ITEM 1. BUSINESS OF THE COMPANY
INTRODUCTION
Bionx Implants, Inc. (the "Company", "Bionx") was incorporated in Delaware in October 1995 to coordinate the business of four related companies controlled by U.S. and Finnish investors. In September 1996, the Company consummated a reorganization pursuant to which it acquired all of the capital stock of the four existing companies and issued in exchange a total of 5,263,160 shares of its Common Stock (the "Reorganization"). The four existing companies were Bioscience, Ltd. (which has been renamed Bionx Implants, Ltd. and has been engaged in the development of resorbable polymer products since 1984), Biocon, Ltd. (which held most of the Company's patents and patent applications and, during 1997, was merged into Bionx Implants, Ltd.) and two companies organized in the U.S. to further sales, marketing and development efforts, Biostent, Inc. ("Biostent") and Orthosorb, Inc. ("Orthosorb"). Of the 5,263,160 shares issued by the Company in the Reorganization, 2,578,949 shares were issued to the former U.S. stockholders of the four existing companies and 2,684,211 shares were issued to a Dutch company (Bionix, B.V.) owned by such stockholders and the former Finnish stockholders of Bionx Implants, Ltd. and Biocon, Ltd. The Company intends to dissolve Biostent and Orthosorb in the future. Unless otherwise indicated, all references herein to the business of the Company include Bionx Implants, Inc. and the four entities acquired by Bionx Implants, Inc. in connection with the Reorganization. On August 27, 1999 the Company was reincorporated in the commonwealth of Pennsylvania. See Note 1 of the Notes to the Company's Consolidated Financial Statements. There was no change in the name, business, management, benefit plans, location, assets, liabilities or net worth of the Company as a result of the reincorporation.
This Annual Report on Form 10-K contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 ("Forward-Looking Statements"). Such Forward-Looking Statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in such Forward-Looking Statements. Certain factors which could materially affect such results and the future performance of the Company are described in Exhibit 99.1 to this Annual Report on Form 10-K.
OVERVIEW
The Company is a leading developer, manufacturer and marketer of Self-Reinforced, resorbable polymer implants, including screws, pins, arrows and stents, for use in a variety of applications which include Orthopedic Trauma, SportsMedicine, Urology and Craniofacial Surgery. The Company has proprietary manufacturing processes for Self-Reinforced resorbable polymers, modifying the brittle polymer structure into a physiologically strong structure with controlled, variable strength retention. The Company currently markets its products through a hybrid sales force comprised of a managed network of independent sales agents and direct sales representatives in the U.S. and independent distributors and dealers in markets outside of the U.S. The Company's sixteen product lines, representing more than 150 distinct products, were designed to address recognized clinical needs. The Company estimates that its products have been used in over 300,000 surgeries worldwide. The Company has received 510(k) clearance from the U.S. Food and Drug Administration (the "FDA") for the fourteen product lines that it currently markets in the U.S. The Company has also received regulatory approvals for its product lines in certain European and Asian markets.
BACKGROUND
The human skeletal system is comprised of bone, connective tissue (ligaments and tendons) and cartilage. Bone, which provides the basic support for the body, may sustain damage by traumatic incident, degenerative disease or surgical procedures designed to repair or correct skeletal abnormalities. As a result of the high vascularity of bone, the healing of bone requires only that the fractured sections be in close proximity to each other. Bone heals through a process that involves structural stress, either through load-bearing or use, resulting in the replacement of old, damaged bone with new healthy tissue.
Healing of bone in healthy individuals generally requires three to 20 weeks, with the fastest healing occurring in children.
Connective tissue, which attaches bones and/or attaches bone to muscle, can either be torn or forcibly pulled from its point of attachment to bone or muscle as a result of either trauma or surgical procedures. Ligaments and, to a lesser degree, tendons are vascular structures that have the capacity to heal and recreate their healthy structure. A critical factor in the proper healing of connective tissue is in reconnection or reattachment at the anatomically correct position to assure the return of functionality to the connection between bones and/or between bone and muscle. Connective tissue heals by creating a scar at the point of injury and then gradually replacing the scar tissue with healthy connective tissue. The more vascular the tissue involved, the faster the healing process. The healing of connective tissue generally occurs over a six to 24 week period that requires rest and immobilization of the tissue.
Cartilage and cartilage-like (cartilaginous) soft tissue, such as the meniscus of the knee, provide cushion and articulating surfaces upon which bones impact during normal activity. These tissues can be damaged through either traumatic injury, long-term physical stress and/or degenerative disease. Since cartilaginous tissue is less vascular than either bone or connective tissue, or is avascular, the healing process in this tissue requires an extremely long time (and may never occur). Unlike bone and connective tissue, damaged cartilaginous tissue must be surgically assisted in the healing process. While damaged articulating cartilage has the potential to partially heal itself by generating replacement tissue, this process can leave a permanent defect in the cartilage since the substitute tissue does not possess the same functional properties as the pre-injury tissue.
Injuries involving skeletal tissue will heal more rapidly when supplemented by physical manipulation and anatomical realignment. When attempting to repair skeletal tissue, orthopaedic surgeons perform surgical procedures to recreate anatomically correct positions and to maintain these positions. The techniques and tools used by surgeons differ according to the skeletal tissue involved and the location in the body. However, the objective in each instance is identical: to reposition the tissue in its correct anatomical position and provide fixation systems to maintain that position during healing.
TRADITIONAL APPROACHES TO FIXATION
To achieve proper skeletal tissue healing, orthopaedic surgeons either (i) use implantable devices, including screws, pins, tacks, plates and nails, to perform various internal fixation and repair techniques and/or (ii) apply external fixators and immobilization systems, such as casts. These techniques are designed to ensure appropriate reduction (close approximation of the separated tissues) and compression (pressure applied to the reduced tissues to assure maintenance of the reduction) during the healing process.
Rigid Internal Fixation
Rigid internal fixation (fracture fixation) procedures are performed to repair bone fractures. These procedures, performed either through an open incision or through percutaneous, minimally invasive techniques, are designed to produce correct realignment of bones, to create appropriate reduction and to fix bones in the anatomically correct position to maximize the potential for healing. Since the 1950's, rigid internal fixation techniques involving the internal placement of metal implants have been the standard of care for fracture management and have resulted in improved healing of fractures. Rigid internal fixation is intended as a temporary measure to allow for the initiation of the healing process by creating appropriate reduction. In practice, most metal implants utilized in rigid internal fixation that are not removed cause stress shielding preventing the underlying bone from returning to full strength.
Connective Tissue Fixation
Connective tissue fixation may involve the reattachment of ligaments or tendons that have been torn at the point of attachment. Alternatively, ligaments or tendons may tear at a point other than the point of attachment, requiring reconnection to return functionality. Connective tissue fixation techniques
are performed either through open incisions or through minimally invasive techniques, and involve the use of tacks, screws, nails or sutures to effect the anatomical reattachment as close to the original point of attachment as possible. The same repair options are available to the surgeon when ligaments are torn in areas other than at their point of attachment. In both fracture fixation and connective tissue repair, the affected joint or limb is immobilized for a period of time to promote healing. While traditional connective tissue fixation techniques have resulted in adequate repairs, metal fixation devices or suture systems can cause long-term problems and complications, including local pain and limited joint functionality.
Cartilage and Cartilaginous Tissue Repair
Repairs to cartilaginous tissue typically involve removal of the torn tissue or difficult and demanding surgical techniques. Removal of tissue can have long-term consequences for the patient and may lead to subsequent surgeries. Since cartilage has minimal vascularity, or is avascular, the healing of injuries to these tissues must be surgically assisted through complex arthroscopic or open surgical techniques. For example, suturing torn menisci is one of the most technically demanding skills in arthroscopic surgery and may result in surgical complications, including damage to the vascular and neural system.
LIMITATIONS OF TRADITIONAL APPROACHES
Metal Implants
For more than 30 years, stainless steel, titanium and metal alloy screws, tacks, pins and plates have been recognized as the standard of care for the fixation of bone and connective tissue as a result of the implants' strength and their relatively low reactivity rates. The use of metal implants as the standard of care has been reinforced through the application of Association for the Study of Internal Fixation ("ASIF") techniques and the training received by most orthopaedic surgeons. As a result, the Company believes that metal fixation devices are currently used in the vast majority of the repairs of skeletal tissue requiring internal fixation.
Despite the nearly universal acceptance of metal fixation devices, the medical community has recognized several important limitations associated with these products. Most significantly, bone repaired with and supported by metal devices relies upon the implant to perform the load-bearing functions previously performed by bone. Physicians refer to this as stress shielding of the healing bones. Since bones grow and repair in response to stress, bones which are not called upon to perform their natural load-bearing functions tend to weaken in the fractured areas. Although it is recommended that metal implants be removed to deter stress shielding, frequently they are not removed. Furthermore, motion at the fracture site can cause metal implants to loosen and to create hollow areas in cancellous (spongy) bone. Connective tissue fixation techniques using metal implants can cause long-term problems, including local pain and loss of functionality due to abrasion of the surrounding tissue by the metal implant. In addition, some patients experience allergic reactions when certain metal fixation devices which remain implanted for extended periods of time.
First Generation Resorbable Implants
Resorbable fixation devices were developed in response to the limitations of metal fixation devices. The first generation of these devices was introduced in Europe in the mid-1980s and in the U.S. in the late 1980s. The majority of these devices were either brittle or overly flexible as a result of the processes, such as injection molding, which were used in their manufacture. The low strength of these implants led designers to create overly large implants with extremely high molecular weights, which, in certain instances, may have caused local inflammation and irritation at the implant site. In addition, due to their large size, these implant configurations could be applied in only certain anatomical areas, which may limit their clinical utility. For screw-shaped implants, the application of torque to effect a successful implantation often results in the breaking of the implant and the release of relatively large particles into joints or soft tissues. Implants that do not have a discernible strength are limited in their application because surgeons are familiar with metal implants and demand similar strength from resorbable implants.
Surgeons have reported that certain of the first generation resorbable implants resorb too quickly and do not provide fixation for the period required for proper bone or tissue healing. The combination of these factors led most surgeons to reject the first generation of resorbable implants, leaving metal implants as the standard of care.
SELF-REINFORCED, RESORBABLE IMPLANTS
The Company has developed a variety of proprietary resorbable polymer fixation implant product lines, including screws, pins, tacks, arrows, plates, membranes and urology stents, which provide an alternative to currently marketed implants. By modifying well-characterized resorbable polymers (e.g., poly-l-lactic acid ("PLLA") and polyglycolic acid ("PGA")) through the use of several proprietary manufacturing and processing techniques, the Company is able to create Self-Reinforced, resorbable implants. The Company's Self-Reinforcing technologies modify a resorbable polymer's properties from a brittle structure into a physiologically strong polymer implant with controlled, variable strength retention (ranging from three weeks to six months, depending upon the medical indication) which can be used safely and reliably in a variety of applications, including orthopaedic surgery, urology and cranio-facial surgery.
The Company's Self-Reinforcing technology also imparts to the processed polymer a number of critical characteristics which enhance the manufacturability of the implants and broadens the clinical applications for these devices. For example, the polymers can be machined using custom metal forming techniques, and, as a result, the Company has been able to design and develop a variety of resorbable implant devices, including pins, screws and other profiled (nonsmooth-surfaced) implants of clinically appropriate sizes that incorporate machined features, such as ridges and barbs, for improved fixation.
The resorption of PLLA and PGA occurs in a predictable three step process. The first two steps are initiated by hydrolysis, which breaks down the polymer molecules into smaller chains, resulting in an initial reduction in molecular weight and a slight swelling of the implant, causing it to lock in place. The third step involves degradation. Unlike first generation unreinforced resorbable polymers which degraded rapidly in an uncontrolled process, the Company's Self-Reinforced, resorbable polymers degrade in a slow controlled fashion. Only when the Self-Reinforced, resorbable implant has degraded into small particles will they be released into the surrounding tissue for final degradation through cellular absorption. The slow and controlled degradation of Self-Reinforced, resorbable polymer implants causes the gradual transfer (ranging from three weeks to six months depending upon the medical indication) of the weight-bearing load from the implant to the tissue.
PRODUCTS
The Company currently markets sixteen product lines representing more than 150 distinct products. The Company's product lines are described below:
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(1) As described herein, FDA clearances for certain of the Company's products are limited to specific indications.
Orthopedic Trauma
PLLA and PGA Pins
Fracture fixation pins are indicated for the management of cancellous bone fractures and osteotomies in the non-loadbearing areas of the skeletal system, including fractures of the ankle, knee, wrist, elbow, hand and foot. Fractures in these anatomical areas are most commonly the result of trauma. Osteotomies in these areas are normally used to correct congenital or induced bone malformation. The use of metal pins often results in pins protruding from the body to allow for their removal. This is especially true in certain pediatric fractures where the current technique is to leave the metal pins protruding from the joint or bone, with the limb awkwardly positioned, to facilitate the removal of the pins. This technique is inconvenient to the patient, is associated with increased levels of infection and results in additional trauma and expense when the pins are removed.
The Company's resorbable pins, which range in diameter from 1.1mm to 4.5mm and in length from 10mm to 70mm, can be cut by a surgeon to the precise length required for an individual patient, thereby reducing the risk of discomfort and infection. The pins are designed to improve the fixation of fractures through two design innovations: (i) the pins are slightly oversized as compared to the drill channel and slightly oval in shape, providing an improved friction fit as compared with round metal pins; and (ii) the pins swell slightly when exposed to the moisture in the surgical site, locking the pin in the drill channel within hours after implantation. The Company's pins can be used in open surgical procedures and percutaneous and endoscopic techniques. In the U.S., while the Company's PLLA pins currently are cleared only for use in bunionectomies, the Company's PGA pins may be used in a variety of cancellous bone fixations.
PLLA and PGA Screws
Although management of fractures in the cancellous areas of bones with metal screws and plates is the standard of care, the procedures present orthopaedic surgeons with several problems. The inherent difference in stiffness between the metal screw and the bone can cause complications, including inducement of relative motion at the fracture site. Such motion can cause screws to loosen and can result in local bone degradation. Metal screws can also protrude from the bone surface after implantation or break under the healing stresses of bone and cause irritation in areas of the body where the skin and muscle covering of the fracture site is thin and contains high concentrations of nerves.
The Company's screws range in diameter from 2.0mm for delicate hand and foot procedures to 4.5mm for use in ankle fractures. The Company's screw threads were specifically designed for use in cancellous fractures. The Company's screws are designed to take advantage of the swelling properties of Self-Reinforced materials to achieve optimum fixation with minimal bone damage. In areas where skin is thin, surgeons may shape the head of the Company's screw to conform to the bone contour in order to prevent irritation. In anatomical situations where breakage will occur after healing, the use of the Company's screws avoids the complications that result from the removal of broken metal implants.
Cannulated SmartScrew
The 4.5mm Cannulated SmartScrew is a bioresorbable implant indicated for the maintenance of alignment of cancellous bone fractures of the malleolus of the ankle. This product was cleared by the FDA during November 1999. The cannulation enables the surgeon to place a guidewire in order to obtain exact reduction and then placement of the resorbable screw, thus allowing for complete fracture fixation that will dissolve over time as the bone heals. The Company's resorbable polymers are designed to diminish the osteopenia associated with stress shielding that accompanies metal implants, and to eliminate the need for a second surgery to remove the implant and have been shown in studies to reduce the overall costs when compared to metallic osteosynthesis. The Company estimates that there are approximately 130,000 ankle fractures that are potential candidates for resorbable fracture fixation in the U.S. The Company believes that the 4.5mm Cannulated SmartScrew provides an innovative clinical solution to the surgeon by offering an improved method for the treatment of ankle fractures.
Sports Medicine
Meniscus Arrows
Tears of the cartilage pads in the knee, known as the menisci, are the most common knee injuries treated by orthopaedic surgeons in the U.S. Prior to the introduction of the Company's Meniscus Arrow, the treatment options available to surgeons were limited to either the removal of the damaged section (meniscectomy) or surgical repair using a variety of complex suturing techniques. The efficacy of meniscetomy, historically the preferred approach given the complex and lengthy nature of the suture repair procedure, has been questioned in peer-reviewed and published studies. These studies have shown that meniscus removal may be detrimental to the long-term outcome of the surgery and may lead to complications requiring further, more invasive, surgeries. The suturing alternative requires surgeons to
tie secure knots arthroscopically, which is one of the most technically demanding skills in arthroscopic surgery. Surgical complications, including damage to the vascular and neural system, can arise during this time-consuming suturing process, due in part to the necessity of creating a small opening at the back of the knee to allow for the passing of sutures and the tying of knots.
The Meniscus Arrow, commercially introduced by the Company in the U.S. during the second quarter of 1996, was the first resorbable, arthroscopically implanted fixation device designed for use in the repair of longitudinal, vertical ("bucket handle") tears of the medial and lateral meniscus. The Meniscus Arrow is a thin, pointed, barbed shaft with a t-shaped head that is driven across the meniscal tear, fixing the torn pieces of the meniscus together. The Meniscus Arrow may be implanted in a straightforward procedure that has been demonstrated to reduce operating room time by approximately 50% as compared with suturing and does not require substantial additional training for its use. This resorbable implant avoids both the long-term consequences of meniscus removal and complications to the arterial and nervous system that can arise from the suturing approach. The Company believes that surgeons who were unwilling to perform meniscus repairs in the past may now attempt such repairs, thereby potentially increasing the available market.
PLLA Tacks
Management of ruptures of the ligaments of the thumb, including ulnar collateral ligaments ("skier's thumb" or "gamekeeper's thumb"), is typically performed using either bone to ligament suturing techniques or metal anchors designed for use in small bones. These techniques are dependent upon the surgeon's skill at achieving good fixation and approximation of the torn section of the ligament without damaging the affected ligament in the suturing process. Even when suturing is successful, damage to the repaired ligament may occur at the site of the repair, since the sutures remain in place after the healing process is complete. Since suturing is performed without direct visualization of both sides of the wound, damage to nerves and vessels may also occur.
The Company developed its PLLA tack to provide the surgeon with an easy to use implant designated to reduce the risk of long-term and intra-operative tissue damage that may occur in traditional suturing techniques. The insertion procedure for the Company's tack involves the use of standard surgical techniques to first create a channel in the ligament and a small drill hole in the bone, and then attaching the ligament with manual pressure. The Company's tack is designed to swell in the drill hole in order to provide immediate fixation and to withstand stresses in the thumb. The degradation of the tack after healing of the reattachment site reduces the risk of long-term tissue damage. In the U.S., the Company's PLLA tacks are cleared for use in repairing ligaments of the thumb.
PLLA Bankart Tacks
Forward dislocations of the shoulder joint involve the separation of the ligaments from the bones that form the shoulder socket. Open surgical procedures to repair the damaged ligaments are the standard of care in treating patients with recurrent forward shoulder dislocations. However, more recently, minimally invasive procedures have also been developed to repair these injuries. Initially, metal screws were used to reattach the ligament to the bone. This approach proved unsatisfactory, however, because the screws often became loose, causing pain. Resorbable sutures have also been used to reattach the soft tissue to the bone. However, while they proved effective, the sutures are sometimes difficult to insert and present a risk of nerve injury. Resorbable tacks, staples or plugs were subsequently developed to avoid the problems associated with metal screws and resorbable sutures. The advantages of resorbable tacks, staples or plugs are that they can be easily inserted into the bone for reattachment of soft tissue and, because they are resorbable, they do not require surgical removal. In addition, unlike metal screws, resorbable tacks or plugs do not cause tissue irritation due to metal corrosion and loosening.
The Bionx Bankart Tack was cleared by the FDA in January 1998 for use in reattaching soft tissue to bone to repair a specific type of forward shoulder dislocation. It is a high-strength, biocompatible, resorbable tack-type product, which can be used in either open or minimally invasive
surgery. The SR-PLLA material enables the device to retain sufficient strength to maintain soft tissue reattachment throughout the healing period, while its gradual resorption eliminates the need to remove the device at a later point in time.
Contour Labral Nail
The Contour Labral Nail is a cannulated bioresorbable device used to reattach soft tissue to bone resulting from traumatic shoulder injuries. This product was cleared by the FDA at the end of 1999. The Contour Labral Nail allows the surgeon to reposition the labrum ligament complex back to the shoulder's glenoid rim with a relatively quick and easy minimally invasive surgical technique. Traditional shoulder surgery, whether open or minimally invasive, involves tacking, anchoring or suturing the soft tissue to the underlying bone. The Company believes that the design of the Contour Labral Nail allows for an easy and safe arthroscopic technique through creation of two portals, resulting in a quick and simple minimally invasive procedure.
The design is anatomically correct, with the objective of reducing the chances for impingement of the implant to the humeral head. The contoured head corners the labrum ligament complex to the glenoid rim, thus creating a bumper effect that eliminates anterior dislocation without the head of the resorbable implant impinging on the humeral head.
SmartNail
The SmartNail is a bioresorbable implant used during orthopedic surgery. This product was cleared by the FDA at the end of 1999. The SmartNail is indicated to maintain fixation and accurate alignment of small bone fractures, osteochondral fragments or osteochondritis dissecans lesions which are generally subchondral bone chips involving the overlying cartiledge. Many osteochondral fragments are derived from repetitive trauma during athletic or recreational activities or can be derived from direct trauma induced from such incidents as a motor vehicle accident.
The SmartNail resorbable implant addresses some of the current issues surrounding the use of fixation implants for osteochondral fragments. The product allows the surgeon to deliver a resorbable implant arthroscopically, thus simplifying the procedure and minimizing the patient morbidity that is associated with open fixation and the use of metal screws. In addition, the SmartNail has the benefits of bioresorbable fixation, which are no second surgery for removal of the metal implant, radiolucency, reduced stress shielding and a history of clinical effectiveness and safety.
SmartScrew ACL
The SmartScrew ACL is a cannulated, bioresorbable interference screw used to attach a graft during cruciate ligament reconstruction, including bone-patella tendon-bone or soft tissue grafts. This product was cleared by the FDA at the end of 1999. The Company estimates that one out of 3,000 Americans and 300,000 people worldwide experience problems with their anterior and posterior cruciate ligaments that may require surgical intervention.
Made from a patented, Self-Reinforcing manufacturing process, the SmartScrew ACL reduces the chances of the screw shearing and breaking during insertion - an occurrence that has been associated with molded polymer implants. The Company believes that the advantages of bioresorbable implants over metal implants are: 1) revision surgery with resorbable implants is believed to be easier and safer; 2) resorbable implants are radiolucent; as a result, they do not interfere with post surgical radiographs; and 3) resorbable interference screw implants are clinically equivalent to metal interference screws. The SmartScrew ACL implant competes in the interference screw product segment, which comprises over 90% of the market for all fixation type devices used during anterior and posterior cruciate ligament reconstruction.
Craniofacial Fixation
Metallic fixation of the facial skeleton has become the accepted standard of care in craniomaxillofacial trauma and reconstruction over the past 15 years. Titanium has become the material of surgical choice due to its strength, malleability, and tissue compatibility. However, implant removal remains an open long-term clinical question. Most metallic plates and screws are not removed. As a result, foreign body metallic properties continue to remain in the body. At present, there are no absolute answers regarding long-term (25-year) viability. This environment creates a surgical receptiveness to resorbable fixation implants in pediatric and adult craniofacial surgery, provided the products are comparable to titanium in mechanical strength, biocompatability and cost.
The Company's BioSorb family of resorbable products includes screws and plates for craniofacial cosmetic, trauma, and reconstructive surgery. These products were launched in the international market in September, 1998. The products were launched in the U.S. market in November, 1998 following FDA clearance in September, 1998.
The Company's self-reinforcing process imparts to the BioSorb line a unique set of performance characteristics including: (i) enhanced strength retention; (ii) resistance to torque damage; and (iii) the ability to bend the BioSorb plates without the need for external devices to heat the plates. The Company believes that these unique characteristics will allow for broader application and acceptance of the products in the clinical setting.
Urology Stents
Benign prostatic hyperplasia ("BPH"), a common condition in older men, is characterized by the non-cancerous enlargement of the prostate gland, which can block the normal flow of urine. The treatment of BPH typically involves either invasive surgical techniques and/or drug therapies. Invasive techniques, including the use of lasers, microwave or RF energy and other surgical options, are designed to remove a portion of the obstructive tissue, thereby enabling a return to normal urine flow. However, patients must typically accept urethral catheterization, together with its discomfort and associated risks of urinary tract infections, following these procedures--often for prolonged periods of time. Patients receiving drug therapy for BPH must accept a continuation of their symptoms, often for many months, before the effect of the drug treatment becomes noticeable. Efforts to address these problems have focused on the need for temporary prostate stents to relieve short term obstructive symptoms, but the experience to date with metallic and various non-resorbable stents have been marked by removal difficulties, stent dislocation, and various negative tissue reactions to these non-resorbable materials.
In response to the needs in the market, the Company has developed a resorbable, self-expanding stent for use in urological procedures. The Company's resorbable prostate stents are used to improve urine flow-rates whenever the temporary relief of BPH symptoms is needed. The design of the Company's stent allows it to be easily inserted under direct vision with a cystoscope, making the device suitable for both hospital as well as physician office use. The self-expanding nature of the Company's stent fixes the device firmly in the prostate to prevent the problems of dislocation so prevalent with previously marketed temporary stents.
In various clinical studies, the Company's prostate stents have been shown to enable patients to avoid the need for catheterization following a variety of surgical procedures, to achieve relief from their symptoms while waiting for a therapeutic procedure, and to improve symptoms while waiting for BPH drug therapy to become effective. The Company's prostate stents are approved for sale in most international markets. In the US, the FDA has advised the Company that its urology stent will require approval under the FDA's Premarket Approval ("PMA") process, which is generally more expensive and time-consuming than the FDA's 510(k) Premarket Notification process. The Company's stents cannot be marketed or sold in the U.S. until approval is obtained from the FDA. See "Government Regulation."
Instrumentation
The Company, with the assistance of certain contract manufacturers, has developed a series of instrumentation systems designed for use with each of the Company's product lines. The Company distributes its instruments both on an instrument-by-instrument basis or in kits. The implant grade stainless steel instruments are manufactured by third-parties and are designed specifically to enable implantation of a particular product manufactured by the Company. All of the Company's currently distributed instrumentation systems are reusable. Accordingly, sales or consignment of instrumentation systems are directed to new customers and to existing customers who are planning to initiate usage of one or more of the Company's new or existing products. In most cases, instrumentation is provided to customers when they purchase a certain level of implant products. The costs of such instruments for dealers and distributors are amortized over their estimated useful life. However, due to increased competitive activity in the hospital setting, the company began expensing instruments during the fourth quarter 1999 as they are placed in hospitals for use by the surgeon. See Notes 2 and 3 of the Notes to the Company's Consolidated Financial Statements.
GEOGRAPHIC INFORMATION
For geographic information regarding the Company, see Note 14 of the Notes to the Company's Consolidated Financial Statements.
PRODUCT DEVELOPMENT
The Company's product development efforts focus upon expanding the use of the Company's platform technology to address the limitations of traditional surgical techniques and existing implants. To date, all of the Company's implants sold in the U.S. have been cleared through the 510(k) Premarket Notification process. Lengthier and more costly PMA submissions will be required in order to obtain approval to sell urological stents and may be required for other new products in the U.S. The Company incurred research and development expenses of $871,101, $2,360,485 and $3,758,680 during 1997, 1998 and 1999, respectively.
During 1999 the Company began to establish product development activities in the U.S. Several key employees were added to focus on new product development programs involving surgeons from the U.S.
During 1999 the Company entered into development, marketing and distribution agreements with Mentor and Toray to fund the development and regulatory costs associated with urology stent applications, to develop the U.S. and international markets and to distribute urology stents.
In addition, The Company is engaged in a number of studies designed to enable the Company to increase the surgical applications and benefits of existing products and to introduce new products.
The Company's estimations of the benefits, criteria, markets, uses, features, market acceptance, medical indication and other items related to its products constitute Forward Looking Statements. See Exhibit 99.1 to this Annual Report on Form 10-K.
Product development involves a high degree of risk. There can be no assurance that the Company's new product candidates in various early stages of development will prove to be safe and effective, will receive the necessary regulatory approvals or will ultimately be commercially successful. These product candidates will require substantial additional investment, laboratory development, clinical testing and FDA or other agency approval prior to their commercialization. The Company's inability to successfully develop and introduce these product candidates on a timely basis or at all, or achieve market acceptance of such products, could have a material adverse effect on the Company's business, financial condition and results of operations.
SALES, MARKETING AND DISTRIBUTION
The Company sells its products through a hybrid sales force comprised of a managed network of independent sales agents and direct sales representatives in the U.S., and independent distributors and dealers in markets outside of the U.S. In the U.S., the Company manages a network of agents who are responsible for particular orthopaedic products and territories. In managing its U.S. network, the Company maintains a direct relationship with its medical community customers by handling all invoicing functions directly and paying commissions to its sales agents. The Company supports its U.S. managed network of sales agents with an in-house staff of trainers and managers who supplement the work of the sales agents, providing training to orthopaedic surgeons with respect to the features and modalities applicable to particular resorbable implant products. In Europe, the Company sells its products through networks of independent distributors and dealers that purchase products from the Company at discounts that vary by product and by market. These international distributors and dealers have the primary relationships with the physicians and hospitals that are using the Company's products. The Company typically operates under written agreements with its domestic and international sales agents, distributors and dealers. These agreements grant the dealers the right to sell the Company's products on an exclusive basis within a defined territory and permit the distributors to sell other medical products.
During 1999 the Company entered into development, marketing and distribution agreements with Mentor and Toray to fund the development and regulatory costs associated with urology stent applications, to develop the U.S. and international markets and to distribute urology stents.
MANUFACTURING
The Company currently manufactures all of its implant products in its Tampere, Finland facility. All finished goods production, packaging and testing are conducted in a validated clean room with physically separate areas of varying types of air quality designed specifically for the production of resorbable polymeric materials and products. Substantially all aspects of the manufacturing process are subject to, and are designed to comply with, the FDA's Good Manufacturing Practices ("GMP") requirements. The facility is subject to inspection by the FDA and European regulatory agencies. The Company has received a European Community ("EC") Design Examination and an EC quality system Certificate and is entitled to affix a CE marking on all of its currently marketed orthopaedic, urological, dental and cranio-facial products. See "Government Regulation."
The Company employs two separate processes to produce its Self-Reinforced polymers. The sintering process, used only for PGA products, involves the compression of polymer threads laid in molds to permit the bonding of such threads without melting the materials. The die drawing process, used for PLLA, PGA and PDLA products, runs polymers through a die in order to create reinforcing elements or fibrils. Both processes are supervised by experienced personnel and are subjected to quality control checks until final sterility testing and batch control paperwork has been completed. Much of the machinery utilized by the Company in the manufacturing process was either created by the Company's technical team or has been modified by that team to meet the Company's requirements.
The raw materials for the Company's PLLA and PDLA materials are currently available from three qualified sources. The raw materials for the Company's PGA products are currently provided to the Company by two qualified sources. These raw materials have been utilized in products cleared by the FDA and the Company's suppliers maintain Device Master Files at the FDA that contain basic toxicology and manufacturing information accessible to the FDA. The Company does not have long-term supply contracts with any of such suppliers. In the event that the Company is unable to obtain sufficient quantities of such raw materials on commercially reasonable terms, or in a timely manner, the Company would not be able to manufacture its products on a timely and cost-competitive basis which, in turn, would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, if any of the raw materials for the Company's PLLA products are no longer available in the marketplace, the Company would be forced to further develop its technology to incorporate alternate
components. The incorporation of new raw materials into the Company's existing products would likely require clearance or approval from the FDA. There can be no assurance that such development would be successful or that, if developed by the Company or licensed from third parties, devices containing such alternative materials would receive FDA clearance on a timely basis, or at all.
The Company intends to add to its manufacturing capabilities by establishing manufacturing capabilities in the U.S. in order to increase its capacity for its existing and new products. The Company anticipates that it will either (i) equip and operate a leased facility in the eastern U.S. or (ii) contract with a third party to provide a manufacturing capability to the Company. The Company presently is exploring both of these alternatives. If the Company chooses to use a contract manufacturer, the Company would likely equip the manufacturer's facility, with the objective of ultimately transitioning to a Company-owned or Company-leased facility. The Company believes that on an interim basis, contract manufacturing may enable the Company to save certain staffing costs and enable senior management to focus on other aspects of its business; however, savings in staffing costs may be outweighed by fees payable to the contract manufacturer. The foregoing statements regarding such plans constitutes a Forward-Looking Statement. Actual timing could differ materially from such plans as a result of a number of factors, including the availability of trained personnel, the availability of necessary resources, space location factors and other factors cited in this paragraph. There can be no assurance that the Company will not encounter difficulties in scaling up production in the U.S., including problems involving production yield, quality control and assurance, and shortage of qualified personnel. In addition, the U.S. facility will be subject to GMP regulations, international quality control standards and other regulatory requirements. Difficulties encountered by the Company in manufacturing scale-up or the failure by the Company to establish and maintain the U.S. facility in accordance with such regulations, standards or other regulatory requirements could entail a delay or termination of production, which could have a material adverse effect on the Company's business, financial condition and results of operations. The Company continues to upgrade its production machinery and processes in Finland to address increased demand. No assurance can be given that the integration of these machines into the production process will occur within the scheduled time frame or will not result in difficulties in scale-up that could lead to delays in filling orders in the future.
LICENSES, TRADE SECRETS, PATENTS AND PROPRIETARY RIGHTS
The Company believes that its success is dependent in part upon its ability to preserve its trade secrets, obtain and maintain patent protection for its technologies, products and processes, and operate without infringing the proprietary rights of other parties. As a result of the substantial length of time and expense associated with developing and commercializing new medical devices, the medical device industry places considerable importance on obtaining and maintaining trade secrets and patent protection for new technologies, products and processes.
The Company's patent strategy has been to seek patent protection for the technologies that produce the Company's Self-Reinforced resorbable polymer products and, when available, for the products themselves. The Company owns or has licenses to patents issued in the United States and in various foreign countries and has patent applications pending at the U.S. PTO and in the patent offices of various foreign countries. The Company's four principal U.S. patents (two of which are owned by the Company and two of which are licensed to the Company on an exclusive basis) will expire between 2004 and 2008. The two principal U.S. patents owned by the Company relate to the Company's Self-Reinforced resorbable polymer products, the Company's sintering process, and resorbable polymer products produced from the Company's controlled drawing process. The Company has a U.S. patent relating to methods of making the Company's resorbable stents. The Company's other patents and patent applications relate to various uses for Self-Reinforced resorbable polymers, either alone or in combination with other resorbable polymers or biocompatible materials, and generally involve specific devices, applications or improvements of the technologies disclosed in the Company's principal patents and patent applications. European counterparts to the two principal U.S. patents that are owned by the Company and the Japanese counterpart to one such patent are currently the subject of opposition proceedings. The Company is vigorously defending its European and Japanese patent positions in these proceedings. One of these European patents was revoked by the European Patent Office for lack of
novelty based on an earlier publication. The Company successfully appealed the European Patent Office's revocation decision and has had that patent reinstated. The other European patent and the Japanese patent applications are being challenged on lack of novelty and inventiveness grounds on the basis of disclosures made in patent and other publications. The validity of the European patent has been recently upheld by the European Patent Office. This favorable decision has been appealed and no assurance can be given that this decision will not be reversed. Further, no assurance may be given as to the outcome of the pending Japanese opposition proceedings. In order to clarify and confirm its U.S. patent position, the Company requested reexamination by the U.S. PTO of the two principal U.S. patents owned by the Company. The issues raised during the reexamination proceedings were resolved in the Company's favor on the patent describing the self-reinforcing method used in approximately 98% of the Company's existing products. The second reexamination is still proceeding through an appeal process. The U.S. PTO allowed some of the claims in the second reexamination, but finally rejected other claims in that application. This final rejection has been appealed by the Company to the U.S. PTO Appeals Board. The appeal in the second reexamination could result in some or all of the patent claims set forth in this U.S. patent being altered to provide narrower coverage or determined to be unpatentable. The claims that were allowed by the U.S. PTO cannot be issued in a reexamination until the appeal of the rejected claims is decided, and there is no guarantee that the allowed claims will be permitted by the Appeals Board to issue in a reexamination certificate. No assurance can be given as to the outcome of the ongoing reexamination process. Narrowing of the coverage or a holding of unpatentability of this U.S. patent may significantly ease entry to the U.S. market for the products of the Company's competitors and could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company also relies upon trade secret protection for certain unpatented aspects of its proprietary technology, including its Self-Reinforcing technology. Although the Company has taken steps to protect its trade secrets and know-how, through the use of confidentiality agreements with its employees and certain of its business partners and suppliers, there can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach, that others will not independently develop or otherwise acquire substantially equivalent proprietary technology, information or techniques, that others will not otherwise gain access to or disclose the Company's proprietary technologies or that any particular proprietary technology will be regarded as a trade secret under applicable law. There can be no assurance that the steps taken by the Company will prevent misappropriation of its trade secrets. As a result of the reliance that the Company places on its trade secrets, loss of the Company's trade secret protection in this area would have a material adverse effect on the Company's business, financial condition and results of operations.
Additionally, the Company has a license to two principal U.S. patents. Pursuant to this license agreement, the Company has the exclusive right in the U.S. to manufacture, use and sell certain devices for fixation of meniscus lesions. This license agreement requires the Company to pay periodic royalties to the licensor, Saul N. Schreiber, M.D., an orthopaedic surgeon. The license has a term expiring in 2006, unless terminated earlier by the licensor for breach by the Company. In 1999, the Company paid or accrued a liability to the licensor for approximately $400,000 in royalties on sales that are covered under the agreement of $10.2 million. There can be no assurance that these patents licensed to the Company are valid and enforceable, and, if enforceable, that they cannot be circumvented or avoided by competitors.
The Company has initiated a patent infringement lawsuit asserting that a third party who is selling self-reinforced devices is infringing one of the principal patents assigned to the Company. The Company is vigorously seeking both monetary and injunctive relief from the third party. The third party has asserted that this patent is invalid and not infringed and filed a motion for summary judgment on an issue of invalidity with the court. The court denied that summary judgment motion. However, if the patent is held to be invalid or not infringed, the third party will be able to continue selling its self-reinforced devices, and this could have a material adverse effect on the Company's business, financial condition and results of operations.
The Company had initiated two separate patent infringement lawsuits, asserting that two third parties who are selling devices for the fixation of meniscal lesions are infringing one of the principal patents licensed to the Company. One of those litigations settled, with the Company granting a royalty bearing license to the third party to sell its meniscal devices under the patent. In the other case, which is still pending, the Company is seeking both monetary and injunctive relief. The third party filed summary judgment motions asserting that the patent was invalid and unenforceable and that they did not infringe. In November 1999, the Company was orally informed by the judge's law clerk that the third party's motions with respect to invalidity and unenforceability will be denied but that the third party will prevail in the non-infringement motion. The Company has not received the judge's final judgment in writing. If the third party does in fact prevail, the Company intends to appeal. This litigation has been expensive, and there can be no assurance of the outcome. If the patent is finally held invalid, unenforceable or not infringed, the third party can continue to sell its meniscal fixation devices, and this could have a material adverse effect on the Company's business, financial condition and results of operations.
There can be no assurance that patent applications to which the Company holds rights will result in the issuance of patents, that any patents issued or licensed to the Company will not be challenged and held to be invalid or narrow in scope, or that the Company's present or future patents will provide significant coverage for or protection to the Company's present or future technologies, products or processes. Since patent applications are secret until patents are issued in the U.S., or corresponding applications are published in foreign countries, and since publication of discoveries in the scientific or patent literature often lags behind actual discoveries, the Company cannot be certain that it was the first to make its inventions, or that it was the first to file patent applications for such inventions.
In the event that a third party has also filed a patent application relating to an invention claimed in a Company patent application, the Company may be required to participate in an interference proceeding declared by the U.S. PTO to determine priority of invention, which could result in substantial uncertainties and cost for the Company, even if the eventual outcome is favorable to the Company. In addition, there can be no assurance that others will not obtain access to the Company's know-how or that others will not be, or have not been, issued patents that may prevent the sale of one or more of the Company's products or the practice of one or more of the Company's processes, or require licensing and the payment of significant fees or royalties by the Company to third parties in order to enable the Company to conduct its business. There can be no assurance that the Company would be able to obtain a license on terms acceptable to the Company or that the Company would be able to successfully redesign its products or processes to avoid such patents. In either such case, such inability could have a material adverse effect on the Company's business, financial condition and results of operations.
Legal standards relating to the scope of claims and the validity of patents in the medical device field are still evolving, and no assurance can be given as to the degree of protection any patents issued to or licensed to the Company would provide. The medical device industry has been characterized by extensive litigation regarding patents and other intellectual property rights, and companies in the medical device industry have employed intellectual property litigation to gain competitive advantage. The Company has initiated an opposition in the European Patent Office challenging the grant of a third party's European patent relating to a drawing process for manufacturing resorbable polymer products. Subsequently, another company has instituted its own opposition against that patent. These oppositions resulted in the revocation of that patent. The third party has appealed, and no assurance can be given that this favorable decision will not be reversed. If an appeal is successful, then no assurance can be given that the third party will not assert that its European patent is infringed by sales of one or more of the Company's products or by the practice of one or more of the Company's processes in any of the eight countries identified in the European patent. The Company has also initiated an opposition in the European Patent Office challenging the grant of a third party's European patent relating to a bioabsorbable membrane. This opposition will resulted in the narrowing of its claims. No assurance can be given that the third party will not assert that its European patent is infringed by sales of one or more of the Company's products or by the practice of one or more of the Company's processes in any of the countries identified in this European patent. Moreover, there can be no assurance that the Company will not be subject to claims that one or more of its products or processes infringe other patents or violate the proprietary rights of third parties. Defense and prosecution of patent claims can be expensive and time
consuming, regardless of whether the outcome is favorable to the Company, and can result in the diversion of substantial financial, management and other resources from the Company's other activities. An adverse outcome could subject the Company to significant liability to third parties, require the Company to obtain licenses from third parties, or require the Company to cease any related product development activities or product sales. In addition, the laws of certain countries may not protect the Company's patent rights, trade secrets, inventions, products or processes to the same extent as in the U.S.
The Company has certain trademark registrations and pending trademark applications in the U.S. and in various countries. The Company's U.S. and foreign trademark registrations have 5-20 year terms and are renewable for additional terms for as long as the Company uses the registered trademark in the manner recited in the registration and makes the appropriate filings to maintain and renew registrations. There can be no assurance that any particular registration, or the mark that is the subject of that registration, will not be held to be invalid, narrow in scope or not owned exclusively by the Company. In the past, the Company has agreed with third-parties that it will not use certain trademarks in connection with certain devices. There can be no assurance that the Company will not enter into other arrangements to avoid or terminate infringement, opposition, cancellation or other proceedings, or to induce third-parties to give up or limit the use of their trademarks, trade names or other designations.
The Company is currently prosecuting two patent infringement cases in the United States. As noted above, the prosecution of such cases can be expensive, and there can be no assurances as to the outcome. Through December 31, 1999, the Company incurred costs of approximately $2.4 million relating to the prosecution of these two matters and the litigation that settled.
COMPETITION
Competition in the medical device industry is intense both in the U.S. and abroad. In orthopaedics, the Company's principal competitors are the numerous companies that sell metal implants The Company competes with the manufacturers and marketers of metal implants by emphasizing the clinical advantages of the Company's Self-Reinforced, resorbable implants, which are the cost effectiveness, strength, reduction of stress shielding and the elimination of risks associated with the failure to perform removal surgeries. Within the resorbable implant market, Johnson & Johnson and Biomet sell an FDA-cleared resorbable product for use in the fracture fixation market. Other companies have reported that they are developing resorbable products for internal fixation. The Company is competing with Johnson & Johnson and Biomet and expects to compete with the other manufacturers of resorbable internal fixation devices primarily on the basis of the physiological strength of the Company's polymers, the length of the strength retention time demonstrated by the Company's products and ease of use.
In knee arthroscopy for meniscal repair, the Company's Meniscus Arrow products compete with a non-resorbable product marketed by Smith & Nephew, resorbable products marketed by U.S. Surgical, Conmed, Johnson & Johnson and Arthrex, and with a series of suturing techniques developed by orthopaedic surgeons for the repair of the meniscus.
In urology, two companies (Boston Scientific and Contimed) have developed temporary metal or non-resorbable polymer stents for use in the ureter or urethra or for use in the treatment of prostate disease. The Company is not presently aware of any substantial development of resorbable stents for this application outside of the Company's efforts in Europe. The Company believes that the difficulty and discomfort associated with the subsequent removal of temporary non-resorbable stents should provide the Company's Self-Reinforced, resorbable urology stents with a potential competitive advantage.
Overall, the Company believes that the primary competitive factors in the markets for its products are safety and efficacy, ease of implantation, quality and reliability, pricing and the cost effectiveness of resorbable products as compared with non-resorbable products. In addition, the length of time required for products to be developed and to receive regulatory approval is an important competitive factor. The Company believes that it competes favorably with respect to these factors, although there can be no
assurance that it will continue to do so. For information regarding the potential impact of certain competitive practices upon the Company's performance, see "Management's Discussion and Analysis of Financial Condition and Results of Operation - Results of Operations For the Years Ended December 31, 1997, 1998 and 1999 - Product Sales."
The medical device industry is characterized by rapid product development and technological advancement. The Company's products could be rendered noncompetitive or obsolete by technological advancements made by the Company's current or potential competitors. There can be no assurance that the Company will be able to respond to technological advancements through the development and introduction of new products. Moreover, many of the Company's existing and potential competitors have substantially greater financial, marketing, sales, distribution and technological resources than the Company. Such existing and potential competitors may be in the process of seeking FDA or other regulatory approvals, or patent protection, for their respective products or may also enjoy substantial advantages over the Company in terms of research and development expertise, experience in conducting clinical trials, experience in regulatory matters, manufacturing efficiency, name recognition, sales and marketing expertise or the development of distribution channels. Since the Company's products compete with procedures that have, over the years, become standard within the medical community, there also can be no assurance that the procedures underlying the Company's resorbable products will be able to replace more established procedures and products. There can be no assurance that the Company will be able to compete successfully against current or future competitors or that competition will not have a material adverse effect on the Company's business, financial condition and results of operations.
GOVERNMENT REGULATION
United States. Products manufactured or marketed by the Company in the U.S. are subject to extensive regulation by the FDA. Pursuant to the Federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder (the "FDC Act"), the FDA regulates the clinical testing, manufacture, labeling, distribution and promotion of medical devices. Noncompliance with applicable requirements can result in, among other things, warnings letters, import detentions, fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of production, failure of the government to grant premarket clearance or premarket approval for devices, withdrawal of marketing approvals and criminal prosecution. The FDA also has the authority to request repair, replacement or refund of the cost of any device manufactured or distributed by the Company.
Under the FDC Act, medical devices are classified into three classes (class I, II or III), on the basis of the controls deemed necessary by the FDA to reasonably assure their safety and efficacy. Under the FDA's regulations, class I devices are subject to general controls (for example, labeling and adherence to GMP requirements) and class II devices are subject to general and special controls (for example, performance standards, postmarket surveillance, patient registries and FDA guidelines). Generally, class III devices are those which must receive premarket approval by the FDA to ensure their safety and efficacy (for example, life-sustaining, life-supporting and certain implantable devices, or new devices which have not been found substantially equivalent to legally marketed class I or class II devices). The Company believes that its products are class II or class III devices.
Before a new device can be introduced into the market in the U.S., the manufacturer or distributor generally must obtain FDA marketing clearance through either a 510(k) premarket notification or a PMA application. The Company believes that it usually takes from four to twelve months from submission to obtain 510(k) clearance, although it can take longer, and that the FDA's review of a PMA application after it is accepted for filing can last from one to three years, or even longer. If a medical device manufacturer or distributor can establish, among other things, that a device is "substantially equivalent" in intended use and technological characteristics to a class I or class II medical device or a "preamendment" (in commercial distribution before May 28, 1976) Class III device for which the FDA has not called for PMA applications (defined below), the manufacturer or distributor may seek clearance from the FDA to market the device by filing a 510(k). The 510(k) must be supported by appropriate information establishing to the satisfaction of the FDA the claim of substantial equivalence to a legally marketed predicate device. In
recent years, the FDA has been requiring a more rigorous demonstration of substantial equivalence, including more frequent requests for clinical data in 510(k) submissions.
If clinical testing of a device is required and if the device presents a "significant risk", an Investigational Device Exemption ("IDE") application must be approved prior to commencing clinical trials. The IDE application must be supported by data, typically including the results of laboratory and animal testing. If the IDE application is approved by the FDA and one or more appropriate Institutional Review Boards ("IRBs"), clinical trials may begin at a specific number of investigational sites with a maximum number of patients, as approved by the agency. If the device presents a "nonsignificant risk" to the patient, a sponsor may begin the clinical trial after obtaining approval for the study by one or more appropriate IRBs without the need for FDA approval. In all cases, the clinical trials must be conducted under the auspices of an IRB pursuant to FDA regulations. The Company's failure to adhere to regulatory requirements generally applicable to clinical trials and to the conditions of an IDE approval could result in a material adverse effect on the Company, including an inability to obtain marketing clearance or approval for its products. There can be no assurance that any clinical study proposed by the Company will be permitted by the FDA, will be completed or, if completed, will provide data and information that supports FDA clearance or approval.
Following submission of the 510(k) notification, the manufacturer or distributor may not place the device into commercial distribution unless and until an order is issued by the FDA finding the product to be substantially equivalent. In response to a 510(k), the FDA may declare that the device is substantially equivalent to another legally marketed device and allow the proposed device to be marketed in the U.S. The FDA, however, may require further information, including clinical data, to make a determination regarding substantial equivalence, or may determine that the proposed device is not substantially equivalent and require a PMA. Such a request for additional information or determination that the device is not substantially equivalent would delay market introduction of the product. There can be no assurance that the Company will obtain 510(k) premarket clearance within satisfactory time frames, if at all, for any of the devices for which it may file a 510(k). For any medical device cleared through the 510(k) process, modifications or enhancements that could significantly affect the safety or effectiveness of the device or that constitute a major change to the intended use of the device will require a new 510(k) submission.
If a manufacturer or distributor of medical devices cannot establish that a proposed device is substantially equivalent to a legally marketed device, the manufacturer or distributor must seek premarket approval of the proposed device through submission of a PMA. A PMA must be supported by extensive data, including laboratory, preclinical and clinical trial data to prove the safety and effectiveness of the device, and extensive manufacturing information. Following receipt of a PMA, if the FDA determines that the application is sufficiently complete to permit a substantive review, the FDA will "file" the application for review. The PMA approval process can be lengthy, expensive and uncertain. If granted, the approval of the PMA may include significant limitations on the indicated uses for which a product may be marketed.
To date, all of the Company's products sold in the U.S. have received 510(k) clearance. Furthermore, the FDA is generally familiar with the toxicological properties of polymers used in the Company's orthopaedic products and to date has not required extensive preclinical or clinical testing with respect to biocompatibility as a condition of granting 510(k) clearance to those products. In certain submissions for orthopaedic products, the Company obtained clearance within 90 days of submission. Other submissions by the Company, however, have taken longer. The FDA has advised the Company that its urology stent will require PMA approval. There can be no assurance that the FDA will not determine that other products currently in development by the Company or future products must also undergo the more costly, lengthy and uncertain PMA approval process or that the FDA's familiarity with the Company's polymers will shorten the FDA's review time or reduce testing requirements for either 510(k) clearance or PMA approval.
There can be no assurance that the Company will be able to obtain further 510(k) clearances or PMA approvals, if required, to market its products for their intended uses on a timely basis, if at all. Moreover, regulatory approvals, if granted, may include significant limitations on the indicated uses for which a product may be marketed. Delays in the receipt of or the failure to obtain such clearances or
approvals, the need for additional clearances or approvals, the loss of previously received clearances or approvals, unfavorable limitations or conditions of approval, or the failure to comply with existing or future regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations.
Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. The Company's PGA pins have received 510(k) clearance for the general intended use of "maintenance of alignment of small fragments of fractured non-load bearing bones in the presence of appropriate immobilization." The Company has promoted this product for numerous specific indications within the general framework of the language quoted above. Although the Company believes that these specific indications are covered by the 510(k) clearance already received for its PGA pins, there can be no assurance that the FDA would not consider promotion of this product for the specific indications to be a change to the intended use of the device requiring a new 510(k) submission.
Manufacturers of medical devices for marketing in the U.S. are required to adhere to the Quality System Regulation ("QSR") setting forth detailed GMP requirements, which include testing, control and documentation requirements. The QSR revises the previous GMP regulation and imposes certain enhanced requirements that are likely to increase the cost of compliance. Enforcement of GMP requirements has increased significantly in the last several years, and the FDA has publicly stated that compliance will be more strictly scrutinized. Manufacturers must also comply with Medical Device Reporting ("MDR") requirements that a company report to the FDA any incident in which its product may have caused or contributed to a death or serious injury, or in which its product malfunctioned and, if the malfunction were to recur, it would be likely to cause or contribute to a death or serious injury. Delays in the receipt of, or the failure to obtain, regulatory clearances and approvals, the restriction, suspension or revocation of regulatory clearances and approvals, if obtained, or any failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations.
From time to time the FDA has made changes to the GMP and other requirements that increase the cost of compliance. Changes in existing laws or requirements or adoption of new laws or requirements could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will not incur significant costs to comply with applicable laws and requirements in the future or that applicable laws and requirements will not have a material adverse effect upon the Company's business, financial condition and results of operations.
The Company also is subject to numerous federal, state and local laws relating to such matters as safe working conditions, environmental protection, and fire hazard control. There can be no assurance that the Company will not be required to incur significant costs to comply with such laws and regulations in the future or that such laws or regulations will not have a material adverse effect upon the Company's business, financial condition and results of operations.
Regulations regarding the development, manufacture and sale of the Company's products are subject to change. The Company cannot predict the impact, if any, that such changes might have on its business, financial condition and results of operations.
International. Sales of medical devices outside the U.S. are subject to foreign regulatory requirements that vary widely from country to country. The time required to obtain clearance required by foreign countries may be longer or shorter than that required for FDA clearance or approval, and the requirements may differ. In most instances, the Company currently relies on its distributors for the receipt of premarket approvals and compliance with clinical trial requirements in those foreign countries that require them. Many countries in which the Company intends to operate either do not currently regulate medical devices or have minimal registration requirements; however, these countries may develop more extensive regulations in the future that could adversely affect the Company's ability to market its products. Other countries have requirements similar to those of the U.S. The disparity in the regulation of medical devices among foreign countries may result in more rapid product clearance in certain countries than in
others. The products sold by the Company are subject to premarket approval as well as other regulatory requirements in many countries.
For all products sold after June 14, 1998, the European Economic Area requires the Company to achieve compliance with the requirements of the Medical Devices Directive (the "MDD") and affix CE marking on its products to attest such compliance. To achieve this, the Company's products must meet the Essential Requirements as defined under the MDD relating to safety and performance of its products and the Company must successfully undergo verification of its regulatory compliance ("conformity assessment") by a Notified Body selected by the Company. The nature of such assessment will depend on the regulatory class of the Company's products. Under European law, the Company's products are likely to be in class III. In the case of class III products, the Company must (as a result of the regulatory structure which the Company has elected to follow) establish and maintain a complete quality system for design and manufacture as described in Annex II of the MDD (this corresponds to a quality system for design described in ISO 9001 and EN 46001 standards). The Notified Body must audit this quality system and determine if it meets the requirements of the MDD. In addition, the Notified Body must approve the specific design of each device in class III. The Company received an EC Design Examination and an EC quality system Certificate from a Notified Body on January 23, 1997. As part of the design approval process, the Notified Body must also verify that the products comply with the Essential Requirements of the MDD. In order to comply with these requirements, the Company must, among other things, complete a risk analysis and present sufficient clinical data. The clinical data presented by the Company must provide evidence that the products meet the performance specifications claimed by the Company, provide sufficient evidence of adequate assessment of unwanted side-effects and demonstrate that the benefits to the patient outweigh the risks associated with the device. The Company will be subject to continued supervision by the Notified Body and will be required to report any serious adverse incidents to the appropriate authorities. The Company also will be required to comply with additional national requirements that are beyond the scope of the MDD. The Company is entitled to affix a CE marking on all of its currently marketed orthopaedic, dental, cranio-facial and urology products. There can be no assurance that the Company will be able to achieve and/or maintain compliance required for CE marking for any or all of its products or that it will be able to produce its products in a timely and profitable manner while complying with the requirements of the MDD and other regulatory requirements.
THIRD-PARTY REIMBURSEMENT
In the U.S. and other markets, health care providers such as hospitals and physicians, that purchase medical devices, such as the Company's products, generally rely on third-party payors, including Medicare, Medicaid and other health insurance plans, to reimburse all or part of the cost of the procedure in which the medical device is being used. The Company believes that, to date, domestic health care providers have been reimbursed in full for the cost of procedures which utilize the Company's products. However, there can be no assurance that third-party reimbursement for such procedures will be consistently available or that such third-party reimbursement will be adequate. There is significant uncertainty concerning third-party reimbursement for the procedures which utilize any medical device incorporating new technology. Reimbursement by a third-party payor may depend on a number of factors, including the payor's determination that the use of the Company's products are clinically useful and cost-effective, medically necessary and not experimental or investigational. Since reimbursement approval is required from each payor individually, seeking such approvals can be a time consuming and costly process which, in the future, could require the Company to provide supporting scientific, clinical and cost-effectiveness data for the use of the Company's products to each payor separately. Congress and certain state legislatures have considered reforms in the health care industry that may affect current reimbursement practices, including controls on health care spending through limitations on the growth of Medicare and Medicaid spending. The development of managed care programs in which the providers contract to provide comprehensive health care to a patient population at a fixed cost per person has also given rise to substantial pressure on health care providers to lower costs.
Outside the U.S., the success of the Company's products is also dependent in part upon the availability of reimbursement and health care payment systems. These reimbursement and health care
payment systems vary significantly by country, and include both government sponsored health care and private insurance plans. Accordingly, there can be no assurance that third-party reimbursement available under any one system will be available for procedures utilizing the Company's products under any other reimbursement system. Several governments have recently attempted to dramatically reshape reimbursement policies affecting medical devices. Typically, the Company's international independent distributors have obtained any necessary reimbursement approvals.
The ability of hospitals and physicians to obtain appropriate reimbursement from government and private third-party payors for procedures in which the Company's products are used is critical to the success of the Company. Failure by such users of the Company's products to obtain sufficient reimbursement from third-party payors for procedures in which the Company's products are used, or adverse changes in government and private payors' policies toward reimbursement for such procedures would have a material adverse effect on the Company's business, financial condition and results of operations.
PRODUCT LIABILITY AND INSURANCE
The Company's business is subject to product liability risks inherent in the testing, manufacturing and marketing of the Company's products. There can be no assurance that product liability claims will not be asserted against the Company or its licensees. While the Company maintains product liability insurance, there can be no assurance that this coverage will be adequate to protect the Company against future product liability claims. In addition, product liability insurance is expensive and there can be no assurance that product liability insurance will be available to the Company in the future, on terms satisfactory to the Company, if at all. A successful product liability claim or series of such claims brought against the Company in excess of its coverage could have a material adverse effect on the Company's business, financial condition and results of operations.
EMPLOYEES
As of December 31, 1999, the Company employed 110 full-time employees; 24 full-time employees in the U.S. and 86 full-time employees in Finland. The Company also contracts with independent consultants from time to time. The Company's Finnish production and office employees are members of a union and the terms of their employment are governed in part by a collective bargaining agreement. The Company believes that it maintains satisfactory relations with its employees.
ITEM 2.
ITEM 2. PROPERTIES
The Company currently operates two facilities, a central manufacturing facility in Tampere, Finland that is part owned and part leased by the Company and office space in Blue Bell, Pennsylvania that is leased by the Company. The Finnish facility, comprising approximately 18,000 square feet, is located in an industrial science park adjacent to the Technical University at Tampere. Currently, that facility houses the Company's manufacturing, quality control and product development functions and serves as the Company's European customer service and central shipping location. The Company operates its corporate headquarters, its executive offices and marketing and sales and product development functions from its 13,500 square foot office space in Pennsylvania. The annual rent on these facilities is approximately $400,000. In addition, in order to establish a U.S. manufacturing presence, the Company anticipates that it will either (i) equip and operate a leased facility in the eastern U.S. or (ii) contract with a third party to provide a manufacturing capability to the Company. No specific site has been selected. See "Business -- Manufacturing".
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Reference is made to "Business -- Licenses, Trade Secrets, Patents and Proprietary Rights" for information regarding certain patent proceedings. The Company is subject from time to time to various other legal proceedings ("Other Proceedings"), including product liability claims, which arise in the
ordinary course of its business. The Company believes that no existing Other Proceedings are likely to have a material adverse effect on its business, financial condition, and results of operations.
ITEM 4.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT
The Company's executive officers, their respective ages (as of December 31, 1999) and their positions with the Company are set forth below:
Terence D. Wall is a founder of the Company and is also the founder of Vital Signs, a manufacturer of disposable anesthesia and respiratory devices, where he serves as President, Chief Executive Officer and Director. He received a Bachelor of Science degree from the University of Maryland and a Master of Business Administration degree from Pace University in 1975.
Gerard S. Carlozzi has been President, Chief Executive Officer and a member of the Board of Directors of Bionx Implants, Inc. and operating subsidiaries since September 1999. He was appointed as the President and Chief Operating Officer in May 1999 and joined the Company in November 1998 as a Vice President. Prior to joining the Company he held positions with Synthes USA, a leader in Orthopedic and Maxillofacial Trauma products, as the Director of Biotechnology Development and the Director of Marketing and Product Development for Maxillofacial Surgical Products, from 1995 to 1998. From 1986 to 1995, Mr. Carlozzi held various positions with Acufex Microsurgical, a pioneer and leader in Arthroscopic orthopedic surgery, which was acquired by Smith & Nephew. At Acufex Microsurgical, as the General Manager for the Spinal Products Group and the Global Director of Research and Development he held positions responsible for Sales and Marketing, Research & Development, Manufacturing, Quality Assurance, Clinical and Regulatory Affairs and other various general management and business development functions. From 1979 to 1986, Mr. Carlozzi held various management positions in Marketing, Sales, Research and Development, for Infusaid Corporation, a manufacturer of implantable drug delivery systems. From 1974 to 1979, he held various product development positions for Boston Gear Works, an industrial manufacturer of power transmission products. Mr. Carlozzi holds degrees in Engineering and a Masters Degree in Business from Northeastern University.
Pertti Tormala is a founder of the Company's Finnish subsidiaries and has directed the Company's research and development work since the mid-1980's. He has been a director of Bionx Implants, Inc. since its inception. Professor Tormala is the Chairman of the Institute of Biomaterials at the Technical University at Tampere and is an international lecturer on the science and application of bioabsorbable Self-Reinforced polymers in medicine. In 1995, Professor Tormala was elected to an Academy Professor Chair by the Finnish Academy. He has written and published a substantial number of peer reviewed articles, many on resorbable polymers. Professor Tormala received a Masters Degree and Ph.D. in Polymer Chemistry from the University of Helsinki.
Pertti Viitanen has been the Managing Director of the Company's Finnish operations since 1990. Prior to joining the Company, he was the production and export manager for a major Finnish plastics manufacturer from 1981 to 1990. From 1968 to 1981, Mr. Viitanen held positions of increasing responsibility in sales and operations at companies in the paper and machine tool industries. Mr. Viitanen received a Masters in Science Degree in Plastics Technology from the Technical University at Tampere.
James Hogan joined the Company in November, 1998 as President, Urology and Non-Vascular Stenting Division. Prior to joining Bionx Implants, Mr. Hogan was President and CEO of ArgoMed, Inc., a privately held urology device company since March 1997. From August, 1993, until March 1997 he was the Vice President of Marketing and International Operations for Lotek, a drug delivery company in Switzerland. Prior to Lotek, Mr. Hogan spent 12 years in urology with American Medical Systems, in a variety of sales and marketing positions, based at various US and international locations.
Drew Karazin joined the Company in December, 1999 as Vice President and Chief Financial Officer. Prior to joining the Company he was Chief Financial Officer of Life Medical Sciences, Inc., a publicly traded cardiovascular research company during 1998 and 1999. Prior to that he was the Chief Financial Officer for SCA Molnlycke, a $200 million subsidiary of a Swedish medical device and incontinence company during 1996 and 1997 and President of Jersey Integrated Healthcare, one of the largest physician management companies in New Jersey, during 1996. From 1992 to 1995 he was the senior executive responsible for Finance, M&A, Business Development, Strategic Planning, Information Systems and certain marketing and product development activities for Calgon Vestal Laboratories Inc., a $100 million division of Merck & Co., Inc. From 1983 to 1995 Mr. Karazin served in financial management positions, and from 1977 to 1983 he served in manufacturing and research positions, with Merck. Prior to the he was a research and manufacturing engineer at Chesebrough-Ponds.
Executive officers serve at the discretion of the Board.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Market and Dividend Information
The Company's Common Stock is traded on the Nasdaq National Market System under the symbol "BINX". The following table sets forth, for the periods indicated, the intra-day high and low sales prices per share of Common Stock on the Nasdaq National Market System:
As of March 29, 2000 there were 63 stockholders of record of the Company's Common Stock. The Company estimates that as of such date, there were approximately 1000 beneficial owners of its Common Stock, although no assurances can be given with respect to the accuracy of this estimate.
The Company has never declared or paid any cash dividends on its capital stock. The Company currently intends to retain any future earnings for funding its growth and, therefore, does not anticipate paying any cash dividends in the foreseeable future.
(b) Use of Proceeds
The Company's initial public offering was effected pursuant to a registration statement on Form S-1 (No. 333-22359) declared effective by the Securities and Exchange Commission (the "SEC") on April 24, 1997. The offering commenced on April 25, 1997 and terminated after all securities were sold. Pursuant to Rule 463, the following information is presented to supplement the related information set forth in the Company's prior public reports.
(i) From April 25, 1997 through December 31, 1999, the Company has used the following amount of the net proceeds from such offering for the following categories enumerated by the SEC:
(ii) None of the above-mentioned uses of proceeds represented direct or indirect payments to directors or officers of the Company or their associates, to persons owning ten percent or more of any class of equity security of the Company or to affiliates of the Company. Such uses do not represent a material change in the use of proceeds described in the above-mentioned registration statement.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following consolidated selected financial data is qualified in its entirety by, and should be read in conjunction with, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements and the related Notes thereto included elsewhere in this Annual Report. The Consolidated Statement of Operations data for the years ended December 31, 1997, 1998 and 1999 and the Consolidated Balance Sheet data as of December 31, 1998 and 1999 are derived from the audited Consolidated Financial Statements of the Company included elsewhere in this Annual Report. The Consolidated Statement of Operations data for the years ended December 31, 1995 and 1996 and the Consolidated Balance Sheet data at December 31, 1995, 1996 and 1997 are derived from audited consolidated financial statements not included in this Annual Report.
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(1) In 1996, the Company was reorganized as described in Note 1 to the Consolidated Financial Statements. Accordingly, earnings (loss) per share is not presented for 1995.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Consolidated Financial Statements and the related Notes thereto presented elsewhere herein. The discussion in this Annual Report on Form 10-K contains Forward-Looking Statements that involve risks and uncertainties. The Company's actual results could differ materially from those discussed in the Forward-Looking Statements. Factors that could cause or contribute to such differences include, without limitation, those discussed in Exhibit 99.1, in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and under the caption "Business" in this Annual Report on Form 10-K.
OVERVIEW
The Company was founded in 1984 to develop certain resorbable polymers for orthopaedic uses. The Company has incurred substantial operating losses since its inception and, as of December 31, 1999, had an accumulated deficit of approximately $16.7 million. Such losses have resulted to a large extent from expenses associated with the write off and reserve of impaired inventory, the development and patenting of the Company's Self-Reinforcing technologies and resorbable implant designs, preclinical and clinical studies, preparation of submissions to the FDA and foreign regulatory agencies, the development of sales, marketing and distribution channels, the write-off of acquired in-process research and development and the development of the Company's manufacturing capabilities. After recording profitable results for a number of quarters, the Company has again recorded losses in recent periods, including a loss of approximately $12.5 million in 1999. Although the Company's revenues grew significantly in the second half of 1996 and during 1997 and 1998, there was no revenue growth during 1999. No assurance can be given that revenues will grow in the future or that revenues will exceed expenses. There can be no assurance that the Company will be able to successfully commercialize its products or that the Company will be profitable again.
In late 1998, the Company entered into an expansion phase building inventory levels and personnel in anticipation of continued growth in its core business and the introduction of new products in the Craniofacial surgical market. Actual sales results were substantially less than planned; thus these increased expenditures, together with legal costs incurred to protect the Company's intellectual property and a 1% year over year (1999 vs 1998) reduction is sales resulted in operating losses during 1999 of approximately $13.1 million.
The Company incurred losses of $865,000 and $3,560,000 in the first and second quarters of 1999. During the second quarter of 1999, the Company began to implement initiatives to refocus its business and reallocate critical resources with a goal of achieving sales growth, profit improvement and a positive cash flow position. Management initiatives included: development and implementation of a management-restructuring plan that included adding critical resources in areas that will have the greatest impact on sales growth and profit improvement; consolidation of sales efforts for craniofacial and orthopedic products designed to improve sales efficiencies, increase market coverage and reduce the Company's cost of sales; reduction in sales administration to reduce the Company's overall selling costs; refocus of R&D investments on new product introductions that will provide complementary product offerings for orthopedic and craniofacial products; consolidation of global inventories to reduce the Company's overall investment in inventories and improve customer service levels; reduction in inventory levels to improve inventory turn rates thereby reducing the Company's cash requirements to support inventory investments; increases in sales and marketing efforts designed to expand sales contributions from markets outside of the US; and the implementation of surgeon educational programs designed to increase surgeon awareness and use of the Company's products. In addition to these initiatives, during the second quarter of 1999, four new patents were issued for the application of the Company's technology for orthopedic indications.
During the third and fourth quarters of 1999, the Company continued to implement these initiatives and refocus its business in an attempt to improve its profitability and operations performance. Four new products were introduced. The loss from operations excluding the special inventory charges, increased reserves and litigation costs; has been reduced from $2,028,000 in the second quarter 1999 to $699,000 in the third quarter and $335,000 in the fourth quarter at December 31, 1999. The Company's cash and cash equivalents improved from $2.9 million at September 30, 1999 to $3.2 million at December 31, 1999, representing the improvements made in cash flow management and our continued efforts to achieve a positive cash flow during 2000.
No assurances can be given that the Company's initiatives will result in profitable operations in the future.
The Company first introduced its PGA pins in 1984 and its PGA screws in 1986. In 1987, the Company introduced its first PLLA products, PLLA pins. PLLA screws were introduced in 1989. Since the introduction of these products, the Company has expanded its PGA and PLLA pin and screw product lines to address additional clinical indications. The Company's PGA membrane product was introduced in 1992, and, in 1995, the Company launched its Meniscus Arrow, PLLA tacks, and PGA and PLLA urology stents. In 1998, the Company launched its cranio-facial product line. Prior to 1996, the Company derived substantially all of its revenue from sales of its PLLA and PGA screws and pins. A substantial portion of the Company's revenues and revenue growth in the second half of 1996 and during 1997 and 1998 resulted from sales of the Meniscus Arrow, which received FDA clearance in March 1996. To date, all products sold by the Company have been launched first in international markets. During 1997, 1998 and 1999, international product sales represented approximately 15%, 20% and 18%, respectively, of the Company's total product sales. See Note 14 of the Notes to the Company's Consolidated Financial Statements.
The Company typically sells, consigns or provides free of charge to hospitals implant grade, stainless steel surgical instruments for use with each of its Self-Reinforced, resorbable products. The sale of these instruments result in margins which are typically lower than the margins applicable to the Company's implant products. For financial statement purposes, revenues from the sale of instrumentation systems are included within product sales and costs associated with such systems are included within cost of goods sold. However, due to increased competitive activity in the hospital setting, the Company began expensing instruments during the fourth quarter 1999 as they are placed in hospitals for use by the surgeon. In the case of consigned product to distributors and dealers, the Company amortizes the cost of the instrumentation over a three to four year period as cost of goods sold. Sales and loans of such systems are likely to be most pronounced in periods shortly after product launches and likely to be less prevalent as penetration of the market increases over the long term. For information regarding the Company's instrumentation practices, see "Business -- Products -- Instrumentation."
The Company sells its products through managed networks of direct sales agents, independent sales agents, distributors and dealers. In the U.S., the Company handles all invoicing functions directly and pays commissions to its sales agents or representatives. Outside the U.S., the Company sells its products directly to distributors and dealers at discounts that vary by product and by market. Accordingly, the Company's U.S. sales result in higher gross margins than international sales.
Outside of the orthopaedic market, the Company may seek to establish licensing or distribution agreements with strategic partners to develop certain products and to market and distribute products that the Company elects not to distribute through its managed networks of independent sales agents, distributors and dealers. No assurance can be given that the Company will be able to enter into license arrangements on satisfactory terms.
The Company has entered into agreements pursuant to which the Company is obligated to pay royalties based on net sales of certain of the Company's products, including the Meniscus
Arrow. To the extent that sales of the Meniscus Arrow products and other licensed products increase in future periods, the Company's license obligations are expected to increase.
The Company invoices more than 85% of its consolidated revenues in US Dollars. Approximately 72% of the expenses incurred by the Company are denominated in US Dollars. The remaining portion of revenues and expenses are denominated in European currencies, predominantly Finnish Markka. The Company seeks to manage its foreign currency risk for these other currencies through the purchase of foreign currency options and forward contracts. No assurances can be given that such hedging techniques will protect the Company from exposure resulting from relative changes in the economic strength of the foreign currencies applicable to the Company. Foreign exchange transaction gains and losses can vary significantly from period to period.
In April, 1999 the Company entered into a distribution agreement with Mentor Corporation. Under the terms of the agreement, Mentor has exclusive distribution rights for all of the Company's current and future bioabsorbable stent products for urology applications in all areas of the world other than the U.S. and Japan. In exchange for exclusive distribution rights, Mentor must achieve certain minimum market penetration objectives, and pay the Company a pre-agreed percentage of the customer sales price on all stent products sold. During December 1999, the Company renegotiated the agreement with Mentor to include the exclusive distribution rights for the U.S. In exchange for the U.S. distribution rights, Mentor will pay all costs and expenses associated with development, clinical and registration costs of current and future stents for urology applications on a global basis, excluding Japan. The Company also entered into an agreement with Toray, a Japanese company, for the exclusive distribution rights for stent products in Japan. Toray will pay all costs and expenses associated with development, clinical and registration costs of current and future stents for urology applications in Japan.
While the Company's operating losses have resulted in net operating loss carryforwards of approximately $ 8.5 million for Federal, foreign and state income tax reporting purposes as of December 31, 1999, the extent to which such carryforwards are available to offset future U.S. and Finnish taxable income may be limited as a result of various ownership changes that have occurred in recent years. Additionally, because tax laws limit the time during which these carryforwards may be applied against future taxes, the Company may not be able to take full advantage of these carryforwards for income tax purposes. Furthermore, income earned by a foreign subsidiary may not be offset against operating losses of U.S. entities. The statutory tax rates applicable to the Company and its foreign subsidiaries vary substantially. Tax rates have fluctuated in the past and may do so in the future. See Note 12 of the Notes to the Company's Consolidated Financial Statements.
The Company's results of operations have fluctuated in the past on an annual and quarterly basis and may fluctuate significantly from period to period in the future, depending on many factors, many of which are outside of the Company's control. Such factors include the timing of government approvals, the medical community's acceptance of the Company's products, the success of competitive products, the ability of the Company to enter into strategic alliances with corporate partners, expenses associated with patent matters, the results of regulatory inspections and the timing of expenses related to product launches.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
Product Sales
The Company's product sales increased by 31% from $15.8 million in 1997 to $20.7 million in 1998, and decreased by 1% to $20.5 million in 1999. The increase in product sales in 1998 reflected continued penetration in Meniscus Arrow sales in the United States and increased sales of several non-Arrow products in both the U.S. and international markets. The decrease in
product sales in 1999 reflected a reduction in sales of Sports Medicine products, including the Meniscus Arrow, offset to a large degree by the increase in sales of Orthopedic Trauma and Craniofacial products. Meniscus Arrow sales were negatively impacted by a reduction in the number of arrows used per surgery and the increase in non-Arrow sales reflects new products and market opportunities. Revenues generated from the sale of instrumentation systems and related loaner fees represented 11%, 8% and 4% of total sales in 1997, 1998 and 1999, amounting to $1.8 million in 1997, $1.7 million in 1998 and $0.9 million in 1999. The decline from 1998 to 1999 in both percentage and dollar terms was primarily due to the increasingly competitive environment and a trend toward giving the instruments to healthcare institutions. Instrumentation revenues relating to the Meniscus Arrow during 1997, 1998 and 1999 were approximately $850,000, $624,000 and $322,000 respectively.
License and grant revenues. License and grant revenues increased by 73% from $242,000 in 1997 to $418,000 in 1998 and by 48% to $618,000 in 1999. The increase in revenues from 1997 to 1998 resulted from an increase in the level of research activity during 1998. The increase in revenues from 1998 to 1999 resulted from increased government and university funding.
Gross profit; gross profit margins. The Company's gross profit increased by 34% from $12.3 million in 1997 to $16.6 million in 1998 and decreased by 46% to $9.0 million in 1999. The increase in the Company's gross profit during 1998 primarily reflected the increased sales of Meniscus Arrow products after their introduction in the U.S. in the second quarter of 1996. The decrease in 1999 includes $6.2 million of special charges related to instrument and obsolete inventory; the gross profit excluding these adjustments would have been $15.2 million. Overall, the Company's gross profit margin increased from 77% in 1997 to 79% in 1998 and decreased to 43% in 1999. Excluding the special charges the gross profit margin would have decreased to 72% in 1999, which includes an increased amortization of instruments placed with distributors and a change in mix towards products with lower gross margins.
The Company amortizes the cost of instrumentation inventory consigned to distributors and dealers, and classifies this as an inventory reserve. The Company's total amortization charge for these items increased from $800,000 at December 31, 1998 to $1,903,000 during 1999. The increase is due to a related increase in the number of instruments consigned versus the previous practice of selling the instruments. During the fourth quarter, the Company began expensing the instruments given to hospitals as their future benefit is unpredictable. During the fourth quarter 1999 the Company changed its accounting estimate for instruments consigned to hospitals. Additionally, in the fourth quarter, the Company identified certain distributor accounts that had been terminated by the Company and had outstanding inventory balances. The Company wrote off $382,000 of gross implant inventory and $886,000 of gross instrument that had been placed with these distributors, used as samples and or it is cost prohibitive to pursue such accounts and retrieve the products.
In the second quarter, the Company recorded a charge of $929,000 for excess implant and instrument inventory due to changes in technology and the introduction of new and competing instruments. This charge was increased by $1,594,000 in the fourth quarter as these continued changes in technology created excess inventory.
In aggregate, the foregoing charges resulted in a Special Charge of $6.241 million during 1999. The net fourth quarter impact of the change in estimate for the hospital instruments was $2.45 million.
Selling, general and administrative expenses. Selling, general and administrative expenses increased by 30% from $9.7 million in 1997 to $12.6 million in 1998, and by 26% to $15.9 million in 1999. Such expenses were 62% of product sales in 1997, 63% of product sales in 1998, and 78% of product sales in 1999. The increases in the dollar amount of selling, general and administrative expenses during these periods is partially attributable to salaries paid to newly employed sales persons (including the costs incurred in the launch of the craniofacial products), the increase in commission payment obligations reflecting the Company's increased product sales in the U.S., and the increase in expenses associated with establishing and supporting a managed network of independent sales agents in the U.S. Also contributing to this increase were costs incurred in connection with the Company's implementation of new business initiatives related to the restructuring of the Company's operations and organization to a system of managed sales agents and distributors from the aforementioned new sales employee structure, and the anticipation of new product launches.
Research and development. Research and development expenses increased by 171% from $871,000 in 1997 to $2,360,000 in 1998 and by 59.1% to $3,758,000 in 1999. Research and development as a percentage of sales increased during this period from 9% in 1997 to 11% in 1998 to 18% in 1999. These increases reflected an increased volume of product development work being performed by the Company and increased staffing levels.
Severance charges. During the second quarter of 1999, the Company incurred a one-time severance charge of $275,000 and incurred further charges of $21,000 during the remainder of the year related to additional employee severances. These severance charges relate to the organizational restructuring of the Company, including severance payments to the Company's former chief executive officer, chief financial officer and vice president of sales. The majority of the severance charges were paid prior to December 31, 1999.
Patent litigation. The Company has incurred $2.1 million in legal fees to prosecute (and in one instance settle) three patent infringements suits during 1999. The patent litigation legal fees incurred during 1999 are part of the Company's efforts to protect and strengthen its proprietary intellectual property position. There were no material comparable charges in 1997. The comparable charge in 1998 was $350,000.
Other income and expense. Other income and expense consists of interest income and expense and miscellaneous expense and income items. The Company generated net interest income of $752,000 in 1997, $986,000 in 1998 and $248,000 in 1999. A foreign currency transaction gain of $408,000 was recorded in "other income" in 1997, compared to a foreign currency transaction loss of $263,000 during 1998 and a gain of $466,0000 in 1999.
Income taxes. In 1997, the Company recorded an income tax provision of $758,000, or 26 % of pretax income, which primarily reflected the income generated in the Company's Finnish subsidiary. In 1998, the Company recorded an income tax provision of $741,000, or 37% of pretax income. This increase in effective tax rate reflected the increase in income generated by the Finnish subsidiary taxed at the rate of 28%. Although an operating loss was recorded by the U.S. entity during 1998, no corresponding tax benefit was recognized due to the net operating loss position in the U.S. During 1999 both the US and Finnish operations had net losses with no benefit recorded. The tax charge of $63,000 was under 1% and represented an adjustment to the net deferred tax asset.
Net income(Loss). The Company reported net income of $2,158,000 and $1,261,000 in 1997 and 1998, respectively and a loss of $12.5 million in 1999.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1999, the staff of the SEC issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 summarizes certain of the staff's views in applying Generally accepted Accounting Principles to revenue recognition in financial statements, including recognition of non-refundable fees received upon entering into agreements. The Company is in the process of evaluating SAB 101 and the effect it will have on our Consolidated Financial Statements and current revenue recognition policy.
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS 133). SFAS133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires companies to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value. Gains or losses resulting from changes in the value
of those derivatives would be accounted for, depending on the use of the derivative and whether it qualifies for hedge accounting under SFAS 133. Prospective application of SFAS 133, as amended, is required commencing with the first quarter of the fiscal year beginning after December 31, 2000, however, earlier application is permitted. We do not expect the impact of SFAS 133 to be material to our financial position and results of operations.
QUARTERLY PRODUCT SALES
The following table presents unaudited product sales information for the quarters indicated. In the opinion of management, this information has been prepared on the same basis as the product sales data included in the Consolidated Financial Statements appearing elsewhere in this Annual Report on Form 10-K. Product sales for any period are not necessarily indicative of product sales to be expected for any future period.
Revenue trends will depend upon many factors, including demand and market acceptance for the Company's existing and future products, the timing of regulatory approvals, the timing and results of clinical trials, the timing of the introduction of new products by the Company and by competing companies, competitive sales practices, the ability of the Company to enter into strategic alliances with corporate partners and the Company's ability to attract and retain highly qualified technical, sales and marketing personnel. Accordingly, there can be no assurance that future revenues will not vary significantly from quarter to quarter.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has relied upon bank loans, capital contributions by its principal stockholders and government grants to fund its operations. In September 1996, the Company completed a private placement of $5.0 million in preferred stock (all of which was converted into Common Stock upon consummation of the Company's initial public offering in April 1997) and warrants (all of which were exercised during April 1997). During 1997, the Company consummated its initial public offering. Net proceeds from the initial public offering and the exercise of warrants during April 1997 were $21.7 million. In addition, the Company made arrangements for a $2 million credit line, secured by the personal property of Bionx Implants, Inc. and a subsidiary. During 1999 this credit line was increased to $4.0 million. Amounts to be advanced thereunder are subject to the lender's discretion and are limited to specific percentages of certain domestic receivables and inventory. To date, no amounts have been borrowed pursuant to this facility.
At December 31, 1998 and 1999, cash and cash equivalents totaled $14.2 million and $3.2 million, respectively.
The Company's liquidity has been weakened substantially during 1999. The Company's liquidity is dependent primarily upon its ability to improve operating results and thereby generate adequate cash flow from operations. Management has taken several steps designed to improve future financial results and reduce the amount of cash used by operations, including (i) developing a management restructuring plan to add critical resources to areas having the greatest impact in sales growth, (ii) consolidating sales efforts to improve sales efficiencies, increase market coverage and reduce selling costs, (iii) refocusing research and development investments on new product introductions, (iv) consolidating and reducing inventory levels, (v) increasing sales and marketing efforts outside the U.S., and (vi) where possible, reducing other operating expenses. However, there can be no assurance that these steps will be successful. The Company's operations may not provide sufficient internally generated cash flows to meet the Company's projected requirements. The Company's ability to continue to finance its operations will depend on its ability to achieve profitability by improving sales and margins, its ability to reduce cash outflows and, if necessary, its ability to obtain other sources of funding sufficient to support the Company's operations. No assurances can be given that such funding will be available on satisfactory terms or at all.
On March 3, 2000, the Company completed a shareholder rights offering, pursuant to which it raised $4,046,485 (before deducting expenses of approximately $100,000) and issued 1,586,857 shares of Common Stock. The Company distributed 0.173 of a subscription right for each share of Common Stock outstanding on the January 10, 2000 record date for a total of 1,586,857 shares offered in the rights offering. The subscription price of $2.55 per share was established by the Board of Directors based on a 15% discount from the market price on January 14, 2000, at the time the offering was priced. The Company plans to use the proceeds of the rights offering for additional working capital to fund operations, for continuing research and development and for surgeon education programs.
To the extent that funds generated from the Company's operations, together with its existing capital resources, and the net interest earned thereon, are insufficient to meet current or planned operating requirements, the Company will be required to obtain additional funds through equity or debt financings, strategic alliances with corporate partners and others, or through other sources. The terms of any further equity financing may be dilutive to stockholders and the terms of any debt financing may contain restrictive covenants, which limit the Company's ability to pursue certain courses of action. The Company does not have any committed sources of additional financing beyond that described above, and there can be no assurance that additional funding, if necessary, will be available on acceptable terms, if at all. Principal stockholders of the Company who previously provided funding to the Company and provided guarantees to sources of credit have indicated that they do not intend to continue furnishing such assistance. If adequate funds are not available, the Company may be required to delay, scale-back or eliminate certain aspects of its operations or attempt to obtain funds through arrangements with strategic partners or others that may require the Company to relinquish rights to certain of its technologies, product candidates, products or potential markets. If adequate funds are not available, the Company's business, financial condition and results of operations could be materially and adversely affected. The Company's future capital requirements and the adequacy of available capital resources will depend on numerous factors, including the Company's ability to successfully perform management initiatives initiated in 1999, market acceptance of its existing and future products, the successful commercialization of products in development, progress in its product development efforts, the magnitude and scope of such efforts, acquisition opportunities, progress with preclinical studies, clinical trials and product clearances by the FDA and other agencies, the cost and timing of the Company's efforts to expand its manufacturing capabilities, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, competing technological and market developments, and the development of strategic alliances for the marketing of certain of the Company's products. The sufficiency of the Company's capital reserves with respect to operations beyond 2000 will depend primarily upon the Company's operating results and the extent to which such results are capable of funding anticipated growth.
The Company believes that existing capital resources from its $4.0 million discretionary credit line and its $4.0 million rights offering completed in 2000, together with cash flow from operations (if, and to the extent, generated), will be sufficient to fund its operations during 2000. This statement constitutes a Forward-Looking Statement. Actual results could differ materially from the Company's expectations regarding its capital requirements and its sources of capital. The Company's future capital requirements and the adequacy of available funds will depend on numerous factors, including management's ability to reverse recent trends, market acceptance of the Company's existing and future products, the successful commercialization of products in development, progress in its product development efforts, the magnitude and scope of such efforts, progress with preclinical studies, clinical trials and product clearances by the FDA and other agencies, the cost and timing of the Company's efforts to expand its manufacturing capabilities, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, competing technological and market developments, and the development of strategic alliances for the marketing of certain of its products. The Company's operations did not produce positive cash flows during 1994, 1995, 1996, 1998 or 1999. To the extent that funds generated from the Company's operations, together with its existing capital resources (including its credit facility), and the net interest earned thereon, are insufficient to meet current or planned operating requirements, the Company will be required to obtain additional funds through equity or debt financing, strategic alliances with corporate partners and others, or through other sources. No assurances can be given that such funds will be made available to the company on acceptable terms or otherwise.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company conducts operations in countries other than the United States, primarily its manufacturing facility in Finland. The Company's consolidated financial statements are denominated in U.S. dollars, and accordingly, changes in exchange rates between foreign currencies and the U.S. dollar will affect the translation of financial results of foreign subsidiaries into U.S. dollars for purposes of recording the Company's consolidated financial results. As of December 31, 1999, the Company had 2 foreign currency contracts outstanding, with a face value of $54,344.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial information is set forth on the following pages immediately following this page:
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders Bionx Implants, Inc.:
We have audited the accompanying consolidated balance sheets of Bionx Implants, Inc. and subsidiaries as of December 31, 1998 and 1999, and the related consolidated statements of operations, stockholders' equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended December 31, 1999. In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Bionx Implants, Inc. and subsidiaries as of December 31, 1998 and 1999, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1999, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
KPMG LLP
Philadelphia, Pennsylvania April 7, 2000
BIONX IMPLANTS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1999
See accompanying notes to consolidated financial statements.
BIONX IMPLANTS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
See accompanying notes to consolidated financial statements.
BIONX IMPLANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
See accompanying notes to consolidated financial statements.
BIONX IMPLANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
BIONX IMPLANTS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
See accompanying notes to consolidated financial statements
BIONX IMPLANTS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(1) ORGANIZATION
Basis of Presentation
On August 27, 1999, the Company reincorporated, changing its state of incorporation from Delaware to Pennsylvania. The reincorporation was approved by the Company's stockholders at the Company's annual meeting of stockholders on August 13, 1999. There was no change in the name, business, management, benefit plans, location, assets, liabilities or net worth of the Company as a result of the reincorporation.
Bionx Implants, Inc. (the Company) was originally incorporated in October 1995 as a Delaware corporation. In 1996, the Company completed a reorganization, whereby four corporate entities that constituted the business activities of the Company were reorganized into Bionx Implants, Inc. The shareholders of the four separate corporations who were shareholders having a common interest in the combined activities of the business exchanged their shares pro-rata, directly or indirectly, for the shares of Bionx Implants, Inc.
Given the common ownership relationship of the four predecessor corporations and the subsequent reorganization into the Company, the accompanying financial statements include the four predecessor corporations' financial statements consolidated as of December 31, 1998 and 1999, and for the years ended December 31, 1997, 1998 and 1999.
Initial Public Offering
During the second quarter of 1997, the Company completed its initial public offering (the "IPO") of 2,300,000 shares of Common Stock (including the exercise of the underwriter's over-allotment option of 300,000 shares) at $10.50 per share. (Note 9)
Business Purpose
The Company is a leading developer, manufacturer and marketer of self-reinforced, resorbable polymer implants, including screws, pins, arrows and stents, for use in a variety of applications which include orthopaedic surgery, urology, dentistry and craniofacial surgery. The Company's proprietary manufacturing processes self-reinforce a resorbable polymer, modifying the gel-like or brittle polymer structure into a physiologically strong structure with controlled, variable strength retention (ranging from three weeks to six months depending upon the medical indication). The Company currently markets its sixteen product lines through managed networks of independent agents, distributors and dealers.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the financial statements of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
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 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.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Cash and cash equivalents include cash on hand and in the bank as well as short-term securities. The carrying amount of cash and cash equivalents approximates its fair value due to its short-term nature.
Inventory
Inventory is valued at the lower of cost or market, with cost being determined under a first-in, first-out (FIFO) method. Reserves are established for excess and obsolete inventory on a specific identification basis. The instrument inventory, to the extent it is released on consignment to dealers and distributors in the US and dealers, distributors and hospitals in the rest of the world, is amortized over its estimated useful life of three years.
Plant and Equipment
Major additions and replacements of assets are capitalized at cost. Maintenance, repairs, and minor replacements are expensed as incurred. Machinery and equipment are depreciated using the straight-line method over a five to fifteen-year period. Leasehold improvements and equipment acquired under capital lease are amortized using the straight-line method over the estimated useful life of the asset or the lease term, whichever is shorter. Upon retirement or sale, the cost of the asset disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations.
Intangibles
Patents and rights are stated at cost. Amortization of patents is recorded using the straight-line method over the remaining legal lives of the patents, generally for periods ranging up to 12 years. Software costs are stated at cost, and are amortized using the straight-line method over 5 to 7 years. Accumulated amortization related to intangibles was $415,484 and $616,398 at December 31, 1998 and 1999, respectively.
The Company's policy is to evaluate the appropriateness of the carrying value of the unamortized balances of intangible assets on the basis of estimated future cash flows (undiscounted) and other factors. If such evaluation were to indicate an impairment of these intangible assets, such impairment would be recognized by a write-down of the applicable assets. The Company continues to evaluate the continuing value of patents and patent applications, particularly as expenses to prosecute or maintain these patents come due. Through this evaluation, the Company may elect to continue to maintain these patents, seek to out-license them or abandon them.
Goodwill
Goodwill, representing costs in excess of the fair value of assets acquired, is amortized on a straight-line basis over 20 years. On a periodic basis, the Company evaluates the carrying value of intangible assets based upon expectations of undiscounted cash flows. Accumulated amortization related to goodwill was $375,550 and $536,473 at December 31, 1998 and 1999, respectively.
Certain Risks and Concentrations
The Company extends unsecured trade credit in connection with its commercial sales to a diversified customer base comprised of both foreign and domestic entities, most of which are concentrated in the healthcare industry.
The Company invests its excess cash in deposits with major U.S. financial institutions and money market funds. To date, the Company has not experienced any losses on its cash equivalents and money market funds.
The Company's products require approvals or clearances from the U.S. Food and Drug Administration (FDA) and international regulatory agencies prior to commercialized sales. There can be no assurance that the Company's products will receive any of the required approvals or clearances. If the Company was denied such approvals or clearances, or such approvals or clearances were delayed, it would have a material adverse impact on the results of operations and financial position of the Company.
Fair Value of Financial Instruments
Financial Accounting Standards Board Statement No. 107, Disclosures About Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. Cash, trade accounts receivable, prepaid expenses and other current assets, trade accounts payable and accrued expenses reported in the balance sheets equal or approximate fair value due to their short maturities. Based on the borrowing rates currently available to the Company, the fair value of all of the Company's loans is approximately their carrying value.
Stock Option Plan
Effective January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosures required by SFAS No. 123.
Revenue Recognition
Revenue from product sales is recognized upon shipment and passage of title to the customer. Revenue from license fees is recognized when the required milestones are met. Revenue from grant agreements is recognized in the period in which the related expenses are incurred and in accordance with the Company's obligations under the terms of the respective grants.
Research and Development
All research and development costs are expensed as incurred.
Foreign Exchange Risk Management
The Company hedges its estimated net economic exposure through foreign exchange options and forward contracts on a rolling 12-month basis. Market value gains are recognized in income currently and the resulting gains offset foreign exchange transaction losses. Determination of hedge activity is based upon market conditions, the magnitude of foreign currency assets and liabilities and perceived risks. Net foreign currency exchange transaction losses of $236,002 were recorded in "other income" in
1998 and net foreign currency exchange transaction gains of $466,197 were recorded in "other income" in 1999.
Foreign Currency Translation
Effective January 1, 1998, the Company changed the functional currency of its Finnish subsidiary, from the Finnish Markka to the US Dollar. This change arose due to certain changes in the economic conditions of the Finnish operations. The underlying economic factors which influenced the Company's decision to change the functional currency was derived from an analysis of the indicators outlined in FAS 52, Appendix A. This included an analysis of the currency denominations of the related assets, cash flows, revenues and expenses of the Finnish operating subsidiary.
Accounting for Income Taxes
Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when such differences are expected to reverse. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits, which are not expected to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate change is enacted.
Comprehensive Income
On January 1, 1998, the Company adopted SFAS No. 130 "Reporting Comprehensive Income". SFAS No. 130 establishes standards for reporting and presentation of the Company's comprehensive income (loss) and its components in a full set of financial statements. Comprehensive income (loss) consists of net income (loss) for the year and foreign currency translation adjustments and is presented in the consolidated statement of changes in stockholder's equity and comprehensive income (loss). The Statement requires only additional disclosures in the consolidated financial statements; it does not affect the Company's financial position or results of operations. Prior year financial statements have been reclassified to conform to the requirements of the statement.
Comprehensive income (Loss) is summarized below:
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed using the weighted average number of shares of common stock outstanding during the period, giving effect to any treasury shares. Diluted earnings (loss) per share are computed using the weighted average number of common and potential dilutive common shares outstanding during the period. Potential dilutive common shares consist of stock options and warrants using the treasury stock method and are excluded if their effect is antidilutive.
The following table sets forth the calculation of the total number of shares used in the computation of earnings (loss) per common share for the years ended December 31, 1997, 1998 and 1999:
During the year ended December 31, 1999 there were approximately 700,000 stock options and warrants that were considered antidilutive and, accordingly, excluded in the calculation of earnings (loss) per share.
Reclassifications
Certain amounts in the 1998 financial statements have been reclassified to conform to the current year presentation.
(3) INVENTORY
Inventory consists of the following components as of December 31, 1998 and 1999:
The Company amortizes the cost of instrumentation inventory consigned to dealers and distributors.
In the fourth quarter of 1999, the Company changed its accounting estimate for instruments consigned to hospitals. Since the Company can not control future purchases from such hospitals and it is cost prohibitive to return the instruments, the Company began expensing the instruments on the initial sale to the hospital. In accordance with APB Opinion 20, the Company wrote off $ 4.0 million of hospital gross inventory and added back an associated $1.6 million of accumulated amortization, for a net $2.45 million write off.
Additionally, in the fourth quarter, the Company identified certain distributor accounts that had been terminated by the Company and had outstanding inventory balances. The Company wrote off $382,000 of gross implant inventory and $886,000 of gross instrument that had been placed with these distributors, used as samples and or it is cost prohibitive to pursue such accounts and retrieve the products.
In the second quarter, the Company recorded a charge of $929,000 for excess implant and instrument inventory due to changes in technology and the introduction of new and competing instruments. This charge was increased by $1,594,000 in the fourth quarter as these continued changes in technology created excess inventory.
In aggregate, the foregoing charges resulted in a Special Charge of $6.241 million during 1999.
(4) PLANT AND EQUIPMENT
Plant and equipment consist of the following components as of December 31, 1998 and 1999:
(5) RELATED PARTY TRANSACTIONS
The Company's product development efforts are dependent upon Dr. Tormala, who is a founder, director, and executive officer of the Company and is currently an Academy Professor at the Technical University in Tampere, Finland and as such is permitted by the University to devote his efforts to developing new products for the Company. This executive utilizes a group of senior researchers, graduate students, and faculty at the Technical University to perform research and development projects involving resorbable polymers and other topics impacting the Company's technology and processes. This arrangement, partially funded by the Company and permitted in Finland as a means of encouraging the commercialization of technological development, has resulted in substantial cost savings to the Company while substantially expanding its product development effort. The Company's funding obligation, which amounted to $271,000, $328,000 and $417,000 during the years ended December 31, 1997, 1998 and 1999 respectively, consists of providing the University with reasonable compensation for University resources (including graduate students) utilized by the Company.
During 1998 the Company made advances of $9,158 (50,000 Finnish Markka) on behalf of a related party, Bioabsorbable Concepts, Inc. This amount was outstanding as of December 31, 1998 and 1999.
The Company has paid certain administrative expenses on behalf of Bionix B.V., a related party. The loan amounts outstanding were $229,791 and $259,311 as of December 31, 1998 and 1999.
An executive in Finland has a non-interest bearing loan with the Company. As of December 31, 1998 and 1999, this executive owed $36,180 for expenses paid on his behalf.
The Company leases office space in Blue Bell, Pennsylvania to a company which is partially owned by several board members of the Company. Bionx was owed $15,900 as of December 31, 1999, which was paid in February of 2000.
(6) ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consist of the following components as of December 31, 1998 and 1999:
During the second quarter of 1999, the Company incurred a one-time severance charge of $275,000 and incurred further charges of $21,000 during the remainder of the year related to additional employee severances. These severance charges relate to the organizational restructuring of the Company, including severance payments to the Company's former chief executive officer, chief financial officer and vice president of sales. The majority of the severance charges were paid prior to December 31, 1999.
(7) LONG-TERM DEBT
Long-term debt consists of the following components as of December 31, 1998 and 1999:
The debt is from the Finnish government, made in order to support technology development and is payable in annual installments with interest rates of one percent (1%).
The aggregate maturities of long-term debt for each of the five years subsequent to December 31, 1999 are as follows: 2000, $ 0, 2001, $8,342, 2002, $8,342, 2003, $8,342 and 2004, $8,344.
(8) LINE OF CREDIT
The Company has a $4 million credit line with a lending institution secured by the personal property of the Company and a subsidiary. Amounts to be advanced thereunder are subject to the lender's discretion at an interest rate approximating the prime rate at the time of advance, and are limited to specific percentages of certain domestic receivables and inventory. To date, no amounts have been borrowed under the credit line.
(9) COMMON STOCKHOLDERS' EQUITY
On February 24, 1997, the Company effected a 1 for 1.9 reverse stock split. All common shares and per share amounts in the accompanying consolidated financial statements have been retroactively adjusted to reflect this common stock reverse split. Preferred stock amounts, other than the shares of common stock into which Series A Preferred is convertible, have not been retroactively adjusted.
During the second quarter of 1997, the Company completed its IPO of 2,300,000 shares of Common Stock (including the exercise of the underwriters' over-allotment of 300,000 shares) at $10.50
per share. Upon consummation of the IPO, the 2,000,000 shares of Series A Preferred outstanding automatically converted into 1,052,638 shares of common stock on a 1 for 1.9 basis. An additional 245,065 shares of Common Stock were issued upon the exercise of all outstanding warrants. The net proceeds of the IPO, after underwriting discounts and costs in connection with the sale and distribution of the securities and the exercise of the warrants, were approximately $21.7 million.
During the fourth quarter of 1998, the Company's board of directors announced a buy-back program to repurchase its common stock from time to time. During 1998 and 1999, the Company repurchased 20,500 shares and 6,000 shares, respectively for a purchase price of $128,198 and $33,497, respectively.
(10) COMMITMENTS AND CONTINGENCIES
The Company leases offices and laboratory facilities, equipment, and vehicles under various non-cancelable operating lease arrangements. Future minimum rental commitments required by such leases are as follows:
Rental expense for the years ended December 31, 1997, 1998 and 1999 aggregated $202,624, $454,702, and $421,609, respectively.
The Company has incurred $2.1 million in legal fees to prosecute (and in one instance settle) three patent infringements suits during 1999. The patent litigation legal fees incurred during 1999 are part of the Company's efforts to protect and strengthen its proprietary intellectual property position. There were no material comparable charges in 1997. The comparable charge in 1998 was $350,000.
(11) STOCK OPTION PLANS
In September 1996, the Board of Directors adopted a stock option plan (the 1996 Option Plan) under which the number of common shares that may be issued under the Option Plan, as amended, cannot exceed 850,000 shares. The 1996 Option Plan permits the granting of both incentive stock options and non-qualified options. Options are exercisable over a period determined by the Board of Directors, but no longer than ten years after the grant date.
At December 31, 1999, there were 131,957 additional shares available for grant under the 1996 Option Plan. The per share weighted-average fair value of stock options granted in 1997, 1998 and 1999 was $16.66, $12.43, and $2.47 respectively, on the date of grant using the Black Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31:
The Company applies APB Opinion No. 25 in accounting for its 1996 Option Plan and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net loss would have been increased and net income decreased as indicated below:
Since no stock options or warrants were granted prior to January 1, 1995, the pro forma net loss reflects the full impact of calculating compensation cost for stock options under SFAS No. 123.
A summary of activity under the 1996 Option Plan from January 1, 1996 to December 31, 1999 is as follows:
The following table summarizes information about stock options outstanding under the 1996 Option Plan at December 31, 1999:
(12.) INCOME TAXES
At December 31, 1999, the Company and its subsidiaries had available U.S. federal net operating loss carryforwards ("NOL") of approximately $5,800,000 and U.S. state net operating loss carryforwards of approximately $2,100,000 for income tax reporting purposes, which are available to offset future federal and state taxable income, if any, through 2019 and 2009, respectively.
The Tax Reform Act of 1986 (the "Act") provides for a limitation on the annual use of U.S. NOL carryforwards (following certain ownership changes, as defined by the Act) that could significantly limit the Company's ability to utilize certain carryforwards. As defined by the Act the utilization of a corporation's net operating loss carryforward is limited following a greater than 50% change in ownership. Due to the Company's prior and current equity transactions, the Company's net operating loss carryforwards may be subject to an annual limitation generally determined by multiplying the value of the Company on the date of the ownership change by the federal long-term tax exempt rate. Any unused annual limitation may be carried forward to future years for the balance of the net operating loss carryforward period.
Income tax expense attributable to the income (loss) before provision for taxes was $758,344, $741,416 and $63,175 for the years ended December 31, 1997, 1998 and 1999, respectively, and differed from the amounts computed by applying the U.S. federal income tax rate of 35 percent to pretax income (loss) as a result of the following:
The income tax expense for the years ended December 31, 1997, 1998, and 1999 relate to the foreign operations of the Company. There were no federal or state income taxes in the United States for the years ended December 31, 1997, 1998 and 1999 due to the operating losses in such jurisdictions. Income tax expense consisted of the following:
The tax effects of temporary differences that give rise to significant portions of the Federal, foreign and state deferred tax assets at December 31, 1998 and 1999 are presented below:
Realization of net deferred tax assets is dependent on future earnings, which are uncertain. Accordingly, a valuation allowance was recorded by the Company against certain assets at December 31, 1998 and 1999. The total valuation allowance increased by $218,936 and $5,150,968 for the years ended December 31, 1998 and 1999, respectively.
The Company's subsidiary in Finland incurred a net operating loss for the year ended December 31, 1999 which can be carried forward to future years. A net deferred tax asset of $517,214 has been established for this net operating loss carryforward since it is the opinion of management that the subsidiary will more likely than not be able to realize this benefit.
(13) LICENSE AND GRANT REVENUE
The Company has applied for grants from the Finnish government to conduct research on resorbable polymers. The revenue from such grants was $241,685, $417,507 and $617,716 for the years ended December 31, 1997, 1998 and 1999, respectively. In connection with such grants, the Company typically commits to perform research projects and to report on the status of, and the conclusions drawn from, its projects.
(14) SEGMENT AND RELATED INFORMATION
The Company adopted SFAS No. 131 Disclosures About Segments of an Enterprise and Related Information, in 1998. The Company believes that all of its material operations are managed under the medical device industry, with similar purpose, production processes, markets, and regulatory requirements, and it currently reports as a single industry segment.
To date, the Company manufactures its products solely in its facility in Finland. The Company sells products in the U.S. through a hybrid sales force comprised of a managed network of independent sales agents and direct sales representatives managed from its U.S. headquarters and sells products internationally through a network of independent distributors and dealers managed from the Company's facility in Finland. Approximately 85%, 80% and 82% of the Company's revenue from external customers in 1997, 1998 and 1999, respectively was generated in the US. The remaining external revenue was generated in foreign countries concentrated in Europe and Asia. Of the remaining 18% of 1999 external revenue, no one particular country accounted for revenues greater than approximately 2% of total revenue. Information regarding the Company's product sales, net income (loss) and identifiable assets by geographic area is set forth below:
Sales from the subsidiary in Finland to the parent company are based upon profit margins, which represent competitive pricing of similar products.
No single customer accounted for more than 5% of consolidated revenue in 1997, 1998 and 1999.
(15) SUBSEQUENT EVENT
On March 3, 2000, the Company completed a shareholder rights offering, pursuant to which it raised $4,046,485 (before deducting expenses of $100,000) and issued 1,586,857 shares of Common Stock. The Company distributed 0.173 of a subscription right for each share of Common Stock outstanding on the January 10, 2000 record date for a total of 1,586,857 shares offered in the rights offering. The subscription price of $2.55 per share was established by the Board of Directors based on a 15% discount from the market price on January 14, 2000, at the time the offering was priced.
Financial Statement Schedule
Bionx Implants Inc. and Subsidiaries Schedule II
Valuation and Qualifying Accounts For the years Ended December 31, 1997, 1998 and 1999
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable
PART III
ITEM 10.
ITEM 10. DIRECTORS OF THE REGISTRANT
The registrant incorporates by reference herein information set forth in its definitive proxy statement for its 2000 annual meeting of shareholders that is responsive to the information required with respect to this Item.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The registrant incorporates by reference herein information set forth in its definitive proxy statement for its 2000 annual meeting of shareholders that is responsive to the information required with respect to this Item.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The registrant incorporates by reference herein information set forth in its definitive proxy statement for its 2000 annual meeting of shareholders that is responsive to the information required with respect to this Item.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The registrant incorporates by reference herein information set forth in its definitive proxy statement for its 2000 annual meeting of shareholders that is responsive to the information required with respect to this Item.
PART IV
ITEM 14
ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) See Item 8 for a list of financial statement information presented herein.
(b) See Item 8 for the financial statement schedule.
All other schedules have been omitted because they are not applicable or the required information is included in the registrant's Consolidated Financial Statements or the notes thereto.
(c) The following exhibits are incorporated by reference herein or annexed to this Annual Report on Form 10-K:
3.1 Restated Certificate of Incorporation of the Registrant. (A)
3.2 Bylaws of the Registrant. (A)
10.1 Reorganization Agreement dated as of September 5, 1996. (1)
10.2 Registrant's 1996 Stock Option/Stock Issuance Plan. (1)
10.3 Form of Amended and Restated Employment Agreement between the Registrant and David W. Anderson. (1)
10.4 Form of Employment Agreement between the Registrant's Subsidiary and Pertti Tormala, as amended. (1)
10.5 Form of Proprietary Information and Inventions Agreement. (1)
10.6 Investors' Rights Agreement, dated as of September 6, 1996, between the Registrant and certain holders of the Registrant's securities. (1)
10.7 Stock Purchase Agreement between the Registrant and purchasers of the Company's Preferred Stock and Warrants. (1)
10.8* License Agreement between the Registrant's Subsidiary and Saul N. Schreiber. (1)
10.9* License Agreement among the Registrant's Subsidiary, Pertti Tormala, Markku Tamminmaki and Menifix I/S. (1)
10.10* Licensing, Manufacturing and Distribution Agreement among the Registrant's Subsidiary, Pertti Tormala and various Danish and Finnish inventors.
10.11 Amended and reinstated Shareholders' Agreement, dated as of October 1, 1998 among Bionix, B.V. and certain shareholders of the Company. (1)
10.12 Headquarters Lease. (1)
10.13 Security Agreements and Secured Promissory Note. (1)
10.14 Form of Employment Agreement between the Registrant and Michael J. O'Brien. (2)
21.1 List of Subsidiaries. (1)
23.1 Consent of KPMG LLP
27.1 Financial Data Schedule.
99.1 Information Regarding Forward-Looking Statements
(A) Incorporated by reference to the applicable exhibit set forth in the Registrant's Quarterly Report on Form 10-Q for the Quarter ended September 30, 1999.
(1) Incorporated by reference to the applicable exhibit set forth in the Registrant's Registration Statement on Form S-1 initially filed with the Commission on February 26, 1997 (No. 333-22359).
(2) Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997.
* Certain portions of this exhibit have been omitted based upon a request for confidential treatment. The omitted portions of this exhibit have been separately filed with the Securities and Exchange Commission.
(d) During the quarter ended December 31, 1999, the Company did not file any Current Reports on Form 8-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 14th day of April, 2000.
BIONX IMPLANTS, INC.
By:___________________ Gerard S. Carlozzi (President and Chief Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report on Form 10-K has been signed by the following persons in the capacities and on the dates indicated: