<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 DECEMBER 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
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 13,392,865 shares of Registrant's Common Stock
issued and outstanding as of February 1, 1998.
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED DECEMBER 31, 1997
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated balance sheets at December 31, 1997
and June 30, 1997. . . . . . . . . . . . . . . . . . . . . . 3
Consolidated statements of operations for the three months
ended December 31, 1997 and December 31, 1996 and for the
six months ended December 31, 1997 and December 31, 1996 . . 4
Consolidated statements of cash flows for the six months
ended December 31, 1997 and December 31, 1996 . . . . . . . 5
Notes to 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 and Use of Proceeds . . . . . . . . . 22
Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . . . 22
Item 4. Submission of Matters to a Vote of Security Holders . . . . 22
Item 5. Other Information . . . . . . . . . . . . . . . . . . . . . 22
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . 22
2
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER, 31 JUNE, 30
1997 1997
------------ ---------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents . . . . . . . . . . . . $ 7,374 $ 7,900
Available-for-sale securities . . . . . . . . . . 33,649 35,831
Accounts receivable, net of allowance for
doubtful accounts of $54 on December 31, 1997
and $47 on June 30, 1997 . . . . . . . . . . . . 2,215 2,131
Inventories . . . . . . . . . . . . . . . . . . . 1,016 1,717
Prepaid expenses and other current assets . . . . 1,124 971
--------- ---------
Total current assets. . . . . . . . . . . . 45,378 48,550
Property and equipment, net. . . . . . . . . . . . . . 2,287 2,251
Intangible and other assets, net . . . . . . . . . . . 227 261
--------- ---------
Total assets. . . . . . . . . . . . . . . . $ 47,892 $ 51,062
--------- ---------
--------- ---------
LIABILITIES
Current liabilities:
Accounts payable. . . . . . . . . . . . . . . . . $ 579 $ 504
Accrued liabilities . . . . . . . . . . . . . . . 790 1,044
Bank borrowings . . . . . . . . . . . . . . . . . 146 167
--------- ---------
Total current liabilities . . . . . . . . . 1,515 1,715
Bank borrowings, less current portion. . . . . . . . . 122 185
Other long-term liabilities. . . . . . . . . . . . . . 193 175
--------- ---------
Total liabilities . . . . . . . . . . . . . 1,830 2,075
--------- ---------
SHAREHOLDERS' EQUITY
Preferred stock, $.001 par value:
Authorized: 2,000,000 shares; issued and
outstanding: none
Common stock, $.001 par value:
Authorized: 50,000,000 shares; issued and
outstanding 13,385,657 on December 31, 1997 and
13,290,644 on June 30, 1997 . . . . . . . . . . . 13 13
Additional paid-in capital . . . . . . . . . . . . . . 65,219 65,089
Notes receivable from shareholders . . . . . . . . . . (87) (87)
Deferred compensation, net . . . . . . . . . . . . . . (228) (297)
Unrealized loss on available-for-sale
securities . . . . . . . . . . . . . . . . . . . . . (5) (38)
Accumulated deficit. . . . . . . . . . . . . . . . . . (18,850) (15,693)
--------- ---------
Total shareholders' equity. . . . . . . . . . . . 46,062 48,987
--------- ---------
Total liabilities and shareholders' equity. $ 47,892 $ 51,062
--------- ---------
--------- ---------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
3
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- --------------------
1997 1996 1997 1996
------- ------ ------- -------
<S> <C> <C> <C> <C>
Sales. . . . . . . . . . . . . . . . . $ 1,408 $ 361 $ 2,975 $ 2,831
Guaranteed payments. . . . . . . . . . 860 1,500 1,635 1,500
------- ------ ------- -------
Total revenue. . . . . . . . . . . . . 2,268 1,861 4,610 4,331
Cost of sales. . . . . . . . . . . . . 1,186 359 2,142 1,352
------- ------ ------- -------
Gross profit. . . . . . . . . . . 1,082 1,502 2,468 2,979
------- ------ ------- -------
Operating Expenses:
Research and development. . . . . 658 484 1,423 946
Sales and marketing . . . . . . . 1,168 1,095 2,294 2,203
General and administrative. . . . 1,738 830 3,084 1,553
------- ------ ------- -------
Total operating expenses. . . . 3,564 2,409 6,801 4,702
------- ------ ------- -------
Operating loss. . . . . . . . (2,482) (907) (4,333) (1,723)
Interest income. . . . . . . . . . . . 594 678 1,197 1,303
Interest expense . . . . . . . . . . . (9) (11) (21) (23)
Other income (expense) . . . . . . . . - 3 - (23)
------- ------ ------- -------
Net loss . . . . . . . . . . $(1,897) $ (237) $(3,157) $ (466)
------- ------ ------- -------
------- ------ ------- -------
Net loss per common share and per
common share - assuming dilution . . $ (0.14) $(0.02) $ (0.23) $ (0.04)
------- ------ ------- -------
------- ------ ------- -------
Shares used in computing net loss per
common share and per common share -
assuming dilution . . . . . . . . . . 13,355 13,183 13,334 13,165
------- ------ ------- -------
------- ------ ------- -------
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
4
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
Six Months Ended
December 31,
---------------------
1997 1996
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss . . . . . . . . . . . . . . . . . . . . . . $ (3,157) $ (466)
Adjustments to reconcile net loss to net cash
used in operating activities:
Amortization of deferred compensation. . . . . . . 69 100
Depreciation and amortization. . . . . . . . . . . 567 402
Provision for uncollectable accounts . . . . . . . 7 (41)
Loss on write-off of fixed assets. . . . . . . . . - 26
Provision for excess and obsolete inventory. . . . (4) 68
Changes in operating assets and liabilities:
Accounts receivable . . . . . . . . . . . . . . (91) (800)
Inventory . . . . . . . . . . . . . . . . . . . 705 (747)
Prepaid expenses and other current assets . . . (153) (125)
Intangible and other assets . . . . . . . . . . (2) -
Accounts payable . . . . . . . . . . . . . . . . 75 (69)
Accrued and other liabilities . . . . . . . . . (267) (248)
Deferred revenue . . . . . . . . . . . . . . . . - (100)
-------- --------
Net cash used in operating
activities . . . . . . . . . . . . . . . . . (2,251) (2,000)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of available-for-sale securities . . . . . (15,800) (37,305)
Proceeds from sales and maturities of
available-for-sale securities . . . . . . . . . . . 17,792 22,500
Acquisition of property and equipment. . . . . . . . (304) (124)
-------- --------
Net cash provided by (used in)
investing activities. . . . . . . . . . . . . 1,688 (14,929)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of common stock . . . . . . . 130 106
Proceeds from payment on shareholders notes
receivable . . . . . . . . . . . . . . . . . . . . - 18
Payments on capital lease obligations . . . . . . . (9) -
Principal payments on bank borrowings . . . . . . . (84) (51)
-------- --------
Net cash provided by financing
activities . . . . . . . . . . . . . . . . . 37 73
-------- --------
Net decrease in cash and cash
equivalents . . . . . . . . . . . . . . . . . . . . (526) (16,856)
Cash and cash equivalents, beginning of period . . . 7,900 28,339
-------- --------
Cash and cash equivalents, end of period . . . . . . $ 7,374 $ 11,483
-------- --------
-------- --------
Cash paid during the period for:
Interest . . . . . . . . . . . . . . . . . . . . . $ 22 $ 27
Taxes. . . . . . . . . . . . . . . . . . . . . . . $ - $ -
NONCASH INVESTING AND FINANCING ACTIVITIES
Issuance of common stock for notes receivable. . . . $ - $ 11
Change in unrealized gain (loss) on available-for-
sale securities . . . . . . . . . . . . . . . . . . $ 33 $ 30
Property acquired under capital leases . . . . . . . $ 40 $ -
</TABLE>
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE
CONSOLIDATED FINANCIAL STATEMENTS.
5
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GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation:
The accompanying unaudited consolidated financial statements as of
December 31, 1997 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 normal recurring
adjustments, considered necessary for a fair presentation have been included.
Operating results for the three and six month periods ended December 31, 1997
are not necessarily indicative of the results that may be expected for the
fiscal year ended June 30, 1998, 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,
1997.
2. Reclassification:
Certain amounts in the financial statements have been reclassified to
conform with current year's presentation. These reclassifications had no
impact on previously reported working capital, operating income, or net
income.
3. Net Loss Per Share:
The Company adopted Financial Accounting Standards Board No. 128
"Earnings Per Share", and accordingly all prior periods have been restated.
Net loss per common share and per common share-assuming dilution are computed
using the weighted average number of common shares outstanding. Common
equivalent shares from stock options are excluded from the computation of net
loss per common share-assuming dilution as their effect is antidilutive.
4. Inventories:
Inventories comprise (IN THOUSANDS):
<TABLE>
<CAPTION>
Dec. 31, June 30,
1997 1997
---- ----
(unaudited)
<S> <C> <C>
Raw materials . . . . . . . . . . . . . $ 699 $ 706
Work in progress . . . . . . . . . . . 72 43
Finished goods . . . . . . . . . . . . 245 968
-------- --------
$ 1,016 $ 1,717
-------- --------
-------- --------
</TABLE>
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 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, 1997.
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, market demand for the Company's products,
the Company's ability to shift market focus successfully, fluctuations in
revenues among different product lines and markets, the timing and number of
orders and shipments, distribution efforts by Ethicon-Endo Surgery, Inc.
("EES"), a Johnson & Johnson company, EES's success in achieving certain
levels of sales growth, the performance of the Company's new corporate
partnering relationships, the Company's ability to establish and develop
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, 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;
ENDOSAPH-TM-, SAPHtrak-TM-, SPACEKEEPER-TM- and Knotmaker-TM-, trademarks 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 six 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
7
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endoscopic perforator surgery, saphenous vein harvesting and breast
reconstruction and augmentation surgery.
In December 1996, the Company entered into a five year OEM supply
agreement (the "Expanded EES Agreement") with EES, pursuant to which GSI
granted EES worldwide sales and marketing rights to sell the
SPACEMAKER-Registered Trademark- Balloon Dissection Systems in the
laparoscopic hernia repair and urinary stress incontinence ("USI") markets.
Under the Expanded EES Agreement, EES has begun selling GSI's dissector for
hernia repair. EES made guaranteed payments of $4.9 million in fiscal year
1997, and additional payments in lieu of product purchases pursuant to a
mutual agreement in the amount of $775,000 in the first quarter of fiscal
year 1998 and $860,000 in the second quarter of fiscal year 1998.
Additional sales in the United States (other than for hernia and USI
applications) are currently made through distributors and a small direct
sales force. The Company currently sells its products (other than for hernia
and USI applications) in international markets through distributors, which
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, almost all of the sales to distributors and by the Company's
direct sales force have been for use in hernia repair procedures. While the
Company has developed or is developing balloon dissection systems for
vascular, urinary stress incontinence and plastic surgery, sales of products
for hernia repair are expected to provide a majority of the Company's
revenues at least through fiscal 1998.
The Company has acquired rights to a significant number of patents from
third parties, including rights that apply to the Company's current balloon
dissection systems. The Company has historically paid and is obligated to pay
in the future to such third parties royalties equal to 4% of sales of such
products. The Company has also acquired patent rights under royalty-bearing
agreements with respect to certain surgical instruments, including the
KnotMaker-TM- product and the balloon valve trocar. The payment of such
royalty amounts will have an adverse impact on the Company's gross profit and
results of operations.
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 year 1998. 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 and research
and development (including marketing-related clinical evaluations). In
addition, the Company has experienced higher administration expenses since
its initial public offering resulting from its obligations as a public
reporting company and defense of its patents.
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 its distributors, its distributors'
ability to achieve certain levels of sales growth, the status of the
Company's relationship
8
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with EES and other partners, the Company's ability to sell its line of
cardiovascular products, 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, sales of
competitive products and the introduction of new products from competitors
(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 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 facility lease in
Cupertino, California and relocated its headquarters and manufacturing
operations to this new location in April 1997. The new facility's lease
comprises approximately 30,460 square feet, and the monthly rent is
approximately $52,000.
In October 1997, the Company received its CE mark certification,
pursuant to the Medical Devices Directive, which enables the Company to affix
CE marking on its products and continue selling its products within the
European Economic Area.
RESULTS OF OPERATIONS
REVENUE. Total revenue increased by 22% to approximately $2.3 million
for the quarter ended December 31, 1997 from $1.9 million for the same period
in 1996. This increase was mainly due to increased sales to EES of the
SPACEMAKER-Registered Trademark- I and II platforms for the hernia market.
Current quarter revenue includes an $860,000 payment from EES in lieu of
product purchases pursuant to a mutual agreement, while the prior year
quarter includes a $1.5 million guaranteed payment. Revenue for the six
months ended December 31, 1997 increased 6% to approximately $4.6 million
from $4.3 million for the six months ended December 31, 1996.
COST OF SALES. Cost of sales increased by 230% to approximately $1.2
million for the quarter ended December 31, 1997 from $359,000 for the same
period in 1996. Cost of sales decreased as a percentage of sales to 84% for
the quarter ended December 31, 1997 from 99% for the quarter ended December
31, 1996. This increase in absolute dollars, as well as the improved gross
margin, was related to increased unit sales, mostly to EES, as compared to
the previous period. Cost of sales for the six months ended December 31,
1997 increased as a percent of sales to 72%, or approximately $2.1 million,
as compared to 48% of sales, or approximately $1.4 million, for the six
months ended December 31, 1996. This increase as a percent of sales is
mainly due to the Company's increased capacity as a result of relocating its
manufacturing facility during April 1997.
9
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RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses,
which include expenditures for marketing-related clinical evaluations and
regulatory expenses, increased by 36% to approximately $658,000 in the
quarter ended December 31, 1997 from $484,000 for the same period in 1996.
R&D expenses for the six months ended December 31, 1997 were approximately
$1.4 million as compared to $946,000 for the same period of the prior fiscal
year, or a 50% increase. These increases are a result of the company
dedicating more resources during the past six months to developing its
cardiovascular products.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses increased by 51% to approximately $2.9 million for
the quarter ended December 31, 1997 from $1.9 million for the quarter ended
December 31, 1996. For the six months ended December 31, 1997, SG&A expenses
were $5.4 million compared to $3.8 million for the same period in 1996.
These increases are primarily due to increased legal expenses related to
intellectual property litigation.
INTEREST INCOME, INTEREST EXPENSE AND OTHER INCOME (EXPENSE). Interest
and other income (net of expense) decreased to approximately $585,000 for the
quarter ended December 31, 1997 from $670,000 for the quarter ended December
31, 1996. For the six months ended December 31, 1997 interest and other
income (net of expense) decreased to $1.2 million from $1.3 million for the
same period in 1996. Decreases are due mainly to lower 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 approximately
$18.9 million at December 31, 1997. The Company has funded its operations
primarily through the sale of equity securities. From its inception through
December 31, 1997 the Company raised approximately $62 million through the
sale of equity securities.
As of December 31, 1997 the Company's principal source of liquidity
consists of cash, cash equivalents and available-for-sale securities of $41.0
million, as compared to $43.7 million at June 30, 1997. In addition, the
Company has a bank line of credit available for $1,500,000. As of December
31, 1997, the Company has no amounts outstanding under this line. The
Company also has an equipment loan with an outstanding balance of
approximately $268,000.
The Company expects to incur substantial additional costs, including
costs related to patent litigation, 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. 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 at least calendar 1998. The
Company may seek additional equity or debt financing to address its working
capital needs or to provide funding for capital expenditures. There can be
no assurance that additional financing, if sought, will be available on
satisfactory terms or at all.
10
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RECENT PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130 (SFAS 130), REPORTING COMPREHENSIVE
INCOME. This statement establishes requirements for disclosure of
comprehensive income and becomes effective for the Company for fiscal years
beginning after December 15, 1997, with reclassification of earlier financial
statements for comparative purposes. Comprehensive income generally
represents all changes in shareholders' equity except those resulting from
investments or contributions by shareholders. The Company is evaluating
alternative formats for presenting this information, but does not expect this
pronouncement to materially impact the Company's results of operations.
In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131 (SFAS 131), DISCLOSURES ABOUT
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. This statement
establishes standards for disclosure about operating segments in annual
financial statements and selected information in interim financial reports.
It also establishes standards for related disclosures about products and
services, geographic areas and major customers. This statement supersedes
Statement of Financial Accounting Standards No. 14, FINANCIAL REPORTING FOR
SEGMENTS OF A BUSINESS ENTERPRISE. The new standard becomes effective for
fiscal years beginning after December 15, 1997, and requires that comparative
information from earlier years be restated to conform to the requirements of
this standard. The Company is evaluating the requirements of SFAS 131 and
the effects, if any, on the Company's current reporting and disclosures.
FACTORS AFFECTING FUTURE RESULTS
LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company has a
limited operating history upon which an evaluation of the Company and its
prospects can be based. As of December 31, 1997, the Company had an
accumulated deficit of $18.9 million. The Company's net operating losses for
the fiscal years ending June 30, 1995, 1996 and 1997 and for the quarters
ended September 30, 1997 and December 31, 1997 were $4.1 million, $5.5
million, $1.9 million, $1.3 million and $1.9 million, respectively. The
Company expects to continue to incur operating losses on a quarterly and
annual basis through at least calendar year 1998. Due to the Company's
limited operating history, there can be no assurance of sales growth or
profitability in the future. The Company intends to increase 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
11
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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. Nearly all of the Company's sales since inception have been
derived from sales of its balloon dissection products, with a substantial
portion derived from sales for hernia repair procedures. Failure of the
Company to develop and successfully 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 market
acceptance of and demand for the Company's products and related procedures,
the nature of the technological advances inherent in the product designs,
reduction in patient trauma or other benefits provided by such products,
results of marketing-related clinical evaluations, continued adoption of
minimally invasive surgery ("MIS") procedures by surgeons, reimbursement for
the Company's products by health care payors and the Company's receipt of
regulatory approvals. There can be no assurance that the Company's products
will have the required technical characteristics, that the Company's products
will provide adequate patient benefits, that 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.
DEPENDENCE ON KEY DISTRIBUTORS. In December 1996, the Company entered
into a five year OEM supply agreement (the "Expanded EES Agreement") with
EES, pursuant to which GSI granted EES worldwide sales and marketing rights
to sell the SPACEMAKER-Registered Trademark- 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. Under the Expanded EES Agreement, EES
was obligated to make $4.9 million in guaranteed payments to the Company
during the year ended June 30, 1997, but is not obligated to make any further
guaranteed payments. In lieu of product purchases, and pursuant to a mutual
agreement, EES made additional payments in the amount of $775,000 in the
first quarter of fiscal year 1998 and $860,000 in the second quarter of
fiscal year 1998. There can be no assurance that EES's marketing or
distribution efforts will be successful. EES's failure to achieve certain
levels of sales growth or product orders could have a material adverse effect
on the Company's business, financial condition and results of operations. In
December 1997, the Company entered into a four year distribution agreement
with Genzyme Surgical Products Corporation ("Genzyme"). Under the agreement,
Genzyme, a biotechnology and health care products company, has exclusive
rights to market and distribute GSI's surgical balloon dissectors worldwide
for use in plastic surgery (reconstructive and aesthetic) procedures.
The Company's products are sold internationally to hospitals, surgeons
and specialists through EES and independent distributors in Europe, Asia,
Latin America and the Middle East. In June 1997, GSI entered into an
exclusive agreement with Japan Lifeline to market and
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distribute in Japan GSI's balloon dissection systems for use in vascular
procedures. Japan Lifeline is expected to begin distribution of the GSI
balloon dissection systems following receipt of the Japanese Ministry of
Health and Welfare approval, which the Company expects to occur in fiscal
1998. Although the Company expanded its international distribution network by
adding several distributors to distribute its cardiovascular products, and
although the Company intends to continue to establish additional
distributorships in the United States and internationally for products in
areas other than hernia repair, urinary stress incontinence and certain
plastic surgery procedures, there can be no assurance that recently appointed
distributors will be successful, or that efforts to establish additional
distributors will be successful. Failure of current distributors to succeed
or failure to add additional distributors to its distribution network could
have a material adverse effect on the Company's business, financial condition
and results of operations.
LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only
limited experience marketing and selling its products through its direct
sales force, and has sold its products in commercial quantities through its
direct sales force to the hernia market and, to a lesser degree, to the
cardiovascular and cosmetic and reconstructive surgery markets. Establishing
marketing and sales capability sufficient to support sales in commercial
quantities for the cardiovascular market targeted by the Company will require
significant resources. There can be no assurance that the Company will be
able to recruit and retain additional qualified marketing or sales personnel,
or that future sales efforts of the Company will be successful. In markets
other than cardiovascular, 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.
UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE.
The Company's success is substantially dependent upon the success of its
SPACEMAKER-Registered Trademark- balloon dissection products. The Company
believes that market acceptance of the Company's products will depend on the
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 third party reimbursement for procedures using the
Company's SPACEMAKER-Registered Trademark- 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 failure to obtain reimbursement for some or all
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of its 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."
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
numerous factors, including (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 its distributors,
(iii) the rate of adoption by surgeons of balloon dissection technology in
markets targeted by the Company, (iv) the sales efforts of the Company's
distributors, (v) the mix of sales among distributors and the Company's
direct sales force, (vi) timing of patent and regulatory approvals, if any,
(vii) timing and growth of 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 December 1996, the Company entered into the Expanded Ethicon
Agreement, pursuant to which GSI granted EES worldwide sales and marketing
rights to sell the SPACEMAKER-TM- Balloon Dissection Systems in the
laparoscopic hernia repair and urinary stress incontinence 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.
EES made approximately $4.9 million in guaranteed payments to the Company in
fiscal year 1997, which constituted 54% of revenues for fiscal year 1997.
Although EES is not obligated to make any such guaranteed payments in future
quarters, EES made payments by mutual consent of $775,000 in the first
quarter of fiscal year 1998 and $860,000 in the second quarter of fiscal year
1998. The Company anticipates that sales to EES may decrease in the future.
Failure by EES to achieve certain levels of sales growth or purchases could
adversely affect the Company's operating results. In addition, announcements
or expected announcements by the Company, its competitors or its distributors
of new products, new technologies or pricing changes could cause existing or
potential customers of the Company to defer purchases of the Company's
existing products and could alter the mix of products 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
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event, the price of the Company's Common Stock would likely be materially and
adversely affected.
RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's success
will depend on its ability to obtain patent protection for its products and
processes, to preserve its trade secrets and proprietary technology and to
operate without infringing upon the patents or proprietary rights of third
parties.
In May 1996, Origin MedSystems, Inc. ("Origin"), a unit of the Guidant
Corporation and a competitor of the Company, 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." In June, 1996, GSI filed an action against Origin 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. In addition, on September 26, 1997, the Company filed
another action against Origin alleging patent infringement of its patent for
a method of serial inflation of tissue dissectors. A decision against the
Company in any of these actions could have a material adverse effect on the
Company's business, financial condition or results of operations.
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. 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 expected in this interference
proceeding in calendar year 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 and infringement involve complex legal and factual
issues and are highly uncertain, and there can be no assurance that any
conclusion reached by the Company regarding patent interference or
infringement will be consistent with the resolution of such issue by a court
or the USPTO. 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 successfully modify 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. As discussed above, the Company is defending itself, and may in
the future have to defend itself, against allegations of infringement of
third-party patents. Patent litigation is expensive, requires extensive
management time, and could subject the Company to significant liabilities,
require disputed rights to be licensed from third parties or require the
Company to cease selling its products.
The validity and breadth of claims in medical technology patents involve
complex legal and factual questions and, therefore, may be highly uncertain.
No assurance can be given that any patents based on pending patent
applications or any future patent applications will be issued, that the scope
of any patent protection will exclude competitors or provide competitive
advantages to the Company, that any of the Company's patents or patents to
which it has licensed rights will be held valid under current
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challenges or if subsequently challenged or that persons or entities in
addition to Origin will not claim rights in or ownership of the patents and
other proprietary rights held or licensed by the Company or that the
Company's existing patents will cover the Company's future products.
Furthermore, there can be no assurance that others have not developed or will
not develop similar products, duplicate any of the Company's products or
design around any patents issued to or licensed by the Company or that may be
issued in the future to the Company. Since patent applications in the United
States are maintained in secrecy until patents issue, the Company also cannot
be certain that others did not first file applications for inventions covered
by the Company's pending patent applications, nor can the Company be certain
that it will not infringe any patents that may issue to others on such
applications.
Legislation has recently been enacted in Congress, the effect of which
tends to immunize physicians and their employers from liability 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 foreign
patent protection for its methods of tissue dissection may 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. The Company has also
acquired patent rights under royalty-bearing agreements with respect to
certain surgical instruments. The payment of such royalty amounts will have
an adverse impact on the Company's gross profit and 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 addition, in January 1997 the Company entered into a real estate lease and
has relocated its headquarters and manufacturing operations in April 1997 to
a new facility. Moreover, the Company has experienced rapid growth in the
number of products under development, the number and amount of products
manufactured, 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 research and
development and sales and marketing. 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
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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 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 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
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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 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 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-Registered
Trademark- 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 and as amended in the Safe Medical Devices Act of 1990, the FDA
regulates the pre-production design controls, 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.
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Labeling and promotional activities are subject to scrutiny by the FDA
and, in certain circumstances, by the Federal Trade Commission. Current FDA
enforcement policy prohibits the marketing of approved medical devices for
unapproved uses. The SPACEMAKER-Registered Trademark- I platform, SPACEMAKER
II-Registered Trademark- platform, SPACEMAKER-Registered Trademark- serial
platform, combined SPACEMAKER-Registered Trademark- surgical balloon
dissector/expander platform and KnotMaker-TM- product each have received
510(k) clearance for use during general, endoscopic, laparoscopic and
cosmetic and reconstructive surgery, either when tissue dissection is
required or, with respect to the KnotMaker-TM- product, when a surgical knot
for suturing is required. The Company has promoted these products for
surgical applications (E.G., hernia repair, treatment of stress urinary
incontinence, 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. saphenous vein harvesting, a variety of orthopaedic
procedures such as anterior spinal fusion, and long bone plating). For any
medical device cleared through the 510(k) process, modifications or
enhancements that could significantly affect the safety or effectiveness of
the device or that constitute a major change to the intended use of the
device will require a new 510(k) submission. The Company has made
modifications to its products which the Company believes do not affect the
safety or effectiveness of the device or constitute a major change to the
intended use and therefore do not require the submission of new 510(k)
notices. There can be no assurance, however, that the FDA will agree with any
of the Company's determinations not to submit a new 510(k) notice for any of
these changes or will not require the Company to submit a new 510(k) notice
for any of the changes made to the product. If such additional 510(k)
clearances are required, there can be no assurance that the Company will
obtain them on a timely basis, if at all, and delays in receipt of or failure
to receive such approvals could have a material adverse effect on the
Company's business, financial condition and results of operations. If the FDA
requires the Company to submit a new 510(k) notice for any product
modification, the Company may be prohibited from marketing the modified
product until the 510(k) notice is cleared by the FDA.
Sales of medical devices outside of the United States are subject to
foreign regulatory requirements that vary widely from country to country. In
October 1997, the Company received its CE mark certification, pursuant to the
Medical Devices Directive which enables the Company to affix CE marking on
its products and continue selling its products within the European Economic
Area. The Company currently relies on its international distributors for the
receipt of premarket approvals and compliance with clinical trial
requirements in those countries that require them, and it expects to continue
to rely on distributors in those countries where the Company continues to use
distributors. In the event that the Company's international distributors fail
to obtain or maintain premarket approvals or compliance in foreign countries
where such approvals or compliance are required, the Company may be required
to cause the applicable distributor to file revised governmental
notifications, cease commercial sales of its products in the applicable
countries or otherwise act so as to stop any ongoing noncompliance in such
countries. Any enforcement action by regulatory authorities with respect to
past or any future regulatory noncompliance could have a material adverse
effect on the Company's business, financial condition and results of
operations.
LIMITED MANUFACTURING EXPERIENCE; 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
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shortages of qualified personnel. Difficulties experienced by the Company in
manufacturing scale-up and manufacturing difficulties (including, in the
event of low demand, over-capacity) 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.
In January 1997, the Company entered into a new facility lease in
Cupertino, California, and 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 $52,000.
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
causes or 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. There were no international
sales in the first quarter of fiscal 1998 and $5,000 in the second quarter of
fiscal 1998. Sales outside of the United States accounted for .5% and 4% of
the Company's sales in fiscal 1997 and 1996, respectively. 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
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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 operations. In addition, the Company's success will be dependent
upon its ability to attract and retain additional highly qualified sales,
management, manufacturing and research and development personnel. The Company
faces intense competition in its recruiting activities and there can be no
assurance that the Company will be able to attract and/or retain qualified
personnel.
POTENTIAL VOLATILITY OF STOCK PRICE. The market prices of the Company's
common stock and the stock of many other publicly held medical device
companies have in the past been, and can in the future be expected to be,
especially volatile. Announcements regarding competitive developments,
product sales, clinical marketing trial results, release of reports by
securities analysts, developments or disputes concerning patents or
proprietary rights, regulatory developments, changes in regulatory or medical
reimbursement policies, economic and other external factors, as well as
period-to-period fluctuations in the Company's financial results, may have a
significant impact on the market price of the Common Stock. In addition, the
securities markets have from time to time experienced significant price and
volume fluctuations that are unrelated to the operating performance of
particular companies.
YEAR 2000 COMPLIANCE. The Company is aware of the issues associated with
the programming code in existing computer systems as the millenium (year
2000) approaches. The "year 2000" problem is pervasive and complex as
virtually every computer operation will be affected in some way by the
rollover of the two digit year value to 00. The issue is whether computer
systems will properly recognize date sensitive information when the year
changes to 2000. Systems that do not properly recognize such information
could generate erroneous data or cause a system to fail.
The Company is utilizing both internal and external resources to
identify, correct or reprogram, and test the systems for the year 2000
compliance. It is anticipated that all reprogramming efforts will be
completed by December 31, 1998 allowing adequate time for testing. Management
believes that there will not be a material effect on the Company's earnings
as a result of this compliance.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In May 1996, Origin MedSystems, Inc., a unit of the Guidant Corporation,
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." In June, 1996,
GSI filed a claim against Origin in the United States District Court for the
Northern District of California, alleging patent infringement of its patent
for a method of tissue plane dissection using balloon systems. In addition,
on September 26, 1997, the Company filed another action against Origin
alleging patent infringement of its patent for a method of serial inflation
of tissue dissectors. A decision against the Company in any of these actions
would have a material adverse effect on the Company's business, financial
condition or results of operations. 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. 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 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 or in either of the
lawsuits described above would have a material adverse effect on the
Company's business, financial condition and results of operations.
21
<PAGE>
From time to time the Company may be exposed to litigation arising out
of its products or operations. The Company is not engaged in any legal
proceedings that are expected, individually or in the aggregate, to have a
material adverse effect on the Company, except for the patent interference
and infringement proceedings discussed herein.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In connection with its initial public offering in 1996, the Company
filed a Registration Statement on Form S-1, SEC File No. 333-02774 (the
"REGISTRATION STATEMENT"), which was declared effective by the Commission on
May 9, 1996. Pursuant to the Registration Statement, the Company registered
and sold 3,450,000 shares of its Common Stock, $0.001 par value per share,
for its own account. The offering commenced on May 10, 1996 and terminated
when all of the registered shares had been sold. The aggregate offering
price of the registered shares was $51,750,000. The managing underwriters of
the offering were Cowen & Company and UBS Securities LLC.
From May 10, 1996 to December 31, 1997, the Company incurred the
following expenses in connection with the offering:
<TABLE>
<S> <C>
Underwriting discounts and commissions $3,622,500
Other expenses $1,187,025
----------
Total Expenses $4,809,525
</TABLE>
All of such expenses were direct or indirect payments to others.
The net offering proceeds to the Company after deducting the total
expenses above were $46,940,475. From May 10, 1996 to December 31, 1997, the
Company used such net offering proceeds, in direct or indirect payments to
others, as follows:
<TABLE>
<S> <C>
Construction of plant, building and facilities $ 1,164,154
Purchase and installment of machinery and equipment $ 1,189,779
Repayment of indebtedness $ 761,434
Working capital $24,389,526
-----------
Total $27,504,893
</TABLE>
This use of proceeds does not represent a material change in the use of
proceeds described in the prospectus of the Registration Statement.
ITEM 3. DEFAULTS IN SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On November 10, 1997, at the Company's Annual Meeting of Shareholders
for the Fiscal Year Ending June 30, 1997, the following matters were
submitted and voted on by securityholders and were adopted:
A. The election of directors to serve until their successors are elected
and qualified.
The results for the vote are as follows:
<TABLE>
<CAPTION>
FOR WITHHELD
--- --------
<S> <C> <C>
Gregory D. Casciaro 9,687,868 16,046
David W. Chonette 9,689,713 14,201
Thomas J. Fogarty 9,685,368 18,546
Paul Goeld 9,690,613 13,301
James R. Sulat 9,685,613 18,301
Mark A. Wan 9,690,613 13,301
Roderick A. Young 9,309,100 394,814
</TABLE>
B. The approval of an amendment to the 1992 Stock Option Plan to
increase the number of shares of Common Stock reserved for issuance
thereunder by 500,000.
The results for the vote are as follows:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN BROKER NON-VOTE
--- -------- ------- ---------------
<S> <C> <C> <C>
9,200,902 482,887 3,050 17,075
</TABLE>
C. The ratification of Coopers & Lybrand, LLP as the Company's
independent accountants for the fiscal year ended June 30, 1998.
The results of the vote are as follows:
<TABLE>
<CAPTION>
FOR AGAINST ABSTAIN
--- -------- -------
<S> <C> <C>
9,695,314 7,100 1,500
</TABLE>
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
22
<PAGE>
(a) Exhibits
Exhibit Description
------- -----------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
The Company filed no reports on Form 8-K during the quarter ended
December 31, 1997.
23
<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
Principal and Chief Financial Officer
Date: February 13, 1998
24
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> OCT-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 7,374
<SECURITIES> 33,649
<RECEIVABLES> 2,269
<ALLOWANCES> 54
<INVENTORY> 1,016
<CURRENT-ASSETS> 45,378
<PP&E> 3,283
<DEPRECIATION> 996
<TOTAL-ASSETS> 47,892
<CURRENT-LIABILITIES> 1,515
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 46,049
<TOTAL-LIABILITY-AND-EQUITY> 47,892
<SALES> 1,408
<TOTAL-REVENUES> 2,268
<CGS> 652
<TOTAL-COSTS> 1,186
<OTHER-EXPENSES> 3,564
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 585
<INCOME-PRETAX> (1,897)
<INCOME-TAX> 0
<INCOME-CONTINUING> (1,897)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (1,897)
<EPS-PRIMARY> (0.14)
<EPS-DILUTED> (0.14)
</TABLE>
