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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
TO FORM 10-K/A
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________ .
COMMISSION FILE NO. 1-10428
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
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<S> <C>
DELAWARE 77-0148208
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER)
3400 WEST WARREN AVENUE, FREMONT, CALIFORNIA 94538
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
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REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(510) 623-9001
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK
(TITLE OF CLASS)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]
Indicate by 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. [ ]
The aggregate market value of the registrant's Common Stock held by
non-affiliates of the registrant was approximately $405,478,600 as of June 15,
1999.
The number of shares of the registrant's Common Stock issued and
outstanding as of June 15, 1999 was 43,880,976.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive proxy statement filed prior to
April 30, 1999, pursuant to Regulation 14A of the Securities Exchange Act of
1934, are incorporated by reference into Part III of this Form 10-K/A.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Sunrise Technologies International, Inc. (the "Company") develops,
manufactures and markets laser systems for applications in ophthalmology.
Substantially all of the Company's business activities, including engineering
and development, manufacturing, assembly and testing, take place at the
Company's facility in Fremont, California. Prior to June 26, 1997, the Company
developed, manufactured and marketed lasers and air abrasion cavity preparation
systems for use in dentistry. On June 26, 1997, the Company sold its dental
business and assets to Lares Research of Chico, California for $4,000,000 in
cash and $1,500,000 in interest-bearing notes due in June 2000 and June 2001.
Since mid-1992, the Company has focused a significant portion of its
efforts on engineering and development of its holmium laser corneal shaping
product or process, known as Laser Thermal Keratoplasty (the "LTK System"), for
the treatment of refractive error of the eye, such as hyperopia (farsightedness)
and presbyopia (age-related loss of near focusing ability). Until late 1998,
refractive surgery in the United States, outside of certain clinical studies,
was solely for the treatment of myopia. Myopia is a refractive disorder that the
Company has not targeted to treat with its LTK System due to the lack of
available resources to pursue that market segment and also due to the number of
competitors already offering products to treat that condition. The Company saw
the treatment of hyperopia and presbyopia as potentially large markets for
products based on its technology. These markets were not being well served by
other companies with products or potential products for refractive surgery. The
combination of these factors led the Company to focus its efforts on hyperopia
and presbyopia. The LTK System is based in part on patented technology acquired
in the Company's acquisitions of in-process technology from Laser Biotech, Inc.
("Laser Biotech") and Emmetropix Corporation ("Emmetropix") in 1992. See
"Products -- LTK System" in this Section.
The Company has incurred substantial losses in the past seven years, which
have seriously depleted its working capital. Sales of its existing ophthalmic
products at current levels will not be sufficient to sustain the continued
development and regulatory licensing of the LTK System. The Company has been
able to raise additional working capital for all aspects of its business through
the private placement of its Common Stock and convertible notes with warrants.
These private placements raised $15,296,000 in 1994, 1995 and 1996 in new equity
for the Company, approximately $3,700,000 in the form of promissory notes with
warrants in 1997 (the "1997 Notes Placement"), approximately $9,300,000, net of
offering costs, in the form of promissory notes with warrants in January 1998
(the "1998 Notes Placement"), approximately $11,800,000, net of offering costs,
from the sale of Common Stock in December 1998 (the "1998 Equity Offering") and
$10,000,000, net of offering costs, in the form of promissory notes with
warrants in January 1999 (the "1999 Notes Placement").
The Company was incorporated in 1987 under the laws of the State of
California and was reincorporated in 1993 under the laws of the State of
Delaware.
PRODUCTS
LTK System
In April 1992, the Company acquired Laser Biotech through a merger of a
wholly-owned subsidiary of the Company with Laser Biotech (the "Merger"). Laser
Biotech was founded in 1986 by Bruce J. Sand, M.D., FACS, to research and
develop a precision laser instrument for eye surgery. In connection with the
Merger, the Company also acquired certain patent and patent applications held by
Dr. Sand covering a patented technique for reshaping the cornea using a laser.
The LTK System alters the shape of the cornea to correct refractive disorders
such as hyperopia and presbyopia without removing corneal tissue. The procedure
employs a laser to shrink, selectively, the collagen in the cornea, changing the
curvature of the cornea and thereby changing the refractive power of the eye. By
comparison, excimer laser systems for corneal reshaping developed by Summit
Technologies, Inc. ("Summit") and VISX, Inc. ("VISX") remove parts of the cornea
to achieve changes in refraction. Laser Biotech conducted pre-clinical studies
to gain preliminary information
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on the efficacy and safety of the product, which resulted in positive
indications that the LTK System could be applied successfully and safely to
correct certain refractive error.
In May 1992, the Company acquired substantially all of the in-process
technology of Emmetropix, including an assignment of certain patent applications
and related technology from an Emmetropix shareholder which the Company believes
may be useful in the further development of the LTK System.
The Company received an Investigational Device Exemption ("IDE") from the
Food and Drug Administration (the "FDA") to begin Phase I clinical trials of the
LTK System on human subjects in the first quarter of 1992. Phase I trials
commenced in June 1992 using a prototype LTK System designed and developed by
the Company. The Company completed Phase I of the clinical work for the LTK
System and filed its results with the FDA in June 1993. In September 1993, the
Company received clearance to begin Phase IIa clinical trials for the treatment
of hyperopia. The trials were conducted at the Doheny Eye Institute at the
University of Southern California and Baylor University and were completed in
November 1994. On September 5, 1996, the FDA authorized the Company to treat an
additional 100 subjects at five United States locations in a continuation of
Phase IIa clinical trials using a treatment algorithm developed by the Company
in the course of the initial Phase IIa clinical trials and in the course of
studies conducted by ophthalmologists in Mexico, Germany, Belgium, Italy and
Canada. On March 31, 1997, the Company added three new investigators to its
Phase IIa clinical study for hyperopia. On July 18, 1997, the Company received
FDA approval to treat the fellow eye of patients who had one eye treated as part
of the clinical trial for hyperopia six months after the first eye was treated.
On August 7, 1997, the Company received approval from the FDA to treat an
additional 100 patients as part of its Phase IIa clinical trial for hyperopia,
bringing the total patients approved for treatment to 228.
On November 19, 1997, the Company completed enrollment in its Phase IIa
clinical trial for hyperopia and also received approval to begin Phase III of
its clinical trial for hyperopia with an additional 200 patients to be treated
at the existing eight clinical sites and up to seven additional clinical sites.
The Company has added three clinical sites, bringing the total to 11 sites. On
February 24, 1998, the Company announced that it had received approval to treat
the fellow eye of patients enrolled in its clinical study for hyperopia on the
same day, as opposed to the earlier requirement to wait six months before
treating fellow eyes. On June 30, 1998, the Company announced that it had
completed enrollment for the Phase III investigation, the final phase of the
study for treatment of low to moderate hyperopia. As of February 22, 1999, 399
primary eyes and 273 fellow eyes of 399 patients have been treated.
On October 8, 1997, the Company received approval to re-treat patients in
its clinical study. As of February 22, 1999, nine eyes of nine patients have
been re-treated.
On September 25, 1997, the Company received approval to treat 60 patients
at four sites for the condition known as presbyopia. Presbyopia is the
age-related loss of near vision. The Company's clinical trial will employ a
technique known as monovision to treat presbyopia. A patient with presbyopia
utilizes one eye primarily for distance vision and the other eye primarily for
reading, or near vision. A fifth site was added on March 30, 1998. On October 8,
1998, the Company received approval to treat an additional 20 patients in its
expanded clinical trial for presbyopia. As of February 22, 1999, the Company has
treated 62 patients under this clinical study.
On March 12, 1998, the Company announced that it had received approval to
initiate a new clinical study to treat patients with the LTK System who were
overcorrected after receiving treatment for myopia (nearsightedness) from other
companies' excimer laser systems. The Company has treated three eyes of three
patients under this clinical study.
On April 7, 1998, the Company received approval to begin a substudy to
investigate treatment of hyperopia between 2.75 to 4.0 diopters using a modified
laser nomogram. As of February 29, 1999, 20 eyes of 20 patients have been
treated.
The Company has obtained FDA clearance to export the LTK System to most
European countries, Turkey, Saudi Arabia, Canada, Mexico, Brazil, China, Korea,
Hong Kong, the Bahamas, South Africa and other countries, although such sales
are subject to the individual regulatory authority of each country.
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Following regulatory approvals, the Company commenced marketing the LTK System
overseas, primarily in Europe, for the treatment of hyperopia and astigmatism in
December 1993. To date, international sales of the LTK System have been limited.
Revenue in the United States cannot reasonably be expected before the second
half of 1999, at the earliest.
As of February 22, 1999, the Company has treated approximately 757 eyes
with the LTK System in its United States clinical trials. On December 14, 1998,
the Company submitted its premarket approval application ("PMA") for low
hyperopia to the FDA. On January 28, 1999, the FDA determined that the PMA for
low hyperopia is suitable for filing. The PMA is scheduled for review at the
July 22 - 23 meeting of the FDA. FDA approval, however, is not expected until
the second half of 1999, at the earliest. See "Government Regulation" and
"Patents and Licenses" in this Section and "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
The LTK System incorporates the Sun 1000, a holmium laser system, into a
delivery system that is built into a standard slit-lamp to perform the LTK
procedure. A slit-lamp is a binocular microscope used regularly by
ophthalmologists to examine an eye binocularly under high magnification. The LTK
System delivers eight simultaneous laser beams disposed in a circle of varying
diameter. This system allows for easy alignment on the patient's eye and the
delivery of two exposures, each less than two seconds.
Ophthalmic Laser System for Glaucoma
In 1990, the Company developed the gLase 210 ophthalmic system (the "gLase
210 system"), a holmium laser system designed to perform a filtering procedure
for the treatment of glaucoma. The gLase 210 system is not currently marketed
actively in the United States or internationally. Sales of the gLase 210 system
have been limited and have never represented more than 11% of the Company's
revenues in any year. From 1995 through December 31, 1998, sales of the gLase
210 system resulted in a loss to the Company of approximately $51,000.
GOVERNMENT REGULATION
The Company's products are subject to significant government regulation in
the United States and other countries. In order to test clinically, produce and
market products for human diagnostic and therapeutic use, the Company must
comply with mandatory procedures and safety standards established by the FDA and
comparable foreign regulatory agencies. Typically, such standards require
products to be approved by the government agency as safe and effective for their
intended use before being marketed for human applications. The clearance process
is expensive and time consuming, and no assurance can be given that any agency
will grant clearance to the Company to sell its products for routine clinical
applications or that the time for the clearance process will not be extensive.
Devices such as the LTK System may be marketed in the United States only
after the FDA has approved a PMA for the device. Under the PMA procedure, the
applicant must obtain an IDE before beginning the substantial clinical testing
required to determine the safety, efficacy and potential hazards of the
products. The preparation of a PMA is significantly complex and time consuming.
The minimum review period under a PMA is 180 days from the date of filing. The
FDA often responds with requests for additional information or clinical reports
that can extend the review period substantially beyond 180 days. The Company
submitted its PMA with the FDA for approval to sell its LTK System in the United
States for hyperopia on December 14, 1998, and the Company received notification
from the FDA in a letter dated January 28, 1999 that its application has been
accepted for filing. The PMA is scheduled for review at the July 22 - 23 meeting
of the FDA. The Company has, and will continue, to focus its efforts and limited
resources on its technology for the treatment of hyperopia and presbyopia.
The FDA imposes various requirements on manufacturers and sellers of
products under its jurisdiction, such as labeling, manufacturing practices,
record keeping and reporting requirements. The FDA also may require postmarket
testing and surveillance programs to monitor a product's effects. All of the
Company's products will require regulatory approval from the FDA. There can be
no assurance that the appropriate approvals from the FDA will be granted for the
Company's products, that the process to obtain such approvals
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will not be excessively expensive or lengthy or that the Company will have
sufficient funds to pursue such approvals. The failure to receive requisite
approvals for the Company's products or processes, when and if developed, or
significant delays in obtaining such approvals, will prevent the Company from
commercializing its products as anticipated and will have a material, adverse
effect on the business of the Company.
The Company is also subject to regulation under the provisions of the Food,
Drug and Cosmetic Act relating to Product Radiation Control which, among other
things, requires laser manufacturers to: (i) file new product and annual
reports; (ii) maintain quality control, product testing and sales records; (iii)
incorporate certain design and operating features in lasers sold to end-users;
and (iv) certify and label each laser sold to conform to all applicable
standards for such lasers. Various warning labels must be affixed and certain
protective devices installed, depending on the class of the product. The FDA's
Center for Devices and Radiological Health is empowered to seek fines and other
remedies for violations of the regulatory requirements.
Marketing and Sales
The Company's strategy is to market its products through established
medical equipment distributors overseas. In the United States, the Company plans
to sell its products through a small direct sales force. The Company has
established relationships with distributors in Great Britain, Belgium, France,
the Netherlands and South Africa.
The extent and nature of the Company's marketing efforts are determined by
a number of factors, including the number of specialists in the area and the
characteristics of the laser applications. The establishment of a successful
distributor network requires providing the distributors with sales instruments
(brochures, clinical data, research papers, educational videos, etc.). Such
marketing efforts are expected to include presentations at conventions and trade
shows, customer training by Company personnel and sponsorship of teaching
seminars, clinical presentations and research by others. The Company also hires
additional marketing and sales consultants from time to time to assist in the
introduction of its products.
Engineering and Development
The Company's success will depend substantially upon its ability to
develop, produce and market innovative new products.
In 1998, the Company recorded $2,107,000 in engineering and development
expenses primarily relating to the LTK System. The Company continues to explore
several other types of lasers with varying characteristics in order to find the
optimal interactions with tissues in specific medical applications. Since the
sale of the Company's dental business and assets in June 1997, to an
unaffiliated party, the Company no longer expends any of its funds on the
engineering and development of dental laser or other dental products. Clinical
testing and sale of the Company's products are subject to obtaining applicable
regulatory approvals, of which there can be no assurance. The Company's research
and development activities are conducted in-house as well as by outside sources,
including consultants and universities.
The laser industry is characterized by extensive research and rapid
technological change. Development by others of new or improved products,
processes or technologies may make product development by the Company obsolete
or less competitive. The Company will be required to devote continuing efforts
and funds to further developments and enhancements for its existing products and
for its research and development of new technologies and products. There can be
no assurance the Company will be able to successfully adapt its operations to
evolving markets and technologies and fund the development of new medical
products to achieve possible technological advantages.
Production
The Company manufactures its ophthalmic lasers from parts, components and
subassemblies obtained from a number of unaffiliated suppliers, and the Company
designs the software incorporated into a microprocessor purchased from an
unaffiliated third party. Prototype production and all manufacturing,
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assembly and testing activities take place at its Fremont, California facility.
Although some of the parts and components used by the Company in producing its
products are available from multiple sources, the Company currently purchases
each of its components from a single source in an effort to obtain volume
discounts. Lack of availability of any of these parts and components could
result in production delays, increased costs or costly redesign of the Company's
products. The Company continually evaluates ways to minimize any impact to its
business from any potential part or component shortage through inventory
stockpiling and design changes to afford opportunities for multiple sources of
supply for these key components.
In addition, the Company has attempted to negotiate with the University of
Miami to reach agreement regarding the non-exclusive use of a component of the
delivery system used in the LTK System which was jointly developed by the
Company and the University. The Company believes that it will be able to make
reasonable arrangements with the University. If, however, the Company is unable
to conclude negotiations with the University successfully, the Company may have
no rights in the delivery system presently configured in the LTK System. If the
Company is forced to redesign the LTK System, such redesign efforts could be
time consuming, expensive and prolong FDA review.
The Company's ophthalmic laser systems have been designed in a modular
fashion to facilitate the assembly process. The Company intends to utilize
modular design and construction concepts in connection with its future products.
The Company will require additional engineering and manufacturing staffing as
new products are introduced into the marketplace. Any loss of availability of a
key system component could result in a material adverse change to the Company's
business, financial conditions and results of operations.
Potential Liability
The testing and use of human health care products entail an inherent risk
of physical injury to patients and resultant product liability or malpractice
litigation. While the Company has obtained product liability coverage in the
amount of $5,000,000 with an umbrella policy for an additional $5,000,000, such
coverage is limited, and there can be no assurance that such coverage will be
sufficient to protect it from all risks to which it may be subject. Those costs
of defending a product liability or malpractice action could have a material
adverse impact on the Company, even if the Company were to prevail ultimately.
Patents and Licenses
In the merger of Laser Biotech into the Company, the Company acquired an
issued United States patent and pending United States and foreign patent
applications previously assigned to Laser Biotech by Dr. Bruce Sand, the
inventor of the patent and founder of Laser Biotech. The issued patent covers a
method for using a laser to shrink collagen in the human body, with specific
application to the cornea. Since the merger, five more patents filed by Dr.
Sand, as the inventor, have been allowed, and have been assigned to the Company.
As a result of the Emmetropix acquisition, the Company now has one issued United
States patent and one pending European regional patent application based on the
issued United States patent, which the Company believes may be useful in further
developing its laser thermal Keratoplasty product. In addition, the Company has
filed a patent application covering the LTK System it developed to make use of
the LTK procedure. The Company owns 22 issued patents on the LTK System and
method for shrinking collagen in the United States and internationally, six of
which have been assigned for collateral purposes pursuant to the terms of the
1997 Notes Placement. These patents protect the Company's technology while the
LTK System is undergoing clinical trials for approval to market the LTK System
in the United States and encompass both the apparatus for treatment with the LTK
System and the method of shrinking collagen in the cornea. These patents begin
to expire in 2009. The Company also has 15 pending patent applications on the
LTK System and the method for shrinking collagen in the United States and
internationally.
Competition
The vision correction industry is subject to intense competition. The
significant competitive factors in the industry include price, convenience,
success relative to vision correction, acceptance of new technologies, patient
satisfaction and government approval. Patients with hyperopia can achieve vision
correction with
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eyeglasses, contact lenses and possibly with other technologies and surgical
techniques currently under development, such as corneal implants, human lens
replacement, intra-ocular implantable contact lenses and surgery using different
types of lasers. The success of any competing alternative to the LTK System for
treating hyperopia could have a material adverse effect on the Company's
business, financial conditions and results of operations. Most of the Company's
competitors have substantially greater financial capabilities for product
development and marketing than the Company, which may enable such competitors to
market their products or procedures to the consumer and to the ophthalmic
community in a more effective manner.
The excimer laser is the dominant laser used for the treatment of
refractive disorders. In the United States, VISX and Summit are the leading
manufacturers of excimer refractive surgical systems. While the Company believes
the LTK System offers several distinct advantages over the use of excimer lasers
for treating hyperopia, including ease of use and decreased invasiveness, both
VISX and Summit have significantly greater financial resources than the Company
and have received FDA approval for their respective excimer laser products for
treating myopia (nearsightedness) and astigmatism. In addition, certain of the
Company's competitors, including Summit, have developed LTK devices for the
treatment of hyperopia and one of the Company's competitors, VISX, has received
FDA approval to treat hyperopia in the United States with its excimer laser. The
Company believes its LTK System is superior to those of its competitors and that
use of Summit's holmium laser system for LTK may violate certain of the
Company's patents. None of the Company's competitors is currently engaged in
United States clinical trials to approve their LTK devices for treating
hyperopia.
Neither the Summit excimer laser products nor the Summit LTK devices are
currently approved for treating hyperopia in the United States. Further, Summit
discontinued its clinical trials for treating hyperopia with its holmium laser
system in 1996. However, any alternative treatment offered by VISX or Summit
will have a competitive advantage because of the name recognition being created
by the current promotion of their excimer laser products for correcting myopia
(nearsightedness) using lasers and the fact that VISX and Summit have an
established base of customers that are currently using their products.
The Company believes the potential use of its process of shrinking collagen
is more attractive than competitive methods of treating certain refractive
errors because it can address refractive error with minimal invasiveness to the
cornea. There can be no assurance, however, that the method can be reduced to
practice using a reliable laser system, or that the Company will receive
regulatory approvals or successfully market such a product.
Export Sales
In 1998, approximately 98% of the Company's revenues were international as
compared to approximately 38% in 1997 and 47% in 1996.
Backlog
On December 31, 1998, the Company had a backlog of approximately $32,000,
all of which the Company expects to ship to its customers prior to the end of
1999.
Warranty and Service
The Company provides a limited warranty on its laser systems. This warranty
is limited to 12 months from date of shipment by the Company. The Company
provides services to systems out of warranty worldwide for a fee. The Company's
laser products include microprocessors and software that perform self-checks
upon start-up and during operation. In addition, the systems feature software
that allows service personnel to perform diagnostic checks in the field. The
Company currently provides support services by telephone to customers with
operational and service problems and makes necessary repairs at its plant or at
the laser site.
To date, actual costs incurred related to warranty work have been minimal.
In the case of sales by distributors, all product service will be provided by
such distributor.
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Employees
At December 31, 1998, the Company had 36 full-time equivalent employees
(including its executive officers); 15 in manufacturing, two in engineering and
development, seven in marketing, sales and regulatory, and twelve in
administration. In addition, the Company has retained a number of consultants to
assist with its product development, regulatory activities and investor
relations.
The Company is primarily dependent upon its engineering and development
employees and consultants for the development and improvement of existing and
proposed products. The Company's future success will depend in a large part upon
its ability to attract and retain highly qualified scientific and management
personnel, and its ability to continue to train and retain highly skilled
technical and marketing personnel. None of the Company's employees are
represented by a labor organization. The Company maintains various benefit plans
and has good employee relations.
Cautionary Statements -- Risk Factors
In the interest of providing the Company's stockholders and potential
investors with certain Company information, including management's assessment of
the Company's future potential, certain statements set forth herein contain or
are based on projections of revenue, income, earnings per share and other
financial items or relate to management's future plans and objectives or to the
Company's future economic performance. Such statements are "forward-looking
statements" within the meaning of Section 27A(i) of the Securities Act of 1933,
as amended, and in Section 21E(i) of the Securities Exchange Act of 1934, as
amended.
Although any forward-looking statements contained herein or otherwise
expressed by or on behalf of the Company are, to the knowledge and in the
judgment of the officers and directors of the Company, expected to prove true
and to come to pass, management is not able to predict the future with absolute
certainty. Accordingly, stockholders and potential investors are hereby
cautioned that certain events or circumstances could cause actual results to
differ materially from those projected or predicted. In addition,
forward-looking statements are based on management's knowledge and judgment as
of the date hereof, and the Company does not intend to update any
forward-looking statements to reflect events occurring or circumstances existing
hereafter.
In particular, the Company believes the following facts could impact
forward-looking statements made herein or in future written or oral releases and
by hindsight, prove such statements to be overly optimistic and unachievable.
WE HAVE SUSTAINED LOSSES IN THE PAST AND WE EXPECT TO REPORT LOSSES IN THE
FUTURE
We have incurred substantial losses that have depleted our working capital
and reduced our stockholders' equity. In addition, we expect that our business
will continue to be a significant consumer of cash. Unless and until the FDA
approves the domestic sale of our LTK system for performing laser thermal
keratoplasty, our revenues will not be sufficient to cover our operating costs.
We filed the premarket approval application for low hyperopia with the FDA on
December 14, 1998. On January 28, 1999, the FDA determined that the premarket
approval application is suitable for filing. The premarket approval application
is scheduled for review at the July 22 - 23 meeting of the FDA. We do not expect
FDA approval of our premarket approval application, however, until the second
half of 1999, at the earliest.
We funded our negative cash flows during 1996, 1997 and 1998 by the sale of
additional equity and convertible debt with warrants. At December 31, 1997, our
cash and cash equivalents were approximately $1,958,000. At December 31, 1998,
after consummation of the offering of promissory notes with warrants in January
1998 (approximate net proceeds of $9,300,000) and the sale of common stock in
December 1998 (approximate net proceeds of $11,800,000), our cash and cash
equivalents were approximately $9,889,000. Notwithstanding the proceeds of the
offering of promissory notes with warrants in January 1999, we may be required
to raise additional working capital during 1999 to fund our activities for late
1999 and beyond. There
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can be no assurance that additional funds can be raised on terms acceptable to
us, if at all. Any additional equity or debt offerings will dilute the holdings
of our stockholders.
We expect to report operating losses during 1999. The losses will come
primarily from the expenses of the FDA approval process and underlying clinical
studies related to the LTK system. We will not have any domestic revenues from
this product line unless and until we obtain the FDA approval. Our international
revenues will not be sufficient to cover the cost of the approval process or our
general operating expenses.
NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE TO US; ADDITIONAL CAPITAL WILL
DILUTE THE HOLDINGS OF OUR STOCKHOLDERS
Our stockholders have no preemptive rights. If we:
1. commence a subsequent public or private offering of common stock,
convertible debt, or preferred stock; or
2. issue securities to consultants or other parties providing goods or
services to us in lieu of or in addition to cash consideration,
our stockholders, who may not participate in any future stock issuance, will
experience dilution of their equity investment. At this time, we cannot
determine the potential dilution to our stockholders.
We cannot assure that additional financing will be available, or if
available, that it will be available on terms favorable to our stockholders. If
funds are not available to satisfy our short-term and long-term operating
requirements, we may limit or suspend our operations in the entirety or, under
certain circumstances, seek protection from creditors. Our recent debt and
equity offerings contained terms adverse to our then existing stockholders, with
stock sales prices below the then market price of the common stock, convertible
debt issued with interest rates above the prime rate of interest and warrants
granted to investors without any substantial cash consideration to the Company.
We believe that future financings undertaken prior to the commencement of sales
of the LTK system in the United States may contain terms that could result in
similar or more substantial dilution than that incurred by our stockholders from
the sales of equity and convertible debt with warrants we undertook during 1996,
1997, 1998 and earlier this year.
WE COULD EXPERIENCE SUBSTANTIAL DELAY IN RECEIVING OR MAY NOT RECEIVE THE
NECESSARY APPROVAL FROM THE FOOD AND DRUG ADMINISTRATION OF OUR PRE-MARKET
APPROVAL APPLICATION FOR OUR LASER THERMAL KEROTOPLASTY SYSTEM.
The FDA and similar health authorities in foreign countries extensively
regulate our activities. The FDA regulates the LTK system under the Food, Drug &
Cosmetic Act, as a Class III medical device. Class III medical devices must have
a premarket approval application ("PMA") approved by the FDA before commercial
sales in the United States commence. The PMA process (and underlying clinical
studies) is lengthy, the outcome is difficult to predict and the process
requires substantial commitments of our financial resources and our management's
time and effort. Delays in obtaining or failure to obtain required regulatory
approvals or clearances in the United States and other countries would postpone
or prevent the marketing of the LTK system and other devices. Consequently,
delays would impair our ability to generate funds from operations, which in turn
would have a material adverse effect on our business, financial condition and
results of operations.
In addition to analyzing the LTK system itself, the FDA may also evaluate
our public disclosures regarding the LTK system as part of the review and
approval process. In this regard, we received in early September 1998 a letter
from the FDA stating that recent press releases contained certain prohibited
representations. The FDA did not require us to respond to the letter. We no
longer, however, include the items described in the FDA letter in our public
disclosures. We submitted our PMA on December 14, 1998 to the FDA, and we
received notification from the FDA in a letter dated January 28, 1999 that our
application has been accepted for filing. The PMA is scheduled for review at the
July 22 - 23 meeting of the FDA.
9
<PAGE> 10
We cannot be certain that we will be able to timely obtain, if at all, the
required approval of our PMA in the United States for our intended uses of the
LTK system, or for any other devices which we may seek approvals or clearances.
The FDA will subject us to pervasive and continuing regulation for any products
that we manufacture or distribute.
A new FDA regulation requires disclosure of the financial interests of
clinical investigators. This new regulation applies to all new PMAs submitted on
or after February 2, 1999. The purpose of this new regulation is to assist the
FDA in determining if, and to what extent, the clinical studies supporting a
marketing application may have been subject to investigator bias. Some of our
current 11 clinical investigators of the LTK system have financial interests in
us that meet the threshold for disclosure under this new FDA regulation. It is
not possible to predict, however, what impact, if any, the disclosure of these
interests would have on the FDA's review of the PMA we submitted for the LTK
system.
We received a CE (European Community) Mark of approval on our LTK device
that allows us to sell the device in these countries. In addition to the CE
Mark, however, some foreign countries may require separate individual foreign
regulatory clearances. Although we have sold our products in approximately 15
countries, sales of the LTK system require rigorous regulatory approvals before
we can sell them in the United States and certain other countries. We cannot
assure that we will be able to obtain regulatory clearances for our products in
the United States or other foreign markets.
WE DEPEND ON THE LTK SYSTEM AND MARKET ACCEPTANCE OF THAT SYSTEM IS UNCLEAR
We intend to continue to concentrate our efforts primarily on the
development of the LTK system and will be dependent upon the successful
development of that system to generate revenues. We have not yet commercially
introduced the LTK system in the United States. There can be no assurance that
if approved by the FDA, the ophthalmic community or the general population will
accept the LTK system as an alternative to existing methods of treating
refractive vision disorders. Many ophthalmologists may have already invested
significant time and resources in developing expertise in other corrective
ophthalmic techniques. Acceptance of the LTK system may be affected adversely by
- its costs,
- concerns related to its safety and efficacy,
- the general resistance to use of laser products on the eye,
- the effectiveness of alternative methods of correcting refractive vision
disorders,
- the lack of long-term follow-up data, or
- the possibility of unknown side effects.
Promotional efforts by suppliers of products or procedures which are
alternatives to the LTK system, including eyeglasses, contact lenses and laser
and non-laser surgical procedures, may also adversely affect the marketplace for
the LTK system. Any failure to achieve broad market acceptance of the LTK system
will have a material adverse effect on our business, financial condition and
results of operations.
ONLY LIMITED CLINICAL DATA ABOUT THE LONG-TERM SAFETY AND EFFICACY OF THE LTK
SYSTEM IS CURRENTLY AVAILABLE AND WE MAY BE REQUIRED TO UNDERTAKE FURTHER
TESTING
We have developed limited clinical data on the safety and efficacy of the
LTK system in correcting hyperopia (farsightedness) and related long-term data.
The FDA has not yet determined whether the LTK system will prove to be safe or
effective for the predictable and reliable treatment of hyperopia or other
10
<PAGE> 11
common vision problems. Potential complications and side effects reported in
studies to date from the use of the LTK system include
- mild foreign body sensation,
- temporary increased light sensitivity,
- modest fluctuations in refractive capabilities during healing,
- unintended over or under-corrections,
- regression of effect, and
- induced astigmatism.
We cannot assure that long-term safety and efficacy data when collected
will be consistent with the clinical trial results previously obtained or will
demonstrate that the LTK system can be used safely and successfully to treat
hyperopia in a broad segment of the population on a long-term basis. The FDA may
require the Company to conduct further testing of the LTK system, thereby
delaying the Company's efforts to generate revenue, or limit the scope of the
FDA approval, thereby limiting the market for the LTK system.
OUR PRODUCT EMPLOYS PROPRIETARY TECHNOLOGY AND THIS TECHNOLOGY MAY INFRINGE ON
THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES
We hold United States process and apparatus patents for the use of holmium
lasers in non-destructive cornea shaping. Other parties, however, hold process
and apparatus patents relating to shaping the cornea with holmium lasers.
Generally, an apparatus patent contains claims to a new and useful machine or
device. A process patent generally contains claims to a new and useful process,
art, or method, which may include a new use of a known process, machine,
manufacture, composition of matter, or material. We believe that we are not
infringing on any patents held by others. However, if patents held by others
were adjudged valid and interpreted broadly in an adversarial proceeding, they
could be deemed to cover one or more aspects of our holmium laser corneal
shaping systems, use of the LTK system, or other procedures. Any claims for
patent infringement could be time-consuming, result in costly litigation, divert
technical and management personnel, or require us to develop non-infringing
technology or enter into royalty or licensing agreements. We cannot be certain
that we will not be subject to one or more claims for patent infringement, that
we would prevail in any such action, or that our patents will afford protection
against competitors with similar technology.
If a court determines that the LTK system infringes, directly or
indirectly, a patent in a particular market, the court may enjoin us from
making, using and selling such system. Furthermore, we may be required to pay
damages or obtain a royalty-bearing license, if available, on acceptable terms.
Alternatively, if a license is not offered or available, we may be required to
redesign those aspects of the LTK system held to infringe, directly or
indirectly, to avoid such infringement. Any redesign could delay reintroduction
of our products into certain markets, or may be so significant as to be
impractical. If redesign efforts were impractical, we could be prevented from
manufacturing and selling the infringing products, which would have a material
adverse effect on our business, financial condition and results of operations.
A COMPONENT OF THE LTK SYSTEM MAY BE COVERED BY A PATENT OWNED OR LICENSED BY A
PARTY UNRELATED TO US WHICH MAY CAUSE US TO REDESIGN THE LTK SYSTEM, WHICH COULD
DELAY COMMERCIALIZATION
A component of the LTK delivery system is possibly covered by a patent
owned by the University of Miami or its licensee. If, however, we are unable to
reach a successful agreement, we may have no rights to the component of the
delivery system presently configured in the LTK system. If we are forced to
redesign the LTK system, such redesign efforts could be time consuming,
expensive and prolong FDA review.
A SIGNIFICANT NUMBER OF OUR SHARES ARE ELIGIBLE FOR SALE AND THEIR SALE COULD
DEPRESS THE MARKET PRICE OF OUR STOCK
Sales of substantial amounts of our common stock (including shares issued
upon exercise of outstanding options and warrants and shares issued upon
conversion of convertible notes) in the public market could depress the market
price of our common stock. As of June 15, 1999, we had 43,880,976 shares
outstanding
11
<PAGE> 12
and 9,932,391 shares reserved for issuance upon exercise of options and warrants
or conversion of convertible notes.
LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN DELAYS, INCREASED
COSTS, OR COSTLY REDESIGN OF OUR PRODUCT
Although some of the parts and components used by us in producing our
products are available from multiple sources, we currently purchase most of our
components from a single source in an effort to obtain volume discounts. Lack of
availability of any of these parts and components could result in production
delays, increased costs, or costly redesign of our products. We continually
evaluate ways to minimize any impact to our business from any potential part or
component shortage through inventory stockpiling and design changes to afford
opportunities for multiple sources of supply for these essential components. Any
loss of availability of an essential system component could result in a material
adverse change to our business, financial condition and results of operations.
THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE AFFECT ON OUR BUSINESS
The vision correction industry is intensely competitive. The significant
competitive factors in the industry include
- price,
- convenience,
- success relative to vision correction,
- acceptance of new technologies,
- patient satisfaction, and
- government approval.
Patients with hyperopia (farsightedness) can achieve vision correction with
eyeglasses, contact lenses and possibly with other technologies and surgical
techniques currently under development, such as
- corneal implants,
- human lens replacement,
- intra-ocular implantable contact lenses, and
- surgery using different types of lasers.
The success of any competing alternative to the LTK system for treating
hyperopia could have a material adverse effect on our business, financial
condition and results of operations. Most of our competitors have substantially
greater financial capabilities for product development and marketing than we do.
These financial capabilities enable our competitors to market their products or
procedures to the consumer and to the ophthalmic community in a more effective
manner.
The excimer laser is the dominant laser used for the treatment of
refractive disorders. In the United States, VISX, Inc. and Summit Technologies,
Inc. are the leading manufacturers of excimer refractive surgical systems. We
believe the LTK system offers several distinct advantages over the use of
excimer lasers for treating hyperopia, including ease of use and decreased
invasiveness. Both VISX and Summit, however, have significantly greater
financial resources than we do and have received FDA approval for their
respective excimer laser products for treating myopia (nearsightedness) and
astigmatism. In addition, certain of our competitors, including Summit, have
developed LTK devices for the treatment of hyperopia. Furthermore, one of our
competitors, VISX, has received FDA approval to treat hyperopia in the United
States with its excimer laser.
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<PAGE> 13
Neither the Summit excimer laser products nor the Summit LTK devices are
currently approved for treating hyperopia in the United States. Furthermore,
Summit discontinued its clinical trials for treating hyperopia with its holmium
laser system in 1996. Any alternative treatment offered by VISX or Summit,
however, will have a competitive advantage. They are promoting their excimer
laser products for correcting myopia (nearsightedness) using lasers and have
established a base of customers that are currently using their products.
WE ARE DEPENDENT ON OUR MANAGEMENT AND KEY PERSONNEL TO SUCCEED
Our principal executive officers and key personnel have extensive
experience with our LTK system, the research and development efforts needed to
bring the LTK system to market and the development of a marketing and sales
program to be utilized in connection with the sales program to be implemented
when the necessary FDA approval is received. The loss of the services of any of
our executive officers or other key personnel, or our failure to attract and
retain other skilled and experienced personnel on acceptable terms, could have a
material adverse effect on our ability to continue the FDA trials related to the
LTK system and subsequent sales and marketing efforts. This could have an
adverse impact on our business and related financial condition.
LOSS OF DENTAL REVENUES SEVERELY REDUCED OUR REVENUES
Before the sale of our dental assets in June 1997, the sale of our dental
laser and air abrasive products constituted the majority of our revenues. These
sales represented 98% and 69% of our revenues in 1996 and 1997, respectively. By
selling the dental assets, we lost a significant source of continued revenue,
although the dental assets made a negative contribution to our financial
results.
THE MARKET PRICE OF OUR STOCK HAS HISTORICALLY BEEN VOLATILE
The volatility of our common stock imposes a greater risk of capital losses
on stockholders as compared to less volatile stocks. In addition, such
volatility makes it difficult to ascribe a stable valuation to a stockholder's
holdings of our common stock. Factors such as announcements of technological
innovations or new products by our competitors, changes in domestic or foreign
governmental regulations or regulatory approval processes, developments or
disputes relating to patent or proprietary rights and public concern as to the
safety and efficacy of the procedures for which the LTK system is used, have and
may continue to have a significant impact on the market price of our common
stock. Moreover, the possibility exists that the stock market (and in particular
the securities of technology companies such as ours) could experience extreme
price and volume fluctuations unrelated to operating performance.
THE FAILURE OF KEY SUPPLIERS AND OUR PRODUCTS TO BE YEAR 2000 COMPLIANT COULD
NEGATIVELY AFFECT OUR BUSINESS
We are aware of the issues associated with computer systems programming
code as the millennium (year 2000) approaches. The "Year 2000" problem is
pervasive and complex because virtually every computer operation will be
affected in the same way by the rollover of the two-digit year value to "00."
The issue is whether computer systems will properly recognize date-sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail.
We are utilizing both internal and external resources to identify, correct
or reprogram, and test our systems for Year 2000 compliance. As of March 31,
1999, the estimated costs of these reprogramming efforts have been approximately
$250,000. We expect that the remaining costs to complete these reprogramming
efforts will be less than $100,000. We anticipate that we will complete all of
our reprogramming efforts by August 31, 1999, allowing adequate time for
testing. This process includes obtaining confirmations from our primary vendors
that they have developed (or are developing) plans to address processing of
transactions in the year 2000. We expect to obtain these confirmations in
writing prior to July 31, 1999. There can be no assurance, however, that the
systems of other companies, on which our systems rely, will also be converted in
a
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<PAGE> 14
timely manner. Moreover, we cannot be certain that any such failure to convert
by another company would not have a material adverse effect on our business,
financial conditions or results of operations.
We believe that we do not have a Year 2000 problem with the products we
have sold in the past. We have not performed, however, an extensive review of
these systems, and we are unlikely to be able to complete a review before
January 1, 2000. In addition, we are designing a new product to replace our
existing LTK system that will properly recognize date-sensitive information for
the year 2000 and beyond. Although we plan to perform extensive testing of our
new product, we cannot be certain that the new system will function properly
until we deploy it in the field and subject it to extensive use. Any malfunction
of a deployed system could have a material adverse effect on our business,
financial condition or results of operations.
We are not expecting to have a material accounts receivable exposure or
significant amount of revenues with any one customer after December 31, 1999.
Therefore, we are not pursuing verification of customer Year 2000 compliance at
this time. Any failure to pay in a timely manner, or place orders for our
products, by a significant number of individual customers or by a customer with
a material accounts receivable balance, due to Year 2000 compliance issues would
have material adverse effects on our business, financial condition or results of
operations.
We are currently developing a contingency plan to evaluate business
disruption scenarios, coordinate the establishment of Year 2000 contingency
plans and identify and implement the strategies. We expect to complete this
detailed contingency plan by July 31, 1999.
ITEM 2. FACILITIES
The Company leases a 55,000 square foot facility at 3400 West Warren
Avenue, Fremont, California, which currently serves as its executive offices and
research and production facility. The facility lease expires in April 2004 and
requires base payments on average of approximately $79,000 per month, subject to
standard pass-throughs and escalations. Management of the Company believes that
the facility can accommodate the expected increases in additional headcount and
operations activities.
ITEM 3. LEGAL PROCEEDINGS
Danville Manufacturing, Inc. (d.b.a. Danville Engineering) ("Danville")
filed a suit in the Superior Court of California, County of Contra Costa,
against the Company, claiming monetary damages for disputed invoices of
approximately $200,000 and alleging misappropriation of intellectual property.
(Danville Manufacturing, Inc. d/b/a. Danville Engineering v. Sunrise
Technologies International, Inc. C98-02123). The Company entered into a
settlement agreement with Danville on April 21, 1999. Pursuant to this
agreement, the Company agreed to pay Danville $120,000 and assign to Danville a
secured promissory note in the principal amount of $1,500,000 issued by Lares
Research, a California corporation, in connection with the sale of the Company's
dental business on June 26, 1997. The note is subject to offset for certain
claims by Lares Research and Danville has a 90-day option either to reject the
note and reassign it to the Company, in which event the Company will pay
Danville an additional $200,000, or accept the note, in which even the proceeds,
less any costs of collection, will be split equally between the Company and
Danville.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
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<PAGE> 15
PART II
ITEM 5.MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Market Information
As of December 31, 1998, there were 667 holders of record of the Company's
common stock. Price information for the Company's common stock may be obtained
from the Nasdaq National Market System and prior to August 13, 1998, the common
stock was traded in the over-the-counter market.
The table below sets forth the reported high and low bid quotations of the
Company's common stock as reported on the OTC Bulletin Board through August 12,
1998 and the reported high and low bid quotations of the Company's common stock
as reported on the Nasdaq National Market System from August 13, 1998 to
December 31, 1998 for the periods indicated.
PRICE FOR COMMON STOCK(1)
<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
------------- ------ -----
<S> <C> <C>
March 31, 1997.............................................. $ 1.75 $0.75
June 30, 1997............................................... 1.44 0.88
September 30, 1997.......................................... 3.94 1.00
December 31, 1997........................................... 5.13 3.13
March 31, 1998.............................................. 7.53 2.91
June 30, 1998............................................... 10.38 5.56
September 30, 1998.......................................... 8.19 3.91
December 31, 1998........................................... 7.38 3.75
</TABLE>
- ---------------
(1) Bid and ask prices are quoted on the Nasdaq National Market System and the
OTC Bulletin Board in increments of 1/32. Certain of the bid and ask prices
set forth in this table have been rounded out the nearest cent.
The over-the-counter market quotations provided herein may reflect
inter-dealer prices, without retail mark-up, mark-down or commission and may not
necessarily represent actual transactions. On June 15, 1999, the closing price
of the common stock as reported on the Nasdaq National Market System was $10.00
per share.
Dividends
In the past three years, the Company has not declared or paid any cash
dividends on its common stock. The Company currently intends to retain any and
all future earnings to finance its business. Accordingly, the Company does not
anticipate paying cash or other dividends on its Common Stock in the foreseeable
future.
Recent Sales of Unregistered Securities
In January 1998, the Company completed a private placement of its 12%
convertible subordinated pay-in-kind notes due 2000 with warrants, raising
approximately $9,350,000. The securities were sold pursuant to Regulation D
promulgated under the Securities Act of 1933, as amended (the "1933 Act"), to
accredited investors as defined in Rule 501 of Regulation D. The notes were
converted into the Company's Common Stock, as of April 22, 1999, at a conversion
price of $3.00 per share and the warrants have an exercise price of $3.00 per
share and an expiration date of January 2003.
In December 1998, the Company completed a private placement of
approximately $11,800,000 of the Company's Common Stock priced at $3.50 per
share. Approximately $6,800,000 of the gross proceeds of the 1998 Equity
Offering were paid in cash with the remainder evidenced by promissory notes due
on March 15, 1999, of which $1,000,000 is currently outstanding and has not been
repaid. The shares of Common Stock
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<PAGE> 16
were sold to accredited investors pursuant to the requirements of Regulation D
under the 1933 Act. The Company has approximately 43 warrant holders of record
for its warrants as of May 28, 1999.
The proceeds of these offerings have been used by the Company for FDA
clinical trials, research and development, offsetting negative cash flows and
general corporate purposes.
ITEM 6. SELECTED FINANCIAL DATA
The following table summarizes certain selected financial data derived from
the audited financial statements for the years ended December 31, 1994, 1995,
1996, 1997 and 1998.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Net revenues............................ $ 7,578 $ 5,294 $ 5,654 $ 2,839 $ 594
Gross profit............................ 1,340 1,637 1,638 293 (1,548)
Operating costs and expenses............ 8,257 5,824 7,658 7,368 12,718
(Loss) from operations.................. (6,917) (4,187) (6,020) (7,075) (14,266)
Gain on sale of dental assets........... -- -- -- 1,740 --
Interest income......................... 7 69 65 99 399
Interest expense........................ -- (12) (13) (1,376) (3,950)
Other expense........................... -- -- -- (6) (4)
Net loss................................ (6,910) (4,130) (5,968) (6,618) (17,821)
Net loss per share, basic and diluted... (0.68) (0.28) (0.23) (0.23) (0.52)
Shares used in calculation of basic and
diluted net loss per share............ 10,129 14,935 26,414 28,550 34,164
Total assets............................ 3,822 6,689 3,741 2,949 11,479
Long term obligations................... -- -- -- 945 7,703
Total stockholders' equity.............. 1,357 4,745 1,272 849 200
Working capital......................... 1,101 4,541 1,073 1,382 6,773
</TABLE>
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations" for information regarding disposition of the Company's
dental business and assets.
16
<PAGE> 17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company develops, manufactures and markets laser systems for
applications in ophthalmology. Substantially all of our business activities,
including engineering and development, manufacturing, assembly and testing take
place at our facility in Fremont, California. Prior to June 26, 1997, we
developed, manufactured and marketed lasers and air abrasion cavity preparation
systems for use in dentistry.
Our working capital is seriously depleted due to our substantial losses in
the past seven years. Sales of our existing ophthalmic products at current
levels will not be sufficient to sustain the continued development and
regulatory licensing of our holmium laser corneal shaping product or process
known as the Laser Thermal Keratoplasty (the "LTK System"). We have been able to
raise additional working capital for all aspects of our business through the
private placements of our common stock and convertible notes with warrants.
These private placements raised $15,296,000 in 1994, 1995 and 1996 in new
equity. We also raised approximately $3,700,000 in the form of promissory notes
with warrants in February and March 1997 (the "1997 Notes Placement"). We raised
approximately $9,300,000, net of offering costs, in the form of promissory notes
with warrants in January 1998 (the "1998 Notes Placement"), and approximately
$11,800,000, net of offering costs, from the sale of common stock in December
1998 (the "1998 Equity Offering"). In January 1999, we raised $10,000,000, net
of offering costs, in the form of promissory notes with warrants (the "1999
Notes Placement").
The Company's current operations continue to be cash flow negative, further
straining our working capital resources. At our current rate of cash
expenditures, we may raise additional working capital during 1999 to fund
operations. We spent approximately $878,000 for capital expenditures in fiscal
year 1998. No assurance can be given that additional financing will be
available, or if available, that it will be available on terms favorable to us
and our stockholders. If funds are not available to satisfy both our short-term
and long-term operating requirements, we may be required to limit or suspend our
operations in their entirety or, under certain circumstances, be forced to seek
protection from creditors. Our long-term ability to continue as a going concern
is dependent upon performing profitably or obtaining further financing.
REVENUES
The Company's revenues have historically been comprised primarily of sales
related to its dental products (none in 1998, 69% in 1997 and 98% in 1996).
Revenues of $594,000 in 1998 reflect sales of its ophthalmic products. Revenues
of $2,839,000 in 1997 reflect sales of the Company's ophthalmic and dental
products. Approximately $1,968,000 of 1997 revenues was attributable to the
dental business that was sold in June 1997. Approximately 98% of the 1996
revenues was from the dental products. Revenues for the ophthalmic business were
$871,000 and $141,000 for 1997 and 1996, respectively.
GROSS PROFITS
Gross loss margins for 1998 were 260%, and gross profit margins were 10%,
and 29% in 1997 and 1996, respectively. The reduction in gross profit in 1998,
from the 1997 level, was due to lower product revenues, under-utilization of
manufacturing capacity and higher manufacturing overhead. The major factors
contributing to the significant reduction in gross profit margins in 1997 from
the 1996 level include lower revenues, under-utilization of manufacturing
capacity due to decreased product shipments related to the sale of our dental
business in June 1997 and increased reserves for excess and obsolete inventory.
Management of the Company decided to increase inventory reserves for excess
and obsolete inventory during 1998 as certain components included in inventory
at year-end were not compatible for use in the re-designed LTK System. In
addition, at December 31, 1998, the Company had a surplus of finished LTK
Systems of the obsolete design as compared to the anticipated demand for these
obsolete systems during the year.
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<PAGE> 18
ENGINEERING AND DEVELOPMENT
Engineering and development expenses were $2,107,000, $964,000 and
$1,326,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in 1998 in engineering and development expenses from 1997 of
approximately 119%, was primarily due to the increase in expenditures related to
the development of the LTK System. Engineering and development expenses
decreased to $964,000 in 1997, an approximately 27% reduction from the 1996
level of expense, principally due to the effect of the sale of the dental
business and subsequent elimination of the engineering and development expenses
relating to the dental business subsequent to the sale.
SALES, MARKETING AND REGULATORY
Sales, marketing and regulatory expenses were $3,824,000, $2,718,000 and
$3,632,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in sales, marketing and regulatory expenses in 1998 of
approximately 41% from the 1997 level was primarily due to costs associated with
higher patient enrollment, approximately 608 patients in 1998 compared to 125
patients in 1997 and higher consulting fees in connection with the ongoing
clinical studies. The increased consulting fees of approximately $109,000 from
the 1997 level was due primarily to the continued monitor of the ongoing
clinical studies. Of the 608 patients enrolled in 1998, approximately 87 were
enrolled in new clinical studies established in 1998. The reduction in sales,
marketing and regulatory expenses in 1997 from 1996 of approximately 25% was
attributable to the elimination of such expenses after the sale of the dental
business in June 1997, offset by an increase of 225% in regulatory expenses
associated with the Company's expansion of its clinical studies for hyperopia
and presbyopia as compared to 1996. In addition, the Company added personnel to
its ophthalmic sales and marketing organization during the second half of 1997,
an increase in personnel of 79% over 1996, in support of its international sales
and international and domestic marketing activities.
The Company currently markets its ophthalmic lasers through an indirect
sales organization. Distribution for all products internationally is handled
through distributors. The Company will not be able to market its LTK System in
the United States until the FDA approves the product for sale in the United
States. The Company is unable to predict when, if at all, the FDA will approve
the LTK System for sale in the United States.
GENERAL AND ADMINISTRATIVE
General and administrative expenses were $6,787,000, $3,686,000, and
$2,700,000 for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in general and administrative expenses in 1998 of approximately 84%
compared to the 1997 level was primarily due to the expense related to the fair
value of warrants of approximately $2,105,000 granted to consultants in lieu of
cash and approximately $1,000,000 of higher compensation costs. Of the
$2,105,000 of the amortization of fair value of the warrants recorded in 1998,
approximately $905,000 and $1,200,000 were due to compensation expense
associated with warrants issued to consultants in 1997 and 1998, respectively.
The warrants issued in 1997 were amortized over the vesting period of two years.
The 1998 warrants were fully vested and amortized on their issuance date. The
compensation expense increase of approximately $1,000,000 between 1997 and 1998
was primarily due to issuances of warrants by the Company's to a consultant for
his financial consulting services in connection with the Company's fund raising
efforts in 1998. The increase in general and administrative expenses for 1997
from 1996 of approximately 37% was primarily due to expenses associated with
severance pay for certain officers, nonstatutory option expenses of
approximately $949,000 in 1997 and an increase in investor relations expenses.
The Company's general and administrative expenses consist primarily of: (i)
salaries and benefits of administrative and certain executive personnel; (ii)
product liability, officer and director liability and other corporate insurance
premiums; (iii) accounting, legal and other fees related to patent and general
corporate matters; and (iv) provisions for the Company's allowance for bad debts
and non-cash expenses associated with the issuance of certain warrants and
non-statutory stock options.
18
<PAGE> 19
INTEREST INCOME AND EXPENSE
Interest income was $399,000, $99,000 and $65,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. The increases in interest income
were primarily due to higher average cash balances in 1998 compared to 1997 and
higher average cash balances in 1997 compared to 1996, in the Company's interest
bearing accounts.
Interest expense was $3,950,000, $1,376,000 and $13,000 for the years ended
December 31, 1998, 1997 and 1996, respectively. Approximately $2,815,000, or
71%, of the Company's interest expense in 1998 was due to non-cash expenses
incurred in connection with the 1997 and 1998 Notes Placement. The fair value of
the warrants, the conversion features and the placement costs of such notes were
recorded as non-cash interest expense in 1998. The 1997 Notes and 1998 Notes
bear a stated interest rate of 5% and 12%, respectively. The effective rate of
interest of such notes, which includes the amortization of the fair value of the
warrants, is approximately 21% and 26%, respectively.
INCOME TAXES
At December 31, 1998, 1997 and 1996, all net deferred tax assets computed
in accordance with Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" have been fully offset by a valuation allowance.
NET LOSSES
The Company reported losses of $17,821,000, $6,618,000 and $5,968,000 in
1998, 1997 and 1996, respectively. The net loss in 1998 was primarily due to
lower product revenues, under-utilization of manufacturing capacity, non-cash
expenses associated with amortization of deferred compensation of approximately
$2,105,000, warrants issued in connection with the 1997 and 1998 Notes Placement
of approximately $2,815,000 and non-statutory stock options expenses of
approximately $974,000, which resulted from the acceleration of stock options
vesting for certain former employees.
The net loss in 1997 was due principally to the low level of revenue,
excess manufacturing capacity and inventory, the Company's continuing clinical
trials for hyperopia and presbyopia, expenses associated with the Company's
issuance of convertible debt with warrants and certain non-statutory stock
options, and the Company's need to maintain its basic corporate infrastructure,
offset by the gain from the sale of the Company's dental business in June 1997.
Although total operating expenses were reduced by 4% from 1996, the reduction
was not sufficient to return the Company to profitability in 1997.
The net loss in 1996 was due primarily to increased selling, marketing and
product development expenses associated with the attempt to grow the dental and
ophthalmic businesses, compounded by the continued low level of revenue and
excess manufacturing capacity. Total operating expenses increased 31% from 1995
while gross profit was essentially the same in both years. This increase in
operating expenses accounts for essentially all of the $1,800,000 increase in
net loss in 1996 from 1995.
The Company expects to report net losses during 1999. The losses will come
primarily from the expenses of the FDA approval process, the underlying clinical
studies related to the LTK System and the expenses associated with maintaining
the Company's basic corporate infrastructure. The Company will not have any
material domestic revenues from this product line unless and until FDA approval
is obtained. The Company's international revenues are not projected to be
sufficient to cover the expenses of maintaining the basic corporate
infrastructure and the Company's costs of the continuing clinical trials for
hyperopia and presbyopia.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1998, the Company had $9,889,000 in cash and cash
equivalents. The Company's operating activities used $8,536,000 in cash during
1998 and $6,774,000 during the same period in 1997. Substantial portions of the
1997 and 1998 losses were funded with the proceeds from the sale of our dental
business in June 1997 and from a series of private placements and equity
offering. The 1997 Notes Placement
19
<PAGE> 20
and 1998 Notes Placement had aggregate net proceeds of approximately $3,700,000,
(gross proceeds of $4,100,000) and $9,350,000, respectively.
On December 4, 1998, the Company completed a private placement of
approximately $11,800,000 of its shares of Common Stock. The subscription price
was $3.50 per share, which represents a 20% discount from the average of the
closing sale price of the Company's common stock, as reported on the Nasdaq
National Market System, on each of the last ten consecutive Nasdaq National
Market System trading days in October 1998. Of the total proceeds, $5,000,000
from the 1998 Equity Offering was received in the form of promissory notes due
on March 15, 1999 bearing interest at a rate of 9% per annum. Of the $5,000,000
in promissory notes, $1,000,000 is currently outstanding and has not been
repaid.
On January 1, 1999, the Company also raised $10,000,000 by issuing
convertible notes and accompanying warrants to purchase common stock. The 1999
Notes are convertible into shares of the Company's Common Stock at predetermined
prices, bear interest at the rate of 5% payable-in-kind semi-annually
(additional convertible notes), and contain certain conversion features. The
single purchaser of the 1999 Notes will be required, on the date the Company
receives conditional approval from the Ophthalmic Devices panel of the FDA
related to the pre-market approval application filed by the Company with the FDA
in December 1998 related to the LTK System (the "Panel Approval"), to convert
one-half of the principal amount of the 1999 Notes into shares of the Company's
common stock at a conversion price of $4.00 per share. The investor will also be
required, on the date the Company receives FDA approval to market the LTK System
in the United States (the "FDA Approval"), to convert the remaining portion of
the 1999 Notes into shares of common stock at a conversion price of $8.00 per
share.
The Company's debt service obligations consist of interest, payable in cash
or in-kind, accruing at a rate of 5% per annum on the remaining $762,000 in
principal and interest on the 1997 Notes as of December 31, 1998, and 12% per
annum on the $10,039,000 of principal and interest on the 1998 Notes as of
December 31, 1998. The Company also pays $5,800 per month on leases for computer
and office equipment. The warrants issued in connection with the 1998 Notes
Placement and 1999 Notes Placement had a fair value of approximately $1.87 and
$5.93 per warrant, respectively, at the time of issuance. The fair value of
these warrants has been reflected as additional consideration for the
convertible notes, recorded as a discount on the debt and accreted as interest
expense to be amortized over the life of the convertible notes. This
amortization of interest expense associated with the warrants will reduce net
income through the term of the 1998 and 1999 Notes, but will have no effect on
future cash flows from operations.
The Company's current operations continue to be cash flow negative,
limiting the Company's working capital resources. Working capital at December
31, 1998 amounted to approximately $6,773,000. At December 31, 1997, working
capital amounted to approximately $1,382,000. At the Company's current rate of
cash expenditures, the Company anticipates that it may be required to raise
additional working capital during 1999 to fund operations. The Company spent
approximately $878,000 for capital expenditures in calendar year 1998 and
expects to spend approximately $1,136,000 for capital expenditures in fiscal
year 1999.
No assurance can be given that additional financing will be available, or
if available, that it will be available on terms favorable to the Company and
its Stockholders. If funds are not available to satisfy the Company's short-term
and long-term operating requirements, the Company may be required to limit or
suspend its operations in their entirety or, under certain circumstances, be
forced to seek protection from creditors. The Company's long-term ability to
continue as a going concern is dependent upon performing profitably or obtaining
further financing.
YEAR 2000 COMPLIANCE
The Company is aware of the issues associated with the programming code in
existing computer systems as the millennium ("Year 2000") approaches. The Year
2000 problem is pervasive and complex, as virtually every computer operation
will be affected in the same way by the rollover of the two digit year value to
00. The issue is whether computer systems will properly recognize date-sensitive
information when the year changes to 2000. Systems that do not properly
recognize such information could generate erroneous data or cause a system to
fail. The Company is utilizing both internal and external resources to identify,
correct or reprogram,
20
<PAGE> 21
and test its systems for Year 2000 compliance. As of March 31, 1999, the
estimated costs of these reprogramming efforts have been approximately $250,000.
It is currently expected that the remaining costs to complete these
reprogramming efforts will be less than $100,000. It is anticipated that all of
the Company's reprogramming efforts will be completed by August 31, 1999,
allowing adequate time for testing. This process includes obtaining
confirmations from the Company's primary vendors that plans are being developed
or are already in place to address processing of transactions in the year 2000.
These confirmations are expected to be obtained in writing by the Company prior
to July 31, 1999. However, there can be no assurance that the systems of other
companies on which the Company's systems rely will also be converted in a timely
manner, or that any such failure to convert by another company would not have a
material adverse effect on the Company's business, financial conditions or
results of operations.
The Company believes that it does not have a Year 2000 problem with its
products that have been sold in the past, however, the Company has not performed
an extensive review of these systems and is unlikely to be able to complete a
review prior to January 1, 2000. In addition, the Company is designing a new
product to replace its existing LTK System that is being designed to properly
recognize date-sensitive information for the Year 2000 and beyond. Although the
Company plans to perform extensive testing of its new product, there can be no
assurance that the new system will function properly until it is deployed in the
field and subjected to extensive use. Any malfunction of a deployed system could
have a material adverse effect on the Company's business, financial conditions
or results of operations.
The Company is not expecting to have a material accounts receivable
exposure, or significant amount of revenues with any one customer after December
31, 1999 and, therefore, verification of customer Year 2000 compliance is not
being pursued by the Company at this time. Any failure to pay in a timely
manner, or place orders for the Company's products, by a significant number of
individual customers or by a customer with a material accounts receivable
balance, due to Year 2000 compliance issues would have material adverse effects
on the Company's business, financial condition or results of operations.
The Company is currently developing a contingency plan to evaluate business
disruption scenarios, coordinate the establishment of Year 2000 contingency
plans, and identify and implement the strategies. This detailed contingency plan
is expected to be completed by July 31, 1999.
CONVERSION
A single currency called the euro was introduced in Europe on January 1,
1999. Eleven of the 15 member countries of the European Union have adopted the
euro as their common legal currency. Fixed conversion rates between these
participating countries' existing currencies (the "Legal Currencies") and the
euro were established. The Legal Currencies are scheduled to remain legal tender
as denominations of the euro until at least January 1, 2002 (but not later than
July 1, 2002). During this transition period, parties may settle transactions
using either the euro or a participating country's legal currency.
The Company does not expect the conversion to the euro will have a material
impact on the Company's financial position or results of operations since the
majority of the Company's business transactions are recorded in U.S. currency.
NEW ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Investments and Hedging Activities." The statement
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of SFAS
No. 133 to have a material effect on the Company's consolidated financial
statements.
21
<PAGE> 22
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to financial market risks due primarily to changes
in interest rates. The Company does not use derivatives to alter the interest
characteristics of its investment securities or its debt instruments. The
Company has no holdings of derivative or commodity instruments and does not
transact business in foreign currencies.
The fair value of the Company's investment portfolio or related income
would not be significantly impacted by changes in interest rates since the
investment maturities are short and the interest rates are primarily fixed.
The Company anticipates interest on cash balances for 1999 to be
approximately $340,000 at an estimated average interest rate of 3%. It is not
possible to anticipate the level of interest and the rates past 1999. Changes in
interest rates have no impact on our debt as all notes are at fixed interest
rates between 5% and 12%.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated balance sheets at December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity and cash flow for
each of the three years ended December 31, 1998, 1997 and 1996 and the notes
thereto appear beginning at page 27.
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
On December 9, 1997, the Company dismissed Ernst & Young LLP ("E&Y") as its
independent accounting firm. E&Y's report on the financial statements for the
past two years did not contain an adverse opinion or a disclaimer of opinion,
however, the report was modified to include an explanatory paragraph with
respect to the Company's ability to continue as a going concern. During the
Company's 1995 and 1996 fiscal years and the subsequent interim period preceding
such dismissal, there were no disagreements with E&Y on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure. The decision to change accountants was recommended and approved by
the Audit Committee of the Company's Board of Directors.
On December 10, 1997, the Company engaged Coopers & Lybrand LLP ("C&L"),
now known as PricewaterhouseCoopers LLP, as the new independent accountant to
audit the Company's financial statements. During the Company's 1995 and 1996
fiscal years and the subsequent interim period prior to engaging C&L, the
Company had not consulted C&L regarding either: (i) the applications of
accounting principles to a specified transactions, either completed or proposed;
or the type of audit opinion that might be rendered on the Company's financial
statements, and no written report was provided to the Company and no oral advice
was provided that C&L concluded was an important factor considered by the
Company in reaching a decision as to the accounting, auditing or financial
reporting issue; or (ii) any matter that was either the subject of a
disagreement (as defined in paragraph 304(a)(l)(iv) of Regulation S-K) or a
reportable event (as described in paragraph 304(a)(l)(v) of Regulation S-K).
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The section entitled "Directors and Executive Officers" located in the
Registrant's Proxy Statement filed pursuant to Regulation 14A for its Annual
Meeting of Stockholders on April 30, 1999 (the "1998 Annual Meeting Proxy
Statement") is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The section entitled "Executive Compensation" in the 1998 Annual Meeting
Proxy Statement is incorporated herein by reference.
22
<PAGE> 23
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The section entitled "Security Ownership of Certain Beneficial Owner's and
Management" in the 1998 Annual Meeting Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The section entitled "Certain Relationships and Related Transactions" in
the 1998 Annual Meeting Proxy Statement is incorporated herein by reference.
23
<PAGE> 24
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. FINANCIAL STATEMENTS
The following documents are filed as part of this report:
<TABLE>
<CAPTION>
PAGE IN THIS
ANNUAL REPORT ON
FORM 10-K
----------------
<S> <C>
Report of PricewaterhouseCoopers LLP, Independent
Accountants............................................... 27
Report of Ernst & Young LLP, former Independent Auditors.... 28
Consolidated Balance Sheets -- December 31, 1998 and 1997... 29
Consolidated Statements of Operations*...................... 30
Consolidated Statement of Stockholders' Equity*............. 31
Consolidated Statements of Cash Flows*...................... 32
Notes to Consolidated Financial Statements.................. 33
Schedule II -- Valuation and qualifying accounts............ 45
</TABLE>
- ---------------
* For the years ended December 31, 1998, 1997 and 1996
All other schedules have been omitted as they are not required, not
applicable or the required information is included in the financial statements
or notes thereto.
3. EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
2.1 Asset Purchase Agreement dated as of March 26, 1997, by and
between the Company and Lares Research, a California
corporation(6)
3.1 Certificate of Incorporation, as amended(1)
3.2 Bylaws(1)
4 Instruments Defining the Rights of Security Holders
4.1 Form of 5% Convertible Notes due 1999(7)
4.2 Form of Security Agreement relating to 5% Convertible Notes
due 1999(7)
4.3 Form of Registration Rights Agreement(7)
4.4 Form of Warrant issued to Pennsylvania Merchant Group(4)
4.5 Form of Rights Agreement, dated as of October 24, 1997,
between the Company and ChaseMellon Shareholder Services,
L.L.C., as rights agent(8)
4.6 Form of 12% Subordinated Pay-In-Kind Note Due 2001(9)
4.7 Form of Registration Rights Agreement(9)
4.8 Form of 5% Convertible Subordinated Pay-In-Kind Note due
2001(13)
4.9 Form of Warrant for the Purchase of Common Stock(13)
4.10 Form of Registration Rights Agreement(13)
10.1 Lease Agreement with Bayside Spinnaker Partners III, as
lessor, for the lease of facilities at 47257 Fremont
Boulevard, Fremont, California, dated July 16, 1991(2)
10.2 Patent License Agreement between the Company and Patlex
Corporation dated January 1, 1990(3)
</TABLE>
24
<PAGE> 25
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
10.3 Agreement between the Company and the University of Miami,
Department of Ophthalmology, dated October 28, 1991(2)
10.4 Joint Development and Exclusive Manufacturing Agreement
dated April 17, 1993 between the Company and Danville
Engineering, Inc.(1)
10.5 Settlement Agreement between the Company and American Dental
Laser, Inc., dated February 4, 1993 (confidential treatment
has previously been granted for portions of this exhibit)(4)
10.6 License Agreement between the Company and American Dental
Laser, Inc., dated February 4, 1993 (confidential treatment
has previously been granted for portions of this exhibit)(4)
10.7 Settlement Agreement between the Company and American Dental
Technologies, dated July 30, 1996
*10.8 Form of Indemnification Agreement between the Company and
each of its officers and directors(3)
*10.9 1988 Stock Option Plan, as amended(5)
*10.10 Employment Agreement, entered into between the Company and
Joseph W. Shaffer, dated April 5, 1989(5)
10.11 Form of U.S. Note and Warrant Purchase Agreement relating to
the Regulation D private placement of 5% convertible notes
due 1999 and warrants in February and March 1997
10.12 Form of Offshore Note and Warrant Purchase Agreement
relating to the Regulation S private placement of 5%
convertible notes due 1999 and warrants in March 1997
*10.13 Form of Change of Control Agreement by and between the
Company and its President and Chief Executive Officer(8)
*10.14 Form of Change of Control Agreement by and between the
Company and its executive officers (other than the President
and Chief Executive Officer)(8)
*10.15 Form of Indemnification Agreement by and between the Company
and its executive officers(8)
10.16 Form of U.S. Note and Warrant Purchase Agreement related to
the Regulation D private placement of 12% Convertible
Subordinated Pay-In-Kind Notes Due 2001 and accompanying
Warrants in January 1998(9)
*10.17 Form of Amended and Restated Change of Control Agreement by
and between the Company and its President and Chief
Executive Officer(11)
*10.18 Form of Amended and Restated Change of Control Agreement by
and between the Company and its executive officers (other
than the President and Chief Executive Officer)(11)
10.19 Lease Agreement with Bayside Spinnaker Partners III, as
lessor, for the lease of facilities at 47265 Fremont
Boulevard, Fremont, California, dated January 23, 1998(10)
10.20 Sublease between Avant! Corporation, as sub-sublandlord, the
Company, as sub-subtenant, Cirrus Logic, Inc., as
sublandlord, Avant! Corporation, as subtenant, Renco
Investment Company, as landlord, and Cirrus Logic, Inc., as
tenant for the lease of facilities at
3400 West Warren Avenue, Fremont, California(12)
10.21 Form of Note and Warrant Purchase Agreement(13)
*10.22 The 1999 Long-Term Equity Compensation Plan
21.1 Subsidiaries of the Company
22 Power of Attorney (included on the signature pages to this
Form 10-K)
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
</TABLE>
25
<PAGE> 26
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<C> <S>
23.2 Consent of Ernst & Young LLP, former Independent Auditors
27 Financial Data Schedule
</TABLE>
- ---------------
* Compensatory plan or management contract
(1) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1994 (File No. 0-17816)
(2) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1991 (File No. 0-17816)
(3) Incorporated by reference from the registrant's Registration Statement on
Form S-1, as amended (File No. 33-36768)
(4) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1992 (File No. 0-17816)
(5) Incorporated by reference from the registrant's Registration Statement on
Form S-18, as amended (File No. 33-27029-LA)
(6) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1996 (File No. 1-10428)
(7) Incorporated by reference from the registrant's Current Report on Form 8-K
dated March 12, 1997 (File No. 0-17816)
(8) Incorporated by reference from the registrant's Current Report on Form 8-K
dated October 24, 1997 (File No. 0-17816)
(9) Incorporated by reference from the registrant's Current Report on Form 8-K
dated January 26, 1998 (File No. 0-17816)
(10) Incorporated by reference from the registrant's Annual Report of Form 10-K
for the year ended December 31, 1997 (File No. 0-17816)
(11) Incorporated by reference from the registrant's Current Report on Form 8-K
dated May 8, 1998 (File No. 0-17816)
(12) Incorporated by reference from the registrant's Registration Statement on
Form S-2 dated September 29, 1998 (File No. 333-64975)
(13) Incorporated by reference from the registrant's Current Report on Form 8-K
dated January 1, 1999 (File No. 1-10428)
(14) Incorporated by reference from the registrant's Registration Statement on
Form S-8 dated March 2, 1999 (File No. 333-73211).
REPORTS ON FORM 8-K
The Company filed a Current Report on Form 8-K dated December 4, 1998 to
report the completion of a private placement of approximately $11,800,000 of the
Company's common stock priced at $3.50 per share, approximately $6,800,000 of
which was paid in cash with the remainder evidenced by promissory notes due on
March 15, 1999.
26
<PAGE> 27
REPORT OF PRICEWATERHOUSECOOPERS LLP, INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Sunrise Technologies International, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, stockholders' equity and cash
flows present fairly, in all material respects, the financial position of
Sunrise Technologies International, Inc. and its subsidiaries (the "Company") at
December 31, 1998 and 1997, and the results of their operations and their cash
flows for the years then ended, in conformity with generally accepted accounting
principles. 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 of these statements in
accordance with generally accepted auditing standards which 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, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above. The consolidated financial statements of Sunrise Technologies
International, Inc. for the year ended December 31, 1996, were audited by other
auditors, whose report, dated March 10, 1997, included an explanatory paragraph
that described substantial doubt as to the Company's ability to continue as a
going concern.
Pricewaterhousecoopers LLP
San Jose, California
February 19, 1999
27
<PAGE> 28
REPORT OF ERNST & YOUNG LLP, FORMER INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sunrise Technologies International, Inc.
We have audited the accompanying consolidated statements of operations,
stockholders' equity, and cash flows for the year ended December 31, 1996 of
Sunrise Technologies International, Inc. 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 audit.
We conducted our audit 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 audit provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated results of operations
and cash flows of Sunrise Technologies International, Inc. for the year ended
December 31, 1996 in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that Sunrise Technologies International, Inc. will continue as a going
concern. The Company has incurred recurring operating losses which condition
raises substantial doubt about the Company's ability to continue as a going
concern. The consolidated financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classifications of liabilities that may result from
the outcome of this uncertainty.
ERNST & YOUNG LLP
Palo Alto, California
March 10, 1997
28
<PAGE> 29
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1997
--------- ---------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 9,889 $ 1,958
Accounts receivable, net of allowance of $11 and $84 in
1998 and 1997.......................................... 135 312
Inventories, net.......................................... 11 127
Prepaid and other expenses................................ 314 140
-------- --------
Total current assets...................................... 10,349 2,537
Property and equipment, net............................... 900 204
Other non-current assets.................................. 230 208
-------- --------
Total assets...................................... $ 11,479 $ 2,949
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ 730 $ 31
Accounts payable.......................................... 694 284
Accrued liabilities....................................... 2,152 840
-------- --------
Total current liabilities................................... 3,576 1,155
Notes payable and other long-term liabilities............... 7,703 945
-------- --------
Total liabilities........................................... 11,279 2,100
-------- --------
Commitments and Contingencies (Note 3)
Stockholders' equity:
Preferred stock, $0.001 par value; 2,000,000 shares
authorized, none issued or outstanding
Common stock, $0.001 par value; 75,000,000 shares
authorized, 38,160,720 and 32,307,990 shares issued and
outstanding at December 31, 1998 and 1997,
respectively........................................... 38 32
Additional paid-in-capital................................ 60,087 38,151
Notes receivable for common stock......................... (5,000) --
Deferred compensation..................................... (42) (272)
Accumulated deficit....................................... (54,883) (37,062)
-------- --------
Total stockholders' equity........................ 200 849
-------- --------
Total liabilities and stockholders' equity........ $ 11,479 $ 2,949
======== ========
</TABLE>
See accompanying notes
29
<PAGE> 30
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net revenues................................................ $ 594 $ 2,839 $ 5,654
Cost of revenues............................................ 2,142 2,546 4,016
-------- ------- -------
Gross profit................................................ (1,548) 293 1,638
-------- ------- -------
Other costs and expenses:
Engineering and development............................... 2,107 964 1,326
Sales, marketing and regulatory........................... 3,824 2,718 3,632
General and administrative................................ 6,787 3,686 2,700
-------- ------- -------
Total other costs and expenses.............................. 12,718 7,368 7,658
-------- ------- -------
Loss from operations........................................ (14,266) (7,075) (6,020)
Gain on sale of dental assets............................... -- 1,740 --
Interest income............................................. 399 99 65
Interest expense............................................ (3,950) (1,376) (13)
Other expense, net.......................................... (4) (6) --
-------- ------- -------
Net loss.................................................... $(17,821) $(6,618) $(5,968)
======== ======= =======
Net loss per share, basic and diluted....................... $ (0.52) $ (0.23) $ (0.23)
======== ======= =======
Shares used in calculation of basic and diluted net loss per
share..................................................... 34,164 28,550 26,414
======== ======= =======
</TABLE>
See accompanying notes
30
<PAGE> 31
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
NOTES
COMMON STOCK ADDITIONAL RECEIVABLE TOTAL
------------------- PAID-IN DEFERRED FOR COMMON ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION STOCK DEFICIT EQUITY
---------- ------ ---------- ------------ ---------- ----------- -------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996......... 25,279,716 $25 $29,196 -- -- $(24,476) $ 4,745
Sale of common stock, net of
offering costs................... 2,333,412 3 2,242 -- -- -- 2,245
Exercise of warrants and options... 243,252 -- 243 -- -- -- 243
Other.............................. 12,233 -- 7 -- -- -- 7
Net loss........................... -- -- -- -- -- (5,968) (5,968)
---------- --- ------- ----- ------- -------- --------
Balance at December 31, 1996....... 27,868,613 28 31,688 -- -- (30,444) 1,272
Issuance of warrants in connection
with 1997 Notes.................. -- -- 1,838 -- -- -- 1,838
Conversion of 1997 Notes........... 2,902,566 3 2,599 -- -- -- 2,602
Exercise of warrants............... 1,270,531 1 1,073 -- -- -- 1,074
Exercise of options................ 247,913 -- 279 -- -- -- 279
Issuance of shares in connection
with the employee stock purchase
plan............................. 18,367 -- 15 -- -- -- 15
Deferred compensation related to
stock option grants.............. -- -- 659 $(272) -- -- 387
Net loss........................... -- -- -- -- -- (6,618) (6,618)
---------- --- ------- ----- ------- -------- --------
Balance at December 31, 1997....... 32,307,990 32 38,151 (272) -- (37,062) 849
Issuance of common stock, net of
offering costs, in connection
with 1998 Equity Offering........ 3,378,218 3 11,739 -- (5,000) -- 6,742
Issuance of warrants in connection
with 1998 Notes.................. -- -- 4,283 -- -- -- 4,283
Issuance of warrants and stock
options.......................... -- -- 2,602 230 -- -- 2,832
Conversion of 1997 and 1998
Notes............................ 1,074,043 1 1,221 -- -- -- 1,222
Exercise of warrants............... 624,407 1 606 -- -- -- 607
Exercise of options................ 765,564 1 1,458 -- -- -- 1,459
Issuance of shares in connection
with employee stock purchase
plan............................. 10,498 -- 27 -- -- -- 27
Net loss........................... -- -- -- -- -- (17,821) (17,821)
---------- --- ------- ----- ------- -------- --------
Balance at December 31, 1998....... 38,160,720 $38 $60,087 $ (42) $(5,000) $(54,883) $ 200
========== === ======= ===== ======= ======== ========
</TABLE>
See accompanying notes
31
<PAGE> 32
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1998 1997 1996
-------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss.................................................... $(17,821) $(6,618) $(5,968)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 182 77 438
Amortization of deferred compensation..................... 3,477 387 --
Amortization of debt issuance costs....................... 210 150 --
Gain on sale of dental assets............................. -- (1,740) --
Warrant accretion and beneficial conversion features
associated with the 1997 and 1998 Notes................ 2,605 1,066 --
Issuance of common stock for services..................... 150 371 --
Provision for obsolete inventory.......................... -- 397 --
Provision for doubtful accounts........................... -- 176 115
Conversion of accrued interest to notes payable........... 557 -- --
Changes in assets and liabilities:
Accounts receivable....................................... 177 (16) 461
Inventories............................................... 116 233 (837)
Other current assets...................................... (174) 148 (31)
Other non-current assets.................................. (218) -- --
Accounts payable.......................................... 410 (1,302) 489
Other accrued liabilities................................. 1,151 (258) 36
Other long-term liabilities............................... 642 155 --
-------- ------- -------
Total adjustments................................. 9,285 (156) 671
-------- ------- -------
Net cash used in operating activities.................. (8,536) (6,774) (5,297)
-------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of property and equipment.......................... (878) (98) (65)
Proceeds from sale of dental assets......................... -- 3,449 --
-------- ------- -------
Net cash provided by (used in) investing activities.... (878) 3,351 (65)
-------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Payment on capital lease obligations........................ (33) (5) --
Issuance of common stock, net of offering costs............. 8,042 996 2,495
Capitalization of debt issuance costs....................... (14) (358) --
Issuance of redeemable convertible notes, net of issuance
costs..................................................... 9,350 4,101 --
-------- ------- -------
Net cash provided by financing activities.............. 17,345 4,734 2,495
-------- ------- -------
Net increase (decrease) in cash and equivalents............. 7,931 1,311 (2,867)
Cash and cash equivalents at beginning of year.............. 1,958 647 3,514
-------- ------- -------
Cash and cash equivalents at end of year.................... $ 9,889 $ 1,958 $ 647
======== ======= =======
</TABLE>
See accompanying notes
32
<PAGE> 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Nature of Business
Sunrise Technologies International, Inc. (the "Company") develops,
manufactures and markets laser systems and other products for applications in
ophthalmology. The Company was organized as a California corporation in March
1987 and was reincorporated in Delaware in June 1993 as Sunrise Technologies
International, Inc. The Company continues to do business under the name Sunrise
Technologies, Inc.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its wholly owned subsidiary after elimination of all intercompany balances
and transactions.
The Company has incurred significant losses for the last several years and
at December 31, 1998 has an accumulated deficit of $54,883,000. The accompanying
financial statements have been prepared assuming the Company will continue as a
going concern. The Company's long term ability to continue as a going concern is
dependent upon returning to profitable operations. Management's plans include
increasing sales through increased direct sales and marketing efforts on
existing products and pursuing timely regulatory approval for certain products
under development. Management also recognized the need for infusion of cash
during the period 1998. In January 1998, the Company completed a $9,300,000
private placement of convertible notes with warrants, net of offering costs. The
Company also raised approximately $11,800,000 from the sale of common stock in
December 1998, and $10,000,000, net of offering costs, in the form of promissory
notes with warrants in January 1999. There can be no assurance that additional
funds can be raised on terms acceptable to the Company, if at all.
Concentration of Risk
Financial instruments, which potentially subject the Company to
concentration of credit risk, consist principally of cash investments and trade
receivables. The Company invests its excess cash in deposits with major banks,
in the United States, U.S. Treasury and U.S. Agency obligations. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. The Company maintains reserves for potential credit losses
and such losses have been within management's expectations.
The Company's activities are subject to extensive regulation by the Food
and Drug Administration ("FDA") and similar health authorities in certain
foreign countries. The LTK System is regulated as a Class III medical device by
the FDA under the Food, Drug & Cosmetic Act. Class III medical devices require a
PMA by the FDA prior to commercial sale in the United States. The Premarket
Approval Application ("PMA") process (and underlying clinical studies) is
lengthy, the outcome is difficult to predict and requires substantial
commitments of the Company's financial resources and management's time and
effort. Delays in obtaining or failure to obtain required regulatory approvals
or clearances in the United States and other countries would postpone or prevent
the marketing of the LTK System and other devices and would impair the Company's
ability to generate funds from operations, which in turn 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 able to obtain in
a timely manner, if at all, the required PMA in the United States for intended
uses of the LTK System, or for any other devices which the Company may seek
approvals or clearances.
Any products manufactured or distributed by the Company will be subject to
pervasive and continuing regulation by the FDA.
In addition, the introduction of the Company's products in foreign
countries may require obtaining both US and foreign individual foreign
regulatory clearances in numerous countries. Although the Company's
33
<PAGE> 34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
products have been sold in approximately 15 countries, sales of the LTK System
require rigorous regulatory approvals before being sold in the United States and
certain other countries. There can be no assurance that the Company will be able
to obtain regulatory clearances for its products in the United States or foreign
markets.
The Company's international business is an important contributor to the
Company's net revenues and gross profits. Substantially all of the Company's
international sales are denominated in the U.S. dollar and an increase in the
value of the U.S. dollar relative to foreign currencies could make products sold
internationally less competitive.
The Company has developed only limited clinical data to date on the safety
and efficacy of the LTK System in correcting hyperopia (farsightedness), and
related long-term safety and efficacy data. The FDA has not yet determined
whether the LTK System will prove to be safe or effective for the predictable
and reliable treatment of hyperopia or other common vision problems. There can
be no assurance that long-term safety and efficacy data when collected will be
consistent with the clinical trial results previously obtained or will
demonstrate that the LTK System can be used safely and successfully to treat
hyperopia in a broad segment of the population on a long-term basis.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash on deposit with the Company's
bank and money market funds with a maturity from the date of purchase of 90 days
or less. As of December 31, 1998 and 1997, the Company did not hold any
investments in debt or equity securities.
Inventories
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market. Inventory at December 31, consists of:
<TABLE>
<CAPTION>
1998 1997
----- -----
(IN THOUSANDS)
<S> <C> <C>
Raw materials....................................... $ 11 $ 416
Work-in-process..................................... 20 167
Finished goods...................................... 166 191
----- -----
197 774
Less reserves....................................... (186) (647)
----- -----
Inventory, net...................................... $ 11 $ 127
===== =====
</TABLE>
Most components used in the Company's laser systems are purchased from
outside sources. Although some of the parts and components used by the Company
in producing its products are available from multiple sources, the Company
currently purchases each of its components from a single source in an effort to
obtain volume discounts. Lack of availability of any of these parts and
components could result in production delays, increased costs or costly
redesigned of the Company's products.
34
<PAGE> 35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
Property and Equipment
Property and equipment is stated at cost and depreciated using the
straight-line method for financial reporting over estimated useful lives of one
to five years. Depreciation expense for years ended December 31, 1998, 1997 and
1996 were $191,000, $77,000 and $477,000, respectively. Assets under capitalized
leases are amortized over the shorter of the term of the lease or their useful
lives, and such amortization is included with depreciation expense. Property and
equipment at December 31, consists of:
<TABLE>
<CAPTION>
1998 1997
------ -----
(IN THOUSANDS)
<S> <C> <C>
Machinery and equipment............................ $ 381 $ 257
Computer equipment................................. 663 231
Furniture and fixtures............................. 87 27
Leasehold improvements............................. 262 --
------ -----
1,393 515
Less accumulated depreciation and amortization..... (493) (311)
------ -----
Property and equipment, net........................ $ 900 $ 204
====== =====
</TABLE>
Other Non-current Assets
Other non-current assets are comprised primarily of the security deposit of
approximately $218,000 for the Company's facility, and note placement costs in
connection with the 1997 and 1998 Notes Placement. The notes placement costs are
being amortized over the life of the notes. The amortization, which is included
in interest expense, was $359,000, $149,000 and none for 1998, 1997 and 1996,
respectively.
Accrued Liabilities
Accrued liabilities consist of:
<TABLE>
<CAPTION>
1998 1997
------ ----
(IN THOUSANDS)
<S> <C> <C>
Accrued payroll and related expenses................ $ 513 $221
Accrued legal....................................... 539 35
Accrued regulatory and clinical expenses............ 456 38
Other accrued expenses.............................. 644 546
------ ----
$2,152 $840
====== ====
</TABLE>
Computation of Net Loss Per Share
Basic Earnings Per Share ("EPS") is computed as net income (loss) divided
by the weighted average number of common shares outstanding for the period.
Diluted EPS reflects the potential dilution that could occur from common shares
issuable through stock options, warrants and other convertible securities.
Common equivalent shares are excluded from the computation of net loss per share
if their effect is anti-dilutive.
35
<PAGE> 36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The following is a reconciliation of the numerator (net loss) and
denominator (number of shares) used in the basic and diluted EPS calculation:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
BASIC EPS:
Net loss............................................. $(17,821) $(6,618) $(5,968)
Average Common Shares Outstanding.................... 34,164 28,550 26,414
======== ======= =======
Basic EPS............................................ $ (0.52) $ (0.23) $ (0.23)
======== ======= =======
DILUTED EPS:
Net loss............................................. $(17,821) $(6,618) $(5,968)
Average Common Shares Outstanding.................... 34,164 28,550 26,414
Convertible Notes, Warrants and Stock Options...... -- -- --
-------- ------- -------
Total Shares....................................... 34,164 28,550 26,414
======== ======= =======
Diluted EPS........................................ $ (0.52) $ (0.23) $ (0.23)
======== ======= =======
</TABLE>
Excluded from the shares used to calculate diluted EPS as their effect is
anti-dilutive was 7,199,795 shares in 1998, 7,303,537 common equivalent shares
in 1997 and 989,637 shares in 1996.
STOCK BASED COMPENSATION
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations in accounting for its employee stock options. Under APB 25,
because the market price of the Company's stock options equals the market price
of the underlying stock on the date of grant, no compensation expense is
recognized. For grants of options or warrants to non-employees, compensation
expense is measured using the Emerging Issues Task Force ("EITF") 96-18 model
and the resulting compensation is deferred and amortized to expense over the
vesting period. The Company has adopted the disclosure only provisions of
Statements of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation."
Revenue Recognition
Revenues are recognized at time of shipment. A provision for the estimated
future cost of warranty is made at the time a sale is recorded.
Research and Development
Research and development expenditures are charged to operations as
incurred. For the years ended December 31, 1998, 1997 and 1996, the expense was
$1,769,000, $362,000 and $0, respectively.
Advertising and Sales Promotion Costs
Advertising and sales promotion costs are charged to operations as
incurred. For the years ended December 31, 1998, 1997 and 1996, the expense was
$612,0000, $200,000 and $434,000, respectively.
36
<PAGE> 37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
Segment Information
The Company, which operates in a single industry segment, designs,
manufactures, markets and services medical laser systems. The Company sells its
products to customers in the field of ophthalmology globally. The following is a
summary of the Company's geographic operations:
<TABLE>
<CAPTION>
1998 1997 1996
---- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Domestic........................................... $ 11 $1,774 $3,016
Europe............................................. 10 314 1,036
Pacific Rim........................................ -- 409 1,602
Canada............................................. 3 180 --
South Africa....................................... 504 162 --
Other.............................................. 66 -- --
---- ------ ------
Total.................................... $594 $2,839 $5,654
==== ====== ======
</TABLE>
The Company's assets are located in the United States. The Company does not
segregate information related to operating income generated by its export sales.
Comprehensive Income
The Company has adopted the Statement of Financial Accounting Standards No.
130, "Reporting Comprehensive Income" (SFAS 130) effective December 31, 1998.
SFAS 130 establishes standards for reporting and display of comprehensive income
and its components for general-purpose financial statements. Comprehensive
income is defined as net income plus all revenues, expenses, gains and losses
that are excluded from net income in accordance with generally accepted
accounting principles. For the years ended December 31, 1996, 1997 and 1998,
there are no material differences between comprehensive income and net income.
Fair Value of Financial Instruments
Carrying amounts of certain of the Company's financial instruments
including cash and cash equivalents, accounts receivable, accounts payable and
other accrued liabilities approximate fair value due to their short maturities.
Based on borrowing rates currently available to the Company for loans with
similar terms, the carrying value of its debt obligations approximates fair
value.
New Accounting Pronouncement
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Investments and Hedging Activities." The statement
establishes accounting and reporting standards requiring that every derivative
instrument be recorded in the balance sheet as either an asset or liability
measured at its fair value. The statement also requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999. The Company does not expect the adoption of SFAS
No. 133 to have a material effect on the Company's consolidated financial
statements.
Reclassifications
Certain reclassifications have been made to the prior year financial
statements to conform to the current year presentation.
37
<PAGE> 38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
2. TAXES ON INCOME
Income taxes are recorded under the liability method. Under this method
deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities and are measured
using enacted tax rates in effect for the year in which the differences are
expected to reverse. The Company's effective tax rate differs from the statutory
federal income tax rate as shown in the following schedule:
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Statutory Rate.......................................... (34)% (34)% (34)%
NOL's not benefited which have been reserved............ 34% 34% 34%
--- --- ---
0% 0% 0%
=== === ===
</TABLE>
Temporary differences and carryforwards which give rise to a significant
portion of deferred tax assets and liabilities for 1998 and 1997 are as follows:
<TABLE>
<CAPTION>
1998 1997
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards..................... $ 15,200 $ 11,100
Research credits (expire 2005 - 2013)................ 950 700
Other................................................ 350 500
-------- --------
Total deferred tax asset..................... 16,500 12,300
Valuation allowance for deferred tax assets............ (16,500) (12,300)
-------- --------
Net deferred tax assets................................ $ -- $ --
======== ========
</TABLE>
As of December 31, 1998, the Company had federal and state net operating
loss carryforwards of approximately $43,100,000 and $15,600,000 respectively.
The change in the Company's valuation allowance from 1997 to 1998 was an
increase of $4,200,000. The net operating loss and credit carryforwards will
expire at various dates through 2018 if not utilized. Due to uncertainty
surrounding the realization of the favorable tax attributes in future tax
returns, the Company has placed a valuation allowance against its net deferred
tax assets.
The ownership change provisions of the Internal Revenue Code of 1986 and
similar state provisions would limit utilization of the carryforwards should
there be a substantial change in the Company's ownership. The annual limitation
may result in the expiration of net operating losses and credits before
utilization.
3. COMMITMENTS AND CONTINGENCIES
Leases
The Company leased certain equipment under a noncancellable capital lease.
The cost of assets under capital leases as of December 31, 1998 and 1997 was
approximately $103,000 and accumulated amortization applied to assets under
capital lease was $34,000 and $8,500 at December 31, 1998 and 1997,
respectively. The Company leases certain of its facilities and equipment under
noncancellable operating leases. Rent expense was $331,000, $233,000 and
$290,000 in 1998, 1997 and 1996, respectively.
38
<PAGE> 39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The following is a schedule by year of future minimum lease payments at
December 31, 1998:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASES
--------- -------
(IN THOUSANDS)
<S> <C> <C>
Year ending December 31,
1999.................................................... $ 907 $36
2000.................................................... 943 24
2001.................................................... 973 --
2002.................................................... 990 --
2003.................................................... 1,029 --
------ ---
Total minimum payments required......................... $4,842 $60
====== ===
</TABLE>
Contingencies
Danville Manufacturing, Inc. (d.b.a. Danville Engineering) ("Danville")
filed a suit in the Superior Court of California, County of Contra Costa,
against the Company, claiming monetary damages for disputed invoices of
approximately $200,000 and alleging misappropriation of intellectual property.
(Danville Manufacturing, Inc. d/b/a. Danville Engineering v. Sunrise
Technologies International, Inc. C98-02123). The Company entered into a
settlement agreement with Danville on April 21, 1999. Pursuant to this
agreement, the Company agreed to pay Danville $120,000 and assign to Danville a
secured promissory note in the principal amount of $1,500,000 issued by Lares
Research, a California corporation, in connection with the sale of the Company's
dental business on June 26, 1997. The note is subject to offset for certain
claims by Lares Research and Danville has a 90-day option either to reject the
note and reassign it to the Company, in which event the Company will pay
Danville an additional $200,000, or accept the note, in which even the proceeds,
less any costs of collection, will be split equally between the Company and
Danville.
4. LONG-TERM DEBT
In January 1998, the Company completed a private placement of convertible
notes (convertible into the Company's common stock) with warrants, raising
approximately $9,350,000. The promissory notes (the "Primary Notes") are
convertible at any time, at the option of the holder. The notes bear a stated
interest rate of 12%, payable-in-kind semi-annually (additional convertible
notes) and convert at a price of $3.00 per share. The resulting discount of
approximately $779,000 increased the effective interest rate and has been
charged to interest expense in 1998. The effective interest rate, which includes
the amortization of the fair value of the warrants, is approximately 26%. The
amount of $779,000 was derived from the calculation of using stock closing price
of $3.25 per share at issuance date less conversion price of $3.00 per share,
multiplying the equivalent of 3,116,667 shares upon the conversion of the
Primary Notes. The Primary Notes have a maturity date of January 2001 and the
Company has an option to extend the maturity date of the notes for an additional
two years for additional warrant consideration. On July 15, 1998, the Company
issued additional convertible notes in the amount of approximately $557,000 (the
"Secondary Notes") to the holders of the Primary Notes to fulfill its interest
obligations pursuant to the terms of the Primary Notes. The Secondary Notes also
bear interest at the rate of 12%, payable-in-kind semi-annually and contain the
same features as the Primary Notes, including a maturity date of January 2001.
Warrants to purchase 1,870,000 shares of the Company's common stock were
issued as part of this private placement with an exercise price of $3.00 per
share and an expiration date of January 2003. The warrants issued had a fair
value of approximately $1.87 per warrant at the time of issuance using the
Black-Scholes pricing model. The aggregate fair value of these warrants of
approximately $3,500,000 has been reflected as additional consideration for the
convertible notes, recorded as a discount on the debt and accreted as interest
expense to be amortized over the life of the convertible notes which is three
years.
39
<PAGE> 40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
During 1998, one of the notes was converted into 133,333 shares of common
stock and a portion of the warrants associated with this note was converted into
10,000 shares of common stock. As of December 31, 1998, the noteholders and
warrantholders had the options to convert 3,169,164 shares and 1,860,000 shares,
respectively. During 1998, the Company recorded approximately $1,905,000 as
non-cash interest expense and $1,089,000 as interest expense from the 1998
Notes.
The Company also leases certain equipment under noncancellable capital
leases. The cost of equipment under capital leases was $103,000 and accumulated
amortization was $34,000 at December 31, 1998.
The following table summarized information about long-term debt balances as
of December 31, as follows:
<TABLE>
<CAPTION>
1998 1997
------- -------
(IN THOUSANDS)
<S> <C> <C>
1997 5% convertible notes................................... $ -- $ 4,132
1998 12% convertible notes (including secondary notes)...... 10,638 --
Unamortized discount relating to stock warrants............. (2,385) (772)
Conversion to common shares................................. (400) (2,602)
Accrued interest............................................ 531 155
Other....................................................... 49 63
$ 8,433 $ 976
======= =======
Less: current portion of long-term debt..................... (730) (31)
------- -------
$ 7,703 $ 945
======= =======
</TABLE>
5. STOCKHOLDERS' EQUITY
Common Stock
In September 1996, the Company completed a private placement of 2,333,412
shares of common stock. In connection with the private placement, the placement
agent received warrants to purchase 116,721 shares of common stock with an
exercise price of $1.0625 per share, which were exercised in full during 1998.
In March 1997, the Company completed a private placement of convertible
notes with warrants. In connection with this private placement, the placement
agent received warrants to purchase 230,756 shares of common stock at an
exercise price of $1.00 per share and expiration dates of February and March
2002. In addition, the notes were convertible into 4,615,143 shares and the
warrants attached to the notes were convertible into 2,307,572 shares with an
exercise price of $1.00 per share and an expiration date of February and March
2002. The Company also issued 200,000 warrants to consultants and 76,000
warrants to members of its Scientific Advisory Board in November 1997 to
purchase shares of common stock at exercise prices ranging from $1.00 to $3.60
per share. These warrants terminate in November 2002. During 1998, 5,000 shares
were exercised. At December 31, 1998, 271,000 shares remained to be exercised.
Certain of the 1997 Notes were converted into 3,833,000 shares and certain
warrants were converted into 1,061,755 shares of common stock. As of December
31, 1998, the noteholders and warrantholders had the options to convert 782,143
shares and 1,476,573 shares, respectively. The principal balance of the 1997
Notes was approximately $684,000 and the accrued interest of approximately
$77,000 at December 31, 1998. These amounts were recorded as short-term and
accrued liabilities on the balance sheet at December 31, 1998 and were fully
converted into common stock in March 1999.
In January 1998, the Company completed a private placement of convertible
notes with warrants, an aggregate gross principal amount of approximately
$9,350,000. The notes are convertible into 3,116,667 shares of common stock and
the warrants are convertible into 1,870,000 shares of common stock with an
exercise
40
<PAGE> 41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
price of $3.00 and an expiration date of January 2003. During 1998, one
noteholder converted one of the notes into 133,333 common shares and converted
certain warrants into 10,000 common shares. On July 15, 1998, accrued interest
from the 1998 Notes was converted into Secondary Notes for 185,830 common
shares. As of December 31, 1998, there remained warrants outstanding and
convertible into 1,860,000 common shares and 3,169,164 shares convertible from
the notes. The Company also issued 440,000 warrants to consultants in 1998 to
purchase shares of common stock at exercise prices ranging from $1.25 to $4.375
per share. These warrants terminate in 2003. As of December 31, 1998, 140,000
shares were exercised and 300,000 shares remained to be exercised.
As of December 31, 1998, there were warrants outstanding to purchase
3,970,073 shares of common stock, which include 1,860,000 warrants from the 1998
Notes.
On December 4, 1998, the Company completed a private placement of
approximately $11,800,000 of its shares of common stock. The subscription price
was $3.50 per share, which represents a 20% discount from the average of the
closing sale price of the Company's common stock, as reported on the Nasdaq
National Market System, on each of the last ten consecutive Nasdaq National
Market System trading days in October 1998. Of the total proceeds, $5,000,000
from the 1998 Equity Offering was received in the form of promissory notes due
on March 15, 1999 bearing interest at a rate of 9% per annum. Of the $5,000,000
in promissory notes, $1,000,000 is currently outstanding and has not been
repaid.
Total deferred compensation balance at December 31, 1997 was approximately
$272,000. During 1998, the account balance was increased by approximately
$676,000 from the issuance of warrants which were fully amortized by the end of
1998. In addition, approximately $228,000 was expensed in 1998. The account
balance was approximately $44,000 at December 31, 1998.
Stock Option Plan
In 1988, the Company adopted the 1988 Stock Option Plan (the "1988 Plan")
under which employees, directors and consultants may be granted incentive or
nonstatutory stock options. Under the 1988 Plan, incentive stock options must be
granted at an exercise price of not less than the fair market value of the
common stock at the date of grant, except that options granted to stockholders
owning greater than 10 percent of the total voting power of all classes of stock
of the Company must have an exercise price of not less than 110 percent of the
fair market value at the date of grant. Nonstatutory options must be at least 85
percent of fair market value at the date of grant. Options granted generally
provide that 25 percent of the shares subject thereto become exercisable one
year after the date of grant and 1/36 of the remaining shares subject to the
option become exercisable each month thereafter. The 1988 Plan expired in
November 1998.
In 1997, the Company adopted the 1997 Stock Option Plan (the "1997 Plan")
under which employees, directors and consultants may be granted incentive or
nonstatutory stock options. Under the Plan, incentive stock options must be
granted at an exercise price of not less than the fair market value of the
common stock at the date of grant, except that options granted to shareholders
owning greater than 10 percent of the total voting power of all classes of stock
of the Company must have an exercise price of not less than 110 percent of the
fair market value at the date of grant. Nonstatutory options must be at least 85
percent of fair market value at the date of grant. Options granted generally
provide that 1/48 of the shares subject to the option become exercisable each
month after the grant. The 1997 Plan expires in 2007. Both the 1988 and 1997
Stock Option Plans have a maximum term of 10 years.
41
<PAGE> 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The fair value of each option grant is estimated at the date of the grant
using the Black-Scholes pricing model with the following weighted average
assumptions for grants in 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Risk-free interest rate............................ 5.03% 6.15% 5.70%
Expected life...................................... 2.5 years 4.8 years 4.8 years
Volatility......................................... 101% 95.5% 95.5%
Dividend yield..................................... -- -- --
</TABLE>
A summary of the Company's option as of December 31, 1998, 1997 and 1996
and changes during the year ending on those dates are as follows:
<TABLE>
<CAPTION>
OUTSTANDING OPTIONS
--------------------------------------------------------------
SHARES
AVAILABLE FOR WEIGHTED AVERAGE
GRANT SHARES SHARE PRICE EXERCISE PRICE
------------- --------- ------------- ----------------
<S> <C> <C> <C> <C>
BALANCE, 12/31/1995............ 1,627,964 1,432,664 $0.91 - $2.50 $1.06
Reserved....................... --
Granted........................ (1,711,000) 1,711,000 $1.03 - $2.87 $1.10
Cancelled...................... 379,974 (379,974) $0.91 - $1.00 $0.99
Exercised...................... -- (251,252) $1.00 - $1.25 $1.02
---------- --------- ------------- -----
BALANCE, 12/31/1996............ 296,938 2,512,438 $0.91 - $2.87 $1.09
Reserved....................... 3,000,000
Granted........................ (2,954,300) 2,954,300 $1.00 - $4.44 $2.69
Cancelled...................... 858,370 (858,370) $0.75 - $2.87 $1.18
Exercised...................... -- (247,913) $0.75 - $1.06 $1.01
---------- --------- ------------- -----
BALANCE, 12/31/1997............ 1,201,008 4,360,455 $1.00 - $4.44 $2.16
Reserved....................... --
Granted........................ (1,080,500) 1,080,500 $3.00 - $9.34 $7.47
Cancelled...................... 13,987 (13,987) $1.00 - $4.44 $3.47
Expired........................ (68,332)
Exercised...................... -- (769,002) $0.75 - $4.38 $1.37
---------- --------- ------------- -----
BALANCE, 12/31/ 1998........... 66,163 4,657,966 $1.00 - $9.34 $3.50
</TABLE>
As of December 31, 1998 and 1997, options to purchase 1,872,292 and
1,621,269 shares, respectively, were vested and of those, 1,285,636 and
1,547,571 shares, respectively, were immediately exercisable. The weighted
average fair market value of those options granted in 1998, 1997 and 1996 was
$2.54, $2.08 and $0.74, respectively.
42
<PAGE> 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The following table summarizes information about stock options outstanding
at December 31, 1998:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------- -------------------------------------------
WEIGHTED WEIGHTED
AVERAGE WEIGHTED AVERAGE
REMAINING AVERAGE REMAINING WEIGHTED
NUMBER CONTRACTUAL EXERCISE NUMBER CONTRACTUAL AVERAGE
OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE LIFE (YEARS) EXERCISE PRICE
----------- ------------ -------- ----------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
$1.00 - $2.00........ 2,108,000 7.8 $1.14 1,105,968 7.3 $1.07
$2.01 - $4.00........ 1,440,466 8.6 $3.89 130,075 8.8 $3.95
$4.01 - $6.00........ 106,000 9.5 $4.21 26,075 9.1 $4.15
$6.01 - $8.00........ 928,500 9.5 $7.61 12,269 9.4 $7.27
$8.01 - $9.34........ 75,000 9.5 $9.17 11,249 9.5 $9.15
--------- --- ----- --------- --- -----
Total...... 4,657,966 8.4 $3.48 1,285,636 7.5 $1.55
========= === ===== ========= === =====
</TABLE>
Employee Stock Purchase Plan
In June 1992, the Company adopted the 1992 Employee Stock Purchase Plan
under which 200,000 shares have been reserved for issuance. Eligible employees
may purchase common stock at 85 percent of the lower of the closing price of the
stock on the offering date or the exercise date determined by the Board of
Directors. Annual purchases are limited to 10 percent of each employee's
compensation and 2,000 shares per employee. There were 69,521 and 59,023 shares
issued under the plan as of December 31, 1998 and 1997, respectively.
Fair market value for the purchase rights issued under the Purchase Plan is
determined under the Black-Scholes valuation model using the following
assumptions for 1998, 1997 and 1996:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Risk-free Interest Rates.......................... 5.03% 6.15% 5.70%
Expected Life..................................... 6 months 6 months 6 months
Volatility........................................ 101% 95.5% 95.5%
Dividend Yield.................................... -- -- --
</TABLE>
The weighted average fair market value of those purchase rights granted in
1998, 1997 and 1996 was $1.07, $0.76 and $0.96, respectively.
The Company has adopted the disclosure-only provisions of the Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based
Compensation." Had compensation cost for the Stock Plans been determined based
on the fair market value at the grant date for awards in 1997, 1996 and 1995
consistent with the provisions of SFAS No. 123, the Company's net loss and net
loss per share for the years ended December 31, 1998, 1997 and 1996 would have
been increased as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------- ------- -------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Net loss -- as reported.............................. $(17,821) $(6,618) $(5,968)
Net loss -- pro forma................................ (20,625) (7,322) (6,390)
Net loss per share -- as reported.................... (0.52) (0.23) (0.23)
Net loss per share -- pro forma...................... (0.60) (0.26) (0.24)
</TABLE>
43
<PAGE> 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
Supplemental Statement of Cash Flows Information
<TABLE>
<CAPTION>
1998 1997 1996
----- ---- ----
(IN THOUSANDS)
<S> <C> <C> <C>
Net cash paid (received) during the year for:
Interest.................................................. $(284) $13 $5
Income taxes.............................................. 5 6 9
</TABLE>
Supplemental Schedule of Noncash Investing and Financing Activities
<TABLE>
<CAPTION>
1998 1997 1996
------- ------ ----
(IN THOUSANDS)
<S> <C> <C> <C>
Promissory notes issued in connection with 12/98
offering................................................ $(5,000) -- --
Exercises of warrants and stock options................... $ (794) -- --
Conversion of notes payable to common stock............... $ 1,222 $2,602 --
Issuance of notes for accrued interest
97 Notes................................................ 3 -- --
98 Notes................................................ 557 -- --
</TABLE>
6. EMPLOYEE BENEFIT PLAN
During 1993, the Company established a 401(k) tax-deferred savings plan
under which all employees meeting certain age and service requirements may
contribute up 15% of their eligible compensation (up to a maximum allowed under
IRS rules). Contributions may be made by the Company at the discretion of the
Board of Directors. Contributions by the Company amounted to $16,000, $20,000
and $24,000 in 1998, 1997 and 1996, respectively.
7. SALE OF DENTAL ASSETS
In June 1997, the Company completed the sale of the Company's assets
associated with its dental laser, air abrasive and composite curing systems (the
"Dental Assets") to Lares Research. The purchase price paid for the Dental
Assets was $5,500,000, consisting of $4,000,000 in cash paid at closing and
$1,500,000 in the form of a promissory note, bearing interest at 8% per annum,
with installments of $1,000,000 of principal plus accrued interest and $500,000
of principal plus accrued interest, due in June 2000 and June 2001, respectively
(the "Lares Note"). Although the Company anticipates collecting interest and
principal on the Lares Note, collection is not reasonably assured due to the
subordination of the Lares Note to Lares' bank and the Company intends to
recognize proceeds from the sale and interest on the note as cash is received.
The gain on sale of the Dental Assets is comprised as follows:
<TABLE>
<CAPTION>
(IN THOUSANDS)
--------------
<S> <C>
Cash proceeds from the sale of the dental assets............ $ 4,000
Less: Inventory and equipment sold.......................... (1,498)
ADT transfer fee.......................................... (275)
Transaction fees.......................................... (237)
Other costs............................................... (250)
-------
Gain on sale of dental assets............................. $ 1,740
=======
</TABLE>
44
<PAGE> 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 1998
The Company sold the Dental Assets as of June 1997 and as a consequence,
had effectively no revenues or earnings from the Dental Assets during the second
half of 1997. Approximately $203,000 of the estimated costs remain unpaid as of
December 31, 1998. On a pro-forma basis, the Company had the following revenues
and earnings from the dental business during the first half of 1997 and 1996,
including the gain on sale of the Dental Assets of $1,740,000 in 1997:
<TABLE>
<CAPTION>
1997 1996
------ -------
(IN THOUSANDS)
<S> <C> <C>
Revenues from dental business............................... $1,968 $ 5,514
Loss from dental business................................... (11) (2,504)
</TABLE>
Revenues from the dental business were $1,968,000 through June 1997. Cost
of revenues were approximately $1,738,000 and operating expenses through June
1997 were $1,980,000. Interest expense and interest income were $11,000 and
$10,000, respectively, through June 1997. The operating loss from the dental
business and the gain on the sale of the dental business were $1,750,000 and
$1,740,000, respectively, in 1997.
Substantially all of the Company's resources to-date were being derived
from the dental business. The Company is not expecting significant revenues from
ophthalmic sales until the FDA approves the LTK System for sale in the United
States.
45
<PAGE> 46
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
ADDITIONS
CHARGED
BALANCE AT TO COSTS BALANCE AT
BEGINNING AND END OF
OF PERIOD EXPENSES DEDUCTIONS OTHER PERIOD
---------- --------- ---------- ----- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1996
Allowance for uncollectible accounts...... $ 25 $ 115 $ -- $-- $ 140
Allowance for inventory................... $ 468 $ -- $(118) $-- $ 350
Year ended December 31, 1997
Allowance for uncollectible accounts...... $ 140 $ 176 $(232) $-- $ 84
Allowance for inventory................... $ 350 $ 397 $(100) $-- $ 647
Allowance for uncollectible notes......... $ -- $1,500 $ -- $-- $1,500
Year ended December 31, 1998
Allowance for uncollectible accounts...... $ 84 $ -- $ (73) $-- $ 11
Allowance for inventory................... $ 647 $ 71 $(532) $-- $ 186
Allowance for uncollectible notes......... $1,500 $ -- $ -- $-- $1,500
</TABLE>
46
<PAGE> 47
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the city of Fremont, State of
California, on the 16th day of June, 1999.
Sunrise Technologies International,
Inc.
By: /s/ C. RUSSELL TRENARY, III
------------------------------------
C. Russell Trenary, III
President and Chief Executive
Officer
POWER OF ATTORNEY
Each of the officers and directors of Sunrise Technologies International,
Inc. whose signature appears below hereby constitutes and appoints C. Russell
Trenary, III and Eric M. Fogel, and each of them, their true and lawful
attorneys-in-fact and agents, with full power and substitution, each with power
to act alone, to sign and execute on behalf of the undersigned any amendment or
amendments to this Report on Form 10-K, and to perform any acts necessary to be
done in order to file such amendment, and each of the undersigned does hereby
ratify and confirm all that such attorneys-in-fact and agents, or their or his
substitutes, shall do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ C. RUSSELL TRENARY, III President and Chief Executive June 16, 1999
- ------------------------------------------------ Officer
/s/ PETER E. JANSEN Vice President, Finance and Chief June 16, 1999
- ------------------------------------------------ Financial Officer (Principal
Financial and Accounting Officer)
/s/ JOSEPH D. KOENIG Director and Chairman of the Board June 16, 1999
- ------------------------------------------------
/s/ R. DALE BOWERMAN Director June 16, 1999
- ------------------------------------------------
/s/ MICHAEL S. MCFARLAND Director June 16, 1999
- ------------------------------------------------
</TABLE>
47
<PAGE> 48
INDEPENDENT ACCOUNTANTS' REPORT ON SCHEDULE
Our report on the consolidated financial statements of Sunrise Technologies
International, Inc. is included on page 27 of this Form 10-K/A. In connection
with our audits of such financial statements, we have also audited the related
financial statement schedule for the years ended December 31, 1998 and 1997
listed in the index of this Form 10-K/A.
In our opinion, the financial statement schedule referred to above, when
considered in relation to the basic financial statements taken as a whole,
presents fairly, in all material respects, the information required to be
included therein.
/s/ PRICEWATERHOUSECOOPERS LLP
San Jose, California
February 19, 1999
48
<PAGE> 49
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
2.1 Asset Purchase Agreement dated as of March 26, 1997, by and
between the Company and Lares Research, a California
corporation(6)
3.1 Certificate of Incorporation, as amended(1)
3.2 Bylaws(1)
4 Instruments Defining the Rights of Security Holders
4.1 Form of 5% Convertible Notes due 1999(7)
4.2 Form of Security Agreement relating to 5% Convertible Notes
due 1999(7)
4.3 Form of Registration Rights Agreement(7)
4.4 Form of Warrant issued to Pennsylvania Merchant Group(4)
4.5 Form of Rights Agreement, dated as of October 24, 1997,
between the Company and ChaseMellon Shareholder Services,
L.L.C., as rights agent(8)
4.6 Form of 12% Subordinated Pay-In-Kind Note Due 2001(9)
4.7 Form of Registration Rights Agreement(9)
4.8 Form of 5% Convertible Subordinated Pay-In-Kind Note due
2001(13)
4.9 Form of Warrant for the Purchase of Common Stock(13)
4.10 Form of Registration Rights Agreement(13)
10.1 Lease Agreement with Bayside Spinnaker Partners III, as
lessor, for the lease of facilities at 47257 Fremont
Boulevard, Fremont, California, dated July 16, 1991(2)
10.2 Patent License Agreement between the Company and Patlex
Corporation dated January 1, 1990(3)
10.3 Agreement between the Company and the University of Miami,
Department of Ophthalmology, dated October 28, 1991(2)
10.4 Joint Development and Exclusive Manufacturing Agreement
dated April 17, 1993 between the Company and Danville
Engineering, Inc.(1)
10.5 Settlement Agreement between the Company and American Dental
Laser, Inc., dated February 4, 1993 (confidential treatment
has previously been granted for portions of this exhibit)(4)
10.6 License Agreement between the Company and American Dental
Laser, Inc., dated February 4, 1993 (confidential treatment
has previously been granted for portions of this exhibit)(4)
10.7 Settlement Agreement between the Company and American Dental
Technologies, dated July 30, 1996
*10.8 Form of Indemnification Agreement between the Company and
each of its officers and directors(3)
*10.9 1988 Stock Option Plan, as amended(5)
*10.10 Employment Agreement, entered into between the Company and
Joseph W. Shaffer, dated April 5, 1989(5)
10.11 Form of U.S. Note and Warrant Purchase Agreement relating to
the Regulation D private placement of 5% convertible notes
due 1999 and warrants in February and March 1997
10.12 Form of Offshore Note and Warrant Purchase Agreement
relating to the Regulation S private placement of 5%
convertible notes due 1999 and warrants in March 1997
*10.13 Form of Change of Control Agreement by and between the
Company and its President and Chief Executive Officer(8)
</TABLE>
<PAGE> 50
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
<S> <C>
*10.14 Form of Change of Control Agreement by and between the
Company and its executive officers (other than the President
and Chief Executive Officer)(8)
*10.15 Form of Indemnification Agreement by and between the Company
and its executive officers(8)
10.16 Form of U.S. Note and Warrant Purchase Agreement related to
the Regulation D private placement of 12% Convertible
Subordinated Pay-In-Kind Notes Due 2001 and accompanying
Warrants in January 1998(9)
*10.17 Form of Amended and Restated Change of Control Agreement by
and between the Company and its President and Chief
Executive Officer(11)
*10.18 Form of Amended and Restated Change of Control Agreement by
and between the Company and its executive officers (other
than the President and Chief Executive Officer)(11)
10.19 Lease Agreement with Bayside Spinnaker Partners III, as
lessor, for the lease of facilities at 47265 Fremont
Boulevard, Fremont, California, dated January 23, 1998(10)
10.20 Sublease between Avant! Corporation, as sub-sublandlord, the
Company, as sub-subtenant, Cirrus Logic, Inc., as
sublandlord, Avant! Corporation, as subtenant, Renco
Investment Company, as landlord, and Cirrus Logic, Inc., as
tenant for the lease of facilities at 3400 West Warren
Avenue, Fremont, California(12)
10.21 Form of Note and Warrant Purchase Agreement(13)
*10.22 The 1999 Long-Term Equity Compensation Plan
21.1 Subsidiaries of the Company
22 Power of Attorney (included on the signature pages to this
Form 10-K)
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
23.2 Consent of Ernst & Young LLP, former Independent Auditors
27 Financial Data Schedule
</TABLE>
- ---------------
* Compensatory plan or management contract
(1) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1994 (File No. 0-17816)
(2) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1991 (File No. 0-17816)
(3) Incorporated by reference from the registrant's Registration Statement on
Form S-1, as amended (File No. 33-36768)
(4) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1992 (File No. 0-17816)
(5) Incorporated by reference from the registrant's Registration Statement on
Form S-18, as amended (File No. 33-27029-LA)
(6) Incorporated by reference from the registrant's Annual Report on Form 10-K
for the year ended December 31, 1996 (File No. 1-10428)
(7) Incorporated by reference from the registrant's Current Report on Form 8-K
dated March 12, 1997 (File No. 0-17816)
(8) Incorporated by reference from the registrant's Current Report on Form 8-K
dated October 24, 1997 (File No. 0-17816)
(9) Incorporated by reference from the registrant's Current Report on Form 8-K
dated January 26, 1998 (File No. 0-17816)
(10) Incorporated by reference from the registrant's Annual Report of Form 10-K
for the year ended December 31, 1997 (File No. 0-17816)
<PAGE> 51
(11) Incorporated by reference from the registrant's Current Report on Form 8-K
dated May 8, 1998 (File No. 0-17816)
(12) Incorporated by reference from the registrant's Registration Statement on
Form S-2 dated September 29, 1998 (File No. 333-64975)
(13) Incorporated by reference from the registrant's Current Report on Form 8-K
dated January 1, 1999 (File No. 1-10428)
(14) Incorporated by reference from the registrant's Registration Statement on
Form S-8 dated March 2, 1999 (File No. 333-73211)
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statement of
Sunrise Technologies International, Inc. on Form S-8 (File No. 33-27029) of our
reports dated February 19, 1999, on our audits of the consolidated financial
statements and the financial statement schedule of Sunrise Technologies
International, Inc. as of December 31, 1998 and 1997, and for the years ended
December 31, 1998 and 1997, which reports are included in this Form 10-K/A.
PricewaterhouseCoopers LLP
San Jose, California
June 16, 1999
<PAGE> 1
EXHIBIT 23.2
SUNRISE TECHNOLOGIES INTERNATIONAL, INC.
CONSENT OF ERNST & YOUNG LLP, FORMER INDEPENDENT AUDITORS
We consent to the incorporation by reference in Registration Statement
(Form S-8, No. 333-73211), of our report dated March 10, 1997 with respect to
the consolidated statements of operations, stockholders equity, and cash flows
of Sunrise Technologies International, Inc. included in the Annual Report (Form
10-K) for the year ended December 31, 1996.
/s/ Ernst & Young LLP
Palo Alto, California
June 16, 1999
