-----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, AGKIwgdviEov4fynF3uXtODpeydM+r/RUxq2TlDIR44di6cGWacF3xG39XRe+tvL W/7eusIZjvWIKCx6Tsylag== 0001047469-99-006237.txt : 19990217 0001047469-99-006237.hdr.sgml : 19990217 ACCESSION NUMBER: 0001047469-99-006237 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990216 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: 99542781 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 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 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 13,478,910 shares of Registrant's Common Stock issued and outstanding as of January 31, 1999. GENERAL SURGICAL INNOVATIONS, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 TABLE OF CONTENTS
Page ---- PART I. FINANCIAL INFORMATION Item 1. Condensed Financial Statements (Unaudited) Condensed balance sheets at December 31, 1998 and June 30, 1998............................................... 3 Condensed statements of operations and comprehensive loss for the three and six months ended December 31, 1998 and December 31, 1997............................................... 4 Condensed statements of cash flows for the six months ended December 31, 1998 and December 31, 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 ..... 20 PART II. OTHER INFORMATION Item 1. Legal Proceedings............................................... 20 Item 2. Changes in Securities and Use of Proceeds....................... 21 Item 3. Defaults Upon Senior Securities ............................... 22 Item 4. Submission of Matters to a Vote of Security Holders............. 22 Item 5. Other Information .............................................. 22 Item 6. Exhibits and Reports on Form 8-K ............................... 22
2 GENERAL SURGICAL INNOVATIONS, INC. CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
December 31, June 30, 1998 1998 -------------------- ------------------- ASSETS Current assets: Cash and cash equivalents..................................... $ 14,501 $ 17,954 Available-for-sale securities................................. 8,323 10,743 Accounts receivable, net...................................... 991 1,043 Inventories................................................... 2,836 1,284 Prepaid expenses and other current assets..................... 671 733 ---------- ---------- Total current assets............................... 27,322 31,757 Available-for-sale securities, non-current......................... 6,768 8,772 Property and equipment, net........................................ 2,434 2,101 Other assets....................................................... 375 194 ---------- ---------- Total assets....................................... $ 36,899 $ 42,824 ---------- ---------- ---------- ---------- LIABILITIES Current liabilities: Accounts payable.............................................. $ 2,015 $ 910 Accrued liabilities........................................... 1,320 1,316 Capital leases................................................ 14 14 Bank borrowings............................................... 82 103 ---------- ---------- Total current liabilities.......................... 3,431 2,343 Other long-term liabilities........................................ 75 149 Capital leases, less current portion............................... 5 12 Bank borrowings, less current portion.............................. 41 82 ---------- ---------- Total liabilities.................................. 3,552 2,586 ---------- ---------- Contingencies (Note 4) SHAREHOLDERS' EQUITY Preferred stock, $.001 par value................................... - - Common stock, $.001 par value...................................... 13 13 Additional paid-in capital......................................... 65,369 65,290 Notes receivable from shareholders................................. (84) (87) Deferred compensation, net......................................... (91) (159) Accumulated other comprehensive income............................. 50 16 Accumulated deficit................................................ (31,910) (24,835) ---------- ---------- Total shareholders' equity......................... 33,347 40,238 ---------- ---------- Total liabilities and shareholders' equity....... $ 36,899 $ 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 SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, -------------------------- ------------------------ 1998 1997 1998 1997 ---------- ---------- ---------- ---------- Sales................................................................... $ 926 $ 1,408 $ 2,947 $ 2,975 Guaranteed payments..................................................... - 860 - 1,635 ---------- ---------- ---------- ---------- Total revenue........................................................... 926 2,268 2,947 4,610 Cost of sales........................................................... 731 1,186 1,815 2,142 ---------- ---------- ---------- ---------- Gross profit..................................................... 195 1,082 1,132 2,468 ---------- ---------- ---------- ---------- Operating expenses: Research and development............................................ 934 658 1,678 1,423 Sales and marketing................................................. 1,836 1,168 3,154 2,294 General and administrative.......................................... 2,359 1,738 4,310 3,084 ---------- ---------- ---------- ---------- Total operating expenses.......................................... 5,129 3,564 9,142 6,801 ---------- ---------- ---------- ---------- Operating loss................................................... (4,934) (2,482) (8,010) (4,333) Interest income......................................................... 450 594 953 1,197 Interest expense........................................................ (4) (9) (10) (21) Other expense, net...................................................... (8) - (8) - ---------- ---------- ---------- ---------- Net loss......................................................... (4,496) (1,897) (7,075) (3,157) Other comprehensive income (loss): Change in unrealized gain or loss on available-for-sale securities (34) (18) 34 33 ---------- ---------- ---------- ---------- Comprehensive loss............................................... $ (4,530) $ (1,915) $ (7,041) $ (3,124) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net loss per common share and per common share-assuming dilution............................................................ $ (0.33) $ (0.14) $ (0.53) $ (0.23) ---------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Shares used in computing net loss per common share and per common share-assuming dilution...................................... 13,446 13,355 13,442 13,334 ---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
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)
Six Months Ended December 31, ----------------------------------- 1998 1997 ---------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss............................................................................. $ (7,075) $ (3,157) Adjustments to reconcile net loss to net cash used in operating activities: Amortization of deferred compensation........................................... 68 69 Depreciation and amortization................................................... 412 567 Provision for uncollectible accounts............................................ 61 7 Provision for excess and obsolete inventory..................................... 50 (4) Changes in operating assets and liabilities: Accounts receivable........................................................ (9) (91) Inventories................................................................ (1,602) 705 Prepaid expenses and other current assets.................................. 62 (153) Other assets............................................................... (217) (2) Accounts payable........................................................... 1,105 75 Accrued liabilities........................................................ (70) (267) --------- ---------- Net cash used in operating activities............................ (7,215) (2,251) --------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of available-for-sale securities........................................... (2,795) (15,800) Proceeds from sales and maturities of available-for-sale securities.................. 7,200 17,792 Acquisition of property and equipment................................................ (656) (304) --------- ---------- Net cash provided by investing activities........................ 3,749 1,688 --------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock............................................... 79 130 Proceeds from payment on notes receivable from shareholders.......................... 3 - Payments on capital lease obligations................................................ (7) (9) Principal payments on bank borrowings................................................ (62) (84) --------- ---------- Net cash provided by financing activities......................... 13 37 --------- ---------- Net decrease in cash and cash equivalents............................................ (3,453) (526) Cash and cash equivalents, beginning of period....................................... 17,954 7,900 --------- ---------- Cash and cash equivalents, end of period............................................. $ 14,501 $ 7,374 --------- ---------- --------- ----------
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 December 31, 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 and six month periods ended December 31, 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 1,858,034 and 1,285,732 shares of common stock at prices ranging from $0.09 to $9.75 per share were outstanding at December 31, 1998 and December 31 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. 3. Inventories: Inventories comprise (IN THOUSANDS):
Dec. 31, June 30, -------- -------- 1998 1998 ---- ---- (unaudited) Raw materials................................... $ 1,323 $ 910 Work in progress................................ 38 - Finished goods.................................. 1,475 374 --------------- --------------- $ 2,836 $ 1,284 --------------- --------------- --------------- ---------------
6 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 has appealed that ruling as well. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that use of Origin's products infringes GSI's U.S. Patent 5,514,153. The court agreed with this allegation in a summary judgment ruling in GSI's favor. On February 8, 1999, a jury found the patent to be valid, that infringement was willful, and granted GSI approximately $12.9 million in damages. GSI is seeking an injunction against further infringements. A second action was filed similarly in September 1997, alleging that use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery is near completion in this case. 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: ENDOSAPH-Registered Trademark-, SPACEMAKER-Registered Trademark-, SAPHtrak-Registered Trademark-, registered trademarks of the Company; SPACEKEEPER-TM-, and Total Solution-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 7 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. During the first six months of fiscal 1999, the Company added eight direct sales personnel and realigned its regional distribution in the United States from one consisting primarily of third-party distributors to a combination of distributors and a GSI direct sales force. The Company plans to continue its direct sales force expansion, which the Company believes will create a more balanced approach to distribution, throughout the remainder of the fiscal year. Any increase in the Company's direct sales force will require significant expenditures and additional management resources. 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 Total Solution-TM- 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. Currently, domestic distribution of GSI's products is made through ten independent distributors covering 45 states for Subfascial Endoscopic Perforator Surgery ("SEPS") and saphenous vein harvest products, and nine independent distributors covering 41 states for hernia and SUI products. The Company currently has a direct sales force distributing products in the remaining portion of the United States as well as managing distributor relationships. In addition, the Company has agreements with USSC and EES to distribute hernia repair and SUI products worldwide. GSI also 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 Europe and the Company has employees located in Europe to manage those distributors. To date, the majority of the sales to distributors and by the Company's direct sales force have been of products 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, SEPS, breast augmentation and reconstruction procedures and SUI. The Company is currently conducting additional marketing-related clinical evaluations for products for use in tissue dissection/expansion. 8 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 calendar 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 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 59% to $926,000 for the quarter ended December 31, 1998 from $2.3 million for the same period in 1997. Revenue for the six months ended December 31, 1998 decreased 36% to approximately $2.9 million from $4.6 million for the six months ended December 31, 1997. Revenues in fiscal 1999 consisted entirely of product sales, while revenues for the three and six months ended December 31, 1997 consisted of $860,000 and $1.6 million, respectively, 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 decreased by 38% to $731,000 for the quarter ended December 31, 1998 from approximately $1.2 million for the same period in 1997. This decrease in absolute dollars was due to a decrease in product sales over this same period. As a percentage of product sales, cost of sales decreased from 84% in the second quarter of fiscal 1998 to 79% in the second quarter of fiscal 1999. Cost of sales for the six months ended December 31, 1998 decreased as a percent of sales to 62%, or approximately $1.8 million, as compared to 72% of sales, or approximately $2.1 million, for the six months ended December 31, 1997. RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses, which include expenditures for marketing-related clinical evaluations and regulatory expenses, increased 42% to $934,000 in the quarter ended December 31, 1998 from $658,00 for the same period in 1997. R&D expenses for the six months ended December 31, 1998 were approximately $1.7 million as compared to $1.4 million for the same period of the prior fiscal year, which represented an 18% increase. Increases are due to new general and vascular surgical product development expenditures. 9 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses increased by 44% to approximately $4.2 million for the quarter ended December 31, 1998 from $2.9 million for the quarter ended December 31, 1997. For the six months ended December 31, 1998, SG&A expenses were $7.5 million compared to $5.4 million for the same period in 1997. These increases are primarily due to increased legal expenses related to intellectual property litigation, as well as increased labor and labor related expenses as the Company expands its sales and marketing infrastructure. INTEREST INCOME, INTEREST EXPENSE, AND OTHER EXPENSE. Interest and other income (net of expense) decreased to $438,000 for the quarter ended December 31, 1998 from $585,000 for the quarter ended December 31, 1997. For the six months ended December 31, 1998, interest and other income (net of expense) decreased to $935,000 from $1.2 million for the same period in 1997. Decreases are due mainly 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 $31.9 million at December 31, 1998. The Company has funded its operations primarily through the sale of equity securities. From its inception through December 31, 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 December 31, 1998 the Company's principal source of liquidity consists of cash, cash equivalents and available-for-sale securities of $29.6 million. In addition, the Company has a bank line of credit available for $5.0 million. As of December 31, 1998, the Company has no amounts outstanding under this line. The Company also has an equipment loan with an outstanding balance of approximately $123,000. 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 10 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 is in the process of fixing or replacing noncompliant software and systems and intends to have this process completed by June 30, 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 December 31, 1998, the Company expended approximately $15,000 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 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 HISTORY OF LOSSES AND ANTICIPATED FUTURE LOSSES. The Company has experienced significant operating losses since inception and as of December 31, 1998, the Company had an accumulated deficit of $31.9 million. The Company's net operating losses for the quarters ended December 31, 1998 and September 30, 1998 were $4.5 million and $2.6 million, respectively. The Company expects to continue to incur operating losses on a quarterly and annual basis through at least calendar year 1999. The Company's limited operating history makes accurate prediction of future operating results difficult or impossible. There can be no assurance that the Company will ever generate substantial revenue or achieve profitability. Failure by the Company to generate substantial revenue would have a material adverse effect on the Company's business, financial condition and results of operations. 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. 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 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-exclusive rights to market and distribute GSI's SPACEMAKER-Registered Trademark- surgical balloon dissectors worldwide for use in hernia repair and incontinence procedures. 12 LIMITED MARKETING AND DIRECT SALES EXPERIENCE. The Company has limited experience marketing and selling its products through its direct sales force, and has sold its products in commercial quantities through its direct sales force only to the hernia market and, to a lesser degree, to the vascular 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 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 has limited long-term outcomes data regarding successful balloon dissection procedures. 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 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. To the extent that laparoscopic techniques are adopted slowly, that surgical balloon dissectors are not incorporated into laparoscopic techniques 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) new product introductions by the Company and its competitors, (vi) fluctuations in revenues among different product lines and markets, (vii) timing of patent and regulatory approvals, if any, (viii) intellectual property litigation, (ix) timing and growth of operating expenses and (x) general market conditions. 13 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. 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 distributors 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 purchased from the Company, which could have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that future products or product enhancements will be successfully introduced or that such introductions will not adversely affect the demand for existing products. As a result of these and other factors, the Company's quarterly operating results have fluctuated in the past, and the Company expects that such results may fluctuate in the future. Due to such quarterly fluctuations in operating results, quarter-to-quarter comparisons of the Company's operating results are not necessarily meaningful and should not be relied upon as indicators of likely future performance or annual operating results. 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 has appealed that ruling as well. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that use of Origin's products infringes GSI's U.S. Patent 5,514,153. The court agreed with this allegation in a summary judgment ruling in GSI's favor. On February 8, 1999, a jury found the patent to be valid, that infringement was willful, and granted GSI approximately $12.9 million in damages. GSI is seeking an injunction against further infringements. A second action was filed similarly in September 1997, alleging that use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery is near completion in this case. 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. 14 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 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. 15 COMPETITION; UNCERTAINTY OF TECHNOLOGICAL CHANGE. Competition in the market for medical devices used in tissue dissection surgical procedures is intense and is expected to increase. The Company competes primarily with other producers of MIS tissue dissection instruments. Origin, a subsidiary of Guidant Corporation, and others currently compete against the Company in the development, production and marketing of MIS tissue dissection instruments and tissue dissection technology. To the extent that surgeons elect to use open surgical procedures rather than MIS, the Company also competes with producers of tissue dissection instruments used in open surgical procedures, such as blunt dissectors or graspers. A number of companies currently compete against the Company in the development, production and marketing of tissue dissection instruments and technology for open surgical procedures. In addition, the Company indirectly competes with producers of therapeutic drugs, when such drugs are used as an alternative to surgery. Many of the Company's competitors have substantially greater capital resources, name recognition, expertise in research and development, manufacturing and marketing and obtaining regulatory approvals. There can be no assurance that the Company's competitors will not succeed in developing 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 some 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 16 on the list or are not available from the exclusive source, the facility or surgeon will need to obtain an exception from the payor or the patient will be required to pay for some or all of the cost of the Company's product. The Company believes that procedures using its balloon dissection products currently may be reimbursed in the United States under certain existing procedure codes. However, there can be no assurance that such procedure codes will remain available or that the reimbursement under these codes will be adequate. Given the efforts to control and decrease health care costs in recent years, there can be no assurance that any reimbursement will be sufficient to permit the Company to increase revenues or achieve or maintain profitability. The unavailability of third-party or other adequate reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. Reimbursement systems in international markets vary significantly by country, and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis. Many international markets have government-managed health care systems that govern reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems. Large-scale market acceptance of the Company's 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. 17 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 KnotMakerTM- 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 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 COMMERCIAL MANUFACTURING EXPERIENCE. The Company has only limited experience in manufacturing its products in commercial quantities. Manufacturers often encounter difficulties in scaling up for commercial 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 contracts with such suppliers. 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 18 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. 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. 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. 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. 19 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 is in the process of fixing or replacing noncompliant software and systems and intends to have this process completed by June 30, 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 December 31, 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 December 31, 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 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 has appealed that ruling as well. In June 1996, GSI filed an action against Origin in the U.S. District Court for the Northern District of California alleging that use of Origin's products infringes GSI's U.S. Patent 5,514,153. The court agreed with this allegation in a summary judgment ruling in GSI's favor. On February 8, 1999, a jury found the patent to be valid, that infringement was willful, and granted GSI approximately $12.9 million in damages. GSI is seeking an injunction against further infringements. A second action was filed similarly in September 1997, alleging that use of Origin's Vasoview product infringes U.S. Patent 5,667,520. Discovery is near completion in this case. 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. 20 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 December 31, 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 December 31, 1998, the Company used such net offering proceeds, in direct or indirect payments to others, as follows: Construction of plant, building and facilities $ 1,227,065 Purchase and installment of machinery and equipment $ 1,937,420 Repayment of indebtedness $ 898,811 Working capital $30,502,324 ----------- Total $34,565,620
21 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. DEFAULTS IN SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On November 19, 1998 at the Company's Annual Meeting of Shareholders for the Fiscal Year Ending June 30, 1998 the following matters were submitted and voted on by securityholders and were adopted: A. The election of Class I directors to serve until the Annual Meeting of the shareholders for fiscal year 2000 or until their successors are elected and qualified. The results of the vote are as follows:
Yes Abstain ---------- ------- Gregory D. Casciaro 12,725,913 50,907 Thomas J. Fogarty 12,694,090 82,730 Roderick A. Young 12,723,990 52,830
The terms of office for the following individuals, who are Class II directors, will continue until the Annual Meeting of Shareholders for fiscal year 1999: David Chonette, Paul Goeld, James Sulat, and Mark Wan. B. The approval of an amendment to the 1992 Stock Option Plan (i) to increase the number of shares of Common Stock reserved for issuance thereunder on the date of each annual meeting of the shareholders during the period beginning on and including November 19, 1998 and ending on September 14, 2002 by an amount equal to the lesser of: (x) four percent (4%) of the total number of shares of the Company's Common Stock issued and outstanding as of the last business day immediately preceding the date of the annual meeting of the shareholders each fiscal year, or (y) 600,000 shares, and (ii) to increase the total maximum number of shares subject to options that may be issued to any one employee during a fiscal year to 1,000,000 effective as of July 1, 1998. The results of the vote are as follows:
Yes No Abstain Broker Non-Vote --------- ------- ------- --------------- 7,292,379 642,631 906,723 3,935,087
C. The ratification of PricewaterhouseCoopers, LLP as the Company's independent accountants for the fiscal year ended June 30, 1999. The results of the vote are as follows:
Yes No Abstain ---------- ------ ------- 12,750,326 18,236 8,258
ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits
Exhibit Description ------- ----------- 10.2 1992 Stock Option Plan, as amended November 1997 and November 1998. 10.27 Written Compensation Agreement Dated April 6, 1998.
22 27.1 Financial Data Schedule.
(b) Reports on Form 8-K The Company filed no reports on Form 8-K during the quarter ended December 31, 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: February 16, 1999 24 EX-10.2 2 EXHIBIT 10.2 GENERAL SURGICAL INNOVATIONS, INC. 1992 STOCK OPTION PLAN (AS AMENDED NOVEMBER 1997 AND NOVEMBER 1998) 1. PURPOSES OF THE PLAN. The purposes of this Stock Option Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to the Employees and Consultants of the Company, and to promote the success of the Company's business. Options granted hereunder may be either Incentive Stock Options or Nonstatutory Stock Options, at the discretion of the Administrator and as reflected in the terms of the written option agreement. 2. DEFINITIONS. As used herein, the following definitions shall apply: (a) "ADMINISTRATOR" shall mean the Board or any of its Committees appointed pursuant to Section 4 of the Plan. (b) "APPLICABLE LAWS" shall have the meaning set forth in Section 4(a) below. (c) "BOARD" shall mean the Board of Directors of the Company. (d) "CODE" shall mean the Internal Revenue Code of 1986, as amended. (e) "COMMON STOCK" shall mean the Common Stock of the Company. (f) "COMMITTEE" shall mean the Committee appointed by the Board of Directors in accordance with Section 4(a) below, if one is appointed. (g) "COMPANY" shall mean GENERAL SURGICAL INNOVATIONS, INC., a California corporation. (h) "CONSULTANT" shall mean (i) any person who is engaged by the Company or any subsidiary to render consulting services and is compensated for such consulting services, and (ii) any director of the Company whether compensated for such services or not. (i) "CONTINUOUS STATUS AS AN EMPLOYEE OR CONSULTANT" shall mean the absence of any interruption or termination of service as an Employee or Consultant. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of sick leave, military leave, or any other leave of absence approved by the Administrator; provided, however, either that such leave must be for a period of not more than ninety (90) days or that re-employment upon the expiration of such leave must be guaranteed by contract or by statute, or is provided pursuant to Company policy adopted from time to time. For purposes of this Plan, a change in status from an Employee to a Consultant or from a Consultant to an Employee shall not constitute an interruption of Continuous Status as an Employee or Consultant. (j) "DIRECTOR" shall mean a member of the Board. (k) "EMPLOYEE" shall mean any person, including Officers and Directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a director's fee by the Company to a Director shall not be sufficient to constitute "employment" of the Director by the Company. (l) "EXCHANGE ACT" shall mean the Securities Exchange Act of 1934, as amended. (m) "FAIR MARKET VALUE" shall mean, as of any date, the value of Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system including without limitation the National Market of the National Association of Securities Dealers, Inc. Automated Quotation ("Nasdaq") System, its Fair Market Value shall be the closing sales price for such stock as quoted on such exchange or system on the date of determination as such price is reported in THE WALL STREET JOURNAL or such other source as the Administrator deems reliable; provided, however, that if no sales were reported on the date of determination, the closing bid on that day shall be used, and that if the date of determination falls on weekends or holidays, its Fair Market Value shall be the closing sales price for such stock as quoted on such exchange or system on the last market trading day prior to the date of determination. (ii) If the Common Stock is quoted on the Nasdaq System (but not on the National Market thereof) or regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the bid and asked prices for the Common Stock; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value thereof shall be determined in good faith by the Administrator. (n) "INCENTIVE STOCK OPTION" shall mean an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code, as designated in the applicable written option agreement. (o) "NAMED EXECUTIVE" shall mean any individual who, on the last day of the Company's fiscal year, is the chief executive officer of the Company (or is acting in such capacity) or among the four highest compensated officers of the Company (other than the chief executive officer). Such officer status shall be determined pursuant to the executive compensation disclosure rules under the Exchange Act. -2- (p) "NONSTATUTORY STOCK OPTION" shall mean an Option not intended to qualify as an Incentive Stock Option, as designated in the applicable written option agreement. (q) "OFFICER" shall mean a person who is an officer of the Company within the meaning of Section 16 of the Exchange Act and the rules and regulations promulgated thereunder. (r) "OPTION" shall mean a stock option granted pursuant to the Plan. (s) "OPTIONED STOCK" shall mean the Common Stock subject to an Option. (t) "OPTIONEE" shall mean an Employee or Consultant who receives an Option. (u) "PARENT" shall mean a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code, or any successor provision. (v) "PLAN" shall mean this 1992 Stock Option Plan. (w) "RULE 16b-3" shall mean Rule 16b-3 promulgated under the Exchange Act as the same may be amended from time to time, or any successor provision. (x) "SHARE" shall mean a share of Common Stock, adjusted in accordance with Section 12 below. (y) "SUBSIDIARY" shall mean a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code, or any successor provision. 3. STOCK SUBJECT TO THE PLAN. Subject to the provisions of Section 13 below, the maximum aggregate number of shares that may be sold under the Plan is 2,615,895 shares of Common Stock, plus an automatic increase on the date of each annual meeting of the shareholders during the period beginning (and including) November 19, 1998 and ending September 14, 2002 (the date of the termination of the Plan) (the "Increase Period") equal to the lesser of: (x) four percent (4%) of the total number of shares of the Company's Common Stock issued and outstanding as of the last business day immediately preceding the date of the annual meeting of the shareholders each fiscal year, or (y) 600,000 shares, for a maximum aggregate of 5,015,895 shares that may be sold under the Plan prior to its termination. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option should expire or become unexercisable for any reason without having been exercised in full, then the unpurchased Shares that were subject to the Option shall, unless the Plan has been terminated, become available for future grant under the Plan. In addition, any Shares of Common Stock which are retained by the Company upon exercise of an Option in order to satisfy the exercise price for such Option or any withholding taxes due with respect to such exercise, shall be treated as not issued and shall continue to be available under the Plan. Notwithstanding any other provision of the Plan, shares issued under the Plan and later repurchased by the Company shall not become available for future grant or sale under the Plan. -3- 4. ADMINISTRATION OF THE PLAN (a) COMPOSITION OF ADMINISTRATOR. (i) MULTIPLE ADMINISTRATIVE BODIES. If permitted by Rule 16b-3 promulgated under the Exchange Act or any successor rule thereto, as in effect at the time that discretion is being exercised with respect to the Plan ("Rule 16b-3"), and by the legal requirements relating to the administration of incentive stock option plans, if any, of applicable securities laws and the Code (collectively, the "Applicable Laws"), grants under the Plan may (but need not) be made by different administrative bodies with respect to Directors, Officers who are not Directors and Employees who are neither Directors nor Officers. (ii) ADMINISTRATION WITH RESPECT TO DIRECTORS AND OFFICERS. With respect to grants of Options to Employees or Consultants who are also Officers or Directors of the Company, grants under the Plan shall be made by (A) the Board, if the Board may make grants under the Plan in compliance with Rule 16b-3 and Section 162(m) of the Code as it applies so as to qualify grants of Options to Named Executives as performance-based compensation, or (B) a Committee designated by the Board to make grants under the Plan, which Committee shall be constituted in such a manner as to permit grants under the Plan to comply with Rule 16b-3, to qualify grants of Options to Named Executives as performance-based compensation under Section 162(m) of the Code and otherwise so as to satisfy the Applicable Laws. (iii) ADMINISTRATION WITH RESPECT TO OTHER PERSONS. With respect to grants of Options to Employees or Consultants who are neither Directors nor Officers of the Company, the Plan shall be administered by (A) the Board or (B) a Committee designated by the Board, which Committee shall be constituted in such a manner as to satisfy the Applicable Laws. (iv) GENERAL. If a Committee has been appointed pursuant to subsection (ii) or (iii) of this Section 4(a), such Committee shall continue to serve in its designated capacity until otherwise directed by the Board. From time to time the Board may increase the size of any Committee and appoint additional members thereof, remove members (with or without cause) and appoint new members in substitution therefor, fill vacancies (however caused) and remove all members of a Committee and thereafter directly administer the Plan, all to the extent permitted by the Applicable Laws and, in the case of a Committee appointed under subsection (ii), to the extent permitted by Rule 16b-3 and to the extent required under Section 162(m) of the Code to qualify grants of Options to Named Executives as performance-based compensation. (b) POWERS OF THE ADMINISTRATOR. Subject to the provisions of the Plan and in the case of a Committee, the specific duties delegated by the Board to such Committee, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(m) of the Plan; -4- (ii) to select the Employees and Consultants to whom Options may from time to time be granted hereunder; (iii) to determine whether and to what extent Options are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder (including, but not limited to, the share price and any restriction or limitation, or any vesting acceleration or waiver of forfeiture restrictions regarding any Option and/or the shares of Common Stock relating thereto, based in each case on such factors as the Administrator shall determine, in its sole discretion); and (vii) to reduce the exercise price of any Option to the then current Fair Market Value if the Fair Market Value of the Common Stock covered by such Option shall have declined since the date the Option was granted. (c) EFFECT OF ADMINISTRATOR'S DECISION. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options. 5. ELIGIBILITY. (a) Options may be granted only to Employees and Consultants. Incentive Stock Options may be granted only to Employees. An Employee or Consultant who has been granted an Option may, if he or she is otherwise eligible, be granted an additional Option or Options. (b) Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designations, to the extent that the aggregate Fair Market Value of Stock Options are exercisable for the first time by an Optionee during any calendar year (under all plans of the Company or any Parent or Subsidiary) exceeds $100,000, such excess Options shall be treated as Nonstatutory Stock Options. (c) For purposes of Section 5(b), Incentive Stock Options shall be taken into account in the order in which they were granted, and the Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. (d) The Plan shall not confer upon any Optionee any right with respect to continuation of employment or consulting relationship with the Company, nor shall it interfere in -5- any way with his or her right or the Company's right to terminate his or her employment or consulting relationship at any time, with or without cause. 6. TERM OF PLAN. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the Shareholders of the Company as described in Section 19 below. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 15 below. 7. TERM OF OPTION. The term of each option shall be the term stated in the Option Agreement, PROVIDED, HOWEVER, that in the case of an Incentive Stock Option, the term shall be no more than ten (10) years from the date of grant thereof or such shorter term as may be provided in the Stock Option Agreement. However, in the case of an Incentive Stock Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant thereof or such shorter time as may be provided in the Stock Option Agreement. 8. LIMITATION GRANTS TO EMPLOYEES. Subject to adjustment as provided in this Plan, the maximum number of shares which may be subject to Options granted to any one Employee under this Plan for any fiscal year of one Company shall be 1,000,000. 9. EXERCISE PRICE AND CONSIDERATION (a) EXERCISE PRICE. The per Share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Administrator, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of the grant of such Incentive Stock Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than one hundred ten percent (110%) of the Fair Market Value per Share on the date of grant. (B) granted to any other Employee, the per Share exercise price shall be no less than one hundred percent (100%) of the Fair Market Value per Share on the date of grant. (ii) In the case of a Nonstatutory Stock Option (A) granted to a person who, at the time of the grant of such Option, is a Named Executive of the Company, the per Share exercise price shall be no less than one hundred percent (100%) of the Fair Market Value on the date of grant. -6- (B) granted to any person other than a Named Executive, the per Share exercise price shall be no less than eighty-five percent (85%) of the Fair Market Value per Share on the date of grant. (b) PERMISSIBLE CONSIDERATION. The Administrator shall determine the acceptable form of consideration for exercising an Option, including the method of payment. In the case of an Incentive Stock Option, the Administrator shall determine the acceptable form of consideration at the time of grant. Such consideration may consist entirely of: (i) cash; (ii) check; (iii) promissory note; (iv) other Shares which (A) in the case of Shares acquired upon exercise of an option, have been owned by the Optionee for more than six months on the date of surrender, and (B) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which said Option shall be exercised; (v) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price; (vi) any combination of the foregoing methods of payment; or (vii) such other consideration and method of payment for the issuance of Shares to the extent permitted by Applicable Laws. 10. EXERCISE OF OPTION (a) PROCEDURE FOR EXERCISE; RIGHTS AS A SHAREHOLDER. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Administrator, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Administrator, consist of any consideration and method of payment allowable under Section 9(b) above. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a Shareholder shall exist with -7- respect to the Optioned Stock, notwithstanding the exercise of the Option. No adjustment shall be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 13 below. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) TERMINATION OF STATUS AS AN EMPLOYEE OR CONSULTANT. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant, he or she may, but only within thirty (30) days (or such other period of time not exceeding three (3) months in the case of an Incentive Stock Option or six (6) months in the case of a Nonstatutory Stock Option, as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of the grant of the Option) after the date of such termination (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), exercise his or her Option to the extent that he or she was entitled to exercise it at the date of such termination. To the extent that he or she was not entitled to exercise the Option at the date of such termination, or if he or she does not exercise such Option (which he or she was entitled to exercise) within the time specified herein, the Option shall terminate. (c) DISABILITY OF OPTIONEE. Notwithstanding the provisions of Section 10(b) above, in the event of termination of an Optionee's Continuous Status as an Employee or Consultant with the Company as a result of his or her total and permanent disability (as defined in Section 22(e)(3) of the Code), then he or she may, but only within six (6) months (or such other period of time not exceeding twelve (12) months as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of the grant of the Option) from the date of termination (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), exercise his or her Option to the extent he or she was entitled to exercise it at the date of termination of employment or consulting. To the extent that he or she was not entitled to exercise the Option at the date of termination, or if he or she does not exercise such Option (which he or she was entitled to exercise) within the time specified herein, the Option shall terminate. (d) DEATH OF OPTIONEE. Notwithstanding the provisions of Section 10(b) above, in the event of the death of an Optionee: (i) during the term of the Option who is at the time of his or her death an Employee or Consultant of the Company and who shall have been in Continuous Status as an Employee or Consultant since the date of grant of the Option, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued had the Optionee continued -8- living and remained in Continuous Status as an Employee or Consultant three (3) months after the date of death; or (ii) within one (1) month (or such other period of time not exceeding three (3) months as is determined by the Administrator, with such determination in the case of an Incentive Stock Option being made at the time of grant of the Option) after the termination of Continuous Status as an Employee or Consultant, the Option may be exercised, at any time within three (3) months following the date of death (but in no event later than the date of expiration of the term of such Option as set forth in the Option Agreement), by the Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. (e) EXTENSION OF EXERCISE PERIOD. Notwithstanding the limitations set forth in Sections 10(b), (c) and (d) above, the Administrator has full power and authority to extend the period of time for which any Option granted under the Plan is to remain exercisable following termination of an Optionee's Continuous Status as an Employee or Consultant from the limited period set forth in the written option agreement to such greater period of time as the Administrator shall deem appropriate; provided, however, that in no event shall such Option be exercisable after the specified expiration date of the Option term. (f) RULE 16b-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. 11. STOCK WITHHOLDING TO SATISFY WITHHOLDING TAX OBLIGATIONS. At the discretion of the Administrator, Optionees may satisfy withholding obligations as provided in this paragraph. When an Optionee incurs tax liability in connection with an Option, which tax liability is subject to tax withholding under applicable tax laws, and the Optionee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the Optionee may satisfy the withholding tax obligation by one or some combination of the following methods: (a) by cash payment, or (b) out of Optionee's current compensation, (c) if permitted by the Administrator, in its discretion, by surrendering to the Company Shares that (i) in the case of Shares previously acquired from the Company, have been owned by the Optionee for more than six months on the date of surrender, and (ii) have a fair market value on the date of surrender equal to or less than Optionee's applicable withholding tax rate times the ordinary income recognized, or (d) by electing to have the Company withhold from the Shares to be issued upon exercise of the Option, if any, that number of Shares having a fair market value equal to the amount required to be withheld. For this purpose, the fair market value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). Any surrender by a Reporting Person of previously owned Shares to satisfy tax withholding obligations arising upon exercise of this Option must comply with the applicable provisions of Rule 16b-3 and shall be subject to such additional conditions or restrictions as may -9- be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. All elections by an Optionee to have Shares withheld to satisfy tax withholding obligations shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; (b) once made, the election shall be irrevocable as to the particular Shares of the Option as to which the election is made; and (c) all elections shall be subject to the consent or disapproval of the Administrator. In the event the election to have Shares withheld is made by an Optionee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the Optionee shall receive the full number of Shares with respect to which the Option is exercised but such Optionee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 12. NON-TRANSFERABILITY OF OPTIONS. An Option may not be sold, pledged, assigned, hypothecated, transferred or disposed of in any manner other than by will or by the laws of descent or distribution. The designation of a beneficiary by an Optionee does not constitute a transfer. An Option may be exercised, during the lifetime of the Optionee, only by the Optionee. 13. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION CORPORATE TRANSACTIONS. (a) CHANGES IN CAPITALIZATION. Subject to any required action by the Shareholders of the Company, the number of shares of Common Stock covered by each outstanding Option, the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, the maximum number of Shares of Common Stock for which Options may be granted to any Employee under Section 8 of the Plan, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Administrator, whose determination in that respect shall be final, binding, and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. -10- (b) CORPORATE TRANSACTIONS. In the event of the proposed dissolution or liquidation of the Company, the Option will terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Administrator. The Administrator may, in the exercise of its sole discretion in such instances, declare that any Option shall terminate as of a date fixed by the Administrator and give each Optionee the right to exercise his or her Option as to all or any part of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. In the event of a proposed sale of all or substantially all of the assets of the Company, or the merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Administrator determines, in lieu of such assumption or substitution, that the Optionee shall have the right to exercise the Option as to some or all of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. If the Administrator makes an Option exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Administrator shall notify the Optionee that the Option shall be exercisable for a period of fifteen (15) days from the date of such notice, and the Option will terminate upon the expiration of such period. 14. TIME OF GRANTING OPTIONS. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option or such other date as is determined by the Administrator. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. 15. AMENDMENT AND TERMINATION OF THE PLAN. (a) AMENDMENT AND TERMINATION. The Board may amend or terminate the Plan from time to time in such respects as the Board may deem advisable; provided, however, that the following revisions or amendments shall require approval of the shareholders of the Company in the manner described in Section 19 of the Plan: (i) any increase in the number of Shares subject to the Plan, other than in connection with an adjustment under Section 13 above; (ii) any change in the designation of the class of persons eligible to be granted Options; or (iii) any change in the limitation on grants to Employees as described in Section 8 of the Plan or other changes which would require shareholder approval to qualify Options granted hereunder as performance-based compensation under Section 162(m). (b) SHAREHOLDER APPROVAL. If any amendment requiring shareholder approval under Section 15(a) above is made subsequent to the first registration of any class of equity security by the Company under Section 12 of the Exchange Act, then such Shareholder approval shall be solicited as described in Section 19 below. -11- (c) EFFECT OF AMENDMENT OR TERMINATION. Any such amendment or termination of the Plan shall not affect Options already granted and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 16. CONDITIONS UPON ISSUANCE OF SHARES. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto complies with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange upon which the Shares may then be listed. The exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 17. RESERVATION OF SHARES. The Company, during the term of this Plan, will at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 18. OPTION AGREEMENT. Options shall be evidenced by written option agreements in such form as the Administrator shall approve. 19. SHAREHOLDER APPROVAL. (a) Continuance of the Plan shall be subject to approval by the shareholders of the Company within twelve (12) months before or after the date the Plan is adopted. Such shareholder approval shall be obtained in the manner and to the degree required under applicable federal and state law and the rules of any stock exchange upon which the Shares are listed. (b) If and in the event that the Company registers any class of equity securities pursuant to Section 12 of the Exchange Act, any required approval of the Shareholders of the Company obtained after such registration shall be solicited substantially in accordance with Section 14(a) of the Exchange Act and the rules and regulations promulgated thereunder. (c) If any required approval by the Shareholders of the Plan itself or of any amendment thereto is solicited at any time otherwise than in the manner described in -12- Section 19(b) hereof, then the Company shall, at or prior to the first annual meeting of Shareholders held subsequent to the later of (1) the first registration of any class of equity securities of the Company under Section 12 of the Exchange Act or (2) the granting of an Option hereunder to an officer or director after such registration, do the following: (i) furnish in writing to the holders entitled to vote for the Plan substantially the same information which would be required (if proxies to be voted with respect to approval or disapproval of the Plan or amendment were then being solicited) by the rules and regulations in effect under Section 14(a) of the Exchange Act at the time such information is furnished; and (ii) file with, or mail for filing to, the Securities and Exchange Commission four copies of the written information referred to in subsection (i) hereof not later than the date on which such information is first sent or given to Shareholders. 20. INFORMATION TO OPTIONEES. The Company shall provide to each Optionee, not less frequently than annually, copies of annual financial statements. The Company shall also provide such statements to each individual who acquires Shares pursuant to the Plan while such individual owns such Shares. The Company shall not be required to provide such statements to key employees whose duties in connection with the Company assure their access to equivalent information. -13- GENERAL SURGICAL INNOVATIONS, INC 1992 STOCK OPTION PLAN NOTICE OF STOCK OPTION GRANT Optionee's Name and Address: < < Optionee > > < < Optionee > > < < Optionee > > You have been granted an option to purchase Common Stock of General Surgical Innovations, Inc., (the "Company") as follows: Date of Grant: < < GrantDate > > Exercise Price Per Share: < < ExercisePrice > > Total Number of Shares Granted: < < SharesGranted > > Total Price of Shares Granted: < < TotalExercisePrice > > Type of Option: < < NoSharesISO > > Shares Incentive Stock Option < < Optionee > > Shares Nonstatutory Stock Option Term/Expiration Date: < < Optionee > >/< < Optionee > > Vesting Commencement Date: < < VestingStartDate > > Vesting Schedule: 25% of the Shares subject to the Option on the first anniversary of the Vesting Commencement Date, and 1/48th of the Shares vest on the monthly anniversary of the Vesting Commencement Date thereafter. Termination Period: Option may be exercised for a period of 30 days after termination of employment or consulting relationship except as set out in Sections 7 and 8 of the Stock Option Agreement (but in no event later than the Expiration Date). By your signature and the signature of the Company's representative below, you and the Company agree that this option is granted under and governed by the terms and conditions of the General Surgical Innovations, Inc. 1992 Stock Option Plan and the Stock Option Agreement, all of which are attached and made a part of this document. OPTIONEE: General Surgical Innovations, Inc. _________________________________ By: _________________________________ Signature _________________________________ Title: ______________________________ Print Name -2- GENERAL SURGICAL INNOVATIONS, INC. STOCK OPTION AGREEMENT 1. GRANT OF OPTION. General Surgical Innovations, Inc., a California corporation (the "COMPANY"), hereby grants to the Optionee named in the Notice of Stock Option Grant attached to this Agreement ("OPTIONEE"), an option (the "OPTION") to purchase the total number of shares of Common Stock (the "SHARES") set forth in the Notice of Stock Option Grant, at the exercise price per share set forth in the Notice of Stock Option Grant (the "EXERCISE PRICE") subject to the terms, definitions and provisions of the 1992 Stock Option Plan (the "PLAN") adopted by the Company, which is incorporated in this Agreement by reference. In the event of a conflict between the terms of the Plan and the terms of this Agreement, the terms of the Plan shall govern. Unless otherwise defined in this Agreement, the terms used in this Agreement shall have the meanings defined in the Plan. To the extent designated an Incentive Stock Option in the Notice of Stock Option Grant, this Option is intended to qualify as an Incentive Stock Option as defined in Section 422 of the Internal Revenue Code of 1986, as amended (the "CODE") and, to the extent not so designated, this Option is intended to be a Nonstatutory Stock Option. 2. EXERCISE OF OPTION. This Option shall be exercisable during its term in accordance with the Vesting Schedule set out in the Notice of Stock Option Grant and with the provisions of Sections 9 and 10 of the Plan as follows: (a) RIGHT TO EXERCISE. (i) This Option may not be exercised for a fraction of a share. (ii) In the event of Optionee's death, disability or other termination of employment, the exercisability of the Option is governed by Sections 6, 7 and 8 below, subject to the limitations contained in paragraphs (iii) and (iv) below. (iii) In no event may this Option be exercised after the date of expiration of the term of this Option as set forth in the Notice of Stock Option Grant. (iv) If designated an Incentive Stock Option in the Notice of Stock Option Grant, in the event that the Shares subject to this Option (and all other Incentive Stock Options granted to Optionee by the Company or any Parent or Subsidiary) that vest in any calendar year have an aggregate fair market value (determined for each Share as of the Date of Grant of the option covering such Share) in excess of $100,000, the Shares in excess of $100,000 shall be treated as subject to a Nonstatutory Stock Option, in accordance with Section 5 of the Plan. (b) METHOD OF EXERCISE. (i) This Option shall be exercisable by delivering to the Company a written notice of exercise (in the form attached as EXHIBIT A) which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised, and such other representations and agreements as to the holder's investment intent with respect to such Shares of Common Stock as may be required by the Company pursuant to the provisions of the Plan. Such written notice shall be signed by Optionee and shall be delivered in person or by certified mail to the Secretary of the Company. The written notice shall be accompanied by payment of the Exercise Price. This Option shall be deemed to be exercised upon receipt by the Company of such written notice accompanied by the Exercise Price. (ii) As a condition to the exercise of this Option, Optionee agrees to make adequate provision for federal, state or other tax withholding obligations, if any, which arise upon the exercise of the Option or disposition of Shares, whether by withholding, direct payment to the Company, or otherwise. (iii) No Shares will be issued pursuant to the exercise of an Option unless such issuance and such exercise shall comply with all relevant provisions of law and the requirements of any stock exchange upon which the Shares may then be listed. Assuming such compliance, for income tax purposes the Shares shall be considered transferred to Optionee on the date on which the Option is exercised with respect to such Shares. 3. OPTIONEE'S REPRESENTATIONS. In the event the Shares purchasable pursuant to the exercise of this Option have not been registered under the Securities Act of 1933, as amended (the "SECURITIES ACT"), at the time this Option is exercised, Optionee shall, if required by the Company, concurrently with the exercise of all or any portion of this Option, deliver to the Company an investment representation statement in customary form, a copy of which is available for Optionee's review from the Company upon request. 4. METHOD OF PAYMENT. Payment of the Exercise Price shall be by any of the following, or a combination of the following, at the election of Optionee: (a) cash; (b) check; (c) surrender of other Shares of Common Stock of the Company that (i) either have been owned by Optionee for more than six (6) months on the date of surrender or were not acquired, directly or indirectly, from the Company, and (ii) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which said Option shall be exercised; (d) authorization from the Company to retain from the total number of Shares as to which the Option is exercised that number of Shares having a Fair Market value on the date of exercise equal to the exercise price for the total number of Shares as to which the Option is exercised; or (e) if there is a public market for the Shares and they are registered under the Securities Act, delivery of a properly executed exercise notice together with irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds required to pay the exercise price. 5. RESTRICTIONS ON EXERCISE. This Option may not be exercised until such time as the Plan has been approved by the shareholders of the Company, or if the issuance of such Shares upon such exercise or the method of payment of consideration for such shares would constitute a violation of any applicable federal or state securities or other law or regulation, including any rule under Part 207 of Title 12 of the Code of Federal Regulations ("REGULATION G") as -2- promulgated by the Federal Reserve Board. As a condition to the exercise of this Option, the Company may require Optionee to make any representation and warranty to the Company as may be required by any applicable law or regulation. 6. TERMINATION OF RELATIONSHIP. In the event of termination of Optionee's Continuous Status as an Employee or Consultant, Optionee may, to the extent otherwise so entitled at the date of such termination (the "TERMINATION DATE"), exercise this Option during the Termination Period set out in the Notice of Stock Option Grant. To the extent that Optionee was not entitled to exercise this Option at the date of such termination, or if Optionee does not exercise this Option within the time specified in the Notice of Stock Option Grant, the Option shall terminate. 7. DISABILITY OF OPTIONEE. Notwithstanding the provisions of Section 6 above, in the event of termination of Optionee's Continuous Status as an Employee or Consultant as a result of total and permanent disability (as defined in Section 22(e)(3) of the Code), Optionee may, but only within six (6) months from the date of termination of employment (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), exercise the Option to the extent otherwise so entitled at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of termination, or if Optionee does not exercise such Option (to the extent otherwise so entitled) within the time specified in this Agreement, the Option shall terminate. 8. DEATH OF OPTIONEE. In the event of the death of Optionee: (a) during the term of this Option and while an Employee of the Company and having been in Continuous Status as an Employee or Consultant since the date of grant of the Option, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), by Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued had Optionee continued living and remained in Continuous Status as an Employee or Consultant three (3) months after the date of death, subject to the limitation contained in Section 2(i)(d) above in the case of an Incentive Stock Option; or (b) within thirty (30) days after the termination of Optionee's Continuous Status as an Employee or Consultant, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), by Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. 9. NON-TRANSFERABILITY OF OPTION. This Option may not be transferred in any manner otherwise than by will or by the laws of descent or distribution. The designation of a beneficiary does not constitute a transfer. An Option may be exercised during the lifetime of Optionee only by Optionee or a transferee permitted by this section. The terms of this Option shall be binding upon the executors, administrators, heirs, successors and assigns of Optionee. -3- 10. TERM OF OPTION. This Option may be exercised only within the term set out in the Notice of Stock Option Grant, and may be exercised during such term only in accordance with the Plan and the terms of this Option. 11. NO ADDITIONAL EMPLOYMENT RIGHTS. Optionee understands and agrees that the vesting of Shares pursuant to the Vesting Schedule is earned only by continuing as an Employee or Consultant at the will of the Company (not through the act of being hired, being granted this Option or acquiring Shares under this Agreement). Optionee further acknowledges and agrees that nothing in this Agreement, nor in the Plan which is incorporated in this Agreement by reference, shall confer upon Optionee any right with respect to continuation as an Employee or Consultant with the Company, nor shall it interfere in any way with his or her right or the Company's right to terminate his or her employment or consulting relationship at any time, with or without cause. 12. TAX CONSEQUENCES. Optionee acknowledges that he or she has read the brief summary set forth below of certain federal tax consequences of exercise of this Option and disposition of the Shares under the law in effect as of the date of grant. OPTIONEE UNDERSTANDS THAT THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. OPTIONEE SHOULD CONSULT HIS OR HER OWN TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES. (a) EXERCISE OF INCENTIVE STOCK OPTION. If this Option is an Incentive Stock Option, there will be no regular federal income tax liability upon the exercise of the Option, although the excess, if any, of the fair market value of the Shares on the date of exercise over the Exercise Price will be treated as an item of alternative minimum taxable income for federal tax purposes and may subject Optionee to the alternative minimum tax in the year of exercise. (b) EXERCISE OF NONSTATUTORY STOCK OPTION. If this Option does not qualify as an Incentive Stock Option, Optionee may incur regular federal income tax liability upon the exercise of the Option. Optionee will be treated as having received compensation income (taxable at ordinary income tax rates) equal to the excess, if any, of the fair market value of the Shares on the date of exercise over the Exercise Price. In addition, if Optionee is an employee of the Company, the Company will be required to withhold from Optionee's compensation or collect from Optionee and pay to the applicable taxing authorities an amount equal to a percentage of this compensation income at the time of exercise. (c) DISPOSITION OF SHARES. If this Option is an Incentive Stock Option and if Shares transferred pursuant to the Option are held for more than one year after exercise and more than two years after the Date of Grant, any gain realized on disposition of the Shares will be treated as long-term capital gain for federal income tax purposes. If Shares purchased under an Incentive Stock Option are disposed of before the end of either of such two holding periods, then any gain realized on such disposition will be treated as compensation income (taxable at ordinary income rates) to the extent of the excess, if any, of the lesser of (i) the fair market value of the Shares on the date of exercise, or (ii) the sales proceeds, over the Exercise Price. If this Option is -4- a Nonstatutory Stock Option, then gain realized on the disposition of Shares will be treated as long-term or short-term capital gain depending on whether or not the disposition occurs more than one year after the exercise date. (d) NOTICE OF DISQUALIFYING DISPOSITION. If the Option granted to Optionee in this Agreement is an Incentive Stock Option, and if Optionee sells or otherwise disposes of any of the Shares acquired pursuant to the Incentive Stock Option on or before the later of (i) the date two years after the Date of Grant, or (ii) the date one year after transfer of such Shares to Optionee upon exercise of the Incentive Stock Option, Optionee shall notify the Company in writing within thirty (30) days after the date of any such disposition. Optionee agrees that Optionee may be subject to income tax withholding by the Company on the compensation income recognized by Optionee from the early disposition by payment in cash or out of the current earnings paid to Optionee. 13. SIGNATURE. This Stock Option Agreement shall be deemed executed by the Company and Optionee upon execution by such parties of the Notice of Stock Option Grant attached to this Stock Option Agreement. -5- EXHIBIT A NOTICE OF EXERCISE To: General Surgical Innovations, Inc. Attn: Stock Option Administrator Subject: NOTICE OF INTENTION TO EXERCISE STOCK OPTION This is official notice that the undersigned ("OPTIONEE") intends to exercise Optionee's option to purchase __________ shares of General Surgical Innovations, Inc. Common Stock, under and pursuant to the Company's 1992 Stock Option Plan and the Stock Option Agreement dated ___________, as follows: Grant Number: ________________________________ Date of Purchase: ________________________________ Number of Shares: ________________________________ Purchase Price: ________________________________ Method of Payment of Purchase Price: ________________________________ Social Security No.: ________________________________ The shares should be issued as follows: Name: ________________________________ Address: ________________________________ Signed: ________________________________ Date: ________________________________ EX-10.27 3 EXHIBIT 10.27 GENERAL SURGICAL INNOVATIONS, INC. NOTICE OF NONSTATUTORY STOCK OPTION GRANT Optionee's Name and Address: Gregory D. Casciaro General Surgical Innovations, Inc. 10460 Bubb Road Cupertino, CA 95014 You have been granted an option to purchase Common Stock of General Surgical Innovations, Inc. (the "Company"), as follows: Board Approval Date: April 6, 1998 Date of Grant (Later of Board Approval Date or Commencement of Employment/Consulting): April 6, 1998 Exercise Price Per Share: $4.00 Total Number of Shares Granted: 25,000 Total Price of Shares Granted: $100,000 Term/Expiration Date: April 6, 2008 Vesting Commencement Date: October 6, 2001 Vesting Schedule: 4,166 of the shares subject to the option shall become exercisable each month beginning on October 6, 2001 with all options vested as of April 6, 2002. Termination Period: Option may be exercised for a period of 30 days after termination of employment or consulting relationship with the Company except as set out in Sections 7 and 8 of the Nonstatutory Stock Option Agreement (but in no event later than the Expiration Date). By your signature and the signature of the Company's representative below, you and the Company agree that this option is granted under and governed by the terms and conditions of the Nonstatutory Stock Option Agreement attached and made a part of this document. GREGORY D. CASCIARO GENERAL SURGICAL INNOVATIONS, INC. By: - ------------------------- ----------------------------- Signature Title: - ------------------------- --------------------------- Print Name -2- GENERAL SURGICAL INNOVATIONS, INC. NONSTATUTORY STOCK OPTION AGREEMENT 1. GRANT OF OPTION. General Surgical Innovations, Inc., a California corporation (the "COMPANY"), hereby grants to the Optionee named in the Notice of Stock Option Grant attached to this Agreement ("OPTIONEE"), an option (the "OPTION") to purchase the total number of shares of Common Stock (the "SHARES") set forth in the Notice of Stock Option Grant, at the exercise price per share set forth in the Notice of Stock Option Grant (the "EXERCISE PRICE") subject to the terms, definitions and provisions of this Nonstatutory Stock Option Agreement (the "Agreement"). This Option is intended to be a Nonstatutory Stock Option. 2. EXERCISE OF OPTION. This Option shall be exercisable during its term in accordance with the Vesting Schedule set out in the Notice of Stock Option Grant as follows: (a) RIGHT TO EXERCISE. (i) This Option may not be exercised for a fraction of a share. (ii) In the event of Optionee's death, disability or other termination of employment, the exercisability of the Option is governed by Sections 6, 7 and 8 below, subject to the limitations contained in paragraph (iii) below. (iii) In no event may this Option be exercised after the date of expiration of the term of this Option as set forth in the Notice of Stock Option Grant. (b) METHOD OF EXERCISE. (i) This Option shall be exercisable by delivering to the Company a written notice of exercise (in the form attached as EXHIBIT A) which shall state the election to exercise the Option, the number of Shares in respect of which the Option is being exercised, and such other representations and agreements as to the holder's investment intent with respect to such Shares of Common Stock as may be required by the Company. Such written notice shall be signed by Optionee and shall be delivered in person or by certified mail to the Secretary of the Company. The written notice shall be accompanied by payment of the Exercise Price. This Option shall be deemed to be exercised upon receipt by the Company of such written notice accompanied by the Exercise Price. (ii) As a condition to the exercise of this Option, Optionee agrees to make adequate provision for federal, state or other tax withholding obligations, if any, which arise upon the exercise of the Option or disposition of Shares, whether by withholding, direct payment to the Company, or otherwise. (iii) No Shares will be issued pursuant to the exercise of an Option unless such issuance and such exercise shall comply with all relevant provisions of law and the requirements of any stock exchange upon which the Shares may then be listed. Assuming such compliance, for income tax purposes the Shares shall be considered transferred to Optionee on the date on which the Option is exercised with respect to such Shares. 3. OPTIONEE'S REPRESENTATIONS. In the event the Shares purchasable pursuant to the exercise of this Option have not been registered under the Securities Act of 1933, as amended (the "SECURITIES ACT"), at the time this Option is exercised, Optionee shall, if required by the Company, concurrently with the exercise of all or any portion of this Option, deliver to the Company an investment representation statement in customary form, a copy of which is available for Optionee's review from the Company upon request. 4. METHOD OF PAYMENT. Payment of the Exercise Price shall be by any of the following, or a combination of the following, at the election of Optionee: (a) cash; (b) check; (c) surrender of other Shares of Common Stock of the Company that (i) either have been owned by Optionee for more than six (6) months on the date of surrender or were not acquired, directly or indirectly, from the Company, and (ii) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which said Option shall be exercised; (d) authorization from the Company to retain from the total number of Shares as to which the Option is exercised that number of Shares having a Fair Market value on the date of exercise equal to the exercise price for the total number of Shares as to which the Option is exercised; or (e) if there is a public market for the Shares and they are registered under the Securities Act, delivery of a properly executed exercise notice together with irrevocable instructions to a broker to deliver promptly to the Company the amount of sale or loan proceeds required to pay the exercise price. 5. RESTRICTIONS ON EXERCISE. This Option may not be exercised if the issuance of such Shares upon such exercise or the method of payment of consideration for such shares would constitute a violation of any applicable federal or state securities or other law or regulation, including any rule under Part 207 of Title 12 of the Code of Federal Regulations ("REGULATION G") as promulgated by the Federal Reserve Board. As a condition to the exercise -2- of this Option, the Company may require Optionee to make any representation and warranty to the Company as may be required by any applicable law or regulation. 6. TERMINATION OF RELATIONSHIP. In the event of termination of Optionee's employment or consulting relationship with the Company, Optionee may, to the extent otherwise so entitled at the date of such termination (the "TERMINATION DATE"), exercise this Option during the Termination Period set out in the Notice of Stock Option Grant. To the extent that Optionee was not entitled to exercise this Option at the date of such termination, or if Optionee does not exercise this Option within the time specified in the Notice of Stock Option Grant, the Option shall terminate. The Optionee's employment or consulting relationship shall not be considered terminated in the case of sick leave, military leave, or any other leave of absence approved by the Company's Board of Directors; provided, however, either that such leave must be for a period of not more than ninety (90) days or that re-employment upon the expiration of such leave must be guaranteed by contract or by statute, or is provided pursuant to Company policy adopted from time to time. For purposes of this Agreement, a change in status from an Employee to a Consultant or from a Consultant to an Employee shall not constitute a termination of relationship. 7. DISABILITY OF OPTIONEE. Notwithstanding the provisions of Section 6 above, in the event of termination of Optionee's employment or consulting relationship with the Company as a result of total and permanent disability (as defined in Section 22(e)(3) of the Internal Revenue Code), Optionee may, but only within six (6) months from the date of termination of such relationship (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), exercise the Option to the extent otherwise so entitled at the date of such termination. To the extent that Optionee was not entitled to exercise the Option at the date of termination, or if Optionee does not exercise such Option (to the extent otherwise so entitled) within the time specified in this Agreement, the Option shall terminate. 8. DEATH OF OPTIONEE. In the event of the death of Optionee: (a) during the term of this Option and while an employee or consultant of the Company and having been an employee or consultant of the Company since the date of grant of the Option, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), by Optionee's estate or by a person who acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that would have accrued had Optionee continued living and remained as a director of the Company three (3) months after the date of death, subject to the limitation contained in Section 2(i)(d) above in the case of an Incentive Stock Option; or (b) within thirty (30) days after the termination of Optionee's employment or consulting relationship with the Company, the Option may be exercised, at any time within six (6) months following the date of death (but in no event later than the date of expiration of the term of this Option as set forth in Section 10 below), by Optionee's estate or by a person who -3- acquired the right to exercise the Option by bequest or inheritance, but only to the extent of the right to exercise that had accrued at the date of termination. 9. NON-TRANSFERABILITY OF OPTION. This Option may not be transferred in any manner otherwise than by will or by the laws of descent or distribution. The designation of a beneficiary does not constitute a transfer. An Option may be exercised during the lifetime of Optionee only by Optionee or a transferee permitted by this section. The terms of this Option shall be binding upon the executors, administrators, heirs, successors and assigns of Optionee. 10. TERM OF OPTION. This Option may be exercised only within the term set out in the Notice of Stock Option Grant, and may be exercised during such term only in accordance with the terms of this Option. 11. NO ADDITIONAL EMPLOYMENT RIGHTS. Optionee understands and agrees that the vesting of Shares pursuant to the Vesting Schedule is earned only by continuing as an employee or consultant of the Company at the will of the Company (not through the act of being hired, being granted this Option or acquiring Shares under this Agreement). Optionee further acknowledges and agrees that nothing in this Agreement shall confer upon Optionee any right with respect to continuation as an employee or consultant of the Company, nor shall it interfere in any way with his or her right or the Company's right to terminate his or her employment or consulting relationship at any time, with or without cause. 12. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION CORPORATE TRANSACTIONS. (a) CHANGES IN CAPITALIZATION. Subject to any required action by the Shareholders of the Company, the number of shares of Common Stock covered by the Option and the price per share of Common Stock covered by this Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board of Directors, whose determination in that respect shall be final, binding, and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to this Option. (b) CORPORATE TRANSACTIONS. In the event of the proposed dissolution or liquidation of the Company, the Option will terminate immediately prior to the consummation of such proposed action, unless otherwise provided by the Board of Directors. The Board of Directors may, in the exercise of its sole discretion in such instances, declare that this Option shall terminate as of a date fixed by the Board of Directors and give the Optionee the right to exercise his Option as to all or any part of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. In the event of a proposed sale of all or substantially -4- all of the assets of the Company, or the merger of the Company with or into another corporation, the Option shall be assumed or an equivalent option shall be substituted by such successor corporation or a parent or subsidiary of such successor corporation, unless the Board of Directors determines, in lieu of such assumption or substitution, that the Optionee shall have the right to exercise the Option as to some or all of the Optioned Stock, including Shares as to which the Option would not otherwise be exercisable. If the Board of Directors makes an Option exercisable in lieu of assumption or substitution in the event of a merger or sale of assets, the Board of Directors shall notify the Optionee that the Option shall be exercisable for a period of fifteen (15) days from the date of such notice, and the Option will terminate upon the expiration of such period. 13. TAX CONSEQUENCES. Optionee acknowledges that he or she has read the brief summary set forth below of certain federal tax consequences of exercise of this Option and disposition of the Shares under the law in effect as of the date of grant. OPTIONEE UNDERSTANDS THAT THIS SUMMARY IS NECESSARILY INCOMPLETE, AND THE TAX LAWS AND REGULATIONS ARE SUBJECT TO CHANGE. OPTIONEE SHOULD CONSULT HIS OR HER OWN TAX ADVISER BEFORE EXERCISING THIS OPTION OR DISPOSING OF THE SHARES. (a) EXERCISE OF NONSTATUTORY STOCK OPTION. Optionee may incur regular federal income tax liability upon the exercise of the Option. Optionee will be treated as having received compensation income (taxable at ordinary income tax rates) equal to the excess, if any, of the fair market value of the Shares on the date of exercise over the Exercise Price. In addition, if Optionee is an employee of the Company, the Company will be required to withhold from Optionee's compensation or collect from Optionee and pay to the applicable taxing authorities an amount equal to a percentage of this compensation income at the time of exercise. (b) DISPOSITION OF SHARES. Gain realized on the disposition of Shares will be treated as long-term or short-term capital gain depending on whether or not the disposition occurs more than one year after the exercise date. 14. AMENDMENT OF OPTION. In addition to any changes or adjustments that may be made pursuant to Section 12 above, the Company's Board of Directors shall have the authority to make the following determinations with respect to, and amendments to, the Option without the consent of Optionee: (a) waiver of any restriction applicable to the Option or the Shares; (b) reduction in the exercise price of the Option to the Fair Market Value of shares of the Company's Common Stock as of the date of such reduction in price; (c) extension of the exercise periods set forth in Section 5, 6 and 7 above; and (d) any other amendment or adjustment that does not materially and adversely affect Optionee's rights hereunder. 15. SIGNATURE. This Stock Option Agreement shall be deemed executed by the Company and Optionee upon execution by such parties of the Notice of Stock Option Grant attached to this Stock Option Agreement. -5- [REMAINDER OF PAGE LEFT INTENTIONALLY BLANK] -6- EXHIBIT A NOTICE OF EXERCISE To: General Surgical Innovations, Inc. Attn: Stock Option Administrator Subject: NOTICE OF INTENTION TO EXERCISE NONSTATUTORY STOCK OPTION This is official notice that the undersigned ("OPTIONEE") intends to exercise Optionee's option to purchase __________ shares of General Surgical Innovations, Inc. Common Stock, under and pursuant to the Nonstatutory Stock Option Agreement dated ___________, as follows: Grant Number: ________________________________ Date of Purchase: ________________________________ Number of Shares: ________________________________ Purchase Price: ________________________________ Method of Payment of Purchase Price: ________________________________ Social Security No.: ________________________________ The shares should be issued as follows: Name: ___________________________ Address: ____________________________ ____________________________ ____________________________ Signed: ____________________________ Date: ____________________________ EX-27.1 4 EXHIBIT 27.1
5 1,000 6-MOS JUN-30-1999 JUL-01-1998 DEC-31-1998 14,501 15,091 991 163 2,836 27,322 2,434 1,546 36,899 3,431 0 0 0 13 33,334 36,899 2,947 2,947 (1,815) (1,815) (9,142) 0 (10) (7,075) 0 (7,075) 0 0 0 (7,075) (.53) (.53)
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