-----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, I1B90xbNVumJtN9pljsfOYmSlRwBaNZDaAcHjdTxubIIOEPnmd7SDNrslci/pz5F VIY8/5+w8Es3eyBptCvHTA== 0000891618-99-005131.txt : 19991115 0000891618-99-005131.hdr.sgml : 19991115 ACCESSION NUMBER: 0000891618-99-005131 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INNERDYNE INC CENTRAL INDEX KEY: 0000822084 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMMERCIAL PHYSICAL & BIOLOGICAL RESEARCH [8731] IRS NUMBER: 870431168 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-19707 FILM NUMBER: 99749402 BUSINESS ADDRESS: STREET 1: 1244 REAMWOOD AVE CITY: SUNNYVALE STATE: CA ZIP: 94089 BUSINESS PHONE: 4087456010 MAIL ADDRESS: STREET 1: 1244 REAMWOOD AVE CITY: SUNNYVALE STATE: CA ZIP: 94089 FORMER COMPANY: FORMER CONFORMED NAME: CARDIOPULMONICS INC DATE OF NAME CHANGE: 19940429 10-Q 1 FORM 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 1999 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1999 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file number 0-19707 INNERDYNE, INC. (Exact name of Registrant as specified in its charter) DELAWARE 87-0431168 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1244 REAMWOOD AVENUE, SUNNYVALE, CA 94089 (Address, including zip code, of principal executive offices) Registrant's telephone number, including area code: (408) 745-6010 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 [ ] The number of shares of Registrant's common stock issued and outstanding as of November 1, 1999 was 22,045,199. ================================================================================ 2 TABLE OF CONTENTS
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Condensed Balance Sheets...................................................... 3 Condensed Statements of Operations............................................ 4 Condensed Statements of Cash Flows............................................ 5 Notes to Condensed Financial Statements....................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................................................... 8 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................... 24 PART II. OTHER INFORMATION............................................................ 25 Item 1. Legal Proceedings............................................................. 25 Item 2. Changes in Securities and Use of Proceeds..................................... 25 Item 3. Defaults upon Senior Securities............................................... 25 Item 4. Submission of Matters to a Vote of Security Holders........................... 25 Item 5. Other Information............................................................. 25 Item 6. Exhibits and Reports on Form 8-K.............................................. 25 Signature Page................................................................ 26
-2- 3 PART I- FINANCIAL INFORMATION ITEM 1. - FINANCIAL STATEMENTS INNERDYNE, INC. CONDENSED BALANCE SHEETS ASSETS
SEPTEMBER 30, DECEMBER 31, 1999 1998 (UNAUDITED) (*SEE NOTE) ------------ ------------ Current assets: Cash and cash equivalents ...................... $ 6,604,184 $ 5,757,538 Accounts receivable ............................ 3,039,868 2,670,811 Interest and other receivables ................. 269,318 383,726 Inventory ...................................... 1,387,994 1,202,982 Prepaid expenses and other ..................... 245,608 213,831 ------------ ------------ Total current assets ......................... 11,546,972 10,228,888 Equipment and leasehold improvements, net ......... 781,714 814,120 Other assets ...................................... 44,967 45,695 ------------ ------------ Total assets ................................. $ 12,373,653 $ 11,088,703 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Line of credit ................................. $ 639,989 $ 300,000 Current installments of long-term debt ......... 284,892 391,040 Accounts payable ............................... 186,774 260,132 Accrued liabilities ............................ 1,153,356 1,120,044 ------------ ------------ Total current liabilities ................... 2,265,011 2,071,216 Long-term debt, excluding current installments .... 303,947 348,723 Stockholders' equity: Common stock ................................... 220,452 218,914 Additional paid-in-capital ..................... 60,423,974 60,206,865 Accumulated deficit ............................ (50,839,731) (51,757,015) ------------ ------------ Net stockholders' equity .................... 9,804,695 8,668,764 ------------ ------------ Total liabilities and stockholders' equity ........ $ 12,373,653 $ 11,088,703 ============ ============
* Condensed from audited financial statements. See accompanying notes to condensed financial statements. -3- 4 INNERDYNE, INC. CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED NINE-MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Product, licensing and contract revenue ............... $ 5,310,622 $ 4,483,730 $14,807,403 $13,062,138 Costs and expenses: Cost of sales ...................................... 1,475,822 1,301,893 4,238,872 4,030,218 Research, development, regulatory and clinical ..... 737,987 748,006 2,126,799 2,275,209 Sales and marketing ................................ 2,211,616 1,719,070 5,995,226 5,203,930 General and administrative ......................... 559,490 472,275 1,635,053 1,521,613 ----------- ----------- ----------- ----------- Total costs and expenses ......................... 4,984,915 4,241,244 13,995,950 13,030,970 ----------- ----------- ----------- ----------- Operating income ...................................... 325,707 242,486 811,453 31,168 Interest/other income, net ............................ 37,587 23,762 120,180 109,559 ----------- ----------- ----------- ----------- Income before income taxes ....................... 363,294 266,248 931,633 140,727 Income tax expense .................................... 4,349 -- 14,349 -- ----------- ----------- ----------- ----------- Net income ....................................... $ 358,945 $ 266,248 $ 917,284 $ 140,727 =========== =========== =========== =========== Basic net income per share ............................ $ 0.02 $ 0.01 $ 0.04 $ 0.01 =========== =========== =========== =========== Diluted net income per share .......................... $ 0.02 $ 0.01 $ 0.04 $ 0.01 =========== =========== =========== =========== Weighted average basic shares outstanding ............. 21,981,153 21,840,155 21,932,527 21,803,651 =========== =========== =========== =========== Weighted average diluted shares outstanding ........... 23,279,748 22,038,548 23,138,315 22,210,017 =========== =========== =========== ===========
See accompanying notes to condensed financial statements. -4- 5 INNERDYNE, INC. CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED ----------------- SEPTEMBER 30, SEPTEMBER 30, 1999 1998 ------------- ------------- Cash flows from operating activities: Net income .......................................................... $ 917,284 $ 140,727 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization ............................... 417,510 404,807 Amortization of deferred compensation on options ............ 8,477 -- Gain on sale of fixed assets ................................ (3,500) (1,185) Decrease (increase) in inventories .......................... (185,012) 159,601 Increase in prepaid expenses and other assets ............... (31,049) (15,035) Decrease in accounts payable ................................ (73,358) (425,895) Increase in accrued expenses ................................ 33,312 211,691 ----------- ----------- Net cash provided by operating activities ........................... 829,015 284,625 ----------- ----------- Cash flows from investing activities: Capital expenditures ........................................ (385,104) (233,907) Proceeds from sale of fixed assets .......................... 3,500 1,500 ----------- ----------- Net cash used in investing activities: .............................. (381,604) (232,407) ----------- ----------- Cash flows from financing activities: Proceeds from issuance of common stock, net ................. 210,170 143,962 Proceeds from issuance of long-term debt .................... 518,634 58,467 Principal payments on long-term debt ........................ (329,569) (221,249) ----------- ----------- Net cash provided by (used in) financing activities ................. 399,235 (18,820) ----------- ----------- Net increase in cash and cash equivalents ........................... 846,646 33,398 Cash and cash equivalents at beginning of period .................... 5,757,538 6,091,497 ----------- ----------- Cash and cash equivalents at end of period .......................... $ 6,604,184 $ 6,124,895 =========== ===========
See accompanying notes to condensed financial statements. -5- 6 INNERDYNE, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accompanying interim condensed financial statements and notes are unaudited, but in the opinion of management reflect all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation of the results of such periods. The results of operations for any interim period are not necessarily indicative of results for the respective full year. These condensed financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) for the nine-month period ended September 30, 1999 should be read in conjunction with the audited financial statements and notes thereto and MD&A included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. (2) INVENTORIES Inventories consist of the following:
(UNAUDITED) SEPTEMBER 30, DECEMBER 31, 1999 1998 ------------- ----------- Raw materials and supplies ............... $ 1,086,639 $ 936,191 Finished goods ........................... 622,605 551,791 Reserve for obsolescence ................. (321,250) (285,000) ----------- ----------- Net inventory ............................ $ 1,387,994 $ 1,202,982 =========== ===========
(3) COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standard No.130 ("SFAS 130"), Reporting Comprehensive Income, effective January 1, 1998. SFAS 130 establishes standards for reporting and display of comprehensive income and its components in financial statements. For the periods ended September 30, 1999 and September 30, 1998 comprehensive income was equal to the net income as presented in the accompanying Statements of Operations. (4) NET INCOME PER COMMON SHARE Net income per common share is computed based on the weighted-average number of common shares and, if appropriate, dilutive common stock equivalents outstanding during the period. Stock options are considered to be common stock equivalents. Basic earnings per common share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per common share is the amount of earnings for the period available to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the period. -6- 7 In calculating net income per common share, the net income was the same for both the basic and diluted calculation. Reconciliation between the basic and diluted weighted-average number of common shares for the three and nine months ended September 30, 1999 and 1998 is summarized as follows:
(Unaudited) (Unaudited) Three Months Ended Nine-Months Ended September 30, September 30, September 30, September 30, 1999 1998 1999 1998 ------------- ------------- ------------- ------------- Basic weighted average number of common shares outstanding during the period 21,981,153 21,840,115 21,932,527 21,803,651 Weighted-average number of dilutive common stock options outstanding during the period 1,298,595 198,393 1,205,788 406,366 ---------- ---------- ---------- ---------- Diluted weighted average number of common and common equivalent shares outstanding during the period 23,279,748 22,038,548 23,138,315 22,210,017 ========== ========== ========== ==========
Common stock equivalents of approximately 689,563 and 3,438,991, and 689,563 and 3,231,081 outstanding during the three and nine month periods ended September 30, 1999 and 1998, respectively, that could potentially dilute basic earnings per share in the future were not included in the computation of diluted earnings per share because to do so would have been anti-dilutive for the period. (5) OPERATING SEGMENTS The Company operates in one line of business; the development and commercialization of access products for minimally invasive procedures. The Company has pursued and/or is also pursuing licensing opportunities related to its proprietary radial dilation, biocompatible coating, and thermal ablation technologies. As such, the Company has only one reportable operating segment as defined by the Financial Accounting Standards Board Statement No. 131, Disclosure About Segments of an Enterprise and Related Information. -7- 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Except for the historical information contained in this Quarterly Report on Form 10-Q, the matters discussed throughout this Quarterly Report on Form 10-Q 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 impact of intense competition in the Company's market, the extent of market acceptance of the Company's StepTM family of products, the timely development and market acceptance of new products, the compliance of the Company's manufacturing facilities with Good Manufacturing Practices ("GMP") regulations, the continued acceptance of minimally invasive surgical procedures, the Company's ability to further expand into international markets, public policy relating to healthcare reform in the United States and other countries, approval of the Company's products by government agencies such as the United States Food and Drug Administration (the "FDA") and the risks set forth in greater detail below under the heading "Additional Factors that May Affect Future Results", as well as those set forth in the Company's Annual Report on Form 10-K for the year ended December 31, 1998 and included from time to time in the Company's other Securities and Exchange Commission ("SEC") reports and press releases, copies of which are available from the Company upon request. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. INTRODUCTION InnerDyne, Inc. (the "Company" or "InnerDyne") is primarily focused upon the development and commercialization of access products based on its proprietary radial dilation technology used to perform minimally invasive surgical ("M.I.S.") procedures. The Company also possesses biocompatible coating technologies which may have utility in enhancing the compatibility and performance of devices placed in contact with human body fluids and tissues, and in delivering pharmaceuticals and radioactive isotopes to selected areas within a human body. The Company intends to continue developing its radial dilation and biocompatible coating technologies, internally or through strategic alliances. INNERDYNE'S PRODUCTS AND TECHNOLOGY Radial Dilation Technology The primary focus of the Company is the development and commercial application of its proprietary radial dilation technology. The key feature of this proprietary technology is the capability to enter the body of a patient by creating a small puncture wound which can subsequently be dilated, or increased in size, to create a larger working channel. Employment of radial dilation within an expandable sheath permits the dilation to be accomplished in a manner that tends to minimize tissue trauma. Upon completion of a procedure, the dilation sequence is reversed; resulting in a smaller residual wound than would be experienced through the employment of similarly sized conventional access devices. Potential benefits of radial dilation technology include reduced risk, less patient trauma and reduced procedure time. Step Product Line. The Company has developed a family of products utilizing InnerDyne's proprietary radial dilation technology. The initial Step products were introduced commercially in late 1994 and are designed to provide access to the abdominal cavity in order to facilitate the visualization and treatment of target areas within the cavity while minimizing the tissue trauma associated with such access. -8- 9 Step. The Step device incorporates the Company's proprietary radial dilation technology and was InnerDyne's first product to be launched on a commercial basis. The Company has received 510(k) clearances from the FDA to market this device for laparoscopic and thorascopic M.I.S. procedures. The Company's Step access device replaces trocars, eliminating the risk of internal organ damage from contact with the sharp surfaces of a trocar. In contrast to conventional trocars, the Step device utilizes a standard insufflation needle for penetration through the abdominal wall, creating only a small puncture wound. Following removal of the needle, a sheath that surrounds the needle is then dilated to a larger working channel through the insertion of a tapered dilator and cannula. Following dilation, the dilator is removed, leaving a rigid sheath that serves as a working channel with an integral insufflation valve at the proximal end. The radial dilation of tissue to an appropriately sized working channel holds the cannula in place and obviates the need for an anchoring system, which may cause a larger residual wound. After completion of a procedure, the rigid cannula is removed and the sheath retracts permitting the opening in each of the muscular layers of the abdominal wall to recover. The residual wound is approximately half the size of that made using a conventional trocar of similar size. The Step product is currently utilized primarily in minimally invasive general, gynecological and pediatric surgical procedures. Management believes that positive attributes of the Step product could significantly affect health care system costs and patient satisfaction with M.I.S. procedures in which trocars have traditionally been used. The results of a Company-sponsored retrospective comparative outcome study examining this issue were released during late 1995. The study included 98 patients and compared an almost equal number of procedures performed using Step devices and conventional trocars for access. Statistically significant results of that study indicated that Step reduced device-related complications during surgery by over 90% and resulted in an approximate 22% saving of surgery time. Based upon published operating room costs, this time savings would equate to dollar savings of $345 to $515 per procedure, a substantial outcome for a product that is believed to be competitively priced with conventional trocars. Management also believes that post-procedure complications, such as infection and incisional hernias at access sites, may be reduced with the use of the Step device as compared to conventional trocars. Two randomized prospective studies involving 331 patients intended to replicate the findings of the initial outcome study were completed during 1997. Results of both studies indicate that Step virtually eliminates complications associated with the use of conventional trocars. These results have been presented at major international conferences and have been submitted for publication. On January 13, 1999, InnerDyne reported the acceptance by the FDA of the Company's 510(k) premarket notification based on the demonstrated safety and clinical performance of the Step line of minimally invasive surgical access devices based on InnerDyne's proprietary radial dilation technology. The product safety premarket notification resulted from the submission of substantial information related to the comparative safety of the Step radially expanding dilation technology for surgical access versus standard cutting trocars. The FDA clearance acknowledged that the Step radially expanding surgical access technology had been shown in independent clinical comparative studies versus conventional cutting trocars to provide safety benefits including, but not limited to: (1) a lower prevalence of abdominal wall bleeding; (2) a lower prevalence of bowel and bladder injuries; (3) a lower incidence of post operative incisional hernias; and (4) a lower prevalence of major vascular injury. In addition, the FDA clearance noted that a substantial number of patients reported reduced pain from Step access sites when compared to conventional trocar sites. Short Step. The Short Step is a conventional Step device that has been reduced in length to be particularly suitable for M.I.S. procedures involving smaller individuals, especially children and thin females. The Short Step was commercially introduced in 1995. In January 1996, the Company announced that its Short Step device had been awarded the Seal of Acceptance by the Alliance of Children's Hospitals, Inc. ("Alliance"). The Alliance is a wholly owned subsidiary of Child Health Corporation of America, which is comprised of 35 freestanding children's hospitals across the United States. The Alliance selected the Step system, after extensive research and review, based upon its ability to reduce both the trauma and operative complications associated with pediatric laparoscopic surgical procedures. In exchange for an ongoing royalty payment, the Company is entitled to use this seal in connection with the marketing and sale of its Step line of products. The Company hopes that the Seal of Acceptance will help the Company expand awareness and sales of its Step product line for use in the pediatric environment. -9- 10 Reposable Step. Launched in 1996, the Reposable Step incorporates the radial dilation features of disposable Step devices in a partially reusable access device. A substantial market for reusable trocars exists, and management expects a trend toward a somewhat more frequent usage of reusable devices. The Reposable Step includes a number of reusable components consisting of a combination of metal and plastic parts that may be cleaned and sterilized by most conventional methods. The dilator, cannula and needle are reusable, while the sheath and valve are single use components designed to be disposed of following surgery. Mini Step. The Mini Step is a small-diameter radially dilating access device designed for use in tubal ligation, pediatric procedures, and micro-laparoscopic surgeries utilizing small instruments. The working diameter of the Mini Step ranges from a nominal 2mm to 8mm. Like the Step device, Mini Step is expected to offer clinicians the potential to reduce device-related surgical complications and surgery time. The Mini Step devices were commercially introduced in 1997. One-Step. The One-Step is a device with a universally adjustable valve and seal system designed to eliminate the need for a reducer. The device is intended to maintain insufflation while accommodating most conventional surgical instruments. The One-Step device was commercially introduced in 1998. Open Step. The Open-Step is a device designed to establish access into the abdominal cavity using a technique known as open laparoscopy. The Open-Step device was commercially introduced in 1998. Distribution of Step Products. The Step family of products is distributed to health care professionals in both domestic and international markets. In the United States, the Company's M.I.S. access product line is generally sold directly to health care professionals by a network of sales representatives, a limited number of whom are employees of the Company. InnerDyne management employees manage these sales representatives on a regional basis. In order to enhance the effectiveness of these domestic sales activities, agreements with buying groups that represent multiple provider institutions have been pursued. InnerDyne signed two buying group agreements in 1997. These agreements cover approximately 1,350 hospitals across the United States. Additional buying group agreements have been approved in 1999, adding approximately 1,900 hospitals to those covered by agreements. In selected foreign countries, local distributors purchase products from the Company for subsequent resale to their respective countries' health care systems. Distributors in selected foreign markets can and have been changed when the Company has deemed the performance of individual distributor organizations to be unsatisfactory. Other Applications & Technology. During the second quarter of 1997, InnerDyne established a business unit to better define the value that radial dilation technology can bring to interventional cardiology and radiology procedures and to develop access products based on this assessment. The Company proceeded with animal studies and device refinements in the third and fourth quarters of 1997 and continued testing the product concept in conjunction with cardiology advisors in early 1998. The study results were positive and human use trials to demonstrate the clinical benefits were initiated in Europe during the second quarter of 1998. In September 1998, InnerDyne announced that it had received clearance from the FDA of a 510(k) application for its radially dilatable access device for use in gaining percutaneous access for the performance of vascular procedures, and limited domestic use evaluations have been ongoing throughout 1999. An additional related 510(k) application was filed with the FDA in August 1999, primarily to update labeling involving the most current version of the radially expanding vascular access device (REVAS) product. If clinical benefits are confirmed in continuing usage, the Company will explore alternative methods of effective distribution in the interventional vascular marketplace and may launch a radial dilation vascular access device in the United States in late 1999, or in subsequent years. Management believes that the positive attributes of the Step product line may also enable minimally invasive access to organs within the abdominal cavity. The only current alternative for this type of access involves the insertion of a long flexible channel and scope through a natural body orifice such as the mouth or the rectum, and only limited procedures are possible due to the restricted size of the channel and the tortuous path that must be navigated. The Step product line has been shown to enable laparoscopic access through the abdominal wall and across the peritoneal space -10- 11 into the stomach for the treatment of benign tumors. InnerDyne believes that the use of Step products could substantially reduce recovery times for these types of procedures. The Company expects that the enhanced capabilities of radially expanding dilation may enable additional surgical procedures to be performed through minimally invasive techniques. The Company is exploring the potential use of its proprietary radial dilation technology in other applications such as access for urologic, thoracic and tracheal procedures, and plans to increase resources associated with the pursuit of percutaneous kidney and bladder access in the ensuing quarters. The Company filed 510(k) applications for urologic and-intra-organ access in 1999 and, in May 1999, received clearance from the FDA for its radially dilatable urologic access device. In August 1999, the Company received notice from the FDA that its application for intra-organ access had been cleared. The Company anticipates that market evaluation and testing of these product concepts in conjunction with surgical advisors will be concluded in late 1999 or early 2000. If the trial results are positive and subsequent human use demonstrates clinical benefits, the Company may begin distribution in the marketplace and may launch urologic and intra-organ access devices during 2000 or in subsequent years. Developmental expenditures for new applications for the Company's proprietary radial dilation technology may reduce the Company's level of profitability. There can be no assurance that these new applications will demonstrate clinical benefits or that the Company can develop a product that will be commercially accepted. The Company entered into an agreement covering the development of a less traumatic means of placing enteral feeding tubes with Sherwood-Davis & Geck ("SDG") in 1997. The Company announced that it had received the single regulatory milestone payment associated with the SDG agreement during the second quarter of 1997. In the first quarter of 1998, InnerDyne and SDG terminated the development agreement when SDG was acquired. In the future, the Company may continue to develop a feeding tube placement system. InnerDyne also committed resources to an investigation of the potential market opportunity in arthroscopic procedures during 1997 and early 1998. Limited clinical usage of the initial design accompanied by substantial exposure and feedback from arthroscopic surgeons was completed during the last half of 1997. InnerDyne completed the arthroscopic market opportunity assessment in the second quarter of 1998. Development efforts relating to a radially dilatable access device for arthroscopic procedures have been terminated, and the Company has no current plans to bring an arthroscopic access device to market. In September 1999, the Company licensed to William Cook Europe A/S (Cook) a Rotatably Actuated Constricting Catheter Valve on a non-exclusive basis for use in the treatment of aortic aneurysms. The agreement requires that Cook pay InnerDyne a licensing fee in two installments and annual minimum royalty payments. Thermal Ablation Technology The Company has developed proprietary technology that is intended to thermally ablate the lining of a body organ. The Company's EnAbl (TM) Thermal Ablation System (the "EnAbl System") is based on this proprietary technology and is designed to treat menorrhagia, or excessive uterine bleeding, by thermally ablating the endometrial lining of the uterus through the controlled introduction and heating of a normal saline solution in situ. In December 1996, InnerDyne announced that it had signed an agreement which granted U.S. Surgical Corporation ("U.S. Surgical") exclusive worldwide sales and marketing rights for the EnAbl System. Under the terms of the agreement, in exchange for initial license fees, milestone payments, and royalties based upon future sales, U.S. Surgical gained the rights to complete development of the EnAbl system and to manufacture and market the technology on a worldwide basis. In July 1997, the Company announced that U.S. Surgical had made the first milestone payment due under the terms of the agreement. In August 1998, InnerDyne announced it had received notification from U. S. Surgical indicating they would not pursue development or commercialization of the Company's EnAbl System. The Company does not presently intend to proceed with commercial development of this product without a corporate partner. -11- 12 Biocompatible Coating Technologies The Company possesses certain proprietary technologies in the area of biocompatible coatings. The technologies that comprise the Company's thromboresistant coating ("TRC") capability are believed to have application when foreign objects remain in contact with various areas of the body, particularly within the blood stream, for sustained periods of time. These technologies include the ability to deposit an extremely thin layer (approximately one micron) of siloxane on a surface and the ability to graft a bioactive substance, such as the drug heparin, to that siloxane layer. The Company's TRC utilizes a "tether" molecule to attach heparin, other bioactive molecules or radioisotopes to the previously applied siloxane subsurface. One end of the tether molecule is covalently bonded to the siloxane coating and the other end of the tether molecule is covalently bonded to the bioactive molecule or radioisotope. Because both points of attachment utilize covalent bonds, the Company believes that its coating process may result in a stronger bond to the surface of a device than many other methods presently in use, which it believes generally use a weaker ionic bond in at least one of the attachment points. TRC coatings, employed with the siloxane layer alone or in combination with bioactive substances, can extend the life of blood-gas exchange devices or provide the capability to extend the duration of contact of a coated device with blood or other body fluids while minimizing the physiological impacts of such contact. InnerDyne is developing a proprietary technology that coats materials with a surface layer to which rhenium-188 or another radioisotope can be attached to reduce restenosis in patients who have had interventional vascular procedures. The Company has begun a research program aimed at developing absorbable brachytherapy products for the treatment of focal or site-specific cancers such as breast, prostate, cervical, and neurological cancers. The program's goal is to develop biocompatible and bio-absorbable brachytherapy sources for use in radiotherapy or simultaneous radiotherapy and chemotherapy drug delivery. These novel combined brachytherapy/chemotherapeutic drug sources are being designed for use in the local-regional treatment of primary cancer, including treatment of the tumor bed after removal of a tumor. The final product could fundamentally differ from both current brachytherapy sources and drug-delivery sources and could provide a highly efficient mechanism to control cancer growth and limit cancer reccurrence. The advantage of localized radiotherapy over other therapies is that local radiotherapy can act upon cancerous cells while sparing normal cells. Other therapies, such as systemic chemotherapy and external beam radiation, affect both cancerous and non-cancerous cells and can result in greater pain, longer recovery times, and higher treatment costs. In contrast, local radiotherapy can lower the cost of the therapeutic procedure, reduce hospital stays, and reduce the pain and suffering experienced by the patient. In December 1997, InnerDyne and Oak Ridge National Laboratory ("ORNL") announced that the Department of Energy had awarded ORNL and Brookhaven National Laboratories ("BNL") a cooperative research and development agreement ("CRADA") for the development of InnerDyne's proprietary method of labeling or attaching radioactivity to implantable devices. Initially, the ORNL researchers helped to optimize chemical methods required to efficiently attach a radioactive source to stents. Generators from ORNL and the new technology were provided to investigators at BNL who, in conjunction with the Interventional Cardiology Group at the State University of New York at Stonybrook, prepared radioactive stents and implanted them into the arteries of swine and rabbits to evaluate the effectiveness of this unique and potentially powerful new approach to inhibit restenosis. Initial testing confirmed the Company's ability to attach radionuclides to metal stents and other substrates. Additional testing to demonstrate the efficacy in animals of InnerDyne's technology for the treatment of restenosis continues at the Washington Heart Center (WHC) and BNL. In October 1998, the CRADA's scope of work was modified to include the development of absorbable brachytherapy devices for the treatment of focal cancers because of the rapid strides made under the radiation coated stent development program. Management believes that the combination of InnerDyne and Oak Ridge National Laboratory technologies, if successful, may positively impact the overall costs associated with stenting procedures by providing a method of attaching a radioisotope just prior to implantation to inhibit restenosis. Additionally, management believes that an absorbable brachytherapy device which can deliver both radiation and a drug or chemotherapy agent concurrently could positively -12- 13 impact the treatment outcomes of focal cancers by lowering the cost of the therapeutic procedure, reducing hospital stays, and reducing the pain and suffering experienced by the patient. In January 1999, InnerDyne announced that it had been awarded a California Cancer Research Program (CRP) Cycle I grant, a Community Initiated Research Collaboration Award (CIRCA), to examine the clinical benefits and the development of absorbable brachytherapy devices. The commercial objective of this project is to develop bio-absorbable brachytherapy sources for use in radiotherapy or simultaneous radiotherapy and chemotherapy drug delivery. These novel combined brachytherapy/chemotherapeutic drug sources will be designed utilizing a proprietary InnerDyne technology for potential use in the treatment of site-specific prostate, breast, and neurological cancers. In June 1999, the Company announced that the National Institutes of Health awarded the Company a Small Business Innovation Research (SBIR) phase 1 research grant to support development of a new form of cancer treatment. The InnerDyne technology allows for the concurrent delivery of drugs and radiation through the use of implantable devices that are absorbed by the body after delivering their therapeutic payloads. The absorbable devices will differ from both current brachytherapy and drug-delivery sources, and could potentially provide a highly efficient and flexible treatment mechanism for the handling of focal cancers. In 1994, the Company signed a license agreement with SENKO Medical Manufacturing Co., Ltd. ("SENKO"), a Japan-based manufacturer and marketer of membrane oxygenators used in open-heart surgery, pursuant to which the Company licensed one of its TRC technologies to SENKO. In connection with this agreement, the Company transferred its siloxane coating technology to SENKO for the coating of microporous hollow fibers used in production of oxygenators. The initial technology transfer was completed during the first quarter of 1995, at which time the Company received the balance of an initial payment from SENKO, and the royalty payment period commenced. In 1996, InnerDyne received an order from SENKO to build a second fiber coating system which was delivered during the first half of 1997. In April 1998, SENKO licensed InnerDyne's less complex method for coating devices with heparin on a non-exclusive basis. The addition of this new means of attaching the drug heparin to prevent the formation of blood clots on a surface is expected to further enhance SENKO's oxygenator product offering. In April 1996, the Company announced the signing of an agreement with Boston Scientific Corporation ("Boston Scientific") covering the potential application and use of InnerDyne's proprietary biocompatible coating technologies with Boston Scientific's stents, grafts, vena cava filters and other implantable medical devices. The agreement involved an equity investment by Boston Scientific in InnerDyne, initial research support and future license fees and royalty payments. Boston Scientific Corporation notified InnerDyne in August 1998 that it had decided to proceed with the transfer of technology for the potential application and use of InnerDyne's proprietary biocompatible coating technology with Boston Scientific's stents, grafts, vena cava filters, and other implantable medical devices. The transfer of the technology has been completed during 1999, though the Company may continue to conduct related research if requested by Boston Scientific. In June 1998, InnerDyne announced the signing of an agreement with U.S. Surgical covering the licensing of InnerDyne's proprietary siloxane coating technology to enhance the performance of selected products used in minimally invasive surgical procedures. Under the terms of the agreement, InnerDyne will construct a custom coating system and provide coated product samples for testing by U.S. Surgical in exchange for payment of initial license fees and capital equipment costs. Assuming the testing confirms that coated samples meet U.S. Surgical's requirements and U.S. Surgical wants to use the technology, InnerDyne will receive a final license fee payment and will assist in the transfer of the system to a location designated by U.S. Surgical. Coincident with transfer and system startup, a royalty payment period would begin. Because of the strength of the covalent bonds used in the Company's TRC technology and other properties noted above, the Company believes that its technology may have advantages over presently available bioactive coating technologies. Potential applications include the treatment of restenosis and specific focal cancers when vascular stents, grafts, vena cava filters and other implantable devices are coated using InnerDyne's proprietary technology with drugs -13- 14 and/or isotopes. The Company has undertaken a number of discussions with potential licensees of the Company's coating technologies, and samples of coated products have been provided to several companies. These discussions have been with parties interested in the use of the technologies to enhance drug delivery or gas exchange, as well as third parties interested in the possible coating of in-dwelling devices for various applications. There can be no assurances that the discussions, or research programs outlined above, will lead to commercial products or relationships on acceptable terms. RESULTS OF OPERATIONS Total revenue for the three and nine-month periods ended September 30, 1999 was $5,310,622 and $14,807,403, respectively, compared to $4,483,730 and $13,062,138 for the corresponding periods in 1998. Total revenue is comprised of revenue from product sales, licensing, and contract revenue. Revenue from product sales increased to $5,217,427 and $14,480,866 for the three and nine-month periods ended September 30, 1999, respectively, from $4,129,633 and $11,879,606 for the corresponding periods in 1998, reflecting increased sales of the Company's Step devices. Licensing and contract revenue fell to $93,195 and $326,537 for the three and nine-month periods ended September 30, 1999, respectively, compared to $354,097 and $1,182,532 for the corresponding periods in 1998. Licensing and contract revenue for the periods related to agreements with third parties covering the development of the Company's proprietary thermal ablation technology, and the licensing and development of the Company's proprietary biocompatible coating technology. Licensing and contract revenue fluctuates from quarter to quarter based upon the number of agreements in effect and the amount and timing of the payments to be made to the Company pursuant to such agreements. Costs of sales were $1,475,822 and $4,238,872, respectively, for the three and nine-month periods ended September 30, 1999, compared to $1,301,893 and $4,030,218 for the same periods in 1998. The increase in cost of sales for the three and nine-month periods ended September 30, 1999 is mainly attributable to the increase in production and sales volumes compared to the same periods in 1998. Gross margins improved for the three and nine-month periods ended September 30, 1999 as compared to the same periods during 1998 due to operational improvements and manufacturing efficiencies gained by allocating fixed costs over a larger sales base. Research, development, regulatory and clinical expenses ("R&D") for the three and nine-month periods ended September 30, 1999 were $737,987 and $2,126,799, respectively, compared to $748,006 and $2,275,209 for the corresponding periods in 1998. In the 1998 periods, a portion of the R&D expenses were reimbursed by development partners, thereby generating off-setting licensing and contract revenue. The reduction in three and nine month comparative R&D expenditures is primarily the result of a transfer of the EnAbl (TM) thermal ablation program to US Surgical in the first quarter of 1998 and R&D cost containment implemented during the third quarter. The Company expects that research, development, regulatory and clinical expenditures will increase in absolute dollars in future periods, though it is possible that expenses associated with one or more research programs could be funded from outside the Company, thereby reducing expected costs. Sales and marketing expenses were $2,211,616 and $5,995,226, respectively, for the three and nine-month periods ended September 30, 1999, compared to $1,719,070 and $5,203,930 for the corresponding periods in 1998, reflecting the growth of the Company's sales and marketing functions to support commercialization of its M.I.S. products and increased expenditures to leverage the expanded 510(k) labeling claims granted by the FDA in January 1999. InnerDyne expects that sales and marketing expenses will generally continue to increase in absolute dollars in future periods. General and administrative expenses were $559,490 and $1,635,053, respectively, for the three and nine-month periods ended September 30, 1999, compared to $472,275 and $1,521,613 for the corresponding periods in 1998. The increase in general and administrative expenses for the three and nine-month periods was primarily the result of increased expenditures in the area of outside services. The Company anticipates that general and administrative expenses will generally increase in absolute dollars in future periods to support expanding operations. -14- 15 Interest/other income, net, was $37,587 and $120,180,respectively, for the three and nine-month periods ended September 30, 1999,compared to $23,762 and $109,559 for the same periods in 1998. The increase is attributable to interest earned on increased cash and cash equivalents balances. Income tax expense for the three and nine-month periods ended September 30, 1999 was $4,349 and $14,349, respectively. LIQUIDITY AND CAPITAL RESOURCES From its inception to September 30, 1999, the Company incurred a cumulative net loss of approximately $51 million. Prior to 1992, the Company was funded primarily through private placements of equity securities. In 1992, the Company completed an initial public offering of 2,875,000 shares of its common stock at $11.00 per share, which raised approximately $28.8 million (net of underwriter's commissions and offering expenses). The 1994 acquisition of InnerDyne Medical, Inc. was accomplished through the issuance of additional common stock of the Company. In June 1995, the Company closed a private placement of 1,435,599 shares of the Company's common stock and warrants to purchase 287,200 additional shares of common stock, with gross proceeds to the Company of approximately $3.2 million. In March and April of 1996, holders of warrants to purchase an aggregate of 242,952 shares of common stock exercised such warrants, resulting in gross proceeds to the Company of $704,561. The Company concluded a public offering on May 20, 1996, with the sale of 2,650,000 shares of common stock at $3.50 per share, which raised $8,015,268 (net of underwriter's commissions and offering expenses). At September 30, 1999, cash and cash equivalents totaled $6,604,184 compared to total cash and cash equivalents balance of $6,115,701 at June 30, 1999. The Company had $385,104 and $233,907 in capital expenditures in the nine months ended September 30, 1999 and September 30, 1998, respectively. Working capital totaled $9,281,961 at September 30, 1999. In addition, the Company had long-term debt, excluding current installments, totaling $303,946 relating to financing of equipment. In April 1999, the Company renewed its credit facility with Silicon Valley Bank. Subject to certain covenants and conditions, the Company may borrow up to $2,000,000 through April 23, 2000 on a revolving credit basis at prime plus .25% based on eligible receivables. The Company also has an equipment advance line of credit, which allows the Company to borrow up to $750,000 per year based on eligible equipment purchases. Amounts outstanding on this equipment advance line of credit are periodically converted to 36-month term loans bearing interest at prime plus .25%. As of September 30, 1999, the Company had drawn $639,989 for financing of working capital needs on the revolving line of credit, secured by certain accounts receivable, and had borrowed $265,388 under the equipment advance line with Silicon Valley Bank for the financing of capital expenditures. In the future, the Company may incur additional operating losses and have cash outflow requirements as a result of expenditures related to expansion of sales and marketing capability, expansion of manufacturing capacity, research and development activities, compliance with regulatory requirements, and possible investment in or acquisition of additional complementary products, technologies or businesses. The timing and amounts of these expenditures will depend upon many factors, such as the progress of the Company's research and development, and will include factors that may be beyond the Company's control, such as the results of product trials, the requirements for and the time required to obtain regulatory approval for existing products and any other products that may be developed or acquired, and the market acceptance of the Company's products. The Company's capital requirements will depend on numerous factors, including market acceptance and demand for its products; the resources the Company devotes to the development, manufacture and marketing of its products; the progress of the Company's clinical research and product development programs; the receipt of, and the time required to obtain regulatory clearances and approvals; the resources required to protect the Company's intellectual property; and other factors. The timing and amount of such capital requirements cannot be accurately predicted. Funds may also be used for the acquisition of businesses, products and technologies that are complementary to those of the Company. Consequently, although the Company believes that the proceeds of the public offering of shares of its common stock completed in May 1996, together with current revenues, credit facilities and other sources of liquidity, will provide -15- 16 adequate funding for its capital requirements through at least the second quarter in 2000, the Company may be required to raise additional funds through public or private financings, collaborative relationships or other arrangements. There can be no assurance that the Company will not require additional funding or that such additional funding, if needed, will be available on terms attractive to the Company, or at all. Any additional equity financings may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants. ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS Operating History; Profitability Uncertain. The Company experienced operating losses from 1985 until mid 1998 totaling $52.3 million. The Company reported net income of $917,284 on revenues of $14.8 million, net income of $425,030 on revenues of $17.6 million for the nine months ended September 30, 1999 and the fiscal year ended December 31, 1998. As of September 30, 1999, the Company had an accumulated deficit of approximately $51 million. In the future, the Company may incur additional operating losses and have cash outflow requirements as a result of expenditures related to expansion of sales and marketing capability, expansion of manufacturing capacity, research and development activities, compliance with regulatory requirements, and possible investment in or acquisition of additional complementary products, technologies or businesses. The timing and amounts of these expenditures will depend upon many factors, such as the availability of capital, progress of the Company's research and development, and factors that may be beyond the Company's control, such as the results of product trials, the requirements for and the time required to obtain regulatory approval for existing products and any other products that may be developed or acquired, and the market acceptance of the Company's products. There can be no assurance that the Company will not incur future losses, that the Company will be able to raise cash as necessary to fund operations or that the Company will maintain profitability. Intense Competition. The primary industry in which the Company competes, minimally invasive surgery, is dominated by two large, well-positioned entities that are intensely competitive and frequently offer substantial discounts as a competitive tactic. U.S. Surgical, a unit of TYCO International, Inc., is primarily engaged in developing, manufacturing and marketing surgical wound management products, and has historically been the firm most responsible for providing products that have led to the growth of the industry. U.S. Surgical supplies a broad line of products to the M.I.S. industry, including products which facilitate access, assessment and treatment. Ethicon Endosurgery, a unit of Johnson & Johnson, Inc., has made a major investment in the M.I.S. field in recent years, and the parent is one of the leading suppliers of hospital products in the world. Furthermore, U.S. Surgical and Ethicon each utilize purchasing contracts that link discounts on the purchase of one product to purchases of other products in their broad product lines. Substantially all of the hospitals in the United States have purchasing contracts with one or both of these entities. Accordingly, customers may be dissuaded from purchasing access products from the Company rather than U.S. Surgical or Ethicon to the extent it would cause them to lose discounts on products that they regularly purchase from U.S. Surgical or Ethicon. The Company faces a formidable task in successfully gaining significant revenues within the M.I.S. access market. In order to succeed, management believes that the Company will need to objectively demonstrate substantial product benefits, and its sales effort must be able to effectively present such benefits to both clinicians and health care administrators. The M.I.S. access market is dominated by U.S. Surgical and Ethicon. Both entities introduced new access devices during the past three years. A number of other entities participate in various segments of the M.I.S. market, including access. There can be no assurance that the Company will be able to successfully compete in the M.I.S. access market, and failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that competitors will not succeed in developing technologies and products that are more effective than any which have been or are being developed by the Company or that would render the Company's technologies or products obsolete or not competitive. Such competition could have a material adverse effect on the -16- 17 Company's business, financial condition and results of operations. As a result of the possible entry of new companies into the M.I.S. market, competition in M.I.S. devices may increase. Continued Dependence on Step Products. To date, substantially all of the Company's revenues from product sales are attributable to Step products, and InnerDyne currently anticipates that sales of Step products will represent the majority of the Company's revenues for the immediate future. Accordingly, the success of the Company is largely dependent upon continued market acceptance of its Step product line by the medical community as a reliable, safe and cost-effective access product for minimally invasive surgery. InnerDyne commenced commercial sales of its Step product in the fourth quarter of 1994 and, to date, sales have been made to a relatively limited number of physicians and hospitals. Recommendations and endorsements by influential members of the medical community are important for the increased market acceptance of the Company's Step products, and there can be no assurance that existing recommendations or endorsements will be maintained or that new ones will be obtained. Failure to increase market acceptance of the Company's Step products would have a material adverse effect upon the Company's business, financial condition and results of operations. Reliance on Future Products and New Applications; Uncertainty of Technology Changes. The medical device industry is characterized by innovation and technological change. The Company has made significant investments in researching and developing its proprietary technologies, including radial dilation and biocompatible coatings. During 2000 or subsequent years, the Company expects to commercially introduce urological and intra-organ access products, and possibly the REVAS vascular access product, each of which is a further enhancement of its radial dilation technology. The future success of the Company will depend in part on the timely commercial introduction and market acceptance of these and other possible products. There can be no assurance that these products will be timely introduced in commercial quantities, if at all, or that such products will achieve market acceptance. Failure by the Company to timely introduce such products or failure of such products to achieve market acceptance could have a material adverse effect on the Company's business, financial condition and results of operations. The future success of the Company will also depend upon, among other factors, the ability to develop and gain regulatory clearance for new and enhanced versions of products in a timely fashion. There can be no assurance that the Company will be able to successfully develop new products or technologies, manufacture new products in commercial volumes, obtain regulatory approvals on a timely basis or gain market acceptance of such products. Delays in development, manufacturing, regulatory approval or market acceptance of new or enhanced products could have a material adverse impact on the Company's business, financial condition and results of operations. Limited Manufacturing Experience; Compliance with Good Manufacturing Practices. The Company initiated manufacture of commercial quantities of its Step access device in its Salt Lake City, Utah facility during late 1994. Accordingly, the Company has limited experience in manufacturing M.I.S. access products or other products in commercial quantities at acceptable costs. The Company's success will depend in part on its ability to manufacture its products in compliance with the FDA's GMP regulations and other regulatory requirements in sufficient quantities and on a timely basis, while maintaining product quality and acceptable manufacturing costs. 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. In connection with its ISO 9001 certification, InnerDyne now undergoes scheduled periodic audits by a European regulatory body. The Company believes that regulatory changes recently introduced by the FDA will result in a system of United States regulatory requirements for manufacturers of medical devices which more closely resembles the ISO 9000 series of quality systems standards adopted by most European countries. Failure to maintain satisfactory regulatory system compliance could have a significant impact on the Company's ability to continue to manufacture and distribute its products and, in the most serious cases, result in the seizure or recall of products. Failure to maintain production volumes or increase production volumes in a timely or cost-effective manner would have a material adverse effect on the Company's business, financial condition and results of operations. Potential Fluctuations in Operating Results. The Company's quarterly operating results have in the past fluctuated and may continue to fluctuate significantly in the future depending on the timing and shipment of product -17- 18 orders, new product introductions and changes in pricing policies by the Company or its competitors, the timing and market acceptance of the Company's new products and product enhancements, the continued market acceptance of InnerDyne's Step product line by the medical community, the Company's product mix, the mix of distribution channels through which the Company's products are sold, the extent to which the Company recognizes non-product revenues during a quarter, and the Company's ability to obtain sufficient supplies of sole or limited source components for its products. In particular, fluctuations in production volumes affect gross margins from quarter to quarter. Furthermore, gross margins and net income or loss can fluctuate from quarter to quarter to the extent the Company recognizes non-product revenue during a quarter because the Company typically derives higher margins from non-product revenue than from product sales. In response to competitive pressures or new product introductions, the Company may take certain pricing or other actions that could materially and adversely affect the Company's operating results. In addition, new product introductions by the Company could contribute to quarterly fluctuations in operating results as orders for new products commence and orders for existing products decline. The Company's expense levels are based, in part, on its expectations of future revenues. Because a substantial portion of the Company's revenue in each quarter normally results from orders booked and shipped in the final weeks of that quarter, revenue levels are extremely difficult to predict. If revenue levels are below expectations, net income will be disproportionately affected because only a small portion of the Company's expenses varies with its revenue during any particular quarter. In addition, the Company typically does not operate with any material backlog as of any particular date. As a result of the foregoing factors and potential fluctuations in operating results, results of operations in any particular quarter should not be relied upon as an indicator of future performance. In addition, in some future quarter the Company's operating results may be below the expectations of public market analysts and investors. In such event, the price of the Company's common stock would likely be materially and adversely affected. Reliance on Collaborative Relationships; Restrictions on Activities. The Company has entered into, and intends to continue to pursue, collaborative arrangements with corporations and research institutions with respect to the research, development, regulatory approval and marketing of certain of its potential products. InnerDyne's future success may depend, in part, on its relationship with such third parties, their strategic interest in the potential products under development and, eventually, their success in marketing or willingness to purchase any such products. The Company's existing and anticipated contracts with such third parties may restrict the rights of InnerDyne to engage in certain areas of product development, manufacturing and marketing. In addition, these third parties often have the unilateral right to terminate any such arrangement without significant penalty. There can be no assurance that InnerDyne will be successful in establishing or maintaining any such collaborative arrangements or that any such arrangements will be successful. Limited Sales, Marketing and Distribution Experience. InnerDyne began commercial sales of its first M.I.S. access product in the fourth quarter of 1994 and, therefore, has limited sales, marketing and distribution experience. The Company is marketing its M.I.S. access products mainly to general surgeons, gynecologists and pediatric laparoscopists. In the United States, InnerDyne markets its products primarily through direct representatives who are employed by the Company within selected geographical areas and a network of independent sales representatives who typically sell other complementary M.I.S. products to the same customer base. If the need arises, the Company may expand its sales force, which will require recruiting and training additional personnel. There can be no assurance that the Company will be able to recruit and train such additional personnel in a timely fashion. Loss of a significant number of InnerDyne's current sales personnel or independent sales representatives, or failure to attract additional personnel, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company markets its products outside of the United States through international distributors in selected foreign countries after regulatory approvals, if necessary, are obtained. Although InnerDyne currently has relationships with a limited number of international distributors, there can be no assurance that the Company will be able to build a network of international distributors capable of effectively marketing its M.I.S. access products or that such distributors will generate significant sales of such products. The Company has limited experience in marketing its products and faces substantial competition from well-entrenched and formidable competitors. As a result, there can be no assurance that the -18- 19 Company will successfully achieve acceptable levels of product sales at prices which provide an adequate return. Failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. Patents and Proprietary Rights. The Company's success will depend in large part on its ability to obtain patent protection for products and processes, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. Although InnerDyne has obtained certain patents and applied for additional United States and foreign patents covering certain aspects of its technology, no assurance can be given that any additional patents will be issued or that the scope of any patent protection will exclude competitors or provide a competitive advantage, or that any of the Company's patents will be held valid if subsequently challenged. The validity and breadth of claims covered in medical technology patents involves complex legal and factual questions and therefore may be highly uncertain. InnerDyne also relies upon unpatented trade secrets, and no assurance can be given that others will not independently develop or otherwise acquire substantially equivalent trade secrets. In addition, whether or not the Company's patents are issued, others may hold or receive patents that contain claims having a scope that covers products developed by InnerDyne. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry, and companies in the medical device industry have used litigation to gain competitive advantage. Litigation involving the Company would result in substantial cost to and diversion of management attention from the day-to-day operation of the business, but could be necessary to enforce patents issued to the Company, to protect trade secrets and other specialized knowledge unknown to outside parties, to defend the Company against claimed infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. An adverse determination in litigation could subject the Company to significant liabilities to third parties, could require the Company to seek licenses from third parties under less favorable terms than might otherwise be possible and could prevent the Company from manufacturing, selling or using its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has in the past, and may in the future, receive correspondence from third parties claiming that the Company's products or technology infringe intellectual property rights of such third parties. The Company and its patent counsel thoroughly review such claims and no such outstanding claims currently exist. However, there can be no assurance that InnerDyne will not receive additional claims that its products or technology infringe third party rights or that third parties will not litigate such claims. Any such occurrence could have a material adverse effect on the Company's business, financial condition and results of operations. Government Regulation. Clinical testing, manufacture and sale of the Company's products, including the Step product line, and the Company's biocompatible coating technology, 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 pre-clinical and clinical testing, 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 recall, repair, replacement or refund of the cost of any device manufactured or distributed by the Company. Before a new device can be introduced in the market, the manufacturer must generally obtain FDA clearance of 510(k) notification or approval of a PMA. 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. The PMA process can be expensive, uncertain and lengthy, and a number of devices for which FDA approval has been sought by other companies have never been approved for marketing. 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. For any of the Company's devices cleared through the 510(k) process, modifications or -19- 20 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. There can be no assurance that the Company will obtain 510(k) premarket clearance within a reasonable time frame, or at all, for any of the devices or modifications for which it may file a 510(k). The Company has received clearance from the FDA for the marketing of its Step device for use in accessing the abdominal and thoracic cavities for the performance of minimally invasive surgical procedures. The Company has also received FDA clearance for the marketing of its original R.E.D. product for use in the areas of gastrostomy, cystostomy, cholecystotomy, the dilation of biliary and urethral strictures, laparoscopy and enterostomy. The Company has also received market clearance for alternative versions of its Step and R.E.D. products, including products designed to employ its radial dilation technology in vascular, arthroscopic, urologic and intra-organ applications and for biliary indications. Although the Company has been successful in preparing requests for 510(k) clearance, there can be no assurance that 510(k) clearances for future products or product modifications can be obtained in a timely manner or at all, or that any existing clearance can be successfully maintained. A delay in receipt of, or failure to receive or maintain, such clearances would have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company is strictly limited to marketing its products for the indications for which they were cleared, physicians are not prohibited by the FDA from using the products for indications other than those cleared by the FDA. There can be no assurance that the Company will not become subject to FDA action resulting from physician use of its products outside of their approved indications. The Company has made modifications to its cleared devices that 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 of these changes 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. Any devices manufactured or distributed by the Company pursuant to FDA clearance or approval are subject to pervasive and continuing regulation by the FDA and certain state agencies and various foreign governments. Manufacturers of medical devices for marketing in the United States are required to adhere to applicable regulations setting forth detailed GMP requirements, which include testing, control and documentation requirements. Manufacturers must also comply with 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. The Company is registered as a manufacturer of medical devices with the FDA. 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. Failure of the Company to maintain satisfactory GMP compliance could have a significant adverse effect on the Company's ability to continue to manufacture and distribute its products and, in the most serious cases, could result in the seizure or recall of products, injunctions and/or civil fines. Dependence on Sole Sources. The materials utilized in the Company's M.I.S. products consist of both standard and custom components that are purchased from a variety of independent sources. The plastic parts used in the Step product are injection molded by outside vendors. The majority of these parts are produced utilizing molds that have been specially machined for and are owned by the Company. Although the Company maintains significant inventories of molded parts, any inability to utilize these molds for any reason might have a material adverse effect on the Company's ability to meet its customers' demand for product. In addition to plastic parts produced from injection molds owned by the Company, a number of other materials are available only from a limited number of sources at the present time, including the sheath component of the Company's Step products. Efforts to identify and qualify additional sources of this sheath component and other key materials and components are underway. Although InnerDyne believes that alternative sources of these components can be obtained, internal testing and qualification of substitute vendors could require significant lead -20- 21 times and additional regulatory submissions. There can be no assurance that such internal testing and qualification or additional regulatory approvals will be obtained in a timely fashion, if at all. Any interruption of supply of raw materials could have a material adverse effect on the Company's ability to manufacture its products and, therefore, on its business, financial condition and results of operations. Uncertainty Relating to Third Party Reimbursement. In the United States, health care providers that purchase medical devices, such as the Company's products, generally rely on third-party payors, principally federal Medicare, state Medicaid and private health insurance plans, to reimburse all or part of the cost of the procedure in which the medical device is being used. In addition, certain health care providers are moving toward a managed care system in which such providers contract to provide comprehensive health care for a fixed cost per person. Managed care providers are attempting to control the cost of health care by authorizing fewer elective surgical procedures. The Company is unable to predict what changes will be made in the reimbursement methods utilized by third-party health care payors. Furthermore, the Company could be adversely affected by changes in reimbursement policies of governmental or private health care payors, particularly to the extent any such changes affect reimbursement for procedures in which the Company's products are used. Failure by physicians, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors for procedures in which the Company's products are used or adverse changes in governmental and private third-party payors' policies toward reimbursement for such procedures would have a material adverse effect on the Company's business, financial condition and results of operations. If the Company obtains the necessary foreign regulatory approvals, market acceptance of the Company's products in international markets would be dependent, in part, upon the availability of reimbursement within prevailing health care payment systems. Reimbursement and health care payment systems in international markets vary significantly by country, and include both government-sponsored health care and private insurance. The Company intends to seek international reimbursement approvals, although there can be no assurance that any such approvals will be obtained in a timely manner, if at all, and failure to receive international reimbursement approvals could have an adverse effect on market acceptance of the Company's products in the international markets in which such approvals are sought. Dependence on International Sales. In the future, the Company expects to derive an increasing portion of its revenue from international sales. To the extent that the Company's international sales increase in future periods, a significant portion of the Company's revenues could be subject to the risks associated with international sales, including economic or political instability, shipping delays, changes in applicable regulatory policies, fluctuations in foreign currency exchange rates and various trade restrictions, all of which could have a significant impact on the Company's ability to deliver products on a competitive and timely basis. Future imposition of, or significant increases in the level of, customs duties, import quotas or other trade restrictions could have an adverse effect on the Company's business, financial condition and results of operations. The regulation of medical devices, particularly in the European Economic Community, continues to expand, and there can be no assurance that new laws or regulations will not have an adverse effect on the Company. Dependence on Key Personnel. InnerDyne is dependent upon a limited number of key management and technical personnel. The Company's future success will depend in part upon its ability to attract and retain highly qualified personnel. The Company will compete for such personnel with other companies, academic institutions, government entities and other organizations. There can be no assurance that the Company will be successful in hiring or retaining qualified personnel. The loss of key personnel or the inability to hire or retain qualified personnel could have a material adverse effect on the Company's business, financial condition and results of operations. Product Liability; Claims in Excess of Insurance Coverage. The development, manufacture and sale of the Company's products entail the risk of product liability claims, involving both potential financial exposure and associated adverse publicity. The Company's current product liability insurance coverage limits are $3,000,000 per occurrence and $3,000,000 in the aggregate, and there can be no assurance that such coverage limits are adequate to protect the Company from any liabilities it might incur in connection with the development, manufacture and sale of its current and potential products. Product liability insurance is expensive and may not be available in the future on acceptable terms, or at all. In -21- 22 addition, if such insurance is available, there can be no assurance that the limits of coverage of such policies will be adequate. A successful product liability claim in excess of the Company's insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. Stock Price Volatility. The stock market in general and stocks of medical device companies in particular, have 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 Company's common stock has been and is likely to continue 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, 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 or general market conditions may have a significant effect on the market price of the common stock. Environmental Regulations. The Company is subject to a variety of local, state and federal governmental regulations relating to the use, storage, handling, manufacture and disposal of toxic and other hazardous substances used to manufacture the Company's products. The Company believes that it is currently in compliance in all material respects with applicable governmental environmental regulations. Nevertheless, the failure by the Company to comply with current or future environmental regulations could result in the imposition of substantial fines on the Company, suspension of production, alteration of its manufacturing processes or cessation of operations. Compliance with such regulations could require the Company to acquire expensive remediation equipment or to incur substantial expenses. Any failure by the Company to control the use, disposal, removal or storage of, or to adequately restrict the discharge of, or assist in the cleanup of, hazardous or toxic substances, could subject the Company to significant liabilities, including joint and several liability under certain statutes. The imposition of such liabilities could have a material adverse effect on the Company's business, financial condition, and results of operations. Control by Directors and Principal Stockholders. As of September 30, 1999, directors and principal stockholders of the Company, and certain of their affiliates, beneficially owned approximately 27% of the Company's outstanding common stock. Accordingly, these persons, as a group, may be able to control the Company and significantly affect the direction of the Company's affairs and business, including any determination with respect to the acquisition or disposition of assets by the Company, future issuances of common stock or other securities by the Company and the election of directors. Such concentration of ownership may also have the effect of delaying, deferring or preventing a change in control of the Company. Anti-Takeover Effect of Certain Charter Provisions of Common Stock. Provisions of the Company's Certificate of Incorporation that allow the Company to issue preferred stock without any vote or further action by the stockholders, the fact that the Company's Certificate of Incorporation does not permit stockholders to cumulate votes in the election of directors as well as the Company's adoption of a poison pill Preferred Share Purchase Rights plan in September 1997 may have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, control of the Company. Certain provisions of Delaware law applicable to the Company could also delay or make more difficult a merger, tender offer or proxy contest involving the Company, including Section 203, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless certain conditions are met. The possible issuance of preferred stock, the inability of stockholders to cumulate votes in the election of directors, the poison pill and provisions of Delaware law could have the effect of delaying, deferring or preventing a change in control of the Company, including without limitation, discouraging a proxy contest or making more difficult the acquisition of a substantial block of the Company's common stock. The possible issuance of preferred stock, the poison pill and these provisions could also limit the price that investors might be willing to pay in the future for shares of the Company's common stock. -22- 23 Risks Associated With Software and Hardware and the Year 2000. InnerDyne relies on a variety of internal computer systems and programs in the operation of its business. The Company is currently in the process of testing and upgrading, where necessary, the software and hardware products used in its operations with respect to the year 2000 issue. The Company's internal systems run on personal computers and microprocessor-based computer servers set up in a workstation environment which the Company believes are not susceptible to universal failures. Were system failures to occur as a result of the year 2000 issue, the Company believes that its on-site engineers and technical personnel should be able to address and resolve such issues prior to the occurrence of any material adverse effect on the Company's business operations. The failure of certain of the systems upon which the Company relies, such as payroll and banking services, could be disruptive to the Company's business operations if such systems were unavailable for an extended period of time. The Company is in the process of making inquiries with the providers of such types of services to determine their year 2000 readiness. However, the Company believes that its business operations would not be materially adversely effected by short disruptions in such services and that the providers of such services (who also typically service many other business customers) will take steps to rectify any failures as soon as possible. More generally, the Company does not believe that the power grid or general communications, building security and similar systems expose the Company to any unique year 2000 risks as compared to other businesses. The Company faces year 2000 risk from third-party suppliers. Notwithstanding written assurances from the Company's vendors regarding year 2000 compliance, there is no guarantee that the year 2000 will not cause a disruption in the supply of critical components necessary for the Company's products. Given the Company's reliance on suppliers of critical, sole-sourced components, the Company is relying on these suppliers to address the year 2000 issues in their own products and operations, and the failure of such suppliers to adequately address these issues could have a material adverse effect on the Company's business, financial condition and results of operations. As a contingency plan in the event that any of such suppliers do not or are unable to address material year 2000 issues, the Company intends to stockpile an inventory of raw materials and molded parts in order to maintain a one month backlog of such components. The Company has not incurred substantial costs to date to address the year 2000 issue and estimates that the additional cost, if any, arising from actions taken by the Company to address year 2000 problems will not be material. Despite the Company's efforts to address the year 2000 impact on its internal systems and business operations, the year 2000 issue may result in a material disruption of its business or have a material adverse effect on the Company's business, financial condition or results of operations. -23- 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The following discusses the Company's exposure to market risk related to changes in interest rates, equity prices, and foreign currency exchange rates. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in Item 2 above. Interest Rate Risk: As of September 30, 1999, the Company had short-term investments of $5,909,075. Substantially all of these short-term investments consist of highly liquid money market funds and commercial paper investments with remaining maturities at the date of purchase of less than ninety days. These investments are subject to interest rate risk and will decrease in value if market interest rates increase. A hypothetical increase or decrease in market interest rates by 10 percent from the September 30, 1999 rates would cause the fair market value of these short-term investments to change by an immaterial amount. The Company has the ability to hold these investments until maturity, and therefore, the Company does not expect the value of these investments to be affected to any significant degree by the effect of a sudden change in market interest rates. Declines in interest rates over time will, however, reduce interest income. The Company has not used derivative financial instruments. The Company does not own any equity investments. Therefore, the Company does not currently have any direct equity price risk. All Company revenues are realized in U.S. dollars; therefore, the Company does not believe that it currently has any significant direct foreign currency exchange rate risk. Foreign Currency Risk: International revenues were less than 10% of total revenue for the quarter ended September 30, 1999. International sales are made mostly through international distributors with payments to the Company typically in U.S. dollars. The Company's international business is subject to risks typical of an international business, including, but not limited to differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, the Company's future results could be materially adversely impacted by changes in these or other factors. The effect of foreign exchange rate fluctuations on the Company through the third quarter of 1999 was not material. -24- 25 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS (a) Not Applicable. (b) Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. ITEM 5. OTHER INFORMATION Not Applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: Exhibit number: 27.01: Financial Data Schedule -25- 26 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. INNERDYNE, INC. /s/ Robert A. Stern Robert A. Stern Vice President and Chief Financial Officer (Duly Authorized Signatory, Principal Financial and Accounting Officer) Date: November 12, 1999 -26- 27 EXHIBIT INDEX
Exhibit # Description - --------- ----------- 27.1 Financial Data Schedule
EX-27.1 2 FINANCIAL DATA SCHEDULE
5 0000822084 INNERDYNE, INC. 9-MOS DEC-31-1999 JAN-01-1999 SEP-30-1999 6,604,184 0 3,135,472 95,604 1,387,994 11,546,972 4,228,768 3,447,054 12,373,653 2,265,011 0 0 0 220,452 9,584,243 12,373,653 14,480,866 14,807,403 4,238,872 13,995,950 0 0 78,615 931,633 14,349 917,284 0 0 0 917,284 0.04 0.04
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