<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Public Accountants.................................. F-2
Consolidated Balance Sheets as of January 2, 1999 and January 1, 2000..... F-3
Consolidated Statements of Operations for the years ended January 3, 1998,
January 2, 1999 and January 1, 2000...................................... F-4
Consolidated Statements of Cash Flows for the years ended January 3, 1998,
January 2, 1999 and January 1, 2000...................................... F-5
Consolidated Statements of Shareholders' (Deficit) Equity at January 3,
1998, January 2, 1999 and January 1, 2000................................ F-6
Notes to Consolidated Financial Statements................................ F-7
</TABLE>
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 2, 1999 and January 1, 2000, and the related
consolidated statements of operations, shareholders' (deficit) equity and cash
flows for each of the three years in the period ended January 1, 2000 and for
the period from inception (January 4, 1989) to January 1, 2000. 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 auditing standards generally
accepted in the United States. 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 2, 1999 and January
1, 2000, and the results of their operations and their cash flows for each of
the three years in the period ended January 1, 2000 and for the period from
inception (January 4, 1989) to January 1, 2000, in conformity with accounting
principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 18, 2000 (except
with respect to the matters
discussed in Note 13, as to which
the date is June 15, 2000)
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
January 2, January 1,
1999 2000
------------ ------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents........................ $ 3,686,457 $ 134,104
Accounts receivable.............................. 260,000 87,500
Inventories...................................... 1,454,706 1,437,557
Prepaid expenses................................. 336,287 146,799
Held to maturity investments (Note 2)............ 1,993,056 --
Other current assets............................. 115,803 32,272
------------ ------------
Total current assets........................... 7,846,309 1,838,232
============ ============
Property and Equipment:
Computer equipment............................... 899,085 960,324
Laboratory and production equipment.............. 926,352 975,408
Clinical site equipment.......................... 801,965 978,898
Furniture and fixtures........................... 165,898 177,883
Leasehold improvements........................... 804,263 805,886
------------ ------------
Property and equipment........................... 3,597,563 3,898,399
Less--Accumulated depreciation and amortization.. 2,308,683 2,872,636
------------ ------------
Net property and equipment....................... 1,288,880 1,025,763
------------ ------------
Total assets................................... $ 9,135,189 $ 2,863,995
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable................................. $ 346,363 $ 256,982
Accrued expenses (Note 3) 561,650 630,495
Accrued payroll and benefits..................... 55,409 75,690
Deferred revenue................................. -- 87,500
Convertible subordinated notes (Note 8).......... 719,100 761,770
Convertible note payable (Note 9)................ -- 804,311
------------ ------------
Total current liabilities...................... 1,682,522 2,616,748
============ ============
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
and none at January 2, 1999, and January 1,
2000, respectively.............................. -- --
Common stock, $0.01 par value--Authorized--
15,000,000 shares issued and outstanding--
7,704,254 and 7,768,754 at January 2, 1999, and
January 1, 2000, respectively................... 77,042 77,688
Capital in excess of par value--common stock..... 38,324,377 38,641,184
Deferred compensation............................ (29,913) (9,986)
Subscription receivable.......................... (5,842) --
Deficit accumulated during development stage..... (30,912,997) (38,461,639)
------------ ------------
Total shareholders' equity..................... 7,452,667 247,247
------------ ------------
Total liabilities and shareholders' equity..... $ 9,135,189 $ 2,863,995
============ ============
</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>
Period
Year Ended from Inception
------------------------------------- (January 4, 1989)
January 3, January 2, January 1, To January 1,
1998 1999 2000 2000
----------- ----------- ----------- -----------------
<S> <C> <C> <C> <C>
Revenues................ $ 725,374 $ 678,000 $ 534,634 $ 1,938,008
Cost of Goods Sold...... 361,536 278,251 266,653 906,440
----------- ----------- ----------- ------------
Gross Margin............ 363,838 399,749 267,981 1,031,568
Operating Expenses:
Research and
development
expenses............. 4,626,390 5,433,471 4,425,739 27,735,868
Selling, general and
administrative
expenses............. 2,306,341 3,107,046 3,426,327 12,463,050
----------- ----------- ----------- ------------
Total operating
expenses........... 6,932,731 8,540,517 7,852,066 40,198,918
----------- ----------- ----------- ------------
Operating loss...... (6,568,893) (8,140,768) (7,584,085) (39,167,350)
----------- ----------- ----------- ------------
Interest income......... 819,675 550,328 130,627 1,948,768
Interest expense........ (106,401) (83,569) (95,184) (1,243,057)
----------- ----------- ----------- ------------
Interest income, net.... 713,274 466,759 35,443 705,711
----------- ----------- ----------- ------------
Net loss................ $(5,855,619) $(7,674,009) $(7,548,642) $(38,461,639)
=========== =========== =========== ============
Basic and diluted net
loss per share (Note
12).................... $ (0.87) $ (1.02) $ (0.97)
=========== =========== ===========
Weighted average basic
and diluted shares
(Note 12).............. 6,693,689 7,489,038 7,749,040
</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>
Period
Year Ended from Inception
-------------------------------------- (January 4, 1989)
January 3, January 2, January 1, To January 1,
1998 1999 2000 2000
------------ ----------- ----------- -----------------
<S> <C> <C> <C> <C>
Cash flows from
operating activities:
Net loss.............. $ (5,855,619) $(7,674,009) $(7,548,642) $(38,461,639)
Adjustments to
reconcile net loss to
net cash used in
operating
activities--
Depreciation and
amortization......... 733,834 676,722 563,953 2,881,227
Noncash interest
converted to notes... 106,401 83,562 46,981 1,107,539
Noncash salary
converted to common
stock................ -- -- -- 250,000
Noncash research and
development expense
converted to
subordinated notes... -- -- -- 9,000
Noncash compensation
expense.............. 1,562 45,653 12,764 1,192,579
Noncash interest
expense on bridge
financing............ -- -- 33,790 33,790
Changes in current
accounts--
Accounts receivable.. -- (260,000) 172,500 (87,500)
Inventories.......... (59,337) (1,071,655) 17,149 (1,437,287)
Prepaid expenses..... 105,699 77,420 189,488 161,401
Other current
assets.............. (240) (6,481) 83,531 47,939
Accounts payable..... (10,281) 48,849 (89,381) 256,982
Accrued expenses..... 150,073 186,902 89,126 505,237
Deferred revenue..... -- -- 87,500 87,500
------------ ----------- ----------- ------------
Net cash used in
operating
activities......... (4,827,908) (7,893,037) (6,341,239) (33,453,230)
------------ ----------- ----------- ------------
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......... (842,023) (622,388) (300,836) (3,873,553)
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......... (12,811,590) 9,273,912 1,692,220 (3,943,919)
------------ ----------- ----------- ------------
Cash flows from
financing activities:
Proceeds from issuance
of common stock...... 17,389,058 281,362 296,668 18,563,536
Proceeds from issuance
of preferred stock... -- -- -- 13,385,370
Proceeds from issuance
of convertible
notes................ -- -- 800,000 6,122,000
Proceeds from issuance
of warrants.......... -- -- -- 236,453
Offering expenses..... -- -- -- (473,006)
Payments under capital
lease obligations.... -- -- -- (40,735)
Payments of
subordinated notes... -- (262,363) -- (262,363)
------------ ----------- ----------- ------------
Net cash provided by
financing
activities......... 17,389,058 18,999 1,096,668 37,531,255
============ =========== =========== ============
Increase (decrease) in
cash and cash
equivalents........... (250,440) 1,399,874 (3,552,353) 134,104
------------ ----------- ----------- ------------
Cash and cash
equivalents, beginning
of period............. 2,537,023 2,286,583 3,686,457 --
------------ ----------- ----------- ------------
Cash and cash
equivalents, end of
period................ 2,286,583 3,686,457 134,104 134,104
============ =========== =========== ============
Cash paid for:
Interest.............. $ -- $ 262,363 $ 14,413 $ 276,776
============ =========== =========== ============
Noncash financing
activities:
Conversion of salary
expense to common
stock................ $ -- $ -- $ -- $ 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 Deficit
Preferred Common Stock Preferred Accumulated
Stock, Stock, Capital in Stock Capital During
$0.01 $0.01 Excess of in Excess of Deferred Subscription Development
Par Value Par Value Par Value Par Value Compensation Receivable Stage
--------- --------- ----------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Initial issuance of
common stock........... $ -- $ 7,475 $ 291,525 $ -- $ -- $ -- $ --
Net Loss............... -- -- -- -- -- -- (414,045)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 28,
1989................... -- 7,475 291,525 -- -- -- (414,045)
Net Loss............... -- -- -- -- -- -- (394,275)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 29,
1990................... -- 7,475 291,525 -- -- -- (808,320)
Net Loss............... -- -- -- -- -- -- (973,773)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 28,
1991................... -- 7,475 291,525 -- -- -- (1,782,093)
Issuance of common
stock................. -- 2,042 147,958 -- -- -- --
Issuance of warrants... -- -- 121,453 -- -- -- --
Net Loss............... -- -- -- -- -- -- (1,586,239)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, January 2,
1993................... -- 9,517 560,936 -- -- -- (3,368,332)
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............... -- -- -- -- -- -- (2,267,460)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, January 1,
1994................... -- 22,503 4,558,964 -- -- -- (5,635,792)
Issuance of common
stock................. -- 1,376 411,625 -- -- (94,874) --
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............... -- -- -- -- -- -- (2,671,648)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 31,
1994................... 17,820 11,059 1,184,394 7,763,966 -- (94,874) (8,307,440)
Issuance of common
stock................. -- 64 49,938 -- -- 21,870 --
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 -- (500,000) --
Extension of stock
options............... -- -- 860,000 -- -- -- --
Net Loss............... -- -- -- -- -- -- (4,117,158)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 30,
1995................... 28,812 15,837 2,343,018 17,102,574 -- (573,004) (12,424,598)
Issuance of common
stock................. -- 142 64,106 -- -- 15,073 --
Proceeds from issuance
of Series C Preferred
Stock................. 111 -- -- 99,889 -- 500,000 --
Extension of stock
options............... -- -- 272,600 -- -- -- --
Net Loss............... -- -- -- -- -- -- (4,958,771)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, December 28,
1996................... 28,923 15,979 2,679,724 17,202,463 -- (57,931) (17,383,369)
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 -- (17,180) -- --
Payment of subscription
receivable............ -- -- -- -- 32,348 --
Net Loss............... -- -- -- -- -- -- (5,855,619)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, January 3,
1998................... -- 73,622 37,220,144 -- (17,180) (25,583) (23,238,988)
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 -- (12,733) -- --
Payment of subscription
receivable............ -- -- -- -- -- 19,741 --
Net Loss............... -- -- -- -- -- -- (7,674,009)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, January 2,
1999................... $ -- $ 77,042 $38,324,377 $ -- $(29,913) $ (5,842) $(30,912,997)
Exercise of stock
options............... -- 646 290,180 -- -- -- --
Recording of deferred
compensation.......... -- -- 26,627 -- 19,927 -- --
Payment of subscription
receivable............ -- -- -- -- -- 5,842 --
Net Loss............... -- -- -- -- -- -- (7,548,642)
-------- -------- ----------- ----------- -------- --------- ------------
Balance, January 1,
2000................... $ -- $ 77,688 $38,641,184 $ -- $ (9,986) $ -- $(38,461,639)
======== ======== =========== =========== ======== ========= ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE>
PHOTOELECTRON CORPORATION AND SUBSIDIARY
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(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 a
miniature x-ray source which is a proprietary, therapeutic device for the
treatment of cancerous tumors through the application of radiation directly
into a tumor. The latest version of this x-ray system is the PRS400 system
which delivers radiation through a thin, minimally invasive, needle-like
probe. The probe 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 PRS400 system 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, the Company obtained a Section 510(k)
marketing clearance on July 21, 1998 for the PRS400 system for the treatment
of intra-cranial tumors, which the Company was developing for introduction as
its first commercial product. Simultaneous with completion of the PRS400
system 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
system. In September 1999, the Company obtained a Section 510(k) marketing
clearance from the FDA to market the system for radiotherapy treatments,
regardless of treatment site.
In the first quarter of 2000, the Company and Toshiba expect to submit to
the Japan Ministry of Health an application for product approval (shonin) of
the PRS400 system. Contingent upon that submission being made in timely
fashion, the Company and Toshiba expect to obtain product approval (shonin) in
Japan for the PRS400 system in the second half of 2000. Once regulatory
approvals for the PRS system are obtained in Japan, Toshiba will serve as its
exclusive distributor in Japan. In 1995, Toshiba 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 10).
In August 1999, the Company entered into a strategic alliance with Carl
Zeiss, an international technology leader whose medical systems division
specializes in high technology equipment such as surgical microscopes for
various medical disciplines and state-of-the-art image-guided surgery
equipment. The Company appointed Carl Zeiss as its exclusive distributor for
the PRS400 system throughout the world (except for Japan where Toshiba Medical
Systems is the Company's distributor of the PRS400 system) for intracranial
applications and spinal radiotherapy and as its non-exclusive distributor for
the PRS400 system in the same territory for all other clinical applications.
In addition, Carl Zeiss agreed to assist the Company in the development of new
intraoperative radiotherapy products and to provide service and support for
the Company's products. The alliance with Carl Zeiss gives the Company access
to a global sales force with an established record of sales of high technology
equipment within the medical field.
F-7
<PAGE>
Fiscal Years
The Company has adopted a fiscal year ending on the Saturday nearest
December 31. References to 1999 1998, and 1997 are for the fiscal years ended
January 1, 2000, January 2, 1999, and January 3, 1998, respectively. Fiscal
year 1997 included 53 weeks; 1999 and 1998 each included 52 weeks.
Inventory
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 systems 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:
<TABLE>
<CAPTION>
Asset Classification Estimated Useful Life
-------------------- ---------------------
<S> <C>
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
</TABLE>
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 1, 2000, 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
F-8
<PAGE>
as held to maturity investments. Cash equivalents are carried at cost, which
approximate market value. The Company did not own any commercial paper at
January 1, 2000.
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. As of January 1, 2000, the Company had no held to
maturity investments.
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.
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 systems 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 intercompany 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.
F-9
<PAGE>
Net Loss Per Share
During the fourth quarter of 1997, the Company adopted SFAS 128, "Earnings
per Share" (Note 12). 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 $749,063, and approximately $761,770 at January 2, 1999 and
January 1, 2000, respectively, based upon the estimated fair value of the
underlying common stock. The fair value of the convertible note is
approximately $804,311 at January 1, 2000 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 option plans (Note 11). Accordingly, no accounting
recognition is given to 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.
(2) Held to Maturity Investments
Investments in commercial paper are classified as held to maturity as of
January 1, 2000. The amortized cost and fair values as of January 2, 1999 and
January 1, 2000 are as follows:
<TABLE>
<CAPTION>
Commercial Paper
--------------------------------
Gross
Amortized Unrealized
Cost Loss Fair Value
---------- ---------- ----------
<S> <C> <C> <C>
January 2, 1999............................. $1,993,056 ($1,396) $1,991,660
January 1, 2000............................. $ -- $ -- $ --
</TABLE>
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:
<TABLE>
<CAPTION>
1998 1999
-------- --------
<S> <C> <C>
Warranty Accrual.......................................... $204,000 $266,000
Annual Report Accrual..................................... 61,000 60,000
Other Accrued Expenses.................................... 296,650 304,495
-------- --------
$561,650 $630,495
======== ========
</TABLE>
F-10
<PAGE>
(4) Income Taxes
The components of the deferred tax asset at January 2, 1999 and January 1,
2000 are as follows:
<TABLE>
<CAPTION>
1998 1999
------------ ------------
<S> <C> <C>
Deferred tax asset--
Federal tax loss carryforwards................. $ 9,185,000 $ 11,846,000
Federal tax credit carryforwards............... 871,000 965,000
State tax loss carryforward.................... 2,070,000 2,602,000
State tax credit carryforward.................. 781,000 904,000
Other, net..................................... 728,000 694,000
------------ ------------
13,635,000 17,011,000
Valuation allowance.............................. (13,635,000) (17,011,000)
------------ ------------
Deferred tax asset............................. -- --
============ ============
</TABLE>
As of January 1, 2000, the Company had federal net operating loss
carryforwards of approximately $34,840,000, state net operating loss
carryforwards of approximately $27,383,000, federal tax credit carryforwards
of approximately $965,000, and state tax credit carryforwards of approximately
$904,000. Due to the fact that the Company has sustained cumulative losses,
the potential future benefit of these attributes, which expire in the years
2000 through 2014, 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
contributions by each employee with at least three months of service to the
401(k) Plan. During 1998 and 1999, the Company contributed approximately
$62,997 and $29,057, respectively.
(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 $3,253, $4,952 and $6,093 in 1997, 1998 and 1999,
respectively, for these services.
Thermo Power Corporation
The Company is provided with certain services by Thermo Power Corporation, a
wholly-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 $113,582,
$229,953, and $147,315 in 1997, 1998 and 1999, respectively, for these
services. As of January 2, 1999, and January 1, 2000, $534, and
F-11
<PAGE>
$7,284 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 $587,820 in 2000, $599,689 in 2001 and $352,360 in 2002.
The total future minimum lease payments are $1,539,869. The accompanying
consolidated statements of operations include expenses for operating leases of
$307,975, $404,914, and $471,859 for 1997, 1998 and 1999, 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
provide for the conversion of accrued interest into Common Stock at maturity.
The accrued interest is 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 1, 2000, 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.
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 1, 2000, warrants to
purchase 810,000 shares of the Company's Common Stock were outstanding. These
remaining
F-12
<PAGE>
warrants expire as follows 575,000, and 235,000 on 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.
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 10).
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 for warrants exercised of $202,000 to PYC
Corporation.
(9) Convertible Note Payable
On November 15, 1999, the Company and PYC Corporation entered into a six
month $2.25 million line of credit at an 8% interest rate. This note is
convertible into Common Stock at the holder's request within 30 days
subsequent to its maturity or upon full prepayment. The conversion price per
share will be equal to the average closing price of the stock for the ten
trading days prior to such conversion. As of January 1, 2000, the Company had
drawn down $800,000 under the line of credit and had issued to PYC Corporation
warrants to purchase an aggregate of 160,000 shares of the Company's Common
Stock with an exercise price equal to the average closing price of the
Company's Common Stock for the ten trading days preceding each draw made under
the line of credit. The warrants were issued in four equal installments on
November 18, 1999, November 30, 1999, December 14, 1999 and December 29, 1999,
with exercise prices of $3.76, $3.44, $2.94 and $2.74 respectively. The fair
value of the warrants issued, in the amount of $33,790, has been recognized as
non cash interest expense.
(10) 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
stock. 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
F-13
<PAGE>
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.
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 $25,583, $5,842 and $0 in 1997, 1998, and 1999 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.
(11) 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.
F-14
<PAGE>
A summary of stock option activity is as follows:
<TABLE>
<CAPTION>
1997 1998 1999
------------------------- ------------------------ -------------------------
Number Number Number
of Range of Option of Range of Option 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...... 817,475 $0.40--$9.00 701,892 $0.40--$9.75 913,592 $0.40--$9.75
Granted................. 61,417 $7.00--$9.75 265,650 $5.38--$8.38 263,000 $2.13--$4.88
Exercised............... (148,000) $0.40--$0.80 (48,500) $0.40--$3.00 (64,500) $0.40--$3.00
Forfeited............... (29,000) $0.40--$9.00 (5,450) $0.80--$7.25 (199,875) $2.13--$9.75
Options outstanding, end
of year................ 701,892 $0.40--$9.75 913,592 $0.40--$9.75 912,217 $0.40--$9.00
Options exercisable..... 408,395 $0.40--$9.00 466,874 $0.40--$9.00 445,468 $0.40--$9.00
Options available for
grant.................. 130,608 145,408 82,283
Weighted average fair
value per share of
options granted during
the year............... $ 4.20 $ 7.24 $ 2.70
</TABLE>
As of January 1, 2000, the options outstanding had a weighted average
remaining contractual life of 7 years.
The Company accounts for stock options under APB No. 25. All stock options
granted to date have been at an exercise price equal to or greater than the
fair value of the Company's Common Stock on the date of grant. Upon exercise
of the options, the net proceeds, including the tax benefit realized, are
credited to equity.
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:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Net Loss
As Reported........................ $(5,855,619) $(7,674,009) $(7,548,642)
Pro Forma.......................... $(6,212,029) $(8,242,514) $(8,198,743)
Basic and Diluted Net Loss Per Share
As Reported........................ $ (0.87) $ (1.02) $ (.97)
Pro Forma.......................... $ (0.93) $ (1.10) $ (1.06)
</TABLE>
Pro forma compensation expense for options granted is reflected over the
vesting period, therefore future pro forma compensation expense may be 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:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Volatility............................... 51% 105% 48%
Risk Free Interest Rate.................. 5.64% 5.00% 5.00%
Expected Life of Options................. 7.00 years 7.00 years 7.00 years
</TABLE>
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.
F-15
<PAGE>
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.
(12) Net Loss per Share
Basic and diluted net loss per share were calculated as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ----------- -----------
<S> <C> <C> <C>
Net loss.......................... $(5,855,619) $(7,674,009) $(7,548,642)
Weighted average shares........... 6,693,689 7,489,038 7,749,040
----------- ----------- -----------
Basic and Diluted net loss per
share............................ $ (0.87) $ (1.02) $ (0.97)
=========== =========== ===========
</TABLE>
The computation of diluted earnings per share for 1997, 1998 and 1999
excludes the effect of assuming the exercise of all outstanding stock options
and the conversion of convertible securities because the effect would be anti-
dilutive, due to the Company's net loss during these years.
(13) Subsequent Event
During the period from June 5, 2000 to June 15, 2000, the Company issued
$5,585,000 in 10% convertible debentures to fund ongoing operations.
F-16
