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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] Annual Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934
For the fiscal year ended October 31, 1997
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: 0-13907
________________________________________________________________________________
BIO-VASCULAR, INC.
(Exact name of Registrant as specified in its charter)
________________________________________________________________________________
Minnesota 41-1526554
------------------------ -----------------------------------
(State of Incorporation) (I.R.S. Employer Identification No.)
2575 UNIVERSITY AVENUE, ST. PAUL, MINNESOTA 55114-1024
(Address of principal executive offices)
TELEPHONE NUMBER: (612) 603-3700
--------------------------
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common Stock Purchase Rights
--------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---- ----
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of November 30, 1997, 9,583,399 shares of Common Stock of the Registrant were
outstanding, and the aggregate market value of the Common Stock of the
Registrant (based upon the last reported sale price of the Common Stock on that
date by the Nasdaq National Market), excluding shares owned beneficially by
executive officers and directors, was approximately $ 30,896,394.
Part III of this Annual Report on Form 10-K incorporates documents incorporated
by reference (to the extent specific sections are referred to herein) from the
Registrant's Proxy Statement for its Annual Meeting of Shareholders to be held
February 24, 1998 (the "1998 Proxy Statement").
Tissue-Guard(TM), Supple Tissue-Guard(TM), Peri-Strips(R), Peri-Strips Dry(R),
PSD Gel(TM), Dura-Guard(R) ,Vascu-Guard(R), Supple Peri-Guard(R), Peri-
Guard(R), CV Peri-Guard(TM), Ocu-Guard(TM), Biograft(R), Flo-Rester(R), and
Bio-Vascular Probe(R), are trademarks of the Company.
FORWARD-LOOKING STATEMENTS
- --------------------------
This Annual Report on Form 10-K contains certain forward-looking statements.
For this purpose, any statements contained in this Form 10-K that are not
statements of historical fact may be deemed to be forward-looking statements.
Without limiting the foregoing, words such as "may," "will," "expect,"
"believe," "anticipate," "estimate" or "continue" or the negative or other
variations thereof or comparable terminology are intended to identify forward-
looking statements. These statements by their nature involve substantial risks
and uncertainties, and actual results may differ materially depending on a
variety of factors, including those set forth in the section below entitled
"Important Factors."
PART I
ITEM 1 - BUSINESS
- -----------------
Bio-Vascular, Inc. ("Bio-Vascular" or "the Company") was incorporated in
Minnesota in July of 1985. The Company's principal executive offices are
located at 2575 University Avenue, St. Paul, Minnesota 55114-1024. The Company
can also be contacted by telephone at (612) 603-3700, facsimile at (612) 642-
9018, or by electronic mail at info@biovascular.com.
SPIN-OFF OF VITAL IMAGES, INC.
- ------------------------------
On May 12, 1997, the Company completed the spin-off distribution of all the
shares of Vital Images, Inc. ("Vital Images") to the shareholders of Bio-
Vascular, with Vital Images thereafter operating as an independent company, with
its own publicly traded securities. All Bio-Vascular shareholders received one
share of Vital Images common stock for each two shares of Bio-Vascular stock
held, with cash issued in lieu of fractional shares. The Company attempted to
structure the transaction as tax free, but since no revenue ruling was sought
from the Internal Revenue Service, no assurance can be made about the final tax
treatment of the transaction.
The Company recorded the distribution of Vital Images common stock to its
shareholders as of March 19, 1997, the date the Board of Directors of the
Company gave final approval for the transaction. The distribution was recorded
by reducing shareholders' equity by $10,124,000, which represents $10,000,000 of
cash and investments, plus the carrying value of Vital Images' net assets.
The Company's financial statements and notes thereto (see list of documents
filed as part of this Report on Page 31) report the business of Vital Images as
discontinued operations. Prior years' financial statements and notes have been
restated accordingly.
GENERAL DEVELOPMENT OF BUSINESS
- -------------------------------
Bio-Vascular develops, manufactures and markets proprietary and patented
specialty medical products for use in thoracic, cardiac, neuro, vascular and
ophthalmic surgery. The Company's products include the Tissue-Guard product
line and the Biograft peripheral vascular graft. The Tissue-Guard product line
includes Peri-Strips, Peri-Strips Dry, Dura-Guard, Vascu-Guard, Supple Peri-
Guard, Peri-Guard, Tissue-Guard and Supple Tissue-Guard. Tissue-Guard products
are made from bovine pericardium (the thin membrane surrounding the heart of
cattle) processed using proprietary tissue-fixation technology. The Tissue-
Guard products, made in various configurations, are used in a wide variety of
surgical procedures and are designed to reinforce, reconstruct and repair tissue
and prevent leaks of air, blood and other body fluids. Biograft is used to
bypass occluded blood vessels and is produced from modified human umbilical
veins. The Company also markets and sells two surgical
2
productivity tools used in cardiac and vascular surgery, Flo-Rester vessel
occluders and the Bio-Vascular Probe.
The Company was incorporated in Minnesota in July of 1985. Through 1985 and
1986 the Company acquired the rights to certain cardio-vascular products,
including Peri-Guard and Flo-Rester, and was spun-off to the shareholders of its
then parent company. In fiscal 1990 the Company acquired Biograft peripheral
vascular graft from Meadox Medicals, Inc. In fiscal 1991 the Company developed
the Bio-Vascular Probe to further compliment its cardio-vascular product line.
Additionally, in fiscal 1991 the Company introduced Supple Peri-Guard in
response to surgeons' requirements for a flexible soft tissue patching material.
Peri-Strips staple-line buttress was introduced in 1994 for use in lung surgical
procedures, primarily lung volume reduction surgery ("LVRS" or "LVR surgery").
Peri-Strips represented the Company's first non-cardio-vascular product as the
Company began to expand its product development strategy to meet the needs of
the broader surgical community. LVRS is performed principally on patients with
late-stage emphysema who have significantly reduced respiratory function.
During the procedure, a portion of each diseased lung is removed from the
patient allowing an improved expansion and contraction movement of the remaining
lung tissue within the chest cavity, providing relief from the symptoms of
emphysema. Peri-Strips are designed to prevent air leakage at the surgical
staple line which is essential to a successful LVRS procedure.
Sales from Peri-Strips fueled significant revenue growth for the Company from
late 1994 through fiscal 1995, increasing from $685,000 in fiscal 1994 to
$5,500,000 in fiscal 1995. Domestic revenue from Peri-Strips continues to be
affected by the Health Care Financing Administration's non-coverage decision in
January 1996 regarding LVRS (see Business - Third Party Reimbursement and Cost
Containment on Page 15 of this Report).
Dura-Guard, which was introduced in 1995, is a dural patch used in cranial
surgery designed to prevent fluid leakage and reduce post-surgical adhesions.
Vascu-Guard, also introduced in 1995, is a vascular patch used primarily in
carotid endarterectomy procedures designed to improve tissue integration and
reduce suture line bleeding. Dura-Guard and Vascu-Guard both are made from
Supple Peri-Guard.
Peri-Strips Dry, an advanced version of Peri-Strips, was launched in July 1997.
The Company believes the Peri-Strips Dry design provides significant advantages
for thorascopic surgical procedures over the original Peri-Strip "sleeve"
design. Peri-Strips Dry eliminates the need to extract the sutured sleeve
backing, that was part of the original design, through the thorascope after the
surgical stapler is fired.
R&D efforts have recently resulted in new product opportunities and the Company
has two products nearing the end of the product development phase, CV Peri-Guard
and Ocu-Guard. The Company filed a 510(k) application with the FDA in May for
CV Peri-Guard. The intended uses for CV Peri-Guard include intra-cardiac
patching and vessel repair. The Company currently expects FDA clearance for CV
Peri-Guard during the first quarter of 1998. CV Peri-Guard will be an addition
to the Tissue Guard product line.
Ocu-Guard, filed with the FDA in September for marketing clearance, will have
indications for use in enucleation surgery. Enucleation removes a patient's
damaged eye and supporting tissue and replaces it with an implant. The
Company's tissue would be used in the procedure as an orbital implant wrap
instead of using cadaver sclera to encase the orbital prosthesis. The Company
currently expects FDA clearance for Ocu-Guard during the first quarter of 1998.
Ocu-Guard uses the Company's Supple tissue and will also be a Tissue Guard
product line extension. The Company estimates that 25,000 to 30,000 enucleation
procedures are performed worldwide each year.
The Company's forward-looking statements regarding FDA clearance for CV Peri-
Guard and Ocu-Guard are dependent on the timing of FDA review and the need for
additional clinical data regarding such products, among other factors. There
can be no assurance that marketing clearance for CV Peri-Guard and Ocu-Guard
will be received on a timely basis, if at all, or if received, that either
device will become commercially successful.
3
Narrative Description of Business
- ---------------------------------
MARKETS AND MEDICAL NEED
While the trend in medicine is toward less invasive surgical procedures,
substantially all surgical procedures, whether invasive or not, involve the
cutting of tissue to access, repair or remove tissue at or from the surgical
site. Tissue which has been cut must either be repaired or replaced so that it
can heal properly. Proper repair of incised tissue is dependent upon a number
of variables, including whether (i) the repair must be leakproof, either for
air, blood or other body fluids, (ii) the incised tissue is under tension or
subject to shrinkage such that additional tissue is needed to bridge the two
tissue surfaces to be repaired, and (iii) the tissue subject to the repair must
be strengthened to accommodate the natural stresses of the human body. In
certain instances, suturing of two tissue surfaces will be effective. In other
instances, however, a patching material, whether autologous (from the body of
the patient), synthetic (from man-made materials) or tissue-based (from
processed biologically based tissue), may be needed. The Company's tissue-based
products are designed to fulfill the medical need for repairing human tissue and
preventing leaks at the surgical site in certain existing surgical procedures,
as well as offering a potential medium for techniques and procedures currently
being developed.
The Company's core competency is the development and manufacture of tissue-based
implantable medical products for use by surgeons in various surgical procedures
where reinforcing, reconstructing and repairing tissue and preventing leaks of
air, blood or other body fluids is necessary for the achievement of a favorable
outcome. Historically, surgeons primarily used autologous tissue in situations
where tissue repair was necessary. Harvesting the autologous material, which is
still performed in many circumstances, necessarily requires the surgeon to
excise the tissue from another part of the patient's body. The second surgical
site increases the cost of the procedure and lengthens the time the patient is
under anesthesia, thereby increasing the risk of complication and resulting in
additional pain and recovery time for the patient. To the extent a surgeon is
confident that the performance of a readily available medical product, whether
tissue-based or synthetic, is equal to or better than the patient's own tissue,
the Company believes the surgeon will choose the tissue-based or synthetic
product to avoid a second surgical site as a means of reducing surgical costs
and improving patient outcomes.
Lung Volume Reduction Surgery ("LVRS"). Emphysema, most often caused by
cigarette smoking, is a progressive disease of the lungs characterized by air-
filled expansions or pocket-like blisters in the tissue of the lungs. Because
the air in the lungs cannot be fully expelled, the effort to inhale fresh air
becomes increasingly difficult, pushing the lung walls farther out and causing
the lungs to expand and lose their elasticity. The diaphragm, the major muscle
used for breathing, becomes flattened and loses its ability to function. As the
disease advances and patient health is progressively compromised, breathing
becomes more difficult. Persons with late-stage emphysema eventually become
incapable of even minor physical activity and often become dependent upon
continuous supplemental oxygen even when at rest. As a result, late-stage
emphysema can significantly reduce mobility, leaving individuals with late-stage
emphysema unable to care for themselves or engage in normal daily activities.
Because of the weakened respiratory condition of these patients, common
illnesses involving pulmonary functions can result in emergency room visits and
hospitalization.
Non-surgical therapies for patients suffering from emphysema include (i)
bronchodilators (pills and inhalers), to open up airways to temporarily relieve
wheezing or shortness of breath, (ii) steroids, to reduce inflammation in the
airways, (iii) pulmonary rehabilitation to increase endurance, and (iv) oxygen
supplements to help decrease the feeling of shortness of breath. Each of these
non-surgical therapies, however, offers only temporary relief and each becomes
less effective as the disease progresses. Data gathered by the Company indicates
that the cost of medication and oxygen supplements for late-stage emphysema
patients can range from $5,000 to $8,000 annually. In addition, visits to the
doctor, in-home health care and equipment, and the need for periodic emergency
room care for persons suffering the effects of late-stage emphysema, can
increase costs substantially.
Lung transplantation is the only known cure for emphysema. A lung transplant
surgical procedure, however, costs
4
up to $250,000 and is typically used only as a last resort because of the high
degree of risk associated with the procedure, an inadequate supply of donor
lungs, and the requirement that the patient receive anti-rejection drugs for the
remainder of his or her lifetime. Only 688 lung transplants were performed in
the United States in 1994.
In the 1950's, a surgical procedure was developed to treat the symptoms of late-
stage emphysema by removing damaged lung tissue. Due to air leaks around the
suture lines, these experimental LVRS procedures resulted in a high mortality
rate and long, painful post-surgical recovery periods. As a result, the LVRS
procedure was abandoned. In the late 1980's, various surgeons began to develop
specialized techniques for accessing and resecting the lung. The use of
surgical staples was introduced to perform LVRS more quickly, a particularly
important consideration in light of the debilitated condition of the patients
requiring the surgery. Despite many advances in LVRS, multiple small air leaks
caused by the staples in the lung continued to limit the effectiveness of the
procedure. In 1994, Dr. Joel Cooper, a pioneer in lung transplant surgery,
modified LVRS using strips of Supple Peri-Guard to reinforce the staple line to
prevent air leakage around the staples.
During LVRS, the surgeon collapses one lung, while allowing the patient to
continue breathing with the other lung with supplemental oxygen. Using a
stapling device, the surgeon removes sections of damaged tissue, typically 20%
to 30% of each lung. The Company's Peri-Strips or Peri-Strips Dry are used to
strengthen these staple lines and prevent air leakage. By removing the most
diseased tissue, the remaining lung tissue has room to expand, improving
breathing capacity by, among other things, enabling the muscles used in
breathing to regain their function and allowing the rib cage and diaphragm to
return to their normal size and state. The Company estimates that the current
cost of LVRS ranges from $25,000 to $45,000 per procedure.
The American Lung Association estimates that in 1992 there were approximately
1.9 million Americans suffering from emphysema. LVRS, however, is currently
only being performed on a small portion of these patients who have late-stage
emphysema and who meet certain criteria established by the attending surgeons.
Currently, most surgeons require that an LVRS candidate be less than 75 years
old, quit smoking at least six months prior to LVRS, have no documented history
of heart disease or previous lung surgery and have no other major diseases. In
addition, most surgeons performing LVRS require that candidates have documented
lung function testing and chest x-rays detailing the severity of the condition.
The Company believes that the patient selection criteria will continue to be
refined as surgeons become more familiar with LVRS and as long-term clinical
results become available.
While LVRS is not a cure for emphysema, the results from the procedure to date
are encouraging based on peer-reviewed published literature. Generally, the
literature shows that patients undergoing the procedure have reduced shortness
of breath, improved exercise tolerance and improved quality of life. However,
LVRS was only re-introduced into the United States in late calendar 1993. While
it is estimated that over 3,000 surgeons have been trained and over 6,000
procedures have been performed, not enough time has elapsed to provide a
statistically significant body of clinical data from which to draw conclusions
concerning the long-term efficacy and long-term outcomes associated with LVRS.
Craniotomy. Craniotomies (surgical operations involving the brain and skull)
are typically performed to treat various brain conditions, such as tumors,
aneurysms, blood clots, head injuries and abscesses. To access the brain, the
surgeon is required to cut through several of the protective layers surrounding
the brain. The dura, the fibrous protective layer below the skull, protects the
brain and spinal cord from bacterial infection and trauma and provides a fluid
tight seal. Once the surgeon has cut through the scalp and the skull, the dura
must be cut with a scalpel or scissors and resected to expose the brain.
After the specific brain condition has been treated by the surgeon, the dura
often must be closed to prevent cerebral spinal fluid leakage. While the dura
is often closed with direct suture, surgeons who consider the prevention of
fluid leakage to be critical to the success of the operation will use a dural
patch. The primary patching materials include autologous tissue, synthetic
patches, processed cadaver tissue or bovine pericardium. The Company's Dura-
Guard Dural Repair Patch is designed to be sewn to the dura to close the
incision by fusing to the native dura with little or no adhesion (an abnormal
union between two tissue surfaces not intended to be joined) to the underlying
5
brain cortex.
The Company estimates that in the United States approximately 140,000 cranial
operations are performed annually. Whether a dural patch is used in such
operations is subject to surgical conditions and surgeon discretion. Dural
patching is most often used when the dura shrinks after incision such that
sutures alone may not provide adequate closure.
Carotid Endarterectomy. Stroke is the third leading cause of death in the
United States with an estimated 500,000 new cases per year. The build-up of
atherosclerotic plaque (fat deposits with a proliferation of fibrous connective
cells along the artery walls) in the carotid arteries (the principal arteries
located in the neck that supply blood to the brain) increases the risk of
stroke. A substantial portion of strokes is caused by a fragment of
atherosclerotic plaque breaking away from the inner wall of the carotid artery
and becoming lodged in an artery in the brain.
Drug therapy is often prescribed to treat the early indications of
atherosclerotic plaque build-up. If the condition progresses to a point where
drug therapy is not effective, surgical intervention may be required. Carotid
endarterectomy is a surgical procedure used to remove atherosclerotic plaque
build-up in the carotid artery. The endarterectomy procedure begins with an
incision in the internal carotid artery. A temporary shunt may be inserted to
maintain blood flow to the brain during the surgery. Once the artery is opened,
the plaque and inner layer of the artery are carefully removed, and the incised
artery must be repaired. Although the artery often can be closed without a
patch, use of an autologous or prosthetic patch is often suggested to expand the
artery, encouraging greater blood flow. In addition, certain patients require
patching due to the small size of their carotid arteries, or in some patients
with a normal carotid artery diameter, a patch is used to decrease the incidence
of post-operative stenosis or occlusion.
While the Company estimates that in the United States approximately 115,000
carotid endarterectomy procedures are performed annually, the use of a patching
material in such procedures is subject to surgeon discretion. Once a surgeon
determines a vascular patch is necessary or desirable, the surgeon has
additional discretion in determining the type of patching material to use.
Characteristics of an effective vascular patch include the ability to imitate
human tissue, to exhibit good blood flow characteristics and to reapproximate
around sutures to prevent blood leaks. The primary patching materials include
autologous tissue, synthetic patches made out of polytetraflurothylene ("PTFE"),
silicone fabric or tissue-based patches made out of bovine pericardium, such as
Vascu-Guard.
Lower Limb Vascular Reconstruction. Certain diseases, such as diabetes, can
cause a restriction or occlusion in the arteries which provide blood to the
legs. If left untreated, insufficient blood flow can ultimately result in the
need for amputation. If drug therapy is not deemed an effective treatment based
upon the severity of the restriction or blockage, the use of a graft in
peripheral vascular reconstructive surgery may be needed. In this type of
surgical procedure, the surgeon can bypass the blocked artery to regain blood
circulation, thereby saving the affected limb. Diabetics, in particular, are
often at risk for amputation of a lower limb due to insufficient blood flow in
the femoral artery in the thigh. By implanting a graft from the upper portion
of the femoral artery to either the lower femoral artery or to the popliteal
artery blow the knee, the surgeon is able to increase blood flow below the site
of the restriction or blockage. Long-term patency (openness), and a thrombo-
resistant surface that provides smooth blood flow are essential qualities of an
effective graft.
Saphenous veins (autologous veins from the leg) typically provide the most
effective grafting material. In many instances, however, a suitable saphenous
vein may be unavailable in sufficient quantity or quality, and a substitute
graft must be used. The primary alternative substitute grafts involve synthetic
grafts made from PTFE or bio-synthetic materials or tissue-based grafts, such as
Biograft. The Company estimates that in the United States approximately 55,000
lower limb vascular reconstructions are performed annually.
6
PRODUCTS
The following table summarizes the Company's product lines and primary products,
the procedures in which such products are used and the type of regulatory
clearance obtained for such products:
REGULATORY
PRODUCT LINE PRODUCT APPLICATION REPRESENTATIVE PROCEDURE CLEARANCE
- -------------------- --------------- ------------------------- --------------------------- -------------
Tissue-Guard Peri-Strips Soft tissue stapling Lung volume reduction/lung
buttress resection 510(k)
Peri-Strips Dry Soft tissue stapling Lung volume reduction/lung
buttress resection 510(k)
Dura-Guard Dural repair patch Craniotomy 510(k)
Vascu-Guard Peripheral vascular patch Carotid Endarterectomy 510(k)
Supple Peri- General soft tissue patch Various surgical procedures 510(k)
Guard
Peri-Guard Pericardial patch Various cardiovascular
procedures 510(k)
Biograft Biograft Peripheral vascular Lower limb vascular
bypass graft reconstruction PMA
Surgical Bio-Vascular Locator of arterial Various surgical bypass
Productivity Tools Probe blockages procedures 510(k)
Flo-Rester Internal vessel occluder Coronary artery bypass
graft surgery 510(k)
The following table summarizes the net revenue contributed by the Company's
products and various product lines for the periods indicated:
YEARS ENDED OCTOBER 31,
PRODUCT/PRODUCT LINE 1997 1996 1995
- -------------------- -------- -------- --------
(IN THOUSANDS)
Tissue-Guard Products:
Peri-Strips and Peri-Strips Dry.. $2,915 $4,336 $5,550
Other Tissue-Guard Products...... 3,852 2,944 1,845
Biograft........................... 800 938 1,198
Surgical Productivity Tools........ 2,127 1,902 1,825
TISSUE-GUARD PRODUCT LINE. The Company's Tissue-Guard products are all produced
from bovine pericardium. Many of the product characteristics and competitive
advantages of this product line are derived from the collagen
7
configuration of the bovine pericardium. Collagen, which is a fibrous protein
found in all multi-cellular animals, makes the pericardium durable and provides
superior fluid interface properties, similar to autologous tissue. These
characteristics allow for effective host tissue incorporation. Host cells
deposit a collagen matrix on the surface of the pericardial product, which helps
the Tissue-Guard product integrate into the host tissue and which the Company
believes enhances the long-term tensile strength (the maximum stress a material
subjected to a stretching load can withstand without tearing) of all the
products in the Tissue-Guard product line.
The Company processes the bovine pericardium using proprietary and patented
tissue-fixation technologies. The tissue is treated with glutaraldehyde and
other proprietary chemical treatments to prevent degradation of the tissue and
to render it biologically compatible with the host tissue. In addition,
according to studies commissioned by the Company, the tissue-fixation
technologies used by the Company reduce the level of residual glutaraldehyde
remaining in the processed tissue to less than six parts per million, resulting
in a lower incidence of host tissue inflammatory response and promoting host
tissue incorporation similar to the body's natural healing process. Tissue-
Guard has in excess of a 15 year history of successful clinical performance as a
surgical patch in a wide variety of clinical applications.
Surgeons have indicated that different pericardial patch characteristics are
useful in different surgical procedures. Accordingly, depending on the
particular tissue-fixation technology used by the Company, the bovine
pericardium is processed into either Supple Peri-Guard or Peri-Guard. While the
raw material used is the same, Supple Peri-Guard has greater elasticity and
flexibility than Peri-Guard, which allows for greater conformity to the surgical
site. The Company's Peri-Guard and Supple Peri-Guard products are produced in
square or rectangular sheets of different sizes, ranging from 4 cm x 4 cm to 12
cm x 25 cm. Supple Peri-Guard is produced for use as a multi-purpose material
designed for reinforcing, reconstructing and repairing tissue and preventing
leaks of air, blood and other body fluids. Each of such products has received
510(k) clearance from the FDA as a general soft-tissue patch.
The products in the Tissue-Guard product line described below are special
configurations of Supple Peri-Guard designed to enable specific surgical
procedures.
Peri-Strips and Peri-Strips Dry
Peri-Strips and Peri-Strips Dry, soft tissue stapling buttress, are currently
used primarily in LVRS but are also used for lobectomy (removal of a lobe),
excision/destruction of a lesion and segmental resection of the lung. The key
competitive features of Peri-Strips and Peri-Strips Dry include the following:
- - Reapproximation. Due to the elastic-like nature of the collagen fibers in
the tissue, Peri-Strips and Peri-Strip Dry reapproximate (close around)
surgical staples to prevent pulmonary air leaks at the staple site.
- - Prevents Enlargement. The elasticity of Peri-Strips and Peri-Strip Dry
prevents staple holes from enlarging, which could lead to additional air
leaks and require additional surgery.
- - Reinforcement. The use of Peri-Strips and Peri-Strip Dry strengthens the
entire staple line, which makes it more durable and less likely to tear.
Also, Peri-Strips and Peri-Strips Dry are thin enough to allow for staple
lines to be overlapped, which is often required during LVRS.
- - Configuration. The sleeve configuration of Peri-Strips is customized to fit
disposable, reusable and endoscopic staplers of varying sizes and produced by
different manufacturers. The Peri-Strip Dry design provides even greater ease
of use for thorascopic surgical procedures over the sleeve configuration. The
Peri-Strip Dry design eliminates the need to extract the sutured sleeve
through the thorascope.
8
Dura-Guard
Dura-Guard, a dural repair patch, is primarily used in craniotomy procedures
when the dura must be repaired and suturing without a patch is not deemed
sufficient. Dura-Guard offers advantages over competitive dural patches
produced from autologous or cadaver tissue. Harvesting autologous tissue
necessarily involves a second surgical site, thereby increasing costs and
recovery time. Cadaver tissue is subject to rigorous tissue bank regulations,
which could impact upon the availability of such tissue. Certain other
competitive advantages of Dura-Guard relate to the specific benefits produced by
the physical properties of Dura-Guard in connection with the craniotomy
procedure. Observations in the course of subsequent surgical procedures on
patients receiving Dura-Guard patches have shown that there is little or no
adhesion formation on the Dura-Guard surface that faces the cerebral cortex, a
complicating factor following any cranial surgery. In addition, Company
commissioned studies have shown that fibrous bone cells invade the Dura-Guard
surface facing the cranium, as they do the human dura, inviting good host tissue
incorporation. The collagen configuration of the processed bovine pericardium
in Dura-Guard reapproximates around the sutures used to affix the patch, thereby
providing a barrier between the skull and the tissue layers underlying the dura
and preventing the leakage of cerebrospinal fluid. Studies have shown synthetic
materials have been unable to perform as effective dura substitutes and have
been associated with late subdural hematoma formation (bleeding between the dura
and the brain).
Vascu-Guard
Vascu-Guard, a vascular repair patch, is primarily used in carotid
endarterectomy and other peripheral vascular procedures when the artery must be
repaired and closing the vessel without a patch is not deemed sufficient. Vascu-
Guard offers advantages over competitive carotid artery repair patches produced
from autologous tissue or synthetics. The use of autologous tissue necessarily
involves a second surgical site and results in increased costs and additional
recovery time. Synthetic patches, which lack the collagen configuration of
tissue, do not reapproximate around sutures as does the Vascu-Guard product,
thereby increasing the risk of suture line bleeding and resulting in longer
operating times. In addition, unlike synthetic patches, the physical attributes
of Vascu-Guard imitate human tissue and certain characteristics associated with
human tissue. Specifically, Company commissioned studies have shown that, once
healed, Vascu-Guard supports endothelialization (growth of a cell layer normally
lining the interior of blood vessels) and its non-thrombogenic blood flow
surface imitates the blood flow characteristics of autologous vessels. In
addition, its pulsatility (ability to reflect movement signifying the rhythmic
pumping of the heart) allows the surgeon to readily verify normal blood flow
after implantation.
BIOGRAFT. Biograft, a peripheral vascular graft manufactured from human
umbilical veins, is indicated for use in lower limb vascular reconstructions
when a saphenous vein is not available. Biograft offers advantages over
competitive vein grafts produced from synthetics, like PTFE, due to its thrombo-
resistant surface which provides smooth blood flow and minimizes turbulence and
risk of occlusion. Other competitive advantages of Biograft include its long-
term patency and its similarity to an autologous blood vessel, minimizing
intimal hyperplasia (a build up of cells on the interior of the blood vessel
which results in restricted blood flow). In addition, a knitted and supportive
Dacron mesh is placed around the graft, which allows for easier handling and
promotes tissue integration for strength and stability.
SURGICAL PRODUCTIVITY TOOLS. Flo-Rester and Bio-Vascular Probe. The Company's
Flo-Rester products are vessel occluders manufactured from medical grade
silicone. The Flo-Rester products are designed to interrupt blood flow in
arteries and to stent them (hold them open) during surgery, thereby facilitating
the suturing together of vessels. These products are primarily used during
coronary artery bypass graft surgeries in which blood is routed past the heart
through a heart-lung bypass machine in order to keep the heart free of blood
during surgery. During such procedures, incidental blood flow obstructs the
surgeon's view of the operative site and interferes with precise suturing.
Flo-Rester consists of a flexible shaft with small bulbs at each end that are
inserted into the blood vessel to stop the blood flow at the point where the
artery bypass is sutured to the artery. Competitive procedures involve external
occlusion through the use of clamps, snares or tapes. The Bio-Vascular Probe is
a flexible shaft with
9
varying sizes of bulbous tips on either end. Surgeons use the Bio-Vascular Probe
to locate occlusions or blockages in arteries and to ascertain the blood flow
characteristics of arteries. The Bio-Vascular Probe is inserted and fed into an
artery. When the tip of the probe meets resistance, the surgeon is able to
identify the exact location of the occlusion. The Bio-Vascular Probe is then
extracted and a bypass is completed below the occlusion. In addition, the Probe
can be used to atraumatically lift the edge of the incision to assist the
surgeon in accurately placing sutures, which can improve the functioning of
bypass grafts.
RESEARCH AND DEVELOPMENT
The Company generally allocates its research and development resources among
three broad functions: research and development support of current products
through training of Company personnel and writing and publishing research papers
on these products; development of product line extensions by improving current
products or developing new applications for current products; and the
development of new products for medical applications that utilize the Company's
proprietary technologies and core competencies in tissue processing and bio-
materials.
As an integral part of both its research and development and sales and marketing
strategies, the Company strives to involve its surgeon-customers in its product
development activities. The Company consults with selected surgeons frequently
as to market needs and assessments of products under development. The Company
believes that this practice allows it to receive early stage assessments of
products in development.
The Company's research and development staff, including engineering, currently
consists of five scientists, four engineers, and three technicians. The Company
also expands its research and development activities through the use of external
consultants and research staff and facilities at research centers and hospitals
on an as-needed basis. The Company spent approximately $1,258,000, $909,000 and
$643,000 on research and development in fiscal 1997, 1996 and 1995,
respectively.
MARKETING
The Company's sales and marketing strategy is designed to ensure that the
Company has an innovative "first in the mind of the customer" focus that
results in timely and effective marketing programs and new product
introductions. These programs include surgical trade shows, support of the
presentation of clinical data and new product information by key physicians,
limited direct-mail campaigns, journal ads and the development of strategic
physician alliances and utilization of the Company's scientific advisory boards.
The Company believes these efforts to be cost-effective in producing awareness
of, and loyalty to, the Company's products.
The sales and marketing strategy of the Company also includes developing and
maintaining a close working relationship with the hospitals and surgeons who
purchase and use the Company's products in order to assess and satisfy their
needs. The Company continues to assist in the education of surgeons in the use
of Peri-Strips in LVRS through sponsorship of workshops and training programs.
These workshops and training sessions have been conducted in the United States,
Canada and certain European and Far Eastern countries. The Company estimates
that over 3,000 surgeons have been trained in LVRS as of the end of fiscal 1997.
The Company has also sponsored "focus group" meetings as a forum for discussion
and the exchange of information for surgeons performing LVRS. In addition, the
Company sponsors surgeon workshops and training programs in the use of Biograft
and Vascu-Guard.
The Company's products are sold to hospitals and surgeons worldwide. For the
fiscal years ended October 31, 1997, 1996 and 1995, approximately 24%, 22%, and
17% of the Company's revenue, respectively, were from sales in international
markets. The lower percent of net revenue attributed to international markets
during fiscal 1995 was primarily due to increases of sales of Peri-Strips in the
United States. The majority of the Company's international sales are in Europe.
In the United States, the Company sells its products through a combination of
distributors and independent sales
10
representatives managed by regional sales managers. To further strengthen the
direct relationship between the Company and the end users of its products, the
Company requires distributors to provide the Company with the names and
addresses of such end users. The Company also ships products directly to end
users for a limited period of time when there is a new product introduction. In
addition to strengthening customer relationships, this practice provides the
Company with some protection in the event a distributor is terminated and
resists providing the Company with customer lists. Internationally, the
Company's products are sold through distributors. In some situations, sales in a
country may occur through more than one distributor due to distributors' varying
market strengths and focus.
The Company currently has written agreements with 43 of its domestic and
international independent sales representatives and distributors. These
agreements generally impose limited geographic exclusivity and minimum purchase
obligations on the Company's independent sales representatives and distributors.
However, significant overlap occurs in many of the Company's international
distribution agreements. These agreements are typically terminable upon breach
of the agreement by the distributor, including breach of the minimum sales
obligations imposed by the agreement, as well as certain extraordinary events.
The Company's marketing and sales department and its national and international
distribution network is managed by the Vice President of Marketing and Sales.
The Company's marketing and sales department currently consists of 15 employees.
These employees include domestic and international sales managers, domestic
regional sales managers, product managers, administrative and customer service
personnel. In fiscal 1997, three domestic distributors accounted for a total of
44% of the Company's gross revenues, each in excess of 10%. In fiscal 1996 and
1995, the same three domestic distributors each accounted for more than 10% of
the Company's gross revenue.
COMPETITION
The Company competes primarily on the basis of product performance, service and
price. The Company believes that product performance is the single most
important factor in selling any of its products and develops and produces its
products accordingly. The surgical products market in which the Company
competes is characterized by intense competition. This market is dominated by
established manufacturers that have broader product lines, greater distribution
capabilities, substantially greater capital resources and larger marketing,
research and development staffs and facilities than the Company. Many of these
competitors offer broader product lines within the Company's specific product
market, particularly in the Company's surgical tool product markets and/or in
the general field of medical devices and supplies. Broad product lines give
many of the Company's competitors the ability to negotiate exclusive, long-term
medical device supply contracts and, consequently, the ability to offer
comprehensive pricing for their products, including those that compete with the
Company's products. By offering a broader product line in the general field of
medical devices and supplies, competitors may also have a significant advantage
in marketing competing products to group purchasing organizations, health
maintenance organizations and other managed care organizations that increasingly
seek to reduce costs through centralization of purchasing functions.
In 1996, the FDA cleared for marketing a synthetic product made from PTFE,
configured for use with surgical staplers in LVRS, and intended to compete with
Peri-Strips. Pictures taken with electron microscopes indicate that PTFE,
unlike Peri-Strips, does not fully reapproximate around surgical staplers.
Additionally, the Company is aware of two tissue products that may be
potentially competitive with Peri-Strips. The Company, however, has three
patents related to the use of Peri-Strips as a soft tissue stapling buttress
(see Intellectual Property on page 16) which the Company intends to vigorously
enforce. To the Company's knowledge, there are dural patches currently
available that compete with Dura-Guard. These are either autologous tissue or
processed cadaver tissue, including Tutoplast/TM/, a processed cadaver product
manufactured by Biodynamics International, Inc., and synthetic patches. In
addition to specifically configured patches, there are multi-purpose patches
made from bovine and other types of animal tissue that compete with the
Company's Supple Peri-Guard, Peri-Guard, and Vascu-Guard products, including
bovine pericardium products produced by Medtronic, Inc. and Baxter International
Inc. The Company does not believe that these alternative bovine pericardium
products have specific FDA marketing clearance for use
11
in the lung, although such products are FDA cleared for pericardial closure and
soft tissue repair. In addition, synthetic multi-purpose patches made out of
PTFE or silicone fabric are currently available. W. L. Gore & Associates, Inc.,
manufacturer of Gore-Tex(R), is believed to have a prominent position in the
synthetic patch market. Synthetic patches are generally cheaper to produce and
to the extent that comparable synthetic patches are available and effective in
procedures, the Company faces significant price competition for its Tissue-Guard
products. The Company believes, however, that the collagen characteristics
exclusive to tissue, the special configuration of its Tissue-Guard products and
the proprietary tissue-fixation technology (Supple Peri-Guard, Peri-Strips,
Dura-Guard and Vascu-Guard) and patented (Peri-Guard) tissue-fixation technology
employed by the Company offer significant product performance advantages over
competing products.
Alternative treatments and competitive products to Biograft include drug
therapies and surgical procedures that use autologous or synthetic grafts. Once
the decision has been made to use surgical intervention, surgeons generally
prefer the patient's own vessels for lower limb vascular reconstruction. When
the patient's own vessels are not available in sufficient quality or quantity,
surgeons choose a prosthesis graft such as Biograft or synthetic grafts made
from expanded PTFE produced by W. L. Gore & Associates, Inc., IMPRA, Inc. or
other grafts made of bio-synthetic materials.
There can be no assurance that competing products will not achieve greater
acceptance or that future products developed by competitors will not offer
similar or enhanced performance advantages relative to the Company's product.
MANUFACTURING
The Company manufactures all of its products at its 36,000 square foot facility
occupied since July 1995 in St. Paul, Minnesota. Previously, the Bio-Vascular
Probe was manufactured to the Company's specifications by a contract
manufacturer, with certain final cleaning, packaging and sterilization testing
procedures performed by the Company at its St. Paul facility. During fiscal
1997, the Company brought the manufacture of this product in-house.
The Company acquires bovine pericardium for use in the Tissue-Guard product line
from a private independent contractor who obtains the tissue from local United
States Department of Agriculture ("USDA") inspected meat packing facilities.
The Company acquires human umbilical cords for use in Biograft from various
hospitals throughout the United States. The Company has not experienced any
product shortages arising from interruptions in the supply of any raw materials
or components, and has identified alternative sources of supply for such raw
materials and components.
GOVERNMENTAL REGULATION
The manufacture and sale of the Company's products are subject to regulation by
numerous governmental authorities, principally the FDA and corresponding foreign
agencies. In the United States, the FDA administers the Federal Food, Drug and
Cosmetics Act and amendments thereto. The Company is subject to the standards
and procedures respecting manufacture and marketing of medical devices contained
in the Federal Food, Drug and Cosmetics Act and the regulations promulgated
thereunder and is subject to inspection by the FDA for compliance with such
standards and procedures.
These regulations classify medical devices as either Class I, II or III devices,
which are subject to general controls, special controls or premarket approval
("PMA") requirements, respectively. All Class I and II devices, as well as some
Class III devices marketed prior to the effective date of the Medical Device
Amendments of 1976, can be cleared for marketing pursuant to a 510(k) pre-market
notification, establishing that the device is "substantially equivalent" to a
device that was legally marketed prior to May 28, 1976, the date on which the
Medical Device Amendments of 1976 became effective. The 510(k) pre-market
notification must be supported by data establishing the claim of substantial
equivalence to the satisfaction of the FDA. The process of obtaining a 510(k)
clearance typically can take several months to a year or longer. If substantial
equivalence cannot be established, or if the FDA
12
determines that the device or the particular application for the device requires
a more rigorous review, the FDA will require that the manufacturer submit a PMA
application that must be carefully reviewed and approved by the FDA prior to
sale and marketing of the device in the United States. The PMA application must
contain the results of clinical trials, the results of all relevant prototype
tests, laboratory and animal studies, a complete description of the device and
its components, and a detailed description of the methods, facilities and
controls used for manufacturing, including the method of sterilization and its
assurance. In addition, the submission must include the proposed labeling,
advertising literature and training methods, if applicable. Most Class III
devices are subject to the PMA requirements rather than the 510(k) pre-market
notification procedure. The process of obtaining a PMA can be expensive,
uncertain and lengthy, frequently requiring anywhere from one to several years
from the date of FDA submission, if approval is obtained at all. Moreover, a
PMA, if granted, may include significant limitations on the indicated uses for
which a product may be marketed. FDA enforcement policy strictly prohibits the
marketing of approved medical devices for unapproved uses. In addition, product
approvals can be withdrawn for failure to comply with regulatory standards or
the occurrence of unforeseen problems following initial marketing.
Of the Company's current products, Biograft and Peri-Guard (when marketed as a
pericardial patch) are Class III devices. Biograft received marketing clearance
from the FDA pursuant to a PMA, while Peri-Guard received clearance for use as a
pericardial patch as the result of a 510(k) submission. Peri-Strips (as
marketed in both strip and sleeve configurations), Peri-Strips Dry, Vascu-Guard,
Dura-Guard, Peri-Guard (when marketed as a patch for soft tissue deficiency),
Supple Peri-Guard (when marketed as a patch for soft tissue deficiency and as a
pericardial patch) and both the disposable and reusable Flo-Rester and the Bio-
Vascular Probe have all been classified as Class II medical devices and have
received 510(k) marketing clearance from the FDA.
The United States and Europe have focused attention on the safety of tissue
banks, spurred by incidents of the transmission of human disease during tissue
transplantation. In the United States, FDA draft regulations have outlined
requirements for tissue banks. These regulations have specifically excluded
medical devices subject to FDA review, including preserved umbilical cord vein
grafts such as Biograft. As a result, the Company does not expect Biograft to
be subject to tissue bank regulations in the United States, including the
expensive donor screening and donor testing procedures. In response to the
increased scrutiny of umbilical cord vein grafts, the Company commissioned an
independent virology laboratory to test Biograft for viral inactivation. The
results of the testing demonstrated that Biograft's chemical manufacturing
processes inactivate a variety of viruses, resulting in a sterile product. The
Company has informed the FDA of these test results and does not anticipate that
the FDA will impose additional regulatory requirements on Biograft. There can
be no assurance, however, that the FDA will not impose additional regulatory
requirements on Biograft at some later date or that Biograft would be able to
meet any such new requirements.
The Company is also subject to regulation in most of the foreign countries in
which it sells its products with regard to product standards, packaging
requirements, labeling requirements, import restrictions, tariff regulations,
duties and tax requirements. Many of the regulations applicable to the
Company's products in such countries are similar to those of the FDA. The
national health or social security organizations of certain such countries
require the Company's products to be qualified before they can be marketed in
those countries. In Japan, a potentially significant market for the Company's
products, clinical trials of certain of the Company's products are required
before such products can be cleared for sale in the Japanese market. To date,
this has delayed the Company's market entry in some cases, but has not
ultimately prevented sales in Japan of any of the Company's devices sold in the
United States. The Company relies on its independent distributors to comply
with the majority of the foreign regulatory requirements, including registration
of the Company's products with the appropriate governmental authorities. To
date, the Company has been successful in complying with the regulatory
requirements in most foreign countries in which its products are marketed.
Bovine Spongiform Encephalopathy ("BSE") has been endemic in cattle in the
United Kingdom (UK) and has received much publicity in Europe regarding beef for
dietary consumption. Under the direction of the USDA, the U.S. government has
had an active program of surveillance and import controls since the late 1980's,
designed to prevent the introduction of BSE into U.S. cattle. To date, all
evidence indicates that U.S. cattle are free of BSE.
13
The Company obtains all of its raw pericardium from USDA slaughterhouses. The
Company cannot predict whether or not a case of BSE may someday be reported in
the U.S. If a case of BSE were reported in the U.S. cattle, it could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's notified body, the British Standards
Institute ("BSI"), and French authorities have specifically reviewed Tissue-
Guard sourcing and manufacturing processes and have then accepted the Company's
bovine pericardium products. Although the Company does not anticipate that
countries will prohibit the sale of Tissue-Guard products as a result of
concerns related to BSE, such prohibition by certain countries could have a
material adverse effect on the Company's business, financial condition and
results of operation.
The Company is subject to periodic inspections by the FDA, whose primary purpose
is to audit the Company's compliance with Good Manufacturing Practices ("GMP")
established by the FDA and other applicable government standards. Strict
regulatory action may be initiated in response to audit deficiencies or to
product performance problems. The Company believes that its manufacturing and
quality control procedures are in compliance with the requirements of the FDA
regulations.
The Company's manufacturing facilities and processes were inspected and audited
by the BSI to verify the Company's compliance with the requirements of the
Medical Device Directive ("MDD") issued by the European Union ("EU"). They have
also verified that the Company's quality system conforms with the ISO 9001
international quality standard and that its products conform with the
"essential requirements" set forth by the MDD for the class of products
produced by the Company. In June of 1996, BSI certified the Company's
conformity with both the ISO 9001 standard and the MDD essential requirements,
entitling the Company to place the "CE" mark on the Company's Tissue-Guard
products. The CE mark enables the Company's products to be marketed, sold and
used throughout the EU, subject to limited "safeguard" powers of member
states. Presently, the CE mark is not required to be affixed to the Company's
products (or those of its competitors) sold in the EU, but may be affixed during
a transition period currently in effect and which began January 1, 1995. This
transition period will end on June 15, 1998, when all of the Company's current
products (and those of its competitors) will be required to comply with the
essential requirements in order to be marketed in the EU.
The long-term future regulatory environment for Biograft in Europe is uncertain.
The MDD explicitly excludes medical devices from human tissue; however, there is
an effort developing to include such devices under a comprehensive regulatory
program. This effort is in the early stages; the Company understands that a
consensus on such a directive would take approximately four to five years. In
addition, if extensive donor screening and donor testing requirements are
imposed, such requirements could make it uneconomical to sell Biograft in Europe
even under a regulatory program. As a result of significant problems with their
blood supply, France has passed national laws and regulations requiring
extensive donor screening and testing on products derived from human tissue.
Accordingly, Biograft is not being sold in France. It is not known whether a
comprehensive regulatory program for Biograft would override such national
requirements or whether other countries in the EU will adopt regulations similar
to those of France. The Company is seeking Biograft registration in Germany,
but cannot predict when or if it will achieve such registration. Biograft is
not marketed generally in Germany, but rather is prescribed by physicians on a
prescription-by-prescription basis only. If the CE mark or other regulatory
program requirements are unavailable for Biograft or if the requirements for
obtaining such designation are too burdensome, the Company intends to seek
country-by-country registration of the product where such registration
requirements exist for as long as it continues to market the Biograft. The
Company cannot predict when or if it would obtain such registrations.
The financial arrangements through which the Company markets, sells and
distributes its products may be subject to certain federal and state laws and
regulations in the United States with respect to the provision of services or
products to patients who are Medicare or Medicaid beneficiaries. The "fraud
and abuse" laws and regulations prohibit the knowing and willful offer, payment
or receipt of anything of value to induce the referral of Medicare or Medicaid
patients for services or goods. In addition, the physician anti-referral laws
prohibit the referral of Medicare or Medicaid patients for certain "Designated
Health Services" to entities in which the referring physician has an ownership
or compensation interest. Violations of these laws and regulations may result
in civil and criminal penalties, including substantial fines and imprisonment.
In a number of states, the scope of fraud and abuse or
14
physician anti-referral laws and regulations, or both, have been extended to
include the provision of services or products to all patients, regardless of the
source of payment, although there is variation from state to state as to the
exact provisions of such laws or regulations. In other states, and, on a
national level, several health care reform initiatives have been proposed which
would have a similar impact. The Company believes that its operations and its
marketing, sales and distribution practices currently comply in all respects
with all current fraud and abuse and physician anti-referral laws and
regulations, to the extent they are applicable. Although the Company does not
believe that it will need to undertake any significant expense or modification
to its operations or its marketing, sales and distribution practices to comply
with federal and state fraud and abuse and physician anti-referral regulations
currently in effect or proposed, financial arrangements between manufacturers of
medical devices and other health care providers may be subject to increasing
regulation in the future. Compliance with such regulation could adversely affect
the Company's marketing, sales and distribution practices, and may affect the
Company in other respects not presently foreseeable, but which could have an
adverse impact on the Company's business, financial condition and results of
operations.
THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT
The Company's products are purchased primarily by hospitals and other users
which then bill various third-party payers for the services provided to the
patients. These payers, which include Medicare, Medicaid, private health
insurance plans and managed care organizations, reimburse part or all of the
costs and fees associated with the procedures utilizing the Company's products.
The availability and level of reimbursement from third-party payers is
significant to the Company's business. For Medicare carriers, HCFA may
establish a national coverage policy, including the amount to be reimbursed, for
coverage of claims submitted for reimbursement related to a specific procedure.
Private health insurance plans and managed care organizations make their own
determinations regarding coverage and reimbursement based either upon "usual and
customary" fees or, increasingly, upon a similar prospective payment system.
During the past several years, the major third party payers have substantially
revised their reimbursement methodologies in an attempt to contain their
healthcare reimbursement costs. Medicare and Medicaid reimbursement for
inpatient hospital services is based on a fixed amount per admission based on
the patient's specific diagnosis. As a result, any illness to be treated or
procedure to be performed will be reimbursed only at a prescribed rate set by
the government that is known in advance to the healthcare provider. If the
treatment costs less, the provider keeps the difference. If it costs more, the
provider cannot bill the patient for the rest. Frequently, reimbursement is
reduced to reflect the availability of a new procedure or technique, and as a
result hospitals are generally willing to implement new cost saving technologies
before these downward adjustments take effect. No separate payment is made in
most cases for products such as the Company's when they are furnished or used in
connection with inpatient care. Any amendments to existing rules and
regulations which restrict or terminate the reimbursement eligibility (or the
extent or amount of coverage) of medical procedures using the Company's products
or the eligibility (or the extent or amount of coverage) of the Company's
products could have an adverse impact on the Company's business, financial
condition and results of operations.
In response to the focus of national attention on rising health care costs, a
number of changes to reduce costs have been proposed or have begun to emerge.
There have been, and may continue to be, proposals by legislators and regulators
and third-party payers to curb these costs. There has also been a significant
increase in the number of Americans enrolling in some form of managed care plan,
and over 80% of hospitals participate in or have agreements with HMOs. It has
become a typical practice for hospitals to affiliate themselves with as many
managed care plans as possible. Higher managed care penetration typically drives
down the prices of health care procedures, which in turn places pressure on
medical supply prices. This causes hospitals to implement tighter vendor
selection and certification processes, by reducing the number of vendors used,
purchasing more products from fewer vendors and trading discounts on price for
guaranteed higher volumes to vendors. Hospitals have also sought to control and
reduce costs over the last decade by joining group purchasing organizations or
purchasing alliances. The Company cannot predict what continuing or future
impact these practices, the existing or proposed legislation, or such third-
15
party payer measures may have on its future business, financial condition or
results of operations.
Because the Company's surgical products are primarily used in thoracic, cardiac,
neuro and vascular surgeries, changes in reimbursement policies and practices of
third party payers with respect to these surgeries could have a substantial and
material impact on sales of the Company's products. The development or increased
use of more cost effective treatments for diseases requiring these surgeries
could cause such payers to decrease or deny reimbursement for such surgeries or
to favor these other treatments over surgical treatment.
In January of 1996, HCFA, the agency of the federal government that administers
Medicare, made a national policy decision not to reimburse LVRS. These
surgeries had been reimbursed nationwide on a regional basis during fiscal 1994
and 1995. The Company estimates that approximately 70% of the patients
undergoing LVRS in fiscal 1995 were Medicare patients. In April of 1996, the
National Institute of Health ("NIH") announced a collaborative study of LVRS
with HCFA. The National Emphysema Treatment Trial ("NETT"), as it is currently
structured, is limited to a small number of patients relative to the number of
Medicare dependent patients who would otherwise be eligible for the procedure.
HCFA and NIH have estimated it will take approximately five years if the study
goes to completion and will include 4,700 Medicare patients, with a little more
than half of those receiving LVRS done bilaterally by open median sternotomy or
thoracoscopic. This represents less than 2% of those currently estimated to
benefit from LVRS.
The Company understands that many private insurance companies and managed care
organizations are continuing to reimburse LVRS based on their own evaluation of
the procedure and its outcomes. It is unknown whether these private payers will
change their reimbursement practices in the future. If these private payers
change their reimbursement practices, it could have an adverse impact on the
Company's business, financial condition and results of operations.
INTELLECTUAL PROPERTY
The Company's success will depend in large part on its ability to preserve its
trade secrets, to obtain patent protection for its products and to operate
without infringing the proprietary rights of third parties. While the Company
has obtained or acquired a license to certain patents and applied for additional
United States and foreign patents covering certain aspects of its products, no
assurance can be given that any additional patents will be issued, that the
scope of any patent protection will exclude competitors or that any of the
Company's rights under such patents will be held valid if subsequently
challenged. The validity and breadth of claims covered in medical technology
patents involve complex legal and factual questions and, therefore, may be
highly uncertain. Whether or not the Company's patent applications are granted,
others may receive patents which contain claims having a scope that covers
products developed by the Company.
The Company has been granted three United States patents relating to the use of
tissue on a removable backing which cover the sleeve configuration of Peri-
Strips, the combination of tissue with a surgical stapling gun, and methods of
performing a surgical procedure to remove diseased tissue. The Company has been
granted one United States patent relating to Peri-Strips Dry covering the
application of buttressing material (tissue or other synthetic material) onto a
surgical stapler for purposes of reinforcing a surgical fastener suture line
utilizing an adhesive substance and a positional and pressure equalization
device to accomplish the adherence of the tissue to the surgical suturing
device. A patent is pending regarding the method of manufacturing the Peri-
Strips Dry tissue. In December 1994, the Company entered into an agreement with
Surgical Research, Inc., which obligates the Company to pay royalties of five
percent (5%) on revenue from sales of Peri-Strips and Peri-Strips Dry for the
life of the patents. In December 1995, the Company purchased the patent for
Peri-Guard. Previously, the Company had an exclusive, worldwide, perpetual
license to make, use and sell its Peri-Guard product for use in connection with
the cardiovascular system. The Company holds no patents and pays no royalties
on Supple Peri-Guard or the configurations of Supple Peri-Guard marketed as
Dura-Guard or Vascu-Guard. The Company also has an exclusive, worldwide,
perpetual license to make, use and sell its Flo-Rester product. The last of the
patents related to the Company's Biograft product expired in November 1993.
16
The Company also relies on trade secrets and proprietary know-how which it seeks
to protect, in part, through confidentiality agreements with employees,
consultants and other parties. Supple Peri-Guard, which is used in the
manufacture of the majority of the Company's Tissue-Guard products, is protected
exclusively by trade secrets. There can be no assurance that these agreements
will not be breached, that the Company will have adequate remedies for any
breach, or that the Company's trade secrets will not otherwise become known to
or independently developed by competitors.
The surgical products industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. The surgical products markets
are characterized by extensive patent and other intellectual property claims
that can create greater potential than in less developed markets for possible
allegations of infringement, particularly with respect to newly developed
technology. Intellectual property litigation is complex and expensive, and the
outcome of such litigation is difficult to predict. Any future litigation,
regardless of outcome, could result in substantial expense to the Company and
significant diversion of the efforts of the Company's technical and management
personnel. Litigation may also be necessary to enforce patents issued to and
licenses held by the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforcement, scope and validity of the proprietary
rights of others. It is the Company's intention to vigorously enforce and
defend these intellectual property rights. An adverse determination in any such
proceeding could subject the Company to significant liabilities to third
parties, or require the Company to seek licenses from third parties or pay
royalties that may be substantial. Furthermore, there can be no assurance that
necessary licenses would be available to the Company on satisfactory terms, if
at all. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent the Company
from manufacturing or selling certain of its products which in turn would have a
material adverse effect on the Company's business, financial condition or
results of operations.
The Company has registered United States trademarks, including Peri-Strips(R),
Peri-Strips Dry(R), Dura-Guard(R), Vascu-Guard(R), Supple Peri-Guard(R), Peri-
Guard(R), Biograft(R), Flo-Rester(R) and Bio-Vascular Probe(R).
EMPLOYEES
At October 31, 1997, the Company employed 92 full-time and 2 part-time
individuals, including 12 in research and development, 47 in manufacturing,
quality control and quality assurance, 15 in sales and marketing, 14 in general
and administrative functions and 6 in regulatory affairs and clinical affairs.
The Company's employees are not represented by a union, and the Company
considers its relationship with its employees to be good.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES
- ----------------------------------------------------------------------------
For information with respect to the Company's revenue attributable to
international markets, see page 49 of this Annual Report on Form 10-K.
ITEM 1A - IMPORTANT FACTORS
- ---------------------------
The following factors are important and should be considered carefully in
connection with any evaluation of the Company's business, financial condition,
results of operations and prospects. Additionally, the following factors could
cause the Company's actual results to materially differ from those reflected in
any forward-looking statements of the Company.
LIMITATIONS ON THIRD-PARTY REIMBURSEMENT
The Company's products are purchased primarily by hospitals and other users,
which bill various third-party payers, such as government health programs,
private health insurance plans, managed care organizations and other similar
programs, for the health care goods and services provided to their patients.
Payers may deny reimbursement if they determine that a product used in a
procedure was not used in accordance with established payer protocol regarding
17
cost-effective treatment methods or was used for an unapproved indication.
Third-party payers are also increasingly challenging the prices charged for
medical products and services and, in some instances, have put pressure on
medical device suppliers to lower their prices. The Company is unable to
predict what changes will be made in the reimbursement methods used by third-
party health care payers. There can be no assurance that the surgical
procedures in which the Company's products are used will continue to be
considered cost-effective by third-party payers, that reimbursement for such
surgeries will be available or, if available will continue, or that payers'
reimbursement levels will not adversely affect the Company's ability to sell its
products on a profitable basis. The cost of health care has risen significantly
over the past decade, and there have been and may continue to be proposals by
legislators, regulators and third-party payers to curb these costs. Failure by
hospitals and other users of the Company's products to obtain reimbursement from
third-party payers, changes in third-party payers' policies towards
reimbursement for procedures using the Company's products or legislative action
could have a material adverse effect on the Company's business, financial
condition and results of operations.
In January of 1996, HCFA, the agency of the federal government that administers
Medicare, made a national policy decision not to reimburse LVRS. These
surgeries had been reimbursed nationwide on a regional basis during fiscal 1994
and 1995. The Company estimates that approximately 70% of the patients
undergoing LVRS in fiscal 1995 were Medicare patients. In April of 1996, the
National Institute of Health ("NIH") announced a collaborative study of LVRS
with HCFA. The National Emphysema Treatment Trial ("NETT"), as it is currently
structured, is limited to a small number of patients relative to the number of
Medicare dependent patients who would otherwise be eligible for the procedure.
HCFA and NIH have estimated it will take approximately five years if the study
goes to completion and will include 4,700 Medicare patients, with a little more
than half of those receiving LVRS done bilaterally by open median sternotomy or
thoracoscopic. This represents less than 2% of those currently estimated to
benefit from LVRS.
The Company understands that many private insurance companies and managed care
organizations are continuing to reimburse LVRS based on their own evaluation of
the procedure and its outcomes. It is unknown whether these private payers will
change their reimbursement practices in the future. If these private payers
change their reimbursement practices, it could have an adverse impact on the
Company's business, financial condition and results of operations.
HIGHLY COMPETITIVE INDUSTRIES AND RISK OF TECHNOLOGICAL OBSOLESCENCE
The Company faces intense competition. The medical products industry is highly
competitive and characterized by rapid innovation and technological change. The
Company expects technology to continue to develop rapidly, and the Company's
success will depend to a large extent on its ability to maintain a competitive
position with its technology. There can be no assurance that the Company will
be able to compete effectively in the marketplace or that products developed by
its competitors will not render its products obsolete or non-competitive.
Similarly, there can be no assurance that the Company's competitors will not
succeed in developing or marketing products that are viewed by physicians as
providing superior clinical performance or are less expensive relative to the
Company's products currently marketed or to be developed. Several established
companies manufacture and sell surgical products which compete with all of the
Company's surgical products. The companies with which the Company competes have
greater distribution capabilities, substantially greater capital resources and
larger marketing, research and development staffs and facilities than the
Company. In addition, many of the Company's competitors offer broader product
lines within the Company's specific product markets. Broad product lines may
give the Company's competitors the ability to negotiate exclusive, long-term
medical product supply contracts and the ability to offer comprehensive pricing
for their products, including those that compete with the Company's products.
By offering a broader product line in the general field of medical products and
supplies, competitors may also have a significant advantage in marketing
competing products to group purchasing organizations and managed care
organizations that increasingly seek to reduce costs. There can be no assurance
that the Company will be able to compete effectively with such manufacturers.
18
RISKS ASSOCIATED WITH INTELLECTUAL PROPERTY
The Company protects its technology through trade secrets and proprietary know-
how and through patents, both owned and licensed. The Company seeks to protect
its trade secrets and proprietary know-how through confidentiality agreements
with employees, consultants and other parties. Supple Peri-Guard, which is used
in the manufacture of the majority of the Company's Tissue-Guard products, is
protected exclusively by trade secrets. There can be no assurance that the
Company's trade secrets or confidentiality agreements will provide meaningful
protection of the Company's proprietary information or, in the event of a breach
of any confidentiality agreement, that the Company will have adequate remedies.
There can be no assurance that any pending or future patent applications will
result in issued patents, or that any current or future patent, regardless of
whether the Company is an owner or licensee of such patent, will not be
challenged, invalidated or circumvented or that the rights granted thereunder or
under its licensing agreements will provide a competitive advantage to the
Company. Furthermore, there can be no assurance that others will not
independently develop similar technologies or duplicate any technology developed
by the Company or that the Company's technology does not or will not infringe
patents or other rights owned by others.
The medical product industry is characterized by frequent and substantial
intellectual property litigation, and competitors may resort to intellectual
property litigation as a means of competition. Intellectual property litigation
is complex and expensive, and the outcome of such litigation is difficult to
predict. Any future litigation, regardless of the outcome, could result in
substantial expense to the Company and significant diversion of the efforts of
the Company's technical and management personnel. Litigation may also be
necessary to enforce patents issued to the Company and license agreements
entered into by the Company, to protect trade secrets or know-how owned by the
Company or to determine the enforcement, scope and validity of the proprietary
rights of others. An adverse determination in any such proceeding could subject
the Company to significant liabilities to third parties, or require the Company
to seek licenses from third parties or pay royalties that may be substantial.
Furthermore, there can be no assurance that necessary licenses would be
available to the Company on satisfactory terms, if at all. Accordingly, an
adverse determination in a judicial or administrative proceeding or failure to
obtain necessary licenses could prevent the Company from manufacturing or
selling certain of its products which, in turn, would have a material adverse
effect on the Company's business, financial condition and results of operations.
See "Intellectual Property" on page 16 of this Report.
RISKS ASSOCIATED WITH HUMAN TISSUE PRODUCTS
Both the United States and Europe have recently focused attention on the safety
of tissue banks, spurred by incidents of the transmission of human disease
during tissue transplantation. In the United States, regulations drafted by the
FDA have outlined requirements for tissue banks. The regulations have
specifically excluded from regulation medical devices subject to FDA review,
including preserved umbilical cord vein grafts such as Biograft. As a result,
the Company does not expect Biograft to be subject to tissue bank regulations in
the United States and the related expensive donor screening and donor testing
procedures. There can be no assurance, however, that the FDA will not impose
additional regulatory requirements on Biograft at some later date or that
Biograft would be able to meet any such new requirements.
The long-term future regulatory environment for Biograft in Europe is uncertain.
The MDD explicitly excludes medical devices from human tissue; however, there is
an effort developing to include such devices under a comprehensive regulatory
program. This effort is in the early stages; the Company understands that a
consensus on such a directive would take approximately four to five years. In
addition, if extensive donor screening and donor testing requirements are
imposed, such requirements could make it uneconomical to sell Biograft in Europe
even under a regulatory program. Biograft accounted for 8% and 16% of the
Company's net revenue and international net revenue, respectively, for the year
ended October 31, 1997.
Bovine Spongiform Encephalopathy ("BSE") has been endemic in cattle in the
United Kingdom (UK) and has received much publicity in Europe regarding beef for
dietary consumption. Under the direction of the USDA, the
19
U.S. government has had an active program of surveillance and import controls
since the late 1980's, designed to prevent the introduction of BSE into U.S.
cattle. To date all evidence indicates that U.S. cattle are free of BSE. The
Company obtains all of its raw pericardium from USDA slaughterhouses. The
Company cannot predict whether or not a case of BSE may someday be reported in
the U.S. If a case of BSE were reported in the U.S. cattle, it could have a
material adverse effect on the Company's business, financial condition and
results of operations. The Company's notified body, the British Standards
Institute, and French authorities have specifically reviewed Tissue-Guard
sourcing and manufacturing processes and have then accepted the Company's bovine
pericardium products. Although the Company does not anticipate that countries
will prohibit the sale of Tissue-Guard products as a result of concerns related
to BSE, such prohibition by certain countries could have a material adverse
effect on the Company's business, financial condition and results of operation.
GOVERNMENTAL REGULATION
The Company's products, development activities and manufacturing processes are
subject to extensive and rigorous regulation by the FDA and by comparable
agencies in foreign countries. In the United States, the FDA regulates the
introduction, manufacturing, labeling and record keeping procedures for medical
devices. The process of obtaining marketing clearance from the FDA for new
products and new applications for existing products can be time-consuming and
expensive, and there is no assurance that such clearances will be granted or
that FDA review will not involve delays that would adversely affect the
Company's ability to commercialize additional products or additional
applications for existing products. In addition, certain of the Company's
products that are in the research and development stage may be subject to a
lengthy and expensive pre-market approval ("PMA") process with the FDA. Even
if regulatory approvals to market a product are obtained from the FDA, these
approvals may entail limitations on the indicated uses of the product. Product
approvals by the FDA can also be withdrawn due to failure to comply with
regulatory standards or the occurrence of unforeseen problems following initial
approval. The FDA could also limit or prevent the manufacture or distribution
of the Company's products and has the power to require the recall of such
products. FDA regulations depend heavily on administrative interpretation, and
there can be no assurance that future interpretations made by the FDA or other
regulatory bodies, with possible retroactive effect, will not adversely affect
the Company. The FDA, various state agencies and foreign regulatory agencies
inspect the Company and its facilities from time to time to determine whether
the Company is in compliance with various regulations relating to manufacturing
practices, validation, testing, quality control and product labeling. A
determination that the Company is in violation of such regulations could lead to
imposition of civil penalties, including fines, product recalls or product
seizures and, in extreme cases, criminal sanctions.
Approximately 24% of the Company's revenue in fiscal 1997 resulted from sales of
its products outside the United States through independent distributors.
International regulatory bodies have established varying regulations governing
product standards, packaging requirements, labeling requirements, import
restrictions, tariff regulations, duties and tax requirements. The Company
relies on independent distributors to comply with foreign regulatory
requirements. As a result, communication between foreign regulatory agencies
and the Company is indirect as it occurs through the foreign distributor. The
inability or failure of independent distributors to comply with the varying
regulations or the imposition of new regulations could restrict such
distributors' ability to sell the Company's products internationally and thereby
adversely affect the Company's business, financial condition and results of
operations.
The registration scheme in the EU requires that the Company's quality system
conform with the ISO 9001 international quality standard and that its products
conform with the "essential requirements" set forth by the MDD for the class
of products produced by the Company. Compliance with these requirements will
allow the Company to issue a "Declaration of Conformity" and apply the CE mark
to products, allowing free sale in the EU. While the Company has obtained the
"CE" mark for its Tissue-Guard products, there can be no assurance that the
Company will be able to maintain compliance with the regulations to retain the
CE mark. In addition, it is uncertain whether the Company will be successful in
obtaining the CE mark for its other products or new product introductions.
Failure to obtain the CE mark authority for the Company's other products by June
15, 1998 would limit the Company's ability to sell such products in Europe and
would have a material adverse effect on the Company's
20
business, financial condition and results of operations. See "Governmental
Regulation" on page 12 of this Report.
EXPOSURE TO PRODUCT LIABILITY CLAIMS; RISK OF PRODUCT RECALL
The medical product industry historically has been litigious, and the
manufacture and sale of the Company's products inherently entails a risk of
product liability claims. Since the Company's principal products are designed
to be permanently placed in the human body, production errors could result in an
unsafe product and injury to the patient. Although the Company maintains
product liability insurance in amounts believed to be adequate based upon the
nature and risks of its business in general and its actual experience to date,
there can be no assurance that one or more liability claims will not exceed the
coverage limits of such policies or that such insurance will continue to be
available on commercially reasonable terms, if at all. Furthermore, the Company
does not expect to be able to obtain insurance covering its costs and losses as
the result of any recall of its products due to alleged defects, whether such a
recall is instituted by the Company or required by a regulatory agency.
In September 1996, the Company voluntarily issued a Safety Alert regarding the
usage of its bovine pericardium as a urethral sling and removed "urethral sling"
from the "indications" statement in its instructions for use. The Company issued
the Safety Alert as a prudent course of action. The deletion of "urethral
sling" from the labeling caused the action to fall into the category of a "field
correction". In November 1996, the FDA acknowledged this field correction and
reported it in the "FDA Weekly Enforcement Report" of November 11, 1996 as a
"recall", as the definition of a recall encompasses field corrections. No
product units were physically recalled and none were returned to the Company.
Although Peri-Guard and Supple Peri-Guard have included the urethral sling
indication in their labeling for several years, the products were rarely used in
this application until late 1995. At that time a handful of urological surgeons
began using the products in place of autologous fascia slings to treat female
urinary incontinence. Approximately 65 transvaginal implants were done,
resulting in 16 explants due to vaginal discharge, opening of the vaginal
incision, and localized inflammation without fever. These results were similar
to those which have been reported for synthetic urethral slings.
A product liability claim, recall or other claim with respect to uninsured
liabilities or in excess of insured liabilities could have a material adverse
effect on the business, financial condition and results of operations of the
Company.
DEPENDENCE ON DISTRIBUTOR SALES
Sales to distributors constitute a significant portion of the Company's current
business. In the year ended October 31, 1997, three domestic distributors
accounted for an aggregate of 44% of gross revenue, with each of such
distributors accounting for in excess of 10% of the Company's gross revenue for
the period. There can be no assurance that the Company will be able to maintain
its relationships with these significant distributors, or, in the event of
termination of any of such relationships, that a new replacement distributor
will be found. The loss of a significant distributor could materially adversely
affect the Company's business, financial condition and results of operations if
a new distributor or other suitable sales organization could not be found on a
timely basis in the relevant geographic market. See Business - "Marketing" on
page 10 of this Report.
ITEM 2 - PROPERTIES
- -------------------
The Company leases approximately 36,000 square feet of office and manufacturing
space at 2575 University Avenue, St. Paul, Minnesota. The base rent of this
lease, which commenced August 1, 1995 and expires July 31, 2005, is
approximately $255,000 annually. The Company also pays apportioned real estate
taxes and common costs on this lease. The Company believes that its current
space is adequate for the foreseeable future.
ITEM 3 - LEGAL PROCEEDINGS
- --------------------------
During the first quarter of fiscal 1997, the Company received notice of a suit
brought against it in Tokyo District Court in Japan by Jostra, Japan, K.K., a
former Japanese distributor, claiming wrongful termination and economic
21
damage of $500,000. The Company settled this matter out of court during the
fourth quarter of fiscal 1997 at an amount considerably less than the original
claim.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- ------------------------------------------------------------
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this Report.
ITEM 4A - EXECUTIVE OFFICERS OF THE REGISTRANT
- ----------------------------------------------
The Company's executive officers, their ages, and their offices held as of
November 30, 1997 are as follows:
NAME AGE TITLE
- -------------------------- --- -------------------------------------------------------
M. Karen Gilles........... 55 President, Chief Executive Officer, Corporate Secretary
and Director
Connie L. Magnuson........ 36 Vice President of Finance and Chief Financial Officer
Donald E. Gardner, Ph.D... 63 Vice President of Regulatory Affairs and Quality Assurance
Kemal Schankereli......... 45 Vice President of Research and Development
Frank A. Stephenson....... 44 Vice President of Marketing and Sales
M. Karen Gilles. Ms. Gilles has served as President and Chief Executive Officer
of the Company since July 1997 and as a Director of the Company since August
1997. Ms. Gilles has also served as Secretary of the Company since November
1991. Prior to July 1997, Ms. Gilles held the positions of Chief Financial
Officer of the Company from December 1990, Vice President of Finance from April
1989 to December 1990 and Director of Finance and Administration of the Company
from April 1989 to December 1989. From 1985 to 1989, Ms. Gilles served as
Controller for VEE Corporation, a production company, and Colin Companies, a
related concession company. From 1983 to 1985, Ms. Gilles was an accountant with
McGladrey & Pullen, a public accounting firm.
Connie L. Magnuson. Ms. Magnuson joined the Company as Chief Financial Officer
and Vice-President of Finance in November 1997. From March 1997 to November
1997, Ms. Magnuson served as Treasurer of Northern Technologies International
Corporation. From 1996 to March 1997, Ms. Magnuson served as a private
financial consultant. From 1983 to 1996, Ms. Magnuson held a series of
positions with Deloitte and Touche, LLP, a public accounting firm, including
Audit Senior Manager and Director of Human Resources for their Minneapolis
office.
Donald E. Gardner. Ph.D. Dr. Gardner has served as Vice President of Regulatory
Affairs and Quality Assurance since September 1997. From June 1995 to September
1997, Dr. Gardner served as a senior associate with Regulatory Strategies
Consultants, Inc., a consulting firm serving clients in the medical device,
diagnostics, pharmaceutical and biologics industries. From June 1993 to June
1995, Dr. Gardner served as Vice-President of Regulatory Affairs and Quality
Assurance with Cryolife, Inc. From August 1984 to May 1993, Dr. Gardner held
quality management and regulatory affairs positions with Alcon Laboratories.
From 1975 to 1984, Dr. Gardner held quality management and regulatory affairs
positions with Abbott Laboratories and Pharmaseal Division of American Hospital
Supply Corp.
Kemal Schankereli. Mr. Schankereli has served as Vice President of Research and
Development since December
22
1993 after serving as Director of Research and Development from January 1993 to
December 1993. From 1991 to December 1992, Mr. Schankereli served as a private
consultant to the bio-medical device industry. From 1983 to 1991, Mr.
Schankereli held the position of Manager of Vascular Product Research at St.
Jude Medical, Inc., a medical device company. From 1978 to 1983, Mr. Schankereli
served as a Senior Research Scientist at Meadox Medicals, Inc., a medical device
company.
Frank A. Stephenson. Mr. Stephenson has served as Vice President of Marketing
and Sales since December 1994. From 1989 to August 1994, Mr. Stephenson served
as Vice President of Marketing and Sales for Spectranetics Corporation, a
medical laser company. From 1985 to 1989, Mr. Stephenson held a series of
marketing management positions with Boston Scientific Corporation, a
manufacturer of medical devices, and served as a senior sales representative and
trainer from 1982 to 1985 with Codman & Shurtleff, a distributor of
neurosurgical products, which is a division of Johnson and Johnson, Inc.
PART II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- ------------------------------------------------------------------------------
The Company's Common Stock is currently traded on the Nasdaq National Market
under the symbol "BVAS". The following table sets forth, for each of the fiscal
periods indicated, the range of high and low closing sale prices per share as
reported by the Nasdaq National Market. These prices do not include adjustments
for retail mark-ups, mark-downs or commissions.
HIGH LOW
------- ------
FISCAL 1997
First Quarter......... $ 7.750 $6.000
Second Quarter........ 6.000 5.000
Third Quarter......... 5.875 3.875
Fourth Quarter........ 5.000 3.750
FISCAL 1996
First Quarter......... $15.000 $7.500
Second Quarter........ 13.125 8.000
Third Quarter......... 9.875 6.125
Fourth Quarter........ 8.375 5.250
The Company has not declared or paid any cash dividends on its Common Stock
since its inception, and the Board of Directors presently intends to retain all
earnings for use in the business for the foreseeable future. As of November 30,
1997, there were approximately 6,600 beneficial owners of the Company's Common
Stock.
23
ITEM 6 - SELECTED FINANCIAL DATA
- --------------------------------
YEAR ENDED OCTOBER 31 1997 1996 1995 1994 1993
===================================================================================================
Net revenue $ 9,694,047 $10,124,709 $10,426,076 $4,951,743 $4,422,775
Gross margin 5,726,587 6,681,611 6,964,259 3,027,708 2,586,354
Operating income (loss) (1,305,235) 571,013 2,121,096 (255,951) 333,058
Income (loss) from continuing (603,613)
operations 1,218,501 1,659,162 (697,025) 650,634
Income (loss) per share from
continuing operations (.06) .13 .20 (.10) .09
Weighted average shares
outstanding 9,531,000 9,433,000 8,172,000 7,277,000 7,055,000
The above information excludes discontinued operations; see Note 2 to the
financial statements
AT OCTOBER 31: 1997 1996 1995 1994 1993
===================================================================================================
Working capital $16,905,823 $22,106,990 $24,059,746 $6,261,521 $6,636,651
Total assets 25,134,451 37,881,279 37,303,375 7,431,793 8,807,445
Long-term debt - - - - 40,016
Shareholders' equity 23,952,235 35,220,535 35,355,336 6,785,539 8,476,742
In connection with the spin-off of Vital Images, Inc. on the distribution date,
Shareholders' Equity was reduced by $10,124,000, which represents the
contribution of cash equivalents and marketable securities plus the carrying
value of Vital Images' net assets.
24
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
- --------------------------------------------------------------------------------
OF OPERATIONS
- -------------
OVERVIEW
Although net revenue for the year was down $431,000 or 4% over fiscal 1996
levels, reflecting the $1,421,000 decline in Peri-Strips revenue, fiscal 1997
has many successes to report. The Company continues to see impressive growth
from its core Tissue Guard product line, excluding Peri-Strips. In particular
within the Tissue Guard product line, Dura-Guard, Vascu-Guard, Peri-Guard and
Supple Peri-Guard had significant revenue increases in the year, increasing
$908,000 or 31% over fiscal 1996 revenues. In the Surgical Productivity Tools
product line, Flo-Rester experienced excellent revenue growth, increasing
$153,000 or 12% over fiscal 1996. Previous Flo-Rester annual revenue increases
have been in the 5-7% range. Fourth quarter fiscal 1997 net revenues exceeded
fiscal 1996 fourth quarter revenue by $212,000. This is the first quarter in
which net revenues increased over the comparable prior year quarter since the
HCFA non-coverage decision in January of 1996. Fourth quarter revenue growth
was again led by Dura-Guard, Vascu-Guard and Supple Peri-Guard.
During fiscal 1997 the Company launched Peri-Strips Dry, an advanced version of
Peri-Strips initially targeted for the European market, and is close to final
development on two new products in the Tissue Guard product line. The Company
also brought the manufacture of the Bio-Vascular Probe in-house which will allow
the Company greater control over the manufacture of this growing product. The
Company continues to expend significant time and resources in the research and
development of new applications using its core tissue products and tissue
processing technology.
Domestic revenue from Peri-Strips continued to be significantly affected by the
HCFA decision in January of 1996 for LVRS. Domestic revenue from Peri-Strips
was down 38% from fiscal 1996. The Company believes that some hospitals in the
U.S. are no longer promoting LVRS cases. However, the Company is encouraged
that surgeons and other medical professionals continue to seek training on the
LVR surgical procedure. Peri-Strips fiscal 1997 revenue was also down from the
Company's original expectations due to a delay in the start date for a study of
LVRS, the National Emphysema Treatment Trial ("NETT") sponsored jointly by HCFA
and NIH. (See "Medicare Non-Coverage Decision" on Page 26 for a more in-depth
discussion). The start date is subject to the completion of organizational and
procedural activities. The Company had orginally received indications that the
study would commence in June 1997. The Company accordingly anticipated demand
for the Peri-Strips product associated with the HCFA study and corresponding
Peri-Strips revenue in the second half of fiscal 1997. The Company now believes
that the earliest surgeries under the study will begin is January 1998. There
can be no assurance, however, that further delays will not impact the
commencement of surgeries under the study, or that the study will proceed on the
basis anticipated by the Company, if at all, as the study is subject to
determinations made by HCFA and NIH and is beyond the control of the Company.
Peri-Strips Dry was launched in July 1997. The Company believes that the Peri-
Strips Dry design provides significant advantages for thorascopic surgical
procedures over the original Peri-Strips "sleeve" design. Peri-Strips Dry
eliminates the need to extract through the thorascope the sutured sleeve backing
that was part of the original design. A specially formulated PSD Gel enables
the Peri-Strip Dry strip to adhere to the surgical stapler. Thorascopic
procedures are currently estimated to comprise 75% of the total LVR surgeries
performed in Europe. The majority of surgeons in Europe have performed LVRS
without benefit of a staple-line buttress. The Company was successful in
convincing a leading European thoracic surgeon to evaluate Peri-Strips Dry. This
surgeon is now the lead investigator for the Company's marketing clinical trials
currently underway at three European sites. The Company expects European
revenue growth from Peri-Strips Dry and Peri-Strips will be gradual as
reimbursement is obtained on a country-by-country basis. However, this forward-
looking statement is dependent upon the receipt of reimbursement approval from
European countries, and will be negatively impacted by any failure or delay in
receiving such reimbursement approvals. Currently, European patients pay
directly for the product. In the U.S., Peri-Strips Dry is expected to replace
the original Peri-Strips sleeve configuration for thorascopic procedures.
25
THE SPIN-OFF OF VITAL IMAGES
On May 12, 1997, the Company completed the spin-off distribution of all the
shares of Vital Images to the shareholders of Bio-Vascular, with Vital Images
thereafter operating as an independent public company. Vital Images is
currently traded on the OTC Bulletin Board under the symbol VTAL. All Bio-
Vascular shareholders received one share of Vital Images common stock for each
two shares of Bio-Vascular stock held, with cash issued in lieu of fractional
shares. The Company attempted to structure the transaction as tax free, but
since no advance ruling was sought from the Internal Revenue Service, no
assurance can be made about the final tax treatment of the transaction.
Both organizations should benefit from a tighter focus on their respective
markets, be able to invest in research and development at levels appropriate to
their respective stages of development and be able to evolve unique
organizational and marketing structures to better serve their substantially
different markets. As a result of the Company's spin-off of Vital Images, the
Company's financial statements and notes thereto report the business of Vital
Images as discontinued operations.
MEDICARE NON-COVERAGE DECISION
Effective January 1, 1996, HCFA made a non-coverage decision with respect to
LVRS, a surgical treatment for late-stage emphysema. This decision
significantly impacted the Company's revenues from sales of Peri-Strips. At the
time that this non-coverage decision was put into effect, the Company estimates
that approximately 70% of the patients undergoing LVRS were Medicare patients.
While the Company understands that several private insurance companies and
managed care organizations continue to reimburse LVRS based on their own
evaluation of the procedure and its outcomes, it is unknown whether these
private payers will change their reimbursement practices in the future or if
more private payers will begin to cover the procedure.
NIH, in collaboration with HCFA, has outlined and is in the process of
organizing a prospective, randomized study of LVRS, the NETT study, to determine
whether it is safe and efficacious. The NETT study, as it is currently
structured, is limited to a small number of patients relative to the number of
Medicare dependent patients who would be otherwise eligible for the procedure.
Congress, responding to the concerns of their constituents and in light of a
significant number of favorable peer-reviewed published medical articles bearing
out the safety and efficacy of LVRS, requested HCFA to present to Congress
updated information on the LVRS procedure by January 1997. HCFA requested an
extension until April 1997 and as of the date of this report had not yet
complied with Congress' request. Because HCFA and NIH appear intent on
proceeding with the study, no assumptions can be made as to whether the efforts
of Congress or the mounting evidence regarding the benefits of this procedure
will cause them to alter the study. The Company continues to work for
restoration of coverage of LVRS for Medicare dependent patients.
RESULTS OF CONTINUING OPERATIONS
COMPARISON OF THE YEAR ENDED OCTOBER 31, 1997 WITH THE YEAR ENDED
OCTOBER 31, 1996
Revenue decreased to $9,694,000 from $10,125,000, primarily due to the decrease
in Peri-Strips revenue. Peri-Strips revenue decreased $1,421,000 to $2,915,000
from $4,336,000. Revenue from sales of other Tissue-Guard products, Dura-Guard,
Vascu-Guard, Peri-Guard and Supple Peri-Guard increased $908,000 to $3,852,000
from $2,944,000. All Tissue Guard products showed significant increases over
the prior year. Increased revenues from Tissue Guard products in the fourth
quarter of fiscal 1997 over the same quarter in fiscal 1996 more than offset the
decreased revenue from Peri-Strips for the first time since the HCFA decision in
January of 1996. Biograft revenue decreased $138,000, or 15%, to $800,000 from
$938,000, continuing a trend representative of the late stage of this product's
life cycle. Revenue from sales of surgical productivity tools (Flo-Rester and
the Bio-Vascular Probe) increased 12% to $2,127,000 from $1,907,000.
26
The gross margin percentage was 59% for 1997 and 66% for 1996. During fiscal
1996 and 1997 the gross margin percentages declined through the quarters,
primarily due to decreases in production volume in response to decreases in
demand for Peri-Strips.. The gross margin percentage was 62% by the fourth
quarter of 1996 and continued to decrease through the third quarter of 1997.
Gross margin improvements in the fourth quarter of 1997 were primarily due to
increased production volume. The Company expects the gross margin percentage
for 1998 to be slightly higher than the 1997 level. This forward looking
statement is influenced primarily by the Company's current estimate of standard
costs and would be impacted by significant increases or decreases in production
volumes of the Company's products, by material changes in the Company's product
mix and by the accuracy of the Company's estimates of standard costs and other
manufacturing costs.
Selling, general and administrative expense increased $573,000 or 11% between
1997 and 1996. General and administrative expenses increased $348,000, or 13%,
and was due in part to increases in regulatory personnel and related market
clearance costs. Selling expense increased $224,000, or 9%. Increases in
selling costs originated from the launch of Peri-Strips Dry in the third quarter
of 1997, increased marketing efforts in Europe including the addition of a
European Sales Manager and renewed focus in the domestic marketplace of the
Company's strong line of tissue products. The Company has maintained and
judiciously added to the basic corporate infrastructure which was developed
during 1995 to support the Company's rapid growth at that time. Although the
rapid growth, which was fueled by Peri-Strips was interrupted, the
infrastructure that was built to support that growth is vital to moving the
Company forward to the next level of its corporate strategy. The Company
continued to incur expenses related to efforts to inform Congress and other
interested parties of the devastating effect of the HCFA decision on patients in
the late-stages of emphysema and to seek consideration of a modification or
reversal of that decision.
Research and development expense increased $349,000 or 38% between 1997 and
1996, with the increase primarily due to the cost of moving projects forward in
the research and development pipeline, including an increase in the number of
animal studies. The Company has several projects under development including the
Company's small diameter graft. R&D efforts have included two new product
opportunities, CV Peri-Guard and Ocu-Guard, which are expected to generate
revenues in fiscal 1998. R&D expense is expected to increase as these and other
projects continue to progress. This forward-looking statement will be
influenced primarily by the number of projects, the related R&D personnel
requirements, the development path and success of each project, the expected
costs, and the timing of these costs.
Primarily due to the continued decrease in revenue from Peri-Strips, componded
by lower gross margins earlier in the year and increased spending on research
and development, regulatory and selling costs, continuing operations had an
operating loss in 1997 of $1,305,000 as compared to operating income of $571,000
for 1996. Other income, primarily interest income, was $1,067,000 and $1,161,000
in 1997 and 1996, respectively. As a result, continuing operations had a loss
before income taxes in 1997 of $238,0000 as compared to income from continuing
operations before income tax of $1,732,000 in 1996.
The Company's provision for income taxes in 1997 is $365,000 including a
$421,000 write-off of an income tax asset in the third quarter. The Company
expected to utilize a significant portion of Vital Images' net operating loss
carryforwards against the Company's anticipated fiscal 1997 taxable income.
These net operating losses were generated by Vital Images prior to its spin-off
and are only available to the Company in the 1997 fiscal year, reverting solely
to Vital Images thereafter. When the Company realized its fiscal 1997 taxable
income would fall short of original expectations, the deferred tax asset had no
further value to Bio-Vascular and was written-off in the third quarter.
In 1996, the Company allocated its provision for income taxes to continuing and
discontinuing operations based on their respective pretax income contributions
and tax attributes. As a result, the amount of the provision allocated to
continuing operations in 1996 was $514,000, representing an effective tax rate
of approximately 30%. Continuing operations' effective tax rate for 1996
reflected the benefit of recognizing a deferred tax asset associated with
capital loss and research and experimentation credit carryforwards created in
prior years.
27
Loss from continuing operations was $604,000, or $0.06 per share in 1997,
compared to income of $1,219,000, or $0.13 per share in 1996.
COMPARISON OF THE YEAR ENDED OCTOBER 31, 1996 WITH THE YEAR ENDED
OCTOBER 31, 1995
Revenue decreased to $10,125,000 from $10,426,000, primarily due to the decrease
in Peri-Strips revenue resulting from the HCFA decision, offset substantially by
an increase in revenue from sales of other Tissue Guard products. Peri-Strips
revenue decreased $1,214,000 to $4,336,000 from $5,550,000. Revenue from sales
of other Tissue-Guard products, Dura-Guard, Vascu-Guard, Peri-Guard and Supple
Peri-Guard, increased by $1,099,000 to $2,944,000 from $1,845,000, primarily due
to the increase in revenue from Dura-Guard, which was cleared to market by the
FDA in June 1995.
Revenue from sales of Biograft decreased to $938,000 from $1,198,000.
Revenues from the sales of Biograft have been decreasing since late 1993 as new
competitive treatments reached the market. Revenue from sales of surgical
productivity tools (Flo-Rester and the Bio-Vascular Probe) increased 4% to
$1,907,000 from $1,818,000.
The gross margin percentage was 66% for 1996 and 67% for 1995. While the annual
gross margin percentages appeared stable, they were not on a quarter-to-quarter
basis during 1996. In 1995, the gross margin percentage was increasing,
primarily due to rapidly increasing production volume associated with rising
Peri-Strips sales, while in 1996, the gross margin percentages declined,
primarily due to decreases in the production volume in response to decreases in
expected demand for Peri-Strips as a result of the HCFA decision.
Selling, general and administrative expense increased $1,002,000 or 24% between
1995 and 1996. Increases were generally across all functions and due in large
part to the presence during much of 1996 of a complete basic corporate
infrastructure, expenses related to the development of a quality system under
ISO 9001and expenses related to efforts to inform Congress and other interested
parties of the devastating effect of the HCFA decision on patients in the late-
stages of emphysema and to seek consideration of a modification or reversal of
that decision.
Research and development expense increased 41% between 1995 and 1996, with the
increase primarily due to the cost of moving projects forward in the research
and development pipeline and including an increase in animal studies.
The increase in infrastructure, the increased level of business activities and
the acceleration and expansion of research and development efforts, resulted in
operating income of $571,000 compared to $2,121,000 for 1995.
Other income was $1,161,000 and $265,000 in 1996 and 1995, respectively and
consisted primarily of interest income. A secondary public offering which the
Company completed in September of 1995 provided approximately $26,000,000 net of
offering costs. This comprised the basis for the increase in interest income in
1996 over 1995.
The Company allocated its provision for income taxes to continuing and
discontinued operations based on their respective pretax income contribution and
tax attributes. As a result, continuing operations recorded a tax provision of
$514,000 for 1996 and $727,000 for 1995, representing an effective tax rate of
approximately 30% in both years. Continuing operations' effective tax rate in
1995 reflected the benefit of utilizing remaining net operating loss carry
forwards to offset 1995 income. Continuing operations' effective tax rate for
1996 reflected the benefit of recognizing a deferred tax asset associated with
capital loss and research and experimentation credit carryforwards created in
prior years. Income from continuing operations was $1,219,000, or $0.13 per
share, compared to $1,659,000, or $0.20 per share for 1995.
LIQUIDITY AND CAPITAL RESOURCES
For the year ended October 31, 1997, activities from continuing operations
provided cash of $1,051,000 (excluding
28
$1,860,920 used by discontinued operations) as compared to $343,000 (excluding
$70,046 used by discontinued operations) of net cash provided by operating
activities in fiscal 1996. Cash was provided by continuing operations in fiscal
1997 through non-cash expenses, increases in accrued liabilities, decreases in
inventories and non-trade receivables in excess of the loss from continuing
operations. These increases in cash were partially offset by an increase in
trade accounts receivable.
The Company invested $654,000 in equipment and leasehold improvements primarily
related to new manufacturing processes related to Peri-Strips Dry and the Bio-
Vascular Probe. Financing activities included $265,000 provided from stock
option exercises and a related tax benefit, net of restricted stock repurchased
from employees. In addition, the Company used $150,000 to repurchase shares of
its own Common Stock in the open market in accordance with the Company's ongoing
stock repurchase program. This program was announced in August 1997 whereby the
Company stated its intention to repurchase up to 500,000 shares of its Common
Stock. Such purchases will be made in the open market from time-to-time as price
opportunities arise.
The Company believes existing cash and investments will be sufficient to satisfy
its cash requirements for the foreseeable future. At October 31, 1997, the
Company has cash and investments totaling $17,987,000. At October 31, 1996, the
Company's cash and investments totaled $29,671,000. The net decrease in cash
and investments was largely attributable to the $11,800,000 funded to Vital
Images.
THE YEAR 2000 ISSUE
Computer designs that use microprocessors have consistently abbreviated dates by
eliminating the first two digits of the year under the assumption that these two
digits would always be 19. As the year 2000 approaches, such systems will be
unable to accurately process certain date-based information. This problem is
commonly referred to as "the Year 2000 Issue".
The Company has not yet determined if it will be necessary to modify or replace
significant portions of its software so that its computer systems will properly
utilize dates beyond December 31, 1999. The Company presently believes that
with modifications to existing software and conversions to new software, the
Year 2000 Issue can be mitigated. However, if such modifications and
conversions are not made, or are not completed timely, the Year 2000 Issue could
have a material impact on the operations of the Company.
INFLATION
Management believes inflation has not had a material effect on the Company's
operations or on its financial condition.
FOREIGN CURRENCY TRANSACTIONS
Substantially all of the Company's foreign transactions are negotiated, invoiced
and paid in U.S. dollars. Fluctuations in currency exchange rates in other
countries may therefore reduce the demand for the Company's products by
increasing the price of the Company's products in the currency of the countries
in which the products are sold.
NEW ACCOUNTING STANDARDS
In February 1997, SFAS No. 128, Earnings per Share (EPS), was issued by the
Financial Accounting Standards Board. This standard, which the Company must
adopt effective with its first quarter of fiscal 1998, requires dual
presentation of basic and diluted EPS on the face of the statement of
operations. Net income per common share currently presented by the Company for
1997 and 1996 is comparable to the basic EPS required under SFAS 128.
29
Diluted EPS for the Company would be calculated based on both common shares
outstanding and consideration of the dilutive effects of common stock
equivalents.
In June 1997, SFAS No. 130 (SFAS 130), Comprehensive Income, was issued by the
Financial Accounting Standards Board. SFAS 130 establishes standards for
reporting and displaying comprehensive income and its components (revenues,
expenses, gains and losses) in the financial statements. Also issued in June
1997 was SFAS No. 131 (SFAS 131), Disclosures about Segments of an Enterprise
and Related Information, which establishes new standards for the way public
business enterprises report information about operating segments. The Company
must adopt SFAS 130 and SFAS 131 in fiscal year 1999.
ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
Not applicable.
ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- ----------------------------------------------------
The Company's Financial Statements and the reports of its independent
accountants are included herein on pages 33 through 49 of this Annual Report on
Form 10-K. The index to such items is included on Page 31 in Item 14 (a)(1).
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
- ------------------------------------------------------------------------
FINANCIAL DISCLOSURE
- --------------------
None.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- ------------------------------------------------------------
(a) Directors of the Registrant
---------------------------
The information under the caption "Election of Directors" in the
Registrant's 1998 Proxy Statement is incorporated by reference herein.
(b) Executive Officers of the Registrant
------------------------------------
Information concerning Executive Officers of the Company is included in
this Report on page 22 under Item 4 A, "Executive Officers of the
Registrant".
(c) Compliance with Section 16(a) of the Exchange Act
-------------------------------------------------
The information under the caption "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Registrant's 1998 Proxy Statement is
incorporated by reference herein.
ITEM 11 - EXECUTIVE COMPENSATION
- --------------------------------
The information under the caption "Executive Compensation" and "Election of
Directors--Directors' Compensation" in the Registrant's 1998 Proxy Statement is
incorporated by reference herein.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
- ------------------------------------------------------------------------
The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in the Registrant's 1998 Proxy Statement is
incorporated by reference herein.
30
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------
In October 1997, the Company entered into a distribution agreement with Scanlan
International, Inc., a medical and surgical products distributor. A Director of
the Company is President and Chief Executive Officer of the Scanlan Group of
Companies, the parent company of Scanlan International. The agreement grants
Scanlan International the exclusive right, acting as a sales representative of
Bio-Vascular, to solicit orders, work with distributors and market listed
products within Latin America until October 31, 2000 subject to annual renewal
thereafter. Scanlan International will receive a commission of 20% on net sales
to Latin America during the term of the agreement. For the year ended October
31, 1997, there was no sales activity resulting from this agreement.
PART IV
ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
- -------------------------------------------------------------------------
(a) List of documents filed as part of this Report
1) Financial Statements:
The following financial statements are included herein (page
numbers refer to pages in this Annual Report on Form 10-K):
Page
-----
- Report of Independent Accountants 33
- Balance Sheets as of October 31, 1997 and 1996 34
- Statements of Operations for the Years Ended
October 31, 1997, 1996 and 1995 35
- Statements of Shareholders' Equity for
the Years Ended October 31, 1997, 1996 and 1995 36
- Statements of Cash Flows for the Years Ended
October 31, 1997, 1996 and 199 37
- Notes to Financial Statements 38-49
2) Financial Statement Schedules
The following financial statement schedules and independent
accountants' report thereon are included herein and should be read in
conjunction with the Financial Statements referred to above (page
numbers refer to pages in this Annual Report on Form 10-K):
Page
-----
- Report of Independent Accountants' on
Financial Statement Schedule 50
- Schedule II - Valuation and Qualifying Accounts 51
All other financial statement schedules not listed have been omitted
because the required information is included in the Financial
Statements or the Notes thereto, or is not applicable.
3) Exhibits
The exhibits to this Annual Report on Form 10-K are listed in the
Exhibit Index hereinafter contained on pages E-1 through E-3 of
this Report.
The Company will furnish a copy of any exhibit to a shareholder
who requests a copy in writing upon payment to the Company of a
fee of $5.00 per exhibit. Requests should be
31
sent to: Connie L. Magnuson, Vice President of Finance and Chief
Financial Officer; Bio-Vascular, Inc.; 2575 University Avenue; St.
Paul, Minnesota 55114-1024.
The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual
Report on Form 10-K pursuant to Item 14 (c):
A. 1988 Stock Option Plan, as amended, (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for
the quarter ended April 30, 1997 (File No. 0-13907)).
B. 1990 Management Incentive Stock Option Adjustment Plan
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1997 (File No. 0-13907)).
C. 1992 Stock Option Adjustment Plan (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for
the quarter ended September 30, 1997 (File No. 0-13907)).
D. 1995 Stock Incentive Plan, as amended (incorporated by reference
to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q
for the period ended April 30, 1997 (File No. 0-139070)).
E. Employee Stock Purchase Plan, as amended (filed herewith
electronically).
F. Employment letter dated November 28, 1994, as amended January 2,
1995, between the Company and Mr. Stephenson (incorporated by
reference to Exhibit 10.20 to the Company's Annual Report on Form
10-K for the year ended October 31, 1995 (File No. 0-13907)).
G. Severance agreement dated June 30, 1997, between the Company and
Mr. Karcanes (filed herewith electronically).
H. Form of Change in Control Agreement entered into between the
Company and each of Ms. Gilles, Mr. Schankereli and Mr.
Stephenson (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October
31, 1994 (File No. 0-13907)).
(b) Reports on Form 8-K
None.
(c) Exhibits:
The response to this portion of Item 14 is included as a separate section
of this Annual Report on Form 10-K.
(d) Financial Statement Schedules:
The response to this portion of Item 14 is included as a separate section
of this Annual Report on Form 10-K.
32
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of
Bio-Vascular, Inc.:
We have audited the accompanying balance sheets of Bio-Vascular, Inc. as
of October 31, 1997 and 1996, and the related statements of operations,
shareholders' equity and cash flows for each of the three years in the period
ended October 31, 1997. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Bio-Vascular, Inc.
as of October 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended October 31, 1997, in
conformity with generally accepted accounting principles.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
December 9, 1997
33
BIO-VASCULAR, INC.
BALANCE SHEETS
OCTOBER 31, 1997 AND 1996
- --------------------------------------------------------------------------------
ASSETS 1997 1996
- ------------------------------------------------------------------ ------------ ------------
Current assets:
Cash and cash equivalents......................................... $ 6,766,687 $ 5,736,650
Marketable securities, short-term................................. 7,229,934 13,761,050
Accounts receivable, net.......................................... 1,846,519 1,465,809
Inventories....................................................... 1,619,395 1,972,728
Deferred income taxes............................................. 144,549 914,300
Other............................................................. 480,955 917,197
----------- -----------
Total current assets........................................... 18,088,039 24,767,734
Equipment and leasehold improvements, net......................... 1,670,446 1,370,256
Intangible assets, net............................................ 1,003,251 1,213,600
Marketable securities, long-term.................................. 3,989,896 10,173,086
Deferred income taxes............................................. 382,819 182,200
Net assets of discontinued operations............................. - 174,403
----------- -----------
TOTAL ASSETS................................................... $25,134,451 $37,881,279
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Accounts payable.................................................. $ 616,941 $ 306,376
Accrued expenses.................................................. 565,275 554,368
Accrued loss on disposal of discontinued operations............... - 1,800,000
----------- -----------
Total current liabilities...................................... 1,182,216 2,660,744
----------- -----------
Commitments (Note 6)
Shareholders' equity:
Preferred stock: authorized 5,000,000 shares of $.01 par value;
None issued or outstanding in 1997 and 1996..................... - -
Common stock: authorized 20,000,000 shares of $.01 par value;
issued and outstanding, 9,563,609 in 1997 and 9,484,898 shares
in 1996......................................................... 95,636 94,849
Additional paid-in capital........................................ 29,664,715 39,500,239
Unearned compensation............................................. (447,254) (484,909)
Unrealized marketable securities holding gain (loss).............. 1,288 (51,107)
Accumulated deficit............................................... (5,362,150) (3,838,537)
----------- -----------
Total shareholders' equity..................................... 23,952,235 35,220,535
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..................... $25,134,451 $37,881,279
=========== ===========
The accompanying notes are an integral part of the financial statements.
34
BIO-VASCULAR, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1997 1996 1995
------------- ------------- ------------
Net revenue....................................... $ 9,694,047 $10,124,709 $10,426,076
Cost of revenue................................... 3,967,460 3,443,098 3,461,817
----------- ----------- -----------
Gross margin...................................... 5,726,587 6,681,611 6,964,259
Operating expenses:
Selling, general and administrative............... 5,773,918 5,201,236 4,199,673
Research and development.......................... 1,257,904 909,362 643,490
----------- ----------- -----------
Operating income (loss)........................... (1,305,235) 571,013 2,121,096
Other income, net................................. 1,066,822 1,161,488 264,898
----------- ----------- -----------
Income (loss) from continuing operations before
provision for income taxes...................... (238,413) 1,732,501 2,385,994
Provision for income taxes........................ 365,200 514,000 726,832
----------- ----------- -----------
Income (loss) from continuing operations.......... (603,613) 1,218,501 1,659,162
Discontinued operations:
Income (loss) from operations of discontinued
business, net of income taxes................... - (1,048,142) 527,304
Loss on disposal of discontinued business,
net of income taxes............................. (920,000) (1,348,000) -
----------- ----------- -----------
NET INCOME (LOSS)................................. $(1,523,613) $(1,177,641) $ 2,186,466
=========== =========== ===========
Net income (loss) per share:
Continuing operations............................. $ (.06) $ .13 $ .20
Discontinued operations........................... (.10) (.25) .06
----------- ----------- -----------
Net income (loss) per share....................... $ (.16) $ (.12) $ .27
=========== =========== ===========
Weighted average shares outstanding............... 9,531,000 9,433,000 8,172,000
=========== =========== ===========
The accompanying notes are an integral part of the financial statements.
35
BIO-VASCULAR, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
UNREALIZED
MARKETABLE
ADDITIONAL SECURITIES
PAID-IN UNEARNED HOLDING ACCUMULATED
COMMON STOCK CAPITAL COMPENSATION GAIN (LOSS) DEFICIT
----------------------- ------------- -------------- ------------- ------------
PAR
SHARES VALUE
---------- -----------
BALANCE AT OCTOBER 31, 1994................. 7,318,125 $73,181 $ 11,685,163 $(125,443) - $(4,847,362)
Stock option activity....................... 197,400 1,974 424,819 4,250
Restricted stock activity................... 41,138 412 78,629 (269,908)
Stock compensation, net..................... 23,105 231 109,519 (39,125)
Issuance of stock, net of offering
costs of $2,277,460...................... 1,800,000 18,000 26,054,530
Net income.................................. 2,186,466
--------- ------- ------------ --------- ------------ -----------
BALANCE AT OCTOBER 31, 1995................. 9,379,768 93,798 38,352,660 (430,226) - (2,660,896)
Stock option activity, net of tax benefit... 82,744 827 1,099,719 (150,387)
Warrant activity............................ 28,929 289 115,427
Employee Stock Purchase Plan
activity.................................. 5,715 57 36,376
Restricted stock activity................... (12,258) (123) (16,616) 71,954
Stock compensation, net..................... 23,750
Offering costs.............................. (87,327)
Unrealized marketable securities
holding loss, net......................... $(51,107)
Net loss.................................... (1,177,641)
--------- ------- ------------ --------- ------------ -----------
BALANCE AT OCTOBER 31, 1996................. 9,484,898 94,849 39,500,239 (484,909) (51,107) (3,838,537)
Stock option activity, net of tax
benefit................................... 48,236 482 654,522 (332,462)
Employee Stock Purchase Plan
activity.................................. 9,190 92 37,217
Restricted stock activity................... 22,185 222 62,998 22,954
Stock compensation, net..................... 36,000 360 143,640 (112,837)
Stock repurchased by the Company............ (36,900) (369) (149,560)
Distribution of net investment in
Vital Images.............................. (10,584,341) 460,000
Unrealized marketable securities
holding gain, net......................... 52,395
Net loss.................................... (1,523,613)
--------- ------- ------------ --------- ------------ -----------
BALANCE AT OCTOBER 31, 1997................. 9,563,609 $95,636 $ 29,664,715 $(447,254) $ 1,288 $(5,362,150)
========= ======= ============ ========= ============ ===========
The accompanying notes are an integral part of the financial statements.
36
BIO-VASCULAR, INC.
STATEMENT OF CASH FLOWS
FOR THE YEARS ENDED OCTOBER 31, 1997, 1996 AND 1995
- --------------------------------------------------------------------------------
1997 1996 1995
------------- ------------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................................... $(1,523,613) $ (1,177,641) $ 2,186,466
Less income (loss) from discontinued operations............................. (920,000) (2,396,142) 527,304
----------- ------------ ------------
Income (loss) from continuing operations.................................... (603,613) 1,218,501 1,659,162
Adjustments to reconcile income from continuing operations
to net cash provided by (used in) operating activities:
Depreciation and amortization............................................... 619,769 591,410 376,423
Provision for inventory obsolescence........................................ 116,031 354,822 176,568
Non-cash compensation....................................................... 212,367 286,018 232,839
Deferred income taxes....................................................... 239,132 (1,096,500) -
Changes in operating assets and liabilities:
Accounts receivable......................................................... (380,710) 704,417 (1,142,845)
Inventories................................................................. 237,302 (359,324) (1,012,125)
Other assets................................................................ 313,365 (268,753) (527,547)
Current liabilities......................................................... 297,247 (1,087,297) 1,331,783
----------- ------------ ------------
Net cash provided by continuing operations............................... 1,050,889 343,294 1,094,258
Net cash provided by (used in) discontinued operations................... (1,860,920) (70,046) 818,283
----------- ------------ ------------
Net cash provided by (used in) operating activities...................... (810,031) (273,248) 1,912,541
----------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment and improvements...................................... (654,153) (402,290) (1,035,537)
Purchase of intangibles..................................................... (43,310) (803,272) (42,799)
Investments in marketable securities........................................ (9,000,000) (25,980,000) (14,872,509)
Maturities of marketable securities......................................... 13,750,000 16,795,920 1,270,841
Discontinued operations, net................................................ (2,327,360) (379,855) (306,014)
----------- ------------ ------------
Net cash (used in) investing activities.................................. 1,725,177 (10,769,497) (14,986,018)
----------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds related to the sale of common stock, net........................... - (87,327) 26,072,530
Proceeds related to stock options, employee stock purchase
plan and restricted stock................................................ 264,821 895,257 77,962
Purchase of common stock.................................................... (149,930) - -
----------- ------------ ------------
Net cash provided by financing activities................................ 114,891 807,930 26,150,492
----------- ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.............................................................. 1,030,037 (9,688,319) 13,077,015
CASH AND CASH EQUIVALENTS AT BEGINNING OF
YEAR..................................................................... 5,736,650 15,424,969 2,347,954
----------- ------------ ------------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................................... $ 6,766,687 $ 5,736,650 $ 15,424,969
=========== ============ ============
The accompanying notes are an integral part of the financial statements.
37
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS
- -------------------------------------------------------------------------------
(1) BUSINESS DESCRIPTION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Business Description:
Bio-Vascular, Inc. ("the Company") develops, manufactures and markets
proprietary specialty medical products used in thoracic, cardiac, neuro and
vascular surgery. The Company markets its products through a worldwide network
of distributors and independent sales representatives.
Use of Estimates:
The preparation of financial statements in conformity with generally accepting
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting periods.
Actual results could differ from those estimates. The most significant areas
which require the use of management's estimates relate to the determination of
the allowance for obsolete inventory, the evaluation of realizability of
intangible and deferred tax assets, and the loss on disposal of discontinued
operations.
Cash and Cash Equivalents:
Cash and cash equivalents consist of cash and highly liquid investments
purchased with an original maturity of three months or less. Cash at October
31, 1997 is primarily concentrated in one money market fund.
Marketable Securities:
Investments having original maturities in excess of three months are classified
as marketable securities and generally consist of U.S. Government or U.S.
Government-backed obligations. Investments are classified as short-term or
long-term in the balance sheet based on their maturity date. At October 31,
1997 and 1996, all of the Company's marketable securities are classified as
available-for-sale and all mature in two years or less. Available-for-sale
investments are recorded at market value with unrealized holding gains and
losses included as a separate component of shareholders' equity.
Inventories:
Inventories are valued at the lower of cost or market, with costs generally
determined on a first-in, first-out method.
Equipment and Leasehold Improvements:
Equipment and leasehold improvements are stated at cost. Depreciation and
amortization are computed using accelerated and straight-line methods over the
shorter of the estimated useful lives (generally three to seven years) or lease
life. Major replacements and improvements are capitalized and maintenance and
repairs which do not improve or extend the useful lives of the respective assets
are charged to operations. The asset and related accumulated depreciation or
amortization accounts are adjusted for asset retirements and disposals with the
resulting gain or loss, if any, is recorded in other income, net, on the
Statement of Operations.
Long-Lived Assets:
The Company adopted the Statement of Financial Accounting Standard (SFAS) No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, in fiscal 1997. The Company
38
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
reviews its long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset in question may not
be recoverable. Impairment losses are recorded whenever indicators of
impairment are present. The adoption of SFAS No. 121 did not have a material
effect on the Company's results of operations, cash flows or financial position.
Goodwill, Patents and Other Intangibles:
Goodwill, patents and other intangibles are recorded at cost and are amortized
using the straight-line method over the estimated useful lives, generally ten to
seventeen years. The Company evaluates the net realizability of goodwill and
other intangibles on an ongoing basis, based on current and anticipated
undiscounted cash flows.
Revenue Recognition:
Revenue is recognized upon shipment of goods to customers.
Research and Development:
Research and development costs are expensed as incurred.
Stock-Based Compensation:
The Company has adopted the disclosure-only provisions of SFAS No. 123,
Accounting for Stock-Based Compensation, effective for fiscal 1997, which
disclosures are presented in Note 5 "Shareholders' Equity". The Company
continues to account for stock-based compensation using the intrinsic value
method as prescribed under Accounting Principles Board Opinion (APB) No. 25,
Accounting for Stock Issued to Employees, and related Interpretations.
Income Taxes:
The Company accounts for income taxes using the liability method. The liability
method provides that deferred tax assets and liabilities are recorded based on
the differences between the tax basis of assets and liabilities and their
carrying amounts for financial reporting purposes ("temporary differences").
Temporary differences relate primarily to operating and capital loss
carryforwards, research and experimentation tax credit carryforwards, and
obsolete inventory reserves. Deferred tax assets are reduced by a valuation
allowance to reflect the realizable value, when necessary.
Net Income (Loss) Per Common Share:
Net income (loss) per common share is computed by dividing net income (loss) by
the weighted average number of common and common equivalent shares outstanding.
Common equivalent shares relate to common stock options and warrants, when their
effect is dilutive.
In February 1997, SFAS No. 128, Earnings per Share (EPS), was issued by the
Financial Accounting Standards Board. This standard, which the Company must
adopt effective with its first quarter of fiscal 1998, requires dual
presentation of basic and diluted EPS on the face of the statement of
operations. Net loss per common share currently presented by the Company for
1997 and 1996 is comparable to the basic EPS required under SFAS 128. Diluted
EPS for the Company would be calculated based on both common shares outstanding
and consideration of the dilutive effects of common equivalent shares.
39
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
(2) DISCONTINUED OPERATIONS:
On May 12, 1997, the Company completed the spin-off distribution of all shares
of Vital Images, Inc. ("Vital Images") to shareholders of Bio-Vascular, with
Vital Images thereafter operating as an independent company with its own
publicly-traded securities. All Bio-Vascular shareholders of record received
one share of Vital Images common stock for every two shares of Bio-Vascular
common stock held, with cash issued in lieu of fractional shares. The Company
attempted to structure the transaction as tax free, but since no revenue ruling
was sought from the Internal Revenue Service, no assurance can be made about the
final tax treatment of the transaction.
The Company recorded the distribution of Vital Images common stock to its
shareholders as of March 19, 1997, the date the Board of Directors of the
Company gave final approval for the transaction. The distribution was recorded
by reducing shareholders' equity by $10,124,000, which represents $10,000,000
of cash and investments, plus the carrying value of Vital Images' net assets.
The accompanying financial statements of the Company for the year ended October
31, 1997 reflect these transactions. The Company's financial statements and
notes report Vital Images as discontinued operations. Prior years' financial
statements and notes have been restated accordingly.
The 1996 loss from operations of the discontinued business included an
allocation of interest income (based on the ratio of net investment assets
contributed to the discontinued business over total investment assets) of
$547,000. Interest income for the year ended October 31, 1995 was determined to
be attributable solely to income from continuing operations.
The 1997 loss on disposal reflects amounts exceeding that previously estimated
and recorded as of October 31, 1996, in part a result of the spin-off taking
longer to complete in 1997 than originally anticipated. The 1996 loss on
disposal of discontinued business of $1,348,000 included the estimated future
operating losses of Vital Images through the estimated date of spin-off. In
addition to the estimate of future results of operations, major components of
the loss on disposal include $400,000 of transaction costs, interest income of
$200,000 and deferred income tax benefits of $452,000. Net cash used by
discontinued operations in 1996 differs from the 1996 loss from discontinued
operations principally due to the loss on disposal for which no cash had been
expended at October 31, 1996, deferred revenues and depreciation. The 1996
discontinued operations cashflow amounts have been reclassified to conform with
the 1997 presentation.
DISCONTINUED OPERATIONS 1997 1996 1995
----------- ------------ -----------
Net revenue - $ 882,126 $2,893,654
Gross margin........................................ - 719,840 2,488,480
Operating income (loss)............................. - (2,357,065) 318,205
Income (loss) from discontinued operations.......... - (1,048,142) 527,304
Loss on disposal, net of income taxes............... $(920,000) (1,348,000) -
Total discontinued operations, net of income taxes.. (920,000) (2,396,142) 527,304
A one-time license fee recorded in the fourth quarter of fiscal 1995 contributed
$1,500,000 to net revenue and $1,322,000 to operating income.
The net assets of discontinued operations were approximately $174,000 at October
31, 1996, comprised primarily of equipment totaling approximately $650,000,
offset by deferred revenues of $510,000. All net assets associated with the
discontinued operations were distributed as part of the May 1997 spin-off.
40
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
(3) SUPPLEMENTAL FINANCIAL STATEMENT INFORMATION:
1997 1996
------------ ------------
Accounts receivable:
Trade receivables................................... $ 1,867,919 $1,487,209
Less allowance for doubtful accounts................ (21,400) (21,400)
----------- ----------
$ 1,846,519 $1,465,809
=========== ==========
Inventories:
Raw materials and supplies.......................... $ 580,354 $ 514,478
Work-in-process..................................... 405,736 541,483
Finished goods...................................... 1,006,305 1,284,767
Less reserve for inventory obsolescence............. (373,000) (368,000)
----------- ----------
$ 1,619,395 $1,972,728
=========== ==========
Equipment and leasehold improvements:
Furniture, fixtures and computer equipment.......... $ 826,360 $ 903,162
Laboratory equipment................................ 210,273 168,463
Manufacturing equipment............................. 780,854 536,688
Leasehold improvements.............................. 874,887 628,949
Less accumulated depreciation and amortization...... (1,021,928) (867,006)
----------- ----------
$ 1,670,446 $1,370,256
=========== ==========
Intangible assets:
Goodwill............................................ $ 1,538,374 $1,538,374
Less accumulated amortization....................... (1,047,024) (889,300)
Patents and other intangibles....................... 708,880 665,570
Less accumulated amortization....................... (196,979) (101,044)
----------- ----------
$ 1,003,251 $1,213,600
=========== ==========
Accrued expenses:
Payroll, other employee benefits and related taxes.. $ 275,015 $ 263,423
Royalties........................................... 52,587 56,185
Other............................................... 237,673 234,760
----------- ----------
$ 565,275 $ 554,368
=========== ==========
41
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
(4) INCOME TAXES:
PROVISION FOR INCOME TAXES
1997 1996 1995
----------- ------------ ------------
Current:
Federal.......................................... $ 95,893 $ 834,720 $ 724,999
State............................................ 43,750 34,606 1,833
--------- ---------- ----------
139,643 869,326 726,832
--------- ---------- ----------
Deferred:
Federal.......................................... 286,159 (345,518) -
State............................................ (60,602) (9,808) -
--------- ---------- ----------
225,557 (355,326) -
--------- ---------- ----------
Total............................................ $ 365,200 $ 514,000 $ 726,832
========= ========== ==========
RECONCILIATION OF EFFECTIVE INCOME TAX RATE
1997 1996 1995
--------- ---------- ----------
Income (loss) from continuing operations......... $(238,413) $1,732,501 $2,385,994
========= ========== ==========
Statutory federal rate........................... $ (81,060) $ 606,375 $ 835,098
Benefit from marginal rate....................... - (17,325) (23,860)
State taxes, net of federal benefit.............. (11,122) 24,798 1,833
Permanent differences............................ (20,269) 36,206 2,047
Write-off of deferred tax asset associated with
discontinued operations......................... 421,000 - -
Increase (decrease) in valuation reserve......... 61,390 (203,058) (239,316)
Other, net....................................... (4,739) 67,004 151,030
--------- ---------- ----------
Total............................................ $ 365,200 $ 514,000 $ 726,832
========= ========== ==========
COMPONENTS OF DEFERRED TAX ASSETS
1997 1996
--------- ----------
Operating and capital loss carryforwards......... $ 318,862 $ 890,900
Credit carryforwards............................. 269,005 128,300
Other............................................ 83,028 151,800
Less: valuation allowance........................ (143,527) (74,500)
--------- ----------
Total............................................ $ 527,368 $1,096,500
========= ==========
Income tax payments included in the Statement of Cash Flows totaled $5,850,
$410,769 and $77,152 for the years ended October 31, 1997, 1996 and 1995.
42
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
The operating loss carryforwards included as a component of deferred tax assets
were generated by continuing operations in the current year and are expected to
be fully utilized in the future.
A tax benefit of $119,738 and $682,200 related to the exercise of stock options
was allocated to additional paid-in capital in 1997 and 1996, respectively.
(5) SHAREHOLDERS' EQUITY:
Increase in Authorized Shares and Designation of Preferred Class of Stock:
In March 1997, the shareholders approved an increase in authorized shares of
capital stock from 20,000,000 shares to 25,000,000 shares and reservation of
5,000,000 of such shares as undesignated shares of preferred stock, having such
rights, preferences and designations as determined by the Board of Directors.
As a result, the Company's authorized capital stock consists of 20,000,000
shares of common stock and 5,000,000 shares of undesignated preferred stock.
Stock Repurchase Plan:
In August 1997, the Company's Board of Directors adopted a stock repurchase plan
and authorized the purchase of up to 500,000 shares of its common stock. In
the year ended October 31, 1997, the Company repurchased 36,900 shares of common
stock.
Warrants:
During 1995, in connection with a public offering of its common shares, the
Company issued the underwriter of the offering warrants to purchase 90,000
shares of common stock at an exercise price of $16.375 per share. These
warrants became exercisable in September 1996 and will remain exercisable until
1999.
Under the agreement governing the Company's spin-off of Vital Images, Vital
Images is required to assume its respective obligations represented by such
underwriter warrants and to issue 45,000 shares of its common stock upon the
exercise thereof, based upon the spin-off distribution ratio of one share of
Vital Images common stock for each two shares of Bio-Vascular common stock. In
exchange, the spin-off agreement provides that Vital Images will receive a
proportionate share of the exercise price set by the terms of the agreement.
Accordingly, upon exercise of the warrants, Bio-Vascular will receive proceeds
of $13.0823 per share and Vital Images will receive proceeds of $3.2927 per
share.
Shareholder Rights Plan:
In June 1996, the Company's Board of Directors declared a dividend distribution
of one Common Stock purchase right (a Right) for each outstanding share of the
Company's common stock on July 15, 1996. The Company also entered into a Rights
Agreement governing the terms of the Rights, and each share of Common Stock
issued subsequent to July 15, 1996, has been issued with an attached Right
pursuant to the terms of the Rights Agreement.
Upon exercise, each Right entitles the holder thereof to purchase one-tenth of a
share of Common Stock at a purchase price currently set at $6.00 per share,
subject to adjustment to reflect the value of the Company following the spin-off
of Vital Images, Inc. Upon the occurrence of certain events in connection with:
(i) a person or group acquiring 15% or more of the Company's outstanding Common
Stock; (ii) a third party announcing an offer to purchase a 15% or greater stake
in the Company; or (iii) the Board of Directors declaring a person to be an
"adverse person" based upon such person being a holder of 10% or more of the
Company's outstanding stock and the
43
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
Board's belief that such person's shares were acquired for short-term financial
gain or that the shareholder might otherwise adversely affect the Company's
business or prospects, the Rights become exercisable and entitle each holder
thereof (other than the acquiring person or "adverse person") to purchase, for a
price equal to ten times the then-current purchase price of the Right, shares of
Common Stock (or other securities of the Company) or equity securities of the
acquiring company, as the case may be, having a market value equal to twenty
times the then-current purchase price of the Right. In general, the Company is
entitled to redeem the Rights in whole at a price of $.001 per Right (payable in
cash, stock or other consideration deemed appropriate by the Board of Directors)
prior to the first to occur of any such set of events. Each Right will expire
on June 11, 2006, if not previously redeemed or exercised.
Restricted Stock:
Under certain compensation agreements, an arrangement which provides for
awards of restricted common stock to key management was adopted in 1992. These
awards of restricted common stock are subject to forfeiture if employment
terminates prior to the end of the prescribed periods. Vesting periods range
from three to four years.
The market value of the shares at the time of grant is recorded as unearned
restricted stock. The unearned amount is amortized to compensation expense over
the periods during which the restrictions lapse. As part of these same
compensation agreements, the Company agreed to buy back the number of shares
which would allow the employees to meet their income tax obligations arising
from the non-cash compensation related to the earned restricted shares. Unearned
restricted stock granted to employees is summarized as follows:
UNEARNED RESTRICTED STOCK MARKET VALUE
BALANCE SHARES AT GRANT
---------- -------- --------------
Balance October 31, 1994... $ 112,818 35,204 $3.25 -- $3.44
Granted.................... 430,809 78,748 4.75 -- 14.50
Earned..................... (144,101) (33,887) 3.25 -- 14.50
Canceled/Forfeited......... (16,800) (3,537) 4.75
---------- -------
Balance October 31, 1995... 382,726 76,528 3.25 -- 14.50
Granted.................... 131,414 11,868 8.63 -- 14.00
Earned..................... (172,463) (35,061) 8.25 -- 14.50
Canceled/Forfeited......... (30,905) (4,002) 4.75 -- 14.00
---------- -------
Balance October 31, 1996... 310,772 49,333 3.25 -- 14.50
Granted.................... 220,064 46,545 4.25 -- 6.50
Earned..................... (134,021) (27,101) 3.25 -- 14.50
Canceled/Forfeited......... (108,997) (13,705) 4.75 -- 14.50
---------- -------
Balance October 31, 1997... $ 287,818 55,072 $4.25 --$14.00
========== =======
Shares of common stock have also been awarded to certain medical professionals
as compensation for services provided in the Company's product development
activities. These awards vest in accordance with the service agreement and
totaled 36,000, 1,000, and 21,000 shares in 1997, 1996, and 1995, respectively.
The weighted average market value at grant date for restricted stock awards was
$ 4.41, $ 11.02 and $ 5.21 for 1997, 1996 and 1995, respectively.
44
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
Stock Option Plans:
The Company has two stock option plans: the 1995 Stock Incentive Plan (the
"1995 Plan") and a Directors' Stock Option ("DSO") Plan.
Options have been granted pursuant to the two stock option plans as well as
certain non-plan options granted to consultants, officers and directors of the
Company. Plan options are exercisable over periods of up to ten years from the
date of grant. Common shares of 190,796 remain available for issuance under the
Company's stock option plans. Plan options outstanding at October 31, 1997
include performance option awards for up to 25,000 shares, assuming maximum
performance payout. The actual number of performance options awarded may vary
depending on the degree to which the performance objectives are met. The
Company has reserved and granted 371,720 shares of common stock for issuance in
connection with non-plan options, which are exercisable over periods of up to
seven years from the date of grant. The difference between the estimated market
value and the exercise price for certain option grants was recorded as unearned
compensation and is being amortized on a straight-line basis over the vesting
period of the related options.
A summary of the status of the Company's stock options for the years ended
October 31is as follows:
1997 1996 1995
---------------------- -------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- ---------- -------- ---------- ---------
Outstanding at beginning of
year................................ 1,148,764 $5.60 1,014,263 $ 3.97 889,850 $2.78
Granted............................... 419,262 5.16 267,108 10.44 485,297 5.34
Exercised............................. (48,236) 3.23 (82,744) 2.59 (197,400) 2.01
Canceled.............................. (214,684) 5.20 (49,863) 8.38 (163,484) 3.23
--------- --------- ---------
Outstanding at end of year............ 1,305,106 5.43 1,148,764 5.60 1,014,263 3.97
========= ========= =========
Options exercisable at end of
year................................ 794,743 $4.98 692,623 $ 4.26 589,803 $3.21
========= ========= =========
45
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at
October 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------------------- -----------------------
Weighted
Average Weighted
Number of Weighted Remaining Number of Average
Options Average Contractual Options Exercise
Range of Prices Outstanding Exercise Price Life (Years) Exercisable Price
--------------- ----------- -------------- ------------ ----------- --------
$ 1.87--$4.25 394,450 $ 3.28 4.49 315,981 $ 3.06
$ 4.38--$6.24 556,399 4.78 5.43 310,698 4.85
$ 6.64--$9.03 310,198 8.51 6.90 143,576 8.47
$9.53--$12.21 44,059 11.04 5.34 24,488 10.96
--------- -------
$1.87--$12.21 1,305,106 $ 5.43 5.49 794,743 $ 4.98
========= =======
New Accounting Standard:
In 1997, the Company adopted Statement of Financial Accounting Standard (SFAS)
No. 123, Accounting for Stock-Based Compensation, which encourages, but does
not require companies to recognize compensation cost for stock-based
compensation plans over the vesting period based upon the fair value of awards
at the date of grant. SFAS No. 123 allows the alternative use of the intrinsic
value method as prescribed in Accounting Principles Board Opinion (APB) No.
25, Accounting for Stock Issued to Employees. As permitted, the Company will
continue to apply APB No. 25, and related Interpretations in accounting for
its employee stock-based compensation.
For the year ended October 31, compensation expense recorded for stock based
compensation awards (restricted stock and stock options) was as follows:
1997 1996 1995
-------- -------- --------
Employee................................. $149,608 $210,836 $186,226
Non-employee............................. 62,759 49,125 28,500
-------- -------- --------
Total stock-based compensation expense... $212,367 $259,961 $214,726
======== ======== ========
46
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
Had compensation expense for the Company's stock-based compensation plans been
determined based on the fair value at the grant dates consistent with SFAS No.
123, the Company's net income and earnings per share would have been reduced to
the pro forma amounts indicated below:
1997 1996
------------ ------------
Net Loss................. As Reported $(1,523,613) $(1,177,641)
................. Pro forma (4,634,523) (2,252,420)
Loss Per Share........... As Reported (.16) (.12)
........... Pro forma (.49) (.24)
The pro forma information includes stock options granted and purchases under the
Employee Stock Purchase Plan (ESPP) in 1997 and 1996. Additionally, the 1997
pro forma information reflects the impact of the modification, occurring as part
of the spin-off of Vital Images, of stock options and other stock based awards
granted in years prior to 1997. The 1997 pro forma loss would have been
significantly lower had the Company recorded in years prior to 1997, pro forma
compensation costs associated with stock options and other stock based awards in
the year of grant. Such pro forma compensation costs were not required prior to
the implementation of SFAS No. 123.
The weighted average fair value per option granted during 1997 and 1996 was
$2.18 and $3.60 for the ESPP and $2.99 and $8.38 for all other options,
respectively. The weighted average fair value was calculated by using the fair
value of each option on the date of grant. The fair value of the ESPP options
was based on the 15 percent purchase discount. The fair value of all other
options was estimated using the Black-Scholes option pricing model with the
following weighted average assumptions for 1997 and 1996:
1997 1996
---------- ----------
Expected Option Term......... 4.2 years 6.6 years
Expected Volatility Factor... 72% 69%
Expected Dividend Yield...... 0% 0%
Risk-Free Interest Rate...... 6.33% 6.02%
(6) COMMITMENTS:
Operating Lease:
The Company has a noncancellable operating lease related to its office and
production facility which expires in July 2005. Total annual base rent expense
for this lease is $255,441. The Company also pays apportioned real estate taxes
and common costs on its leased facilities. Total rent expense was $293,059,
$296,486 and $154,622 for the years ended October 31, 1997, 1996 and 1995,
respectively.
Future minimum payments at October 31, 1997 are payable in the amount of
$255,441 each year for 1998 through 2002 and total $702,480 thereafter.
47
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
Royalties:
In connection with the acquisition of product licenses and product manufacturing
rights, the Company is obligated for the payment of royalties as follows:
- 5% on net sales of Peri-Strips and Peri-Strips Dry until the expiration of
the related patents.
- 2.5% of net sales of the Biograft through 1998.
- 3% of net sales of the Bio-Vascular Probe through 2001.
Royalty expense was approximately $191,000, $291,000 and $393,000 for the
years ended October 31, 1997, 1996, and 1995, respectively, and is included in
cost of revenue.
(7) RELATED PARTY TRANSACTIONS:
In October 1997, the Company entered into a distribution agreement with Scanlan
International, Inc., a medical and surgical products distributor. A Director of
the Company is President and Chief Executive Officer of the Scanlan Group of
Companies, the parent company of Scanlan International. The agreement grants
Scanlan International the exclusive right, acting as a sales representative of
Bio-Vascular, to solicit orders, work with distributors and market listed
products within Latin America until October 31, 2000 subject to annual renewal
thereafter. Scanlan International will receive a commission of 20% on net sales
to Latin America during the term of the agreement. For the year ended October
31, 1997, there was no sales activity resulting from this agreement.
(8) EMPLOYEE BENEFIT PLANS:
Salary Reduction Plan:
The Company sponsors a salary reduction plan established on January 1, 1991,
which qualifies under Section 401(k) of the Internal Revenue Code. Employee
contributions are limited to 15% of their annual compensation, subject to annual
limitations. At the discretion of the Board of Directors, the Company may make
matching contributions equal to a percentage of the salary reduction or other
discretionary amount. The Company has made no contributions to the plan since
its inception.
Employee Stock Purchase Plan:
The Company sponsors an Employee Stock Purchase Plan under which 300,000 shares
of common stock were reserved for future issuance. The Plan was established to
enable employees of the Company to invest in Company stock through payroll
deduction. Options are granted to employees to purchase shares of stock at 85
percent of market value. There were 9,190 and 5,715 shares purchased through
the Plan in 1997 and 1996, respectively.
48
BIO-VASCULAR, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
- ------------------------------------------------------------------------
(9) MAJOR CUSTOMERS AND GEOGRAPHIC DATA:
PERCENTAGE
-------------------------
SIGNIFICANT ACCOUNTS
CUSTOMER GROSS SALES RECEIVABLE
-------------- ------------ -----------
Year ended October 31, 1997...... Futuretech 19% 20%
Life Systems 14% 13%
Cardio Medical 11% 10%
Year ended October 31, 1996...... Futuretech 18% 21%
Life Systems 15% 16%
Cardio Medical 12% 14%
Year ended October 31, 1995...... Futuretech 19% 20%
Life Systems 16% 19%
Cardio Medical 11% 14%
International net revenues amounted to 24%, 22%, and 17% of total revenues for
1997, 1996 and 1995, respectively. Substantially all of the Company's
international revenues are negotiated, invoiced and paid in U.S. dollars. Gross
export revenues by significant geographic area are summarized as follows:
1997 1996 1995
---------- ---------- ----------
Europe and Middle East... $1,412,675 $1,371,867 $1,102,720
Asia and Pacific Region.. 666,201 623,884 521,642
49
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
Our report on the financial statements of Bio-Vascular, Inc. is included on page
35 of this Form 10-K. In connection with our audits of such financial
statements, we have also audited the related financial statement schedule listed
in the index on page 30 of this Form 10-K.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
COOPERS & LYBRAND L.L.P.
Minneapolis, Minnesota
December 9, 1997
50
SCHEDULE II
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BIO-VASCULAR, INC.
VALUATION AND QUALIFYING ACCOUNTS
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Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- ------------------------------------------------------------------------------------------
Allowance for doubtful accounts:
Year ended October 31, 1997 $21,400 - - $21,400
Year ended October 31, 1996 20,000 36,592 35,192 21,400
Year ended October 31, 1995 30,000 (1,901) 8,099 20,000
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Balance at Charged to Balance
beginning cost and at end of
Description of period expenses Deductions period
- ------------------------------------------------------------------------------------------
Reserve for obsolete inventories:
Year ended October 31, 1997 $368,000 $116,031 $111,031 $373,000
Year ended October 31, 1996 46,000 354,822 32,822 368,000
Year ended October 31, 1995 10,000 176,568 140,568 46,000
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51
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
BIO-VASCULAR, INC.
By /s/ M. Karen Gilles
--------------------------------
M. Karen Gilles, President and Chief
Executive Officer
(Principal Executive Officer)
Dated: December 23, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below on December 23, 1997 by the following persons on behalf of
the registrant and in the capacities indicated.
/s/ M. Karen Gilles
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M. Karen Gilles
President, Chief Executive Officer and Director
/s/ Connie L. Magnuson
- ----------------------------------
Connie L. Magnuson
Vice President of Finance and Chief Financial Officer
(Principal Financial and Accounting Officer)
/s/ James F. Lyons
- ----------------------------------
James F. Lyons
Chairman, Board of Directors
/s/ Richard W. Perkins
- ----------------------------------
Richard W. Perkins, Director
/s/ Anton R. Potami
- ----------------------------------
Anton R. Potami, Director
/s/ Timothy M. Scanlan
- ----------------------------------
Timothy M. Scanlan, Director
/s/ Edward E. Strickland
- ----------------------------------
Edward E. Strickland, Director
52
BI0-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1997
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3.1 Restated Articles of Incorporation of the Company, as amended,
(incorporated by reference to Exhibit 3.1 to the Company's Quarterly
Report on Form 10-Q for the quarter ended April 30, 1997 (File
No. 0-13907)).
3.2 Amended and Restated Bylaws of the Company (incorporated by reference to
Exhibit 3.2 to the Company's Registration Statement on Form S-4 (File
No.33-74750)).
4.1 Form of common stock Certificate of the Company (incorporated by
reference to Exhibit 4.1 to the Company's registration statement on Form
10 (File No. 0-13907)).
4.2 Form of Rights Agreement, dated as of June 12, 1996, between Bio-
Vascular, Inc. and American Stock Transfer & Trust Company, which
includes as Exhibit A the form of Rights Certificate (incorporated by
reference to Exhibit 4.1 to the Company's Current Report on Form 8-K
dated June 12, 1996 (File No. 0-13907)).
4.3 Restated Articles of Incorporation of the Company, as amended (see
Exhibit 3.1).
4.4 Amended and Restated Bylaws of the Company (see Exhibit 3.2).
10.1 Agreement dated as of July 31, 1985 among Genetic Laboratories, Inc.,
Vascular Services Diversified, Inc., and the Company, including first
amendment thereto, dated September 25, 1985 (incorporated by reference
to Exhibit 2.1 to the Company's registration statement on Form 10 (File
No. 0-13907)).
10.2 Amendment No. 2 to the Agreement referred to in Exhibit 10.1, effective
July 31, 1985 (incorporated by reference to Exhibit 19.1 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).
10.3 License Agreement dated September 25, 1985 between the Company and
Genetic Laboratories, Inc. (incorporated by reference to Exhibit 10.1 to
the Company's registration statement on Form 10 (File No. 0-13907)).
10.4 Amendment to License Agreement dated June 13, 1986 between the Company
and Genetic Laboratories, Inc. (incorporated by reference to Exhibit
10.4 to the Company's Current Report on Form 8-K dated June 15, 1986
(File No. 0-13907)).
10.5 Debt and Royalty Restatement Agreement dated June 16, 1986 among Genetic
Laboratories, Inc., Vascular Services Diversified, Inc. and the Company
(incorporated by reference to Exhibit 19.3 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File
No. 0-13907)).
10.6 Purchase Agreement dated February 17, 1986, between the Company and
Genetic Laboratories, Inc. including Bill of Sale and Assignment
(incorporated by reference to Exhibit 19.4 to the Company's Quarterly
Report on Form 10-Q (File No. 0-13907)).
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BI0-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1997
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10.7 Purchase and sale agreement dated October 30, 1989 and closed December
28, 1989 between the Company and Meadox Medicals, Inc. (incorporated by
reference to Exhibit 2.1 to the Company's Current Report on Form 8-K
dated January 11, 1990 (File No. 0-13907)).
10.8 Assignment and Assumption Agreement dated July 31, 1985 between the
Company and Genetic Laboratories, Inc., including the Purchase Agreement
dated June 4, 1984 between Genetic Laboratories, Inc. and Xomed, Inc.
(incorporated by reference to Exhibit 19.5 to the Company's Quarterly
Report on Form 10-Q for the period ended April 30, 1986 (File No. 0-
13907)).
10.9 Assignment dated June 13, 1986 by Genetic Laboratories, Inc. to the
Company (incorporated by reference to Exhibit 10.1 to the Company's
Current Report on Form 8-K dated June 15, 1986 (File No. 0-13907)).
10.10 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories,
Inc., to the Company (incorporated by reference to Exhibit 10.2 to the
Company's Current Report on Form 8-K dated June 15, 1986 (File
No. 0-13907)).
10.11 Confirmatory Assignment dated June 13, 1986 by Genetic Laboratories,
Inc., to the Company (incorporated by reference to Exhibit 10.3 to the
Company's Current Report on Form 8-K dated June 15, 1986 (File
No. 0-13907)).
10.12 Trademark Assignment Agreement dated June 19, 1986 between the Company
and Genetic Laboratories, Inc. (incorporated by reference to Exhibit
19.10 to the Company's Quarterly Report on Form 10-Q for the period
ended April 30, 1986 (File No. 0-13907)).
10.13 Assignment dated June 26, 1986 between the Company and Genetic
Laboratories, Inc. (incorporated by reference to Exhibit 19.11 to the
Company's Quarterly Report on Form 10-Q for the period ended April 30,
1986 (File No. 0-13907)).
10.14 1988 Stock Option Plan, as amended, (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended April 30, 1997 (File No. 0-13907)).
10.15 1990 Management Incentive Stock Option Adjustment Plan (incorporated by
reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the quarter ended September 30, 1997 (File No. 0-13907)).
10.16 1992 Stock Option Adjustment Plan (incorporated by reference to Exhibit
10.2 to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997 (File No. 0-13907)).
10.17 1995 Stock Incentive Plan, as amended (incorporated by reference to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
period ended April 30, 1997 (File No. 0-139070)).
10.18 Employee Stock Purchase Plan, as amended (filed herewith
electronically).
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BIO-VASCULAR, INC.
EXHIBIT INDEX TO ANNUAL REPORT
ON FORM 10-K
FOR THE YEAR ENDED OCTOBER 31, 1997
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10.19 Employment letter dated November 28, 1994, as amended January 2, 1995,
between the Company and Mr. Stephenson (incorporated by reference to
Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
10.20 Severance agreement dated June 30, 1997 between the Company and Mr.
Karcanes (filed herewith electronically).
10.21 Form of Change in Control Agreement entered into between the Company and
each of Ms. Gilles, Mr. Schankereli and Mr. Stephenson (incorporated by
reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K
for the year ended October 31, 1994 (File No. 0-13907)).
10.22 Lease Agreement effective August 1, 1995 between the Company and CMS
Investors, Inc. (incorporated by reference to Exhibit 10.25 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.23 Purchase and Sale Agreement dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to
Exhibit 10.27 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
10.24 License Agreement dated December 1, 1995 between the Company and
Uroplasty, Inc. (incorporated by reference to Exhibit 10.28 to the
Company's Annual Report on Form 10-K for the year ended October 31, 1995
(File No. 0-13907)).
10.25 Assignment of U.S. Patent dated December 1, 1995 among the Company,
Bioplasty, Inc. and Uroplasty, Inc. (incorporated by reference to
Exhibit 10.29 to the Company's Annual Report on Form 10-K for the year
ended October 31, 1995 (File No. 0-13907)).
21.1 List of Subsidiaries of the Company (filed herewith electronically).
23.1 Consent of Coopers & Lybrand L.L.P. (filed herewith electronically).
27.1 Financial Data Schedule for the year ended October 31, 1997 (filed
herewith electronically).
E-3