-----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, CEpF+u7s9DFqfVG50RWmt7ma0Tg80tgnTxFh/ZIHNSIDCKN1y3Ei5nB16IE88H+Q 3+FvJS3h2O11sIuWiw/36A== 0000912057-96-026589.txt : 19961118 0000912057-96-026589.hdr.sgml : 19961118 ACCESSION NUMBER: 0000912057-96-026589 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19960930 FILED AS OF DATE: 19961114 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENERAL SURGICAL INNOVATIONS INC CENTRAL INDEX KEY: 0000890763 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 973170244 STATE OF INCORPORATION: CA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-28448 FILM NUMBER: 96666605 BUSINESS ADDRESS: STREET 1: 3172A PORTER DR CITY: PALO ALTO STATE: CA ZIP: 94304 BUSINESS PHONE: 4158129740 MAIL ADDRESS: STREET 1: 3172A PORTER DRIVE CITY: PALO ALTO STATE: CA ZIP: 94304 10-Q 1 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996. Commission file number: 0-28448 GENERAL SURGICAL INNOVATIONS, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 97-3170244 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3172A PORTER DRIVE, PALO ALTO, CALIFORNIA 94304 (Address of principal executive offices) Registrant's telephone number, including area code: (415) 812-9730 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- There were 13,172,765 shares of Registrant's Common Stock issued and outstanding as of November 1, 1996. ________________________________ GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 TABLE OF CONTENTS PAGE PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed, consolidated balance sheets at September 30, 1996 (unaudited) and June 30, 1996............................... 3 Condensed, consolidated statements of operations for the three months ended September 30, 1996 (unaudited) and September 30, 1995.......................... 4 Condensed, consolidated statements of cash flows for the three months ended September 30, 1996 (unaudited) and September 30, 1995.......................... 5 Notes to condensed, consolidated financial statements.................................. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.............................. 8 PART II. OTHER INFORMATION GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY Condensed, Consolidated Balance Sheets (In thousands, except share amounts)
September 30, June 30, 1996 1996 ------------- ------------ (Unaudited) Assets Current assets: Cash and cash equivalents $ 20,441 $ 28,339 Available-for-sale securities 29,377 21,451 Accounts receivable, net of allowance for doubtful accounts of $50 on September 30, 1996 and $78 on June 30, 1996 678 873 Inventories 890 700 Prepaid expenses and other current assets 229 438 ------------- ------------ Total current assets 51,615 51,801 Property and equipment, net 669 702 Intangible and other assets, net 247 264 ------------- ------------ Total assets $ 52,531 $ 52,767 ============= ============ Liabilities, Convertible Redeemable Preferred Stock and Shareholders' Equity (Deficit) Current liabilities: Accounts payable $ 478 $ 614 Accrued liabilities 996 892 Bank borrowings 127 127 Deferred revenue 66 100 ------------- ------------ Total current liabilities 1,667 1,733 Bank borrowings, less current portion 331 360 Deferred revenue, less current portion - - Other long-term liabilities 200 200 ------------- ------------ Total liabilities 2,198 2,293 Convertible redeemable preferred stock, $.001 par value: Authorized: 6,123,867 shares: issued and outstanding, no shares at September 30, 1996 and no shares at June 30, 1996 - - ------------- ------------ Shareholders' equity (deficit): Preferred stock, $.001 par value: Authorized: 2,000,000 shares; none issued and outstanding: Common stock, $.001 par value: Authorized: 50,000,000 shares; issued and outstanding: 13,161,723 in Q1 1997 and 13,132,903 in 1996 13 13 Additional paid in capital 64,932 64,885 Notes receivable from shareholders (123) (112) Deferred compensation, net (446) (496) Unrealized gain/(loss) on available-for-sale securities 3 1 Accumulated deficit (14,046) (13,817) ------------- ------------ Total shareholders' equity (deficit) 50,333 50,474 ------------- ------------ $ 52,531 $ 52,767 ============= ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 3 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended September 30, ---------------------------- 1996 1995 ---------- --------- Sales $ 2,470 $ 491 Cost of Sales 993 334 ----------- ---------- Gross Profit 1,477 157 ----------- ---------- Operating Expenses: Research and development 462 202 Sales and marketing 1,108 755 General and administrative 723 311 ----------- ---------- Total operating expenses 2,293 1,268 ----------- ---------- Operating loss (816) (1,111) Interest and other income (expense) 587 63 ----------- ---------- Net loss $ (229) $ (1,048) ----------- ---------- ----------- ---------- Net loss per share $ (0.02) $ (0.16) ----------- ---------- ----------- ---------- Shares used in computing net loss per share 13,146,816 6,553,482 ----------- ---------- ----------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 4 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
Three Months Ended September 30, ------------------------- 1996 1995 ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net Income/loss $ (229) $(1,046) Adjustments to reconcile net income/loss to net cash used by operating activities: Amortization of deferred compensation 50 - Depreciation and amortization 104 73 Loss on write-off of fixed assets 26 - Provision for uncollectable accounts (28) 17 Provision for excess and obsolete inventory - 40 Changes in operating assets and liabilities: Accounts receivable 223 (188) Inventory (190) (138) Prepaid expenses and other current assets 209 - Intangible and other assets - - Accounts payable (137) (71) Accrued liabilities 104 153 Deferred revenue (33) (33) Other long-term liabilities - (200) ---------- --------- Net cash used in operating activities 98 (1,394) ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities (7,924) - Acquisition of property and equipment (78) (72) ---------- --------- Net cash used in investing activities (8,002) (72) ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES Issuance of common stock for notes receivable (11) - Payments on obligations under capital leases and capital loans (29) (22) Proceeds from issuance of common stock, net of issuance costs 47 - ---------- --------- Net cash provided by financing activities 7 (22) ---------- --------- Net decrease in cash and cash equivalents (7,897) (1,488) Cash and cash equivalents, beginning of period 28,339 4,541 ---------- --------- Cash and cash equivalents, end of period $20,441 $ 3,053 ---------- --------- ---------- --------- SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 10 $ 8 ---------- --------- ---------- --------- Taxes $ - $ - ---------- --------- ---------- --------- NONCASH INVESTING AND FINANCING ACTIVITIES Issuance of common stock for notes receivable $ (11) $ - ---------- --------- ---------- --------- Accumulated unrealized gain on available-for-sale securities $ (2) $ - ---------- --------- ---------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 5 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation: The accompanying unaudited consolidated financial statements as of September 30, 1996 of General Surgical Innovations, Inc. (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Operating results for the three month period ended September 30, 1996 are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 1997. These financial statements and notes should be read in conjunction with the Company's audited financial statements and footnotes thereto included in the Registrant Company and Subsidiaries' Annual Report on Form 10-K for the fiscal year ended June 30, 1996. 2. NET LOSS PER SHARE: The net loss per share is computed using the weighted average number of shares of Common Stock outstanding for all periods presented. Common equivalent shares from stock options and convertible redeemable preferred stock are excluded from the computation as their effect is anti-dilutive, except that, pursuant to the Securities and Exchange Commission Staff Accounting Bulletin No. 83, common and common equivalent shares issued during the period beginning twelve months prior to the initial filing of the Company's initial public offering at prices substantially below the initial public offering price have been included in the calculation as if they were outstanding for all periods presented (using the treasury stock method and the assumed initial public offering price). 3. RECENT PRONOUNCEMENTS: 6 In March 1995, the Financial Accounting Standards Board issued Statement No. 121 ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (SFAS No. 121) which requires the Company to review for impairment long-lived assets and intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In certain situations, an impairment loss would be recognized. SFAS 121 will become effective for the Company's 1997 fiscal year. The Company has studied the implications of the statement, and based on its initial evaluation, does not expect it to have a material impact on the Company's financial condition or results of operations. In October 1995, the Financial Accounting Standards Board issued Statement No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION (SFAS No. 123), which establishes a fair value based method of accounting for stock-based compensation plans and requires additional disclosures for those companies that elect not to adopt the new method of accounting. While the Company studies the impact of the pronouncement, it continues to account for employees' stock options under APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123 will be effective for the Company's 1997 fiscal year. 4. Inventories: Inventories comprise: SEPTEMBER 30, ------------- 1996 1995 ----- ----- (in thousands) Raw Materials................... $ 554 $ 244 Work in progress................ 153 67 Finished goods.................. 183 208 ----- ----- $ 890 $ 519 ===== ===== 5. Subsequent Event: On November 13, 1996, the Company and United States Surgical Corporation (USSC) entered into an early termination of the USSC distribution agreement by mutual agreement. 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited condensed, consolidated financial statements and notes thereto included in part I, Item I of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K dated June 30, 1996. Except for the historical information contained in this Quarterly Report on Form 10-Q, the matters discussed herein are forward-looking statements that are subject to certain risks and uncertainties that could cause the actual results to differ materially from those projected. Factors that could cause actual results to differ materially include, but are not limited to, the timing of orders and shipments, the termination of the Company's distributorship agreement with United Stated Surgical Corporation ("USSC") (described below), the status of the Company's relationship with Ethicon-Endo Surgery, Inc. ("EES") or other corporate partners, the Company's ability to manage growth and possible transition to EES and other new corporate partnering relationships, the timely development and market acceptance of new products and surgical procedures, the impact of competitive products and pricing, results of ongoing litigation, the Company's ability to further expand into international markets, approval of its products by government agencies such as the United States Food and Drug Administration, public policy relating to health care reform in the United States and other countries, and other risks detailed below and included from time to time in the Company's other SEC reports and press releases, copies of which are available from the Company upon request. The Company assumes no obligation to update any forward-looking statements contained herein. In addition, the factors listed below under "Additional Factors that May Affect Future Results," as well as other factors, could in the future affect the Company's actual results and could cause the Company's results for future quarters to differ materially from those expressed in any forward-looking statements contained in the following discussion. References made in this Quarterly Report on Form 10-Q to "General Surgical Innovations, Inc.," the "Company" or the "Registrant" refer to General Surgical Innovations, Inc. and its subsidiaries. The following General Surgical Innovations, Inc. trademarks are mentioned in this Quarterly Report: Spacemaker -Registered Trademark-, registered trademark of the Company; and Knotmaker -TM-, trademark of the Company. Overview Since its inception in April 1992, GSI has been engaged in the development, manufacturing and marketing of balloon dissection systems and related minimally invasive surgical instruments. The Company began commercial sales of its balloon dissection systems for hernia repair in September 1993. To date, the Company has received from the FDA four 510(k) clearances for use of the Company's technology to perform dissection of tissue planes anywhere in the body using a broad range of balloon sizes and shapes. The Company currently sells products in the United States and certain other countries in Europe, Asia and South America for selected applications, such as hernia repair, saphenous endoscopic perforator surgery and breast augmentation and reconstruction surgery. In March 1994, the Company entered into a distribution agreement with United States Surgical Corporation (USSC) providing USSC with limited exclusive rights to distribute the Company's balloon dissection systems in the hernia repair market in both the United States and certain international countries, pursuant to which USSC was obligated to purchase minimum quantities of the Company's products. Substantially all of the Company's revenues have been derived from sales to USSC, which have included sales to Autosuture, Inc., a 8 subsidiary of USSC, with USSC representing approximately 75% and 92% of the Company's total net revenues for fiscal 1995 and 1996, respectively, and 93% for the first quarter of fiscal 1997. On November 12, 1996, the Company and USSC entered into an early termination of this distributorship agreement by mutual agreement. Sales outside of the United States accounted for approximately 3%, 4% and 0.5% of the Company's sales in fiscal 1995, fiscal 1996, and the first quarter of fiscal 1997, respectively, and the Company expects that international sales will represent an increasing portion of revenue in the future. The Company has recorded all sales to USSC as domestic sales; however, sales of the Company's products by USSC have included sales to European and other foreign countries, made through Autosuture. The Company's sales to USSC have fluctuated significantly in the past, and, as a result of the mutual termination of the USSC distributorship and possible transition to EES (as described below), the Company anticipates that such sales will fluctuate in the future. In addition, USSC may have built up its inventory of GSI balloon dissector products. The early termination of the USSC distributorship agreement could have a material adverse effect on the Company's business, financial condition and results of operations. See "Factors Affecting Future Results-- Dependence Upon Key Distributor; Limited Marketing and Direct Sales Experience." The Company also entered into a license and distribution agreement (the "EES Agreement") with Ethicon-Endo Surgery, Inc. ("EES") in the fourth quarter of its fiscal year 1996 under which the Company has the right to manufacture EES baloon dissectors for EES and EES has the right to market its balloon dissection system in the laparoscopic hernia and stress urinary incontinence ("SUI") repair markets. As contemplated by the original EES Agreement, the parties are currently in the process of negotiating an amendment of the EES Agreement, to expand the license to include exclusivity for GSI products in the field of hernia repair and SUI. The parties expect jointly to develop and market a dissector for SUI repair in early calendar 1997. No manufacturing or distribution of products has occurred to date pursuant to the EES Agreement, and there can be no assurance that such manufacturing or distribution efforts will be successful, or that the parties will satisfactorily conclude such an expansion of the EES Agreement. Failure to successfully complete an expanded agreement could have a material adverse effect on the business, financial condition and/or results of operations of the Company. Additional sales in the United States are currently made through a small direct sales force. The Company currently sells its products in international 9 markets through a limited number of distributors who resell to surgeons and hospitals. The Company plans to increase its direct sales force in the United States and may seek to establish a direct sales force in one or more other countries in the future. Any increase in the Company's direct sales force will require significant expenditures and additional management resources. There can be no assurance that any such direct sales force, if established, will be successful. To date, all of the sales to USSC and other distributors and almost all of the sales by the Company's direct sales force have been for use in hernia repair procedures. While the Company has developed balloon dissection systems for other applications, sales of products for hernia repair are expected to provide a majority of the Company's revenues at least through fiscal 1997. There can be no assurance that the Company will be successful in generating sales of such products for any other applications. The Company has acquired a significant number of patent rights from third parties, including rights that apply to the Company's current balloon dissection systems. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to 4% of sales of such products, which payments are expected to exceed certain minimum royalty payments due under agreements with such parties. The Company has also acquired patent rights under royalty-bearing agreements with respect to certain surgical instruments, including the KnotMaker product and the balloon valve trocar currently under development. In February 1996, the Company acquired Adjacent Surgical, Inc., a company engaged in the development of balloon dissection systems for use in vascular applications. The transaction resulted in a one-time expense related to in-process research and development of approximately $2.8 million in the quarter ended March 31, 1996. From time to time, the Company has had discussions with third parties regarding various strategic relationships, including the potential sale of the Company, although the Company currently has no commitments with respect to any such relationships. The Company may continue to have discussions regarding potential strategic relationships in the future. 10 However, there can be no assurance that any such strategic relationship will occur. The Company has a limited history of operations and has experienced significant operating losses since inception. The Company expects such operating losses to continue at least through calendar 1996. The increase in the Company's sales to date has been due to demand for the Company's balloon dissector systems principally for hernia repair. In order to support increased levels of sales in the future and to augment its long-term competitive position, including the development of balloon dissection systems for other applications, the Company anticipates that it will be required to make significant additional expenditures in manufacturing, research and development (including marketing-related clinical evaluations), sales and marketing and administration. In addition, the Company anticipates higher administration expenses resulting from its obligations as a public reporting company. The Company anticipates that its results of operations will fluctuate for the foreseeable future because of several factors, including the early termination by mutual agreement of the Company's relationship with USSC, the status of the Company's relationship with and possible transition to EES and other partners, the mix of sales among the distributors and the Company's direct sales force, timing of new product introductions or transitions to new products, the margins recognized from products for various surgical procedures, the progress of marketing-related clinical evaluations, the introduction of competitive products (including pricing pressures), activities related to patents and patent approvals (including litigation) and regulatory and third-party reimbursement matters, the Company's ability to manufacture its products efficiently, and the timing of research and development expenses (including marketing-related clinical evaluations). In addition, the Company's results of operations could be affected by the timing of orders from distributors, expansion of the Company's distributor network, the ability of the Company's distributors to promote effectively the Company's products and the ability of the Company to quickly and cost effectively increase its direct domestic sales force. The Company's limited operating history makes accurate prediction of future operating results difficult or impossible. Although the 11 Company has experienced sales growth in recent periods, there can be no assurance that, in the future, the Company will sustain sales growth or gain profitability on a quarterly or annual basis or that its growth will be consistent with predictions made by securities analysts. The Company currently manufactures and ships product shortly after the receipt of orders, and anticipates that it will do so in the future. Accordingly, the Company has not developed a significant backlog and does not anticipate that it will develop a material backlog in the future. RESULTS OF OPERATIONS SALES. Sales increased by 403% to approximately $2,470,000 for the quarter ended September 30,1996 from $491,000 for the same period in 1995. This increase was due primarily to the growth in unit sales of the Spacemaker I platform to USSC for the hernia market and, to a lesser extent, from sales of the Spacemaker II platform, which was introduced in October 1995. Approximately $300,000 of revenue during the first quarter of fiscal 1997 was not recognized as a result of disagreements between the Company and USSC regarding USSC's purchase obligations under the USSC distributorship agreement. As the Company begins its transition to EES and other corporate partners, the Company believes that its sales results will fluctuate from quarter to quarter during at least the next several quarters. COST OF SALES. Cost of sales increased by 197% to approximately $993,000 for the quarter ended September 30, 1996 from $334,000 for the same period in 1995, and decreased as a percentage of sales to 40% in the quarter ended September 30, 1996 from 68% in the quarter ended September 30, 1995. This increase in absolute dollars was primarily a result of the costs of additional manufacturing capacity and personnel necessary to support increased sales volume, which was offset by leveraging certain fixed overhead expenses across a higher base of sales. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses, which include expenditures for marketing-related clinical evaluations and regulatory expenses, increased by 128% to $462,000 in the quarter ended September 30, 1996 from $202,000 for the 12 quarter ended September 30, 1995 and decreased as a percentage of sales to 17% in the quarter ended September 30, 1996 period from 41% in the quarter ended September 30, 1995 as a result of higher sales volume in the 1996 period. The Company expects research and development expenses to increase in absolute dollars as the Company pursues development of new products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased by 72% to $1.8 million for the quarter ended September 30, 1996 from $1.1 million for the quarter ended September 30, 1995. This increase was primarily due to the growth of a direct sales force in the United States and the growth in marketing and other personnel associated with the Company's higher levels of operations. The Company expects selling, general and administrative expenses to continue to increase in absolute dollars as the Company's level of sales and manufacturing operations increases and as the Company increases its finance and administrative expenditures to meet its obligations as a public reporting company. INTEREST AND OTHER INCOME/(EXPENSE). Interest and other income/(expense) increased to $587,000 for the quarter ended September 30, 1996 from $63,000 for the quarter ended September 30, 1995 because of higher average cash, cash equivalents and available-for-sale securities balances. Interest earned in the future will depend on Company funding cycles and prevailing interest rates. NET LOSS. The Company had a net loss of approximately $229,000 for the quarter ended September 30, 1996 compared to a net loss of $1.0 million for the quarter ended September 30, 1995. The Company expects to continue to incur losses through at least calander year 1996. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company's cash expenditures have significantly exceeded its sales, resulting in an accumulated deficit of $14 million at September 30, 1996. The Company has funded its operations primarily through the sale of equity securities. From its 13 inception through September 30, 1996 the Company raised approximately $15.2 million through the private placement of equity securities and approximately $46.9 million (net of underwriting discounts and commissions) in an initial public offering. As of September 30, 1996 the Company's principal source of liquidity consists of cash, cash equivalents and short-term investments of $49.8 million. The Company expects to incur substantial additional costs, including costs related to increased sales and marketing activities, increased research and development, expenditures in connection with seeking regulatory approvals and conducting additional marketing-related clinical evaluations, capital equipment and other costs associated with expansion of the Company's manufacturing capabilities and higher administration costs resulting from its obligations as a public reporting company. While the Company believes that its current cash balances and short-term investments along with cash generated from the future sales of products will be sufficient to meet the Company's operating and capital requirements through calendar 1997, there can be no assurance that the Company will not require additional financing within this time frame. The Company may seek additional equity or debt financing to address its working capital needs or to provide funding for capital expenditures. There can be no assurance that additional financing, if required, will be available on satisfactory terms or at all. FACTORS AFFECTING FUTURE RESULTS LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company was organized in April 1992 and began commercially shipping its first Spacemaker products in September 1993. Accordingly, the Company has only a limited operating history upon which an evaluation of the Company and its prospects can be based. As of September 30, 1996, the Company had an accumulated deficit of $14 million. The Company's operating net losses for the quarter ended September 30, 1996 and the fiscal years ending June 30, 1994, 1995 and 1996 were $229,000, $3.1 million, $4.1 million and $5.5 million, respectively. The Company expects to continue to incur significant operating losses on a 14 quarterly and annual basis. Since the introduction of its initial products, the Company has yet to achieve profitability and may never do so in the future. Due to the Company's limited operating history, there can be no assurance of sales growth or profitability on a quarterly or annual basis in the future. The Company intends to increase significantly its investments in research and development, sales and marketing, marketing-related clinical evaluations and related infrastructure. Due to the anticipated increases in the Company's operating expenses, the Company's operating results will be adversely affected if sales do not increase. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in rapidly evolving markets. To address these risks, the Company must respond to competitive developments, continue to attract, retain and motivate qualified persons and successfully commercialize products incorporating advanced technologies. There can be no assurance that the Company will be successful in addressing such risks. DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL OBSOLESCENCE. All of the Company's sales since inception have been derived from sales of its balloon dissection products, with a substantial portion derived from sales for hernia repair procedures. Failure of the Company to develop successfully and commercialize balloon dissection products for applications other than hernia repair could have a material adverse effect on the Company's business, financial condition and results of operations. The success of the Company's products depends on the nature of the technological advances inherent in the product designs, reductions in patient trauma or other benefits provided by such products, results of marketing-related clinical evaluations, continued adoption of MIS procedures by surgeons, market acceptance of the Company's products and related procedures, reimbursement for the Company's products by health care payors and the Company's receipt of regulatory approvals. There can be no assurance that the Company's products will have the required technical 15 characteristics, that the Company's products will provide adequate patient benefits, that marketing-related clinical evaluations results will be favorable, that surgeons will continue to adopt MIS procedures, that recently-introduced products or future products of the Company or related procedures will gain market acceptance, or that required regulatory approvals will be obtained. The failure to achieve any of the foregoing could have a material adverse effect on the Company's business, financial condition and results of operations. To the extent demand for the Company's balloon dissection systems for hernia repair declines and the Company's newly-introduced products are not commercially accepted or its existing products are not developed for new procedures, there could be a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON KEY DISTRIBUTOR. In March 1994, the Company entered into a distribution agreement with United States Surgical Corporation ("USSC"), a large manufacturer and distributor of medical devices. Pursuant to this agreement USSC had rights, which were co-exclusive with the rights of GSI, to distribute the Spacemaker I product for hernia repair and, to the extent permitted by the Company's initial 510(k) clearance for the Spacemaker I product, other applications. USSC's distribution rights were limited to only those products that are or could be covered by the Company's initial 510(k) clearance. On November 12, 1996, the two parties, by mutual agreement, entered into an early termination of this distributorship agreement. USSC historically purchased substantially more product than was required under this agreement. In fiscal 1995 and 1996, sales to USSC, which have included sales to Autosuture, Inc., a subsidiary of USSC, represented approximately 75% and 92%, respectively, of the Company's net sales. The Company's sales to USSC have fluctuated in the past and as the Company begins its transition to EES, the Company expects that sales will continue to fluctuate for at least the next several quarters. 16 Approximately $300,000 of revenue during the first quarter of fiscal 1997 was not recognized as a result of disagreements between the Company and USSC regarding USSC's purchase obligations under the USSC distributorship agreement. This early termination of the agreement with USSC could have a material adverse effect on the Company's business, financial condition and results of operations. In June 1996, the Company signed an agreement with Ethicon Endo-Surgery, Inc. ("EES") under which the Company can manufacture EES balloon dissectors for EES, and EES has the right to market its balloon tissue dissection system in the laparoscopic hernia repair market. As contemplated by the original EES Agreement, the parties are currently in the process of negotiating an expansion of the EES Agreement in order to expand the license to include exclusivity for GSI products in the field of hernia repair and SUI. The parties expect jointly to develop and market a dissector for SUI repair in early calendar 1997. No manufacture or distribution of products has occurred to date pursuant to the EES Agreement, and there can be no assurance that efforts to do so will be successful, or that the parties will successfully conclude an expansion of the EES Agreement. Although the Company intends to establish additional distributorships in the United States for products in areas other than hernia repair and SUI, there can be no assurance that such efforts will be successful. Failure to diversify its distribution network in the United States could have a material adverse effect on the Company's business, financial condition and results of operations. To date, substantially all of the Company's international sales for hernia repair procedures have been made through Autosuture under the same terms and conditions as the Company's agreement with USSC. Although the Company may in the future seek to diversify its international distribution network, there can be no assurance that such efforts will be 17 successful. Failure to diversify its international distribution network and the termination of the relationship with USSC and Autosuture could have a material adverse effect on the Company's business, financial condition and results of operations. LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only limited experience marketing and selling its products through its direct sales force, and has sold its products in commercial quantities through its direct sales force only to the hernia market and, to a lesser degree, to the cosmetic and reconstructive surgery market. Establishing marketing and sales capability sufficient to support sales in commercial quantities for the other markets targeted by the Company, including additional hernia, vascular, urology, obstetrics, gynecology and orthopedic surgery markets, will require significant resources, and there can be no assurance that the Company will be able to recruit and retain additional qualified marketing personnel, or direct sales personnel or that future sales efforts of the Company will be successful. In markets where there is a large potential customer base, the Company intends to establish partnership relationships with additional distribution partners. The Company has no significant relationships other than with Ethicon Endo-Surgery, Inc. and there can be no assurance that the Company will be successful in establishing such partnership relationships on commercially reasonable terms, if at all. The failure to establish and maintain an effective distribution channel for the Company's products, or establish and retain qualified and effective sales personnel to support commercial sales of the Company's products, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE. The Company's success is substantially dependent upon the success of its Spacemaker balloon dissection products. The Company believes that market acceptance of the Company's 18 products will depend on the Company's ability to provide evidence to the medical community of the safety, efficacy and cost-effectiveness of its products and the procedures in which these products are intended to be used. Market acceptance is also dependent on the adoption of laparoscopic techniques generally and the conversion of non-balloon dissection techniques to balloon dissection techniques specifically. To date, the Company's products have only been used to treat a limited number of patients and the Company has limited long-term outcomes data. If the Company is not able to demonstrate consistent clinical benefits resulting from the use of its products (including reduced procedure time, reduced patient trauma and lower costs), the Company's business, financial condition and results of operations could be materially and adversely affected. The Company further believes that the ability of health care providers to obtain adequate reimbursement for procedures using the Company's Spacemaker balloon dissector products and related instruments will be critical to market acceptance of the Company's products. Although the Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes, there can be no assurance that such procedure codes will remain available or that reimbursement under these codes will be adequate. The Company has limited experience in obtaining third-party reimbursement, and the inability to obtain reimbursement for some or all of its products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company introduced its balloon dissectors in late 1993 and to date there has been relatively little education among surgeons about the benefits of balloon dissection technology. Furthermore, because of the novelty of balloon dissection procedures, many surgeons and surgeons' assistants have not developed the requisite skills to perform balloon dissection procedures. To the extent that laparoscopic techniques are adopted slowly, that balloon dissectors are incorporated into laparoscopic techniques less often or that surgeons are unwilling or unable to develop the skills necessary to utilize balloon dissectors, the 19 Company's business, financial condition and results of operations could be materially adversely affected. FLUCTUATIONS IN QUARTERLY RESULTS. Results of the Company's operations may fluctuate significantly from quarter to quarter and will depend on (i) new product introductions by the Company and its competitors and the resulting product transitions, (ii) the effect of the termination of the Company's relationship with USSC, (iii) the status of the Company's relationship with EES, (iv) the rate of adoption by surgeons of balloon dissection technology in markets targeted by the Company, (v) the sales efforts of the Company's distributors, (vi) the mix of sales among distributors and the Company's direct sales force, (vii) timing of patent and regulatory approvals, (viii) timing of operating expenditures, (ix) the Company's ability to manufacture its products efficiently, (x) timing of research and development expenses, including marketing-related clinical evaluation expenditures, (xi) intellectual property litigation and (xii) general market conditions. The Company's sales in any period have been highly dependent upon the marketing efforts and success of USSC. The Company's sales to USSC have fluctuated significantly in the past, and, as a result of the mutual termination of the USSC distributorship and possible transition to EES, the Company anticipates that such sales will fluctuate in the future. For example, approximately $300,000 of revenue during the first quarter of fiscal 1997 was not recognized as a result of disagreements between the Company and USSC regarding USSC's purchase obligations under the USSC distributorship agreement. This early termination of the agreement could result in a decline in sales and adversely affect the Company's operating results. The Company also recently entered into a license and distribution agreement (the "EES Agreement") with Ethicon Endo-Surgery, Inc. ("EES") under which the Company can manufacture balloon dissectors for EES and EES has the right to market its balloon dissection system in the laparoscopic hernia repair market. As contemplated by the original EES Agreement, the parties are currently in the process of negotiating an expansion of the EES Agreement in order to expand the license to include exclusivity for GSI products in the field of hernia repair and SUI. The parties expect to jointly develop and market a dissector for SUI repair in early calendar 1997. No manufacture or distribution of products has occurred to date pursuant to the EES Agreement, and there can be no assurance that efforts to do so will be successful or that the expansion of the EES Agreement will be successfully concluded. In addition, announcements or expected announcements by 20 the Company, its competitors or its distributors of new products, new technologies or pricing changes could cause existing or potential customers of the Company to defer purchases of the Company's existing products and could alter the mix of products sold by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that future products or product enhancements will be successfully introduced or that such introductions will not adversely affect the demand for existing products. As a result of these and other factors, the Company's quarterly operating results have fluctuated in the past, and the Company expects that such results may fluctuate in the future. Due to such quarterly fluctuations in operating results, quarter-to-quarter comparisons of the Company's operating results are not necessarily meaningful and should not be relied upon as indicators of likely future performance or annual operating results. In addition, the Company's limited operating history makes accurate prediction of future operating results difficult or impossible to make. There can be no assurance that in the future the Company will achieve sales growth or become profitable on a quarterly or annual basis or that its growth will be consistent with predictions by securities analysts and investors. In such event, the price of the Company's Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's success will depend on its ability to obtain patent protection for its products and processes, to preserve its trade secrets and proprietary technology and to operate without infringing upon the patents or proprietary rights of third parties. As of June 30, 1996, GSI had 16 United States patents issued, and had applied for an additional 45 United States patents, four of which had been allowed. In addition, GSI had two foreign patents issued, and 17 still in prosecution as of such date. In May 1996, the Company was issued a United States patent 21 that contains claims regarding the use of balloons to dissect tissue planes anywhere in the body. In May 1996, the Guidant Corporation unit of Origin MedSystems, Inc. filed an action against GSI in the U.S. District Court for the Northern District of California, alleging patent infringement of its patent entitled "Apparatus and Method for Peritoneal Retraction". GSI subsequently filed an action against Origin Medsystems, Inc. in the U.S. District Court for the Northern District of California alleging patent infringement of its patent for a method of tissue plane dissection using balloon systems. A decision against the Company in either of these actions could have a material adverse effect on the Company's business, financial condition or results of operations. The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, are highly uncertain. No assurance can be given that any patents based on pending patent applications or any future patent applications will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to the Company, that any of the Company's patents or patents to which it has licensed rights will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held or licensed by the Company or that the Company's existing patents will cover the Company's future products. Furthermore, there can be no assurance that others have not developed or will not develop similar products, duplicate any of the Company's products or design around any patents issued to or licensed by the Company or that may be issued in the future to the Company. Since patent applications in the United States are maintained in secrecy until patents issue, the Company also cannot be certain that others did not first file applications for inventions covered by the Company's pending patent applications, nor can the Company be certain that it will not infringe any patents that may issue to others on such applications. One of the patent applications filed by the Company, which is directed to a surgical method using balloon dissection technology, has been placed in interference with a patent application filed by Origin 22 Medsystems, Inc. ("Origin"), a competitor of the Company. The Company believes that the inventor named in its patent application was the first to invent this subject matter, and has asserted that the Origin patent application was filed after a disclosure made by such inventor to employees of Origin. Origin takes a contrary position. This interference is presently pending in the United States Patent and Trademark Office ("USPTO") and, as permitted by the rules of the USPTO, has been referred to an arbitrator for completion of the interference proceeding. A decision is not expected in this interference proceeding until 1997. Failure of the Company to prevail in such interference proceeding could have a material adverse effect on the Company's business, financial condition and results of operations. Patent interference or infringement involves complex legal and factual issues and is highly uncertain, and there can be no assurance that any conclusion reached by the Company regarding patent interference or infringement will be consistent with the resolution of such issue by a court. In the event the Company's products are found to infringe patents held by competitors, there can be no assurance that the Company will be able to modify successfully its products to avoid infringement, or that any modified products will be commercially successful. Failure in such event to either develop a commercially successful alternative or obtain a license to such patent on commercially reasonable terms could have a material adverse effect on the Company's business, financial condition and results of operations. In any event, there can be no assurance that the Company will not be required to defend itself in court against allegations of infringement of third-party patents. Patent litigation is expensive, requires extensive management time, and could subject the Company to significant liabilities, require disputed rights to be licensed from third parties or require the Company to cease selling its products. Legislation has recently been enacted in Congress, the effect of which is to immunize physicians and their employers from liability for patent infringement for alleged infringement of patent claims directed to medical procedures. 23 In addition, the patent laws of European and certain other foreign countries generally do not allow for the issuance of patents for methods of surgery on the human body. Accordingly, the ability of the Company to gain patent protection for its methods of tissue dissection will be significantly limited. As a result, there can be no assurance that the Company will be able to develop a patent portfolio in Europe or that the scope of any patent protection will provide competitive advantages to the Company. ROYALTY PAYMENT OBLIGATIONS. The Company has acquired a significant number of patent rights from third parties, including rights that apply to the Company's current balloon dissection systems. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to 4% of sales of such products, which payments are expected to exceed minimum royalty payments due under agreements with such parties. The Company also has acquired patent rights under royalty-bearing agreements with respect to certain surgical instruments, including the KnotMaker product and the balloon valve trocar currently under development. The payment of such royalty amounts will have an adverse impact on the Company's gross profit and other results of operations. There can be no assurance that the Company will be able to continue to satisfy such royalty payment obligations in the future, and a failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations. EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY TO MANAGE GROWTH. The Company began commercial sales of its balloon dissection products in September 1993 and, as a result, has limited experience in manufacturing, marketing and 24 selling its products commercially. The Company has recently experienced rapid growth in its facilities and the number of its employees, the number of products under development, the number and amount of products manufactured and sold, and the geographic scope of its sales. In order to support increased levels of sales in the future and to augment its long-term competitive position, the Company anticipates that it will be required to make significant additional expenditures in manufacturing, research and development, sales and marketing, and administration. The Company's acquisition of Adjacent Surgical, Inc. in February 1996 has resulted in additional demands on the Company's limited management resources. The Company's inability to manage its growth effectively could have a material adverse effect on the Company's business, financial condition and results of operations. COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in the market for medical devices used in tissue dissection surgical procedures is intense and is expected to increase. The Company competes primarily with other producers of MIS tissue dissection instruments. Origin, a subsidiary of Guidant Corporation, and others, currently compete against the Company in the development, production and marketing of MIS tissue dissection instruments and tissue dissection technology. To the extent that surgeons elect to use open surgical procedures rather than MIS, the Company also competes with producers of tissue dissection instruments used in open surgical procedures, such as blunt dissectors or graspers. A number of companies currently compete against the Company in the development, production and marketing of tissue dissection instruments and technology for open surgical procedures. In addition, the Company indirectly competes with producers of therapeutic drugs, when such drugs are used as an alternative to surgery. Many of the Company's competitors have substantially greater capital resources, name recognition, expertise in research and development, manufacturing and marketing and obtaining regulatory approvals. There can be no assurance that the Company's competitors will not succeed in developing balloon dissectors or competing technologies that are more effective than products 25 marketed by the Company or that render the Company's technology obsolete. Additionally, even if the Company's products provide performance comparable to competing products or procedures, there can be no assurance that the Company will be able to obtain necessary regulatory approvals or compete against competitors in terms of price, manufacturing, marketing and sales. Many of the alternative treatments for medical indications that can be treated by balloon dissection products and laparoscopic surgery are widely accepted in the medical community and have a long history of use. In addition, technological advances with other therapies could make such other therapies more effective or cost-effective than balloon dissectors and minimally invasive surgery, and could render the Company's technology non-competitive or obsolete. There can be no assurance that surgeons will use MIS to replace or supplement established treatments or that MIS will remain competitive with current or future treatments. The failure of surgeons to adopt MIS could have a material adverse effect on the Company's business, financial condition and results of operations. In addition to the Company's focus on the development of its balloon dissection systems, the Company has also developed surgical instruments for use in MIS. There can be no assurance that the Company's surgical instruments will successfully compete with those manufactured by other producers of such surgical instruments. The failure to achieve commercial market acceptance of such surgical instruments could have a material adverse effect on the Company's business, financial condition and results of operations. UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT. The Company's success will depend upon the ability of surgeons to obtain satisfactory reimbursement from healthcare payors for the Company's products. In the United States, hospitals, physicians and other healthcare providers that purchase medical devices generally rely on third-party payors, such as private health insurance plans, to reimburse all or part of the costs associated with the treatment of 26 patients. Reimbursement in the United States for the Company's balloon dissection products is currently available from most third-party payors, including most major private health care insurance plans and Medicaid, under existing surgical procedure codes. The Company does not expect that third-party reimbursement in the United States will be available for use of its other products unless and until clearance or approval is received from the federal Food and Drug Administration (the "FDA"). If FDA clearance or approval is received, third-party reimbursement for these products will depend upon decisions by individual health maintenance organizations, private insurers and other payors. Many payors, including the federal Medicare program, pay a preset amount for the surgical facility component of a surgical procedure. This amount typically includes medical devices such as the Company's. Thus, the surgical facility or surgeon may not recover the added cost of the Company's products. In addition, managed care payors often limit coverage to surgical devices on a preapproved list or obtained from an exclusive source. If the Company's products are not on the list or are not available from the exclusive source, the facility or surgeon will need to obtain an exception from the payor or the patient will be required to pay for some or all of the cost of the Company's product. The Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes. However, there can be no assurance that such procedure codes will remain available or that the reimbursement under these codes will be adequate. Given the efforts to control and decrease health care costs in recent years, there can be no assurance that any reimbursement will be sufficient to permit the Company to increase revenues or achieve or maintain profitability. The unavailability of third-party or other adequate reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. Reimbursement systems in international markets vary significantly by country, and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed health 27 care systems that govern reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems. Large-scale market acceptance of the Company's balloon dissection systems and other products will depend on the availability and level of reimbursement in international markets targeted by the Company. Currently, the Company has been informed by its international distributors that the balloon dissectors have been approved for reimbursement in many of the countries in which the Company markets its products. Obtaining reimbursement approvals can require 12 to 18 months or longer. There can be no assurance that the Company will obtain reimbursement in any country within a particular time, for a particular amount, or at all. Failure to obtain such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. Regardless of the type of reimbursement system, the Company believes that surgeon advocacy of its products will be required to obtain reimbursement. Availability of reimbursement will depend on the clinical efficacy of the procedure and the utility and cost of the Company's products. There can be no assurance that reimbursement for the Company's products will be available in the United States or in international markets under either government or private reimbursement systems, or that surgeons will support and advocate reimbursement for use of the Company's systems for all applications intended by the Company. Failure by surgeons, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors or adverse changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. GOVERNMENT REGULATION. The Company's Spacemaker balloon dissection systems and other products are subject to extensive and rigorous regulation by the FDA and, to varying degrees, by state and foreign regulatory agencies. Under the federal Food, Drug, and 28 Cosmetic Act, the FDA regulates the clinical testing, manufacture, labeling, packaging, marketing, distribution and record keeping for medical devices, in order to ensure that medical devices distributed in the United States are safe and effective for their intended use. Prior to commercialization, a medical device generally must receive FDA and foreign regulatory clearance or approval, which can be an expensive, lengthy and uncertain process. The Company is also subject to routine inspection by the FDA and state agencies, such as the California Department of Health Services ("CDHS"), for compliance with Good Manufacturing Practice requirements, Medical Device Reporting requirements and other applicable regulations. Noncompliance with applicable requirements can result in warning letters, import detentions, fines, civil penalties, injunctions, suspensions or losses of regulatory approvals, recall or seizure of products, operating restrictions, refusal of the government to approve product export applications or allow the Company to enter into supply contracts, and criminal prosecution. Delays in receipt of, or failure to obtain, regulatory clearances and approvals, if obtained, or any failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. Labeling and promotional activities are subject to scrutiny by the FDA and,in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. The Spacemaker I platform, Spacemaker II platform, Spacemaker Resposable platform, and KnotMaker product each have received 510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic and reconstructive surgery, either when tissue dissection is required or, with respect to the KnotMaker product, when a surgical knot for suturing is required. The Company has promoted these products for surgical applications (e.g., hernia repair, subfascial endoscopic perforator surgery and breast augmentation and reconstruction), and may in the future promote these products for the dissection or knotmaking required for additional selected applications (e.g., treatment of stress urinary 29 incontinence, saphenous vein harvesting and a variety of orthopedic procedures such as anterior spinal fusion). For any medical device cleared through the 510(k) process, modifications or enhancements that could significantly affect the safety or effectiveness of the device or that constitute a major change to the intended use of the device will require a new 510(k) submission. The Company has made modifications to its products which the Company believes do not affect the safety or effectiveness of the device or constitute a major change to the intended use and therefore do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA will agree with any of the Company's determinations not to submit a new 510(k) notice for any of these changes or will not require the Company to submit a new 510(k) notice for any of the changes made to the product. If such additional 510(k) clearances are required, there can be no assurance that the Company will obtain them on a timely basis, if at all, and delays in receipt of or failure to receive such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. If the FDA requires the Company to submit a new 510(k) notice for any product modification, the Company may be prohibited from marketing the modified product until the 510(k) notice is cleared by the FDA. The Company plans to file a 510(k) submission for its specialized trocar with a balloon valve, which provides a seal to maintain insufflation of the surgical space during MIS. There can be no assurance that the FDA will grant 510(k) clearance for the Company's specialized trocar on a timely basis, if at all. Sales of medical devices outside of the United States are subject to foreign regulatory requirements that vary widely from country to country. The Company currently relies on its international distributors for the receipt of premarket approvals and compliance with clinical trial requirements in those countries that require them, and it expects to continue to rely on distributors in those countries where the Company continues to use distributors. In the event that the Company's international distributors fail to obtain or maintain premarket approvals or compliance in foreign countries where such approvals or compliance are 30 required, the Company may be required to cause the applicable distributor to file revised governmental notifications, cease commercial sales of its products in the applicable countries or otherwise act so as to stop any ongoing noncompliance in such countries. Any enforcement action by regulatory authorities with respect to past or any future regulatory noncompliance could have a material adverse effect on the Company's business, financial condition and results of operations. In order to continue selling its products within the European Economic Area following June 14, 1998, the Company will be required to achieve compliance with the requirements of the Medical Devices Directive (the "MDD") and to affix CE marking on its products to attest such compliance. Failure by the Company to comply with CE marking requirements by June 1998 would mean that the Company would be unable to sell its products in the European Economic Area unless and until compliance was achieved, which could have a material adverse effect upon the Company's business, financial condition and results of operations. LIMITED MANUFACTURING EXPERIENCE; UNCERTAINTY REGARDING FUTURE FACILITIES. The Company has only limited experience in manufacturing its products in commercial quantities. The Company intends to scale up its production of new products and to increase its manufacturing capacity for existing and new products. However, manufacturers often encounter difficulties in scaling up production of new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. Difficulties experienced by the Company in manufacturing scale-up and manufacturing difficulties could have a material adverse effect on its business, financial condition and results of operations. There can be no assurance that the Company will be successful in scaling up or that it will not experience manufacturing difficulties or product recalls in the future. The Company occupies a single facility in Palo Alto, California that houses its headquarters, administrative offices, research laboratories and 31 manufacturing facilities. This facility is subject to a lease that expires in March 1998. While the Company believes that this space is adequate for its immediate needs, GSI will need to obtain additional office, development and manufacturing space to accommodate expected business growth during 1997 and the first calendar quarter of 1998. There can be no assurance that the Company will be able to obtain such additional facilities on commercially reasonable terms, or at all. If the Company is able to lease such additional space, there can be no assurance that the Company will be able to establish and certify adequate manufacturing capacity in a timely manner, or at all, in such space. Failure to obtain additional space or establish and certify adequate manufacturing capacity in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL ARRANGEMENTS. The Company currently relies upon single source suppliers for several components of its balloon dissection products, and in most cases there are no formal supply contracts. There can be no assurance that the component materials obtained from single source suppliers will continue to be available in adequate quantities or, if required, that the Company will be able to locate alternative sources of such component materials on a timely basis to market its products. In addition, there can be no assurance that the single source suppliers will meet the Company's future requirements for timely delivery of products of sufficient quality and quantity. The failure to obtain sufficient quantities and qualities of such component materials, or the loss of any of the Company's single source suppliers, could cause a delay in GSI's ability to fulfill orders while it identifies and certifies a replacement supplier, and could have a material adverse effect on the Company's business, financial condition and results of operations. PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE. The Company's business exposes it to potential product liability risks or product recalls 32 that are inherent in the design, development, manufacture and marketing of medical devices, in the event the use of the Company's products is alleged to have caused adverse effects on a patient or such products are believed to be defective. The Company's products are designed to be used in certain procedures where there is a high risk of serious injury or death. Such risks will exist even with respect to those products that have received, or may in the future receive, regulatory clearance for commercial sale. As a result, there can be no assurance that the Company's product liability insurance is adequate or that such insurance coverage will continue to be available on commercially reasonable terms or at all. Particularly given the lack of data regarding the long-term results of the use of balloon dissection products, there can be no assurance the Company will avoid significant product liability claims. Consequently, a product liability claim or other claim with respect to uninsured or underinsured liabilities could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH INTERNATIONAL SALES. Sales outside of the United States accounted for approximately 3% and 4% of the Company's sales in fiscal 1995 and 1996, respectively, and the Company expects that international sales will represent an increasing portion of revenue in the future. The Company intends to continue to expand its sales outside of the United States and to enter additional international markets, which will require significant management attention and financial resources and subject the Company further to the risks of selling internationally. These risks include unexpected changes in regulatory requirements, tariffs and other barriers and restrictions, reduced protection for intellectual property rights, and the burdens of complying with a variety of foreign laws. In addition, because all of the Company's sales are denominated in U.S. dollars, fluctuations in the U.S. dollar could increase the price in local currencies of the Company's products in foreign markets and make the Company's products relatively more expensive than competitors' products 33 that are denominated in local currencies. There can be no assurance that regulatory, currency and other factors will not adversely impact the Company's operations in the future or require the Company to modify its current business practices. DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL. The Company is dependent upon a limited number of key management and technical personnel. The loss of the services of one or more of such key employees could have a material adverse effect on the Company's business, financial condition, and results of operations. In addition, the Company's success will be dependent upon its ability to attract and retain additional highly qualified sales, management, manufacturing and research and development personnel. The Company faces intense competition in its recruiting activities and there can be no assurance that the Company will be able to attract and/or retain qualified personnel. POTENTIAL VOLATILITY OF STOCK PRICE. The market prices of the common stock of many publicly held medical device companies have in the past been, and can in the future be expected to be, especially volatile. Announcements of technological innovations or new products by the Company or its competitors, clinical marketing trial results, release of reports by securities analysts, developments or disputes concerning patents or proprietary rights, regulatory developments, changes in regulatory or medical reimbursement policies, economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may 34 have a significant impact on the market price of the Common Stock. In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In May, 1996, the Guidant Corporation unit of Origin MedSystems, Inc. filed an action against GSI in the United States District Court for the Northern District of California, alleging patent infringement of its patent entitled "Apperatus and Methods for Peritoneal Retraction." GSI subsequently filed a claim against Origin Medsystems, Inc. in the United States District Court for the Northern District of California, alleging that the use of Origin's balloon dissection products infringe its patent for a method of tissue plane dissection using balloon systems. In addition, one of the patent applications filed by the Company, which is directed to a surgical method using balloon dissection technology, has been placed in interference with a patent application filed by Origin, a competitor of the Company. The Company believes that the inventor named in its patent application was the first to invent this subject matter, and the Company has asserted that the Origin patent application was filed after a disclosure made by such inventor to employees of Origin. Origin takes a contrary position. This interference is presently pending in the United States Patent and Trademark Office ("USPTO") and, as permitted by the rules of the USPTO, has been referred to an arbitrator for completion of the interference proceeding. A decision is not expected in the interference proceeding until calendar year 1997, and, while the Company believes it will be successful in this interference proceeding, there can be no assurance of such success. Failure of the Company to prevail in such interference proceeding could have a material adverse effect on the Company's business, financial condition or results of operation. A decision against the Company in either of these actions could have a material adverse effect on the Company's business, financial condition or results of operations. From time to time the Company may be exposed to litigation arising out of its products or operations. The Company is not engaged in any legal proceedings 35 that are expected, individually or in the aggregate, to have a material adverse effect on the Company, except for the patent interference proceedings discussed herein. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. 36 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit Description ------- ----------- 11.1 Statement of Computation of Earnings (Net Loss) Per Share 27.1 Financial Data Schedule (b) REPORTS ON FORM 8-K The Company filed no reports on Form 8-K during the quarter ended September 30, 1996. 37 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. GENERAL SURGICAL INNOVATIONS, INC. By: /s/ STEPHEN J. BONELLI ------------------------------------ Stephen J. Bonelli Vice President, Finance and Administration and Chief Financial Officer Date: November 14, 1996 38 EX-11.1 2 EXHIBIT 11.1 EXHIBIT 11.1 GENERAL SURGICAL INOVATIONS, INC. AND SUBSIDIARY COMPUTATION OF NET LOSS PER SHARE (1) (In thousands, expect per share data)
Quarter Ended September 30 -------------------------------- 1996 1995 -------- -------- Primarily and Fully Diluted: Weighted average common shares........ 13,147 3,352 Common and common equivalent shares pursuant to Staff Accounting Bulletin No. 63...................... 3,201 -------- -------- Shares used in per share calculation.... 13,147 6,553 -------- -------- -------- -------- Net loss................................ $ (229) $ (1,048) -------- -------- -------- -------- Net loss per share...................... $ (0.02) $ (0.16) -------- -------- -------- --------
- ------------------- (1) There is no difference between primary and fully diluted net loss per share for all periods presented. EX-27 3 EXHIBIT 27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 3-MOS JUN-30-1997 JUL-01-1996 SEP-30-1996 20,441 29,377 678 50 890 51,615 669 508 52,531 1,667 0 0 0 13 50,320 52,531 2,470 2,470 993 993 2,293 0 587 (229) 0 (229) 0 0 0 (229) (0.02) (0.02)
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