<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996.
Commission file number: 0-28448
GENERAL SURGICAL INNOVATIONS, INC.
(Exact name of Registrant as specified in its charter)
CALIFORNIA 97-3170244
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3172A PORTER DRIVE, PALO ALTO, CALIFORNIA 94304
(Address of principal executive offices)
Registrant's telephone number, including area code: (415) 812-9730
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
There were 13,172,765 shares of Registrant's Common Stock issued and outstanding
as of November 1, 1996.
________________________________
<PAGE>
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed, consolidated balance sheets at
September 30, 1996 (unaudited) and
June 30, 1996............................... 3
Condensed, consolidated statements of
operations for the three months ended
September 30, 1996 (unaudited) and
September 30, 1995.......................... 4
Condensed, consolidated statements of cash
flows for the three months ended
September 30, 1996 (unaudited) and
September 30, 1995.......................... 5
Notes to condensed, consolidated financial
statements.................................. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of
Operations.............................. 8
PART II. OTHER INFORMATION
<PAGE>
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
Condensed, Consolidated Balance Sheets
(In thousands, except share amounts)
<TABLE>
<CAPTION>
September 30, June 30,
1996 1996
------------- ------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 20,441 $ 28,339
Available-for-sale securities 29,377 21,451
Accounts receivable, net of allowance for doubtful accounts
of $50 on September 30, 1996 and $78 on June 30, 1996 678 873
Inventories 890 700
Prepaid expenses and other current assets 229 438
------------- ------------
Total current assets 51,615 51,801
Property and equipment, net 669 702
Intangible and other assets, net 247 264
------------- ------------
Total assets $ 52,531 $ 52,767
============= ============
Liabilities, Convertible Redeemable Preferred Stock and Shareholders' Equity (Deficit)
Current liabilities:
Accounts payable $ 478 $ 614
Accrued liabilities 996 892
Bank borrowings 127 127
Deferred revenue 66 100
------------- ------------
Total current liabilities 1,667 1,733
Bank borrowings, less current portion 331 360
Deferred revenue, less current portion - -
Other long-term liabilities 200 200
------------- ------------
Total liabilities 2,198 2,293
Convertible redeemable preferred stock, $.001 par value:
Authorized: 6,123,867 shares: issued and outstanding,
no shares at September 30, 1996 and no shares at June 30, 1996 - -
------------- ------------
Shareholders' equity (deficit):
Preferred stock, $.001 par value:
Authorized: 2,000,000 shares; none issued and outstanding:
Common stock, $.001 par value:
Authorized: 50,000,000 shares; issued and outstanding:
13,161,723 in Q1 1997 and 13,132,903 in 1996 13 13
Additional paid in capital 64,932 64,885
Notes receivable from shareholders (123) (112)
Deferred compensation, net (446) (496)
Unrealized gain/(loss) on available-for-sale securities 3 1
Accumulated deficit (14,046) (13,817)
------------- ------------
Total shareholders' equity (deficit) 50,333 50,474
------------- ------------
$ 52,531 $ 52,767
============= ============
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
3
<PAGE>
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
----------------------------
1996 1995
---------- ---------
<S> <C> <C>
Sales $ 2,470 $ 491
Cost of Sales 993 334
----------- ----------
Gross Profit 1,477 157
----------- ----------
Operating Expenses:
Research and development 462 202
Sales and marketing 1,108 755
General and administrative 723 311
----------- ----------
Total operating expenses 2,293 1,268
----------- ----------
Operating loss (816) (1,111)
Interest and other income (expense) 587 63
----------- ----------
Net loss $ (229) $ (1,048)
----------- ----------
----------- ----------
Net loss per share $ (0.02) $ (0.16)
----------- ----------
----------- ----------
Shares used in computing net loss per share 13,146,816 6,553,482
----------- ----------
----------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
4
<PAGE>
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Three Months Ended
September 30,
-------------------------
1996 1995
---------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income/loss $ (229) $(1,046)
Adjustments to reconcile net income/loss to net cash used by operating activities:
Amortization of deferred compensation 50 -
Depreciation and amortization 104 73
Loss on write-off of fixed assets 26 -
Provision for uncollectable accounts (28) 17
Provision for excess and obsolete inventory - 40
Changes in operating assets and liabilities:
Accounts receivable 223 (188)
Inventory (190) (138)
Prepaid expenses and other current assets 209 -
Intangible and other assets - -
Accounts payable (137) (71)
Accrued liabilities 104 153
Deferred revenue (33) (33)
Other long-term liabilities - (200)
---------- ---------
Net cash used in operating activities 98 (1,394)
---------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities (7,924) -
Acquisition of property and equipment (78) (72)
---------- ---------
Net cash used in investing activities (8,002) (72)
---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Issuance of common stock for notes receivable (11) -
Payments on obligations under capital leases and capital loans (29) (22)
Proceeds from issuance of common stock, net of issuance costs 47 -
---------- ---------
Net cash provided by financing activities 7 (22)
---------- ---------
Net decrease in cash and cash equivalents (7,897) (1,488)
Cash and cash equivalents, beginning of period 28,339 4,541
---------- ---------
Cash and cash equivalents, end of period $20,441 $ 3,053
---------- ---------
---------- ---------
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 10 $ 8
---------- ---------
---------- ---------
Taxes $ - $ -
---------- ---------
---------- ---------
NONCASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock for notes receivable $ (11) $ -
---------- ---------
---------- ---------
Accumulated unrealized gain on available-for-sale securities $ (2) $ -
---------- ---------
---------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART
OF THESE CONSOLIDATED FINANCIAL STATEMENTS.
5
<PAGE>
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements as of
September 30, 1996 of General Surgical Innovations, Inc. (the "Company") have
been prepared in accordance with generally accepted accounting principles for
interim financial information and pursuant to the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management,
all adjustments, consisting of normal recurring accruals, considered
necessary for a fair presentation have been included. Operating results for
the three month period ended September 30, 1996 are not necessarily
indicative of the results that may be expected for the fiscal year ended June
30, 1997.
These financial statements and notes should be read in conjunction
with the Company's audited financial statements and footnotes thereto
included in the Registrant Company and Subsidiaries' Annual Report on Form
10-K for the fiscal year ended June 30, 1996.
2. NET LOSS PER SHARE:
The net loss per share is computed using the weighted average number
of shares of Common Stock outstanding for all periods presented. Common
equivalent shares from stock options and convertible redeemable preferred
stock are excluded from the computation as their effect is anti-dilutive,
except that, pursuant to the Securities and Exchange Commission Staff
Accounting Bulletin No. 83, common and common equivalent shares issued during
the period beginning twelve months prior to the initial filing of the
Company's initial public offering at prices substantially below the initial
public offering price have been included in the calculation as if they were
outstanding for all periods presented (using the treasury stock method and
the assumed initial public offering price).
3. RECENT PRONOUNCEMENTS:
6
<PAGE>
In March 1995, the Financial Accounting Standards Board issued Statement
No. 121 ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF (SFAS No. 121) which requires the Company to review
for impairment long-lived assets and intangibles whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. In certain situations, an impairment loss would be recognized.
SFAS 121 will become effective for the Company's 1997 fiscal year. The
Company has studied the implications of the statement, and based on its
initial evaluation, does not expect it to have a material impact on the
Company's financial condition or results of operations. In October 1995, the
Financial Accounting Standards Board issued Statement No. 123 ACCOUNTING FOR
STOCK-BASED COMPENSATION (SFAS No. 123), which establishes a fair value based
method of accounting for stock-based compensation plans and requires
additional disclosures for those companies that elect not to adopt the new
method of accounting. While the Company studies the impact of the
pronouncement, it continues to account for employees' stock options under APB
Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123 will
be effective for the Company's 1997 fiscal year.
4. Inventories:
Inventories comprise:
SEPTEMBER 30,
-------------
1996 1995
----- -----
(in thousands)
Raw Materials................... $ 554 $ 244
Work in progress................ 153 67
Finished goods.................. 183 208
----- -----
$ 890 $ 519
===== =====
5. Subsequent Event:
On November 13, 1996, the Company and United States Surgical Corporation
(USSC) entered into an early termination of the USSC distribution agreement
by mutual agreement.
7
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
unaudited condensed, consolidated financial statements and notes thereto
included in part I, Item I of this Quarterly Report and with Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K dated June 30, 1996.
Except for the historical information contained in this Quarterly
Report on Form 10-Q, the matters discussed herein are forward-looking
statements that are subject to certain risks and uncertainties that could
cause the actual results to differ materially from those projected. Factors
that could cause actual results to differ materially include, but are not
limited to, the timing of orders and shipments, the termination of the
Company's distributorship agreement with United Stated Surgical Corporation
("USSC") (described below), the status of the Company's relationship with
Ethicon-Endo Surgery, Inc. ("EES") or other corporate partners, the Company's
ability to manage growth and possible transition to EES and other new
corporate partnering relationships, the timely development and market
acceptance of new products and surgical procedures, the impact of competitive
products and pricing, results of ongoing litigation, the Company's ability to
further expand into international markets, approval of its products by
government agencies such as the United States Food and Drug Administration,
public policy relating to health care reform in the United States and other
countries, and other risks detailed below and included from time to time in
the Company's other SEC reports and press releases, copies of which are
available from the Company upon request. The Company assumes no obligation to
update any forward-looking statements contained herein. In addition, the
factors listed below under "Additional Factors that May Affect Future
Results," as well as other factors, could in the future affect the Company's
actual results and could cause the Company's results for future quarters to
differ materially from those expressed in any forward-looking statements
contained in the following discussion.
References made in this Quarterly Report on Form 10-Q to "General
Surgical Innovations, Inc.," the "Company" or the "Registrant" refer to
General Surgical Innovations, Inc. and its subsidiaries. The following
General Surgical Innovations, Inc. trademarks are mentioned in this Quarterly
Report: Spacemaker -Registered Trademark-, registered trademark of the
Company; and Knotmaker -TM-, trademark of the Company.
Overview
Since its inception in April 1992, GSI has been engaged in the
development, manufacturing and marketing of balloon dissection systems and
related minimally invasive surgical instruments. The Company began commercial
sales of its balloon dissection systems for hernia repair in September 1993.
To date, the Company has received from the FDA four 510(k) clearances for use
of the Company's technology to perform dissection of tissue planes anywhere
in the body using a broad range of balloon sizes and shapes. The Company
currently sells products in the United States and certain other countries in
Europe, Asia and South America for selected applications, such as hernia
repair, saphenous endoscopic perforator surgery and breast augmentation and
reconstruction surgery.
In March 1994, the Company entered into a distribution agreement with
United States Surgical Corporation (USSC) providing USSC with limited
exclusive rights to distribute the Company's balloon dissection systems in
the hernia repair market in both the United States and certain international
countries, pursuant to which USSC was obligated to purchase minimum
quantities of the Company's products. Substantially all of the Company's
revenues have been derived from sales to USSC, which have included sales to
Autosuture, Inc., a
8
<PAGE>
subsidiary of USSC, with USSC representing approximately 75% and 92% of the
Company's total net revenues for fiscal 1995 and 1996, respectively, and 93%
for the first quarter of fiscal 1997. On November 12, 1996, the Company and
USSC entered into an early termination of this distributorship agreement by
mutual agreement. Sales outside of the United States accounted for
approximately 3%, 4% and 0.5% of the Company's sales in fiscal 1995, fiscal
1996, and the first quarter of fiscal 1997, respectively, and the Company
expects that international sales will represent an increasing portion of
revenue in the future. The Company has recorded all sales to USSC as domestic
sales; however, sales of the Company's products by USSC have included sales
to European and other foreign countries, made through Autosuture. The
Company's sales to USSC have fluctuated significantly in the past, and, as a
result of the mutual termination of the USSC distributorship and possible
transition to EES (as described below), the Company anticipates that such
sales will fluctuate in the future. In addition, USSC may have built up its
inventory of GSI balloon dissector products. The early termination of the
USSC distributorship agreement could have a material adverse effect on the
Company's business, financial condition and results of operations. See
"Factors Affecting Future Results-- Dependence Upon Key Distributor; Limited
Marketing and Direct Sales Experience."
The Company also entered into a license and distribution agreement (the
"EES Agreement") with Ethicon-Endo Surgery, Inc. ("EES") in the fourth
quarter of its fiscal year 1996 under which the Company has the right to
manufacture EES baloon dissectors for EES and EES has the right to market its
balloon dissection system in the laparoscopic hernia and stress urinary
incontinence ("SUI") repair markets. As contemplated by the original EES
Agreement, the parties are currently in the process of negotiating an
amendment of the EES Agreement, to expand the license to include exclusivity
for GSI products in the field of hernia repair and SUI. The parties expect
jointly to develop and market a dissector for SUI repair in early calendar
1997. No manufacturing or distribution of products has occurred to date
pursuant to the EES Agreement, and there can be no assurance that such
manufacturing or distribution efforts will be successful, or that the parties
will satisfactorily conclude such an expansion of the EES Agreement. Failure
to successfully complete an expanded agreement could have a material adverse
effect on the business, financial condition and/or results of operations of
the Company.
Additional sales in the United States are currently made through a small
direct sales force. The Company currently sells its products in international
9
<PAGE>
markets through a limited number of distributors who resell to surgeons and
hospitals. The Company plans to increase its direct sales force in the United
States and may seek to establish a direct sales force in one or more other
countries in the future. Any increase in the Company's direct sales force
will require significant expenditures and additional management resources.
There can be no assurance that any such direct sales force, if established,
will be successful.
To date, all of the sales to USSC and other distributors and almost all
of the sales by the Company's direct sales force have been for use in hernia
repair procedures. While the Company has developed balloon dissection systems
for other applications, sales of products for hernia repair are expected to
provide a majority of the Company's revenues at least through fiscal 1997.
There can be no assurance that the Company will be successful in generating
sales of such products for any other applications.
The Company has acquired a significant number of patent rights from third
parties, including rights that apply to the Company's current balloon
dissection systems. The Company has historically paid and is obligated to pay
in the future to such third parties royalties equal to 4% of sales of such
products, which payments are expected to exceed certain minimum royalty
payments due under agreements with such parties. The Company has also
acquired patent rights under royalty-bearing agreements with respect to
certain surgical instruments, including the KnotMaker product and the balloon
valve trocar currently under development.
In February 1996, the Company acquired Adjacent Surgical, Inc., a
company engaged in the development of balloon dissection systems for use in
vascular applications. The transaction resulted in a one-time expense related
to in-process research and development of approximately $2.8 million in the
quarter ended March 31, 1996. From time to time, the Company has had
discussions with third parties regarding various strategic relationships,
including the potential sale of the Company, although the Company currently
has no commitments with respect to any such relationships. The Company may
continue to have discussions regarding potential strategic relationships in
the future.
10
<PAGE>
However, there can be no assurance that any such strategic
relationship will occur.
The Company has a limited history of operations and has experienced
significant operating losses since inception. The Company expects such
operating losses to continue at least through calendar 1996. The increase in
the Company's sales to date has been due to demand for the Company's balloon
dissector systems principally for hernia repair. In order to support
increased levels of sales in the future and to augment its long-term
competitive position, including the development of balloon dissection systems
for other applications, the Company anticipates that it will be required to
make significant additional expenditures in manufacturing, research and
development (including marketing-related clinical evaluations), sales and
marketing and administration. In addition, the Company anticipates higher
administration expenses resulting from its obligations as a public reporting
company.
The Company anticipates that its results of operations will fluctuate for
the foreseeable future because of several factors, including the early
termination by mutual agreement of the Company's relationship with USSC, the
status of the Company's relationship with and possible transition to EES and
other partners, the mix of sales among the distributors and the Company's
direct sales force, timing of new product introductions or transitions to new
products, the margins recognized from products for various surgical
procedures, the progress of marketing-related clinical evaluations, the
introduction of competitive products (including pricing pressures),
activities related to patents and patent approvals (including litigation) and
regulatory and third-party reimbursement matters, the Company's ability to
manufacture its products efficiently, and the timing of research and
development expenses (including marketing-related clinical evaluations). In
addition, the Company's results of operations could be affected by the timing
of orders from distributors, expansion of the Company's distributor network,
the ability of the Company's distributors to promote effectively the
Company's products and the ability of the Company to quickly and cost
effectively increase its direct domestic sales force. The Company's limited
operating history makes accurate prediction of future operating results
difficult or impossible. Although the
11
<PAGE>
Company has experienced sales growth in recent periods, there can be no
assurance that, in the future, the Company will sustain sales growth or gain
profitability on a quarterly or annual basis or that its growth will be
consistent with predictions made by securities analysts.
The Company currently manufactures and ships product shortly after the
receipt of orders, and anticipates that it will do so in the future.
Accordingly, the Company has not developed a significant backlog and does not
anticipate that it will develop a material backlog in the future.
RESULTS OF OPERATIONS
SALES. Sales increased by 403% to approximately $2,470,000 for the
quarter ended September 30,1996 from $491,000 for the same period in 1995.
This increase was due primarily to the growth in unit sales of the Spacemaker
I platform to USSC for the hernia market and, to a lesser extent, from sales
of the Spacemaker II platform, which was introduced in October 1995.
Approximately $300,000 of revenue during the first quarter of fiscal 1997
was not recognized as a result of disagreements between the Company and USSC
regarding USSC's purchase obligations under the USSC distributorship
agreement. As the Company begins its transition to EES and other corporate
partners, the Company believes that its sales results will fluctuate from
quarter to quarter during at least the next several quarters.
COST OF SALES. Cost of sales increased by 197% to approximately $993,000
for the quarter ended September 30, 1996 from $334,000 for the same period in
1995, and decreased as a percentage of sales to 40% in the quarter ended
September 30, 1996 from 68% in the quarter ended September 30, 1995. This
increase in absolute dollars was primarily a result of the costs of
additional manufacturing capacity and personnel necessary to support
increased sales volume, which was offset by leveraging certain fixed overhead
expenses across a higher base of sales.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses,
which include expenditures for marketing-related clinical evaluations and
regulatory expenses, increased by 128% to $462,000 in the quarter ended
September 30, 1996 from $202,000 for the
12
<PAGE>
quarter ended September 30, 1995 and decreased as a percentage of sales to
17% in the quarter ended September 30, 1996 period from 41% in the quarter
ended September 30, 1995 as a result of higher sales volume in the 1996
period. The Company expects research and development expenses to increase in
absolute dollars as the Company pursues development of new products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 72% to $1.8 million for the quarter
ended September 30, 1996 from $1.1 million for the quarter ended September
30, 1995. This increase was primarily due to the growth of a direct sales
force in the United States and the growth in marketing and other personnel
associated with the Company's higher levels of operations. The Company
expects selling, general and administrative expenses to continue to increase
in absolute dollars as the Company's level of sales and manufacturing
operations increases and as the Company increases its finance and
administrative expenditures to meet its obligations as a public reporting
company.
INTEREST AND OTHER INCOME/(EXPENSE). Interest and other
income/(expense) increased to $587,000 for the quarter ended September 30,
1996 from $63,000 for the quarter ended September 30, 1995 because of higher
average cash, cash equivalents and available-for-sale securities balances.
Interest earned in the future will depend on Company funding cycles and
prevailing interest rates.
NET LOSS. The Company had a net loss of approximately $229,000 for the
quarter ended September 30, 1996 compared to a net loss of $1.0 million for
the quarter ended September 30, 1995. The Company expects to continue to
incur losses through at least calander year 1996.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's cash expenditures have significantly
exceeded its sales, resulting in an accumulated deficit of $14 million at
September 30, 1996. The Company has funded its operations primarily through
the sale of equity securities. From its
13
<PAGE>
inception through September 30, 1996 the Company raised approximately $15.2
million through the private placement of equity securities and approximately
$46.9 million (net of underwriting discounts and commissions) in an initial
public offering.
As of September 30, 1996 the Company's principal source of liquidity
consists of cash, cash equivalents and short-term investments of $49.8
million.
The Company expects to incur substantial additional costs, including
costs related to increased sales and marketing activities, increased research
and development, expenditures in connection with seeking regulatory approvals
and conducting additional marketing-related clinical evaluations, capital
equipment and other costs associated with expansion of the Company's
manufacturing capabilities and higher administration costs resulting from its
obligations as a public reporting company. While the Company believes that
its current cash balances and short-term investments along with cash
generated from the future sales of products will be sufficient to meet the
Company's operating and capital requirements through calendar 1997, there can
be no assurance that the Company will not require additional financing within
this time frame. The Company may seek additional equity or debt financing to
address its working capital needs or to provide funding for capital
expenditures. There can be no assurance that additional financing, if
required, will be available on satisfactory terms or at all.
FACTORS AFFECTING FUTURE RESULTS
LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company was
organized in April 1992 and began commercially shipping its first Spacemaker
products in September 1993. Accordingly, the Company has only a limited
operating history upon which an evaluation of the Company and its prospects
can be based. As of September 30, 1996, the Company had an accumulated
deficit of $14 million. The Company's operating net losses for the quarter
ended September 30, 1996 and the fiscal years ending June 30, 1994, 1995 and
1996 were $229,000, $3.1 million, $4.1 million and $5.5 million,
respectively. The Company expects to continue to incur significant operating
losses on a
14
<PAGE>
quarterly and annual basis. Since the introduction of its initial products,
the Company has yet to achieve profitability and may never do so in the
future. Due to the Company's limited operating history, there can be no
assurance of sales growth or profitability on a quarterly or annual basis in
the future. The Company intends to increase significantly its investments in
research and development, sales and marketing, marketing-related clinical
evaluations and related infrastructure. Due to the anticipated increases in
the Company's operating expenses, the Company's operating results will be
adversely affected if sales do not increase. The Company's prospects must be
considered in light of the risks, expenses and difficulties frequently
encountered by companies in their early stage of development, particularly
companies in rapidly evolving markets. To address these risks, the Company
must respond to competitive developments, continue to attract, retain and
motivate qualified persons and successfully commercialize products
incorporating advanced technologies. There can be no assurance that the
Company will be successful in addressing such risks.
DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL
OBSOLESCENCE. All of the Company's sales since inception have been derived
from sales of its balloon dissection products, with a substantial portion
derived from sales for hernia repair procedures. Failure of the Company to
develop successfully and commercialize balloon dissection products for
applications other than hernia repair could have a material adverse effect on
the Company's business, financial condition and results of operations. The
success of the Company's products depends on the nature of the technological
advances inherent in the product designs, reductions in patient trauma or
other benefits provided by such products, results of marketing-related
clinical evaluations, continued adoption of MIS procedures by surgeons,
market acceptance of the Company's products and related procedures,
reimbursement for the Company's products by health care payors and the
Company's receipt of regulatory approvals. There can be no assurance that the
Company's products will have the required technical
15
<PAGE>
characteristics, that the Company's products will provide adequate patient
benefits, that marketing-related clinical evaluations results will be
favorable, that surgeons will continue to adopt MIS procedures, that
recently-introduced products or future products of the Company or related
procedures will gain market acceptance, or that required regulatory approvals
will be obtained. The failure to achieve any of the foregoing could have a
material adverse effect on the Company's business, financial condition and
results of operations. To the extent demand for the Company's balloon
dissection systems for hernia repair declines and the Company's
newly-introduced products are not commercially accepted or its existing
products are not developed for new procedures, there could be a material
adverse effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
DEPENDENCE ON KEY DISTRIBUTOR. In March 1994, the Company entered into a
distribution agreement with United States Surgical Corporation ("USSC"), a
large manufacturer and distributor of medical devices. Pursuant to this
agreement USSC had rights, which were co-exclusive with the rights of GSI, to
distribute the Spacemaker I product for hernia repair and, to the extent
permitted by the Company's initial 510(k) clearance for the Spacemaker I
product, other applications. USSC's distribution rights were limited to only
those products that are or could be covered by the Company's initial 510(k)
clearance. On November 12, 1996, the two parties, by mutual agreement,
entered into an early termination of this distributorship agreement. USSC
historically purchased substantially more product than was required under
this agreement. In fiscal 1995 and 1996, sales to USSC, which have included
sales to Autosuture, Inc., a subsidiary of USSC, represented approximately
75% and 92%, respectively, of the Company's net sales. The Company's sales to
USSC have fluctuated in the past and as the Company begins its transition to
EES, the Company expects that sales will continue to fluctuate for at least
the next several quarters.
16
<PAGE>
Approximately $300,000 of revenue during the first quarter of fiscal 1997 was
not recognized as a result of disagreements between the Company and USSC
regarding USSC's purchase obligations under the USSC distributorship
agreement. This early termination of the agreement with USSC could have a
material adverse effect on the Company's business, financial condition and
results of operations.
In June 1996, the Company signed an agreement with Ethicon
Endo-Surgery, Inc. ("EES") under which the Company can manufacture EES
balloon dissectors for EES, and EES has the right to market its balloon
tissue dissection system in the laparoscopic hernia repair market. As
contemplated by the original EES Agreement, the parties are currently in the
process of negotiating an expansion of the EES Agreement in order to expand
the license to include exclusivity for GSI products in the field of hernia
repair and SUI. The parties expect jointly to develop and market a dissector
for SUI repair in early calendar 1997. No manufacture or distribution of
products has occurred to date pursuant to the EES Agreement, and there can be
no assurance that efforts to do so will be successful, or that the parties
will successfully conclude an expansion of the EES Agreement. Although the
Company intends to establish additional distributorships in the United States
for products in areas other than hernia repair and SUI, there can be no
assurance that such efforts will be successful. Failure to diversify its
distribution network in the United States could have a material adverse
effect on the Company's business, financial condition and results of
operations.
To date, substantially all of the Company's international sales for
hernia repair procedures have been made through Autosuture under the same
terms and conditions as the Company's agreement with USSC. Although the
Company may in the future seek to diversify its international distribution
network, there can be no assurance that such efforts will be
17
<PAGE>
successful. Failure to diversify its international distribution network and
the termination of the relationship with USSC and Autosuture could have a
material adverse effect on the Company's business, financial condition and
results of operations.
LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only
limited experience marketing and selling its products through its direct
sales force, and has sold its products in commercial quantities through its
direct sales force only to the hernia market and, to a lesser degree, to the
cosmetic and reconstructive surgery market. Establishing marketing and sales
capability sufficient to support sales in commercial quantities for the other
markets targeted by the Company, including additional hernia, vascular,
urology, obstetrics, gynecology and orthopedic surgery markets, will require
significant resources, and there can be no assurance that the Company will be
able to recruit and retain additional qualified marketing personnel, or
direct sales personnel or that future sales efforts of the Company will be
successful. In markets where there is a large potential customer base, the
Company intends to establish partnership relationships with additional
distribution partners. The Company has no significant relationships other
than with Ethicon Endo-Surgery, Inc. and there can be no assurance that the
Company will be successful in establishing such partnership relationships on
commercially reasonable terms, if at all. The failure to establish and
maintain an effective distribution channel for the Company's products, or
establish and retain qualified and effective sales personnel to support
commercial sales of the Company's products, could have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE.
The Company's success is substantially dependent upon the success of its
Spacemaker balloon dissection products. The Company believes that market
acceptance of the Company's
18
<PAGE>
products will depend on the Company's ability to provide evidence to the
medical community of the safety, efficacy and cost-effectiveness of its
products and the procedures in which these products are intended to be used.
Market acceptance is also dependent on the adoption of laparoscopic
techniques generally and the conversion of non-balloon dissection techniques
to balloon dissection techniques specifically. To date, the Company's
products have only been used to treat a limited number of patients and the
Company has limited long-term outcomes data. If the Company is not able to
demonstrate consistent clinical benefits resulting from the use of its
products (including reduced procedure time, reduced patient trauma and lower
costs), the Company's business, financial condition and results of operations
could be materially and adversely affected.
The Company further believes that the ability of health care providers
to obtain adequate reimbursement for procedures using the Company's
Spacemaker balloon dissector products and related instruments will be
critical to market acceptance of the Company's products. Although the Company
believes that procedures using its balloon dissection products currently may
be reimbursed in the United States under certain existing procedure codes,
there can be no assurance that such procedure codes will remain available or
that reimbursement under these codes will be adequate. The Company has
limited experience in obtaining third-party reimbursement, and the inability
to obtain reimbursement for some or all of its products could have a material
adverse effect on the Company's business, financial condition and results of
operations.
The Company introduced its balloon dissectors in late 1993 and to date
there has been relatively little education among surgeons about the benefits
of balloon dissection technology. Furthermore, because of the novelty of
balloon dissection procedures, many surgeons and surgeons' assistants have
not developed the requisite skills to perform balloon dissection procedures.
To the extent that laparoscopic techniques are adopted slowly, that balloon
dissectors are incorporated into laparoscopic techniques less often or that
surgeons are unwilling or unable to develop the skills necessary to utilize
balloon dissectors, the
19
<PAGE>
Company's business, financial condition and results of operations could be
materially adversely affected.
FLUCTUATIONS IN QUARTERLY RESULTS. Results of the Company's operations
may fluctuate significantly from quarter to quarter and will depend on (i)
new product introductions by the Company and its competitors and the
resulting product transitions, (ii) the effect of the termination of the
Company's relationship with USSC, (iii) the status of the Company's
relationship with EES, (iv) the rate of adoption by surgeons of balloon
dissection technology in markets targeted by the Company, (v) the sales
efforts of the Company's distributors, (vi) the mix of sales among
distributors and the Company's direct sales force, (vii) timing of patent and
regulatory approvals, (viii) timing of operating expenditures, (ix) the
Company's ability to manufacture its products efficiently, (x) timing of
research and development expenses, including marketing-related clinical
evaluation expenditures, (xi) intellectual property litigation and (xii)
general market conditions. The Company's sales in any period have been highly
dependent upon the marketing efforts and success of USSC. The Company's sales
to USSC have fluctuated significantly in the past, and, as a result of the
mutual termination of the USSC distributorship and possible transition to
EES, the Company anticipates that such sales will fluctuate in the future.
For example, approximately $300,000 of revenue during the first quarter of
fiscal 1997 was not recognized as a result of disagreements between the
Company and USSC regarding USSC's purchase obligations under the USSC
distributorship agreement. This early termination of the agreement could
result in a decline in sales and adversely affect the Company's operating
results. The Company also recently entered into a license and distribution
agreement (the "EES Agreement") with Ethicon Endo-Surgery, Inc. ("EES") under
which the Company can manufacture balloon dissectors for EES and EES has the
right to market its balloon dissection system in the laparoscopic hernia
repair market. As contemplated by the original EES Agreement, the parties are
currently in the process of negotiating an expansion of the EES Agreement in
order to expand the license to include exclusivity for GSI products in the
field of hernia repair and SUI. The parties expect to jointly develop and
market a dissector for SUI repair in early calendar 1997. No manufacture or
distribution of products has occurred to date pursuant to the EES Agreement,
and there can be no assurance that efforts to do so will be successful or
that the expansion of the EES Agreement will be successfully concluded. In
addition, announcements or expected announcements by
20
<PAGE>
the Company, its competitors or its distributors of new products, new
technologies or pricing changes could cause existing or potential customers
of the Company to defer purchases of the Company's existing products and
could alter the mix of products sold by the Company, which could have a
material adverse effect on the Company's business, financial condition and
results of operations. There can be no assurance that future products or
product enhancements will be successfully introduced or that such
introductions will not adversely affect the demand for existing products. As
a result of these and other factors, the Company's quarterly operating
results have fluctuated in the past, and the Company expects that such
results may fluctuate in the future. Due to such quarterly fluctuations in
operating results, quarter-to-quarter comparisons of the Company's operating
results are not necessarily meaningful and should not be relied upon as
indicators of likely future performance or annual operating results. In
addition, the Company's limited operating history makes accurate prediction
of future operating results difficult or impossible to make. There can be no
assurance that in the future the Company will achieve sales growth or become
profitable on a quarterly or annual basis or that its growth will be
consistent with predictions by securities analysts and investors. In such
event, the price of the Company's Common Stock would likely be materially and
adversely affected. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's success
will depend on its ability to obtain patent protection for its products and
processes, to preserve its trade secrets and proprietary technology and to
operate without infringing upon the patents or proprietary rights of third
parties. As of June 30, 1996, GSI had 16 United States patents issued, and
had applied for an additional 45 United States patents, four of which had
been allowed. In addition, GSI had two foreign patents issued, and 17 still
in prosecution as of such date. In May 1996, the Company was issued a United
States patent
21
<PAGE>
that contains claims regarding the use of balloons to dissect tissue planes
anywhere in the body.
In May 1996, the Guidant Corporation unit of Origin MedSystems, Inc.
filed an action against GSI in the U.S. District Court for the Northern
District of California, alleging patent infringement of its patent entitled
"Apparatus and Method for Peritoneal Retraction". GSI subsequently filed an
action against Origin Medsystems, Inc. in the U.S. District Court for the
Northern District of California alleging patent infringement of its patent
for a method of tissue plane dissection using balloon systems. A decision
against the Company in either of these actions could have a material adverse
effect on the Company's business, financial condition or results of
operations. The validity and breadth of claims in medical technology patents
involve complex legal and factual questions and, therefore, are highly
uncertain. No assurance can be given that any patents based on pending patent
applications or any future patent applications will be issued, that the scope
of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents or patents to
which it has licensed rights will be held valid if subsequently challenged or
that others will not claim rights in or ownership of the patents and other
proprietary rights held or licensed by the Company or that the Company's
existing patents will cover the Company's future products. Furthermore, there
can be no assurance that others have not developed or will not develop
similar products, duplicate any of the Company's products or design around
any patents issued to or licensed by the Company or that may be issued in the
future to the Company. Since patent applications in the United States are
maintained in secrecy until patents issue, the Company also cannot be certain
that others did not first file applications for inventions covered by the
Company's pending patent applications, nor can the Company be certain that it
will not infringe any patents that may issue to others on such applications.
One of the patent applications filed by the Company, which is directed
to a surgical method using balloon dissection technology, has been placed in
interference with a patent application filed by Origin
22
<PAGE>
Medsystems, Inc. ("Origin"), a competitor of the Company. The Company
believes that the inventor named in its patent application was the first to
invent this subject matter, and has asserted that the Origin patent
application was filed after a disclosure made by such inventor to employees
of Origin. Origin takes a contrary position. This interference is presently
pending in the United States Patent and Trademark Office ("USPTO") and, as
permitted by the rules of the USPTO, has been referred to an arbitrator for
completion of the interference proceeding. A decision is not expected in this
interference proceeding until 1997. Failure of the Company to prevail in such
interference proceeding could have a material adverse effect on the Company's
business, financial condition and results of operations.
Patent interference or infringement involves complex legal and factual
issues and is highly uncertain, and there can be no assurance that any
conclusion reached by the Company regarding patent interference or
infringement will be consistent with the resolution of such issue by a court.
In the event the Company's products are found to infringe patents held by
competitors, there can be no assurance that the Company will be able to
modify successfully its products to avoid infringement, or that any modified
products will be commercially successful. Failure in such event to either
develop a commercially successful alternative or obtain a license to such
patent on commercially reasonable terms could have a material adverse effect
on the Company's business, financial condition and results of operations. In
any event, there can be no assurance that the Company will not be required to
defend itself in court against allegations of infringement of third-party
patents. Patent litigation is expensive, requires extensive management time,
and could subject the Company to significant liabilities, require disputed
rights to be licensed from third parties or require the Company to cease
selling its products.
Legislation has recently been enacted in Congress, the effect of which is
to immunize physicians and their employers from liability for patent
infringement for alleged infringement of patent claims directed to medical
procedures.
23
<PAGE>
In addition, the patent laws of European and certain other
foreign countries generally do not allow for the issuance of patents for
methods of surgery on the human body. Accordingly, the ability of the Company
to gain patent protection for its methods of tissue dissection will be
significantly limited. As a result, there can be no assurance that the
Company will be able to develop a patent portfolio in Europe or that the
scope of any patent protection will provide competitive advantages to the
Company.
ROYALTY PAYMENT OBLIGATIONS. The Company has acquired a significant
number of patent rights from third parties, including rights that apply to
the Company's current balloon dissection systems. The Company has
historically paid and is obligated to pay in the future to such third parties
royalties equal to 4% of sales of such products, which payments are expected
to exceed minimum royalty payments due under agreements with such parties.
The Company also has acquired patent rights under royalty-bearing agreements
with respect to certain surgical instruments, including the KnotMaker product
and the balloon valve trocar currently under development. The payment of such
royalty amounts will have an adverse impact on the Company's gross profit and
other results of operations. There can be no assurance that the Company will
be able to continue to satisfy such royalty payment obligations in the
future, and a failure to do so could have a material adverse effect on the
Company's business, financial condition and results of operations.
EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY
TO MANAGE GROWTH. The Company began commercial sales of its balloon
dissection products in September 1993 and, as a result, has limited
experience in manufacturing, marketing and
24
<PAGE>
selling its products commercially. The Company has recently experienced rapid
growth in its facilities and the number of its employees, the number of
products under development, the number and amount of products manufactured
and sold, and the geographic scope of its sales. In order to support
increased levels of sales in the future and to augment its long-term
competitive position, the Company anticipates that it will be required to
make significant additional expenditures in manufacturing, research and
development, sales and marketing, and administration. The Company's
acquisition of Adjacent Surgical, Inc. in February 1996 has resulted in
additional demands on the Company's limited management resources. The
Company's inability to manage its growth effectively could have a material
adverse effect on the Company's business, financial condition and results of
operations.
COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in the
market for medical devices used in tissue dissection surgical procedures is
intense and is expected to increase. The Company competes primarily with
other producers of MIS tissue dissection instruments. Origin, a subsidiary of
Guidant Corporation, and others, currently compete against the Company in the
development, production and marketing of MIS tissue dissection instruments
and tissue dissection technology. To the extent that surgeons elect to use
open surgical procedures rather than MIS, the Company also competes with
producers of tissue dissection instruments used in open surgical procedures,
such as blunt dissectors or graspers. A number of companies currently compete
against the Company in the development, production and marketing of tissue
dissection instruments and technology for open surgical procedures. In
addition, the Company indirectly competes with producers of therapeutic
drugs, when such drugs are used as an alternative to surgery. Many of the
Company's competitors have substantially greater capital resources, name
recognition, expertise in research and development, manufacturing and
marketing and obtaining regulatory approvals. There can be no assurance that
the Company's competitors will not succeed in developing balloon dissectors
or competing technologies that are more effective than products
25
<PAGE>
marketed by the Company or that render the Company's technology obsolete.
Additionally, even if the Company's products provide performance comparable
to competing products or procedures, there can be no assurance that the
Company will be able to obtain necessary regulatory approvals or compete
against competitors in terms of price, manufacturing, marketing and sales.
Many of the alternative treatments for medical indications that can be
treated by balloon dissection products and laparoscopic surgery are widely
accepted in the medical community and have a long history of use. In
addition, technological advances with other therapies could make such other
therapies more effective or cost-effective than balloon dissectors and
minimally invasive surgery, and could render the Company's technology
non-competitive or obsolete. There can be no assurance that surgeons will use
MIS to replace or supplement established treatments or that MIS will remain
competitive with current or future treatments. The failure of surgeons to
adopt MIS could have a material adverse effect on the Company's business,
financial condition and results of operations.
In addition to the Company's focus on the development of its balloon
dissection systems, the Company has also developed surgical instruments for
use in MIS. There can be no assurance that the Company's surgical instruments
will successfully compete with those manufactured by other producers of such
surgical instruments. The failure to achieve commercial market acceptance of
such surgical instruments could have a material adverse effect on the
Company's business, financial condition and results of operations.
UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT. The Company's
success will depend upon the ability of surgeons to obtain satisfactory
reimbursement from healthcare payors for the Company's products. In the
United States, hospitals, physicians and other healthcare providers that
purchase medical devices generally rely on third-party payors, such as
private health insurance plans, to reimburse all or part of the costs
associated with the treatment of
26
<PAGE>
patients. Reimbursement in the United States for the Company's balloon
dissection products is currently available from most third-party payors,
including most major private health care insurance plans and Medicaid, under
existing surgical procedure codes. The Company does not expect that
third-party reimbursement in the United States will be available for use of
its other products unless and until clearance or approval is received from
the federal Food and Drug Administration (the "FDA"). If FDA clearance or
approval is received, third-party reimbursement for these products will
depend upon decisions by individual health maintenance organizations, private
insurers and other payors. Many payors, including the federal Medicare
program, pay a preset amount for the surgical facility component of a
surgical procedure. This amount typically includes medical devices such as
the Company's. Thus, the surgical facility or surgeon may not recover the
added cost of the Company's products. In addition, managed care payors often
limit coverage to surgical devices on a preapproved list or obtained from an
exclusive source. If the Company's products are not on the list or are not
available from the exclusive source, the facility or surgeon will need to
obtain an exception from the payor or the patient will be required to pay for
some or all of the cost of the Company's product. The Company believes that
procedures using its balloon dissection products currently may be reimbursed
in the United States under certain existing procedure codes. However, there
can be no assurance that such procedure codes will remain available or that
the reimbursement under these codes will be adequate. Given the efforts to
control and decrease health care costs in recent years, there can be no
assurance that any reimbursement will be sufficient to permit the Company to
increase revenues or achieve or maintain profitability. The unavailability of
third-party or other adequate reimbursement could have a material adverse
effect on the Company's business, financial condition and results of
operations.
Reimbursement systems in international markets vary significantly by
country, and by region within some countries, and reimbursement approvals
must be obtained on a country-by-country basis. Many international markets
have government-managed health
27
<PAGE>
care systems that govern reimbursement for new devices and procedures. In
most markets, there are private insurance systems as well as
government-managed systems. Large-scale market acceptance of the Company's
balloon dissection systems and other products will depend on the availability
and level of reimbursement in international markets targeted by the Company.
Currently, the Company has been informed by its international distributors
that the balloon dissectors have been approved for reimbursement in many of
the countries in which the Company markets its products. Obtaining
reimbursement approvals can require 12 to 18 months or longer. There can be
no assurance that the Company will obtain reimbursement in any country within
a particular time, for a particular amount, or at all. Failure to obtain such
approvals could have a material adverse effect on the Company's business,
financial condition and results of operations.
Regardless of the type of reimbursement system, the Company believes that
surgeon advocacy of its products will be required to obtain reimbursement.
Availability of reimbursement will depend on the clinical efficacy of the
procedure and the utility and cost of the Company's products. There can be no
assurance that reimbursement for the Company's products will be available in
the United States or in international markets under either government or
private reimbursement systems, or that surgeons will support and advocate
reimbursement for use of the Company's systems for all applications intended
by the Company. Failure by surgeons, hospitals and other users of the
Company's products to obtain sufficient reimbursement from health care payors
or adverse changes in government and private third-party payors' policies
toward reimbursement for procedures employing the Company's products could
have a material adverse effect on the Company's business, financial condition
and results of operations.
GOVERNMENT REGULATION. The Company's Spacemaker balloon dissection
systems and other products are subject to extensive and rigorous regulation
by the FDA and, to varying degrees, by state and foreign regulatory agencies.
Under the federal Food, Drug, and
28
<PAGE>
Cosmetic Act, the FDA regulates the clinical testing, manufacture, labeling,
packaging, marketing, distribution and record keeping for medical devices, in
order to ensure that medical devices distributed in the United States are
safe and effective for their intended use. Prior to commercialization, a
medical device generally must receive FDA and foreign regulatory clearance or
approval, which can be an expensive, lengthy and uncertain process. The
Company is also subject to routine inspection by the FDA and state agencies,
such as the California Department of Health Services ("CDHS"), for compliance
with Good Manufacturing Practice requirements, Medical Device Reporting
requirements and other applicable regulations. Noncompliance with applicable
requirements can result in warning letters, import detentions, fines, civil
penalties, injunctions, suspensions or losses of regulatory approvals, recall
or seizure of products, operating restrictions, refusal of the government to
approve product export applications or allow the Company to enter into supply
contracts, and criminal prosecution. Delays in receipt of, or failure to
obtain, regulatory clearances and approvals, if obtained, or any failure to
comply with regulatory requirements could have a material adverse effect on
the Company's business, financial condition and results of operations.
Labeling and promotional activities are subject to scrutiny by the FDA
and,in certain circumstances, by the Federal Trade Commission. Current FDA
enforcement policy prohibits the marketing of approved medical devices for
unapproved uses. The Spacemaker I platform, Spacemaker II platform,
Spacemaker Resposable platform, and KnotMaker product each have received
510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic
and reconstructive surgery, either when tissue dissection is required or,
with respect to the KnotMaker product, when a surgical knot for suturing is
required. The Company has promoted these products for surgical applications
(e.g., hernia repair, subfascial endoscopic perforator surgery and breast
augmentation and reconstruction), and may in the future promote these
products for the dissection or knotmaking required for additional selected
applications (e.g., treatment of stress urinary
29
<PAGE>
incontinence, saphenous vein harvesting and a variety of orthopedic
procedures such as anterior spinal fusion). For any medical device cleared
through the 510(k) process, modifications or enhancements that could
significantly affect the safety or effectiveness of the device or that
constitute a major change to the intended use of the device will require a
new 510(k) submission. The Company has made modifications to its products
which the Company believes do not affect the safety or effectiveness of the
device or constitute a major change to the intended use and therefore do not
require the submission of new 510(k) notices. There can be no assurance,
however, that the FDA will agree with any of the Company's determinations not
to submit a new 510(k) notice for any of these changes or will not require
the Company to submit a new 510(k) notice for any of the changes made to the
product. If such additional 510(k) clearances are required, there can be no
assurance that the Company will obtain them on a timely basis, if at all, and
delays in receipt of or failure to receive such approvals could have a
material adverse effect on the Company's business, financial condition and
results of operations. If the FDA requires the Company to submit a new 510(k)
notice for any product modification, the Company may be prohibited from
marketing the modified product until the 510(k) notice is cleared by the FDA.
The Company plans to file a 510(k) submission for its specialized trocar with
a balloon valve, which provides a seal to maintain insufflation of the
surgical space during MIS. There can be no assurance that the FDA will grant
510(k) clearance for the Company's specialized trocar on a timely basis, if
at all.
Sales of medical devices outside of the United States are subject to
foreign regulatory requirements that vary widely from country to country. The
Company currently relies on its international distributors for the receipt of
premarket approvals and compliance with clinical trial requirements in those
countries that require them, and it expects to continue to rely on
distributors in those countries where the Company continues to use
distributors. In the event that the Company's international distributors fail
to obtain or maintain premarket approvals or compliance in foreign countries
where such approvals or compliance are
30
<PAGE>
required, the Company may be required to cause the applicable distributor to
file revised governmental notifications, cease commercial sales of its
products in the applicable countries or otherwise act so as to stop any
ongoing noncompliance in such countries. Any enforcement action by regulatory
authorities with respect to past or any future regulatory noncompliance could
have a material adverse effect on the Company's business, financial condition
and results of operations.
In order to continue selling its products within the European Economic
Area following June 14, 1998, the Company will be required to achieve
compliance with the requirements of the Medical Devices Directive (the "MDD")
and to affix CE marking on its products to attest such compliance. Failure by
the Company to comply with CE marking requirements by June 1998 would mean
that the Company would be unable to sell its products in the European
Economic Area unless and until compliance was achieved, which could have a
material adverse effect upon the Company's business, financial condition and
results of operations.
LIMITED MANUFACTURING EXPERIENCE; UNCERTAINTY REGARDING FUTURE
FACILITIES. The Company has only limited experience in manufacturing its
products in commercial quantities. The Company intends to scale up its
production of new products and to increase its manufacturing capacity for
existing and new products. However, manufacturers often encounter
difficulties in scaling up production of new products, including problems
involving production yields, quality control and assurance, component supply
and shortages of qualified personnel. Difficulties experienced by the Company
in manufacturing scale-up and manufacturing difficulties could have a
material adverse effect on its business, financial condition and results of
operations. There can be no assurance that the Company will be successful in
scaling up or that it will not experience manufacturing difficulties or
product recalls in the future.
The Company occupies a single facility in Palo Alto, California that
houses its headquarters, administrative offices, research laboratories and
31
<PAGE>
manufacturing facilities. This facility is subject to a lease that expires in
March 1998. While the Company believes that this space is adequate for its
immediate needs, GSI will need to obtain additional office, development and
manufacturing space to accommodate expected business growth during 1997 and
the first calendar quarter of 1998. There can be no assurance that the
Company will be able to obtain such additional facilities on commercially
reasonable terms, or at all. If the Company is able to lease such additional
space, there can be no assurance that the Company will be able to establish
and certify adequate manufacturing capacity in a timely manner, or at all, in
such space. Failure to obtain additional space or establish and certify
adequate manufacturing capacity in a timely manner could have a material
adverse effect on the Company's business, financial condition and results of
operations.
DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL ARRANGEMENTS.
The Company currently relies upon single source suppliers for several
components of its balloon dissection products, and in most cases there are no
formal supply contracts. There can be no assurance that the component
materials obtained from single source suppliers will continue to be available
in adequate quantities or, if required, that the Company will be able to
locate alternative sources of such component materials on a timely basis to
market its products. In addition, there can be no assurance that the single
source suppliers will meet the Company's future requirements for timely
delivery of products of sufficient quality and quantity. The failure to
obtain sufficient quantities and qualities of such component materials, or
the loss of any of the Company's single source suppliers, could cause a delay
in GSI's ability to fulfill orders while it identifies and certifies a
replacement supplier, and could have a material adverse effect on the
Company's business, financial condition and results of operations.
PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE.
The Company's business exposes it to potential product liability risks or
product recalls
32
<PAGE>
that are inherent in the design, development, manufacture and
marketing of medical devices, in the event the use of the Company's products
is alleged to have caused adverse effects on a patient or such products are
believed to be defective. The Company's products are designed to be used in
certain procedures where there is a high risk of serious injury or death.
Such risks will exist even with respect to those products that have received,
or may in the future receive, regulatory clearance for commercial sale. As a
result, there can be no assurance that the Company's product liability
insurance is adequate or that such insurance coverage will continue to be
available on commercially reasonable terms or at all. Particularly given the
lack of data regarding the long-term results of the use of balloon dissection
products, there can be no assurance the Company will avoid significant
product liability claims. Consequently, a product liability claim or other
claim with respect to uninsured or underinsured liabilities could have a
material adverse effect on the Company's business, financial condition and
results of operations.
RISKS ASSOCIATED WITH INTERNATIONAL SALES. Sales outside of the United
States accounted for approximately 3% and 4% of the Company's sales in fiscal
1995 and 1996, respectively, and the Company expects that international sales
will represent an increasing portion of revenue in the future. The Company
intends to continue to expand its sales outside of the United States and to
enter additional international markets, which will require significant
management attention and financial resources and subject the Company further
to the risks of selling internationally. These risks include unexpected
changes in regulatory requirements, tariffs and other barriers and
restrictions, reduced protection for intellectual property rights, and the
burdens of complying with a variety of foreign laws. In addition, because all
of the Company's sales are denominated in U.S. dollars, fluctuations in the
U.S. dollar could increase the price in local currencies of the Company's
products in foreign markets and make the Company's products relatively more
expensive than competitors' products
33
<PAGE>
that are denominated in local currencies. There can be no assurance that
regulatory, currency and other factors will not adversely impact the
Company's operations in the future or require the Company to modify its
current business practices.
DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL. The Company is
dependent upon a limited number of key management and technical personnel.
The loss of the services of one or more of such key employees could have a
material adverse effect on the Company's business, financial condition, and
results of operations. In addition, the Company's success will be dependent
upon its ability to attract and retain additional highly qualified sales,
management, manufacturing and research and development personnel. The Company
faces intense competition in its recruiting activities and there can be no
assurance that the Company will be able to attract and/or retain qualified
personnel.
POTENTIAL VOLATILITY OF STOCK PRICE. The market prices of the common
stock of many publicly held medical device companies have in the past been,
and can in the future be expected to be, especially volatile. Announcements
of technological innovations or new products by the Company or its
competitors, clinical marketing trial results, release of reports by
securities analysts, developments or disputes concerning patents or
proprietary rights, regulatory developments, changes in regulatory or medical
reimbursement policies, economic and other external factors, as well as
period-to-period fluctuations in the Company's financial results, may
34
<PAGE>
have a significant impact on the market price of the Common Stock. In
addition, the securities markets have from time to time experienced
significant price and volume fluctuations that are unrelated to the operating
performance of particular companies.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May, 1996, the Guidant Corporation unit of Origin MedSystems, Inc.
filed an action against GSI in the United States District Court for the
Northern District of California, alleging patent infringement of its patent
entitled "Apperatus and Methods for Peritoneal Retraction." GSI subsequently
filed a claim against Origin Medsystems, Inc. in the United States District
Court for the Northern District of California, alleging that the use of
Origin's balloon dissection products infringe its patent for a method of
tissue plane dissection using balloon systems. In addition, one of the patent
applications filed by the Company, which is directed to a surgical method
using balloon dissection technology, has been placed in interference with a
patent application filed by Origin, a competitor of the Company. The Company
believes that the inventor named in its patent application was the first to
invent this subject matter, and the Company has asserted that the Origin
patent application was filed after a disclosure made by such inventor to
employees of Origin. Origin takes a contrary position. This interference is
presently pending in the United States Patent and Trademark Office ("USPTO")
and, as permitted by the rules of the USPTO, has been referred to an
arbitrator for completion of the interference proceeding. A decision is not
expected in the interference proceeding until calendar year 1997, and, while
the Company believes it will be successful in this interference proceeding,
there can be no assurance of such success. Failure of the Company to prevail
in such interference proceeding could have a material adverse effect on the
Company's business, financial condition or results of operation. A decision
against the Company in either of these actions could have a material adverse
effect on the Company's business, financial condition or results of
operations.
From time to time the Company may be exposed to litigation arising out of
its products or operations. The Company is not engaged in any legal proceedings
35
<PAGE>
that are expected, individually or in the aggregate, to have a material adverse
effect on the Company, except for the patent interference proceedings discussed
herein.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS IN SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
36
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit Description
------- -----------
11.1 Statement of Computation of Earnings (Net Loss)
Per Share
27.1 Financial Data Schedule
(b) REPORTS ON FORM 8-K
The Company filed no reports on Form 8-K during the quarter ended
September 30, 1996.
37
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
GENERAL SURGICAL INNOVATIONS, INC.
By: /s/ STEPHEN J. BONELLI
------------------------------------
Stephen J. Bonelli
Vice President, Finance and Administration
and Chief Financial Officer
Date: November 14, 1996
38
<PAGE>
EXHIBIT 11.1
GENERAL SURGICAL INOVATIONS, INC. AND SUBSIDIARY
COMPUTATION OF NET LOSS PER SHARE (1)
(In thousands, expect per share data)
<TABLE>
<CAPTION>
Quarter Ended September 30
--------------------------------
1996 1995
-------- --------
<S> <C> <C>
Primarily and Fully Diluted:
Weighted average common shares........ 13,147 3,352
Common and common equivalent shares
pursuant to Staff Accounting
Bulletin No. 63...................... 3,201
-------- --------
Shares used in per share calculation.... 13,147 6,553
-------- --------
-------- --------
Net loss................................ $ (229) $ (1,048)
-------- --------
-------- --------
Net loss per share...................... $ (0.02) $ (0.16)
-------- --------
-------- --------
</TABLE>
- -------------------
(1) There is no difference between primary and fully diluted net loss per
share for all periods presented.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON
PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JUL-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 20,441
<SECURITIES> 29,377
<RECEIVABLES> 678
<ALLOWANCES> 50
<INVENTORY> 890
<CURRENT-ASSETS> 51,615
<PP&E> 669
<DEPRECIATION> 508
<TOTAL-ASSETS> 52,531
<CURRENT-LIABILITIES> 1,667
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 50,320
<TOTAL-LIABILITY-AND-EQUITY> 52,531
<SALES> 2,470
<TOTAL-REVENUES> 2,470
<CGS> 993
<TOTAL-COSTS> 993
<OTHER-EXPENSES> 2,293
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 587
<INCOME-PRETAX> (229)
<INCOME-TAX> 0
<INCOME-CONTINUING> (229)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (229)
<EPS-PRIMARY> (0.02)
<EPS-DILUTED> (0.02)
</TABLE>
