is uncertain. There can be no assurance that the
patent related to the Karlin Technology will be upheld or that the Company will
continue to have such patent protection for its products. The Company also
relies on trade secrets and proprietary know-how that it seeks to protect, in
part, through confidentiality agreements with employees, consultants and other
parties. 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.
GOVERNMENT 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. The FDA administers the Federal Food, Drug, and
Cosmetic Act and the amendments thereto contained in the Safe Medical Devices
Act of 1990. The Company is subject to the Federal Food, Drug, and Cosmetic Act
and the regulations promulgated thereunder and is subject to inspection by the
FDA for compliance therewith.
The Company's products are classified by the FDA as Class I, Class II and
Class III devices. Certain Class I devices, such as instruments, are exempt
from "510(k) clearance" requirements. Class II
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devices, such as laparoscopic instruments and certain implants, including the
Cervi-Lok system, must secure a 510(k) clearance. The process of obtaining a
510(k) clearance typically can take a year or longer and may require the
submission of laboratory or clinical data supporting assertions that the product
is substantially equivalent to another medical device on the market.
Class III devices require PMAs before they can be introduced to the market.
The PMA approval process is more costly and burdensome than the 510(k) clearance
process and generally takes a number of years. The PMA process generally
requires more detailed preclinical and clinical studies pursuant to an IDE, as
well as manufacturing data and other information. The PMA must report on the
results of the clinical trial, 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. In addition, the
submission must include the proposed labeling, advertising literature and
training methods, if applicable. After completion of the FDA's preliminary
review, the FDA will determine whether the PMA is technically fileable. If the
PMA is accepted for filing, the FDA begins a more in-depth review. The
submission is typically sent to a scientific advisory panel composed of
physicians and scientists with expertise in the particular field. The FDA
scientific advisory panel issues a recommendation to the FDA that the PMA should
either be approved, approved with certain conditions or denied. The FDA is not
bound by the recommendations of the advisory panel. During the PMA review
process, the FDA conducts an inspection of the manufacturer's facilities to
ensure that they are in compliance with the applicable GMP requirements. If the
FDA evaluation of both the PMA and the manufacturing facilities is favorable,
the FDA will issue an "approvable" letter, which usually contains a number of
conditions that must be met in order to secure final approval of the PMA. When
those conditions have been fulfilled to the satisfaction of the FDA, the agency
will issue a final PMA approval letter, authorizing commercial distribution of
the device. An approved PMA indicates that the FDA has determined that a device
has been demonstrated, through the submission of clinical data and manufacturing
and other information, to be safe and effective for its intended uses. The FDA
may determine in its discretion to grant marketing clearance for certain
improvements in, and changes to indications of, a PMA approved product based on
additional data, possibly including clinical data, submitted to the FDA in the
form of a supplement to the original PMA ("PMA supplement").
The BAK/L is designated as a Class III device by the FDA. On September 23,
1996 the Company announced that the FDA had approved the Company's BAK/L for
marketing in the United States. The Company is required to obtain further
approval from the FDA, however, to label the BAK/L for laparoscopic
implantation. The Company has submitted a PMA supplement seeking this approval.
There can be no assurance that marketing clearances from the FDA will be
obtained for the laparoscopic procedure on a timely basis or at all.
The Company has initiated clinical trials for the BAK/C implants under an
IDE approved by the FDA in November 1994, and received conditional approval for
its IDE application for the BAK/T device in April 1995. Patient enrollment for
a feasibility study of the BAK/T commenced in May 1995. The IDE study for each
of these products is expected to take several years. These devices are
classified as Class III devices requiring PMA approval. The Company plans to
perform these clinical trials and submit the results in PMAs if the results
merit such submissions.* There can be no assurances that the clinical results
from these trials will be completed or result in a PMA, or that the marketing
clearance will ever be received. The Company may apply to the FDA for approval
of the BAK/C and BAK/T devices on a PMA supplement to the approved BAK/L PMA.*
The availability of the use of a PMA supplement for a product is subject to the
discretion of the FDA.
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The Company markets certain other of its products pursuant to 510(k)
clearances received from the FDA.
Government regulations may prevent or substantially delay the marketing of
the Company's proposed products, cause the Company to undertake costly
procedures, and furnish a competitive advantage to the more substantially
capitalized companies with which the Company competes. After approval, the FDA
has required post-marketing approval surveillance programs to monitor the
effects of an approved medical device. FDA approval may be withdrawn for
noncompliance with regulatory standards or the occurrence of unforeseen problems
following initial marketing. In addition, the extent of potentially adverse
government regulations that might arise from future administrative action or
legislation cannot be predicted. There can be no assurances that marketing
clearances or approvals will be obtained on a timely basis, or at all. Delays
in receiving, or failure to receive, such clearances could have a material
adverse effect on the Company.
Every company that manufactures or assembles medical devices is required to
register with the FDA and adhere to GMP requirements which prescribe
recordkeeping, validation and quality assurance procedures and provide for the
unscheduled inspection of facilities. The Company believes that its design,
manufacturing and quality control procedures comply with the FDA's GMP
regulations. In addition, marketed products are subject to continuing FDA
scrutiny for compliance with the FDA's requirements relating to promotional
activities. Failure to comply with these requirements may result in FDA
enforcement actions, including warning letters, seizure, injunction or civil
penalties.
The Company is also subject to regulation in each of the foreign countries
where it sells its products in the areas of 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 countries require
the Company's products to be qualified before they can be marketed in those
countries. The Company relies on its independent distributors to comply with
the majority of the foreign regulatory requirements. To date, the Company has
not experienced significant difficulty in complying with these regulations.
The Company has implemented policies and procedures that allowed the
Company to receive ISO 9001 certification. ISO 9001 standards for quality
operations have been developed to ensure that companies know, on a worldwide
basis, the standards of quality to which they will be held. The European Union
has promulgated rules which require that medical products receive a CE mark, an
international symbol of quality and compliance with applicable European medical
device directives, by mid-1998. ISO 9001 certification is one of the CE mark
certification requirements. The Company has received CE mark certification.
There can be no assurance that the Company will be successful in maintaining
certification requirements, which would prohibit the Company from selling its
products in Europe.
Regulations regarding the manufacture and sale of the Company's products
are subject to change. The Company cannot predict what impact, if any, such
changes might have on its business, financial condition or results of
operations.
COMPETITION
Competition in the market for spinal implants is intense. To date, the
market has been dominated by manufacturers of pedicle screw implants, including
Danek and Acromed, Inc. The Company will also
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likely be directly competing with other manufacturers of less invasive
implantable devices, including Danek and Surgical Dynamics. In addition,
several other companies active in other areas of the orthopaedic market could
enter the market at any time. Many of the Company's competitors have capital
resources, research and development staffs, facilities, experience in conducting
clinical trials and obtaining regulatory approvals and experience in
manufacturing and marketing medical devices significantly greater than those of
the Company. In addition, competitors may employ litigation to gain a
competitive advantage. There can be no assurance that the Company's competitors
will not develop or obtain regulatory approval for spinal implants that may be
more effective in treating degenerative disc disease and other spinal conditions
than the Company's current or future products, and that the Company's
technologies and products would not be rendered obsolete by such developments.
Any product developed by the Company that gains regulatory approval will
have to compete for market acceptance and market share. The Company believes
that competition in the spinal implant market is based, among other things, on
the ability to safely and effectively treat degenerative disc disease and other
spinal conditions, the availability of devices that can be implanted using less
invasive surgical procedures, product reliability, physician familiarity with
the procedure, patent position, price, sales and marketing capability, third-
party reimbursement policies and reputation.
Both Danek and Surgical Dynamics are pursuing development of less invasive
implantable technology similar to the BAK device for spinal fusion. Danek has
the Karlin Technology and has indicated that it received approval in March 1995
to initiate IDE clinical trials for its implantable lumbar fusion device.
Surgical Dynamics has completed an IDE clinical trial with its implantable
lumbar fusion device and has received FDA approval for this product. In
addition, Danek and Surgical Dynamics are both marketing their devices
internationally and compete with the Company in several markets. Danek and
Surgical Dynamics are involved in patent litigation related to the Karlin
Technology. If the patent that covers the Karlin Technology is declared invalid
or if the license agreement with the Company is terminated, the Company may be
subject to increased competition since it will not be able to prevent
competitors from selling similar devices.
PRODUCT LIABILITY
Medical device companies are subject to inherent risk of product liability.
Spinal implants, specifically pedicle screw systems, have been targeted in many
product liability lawsuits in recent years. Since the Company's principal
products are designed to be permanently implanted in the human body,
manufacturing errors or design defects could result in an unsafe condition,
injury or death to the patient. Although the Company maintains liability
insurance, there can be no assurance that the coverage limits of the Company's
insurance policies will be adequate in the event that claims are brought. Such
insurance is expensive, difficult to obtain and may not be available in the
future on acceptable terms, or at all. Although the Company has never been
subject to a product liability claim, one or more successful claims brought
against the Company would have a material adverse effect upon its business,
financial condition and results of operations.
EMPLOYEES
The Company had 96 employees at December 31, 1996. No employee of the
Company is represented by a labor union or is subject to a collective bargaining
agreement. All employees are covered by agreements containing confidentiality
provisions. The Company believes it maintains good relations with its
employees.
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RISK FACTORS
Certain statements made in this Annual Report on Form 10-K, including those
indicated by an asterisk, are forward-looking statements that involve risks and
uncertainties, and actual results may differ. Factors that could cause actual
results to differ include those identified below.
COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. The orthopaedic device
and instrument market is highly competitive and is characterized by innovation
and technological change. The Company currently competes with a number of
companies that have capital resources, research and development staffs,
facilities, experience in conducting clinical trials and obtaining regulatory
approvals, and experience in manufacturing and marketing medical devices that
are significantly greater than those of the Company. In addition, there are
several companies developing new technologies, such as bone growth factors and
bone growth stimulation devices, which may have application in spinal fusions.
There can be no assurance that the Company's competitors will not succeed in
developing technologies and products that are more effective than any that are
being developed by the Company or that would render the Company's products
obsolete or noncompetitive. In addition, certain of the Company's competitors
may achieve patent protection, regulatory approval or product commercialization
that would limit the Company's ability to compete. Both Danek and Surgical
Dynamics are pursuing development of less invasive implantable technology
similar to the BAK/L device for spinal fusion. Danek, the co-licensee of the
Karlin Technology, has indicated that it is in IDE clinical trials for its
implantable lumbar fusion device. Surgical Dynamics has indicated that it has
received PMA approval from the FDA for its implantable lumbar fusion device. In
addition, Danek and Surgical Dynamics are both marketing their devices
internationally and compete with the Company in several global markets. Danek
and Surgical Dynamics are involved in patent litigation related to the Karlin
Technology. If the patent that covers the Karlin Technology is declared
invalid, or if the Karlin license is terminated, the Company may be subject to
increased competition since it will not be able to prevent competitors from
selling similar devices. The Company's inability to compete successfully could
have a material adverse effect on the Company's business, financial condition
and results of operations.
RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company relies heavily
on proprietary technology, which it protects primarily through licensing
arrangements, patents, trade secrets and proprietary know-how. The Company
holds patents and has pending patent applications that cover certain aspects of
its technology. The Company is a co-licensee of certain patented technology
that covers key aspects of the design of the Company's BAK products. The
Company is currently in litigation with the owners of this patent regarding
contractual rights under the license agreement and other matters. Also, the
owners of this patent and the other co-licensee, Danek, are involved in
litigation with Surgical Dynamics, a competitor of the Company, which is
challenging the validity and enforceability of the patent. There can be no
assurance that the patent related to such technology will be upheld or that the
Company will continue to have such patent protection for its products. See
"Litigation; Potential for Adverse Outcomes" below. The Company also has an
exclusive license under two method patents for conducting spinal surgery through
minimally invasive laparoscopic procedures. There can be no assurance that any
pending or future patent applications will be granted or that any current or
future patents, regardless of whether the Company is an owner or a licensee of
such patent, will not be challenged, rendered unenforceable, invalidated or
circumvented or that the rights granted thereunder or under its licensing
agreements will provide a competitive advantage to the Company. There can also
be no assurance that the Company's trade secrets or non-disclosure
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agreements will provide meaningful protection of the Company's proprietary
information. Furthermore, there can also 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 will not infringe upon patents
or other rights owned by others. The Company's inability to maintain its
proprietary rights, including the patent protection of the Karlin Technology,
would have a material adverse effect on its business, financial condition and
results of operations.
LITIGATION; POTENTIAL FOR ADVERSE OUTCOMES. The medical device market is
characterized by frequent and substantial intellectual property litigation.
Intellectual property litigation is complex and expensive, and the outcome of
such litigation is difficult to predict. The Company is currently in litigation
with Dr. Michelson and an affiliated company, Karlin, the co-owners of the
patent licensed by the Company which covers key aspects of the design of the
Company's BAK products. The suits against the Company allege various causes of
action concerning, among other things, Dr. Michelson's and Karlin's right to co-
license the technology covered by the patent to a third party and termination of
the Company's license agreement. The suits further allege that Dr. Michelson is
the true inventor of certain innovations claimed by the Company in a patent.
Although the Company believes that these claims are without merit and intends to
contest these claims vigorously, the Company expects to incur substantial legal
expenses in connection with the litigation. A finding against the Company could
have a material adverse effect on the Company's business, financial condition
and results of operations.
Surgical Dynamics has filed a complaint for declaratory judgment of patent
invalidity, unenforceability and non-infringement against Karlin and Danek
regarding the Karlin Technology. Karlin and Danek have counterclaimed against
Surgical Dynamics claiming patent infringement. The outcome of the litigation
is uncertain. There can be no assurance that the patent related to the Karlin
Technology will be upheld or that the Company will continue to have such patent
protection for its products. The Company is not aware of any other patent
infringement charge or any violation of other proprietary rights claimed by any
third party relating to the Company or the Company's products. However, no
assurance can be given that the Company or its products will not become the
subject of such a claim in the future. Any current or future litigation
involving the Company or its products could result in substantial expense to the
Company and significant diversion of effort by the Company's technical and
management personnel. Litigation may also be necessary to enforce patents
issued to 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 require the Company to seek licenses from
third parties or pay royalties that may be substantial. Furthermore, there can
be no assurance that the necessary licenses would be available to the Company on
satisfactory terms, or at all. Accordingly, an adverse determination in a
judicial or administrative proceeding, including rescission or termination of
its license agreement with Karlin or failure to obtain the necessary licenses,
could prevent the Company from manufacturing and selling certain of its
products, which would have a material adverse effect on the Company's business,
financial condition and results of operations.
GOVERNMENT REGULATION. In the United States, the FDA regulates the sale of
medical devices as well as manufacturing procedures, labeling and recordkeeping
with respect to such products. The process of obtaining marketing clearances
and approvals from the FDA for new products can be time consuming and expensive,
and there is no assurance that such clearances or approvals will be granted or
that FDA review will not involve delays that would adversely affect the
Company's ability to
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commercialize its products. The FDA requires that a new device and related
instruments secure either a 510(k) clearance or an approved PMA, depending upon
their classification, prior to marketing in the United States. The process of
obtaining a 510(k) clearance, which is available for products demonstrated to be
substantially equivalent to products which are already commercially available,
typically takes several months and may require the submission of supporting
laboratory or clinical data. The PMA process generally takes years and may
require the submission of significant supporting data and clinical information
and can be very expensive. The Company obtained PMA approval from the FDA for
its BAK/L product in September 1996. The Company's BAK/C and BAK/T products
must obtain PMA approval before they can be sold in the United States. No
assurance can be given that the Company will ever receive FDA marketing approval
for these products. Even if regulatory approvals to market a product are
obtained from the FDA, such 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 requirements 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 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 recall orders or product seizures, and, in extreme
cases, criminal sanctions.
International regulatory bodies often establish varying regulations
governing products standards, packaging requirements, labeling requirements,
import restrictions, tariff regulations, duties and tax requirements. As a
result of the Company's sales in Europe, the Company was required to be
certified as ISO 9001 compliant and to receive CE mark certification. Failure
to maintain CE mark certification would have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
relies on its independent distributors to comply with the majority of the
foreign regulatory requirements. The inability or failure of the 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 and thereby materially adversely affect the Company's business,
financial condition and results of operations.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT. The Company's ability to sell
its products depends in part on the extent to which reimbursement for the cost
of such products and related treatments are available to patients under domestic
and foreign governmental health programs, private health insurance, managed care
organizations, workers' compensation insurers, and other similar programs. Over
the past decade, the cost of health care has risen significantly, and there have
been numerous proposals by legislators, regulators and third-party health care
payors to curb these costs. Some of these proposals have involved limitations
on the amount of reimbursement for certain surgical procedures. Certain of the
Company's products are still investigational and certain payors will not provide
reimbursement since these devices have not received FDA clearance. There can be
no assurance that adequate third-party reimbursement will be achieved even if
FDA clearance for these products is obtained. In addition, certain health care
providers are moving towards a managed care system in which such providers
contract to provide comprehensive health care for a fixed cost per
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person. Managed care providers are attempting to control the cost of health
care by authorizing fewer elective surgical procedures, such as spinal fusions.
The Company is unable to predict what changes will be made in the reimbursement
methods utilized by third-party health care payors. In addition, hospitals and
other health care providers have become increasingly price competitive and, in
some instances, have put pressure on medical suppliers to lower their prices.
The Company's BAK implants are currently priced at a premium to pedicle screw
implants in the United States. Any reproductions in coverage or price
limitations by third-party payors could have a material adverse effect on the
Company's business, financial condition and results of operations.
LACK OF MARKET ACCEPTANCE. The Company received FDA approval for its
principal product, the BAK/L (for lumbar spinal fusions), in September 1996.
The Company's other spinal fusion products, the BAK/C (for cervical spinal
fusions) and the BAK/T (for thoracic spinal fusions) are in various stages of
clinical testing in the United States. Prior to FDA approval, the Company had
very limited sales and marketing opportunities in the United States. Although
various products of the Company have received marketing approval outside the
United States, those products have been marketed internationally only for a
limited period of time. The Company's principal products and related
instrumentation are based upon innovative surgical concepts and procedures
relating to interbody spinal fusion and minimally invasive surgery. A majority
of the Company's BAK devices have been surgically implanted from the front
rather than from the back, which is the conventional method of implanting
pedicle screws. The Company believes that market acceptance of the Company's
products will depend, in part, on the Company's ability to convince the medical
community of the safety, efficacy and cost effectiveness of the Company's
products as compared to existing fusion implants and surgical techniques.
Market acceptance will further depend on the Company's ability to train surgeons
in the use of its products. There can be no assurance that spine surgeons will
readily adopt new device concepts and surgical techniques. Furthermore, even
though the number of spinal fusion procedures has been increasing each year,
there can be no assurance that this growth will continue. The Company's
inability to gain market acceptance for its products and surgical techniques
would have a material adverse effect on the Company's business, financial
condition and results of operations.
DEVELOPMENT OF DOMESTIC SALES FORCE. The Company has sold its principal
products in the United States only on a limited basis and is in the process of
developing a domestic sales and marketing staff. The Company plans to market
and sell such products in the United States through a combination of direct
sales and marketing staff and independent sales and support representatives that
have been specially trained by the Company. There can be no assurance that the
Company will be able to develop such a network or that these persons will be
able to successfully sell the Company's products.
RELIANCE ON INTERNATIONAL DISTRIBUTORS. Prior to February 1996, the
Company had an exclusive international distribution agreement with Smith &
Nephew for the BAK/L implant. In February 1996, the Company determined to
terminate its agreement with Smith & Nephew and to establish alternative
international distribution channels of independent distributors. There can be
no assurance that the Company will be able to establish such alternative
international distribution channels on terms acceptable to the Company, or at
all.
TRAINING OF MEDICAL PERSONNEL. Market acceptance of the Company's products
will depend on the Company's ability to train spine surgeons and other medical
personnel in the use of the Company's
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products. The Company requires that all surgeons receive training in
Company-sponsored sessions prior to using the Company's products in the United
States. In addition, in the United States each surgeon receives support during
surgery from medical personnel who have received the Company's training. The
Company's inability to train a sufficient number of spine surgeons and other
medical personnel on a timely basis, whether because of inadequate facilities,
surgeon reluctance or otherwise, could have a material adverse effect on the
Company's business, financial condition and results of operations.
PRODUCT LIABILITY. The medical device industry has been historically
litigious and the Company faces an inherent business risk of financial exposure
to product liability claims in the event that the use of its products results in
personal injury. Since the Company's principal products are designed to be
permanently implanted in the human body, manufacturing errors or design defects
could result in an unsafe condition, injury or death to the patient, and could
result in a recall of the Company's products and substantial monetary damages.
There can be no assurance that the Company will not experience losses due to
product liability claims in the future. Although the Company currently
maintains liability insurance, there can be no assurance that the coverage
limits of the Company's insurance policies will be adequate. Such insurance is
expensive, difficult to obtain and may not be available in the future on
acceptable terms, or at all. Any claims against the Company, regardless of
their merit or eventual outcome, would have a material adverse effect upon the
Company's business financial condition and results of operations.
DEPENDENCE ON KEY PERSONNEL. The Company's success depends in large part
on its ability to attract and retain highly qualified scientific, technical,
management and marketing personnel. Competition for such personnel is intense
and there can be no assurance that the Company will be able to attract and
retain the personnel necessary for the development and operation of its
business. The loss of the services of key personnel could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON CONTRACT MANUFACTURERS. The Company does not conduct
manufacturing operations and is dependent upon several contract manufacturers
for the production of its products and expects to continue to be dependent upon
such manufacturers for the foreseeable future. The Company is dependent upon
these manufacturers for timely and cost-effective manufacturing services. In
the event that the Company is unable to obtain contract manufacturing, or obtain
such manufacturing on commercially reasonable terms, it may not be able to
manufacture products on a timely and competitive basis, or at all.
POSSIBLE VOLATILITY OF SHARE PRICE. Market prices for securities of
medical technology companies are highly volatile and the trading price of the
Company's Common Stock could be subject to significant fluctuations in response
to quarterly variations in operating results, announcements of technological
innovations by the Company or its competitors, government regulation and other
events or factors, including the various risk actors discussed above. In
addition, market prices of securities of medical technology companies have from
time to time experienced extreme price and volume fluctuations, which may be
unrelated to the operating performance of particular companies. These broad
market fluctuations may materially adversely affect the market price of the
Company's Common Stock.
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ABSENCE OF DIVIDENDS. The Company has not paid any cash dividends since
its inception and does not anticipate paying cash dividends in the foreseeable
future.
ANTI-TAKEOVER CONSIDERATIONS. The Board of Directors of the Company has
the authority, without any action by the stockholders, to fix the rights and
preferences of any shares of the Company's Preferred Stock to be issued from
time to time. In addition, as a Minnesota corporation, the Company is subject
to certain anti-takeover provisions of the Minnesota Business Corporation Act
(the "MBCA"). The Company has also adopted a Shareholder Rights Agreement. The
authority of the Board with regard to the Preferred Stock, the provisions of the
MBCA and the Shareholder Rights Agreement could have the effect of delaying,
deferring or preventing a change in control of the Company, may discourage bids
for the Company's Common Stock at a premium over the then prevailing market
price of the Common Stock, and may adversely effect the market price of, and the
voting and other rights of the holders of, Common Stock.
ITEM 2. PROPERTIES
The Company's headquarters and research facilities are located in a 42,000
square foot office building in Edina, Minnesota, which the Company acquired in
November 1995 and has occupied since December of that year. Management believes
that the Company's facilities are suitable and adequate for current office,
research and warehouse requirements, and will meet the Company's currently
anticipated needs.*
ITEM 3. LEGAL PROCEEDINGS
The medical device market is characterized by frequent and substantial
intellectual property litigation. Intellectual property litigation is complex
and expensive, and the outcome of such litigation is difficult to predict.
The Company is not aware of any patent infringement charge or any violation
of other proprietary rights claimed by any third party relating to the Company
or the Company's products, except as set forth below. However, no assurance can
be given that the Company or its products will not become the subject of such a
claim in the future. Any future litigation could result in substantial expense
to the Company and significant diversion of effort by its technical and
management personnel. Litigation may also be necessary to enforce patents
issued to the Company, to protect trade secrets or know-how owned by it 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 it to seek
licenses from, and pay substantial royalties to, third parties. Furthermore,
there can be no assurance that necessary licenses would be available to the
Company on satisfactory terms, or at all. Accordingly, an adverse determination
in a judicial or administrative proceeding or failure to obtain necessary
licenses could prevent the Company from manufacturing and selling certain of its
products, which would have a material adverse effect on its business, financial
condition and results of operations.
The Company is involved in litigation related to its license of the Karlin
Technology from Dr. Michelson and Karlin, co-owners of the Karlin Technology.
The litigation principally relates to the interpretation of Dr. Michelson's and
Karlin's right to co-license the Karlin Technology to a third party and to the
inventorship of one of the Company's patents. In December 1993, Dr. Michelson
and Karlin filed a complaint against the Company and Smith & Nephew Group, an
entity under common control with Smith &
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Nephew, in United States District Court, Central District of California. In
December 1994, the plaintiffs served the defendants with a second amended
complaint (the "Complaint"). The Company filed an answer to the Complaint in
January 1995 denying the material allegations and setting forth affirmative
defenses. The Complaint alleged various causes of action, including tortious
interference with prospective and contractual business relationships, unfair
competition and breach of contract, and requested various types of relief,
including money damages, injunctive relief and declaratory judgment. In
addition, in the event the Company objected to the co-license of the Karlin
Technology to a third party, the Complaint requested rescission of the license
agreement. Danek, a competitor of the Company, is the other co-licensee of the
Karlin Technology. The Company is not contesting the co-license of the Karlin
Technology to Danek. Each of the claims relating to the Karlin Technology has
been the subject of a dispositive motion resulting in an order by the court
granting its dismissal in the Company's favor. On February 12, 1996, the court
entered judgment finding that the Company was the prevailing party on all counts
of the Complaint. Dr. Michelson and Karlin have appealed the judgment to the
Ninth Circuit Court of Appeals. The parties have filed briefs and are awaiting
an oral hearing before the appellate court.
On June 19, 1995, the Company received a purported notice of termination of
the Karlin license agreement based on alleged inadequacy in the reporting of the
royalty payments due by the Company to Karlin under the license agreement.
Karlin has claimed that the Company has therefore breached the license
agreement. The Company denies, however, that it has breached the agreement.
Under the terms of the agreement, the license agreement may not be terminated
until after a final, non-appealable determination of the existence of the breach
by a court of competent jurisdiction. The license agreement also provides for
non-binding arbitration and the right of a breaching party to cure a breach by
adopting the recommendation of the arbitrator. On September 15, 1995, the
Company commenced a non-binding arbitration against Dr. Michelson and Karlin in
Minneapolis before the American Arbitration Association asserting that the
purported termination of the license agreement is meritless and ineffective.
Dr. Michelson and Karlin have taken the position in the arbitration that they do
not intend to seek to enforce the purported termination. They also contend,
however, that they may in the future terminate the license agreement if the
royalty reports are determined to have been inadequate. Although the Company
believes that a valid termination of the agreement will not be a remedy
available to Karlin and Dr. Michelson, a determination against the Company could
have a material adverse effect on its business, financial condition and results
of operations.*
On August 13, 1996, Karlin and Dr. Michelson filed an arbitration before
the American Arbitration Association in Los Angeles. Karlin and Dr. Michelson
seek in this arbitration (i) an award of royalties which they claim the Company
has not paid, and (ii) a declaration that Dr. Michelson is the inventor of
certain surgical methods used by or claimed to be invented by the Company,
damages for failure to give Dr. Michelson inventive credit for these methods,
and an order that the Company place corrective advertising to ameliorate the
purported failure. After the Company objected to Los Angeles as the forum for
this arbitration, the AAA transferred the arbitration to Minnesota so that it
could be coordinated with the prior pending arbitration filed by the Company.
Both arbitrations are currently pending before the AAA in Minnesota. No
discovery has yet taken place and no hearing dates have been set.
The Company and Karlin and Dr. Michelson are also in litigation in the
United States District Court for the District of Minnesota concerning
inventorship of U.S. Patent No. 5,489,307. Prior to the issuance of the patent
to the Company, Dr. Michelson in the above-referenced California action asserted
that he was the true inventor of the then pending patent application for the
patent. This claim was dismissed for lack of a justiciable controversy. In the
Minnesota action brought by the Company, Dr. Michelson has filed a motion to
dismiss for lack of personal jurisdiction, which was denied. Karlin and
Dr. Michelson have since
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filed a pending motion to dismiss, transfer or stay the action, asserting that
the action should be heard only in the United States District Court for the
Central District of California. On December 16, 1996, Karlin and Dr. Michelson
filed an action against the Company in the United States District Court for the
Central District of California. The complaint seeks (i) declaratory relief that
Dr. Michelson is the true inventor and owner of the patent, or in the
alternative, that the patent is invalid; (ii) unspecified damages and an
injunction based upon the Company's acquisition and exploitation of the patent;
(iii) unspecified damages and termination of the Karlin license agreement based
upon numerous allegedly false representations made by the Company in connection
with the entry into the License Agreement; (iv) unspecified damages for alleged
disparagement of title in connection with the bilateral pre-distraction method
and associated instruments specified in the patent; (v) unspecified damages for
breach of fiduciary duty in connection with alleged failures by the Company to
pay royalties due and the Company's conduct related to the patent;
(vi) unspecified damages for misappropriation of trade secrets in connection
with the application for and exploitation of the patent; and (vii) unspecified
damages for statutory unfair competition in connection with the same alleged
conduct. The complaint also seeks unspecified punitive damages. The parties
have stipulated to extend the time for the Company to respond to this complaint
while Karlin's and Dr. Michelson's motion to dismiss is pending in Minnesota.
Although the Company believes that neither a termination of the agreement nor
substantial damages will be remedies available to Karlin and Dr. Michelson in
this action, a determination against the Company could have a material adverse
effect on its business, financial condition and results of operation.*
Surgical Dynamics, Inc., a competitor of the Company, has filed a complaint
for declaratory judgment in the United States District Court for the Central
District of California of patent invalidity, unenforceability and
non-infringement against Karlin and Danek regarding U.S. Patent No. 5,015,247,
which is part of the Karlin Technology. Karlin and Danek have counterclaimed
against Surgical Dynamics claiming patent infringement. The outcome of the
litigation is uncertain. There can be no assurances that the patent related to
the Karlin Technology will be upheld or that the Company will continue to have
such patent protection for its products.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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ITEM X. EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers and directors of the Company are as follows:
NAME AGE POSITION
-------------------- --- ----------------------------------------
David W. Stassen 45 Chief Executive Officer, President and
Director
Keith M. Eastman 47 Chief Financial Officer and Secretary
Ted K. Schwarzrock 47 Vice President, Sales and Marketing
Douglas W. Kohrs 39 Vice President, Research and Product
Development
Richard C. Jansen 48 Vice President, Regulatory and Clinical
Affairs
David L. Shaw 51 Vice President, Manufacturing
Operations
DAVID W. STASSEN has served as President and Chief Executive Officer of the
Company since June 1992 and as a director of the Company since June 1991. From
1990 to June 1992, Mr. Stassen served as Executive Vice President of St. Paul
Venture Capital, Inc., a venture capital company. He is currently a director of
Avecor Cardiovascular, Inc. and RSI Systems, Inc.
KEITH M. EASTMAN has served as Chief Financial Officer of the Company since
September 1992. Mr. Eastman was an independent consultant from January 1991 to
September 1992 and served as Chief Financial Officer of CIMA Labs, Inc., a
pharmaceutical manufacturer, from December 1991 to August 1992.
TED K. SCHWARZROCK has served as Vice President, Sales and Marketing since
November 1993. From June 1991 to October 1993, he served as Vice President of
Ergodyne, Inc., a developer of ergonomic products for the workplace. He is
currently a director of HPS Medical, Inc. and MedAmicus Inc.
DOUGLAS W. KOHRS has served as Vice President, Research and Product
Development since January 1993 and previously served as Director of Product
Development and Marketing for the Company from August 1991 to January 1993.
RICHARD C. JANSEN, PHARM.D., has served as Vice President, Regulatory and
Clinical Affairs since August 1993 and previously served as Director of
Regulatory Affairs and Operations of the Company from August 1991 to August
1993.
DAVID L. SHAW has served as Vice President, Manufacturing Operations since
June 1994 and previously served as Director of Manufacturing of the Company from
June 1992 to June 1994. From December 1991 to June 1992, Mr. Shaw worked as a
manufacturing consultant for the Company.
Executive officers are elected annually by the Board of Directors and serve
a one-year period or until their successors are elected.
None of the above executive officers is related to each other or to any
director of the Company.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Incorporated herein by reference is the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996, page 24.
ITEM 6. SELECTED FINANCIAL DATA
Incorporated herein by reference is the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996, page 8.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Incorporated herein by reference is the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996, pages 8-11.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated herein by reference is the Company's Annual Report to
Shareholders for the fiscal year ended December 31, 1996, pages 12-23.
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
Incorporated herein by reference is the information appearing under
the headings "Election of Directors" and "Section 16(a) Beneficial Ownership
Reporting Compliance," pages 3, 4 and 17, in the Company's Proxy Statement dated
March 28, 1997. See also Part I hereof under the heading "Item X. Executive
Officers of the Registrant."
ITEM 11. EXECUTIVE COMPENSATION
Incorporated herein by reference is the information appearing under
the headings "Election of Directors," "Report of the Compensation Committee,"
"Executive Compensation" and "Performance Graph," pages 10 and 16, in the
Company's Proxy Statement dated March 28, 1997.
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference is the information appearing under
the heading "Security Ownership of Principal Shareholders and Management," page
2, in the Company's Proxy Statement dated March 28, 1997.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference is the information appearing under
the heading "Certain Relationships and Transactions," page 17, in the Company's
Proxy Statement dated March 28, 1997.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements:
Report of Independent Auditors
Statements of Operations for the years ended December 31, 1996, 1995
and 1994
Balance Sheets as of December 31, 1996 and 1995
Statements of Cash Flows for the years ended December 31, 1996, 1995
and 1994
Statements of Shareholders' Equity for the years ended December 31,
1996, 1995 and 1994
Notes to Financial Statements
(Incorporated by reference to pages 12-23 of the Company's Annual
Report to Shareholders for the fiscal year ended December 31, 1996.)
2. Financial Statement Schedules:
Schedule II--Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
3. Exhibits:
3.1 Amended and Restated Articles of Incorporation of the Company.
(1) (2) (3)
3.2 Restated By-Laws of the Company and Amendment to Restated By-Laws
of the Company. (4)
4.1 Specimen of Common Stock certificate. (5)
21
<PAGE>
4.2 Form of Rights Agreement dated as of August 21, 1996 between the
Company and Norwest Bank Minnesota, N.A. (3)
#10.1 1994 Spine-Tech, Inc. Stock Option Plan. (6)
#10.2 Spine-Tech, Inc. 1993 Non-Employee Director Stock Option Plan.
(7)
#10.3 Spine-Tech, Inc. 1991 Stock Option Plan. (8)
10.4 Loan Agreement between the Company and Riverside Bank dated April
20, 1995. (9)
#10.5 Spine-Tech, Inc. 1996 Employee Stock Purchase Plan. (10)
#10.6 Spine-Tech, Inc. 1996 Omnibus Stock Plan. (11)
10.7 License Agreement dated as of May 10, 1992, among the Company,
Karlin Technology, Inc. and Gary K. Michelson. (12) (13)
10.8 License Agreement dated as of January 1, 1995 between the Company
and Dr. Ted Obenchain. (13) (14)
#10.9 Employment Agreement between the Company and David W. Stassen
dated June 15, 1992. (15)
#10.10 Employment Letter from the Company to David W. Stassen dated
June 2, 1992. (16)
#10.11 Employment Agreement between the Company and Ted K. Schwarzrock
dated November 1, 1993. (17)
#10.12 Management Agreement dated as of February 1, 1996 between the
Company and David W. Stassen. (18)
#10.13 Management Agreement dated as of February 1, 1996 between the
Company and Keith M. Eastman. (19)
#10.14 Management Agreement dated as of February 1, 1996 between the
Company and Ted K. Schwarzrock. (20)
#10.15 Management Agreement dated as of February 1, 1996 between the
Company and Douglas W. Kohrs. (21)
#10.16 Management Agreement dated as of February 1, 1996 between the
Company and Richard C. Jansen. (22)
#10.17 Management Agreement dated as of February 1, 1996 between the
Company and David L. Shaw. (23)
22
<PAGE>
10.18 Collaberation Agreement between the Company and Ethicon Endo
Surgery dated June 27, 1994 (24)
11 Statement of Computation of Net Income (Loss).
13 Annual report to Shareholders for the fiscal year ended
December 31, 1996 (only those portions specifically incorporated
by reference herein shall be deemed filed with the Securities and
Exchange Commission).
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule (EDGAR version only).
- ------------------------------
# Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form pursuant to Item 14(c).
(1) Incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 1995 (File
No. 0-26116).
(2) Incorporated by reference to Exhibit 3.2 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(3) Incorporated by reference to Exhibit 1 to the Company's Current Report
on Form 8-K dated August 21, 1996.
(4) Incorporated by reference to Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1996.
(5) Incorporated by reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(6) Incorporated by reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(7) Incorporated by reference to Exhibit 10.2 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(8) Incorporated by reference to Exhibit 10.3 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(9) Incorporated by reference to Exhibit 10.11 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(10) Incorporated by reference to Exhibit 10.13 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
23
<PAGE>
(11) Incorporated by reference to Exhibit 10.14 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(12) Incorporated by reference to Exhibit 10.17 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(13) Exhibit contains portions for which confidential treatment has been
granted to the Company.
(14) Incorporated by reference to Exhibit 10.18 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(15) Incorporated by reference to Exhibit 10.19 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(16) Incorporated by reference to Exhibit 10.20 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(17) Incorporated by reference to Exhibit 10.21 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(18) Incorporated by reference to Exhibit 10.22 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(19) Incorporated by reference to Exhibit 10.23 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(20) Incorporated by reference to Exhibit 10.24 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(21) Incorporated by reference to Exhibit 10.25 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(22) Incorporated by reference to Exhibit 10.26 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(23) Incorporated by reference to Exhibit 10.27 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
(24) Incorporated by reference to Exhibit 10.12 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
24
<PAGE>
(b) Reports on Form 8-K
No reports were filed during the fourth quarter of the fiscal year ended
December 31, 1996.
25
<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, on March 26, 1997.
SPINE-TECH, INC.
By /s/ David W. Stassen
-------------------------------------------
David W. Stassen
Chief Executive Officer and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities indicated on March 26, 1997.
/s/ David W. Stassen
---------------------------------------------
David W. Stassen, Chief Executive Officer and
President (Principal Executive Officer) and
Director
/s/ Keith M. Eastman
---------------------------------------------
Keith M. Eastman, Chief Financial Officer and
Secretary (Principal Financial Officer and
Principal Accounting Officer)
/s/ Kenneth W. Anstey
---------------------------------------------
Kenneth W. Anstey, Director
/s/ Robert J. DePasqua
---------------------------------------------
Robert J. DePasqua, Director
/s/ Stephen D. Kuslich
---------------------------------------------
Stephen D. Kuslich, Director
/s/ James F. Lyons
---------------------------------------------
James F. Lyons, Director
26
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit Description Page
- ------- ----------- ----
<S> <C> <C>
3.1 Amended and Restated Articles of Incorporation of the
Company. (1) (2) (3) . . . . . . . . . . . . . . . . . . . .Incorporated by Reference
3.2 Restated By-Laws of the Company and Amendment to Restated
By-Laws of the Company. (4). . . . . . . . . . . . . . . . .Incorporated by Reference
4.1 Specimen of Common Stock certificate. (5). . . . . . . . . .Incorporated by Reference
4.2 Form of Rights Agreement dated as of August 21, 1996
between the Company and Norwest Bank Minnesota, N.A. (3) . .Incorporated by Reference
#10.1 1994 Spine-Tech, Inc. Stock Option Plan. (6) . . . . . . . .Incorporated by Reference
#10.2 Spine-Tech, Inc. 1993 Non-Employee Director Stock
Option Plan. (7) . . . . . . . . . . . . . . . . . . . . . .Incorporated by Reference
#10.3 Spine-Tech, Inc. 1991 Stock Option Plan. (8) . . . . . . . .Incorporated by Reference
10.4 Loan Agreement between the Company and Riverside Bank
dated April 20, 1995. (9). . . . . . . . . . . . . . . . . .Incorporated by Reference
#10.5 Spine-Tech, Inc. 1996 Employee Stock Purchase Plan. (10) . .Incorporated by Reference
#10.6 Spine-Tech, Inc. 1996 Omnibus Stock Plan. (11) . . . . . . .Incorporated by Reference
10.7 License Agreement dated as of May 10, 1992, among the
Company, Karlin Technology, Inc. and Gary K. Michelson.
(12) (13). . . . . . . . . . . . . . . . . . . . . . . . . .Incorporated by Reference
10.8 License Agreement dated as of January 1, 1995 between
the Company and Dr. Ted Obenchain. (13) (14) . . . . . . . .Incorporated by Reference
#10.9 Employment Agreement between the Company and
David W. Stassen dated June 15, 1992. (15) . . . . . . . . .Incorporated by Reference
#10.10 Employment Letter from the Company to David W. Stassen
dated June 2, 1992. (16) . . . . . . . . . . . . . . . . . .Incorporated by Reference
#10.11 Employment Agreement between the Company and
Ted K. Schwarzrock dated November 1, 1993. (17). . . . . . .Incorporated by Reference
#10.12 Management Agreement dated as of February 1, 1996
between the Company and David W. Stassen. (18) . . . . . . .Incorporated by Reference
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
#10.13 Management Agreement dated as of February 1, 1996
between the Company and Keith M. Eastman. (19) . . . . . . .Incorporated by Reference
#10.14 Management Agreement dated as of February 1, 1996
between the Company and Ted K. Schwarzrock. (20) . . . . . .Incorporated by Reference
#10.15 Management Agreement dated as of February 1, 1996
between the Company and Douglas W. Kohrs. (21) . . . . . . .Incorporated by Reference
#10.16 Management Agreement dated as of February 1, 1996
between the Company and Richard C. Jansen. (22). . . . . . .Incorporated by Reference
#10.17 Management Agreement dated as of February 1, 1996
between the Company and David L. Shaw. (23). . . . . . . . .Incorporated by Reference
10.18 Collaberation Agreement between the Company and
Ethicon Endo Surgery dated June 27, 1994 (24). . . . . . . .Incorporated by Reference
11 Statement of Computation of Net Income (Loss). . . . . . . .Filed Electronically
13 Annual report to Shareholders for the fiscal year
ended December 31, 1996 (only those portions
specifically incorporated by reference herein shall
be deemed filed with the Securities and Exchange
Commission). . . . . . . . . . . . . . . . . . . . . . . . .Incorporated by Reference
23 Consent of Ernst & Young LLP . . . . . . . . . . . . . . . .Filed Electronically
27 Financial Data Schedule (EDGAR version only).. . . . . . . .Filed Electronically
</TABLE>
- ------------------------------
# Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this form pursuant to Item 14(c).
(1) Incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 1995 (File
No. 0-26116).
(2) Incorporated by reference to Exhibit 3.2 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(3) Incorporated by reference to Exhibit 1 to the Company's Current Report on
Form 8-K dated August 21, 1996.
(4) Incorporated by reference to Exhibit 3.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended March 31, 1996.
(5) Incorporated by reference to Exhibit 4.1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
<PAGE>
(6) Incorporated by reference to Exhibit 10.1 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(7) Incorporated by reference to Exhibit 10.2 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(8) Incorporated by reference to Exhibit 10.3 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(9) Incorporated by reference to Exhibit 10.11 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(10) Incorporated by reference to Exhibit 10.13 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(11) Incorporated by reference to Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(12) Incorporated by reference to Exhibit 10.17 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(13) Exhibit contains portions for which confidential treatment has been
granted to the Company.
(14) Incorporated by reference to Exhibit 10.18 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(15) Incorporated by reference to Exhibit 10.19 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(16) Incorporated by reference to Exhibit 10.20 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(17) Incorporated by reference to Exhibit 10.21 to the Company's Registration
Statement on Form S-1 (Registration No. 33-91928).
(18) Incorporated by reference to Exhibit 10.22 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(19) Incorporated by reference to Exhibit 10.23 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(20) Incorporated by reference to Exhibit 10.24 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(21) Incorporated by reference to Exhibit 10.25 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
<PAGE>
(22) Incorporated by reference to Exhibit 10.26 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
(23) Incorporated by reference to Exhibit 10.27 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995.
<PAGE>
SPINE-TECH, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
Balance at Additions
Beginning of Charged to Cost Less Balance at End
Description Year and Expenses Deductions of Year
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
YEAR ENDED DECEMBER 31, 1996:
Allowance for doubtful accounts $ 61,000 $ - $ - $ 61,000
Reserve for obsolete inventory 100,000 49,000 81,000 68,000
----------------------------------------------------------------------
$ 161,000 $ 49,000 $ 81,000 $ 129,000
----------------------------------------------------------------------
----------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1995:
Allowance for doubtful accounts $ - $ 61,000 $ - $ 61,000
Reserve for obsolete inventory 60,000 40,000 - 100,000
----------------------------------------------------------------------
$ 60,000 $ 101,000 $ - $ 161,000
----------------------------------------------------------------------
----------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 1994:
Allowance for doubtful accounts $ - $ - $ - $ -
Reserve for obsolete inventory 15,000 45,000 - 60,000
----------------------------------------------------------------------
$ 15,000 $ 45,000 $ - $ 60,000
----------------------------------------------------------------------
----------------------------------------------------------------------
</TABLE>
<PAGE>
SPINE-TECH, INC.
EXHIBIT 11 - STATEMENT RE: COMPUTATION OF NET INCOME (LOSS) PER SHARE
<TABLE>
<CAPTION>
Year ended December 31,
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
PRIMARY LOSS PER SHARE:
Average shares outstanding 9,831,733 5,633,473 2,090,000
Common share equivalents -- 1,534,143 --
SAB No. 83 shares -- for stock options
granted at an exercise price less than the
initial public offering price during the
12 months preceding the initial public
offering using the treasury method -- 93,850 375,398
---------- ---------- ----------
Total 9,831,733 7,261,466 2,465,398
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) $ (247,000) $ 268,000 $ (379,000)
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) per share $ (0.02) $ 0.04 $ (0.18)
---------- ---------- ----------
---------- ---------- ----------
FULLY DILUTED LOSS PER SHARE:
Average shares outstanding 9,831,733 5,633,473 2,090,000
Common share equivalents -- 1,637,220 --
Preferred stock on an as if converted basis 2,277,208 4,135,232
SAB No. 83 shares -- for stock options
granted at an exercise price less than the
initial public offering price during the
12 months preceding the initial public
offering using the treasury method -- 93,850 375,398
---------- ---------- ----------
Total 9,831,733 9,641,751 6,600,630
---------- ---------- ----------
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) $ (247,000) $ 268,000 $ (379,000)
---------- ---------- ----------
---------- ---------- ----------
Net income (loss) per share $ (0.02) $ 0.03 $ (0.06)
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
<PAGE>
ABOUT THE COMPANY
Spine-Tech, Inc. designs, manufactures and markets an innovative series of
spinal implants, instruments and procedures based on the company's BAK-TM-
technology for the treatment of degenerative conditions of the human spine. The
company's BAK systems are designed for the lumbar (BAK) and cervical
(BAK/C-Registered Trademark-) regions of the spine.
Spine-Tech intends to become an internationally recognized leader in this
market by:
- Expanding technological leadership;
- Enhancing minimally invasive surgical treatments for degenerative
spinal conditions;
- Establishing the clinical utility and cost-effectiveness of its
products;
- Providing superior clinical, engineering and educational support to
patients and customers; and
- Developing focused worldwide marketing and sales capabilities.
1996 MILESTONES
|
|
| U.S. PATENT OFFICE ISSUES TWO
| PATENTS FOR BAK IMPLANTS, SURGICAL SURGICAL TRAINING CENTER
| PROCEDURES AND INSTRUMENTS. OPENS AT HEADQUARTERS.
| | |
--------FEBRUARY-------------MAY----------------------AUGUST--------------
|
U.S. FDA ORTHOPAEDIC AND
REHABILITATION DEVICES PANEL RECOMMENDS
APPROVAL OF SPINE-TECH'S BAK TECHNOLOGY.
ISO 9001 QUALITY SYSTEMS AND
CE MARK CERTIFICATIONS RECEIVED.
<PAGE>
LETTER TO SHAREHOLDERS
ON SEPTEMBER 23, 1996, the U.S. Food and Drug Administration (FDA) approved the
Spine-Tech BAK-TM- system, designed to treat chronic low back pain caused
by degenerative disc disease in the lumbar spine, for marketing in the
United States. This first FDA approval of a Spine-Tech product is a pivotal
event for our company - establishing the opportunity to launch the BAK
system in the United States and laying the foundation for future approvals
of other BAK-based products. Now, we are transforming Spine-Tech from a
development-stage entity to a company with full-fledged marketing and
manufacturing operations.
Our innovative series of proprietary implantable devices, instruments
and surgical methods has been evaluated in clinical trials at more than 20
medical centers over five years. More than 1,900 patients have received BAK
implants in clinical trials; an additional 900 patients have received BAK
implants since commercial launch. The BAK system has produced outstanding
results in comparison to traditional fusion techniques, and patient
outcomes after commercial introduction have been consistent with data
collected in clinical trials. The surgical procedure is less traumatic,
operating times are short, pain relief is fast and patients recover
quickly, reducing lost worker productivity.
FINANCIAL RESULTS Revenues for the year ended December 31, 1996, reached $10.2
million, a 36 percent increase over revenues of $7.5 million in 1995. For
the year ended December 31, 1996, we reported a loss of $247,000, or $.02
per share, compared to earnings of $268,000, or $.03 per share, in 1995.
In the 1996 fourth quarter, which includes our first commercial sales
of the BAK system in the United States, we recorded revenues of $5.7
million, a 159 percent increase over fourth quarter 1995 revenues, and
earned $2.1 million, or $.19 per share. We believe this quarter begins to
reflect Spine-Tech's potential. The commercial launch of the BAK system is
well under way. We also continue to generate revenues from the sale of
other BAK products in clinical trials, including trials using laparoscopic
surgical procedures.
SURGICAL TRAINING SEMINARS HELD AT
NORTH AMERICAN SPINE SOCIETY MEETING.
|
|
- -SEPTEMBER ------------------------ OCTOBER ---------------- DECEMBER
| |
FDA APPROVAL RECEIVED FOR THE BAK |
SYSTEM FOR USE IN THE LUMBAR SPINE. |
|
AGREEMENT SIGNED WITH ORQUEST CORPORATION
TO EVALUATE AND COMMERCIALIZE SYNTHETIC
BONE GRAFT WITH BAK IMPLANTS.
|
|
SUPPLEMENTAL PRE-MARKET APPROVAL (PMA)
APPLICATION SUBMITTED TO FDA FOR A LAPAROSCOPIC
PROCEDURE FOR THE BAK SYSTEM.
1
<PAGE>
LETTER TO SHAREHOLDERS CONT'D
Three significant factors affected 1996 results. First, we received
FDA approval for the commercial launch of our principal product, which
positively affected our revenue growth and established a foundation for
future revenue growth in our major market. Second, we ended our
distribution agreement outside the United States with Smith & Nephew, an
orthopaedic products company based in the United Kingdom, and started to
develop our own independent distributor network. This had a negative
short-term effect on revenue. We believe that the overseas market offers
strong potential and that we will be better served by developing our own
network of independent distributors. Third, we decided to build a direct
sales force in the United States to assure consistency in how the
innovative BAK system is presented. Consequently, sales and marketing
expenses were higher than originally projected.
EXECUTING OUR PLAN In 1996, we established our surgeon education program and
developed our marketing and sales organization - both essential to our
commercial launch. As 1997 unfolds, we are focused on executing our plan
for the commercial launch of the BAK system while continuing clinical
trials for other BAK systems and conducting research and development to
refine and develop complementary products.
We have confidence in the design of the BAK system and recognize that
surgeon training is critical to consistent, strong patient outcomes. In
August, we opened our surgeon education center at our headquarters. By the
end of 1996, more than 600 surgeons had attended our BAK surgical seminars.
We plan to train more than 100 surgeons monthly during 1997 and expect to
have trained most of the 1,800 spine surgeons who regularly perform lumbar
fusion surgery in the United States by the end of 1997. Our seminar faculty
includes 30 surgeons involved in our clinical trials, most of whom have
three to five years of experience with the BAK system. In addition, we have
developed a network of more than 100 sales and support specialists who are
available to assist BAK-trained surgeons in operating rooms across the
United States.
Spine-Tech has become a familiar and exciting participant in major
medical conferences. In 1996, we exhibited at the annual meetings of the
North American Spine Society, American Association of Neurological
Surgeons, Congress of Neurological Surgeons, American Academy of
Orthopaedic Surgeons and the European Spine Society. At each of these
meetings, several papers on the BAK system were presented, which
consistently showed strong findings.
To date, the feedback about the BAK system from surgeons, patients and
payors has been consistently positive. Physicians appreciate the
thoroughness of our clinical research, quality of our training and
continuing technical support. Patients have been pleased with surgical
outcomes. And payors note the low cost of the procedure itself and
patients' faster return to work.
1996 REVENUES
(IN MILLIONS)
Q1 $1.4
Q2 $1.5
Q3 $1.5
Q4 $5.7
1996 NET INCOME
(LOSS)
Q1 $(355)
Q2 $(585)
Q3 $(1,449)
Q4 $2,144
2
<PAGE>
[PHOTO]
(LEFT TO RIGHT)
STEPHEN D. KUSLICH, M.D., ORTHOPAEDIC SURGEON
AND MEDICAL DIRECTOR; DAVID W. STASSEN, CHIEF
EXECUTIVE OFFICER AND PRESIDENT; DOUGLAS W. KOHRS,
VICE PRESIDENT OF RESEARCH AND PRODUCT DEVELOPMENT.
As in the United States, patients and surgeons in other nations
have been awaiting the results of clinical trials and FDA approval
before adopting BAK technology. We believe that the strength of our
clinical trial results and FDA approval in the United States will
support increasing international acceptance of the BAK system.
BUILDING THE MOMENTUM The commercial launch of the BAK system will accelerate
the growth of Spine-Tech's sales in 1997. Nearly half of our 96 employees
are devoted to sales, education and clinical support. This reflects our
commitment to the successful commercial launch of the BAK system. We now
have 25 direct sales representatives, all with successful experience
selling medical/surgical specialty devices, four regional sales managers
and a network of seven agent groups.
In December, we submitted a Pre-Market Approval (PMA) supplemental
application to the FDA for a laparoscopic procedure to implant BAK devices.
This is a less invasive procedure that significantly reduces surgical
trauma and further shortens recovery times. We are optimistic that we will
receive FDA clearance for this procedure during 1997.
Clinical trials for the BAK/C-Registered Trademark- system, implants
and procedures for the cervical spine (neck) are progressing. Patient
enrollment continues in these clinical trials.
Our commitment to research and development continues, with more than
17 percent of revenues devoted to this effort in 1996. Our focus is on
refining our current implants, instruments and procedures, and developing
new products related to treatment of spinal diseases. In December, we
signed an agreement with Orquest Corporation, a medical manufacturer based
in Mountain View, California, to evaluate and commercialize
Healos-Registered Trademark-, a synthetic bone graft material. Healos has
the potential to fill the BAK device and eliminate the need for a second
surgery to harvest bone graft from the patient's hip.
In closing, we are appreciative of our surgeon customers who have
embraced the BAK technology and are adopting it in their practices. I am
proud of the contributions of our employees. Through their hard work and
commitment, we are moving forward with full-scale manufacturing and
marketing of our BAK system.
Sincerely,
/s/ David W. Stassen DAVID W. STASSEN
CHIEF EXECUTIVE OFFICER
AND PRESIDENT
3
SPINE-TECH 1996 ANNUAL REPORT
<PAGE>
REVIEW OF OPERATIONS
BACK PAIN CAUSED BY DEGENERATIVE DISC DISEASE disables millions annually and
absorbs a large portion of health care resources in the United States and
around the world. In the United States alone, back pain leads to an
estimated $25 billion annually in medical treatment costs and $60 billion
in lost worker productivity.
The treatment of last resort for many back pain patients is spinal
fusion surgery, in which adjacent vertebrae are joined to stabilize the
joint and reduce pressure on nerves. Each year, more than 200,000 spinal
fusion surgical procedures are performed in the United States and 400,000
such procedures are performed worldwide.
The BAK system of implants, surgical procedures and instruments offers
physicians and their patients an innovative approach to spinal fusion in
the lumbar area of the spine, offering less invasive surgery, lower
treatment costs and superior patient outcomes.
Between 1992 and 1996, 1,900 patients were enrolled in BAK clinical
trials conducted by 42 surgeons at 23 medical centers. On September 23,
1996, Spine-Tech received FDA approval to begin marketing the BAK system
for spinal fusion in the lumbar area, the most common region for
degenerative disc disease. Since then, Spine-Tech's sales and marketing
efforts have focused on the U.S. introduction of the BAK system. By year-
end 1996, more than 2,800 patients had received BAK implants.
The adoption of a new technology is a process of creating awareness,
building credibility and gaining acceptance. We offer comprehensive
training programs to assist surgeons in understanding BAK procedures and to
ensure their appropriate use. To assure physicians and patients of the
efficacy of the BAK technology, Spine-Tech conducted extensive FDA-approved
clinical trials. We continue to follow up with patients and collect long-
term outcomes data.
AVERAGE PATIENT PAIN SCORES
AT FOLLOW-UP
[CHART]
[PHOTO]
DIRECTOR OF PROFESSIONAL EDUCTION,
DUANE LINENKUGEL, IN SPINE-TECH'S TRAINING LAB.
SPINE-TECH 1996 ANNUAL REPORT
4
<PAGE>
TRAINING FOR SUCCESSFUL OUTCOMES Spine-Tech is committed to preparing surgeons
to use the BAK system by providing a comprehensive training program and
follow-up technical support. As soon as we received FDA approval for the
BAK system in late September, we launched the first seminars at our
headquarters training facility. By year-end 1996, we had trained more
than 600 surgeons.
Currently, we provide training programs for four groups:
ORTHOPAEDIC OR NEUROLOGICAL SURGEONS, whose practices are dedicated to
spinal surgery. Surgeons invited to attend training seminars have the
appropriate patient volume, referral patterns, surgical judgment and
experience. Our goal is to only have surgeons who have completed training
use the BAK system.
CLINICAL PROFESSIONALS, such as physician's assistants and surgical
technicians, who assist with BAK procedures and patients.
CLINICAL SUPPORT NURSES, who are available for support in the
operating room during BAK surgery.
SPINE-TECH DIRECT AND INDIRECT SALES REPRESENTATIVES, who are
technically oriented and have previous experience with medical and surgical
products.
The training seminar encompasses lectures on the bioscience and design
of the BAK implant, patient indications and evaluation for BAK surgery. A
review of clinical results helps surgeons determine which patients will
benefit the most from BAK implants.
TRAINING IS ESSENTIAL
"BAK implants are re-engineering the management of degenerative disc
disease. At Spine-Tech, we believe education is essential to the adoption
of new technology and to preserving our consistently outstanding clinical
results. We invite appropriate surgeons to attend our training seminars and
require that surgeons complete training before performing BAK procedures."
- Duane Linenkugel
Director of
Professional Education
5
<PAGE>
REVIEW OF OPERATIONS CONT'D
Anterior (from the front) and posterior (from the back) surgical
procedures are reviewed in detail, as well as unusual situations. The
anterior approach is new to many surgeons, but gaining acceptance as
they see reduced operating times and less patient discomfort with this
procedure. The traditional posterior approach involves dissecting back
muscles to expose the spine; this additional surgical trauma can
lengthen patient recovery time compared to our anterior approach.
Our 30 faculty members performed BAK procedures under our U.S.
clinical trials. Each has an average of three years of experience with
the BAK system. Surgeons attending our seminars appreciate the
opportunity to learn from their peers.
In 1997, our training program will continue its focus on
introducing BAK technology to U.S. spinal surgeons. In addition, we
anticipate offering training in laparoscopic procedures, pending FDA
approval for this less invasive surgical technique. As the BAK system
gains acceptance overseas, we expect to train more surgeons in other
nations.
PREDICTABLE PATIENT OUTCOMES
Traditional spinal fusion methods have met with mixed success,
often leading to the need for second surgeries. In extensive clinical
trials and early U.S. commercialization, the Spine-Tech BAK system has
provided exceptional spinal stability and predictable patient outcomes.
BAK instruments and procedures provide accuracy, precision and safety -
for consistent results. BAK implants differ from previous spinal fusion
devices by
[GRAPHIC]
A SUCCESS STORY
"In 1992, I was in constant pain and needed to get back to living. My doctor
said I needed spinal fusion surgery and recommended a traditional technique. He
also said it would be six to 12 months before I could work, and I would have
life-long limitations. The BAK implants made more sense to me. I was discharged
three days after BAK surgery and, in five weeks, returned to work full-time in
my position as a disability manager. Less than six months later, I could garden,
go grocery shopping and do everything I couldn't do before surgery."
- Vicki Carlson
BAK patient
SPINE-TECH 1996 ANNUAL REPORT
6
<PAGE>
[PHOTO]
VICKI CARLSON, BAK PATIENT, IS BACK TO ENJOYING THE THINGS
SHE COULDN'T DO BEFORE SURGERY.
directly addressing the pain source - the instability in the vertebral
joint caused by a degenerative disc. The traditional instrumented spinal
fusion involves attaching a device to the side of the spine. The BAK
implants - two titanium alloy cylinders - are inserted between the
vertebrae. The ribbed structure of the BAK implants enables them to
withstand the enormous loading forces of the spine. In testing, BAK
implants tolerated forces many times greater than those experienced in
the lumbar spine. Further, the large hole design encourages bone growth
through the implant for long-term stability.
The BAK system offers improvements beginning with the surgical
procedure and extending through recovery. The BAK fusion procedure is a
less invasive surgical technique, reducing operating times and blood
loss. The anterior approach, discussed above, results in even less
surgical trauma. The average hospital stay experienced during clinical
trials has been 4.1 days, compared to 6-7 days for traditional
instrumented spinal fusion surgery.
In clinical trials, BAK patients consistently reported improvements
in pain relief. After one year, 83.3 percent of patients reported less
pain, and after three years, 90.3 percent of patients reported less
pain. Moreover, major complications have been minimal.
Fast recovery and rehabilitation lead to exceptional return-to-work
times. Of the patients who were not working prior to surgery due to
disability, 38 percent were working within one year of surgery and 90
percent were working three years later.
As we enter 1997, Spine-Tech is committed to providing physicians
and their patients with innovative, effective solutions to degenerative
disc disease, supported by thorough research, an exceptional training
program and continuing technical support.
BAK FUSION RESULTS
(% OF PATIENTS WITH
SUCCESSFUL FUSION)
YEAR
1 86.2%
2 92.0%
3 98.3%
7
<PAGE>
SPINAL FUSION AND THE BAK SYSTEM
IN THE UNITED STATE back pain is the leading cause of workers' compensation
expense, the second leading reason for physician office visits and a
leading reason for surgical procedures. A commonly performed surgical
treatment for back pain is spinal fusion, in which the disc between two
adjacent vertebrae is removed and the two vertebrae are fused together
using bone graft. Worldwide, an estimated 400,000 spinal fusion surgical
procedures are performed each year, with approximately half of these
occurring in the United States.
[GRAPHIC]
The Spine-Tech BAK system is a patented series of spinal implants,
surgical instruments and procedures that aid the positioning of the
implants between the vertebrae to stabilize the spine and facilitate the
fusion of the vertebrae. The BAK implants are hollow, threaded titanium
alloy cylinders that are implanted between two or more vertebrae. The
implants are packed with bone graft and fusion is achieved when adjoining
vertebrae grow together through the implant, resulting in stabilization and
pain relief.
In the United States, more than 2,800 patients have received BAK
implants and have shown that the BAK system offers significant improvements
over traditional fusion techniques, including:
[GRAPHIC]
- A high fusion success rate;
- Quick functional recovery and rehabilitation, leading to
exceptional return-to-work outcomes;
- A low re-operation rate resulting from a predictable, definitive
surgical procedure; and
- Less invasive surgical techniques that can reduce operating
times, hospitalization and blood loss, resulting in minimized
patient stress and lower health care costs.
Spine-Tech-Registered Trademark-, BAK/C-Registered Trademark- and Cervi-Lok-
Registered Trademark- are registered trademarks of Spine-Tech, Inc.
BAKTM is a trademark of Spine-Tech, Inc.
Healos-Registered Trademark- is a registered trademark of Orquest Corporation.
<PAGE>
SPINE-TECH, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS
The following table sets forth selected financial data for the Company and
should be read in conjunction with the financial statements and related notes
included in this document and with the balance of the management's discussion
and analysis.
STATEMENT OF OPERATIONS DATA
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net sales $10,153 $7,517 $4,398 $2,001 $ 321
Cost of goods sold 2,849 2,488 1,330 391 38
---------------------------------------------------------------------
Gross profit 7,304 5,029 3,068 1,610 283
Operating expenses:
Sales and marketing 5,387 1,563 962 -- --
General and administrative 3,294 2,487 1,491 1,638 879
Research and development 1,777 1,597 1,202 675 807
----------------------------------------------------------------------
Total operating expenses 10,458 5,647 3,655 2,313 1,686
----------------------------------------------------------------------
Operating loss (3,154) (618) (587) (703) (1,403)
Exclusive distribution agreement -- 40 677 --
Interest income 1,223 896 168 38 25
----------------------------------------------------------------------
Net pretax income (loss) (1,931) 278 (379) 12 (1,378)
Provision (benefit) for income taxes (1,684) 10 -- -- --
Net income (loss) (247) 268 (379) 12 (1,378)
Net income (loss) per weighted
average common share $ (.02) $ .03 $ (.06) $ -- $ (.30)
<CAPTION>
BALANCE SHEET DATA
DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 1996 1995 1994 1993 1992
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Current assets $24,053 $27,652 $ 4,337 $ 5,809 $ 1,345
Current liabilities 1,412 862 566 665 111
----------------------------------------------------------------------
Working capital $22,641 $26,790 $ 3,771 $ 5,144 $ 1,234
Total assets $34,058 $32,667 $ 5,549 $ 5,955 $ 1,429
Accumulated deficit $ (2,562) $ (2,315) $(2,378) $(1,999) $(2,011)
Shareholders' equity $32,646 $31,805 $ 4,983 $ 5,290 $ 1,317
</TABLE>
All international sales are conducted in U.S. dollars. International
revenues were $1.9 million, $5.2 million, $2.0 million and $607,000 for 1996,
1995, 1994 and 1993, respectively. No assets other than accounts receivable are
specifically attributable to international sales. International accounts
receivable at the end of the year were $800,000, $1.6 million, $467,000 and
$173,000 for 1996, 1995, 1994 and 1993, respectively.
1996 COMPARED TO 1995
YEARS ENDED DECEMBER 31, 1996, AND
DECEMBER 31, 1995
Net sales increased to $10.2 million for 1996 compared to $7.5 million for
1995 primarily as a result of increased sales of the BAK Interbody Fusion System
in the United States. Domestic sales of the BAK Interbody Fusion System in the
United States increased to $7.7 million for 1996 from $2.0 million for 1995.
Sales of the BAK Interbody Fusion System to Smith & Nephew Richards, Inc. (Smith
& Nephew) for international distribution decreased to $350,000 for 1996 compared
to $4.7 million for 1995, decreasing to 3 percent of sales in 1996 from 61
percent for 1995. In February 1996, the Company ended its exclusive distribution
agreement with Smith & Nephew and has been establishing a network of independent
distributors for international
SPINE-TECH 1996 ANNUAL REPORT
8
<PAGE>
markets. As a result, international sales of the BAK/C-Registered Trademark- and
Cervi-Lok-Registered Trademark- products exceeded $800,000 for 1996, compared to
approximately $500,000 for 1995. Domestically, BAK/C and Cervi-Lok sales
increased to $500,000 for 1996 from approximately $300,000 for 1995.
Gross profit increased to $7.3 million for 1996 from $5.0 million for 1995.
This increase is directly related to the increase in sales in 1996 versus 1995.
As a percentage of net sales, gross profit increased to 71.9 percent in 1996 as
compared to 66.9 percent in 1995, due primarily to the stabilization in prices
paid to outside vendors for the manufacture of implants and instruments and
increased utilization of the Company's manufacturing operations.
Total operating expenses increased to $10.5 million for 1996 compared to
$5.6 million for 1995. Sales and marketing expenses increased to $5.4 million
for 1996 from $1.6 million for 1995, increasing as a percentage of net sales to
53.1 percent in 1996 compared to 20.8 percent in 1995. This increase occurred as
the result of the Company's expansion of its capabilities to support both
international and domestic sales activity. In June 1996, the Company began
establishing a network of direct sales persons to complement the seven
independent agency groups which service customers in certain geographic areas in
the United States. This decision to establish a direct sales force across most
of the United States resulted in higher than anticipated sales and marketing
expenses for the last half of 1996. General and administrative expenses
increased to $3.3 million for 1996 from $2.5 million for 1995, but decreased as
a percentage of net sales to 32.4 percent in 1996 from 33.1 percent in 1995. The
increase in these expenses was primarily the result of increased corporate
activities required to support the expanded sales and marketing activities.
Research and development expenses increased to $1.8 million for 1996 compared to
$1.6 million for 1995, but decreased as a percentage of net sales to 17.5
percent in 1996 from 21.2 percent in 1995. The increase in these expenses
reflects the hiring of additional development engineers and payments to outside
contractors for prototype development projects.
The Company's operating loss increased to $3.2 million in 1996 from
$600,000 in 1995. The pre-tax loss for 1996 was $1.9 million, which included an
increase in interest income to $1.2 million, compared to pre-tax income of
$278,000 for 1995, which included interest income of $896,000. In 1996, a one-
time income tax benefit of $1.7 million was recognized. Until the fourth quarter
of 1996, there was substantial doubt whether the Company would be able to
realize the benefits of its loss carry-forward. In recognition of this doubt,
the Company had provided a full valuation allowance for the net deferred tax
assets. With the Company receiving approval from the FDA in September 1996 to
market the BAK Interbody Fusion System in the United States, the Company
determined that the realization of the net deferred tax assets would be more
likely than not. As a result, in the fourth quarter of 1996 the Company reversed
the valuation allowance and recognized an income tax benefit of $1.7 million, or
$.17 per share. This one-time event resulted in the Company recording a net loss
of $247,000 for 1996 compared to net income of $268,000 in 1995. The 1996 loss
before recognition of the $1.7 million income tax benefit was $1.9 million.
1995 COMPARED TO 1994
YEARS ENDED DECEMBER 31, 1995, AND
DECEMBER 31, 1994
Net sales increased to $7.5 million for 1995 compared to $4.4 million for
1994
9
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS CONT'D
reflecting primarily increased sales of the BAK Interbody Fusion System to Smith
& Nephew for international distribution and sales of the BAK/C and Cervi-Lok
implants (which were introduced in 1995). Sales of BAK devices to Smith & Nephew
accounted for 61 percent of the Company's net sales in 1995. Domestic sales of
BAK implants remained relatively constant between 1994 and 1995, reflecting the
continuation of clinical trials. International sales of the BAK/C and Cervi-Lok
products were approximately $500,000 for 1995. Domestically, BAK/C and Cervi-Lok
sales increased to approximately $300,000.
Gross profit increased to $5.0 million for 1995 from $3.1 million in 1994.
This increase is directly related to the increase in net sales in 1995 versus
1994. As a percentage of net sales, gross profit decreased to 66.9 percent in
1995 from 69.8 percent in 1994, due primarily to variations in prices paid by
the Company to outside vendors for the manufacture of implants and instruments
and because of the costs associated with the introduction of new products.
Total operating expenses increased to $5.6 million for 1995 compared to
$3.7 million for 1994. Sales and marketing expenses increased to $1.6 million
for 1995 from $1.0 million for 1994, but decreased as a percentage of net sales
to 20.8 percent in 1995 compared to 21.9 percent in 1995. Increased expenses
related primarily to the addition of personnel to support increased domestic and
international sales activities. General and administrative expenses increased to
$2.5 million for 1995 from $1.5 million for 1994, but decreased as a percentage
of net sales to 33.1 percent in 1995 from 33.9 percent in 1994. Increased
expenses resulted primarily from the Company's preparation for FDA approval of
the BAK and the addition of personnel to support the increased levels of sales
and corporate activities. Research and development expenses increased to $1.6
million in 1995 from $1.2 million in 1994. Research and development expenses
declined as a percentage of net sales to 21.2 percent in 1995 from 27.3 percent
in 1994. The increase in the amount of these expenses reflects the hiring of
additional development engineers and payment to outside contractors for
prototype development projects and the increase in clinical study activity.
The Company's operating loss remained relatively constant at $600,000;
however, the Company had net income of $268,000 in 1995 compared to a loss of
$379,000 in 1994, due primarily to an increase in interest income to $896,000 in
1995 from $168,000 in 1994, due to a higher level of cash available for short-
term investments resulting from the Company's initial public offering which was
completed in June 1995.
LIQUIDITY AND CAPITAL RESOURCES
In June 1995, the Company successfully completed its initial public
offering of 3,225,000 shares of newly issued Common Stock. After selling
expenses, the Company received proceeds of just over $26 million from the
offering. The Company expects to use these proceeds for working capital
requirements, funding of clinical trials, expansion of research and development
and sales and marketing activities, and other general corporate purposes. In
November 1995, the Company used a portion of these proceeds to acquire and
relocate to a new facility, and to renovate such new facility. During 1996, the
Company used approximately $12.2 million for operating activities and for
capital asset acquisitions. Of this amount, $5.2 million was used to increase
inventory, $1.2 million was due to an increase in accounts receivable, and
SPINE-TECH 1996 ANNUAL REPORT
10
<PAGE>
$4.7 million was used to renovate the new facility and purchase equipment. Also
during 1996 approximately $600,000 was provided by proceeds from the exercise of
stock options and the purchase of Common Stock pursuant to the Employee Stock
Purchase Plan.
Cash and cash equivalents are invested in U.S. government obligations and
corporate debt securities. Securities totaling $9.6 million and $3.5 million
will mature during 1997 and 1998, respectively. During the first half of 1997,
the Company expects to continue to use cash and cash equivalents to fund working
capital needs associated with continued building of inventory and financing of
accounts receivable associated with product sales. The Company may also use a
portion of its available capital resources to acquire or license technology,
products or businesses related to the Company's current business, although no
such acquisitions or licenses are currently being negotiated or planned. During
the second half of 1997, the Company expects, based upon existing operations, to
begin generating cash resources from operations. The Company believes that its
currently available cash and cash equivalents, combined with additional cash
flow from operations, will be adequate to finance ongoing operations for the
foreseeable future.
The Company's future liquidity and capital requirements will depend on
numerous factors, including FDA regulatory actions and continued domestic and
international sales of its entire product line.
FORWARD-LOOKING STATEMENTS
Certain statements made above in Management's Discussion and Analysis and
elsewhere in the Annual Report, which are summarized below, are forward-looking
statements that inherently involve risks and uncertainties. Actual results may
be materially different. Factors that could cause actual results to differ
include the following:
INCREASE IN REVENUES AND EARNINGS - General market conditions and
competitive conditions within the market for the Company's products; acceptance
by spine surgeons and other medical professionals; absence of adverse patient
outcomes; continued intellectual property protection; development of direct
internal sales force; development, acceptance and regulatory approval of the
Company's new products and procedures; the entrance of additional competitors
into the market.
INCREASED TRAINING OF MEDICAL PROFESSIONALS - Continued acceptance of the
BAK system by spine surgeons and other medical professionals; absence of adverse
patient outcomes; continued acceptance by patients and payors; marketing efforts
by competitors.
INCREASED INTERNATIONAL SALES - Establishment of a network of independent
distributors for the international market; obtaining necessary foreign
regulatory approvals and acceptance by foreign spine surgeons and other medical
professionals; absence of adverse patient outcomes; continued acceptance by
patients and payors; continued intellectual property protection in foreign
markets.
FDA APPROVAL OF LAPAROSCOPIC PROCEDURES - Approval by the FDA of these
procedures in line with the Company's projected timetable.
ADEQUATE FUNDING - Unanticipated events or circumstances may alter the
Company's capital requirements, including demand for the Company's products;
general market and competitive conditions within the market for the Company's
products; potential adverse patient outcomes; potential litigation relating to
protection of the Company's intellectual property; development, acceptance and
regulatory approval of the Company's new products and procedures.
11
<PAGE>
SPINE-TECH, INC. BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996 1995
- ------------------------------------------------------------------------------------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 1,724 $ 1,171
Short-term investments 9,674 22,416
Accounts receivable, less allowances
of $187--1996; $158--1995 3,151 1,957
Inventories 6,982 1,822
Deferred tax asset 2,155 --
Interest receivable 221 228
Prepaid expenses 146 58
-----------------------------
Total current assets 24,053 27,652
Property, plant and equipment:
Land 438 438
Building, furniture and fixtures 5,317 1,429
Equipment 1,087 388
-----------------------------
6,842 2,255
Accumulated depreciation (373) (196)
-----------------------------
6,469 2,059
Investments 3,536 2,956
-----------------------------
Total assets $34,058 $32,667
-----------------------------
-----------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 567 $ 233
Accrued clinical payments 42 330
Accrued royalties 365 199
Accrued commissions 337 16
Other accrued expenses 101 84
-----------------------------
Total current liabilities 1,412 862
Shareholders' equity:
Preferred Stock, par value $.01 per share:
Authorized shares--300,000
Issued and outstanding shares:
1996--none; 1995--none -- --
Common Stock, par value $.01 per share:
Authorized shares--15,000,000
Issued and outstanding shares:
1996--9,939,055; 1995--9,653,252 99 96
Additional paid-in capital 35,109 34,024
Accumulated deficit (2,562) (2,315)
-----------------------------
Total shareholders' equity 32,646 31,805
-----------------------------
Total liabilities and shareholders' equity $34,058 $32,667
-----------------------------
-----------------------------
</TABLE>
See accompanying notes.
SPINE-TECH 1996 ANNUAL REPORT
12
<PAGE>
STATEMENTS OF OPERATIONS SPINE-TECH, INC
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net sales $ 10,153 $ 7,517 $ 4,398
Cost of goods sold 2,849 2,488 1,330
----------------------------------------------
Gross profit 7,304 5,029 3,068
Operating expenses:
Sales and marketing 5,387 1,563 962
General and administrative 3,294 2,487 1,491
Research and development 1,777 1,597 1,202
----------------------------------------------
Total operating expenses 10,458 5,647 3,655
Other operating income:
Exclusive distribution agreement fee -- -- 40
----------------------------------------------
Operating loss (3,154) (618) (547)
Interest income 1,223 896 168
----------------------------------------------
(Loss) income before income taxes (1,931) 278 (379)
Income tax (benefit) expense 1,684) 10 --
----------------------------------------------
Net (loss) income $ (247) $ 268 $ (379)
----------------------------------------------
----------------------------------------------
Net (loss) income per share:
Primary $ (.02) $ .04 $ (.18)
Fully diluted $ (.02) $ .03 $ (.06)
Weighted average number of shares outstanding:
Primary 9,831,733 7,261,466 2,465,398
Fully diluted 9,831,733 9,641,751 6,600,630
</TABLE>
SEE ACCOMPANYING NOTES.
13
<PAGE>
SPINE-TECH, INC STATEMENT OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
CONVERTIBLE ADDITIONAL ACCUM-
PREFERRED STOCK COMMON STOCK PAID-IN ULATED
(IN THOUSANDS) SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 2,757 $27 2,070 $21 $ 7,241 $(1,999) $ 5,290
Exercise of stock option in
April 1994 -- -- 30 -- 30 -- 30
Value of stock options issued for
research and development in
process -- -- -- -- 42 -- 42
Net loss -- -- -- -- -- (379) (379)
--------------------------------------------------------------------------------------
Balance at December 31, 1994 2,757 27 2,100 21 7,313 (2,378) 4,983
Issuance of Common Stock for
consulting services in January
1995 -- -- 8 -- 27 -- 27
Value of stock options issued for
consulting services in March 1995 -- -- -- -- 24 -- 24
Exercise of stock options -- -- 91 1 109 -- 110
Issuance of Common Stock, net of
offering expense -- -- 3,225 32 26,361 -- 26,393
Conversion of Preferred Stock in
July 1995 (2,757) (27) 4,135 41 (14) -- --
Exercise of warrants in
October 1995 -- -- 94 1 204 (205) --
Net income -- -- -- -- -- 268 268
--------------------------------------------------------------------------------------
Balance at December 31, 1995 -- -- 9,653 96 34,024 (2,315) 31,805
Shares purchased for Employee
Stock Purchase Plan -- -- 1 -- 22 -- 22
Tax benefit of stock options -- -- -- -- 471 -- 471
Exercise of stock options -- -- 285 3 592 -- 595
Net loss -- -- -- -- -- (247) (247)
--------------------------------------------------------------------------------------
Balance at December 31, 1996 -- $-- 9,939 $99 $35,109 $(2,562) $32,646
--------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
SPINE-TECH 1996 ANNUAL REPORT
14
<PAGE>
STATEMENTS OF CASH FLOWS SPINE-TECH, INC
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
(IN THOUSANDS) 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating activities:
Net income (loss) $ (247) $ 268 $ (379)
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Depreciation 215 103 72
Common Stock and stock options issued for
services provided -- 51 42
Deferred tax benefit (1,684) -- --
Loss on sale of equipment 31 -- --
Changes in operating assets and liabilities:
Accounts receivable (1,194) (1,254) (292)
Inventories (5,160) (906) (567)
Interest receivable 7 (228) --
Prepaid expenses (88) (4) (51)
Accounts payable and accrued expenses 550 296 (99)
--------------------------------------------
Net cash used in operating activities (7,570) (1,674) (1,274)
Investing activities:
Purchases of property, plant and equipment (4,656) (1,866) (225)
Purchase of investments (41,320) (22,211) (3,161)
Proceeds from sales and maturities of investments 53,482 -- --
--------------------------------------------
Net cash provided by (used in) investing activities 7,506 (24,077) (3,386)
Financing activities:
Proceeds from sale of Common Stock 22 26,393 30
Proceeds from exercise of stock options 595 110 --
--------------------------------------------
Net cash provided by financing activities 617 26,503 30
--------------------------------------------
Increase (decrease) in cash and cash equivalents 553 752 (4,630)
Cash and cash equivalents at beginning of year 1,171 419 5,049
--------------------------------------------
Cash and cash equivalents at end of year $ 1,724 $ 1,171 $ 419
--------------------------------------------
--------------------------------------------
</TABLE>
See accompanying notes.
15
<PAGE>
SPINE-TECH, INC. NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS
The Company designs, develops, manufactures and sells spinal implant
devices and instruments which facilitate the minimally invasive surgical
treatment of degenerative diseases. The Company's primary products, the BAK-
Lumbar, BAK-Cervical and BAK-Thoracic Interbody Fusion Systems and the Cervi-Lok
System are designed to surgically treat spinal instability which can cause
chronic, disabling back pain. The Company has, or has licensed, several patents
and is currently developing additional instruments and techniques for use in
spinal surgery. In the United States and internationally, customers consist of
hospitals and medical centers.
2. SUMMARY OF ACCOUNTING POLICIES
REVENUE RECOGNITION
Revenue is recognized for domestic sales when implants or instruments are
shipped to a hospital or medical center based upon a purchase order number
generated by the hospital or medical center.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from the estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments which are available
immediately or upon a one-day notice to be cash equivalents. This includes all
demand deposits, savings and money market accounts.
MARKETABLE SECURITIES
Short-term investments include all purchased U.S. government obligations
and corporate debt securities with maturities of less than one year. Investments
with a remaining maturity of more than one year are classified as long-term
investments. Management determines the appropriate classification of debt and
equity securities at the time of purchase and reevaluates such designation as of
each balance sheet date. Debt securities are classified as held-to-maturity
because the Company has the positive intent and ability to hold such securities
to maturity. Investments are stated at amortized cost, which approximates market
value. Interest on securities is included in interest income.
INVENTORIES
Inventories are valued at the lower of cost, first-in, first-out (FIFO)
method, or market. As a medical device company, inventories are maintained and
costed by lot. Inventory cost elements consist of:
RAW MATERIALS - primarily packaging and labeling materials for implants
WORK-IN-PROCESS - outside manufacturing costs for implants and instruments
which have not been released into finished goods
FINISHED GOODS-IMPLANTS - outside manufacturing costs, packaging materials
and sterilization costs
FINISHED GOODS-INSTRUMENTS - outside manufacturing costs
PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. Depreciation and amortization
expense is recognized on the straight-line basis over lives ranging from 5-20
years.
SPINE-TECH 1996 ANNUAL REPORT
16
<PAGE>
INCOME TAXES
The Company accounts for income taxes using the liability method. Deferred
income taxes are provided for temporary differences between the financial
reporting and tax bases of assets and liabilities.
NET INCOME (LOSS) PER COMMON SHARE
Income (loss) per common share for the years ended December 31, 1996, 1995
and 1994 is computed using the weighted average number of shares of Common Stock
and Common Stock equivalents, if dilutive, outstanding during the periods
presented. Additionally, for 1994 and for the first quarter of 1995, pursuant to
the rules of the Securities and Exchange Commission, Common Stock issued by the
Company at prices less than the initial public offering price during the 12
months immediately preceding the initial public offering, plus stock options
granted at exercise prices less than the initial public offering price during
the same period, have been included in the calculation of shares used in the
calculation of net income (loss) per share as if they were outstanding for all
periods prior to the initial public offering. The fully diluted loss per share
is presented using the "if converted" method and reflects the impact of the
conversion of the Preferred Stock to Common Stock at the beginning of the
earliest period presented or at the date of issuance, if later.
STOCK-BASED COMPENSATION
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation," but applies Accounting Principles Board Opinion No. 25 (APB 25)
and related interpretations in accounting for its plans. Under APB 25, when the
exercise price of employee stock options equals the market price of the
underlying stock on the date of grant, no compensation expense is recognized.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company will record impairment losses on long-lived assets used in
operations when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
RECLASSIFICATION
Certain prior year items have been reclassified to conform with the 1996
presentation.
3. INVESTMENTS
The amortized cost and estimated market value of investments are as
follows:
<TABLE>
<CAPTION>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED MARKET
COST GAINS LOSSES VALUE
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
As of December 31, 1996:
U.S. government obligations $ 3,525,974 $ 7,691 $ -- $ 3,533,665
Corporate debt securities 6,022,928 -- 66,288 5,956,640
Commercial paper 3,660,794 15,059 -- 3,675,853
----------------------------------------------------------------
$13,209,696 $ 22,750 $66,288 $13,166,158
----------------------------------------------------------------
----------------------------------------------------------------
As of December 31, 1995:
U.S. government obligations $ 4,000,110 $ -- $ 149 $ 3,999,961
Corporate debt securities 6,102,249 -- 22,163 6,080,086
Commercial paper 15,269,432 142,661 -- 15,412,093
---------------------------------------------------------------
$25,371,791 $142,661 $22,312 $25,492,140
---------------------------------------------------------------
---------------------------------------------------------------
</TABLE>
17
<PAGE>
NOTES TO FINANCIAL STATEMENTS CONT'D
The amortized cost and estimated fair market value of investments at
December 31st by contractual maturity are shown below.
<TABLE>
<CAPTION>
1996 1995
----------------------------------------------------------------------
ESTIMATED ESTIMATED
AMORTIZED MARKET AMORTIZED MARKET
COST VALUE COST VALUE
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Due in one year or less $ 9,674,222 $ 9,645,727 $22,416,043 $22,545,909
Due after one year through two years 3,535,474 3,520,431 2,955,748 2,946,231
--------------------------------------------------------------------
$13,209,696 $13,166,158 $25,371,791 $25,492,140
--------------------------------------------------------------------
--------------------------------------------------------------------
</TABLE>
4. INVENTORIES
Inventories consist of the following:
DECEMBER 31,
1996 1995
- ---------------------------------------------------------------------------
Raw materials $ 38,653 $ 18,423
Work-in-process 1,285,133 213,202
Finished goods 5,657,986 1,589,934
---------------------------------
$6,981,772 $1,821,559
---------------------------------
At December 31, 1996, finished goods were comprised of $4,184,117 of final
product implants and instruments, $1,233,117 of consigned implants and
instruments, and $240,752 of instruments used in the training facility.
5. LINE OF CREDIT
The Company has a line of credit arrangement that allows it to borrow up to
$500,000. Any borrowings under this agreement bear interest at the prime rate
plus 1 1/2 percent. Borrowings under the facility are limited to 75 percent of
eligible domestic accounts receivable. The agreement contains certain financial
and operational covenants. At December 31, 1996, the Company had no
outstanding balance on the line of credit.
6. SHAREHOLDERS' EQUITY
On April 7, 1995, the Board of Directors increased the authorized shares of
Common Stock from 10,000,000 to 15,000,000 and approved a 3-for-2 stock split of
the Common Stock to be effected in the form of a stock dividend, payable to
shareholders of record as of April 21, 1995. Accordingly, all share, per share,
weighted average share, and stock option information has been restated to
reflect the split.
The Company completed an initial public offering of Common Stock in 1995 in
which it sold 3,225,000 shares of Common Stock, resulting in net proceeds to the
Company of $26,391,000.
At the time of the initial public offering, all outstanding Convertible
Preferred Stock was converted into 4,135,232 shares of Common Stock on a one-
for-one and one-half share basis.
In connection with the sale of series of Convertible Preferred Stock in
1992, the Company issued warrants to purchase 71,067 shares of Series B
Convertible Preferred Stock at $3.25 per share. The warrants were exercised in a
cashless transaction in October 1995.
SHAREHOLDER RIGHTS PLAN
In 1996, the Company's Board of Directors adopted a Shareholder Rights Plan
by declaring a dividend of one preferred share purchase right (the "Right") for
each outstanding share of Common Stock. Under certain circumstances, a Right may
be exercised to purchase one one-hundredth of a share of Series A Junior
Preferred Stock for $150. The rights become exercisable if a person or group
acquires 20 percent or more of the
SPINE-TECH 1996 ANNUAL REPORT
18
<PAGE>
Company's outstanding Common Stock, subject to certain exceptions, or announces
an offer which would result in such person or group acquiring 20 percent or more
of the Company's outstanding Common Stock. If a person or group acquires 20
percent or more of the Company's outstanding Common Stock, subject to certain
exceptions, each right will entitle its holder to buy Common Stock of the
Company having a market value of twice the exercise price of the Right. The
Rights expire in 2006 and may be redeemed by the Company for $.01 per Right at
any timebefore, or, in certain circumstances, within 20 days (subject to
extension) following, the announcement that a person has acquired 20 percent or
more of the Company's outstanding Common Stock. Until a Right is exercised, the
holder of a Right, as such, has no rights as a shareholder of the Company.
In connection with the adoption of the Shareholder Rights Plan, the Company
authorized 300,000 shares of Series A Junior Participating Preferred Stock (the
"Preferred Stock"). Holders of the Preferred Stock are entitled to quarterly
dividends in the amount of $1.00 or one hundred times the aggregate per share
amount of dividends paid to Common Stock shareholders, whichever is greater.
Each Preferred Stock share is entitled to one hundred votes on all matters
submitted to a vote of the shareholders of the Company. The Preferred Stock has
liquidation preference over the Company's Common Stock. The liquidation rate on
the Preferred Stock is the greater of $100 per share or an amount one hundred
times greater than the amount distributed to the Common Stock shareholders.
7. STOCK PURCHASE AND OPTION PLANS
STOCK PURCHASE PLAN
The Company has an employee stock purchase plan under which the sale of
500,000 shares of its Common Stock has been authorized. The purchase price of
the shares under the plan is the lesser of 85 percent of the fair market value
on the first or last day of the offering period. Offering periods are three
months each. Employees may designate up to 10 percent of their compensation for
the purchase of stock.
STOCK OPTION PLANS
Under the Company's stock option plans, the Company may grant employees,
Directors and consultants options to purchase Common Stock of the Company. Such
options are generally granted at the fair market value on date of grant and vest
over four years.
The Company also has options outstanding to Smith & Nephew Richards Inc.
("Smith & Nephew"), pursuant to certain preemptive rights, to purchase an
aggregate of 51,788 shares of Common Stock at exercise prices of $3.27 to $9.00
per share. These options were valued at the fair market value of the stock on
the date of grant and generally vest over a four-year period.
The following table summarizes the options to purchase shares of the
Company's stock option plans:
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS CONT'D
<TABLE>
<CAPTION>
WEIGHTED
SHARES NON-PLAN AVERAGE
AVAILABLE OPTIONS OPTIONS EXERCISE PRICE
FOR GRANT OUTSTANDING OUTSTANDING PER SHARE
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at December 31, 1993 89,250 1,253,250 -- $ 1.20
Shares reserved 645,000 -- -- --
Granted (601,950) 601,950 38,981 3.28
Became exercisable -- -- -- --
Exercised -- (30,000) -- 1.00
Canceled 45,000 (45,000) -- 1.00
----------------------------------------------------
Balance at December 31, 1994 177,300 1,780,200 38,981 1.90
Granted (173,950) 173,950 12,807 10.42
Became exercisable -- -- --
Exercised -- (91,000) -- 1.21
Canceled 55,750 (55,750) -- 5.00
---------------------------------------------------
Balance at December 31, 1995 59,100 1,807,400 51,7880 2.65
Shares reserved 500,000 -- -- --
Granted (558,200) 558,200 -- 24.08
Became exercisable -- -- -- --
Exercised -- (284,875) -- 2.09
Canceled 30,400 (30,400) -- 12.50
--------------------------------------------------
Balance at December 31, 1996 31,300 2,050,325 51,788 $ 8.41
--------------------------------------------------
--------------------------------------------------
</TABLE>
The following table summarizes information about stock options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------------------------------------------------------
RANGE OF NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
EXERCISE OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
PRICES DECEMBER 31, 1996 CONTRACTUAL LIFE PRICE DECEMBER 31, 1996 EXERCISE PRICE
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ .34 to 1.67 738,250 5 years $ 0.96 738,250 $ .96
2.17 to 3.67 672,425 7 years 3.10 401,750 3.01
9.00 to 15.00 52,250 9 years 11.42 17,750 10.78
15.25 to 22.50 230,450 9.5 years 20.94 23,337 18.93
22.75 to 30.00 356,950 10 years 25.38 2,084 26.50
----------- -----------------------------------------------------
2,050,325 $ 8.41 1,183,171 $ 2.20
----------- ------------------------------------------------------
----------- ------------------------------------------------------
</TABLE>
The weighted-average fair value of options granted during the years ended
December 31, 1996 and 1995 were $13.33 and $5.20, respectively.
PRO FORMA DISCLOSURES
Pro forma information regarding net income and earnings per share is
required by Statement 123, and has been determined as if the Company had
accounted for its employee stock options under the fair value method of
the Statement. The fair value for these options was estimated at the date of the
grant using a Black-Scholes option pricing model with the following weighted
average assumptions for 1996 and 1995, respectively: risk free interest rates
of 5 1/2 percent; dividend yield of 0 percent; volatility factors of the
expected market price of the Company's stock of .582 and .517; and a
weighted-average expected life of the option of five years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models
SPINE-TECH 1996 ANNUAL REPORT
20
<PAGE>
require the input of highly subjective assumptions including the expected stock
price volatility. Because the Company's employee stock options have
characteristics significantly different than those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in management's opinion, the existing models do not
necessarily provide a reliable single measure of the fair value of its employee
stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information follows:
DECEMBER 31,
1996 1995
- ------------------------------------------------------------------------
Pro forma net (loss) income
(in thousands) $(866) $204
Pro forma (loss) income per share:
Primary (.09) .03
Fully diluted (.09) .02
NOTE: THE PRO FORMA EFFECT ON NET INCOME FOR 1996 AND 1995 IS NOT
REPRESENTATIVE OF THE PRO FORMA EFFECT ON NET INCOME IN FUTURE YEARS BECAUSE
IT DOES NOT TAKE INTO CONSIDERATION PRO FORMA COMPENSATION EXPENSE RELATED TO
GRANTS MADE PRIOR TO 1995.
8. LEASES
The Company leased its administrative facilities under an operating lease
through December 1995 and furniture and fixtures under operating leases through
June 1996. Total rent expense was $46,143, $80,006 and $80,791 in 1996, 1995 and
1994, respectively.
9. INCOME TAXES
The Company has operating loss carryforwards for income tax purposes
expiring at various times through 2011 of approximately $2,872,000 at December
31, 1996, which can be used to offset future earnings.
Until the fourth quarter of 1996, there was substantial doubt that the
Company would be able to realize the benefits of its net deferred tax assets. In
recognition of this doubt, the Company had provided a full valuation allowance
for the net deferred tax assets. In September 1996, the Company obtained FDA
approval of its BAK Interbody Fusion System, which caused the Company to
consider the realization of the net deferred tax assets to be more likely than
not. As a result, in the fourth quarter of 1996, the Company reversed the
valuation allowance and recorded an income tax benefit of $1,684,000 or $.17 per
share.
Components of deferred tax assets and
liabilities are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss
carryforwards $1,106,000 $ 608,000
Tax benefit of stock options 471,000 --
Inventory capitalization
and reserves 387,000 224,000
Research and development
credits 194,000 159,000
Other 36,000 10,000
- --------------------------------------------------------------------------------------------
Total deferred tax assets 2,194,000 1,001,000
Deferred tax liabilities:
Depreciation and amortization (39,000) (29,000)
- -------------------------------------------------------------------------------------------
Net deferred tax assets 2,155,000 972,000
Valuation allowance -- (972,000)
- -------------------------------------------------------------------------------------------
Total deferred tax assets $2,155,000 $ --
- -------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------
</TABLE>
Income tax expense consists of:
<TABLE>
<CAPTION>
1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ -- $ -- $ --
State -- -- --
Alternative
minimum tax -- 10,000 --
Deferred:
Federal (629,000) -- --
State (83,000) -- --
Change in valu-
ation allowance (972,000) -- --
---------------------------------------------------------------
$(1,684,000) $10,000 $ --
--------------------------------------------------------------
</TABLE>
21
<PAGE>
NOTES TO FINANCIAL STATEMENTS CONT'D
Reconciliation of the statutory federal income tax rate to the Company's
effective tax rate follows:
1996 1995 1994
- ----------------------------------------------------------------------------
Tax at statutory rate 34.0% 34.0% 34.0%
State income taxes 4.5 6.5 6.5
Alternative minimum tax -- 1.0 --
Impact of net operating
loss carryforward (38.5) (39.5) (40.5)
Change in valuation
allowance (87.2) -- --
------------------------------------------
(87.2)% 2.0% --
------------------------------------------
------------------------------------------
10. DISTRIBUTION AGREEMENT
In September 1993, the Company entered into an exclusive distribution
agreement for the Spine-Tech BAK Lumbar Interbody Fusion System with Smith &
Nephew for which the Company received a non-refundable fee of $1,000,000. The
agreement grants Smith & Nephew sales exclusivity for the BAK-Lumbar product
in all countries in the world other than the United States. Included in
accounts receivable at December 31, 1996 and 1995 is $26,560 and $1,314,700,
respectively, reflecting purchases of BAK Systems by Smith & Nephew. The
agreement was terminated in February 1996 as certain minimum annual purchase
requirements were not met.
11. LICENSE AGREEMENTS
During 1992, the Company entered into a license agreement with Dr. Gary
Michelson and an affiliated company, Karlin Technology, Inc. ("Karlin"), as the
owners of certain patents and patent applications relating to threaded
cylindrical spinal implants (the "Karlin Technology"), the technology which is
the basis of the Company's BAK system. Pursuant to the license agreement, the
Company has a co-exclusive worldwide license during the life of the patent to
make, use or sell products covered by the Karlin Technology.
During 1994, the Company entered into license agreements relating to the
development of the BAK/C system, the Cervi-Lok System, and a set of minimally
invasive hand-held dissectomy techniques and instruments. In connection with
these license agreements, the Company granted options to purchase 90,000 shares
of the Company's Common Stock at prices of $2.67 to $3.27 per share. In
addition, the Company will pay royalties under some of these agreements based
upon a percentage of net sales under these agreements. The Company determined
the value of the technology associated with these license agreements to be
$42,500 and expensed the entire amount as research and development in-process
during 1994.
12. SIGNIFICANT CUSTOMERS
Sales to Smith & Nephew, consisting entirely of export sales, accounted for
$354,302, $4,670,595 and $1,813,000 or 3 percent, 61 percent and 41 percent of
net sales for the years ended December 31, 1996, 1995 and 1994, respectively. In
1994, the Company had sales to a domestic customer which accounted for $474,000,
or 11 percent of net sales.
13. LEGAL PROCEEDINGS
In 1994, the Company was served with a lawsuit related to its license of the
Karlin Technology. The suit alleged various causes of action concerning Dr.
Michelson's and Karlin's (the plaintiffs) right to co-license the Karlin
Technology to a third party, including tortious interference with prospective
and contractual business relationships, unfair competition and breach of
contract, and requested various types of relief, including money damages,
injunctive relief and declaratory judgment. In February 1996, a final judgment
was entered in favor of the Company regarding the lawsuit related to this
license. The plaintiffs have appealed the decision.
SPINE-TECH 1996 ANNUAL REPORT
22
<PAGE>
In June 1995, the Company received a purported notice of termination of the
license agreement with respect to the Karlin Technology. The Company has
commenced non-binding arbitration against the plaintiffs concerning the
termination of the license agreement. The plaintiffs have taken the position in
the arbitration that they do not intend to seek to enforce the purported
termination; however, they have also contended that they may in the future
terminate the license agreement if the royalty reports are determined to have
been inadequate.
In February 1996, the Company filed a lawsuit which seeks a declaratory
judgment concerning the respective rights of the Company and the plaintiffs on a
patent issued to the Company in 1996. Procedural hearings and discovery continue
in this case.
In August 1996, the plaintiffs commenced non-binding arbitration to seek
purported unpaid royalties and damages for failure to give Dr. Michelson
credit as the inventor for certain surgical methods used or claimed to be
invented by the Company.
Arbitration is pending and no hearing date has been set.
In December 1996, the plaintiffs served the Company with an additional
lawsuit related to the 1996 patent and license agreement referred to above. The
suit alleges that Dr. Michelson is the inventor of the Company patent and
requests various types of relief including money damages, punitive damages and
declaratory judgment. The Company has not yet responded to the Complaint and
expects to vigorously contest the action both on procedural and substantive
grounds.
It is not possible at this time to estimate the loss, if any, the Company
will incur with regards to the legal proceedings, and thus the Company has not
established a reserve for the outcome of the proceedings.
AUDITOR'S REPORT
REPORT OF INDEPENDENT AUDITORS
To the Shareholders
Spine-Tech, Inc.
We have audited the accompanying balance sheets of Spine-Tech, Inc. as of
December 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 December 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 Spine-Tech, Inc. at December
31, 1996 and 1995, and the results of its operations and cash flows for each of
the three years in the period ended December 31, 1996, in conformity with
generally accepted accounting principles.
/s/ Ernst & Young LLP
Minneapolis, Minnesota
February 7, 1997
23
<PAGE>
CORPORATE INFORMATION
EXECUTIVE OFFICERS
DAVID W. STASSEN
Chief Executive Officer and President
KEITH M. EASTMAN
Chief Financial Officer and Secretary
RICHARD C. JANSEN
Vice President, Regulatory and Clinical Affairs
DOUGLAS W. KOHRS
Vice President, Research and Product
Development
TED K. SCHWARZROCK
Vice President, Sales and Marketing
DAVID L. SHAW
Vice President, Manufacturing Operations
DIRECTORS
KENNETH W. ANSTEY
President and Chief Executive Officer
Bio-field Corporation
(medical technology company)
ROBERT J. DEPASQUA(1, 2)
Private Investor
STEPHEN D. KUSLICH, M.D.
Orthopaedic Surgeon
Medical Director of the Company
JAMES F. LYONS(1, 2)
Chairman of the Board of Directors
Biovascular, Inc.
(medical technology company)
DAVID W. Stassen
Chief Executive Officer and President
1 Member of the Compensation Committee
2 Member of the Audit Committee
SHAREHOLDER INFORMATION
STOCK LISTING
The Company's Common Stock trades on the Nasdaq National Market tier of the
Nasdaq Stock Market under the symbol: SPYN.
TRANSFER AGENT AND REGISTRAR
Norwest Bank Minnesota, N.A.
Stock Transfer Department
161 North Concord Exchange
P.O. Box 738
South St. Paul, Minnesota 55075-0738
FORM 10-K
A copy of the Company's annual report on Form 10-K as filed with the Securities
and Exchange Commission is available free of charge by writing to Keith M.
Eastman at the Company (see Investor Inquiries).
ANNUAL MEETING
The annual meeting of Spine-Tech shareholders will
be held May 8, 1997, at 3:30 p.m. at Minneapolis
Marriot Southwest, 5801 Opus Parkway, Minnetonka, Minnesota 55343. All
shareholders and other
interested parties are invited to attend.
INVESTOR INQUIRIES
Please direct all inquiries to: Keith M. Eastman,
Chief Financial Officer, Spine-Tech, Inc., 7375 Bush Lake Road, Minneapolis,
Minnesota 55439-2029.
Phone: (612) 832-5600
STOCK INFORMATION
High and low quarterly closing prices for
Spine-Tech, Inc., Common Stock as quoted on
the Nasdaq Stock Market were:
1996 1995
High Low High Low
- ------------------------------------------------------------------------------
First Quarter $27 3/8 $21 1/4 $-- $ --
Second Quarter $34 $23 3/4 $11 $ 9
Third Quarter $28 3/8 $18 11/16 $16 7/8 $ 9 7/8
Fourth Quarter $28 3/4 $23 $23 1/4 $ 15
Public trading of the Company's Common Stock commenced June 23, 1995, the
effective date of the initial public offering.
There were 238 common shareholders of record as of December 31, 1996. The
Company has not paid any stock dividends on its Common Stock since its
inception, and management does not anticipate paying cash dividends in the
foreseeable future.
SPINE-TECH 1996 ANNUAL REPORT
24
<PAGE>
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Annual Report (Form 10-K)
of Spine-Tech, Inc. of our report dated February 7, 1997, included in the
1996 Annual Report to Shareholders of Spine-Tech, Inc.
Our audits also included the financial statement schedule of Spine-Tech, Inc.
listed in Item 14(a). This schedule is the responsibility of the Company's
management. Our responsibility is to express an opinion based on our audits.
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 set forth therein.
We also consent to the incorporation by reference in the Registration
Statement on Form S-8 (No. 33-99048) pertaining to the 1994 Spine-Tech, Inc.
Stock Option Plan, the Spine-Tech, Inc. Non-Employee Director Stock Option
Plan and the Spine-Tech, Inc. 1991 Stock Option Plan and Registration
Statement on Form S-8 (No. 333-07349) pertaining to the 1996 Omnibus Stock
Plan, of our report dated February 7, 1997, with respect to the financial
statements incorporated herein by reference, and our report included in the
preceding paragraph with respect to the financial statement schedule included
in this Annual Report (Form 10-K) of Spine-Tech, Inc.
/s/ Ernst & Young LLP
-------------------------
Ernst & Young LLP
Minneapolis, Minnesota
March 26, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
BALANCE SHEET AND STATEMENT OF OPERATIONS OF SPINE-TECH, INC. FOR THE
TWELVE MONTHS ENDED DECEMBER 31, 1996, AND IS QUALIFIED IN ITS ENTIRETY
BY REFERENCE TO SUCH FINANCIAL STATMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 1724
<SECURITIES> 13210
<RECEIVABLES> 3338
<ALLOWANCES> 187
<INVENTORY> 6982
<CURRENT-ASSETS> 24053
<PP&E> 6842
<DEPRECIATION> 373
<TOTAL-ASSETS> 34058
<CURRENT-LIABILITIES> 1412
<BONDS> 0
0
0
<COMMON> 99
<OTHER-SE> 32547
<TOTAL-LIABILITY-AND-EQUITY> 34058
<SALES> 10153
<TOTAL-REVENUES> 10153
<CGS> 2849
<TOTAL-COSTS> 2849
<OTHER-EXPENSES> 10458
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> (1931)
<INCOME-TAX> (1684)
<INCOME-CONTINUING> (247)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (247)
<EPS-PRIMARY> (.02)
<EPS-DILUTED> (.02)
</TABLE>
