-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GRw+6D7oa2qlgExt+dZ1nT/Dh9RmxqLmZAx51O240gvwRR7liTv8pnRX6vtYGCyF f4IcGiuRcTiWoGCvCJQLyw== 0000891618-00-001885.txt : 20000331 0000891618-00-001885.hdr.sgml : 20000331 ACCESSION NUMBER: 0000891618-00-001885 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SUNRISE TECHNOLOGIES INTERNATIONAL INC CENTRAL INDEX KEY: 0000846771 STANDARD INDUSTRIAL CLASSIFICATION: DENTAL EQUIPMENT & SUPPLIES [3843] IRS NUMBER: 770148208 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-10428 FILM NUMBER: 588445 BUSINESS ADDRESS: STREET 1: 3400 WEST WARREN AVENUE CITY: FREMONT STATE: CA ZIP: 94538 BUSINESS PHONE: 5106239001 MAIL ADDRESS: STREET 1: 47265 FREMONT BLVD CITY: FREMONT STATE: CA ZIP: 94538 FORMER COMPANY: FORMER CONFORMED NAME: SUNRISE TECHNOLOGIES INC DATE OF NAME CHANGE: 19920703 10-K 1 FORM 10-K 1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------- FORM 10-K ------------------------- [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ____________ TO____________ . COMMISSION FILE NO. 1-10428 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 77-0148208 (STATE OR OTHER JURISDICTION OF (I. R. S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 3400 WEST WARREN AVENUE, FREMONT, CALIFORNIA 94538 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (510) 623-9001 SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK (TITLE OF CLASS) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant was approximately $351,032,000 as of March 10, 2000. The number of shares of the registrant's Common Stock issued and outstanding as of March 10, 2000 was 46,414,401. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement to be filed prior to April 30, 2000, pursuant to Regulation 14A of the Securities Exchange Act of 1934 are incorporated by reference into Part III of this Form 10-K. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 2 PART I ITEM 1. BUSINESS OVERVIEW Sunrise Technologies International, Inc. (the "Company") develops, manufactures and markets laser systems for applications in ophthalmology. Substantially all of the Company's business activities, including engineering and development, manufacturing, assembly and testing, take place at the Company's facility in Fremont, California. Prior to June 26, 1997, the Company developed, manufactured and marketed lasers and air abrasion cavity preparation systems for use in dentistry. On June 26, 1997, the Company sold its dental business and assets to Lares Research of Chico, California for $4,000,000 in cash and $1,500,000 in interest-bearing notes due in June 2000 and June 2001. Since mid-1992, the Company has focused a significant portion of its efforts on engineering and development of its holmium laser corneal shaping product or process, known as Laser Thermal Keratoplasty (the "LTK System"), for the treatment of refractive error of the eye, such as hyperopia (farsightedness) and presbyopia (age-related loss of near focusing ability). Until late 1998, refractive surgery in the United States, outside of certain clinical studies, was solely for the treatment of myopia. Myopia is a refractive disorder that the Company has not targeted to treat with its LTK System due to the lack of available resources to pursue that market segment and also due to the number of competitors already offering products to treat that condition. The Company saw the treatment of hyperopia and presbyopia as potentially large markets for products based on its technology. These markets were not being well served by other companies with products or potential products for refractive surgery. The combination of these factors led the Company to focus its efforts on hyperopia and presbyopia. The LTK System is based in part on patented technology acquired in the Company's acquisitions of in-process technology from Laser Biotech, Inc. ("Laser Biotech") and Emmetropix Corporation ("Emmetropix") in 1992. See "Products -- LTK System" in this Section. The Company has incurred substantial losses in the past eight years, which have seriously depleted its working capital. Sales of its existing ophthalmic products at current levels will not be sufficient to sustain the continued development and regulatory licensing of the LTK System. The Company has been able to raise additional working capital for all aspects of its business through the private placement of its Common Stock and convertible notes with warrants. These private placements raised a total of $15,296,000 in new capital, for the Company in 1994, 1995 and 1996, approximately $3,700,000 net of offering costs in the form of promissory notes with warrants in 1997 (the "1997 Notes Placement"), approximately $9,300,000, net of offering costs, in the form of promissory notes with warrants in January 1998 (the "1998 Notes Placement"), approximately $11,800,000, net of offering costs, from the sale of Common Stock in December 1998 (the "1998 Equity Offering"), $10,000,000, net of offering costs, in the form of promissory notes with warrants in January 1999 (the "1999 Notes Placement") and approximately $11,200,000, net of offering costs, in the form of convertible debentures with warrants in January 2000 (the "2000 Debentures"). The Company was incorporated in 1987 under the laws of the State of California and was reincorporated in 1993 under the laws of the State of Delaware. PRODUCTS LTK System In April 1992, the Company acquired Laser Biotech through a merger of a wholly-owned subsidiary of the Company with Laser Biotech (the "Merger"). Laser Biotech was founded in 1986 by Bruce J. Sand, M.D., FACS, to research and develop a precision laser instrument for eye surgery. In connection with the Merger, the Company also acquired certain patent and patent applications held by Dr. Sand covering a patented technique for reshaping the cornea using a laser. The LTK System alters the shape of the cornea to correct refractive disorders such as hyperopia and presbyopia without removing corneal tissue. The procedure employs a laser to shrink, selectively, the collagen in the cornea, changing the curvature of the cornea and thereby changing the refractive power of the eye. By comparison, excimer laser systems for corneal reshaping developed by Summit Technologies, Inc. ("Summit") and VISX, Inc. ("VISX") remove parts of the cornea 2 3 to achieve changes in refraction. Laser Biotech conducted pre-clinical studies to gain preliminary information on the efficacy and safety of the product, which resulted in positive indications that the LTK System could be applied successfully and safely to correct certain refractive error. The Company received an Investigational Device Exemption ("IDE") from the Food and Drug Administration (the "FDA") to begin Phase I clinical trials of the LTK System on human subjects in the first quarter of 1992. Phase I trials commenced in June 1992 using a prototype LTK System designed and developed by the Company. Sunrise completed Phase I of the clinical work for the LTK System and filed its results with the FDA in June 1993. In September 1993, the Company received clearance to begin Phase IIa clinical trials for the treatment of hyperopia. The trials were conducted at the Doheny Eye Institute at the University of Southern California and Baylor University and were completed in November 1994. On September 5, 1996, the FDA authorized the Company to treat an additional 100 subjects at five United States locations in a continuation of Phase IIa clinical trials using a treatment algorithm developed by Sunrise in the course of the initial Phase IIa clinical trials and in the course of studies conducted by ophthalmologists in Mexico, Germany, Belgium, Italy and Canada. On March 31, 1997, the Company added three new investigators to its Phase IIa clinical study for hyperopia. On July 18, 1997, the Company received FDA approval to treat the fellow eye of patients who had one eye treated as part of the clinical trial for hyperopia six months after the first eye was treated. On August 7, 1997, the Company received approval from the FDA to treat an additional 100 patients as part of its Phase IIa clinical trial for hyperopia, bringing the total patients approved for treatment at that time to 228. On September 25, 1997, the Company received approval to treat 60 patients at four sites for the condition known as presbyopia. Presbyopia is the age-related loss of near vision. This clinical trial employs a technique known as monovision to treat presbyopia. A patient with presbyopia utilizes one eye primarily for distance vision and the other eye primarily for reading, or near vision. A fifth site was added on March 30, 1998. On October 8, 1998, the Company received approval to treat an additional 20 patients in its expanded clinical trial for presbyopia. As of March 10, 2000, the Company has treated 67 patients under this clinical study. On October 8, 1997, the Company received approval to re-treat patients in its clinical study. As of March 10, 2000, ten eyes of ten patients have been treated. On November 19, 1997, the Company completed enrollment in its Phase IIa clinical trial for hyperopia and also received approval to begin Phase III of its clinical trial for hyperopia with an additional 200 patients to be treated at the existing eight clinical sites and up to seven additional clinical sites. The Company added three clinical sites, bringing the total to 11 sites. On February 24, 1998, the Company announced that it had received approval to treat the fellow eye of patients enrolled in its clinical study for hyperopia on the same day, as opposed to the earlier requirement to wait six months before treating fellow eyes. On June 30, 1998, the Company announced that it had completed enrollment for the Phase III investigation, the final phase of the study for treatment of low to moderate hyperopia. As of March 10, 2000, 399 primary eyes and 279 fellow eyes of 399 patients have been treated. On March 12, 1998, the Company announced that it had received approval to initiate a new clinical study to treat patients with the LTK System who were overcorrected after receiving treatment for myopia (nearsightedness) from LASIK procedures or excimer laser systems which are manufactured by other companies. As of March 10, 2000, the Company has treated 3 eyes of the 10 patients under this clinical study. On April 7, 1998, the Company received approval to begin a sub-study to investigate treatment of hyperopia between 2.75 to 4.0 diopters using a modified laser nomogram. As of March 10, 2000, 20 eyes of the 20 patients have been treated. On October 14, 1999, the Company received approval to modify the algorithm for treatment of hyperopia in the range of 1.25 to 5.625 diopters for sixty patients at eight clinical sites. As of March 10, 2000, 12 patients have been treated. The Company has obtained FDA clearance to export the LTK System to most European countries, Turkey, Saudi Arabia, Canada, Mexico, Brazil, China, Korea, Hong Kong, the Bahamas, South Africa and other countries, although such sales are subject to the individual regulatory authority of each country. 3 4 Following local regulatory approvals, the Company commenced marketing the LTK System overseas, primarily in Europe, for the treatment of hyperopia and astigmatism in December 1993. To date, international sales of the LTK System have been limited. Revenue in the United States cannot reasonably be expected before the second half of 2000 at the earliest, and is dependent on final FDA approval. As of March 10, 2000, the Company had treated approximately 763 eyes with the LTK System in its United States clinical trials. On December 14, 1998, the Company submitted its premarket approval application ("PMA") for low hyperopia to the FDA. On January 28, 1999, the FDA determined that the PMA for low hyperopia was suitable for filing. At a July 22, 1999 meeting of the Ophthalmic Devices Panel ("ODP"), an advisory committee of the U.S. Food and Drug Administration ("FDA"), the ODP requested additional long-term data and recommended to the FDA not to approve the Sunrise LTK System at that time. In October 1999, the Company prepared an amendment to its PMA which contained a substantial increase in the number of patients followed through two years compared to that presented at the July ODP meeting. On January 13, 2000, the ODP unanimously voted to recommend that the FDA approve the Sunrise LTK System in the United States for the temporary reduction of low to moderate hyperopia with conditions relating to labeling regarding patient symptoms, longevity of effect and the effect of retreatment. Final FDA approval is expected sometime within three to nine months from the January 13, 2000 ODP approval, although we can not be certain we will obtain that approval within that time frame, if at all. See "Government Regulation" and "Patents and Licenses" in this Section and "Management's Discussion and Analysis of Financial Condition and Results of Operations." On January 27, 2000 the Company announced that it had passed its ISO9001/EN46001 certification audit for the Company's quality system and therefore is certified for the International Organization for Standards ISO 9001, European Commission EN 46001 and CE marking (European Community Seal of Approval). The LTK System incorporates a holmium laser system into a delivery system that is built into a custom slit-lamp to perform the LTK procedure. A slit-lamp is a binocular microscope used regularly by ophthalmologists to examine an eye binocularly under high magnification. The LTK System delivers eight simultaneous laser beams disposed in a circle of varying diameter. This system allows for easy alignment on the patient's eye and the delivery of multiple laser exposures, each less than two seconds. GOVERNMENT REGULATION The Company's products are subject to significant government regulation in the United States and other countries. In order to test clinically, produce and market products for human diagnostic and therapeutic use, the Company must comply with mandatory procedures and safety standards established by the FDA and comparable foreign regulatory agencies. Typically, such standards require products to be approved by the government agency as safe and effective for their intended use before being marketed for human applications. The clearance process is expensive and time consuming, and no assurance can be given that any agency will grant clearance to the Company to sell its products for routine clinical applications or that the time for the clearance process will not be extensive. Devices such as the LTK System may be marketed in the United States only after the FDA has approved a PMA for the device. Under the PMA procedure, the applicant must obtain an IDE before beginning the substantial clinical testing required to determine the safety, efficacy and potential hazards of the products. The preparation of a PMA is significantly complex and time consuming. The minimum review period under a PMA is 180 days from the date of filing. The FDA often responds with requests for additional information or clinical reports that can extend the review period substantially beyond 180 days. The Company submitted its PMA with the FDA for approval to sell its LTK System in the United States for hyperopia on December 14, 1998. FDA approval is expected sometime within three to nine months from the January 13 ODP approval, although we can not be certain we will obtain that approval within that time frame, if at all. The Company has, and will continue, to focus its efforts and limited resources on its technology for the treatment of hyperopia and presbyopia. 4 5 The FDA imposes various requirements on manufacturers and sellers of products under its jurisdiction, such as labeling, manufacturing practices, record keeping and reporting requirements. The FDA also may require post-market testing and surveillance programs to monitor a product's effects. All of the Company's products will require regulatory approval from the FDA. There can be no assurance that the appropriate approvals from the FDA will be granted for the Company's products, that the process to obtain such approvals will not be excessively expensive or lengthy or that the Company will have sufficient funds to pursue such approvals. The failure to receive requisite approvals for the Company's products or processes, when and if developed, or significant delays in obtaining such approvals, will prevent the Company from commercializing its products as anticipated and will have a material adverse effect on the business of the Company. The Company is also subject to regulation under the provisions of the Food, Drug and Cosmetic Act relating to Product Radiation Control which, among other things, requires laser manufacturers to: (i) file new product and annual reports; (ii) maintain quality control, product testing and sales records; (iii) incorporate certain design and operating features in lasers sold to end-users; and (iv) certify and label each laser sold to conform to all applicable standards for such lasers. Various warning labels must be affixed and certain protective devices installed, depending on the class of the product. The FDA's Center for Devices and Radiological Health is empowered to seek fines and other remedies for violations of the regulatory requirements. Marketing and Sales In the United States, the Company plans to sell its products through a small direct sales force. International sales will be made through established medical equipment distributors overseas. The Company has established relationships with distributors in Great Britain, Belgium, France, the Netherlands and South Africa. The extent and nature of the Company's marketing efforts are determined by a number of factors, including the number of specialists in the area and the characteristics of the laser applications. The establishment of a successful distributor network requires providing the distributors with sales instruments (brochures, clinical data, research papers, educational videos, etc.). Such marketing efforts are expected to include presentations at conventions and trade shows, customer training by Company personnel and sponsorship of teaching seminars, clinical presentations and research by others. The Company also hires additional marketing and sales consultants from time to time to assist in the marketing of its products. Research and Development The Company's success will depend substantially upon its ability to develop, manufacture and market innovative new products. In 1999, the Company recorded $4,774,000 in research and development expenses primarily relating to development of the LTK System. Related expenses were $2,107,000 and $964,000 in 1998 and 1997, respectively. The Company continues to explore several other types of lasers with varying characteristics in order to find the optimal interactions with tissues in specific medical applications. Since the sale of the Company's dental business and assets in June 1997 to an unaffiliated party, the Company no longer expends any of its funds on the research and development of dental lasers or other dental products. Clinical testing and sale of the Company's products are subject to obtaining applicable regulatory approvals, of which there can be no assurance. The Company's research and development activities are conducted in-house as well as by outside sources, including consultants and universities. The laser industry is characterized by extensive research and rapid technological change. Development by others of new or improved products, processes or technologies may make product development by the Company obsolete or less competitive. The Company will be required to devote continuing efforts and funds to further developments and enhancements for its existing products and for its research and development of new technologies and products. There can be no assurance the Company will be able to successfully adapt its operations to evolving markets and technologies and fund the development of new medical products to achieve possible technological advantages. 5 6 Production The Company manufactures its ophthalmic lasers from parts, components and subassemblies obtained from a number of unaffiliated suppliers, and the Company designs the software incorporated into a microprocessor purchased from an unaffiliated third party. Prototype production and all manufacturing, assembly and testing activities take place at its Fremont, California facility. Although some of the parts and components used by the Company to manufacture its products are available from multiple sources, the Company currently purchases each of its components from a single source in an effort to obtain volume discounts. Lack of availability of any of these parts and components could result in production delays, increased costs or costly redesign of the Company's products. The Company continually evaluates ways to minimize any impact to its business from any potential part or component shortage through inventory stockpiling and design changes to afford opportunities for multiple sources of supply for these key components. In addition, the Company has attempted to negotiate with the University of Miami to reach agreement regarding the non-exclusive use of a component of the delivery system used in the LTK System that was jointly developed by the Company and the University. The Company believes that it will be able to make reasonable arrangements with the University. If, however, the Company is unable to conclude negotiations with the University successfully, the Company may have no rights in the delivery system presently configured in the LTK System. If the Company is forced to redesign the LTK System, such redesign efforts could be time consuming, expensive and prolong FDA review. The Company's ophthalmic laser systems have been designed in a modular fashion to facilitate the assembly process. The Company intends to utilize modular design and construction concepts in connection with its future products. The Company will require additional engineering and manufacturing staffing as new products are introduced into the marketplace. Any loss of availability of a key system component could result in a material adverse change to the Company's business, financial condition and results of operations. Potential Liability The testing and use of human health care products entail an inherent risk of physical injury to patients and resultant product liability or malpractice litigation. While the Company has obtained product liability coverage in the amount of $10,000,000 with an umbrella policy for an additional $10,000,000, such coverage is limited, and there can be no assurance that such coverage will be sufficient to protect it from all risks to which it may be subject. Those costs of defending a product liability or malpractice action could have a material adverse impact on the Company, even if the Company were to prevail ultimately. Patents and Licenses In the merger of Laser Biotech into the Company, the Company acquired an issued United States patent and pending United States and foreign patent applications previously assigned to Laser Biotech by Dr. Bruce Sand, the inventor of the patent and founder of Laser Biotech. The issued patent covers a method for using a laser to shrink collagen in the human body, with specific application to the cornea. Since the merger, five more patents filed by Dr. Sand, as the inventor, have been allowed, and have been assigned to the Company. As a result of the Emmetropix acquisition, the Company now has one issued United States patent and one pending European regional patent application based on the issued United States patent, which the Company believes may be useful in further developing its Laser Thermal Keratoplasty product. In addition, the Company has filed a patent application covering the LTK System it developed to make use of the LTK procedure. The Company owns 66 issued patents on the LTK System and method for shrinking collagen in the United States and internationally. These patents protect the Company's technology while the LTK System is undergoing clinical trials for approval to market the LTK System in the United States and encompass both the apparatus for treatment with the LTK System and the method of shrinking collagen in the cornea. These patents begin to expire in 2009. The Company also has 43 pending patent applications on the LTK System and the method for shrinking collagen in the United States and internationally. 6 7 Competition The vision correction industry is subject to intense competition. The significant competitive factors in the industry include price, convenience, success relative to vision correction, acceptance of new technologies, patient satisfaction and government approval. Patients with hyperopia can achieve vision correction with eyeglasses, contact lenses and possibly with other technologies and surgical techniques currently under development, such as corneal implants, human lens replacement, intra-ocular implantable contact lenses and surgery using different types of lasers. The success of any competing alternative to the LTK System for treating hyperopia could have a material adverse effect on the Company's business, financial condition and results of operations. Most of the Company's competitors have substantially greater financial capabilities for product development and marketing than the Company, which may enable such competitors to market their products or procedures to the consumer and to the ophthalmic community in a more effective manner. The excimer laser is the dominant laser used for the treatment of refractive disorders. In the United States, VISX and Summit are the leading manufacturers of excimer refractive surgical systems. While the Company believes the LTK System offers several distinct advantages over the use of excimer lasers for treating hyperopia, including ease of use and decreased invasiveness, both VISX and Summit have significantly greater financial resources than the Company and have received FDA approval for their respective excimer laser products for treating myopia (nearsightedness), astigmatism and hyperopia. In addition, certain of the Company's competitors, including Summit, have developed LTK devices for the treatment of hyperopia. The Company believes its LTK System is superior to those of its competitors and that use of Summit's holmium laser system for LTK may violate certain of the Company's patents. None of the Company's competitors is currently engaged in United States clinical trials to approve their LTK devices for treating hyperopia. Further, Summit discontinued its clinical trials for treating hyperopia with its holmium laser system in 1996. However, any alternative treatment offered by VISX or Summit will have a competitive advantage because of the name recognition being created by the current promotion of their excimer laser products for correcting myopia (nearsightedness) using lasers and the fact that VISX and Summit have an established base of customers that are currently using their products. The Company believes the potential use of its process of shrinking collagen is more attractive than competitive methods of treating certain refractive errors because it can address refractive error with minimal invasiveness to the cornea. There can be no assurance, however, that the method can be reduced to practice using a reliable laser system, or that the Company will receive regulatory approvals or successfully market such a product. Export Sales In 1999, approximately 71% of the Company's gross revenues, or $25,500, were international as compared to approximately 98% in 1998 and 38% in 1997. Warranty and Service The Company provides a limited warranty on its laser systems. This warranty is limited to 12 months from date of shipment by the Company. The Company provides services to systems out of warranty worldwide for a fee. The Company's laser products include microprocessors and software that perform self-checks upon start-up and during operation. In addition, the systems feature software that allows service personnel to perform diagnostic checks in the field. The Company currently provides support services by telephone to customers with operational and service problems and makes necessary repairs at its plant or at the laser site. To date, actual costs incurred related to warranty work have been minimal. In the case of sales by distributors, all product services are provided by such distributor. 7 8 Employees At December 31, 1999, the Company had 63 full-time equivalent employees (including its executive officers), 27 in manufacturing, engineering and development, 20 in marketing, sales and regulatory, and 16 in administration. In addition, the Company has retained a number of consultants to assist with its product development, regulatory activities and investor relations. The Company is primarily dependent upon its engineering and development employees and consultants for the development and improvement of existing and proposed products. The Company's future success will depend in a large part upon its ability to attract and retain highly qualified engineering and management personnel, and its ability to continue to train and retain highly skilled technical and marketing personnel. None of the Company's employees are represented by a labor organization. The Company maintains various benefit plans and has good employee relations. Cautionary Statements -- Risk Factors In the interest of providing the Company's stockholders and potential investors with certain Company information, including management's assessment of the Company's future potential, certain statements set forth herein contain or are based on projections of revenue, income, earnings per share and other financial items or relate to management's future plans and objectives or to the Company's future economic performance. Such statements are "forward-looking statements" within the meaning of Section 27A(I) of the Securities Act of 1933, as amended, and in Section 21E(I) of the Securities Exchange Act of 1934, as amended. Although any forward-looking statements contained herein or otherwise expressed by or on behalf of the Company are, to the knowledge and in the judgment of the officers and directors of the Company, expected to prove true and to come to pass, management is not able to predict the future with absolute certainty. Accordingly, stockholders and potential investors are hereby cautioned that certain events or circumstances could cause actual results to differ materially from those projected or predicted. In addition, forward-looking statements are based on management's knowledge and judgment as of the date hereof, and the Company does not intend to update any forward-looking statements to reflect events occurring or circumstances existing hereafter. In particular, the Company believes the following facts could impact forward-looking statements made herein or in future written or oral releases and by hindsight, prove such statements to be overly optimistic and unachievable. WE HAVE SUSTAINED LOSSES IN THE PAST AND WE EXPECT TO REPORT LOSSES IN THE FUTURE We have incurred substantial losses that have depleted our working capital and reduced our stockholders' equity. In addition, we expect that our business will continue to be a significant consumer of cash. Unless and until the FDA approves the domestic sale of the LTK System for performing laser thermal keratoplasty, our revenues will not be sufficient to cover our operating costs. We do not expect FDA approval, however, until sometime within three to nine months from the January 13, 2000 ODP approval, although we can not be certain we will obtain that approval within that time frame, if at all. We funded our negative cash flows during 1997, 1998 and 1999 by the sale of additional equity and convertible debt with warrants. At December 31, 1998, after consummation of the 1998 Notes Placement (approximate net proceeds of $9,300,000) and the 1998 Equity Offering (approximate net proceeds of $11,800,000), cash and cash equivalents of the Company were approximately $9,889,000. In January 1999 we raised $10,000,000 net of offering expenses through the 1999 Notes Placement. The December 31, 1999 cash and cash equivalents were $10,643,000. In January 2000, we raised approximately $11,200,000 by means of a convertible debenture with warrants. Due to the uncertainty of the timing of final FDA approval of the LTK system and consequently its market launch, it is reasonable to expect that we will need to raise additional working capital during 2000 to fund our activities. There can be no assurance that additional funds can be 8 9 raised on terms acceptable to the Company, if at all. Any additional equity or debt offerings will dilute the holdings of our stockholders. We expect to report operating losses during 2000. The losses will come primarily from the expenses of the FDA approval process and underlying clinical studies related to the LTK System, the cost to ramp up manufacturing of the initial production units and the preparation costs associated with the market launch of the LTK System. We will not have any domestic revenues from this product line unless and until we obtain the FDA approval. Our international revenues will not be sufficient to cover the costs of the approval process or our general operating expenses. NO ASSURANCE FUTURE CAPITAL WILL BE AVAILABLE; ADDITIONAL CAPITAL WILL DILUTE THE HOLDINGS OF OUR STOCKHOLDERS Our stockholders have no preemptive rights. If we: 1. Commence a subsequent public or private offering of Common Stock, convertible debt, or Preferred Stock; or 2. Issue Preferred Stock or shares of Common Stock upon exercise of warrants to consultants or other parties providing goods or services to us in lieu of or in addition to cash consideration. Our stockholders, who do not participate in any future stock issuance, will experience dilution of their equity investment in the Company. At this time, we cannot determine the potential dilution to our stockholders. We cannot assure that additional financing will be available, or if available, that it will be available on terms favorable to our Company and our stockholders. If funds are not available to satisfy our short-term and long-term operating requirements, we may limit or suspend our operations in the entirety or, under certain circumstances, seek protection from creditors. Our recent debt and equity offerings contained terms adverse to our then existing stockholders. It is possible that future financing undertaken prior to the commencement of sales of the LTK System in the United States may contain terms that could result in similar or more substantial dilution than that incurred by our stockholders from the 1998 Notes Placement, the 1998 Equity Offering, the 1999 Notes Placement and the 2000 Debentures. WE COULD EXPERIENCE SUBSTANTIAL DELAY IN RECEIVING AND MAY NOT CONTINUE TO RECEIVE NECESSARY APPROVAL FROM THE FDA OF OUR PRE-MARKET APPROVAL APPLICATION FOR OUR LASER THERMAL KEROTOPLASTY SYSTEM. The FDA and similar health authorities in foreign countries extensively regulate our activities. The FDA regulates the LTK System, under the Food, Drug & Cosmetic Act, as a Class III medical device. Class III medical devices must have a PMA approved by the FDA before commercial sales in the United States commence. The PMA process (and underlying clinical studies) is lengthy, the outcome is difficult to predict, and the process requires substantial commitments of our financial resources and our management's time and effort. Delays in obtaining or failure to obtain required regulatory approvals or clearances in the United States and other countries would postpone or prevent the marketing of the LTK System and other devices. Consequently, delays would impair our ability to generate funds from operations, which in turn would have a material adverse effect on our business, financial condition and results of operations. We cannot be certain that we will be able to timely obtain, if at all, the required approval of our PMA in the United States for our intended uses of the LTK System, or for any other devices for which we may seek approvals or clearances. The FDA will subject us to pervasive and continuing regulation for any products that we manufacture or distribute. A new FDA regulation requires disclosure of the financial interests of clinical investigators. This new regulation applies to all new PMAs submitted on or after February 2, 1999. The purpose of this new regulation is to assist the FDA in determining if, and to what extent, the clinical studies supporting a marketing application may have been subject to investigator bias. Some of our current 11 clinical investigators of the 9 10 LTK System have financial interests in the Company that meet the threshold for disclosure under this new FDA regulation. It is not possible to predict, however, what impact, if any, the disclosure of these interests would have on the FDA's review of the PMA the Company submitted for the LTK System. We received a CE (European Community) Mark of approval on our LTK device that allows us to sell the device in these countries of the European Community. In addition to the CE Mark, however, some foreign countries may require separate individual foreign regulatory clearances. Although we have sold our products in approximately 15 countries, sales of the LTK System require rigorous regulatory approvals before we can sell them in the United States and certain other countries. We cannot assure that we will be able to obtain regulatory clearances for our products in the United States or other foreign markets. WE DEPEND ON THE LTK SYSTEM AND MARKET ACCEPTANCE OF THAT SYSTEM IS UNCLEAR We intend to continue to concentrate our efforts primarily on the development of the LTK System and will be dependent upon the successful development of that system to generate revenues. We have not yet commercially introduced the LTK System in the United States. There can be no assurance that if approved by the FDA, the ophthalmic community or the general population will accept the LTK System as an alternative to existing methods of treating refractive vision disorders. Many ophthalmologists may have already invested significant time and resources in developing expertise in other corrective ophthalmic techniques. Acceptance of the LTK System may be affected adversely by - its costs, - concerns related to its safety and efficacy, - the general resistance to use of laser procedures on the eye, - the effectiveness of alternative methods of correcting refractive vision disorders, - the lack of long-term follow-up data, or - the possibility of unknown side effects. Promotional efforts by suppliers of products or procedures which are alternatives to the LTK System, including eyeglasses, contact lenses and laser and non-laser surgical procedures, may also adversely affect the marketplace for the LTK System. Any failure to achieve broad market acceptance of the LTK System will have a material adverse effect on our business, financial condition and results of operations. CLINICAL DATA ABOUT THE LONG-TERM SAFETY AND EFFICACY OF THE LTK SYSTEM IS CURRENTLY AVAILABLE, BUT WE MAY BE REQUIRED TO UNDERTAKE FURTHER TESTING We have developed substantial clinical data on the safety and efficacy of the LTK System in correcting hyperopia (farsightedness). Following the ODP recommendation to approve the LTK system for temporary reduction of hyperopia in January 2000, the FDA is reviewing the data submitted in the PMA and is in the process of completing the inspections and labeling review needed to determine whether the LTK System is safe and effective for the treatment of hyperopia. This final FDA determination may take from three to nine months from the date of the PMA submission and we think that any approval of our PMA will not be forthcoming before the second quarter of 2000, at the earliest. Potential complications and side effects reported in clinical studies to date from the use of the LTK System include: - mild foreign body sensation, - temporary increased light sensitivity, - modest fluctuations in refractive capabilities during healing, - unintended over or under-corrections, - regression of effect, and 10 11 - induced astigmatism. The FDA may require the Company to conduct further testing of the LTK System, thereby delaying the Company's efforts to generate revenue, or limit the scope of the FDA approval, thereby limiting the market for the LTK System. OUR PRODUCT EMPLOYS PROPRIETARY TECHNOLOGY AND THIS TECHNOLOGY MAY INFRINGE ON THE INTELLECTUAL PROPERTY RIGHTS OF THIRD PARTIES We hold United States process and apparatus patents for the use of holmium lasers in non-destructive cornea shaping. Other parties, however, hold process and apparatus patents relating to shaping the cornea with holmium lasers. Generally, an apparatus patent contains claims to a new and useful machine or device. A process patent generally contains claims to a new and useful process, art, or method, which may include a new use of a known process, machine, manufacture, composition of matter, or material. We believe that we are not infringing on any patents held by others. However, if patents held by others were adjudged valid and interpreted broadly in an adversarial proceeding, they could be deemed to cover one or more aspects of our holmium laser corneal shaping systems, use of the LTK System, or other procedures. Any claims for patent infringement could be time-consuming, result in costly litigation, divert technical and management personnel, or require us to develop non-infringing technology or to enter into royalty or licensing agreements. We cannot be certain that we will not be subject to one or more claims for patent infringement, that we would prevail in any such action, or that our patents will afford protection against competitors with similar technology. If a court determines that the LTK System infringes, directly or indirectly, a patent in a particular market, the court may enjoin us from making, using and selling such system. Furthermore, we may be required to pay damages or obtain a royalty-bearing license, if available, on acceptable terms. Alternatively, if a license is not offered or available, we may be required to redesign those aspects of the LTK System held to infringe, directly or indirectly, to avoid such infringement. Any redesign could delay reintroduction of our products into certain markets, or may be so significant as to be impractical. If redesign efforts were impractical, we could be prevented from manufacturing and selling the infringing products, which would have a material adverse effect on our business, financial condition and results of operations. A COMPONENT OF THE LTK SYSTEM MAY BE COVERED BY A PATENT OWNED OR LICENSED BY A PARTY UNRELATED TO US WHICH MAY CAUSE US TO REDESIGN THE LTK SYSTEM, WHICH COULD DELAY COMMERCIALIZATION A component of the LTK delivery system is possibly covered by a patent owned by the University of Miami or licensed to another party. We believe that we will be able to conclude a satisfactory arrangement with the University of Miami or its licensee. If, however, we are unable to reach a successful agreement, we may have no rights to the component of the delivery system presently configured in the LTK System. If we are forced to redesign the LTK System, such redesign efforts could be time consuming, expensive and prolong FDA review. A SIGNIFICANT NUMBER OF OUR SHARES ARE ELIGIBLE FOR SALE AND THEIR SALE COULD DEPRESS THE MARKET PRICE OF OUR STOCK Sales of substantial amounts of our common stock (including shares issued upon exercise of outstanding options and warrants and shares issued upon conversion of convertible notes) in the public market could depress the market price of our common stock. As of March 10, 2000, we had 46,414,401 shares outstanding and 9,667,499 shares reserved for issuance upon exercise of options and warrants or conversion of convertible notes. LACK OF AVAILABILITY OF KEY SYSTEM COMPONENTS COULD RESULT IN DELAYS, INCREASED COSTS, OR COSTLY REDESIGN OF OUR PRODUCT Although some of the parts and components used by us to manufacture our products are available from multiple sources, we currently purchase most of our components from single sources in an effort to obtain volume discounts. Lack of availability of any of these parts and components could result in production delays, 11 12 increased costs, or costly redesign of our products. We continually evaluate ways to minimize any impact to our business from any potential part or component shortage through inventory stockpiling and design changes to afford opportunities for multiple sources of supply for these essential components. Any loss of availability of an essential system component could result in a material adverse change to our business, financial condition and results of operations. THE SUCCESS OF COMPETITIVE PRODUCTS COULD HAVE AN ADVERSE AFFECT ON OUR BUSINESS The vision correction industry is intensely competitive. The significant competitive factors in the industry include - price, - convenience, - success relative to vision correction, - acceptance of new technologies, - patient satisfaction, and - government approval. Patients with hyperopia (farsightedness) can achieve vision correction with eyeglasses, contact lenses and possibly with other technologies and surgical techniques currently under development, such as - corneal implants, - human lens replacement, - intra-ocular implantable contact lenses, and - surgery using different types of lasers. The success of any competing alternative to the LTK System for treating hyperopia could have a material adverse effect on our business, financial condition and results of operations. Most of our competitors have substantially greater financial capabilities for product development and marketing than we do. These financial capabilities enable our competitors to market their products or procedures to the consumer and to the ophthalmic community in a more effective manner. The excimer laser is the dominant laser used for the treatment of refractive disorders. In the United States, VISX and Summit are the leading manufacturers of excimer refractive surgical systems. Both Summit and VISX excimer laser are currently approved for treating hyperopia in the United States. We believe the LTK System offers several distinct advantages over the use of excimer lasers for treating hyperopia, including ease of use, non-invasiveness and a better safety record. From an ophthalmologist's standpoint, the LTK system is also attractive because the procedure is quicker than the excimer, which allows him to perform more procedures per period of time than the excimer. Both VISX and Summit, however, have significantly greater financial resources than we do and have received FDA approval for their respective excimer laser products for treating myopia (nearsightedness), hyperopia (farsightedness) and astigmatism. Summit discontinued its clinical trials for treating hyperopia with its holmium laser system in 1996. Any alternative treatment offered by VISX or Summit, however, will have a competitive advantage because they already have an established customer base currently using their products. WE ARE DEPENDENT ON OUR MANAGEMENT AND KEY PERSONNEL TO SUCCEED Our principal executive officers and key personnel have extensive experience with our LTK System, the research and development efforts needed to bring it to market, the development of marketing and sales programs for its launch and the necessary services to be provided to our customers to support the system. The loss of the services of any of our executive officers or other key personnel, or our failure to attract and retain other skilled and experienced personnel, could have a material adverse effect on our ability to continue the 12 13 FDA approval process for the LTK System and adversely affect our ability to manufacture, sell and market the product. Such events would probably have a negative impact on our business and financial condition. OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY INHIBIT A TAKEOVER The provisions of - our Certificate of Incorporation, as amended; - our Bylaws, as amended; and - the Delaware General Corporation Law (the Delaware Law) may have the effect of delaying, discouraging, inhibiting, preventing or rendering more difficult an attempt to obtain control of the Company by means of a tender offer, business combination, proxy contest or otherwise. These provisions include - charter authorization of "blank check" preferred stock, - classification of the Board of Directors, - a restriction on the ability of the stockholders to take actions by written consent, and - a Delaware Law provision imposing restrictions on business combinations with certain interested parties. In addition, we adopted a Stockholder Rights Plan. Under this Plan, each issued and outstanding share of our Common Stock has associated with it one Right to purchase a share of our Common Stock from us at a price of $70, subject to adjustment. These Rights will be exercisable if a person or group either: 1. acquires beneficial ownership of 15% or more of the Company; or 2. commences a tender or exchange offer upon consummation of which such person or group would beneficially own 15% or more of the Common Stock. We will be entitled to redeem the Rights at $.001 per Right at any time until ten days following a public announcement that a 15% position has been acquired. THE MARKET PRICE OF OUR STOCK HAS HISTORICALLY BEEN VOLATILE The volatility of our common stock imposes a greater risk of capital losses on stockholders as compared to less volatile stocks. In addition, such volatility makes it difficult to ascribe a stable valuation to a stockholder's holdings of our common stock. Factors such as announcements of technological innovations, changes in marketing, product pricing and sales strategies or new products by our competitors, changes in domestic or foreign governmental regulations or regulatory approval processes, developments or disputes relating to patent or proprietary rights and public concern as to the safety and efficacy of the procedures for which the LTK System is used, have and may continue to have a significant impact on the market price of our common stock. Moreover, the possibility exists that the stock market (and in particular the securities of technology companies such as ours) could experience extreme price and volume fluctuations unrelated to operating performance. ITEM 2. FACILITIES The Company leases a 55,000 square foot facility at 3400 West Warren Avenue, Fremont, California, which currently serves as its executive offices and research and production facility. The facility lease expires in April 2004 and requires base payments on average of approximately $79,000 per month, subject to standard pass-throughs and escalations. Management of the Company believes that the facility can accommodate the expected increases in additional headcount and operations activities. 13 14 ITEM 3. LEGAL PROCEEDINGS On July 13, 1999, the Company filed two suits in the United States District Court for the Northern District of California against (i) Sturza's Institutional Research, Inc. and Evan Sturza (Number C99-3393 CQAL); and (ii) Avalon Research Group, Inc. ("ARG") (Number C99-3394 CAL) for defamation. Sturza's Institutional Research ("SIR") published a weekly newsletter to its investor-subscribers and others. SIR analyzes publicly traded companies in the healthcare sector. SIR is part of a family of companies under common control in medical technology investment. ARG specialized in writing, publishing, and selling weekly written investment and money management reports on publicly traded companies. ARG's reports are available to paying subscribers and others. The complaint alleges that SIR, ARG, and others associated with them issued and disseminated a report which defamed the Company and led to the devaluation of the Company's shares. Both complaints request injunctive relief, including the cessation of the publication of all misleading statements, a retraction and payment of monetary damages. Both complaints have been settled in principal pending documentation. Neither settlement will have a material impact on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable 14 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Market Information As of December 31, 1999, there were 935 holders of record of the Company's common stock. Price information for the Company's common stock may be obtained from the Nasdaq National Market System and prior to August 13, 1998, the common stock was traded in the over-the-counter market. The table below sets forth the reported high and low bid quotations of the Company's common stock as reported on the OTC Bulletin Board through August 12, 1998 and the reported high and low bid quotations of the Company's common stock as reported on the Nasdaq National Market System from August 13, 1998 to December 31, 1999 for the periods indicated. PRICE FOR COMMON STOCK(1)
QUARTER ENDED HIGH LOW ------------- ------ ----- March 31, 1998.............................. $ 7.53 $2.91 June 30, 1998............................... 10.38 5.56 September 30, 1998.......................... 8.19 3.91 December 31, 1998........................... 7.38 3.75 March 31, 1999.............................. 14.00 5.88 June 30, 1999............................... 14.94 8.75 September 30, 1999.......................... 20.38 2.75 December 31, 1999........................... 14.56 4.50
- --------------- (1) Bid and ask prices are quoted on the Nasdaq National Market System and the OTC Bulletin Board in increments of 1/32. Certain of the bid and ask prices set forth in this table have been rounded to the nearest cent. The over-the-counter market quotations provided herein may reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. On March 10, 2000, the closing price of the common stock as reported on the Nasdaq National Market System was $7.563 per share. Dividends In the past three years, the Company has not declared or paid any cash dividends on its common stock. The Company currently intends to retain any and all future earnings to finance its business. Accordingly, the Company does not anticipate paying cash or other dividends on its Common Stock in the foreseeable future. Recent Sales of Unregistered Securities In January 1999, the Company completed a $10,000,000 private placement of convertible notes with warrants. These notes are convertible into the Company's Common Stock at predetermined prices and bear interest at the rate of 5% payable-in-kind semi annually. The securities were sold pursuant to Regulation D promulgated under the Securities Act of 1933, as amended (the "Securities Act"), to an accredited investor, as defined in Rule 501 of Regulation D. One-half of the notes became convertible into the Company's Common Stock at a conversion price of $4.00 per share upon the January 13, 2000, ODP recommendation to the FDA to approve the LTK System. The remaining one-half of the notes are convertible at $8.00 per share upon final FDA approval. In January 2000, the Company completed a $11,200,000, net of offering costs, private placement of convertible debentures with warrants. These debentures are convertible into the Company's common stock at a conversion price of $5.916, at the option of the holder, and mature in June 2002. The debentures bear an interest rate of 7% per annum, payable in kind or cash at the option of the Company and are payable quarterly. 15 16 There are two types of associated warrants issued in connection with the debentures. Type A warrants are five year warrants with an exercise price of $6.803. Type B warrants are two year warrants with an exercise price of $6.803 and are callable at the Company's option once the closing stock price is equal to or higher than $7.823 for a continuous period of twenty trading days. The proceeds of these offerings have been used by the Company for the funding of clinical trials, research and development activities, and general corporate purposes. ITEM 6. SELECTED FINANCIAL DATA The following table summarizes certain selected financial data derived from the audited financial statements for the years ended December 31, 1995, 1996, 1997, 1998 and 1999.
YEAR ENDED DECEMBER 31, ----------------------------------------------------- 1995 1996 1997 1998 1999 ------- ------- ------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net revenues........................... $ 5,294 $ 5,654 $ 2,839 $ 594 $ 26 Gross profit........................... 1,637 1,638 293 (1,548) (2,333) Operating expenses..................... 5,824 7,658 7,368 12,718 18,875 Loss from operations................... (4,187) (6,020) (7,075) (14,266) (21,208) Gain on sale of dental assets.......... -- -- 1,740 -- -- Interest income........................ 69 65 99 399 955 Interest expense....................... (12) (13) (1,376) (3,950) (5,890) Other expense, net..................... -- -- (6) (4) (2) Net loss............................... (4,130) (5,968) (6,618) (17,821) (26,145) Net loss per share, basic and diluted.............................. $ (0.28) $ (0.23) $ (0.23) $ (0.52) $ (0.60) Shares used in calculation of basic and diluted net loss per share........... 14,935 26,414 28,550 34,164 43,867 Total assets........................... $ 6,689 $ 3,741 $ 2,949 $ 11,479 $ 14,905 Long term obligations.................. -- -- 945 7,703 10,155 Total stockholders' equity............. 4,745 1,272 849 200 2,101 Working capital........................ 4,541 1,073 1,382 6,773 10,765
See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for information regarding disposition of the Company's dental business and assets. 16 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company develops, manufactures and markets laser systems for applications in ophthalmology. Substantially all of our business activities, including engineering and development, manufacturing, assembly and testing take place at our facility in Fremont, California. Prior to June 26, 1997, we developed, manufactured and marketed lasers and air abrasion cavity preparation systems for use in dentistry. Our working capital is seriously depleted due to our substantial losses in the past eight years. Sales of our existing ophthalmic products at current levels will not be sufficient to sustain the continued development and regulatory licensing of our holmium laser corneal shaping product or process known as the Laser Thermal Keratoplasty System (the "LTK System"). We have been able to raise additional working capital for all aspects of our business through private placements of our common stock and convertible notes with warrants. These private placements raised $15,296,000 in 1994, 1995 and 1996 in new equity. We also raised approximately $3,700,000 in the form of promissory notes with warrants in February and March 1997 (the "1997 Notes Placement"). We raised approximately $9,300,000, net of offering costs, in the form of promissory notes with warrants in January 1998 (the "1998 Notes Placement"), and approximately $11,800,000, net of offering costs, from the sale of common stock in December 1998 (the "1998 Equity Offering"). In January 1999, we raised $10,000,000, net of offering costs, in the form of promissory notes with warrants (the "1999 Notes Placement"). In January 2000, we raised approximately $11,200,000, net of offering costs, in the form of convertible debentures (the "2000 Debentures") with warrants. The Company's current operations continue to be cash flow negative, further straining our working capital resources. At our current rate of cash expenditures, we expect to need to raise additional working capital during 2000 to fund operations. We spent approximately $800,000 for capital expenditures in fiscal year 1999. No assurance can be given that additional financing will be available, or if available, that it will be available on terms favorable to us and our stockholders. In the event needed additional working capital is not raised, the Company has the option of scaling back its expenditures to conserve cash until such financing or alternative business solutions are implemented. REVENUES The Company's revenues have historically been comprised primarily of sales related to its dental products (none in 1999 and 1998, 69% in 1997). Revenues of $26,000 and $594,000 in 1999 and 1998, respectively, reflect sales of its ophthalmic products. Approximately $1,968,000 of 1997 revenues were attributable to the dental business that was sold in June 1997. Revenues for the ophthalmic business for 1997 were $871,000. GROSS MARGIN Gross margins were a negative $2,333,000 and $1,548,000 in 1999 and 1998, respectively, and a positive $293,000 in 1997. The negative margin in 1999 is reflective of having no material sales during the year while incurring manufacturing costs for the development of prototype LTK instruments. The negative gross margin in 1999 was substantially higher than that of 1998 because in 1999 we invested significantly in the development of the LTK instrument, the Hyperion. The 1998 negative gross margin was driven essentially by inventory write-downs from obsolete parts and components of the Sun 1000 LTK System that was being discontinued. RESEARCH AND DEVELOPMENT Research and development expenses were $4,774,000, $2,107,000 and $964,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The 127% increase in 1999 over 1998 for these expenses was driven by the investment in the development of the new LTK System, including a 59% increase in headcount and additional consulting fees. Engineering and development expenses of $2,107,000 in 1998, representing a 119% increase from the 1997 level, were also due to development of the LTK System. 17 18 SALES, MARKETING AND REGULATORY Sales, marketing and regulatory expenses were $7,182,000, $3,824,000 and $2,718,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The 88% increase in this category of expenses in 1999 as compared to 1998 was due in part to costs associated with higher patient enrollment in clinical trials -- 763 patients in 1999 compared to 608 patients in 1998 -- and the expansion of clinical studies for hyperopia and presbyopia. The most significant expenditures of the regulatory process were those relative to costs of the submission of the original PMA, the preparation for the July 1999 ODP meeting and the preparation of the amendments to the PMA leading to the January 2000 ODP meeting. Sales and marketing expenditures also increased in 1999 as compared to 1998 as we initiated the preparation of our marketing plan for product launch of the LTK system. Distribution of LTK lasers in international markets has been performed by selected distributors with the assistance of our own internal sales and marketing team. For the US market, once we have received FDA approval, we plan to sell our laser systems directly to ophthalmologists and ophthalmic laser service organizations. We do not anticipate final FDA approval before the second quarter of 2000. GENERAL AND ADMINISTRATIVE General and administrative expenses were $6,919,000, $6,787,000, and $3,686,000 for the years ended December 31, 1999, 1998 and 1997, respectively. General and administrative expenses in 1999 were in line with those of 1998 with only a 2% increase reflecting our emphasis on keeping overhead as low as possible while making investments intended to help achieve our milestones such as FDA approval and product development. The increase in general and administrative expenses for 1998 as compared to 1997 of approximately 84% was, in major part, due to the non cash charges in recognition of the fair value of warrants granted to consultants in lieu of cash compensation. This charge in 1998 amounted to approximately $2,105,000 of which $905,000 was a result of warrants issued in 1997 and $1,200,000 resulted from warrants issued in 1998. The warrants issued in 1997 were amortized over a vesting period of two years. The 1998 warrants were fully vested in 1998 and amortized fully in that year. An additional compensation expense of approximately $1,000,000 in 1998 originated from warrants granted to a consultant for his services. The Company's general and administrative expenses consist primarily of: (i) salaries and benefits of administrative and certain executive personnel; (ii) product liability, officer and director liability and other corporate insurance premiums; (iii) accounting, legal and other fees related to patent and general corporate matters; and (iv) provisions for the Company's allowance for bad debts and non-cash expenses associated with the issuance of certain warrants and non-statutory stock options. INTEREST INCOME AND EXPENSE Interest income was $955,000, $399,000 and $99,000 for the years ended December 31, 1999, 1998 and 1997, respectively. The significant increase in interest income in 1999 over 1998 was due to higher average cash balances in 1999 compared to 1998 and $279,000 in interest accrued for Promissory Notes issued to third parties in 1999 with an average interest rate of 8.5% interest. The increase in interest income of 1998 compared to 1997 was due to higher average cash balances in 1998 compared to 1997, maintained in interest bearing accounts. Interest expense was $5,890,000, $3,950,000 and $1,376,000 for the years ended December 31, 1999, 1998 and 1997, respectively. Approximately $5,160,000, or 88%, of our interest expense in 1999 was due to non-cash expenses incurred in connection with the 1998 and 1999 Notes Placement. The fair value of the warrants, the conversion features and the placement costs of such notes were recorded as non-cash interest expense in 1999. The 1999 Notes and 1998 Notes bear a stated interest rate of 5% and 12%, respectively. The effective rate of interest of such notes, which includes the amortization of the fair value of the warrants, is approximately 16% and 26%, respectively. In 1998, approximately $2,815,000, or 71%, of the Company's interest expense was due to non-cash expenses incurred in connection with the 1998 and 1997 Notes Placement. The fair value of the warrants, the conversion features and the placement costs of such notes were recorded as non-cash interest expense in 1998. The 1998 Notes and 1997 Notes bear a stated interest rate of 18 19 12% and 5%, respectively. The effective rate of interest of such notes, which includes the amortization of the fair value of the warrants, is approximately 26% and 21%, respectively. The 2000 Debenture financing will generate non-cash charges over the funding period which, for purposes of recognizing the full effect of such non-cash charges, could extend to the year 2005. For the full year 2000, we anticipate a non-cash charge of close to $12,800,000. Of this amount, approximately $9,400,000 is a one-time, non-cash charge based on the difference between the debenture conversion price of $5.916 and the stock market closing price for Sunrise's stock of $10.688 on January 11, 2000. In addition, the valuation of the 1,088,882 warrants issued with respect to the 2000 Debenture financing, using Black-Scholes valuation model, will result in an estimated non-cash charge for the year 2000 of approximately $3,400,000. INCOME TAXES At December 31, 1999, 1998 and 1997, all net deferred tax assets were computed in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" and have been fully offset by a valuation allowance. NET LOSSES The Company reported losses of $26,145,000, $17,821,000 and $6,618,000 in 1999, 1998 and 1997, respectively. The net loss in 1999 was due to minimal product revenue; under-utilization of the expanded manufacturing capacity; increased marketing, sales and regulatory efforts; increased personnel costs; and non-cash expenses. The non cash expenses are associated with the amortization of deferred compensation of approximately $1,887,000 from the issuance of warrants and non-qualified stock options to consultants in lieu of cash and approximately $5,160,000 associated with warrants issued in connection with the 1998 and 1999 Notes Placement. The net loss in 1998 was similarly due to lower product revenues, under-utilization of manufacturing capacity, non-cash expenses associated with amortization of deferred compensation of approximately $2,105,000, warrants issued in connection with the 1997 and 1998 Notes Placements of approximately $2,815,000 and non-statutory stock option expenses of approximately $974,000, which resulted from the acceleration of stock options vesting for certain former employees. The net loss in 1997 was due also to the low level of revenues, excess manufacturing capacity and inventory, the Company's continuing clinical trials for hyperopia and presbyopia, expenses associated with the Company's issuance of convertible debt with warrants and certain non-statutory stock options, and the Company's need to maintain its basic corporate infrastructure, offset by the gain from the sale of the Company's dental business in June 1997. Although total operating expenses were reduced by 4% from 1996, the reduction was not sufficient to return the Company to profitability in 1997. We expect to report net losses during 2000. The losses will come primarily from the expenses of the FDA approval process, the underlying clinical studies related to the LTK System and the expenses associated with maintaining our basic corporate infrastructure. We will not have any material domestic revenues from the LTK system product line unless and until FDA approval is obtained. On the other hand our international revenues are not projected to be sufficient to cover the expenses of maintaining the basic corporate infrastructure and our costs of the continuing clinical trials for hyperopia and presbyopia. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1999, we had $10,643,000 in cash and cash equivalents. Our operating activities used $20,659,000 in cash during 1999 and $8,536,000 during the same period in 1998. On January 1, 1999, we raised $10,000,000 by issuing convertible notes and accompanying warrants to purchase common stock. The 1999 Notes are convertible into shares of the Company's Common Stock at predetermined prices, bear interest at the rate of 5% payable-in-kind semi-annually (additional convertible notes), and contain certain conversion features. One-half of the principal amount of the 1999 Notes became convertible into shares of the Company's common stock at a conversion price of $4.00 per share after we 19 20 received conditional approval from the ODP for the LTK System. The investor will also be required to convert the remaining portion of the 1999 Notes into shares of common stock at a conversion price of $8.00 per share on the date the Company receives FDA approval to market the LTK System in the United States. Substantial portions of the 1997 and 1998 losses were funded with the proceeds from the sale of our dental business in June 1997 and from a series of private placements and equity offerings. The 1997 Notes Placement and 1998 Notes Placement had aggregate net proceeds of approximately $3,700,000, (gross proceeds of $4,100,000) and $9,350,000, respectively. On December 4, 1998, we completed a private placement of approximately $11,800,000 in shares of Common Stock. The subscription price was $3.50 per share, which represents a 20% discount from the average of the closing sale price of our common stock, as reported on the Nasdaq National Market System, on each of the last ten consecutive Nasdaq National Market System trading days in October 1998. Of the total proceeds, $5,000,000 from the 1998 Equity Offering was received in the form of promissory notes due on March 15, 1999 bearing interest at a rate of 9% per annum. Of the $5,000,000 in promissory notes, $1,000,000 is currently outstanding and has not been repaid. The Company's debt service obligations consist of interest, payable in cash or in-kind, accruing at a rate of 12% per annum on the $168,644 in principal and interest on the 1998 Notes as of December 31, 1999, and 5% per annum on the $10,500,000 of principal and interest on the 1999 Notes as of December 31, 1999. The Company also pays $5,800 per month on leases for computer and office equipment. The warrants issued in connection with the 1999 Notes Placement and 1998 Notes Placement had a fair value of approximately $5.93 and $1.87 per warrant, respectively, at the time of issuance. The fair value of these warrants has been reflected as additional consideration for the convertible notes, recorded as a discount on the debt and accreted as interest expense to be amortized over the life of the convertible notes. This amortization of interest expense associated with the warrants will reduce net income through the term of the 1998 and 1999 Notes, but will have no effect on future cash flows from operations. Our current operations continue to be cash flow negative, limiting our working capital resources. Working capital at December 31, 1999 amounted to approximately $10,765,000. In January 2000 we raised an additional $11,200,000, net of closing costs. Our existing cash resources, as supplemented by these proceeds, may not be sufficient to fund our year 2000 activities. At the Company's current rate of cash expenditures, it is likely that we may need to raise additional working capital during 2000. At December 31, 1998, working capital amounted to approximately $6,773,000. The Company spent approximately $800,000 for capital expenditures in calendar year 1999 and expects to spend more than that amount for capital expenditures in fiscal year 2000. We expect our expenses to increase in 2000 due to the ramp up to manufacture initial production units of our LTK System and the preparation costs associated with the anticipated market launch of the LTK System. No assurance can be given that additional financing will be available, or if available, that it will be available on terms favorable to the Company and its Stockholders. In the event needed additional working capital is not raised, the Company has the option of scaling back its expenditures to conserve cash until such financing or alternative business solutions are implemented. CONVERSION A single currency called the Euro was introduced in Europe on January 1, 1999. Eleven of the 15 member countries of the European Union have adopted the Euro as their common legal currency. Fixed conversion rates between these participating countries' existing currencies (the "Legal Currencies") and the Euro were established. The Legal Currencies are scheduled to remain legal tender as denominations of the Euro until at least January 1, 2002 (but not later than July 1, 2002). During this transition period, parties may settle transactions using either the Euro or a participating country's legal currency. We do not expect the conversion to the Euro will have a material impact on our financial position or results of operations since the majority of our business transactions are recorded in U.S. currency. 20 21 NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Standards No. 133 ("SFAS 133"), "Accounting for Derivative Investments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In July of 1999, the FASB issued Statement of Financial Standards No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has not yet evaluated the effects of this change on its operations. The Company will adopt SFAS 133 as required for its first quarterly filing of the fiscal year 2001. In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance for revenue recognition under certain circumstances. The Company believes that SAB 101 will not have a material impact on its financial position or results of operations. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to financial market risks due primarily to changes in interest rates. The Company does not use derivatives to alter the interest characteristics of its investment securities or its debt instruments. The Company has no holdings of derivative or commodity instruments and does not transact business in foreign currencies. The fair value of the Company's investment portfolio or related income would not be significantly impacted by changes in interest rates since the investment maturities are short and the interest rates are primarily fixed. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated balance sheets at December 31, 1999 and 1998, and the related consolidated statements of operations, stockholders' equity and cash flow for each of the three years ended December 31, 1999, 1998 and 1997 and the notes thereto appear beginning at page 27. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable 21 22 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The section entitled "Directors and Executive Officers" located in the Registrant's Proxy Statement to be filed pursuant to Regulation 14A for its Annual Meeting of Stockholders on June 8, 2000 (the "2000 Annual Meeting Proxy Statement") is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The section entitled "Executive Compensation" in the 2000 Annual Meeting Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The section entitled "Security Ownership of Certain Beneficial Owner's and Management" in the 2000 Annual Meeting Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The section entitled "Certain Relationships and Related Transactions" in the 2000 Annual Meeting Proxy Statement is incorporated herein by reference. 22 23 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. FINANCIAL STATEMENTS The following documents are filed as part of this report:
PAGE IN THIS ANNUAL REPORT ON FORM 10-K ---------------- Report of Independent Accountants........................... 26 Consolidated Balance Sheets -- December 31, 1999 and 1998... 27 Consolidated Statements of Operations*...................... 28 Consolidated Statement of Stockholders' Equity*............. 29 Consolidated Statements of Cash Flows*...................... 30 Notes to Consolidated Financial Statements.................. 31
- --------------- * For the years ended December 31, 1999, 1998 and 1997 2. FINANCIAL STATEMENTS Schedule II -- Valuation and Qualifying Accounts............ 43
All other schedules have been omitted as they are not required, not applicable or the required information is included in the financial statements or notes thereto. 3. EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1 Asset Purchase Agreement dated as of March 26, 1997, by and between the Company and Lares Research, a California corporation(1) 3.1 Certificate of Incorporation, as amended(2) 3.2 Bylaws(2) 4.1 Form of Rights Agreement, dated as of October 24, 1997, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(3) 4.2 Form of Warrant issued to Pennsylvania Merchant Group(4) 4.3 Form of 12% Subordinated Pay-In-Kind Note Due 2001(5) 4.4 Form of Registration Rights Agreement(5) 4.5 Form of 5% Convertible Subordinated Pay-In-Kind Note due 2001(6) 4.6 Form of Warrant for the Purchase of Common Stock(6) 4.7 Form of Registration Rights Agreement(6) 4.8 Form of Amendment to Rights Agreement, dated as of May 3, 1999, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(7) 4.9 Form of 7% Convertible Debenture dated January 11, 2000(8) 4.10 Form of A Warrant dated January 11, 2000(8) 4.11 Form of B Warrant dated January 11, 2000(8) 4.12 Registration Rights Agreement dated January 11, 2000 among the Company, The Tail Wind Fund, Ltd., LBI Group Inc., Jeddy Development Inc., Donald Sanders M.D., PhD., Donald Wanda Sanders IRA, CIBC Oppenheimer Corp., as Custodian, Meyer Temkin and Charles D. Kelman, M.D. (8)
23 24
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 4.13 Form of Warrant dated January 11, 2000, issued to Dunwoody Brokerage Services, Inc. 10.1 Patent License Agreement between the Company and Patlex Corporation dated January 1, 1990(9) 10.2 Agreement between the Company and the University of Miami, Department of Ophthalmology, dated October 28, 1991(10) 10.3 Settlement Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.4 License Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.5 Settlement Agreement between the Company and American Dental Technologies, dated July 30, 1996 (1) *10.6 Form of Indemnification Agreement between the Company and each of its officers and directors(9) *10.7 1988 Stock Option Plan, as amended(5) *10.8 Form of Indemnification Agreement by and between the Company and its executive officers(3) 10.9 Form of U.S. Note and Warrant Purchase Agreement related to the Regulation D private placement of 12% Convertible Subordinated Pay-In-Kind Notes Due 2001 and accompanying Warrants in January 1998(5) *10.10 Form of Amended and Restated Change of Control Agreement by and between the Company and its President and Chief Executive Officer(12) *10.11 Form of Amended and Restated Change of Control Agreement by and between the Company and its executive officers (other than the President and Chief Executive Officer)(12) 10.12 Sublease between Avant! Corporation, as sub-sublandlord, the Company, as sub-subtenant, Cirrus Logic, Inc., as sublandlord, Avant! Corporation, as subtenant, Renco Investment Company, as landlord, and Cirrus Logic, Inc., as tenant for the lease of facilities at 3400 West Warren Avenue, Fremont, California(13) 10.13 Form of Note and Warrant Purchase Agreement(6) *10.14 The 1997 Stock Option Plan(14) *10.15 The 1999 Long-Term Equity Compensation Plan(15) 10.16 Purchase Agreement dated January 11, 2000 between the Company and the Tail Wind fund, Ltd., LBI Group, Inc., Jeddy Development, Inc., Donald Sanders M.D., PhD., Donald Sanders IRA, CIBC Oppenheimer Corp., as Custodian, Monica Sanders, Kendra Sanders, Wanda Sanders IRA, CIBC Oppenheimer Corp. as Custodian, Meyer Temkin and Charles D. Kelman, M.D.(8) 21.1 Subsidiaries of the Company 22 Power of Attorney (included on the signature pages to this Form 10-K) 23 Consent of PricewaterhouseCoopers LLP, Independent Accountants 27 Financial Data Schedule
- --------------- * Compensatory plan or management contract (1) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 1-10428) (2) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-17816) 24 25 (3) Incorporated by reference from the registrant's Current Report on Form 8-K dated October 24, 1997 (File No. 0-17816) (4) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-17816) (5) Incorporated by reference from the registrant's Current Report on Form 8-K January 26, 1998 (File No. 0-17816) (6) Incorporated by reference from the registrant's Current Report on Form 8-K dated January 1, 1999 (File No. 1-10428) (7) Incorporated by reference from the registrant's Current Report on Form 8-K filed September 30, 1999 (File No. 0-17816) (8) Incorporated by reference from the registrant's Current Report on Form 8-K filed January 14, 2000 (File No. 0-17816) (9) Incorporated by reference from the registrant's Registration Statement on Form S-1, as amended (File No. 33-36768) (10) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-17816) (11) Incorporated by reference from the registrant's Registration Statement on Form S-18, as amended (File No. 33-27029-LA) (12) Incorporated by reference from the registrant's Current Report on Form 8-K dated May 8, 1998 (File No. 0-17816) (13) Incorporated by reference from the registrant's Registration Statement on Form S-2 dated September 29, 1998 (File No. 333-64975) (14) Incorporated by reference from the registrant's Registration Statement on Form S-8 dated March 2, 1999 (File No. 333-73211). (15) Incorporated by reference from the registrant's Registration Statement on Form S-8 dated November 24, 1999 (File No. 333-91669) (b) REPORTS ON FORM 8-K Not applicable. (c) EXHIBITS. See (a)3. above. (d) FINANCIAL SCHEDULES. See (a)2. above. 25 26 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Sunrise Technologies International, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 23 present fairly, in all material respects, the financial position of Sunrise Technologies International, Inc. and its subsidiary (the "Company") at December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14(a)(2) on page 23 presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PRICEWATERHOUSECOOPERS LLP San Jose, California February 11, 2000 26 27 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, ---------------------- 1999 1998 --------- --------- (IN THOUSANDS, EXCEPT SHARE DATA) Current assets: Cash and cash equivalents................................. $ 10,643 $ 9,889 Accounts receivable, net of allowance of $3 and $11 in 1999 and 1998, respectively............................ 327 135 Inventories, net.......................................... 1,973 11 Prepaid and other expenses................................ 471 314 -------- -------- Total current assets.............................. 13,414 10,349 Property and equipment, net............................... 1,271 900 Other non-current assets.................................. 220 230 -------- -------- Total assets...................................... $ 14,905 $ 11,479 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of capital lease obligation............... $ 28 $ 38 Current portion of notes payable.......................... 5,000 692 Accounts payable.......................................... 416 694 Accrued liabilities....................................... 2,205 2,152 -------- -------- Total current liabilities......................... 7,649 3,576 Capital lease obligations, less current portion............. -- 28 Notes payable, less current portion......................... 5,065 7,658 Other long-term liabilities................................. 90 17 -------- -------- Total liabilities................................. 12,804 11,279 -------- -------- Commitments and Contingencies (Note 5) Stockholders' equity: Preferred stock, $0.001 par value; 2,000,000 shares authorized, none issued or outstanding Common stock, $0.001 par value; 75,000,000 shares authorized, 46,321,157 and 38,160,720 shares issued and outstanding at December 31, 1999 and 1998, respectively........................................... 46 38 Additional paid-in-capital................................ 85,139 60,087 Deferred compensation..................................... (506) (42) Notes receivable for common stock......................... (1,550) (5,000) Accumulated deficit....................................... (81,028) (54,883) -------- -------- Total stockholders' equity........................ 2,101 200 -------- -------- Total liabilities and stockholders' equity........ $ 14,905 $ 11,479 ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 27 28 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF OPERATIONS
YEARS ENDED DECEMBER 31, ------------------------------------- 1999 1998 1997 ---------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net revenues................................................ $ 26 $ 594 $ 2,839 Cost of revenues............................................ 2,359 2,142 2,546 -------- -------- ------- Gross margin................................................ (2,333) (1,548) 293 -------- -------- ------- Operating expenses: Research and development.................................. 4,774 2,107 964 Sales, marketing and regulatory........................... 7,182 3,824 2,718 General and administrative................................ 6,919 6,787 3,686 -------- -------- ------- Total operating expenses.................................... 18,875 12,718 7,368 -------- -------- ------- Loss from operations........................................ (21,208) (14,266) (7,075) Gain on sale of dental assets............................... -- -- 1,740 Interest income............................................. 955 399 99 Interest expense............................................ (5,890) (3,950) (1,376) Other expense, net.......................................... (2) (4) (6) -------- -------- ------- Net loss.................................................... $(26,145) $(17,821) $(6,618) ======== ======== ======= Net loss per share, basic and diluted....................... $ (0.60) $ (0.52) $ (0.23) ======== ======== ======= Shares used in calculation of basic and diluted net loss per share..................................................... 43,867 34,164 28,550 ======== ======== =======
The accompanying notes are an integral part of these consolidated financial statements. 28 29 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
COMMON STOCK ADDITIONAL NOTES RECEIVABLE TOTAL ------------------- PAID-IN DEFERRED FOR COMMON ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL COMPENSATION STOCK DEFICIT EQUITY ---------- ------ ---------- ------------ ---------------- ----------- ------------- (IN THOUSANDS, EXCEPT SHARE DATA) Balance at January 1, 1997..... 27,868,613 $28 $31,688 $ -- $ -- $(30,444) $ 1,272 Issuance of warrants in connection with 1997 Notes... -- -- 1,838 -- -- -- 1,838 Conversion of 1997 Notes....... 2,902,566 3 2,599 -- -- -- 2,602 Exercise of warrants........... 1,270,531 1 1,073 -- -- -- 1,074 Exercise of options............ 247,913 -- 279 -- -- -- 279 Issuance of shares in connection with employee stock purchase plan.......... 18,367 -- 15 -- -- -- 15 Deferred compensation related to stock option grants....... -- -- 659 (272) -- -- -- Net loss....................... -- -- -- -- -- (6,618) (6,618) ---------- --- ------- ----- ------- -------- -------- Balance at December 31, 1997... 32,307,990 32 38,151 (272) -- (37,062) 849 Issuance of common stock, net of offering costs, in connection with 1998 Equity Offering..................... 3,378,218 3 11,739 -- -- -- 11,742 Issuance of warrants in connection with 1998 Notes... -- -- 4,283 -- -- -- 4,283 Issuance of warrants and stock options...................... -- -- 2,602 -- -- -- 2,602 Amortization of deferred compensation................. -- -- -- 230 -- -- 230 Conversion of 1997 and 1998 Notes........................ 1,074,043 1 1,221 -- -- -- 1,222 Exercise of warrants........... 624,407 1 606 -- -- -- 607 Exercise of options............ 765,564 1 1,458 -- -- -- 1,459 Issuance of shares in connection with employee stock purchase plan.......... 10,498 -- 27 -- -- -- 27 Issuance of promissory notes in connection with 1998 Equity Offering..................... -- -- -- -- (5,000) -- (5,000) Net loss....................... -- -- -- -- -- (17,821) (17,821) ---------- --- ------- ----- ------- -------- -------- Balance at December 31, 1998... 38,160,720 38 60,087 (42) (5,000) (54,883) 200 Issuance of warrants in connection with 1999 Notes... -- -- 3,308 -- -- -- 3,308 Issuance of warrants and stock options...................... -- -- 2,350 (702) -- -- 1,648 Amortization of deferred compensation................. -- -- -- 238 -- -- 238 Conversion of 1997 and 1998 Notes........................ 4,087,763 4 10,597 -- -- -- 10,601 Exercise of warrants........... 3,235,077 3 7,208 -- (550) -- 6,661 Exercise of options............ 813,377 1 1,433 -- -- -- 1,434 Issuance of shares in connection with employee stock purchase plan.......... 24,220 -- 156 -- -- -- 156 Repayment of promissory notes........................ -- -- -- -- 4,000 -- 4,000 Net loss....................... -- -- -- -- -- (26,145) (26,145) ---------- --- ------- ----- ------- -------- -------- Balance at December 31, 1999... 46,321,157 $46 $85,139 $(506) $(1,550) $(81,028) $ 2,101 ========== === ======= ===== ======= ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 29 30 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------- 1999 1998 1997 -------- -------- ------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net loss.................................................... $(26,145) $(17,821) $(6,618) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................. 429 182 77 Amortization of deferred compensation..................... 238 3,477 387 Amortization of debt issuance costs....................... 12 210 150 Beneficial conversion feature............................. 2,425 -- -- Gain on sale of dental assets............................. -- -- (1,740) Warrant accretion associated with the 1997, 1998 and 1999 Notes................................................... 2,723 2,605 1,066 Issuance of common stock for services..................... -- 150 371 Issuance of warrants and stock options for services rendered................................................ 1,648 -- -- Provision for obsolete inventory.......................... 79 -- 397 Provision for doubtful accounts........................... (8) -- 176 Conversion of accrued interest to notes payable........... 46 557 -- Changes in assets and liabilities: Accounts receivable..................................... (184) 177 (16) Inventories............................................. (2,041) 116 233 Other current assets.................................... (157) (174) 148 Other non-current assets................................ (2) (218) -- Accounts payable........................................ (278) 410 (1,302) Other accrued liabilities............................... 53 1,151 (258) Other liabilities....................................... 503 642 155 -------- -------- ------- Total adjustments.................................. 5,486 9,285 (156) -------- -------- ------- Net cash used in operating activities....................... (20,659) (8,536) (6,774) -------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment.......................... (800) (878) (98) Proceeds from sale of dental assets......................... -- -- 3,449 -------- -------- ------- Net cash provided by (used in) investing activities....... (800) (878) 3,351 -------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Payment on capital lease obligations........................ (38) (33) (5) Payments received on promissory notes....................... 4,000 -- -- Issuance of common stock, net of offering costs............. 8,251 8,042 996 Capitalization of debt issuance costs....................... -- (14) (358) Issuance of redeemable convertible notes, net of issuance costs..................................................... 10,000 9,350 4,101 -------- -------- ------- Net cash provided by financing activities................. 22,213 17,345 4,734 -------- -------- ------- Net increase in cash and equivalents........................ 754 7,931 1,311 Cash and cash equivalents at beginning of year.............. 9,889 1,958 647 -------- -------- ------- Cash and cash equivalents at end of year.................... $ 10,643 $ 9,889 $ 1,958 ======== ======== ======= SUPPLEMENTAL DISCLOSURES FOR CASH FLOW INFORMATION Cash (paid)/received for interest........................... $ (454) $ (284) $ 13 Cash paid for income taxes.................................. $ 10 $ 5 $ 6 NON-CASH FINANCING ACTIVITIES Promissory notes issued in exchange for common stock........ $ 550 $ 5,000 $ -- Conversion of 1997 and 1998 notes into common stock......... $ 10,601 $ 1,222 $ 2,602
The accompanying notes are an integral part of these consolidated financial statements. 30 31 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1999 1. ORGANIZATION AND NATURE OF BUSINESS Sunrise Technologies International, Inc. (the "Company") develops, manufactures and markets laser systems and other products for applications in ophthalmology. The Company was organized as a California corporation in March 1987 and was reincorporated in Delaware in June 1993 as Sunrise Technologies International, Inc. The Company continues to do business under the name Sunrise Technologies, Inc. The Company has incurred significant losses for the last several years and at December 31, 1999 has an accumulated deficit of $81,028,000. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company's long term ability to continue as a going concern is dependent upon returning to profitable operations. Management's plans include increasing sales through increased direct sales and marketing efforts on existing products and pursuing timely regulatory approval for certain products under development. Management recognizes the need for infusion of cash during the 2000 fiscal year. In January 2000, the Company raised approximately $11,200,000, net of offering costs in the form of convertible debentures with warrants. There can be no assurance that additional funds can be raised on terms acceptable to the Company, if at all. In the event needed additional working capital is not raised, the Company has the option of scaling back its expenditures to conserve cash until such financing or alternative business solutions are implemented. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary after elimination of all inter-company balances and transactions. Concentration of Risks Financial instruments, which potentially subject the Company to concentration of credit risk, consist principally of cash investments and trade receivables. The Company invests its excess cash in deposits with major banks in the United States and in U.S. Treasury obligations. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. Certain Risks and Uncertainties The Company's activities are subject to extensive regulation by the Food and Drug Administration ("FDA") and similar health authorities in certain foreign countries. The LTK System is regulated as a Class III medical device by the FDA under the Food, Drug & Cosmetic Act. Class III medical devices require a Premarket Approval Application ("PMA") by the FDA prior to commercial sale in the United States. The PMA process (and underlying clinical studies) is lengthy, the outcome is difficult to predict and requires substantial commitments of the Company's financial resources and management's time and effort. Delays in obtaining or failure to obtain required regulatory approvals or clearances in the United States and other countries would postpone or prevent the marketing of the LTK System and other devices and would impair the Company's ability to generate funds from operations, which in turn would have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to obtain, in a timely manner, if at all, the required FDA approval of the Company's PMA in the United States for intended uses of the LTK System, or for any other devices for which the Company may seek approvals or clearances. Any products manufactured or distributed by the Company will be subject to pervasive and continuing regulation by the FDA. 31 32 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 In addition, the introduction of the Company's products in foreign countries may require obtaining both US and individual foreign regulatory clearances in numerous countries. Although the Company's products have been sold in approximately 15 countries, sales of the LTK System require rigorous regulatory approvals before being sold in the United States and certain other countries. There can be no assurance that the Company will be able to obtain regulatory clearances for its products in the United States or certain foreign markets. 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 the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents consist of cash on deposit with the Company's bank and money market funds with a maturity from the date of purchase of 90 days or less. As of December 31, 1999 and 1998, the Company did not hold any investments in debt or equity securities. Inventories Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market value. Appropriate allowances are made to reduce the value of inventories to the net realizable value, where this is below cost. This may occur where the Company determines that inventories may be slow moving or obsolete. Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the shorter of the estimated useful lives of the assets, generally one to five years, or the lease term. Upon retirement or sale, the cost and related accumulated depreciation are removed from the balance sheet and the resulting gain or loss is reflected in operations. Maintenance and repairs are charged to operations as incurred. Impairment of Long-Lived Assets Long-lived assets are reviewed for impairment when events or circumstances indicate the carry amount of the asset may not be recoverable. Recovery is measured by comparison of the carrying amounts to future undiscounted cash flows expected to be generated by such assets. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset's fair value or discounted estimates of future cash flows. The Company has not identified any such impairment losses to date. Revenue Recognition Revenues are recognized at time of shipment provided no significant obligations remain and collection of receivables are deemed probable. A provision for the estimated future cost of warranty is made at the time a sale is recorded. Research and Development Research and development expenditures are charged to operations as incurred. For the years ended December 31, 1999, 1998 and 1997, the expense was $4,774,000, $2,107,000 and $964,000, respectively. 32 33 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Advertising and Sales Promotion Costs Advertising and sales promotion costs, included in General and Administrative expenses, are charged to operations as incurred. For the years ended December 31, 1999, 1998 and 1997, the expense was $1,711,000, $612,000 and $200,000, respectively. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and operating loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recorded for loss carryforwards and other deferred tax assets where it is more likely than not that such loss carryforwards and deferred tax assets will not be realized. Computation of Net Loss Per Share Basic net loss per share ("basic EPS") is computed as net loss divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants and other convertible securities. Common equivalent shares are excluded from the computation of net loss per share if their effect is anti-dilutive. The following is a reconciliation of the numerator (net loss) and denominator (number of shares) used in the basic and diluted net loss ("diluted EPS") per share calculation:
YEARS ENDED DECEMBER 31, ------------------------------------- 1999 1998 1997 ---------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC AND DILUTED EPS: Net loss.................................. $(26,145) $(17,821) $(6,618) -------- -------- ------- Average Common Shares Outstanding......... 43,867 34,164 28,550 -------- -------- ------- Basic and diluted EPS..................... $ (0.60) $ (0.52) $ (0.23) ======== ======== =======
Excluded from the shares used to calculate diluted EPS as their effect is anti-dilutive were 5,901,357 common equivalent shares in 1999, 7,199,795 common equivalent shares in 1998 and 7,303,537 common equivalent shares in 1997. Stock Based Compensation The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options. Under APB 25, because the market price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. For grants of options or warrants to non-employees, compensation expense is measured using the Emerging Issues Task Force ("EITF") 96-18 model and the resulting compensation is deferred and amortized to expense over the vesting period. The Company has adopted the disclosure only provisions of Statements of Financial Accounting Standards No. 123, "Accounting for Stock Based Compensation." 33 34 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Segment Information All of the Company's assets are located in the United States. The Company, which operates in a single industry segment, designs, manufactures, markets and services medical laser systems. The Company sells its products globally to customers in the field of ophthalmology. The following is a summary of the Company's geographic sales:
1999 1998 1997 ---- ---- ------ (IN THOUSANDS) Domestic............................................. $ 8 $ 11 $1,774 Europe............................................... 4 10 314 Pacific Rim.......................................... -- -- 409 Canada............................................... 9 3 180 South Africa......................................... 5 504 162 Other................................................ -- 66 -- --- ---- ------ Total...................................... $26 $594 $2,839 === ==== ======
The Company does not segregate information related to operating income generated by its export sales. Comprehensive Income The Company has adopted the Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130) effective December 31, 1998. SFAS 130 establishes standards for reporting and display of comprehensive income and its components for general-purpose financial statements. Comprehensive income is defined as net income plus all revenues, expenses, gains and losses that are excluded from net income in accordance with generally accepted accounting principles. For the years ended December 31, 1999, 1998 and 1997, there are no differences between comprehensive income and net income. Fair Value of Financial Instruments Carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts receivable and accounts payable approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations approximates fair value. New Accounting Pronouncements In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Standards No. 133 ("SFAS 133"), "Accounting for Derivative Investments and Hedging Activities" which is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. In July of 1999, the FASB issued Statement of Financial Standards No. 137 ("SFAS 137"), "Accounting for Derivative Instruments and Hedging Activities -- Deferral of the Effective Date of FASB Statement No. 133," which defers the effective date to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company has not yet evaluated the effects of this change on its operations. The Company will adopt SFAS 133 as required for its first quarterly filing of the fiscal year 2001. In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements." SAB 101 provides guidance for revenue recognition under certain circumstances. The Company believes that SAB 101 will not have a material impact on its financial position or results of operations. 34 35 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 3. BALANCE SHEET COMPONENTS Inventory at December 31 consists of :
1999 1998 ------ ---- (IN THOUSANDS) Raw materials............................................... $1,589 $11 Work-in-process............................................. 344 -- Finished goods.............................................. 40 -- ------ --- Inventory, net.............................................. $1,973 $11 ====== ===
Property and equipment at December 31 consists of:
1999 1998 ------ ------ (IN THOUSANDS) Machinery and equipment..................................... $ 598 $ 381 Computer equipment.......................................... 872 663 Furniture and fixtures...................................... 238 87 Leasehold improvements...................................... 485 262 ------ ------ 2,193 1,393 Less accumulated depreciation and amortization (922) (493) ------ ------ Property and equipment, net................................. $1,271 $ 900 ====== ======
Included in computer equipment is equipment acquired under capital leases of $103,000 and related accumulated amortization of $77,000 and $43,000 at December 31, 1999 and 1998, respectively. Depreciation and amortization expense for the years ended December 31, 1999, 1998 and 1997 was $429,000, $182,000 and $77,000, respectively. Accrued liabilities consist of:
1999 1998 ------ ------ (IN THOUSANDS) Accrued payroll and related expense.................... $1,008 $ 513 Accrued professional fees.............................. 427 641 Accrued regulatory and clinical........................ 462 456 Other accrued expenses................................. 308 542 ------ ------ $2,205 $2,152 ====== ======
4. INCOME TAXES The Company's effective tax rate differs from the statutory federal income tax rate as shown in the following schedule:
1999 1998 1997 ---- ---- ---- Statutory Rate.......................................... (34)% (34)% (34)% NOL's not benefited which have been reserved............ 34% 34% 34% --- --- --- 0% 0% 0% === === ===
35 36 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Temporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities are as follows:
1999 1998 -------- ------- (IN THOUSANDS) Deferred tax assets: Net operating loss carryforwards...................... $ 23,212 $15,200 Research credits (expire 2005-2013)................ 1,332 950 Other................................................. 700 350 -------- ------- Total deferred tax asset...................... 25,244 16,500 Valuation allowance for deferred tax assets............. (25,244) (16,500) -------- ------- Net deferred tax assets................................. $ -- $ -- ======== =======
As of December 31, 1999, the Company had federal and state net operating loss carryforwards of approximately $61,960,000 and $36,800,000 respectively. The change in the Company's valuation allowance from 1998 to 1999 was an increase of $8,744,000. Due to uncertainty surrounding the realization of the favorable tax attributes in future tax returns, the Company has placed a valuation allowance against its net deferred tax assets. The ownership change provisions of the Internal Revenue Code of 1986 and similar state provisions would limit utilization of the carryforwards should there be a substantial change in the Company's ownership. The annual limitation may result in the expiration of net operating losses and credits before utilization. 5. COMMITMENTS Leases The Company leases certain of its facilities and equipment under non-cancelable operating and capital leases with various expiration dates through 2004. Rent expense was $979,000, $331,000 and $233,000 in 1999, 1998 and 1997, respectively. The following is a schedule by year of future minimum lease payments at December 31, 1999:
OPERATING CAPITAL LEASES LEASES --------- ------- (IN THOUSANDS) Year ending December 31, 2000............................. $ 946 $30 2001...................................................... 976 -- 2002...................................................... 993 -- 2003...................................................... 1,033 -- 2004...................................................... 272 -- ------ --- Total minimum payments required........................... $4,220 30 Less: Amount representing interest........................ 2 --- Present value of capital lease obligation................. $28 ===
6. LONG-TERM DEBT In January 1999, the Company completed a $10,000,000 private placement of convertible notes with warrants. The 1999 Notes are convertible into shares of the Company's Common Stock at predetermined prices, bear interest at the rate of 5% payable semi-annually in cash or in-kind (additional convertible notes), and contain certain conversion features. One-half of the principal amount of the 1999 Notes became 36 37 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 convertible into the Company's Common Stock at a conversion price of $4.00 per share upon the January 13, 2000 ODP recommendation to the FDA to approve the LTK System. The remaining one-half of the 1999 Notes are convertible into 1,250,00 shares of Common Stock at a conversion price of $8.00 per share upon final FDA approval. Warrants were issued to the investor to purchase 148,950 shares of the Company's Common Stock at an exercise price of $0.01 per share with an expiration date of December 31, 2003. In 1999, the Company recognized a non cash charge of $2,425,000, calculated from the Company's closing stock price of $5.94 on January 1, 1999, less the conversion price of $4.00 for one half of the notes. In addition, the Company recognized a deferred non-cash charge of approximately $883,000 for the aggregate fair market value of the warrants based on the Black-Scholes Model Valuation that is amortized over the life of the 1999 Notes. As of December 31, 1999, the holder of the 1999 Notes had the option to convert notes into 2,500,000 shares of the Company's common stock and warrants into 148,950 shares. During 1999, the Company recorded approximately $2,719,000 as non-cash interest expense and $500,000 as interest expense from the 1999 Notes. The following table summarizes information about the notes payable balances as of December 31, as follows:
1999 1998 ------- ------- (IN THOUSANDS) 1997 5% convertible notes................................ $ -- $ 684 1998 12% convertible notes (including secondary notes)... 169 9,507 1999 5% convertible notes................................ 10,000 -- Unamortized discount relating to stock warrants.......... (611) (2,450) Accrued interest......................................... 507 609 ------- ------- 10,065 8,350 Less: current portion of notes payable................... (5,000) (692) ------- ------- $ 5,065 $ 7,658 ======= =======
7. STOCKHOLDERS' EQUITY Common Stock In March 1997, the Company completed a private placement of convertible notes with warrants. In connection with this private placement, the placement agent received warrants to purchase 230,756 shares of common stock at an exercise price of $1.00 per share and with expiration dates of February and March 2002. In addition, the notes were convertible into 4,615,143 shares and the warrants attached to the notes were convertible into 2,307,572 shares with an exercise price of $1.00 per share with an expiration date of February and March 2002. These warrants were fair valued using the Black-Scholes valuation model and are being amortized over the term of the notes. As of December 31, 1999 all of the notes were converted into 4,615,143 shares and certain warrants were converted into 2,419,757 shares of common stock. As of December 31, 1999, there remained warrants outstanding convertible into 118,571 common shares. 37 38 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 In January 1998, the Company completed a private placement of convertible notes with warrants. The notes are convertible into 3,116,667 shares of common stock and the warrants are convertible into 1,870,000 shares of common stock with an exercise price of $3.00 and an expiration date of January 2003. These warrants were fair valued using the Black-Scholes valuation model and are being amortized over the term of the notes. On July 15, 1998 and January 15, 1999, accrued interest from the 1998 Notes was converted into Secondary Notes for 185,830 and 190,626 common shares, respectively. As of December 31, 1999 certain of the notes were converted into 3,436,907 shares and certain warrants were converted into 1,340,000 shares of common stock. As of December 31, 1999, there remained warrants outstanding and convertible into 530,000 common shares and 56,216 shares convertible from the notes. In January 1999, the Company completed a $10,000,000 private placement of convertible notes with warrants. The 1999 Notes are convertible into 1,250,000 shares of the Company's Common Stock at predetermined prices, bear interest at the rate of 5% payable-in-kind semi-annually (additional convertible notes), and contain certain conversion features. One-half of the 1999 Notes became convertible into the Company's Common Stock at a conversion price of $4.00 per share when conditional approval was received on January 13, 2000 from the ODP for the LTK System. The investor will also be required, on the date the Company receives FDA approval to market the LTK System in the United States (the "FDA Approval"), to convert the remaining one-half of the 1999 Notes into shares of Common Stock at a conversion price of $8.00 per share. Warrants were issued to the investor to purchase 148,950 shares of the Company's Common Stock at an exercise price of $0.01 per share with an expiration date of December 31, 2003. These warrants were fair valued using the Black-Scholes valuation model at the date of issuance using the following assumptions: dividend yield of 0%, expected term of warrants 1 year, risk free interest rate of 5.5%, and volatility of 92.36%. These warrants are being amortized over the term of the notes. In addition to the warrants issued in conjunction with the convertible notes, the Company issued warrants to employees to purchase 907,000 shares of common stock during 1999. The Company also issued warrants to consultants to purchase 190,000, 610,000 and 276,000 shares of common stock for the years ended December 31, 1999, 1998 and 1997, respectively. The Company calculated the fair value of each warrant issued to non-employees on the date of issuance using the Black-Scholes pricing method with the following assumptions: dividend yield of 0%, expected term of the warrants between 5 to 10 years, risk-free interest rate between 4.75% and 5.5%, and volatility between 92% and 171%. As of December 31, 1999, there were warrants outstanding to purchase 1,940,521 shares of common stock. 38 39 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Stock Option Plan In 1999, the Company adopted the 1999 Long-Term Stock Equity Compensation Plan (the "1999 Plan") under which employees, directors and consultants may be granted incentive and non-statutory stock options, stock appreciation rights, restricted stock, performance units and performance shares. Each option issued under the Plan must be exercised within the period of 10 years from the date of grant and the exercise price of an option may not be less than the fair market value of the underlying shares of common stock on the date of grant. Options granted generally provide that 1/48th of the shares subject to option become exercisable each month after the grant. The exercise price of a free standing stock appreciation right must equal the fair market value of a share of common stock on the date of grant while the exercise price of a tandem stock appreciation right issued in connection with the stock option must equal the option price of the related option. The Compensation Committee may also award shares of restricted stock and performance units and performance shares upon such terms and conditions as it shall establish. The 1999 Plan expires in 2009. In 1997, the Company adopted the 1997 Stock Option Plan (the "1997 Plan") under which employees, directors and consultants may be granted incentive or nonstatutory stock options. Under the Plan, incentive stock options must be granted at an exercise price of not less than the fair market value of the common stock at the date of grant, except that options granted to shareholders owning greater than 10 percent of the total voting power of all classes of stock of the Company must have an exercise price of not less than 110 percent of the fair market value at the date of grant. Nonstatutory options must be at least 85 percent of fair market value at the date of grant. Options granted generally provide that 1/48 of the shares subject to the option become exercisable each month after the grant. The 1997 Plan expires in 2007. In 1988, the Company adopted the 1988 Stock Option Plan (the "1988 Plan") under which employees, directors and consultants may be granted incentive or non-statutory stock options. Under the 1988 Plan, incentive stock options must be granted at an exercise price of not less than the fair market value of the common stock at the date of grant, except that options granted to shareholders owning greater than 10 percent of the total voting power of all classes of stock of the Company must have an exercise price of not less than 110 percent of the fair market value at the date of grant. Non-statutory options must be at least 85 percent of fair market value at the date of grant. Options granted generally provide that 25 percent of the shares subject to the option become exercisable one year after the date of grant and 1/36th of the remaining shares subject to the option become exercisable each month thereafter. The 1988 Plan expired in November 1998. The fair value of each option grant is estimated at the date of the grant using the Black-Scholes pricing model with the following weighted average assumptions for grants in 1999, 1998 and 1997:
1999 1998 1997 --------- --------- --------- Risk-free interest rate.................... 5.50% 5.03% 6.15% Expected life.............................. 2.0 years 2.5 years 4.8 years Volatility................................. 173.1% 101% 95.5% Dividend yield............................. -- -- --
39 40 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 A summary of the Company's option activity as of December 31, 1999, 1998 and 1997 and changes during the years-ending on those dates are as follows:
OUTSTANDING OPTIONS ------------------------------------------------------------------ OPTIONS AVAILABLE FOR OPTIONS WEIGHTED AVERAGE GRANT OUTSTANDING EXERCISE PRICE EXERCISE PRICE ------------- ----------- -------------- ---------------- BALANCE, 01/01/1997................. 296,938 2,512,438 $0.91-$2.87 $ 1.09 Reserved............................ 3,000,000 Granted............................. (2,954,300) 2,954,300 $1.00-$4.44 2.69 Cancelled........................... 858,370 (858,370) $0.75-$2.87 1.18 Exercised........................... -- (247,913) $0.75-$1.06 1.01 ---------- --------- ------------- BALANCE, 12/31/1997................. 1,201,008 4,360,455 $1.00-$4.44 2.16 Granted............................. (1,080,500) 1,080,500 $3.00-$9.34 7.47 Cancelled........................... 13,987 (13,987) $1.00-$4.44 3.47 Expired............................. (68,332) Exercised........................... -- (769,002) $0.75-$4.38 1.37 ---------- --------- ------------- BALANCE, 12/31/1998................. 66,163 4,657,966 $1.00-$9.34 3.50 Reserved............................ 2,100,000 Granted............................. (2,468,977) 2,468,977 $3.80-$13.00 10.34 Cancelled........................... 423,458 (423,458) $1.44-$12.62 4.70 Exercised........................... -- (813,377) $1.00-$9.16 1.76 ---------- --------- ------------- BALANCE, 12/31/1999................. 120,644 5,890,108 $1.03-$13.00 $ 6.52 ========== =========
As of December 31, 1999, 1998 and 1997, options to purchase 2,126,110, 1,872,292 and 1,621,269 shares, respectively, were vested and of those, 1,109,968, 1,285,636 and 1,547,571 shares, respectively, were immediately exercisable. The weighted average fair value of those options granted in 1999, 1998 and 1997 was $7.73, $2.54 and $2.08, respectively. The following table summarizes information about stock options outstanding at December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------- ------------------------------------------- WEIGHTED WEIGHTED AVERAGE WEIGHTED AVERAGE REMAINING AVERAGE REMAINING WEIGHTED NUMBER CONTRACTUAL EXERCISE NUMBER CONTRACTUAL AVERAGE OUTSTANDING LIFE (YEARS) PRICE EXERCISABLE LIFE (YEARS) EXERCISE PRICE ----------- ------------ -------- ----------- ------------ -------------- $ 1.00 - $ 2.00.............. 1,353,541 7.2 $ 1.17 721,659 7.0 $ 1.13 $ 2.01 - $ 4.00.............. 1,255,248 7.9 3.93 182,026 8.1 3.92 $ 4.01 - $ 6.00.............. 397,719 9.4 4.81 52,339 8.2 4.19 $ 6.01 - $ 8.00.............. 813,500 8.3 7.59 25,478 8.3 7.36 $ 8.01 - $10.00.............. 396,300 9.3 8.65 102,218 9.2 8.68 $10.01 - $12.00.............. 1,082,500 10.0 11.77 8,019 9.2 10.84 $12.01 - $13.00.............. 591,300 9.4 12.92 18,229 9.4 9.41 --------- ------ --------- ------ TOTAL.............. 5,890,108 $ 6.52 1,109,968 $ 2.78 ========= ====== ========= ======
40 41 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Employee Stock Purchase Plan In June 1992, the Company adopted the 1992 Employee Stock Purchase Plan under which 200,000 shares have been reserved for issuance. Eligible employees may purchase common stock at 85 percent of the lower of the closing price of the stock on the offering date or the exercise date determined by the Board of Directors. Annual purchases are limited to 10 percent of each employee's compensation or 4,000 shares per employee. There were 93,741, 69,521 and 59,023 shares issued under the plan as of December 31, 1999, 1998 and 1997, respectively. Fair market value for the purchase rights issued under the Purchase Plan is determined under the Black-Scholes Valuation Model using the following assumptions for 1999, 1998 and 1997:
1999 1998 1997 -------- -------- -------- Risk-free Interest Rates.................. 5.50% 5.03% 6.15% Expected Life............................. 6 months 6 months 6 months Volatility................................ 184% 101% 95.5% Dividend Yield............................ -- -- --
The weighted average fair market value of those purchase rights granted in 1999, 1998 and 1997 was $6.46, $1.07 and $0.76, respectively. The Company has adopted the disclosure-only provisions of the Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation." Had compensation cost for the Stock Plans been determined based on the fair market value at the grant date for awards in 1999, 1998 and 1997 consistent with the provisions of SFAS No. 123, the Company's net loss and net loss per share for the years ended December 31, 1999, 1998 and 1997 would have been increased as follows:
1999 1998 1997 ---------- ---------- --------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Net loss -- as reported..................... $(26,145) $(17,821) $(6,618) Net loss -- pro forma....................... (35,122) (23,343) (8,001) Net loss per share -- as reported........... $ (0.60) $ (0.52) $ (0.23) Net loss per share -- pro forma............. $ (0.80) $ (0.68) $ (0.28)
8. EMPLOYEE BENEFIT PLAN During 1993, the Company established a 401(k) tax-deferred savings plan under which all employees meeting certain age and service requirements may contribute up 15% of their eligible compensation (up to a maximum allowed under IRS rules). Contributions may be made by the Company at the discretion of the Board of Directors. Contributions by the Company amounted to $25,000, $16,000 and $20,000 in 1999, 1998 and 1997, respectively. 9. SALE OF DENTAL ASSETS In June 1997, the Company completed the sale of the Company's assets associated with its dental laser, air abrasive and composite curing systems (the "Dental Assets") to Lares Research. The purchase price paid for the Dental Assets was $5,500,000, consisting of $4,000,000 in cash paid at closing and $1,500,000 in the form of a promissory note, bearing interest at 8% per annum, with installments of $1,000,000 of principal plus accrued interest and $500,000 of principal plus accrued interest, due in June 2000 and June 2001, respectively (the "Lares Note"). Although the Company anticipates collecting interest and principal on the Lares Note, collection is not reasonably assured due to the subordination of the Lares Note to Lares' bank and the 41 42 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1999 Company intends to recognize proceeds from the sale and interest on the note as cash is received. The gain on sale of the Dental Assets is comprised as follows:
(IN THOUSANDS) -------------- Cash proceeds from the sale of the dental assets............ $4,000 Less: Inventory and equipment sold.......................... (1,498) ADT transfer fee.......................................... (275) Transaction fees.......................................... (237) Other costs............................................... (250) ------ Gain on sale of dental assets............................. $1,740 ======
The Company sold the Dental Assets as of June 1997 and as a consequence, had effectively no revenues or earnings from the Dental Assets during the second half of 1997. Revenues from the dental business were $1,968,000 through June 1997. Cost of revenues were approximately $1,738,000 and operating expenses through June 1997 were $1,980,000. Interest expense and interest income were $11,000 and $10,000, respectively, through June 1997. The operating loss from the dental business and the gain on the sale of the dental business were $1,750,000 and $1,740,000, respectively, in 1997. The Company is not expecting significant revenues from ophthalmic sales until the FDA approves the LTK System for sale in the United States. 10. SUBSEQUENT EVENTS On January 11, 2000, the Company completed an $11,200,000, net of offering costs, private placement of convertible debentures with warrants. These debentures are convertible into the Company's common stock at a conversion price of $5.916, at the option of the holder, and mature in June 2002. The debentures bear interest at a rate of 7% per annum, payable quarterly in kind or cash at the option of the Company. There are two types of associated warrants issued in connection with the debentures. Type A are five year warrants with an exercise price of $6.803. Type B warrants are two year warrants with an exercise price of $6.803 and are callable at the Company's option once the closing stock price is equal to or higher than $7.823 for a continuous period of twenty trading days. On January 13, 2000, $5,000,000 of the principal amount of the 1999 Notes became convertible into the Company's Common Stock at a conversion price of $4.00 per share when the ODP unanimously voted to recommend that the FDA approve the Company's LTK System in the United States for the temporary reduction of low to moderate hyperopia with conditions relating to labeling regarding patient symptoms, longevity of effect and the effect of retreatment. 42 43 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
BALANCE ADDITIONS BALANCE AT CHARGED TO AT BEGINNING COSTS AND END OF PERIOD EXPENSES DEDUCTIONS OTHER OF PERIOD ---------- ---------- ---------- ----- ---------- (IN THOUSANDS) Year ended December 31, 1997 Allowance for uncollectible accounts...... $ 140 $ 176 $(232) $-- $ 84 Allowance for inventory................... $ 350 $ 397 $(100) $-- $ 647 Allowance for uncollectible notes......... $ -- $1,500 $ -- $-- $1,500 Year ended December 31, 1998 Allowance for uncollectible accounts...... $ 84 $ -- $ (73) $-- $ 11 Allowance for inventory................... $ 647 $ -- $(461) $-- $ 186 Year ended December 31, 1999 Allowance for uncollectible accounts...... $ 11 $ -- $ (8) $-- $ 3 Allowance for inventory................... $ 186 $ 79 $ -- $-- $ 265
43 44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the city of Fremont, State of California, on the 28th day of March, 2000. Sunrise Technologies International, Inc. By: /s/ C. RUSSELL TRENARY, III ------------------------------------ C. Russell Trenary, III President and Chief Executive Officer POWER OF ATTORNEY Each of the officers and directors of Sunrise Technologies International, Inc. whose signature appears below hereby constitutes and appoints C. Russell Trenary, III and Eric M. Fogel, and each of them, their true and lawful attorneys-in-fact and agents, with full power and substitution, each with power to act alone, to sign and execute on behalf of the undersigned any amendment or amendments to this Report on Form 10-K, and to perform any acts necessary to be done in order to file such amendment, and each of the undersigned does hereby ratify and confirm all that such attorneys-in-fact and agents, or their or his substitutes, shall do or cause to be done by virtue hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ C. RUSSELL TRENARY, III President and March 28, 2000 - -------------------------------------------------------- Chief Executive Officer C. Russell Trenary, III /s/ PETER E. JANSEN Vice President, Finance and March 28, 2000 - -------------------------------------------------------- Chief Financial Officer Peter E. Jansen (Principal Financial and Accounting Officer) /s/ JOSEPH D. KOENIG Director and March 28, 2000 - -------------------------------------------------------- Chairman of the Board Joseph D. Koenig /s/ R. DALE BOWERMAN Director March 28, 2000 - -------------------------------------------------------- R. Dale Bowerman /s/ MICHAEL S. MCFARLAND Director March 28, 2000 - -------------------------------------------------------- Michael S. McFarland /s/ ALAN H. MAGAZINE Director March 28, 2000 - -------------------------------------------------------- Alan H. Magazine
44 45 INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION - ------- ----------- 2.1 Asset Purchase Agreement dated as of March 26, 1997, by and between the Company and Lares Research, a California corporation(1) 3.1 Certificate of Incorporation, as amended(2) 3.2 Bylaws(2) 4.1 Form of Rights Agreement, dated as of October 24, 1997, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(3) 4.2 Form of Warrant issued to Pennsylvania Merchant Group(4) 4.3 Form of 12% Subordinated Pay-In-Kind Note Due 2001(5) 4.4 Form of Registration Rights Agreement(5) 4.5 Form of 5% Convertible Subordinated Pay-In-Kind Note due 2001(6) 4.6 Form of Warrant for the Purchase of Common Stock(6) 4.7 Form of Registration Rights Agreement(6) 4.8 Form of Amendment to Rights Agreement, dated as of May 3, 1999, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(7) 4.9 Form of 7% Convertible Debenture dated January 11, 2000(8) 4.10 Form of A Warrant dated January 11, 2000(8) 4.11 Form of B Warrant dated January 11, 2000(8) 4.12 Registration rights Agreement dated January 11, 2000 among the Company, The Tail Wind Fund, Ltd., LBI Group, Inc., Jeddy Development Inc., Donald Sanders M.D., PhD., Donald Sanders IRA, CIBC Oppenheimer Corp. as Custodian, Monica Sanders, Kendra Sanders, Wanda Sanders IRA, CIBC Oppenheimer Corp., as Custodian, Meyer Temkin and Charles D. Kelman, M.D.(8) 4.13 Form of warrant dated January 11, 2000, issued to Dunwoody Brokerage Services, Inc. 10.1 Patent License Agreement between the Company and Patlex Corporation dated January 1, 1990(9) 10.2 Agreement between the Company and the University of Miami, Department of Ophthalmology, dated October 28, 1991(10) 10.3 Settlement Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.4 License Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.5 Settlement Agreement between the Company and American Dental Technologies, dated July 30, 1996(1) *10.6 Form of Indemnification Agreement between the Company and each of its officers and directors(9) *10.7 1988 Stock Option Plan, as amended(5) *10.8 Form of Indemnification Agreement by and between the Company and its executive officers(3) 10.9 Form of U.S. Note and Warrant Purchase Agreement related to the Regulation D private placement of 12% Convertible Subordinated Pay-In-Kind Notes Due 2001 and accompanying Warrants in January 1998(5)
45 46
EXHIBIT NUMBER DESCRIPTION - ------- ----------- *10.10 Form of Amended and Restated Change of Control Agreement by and between the Company and its President and Chief Executive Officer(12) *10.11 Form of Amended and Restated Change of Control Agreement by and between the Company and its executive officers (other than the President and Chief Executive Officer)(12) 10.12 Sublease between Avant! Corporation, as sub-sublandlord, the Company, as sub-subtenant, Cirrus Logic, Inc., as sublandlord, Avant! Corporation, as subtenant, Renco Investment Company, as landlord, and Cirrus Logic, Inc., as tenant for the lease of facilities at 3400 West Warren Avenue, Fremont, California(13) 10.13 Form of Note and Warrant Purchase Agreement(6) *10.14 The 1997 Stock Option Plan (14) *10.15 The 1999 Long-Term Equity Compensation Plan(15) 10.16 Purchase Agreement dated January 11, 2000 between the Company and The Tail Wind Fund, Ltd., LBI Group, Inc., Jeddy Development, Inc., Donald Sanders M.D., PhD., Donald Sanders IRA, CIBC Oppenheimer Corp., as Custodian, Monica Sanders, Kendra Sanders, Wanda Sanders IRA, CIBC Oppenheimer Corp. as Custodian, Meyer Temkin and Charles D. Kelman, M.D.(8) 21.1 Subsidiaries of the Company 22 Power of Attorney (included on the signature pages to this Form 10-K) 23 Consent of PricewaterhouseCoopers LLP, Independent Accountants 27 Financial Data Schedule
- --------------- * Compensatory plan or management contract (1) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 0-10428) (2) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1994 (File No. 0-17816) (3) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-17816) (4) Incorporated by reference from the registrant's Current Report on Form 8-K dated October 24, 1997 (File No. 0-17816) (5) Incorporated by reference from the registrant's Current Report on Form 8-K dated January 26, 1998 (File No. 0-17816) (6) Incorporated by reference from the registrant's Current Report on Form 8-K dated January 1, 1999 (File No. 0-10428) (7) Incorporated by reference from the registrant's Current Report on Form 8-K filed September 31, 1999 (File No. 0-17816) (8) Incorporated by reference from the registrant's Current Report on Form 8-K filed January 14, 1999 (File No. 0-17816) (9) Incorporated by reference from the registrant's Registration Statement on Form S-1, as amended (File No. 33-36768) (10) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 0-17816) (11) Incorporated by reference from the registrant's Registration Statement on Form S-18, as amended (File No., 33-27029-LA) 46 47 (12) Incorporated by reference from the registrant's Current Report on Form 8-K dated May 8, 1998 (File No. 0-17816) (13) Incorporated by reference from the registrant's Registration Statement on Form S-2 dated September 29, 1998 (File No. 333-64975) (14) Incorporated by reference from the registrant's Registration Statement on Form S-8 dated March 2, 1999 (File No. 333-73211) (15) Incorporated by reference from the registrant's Registration Statement on Form S-8 dated November 24, 1999 (File No. 333-91669) 47 EX-4.13 2 EXHIBIT 4.13 1 EXHIBIT 4.13 THIS WARRANT ("WARRANT") HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY NOT BE SOLD, TRANSFERRED, PLEDGED OR HYPOTHECATED IN THE ABSENCE OF A REGISTRATION STATEMENT COVERING THIS WARRANT UNDER SAID ACT OR AN EXEMPTION FROM REGISTRATION UNDER SAID ACT. VOID AFTER 5:00 P.M. EASTERN TIME ON JANUARY 10, 2005 ("EXPIRATION DATE"). SUNRISE TECHNOLOGIES INTERNATIONAL, INC. WARRANT TO PURCHASE SHARES OF COMMON STOCK, PAR VALUE $.001 PER SHARE This is to certify that, for VALUE RECEIVED, DUNWOODY BROKERAGE SERVICES, INC. ("Warrantholder"), is entitled to purchase, subject to the provisions of this Warrant, from Sunrise Technologies International, Inc., a corporation organized under the laws of Delaware ("Company"), at any time not later than 5:00 P.M., Eastern Time, on the Expiration Date, at an exercise price per share equal to $10.68 (the exercise price in effect from time to time hereafter being herein called the "Warrant Price"), 100,000 shares ("Warrant Shares") of Common Stock, par value $.001 per share ("Common Stock") of the Company. The number of Warrant Shares purchasable upon exercise of this Warrant and the Warrant Price shall be subject to adjustment from time to time as described herein. This Warrant has been issued pursuant to the terms of the Purchase Agreement ("Purchase Agreement") dated on or about the date hereof between the Company and the Warrantholder. Capitalized terms used herein and not defined shall have the meaning specified in the Purchase Agreement. Section 1. Registration. The Company shall maintain books for the transfer and registration of the Warrant. Upon the initial issuance of the Warrant, the Company shall issue and register the Warrant in the name of the Warrantholder. Section 2. Transfers. As provided herein, the Warrant may be transferred only pursuant to a registration statement filed under the Securities Act of 1933, as amended ("Securities Act") or an exemption from registration thereunder. Subject to such restrictions, the Company shall transfer from time to time, the Warrant, upon the books to be maintained by the Company for that purpose, upon surrender thereof for transfer properly endorsed or accompanied 2 by appropriate instructions for transfer upon any such transfer, and a new Warrant shall be issued to the transferee and the surrendered Warrant shall be canceled by the Company. Section 3. (a) Exercise of Warrant. Subject to the provisions hereof, the Warrantholder may exercise the Warrant in whole or in part at any time upon surrender of the Warrant, together with delivery of the duly executed Warrant exercise form attached hereto (the "Exercise Agreement"), to the Company during normal business hours on any business day at the Company's principal executive offices (or such other office or agency of the Company as it may designate by notice to the holder hereof), and upon (i) payment to the Company in cash, by certified or official bank check or by wire transfer for the account of the Company of the Warrant Price for the Warrant Shares specified in the Exercise Agreement or (ii) delivery to the Company of a written notice of an election to effect a "Cashless Exercise" (as defined below) for the Warrant Shares specified in the Exercise Agreement. The Warrant Shares so purchased shall be deemed to be issued to the holder hereof or such holder's designee, as the record owner of such shares, as of the close of business on the date on which this Warrant (or evidence of loss, theft or destruction thereof) shall have been surrendered, the completed Exercise Agreement shall have been delivered, and payment shall have been made for such shares as set forth above. Certificates for the Warrant Shares so purchased, representing the aggregate number of shares specified in the Exercise Agreement, shall be delivered to the holder hereof within a reasonable time, not exceeding two (2) business days, after this Warrant shall have been so exercised. The certificates so delivered shall be in such denominations as may be requested by the holder hereof and shall be registered in the name of such holder or such other name as shall be designated by such holder. If this Warrant shall have been exercised only in part, then, unless this Warrant has expired, the Company shall, at its expense, at the time of delivery of such certificates, deliver to the holder a new Warrant representing the number of shares with respect to which this Warrant shall not then have been exercised. To effect a Cashless Exercise, the holder shall submit to the Company with the Exercise Agreement, written notice of the holder's intention to do so, including a calculation of the number of shares of Common Stock to be issued upon such exercise in accordance with the terms hereof. In the event of a Cashless Exercise, in lieu of paying the Warrant Price in cash, the holder shall surrender this Warrant for that number of shares of Common Stock determined by multiplying the number of Warrant Shares to which it would otherwise be entitled by a fraction, the numerator of which shall be the difference between the then current Market Price per share of the Common Stock and the Warrant Price, and the denominator of which shall be the then current Market Price per share of the Common Stock. For this purpose, the "Market Price" of the Common Stock shall be the Market Price on the trading day immediately preceding the date of the Exercise Agreement. (b) No Redemption of Warrant. The Company may not redeem this Warrant in whole or in part. 2 3 Section 4. Compliance with the Securities Act of 1933. Neither this Warrant not the Common Stock issued upon exercise hereof nor any other security issued or issuable upon exercise of this Warrant may be offered or sold except as provided in this agreement and in conformity with the Securities Act of 1933, as amended, and then only against receipt of an agreement of such person to whom such offer of sale is made to comply with the provisions of this Section 4 with respect to any resale or other disposition of such security. The Company may cause the legend set forth on the first page of this Warrant to be set forth on each Warrant or similar legend on any security issued or issuable upon exercise of this Warrant until the Warrant Shares have been registered for resale under the Registration Rights Agreement or until Rule 144 is available, unless counsel for the Company is of the opinion as to any such security that such legend is unnecessary. Section 5. Payment of Taxes. The Company will pay any documentary stamp taxes attributable to the initial issuance of Warrant Shares issuable upon the exercise of the Warrant; provided, however, that the Company shall not be required to pay any tax or taxes which may be payable in respect of any transfer involved in the issue or delivery of any certificates for Warrant Shares in a name other than that of the registered holder of the Warrant in respect of which such shares are issued, and in such case, the Company shall not be required to issue or deliver any certificate for Warrant Shares or any Warrant until the person requesting the same has paid to the Company the amount of such tax or has established to the Company's satisfaction that such tax has been paid. The holder shall be responsible for income taxes due under federal or state law, if any such tax is due. Section 6. Mutilated or Missing Warrants. In case the Warrant shall be mutilated, lost, stolen, or destroyed, the Company shall issue in exchange and substitution of and upon cancellation of the mutilated Warrant, or in lieu of and substitution for the Warrant lost, stolen or destroyed, a new Warrant of like tenor and for the purchase of a like number of Warrant Shares, but only upon receipt of evidence reasonably satisfactory to the Company of such loss, theft or destruction of the Warrant, and with respect to a lost, stolen or destroyed Warrant, reasonable indemnity or bond, if requested by the Company. Section 7. Reservation of Common Stock. The Company hereby represents and warrants that there have been reserved, and the Company shall at all applicable times keep reserved, out of the authorized and unissued Common Stock, a number of shares sufficient to provide for the exercise of the rights of purchase represented by the Warrant, and the transfer agent for the Common Stock ("Transfer Agent"), and every subsequent transfer agent for the Common Stock or other shares of the Company's capital stock issuable upon the exercise of any of the right of purchase aforesaid, shall be irrevocably authorized and directed at all times to reserve such number of authorized and unissued shares of Common Stock as shall be requisite for such purpose. The Company agrees that all Warrant Shares issued upon exercise of the Warrant shall be, at the time of delivery of the certificates for such Warrant Shares, duly authorized, validly issued, fully paid and non-assessable shares of Common Stock of the Company. The Company will keep a conformed copy of this Warrant on file with the Transfer Agent and with every subsequent transfer agent for the Common Stock or other shares of the 3 4 Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrant. The Company will supply from time to time the Transfer Agent with duly executed stock certificates required to honor the outstanding Warrant. Section 8. Warrant Price. The Warrant Price, subject to adjustment as provided in Section 9, shall, if payment is made in cash or by certified check, be payable in lawful money of the United States of America. Section 9. Adjustments. Subject and pursuant to the provisions of this Section 9, the Warrant Price and number of Warrant Shares subject to this Warrant shall be subject to adjustment from time to time as set forth hereinafter. (a) If the Company shall at any time or from time to time while the Warrant is outstanding, pay a dividend or make a distribution on its Common Stock in shares of Common Stock, subdivide its outstanding shares of Common Stock into a greater number of shares or combine its outstanding shares into a smaller number of shares or issue by reclassification of its outstanding shares of Common Stock any shares of its capital stock (including any such reclassification in connection with a consolidation or merger in which the Company is the continuing corporation), then the number of Warrant Shares purchasable upon exercise of the Warrant and the Warrant Price in effect immediately prior to the date upon which such change shall become effective, shall be adjusted by the Company so that the Warrantholder thereafter exercising the Warrant shall be entitled to receive the number of shares of Common Stock or other capital stock which the Warrantholder would have received if the Warrant had been exercised immediately prior to such event. Such adjustment shall be made successively whenever any event listed above shall occur. (b) If any capital reorganization, reclassification of the capital stock of the Company, consolidation or merger of the Company with another corporation, or sale, transfer or other disposition of all or substantially all of the Company's properties to another corporation shall be effected, then, as a condition of such reorganization, reclassification, consolidation, merger, sale, transfer or other disposition, lawful and adequate provision shall be made whereby each Warrantholder shall thereafter have the right to purchase and receive upon the basis and upon the terms and conditions herein specified and in lieu of the Warrant Shares immediately theretofore issuable upon exercise of the Warrant, such shares of stock, securities or properties as may be issuable or payable with respect to or in exchange for a number of outstanding Warrant Shares equal to the number of Warrant Shares immediately theretofore issuable upon exercise of the Warrant, had such reorganization, reclassification, consolidation, merger, sale, transfer or other disposition not taken place, and in any such case appropriate provision shall be made with respect to the rights and interests of each Warrantholder to the end that the provisions hereof (including, without limitations, provision for adjustment of the Warrant Price) shall thereafter be applicable, as nearly equivalent as may be practicable in relation to any shares of stock, securities or properties thereafter deliverable upon the exercise hereof. The Company shall not effect any such consolidation, merger, sale, transfer or other disposition unless prior to or simultaneously with the consummation thereof the successor corporation (if other than the Company) resulting 4 5 from such consolidation or merger, or the corporation purchasing or otherwise acquiring such assets or other appropriate corporation or entity shall assume, by written instrument executed and delivered to the Company, the obligation to deliver to the holder of the Warrant such shares of stock, securities or assets as, in accordance with the foregoing provisions, such holder may be entitled to purchase and the other obligations under this Warrant. The provisions of this paragraph (b) shall similarly apply to successive reorganizations, reclassifications, consolidations, mergers, sales, transfers or other dispositions. (c) In case the Company shall fix a record date for the making of a distribution to all holders of Common Stock (including any such distribution made in connection with a consolidation or merger in which the Company is the continuing corporation) or evidences of indebtedness or assets (other than cash dividends or cash distributions payable out of consolidated earnings or earned surplus or dividends or distributions referred to in Section 9(a)), or subscription rights or warrants, the Warrant Price to be in effect after such record date shall be determined by multiplying the Warrant Price in effect immediately prior to such record date by a fraction, the numerator of which shall be the total number of shares of Common Stock outstanding multiplied by the Market Price per share of Common Stock (as determined pursuant to Section 3), less the fair market value (as determined by the Company's Board of Directors in good faith) of said assets or evidences of indebtedness so distributed, or of such subscription rights or warrants, and the denominator of which shall be the total number of shares of Common Stock outstanding multiplied by such current Market Price per share of Common Stock. Such adjustment shall be made successively whenever such a record date is fixed. (d) An adjustment shall become effective immediately after the record date in the case of each dividend or distribution and immediately after the effective date of each other event which requires an adjustment. (e) In the event that, as a result of an adjustment made pursuant to Section 9, the holder of the Warrant shall become entitled to receive any shares of capital stock of the Company other than shares of Common Stock, the number of such other shares so receivable upon exercise of the Warrant shall be subject thereafter to adjustment from time to time in a manner and on terms as nearly equivalent as practicable to the provisions with respect to the Warrant Shares contained in this Warrant. Section 10. Fractional Interest. The Company shall not be required to issue fractions of Warrant Shares upon the exercise of the Warrant. If any fraction of a Warrant Share would, except for the provisions of this Section, be issuable upon the exercise of the Warrant (or specified portions thereof), the Company shall round such calculation to the nearest whole number and disregard the fraction. Section 11. Benefits. Nothing in this Warrant shall be construed to give any person, firm or corporation (other than the Company and the Warrantholder) any legal or equitable right, remedy or claim, it being agreed that this Warrant shall be for the sole and exclusive benefit of the Company and the Warrantholder. 5 6 Section 12. Notices to Warrantholder. Upon the happening of any event requiring an adjustment of the Warrant Price, the Company shall forthwith give written notice thereof to the Warrantholder at the address appearing in the records of the Company, stating the adjusted Warrant Price and the adjusted number of Warrant Shares resulting from such event and setting forth in reasonable detail the method of calculation and the facts upon which such calculation is based. The certificate of the Company's independent certified public accountants shall be conclusive evidence of the correctness of any computation made, absent manifest error. Failure to give such notice to the Warrantholder or any defect therein shall not affect the legality or validity of the subject adjustment. At the Warrantholder's request, the Company shall deliver to the Warrantholder as of a requested date a notice specifying the number of Warrant Shares into which this Warrant is exercisable as of such date. Section 13. Identity of Transfer Agent. The Transfer Agent for the Common Stock is ChaseMellon Shareholder Services, c/o Gloria Pouncil, 235 Montgomery Street, 23rd Floor, San Francisco, CA 94104, Phone: (415) 643-1427. Forthwith upon the appointment of any subsequent transfer agent for the Common Stock or other shares of the Company's capital stock issuable upon the exercise of the rights of purchase represented by the Warrant, the Company will fax to the Warrantholder a statement setting forth the name and address of such transfer agent. Section 14. Notices. Any notice pursuant hereto to be given or made by the Warrantholder to or on the Company shall be sufficiently given or made personally or if sent by an internationally recognized courier by next day or two day delivery service, addressed as follows: Sunrise Technologies International, Inc. 3400 West Warren Avenue Fremont, California 94538 Telephone: (510) 623-9001 Telefax: (510) 623-9009 Attention: Mr. Peter Jansen Chief Financial Officer or such other address as the Company may specify in writing by notice to the Warrantholder complying as to delivery with the terms of this Section 14. Any notice pursuant hereto to be given or made by the Company to or on the Warrantholder shall be sufficiently given or made if personally delivered or if sent by an internationally recognized courier service by overnight or two-day service, to the address set forth on the books of the Company or, as to each of the Company and the Warrantholder, at such other address as shall be designated by such party by written notice to the other party complying as to delivery with the terms of this Section 14. 6 7 All such notices, requests, demands, directions and other communications shall, when sent by courier, be effective two (2) days after delivery to such courier as provided and addressed as aforesaid. Section 15. Registration Rights. The initial holder of this Warrant is entitled to the benefit of certain registration rights in respect of the Warrant Shares as provided in the Registration Rights Agreement. Section 16. Successors. All the covenants and provisions hereof by or for the benefit of the Warrantholder shall bind and inure to the benefit of its respective successors and permitted assigns hereunder. The Warrantholder may assign or transfer this Warrant to any transferee only with the prior consent of the Company, which may not be unreasonably withheld or delayed, provided that the Warrantholder may assign or transfer this Warrant to any of its affiliates without the consent of the Company. Section 17. Governing Law. This Warrant shall be deemed to be a contract made under the laws of the State of New York, and for all purposes shall be construed in accordance with the laws of said State. Section 18. 9.9% and 19.9% Limitations. (a) Notwithstanding anything to the contrary contained herein, the number of shares of Common Stock that may be acquired by the holder upon exercise pursuant to the terms hereof shall not exceed a number that, when added to the total number of shares of Common Stock deemed beneficially owned by such holder (other than by virtue of the ownership of securities or rights to acquire securities that have limitations on the Holder's right to convert, exercise or purchase similar to the limitation set forth herein), together with all shares of Common Stock deemed beneficially owned by the holder's "affiliates" (as defined in Rule 144 of the Securities Act) that would be aggregated for purposes of determining whether a group under Section 13(d) of the Securities Exchange Act of 1934, as amended, exists, would exceed 9.99% of the total issued and outstanding shares of the Company's Common Stock (the "RESTRICTED OWNERSHIP PERCENTAGE"); provided that (w) each holder shall have the right at any time and from time to time to reduce its Restricted Ownership Percentage immediately upon notice to the Company and (x) each holder shall have the right at any time and from time to time, to increase its Restricted Ownership Percentage immediately (subject to waiver) in the event of a pending or announced change of control transaction (including without limitation a transaction that would result in a transfer of more than 50% of the Company's voting power or equity, or a transaction that would result in a person or "group" being deemed the beneficial owner of 50% or more of the Company's voting power or equity). (b) Each time (a "COVENANT TIME") the holder makes a Triggering Acquisition (as defined below) of shares of Common Stock (the "TRIGGERING SHARES") pursuant to the Agreement, the holder will be deemed to covenant that it will not, during the balance of the day on which such Triggering Acquisition occurs, and during the 61-day period beginning immediately after that day, acquire additional shares of Common Stock pursuant to Warrants 7 8 existing at that Covenant Time, if the aggregate amount of such additional shares so acquired (without reducing that amount by any dispositions) would exceed (x) 9.99% of the number of shares of Common Stock outstanding at that Covenant Time (including the Triggering Shares) minus (y) the number of shares of Common Stock actually owned by the Holder at that Covenant Time (regardless of how or when acquired, and including the Triggering Shares). "TRIGGERING ACQUISITION" means the exercise of the Warrant by the holder; provided, however, that with respect to the exercise of this Warrant, if the associated issuance of shares of Common Stock does not occur, such event shall cease to be a Triggering Acquisition and the related covenant under this paragraph shall terminate. At each Covenant Time, the Holder shall be deemed to waive any right it would otherwise have to acquire shares of Common Stock to the extent that such acquisition would violate any covenant given by the Holder under this paragraph. (i) The covenant to be given pursuant to this paragraph will be given at every Covenant Time and shall be calculated based on the circumstances then in effect. The making of a covenant at one Covenant Time shall not terminate or modify any prior covenants. (ii) The Warrantholder may therefore from time to time be subject to multiple such covenants, each one having been made at a different Covenant Time, and some possibly being more restrictive than others. The Warrant- holder must comply with all such covenants then in effect. (c) Notwithstanding anything contained herein, in no event shall the Company issue shares of Common Stock hereunder to the extent that the total number of shares issued or deemed issued to the Investors (when added to the Underlying Shares and Warrant Shares) under the Purchase Agreement would exceed 19.9% of the Company's issued and outstanding shares of Common Stock on the date hereof. Instead, the Company shall redeem this Warrant to the extent necessary at such consideration required to place the Investors in the same economic position they would have been if not for such limitation. Only shares acquired pursuant to the Purchase Agreement will be included in determining whether the limitation would be exceeded for purposes of this paragraph. [Signature Page Follows] 8 9 IN WITNESS WHEREOF, the Company has caused this Warrant to be duly executed as of January 10th, 2000. SUNRISE TECHNOLOGIES INTERNATIONAL, INC. By: /s/ PETER E. JANSEN ----------------------- Name: Peter E. Jansen Title: VP Finance & CFO Attest: - --------------------------- 9 EX-21.1 3 EXHIBIT 21.1 1 Exhibit 21.1 SUNRISE TECHNOLOGIES INTERNATIONAL, Inc. Subsidiaries of the Company Laser Biotech, Inc. EX-23 4 EXHIBIT 23 1 Exhibit 23 CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statement on Form S-3 (No. 333-72829) and Form S-8 (Nos. 333-91669, 333-73211, 33-27029) of Sunrise Technologies International, Inc. of our report dated February 11, 2000 relating to the financial statements and financial statement schedule, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP San Jose, California March 30, 2000 EX-27 5 EXHIBIT 27
5 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 10,643,000 0 330,000 (3,000) 1,973,000 13,414,000 2,193,000 (922,000) 14,905,000 7,649,000 0 0 0 46 84,600,000 14,905,000 26,000 26,000 5,000 2,359,000 18,875,000 (11,000) 5,980,000 (26,145,000) 0 0 0 0 0 (26,145,000) (0.60) (0.60)
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