-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KmXgp9lv+onMBQRzschA5LbevimCupT3CBVJvVExsYoArJ2CaNvSyC2UycRc+ztz lucnB1y3lNtvU3hdkcLh4Q== 0000912057-97-005190.txt : 19970222 0000912057-97-005190.hdr.sgml : 19970222 ACCESSION NUMBER: 0000912057-97-005190 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970214 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: GENERAL SURGICAL INNOVATIONS INC CENTRAL INDEX KEY: 0000890763 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 973170244 STATE OF INCORPORATION: CA FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-28448 FILM NUMBER: 97532410 BUSINESS ADDRESS: STREET 1: 3172A PORTER DR CITY: PALO ALTO STATE: CA ZIP: 94304 BUSINESS PHONE: 4158129740 MAIL ADDRESS: STREET 1: 3172A PORTER DRIVE CITY: PALO ALTO STATE: CA ZIP: 94304 10-Q 1 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996. Commission file number: 0-28448 GENERAL SURGICAL INNOVATIONS, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 97-3170244 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3172A PORTER DRIVE, PALO ALTO, CALIFORNIA 94304 (Address of principal executive offices) Registrant's telephone number, including area code: (415) 812-9730 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- There were approximately 13,199,353 shares of Registrant's Common Stock issued and outstanding as of December 31, 1996. ------------------------------------- GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED DECEMBER 31, 1996 TABLE OF CONTENTS Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Condensed, consolidated balance sheets at December 31, 1996 and June 30, 1996......................................................... 3 Condensed, consolidated statements of operations for the three months ended December 31, 1996 and 1995 and for the six months ended December 31, 1996 and 1995............................................ 4 Condensed, consolidated statements of cash flows for the six months ended December 31, 1996 and 1995...................................... 5 Notes to condensed, consolidated financial statements................. 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.................................... 8 PART II. OTHER INFORMATION 2 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY CONDENSED, CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
December 31, June 30, 1996 1996 ------------- ------------ (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 11,483 $ 28,339 Available-for-sale securities 36,412 21,451 Accounts receivable, net 1,714 873 Inventories 1,379 700 Prepaid expenses and other current assets 160 438 --------- --------- TOTAL CURRENT ASSETS 51,148 51,801 Property and equipment, net 632 702 Intangible and other assets, net 247 264 --------- --------- Total assets $ 52,027 $ 52,767 --------- --------- --------- --------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 545 $ 614 Accrued liabilities 644 892 Bank borrowings 167 127 Deferred revenue - 100 --------- --------- TOTAL CURRENT LIABILITIES 1,356 1,733 Bank borrowings, less current portion 269 360 Other long-term liabilities 200 200 --------- --------- Total liabilities 1,825 2,293 Shareholders' equity: Preferred stock, $.001 par value: Authorized: 2,000,000 shares; none issued and outstanding Common stock, $.001 par value: Authorized: 50,000,000 shares; issued and outstanding 13,199,353 13 13 on Dec. 31, 1996 and 13,132,903 on June 30, 1996 Additional paid in capital 65,002 64,885 Notes receivable from shareholders (105) (112) Deferred compensation, net (396) (496) Unrealized gain/(loss) on available-for-sale securities (29) 1 Accumulated deficit (14,283) (13,817) --------- --------- Total shareholders' equity 50,202 50,474 --------- --------- Total liabilities and shareholders' equity $ 52,027 $ 52,767 --------- --------- --------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS. 3 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY CONDENSED, CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Three Months Ended Six Months Ended December 31, December 31, -------------------------- ------------------------ 1996 1995 1996 1995 -------- -------- -------- -------- Sales $ 361 $ 1,217 $ 2,831 $ 1,708 Guaranteed payments 1,500 - 1,500 - ---------- --------- ---------- --------- Gross Sales 1,861 1,217 4,331 1,708 Cost of Sales 359 586 1,352 920 ---------- --------- ---------- --------- Gross Profit 1,502 631 2,979 788 ---------- --------- ---------- --------- Operating Expenses: Research and development 484 278 946 480 Sales and marketing 1,095 998 2,203 1,753 General and administrative 830 395 1,553 706 ---------- --------- ---------- --------- Total operating expenses 2,409 1,671 4,702 2,939 ---------- --------- ---------- --------- Operating loss (907) (1,040) (1,723) (2,151) Interest and other income 670 25 1,257 88 ---------- --------- ---------- --------- Net loss $ (237) $ (1,015) $ (466) $ (2,063) ---------- --------- ---------- --------- ---------- --------- ---------- --------- Net loss per share $ (0.02) $ (0.15) $ (0.04) $ (0.31) ---------- --------- ---------- --------- ---------- --------- ---------- --------- Shares used in computing net loss per share 13,183,440 6,555,770 13,165,128 6,554,626 ---------- --------- ---------- --------- ---------- --------- ---------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS. 4 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY CONDENSED, CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (IN THOUSANDS)
Six Months Ended December 31, ------------------------------ 1996 1995 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net cash used in operating activities (2,000) (2,434) ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities (37,305) - Maturities of available-for-sale securities 22,500 - Acquisition of property and equipment (124) (161) Proceeds from payments on shareholder notes receivable 18 - ------------ ------------ Net cash used in investing activities (14,911) (161) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES Payments on obligations under capital leases and capital loans (51) (43) Proceeds from issuance of common stock, net of issuance costs 106 1 ------------ ------------ Net cash provided by (used in) financing activities 55 (42) ------------ ------------ Net decrease in cash and cash equivalents (16,856) (2,637) Cash and cash equivalents, beginning of period 28,339 4,541 ------------ ------------ Cash and cash equivalents, end of period $ 11,483 $ 1,904 ------------ ------------ ------------ ------------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS. 5 GENERAL SURGICAL INNOVATIONS, INC. AND SUBSIDIARY NOTES TO CONDENSED, CONSOLIDATED FINANCIAL STATEMENTS 1. Basis of Presentation: The accompanying unaudited condensed, consolidated financial statements as of December 31, 1996 and for the three and six month periods ended December 31, 1996 and 1995 of General Surgical Innovations, Inc. and subsidiary (the "Company") have been prepared in accordance with generally accepted accounting principles for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three month and six month periods ended December 31, 1996 are not necessarily indicative of the results that may be expected for the fiscal year ended June 30, 1997, or any future interim period. These financial statements and notes should be read in conjunction with the Company's audited financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1996. 2. RECENT PRONOUNCEMENTS: In October 1995, the Financial Accounting Standards Board issued Statement No. 123 ACCOUNTING FOR STOCK-BASED COMPENSATION (SFAS No. 123), which establishes a fair value based method of accounting for stock-based compensation plans and requires additional disclosures for those companies that elect not to adopt the new method of accounting. While the Company studies the impact of the pronouncement, it continues to 6 account for employees' stock options under APB Opinion No. 25, "Accounting for Stock Issued to Employees." SFAS No. 123 will be effective for the Company's 1997 fiscal year. 3. Inventories: Inventories comprise: Dec 31, Jun 30, ------------------- 1996 1995 ---- ---- (in thousands) Raw Materials................ $ 767 $ 387 Work in progress............. 93 153 Finished goods............... 519 160 ------ ------ $1,379 $ 700 ------ ------ ------ ------ 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the unaudited condensed, consolidated financial statements and notes thereto included in part I, Item I of this Quarterly Report and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended June 30, 1996. Except for the historical information contained in this Quarterly Report on Form 10-Q, the matters discussed herein are forward-looking statements that are subject to certain risks and uncertainties that could cause the actual results to differ materially from those projected. Factors that could cause actual results to differ materially include, but are not limited to, fluctuations in revenues among different product lines and markets, the timing of orders and shipments, the ramp-up of distribution efforts by Ethicon-Endo Surgery, Inc. ("EES"), EES's success in achieving certain levels of sales growth, the Company's ability to manage growth and the transition to EES and possible other new corporate partnering relationships, the timely development and market acceptance of new products and surgical procedures, the impact of competitive products and pricing, results of ongoing litigation, the Company's ability to further expand into international markets, approval of its products by government agencies such as the United States Food and Drug Administration, the termination of the Company's distributorship agreement with United States Surgical Corporation ("USSC"), and other risks detailed below and included from time to time in the Company's other SEC reports and press releases, copies of which are available from the Company upon request. The Company assumes no obligation to update any forward-looking statements contained herein. The factors listed below under "Factors Affecting Future Results," as well as other factors, could in the future affect the Company's actual results and could cause the Company's results for future quarters to differ materially from those expressed in any forward-looking statements contained in the following discussion. References made in this Quarterly Report on Form 10-Q to "General Surgical Innovations, Inc.," the "Company" or the "Registrant" refer to General Surgical Innovations, Inc. and its subsidiary. The following General Surgical Innovations, Inc. trademarks are mentioned in this Quarterly Report: Spacemaker - -Registered Trademark-, registered trademark of the Company; and Knotmaker -TM-, trademark of the Company. Overview Since its inception in April 1992, GSI has been engaged in the development, manufacturing and marketing of balloon dissection systems and related minimally invasive surgical instruments. The Company began commercial sales of its balloon dissection systems for hernia repair in September 1993. To date, the Company has received from the FDA four 510(k) clearances for use of the Company's technology to perform dissection of tissue planes anywhere in the body using a broad range of balloon sizes and shapes. The Company currently sells products in the United States and certain other countries in Europe, Asia and South America for selected 8 applications, such as hernia repair, subfascial endoscopic perforator surgery and breast augmentation and reconstruction surgery. In November 1996, the Company terminated its distribution agreement with USSC which provided USSC with limited exclusive rights to distribute the Company's balloon dissection systems in the hernia repair market in both the United States and certain international countries. In December 1996, the Company entered into a five year OEM supply agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery,Inc. ("EES"), a Johnson & Johnson company ("JNJ") pursuant to which GSI granted EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM- Balloon Dissection Systems in the laparoscopic hernia repair and urinary stress incontinence ("USI") markets. The Expanded EES Agreement supersedes the June 1996 licensing agreement between the Company and EES pursuant to which GSI granted EES the right to market its new balloon dissection product. Under the Expanded EES Agreement, GSI will manufacture certain products and EES will market and distribute these products in the hernia and USI markets. In addition to the development of balloon dissection systems, the companies will collaborate on development of additional products for these markets. EES made an initial guaranteed payment of $1.5 million under the Expanded EES Agreement. In addition, the Expanded EES Agreement provides that EES will either purchase products, or make payments in lieu of such purchases, to ensure that GSI maintains a gross margin of $1.6 million and $1.7 million in the third and fourth quarters of fiscal 1997, respectively (ie through June 30, 1997). Following this initial ramp-up period, EES is required to make certain minimum quarterly product purchases. Additional sales in the United States are currently made through a small direct sales force. The Company currently sells its products (other than for hernia and SUI applications) in international markets through a limited number of distributors who resell to surgeons and hospitals. The Company plans to increase its direct sales force in the United States and may seek to establish a direct sales force in one or more other countries in the future. Any increase in the Company's direct sales force will require significant expenditures and additional management resources. To date, all of the sales made through distributors and almost all of the sales by the Company's direct sales force have been for use in hernia repair procedures. While the Company has developed or is developing balloon dissection systems for urinary stress incontinence, vascular, plastic surgery and orthopedics applications, sales of products for hernia repair are expected to provide a substantial majority of the Company's revenues at least through fiscal 1997. The Company has acquired significant patent rights from third parties, including rights that apply to the Company's current balloon dissection systems. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to 4% of sales of such products, which payments are expected to exceed certain minimum royalty payments due under agreements with such parties. The Company has also acquired patent rights under royalty-bearing agreements with respect to certain surgical instruments, including the KnotMaker product and the balloon valve trocar currently under development. In February 1996, the Company acquired Adjacent Surgical, Inc., a company engaged in the development of balloon dissection systems for use in vascular applications. The transaction resulted in a one-time expense related to in-process research and development of approximately $2.8 million, in the quarter ended March 31, 1996. From time to time, the Company has had discussions with third parties regarding various strategic relationships, although the Company currently has no commitments with respect to any such relationships. The Company plans 9 to continue to investigate potential strategic relationships in the future. The Company has a limited history of operations and has experienced significant operating losses since inception. The Company expects such operating losses to continue at least through calendar year 1997. The increase in the Company's sales to date has been due to demand for the Company's balloon dissector systems principally for hernia repair. In order to support increased levels of sales in the future and to augment its long-term competitive position, including the development of balloon dissection systems for other applications, the Company anticipates that it will be required to make significant additional expenditures in manufacturing, research and development (including marketing-related clinical evaluations), sales and marketing and administration. In addition, the Company anticipates higher administration expenses resulting from its obligations as a public reporting company. The Company anticipates that its results of operations may fluctuate for the foreseeable future due to several factors, including fluctuations in purchases of the Company's products by EES, EES's ability to achieve certain levels of sales growth, the status of the Company's relationship with EES or other partners, fluctuations in revenues among different product lines and markets, the mix of sales among the distributors and the Company's direct sales force, timing of new product introductions or transitions to new products, the margins recognized from products for various surgical procedures, the progress of marketing-related clinical evaluations, the introduction of competitive products (including pricing pressures), activities related to patents and patent approvals (including litigation) and regulatory and third-party reimbursement matters, and the timing of research and development expenses (including marketing-related clinical evaluations). In addition, the Company's results of operations could be affected by the timing of orders from distributors, expansion of the Company's distributor network, the ability of the Company's distributors to effectively promote the Company's products and the ability of the Company to quickly and cost effectively increase its direct domestic sales force. The Company's limited operating history makes accurate prediction of future operating results difficult or impossible. The Company currently manufactures and ships product shortly after the receipt of orders, and anticipates that it will do so in the future. Accordingly, the Company has not developed a significant backlog and does not anticipate that it will develop a material backlog in the future. In January 1997, the Company entered into a new local facility lease and is planning to relocate its headquarters and manufacturing operations to this new location during April 1997. The new facility's lease comprises approximately 30,460 square feet and the monthly rent is approximately $47,000. RESULTS OF OPERATIONS REVENUE. Revenue increased by 53% to approximately $1.9 million for the quarter ended December 31, 1996 from $1.2 million for the same period in 1995. Revenue for the six months ended December 31, 1996 increased 154% to approximately $4.3 million from $1.7 million for the six months ended December 31, 1995. This increase was due to growth in direct unit sales of the Spacemaker I and II platforms for the hernia market and an initial guaranteed payment of $1.5 million from EES pursuant to the Expanded EES Agreement. The Expanded EES Agreement provides that EES will purchase products, or make payments in lieu of such purchases, to ensure that GSI maintains a gross margin of $1.6 million and $1.7 million in the third and fourth quarters of fiscal 1997, respectively (ie through June 30, 1997). As the Company begins its transition to EES, the Company believes that its sales results will fluctuate from quarter to quarter during at least the next several quarters. 10 COST OF SALES. Cost of sales decreased by 39% to approximately $359,000 for the quarter ended December 31, 1996 from $586,000 for the same period in 1995, and increased as a percentage of sales to 99% for the quarter ended December 31, 1996 from 48% for the quarter ended December 31, 1995. This increase in cost of sales as a percentage of sales was primarily a result of under-utilized manufacturing capacity as the Company had lower sales during its transition to EES as its new major distributor. Cost of sales for the six months ended December 31, 1996 decreased as a percent of sales to 48% or approximately $1.4 million as compared to 54% of sales or approximately $920,000 for the six months ended December 31, 1995. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses, which include expenditures for marketing-related clinical evaluations and regulatory expenses, increased by 74% to $484,000 in the quarter ended December 31, 1996 from $278,000 for the same period in 1995 due to increased funding of new product development. Research and development expenses for the six months ended December 31, 1996 were approximately $946,000 compared to $480,000 for the six months ended December 31, 1995. The Company expects research and development expenses to increase in absolute dollars as the Company pursues development of new products. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative (SG&A) expenses increased by 38% to $1.9 million for the quarter ended December 31, 1996 from $1.4 million for the quarter ended December 31, 1995. For the six months ended December 31, 1996 SG&A expenses were $3.8 million compared to $2.5 million for the six months ended December 31, 1995. This increase was primarily due to the growth of a direct sales force in the United States and the growth in marketing and other personnel associated with the Company's higher levels of operations. The Company expects selling, general and administrative expenses to continue to increase in absolute dollars as the Company's sales and manufacturing infrastructure (including additional sales personnel) increases and as the Company increases its finance and administrative expenditures to meet its obligations as a public reporting company. INTEREST AND OTHER INCOME. Interest and other income increased to $670,000 for the quarter ended December 31, 1996 from $25,000 for the quarter ended December 31, 1995. For the six months ended December 31, 1996 interest and other income increased to $1.3 million from $88,000 for the same period in 1995 due to higher average cash, cash equivalents and available-for-sale securities balances. Interest earned in the future will depend on the Company's funding cycles and prevailing interest rates. LIQUIDITY AND CAPITAL RESOURCES Since inception, the Company's cash expenditures have significantly exceeded its sales, resulting in an accumulated deficit of $14.3 million at December 31, 1996. The Company has funded its operations primarily through the sale of equity securities. From its inception through December 31, 1996 the Company raised approximately $15.2 million through the private placement of equity securities and approximately $46.9 million (net of underwriting discounts and commissions) in an initial public offering. 11 As of December 31, 1996 the Company's principal source of liquidity consists of cash, cash equivalents and short-term investments of $47.9 million, as compared to approximately $49.8 million at June 30, 1996. This decrease reflects approximately $2 million used to fund operations. The Company expects to incur substantial additional costs, including costs related to increased sales and marketing activities, increased research and development, expenditures in connection with seeking regulatory approvals and conducting additional marketing-related clinical evaluations, capital equipment and other costs associated with expansion of the Company's manufacturing capabilities and higher administration costs resulting from its obligations as a reporting company. While the Company believes that its current cash balances and short-term investments along with cash generated from the future sales of products will be sufficient to meet the Company's operating and capital requirements through calendar 1997, there can be no assurance that the Company will not require additional financing within this time frame. The Company may seek additional equity or debt financing to address its working capital needs or to provide funding for capital expenditures. There can be no assurance that additional financing, if required, will be available on satisfactory terms or at all. FACTORS AFFECTING FUTURE RESULTS LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company was organized in April 1992 and began commercially shipping its first Spacemaker products in September 1993. Accordingly, the Company has only a limited operating history upon which an evaluation of the Company and its prospects can be based. As of December 31, 1996, the Company had an accumulated deficit of $14.3 million. The Company's net operating losses for the fiscal years ending June 30, 1994, 1995 and 1996 and for the quarter ended December 31, 1996 were, $3.1 million, $4.1 million, $5.5 million, and $237,000 respectively. The Company expects to continue to incur operating losses on a quarterly and annual basis through at least calendar year 1997. Due to the Company's limited operating history, and the recent transition to EES as its major distributor, there can be no assurance of sales growth or profitability in the future. The Company intends to increase significantly its investments in research and development, sales and marketing, marketing-related clinical evaluations and related infrastructure. Due to the anticipated increases in the Company's operating expenses, the Company's operating results will be adversely affected if sales do not increase. The Company's prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in their early stage of development, particularly companies in rapidly evolving markets. To address these risks, the Company must respond to competitive developments, continue to attract, retain and motivate qualified persons and successfully commercialize products incorporating advanced technologies. There can be no assurance that the Company will be successful in addressing such risks. DEPENDENCE UPON BALLOON DISSECTION PRODUCTS; RISK OF TECHNOLOGICAL OBSOLESCENCE. All of the Company's sales since inception have been derived from sales of its balloon dissection products, with a substantial portion derived from sales for hernia repair procedures. Failure of the Company to develop successfully and commercialize balloon dissection products for applications other than hernia repair could have a material adverse effect on the Company's business, financial condition and results of operations. The success of the Company's products depends on the nature of the technological advances inherent in the product designs, reductions in patient trauma or other benefits provided by such products, results of marketing-related clinical evaluations, continued adoption of minimally invasive surgery ("MIS") procedures by surgeons, market acceptance of the Company's products and related procedures, reimbursement for the Company's products by health care payors and the Company's receipt of regulatory approvals. There can be no assurance that the Company's products will have the required technical characteristics, that the Company's products will provide adequate patient benefits, that marketing-related clinical evaluations results will be favorable, that surgeons will continue to adopt MIS procedures, that recently-introduced products or future products of the Company or related procedures will gain market acceptance, or that required regulatory approvals 12 will be obtained. The failure to achieve any of the foregoing could have a material adverse effect on the Company's business, financial condition and results of operations. To the extent demand for the Company's balloon dissection systems for hernia repair declines and the Company's newly-introduced products are not commercially accepted or its existing products are not developed for new procedures, there could be a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." DEPENDENCE ON KEY DISTRIBUTOR. In December 1996, the Company entered into a five year OEM supply agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery,Inc. ("EES"), a Johnson & Johnson company ("JNJ") pursuant to which GSI granted EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM- Balloon Dissection Systems in the laparoscopic hernia repair and urinary stress incontinence ("USI") markets. The Expanded EES Agreement supersedes the June 1996 licensing agreement between the Company and EES pursuant to which GSI granted EES the right to market its new balloon dissection product. Under the Expanded EES agreement, GSI will manufacture certain products and EES will market and distribute these products in the hernia and USI markets. The parties expect to jointly develop and begin marketing this dissector for SUI repair in early calendar 1997. In addition to the development of balloon dissection systems, the companies will collaborate on development of additional products for these markets. EES made an initial payment of $1.5 million under the Expanded EES Agreement. In addition, the Expanded EES Agreement provides that EES will either purchase products, or make payments in lieu of such purchases, to ensure that GSI maintains a gross margin of $1.6 million and $1.7 million in the third and fourth quarter of fiscal 1997, respectively (ie through June 30, 1997). Following this initial ramp-up period, EES is required to make certain minimum quarterly product purchases. No manufacture or distribution of products has occurred to date pursuant to the Expanded EES Agreement, and there can be no assurance that such manufacturing, marketing or distribution efforts will be successful. EES's failure to achieve certain levels of sales growth or a reduction in orders from EES could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company intends to establish additional distributorships in the United States for products in areas other than hernia repair and urinary stress incontinence, there can be no assurance that such efforts will be successful. Failure to diversify its distribution network in the United States could have a material adverse effect on the Company's business, financial condition and results of operations. To date, substantially all of the Company's international sales for hernia repair procedures have been made through Autosuture under the same terms and conditions as the Company's agreement with USSC, which was terminated in November 1996. Thus, the Company does not anticipate that it will have future sales through Autosuture. Although the Company has replaced this international distributor network through its agreement with Ethicon Endo-Surgery, there can be no assurance that EES's efforts in international distribution will be successful. LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has only limited experience marketing and selling its products through its direct sales force, and has sold its products in commercial quantities through its direct sales force only to the hernia market and, to a lesser degree, to the cosmetic and reconstructive surgery market. Establishing marketing and sales capability sufficient to support sales in commercial quantities for the other markets targeted by the Company, including additional hernia, vascular, urology, obstetrics, gynecology and orthopedic surgery markets, will require significant resources, and there can be no assurance that the Company will be able to recruit and retain additional qualified marketing personnel or direct sales personnel or that future sales efforts of the Company will be successful. In markets where there is a large potential customer base, the Company intends to establish partnership relationships with additional distribution partners, and there can be no assurance that the Company will be successful in establishing such partnership relationships on commercially reasonable terms, if at all. The failure to establish and maintain an effective distribution channel for the Company's products, or establish and retain qualified and effective sales personnel to support commercial 13 sales of the Company's products, could have a material adverse effect on the Company's business, financial condition and results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." UNCERTAINTY OF MARKET ACCEPTANCE; NO ASSURANCE OF CLINICAL ADVANTAGE. The Company's success is substantially dependent upon the success of its Spacemaker balloon dissection products. The Company believes that market acceptance of the Company's products will depend on the Company's ability to provide evidence to the medical community of the safety, efficacy and cost-effectiveness of its products and the procedures in which these products are intended to be used. Market acceptance is also dependent on the adoption of laparoscopic techniques generally and the conversion of non-balloon dissection techniques to balloon dissection techniques specifically. To date, the Company's products have only been used to treat a limited number of patients and the Company has limited long-term outcomes data. If the Company is not able to demonstrate consistent clinical benefits resulting from the use of its products (including reduced procedure time, reduced patient trauma and lower costs), the Company's business, financial condition and results of operations could be materially and adversely affected. The Company further believes that the ability of health care providers to obtain adequate reimbursement for procedures using the Company's Spacemaker balloon dissector products and related instruments will be critical to market acceptance of the Company's products. Although the Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes, there can be no assurance that such procedure codes will remain available or that reimbursement under these codes will be adequate. The Company has limited experience in obtaining third-party reimbursement, and the inability to obtain reimbursement for some or all of its products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company introduced its balloon dissectors in late 1993 and to date there has been relatively little education among surgeons about the benefits of balloon dissection technology. Further, due to the novelty of balloon dissection procedures, many surgeons and surgeons' assistants have not developed the requisite skills to perform balloon dissection procedures. To the extent that laparoscopic techniques are adopted slowly, that balloon dissectors are incorporated into laparoscopic techniques less often or that surgeons are unwilling or unable to develop the skills necessary to utilize balloon dissectors, the Company's business, financial condition and results of operations could be materially adversely affected. FLUCTUATIONS IN QUARTERLY RESULTS. Results of the Company's operations may fluctuate significantly from quarter to quarter and will depend on (i) new product introductions by the Company and its competitors and fluctuations in revenues among different product lines and markets, (ii) purchases of the Company's products by EES, (iii) the rate of adoption by surgeons of balloon dissection technology in markets targeted by the Company, (iv) the sales efforts of EES, (v) the mix of sales among distributor and the Company's direct sales force, (vi) timing of patent and regulatory approvals, if any, (vii) timing and growth in operating expenditures, (viii) timing of research and development expenses, including marketing-related clinical evaluation expenditures, (ix) intellectual property litigation and (x) general market conditions. In the past, the Company's sales were highly dependent upon the marketing efforts and success of United States Surgical Corporation, which was the Company's major distributor until the relationship was mutually terminated in November 1996. In December 1996 the Company entered into the Expanded Ethicon Agreement, pursuant to which GSI granted EES exclusive worldwide sales and marketing rights to sell the Spacemaker-TM- Balloon Dissection Systems in the laparoscopic hernia repair and urinary stress incontinence (USI) markets. The Company's sales in any period will be highly dependent upon the marketing efforts and success of EES, which are not within the control of the Company. The Company anticipates that sales to EES will fluctuate in the future. Failure by EES to achieve 14 certain levels of sales growth or a decline in purchases by EES could result in a decline in sales and adversely affect the Company's operating results. No manufacture or distribution of products has occurred to date pursuant to the EES Agreement, and there can be no assurance that efforts to do so will be effective. In addition, announcements or expected announcements by the Company, its competitors or its distributor of new products, new technologies or pricing changes could cause existing or potential customers of the Company to defer purchases of the Company's existing products and could alter the mix of products sold by the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that future products or product enhancements will be successfully introduced or that such introductions will not adversely affect the demand for existing products. As a result of these and other factors, the Company's quarterly operating results have fluctuated in the past, and the Company expects that such results may fluctuate in the future. Due to such quarterly fluctuations in operating results, quarter-to-quarter comparisons of the Company's operating results are not necessarily meaningful and should not be relied upon as indicators of likely future performance or annual operating results. In addition, the Company's limited operating history makes accurate prediction of future operating results difficult or impossible to make. There can be no assurance that in the future the Company will achieve sales growth or become profitable on a quarterly or annual basis, if at all, or that its growth, if any, will be consistent with predictions by securities analysts and investors. In such event, the price of the Company's Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." RELIANCE ON PATENTS AND PROPRIETARY TECHNOLOGY. The Company's success will depend on its ability to obtain patent protection for its products and processes, to preserve its trade secrets and proprietary technology and to operate without infringing upon the patents or proprietary rights of third parties. As of December 31, 1996, GSI had 17 United States patents issued, and had applied for an additional 48 United States patents, 11 of which had been allowed. In addition, GSI had two foreign patents issued, and 20 in prosecution as of such date. In May 1996, the Company was issued a United States patent that contains claims regarding the use of balloons to dissect tissue planes anywhere in the body. In May 1996, the Guidant Corporation unit of Origin MedSystems, Inc. filed an action against GSI in the U.S. District Court for the Northern District of California, alleging patent infringement of its patent entitled "Apparatus and Method for Peritoneal Retraction". GSI subsequently filed an action against Origin Medsystems, Inc. in the U.S. District Court for the Northern District of California alleging patent infringement of its patent for a method of tissue plane dissection using balloon systems. A decision against the Company in either of these actions could have a material adverse effect on the Company's business, financial condition or results of operations. The validity and breadth of claims in medical technology patents involve complex legal and factual questions and, therefore, may be highly uncertain. No assurance can be given that any patents based on pending patent applications or any future patent applications will be issued, that the scope of any patent protection will exclude competitors or provide competitive advantages to the Company, that any of the Company's patents or patents to which it has licensed rights will be held valid if subsequently challenged or that others will not claim rights in or ownership of the patents and other proprietary rights held or licensed by the Company or that the Company's existing patents will cover the Company's future products. Furthermore, there can be no assurance that others have not developed or will not develop similar products, duplicate any of the Company's products or design around any patents issued to or licensed by the Company or that may be issued in the future to the Company. Since patent applications in the United States are maintained in secrecy until patents issue, the Company also cannot be certain that others did not first file applications for inventions covered by the Company's pending patent applications, nor can the Company be certain that it will not infringe any patents that may issue to others on such applications. One of the patent applications filed by the Company, which is directed to a surgical method using balloon dissection technology, has been placed in interference with a patent application filed by Origin Medsystems, Inc. ("Origin"), a competitor of the Company. The Company believes that the inventor named in its patent application 15 was the first to invent this subject matter, and has asserted that the Origin patent application was filed after a disclosure made by such inventor to employees of Origin. Origin takes a contrary position. This interference is presently pending in the United States Patent and Trademark Office ("USPTO") and, as permitted by the rules of the USPTO, has been referred to an arbitrator for completion of the interference proceeding. A decision is not expected in this interference proceeding until 1998. Failure of the Company to prevail in such interference proceeding could have a material adverse effect on the Company's business, financial condition and results of operations. Patent interference or infringement involves complex legal and factual issues and is highly uncertain, and there can be no assurance that any conclusion reached by the Company regarding patent interference or infringement will be consistent with the resolution of such issue by a court. In the event the Company's products are found to infringe patents held by competitors, there can be no assurance that the Company will be able to modify successfully its products to avoid infringement, or that any modified products will be commercially successful. Failure in such event to either develop a commercially successful alternative or obtain a license to such patent on commercially reasonable terms could have a material adverse effect on the Company's business, financial condition and results of operations. In any event, there can be no assurance that the Company will not be required to defend itself in court against allegations of infringement of third-party patents. Patent litigation is expensive, requires extensive management time, and could subject the Company to significant liabilities, require disputed rights to be licensed from third parties or require the Company to cease selling its products. Legislation has recently been enacted in Congress, the effect of which is to immunize physicians and their employers from liability for patent infringement for alleged infringement of patent claims directed to medical procedures. The patent laws of European and certain other foreign countries generally do not allow for the issuance of patents for methods of surgery on the human body. Accordingly, the ability of the Company to gain patent protection for its methods of tissue dissection will be significantly limited. As a result, there can be no assurance that the Company will be able to develop a patent portfolio in Europe or that the scope of any patent protection will provide competitive advantages to the Company. ROYALTY PAYMENT OBLIGATIONS. The Company has acquired a significant number of patent rights from third parties, including rights that apply to the Company's current balloon dissection systems. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to 4% of sales of such products, which payments are expected to exceed minimum royalty payments due under agreements with such parties. The Company also has acquired patent rights under royalty-bearing agreements with respect to certain surgical instruments, including the KnotMaker product and the balloon valve trocar currently under development. The payment of such royalty amounts will have an adverse impact on the Company's gross profit and other results of operations. There can be no assurance that the Company will be able to continue to satisfy such royalty payment obligations in the future, and a failure to do so could have a material adverse effect on the Company's business, financial condition and results of operations. EARLY STAGE OF DEVELOPMENT AND COMMERCIALIZATION; NO ASSURANCE OF ABILITY TO MANAGE GROWTH. The Company began commercial sales of its balloon dissection products in September 1993 and, as a result, has limited experience in manufacturing, marketing and selling its products commercially. In January 1997 the Company entered into a real estate lease and will be relocating its headquarters and manufacturing operations in April 1997 to this new facility. In addition, the Company experienced rapid growth in the number of its employees, the number of products under development, the number and amount of products manufactured and sold, and the geographic scope of its sales. In order to augment its long-term competitive 16 position, the Company anticipates that it will be required to make significant additional expenditures in manufacturing, research and development, sales and marketing, and administration. The Company's inability to manage its growth effectively could have a material adverse effect on the Company's business, financial condition and results of operations. COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in the market for medical devices used in tissue dissection surgical procedures is intense and is expected to increase. The Company competes primarily with other producers of MIS tissue dissection instruments. Origin, a subsidiary of Guidant Corporation, and others, currently compete against the Company in the development, production and marketing of MIS tissue dissection instruments and tissue dissection technology. To the extent that surgeons elect to use open surgical procedures rather than MIS, the Company also competes with producers of tissue dissection instruments used in open surgical procedures, such as blunt dissectors or graspers. A number of companies currently compete against the Company in the development, production and marketing of tissue dissection instruments and technology for open surgical procedures. In addition, the Company indirectly competes with producers of therapeutic drugs, when such drugs are used as an alternative to surgery. Many of the Company's competitors have substantially greater capital resources, name recognition, expertise in research and development, manufacturing and marketing and obtaining regulatory approvals. There can be no assurance that the Company's competitors will not succeed in developing balloon dissectors or competing technologies that are more effective than products marketed by the Company or that render the Company's technology obsolete. Additionally, even if the Company's products provide performance comparable to competing products or procedures, there can be no assurance that the Company will be able to obtain necessary regulatory approvals or compete against competitors in terms of price, manufacturing, marketing and sales. Many of the alternative treatments for medical indications that can be treated by balloon dissection products and laparoscopic surgery are widely accepted in the medical community and have a long history of use. In addition, technological advances with other therapies could make such other therapies more effective or cost-effective than balloon dissectors and minimally invasive surgery, and could render the Company's technology non-competitive or obsolete. There can be no assurance that surgeons will use MIS to replace or supplement established treatments or that MIS will remain competitive with current or future treatments. The failure of surgeons to adopt MIS could have a material adverse effect on the Company's business, financial condition and results of operations. In addition to the Company's focus on the development of its balloon dissection systems, the Company has also developed surgical instruments for use in MIS. There can be no assurance that the Company's surgical instruments will successfully compete with those manufactured by other producers of such surgical instruments. The failure to achieve commercial market acceptance of such surgical instruments could have a material adverse effect on the Company's business, financial condition and results of operations. UNCERTAIN AVAILABILITY OF THIRD-PARTY REIMBURSEMENT. The Company's success will depend upon the ability of surgeons to obtain satisfactory reimbursement from healthcare payors for the Company's products. In the United States, hospitals, physicians and other healthcare providers that purchase medical devices generally rely on third-party payors, such as private health insurance plans, to reimburse all or part of the costs associated with the treatment of patients. Reimbursement in the United States for the Company's balloon dissection products is currently available from most third-party payors, including most major private health care insurance plans and Medicaid, under existing surgical procedure codes. The Company does not expect that third-party reimbursement in the United States will be available for use of its other products unless and until clearance or approval is received from the federal Food and Drug Administration (the "FDA"). If FDA clearance or approval is received, third-party reimbursement for these products will depend upon decisions by individual 17 health maintenance organizations, private insurers and other payors. Many payors, including the federal Medicare program, pay a preset amount for the surgical facility component of a surgical procedure. This amount typically includes medical devices such as the Company's. Thus, the surgical facility or surgeon may not recover the added cost of the Company's products. In addition, managed care payors often limit coverage to surgical devices on a preapproved list or obtained from an exclusive source. If the Company's products are not on the list or are not available from the exclusive source, the facility or surgeon will need to obtain an exception from the payor or the patient will be required to pay for some or all of the cost of the Company's product. The Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes. However, there can be no assurance that such procedure codes will remain available or that the reimbursement under these codes will be adequate. Given the efforts to control and decrease health care costs in recent years, there can be no assurance that any reimbursement will be sufficient to permit the Company to increase revenues or achieve or maintain profitability. The unavailability of third-party or other adequate reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. Reimbursement systems in international markets vary significantly by country, and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed health care systems that govern reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems. Large-scale market acceptance of the Company's balloon dissection systems and other products will depend on the availability and level of reimbursement in international markets targeted by the Company. Currently, the Company has been informed by its international distributors that the balloon dissectors have been approved for reimbursement in many of the countries in which the Company markets its products. Obtaining reimbursement approvals can require 12 to 18 months or longer. There can be no assurance that the Company will obtain reimbursement in any country within a particular time, for a particular amount, or at all. Failure to obtain such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. Regardless of the type of reimbursement system, the Company believes that surgeon advocacy of its products will be required to obtain reimbursement. Availability of reimbursement will depend on the clinical efficacy of the procedure and the utility and cost of the Company's products. There can be no assurance that reimbursement for the Company's products will be available in the United States or in international markets under either government or private reimbursement systems, or that surgeons will support and advocate reimbursement for use of the Company's systems for all applications intended by the Company. Failure by surgeons, hospitals and other users of the Company's products to obtain sufficient reimbursement from health care payors or adverse changes in government and private third-party payors' policies toward reimbursement for procedures employing the Company's products could have a material adverse effect on the Company's business, financial condition and results of operations. GOVERNMENT REGULATION. The Company's Spacemaker balloon dissection systems and other products are subject to extensive and rigorous regulation by the FDA and, to varying degrees, by state and foreign regulatory agencies. Under the federal Food, Drug, and Cosmetic Act, the FDA regulates the clinical testing, manufacture, labeling, packaging, marketing, distribution and record keeping for medical devices, in order to ensure that medical devices distributed in the United States are safe and effective for their intended use. Prior to commercialization, a medical device generally must receive FDA and foreign regulatory clearance or approval, which can be an expensive, lengthy and uncertain process. The Company is also subject to routine inspection by the FDA and state agencies, such as the California Department of Health Services ("CDHS"), for compliance with Good Manufacturing Practice requirements, Medical Device Reporting requirements and other applicable regulations. Noncompliance with applicable requirements can result in warning letters, import detentions, fines, civil penalties, injunctions, suspensions or losses of regulatory approvals, recall or seizure of products, operating 18 restrictions, refusal of the government to approve product export applications or allow the Company to enter into supply contracts, and criminal prosecution. Delays in receipt of, or failure to obtain, regulatory clearances and approvals, or any failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the Federal Trade Commission. Current FDA enforcement policy prohibits the marketing of approved medical devices for unapproved uses. The Spacemaker I platform, Spacemaker II platform, Spacemaker Resposable platform, and KnotMaker product each have received 510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic and reconstructive surgery, either when tissue dissection is required or, with respect to the KnotMaker product, when a surgical knot for suturing is required. The Company has promoted these products for surgical applications (e.g., hernia repair, subfascial endoscopic perforator surgery and breast augmentation and reconstruction), and may in the future promote these products for the dissection or knotmaking required for additional selected applications (e.g., treatment of stress urinary incontinence, saphenous vein harvesting and a variety of orthopedic procedures such as anterior spinal fusion). For any medical device cleared through the 510(k) process, modifications or enhancements that could significantly affect the safety or effectiveness of the device or that constitute a major change to the intended use of the device will require a new 510(k) submission. The Company has made modifications to its products which the Company believes do not affect the safety or effectiveness of the device or constitute a major change to the intended use and therefore do not require the submission of new 510(k) notices. There can be no assurance, however, that the FDA will agree with any of the Company's determinations not to submit a new 510(k) notice for any of these changes or will not require the Company to submit a new 510(k) notice for any of the changes made to the product. If such additional 510(k) clearances are required, there can be no assurance that the Company will obtain them on a timely basis, if at all, and delays in receipt of or failure to receive such approvals could have a material adverse effect on the Company's business, financial condition and results of operations. If the FDA requires the Company to submit a new 510(k) notice for any product modification, the Company may be prohibited from marketing the modified product until the 510(k) notice is cleared by the FDA. The Company plans to file a 510(k) submission for its specialized trocar with a balloon valve, which is intended to provide a seal to maintain insufflation of the surgical space during MIS. There can be no assurance that the FDA will grant 510(k) clearance for the Company's specialized trocar on a timely basis, if at all. Sales of medical devices outside of the United States are subject to foreign regulatory requirements that vary widely from country to country. The Company currently relies on its international distributors for the receipt of premarket approvals and compliance with clinical trial requirements in those countries that require them, and it expects to continue to rely on distributors in those countries where the Company continues to use distributors. In the event that the Company's international distributors fail to obtain or maintain premarket approvals or compliance in foreign countries where such approvals or compliance are required, the Company may be required to cause the applicable distributor to file revised governmental notifications, cease commercial sales of its products in the applicable countries or otherwise act so as to stop any ongoing noncompliance in such countries. Any enforcement action by regulatory authorities with respect to past or any future regulatory noncompliance could have a material adverse effect on the Company's business, financial condition and results of operations. In order to continue selling its products within the European Economic Area following June 14, 1998, the Company will be required to achieve compliance with the requirements of the Medical Devices Directive (the "MDD") and to affix CE marking on its products to attest such compliance. Failure by the Company to comply with CE marking requirements by June 1998 would prohibit the Company from selling its products in the European Economic Area unless and until compliance was achieved, which could have a material adverse effect upon the Company's business, financial condition and results of operations. 19 LIMITED MANUFACTURING EXPERIENCE; UNCERTAINTY REGARDING FUTURE FACILITIES. The Company has only limited experience in manufacturing its products in commercial quantities. The Company intends to scale up its production of new products and to increase its manufacturing capacity for existing and new products. However, manufacturers often encounter difficulties in scaling up production of new products, including problems involving production yields, quality control and assurance, component supply and shortages of qualified personnel. Difficulties experienced by the Company in manufacturing scale-up and manufacturing difficulties could have a material adverse effect on its business, financial condition and results of operations. There can be no assurance that the Company will be successful in scaling up or that it will not experience manufacturing difficulties or product recalls in the future. The Company currently occupies a single facility in Palo Alto, California that houses its headquarters, administrative offices, research laboratories and manufacturing facilities. In January 1997, the Company entered into a new facility lease for premises in Cupertino, California, and is planning to relocate its headquarters and manufacturing operations to this new location during April 1997. The new facilities lease comprises approximately 30,460 square feet and the monthly rent is approximately $47,000. There can be no guarantee that the Company will be able to establish and certify adequate manufacturing capacity in a timely manner, or at all, in the new space. Failure to establish and certify adequate manufacturing capacity in a timely manner could have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON SINGLE SOURCE SUPPLIERS; LACK OF CONTRACTUAL ARRANGEMENTS. The Company currently relies upon single source suppliers for several components of its balloon dissection products, and in most cases there are no formal supply contracts. There can be no assurance that the component materials obtained from single source suppliers will continue to be available in adequate quantities, if at all, or, if required, that the Company will be able to locate alternative sources of such component materials on a timely basis, if at all, to market its products. In addition, there can be no assurance that the single source suppliers will meet the Company's future requirements for timely delivery of products of sufficient quality and quantity. The failure to obtain sufficient quantities and qualities of such component materials, or the loss of any of the Company's single source suppliers, could cause a delay in GSI's ability to fulfill orders while it identifies and certifies a replacement supplier, if any, and could have a material adverse effect on the Company's business, financial condition and results of operations. PRODUCT LIABILITY RISK AND PRODUCT RECALL; LIMITED INSURANCE COVERAGE. The Company's business exposes it to potential product liability risks or product recalls that are inherent in the design, development, manufacture and marketing of medical devices, in the event the use of the Company's products is alleged to have caused adverse effects on a patient or such products are believed to be defective. The Company's products are designed to be used in certain procedures where there is a high risk of serious injury or death. Such risks will exist even with respect to those products that have received, or may in the future receive, regulatory clearance for commercial sale. As a result, there can be no assurance that the Company's product liability insurance is adequate or that such insurance coverage will continue to be available on commercially reasonable terms or at all. Particularly given the lack of data regarding the long-term results of the use of balloon dissection products, there can be no assurance the Company will avoid significant product liability claims. Consequently, a product liability claim or other claim with respect to uninsured or underinsured liabilities could have a material adverse effect on the Company's business, financial condition and results of operations. RISKS ASSOCIATED WITH INTERNATIONAL SALES. Sales outside of the United States accounted for approximately 3% and 4% of the Company's sales in fiscal 1995 and 1996, respectively, and the Company 20 expects that international sales will represent an increasing portion of revenue in the future. The Company intends to continue to expand its sales outside of the United States and to enter additional international markets, which will require significant management attention and financial resources and subject the Company further to the risks of selling internationally. These risks include unexpected changes in regulatory requirements, tariffs and other barriers and restrictions, reduced protection for intellectual property rights, and the burdens of complying with a variety of foreign laws. In addition, because all of the Company's sales are denominated in U.S. dollars, fluctuations in the U.S. dollar could increase the price in local currencies of the Company's products in foreign markets and make the Company's products relatively more expensive than competitors' products that are denominated in local currencies. There can be no assurance that regulatory, currency and other factors will not adversely impact the Company's operations in the future or require the Company to modify its current business practices. DEPENDENCE ON MANAGEMENT AND OTHER KEY PERSONNEL. The Company is dependent upon a limited number of key management and technical personnel. The loss of the services of one or more of such key employees could have a material adverse effect on the Company's business, financial condition, and results of operations. In addition, the Company's success will be dependent upon its ability to attract and retain additional highly qualified sales, management, manufacturing and research and development personnel. The Company faces intense competition in its recruiting activities and there can be no assurance that the Company will be able to attract and/or retain qualified personnel. POTENTIAL VOLATILITY OF STOCK PRICE. The market prices of the common stock of many publicly held medical device companies have in the past been, and can in the future be expected to be, especially volatile. Announcements of technological innovations or new products by the Company or its competitors, clinical marketing trial results, release of reports by securities analysts, developments or disputes concerning patents or proprietary rights, regulatory developments, changes in regulatory or medical reimbursement policies, economic and other external factors, as well as period-to-period fluctuations in the Company's financial results, may have a significant impact on the market price of the Common Stock. In addition, the securities markets have from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In May, 1996, the Guidant Corporation unit of Origin MedSystems, Inc. filed an action against GSI in the United States District Court for the Northern District of California, alleging patent infringement of its patent entitled "Apparatus and Methods for Peritoneal Retraction." GSI subsequently filed a claim against Origin Medsystems, Inc. in the United States District Court for the Northern District of California, alleging that the use of Origin's balloon dissection products infringe its patent for a method of tissue plane dissection using balloon systems. In addition, one of the patent applications filed by the Company, which is directed to a surgical method using balloon dissection technology, has been placed in interference with a patent application filed by Origin, a competitor of the Company. The Company believes that the inventor named in its patent application was the first to invent this subject matter, and the Company has asserted that the Origin patent application was filed after a disclosure made by such inventor to employees of Origin. Origin takes a contrary position. This interference is presently pending in the United States Patent and Trademark Office ("USPTO") and, as permitted by the rules of the USPTO, has been referred to an arbitrator for completion of the interference proceeding. A decision is not expected in the interference proceeding until calendar year 1998, and, while the Company believes it will be successful in this interference proceeding there can be no assurance of such success. Failure of the Company to prevail in such interference proceeding could have a material adverse effect on the Company business, financial 21 condition or results of operation. A decision against the Company in either of these actions could have a material adverse effect on the Company's business, financial condition or results of operations. From time to time the Company may be exposed to litigation arising out of its products or operations. The Company is not engaged in any legal proceedings that are expected, individually or in the aggregate, to have a material adverse effect on the Company, expect for the patent interference proceedings discussed herein. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY Holders On November 19, 1996, the Company held its annual meeting of shareholders. At the annual meeting, the Company's shareholders approved the following matters by the following votes: 1. Election of the following directors of the Company: NOMINEE FOR ABSTAIN - -------------------------- ----------- -------------- Roderick A. Young 7,473,233 1,300 ----------- -------------- Thomas J. Fogarty 7,454,233 20,300 ----------- -------------- David W. Chonette 7,473,233 1,300 ----------- -------------- Paul Goeld 7,454,233 20,300 ----------- -------------- Mark A. Wan 7,472,933 1,600 ----------- -------------- 2. Amendments to the Company's 1992 Stock Option Plan to increase the number of shares of Common Stock reserved for issuance thereunder by 400,000 shares to an aggregate of 2,115,882 shares. FOR 7,388,727 AGAINST 84,406 ABSTAIN 1,400 --------- ------ ----- 3. Ratification of the appointment of Coopers & Lybrand L.L.P. as independent accountants for the Company for the fiscal year ending June 30, 1997. FOR 7,472,033 AGAINST 1,200 ABSTAIN 1,300 --------- ----- ----- ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit Description ------- ----------- 10.20 (1)(2) OEM Supply Agreement (Expanded Field) dated December 20, 1996, between Ethicon Endo-Surgery, Inc. and the Company ("Expanded EES Agreement"). 22 10.21(2) Modification and Termination Agreement and Mutual Release dated November 12, 1996, between United States Surgical Corporation and the Company. 10.22 Real Estate Lease between Berg & Berg Developers and the Company. 11.1 Statement of Computation of Earnings (Net Loss) Per Share 27.1 Financial Data Schedule (1) This exhibit supercedes Exhibit 10.19. (2) Confidential treatment has been requested with regard to certain portions of this exhibit. (b) REPORTS ON FORM 8-K The Company filed no reports on Form 8-K during the quarter ended December 31, 1996. 23 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. GENERAL SURGICAL INNOVATIONS, INC. By:/s/ STEPHEN J. BONELLI ------------------------ Stephen J. Bonelli Vice President, Finance and Chief Financial Officer Date: February , 1997 24 EX-10.20 2 EXHIBIT 10.20 EXHIBIT 10.20 OEM SUPPLY AGREEMENT (EXPANDED FIELD) This is an Agreement dated and effective as of the last date of signature below ("Effective Date") by and between Ethicon Endo-Surgery, Inc., a corporation organized under the laws of the State of Ohio, having a business address at 4545 Creek Road, Cincinnati, Ohio 45242 ("Ethicon"); and General Surgical Innovations, Inc., a corporation organized under the laws of the State of California, having a business address at 3172A Porter Drive, Palo Alto, California 94304 ("GSI"). ARTICLE 1 - BACKGROUND 1.1 Ethicon manufactures and markets surgical instruments and accessories for minimally invasive surgery, including trocars, staplers, ligation devices, hand-held instruments, retractors, manipulation devices and electrosurgery products. Prior to the Effective Date hereof, Ethicon had developed and began marketing a balloon dissector to facilitate minimally invasive surgery for hernia repair. 1.2 GSI has developed and patented an array of balloon dissectors and their methods of use to facilitate minimally invasive surgery for hernia repair, urinary stress incontinence ("USI"), plastic and reconstructive surgery, vascular surgery, and other surgical methods. 1.3 Ethicon desires to qualify GSI as an original equipment manufacturer ("OEM") supplier for certain balloon dissectors, and to thereafter purchase from GSI certain balloon dissectors meeting agreed-upon specifications for resale to Ethicon's customers. Correspondingly, GSI desires to be qualified as an OEM supplier of certain balloon dissectors to Ethicon, and to thereafter sell certain balloon dissectors to Ethicon meeting agreed-upon specifications. 1.4 The parties entered into an OEM Supply Agreement dated as of June 25, 1996 (the "OEM Agreement"). The parties desire to expand the OEM Agreement to include dissectors in the Expanded Field (defined below). Upon execution of this Agreement for the Expanded Field, the OEM Agreement shall be terminated, and this Agreement shall replace and supercede the OEM Agreement in its entirety. Therefore, GSI agrees to supply to Ethicon, and Ethicon agrees to purchase from GSI, certain balloon dissectors upon the terms and conditions set forth below. ARTICLE 2 - DEFINITIONS The following terms, when used with initial capital letters, shall have the following meanings, whether used in the singular or the plural: 2.1 "Affiliate" is any entity that directly or indirectly controls, is controlled by, or is under common control with a party, and for such purpose "control" shall mean the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of the entity, whether through the ownership of voting securities, by contract or otherwise. 2.2 A "Change of Control" shall be deemed to have occurred if any of the following occurs: a) any "person" (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") is or becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or PAGE 1 indirectly, of securities of GSI representing thirty percent (30%) or more of the combined voting power of GSI's then outstanding securities; b) the stockholders of GSI approve a merger or consolidation of GSI with any other corporation, other than a merger or consolidation which would result in the voting securities of GSI outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity) at least sixty percent (60%) of the combined voting power of the voting securities of GSI or such surviving entity outstanding immediately after such merger or consolidation, or c) or the stockholders of GSI approve a plan of complete liquidation of GSI or an agreement for the sale or disposition by GSI of all or substantially all of GSI's assets. 2.3 "Bonutti Agreement" is an agreement between Apogee Medical Products, Inc. and GSI, whose last date of signature therein is March 9, 1995, a copy of which is provided by GSI to Ethicon as of the Effective Date. 2.4 "Calendar Quarter" is the usual and customary Ethicon calendar quarter, used for internal accounting purposes, of approximately three (3) months, in which each of the first two months consist of four weeks and the third month consists of five weeks. 2.5 "Ethicon Balloon Dissector" is the balloon dissector Ethicon has itself begun to manufacture and sell to its customers, identified as the ENDOPATH TED 12 Balloon Dissector, or any substantially identical modifications thereof. 2.6 "Existing OEM Supply Agreement" was an agreement between GSI and U.S. Surgical Corporation effective March 9, 1994 and terminated November 12, 1996, a redacted copy of which has been made publicly available and is on file with the Securities and Exchange Commission ("SEC"). 2.7 "Expanded Field" shall mean all Tissue Dissectors, inclusive of all products covered under the Existing OEM Supply Agreement and the Spacemaker Balloon Dissectors, in the field of hernia repair and USI. 2.8 "FDA" shall mean the U.S. Department of Health and Human Services, Food and Drug Administration, or any successor governmental organization. 2.9 "First Accounting Quarter" is the first Calendar Quarter beginning on or about July 1, 1997. The successive Calendar Quarters following the First Accounting Quarter shall be referred to in their numerical order as, for example, the "Second", "Third", "Fourth" and "Fifth" Accounting Quarter, until the expiration or termination of this Agreement. For purposes of this Agreement, the final Accounting Quarter shall extend from the end of its preceding Accounting Quarter to the termination or expiration of this Agreement. 2.10 "First OEM Balloon Dissector" is the balloon dissector labeled under the Ethicon name which GSI initially supplies to Ethicon hereunder in accordance with and meeting the product and quality assurance specifications mutually agreed to between the parties. The parties may hereinafter modify such specifications upon mutual written consent. 2.11 "First Commercial Delivery" is the first delivery of the First OEM Balloon Dissector from GSI to Ethicon, pursuant to Article 4.7 below, excluding sales samples and training aids intended for promotional use only. PAGE 2 2.12 "510(k) Clearance" shall mean premarket concurrence of substantial equivalence in accordance with Article 510(k) of the U.S. Food, Drug and Cosmetic Act of 1938, as amended. 2.13 "GSI Patents" are each patent and patent application, U.S. and foreign, which GSI owns or is empowered to grant a license to Ethicon prior to or during the term of this Agreement or any extension thereof, the practice of which is reasonably necessary for Ethicon to sell Tissue Dissectors. 2.14 "GSI Total Gross Margin" is the gross margin calculated according to generally accepted accounting principles (GAAP) and attributable to GSI Sales, OEM Purchases, and Royalty Payments. 2.15 "GSI Sales" shall mean sales from GSI to end users of Spacemaker Balloon Dissectors pursuant to Article 9.1B below. 2.16 "Guaranteed Payment" shall mean a negotiated transfer price for the Tissue Dissectors multiplied by a guaranteed minimum number of units of such dissectors which a potential purchaser (either Ethicon or a third party) would be obligated to purchase from GSI in a given [*********************** ********************************]. In the case of Ethicon, such negotiated transfer price will not exceed [**************************** ****************************************************]. 2.17 "Insolvency Event" shall mean the occurrence of any of the following events: (a) GSI shall admit in writing its inability, or be generally unable, to pay its debts as such debts become due; or (b) GSI shall (1) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee or liquidator of itself or of all or a substantial part of its property, (2) make a general assignment for the benefit of its creditors, (3) commence a voluntary case under the United States Bankruptcy Code, as now or hereafter in effect (the "Bankruptcy Code"), (4) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, winding-up, or composition or readjustment of debts, (5) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in any involuntary case under the Bankruptcy Code, or (6) take any corporate action for the purpose of effecting any of the foregoing; or (c) A proceeding or case shall be commenced against GSI in any court of competent jurisdiction, seeking (1) its liquidation, reorganization, dissolution or winding-up, or the composition or readjustment of its debts, (2) the appointment of a trustee, receiver, custodian, liquidator or the like of GSI or of all or any substantial part of its assets, or (3) similar relief in respect of GSI under any law relating to bankruptcy, insolvency, reorganization, winding-up, or composition or adjustment of debts, or an order, judgment or decree approving or ordering any of the foregoing shall be entered and continue unstayed and in effect for a period of 90 days; or an order for relief against GSI shall be entered in an insolvency case under the Bankruptcy Code. 2.18 "Kieturakis Agreements" are agreements between Thomas J. Fogarty, M.D. or his designee (represented by GSI to be GSI) and Maciej Kieturakis, M.D., and as filed with the SEC. [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 3 2.19 "OEM Balloon Dissectors" are collectively the First OEM Balloon Dissector and the Subsequent OEM Balloon Dissectors. 2.20 "OEM Purchases" shall mean Ethicon's purchases of OEM Balloon Dissectors from GSI. 2.21 "Regulatory Compliance" shall mean compliance with (i) all applicable statutes, laws, and regulations, including good manufacturing practices ("GMP"); (ii) Ethicon Endo-Surgery, Inc. Quality Assurance requirements, and (iii) Johnson & Johnson Corporate Quality Assurance requirements generally applicable to all suppliers of products to Johnson & Johnson companies in effect as of the Effective Date, and as amended by Johnson & Johnson, so long as Ethicon uses reasonable efforts to communicate such amendments to GSI. 2.22 "Royalty Payments" shall mean Ethicon's payment of earned royalties to GSI pursuant to Article 9.1 below for the sale of the Ethicon Balloon Dissector. 2.23 "Spacemaker Balloon Dissectors" are collectively the Spacemaker I and II balloon dissectors and Spacemaker World balloon dissector each of which GSI has made commercially available. 2.24 "Subsequent OEM Balloon Dissectors" are balloon dissectors labeled under the Ethicon name which GSI subsequently supplies to Ethicon hereunder following the initial supply of the First OEM Balloon Dissector, and supplied in accordance with and meeting the product and quality assurance specifications mutually agreed to between the parties and set forth hereinafter in successive appendices to this Agreement. The parties may modify such specifications upon mutual written consent. 2.25 "Tissue Dissectors" are surgical instruments or the use of such instruments, which are covered by a Valid Claim of any of the GSI Patents for separating adjacent tissue layers to create an operative space during or in connection with a medical or surgical procedure, including but not limited to the OEM Balloon Dissectors and the Ethicon Balloon Dissector, and whether for open or endoscopic surgery. 2.26 "Trademarks" are (i) U.S. Trademark Registration No. 1,860,825, "Spacemaker" and (ii) the "General Surgical Innovations, Inc." and "GSI" names, unregistered. 2.27 "Valid Claim" means any claim of the issued GSI Patents. Notwithstanding the foregoing, the term "Valid Claim" will not include (x) any claims which have been declared or rendered invalid or otherwise become unenforceable by reissue, disclaimer, or any unappealed or unappealable decision or judgment of a court or governmental agency of competent jurisdiction, or (y) any claims of the GSI Patents that have lapsed or become abandoned. ARTICLE 3 - TERM 3.1 The term of this Agreement shall be for a period of five (5) years from the Effective Date unless earlier terminated under Article 10 below. The parties may extend the term of this Agreement for successive one (1) year periods upon the terms and conditions set forth herein, provided the parties mutually agree on a transfer price and minimum purchase requirements for the OEM Balloon Dissectors. Unless terminated early pursuant to Article 4.6(a)(iii), for a period of [**************] following the termination of this Agreement, or any extension thereof, GSI shall not enter into any [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 4 agreement with a single distributor or OEM for exclusive rights to supply Tissue Dissectors for resale in the Expanded Field to such party upon terms requiring such distributor or OEM to make a Guaranteed Payment less than the midpoint of those terms last offered in writing by GSI and by Ethicon. Ethicon's offer will be deemed to be zero if Ethicon fails to make an offer in writing. ARTICLE 4 - RESPONSIBILITIES OF THE PARTIES 4.1 The parties shall cooperate with each other to qualify GSI as an OEM supplier of OEM Balloon Dissectors for Ethicon, and to ensure that GSI satisfactorily meets Ethicon's requirements for Regulatory Compliance and manufacturing capacity. Ethicon shall render assistance to GSI as necessary or desirable to reasonably expedite the qualification process, without charge to GSI. Any costs incurred by GSI to expedite the qualification process, and to meet the requirements of Regulatory Compliance, shall be borne by GSI. 4.2 Once Ethicon has qualified GSI as an OEM supplier, and GSI is capable of meeting Ethicon's requirements for Regulatory Compliance, GSI shall manufacture and sell the OEM Balloon Dissectors exclusively to Ethicon in the Expanded Field, and shall not sell the OEM Balloon Dissector to any third party in the Expanded Field. After the date that (i) Ethicon has qualified GSI as an OEM supplier, and (ii) GSI is capable of meeting Ethicon's requirements for Regulatory Compliance, Ethicon will exclusively purchase Tissue Dissectors in the Expanded Field from GSI, and will not manufacture or have manufactured for it (except by GSI) such dissectors, except as permitted under Article 8 below. Ethicon also agrees not to manufacture, have manufactured, sell or market Tissue Dissectors, except for (a) the Ethicon Balloon Dissector manufactured prior to GSI's qualification as an OEM supplier, (b) Tissue Dissectors purchased from or on behalf of GSI, or (c) as permitted under Article 8 below. GSI shall not change the form, fit, function, color, components or materials of the OEM Balloon Dissectors, or the process by which the OEM Balloon Dissectors are manufactured, without the prior written consent of Ethicon (which consent will not be unreasonably withheld). 4.3 (a) During the term of this Agreement, Ethicon shall pay [******* *************] for each unit of the First OEM Balloon Dissector as set forth in Appendix 1. (b) The parties shall negotiate in good faith the transfer price of any Subsequent OEM Balloon Dissectors which GSI desires to supply to Ethicon and Ethicon desires to purchase from GSI. (c) During the term of this Agreement or any extension thereof, the [*****************] for fully functional sample units of the First OEM Balloon Dissector shall be set forth in Appendix 1. The [*****************] for fully functional sample units of Subsequent OEM Balloon Dissectors shall be mutually agreed upon. 4.3A (a) During the term of this Agreement, GSI shall pay [*********** *****] for each component or subassembly purchased from Ethicon for use in the First OEM Balloon Dissector as set forth in Appendix 1. (b) The parties shall negotiate in good faith the transfer price of any components or subassemblies purchased from Ethicon for use in Subsequent OEM Balloon Dissectors. [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 5 (c) During the term of this Agreement or any extension thereof, the [********************] for fully functional sample components or subassemblies for the First OEM Balloon Dissector shall be set forth in Appendix 1. The [**** ***********] for fully functional sample components or subassemblies of Subsequent OEM Balloon Dissectors shall be mutually agreed upon. 4.4 Ethicon shall pay [***************] set forth in Article 4.3 above for delivery of the OEM Balloon Dissectors within thirty (30) days from the date of invoice, F.O.B. GSI's factory in Palo Alto, California, or other location mutually agreed upon between the parties. The date of invoice shall not be earlier than the date of shipment. GSI shall ship, at Ethicon's cost, to any location chosen by Ethicon utilizing carriers chosen by Ethicon. The risk of loss with respect to the OEM Balloon Dissectors shall remain with GSI until the OEM Balloon Dissectors are loaded aboard the common carrier in Palo Alto, or other location mutually agreed upon between the parties. GSI will pack the OEM Balloon Dissectors in a manner suitable for shipment to enable the OEM Balloon Dissectors to withstand the effects of shipping, including handling during loading and unloading. 4.5 GSI shall provide the following information at no cost to Ethicon: (a) necessary data, descriptions, processes, photographs and statements of claims for safety, efficacy or performance so that Ethicon may prepare, at its cost, labeling, inserts and sales literature relating to the OEM Balloon Dissectors; (b) technical data to allow Ethicon to prepare up-to-date customer instruction for the OEM Balloon Dissectors; (c) a copy of the Device Master Record and the Device History Record, as defined in 21 Code of Federal Regulations 800, for the OEM Balloon Dissectors and components thereof; and (d) copies of all U.S. and foreign regulatory submissions, including the 510(k) submission, for the OEM Balloon Dissectors. 4.5A Ethicon shall provide the following information at no cost to GSI: (a) Any information reasonably necessary for GSI to meet the requirements of Regulatory Compliance for the purchase by or on behalf of Ethicon of the OEM Balloon Dissectors, including but not limited to, reasonable efforts to provide copies of U.S. and foreign regulatory submissions for OEM Balloon Dissectors (such copies to be deemed confidential by GSI). 4.6 (a)(i) GSI Total Gross Margin Guarantee For the time period from October 4, 1996, until June 30, 1997 (the "Gross Margin Guarantee Period"), GSI shall be guaranteed a GSI Total Gross Margin of Four Million Eight Hundred Thousand dollars ($4,800,000.00). The minimum GSI Total Gross Margin on a quarterly basis shall be as follows: QUARTERLY GSI TOTAL GROSS MARGIN GSI CALENDAR QUARTER TRACKING DATE MINIMUM GSI TOTAL GROSS MARGIN - -------------------- ------------- ------------------------------ 4th Quarter '96 12/31/96 $1,500,000 1st Quarter '97 3/31/97 $1,600,000 2nd Quarter '97 6/30/97 $1,700,000 [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 6 If it is projected within fifteen (15) days prior to the end of any of the three GSI Calendar Quarters set forth above that the actual GSI Total Gross Margin through the end of such quarter is less than the Minimum GSI Total Gross Margin for that quarter, then Ethicon shall pay GSI the difference between such actual GSI Total Gross Margin and the Minimum GSI Total Gross Margin within ten (10) days prior to the end of such quarter. The parties acknowledge that any deficiencies or overpayments, if any, made as a result of GSI Total Gross Margin projections (for example, as described in Article 9.1B below), shall be reconciled during the subsequent calendar quarter. Until such time as Ethicon has qualified GSI as an OEM supplier of Spacemaker Balloon Dissectors, GSI shall use its reasonable commercial efforts to procure GSI sales. (a)(ii) During each of the [**************] Accounting Quarters, Ethicon shall purchase a minimum number of units qualifying as OEM Purchases as follows: ACCOUNTING QUARTER QUARTERLY MINIMUM UNIT PURCHASE REQUIREMENT ------------------ ------------------------------------------- HERNIA USI ------ --- [*******] [*****] [*****] [*******] [*****] [*****] [*******] [*****] [*****] [*******] [*****] [*****] If the actual number of units of OEM Purchases for either procedural category set forth above (Hernia or USI) in any Accounting Quarter exceeds the quarterly minimum unit purchase requirement for such quarter, then such excess may be applied as a credit to the other procedural category for such quarter in an amount not exceeding [******************] of such minimum unit purchase requirement for such other procedural category for such quarter. During the Accounting Quarters following the [******] Accounting Quarter, Ethicon's quarterly minimum unit purchase requirement shall be based on the greater of (i) [****************] of the actual units of the OEM Balloon Dissectors shipped by Ethicon to non-Affiliates in the preceding Accounting Quarter, or (ii) [**************************************************** **********************]. Notwithstanding the preceding sentence, the Minimums for the [****] Accounting Quarter shall not be less than [******* *******************] units. (a)(iii) QUARTERLY MINIMUM UNIT PURCHASE REQUIREMENTS ("MINIMUMS") GSI shall consider satisfaction of the Minimums set forth in Article 4.6(a)(ii) and satisfaction of the mutual initiatives set forth in Article 13.12A (provided GSI satisfies such initiatives in cooperation with Ethicon) herein as complete satisfaction of any duty, whether express or implied, which could be imposed upon Ethicon to commercially exploit its rights under this Agreement, and is accepted by GSI in lieu of any best efforts obligation on the part of Ethicon. If Ethicon fails to make its Minimums to GSI, then GSI may provide Ethicon with written notice of such failure. Ethicon shall have thirty (30) days after receiving such written notice to deliver a binding purchase order to GSI for the OEM Balloon Dissectors for delivery within the applicable quarter or to make a [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 7 payment to GSI in order to make up any deficiencies in its Minimums. Such payment to make up any deficiences shall be calculated by multiplying any unit deficiency times the average transfer price from GSI to Ethicon of OEM Balloon Dissectors in the preceding quarter. If Ethicon fails to take this action, then GSI may manufacture and sell the Tissue Dissectors to third parties upon written notice, or otherwise terminate this Agreement upon written notice to Ethicon; provided, however, that Ethicon will not be relieved from its obligation to make the Minimums occurring prior to the termination of this Agreement, or in the event the date of such termination occurs prior to the First Accounting Quarter, Ethicon will not be relieved from its obligation to make the Minimums for the First Accounting Quarter. (b) The quarterly minimum gross margin requirements set forth under 4.6(a)(i) above, or the Minimums set forth under Article 4.6(a)(ii) above, shall for any applicable quarter be changed in the following circumstances: (i) If GSI fails for any reason within GSI's reasonable control (other than (1) a Major Forces event under Article 13.8 below, (2) a failure by Ethicon to supply components or subassemblies to GSI for use in OEM Balloon Dissectors, or (3) breach by Ethicon) to deliver the OEM Balloon Dissectors to Ethicon in accordance with the terms of this Agreement, or replace OEM Balloon Dissectors which are defective under Article 5.1 below, then the Minimums or gross margin requirements set forth under 4.6(a)(i) above for the applicable quarter(s) shall be reduced. Such reduction shall be in an amount equal to a) in the case of reductions to Minimums, [****************************] of the units not delivered or replaced or b) in the case of reductions to quarterly minimum gross margin requirements, the applicable [************] set forth in Appendix 1 multiplied by [**************************] of the number of units of OEM Balloon Dissectors not delivered or replaced. (ii) If any of the OEM Balloon Dissectors are recalled from market or withdrawn from sale for reason of safety, efficacy or quality primarily due to GSI (and beyond Ethicon's reasonable control), (i) involuntarily regardless of lot size, (ii) voluntarily and involving multiple lots, or (iii) voluntarily and involving a single lot where such lot is not immediately replaced; or if a Major Forces event under Article 13.8 occurs, then the Minimums or gross profit requirements shall be waived until a period of [** ******] shall have elapsed after either market re-entry or the Major Forces event is removed, whichever is applicable, and shall then be proportionately reduced. (iii) If GSI fails to meet its obligations under Article 9.2 below, then the Minimums or gross profit requirements shall be waived until such time as GSI does, in fact, meet its obligation under such article. (iv) If this Agreement is terminated pursuant to either Article 4.6(a)(iii) or Article 10 during any applicable quarter set forth in this Article 4.6(a)(ii), then the Minimums shall be proportionately reduced for such quarter, and Ethicon shall be relieved of Minimums thereafter. (v) If the third party which GSI has sued prior to the Effective Date for patent infringement voluntarily or involuntarily withdraws its Tissue Dissectors from the marketplace and such withdrawal lasts longer than 30 days, then the Hernia Minimums for that Accounting Quarter in which such withdrawal occured and [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 8 subsequent quarters of the Agreement shall be increased by [*****] units provided such withdrawal continues. 4.7 Within thirty (30) days of the First Commercial Delivery, Ethicon shall provide GSI with a forecast of its expected purchases of the OEM Balloon Dissectors, including a schedule of desired delivery dates, for the following [**********], and the [***************] of this forecast shall constitute a binding purchase order. Thereafter, Ethicon shall update the forecast monthly so that its expected purchases and schedule of desired delivery dates are continually forecast for a [*******] time period, the [****************] of such rolling forecasts constituting a binding purchase order. Unless both parties otherwise agree, the [****] month of each binding purchase order will be at least [************] or not more than [************************ *****] of the prior month's forecast for that same month. Furthermore, Ethicon's forecasts and purchase orders must be consistent with reasonable expected usage based on historical procedural volumes and shall also be consistent with its practices with other suppliers. 4.8 Ethicon may adjust the total number of OEM Balloon Dissectors to be delivered pursuant to Article 4.7 above upon thirty (30) days written notice, provided however, that any such adjustment shall not serve to reduce Ethicon's obligation to purchase the total number of OEM Balloon Dissectors indicated in the binding purchase order. In any given month, if Ethicon wants GSI to deliver more than [************************] of the total number of the OEM Balloon Dissectors indicated in the binding purchase order, then GSI shall not be obligated to supply the excess above [*********************************], but GSI shall nevertheless use its reasonable commercial efforts to deliver to Ethicon any such excess above [*******************************] on a priority basis. 4.9 GSI shall use reasonable commercial efforts to deliver the OEM Balloon Dissectors to Ethicon in accordance with the schedule of delivery dates specified in the binding purchase orders set forth in Article 4.7 above. 4.9A Insofar as the terms and conditions of Ethicon's standard purchase order (a copy of which is attached as Appendix 2) are contrary to or inconsistent with the terms and conditions of this Agreement, the terms and conditions of this Agreement shall control. The parties acknowledge that as of the Effective Date there are existing terms and conditions of the Ethicon standard purchase order that are contrary to or inconsistent with the terms and conditions of this Agreement, and that the terms and conditions of this Agreement shall control. Insofar as terms and conditions are added to such purchase order after the Effective Date hereof, GSI shall not be subject to such added terms and conditions unless specifically agreed to in writing. 4.9B All amounts due hereunder are payable in full to GSI without deduction and are net of taxes (including any withholding tax) and custom duties. 4.9C Ethicon shall, at Ethicon's own expense, obtain and pay for import and export licenses and permits, pay customs charges and duty fees, and take all other actions required to accomplish the export and import of the OEM Balloon Dissectors purchased by Ethicon. Ethicon understands that both Ethicon and GSI are subject to regulation by agencies of the United States of America government, including the United States of America Department of Commerce, which prohibit export or diversion of certain technical products to certain countries. Ethicon warrants that Ethicon will comply in all [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 9 respects with all such export regulations to the extent they relate to the OEM Balloon Dissector. 4.9D Ethicon shall provide GSI within ninety (90) days after the end of each Calendar Quarter (for purposes of international information) and within sixty (60) days after the end of each Calendar Quarter (for purposes of U.S. information) the following information with respect to the term of this Agreement: (i) a summary of the number of units of OEM Balloon Dissectors sold (broken down (X) by the five digit customer's zip code (or as the Parties otherwise mutually agree as necessary and reasonably available in order for GSI to comply with its obligations to compensate its sales representatives and employees), for sales in the United States and (Y) by country for sales internationally), (ii) a copy of any market research which Ethicon has in its discretion conducted regarding competition with respect to the OEM Balloon Dissectors and changes in the market for the OEM Balloon Dissectors in the United States or internationally, and (iii) a summary of the number of OEM Balloon Dissectors held by Ethicon at the end of such quarter. Notwithstanding whether Ethicon designates such information or any portion therof as confidential, such information shall be deemed to be confidential and GSI shall treat such information as confidential information in accordance with Article 9.4 below. 4.10 During the eighteen (18) months following the Effective Date, Ethicon's president and members of his management team agree to meet quarterly in Cincinnati, or elsewhere as mutually agreed to by the parties, and at a time mutually agreed to by the parties, with the president of GSI and members of his management team in order to discuss plans and results of the marketing by Ethicon of GSI products. 4.11 During [********************] immediately following the Effective Date, Ethicon agrees to compensate its sales representatives for the sales of OEM Balloon Dissectors at the [****************************]. ARTICLE 5 - WARRANTY 5.1 GSI warrants during the warranty period set forth under Article 5.2 below that the OEM Balloon Dissectors delivered to Ethicon under this Agreement shall be manufactured in accordance with the mutually agreed-upon specifications, and that the OEM Balloon Dissectors so delivered shall be free from material defects in design, construction, materials and workmanship (except for components and design supplied solely by Ethicon). Ethicon may inspect the OEM Balloon Dissectors within thirty (30) days of receipt of a shipment, on a sample basis, to determine conformity with such specifications. If this inspection shows a failure to meet such specifications, then Ethicon may return the entire lot in question to GSI for a full credit, including credit for freight and insurance costs incurred by Ethicon, with a written reasonably detailed description of the reasons for rejection. Prior to issuing credit, GSI shall have thirty (30) days to modify or correct the OEM Balloon Dissectors to conform to such specification. Notwithstanding failure of Ethicon to inspect or return any shipment, or its acceptance of any shipment, Ethicon shall be entitled during the warranty period to return to GSI for exchange or full credit at Ethicon's original cost, including incurred freight and insurance costs, OEM Balloon Dissectors returned by a customer of Ethicon for material defects in design, construction, materials or workmanship or failure to meet mutually agreed upon specifications, except for components and designs provided by Ethicon. Any inspection [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 10 by Ethicon shall not relieve GSI of its obligation to manufacture OEM Balloon Dissectors which meet the Specifications and comply with good manufacturing practices. EXCEPT FOR THE EXPRESS LIMITED WARRANTY SET FORTH IN THIS ARTICLE 5.1, GSI GRANTS NO WARRANTIES FOR THE OEM BALLOON DISSECTORS, EXPRESS OR IMPLIED, EITHER IN FACT OR BY OPERATION OF LAW, BY STATUTE OR OTHERWISE, AND GSI SPECIFICALLY DISCLAIMS ANY IMPLIED WARRANTY OF QUALITY, WARRANTY OF MERCHANTABILITY OR WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE. 5.2 The warranty period shall be for a period of [*********] from the date of GSI's shipment of an OEM Balloon Dissector to Ethicon. GSI shall reasonably agree to extend this warranty period, up to an additional [**** ****], based on applicable data generated by the parties during the term of this Agreement or any extension thereof . 5.3 GSI agrees that Ethicon may pass the warranty given to Ethicon under Article 5 above along to Ethicon's customers. ARTICLE 6 - REGULATORY COMPLIANCE 6.1 GSI shall promptly file for 510(K) Clearance from the FDA to manufacture and sell the First OEM Balloon Dissector as required by applicable laws, rules and regulations, as soon as accurate and complete data and information regarding the First OEM Balloon Dissector is made available to GSI as required by applicable laws, rules and regulations. In addition, GSI shall likewise file for 510(K) clearance for Subsequent OEM Balloon Dissectors which GSI desires to sell to Ethicon and Ethicon desires to purchase from GSI. GSI shall maintain and make available for Ethicon's review for the term of this Agreement or any extension thereof all of the 510(K) Clearances for the OEM Balloon Dissectors. Furthermore, GSI shall file, and maintain at its own cost, all registrations for which GSI would be the appropriate party to so file and maintain such registrations with the FDA and similar regulatory authorities in the United States and in foreign countries which have the authority to approve the sale of the OEM Balloon Dissectors for use in humans. 6.2 GSI represents and warrants that all OEM Balloon Dissectors sold or delivered to Ethicon during the term of this Agreement or any extension thereof shall be manufactured and delivered in accordance with Regulatory Compliance, and that continually during the term of this Agreement or any extension thereof no OEM Balloon Dissectors delivered by GSI to Ethicon will be adulterated or misbranded at the time of delivery by GSI to Ethicon within the meaning of the Federal Food, Drug and Cosmetic Act. GSI shall notify Ethicon as soon as practicable after receiving notice of any claim or action by the FDA relating to non-compliance with this Article or any notice with respect to any violation of any applicable laws, rules or regulations. Both parties shall notify each other of any adverse reaction, malfunction, injury or other similar claims with respect to the OEM Balloon Dissectors of which either becomes aware. 6.3 GSI shall notify Ethicon of any FDA audit, or any audit from any other regulatory body, of its factories for the manufacture of the OEM Balloon Dissectors, or any request for information from the FDA or other regulatory body related to the manufacture of the OEM Balloon Dissectors, as soon as practically possible after GSI [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 11 receives notice of such audit or such request. Ethicon shall make reasonable efforts to provide copies of its customer inquiries related to OEM Balloon Dissectors as well as the results of any related investigations which, in Ethicon's sole determination, are deemed to be material. 6.4 Ethicon or its designated representative may, at its discretion and upon ten (10) days written notice to GSI, conduct periodic GMP audits of GSI's factories for the manufacture of the OEM Balloon Dissectors. 6.5 Upon mutual consent of the parties, which consent may not be unreasonably withheld, or in the case of a recall required by an agency with competent jurisdiction, GSI shall be required to institute and fund any recall, field corrective action, or the like in circumstances relating to a breach by GSI of the warranty set forth in Article 5 above or other breach of its obligations hereunder. In such circumstances, the actual retrieval of the OEM Balloon Dissectors and costs associated with that retrieval will be undertaken and absorbed by Ethicon. The parties shall maintain adequate records concerning traceability of the OEM Balloon Dissectors, and shall cooperate with each other in the event that any procedures described in this paragraph are undertaken. In the event of any such recall, GSI shall accept recalled OEM Balloon Dissectors and deliver to Ethicon replacement OEM Balloon Dissectors at GSI's sole cost and expense. 6.6 Because regulatory requirements vary throughout the world, the parties agree to cooperate with one another to obtain regulatory approvals. 6.7 Both parties agree to comply with their state, federal, and international regulatory requirements as are required for their status as a medical device manufacturer or medical device distributor. ARTICLE 7 - RESPONSIBILITY FOR CLAIMS In order to distribute between themselves the responsibility for the handling and expense of claims arising out of the manufacture, distribution, sale or use of the OEM Balloon Dissectors, the parties agree as follows: 7.1 GSI shall be liable for and shall indemnify and hold Ethicon harmless against any liability, damages or loss (other than loss of potential sales) and from any claims, suits, proceedings, demands, recoveries or expenses, including without limitation, expenses of total or partial device recalls, in connection with the OEM Balloon Dissectors manufactured by GSI (other than (i) the Ethicon Balloon Dissector which is manufactured by GSI or changes thereto requested solely by Ethicon, and (ii) components or designs supplied solely by Ethicon) arising out of, based on, or caused by: (a) alleged defects in materials, workmanship or design of the OEM Balloon Dissectors manufactured by or on behalf of GSI; or (b) failure of the OEM Balloon Dissectors manufactured by or on behalf of GSI to fulfill claims relating to safety, efficacy or performance furnished by GSI under Article 4.5 above (excluding matters for which Ethicon is responsible under Article 7.2 below); and (c) claims of patent infringement made with respect to the OEM Balloon Dissectors manufactured by or on behalf of GSI, or claims of trademark infringement made with respect to Ethicon's use of GSI's Trademarks; and PAGE 12 (d) a breach of the representations and warranties set forth in Article 14.1 below. GSI shall obtain and maintain in full force and effect valid and collectible product liability insurance in respect of the OEM Balloon Dissectors for death, illness, bodily injury and property damage in an amount not less than $2 million per occurrence. Such policy shall name Ethicon as an insured or an additional insured thereunder and GSI shall grant like coverage to Ethicon under a standard broad form vendor's endorsement thereto. GSI shall within ten (10) days of the Effective Date provide Ethicon with evidence of this coverage, provided that the existence of such coverage shall in no way limit GSI's liability or obligations hereunder. Such insurance policy shall provide that in the event such insurance coverage should be materially adversely changed or terminated for any reason, the insurer thereunder will give GSI and Ethicon ten (10) days prior notice of such change or termination. 7.2 Ethicon shall be liable for and shall indemnify and hold GSI harmless against any liability, damages or loss (other than loss of potential sales) and from any claims, suits, proceedings, demands, recoveries or expenses, including without limitation, expenses of total or partial device recalls, (i) in connection with the OEM Balloon Dissectors, and/or the Ethicon Balloon Dissectors sold by Ethicon, or (ii) arising out of, based on, or caused by claims whether written or oral, made or alleged to be made, by Ethicon in its advertising, publicity, promotion, or sale of the OEM Balloon Dissectors where such claims were not substantially the same as those claims furnished by GSI under Article 4.5 above, or (iii) arising out of, based on, or caused by the Ethicon Balloon Dissector which is manufactured by GSI or changes thereto requested solely by Ethicon, or (iv) arising out of, based on or caused by components or designs supplied solely by Ethicon, or (v) arising out of, based on, or caused by the labeling of the OEM Balloon Dissectors where such labeling was not substantially the same labeling information furnished by GSI under Article 4.5 above, or by negligent handling by Ethicon of the OEM Balloon Dissectors (excluding matters for which GSI is responsible under Article 7.1 above). 7.3 (a) GSI is the "Indemnifying Party" and Ethicon is the "Indemnified Party" for purposes of Section 7.1, and Ethicon is the "Indemnifying Party" and GSI is the "Indemnified Party" for purposes of Section 7.2. In the event a Claim is made upon the Indemnified Party, the Indemnified Party shall promptly give notice of such Claim to the Indemnifying Party, and shall promptly deliver to such Indemnifying party all information and written material available to the indemnified Party relating to such Claim. If such Claim is first made upon the Indemnifying Party, the Indemnifying Party shall promptly give notice of such Claim to the Indemnified Party. (b) The Indemnified Party will, if notified of the Indemnifying Party's election to do so within fifteen (15) days of the date of notice of a Claim, permit the Indemnifying Party to defend in the name of the Indemnified Party any Claim in any appropriate administrative or judicial proceedings and take whatever actions may be reasonably requested of the Indemnified Party to permit the Indemnifying Party to make such defense and obtain an adjudication of such Claim on the merits, including the signing of pleadings and other documents, if necessary; provided that the Indemnifying Party shall defend the Claim with counsel reasonably satisfactory to the Indemnified PAGE 13 Party. In addition to the liability for the ultimate settlement or judgment, if any, arising out of such Claim under this Agreement, the Indemnifying Party shall be solely responsible for all the expenses incurred in connection with such defense or proceedings, regardless of their outcome. However, the Indemnifying Party shall not be responsible for any expenses, including attorneys fees and costs, incurred by the Indemnified Party to monitor the defense of the Claim by the Indemnifying Party. (c) In the event the Indemnifying Party does not accept the defense of such Claim under the terms hereof, the Indemnified Party shall be entitled to conduct such defense and settle or compromise such Claim, and the Indemnifying Party's indemnification obligation under this Agreement shall be absolute, regardless of the outcome of such Claim. The Indemnified Party, at its option, may elect not to permit the Indemnifying Party to control the defense against a Claim. If the Indemnified Party so elects, then the Indemnifying Party shall not be obligated to indemnify the Indemnified Party against any settlements, judgments or other costs or obligations arising thereunder which the Indemnified Party may make or incur relating to such Claim. ARTICLE 8 - FAILURE TO SUPPLY, CHANGE OF CONTROL OR INSOLVENCY EVENT 8.1 If GSI fails to supply the quantity of the OEM Balloon Dissectors on a desired delivery date specified on a binding purchase order issued in compliance with the terms of this Agreement (a "Failure to Supply Event") for any reason other than those set forth under Article 13.8 below, and this failure lasts longer than sixty (60) days from such desired delivery date, then so long as (i) Ethicon is then in compliance with Articles 4.7 and 4.8 above at the time of such Failure to Supply Event, and (ii) at such time, such event has not been caused by Ethicon's failure to supply or have supplied components to GSI, Ethicon shall thereafter have the right to immediately terminate this Agreement upon written notice to GSI and to manufacture or have manufactured the Tissue Dissectors. During such sixty (60) days, Ethicon agrees to cooperate with GSI in any commercially reasonable manner in an effort to cure such event. Additionally, if a Failure to Supply Event occurs following a Change of Control or an Insolvency Event, and such failure lasts longer than thirty (30) days from the date specified on the binding purchase order, then immediately upon written notice to GSI, Ethicon shall have the right to immediately terminate this Agreement and to manufacture or have manufactured the Tissue Dissectors. If Ethicon exercises its rights under this Article 8.1, GSI grants Ethicon an exclusive worldwide license in the Expanded Field under the GSI Patents to make, have made, use or sell the Tissue Dissectors, rights under GSI's regulatory clearances in the Expanded Field, including 510(K) Clearances, to market the Tissue Dissectors, and all know-how necessary to make, have made, use or sell the Tissue Dissectors in the Expanded Field, such license and rights to expire upon the date when this Agreement would have expired without the intervention of this paragraph (the "Default License"). In consideration for the grant of the Default License, Ethicon shall pay GSI an earned royalty of [**************]per unit sold of the Tissue Dissectors (the "Default Royalty"). The royalty and accounting provisions for paying such earned royalty are set forth in Appendix 3 attached to this Agreement. In the event Ethicon exercises its rights under this Article 8.1, GSI shall make available to Ethicon all of the information then in GSI's possession or at its free disposal relating to the [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 14 manufacture of the Tissue Dissectors (including information placed in escrow pursuant to Article 14.2 below). 8.1A If a Failure to Supply Event occurs for any reason set forth in Article 13.8 below, then GSI shall have the option, upon written notice within forty five (45) days of such event, to inform Ethicon of its inability to cure such event within ninety (90) days of the desired delivery date specified on the binding purchase order, and to agree to fully reimburse Ethicon for its costs in connection with the manufacture of the Tissue Dissectors by or on behalf of Ethicon for resale to its customers to satisfy forecasted demand (the "Default Option"). If GSI elects the Default Option, and Ethicon correspondingly is therefore capable of providing its customers with forecasted requirements, then GSI may thereafter renew its exclusive distributorship arrangement with Ethicon provided GSI once again satisfactorily meets Ethicon's requirements for Regulatory Compliance and manufacturing capacity. If GSI does not elect the Default Option, and such Failure to Supply Event lasts longer than ninety (90) days from such desired delivery date, then upon written notice to GSI, Ethicon may terminate this Agreement, and GSI thereafter grants Ethicon the Default License to immediately manufacture or have manufactured the Tissue Dissectors. During such ninety (90) days, Ethicon agrees to cooperate with GSI in any commercially reasonable manner in an effort to cure such event. In consideration of the Default License, Ethicon shall pay GSI the Default Royalty for any units sold of the Tissue Dissectors. The royalty and accounting provisions for paying such earned royalty are set forth in Appendix 3 attached to this agreement. In the event Ethicon exercises its rights under this Article 8.1A, GSI shall make available to Ethicon all of the information then in GSI's possession or at its free disposal related to the manufacture of the Tissue Dissectors including information placed in escrow pursuant to Article 14.2 below. 8.2 The remedy provided in Article 8.1 and 8.1A above for failure to supply shall be in addition to and not in lieu of Ethicon's other remedies under applicable law. However, notwithstanding the foregoing, in the event of such failure to supply, Ethicon shall not be entitled to recover its lost profits or other incidental or consequential damages from GSI. ARTICLE 9 - PATENTS, TRADEMARKS AND SECRETS 9.1 PATENTS. Subject to Article 9.1B below, during the time period preceding GSI's qualification as Ethicon's OEM supplier of OEM Balloon Dissectors pursuant to Article 4.1 above, Ethicon and its Affiliates shall have a worldwide, exclusive license in the Expanded Field under the GSI Patents to make, have made, use or sell the Ethicon Balloon Dissector (the "Pre-Qualification License"). During such time period, Ethicon shall pay GSI an earned royalty of [********************] per unit sold of the Ethicon Balloon Dissector. The royalty and accounting provisions for paying such earned royalty are set forth in Appendix 3 attached to this Agreement. Following such time period, and when GSI becomes qualified, the Pre-Qualification License shall expire, and subject to Articles 9.1B and 9.1C below, Ethicon and its Affiliates shall thereafter have a worldwide, exclusive license in the Expanded Field under the GSI Patents to use or sell the Tissue Dissectors purchased from GSI for the remainder of the term of this Agreement or any extension thereof (the Post-Qualification License). The parties acknowledge that the Pre-Qualification License and the Post-Qualification License are [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 15 subject to as of the Effective Date hereof certain GSI International Distributorship Agreements, a list of which, if any, is attached in Appendix 4, and GSI shall use its best efforts to either terminate such agreements or allow such agreements to expire as promptly as possible after the Effective Date hereof. 9.1A Ethicon grants GSI a nonexclusive, worldwide license (to the extent such license is available) outside the Expanded Field under any patents which it owns or is empowered to grant a license thereunder to make, have made, use or sell Tissue Dissectors. GSI will pay Ethicon an earned royalty of [******** ****] per unit sold of such dissectors. The royalty and accounting provisions for paying such earned royalties are set forth in Appendix 3A attached to this Agreement. 9.1B Until such time as Ethicon has qualified GSI as an OEM supplier of Spacemaker Balloon Dissectors, GSI may make and sell to end users the Spacemaker Balloon Dissectors, GSI shall provide Ethicon with written projections as soon as practically possible before the end of each calendar quarter, of the number of units of such dissectors sold, and the gross profit anticipated to be received, for such calendar quarter. As promptly as practically possible thereafter, GSI shall provide Ethicon with actual numbers of units sold and gross profit received for such quarter. 9.1C Once GSI has become qualified as an OEM Supplier of Spacemaker Balloon Dissectors, GSI may, upon Ethicon's written consent (which shall not be unreasonably withheld), make and sell to certain targeted end users the Spacemaker Balloon Dissectors under limited circumstances and for limited time periods as the parties may mutually agree. Any such sales shall be credited against the quarterly minimums set forth under Article 4.6(a)(ii) above, and GSI shall provide Ethicon with an accounting in writing of such sales as soon as practically possible following the Accounting Quarter in which such sales were made. 9.2 PATENT ENFORCEMENT. The parties acknowledge that prior to the Effective Date hereof, GSI has sued a third party having a significant presence in the marketplace for Tissue Dissectors. GSI shall diligently prosecute such suit until the litigation upon which such suit is founded results in such third party voluntarily or involuntarily withdrawing such dissectors from the marketplace in the Expanded Field. Furthermore, upon resolution of such suit, if another third party is then or thereafter offers Tissue Dissectors for sale in the Expanded Field, and such dissectors have a market share in the Expanded Field in the United States of [******************************************* ****], then GSI shall promptly sue such other third party for patent infringement if such third party does not cease or continue to cease its infringing activities, and GSI shall diligently prosecute such infringement suit in the same manner as described in the preceding sentence. GSI does not have any obligation to diligently prosecute more than one patent infringement suit at any one time. If GSI fails to meet its obligations pursuant to this Article 9.2 after thirty days written notice from Ethicon, then the minimums set forth in Article 4.6 above will be waived until such time as GSI once again fulfills its obligations hereunder. 9.3 TRADEMARKS. Ethicon shall have the right to promote and sell the OEM Balloon Dissectors under any trademark selected by Ethicon which trademark shall be and shall remain the property of Ethicon. Ethicon agrees to indicate on its packaging for the OEM Balloon Dissectors that such dissectors are manufactured by GSI. In addition, [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 16 Ethicon shall label the OEM Balloon Dissectors with the Spacemaker tm logo. Nothing herein shall be deemed to give one party, either during the term of this Agreement or thereafter, any right to trademarks or copyrights of the other party or to their use except that Ethicon shall have the right to use GSI's name in association with the marketing and sale of the OEM Balloon Dissectors during the term of this Agreement or any extension thereof if it chooses to do so, but such use by Ethicon shall be for the benefit of GSI and Ethicon shall acquire no ownership rights to the GSI Trademarks. 9.4 CONFIDENTIAL INFORMATION. All written information designated as confidential and exchanged between GSI and Ethicon while this Agreement is, or the OEM Agreement was, in effect shall be treated as confidential information. Neither party shall for three (3) years after such exchange, use (other than in the performance of its obligations hereunder) or disclose such information to any third party without the prior written approval of the other party (other than in the performance of its obligations hereunder), unless such information has become public knowledge through no fault of the party receiving such information, or comes to such party from a third party under no obligation of confidentiality with respect to such information, or was in the possession of such party prior to the date of disclosure, or is developed by or on behalf of such party without reliance on confidential information received hereunder, or is requested to be disclosed in compliance with applicable laws or regulations in connection with the sale of the OEM Balloon Dissectors, or is otherwise required to be disclosed in compliance with applicable law, an order by a court or other regulatory body having competent jurisdiction, or is product-related information which is reasonably required to be disclosed in connection with marketing the OEM Balloon Dissectors. The obligations imposed by this section shall not limit any rights provided to Ethicon pursuant to Article 8.1 above to manufacture or have manufactured the OEM Balloon Dissectors following GSI's failure to supply pursuant to this Agreement; provided that the disclosure of confidential information to a third party (except as may be reasonably required in preliminary discussions with such third party) for the purpose of enabling such party to manufacture or distribute the OEM Balloon Dissectors shall be conditioned upon such third party signing a confidentiality agreement prohibiting the disclosure of such information to any other party and limiting the use of such information to the manufacturing or distribution of the OEM Balloon Dissectors. ARTICLE 10 - TERMINATION 10.1 Except as stated in Article 4.6(a)(iii), this Agreement may be terminated by either party in the event the other substantially fails to perform or otherwise substantially breaches any of its obligations under this Agreement by giving written notice of its intent to terminate and stating the grounds for termination. The party receiving the notice shall have three (3) months from the date of receipt of the notice to cure the failure or breach. In the event it is cured, the notice shall be of no effect. In the event it is not cured, this Agreement then shall, without any further action, terminate at the end of such three (3) month period. If the failure to perform or other breach is due to circumstances covered under Article 13.8 below, then this subsection shall not apply until such circumstances have ceased. PAGE 17 10.2 If Ethicon discovers a patent of a third party which Ethicon reasonably believes, upon advice of patent counsel, covers in whole or in part any aspect of the OEM Balloon Dissector or the Ethicon Balloon Dissector which is then offered for sale by or for Ethicon, and if the parties are unable to either design around such patent to the satisfaction of patent counsel for Ethicon, or to obtain a license to such patent, within three months of Ethicon's notice of such discovery to GSI, Ethicon may automatically terminate this Agreement upon notice to GSI. 10.3 Ethicon may terminate this Agreement upon written notice pursuant to the conditions set forth under Articles 8.1 and 8.1A above. 10.4 Termination of this Agreement for any reason shall not affect rights and obligations of the parties accrued through the effective date of termination, including without limitation indemnification provisions relating to the OEM Balloon Dissectors manufactured or distributed by or on behalf of GSI during the term of this Agreement or any extension thereof. 10.5 In the event of a termination of this Agreement by GSI pursuant to Article 4.6(a)(iii), Ethicon shall use reasonable efforts to facilitate GSI in becoming part of JJHCS corporate account programs and eligible for inclusion in J&J corporate contracts with large buying institutions. ARTICLE 11 - ARBITRATION OF DISPUTES 11.1 Any controversy or claim arising out of or relating to this Agreement, except for any controversy regarding the validity of a patent licensed hereunder by either party to the other, any claim seeking injunctive relief based on or related to a claim of patent infringement, and the decision to enter into this Agreement, shall be settled exclusively by binding arbitration by a single arbitrator chosen by agreement of the parties, which agreement shall not be unreasonably withheld. The law of the state where the arbitration is conducted pursuant to Article 11.2 below shall apply to the arbitration proceeding (without regard to its conflict of law principles). Judgment upon the award rendered by the arbitrator may be entered in any court having jurisdiction over the matter. In connection with any such arbitration, the prevailing party shall be entitled to recover from the non-prevailing party reasonable expenses, including, without limitation, reasonable attorneys' fees and reasonable accountants' fees. If the arbitrator is unable to designate a prevailing party, the arbitration award shall so state and the expenses shall be split equally between the parties. 11.2 If Ethicon submits a claim or controversy to arbitration pursuant to Article 11.1 above, then such arbitration shall be conducted in Palo Alto, California. If GSI submits a claim or controversy to arbitration, then such arbitration shall be conducted in Cincinnati, Ohio. 11.3 Notwithstanding any other provision hereof, any arbitration conducted pursuant to this Article 11 shall adopt the procedural rules of the Federal Rules of Civil Procedure and the evidentiary rules of the Federal Rules of Evidence. The parties and the arbitrator shall use all reasonable efforts to conclude arbitration proceedings within six (6) months from the date of selection of the arbitrator. The arbitrator shall render a decision, setting forth findings and conclusions of law, within thirty (30) days after completion of hearing the arbitration evidence on the merits. PAGE 18 11.4 The arbitrator shall be bound by the express terms of this Agreement and may not amend or modify such terms in any manner. Any award rendered by the arbitrator shall be consistent with the terms of this Agreement, and such terms shall control the rights and obligations of the parties. Notwithstanding anything to the contrary set forth in this Agreement, in no event shall the arbitrator be empowered to award exemplary, consequential or punitive damages, and the parties shall be deemed to have waived any right to such damages. The proceedings shall be confidential and the arbitrator shall issue appropriate protective orders to safeguard both parties confidential information. 11.5 From the date one party notifies the other it wishes to commence an arbitration proceeding until such time as the matter has been finally settled by arbitration, the running of the time period set forth in Article 10.1 above, as to which a party must cure a breach, shall be suspended as to the subject matter of the dispute. ARTICLE 12 - DISCLAIMER 12.1 Ethicon makes no representation or warranty that it will market the OEM Balloon Dissectors (or the Ethicon Balloon Dissector), or if it does market the OEM Balloon Dissectors (or the Ethicon Balloon Dissector), that the OEM Balloon Dissectors (or the Ethicon Balloon Dissector) shall be the exclusive means by which Ethicon shall participate in the marketing of surgical devices for hernia repair and USI. Furthermore, all business decisions, including without limitation, the design, manufacture, sale, price and promotion of the OEM Balloon Dissectors (or the Ethicon Balloon Dissector) marketed under this Agreement and the decision whether to sell the OEM Balloon Dissectors (or the Ethicon Balloon Dissector) shall be within the sole discretion of Ethicon. GSI realizes that Ethicon already sells a line of surgical devices for hernia repair and USI and that Ethicon may itself or with others develop new surgical devices which may compete with the OEM Balloon Dissectors (or the Ethicon Balloon Dissector) sold under this Agreement. ARTICLE 13 - MISCELLANEOUS 13.1 REPRESENTATIONS AND WARRANTIES. GSI expressly warrants and represents that (a) it owns all of the right, title and interest in and to the Tissue Dissectors supplied by or on behalf of GSI under this Agreement; (b) it is empowered to supply the OEM Balloon Dissectors to Ethicon in the Expanded Field; (c) to the best of its knowledge, either actual or constructive, it has no outstanding encumbrances or agreements, including but not limited to the Existing OEM Supply Agreement, or arrangements of any kind pursuant to which any entity is entitled to purchase from GSI, or has the right to sell or market, the OEM Balloon Dissectors or any component thereof in the Expanded Field except for Tissue Dissectors provided to U.S. Surgical Corporation prior to the Effective Date hereof pursuant to the Existing OEM Supply Agreement; (d) it shall not enter into any such agreements or arrangements during the term of this Agreement or any extension thereof; (e) it is empowered to grant Ethicon an exclusive license of the scope set forth in Article 8 above if Ethicon exercises its rights to such a license; (f) it has the financial capacity to supply the OEM Balloon Dissectors to Ethicon in view of the terms and conditions set forth in this Agreement; (g) the "BONUTTI INVENTIONS" as defined in PAGE 19 the Bonutti Agreement have in fact been assigned to GSI; (h) any licenses granted to Ethicon herein under the BONUTTI INVENTIONS survive an Insolvency Event; (i) the BONUTTI INVENTIONS include all counterparts to the patents and patent applications listed in the Bonutti Agreement, including all continuations and divisionals thereof; (j) GSI owns all of the BONUTTI INVENTIONS regardless whether GSI prosecutes or maintains patent applications or patents thereon; (k) neither GSI nor Ethicon is required to credit Bonutti on packaging inserts and labels which specify patent numbers for the BONUTTI INVENTIONS; (l) any licenses or sublicenses granted to Ethicon herein under the Kieturakis Agreement survive the termination of such agreement; (m) GSI neither has been nor is, as of the Effective Date hereof, in material breach of the Bonutti Agreement or the Kieturakis Agreement, and GSI shall not materially breach such agreements prior to the expiration or termination of this Agreement, including extensions thereof; (n) it has terminated the Existing OEM Supply Agreement pursuant to Article 11.2 (Early Termination) of such agreement; and (o) the terms of this Agreement are not more favorable to Ethicon than those last offered by U.S. Surgical Corporation in writing to GSI as prohibited in accordance with Article 11.5 (Renewal) of the Existing OEM Supply Agreement. 13.2 ESCROW. GSI shall place with an escrow agent mutually acceptable to GSI and Ethicon, a description of GSI's process for the manufacture of the OEM Balloon Dissectors in sufficiently clear and detailed terms that it can be readily followed and carried out by a trained scientist or engineer to make the OEM Balloon Dissectors in the manner GSI considers most efficient. Furthermore, should GSI alter, modify or change its process for manufacturing the OEM Balloon Dissectors, GSI shall amend the description in escrow to include such alteration, modification or change. The description held in escrow pursuant to this Article 13.2, shall be available to Ethicon or its designee only in the event GSI is unable to supply or fails to supply Ethicon with the OEM Balloon Dissectors pursuant to this Agreement for any reason other than those set forth under Article 13.8 below, or if a Change of Control or Insolvency Event occurs and Ethicon exercises its rights under Article 8 above. Each party represents, warrants and covenants, that it shall treat as confidential information in accordance with Article 9.4 above any written information designated as confidential concerning the other party disclosed in accordance with this Escrow provision of this Agreement. 13.3 ASSIGNABILITY. Neither party shall transfer or assign this Agreement, in whole or in part, without the prior written consent of the other party (which shall not be unreasonably withheld); except that either party may, without such consent, assign this Agreement to an Affiliate or with the sale of substantially all of the assets of the business, including by way of merger, to which the OEM Balloon Dissectors relates. PAGE 20 13.4 NOTICES. All notices hereunder shall be in writing and shall be deemed to have been duly given if delivered personally, one day after delivery to a nationally recognized overnight delivery service, charges prepaid, three days after sent by registered or certified mail, postage prepaid, or when receipt is confirmed if by telex, facsimile or other telegraphic means: In the case of GSI: General Surgical Innovations, Inc. 3172-A Porter Drive Palo Alto, CA 94304 Attn: Roderick A. Young, President With a copy to: Venture Law Group 2800 Sand Hill Road Menlo Park, CA 94025 Attn: Tae Hea Nahm In the case of Ethicon: Ethicon Endo-Surgery, Inc. 4545 Creek Road Cincinnati, Ohio 45242 With a copy to: Chief Patent Counsel Johnson & Johnson One Johnson & Johnson Plaza New Brunswick, New Jersey 08933 Such addresses may be altered by written notice given in accordance with this Article 14.4. 13.5 RELATIONSHIP OF PARTIES. The parties hereto are entering into this Agreement as independent contractors, and nothing herein is intended or shall be construed to create between the parties a relationship of principal and agent, partners, joint venturers or employer and employee. Neither party shall hold itself out to others or seek to bind or commit the other party in any manner inconsistent with the foregoing provisions of this Article. 13.6 WAIVER. The failure of either party to enforce at any time for any period the provisions of this Agreement shall not be construed to be a waiver of such provisions or of the right of such party thereafter to enforce each such provision. 13.7 GOVERNING LAW. This Agreement and its performance are to be governed by the laws of the state where the arbitration occurs, except that the arbitration provisions set forth in Article 11 above shall be governed by the provisions of the Federal Arbitration Act as well as the laws of the state where the arbitration occurs. 13.8 MAJOR FORCES. Subject to Ethicon's rights set forth in Article 8 above, neither party shall be responsible for and the terms of this Agreement shall be inapplicable to any defaults or delays which are due to unforeseen causes beyond the parties control including, but without limitation, acts of God or public enemy, acts or PAGE 21 other order of a government, particularly full market approval by the United States Food and Drug Administration and any foreign government equivalent approval, fire, flood or other natural disasters, embargoes, accidents, explosions, strikes or other labor disturbances (regardless of the reasonableness of the demands of labor), shortage of fuel, power or raw materials, inability to obtain or delays of transportation facilities, incidents of war, or other unforeseen events causing the inability of a party, acting in good faith with due diligence, to perform its obligations under this Agreement. 13.9 PUBLICITY. With respect to any other publicity, neither party shall originate any such publicity, news release or public announcement, written or oral, whether to the public or press, stockholders or otherwise, relating to this Agreement, to any amendment or performances under the Agreement, save only such announcements as in the opinion of counsel for the party making such announcement is required by law to be made. If a party decides to make an additional announcement required by law under this Agreement, it will give the other party thirty (30) days advance written notice, or any shorter notice period otherwise required by law, of the text of the announcement so that the other party will have an opportunity to comment upon the announcement. 13.10 RELEASE FOR PAST INFRINGEMENT. GSI forever releases Ethicon from any claims, liabilities, demands, damages, expenses and losses for patent infringement which GSI may have had against Ethicon for the sale of the Ethicon Balloon Dissector prior to the Effective Date hereof. 13.11 BANKRUPTCY. All rights and licenses granted under or pursuant to this Agreement by GSI to Ethicon are, and shall otherwise be deemed to be, for purposes of Section 365(n) of Title 11, U.S. Code (the "Bankruptcy Code"), licenses of rights to "intellectual property" as defined in the Bankruptcy Code. The parties agree that Ethicon, as a licensee of such rights under this Agreement, shall retain and may fully exercise all of its rights and elections under the Bankruptcy Code. GSI agrees during the term of this Agreement to create and maintain current copies or, if not amenable to copying, detailed descriptions or other appropriate embodiments, of all such intellectual property. The parties further agree that, in the event of the commencement of a bankruptcy proceeding by or against GSI under the Bankruptcy Code, Ethicon shall be entitled to a complete duplicate of (or complete access to, as appropriate) any such intellectual property and all embodiments of such intellectual property, and same, if not already in its possession, shall be promptly delivered to Ethicon (i) upon any such commencement of a bankruptcy proceeding upon Ethicon's written request, unless GSI elects to continue to perform all of its obligations under this Agreement, or (ii) if not delivered under (i) above, upon the rejection of this Agreement by or on behalf of GSI upon Ethicon's written request. All rights, powers and remedies of Ethicon provided under this Article are in addition to and not in substitution for any and all other rights, powers and remedies now or hereafter existing at law or in equity in the event of any such commencement of a bankruptcy proceeding by or against GSI. 13.12 ENHANCEMENTS. The parties agree to meet periodically at their respective facilities to discuss proposed enhancements to the OEM Balloon Dissectors and other areas of potential cooperation. If Ethicon wishes to engage GSI's services to develop an enhanced OEM Balloon Dissector, or other products, and GSI wishes to perform such services, and Ethicon agrees to pay for such services or any portion thereof, then Ethicon PAGE 22 and GSI shall enter into a development agreement in a form mutually acceptable to both parties. As of this date, the parties wish to evaluate the potential for development by GSI of a balloon blunt tip trocar. 13.12A USI INITIATIVES. As of the Effective Date hereof, the parties will use their reasonable commercial efforts to develop and market a Tissue Dissector in the Expanded Field only for USI. The parties agree to cooperate to define the specifications for such dissector and, within 90 days after the development of such dissector, the sales and marketing program to promote such dissector. In addition, Ethicon will make available its Institute to train surgeons to use such dissector in a minimum of twenty training sessions during the term of this Agreement, the exact time and duration of which shall be mutually agreed upon by the parties. Within 30 days after the development of such dissector, the parties will mutually evaluate promotional efforts, such as patient education, consumer awareness, education of referring doctors, and comarketing programs with Affiliates. The parties shall use good faith efforts to develop a procedural kit using such dissector promptly after the date such dissector is first commercially available. 13.13 IN NO EVENT SHALL EITHER PARTY BE LIABLE TO THE OTHER FOR ANY CONSEQUENTIAL DAMAGES, HOWEVER CAUSED, ON ANY THEORY OF LIABILITY, WHETHER CONTRACT, TORT (INCLUDING NEGLIGENCE) OR OTHERWISE, WHETHER OR NOT A PARTY HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGE. 13.14 PRIOR UNDERSTANDINGS. The parties have, in this Agreement, incorporated all representations, warranties, covenants, commitments and understandings on which they have relied in entering into this Agreement and, except as provided herein, the parties make no covenants or other commitments to the other concerning their future actions. Accordingly, this Agreement: (i) constitutes the entire agreement and understanding between the parties, and there are no promises, representations, conditions, provisions or terms relating to it other than as set forth in this Agreement, and (ii) supersedes all previous understandings, agreements and representations between the parties, written or oral, relating to the subject matter of this Agreement. This Agreement may be altered or amended only upon mutual written consent. PAGE 23 13.15 COUNTERPARTS. This Agreement may be executed in any number of counterparts, each of which shall be considered an original and all of which taken together shall constitute one and the same instrument, provided that this Agreement shall not become effective until each party has received the counterparts executed by the other party. The parties agree to the terms of this Agreement, as indicated by the signatures of their respective corporate officers, duly authorized as of the last date of signature below. General Surgical Innovations, Inc. Ethicon Endo-Surgery, Inc. By: /s/ Roderick A. Young By: /s/ Robert Salerno -------------------------- ------------------------------- Roderick A. Young, President Robert Salerno, Vice President Business Development & Strategic Planning Date: 12/20/96 Date: 12/20/96 ------------------------ ---------------------------- PAGE 24 APPENDIX 1 TRANSFER PRICES First OEM Balloon Dissector for Resale [******] First OEM Balloon Dissector for Samples [******] Spacemaker, Distal 900 DBD-900 99-1140-01 [******] Spacemaker, Distal 1500 DBD-1500 99-1141-01 [******] Spacemaker II, with cann VSM-2900 99-1201-02 [******] Spacemaker II, w/o cann VSM-2900-01 99-1202-01 [******] Air Bulb, 2 pk AB-050 99-1301-01 [***] COMPONENTS [****************] [**********] [****************] [**********************] [**********] [****************] [**********************] [**********] [****************] [***] CONFIDENTIAL TREATMENT REQUESTED PAGE 25 APPENDIX 2 ETHICON STANDARD PURCHASE ORDER PAGE 26 APPENDIX 3 ROYALTY AND ACCOUNTING PROVISIONS Ethicon shall keep accurate books and records of all payments due GSI. Ethicon shall deliver to GSI written reports of the number of units sold of the Ethicon Balloon Dissector during the preceding Accounting Quarter, on or before the sixtieth day following the end of each Accounting Quarter. Such report shall include a calculation of the earned royalty due and the earned royalty payment. GSI shall have the right to nominate an independent accountant acceptable to and approved by Ethicon (which approval shall not be unreasonably withheld) who shall have access to Ethicon's records during reasonable business hours for the purpose of verifying, at GSI's expense, the royalty payable as provided for in this Agreement for the two preceding years, but this right may not be exercised more than once in any year. GSI shall solicit or receive only information relating to the accuracy of the royalty report and the royalty payments made. Ethicon shall be entitled to withhold approval of an accountant which GSI nominates unless the accountant agrees to sign a confidentiality agreement with Ethicon which shall obligate such accountant to hold the information he receives from Ethicon in confidence, except for information necessary for disclosure to GSI necessary to establish the accuracy of the royalty reports. The remittance of royalties payable on sales outside the United States will be payable to the GSI in United States Dollar equivalents at the official rate of exchange of the currency of the country from which the royalties are payable as quoted by The Wall Street Journal, New York Edition, for the day upon which the transfer of funds for the royalty payment is made. If the transfer or the conversion into United States Dollar equivalents in any such instance is not lawful or possible, the payment of such part of the royalties as is necessary shall be made by the deposit thereof, in the currency of the country where the sales were made on which the royalty was based, to the credit and account of GSI or its nominee in any commercial bank or trust company of its choice located in that country, prompt notice of which shall be given by Ethicon to GSI. In order to facilitate payments from countries other than the United States, GSI shall, whenever requested by Ethicon, enter into a direct agreement in writing with a foreign affiliate of Ethicon. Such shall be obligated to remit any earned royalties due for sales in such country directly to GSI, and GSI shall execute such direct agreement as Ethicon may request which may be necessary to effect such purpose. Such direct agreement shall provide generally for the payment of earned royalties under the same terms as provided for herein, insofar as such terms are lawful under the applicable laws and regulations of the particular country. Notwithstanding the provisions of this paragraph, Ethicon shall remain primarily liable for all payments due GSI. Any tax required to be withheld on royalties payable to GSI under the laws of any country, shall be promptly paid by Ethicon on behalf of GSI to the appropriate PAGE 27 governmental authority, and Ethicon shall furnish GSI with proof of payment of such tax together with official or other appropriate evidence issued by the appropriate governmental authority, sufficient to enable GSI to support a claim for income tax credit for the sum withheld. Any such tax required to be withheld shall be an expense of GSI. Notwithstanding whether the Ethicon Balloon Dissector is covered by more than one patent, only one royalty payment shall be payable to consultant for the Ethicon Balloon Dissector. PAGE 28 APPENDIX 3A ROYALTY AND ACCOUNTING PROVISIONS GSI shall keep accurate books and records of all payments due Ethicon. GSI shall deliver to Ethicon written reports of the number of units sold of Tissue Dissectors during the preceding Accounting Quarter, on or before the sixtieth day following the end of each Accounting Quarter. Such report shall include a calculation of the earned royalty due and the earned royalty payment. Ethicon shall have the right to nominate an independent accountant acceptable to and approved by GSI (which approval shall not be unreasonably withheld) who shall have access to GSI's records during reasonable business hours for the purpose of verifying, at Ethicon's expense, the royalty payable as provided for in this Agreement for the two preceding years, but this right may not be exercised more than once in any year. Ethicon shall solicit or receive only information relating to the accuracy of the royalty report and the royalty payments made. GSI shall be entitled to withhold approval of an accountant which Ethicon nominates unless the accountant agrees to sign a confidentiality agreement with GSI which shall obligate such accountant to hold the information he receives from GSI in confidence, except for information necessary for disclosure to Ethicon necessary to establish the accuracy of the royalty reports. The remittance of royalties payable on sales outside the United States will be payable to Ethicon in United States Dollar equivalents at the official rate of exchange of the currency of the country from which the royalties are payable as quoted by The Wall Street Journal, New York Edition, for the day upon which the transfer of funds for the royalty payment is made. If the transfer or the conversion into United States Dollar equivalents in any such instance is not lawful or possible, the payment of such part of the royalties as is necessary shall be made by the deposit thereof, in the currency of the country where the sales were made on which the royalty was based, to the credit and account of Ethicon or its nominee in any commercial bank or trust company of its choice located in that country, prompt notice of which shall be given by GSI to Ethicon. In order to facilitate payments from countries other than the United States, Ethicon shall, whenever requested by GSI, enter into a direct agreement in writing with a foreign affiliate of GSI. Such shall be obligated to remit any earned royalties due for sales in such country directly to Ethicon, and Ethicon shall execute such direct agreement as GSI may request which may be necessary to effect such purpose. Such direct agreement shall provide generally for the payment of earned royalties under the same terms as provided for herein, insofar as such terms are lawful under the applicable laws and regulations of the particular country. Notwithstanding the provisions of this paragraph, GSI shall remain primarily liable for all payments due Ethicon. PAGE 29 Any tax required to be withheld on royalties payable to Ethicon under the laws of any country, shall be promptly paid by GSI on behalf of Ethicon to the appropriate governmental authority, and GSI shall furnish Ethicon with proof of payment of such tax together with official or other appropriate evidence issued by the appropriate governmental authority, sufficient to enable Ethicon to support a claim for income tax credit for the sum withheld. Any such tax required to be withheld shall be an expense of Ethicon. Notwithstanding whether the Tissue Dissectors are covered by more than one patent, only one royalty payment shall be payable to Ethicon for such dissectors. PAGE 30 APPENDIX 4 LIST OF INTERNATIONAL DISTRIBUTORS DISTRIBUTOR COUNTRY ------------- --------- Blue Mountain International Korea China Hong Kong Macau Escor Oy Finland PRIM Spain Portugal PAGE 31 EX-10.21 3 EXHIBIT 10.21 MODIFICATION AND TERMINATION AGREEMENT AND MUTUAL RELEASE This Agreement is made as of November 12, 1996 by and among General Surgical Innovations, Inc., a California corporation ("GSI"), and United States Surgical Corporation, a Delaware corporation ("USSC"). WHEREAS, GSI and USSC have entered into a certain Distributorship Agreement dated as of March 9, 1994, as amended (the "Distributorship Agreement"); and WHEREAS, GSI and USSC wish to modify and terminate the Distributorship Agreement and agree to a mutual release as set forth below. The parties agree that as of the date of this Agreement set forth above (the "Effective Date"): 1.1 MODIFICATION AND TERMINATION. Subject to the provisions set forth below, GSI and USSC hereby agree to terminate the Distributorship Agreement. Upon execution of this Agreement, USSC shall not be obligated to purchase, and GSI shall not be obligated to supply, any products, including, but not limited to, the products set forth on EXHIBIT A hereto. The parties further agree to amend Section 11.3 of the Distributorship Agreement such that USSC shall have the right (to the extent permitted under applicable laws and regulations) to sell its existing inventory of products purchased from GSI until [************ *********]. 1.2 This Agreement will be effective on the date it is executed by both parties (the "Termination Date"). Within [********] days after the Termination Date, USSC shall pay in full the amount set forth in the EXHIBIT B and thereafter shall no longer owe any amounts to GSI. USSC shall have no right to [**********] under the Distributorship Agreement after the Termination Date. 2.0 ACKNOWLEDGMENT OF INTELLECTUAL PROPERTY RIGHTS . Each party acknowledges that it has no rights, claims or interests in the other party's intellectual property rights except as set forth in the Distributorship Agreement. 3.0 MUTUAL RELEASE. Except for warranty and indemnity obligations of the parties (as set forth in Articles 4.4 and 7 of the Distributorship Agreement, respectively), GSI and USSC, on behalf of itself, each of its past and present affiliates, representatives, successors, assigns and transferees does hereby release, discharge and acquit forever such other party and such party's affiliates, successors, assigns and transferees from any and all demands, claims or other liabilities (or potential demands, claims or liabilities) of every kind and character whatsoever, arising in connection with any rights, obligations, duties or interests arising under the Distributorship Agreement occurring on or prior to the date of this Agreement, whether known or unknown, suspected or unsuspected and each expressly waives the benefits of Section 1542 of the California Civil Code which provides that: [***] CONFIDENTIAL TREATMENT REQUESTED "A GENERAL RELEASE DOES NOT EXTEND THE RELEASE TO CLAIMS WHICH THE CREDITOR DOES NOT KNOW OR SUSPECT TO EXIST IN HIS FAVOR AT THE TIME OF EXECUTING THE RELEASE, WHICH IF KNOWN BY HIM MUST HAVE MATERIALLY AFFECTED HIS SETTLEMENT WITH THE DEBTOR." Each of GSI and USSC understands and acknowledges the significance and consequences of such specific waiver of Section 1542, and hereby assumes full responsibilities for any injuries, damages or losses that each may incur as a result of such waiver. 4.0 SURVIVAL OF CERTAIN TERMS. USSC and GSI acknowledge and agree that the following provisions survive the termination of the Distributorship Agreement: Sections 2.1(e), 3.7, 3.8, 4.4, the last two sentences of 5.2, 5.3, 5.4, 5.5, 6.1, 6.4, 6.5, 6.6, 6.7, 6.8, 6.12, 7.1, 8.2, 8.3, 10.1, 10.2, 10.3, 11.3 [******************************************************************* ****] in Section 1.1 above), 13.1, 13.2, 13.3, 14.1, 14.2, 14.3, 14.4, 14.5, 14.6, 14.7, 14.8. 5.0 CLARIFICATION OF ARTICLE 11.2. USSC and GSI acknowledge and agree that the Distribution Agreement is being terminated by mutual agreement and not pursuant to Sections 11.2(e) or 11.2(f) and therefore the parties agree that the restriction on USSC contained in the last unnumbered paragraph of Article 11.2 does not apply. IN WITNESS WHEREOF, the undersigned GSI and USSC have duly executed this Agreement as of the date first set forth above. GENERAL SURGICAL INNOVATIONS, INC. UNITED STATES SURGICAL CORPORATION By:_______________________________ By:___________________________ Its:______________________________ Its:__________________________ [***] CONFIDENTIAL TREATMENT REQUESTED -2- EXHIBIT A (CANCELED USSC FINANCIAL OBLIGATIONS) QUANTITY $ -------- - [************] [************] [*****] [*******] [************] [************] [*****] [*******] [************] [************] [*****] [*******] [************] [************] [*****] [*******] [************] [************] [*****] [*******] [************] [************] [*****] [*******] [***********************************************] QUANTITY $ -------- - [************************] [*****] [*******] [************************************] QUANTITY $ -------- - [***************************] [*****] [*******] [***************************] [*****] [*******] [***************************] [*****] [*******] [***] CONFIDENTIAL TREATMENT REQUESTED -3- EXHIBIT B (USSC FINANCIAL OBLIGATIONS) [*************************] INVOICE NO. $ ----------- - [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] [****] [**********] ---------- [**********] [***] CONFIDENTIAL TREATMENT REQUESTED -4- EX-10.22 4 EXHIBIT 10.22 EXHIBIT 10.22 - ------------------------------------------------------------------------------- STANDARD FORM LEASE - ------------------------------------------------------------------------------- PARTIES: This Lease, executed in duplicate at Cupertino, California, on December__, 1996, by and between Berg & Berg Enterprises, Inc., a California Corporation, and General Surgical Innovations Inc., a California Corporation, hereinafter called respectively Lessor and Lessee, without regard to number or gender. USE: WITNESSETH: That Lessor hereby leases to Lessee, and Lessee hires from Lessor, for the purpose of conducting therein office, research and development, light manufacturing, and warehouse activities, and any other legal activity; and for no other purpose without obtaining the prior written consent of Lessor. PREMISES: The real property with appurtenances as shown on Exhibit A.1 (the "Premises") situated in the City of Cupertino, County of Santa Clara, State of California, and more particularly described as follows: A 30,460 square foot building including all improvements thereto and the right to use up to 116 unreserved parking spaces as shown on Exhibit A.2 ("Phase I") with the addition of approximately 15,000 square feet of building and improvements including the right to use approximately 57 additional unreserved parking spaces at the Premises effective September 1, 1998 as shown on Exhibit A.2 ("Phase II"). Phase I and Phase II are collectively referred to herein as the Building (the "Building"). The address for the Building is 10460 Bubb Road, Cupertino, California. Lessee's pro-rata share of the Building is 100%. TERM: The term shall be for eighty-four (84) months unless extended pursuant to Section 35 of this Lease (the "Lease Term"), commencing on the Commencement Date as defined in Section 1, and ending on the day eighty-four (84) months thereafter. RENT: Base rent shall be payable in monthly installments as follows: Base rent Estimated CAC* Total --------- -------------- ----- Months 1 through 12 $46,895 $5,010* $51,905 Months 13 through 18 $48,302 $5,010* $53,312 Months 19 through 24 $72,100 $7,470* $79,570 Monthly base rent, net of CAC charges, shall increase by 3% on the annual anniversary of the Commencement Date each year during the Lease Term over the prior year's rent. The base rent starting on the 25th month of the Lease Term shall be $74,263. * CAC charges to be adjusted per Common Area Charges Section below. Base rent as scheduled above shall be payable in advance on or before the first day of each calendar month during the Lease Term. The term "Rent," as used herein, shall be deemed to be and to mean the base monthly rent and all other sums required to be paid by Lessee pursuant to the terms of this Lease. Rent shall be paid in lawful money of the United States of America, without offset or deduction, and shall be paid to Lessor at such place or places as may be designated from time to time by Lessor. Rent for any period less than a calendar month shall be a pro rata portion of the monthly installment. Upon execution of this Lease, Lessee shall deposit with Lessor the first month's rent. SECURITY DEPOSIT: Lessee shall deposit with Lessor the sum of Fifty-One Thousand Nine Hundred Five Dollars ($51,905) (the "Security Deposit"). The Security Deposit shall be held by Lessor as security for the faithful performance by Lessee of all of the terms, covenants, and conditions of this Lease applicable to Lessee. If Lessee commits a default as provided for herein, including but not limited to a default with respect to the provisions contained herein relating to the condition of the Premises, Lessor may (but shall not be required to) use, apply or retain all or any part of the Security Deposit for the payment of any amount which Lessor may spend by reason of default by Lessee. If any portion of the Security Deposit is so used or applied, Lessee shall, within ten days after written demand therefor, deposit cash with Lessor in an amount sufficient to restore the Security Deposit to its original amount. Lessee's failure to do so shall be a default by Lessee. Any attempt by Lessee to transfer or encumber its interest in the Security Deposit shall be null and void. Upon execution of this Lease by Lessee and Lessor, Lessee shall deposit with Lessor the Security Deposit. Provided Lessee meets all of its obligations under this Lease, within 30 days after the termination of this Lease, Lessee shall refund the Security Deposit less any amount properly applied under the terms of this Lease. LATE CHARGES: Lessee hereby acknowledges that a late payment made by Lessee to Lessor of Rent and other sums due hereunder will cause Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Such costs include, but are not limited to, processing and accounting charges, and late charges, which may be imposed on Lessor according to the terms of any mortgage or trust deed covering the Premises. Accordingly, if any installment of Rent or any other sum due from Lessee is not received by Lessor or Lessor's designee within ten (10) days after such amount is due, Lessee shall pay to Lessor a late charge equal to five (5%) percent of such overdue amount. The parties hereby agree that such late charge represents a fair and reasonable estimate of the costs Lessor will incur by reason of late payments made by Lessee. Acceptance of such late charges by Lessor shall in no event constitute a waiver of Lessee's default with respect to such overdue amount, nor shall it prevent Lessor from exercising any of the other rights and remedies granted hereunder. Notwithstanding the above, Lessee shall not be required to pay a late charge if it is the result of a non-recurring unusual event such as a accounting error and not occurring more than five (5) times during the Lease Term. QUIET ENJOYMENT: Lessor covenants and agrees with Lessee that upon Lessee paying Rent and performing its covenants and conditions under this Lease, Lessee shall and may peaceably and quietly have, hold and enjoy the Premises for the Lease Term, subject, however, to the rights reserved by Lessor hereunder. COMMON AREA CHARGES: Lessee shall pay to Lessor, as additional Rent, an amount equal to Lessee's prorata share of the total common area charges of the Premises and Lessee's pro rata share of the total common area charges for the Building as defined below (the common area charges for the Premises and the common area charges for the Building collectively referred to herein as ("CAC")). Lessee shall pay to Lessor as Rent, on or before the first day of each calendar month during the Lease Term, subject to adjustment and reconciliation as provided hereinbelow, the sum of Five Thousand Ten Dollars ($5,010), said sum representing Lessee's estimated monthly payment of Lessee's percentage share of CAC for 1997. It is understood and agreed that Lessee's obligation under this paragraph shall be prorated to reflect the Commencement Date and the end of the Lease Term. Lessee's estimated monthly payment of CAC payable by Lessee during the calendar year in which the Lease commences is set forth above. At or prior to the commencement of each succeeding calendar year term (or as soon as practical thereafter), Lessor shall provide Lessee with a description of Lessee's estimated monthly payment for CAC which Lessee shall pay to Lessor as Rent. Within 120 days of the end of the calendar year and the end of the Lease Term, Lessor shall provide Lessee a statement of actual CAC incurred including capital reserves for the preceding year or other applicable period in the case of a termination year. If such statement shows that Lessee has paid less than its actual percentage, then Lessee shall on demand pay to Lessor the amount of such deficiency within 30 days after the receipt of the statement therefore. If such statement shows that Lessee has paid more than its actual percentage, then Lessor shall, at its option, promptly refund such excess to Lessee or credit the amount thereof to the Rent next becoming due from Lessee. Lessor reserves the right to revise any estimate of CAC if the actual or projected CAC show an increase or decrease in excess of 10% from an earlier estimate for the same period. In such event, Lessor shall provide a revised estimate to Lessee, together with an explanation of the reasons therefor, and Lessee shall revise its monthly payments accordingly. Lessor's and Lessee's obligation with respect to adjustments at the end of the Lease Term or earlier expiration of this Lease shall survive the Lease Term or earlier expiration. Notwithstanding the above, CAC shall be limited to a maximum increase of 5% over the prior year during the initial Lease Term except that this limitation shall not apply to (i) tax increases and (ii) the increase resulting from the Substantial Completion of the Phase II Improvements. Page 2 As used in this Lease, CAC shall include, but are not limited to (i) items specified as CAC items in Paragraphs 5(b), 6, 16 and 31; (ii) utility costs related to the common areas of the Premises as shown on Exhibit A.1; (iii) all costs and expenses including but not limited to supplies, materials, equipment and tools used or required in connection with the operation and maintenance of the Premises; (iv) licenses, permits and inspection fees; (v) all other costs incurred by Lessor in maintaining and operating the Premises; (vi) all reserves for capital replacements for HVAC, roof, parking lot and exterior painting shall not exceed Twelve Thousand Eight Hundred Seventy-Two Dollars ($12,872) per year prior to September 1, 1998 and Eighteen Thousand Five Hundred Dollars per year after September 1, 1998 or upon Substantial Completion of the Phase II Improvements plus annual increases equal to the consumer price index; and (vii) an amount equal to five percent (5%) of the aggregate of all CAC, as compensation for Lessor's accounting and processing services. Lessee shall have the right to review the books or records related to the CAC applicable to this Lease annually. CAC shall not include any cost related to: (a) hazardous or toxic materials unless some type of area-wide assessment is made by a government agency or commission; (b) structural defects or construction defects or non-compliance with codes existing as of the Commencement Date with respect to the Building Shell and Lessee Interior Improvements; (c) leasing and marketing costs or costs incurred in enforcing or administering leases (except for above accounting); (d) casualty damage covered by insurance or costs for which Lessor obtains reimbursement from other sources; and (e) capital improvement costs to the extent that Lessee has paid to Lessor reserve amounts for such capital improvements. If Lessee's share of the cost of capital improvements due to governmental regulations as provided in Section 9 exceeds $5,000, and there are no reserves paid by Lessee to Lessor available for Section 9 capital improvements, and the capital improvement is not required due to Lessee's particular use of the Premises, such capital improvement cost shall be amortized over the estimated useful life of the improvement, not to exceed 10 years at Wells Fargo prime rate plus one percent (1%). Lessee shall pay to Lessor the amortized costs of such improvement on a monthly basis over the Lease Term as part of the CAC. Notwithstanding the above exceptions to CAC, Lessee shall not be relieved of any of Lessee's obligations under this Lease. COMMENCEMENT DATE MEMORANDUM: When the actual Commencement Date is determined, the parties shall execute a Commencement Date Memorandum setting forth the Commencement Date, the expiration date of the Lease Term and any required adjustments to base rent as provided in this Lease, but failure to do so shall not affect the continuing validity and enforceability of this Lease, which shall remain in full force and effect. IT IS FURTHER MUTUALLY AGREED BETWEEN THE PARTIES AS FOLLOWS: 1. POSSESSION: Possession shall be deemed tendered and the term shall commence on the first to occur of the following (the "Commencement Date"): (i) the Phase I Improvements are Substantially Complete or (ii) Lessee occupies Phase I and commences to conduct business operations or (iii) if Lessor is prevented from or delayed in completing its work under Section 2 of this Lease due to Lessee Delays, such work will be deemed Substantially Complete as of the date on which it would have been Substantially Complete had it not been for such Lessee Delays. It is the intention of Lessee and Lessor that March 1, 1997 shall be the Commencement Date. "Substantially Complete" shall mean that: (i) Lessor has tendered possession of Phase I to Lessee, (ii) Lessor has met all legal requirements for occupancy of Phase I, (iii) the Lessee Interior Improvements for Phase I are materially complete per the approved plans, exclusive of telephone or other communication systems, punchlist items and there remains no incomplete or defective items of work which would materially adversely affect Lessee's intended use of the Premises and (iv) said interior of the building is in a "broom clean" condition. 2. IMPROVEMENTS Page 3 A. PHASE I IMPROVEMENTS: The "Phase I Improvements" shall be defined as all items necessary for a turnkey remodel of Phase I. The Phase I Improvements shall be constructed by independent contractors to be employed by and under the supervision of Lessor in accordance with complete plans and specifications prepared by Lessor for submission to the City of Cupertino ("Phase I Improvement Plans"), complete with all mechanical and electrical design, approved by Lessee, and then attached hereto as Exhibit B.1. Lessee and its designated representatives, shall at all times during the construction of the Phase I Improvements have access to the building to monitor the progress of construction and Lessor's compliance with its obligations hereunder, provided however, that such access shall not unreasonably interfere with the activities of Lessor or its contractors. If Lessor notifies Lessee that any fittings, finishes, or other materials included in the specifications for the Phase I Improvements cannot be obtained within fifteen (15) days after an order therefor, Lessee shall be responsible for selecting alternative fittings, finishes, or other materials which can be obtained within said fifteen (15) day period including Rent for each day of delay. Lessor shall be responsible for ensuring that the Phase I Improvements conform to the approved plans and all applicable statutes, rules, regulations, ordinances, and City of Cupertino Building Department. Lessor estimates the total cost of the turnkey Phase I Improvements will be one million one hundred fifty thousand dollars ($1,150,000) including all items shown on Exhibit B. Lessor shall be responsible for and shall pay the cost of the Phase I Improvements up to the amount of Two Hundred Thousand Dollars ($200,000) (the "Phase I TI Allowance"). Lessee's cash budget for the Phase I Improvements shall be Nine Hundred Fifty Thousand Dollars ($950,000) ("Lessee's Phase I Costs"). Costs in excess of the Phase I TI Allowance and Lessee's Phase I Costs shall not be incurred without the advance approval of Lessee. Any approved cost over the Phase I TI Allowance shall be paid for by Lessee in cash within fifteen (15) days after Lessor has provided Lessee with evidence that the billed work is complete. Lessor shall be entitled to a construction management fee covering its overhead and profit on the Phase I TI Allowance and Lessee's Phase I Costs of six percent (6%). All costs for the Phase I Improvements shall be documented and subject to verification by Lessee. For any contract to be entered into between Lessor and any contractor furnishing labor or materials in connection with the construction of the Lessee Interior Improvements where the payment due under such contract is estimated by Lessor to be in excess of One Hundred Thousand Dollars $100,000, Lessor shall request bids from at least three (3) qualified contractors selected by Lessor for bidding. Lessor will accept the lowest qualified bid. Lessee shall have the opportunity to review the qualified bidders list and may select a bidder of their choice for any bid provided the bidder meets Lessor's reasonable requirements. Within five (5) business days after approval by Lessee of Lessor's single line drawings depicting the Phase I Improvements, together with specifications for HVAC and electrical installations which will be included in the Phase I Improvements, Lessor shall provide Lessee with a guaranteed maximum price for the construction of the Phase I Improvements. Following approval of that amount by Lessee, Lessee shall have no obligation to pay any costs in excess of the guaranteed maximum price in connection with the construction of the Phase I Improvements, except to the extent that the cost of such construction is increased by changes approved by Lessee. Lessor shall use its best efforts to cause the Commencement Date of the initial term to occur not later than March 1, 1997. If the Commencement Date has not occurred by April 1, 1997, Lessee shall receive one day of base rent abatement for each day after April 1, 1997 until the Commencement Date. Lessor and Lessee agree that having a Commencement Date after April 1, 1997 will cause Lessee and Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Accordingly, the parties hereby agree that Lessee's right to the amount of one day's rent for each day of delay after April 1, 1997 represents a fair and reasonable settlement for both parties and neither party shall Page 4 have further liability to the other for any damages. If the Commencement Date has not occurred by April 30, 1997, Lessee may at its sole option, by written notice to Lessor, have the right to terminate this Lease at any time after April 30, 1997 until the Commencement Date. Notwithstanding anything to the contrary herein, all dates stated herein shall be extended for the number of days Lessor is unable to Substantially Complete the Building as a result of delays (i) due to governmental actions (other than governmental action of refusing to approve work which fails to comply with the law or the building permit) which occurs after receipt of normal building permits, (ii) due to acts of God, , and (iii) due to Lessee Delays. Items (i) and (ii) are referred to herein as Third Party Delays ("Third Party Delays"). "Lessee Delays" means a delay in Substantial Completion resulting from (a) Lessee's failure to meet Lessee's deadlines for approval as shown on Exhibit E, (b) delays due to change orders, (c) delays due to Lessee's failure to meet the deadlines for approving any plans or change orders, and (d) delays because of the inability to obtain any product, materials, design, color, fitting, or finish pursuant to this Section 2. Lessee shall have a maximum of 3 business days to approve or disapprove any preliminary plans or change orders and a maximum of 10 business days to approve or disapprove any final plans. If Lessee does not disapprove any plans or change orders within the time period set forth herein in writing, Lessor may proceed on the basis that the plans or change orders are approved by Lessee. If plans or change orders are disapproved, Lessee shall state the reason for disapproval and Lessor and Lessee shall act in good faith to resolve any issues. Lessor shall charge Lessee $250 per change order after the fifth (5th) change order for processing. Notwithstanding any other provisions herein, Lessee shall during the Lease Term own all Phase I Improvements paid for by Lessee. Ownership of these improvements shall, for the sum of $1.00, the receipt of which is hereby acknowledged, revert to Lessor at the end of the Lease Term or earlier expiration of this Lease. B. PHASE II BUILDING SHELL AND LESSEE'S INTERIOR IMPROVEMENTS: The "Building Shell", as defined on the attached Exhibit C shall be constructed at Lessor's sole cost and expense. The "Phase II Lessee Interior Improvements" shall be defined as all items that are not part of the Building Shell and shall be constructed by independent contractors to be employed by and under the supervision of Lessor in accordance with complete plans and specifications prepared by Lessor for submission to the City of Cupertino ("Phase II Lessee Improvement Plans"), complete with all mechanical and electrical design, approved by Lessee, and then to be attached hereto as Exhibit D. Lessee and its designated representatives, shall at all times during the construction of the Phase II Lessee Interior Improvements have access to the building to monitor the progress of construction and Lessor's compliance with its obligation hereunder; provided however, that such access shall not unreasonably interfere with the activities of Lessor or its contractors. If Lessor notifies Lessee that any fittings, finishes or other materials included in the specifications for the Lessee Interior Improvements cannot be obtained within fifteen (15) days after placing an order therefor, Lessee shall be responsible for selecting alternative fittings, finishes, or other materials which can be obtained within said fifteen (15) day period, or, if Lessee does not specify any alternative, Lessee shall be responsible for any delay beyond said fifteen (15) day period including Rent for each day of delay. Lessor shall be responsible for ensuring that the Phase II Lessee Interior Improvements conform to the approved plans and all applicable statutes, rules, regulations, ordinances, and City of Cupertino Building Department. For any contract to be entered into between Lessor and any contractor furnishing labor or materials in connection with the construction of the Lessee Interior Improvements where the payment due under such contract is estimated by Lessor to be in excess of One Hundred Thousand Dollars $100,000, Lessor shall request bids from at least three (3) qualified contractors selected by Lessor for bidding. Lessor will accept the lowest qualified bid. Lessee shall have the opportunity to review the qualified bidders list and may select a bidder of their choice for any bid provided the bidder meets Lessor's Page 5 reasonable requirements. Within five (5) business days after approval by Lessee of Lessor's single line drawings depicting the Phase II Lessee Interior Improvements, together with specifications for HVAC and electrical installations which will be included in the Phase II Lessee Interior Improvements, Lessor shall provide Lessee with a guaranteed maximum price for the construction of the Phase II Lessee Interior Improvements. Following approval of that amount by Lessee, Lessee shall have no obligation to pay any costs in excess of the guaranteed maximum price in connection with the construction of the Phase II Lessee Interior Improvements, except to the extent that the cost of such construction is increased by changes approved by Lessee. Lessor shall be responsible for and shall pay the cost of the Phase II Lessee Interior Improvements up to the amount of Five Hundred Thousand Dollars ($500,000) (the "Phase II TI Allowance"). In the event the approved cost of the Phase II Lessee Interior Improvements is more than the Phase II TI Allowance Lessee shall pay the excess cost in cash, as provided for herein. Costs in excess of the Phase II TI Allowance, if any, will not be incurred without advance approval of Lessee. Any approved cost over the Phase II TI Allowance shall be paid in cash within fifteen (15) days after Lessor has provided Lessee with any invoice for the portion of the work that has been completed. Lessor shall be entitled to a construction management fee covering its overhead and profit on the costs of the Phase II Lessee Interior Improvements of six percent (6%). All costs for Phase II Lessee Interior Improvements shall be documented and subject to verification by Lessee. Lessor shall use its best efforts to cause the Substantial Completion of Phase II to occur not later than September 1, 1998. All base rent related to Phase II shall be adjusted for each day the Phase II Lessee Interior Improvements are not Substantially Complete after September 1, 1998. Lessor and Lessee agree that having a Substantial Completion date for Phase II after September 1, 1998 will cause Lessee and Lessor to incur costs not contemplated by this Lease, the exact amount of which will be extremely difficult to ascertain. Accordingly, the parties hereby agree that Lessee's right to the abatement of base rent specified herein represents a fair and reasonable settlement for both parties and neither party shall have further liability to the other for any damages. If the Phase II Lessee Interior Improvements are not Substantially Complete by October 1, 1998, Lessee may at its sole option, by written notice to Lessor, have the right to terminate this Lease for applicable to the Phase II space at any time after October 1, 1998 until the Commencement Date. Notwithstanding anything to the contrary herein, all dates stated herein shall be extended for the number of days Lessor is unable to Substantially Complete the Building as a result of delays (i) due to governmental actions (other than governmental action of refusing to approve work which fails to comply with the law or the building permit) which occurs after receipt of normal building permits, (ii) due to acts of God, , and (iii) due to Lessee Delays. Items (i) and (ii) are referred to herein as Third Party Delays ("Third Party Delays"). "Lessee Delays" means a delay in Substantial Completion resulting from (a) Lessee's failure to meet Lessee's deadlines for approval as shown on Exhibit E, (b) delays due to change orders, (c) delays due to Lessee's failure to meet the deadlines for approving any plans or change orders, and (d) delays because of the inability to obtain any product, materials, design, color, fitting, or finish pursuant to this Section 2. Lessee shall have a maximum of 3 business days to approve or disapprove any preliminary plans or change orders and a maximum of 10 business days to approve or disapprove any final plans. If Lessee does not disapprove any plans or change orders within the time period set forth herein in writing, Lessor may proceed on the basis that the plans or change orders are approved by Lessee. If plans or change orders are disapproved, Lessee shall state the reason for disapproval and Lessor and Lessee shall act in good faith to resolve any issues. Lessor shall charge Lessee $250 per change order after the fifth (5th) change order for processing. Lessor further agrees, at its cost, to spend up to Fifty Thousand Dollars ($50,000) to upgrade the exterior of Phase I as part of the Phase II Lessee Interior Improvements. Page 6 Notwithstanding the above obligations with respect to the Building Shell and the Phase II Lessee Interior Improvements, Lessor's obligation to proceed with the indicated improvements shall be subject to Lessee having available cash of a minimum of Ten Million Dollars ($10,000,000) as of the start of the Phase II construction. 2.1 ACCEPTANCE OF PREMISES AND COVENANTS TO SURRENDER: Lessor represents that the Premises shall be in good order and repair, and shall comply with all requirements for occupancy as of the Commencement Date. Lessee agrees on the last day of the Lease Term, or on the sooner termination of this Lease, to surrender the Building to Lessor in Good Condition and Repair. Good Condition and Repair ("Good Condition and Repair") shall not mean original condition, but shall mean that the Building are in a commercially acceptable condition suitable for occupancy by a reasonable lessee. The interior walls of all office and warehouse areas, the floors of all office and warehouse areas, all suspended ceilings and any carpeting are to be cleaned and in Good Condition and Repair Lessee also agrees to surrender unto Lessor all alterations, additions, and improvements which may have been made in, to, or on the Building by Lessee. Lessor agrees to allow any reasonable alterations and improvements and will notify Lessee at the time of approval if such improvements or alterations are to be removed at the end of the Lease Term or earlier termination of this Lease and the Building restored to its condition as of the Commencement Date of the Lease. Lessee, on or before the end of the Lease Term or sooner termination of this Lease, shall remove all its personal property and trade fixtures from the Building, and all such property not so removed shall be deemed to be abandoned by Lessee. Lessee shall reimburse Lessor for all disposition costs incurred by Lessor relative to Lessee's abandoned property. If the Building are not surrendered at the end of the Lease Term or earlier termination of this Lease, Lessee shall indemnify Lessor against loss or liability resulting from any delay caused by Lessee in surrendering the Building including, without limitation, any claims made by any succeeding Lessee founded on such delay. 3. USES PROHIBITED: Lessee shall not commit, or suffer to be committed, any waste upon the Premises, or any nuisance, or other act or thing which may disturb the quiet enjoyment of any other tenant in or around the buildings in which the subject Premises are located or allow any sale by auction upon the Premises, or allow the Premises to be used for any improper, immoral, unlawful or objectionable purpose, or place any loads upon the floor, walls, or ceiling which may endanger the structure, or use any machinery or apparatus which will in any manner vibrate or shake the Building, or place any harmful liquids in the drainage system of the building. No waste materials or refuse shall be dumped upon or permitted to remain upon any part of the Premises outside of the building proper. No materials, supplies, equipment, finished products or semi-finished products, raw materials or articles of any nature shall be stored upon or permitted to remain on any portion of the Premises outside of the building structure, unless approved by the local, state federal or other applicable governing authority. Lessor consents to Lessee's use of materials which are incidental to the normal, day-to-day operations of any office user, such as copier fluids, cleaning materials, etc., but this does not relieve Lessee of any of its obligations not to contaminate the Premises or related real property or violated any Hazardous Materials Laws. 4. ALTERATIONS AND ADDITIONS: Lessee shall not make, or suffer to be made, any alteration or addition to the Building, or any part thereof, without the express, advance written consent of Lessor; any addition or alteration to said Building, except movable furniture and trade fixtures, shall become at once a part of the realty and belong to Lessor at the end of the Lease Term or earlier termination of this Lease. Alterations and additions which are not deemed as trade fixtures shall include HVAC systems, lighting systems, electrical systems, partitioning, carpeting, or any other installation which has become an integral part of the Building. Lessee agrees that it will not proceed to make such alterations or additions until all required government permits have been obtained and after having obtained consent from Lessor to do so, until five (5) days from the receipt of such consent, so that Lessor may post appropriate notices to avoid any liability to contractors or material suppliers for payment for Lessee's improvements. Lessee shall at all times permit such notices to be posted and to remain posted until the completion of work. At the end of the Lease Term or earlier termination of this Lease, Lessee shall remove and shall be required to remove its special tenant improvements and all related equipment installed by Lessee at or during the Lease Term and Lessee shall Page 7 return the Building to the condition that existed before the installation of the special tenant improvements. Notwithstanding the above, Lessor agrees to allow any reasonable alterations and improvements and will notify Lessee at the time of approval if such improvements or alterations are to be removed at the end of the Lease Term or earlier termination of this Lease. 5. MAINTENANCE OF PREMISES: (a) Lessee shall at its sole cost and expense keep and maintain the interior of the Building, including, but not limited to, all lighting systems, temperature control systems, all window washing, exterior and interior, clean room systems other than base HVAC units and plumbing systems, in Good Condition and Repair, including any required replacements. Lessee shall maintain all wall surfaces and floor coverings in Good Condition and Repair, free of holes, gouges, or defacements. (b) Lessor shall keep and maintain in Good Condition and Repair including replacements, at Lessee's expense, based on a pro-rata share of cost based on square footage or costs directly related to Lessee's use of the Premises the following, which shall be included in the monthly CAC: 1. The exterior of the building, any appurtenances and every part thereof, including but not limited to, glazing, sidewalks, parking areas, electrical systems, HVAC systems, roof membrane, and painting of exterior walls. 2. The HVAC by a service contract with a licensed air conditioning and heating contractor which contract shall provide for a minimum of quarterly maintenance of all air conditioning and heating equipment at the Building including HVAC repairs or replacements which are either excluded from such service contract or any existing equipment warranties. 3. The landscaping by a landscape contractor to water, maintain, trim and replace, when necessary, any shrubbery and landscaping at the Premises. 4. The roof membrane by a service contract with a licensed reputable roofing contractor which contract shall provide for a minimum of semi- annual maintenance, cleaning of storm gutters, drains, removing of debris and trimming overhanging trees, repair of the roof and application of a finish coat every five years at the Building. 5. Extermination services. 6. Fire monitoring services. (c) Lessee hereby waives any and all rights to make repairs at the expense of Lessor as provided in Section 1942 of the Civil Code of the State of California, and all rights provided for by Section 1941 of said Civil Code. Lessor shall assign any warranties, guaranties and similar rights which would apply to the Building elements to be maintained by Lessee and shall cooperate with Lessee as reasonably necessary to enforce such rights. (d) Lessor shall be responsible and pay for the repair of any structural defects in the Building including the roof structure (not membrane, except as provided at Lessee's expense in 5(b) above), exterior walls and foundation and to correct any condition which does not comply with applicable laws after completion of the Phase I or Phase II Improvements. 6. HAZARD INSURANCE: Lessee shall not use, or permit said Premises, or any part thereof, to be used, for any purpose other than that for which said Premises are hereby leased; and no use shall be made or permitted to be made of the Premises, nor acts done, which may cause a cancellation of any insurance policy covering said building, or any part thereof, nor shall Lessee sell or permit to be kept, used or sold, in or about said Premises, any article which may be prohibited by a standard form fire insurance policy. Lessee shall, at its sole cost and expense, comply with any and all requirements, pertaining to said Premises, of any insurance organization or company, necessary for the maintenance of reasonable fire and general liability insurance, Page 8 covering said building and appurtenances. Lessor agrees to purchase and keep in force fire and extended coverage insurance covering loss or damage to the Premises in amounts equal to the full replacement cost of the Premises as determined by Lessor, with proceeds payable to Lessor. Lessee acknowledges that the insurance referenced above does not include coverage for Lessee's personal property. In the event of a loss per the insurance provisions of this paragraph, Lessee shall be responsible for deductibles up to a maximum of $5,000 per occurrence. Lessee agrees to pay to the Lessor as additional Rent, on demand, the full cost of said insurance as evidenced by insurance billings to the Lessor which shall be included in Lessee's monthly CAC. If said insurance billings cover the Premises, and Lessee does not occupy the entire Premises, the insurance premiums and deductibles shall be allocated to the portion of the Premises occupied by Lessee on a pro-rata square footage or other equitable basis, as determined by Lessor. It is understood and agreed that Lessee's obligation under this paragraph will be prorated to reflect the Commencement Date and the end of the Lease Term. Lessor and Lessee hereby waive any rights each may have against the other related to any loss or damage caused to Lessor or Lessee as the case may be, or to the Premises, the Building, or its contents, and which may arise from any risk generally covered by fire and extended coverage insurance. The parties shall provide that their respective insurance policies insuring the property or the personal property include a waiver of any right of subrogation which said insurance company may have against Lessor or Lessee, as the case may be. Lessor shall maintain in full force and effect, a policy of rental loss insurance, in an amount equal to the amount of Rent payable by Lessee commencing on the date of loss during the next ensuing one (1) year, as reasonably determined by Lessor with proceeds payable to Lessor ("Loss of Rents Insurance"). Lessee shall reimburse Lessor for Lessee's pro-rata share of the cost of said rental loss insurance coverage. 7. ABANDONMENT: Lessee shall not vacate or abandon the Building at any time during the Lease Term; and if Lessee shall abandon, vacate or surrender the Building, or be dispossessed by process of law, or otherwise, any personal property belonging to Lessee and left on the Building shall be deemed to be abandoned, at the option of Lessor. Notwithstanding the above, the Building shall not be considered vacated or abandoned if Lessee maintains the Building in Good Condition and Repair, provides security and is not in default. 8. FREE FROM LIENS: Lessee shall keep the subject Premises and the property in which the subject Premises are situated, free from any and all liens including but not limited to liens arising out of any work performed, materials furnished, or obligations incurred by Lessee. However, the Lessor shall allow Lessee to contest a lien claim, so long as the claim is discharged prior to any foreclosure proceeding being initiated against the property and provided Lessee provides Lessor a bond if the lien exceeds $5,000. 9. COMPLIANCE WITH GOVERNMENTAL REGULATIONS: Lessee shall, at its sole cost and expense, comply with all of the requirements of all local, municipal, state and federal authorities after the Commencement Date, or which may hereafter be in force, pertaining to Lessee's use and occupancy of the said Premises, and shall faithfully observe in the use of the Premises all local and municipal ordinances and state and federal statutes in force after the Commencement Date or which may hereafter be in force. Except as stated above, Lessee shall not be required to pay for the construction of any single improvement resulting from future government regulation under this paragraph in excess of $5,000, unless such improvement is required to comply with Lessee's particular use of the Premises; if such improvement is not required due to Lessee's particular use of the Premises and such improvement cost exceeds $5,000, such improvement cost shall be amortized over ten (10) years at Wells Fargo prime rate plus one percent (1%). Lessee shall pay to Lessor the amortized costs of such improvement on a monthly basis over the Lease Term. 10. LESSEE'S INSURANCE: Lessee, as a material part of the consideration to be rendered to Lessor, hereby waives all claims against Lessor and Lessor's Agents for damages to goods, wares and merchandise, and all other personal property in, upon or Page 9 about said Premises, and for injuries to persons in, upon or about said Premises, from any cause arising at any time, and Lessee will hold Lessor and Lessor's Agents exempt and harmless from any damage or injury to any person, or to the goods, wares and merchandise and all other personal property of any person, arising from the use or occupancy of the Premises by Lessee, or from the failure of Lessee to keep the Building in good condition and repair, as herein provided. Lessee shall secure and keep in force a standard policy of commercial general liability insurance and property damage policy covering the Premises, including parking areas, insuring the Lessee. A certificate of said policy naming Lessor as an additional insured shall be delivered to Lessor and will have a combined single limit for both bodily injury, death and property damage in an amount not less than five million dollars ($5,000,000.00). The limits of said insurance shall not, however, limit the liability of Lessee hereunder. Lessee shall obtain a written obligation on the part of the insurer to notify Lessor 30 days in advance in writing before any cancellation thereof. Lessee shall obtain, at Lessee's sole cost and expense, a policy of fire and extended coverage insurance including coverage for direct physical loss special form, and a sprinkler leakage endorsement insuring the personal property of Lessee. The proceeds from any personal property damage policy shall be payable to Lessee. Lessee shall, at its sole cost and expense, comply with all of the insurance requirements of all local, municipal, state and federal authorities now in force, or which may hereafter be in force, pertaining to Lessee's use and occupancy of the said Premises. 11. ADVERTISEMENTS AND SIGNS: Lessee shall not place or permit to be placed, in, upon or about the Premises any unusual or extraordinary signs, or any signs not approved by the city, local, state, federal or other applicable governing authority. Lessee shall not place, or permit to be placed upon the Premises, any signs, advertisements or notices without the written consent of the Lessor, and such consent shall not be unreasonably withheld. A sign so placed on the Premises shall be so placed upon the understanding and agreement that Lessee will remove same at the end of the Lease Term or earlier termination of this Lease and repair any damage or injury to the Premises caused thereby, and if not so removed by Lessee, then Lessor may have the same removed at Lessee's expense. Lessor hereby consents to the placement of a monument sign identifying Lessee, subject to Lessor's reasonable approval as to the placement and appearance of the signage, and further subject to compliance with the requirements of applicable government agencies. 12. UTILITIES: Lessee shall pay for all water, gas, heat, light, power, telephone and other utilities supplied to the Building. Any charges for sewer usage or related fees shall be the obligation of Lessee and paid for by Lessee. If any such services are not separately metered to Lessee, Lessee shall pay a reasonable proportion of all charges which are jointly metered, the determination to be made by Lessor acting reasonably and on any equitable basis. Lessor shall not be liable to Lessee for any disruption in any of the utility services to the Building or Premises. 13. ATTORNEY'S FEES: In case suit should be brought for the possession of the Building or Premises, for the recovery of any sum due hereunder, or because of the breach of any other covenant herein, the losing party shall pay to the prevailing party reasonable attorney's fee which shall be deemed to have accrued on the commencement of such action and shall be enforceable whether or not such action is prosecuted to judgment. 14.1 DEFAULT: The occurrence of any of the following shall constitute a default and breach of this Lease by Lessee: a) Any failure by Lessee to pay Rent or to make any other payment required to be made by Lessee hereunder when due if not cured within ten (10) days after written notice thereof by Lessor to Lessee; b) The abandonment or vacation of the Premises by Lessee except as provided in Section 7; c) A failure by Lessee to observe and perform any other provision of this Lease to be observed or performed by Lessee, where such failure continues for thirty days after written notice thereof by Lessor to Lessee; provided, however, that if the nature of such default is such that the same cannot be reasonably cured within such thirty (30) day period, Lessee shall not be deemed to be in default if Lessee shall, within such period, commence such cure and thereafter diligently prosecute the same to completion; d) The making by Lessee of any general assignment for the benefit of creditors; the filing by or against Lessee of a petition to have Lessee adjudged a bankrupt or of a petition for reorganization or arrangement under any Page 10 law relating to bankruptcy; e) the appointment of a trustee or receiver to take possession of substantially all of Lessee's assets or Lessee's interest in this Lease, or the attachment, execution or other judicial seizure of substantially all of Lessee's assets located at the Premises or of Lessee's interest in this Lease. 14.2 SURRENDER OF LEASE: In the event of any such default by Lessee, then in addition to any other remedies available to Lessor at law or in equity, Lessor shall have the immediate option to terminate this Lease before the end of the Lease Term and all rights of Lessee hereunder, by giving written notice of such intention to terminate. In the event that Lessor terminates this Lease due to a default of Lessee, then Lessor may recover from Lessee: a) the worth at the time of award of any unpaid Rent which had been earned at the time of such termination; plus b) the worth at the time of award of unpaid Rent which would have been earned after termination until the time of award exceeding the amount of such rental loss that the Lessee proves could have been reasonably avoided; plus c) the worth at the time of award of the amount by which the unpaid Rent for the balance of the Lease Term after the time of award exceeds the amount of such rental loss that the Lessee proves could have been reasonably avoided; plus d) any other amount necessary to compensate Lessor for all the detriment proximately caused by Lessee's failure to perform his obligations under this Lease or which in the ordinary course of things would be likely to result therefrom; and e) at Lessor's election, such other amounts in addition to or in lieu of the foregoing as may be permitted from time to time by applicable California law. As used in (a) and (b) above, the "worth at the time of award" is computed by allowing interest at the rate of Wells Fargo's prime rate plus two percent (2%) per annum. As used in (c) above, the "worth at the time of award" is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent (1%). 14.3 RIGHT OF ENTRY AND REMOVAL: In the event of any such default by Lessee, Lessor shall also have the right, with or without terminating this Lease, to re-enter the Building and remove all persons and property from the Building; such property may be removed and stored in a public warehouse or elsewhere at the cost of and for the account of Lessee. 14.4 ABANDONMENT: In the event of the vacation or abandonment, except as provided in Section 7, of the Building by Lessee or in the event that Lessor shall elect to re-enter as provided in paragraph 14.3 above or shall take possession of the Premises pursuant to legal proceeding or pursuant to any notice provided by law, and Lessor does not elect to terminate this Lease as provided in paragraph 14.2 above, then Lessor may from time to time, without terminating this Lease, either recover all Rent as it becomes due or relet the Building or any part thereof for such term or terms and at such rental rates and upon such other terms and conditions as Lessor, in its sole discretion, may deem advisable with the right to make alterations and repairs to the Building. In the event that Lessor elects to relet the Building, then Rent received by Lessor from such reletting shall be applied; first, to the payment of any indebtedness other than Rent due hereunder from Lessee to Lessor; second, to the payment of any cost of such reletting; third, to the payment of the cost of any alterations and repairs to the Building; fourth, to the payment of Rent due and unpaid hereunder; and the residue, if any, shall be held by Lessor and applied to the payment of future Rent as the same may become due and payable hereunder. Should that portion of such Rent received from such reletting during any month, which is applied by the payment of Rent hereunder according to the application procedure outlined above, be less than the Rent payable during that month by Lessee hereunder, then Lessee shall pay such deficiency to Lessor immediately upon demand therefor by Lessor. Such deficiency shall be calculated and paid monthly. Lessee shall also pay to Lessor, as soon as ascertained, any costs and expenses incurred by Lessor in such reletting or in making such alterations and repairs not covered by the rentals received from such reletting. 14.5 NO IMPLIED TERMINATION: No re-entry or taking possession of the Building by Lessor pursuant to 14.3 or 14.4 of this Article 14 shall be construed as an election to terminate this Lease unless a written notice of such intention is given to Lessee or unless the termination thereof is decreed by a court of competent jurisdiction. Notwithstanding any reletting without Page 11 termination by Lessor because of any default by Lessee, Lessor may at any time after such reletting elect to terminate this Lease for any such default. 15. SURRENDER OF LEASE: The voluntary or other surrender of this Lease by Lessee, or a mutual cancellation thereof, shall not work a merger, and shall, at the option of Lessor, terminate all or any existing subleases or sub tenancies, or may, at the option of Lessor, operate as an assignment to him of any or all such subleases or sub tenancies. 16. TAXES: Lessee shall pay and discharge punctually and when the same shall become due and payable without penalty, all real estate taxes, personal property taxes, taxes based on vehicles utilizing parking areas in the Premises, taxes computed or based on rental income (other than federal, state and municipal net income taxes), Environmental Surcharges, privilege taxes, excise taxes, business and occupation taxes, school fees or surcharges, gross receipts taxes, sales and/or use taxes, employee taxes, occupational license taxes, water and sewer taxes, assessments (including, but not limited to, assessments for public improvements or benefit), assessments for local improvement and maintenance districts, and all other governmental impositions and charges of every kind and nature whatsoever, regardless of whether now customary or within the contemplation of the parties hereto and regardless of whether resulting from increased rate and/or valuation, or whether extraordinary or ordinary, general or special, unforeseen or foreseen, or similar or dissimilar to any of the foregoing (all of the foregoing being hereinafter collectively called "Tax" or "Taxes") which, at any time during the Lease Term, shall be applicable or against the Premises, or shall become due and payable and a lien or charge upon the Premises under or by virtue of any present or future laws, statutes, ordinances, regulations, or other requirements of any governmental authority whatsoever. The term "Environmental Surcharge" shall include any and all expenses, taxes, charges or penalties imposed by the Federal Department of Energy, Federal Environmental Protection Agency, the Federal Clean Air Act, or any regulations promulgated thereunder, or any other local, state or federal governmental agency or entity now or hereafter vested with the power to impose taxes, assessments or other types of surcharges as a means of controlling or abating environmental pollution or the use of energy (i) generally imposed on similar properties in a wide geographic area without regard to whether the properties are subject to the tax are contaminated by Hazardous Materials and which is part of a comprehensive plan imposed by a governmental unit or (ii) imposed with respect to the Premises as the result of presence of Hazardous Materials for which Lessee is required to indemnify Lessor under Section 33.The term "Tax" shall include, without limitation, all taxes, assessments, levies, fees, impositions or charges levied, imposed, assessed, measured, or based in any manner whatsoever (i) in whole or in part on the Rent payable by Lessee under this Lease, (ii) upon or with respect to the use, possession, occupancy, leasing, operation or management of the Premises, (iii) upon this transaction or any document to which Lessee is a party creating or transferring an interest or an estate in the Premises, (iv) upon Lessee's business operations conducted at the Premises, (v) upon, measured by or reasonably attributable to the cost or value of Lessee's equipment, furniture, fixtures and other personal property located on the Premises or the cost or value of any leasehold improvements made in or to the Premises by or for Lessee, regardless of whether title to such improvements shall be in Lessor or Lessee, or (vi) in lieu of or equivalent to any Tax set forth in this Section 16. In the event any such Taxes are payable by Lessor and it shall not be lawful for Lessee to reimburse Lessor for such Taxes, then the Rent payable thereunder shall be increased to net Lessor the same net rent after imposition of any such Tax upon Lessor as would have been payable to Lessor prior to the imposition of any such Tax. It is the intention of the parties that Lessor shall be free from all such Taxes and all other governmental impositions and charges of every kind and nature whatsoever. However, nothing contained in this Section 16 shall require Lessee to pay any Federal or State income, franchise, estate, inheritance, succession, transfer or excess profits tax imposed upon Lessor. If any general or special assessment is levied and assessed against the Premises, Lessor agrees to use its best reasonable efforts to cause the assessment to become a lien on the Premises securing repayment of a bond sold to finance the improvements to which the assessment relates which is payable in installments of principal and interest over the maximum term allowed by law. It is understood and agreed that Lessee's obligation under this paragraph will be prorated to reflect the Commencement Date and the end of the Lease Term. It is further understood that if Taxes cover the Premises and Lessee does not occupy the entire Premises, the Taxes will be Page 12 allocated to the portion of the Premises occupied by Lessee based on a pro-rata square footage or other equitable basis. Taxes billed by Lessor to Lessee shall be included in the monthly CAC. Subject to any limitations or restrictions imposed by any deeds of trust or mortgages now or hereafter covering or affecting the Premises, Lessee shall have the right to contest or review the amount or validity of any Tax by appropriate legal proceedings but which is not to be deemed or construed in any way as relieving, modifying or extending Lessee's covenant to pay such Tax at the time and in the manner as provided in this Section 16. However, as a condition of Lessee's right to contest, if such contested Tax is not paid before such contest and if the legal proceedings shall not operate to prevent or stay the collection of the Tax so contested, Lessee shall, before instituting any such proceeding, protect the Premises and the interest of Lessor and of the beneficiary of a deed of trust or the mortgagee of a mortgage affecting the Premises against any lien upon the Premises by a surety bond, issued by an insurance company acceptable to Lessor and in an amount equal to one and one-half (1 1/2) times the amount contested or, at Lessor's option, the amount of the contested Tax and the interest and penalties in connection therewith. Any contest as to the validity or amount of any Tax, whether before or after payment, shall be made by Lessee in Lessee's own name, or if required by law, in the name of Lessor or both Lessor and Lessee. Lessee shall defend, indemnify and hold harmless Lessor from and against any and all costs or expenses, including attorneys' fees, in connection with any such proceedings brought by Lessee, whether in its own name or not. Lessee shall be entitled to retain any refund of any such contested Tax and penalties or interest thereon which have been paid by Lessee. Nothing contained herein shall be construed as affecting or limiting Lessor's right to contest any Tax at Lessor's expense. 17. NOTICES: Unless otherwise provided for in this Lease, any and all written notices or other communication (the "Communication") to be given in connection with this Lease shall be given in writing and shall be given by personal delivery, facsimile transmission or by mailing by registered or certified mail with postage thereon or recognized overnight courier, fully prepaid, in a sealed envelope addressed to the intended recipient as follows: (a) to the Lessor at: 10050 Bandley Drive Cupertino, California 95014 Attention: Carl E. Berg Fax No: (408) 725-1626 (b) to the Lessee at: 3172 A Porter Drive Palo Alto, California 94304 Attention: CFO Fax No: (415) 812-9731 or such other addresses, facsimile number or individual as may be designated by a Communication given by a party to the other parties as aforesaid. Any Communication given by personal delivery shall be conclusively deemed to have been given and received on a date it is so delivered at such address provided that such date is a business day, otherwise on the first business day following its receipt, and if given by registered or certified mail, on the day on which delivery is made or refused or if given by recognized overnight courier, on the first business day following deposit with such overnight courier and if given by facsimile transmission, on the day on which it was transmitted provided such day is a business day, failing which, on the next business day thereafter. 18. ENTRY BY LESSOR: Lessee shall permit Lessor and its agents to enter into the Building at all reasonable times using the minimum amount of interference and inconvenience to Lessee and Lessee's business, subject to any security regulations of Lessee, for the purpose of inspecting the same or for the purpose of maintaining the Building, or for the purpose of making Page 13 repairs, alterations or additions to any other portion of said Building, including the erection and maintenance of such scaffolding, canopies, fences and props as may be required, without any rebate of Rent and without any liability to Lessee for any loss of occupation or quiet enjoyment of the Premises; and shall permit Lessor and his agents, at any time within ninety (90) days prior to the end of the Lease Term, to place upon said Premises any usual or ordinary "For Sale" or "For Lease" signs and exhibit the Premises and the Building to prospective tenants at reasonable hours. 19. DESTRUCTION OF PREMISES: In the event of a partial destruction of the said Premises during the Lease Term from any cause which is covered by Lessor's property insurance, Lessor shall forthwith repair the same, provided such repairs can be made within ninety (90) days after the issuance of a building permit under the laws and regulations of State, Federal, County, or Municipal authorities, but such partial destruction shall in no way annul or void this Lease, except that Lessee shall be entitled to a proportionate reduction of Rent while such repairs are being made to the extent of payments received by Lessor under its Loss of Rents Insurance coverage. With respect to any partial destruction which Lessor is obligated to repair or may elect to repair under the terms of this paragraph, the provision of Section 1932, Subdivision 2, and of Section 1933, Subdivision 4, of the Civil Code of the State of California are waived by Lessee. In the event that the Building is destroyed to an extent greater than thirty-three and one-third (33 1/3%) of the replacement cost thereof, Lessor may, at its sole option, elect to terminate this Lease, whether the subject Premises is insured or not. A total destruction of the Building shall terminate this Lease. Notwithstanding the above, Lessor is only obligated to repair or rebuild to the extent of any available insurance proceeds including any deductible amount. Should Lessor determine that insufficient or no insurance proceeds are available for repair or reconstruction of Premises, Lessor, at its sole option, may terminate the Lease. Lessee shall have the option of continuing this Lease by agreeing to pay all repair costs which are not covered by insurance available to Lessor. If Lessor reasonably estimates that the repair of any damage or destruction to the Premises will require in excess of 120 days to repair from the date of damage, Lessee shall be entitled to terminate this Lease effective upon written notice to Lessor delivered within 15 days of receipt of such notice that repairs will exceed 120 days. 20. ASSIGNMENT AND SUBLETTING: Lessee shall not assign this Lease, or any interest therein, and shall not sublet the said Building or any part thereof, or any right or privilege appurtenant thereto, or cause any other person or entity (a bona fide subsidiary or affiliate of Lessee, any entity which controls Lessee and any entity which results from the merger, consolidation or reorganization of Lessee excepted ("Lessee Affiliate")) to occupy or use the Building, or any portion thereof, without the advance written consent of Lessor. Any such assignment or subletting without such consent shall be void, and shall, at the option of the Lessor, terminate this Lease. This Lease shall not, or shall any interest therein, be assignable, as to the interest of Lessee, by operation of law, without the written consent of Lessor. Notwithstanding Lessor's obligation to provide reasonable approval, Lessor reserves the right to withhold its consent for any proposed sublessee or assignee of Lessee if the proposed sublessee or assignee is a user or generator of Hazardous Materials. If Lessee desires to assign its rights under this Lease or to sublet, all or a portion of the subject Building to a party other than a Lessee Affiliate, Lessee shall first notify Lessor of the proposed terms and conditions of such assignment or subletting. Lessor and Lessee shall split any net proceeds of any sublease other than to a Lessee Affiliate 50/50 after deducting amortized leasing costs, the amortization of Lessee's TI Allowance, tenant improvements for the subtenant and reasonable legal fees in conjunction with securing the subtenant. Notwithstanding the foregoing, Lessee may assign this Lease to a successor in interest, whether by merger or acquisition, provided there is no substantial reduction in the net worth of the resulting entity and the resulting entity is not a user or generator of Hazardous Materials. Whether or not Lessor's consent to a sublease or assignment is required, in the event of any sublease or assignment, Lessee shall be and shall remain primarily liable for the performance of all conditions, covenants, and obligations of Lessee hereunder and, in the event of a default by an assignee or sublessee, Lessor may proceed directly against the original Lessee hereunder and/or any other predecessor of such assignee or sublessee without the necessity of exhausting remedies against said assignee or sublessee. Page 14 21. CONDEMNATION: If any part of the Building shall be taken for any public or quasi-public use, under any statute or by right of eminent domain or private purchase in lieu thereof, and a part thereof remains which is susceptible of occupation hereunder, this Lease shall as to the part so taken, terminate as of the date title vests in the condemnor or purchaser, and the Rent payable hereunder shall be adjusted so that the Lessee shall be required to pay for the remainder of the Lease Term only that portion of Rent as the value of the part remaining. The rental adjustment resulting will be computed at the same Rental rate for the remaining part not taken; however, Lessor shall have the option to terminate this Lease as of the date when title to the part so taken vests in the condemnor or purchaser. If all of the Building, or such part thereof be taken so that there does not remain a portion susceptible for occupation hereunder, this Lease shall thereupon terminate. If a part or all of the Building be taken, all compensation awarded upon such taking shall be payable to the Lessor. Lessee may file a separate claim and be entitled to any award granted to Lessee. 22. EFFECTS OF CONVEYANCE: The term "Lessor" as used in this Lease, means only the owner for the time being of the land and building constituting the Premises, so that, in the event of any sale of said land or building, or in the event of a Lease of said building, Lessor shall be and hereby is entirely freed and relieved of all covenants and obligations of Lessor hereunder, and it shall be deemed and construed, without further agreement between the parties and the purchaser of any such sale, or the Lessor of the building, that the purchaser or lessor of the building has assumed and agreed to carry out any and all covenants and obligations of the Lessor hereunder. If any security is given by Lessee to secure the faithful performance of all or any of the covenants of this Lease on the part of Lessee, Lessor may transfer and deliver the security, as such, to the purchaser at any such sale of the building, and thereupon the Lessor shall be discharged from any further liability. 23. SUBORDINATION: This Lease, in the event Lessor notifies Lessee in writing, shall be subordinate to any ground lease, deed of trust, or other hypothecation for security now or hereafter placed upon the real property at which the Premises are a part and to any and all advances made on the security thereof and to renewals, modifications, replacements and extensions thereof. Lessee agrees to promptly execute any documents which may be required to effectuate such subordination. Notwithstanding such subordination, if Lessee is not in default and so long as Lessee shall pay the Rent and observe and perform all of the provisions and covenants required under this Lease, Lessee's right to quiet possession of the Premises shall not be disturbed or effected by any subordination. 24. WAIVER: The waiver by Lessor of any breach of any term, covenant or condition, herein contained shall not be construed to be a waiver of such term, covenant or condition or any subsequent breach of the same or any other term, covenant or condition therein contained. The subsequent acceptance of Rent hereunder by Lessor shall not be deemed to be a waiver of Lessee's breach of any term, covenant, or condition of the Lease. 25. HOLDING OVER: Any holding over after the end of the Lease Term requires Lessor's written approval prior to the end of the Lease Term, which, notwithstanding any other provisions of this Lease, Lessor may withhold and shall be construed to be a tenancy at sufferance from month to month. Lessee shall pay to Lessor monthly base rent equal to one and one-quarter (1.25) times the monthly base rent installment due in the last month of the Lease Term and all other additional rent and all other terms and conditions of the Lease shall apply, so far as applicable. Holding over by Lessee without written approval of Lessor shall subject Lessee to the liabilities and obligations provided for in this Lease and by law, including, but not limited to those in Section 2.1 of this Lease. Lessee shall indemnify and hold Lessor harmless against any loss or liability resulting from any delay caused by Lessee in surrendering the Building, including without limitation, any claims made or penalties incurred by any succeeding lessee or by Lessor. No holding over shall be deemed or construed to exercise any option to extend or renew this Lease in lieu of full and timely exercise of any such option as required hereunder. Page 15 26. SUCCESSORS AND ASSIGNS: The covenants and conditions herein contained shall, subject to the provisions as to assignment, apply to and bind the heirs, successors, executors, administrators and assigns of all of the parties hereto; and all of the parties hereto shall be jointly and severally liable hereunder. 27. ESTOPPEL CERTIFICATES: Lessee shall at any time during the Lease Term, upon not less than ten (10) days prior written notice from Lessor, execute and deliver to Lessor a statement in writing certifying that, this Lease is unmodified and in full force and effect (or, if modified, stating the nature of such modification) and the dates to which the Rent and other charges have been paid in advance, if any, and acknowledging that there are not, to Lessee's knowledge, any uncured defaults on the part of Lessor hereunder or specifying such defaults if they are claimed. Any such statement may be conclusively relied upon by any prospective purchaser or encumbrancer of the Premises. Lessee's failure to deliver such a statement within such time shall be conclusive upon the Lessee that (a) this Lease is in full force and effect, without modification except as may be represented by Lessor; (b) there are no uncured defaults in Lessor's performance. 28. TIME: Time is of the essence of the Lease. 29. CAPTIONS: The headings on titles to the paragraphs of this Lease are not a part of this Lease and shall have no effect upon the construction or interpretation of any part thereof. This instrument contains all of the agreements and conditions made between the parties hereto and may not be modified orally or in any other manner than by an agreement in writing signed by all of the parties hereto or their respective successors in interest. 30. PARTY NAMES: Landlord and Tenant may be used in various places in this Lease as a substitute for Lessor and Lessee respectively. 31. EARTHQUAKE INSURANCE: As a condition of Lessor agreeing to waive the requirement for earthquake insurance, Lessee agrees that it will pay, as additional Rent, which shall be included in the monthly CAC, an amount not to exceed eighteen thousand two hundred dollars ($18,200) per year for earthquake insurance if Lessor desires to obtain some form of earthquake insurance in the future, if and when available, on terms acceptable to Lessor. 32. HABITUAL DEFAULT: Notwithstanding anything to the contrary contained in Section 14 herein, Lessor and Lessee agree that if Lessee shall have defaulted in the payment of Rent for three or more times during any twelve month period during the Lease Term, then such conduct shall, at the option of the Lessor, represent a separate event of default which cannot be cured by Lessee. Lessee acknowledges that the purpose of this provision is to prevent repetitive defaults in the payment of Rent by the Lessee under the Lease, which constitute a hardship to the Lessor and deprive the Lessor of the timely performance by the Lessee hereunder. 33. HAZARDOUS MATERIALS 33.1 DEFINITIONS: As used in this Lease, the following terms shall have the following meaning: a. The term "Hazardous Materials" shall mean (i) polychlorinated biphenyls; (ii) radioactive materials and (iii) any chemical, material or substance now or hereafter defined as or included in the definitions of "hazardous substance" "hazardous water", "hazardous material", "extremely hazardous waste", "restricted hazardous waste" under Section 25115, 25117 or 15122.7, or listed pursuant to Section 25140 of the California Health and Safety Code, Division 20, Chapter 6.5 (Hazardous Waste Control Law), (ii) defined as "hazardous substance" under Section 25316 of the California Health and Safety Code, Division 20, Chapter 6.8 (Carpenter- Presley-Tanner Hazardous Substances Account Act), (iii) defined as "hazardous material", "hazardous substance", or "hazardous waste" under Section 25501 of the California Health and Safety Code, Division 20, Chapter 6.95 (Hazardous Materials Release, Response, Page 16 Plans and Inventory), (iv) defined as a "hazardous substance" under Section 25181 of the California Health and Safety Code, Division 20l, Chapter 6.7 (Underground Storage of Hazardous Substances), (v) petroleum, (vi) asbestos, (vii) listed under Article 9 or defined as "hazardous" or "extremely hazardous" pursuant to Article II of Title 22 of the California Administrative Code, Division 4, Chapter 20, (viii) defined as "hazardous substance" pursuant to Section 311 of the Federal Water Pollution Control Act, 33 U.S.C. 1251 et seq. or listed pursuant to Section 1004 of the Federal Water Pollution Control Act (33 U.S.C. 1317), (ix) defined as a "hazardous waste", pursuant to Section 1004 of the Federal Resource Conservation and Recovery Act, 42 U.S.C. 6901 et seq., (x) defined as "hazardous substance" pursuant to Section 101 of the Comprehensive Environmental Responsibility Compensations, and Liability Act, 42 U.S.C. 9601 et seq., or (xi) regulated under the Toxic Substances Control Act, 156 U.S.C. 2601 et seq. b. The term "Hazardous Materials Laws" shall mean any local, state and federal laws, rules, regulations, or ordinances relating to the use, generation, transportation, analysis, manufacture, installation, release, discharge, storage or disposal of Hazardous Material. c. The term "Lessor's Agents" as used herein shall mean Lessor's agents, representatives, employees, contractors, subcontractors, directors, officers and partners. d. The term "Lessee's Agents" as used herein shall mean Lessee's agents, representatives, employees, contractors, subcontractors, directors, officers, partners, invitees or any other person in or about the Premises. 33.2 LESSEE'S RIGHT TO INVESTIGATE: Lessee shall be entitled to cause such inspection, soils and ground water tests, and other evaluations to be made of the Premises as Lessee deems necessary regarding (i) the presence and use of Hazardous Materials in or about the Premises, and (ii) the potential for exposure to Lessee's employees and other persons to any Hazardous Materials used and stored by previous occupants in or about the Premises. Lessee shall provide Lessor with copies of all inspections, tests and evaluations. Lessee shall indemnify, defend and hold Lessor harmless from any cost, claim or expense arising from such entry by Lessee or from the performance of any such investigation by such Lessee. 33.3 LESSOR'S REPRESENTATIONS: Lessor hereby represents and warrants to the best of Lessor's knowledge that the Premises are, as of the date of this Lease, in compliance with all Hazardous Material Laws. 33.4 LESSEE'S OBLIGATION TO INDEMNIFY: Lessee, at its sole cost and expense, shall indemnify, defend, protect and hold Lessor and Lessor's Agents harmless from and against any and all cost or expenses, including those described under subparagraphs i, ii and iii herein below set forth, arising from or caused in whole or in part, directly or indirectly by: a. Lessee's or Lessee's Agents' use, analysis, storage, transportation, disposal, release, threatened release, discharge or generation of Hazardous Material to, in, on, under, about or from the Premises; or b. Lessee's or Lessee's Agents failure to comply with Hazardous Material laws; or c. Any release of Hazardous Material to, in, on, under, about, from or onto the Premises caused by or occurring as a result of acts or omissions of Lessee or Lessee's Agents, except ground water contamination from other parcels where the source is from off the Premises not arising from or caused by Lessee or Lessee's Agents. The cost and expenses indemnified against include, but are not limited to the following: i. Any and all claims, actions, suits, proceedings, losses, damages, liabilities, deficiencies, forfeitures, penalties, fines, punitive damages, cost or expenses; ii. Any claim, action, suit or proceeding for personal injury (including sickness, disease, or death), tangible or intangible property damage, compensation for lost wages, business income, profits or other economic loss, damage to the natural resources of the environment, nuisance, pollution, contamination, leaks, spills, release or other adverse effects on the environment; Page 17 iii. The cost of any repair, clean-up, treatment or detoxification of the Premises necessary to bring the Premises into compliance with all Hazardous Material Laws, including the preparation and implementation of any closure, disposal, remedial action, or other actions with regard to the Premises, and expenses (including, without limitation, reasonable attorney's fees and consultants fees, investigation and laboratory fees, court cost and litigation expenses). 33.5 LESSEE'S OBLIGATION TO REMEDIATE CONTAMINATION: Lessee shall, at its sole cost and expense, promptly take any and all action necessary to remediate contamination of the Premises by Hazardous Materials arising or occurring as a result of acts or omissions of Lessee or Lessee's Agents during the Lease Term. Lessee shall not be responsible to remediate contamination of the Premises caused by acts or omissions of adjoining tenants or from groundwater contamination from sources off the Premises not caused by or arising from Lessee or Lessee's Agents. If Lessee desires, Lessee may obtain, at its sole cost and expense, obtain insurance coverage for "midnight dumping" and similar- type events if available on terms acceptable to Lessee. 33.6 OBLIGATION TO NOTIFY: Lessor and Lessee shall each give written notice to the other as soon as reasonably practical of (i) any communication received from any governmental authority concerning Hazardous Material which related to the Premises and (ii) any contamination of the Premises by Hazardous Materials which constitutes a violation of any Hazardous Material Laws. 33.7 SURVIVAL: The obligations of Lessee under this Section 33 shall survive the Lease Term or earlier termination of this Lease. 33.8 CERTIFICATION AND CLOSURE: On or before the end of the Lease Term or earlier termination of this Lease, Lessee shall deliver to Lessor a certification executed by Lessee stating that, to the best of Lessee's knowledge, there exists no violation of Hazardous Material Laws resulting from Lessee's obligation in Paragraph 33. If pursuant to local ordinance, state or federal law, Lessee is required, at the expiration of the Lease Term, to submit a closure plan for the Premises to a local, state or federal agency, then Lessee shall furnish to Lessor a copy of such plan. 33.9 PRIOR HAZARDOUS MATERIALS: Notwithstanding anything contained to the contrary herein, Lessee shall have no obligation to clean up or to hold Lessor harmless or make any payment with respect to: (i) any Hazardous Material or wastes discovered on the Premises which were not introduced into, in, on, about, from or under the Premises during the Lease Term; or (ii) ground water contamination from other parcels where the source is from off the Premises not arising from or caused by Lessee or Lessee's Agents. 34. BROKERS: Lessor and Lessee represent that they have not utilized or contacted a real estate broker or finder with respect to this Lease other than Cornish & Carey ("CC") and Lessee agrees to indemnify and hold Lessor harmless against any claim, cost, liability or cause of action asserted by any broker or finder claiming through Lessee other than CC. Lessor shall at its sole cost and expense pay the brokerage commission per Lessor's standard commission schedule to CC in connection with this transaction. Lessor represents and warrants that it has not utilized or contacted a real estate broker or finder with respect to this Lease other than CC and Lessor agrees to indemnify and hold Lessee harmless against any claim, cost, liability or cause of action asserted by any broker or finder claiming through Lessor. 35. OPTION TO EXTEND A. OPTION: Lessor hereby grants to Lessee two (2) options to extend the Lease Term, with each extended term to be for a period of five (5) years, on the following terms and conditions, which shall apply separately to each option to extend: Page 18 (i) Lessee shall give Lessor written notice of its exercise of one of its options to extend no earlier than twenty-four (24) calendar months, nor later than six (6) calendar months before the Lease Term would end but for said exercise. Time is of the essence. Lessee may withdraw from its option at any time prior to six (6) months before the end of the Lease Term and therefore must give notice in sufficient time to complete all lease negotiations and appraisal six (6) months before the end of the Lease Term. (ii) Lessee may not extend the Lease Term pursuant to any option granted by this section 35 if Lessee is in default as of the date of the exercise of one of its options. If Lessee has committed a default by Lessee as defined in Section 14 or 32 that has not been cured or waived by Lessor in writing by the date that any extended term is to commence, then Lessor may elect not to allow the Lease Term to be extended, notwithstanding any notice given by Lessee of an exercise of this option to extend. (iii) Lessee must exercise each option consecutively, and if it fails to exercise any one option, it waives the right to exercise the subsequent option and the Lease Term shall not be extended further. (iv) All terms and conditions of this Lease shall apply during each extended term, except that the Base Rent and rental increases for each extended term shall be determined as provided in Section 35 (B) below (v) Once Lessee delivers a notice of exercise of one of its options to extend the Lease Term, Lessee may not withdraw such exercise and subject to the provisions of this Section 35, such notice shall operate to extend the Lease Term. Upon any extension of the Lease Term pursuant to this Section 35, the term "Lease Term" as used in this Lease shall thereafter include the then extended term. (v) The option rights of General Surgical Innovations Corporation granted under this Section 35 may not be assigned or transferred by General Surgical Innovations Corporation other than to an entity which controls, is controlled by, or is under common control with Lessee, or which results from a merger, consolidation, or reorganization of Lessee, to whom such option may be assigned in connection with an assignment of this Lease, provided the assignment otherwise complies with the requirements of Section 20. B. EXTENDED TERM RENT - OPTION PERIOD: The monthly Rent for the Building during the extended term(s) shall equal ninety-five percent (95%) of the fair market monthly Rent for the Building as of the commencement date of the extended term, but in no case (i) less than the Rent during the last month of the prior lease term and (ii) greater than one hundred five percent (105%) of the Rent during the last month of the prior lease term. Promptly upon Lessee's exercise of the option to extend, Lessee and Lessor shall meet and attempt to agree on the fair market monthly Rent for the Building as of the commencement date of the extended term. In the event the parties fail to agree upon the amount of the monthly Rent for the extended term prior to commencement thereof, the monthly Rent for the extended term shall be determined by appraisal in the manner hereafter set forth; provided, however, that in no event shall the monthly Rent for the extended term be less than in the immediate preceding period. Annual base rent increases during the extended term shall be 3% per year. In the event it becomes necessary under this paragraph to determine the fair market monthly Rent of the Building by appraisal, Lessor and Lessee each shall appoint a real estate appraiser who shall be a member of the American Institute of Real Estate Appraiser ("AIREA") and such appraisers shall each determine the fair market monthly Rent for the Building taking into account the value of the Premises and the amenities provided by the outside areas, the common areas, and the Building, and prevailing comparable Rentals in the area. Such appraisers shall, within twenty (20) business days after their appointment, complete their appraisals and submit their appraisal reports to Lessor and Lessee. If the fair market monthly Rent of the Building established in the two (2) appraisals varies by five percent (5%) or less of the higher Rent, the average of the two shall be controlling. If said fair market monthly Page 19 Rent varies by more than five percent (5%) of the higher Rental, said appraisers, within ten (10) days after submission of the last appraisal, shall appoint a third appraiser who shall be a member of the AIREA and who shall also be experienced in the appraisal of Rent values and adjustment practices for commercial properties in the vicinity of the Building. Such third appraiser shall, within twenty (20) business days after his appointment, determine by appraisal the fair market monthly Rent of the Building taking into account the same factors referred to above, and submit his appraisal report to Lessor and Lessee. The fair market monthly Rent determined by the third appraiser for the Building shall be controlling, unless it is less than that set forth in the lower appraisal previously obtained, in which case the value set forth in said lower appraisal shall be controlling, or unless it is greater than that set forth in the higher appraisal previously obtained in which case the Rent set for in said higher appraisal shall be controlling. If either Lessor or Lessee fails to appoint an appraiser, or if an appraiser appointed by either of them fails, after his appointment to submit his appraisal within the required period in accordance with the foregoing, the appraisal submitted by the appraiser properly appointed and timely submitting his appraisal shall be controlling. If the two appraisers appointed by Lessor and Lessee are unable to agree upon a third appraiser within the required period in accordance with the foregoing, application shall be made within twenty (20) days thereafter by either Lessor or Lessee to AIREA, which shall appoint a member of said institute willing to serve as appraiser. The cost of all appraisals under this subparagraph shall be borne equally be Lessor and Lessee. 36. APPROVALS: Whenever in this Lease the Lessor's or Lessee's consent is required, such consent shall not be unreasonably or arbitrarily withheld or delayed. In the event that the Lessor or Lessee does not respond to a request for any consents which may be required of it in this Lease within ten business days of the request of such consent in writing by the Lessee or Lessor, such consent shall be deemed to have been given by the Lessor or Lessee. 37. AUTHORITY: Each party executing this Lease represents and warrants that he or she is duly authorized to execute and deliver the Lease. If executed on behalf of a corporation, that the Lease is executed in accordance with the by- laws of said corporation (or a partnership that the Lease is executed in accordance with the partnership agreement of such partnership), that no other party's approval or consent to such execution and delivery is required, and that the Lease is binding upon said individual, corporation (or partnership) as the case may be in accordance with its terms. 38. INDEMNIFICATION OF LESSOR: Except to the extent caused by the sole negligence or willful misconduct of Lessor or Lessor's Agents, Lessee shall defend, indemnify and hold Lessor harmless from and against any and all obligations, losses, costs, expenses, claims, demands, attorney's fees, investigation costs or liabilities on account of, or arising out of the use, condition or occupancy of the Premises or any act or omission to act of Lessee or Lessee's Agents or any occurrence in, upon, about or at the Premises, including, without limitation, any of the foregoing provisions arising out of the use, generation, manufacture, installation, release, discharge, storage, or disposal of Hazardous Materials by Lessee or Lessee's Agents. It is understood that Lessee is and shall be in control and possession of the Premises and that Lessor shall in no event be responsible or liable for any injury or damage or injury to any person whatsoever, happening on, in, about, or in connection with the Premises, or for any injury or damage to the Premises or any part thereof. This Lease is entered into on the express condition that Lessor shall not be liable for, or suffer loss by reason of injury to person or property, from whatever cause, which in any way may be connected with the use, condition or occupancy of the Premises or personal property located herein. The provisions of this Lease permitting Lessor to enter and inspect the Premises are for the purpose of enabling Lessor to become informed as to whether Lessee is complying with the terms of this Lease and Lessor shall be under no duty to enter, inspect or to perform any of Lessee's covenants set forth in this Lease. Lessee shall further indemnify, defend and hold harmless Lessor from and against any and all claims arising from any breach or default in the performance of any obligation to Lessee's part to be performed under the terms of this Lease. The provisions of Section 38 shall survive the Lease Term or earlier termination of this Lease with respect to any damage, injury or death occurring during the Lease Term. Page 20 39. LESSOR'S LIABILITY: If Lessee should recover a money judgment against Lessor arising in connection with this Lease, the judgment shall be satisfied only out of the Lessor's interest in the Building and neither Lessor or any of its partners shall be liable personally for any deficiency. 40. INTENTIONALLY OMITTED. 41. LESSEE'S RIGHT OF OFFER: Lessor hereby agrees to telephone and fax notice to Lessee of any available space owned by Lessor on Bubb Road. This notice shall be subordinate to any existing rights of any existing tenants on Bubb Road. 42. ARBITRATION OF DISPUTES: If the parties are unable to resolve any dispute regarding the terms of this Lease or Lessor or Lessee's rights hereunder, except money to be paid, within 30 days after commencement of good faith negotiations, any such dispute may be referred to arbitration by either party. Any unresolved dispute as to any amount or sum of money to be paid by one party to the other party under the provisions hereof, the party against whom the obligation to pay the money is asserted shall have the right to make payment "under protest," such payment not being regarded as voluntary payment and there shall survive the right on the part of said party to request that the matter be submitted to arbitration as provided below concerning the recovery of such sum. Notwithstanding the above, this provision shall not apply to payments of the base rent or to the initial CAC payable under this Lease or any amount based on Lessee's pro rata share. If it shall be adjudged that there was no legal obligation on the part of said party to pay such sum or any part thereof, said party shall be entitled to recover such sum or so much thereof as it was not legally required to pay under the provisions of this Lease. In the event of such dispute between Lessor and Lessee regarding the terms of this Lease, or Lessor and Lessee's rights and obligations hereunder, such dispute shall be resolved by binding arbitration pursuant to California Code of Civil Procedure Sections 1280 through 1294.2 or successor stature. Any such arbitration shall be held and conducted in San Jose, California. The prevailing party in such arbitration shall be entitled to recover its reasonable attorneys' fees and costs. NOTICE: BY INITIALING IN THE SPACE BELOW YOU ARE AGREEING TO HAVE ANY DISPUTE ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION DECIDED BY NEUTRAL ARBITRATION AS PROVIDED BY CALIFORNIA LAW AND YOU ARE GIVING UP ANY RIGHTS YOU MIGHT POSSESS TO HAVE THE DISPUTE LITIGATED IN A COURT OR JURY TRIAL. BY INITIALING IN THE SPACE BELOW YOU ARE GIVING UP YOUR JUDICIAL RIGHTS TO DISCOVERY AND APPEAL, UNLESS THOSE RIGHTS ARE SPECIFICALLY INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION. IF YOU REFUSE TO SUBMIT TO ARBITRATION AFTER AGREEING TO THIS PROVISION, YOU MAY BE COMPELLED TO ARBITRATE UNDER THE AUTHORITY OF THE CALIFORNIA CODE OF CIVIL PROCEDURE. YOUR AGREEMENT TO THIS ARBITRATION PROVISION IS VOLUNTARY. WE HAVE READ AND UNDERSTAND THE FOREGOING AND AGREE TO SUBMIT DISPUTES ARISING OUT OF THE MATTERS INCLUDED IN THE "ARBITRATION OF DISPUTES" PROVISION TO NEUTRAL ARBITRATION. LESSOR:____________ LESSEE:____________ 43. MISCELLANEOUS PROVISIONS: All rights and remedies hereunder are cumulative and not alternative to the extent permitted by law and are in addition to all other rights or remedies in law and in equity. Page 21 44. CHOICE OF LAW: This lease shall be construed and enforced in accordance with the substantive laws of the State of California. The language of all parts of this lease shall in all cases be construed as a whole according to its fair meaning and not strictly for or against either Lessor or Lessee. 45. ENTIRE AGREEMENT: This Lease is the entire agreement between the parties, and there are no agreements or representations between the parties except as expressed herein. Except as otherwise provided for herein, no subsequent change or addition to this Lease shall be binding unless in writing and signed by the parties hereto. IN WITNESS WHEREOF, Lessor and Lessee have executed these presents, the day and year first above written. LESSOR LESSEE BERG & BERG DEVELOPERS GENERAL SURGICAL INNOVATIONS CORPORATION By:___________________________________ By:___________________________________ signature of authorized representative signature of authorized representative ______________________________________ ______________________________________ printed name printed name ______________________________________ ______________________________________ title title ______________________________________ ______________________________________ date date Page 22 Exhibit A.1 Site plan to be attached with 30,460 square foot building to be attached. Page 23 Exhibit A.2 Site plan to be attached with 30,460 square foot building and 15,000 square foot addition to be attached. Page 24 Exhibit B Phase I Improvements Listing to be attached. Page 25 Exhibit B.1 Phase I Improvement Plans to be attached. Page 26 Exhibit C Berg & Berg ("Building Shell") includes the following items in customary quantities and quality. All items not listed are part of Lessee Interior Improvements. Exterior walls Foundation Floor slabs Roof structure and membrane Glazing Exit doors Truck doors Landscaping Parking and paving Storm sewer line to building Sanitary sewer line to building Water line to building Paint of exterior walls Shell architecture and engineering All permits for the above items Page 27 Exhibit D Phase II Lessee Interior Improvement plans to be attached. Page 28 Exhibit E Lessee Approval Deadlines Lease signed 01/03/97 Approval of Phase I floor plan and single line drawing Approved Approval of Phase II site plan Approved Final selection of all material and interior finishes for construction such as carpet, ceramic tile, paint and any other lessee selected materials & finishes for Phase I 01/15/97 Approval of Building Shell and Upgrades 02/01/97 Approval of Phase II floor plan and single line drawing 06/30/97 Final selection of all material and interior finishes for construction such as carpet, ceramic tile, paint and any other lessee selected materials & finishes for Phase I 09/30/97 Lessee shall not unreasonably withhold approval of any plans requiring Lessee approval if they conform in general to the floor plans, single line drawings or site plan. Notwithstanding any other provisions of this Lease, Lessee shall be allowed five (5) business days after Substantial Completion at no rent to install furniture and may have it's network installed during the construction of the Lessee Interior Improvements provided Lessee's installation does not interfere with Lessor's installation of the Lessee Interior Improvements and Lessee meets the approval deadlines set forth above. Page 29 EX-11.1 5 EXHIBIT 11.1 EXHIBIT 11.1 GENERAL SURGICAL INOVATIONS, INC. AND SUBSIDIARY COMPUTATION OF NET LOSS PER SHARE (1) (In thousands, expect per share data)
Quarter Ended Six Months Ended December 31, December 31, ------------------------- ----------------------- 1996 1995 1996 1995 -------- -------- -------- -------- Primarily and Fully Diluted: Weighted average common shares 13,183 3,355 13,165 3,354 Common and common equivalent shares pursuant to Staff Accounting Bulletin No. 83...................... 3,201 3,201 ---------- --------- ---------- -------- Shares used in per share calculation.... 13,183 6,556 13,165 6,555 ---------- --------- ---------- -------- ---------- --------- ---------- -------- Net loss................................ $ (237) $(1,015) $ (466) $(2,063) ---------- --------- ---------- -------- ---------- --------- ---------- -------- Net loss per share...................... $ (0.02) $ (0.15) $ (0.04) $ (0.31) ---------- --------- ---------- -------- ---------- --------- ---------- --------
- ------------------- (1) There is no difference between primary and fully diluted net loss per share for all periods presented. 25 EX-27.1 6 EXHIBIT 27.1
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS FOUND ON PAGES 3 AND 4 OF THE COMPANY'S FORM 10-Q FOR THE YEAR-TO-DATE, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 3-MOS JUN-30-1997 OCT-01-1996 DEC-31-1996 11,483 36,412 1,714 94 1,379 51,148 632 591 52,027 1,356 0 0 0 13 50,189 52,027 361 1,861 359 359 2,409 0 670 (237) 0 (237) 0 0 0 (237) (0.02) (0.02)
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