Item 1. Business:
General
The Company was incorporated in 1956 and went public in 1960 as Possis Machine Corporation. Initial operations consisted of design, manufacturing, and sales of industrial equipment and a division that provided temporary technical personnel. The Company's involvement with medical products began in 1976, when it sold its rights to a patented bileaflet mechanical heart valve, which it had obtained from Zinon C. Possis, the founder of the Company, to St. Jude Medical, Inc. for royalty payments based on St. Jude's valve sales (the "St. Jude Royalties"). See Note 6 of Notes to Consolidated Financial Statements contained in Part II, Item 8. In 1982 a subsidiary was established to focus initially on the development of a synthetic blood vessel used to bypass blocked coronary arteries. In the late 1980's the Company decided to leverage existing management expertise and entered the pacemaker lead business. The strategic role of the pacemaker lead business was to provide cash flow to fund the development of synthetic grafts and thrombectomy systems and to give the Company access to and name recognition within the medical device industry. In 1990 the Company made the decision to focus on medical products and subsequently divested all non-medical operations, beginning with its Technical Services division in September 1991 followed by its industrial equipment subsidiary and related land and buildings in January 1994. See Notes 2 and 12 of Notes to Consolidated Financial Statements contained in Part II, Item 8. In March 1994 the Company sold its pacemaker lead business because it anticipated that revenues from this business would decrease due to a pacemaker lead technology shift. In connection with this sale, the Company received $1.1 million in cash and the right to receive royalty payments over a twelve-month period. See Note 11 of Notes to Consolidated Financial Statements contained in Part II, Item 8. The sale of the pacemaker lead business has enabled Possis to focus its human and financial resources exclusively on its other products, which are currently in clinical trials in the United States and in early stages of commercialization in Europe, Japan and Canada.
Products
ANGIOJET THROMBECTOMY SYSTEM. The development of blood clots in various parts of the vascular system is common and is one of the leading causes of morbidity and death. Blood clots may be caused by various factors, including cardiovascular disease, trauma, interventional procedures using catheters and needles or prolonged bed rest. If a blood clot becomes large enough, it can block an artery, preventing oxygenated blood from reaching the organ or tissue supplied by the artery. In addition, if a blood clot breaks off it can travel through the bloodstream and block oxygenated blood flow to other organs and tissue. Conditions caused by blood clots include peripheral ischemia, which can lead to limb loss, vascular access failure, pulmonary embolism, acute myocardial infarction (heart attack), stroke and deep vein obstruction.
Currently, the two primary methods of removing blood clots are thrombolytic drugs and mechanical devices. Thrombolytic drug treatment involves the administration of a drug designed to dissolve the blood clot in an intensive or critical care setting. Thrombolytic drugs may require several administrations to be effective, and then may only partially remove the clot. In addition, thrombolytic drugs may require significant time to take effect, which is costly in an intensive or critical care setting, and may cause uncontrolled bleeding. Mechanical devices such as the Fogarty-type catheter operate by inflating a balloon past the point of the blood clot and then dragging the blood clot out of the patient's body through the artery. Fogarty-type catheters require surgical intervention, which may result in overnight hospital stays, are more limited in their applications and may cause vascular trauma.
Possis believes that its AngioJet System represents a new approach to the removal of blood clots from arteries, veins and grafts and offers certain potential advantages over current methods of treatment. The AngioJet System is a minimally invasive catheter system designed for rapidly removing blood clots with minimal vascular trauma. The system's principal components are a reusable drive unit, a high-pressure single use pump and a single use small diameter (3.5 to 5F or 1.2 to 1.7 mm) catheter. In early clinical use outside the United States and in U.S. clinical trials, the AngioJet System has demonstrated the ability to remove blood clots within minutes without surgical intervention and without the risk of uncontrolled bleeding.
The AngioJet System removes blood clots through the non-surgical insertion of the catheter over a guidewire into the patient's blood vessel and then, with the aid of fluoroscopy, the catheter is directed to the site of the blood clot. The drive unit is then activated to deliver pressurized saline through tiny openings in the catheter's tip. These small waterjets clean the blood clot from the vessel wall, break it into small fragments and, in order to prevent formation of a new blood clot downstream, propel the debris down the central lumen of the catheter and into a collection bag attached to the drive unit, without the need for a separate suction or vacuum device. Unlike certain other mechanical devices that are able only to create channels through blood clots of a size similar to that of the catheter used, the AngioJet System's waterjet technology enables it to break up large blood clots from vessels much larger than its catheter diameter.
Because the Possis AngioJet System is unlike any existing procedure or device, market potential is difficult to quantify, but may be estimated by determining the number of thrombectomy and thrombolytic procedures performed using other therapies and devices and estimating the number of procedures that might reasonably be replaced or supplemented by using the AngioJet System.
Based upon information provided by medical practitioners and its own analysis, the Company believes that the AngioJet System may potentially be used for alternative or supplemental therapy for the 60,000 thrombectomy procedures using lytic drugs, the 380,000 thrombectomy procedures using mechanical devices and the 60,000 thrombolysis/revision procedures involving dialysis access grafts estimated to be performed each year in the United States. The Company also believes that the AngioJet System may be used in Percutaneous Transluminal Angioplasty ("PTA") procedures that involve the presence of clinically significant clot. The Company also believes that of the five million patients with deep vein thrombosis, 10% would be suitable for treatment with the AngioJet System. Additionally, the Company believes that the approximately 600,000 patients with pulmonary embolism annually in the United States are candidates for treatment with the AngioJet System. Further, the Company estimates that more than 550,000 patients annually are candidates for AngioJet System treatment of failed or occluded saphenous vein grafts, unstable angina and acute myocardial infarction. An emerging market for interventional therapy is the treatment of the brain and the Company believes its technology may be suitable for 500,000 neuro procedures annually including stroke victims.
Although the Company has not yet established pricing for the AngioJet System, it anticipates that the price to the hospital for the single use catheter and pump set will be between $800 and $1,500 and for the drive unit the price will be between $30,000 and $60,000. The Company cannot estimate the ultimate charge for this procedure to the patient. The average mechanical thrombectomy procedure is performed in a surgical setting with an overnight hospital stay and could result in charges to the patient exceeding $20,000. Lytic drug therapy may cost $500 to $5,000 for the drug plus hospital and procedure charges, resulting in a total patient cost of as much as $25,000.
The Company is currently conducting clinical trials in the United States with the AngioJet System for removing blood clots from peripheral arteries and vascular grafts and for use in removing blood clots from coronary arteries and coronary bypass grafts. Possis received FDA approval to initiate clinical testing of its AngioJet System for use in removing blood clots from peripheral arteries and vascular grafts in December 1992. The first patient was enrolled in the trial in July 1993 and by March 31, 1994, Phase 1 of the trial, consisting of 19 patients undergoing 23 treatments, was complete and the summary report had been submitted to the FDA. In July 1994, the Company received approval from the FDA to commence Phase 2 of the trial, in which patients receive, on a one-to-one randomized basis, treatment with either the AngioJet System or a Fogarty-type catheter already marketed for blood clot removal. As of September 1996, 187 patients had been treated in both phases of the trial, of which 108 were treated with the AngioJet System. The Company expects to receive a response from the FDA in December 1996 and is making plans to introduce the AngioJet System for peripheral use to the U.S. market in early 1997.
In March 1996, Possis received FDA approval to initiate Phase 2 clinical testing of its AngioJet System for use in removing blood clots from coronary arteries and bypass grafts. As of September 1996, 74 patients have been enrolled in Phase 2 comparing the performance of the AngioJet System to the drug urokinase. The Company believes that the coronary application of the AngioJet System will be subject to a PMA approval process and anticipates filing a PMA application in 1997.
PERMA-FLOW GRAFT. Coronary artery bypass graft ("CABG") surgery is performed to treat impairment of blood flow to portions of the heart. CABG surgery involves the addition of one or more new vessels to the heart to re-route blood around blocked coronary arteries.
Autogenous grafts (using the patient's own saphenous vein or mammary artery) have been successfully used in CABG procedures for a number of years and have shown a relatively high patency rate (80% to 90% for saphenous veins and over 90% for mammary arteries one year after surgery) with no risk of tissue rejection. However, the surgical harvesting of vessels for autogenous grafts involves significant trauma and expense. In addition, not all patients requiring CABG surgery have sufficient native vessels as a result of previous bypass surgeries, or their vessels may be of inferior quality due to trauma or disease. Cryopreserved saphenous veins are available, but these veins often deteriorate due to the body's immune system.
The Possis Perma-Flow Graft is a synthetic graft 5mm in diameter for use in CABG surgery. The Perma-Flow Graft is intended initially to provide an alternative to patients with insufficient or inadequate native vessels for use in bypass surgery as a result of repeat procedures, trauma, disease or other factors. The Company believes, however, that the Perma-Flow Graft may ultimately be used as a substitute for native saphenous veins, thus avoiding the trauma and expense associated with the surgical harvesting of the vein.
The Perma-Flow Graft is made of ePTFE, a standard grafting marterial, and contains a molded silicone venturi-shaped flow resistance element approximately 2mm in diameter. The Perma-Flow Graft is designed to be implanted by initially suturing it to the vena cava followed by side-to-side anastomoses (connections) of the graft to the coronary arteries beyond the blockages and finally suturing the graft to the aorta. The formation of this artery-to-vein shunt is designed to create a continuous blood flow at a sufficiently high rate through the graft to reduce the incidence of blood clot formation, the major reason for synthetic graft failure in the past. The flow resistance element is designed to prevent excessive shunting of blood to the vena cava and to maintain high arterial pressure for effective coronary perfusion.
The Company believes that in 1995 approximately 540,000 CABG procedures were performed worldwide, of which approximately 300,000 were performed in the United States, and that approximately 20% of these CABG procedures were performed on patients who had previously undergone bypass surgery. The Company further believes that the number of repeat procedures will continue to increase as a percentage of procedures performed, as the number of patients who have the procedure increases. Currently, approximately 70% of CABG procedures are performed utilizing the saphenous vein. Based upon its interviews with cardiovascular surgeons, including those involved in the clinical trials, the Company believes that patients whose native vessels are not available for use in bypass surgery comprise approximately 4% of those receiving CABG procedures, or approximately 20,000 annually, and that approximately 80,000 patients annually are determined by the treating physician to have native vessels inadequate to be used in bypass surgery. If initial use of the Perma-Flow Graft is shown to be clinically acceptable, the Company believes that the graft may be used for these patients. The Company further believes that if long-term clinical results are acceptable to clinicians (generally greater than 50% patency five years after implant), the graft may ultimately be used as a substitute for native saphenous veins.
Currently, no synthetic coronary graft has been approved by the FDA. Cryopreserved saphenous veins sell to hospitals for approximately $3,500 to $4,000 in the United States. The Company anticipates pricing for the Perma-Flow Graft will be competitive with cryopreserved saphenous veins.
The Company received FDA approval to initiate clinical testing of its Perma-Flow Graft in November 1991. In July 1995, the Company received approval to commence Phase 2 of the study comprising 150 additional patients at up to 20 sites. As of September 1996, 32 Phase 1 and 20 Phase 2 study patients have been enrolled at 10 sites. Angiographic results at 30 days following surgery have been reported on 38 patients, which confirmed 77 of 80 side-to-side anastomoses to be patent (providing blood to the coronary arteries). Within this 30-day interval, of the remaining 14 patients, angiographic results were not reported for nine and five died of causes reported by the investigator to be unrelated to the graft. In addition, angiographic follow-up was performed approximately 12 months from implant on 13 patients, which confirmed that 19 of 25 anastomoses were patent. The Company believes this performance is substantially equivalent to saphenous vein. The Company anticipates filing a PMA application for U.S. marketing authorization in 1998.
PERMA-SEAL GRAFT. Patients suffering from renal disease may be required to undergo long-term kidney dialysis. The majority of these patients require long-term vascular access to facilitate treatment. A point of access for dialysis needles may be created by connecting an artery and a vein in the patient's arm. However, because kidney dialysis therapy typically requires patients to undergo blood dialysis treatment three times per week, these connections often become unusable over time. Other methods of vascular access for kidney dialysis such as temporary catheters are not designed for long-term use.
A synthetic graft may be implanted in kidney dialysis patients to provide the necessary vascular access. The vast majority of these synthetic grafts are made of ePTFE. The use of synthetic grafts currently available is often accompanied by excessive bleeding when the dialysis needle is withdrawn, requiring a nurse to apply pressure to help stop the bleeding and requiring the patient to remain in the treatment area until the bleeding has been stopped. In addition, to limit the risk of graft infection following implant, at least a two-week healing period following implantation is required to allow for tissue ingrowth into the graft before initiating dialysis.
The Possis Perma-Seal Graft is a self-sealing synthetic graft comprised of silicone elastomers, with a winding of polyester yarn encapsulated within its wall, and is manufactured using proprietary electrostatic spinning technology developed by the Company. The Company believes that its Perma-Seal Graft may offer advantages over currently used synthetic grafts because of its needle hole sealing capability. The Company believes that this characteristic will be effective in sealing puncture sites in the grafts with minimal compression time and bleeding as compared with other currently available graft products and, as a result, will reduce dialysis procedure and administrative time per patient and the costs associated therewith. In addition, because of its ability to seal a needle puncture without depending on tissue ingrowth, the Perma-Seal Graft may provide an option for patients who require dialysis immediately after implant.
Approximately 170,000 patients in the United States undergo kidney dialysis each year, of which approximately 140,000 receive vascular access procedures utilizing either natural vessel grafts or synthetic access grafts. The Company estimates that of these patients approximately 40,000 are implanted with a synthetic graft. The Company believes that a comparable market exists outside the United States as well.
The hospital prices of ePTFE and biological graft products manufactured by certain other manufacturers currently range from $400 to $700 per unit, depending on length, style, and configuration. Although final pricing of the Company's Perma-Seal Graft will depend upon manufacturing costs, distribution methods, and competitive pressures, the Company anticipates that pricing for the Perma-Seal Graft will be at a premium relative to standard ePTFE graft products.
In July 1992, Possis received FDA approval to initiate clinical testing of its Perma-Seal Graft. The study is randomized on a one-to-one basis with patients receiving either a Perma-Seal Graft or a conventional ePTFE graft. As of September 1996, 205 patients at five clinical sites had been enrolled in the study, 104 of which had received the Perma-Seal Graft. Clinical data indicates that Perma-Seal Graft patients who have been accessed for dialysis have reduced compression times to stop bleeding after removing the dialysis needles and the graft can be used for dialysis the same day it is implanted. The Company filed a 510(k) application for marketing authorization with the FDA in August 1994. In May 1995, the Company received a request for additional information from the FDA and the Company responded to the request on August 31, 1995. In November 1995, the FDA responded to the 510(k) with additional questions and in February 1996, the FDA told the Company it wanted to see data on 124 study patients followed for 12 months. The Company expects to resubmit the 510(k) application in early calendar 1997.
Research and Development
The Company's product development efforts for its existing products are focused primarily on clinical testing, obtaining necessary FDA product registrations and validating manufacturing processes. The Company's new product development efforts are focused primarily on developing additional applications of the AngioJet Thrombectomy System, including venous and neuro applications, and on utilizing its Perma-Flow Graft and Perma-Seal Graft technologies to develop other graft products, including endovascular stent grafts. The Company also believes its AngioJet technology has application beyond thrombectomy, for minimally invasive tissue removal. Research and development expenses are generally incurred for product design, development and qualification, manufacturing process development and validation, the conduct of clinical trials and governmental approvals. The Company's research and development expense is expected to increase as the Company continues its clinical trials and current product development plans.
As of September 30, 1996, the Company employed approximately 35 full-time employees in research and development, including 24 in new product concept screening, protoype building, product and process development and validation and 11 in quality systems, regulatory and clinical affairs. The Company performs substantially all of its research and development activities at its headquarters in Coon Rapids, Minnesota. The Company spent $3.2 million, $3.3 million and $3.7 million in fiscal 1996, 1995 and 1994, respectively, on medical product research and development.
Marketing and Sales
The Company expects to market its AngioJet System and graft products to physician specialty groups, including vascular surgeons, cardiovascular and thoracic surgeons, interventional radiologists and interventional cardiologists. The Company will initially market the AngioJet System for peripheral arterial and vascular graft thrombosis, targeting vascular surgeons and interventional clinicians who perform PTA and other thrombectomy or lytic procedures. AngioJet Systems for coronary applications will be marketed to interventional cardiologists and cardiovascular surgeons. The primary customer for the Perma-Flow Graft is expected to be the cardiovascular surgeon and thoracic surgeon. The initial focus of the Company's marketing will be for use in procedures involving patients having inadequate native vessels. The Perma-Seal Graft will be marketed to vascular surgeons, who typically are the primary decisionmakers with respect to the placement of vascular access grafts for patients receiving dialysis for renal failure.
The Company will also target other clinicians influential in dialysis treatment selection, including nephrologists, internists, and dialysis unit technicians.
Possis is currently marketing its AngioJet System outside the United States using an independent distributor network. The Company has entered into distributorship agreements with 16 distributors covering Belgium, Denmark, Germany, Greece, Italy, Luxembourg, The Netherlands, Norway, Spain, Switzerland, Austria, France, Sweden, Saudi Arabia, Israel, Australia, New Zealand, Russia and Japan. Generally, the distributorship agreements are for a five-year term and provide that the distributors, at their own expense, will investigate, negotiate and obtain regulatory approvals for the Company's products in the specified territory. Possis Medical Europe B.V., the Company's subsidiary in The Netherlands, acts as a point of centralized warehousing and distribution in Europe in order to enhance response time, efficiency and service to European customers. All sales made to the Company's independent distributors are denominated in United States dollars.
The Company will begin commercial marketing of the AngioJet System in the United States following receipt of FDA marketing authorization. The Company intends to market and distribute the AngioJet System in the United States utilizing a direct sales force.
In early 1995, the Company entered into a 10 year distribution agreement with C. R. Bard ("Bard") pursuant to which the Company granted Bard the exclusive worldwide right to market, sell and distribute the Company's Perma-Seal Graft. Under the agreement, Bard agreed to purchase the Perma-Seal Graft from the Company at certain transfer prices, to purchase certain minimum quantities and to make certain milestone payments to the Company relating to the commercialization of the product. The initial grafts were shipped to Bard in May 1996 and the Company expects non-U.S. sales of Perma-Seal Grafts to begin in fiscal 1997.
In March 1996, the Company entered into a three year distribution agreement with Baxter Healthcare Corporation ("Baxter") granting Baxter worldwide rights to market, sell and distribute the Perma-Flow Graft. Under the agreement, Baxter agreed to purchase the Perma-Flow Graft from the Company at certain transfer prices, to purchase certain quantities and to make certain milestone payments to the Company based on the continuation of the agreement. The initial shipment of Perma-Flow Grafts was made in July 1996 and the Company expects non-U.S. sales of the product to begin in fiscal 1997.
Promotional activities by the Company are designed primarily to enlist the support of key medical opinion leaders in the United States and abroad. The Company believes that sales to key opinion leaders in European countries will be especially important to encourage broader acceptance of its products and will give the Company experience in marketing its products prior to their introduction in the United States. Other promotional activities may include publishing analytical papers, making scientific symposium presentations and conducting comparative clinical trials demonstrating the uses, costs and effectiveness of the Company's products.
Patents, Patent Applications, Licenses and Proprietary Rights
The Company's success depends and will continue to depend in part on its ability to maintain patent protection for products and processes, to preserve its trade secrets and to operate without infringing the proprietary rights of third parties. The Company's policy is to attempt to protect its technology by, among other things, filing patent applications for technology that it considers important to the development of its business. The Company currently holds five United States patents and 17 foreign patents related to the Perma-Flow Graft and has two patent applications pending in the United States and two patent applications pending in foreign jurisdictions. The Company also holds two United States patents relating to the AngioJet System. In addition, the Company has 11 United States and 13 foreign patent applications pending relating to the AngioJet System. Two AngioJet System patent applications have been accepted by the European Patent Office. In connection with the Perma-Seal Graft, one United States patent is pending, one of the claims included in which has been allowed, and four foreign patent applications are pending. The validity and breadth of claims covered in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that the Company's pending applications will result in patents being issued or, if issued, that such patents, or the Company's existing patents, will provide a competitive advantage, or that competitors of the Company will not design around any patents issued to the Company. The Company is aware of one pending foreign patent application relating to a water jet system for removing blood clots. Although the application was filed after the AngioJet System patent application, no assurance can be given that such third party will not receive a patent.
The Company has acquired rights through licensing agreements to patents relating to processes used in the manufacture of the Perma-Seal Graft. Under these agreements, Possis is required to pay certain annual fees and royalties based on net sales of products using the technology covered by these patents.
The Company requires its employees having access to proprietary information to execute non-disclosure agreements upon commencement of employment with the Company. These agreements generally provide that all confidential information developed or made known to the individual by the Company during the course of the individual's employment with the Company is to be kept confidential and not disclosed to third parties.
There can be no assurance that the Company's non-disclosure agreements and other safeguards will protect its proprietary information and know-how or provide adequate remedies for the Company in the event of unauthorized use or disclosure of such information, or that others will not be able to independently develop such information. There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Litigation, which could result in substantial cost to and diversion of effort by the Company, may be necessary to enforce patents issued to the Company, to protect trade secrets or know-how owned by the Company, to defend the Company against claimed infringement of the rights of others or to determine the ownership, scope or validity of the proprietary rights of the Company and others. An adverse determination in any such litigation could subject the Company to significant liabilities to third parties, could require the Company to seek licenses from third parties and could prevent the Company from manufacturing, selling or using its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations.
Competition
The Company's products will compete with a number of different products and methods of treatment for the conditions they address. The Company believes that its AngioJet System will face intense competition from a variety of treatments for the ablation and removal of blood clots, including thrombolytic drug therapies, surgical intervention, balloon embolectomy, mechanical and laser thrombectomy devices, ultrasound ablators, and other thrombectomy devices based on waterjet systems that are currently being developed by other companies. The Company is aware that Cordis Corporation has a waterjet-based thrombectomy system in early stage sales in Europe and Canada.
The Company is not aware of any synthetic graft being developed that will compete with the Perma-Flow Graft and believes it is the first developer to obtain FDA approval for clinical trials with a synthetic coronary bypass graft. The Company's Perma-Seal Graft will compete with ePTFE grafts and other grafts with needle sealing properties marketed by W. L. Gore and Associates, the largest synthetic graft company, and other companies.
The medical products market is characterized by rapidly evolving technology and intense competition. The future success of the Company will depend on its ability to keep pace with advancing technology and competitive innovations. Many potential competitors have significantly greater research and development capabilities, experience in obtaining regulatory approvals and marketing, and financial and managerial resources than the Company. Many potential competitors have developed or are in the process of developing technologies that are, or in the future may be, the basis for competitive products, some of which may employ an entirely different approach or means of accomplishing the desired therapeutic effect than products being developed by the Company.
Government Regulation
Government regulation in the United States and other countries is a significant factor in the development and marketing of the Company's products and in the Company's ongoing manufacturing and research and development activities. The Company and its products are regulated by the FDA under a number of statutes, including the FDC Act.
Under the FDC Act, medical devices are classified into one of three classes (i.e., Class I, II or III) on the basis of the controls deemed necessary to reasonably ensure their safety and effectiveness. Class I devices are subject to the least extensive controls, as the safety and effectiveness reasonably can be assured through general controls (e.g., labeling, premarket notification and adherence to GMP). For Class II devices, safety and effectiveness can be assured through the use of special controls (e.g., performance standards, post market surveillance, patient registries and FDA guidelines). Class III devices (i.e., life-sustaining or life-supporting implantable devices, or new devices which have been found, or are determined to be not substantially equivalent to legally marketed devices) require the highest level of control, including premarket approval by the FDA to ensure their safety and effectiveness.
If a manufacturer or distributor of medical devices can establish that a proposed device is "substantially equivalent" to a legally marketed Class I or Class II medical device or to a Class III medical device for which the FDA has not required a PMA application, the manufacturer or distributor may seek FDA marketing clearance for the device by filing a 510(k) notification. Following submission of the 510(k) notification, the manufacturer or distributor may not place the device into commercial distribution in the United States until an order has been issued by the FDA. The FDA's target for issuing such orders is within 90 days of submission, but the process can take significantly longer. The order may declare the FDA's determination that the device is "substantially equivalent" to another legally marketed device and allow the proposed device to be marketed in the United States. The FDA may, however, determine that the proposed device is not substantially equivalent or may require further information, such as additional test data, before making a determination regarding substantial equivalence. Any adverse determination or request for additional information could delay market introduction and have a materially adverse effect on the Company's continued operations.
If a manufacturer or distributor of medical devices cannot establish that a proposed device is substantially equivalent to another device via the 510(k) process, the manufacturer or distributor must seek PMA approval of the proposed device. A PMA application must be submitted, supported by extensive data, including preclinical and clinical trial data to prove the safety and efficacy of the device. Generally, a company is required to obtain an IDE before it commences clinical testing in the United States in support of such PMA. The FDA monitors and oversees the use and distribution of such "research use only" and "investigational use only" products. Although by statute the FDA has 180 days to review a PMA application once it has been accepted for filing, during which time an advisory committee may also evaluate the application and provide recommendations to the FDA, PMA reviews often extend over a significantly protracted time period, usually 12 to 24 months or longer from filing. Accordingly, there can be no assurance that FDA review of any PMA application submitted by the Company will not encounter prolonged delays or that the data collected and submitted by the Company in its PMA will support approval.
Labeling and promotional activities are subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The FDA also imposes post-marketing controls on the Company and its products, and registration, listing, medical device reporting, post-market surveillance, device tracking and other requirements on medical devices. Failure to meet these pervasive FDA requirements or adverse FDA determinations regarding the Company's clinical and preclinical trials could subject the Company and/or its employees to injunction, prosecution, civil fines, seizure or recall of products, prohibition of sales or suspension or withdrawal of any previously granted approvals.
The FDC Act regulates the Company's quality control and manufacturing procedures by requiring the Company to demonstrate compliance with current GMP as specified in published FDA regulations. The FDA monitors compliance with GMP by requiring manufacturers to register with the FDA, which subjects them to periodic unannounced FDA inspections of manufacturing facilities. If violations of applicable regulations are noted during FDA inspections of the Company's manufacturing facilities, the continued marketing of the Company's products may be adversely affected. Such regulations are subject to change and depend heavily on administrative interpretations.
There can be no assurance that future changes in regulations or interpretations made by the FDA or other regulatory bodies, with possible retroactive effect, will not adversely affect the Company.
The Company has complied with GMP requirements in the past and believes it will be able to comply with all applicable regulations regarding the manufacture and sale of medical devices.
The export and sale of medical devices outside of the United States are subject to United States export requirements and foreign regulatory requirements. A device under a U.S. IDE may be exported to any country, so long as its import to the receiving country complied with its requirements, and so long as at least one of the industrialized countries has ageeed to its import. Legal restrictions on the sale of imported medical devices vary from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA approval, and the requirements may differ. For countries in the European Union, in January 1995, CE Mark certification procedures became available for medical devices, the successful completion of which would allow certified devices to be placed on the market in all European Union countries. After June 1998, medical devices may not be sold in European Union countries unless they display the CE Mark. The Company expects to obtain the right to affix the CE Mark to its products in 1997. There can be no assurance that Possis will be able to obtain regulatory approvals or clearances for its products in foreign countries.
Employees
As of September 30, 1996, the Company had 138 full-time employees and five contract employees. Of these full-time employees, 35 are in research and development, 69 are in manufacturing and production, 8 are in quality systems, 5 are in facilities/maintenance, and 21 are in management or administrative positions. None of the Company's employees is covered by a collective bargaining agreement, and management considers its relations with its employees to be good.
Item 2.

Item 2. Properties:
The Company leases approximately 51,000 square feet of office and manufacturing space (including approximately 6,500 square feet of clean manufacturing space) at 9055 Evergreen Boulevard NW, Minneapolis, Minnesota 55433-8003. See Note 8 of Notes to Consolidated Financial Statements in Part II, Item 8.
Item 3.

Item 4. Submission of Matters to a Vote of Security-Holders:
None
EXECUTIVE OFFICERS OF THE REGISTRANT
Robert G. Dutcher served as Executive Vice President of the Company from June 1992 until October 1993 and has served as President, Chief Executive Officer and a director of the Company since October 1993 and as President and Chief Operating Officer of Possis Holdings, Inc. (a subsidiary formerly known as Possis Medical, Inc.) since 1987. Prior to joining the Company, Mr. Dutcher had served in several positions (most recently as Director of Research and Development) at Medtronic, Inc. since 1972. Mr. Dutcher received a master's degree in biomedical engineering from the University of Minnesota.
Joseph J. Afryl Jr has served as Vice President of the Company since April 1994. Prior to joining the Company, Mr. Afryl served as Vice President of Sales and Marketing for Bio-Vascular, Inc. from July 1992 to March 1994, as Director of Sales for Angeion Corporation from September 1991 through July 1992, and as Director of Marketing at St. Jude Medical, Inc. from May 1987 to September 1991. Each of these companies is a manufacturer of medical devices.
Russel E. Carlson joined the Company in September 1991 and has served as Vice President and Chief Financial Officer of the Company since June 1992. Prior to joining the Company, Mr. Carlson had been Chief Financial Officer of SpectraScience, Inc. (formerly GV Medical, Inc.), a Minneapolis, Minnesota medical device company, since September 1989 and had served in several financial management positions with The Pillsbury Company, a food manufacturer and processor, since 1972.
Irving R. Colacci has served as Secretary and Corporate Counsel of the Company since July 1988 and as Vice President and General Counsel since December 1993. Prior to joining the Company, Mr. Colacci had been an attorney at Dorsey & Whitney LLP
William J. Drasler has served as Vice President of the Company since December 1993 and as Vice President of Research and Development and Director of New Product Development of Possis Holdings, Inc. since 1986. Prior to joining the Company, Dr. Drasler had served as an engineering and program manager at SciMed Life Systems, Inc. since 1983. Dr. Drasler received a Ph.D. in biomedical engineering and a M.S. in chemical engineering from the University of Minnesota.
James D. Gustafson has served as a Vice President of the Company since January 1, 1994 and has been Director of Quality Systems and Regulatory/Clinical Affairs for Possis Holdings, Inc. since June 1993. Prior to joining the Company, Mr. Gustafson had served as a Manager of Clinical and Regulatory Affairs and of Clinical Programs at St. Jude Medical, Inc., a medical device manufacturer, since June 1989, and as a Senior Clinical Scientist at Shiley, Inc., Irvine, California, since March 1985. Mr. Gustafson received a master's degree in management from University of Redlands and a master's degree in biology from the University of California at Irvine.
Robert J. Scott has served as Vice President of the Company since December 1993 and as Vice President of Manufacturing Operations of Possis Holdings, Inc. since 1988 and was Director of Manufacturing Operations for Possis Holdings, Inc. from 1984 through 1988. Prior to joining the Company, Mr. Scott had served as a consultant to various medical and nonmedical manufacturing companies and as Manufacturing Manager for Aequitron Medical, Inc. and Resistance Technology Incorporated and in various positions for Daig Corporation and Medtronic, Inc.
PART II
Item 5.

Item 5. Market for the Registrant's Common Equity and Related StockholderMatters:
The Company had 1,781 common shareholders of record at July 31, 1996. The common stock is traded on The Nasdaq Stock Market under the symbol POSS. High and low closing sale prices for each quarter of fiscal years ended July 31, 1996 and 1995 are presented below:
Additional information is contained in Note 5 of Notes to Consoldiated Financial Statements included in Part II, Item 8.
The Company has not paid cash dividends on its common stock since 1983. The Company currently intends to retain all earnings for use in its business and does not anticipate paying cash dividends in the foreseeable future.
Item 6.

Item 6. Selected Financial Data:
SELECTED FINANCIAL DATA POSSIS MEDICAL, INC. AND SUBSIDIARIES
Item 7.

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The Company was incorporated in 1956 and went public in 1960 as Possis Machine Corporation. Initial operations consisted of design, manufacturing, and sales of industrial equipment and a division that provided temporary technical personnel. The Company's involvement with medical products began in 1976, when it sold its rights to a patented bileaflet mechanical heart valve, which it had obtained from Zinon C. Possis, the founder of the Company, to St. Jude Medical, Inc. for royalty payments based on St. Jude's valve sales (the "St. Jude Royalties"). See Note 6 of Notes to Consolidated Financial Statements contained in the Annual Report. In 1982 a subsidiary was established to focus initially on the development of a synthetic blood vessel used to bypass blocked coronary arteries. In the late 1980's the Company decided to leverage existing management expertise and entered the pacemaker lead business. The strategic role of the pacemaker lead business was to provide cash flow to fund the development of synthetic grafts and thrombectomy systems and to give the Company access to and name recognition within the medical device industry. In 1990 the Company made the decision to focus on medical products and subsequently divested all non-medical operations, beginning with its Technical Services division in September 1991 followed by its industrial equipment subsidiary and related land and buildings in January 1994. See Notes 2 and 12 of Notes to Consolidated Financial Statements contained in the Annual Report. In March 1994 the Company sold its pacemaker lead business because it anticipated that revenues from this business would decrease due to a pacemaker lead technology shift. In connection with this sale, the Company received $1.1 million in cash and the right to receive royalty payments over a twelve-month period. See Note 11 of Notes to Consolidated Financial Statements contained in the Annual Report. The sale of the pacemaker lead business has enabled Possis to focus its human and financial resources exclusively on its other products, which are currently in clinical trials in the United States and in early stages of commercialization in Europe, Japan and Canada.
Over the past three fiscal years, the Company has transitioned its revenue stream from pacemaker leads and royalty revenues to revenues from the sale of its new products and related sales agreements. The resulting cash flow, together with the approximately $34.0 million net proceeds from the Company's 1994 and 1995 Common Stock offerings, has been used to fund the Company's operations, including research and development related to its products. With the sale of its pacemaker lead business and the expiration of royalty payments from St. Jude in March 1995, Possis does not expect to become profitable unless it achieves significant sales outside the United States and its products receive United States Food and Drug Agency ("FDA") marketing approval. There can be no assurance that significant sales or marketing approvals will occur.
Results of Operations
Fiscal Years ended July 31, 1996, 1995 and 1994
Total revenues decreased 50% in fiscal 1996 and 60% in fiscal 1995 compared to the prior years. Significant factors in the revenue declines were the March 1994 sale of the Company's pacemaker leads business and the ending of the St. Jude Royalties in March 1995. Fiscal 1996 medical products revenues are primarily non-U.S. sales of the AngioJet Thrombectomy System to prominent physicians for early clinical use. The Company also made the initial shipments of Perma-Flow and Perma-Seal Grafts to Baxter Healthcare Corporation and C. R. Bard, respectively, the Company's product marketing partners, both of which are expected to begin product sales outside the United States in fiscal 1997. Sales agreement revenue received during fiscal 1996 and fiscal 1995 from Baxter Healthcare Corporation and C. R. Bard was $0.2 million and $1.0, respectively. The Company believes that future revenues will come primarily from the sale of its current products.
Cost of medical products for the years ended July 31, 1996, 1995 and 1994 includes manufacturing start-up expenses of approximately $4.5 million, $3.0 million and $2.3 million, respectively. The Company's products incorporate new technology and their manufacture requires the development of new processes and equipment. Manufacturing start-up expense includes excess labor and material costs, higher than normal levels of scrap product and unabsorbed manufacturing overhead expense. Additional start-up expenses are expected as the Company continues to refine its manufacturing processes and until the Company begins to produce its products in higher volumes.
Selling, general and administrative expense increased 44% to $3.1 million in fiscal 1996 from $2.1 million in fiscal 1995 which increased 24% from $1.7 million in fiscal 1994. The increases in both years result from a 65-70% annual growth in sales and marketing expenditures for personnel, travel, conventions and related expenses necessary to broaden non-U.S. distribution and to prepare for FDA marketing clearance of its initial products. The Company expects continued increases in sales and marketing expenditures as it builds a United States direct sales organization to sell the AngioJet Thrombectomy System and as it develops the distribution systems for its other products.
Research and development expenditures declined 4% in fiscal 1996 and 12% in fiscal 1995 from prior year spending. The Company's research activities over the last three years have been primarily focused on completing the development of its thrombectomy system and two graft products, including product and process development, FDA-required human clinical trials and filing U.S. product registrations on two products. In addition, the Company has a program to screen new product ideas and identify new product and business opportunities for the future. FDA regulatory, clinical study and product registration costs were 15% of total research and development spending in fiscal 1994 and increased to 68% of total spending in fiscal 1996 as the Company has moved into mid and later stages of the clinical process on its products. Total research and development expenditures are expected to grow in future years.
Interest expense has decreased to approximately $14,000 in fiscal 1996 from $24,000 in fiscal 1995 and $124,000 in fiscal 1994. The Company used a portion of the proceeds from its fiscal 1995 stock offering to retire $500,000 of debt in early fiscal 1995. The Company incurred a loss of approximately $64,000 in fiscal 1996 on the sale of a U.S. government security. The sale proceeds were reinvested in government securities offering a greater return.
Liquidity and Capital Resources
The Company's cash, cash equivalents and short-term investments were approximately $23.5 million at July 31, 1996, an increase of $16.8 million from the prior year. The primary factor in the improved cash position was the completion in October 1995 of a stock offering of 1,971,258 shares of common stock by the Company netting the Company approximately $26.7 million.
During fiscal 1996, cash used in operating activities was $8.8 million, which resulted primarily from an $8.2 million net loss and a $1.9 million increase in receivables, inventories and other current assets, offset by depreciation, amortization of goodwill, stock compensation and an increase in trade accounts payable totaling $1.1 million. Cash used in investing activities was $15.6 million, which resulted primarily from net purchases of marketable securities of $14.8 million and additions to plant and equipment of $1.5 million, offset by the proceeds from the sale of discontinued operations of $589,000. Fiscal 1996 additions to plant include approximately $1.2 million associated with the Company's April 1996 relocation to a larger leased facility. Proceeds from discontinued operations increased $240,000 in fiscal 1996 as a result of the prepayment by Advanced Technical Services, Inc. ("ATS") of the notes receivable and estimated remaining royalty payments in connection with the sale of ATS. See Note 2 of Notes to Consolidated Financial Statements. Net cash provided by financing activities of $26.7 million resulted primarily from the Company's October 1996 common stock offering netting approximately $26.7 million.
During fiscal 1995, cash used in operating activities was $1.9 million, which resulted principally from the net loss of $4.7 million and a decrease in accrued and other current liabilities of $1.1 million, offset by depreciation, amortization of goodwill and stock compensation totaling $546,000 and a decrease in accounts receivable of $3.2 million. Cash used in investing activities was $1.5 million, which resulted primarily from net purchases of marketable securities of $1.3 million and additions to plant and equipment of $562,000, offset by proceeds from the sale of discontinued operations of $350,000. Net cash provided by financing activities of $7.1 million resulted principally from the September 1994 common stock offering of $7.2 million, the exercise of stock options of $297,000 and proceeds from notes payable of $116,000, offset by the repayment of long-term debt of $595,000.
During fiscal 1994, cash used in operating activities was $1.2 million, which resulted principally from a net loss before gains on the sale of the pacemaker lead business and real estate of approximately $2.3 million and decreases in accounts payable and accrued and other current liabilities of $825,000, offset by depreciation, amortization of goodwill and stock compensation totaling $665,000 and a decrease in accounts receivable of $1.5 million. Cash provided by investing activities was $2.9 million, including primarily proceeds from the sale of discontinued operations of $1.1 million and proceeds from the sale of real estate and the pacemaker lead business of $1.2 million and $1.1 million, respectively, offset by additions to plant and equipment of $554,000. Net cash used in financing activities of $460,000 resulted principally from repayment of long-term debt of $803,000 offset by proceeds from notes payable of $144,000 and proceeds from the issuance of stock and exercise of options and warrants of $199,000.
The Company is growing non-U.S. sales of its current products, but sales to date have been limited to influential healthcare professionals to gain clinical experience. The thrombectomy system clinical experience base has grown and the Company believes non-U.S. sales will increase in countries where the Company has distributor presence and will also increase as the Company broadens its distribution to new countries. Non-U.S. marketing of the Company's two graft products is expected to begin in fiscal 1997. To sell its products in the United States, the Company must first obtain a clearance or an approval from the FDA. The Company expects to receive marketing clearance for one and possibly two of its products during fiscal 1997, which the Company believes will result in increased product sales. The Company can provide no assurance that it will obtain the U.S. FDA clearances and approvals required to sell its products in the United States in a timely manner or at all.
The Company expects it will report another loss in fiscal 1997 as it continues to incur significant U.S. clinical trial expenses and manufacturing and sales and marketing start-up costs. The Company believes that the capital available at July 31, 1996 plus the expected product sales and revenues from sales agreements will provide sufficient cash to fund expected losses and meet other cash usage needs until such time as it generates positive cash flow. The Company can provide no assurance, however, that it will ever become profitable.
Item 8.

Item 8. Financial Statements and Supplementary Data:
INDEPENDENT AUDITORS' REPORT
To the Shareholders of Possis Medical, Inc.:
We have audited the accompanying consolidated balance sheets of Possis Medical, Inc. and subsidiaries (the Company) as of July 31, 1996 and 1995 and the related consolidated statements of operations, cash flows, and changes in shareholders' equity for each of the three years in the period ended July 31, 1996. Our audit also included the financial statement schedule listed in the Index at Item 14. These financial statements and financial statement schedule 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 audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Possis Medical, Inc. and subsidiaries as of July 31, 1996 and 1995 and the results of their operations and their cash flows for each of the three years in the period ended July 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
Minneapolis, Minnesota September 6, 1996
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation The accompanying consolidated financial statements include the accounts of Possis Medical, Inc. (the Company) and its wholly-owned subsidiaries, Possis Holdings, Inc., JEI Liquidation, Inc.(Jet Edge) (Note 2) and Possis Medical Europe B.V., after elimination of intercompany accounts and transactions.
The Company is a developer, manufacturer and marketer of medical devices. The Company was incorporated in 1956 and has operated several businesses over the last 40 years. In 1990 the Board of Directors decided to focus on medical products, which led to the sale of the Technical Services Division in 1991 and the Jet Edge industrial waterjet business in 1994. In March 1994 the Company sold its pacemaker lead business because it anticipated that revenues from this business would decline due to a pacemaker lead technology shift. The name of the Company was changed to Possis Medical, Inc. in 1993. In January 1995, the Company established a 100% owned subsidiary (Possis Medical Europe B.V.) in the Netherlands to support international product distribution.
The Company's thrombectomy and graft products utilize new technology and the production processes and production equipment used to manufacture them are unique and have been designed and constructed by Company employees. In addition, the medical device industry is subject to the laws and oversight of the United States Food and Drug Agency ("FDA") as well as non-U.S. regulatory bodies in countries where the Company does business.
Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Inventories Inventories are stated at the lower of cost (on the first-in, first-out basis) or market.
Property, Depreciation, and Amortization Property is carried at cost and depreciated using the straight-line method over estimated useful lives of the assets at the following annual rates:
Leasehold improvements ............................. 3-10% Machinery and equipment ............................. 10-25%
Goodwill Goodwill is being amortized on a straight-line basis over 13-1/2 years, based on the remaining life of patent rights related to the Perma-Flow Graft acquired in 1988. Accumulated amortization at July 31, 1996 and 1995 was $573,500 and $501,500, respectively.
Income Taxes The Company accounts for income taxes under Statement of Financial Accounting Standard ("SFAS") No. 109, "Accounting for Income Taxes." Certain items are accounted for tax purposes in a different period than for financial statement purposes.
Revenue Recognition Revenue associated with medical products sales is recognized when products are shipped. Heart valve patent revenue and royalty payments related to the pacemaker leads business sale were accrued based on estimated sales of the companies making the royalty payments. Revenue under product supply and distribution agreements is recognized when the required milestones have been achieved.
Fair Value of Financial Instruments Marketable securities are carried at fair value. The carrying value of all other financial instruments, except long-term debt, approximates fair value due to the short-term nature of the instrument. The carrying value of long-term debt approximates fair value due to the fixed interest rates being consistent with current market rates of interest.
Earnings (Loss) Per Share The Company's outstanding stock options and stock warrants are not considered in the computation of earnings per share because the impact would be antidilutive because of the net loss. The difference between primary and fully diluted earnings per share was not significant in any period.
Cash Equivalents The Company considers highly liquid investments with original maturities of three months or less to be cash equivalents.
Marketable Securities Effective August 1, 1994 the Company adopted SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities." All Company securities as of July 31, 1996 are classified as available-for-sale and consist primarily of U.S. government securities. These investments are reported at fair value with a net unrealized loss of $145,276 included in shareholders' equity. These securities have maturity dates ranging from January 15, 1997 to March 5, 2001. The Company utilizes the specific identification method in computing gains or losses. During 1996 the Company sold available-for-sale securities aggregating approximately $1,941,000, realizing a loss of $64,007. There was no material difference between amortized cost and fair value for the marketable securities at adoption or at July 31, 1995.
Impairment of Long-Lived Assets SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," was issued in March 1995 and will be adopted by the Company in fiscal 1997. The Company does not expect that adoption of this Standard will have a material impact on the consolidated financial statements.
Stock-Based Compensation SFAS No.123, "Accounting for Stock-Based Compensation," was issued in October 1995 and must be adopted no later than fiscal 1997, except for transactions with nonemployees which is effective for all transactions entered into subsequent to December 15, 1996. The Company intends to continue to measure compensation cost for employee-based stock compensation plans under APB Opinion No. 25, "Accounting for Stock Issued to Employees," and will follow the disclosure requirements of SFAS No. 123 beginning in fiscal 1997.
2. DISCONTINUED OPERATIONS
Waterjet Equipment In January 1994, the Company sold its waterjet equipment business (Jet Edge) to TC/American Monorail, Inc. The sale resulted in a book gain of $68,123. Technical Services On September 29, 1991, the Company sold its Technical Services division to Advance Technical Services, Inc. (ATS), which is 51% owned by a former officer of the Company. Under the terms of the sale, the Company received approximately $550,000 in cash and a note of $250,000 for the net assets of the business and realized a gain of $66,517. In addition, the Company will receive a percentage of ATS's annual revenues in excess of a specified amount through September 1996, up to a maximum of $2,000,000. These amounts are recognized as income when received or when collection is reasonably assured. As part of the sale, the Company also received $200,000 in cash and a note of $500,000 for an agreement not to compete for a five-year period; income from this agreement is recognized ratably over the period of the agreement.
During 1996, ATS prepaid the notes receivable and the estimated remaining royalty payments in connection with the sale of ATS. At July 31, 1996, the only remaining balance outstanding related to the Company's sale of ATS is deferred revenue of $41,768 related to estimated royalties from August and September of 1996.
Notes receivable related to the Technical Services division at July 31, 1995 are as follows:
Income from Discontinued Operations Operating results of the waterjet equipment business and Technical Services division were as follows for the years ended July 31, 1996, 1995 and 1994:
3. OTHER CURRENT LIABILITIES AND LONG-TERM DEBT
Other current liabilities at July 31, 1996 and 1995 are as follows:
Maturities of long-term debt are $73,386 in 1997, $28,356 in 1998 and $10,213 in 1999.
4. INCOME TAXES At July 31, 1996, the Company has net operating loss carryforwards of approximately $14,145,000 for federal tax purposes which expire in 2003 through 2011 and $5,138,000 for Minnesota tax purposes which expire in 2003 through 2011.
In addition, at July 31, 1996 the Company has approximately $1,441,000 in federal tax credits, substantially all of which is a research and development tax credit, which expire from 1999 through 2011, and a $65,182 AMT credit which does not expire.
Deferred tax assets and liabilities as of July 31, 1996 and 1995 are described in the table below. The Company has not recorded any net deferred tax assets due to the uncertainty of realizing such assets:
The effective income tax rate differed from the U.S. federal statutory rate for each of the three years ended July 31, 1996, 1995 and 1994 as follows:
5. COMMON STOCK
Stock Options Certain officers, directors, key employees, and certain other individuals may purchase common stock of the Company under stock option plans. In 1992, the Company established the 1992 Stock Compensation Plan (the 1992 Plan), which replaced the 1983 and 1985 plans. Although the 1983 and 1985 plans remain in effect for options outstanding, no new options may be granted under these plans.
The 1992 Plan authorizes awards of the following types of equity-based compensation: Incentive Stock Options, Nonqualified Stock Options, Stock Appreciation Rights, Restricted Stock, Deferred Stock, Annual Grants of Stock Options to Directors, Stock Options to Directors in Lieu of Compensation for Services rendered as Directors, and Other Stock-Based Awards valued in whole or in part by reference to stock of the Company. No Incentive Stock Options may be granted on or after August 1, 2002, nor shall such options remain valid beyond ten years following the date of grant.
The total number of shares of stock reserved and available for distribution under the 1992 Plan originally was 600,000 shares, a maximum of 350,000 of which may be issued as Incentive Stock Options. The total number of shares reserved and available for distribution under the plan was increased annually on January 2, 1993, 1994 and 1995, by 1% of the number of shares of the Company's common stock outstanding at July 31 of the prior fiscal year. In 1995 the Company amended the 1992 Stock Compensation Plan by increasing the number of common shares issuable under the plan each year from 1% to 2% of the total number of shares outstanding at July 31 of the prior fiscal year. In addition, the number of common shares issuable as Incentive Stock Options under the plan was increased to 1,000,000. At July 31, 1996, there were 1,587,519 shares reserved and 1,024,531 shares available for granting under the 1992 Plan.
In 1983, the Company established an Incentive Stock Option Plan. A maximum of 545,000 shares were authorized under the plan at an option price of at least 100% of the fair market value at date of grant. The options become exercisable at date of grant, except for those options granted after March 17, 1985, which vest ratably over a three or four year period. All options expire ten years from date of grant.
In 1985, the Company established a Nonqualified Stock Option Plan under which a maximum of 200,000 shares were authorized to be granted at a price of at least 100% of the fair market value at date of grant. The options vest ratably over a three or four year period and expire not more than ten years from date of grant.
In fiscal 1996, 1995 and 1994, the Company granted 4,760, 11,574 and 16,560 compensatory options, respectively, to its outside directors in lieu of cash payments for directors fees. These options were granted under the 1992 Plan.
A summary of changes in outstanding options for each of the three years ended July 31, 1996 follows:
In 1993, the Company granted 37,000 shares of restricted stock to employees under the terms of the 1992 Plan, which vest 7,400 shares each on December 2, 1993 and on June 3, 1994, 1995, 1996 and 1997. Approximately $128,000 was accrued to pay the estimated withholding taxes on those shares as management believes that the employees will elect to receive fewer shares in lieu of paying the withholding taxes. In case of termination of the employees, with the exception of those shares that vested December 2, 1993, unvested shares are forfeited. Unearned compensation of $342,250 was recorded at the date of grant and is being recognized over the vesting period. In addition, the Company issued 5,717 shares of deferred stock under the 1992 Plan which were fully vested at July 31, 1993. In 1996 the Company granted 18,000 shares of restricted stock to employees which vest 9,000 shares each on June 3, 1996 and 1997, under terms similar to the 1993 grants. Approximately $112,000 was accrued to pay the estimated withholding taxes on those shares as management believes that the employees will elect to receive fewer shares in lieu of paying the withholding taxes. Unearned compensation of $265,540 was recorded at the date of grant and is being recognized over the vesting period. In fiscal 1996, 1995 and 1994, total compensation expense of $213,197, $68,449 and $176,832, respectively, was recognized on these shares.
During 1996, the Company issued options to purchase 55,000 shares of common stock to various distributors of the Company's products. The options are exercisable at $12.56 - $14.39 per share and expire in 2001. SG&A expense of approximately $251,000 was recorded in connection with these transactions.
Stock Warrants Stock purchase warrants held by unrelated parties representing the right to purchase an aggregate of 26,400 shares of the Company's common stock at $8.52 a share were outstanding at July 31, 1996. These warrants do not have an expiration date and must be exercised if the market value of the Company's common stock exceeds $22.73 per share for a specified period.
On September 15, 1994, warrants to purchase 120,000 shares of common stock at $6.90 per share were issued to John G. Kinnard & Company in conjunction with the Company's September 1994 public stock offering. As of July 31, 1996, all such warrants were outstanding.
Employee Stock Purchase Plan The Employee Stock Purchase Plan, effective January 1, 1991, enables eligible employees, through payroll deduction, to purchase the Company's common stock at the end of each calendar year. The purchase price is the lower of 85% of the fair market value of the stock on the first or last day of the calendar year. The Company issued 17,194 shares in 1996, 10,932 shares in 1995 and 16,019 shares in 1994 under this plan.
6. RELATED-PARTY TRANSACTIONS The Company and St. Jude Medical, Inc. (St. Jude), an unrelated corporation, entered into an agreement under which the Company transferred to St. Jude its entire right, title, and interest in the patents relating to a prosthetic heart valve developed by Z. C. Possis, former Chief Executive Officer of the Company, on his own time and without consideration. Under the terms of the agreement, St. Jude remitted royalty payments to the Company through March 14, 1995 equal to 2% of St. Jude's total net sales of heart valves in excess of $4,052,000 per year. The Company paid 25% of such payments to a group of individuals including a shareholder of the Company, three relatives of Z. C. Possis and four unrelated persons and 11.25% (7.5% through February 1992) to Z. C. Possis or his estate.
7. 401 K PLAN The Company has an employees' savings and profit sharing plan for all qualified employees who have completed one year of service. Company contributions are made at the discretion of the Board of Directors subject to the maximum amount allowed under the Internal Revenue Code. Contributions for the years ended July 31, 1996, 1995, and 1994 were $90,114, $77,907 and $98,417, respectively.
8. LEASE COMMITMENTS The Company's medical products operation is conducted from a leased facility under an operating lease which expires in 2006. Rental payments under the lease are guaranteed by a letter of credit in the amount of $20,000 at July 31, 1996. Rental expense charged against earnings was $329,340 in fiscal 1996, $379,706 in fiscal 1995, and $340,342 in fiscal 1994. The future annual rentals on this operating lease are $242,000 per year through 2006. The lease is noncancelable before April 2001, after which it can be canceled with notice and payment of a termination fee.
9. RESEARCH AND DEVELOPMENT The Company has had agreements for joint funding of certain research and development costs related to the Company's products and projects. In connection therewith, the Company recorded medical products revenue of approximately $576,000 in fiscal 1994 in exchange for the rights to the use of certain technology and products.
10. SALES TO MAJOR CUSTOMERS The Company's continuing operations are in one segment, the design, manufacture and distribution of cardiovascular and vascular medical devices. Approximately 80% of medical product sales are to foreign customers. In 1996, sales to four customers amounted to 21%, 17%, 14% and 12% of medical products revenues, and the receivables related to these customers were 21%, 2%, 0%, and 6% of total receivables, respectively. In 1995, sales to two customers amounted to 62% and 15% of medical products revenues and in 1994, sales to two customers totaled 70% and 14% of medical product revenues.
11. SALE OF PACEMAKER LEADS BUSINESS On March 18, 1994, the Company sold the assets of the pacemaker lead product line to Innovex, Inc. The Company received $1,100,000 in cash in exchange for $451,786 in inventories and fixed assets, recording a gain of $647,816. In addition, the Company received a 75% royalty on gross sales of certain leads and related services for one year. The pacemaker leads was a product line and component of the medical products segment. Since other components of this segment (research and development activities and initial production of new products) are continuing, the sale of the lead business has not been reported as a discontinued operation.
12. SALE OF REAL ESTATE In March 1994, the Company closed on the sale of its land, buildings and leasehold improvements associated with the Jet Edge business to TC/American Monorail, Inc. The property sold for $1,200,000 and the Company recorded a gain on the sale of $957,573. All Company operations are now conducted at the leased facility in Coon Rapids, Minnesota.
13. PRODUCT SUPPLY AND DISTRIBUTION AGREEMENTS On December 30, 1994, the Company executed a Supply and Distribution Agreement with Bard Vascular Systems Division, C.R. Bard, Inc. ("Bard"). This Agreement grants to Bard exclusive worldwide sales and marketing rights to the Possis Perma-Seal Dialysis Access graft for an initial 10-year term, renewable for the life of applicable patents. Under this Agreement, through July 31, 1996, the Company has received $1,000,000 and will receive up to an additional $1,500,000 if the Company achieves certain additional regulatory and commercialization milestones.
On March 15, 1996 the Company entered into a Distribution Agreement with Baxter Healthcare Corporation ("Baxter"). This Agreement grants Baxter exclusive worldwide distribution rights to the Possis Perma-Flow Coronary Bypass Graft for a three-year term. Under this Agreement, through July 31, 1996, the Company received $200,000 and will receive up to an additional $400,000, $200,000 on each of the first and second anniversary dates of agreement signing, as long as the agreement is in effect.
Item 9.

Item 9. Changes in and disagreements with Accountants on Accounting andFinancial Disclosure:
During fiscal 1995 and 1996, there were no changes in or disagreements with the Company's independent certified public accountants on accounting procedures or accounting and financial disclosures.
PART III
Item 10.

Item 10. Directors and Executive Officers of the Registrant:
Information under the heading "Election of Directors" in the Proxy Statement is incorporated herein by reference. The information regarding executive officers is included in Part I of this report under the caption "Executive Officers of the Registrant."
Item 11.

Item 11. Executive Compensation:
Information regarding compensation of directors and officers for the fiscal year ended July 31, 1996 is in the Proxy Statement and is incorporated herein by reference.
Item 12.

Item 12. Security Ownership of Certain Beneficial Owners and Management:
The security ownership of certain beneficial owners and management is in the Proxy Statement and is incorporated herein by reference.
Item 13.

Item 13. Certain Relationships and Related Transactions:
Information regarding related party transactions is contained in Note 6 of Notes to Consolidated Financial Statements in Part II, Item 8 and "Certain Relationships and Related Transactions" in the Proxy Statement and is incorporated herein by reference.
PART IV
Item 14.

Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K:
(a) 1. Financial Statements
The following financial statements of the Company, accompanied by an Independent Auditors' Report, are contained in Part II, Item 8:
Consolidated Statements of Operations for each of the three years in the period ended July 31, 1996 Consolidated Balance Sheets, July 31, 1996 and 1995 Consolidated Statements of Cash Flows for each of the three years in the period ended July 31, 1996. Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended July 31, 1996. Notes to Consolidated Financial Statements
2. Schedules
The following financial statement schedules are submitted herewith:
Consent of independent certified public accountants.
SCHEDULE VIII - Valuation Accounts
Other schedules are omitted because they are not required or are not applicable or because the required information is included in the financial statements listed above.
3. Exhibits
Certain of the following exhibits are incorporated by reference from prior filings. The form with which each exhibit was filed and the date of filing are indicated on the following two pages.
Exhibit Form Date Filed Description
3.1 10-K Fiscal year ended Articles of incorporation July 31, 1994 as amended and restated to date
3.2 S-2 Amendment No.1 Bylaws as amended and restated August 9, 1994 to date
4.3 10-K Fiscal year ended Norwest Equipment Finance, Inc. July 31, 1994 loan agreement, dated January 12, 1994
10.1 S-1 June 30, 1988 Agreement with St. Jude Medical, Inc., dated August 2, 1983
10.2 8-K February 14, 1994 Asset purchase agreement with TC/American Monorail, Inc., dated January 28, 1994
10.3 S-2 July 1, 1994 Real estate purchase agreement with TC/AmericanMonorail, Inc., dated January 28, 1994
10.4 10-Q Quarter ended Asset purchase agreement with January 31, 1994 Innovex, Inc., dated March 11,
10.5 S-2 July 1, 1994 Lease agreement for corporate headquarters and manufacturing facility, dated January 4, 1991
10.6 S-2 Amendment No.1 License agreement with Imperial August 9, 1994 Chemical Industries Plc., dated April 15, 1991
10.7 S-2 Amendment No.1 License agreement with the August 9, 1994 University of Liverpool, dated May 10, 1990
10.8 S-1 June 30, 1988 Form of indemnification agreement with officers and directors of Registrant
* 10.9 S-8 February 7, 1990 1983 Incentive Stock Option Plan as amended to date
* 10.10 S-1 June 30, 1988 1985 Nonqualified Stock Option Plan as amended to date
Exhibit Form Date Filed Description * 10.11 10-K Fiscal year ended Form of incentive stock option July 31, 1989 agreement for officers
* 10.12 10-K Fiscal year ended Form of stock option agreement July 31, 1989 for directors
* 10.13 S-8 December 30, 1992 1992 Stock Compensation Plan
* 10.14 10-K Fiscal year ended Form of restricted stock July 31, 1993 agreement for officers (1992 Plan)
* 10.15 10-K Fiscal year ended Form of nonqualified stock July 31, 1993 option agreement for officers (1992 Plan)
* 10.16 10-K Fiscal year ended Form of incentive stock option July 31, 1993 agreement for officers (1992 Plan)
* 10.17 10-K Fiscal year ended Form of nonqualified stock July 31, 1993 option agreement for 1992 directors' fees (1992 Plan)
* 10.18 10-K Fiscal year ended Form of nonqualified stock July 31, 1993 option agreement for 1990 directors' fees
* 10.19 10-K Fiscal year ended Form of nonqualified stock July 31, 1993 option agreement for 1989 directors' fees
10.20 S-2 Amendment No. 1 Underwriting agreement entered August 9, 1994 into between the Company and John G. Kinnard and Company, Incorporated including form of warrant to representative dated September 8, 1994
10.21 10-Q Quarter ended Supply & distribution agreement January 31, 1995 with Bard Vascular Systems Division, C.R.Bard, Inc.
10.22 S-3 Amendment No. 2 Underwriting agreement entered September 29, 1995 into between the Company, Dain Bosworth Incorporated and John G. Kinnard and Company, Incorporated dated October 2, 1995.
Exhibit Form Date Filed Description
10.23 10-Q Quarter ended Lease agreement for corporate January 31, 1996 headquarters and manufacturing facility dated December 15, 1995.
10.24 8-K March 28, 1996 Supply and distribution agreement with Edwards CVS Division, Baxter Healthcare Corporation
21 10-K Fiscal year ended Subsidiaries of registrant July 31, 1995
23 Consent of independent certified public accountants
27 Financial data schedule
* Indicates management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K
Possis Medical, Inc. filed no reports on Form 8-K during the quarter ended July 31, 1996.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
POSSIS MEDICAL, INC.
by: /s/ Russel E. Carlson Russel E. Carlson Vice President of Finance Chief Financial and Accounting Officer
Dated: October 21, 1996
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
Signature Title Date
/s/ Donald C. Wegmiller Chairman of the Board October 21, 1996 Donald C. Wegmiller
/s/ Robert G. Dutcher Director, President and October 21, 1996 Robert G. Dutcher Chief Executive Officer
/s/ Dean Belbas Director October 21, 1996 Dean Belbas
/s/ Seymour J. Mansfield Director October 21, 1996 Seymour J. Mansfield
/s/ Demetre Nicoloff, MD Director October 21, 1996 Demetre Nicoloff, MD
/s/ Ann M. Possis Director October 21, 1996 Ann M. Possis
/s/ Joe A. Walters Director October 21, 1996 Joe A. Walters
SCHEDULE VIII
POSSIS MEDICAL, INC.
VALUATION ACCOUNTS YEARS ENDED JULY 31, 1996, 1995 AND 1994 ______________________________________________________________________________
Column A Column B Column C Column D Column E
Additions Balance at Charged to Beginning Costs and Deductions Balance at Description of Year Expenses Write-offs End of Year
Allowance for doubtful accounts - deducted from trade receivables in the balance sheet:
Year ended July 31, 1996 $ 27,019 $ 50,000 $ 17,019 $ 60,000 Year ended July 31, 1995 120,000 (76,375) 16,606 27,019 Year ended July 31, 1994 309,000 (93,220) 95,780 120,000
Reserve for loss on disposal of discontinued waterjet equipment segment:
Year ended July 31, 1996 $ -- $ -- $ -- $ -- Year ended July 31, 1995 -- -- -- -- Year ended July 31, 1994 850,000 (68,123) 781,877 --
Valuation allowance on deferred tax asset:
Year ended July 31, 1996 $4,898,000 $2,003,000 $ -- $6,901,000 Year ended July 31, 1995 2,556,000 2,342,000 -- 4,898,000 Year ended July 31, 1994 2,298,000 515,000 257,000 2,556,000
Reserve for inventory obsolescence:
Year ended July 31, 1996 $125,000 $ 38,795 $ 13,795 $150,000 Year ended July 31, 1995 150,000 136,086 161,086 125,000 Year ended July 31, 1994 27,775 135,051 12,826 150,000
POSSIS MEDICAL, INC. FORM 10-K - ITEM 14(a)3
EXHIBIT INDEX Exhibit
Number Description
3.1 Articles of incorporation as amended and restated to date
3.2 Bylaws as amended and restated to date
4.1 Loan agreement with Norwest Equipment Finance, Inc., dated January 12, 1994
10.1 Agreement with St. Jude Medical, Inc., dated August 2, 1983
10.2 Asset purchase agreement with TC/American Monorail, Inc., dated January 28, 1994
10.3 Real estate purchase agreement with TC/American Monorail, Inc., dated January 28, 1994
10.4 Asset purchase agreement with Innovex, Inc., dated March 11, 1994
10.5 Lease agreement for corporate headquarters and manufacturing facility, dated January 4, 1991
10.6 License agreement with Imperial Chemical Industries Plc., dated April 15, 1991
10.7 License agreement with the University of Liverpool, dated May 10, 1990
10.8 Form of indemnification agreement with officers and directors of Registrant
10.9 1983 Incentive Stock Option Plan as amended to date
10.10 1985 Nonqualified Stock Option Plan as amended to date
10.11 Form of incentive stock option agreement for officers
Exhibit
Number Description
10.12 Form of stock option agreement for directors
10.13 Restated 1992 Stock Compensation Plan
10.14 Form of restricted stock agreement for officers (1992 Plan)
10.15 Form of nonqualified stock option agreement for officers (1992 Plan)
10.16 Form of incentive stock option agreement for officers (1992 Plan)
10.17 Form of nonqualified stock option agreement for 1992 directors' fees (1992 Plan)
10.18 Form of nonqualified stock option agreement for 1990 directors' fees
10.19 Form of nonqualified stock option agreement for 1989 directors' fees
10.20 Underwriting agreement entered into between the Company and John G. Kinnard and Company, Incorporated including form of warrant to representative dated September 9, 1994
10.21 Supply and distribution agreement with Bard Vascular Systems Division, C. R. Bard, Inc.
10.22 Underwriting agreement entered into between the Company, Dain Bosworth Incorporated and John G. Kinnard and Company, Incorporated dated October 2, 1995
10.23 Lease agreement for corporate headquarters and manufacturing facility dated December 15, 1995
10.24 Supply and distribution agreement with Edwards CVS Division, Baxter Healthcare Corporation
21 Subsidiaries of registrant
23 Consent of independent certified public accountants
27 Financial data schedule
Document has heretofore been filed with the Securities and Exchange Commission as indicated in Item 14(a) 3 and is incorporated herein by reference.
EXHIBIT 23
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Possis Medical, Inc.:
We consent to the incorporation by reference in Post-Effective Amendment No. 1 to Registration Statement No. 33-5467 on Form S-8, Post-Effective Amendment No. 1 to Registration Statement No. 33-33416 on Form S-8, Registration Statement No. 33-39987 on Form S-8, and Registration Statement No. 33-56728 on Form S-8 of our report, dated September 6, 1996, appearing in this Annual Report on Form 10-K of Possis Medical, Inc. for the year ended July 31, 1996.
Minneapolis, Minnesota October 25, 1996