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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 MARCH 31, 1997.
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.)
10460 BUBB ROAD, CUPERTINO, CALIFORNIA 95014
(Address of principal executive offices)
Registrant's telephone number, including area code: (408) 863-2500
3172A Porter Drive, Palo Alto, California 94304
Former Address (Changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
There were approximately 13,208,765 shares of Registrant's Common Stock
issued and outstanding as of March 31, 1997.
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 1997
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed, consolidated balance sheets at March 31, 1997 and
June 30, 1996................................................ 3
Condensed, consolidated statements of operations for the
three months ended March 31, 1997 and 1996 and for the nine
months ended March 31, 1997 and 1996......................... 4
Condensed, consolidated statements of cash flows for the nine
months ended March 31, 1997 and 1996......................... 5
Notes to condensed, consolidated financial statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings............................................ 21
Item 2. Changes in Securities........................................ 21
Item 3. Defaults Upon Senior Securities.............................. 21
Item 4. Submission of Matters to a Vote of Security Holders.......... 21
Item 5. Other Information............................................ 22
Item 6. Exhibits and Reports on Form 8-K............................. 22
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
March 31, June 30,
1997 1996
------------ -----------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,780 $28,339
Available-for-sale securities 43,615 21,451
Accounts receivable, net 2,059 873
Inventories 1,576 700
Prepaid expenses and other current assets 597 438
------------ -----------
TOTAL CURRENT ASSETS 50,627 51,801
Property and equipment, net 638 702
Intangible and other assets, net 279 264
------------ -----------
Total assets $ 51,544 $ 52,767
------------ -----------
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 210 $ 614
Accrued liabilities 999 892
Bank borrowings 167 127
Deferred revenue -- 100
------------ -----------
TOTAL CURRENT LIABILITIES 1,376 1,733
Bank borrowings, less current portion 227 360
Other long-term liabilities 200 200
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Total liabilities 1,803 2,293
------------ -----------
Shareholders' equity:
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 13,208,765
on March 31, 1997 and 13,132,903 on June 30, 1996 13 13
Additional paid in capital 65,012 64,885
Notes receivable from shareholders (90) (112)
Deferred compensation, net (346) (496)
Unrealized gain/(loss) on available-for-sale securities (126) 1
Accumulated deficit (14,722) (13,817)
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Total shareholders' equity 49,741 50,474
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Total liabilities and shareholders' equity $ 51,544 $ 52,767
------------ -----------
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</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED
FINANCIAL STATEMENTS.
3
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
March 31, March 31,
-------------------- --------------------
1997 1996 1997 1996
--------- ---------- --------- ----------
<S> <C> <C> <C> <C>
Sales $ 693 $ 1,713 $ 3,524 $ 3,421
Guaranteed payments 1,480 -- 2,980 --
---------- ---------- ---------- ---------
Gross Sales 2,173 1,713 6,504 3,421
Cost of Sales 397 734 1,749 1,654
---------- ---------- ---------- ---------
Gross Profit 1,776 979 4,755 1,767
---------- ---------- ---------- ---------
Operating Expenses:
Research and development 581 384 1,527 864
Sales and marketing 1,216 825 3,419 2,578
General and administrative 1,044 414 2,597 1,120
Write-off of acquired in-process R&D 2,791 2,791
---------- ---------- ---------- ---------
Total operating expenses 2,841 4,414 7,543 7,353
---------- ---------- ---------- ---------
Operating loss (1,065) (3,435) (2,788) (5,586)
Interest and other income 626 63 1,883 151
---------- ---------- ---------- ---------
Net loss $ (439) $ (3,372) $ (905) $ (5,435)
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Net loss per share $ (0.03) $ (0.51) $ (0.07) $ (0.83)
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
Shares used in computing net
loss per share 13,211 6,557 13,181 6,556
---------- ---------- ---------- ---------
---------- ---------- ---------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED
FINANCIAL STATEMENTS.
4
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Nine Months Ended
March 31,
------------------------
1997 1996
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net cash used in operating activities (3,235) (2,768)
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities (54,666) --
Maturities of available-for-sale securities 32,500 --
Disposal of property and equipment 39
Acquisition of property and equipment (214) (261)
Cash received on acquisition of Adjacent Surgical, Inc. 21
----------- ----------
Net cash used in investing activities (22,380) (201)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from bank borrowings 786
Principal payments on note payable (145)
Payments on obligations under capital leases and capital loans (93) (64)
Proceeds from issuance of Series D convertible
redeemable preferred stock 1,753
Proceeds from issuance of common stock, net of issuance costs 125 2
Proceeds from payments on shareholder notes receivable 24 --
----------- ----------
Net cash provided by financing activities 56 2,332
----------- ----------
Net decrease in cash and cash equivalents (25,559) (637)
Cash and cash equivalents, beginning of period 28,339 4,541
----------- ----------
Cash and cash equivalents, end of period $ 2,780 $ 3,904
----------- ----------
----------- ----------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED
FINANCIAL STATEMENTS.
5
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited condensed, consolidated financial
statements as of March 31, 1997 and for the three and nine month periods
ended March 31, 1997 and 1996 of General Surgical Innovations, Inc. (the
"Company") and subsidiary 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 only
normal recurring adjustments, considered necessary for a fair presentation
have been included. Operating results for the three month and nine month
periods ended March 31, 1997 are not necessarily indicative of the results
that may be expected for the fiscal year ended June 30, 1997, or any future
interim period.
These financial statements and notes should be read in conjunction
with the Company's audited financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year
ended June 30, 1996.
2. RECENT PRONOUNCEMENTS:
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. The Company plans to
adopt the disclosure only provisions of SFAS No. 123 and to continue 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.
During February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share" (SFAS 128), which specifies the
computation, presentation and disclosure requirements for Earnings Per Share.
SFAS 128 will become effective for the Company's 1998 fiscal year. The impact
of adopting SFAS 128 on the Company's financial statements has not yet been
determined.
3. Inventories:
Inventories comprise:
Mar 31, Jun 30,
------------------
1997 1996
---- ----
(in thousands)
Raw Materials.................. $ 769 $ 387
Work in progress............... 117 153
Finished goods................. 690 160
--------- -------
$1,576 $ 700
--------- -------
--------- -------
6
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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 for the year ended June
30, 1996.
The Company desires to take advantage of the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995.
Specifically the Company wishes to alert readers that, except for the
historical information contained in this Quarterly Report on Form 10-Q, the
matters discussed herein are forward-looking statements that are subject to
certain risks and uncertainties that could cause the actual results to differ
materially from those projected. Factors that could cause actual results to
differ materially include, but are not limited to, fluctuations in revenues
among different product lines and markets, the timing of orders and
shipments, the ramp-up of distribution efforts by Ethicon-Endo Surgery, Inc.
("EES"), EES's success in achieving certain levels of sales growth, the
Company's ability to manage growth and the transition to EES and possible
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, the termination of the Company's distributorship agreement
with United States Surgical Corporation ("USSC"), and other risks detailed
below and included from time to time in the Company's other SEC reports and
press releases, copies of which are available from the Company upon request.
The Company assumes no obligation to update any forward-looking statements
contained herein. The factors listed below under "Factors Affecting Future
Results," as well as other factors, have in the past affected, and could in
the future affect, the Company's actual results and could cause the Company's
results for future 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 subsidiary. 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 five 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, subfascial endoscopic perforator surgery and breast augmentation and
reconstruction surgery.
7
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In November 1996, the Company terminated its distribution
agreement with USSC which provided 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.
In December 1996, the Company entered into a five year OEM supply
agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery,Inc.
("EES"), a Johnson & Johnson ("JNJ") company pursuant to which GSI granted
EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM-
Balloon Dissection Systems in the laparoscopic hernia repair and urinary
stress incontinence ("USI") markets. The Expanded EES Agreement supersedes
the June 1996 licensing agreement between the Company and EES pursuant to
which GSI granted EES the right to market the EES balloon dissection product.
Under the Expanded EES Agreement, GSI will manufacture certain products and
EES will market and distribute these products in the hernia and USI markets.
EES has begun selling GSI's dissector for hernia repair, and the Company
expects EES to begin selling GSI's dissector for USI repair in the quarter
ending June 30, 1997. The Company currently expects EES to commence a
focused marketing campaign for the USI balloon dissector in calendar year
1998. In addition to the development of balloon dissection systems, the
companies will collaborate on development of additional products for these
markets. EES made a guaranteed payment of $1.5 million in the second quarter
of fiscal year 1997, and a third quarter (ending March 31, 1997) payment of
$1.6 million which represents a combination of purchased products and margin
guarantees under the Expanded EES Agreement. In addition, the Expanded EES
Agreement provides that EES will either purchase products, or make payments
in lieu of such purchases, to support GSI's gross margin of $1.7 million in
the fourth quarter of 1997 (through June 30, 1997). Following this initial
ramp-up period, EES is required to make certain minimum quarterly product
purchases.
Additional sales in the United States are currently made through a small
direct sales force. The Company currently sells its products (other than for
hernia and USI applications) in international 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.
To date, all of the sales made through 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 or is developing balloon
dissection systems for urinary stress incontinence, vascular, plastic surgery
and orthopedics applications, sales of products for hernia repair are
expected to provide a substantial majority of the Company's revenues at least
through fiscal 1997.
The Company has acquired significant 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.
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,
although the Company currently has no commitments with respect to any such
relationships. The Company plans to continue to investigate potential
strategic relationships in the future.
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 March 31, 1998. The
8
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Company's sales to date have consisted almost entirely of balloon dissector
systems 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 sales and marketing, research and development (including
marketing-related clinical evaluations), manufacturing and administration. In
addition, the Company has experienced higher administration expenses since
its initial public offering resulting from its obligations as a public
reporting company.
The Company anticipates that its results of operations may fluctuate for
the foreseeable future due to several factors, including fluctuations in
purchases of the Company's products by EES, EES's ability to achieve certain
levels of sales growth, the status of the Company's relationship with EES or
other potential partners, fluctuations in revenues among different product
lines and markets, 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, 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 effectively promote 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.
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.
In January 1997, the Company entered into a new local facility lease and
has relocated its headquarters and manufacturing operations to this new
location during April 1997. The new facility's lease comprises approximately
30,460 square feet and the monthly rent is approximately $47,000.
9
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RESULTS OF OPERATIONS
REVENUE. Revenue increased by 27% to approximately $2.2 million
for the quarter ended March 31, 1997 from $1.7 million for the same period in
1996. Revenue for the nine months ended March 31, 1997 increased 90% to
approximately $6.5 million from $3.4 million for the nine months ended March
31, 1996. This increase was due to growth in direct unit sales of the
Spacemaker I and II platforms for the hernia market and from initial product
purchases by EES combined with guaranteed payments from EES pursuant to the
Expanded EES Agreement. The Expanded EES Agreement provides that EES will
purchase products, or make payments in lieu of such purchases, to ensure that
GSI maintains certain gross margin levels during Ethicon's initial ramp-up
from October 4, 1996 to June 30, 1997. As the Company continues its transition
to EES, the Company believes that its sales results will fluctuate from
quarter to quarter during at least the next several quarters.
COST OF SALES. Cost of sales decreased by 46% to approximately $397,000
for the quarter ended March 31, 1997 from $734,000 for the same period in
1996, and increased as a percentage of sales to 57% for the quarter ended
March 31, 1997 from 43% for the quarter ended March 31, 1996. This increase
in cost of sales as a percentage of sales was primarily a result of
under-utilized manufacturing capacity as the Company had lower sales during
its transition to EES as its new major distributor. Cost of sales for the
nine months ended March 31, 1997 increased 6% to approximately $1.75 million
from approximately $1.65 million for the nine months ended March 31, 1996 as
a result of the direct costs associated with greater product sales.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development ("R & D")
expenses, which include expenditures for marketing-related clinical
evaluations and regulatory expenses, increased by 51% to $581,000 in the
quarter ended March 31, 1997 from $384,000 for the same period in 1996 and
increased as a percentage of revenue to 27% in the quarter ended March 31,
1997 from 22% in the quarter ended March 31, 1996 as a result of increased
efforts to develop new products. R & D expenses for the nine months ended
March 31, 1997 were approximately $1.5 million versus $864,000 for the nine
months ended March 31, 1996. 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 ("SG&A") expenses increased by 92% to approximately $2.3
million for the quarter ended March 31, 1997 from $1.2 million for the
quarter ended March 31, 1996 primarily due to increased legal expenses
related to intellectual property litigation and expenses associated with the
growth of a direct sales force in the United States. For the nine months
ended March 31, 1997 SG&A expenses were $6.0 million compared to $3.7 million
for the nine months ended March 31, 1996. 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 sales and
manufacturing infrastructure (including additional sales personnel) increases.
INTEREST AND OTHER INCOME/(EXPENSE). Interest and other
income/(expense) increased to $626,000 for the quarter ended March 31, 1997
from $63,000 for the quarter ended March 31, 1996. For the nine months ended
March 31, 1997 interest and other income/(expense) increased to $1.9 million
10
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from $151,000 for the same period in 1996. These increases were due to
higher average cash, cash equivalents and available-for-sale securities
balances. Interest earned in the future will depend on the Company's funding
cycles and prevailing interest rates.
LIQUIDITY AND CAPITAL RESOURCES
Since inception, the Company's cash expenditures have significantly
exceeded its sales, resulting in an accumulated deficit of $14.7 million at
March 31, 1997. The Company has funded its operations primarily through the
sale of equity securities. From its inception through March 31, 1997 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 March 31, 1997 the Company's principal source of liquidity
consists of cash, cash equivalents and short-term investments of $46.4
million, as compared to approximately $49.8 million at June 30, 1996. This
decrease principally reflects approximately $3.2 million used to fund
operations. In addition the Company is currently negotiating an extension of
a $1.5 million bank line of credit to March 31, 1998. There are no
outstanding borrowings under this line of credit.
The Company expects to make approximately $1.5 million in leasehold
improvements by the end of fiscal 1997 (June 31, 1997) relating to the
relocation of the Company's headquarters. 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 a
continuation of 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.
RECENT PRONOUNCEMENTS:
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. The Company plans to
adopt the disclosure only provisions of SFAS No. 123 and to continue 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.
During February 1997, the Financial Accounting Standards Board issued
Statement No. 128, "Earnings per Share" (SFAS 128), which specifies the
computation, presentation and disclosure requirements for Earnings Per Share.
SFAS 128 will become effective for the Company's 1998 fiscal year. The impact
of adopting SFAS 128 on the Company's financial statements has not yet been
determined.
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 March 31, 1997, the Company had an accumulated deficit of
$14.7 million. The Company's net operating losses for the fiscal years ending
June 30, 1994, 1995 and 1996 and for the nine months ended March 31, 1997 were
$3.1 million, $4.1 million and $5.5 million, and $905,000, respectively. The
Company expects to continue to incur operating losses on a quarterly and annual
basis through at least March 31, 1998. Due to the Company's limited operating
history, and the recent transition to EES as its major distributor, there can
be no assurance of sales growth or profitability 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
11
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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 minimally invasive surgery
("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
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 December 1996, the Company
entered into a five year OEM supply agreement (the "Expanded EES Agreement")
with Ethicon Endo-Surgery,Inc. ("EES"), a Johnson & Johnson ("JNJ") company,
pursuant to which GSI granted EES exclusive worldwide sales and marketing
rights to sell the Spacemaker-TM- Balloon Dissection Systems in the
laparoscopic hernia repair and urinary stress incontinence ("USI") markets.
The Expanded EES Agreement supersedes the June 1996 licensing agreement
between the Company and EES, pursuant to which GSI granted EES the right to
market the EES balloon dissection product. Under the Expanded EES
agreement, GSI will manufacture certain products and EES will market and
distribute these products in the hernia and USI markets. EES has begun
selling GSI's dissector for hernia repair, and the Company expects EES to
begin selling GSI's dissector for USI repair in the quarter ending June 30,
1997. The Company currently expects EES to commence a focused marketing
campaign for the USI balloon dissector in calendar year 1998. In addition to
the development of balloon dissection systems, the companies will collaborate
on development of additional products for these markets. EES made initial
payments of $1.5 million and $1.6 million in the second and third quarters
of 1997, respectively, under the Expanded EES Agreement. In addition, the
Expanded EES Agreement provides that EES will either purchase products, or
make payments in lieu of such purchases, to support GSI's gross margin of
$1.7 million in the fourth quarter of 1997 (through June 30, 1997).
Following this initial ramp-up period, EES is required to make certain
minimum quarterly product purchases. There can be no assurance that EES's
manufacturing, marketing or distribution efforts will be successful. EES's
failure to achieve certain levels of sales growth or a reduction in orders
from EES could have a material adverse effect on the Company's business,
financial condition and results of operations. Although the Company intends
to establish additional distributorships in the United States for products in
areas other than hernia repair and urinary stress incontinence,
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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, a USSC affiliate,
under the same terms and conditions as the Company's agreement with USSC,
which was terminated in November 1996. Thus, the Company does not anticipate
that it will have future sales through Autosuture. Although EES has taken
over as the Company's international distributor, there can be no assurance
that EES's efforts in international distribution will be successful.
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
vascular and cosmetic and reconstructive surgery markets. 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, 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-TM- balloon dissection products. The Company believes that market
acceptance of the Company's products will depend on the Company's ability to
provide evidence to the medical community of the safety, efficacy, clinical
advantage 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.
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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. Further, due to 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 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 fluctuations
in revenues among different product lines and markets, (ii) purchases of the
Company's products by EES, (iii) the rate of adoption by surgeons of balloon
dissection technology in markets targeted by the Company, (iv) the sales
efforts of EES, (v) the mix of sales among distributor and the Company's
direct sales force, (vi) timing of patent and regulatory approvals, if any,
(vii) timing and growth in operating expenditures, (viii) timing of research
and development expenses, including marketing-related clinical evaluation
expenditures, (ix) intellectual property litigation and (x) general market
conditions. In the past, the Company's sales were highly dependent upon the
marketing efforts and success of United States Surgical Corporation, which
was the Company's major distributor until the relationship was mutually
terminated in November 1996. In December 1996 the Company entered into the
Expanded Ethicon Agreement, pursuant to which GSI granted EES exclusive
worldwide sales and marketing rights to sell the Spacemaker-TM- Balloon
Dissection Systems in the laparoscopic hernia repair and urinary stress
incontinence (USI) markets. The Company's sales in any period will be highly
dependent upon the marketing efforts and success of EES, which are not within
the control of the Company. The Company anticipates that sales to EES will
fluctuate in the future. Failure by EES to achieve certain levels of sales
growth or a decline in purchases by EES could result in a decline in sales
and adversely affect the Company's operating results. In addition,
announcements or expected announcements by the Company, its competitors or
its distributor 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, if at all, or that its
growth, if any, will be consistent with predictions by securities analysts
and investors. In such event, the price of the Company's Common Stock would
likely be materially and adversely affected. 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 March 31, 1997, GSI had 22 United States
patents issued, and had applied for an additional 47 United States patents,
11 of which had been allowed. In addition, GSI had two foreign patents
issued, and 22 in prosecution as of such date. In May 1996, the Company was
issued a United States patent that contains claims regarding the use of
balloons to dissect tissue planes anywhere in the body.
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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, may be highly
uncertain. No assurance can be given that any patents based on pending patent
applications or any future patent applications will be issued, that the scope
of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents or patents to
which it has licensed rights will be held valid 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 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 1998. 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.
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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.
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-TM-
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 selling its products commercially.
In January 1997 the Company entered into a real estate lease and has
relocated its headquarters and manufacturing operations in April 1997 to this
new facility. In addition, the Company experienced rapid growth in 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 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 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
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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 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 with the use of 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 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.
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Reimbursement systems in international markets vary significantly by
country, and by region within some countries, and reimbursement approvals
must be obtained on a country-by-country basis. Many international markets
have government-managed health care systems that govern reimbursement for new
devices and procedures. In most markets, there are private insurance systems
as well as government-managed systems. Large-scale market acceptance of the
Company's balloon dissection systems and other products will depend on the
availability and level of reimbursement in international markets targeted by
the Company. Obtaining reimbursement approvals can require 12 to 18 months or
longer. EES will handle the reimbursement approval process for the Company's
products in most international countries and is in the process of assessing
its regulatory plan regarding such approvals. 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 Cosmetic Act, the FDA regulates the clinical testing,
manufacture, labeling, packaging, marketing, distribution and record keeping for
medical devices, in order to ensure that medical devices distributed in the
United States are safe and effective for their intended use. Prior to
commercialization, a medical device generally must receive FDA and foreign
regulatory clearance or approval, which can be an expensive, lengthy and
uncertain process. The Company is also subject to routine inspection by the FDA
and state agencies, such as the California Department of Health Services
("CDHS"), for compliance with Good Manufacturing Practice requirements, Medical
Device Reporting requirements and other applicable regulations. Noncompliance
with applicable requirements can result in warning letters, import detentions,
fines, civil penalties, injunctions, suspensions or losses of regulatory
approvals, recall or seizure of products, operating restrictions, refusal of the
government to approve product export applications or allow the Company to enter
into supply contracts, and criminal prosecution. Delays in receipt of, or
failure to obtain, regulatory clearances and approvals, or any failure to comply
with regulatory requirements could have a material adverse effect on the
Company's business, financial condition and results of operations.
Labeling and promotional activities are subject to scrutiny by the FDA
and, in certain circumstances, by the Federal Trade Commission. Current FDA
enforcement policy prohibits the marketing of approved medical devices for
unapproved uses. The Spacemaker I platform, Spacemaker II platform,
Spacemaker Resposable platform, Spacemaker SAPHTrak 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
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additional selected applications (e.g., treatment of stress urinary
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 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 change to the intended use and therefore do not
require the submission of new 510(k) notices. There can be no assurance,
however, that the FDA will agree with any of the Company's determinations not
to submit a new 510(k) notice for any of these changes or will not require
the Company to submit a new 510(k) notice for any of the changes made to the
product. If such additional 510(k) clearances are required, there can be no
assurance that the Company will obtain them on a timely basis, if at all, and
delays in receipt of, or failure to receive, such approvals could have a
material adverse effect on the Company's business, financial condition and
results of operations. If the FDA requires the Company to submit a new 510(k)
notice for any product modification, the Company may be prohibited from
marketing the modified product until the 510(k) notice is cleared by the FDA.
Sales of medical devices outside of the United States are subject to
foreign regulatory requirements that vary widely from country to country. The
Company currently relies on its international distributors for the receipt of
premarket approvals and compliance with clinical trial requirements in those
countries that require them, and it expects to continue to rely on
distributors in those countries where the Company continues to use
distributors. In the event that the Company's international distributors fail
to obtain or maintain premarket approvals or compliance in foreign countries
where such approvals or compliance are required, the Company may be required
to cause the applicable distributor to file revised governmental
notifications, cease commercial sales of its products in the applicable
countries or otherwise act so as to stop any ongoing noncompliance in such
countries. Any enforcement action by regulatory authorities with respect to
past or any future regulatory noncompliance could have a material adverse
effect on the Company's business, financial condition and results of
operations.
In order to continue selling its products within the European Economic
Area 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 to such compliance. The
Company is currently in the process of seeking CE marking for the products it
intends to market internationally and expects to receive this marking in the
second quarter of fiscal 1998 (ending December 31, 1997). Failure by the
Company to comply with CE marking requirements by June 1998 would prohibit
the Company from selling 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 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.
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In January 1997, the Company entered into a new facility lease in
Cupertino, California, and has relocated its headquarters and manufacturing
operations to this new location during April 1997. The new facilities lease
comprises approximately 30,460 square feet, and the monthly rent is
approximately $47,000. In addition, the Company has a lease on a Palo Alto,
California facility, which it is in the process of terminating and another
lease in Dublin, California that houses its orthopedic sales, marketing and
research 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, if at all, or, if required, that the Company will be
able to locate alternative sources of such component materials on a timely
basis, if at all, 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, if any, and could have a
material adverse effect on the Company's business, financial condition and
results of operations.
PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE.
The Company's business exposes it to potential product liability risks or
product recalls that are inherent in the design, development, manufacture and
marketing of medical devices, in the event the use of the Company's products
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 during
the nine month period ended March 31, 1996 and 1997, 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 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
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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 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 "Apparatus 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 1998, 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 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 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 UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
21
<PAGE>
ITEM 5. OTHER INFORMATION
None.
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
March 31, 1997.
22
<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 Chief Financial Officer
(Principal Financial Officer and Duly
Authorized Officer)
Date: May 13, 1997
23
<PAGE>
EXHIBIT 11.1
GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
COMPUTATION OF NET LOSS PER SHARE (1) (2)
(In thousands, expect per share data)
<TABLE>
<CAPTION>
Quarter Ended March 31, Nine Months Ended March 31,
----------------------------------- -----------------------------------
1997 1996 1997 1996
------------ -------------- -------------- -------------
<S> <C> <C> <C> <C>
Primary and Fully Diluted:
Weighted average common shares........ 13,211 3,356 13,181 3,355
Common and common equivalent shares
pursuant to Staff Accounting
Bulletin No. 63...................... 3,201 3,201
------------ -------------- -------------- -------------
Shares used in per share calculation.... 13,211 6,557 13,181 6,556
------------ -------------- -------------- -------------
------------ -------------- -------------- -------------
Net loss................................ $ (439) $(3,372) $ (905) $ (5,435)
------------ -------------- -------------- -------------
------------ -------------- -------------- -------------
Net loss per share...................... $ (0.03) $ (0.51) $ (0.07) $ (0.83)
------------ -------------- -------------- -------------
------------ -------------- -------------- -------------
</TABLE>
- -------------------
(1) There is no difference between primary and fully diluted net loss per share
for all periods presented.
(2) 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.
<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>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 2,780
<SECURITIES> 43,615
<RECEIVABLES> 2,097
<ALLOWANCES> 38
<INVENTORY> 1,576
<CURRENT-ASSETS> 50,627
<PP&E> 638
<DEPRECIATION> 675
<TOTAL-ASSETS> 51,544
<CURRENT-LIABILITIES> 1,376
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 49,728
<TOTAL-LIABILITY-AND-EQUITY> 51,544
<SALES> 693
<TOTAL-REVENUES> 2,173
<CGS> 397
<TOTAL-COSTS> 397
<OTHER-EXPENSES> 2,841
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 626
<INCOME-PRETAX> (439)
<INCOME-TAX> 0
<INCOME-CONTINUING> (439)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (439)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
