-----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, OP81+SGEr+S52cSixPmx/i7YE9rVoyUsB3rbeLT1tAZMcpuF3TmlZspkXexitt0a 1RNz7a5bjmFuP6jhHwbdtQ== 0001047469-98-041161.txt : 19981118 0001047469-98-041161.hdr.sgml : 19981118 ACCESSION NUMBER: 0001047469-98-041161 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 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: SEC FILE NUMBER: 000-28448 FILM NUMBER: 98751374 BUSINESS ADDRESS: STREET 1: 10460 BUBB RD CITY: CUPERTINO STATE: CA ZIP: 95014 BUSINESS PHONE: 4158129740 MAIL ADDRESS: STREET 1: 3172A PORTER DRIVE CITY: PALO ALTO STATE: CA ZIP: 94304 10-Q 1 FORM 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 SEPTEMBER 30, 1998. Commission file number: 0-28448 GENERAL SURGICAL INNOVATIONS, INC. (Exact name of Registrant as specified in its charter) CALIFORNIA 94-3160456 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10460 BUBB ROAD, CUPERTINO, CALIFORNIA 95014 (Address of principal executive offices) Registrant's telephone number, including area code: (408) 863-2500 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 13,441,974 shares of Registrant's Common Stock issued and outstanding as of October 31, 1998. GENERAL SURGICAL INNOVATIONS, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1998 TABLE OF CONTENTS -----------------
PAGE ---- PART I. FINANCIAL INFORMATION Item 1. Condensed Financial Statements (Unaudited) Condensed balance sheets at September 30, 1998 and June 30, 1998. . . . . . . . . . . . . . . . . . . . . . . . . 3 Condensed statements of operations and comprehensive loss for the three months ended September 30, 1998 and September 30, 1997 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Condensed statements of cash flows for the three months ended September 30, 1998 and September 30, 1997. . . . . . . . . . . . . 5 Notes to condensed financial statements. . . . . . . . . . . . . . 6 Item. 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. . . . . . . . . . . . . . . . . . . . . 7 Item 3. Quantitative and Qualitative Disclosures About Market Risk . . . .21 PART II. OTHER INFORMATION Item 1. Legal Proceedings. . . . . . . . . . . . . . . . . . . . . . . . .21 Item 2. Changes in Securities and Use of Proceeds. . . . . . . . . . . . .22 Item 3. Defaults Upon Senior Securities. . . . . . . . . . . . . . . . . .23 Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . .23 Item 5. Other Information. . . . . . . . . . . . . . . . . . . . . . . . .23 Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . .23
2 GENERAL SURGICAL INNOVATIONS, INC. CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
September 30, June 30, 1998 1998 ------------- -------- ASSETS Current assets: Cash and cash equivalents . . . . . . . . . . . . $ 17,065 $ 17,954 Available-for-sale securities . . . . . . . . . . 10,744 10,743 Accounts receivable, net. . . . . . . . . . . . . 1,847 1,043 Inventories . . . . . . . . . . . . . . . . . . . 1,547 1,284 Prepaid expenses and other current assets . . . . 691 733 --------- ---------- Total current assets . . . . . . . . . . . . 31,894 31,757 Available-for-sale securities, non-current . . . . . . 6,807 8,772 Property and equipment, net. . . . . . . . . . . . . . 2,182 2,101 Intangible and other assets, net . . . . . . . . . . . 409 194 --------- ---------- Total assets . . . . . . . . . . . . . . . . $ 41,292 $ 42,824 --------- ---------- --------- ---------- LIABILITIES Current liabilities: Accounts payable. . . . . . . . . . . . . . . . . $ 1,202 $ 910 Accrued liabilities . . . . . . . . . . . . . . . 2,060 1,316 Capital leases. . . . . . . . . . . . . . . . . . 14 14 Bank borrowings . . . . . . . . . . . . . . . . . 82 103 --------- ---------- Total current liabilities. . . . . . . . . . 3,358 2,343 Other long-term liabilities. . . . . . . . . . . . . . 94 149 Capital leases, less current portion . . . . . . . . . 8 12 Bank borrowings, less current portion. . . . . . . . . 61 82 --------- ---------- Total liabilities. . . . . . . . . . . . . . 3,521 2,586 --------- ---------- Contingencies (Note 4) SHAREHOLDERS' EQUITY Preferred stock, $.001 par value . . . . . . . . . . . - - Common stock, $.001 par value. . . . . . . . . . . . . 13 13 Additional paid-in capital . . . . . . . . . . . . . . 65,300 65,290 Notes receivable from shareholders . . . . . . . . . . (87) (87) Deferred compensation, net . . . . . . . . . . . . . . (125) (159) Accumulated other comprehensive income . . . . . . . . 84 16 Accumulated deficit. . . . . . . . . . . . . . . . . . (27,414) (24,835) --------- ---------- Total shareholders' equity . . . . . . . . . . . . . . 37,771 40,238 --------- ---------- Total liabilities and shareholders' equity . . . . . . $ 41,292 $ 42,824 --------- ---------- --------- ----------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL STATEMENTS. 3 GENERAL SURGICAL INNOVATIONS, INC. CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Three Months Ended September 30, --------------------- 1998 1997 -------- -------- Sales . . . . . . . . . . . . . . . . . . . . . . . . $ 2,021 $ 1,567 Guaranteed payments. . . . . . . . . . . . . . . . . . - 775 -------- -------- Total revenue. . . . . . . . . . . . . . . . . . . . . 2,021 2,342 Cost of sales. . . . . . . . . . . . . . . . . . . . . 1,084 956 -------- -------- Gross profit. . . . . . . . . . . . . . . . . . . 937 1,386 -------- -------- Operating expenses: Research and development. . . . . . . . . . . . . 744 765 Sales and marketing . . . . . . . . . . . . . . . 1,318 1,126 General and administrative. . . . . . . . . . . . 1,951 1,346 -------- -------- Total operating expenses. . . . . . . . . . . . . 4,013 3,237 -------- -------- Operating loss. . . . . . . . . . . . . . . . . . (3,076) (1,851) Interest income. . . . . . . . . . . . . . . . . . . . 503 603 Interest expense . . . . . . . . . . . . . . . . . . . (6) (12) -------- -------- Net loss. . . . . . . . . . . . . . . . . . . . . (2,579) (1,260) Other comprehensive income: Change in unrealized gain or loss on available-for- sale securities . . . . . . . . . . . . . . . . . 68 51 -------- -------- Comprehensive loss. . . . . . . . . . . . . . . . $ (2,511) $ (1,209) -------- -------- -------- -------- Net loss per common share and per common share-assuming dilution. . . . . . . . . . . . . . . . . . . . . $ (0.19) $ (0.09) -------- -------- -------- -------- Shares used in computing net loss per common share and per common share-assuming dilution. . . . . . . . 13,439 13,314 -------- -------- -------- --------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL STATEMENTS. 4 GENERAL SURGICAL INNOVATIONS, INC. CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
Three Months Ended September 30, ---------------------- 1998 1997 ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss . . . . . . . . . . . . . . . . . . . . . . . $ (2,579) $ (1,260) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of deferred compensation . . . . . . 34 34 Depreciation and amortization . . . . . . . . . . 208 282 Provision for uncollectible accounts. . . . . . . 8 16 Provision for excess and obsolete inventory . . . 32 (4) Changes in operating assets and liabilities: Accounts receivable. . . . . . . . . . . . . (812) 664 Inventories. . . . . . . . . . . . . . . . . (295) 232 Prepaid expenses and other current assets. . 42 (190) Other assets . . . . . . . . . . . . . . . . (233) (2) Accounts payable . . . . . . . . . . . . . . 292 105 Accrued liabilities. . . . . . . . . . . . . 689 (273) ---------- --------- Net cash used in operating activities . (2,614) (396) ---------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of available-for-sale securities . . . . . . - (6,060) Proceeds from sales and maturities of available-for-sale securities. . . . . . . . . . . . . . . . . . . . 2,000 3,542 Acquisition of property and equipment. . . . . . . . . (239) (211) ---------- --------- Net cash provided by (used in) investing activities. . . . . . . . . . . . . . . 1,761 (2,729) ---------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock . . . . . . . . 10 25 Payments on capital lease obligations. . . . . . . . . (4) (5) Principal payments on bank borrowings. . . . . . . . . (42) (42) ---------- --------- Net cash used in financing activities . (36) (22) ---------- --------- Net decrease in cash and cash equivalents. . . . . . . (889) (3,147) Cash and cash equivalents, beginning of period . . . . 17,954 7,900 ---------- --------- Cash and cash equivalents, end of period . . . . . . . $ 17,065 $ 4,753 ---------- --------- ---------- ---------
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONDENSED FINANCIAL STATEMENTS. 5 GENERAL SURGICAL INNOVATIONS, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS 1. Basis of Presentation: The accompanying unaudited condensed financial statements as of September 30, 1998 of General Surgical Innovations, Inc. (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 of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three month period ended September 30, 1998 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 1999, 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, 1998. 2. Computation of Net Loss per Common Share and per Common Share-Assuming Dilution: Effective December 15, 1997, the Company adopted Financial Accounting Standards Board ("FASB") No. 128 "Earnings Per Share", and the provisions of the Securities and Exchange Commission Staff Accounting Bulletin ("SAB 98"), and accordingly all prior periods have been restated. Net loss per common share and per common share-assuming dilution are computed using the weighted average number of shares of common stock outstanding. Common equivalent shares from stock options are excluded from the computation of net loss per common share-assuming dilution as their effect is antidilutive. The Company has determined that no incremental shares should be included in the computations in accordance with SAB 98. Stock options to purchase 1,867,247 and 1,230,056 shares of common stock at prices ranging from $0.09 to $9.75 per share were outstanding at September 30, 1998 and September 30 1997, respectively, but were not included in the computation of net loss per common share-assuming dilution because they were antidilutive. The aforementioned stock options could potentially dilute earnings per share in the future. 6 3. Inventories: Inventories comprise (IN THOUSANDS):
Sept. 30, June 30, 1998 1998 ----------- -------- (unaudited) Raw materials... . . . . . . . . . . . . . . . . . . . $ 1,014 $ 910 Work in progress.. . . . . . . . . . . . . . . . . . . 25 - Finished goods.. . . . . . . . . . . . . . . . . . . . 508 374 -------- -------- $ 1,547 $ 1,284 -------- -------- -------- --------
4. Contingencies: In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant Corporation, filed suit against GSI for infringement of U.S. Patent No. 5,520,609 in the United States District Court for the Northern District of California. That suit was resolved in GSI's favor by judgment entered on May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that judgment is pending, and is expected to be decided in 1999. The District Court has also awarded $990,000 in attorneys' fees to GSI and Origin is expected to appeal that ruling. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 1997, the Company filed an action against Origin alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,667,520. Both actions are still pending. In the first action, the Court has ruled that all of Origin's existing balloon dissection products infringe the claims of Patent No. 5,514,153. Discovery is near completion in the second case. At present, the first of these actions is scheduled for trial in early 1999 and the second is expected to go to trial later in 1999. While the Company believes it will be successful in these proceedings, there can be no assurance of such success. GSI is also involved in an interference proceeding in the U.S. Patent Office to determine whether certain subject matter was first invented by GSI's inventor. The priority portion of this interference has been decided in GSI's favor by an arbitrator to whom this issue was referred. The patentability portion of this interference was decided in GSI's favor by the United States Patent and Trademark Office ("PTO"). Origin is expected to appeal the PTO's decision, but GSI believes that the arbitrator's priority decision is not appealable. 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 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, 1998. 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. The following General Surgical Innovations, Inc. trademarks are mentioned in this Quarterly Report: SPACEMAKER-Registered Trademark-, SAPHtrak-Registered Trademark-, 7 registered trademarks of the Company; ENDOSAPH-TM- and SPACEKEEPER-TM-, trademarks 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 seven 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, Europe, Asia and South America for selected applications, such as hernia repair, subfascial endoscopic perforator surgery, saphenous vein harvesting and breast augmentation and reconstruction surgery. In December 1996, the Company entered into a five year OEM supply agreement (the "Expanded EES Agreement") with Ethicon Endo-Surgery, Inc. ("EES"), pursuant to which GSI granted EES worldwide sales and marketing rights to sell the SPACEMAKER-Registered Trademark- surgical balloon dissectors in the laparoscopic hernia repair and stress urinary incontinence ("SUI") markets. In February 1998, the Company and EES signed a non-exclusive distribution agreement for the laparoscopic hernia repair and SUI markets. This agreement supersedes the December 1996 Expanded EES Agreement. In September 1998, the Company signed two non-exclusive, three-year agreements with United States Surgical Corporation ("USSC"). Under the terms of the first agreement, USSC has obtained non-exclusive rights to market and distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors worldwide for use in hernia repair and incontinence procedures. Under the terms of the second agreement, GSI has secured non-exclusive worldwide rights to market and distribute several products, including USSC's 5mm mesh fixation device, the ProTack-TM-, which is offered with GSI's balloon dissectors in a complete hernia repair kit. In October 1998, GSI entered into non-exclusive agreements with seven leading surgical suppliers to distribute its SPACEMAKER-Registered Trademark-surgical balloon dissector kits used for hernia repair in the United States. The agreements provide for distribution of hernia kits in 31 States. The Company currently has a direct sales force covering the remaining portion of the United States and has agreements with USSC and EES to distribute these hernia repair products worldwide. In addition, the Company currently sells its products (other than for hernia and SUI applications) in international markets through other distributors, which resell to surgeons and hospitals. At present, the Company has exclusive distribution agreements with eight international distributors, including Baxter International, to distribute GSI's cardiovascular products in 18 European countries. In August 1997, the Company achieved compliance with the requirements of the European Economic Area Medical Devices Directive and the Company currently affixes CE markings on its products to attest to such compliance. During the first quarter of fiscal year 1999, the Company has increased its direct sales force in the United States, and plans to continue this expansion throughout the remainder of the fiscal year. Any increase in the Company's direct sales force will require significant expenditures and additional management resources. 8 To date, the majority of the sales to distributors and by the Company's direct sales force have been for use in hernia repair procedures. The Company's initial market focus was the application of its SPACEMAKER-Registered Trademark- balloon dissection technology for hernia repair. Subsequent to this, the Company has developed additional products for use in general surgery, as well as products for plastic surgery and cardiovascular applications. The Company has completed marketing-related clinical evaluations of, and has introduced products for, saphenous vein harvesting, subfascial endoscopic perforator surgery (SEPS"), breast augmentation and reconstruction procedures and SUI. The Company is currently conducting additional marketing-related clinical evaluations for tissue dissection/expansion. While the Company has developed or is developing balloon dissection systems for stress urinary incontinence, vascular and plastic surgery, sales of products for hernia repair are expected to provide a majority of the Company's revenues at least through fiscal 1999. The Company has acquired rights to a significant number of patents 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 between one and four percent of sales of such products, which payments are expected to exceed certain minimum royalty payments due under the agreements with such parties. The payment of such royalty amounts will have an adverse impact on the Company's gross profit and results of operations. 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 fiscal 1999. The Company's sales to date have consisted primarily of surgical balloon dissectors 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 surgical balloon dissectors for other applications, the Company anticipates that it will be required to make significant additional expenditures in sales and marketing, and in research and development (including marketing-related clinical evaluations). 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. RESULTS OF OPERATIONS REVENUE. Total revenue, including product sales and guaranteed payments, decreased by 14% to approximately $2.0 million for the quarter ended September 30, 1998 from $2.3 million for the same period in 1997. Product sales for the quarter ended September 30, 1998 reflect an increase of 29% over product sales for the quarter ended September 30, 1997. Revenues for the first quarter of fiscal 1999 consisted entirely of product sales while revenues for the first quarter of fiscal 1998 consisted of approximately $1.6 million in product sales and approximately $700,000 in guaranteed payments from EES. The Company believes that its sales results will fluctuate from quarter to quarter during at least the next several quarters. COST OF SALES. Cost of sales increased by 13% to approximately $1.1 million for the quarter ended September 30, 1998 from $956,000 for the same period in 1997. This increase in absolute dollars was due to an increase in product sales over this same period. As a percentage of product sales, cost of sales decreased from 61% in the first quarter of fiscal 1998 to 54% in the first quarter of fiscal 1999 primarily due to higher production during this time period. 9 RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses, which include expenditures for marketing-related clinical evaluations and regulatory expenses, remained relatively stable at $744,000 in the quarter ended September 30, 1998, compared to $765,00 for the same period on 1997. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased by 32% to approximately $3.3 million for the quarter ended September 30, 1998 from $2.5 million for the quarter ended September 30, 1997 primarily due to increased legal expenses related to intellectual property litigation. The Company expects selling expenses to continue to increase in absolute dollars as the Company continues to build its sales infrastructure. INTEREST INCOME AND INTEREST EXPENSE. Interest income and interest expense decreased to $497,000 for the quarter ended September 30, 1998 from $591,000 for the quarter ended September 30, 1997. The decrease is mainly due to lower 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 approximately $27.4 million at September 30, 1998. The Company has funded its operations primarily through the sale of equity securities. From its inception through September 30, 1998 the Company raised approximately $15.5 million through the private placement of equity securities and approximately $46.9 million (net of underwriting discounts and commissions) in an initial public offering. As of September 30, 1998 the Company's principal source of liquidity consists of cash, cash equivalents and available-for-sale securities of $34.6 million. In addition, the Company has a bank line of credit available for $5.0 million. As of September 30, 1998, the company has no amounts outstanding under this line. The Company also has an equipment loan with an outstanding balance of approximately $143,000. The Company expects to continue to incur costs over the next fiscal year, including costs related to increased sales and marketing activities, increased research and development, additional marketing-related clinical evaluations, and costs to defend its patent positions. 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 year 2000. 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 sought, will be available on satisfactory terms or at all. YEAR 2000 COMPLIANCE The Year 2000 ("Y2K") issue arises from computer programs using two digits rather than four to define the applicable year. Such software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations leading to disruptions or delays in the Company's activities and operations. If the Company, its key customers or suppliers fail to make necessary modifications to their information technology or non-information technology systems on a timely basis, the Y2K issue could have a material adverse effect on Company operations. However, the impact cannot be quantified at this time. 10 In January 1998 the Company began to evaluate and assess the Company's information technology and non-information technology systems for compliance with the Y2K issue. The Company intends to fix or replace noncompliant software and systems by March 31, 1999, but there can be no assurance that such fixes or replacements will occur by such date. The Company is currently conducting testing and remediation activities on its systems, and intends to survey major customers and suppliers to assess their systems' compliance as well as their systems' compatibility with the Company's existing or projected compliant systems. There can be no assurance that there will not be an adverse material effect on the Company's business, financial condition or results of operations if the Company or its suppliers or customers do not convert or replace their systems in a timely manner to comply with the Y2K issue. The Company's costs related to the Y2K issue are funded through operating cash flows. Through September 30, 1998, the Company expended approximately $5,000 in evaluating and planning. The Company estimates total costs to be between $50,000 and $100,000 for fixing and replacing noncompliant systems, including the cost of new software and modifying the applicable code of existing software. The Company currently believes that the total cost of achieving Y2K compliant systems will not be material to its business, financial condition or results of operations. In the event that the Company will be unable to achieve Y2K compliance in a timely manner with existing personnel, as a contingency the Company expects to hire outside Y2K solution providers to assist in achieving such compliance. Time and cost estimates are based on currently available information. Factors that could affect these estimates include, but are not limited to, the availability and cost of trained personnel to evaluate and implement the changes, the ability to locate and correct all noncompliant systems, and the ability of the Company's customers and suppliers to successfully implement Y2K compliant systems or fixes. FACTORS AFFECTING FUTURE RESULTS The following discussion should be read in conjunction with the condensed financial statements and notes thereto included herein. The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. Specifically the Company wishes to alert readers that, 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, market demand for the Company's products, the Company's ability to shift market focus successfully, the timing of orders and shipments, the timely development and market acceptance of new products and surgical procedures, the impact of performance of the Company's distributors, the Company's ability to further expand into international markets, public policy relating to health care reform in the United States and other countries, approval of its products by government agencies such as the United States Food and Drug Administration, 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, have in the past affected, and could in the future affect, the Company's actual results and could cause the Company's results for future periods to differ materially from those expressed in any forward-looking statements contained in the following discussion. 11 LIMITED OPERATING HISTORY; ANTICIPATED FUTURE LOSSES. The Company has a limited operating history upon which an evaluation of the Company and its prospects can be based. As of September 30, 1998, the Company had an accumulated deficit of $27.4 million. The Company's net operating losses for the fiscal years ending June 30, 1998, 1997 and 1996 and for the quarter ended September 30, 1998 were $9.1 million, $1.9 million, $5.5 million and $2.6 million, respectively. The Company expects to continue to incur operating losses on a quarterly and annual basis through at least fiscal 1999. Due to the Company's limited operating history there can be no assurance of sales growth or profitability in the future. The Company intends to increase 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. Nearly 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 market acceptance of and demand for the Company's products and related procedures, the nature of the technological advances inherent in the product designs, reduction in patient trauma or other benefits provided by such products, continued adoption of minimally invasive surgery ("MIS") procedures by surgeons, 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 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 surgical balloon dissectors 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. DEPENDENCE ON KEY DISTRIBUTORS. In February 1998, the Company replaced its five-year OEM supply agreement with EES with a non-exclusive distribution agreement which granted EES worldwide sales and marketing rights to sell the SPACEMAKER-Registered Trademark- surgical balloon dissectors in the laparoscopic hernia repair and stress urinary incontinence ("SUI") markets. Unlike the prior EES OEM Agreement, this new EES non-exclusive agreement does not provide for any minimum payments from EES to the Company. In December 1997, the Company entered into a four-year distribution agreement with Genzyme Surgical Products Corporation ("Genzyme"). Under the agreement, Genzyme has exclusive rights to market and distribute GSI's surgical surgical balloon dissectors worldwide for use in reconstructive and cosmetic plastic surgery procedures. In September 1998, the Company signed a non-exclusive, three-year agreement with United States Surgical Corporation ("USSC"). Under the terms of the agreement, USSC has obtained non- 12 exclusive rights to market and distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors worldwide for use in hernia repair and incontinence procedures. The Company's products are sold internationally to hospitals, surgeons and specialists through USSC, EES and independent distributors in Europe, Asia, Latin America and the Middle East. During the third quarter of fiscal year 1998, the Company expanded its international distribution network by adding eight international distributors, including Baxter International, to distribute its cardiovascular products. Although the Company intends to continue to establish additional distributorships in the United States and internationally for products in areas other than certain plastic surgery procedures, there can be no assurance that recently appointed distributors will be successful, or that efforts to establish additional distributors will be successful. Failure of current distributors to succeed, or failure to add additional distributors to its distribution network, could have a material adverse effect on the Company's business, financial condition and results of operations. 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 to the hernia market and, to a lesser degree, to the cardiovascular and cosmetic and reconstructive surgery markets. The Company intends to establish relationships with additional distribution partners, and there can be no assurance that the Company will be successful in establishing such 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 sales of the Company's products, could have a material adverse effect on the Company's business, 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-Registered Trademark- 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, clinical advantage 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 surgical techniques and treatments 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-Registered Trademark- balloon dissection 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 13 third-party reimbursement, and the failure 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 surgical balloon dissectors in late 1993 and to date there has been relatively little education among surgeons about the benefits of balloon dissection technology. Furthermore, because of 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 surgical balloon dissectors are incorporated into laparoscopic techniques less often or that surgeons are unwilling or unable to develop the skills necessary to utilize surgical 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 numerous factors, including (i) fluctuations in purchases of the Company's products by its distributors, (ii) the ability of the Company's distributors to effectively promote and sell the Company's products, (iii) the rate of adoption by surgeons of balloon dissection technology in markets targeted by the Company, (iv) the mix of sales among distributors and the Company's direct sales force, (v) the timing and cost of increasing the Company's direct domestic sales force, (vi) the expansion of the Company's distribution network, (vii) new product introductions by the Company and its competitors, (viii) fluctuations in revenues among different product lines and markets, (ix) timing of patent and regulatory approvals, if any, (x) intellectual property litigation, (xi) timing and growth of operating expenses and (xii) general market conditions. In December 1996, the Company entered into the Expanded Ethicon Agreement, pursuant to which EES made approximately $4.9 million in guaranteed payments to the Company in fiscal year 1997, which constituted 54% of revenues for fiscal year 1997 and payments by mutual consent of $775,000 in the first quarter of fiscal year 1998 and $860,000 in the second quarter of fiscal 1998. The company and EES entered into a nonexclusive distribution agreement for the laparoscopic hernia repair and stress urinary incontinence markets in February 1998, which supersedes the Expanded Ethicon Agreement and which does not include a provision for minimum quarterly payments. The Company anticipates that sales to EES may decrease in the future. Failure by EES to achieve certain levels of sales growth or purchases could adversely affect the Company's operating results. In September 1998, the Company signed two non-exclusive, three-year agreements with United States Surgical Corporation. Under the terms of the first agreement, USSC has obtained non-exclusive rights to market and distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors worldwide for use in hernia repair and incontinence procedures. Under the terms of the second agreement, GSI has secured non-exclusive worldwide rights to market and distribute several products, including USSC's 5mm mesh fixation device, the ProTack-TM-, which is offered with GSI's balloon dissectors in a complete hernia repair kit. Failure by the Company or USSC to achieve certain levels of sales growth or purchases could adversely affect the Company's operating results. 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 14 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. 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. 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. In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant Corporation, filed suit against GSI for infringement of U.S. Patent No. 5,520,609 in the United States District Court for the Northern District of California. That suit was resolved in GSI's favor by judgment entered on May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that judgment is pending and is expected to be decided in 1999. The District Court has also awarded $990,000 in attorneys' fees to GSI and Origin is expected to appeal that ruling. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 1997, the Company filed an action against Origin alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,667,520. Both actions are still pending. In the first action, the Court has ruled that all of Origin's existing balloon dissection products infringe the claims of Patent No. 5,514,153. Discovery is near completion in the second case. At present, the first of these actions is scheduled for trial in early 1999 and the second is expected to go to trial later in 1999. While the Company believes it will be successful in these proceedings, there can be no assurance of such success. GSI is also involved in an interference proceeding in the U.S. Patent Office to determine whether certain subject matter was first invented by GSI's inventor. The priority portion of this interference has been decided in GSI's favor by an arbitrator to whom this issue was referred. The patentability portion of this interference was decided in GSI's favor by the United States Patent and Trademark Office ("PTO"). Origin is expected to appeal the PTO's decision, but GSI believes that the arbitrator's priority decision is not appealable. 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 would have a material adverse effect on the Company's business, financial condition and results of operations. As discussed above, the Company is defending itself, and may in the future have 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. 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 15 Company's patents or patents to which it has licensed rights will be held valid under current challenges or if subsequently challenged or that persons or entities in addition to Origin 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. 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 rights to patents from third parties, including rights that apply to the Company's current surgical balloon dissectors. The Company has historically paid and is obligated to pay in the future to such third parties royalties equal to between one and four percent of sales of such products, which payments are expected to exceed minimum royalty payments due under agreements with such parties. 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 has limited experience in manufacturing, marketing and selling its products commercially. In addition, the Company has experienced rapid growth in the number of products under development, the number and amount of products manufactured, and the geographic scope of its sales. In order to augment its long-term competitive position, the Company anticipates that it will be required to make significant additional expenditures in research and development and sales and marketing. 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 16 the Company's competitors will not succeed in developing surgical 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 surgical balloon dissectors 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 surgical 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 development of its surgical balloon dissectors, 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 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 17 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 surgical balloon dissectors 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 surgical 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 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-Registered Trademark-surgical balloon dissectors 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 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, if obtained, or any failure to comply with regulatory requirements could have a material adverse effect on the Company's business, financial condition and results of operations. 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-Registered Trademark- I platform, SPACEMAKER-Registered Trademark- II platform, SPACEMAKER-Registered Trademark-Plastics platform, SPACEMAKER-Registered Trademark- SAPHtrak-Registered Trademark- platform and KnotMaker-TM- product each have received 510(k) clearance for use during general, endoscopic, laparoscopic or cosmetic and reconstructive surgery, and certain vascular surgery (including saphenous vein procedures) when tissue dissection is required. The Company has promoted these products for surgical applications (E.G., hernia repair, subfascial endoscopic perforator surgery, breast augmentation and reconstruction, treatment of stress urinary incontinence and saphenous vein harvesting), and may in the future promote these products for the dissection required for additional selected applications (E.G. tissue dissection/expansion and a variety of orthopedic procedures such as anterior spinal fusion and long-bone plating). For any medical device cleared through the 510(k) process, modifications or enhancements that could 18 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. 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. LIMITED MANUFACTURING EXPERIENCE. The Company has only limited experience in manufacturing its products in commercial quantities. The Company intends to scale up its production of 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. 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 or, if required, that the Company will be able to locate alternative sources of such component materials on a timely basis to market its products, if at all. 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 attempts to identify and certify a replacement supplier, if any, and could have a material adverse effect on the Company's business, financial condition and results of operations. 19 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 cause or are 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 .2%, .4% and .5% of the Company's sales in the quarter ended September 30, 1998, and for the fiscal years ended June 30, 1998 and 1997, respectively. The Company 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 Company's common stock and the stock of many other publicly held medical device companies have in the past been, and can in the future be expected to be, especially volatile. Announcements regarding competitive developments, product sales, 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. 20 YEAR 2000 COMPLIANCE. The Year 2000 ("Y2K") issue arises from computer programs using two digits rather than four to define the applicable year. Such software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations leading to disruptions or delays in the Company's activities and operations. If the Company, its key customers or suppliers fail to make necessary modifications to their information technology or non-information technology systems on a timely basis, the Y2K issue could have a material adverse effect on Company operations. However, the impact cannot be quantified at this time. In January 1998 the Company began to evaluate and assess the Company's information technology and non-information technology systems for compliance with the Y2K issue. The Company intends to fix or replace noncompliant software and systems by March, 31, 1999, but there can be no assurance that such fixes or replacements will occur by such date. The Company is currently conducting testing and remediation activities on its systems, and intends to survey major customers and suppliers to assess their systems' compliance as well as their systems' compatibility with the Company's existing or projected compliant systems. There can be no assurance that there will not be an adverse material effect on the Company's business, financial condition or results of operations if the Company or its suppliers or customers do not convert or replace their systems in a timely manner to comply with the Y2K issue. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Year 2000 Compliance." RECENT PRONOUNCEMENTS In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131 ("SFAS 131"), "Disclosures about Segments of an Enterprise and Related Information." This statement establishes standards for disclosure about operating segments in annual financial statements and selected information in interim financial reports. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This statement supersedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise." The new standard becomes effective for fiscal years beginning after December 15, 1997, and requires that comparative information from earlier years be restated to conform to the requirements of this standard. The Company is evaluating the requirements of SFAS 131 and the effects, if any, on the Company's current reporting and disclosures. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company had no holdings of derivative financial or commodity instruments at September 30, 1998. A review of the Company's other financial instruments and risk exposures at that date revealed that the Company had exposure to interest rate risk. At September 30, 1998 the Company performed sensitivity analyses to assess the potential effect of this risk and concluded that near-term changes in interest rates should not materially adversely affect the Company's financial position, results of operations or cash flows. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 21 In May 1996, Origin Medsystems, Inc. ("Origin"), a unit of Guidant Corporation, filed suit against GSI for infringement of U.S. Patent No. 5,520,609 in the United States District Court for the Northern District of California. That suit was resolved in GSI's favor by judgment entered on May 15, 1998, finding Origin's patent unenforceable. Origin's appeal of that judgment is pending and is expected to be decided in 1999. The District Court has also awarded $990,000 in attorneys' fees to GSI and Origin is expected to appeal that ruling. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,514,153. In September 1997, the Company filed an action against Origin alleging that the use of Origin's products infringes GSI's U.S. Patent No. 5,667,520. Both actions are still pending. In the first action, the Court has ruled that all of Origin's existing balloon dissection products infringe the claims of Patent No. 5,514,153. Discovery is near completion in the second case. At present, the first of these actions is scheduled for trial in early 1999 and the second is expected to go to trial later in 1999. While the Company believes it will be successful in these proceedings, there can be no assurance of such success. GSI is also involved in an interference proceeding in the U.S. Patent Office to determine whether certain subject matter was first invented by GSI's inventor. The priority portion of this interference has been decided in GSI's favor by an arbitrator to whom this issue was referred. The patentability portion of this interference was decided in GSI's favor by the United States Patent and Trademark Office ("PTO"). Origin is expected to appeal the PTO's decision, but GSI believes that the arbitrator's priority decision is not appealable. 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, except for the patent interference and infringement proceedings discussed herein. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS In connection with its initial public offering in 1996, the Company filed a Registration Statement on Form S-1, SEC File No. 333-2774 (the "REGISTRATION STATEMENT"), which was declared effective by the Commission on May 9, 1996. Pursuant to the Registration Statement, the Company registered and sold 3,450,000 shares of its Common Stock, $0.001 par value per share, for its own account. The offering commenced on May 10, 1996 and terminated when all of the registered shares had been sold. The aggregate offering price of the registered shares was $51,750,000. The managing underwriters of the offering were Cowen & Company and UBS Securities LLC. From May 10, 1996 to September 30, 1998, the Company incurred the following expenses in connection with the offering: Underwriting discounts and commissions. . . . . . $3,622,500 Other expenses. . . . . . . . . . . . . . . . . . $1,187,025 ---------- Total Expenses . . . . . . . . . . . . . . . $4,809,525
All of such expenses were direct or indirect payments to others. The net offering proceeds to the Company after deducting the total expenses above were $46,940,475. From May 10, 1996 to September 30, 1998, the Company used such net offering proceeds, in direct or indirect payments to others, as follows: 22 Construction of plant, building and facilities $ 1,227,065 Purchase and installment of machinery and equipment $ 1,520,383 Repayment of indebtedness $ 856,970 Working capital $25,011,284 ----------- Total $28,615,702
This use of proceeds does not represent a material change in the use of proceeds described in the prospectus of the Registration Statement. ITEM 3. DEFUALTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit Description ------- ----------- 27.1 Financial Data Schedule 10.25 Consulting Agreement between the Company and Roderick A. Young, dated as of November 1, 1998. 10.26 Promissory Note and Bonus Agreement between the Company and Gregory D. Casciaro dated as of September 3, 1998. (b) Reports on Form 8-K The Company filed no reports on Form 8-K during the quarter ended September 30, 1998. 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 Administration Principal and Chief Financial Officer Date: November 13, 1998 24 EX-10.25 2 EXHIBIT 10.25 GENERAL SURGICAL INNOVATIONS, INC. CONSULTING AGREEMENT This Consulting Agreement (the "AGREEMENT") is entered into by and between General Surgical Innovations, Inc. (the "COMPANY") and Roderick Young ("CONSULTANT"), effective as of this 1st day of November, 1998 (the "Effective Date"). 1. CONSULTING RELATIONSHIP. Beginning on the Effective Date and during the term of this agreement, Consultant will provide consulting services (the "SERVICES") to the Company as described on EXHIBIT A attached to this Agreement. Consultant shall use Consultant's best efforts to perform the Services in a manner satisfactory to the Company. 2. FEES; SUPPORT. As consideration for the Services to be provided by Consultant and other obligations, the Company will compensate Consultant as described in EXHIBIT B to this Agreement. As additional consideration for the Services, the Company will provide Consultant with such support facilities and space as may be required in the Company's judgment to enable Consultant to properly perform the Services. 3. EXPENSES. Consultant shall not be authorized to incur on behalf of the Company any expenses, except in compliance with the Company's policies without the prior written consent of the Company's Chief Financial Officer. As a condition to receipt of reimbursement, Consultant shall be required to submit to the Company reasonable evidence that the amount involved was expended and related to Services provided under this Agreement. 4. TERM AND TERMINATION. Consultant shall serve as a consultant to the Company for a period commencing on the Effective Date and terminating on the earlier of: (i) April 1, 1999, (ii) the date Consultant begins rendering services as an employee or consultant in excess of thirty hours per week to any person or entity other than the Company, or (iii) Consultant's termination of this Agreement at any time upon ten (10) days' written notice to the Company (which date shall be the "TERMINATION DATE"). 5. INDEPENDENT CONTRACTOR. Consultant's relationship with the Company will be that of an independent contractor and not that of an employee. Consultant will not be eligible for any employee benefits, nor will the Company make deductions from payments made to Consultant for taxes, all of which will be Consultant's responsibility. Consultant agrees to indemnify and hold the Company harmless from any liability for, or assessment of, any such taxes imposed on the Company by relevant taxing authorities. Consultant will have no authority to enter into contracts that bind the Company or create obligations on the part of the Company without the prior written authorization of the Company. 6. SUPERVISION OF CONSULTANT'S SERVICES. All services to be performed by Consultant, including but not limited to the Services, will be as agreed between Consultant and the Company's Chief Executive Officer. Consultant will be required to report to the Chief Executive Officer concerning the Services performed under this Agreement. The nature and frequency of these reports will be left to the discretion of the Chief Executive Officer. 7. CONSULTING OR OTHER SERVICES FOR COMPETITORS. Consultant represents and warrants that Consultant will not, during the term of this Agreement, perform any consulting or other services for any company, person or entity whose business or proposed business in any way involves products or services which could reasonably be determined to be competitive with the products or services or proposed products or services of the Company. 8. CONFIDENTIALITY AGREEMENT. Consultant has signed a Confidential Information and Invention Assignment Agreement substantially in the form attached to this Agreement as EXHIBIT C (the "CONFIDENTIALITY AGREEMENT"), prior to the date hereof. 9. CONFLICTS WITH THIS AGREEMENT. Consultant represents and warrants that Consultant is not under any pre-existing obligation in conflict or in any way inconsistent with the provisions of this Agreement. Consultant warrants that Consultant has the right to disclose or use all ideas, processes, techniques and other information, if any, which Consultant has gained from third parties, and which Consultant discloses to the Company in the course of performance of this Agreement, without liability to such third parties. Consultant represents and warrants that Consultant has not granted any rights or licenses to any intellectual property or technology that would conflict with Consultant's obligations under this Agreement. Consultant will not knowingly infringe upon any copyright, patent, trade secret or other property right of any former client, employer or third party in the performance of the services required by this Agreement. 10. STOCK VESTING. As of the date hereof, Consultant owns options to purchase an aggregate of 159,817 shares of Common Stock of the Company. Such options shall continue to vest in accordance with their vesting schedules on EXHIBIT D until the Termination Date, PROVIDED, HOWEVER, that if Consultant terminates this Agreement pursuant to subsection 4(iii) Consultant will not be eligible to exercise any options that were repriced in October, 1998. 11. MISCELLANEOUS. (a) AMENDMENTS AND WAIVERS. Any term of this Agreement may be amended or waived only with the written consent of the parties. (b) SOLE AGREEMENT. This Agreement, including the Exhibits hereto, constitutes the sole agreement of the parties and supersedes all oral negotiations and prior writings with respect to the subject matter hereof. The parties hereby agree and acknowledge that the Change of Control Agreement between the Company and Consultant dated January 20, 1998 is hereby terminated as of the Effective Date. The parties hereby agree and acknowledge that the offer letter between the Company and Consultant is hereby terminated as of the Effective Date. (c) NOTICES. Any notice required or permitted by this Agreement shall be in writing and shall be deemed sufficient upon receipt, when delivered personally or by courier, -2- overnight delivery service or confirmed facsimile, or forty-eight (48) hours after being deposited in the regular mail as certified or registered mail (airmail if sent internationally) with postage prepaid, if such notice is addressed to the party to be notified at such party's address or facsimile number as set forth below, or as subsequently modified by written notice. (d) CHOICE OF LAW. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of California, without giving effect to the principles of conflict of laws. (e) SEVERABILITY. If one or more provisions of this Agreement are held to be unenforceable under applicable law, the parties agree to renegotiate such provision in good faith. In the event that the parties cannot reach a mutually agreeable and enforceable replacement for such provision, then (i) such provision shall be excluded from this Agreement, (ii) the balance of the Agreement shall be interpreted as if such provision were so excluded and (iii) the balance of the Agreement shall be enforceable in accordance with its terms. (f) COUNTERPARTS. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which together will constitute one and the same instrument. (g) ARBITRATION. Any dispute or claim arising out of or in connection with any provision of this Agreement, excluding Section 7 hereof, will be finally settled by binding arbitration in Santa Clara County, California in accordance with the rules of the American Arbitration Association by one arbitrator appointed in accordance with said rules. The arbitrator shall apply California law, without reference to rules of conflicts of law or rules of statutory arbitration, to the resolution of any dispute. Judgment on the award rendered by the arbitrator may be entered in any court having jurisdiction thereof. Notwithstanding the foregoing, the parties may apply to any court of competent jurisdiction for preliminary or interim equitable relief, or to compel arbitration in accordance with this paragraph, without breach of this arbitration provision. This Section 11(g) shall not apply to the Confidentiality Agreement. (h) ADVICE OF COUNSEL. EACH PARTY ACKNOWLEDGES THAT, IN EXECUTING THIS AGREEMENT, SUCH PARTY HAS HAD THE OPPORTUNITY TO SEEK THE ADVICE OF INDEPENDENT LEGAL COUNSEL, AND HAS READ AND UNDERSTOOD ALL OF THE TERMS AND PROVISIONS OF THIS AGREEMENT. THIS AGREEMENT SHALL NOT BE CONSTRUED AGAINST ANY PARTY BY REASON OF THE DRAFTING OR PREPARATION HEREOF. -3- The parties have executed this Agreement on the respective dates set forth below. GENERAL SURGICAL INNOVATIONS, INC. By: /s/ Gregory Casciaro ------------------------------ Name: Gregory Casciaro --------------------------- Title: Chief Executive Officer ------------------------- 10460 Bubb Road Cupertino, CA 95014 Date: November 13, 1998 ---------------------------- RODERICK YOUNG /s/ Roderick Young ---------------------------------- Signature Address: 679 Mirada Avenue Stanford, CA 94305 ------------------------- Date: November 12, 1998 ---------------------------- SIGNATURE PAGE TO GENERAL SURGICAL INNOVATIONS, INC. CONSULTING AGREEMENT EXHIBIT A DESCRIPTION OF CONSULTING SERVICES Consulting to the Chief Executive Officer and the Board of Directors with regard to strategic business considerations, with specific projects to be as mutually determined by the Consultant and the Chief Executive Officer. EXHIBIT B COMPENSATION Consultant shall be paid the following monthly fees payable in accordance with the Company's normal payroll policies: November 1998 $10,000 December 1998 $10,000 January 1998 $10,000 February 1998 $5,000 March 1998 $5,000
EX-10.26 3 EXHIBIT 10.26 THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AND HAVE BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. NO SUCH SALE OR DISTRIBUTION MAY BE EFFECTED WITHOUT AN EFFECTIVE REGISTRATION STATEMENT RELATED THERETO OR AN OPINION OF COUNSEL IN A FORM SATISFACTORY TO THE COMPANY THAT SUCH REGISTRATION IS NOT REQUIRED UNDER THE SECURITIES ACT OF 1933. PROMISSORY NOTE $300,000.00 September 3, 1998 Cupertino, California For value received, Gregory Casciaro, (the "EMPLOYEE"), promises to pay to General Surgical Innovations, Inc. (the "HOLDER"), the principal sum of Three Hundred Thousand Dollars ($300,000.00). Interest shall accrue from the date of this Note on the unpaid principal amount at a rate equal to five and 42/100 percent (5.42 %) per annum, compounded monthly. This Note is subject to the following terms and conditions: 1. MATURITY. Principal and any accrued but unpaid interest under this Note shall be due and payable upon demand by the Holder at any time after the earlier of (i) April 3, 2003 or (ii) the date on which the Employee is no longer Chief Executive Officer of the Holder. 2. PAYMENT. All payments shall be made in lawful money of the United States of America at such place as the Holder hereof may from time to time designate in writing to the Employee. Payment shall be credited first to the accrued interest then due and payable and the remainder applied to principal. Prepayment of this Note may be made at any time without penalty. 3. TRANSFER; SUCCESSORS AND ASSIGNS. The terms and conditions of this Note shall inure to the benefit of and be binding upon the respective successors and assigns of the parties. Notwithstanding the foregoing, the Employee may not assign, pledge, or otherwise transfer this Note without the prior written consent of the Holder. Subject to the preceding sentence, this Note may be transferred only upon surrender of the original Note for registration of transfer, duly endorsed, or accompanied by a duly executed written instrument of transfer in form satisfactory to the Holder. Thereupon, a new note for the same principal amount and interest will be issued to, and registered in the name of, the transferee. Interest and principal are payable only to the registered holder of this Note. 4. GOVERNING LAW. This Note and all acts and transactions pursuant hereto and the rights and obligations of the parties hereto shall be governed, construed and interpreted in accordance with the laws of the State of California, without giving effect to principles of conflicts of law. 5. NOTICES. Any notice required or permitted by this Note shall be in writing and shall be deemed sufficient upon delivery, when delivered personally or by a nationally-recognized delivery service (such as Federal Express or UPS), or forty-eight (48) hours after being deposited in the U.S. mail, as certified or registered mail, with postage prepaid, addressed to the party to be notified at such party's address as set forth below or as subsequently modified by written notice. 6. AMENDMENTS AND WAIVERS. Any term of this Note may be amended only with the written consent of the Employee and the Holder. Any amendment or waiver effected in accordance with this Section 6 shall be binding upon the Employee, the Holder and each transferee of the Note. 7. ACTION TO COLLECT ON NOTE. If action is instituted to collect on this Note, the Employee promises to pay all costs and expenses, including reasonable attorney's fees, incurred in connection with such action. EMPLOYEE GREGORY CASCIARO By: /s/ Gregory Casciaro ------------------------------- Address: 10460 Bubb Road Cupertino, CA 95014 -------------------------- AGREED TO AND ACCEPTED: HOLDER GENERAL SURGICAL INNOVATIONS, INC. By: /s/ Mark Wan ------------------------------ Name: Mark Wan ----------------------------- (print) Title: Director --------------------------- Address: 10460 Bubb Road Cupertino, CA 95014 CASH BONUS AGREEMENT THIS CASH BONUS AGREEMENT ("Agreement") is entered into this 3rd day of September, 1998, by and between GENERAL SURGICAL INNOVATIONS, INC., a California corporation ("Company") and GREGORY CASCIARO ("Executive"). WHEREAS, the board of directors has determined that it is in the Company's best interests to enter into this Agreement for the purpose of retaining Executive as a valued employee of the Company and providing an incentive for him to maximize his efforts on the Company's behalf; NOW, THEREFORE, the Company and Executive agree as follows: 1. PAYMENT OF CASH BONUSES. Company agrees to pay Executive a cash bonus in the amount of $68,750 on September 3, 1998 and in the amount of $4,737.13 on the Third day of each calendar month thereafter until and including April 3, 2003, provided that Executive continues to serve as the chief executive officer of the Company as of the applicable date. If (a) Executive is terminated on or prior to a bonus payment date without cause or (b) in the event of the acquisition, sale or transfer of a majority of the outstanding shares, a sale of all or substantially all of the assets or another change of control of the Company (except a merger or sale effected solely for the purpose of changing the domicile of the Company), the Company shall pay to Executive a cash bonus in an amount equal to the aggregate value of all bonus payments that would otherwise have been received by Executive pursuant to this Section 1. 2. FORFEITURE OF FUTURE CASH BONUSES. Except as set forth in Section 1, if Executive terminates employment with the Company for any reason, whether voluntarily or involuntarily, prior to a bonus payment date specified in Section 1, then he shall not be entitled to receive any further cash bonuses under this Agreement but shall be entitled to retain such cash bonuses that have previously been paid to him. 3. TAX WITHHOLDING. All payments under this Agreement shall be subject to and net of all applicable federal, state and local tax withholding requirements. 4. GROSS-UP AMOUNT. Each bonus payment set forth in Section 1 will be increased by an amount sufficient to permit the Executive to pay his taxes on such payment (the "Gross Up Payment") and on the amount of the Gross Up Payment itself. 5. NON-TRANSFERABILITY; CREDITOR RIGHTS. Executive's right to receive cash bonuses under this Agreement may not be sold, pledged assigned hypothecated, transferred, or disposed of in any manner. Executive shall have no greater rights pursuant to this Agreement than that of a general unsecured creditor of the Company. Company shall have no obligation to set aside any property to fund its obligations hereunder and Executive shall have no rights in any particular property of the Company as a result of the award hereunder. 6. GOVERNING LAW. This Cash Bonus Agreement shall be governed by and construed in accordance with the laws of the State of California applicable to contracts wholly made and performed in the state of California. COMPANY: GENERAL SURGICAL INNOVATIONS, INC. By: /s/ Mark Wan --------------------------------------- Its: Director -------------------------------------- EXECUTIVE: GREGORY CASCIARO /s/ Gregory Casciaro ------------------------------------------- EX-27.1 4 EXHIBIT 27.1
5 1,000 3-MOS JUN-30-1999 JUN-30-1998 SEP-30-1998 17,065 17,551 1,847 151 1,547 31,894 2,182 1,381 41,292 3,358 0 0 0 13 37,758 41,292 2,021 2,021 (1,084) (1,084) (4,013) 0 (6) (2,579) 0 (2,579) 0 0 0 (2,579) (.19) (.19)
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