-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TGY2nxaQ60PAq9vVsWWHzBMGkXzBHWlydD23PNmU5QkMF5rimVAt+UI567sam5U7 1HjfsopN+yUoUlGL4cavyQ== 0000927016-98-001299.txt : 19980401 0000927016-98-001299.hdr.sgml : 19980401 ACCESSION NUMBER: 0000927016-98-001299 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INNOVASIVE DEVICES INC CENTRAL INDEX KEY: 0001003608 STANDARD INDUSTRIAL CLASSIFICATION: ORTHOPEDIC, PROSTHETIC & SURGICAL APPLIANCES & SUPPLIES [3842] IRS NUMBER: 043132641 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-28492 FILM NUMBER: 98581468 BUSINESS ADDRESS: STREET 1: 734 FOREST ST CITY: MARLBOROUGH STATE: MA ZIP: 01752 BUSINESS PHONE: 5084346000 MAIL ADDRESS: STREET 1: 734 FOREST STREET CITY: MARLBOROUGH STATE: MA ZIP: 01752 10-K 1 FORM 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year Ended December 31, 1997 Commission file number 0-28492 ----------------- - -------------------------------------------------------------------------------- INNOVASIVE DEVICES, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Massachusetts 04-3132641 - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 734 Forest Street, Marlborough MA 01752 - -------------------------------------------------------------------------------- (Address of principal executive offices) Registrant's telephone number, including area code 508/460-8229 ------------ N/A - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: COMMON STOCK $.0001 PAR VALUE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No. --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the Registrant, based upon the closing price of the Common Stock on March 24, 1998 , on the Nasdaq Stock Market, was approximately $ 39,975,000. Shares of Common Stock held by each officer and director and by each person who owns 5% or more of the outstanding Common Stock have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes. As of March 24, 1998 the Registrant had 9,170,510 shares of Common Stock outstanding. PART I ITEM 1. BUSINESS GENERAL The Company designs, develops, manufactures and markets proprietary tissue repair systems which facilitate the repair of soft tissue injuries. The Company's tissue repair systems are designed to be used in either open surgical or minimally invasive arthroscopic procedures. Performing repairs arthroscopically offers several benefits, including reduced patient trauma and shorter rehabilitation times, resulting in an expedited return to full physical activity. The Company's initial products consisted of the ROC (Radial Osteo Compression) family of suture fasteners and related arthroscopic instruments which are marketed for use in the sports medicine/arthroscopy segment of the orthopaedic market. The Company currently markets a broad based product line within four product platforms: suture fasteners, suturing systems, cartilage repair and anterior cruciate ligament ("ACL") reconstruction products. These product platforms have been developed to drive the emerging growth trends in sports medicine: the movement away from metallic implants in and around the joints and the development of definitive soft tissue repairs to replace existing palliative treatments. The Company competes in the soft tissue repair segment of the sports medicine/arthroscopic surgery market. The Company markets its products and related instruments principally to sports medicine orthopeadic surgeons who treat and repair soft tissues, within and around joints, which have been damaged by traumatic injury or degenerative disease. The Company is focusing its efforts on this market primarily because of two factors: the growth of the segment and the potential for improvement over conventional clinical methods and products. The Company's products are based on unique and proprietary technologies. Based on its existing designs, the Company is developing and currently testing next generation products using bioabsorbable composites, which degrade and absorb into surrounding tissue, and collagen-based biomaterial composites, which remodel into surrounding tissue. In addition, the Company is pursuing opportunities to apply its core technologies outside of orthopaedics. 2 PRINCIPAL PRODUCTS AND APPLICATIONS The Company currently markets proprietary devices and instruments encompassing four product platforms: Suture Fasteners, Suture Systems, Cartilage Repair Systems and Anterior Cruciate Ligament ("ACL") Repair Systems. All of the Company's current products have received 510(K) clearance or have been exempted by the FDA from the 510(K) clearance process. The following chart sets forth the product release date, current applications and features and benefits of the Company's principal products:
- --------------------------------------------------------------------------------------------------------------------------------- INITIAL CURRENT PRODUCT RELEASE DATE APPLICATIONS FEATURES AND BENEFITS - --------------------------------------------------------------------------------------------------------------------------------- Suture Fasteners - --------------------------------------------------------------------------------------------------------------------------------- ROC EZ Suture Fastener June 1997 Shoulder, knee, foot, ankle, . primary fastener for hard bone bladder neck suspension . all polymer design . revisable . available for open and arthroscopic repair - --------------------------------------------------------------------------------------------------------------------------------- ROC XS Suture Fastener May 1996 Shoulder, bladder neck suspension . primary fastener for soft bone . all polymer design - --------------------------------------------------------------------------------------------------------------------------------- MiniROC Suture Fastener April 1996 Shoulder, hand and wrist . primary fastener for small bones . all polymer design . revisable . 5mm fastener length - --------------------------------------------------------------------------------------------------------------------------------- Suture Systems - --------------------------------------------------------------------------------------------------------------------------------- Cuff Link July 1997 Rotator Cuff . prevents suture migration though bone following rotator cuff repair . protects the suture/bone interface when using transosseous tunnels - --------------------------------------------------------------------------------------------------------------------------------- IDeal Suture Grasper January 1995 Open and arthroscopic knot tying . 15, 30, 45 and 60 degree angles . athroscopically sutures tissue without needles - --------------------------------------------------------------------------------------------------------------------------------- Cartilage Repair - --------------------------------------------------------------------------------------------------------------------------------- COR System September 1996 Grafting of bone plugs in the . cutter allows for precise cutting of bone knee plugs . bone plugs are cleanly transferred to donor site . 4, 6 and 8mm cutter diameters - --------------------------------------------------------------------------------------------------------------------------------- ACL Repair - --------------------------------------------------------------------------------------------------------------------------------- Linx HT November 1997 ACL soft tissue graft femoral . Links hamstring directly to bone fixation . Provides permanent biocompatible fixation . Strong fixation using conventional technique - --------------------------------------------------------------------------------------------------------------------------------- Cannulated Interference August 1997 ACL bone-tendon-bone fixation . Design minimized tissue trauma Screw System . Locking thread secures bone block fixation - --------------------------------------------------------------------------------------------------------------------------------- Geo-Fit Screw and Washer October 1997 ACL soft tissue graft femoral . Low profile screws and washers minimize System and tibial fixation tissue irritation . Washers shaped to conform to bone contours - ---------------------------------------------------------------------------------------------------------------------------------
3 In 1997 the Company expanded its line of products beyond the ROC family of suture bone fasteners. New fasteners added to the offering include the 2.8mm and 3.5mm ROC EZ fastener introduced in June of 1997 for shoulder, knee, foot, ankle and bladder neck suspension applications. An arthroscopic version of the ROC XS was also introduced in October 1997. A new platform of suture system products was started with the July 1997 introduction of the Cuff Link. This product was designed specifically for bone tunnel augmentation in transosseous repair of the rotator cuff. The Company introduced its first products for ACL repair in August 1997 with the introduction of the Cannulated Interference Screw System. In October 1997 the Geo-Fit Screw and Washer system was introduced for the same application. These products also represent the first offerings resulting from the acquisition of MedicineLodge, Inc. ("MLI"). In November 1997, the Company expanded its ACL repair offerings with the introduction of the Linx HT. This polymer device is designed for direct fixation of soft tissue grafts for femoral fixation. The Company also introduced an extension of its COR System with the release of the 4mm and 8mm COR System for treating cartilage defects in the knee. These products were based on the successful introduction of the 6mm COR System in September 1996. PRODUCT DEVELOPMENT The Company has a variety of new products in various stages of development designed to address a number of clinical needs. The Company does not currently have FDA clearance to market any of these products, other than the Bioabsorbable ROC EZ Suture Fasteners and Arthroscopic Knot Replacement System described below. NEXT GENERATION SUTURE FASTENERS Bioabsorbable ROC EZ Suture Fasteners. The Company has been developing bioabsorbable suture fasteners employing the ROC EZ technology. Suitable bioabsorbable materials have been identified, fasteners have been manufactured and pre-clinical testing has been completed. The goal is to develop a suture fastener with mechanical properties similar to the ROC EZ fastener in a format that will degrade and absorb into surrounding tissue after the damaged tissue has securely reattached to the bone. The Company received FDA 510k clearance for this product in February 1998. Collagen Biomaterial Tissue Repair System. The Company has a collaborative agreement with Collagen Corporation to develop tissue repair systems using the biomaterial collagen. Products are being designed to degrade into by-products which will be reincorporated, or remodeled, into surrounding tissues, such as cartilage or bone. The initial project, a collagen suture fastener, is in pre- clinical testing. 4 SUTURE SYSTEMS Arthroscopic Knot replacement. The Company has developed a device to be used as an alternative to the conventional surgical suture knot. This device can be easily delivered through a cannula when used arthroscopically and will tightly secure suture used in the tissue to bone interface. The Company received 510K clearance in December 1997 and is currently concluding market preference testing. ACL REPAIR Modular Staple and Washer System. The Company is in the final phase of development of an integrated modular staple and washer system. This system was developed for the attachment of a soft tissue ACL graft at the tibia. The Company received 510k clearance in October 1996. Transverse Fixation System. The Company has developed an ACL repair system to address the segment of the market which prefers to remove the repair device after the tissue has healed. This system also provides the surgeon an alternative to conventional ACL fixation techniques. The system primarily consists of a Cross Pin, which is used for soft tissue grafts, and a Set Screw, which is used for bone-patella-bone graft fixation. The Company received 510K clearance in September 1996. MENISCAL AND CARTILAGE REPAIR The meniscus is a pad of spongy cartilage tissue which acts as a shock absorber between the two major bones which form the knee. The surfaces of the knee bones are covered by articular cartilage that are the gliding surfaces that allow the knee to bend smoothly. Tears of the meniscus and damage to the articular cartilage are two common orthopaedic injuries. Conventional techniques for meniscal and cartilage repair may be rather tedious, time-consuming and accompanied by risks of complications. Meniscal Repair. Tears of the meniscus are currently treated primarily by arthroscopic menisectomy, the removal of torn tissue. Partial menisectomies can be performed in a matter of minutes with limited risks of complications and often result in short-term functional improvements of the knee due to the removal of attached and detached tissue fragments. However, menisectomies may lead to greater knee instability and accelerate the onset of degenerative knee disease. An alternative treatment for tears of the meniscus is meniscal suture repair, which involves the repeated passing of long needles and suture through the tight confines of the knee joint to reapproximate the torn tissue. The Company intends to expand its product offering to knee applications with the development of an arthroscopic system designed to repair the torn meniscus. RECONSTRUCTIVE AND ENDOSCOPIC PLASTIC SURGERY. Reconstructive plastic surgery typically requires the reattachment of bone and tissue to surrounding bone. Occasionally, tissue must be removed and replaced for aesthetic considerations. The Company believes its proprietary fixation technology can be developed to provide a means to reattach bone and tissue structures using conventional or biomaterial fracture fixation plates. The Company also believes that suture fasteners using its proprietary ROC technology in a minimally invasive endoscopic procedure can be developed to attach sagging tissue which cause facial wrinkles. If products are developed for endoscopic plastic surgery using Collagen Corporation's proprietary technology, Collagen Corporation would have the right to distribute such products under its distribution agreement with the Company. See "Business-Relationship with Collagen Corporation." 5 RESEARCH AND DEVELOPMENT The Company's objective is to continue to develop innovative products for the sports medicine/arthroscopy market and to maximize the potential of its core proprietary technology in nonorthopaedic markets. The Company's research and development department currently consists of ten engineers with substantial design experience in the field of orthopeadics and arthroscopy. During the fiscal year ended December 31, 1997 and 1996, the Company incurred expenses of $4.0 million and $2.7 million, respectively, in connection with its research and development efforts. The Company's research and development department is continually engaged in assessing new tissue repair device technologies and techniques which are applicable to the Company's business strategy. The research and development engineers spend a significant amount of time with surgeon advisors and members of the Company's Medical Advisory Board in evaluating new product ideas. The Company has collaborative arrangements with university-based research centers for pre-clinical design testing. In the future, the Company's research and development efforts may include the identification of new technologies developed by others and the acquisition or licensing of new technologies and product lines and extensions. SALES AND MARKETING The Company's sales and marketing strategy is to focus its efforts on arthroscopic/sports medicine surgeons through a combination of direct sales calls, clinical workshops and presentations to medical arthroscopic surgeons and sports medicine specialists. The Company's clinical sales agents and marketing personnel meet with surgeons to conduct product demonstrations, attend surgical procedures and provide training. Sales and marketing personnel also attend numerous domestic and foreign medical conventions each year where they exhibit and demonstrate the Company's products. The Company markets its products to surgeons in the United States through a network of seventeen clinical employee sales representatives, 104 independent sales agents and five regional sales managers. In addition to its field sales force, as of March 24, 1998 the Company employed a staff of thirteen corporate marketing, sales and customer service support staff employees. This staff manages clinical training workshops, sales management, print and video promotion, sales data analysis, convention management and international marketing. The Company ships to and invoices its hospital customers directly in the US. The Company markets its products internationally through fifteen established distributors of orthopaedic medical devices. The Company's products are sold directly to stocking distributors who sell the products to hospitals and clinics. For the year ended December 31, 1997, international sales accounted for 15% of net sales. The Company also works with a Medical Advisory Board (the MAB) of nine surgeons and a Clinical Advisory Group (the "CAG") of nineteen surgeons located across the United States. The members of the MAB and CAG are opinion leaders in the field of arthroscopy and sports medicine and are affiliated with professional athletic teams, collegiate athletic departments and major orthopaedic hospitals. The Company relies on the MAB and CAG to conduct workshops at which new surgeons train on the use of the Company's products, evaluate products clinically prior to their general market release, present the Company's products at conferences, assist in creating training videos and advise the Company on new surgical and product techniques. 6 MANUFACTURING AND QUALITY CONTROL The manufacture of the Company's devices and instruments consists of inspection, assembly, testing, packaging and sterilization of components that have been molded, machined or manufactured by the Company or to the Company's specifications by outside contractors. Samples of sterilized products are sent to a certified laboratory to validate that sterilization procedures have been adequately performed. After this validation, the products are shipped to customers. The Company maintains a high level of quality control and inspects each lot of components to ensure that they comply with the Company's exacting specifications. Most purchased components are available from more than one vendor. For certain of these components, there are relatively few alternative sources of supply and establishment of additional or replacement suppliers for such components cannot be accomplished quickly. Many components are injection molded using Company owned molds. Many polymer components have only one mold and replacement of the molds can take 12 to 16 weeks. Any bioabsorbable materials used in future products will likely be available from a single source. Any supply interruption from single source vendors could have a material adverse effect on the Company's ability to supply products. There is risk that certain suppliers may terminate sales of certain materials to companies that manufacture medical devices in an attempt to limit their potential product liability exposure. If the polymers which are used to manufacture the Company's ROC suture fasteners become unavailable, the Company would be required to identify a new polymer material for the suture fasteners and certify the quality and suitability of the new material. In addition, a new 510(k) clearance would have to be obtained to market products manufactured from the new materials. This process could take a substantial period of time and there is no assurance that the Company would be able to identify, certify or obtain clearance for the new polymer based fasteners. The Company operates manufacturing facilities in Marlborough, MA and Logan UT. The Company abides by the FDA's Good Manufacturing Practices and the requirements of foreign regulatory agencies. The Marlborough, MA facility received ISO 9001 registration and EN 46001 certification in October 1997. The Logan, UT manufacturing facility is currently pursuing ISO 9001 registration and EN 46001 certification. RELATIONSHIP WITH COLLAGEN CORPORATION The Company is a party to a Research and Development Agreement, a Manufacturing and Supply Agreement and a Distribution Agreement with Collagen Corporation, a leading developer of implantable bovine collagen. Pursuant to these agreements, the Company and Collagen Corporation have crosslicensed their respective technologies relating to collagen materials and medical devices. Collagen Corporation holds approximately 9.2% of the Company's Common Stock. Pursuant to an agreement among the Company and certain of its stockholders, Collagen Corporation has the right to designate one member of the Company's Board of Directors so long as it holds at least five percent of the Company's outstanding Common Stock on a fully-diluted basis. David Foster, Sr. Vice President of Collagen Corporation, currently serves as Collagen Corporation's designee on the Company's Board of Directors. Under the Research and Development Agreement, the Company and Collagen Corporation have agreed to undertake the joint development of suture fasteners made from collagen-based materials, to be funded by the Company up to certain amounts as specified in an agreed project plan. The Research and Development Agreement contemplates subsequent development of collagen-based tissue fixation devices if the parties can agree on a project plan and budget for their development. Any technology jointly developed pursuant to a project plan is to be owned jointly by the parties. Until 7 October 17, 2000, the parties have agreed to work exclusively together with respect to the development of products covered by the agreement. With respect to products for which a project plan has been approved by the parties prior to October 17, 2000 and for which there is funding through completion of development, Collagen Corporation and the Company have agreed not to commence the development of competing products until after the second anniversary of the first commercial sale of such products. The Manufacturing and Supply Agreement provides that Collagen Corporation will be the exclusive supplier to the Company for products manufactured from collagen and developed under the Research and Development Agreement. If Collagen Corporation is unable to supply such products, the Company is entitled to develop a second source of supply. The Manufacturing and Supply Agreement remains in effect with respect to a product until either the Distribution Agreement between Collagen Corporation and the Company relating to such product terminates or expires or until the Manufacturing Agreement is terminated by reason of default or as the result of the bankruptcy or insolvency of a contracting party. The Distribution Agreement provides that Collagen Corporation will have exclusive distribution rights to the Company's 3.5mm, 2.8mm and 1.9mm ROC suture fasteners and collagen-based products developed under the Research and Development Agreement which are labeled for facial plastic surgery or dermatology applications. Under the agreement, the Company will have exclusive distribution rights to collagen-based products developed under the Research and Development Agreement which are labeled for orthopaedic applications. Each party must sell a minimum number of units of products in its exclusive field to maintain exclusivity; otherwise, the other party gains co-exclusive rights to market and distribute products in that field. Under the agreement, a distributing party will purchase products from a manufacturing party at various discounts from the actual average selling price of the products, and Collagen Corporation is required to pay royalties to the Company with respect to Collagen Corporation's net sales of products for which development was funded by the Company pursuant to the Research and Development Agreement. PATENTS AND PROPRIETARY TECHNOLOGY The Company believes that a key element of its competitive advantage depends on its ability to develop and maintain proprietary aspects of its technology. To this end, the Company files patent applications to protect technology, inventions and improvements that it believes are significant to the growth of its business. As of March 24, 1998 the Company had 20 issued patents and more than 70 U.S. and foreign patent applications pending. As of March 24, 1998 the Company had rights to license products under 18 issued patents and 2 patents pending. These issued patents and pending patent applications cover its radial osteo compression (ROC) technology, its COR cartilage repair technology, meniscal repair systems, suture systems, ACL repair systems and various surgical tools, systems and methods. As of March 24, 1998 the Company was not subject to material patent infringement claims or litigation or interference proceedings. However, there can be no assurance that current and potential competitors and other third parties have not filed or in the future will not file applications for, or have not received or in the future will not receive, patents and will not obtain additional proprietary rights relating to materials or processes used or proposed to be used by the Company. Accordingly, there can be no assurance that the Company's products have not, do not or will not infringe any patents or other proprietary rights of third parties. The Company typically requires its employees, consultants and advisors to execute appropriate confidentiality agreements in connection with their employment, consulting or advisory relationships with the Company. The Company also typically requires its employees, consultants and certain advisors to agree to disclose and assign to the Company all inventions conceived of on Company time, using Company property or which relate to the Company's business. There can be no 8 assurance, however, that the foregoing agreements will effectively prevent disclosure of the Company's confidential information or provide meaningful protection for the Company's confidential information if there is unauthorized use or disclosure. Furthermore, no assurance can be given that competitors will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to the Company's proprietary technology. COMPETITION The Company faces strong competition in the marketplace from large corporations with orthopaedic divisions. Mitek Surgical Products, Inc. ("Mitek"), a division of Johnson & Johnson, the Zimmer division of Bristol-Meyers Squibb Company and the Linvatec division of ConMed Inc., Smith & Nephew Endoscopy, ("Dyonics" and "Acufex"), subsidiaries of Smith & Nephew, Inc., Arthrotek Inc., a division of Biomet, Inc. and Arthrex, Inc., all compete in the Company's market with metal suture anchors and devices for arthroscopic soft tissue reconstruction of the knee. Dyonics currently sells an all plastic design as well as a bioabsorbable suture fastener. These competitors have significantly greater financial, manufacturing, marketing, distribution and technical resources than the Company. Mitek, which sells metal barbed anchors and bioabsorbable bone anchors, currently has the largest share of the suture fastener market. The Company also faces competition from smaller companies including Li Medical, Inc. and Orthopaedic Biosystems Ltd., Inc. The Company believes that its suture fastener products compete favorably against its competition based on a number of factors, including the Company's proprietary radial osteo compression design which permits excellent holding strength in both large and small bones and can be modeled from plastic, bioabsorbable polymers and biomaterials; the revisability of the Company's fasteners; the availability of a proprietary arthroscopic delivery system without the need to tie suture knots for its products; and the small profile of the Company's products when inserted into bone, which permits its fasteners to be deployed in the small bones of the wrist, hand, ankle and foot. Furthermore, the Company believes that its products compete favorably against its competition in soft tissue reconstruction of the knee based on a number of factors, including the Company's proprietary ACL ligament fastener devices for soft tissue reconstruction, which can be modeled from plastic and bioabsorbable polymers. However, there can be no assurance that the Company's competitors will not succeed in developing products and technologies that are more effective or less costly than those that have been or may be developed by the Company. GOVERNMENT REGULATION Clinical testing, manufacture and sale of the Company's products are subject to regulation by the FDA and corresponding state and foreign regulatory agencies. Pursuant to the Federal Food, Drug, and Cosmetic Act, and the regulations promulgated thereunder, the FDA regulates the clinical testing, design, manufacture, labeling, distribution and promotion of medical devices. Noncompliance with applicable requirements can result in, among other things, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant pre-market clearance or pre-market approval for devices, withdrawal of marketing approvals and criminal prosecution. The FDA also has the authority to request repair, replacement or refund of the cost of any device manufactured or distributed by the Company. In the United States, medical devices are classified into one of three classes (i.e., Class I, II, or III) on the basis of the controls deemed necessary by the FDA to reasonably ensure their safety and effectiveness. Class I devices are generally exempt from the premarket notification (510(K)) and 9 premarket approval regulations. Class II devices are subject to general and special controls (e.g., performance standards, postmarket surveillance, patient registries and FDA guidelines). Generally, Class III devices are those which must receive premarket approval by the FDA to ensure their safety and effectiveness (e.,g., life-sustaining, life-supporting and implantable devices, or new devices which have been found not to be substantially equivalent to legally marketed devices). Before a new device can be introduced in the market, the Company must generally obtain FDA clearance through a 510(k) notification or approval of a Premarket Approval (a "PMA"). A 510(k) clearance will be granted if the submitted information establishes that the proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or a Class III medical device for which the FDA has not called for PMAs. The FDA recently has been requiring more rigorous demonstration of substantial equivalence than in the past, including in some cases requiring submission of clinical trial data. The FDA may determine that the proposed device is not substantially equivalent to a predicate device or that additional information is needed before a substantial equivalence determination can be made. It generally takes from four to twelve months from submission to obtain 510(k) premarket clearance, but the process may take longer. The FDA may determine that a proposed device is not substantially equivalent to a legally marketed device or that additional information is needed before a substantial equivalence determination can be made. A "not substantially equivalent" determination or a request for additional information could prevent or delay the market introduction of new products that fall into this category and could have a material adverse effect on the Company's business, financial condition or results of operations. For any of the Company's devices that are 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. A PMA application must be filed if a proposed device is not substantially equivalent to a legally marketed Class I or Class II device, or if it is a Class III device for which the FDA has called for PMAs. A PMA application must be supported by valid scientific evidence which typically includes extensive information (including relevant bench tests, laboratory and animal studies and clinical trial data) to demonstrate the safety and effectiveness of the device. The PMA application also must contain a complete description of the device and its components; a detailed description of the methods, facilities and controls used to manufacture the device; and the proposed labeling, advertising literature and training materials (if any). The PMA process can be expensive, uncertain and lengthy. A number of devices for which FDA approval has been sought by other companies have never been approved for marketing. Modifications to a device that is the subject of an approved PMA, its labeling, or manufacturing process may require approval by the FDA or PMA supplements or new PMAs. If human clinical trials of a device are required and the device presents a "significant risk," the sponsor of the trial (usually the manufacturer or the distributor of the device) will have to file an IDE application prior to commencing human clinical trials. The IDE application must be supported by data, typically including the results of animal and laboratory testing. If the IDE application is approved by the FDA and one or more appropriate Institutional Review Boards ("IRBs"), human clinical trials may begin at a specific number of investigational sites with a specific number of patients, as approved by the FDA. If the device presents a "nonsignificant risk" to the patient, a sponsor may begin the clinical trial after obtaining approval for the study by one or more appropriate IRBs without the need for FDA approval. Sponsors of clinical trials are permitted to sell investigational devices distributed in the course of the study provided that compensation does not exceed recovery of the costs of manufacture, research, development and handling. An IDE supplement must be submitted to and approved by the FDA before a sponsor or investigator may make a change to the investigational plan that may affect its scientific soundness or the rights, safety or welfare of human subjects. To date, all of the Company's products have received 510(k) clearance or have been exempted by the 10 FDA from the 510(k) clearance process. The Company has made modifications to its devices which the Company believes do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA would agree with any of the Company's determinations not to submit a new 510(k) notice for any device modification, or would not require the Company to submit a new 510(k) notice for any of the changes made to the device. If the FDA requires the Company to submit a new 510(k) notice for any device modification, the Company may be prohibited from marketing the modified device until the 510(k) notice is cleared by the FDA. There can be no assurance that any proposed modification will be cleared on a timely basis, if at all. The Company anticipates that its bioabsorbable devices presently under development will be considered a Class II device subject to the 510(k) clearance process. To the Company's knowledge, collagen-based medical devices currently being marketed have required PMA approval. The Company anticipates that the FDA will require clinical trial data for its biomaterial suture fastener, regardless of which regulatory path the FDA ultimately requires. There can be no assurance the FDA will not determine that the Company's future products, including the bioabsorbable and biomaterial suture fasteners now in development, must adhere to the more costly, lengthy, and uncertain PMA approval process. There also can be no assurance that the Company will obtain FDA clearance or approval for such future products on a timely basis, if at all, or that the FDA will not impose limitations on the intended use of such products as a condition of clearance or approval. Any delay in receipt of, failure to obtain, or limitations on clearance or approval could have a material adverse effect on the Company's business, financial condition or results of operation. Any devices manufactured or distributed by the Company pursuant to FDA clearances or approvals are subject to pervasive and continuing regulation by the FDA and certain state agencies. Manufacturers of medical devices for marketing in the United States are required to adhere to applicable regulations setting forth detailed Good Manufacturing Practices ("GMP") requirements, which include design, testing, control and documentation requirements. Manufacturers must also comply with Medical Devices Reporting ("MDR") requirements that a firm report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury. 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 Company is subject to routine inspection by the FDA and certain state agencies for compliance with GMP requirements, MDR requirements, and other applicable regulations. In October 1996, the FDA authorized changes to the GMP regulations which will likely increase the cost of compliance with GMP requirements. Changes in existing requirements or adoption of new requirements could have a material adverse effect on the Company's business, financial condition or results of operation. The Company is also subject to regulation in each of the foreign countries in which it sells its products in the areas of product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of the regulations applicable to the Company's products in these countries are similar to those of the FDA. The national health organization of some countries require the Company's products to be qualified before they can be marketed in those countries. The Company relies on its international distributors to comply with these requirements. To date, the Company has not experienced significant difficulty in complying with these regulations. 11 The Company has implemented policies and procedures which has allowed the Company to receive ISO 9001 registration and EN 46001 certification. These standards for quality systems in manufacturing have been developed to ensure that companies know, on a worldwide basis, the standards of quality to which they will be held. The European Union has promulgated rules which require that medical products receive the CE mark by mid-1998. The CE mark is an intentional symbol of quality and compliance with applicable European medical device directives. The Company is in the process of CE marking its products. Failure to receive CE mark certification will prohibit the Company from selling its products in Europe. There can be no assurance that the Company will be successful in meeting the certification requirements. ISO 9001 registration is one of the CE mark certification requirements. The Company is subject to numerous federal, state and local laws relating to such matters as safe working conditions and environmental protection. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition or results of operations. PRODUCT LIABILITY AND INSURANCE Medical device companies are subject to an inherent risk of product liability and other liability claims in the event that the use of their products results in personal injury. The Company maintains liability insurance coverage in the amounts deemed appropriate by management based upon the nature and risks of its business in general and its actual experience to date. There can be no assurance that a future claim will not exceed insurance coverage or that such coverage will continue to be available. In addition, any substantial increase in the cost of such insurance could have a material adverse effect on the Company's business, financial condition and results of operations. EMPLOYEES As of February 28, 1998, the Company employed 125 individuals, 26 of whom were engaged in research and development and regulatory, 46 in manufacturing and quality assurance and 53 in marketing, sales and administrative positions. The Company also contracts with outside consultants. None of the Company's employees are covered by a collective bargaining agreement. The Company believes that it maintains good relations with its employees. 12 ITEM 2. PROPERTIES As of December 31, 1997, the Company leased the following facilities:
APPX. SQUARE LOCATION TYPE OF FACILITY FOOTAGE Marlborough, MA..................... Executive Offices, Research and Development, 28,000 Manufacturing, Warehousing and Distribution Attleboro, MA....................... Research and Development 2,500 Logan, UT........................... Research and Development , Manufacturing 12,500
ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded in the over-the-counter market on The Nasdaq National Market under the symbol IDEA. The table below lists the quarterly range of the high and low per share closing bids of the Company's Common Stock on the Nasdaq National Market during the periods indicated.
FISCAL PERIOD HIGH LOW - ------------- ----- ----- First Quarter - 1997 $ 12 3/8 $7 3/4 Second Quarter - 1997 $ 12 5/8 $9 1/4 Third Quarter - 1997 $ 11 7/8 $7 7/8 Fourth Quarter - 1997 $ 10 1/16 $7 1/2
The Company has never declared or paid any cash dividends on its Common Stock. The Company currently intends to retain all earnings for the operation and expansion of its business and therefore does not anticipate paying any cash dividends in the foreseeable future. On March 24, 1998 there were 84 stockholders of record of the Company's common stock. 14 ITEM 6. SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 --------------- --------------- --------------- --------------- --------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) STATEMENT OF OPERATIONS DATA: Net sales $ 7,754 $ 4,353 $ 1,234 $ 244 $ 126 Cost of sales 2,232 1,611 1,000 465 263 --------------- --------------- --------------- --------------- --------------- Gross profit (loss) 5,522 2,742 234 (221) (137) Selling, general and administrative expenses 8,407 4,922 2,435 1,533 914 Purchased in-process research and development (1) 13,370 - - - - Research and development expenses (2) 3,952 2,667 1,597 1,172 922 --------------- --------------- --------------- --------------- --------------- Loss from operations (20,207) (4,847) (3,798) (2,926) (1,973) Interest income (expense), net 1,053 785 64 34 (238) --------------- --------------- --------------- --------------- --------------- Net loss $(19,154) $(4,062) $(3,734) $(2,892) $(2,211) =============== =============== =============== =============== =============== Basic and diluted net loss per share $(2.33) $(0.83) $(2.06) $(1.79) $(2.34) =============== =============== =============== =============== =============== Shares used in computing basic and diluted net loss per share (3) 8,225 4,911 1,811 1,621 944 =============== =============== =============== =============== =============== DECEMBER 31, ----------------------------------------------------------------------------------- 1997 1996 1995 1994 1993 --------------- --------------- --------------- --------------- --------------- (IN THOUSANDS) BALANCE SHEET DATA: Cash and cash equivalents $ 2,916 $12,825 $ 5,052 $ 2,051 $ 294 Working capital 15,885 22,841 4,857 1,628 (3,835) Total assets 21,520 25,363 6,399 3,099 869 Mandatorily redeemable convertible preferred stock - - 13,970 6,993 - Stockholders' equity (deficit) $ 19,197 $23,788 $(8,501) $(4,759) $(3,426)
(1) See Note 2 of Notes to Financial Statements. (2) Includes research and development costs payable to a related party of $428 in 1997, $664 in 1996 and $265 in 1995. (3) See Note 1 of Notes to Financial Statements. 15 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Innovasive Devices, Inc. (the "Company") is primarily engaged in the development, manufacture and marketing of proprietary devices and instrumentation which facilitate the reattachment of soft tissue structures, such as ligaments and tendons, to bones and other tissues. The Company has a limited operating history and has expended significant resources to fund research and development, the establishment of its manufacturing capabilities and the expansion of its marketing and sales organization. The Company plans to continue investing aggressively in these areas. Although the Company's sales have been principally derived from the sale of its family of shoulder related products, the Company now markets four product platforms: suture fasteners, suture systems, cartilage repair products and anterior cruciate ligament ("ACL") reconstruction products. The Company broadened its product portfolio with the June 27, 1997 acquisition of MedicineLodge, Inc. ("MLI"), a company which designs develops and manufactures orthopaedic medical devices - particularly implants and related instrumentation used in minimally invasive arthroscopic procedures to repair injuries to the knee. The Company acquired substantially all of the assets, including intellectual property, and assumed substantially all of the liabilities of MLI, a Delaware corporation in exchange for 1,885,000 shares of the Company's common stock . A portion of the purchase price was allocated to in-process research and development, resulting in a charge to the Company's operations of $13,370. The excess of cost over the fair value of net assets acquired (goodwill) of $1,403 is being amortized over a ten year period on a straight-line basis. The operating results of MLI are included in the Company's results from the date of acquisition. The following information should be read in conjunction with the Financial Statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations contained in this Annual Report. Any statements in this report expressing the beliefs and expectations of management regarding the Company's future results and performance are forward- looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on current expectations that involve a number of risks and uncertainties. The Company wishes to caution readers not to place undue reliance on any such forward- looking statements, which speak only as of the date made. Such forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These risks include the receipt of regulatory approvals, progress of product development programs, manufacturing of higher volume product requirements, clinical efficacy of and market demand for the products and the establishment of an effective distribution channel. Certain of such risks and uncertainties are described in Exhibit 99 of the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 1998. 16 RESULTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997 AND 1996 Net sales increased to $7.8 million for the year ended December 31, 1997 from $4.4 million for the year ended December 31, 1996. Sales of shoulder related products, including the Company's family of ROC suture fasteners, suture systems and related surgical instrumentation increased to $5.9 million for the year ended December 31, 1997 from $4.1 million in the prior year. In June 1997, the Company introduced the ROC EZ, an improved version of the original ROC fastener used in hardbone applications, and the CuffLink, used to augment tunnels made in the bone for rotator cuff repair procedures. Sales of the Company's knee related products increased to $1.7 million for the year ended December 31, 1997 from $0.3 million in the prior year. The COR system, introduced in October 1996, used to repair osteochondral defects in the knee, and the Linx HT, introduced in December 1997, used to facilitate repair of the ACL, both contributed to the increase in knee related products for the year ended December 31, 1997 over the prior year. Domestic sales increased to $6.6 million for the year ended December 31, 1997 from $3.2 million in the prior year. The increase was attributable to an increase in the unit sales and expansion of the Company's line of shoulder and knee related product offerings and the expansion of the Company's direct sales force and domestic distribution network. International sales, which are denominated in US dollars, decreased to $1.1 million for the year ended December 31, 1997 from $1.2 million in the prior year. The decrease was primarily a result of a delay in the regulatory process for the release of the ROC EZ in certain international markets and a transition of an international distributor. Gross profit increased to $5.5 million for the year ended December 31, 1997 from $2.7 million in the prior year. As a percentage of net sales, gross profit increased to 71% for the year ended December 31, 1997 from 63% for the year ended December 31, 1996. The increase in gross profit was primarily due to the increased sales of higher margin implants and the efficiencies resulting from increased production volumes. Selling, general and administrative expenses increased to $8.4 million for the year ended December 31, 1997 from $4.9 million for the year ended December 31, 1996. The increase resulted primarily from higher commission expense on the increased sales volume and the expansion of the domestic direct sales force and external distribution network. The Company also experienced cost increases in the following areas : salary and travel, product sample expenses, product advertising, depreciation and incremental administrative costs resulting from the acquisition of MLI on June 27, 1997. Research and development expenses increased to $4.0 million for the year ended December 31, 1997 from $2.7 million for the year ended December 31, 1996. The increase was primarily attributable to the following: research and development costs incurred by MLI to support research project in process at the time of the acquisition, product development costs in support of the Company's meniscal repair and bioabsorbable programs, compensation related to the grant of stock options and patent preparation and filing costs. As a result of the Company's transaction with MLI, the Company incurred a charge to operations of $13,370,000 representing the portion of the purchase price allocated to in-process research and development. 17 Net interest income increased to $1.1 million for the year ended December 31, 1997 from $785,000 for the year ended December 31, 1996. The primary reason for the increase was due to investment returns earned on higher average cash balances resulting from the proceeds of the initial public offering closed during the second quarter of 1996. As a result of the foregoing, the net loss increased to $19.2 million for the year ended December 31, 1997 from $4.1 million for the year ended December 31, 1996. YEARS ENDED DECEMBER 31, 1996 AND 1995 Net sales increased to $4.4 million for the year ended December 31, 1996 from $1.2 million for the year ended December 31, 1995. Sales of ROC suture fasteners and related surgical instruments increased to $4.1 million for the year ended December 31, 1996 from $1.1 million for the year ended December 31, 1995. The introduction of additional ROC suture fasteners and the expansion of the direct sales force contributed to the increase in domestic sales, which increased to $3.2 million from $1.0 million in the prior year. In the second quarter of 1996, the Company introduced the ROC XS and Mini-ROC suture fasteners, extending its ROC suture fastener product line. In the fourth quarter of 1996, the Company introduced the COR system, an articular cartilage repair system, which represented an expansion of its product offerings from shoulder and small joint applications to a third clinical area, the knee. International sales, which are denominated in US dollars, increased to $1.2 million from $188,000 in the prior year primarily due to the expansion of the product offering and the addition of international distributors. The $1.2 million of international sales for the year ended December 31, 1996 were derived from Japan (48.4%), Europe (36.4%) Africa (10.2%) and other countries (5.0%). The $188,000 of international sales for the year ended December 31, 1995 were derived from Europe (88.0%) and Africa (12.0%). Gross profit increased to $2.7 million for the year ended December 31, 1996 from $234,000 for the year ended December 31, 1995. As a percentage of net sales, gross profit increased to 63.0% for the year ended December 31, 1996 from 19.0% for the year ended December 31, 1995. The increase in gross profit was primarily the result of increased sales of ROC suture fasteners and improved manufacturing efficiencies from increased production levels. Selling, general and administrative expenses increased to $4.9 million for the year ended December 31, 1996 from $2.4 million for the year ended December 31, 1995. The increase resulted primarily from the expansion of the domestic direct sales force, increased salary and travel costs, higher aggregate selling commissions resulting from higher sales volume, increased sample expenses and the increased costs associated with operating as a public company. Research and development expenses increased to $2.7 million for the year ended December 31, 1996 from $1.6 million for the year ended December 31, 1995. The increase was primarily attributable to the collaborative development effort with Collagen Corporation, product development costs associated with the meniscal repair and bioabsorbable programs, patent preparation and filing costs, and salary related expenses. Net interest income increased to $785,000 for the year ended December 31, 1996 from $64,000 for the year ended December 31, 1995. The primary reason for the increase was due to the interest received on the investment of the proceeds of the initial public offering closed during the second quarter of 1996. 18 As a result of the foregoing, the net loss increased to $4.1 million for the year ended December 31, 1996 from $3.7 million for the year ended December 31, 1995. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company had cash, cash equivalents and marketable securities of $13.5 million as compared to a balance of $22.7 million on December 31, 1996. Working capital decreased to $15.9 million from $22.8 million in 1996. Cash used in the Company's operations increased to $7.3 million for the year ended December 31, 1997 from $4.2 million in 1996. The net loss in 1997 increased to $19.2 million, which included a $13.4 million non-cash charge for in-process research and development resulting from the MLI transaction, from $4.1 million in 1996. Accounts receivable increased to $1.6 million in 1997 from $759,000 in 1996 as a result of increased sales volume. Inventories increased to $2.9 million in 1997 from $859,000 in 1996. The increase was primarily attributable to the production of knee related products as the Company prepares to expand its product offerings related to ACL repair, increased inventory levels to support higher sales volumes and inventory acquired in the MLI transaction. Cash used in investing activities totaled $2.1 million in 1997 resulting from capital expenditures of $856,000, net purchases of marketable securities of $743,000, and direct transaction costs related to the MLI transaction of $544,000. Cash used for financing activities totaled $485,000 in 1997 resulting primarily from the payment in full of a note payable the Company assumed resulting from the MLI transaction totaling $602,000. The Company's future liquidity and capital requirements will depend upon the progress of the research and development programs, regulatory matters and the expansion of its manufacturing capabilities to satisfy increasing volume requirements. In addition, the Company's capital requirements will depend upon, among other factors, the timing of the establishment of effective sales channels in the United States and abroad and the extent to which the Company's products gain market acceptance. Therefore the Company cannot provide assurances that it will not require additional financing in the future. If additional financing is necessary, the Company would seek to raise these funds through bank facilities or debt or equity offerings. There can be no assurance that such funds would be available on terms acceptable to the Company. IMPACT OF THE YEAR 2000 ISSUE The Year 2000 issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any computer programs that have date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities. Based on representations made by the Company's business software systems vendor, the Company believes that its business software system is year 2000 compliant. However, the Company has not yet initiated formal testing of its business software system and has not yet engaged in formal communications with all of its significant suppliers and large customers to determine the extent to which the Company is vulnerable to those third parties failure to remediate their own Year 2000 issue. However, as the Company's computer system does not currently interact with those of its major suppliers and customers, it is not expected that the Year 2000 issue would have a material impact on the Company's future operating results or financial condition. 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INNOVASIVE DEVICES, INC. INDEX TO COSOLIDATED FINANCIAL STATEMENTS
Page ---- Report of Independent Accountants 21 Consolidated Balance Sheet at December 31, 1997 and 1996 22 Consolidated Statement of Operations for the three years ended 23 December 31, 1997 Consolidated Statement of Stockholders' Equity (Deficit) for the 24 three years ended December 31, 1997 Consolidated Statement of Cash Flows for the three years ended 25 December 31, 1997 Notes to Consolidated Financial Statements 26 Financial Statement Schedule: II. Valuation and Qualifying Accounts and Reserves for the three 41 years ended December 31, 1997
All other schedules are omitted because they are not applicable. 20 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Innovasive Devices, Inc. In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Innovasive Devices, Inc. and its subsidiary at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP Boston, Massachusetts February 19, 1998 21 INNOVASIVE DEVICES, INC. CONSOLIDATED BALANCE SHEET (In thousands, except share data)
ASSETS DECEMBER 31, ------------------------------ 1997 1996 ---------------- ------------ Current assets: Cash and cash equivalents $ 2,916 $ 12,825 Marketable securities 10,604 9,861 Accounts receivable, net of allowance for doubtful accounts of $121 and $89 at December 31, 1997 and 1996, respectively 1,625 759 Inventories 2,947 859 Prepaid expenses 116 112 ---------------- ------------- Total current assets 18,208 24,416 Fixed assets, net 1,960 922 Goodwill, net 1,326 - Other assets 26 25 ---------------- ------------- $ 21,520 $ 25,363 ================ ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 809 $ 628 Accounts payable to related party 392 170 Accrued expenses 1,122 777 ---------------- ------------- Total current liabilities 2,323 1,575 ---------------- ------------- Stockholders equity: Common stock, $.0001 par value; shares authorized: 15,000,000; shares issued and outstanding: 9,164,848 and 7,260,408 at December 31, 1997 and 1996, respectively 1 1 Additional paid-in capital 54,702 39,789 Accumulated deficit (35,156) (16,002) Deferred compensation (350) - ---------------- ------------- Total stockholders' equity 19,197 23,788 Commitments (Note 14) - - ---------------- ------------- $ 21,520 $ 25,363 ================ =============
The accompanying notes are an integral part of the consolidated financial statements. 22 INNOVASIVE DEVICES, INC. CONSOLIDATED STATEMENT OF OPERATIONS (In thousands, except per share data)
Year Ended December 31, --------------------------------------------------------- 1997 1996 1995 ---------------- ---------------- ---------------- Net sales $ 7,754 $ 4,353 $ 1,234 Cost of sales 2,232 1,611 1,000 ---------------- ---------------- ---------------- Gross profit 5,522 2,742 234 Selling, general and administrative expenses 8,407 4,922 2,435 Research and development 3,524 2,003 1,332 Research and development - related party 428 664 265 Purchased in-process research and development 13,370 - - ---------------- ---------------- ---------------- Loss from operations (20,207) (4,847) (3,798) Interest income 1,053 785 84 Interest expense - - (20) ---------------- ---------------- ---------------- Net loss $(19,154) $(4,062) $(3,734) =============== ================ ================ Basic and diluted net loss per share (Note 1) $( 2.33) $( 0.83) $(2.06) =============== ================ ================ Shares used in computing basic and diluted net loss per share 8,225 4,911 1,811 =============== ================ ================
The accompanying notes are an integral part of the consolidated financial statements. 23 INNOVASIVE DEVICES, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT) (In thousands, except share data)
COMMON STOCK -------------------- NUMBER ADDITIONAL TOTAL OF PAR PAID-IN ACCUMULATED TREASURY DEFERRED STOCKHOLDER'S SHARES VALUE CAPITAL DEFICIT STOCK COMPENSATION EQUITY (DEFICIT) ----------- ----- ---------- ------------ --------- ------------- ---------------- Balance at December 31, 1994 1,815,922 $1 $ 3,459 $ (8,194) $(25) $ - $ (4,759) Accretion of Series A and Series B mandatorily redeemable preferred stock to redemption value (8) (8) Net loss (3,734) (3,734) ----------- ----- ---------- ------------ --------- ------------- ---------------- Balance at December 31, 1995 1,815,922 1 3,459 (11,936) (25) - (8,501) Accretion of Series A and Series B mandatorily redeemable preferred stock to redemption value (4) (4) Issuance of common stock under stock option plan 5,111 - 9 9 Conversion of Series A and Series B mandatorily redeemable preferred stock into common stock - (Note 9) 3,543,819 14,901 14,901 Issuance of common stock, net of issuance costs of $2,305 1,895,556 - 21,420 25 21,445 Net loss (4,062) (4,062) ----------- ----- ---------- ------------ --------- ------------- ---------------- Balance at December 31, 1996 7,260,408 1 39,789 (16,002) - - 23,788 Issuance of common stock under stock option plan 9,940 - 35 35 Issuance of common stock - acquisition of business (Note 2) 1,885,000 - 14,326 14,326 Issuance of common stock under employee stock purchase plan (Note 11) 9,500 - 82 82 Compensation related to the grant of common stock options 470 (470) - Amortization of deferred compensation 120 120 Net loss (19,154) (19,154) ----------- ----- ---------- ------------ --------- ------------- ---------------- Balance at December 31, 1997 9,164,848 $1 $54,702 $(35,156) $ - $(350) $ 19,197 =========== ===== ========== ============ ========= ============= ================
The accompanying notes are an integral part of the consolidated financial statements. 24 INNOVASIVE DEVICES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands, except share data)
DECEMBER 31, ------------------------------------- 1997 1996 1995 ----------- ---------- --------- Cash flows from operating activities Net loss $(19,154) $ (4,062) $(3,734) Adjustments to reconcile net loss to net cash provided by (used for) operating activities: Depreciation and amortization 571 273 202 Amortization of deferred compensation 120 - - Purchased in-process research and development 13,370 - - Changes in assets and liabilities: Accounts receivable (854) (476) (213) Inventories (1,853) (454) (67) Prepaid expenses 7 (64) (14) Other assets (1) (13) 1 Accounts payable 37 169 205 Accounts payable to related party 222 (95) 265 Accrued expenses 254 571 60 ---------- ---------- --------- Net cash used for operating activities (7,281) (4,151) (3,295) Cash flows from investing activities Purchases of fixed assets (856) (596) (208) Purchases of marketable securities (11,374) (9,861) - Redemption of marketable securities 10,631 - - Acquisition of business, net of cash acquired (544) - - ---------- ---------- --------- Net cash used for investing activities (2,143) (10,457) (208) Cash flows from financing activities Proceeds from issuance of preferred stock, net of issuance costs - 927 5,968 Proceeds from issuance of common stock, net of issuance costs 117 21,454 - Principal payments on note payable (602) - (464) Proceeds from issuance of convertible note payable - - 1,000 ---------- ---------- --------- Net cash provided by (used for) financing activities (485) 22,381 6,504 ---------- ---------- --------- Net increase (decrease) in cash and cash equivalents (9,909) 7,773 3,001 Cash and cash equivalents at beginning of period 12,825 5,052 2,051 ---------- ---------- --------- Cash and cash equivalents at end of period $ 2,916 $ 12,825 $ 5,052 ========== ========== ========= Supplemental disclosure of cash flow information Cash paid for interest $ - $ - $ 44 ========== ========== =========
Supplemental disclosure of non-cash financing activities: In June 1997, the Company acquired substantially all of the operating assets of MedicineLodge, Inc. in exchange for 1,885,000 shares of the Company's common stock and the asuumtion of certain liabilities. (Note 2) In connection with the issuance of Series B preferred stock in 1995, holders of convertible notes payable totaling $1,000 accepted 467,290 shares of Series B preferred stock as consideration for full payment of these obligations. The accompanying notes are an integral part of the consolidated financial statements. 25 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS (In thousands, except share data) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The Company is engaged in the research, development, manufacture and distribution of medical devices focused on less invasive, arthroscopic surgical repair, and restoration of traumatized or diseased tissue. The Company's products are sold to customers in the healthcare industry primarily in the U.S. REVENUE RECOGNITION, ACCOUNTS RECEIVABLE AND CONCENTRATION OF CREDIT RISK Revenue is recognized upon shipment of product. Ongoing credit evaluations of customers' financial condition are performed and collateral is not required. Concentration of credit risk with respect to accounts receivable is limited due to the number of customers comprising the Company's customer base. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not exceeded management's expectations. PRINCIPLES OF CONSOLIDATION The consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents and those with maturities greater than three months are considered to be marketable securities. Marketable securities are stated at amortized cost plus accrued interest, which approximates fair value. Cash equivalents and marketable securities consist primarily of corporate debt securities, U.S. government agency obligations and money market instruments. The Company accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under the provision of SFAS No. 115, the Company has classified its investments as "available-for-sale" and any associated unrealized gains or losses, if material, are recorded as a separate component of equity until realized. At December 31, 1997 and 1996, any unrealized gains or losses were immaterial. INVENTORIES Inventories are stated at the lower of cost or market, with cost being determined using the first-in, first-out method. FIXED ASSETS Fixed assets are recorded at cost and depreciated using the straight-line method over their estimated useful lives. Repair and maintenance costs are expensed as incurred. 26 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) GOODWILL Goodwill represents the excess of cost over the fair value of net assets acquired, and is being amortized on a straight-line basis over the estimated useful life of ten years. Accumulated amortization at December 31, 1997 totaled $77. BASIC AND DILUTED NET LOSS PER SHARE In February 1997, the Financial Accounting Standards Board issued SFAS No. 128, "Earnings per Share", which supersedes Accounting Principles Board Opinion No. 15 and specifies the computation, presentation and disclosure requirements of earning per share. SFAS No. 128 requires the presentation of "basic" and "diluted" earnings per share. Basic earnings per share is computed by dividing the income available to common stockholders by the weighted average number of common shares outstanding for the period. For purposes of calculating diluted earnings per share, the denominator includes both the weighted average number of common shares outstanding and potential dilutive common shares outstanding for the period. The Company adopted SFAS No. 128 in the fourth quarter of 1997. All prior periods earnings per share amounts have been restated to comply with SFAS No. 128. For each of the years presented, basic and diluted earnings per share are the same due to the antidilutive effect of potential common shares outstanding. Antidilutive potential common shares excluded from the 1997, 1996 and 1995 computation include 1,505,608, 732,536 and 478,878 common shares, respectively, issuable upon the exercise of stock options. Antidilutive potential common shares excluded from the 1995 computation also includes 3,374,274 common shares issuable upon the conversion of redeemable convertible preferred stock. In February 1998, the Securities and Exchange Commission issued Staff Accounting Bulletin ("SAB") No. 98, which supersedes SAB No. 83 and includes new guidance with respect to the calculation of earnings per share in an initial public offering ("IPO") and reporting of historical earnings per share. SAB No. 98 now requires the reporting of historical earnings per share for all periods prior to an IPO, even in situations where the entities capital structure was not indicative of the ongoing entity. The Company had previously reported earnings per share for periods through June 1996 (the closing of the Company's IPO) on a pro forma basis. The Company adopted SAB No. 98 in February 1998, accordingly, pro forma earnings per share previously reported for 1996 and 1995 have been eliminated and replaced with historical earnings per share. STOCK-BASED COMPENSATION Stock-based compensation awards to employees under the Company's stock plans are accounted for using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations. The Company has adopted the disclosure requirements of SFAS No. 123, "Accounting for Stock-Based Compensation." 27 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingencies at December 31, 1997 and 1996, and the reported amounts of revenues and expenses during the three years in the period ended December 31, 1997. Actual results could differ from those estimates. 2. ACQUISITION On June 27, 1997, the Company, through a newly formed subsidiary, acquired substantially all of the operating assets of MedicineLodge, Inc. ("MLI"), in exchange for 1,885,000 shares of the Company's common stock valued at $14,326 and the assumption of certain liabilities. MLI designs, develops, manufactures and is in the early stages of marketing proprietary surgical implants which facilitate the repair of the Anterior Cruciate Ligament (ACL) of the knee. The acquisition has been accounted for under the purchase method and, accordingly, the purchase price has been allocated based on the estimated fair value of assets purchased and liabilities assumed upon acquisition. A portion of the purchase price relating to research projects which had not yet reached technological feasability and had no alternative future use, was allocated to in-process research and development, resulting in a charge to the Company's operations of $13,370. The excess of cost over the fair value of net assets acquired (goodwill) of $1,403 is being amortized over 10 years on a straight-line basis. The operating results of MLI are included in the Company's results from the date of acquisition. The following unaudited pro forma summary combines the results of operations of the Company and MLI as if the acquisition had occurred at the beginning of 1997 and 1996, after giving effect to certain adjustments, including the write-off of purchased in-process research and development and amortization of goodwill. The unaudited pro forma summary does not necessarily reflect the results of operations as they would have been if the Company and MLI had constituted a single entity during such periods.
YEAR ENDED DECEMBER 31, --------------------------------------- 1997 1996 ---------------- ------------------ Net sales $ 8,298 $ 5,659 Net loss (20,080) (18,849) Basic and diluted net loss per share $ (2.19) $ (1.74)
28 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) 3. MARKETABLE SECURITIES The amortized cost of available-for-sale securities (including accrued interest), which approximates fair value, consists of the following:
DECEMBER 31, ---------------------------------- 1997 1996 ----------- ------------ Corporate debt securities $ 6,779 $ 10,176 U.S. government agency obligations 5,011 7,154 Money market instruments 1,694 2,817 ----------- ----------- Total available for sale 13,484 20,147 Less cash equivalents (2,880) (10,286) ----------- ----------- Total marketable securities $10,604 $ 9,861 =========== ===========
The amortized cost of the Company's investment in debt securities at December 31, 1997 was comprised of $9.3 million due in one year or less and $2.5 million due in one to two years. Due to the short-term nature of the investments, expected maturities and contractual maturities are normally the same. The Company did not realize any gains or losses on available-for-sale securities during the three years ended December 31, 1997 as the securities have been held to maturity. 4. INVENTORIES Inventories consist of the following:
DECEMBER 31, ------------------------------- 1997 1996 ---------- -------- Raw materials $1,360 $282 Work-in-process 329 117 Finished goods 1,258 460 ---------- -------- $2,947 $859 ========== ========
Inventories are shown net of a reserve which has been established to provide for estimated losses arising from inventory obsolescence. The Company estimates its reserve requirement for obsolete inventory based upon such factors as the aging of inventory, historical usage, projected sales and the impact of new product introductions. Amounts charged to cost of sales relating to the obsolescence reserve were approximately $309, $293 and $233 in 1997, 1996 and 1995, respectively. 29 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) 5. FIXED ASSETS Fixed assets consist of the following:
DECEMBER 31, USEFUL LIFE -------------------------------------------- IN YEARS 1997 1996 ------------------ -------------------- Furniture and fixtures 3 - 7 $1,042 $ 555 Machinery and equipment 5 995 318 Leasehold improvements 3 141 53 Tooling 3 - 5 916 636 ------------------ -------------------- 3,094 1,562 Less - Accumulated depreciation and amortization 1,134 640 ------------------ -------------------- $1,960 $ 922 ================== ====================
Depreciation and amortization expense relating to fixed assets was $522, $273 and $202 for 1997, 1996 and 1995, respectively. 6. ACCRUED EXPENSES Accrued expenses consists of the following:
DECEMBER 31, ---------------------------------- 1997 1996 --------------- --------------- Employee compensation and benefits $ 445 $284 Commissions 250 106 Professional fees 164 189 Other 263 198 ------------ ------------- $1,122 $777 ============ =============
7. NOTE PAYABLE In connection with the acquisition of MLI in June 1997 (Note 2), the Company assumed a note payable in the amount of $602. The Company paid the note in full in July 1997. 30 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) 8. INCOME TAXES The provision (benefit) for incomes taxes was as follows:
DECEMBER 31, --------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- ------------- Deferred tax benefit Federal $(1,941) $(1,337) $(1,204) State (579) (383) (397) ---------- ---------- ---------- Total deferred (2,520) (1,720) (1,601) Tax asset valuation allowance 2,520 1,720 1,601 ---------- ---------- ---------- $ - $ - $ - ========== ========== ==========
Deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Under SFAS No. 109, the benefit associated with future deductible temporary differences is recognized if it is more likely than not that a benefit will be realized. Based on historical evidence of net losses, the Company has recorded a valuation allowance that offsets all net deferred tax assets. Principal components of the deferred tax assets and liabilities included on the balance sheet at December 31, 1997 and 1996 were as follows:
DECEMBER 31, --------------------------------------- 1997 1996 ------------------- ---------------- Deferred tax assets: Net operating loss carryforwards $ 6,217 $ 4,093 Inventory 404 290 Research and development tax credit 407 204 Other items 268 189 ----------- --------- Gross deferred tax assets 7,296 4,776 Deferred tax asset valuation allowance (7,296) (4,776) ----------- --------- $ - $ - ============ =========
A reconciliation between the amount of reported tax benefit and the amount computed using the U.S. Federal statutory rate of 35% for 1997, 1996 and 1995 follows:
DECEMBER 31, ------------------------------------------------------------- 1997 1996 1995 ------------------- ------------------- --------------- Tax benefit at statutory rate $(6,704) $(1,422) $(1,307) State tax, net of federal benefit (307) (196) (273) In-process research and development charge for the purchase of MLI 4,680 - - Research and development credit (209) (107) (19) Other 20 5 (2) --------- -------- --------- (2,520) (1,720) (1,601) Increase in valuation allowance 2,520 1,720 1,601 --------- -------- --------- $ - $ - $ - ========= ========= =========
31 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) The Company has U.S. Federal net operating loss carryforwards of approximately $15.1 million and tax credit carryforwards of approximately $282. The operating loss and tax credit carryforwards expire in the years 2009 through 2012. An ownership change, as defined by Section 382 of the Internal Revenue Code, resulting from the Company's initial public offering in June 1996, will limit the utilization of net operating loss and tax credit carryforwards generated prior to June 1996 to approximately $3.9 million per year. Subsequent significant ownership changes could, however, further limit the utilization of these carryforwards in future years. 9. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK In February and March 1994, the Company issued 4,260,337 shares of Series A mandatorily redeemable convertible preferred stock ("Series A Preferred Stock") and 695,032 shares of common stock. Upon issuance of the preferred stock and the common stock, the Company received net proceeds of $6 million and converted notes payable in the amount of $2.5 million plus accrued interest of $107. In October 1995, the Company issued 3,271,000 shares of Series B mandatorily redeemable convertible preferred stock ("Series B Preferred Stock"). Upon issuance, the Company received net proceeds of $6 million and converted notes payable in the amount of $1 million which was issued in August 1995 in the form of a bridge loan. In January 1996, the Company issued an additional 442,235 shares of Series B Preferred Stock, resulting in net proceeds to the Company of $927. All shares of Series A and Series B Preferred Stock converted into 3,543,819 shares of common stock at the conversion ratio of 2.25 shares of Preferred Stock for each share of common stock upon the closing of the Company's initial public offering in June 1996. 10. STOCKHOLDERS' EQUITY REVERSE COMMON STOCK SPLIT A 1-for-2.25 reverse stock split of the Company's common stock became effective on May 7,1996. All shares of common stock, options and per share amounts included in the accompanying financial statements have been adjusted to give retroactive effect to the reverse stock split for all years presented. INITIAL PUBLIC OFFERING In June 1996, the Company completed an initial public offering of 1,900,000 shares of its common stock. The net proceeds to the Company were approximately $21.5 million. 32 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) PREFERRED STOCK On April 3, 1996, the stockholders of the Company authorized 1,000,000 shares of $0.01 par value preferred stock. Preferred stock may be issued at the discretion of the Board of Directors of the Company (without stockholder approval) with such designations, rights and preferences as the Board of Directors may determine from time to time. The preferred stock may have dividend, liquidation, redemption, conversion, voting or other rights which may be more expansive than the rights of the holders of common stock. TREASURY STOCK Common stock held in treasury at December 31, 1995 represents the Company's repurchase of common stock at cost. These shares were reissued in conjunction with the Company's initial public offering in June 1996. 11. STOCK PLAN The Company maintains three stock plans which provide for the granting of incentive stock options, non-qualified stock options and restricted stock to employees, directors and certain other individuals. The 1992 Stock Option Plan (the "1992 Plan") provides for the issuance of a maximum of 692,869 shares of common stock pursuant to the grant of incentive and non-qualified stock options. Incentive stock options may be granted to any officer or employee at an exercise price per share of not less than the fair market value per common share on the date of such grant (not less than 110% of such value in the case of holders of 10% or more of the total combined voting power of all classes of the Company's stock). Non-qualified options may be granted to any employee, officer, director or consultant at an exercise price per share to be specified by the Board of Directors on the date of grant. Options granted under the 1992 Plan are exercisable over periods determined by the Board of Directors, not to exceed ten years from the date of grant. The Company does not intend to issue any additional options under the 1992 Plan, but options that are forfeited will become available for grant under the 1996 Omnibus Stock Plan (the "Omnibus Plan"). Under the terms of the Omnibus Plan, employees, directors and certain other individuals may be awarded incentive stock options, nonqualified stock options or restricted stock. The Omnibus Plan provides for the issuance of a maximum of 800,000 shares of common stock, plus such additional number of shares that become available due to the forfeiture of options granted under the 1992 Plan. The term of each option cannot exceed ten years (five years for options granted to holders of 10% or more of the total voting power of all classes of the Company's stock). Incentive stock options must be granted at an exercise price equal to the fair market value of the stock on the date of grant and vest over a period not to exceed 10 years. The 1996 Non-Employee Director Stock Option Plan (the "Director Plan") provides for the grant of options for the purchase of up to 150,000 shares of common stock of the Company. Under the terms of the Director Plan, each non-employee director will receive an option to purchase 2,500 shares of common stock at each annual meeting of stockholders. In addition, each new non-employee director will receive upon his or her initial 33 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) election an option to purchase 10,000 shares of common stock. The term of each option cannot exceed ten years. All options granted under the Directors plan will be at an exercise price equal to the fair market value of the stock on the date of grant and will vest evenly over a four year period. Stock option activity is summarized as follows:
WEIGHTED NUMBER OF AVERAGE SHARES EXERCISE PRICE ------------------- ------------------- Outstanding at December 31, 1994 433,641 $1.80 Granted 49,548 1.69 Forfeited (4,311) 1.69 Exercised - ----------- Outstanding at December 31, 1995 478,878 1.78 Granted 262,324 7.34 Forfeited (3,555) 2.47 Exercised (5,111) 1.69 ----------- Outstanding at December 31, 1996 732,536 3.77 Granted 807,100 10.35 Forfeited (24,628) 8.18 Exercised (9,940) 3.55 ----------- Outstanding at December 31, 1997 1,505,068 $7.23 ===========
The number and weighted average exercise price of options exercisable at December 31, 1997, 1996 and 1995 is 421,738 and $2.58; 284,222 and $1.81 and 141,889 and $1.82, respectively. The following table summarizes information about stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING - ------------------------------------------------------------------------- WEIGHTED AVERAGE NUMBER REMINING CONTRACTUAL NUMBER EXERCISABLE EXERCISE PRICE OUTSTANDING LIFE - ------------------------ ------------------- ------------------------ -------------------- $ 1.69 455,438 6.37 357,883 5.63 7,998 5.02 7,019 6.75 194,438 8.14 38,600 8.75 217,200 9.94 - 9.25 12,500 9.33 - 9.50 79,450 9.77 - 9.60 4,444 8.25 1,111 10.00 47,000 8.48 11,750 10.13 200,550 9.10 5,375 12.00 286,050 9.49 - ------------------- -------------------- 1,505,068 421,738 =================== ====================
34 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) An aggregate of 50,000 shares of common stock is reserved for issuance pursuant to the 1996 Employee Stock Purchase Plan (the "Stock Purchase Plan"). Employees whose customary employment is in excess of 20 hours per week and five months per year and who own less than 5% of stock in the Company are eligible to participate in the plan. Employees participating in the plan will have the opportunity to purchase common stock at a price equal to the lesser of 85% of the fair market value on the date the right was granted or 85% of the fair market value on the date the right was exercised. The Company issued 9,500 shares to employees participating in the plan in 1997. Compensation cost based upon the fair value approach as prescribed under SFAS No. 123 has not been recognized for the stock options granted to employees as the Company adopted the disclosure-only provision of SFAS No. 123. Had compensation for the Company's stock plans been determined based on the fair value at the grant date for awards in 1997, 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net loss and net loss per share would have been as follows:
YEAR ENDED DECEMBER 31, -------------------------------- 1997 1996 1995 --------- -------- -------- Net Loss: As reported $(19,154) $(4,062) $ (3,734) Pro forma (19,682) (4,168) (3,736) Basic and diluted net loss per share As reported $(2.33) $(0.83) $ (2.06) Pro forma (2.39) (0.85) (2.06)
The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for 1997, 1996 and 1995: expected option term of five years; dividend yield of 0%; risk free interest rate of 5.7 %, 6.2 % and 5.6% in 1997, 1996 and 1995, respectively; and expected volatility of 0% for options granted prior to the initial filing of the Company's registration statement in April 1996, 55% for options granted from April 1996 to December 1996 and 44%-55% for options granted from January 1997 through December 1997. The weighted average fair value per option for options granted in 1997, 1996 and 1995 was $10.35, $2.46 and $0.44, respectively. Because options vest over several years and additional option grants are expected to be made in subsequent years, the pro forma impact on 1997, 1996 and 1995 is not representative of the pro forma effects of reported net income (loss) and net income (loss) per share for future years. During 1997, the Company granted options in the amount of 154,000 shares to nonemployees under the Omnibus Plan. The estimated fair value of these options totaled $470, was recorded as deferred compensation and is being amortized over the vesting period of the options. In November 1997, the Emerging Issues Task Force of the Financial Accounting Standards Board finalized Issue No. 96-18 "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services" ("EITF 96-18"). Under EITF 96-18, the compensation expense that will ultimately be recognized for certain of the options issued to nonemployees in 1997 will be measured at the vesting date of the underlying options. 35 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) The Company has recorded deferred compensation at a preliminary value of $341 for 131,500 of these options which have not vested as of December 31, 1997. As these options vest over periods of one to four years, the Company will be required to remeasure the fair value of these options at each reporting period prior to vesting and then finally at the vesting date of the options. Changes in the estimated fair value of these options will be recognized as compensation expense in the period of the change. 12. RETIREMENT SAVINGS PLAN The Company provides an employee retirement savings plan under Section 401(k) of the Internal Revenue Code (the "Plan") which covers substantially all employees. Under the terms of the Plan, employees may contribute a percentage of their salary, up to a maximum of 15%, which is then invested in one or more of several mutual funds selected by the employee. The Company may make contributions to the Plan at its discretion; no contributions have been made since inception of the Plan. 13. SIGNIFICANT CUSTOMERS AND GEOGRAPHIC INFORMATION For 1996 and 1995, sales approximating 13% of total sales for both years were attributable to one customer. No customer accounted for greater than 10% of net sales for 1997. Export sales were 15% (7% to Japan, 7% to Europe and 1% to other regions), 27% (13% to Japan, 10% to Europe and 4% to other regions) and 15% (13% to Europe and 2% to other regions) of total sales for 1997, 1996 and 1995, respectively. 14. COMMITMENTS RELATED PARTY TRANSACTION In October 1995, the Company entered into Research & Development, Distribution and Supply agreements (the "Agreements") with Collagen Corporation. At December 31, 1997 Collagen Corporation beneficially owned 843,936 shares of the Company's common stock representing a 9.2% ownership interest. Pursuant to the Agreements, the Company will fund up to $1.7 million of research and development efforts performed by Collagen Corporation to develop certain products. In consideration for the funding provided, the Company will receive certain rights to market, sell and distribute certain products, subject to satisfying certain minimum sales requirements, resulting from such research and development efforts. Total research and development expense incurred under the Agreements was $428, $664 and $265 for 1997, 1996 and 1995, respectively. 36 INNOVASIVE DEVICES, INC. NOTES TO FINANCIAL STATEMENTS - (Continued) (In thousands, except share data) FACILITY LEASE The Company leases office and manufacturing facilities under various non- cancelable operating leases ranging from one to five years. Future minimum lease commitments are approximately as follows: 1998 $ 243 1999 271 2000 250 2001 221 2002 92 ------ $1,077 ======
Total rent expense under non-cancelable facility leases was approximately $181, $172 and $110 for the years ended December 31, 1997, 1996 and 1995, respectively. 37 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable 38 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to Directors may be found under the caption "Election of Directors" appearing in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders. Such information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information set forth under the captions "Executive Officer Compensation" and "Director Compensation" appearing in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the captions "Principal Stockholders" and "Stock Ownership of Directors and Executive Officers" appearing in the Company's definitive Proxy Statement for the 1998 Annual Meeting of Stockholders is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS RELATED PARTY TRANSACTION In October 1995, the Company entered into Research & Development, Distribution and Supply agreements (the "Agreements") with Collagen Corporation. At December 31, 1997 Collagen Corporation beneficially owned 843,936 shares of the Company's common stock representing an 9.2% ownership interest. At December 31, 1997, the Company had expended approximately $1,356,000 pursuant to the Agreements. Collagen Corporation has the right to designate one member of the Company's Board of Directors so long as it holds at least five percent of the Company's outstanding Common Stock on a fully-diluted basis. Mr. David Foster, Sr. Vice President of Collagen Corporation, currently serves as Collagen Corporation's designee on the Company's Board of Directors. 39 Part IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as a part of this report: (1) Financial Statements - See Index to Financial Statements at Item 8 of this report. (2) Financial Statement Schedules (3) Exhibits 40 ITEM 14. (A) (2) FINANCIAL STATEMENT SCHEDULES Schedule II Valuation and Qualifying Accounts and Reserves for the Three Years Ended December 31, 1996
BALANCE AT CHARGED TO CHARGED DEDUCTIONS BALANCE (IN THOUSANDS) BEGINNING COSTS AND TO OTHER AND AT END OF OF PERIOD EXPENSES ACCOUNTS WRITE-OFFS PERIOD ------------- ----------- ----------- --------------- ------------- Allowance for doubtful accounts December 31, 1995 8 50 - (8) 50 December 31, 1996 50 52 - (15) 89 December 31, 1997 89 36 - (4) 121 Inventory obsolescence reserve December 31, 1995 240 233 - (84) 389 December 31, 1996 389 293 - (60) 622 December 31, 1997 622 309 - (330) 601 Deferred tax assets valuation allowance December 31, 1995 1,455 - 1,601 - 3,056 December 31, 1996 3,056 - 1,720 - 4,776 December 31, 1997 4,776 - 2,520 - 7,296
41 ITEM 14. (A) (3) EXHIBITS INNOVASIVE DEVICES, INC. EXHIBIT INDEX Exhibit 10.1 Employment Agreement, dated June 27, 1997, between Registrant and Alan Chervitz 10.2 Employment Agreement, dated June 27, 1997, between Registrant and T. Wade Fallin 10.3 Consulting Agreement dated June 27, 1997, between Registrant and Richard B. Caspari, M.D. 23 Consent of Price Waterhouse LLP, Independent Auditors 23.1 Consent of Price Waterhouse LLP, Independent Auditors 27 Financial Data Schedule 99 Cautionary statement for purposes of the "Safe Harbor" provisions of the Private Securites Litigation Reform Act of 1995. 42 Exhibit 10.1 Employment Agreement, dated June 27, 1997, between Registrant and Alan Chervitz Incorporated by reference to the Company's Form 10-Q for the Quarter ended June 30, 1997. Exhibit 10.2 Employment Agreement, dated June 27, 1997, between Registrant and T. Wade Fallin Incorporated by reference to the Company's Form 10-Q for the Quarter ended June 30, 1997. Exhibit 10.3 Consulting Agreement, dated June 27, 1997, between Registrant and Richard B. Caspari, M.D. Incorporated by reference to the Company's Form 10-Q for the Quarter ended June 30, 1997. Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-11815) of Innovasive Devices, Inc. of our report dated February 19, 1998 appearing on page 21 of this Form 10-K. PRICE WATERHOUSE LLP Boston, Massachusetts March 30, 1998 Exhibit 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 (No. 333-32523) of Innovasive Devices, Inc. of our report dated February 19, 1998 appearing on page 21 of this Form 10-K. PRICE WATERHOUSE LLP Boston, Massachusetts March 30, 1998 43 EX-27 2 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEET AT DECEMBER 31, 1997 AND THE STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 U.S. DOLLARS YEAR DEC-31-1997 JAN-01-1997 DEC-31-1997 1 2,916 10,604 1,746 121 2,947 18,208 3,094 1,134 21,520 2,323 0 0 0 1 19,196 21,520 7,754 7,754 2,232 2,232 0 0 0 (19,154) 0 (19,154) 0 0 0 (19,154) (2.33) (2.33)
EX-99 3 CAUTIONARY STATEMENT FOR "SAFE HARBOR" EXHIBIT 99 CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Innovasive Devices, Inc. (the "Company") desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 (the "Act"). Except for the Conference Report, no official interpretations of the Act's provisions have been published. All of the following important factors discussed below have been discussed in the Company's Registration on Form S-1, File No. 333-3368 under the Securities Act of 1933, which was declared effective by the Securities Exchange Commission (the "Commission") on June 5, 1996. Forward Looking Statements; Cautionary Statement. When used anywhere in future filings by the Company with the Securities and Exchange Commission, in the Company's press releases and in oral statements made with the approval of an authorized executive officer of the Company, the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "project", or "outlook" or similar expressions (including confirmations by an authorized executive officer of the Company of any such expressions made by a third party with respect to the Company) are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. These risk factors are described below. The Company specifically declines any obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements. The Company wishes to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause the Company's actual consolidated results for the Company's current quarter and beyond, to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company: History of Losses; Probability of Substantial Additional Future Losses; Uncertainty of Future Results; Seasonality of Sales. The Company has incurred substantial operating losses since its inception and, as of December 31, 1997, had an accumulated deficit of $35.2 million. These losses have resulted principally from expenses associated with research and development efforts, expenses associated with obtaining United States Food and Drug Administration ("FDA") clearance and the establishment of the Company's sales and marketing organization. The Company expects to generate additional losses as it continues to expend substantial resources in research and product development, funding of clinical trials in support of obtaining necessary regulatory clearances or approvals and expanding its manufacturing capabilities and marketing and sales activities. Results of operations may fluctuate significantly from quarter to quarter due to the timing of such expenditures, absence of a backlog of orders, timing of the receipt of orders, promotional discounts of the Company's products, timing of regulatory actions, introduction of new products by competitors of the Company, pricing of competitive products and the cost and effect of promotional and marketing programs. In addition, the Company anticipates some seasonality due to the fact that generally fewer surgical procedures are performed during the third quarter. The seasonal pattern may cause fluctuations in the Company's results of operations. It is difficult to predict the impact that this seasonality will have on the Company's results of operations because of its limited operating history. The Company's revenue and profitability will be critically dependent on expanding applications for its current product lines both within arthroscopy and in other clinical specialties. In addition, the Company's profitability could be adversely affected if it is required to sell its products at reduced prices. There can be no assurance that significant revenues or profitability will ever be achieved. Potential Volatility of Stock Price. The stock market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the market price of the Company's Common Stock. In addition, the market price of the shares of Common Stock is likely to be highly volatile. Factors such as fluctuations in the Company's operating results, announcements of technological innovations or new products by the Company or its competitors, FDA and international regulatory actions, actions with respect to reimbursement matters, developments with respect to patents or proprietary rights, mergers or acquisitions involving competitors, public concern as to the safety of products developed by the Company or others, changes in health care policy in the United States and internationally, changes in stock market analyst recommendations regarding the Company, other medical device companies or the medical device industry generally and general market conditions may have a significant effect on the market price of the Common Stock. Uncertainty of Market Acceptance. The Company's future prospects depend significantly on increasing penetration of existing markets, acceptance of the Company's products in new markets, and the development of new products for its existing and future markets. There can be no assurance that any of the Company's existing or future products will gain market acceptance among physicians, patients or healthcare payors, even if reimbursement and necessary regulatory approvals are obtained. To date, the Company's marketing efforts have been directed primarily to the sports medicine segment of the orthopedic market for tissue-to-bone fixation applications. The Company has no experience in establishing marketing or distribution channels in other clinical areas. With respect to its current products, the Company was not the first to market devices for the attachment of soft tissue to bone and therefore, to succeed must both take market share away from its existing competitors and create new demand for its products. The size of the market for the Company's products will depend in part on the Company's ability to persuade physicians that its products offer clinical and other advantages over existing means of attaching soft tissue structures to tissue or bone and that its fixation devices could be used for a wider variety of clinical applications, such as repair of tears in the meniscus cartilage of the knee, or repair of ligament or tendon damage in the fingers or toes. In addition, the Company will need to demonstrate that its products are cost-effective and convenient to use and that the techniques for their use are relatively straightforward and simple. There can be no assurance that the market for the Company's products will continue to grow or that they will be accepted for orthopedic procedures not currently using fixation devices and in markets outside of the sports medicine segment of the orthopedic market. Limited Product Line. A substantial portion of the Company's sales to date have derived from the Company's suture fasteners and related instruments. The Company now markets a broader line of products within four product platforms: suture fasteners, suturing systems, cartilage repair products and anterior cruciate ligament ("ACL") reconstruction products. The Company's clinical experience has been primarily in open surgery shoulder procedures. The Company's future prospects depend in part on its ability to broaden its clinical expertise to include arthroscopic procedures in the shoulder and knee. The Company must also develop and train its distribution channels to market and sell the expanded product offerings. For the fiscal years ended December 31, 1997 and 1996, suture fasteners and related instruments accounted for approximately 68% and 95%, respectively, of the Company's sales. The Company expects that a significant portion of its revenue in the foreseeable future will continue to be derived from sales of its suture fasteners and related instruments. If the Company is unable to maintain and gain market acceptance for each of its product platforms there would be a material adverse effect on the Company's business, financial condition and results of operations. Rapid Technological Change and New Product Innovation. The medical device market is subject to rapid technological change and new product introductions and enhancements. The Company's ability to remain competitive in this market will depend in significant part on its ability to develop and introduce new products and enhancements on a timely and cost effective basis. The ability of the Company to develop new and enhanced tissue fixation devices depends on a number of factors, including product selection, timely and efficient completion of product design, development of new materials and manufacturing processes, timely regulatory approval, implementation of manufacturing and assembly processes and effective sales and marketing and there is no assurance that the Company will be successful in developing such products. If the Company experiences quality or reliability problems with new products, reductions in orders, higher manufacturing costs and additional warranty expenses may result. Because new product development commitments must be made well in advance of sales, new product decisions must anticipate both future demand and the availability of technology to satisfy that demand. In the meantime, competitors may achieve technological advances which provide a competitive advantage over the Company's products. In addition, advances or developments in other fixation technologies, including those relating to bioabsorbable materials or biomaterials, could render the Company's products obsolete or less desirable. There can be no assurance that the Company will successfully develop and introduce new products and enhancements or that such products will achieve market acceptance. Reliance on Patents and Proprietary Technology. The Company relies on proprietary technology which it seeks to protect primarily through patents, trade secrets and proprietary know-how. The Company currently holds twenty patents and more than seventy United States and foreign patent applications pending which cover certain aspects of its technology. With respect to the patent applications, however, the breadth of the claims that will be covered by the issued patents cannot be known until they are issued. Moreover, the degree of protection against competing devices afforded by the Company's patents is subject to uncertainties. There can be no assurance that others will not be successful in challenging, invalidating or circumventing the Company's patents or that the Company's patents and intellectual property rights will confer a competitive advantage on the Company. In addition, there can be no assurance that the Company will be able to obtain patents on future products, or that the Company's products will not infringe the patents and proprietary rights of third parties. The medical device industry has been characterized by extensive litigation involving patents and other intellectual property rights, and certain companies in the medical device industry have employed intellectual property litigation to gain a competitive advantage. The Company may not be able to successfully defend against a claimed infringement and there can be no assurance that the Company will not become subject to patent infringement claims or litigation or interference proceedings. Litigation may be necessary to enforce patents issued to the Company or to protect its trade secrets and other intellectual property rights. Any litigation or interference proceedings will result in substantial expense to the Company and a significant diversion of effort by its employees, and, if adversely determined to the Company, could result in significant liabilities to third parties and limitations on the manufacture, distribution or sale of the Company's products or on the use of certain technologies in the Company's products. Future Capital Needs; Uncertainty of Additional Funding. There can be no assurance that additional equity or debt financing will not be required prior to the time, if ever, the Company achieves and sustains profitability. The Company may require additional financing to fund its operations. The Company's future capital requirements will depend on many factors, including the progress of the Company's research and development, the scope and results of preclinical studies and clinical trials, the cost, timing and outcome of regulatory reviews, the rate of technological advances, the market acceptance of any of the Company's products, administrative and legal expenses, competitive products, and manufacturing and marketing arrangements. Any additional equity financing may result in dilution to the Company's stockholders. There can be no assurance that funds will be available on favorable terms, if at all. If adequate funds are not available, the Company may be required to cut back or discontinue one or more of its product development programs, or obtain funds through strategic alliances that may require the Company to relinquish rights to certain of its technologies or products. Regulatory Risks. The manufacturing, labeling, distribution and marketing of the Company's products are subject to extensive and rigorous governmental regulation in the United States and certain other countries where the process of obtaining and maintaining required regulatory approvals is lengthy, expensive and uncertain. In order initially to market its products for clinical use in the United States, the Company must obtain clearance from the FDA either through a procedure known as 510(k) pre-market notification or must receive approval by a lengthier and more difficult procedure known as pre-market approval ("PMA"). Although all of the Company's current products have been cleared using the 510 (k) procedure, there can be no assurance that the Company's future products or modifications to the Company's existing products will be cleared by the FDA using the 510(k) process rather than the more arduous and lengthy procedures required for a PMA application, which may include extensive clinical studies, manufacturing information and review by a panel of experts outside the FDA. For example, to the Company's knowledge, the closest predicate device for a collagen-based fastener required PMA approval. If the FDA were to require the Company to obtain pre-market approval for the sale of its future products using the PMA process, the time from development to marketing of those products could be significantly extended, with a concomitant negative impact on the Company's financial performance. The Company may market its products only for indications that have been cleared by the FDA. The Company has no control over the use of its devices by physicians. There can be no assurance that the Company will not become subject to FDA actions resulting from physician use of its products for non-approved indications. FDA regulations for the commercial sale of products is subject to interpretation. Failure to comply with FDA requirements could result in the FDA's refusal to accept clinical data from the Company or the imposition of regulatory sanctions. In addition, there can be no assurance that the FDA will not place significant limitations upon the intended use of the Company's products as a condition to 510(k) clearance or PMA approval. Failure to receive, or delays in receipt of, FDA clearances or approvals, including the need for clinical trials or additional data as a prerequisite to clearance or approval, or any FDA limitations on the intended use of the Company's products, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has not obtained regulatory approval in all foreign countries for all products which it plans to sell product. Starting in mid-1998, the Company will be required to obtain "CE" mark certification, which is an international symbol of quality and compliance with applicable European medical device directives, in order for it to sell its products in Europe. There can be no assurance that the Company will be able to obtain the proper certification. If the Company obtains regulatory approval to sell its products in foreign countries, it would rely on independent distributors to comply with certain of the foreign regulatory requirements. The inability or failure of the Company's independent distributors to comply with applicable regulatory requirements could materially and adversely affect the Company's business, financial condition and results of operations. The Company and its contract manufacturers will be required to adhere to "Good Manufacturing Practices" of the FDA and similar requirements in other countries, which include testing, control and documentation requirements. Ongoing compliance with good manufacturing practices ("GMP") and other applicable regulatory requirements will be monitored through periodic inspections by state and federal agencies, including the FDA, and by comparable foreign agencies. Failure to comply with applicable regulatory requirements could result in, among other things, warning letters, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, refusal of the government to grant clearance or approval to the marketing of devices, withdrawals of approvals and criminal prosecution. The restriction, suspension or revocation of regulatory approvals or any other failure to comply with regulatory requirements could have a material adverse effect on the Company. Limited Manufacturing Experience. The Company manufactures and assembles its suture fastener, suture systems, COR systems and ACL repair products, but has yet to manufacture the volumes necessary for the Company to achieve profitability. There can be no assurance that reliable, high-volume manufacturing can be achieved at a commercially reasonable cost. The Company intends to expand its manufacturing capabilities to include bioabsorbable products and biomaterials, and if the Company encounters difficulties in scaling up production of new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel, such problems could have a material adverse effect on the Company's business, financial condition and results of operations. Reliance on Sole or Limited Sources of Supply. The Company's suture fasteners are manufactured from molded polymers. The Company owns only one set of molds for each of its products requiring a molding manufacturing process. In the event that the molds are damaged, approximately 12 to 16 weeks would be required for the manufacture of new molds. Should the Company's manufacturing process be disrupted, there can be no assurance that the Company would be able to meet its commitments to customers. The failure of the Company to meet its commitments could have a material adverse effect on the Company's business, financial condition and results of operations. In addition, certain suppliers may terminate sales of certain materials to companies that manufacture medical devices in an attempt to limit their potential product liability exposure. If the polymers which are used to manufacture the Company's ROC suture fasteners became unavailable, the Company would be required to identify a new polymer material for the suture fasteners and certify the quality and suitability of the new material. In additional, a new 510(k) clearance would have to be obtained to market products manufactured from the new materials. This process could take a substantial period of time and there is no assurance that the Company would be able to identify, certify or obtain clearance for the new polymer-based fasteners. The Company is attempting to develop new tissue fixation devices from bioabsorbable materials and biomaterials, particularly collagen. The Company believes that there are only a few sources of bioabsorbable materials with the ability and expertise to manufacture bioabsorbable materials for the Company's products. The Company believes that even fewer sources of supply for collagen materials currently exist. The Company has entered into a research and development and a manufacturing and supply agreement with Collagen Corporation in connection with a program to develop tissue fixation devices from collagen, but there are provisions in those agreements that would enable either party to terminate the arrangements in certain circumstances. If the Company were unable to obtain sources of bioabsorbable materials or biomaterials to produce the next generation of its products, the Company's future prospects and opportunities would be substantially reduced, resulting in a material adverse effect on its business, financial condition and results of operations. Reliance on International Distributors. The Company depends primarily on outside independent sales representatives and distributors for its international sales. None of the Company's foreign representatives are subject to any long-term commitments to the Company, and all of them represent a number of manufacturers and sell a broad range of products in addition to those offered by the Company. The revenues that such representatives are likely to receive from the promotion and sale of other products may be substantially greater than the compensation they may receive from the sale of the Company's products, and it may be difficult for the Company to provide incentives to such representatives in order to cause them to devote substantial attention to marketing and selling the Company's products. International sales accounted for 15% of the Company's revenues in 1997. The failure of the Company's foreign independent representatives to generate substantial sales for the Company could have a material adverse effect on the Company's business, financial condition and results of operations. The loss of such sales representatives or distributors or the inability of the Company to develop and maintain an alternative foreign distribution network could have a material adverse impact on the Company's international sales. The Company will depend in part on its international sales representatives to obtain needed regulatory approval for the sale of the Company's products in overseas markets. The failure of its international sales representatives to obtain or maintain the necessary approvals could have a material adverse effect on the Company's business, financial condition and results of operations. Certain risks are inherent in international operations, including changes in demand resulting from fluctuations in exchange rates, the risk of government financed or subsidized competition, changes in trade policies and tariff regulations. Although the Company's international sales are denominated in dollars, fluctuations in foreign currencies can impact the prices quoted by the Company to prospective customers and thereby affect the Company's ability to obtain orders from foreign customers. Product Liability Risk. The development, manufacture and sale of medical devices entail significant risks of product liability claims. There can be no assurance that the amount of the Company's insurance coverage will be adequate to protect it from product liability claims, that the Company will be able to obtain adequate coverage at competitive rates in the future, or that the Company's product liability experience in the future will enable it to obtain insurance coverage in the future. Product liability insurance is expensive, and may not be available on acceptable terms, if at all, in the future. A successful product liability suit not covered by such insurance would have a material adverse effect on the Company's business, financial condition and results of operations. Influence of Collagen Corporation. An important part of the Company's long-term strategy is to develop and sell products manufactured from collagen. Collagen Corporation holds approximately 9.2% of the Company's Common Stock. Collagen Corporation is entitled to designate one member of the Company's Board of Directors so long as it holds at least five percent of the Company's Common Stock on a fully-diluted basis and a representative of Collagen Corporation currently serves on the Board of Directors of the Company. In addition, the Company and Collagen Corporation are parties to a research and development agreement, a manufacturing and supply agreement and a distribution agreement with respect to tissue fixation devices manufactured from collagen-based materials using Collagen Corporation's proprietary technology. Pursuant to those agreements, certain of the Company's products under development will be based upon patents and intellectual property owned by Collagen Corporation. Accordingly, Collagen Corporation may be able to exercise influence over the business and financial affairs of the Company. If Collagen Corporation's licensed technology is invalidated or challenged, the Company's ability to sell products based on such technology could be severely limited. In the event that the Company materially breaches any of the terms of its agreements with Collagen Corporation, Collagen Corporation could terminate the Company's license to develop, manufacture and sell products using Collagen Corporation's technology, which could have a material adverse effect on the Company's business, financial condition and results of operations. Risk of Intense Competition. The medical device industry is highly competitive and characterized by innovation and rapid technological change. Among the Company's principal competitors are Mitek Surgical Products, Inc. ("Mitek"), a division of Johnson & Johnson, the Zimmer and Linvatec divisions of Bristol- Meyers Squibb Company and ConMed Inc. respectively, Smith & Nephew Endoscopy, ("Dyonics" and "Acufex"), a subsidiary of Smith & Nephew, Inc., Arthrotek Inc., a division of Biomet, Inc. and Arthrex, Inc. Each of these competitors has significantly greater financial, manufacturing, marketing, distribution and technical resources than the Company and a greater share of the tissue fixation market than the Company. In addition, a number of smaller companies are entering or have entered the tissue fixation market. Dyonics, Inc. and Mitek have already released to the market a number of bioabsorbable products. Many of the Company's competitors have large existing sales organizations devoted to a wide variety of orthopedic products. These companies are well capitalized and may be able to withstand price pressures and deep discounting better than the Company. The Company has a small number of sales employees and independent sales representatives focused on tissue fixation devices in the sports medicine market and with relatively little experience selling the Company's products. There can be no assurance that the Company's competitors will not succeed in developing technologies and products that are more effective or less costly than any which have been developed or may be developed by the Company or that would render the Company's products obsolete or not competitive. Price Pressure Resulting From Consolidation of Health Care Industry. The health care industry is undergoing rapid change and consolidation as health care systems merge to effect cost savings and operating efficiencies. In addition, a number of large, national buying consortiums have formed to engage in group purchasing of medical supplies and services in an effort at cost containment for member hospital systems and health care providers. These consolidated systems and large purchasing organizations are likely to apply pressure to manufacturers and distributors of medical devices to reduce the purchase prices of their goods. Manufacturers such as the Company may be forced to lower prices in response to those pressures in order for their products to be approved for purchase by those organizations, which could have a material adverse effect on the Company's business, financial condition and results of operations. Possible Limitations on Third-Party Reimbursement. The Company's products are generally purchased directly by hospitals and other health care providers, which in turn bill third-party payors such as Medicare, Medicaid and private insurance companies. Many of these payors are attempting to control health care costs by authorizing fewer surgical procedures and by limiting reimbursement for procedures to fixed amounts. The Company's strategy includes the expansion of its market by encouraging physicians to use its tissue fixation devices for procedures that are not routinely performed, or if performed, are performed without the use of tissue fasteners. Failure by physicians, hospitals and other users of the Company's products to obtain sufficient reimbursement from third- party payors for procedures in which the Company's products are used, or adverse changes in government and private third-party payors' policies toward reimbursement for such procedures, could have a material adverse effect on the Company's business, financial condition and results of operations. 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. INNOVASIVE DEVICES, INC, DATE: MARCH 31, 1998 BY:/S/ RICHARD D. RANDALL --------------------------------------- RICHARD D. RANDALL PRESIDENT, CHIEF EXECUTIVE OFFICER AND DIRECTOR (PRINCIPAL EXECUTIVE OFFICER) DATE: MARCH 31, 1998 BY:/S/ JAMES V. BARRILE --------------------------------------- JAMES V. BARRILE EXECUTIVE VICE PRESIDENT OF FINANCE, CHIEF FINANCIAL OFFICER AND TREASURER (PRINCIPAL FINANCIAL OFFICER) -----END PRIVACY-ENHANCED MESSAGE-----