<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended January 2, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21667
PHOTOELECTRON CORPORATION
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3035323
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
5 FORBES ROAD, LEXINGTON, MASSACHUSETTS 02421
(Address of principal executive offices) (Zip Code)
Registrant's telephone number including area code: (781) 861-2069
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock--$.01 Par Value
(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 in response 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. [ ]
As of March 29, 1999, there were 7,740,454 outstanding shares of Common Stock.
The aggregate market value of shares of Common Stock held by non-affiliates of
the registrant on that date, based on the last sale price for such stock on that
date as reported by Nasdaq, was $15,120,809.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Definitive Proxy Statement for the Special Meeting in lieu of
the Annual Meeting of Stockholders of the Company on May 25, 1999 are
incorporated by reference into Part III of this Report.
<PAGE>
PHOTOELECTRON CORPORATION
1998 ANNUAL REPORT ON FORM 10-K
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Item Page
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Number Number
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<S> <C>
1. Business ................................................................................. 3
2. Properties ............................................................................... 19
3. Legal Proceedings ........................................................................ 19
4. Submission of Matters to a Vote of Security Holders ...................................... 19
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters .................... 20
6. Selected Financial Data .................................................................. 20
7. Management's Discussion and Analysis of Financial Condition and Results of Operation ..... 21
8. Financial Statements and Supplementary Data .............................................. 26
9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure ..... 26
PART III
10. Directors and Executive Officers of the Registrant ...................................... 26
11. Executive Compensation .................................................................. 26
12. Security Ownership of Certain Beneficial Owners and Management .......................... 26
13. Certain Relationships and Related Transactions .......................................... 26
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K ........................ 26
</TABLE>
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Cautionary Statement Regarding Forward Looking Statements
Certain statements contained in this report, including, without limitation,
statements containing the words "expects," "anticipates," "believes," and words
of similar import, constitute "forward loking statements" within the meaning of
the Private Securities Litigation Reform Act of 1995. These forward looking
statements are subject to various risks and uncertainties, including, without
limitation, those referred to in this Report, that could cause actual future
results and events to differ materially from those currently anticipated.
Readers are cautioned not to place undue reliance on these forward looking
statements.
PART I
Item 1. Business.
Photoelectron Corporation (the "Company") does not expect to be able to
generate sufficient revenue in the near future for it to be able to continue
operations without raising additional capital. Accordingly, the Company is
currently considering alternatives by which to raise additional capital. Should
the necessary funds not be available to the Company on acceptable terms, there
is substantial doubt that the Company will be able to continue as a going
concern.
Overview
The Company is the manufacturer of a miniature x-ray device called the
Photon Radiosurgery System (the "PRS"). The PRS produces x-rays at the tip of a
long, needle-like, probe that can be directly implanted into a tumor, enabling
treatment from inside the tumor. Using this approach, the soft x-rays produced
by the PRS are almost completely absorbed within the target tissue, minimizing
damage to surrounding tissues. The PRS is being used to treat an ever-increasing
range of clinical conditions, which so far include brain, bowel and
gynaecological tumors, breast cancer and skin lesions. Clinical trials using the
system are in place in the United States (the "U.S."), Europe and Asia under the
guidance of world-renowned physicians.
The latest version of the PRS is the PRS400, a powerful microprocessor
based system that precisely controls the performance characteristics of the x-
ray source. The PRS400 includes a full range of quality assurance tools to
confirm the uniformity and calibration of the x-ray source prior to its use. As
treatment progresses the rate of radiation delivery is monitored using integral
radiation detectors. The PRS400 therefore represents a complete turn-key
solution. The Company believes that no other x-ray system can match this
intense, geometrically precise and highly localized method of radiation therapy.
Recent system developments have further increased the potential clinical
applications of the PRS. The Company has developed spherical `applicators'
which surround the x-ray source during treatment. With this new development, the
x-ray source and applicator may be placed inside a tumor cavity after a tumor
has been removed. An intense but localized radiation dose may then be delivered
to the tumor bed in order to reduce the likelihood of local recurrence of the
disease. This approach has so far been used to treat patients with breast and
bowel tumors and new clinical applications are under consideration.
To date, the Company has focused its clinical and commercial efforts
primarily on the treatment of brain tumors. The Company is committed to
increasing its range of clinical applications. The new applications of the PRS
include the treatment of breast, skin, bowel, kidney, liver, and gynecological
tumors. PRS-based treatments for some of these disorders have already taken
place. The method of treatment will depend on the application and the Company
intends to provide complete, packaged solutions for as many treatment categories
as possible. The Company expects that the four basic PRS treatment methods will
be: (i) interstitial irradiation where the x-ray source is directly inserted
into a tumor to irradiate it from the inside; (ii) intracavity irradiation where
the x-ray source is inserted into a body cavity; (iii) intraoperative
irradiation using the x-ray source inside an applicator placed in a tumour
cavity; and (iv) superficial treatments using conical applicators that direct
the radiation towards the skin or internal tissue surface. The Company is also
in the progress of developing highly precise micro-collimation systems that may
be directed through the eye to treat age-related macular degeneration.
In 1998, the United States Food and Drug Administration (the "FDA") granted
the Company clearance under Section 510(k) of the Federal Food, Drug and
Cosmetic Act, as amended (the "FDC Act") to market the PRS400 for use in the
treatment of intracranial (brain) tumors. Additionally in 1998, the Company
demonstrated to the British Standards Institution, an independent auditing
organization recognized by the European Community ("EC") regulatory authorities,
that it complies with applicable standards for quality management system (BS EN
ISO 9001:1994) and for product assessment (Annex II, Section 3, Medical Device
Directives) of its medical products. As such, the Company is able to affix the
CE Mark to the PRS400 enabling commercial distribution of the product throughout
the EC and cooperating countries.
Concurrently, as indicated above, the Company expanded its clinical
programs to include other tumor sites, and expects
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results from these trials in the near future to enable it to gain general FDA
market clearance for treatment of a broad range of clinical applications. Trials
on malignancies in the breast, skin, kidney, liver and colorectal region are
currently underway in medical centers worldwide. A broad array of intraoperative
and surface applicators, as well as associated fixtures to support new and
expanding applications of the technology, are currently in development.
During 1998, the Company exhibited the PRS400 at professional trade shows,
workshops, and focus groups. The Company's Vice President of Sales and Marketing
expanded the Company's direct sales force by hiring two people experienced in
selling radiosurgery products. The Company plans to expand its distribution
network to cover the United States and Europe. The Company and Toshiba Medical
Systems Company, Ltd. ("Toshiba") have entered into agreements relating to
performance of clinical trials, and to future product distribution arrangements
in Japan.
In addition to the technical advantages offered by the PRS400, the Company
believes that by reducing capital expenditures, shortening hospital stays, and
decreasing the number of treatments, the PRS400 can provide significant cost
savings to hospitals and third party payors. In order to make the PRS400 widely
available to major critical care hospitals, university teaching hospitals, and
progressive community hospitals, the Company is offering flexible leasing and
rental packages through the cooperative relationship with major medical
equipment leasing organization. Moreover, in 1998, the Company instituted
comprehensive warranty and equipment maintenance programs and hired an
experienced field service manager. In addition to the turn-key PRS400, with its
full complement of therapeutic and calibration components, a less expensive
entry, or "platform," system was introduced. The Company believes that the
concept of the platform system will facilitate early sales, by providing
hospitals as economical means of building its use of the equipment. The modular
configuration of the PRS400 allows expansion and upgrade of the platform system
as dictated by a hospital's increasing needs.
The most common form of treatment of cancerous tumors is by invasive
surgery. The Company believes that the PRS provides an attractive, minimally
invasive alternative to surgery, resulting in significantly less patient trauma,
shorter hospital stays, and lower treatment costs than surgery. The PRS can be
applied after performing a biopsy and, when desirable, use of the PRS can be
coupled with surgical procedures.
Next to surgery, radiation therapy is the most common modality of treating
cancer. The majority of radiation treatments are administered using external
beams of x-rays. With this approach, radiation must pass through, and may
potentially damage, healthy tissue before reaching the tumor. The PRS delivers
radiation directly from inside the tumor site, minimizing the risk of damage to
surrounding tissues.
Another established form of treatment, called brachytherapy, delivers
radiation directly to a tumor site by the insertion of radioactive isotopes. In
comparison to this form of treatment, the Company believes that the PRS offers a
greater ability to control and localize low energy radiation doses, and avoids
the costs and risks associated with the storage, handling, and disposal of
radioactive materials. The Company believes that the PRS also offers significant
advantages over other forms of therapy, such as the destruction of cancerous
cells by heating, cooling, or by use of photodynamic laser light.
The Company holds twelve U.S. patents and one U.S. patent applications
relating to the PRS or its constituent or ancillary components. The Company has
also obtained four patents and filed thirty-eight patent applications in
selected foreign countries.
The Company was formed in 1989 as a joint venture between Thermo Electron
Corporation ("Thermo Electron") and an investment entity organized by Peter M.
Nomikos, the Company's Chairman of the Board, Chief Executive Officer, and
Treasurer. Mr. Nomikos co-founded Thermo Electron with George N. Hatsopoulos,
Ph.D., a director of the Company.
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Specific Applications of the PRS
To date, the Company has focused its clinical and commercial efforts on the
treatment of brain tumors, either interstitially or as an adjunct to surgery, to
irradiate parts of the tumor surgically inaccessible or to provide a post-
surgical boost to the tumor bed to eliminate any remaining cancerous cells. In
addition to brain tumors, the Company is currently conducting clinical trials of
the PRS in treating breast, colo-rectal and skin tumors and plans to conduct
clinical trials in treating kidney liver, and other tumors after obtaining
required approvals. The use of the PRS for any such additional treatments will
require the Company to complete clinical testing and to procure additional
regulatory clearances, and, therefore, the U.S. commercialization of the PRS for
such treatments cannot reasonably be expected to occur in the foreseeable
future. Depending on the nature and location of the cancerous tumor, these
additional treatment applications may require the use of separate components or
accessories (a number of which are currently in development) in connection with
the PRS, but the Company believes that the basic core technology of the PRS will
not need to be significantly modified. The Company will consider the use of the
PRS for other potential applications on an ongoing basis.
Brain Tumors
The brain is a leading site for the formation of metastatic, or secondary,
tumors. Aggressive treatment of metastatic brain tumors traditionally has been
limited. Patients with these tumors typically have received a fractionated
series of external beam whole brain radiation, which, because of the cumulative
effect on healthy tissue through which it passes, cannot be used to treat
subsequent tumors which frequently reoccur. Because of the particularly
sensitive nature of the brain and its surrounding critical organs and
structures, such as the optic nerves, damage from external radiation can
severely harm patients. The Company believes the PRS is particularly well-suited
for this application because of its targeted, low-energy approach. In addition,
although external beam radiotherapy is not recommended for young children whose
brains are still developing, the Company believes that highly confined
interstitial irradiation with the PRS may reduce the risk of radiotherapy to
maturing brains.
Clinical studies to evaluate the safety and effectiveness of the PRS for
treatment of brain tumors began in 1992 under an Investigational Device
Exemption ("IDE") approved by the FDA. Initially, a single-center feasibility
study was conducted at the Massachusetts General Hospital in Boston,
Massachusetts. This study demonstrated the feasibility of treating brain tumors
with the PRS in a simple, rapid, minimally-invasive procedure that greatly
reduced the risk of complications and the recovery from surgery. Successful
control of the tumor was obtained in 79% of the patients treated who had
cancerous brain tumors. In patients whose tumor was not controlled, the
recurrence appeared at the periphery of the tumor. The Company believes that the
reoccurrence of the tumor was most likely due to the fact that the patients in
this study were administered especially cautious amounts of radiation or to the
difficulty in establishing the true boundaries of a tumor.
In 1994, with FDA approval, the Company began multi-center clinical studies
of PRS treatment of both newly diagnosed and recurrent metastatic brain tumors.
These parallel studies involved clinical sites in the U.S. and a site in London,
England. Control of the tumor was achieved at rates approaching 90% with minimal
side effects or complications. As physicians gained experience using the PRS,
they enhanced their ability to deliver radiation strictly to the tumor, thus
protecting nearby critical structures from damage. Since 1995 clinical studies
have also been performed in Japan, Germany, and Italy. Physicians in those
countries have been exploring PRS treatment in a broader range of patients than
was allowed in the FDA-approved studies. Much of their focus has been treating
adult patients with primary brain tumors, determining the role for PRS treatment
in children, and using the PRS as adjunct to surgical removal of the tumor.
Treatments in Germany have demonstrated that the PRS, besides providing control
of the tumor, also achieves rapid resolution of symptoms and side effects
associated with metastatic tumors. Treatments in Japan have demonstrated that a
procedure using surgery combined with PRS treatment of the residual cancerous
tissue will be a prominent and beneficial use of the PRS. In June 1997 the
Company received a 510(k) clearance from the FDA for use of the PRS Model 3 to
treat all intracranial tumors and received a 510(k) clearance for the PRS400 in
July 1998.
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Breast Tumors
Breast cancer is a leading cause of cancer deaths in women in the United
States. Current conventional treatment methods for breast cancer include breast
conserving surgery, mastectomy, radiation, chemotherapy and hormone therapies
or, as often is the case, a combination of several of these methods.
The Company believes that the PRS could provide treatment for breast cancer
both interstitially (directly into the tumor) as a substitute for surgery and as
a post-surgical boost to the tumor bed after the tumor has been removed
surgically, with the goal of destroying any malignant cells remaining in the
tumor bed. In 1998, the Company initiated clinical trials in England to
ascertain the safety of the PRS for treatment of breast cancer. In one trial
currently in progress, the PRS is being tested as a means to irradiate early
breast cancer tumors interstitially immediately after their diagnosis by
stereotactic biopsy. Several hundred stereotactic breast imaging systems are
already in use in hospitals to allow precise targeting and biopsy of suspected
breast tumors. The PRS can be mounted in place of the biopsy needle in these
devices and introduced into the tumor in order to irradiate it from the inside
out. The Company believes that this procedure could develop into a substitute
for surgery in certain patients.
In a related trial in England, the PRS is currently being tested as a means
to provide an irradiative boost to the tumor bed immediately after surgical
excision of the tumor. Administering such a boost is a well established
treatment designed to reduce the possibility of tumor recurrence. Typically
performed late in the lengthy post-operative course of radiotherapy, targeting
the specific tumor site is problematic due to the length of time between surgery
and the irradiative boost, the change in medical personnel, and tissue
remodeling which occurs over time. Other perioperative techniques used to
administer a localized radiation boost to the breast are complex, time
consuming, and plagued by problems of transporting, handling, storing and
disposing of radioactive isotopes. The Company believes that the PRS offers the
opportunity to quickly and easily administer the localized boost
intraoperatively immediately after resection, thereby overcoming these
difficulties. The Company has developed for this intraoperative study treatment
applicators and a floor stand instrument holder to support the PRS's x-ray
probe. The concept of providing a localized radiative boost to the tumor bed or
surgical cavity following excision of a tumor has been extended to include PRS
treatment of patients with colo-rectal tumors. Immediately following removal of
the affected portion of the gastro-intestinal tract, the PRS is used to
irradiate an area within the pelvic bed of the patient to lessen the possibility
of tumor recurrence due to cancerous cells in adjacent areas remaining
untreated. The Company believes that the PRS offers an effective and especially
convenient means by which to administer such treatment.
Skin Tumors
Skin cancer is among the most frequently diagnosed forms of cancer. In many
cases, radiation treatment can destroy the cancer without the disfigurement
often caused by surgery. Currently, there are four primary methods of treatment
utilized for skin cancers. Surgery is the primary modality used in skin cancer
cases. The others are radiation therapy, electrodesiccation (in which tissue is
destroyed by heat), cryosurgery (in which tissue is destroyed by freezing), and
laser therapy for early skin cancer. The Company believes a significant number
of cases of skin cancers are amenable to treatment with the PRS either as an
alternative to present radiation therapies or as an adjunct to surgery.
For topical treatment of superficial tumors, the Company has developed an
x-ray "shielding cone," which is intended, when fitted onto the PRS's probe tip,
to restrict the area of x-ray exposure to the region of the tumor being treated.
In 1998, the Company initiated clinical trials of PRS treatment of non-melanoma
skin cancers, especially those in areas of the body that are visible (e.g.,
head, neck, extremities) or difficult to treat (e.g., mouth, nose, eyelids).
Types of tumors include squamous cell and basal cell carcinomas, which appear in
very large numbers of patients, especially in fair-skinned individuals, and
Karposi's sarcoma, which appear most often in patients with compromised immune
systems (e.g., AIDS, transplant recipients).
Other Potential Applications
Early in 1998, the Company initiated animal studies in collaboration with
physicians at Johns Hopkins University School of Medicine, Baltimore, Maryland
to characterize PRS treatment of kidney and liver tumors and to test specialized
accessory positioning equipment designed for use with the PRS.
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If these pre-clinical are successfully completed, the Company plans on seeking
approval to initiate human clinical trials.
In order to expedite clinical application of the PRS into treatment of
various types of tumors using interstitial, intracavitary, or topical delivery
of the radiative treatment, the Company is developing applications to the FDA
and other regulatory agencies to seek approval to use the PRS for the treatment
of various target lesions, as long as the lesion is suitable for treatment and
the patient meets defined selection criteria. These clinical trials are intended
to utilize the PRS in broader-based application in 1999 and to develop data to
support planned product marketing applications for "general use" labeling of the
PRS.
The Company prioritizes the types of tumor applications it explores based
on several factors. Such factors include, among other things, potential market
size, physician interest in trials, and available corporate resources.
Periodically, the Company reviews existing applications being pursued as well as
alternative applications. There can be no assurance that the applications
selected for study will lead to successful commercial applications of the PRS.
Accordingly, the application of the PRS to the treatment of various types of
tumors described above is subject to change. For example, the Company is
considering the applicability of the PRS for minimally invasive therapy for
lung, colon, rectal, pancreatic and nasopharyngeal cancers. For these other
cancers, fixturing devices will need to be developed, or existing fixturing
devices will need to be modified, for compatibility with the PRS. As it has
previously done with respect to stereotactic systems used in treating brain and
breast tumors, the Company intends to design its own devices, as well as pursue
collaborative relationships with other organizations in order to develop or
modify their devices, to ensure compatibility of the fixturing devices with the
PRS.
Clinical Trials
Before medical devices like the PRS can be marketed in the U.S., successful
completion of clinical trials, along with FDA clearance, is often required. In
June 1997, the FDA granted to the Company a 510(k) clearance which enabled the
Company to market the PRS's Model 3 used in all of the U.S. Phase II clinical
trials. In July of 1998, the FDA granted a 510(k) clearance to market the PRS400
for the irradiation of intracranial tumors. The PRS400 is an upgraded version of
the Model 3, with similar radiation output but with enhanced safety and user
interface features. The Company introduced the PRS400 as its first commercial
product and initiated distribution of the systems in December of 1998.
The Company initiated clinical trials for the application of the PRS to the
treatment of breast tumors in the United Kingdom in 1998. In early 1999, the
Company extended those clinical trials to include treatment of patients with
colo-rectal tumors. The Company intends to submit an application to the FDA to
begin Phase I human clinical trials in the U.S. In addition, the Company
initiated human clinical trials of non-melanoma skin cancers in 1998. The
Company plans to request permission from the FDA to extend these clinical trials
to include patients with melanoma tumors. The Company expects to continue to
consider the use of the PRS for other potential applications on an on-going
basis.
The following table summarizes by treatment application the status of
clinical trials in the U.S., Europe and Japan:
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Application Status
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Brain tumors (interstitial
and as post-surgery
radiation "boost") ...... U.S.: Post-Market studies
Europe: Post-Market studies
Japan: Ministry of Health and Welfare approved trials completed. Application for
PRS product approval in progress
Breast tumors (interstitial
and as post-surgery
radiation "boost") ...... U.S.: Trial sites being evaluated *
Europe: Clinical trials began in 1998 and are on-going
Skin tumors ................ U.S.: Clinical trials began in 1998 and are on-going
Kidney & Liver tumors ....... U.S.: Pre-clinical trials began in 1998 and are on-going
Other tumors ................ U.S.: Proposed clinical trial under development to include multiple tumor types as
suitable targets for PRS treatment*
</TABLE>
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* FDA or local approvals are needed before commencing clinical trials.
Research studies for medical devices such as the PRS are often conducted in
a phased approach. Before the Company can start to sell the PRS commercially in
the U.S., the Company must successfully complete these clinical trials and gain
FDA approval.
Phase I trials are used to demonstrate feasibility, to delineate an initial
safety profile and to identify technical, procedural and clinical factors which
may be material to the successful use of the device. Phase II clinical trials
are normally conducted on a larger population group in order to identify
possible adverse health and safety risks and to begin gathering efficacy data.
Each of the clinical trials is to be conducted pursuant to certain standards
under protocols setting forth the objectives of the study, the parameters to be
used to monitor safety during the trials, and the efficacy criteria which are to
be evaluated. In turn, each protocol must be submitted to the FDA. The data
obtained from these trials are then used to support a 510(k) Premarket
Notification or other application to the FDA requesting commercialization
approval.
Products and Product Development
A complete PRS consists of (i) equipment for clinical use in treating
patients, principally consisting of the x-ray emitting probe, its electronic
control box and a standard computer-based treatment system, (ii) clinical
quality assurance equipment for use in the operating room to verify the accuracy
of the treatment, (iii) custom equipment for use in the laboratory to calibrate
the output of the probe, and (iv) various accessories such as applicators to
irradiate, for example, body cavities or surfaces, and fixturing devices to
support the PRS's x-ray probe during patient treatment.
The PRS is intended to be a turn-key system. However, the Company believes
that certain PRS components or accessories will have other uses for which they
may be marketed separately. For example, the Company believes that the CCD-
microdensitometer, which is part of the PRS and which allows for testing of
radiation dosage and distribution prior to patient exposure, could be used with
conventional x-ray sources as well as with the PRS. The Company may seek
clearance to market it on a separate basis the CCD-microdensitometer. In
addition, the Company has also designed, in support of its proprietary x-ray
technology, an automated dosimetry water tank. The water tank provides a rapid
computer-based means of measuring the spatially distributed x-ray dose around
the probe tip. While the tank was originally designed by the Company to
facilitate periodic calibration of PRS units by hospitals, the tank can also be
used to measure the dose delivered by radioactive seeds. The Company intends to
further explore the market potential for sales of tanks for this purpose.
The Company is developing for intraoperative use, immediately after
surgical removal of a tumor, treatment applicators to administer a localized
boost of radiation to the tumor bed in order to destroy any remaining malignant
cells. For treating skin and surface tumors, the Company has designed conical
applicators. In addition, the Company is developing a floor stand instrument
holder which supports the PRS's x-ray probe when used for treatment of various
body sites other than the head.
Marketing and Sales; Collaborative Relationships
The Company recorded the first two sales of the PRS400 system in December
1998 to New York Medical College, Our Lady of Mercy Medical Center, Bronx, New
York and Massachusetts General Hospital, Boston, Massachusetts. These purchasers
of the PRS400 system are also the first key hospital centers to be designated
"PRS Centers of Excellence". The designation of these hospitals as "PRS Centers
of Excellence" means that these hospitals, together with a planned additional
fifteen such designees worldwide, will act as regional referral sites, and will
be engaged in a variety of clinical research, clinical trial, and product
evaluation activities with the Company. The Company will pay an annual fee to
each hospital participating in the program.
As the Company makes the transition from being a company with products
in development but no product sales to also being a manufacturing and marketing
company, it will require significant additional expenditures, management
resources, and time to develop its sales staff, and to make arrangements for
sale or lease of the Company's products through third parties. The
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Company plans to market and distribute its products through a combination of in-
house sales, collaborative relationships, and third party distributors. It is
possible, however, that the Company will not be able to establish an adequate
sales force or make adequate third party arrangements for product leasing or
sales.
Since joining the Company in November 1997, Mr. John Brink, the Company's
Vice President of Sales and Marketing, has hired two regional sales managers and
a marketing coordinator to his staff. Mr. Brink has developed an active sales
and marketing plan and launched the PRS400 at the convention of the Congress of
Neurological Surgeons, Seattle, Washington, in October 1998.
The Company believes that the acceptance of the PRS by health care
providers as a viable, cost-effective alternative to conventional cancer
treatment methods will be critical to the successful commercialization of the
PRS. The Company intends to target potential customers such as hospitals, out-
patient providers, cancer centers, and regional facilities, both within the U.S.
and abroad.
In December 1995, the Company entered into a Clinical Trial Agreement with
Toshiba. Under the Clinical Trial Agreement, Toshiba purchased from the Company
at a discounted price two PRS Model 3 units for use in clinical trials. The
Company has agreed to upgrade those units at no additional cost to Toshiba once
approvals are obtained to sell the PRS in Japan. Toshiba also agreed, subject to
certain conditions and limitations, to bear overall responsibility for the
performance of the Japanese clinical trials and for obtaining approval under
Japan's Pharmaceutical Affairs Law to import, market, sell, and use the PRS.
Under this agreement, the Company has agreed to make available certain training
and installation services, and to provide technical information and PRS spare
parts. Also in December 1995, the Company entered into an International
Distributor Sales and Service Agreement with Toshiba pursuant to which the
Company granted to Toshiba an exclusive right to sell and service the PRS in
Japan, once regulatory approvals are obtained, during the term of the agreement.
Toshiba agreed to provide certain training services to PRS customers and to
perform certain PRS repairs (to the extent such repairs are not then covered by
the Company warranty on the PRS). Upon entering into clinical trial and
distribution arrangement, Toshiba purchased an equity interest in the Company
for a purchase price of approximately $2 million. Subject to certain early
termination rights, the International Distributor Sales and Service Agreement
expires three years after all necessary legal, regulatory, or administrative
approvals are obtained that are necessary to import, market, sell and use the
PRS. Toshiba is one of the leading medical device manufacturers and distributors
in the world, and the Company believes that Toshiba's support for the PRS will
be a significant factor in gaining acceptance for the device in the medical
marketplace in Japan.
The Company also has entered into, and plans to continue entering into,
strategic relationships with manufacturers or designers of components and
accessories relating to, or to be used in conjunction with, the PRS. The Company
believes that such relationships will enable the Company to focus its
development efforts and devote its economic resources to its core technologies,
while simultaneously providing access to those parties' customers and
distribution channels. For example, two manufacturers of stereotactic frames,
Radionics Incorporated ("Radionics") and Medical High Tech GmbH, have adapted
their frames to be compatible with the PRS, and a third frame manufacturer has
submitted designs to the Company indicating a similar intention. The Company
hopes to leverage its relationships with these third parties in order to
increase market opportunities.
Medical Advisory Board
The Company's Medical Advisory Board consults with the Company's Board of
Directors and senior management from time to time as requested by the Company's
Board of Directors and as the schedules of the members of the Medical Advisory
Board permit. These consultations provide general advice to the Company on its
business and products, including the PRS. The members of the Medical Advisory
Board are employed on a full-time basis by employers other than the Company. In
addition, the members have commitments to, or consulting, advisory or other
contractual relationships with other third parties. These third party
commitments and relationships limit the availability of the Medical Advisory
Board members to the Company, and may potentially result in conflicts of
interest. The following individuals currently serve as members of the Medical
Advisory Board:
<TABLE>
<CAPTION>
Name Position
- ---- --------
<S> <C>
Nicholas T. Zervas, M.D. (Chairman) ... Higgins Professor of Neurosurgery, Chief of the Neurosurgical
Service, Massachusetts General Hospital, Boston, Massachusetts
Michael Baum, ChM. FRCS ............... Professor of Surgery, The Institute of Surgical Studies, University
College, London Medical School, London, England
</TABLE>
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<TABLE>
<S> <C>
Basil S. Hilaris, M.D., FACR .......... Professor and Chairman of the Department of Radiation Medicine,
Our Lady of Mercy Medical Center, New York Medical College,
New York, New York
Christoph B. Ostertag, M.D. ........... Professor and Director of Department of Stereotactic Neurosurgery,
Neurosurgical University Clinic, Albert-Ludwigs University,
Freiburg, Germany
Kintomo Takakura, M.D., Ph.D .......... President and Professor of Neurosurgery, Tokyo Women's Medical
University, Tokyo, Japan
Jay S. Loeffler, M.D. ................ Director of Northeast Proton Therapy Center, Massachusetts General
Hospital, Boston, Massachusetts
</TABLE>
The Company has committed that it will grant to each member of the Medical
Advisory Board, with the exception of Dr. Zervas, options to purchase 1,000
shares of the Company's Common Stock for each full year that such member serves
on the Medical Advisory Board. The exercise price per share for options granted
to the individuals who were members of the Medical Advisory Board on July 31,
1998 is $7.25. The exercise price per share for options granted with respect to
subsequent years of service and to any members who join the Medical Advisory
Board after July 31, 1998 is the lesser of the fair market value of such share
on August 1 and the subsequent July 31, or if the member joins after August 1,
the lesser of the fair market value of such share on the date the member joins
and the subsequent July 31. The Company is paying Dr. Zervas, the current
Chairman of the Medical Advisory Board, a stipend of $10,000 for each year that
he serves on the Medical Advisory Board. Each member also receives a fee of
$1,000 per regular or special Medical Advisory Board meeting attended in person
(together with reimbursement of reasonable travel expenses), and a fee of $500
per each such Medical Advisory Board meeting participated in by means of
conference telephone arrangements.
Patents and Proprietary Rights
A U.S. patent directed to the base PRS technology was issued to the Company
in October 1992. Two patents were issued to the Company in 1995 directed to
shaped radiation patterns and electron beam steering. From 1994 through 1996,
three U.S. patents directed to use of the PRS to treat brain tumors were issued
to the Company. A U.S. patent, directed to a flexible probe PRS for endoscopic
purposes, was also issued to the Company in 1995. Another U.S. patent was issued
to the Company in 1996 for an apparatus for use in x-ray dosimetry for the PRS.
One U.S. patent issued in 1996, one U.S. patent issued in 1997, and one pending
U.S. patent application are directed to use of the PRS to deliver x-rays to
internal surfaces and adjoining regions of body cavities, such as the bladder,
esophagus, anal region, nasal orifice and gynecological area. The Company was
issued two other patents in 1997 relating to accessory equipment, including the
Company's CCD microdensitometer. The Company has foreign patent applications in
selected foreign countries which correspond to certain of its U.S. patent
applications. As of March 20, 1997, two patents corresponding to the Company's
initial U.S. patents have been issued in Australia and two patents directed to
the treatment of brain tumors have been issued in Japan. The Company has thirty-
eight other foreign applications currently pending.
Manufacturing
The Company intends to continue its practice of sub-contracting the
fabrication of most of its electrical and mechanical components while
maintaining in-house responsibility for unit assembly and for manufacture of
certain proprietary components. The Company believes that this strategy can
serve to reduce administrative costs, facilitate supplier partnerships, and
reduce inventory requirements. In general, the Company's procurement strategy is
to keep the number of its suppliers to a minimum while identifying as many
multiple sources as possible. Due to the Company's current limited supply needs
the Company acquires certain supplies, over time, from the same vendors. While
the Company intends to negotiate supply contracts, where appropriate, with
certain of its key suppliers, the Company currently procures its supplies
through open purchase orders. There can be no assurance that the Company's
vendors will continue to provide such supplies on terms acceptable to the
Company, if at all. In addition, the Company has sole-source suppliers for some
of the PRS parts. If the sole-source suppliers are unwilling or unable to
provide such parts to the Company, it could have a material adverse affect on
the ability of the Company to manufacture its products.
The Company intends to implement the necessary operational systems to
support the successful commercial production of the PRS and any other products.
Specifically, the Company intends to continue to pursue full functional
compliance with ISO
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9001 , EN46001, and the FDA's current Good Manufacturing
Practices ("cGMP") standards that govern, among other things, quality assurance,
personnel training, process control, customer service, design control, supply
management and facility and equipment maintenance. The Company engaged British
Standards Institution ("BSI"), a registered Notified Body, to certify its
compliance with BS EN ISO9001:1994 (ISO9001) standards for a quality management
system. BSI issued to the Company a Certificate of Registration signifying
compliance with the requirements of BS EN ISO9001:1994 on September 22, 1997.
Subsequently, the Company engaged BSI to assess its compliance to Annex II
Section 3 of the Medical Device Directive (93/42/EEC), the applicable
regulations pertaining to the design manufacture and other aspects of medical
devices intended to be distributed in the European Community. On May 13, 1998,
BSI issued an EC-Certificate to the Company signifying its compliance with
requirements stipulated in Annex II Section 3 of the Medical Device Directive.
Competition
The medical device industry is highly competitive. The Company believes that
there are numerous universities, research institutions and medical device,
chemical and biotechnology companies that are engaged in the development of
cancer treatment therapies. Many of these entities have substantially greater
technical, financial and regulatory resources than the Company and may be better
equipped to develop, manufacture, and market their products.
In order to achieve successful commercialization, the PRS will need to compete
with established radiation therapy devices such as Linear Accelerators and the
Gamma Knife (TM). In addition the Company will need to compete with lesser known
radiation therapies such as proton beam treatment and brachytherapy. The Company
is also aware of various other cancer tumor treatment methods currently under
development. Any of these other treatment methods, if successfully developed,
could have a different approach or means of accomplishing the intended purposes
of the Company's product. As a result, one of these methods may render the
Company's technology non-competitive. While the Company believes that the PRS
offers certain therapeutic, operational, and economic advantages over the cancer
treatment methods likely to compete with the PRS, there can be no assurance that
the Company will be able to compete successfully within this highly competitive
market.
The Company believes that its ability to compete in the marketplace will
depend on its technological advantages and the strength of its patent position,
its ability to complete clinical trials and to obtain regulatory approvals for
its products in a timely fashion, its success in developing and maintaining
collaborative relationships, its transition to commercial manufacturing and
marketing, and its ability to achieve and maintain a superior cost structure
relative to other competitive treatments.
Government Regulation
U.S.
The PRS is subject to regulation in the United States by the FDA.
Manufacturers of medical devices must comply with applicable provisions of the
FDC Act, the Safe Medical Devices Act of 1990 (the "SMDA"), the Modernization
Act of 1997, and certain associated regulations governing the safety,
effectiveness, design, testing, manufacturing, labeling, marketing and
distribution of medical devices and the reporting of certain information after
initiating distribution. Both the FDC Act and the SMDA require certain
clearances from the FDA before medical devices, such as the PRS, can be
marketed. The Company intends to pursue a strategy intended to result in
marketing clearance of as many PRS components as possible as quickly as possible
in order to maximize flexibility in the marketing of the PRS and its components.
FDA authorization to commercially distribute a new device can be obtained in
either of two ways, depending on the device. The first process (which is the
more comprehensive of the two) applies to a new device that is not substantially
equivalent to an existing, legally marketed product, and requires generally that
the Company establish the safety and effectiveness of the device through
specific procedures. A Premarket Approval ("PMA") application must be submitted
to the FDA that contains, among other things, the results of clinical trials
performed pursuant to FDA-approved protocols. The PMA application also contains
other information required under the FDC Act such as a full description of the
device and its components, a full description of the methods, facilities and
controls used for manufacturing and proposed labeling. Finally, the
manufacturing site for the device subject to the PMA must pass an FDA pre-
approval inspection. The PMA process can be expensive, uncertain and lengthy,
often requiring several years to complete.
The second of the two FDA processes is available for a new or significantly
modified device which is ''substantially equivalent'' to an existing legally
marketed device. Such a new device may be commercially introduced when, after
submission of a pre-market notification to the FDA under Section 510(k) of the
FDC Act, the FDA issues an order permitting commercial
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distribution. The FDA has recently been requiring a more rigorous demonstration
of substantial equivalence than in the past, including in many instances the
results of clinical trials performed pursuant to FDA approved protocols. As
between the two sets of procedures (the PMA approval procedure and the Section
510(k) clearance procedure), the PMA procedures are normally more complex and
time consuming than 510(k) Premarket Notification procedures, since the PMA
procedures are for products that are not comparable to any other product in the
market. However, even the Section 510(k) procedures are time-consuming and
expensive. The FDA may also require the ongoing monitoring of products which
have been cleared for commercialization under those procedures.
On February 9, 1998 the Company filed a Section 510(k) pre-market notification
with respect to the current model of the PRS, the PRS400, for the treatment of
intracranial tumors. On July 27, 1998, the FDA granted Section 510(k) marketing
clearance for the PRS400 for use in the irradiation of intracranial tumors.
In addition to the clearance and approval procedures described above, the FDA
also imposes various requirements on manufacturers and sellers of medical
devices under its jurisdiction, such as labeling, manufacturing practices,
record keeping and reporting requirements. Prior to selling a product, a
company's manufacturing operations need to comply with the FDA's cGMP standards.
The Company believes that the combination of its ISO9001 registration and
satisfaction of the prerequisites for use of the CE Mark will be sufficient to
comply with the FDA's cGMP standards.
There can be no assurance that clearances will be granted for the PRS400 for
uses other than in the irradiation of intracranial tumors, or for any other
future products, if any. In addition, there can be no assurances that the length
of time required for any clearances will not be extensive, that the cost of
attempting to obtain any such clearances will not be prohibitive, or that the
Company will have sufficient funds to pursue such clearance. Failure to obtain
or maintain requisite governmental approvals could delay or preclude the Company
from further developing and marketing the PRS and other products. Such delays
could 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, even after regulatory clearance is
obtained.
Even if regulatory clearances or approvals are obtained, such clearances or
approvals may include significant limitations on particular uses. In addition,
those clearances or approvals may be withdrawn or limited for non-compliance
with regulatory standards or the occurrence of unforeseen problems following the
initial clearance or approval (either of which could result in restrictions,
including withdrawal of the product from the market or sanctions or fines being
imposed on the Company).
In addition, the Company may need to obtain export licenses from the U.S.
Government in order to export products manufactured by the Company. Such
licenses may be required for equipment used in foreign clinical trials. The
Company has already been granted export licenses and corresponding foreign
import licenses for clinical trials in England, Japan, Australia, Germany, and
Italy.
Foreign Countries
The Medical Device Directive (June 1993) sets forth the regulatory
requirements adopted by the European Union, pursuant to which "National
Competent Authorities" approve European commercialization of new medical
products through a procedure whereby both the products and the manufacturing
facilities must conform to well defined specifications.
The transition period for the Medical Device Directive ended in June 1998
after the expiration of a 5 year transition period. Currently, all new medical
devices to be marketed in any European Union country must first obtain a CE
Mark. Obtaining a CE Mark with respect to a particular medical device requires
the accumulation of information that is similar in certain respects to that
which is submitted to the FDA in connection with a Section 510(k) notification.
In order for the Company to sell its products in Europe, it must comply with EC
Medical Device Directives relating to manufacturing, quality assurance and
documentation under the BS EN ISO 9001:1994 series standards and relating to the
design, manufacture, quality control, safety and performance of the particular
device.
In order to have the capacity to examine a large number of new products, the
National Competent Authorities have mandated "Notified Bodies" (non-governmental
organizations) to act as their agents and qualify manufacturers equipment in
accordance with EC standards. The Company is thereby able to affix the CE Mark
to its PRS400 products and to freely distribute them within the European
Community and cooperating countries.
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Sales of medical devices within other jurisdictions outside the U.S. and
Europe are subject to regulatory requirements that vary widely from country to
country. The time required to obtain approval for sale in a foreign country may
be longer or shorter than that required for FDA approval, and the requirements
for obtaining such approvals may also be different.
Third Party Reimbursement
The Company's ability to generate revenues from the marketing of the PRS will
depend in large part upon whether the PRS will qualify for reimbursement from
third party payors. Such third party payors include, among other sources,
private insurance companies, self-insured employers, health maintenance
organizations, and federal and state sources of payment under the Medicare and
Medicaid programs. As a general matter, each third party payor has developed
independent criteria for determining whether a particular device or treatment
modality should be reimbursable and the Company cannot predict whether or to
what extent the PRS will gain acceptance for reimbursement with any third party
payors. The Company believes, however, that the reduced capital and operation
costs of the PRS, when compared to competing modalities together with the
expected lower hospitalization costs, will encourage third party payors to
provide reimbursement for PRS based procedures.
In addition, many third party payors in the U.S., including the federal
Medicare program and many state Medicaid programs, have shifted or are planning
to shift to partially or fully capitated systems. Under such systems, providers
receive either a fixed payment amount per diagnosis or general treatment
approach regardless of the specific treatment modality, or a fixed payment
amount to provide for all the care needs of a patient over time regardless of
illness. To the extent that the PRS is comparatively more cost effective than
existing treatment modalities, providers subject to partial or fully capitated
systems will have an incentive to utilize the PRS. The Company has engaged two
experienced consultants in radiation therapy to complete the development of a
Reimbursement Strategy Handbook for its existing and potential customers. The
Company will provide ongoing assistance for all customers through a user's group
information base and the general exchange of coding, cost, and general
reimbursement information.
The level of revenues and profitability of sales of medical devices may be
affected by the continuing efforts of governmental and third party payors to
contain or reduce the costs of health care through various means and the
initiatives of third party payors with respect to the availability of
reimbursement. For example, in the U.S. there have been, and the Company expects
that there will continue to be, a number of federal and state proposals to
subject pricing or profitability of medical devices to governmental control.
Although the Company cannot predict what legislative reforms may be proposed or
adopted or what actions federal, state or private payors for health care
products may take in response to any health care reform proposals or
legislation, the existence and pendency of such proposals could have a material
adverse effect on the Company in general.
With respect to health care reimbursement in the European Community (the
"EC"), the Company believes there are presently no EC-wide reimbursement
procedures. The majority of the EC member nations each have a dominant national
health service with distinct and unique reimbursement policies and procedures.
In addition, private insurers within the EC offer a great variety of benefits.
With the Medical Devices Directive becoming mandatory in the EC, the principal
prerequisite for reimbursing a procedure involving new medical equipment is
obtaining a CE Mark.
Other foreign countries also have their own health care reimbursement systems,
and there can be no assurance that third party reimbursement will be made
available to the Company under any foreign reimbursement system.
Employees
As of January 2, 1999, the Company had 48 employees. None of the Company's
employees are covered by a collective bargaining agreement, and the Company
believes that its relationship with its employees is good.
Subsequent Events
On March 26, 1999, the Board of Directors of the Company formally elected Euan
Thomson, Ph.D., President and Chief Operating Officer of the Company. Dr.
Thomson has previously served as Managing Director of Photoelectron (Europe)
Limited, a London-based subsidiary of the Company.
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Dr. Thomson replaced Peter E. Oettinger, Ph.D., who had served as Vice
President and Chief Operating Officer of the Company. Mr. Peter M. Nomikos
voluntarily resigned as President of the Company prior to the March 26, 1999
Board of Directors' meeting but remains Chairman of the Board, Chief Executive
Officer, and Treasurer of the Company.
Risk factors that may affect future results
The Company wishes to caution readers that in addition to the important factors
described elsewhere in this Report, the following important factors, among
others, sometimes have affected, and in the future could affect, the Company's
business, financial condition, or operating results. These factors could cause
the Company's future results to differ materially from those expressed in any
forward- looking statements made by, or on behalf of, the Company.
The Company has significant capital needs and may not be able to raise
additional capital that would enable it to continue as a going concern
The Company has expended, and will continue to expend, substantial funds on
the following:
. Research and development of the PRS and other potential products;
. Clinical trials;
. Cost of regulatory approvals;
. Establishing commercial scale manufacturing in the Company's own facilities
or in the facilities of others; and
. Marketing the PRS and any other products.
The Company's future capital requirements will depend on a variety of
factors, including the following:
. Time and costs involved in obtaining further regulatory approvals;
. Results of ongoing clinical trials;
. Market acceptance of the PRS and any of the Company's other products;
. Expense and results of the Company's continued scientific research and
development programs;
. Time and costs expended in filing, prosecuting, and enforcing patent claims;
and
. Development of competing technologies.
The Company does not expect to be able to generate sufficient revenue in
the near future to continue operations without raising additional capital. If
the necessary funds are not available to the Company on acceptable terms, it is
likely that the Company will not be able to continue as a going concern. The
Company estimates that, as of January 2, 1999, available cash and cash
equivalents, together with revenues from product sales, if any, will allow it to
continue operations for approximately 6 months.
The Company is an early stage company and has a limited operating history
The Company was incorporated in January of 1989 and has thus had a relatively
short operating history. The Company is still in the process of developing and
commercializing the PRS, the Company's primary product. The Company may not
succeed in completing the development and commercialization of the PRS. The
Company has received regulatory approval only from the FDA and clearance from
the European Union to market the PRS in the United States and Europe for the
treatment of brain tumors, and is still waiting for approval from other
countries in which the Company may market the PRS. The Company cannot be sure
that any other countries will grant us regulatory approval to market the PRS. In
addition, the Company has only sold two PRS systems and may not be able to sell
any more PRS systems even if the Company receives all necessary regulatory
approvals and completes the development and commercialization of the PRS.
The Company may not be reimbursed by third party payors
The Company's ability to be reimbursed for the cost of its products and
related treatments from third party payors will have a significant impact on the
Company's ability to commercialize its products. Such third party payors
include, among others, private insurance companies, self-insured employers,
health maintenance organizations, and federal and state sources of payment under
the Medicare and Medicaid programs. There is no uniform policy on reimbursement
among third party payors, and the PRS or any of the Company's other products may
not qualify for reimbursement. In addition, foreign countries have
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their own health care reimbursement systems, and the Company may not qualify for
reimbursement from such foreign third party payors.
In addition, the continuing efforts of many third party payors to reduce
the costs of health care by decreasing reimbursement rates, or limiting or
prohibiting reimbursement for certain services or devices, may have an adverse
effect on the Company's revenues. Furthermore, legislative proposals to reform
government health care insurance programs, including the Medicare and Medicaid
programs, could have a significant impact the purchase of health care services
and products and could result in lower prices and reduced demand for the
Company's products. The Company is unable to predict whether such proposals will
be enacted or whether other health care legislation or regulation affecting the
Company's business may be proposed in the future.
The Company only markets one product
The PRS and its related accessories and components are currently the
Company's only product. The Company's ability to sell the PRS and generate
revenue could be adversely affected by problems such as loss of a patent
protection, unexpected side effects, negative publicity, or the introduction of
a new, more effective treatment that would render the PRS obsolete.
The Company has a history of significant operating losses and anticipates
further substantial losses
The Company has experienced significant operating losses in each year since
its incorporation, primarily due to the cost of substantial research and
development of the PRS. As of January 2, 1999, the Company had an accumulated
deficit of approximately $30.9 million and expects to continue to incur losses
until the Company generates revenues to offset the funds spent on
commercializing the PRS. The Company's ability to achieve profitable operations
will depend, in large part, on whether the Company can successfully develop and
commercialize the PRS and/or any other products, and whether the Company can
effectively make the transition to a manufacturing and marketing company. It is
possible that the PRS will never gain commercial acceptance, and the Company may
never generate significant revenues or achieve profitability. For these reasons,
the Company believes it will continue to incur substantial operating losses for
the foreseeable future, and that these losses may be significantly higher than
the Company's current losses.
Product development risks; Uncertainties relating to clinical trials
The PRS is a new product and, accordingly, its safety and efficacy have not
yet been fully established. The FDA and the European Union have granted the
Company clearance to market the PRS as a treatment only for brain tumors. As a
result, there are several problems the Company may encounter in conducting
clinical trials for other potential uses of the PRS that include, but are not
limited to, the following:
. The results obtained from Phase I trials of the PRS as a treatment for
metastatic brain tumors may not be an accurate indicator of the results in
subsequent clinical trials or in clinical trials for other specific
applications for the PRS;
. Medical device companies often suffer significant setbacks in Phase II or
other clinical trials, even after obtaining promising results in Phase I or
other prior trials;
. The Company has conducted and expects to continue to conduct clinical trials
of the PRS with patients in advanced stages of cancer. These patients could
die or suffer adverse effects for reasons unrelated to the PRS, but such
events could nevertheless have an adverse effect on clinical trial results or
regulatory approvals of the PRS; and
. The Company relies upon unaffiliated medical institutions to perform clinical
trials in accordance with the FDA's approval process. Work carried out at the
institutions currently performing Phase I or II clinical trials, or at any
institutions performing clinical trials in the future, may not be
satisfactory. In addition, such institutions may cancel, suspend, or delay
such trials.
Furthermore, the number of patients that have completed the Company's
clinical trials to date has been limited by a number of factors, including the
reluctance of patients or physicians to participate in experimental clinical
trials. The Company's ability to collect randomized data has been impeded by
patients who quit the clinical trials because they wanted to receive the PRS
treatment but were assigned to the trials' non-PRS control groups. Any delays
in or termination of the clinical trials could have a material adverse effect on
the Company's business, financial condition, and results of operations. In
addition, it is possible that the Company's clinical trials will not be
successful, that such clinical trials will be delayed, or that the PRS or any
other product will not be safe or effective or capable of being successfully
developed for all their respective intended applications.
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The Company is still waiting for certain regulatory clearances in order to
market the PRS
The PRS has not been approved for commercial use in countries outside the
U.S. and Europe, including Japan. The PRS is subject to extensive regulation in
the U.S. by the FDA and, in many instances, by comparable agencies in foreign
countries where the Company plans on manufacturing and/or distributing the PRS.
Sales of medical devices outside the United States are subject to regulatory
requirements that vary widely from country to country. The PRS may not meet the
regulatory standards of countries that have not yet approved the PRS for
commercial use.
In addition, the length of time the Company will need to wait to obtain
approval for the sale of the PRS in a foreign country may be longer, and the
requirements may be more burdensome or expensive, than that required for FDA
approval. The Company will also need to obtain export licenses from the U.S.
government in order to export its products to certain countries. The U.S.
government may not grant the Company any other export licenses other than those
previously granted for clinical trials in England, Japan, Australia, and
Germany, and the corresponding foreign countries may not grant the Company any
import licenses.
Furthermore, the Company may not receive any necessary regulatory approvals
if the Company develops any additional products in the future, the length of
time for such approvals may be extensive, and the cost of attempting to obtain
any such approvals may be prohibitive. In addition, the Company's inability to
obtain or maintain requisite governmental approvals could delay or preclude the
Company from further developing and marketing the PRS and other products.
Consequently, such delays could impair the Company's ability to generate
revenues and continue as a going concern.
The PRS is subject to extensive ongoing government regulation
The FDA and the European Union have approved the PRS for commercial use in
the U.S. and Europe only for the treatment of brain tumors. Because the FDA
strictly prohibits the marketing or sale of approved medical devices for
unapproved uses, the Company may only market and sell the PRS for the approved
use. Any possible additional uses of the PRS will be subject to extensive
additional clinical trials and FDA and foreign regulation and approval. In
addition, the FDA imposes strict labeling requirements and may also impose
burdensome training or other requirements, any of which could limit the
Company's ability to market the PRS.
The Company may also need to obtain additional approvals from the FDA if
the Company decides to change or modify the PRS. In that case, the FDA might
withdraw its previously granted approvals. In addition, if the Company fails to
comply with FDA regulatory standards, the FDA could force the Company to
withdraw its products from the market or impose sanctions or fines, each of
which could have a material adverse effect on the Company's business, financial
condition, and results of operations.
In addition, manufacturers of medical devices are subject to strict federal
regulations regarding quality of manufacturing, including periodic FDA
inspections of manufacturing facilities to determine compliance with FDA
regulations. Such regulations impose certain requirements on, among other
things, the design, testing, production, control, and documentation of products.
The Company may not be able to attain or maintain compliance with cGMP standards
or with ISO Standards. In addition, the Company may not be able to identify and
retain manufacturers on commercially acceptable terms, if at all, and any
manufacturers the Company does retain might not be able to meet all relevant
regulatory requirements. Any problems with the Company's ability to meet
regulatory standards could prevent the Company from marketing the PRS.
Rapid, unpredictable, and significant technological change; highly competitive
industry
The medical device industry is subject to rapid, unpredictable, and
significant technological change. The Company's business is subject to
competition in the U.S. and abroad from a variety of sources, including
universities, research institutions, and medical device, chemical, and
biotechnology companies. Many of these potential competitors have substantially
greater technical, financial, and regulatory resources than the Company and are
accordingly better equipped to develop, manufacture, and market their products.
If these companies develop and introduce products and processes competitive with
or superior to the Company's products, the Company may not be able to compete
successfully against such competitors.
The Company depends on one product
The PRS and its related accessories and components are currently the
Company's only product. The Company currently expects that the PRS will be the
primary source of revenues, if any, for the foreseeable future. All additional
potential products using the Company's core technology are in their early stages
of development. Any such additional
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products in development may not be safe or effective, approved by regulatory
authorities, capable of being manufactured in commercial quantities at
acceptable costs, or introduced into the market successfully.
The Company has limited marketing experience
As the Company makes the transition from a company with products in
development but no product sales to a manufacturing and marketing company, the
Company will require significant additional expenditures, management resources,
and time to develop its sales staff and to make arrangements for the sale or
lease of its products through third parties. The Company plans to market and
distribute its products through a combination of in-house sales, collaborative
relationships, and third party distributors. The Company may not be able,
however, to establish an adequate sales force or make adequate third party
arrangements for product leasing or sales.
Adverse effect of short patient life expectancies on market for the approved
application
To date, the Company has focused substantially all its efforts on one
specific application of the PRS--the treatment of brain tumors. Patients with
metastatic brain tumors already suffer from primary cancer, which is separate
from the metastatic brain tumors. The average life expectancy of patients with
metastatic brain tumors is very short. Although the PRS is designed to provide
either curative or palliative cancer treatment, health care providers and third
party payors may be reluctant to undertake, authorize, or provide reimbursement
for PRS treatment of patients whose anticipated life expectancies are below
certain levels.
Neither the FDA nor any foreign authorities have approved the PRS for
applications, such as breast, prostate, bladder, or skin cancer, where patient
life expectancies are higher than those for patients with metastatic brain
tumors. Accordingly, the Company cannot market the PRS to treat such other
cancers.
Uncertain protection of intellectual property
The Company's ability to compete effectively in the marketplace will
depend, in part, on the Company's ability to protect its intellectual property
rights. The Company relies on patents, trade secrets, and know-how to establish
and maintain a competitive position in the marketplace. The enforceability of
medical device patents, however, can be highly uncertain. Any limitation or
reduction in the Company's rights to obtain or enforce the Company's patents
could have a material adverse effect on the Company's ability to maintain or
protect its intellectual property rights.
The Company holds twelve U.S. patents and one U.S. patent application
relating to the PRS. In addition, the Company has filed foreign patent
applications in selected foreign countries, which correspond, to certain of the
Company's U.S. patents and patent applications. Such applications may not result
in issued patents, and the Company cannot be sure that once issued, any issues
relating to the validity and scope of the patents will be resolved in the
Company's favor. In addition, the Company's current or future patents, trade
secrets, or know-how may not protect the Company against competitors with
similar technologies or processes. Also, others may infringe any patents issued
to the Company and other companies may independently develop proprietary
technologies or processes, which are the same as or substantially equivalent to
the Company's proprietary technologies or processes.
The Company may also become subject to patent infringement claims or
litigation initiated by third parties. The defense and prosecution of such
claims or suits are very costly and time-consuming, and any such proceeding
would result in substantial expense and a significant diversion of effort by
technical and management personnel of the Company. Further, any adverse
determination in such litigation or proceeding could subject the Company to
significant liability and could prevent the Company from manufacturing or
marketing its products.
Peter M. Nomikos has the ability to significantly influence all stockholder
votes
As of March 29, 1999, Mr. Peter M. Nomikos, Chairman of the Board, Chief
Executive Officer, and Treasurer of the Company beneficially owned approximately
47% of the issued and outstanding shares of Common Stock, and the Company's
principal stockholders and certain affiliates of the Company (including Mr.
Nomikos) beneficially owned in the aggregate approximately 56% of the issued and
outstanding shares of Common Stock. Certain principal stockholders serve as
directors or have representatives who serve as directors of the Company. Due to
Mr. Nomikos's ownership of Common Stock coupled with the positions he holds in
the Company, Mr. Nomikos, either alone or with the other principal stockholders,
has the ability to significantly influence all matters requiring approval by the
stockholders of the Company, including the election of all directors,
acquisitions, sales of all or substantially all of the Company's stock or
assets, and other extraordinary transactions.
-17-
<PAGE>
The Company depends on key personnel
The Company depends on the continued services and performance of its
scientific personnel and senior management. If the Company loses any key
personnel, it could significantly and adversely impact the Company's research
and development efforts or its strategic objectives. In addition, competition
among medical device companies for highly skilled scientific and management
personnel is increasingly intense. In order to achieve and maintain the
commercialization of the PRS, the Company will need to attract and retain
additional key personnel, and the Company cannot be sure that it will be able to
do so. The Company has no employment agreements with any of its employees, nor
has the Company purchased "key person" life insurance.
The Company may experience shortages of PRS components; The Company relies on a
small number of suppliers
The Company manufactures its products based on anticipated product orders.
The different lead times for the supply and delivery of materials and components
can vary significantly, as can the relative availability and cost of those
materials and components. As a result, the Company has built up and maintains an
inventory of certain components for the PRS. The Company also tries to identify,
where feasible, multiple suppliers of materials and components.
While the Company sometimes negotiates supply contracts with certain key
suppliers, the Company currently purchases its supplies through open purchase
orders. The Company's vendors may not continue to provide supplies on acceptable
terms, if at all. In addition, if the Company's forecasted product orders prove
to be different than actual product orders, the Company may have excess or
inadequate inventory.
In addition, the Company may not be able to find alternative suppliers for
the PRS components on a timely basis, if at all, in the event that the Company
needs such alternative suppliers. Any significant delay or interruption in the
Company's ability to acquire product components and materials could have an
adverse effect on the manufacture of the Company's products.
Product liability risks
The Company will be exposed to the risk of medical product liability claims
if any of its products causes harm or injury. The Company might not have
sufficient resources to satisfy any liability resulting from such claims. The
level or scope of the Company's liability insurance with respect to the clinical
testing of the PRS may not be sufficient to cover potential claims. In addition,
medical product liability insurance may not continue to be available at an
acceptable cost, if at all. As a result, a medical product liability claim could
cause the Company significant financial harm.
Anti-takeover provisions; Effects of issuance of preferred stock
Certain provisions of the Company's Articles of Organization and By-Laws
are intended to enhance the likelihood of continuity and stability in the
composition of the Company's Board of Directors and in the policies formulated
by the Board and to delay or prevent a change in control of the Company if the
Board determines that such a change in control is not in the best interest of
the Company. These provisions could have the effect of discouraging certain
attempts to acquire the Company or to remove incumbent management even if some
or even a majority of the Company's stockholders deem such an attempt to be in
the Company's best interest. As a result, the anti-takeover provisions could
limit the price that investors might be willing to pay in the future for shares
of Common Stock, thereby depriving stockholders of certain opportunities to sell
their stock at temporarily higher prices. In addition, the provisions of Chapter
110F of the Massachusetts General Laws, the Business Combination Statute, cover
the Company. This statute prohibits the Company from engaging in a merger, stock
or asset sale, and other transactions with an "interested stockholder" that
would result in a financial benefit to the interested stockholder for a period
of three years after the date of the transaction in which the person became an
interested stockholder, unless the business combination is approved in a manner
set forth in the statute. The application of this statute could have the effect
of delaying or preventing a change of control of the Company.
In addition, the Board of Directors is authorized, subject to certain
limitations, to cause the Company to issue one or more series of Preferred Stock
and, to the extent permitted by Massachusetts law, to grant different classes of
stock certain rights and preferences. In the event the Board issues any
Preferred Stock, it could be utilized, under certain circumstances, as a method
of discouraging, delaying, or preventing a change of control of the Company. The
Company currently has no current plans to issue any shares of Preferred Stock
but the Board of Directors may elect do so at some time in the future.
-18-
<PAGE>
Year 2000
As described in this report, the Company is working to address Y2K
problems. If the Company should fail to identify or fix all such problems in the
Company's own operations, or if the Company is affected by the inability of a
supplier to continue operations due to such a problem, it could have a material
adverse effect on the Company's business, financial condition, and results of
operations.
Volatile stock price
The trading price of the Company's common stock fluctuates
significantly. The Company's stock price may fluctuate as a result of various
factors such as variations in the Company's financial performance, announcements
of technological innovations by competitors or providers of alternative
products, and changes in the economy, the financial markets, or the health care
industry. In addition, stock market have experienced price and volume
fluctuations that have particularly affected medical device companies and has
often been unrelated to such companies' operating performance. Such broad market
fluctuations may adversely affect the market price of the Company's common
stock.
Absence of dividends
The Company has never paid any dividends on its capital stock and does
not anticipate paying any cash dividends to holders of the Company's capital
stock in the foreseeable future.
Item 2. Properties.
The Company currently occupies approximately 17,600 square feet of space in
a building located in Lexington, Massachusetts under a lease expiring in 2002.
The Company recently exercised an option under that lease to rent the remaining
space in the building, approximately 13,100 square feet of space, for the
balance of the lease term. This facility is suitable for research and
development, corporate administration and assembly of the PRS. The Company
believes that its facility will be adequate to meet its foreseeable requirements
through at least the year 2000. The Company has also exercised its option to
lease additional space in the same building.
Item 3. Legal Proceedings.
The Company is not currently involved in any material pending legal
proceeding.
Item 4. Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of the Company's security holders
during the last quarter of the fiscal year ended January 2, 1999.
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<PAGE>
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
There were 100 holders of record of the Company's Common Stock as of
March 1, 1999. The Company believes that there are approximately 1,950 holders
of its Common Stock. The Company has not declared or paid any dividends on its
Common Stock since its inception. The current policy of the Company's Board of
Directors is to retain any earnings to finance the operation of the Company's
business. Accordingly, it is anticipated that no cash dividends will be paid to
the holders of the Common Stock in the foreseeable future.
The Company's Common Stock has been listed on the Nasdaq National Market
under the symbol "PECX" and traded publicly since January 29, 1997. The price
ranges presented below represent the high and low sale prices for each quarter,
as reported by "The Nasdaq Stock Market Summary of Activity Report."
1998 High Low
- ----------------------------------------------------------------------------
First Quarter ......................................... 9 7/8 5 3/4
Second Quarter ........................................ 9 5 3/4
Third Quarter ......................................... 9 3/4 3 3/4
Fourth Quarter ........................................ 7 1/2 2 1/4
Sales of Unregistered Securities:
1. On July 31, 1998, the Company issued to Mr. Peter M. Nomikos 226,170 shares
of Common Stock upon conversion of convertible debt consisting of an aggregate
of $787,647 in principal and accrued interest.
2. On September 24, 1998, October 18, 1998 and November 14, 1998, the Company
issued to Mr. Peter M. Nomikos 7,333, 26,667 and 33,333 shares of Common
Stock, respectively, upon the exercise of outstanding warrants.
The above securities were sold pursuant to Section 4(2) under the
Securities Act of 1933.
Report of Use of Proceeds From Initial Public Offering
The Company's Registration Statement on Form S-1 (Registration number 333-
14541) with respect to the initial public offering of the Company's Common
Stock was declared effective on January 23, 1997. As of January 2, 1999, the
Company has used the following amounts of the net proceeds from the offering for
the following purposes: $10,059,861 for research and development expense and
$5,413,387 for general and administrative expenses.
Item 6. Selected Consolidated Financial Data.
The selected consolidated statement of operations data and consolidated
balance sheet data presented below as of and for the years ended January 3, 1998
and January 2, 1999 and the consolidated statement of operations data presented
below as of December 28, 1996, are derived from the Company's Consolidated
Financial Statements and Notes thereto included elsewhere in this Form 10-K,
which have been audited by Arthur Andersen LLP, independent public accountants.
The selected consolidated statement of operations data and consolidated balance
sheet data presented below as of and for the years ended December 31, 1994 and
December 30, 1995 and the consolidated balance sheet data presented below as of
December 28, 1996, are derived from the Company's Consolidated Financial
Statements and Notes thereto not included in this Form 10-K, which have been
audited by Arthur Andersen LLP, independent public accountants. The selected
consolidated financial data set forth below should be read in conjunction with
the Consolidated Financial Statements and Notes thereto, "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
other financial information included elsewhere in this Form 10-K.
-20-
<PAGE>
<TABLE>
<CAPTION>
Fiscal Year Ended
--------------------------------------------------------------------
December 31, December 30, December 28, January 3, January 2,
1994 1995 1996 1998 1999
------------ ------------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
(in thousands, except per share data)
Consolidated Statement of Operations
Data:
Revenues.................................. $ - $ - $ - $ 725 $ 678
Cost of goods sold........................ - - - 361 278
------- ------- ------- ------- -------
Gross margin ............................. -- -- -- 364 400
Operating expenses:
Research and development expenses ...... 2,086 3,226 3,577 4,626 5,434
General and administrative expenses..... 505 866 1,512 2,306 3,107
------- ------- ------- ------- -------
Total operating expenses ............... 2,591 4,092 5,089 6,933 8,541
------- ------- ------- ------- -------
Operating loss .......................... (2,591) (4,092) (5,089) (6,569) (8,541)
Interest income (expense), net ........ (81) (25) 130 713 467
------- ------- ------- ------- -------
Net loss ................................ $(2,672) $(4,117) $(4,959) $(5,856) $(7,674)
======= ======= ======= ======= =======
Net loss per share ...................... $(2.01) $(3.72) $(3.12) $(0.87) $(1.02)
======= ======= ======= ======= =======
Weighted average basic and diluted
shares.................................. 1,329 1,107 1,588 6,694 7,489
</TABLE>
<TABLE>
<CAPTION>
December 31, December 30, December 28, January 3, January 2,
1994 1995 1996 1998 1999
------------ ------------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Data:
Cash and cash equivalents.......................... $ 1,778 $ 7,191 $ 2,537 $ 2,287 $ 3,686
Total assets....................................... 2,949 8,703 5,117 16,425 9,135
Total long-term debt, including current portion.... 2,115 1,940 2,043 1,686 719
Deficit accumulated during development stage....... (8,307) (12,425) (17,383) (23,239) (30,913)
Total shareholders' equity ........................ $ 575 $ 6,493 $ 2,486 $ 14,012 $ 7,453
</TABLE>
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
The Company is engaged in the design, development and commercialization of the
PRS, a proprietary, therapeutic device for the treatment of cancerous tumors
through the application of radiation directly into a tumor. To date, the Company
has not received any significant revenue from the sale of its current PRS400
model.
The Company has experienced significant operating losses in each year since
its inception, due primarily to substantial research and development
expenditures. As of January 2, 1999, the Company had an accumulated deficit
totaling approximately $30.9 million and expects to continue to incur losses
until such time as its commercialization efforts yield offsetting revenues.
There can be no assurance that the PRS will ever gain commercial acceptance, or
that the Company will ever generate significant revenues or achieve
profitability. The Company's ability to achieve profitable operations will be
dependent in a large part on whether it can successfully develop and
commercialize the PRS and make the transition to a manufacturing and marketing
company. The Company anticipates that its sales and marketing, and manufacturing
expenses will continue to significantly increase during 1999 as it continues the
commercialization of the PRS400. The Company anticipates that its research and
development, and general and administrative expenses will increase minimally
during 1999.
The Company does not expect to be able to generate sufficient revenue in the
near future for it to continue operations without raising additional capital.
Should the necessary funds not be available to the Company on acceptable terms
there is substantial doubt that the Company will be able to continue as a going
concern.
The Company has completed clinical studies of PRS treatment of brain tumors
under an IDE granted by the FDA and similar approvals in other countries. Based
on results of these clinical trials, on June 20, 1997, the Company received a
510(k) marketing clearance from the FDA to market the Model 3 of the PRS for
treatment of intracranial tumors. Subsequently, the Company obtained a 510(k)
marketing clearance for the PRS400 on July 21, 1998, which the Company developed
for introduction as its first commercial product. Simultaneous with completion
of PRS400 product development, the Company completed the implementation of
programs designed to ensure compliance with the FDA's cGMP standards. The
Company also completed the process of seeking certification to the Medical
Device Directive Annex II, enabling self-certification of the European Community
Mark (CE). On December 18, 1998, the Company initiated commercial distribution
of the PRS400.
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<PAGE>
On December 13, 1995, the Company and Toshiba entered into an agreement
pursuant to which Toshiba is helping to develop and support clinical trials of
the PRS in Japan. The development and support of the clinical trials included
purchasing two complete systems of the PRS for use in the clinical trials,
installing and maintaining the PRS systems, and providing assistance to the
physicians and hospitals conducting the trials, including collection and
analysis of clinical data. The application to conduct clinical trials was
approved by the Ministry of Health and Welfare (MHW) in Japan in 1995. In 1997,
Toshiba purchased, took delivery of and installed the first of the two PRS
systems to be used in these clinical trials. The first clinical site began
treatment of patients in the MHW approved clinical trials in February of 1997.
The Company delivered the second PRS system to Toshiba in the third quarter of
1997, and the clinical trials began at the second site in the fourth quarter of
1997. Clinical trials of the PRS in Japan were completed at the first clinical
site in 1998 and the second clinical site in the first quarter of 1999. The
Company and Toshiba Medical expect to submit to the Japan Ministry of Health an
application for product approval (shonin) of the PRS in the second quarter of
1999. Contingent upon that submission being made in timely fashion, the Company
and Toshiba expect to obtain product approval (shonin) in Japan for the PRS in
the second half of 1999. Once regulatory approvals for the PRS are obtained in
Japan, Toshiba will serve as the Company's exclusive distributor in Japan.
The Company is currently conducting clinical trials in England to determine
the safety of the PRS for treatment of breast cancer. Early results from these
trials in England, if favorable, will be used to support an application to the
FDA to begin human clinical trials using the PRS for the treatment of breast
cancer in the U.S.. The Company has also obtained a conditional IDE from the FDA
for use of the PRS in the treatment of certain skin cancer tumors (basal cell
and squamous cell carcinomas and Karposi's sarcoma). Clinical treatment of
patients in the study has begun at the U.S. hospital where this program was
initiated.
-22-
<PAGE>
Results of Operations
Fiscal Year Ended January 2, 1999 and January 3, 1998
Revenues: Revenues decreased by $47,374 from $725,374 in 1997 to $678,000
in 1998. The 1997 revenues reflect the sale of two Model 3 PRS systems to
Toshiba. The 1998 revenues reflect the Company's initial sales of the PRS400
system. Cost of Goods Sold decreased by $83,285 from $361,536 in 1997 to
$278,251 in 1998.
Research and development expenses: Research and development expenses
increased by $807,081 from approximately $4.6 million in 1997 to $5.4 million in
1998. The principal costs in research and development were the completion of the
development of the PRS400 for commercialization. The variation also reflects
significant increases in expenses related to the Company's clinical trial
efforts in skin and breast cancer research and development programs, and the
development of applicators for the interstitial portion of the breast program as
well as macular degeneration. Finally, additional costs were incurred in
complying with regulatory agencies in the U.K. concerning breast cancer
research and trial protocol.
General and administrative expenses: General and administrative expenses
increased by $800,705 from approximately $2.3 million in 1997 to approximately
$3.1 million in 1998. The increase is attributable to a growth in personnel from
38 in 1997 to 48 employees in 1998 and related costs. Additional increases
related to legal and professional fees related to the Company's reporting
requirements and other obligations under the Securities Exchange Act of 1934,
general corporate representation, and the protection of intellectual property
rights.
Interest income: Interest income decreased by $269,347 from $819,675 in 1997
to $550,328 in 1998. The change resulted from a reduction in amounts invested as
net proceeds from the Company's initial public offering were used for research
and development and general and administrative expenses and for working capital.
Fiscal Year Ended January 3, 1998 and December 28, 1996
Revenues: The Company had revenues of $725,374 in 1997 compared with $0 in
1996. This change reflects the sale of two PRS Model 3s to Toshiba. Cost of
Goods Sold were $361,536 in 1997 as a result of the sales of the PRS Model 3.
Research and development expenses: Research and development expenses
increased by $1,049,789 from approximately $3.6 million in 1996 to approximately
$4.6 million in 1997. In 1996 certain options were extended two months after the
expiration of the lock-up agreements signed in connection with the Company's
Initial Public Offering. These options were extended to a date which is two
months after the expiration of the lock-up agreements. The Company recorded
compensation expense of $272,600 pursuant to Accounting Principles Board Opinion
No. 25 and allocated $258,100 to research and development expenses. Without
giving effect to the allocation to research and development expenses due to the
extension of stock options, research and development expenses would have
increased by $1,307,889. The principal costs in research and development were
the continued development of the PRS400 for commercialization. The increase also
reflects significant increases in expenses related to the Company's clinical
trial efforts in skin and breast cancer research and development programs, and
the development of applicators for the interstitial portion of the breast
program. Finally, additional costs were incurred in complying with regulatory
agencies in the U.K. concerning breast cancer research and trial protocol,
which the Company anticipates receiving approval in mid 1998.
General and administrative expenses: General and administrative expenses
increased by $794,066 from approximately $1.5 million in 1996 to approximately
$2.3 million in 1997. The increase is attributable to a growth in personnel from
27 in 1996 to 38 employees in 1997 and related costs. Additional increases
related to legal and professional fees related to initial public offering
expenses, and the Company's reporting requirements and other obligations under
the Securities Exchange Act of 1934, as amended, general corporate
representation and the protection of intellectual property rights.
Interest income: Interest income increased by $569,133 from $250,542 in 1996
to $819,675 in 1997. The change resulted from investing the net proceeds of the
Company's initial public offering.
Liquidity and Capital Resources
The Company has expended substantial funds to research and develop the PRS and
other potential products, conduct clinical trials, pursue regulatory approvals,
establish commercial scale manufacturing in its own facilities or in the
facilities
-23-
<PAGE>
of others, and market the PRS. The Company anticipates it will continue to
expend substantial funds in the future on such activities as funds become
available.
Since its inception, the Company has financed its operations through the
issuance of convertible debt and equity in a series of private placements
totaling approximately $20.8 million. On February 4, 1997, the Company completed
an initial public offering of 2,275,000 shares of Common Stock, including the
underwriters' overallotment option, at a price of $8.50 per share. Net proceeds
to the Company from the offering were approximately $16,818,854.
Consolidated working capital was approximately $6.2 million at January 2,
1999, compared with $14.3 million at January 3, 1998. Included in working
capital are cash and cash equivalents of $3.7 million at January 2, 1999,
compared with $2.3 million at January 3, 1998. During 1998, $7.9 million of cash
was used for operating activities.
The Company used $622,388 of cash in 1998 for fixed assets and leasehold
improvements associated with its facility.
The Company received $327,015 of cash in 1998 from the exercise of warrants to
purchase Common Stock.
The Company maintains medical product liability insurance policies with
respect to its clinical trials which the Company believes contain reasonable
deductibles and other ordinary and customary provisions. The Company believes
that these policies cover such risks in such amounts as are reasonable and
prudent under the circumstances, and the Company does not anticipate that claims
under these policies, if any, will have a material adverse impact on the
Company's liquidity or capital resources. Prior to commercial sale of its
products, the Company obtained product liability insurance covering the
commercial use of its products.
During 1998, the Company concluded settlement discussions with a physician and
his employer. The Company had been notified that such physician and his employer
believed that they had certain rights with regard to their understanding of the
Company's planned use of the PRS for treatment of tumors in body cavities. No
formal legal proceedings were initiated and the Company reached an agreement
with the parties as to settlement of the matter. The Company's management
believes that the settlement of the matter will not have a material effect on
the Company's financial position or results of operations.
The Company's business plan calls for various applications of the PRS,
including the treatment of metastatic brain tumors, primary brain tumors, and
tumors in the breast, skin, liver and kidney. The Company estimates that the
capital requirements to complete the commercialization of the PRS400 to treat
brain tumors will be approximately $1.0 million. The Company believes that such
amount is needed to purchase capital equipment for assembly and manufacturing of
components for the PRS400, and to support a sales and marketing structure. At
this point, the Company is not able to estimate the capital requirements of
commercializing other potential applications of the PRS.
The Company's future capital requirements will depend on a variety of factors,
including the time and costs involved in obtaining FDA and other regulatory
approvals, the results of the Company's ongoing clinical trials, the market
acceptance of the PRS and any other Company products, the expense and results of
the Company's continued scientific research and development programs, the time
and costs expended in filing, prosecuting and enforcing patent claims, and the
development of competing technologies. As of January 2, 1999, the Company
estimates that its available cash and cash equivalents, together with revenues,
if any, from product sales, will allow the Company to continue operations for
approximately six months, and that it therefore will be necessary for the
Company to raise additional capital in the near future. Any additional equity
financings may be dilutive to the Company's stockholders. No assurance can be
given that the necessary funds will be available to the Company on acceptable
terms, if at all. Should the Company be unable to raise additional capital on
acceptable terms, there is substantial doubt that the Company will be able to
continue as a going concern.
Market Risk
The Company is exposed to market risk from changes in equity prices, which
could effect its future results of operations and its financial condition. The
Company manages its exposure to this risk through its regular operating and
financing activities. The Company's convertible subordinated note is sensitive
to fluctuations in the price of the Company's common stock into which the note
is convertible. Changes in the price of the underlying common stock would result
in changes in the fair value of the Company's convertible subordinated note due
to the difference between the current market price and the market price at which
the holder of the note may convert. A 10% increase in the year-end 1998 market
equity price would result in a negative impact to the Company of $74,906 on the
fair value of its convertible subordinated note.
Other Matters -- Year 2000 Disclosure:
The Company is well aware of the ramifications of the Year 2000 ("Y2K")
problem. The Company has put together a project team and budget to handle the
tasks required to ensure that Company is Y2K compliant. The project team is
headed by the Company's Information Systems ("IS") department and includes
members from all functional departments of the Company. The Company has broken
the project into five areas of concern: Internal Information Technology ("IT")
systems, internal non-IT systems (embedded processors), Company products,
outside significant third parties (suppliers, financial institutions, customers,
vendors), and contingency planning.
The Company plans to complete the Y2K readiness project with a six phase
approach to dealing with the five areas of concern mentioned above. The phases
will be as follows:
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<PAGE>
1) Identification -- the Company will identify each and every issue it believes
it needs to address in accordance with the concerns set forth above.
2) Detailed Assessment -- the Company will conduct a detailed assessment of the
issues identified so it can document all specific areas to address.
3) Corrective Action Plans -- the Company will define/propose the proper
changes including upgrades, retirements, or new systems.
4) Testing and Certification -- the Company will fully test the proposed
changes and certify the results.
5) Implementation -- the Company will implement the proper changes that were
tested and certified.
6) Contingency Planning -- the Company will define contingencies for all
areas of concerns.
The Company defines the phrase "Y2K compliance" as follows: "That all our
business processes have been tested to our satisfaction so we can state that the
year 2000 date rollover will not affect our ability to manufacture our products
and properly report the financial status of our company". The Company
anticipates that it will be Y2K compliant by the end of third quarter in 1999.
IT systems - 80% completed. The Company has spent the last year upgrading its
Personal Computers (PCs) and servers and has only a few PCs left to upgrade.
The Company is currently in the final testing phase of the upgrade project of
its Enterprise Resource Planning (ERP) software. The Company anticipates
completing that project by the end of March. The Company has upgraded to
compliant versions for most of our desktop applications, with only a few
applications left to research.
Non IT systems - 25% completed. The Company has identified many embedded
processors that are in use around the Company. We have not yet performed any
investigation regarding the processors' Y2K compliance.
Company Products
The embedded software in the PRS400 Treatment System is fully Y2K compliant.
This was a design requirement established during the development of the
software. Additionally, Y2K compliance is formally tested as part of the
software validation testing. The Company completed (the validation testing) in
November of 1998.
The software used to run the Water Phantom System is fully Y2K compliant.
The software does not use any dates for calculations or comparisons. It is
written in a Y2K compliant version of Labview. It runs on a PC with the Windows
3.1 operating system, which is not Y2K compliant. Currently a project is
underway to convert the software to run on Windows 95, which is a Y2K compliant
operating system. The project is about 85% complete with an expected completion
by the end of April, 1999.
Outside Third Parties
The Company has identified many of the outside parties that it will survey
for Y2K compliance. The Company has completed a first draft plan of how the
Company will perform the analysis and survey. The Company will identify the most
critical partners, send them a survey by mail, and then follow up with a phone
call or site visit.
Contingency Planning
The Company plans on completing the Y2K risk analysis before creating a
contingency plan. Although the Company is dedicating substantial resources
towards attaining Y2K readiness, there is no assurance it will be successful in
its efforts to identify and address all Y2K issues. Even if the Company acts in
a timely manner to complete all of its assessments, identify, develop and
implement corrective action plans believed to be adequate, develop contingency
plans believed to be adequate, some problems may not be identified or corrected
in time to prevent material adverse consequences to the Company.
Cost of Compliance
To date, costs incurred in connection with the Y2K issue have not been
material. The Company does not expect total Y2K remediation costs to be
material, but there can be no assurance that the Company will not encounter
unexpected costs or delays in achieving Y2K compliance.
Forward-Looking Statements:
Certain statements contained in this Report, including without limitations,
statements containing the words "expects," "anticipates," "believes" and words
of similar import, constitute "forward looking statements" within the meaning of
the
-25-
<PAGE>
Private Securities Litigation Reform Act of 1995. These forward looking
statements are subject to various risks and uncertainties, including, without
limitation, those referred to herein, that could cause actual future results and
events to differ materially from those currently anticipated. Readers are
cautioned not to place undue reliance on these forward looking statements.
Item 8. Financial Statements and Supplementary Data.
The Company's financial statements begin on page F-3. Reference is made to the
Index to Financial Statements on page F-1 herein.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of The Registrant.
The information required by this item is included in the Definitive Proxy
Statement for the Special Meeting in lieu of the Annual Meeting of Stockholders
on May 25, 1999 to be filed with the Commission on or about April 23, 1999 (the
"Proxy Statement"), under "Director and Executive Officers" and is incorporated
herein by reference.
Item 11. Executive Compensation.
The information required by this Item is included in the Company's Proxy
Statement under "Executive Compensation" and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this Item is included in the Company's Proxy
Statement under "Security Ownership of Certain Beneficial Owners and Management"
and is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information required by this Item is included in the Company's Proxy
Statement under "Certain Relationships and related Transactions" and is
incorporated herein by reference.
PART IV
Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.
(a) See the Exhibit Index included immediately preceding the exhibits to this
Form 10-K.
(b) Financial Data Schedule is included as Exhibit 27 to this Form 10-K. All
other Schedules are not required under the instructions relating to the
applicable accounting regulations of the Securities and Exchange Commission or
are inapplicable, and therefore have been omitted.
(c) Reports on Form 8-K
None.
-26-
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants ............................... F-2
Consolidated Balance Sheets as of January 2, 1999
and January 3, 1998 ............................................... F-3
Consolidated Statements of Operations for the years ended January 2,
1999, January 3, 1998 and December 28, 1996 ....................... F-4
Consolidated Statements of Cash Flows for the years ended January 2,
1999, January 3, 1998 and December 28, 1996 ....................... F-5
Consolidated Statements of Shareholders' (Deficit) Equity at
January 2, 1999, January 3, 1998 and December 28, 1996 ............ F-6
Notes to Consolidated Financial Statements ...................... F-7 to F-15
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Photoelectron Corporation and Subsidiary:
We have audited the accompanying consolidated balance sheets of Photoelectron
Corporation and its subsidiary (a Massachusetts corporation in the development
stage) as of January 3, 1998 and January 2, 1999, and the related consolidated
statements of operations, shareholders' (deficit) equity and cash flows for the
three years ended January 2, 1999 and for the period from inception (January 4,
1989) to January 2, 1999. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of
Photoelectron Corporation and its subsidiary as of January 3, 1998 and January
2, 1999, and the results of their operations and their cash flows for the three
years ended January 2, 1999 and for the period from inception (January 4, 1989)
to January 2, 1999, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. The Company has incurred losses from
operations for the year ended January 2, 1999 and from inception (January 4,
1989) to January 2, 1999, and anticipates operating losses and other cash
requirements in the next 12 months in excess of available cash. Therefore, the
Company will need to obtain additional funding or alternative means of support
or both, in order to continue as a going concern. In the event such funding or
financial support is not available, there is substantial doubt concerning the
Company's ability to continue as a going concern. Management's plans in regard
to these matters are discussed in Note 1. The accompanying financial statements
do not include any adjustments relating to the recoverability of asset carrying
amounts that might result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 17, 1999
(except with respect
to the matters
discussed in Note 12
as to which the date
is March 26, 1999)
F-2
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
January 3, January 2,
1998 1999
------------- -------------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents ...................................... $ 2,286,583 $ 3,686,457
Inventories .................................................... 383,051 1,454,706
Prepaid expenses ............................................... 413,707 336,287
Held to maturity investments (Note 2)............................ 11,889,356 1,993,056
Other current assets ........................................... 29,111 375,803
------------ ------------
Total current assets ........................................ 15,001,808 7,846,309
------------ ------------
Property and Equipment:
Computer equipment ............................................. 684,027 899,085
Laboratory and production equipment ............................ 630,472 926,352
Clinical site equipment ........................................ 752,952 801,965
Furniture and fixtures ......................................... 149,513 165,898
Leasehold improvements ......................................... 758,211 804,263
------------ ------------
Property and equipment........................................... 2,975,175 3,597,563
Less--Accumulated depreciation and amortization ................ 1,631,961 2,308,683
------------ ------------
Net property and equipment............................... 1,343,214 1,288,880
------------ ------------
Other long-term assets ......................................... 80,211 -
Total assets ................................................ $ 16,425,233 $ 9,135,189
============ ============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable ............................................... $ 297,514 $ 346,363
Accrued expenses (Note 3) ..................................... 398,180 561,650
Accrued payroll and benefits ................................... 31,977 55,409
Current portion of convertible subordinated notes (Note 8) ..... - 719,100
------------ ------------
Total current liabilities ................................... 727,671 1,682,522
------------ ------------
Long-Term Debt:
Convertible subordinated notes and other advances, net of
Current portion (Note 8) .................................... 1,685,547 -
------------ ------------
Commitments and Contingencies (Note 7)
Shareholders' Equity (Notes 8 , 9 and 10):
Preferred stock, $0.01 par value--
Authorized--7,500,000 shares
Issued and outstanding--none at January 3, 1998, and
January 2, 1999 ............................................... - -
Common stock, $0.01 par value --
Authorized--15,000,000 shares
Issued and outstanding--7,362,251 and 7,704,254 at
January 3, 1998, and January 2, 1999
respectively ................................................ 73,622 77,042
Capital in excess of par value--common stock ..................... 37,220,144 38,324,377
Deferred compensation ............................................ (17,180) (29,913)
Subscription receivable .......................................... (25,583) ( 5,842)
Deficit accumulated during development stage ..................... (23,238,988) (30,912,997)
------------ ------------
Total shareholders' equity .................................. 14,012,015 7,452,667
------------ ------------
Total liabilities and shareholders' equity .................. $ 16,425,233 $ 9,135,189
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended Period
----------------------------------------- from Inception
December 28, January 3, January 2, (January 4, 1989)
1996 1998 1999 To January 2, 1999
------------- ------------ ------------ -----------------
<S> <C> <C> <C> <C>
Revenues.............................................. $ -- $ 725,374 $ 678,000 $ 1,403,374
Cost of Goods Sold.................................... -- 361,536 278,251 639,787
----------- ----------- ----------- ------------
Gross Margin.......................................... -- 363,838 399,749 763,587
Operating Expenses:
Research and development expenses ................. 3,576,601 4,626,390 5,433,471 23,310,129
Selling, general and administrative expenses........ 1,512,275 2,306,341 3,107,046 9,036,723
----------- ----------- ----------- ------------
Total operating expenses.......................... 5,088,876 6,932,731 8,540,517 32,346,852
----------- ----------- ----------- ------------
Operating loss .................................. (5,088,876) (6,568,893) (8,140,768) (31,583,265)
----------- ----------- ----------- ------------
Interest income ..................................... 250,542 819,675 550,328 1,818,141
Interest expense .................................... (120,437) (106,401) ( 83,569) (1,147,873)
----------- ----------- ----------- ------------
Interest income, net ................................ 130,105 713,274 466,759 670,268
----------- ----------- ----------- ------------
Net loss.............................................. $(4,958,771) $(5,855,619) $(7,674,009) $(30,912,997)
=========== =========== =========== ============
Basic and diluted net loss per share (Note 11)........ $(3.12) $(0.87) $(1.02)
=========== =========== ===========
Weighted average basic and diluted shares (Note 11)... 1,587,968 6,693,689 7,489,038
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
Year Ended Period
------------------------------------------- from Inception
December 28, January 3, January 2, (January 4, 1989 to
1996 1998 1999 January 2, 1999)
---- ---- ---- ----------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss....................................................... $(4,958,771) $ (5,855,619) $ (7,674,009) $ (30,912,997)
Adjustments to reconcile net loss to net cash used in
Operating activities--
Depreciation and amortization.................................. 325,939 733,834 676,722 2,317,274
Noncash interest converted to subordinated notes............... 103,147 106,401 83,562 1,060,558
Noncash salary converted to common stock ..................... 50,000 -- -- 250,000
Noncash research and development expense converted to
subordinated notes ......................................... -- -- -- 9,000
Noncash compensation expense ................................. 272,600 1,562 45,653 1,179,815
Changes in current accounts--
Inventories .................................................. 171,876 (59,337) (1,071,655) (1,454,436)
Prepaid expenses ............................................. (89,270) 105,699 77,420 (28,087)
Other current assets ......................................... 41,403 (240) (266,481) (295,592)
Accounts payable ............................................. 103,772 (10,281) 48,849 346,363
Accrued expenses ............................................. (93,725) 150,073 186,902 416,111
----------- ------------ ------------ -------------
Net cash used in operating activities ........................ (4,073,029) (4,827,908) (7,893,037) (27,111,991)
----------- ------------ ------------ -------------
Cash flows from investing activities:
(Purchases) Maturation of held to maturity investments ....... -- (11,889,356) 9,896,300 (1,993,056)
Purchases of equipment and leasehold improvements ............ (737,531) (842,023) (622,388) (3,572,717)
Loan to officer................................................ -- (80,211) -- (80,211)
Proceeds from sale of equipment and leasehold
Improvements ............................................... -- -- -- 9,845
----------- ------------ ------------ -------------
Net cash (used in) provided by investing activities .......... (737,531) (12,811,590) 9,273,912 (5,636,139)
----------- ------------ ------------ -------------
Cash flows from financing activities:
Proceeds from issuance of common stock ....................... 29,321 17,389,058 281,362 18,266,868
Proceeds from issuance of preferred stock .................... 600,000 -- -- 13,385,370
Proceeds from issuance of subordinated convertible notes ..... -- -- -- 5,322,000
Proceeds from issuance of warrants ........................... -- -- -- 236,453
Offering expenses ............................................ (473,006) -- -- (473,006)
Payments under capital lease obligations ..................... -- -- -- (40,735)
Payments of subordinated notes ............................... -- -- (262,363) (262,363)
----------- ------------ ------------ -------------
Net cash provided by financing activities .................... 156,315 17,389,058 18,999 36,434,587
----------- ------------ ------------ -------------
Increase (decrease) in cash and cash equivalents ............... (4,654,245) (250,440) 1,399,874 3,686,457
----------- ------------ ------------ -------------
Cash and cash equivalents, beginning of period ................. 7,191,268 2,537,023 2,286,583 --
----------- ------------ ------------ -------------
Cash and cash equivalents, end of period ....................... 2,537,023 2,286,583 3,686,457 3,686,457
=========== ============ ============ =============
Noncash financing activities:
Conversion of salary expense to common stock ................. $ 50,000 $ -- $ -- $ 250,000
=========== ============ ============ =============
Conversion of convertible subordinated notes to common stock... $ -- $ 464,230 $ 787,647 $ 5,278,892
=========== ============ ============ =============
Conversion of common stock to preferred stock ................ $ -- $ -- $ -- $ 3,846,015
=========== ============ ============ =============
Capital lease obligation incurred for equipment .............. $ -- $ -- $ -- $ 40,383
=========== ============ ============ =============
Conversion of preferred stock to common stock ................ $ -- $ 28,923 $ -- $ 28,923
=========== ============ ============ =============
Conversion of convertible subordinated notes to warrants ..... $ -- $ -- $ -- $ 47,000
=========== ============ ============ =============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' (DEFICIT) EQUITY
<TABLE>
<CAPTION>
Common
Preferred Common Stock Preferred
Stock, Stock, Capital in Stock Capital
$0.01 $0.01 Excess of in Excess of
Par Value Par Value Par Value Par Value
--------- --------- ------------ -------------
<S> <C> <C> <C> <C>
Initial issuance of common stock ........................ $ -- $ 7,475 $ 291,525 $ --
Net Loss .............................................. -- -- -- --
--------- -------- ----------- -------------
Balance, December 28, 1989 .............................. -- 7,475 291,525 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, December 29, 1990 .............................. -- 7,475 291,525 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, December 28, 1991 .............................. -- 7,475 291,525 --
Issuance of common stock .............................. -- 2,042 147,958 --
Issuance of warrants .................................. -- -- 121,453 --
Net Loss ............................................... -- -- -- --
-------- -------- ----------- -------------
Balance, January 2, 1993 ................................ -- 9,517 560,936 --
Issuance of common stock .............................. -- 166 49,833 --
Conversion of convertible
Subordinated notes and related
Accrued interest into common
Stock ............................................... -- 12,820 3,833,195 --
Issuance of warrants .................................. -- -- 115,000 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, January 1, 1994 ................................ -- 22,503 4,558,964 --
Issuance of common stock .............................. -- 1,376 411,625 --
Conversion of common stock into
Preferred stock, Series A ........................... 12,820 (12,820) (3,833,195) 3,833,195
Issuance of preferred stock, Series B ................. 5,000 -- -- 3,930,771
Issuance of warrants .................................. -- -- 47,000 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, December 31, 1994 .............................. 17,820 11,059 1,184,394 7,763,966
Issuance of common stock .............................. -- 64 49,938 --
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock ................................... -- 4,714 248,686 --
Issuance of preferred stock, Series C ................. 10,992 -- -- 9,338,608
Extension of stock options ............................ -- -- 860,000 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, December 30, 1995 .............................. 28,812 15,837 2,343,018 17,102,574
Issuance of common stock .............................. -- 142 64,106 --
Proceeds from issuance of Series
Preferred stock ..................................... 111 -- -- 99,889
Extension of stock options.............................. -- -- 272,600 --
Net Loss .............................................. -- -- -- --
-------- -------- ----------- -------------
Balance, December 28, 1996 .............................. 28,923 15,979 2,679,724 17,202,463
Issuance of common stock .............................. -- 22,750 16,796,104 --
Anti-dilution, preferred stock, Series C................. -- 355 (355) --
Conversion of preferred stock, Series A................. (12,820) 12,820 3,833,195 (3,833,195
Conversion of preferred stock, Series B.................. (5,000) 5,000 3,930,771 (3,930,771
Conversion of preferred stock, Series C.................. (11,103) 11,103 9,438,497 (9,438,497
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock .................................... -- 4,135 460,095 --
Exercise of stock options................................ -- 1,480 63,370 --
Recording of deferred compensation....................... -- -- 18,743 --
Payment of subscription receivable....................... -- -- -- --
Net Loss................................................ -- -- -- --
-------- -------- ----------- -------------
Balance, January 3, 1998.................................. $ - 73,622 37,220,144 --
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock ................................... -- 2,262 785,385 --
Exercise of stock options............................... -- 485 59,135 --
Exercise of warrants.................................... -- 673 201,327 --
Recording of deferred compensation...................... -- -- 58,386 --
Payment of subscription receivable...................... -- -- -- --
Net Loss................................................ -- -- -- --
-------- -------- ----------- -------------
Balance, January 2, 1999.................................. $ -- $ 77,042 $38,324,377 $ --
-------- -------- ----------- -------------
<PAGE>
Deficit
Accumulated
During
Deferred Subscription Development
Compensation Receivable Stage
------------ ------------ -------------
<S> <C> <C> <C>
Initial issuance of common stock ........................ $ -- $ -- $ --
Net Loss .............................................. -- -- (414,045)
------------ --------- ------------
Balance, December 28, 1989 .............................. -- -- (414,045)
Net Loss .............................................. -- -- (394,275)
------------ --------- ------------
Balance, December 29, 1990 .............................. -- -- (808,320)
Net Loss .............................................. -- -- (973,773)
------------ --------- ------------
Balance, December 28, 1991 .............................. -- -- (1,782,093)
Issuance of common stock .............................. -- -- --
Issuance of warrants .................................. -- -- --
Net Loss ............................................... -- -- (1,586,239)
------------ --------- ------------
Balance, January 2, 1993 ................................ -- -- (3,368,332)
Issuance of common stock .............................. -- -- --
Conversion of convertible
Subordinated notes and related
Accrued interest into common
Stock ............................................... -- -- --
Issuance of warrants .................................. -- -- --
Net Loss .............................................. -- -- (2,267,460)
------------ --------- ------------
Balance, January 1, 1994 ................................ -- -- (5,635,792)
Issuance of common stock .............................. -- (94,874) --
Conversion of common stock into --
Preferred stock, Series A ........................... -- --
Issuance of preferred stock, Series B ................. -- -- --
Issuance of warrants .................................. -- -- --
Net Loss .............................................. -- -- (2,671,648)
------------ --------- ------------
Balance, December 31, 1994 .............................. -- (94,874) (8,307,440)
Issuance of common stock .............................. -- 21,870 --
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock ................................... -- -- --
Issuance of preferred stock, Series C ................. -- (500,000)
Extension of stock options ............................ -- -- --
Net Loss .............................................. -- -- (4,117,158)
------------ --------- ------------
Balance, December 30, 1995 .............................. -- (573,004) (12,424,598)
Issuance of common stock .............................. -- 15,073 --
Proceeds from issuance of Series
Preferred stock ..................................... -- 500,000 --
Extension of stock options.............................. -- -- --
Net Loss .............................................. -- -- (4,958,771)
------------ --------- ------------
Balance, December 28, 1996 .............................. -- (57,931) (17,383,369)
Issuance of common stock .............................. -- -- --
Anti-dilution, preferred stock, Series C................. -- -- --
Conversion of preferred stock, Series A................. -- -- --
Conversion of preferred stock, Series B.................. -- -- --
Conversion of preferred stock, Series C.................. -- -- --
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock .................................... -- -- --
Exercise of stock options................................ -- -- --
Recording of deferred compensation....................... (17,180) -- --
Payment of subscription receivable....................... 32,348 --
Net Loss................................................ -- -- (5,855,619)
------------ --------- ------------
Balance, January 3, 1998.................................. (17,180) (25,583) (23,238,988)
Conversion of convertible subordinated
Notes and related accrued interest
Into common stock ...................................
Exercise of stock options............................... -- -- --
Exercise of warrants.................................... -- -- --
Recording of deferred compensation...................... -- -- --
Payment of subscription receivable...................... (12,733) -- --
Net Loss................................................ -- 19,741 --
Balance, January 2, 1999.................................. -- -- (7,674,009)
------------ --------- ------------
Balance, January 2, 1999.................................. (29,913) $ (5,842) $(30,912,997)
------------ --------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
(1) Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations and Relationship to Principal Shareholders
On January 4, 1989, Photoelectron Corporation (the "Company") was founded as
a joint financing by Thermo Electron Corporation ("Thermo Electron") and PYC
Corporation ("PYC"), which is owned by members of the immediate family of Mr.
Peter M. Nomikos. Since inception, the majority of the Company's time and effort
has been focused on the design, development and commercialization of the Photon
Radiosurgery System ("PRS"), a proprietary, therapeutic device for the
treatment of cancerous tumors through the application of radiation directly into
a tumor. The PRS delivers radiation through a thin, minimally invasive, needle-
like probe, which emits from its tip precisely regulated x-ray photons. To
management's knowledge, no company has yet marketed a salable product using
technology similar to the PRS that has been developed by the Company. Even if
marketing efforts are successful, substantial time will pass before significant
revenues will be realized, and the Company may require additional funds during
this period. These funds may not be readily available to the Company.
The Company has completed clinical studies of PRS treatment of brain tumors
under an Investigational Device Exemption (IDE) granted by the U.S. Food and
Drug Administration (FDA) and similar approvals in other countries. Based on
results of these clinical trials, on June 20, 1997, the Company received a
510(k) marketing clearance from the FDA to market the Model 3 of the PRS for
treatment of intracranial tumors. Subsequently, the Company obtained a 510(k)
marketing clearance on July 21, 1998, for the PRS400, which the Company was
developing for introduction as its first commercial product. Simultaneous with
completion of PRS400 product development, the Company was completing
implementation of programs to insure compliance with the FDA's cGMP standards.
The Company also completed the process of seeking certification to the Medical
Device Directive Annex II, enabling self-certification of the European Community
Mark (CE). On December 18, 1998, the Company initiated commercial distribution
of the PRS400.
On December 13, 1995, the Company and Toshiba Medical Systems Company Ltd.
("'Toshiba") entered into an agreement pursuant to which Toshiba is helping to
develop and support clinical trials of the PRS in Japan. The development and
support of the clinical trials included purchasing two complete systems of the
PRS for use in the clinical trials, installing and maintaining the PRS systems,
and providing assistance to the physicians and hospitals conducting the trials,
including collection and analysis of clinical data. The application to conduct
clinical trials was approved by the Ministry of Health and Welfare (MHW) in
Japan in 1995. In 1997, Toshiba purchased, took delivery and installed the first
of the two PRS systems to be used in these clinical trials. The first clinical
site began treatment of patients in the MHW approved clinical trials in February
of 1997. The Company delivered the second PRS system to Toshiba in the third
quarter of 1997, and the clinical trials began at the second site in the fourth
quarter of 1997. Clinical trials of the PRS in Japan were completed at the first
clinical site in 1998 and the second clinical site in the first quarter of 1999.
The Company and Toshiba expect to submit to the Japan Ministry of Health an
application for product approval (shonin) of the PRS400 in the second quarter of
1999. Contingent upon that submission being made in timely fashion, the Company
and Toshiba expect to obtain product approval (shonin) in Japan for the PRS400
in the second half of 1999. Once regulatory approvals for the PRS are obtained
in Japan, Toshiba will serve as its exclusive distributor in Japan. Toshiba also
invested approximately $2 million in equity of the Company's Series C Preferred
Stock offering, which converted to common stock upon the closing of the
Company's initial public offering. (See Note 9).
The Company has incurred a net loss for the year ended January 2, 1999, as
well as for the period since inception. The Company has funded these losses
principally through debt and equity financings. The Company is anticipating
operating losses and other cash requirements in the next 12 months in excess of
available cash. Management will be required to obtain additional funding or
alternative means of financial support, or both; however, there can be no
assurances that such funding or financial support will be available or adequate
to allow the Company to continue as a going concern. Management is currently
pursuing various sources of financial support including obtaining private
funding. In the event that these or other plans are not successful, there is
substantial doubt concerning the Company's ability to continue as a going
concern.
Fiscal Years
The Company has adopted a fiscal year ending on the Saturday nearest December
31. References to 1998, 1997, and 1996 are for the fiscal years ended January 2,
1999, January 3, 1998, and December 28, 1996, respectively. Fiscal year 1997
included 53 weeks; 1998 and 1996 each included 52 weeks.
Inventory
F-7
<PAGE>
Inventories are stated at the lower of cost (first-in, first-out basis) or
market and include materials, labor and overhead. The Company has parts,
supplies and manufactured parts in inventory which are intended to be used and
capitalized as part of the Company's PRS units that will be used for
distribution and in clinical trials.
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 expenses and income during the reporting period. Actual
results could differ from those estimates.
Property and Equipment
The cost of additions and improvements are capitalized while maintenance and
repairs are charged to expense as incurred. The Company provides for
depreciation and amortization on the straight-line method over the estimated
useful lives of the property as follows:
Asset Classification Estimated Useful Life
- -------------------- -----------------------------------------
Machinery and equipment ......... 5 Years
Clinical site equipment ......... The shorter of three years or the life
of the agreement
Furniture and fixtures .......... 3-5 Years
Computer equipment & software..... 2-5 Years
Leasehold improvements............ The shorter of the term of the lease
or the life of the asset
Management believes that the useful lives selected result in net book values
which approximate net realizable values based upon alternate future uses.
Periodically, management reviews specific assets to verify this assertion.
Cash and Cash Equivalents
As of January 2, 1999, cash and cash equivalents include the Company's
operating accounts and holdings of a money market mutual fund as well as
commercial paper which has an original maturity of three months or less. Highly
liquid investments with an original maturity of 3 months or less at the date of
the acquisition are considered to be cash equivalents. Similar investments with
original maturity beyond three months are classified as held to maturity
investments. Cash equivalents are carried at cost, which approximate market
value.
Held to Maturity Investments
Pursuant to Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities", the Company
classifies its investments in commercial paper as held to maturity and measures
the value of such investments at amortized cost if the Company has the positive
intent and ability to hold such investments to maturity. Interest income,
including amortization of premiums and discounts, is recorded in earnings.
Management reviews all reductions in fair value below book value to determine if
an impairment is other than temporary in nature; if this occurs, the carrying
value of the investment is written down to the appropriate level by a charge to
earnings.
Income Taxes
The Company adopted SFAS No. 109, "Accounting for Income Taxes", as of the
beginning of 1989. Under SFAS No. 109, deferred tax assets and liabilities are
recognized for the expected future tax consequences of events that have been
included in the financial statements or in the tax returns. The amount of
deferred tax asset or liability is based on the difference between the financial
statement and tax basis of assets and liabilities using enacted tax rates in
effect for the year in which the differences are expected to be reflected in the
tax return.
F-8
<PAGE>
Revenue Recognition
The Company generally recognizes revenue and provides a reserve for its
estimated warranty upon the acceptance of its product by the customer.
Research and Development Expenses
Research and development expenses include the portion of indirect costs
allocable to research and development efforts based on actual labor hours
incurred.
In connection with the Phase II FDA clinical trials, as well as the efforts to
obtain the CE Mark, PRS units have been provided to certain hospitals to conduct
the clinical trials. The cost of these units and the related accumulated
depreciation is included in property and equipment in the accompanying
consolidated balance sheets. The cost of the units is charged to research and
development expenses over the term of the agreements with the hospitals.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiary, Photoelectron (Europe) Ltd. All
material inter-company accounts and transactions have been eliminated.
Foreign Currency
All assets and liabilities of the Company's foreign subsidiary are translated
at year-end exchange rates, and revenues and expenses are translated at average
exchange rates for the year in accordance with SFAS No. 52, "Foreign Currency
Translation". Resulting translation adjustments are not material. Foreign
currency transaction gains and losses included in the accompanying consolidated
statements of operations are not material for the three years presented.
Net Loss Per Share
During the fourth quarter of 1997, the Company adopted SFAS 128, "Earnings
per Share" (Note 11). As a result, all previously reported loss per share data
have been restated. Basic loss per share have been computed by dividing net loss
by the weighted average number of shares outstanding during the year. Diluted
loss per share has been computed by excluding the effect of exercising the stock
options which are all anti-dilutive given the operating losses of the company,
and excluding the exercise of stock options and convertible securities, which
were deemed to be anti-dilutive.
Fair Value of Financial Instruments
The Company's financial instruments primarily consist of cash and cash
equivalents, held to maturity investments, accounts payable and convertible
subordinated notes. The fair value of the Company's convertible subordinated
notes is primarily determined by the ability to convert those notes into common
stock. The fair value of the convertible subordinated notes is approximately
$4,674,728, and approximately $749,063 at January 3, 1998 and January 2, 1999,
respectively, based upon the estimated fair value of the underlying common
stock. The held to maturity investments are carried at amortized cost on the
accompanying balance sheet. See Note 2 for fair value disclosure. The carrying
amounts of the Company's remaining financial instruments approximate fair value
due to their short-term nature.
Stock Option Plans
The Company applies Accounting Principles Board Opinion (APB) No. 25,
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for its stock options granted to employees (Note 10). Accordingly, no
accounting recognition is given to such stock options granted at fair market
value until they are exercised. Upon exercise, net proceeds including tax
benefits realized, if any, are credited to equity. Stock options granted to
non-employees are accounted for under the provisions of SFAS 123, "Accounting
for Stock Based Compensation" and EITF 96-18. Such guidance requires that
options granted to non-employees are recorded at fair market value.
(2) Held to Maturity Investments
Investments in commercial paper are classified as held to maturity as of
January 2, 1999. The amortized cost and fair values as of January 3, 1998 and
January 2, 1999 are as follows:
F-9
<PAGE>
Commercial Paper
Amortized Cost Gross Unrealized Loss Fair Value
-------------- --------------------- ------------
January 3, 1998 $11,889,356 $12,056 $11,877,300
January 2, 1999 $ 1,993,056 $ 1,396 $ 1,991,660
All the commercial paper has a contractual maturity due within one year.
(3) Accrued Liabilities
Accrued expenses in the accompanying balance sheet includes the following
balances:
1997 1998
-------- --------
Warranty Accrual $180,000 $204,000
Annual Report Accrual 60,000 61,000
Other Accrued Expenses 158,180 296,650
-------- --------
$398,180 $561,650
======== ========
(4) Income Taxes
The components of the deferred tax asset at January 3, 1998 and January 2,
1999 are as follows:
1997 1998
------------- -------------
Deferred tax asset--
Federal tax loss carryforwards ......... $ 6,707,000 $ 9,185,000
Federal tax credit carryforwards ....... 645,000 871,000
State tax loss carryforwards ........... 1,589,000 2,070,000
State tax credit carryforwards ......... 689,000 781,000
Other, net ............................. 671,000 728,000
------------ ------------
10,301,000 13,635,000
Valuation allowance .................... (10,301,000) (13,635,000)
------------ ------------
Deferred tax asset .................. $ -- $ --
============ ============
As of January 2 1999, the Company had federal net operating loss carryforwards
of approximately $27,014,000, state net operating loss carryforwards of
approximately $21,787,000, federal tax credit carryforwards of approximately
$871,000, and state tax credit carryforwards of approximately $781,000. Due to
the fact that the Company has sustained cumulative losses, the potential future
benefit of these attributes, which expire in the years 1999 through 2013, is
fully reserved by means of a valuation allowance because their realization is
uncertain.
Certain stock transactions may result in a change of control under Sections
382 and 383 of the Internal Revenue Code of 1986, as amended; and as a result,
the net operating loss and tax credit carryforwards available to be utilized in
any given year may be limited, and certain amounts of the net operating loss
carryforwards may expire unutilized due to such limitations.
(5) Employee Benefit Plan
In April 1995, the Company terminated its Simplified Employee Pension Plan
("SEPP") and adopted a 401(k) Plan. No obligations arose from the termination
of the SEPP. The impact of the SEPP was not material to the operating results
prior to termination. The Company contributes 50% of the first 6% of annual
earnings for each employee with at least three months of service. During 1997
and 1998, the Company contributed approximately $37,224 and $62,997,
respectively.
F-10
<PAGE>
(6) Related Party Transactions
Thermo Electron Corporation
On January 4, 1989, the Company entered into a corporate service agreement
with Thermo Electron. Under this agreement, Thermo Electron provided certain
administrative services, including legal advice and services, certain employee
benefit administration, tax advice and preparation, space allocation and
utilities. This agreement terminated on December 31, 1989. The Company has
continued to utilize Thermo Electron's resources since that date on an as-needed
basis without a formal contract and is charged at actual cost for such services.
The Company paid $3,582, $3,253 and $4,952 in 1996, 1997 and 1998, respectively,
for these services.
Thermo Power Corporation
The Company is provided with certain services by Thermo Power Corporation, a
79%-owned subsidiary of Thermo Electron. These services include data processing
services, administrative services and machine shop services, which are charged
to the Company at actual cost. The Company paid $159,263, $113,582, and $229,953
in 1996, 1997 and 1998, respectively, for these services. As of January 3, 1998,
and January 2, 1999, $15,599, and $534 respectively, was payable to Thermo Power
Corporation and was included in accounts payable in the accompanying
consolidated balance sheets.
Management believes that the fees charged by Thermo Electron and Thermo Power
Corporation are reasonable and such fees are representative of the expenses the
Company would have incurred on a stand-alone basis.
(7) Commitments and Contingencies
Litigation
The Company is party to legal matters which arise in the normal course of
business. Management, after reviewing these matters with legal counsel, is of
the opinion that the resolution of these matters will not have a material effect
on the financial condition or results of operations.
Leases
In 1996, the Company entered into a new operating lease for its office and
research facilities expiring in July, 2002. The minimum lease payments under the
new agreement are $286,162 in 1999, $273,854 in 2000, $285,723 in 2001 and
$169,222 in 2002. The total future minimum lease payments are $1,014,961. The
accompanying consolidated statements of operations include expenses for
operating leases of $135,472, $307,975, and $404,914 for 1996, 1997 and 1998,
respectively.
(8) Convertible Subordinated Notes
On January 4, 1989, the Company issued and sold $181,000 of 8% subordinated
convertible debenture to Thermo Electron, due in 1995. The debentures were
convertible into shares of the Company's Common Stock at a conversion price of
$0.30. On December 30, 1995, Thermo Electron elected to convert its $181,000
subordinated convertible debenture and accrued interest into 471,354 shares of
Common Stock. On May 22, 1990, the Company issued and sold $125,000 and $175,000
principal amounts of 8% subordinated convertible debentures to Thermo Electron
and Mr. Peter M. Nomikos, respectively, due in 1998. The debentures were
convertible into shares of the Company's Common Stock at a conversion price of
$0.80. Also in 1990, the Company issued and sold $52,000 principal amount of 8%
subordinated convertible debentures to Mr. Peter M. Nomikos, due in 1998. The
note was convertible into shares of the Company's Common Stock at a conversion
price of $3.00. In 1991, the Company issued and sold $448,000 principal amount
of 8% subordinated convertible debentures to Mr. Peter M. Nomikos, due in 1998.
The note was convertible into shares of the Company's Common Stock at a
conversion price of $3.00. All of these debentures also provided for the
conversion of accrued interest into Common Stock at maturity. The accrued
interest was convertible into Common Stock at a conversion price equal to the
average fair market value of the Company's Common Stock on the first ten days of
trading of the fiscal quarter in which the interest to be converted accrued.
On May 13, 1992, the Company entered into a $4,500,000 8% convertible
subordinated demand note and warrant purchase agreement with Mr. Peter M.
Nomikos. These notes are convertible into Common Stock at a conversion price of
$3.00 on demand. The Company borrowed $4,252,000 in the form of a demand loan
with detachable warrant purchase rights under this agreement, of which $705,000
is still outstanding. At January 2, 1999, the Company is not aware of any
intention by Mr. Peter M. Nomikos of converting these debentures into shares of
the Company's common stock. All earned but unpaid interest on the subordinated
demand loan is convertible into Common Stock at a conversion price equal to the
fair market value of the Company's Common Stock on the first day of the fiscal
quarter in which the interest to be converted accrued.
F-11
<PAGE>
The warrant purchase rights entitled the holder to purchase warrants for
$0.20. Each warrant is exercisable upon issuance and allows the holder to
purchase one share of Common Stock at $3.00. At January 2, 1999, warrants to
purchase 1,310,000 shares of the Company's Common Stock were outstanding. These
remaining warrants expire as follows 120,000, 140,000, 140,000, 100,000,
575,000, and 235,000 on March 28, 1999, June 27, 1999, September 26, 1999,
December 28, 1999, September 29, 2000, and January 27, 2002, respectively. All
warrants purchased by Mr. Nomikos have been accounted for as Capital in excess
of par value common stock. All warrants issued to date are now held by PYC
Corporation.
In 1993, 1,282,005 shares of Common Stock were issued upon the conversion of
$3,547,000 principal amount of subordinated convertible debentures and $299,015
of related accrued interest. In 1994, these shares of Common Stock were
converted into Series A Convertible Preferred Stock and, upon the closing of the
Company's initial public offering in 1997, converted again into stock. (See Note
9).
In 1997, 171,257 and 242,334 shares of Common Stock were issued upon the
conversion of $125,000 principle amount and $65,210 of related accrued interest
and $175,000 principle amount and $99,020 accrued interest of subordinated
convertible debentures to Thermo Electron Corporation and Mr. Peter M. Nomikos,
respectively.
In 1998, 226,170 shares of Common Stock were issued upon conversion of
$500,000 principal amount and $287,647 accrued interest of subordinated
convertible debentures to Mr. Peter M. Nomikos. Also in 1998, 67,333 shares of
Common Stock were issued to PYC Corporation for warrants exercised for the
consideration of $202,000.
(9) Common and Preferred Stock
On January 4, 1989, the Company authorized 6,000,000 shares of $0.01 par value
Common Stock and issued 147,488 shares to Thermo Electron and 600,000 shares to
PYC Corporation at $0.40 per share. The Company authorized an additional
9,000,000 shares of Common Stock in 1994 to accommodate possible stock issuance
as a result of stock splits, note conversions and options issued under the stock
option plan and potential future stock offerings. In 1992, Mr. Peter M. Nomikos
was granted stock in lieu of compensation for 1990, 1991 and 1992 in the
cumulative amount of 204,167 common shares. In 1994, 1995 and 1996, Mr. Peter M.
Nomikos was granted stock in lieu of compensation in the amount of 16,667, 6,250
and 5,556 shares of Common Stock, respectively. All such shares were recorded as
compensation expense at the estimated fair value per share on the date that such
shares were granted to Mr. Nomikos. In fiscal 1993, 1,282,005 shares of Common
Stock were issued upon the conversion of $3,846,015 of subordinated convertible
debentures and accrued interest (See Note 8).
The Company has authorized 7,500,000 shares of $0.01 par value preferred. On
March 18, 1994, the Board of Directors approved the conversion of 1,282,005
shares of Common Stock held by Mr. Peter M. Nomikos into Series A Convertible
Preferred Stock on a one-for-one basis. These shares permit the holder to
convert his or her holdings into Common Stock on a one-for-one basis, subject to
certain anti-dilution provisions. The Series A Convertible Preferred Stock had a
liquidation preference of $3.00 per share (See Note 8).
The Company sold 500,000 shares of Series B Convertible Preferred Stock at
$8.00 per share in 1994. These shares permit the holder to convert his or her
holdings into Common Stock on a one-for-one basis, subject to certain anti-
dilution provisions. The Series B Convertible Preferred Stock had a liquidation
preference of $8.00 per share, which is senior to the Company's Common Stock and
junior to the Series A Convertible Preferred Stock. The purchase of the Series B
shares also entitled the purchaser to rights to participate in the Company's
next offering of preferred stock at a 10% discount. The rights entitle the
purchaser to this discount on an amount of shares equal to the purchaser's pro
rata participation in the Series B offering.
The Company sold 680,005 shares of Series C Convertible Preferred Stock at
$9.00 per share in 1995. The Company also sold 419,191 additional shares of
Series C Convertible Preferred Stock in exchange for $8.10 per share. This
latter, discounted price was paid by those stockholders who acquired such right
in the Series B offering as described above. These shares permit the holder to
convert his or her holdings into Common Stock on a one-for-one basis, subject to
certain anti-dilution provisions. The Series C Convertible Preferred Stock has a
liquidation preference of $9.00 per share, which is senior to the Company's
Common Stock and junior to the Series A and B Convertible Preferred Stock.
All of the Company's convertible preferred stock automatically converted to
Common Stock upon the closing of the Company's Initial Public Offering.
F-12
<PAGE>
In 1994, the Company sold 121,000 shares of Common Stock to employees of the
Company for $3.00 per share pursuant to a one-time employee stock purchase
offering. A total of 85,500 of those shares were paid for at the time of the
offering. Consideration for the remaining 35,500 shares was in the form of
promissory notes executed by employees in favor of the Company. The balance of
these notes is $57,931 ,$25,583 and $5,842 in 1996, 1997, and 1998 respectively,
and is described in the accompanying balance sheet as a subscription receivable.
On December 3, 1996, the stockholders of the Company approved a one-for-two
reverse stock split of the Company's Common Stock and Preferred Stock. All share
and per share information has been retroactively restated to reflect this
reverse stock split.
F-13
<PAGE>
(10) Stock Option Plan
In 1989, the Company adopted the 1989 Stock Option Plan (the "1989 Plan"). The
1989 Plan provided that options may be granted at any price determined by the
Board of Directors for key employees, directors and consultants. The Board of
Directors granted 733,225 non-qualified stock options under the 1989 Plan.
Options granted under the 1989 Plan expire seven to twelve years after the date
of grant and in general vest at 20% per year. When an optionee ceases to be an
employee, director or consultant of the Company, their options terminate either
upon or shortly after termination of employment. The Company's Board of
Directors voted on July 17, 1996 to terminate the 1989 Plan, and no further
options may be issued under the 1989 Plan after that date.
On July 17,1996, the Board of Directors of the Company adopted the 1996 Equity
Incentive Plan (the "1996 Plan") for employees, officers, directors and others
of the Company and its subsidiary, and recommended approval of the plan by the
stockholders. The 1996 Plan provides for grants of incentive stock options to
employees (including officers) of the Company, and for grants of non-qualified
stock options to such employees as well as to directors and others of the
Company and its subsidiary. In addition, persons eligible to receive non-
qualified stock options can be awarded shares of Common Stock and given the
opportunity to purchase shares of Common Stock. A total of 541,775 shares of
Common Stock may be issued under the 1996 Plan. Of the 207,475 options to
purchase shares of Common Stock granted in 1996, options to purchase 91,750
shares of Common Stock have been granted under the 1996 plan.
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
Number of Range of Option Number of Range of Option Number of Range of Option
Shares Price per Share Shares Price per Share Shares Price per Share
--------- --------------- --------- ---------------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Options
outstanding,
beginning of year 617,500 $0.40 - $8.00 817,475 $0.40 - $9.00 701,892 $0.40 - $9.75
Granted 207,475 $8.50 - $9.00 61,417 $7.00 - $9.75 265,650 $5.38 - $8.38
Exercised 7,500 $0.40 - $9.00 148,000 $0.40 - $0.80 48,500 $0.40 - $3.00
Forfeited - 29,000 $0.40 - $9.00 5,450 $0.80 - $7.25
Options
outstanding, end
of year 817,475 $0.40 - $9.00 701,892 $0.40 - $9.75 913,592 $0.40 - $9.75
Options exercisable 399,250 $0.40 - $9.00 408,395 $0.40 - $9.00 466,874 $0.40 - $9.75
Options available
for grant 175,025 130,608 145,408
Weighted average
fair value per
share of options
granted during the year $ 5.45 $ 4.20 $ 7.24
</TABLE>
As of January 2, 1999, the options outstanding had a weighted average
remaining contractual life of 7 years.
In 1995, the Company extended the term of options to purchase 100,000 shares
of Common Stock at $0.40 per share from seven to twelve years. This extension
resulted in a new measurement date under APB No. 25, and accordingly, based upon
a current fair value of $9.00 per share the Company recorded $860,000 of
compensation expense. Upon exercise of the options, the net proceeds, including
the tax benefit realized, are credited to equity.
In the fourth quarter of 1996, the Company extended the terms of certain
options issued to four employees of the Company. These options, by their terms,
would have expired but for such extension during the 180-day "lock-up period"
following the Company's initial public offering. These options were extended to
a date which was two months after the expiration of the
F-14
<PAGE>
lock-up agreements. These options are exercisable into an aggregate of 23,500
shares of Common Stock, and none of said employees is an officer or director of
the Company. As a result of the extension the Company recorded compensation
expense of $272,600.
In October 1995, the Financial Accounting Standards Board issued SFAS No. 123,
"Accounting for Stock Based Compensation", which sets forth a fair value based
method of recognizing stock based compensation expense. As permitted by SFAS No.
123, the Company has elected to continue to apply APB No. 25 to account for its
stock based compensation plans. Had the compensation cost for these plans been
determined based on the fair value at the grant dates consistent with the method
set forth under SFAS 123, the Company's net loss and basic and diluted net loss
per share would have been the following pro forma amounts:
1996 1997 1998
------------ ------------ ------------
Net Loss ................ As Reported $(4,958,771) $(5,855,619) $(7,674,009)
Pro Forma $(5,146,911) $(6,212,029) $(8,242,514)
Basic and Diluted Net
Loss Per Share.......... As Reported $ (3.12) $ (0.87) $ (1.02)
Pro Forma $ (3.24) $ (0.93) $ (1.10)
Pro forma compensation expense for options granted is reflected over the
vesting period, therefore future pro forma compensation expense maybe greater as
additional options are granted. The fair value of each option grant is estimated
on the grant date using the Black-Scholes option - pricing model with the
following weighted average assumptions:
1996 1997 1998
----------- ----------- -----------
Volatility ......................... 30% 51% 105%
Risk Free Interest Rate ............ 6.34% 5.64% 5.00%
Expected Life of Options ......... 6.36 years 7.00 years 7.00 years
Because the pro forma compensation cost under SFAS 123 has not been applied to
option grants prior to January 1, 1995, the resulting pro forma compensation
cost may not be representative of that to be expected in future years as it is
reflected over the vesting period of the options.
The Black Scholes option-pricing model was developed for use in estimating the
fair value of traded option which have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions including expected stock price volatility. Because the
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective assumptions
can materially affect the fair value estimate, in management's opinion, the
existing models do not necessarily provide a reliable single measure of the fair
value of its employee stock options.
(11) Net Loss per Share
Basic and diluted net loss per share were calculated as follows:
1996 1997 1998
------------- ------------- -------------
Basic:
Net loss $( 4,958,771) $( 5,855,619) $( 7,674,009)
Weighted average shares 1,587,968 6,693,689 7,489,038
------------ ------------ ------------
Basic net loss per share $ (3.12) $ (0.87) $ (1.02)
============ ============ ============
Diluted:
Net loss $( 4,958,771) $( 5,855,619) $( 7,674,009)
Weighted average shares 1,587,968 6,693,689 7,489,038
------------ ------------ ------------
Diluted net loss per share $ (3.12) $ (0.87) $ (1.02)
============ ============ ============
F-15
<PAGE>
The computation of diluted earnings per share for 1996, 1997 and 1998 excludes
the effect of assuming the exercise of all outstanding stock options, warrants,
and the conversion of convertible securities because the effect would be anti-
dilutive, due to the Company's net losses during these years.
(12) Subsequent Events
On March 26, 1999, the Board of Directors of the Company formally elected Euan
Thomson, Ph.D., President and Chief Operating Officer of the Company.
Dr. Thomson has previously served as Managing Director of Photoelectron (Europe)
Limited, a London-based subsidiary of the Company.
Dr. Thomson replaced Peter E. Oettinger, Ph.D., who had served as Vice
President and Chief Operating Officer of the Company. Mr. Peter M. Nomikos
voluntarily resigned as President of the Company prior to the March 26, 1999
Board of Directors Meeting but remains Chairman of the Board, Chief Executive
Officer, and Treasurer of the Company.
F-16
<PAGE>
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the undersigned
thereunto duly authorized on April 2, 1999.
Photoelectron Corporation
Peter M. Nomikos
-------------------------------------------
By: Peter M. Nomikos
Its: Chairman of the Board,
Chief Executive Officer and Treasurer
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
hereby constitutes and appoints Euan Thomson and Gerald J. Bojas, and each of
them, his true and lawful proxies, attorneys-in-fact and agents, with full power
of substitution and resubstitution, for him and in his name, place and stead, in
any and all capacities, to (i) act on, sign and title with the Securities and
Exchange Commission any and all amendments to this Annual Report on Form 10-K,
together with all exhibits thereto, (ii) act, sign and file such certificates,
instruments, agreements and other documents as may be necessary or appropriate
in connection therewith, and (iii) take any and all actions which may be
necessary or appropriate in connection therewith, granting unto such agents,
proxies and attorneys-in-fact, and each of them and his and their substitute or
substitutes, full power and authority to do and perform each and every act and
thing necessary or appropriate to be done in connection therewith, as fully for
all intents and purposes as he might or could do in person, hereby approving,
ratifying and confirming all that such agents, proxies and attorneys-in-fact,
any of them or any of his or their substitute or substitutes may lawfully do or
cause to be done by virtue hereof.
In accordance with 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.
Signature Title Date
- ------------------------- ---------------------------------- -------------
Peter M. Nomikos Chairman of the Board, Chief April 2, 1999
- ------------------------- Executive Officer, and Treasurer
(Peter M. Nomikos) (Principal Executive Officer)
Gerlad J. Bojas Chief Financial Officer April 2, 1999
- ------------------------- (Principal Financial Officer and
(Gerald J. Bojas) Principal Accounting Officer)
George N. Hatsopoulos Director April 2, 1999
- -------------------------
(George N. Hatsopoulos)
Roger D. Wellington Director April 2, 1999
- -------------------------
(Roger D. Wellington)
<PAGE>
EXHIBIT INDEX
Exhibit
No. Description
- ------- -----------
*3.1 Articles of Organization of the Company, as amended.
*3.2 Forms of Articles of Amendment of the Company.
*3.3 By-Laws of the Company, as amended.
*4.1 Specimen Certificate representing the Company's Common Stock.
*4.2 Subordinated Convertible Note Purchase Agreement among the Company,
Thermo Electron Corporation and Photoelectron Investments Corporation
of Liberia dated as of May 22, 1990, and Exhibits thereto.
*4.3 Amendment and Waiver of Subordinated Convertible Note Purchase
Agreement among the Company, Thermo Electron Corporation and
Photoelectron Investments Corporation of Liberia dated as of August 1,
1996, and Exhibits thereto.
*4.4 Amended and Restated 8% Subordinated Note Due 1997 from the Company to
Thermo Electron Corporation in the principal amount of $125,000 dated
as of August 1, 1996.
*4.5 Amended and Restated 8% Subordinated Note Due 1997 from the Company to
Peter M. Nomikos in the principal amount of $175,000 dated as of
August 1, 1996.
*4.6 Amended and Restated Convertible Note Purchase Agreement originally
dated as of July 11, 1991, among the Company, PYC Corporation
(formerly known as Photoelectron Investments Corporation of Liberia)
and Peter M. Nomikos, and Exhibits thereto.
*4.7 8% Subordinated Convertible Note Due 1998 from the Company to Peter M.
Nomikos in the principal amount of $500,000 dated as of August 8,
1996.
*4.8 Convertible Note and Warrant Purchase Agreement between the Company
and Peter M. Nomikos dated as of May 13, 1992, and Exhibits thereto.
*4.9 Amendment and Waiver of Convertible Note and Warrant Purchase
Agreement dated as of May 13, 1992 between the Company and Peter M.
Nomikos, dated as of August 1, 1996 and Exhibits thereto.
*4.10 Amended and Restated 8% Subordinated Convertible Note Due on Demand
from the Company to Peter M. Nomikos in the principal amount of
$705,000 dated as of August 1, 1996.
*10.1 Lease Agreement dated June 12, 1996 between Lexington Development
Company Trust and the Company.
*10.2 Cash or Deferred Profit Sharing Plan and Trust dated April 1, 1995, as
amended, of the Company.
*10.3 Employee Stock Purchase Plan of the Company and form of Subscription
Agreement.
*10.4 1989 Employee Stock Option Plan of the Company and forms of Stock
Option Agreements.
*10.5 1996 Equity Incentive Plan of the Company.
*10.6 Form of Stock Purchase Warrant issued to certain security holders of
the Company and Schedule of Substantially Identical Documents from
Exhibits.
<PAGE>
*10.7 Stock Option Agreements variously dated between certain directors and
officers of the Company and the Company.
Exhibit
No. Description
--- -----------
*10.12 Form of Registration Rights Agreement between the Company and holders
of Series C Preferred Stock.
*10.13 Registration Rights Agreement dated December 22, 1995 between the
Company and Toshiba Medical Systems Co., Ltd.
*10.14 Technology Cross License Agreement dated as of January 4, 1989 between
the Company and Thermo Electron Corporation.
*10.15 International Distributor Sales and Service Agreement dated December
13, 1995, as amended, between the Company and Toshiba Medical Systems
Co., Ltd.
*10.16 Agreement dated as of February 1, 1991, as amended, between the
Company and the General Hospital Corporation.
*10.17 Clinical Trial Agreement dated as of August 1, 1992, as amended,
between the General Hospital Corporation, Nicholas T. Zervas, M. D.
and the Company.
*10.18 Investigational Treatment Agreement dated as of September 1, 1994
between the General Hospital Corporation, Rees G. Cosgrove, M.D. and
the Company.
*10.19 Clinical Research Agreement dated as of April 1, 1995, as amended,
between the Brigham and Women's Hospital Corporation, Peter Black,
M.D. and the Company.
*10.20 Clinical Trial Agreement dated as of January 1, 1995 between the Tokyo
Women's Medical College, Kintomo Takakura, M.D. and the Company.
*10.21 Clinical Trial Agreement dated December 13, 1995, as amended, between
the Company and Toshiba Medical Systems Co., Ltd.
*10.22 Clinical Research Agreement dated as of November 1, 1995 between The
Royal Free Hampstead (NHS), Felix Senanayake, M.D. and the Company.
*10.24 Forms of Medical Advisory Board Agreements between the Company and
members of its Medical Advisory Board.
*21.1 Subsidiaries of the Company.
23 Consent of independent accountants.
24.1 Power of Attorney (included in signature page to this Form 10-K).
27 Financial Data Schedule.
- --------------
* Filed as same numbered exhibit to the Company's Registration Statement on Form
S-1 (Reg. No. 333-14541) and incorporated herein by reference.
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation of
our report included in this Form 10-K, into the Company's previously filed
Registration Statement File No. 333-32957.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Boston, Massachusetts
April 2, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10(k)
FOR THE PERIOD ENDING JANUARY 2, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JAN-02-1999 JAN-03-1998
<PERIOD-START> JAN-04-1998 DEC-29-1996
<PERIOD-END> JAN-02-1999 JAN-03-1998
<CASH> 3,686,457 2,286,583
<SECURITIES> 0 0
<RECEIVABLES> 0 0
<ALLOWANCES> 0 0
<INVENTORY> 1,454,706 383,051
<CURRENT-ASSETS> 7,846,309 15,001,808
<PP&E> 3,597,563 2,975,175
<DEPRECIATION> 2,308,683 1,631,961
<TOTAL-ASSETS> 9,135,189 16,425,233
<CURRENT-LIABILITIES> 1,682,522 727,672
<BONDS> 0 0
0 0
0 0
<COMMON> 77,042 73,622
<OTHER-SE> 0 0
<TOTAL-LIABILITY-AND-EQUITY> 9,135,189 16,425,233
<SALES> 678,000 725,374
<TOTAL-REVENUES> 678,000 725,374
<CGS> 278,251 361,536
<TOTAL-COSTS> 8,540,517 6,568,893
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 83,569 106,401
<INCOME-PRETAX> (7,674,009) (5,855,619)
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (7,674,009) (5,855,619)
<EPS-PRIMARY> (1.02) (0.87)
<EPS-DILUTED> (1.02) (0.87)
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