-----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, UPks5pEB6JKHGMdPpJ9+H1kM5QL07PToPGKSJH2n7VGuu2Cz6eDGpCHPMa/Rbvcz 4hTP93jMt2px9nqgyVAjNw== 0000950149-99-000498.txt : 19990325 0000950149-99-000498.hdr.sgml : 19990325 ACCESSION NUMBER: 0000950149-99-000498 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990102 FILED AS OF DATE: 19990324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: THORATEC LABORATORIES CORP CENTRAL INDEX KEY: 0000350907 STANDARD INDUSTRIAL CLASSIFICATION: SURGICAL & MEDICAL INSTRUMENTS & APPARATUS [3841] IRS NUMBER: 942340464 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 033-72502 FILM NUMBER: 99571815 BUSINESS ADDRESS: STREET 1: 6035 STONERIDGE DR CITY: PLEASANTON STATE: CA ZIP: 94588 BUSINESS PHONE: 9258478600 MAIL ADDRESS: STREET 1: 6035 STONERIDGE DR CITY: PLEASANTON STATE: CA ZIP: 94588 10-K 1 FORM 10-K FOR THE YEAR ENDED 1/2/1999 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED) FOR THE FISCAL YEAR ENDED JANUARY 2, 1999 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (NO FEE REQUIRED) FOR THE TRANSITION PERIOD FROM ____________ TO ____________. COMMISSION FILE NUMBER: 1-8145 THORATEC LABORATORIES CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 94-2340464 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 6035 STONERIDGE DRIVE, PLEASANTON, CALIFORNIA 94588 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (925) 847-8600 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE EXCHANGE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE EXCHANGE ACT: COMMON STOCK Indicate by a 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 [ ] Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the voting stock held by non-affiliates was $82,249,000 computed by reference to the last sale reported of such stock on March 22, 1999 as reported by the Nasdaq National Market tier of The Nasdaq Stock Market.(1) As of March 22, 1999, registrant had 20,428,179 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: The registrant is incorporating by reference into Part III (Items 10, 11, 12 and 13) certain portions of the registrant's definitive Proxy Statement for the 1999 Annual Meeting of Shareholders. - --------------- (1) Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to cause the direction of the management or policies of the issuer, or that such person is controlled by or under common control with the issuer. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART 1 The statements in this Annual Report on Form 10-K and other statements made by the Company from time to time that relate to future plans, events or performance are forward-looking statements which involve risks and uncertainties. Actual results, events or performance may differ materially from those anticipated in any forward-looking statements as a result of a variety of factors, including those set forth below and elsewhere in this Annual Report on Form 10-K. The risk factors set forth at pages 15 to 21 should be considered carefully in evaluating the Company and its business by the Company's shareholders and prospective investors in the Company. ITEM. 1 BUSINESS GENERAL Thoratec Laboratories Corporation ("Thoratec" or the "Company") operates in a single business segment which develops, manufactures and markets medical devices for circulatory support and vascular graft applications. The Company's first product, the Thoratec(R) Ventricular Assist Device System ("VAD System") is being marketed in the U.S. and internationally for use as a bridge to heart transplant and is currently the only device approved by the U.S. Food and Drug Administration (the "FDA") that can provide left, right or biventricular support for both bridge to heart transplant and post cardiotomy recovery. The Company believes that the VAD System provides a number of significant advantages over other ventricular assist devices. The Company is pursuing additional indications for the VAD System and is developing other circulatory support products for patients suffering from heart failure. The Company is also developing vascular grafts for hemodialysis and coronary artery bypass surgery. All of the Company's products utilize its proprietary biomaterial, Thoralon(TM), which provides improved thromboresistance, biocompatibility, patency and durability. The Company operates in a single business segment with different products in circulatory support and vascular grafts. The Company presents its business geographically as its Domestic operation which comprises the Company's business in the United States, and its International operation, which comprises its business in Europe and the rest of the world. CIRCULATORY SUPPORT PRODUCTS Cardiac failure is the leading cause of death in the U.S., accounting for more deaths than all forms of cancer combined. Deaths associated with cardiac failure fall into two broad categories: chronic congestive heart failure ("CHF"), which is a slow, degenerative process leading to cardiac insufficiency; and acute cardiac failure resulting from heart attacks and various infections of the heart muscle (myocarditis). CHF is a chronic disorder that occurs when the pumping power of the heart is reduced by a weakening of the heart muscle. This results in a decreased supply of oxygen and nutrient rich blood to various vital organs such as the lungs, brain and kidneys. CHF tends to be progressive and is associated with profound symptoms that limit daily activities. Long-term survival rates are low and it is estimated that more than 85% of patients die within eight to twelve years of diagnosis. CHF is estimated to be the most common cause of hospitalization in patients over 65 years of age. According to the American Heart Association, there are approximately four to five million CHF patients in the U.S., and approximately 400,000 newly diagnosed patients each year. Most patients suffering from CHF are initially treated with medication and, while conventional drug therapy may delay the progress of CHF, it is not curative. The only available method of treating end-stage CHF is a heart transplant. Although heart transplants have been very successful, there are too few donor hearts available to address adequately the problem of cardiac failure. The United Network for Organ Sharing reported that there were only approximately 2,400 hearts available for transplant in the U.S. in 1996, a level that has remained relatively unchanged for the last several years. However, published government sources estimate that the number of patients suffering from CHF who could benefit from some form of permanent cardiac assist is 30,000 to 50,000 per year. The average wait for a donor heart by patients on a heart transplant waiting list is 1 3 approximately eight months, and many patients have to wait as long as one to two years before receiving one of the few donor hearts available each year. In 1996, approximately 20% of such patients died while waiting for a donor heart. Ventricular assist devices are mechanical systems used to assist the heart's function, and, when other therapies are unsuccessful, they can be used to support one or both sides of the patient's heart until a donor heart can be found. In patients awaiting heart transplants, the decision to use a ventricular assist device is made when death appears imminent. In addition to providing a bridge to heart transplant, ventricular assist devices have potential usefulness for other applications. It is estimated that out of approximately 600,000 open heart surgeries performed annually in the U.S., some 15,000 to 18,000 patients die following such procedures. Many of these deaths are caused by heart failure when the heart, weakened by disease and the additional trauma of surgery, fails to maintain adequate blood circulation. The use of a ventricular assist device after surgery can provide support to the heart until it can recover. In addition, ventricular assist devices may also be useful in assisting the recovery of the heart in a small portion of patients suffering from acute cardiac failure that may result from myocardial infarction, myocarditis or other acute cardiomyopathies. While there is significant demand for effective ventricular assist devices, most systems available today or under development have certain limitations. Certain systems cannot be used in smaller patients because the blood pump must be implanted in the abdomen and is too large to fit in such patients. Other systems require large incisions at the apex of the heart muscle, making recovery of the heart more difficult if too large an incision is made. Some systems cannot be used for more than a few days because their blood contacting parts cause an adverse reaction in the body, resulting in clotting which clogs the system or can cause a stroke. In addition, much of the development work on ventricular assist devices has historically been in the area of left ventricular support, and most systems available today or under development only provide left ventricular support. While many patients do well with isolated left ventricular support, some patients supported with systems designed solely for isolated left ventricular assist also have or can develop right ventricular failure and require right ventricular device support with another system. Mortality and morbidity are extremely high for this patient group. It has been reported that 20% to 40% of patients supported by a left ventricular assist device either died of right heart failure or required the placement of a right heart ventricular assist device. The one other available system that provides biventricular assistance for postcardiotomy recovery confines the patient to the bed and is recommended for short term use only. There are no risk factors that allow a surgeon to predict reliably which patients will require biventricular support. Thoratec believes that the VAD System is able to make ventricular support available to a broader patient population and to better serve the existing patient population by (i) providing biventricular support, which is necessary in 20% to 40% of patients receiving ventricular assistance, (ii) placing the pump paracorporeally (worn on the outside of the body), enabling it to support patients of varying sizes, including very small patients, (iii) providing the surgeon with multiple options in positioning the cannulae and in the size and shape of the cannulae used, potentially reducing damage to the heart, (iv) incorporating proprietary Thoralon(TM) in most blood contacting parts, potentially reducing or eliminating the risks of certain adverse reactions by the body and permitting the system to be used for potentially extended periods, and (v) providing circulatory support for both bridge to transplant and postcardiotomy recovery of the natural heart. VASCULAR GRAFTS Vascular Access. The principal use of vascular access grafts is for hemodialysis. Severe acute and chronic diseases, including kidney disease, diabetes and hypertension, may destroy normal kidney function, resulting in acute renal failure. End stage renal disease is irreversible and currently approximately 60% of all patients suffering from this disease are maintained by hemodialysis. According to the Health Care Financing Administration's ("HCFA") 1997 dialysis patient database, there were 200,000 patients in the U.S. at the end of 1997 undergoing hemodialysis. The Company estimates that the U.S. represents less than one-half of the worldwide hemodialysis patient population. Hemodialysis removes blood from the body and routes it to an artificial kidney machine where it is cleansed and returned to the patient. Patients undergoing hemodialysis require easy, routine access to the 2 4 blood stream at a high flow rate, which generally requires the attachment of a high pressure artery to a low pressure vein. Two different methods are typically used. The first, called an autologous arterio-venous ("A/V") fistula, involves cutting one of the arteries in the patient's arm and sewing the artery to an adjacent vein. The second method uses a prosthetic vascular graft, most often an expanded polytetrafluorethylene ("ePTFE") graft, which is surgically connected between an artery and a vein. A hemodialysis technician inserts two large needles into either the vein of the A/V fistula or the synthetic graft. One needle removes the blood and routes it to the artificial kidney machine and the second returns the blood to the patient. This procedure is generally repeated three times per week. Vascular access methods currently available for hemodialysis applications have certain limitations. Both natural and ePTFE access grafts must mature for three to four weeks before use and therefore patients receiving such grafts require temporary routes of access. These temporary access procedures entail additional cost and risk to the patient. ePTFE grafts are relatively inflexible, which often leads to kinking and a higher risk of thrombosis. ePTFE grafts also lose integrity after repeated punctures, which renders the patient susceptible to bleeding and infection. If prosthetic grafts bleed profusely when needles used for hemodialysis are removed, a technician may need to apply pressure to the graft for up to 20 minutes to permit clotting. Such problems associated with currently available vascular grafts sometimes require them to be surgically replaced or modified on a periodic basis. The Company estimates that approximately 200,000 new and existing hemodialysis patients per year worldwide undergo vascular access procedures. The Company estimates that approximately 50% to 60% of these patients receive prosthetic grafts. In January 1999, the Company signed a worldwide distribution agreement with Guidant Corporation ("Guidant") under which Guidant will market the Vectra(TM) VAG in all countries except Japan. Coronary Artery Bypass Surgery. Currently, obstructed coronary arteries are either partially cleared through the use of angioplasty or related procedures or treated surgically through coronary artery bypass surgery. Coronary artery bypass surgery involves connecting one or more new vessels from the aorta to the heart to re-route blood around blockages in the coronary arteries. Autologous grafts using saphenous veins (from the leg) or the internal mammary artery have been successfully used in bypass procedures for a number of years and have shown a relatively high patency with no risk of tissue rejection. The Company estimates that in 1997 there were approximately 500,000 coronary artery bypass surgery procedures performed in the U.S. and approximately 250,000 performed outside of the U.S. The Company estimates that on average three bypasses are performed in each surgical procedure. While the use of natural vessels is the standard of care in coronary artery bypass surgery, the harvesting of vessels for autologous grafts involves significant trauma and expense. Use of these vessels requires additional time in surgery and results in patient morbidity associated with removal of the blood vessel. In addition, a significant number of patients requiring coronary artery bypass surgery have insufficient autologous vessels as a result of previous bypass surgeries, or their vessels are of inferior quality due to trauma or disease. The Company estimates that these patients may represent as much as 20% of the total. No synthetic graft is currently commercially available in the U.S. for coronary artery bypass surgery, but the Company believes a significant market opportunity for such grafts exists. The major reason for the unavailability of a synthetic graft for this indication has been that synthetic grafts configured in small diameters (less than five mm) necessary for this indication generally do not remain patent. THORATEC BIOMATERIALS -- THORALON(TM) The Company has developed expertise in the design and production of proprietary biomaterials that are highly biocompatible (i.e., they do not cause adverse reactions within the body), strong and flexible. This technology is critical to the successful performance of all of Thoratec's products that come into contact with human tissue. All of the Company's current products and those under development incorporate these proprietary biomaterials in order to minimize clotting and inflammatory responses. In addition, these products must maintain their strength and flexibility. A VAD System blood pump, for instance, must contract and expand approximately 40 million times per year without a decrease in performance or failure. The two major components of Thoralon(TM) are surface modifying additives ("SMAs") and BPS-215 polyurethaneurea ("BPS-215"), a high flex life elastomer. 3 5 SMAs are proprietary multipolymers designed to enhance the biocompatibility of the surface of a device that comes into contact with blood or other tissues. SMAs are added to the base polymer component of the biomaterial in the bulk fabrication stage. A unique property of SMAs is their ability to concentrate at the surface of any finished part, thus determining its surface properties independent of the base polymer. This SMA-based surface layer is not a coating but a fully integrated part of the polymer which is not soluble in water or blood. The result is a biocompatible, thromboresistant surface. BPS-215 is the base component that provides the bulk properties of strength and flexibility to Thoralon(TM). The combination of bulk and surface properties provided by SMAs and BPS-215 provides Thoralon(TM) with the critical properties necessary for implantable cardiovascular and other medical devices. In 1992, Thoratec granted COBE a royalty-bearing license and sublicense to use Thoratec's SMAs in certain COBE medical devices. CIRCULATORY SUPPORT PRODUCTS Thoratec received FDA clearance in December 1995 to market the VAD System as a bridge to heart transplant in patients suffering from heart failure, and began marketing the VAD System in the U.S. in January 1996. The VAD System has also received regulatory clearance and is currently being marketed in major European countries, Canada and certain other major international markets. Building on the proprietary technologies contained in the VAD System, Thoratec is attempting to develop a broad line of circulatory support products to meet the wide range of needs of patients suffering from heart failure. Overview of the VAD System. The VAD System consists of three major components: the blood pump, a type of artificial heart; the Thoratec Dual Drive Console (the "Dual Drive Console"), which pneumatically activates the blood pump; and cannulae which connect the blood pump to the heart and vessels. The VAD System provides partial or total circulatory assistance when the natural heart is unable to maintain adequate circulation to perfuse vital organs and permits left, right, or biventricular support. Advantages of the VAD System. Compared to other ventricular assist devices, Thoratec believes that the VAD System has the following principal advantages: - Biventricular Support. Development of ventricular assist devices evolved from the concept that most patients could be successfully supported with a left ventricular assist device ("LVAD"). While many patients do well with isolated left ventricular support, some patients supported with systems designed solely for isolated left ventricular assist also have or can develop right ventricular failure and require right ventricular assist device ("RVAD") support with another system. Mortality and morbidity are extremely high for this patient group if not adequately supported. Most systems available today provide only left ventricular support and the only system other than the VAD System that provides biventricular support is indicated for temporary use in postcardiotomy recovery and post-transplant patients and severely limits patient mobility. There are no risk factors that allow a surgeon to predict reliably which patients will require biventricular support. The decision for univentricular or biventricular support is simplified with the VAD System. In situations where there are no physiologic markers of right heart failure, an LVAD can be used. An RVAD can be used in addition to an LVAD if right heart failure is evident or subsequently occurs. Biventricular support is also indicated in patients with potentially lethal arrhythmias, or severe right ventricular infarction that could result in death during univentricular support. With the VAD System, RVAD support may be employed at the time of LVAD placement, thus eliminating the need for reoperation to insert an RVAD. Isolated RVAD support may also be suitable for patients with right heart failure only. - Paracorporeal Attachment. In the VAD System, the pump is worn outside of the body, allowing the system to support patients of varying sizes, including very small patients such as small women and adolescents. To date, the VAD System has been used in patients as small as 38 pounds. In contrast, other commercially available ventricular assist devices for bridge to heart transplant must be implanted and can only be used in patients large enough to accommodate the device within their abdomen. The 4 6 other benefit derived from paracorporeal attachment is that it does not require invasive abdominal surgery. This makes the VAD System more suitable for critically ill patients who may potentially recover normal function of the heart without this additional surgical trauma. Finally, the attachment of the pump to the body facilitates patient movement, allowing patients to walk, exercise and move around the hospital. - Multiple Cannulation Options. Cannulae for the VAD System come in a number of shapes and sizes, allowing the surgeon to fit the size of the cannulae to the size of the patient and to place the cannulae in different parts of the heart. Other commercially available systems have only limited cannula shape and size. The small size of the Thoratec cannulae, compared to other systems, could make it easier for the heart to recover when the cannulae are removed. Variations of the Thoratec cannulae also allow the surgeon to place the cannulae in places other than the apex of the heart (the only place used by the currently available left ventricular-only system) when heart shape or disease state make apex cannulation undesirable. - Thoratec Biomaterials. Thoratec's proprietary biomaterials are used in most portions of the VAD System that contact blood or are implanted in the body, providing biocompatibility, thromboresistance, flex life and strength. - Multiple Indications. The Company believes that the VAD System is the only device cleared to provide circulatory support for both postcardiotomy recovery and bridge to transplant indications. To date, the VAD System has been used to support patients for periods ranging from a few hours to over one year. Current and Potential Indications. Thoratec has identified three basic clinical needs for circulatory support products: as a bridge to heart transplant; for recovery of the natural heart weakened or damaged by surgery or disease; and as permanent support as an alternative to heart transplant. As of February 1999, the VAD System had been used in more than 1000 patients worldwide ranging in age from 7 to 77 years and in weight from 38 to 316 pounds (17 to 143 kg). BRIDGE TO HEART TRANSPLANT The Company commenced marketing the VAD System in the U.S. in January 1996 for use as a bridge to heart transplant in patients suffering from heart failure following receipt of pre-market approval ("PMA") approval from the FDA in December 1995. In 1998, the Company sold 403 VAD pumps to heart transplant centers worldwide. The Company's submission to the FDA included clinical results in 375 patients (299 males, 76 females), all of whom were awaiting donor hearts and were in imminent risk of dying without ventricular assistance. In spite of the extreme illness and the zero percent survival rate expected with the use of conventional therapy alone for these patients, the VAD System was successful in assisting 233 (62%) of the 375 patients to survive until a donor heart was available. Of the 233 patients who received a heart transplant, 85% survived the transplant and were discharged from the hospital, and the longest duration of VAD System support was 247 days. Sixty-five percent of the 375 patients received biventricular ("BiVAD") support and 34% received LVAD-only support. The large percentage of patients needing BiVAD support reflects the greater severity of disease in patients selected for biventricular support with the VAD System. As a result, LVAD and RVAD patients showed correspondingly improved survival rates: 92% for LVAD and RVAD and 82% for BiVAD post-transplant. The PMA approval was granted based on an in-depth analysis performed in 71 of the 375 patients. Of these patients, 49 (69%) survived to receive a heart transplant and 44 of those (90%) were discharged. None of the control patients survived to receive a heart transplant. Based on these clinical results, the FDA determined that the VAD System was safe and effective in restoring hemodynamic stability to patients awaiting heart transplant. RECOVERY OF THE NATURAL HEART A certain portion of patients who undergo open heart surgery have difficulty recovering normal cardiac function, which makes it difficult to wean the patient from the heart/lung machine. Patients can only stay on the heart/lung machine after surgery for a limited period of time (generally less than six hours), and if they 5 7 are unable to regain normal heart function, they will not survive without ventricular support. The use of a ventricular assist device after surgery can provide support to the heart until the heart can recover. The Company received approval for this indication in May 1998. In addition, ventricular assist devices may also be useful in assisting the recovery of hearts in patients suffering from acute heart failure, such as myocardial infarction and myocarditis, or other acute cardiomyopathies. Thoratec believes that since the Thoralon(TM) used in the blood-contacting parts of the VAD System may not cause an adverse reaction by the body, the VAD System may be used for both short-term and long-term support. In contrast, a competing system that is also approved for the post-cardiotomy recovery indication can only be used for temporary circulatory support and requires that the patient remain bed-ridden. Thoratec believes that other ventricular assist devices currently available or under development are not suitable for recovery of the natural heart because (i) they require surgical implantation and removal of the blood pump from the abdomen, which adds greater surgical trauma to critically ill patients, (ii) they cannot be used in smaller patients due to their size, (iii) the large incision required to be made at the apex of the heart may make recovery of the natural heart more difficult, leaving heart transplant or chronic ventricular assist device support as the only alternatives and (iv) they do not provide biventricular support, which is often required by patients in recovery. As of February 1999, the VAD System had been used in 158 patients who were unable to regain normal heart function following surgery requiring cardiopulmonary bypass and were, therefore, unable to be removed from the heart/lung machine following surgery. Of the 158 patients who have been placed on the VAD System, 37% (59 patients) recovered sufficiently to be weaned from the heart/lung machine, and of those patients, 53% were discharged from the hospital. Duration of patient cardiac support ranged from one to 80 days. Although most patients were supported less than ten days, several required support for between one and three months before they successfully recovered cardiac function. ALTERNATIVE TO HEART TRANSPLANT Given the shortage of donor hearts for patients requiring heart transplant, the Company believes that ventricular assist devices may become a long-term solution for many patients who would otherwise require a heart transplant. To address this need, the Company has developed the TLC-II(TM), a compact and lightweight portable driver to substitute for the Dual Drive Console currently used with the VAD System. The Company believes that this product may enable patients to eventually return home and to work and receive long-term ventricular support without undergoing a heart transplant. Products Under Development. Thoratec currently has under development the circulatory support products described below. There can be no assurance that the Company will successfully develop any of these products, or if successfully developed, that these products will obtain regulatory approval or market acceptance or can be manufactured and sold on commercially acceptable terms. TLC-II(TM) PORTABLE VAD DRIVER ("TLC-II(TM)") Although patients supported with the Dual Drive Console can ambulate throughout the hospital and transfer from critical care units to general wards, they usually cannot leave the hospital because of the size of the console. Thoratec has developed the TLC-II(TM), a compact and lightweight (9.1kg), battery or line-operated biventricular pneumatic drive unit designed to promote greater mobility and self-care. It is intended to allow the patient to more easily exercise and move freely around the hospital grounds, and eventually away from the medical facility. This device provides several portability options, either by hand-carrying the driver or by using a shoulder strap or a small custom trolley. This portable device will connect with a central system cart, which will house a battery charger and the external monitoring computer. The first clinical use of this product was in Germany in the fall of 1997. Thoratec received authority to CE mark (an international symbol of quality which allows products to be distributed in the European Community) this product in March 1998 and introduced the TLC-II(TM) in Europe in the middle of that year. Thoratec received approval for an Investigational Device Exemption ("IDE") from the FDA in November 1998 to begin a clinical trial of this device in the U.S. for use in conjunction with the approved VAD System. 6 8 The Company believes that the regulatory path to approval for this device will be facilitated by the fact that it activates the same VAD System blood pumps that have received FDA approval. IMPLANTABLE VAD ("IVAD") While the paracorporeal placement of the VAD System has certain advantages, especially for small patients and patients in whom additional abdominal surgery presents a high risk, Thoratec is developing an implantable version of its existing VAD blood pump and cannulae to provide additional options for surgeons. Prototypes have been developed and a pre-IDE filing is expected in 1999. Thoratec believes that the regulatory process for the IVAD may be facilitated, in part, by the fact that the VAD System has already undergone preclinical testing in the implantable configuration prior to being introduced for clinical use in the paracorporeal configuration. MUSCLE-POWERED VAD ("MVAD") Thoratec is in the early stage of developing an implantable, muscle-powered circulatory support device to serve as an alternative to heart transplant. The MVAD utilizes conventional pacemaker technology, along with a linear mechanical-to-hydraulic energy converter, to harness the power available in a patient's latissimus dorsi muscle to drive an implanted ventricular assist device. This system is designed to operate without batteries, electrical power transmission systems or other bulky hardware required with electromechanical systems. The MVAD is undergoing laboratory testing, and the Company has received a $500,000 Phase II grant from the Small Business Technology Transfer Program of the National Institutes of Health to support research and development of the energy converter. Extensive technical development and laboratory testing will be required before clinical trials could begin, and this project could be discontinued at any time if feasibility is not demonstrated. There can be no assurance that this product can be successfully developed. VASCULAR GRAFT PRODUCTS Thoratec is developing small diameter vascular graft products intended initially to address the vascular access and coronary artery bypass surgery markets. Both products utilize the Company's proprietary biomaterial, Thoralon(TM), and are protected by several patents covering Thoralon(TM) as well as the graft design and manufacturing processes. Thoratec believes that its vascular grafts are highly compliant, have excellent handling and suturing properties and have the "feel" of a natural vessel. The fabrication process creates a structure in which the three different layers in the wall have different properties which make the graft closely resemble natural blood vessels. The inner textured layer is designed for contact with blood and provides improved thromboresistance, the solid middle layer gives the graft its strength and self-sealing properties, and the outer textured layer is designed to promote tissue ingrowth to promote graft stability. Vectra(TM) Vascular Access Graft ("Vectra(TM)" or "VAG"). Currently available vascular access grafts are commonly made out of ePTFE, which can lose integrity after repeated punctures and render the patient susceptible to bleeding and infection. The Vectra(TM) is designed for use as a shunt between an artery and a vein, primarily to provide access to the bloodstream for renal hemodialysis patients requiring frequent needle punctures during treatment. The Company believes that the Vectra(TM) may provide significant advantages over existing synthetic vascular access grafts and may encourage its use by surgeons who are currently using natural vessels for vascular access. The Vectra(TM) received marketing approval from the Canadian Ministry of Health in March 1996, from the Japanese Ministry of Health in May 1997, and authority to CE Mark the product in January 1998. The Vectra(TM) is also marketed in several other countries, including Australia, Taiwan and South America. Thoratec received approval for an IDE from the FDA in mid-1998 to commence clinical trials in the U.S. The Company believes that these clinical trials will be necessary to support the submission of a 510(k) premarket notification to the FDA. Clinical experience with the Vectra(TM) has been very encouraging. In one retrospective study of the VAG in Australia, 134 patients who were implanted by 31 different surgeons were evaluated. Based on data obtained in this study as well as other clinical trials conducted outside the U.S., the Company believes that the Vectra(TM) offers the following advantages: (i) reduced inflammatory response after implantation; (ii) the 7 9 ability to begin hemodialysis within one to three days after implantation, as opposed to several weeks for ePTFE grafts; (iii) reduced bleeding complications during routine use because of the VAG's self-sealing properties; and (iv) improved handling and suturability. In the Australian study, the median hospital stay was four days and initial use of the VAG for dialysis was performed with a median time after implant of three days. The median follow-up period was 306 days. The patency at both one and two years of dialysis use was comparable to or better than ePTFE grafts, notwithstanding that 73% of the patients who received the Thoratec graft previously demonstrated that they could not tolerate ePTFE grafts. In the second phase of a Japanese 87-patient study, the current model of the Vectra(TM) was implanted in 51 hemodialysis patients. These patients had a three-month cumulative patency rate (unobstructed grafts) of 100% and a 12-month cumulative patency rate of 91%. In contrast, a recent review of literature reporting patency rates for standard ePTFE grafts in 13 different studies demonstrated one-year weighted-average patency of 69.7%. A form of Teflon, ePTFE is the material used in products currently marketed in the U.S. Subsequent to January 2, 1999, the Company entered into a distribution agreement with Guidant Corporation ("Guidant"). Under the terms of agreement, Guidant receives exclusive worldwide marketing and distribution rights to the Thoratec Vectra(TM) Vascular Access Graft product line, except in Japan. In exchange for these rights, Guidant has paid Thoratec $1.5 million, and will pay up to an additional $2 million when the Vectra(TM) product line receives FDA approval for use in the U.S. Guidant also issued a four-year, unsecured line of credit in the amount of $10 million to Thoratec, which may be used, if needed, for a variety of business purposes. Aria(TM) Coronary Artery Bypass Graft ("Aria(TM)" or "CABG"). Coronary artery bypass surgery requires the insertion of substitute vessels to bypass one or more blocked arteries in the heart. These substitute vessels typically require either harvesting the patient's saphenous veins or using the internal mammary artery. These procedures, however, can involve significant trauma and expense, and are sometimes not an option for patients who have undergone previous bypass surgery or who have vessels of inferior quality. The Aria(TM) graft is initially intended for use in coronary artery bypass surgery patients who have no suitable vessels of their own. To date, a total of 27 patients in Canada and Germany have received Thoratec's CABG grafts, ranging in size from 2.0 to 3.5mm. All patients were extremely ill at the time of surgery, and the grafts were implanted on a compassionate use basis (i.e., the patients were found to have no other viable therapeutic options). Follow-up data in a small number of these patients have demonstrated that some CABG grafts remained patent up to one year after surgery. All 22 surviving patients were asymptomatic as of December 1997, with the longest term patient implanted for over four and a half years. None of the remaining five patients are known to have died from causes related to the graft. Long-term test results from a controlled clinical trial on a much larger patient population are required before the capabilities of this graft can be demonstrated. The potential for improved long-term patency in small diameter grafts is the most unique aspect of the Aria(TM) CABG graft. The Company believes that to date no other suitable small diameter graft has been developed which will remain patent over long periods of time when used in this critical application. In January 1999 the Company submitted data to the Canadian Health authorities supporting the request to begin a 330 patient study of the Aria(TM) graft. Thoratec expects to submit a pre-IDE for the Aria(TM) to the U.S. FDA later in 1999. The Company believes this product will require submission of a PMA application to the FDA. Peripheral Graft Applications. In addition to the VAG and CABG graft, Thoratec's graft products may potentially be used in other applications such as peripheral vascular grafts for patients who require restoration of circulation to their arms or legs due to blockages caused by certain disease processes. While the Company is not currently pursuing development of these applications, it has completed sufficient early stage preclinical work in the graft area to believe its graft products could be developed for these applications. Guidant has the right to negotiate for these applications for a short period if Thoratec decides to develop them during the term of the Vectra(TM)distribution agreement. SALES AND MARKETING Circulatory Support Products. The potential customers for Thoratec's circulatory support products are hospitals that perform open heart surgery procedures and heart transplants. Based on published sources, the 8 10 Company estimates that 130 of the approximately 800 hospitals in the U.S. that perform open heart surgery also perform heart transplants. The Company is initially targeting these 130 heart transplant hospitals plus an additional 110 heart transplant hospitals in Europe. Thoratec has recruited and trained a direct sales force that is comprised of nine experienced cardiovascular salespeople to sell the VAD System in the United States, Canada, France, Germany, Spain, United Kingdom, Greece, Netherlands, Portugal and South Africa. The sales effort is complemented by six direct clinical specialists that conduct clinical educational seminars, assist with a new open heart center's first VAD implant and resolve clinical questions or issues. Thoratec also partners with universities, experienced clinicians and opinion leaders to assist with expanding clinical educational needs. The sales team focuses on cardiac surgeons that perform heart transplantation as well as transplant cardiologists, perfusionists and the transplant nursing staff. In addition to its direct selling effort, Thoratec has established a network of international distributors that cover those markets that represent the majority of ventricular assist device potential. The Company's internal marketing staff includes a director of marketing, a marketing manager, a marketing communications manager and an administrator. Thoratec employs sales and marketing tactics commonly found within the cardiovascular capital equipment device market such as direct mail, clinical education seminars, symposia, equipment purchase and lease programs, and journal advertisement. Thoratec has also assembled a Medical Advisory Board consisting of opinion leaders who provide clinical input and direction on product development, marketing and market issues. Hospitals or other medical institutions that acquire the VAD System generally purchase two Dual Drive Consoles (to ensure that a back up Console is available), VADs, related disposables and training. The time from the initial contact with the cardiac surgeon until purchase is generally between nine and eighteen months, due to the expense of the product and common hospital capital equipment acquisition procedures. Upon receipt of a purchase order, the Company will usually ship the products within thirty days. The introduction of a new system requires training of the appropriate personnel. Thoratec provides initial training for the surgical as well as the clinical support teams when a center purchases and takes delivery of the VAD System. As a follow-up to the initial training, Thoratec provides clinical support at the first implant whenever possible. The Company also provides 24-hour access to clinically trained personnel. The Thoratec sales force also assists customers with obtaining reimbursement from third-party payors. Vascular Graft Products. The Company intends to market the Vectra(TM) VAG through its distributor in Japan and through Guidant in the rest of the world, and to market the Aria(TM) CABG graft through a direct sales force in the U.S. and Europe and through distributors in other international markets. The Company envisions the market positioning of the Vectra(TM) as one that replaces an existing product used in an accepted procedure, and at a comparable price. The Company plans to commission studies comparing its products to ePTFE grafts. The Company believes the Vectra(TM) VAG will have significant advantages over these existing products and will therefore offer significant benefits to users and patients, without the need for additional clinical training. The Company also believes that more clinicians using natural A/V fistulas will utilize a synthetic option when presented with these benefits, and intends to target these users as well. The Aria(TM) CABG graft will be positioned initially as a preferable clinical option for patients who lack suitable native vessels. The Company believes that more clinician education will be required for the CABG graft in terms of patient indications, product use, and product capabilities. This may be accomplished through Company-sponsored educational programs, video educational tools, and scientific lecture programs. The Company also anticipates a much larger domestic sales force structure to effectively market the CABG graft, which may overlap or work with the VAD System sales force. Finally, the Company recognizes the impact of clinical thought-leaders in any surgical specialty, and will begin cultivating these relationships during the clinical trials of the graft. MANUFACTURING Thoratec manufactures VAD blood pumps and cannulae, and assembles and tests the VAD System at its Berkeley, California facility. This facility has been inspected and cleared by the FDA under cGMP guidelines and has received the International Standards Organization ("ISO") 9001 certification. The manufacturing of 9 11 specialty polymers and graft fabrication have been moved to a new facility in Pleasanton, California (see discussion below). The Company's manufacturing processes for the VAD System consist of the assembly of standard and custom component parts, including blood-contacting components fabricated from Thoratec's proprietary biomaterials, and the testing of completed products. The Company relies on single sources of supply for several components of the VAD System. The Company is aware of alternative suppliers for all single-sourced items other than the mechanical valves, and believes the loss of any one supplier would have only a short-term impact on its production schedule. In October 1997, the Company executed a four-year supply agreement with Arrow for the mechanical valves for the VAD system. The Company devotes significant attention to quality control. Its quality control measures begin at the manufacturing level where components are assembled in a "clean-room" environment designed and maintained to reduce product exposure to particulate matter. Products are tested throughout the manufacturing process for adherence to specifications. Finished components are shipped to outside processors for sterilization through radiation or treatment with ethylene oxide gas. After sterilization, the products are quarantined and tested before they are shipped to customers. The Company believes its Berkeley facility is capable of supplying the Company's expected sales of VAD Systems through 1999. The Company plans to relocate its manufacturing to a larger facility in Pleasanton, California, in the San Francisco Bay Area, where in 1997 it already moved the corporate, research and development, and sales offices. A lease was executed in 1996 for this new 62,000 square foot facility. Construction of the new manufacturing facility is complete and the Company is awaiting FDA inspection and approval as the final steps before relocation. PATENTS AND PROPRIETARY RIGHTS The Company has adopted a policy of seeking to patent certain aspects of its technology. The Company holds, or has exclusive rights to, 19 U.S. patents and has one U.S. patent application currently in prosecution. Except for the biomaterials patents mentioned below, which are utilized in the VAD blood pump and cannulae, the VAD System is not protected by any patents. The Company does not believe that this lack of patent protection will have a material adverse effect on the Company or its ability to sell the VAD System because of the lengthy regulatory period required to obtain approval of a ventricular assist device. The Company is not aware of any ventricular assist devices currently approved by the FDA or undergoing clinical trials based on the Company's product design. Thoratec's proprietary biomaterials technology is covered by seven patents. Five of these were sold to Th. Goldschmidt AG ("Goldschmidt"), a German chemical manufacturer, in 1989, but the Company has retained worldwide, royalty-free, exclusive rights to these patents for most medical applications. The Company's vascular graft products are covered by three manufacturing process patents. The MVAD is currently covered by four U.S. patents, three of which are held by the Company, and one of which is owned by Dr. Hill, Chairman of the Board of Directors of the Company, and the Company currently has a nonexclusive right to use that patent. Of the three patents held by the Company, one covers the overall MVAD system design and operation, one covers a component of the MVAD energy conversion system, and one covers methods of surgically attaching a skeletal muscle to a component of the MVAD energy conversion system. Dr. Hill's patent also covers the overall design of the device. Three of the Company's 19 patents are for products which are not commercially pertinent to Thoratec today. The Company holds, or has exclusive rights to, 38 international patents, with 18 applications currently in prosecution. All 38 international patents apply to products for which patents have been applied for or issued under U.S. patent law. Eleven biomaterial patents, valid in 13 countries, are licensed from Goldschmidt. The three graft patents held by the Company are valid in Canada, France and the U.K., and one of these patents is valid in Japan. Of the 18 currently pending patent applications, all are related to biomaterials. The validity of any patents issued to the Company may be challenged by others, and the Company could encounter legal and financial difficulties in enforcing its patent rights against alleged infringers. In addition, there can be no assurance that other technologies cannot or will not be developed or that patents will not be obtained by others which would render the Company's patents obsolete. Although the Company does not 10 12 believe the patents are the sole determinant in the commercial success of its products, the loss of a significant percentage of its patents or its patents relating to its graft products could have a material adverse effect on the Company's business, financial condition and results of operations. The Company has developed significant technical knowledge which, although nonpatentable, is considered by the Company to be significant in enabling it to compete. However, the proprietary nature of such knowledge may be difficult to protect. The Company has entered into an agreement with each key employee prohibiting such employee from disclosing any confidential information or trade secrets of the Company. In addition, these agreements also provide that any inventions or discoveries relating to the business of the Company by these individuals will be assigned to the Company and become the Company's sole property. Claims by competitors and other third parties that the Company's products allegedly infringe the patent rights of others could have a material adverse effect on the Company. The medical device industry is characterized by frequent and substantial intellectual property litigation. The cardiovascular device market is characterized by extensive patent and other intellectual property claims. Intellectual property litigation is complex and expensive and the outcome of this litigation is difficult to predict. Any future litigation, regardless of outcome, could result in substantial expense to the Company and significant diversion of the efforts of the Company's technical and management personnel. An adverse determination in any such proceeding could subject the Company to significant liabilities or require the Company to seek licenses from third parties or pay royalties that may be substantial. Furthermore, there can be no assurance that necessary licenses would be available on satisfactory terms, or at all. Accordingly, an adverse determination in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent the Company from manufacturing or selling certain of its products, any of which could have a material adverse effect on the Company's business, financial condition and results of operations. COMPETITION Principal competitors of the VAD System include Thermo Cardiosystems Inc., and Novacor, a division of Baxter International Inc., which manufacture and market an implantable left ventricular assist device approved only for bridge to heart transplant in the U.S., and ABIOMED, Inc., which manufactures and markets an FDA-cleared biventricular assist device for temporary circulatory support of patients in postcardiotomy shock and treatment of cardiogenic shock following heart transplants. The Company believes that the principal competitive factors in the ventricular assist device market are impact on patient outcomes, product performance, size and portability, quality, cost-effectiveness and customer service. The Company believes that its principal competitive advantages are the fact that the VAD System can provide left, right or biventricular support, the smaller size and paracorporeal placement of the system that allows its use with a greater range of patients than competitive devices, the greater range of cannulation options available and the quality of its biomaterials. Although Thoratec believes that these attributes of the VAD System offer certain advantages over existing ventricular assist devices, current competitors can be expected to defend their market positions vigorously. The principal competitors in the vascular access graft market are W.R. Gore, Inc., IMPRA, Inc. (C.R. Bard) and Meadox (Boston Scientific), which manufacture and market ePTFE grafts, Corvita Corporation (Pfizer) and Cardiotech International, Inc., which are developing polyurethane grafts, and Possis Medical, Inc. ("Possis"), which is developing spun polyester grafts. In addition, Possis has received a Humanitarian Device Exemption from the FDA for its 5 mm ePTFE coronary artery bypass grafts. There are currently no other coronary artery bypass graft products approved for use in the U.S. The Company believes that the principal competitive factors in the graft market are biocompatibility, patency, reliability, cost, suturability and ease of use. The Company expects that significant competition in the synthetic vascular graft market will continue. There are many companies focusing on the development of circulatory support devices or vascular grafts that have substantially greater financial resources, have substantially larger and more experienced sales and marketing organizations and engage in substantially greater research and development efforts than the Company. One or more of these or other companies could design and develop products that compete directly 11 13 with the Company's products, in which case the Company would face intense competition. Moreover, certain academic institutions, government agencies and other research organizations are conducting research in areas in which the Company is working. These institutions are becoming increasingly aware of the commercial value of their findings and are becoming more active in seeking patent protection and licensing arrangements to collect royalties for use of technology that they have developed. These institutions may also market competitive commercial products on their own or through joint ventures and will compete with the Company in recruiting highly qualified scientific personnel. Competition from commercial or other institutions or organizations could have a material adverse effect on the Company's business, financial condition and results of operations. GOVERNMENT REGULATION Regulation by governmental authorities in the U.S. and foreign countries is a significant factor in the manufacture and marketing of the Company's current and future products and in its ongoing product research and development activities. All of the Company's proposed products will require regulatory approval prior to commercialization. In particular, medical devices are subject to rigorous preclinical testing as a condition of approval by the FDA and by similar authorities in foreign countries. U.S. REGULATIONS In the U.S., the FDA regulates the manufacture, distribution and promotion of medical devices pursuant to the Federal Food, Drug, and Cosmetic Act and the regulations promulgated thereunder (the "FDC Act and Regulations"). The VAD System, TLC-II(TM), IVAD, MVAD and graft products are, or will be regulated as medical devices. To obtain FDA approval to market medical devices similar to those under development by the Company, the FDA requires proof of safety and efficacy in human clinical trials performed under an IDE. An IDE application must contain preclinical test data demonstrating the safety of the product for human investigational use, information on manufacturing processes and procedures, and proposed clinical protocols. If the IDE application is accepted, human clinical trials may begin. The results obtained from these trials, if satisfactory, are accumulated and submitted to the FDA in support of either a PMA application or a 510(k) premarket notification. Premarket approval from the FDA is required before commercial distribution of devices similar to those under development by the Company is permitted in the U.S. The PMA application must be supported by extensive data, including preclinical and human clinical data, to prove the safety and efficacy of the device. By regulation, the FDA has 180 days to review a PMA application and during that time an advisory committee may evaluate the application and provide recommendations to the FDA. While the FDA has responded to PMA applications within the allotted time period, reviews more often occur over a significantly protracted period, usually 18 to 36 months, and a number of devices have never been cleared for marketing. This is a lengthy and expensive process and there can be no assurance that such FDA approval will be obtained. Under the FDA's requirements, if a manufacturer can establish that a newly developed device is "substantially equivalent" to a legally marketed device, the manufacturer may seek marketing clearance from the FDA to market the device by filing a 510(k) premarket notification with the FDA. The 510(k) premarket notification must be supported by data establishing the claim of substantial equivalence to the satisfaction of the FDA. The process of obtaining a 510(k) clearance typically can take several months to a year or longer. If substantial equivalence cannot be established, or if the FDA determines that the device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA application that must be reviewed and approved by the FDA prior to sale and marketing of the device in the U.S. Both a 510(k) and a PMA, if granted, may include significant limitations on the indicated uses for which a product may be marketed. FDA enforcement policy strictly prohibits the promotion of approved medical devices for unapproved uses. In addition, product approvals can be withdrawn for failure to comply with regulatory requirements or the occurrence of unforeseen problems following initial marketing. In December 1995, the Company received FDA approval of its PMA for the bridge to heart transplant indication for the VAD System and in May 1998 received FDA approval to use the VAD system in the post 12 14 cardiotomy recovery indication. The VAD System is classified as a Class III medical device under the FDC Act. Prior to approval by the FDA, this device was marketed pursuant to an IDE for use in clinical trials under controlled conditions by a limited number of qualified medical institutions. The process of obtaining FDA approval for the VAD System required 13 years after approval of the IDE. The Company expects that its graft products will be classified as either Class II or Class III medical devices. The Company received approval for an IDE for its Vectra(TM) VAG in mid 1998 and believes that it will then be able to file a 510(k) after the clinical data is gathered. The Company has limited clinical experience with its CABG graft product, all outside the U.S. The approval process for any of the Company's products is expensive and time consuming and no assurance can be given that any regulatory agency will grant its approval. The inability to obtain, or delays in obtaining, such approval would adversely affect the Company's ability to commence marketing therapeutic applications of its products. There can be no assurance that the Company will have sufficient resources to complete the required testing and regulatory review processes. Furthermore, the Company is unable to predict the extent of adverse governmental regulation which might arise from future United States or foreign legislative or administrative action. In addition, any products distributed by the Company pursuant to the above authorizations are subject to pervasive and continuing regulation by the FDA. Products must be manufactured in registered establishments and must be manufactured in accordance with Quality System ("cGMP") and Good Laboratory Practice ("GLP") regulations. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The failure to comply with the FDA's regulations can result in enforcement action, including seizure, injunction, prosecution, civil penalties, recall and suspension of FDA approval. The export of devices also is subject to regulation in certain instances. INTERNATIONAL REGULATIONS The Company is also subject to regulation in each of the foreign countries in which it sells its products with regard to product standards, packaging requirements, labeling requirements, import restrictions, tariff regulations, duties and tax requirements. Many of the regulations applicable to the Company's products in such countries are similar to those of the FDA. The national health or social security organizations of certain countries require the Company's products to be qualified before they can be marketed in those countries. To position itself for access to European and other international markets, Thoratec sought and obtained certification under the ISO 9000 Series of Standards. ISO 9000 is a set of integrated requirements, which when implemented, form the foundation and framework for an effective quality management system. These standards were developed and published by the ISO, a worldwide federation of national bodies, founded in Geneva, Switzerland in 1946. ISO has over 92 member countries. ISO certification is widely regarded as essential to enter Western European markets. The Company obtained certification and was registered as an ISO 9002 compliant company in January 1995. Commencing in mid-1998, all companies are required to obtain CE marking for medical devices sold or distributed in the European Community. The CE mark is an international symbol of quality and with it, medical devices can be distributed within the European Community which is comprised of fifteen European countries representing a population of over 360 million people. A prerequisite for the Company obtaining authority to CE mark its products is to achieve full quality system certification in accordance with ISO 9001 and EN 46001. These are quality standards that cover design, production, installation and servicing of medical devices. The Company received its ISO 9001/EN 46001 certification in September 1997. The Company received authority to CE mark the VAG in January 1998 and the TLC-II(TM) in March 1998. OTHER REGULATIONS The Company is also subject to various federal, state and local laws and regulations relating to such matters as safe working conditions, laboratory and manufacturing practices and the use, handling and disposal of hazardous or potentially hazardous substances used in connection with the Company's research and development work. Specifically, the manufacture of the Company's biomaterials is subject to compliance with 13 15 federal environmental regulations and by various state and local agencies. Although the Company believes it is in compliance with these laws and regulations in all material respects, there can be no assurance that the Company will not be required to incur significant costs to comply with environmental laws or regulations in the future. THIRD PARTY REIMBURSEMENT AND COST CONTAINMENT The Company's products are purchased primarily by hospitals and other users, which then bill various third party payors for the services provided to the patients. These payors, which include Medicare, Medicaid, private insurance companies and managed care organizations, reimburse part or all of the costs and fees associated with the procedures performed with these devices. Medicare and Medicaid reimbursement for hospitals is based on a fixed amount for admitting a patient with a specific diagnosis. Because of this fixed reimbursement method, hospitals have incentives to use less costly methods in treating Medicare and Medicaid patients, and will frequently make capital expenditures to take advantage of less costly treatment technologies. Frequently, reimbursement is reduced to reflect the availability of a new procedure or technique, and as a result hospitals are generally willing to implement new cost saving technologies before these downward adjustments take effect. Likewise, because the rate of reimbursement for certain physicians who perform certain procedures has been and may in the future be reduced in the event of further changes in the resource-based relative value scale method of payment calculation, physicians may seek greater cost efficiency in treatment to minimize any negative impact of reduced reimbursement. Third party payors are increasingly challenging the prices charged for medical products and services and may deny reimbursement if they determine that a device was not used in accordance with cost-effective treatment methods as determined by the payor, was experimental or was used for an unapproved application. Changes in reimbursement policies and practices of third party payors could have a substantial and material impact on sales of certain of the Company's products. The development or increased use of more cost-effective treatment could cause such payors to decrease or deny reimbursement to favor these treatments. To date, the HCFA and some private insurers have determined to reimburse the costs of the VAD System. It is uncertain what legislative proposals will be adopted or what actions federal, state or private payors for health care goods and services may take to limit their payments for such goods and services. The Company cannot predict whether the VAD System will be approved for reimbursement and cannot predict the effect the changes in the health care system may have on its business. As a result, no assurance can be given that any such changes will not have a material adverse effect on the Company's business, financial condition and results of operations. EMPLOYEES As of February 27, 1999, the Company had 138 full-time employees, 48 of whom worked in manufacturing, 22 in engineering, 19 in quality control and regulatory affairs, 25 in marketing and sales support, 12 in administration and finance and 12 in other support functions (including personnel, management information, purchasing, facility). None of the Company's employees are covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. 14 16 RISK FACTORS The statements in this Annual Report on Form 10-K and other statements made by the Company from time to time that relate to future plans, events or performance are forward-looking statements which involve risks and uncertainties. Actual results, events or performance may differ materially from those anticipated in any forward-looking statements as a result of a variety of factors, including those set forth below and elsewhere in this Annual Report on Form 10-K. The following risk factors should be considered carefully in evaluating the Company and its business by the Company's shareholders and prospective investors in the Company. LACK OF PROFITABILITY; EXPECTED FUTURE LOSSES The Company was formed in 1976 and has reported a loss from operations in all but one year of its existence. As of January 2, 1999, the Company's accumulated deficit was approximately $53.4 million. Thoratec expects to continue to incur additional losses until it can achieve substantial product revenues. Furthermore, the Company expects that its expenses will increase as a result of increased research and development, preclinical and clinical testing, and selling, general and administrative expenses. Although sales of the VAD System as a bridge to heart transplant and for post-cardiotomy recovery have commenced in the U.S., sales of the Company's other products in the U.S. cannot begin until the products have received FDA approval, which may not occur for several years, if at all. There can be no assurance that any other products of the Company will be approved, can be successfully commercialized or that the Company will achieve significant revenues from sales of such products. In addition, there can be no assurance that the Company will achieve profitability in the future. Failure to achieve significant revenues or profitability would have a material adverse effect on the Company's business, financial condition and results of operations, and would require the Company to seek additional funds primarily through public or private offerings of debt or equity securities. There can be no assurance that additional financing will be available on acceptable terms, if at all. FUTURE CAPITAL REQUIREMENTS; NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE The Company anticipates that its working capital and the Guidant line of credit (See Management's Discussion and Analysis of Financial Condition-Liquidity and Capital Resources) will be sufficient to meet its present operating and capital requirements for at least the next year, but that it will need substantial additional funds to expand operations thereafter. The Company's future liquidity and capital requirements will depend upon numerous factors, including the progress of clinical trials, the timing and cost of future filings with, and obtaining approval from, the FDA and foreign government authorities, the timing and cost of product introductions, the cost of developing marketing and distribution capabilities assuming the required regulatory approvals are received, and market acceptance of the Company's products. The Company anticipates that it will seek additional funds primarily through public or private offerings of debt or equity securities. There can be no assurance that additional financing will be available on acceptable terms, if at all. The unavailability of such financing could delay research and development, regulatory approval, manufacturing or marketing of some or all of the Company's products and would have a material adverse effect on the Company's business, financial condition and results of operations. DEPENDENCE ON THIRD PARTIES FOR SUPPLIES Thoratec depends on single source suppliers for certain of the raw materials used in the manufacture of its products. The Company also utilizes materials and component parts supplied by third parties in its products. In the event the Company must obtain alternative sources for key raw materials or component parts, there can be no assurance that such materials or component parts will be available for purchase from alternative suppliers, that alternative suppliers will agree to supply the Company, that the Company's use of such suppliers would be approved by the FDA, or if unavailable, that the Company would have the expertise or resources necessary to produce such materials or component parts internally. As such, any interruption in supply of raw materials or component parts could have a material adverse effect on the Company's ability to manufacture its products until a new source of supply is located and, therefore, could have a material adverse effect on its business, financial condition and results of operations. 15 17 In October 1997, the Company executed a four-year agreement with Arrow International, Inc. ("Arrow") to supply the valves used in the Company's VAD system. Arrow was, until June 1997, the Company's distributor of its VAD System in certain European countries, may also be a future competitor of the Company in the circulatory support market and is currently the single source of supply for such valves. Sales of the VAD System accounted for substantially all of the Company's revenue in 1996, for over 90% of revenue in 1997 and 1998 and are expected to account for over 90% of the Company's revenue for at least the next year. Cessation or interruption of VAD System sales would have a material adverse effect on the Company's business, financial condition and results of operations. LIMITED MANUFACTURING CAPABILITY The Company currently manufactures the VAD System at its Berkeley, California facility and its remaining products in its Pleasanton, California facility. The Company is leasing a build-to-suit 62,000 square foot corporate headquarters and manufacturing plant in Pleasanton. All manufacturing will move to the Pleasanton facility in 1999. To date, the Company's manufacturing activities have consisted primarily of manufacturing limited quantities of the VAD System and the VAG. Although the Company believes that it currently has the ability to produce sufficient quantities of the VAD System and the VAG to support its current needs and its needs for early-stage clinical trials of the TLC-II(TM), MVAD and certain of its graft products, it will need to complete the move to the new Pleasanton production facility and improve its manufacturing technology in order to meet the volume and cost requirements for significant commercial sales of these products. In addition, the Company does not have experience in manufacturing its products in the commercial quantities that might be required if the Company successfully receives FDA approval of several or all of the products currently under development. The failure to commence manufacturing at the Pleasanton facility or to develop the necessary manufacturing expertise would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the manufacture of the Company's products is complex and costly, involving a number of separate processes and components. Certain manufacturing processes of the VAD System are labor intensive, and achieving significant cost reductions will depend in part upon reducing the time required to complete these processes. There can be no assurance that the Company will be able to achieve cost reductions in the manufacture of its products. In addition, manufacturers often encounter difficulties in scaling up manufacturing of new products, including problems involving product yields, quality control and assurance, component and service availability, adequacy of control policies and procedures and lack of qualified personnel. The Company has and will continue to consider as appropriate the internal manufacture of components currently provided by third parties, as well as the implementation of new production processes. There can be no assurance that Thoratec will be able to obtain or manufacture such products in a timely fashion at acceptable quality and prices, that it can comply with the FDA's cGMP or GLP requirements, or that it or its suppliers will be able to manufacture an adequate supply of products. NO ASSURANCE OF MARKET ACCEPTANCE The commercial success of the Company's current and future products will require acceptance by cardiovascular and vascular surgeons and interventional cardiologists. Such acceptance will depend on clinical results and the conclusion by these physicians that the Company's products are safe, cost-effective and acceptable alternative methods of treatment. There can be no assurance that the Company's products will provide benefits considered adequate by providers of cardiovascular and vascular treatments or that a sufficient number of such providers will use the Company's products for commercial success to be achieved. In addition, because the Company's products are based on innovative technologies and, in some cases, represent new methods of treatment, there may be greater reluctance to accept these products than would occur with products utilizing established technologies or methods of treatment. Even if the safety and efficacy of these products are established, physicians may elect not to use them for a number of reasons, including the high cost of equipment and training associated with the use of the Company's products or unfavorable reimbursement from health care payors. Failure of the Company's products to achieve significant market acceptance would have a material adverse effect on the Company's business, financial condition and results of operations. A 16 18 limited number of cardiovascular and vascular surgeons and interventional cardiologists influence medical device selection and purchase decisions for a large portion of the target cardiac patient population. The Company has developed working relationships with cardiac surgeons and cardiologists at a number of leading medical centers in connection with the development of the VAD System. In addition, surgical teams at these medical institutions have performed clinical trials to support the Company's applications to be filed with the FDA. A continuing working relationship with these and other physicians and medical centers will be important to the commercial acceptance of the VAD System and future circulatory support and graft products. No assurance can be given that existing relationships and arrangements can be maintained or that new relationships will be established in support of the Company's circulatory support and graft technology. Furthermore, economic, psychological, ethical and other concerns may limit general acceptance of ventricular assist devices. SUBSTANTIAL DEPENDENCE ON LIMITED PRODUCT LINE; DEPENDENCE ON DEVELOPMENT AND INTRODUCTION OF NEW PRODUCTS To date, substantially all of the Company's revenues have resulted from sales of the VAD System. The Company expects sales from the VAD System worldwide and limited sales of the VAG products in certain markets outside of the U.S. to account for a significant portion of the Company's near-term revenues. As a result, factors adversely affecting the pricing of or demand for such products, such as market acceptance, competition or technological change, could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's future financial performance will depend, in significant part, on the successful development, introduction and customer acceptance of its products under development. Existing preclinical and clinical data relating to the Company's products under development are very limited. Prior to any commercial use, the products and technologies currently under development by the Company will require significant additional research and development efforts, extensive preclinical and clinical testing and regulatory approval. New product development is highly uncertain and unanticipated developments, clinical and regulatory delays, adverse or unexpected side effects or inadequate therapeutic efficacy could slow or prevent the successful completion of the Company's product and technology development efforts. There can be no assurance that the Company will not experience difficulties that could delay or prevent the successful development, regulatory approval, introduction or market acceptance of these products. LIMITED SALES AND MARKETING EXPERIENCE; DEPENDENCE UPON DISTRIBUTORS The Company currently has limited sales and marketing capabilities, and expects to expend substantial resources in 1999 to increase its sales and marketing capabilities in the U.S. and Europe. There can be no assurance that the Company will be able to recruit and train adequate sales and marketing personnel or that such sales and marketing efforts will be successful. In addition, Thoratec competes with other companies that have extensive and well-funded sales and marketing organizations. There can be no assurance that Thoratec's sales and marketing staff will compete successfully against such other companies. The Company sells the VAD System in foreign markets (other than Canada and Europe) through distributors. In addition, Thoratec sells its graft products through its distributor in Japan and through Guidant in the rest of the world and will rely on Guidant for sales of the Vectra(TM) VAG in the U.S., if regulatory approval is received. To the extent the Company relies on distributors, its success will depend upon the efforts of others, over which it may have little control. The loss of, or lack of performance by, distributors could have a material adverse effect on the Company's business, financial condition and results of operations. COMPETITION Competition from medical device companies and medical device subsidiaries of health care and pharmaceutical companies is intense and expected to increase. Many of the Company's competitors have substantially greater financial, technical, distribution and marketing resources than the Company. In addition, many of these competitors have significantly greater experience than the Company in obtaining regulatory approvals for medical devices. Accordingly, the Company's competitors may succeed in obtaining regulatory approval for products more rapidly than the Company. Furthermore, many of these competitors have superior 17 19 manufacturing capabilities, and such competitors may be able to manufacture products more efficiently and at a lower cost than the Company and, therefore, offer comparable products at a lower cost. Any product developed by the Company that gains regulatory approval will have to compete for market acceptance and market share. An important factor in such competition may be the timing of market introduction of competitive products. Accordingly, the relative speeds with which the Company can develop products, complete clinical testing, receive regulatory approval and manufacture and sell commercial quantities of products are expected to be important competitive factors. The Company believes that the primary competitive factors in the market for ventricular assist devices are impact on patient outcomes, product performance, quality and cost-effectiveness, and that the primary competitive factors for vascular graft products are biocompatibility, patency, reliability, cost, suturability and ease of use. The Company also believes that physician relationships and customer support are important competitive factors. U.S. GOVERNMENT REGULATIONS The research and development, manufacturing, marketing and distribution of the Company's products in the U.S. are governed by the Federal Food, Drug, and Cosmetic Act and the regulations promulgated thereunder (the "FDC Act and Regulations"). The FDA administers the FDC Act and Regulations, and the Company is subject to inspection by the FDA for compliance with such regulations and procedures. The process of obtaining FDA approval is lengthy and uncertain. In order for the Company to market future products in the U.S., the Company must obtain clearance from the FDA of a 510(k) premarket notification or approval of a more extensive submission known as a PMA. The Company is also subject to the FDA's cGMP and GLP regulations. These regulations require that the Company manufacture its products and maintain its records in a prescribed manner. The FDA periodically inspects the Company's facilities for compliance with cGMP. Under FDA requirements, if a manufacturer can establish that a newly developed device is "substantially equivalent" to a device marketed prior to 1976, the manufacturer may seek marketing clearance by filing a 510(k) premarket notification with the FDA. The 510(k) premarket notification must be supported by data establishing the claim of substantial equivalence to the satisfaction of the FDA. The process of obtaining a 510(k) clearance typically can take several months to a year or longer. If substantial equivalence cannot be established, or if the FDA determines that the device requires a more rigorous review, the FDA will require that the manufacturer submit a PMA application that must be reviewed and approved by the FDA prior to sale and marketing of the device in the U.S. The process of obtaining approval for a PMA can be expensive, uncertain and lengthy, frequently requiring anywhere from one to several or more years from the date of FDA submission. Both a 510(k) and a PMA, if accepted or approved, may include significant limitations on the indicated uses for which a product may be marketed. FDA enforcement policy strictly prohibits the promotion of approved medical devices for unapproved indications. In addition, product approvals can be withdrawn for failure to comply with regulatory requirements or the occurrence of unforeseen problems following initial marketing. In December 1995, the Company received FDA approval to market the VAD System in the U.S. as a bridge to heart transplant and in May 1998 for the postcardiotomy recovery indication. The Company may file other PMA Supplements. The Company received approval for an IDE for the TLC-II(TM) in November 1998. All of the Company's other circulatory support products are in preclinical development. The Company received approval of an IDE for the Vectra(TM) VAG in April 1998 and expects to file a 510(k) premarket notification after the clinical data is gathered. However, submissions of data do not constitute filings, and there can be no assurance that filings will be made or that the filings will be accepted or products will be approved by the FDA. The Company will need to complete its preclinical testing before an IDE application can be filed for the CABG graft. The PMA application required for the CABG graft will need to include the results of extensive clinical studies and manufacturing information. There can be no assurance that the FDA will act favorably or quickly in its review of the Company's 510(k) submissions or PMA applications, and significant difficulties and costs may be encountered by the Company in its efforts to obtain FDA clearance that could delay or preclude the Company from selling its graft or additional circulatory support products in the U.S. Furthermore, there can be no assurance that the 18 20 FDA will not limit the intended use of the Company's products as a condition of 510(k) acceptance or PMA approval. Further, if the Company proposes modifications to a product after FDA clearance of a 510(k) premarket notification or approval of a PMA, including changes in indications (as is the case with the VAD System) or other significant modifications to labeling or manufacturing, the Company will be required to obtain additional approvals from the FDA. Failure to receive or delays in receipt of FDA clearances or approvals, including the need for extensive clinical trials or additional data as a prerequisite to clearance or approval, or any FDA limitations on the intended use of the Company's products, would have a material adverse effect on the Company's business, financial condition and results of operations. INTERNATIONAL REGULATIONS A significant percentage of the Company's product revenues are derived from sales outside the U.S., and distribution of the Company's products outside the U.S. is subject to extensive government regulation. These regulations, including the requirements for approvals or clearance to market, and the time required for regulatory review and the sanctions imposed for violations, vary from country to country. There can be no assurance that the Company will obtain regulatory approvals in such countries or that it will not be required to incur significant costs in obtaining or maintaining its foreign regulatory approvals. In addition, the export by the Company of certain of its products which have not yet been cleared for domestic commercial distribution may be subject to FDA export restrictions. Failure to obtain necessary regulatory approvals, the restriction, suspension or revocation of existing approvals or any other failure to comply with regulatory requirements would have a material adverse effect on the Company's business, financial condition and results of operations. To position itself for access to European and other international markets, Thoratec has obtained certification under the ISO 9000 Series of Standards. ISO 9000 is a set of integrated requirements which, when implemented, form the foundation and framework for an effective quality management system. Commencing in mid-1998, all companies will be required to obtain CE marking for medical devices sold or distributed in the European Community. The CE mark is an international symbol of quality and with it, medical devices can be distributed within the population of over 360 million people in the European Community. A prerequisite for the Company obtaining authority to CE mark its products is to achieve full quality system certification in accordance with ISO 9001 and EN 46001. These are quality standards that cover design, production, installation and servicing of medical devices. The Company received its ISO 9001/EN 46001 certification in September 1997. The Company received authority to CE mark the Vectra(TM) VAG in January 1998 and the TLC-II(TM) in March 1998. Failure to receive a CE mark certification for subsequently developed products will prohibit the Company from selling such products in Europe and would have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be successful in meeting such certification requirements for its future products. RISK OF TECHNOLOGICAL OBSOLESCENCE There can be no assurance that third parties will not succeed in developing or marketing technologies and products that are more effective than those developed or marketed by the Company or that would render the Company's technology and products obsolete or noncompetitive. Additionally, new surgical procedures and medications could be developed that replace or reduce the importance of current procedures that use the Company's products. Accordingly, the Company's success will depend in part on its ability to respond quickly to medical and technological changes through the development and introduction of new products, or modification of existing products. There can be no assurance that the Company will be successful in these efforts. UNCERTAINTY RELATED TO THIRD PARTY REIMBURSEMENT FOR THE VAD SYSTEM Significant uncertainty exists as to the reimbursement status of newly approved health care products such as the VAD System. Government and other third party payors are increasingly attempting to contain health care costs by limiting both coverage and the level of reimbursement of new therapeutic products and by refusing in some cases to provide any coverage of uses of approved products for disease indications other than 19 21 those for which the FDA has granted marketing approval. To date, the HCFA, the federal agency responsible for determining whether, and to what extent, medical products and procedures are reimbursable under Medicare and Medicaid, and some private insurers, have determined to reimburse the costs of the VAD System. The Company cannot predict whether the VAD System will continue to be approved for reimbursement and cannot predict the effect that changes in the health care system may have on the reimbursability of future products. Failure to obtain such reimbursement could have a material adverse effect on the Company's business, financial condition and results of operations. PATENTS AND PROTECTION OF PROPRIETARY TECHNOLOGY The Company's ability to compete effectively with other companies will depend, in part, on its ability to maintain the proprietary nature of its technology, products and manufacturing processes. The Company relies on patents, trade secrets and know-how to maintain its competitive position. The Company has been issued or has licensed a number of U.S. and foreign patents covering its core biomaterials technology and its graft technologies. In addition, many other U.S. and foreign patent applications have been filed. Aside from the biomaterials patents mentioned above, which are utilized in the VAD blood pump and cannulae, the VAD System is not protected by any patents. The Company does not believe that this lack of patent protection will have a material adverse effect on the Company or its ability to sell the VAD System because of the lengthy regulatory period required to obtain approval of a ventricular assist device. The Company is not aware of any ventricular assist devices currently approved by the FDA or undergoing clinical trials based on the Company's product design. There can be no assurance that any existing or future patent applications by the Company will result in issued patents or that any current or future issued or licensed patents, trade secrets or know-how will afford sufficient protection against competitors with similar technologies or processes, or that any patents issued will not be infringed upon or designed around by others. In addition, there can be no assurance that others will not independently develop proprietary technologies and processes which are the same as or substantially equivalent to those of the Company. Further, there can be no assurance that the Company will not infringe prior or future patents owned by others, that the Company will not need to acquire licenses under patents belonging to others for technology potentially useful or necessary to the Company, or that such licenses will be available to the Company, if at all, on terms acceptable to the Company. The Company could incur substantial costs in defending itself in suits brought against it on such patents or in bringing suits to protect the Company's patents or patents licensed by the Company against infringement. The Company also protects its proprietary technology and processes in part by confidentiality agreements with its licensees, employees and consultants. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known or independently discovered by competitors. EXPOSURE TO CLAIMS The Company's business exposes it to an inherent risk of potential product liability claims related to the manufacturing, marketing and sale of human medical devices. The Company maintains only a limited amount of product liability insurance but will seek to obtain additional product liability insurance as its products are commercialized. The Company also maintains commercial general and property insurance. The Company's insurance policies generally must be renewed on an annual basis. There can be no assurance that the Company will be able to maintain or increase such insurance on acceptable terms or at reasonable costs, or that such insurance will provide the Company with adequate coverage against potential liabilities. A successful claim brought against the Company in excess of, or outside of, its insurance coverage could have a material adverse effect on the Company's business, financial condition and results of operations. Claims against the Company, regardless of their merit or potential outcome, may also have a material adverse effect on the Company's ability to obtain physician endorsement of its products or expand its business. ATTRACTION AND RETENTION OF KEY EMPLOYEES The Company's future business and operating results will depend in significant part on the continued contributions of principal members of its management and scientific staff, the loss of any of whose services 20 22 might adversely impact the achievement of planned development and product introduction objectives. In addition, the Company's anticipated growth and product introductions will require additional expertise in the areas of clinical testing, government approvals, finance, engineering and marketing, all of which will place increased demand on the Company's resources. These demands are expected to require the addition of new management personnel and the development of additional expertise by existing management personnel. Recruiting and retaining qualified personnel to perform these functions will be critical to the Company's success. Competition for such personnel is intense and there can be no assurance that the Company will be able to recruit and retain such individuals on acceptable terms given the competition for experienced personnel from numerous medical device, health care and pharmaceutical companies and academic and other research institutions. The loss of key employees, the Company's inability to attract and retain skilled employees, as needed, or the failure to acquire or develop necessary expertise could have a material adverse effect on the Company's business, financial condition and results of operations. VOLATILITY OF STOCK PRICE The price of the Common Stock has been, and is likely to continue to be, highly volatile. Future announcements concerning the Company or its competitors, quarterly variations in operating results, introduction of new products or changes in product pricing policies by the Company or its competitors, acquisition or loss of significant customers, partners, distributors and suppliers, changes in earnings estimates by analysts, regulatory developments, or fluctuations in the economy or general market conditions, among other factors, could cause the market price of the Common Stock to fluctuate substantially. In addition, stock markets in general, and the market for shares of health care stocks in particular, have experienced extreme price and volume fluctuations in recent years which have frequently been unrelated to the operating performance of the affected companies. These broad market fluctuations may adversely affect the market price of the Common Stock. There can be no assurance that the market price of the Common Stock will not decline below its current price or that it will not experience significant fluctuations in the future, including fluctuations that are unrelated to the Company's performance. ITEM 2. PROPERTY FACILITIES Thoratec occupies leased facilities in Pleasanton, California totaling approximately 62,000 square feet and in Berkeley, California, totaling approximately 28,000 square feet where its manufacturing activities are carried out. The manufacturing areas have been inspected, approved, and licensed by the U.S. FDA and the State of California Department of Health Services, Food and Drug Section for the manufacture of medical devices. The lease on the Berkeley building will expire in August 1999. The Company also has small leased facilities in the United Kingdom. In 1996, the Company entered into a lease agreement on a new manufacturing facility in Pleasanton, which will accommodate all of the Company's manufacturing, engineering and administrative activities. The administrative and engineering portion of the building was completed and occupied in late 1997. The manufacturing portion was completed in 1998. The Company invested approximately $9 million in equipment and leasehold improvements to the building. Annual payments under the amended lease are approximately $722,000 for a lease term of 15 years and commenced in August 1997. The lease includes provisions, among others, for annual cost of living adjustments to the lease payments, two five-year renewal options, a purchase option, and a security deposit of $885,600, which the Company paid in 1996, and an additional $500,000 paid in 1997. The 1997 payment was returned to the Company in 1998. A significant portion ($750,000) of the remaining security deposit can be reduced or eliminated before the end of the initial lease term if the Company meets certain criteria as specified by the contract. ITEM 3. LEGAL PROCEEDINGS The Company is not party to any material legal proceedings. 21 23 ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS None. EXECUTIVE OFFICERS OF REGISTRANT D. KEITH GROSSMAN, PRESIDENT, CHIEF EXECUTIVE OFFICER AND DIRECTOR Mr. Grossman, age 39, joined Thoratec Laboratories Corporation as President and Chief Executive Officer in January 1996. He was elected to the Board of Directors in February 1996. Prior to joining Thoratec, Mr. Grossman was a Division President of Major Pharmaceuticals, Inc., from June 1992 to September 1995, at which time it was sold. From July 1988 to June 1992, Mr. Grossman served as the Vice President of Sales and Marketing for Calcitek, Inc., a manufacturer of implantable medical devices, and division of Sulzermedica (formerly Intermedics, Inc.). Prior to 1988, Mr. Grossman held various other sales and marketing management positions within the McGaw Laboratories Division of American Hospital Supply Corporation. CHERYL D. HESS, VICE PRESIDENT -- FINANCE, CHIEF FINANCIAL OFFICER AND SECRETARY Ms. Hess, age 52, joined the Company as Vice President -- Finance and Chief Financial Officer in December 1983 and became Secretary in 1994. Prior to joining Thoratec, Ms. Hess was a manager with the public accounting firm of Deloitte & Touche LLP, where she specialized in audit and financial advisory services for entrepreneurial, rapidly-growing, high technology companies. Ms. Hess is responsible for the direction of all financial management, control and reporting activities for Thoratec, as well as certain administrative and operational activities. Ms. Hess is a Certified Public Accountant. THOMAS E. BURNETT, JR., VICE PRESIDENT -- SALES AND MARKETING Mr. Burnett, age 36, joined the Company as Vice President -- Sales and Marketing in August 1996. Prior to joining Thoratec, Mr. Burnett was Vice President of Sales and Marketing at Calcitek, Inc. from June 1992 to August 1996, where he was responsible for global sales and marketing which included a direct domestic sales force and an international network encompassing 30 countries as well as new business development, strategic and operational planning. Other positions at Calcitek, included Director of Sales from January 1992 to June 1992 and National Sales Manager from January 1991 to January 1992. Prior to Calcitek, Mr. Burnett held a variety of sales and sales management positions for Kendall McGaw Laboratories, a producer of intravenous solutions, infusion equipment and parenteral pharmaceuticals. DAVID J. FARRAR, PH.D., VICE PRESIDENT -- RESEARCH AND DEVELOPMENT Dr. Farrar, age 52, joined the Company as Program Manager of the VAD System in January 1980 and became Vice President -- Circulatory Support Products in 1988, and Vice President -- Research & Development in 1996. In addition, Dr. Farrar has a research appointment in the Department of Cardiac Surgery at the California Pacific Medical Center of San Francisco. Dr. Farrar has over 20 years of research experience in the cardiovascular and medical device industry. DONALD A. MIDDLEBROOK, VICE PRESIDENT -- REGULATORY AFFAIRS/QUALITY ASSURANCE Mr. Middlebrook, age 48, joined the Company as Vice President -- Regulatory Affairs/Quality Assurance in September 1996. Before joining Thoratec, he held the position of Senior Director, Global Regulatory Affairs and Assurance for Chiron Vision Corporation, a manufacturer of implantable ophthalmic devices and surgical equipment. Prior to this, Mr. Middlebrook spent fifteen years with Baxter International in a number of progressing positions, including Vice President of Regulatory Affairs and Quality Assurance for the CardioVascular Group, a producer of a wide range of cardio, critical care, vascular, and less invasive cardiovascular products. JOSEPH G. SHARPE, VICE PRESIDENT -- OPERATIONS Mr. Sharpe, age 40, joined the Company as Vice President -- Operations in September 1997. Prior to joining Thoratec, Mr. Sharpe was Director of Operations for the IV Systems Division of Baxter International, Inc. from 1992 to September 1997. Prior thereto, Mr. Sharpe held a number of other positions at Baxter International, Inc., including Director of Engineering of the Pharmaseal Division, and Honeywell Information Systems. 22 24 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The common stock of the Company is currently traded on the Nasdaq National Market under the symbol "THOR". The following table sets forth, for the periods indicated, the high and low closing sales price per share for the common stock, as reported by the Nasdaq National Market. At February 26, 1999 there were approximately 760 registered holders of the Company's common stock.
HIGH LOW ------ ----- 1997 First Quarter................................... $11.00 $8.00 Second Quarter.................................. 8.13 4.88 Third Quarter................................... 8.75 6.75 Fourth Quarter.................................. 7.50 4.38 1998 First Quarter................................... $ 7.50 $5.56 Second Quarter.................................. 9.63 7.38 Third Quarter................................... 9.06 6.13 Fourth Quarter.................................. 7.50 4.00
The Company has not declared any dividends on its common stock. 23 25 ITEM 6. SELECTED FINANCIAL DATA
1998 1997 1996 1995 1994 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE DATA) INCOME STATEMENT DATA: Total revenue................................ $16,981 $10,195 $ 8,087 $ 3,548 $ 2,788 Research and development..................... 5,096 4,583 3,724 1,984 1,360 Net loss..................................... (2,321) (4,402) (3,263) (1,894) (1,647) Basic and diluted loss per share............. (0.11) (0.24) (0.20) (0.13) (0.12) Number of shares used in the computation*.... 20,340 18,360 16,694 14,429 14,193 BALANCE SHEET DATA: Working capital.............................. $11,251 $15,885 $17,266 $ 2,808 $ 2,025 Total assets................................. 25,208 28,477 21,847 4,380 3,605 Long-term obligations........................ 1,675 1,675 Shareholders' equity......................... 21,877 24,027 19,330 1,663 1,057
- --------------- * As adjusted to reflect the one-for-three reverse split of the Company's Common Stock effected in June 1996. 24 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The statements in "Management's Discussion and Analysis of Financial Condition and Results of Operations" that relate to future plans, events or performance are forward-looking statements which involve risks and uncertainties. Actual results, events or performance may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including those set forth under "Item 1 -- Risk Factors" and elsewhere in this Annual Report on Form 10-K. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be needed to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. OVERVIEW The Company operates in a single business segment with different products in circulatory support and vascular grafts. The Company presents its business geographically as its Domestic operation, which comprises the Company's business in the United States, and its International operation, which comprises its business in Europe and the rest of the world. LIQUIDITY AND CAPITAL RESOURCES At the end of 1998 the Company had working capital of $11,251,000 compared with $15,885,000 at the end of 1997. The decrease in working capital was due to expenditures on the Company's new manufacturing facility and the loss from continuing operations partially offset by proceeds received from stock option exercises. Receivables increased principally due to increased sales. Inventory increased in preparation for planned increases in sales activity and the introduction of a new product. Accounts payable and accrued liabilities decreased principally due to payment of construction costs partially offset by increased personnel costs. Subsequent to January 2, 1999, the Company entered into a distribution agreement with Guidant Corporation. Under the terms of agreement, Guidant receives exclusive worldwide marketing and distribution rights to the Thoratec Vectra(TM) Vascular Access Graft product line, except in Japan. In exchange for these rights, Guidant has paid Thoratec $1.5 million, and will pay up to an additional $2 million when the Vectra(TM) product line receives FDA approval for use in the U.S. Guidant also issued a four-year, unsecured line of credit in the amount of $10 million to Thoratec, which may be used, if needed, for a variety of business purposes. In 1996, the Company entered into a lease agreement on a new manufacturing facility in Pleasanton, which will accommodate all of the Company's manufacturing, engineering and administrative activities. The administrative and engineering portion of the building was completed and occupied in late 1997. The manufacturing portion was completed in 1998. The Company invested approximately $9 million in equipment and leasehold improvements to the building. Annual payments under the amended lease are approximately $722,000 for a lease term of 15 years and commenced in August 1997. The lease includes provisions, among others, for annual cost of living adjustments to the lease payments, two five-year renewal options, a purchase option, and a security deposit of $885,600, which the Company paid in 1996, and an additional $500,000 paid in 1997. The 1997 payment was returned to the Company in 1998. A significant portion ($750,000) of the remaining security deposit can be reduced or eliminated before the end of the initial lease term if the Company meets certain criteria as specified by the contract. The Company believes that current cash and short term investments together with its cash flow from operations and funds available from its line of credit agreement with Guidant, will be sufficient to fund the Company's operation for the next 12 months. The Company does not expect that inflation will have a material impact on its operations. 25 27 RESULTS OF OPERATIONS Product sales in 1998 were $16,320,000 compared to $9,441,000 in 1997. The 73% increase is primarily the result of increased sales of the VAD System in the United States and international markets. Domestic sales increased $4,550,000, or 60% in 1998. Interest and other income decreased $92,000 to $661,000 in 1998 due principally to lower interest earned on lower average cash balances. This was partially offset by revenue received from a government funded MVAD project grant. Product sales in 1997 were $9,441,000 compared to $7,503,000 in 1996. The 26% increase is primarily the result of increased sales of the VAD System in the United States following FDA approval of the System in late 1995 and efforts of a direct sales organization established in late 1995 and early 1996. Domestic sales increased $2,085,000, or 38% in 1997. Interest and other income increased $169,000 to $753,000 in 1997 due principally to interest earned on higher average cash balances obtained from the Company's public stock offerings in November 1997 and September 1996. Cost of sales increased $2,499,000, or 62%, in 1998 compared to 1997 as a result of the higher sales volume in 1998. Gross margins increased from 58% in 1997 to 60% in 1998 due to the ability of the Company to raise selling prices of its VAD pumps and cannula. Cost of sales increased $752,000, or 23%, in 1997 compared to 1996 as a result of the higher sales volume in 1997. Gross margins increased from 57% in 1996 to 58% in 1997 due to the ability of the Company to raise selling prices of its VAD pumps beginning in the second quarter of 1996 partially offset by increased operating costs in 1997 associated with the new manufacturing facility and increased personnel and related costs. Research and development expenses for 1998 increased $513,000, or 11%, compared to 1997 due to increased costs associated with the Company's graft products, VAD pump and continued development of the Company's implantable VAD. Selling, general and administrative expenses in 1998 increased $1,692,000, or 28%, compared to 1997 principally from advertising costs associated with new product introductions and continued development and expansion of the domestic sales and marketing organization. Research and development expenses for 1997 increased $859,000, or 23%, compared to 1996 due to increased costs associated with the Company's graft products and continued development of the Company's portable VAD driver, the TLC-II(TM). Selling, general and administrative expenses in 1997 increased $2,061,000, or 52%, compared to 1996 principally from costs associated with implementing a direct sales strategy in Europe and continued development and expansion of the domestic sales and marketing organization. The Company expects profitability may continue to be adversely impacted by various fixed costs until all its current products have received pre-market approval in the United States and approval for sale in its major international markets. In December 1995, the Company received FDA approval for its VAD System as a bridge to transplantation and in May 1998 received FDA approval for an additional indication for the VAD System for post cardiotomy recovery of the natural heart. YEAR 2000 COMPLIANCE The Year 2000 issue involves computer programs and embedded microprocessors in computer systems and other equipment that utilize two digits rather than four to define the applicable year. These systems may be programmed to assume that all two digit dates are preceded by "19", causing "00" to be interpreted as 1900 versus 2000. This could result in the possible failure of those programs and devices to properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize date sensitive information could generate erroneous data or a system failure. The Company's objective is to ensure an uninterrupted transition into Year 2000 and has a plan currently in place. The scope of the Year 2000 plan includes: (1) information technology ("IT") such as software and hardware; (2) non-IT systems or embedded technology such as microcontrollers contained in various manufacturing and lab equipment, environmental and safety systems, facilities and utilities and Company 26 28 products with date sensitivity; (3) and readiness of key third parties, including suppliers, customers and key financial institutions. The Company has a formal Year 2000 compliance project that addresses the Company's information technology systems. The Company has identified the following phases of its Year 2000 project: 1) educate IT personnel and company management about Year 2000 issue, 2) identify required resources to execute the Year 2000 action plan, 3) create priority schedule for critical systems, 4) estimate total cost of Year 2000 action plan, 5) determine and implement corrections to noncompliant systems, 6) test and verify corrections, 7) place corrected systems into service, and 8) monitor Year 2000 compliance with new vendors, software and hardware. Phases 1 through 4 have been completed. Phase 5 is currently in process and is scheduled for completion by July 1999. Phases 6 and 7 are on schedule to be completed by the end of 1999. Phase 8 will continue into the year 2000. The Company has requested written confirmation from what it believes to be all of its significant vendors as to their Year 2000 compliance status, and has taken steps to determine the extent to which the Company's systems are vulnerable to those third parties' failures to remedy their own Year 2000 issues. There can be no assurance that the systems of other companies with which the Company does business will be timely converted or that any such failure to upgrade or convert would not have an adverse effect on the Company's systems and operations. However responses to date have indicated no significant problems. Through year-end January 2, 1999, the Company has incurred less than $25,000 of Year 2000 cost and expects to spend less than $10,000 during each of 1999 and 2000. All costs associated with Year 2000 compliance are being funded with cash flow generated from operations and existing cash balances and are being expensed as incurred. The Company believes that the most reasonably likely worst-case scenario arising from the Year 2000 issue is a temporary interruption in the Company's operations resulting from non-compliant systems of third parties. Based on the status of its Year 2000 compliance program, the Company currently believes that the Year 2000 issue will not pose significant operational problems for the Company's internal computer systems. However, the company does not have, nor plan to have, a formal contingency plan in the event its Year 2000 compliance program is unsuccessful or not completed on a timely basis. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not use derivative financial instruments in its operations or investment portfolio. The Company does not have material exposure to market risk associated with changes in interest rates as it has no long-term debt obligations outstanding. The Company does not believe it has any other material exposure to market risk associated with interest rates. Although the Company conducts business in foreign countries, international operations consist primarily of sales and service personnel for its VAD System. These employees report into the U.S. sales and marketing group and are internally reported as part of that group. Additionally, foreign currency transaction gains and losses were not material to the Company's results of operations for the year ended January 2, 1999. Accordingly, the Company does not expect to be subject to material foreign currency risk with respect to future costs or cash flows from its foreign subsidiary. To date, the Company has not entered into any significant foreign currency forward exchange contracts or other derivative financial instruments to hedge the effects of adverse fluctuations in foreign currency exchange. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company, together with the report thereon by Deloitte & Touche LLP, Independent Auditors, are set forth at pages F-1 to F-15 of this Report on Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 27 29 PART III Certain information required by Part III is omitted from this Report on Form 10-K in that the Company will file its definitive Proxy Statement for its Annual Meeting for Shareholders to be held on May 14, 1999 pursuant to Regulation 14A of the Securities and Exchange Act of 1934, as amended (the "Proxy Statement"), not later than 120 days after the end of the fiscal year covered by this Report, and certain information included in the Proxy Statement is incorporated herein by reference. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Executive Officers -- See the section titled "Executive Officers" in Part I, Item 4 hereof. (b) Directors -- The information required by this Item is incorporated by reference to the section entitled "Election of Directors" in the Proxy Statement. The disclosure required by Item 405 of Regulation S-K is incorporated by reference to the section entitled "Section 16(a) Reporting Delinquencies" in the Proxy Statement. ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the section entitled "Executive Compensation" in the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the section entitled "Security Ownership of Certain Beneficial Owners and Management" in the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the section entitled "Certain Transactions" in the Proxy Statement. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a). EXHIBITS AND INDEX OF EXHIBITS
EXHIBIT NO. EXHIBIT ----------- ------- 3(a) Registrant's Certificate of Incorporation, as amended.(1) 3(b) Registrant's By-Laws, as amended.(1) 4(a) Form of Convertible Secured Promissory Note.(7) 10(p) Lease Agreement dated July 5, 1979, between the Registrant and Scenic Arts Incorporated, as amended.(2) 10(ii) Amended 1984 Incentive Stock Option Plan.(4) 10(eee) Amended 1988 Non-Qualified Stock Option Plan.(4) 10(fff) 1993 Stock Option Plan.(6) 10(ggg) Agreement for the Acquisition of Th. Goldschmidt AG of Certain of the Assets of Thoratec Laboratories Corporation dated as of March 29, 1989.(3) 10(jjj) Thoratec Laboratories Corporation and COBE Laboratories, Inc. Common Stock Purchase Agreement dated November 23, 1992.(5) 10(kkk) License Agreement Between Thoratec Laboratories Corporation and COBE Laboratories, Inc. dated as of November 23, 1992.(5) 10(lll) Lease Agreement dated July 25, 1996, between Registrant and Main Street Associates, as amended.(8) 10(mmm) 1996 Stock Option Plan.(9) 10(nnn) 1996 Nonemployee Directors Stock Option Plan.(9)
28 30
EXHIBIT NO. EXHIBIT ----------- ------- 10(ooo) First Amendment to Lease Agreement Originally By and Between Mainstreet Associates and Thoratec Laboratories Corporation dated July 25, 1996.(10) 10(ppp) 1997 Stock Option Plan.(11) 10(qqq) Amended 1996 Nonemployee Directors Stock Option Plan.(10) 10(rrr) Second Amendment to Lease Agreement Originally By and Between Mainstreet Associates and Thoratec Laboratories Corporation dated July 25, 1996.(12) 10(sss) Distribution Agreement By and Between Guidant Corporation and dated Thoratec Laboratories Corporation dated January 13, 1999.(13) 10(ttt) Credit Agreement By and Between Thoratec Laboratories Corporation Borrower, and Guidant Corporation, Lender dated As of January 13, 1999.(13) 23 Independent Auditors' Consent -- Deloitte & Touche LLP. 24 Power of Attorney -- Reference is made to page 30 hereof. 27 Financial Data Schedule
- --------------- (1) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-1 (Registration No. 2-87293) and incorporated herein by reference. (2) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-1 (Registration No. 2-70903) and incorporated herein by reference. (3) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 30, 1989 and incorporated herein by reference. (4) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 29, 1990 and incorporated herein by reference. (5) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended January 2, 1993 and incorporated herein by reference. (6) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended January 1, 1994 and incorporated herein by reference. (7) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 31, 1994 and incorporated herein by reference. (8) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended June 29, 1996 and incorporated herein by reference. (9) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-8 (Registration No. 333-11883) and incorporated herein by reference. (10) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended June 28, 1997 and incorporated herein by reference. (11) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-8 (Registration No. 333-32223) and incorporated herein by reference. (12) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 1997 and incorporated herein by reference. (13) Certain confidential information has been deleted from this exhibit pursuant to a confidential treatment request order that was granted. (b) REPORTS ON FORM 8-K None filed in 1998. 29 31 SIGNATURES In accordance with Section 13 or Section 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THORATEC LABORATORIES CORPORATION By: /s/D. KEITH GROSSMAN --------------------------------- D. Keith Grossman, Chief Executive Officer Date: March 24, 1999 POWER OF ATTORNEY KNOW ALL PERSONS BY THESE PRESENTS that each person whose signature appears below constitutes and appoints D. Keith Grossman, his true and lawful attorney-in-fact, with full power of substitution and resubstitution, to act for him and in his name, place and stead, in any and all capacities to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorney-in-fact and agent, full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises, and fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that each of attorney-in-fact and agent, or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ D. KEITH GROSSMAN Chief Executive Officer, February 23, 1999 - ----------------------------------------------------- President and Director D. Keith Grossman /s/ CHRISTY W. BELL Director February 25, 1999 - ----------------------------------------------------- Christy W. Bell /s/ HOWARD E. CHASE Director February 23, 1999 - ----------------------------------------------------- Howard E. Chase /s/ J. DANIEL COLE Director March 1, 1999 - ----------------------------------------------------- J. Daniel Cole /s/ J. DONALD HILL Director and Chairman of February 24, 1999 - ----------------------------------------------------- the Board of Directors J. Donald Hill /s/ WILLIAM M. HITCHCOCK Director February 23, 1999 - ----------------------------------------------------- William M. Hitchcock /s/ GEORGE W. HOLBROOK, JR. Director February 23, 1999 - ----------------------------------------------------- George W. Holbrook, Jr. /s/ DANIEL M. MULVENA Director February 22, 1999 - ----------------------------------------------------- Daniel M. Mulvena /s/ CHERYL D. HESS Vice February 22, 1999 - ----------------------------------------------------- President -- Finance, Cheryl D. Hess Chief Financial Officer and Secretary (Principal Financial and Accounting Officer)
30 32 INDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Directors of Thoratec Laboratories Corporation: We have audited the accompanying consolidated balance sheets of Thoratec Laboratories Corporation and Subsidiary (the "Company") as of January 2, 1999 and January 3, 1998, and the related consolidated statements of operations and comprehensive loss, shareholders' equity and cash flows for the fiscal years ended January 2, 1999, January 3, 1998, and December 28, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Thoratec Laboratories Corporation and Subsidiary as of January 2, 1999 and January 3, 1998 and the results of their operations and their cash flows for the fiscal years ended January 2, 1999, January 3, 1998 and December 28, 1996 in conformity with generally accepted accounting principles. /s/ DELOITTE & TOUCHE, LLP San Francisco, California February 19, 1999 F-1 33 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS ASSETS
FISCAL YEAR END -------------------------- JANUARY 2, JANUARY 3, 1999 1998 ----------- ----------- CURRENT ASSETS: Cash and cash equivalents................................. $ 2,712,686 $ 9,469,311 Short-term investments available-for-sale (Note 3)........ 2,032,107 5,390,663 Receivables, net of allowance for doubtful accounts of $47,591 in 1998 and $0 in 1997 (Note 9)................ 4,141,854 1,302,323 Inventories (Note 4)...................................... 5,290,745 3,901,258 Prepaid expenses and other................................ 404,737 270,865 ----------- ----------- Total current assets.............................. 14,582,129 20,334,420 EQUIPMENT AND IMPROVEMENTS -- AT COST (Note 5): Equipment................................................. 3,458,804 2,671,015 Leasehold improvements.................................... 4,875,339 4,851,701 Construction in progress.................................. 4,126,612 1,300,963 ----------- ----------- Total............................................. 12,460,755 8,823,679 Accumulated depreciation and amortization................... (2,835,365) (2,154,105) ----------- ----------- Equipment and improvements -- net........................... 9,625,390 6,669,574 OTHER ASSETS (Note 5)....................................... 1,000,898 1,473,180 ----------- ----------- TOTAL ASSETS...................................... $25,208,417 $28,477,174 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable.......................................... $ 1,307,768 $ 2,804,400 Accrued compensation...................................... 1,613,334 929,920 Product sales advances.................................... 121,373 255,199 Other..................................................... 288,585 460,378 ----------- ----------- Total current liabilities......................... 3,331,060 4,449,897 COMMITMENTS (Notes 5 and 12) SHAREHOLDER'S EQUITY: (Notes 2, 6, 7, 8, and 9) Preferred shares -- none issued and outstanding Common shares, 100,000,000 authorized; issued and outstanding -- 20,422,952 in 1998 and 20,172,445 in 1997...................................................... 72,810,450 72,664,107 Additional capital.......................................... 2,482,229 2,482,229 Accumulated deficit......................................... (53,402,106) (51,081,554) Accumulated other comprehensive loss: Unrealized gain (loss) on investments -- net................ 8 (7,539) Cumulative translation adjustment........................... (13,224) (29,966) ----------- ----------- Total accumulated other comprehensive loss.................. (13,216) (37,505) ----------- ----------- Total shareholders' equity.................................. 21,877,357 24,027,277 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........ $25,208,417 $28,477,174 =========== ===========
See notes to condensed consolidated financial statements F-2 34 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE FISCAL YEARS ENDED ------------------------------------------------------- JANUARY 2, 1999 JANUARY 3, 1998 DECEMBER 28, 1996 --------------- --------------- ----------------- REVENUE: Product sales -- net (Notes 9 and 11).......... $16,319,531 $ 9,441,302 $ 7,502,536 Interest and other............................. 661,385 753,369 584,406 ----------- ----------- ----------- Total revenue........................ 16,980,916 10,194,671 8,086,942 ----------- ----------- ----------- COSTS AND EXPENSES: (Notes 5 and 13) Cost of products sold.......................... 6,503,986 4,005,242 3,253,626 Research and development....................... 5,096,110 4,582,745 3,723,713 Selling, general, and administrative........... 7,701,372 6,009,043 3,948,238 Debt conversion expense (Note 6)............... 378,295 Interest expense (Note 6)...................... 45,811 ----------- ----------- ----------- Total costs and expenses............. 19,301,468 14,597,030 11,349,683 ----------- ----------- ----------- NET LOSS....................................... (2,320,552) (4,402,359) (3,262,741) ----------- ----------- ----------- Other comprehensive income (loss): Unrealized gain (loss) on investments.......... 7,547 (13,190) 5,651 Foreign currency translation adjustments....... 16,742 (42,384) 13,403 ----------- ----------- ----------- Other comprehensive income (loss).............. 24,289 (55,574) 19,054 ----------- ----------- ----------- COMPREHENSIVE LOSS............................. $(2,296,263) $(4,457,933) $(3,243,687) =========== =========== =========== Basic and diluted loss per share (Note 14)..... $ (0.11) $ (0.24) $ (0.20) =========== =========== =========== Shares used to compute basic and diluted loss per share.................................... 20,339,816 18,360,336 16,693,820
See notes to consolidated financial statements. F-3 35 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED OTHER TOTAL COMMON ADDITIONAL ACCUMULATED COMPREHENSIVE SHAREHOLDERS' STOCK CAPITAL DEFICIT GAIN (LOSS) EQUITY ----------- ---------- ------------ ------------- ------------- BALANCE, DECEMBER 30, 1995.......... $42,746,421 $2,333,689 $(43,416,454) $ (985) $ 1,662,671 Issuance of 342,537 shares of common stock for conversion of notes payable........................... 1,675,000 1,675,000 Exercise of 880,304 common stock warrants for cash and exchange for 83 shares of common stock which were canceled..................... 1,340,034 1,340,034 Issuance of 1,644,000 shares of common stock for cash............. 17,591,204 17,591,204 Exercise of 146,185 common stock options for cash and exchange for 3,518 shares of common stock which were canceled..................... 166,480 166,480 Issuance of common stock options for nonemployee services.............. 138,188 138,188 Other comprehensive gain: Unrealized gain on investments.... 5,651 5,651 Foreign currency translation adjustments..................... 13,403 13,403 Net Loss............................ (3,262,741) (3,262,741) ----------- ---------- ------------ -------- ----------- BALANCE, DECEMBER 28, 1996.......... 63,519,139 2,471,877 (46,679,195) 18,069 19,329,890 Exercise of 241,937 common stock options for cash and exchange for 11,609 shares of common stock which were canceled............... 335,681 335,681 Issuance of 2,000,000 shares of common stock for cash............. 8,809,287 8,809,287 Issuance of common stock options for nonemployee services.............. 10,352 10,352 Other comprehensive loss: Unrealized gain on investments.... (13,190) (13,190) Foreign currency translation adjustments..................... (42,384) (42,384) Net Loss............................ (4,402,359) (4,402,359) ----------- ---------- ------------ -------- ----------- BALANCE, JANUARY 3, 1998............ 72,664,107 2,482,229 (51,081,554) (37,505) 24,027,277 Exercise of 292,535 common stock options for cash and exchange for 42,028 shares of common stock which were canceled............... 146,343 146,343 Other comprehensive gain: Unrealized gain on investments.... 7,547 7,547 Foreign currency translation adjustments..................... 16,742 16,742 Net Loss............................ (2,320,552) (2,320,552) ----------- ---------- ------------ -------- ----------- BALANCE, JANUARY 2, 1999............ $72,810,450 $2,482,229 $(53,402,106) $(13,216) $21,877,357 =========== ========== ============ ======== ===========
See notes to consolidated financial statements F-4 36 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE FISCAL YEARS ENDED ----------------------------------------------------- JANUARY 2, 1999 JANUARY 3, 1998 DECEMBER 28, 1996 --------------- --------------- ----------------- Cash flows from operating activities: Net loss......................................... $ (2,320,552) $ (4,402,359) $ (3,262,741) Adjustments to reconcile net loss to net cash used in operating activities: Debt conversion expense (Note 6).............. 378,295 Common stock options granted for services (Note 8).................................... 10,352 138,188 Depreciation and amortization................. 681,260 260,895 195,441 Changes in assets and liabilities: Receivables................................. (2,839,531) (468,623) (252,402) Prepaid expenses and other.................. (133,872) (4,346) (17,471) Inventories................................. (1,389,487) (1,198,062) (1,329,032) Other assets................................ 472,282 (595,444) (791,947) Accounts payable and other liabilities...... 228,122 816,745 1,188,741 ------------ ------------ ------------ Net cash used in operating activities......... (5,301,778) (5,580,842) (3,752,928) ------------ ------------ ------------ Cash flows from investing activities: Purchases of short-term investments available-for-sale............................ (16,176,045) (85,482,972) (69,738,523) Maturities of short-term investments available-for-sale............................ 18,620,000 83,400,000 47,560,000 Sales of short-term investments available-for-sale............................ 922,148 7,311,109 11,552,184 Capital expenditures............................. (4,967,293) (4,670,952) (637,679) ------------ ------------ ------------ Net cash provided by (used in) investing activities.................................. (1,601,190) 557,185 (11,264,018) ------------ ------------ ------------ Cash flows from financing activities: Common stock issued upon exercise of warrants.... 961,739 Common stock issued in public placement -- net... 8,809,287 17,591,204 Common stock issued upon exercise of options..... 146,343 335,681 166,480 ------------ ------------ ------------ Net cash provided by financing activities..... 146,343 9,144,968 18,719,423 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents...................................... (6,756,625) 4,121,311 3,702,477 Cash and cash equivalents at beginning of year..... 9,469,311 5,348,000 1,645,523 ------------ ------------ ------------ Cash and cash equivalents at end of year........... $ 2,712,686 $ 9,469,311 $ 5,348,000 ============ ============ ============ Noncash Financing Transaction: Conversion of notes into common stock (Note 6)... $ 1,675,000 Noncash Investing Transactions: Construction costs and capital assets in accounts payable....................................... $ 71,828 $ 1,402,045 $ 286,424 Other Cash Flow Information: Interest paid (Note 6)........................... $ 45,811
See notes to consolidated financial statements. F-5 37 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES Operations -- Thoratec Laboratories Corporation and its subsidiary (the "Company") manufactures and markets medical devices utilizing specialty polymers and is engaged in ongoing research and development. Thoratec's products are marketed worldwide. The Company reports on a 52 - 53 week fiscal year, which ends on the Saturday closest to December 31. The fiscal year ended January 2, 1999 (fiscal 1998) includes 52 weeks. The fiscal years ended January 3, 1998 (fiscal 1997), includes 53 weeks and December 28, 1996 (fiscal 1995) include 52 weeks. Principles of Consolidation -- The consolidated financial statements include Thoratec Laboratories Corporation (a California corporation) and its subsidiary company, Thoratec Europe Limited. All significant intercompany balances and transactions are eliminated in consolidation. Use of Estimates -- The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles necessarily requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the consolidated balance sheet dates and the reported amounts of revenues and expenses for the periods presented. Actual results could differ from these estimates. Cash and Cash Equivalents -- Cash and cash equivalents include money market securities stated at cost, which approximates market value. Investments -- The Company's short-term investments are classified as available-for-sale and reported at fair value. Net unrealized gains and losses are excluded from earnings and reported as a separate component of shareholders' equity. A portion of the funds provided by the public offerings of the Company's common stock in 1996 and 1997 are currently being held for investment until such time that the funds are needed by the Company for operations and capital expenditures. As of the end of 1998, short-term investments were comprised primarily of commercial paper, corporate notes and U.S. Government treasury and agency notes with maturity dates within 12 months of the date of investment. Inventories are stated at the lower of first-in, first-out cost or market. Depreciation and Amortization -- Equipment is depreciated over estimated useful lives which range from two to eight years. Leasehold improvements are amortized over the remaining period of the lease or over the estimated useful life of the improvement, whichever is shorter. The straight-line method is used for depreciation and amortization. Income Taxes -- The Company follows an asset and liability approach for financial accounting and reporting of income taxes. Under this approach, the Company computes its tax liability at each consolidated financial statement date by applying provisions of current tax laws to temporary differences between consolidated financial statement and income tax bases. Changes in tax law may result in an adjustment to deferred tax assets. Fair Value of Financial Instruments -- The Company's financial instruments include cash and equivalents, customer receivables, accounts payable, and certain other accrued liabilities. The carrying amounts of these items are a reasonable estimate of their fair values. Foreign Currency Translation -- All assets and liabilities of the Company's non-United States operations are translated into United States dollars at fiscal period-end exchange rates, and the resulting translation adjustments are recorded as cumulative translation adjustments in shareholders' equity. Income items are translated at actual or average monthly rates of exchange. F-6 38 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Revenue Recognition and Product Warranty -- The Company recognizes product revenues upon shipment of the related product. A provision for estimated future costs relating to warranty expense is recorded when products are shipped. Accounting for Stock-Based Compensation -- The Company accounts for stock-based awards to employees using the intrinsic value method in accordance with Accounting Principals Board Opinion No. 25, "Accounting for Stock Issued to Employees." Proforma disclosures of net earnings and earnings per share consistent with the method of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" are included in Note 8. Loss Per Share -- In February 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). The Company adopted SFAS 128 in the year ended January 3,1998 as required and all earnings per share (EPS) data presented conforms with SFAS 128, including all prior periods presented. SFAS 128 replaces current EPS reporting requirements and requires a dual presentation of basic and diluted EPS. Basic EPS is computed by dividing net income (loss) by the weighted average number of common shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Diluted EPS for 1998, 1997 and 1996 excludes any effect from such securities as their inclusion would be antidilutive. Comprehensive Loss -- In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). The Company has adopted this standard which requires the display of comprehensive income (loss) and its components in the financial statements. In the Company's case, comprehensive loss includes net loss, unrealized gains and losses on investments and foreign currency translation adjustments. Operating Segments -- Effective December 15, 1997, the FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131), which established annual and interim standards for an enterprise's operating segments and related disclosures about its products and services, geographic areas, and major customers. The Company is organized as a single operating segment, whereby the chief operating decision maker assesses the performance of and allocates resources to the business as a whole. The adoption of SFAS 131 did not affect the Company's results of operations, liquidity or financial position but resulted in revised and additional disclosures. See Note 11. Reclassifications -- Certain reclassifications have been made to the 1996 amounts to conform to the 1997 presentation. 2. FINANCIAL POSITION AND LIQUIDITY Subsequent to January 2, 1999, the Company entered into a distribution agreement with Guidant Corporation ("Guidant"). Under the terms of the agreement, Guidant receives exclusive worldwide marketing and distribution rights to the Company's Vectra(TM) Vascular Access Graft product line, except in Japan. In exchange for these rights, Guidant has paid the Company $1.5 million, and will pay up to an additional $2 million when the Vectra(TM) product line receives FDA approval for use in the U.S. Guidant also issued a four-year, unsecured line of credit in the amount of $10 million to the Company, which may be used, if needed, for a variety of business purposes. In November 1997, the Company sold through a public offering 2,000,000 shares of common stock at five dollars per share. Net cash proceeds received by the Company related to this offering were approximately $8,809,000 after placement agents' fees and approximately $491,000 of other costs. In July 1996, the Company sold, through an underwritten public offering, 1,644,000 shares of common stock at $12.00 per share. Included in the 1,644,000 shares are 144,000 shares sold pursuant to an F-7 39 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) underwriters' over-allotment option. Also issued to the underwriters in connection with the public offering were five-year warrants to purchase 164,400 shares of the Company's common stock at $14.40 per share. The warrants are currently exercisable and include a net exercise provision. Net cash proceeds received by the Company related to this offering were approximately $17,591,000. Underwriters' commissions, the fair value of warrants issued to the underwriters, and approximately $1,050,000 of other estimated costs have been recorded as an offset to common stock at the closing of the offering. With the proceeds of these offerings and line of credit, the Company believes that it has sufficient funds to increase its marketing efforts, to conduct clinical trials on its new products, and to develop new sources of revenue, including new products, for at least the next year. However, the Company expects that its operating expenses will increase in future periods as the Company expends increased amounts on product manufacturing, marketing, and research and development of new product lines. As a result the Company expects to break even for the next year. There can be no assurance that the Company will achieve profitability or positive cash flow. 3. SHORT-TERM INVESTMENTS Short term investments available-for-sale are summarized as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ---------- ---------- ---------- JANUARY 2, 1999 Corporate debt instruments................... $1,025,220 $79 $ (0) $1,025,299 Federal government agency.................... 1,006,879 0 (71) 1,006,808 ---------- --- ------- ---------- Total........................................ 2,032,099 79 (71) 2,032,107 ========== === ======= ========== JANUARY 3, 1998 Corporate debt instruments................... $5,398,202 $79 $(7,618) $5,390,663 ========== === ======= ==========
The Company classifies those investments which mature in less than one year as short-term investments. 4. INVENTORIES Inventories consist of the following:
FISCAL YEAR ENDED ---------------------------------- JANUARY 2, 1999 JANUARY 3, 1998 --------------- --------------- Finished goods.................................. $2,712,543 $1,652,312 Work-in-process................................. 1,456,784 803,606 Raw materials................................... 1,121,418 1,445,340 ---------- ---------- Total................................. $5,290,745 $3,901,258 ========== ==========
5. LEASES The Company leases offices, laboratory and manufacturing space under noncancelable operating leases. In 1996 the Company entered into a lease agreement on a new manufacturing facility located in Pleasanton, California, which, will accommodate all of the Company's manufacturing, engineering and administrative activities. The administrative and engineering portion of the building was completed and occupied in late 1997. The manufacturing portion was completed in 1998. The Company invested approximately $9 million in equipment and leasehold improvements to the building. Annual payments under the amended lease are approximately $722,000 for a lease term of 15 years and commenced in August 1997. The lease includes F-8 40 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) provisions, among others, for annual cost of living adjustments to the lease payments, two five-year renewal options, a purchase option, and a security deposit of $885,600, which the Company paid in 1996, and an additional $500,000 paid in 1997. The 1997 payment was returned to the Company in 1998. A significant portion ($750,000) of the remaining security deposit can be reduced or eliminated before the end of the initial lease term if the Company meets certain criteria as specified by the contract. Future minimum lease payments as of January 2, 1999 are noted below:
AS OF JANUARY 2, 1999 --------------- Fiscal year: 1999........................... $ 853,315 2000........................... 746,465 2001........................... 746,465 2002........................... 746,465 2003........................... 746,465 Thereafter..................... 6,324,010 ----------- Total................ $10,163,185 ===========
Rent expense for all operating leases was $911,609 in 1998, $473,237 in 1997, and $200,121 in 1996. 6. LONG-TERM DEBT In 1994, the Company placed $1.675 million of convertible secured debt with private lenders. The notes were convertible into common stock at rates ranging from $4.92 to $6.38 per share, bore interest at 11% and were due in three years. The debt was secured by the royalties payable pursuant to the Licensing Agreement with COBE Laboratories, Inc. ("COBE") (see Note 9), all accounts receivable, equipment and inventory. Five-year warrants to purchase 210,201 shares of Thoratec common stock at $6.38 per share were also issued with the convertible notes. In the first quarter of 1996, all $1.675 million of these notes were converted into 342,537 shares of common stock, according to the terms of the original transaction. In connection with this conversion, the Company reduced the exercise price of the related five-year warrants to $4.50 per share for a thirty day period. All warrants issued in connection with the above noted convertible secured debt (representing 213,720 shares as adjusted for antidilutive provisions) were exercised for a total of approximately $960,000. As all warrants were exchanged and the exercise price reduced, $378,000 of noncash debt conversion expense was recorded. 7. COMMON AND PREFERRED STOCK The Company has authorized 100,000,000 no par common shares, and 2,500,000 shares of preferred stock, of which 540,541 shares have been designated Series A and 500,000 shares designated Series B. On April 26, 1996, the Board of Directors authorized a one-for-three reverse split of the Company's common stock which was approved by the shareholders on June 3, 1996. All references in the consolidated financial statements to number of shares, per share amounts and prices of the Company's common stock have been retroactively restated to reflect the decreased number of common shares outstanding. For other common stock transactions, see Note 2. The Series A preferred stock is entitled to cumulative annual dividends of $1.30 per share and has a liquidation preference of $9.25 plus cumulative unpaid dividends. The Company may redeem the Series A preferred stock at any time for its liquidation preference. Each share of preferred stock is convertible into one- F-9 41 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) third shares of common stock, after adjusting for earned but unpaid dividends. At January 2, 1999, no shares of Series A preferred stock were outstanding. Series B preferred stock is senior to Series A in all preferences. Series B is entitled to cumulative annual dividends of $.96 per share and has a liquidation preference of $8.00 plus cumulative unpaid dividends. The Series B preferred stock is redeemable by the Company five years after issuance for $8.00 per share plus cumulative unpaid dividends. Each share of Series B preferred stock is convertible at any time into three and one-third shares of common stock and has certain anti-dilution provisions. Series B preferred votes on an as- converted basis. At January 2, 1999, no shares of the Series B preferred stock were outstanding. 8. OPTIONS AND WARRANTS In 1993, the Directors approved the 1993 Stock Option Plan ("1993 SOP"), which permits the Company to grant options to purchase up to 666,667 shares of common stock. During 1998 and 1996, 52,500 and 69,693 options, respectively, were granted under this plan. No options were granted under this plan in 1997. In 1996, the Directors adopted the 1996 Stock Option Plan ("1996 SOP") and the 1996 Nonemployee Directors Stock Option Plan ("Directors Option Plan"). The 1996 SOP consists of two parts. Part One permits the Company to grant options to purchase up to 500,000 shares of common stock. During 1998, 1997 and 1996, 132,500, 653,166 and 184,333 options, respectively, were granted at fair market value under this Part of the Plan. Part Two related to the Chief Executive Officer (CEO) and permits the Company to grant non-qualified options to the CEO to purchase up to 333,333 shares of common stock. During 1996, 333,333 options were granted at fair market value under this Part of the Plan. In November 1997, these options were repriced to the then fair market value of five dollars per share. All other options of the CEO were canceled in conjunction with the repricing. The Directors Option Plan permits the Company to grant options to purchase up to 150,000 shares of common stock. The Company currently has seven non-employee directors who are eligible to participate in the Directors Option Plan. During 1998, 1997 and 1996, 35,000, 45,000 and 16,665 options, respectively, were granted at fair market value. In 1997, the Directors adopted the 1997 Stock Option Plan ("1997 SOP"). The 1997 SOP permits the Company to grant options to purchase up to 1,000,000 shares of common stock. During 1998 and 1997, 718,960 and 294,834 options, respectively, were granted at fair market value under this plan. Including the 1993 SOP, the 1996 SOP, the Directors Option Plan, the 1997 SOP, and several older plans, the Company had nine common stock option plans. Options may be granted by the Board of Directors at fair market value at the date of grant. Options under plans become exercisable within four or five years of grant and expire between five and ten years from date of grant. At January 2, 1999, 215,371 common shares remain available for grant. Agreements have been entered into with selected consultants whereby options to purchase the Company's common stock were accepted by these consultants as partial payment for the services they render to the Company. The fair market value of the consulting service is the basis for recording the transaction in the Company's financial records and is recognized as the related services are performed. Options issued under these agreements totaled 61,358 and are included in the grant activity previously discussed. The Company applies APB Opinion 25 and related Interpretations in accounting for its employee stock-based compensation plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost for the Company's stock-based plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of FASB Statement 123, the Company's net loss and net loss per share would have been increased to the proforma amounts indicated in the following table. As 1996 was the initial phase-in period for applying this Statement, the proforma results indicated are F-10 42 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) not necessarily representative of the effects on proforma disclosures of net income for future periods as they exclude options that were granted prior to January 1, 1995, with vesting periods in 1995 and later.
FISCAL YEAR ----------------------------------------- 1998 1997 1996 ----------- ----------- ----------- Net Loss As reported....................................... $(2,320,552) $(4,402,359) $(3,262,741) Pro Forma......................................... (4,565,552) (6,582,359) (5,182,741) Basic and diluted loss per share As reported....................................... $ (0.11) $ (0.24) $ (0.20) Pro Forma......................................... (0.22) (0.36) (0.31)
The fair value of each option grant is estimated as of the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants made in 1998, 1997, and 1996: risk-free interest rates of 5.09% in 1998, 6.32% in 1997, and 5.81% in 1996; expected volatility of 81% for 1998, 88% for 1997, and 67% for 1996; expected lives in all years of two years beyond each incremental vesting period (total life of 2 1/2 to 7 years, depending upon each grant's individual vesting schedule). No dividends are assumed for any plan in any year. Option activity is summarized as follows:
NUMBER OF WEIGHTED AVERAGE OPTIONS EXERCISE PRICE --------- ---------------- Outstanding at fiscal year end 1995 (807,468 exercisable at $1.37 weighted average exercise price per share).......... 1,300,825 $ 1.94 Granted ($7.71 weighted average fair value per share)................................................ 604,024 14.14 Canceled............................................... (183,473) 6.06 Exercised(1)........................................... (146,185) 1.47 --------- ------ Outstanding at fiscal year end 1996 (783,396 exercisable at $2.18 weighted average exercise price per share).......... 1,575,191 $ 6.18 Granted ($3.59 weighted average fair value per share)................................................ 993,000 6.06 Canceled and expired................................... (531,135) 12.02 Exercised(2)........................................... (241,937) 1.81 --------- ------ Outstanding at fiscal year end 1997 (844,747 exercisable at $3.56 weighted average exercise price per share).......... 1,795,119 $ 4.98 Granted ($4.08 weighted average fair value per share)................................................ 938,960 6.44 Canceled and expired................................... (143,288) 4.45 Exercised(3)........................................... (292,535) 1.50 --------- ------ Outstanding at fiscal year end 1998 (790,934 exercisable at $5.60 weighted average exercise price per share).......... 2,298,256 $ 6.05 ========= ======
- --------------- (1) Includes 110,204 options exercised for $166,480 cash and 35,981 options exercised by exchange for 3,518 shares of common stock, which were canceled. (2) Includes 193,371 options exercised for $335,681 cash and 48,566 options exercised by exchange for 11,609 shares of common stock, which were canceled. (3) Includes 68,893 options exercised for $146,343 cash and 223,642 options exercised by exchange for 42,028 shares of common stock, which were canceled. F-11 43 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The status of options outstanding as of January 2, 1999 is summarized as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------ ---------------------- WEIGHTED AVERAGE WEIGHTED WEIGHTED REMAINING AVERAGE AVERAGE PRICE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE CATEGORY OUTSTANDING LIFE PRICE OUTSTANDING PRICE -------- ----------- ----------- -------- ----------- -------- $.18 to $.75............................... 66,616 1.70 years $ .60 50,711 $ .66 $1.14 to $2.25............................. 247,879 4.57 years 2.18 247,879 2.18 $4.375 to $5.938........................... 720,834 8.65 years 5.23 262,801 5.20 $6.00 to $9.875............................ 1,071,403 8.95 years 6.68 118,068 7.85 $10.00 to $15.75........................... 178,192 7.49 years 11.21 98,143 11.85 $30.00..................................... 13,332 7.42 years 30.00 13,332 30.00 --------- ---------- ------ ------- ------ $.18 to $30.00............................. 2,298,256 8.05 years $ 6.05 790,934 $ 5.60 ========= ========== ====== ======= ======
In the second quarter of 1996 the Company amended the terms of an outstanding warrant to purchase 666,667 shares of the Company's common stock at $.003 per share to add a net exercise provision. Subsequently, the warrant was exercised using this provision and the Company issued 666,584 shares of stock to the warrant holder and withheld 83 shares to effect the exercise. For other warrant transactions, see Notes 2 and 6. 9. RELATED PARTIES In 1992 the Company entered into an agreement to sell common stock, representing 26% of the Company, to COBE Laboratories, Inc., which included several provisions, including two seats on the Company's Board of Directors for COBE designees, a standstill agreement, and a participation agreement for future financings. The Company and COBE also finalized a licensing, manufacturing, and distribution agreement which provides for a royalty-bearing license to the Company's biomaterial technology for use in certain of COBE's products, the right for the Company to manufacture these biomaterials for a period of time before the royalty provisions become effective, a provision that COBE and the Company negotiate for COBE to be the distributor of certain future products of the Company, and a right of COBE to first negotiation on certain future licensing rights. For the fiscal years 1997 and 1996, COBE purchases of materials from the Company under the manufacturing agreement totaled $309,727 and $99,150, respectively. The Company's obligation to manufacture biomaterials terminated and there were no purchases by COBE in 1998. There were no receivables outstanding from COBE affiliates at the end of fiscal 1998. Receivables at the end of fiscal 1997 included $1,000 from COBE affiliates. For other related party transactions, see Note 11. 10. TAXES ON INCOME Deferred income taxes reflect the net tax effects of (a) temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and (b) operating loss and tax credit carryforwards. F-12 44 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Significant components of the Company's net deferred taxes are as follows:
FISCAL YEAR ENDED ---------------------------------- JANUARY 2, 1999 DECEMBER 3, 1998 --------------- ---------------- Deferred tax assets: Federal tax loss carryforward (as adjusted for the limitation on change in ownership)..... $ 7,400,000 $ 6,600,000 State tax loss carryforward................... 425,000 350,000 Other, net.................................... 1,600,000 1,500,000 ----------- ----------- Total........................................... 9,425,000 8,450,000 Less: Valuation allowance..................... (9,425,000) (8,450,000) ----------- ----------- -- -- =========== ===========
At January 2, 1999, the Company had net operating loss ("NOL") carryforwards of approximately $21.7 million. The majority of such carryforwards expire from 2003 through 2013. Use of the $7.4 million NOL which arose prior to the greater than 50% change in ownership which occurred in 1992 is limited to approximately $440,000 per year due to such change. Due to these limitations and due to the fact that the Company has sustained cumulative losses, the potential future benefit from these deferred assets are fully reserved by means of a valuation allowance and will therefore produce a financial statement benefit if and when utilized. 11. ENTERPRISE AND RELATED GEOGRAPHIC INFORMATION In accordance with SFAS 131, "Disclosures about Segments of an Enterprise and Related Information", the Company manages its business on the basis of one reportable operating segment. (See Note 1 for a brief description of the Company's business.) Net sales by geographic area are presented by attributing revenues from external customers or distributors on the basis of where the products are sold. Long-lived assets by geographic area and information about products and services are included as enterprise-wide disclosures. Included in European sales for 1998, 1997, and 1996 are $148,294, $1,932, and $116,674, respectively, of sales to COBE and its affiliates, which began distributing the Thoratec VAD System in several European markets in late 1992. In the Spring of 1995, Thoratec signed an agreement with Arrow International ("Arrow") to take over the distribution in most of the COBE territories. Included in European sales for 1997 and 1996 are $282,275 and $1,476,253 respectively, of sales to Arrow. Since the Arrow distribution agreement ended in 1997, there were no amounts in 1998. No customer accounted for greater than 10% of sales in 1998 or 1997. F-13 45 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Included in domestic sales for 1998, 1997 and 1996 are approximately $1,064,000, $461,000 and $250,000 of income earned from the rental of certain Company product. GEOGRAPHIC AREAS
FISCAL YEAR --------------------------------------- 1998 1997 1996 ----------- ---------- ---------- Net Sales: International Europe........................... $ 2,718,794 $1,094,516 $1,731,642 All Other........................ 1,497,584 793,339 302,170 ----------- ---------- ---------- Subtotal.................... 4,216,378 1,887,855 2,033,812 Domestic............................ 12,103,153 7,553,447 5,468,724 ----------- ---------- ---------- Total....................... $16,319,531 $9,441,302 $7,502,536 =========== ========== ==========
FISCAL YEAR ------------------------ 1998 1997 ---------- ---------- Long-lived assets: International -- Europe.............. $ 318,310 $ 230,648 Domestic............................. 9,307,080 6,438,926 ---------- ---------- Total........................ $9,625,390 $6,669,574 ========== ==========
CLASSES OF SIMILAR PRODUCTS
FISCAL YEAR --------------------------------------- 1998 1997 1996 ----------- ---------- ---------- Net Sales: Circulatory Support................. $15,637,756 $8,831,455 $7,292,110 Vascular Graft...................... 681,775 300,120 111,276 Biomaterial Manufacturing........... -- 309,727 99,150 ----------- ---------- ---------- Total....................... $16,319,531 $9,441,302 $7,502,536 =========== ========== ==========
See Note 9 for discussion of Biomaterial Manufacturing. 12. COMMITMENTS In July 1998, the Company established an Executive Officer Severance Benefits Plan and an Employee Severance Benefits Plan as part of the employee benefits package. The plans provide severance benefits to certain employees whose employment is terminated, other than for cause. An Executive Officer's standard severance pay benefit is equal to one times annualized base salary. An employee's severance pay benefit is equal to an amount based on job level and length of service. In October 1997, the Company executed a four-year agreement with Arrow International, Inc. ("Arrow") to supply the mechanical valves for the VAD system used in the Company's VAD system. As of January 2, 1999, the remaining long-term purchase commitment associated with this agreement was approximately $2.4 million. In January 1996, the Company entered into a four-year employment agreement with a key executive officer. This employment agreement provides for, among other provisions, a minimum base salary, an annual bonus based on performance, a severance package and the issuance of 333,333 non-qualified stock options. F-14 46 THORATEC LABORATORIES CORPORATION AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company is not party to any legal proceedings other than ordinary routine litigation incidental to the Company's business. The Company believes that the ultimate resolution of these matters will not have a material adverse effect on the Company's consolidated financial statements taken as a whole. See Notes 5 and 8 for additional commitments. 13. RETIREMENT SAVINGS PLAN Effective January 1997, the Company implemented a 401(k) Plan (the "Plan") covering all employees who have met certain eligibility requirements. Under the Plan, employees may elect to contribute up to 18% of their eligible compensation to the Plan, subject to certain limitations. The Company matches employee contributions at 25% up to the first 6% of employees' compensation. Employees vest at the rate of 25% per year with full vesting after four years of service with the Company. For the years ended January 2, 1999 and January 3, 1998 the Company made contributions to the Plan of approximately $54,000 and $40,000, respectively. 14. EARNINGS PER SHARE The Company calculates basic earnings per share (EPS) and diluted EPS in accordance with Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). Basic EPS is computed by dividing net income (loss) for the period by the weighted average number of common shares outstanding for that period. Diluted EPS takes into account the effect of dilutive instruments, such as stock options, and uses the average share price for the period in determining the number of incremental shares that are to be added to the weighted average number of shares outstanding. Diluted EPS for 1998, 1997 and 1996 excludes any effect of such instruments because their inclusion would be antidilutive. The following is a summary of the calculation of the number of shares used in calculating basic and diluted EPS:
FISCAL YEAR -------------------------------------- 1998 1997 1996 ---------- ---------- ---------- Shares used to compute basic EPS....... 20,339,816 18,360,336 16,693,820 Add: effect of dilutive securities..... -- -- -- ---------- ---------- ---------- Shares used to compute diluted EPS..... 20,339,816 18,360,336 16,693,820 ========== ========== ==========
F-15 47 EXHIBIT INDEX
EXHIBIT NO. EXHIBIT ----------- ------- 3(a) Registrant's Certificate of Incorporation, as amended.(1) 3(b) Registrant's By-Laws, as amended.(1) 4(a) Form of Convertible Secured Promissory Note.(7) 10(p) Lease Agreement dated July 5, 1979, between the Registrant and Scenic Arts Incorporated, as amended.(2) 10(ii) Amended 1984 Incentive Stock Option Plan.(4) 10(eee) Amended 1988 Non-Qualified Stock Option Plan.(4) 10(fff) 1993 Stock Option Plan.(6) 10(ggg) Agreement for the Acquisition of Th. Goldschmidt AG of Certain of the Assets of Thoratec Laboratories Corporation dated as of March 29, 1989.(3) 10(jjj) Thoratec Laboratories Corporation and COBE Laboratories, Inc. Common Stock Purchase Agreement dated November 23, 1992.(5) 10(kkk) License Agreement Between Thoratec Laboratories Corporation and COBE Laboratories, Inc. dated as of November 23, 1992.(5) 10(lll) Lease Agreement dated July 25, 1996, between Registrant and Main Street Associates, as amended.(8) 10(mmm) 1996 Stock Option Plan.(9) 10(nnn) 1996 Nonemployee Directors Stock Option Plan.(9) 10(ooo) First Amendment to Lease Agreement Originally By and Between Mainstreet Associates and Thoratec Laboratories Corporation dated July 25, 1996.(10) 10(ppp) 1997 Stock Option Plan.(11) 10(qqq) Amended 1996 Nonemployee Directors Stock Option Plan.(10) 10(rrr) Second Amendment to Lease Agreement Originally By and Between Mainstreet Associates and Thoratec Laboratories Corporation dated July 25, 1996.(12) 10(sss) Distribution Agreement By and Between Guidant Corporation and dated Thoratec Laboratories Corporation dated January 13, 1999.(13) 10(ttt) Credit Agreement By and Between Thoratec Laboratories Corporation Borrower, and Guidant Corporation, Lender dated As of January 13, 1999.(13) 23 Independent Auditors' Consent -- Deloitte & Touche LLP. 24 Power of Attorney -- Reference is made to page 30 hereof. 27 Financial Data Schedule
- --------------- (1) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-1 (Registration No. 2-87293) and incorporated herein by reference. (2) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-1 (Registration No. 2-70903) and incorporated herein by reference. (3) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 30, 1989 and incorporated herein by reference. (4) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 29, 1990 and incorporated herein by reference. (5) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended January 2, 1993 and incorporated herein by reference. 48 (6) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended January 1, 1994 and incorporated herein by reference. (7) Filed as an Exhibit with corresponding exhibit number to Thoratec's Annual Report for the fiscal year ended December 31, 1994 and incorporated herein by reference. (8) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended June 29, 1996 and incorporated herein by reference. (9) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-8 (Registration No. 333-11883) and incorporated herein by reference. (10) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended June 28, 1997 and incorporated herein by reference. (11) Filed as an Exhibit with corresponding exhibit number to Thoratec's Registration Statement on Form S-8 (Registration No. 333-32223) and incorporated herein by reference. (12) Filed as an Exhibit with corresponding exhibit number to Thoratec's Quarterly Report on Form 10-Q for the fiscal quarter ended September 27, 1997 and incorporated herein by reference. (13) Certain confidential information has been deleted from this exhibit pursuant to a confidential treatment request order that was granted. EX-10.(SSS) 2 EXHIBIT-10.(SSS) DISTRIBUTION AGREEMENT 1 EXHIBIT 10.(sss) EXECUTION COPY DISTRIBUTION AGREEMENT THIS AGREEMENT ("Agreement") is made and entered into as of February 14, 1999 (the "Effective Date"), by and between GUIDANT CORPORATION, an Indiana corporation, and its Affiliates ("Guidant"), having its place of business at 1360 O'Brien Drive, Menlo Park, California 94025, and THORATEC LABORATORIES CORPORATION, a California corporation ("Thoratec"), having a place of business at 6035 Stoneridge Drive, Pleasanton, California 94588. RECITALS A. Thoratec is engaged in the business of developing the Products (as defined below), and Guidant is in the business of developing, manufacturing and distributing medical devices; and B. The parties desire that Guidant act as an exclusive independent distributor of the Products within the Territory (as defined below) under the terms and conditions of this Agreement; NOW, THEREFORE, in consideration of the mutual promises and covenants set forth below, the parties agree as follows: 1. Definitions. 1.1 "Affiliate" means any company or entity that controls, is controlled by or is under common control with, a party to this Agreement. 1.2 "Confidential Information" includes, but is not limited to, trade secrets, discoveries, ideas, concepts, know-how, techniques, designs, specifications, drawings, diagrams, data, business activities and operations, customer lists, reports, studies and other technical and business information. 1.3 "Effective Date" means the date first set forth above. 1.4 "Initial Term" means the period beginning with the Effective Date and ending four (4) years from the date of approval for marketing and sale in the United States by the Federal Food and Drug Administration (FDA). 1.5 "Initial Territory" means worldwide other than the United States and Japan. THE SYMBOL '[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 2 1.6 "Milestone Date" means the date on which Thoratec meets all of the Milestones. 1.7 "Milestones" means the clinical requirements set forth in Section 2.3 relating to approval for distribution of the Products within the United States. 1.8 "Minimum Purchase Requirement" shall mean for each year during the term of this Agreement the minimum quantity of units of the graft Products that Guidant is required to purchase as provided in Section 3.3 of this Agreement. 1.9 "Other Graft Products" means any and all vascular graft products (other than the Products) that may be used in the vasculature (not to include coronary arterial grafting) that Thoratec may develop, manufacture, license, or otherwise acquire during the term of this Agreement. 1.10 "Product" means each of Thoratec's devices, products or technology, currently or hereafter developed or otherwise acquired by Thoratec, that is part of Thoratec's Vectra(TM) vascular access graft product line which includes grafts for vascular access for hemodialysis and associated tunnelers, and any improvements, enhancements or line extensions thereto. 1.11 "Territory" means worldwide (including the United States) but excluding Japan. 2. Appointment of Guidant. 2.1 Appointment. Thoratec hereby appoints Guidant as the exclusive distributor of the Products within the Initial Territory, and subject to Section 2.3, within the United States. During the term of this Agreement, Thoratec will not appoint or authorize any other distributor or sales representative to make sales of all or any part of the Products within the Territory. Guidant shall have the right during the term of this Agreement to represent to the public that it is an authorized independent distributor of the Products within the Territory. 2.2 Independent Contractor. Guidant is and at all times shall be an independent contractor in all matters relating to this Agreement. Guidant and its employees are not agents of Thoratec for any purposes and have no power or authority to bind or commit Thoratec in any way. 2 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 3 2.3 Clinical Milestones. Upon Thoratec's achievement of the following Milestones, and subject to Section 3.7, Guidant shall have exclusive distribution rights with respect to the Products in the United States. Thoratec agrees to use commercially reasonable best efforts to achieve all of the following Milestones: 2.3.1 Receipt for 510(k) approval of the Product as a vascular access device for hemodialysis under the current investigational device exemption ("IDE") protocol as of the Effective Date. 2.3.2 IDE clinical trial data as submitted to the FDA shall demonstrate the Product to have less bleeding during surgery and improved times to hemostasis after dialysis cannulation, as compared to the control graft (ePTFE). 2.3.3 IDE clinical trial data as submitted to the FDA shall demonstrate at least statistical equivalence to the control graft in terms of patency measurements (mean time to first thrombosis and total incidence of thrombosis). 2.3.4 Approved labeling of the Product to include the ability to access for dialysis within 72 hours of implantation. 3. Guidant's Duties. Guidant shall introduce, promote the sale of, solicit and obtain orders for Products from customers in accordance with the terms of this Agreement. In particular, Guidant agrees as follows: 3.1 Personnel. Guidant shall make the Products available to Guidant's Cardiac & Vascular Surgery Group's vascular sales representatives in the Territory. Such representatives may, at Guidant's sole option and discretion, market and sell other products in addition to the Products. 3.2 Forecast. Guidant shall prepare and submit to Thoratec on or before the date that is thirty (30) days after the Effective Date and on or before the first day of each calendar quarter during the term of this Agreement a rolling six (6) month sales forecast of the number of units of each Product that Guidant expects to purchase during each month of that time period. Guidant agrees that, unless otherwise agreed by both parties, the forecast for each quarterly period (other than the first forecast) shall be no greater than two times the forecast for the previous quarter. For each such forecast, 100% of the forecast for the first three months shall be binding, and 50% of the forecast for the fourth through sixth months shall be binding, whether or not such forecasts are in excess 3 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 4 of the Minimum Purchase Requirements. Other than the foregoing, all forecasts and estimates are provided by Guidant to Thoratec for planning purposes only. 3.3 Minimum Purchase Requirements. 3.3.1 For the Initial Territory. During calendar year 1999, Guidant will have no Minimum Purchase Requirements; provided, however, that Guidant agrees to use reasonable commercial efforts to distribute the Product in Europe in 1999, in light of Guidant's existing European sales force. Such efforts will not include a requirement for Guidant to hire additional sales force or support personnel to support the Product sales in 1999. During calendar year 2000 and each remaining calendar year during the Initial Term (except as provided in Section 3.3.2 below), the Minimum Purchase Requirements for sales of Products in the Initial Territory will be [***] of the greater of the previous calendar year's Minimum Purchase Requirements or [***] of units actually sold to Guidant for distribution in the Initial Territory during the previous calendar year. 3.3.2 After Milestone Date. If the Milestone Date occurs on or after July 1 of a calendar year, Guidant will have no Minimum Purchase Requirements with respect to Products distributed in the United States for such year. However, if the Milestone Date occurs prior to July 1 of that year, then the Minimum Purchase Requirement for that calendar year for United States distribution shall be [***] units of the Products. For the first full calendar year after the Milestone Date, Guidant's Minimum Purchase Requirement shall be [***] units of the Products for distribution in both the United States and the Initial Territory. For the second full calendar year after the Milestone Date, the Minimum Purchase Requirement will equal the greater of [***] units or [***] percent ([***]%) times the actual sales for the previous calendar year. Thereafter, during the term of this Agreement (including, if applicable, the Renewal Term as provided in Section 13.2), the parties agree to negotiate in good faith the Minimum Purchase Requirement for the following year prior to the beginning of that year. The parties agree that such negotiations shall be based upon the following and other similar factors: (a) the previous years' Minimum Purchase Requirement; (b) the competitive marketplace for the Products in the Territory, including any recent changes, such as the introduction of competitive products; and (c) any changes in the market price(s) for the Products and competitive products. Further, unless the parties otherwise agree, the Minimum Purchase Requirement for each such year shall be no less than [***]% nor more than [***]% of the greater of the previous year's Minimum Purchase Requirement or [***] of units actually sold to Guidant for distribution in the previous year. 4 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 5 3.3.3 Failure to Meet Minimum Purchase Requirements. If, during any six month period of any calendar year during which Minimum Purchase Requirements apply, Guidant shall fail to purchase at least [***] percent ([***]%) of its Minimum Purchase Requirement (with the difference between Guidant's actual quantity of purchases of the Product and [***] percent ([***]%) of the Minimum Purchase Requirement being referred to as the "Shortfall"), Thoratec shall provide Guidant with written notice of the Shortfall. Such notice shall indicate the amount of the Shortfall as well as the profit margin that Thoratec was otherwise entitled to receive on the amount of Products making up the Shortfall ("Shortfall Profit Margin"). The Shortfall Profit Margin shall be determined in accordance with generally accepted accounting principles, and Thoratec shall provide, upon Guidant's request, written documentation supporting such calculation. In addition, Guidant shall have the right to audit Thoratec's books and records used in calculating the Shortfall Profit Margin. Guidant shall have thirty (30) days from receipt of Thoratec's notice to submit a purchase order to Thoratec for a minimum of one-third of the amount of the Shortfall and to pay the remaining Shortfall Profit Margin. If Guidant fails to do the foregoing within the 30-day period, Thoratec may convert Guidant's distribution rights in the Territory to non-exclusive for a period of three (3) months, at the end of which time Thoratec may terminate this Agreement. 3.3.4 Allocation of Minimum Purchase Requirements. At the beginning of each calendar year during which Minimum Purchase Requirements apply, the parties agree to designate the portion of the Minimum Purchase Requirement for that year that will be allocated to purchases made during the first six months of that year and the portion that will be allocated to purchases made during the last six months of that year. 3.4 Compliance with Laws. Subject to Section 4 below, Guidant will have the necessary legal permits and licenses required by any governmental unit or agency and will comply with applicable international, national, state, regional and local laws and regulations, in performing its duties hereunder and in any of its dealings with respect to the Products. Upon termination of this Agreement, Guidant agrees to cooperate, at Thoratec's expense, in transferring to Thoratec all Product authorizations, registrations, permits and approvals with respect to the Products. 3.5 Non-compete. Guidant agrees that, during the term of this Agreement, and so long as Thoratec fulfills all of Guidant's purchase orders for Products 5 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 6 as provided in this Agreement, Guidant will not develop, acquire or distribute any other arterio/venus vascular access graft technology products for hemodialysis. 3.6 Marketing Plan. Within sixty (60) days of the Effective Date of this Agreement, and at each yearly anniversary thereafter during the term of this Agreement, upon Thoratec's request, Guidant shall submit to Thoratec a marketing plan for the distribution of the Products during the upcoming 12-month period. Such plan will include a review of planned selling and marketing tactics, pricing strategy, competition, and projected units and market share and generally will be comparable to Guidant's marketing plans for its own similar products. 3.7 Milestone Payments. In consideration of the rights granted herein, Guidant shall pay to Thoratec the amount of One Million Five Hundred Thousand U.S. Dollars (US $1,500,000) upon execution of this Agreement. In addition, on or within thirty (30) days of Guidant's receipt of written notice from Thoratec of its achievement of the Milestones (which notice shall include sufficient written evidence and documentation of such achievement), Guidant shall pay for exclusive United States distribution rights as provided under this Agreement in the amount of Two Million U.S. Dollars (US $2,000,000); provided that if Thoratec has not achieved the Milestones by the following dates, the Milestone payment required to be made by Guidant for U.S. distribution rights ("U.S. Milestone Payment") shall be reduced as follows: If the Milestones are achieved on or before March 31, 2001, the U.S. Milestone Payment shall be Two Million U.S. Dollars (US $2,000,000). If the Milestones are achieved between April 1, 2001 and June 30, 2001, the U.S. Milestone Payment shall be One Million Seven Hundred Fifty Thousand U.S. Dollars (US $1,750,000). If the Milestones are achieved between July 1, 2001 and September 30, 2001, the U.S. Milestone Payment shall be One Million Five Hundred Thousand U.S. Dollars (US $1,500,000). If the Milestones are achieved between October 1, 2001 and December 31, 2001, the U.S. Milestone Payment shall be One Million Two Hundred Fifty Thousand U.S. Dollars (US $1,250,000). 6 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 7 If the Milestones are achieved after December 31, 2001 but on or before December 31, 2003, the U.S. Milestone Payment shall be One Million U.S. Dollars (US $1,000,000), provided that prior to achievement of the Milestones, Guidant shall have the right to terminate this Agreement upon ninety (90) days prior written notice to Thoratec. Such termination shall be effective notwithstanding Thoratec's achievement of the Milestones during the 90-day notice period. If the Milestones are not achieved by December 31, 2003, then this Agreement shall terminate. Milestone payments made under this Section 3.7 shall be nonrefundable. 3.8 Post-Market Surveillance. With respect to Guidant's distribution of the Products under this Agreement, Guidant agrees to comply with the United States Food and Drug Administration regulations as outlined in Exhibit B attached hereto. 4. Thoratec's Duties. 4.1 Responsibility for Regulatory and Safety Testing Requirements and for Obtaining Required Approvals and Registrations. 4.1.1 Regulatory and Safety Testing Requirements. Thoratec will be considered to be the finished device manufacturer for the Products, and will be responsible for compliance with all regulatory and safety testing requirements in the Territory. 4.1.2 Regulatory Approvals and Registrations. Thoratec, at its expense, shall obtain all regulatory approvals for the Products in the Territory. This includes, without limitation, designing, implementing and funding the IDE application and the FDA market approval applications in the United States and obtaining and maintaining a CE Mark or other equivalent requirements to market the Product. 4.1.3 Quality System Compliance. Thoratec will be solely responsible for quality system compliance affecting the Products, including, at a minimum, ISO certification and compliance with FDA Quality System Regulations and similar requirements in other jurisdictions within the Territory. During the term of this Agreement, Thoratec will manage the complaint files associated with the Products in the Territory. 7 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 8 4.1.4 Post-Market Surveillance. Thoratec will be responsible for any reportable events, such as patient death or injury, associated with the Products and will be solely responsible for any recall activity associated with the Products; provided, however, that to the extent required by applicable law each party may report such events to the applicable authorities. Each party agrees to provide the other party with any assistance required in connection with such activities, including without limitation access to the Products files and access to customers or end users, as required. 4.2 Literature. Upon Guidant's reasonable request, Thoratec shall furnish Guidant, without charge (except as otherwise agreed), with technical, advertising and selling information and literature concerning the Products as available. 4.3 Marketing Support. To assist Guidant in marketing the Products in the Territory, Thoratec shall: 4.3.1 provide Guidant with any information reasonably requested by Guidant for the purpose of complying with governmental requirements. 4.3.2 provide Guidant with information on marketing and promotional plans of Thoratec for the Products as well as copies of marketing, advertising, sales and promotional literature concerning the Products produced by or for Thoratec, if any; and 4.3.3 provide Guidant with all certificates of analysis concerning the Products, certificates of free sale, trademark authorizations and any other documents which Guidant may reasonably request to satisfy the requirements of the laws of the various jurisdictions within the Territory and of any competent authority. 4.4 Sales and Training. Thoratec shall provide training of Guidant's personnel in the use of the Products initially and after any material changes to the Products upon Guidant's request at a mutually-agreeable location; provided that the initial training shall at a minimum include Thoratec's providing, at its expense, two Thoratec employees to train Guidant's European sales force at a European location designated by Guidant. Guidant will pay the cost of any travel and lodging for its personnel attending any such training, and Thoratec will pay the cost of the trainers and materials. 4.5 Changed Product. Thoratec shall notify Guidant at least sixty (60) days in advance of any change in the processes, materials, equipment, inspection, testing, 8 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 9 manufacturing location and the like of which it has knowledge that may have any effect on the Products or their uses, and Guidant will have the right to make a "last buy" of Product (in no greater quantity than the last three months' forecast) prior to any such material changes. 4.6 Insurance. Thoratec shall at all times maintain product liability insurance covering the Products with minimum annual limits of Two Million U.S. Dollars (US $2,000,000) per occurrence and Two Million U.S. Dollars (US $2,000,000) in the aggregate. Thoratec shall maintain such insurance for a minimum of five (5) years after termination of this Agreement. Within thirty (30) days of the Effective Date, Thoratec shall deliver to Guidant a certificate of insurance evidencing such insurance and stating that the policy will not be canceled or modified without at least thirty (30) days prior written notice to Guidant. 4.7 Non-Revenue Units. During the term of this Agreement, Thoratec agrees to provide Guidant with non-sterile Products, at no charge, as requested by Guidant and as available, for demonstration and testing purposes. 4.8 Right of First Offer for Other Graft Products. During the Initial Term of this Agreement, if Thoratec intends to negotiate with a third party for the granting of license, marketing or distribution rights with respect to any Other Graft Product, Thoratec shall notify Guidant as soon as possible after Thoratec's having first contact with such third party. Thoratec and Guidant shall negotiate in good faith with respect to the licensing, marketing or distribution of such Other Graft Product(s) for a period of no less than sixty (60) days after such notification. During such negotiations, Thoratec agrees that it will not enter into any binding commitments with any third party with respect to the Other Graft Products. 5. Trademarks. 5.1 Trademark License. Thoratec hereby grants to Guidant an exclusive, royalty-free license to use the trademarks, trade names and logos used by Thoratec to identify the Products (the "Trademarks") solely in the course of Guidant's advertisement, promotion, distribution and sale of the Products as provided in this Agreement. Guidant's use of the Trademarks will be in accordance with Thoratec's policies that are provided to Guidant in writing from time to time. Use of the Trademarks on the Products shall not give Guidant any proprietary rights in the Trademarks. 9 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 10 5.2 Ownership. Guidant acknowledges that, subject only to the license granted herein to Guidant, Thoratec owns and retains all proprietary rights in all of its Trademarks. 5.3 No Continuing Rights. Upon termination of this Agreement, Guidant will cease all further display, advertising and use of all Trademarks except in connection with the sale of Products in inventory as provided in Section 13.6 below. 5.4 Labeling of Products. Guidant shall have the right to label the Products distributed under this Agreement; provided, however, that Guidant agrees to credit Thoratec as the manufacturer, and to include the Thoralon(TM) biomaterial brand name, on the Product packaging, brochures, advertisements and any other promotional materials or devices; and provided further that Guidant may use either Thoratec's Vectra(TM) vascular access graft mark or Guidant's own mark to identify the Products. If Guidant uses its own mark to identify the Products, Guidant agrees that, upon termination of this Agreement, it will assign to Thoratec its rights in such mark for no additional consideration. Both parties agree that the labeling of the Products shall be in accordance with applicable regulations in the Territory. Guidant shall provide to Thoratec a sample of Product packaging, brochures, advertising and other promotional materials that include the Vectra(TM) mark or that contain technical information regarding the Products for review and approval prior to Guidant's commercial use of such materials. If Thoratec has not provided Guidant with written notice of its disapproval and request for correction within ten (10) days of receipt of such materials, Thoratec shall be deemed to have approved such materials. 6. Order Placement. 6.1 Transfer Price. Prior to the Milestone Date, the transfer price for each Product purchased by Guidant under this Agreement shall be [***] U.S. Dollars (US $[***]). After the Milestone Date, the transfer price for each Product shall be equal to [***] percent ([***]%) of the worldwide weighted average selling price of the Products in the Territory (excluding non-revenue units distributed by Guidant), determined on a calendar quarterly basis; provided, however, that in no event will the price be lower than [***] U.S. Dollars (US $[***]). All prices are FOB Guidant's distribution facilities in Menlo Park, and are exclusive of transportation, duties and taxes, including sales, use, excise, value-added, withholding or other similar tax of any kind. Foreign currency conversion shall be pursuant to Guidant's standard procedures for converting foreign 10 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 11 currency. Upon no less than thirty (30) days prior written notice to Guidant, Thoratec shall have the right, at its own expense, through an established and reputable certified public accounting firm, to examine Guidant's relevant books and records with respect to sales of Products under this Agreement. Such examination shall be during Guidant's normal business hours, shall be no more frequently than one each year and shall cover no more than the preceding two (2) calendar years. If such examination reveals that Guidant has underreported the worldwide weighted average selling price by 5% or more, then Guidant shall immediately pay the underreported amounts and shall pay for reasonable costs incurred by Thoratec for such audit. 6.2 Purchase Orders and Acknowledgements. 6.2.1 Purchase Orders. All purchases of the Products by Guidant shall be made by written purchase order specifying by Product, the quantity, price, requested delivery schedule, and shipping instructions. All purchases of the Products by Guidant from Thoratec during the term of this Agreement shall be subject to the terms and conditions of this Agreement, and any additional or different terms and conditions in a purchase order or confirmation form which conflicts with this Agreement, shall be of no force and effect, unless the parties specifically agree in writing to the terms and conditions which conflict with this Agreement. 6.2.2 Acceptance of Orders. All orders and modifications to orders are subject to acceptance by Thoratec; provided, however, that Thoratec agrees to accept all purchase orders by Guidant for the Products as long as such orders are consistent with Guidant's forecasts of its expected orders of the Products (as described in Section 3.2 above). In addition, Thoratec shall use reasonable best efforts to fulfill all orders by Guidant for the Products in excess of Guidant's forecasts. If Thoratec believes that it will not be able to satisfy Guidant's orders for the Products, it shall promptly notify Guidant, specifying the reasons for the delay and its expected duration. 6.2.3 Packaging. All Products shall be suitably packed for shipment in the current sterile and finished-goods configuration, unless otherwise agreed by Thoratec and Guidant in writing. Cost of packaging of the Products for shipment to Guidant as specified in this Agreement shall be paid by Thoratec. 6.3 Title and Delivery of Products. 11 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 12 6.3.1 Delivery of the Products shall be completed upon delivery of the Products to Guidant at Guidant's facility specified in Section 6.1, and in all cases, Thoratec's title and the risk of loss or damage to any Products shall pass to Guidant upon delivery of the Products to Guidant at its facility. 6.3.2 Thoratec may make partial shipments against Guidant's purchase orders upon mutual agreement of the parties. 6.4 Cancellation/Reschedules. 6.4.1 Guidant may reschedule each order once and no such reschedule will exceed forty-five (45) days from the originally scheduled ship date. Thoratec will work with Guidant on a case by case basis to resolve issues related to market changes and potential impact on orders placed with Thoratec. 6.4.2 Subject to Guidant's obligations under Section 3.2 of this Agreement, Guidant may cancel all or any portion of an order or change the scope of an order at any time prior to fifteen (15) days before the scheduled ship date. Thereafter, Guidant may do so only with Thoratec's written approval. 6.5 Recalls. The parties will give prompt notice of any contemplated recall of the Products to the other party. The parties shall give each other full cooperation throughout the recall process whether such recall is voluntary or otherwise. 7. Payment Terms. Thoratec will invoice Guidant for ordered units of the Products when Thoratec delivers such units to Guidant in accordance with Section 6.3 of this Agreement. All payments due pursuant to this Agreement shall be made within forty-five (45) days of Guidant's receipt of each invoice. All payments shall be made in United States dollars. 8. Returns. 8.1 Returns. Guidant may return for credit or a refund, at Thoratec's option, any Product that does not meet Thoratec's warranty as set forth in Section 10 of this Agreement. Thoratec will issue a return material authorization (RMA) number for such defective Product upon Guidant's request. Guidant shall return any such defective Product to Thoratec with documentation referencing the applicable RMA number. Thoratec shall submit any refund to Guidant within forty-five (45) days of receiving the 12 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 13 defective Product, or if credit is provided, such credit shall be applied to any outstanding purchase orders first and then to the next purchase order(s) submitted by Guidant. 8.2 Minimum Shelf Life. Each Product delivered under this Agreement must have, upon Guidant's receipt of such Product, a minimum remaining shelf life of two-thirds (2/3) of the Product's approved shelf life. At Thoratec's expense, Guidant may return for a refund or replacement, at Guidant's option, any Product that does not meet this requirement. Thoratec shall submit such refund and reimbursement for shipping costs or replacement Product to Guidant within forty-five (45) days of receiving the returned Product. Thoratec represents that, by June 30, 1999, the approved shelf life of the Products shall be three (3) years for each of the Products. 9. Confidential Information. 9.1 Identification of Confidential Information. Confidential Information provided by the disclosing party and entitled to protection under this Agreement shall be identified as such by appropriate markings on any documents exchanged. If the disclosing party provides information other than in written form, such information shall be considered Confidential Information only if the information by its nature would reasonably be considered of a confidential nature or if the receiving party, due to the context in which the information was disclosed, should have reasonably known it to be confidential, and the disclosing party gives written notice within ten (10) days of disclosure that such information is to remain confidential or the disclosing party had previously confirmed in writing that such information was confidential. 9.2 Protection of Confidential Information. Each party acknowledges that the other party claims its Confidential Information as a special, valuable and unique asset. During the term of this Agreement and for three (3) years thereafter, for itself and on behalf of its officers, directors, agents, and employees, each party agrees to the following: 9.2.1 Receiving party will not disclose the Confidential Information to any third party or disclose to an employee unless such third party or employee has a need to know the Confidential Information in order to enable the disclosing party to exercise its rights or perform its obligations under this Agreement. Receiving party will use the Confidential Information only for the purposes of exercising its rights or fulfilling its obligations under this Agreement and will not otherwise use it for its own benefit. In 13 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 14 no event shall the receiving party use less than the same degree of care to protect the Confidential Information as it would employ with respect to its own information of like importance which it does not desire to have published or disseminated; 9.2.2 If the receiving party faces legal action or is subject to legal proceedings requiring disclosure of Confidential Information, then, prior to disclosing any such Confidential Information, the receiving party shall promptly notify the disclosing party and, upon the disclosing party's request, shall cooperate with the disclosing party in contesting such request. 9.3 Return of Confidential Information. All information furnished under this Agreement shall remain the property of the disclosing party and shall be returned to it or destroyed or purged promptly as its request upon termination of this Agreement; provided, however, that Guidant may retain Confidential Information of Thoratec as reasonably necessary for Guidant to be able to complete the sale of Products on order or in inventory at the time of termination and to support Products already sold by Guidant under this Agreement. All documents, memoranda, notes and other tangible embodiments whatsoever prepared by the receiving party based on or which includes Confidential Information shall be destroyed to the extent necessary to remove all such Confidential Information upon the disclosing party's request. All destruction under this Section 9.3 shall be certified in writing to the disclosing party by an authorized officer of the receiving party. 9.4 Residual Information. Either party shall be free to use for any purpose (including, but not limited to, use in the development, manufacture, marketing and maintenance of its own products and services) the Residuals resulting from access to or work with Confidential Information of the other party, provided that the party maintains the confidentiality of the Confidential Information as provided herein. The term "Residuals" shall mean information in non-tangible form that may be inadvertently retained by persons who have had rightful access to the Confidential Information, including the ideas, concepts, know-how or techniques contained therein. Notwithstanding the provisions of this Section 9.4, during the term of this Agreement, neither party may avoid its obligations toward a particular item of the Confidential Information merely by having a person commit such item to memory so as to reduce it to a non-tangible form. 14 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 15 9.5 Limitations. The confidentiality obligations in this Section 9 shall not apply to disclosed information which the receiving party can prove: receiving party knows at the time of disclosure, free of any obligation to keep it confidential, as evidenced by written records; is or becomes generally publicly known through authorized disclosure, receiving party independently developed without the use of any Confidential Information as evidenced by written records; or receiving party rightfully obtains from a third party who has the right to transfer or disclose it. 9.6 Public Announcements. Notwithstanding anything to the contrary contained in this Agreement, neither party may initiate any public announcement concerning the subject matter of this Agreement without the prior written approval of the other party; provided, however, that this Section 9.6 shall not be construed to limit Guidant's ability to market the Products as it deems necessary or appropriate. 10. Warranty. Thoratec warrants that each Product to be delivered hereunder shall be free of defects in materials and workmanship and shall conform to Thoratec's specifications for such Product, at the time of delivery and for the remaining shelf life thereafter. The warranty period shall be extended to Guidant's customers, but will not exceed the shelf life of the Product. Thoratec warrants that the Products do not and will not infringe the proprietary rights of any third party. THERE ARE NO WARRANTIES THAT EXTEND BEYOND THE FACE OF THIS AGREEMENT. THORATEC DISCLAIMS ALL OTHER WARRANTIES, EXPRESS OR IMPLIED, REGARDING THE PRODUCTS, INCLUDING, BUT NOT LIMITED TO, ANY IMPLIED WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE. 11. Indemnification. 11.1 Indemnification. Subject to Section 11.3 below, Thoratec agrees, at its own expense, to defend Guidant against an "Indemnified Claim," as defined in Section 11.2 below, and to hold Guidant harmless and indemnify Guidant from any loss, expense, liability and/or settlement (including attorneys' fees) resulting from an Indemnified Claim. 11.2 Indemnified Claim. For purposes of this Agreement, an "Indemnified Claim" shall mean: (i) any claim asserting that the Products or any part thereof infringes any third party patent, trade secret, trademark, copyright or other 15 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 16 proprietary right; (ii) any claim arising from or related to a material failure of Thoratec to comply with its warranties under this Agreement; and (iii) any claim asserting that the Products caused injury, or death to person or damage to property. 11.3 Limitations. Thoratec's obligation to indemnify Guidant is contingent upon Guidant (i) promptly notifying Thoratec of such claim and (ii) cooperating with Thoratec in the defense thereof, of which Thoratec will have control at Thoratec's expense. Notwithstanding the above, Guidant shall have the right but not the obligation, at Guidant's expense, to participate in any such defense. 11.4 Infringements. If a claim of infringement is made with respect to a Product, then Thoratec at its option shall (i) obtain for Guidant the right to continue to market and distribute the Product, (ii) replace the Product with a functionally-equivalent noninfringing Product, or (iii) modify said Product so that it become noninfringing, so long as the functionality of the Product is not adversely affected. If Thoratec is unable to do any of the foregoing, it shall grant Guidant a full refund for all affected Products and accept return of them, and refund to Guidant the amounts paid by Guidant under Section 3.7. 11.5 Guidant Indemnification. Guidant agrees, at its own expense, to defend Thoratec against (i) any claim asserting that Guidant mishandled the Products, (ii) any claim asserting a misrepresentation by Guidant concerning any of the characteristics of the Products, and (iii) any claim asserting any negligent act or omission of Guidant relating to the Products. Guidant's obligation to indemnify Thoratec is contingent upon Thoratec (i) promptly notifying Guidant of such claim and (ii) cooperating with Guidant in the defense thereof, of which Guidant will have control at its expense. Notwithstanding the above, Thoratec shall have the right but not the obligation, at its expense, to participate in any such defense. 12. Limitation of Liability. NEITHER PARTY SHALL, BY REASON OF THE TERMINATION OF THIS AGREEMENT OR OTHERWISE, BE LIABLE TO THE OTHER PARTY FOR ANY CONSEQUENTIAL, SPECIAL, INCIDENTAL, OR OTHER DAMAGES (INCLUDING WITHOUT LIMITATION LOSS OF PROFIT) WHETHER OR NOT ADVISED TO THE POSSIBILITY OF SUCH DAMAGES. THIS LIMITATION SHALL APPLY TO ANY CLAIM OR CAUSE OF ACTION WHETHER IN CONTRACT OR TORT (INCLUDING NEGLIGENCE), STRICT LIABILITY, OR BREACH OF WARRANTY, BUT SHALL NOT APPLY IF A PRODUCT IS 16 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 17 DETERMINED TO BE DEFECTIVE AND TO HAVE CAUSED BODILY INJURY OR DEATH, NOR SHALL IT APPLY TO LIABILITY UNDER SECTION 11. 13. Term and Termination. 13.1 Term. This Agreement is effective as of the Effective Date and shall continue until the end of the Initial Term unless terminated earlier pursuant to this Section 13 or as provided in Section 3.3 or Section 3.7. 13.2 Renewal. After the Initial Term, Guidant shall have the right, for no additional payment or other consideration, to renew this Agreement for an additional five (5) year period ("Renewal Term") under the same terms and conditions, including the same transfer pricing terms described herein, except that the Minimum Purchase Requirements shall be negotiated in good faith for each year during the Renewal Term. Unless the parties otherwise agree, the Minimum Purchase Requirement for each year during the Renewal Term shall be no less than [***]% nor more than [***]% of the previous year's Minimum Purchase Requirement. The parties shall commence such negotiations promptly after Guidant provides notice of its intent to renew this Agreement and before the beginning of the Renewal Term. If the parties have engaged in good faith negotiations (with each party represented by persons with authority to settle the matter), for a period of no less than ninety (90) days or in such other time frame as the parties may otherwise agree, and the parties are still unable to agree on such Minimum Purchase Requirements for any of the Products, then such disagreement shall be resolved by binding arbitration as provided in Exhibit A. 13.3 Immediate Termination For Cause. Either party may terminate this Agreement by giving the other party thirty (30) days' written notice of such termination if the other party materially breaches or defaults in any of the material terms or conditions of this Agreement and fails to cure such breach or default within thirty (30) days of receiving notice thereof. 13.4 Effect of Termination. 13.4.1 Upon any termination of this Agreement by Thoratec, Guidant will be entitled to have delivered the Products ordered prior to termination. In addition, upon any termination of this Agreement, Guidant may, at its option, either sell all or any part of its remaining inventory of the Products to customers or, if the Agreement terminated for Thoratec's breach, sell to Thoratec all or any part of Guidant's 17 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 18 inventory of the Products (excluding demonstration units and Products with less than 6 months shelf life remaining as of the effective date of termination). Thoratec agrees to repurchase all of such Products that Guidant may decide to sell to Thoratec. Guidant must exercise the right to resell within sixty (60) days after termination of this Agreement. The price for such inventory shall be the total invoice price paid by Guidant for such Products. 13.4.2 Sections 1, 3.4, 3.8, 4.6, 6.5, 9, 10, 11, 12, 13.4 and 14 shall survive termination of this Agreement for any reason. 14. General Provisions. 14.1 No Waiver. The failure of either party to enforce at any time or for any period any of the provisions of this Agreement shall not be construed to be waiver of those provisions or of the right of that party thereafter to enforce each and every provision hereof. 14.2 Assignment. This Agreement shall not be assignable by either party without the prior written consent of the other party; provided, however, that, upon thirty (30) days prior written notice to Thoratec, Guidant may assign this Agreement to any of its Affiliates without Thoratec's consent. For purposes of this Section, the term "assignment" will be deemed to include a sale of all or substantially all of the stock or assets of either party (including by way of merger), or a sale of all or substantially all of the assets of that portion of the either party's business to which this Agreement relates. Any attempted assignment not otherwise permitted herein shall be void. The provisions hereof shall be binding upon and inure to the benefit of the parties, their successors and permitted assigns. 14.3 Notices. Any notice, report or statement to either party required or permitted under this Agreement shall be in writing and shall be sent by certified mail, return receipt requested, postage prepaid, or by facsimile transmission with confirmation sent by certified mail as above, or by courier, such as Federal Express, DHL or the like, with confirmation of receipt by signature requested, directed to the other party at its mailing address set forth below, or to such other mailing address as the party may from time to time designate by prior notice in accordance herewith. Any such notice, report or statement sent in accordance with this Section 14.3 shall be deemed duly given upon dispatch, subject to proof of receipt. 18 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 19 14.4 Governing Law. This Agreement (and any other documents referred to herein) shall be construed in accordance with the laws of the State of California without reference to choice of law principles, as to all matters, including, but not limited to, matters of validity, construction, effect or performance. The exclusive venue and jurisdiction for resolution of disputes hereunder shall be the courts located in San Mateo County, California, or, if applicable, the Federal Courts in the Northern District of California. The United Nations' Convention on the Contracts for the International Sale of Goods shall not apply to this Agreement. 14.5 Force Majeure. The parties shall not be liable for any delay or failure of obligations under this Agreement, in whole or in part, for any causes beyond the reasonable control of the parties, including, but not limited to, acts of God, war, riot, civil disturbances, strikes, lockouts or other labor disputes, accident of transportation or other force majeure. 14.6 Titles of Sections. The title of the various sections of this Agreement are used for convenience of reference only and are not intended to and shall not in any way enlarge or diminish the rights or obligations of the parties or affect the meaning or construction of this document. 14.7 Investigation; Joint Preparation. Each party acknowledges that it has had adequate opportunity to make whatever investigation or inquiry it deems necessary or desirable in connection with the subject matter of this Agreement prior to the execution hereof. Each party further acknowledges that it has read and understands each provision of this Agreement. This Agreement has been prepared jointly by the parties and shall not be strictly construed against either party, it being agreed that each party has had an opportunity to consult with counsel of its own choosing regarding the terms and conditions of this Agreement. 14.8 Integration/Modification/Entire Agreement. This Agreement (including any Exhibits) sets forth the entire agreement and understanding between the parties as to the subject matter hereof, and supersedes, integrates and merges all prior discussions, correspondence, negotiations, understandings or agreements. This Agreement may not be altered, amended, modified or otherwise changed in any way except by a written instrument, which specifically identifies the intended alteration, amendment, modification or other change and clearly expresses the intention to so change this Agreement, signed by authorized representative of the parties. 19 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 20 14.9 Counterparts. This Agreement may be executed in two or more counterparts, each of which when executed shall be deemed an original, and all of which together shall constitute one and the same instrument. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed as of the Effective Date. THORATEC LABORATORIES CORPORATION GUIDANT CORPORATION /s/ D. KEITH GROSSMAN /s/ RONALD W. DOLLENS - ----------------------------------- ----------------------------------- (signature) (signature) BY: D. Keith Grossman BY: Ronald W. Dollens ------------------------------ ------------------------------- (print name) (print name) TITLE: President and Chief TITLE: President and Chief Executive Officer Executive Officer 20 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 21 EXHIBIT A BINDING ARBITRATION FOR MINIMUM PURCHASE REQUIREMENTS (a) The disputed Minimum Purchase Requirements during each year shall be resolved by final and binding arbitration conducted in accordance with the commercial arbitration rules of the American Arbitration Association ("AAA") then in effect, except as set forth herein. (b) There shall be a sole arbitrator mutually agreed to by the parties. If the parties cannot agree on a sole arbitrator on or before the date that is sixty (60) days before the start of the applicable year, then the arbitrator shall be appointed by AAA in accordance with its rules. The arbitrator shall be neutral, independent and impartial. (c) Arbitration of the dispute shall consist of a one-day hearing in which each party shall have equal time to present to the arbitrator the party's evidence relating to the disputed Minimum Purchase Requirements of the Product(s). On the day following the hearing, each party shall deliver simultaneously to the other and to the arbitrator an offer setting forth the party's final position as to what the Minimum Purchase Requirements for each of the Products and for each year in dispute should be, together with a short explanation of the reasons supporting such offer. (d) Unless the parties have entered into a final and binding agreement resolving each dispute submitted to arbitration hereunder as to the Minimum Purchase Requirement for each Product during each year, the arbitrator shall, within ten (10) business days after the hearing, choose one of the two offers submitted by the parties on a Product by Product basis and render to the parties simultaneously a reasoned written decision explaining the basis for deciding between the submitted offers. (e) That decision shall be binding upon the parties, and the chosen Minimum Purchase Requirement for each Product for each year specified in such decision (the "Chosen MPR") shall be the Minimum Purchase Requirements of Guidant during the applicable year under this Agreement. (f) If the final decision of the arbitrator is not rendered by the beginning of the applicable year, then the Minimum Purchase Requirements for the Products during the 21 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 22 preceding year (the "Previous MPR") shall continue to apply until the final decision is rendered. Upon the rendering of the arbitrator's decision, the Chosen MPR for each Product for the then-current year shall be applied on a prorated basis. (g) The arbitration proceedings contemplated by this Section shall be as confidential and private as permitted by law. To that end, the parties shall not disclose the existence, content or results of the proceedings conducted in accordance with this Section, and materials prepared and submitted in connection with such proceedings shall not be admissible in any other proceeding; provided, however, that this confidentiality provision shall not prevent a petition to vacate or enforce an arbitral decision, and shall not bar disclosures required by law. The parties agree that any decision resulting from proceedings in accordance with this dispute resolution provision shall have no preclusive effect in any other matter involving third parties. (h) Judgment on an arbitral decision may be entered by any court of competent jurisdiction, or application may be made to such a court for judicial recognition and acceptance of the decision and any appropriate order including enforcement. (i) Each party shall bear its own legal costs and expenses, and the parties shall share the costs and fees of the arbitrator. (j) All proceedings and meetings referred to in this Section shall take place in San Mateo County, California, or at such other location as the parties may agree. 22 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 23 EXHIBIT B UNITED STATES FOOD & DRUG ADMINISTRATION (FDA) REGULATORY REQUIREMENTS 1. The United States Food & Drug Administration (FDA) requires a device manufacturer or importer "to report to FDA whenever the manufacturer or importer receives or otherwise becomes aware of information that reasonably suggests that one of its marketed devices (1) may have caused or contributed to a death or serious injury or (2) has malfunctioned and that the device or any other device marketed by the manufacturer or importer would be likely to cause or contribute to a death or serious injury if the malfunction were to recur." (Section 803.1 of Title 21 Code of Federal Regulations. 2. Therefore, Thoratec requires, as a condition to entering into a distribution agreement for its products, that the distributor, in the circumstances outlined in paragraph 1 above, will give to Thoratec the following information as soon as possible, but not later than 5 calendar days after the distributor's receipt of such information: A. Identify the device, including model, catalog or other identifying number, including manufacturing lot or serial number. B. Identify by name, address and telephone number the individual making the report. C. Describe, to the extent known, the event giving rise to the information received by the distributor, including (1) whether any deaths or serious injuries have occurred and (2) the number of persons who died or were seriously injured. D. State whether distributor intends to submit additional information and, if so, when such information will be submitted. The information outlined in paragraph 2 above is required to be collected and transmitted by telephone call or facsimile to Thoratec for its reporting to FDA as soon as possible but no later than 5 calendar days after receipt. If this information was transmitted by telephone call to Thoratec, such call shall be followed by a written report. 23 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 24 In addition, pursuant to FDA regulation, Thoratec requires that the distributor of any of its products give to Thoratec all information in its possession regarding bench tests, in vitro tests, and in vivo tests relating to Thoratec's products. Summaries of the tests performed and the results are initially required, with the agreement that, if the FDA asks questions about the summaries, the actual test reports or other raw data will be provided to Thoratec by the distributor. (Section 814, Title 21 CFR) 24 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION EX-10.(TTT) 3 EXHIBIT-10.(TTT) CREDIT AGREEMENT 1 EXHIBIT 10.(ttt) EXECUTION COPY CREDIT AGREEMENT By and Between THORATEC LABORATORIES CORPORATION Borrower, and GUIDANT CORPORATION Lender, Dated as of January 14, 1999 --------------------- $10,000,000 2 TABLE OF CONTENTS
Page ARTICLE 1 Definitions ................................................... 1 ARTICLE 2 Loan .......................................................... 8 2.1 Loan ............................................................... 8 2.2 Interest ........................................................... 8 2.3 Payments ........................................................... 9 ARTICLE 3 Conditions Precedent .......................................... 11 3.1 Conditions to First Disbursement ................................... 11 3.2 Conditions to Subsequent Disbursements ............................. 12 3.3 Conditions for the Benefit of the Lender ........................... 13 3.4 Failure of Conditions .............................................. 13 ARTICLE 4 Representations and Warranties of the Borrower ................ 14 4.1 Due Organization ................................................... 14 4.2 Capitalization ..................................................... 14 4.3 Requisite Power .................................................... 14 4.4 Authorization ...................................................... 14 4.5 Officer Authorization .............................................. 15 4.6 Binding Nature ..................................................... 15 4.7 No Conflict ........................................................ 15 4.8 No Event of Default ................................................ 15 4.9 Tax Returns and Tax Matters ........................................ 15 4.10 Compliance with Laws .............................................. 16 4.11 Full Disclosure ................................................... 16 4.12 Title to Assets ................................................... 17 4.13 Environmental Matters ............................................. 17 4.14 Employee Benefits ................................................. 18 ARTICLE 5 Affirmative Covenants ......................................... 18 5.1 Financial Statements and Notices ................................... 18 5.2 Access ............................................................. 20 5.3 Maintenance of Existence ........................................... 20 5.4 Facilities ......................................................... 20 5.5 Compliance with Laws ............................................... 20 5.6 Material Agreements ................................................ 21 5.7 Insurance .......................................................... 21
i 3 5.8 Taxes and Other Liabilities ........................................ 21 5.9 Governmental Approvals ............................................. 21 ARTICLE 6 Negative Covenants ............................................ 21 6.1 Distributions ...................................................... 22 6.2 Change of Business ................................................. 22 6.3 Liens and Encumbrances ............................................. 22 6.4 Indebtedness ....................................................... 22 6.5 Sale-Leasebacks .................................................... 23 6.6 Transactions With Affiliates ....................................... 23 6.7 Investments ........................................................ 23 ARTICLE 7 Events of Default ............................................. 23 7.1 Events of Default .................................................. 23 7.2 Acceleration ....................................................... 25 ARTICLE 8 Representations and Warranties of the Lender .................. 26 8.1 Due Organization ................................................... 26 8.2 Requisite Power .................................................... 26 8.3 Authorization ...................................................... 26 8.4 Officer Authorization .............................................. 26 8.5 Binding Nature ..................................................... 26 8.6 No Conflict ........................................................ 26 ARTICLE 9 Miscellaneous ................................................. 27 9.1 Successors and Assigns and Sale of Interests ....................... 27 9.2 No Implied Waiver .................................................. 27 9.3 Amendments and Waivers ............................................. 27 9.4 Remedies Cumulative ................................................ 27 9.5 Severability ....................................................... 28 9.6 Costs, Expenses and Attorneys' Fees ................................ 28 9.7 General Indemnification ............................................ 28 9.8 Confidentiality .................................................... 29 9.9 Notices ............................................................ 29 9.10 Entire Agreement .................................................. 30 9.11 Governing Law and Consent to Jurisdiction ......................... 30 9.12 Publicity ......................................................... 31 9.13 Counterparts ...................................................... 31 9.14 Headings .......................................................... 31
ii 4 EXHIBITS AND SCHEDULES
No. Description - --- ----------- Exhibit 2.1(b) Form of Note Exhibit 9.12 Initial Press Release of Borrower Schedule 4.13 Environmental Disclosure
iii 5 CREDIT AGREEMENT THIS CREDIT AGREEMENT (this "Agreement") is entered into as of the date on the cover of this Agreement between THORATEC LABORATORIES CORPORATION, a California corporation (the "Borrower"), and GUIDANT CORPORATION, an Indiana corporation (the "Lender"). W I T N E S S E T H: In consideration of the premises and mutual agreements herein contained, the parties hereto agree as follows: ARTICLE 1 DEFINITIONS In addition to any terms defined elsewhere in this Agreement, the following terms have the meanings indicated for purposes of this Agreement (such definitions being equally applicable to the singular and plural forms of the defined term): "Acceleration" means that the Loan (a) shall not have been paid at the Maturity Date, or (b) shall have become due and payable prior to its stated maturity pursuant to Section 7.2 hereof. "Agreement" or "Credit Agreement" means this Credit Agreement, as from time to time amended, modified or supplemented. "Banking Day" means a day other than a Saturday or a Sunday when commercial banks are open for business in San Francisco, California. "Borrower" shall have the meaning specified in the heading to this Agreement. "Borrower Reports" shall have the meaning set forth in Section 4.11 of this Agreement. "Business" means the research, development, manufacture and commercialization of medical devices and related products for circulatory support and vascular graft and other cardiovascular applications. "Cash Equivalents" means the net current cash value of (a) obligations issued or guaranteed by the United States of America; (b) certificates of deposit, bankers' acceptances and other money market instruments issued by any Permissible Bank; (c) open THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 6 market commercial paper bearing the highest credit rating issued by Standard & Poor's Corp. or by another nationally recognized credit rating firm; (d) repurchase agreements entered into with any Permissible Bank; and (e) shares of money market funds, each having net assets of not less than $500,000,000. "Cash Interest Payment Date" shall mean the earlier of the date that is twenty four (24) months after the First Disbursement Date (but in no event later than the Maturity Date) or a date which is the last day of a calendar quarter and is designated in a written notice from the Borrower to the Lender which notice is received at least five (5) Banking Days prior to such date. "Change of Control" means the occurrence of any of the following events: (a) the Borrower is merged or consolidated with or into another corporation with the effect that the common stockholders of the Borrower immediately prior to such merger or consolidation hold less than fifty percent (50%) of the ordinary voting power of the outstanding securities of the surviving corporation of such merger or the corporation resulting from such consolidation; (b) a change in the composition of the board of directors of the Borrower after the date hereof as a result of which fewer than a majority of the incumbent directors are directors who either (i) had been directors of the Borrower 12 months prior to such change, or (ii) were elected, or nominated for election, to the board of directors with the affirmative votes of a majority of the directors who had been directors of the Borrower 12 months prior to such change and who were still in office at the time of the election or nomination; or (c) a Person or group (as such term is used in Rule 13d-5 under the Securities Exchange Act of 1934) of Persons shall, as a result of a tender or exchange offer, open market purchases, merger, privately negotiated purchases or otherwise, have become, directly or indirectly, the beneficial owner (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934) of securities having twenty percent (20%) or more of the ordinary voting power of then outstanding securities of Borrower. "Code" means the Internal Revenue Code of 1986, as amended. "Confidentiality Agreement" means that certain Confidentiality Agreement, dated as of November 19, 1997, as amended May 4, 1998, by and between the Lender and the Borrower. "Disbursement Date" means any date after the First Disbursement Date but prior to December 31, 2000 on which a disbursement of the Loan is made. Each Disbursement Date shall be on the date designated in a written notice from the Borrower to the Lender (which date shall be not less than five (5) Banking Days after receipt by the Lender of such notice); provided, however, that (a) the Lender shall not be required to make any disbursement if the conditions thereto are not satisfied, and (b) the Lender shall in no event be required to make any disbursement after December 31, 2000. 2 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 7 "Dollars" and "$" mean United States Dollars. "Effective Date" means the date of this Agreement. "Environmental Claim" means all claims, however asserted, by any Governmental Authority or other Person alleging potential liability or responsibility for violation of any Environmental Law or for release or injury to the environment or threat to public health, personal injury (including sickness, disease or death), property damage, natural resources damage, or otherwise alleging liability or responsibility for damages (punitive or otherwise), cleanup, removal, remedial or response costs, restitution, civil or criminal penalties, injunctive relief, or other type of relief. "Environmental Laws" means any Governmental Requirement pertaining to land use, air, soil, surface water, groundwater (including the protection, cleanup, removal, remediation or damage thereof), public or employee health or safety or any other environmental matter; including without limitation, the following laws as the same may be amended from time to time: (1) Clean Air Act (42 U.S.C. Section 7401, et seq.); (2) Clean Water Act (33 U.S.C. Section 1251, et seq.); (3) Resource Conservation and Recovery Act (42 U.S.C. Section 6901, et seq.); (4) Comprehensive Environmental Response, Compensation and Liability Act (42 U.S.C. Section 9601, et seq.); (5) Safe Drinking Water Act (42 U.S.C. Section 300f, et seq.); (6) Toxic Substances Control Act (15 U.S.C. Section 2601, et seq.); (7) Rivers and Harbors Act (33 U.S.C. Section 401, et seq.); (8) Endangered Species Act (16 U.S.C. Section 1531, et seq.); (9) Occupational Safety and Health Act (29 U.S.C. Section 651, et seq.). "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "Event of Default" shall have the meaning set forth in Article 7 hereof. "Exchange Act" means the Securities Exchange Act of 1934, as amended. 3 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 8 "First Disbursement Date" means the date on which the first disbursement of the Loan occurs. The First Disbursement Date shall be on the date designated in a written notice from the Borrower to the Lender (which date shall be not less than five (5) Banking Days after receipt by the Lender of such notice); provided, however, that (a) the Lender shall not be required to make any disbursement if the conditions thereto are not satisfied, and (b) the Lender shall in no event be required to make any disbursement after December 31, 2000. "Fully Diluted Common Equity" means the number of shares of the Borrower's common stock that would be outstanding assuming the exercise or conversion of all outstanding options, warrants, convertible securities and any other rights to acquire common stock. "GAAP" means generally accepted accounting principles set forth in the pronouncements of the Financial Accounting Standards Board or in such other statements, opinions or interpretive releases by such other entities as may be approved by a significant segment of the accounting profession, which are applicable to the circumstances as of the date of determination, applied on a consistent basis. Each accounting term not defined herein and each accounting term partly defined herein to the extent not defined shall have the meaning given to it under GAAP. "Governmental Approvals" means any consent, right, exemption, concession, permit, license, authorization, certificate, order, franchise, determination or approval of any federal, state, provincial, municipal or governmental department, commission, board, bureau, agency or instrumentality required for the ownership of, or activities of the Borrower or any other Person in connection with the business, assets or properties of the Borrower. "Governmental Authority" means any nation or government, any state, province or other political subdivision thereof or any entity exercising executive, legislative, judicial, regulatory or administrative functions of or pertaining to government. "Governmental Requirements" means all legal requirements in effect from time to time including all laws, statutes, codes, acts, ordinances, orders, judgments, decrees, injunctions, rules, regulations, permits, licenses, authorizations, certificates, orders, franchises, determinations, approvals, notices, demand letters, directions and requirements of all Governmental Authorities, departments, commissions, boards, courts, authorities, agencies, officials and officers, and all instruments of record, foreseen or unforeseen, ordinary or extraordinary, including but not limited to any change in any law, regulation or the interpretation thereof by any foreign or domestic Governmental Authority (whether or not having the force of law), relating now or at any time heretofore or hereafter to the business or operations of the Borrower or to any of the property owned, leased or used by 4 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 9 the Borrower, including, without limitation, the development, design, construction, acquisition, start-up, ownership and operation and maintenance of property. "Hazardous Substance" means any pollutant, contaminant, toxic or hazardous substance, material, constituent or waste as such terms are defined in or pursuant to any Environmental Law. "Incipient Default" shall have the meaning set forth in Section 3.1(c) hereof. "Indebtedness" means (a) any obligation for borrowed money; (b) any obligation evidenced by bonds, debentures, notes or other similar instruments; (c) any obligation to pay the deferred purchase price of property or for services (other than in the ordinary course of business); (d) any capitalized lease obligation; (e) any obligation or liability secured by a lien on any asset of the Borrower, whether or not such obligation or liability is assumed; and (f) any other long-term obligation or liability which is required by GAAP to be shown as part of the liabilities on a balance sheet; provided, however, that Indebtedness shall not mean obligations incurred in connection with (x) the acquisition of equipment which is less than or equal to two million dollars ($2,000,000) in the aggregate at any time outstanding or (y) any judgment, order or decree that does not constitute an Event of Default pursuant to Section 7.1(e) hereof. "Insolvency Proceeding" means (a) any voluntary or involuntary case, action or proceeding before any court or other Governmental Authority relating to bankruptcy, reorganization, insolvency, liquidation, receivership, dissolution, winding-up or relief of debtors; and (b) any general assignment for the benefit of creditors, composition, marshalling of assets for creditors or other, similar arrangement. "Investment" as applied to any party, means any direct or indirect ownership or purchase or other acquisition by that party of any capital stock, equity interest, obligations or other securities, or a beneficial interest in any capital stock, equity interest, obligations, or other securities, or all or substantially all assets used to conduct a business or a line of business, or any direct or indirect loan, or capital contribution by that party to any other party, or any joint venture or other arrangement involving the sharing of profits or losses from joint business activities. "Lender" shall have the meaning specified in the heading of this Agreement. "Lien" means any mortgage, deed of trust, pledge, hypothecation, assignment, charge or deposit arrangement, encumbrance, lien (statutory or other) or preference, priority or other security interest or preferential arrangement of any kind or nature whatsoever (including, without limitation, those created by, arising under or evidenced by any conditional sale or other title retention agreement, the interest of a lessor under a capital 5 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 10 lease obligation, any financing lease having substantially the same economic effect as any of the foregoing, or the filing of any financing statement naming the owner of the asset to which such lien relates as debtor, under the Uniform Commercial Code or any comparable law) and any contingent or other agreement to provide any of the foregoing; provided, however, that Lien shall not mean liens created in connection with the acquisition of equipment which secure obligations less than or equal to two million dollars ($2,000,000) in the aggregate at any time outstanding. "Loan" shall have the meaning set forth in Section 2.1(a) hereof. "Loan Documents" means this Agreement and the Note and all agreements, instruments and documents (including, without limitation, if any, security agreements, loan agreements, notes, fee agreements, guaranties, mortgages, deeds of trust, subordination agreements, pledges, assignments of intellectual property, powers of attorney, consents, assignments, contracts, notices, leases, financing statements, letter of credit applications, reimbursement agreements, certificates, statements, reports and notices and all other writings) heretofore, now or hereafter executed by, on behalf of or for the benefit of the Borrower and delivered to the Lender pursuant to or in connection with this Agreement or the transactions contemplated hereby, together with all amendments, modifications and supplements thereto. "Material Adverse Change" means a material adverse change in the business, assets, operations, or financial condition of the Borrower and its subsidiaries considered as a whole. "Material Adverse Effect" means a material adverse effect on the business, assets, operations, or financial condition of the Borrower and its subsidiaries considered as a whole. "Maturity" means the date on which the Loan or any portion thereof becomes due and payable whether as stated, by virtue of mandatory prepayment, by acceleration or otherwise. "Maturity Date" means the date that is four years from the Effective Date. "Note" has the meaning specified in Section 2.1(b). "Obligations" means all loans, advances, debts, liabilities, obligations, covenants and duties owing, to the Lender by the Borrower of any kind or nature, present or future, whether or not evidenced by any note, guaranty or other instrument, arising under any Loan Document, whether or not for the payment of money, arising by reason of an extension of credit, absolute or contingent, due or to become due, now existing or hereafter arising, 6 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 11 including all principal, interest, charges, expenses, fees, attorneys' fees and disbursements and any other sum chargeable to the Borrower under this Agreement or any other Loan Document. "Permissible Bank" means any bank or trust company organized under the laws of the United States of America or any state thereof and having capital and surplus of an aggregate amount not less than $500,000,000. "Permitted Encumbrances" means: (a) liens arising in connection with worker's compensation and unemployment insurance; (b) any lien existing or arising by operation of law in the ordinary course of business, such as a banker's lien or similar right of offset; (c) liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith by appropriate proceedings; (d) liens arising from judgments, decrees or attachments in circumstances not constituting an Event of Default hereunder; (e) easements, reservations, rights-of-way, restrictions, minor defects or irregularities in title or similar encumbrances affecting real property not interfering in any material respect with the ordinary conduct of business; (f) liens in favor of customs and revenue authorities arising in the ordinary course of business; (g) liens (including a lien consisting of the rights of a lessor under a sale-leaseback transaction) created in connection with the acquisition of equipment, which liens secure obligations not in excess of two million dollars ($2,000,000) in the aggregate at any time outstanding; and (h) liens securing Indebtedness not in excess of one million two hundred thousand dollars ($1,200,000) in the aggregate at any time outstanding. "Person" means any individual, corporation, partnership, trust, association or other entity or organization, including any government, political subdivision, agency or instrumentality thereof. "Prepayment Fee" means a fee owing from the Borrower to the Lender upon exercise of the Borrower's right to pay principal and interest prior to Maturity under Section 2.3(c), or obligation to pay principal and interest prior to Maturity under Section 2.3(d), or on a Change of Control as described in Section 2.3(f), based on a percentage of the amount prepaid. The initial Prepayment Fee shall be [***] of the prepaid principal and such fee shall decrease by [***] each year on the anniversary of the Effective Date until the third anniversary, whereupon the Prepayment Fee shall be [***]. Notwithstanding the foregoing, the Prepayment Fee shall be [***] of the outstanding principal amount of the Loan if the Borrower's obligation to pay the Prepayment Fee occurs as a result of a Change of Control. "SEC" means the United States Securities and Exchange Commission. "Securities Act" means the Securities Act of 1933, as amended. 7 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 12 ARTICLE 2 LOAN 2.1 Loan. (a) Loan. Subject to all of the terms and conditions of this Agreement, Lender agrees to make a loan (the "Loan") to the Borrower in the amount of ten million dollars ($10,000,000) to be governed by the terms and conditions of, and repaid in accordance with, this Agreement. The Borrower shall provide the Lender with at least five (5) Banking Days' written notice of a requested disbursement. Disbursement amounts shall be a minimum of five hundred thousand dollars ($500,000) and shall be in multiples of one hundred thousand dollars ($100,000) in excess thereof. Subject to the satisfaction of applicable conditions set forth in Article 3 hereof, the Loan shall be disbursed to the Borrower as follows: up to three million dollars ($3,000,000) shall be disbursed on the First Disbursement Date and any subsequent Disbursement Date. In no event shall the Lender be obligated to disburse to the Borrower more than three million dollars ($3,000,000) in any calendar quarter or more than ten million dollars ($10,000,000) in total. In addition, no more than two Disbursement Dates shall occur in any calendar quarter. The Borrower shall use the proceeds of the Loan solely for the general corporate purposes of the Business. Amounts prepaid in respect of the Loan (whether repaid when due or prepaid) may not be reborrowed. (b) Note. The Borrower's obligation to the Lender to repay the Loan shall be evidenced by a promissory note of the Borrower (the "Note") in the form attached hereto as Exhibit 2.1(b). (c) Disbursement. Upon the prior or contemporaneous satisfaction of all the applicable conditions precedent set forth in Article 3 hereof, or waiver by the Lender of any conditions not so satisfied, the Lender shall disburse the proceeds of each disbursement of the Loan to the Borrower (or to such other Person as the Borrower may designate in writing) by wire transfer of immediately available funds to such bank account as is specified in writing by Borrower to Lender. 2.2 Interest. (a) Interest. The outstanding principal amount of the Loan shall bear interest at a rate per annum initially equal to [***]. Unless the Borrower gives the Lender notice to cause the occurrence of the Cash Interest Payment Date (in which event interest hereunder shall be fixed at the rate of interest in effect on the Cash Interest Payment Date), such rate of interest shall increase by [***] basis points) on the first day of the first calendar quarter following the First Disbursement Date and thereafter on the first day of 8 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 13 each calendar quarter; provided, however, that (except upon the occurrence and during the continuation of an Incipient Default or an Event of Default) the rate of interest hereunder shall not exceed [***] per annum. Upon the occurrence and during the continuation of an Incipient Default or an Event of Default, the outstanding principal amount of the Loan shall, to the extent permitted by applicable law, bear interest at a rate equal to the applicable rate provided above plus [***] per annum. Interest shall be payable as set forth in Section 2.3(a) below. (b) Computation of Interest. Interest shall be computed for the actual number of days elapsed on the basis of a year consisting of 360 days. 2.3 Payments. (a) Interest Payments. Prior to the Cash Interest Payment Date, interest accrued in respect of the Loan shall be added to the outstanding principal amount thereof as of the last day of each calendar quarter. The Lender and the Borrower acknowledge that the outstanding principal amount of the Loan may thereby exceed ten million dollars ($10,000,000) by an amount equal to the aggregate amount of accrued interest that is added to outstanding principal. On the Cash Interest Payment Date and on the last day of each calendar quarter after the Cash Interest Payment Date until the Maturity Date, and on the Maturity Date, the Borrower shall pay the Lender all interest then accrued and unpaid. Amounts added to principal pursuant to the first sentence of this Section shall be treated as principal rather than interest and shall not be due and payable by the Borrower on the Cash Interest Payment Date. (b) Loan Payment. The Borrower shall repay the entire outstanding principal amount of the Loan in full on the Maturity Date. (c) Optional Prepayment. Upon not less than five (5) Banking Days' prior written notice to the Lender, the Borrower may at any time prepay the entire outstanding principal amount of the Loan or any portion thereof; provided that (i) all accrued and unpaid interest on the amount so prepaid shall be paid in full, (ii) the Borrower shall also pay to the Lender on the date the Prepayment Fee, and (iii) in the case of a prepayment of less than the entire outstanding principal amount of the Loan, the principal amount outstanding after such prepayment shall be an integral multiple of one hundred thousand dollars ($100,000). The Lender shall not be obligated to make any further disbursements under this Agreement with respect to any amounts prepaid. If the Borrower gives the Lender notice of the Borrowers intent to repay the outstanding principal balance of the Loan in full, the Lender shall not be obligated to make any further disbursements under this Agreement. 9 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 14 (d) Prepayment for Sale of Assets. The Borrower shall repay the outstanding principal amount of the Loan in its entirety, plus all interest accrued and unpaid to the date of prepayment, plus the Prepayment Fee, immediately upon the occurrence of a sale, lease, exchange or transfer of all or substantially all of the assets of the Borrower, and in such event the Lender shall have no further obligation to make any further disbursements under this Agreement. (e) Prepayment for Sale of Securities. In the event of a sale, exchange, transfer or other issuance by the Borrower of any of its securities or any rights to purchase or otherwise acquire any of its securities (except for the issuance or sale to officers, directors and employees of and consultants to Borrower for the primary purpose of retaining the services of such persons pursuant to option plans approved by the Borrower's shareholders) or a sale, exchange, transfer or other issuance by the Borrower or any of its subsidiaries of any securities or rights to purchase or otherwise acquire securities of any subsidiary of the Borrower, the Borrower shall immediately upon the occurrence of any of such events repay to the Lender the entire net proceeds thereof, up to the entire amount of the Obligations. (f) Change of Control-Repayment. Upon the occurrence of a Change of Control, the Borrower shall immediately notify the Lender in writing of such occurrence and offer to pay to the Lender the outstanding principal amount of the Loan, plus all interest accrued and unpaid to date, plus the Prepayment Fee. The Lender shall have the option of requiring the Borrower to repay the Loan in accordance with this Section 2.3(f) by giving the Borrower written notice to such effect. The Borrower shall repay such amounts within ten (10) days after the Lender's notice. (g) Payments by the Borrower. All payments (including prepayments) to be made by the Borrower on account of Principal and interest shall be made without set-off or counterclaim and shall be made to the Lender by wire transfer in dollars and in immediately available funds to Lender's Account No. 102-7141, at Mellon Bank, located in Pittsburgh, Pennsylvania, A.B.A. No. 0430-0026-1 or such other location as the Lender may designate in writing to the Borrower from time to time, such payments to be made no later than 12:00 noon (Eastern Standard Time) on the Banking Day on which payment is due. Any payment which is received by the Lender later than 12:00 noon (Eastern Standard Time) shall be deemed to have been received on the immediately succeeding Banking Day. Whenever any payment hereunder shall be stated to be due on a day other than a Banking Day, such payment shall be made on the next succeeding Banking Day, and such extension of time shall in such case be included in the computation of interest. 10 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 15 (h) Offset. In addition to and not in limitation of all rights of offset that the Lender may have under applicable law, Lender, upon the occurrence and during the continuance of an Acceleration, shall have the right to appropriate and apply to the payment of all Obligations any and all amounts that Lender may owe Borrower for any reason. Lender agrees promptly to notify the Borrower after any such offset and application; provided, however, that the failure to give such notice shall not affect the validity of such offset and application. The rights of Lender under this Section 2.3(h) are in addition to the other rights and remedies which the Lender may have. ARTICLE 3 CONDITIONS PRECEDENT 3.1 Conditions to First Disbursement. The obligation of the Lender to make the first disbursement of the Loan shall be subject to the prior or contemporaneous satisfaction of each of the following conditions: (a) Delivery of Documents. The Note shall have been duly executed and delivered to the Lender on the First Disbursement Date; (b) Reports, Certificates and Other Information. The Lender have received the following, dated and in full force and effect on the First Disbursement Date: (i) a certificate of the Secretary or an Assistant Secretary of the Borrower as to authorization of the execution, delivery and performance of this Agreement and all of the other Loan Documents by the Borrower; (ii) a certificate, signed by an authorized officer of the Borrower, stating (A) that the representations and warranties contained in Article 4 hereof are then accurate and complete in all material respects (except with respect to any representation or warranty which is already qualified by a materiality standard in which case such representation or warranty shall be accurate and complete in all respects) as though made on and as of such date and (B) that there has then occurred no Event of Default or Incipient Default which is continuing; and (iii) such other instruments or documents as the Lender may reasonably request relating to the existence and good standing of the Borrower or to the corporate authorization by the Borrower for execution, delivery and performance of this Agreement or any of the other Loan Documents. 11 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 16 (c) No Existing Default. No Event of Default or event which, upon the lapse of time or the giving of notice or both, would constitute an Event of Default (an "Incipient Default") shall exist on the First Disbursement Date or after giving effect to the transactions contemplated to take place hereunder on such date; (d) Representations and Warranties Correct. The representations and warranties set forth in Article 4 hereof shall be true and correct in all material respects (except with respect to any representation or warranty which is already qualified by a materiality standard in which case such representation or warranty shall be true and correct in all respects) on and as of the First Disbursement Date, and after giving effect to the transactions contemplated to occur on such date; (e) Cash Balances. The Lender shall have received a certificate of the Chief Financial Officer of the Borrower in form and substance satisfactory to the Lender stating that as of the close of the second Banking Day prior to the First Disbursement Date, the aggregate amount of cash and Cash Equivalents of the Borrower and its subsidiaries on a consolidated basis does not exceed $10,000,000; (f) Legal Opinion. The Lender shall have received an opinion of counsel to the Borrower, in form and substance satisfactory to the Lender and its counsel, as to the enforceability of this Agreement and the other Loan Documents and as to such other matters as the Lender and its counsel may reasonably request; and (g) Other Documents. The Lender shall have received any other document, instrument, undertaking or certificate stated in any of the Loan Documents to be delivered on the First Disbursement Date or as the Lender may reasonably request. 3.2 Conditions to Subsequent Disbursements. The obligation of the Lender to make each disbursement of the Loan after the first disbursement thereof shall be subject to the prior or contemporaneous satisfaction of each of the following conditions: (a) First Disbursement. The first disbursement of the loan shall have occurred. (b) Reports, Certificates and Other Information. The Lender shall have received the following, dated and in full force and effect on the respective Disbursement Date: (i) a certificate, signed by an authorized officer of the Borrower, stating (A) that the representations and warranties contained in Article 4 hereof are then accurate and complete in all material respects (except with respect to any 12 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 17 representation or warranty which is already qualified by a materiality standard in which case such representation or warranty shall be accurate and complete in all respects) as though made on and as of such date and (B) that there has then occurred no Event of Default or Incipient Default which is continuing; and (ii) such other instruments or documents as the Lender may reasonably request relating to the existence and good standing of the Borrower or to the corporate authorization by the Borrower for execution, delivery and performance of this Agreement or any of the other Loan Documents. (c) No Existing Default. No Event of Default or Incipient Default shall exist on the respective Disbursement Date or after giving effect to the transactions contemplated to take place hereunder on such date; (d) Representations and Warranties Correct. The representations and warranties set forth in Article 4 hereof shall be true and correct in all material respects (except with respect to any representation or warranty which is already qualified by a materiality standard in which case such representation or warranty shall be true and correct in all respects) on and as of the respective Disbursement Date, and after giving effect to the transactions contemplated to occur on such date; (e) Cash Balances. The Lender shall have received a certificate of the Chief Financial Officer of the Borrower in form and substance satisfactory to the Lender stating that as of the close of the second Banking Day prior to the respective Disbursement Date, the aggregate amount of cash and cash equivalents of the Borrower and its subsidiaries on a consolidated basis does not exceed $10,000,000; and (f) Other Documents. The Lender shall have received any other document, instrument, undertaking or certificate stated in any of the Loan Documents to be delivered on the Disbursement Date or as the Lender may reasonably request. 3.3 Conditions for the Benefit of the Lender. The conditions set forth in this Article 3 are for the exclusive benefit of the Lender and may be waived, for purposes of this Agreement, only by a written waiver declaration signed by the Lender. 3.4 Failure of Conditions. Lender's obligations hereunder shall terminate, and the Lender shall have no further obligation to disburse the Loan, if the first Disbursement Date shall not have occurred by December 31, 2000. 13 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 18 ARTICLE 4 REPRESENTATIONS AND WARRANTIES OF THE BORROWER In order to induce Lender to enter into or become party to this Agreement and to make the Loan, the Borrower makes the following representations and warranties to the Lender: 4.1 Due Organization. The Borrower is a corporation duly organized, validly existing and in good standing under the laws of the State of California. The Borrower is duly licensed or qualified to conduct business and in good standing in each jurisdiction wherein the character of the property owned or the nature of the business transacted by it makes such licensing or qualifications necessary, except as to jurisdictions where the failure to be so licensed or qualified would not have a Material Adverse Effect. 4.2 Capitalization. (a) The corporate charter or certificate of incorporation and all amendments thereto for the Borrower have been duly filed and are in proper order. All of the outstanding capital stock of the Borrower has been validly issued in compliance with all federal and state securities laws and is fully paid and nonassessable. (b) As of the First Disbursement Date and each Disbursement Date the Borrower is not subject to any obligation (contingent or otherwise) to repurchase or otherwise acquire or retire any shares of its capital stock. 4.3 Requisite Power. The Borrower has all requisite corporate or other legal power and all Governmental Approvals necessary to own and operate its properties and to carry on its business as now conducted and as proposed to be conducted. The Borrower has all requisite power to borrow the sums provided for in this Agreement and to execute, deliver, issue and perform this Agreement and the Note. 4.4 Authorization. All corporate action on the part of the Borrower and its directors and stockholders necessary for the authorization, execution, delivery and performance of this Agreement and the Note and the other Loan Documents has been duly taken and is in full force and effect. 14 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 19 4.5 Officer Authorization. Each authorized officer of the Borrower executing this Agreement or any of the other Loan Documents is (as of the date of such execution) duly and properly in office and fully authorized to execute and deliver the same. 4.6 Binding Nature. This Agreement, the Note and each of the other Loan Documents is, or upon the execution and delivery thereof will be, a legal, valid and binding obligation of the Borrower, and in full force and effect and enforceable in accordance with its respective terms, except for the effect of applicable laws regarding bankruptcy or insolvency or similar laws affecting creditors' rights generally and by general principles of equity relating to enforceability. 4.7 No Conflict. Neither the execution nor delivery of this Agreement, the Note or any of the other Loan Documents nor fulfillment of nor compliance with the terms and provisions hereof or thereof will (a) conflict with or result in a breach of any Governmental Requirement, or of any agreement or instrument binding upon the Borrower, where such conflict or breach is reasonably likely to have a Material Adverse Effect, or conflict with or result in a breach of any provision of the corporate charter or by-laws of the Borrower, or (b) result in the creation or imposition of any Lien (other than a Permitted Lien) upon any property of the Borrower pursuant to any such agreement or instrument, except pursuant to or as contemplated by this Agreement or any other Loan Documents. No authorization, consent or approval or other action by, and no notice to or filing with, any Governmental Authority or any other Person is required to be obtained or made by the Borrower, for the due execution, delivery and performance by the Borrower of this Agreement, the Note or any of the other Loan Documents or for the validity or enforceability thereof. 4.8 No Event of Default. No Event of Default or Incipient Default has occurred and is continuing or would result from the execution of this Agreement. 4.9 Tax Returns and Tax Matters. Borrower has filed all federal and state income tax returns which are required to be filed, and has paid all taxes as shown on said returns and on all assessments received by it to the extent that such taxes have become due. There is no proposed, asserted or assessed tax deficiency against the Borrower where any such deficiency or all such deficiencies, considered in the aggregate, could have a Material Adverse Effect. 15 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 20 4.10 Compliance with Laws. The Borrower is in compliance with all Governmental Requirements applicable to its properties, assets and business, except where the failure to so comply would not in the aggregate have a Material Adverse Effect. There are no proceedings pending or, to its knowledge, threatened, to terminate or modify any Government Approvals, which termination or modification would have a Material Adverse Effect. 4.11 Full Disclosure. (a) None of the representations or warranties made by the Borrower in the Loan Documents as of the date of such representations and warranties contains any untrue statement of a material fact or omits any material fact required to be stated therein or necessary to make the statements made therein, in light of the circumstances under which they are made, not misleading. (b) As of their respective dates, each registration statement, report, proxy statement or information statement (as defined in Regulation 14C under the Exchange Act) or other document filed with the SEC of or by the Borrower filed by it since its initial public offering (including, without limitation, the Registration Statement on Form S-1 with respect to its initial offering), in the form (including exhibits and any amendments thereto) filed with the SEC, (collectively, the "the Borrower Reports") (i) complied as to form in all material respects with the applicable requirements of the Securities Act and the Exchange Act and the rules and regulations thereunder and (ii) did not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements made therein, in the light of the circumstances under which they were made, not misleading. (c) Each of the financial statements (including the related notes and schedules) furnished by the Borrower to the Lender pursuant to Section 5.1 hereof and the consolidated balance sheets (including the related notes and schedules) included in or incorporated by reference into the Borrower Reports, including, without limitation, the financial statements of the Borrower and its subsidiaries on a consolidated basis dated as of January 3, 1998 and October 3, 1998, and for the year and nine months, respectively, then ended, fairly presents the consolidated financial position of the Borrower as of its date, and each of the consolidated statements of income, retained earnings and cash flows (including the related notes and schedules) included in or incorporated by reference into the Borrower Reports or the financial statements furnished by the Borrower to the Lender pursuant to Section 5.1 hereof (including the related notes and schedules) fairly presents the results of operations, retained earnings or cash flows, as the case may be, of the Borrower for the periods set forth therein (subject, in the case of unaudited statements, to normal year-end audit adjustments which would not be material in amount or effect and subject to the 16 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 21 absence of a statement of shareholder equity in the case of the unaudited statements), in each case in accordance with GAAP consistently applied during the periods involved, except as may be noted therein. The Borrower has no liabilities or obligations of any nature (whether accrued, absolute, contingent or otherwise) except (a) as set forth in the Borrower Reports, (b) liabilities or obligations reflected on, or reserved against in, a balance sheet of the Borrower or in the notes thereto, prepared in accordance with GAAP consistently applied and included in the Borrower Reports, (c) liabilities or obligations incurred in the ordinary course of business which do not have a Material Adverse Effect and (d) arising under executory contracts not currently in default. 4.12 Title to Assets. The Borrower and its subsidiaries have good and marketable title, free and clear of all Liens other than Permitted Liens, to such properties and assets as are reasonably necessary for the conduct of their business, taken as a whole. 4.13 Environmental Matters. Except as disclosed in Schedule 4.13 attached hereto, (a) to the knowledge of the Borrower, the Borrower has complied with and is currently in compliance in all respects with all applicable Environmental Laws; (b) to the knowledge of the Borrower, none of the properties or operations of the Borrower is subject to any judicial or administrative proceeding alleging the violation of any Environmental Law; (c) to the knowledge of the Borrower, none of the properties or operations of the Borrower is the subject of any federal or state investigation concerning any use or release of any Hazardous Substance; (d) neither the Borrower, nor, to the knowledge of the Borrower, any predecessor of the Borrower, has filed any notice under any federal or state law indicating past or present treatment, storage or disposal of a hazardous waste or reporting a spill or release of a Hazardous Substance into the environment; (e) to the knowledge of the Borrower, the Borrower does not have any contingent liability in connection with any release of any Hazardous Substance into the environment by Borrower, and no release which could require remediation has occurred; (f) none of the Borrower's operations involve the generation, transportation, treatment, storage or disposal of Hazardous Substances (other than in the normal course of and incidental to the ordinary conduct of its business); (g) the Borrower has not disposed of any material amount of any Hazardous Substance in, on or about any premises owned, leased or used by the Borrower and, to the Borrower's knowledge, neither has any lessee, prior owner, or other Person; (h) no surface impoundments or, to the Borrower's knowledge, underground storage tanks are located in, on or about any of the premises owned, leased or used by the Borrower or any of its subsidiaries; and (i) to the knowledge of Borrower, no Lien in favor of any Governmental Authority exists for (i) any liability under environmental Laws, or (ii) damages arising from or costs incurred by such Governmental Authority in response to a 17 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 22 release of any Hazardous Substance into the environment has been filed or attached to any of the premises owned, leased or used by the Borrower or any of its subsidiaries. 4.14 Employee Benefits. Neither the Borrower nor any other corporation, trade or business which, together with the Borrower, would be treated as a single employer under Sections 414(b), (c), (m) or (o) of the Code (controlled group member) is now or has at any time during the last five years been a contributing sponsor (as defined in Section 4001(a)(13) of ERISA) with respect to any defined benefit pension plan covered by Title IV of ERISA by reason of Section 4021 of ERISA. Neither the Borrower no any controlled group member is now or has at any time during the last five years been obligated to contribute to any multiemployer plan within the meaning of Section 4001(a)(3) of ERISA. Other than continuation coverage required under Section 601 of ERISA the Borrower does not pay or provide for any post-retirement welfare benefits for its retired employees. ARTICLE 5 AFFIRMATIVE COVENANTS The Borrower covenants and agrees that so long as any Obligation is outstanding it will comply with and, if applicable, cause any of its subsidiaries to comply with the following provisions: 5.1 Financial Statements and Notices. The Borrower shall furnish to the Lender the following financial statements, information and notices: (a) Within forty-five (45) days after the close of the first three quarters of Borrower's fiscal year, for the Borrower and its subsidiaries on a consolidated basis, commencing with the fiscal quarter ending March 31, 1999: (i) a statement of stockholders' equity for such quarter; (ii) a statement of cash flows for such quarter; (iii) an income statement for such quarter; and (iv) a balance sheet as of the end of such quarter. All such statements shall be prepared on a consolidated and consolidating basis for the Borrower and its subsidiaries, in reasonable detail, subject to year-end audit adjustments and without footnotes, shall include appropriate comparisons to the same period for the prior year, and shall be certified by the Chief Financial Officer of the Borrower to have been prepared in accordance with GAAP consistently applied, subject to year-end audit adjustments; 18 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 23 (b) Within ninety (90) days after the close of Borrower's fiscal year, commencing with the fiscal year ending December 31, 1998, (i) a copy of the annual audit report for such year for the Borrower, including for the Borrower and its subsidiaries on a consolidated basis, (ii) a statement of stockholders' equity for such fiscal year; (iii) a statement of cash flows for such fiscal year, (iv) an income statement for such fiscal year, and (v) a balance sheet as of the end of such fiscal year, together with like internal unaudited consolidating financial statements for the Borrower and its subsidiaries. All statements required by this Section 5.1(b) shall include appropriate comparisons to the prior year. Such consolidated financial statements shall be audited by an independent certified public accounting firm and shall include a report of such accounting firm, which report shall be unqualified as to the Borrower's status as a going concern and as to the scope of the audit performed by such accounting firm and shall state that such financial statements fairly present in all material respects the financial position of the Borrower and its subsidiaries as at the dates indicated and the results of their operations and their cash flows for the periods indicated in conformity with GAAP, consistently applied; (c) Promptly after they are sent, made available or filed, copies of all reports, proxy statements and financial statements that the Borrower sends or makes available to its stockholders and all registration statements and reports that the Borrower may file with the SEC; (d) Promptly but in no event later than five (5) Banking Days after the Borrower obtains knowledge of the occurrence of an Event of Default or an Incipient Default, provide the Lender with a statement of an authorized officer of the Borrower setting forth details of such Event of Default or Incipient Default and the action which the Borrower proposes to take with respect thereto; (e) Promptly but in no event later than five (5) Banking Days after the Borrower learns thereof, written notice of any actual or threatened claims, litigation, suits, investigations, or proceedings against or affecting the Borrower or any of its subsidiaries, including, without limitation: (i) any claim, litigation, suit, investigation, proceeding or dispute involving a monetary amount, whether or not covered by insurance, in excess of two million dollars ($2,000,000), (ii) any denial, suspension, or revocation of any material Governmental Approval; (iii) any investigation or proceeding before or by any Governmental Authority which is reasonably likely to have a Material Adverse Effect; (iv) any Environmental Claim from any person concerning any alleged violation of any Environmental Law by the Borrower or any of its subsidiaries or any of its or their predecessors which is reasonably likely to either (x) have a Material Adverse Effect or (y) result in a liability to the Borrower or any of its subsidiaries, whether or not insured, in excess of two million dollars ($2,000,000); or (v) the commencement of any investigation by any Government Authority, or the receipt by the Borrower or any of its subsidiaries of 19 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 24 written request by any Government Authority for information, relating to the handling, storage or disposal of any Hazardous Substance, or the release thereof into the environment, by the Borrower or any of its subsidiaries or any of its or their predecessors, or any other Person, which investigation or request is other than routine; and (f) Within a reasonable time after a request therefor, such other information as the Lender may reasonably request. Each notice pursuant to this Section 5.1 (d), (e) or (f) shall be accompanied by a written statement by an authorized officer of the Borrower setting forth details of the occurrence referred to therein known to such officer and stating what action the Borrower proposes to take with respect thereto. 5.2 Access. Subject to the confidentiality limitations contained in Section 9.8, the Borrower shall permit the Lender, at such reasonable times and intervals as the Lender may designate upon reasonable notice, at its own expense by and through the representatives and agents of the Lender, to inspect, audit and examine its books and records, to make copies thereof, to discuss its affairs, finances and accounts with its officers and independent public accountants, and to visit and inspect its properties. 5.3 Maintenance of Existence. The Borrower shall preserve and maintain its corporate existence and all of its licenses, privileges and franchises and other rights necessary or desirable in the normal course of its businesses. 5.4 Facilities. The Borrower and its subsidiaries shall use commercially reasonable efforts to keep the properties used in their respective businesses in good repair, working order and condition, and from time to time shall use commercially reasonable efforts to make necessary repairs or replacements thereto so that their property shall be maintained adequately for its intended use. The foregoing notwithstanding, the Borrower may dispose of obsolete and unneeded property. 5.5 Compliance with Laws. The Borrower and its subsidiaries shall use commercially reasonable efforts to comply in all respects with all Governmental Requirements, except where the failure to do so could not in the aggregate have a Material Adverse Effect. 20 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 25 5.6 Material Agreements. The Borrower and its subsidiaries shall use commercially reasonable efforts to comply in all material respects with the terms of each material agreement to which any of them is a party. 5.7 Insurance. The Borrower and its subsidiaries shall maintain in full force and effect insurance of such types and in such amounts as are customarily carried in their respective lines of business, including, but not limited to, fire, public liability, property damage, hazard insurance, products liability and workers' compensation insurance. 5.8 Taxes and Other Liabilities. The Borrower and its subsidiaries shall pay and discharge when due any and all indebtedness, obligations, liabilities and assessments, including, but not limited to, federal and state income and personal and real property taxes, except as may be subject to good faith contest or as to which a bona fide dispute may arise; provided, however, that an adequate reserve therefor is made in accordance with GAAP. 5.9 Governmental Approvals. The Borrower and its subsidiaries shall use commercially reasonable efforts to apply for, diligently pursue, and obtain or cause to be obtained, and shall thereafter maintain in full force and effect all material Governmental Approvals that shall now or hereafter be necessary under any Governmental Requirement (a) for land use, public and employee health and safety, pollution or protection of the environment and (b) for the operation of the business of the Borrower and the subsidiaries, except where the failure to obtain or maintain such Governmental Approval would not have a Material Adverse Effect. ARTICLE 6 NEGATIVE COVENANTS The Borrower covenants and agrees that so long as any Obligation is outstanding and the Lender has not failed to make a disbursement of the Loan which Lender was required to make, the Borrower will comply with and, if applicable, cause any of its subsidiaries to comply with, the following provisions: 21 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 26 6.1 Distributions. The Borrower shall not, directly or indirectly, make or declare any dividend (in cash, securities or any other form of property) on, or other payment or distribution on account of, or set aside assets for a sinking or other similar fund for purchase, or redeem, purchase, retire or otherwise acquire, any capital stock of the Borrower or securities convertible into or exercisable for capital stock of the Borrower, or make any other distribution in respect thereof, whether in cash or other property (provided, however, that the Borrower may repurchase shares of its capital stock at cost from officers, directors, employees and consultants following termination of their services pursuant to option plans approved by the Borrower's shareholders and may accept shares as payment in connection with option exercises). The Borrower shall not permit any subsidiary of the Borrower to make or declare any dividend (in cash, securities or any other form of property) on, or other payment or distribution on account of, or set aside assets for a sinking or other similar fund for purchase, or redeem, purchase, retire or otherwise acquire, any capital stock of the Borrower or any subsidiary of the Borrower or securities convertible into or exercisable for capital stock of the Borrower or any subsidiary of the Borrower, except that a wholly owned subsidiary of the Borrower may declare and pay cash dividends or otherwise distribute capital to the Borrower. 6.2 Change of Business. The Borrower shall not engage in any business other than the Business. 6.3 Liens and Encumbrances. The Borrower shall not, and shall not allow any of its subsidiaries to, create, incur, assume, or permit to exist any Lien of any kind upon any of the property or assets of the Borrower or such subsidiary now owned or hereafter acquired, other than Permitted Encumbrances. 6.4 Indebtedness. Neither the Borrower nor any of its subsidiaries shall incur, create, assume or permit to exist any Indebtedness except: (a) the Obligations; (b) trade Indebtedness incurred in the ordinary course of business; (c) taxes, assessments and governmental charges or levies which are not delinquent or which are being contested in good faith and for which adequate reserves have been set aside on the books of the Borrower or the affected subsidiary; and (d) current liabilities incurred in connection with the obtaining of goods or services in the ordinary course of business. 22 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 27 6.5 Sale-Leasebacks. Neither the Borrower nor any of its subsidiaries shall enter into or become liable in connection with any sale-leaseback transaction, except for a sale-leaseback in connection with which the property subject thereto is subject to a Permitted Encumbrance. 6.6 Transactions With Affiliates. Except on terms no less favorable to the Borrower than would be obtainable if no such relationship existed, Borrower shall not purchase, acquire or lease any property from, or sell, transfer or lease any property to, or loan or advance money to, or otherwise deal with any affiliate or subsidiary (except for loans to Thoratec Europe Limited in amounts necessary to fund working capital consistent with past practices). 6.7 Investments. Neither the Borrower nor any of its subsidiaries shall make or permit to remain outstanding any Investment, except (a) Investments by the Borrower in its subsidiaries; (b) Investments made in accordance with Borrower's standard investment policies attached hereto as Exhibit 6.7; (c) Investments received in the settlement of any debt owing to the Borrower or any of its subsidiaries, where such debt was incurred in the ordinary course of business; (d) other Investments not to exceed three million dollars ($3,000,000) in the aggregate at any time outstanding; and (e) other Investments in connection with a bona fide acquisition, joint venture or other business relationship; provided such Investment is in furtherance of the Business and does not result in the issuance of securities representing twenty percent (20%) or more of the Fully Diluted Common Equity outstanding immediately prior to such sale or other issuance. ARTICLE 7 EVENTS OF DEFAULT 7.1 Events of Default. Each of the following shall constitute an Event of Default under this Agreement: (a) Principal Payments. The Borrower shall fail to pay when due (whether due when scheduled or as a result of a mandatory prepayment) any payment of principal or Prepayment Fee in respect of the Loan; (b) Interest and Other Payments. The Borrower shall fail to pay when due any payment of interest or other sum payable hereunder or under any of the other 23 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 28 Loan Documents and continuance of such default for fifteen (15) Banking Days after notice thereof to the Borrower from the Lender; (c) Other Covenants and Loan Agreements. The Borrower shall default in the performance of any of its respective agreements set forth in any provision herein or in any of the other Loan Documents (and not constituting an Event of Default under any of the other clauses of this Section 7.1) and such default shall continue for thirty (30) days after notice thereof to the Borrower from the Lender; (d) Representations and Warranties. Any representation or warranty contained in Section 4 hereof or certification pursuant to Section 3.1(b)(i), Section 3.2(b)(i) or 5.1 made by the Borrower or any officer of the Borrower, shall be untrue in any material respect, in any case on any date as of which the facts set forth are stated or certified; (e) Judgments. Any final judgment, order or decree shall be rendered against the Borrower or any subsidiary of the Borrower in an amount equal to or greater than four million dollars ($4,000,000), and either (i) enforcement proceedings shall have been commenced by any Person upon such judgment or order or (ii) there shall be any period of thirty (30) consecutive days during which a stay of enforcement of such judgment or order, by reason of a pending appeal or otherwise, shall not be in effect, unless such judgment, order or decree shall, within such 30-day period, be vacated or discharged (other than by satisfaction thereof); (f) Cross-Default. The Borrower or any subsidiary of the Borrower shall (i) fail to pay when due, by stated maturity, acceleration or otherwise, any Indebtedness for borrowed money of, or any guaranty of Indebtedness for borrowed money by, the Borrower or any subsidiary of the Borrower (not arising hereunder or under any of the other Loan Documents) outstanding in aggregate principal amount greater than two million dollars ($2,000,000), and such failure continues after the applicable grace period, if any, specified in the document relating thereto, or (ii) fail to perform or observe (subject to any applicable grace period) any agreement, covenant or condition with respect to any such Indebtedness or guaranty if the effect of such failure is to accelerate the maturity of any such Indebtedness or to permit the holder or holders of any such Indebtedness or guaranty, or any trustee or agent for such holders, to cause such Indebtedness to become due and payable prior to its expressed maturity or to call upon such guaranty in advance of nonpayment of the guaranteed Indebtedness; (g) Insolvency. An Insolvency Proceeding (whether voluntary or involuntary) shall be commended against the Borrower or any subsidiary of the Borrower; or the Borrower or any subsidiary of the Borrower shall file a petition initiating or shall otherwise institute any similar Insolvency Proceeding under any other applicable federal or 24 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 29 state law, or shall consent thereto; or the Borrower or any subsidiary of the Borrower shall apply for, or by consent or acquiescence there shall be an appointment of, a receiver, liquidator, sequestrator, trustee or other officer with similar powers, or the Borrower or any subsidiary of the Borrower shall make an assignment for the benefit of creditors; or the Borrower or any subsidiary of the Borrower shall admit in writing its inability to pay its debts generally as they become due; or, if an involuntary case shall be commenced seeking the liquidation or reorganization of the Borrower or any subsidiary of the Borrower under Chapter 7 or Chapter 11, respectively, of the United States Bankruptcy Code, or any similar proceeding shall be commenced against the Borrower or any subsidiary of the Borrower under any other applicable federal or state law, and (i) the petition commencing the involuntary case is not timely controverted; or (ii) the petition commencing the involuntary case is not dismissed within forty-five (45) days of its filing; or (iii) an interim trustee is appointed to take possession of all or a portion of the property and/or to operate all or any part of the business of the debtor; or (iv) an order for relief shall have been issued or entered therein; or a decree or order of a court having jurisdiction in the premises for the appointment of a receiver, liquidator, sequestrator, trustee or other officer having similar powers over the debtor, or of all or any part of the property of any of the foregoing, shall have been entered; or any other similar relief shall be granted against the Borrower or any subsidiary of the Borrower, under any applicable federal or state law; or (h) Invalidity of Loan Documents. Any of the Loan Documents shall cease for any reason to be in full force and effect and the Lender shall be substantially deprived of any of its rights under the Loan Documents or any party thereto (other than Lender) shall purport to disavow its obligations thereunder, shall declare that it does not have any further obligation thereunder or shall contest the validity or enforceability thereof. 7.2 Acceleration. If any Event of Default described in Section 7.1(g) hereof shall occur, the Note and all other Obligations shall become immediately due and payable, all without notice of any kind, and the Lender shall have no further obligation to make any disbursement of the Loan which has not then been made. Notwithstanding any other provision in this Agreement, if any other Event of Default shall occur, the Lender shall have no further obligation to make any disbursement of the Loan which has not then been made and may declare, at any time after the occurrence of an Event of Default, the Note and all other Obligations to be due and payable, whereupon the Note and all other Obligations shall immediately become due and payable, all as so declared by the Lender and without presentment, demand, protest or other notice of any kind. Any such declaration made pursuant to this Section 7.2 may be rescinded by the Lender. 25 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 30 ARTICLE 8 REPRESENTATIONS AND WARRANTIES OF THE LENDER The Lender makes the following representations and warranties to the Borrower: 8.1 Due Organization. The Lender is a corporation duly organized, validly existing and in good standing under the laws of the State of Indiana. 8.2 Requisite Power. The Lender has all requisite corporate or other legal power and all governmental licenses, permits, authorizations, consents and approvals necessary to enter into and perform its obligations under this Agreement. 8.3 Authorization. All corporate action on the part of the Lender and its directors and stockholders necessary for the authorization, execution, delivery and performance of this Agreement and the other Loan Documents has been duly taken and is in full force and effect. 8.4 Officer Authorization. Each authorized officer of the Lender executing this Agreement or any of the other Loan Documents is (as of the date of such execution) duly and properly in office and fully authorized to execute and deliver the same. 8.5 Binding Nature. This Agreement is a legal, valid and binding obligation of the Lender, and in full force and effect and enforceable in accordance with its terms, except for the effect of applicable laws regarding bankruptcy or insolvency or similar laws affecting creditors' rights generally and by general principles of equity relating to enforceability. 8.6 No Conflict. Neither the execution nor delivery of this Agreement or any of the other Loan Documents nor fulfillment of nor compliance with the terms and provisions hereof or thereof will (a) conflict with or result in a breach of any Governmental Requirement, or of any agreement or instrument binding upon the Lender, or conflict with or result in a breach of any provision of the articles of incorporation or by-laws of the Lender. No authorization, 26 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 31 consent or approval or other action by, and no notice to or filing with, any Governmental Authority or any other Person is required to be obtained or made by the Lender, for the due execution, delivery and performance by the Lender of this Agreement or any of the other Loan Documents or for the validity or enforceability thereof. ARTICLE 9 MISCELLANEOUS 9.1 Successors and Assigns and Sale of Interests. The terms and provisions of this Agreement shall be binding upon, and, subject to the provisions of this Section 9.1, the benefits thereof shall inure to, the parties hereto and their respective successors and assigns; provided, however, that the Borrower shall not assign this Agreement or any of its rights, duties or obligations hereunder without the prior written consent of the Lender, and the Lender shall not delegate its obligations or duties hereunder without the prior written consent of the Borrower. 9.2 No Implied Waiver. No delay or omission to exercise any right, power or remedy accruing to the Lender upon any breach or default of the Borrower under this Agreement or under any of the other Loan Documents shall impair any such right, power or remedy of the Lender, nor shall it be construed to be a waiver of any such breach or default, or an acquiescence therein, or of or in any similar breach or default occurring thereafter, nor shall any waiver of any single breach or default be deemed a waiver of any other breach or default occurring theretofore or thereafter. 9.3 Amendments and Waivers. No amendment or waiver of any provision of this Agreement or any other Loan Document and no consent with respect to any departure by the Borrower therefrom, shall be effective unless the same shall be in writing and signed by the Lender, and then any such waiver shall be effective only in the specific instance and for the specific purpose for which given. 9.4 Remedies Cumulative. All rights and remedies, either under this Agreement, by law or otherwise afforded to the Lender shall be cumulative and not exclusive, and any single or partial exercise of any power or right hereunder or thereunder does not preclude other or further exercise thereof, 27 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 32 or the exercise of any other power or right. In no event shall either party hereto be liable for consequential damages for breach hereof, even if foreseeable. 9.5 Severability. Any provision of this Agreement, the Note or any of the other Loan Documents which is prohibited or unenforceable in any jurisdiction, shall be, only as to such jurisdiction, ineffective to the extent of such prohibition or unenforceability, but all the remaining provisions of this Agreement, the Note and the other Loan Documents shall remain valid. 9.6 Costs, Expenses and Attorneys' Fees. Each party shall pay all of its fees and expenses associated with the negotiation, preparation, execution and closing of this Agreement and each disbursement of the Loan, including, but not limited to, attorneys' fees and expenses. The Borrower shall pay all costs and expenses, including, but not limited to, reasonable attorneys' fees and expenses (including the allocated cost of in-house counsel), expended or incurred by the Lender in collecting any sum which becomes due under the Note or under this Agreement, any of the other Loan Documents, or in the protection, perfection, preservation and enforcement of any and all rights of the Lender in connection with the Loan Documents including, without limitation, the fees and costs incurred in any out-of-court work-out or a bankruptcy or reorganization proceeding. This obligation on the part of the Borrower shall survive the expiration or termination of this Agreement, without occurrence of the Closing Date and shall survive repayment of the Loan in full. 9.7 General Indemnification. The Borrower shall indemnify and hold the Lender and each of its directors, officers, employees, affiliates, attorneys and agents (collectively referred to herein as the "Lender Indemnitees") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, claims, costs, expenses and disbursements of any kind or nature whatsoever (including without limitation, any expenses (including attorneys' fees and the allocated cost of in-house counsel) incurred by any such Lender Indemnitee in connection with any investigation in connection with any such matter, whether or not any such Lender Indemnitee shall be designated a party thereto) which may be imposed on, incurred by or asserted against such Lender Indemnities by any Person other than the Lender with which such Lender Indemnitee is affiliated (whether direct, indirect or consequential and whether based on any federal or state laws or other statutory regulations, including, without limitation, securities, environmental and commercial laws and regulations, under common law or at equitable cause, or on contract or otherwise) in any manner relating to or arising out of this Agreement and any other Loan Documents, or any 28 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 33 act, event or transaction related or attendant thereto; the making of the Loan hereunder, the management of the Loan (including any liability under federal, state or local environmental laws or regulations), and the use or intended use of the proceeds of the Loan (collectively, the "Indemnified Matters"); provided, however, that the Borrower shall have no obligation to any Lender Indemnitee under this Section 9.7 with respect to Indemnified Matters to the extent such Indemnified Matters were caused by or resulted from the gross negligence or willful misconduct of a Lender Indemnitee. To the extent that the undertaking to indemnify, pay and hold harmless set forth in the preceding sentence may be unenforceable because it is violative of any law or public policy, the Borrower shall contribute to the payment and satisfaction of all Indemnified Matters incurred by the Lender Indemnities the maximum portion which the Borrower is permitted to pay and satisfy under applicable law. This indemnification shall survive repayment by the Borrower of the Loan made under this Agreement, and the termination of this Agreement without occurrence of the Closing Date. 9.8 Confidentiality. Each party agrees that all information furnished by one party to the other pursuant to this Agreement will be held under the that party's obligations pursuant to the Confidentiality Agreement; provided, however, that each party may disclose such information to the extent necessary to enforce the terms and conditions of this Agreement. The parties also agree that the term of the Confidentiality Agreement will be extended through the term of this Agreement. 9.9 Notices. Any notice which the Borrower or the Lender may be required or may desire to give to the other party under any provision of this Agreement shall be in writing by electronic facsimile transmission and shall be deemed to have been given or made when transmitted to the Lender or the Borrower as follows: To the Borrower: Thoratec Laboratories Corporation 6035 Stoneridge Drive Pleasanton, CA 94588 Attention: Chief Financial Officer Facsimile: (925) 847-8625 with a copy to: Heller Ehrman White & McAuliffe 2500 Sand Hill Road Menlo Park, California 94025-7063 Attention: August Moretti, Esq. Facsimile: (650) 234-4299 29 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 34 To the Lender: Guidant Corporation 111 Monument Circle, 29th Floor Indianapolis, IN 46204-5129 Attention: Treasurer Facsimile: (317) 971-2050 with a copy to: Guidant Corporation 1360 O'Brien Drive Menlo Park, CA 94025 Attention: General Counsel Facsimile: (650) 470-6320 Any party may change the address to which all notices, requests and other communications are to be sent to it by giving written notice of such address change to the other parties in conformity with this paragraph, but such change shall not be effective until notice of such change has been received by the other parties. 9.10 Entire Agreement. This Agreement, together with the exhibits to this Agreement, all of the other Loan Documents and the Confidentiality Agreement, is intended by the Borrower and the Lender as a final expression of their agreement and, together with all of the other Loan Documents and the Confidentiality Agreement, is intended as a complete statement of the terms and conditions of their agreement. This Agreement, the other Loan Documents and the Confidentiality Agreement contain all of the agreements and understandings between the Borrower and the Lender concerning the Loan and the other transactions contemplated hereby. 9.11 Governing Law and Consent to Jurisdiction. The validity, construction and effect of this Agreement, the Note and all of the other Loan Documents shall be governed by the laws of the State of California, without regard to its laws regarding choice of applicable law. All judicial proceedings brought against the Borrower with respect to this Agreement, the Note or any of the other Loan Documents may be brought in any state or federal court of competent jurisdiction in the State of California, and the Borrower accepts for itself and its assets and properties, generally and unconditionally, the nonexclusive jurisdiction of the aforesaid courts. The Borrower waives, to the fullest extent permitted by applicable law, any objection (including, without limitation, any objection to the laying of venue or based on the grounds of forum non conveniens) which it may now or hereafter have to the bringing of any such action or proceeding in any such jurisdiction. Nothing herein shall limit the right of Lender to bring 30 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 35 proceedings against the Borrower in the court of any other jurisdiction. TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, THE BORROWER WAIVES COMPLETELY ANY RIGHT WHICH IT MIGHT OTHERWISE HAVE TO TRIAL BY JURY. 9.12 Publicity. Neither party may disclose the existence or content of this Agreement without the prior written consent of the other party, unless such disclosure is in the judgment of the disclosing party reasonably necessary to comply with applicable law or the rules of any stock exchange. Each party shall have the opportunity to review and approve any press releases with respect to this Agreement and/or the transaction contemplated hereunder prior to disclosure. A copy of the initial press release to be issued by the Borrower in connection with the execution of the Agreement, which such release has been approved by the Lender, is attached hereto as Exhibit 9.12. In the case of any disclosure required by law or the rules of any stock exchange, the parties shall consult with each other for the purpose of limiting disclosure to such matters as are required by law or the rules of any stock exchange. 9.13 Counterparts. This Agreement may be executed in any number of counterparts each of which shall be an original with the same effect as if the signatures thereto and hereto were upon the same instrument. 9.14 Headings. Captions, headings and the table of contents in this Agreement are for convenience only, and are not to be deemed part of this Agreement. [Signature Page Follows] 31 THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 36 IN WITNESS WHEREOF, the parties hereto have executed this Agreement by its duly authorized officers as of the date and year first above written. THORATEC LABORATORIES CORPORATION By: /s/ D. KEITH GROSSMAN ------------------------------------ D. Keith Grossman President & Chief Executive Officer GUIDANT CORPORATION By: /s/ RONALD W. DOLLENS ------------------------------------ Ronald W. Dollens President & Chief Executive Officer THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 37 EXHIBIT 2.1(b) Form of Note PROMISSORY NOTE $10,000,000 Menlo Park, California ___________, 199_ On or before December 31, 2003, the undersigned, for value received, promises to pay to the order of Guidant Corporation ("Payee"), at 111 Monument Circle, 29th Floor, Indianapolis, Indiana 46204-5129, the principal sum of ten million dollars ($10,000,000) plus interest added to such principal sum or, if less, the aggregate unpaid principal amount of all disbursements of the Loan made by the Payee to the undersigned pursuant to the Credit Agreement (as hereinafter defined) plus interest added to such principal amount, and, if applicable, any Prepayment Fee, as shown in the records of the Payee. Prior to the Cash Interest Payment Date, interest accrued hereunder shall be added to the outstanding principal amount hereof as of the last day of each calendar quarter. The unpaid principal amount hereof from time to time outstanding shall bear interest from the First Disbursement Date at a rate per annum initially equal to [***]. Unless the undersigned gives Payee notice to cause the occurrence of the Cash Interest Payment Date (in which event interest hereunder shall be fixed at the rate of interest in effect on the Cash Interest Payment Date), such rate of interest shall increase by [***] basis points) on the first day of the first calendar quarter following the First Disbursement Date and thereafter on the first day of each calendar quarter; provided, however, that (except upon the occurrence and during the continuation of an Incipient Default or an Event of Default) the rate of interest hereunder shall not exceed [***] per annum. Upon the occurrence and during the continuation of an Incipient Default or an Event of Default, the outstanding principal amount of the Loan shall, to the extent permitted by applicable law, bear interest at a rate equal to the applicable rate provided above plus [***] per annum. Interest on the Loan shall be payable in arrears on the last Banking Day of each calendar quarter, commencing with the Cash Interest Payment Date and ending on the Maturity Date. Payments of both principal and interest shall be made in immediately available funds in lawful money of the United States of America. This Note evidences indebtedness incurred under, and is subject to the terms and provisions of, that certain Credit Agreement dated as of January __, 1999 (as from time to time amended, modified or supplemented) between the undersigned and the Payee (said Credit Agreement, as so amended, modified or supplemented being herein referred to as the "Credit Agreement"), to which Credit Agreement reference is hereby made for a statement THE SYMBOL `[***]' IS USED TO INDICATE THAT A PORTION OF THE EXHIBIT HAS BEEN OMITTED AND FILED SEPARATELY WITH THE COMMISSION 38 of said terms and provisions, including those under which this Note may be paid prior to its due date or under which its due date may be accelerated. Capitalized terms used in this Note and not otherwise defined shall have the meaning set forth in the Credit Agreement. 3 39 This Note is made under and governed by the internal laws of the State of California. THORATEC LABORATORIES CORPORATION By: ___________________________________ Name: Title: Address: Thoratec Laboratories Corporation 6035 Stoneridge Drive Pleasanton, CA 94588 4 EX-23 4 EXHIBIT-23 INDEPENDENT AUDITOR'S CONSENT 1 EXHIBIT 23 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 333-32223, Registration Statement No. 333-11883, Registration Statement No. 33-35549, Registration Statement No. 33-35719, Registration Statement No. 33-72502, Post-Effective Amendment No. 1 to Registration Statement No. 2-97542, Post-Effective Amendment No. 1 to Registration Statement No. 2-78926, and Post-Effective Amendment No. 3 to Registration Statement No. 2-78925 on Forms S-8 of our report dated February 19, 1999, appearing in this Annual Report on Form 10-K of Thoratec Laboratories Corporation for the year ended January 2, 1999. /s/ DELOITTE & TOUCHE, LLP San Francisco, CA March 24, 1999 EX-27 5 EXHIBIT-27 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE BALANCE SHEETS AND CONSOLIDATED STATEMENTS OF OPERATIONS OF THORATEC LABORATORIES CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH ANNUAL REPORT ON FORM 10K PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JANUARY 2, 1999. YEAR JAN-02-1999 JAN-04-1998 JAN-02-1999 2,712,686 2,032,107 4,141,854 47,591 5,290,745 14,582,129 12,460,755 (2,835,365) 25,208,417 3,331,060 0 0 0 72,810,450 (53,402,106) 25,208,417 16,319,531 16,980,916 6,503,986 6,503,986 12,797,482 0 0 (2,320,552) 0 (2,320,552) 0 0 0 (2,320,552) (.11) (.11)
-----END PRIVACY-ENHANCED MESSAGE-----