-----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, D7IjY5G5+jfsv/9EVVL+T6uoh1IoaYSHvnNHKCZylXchtqBvUeoFPi7eJazyWy2K 6IctEcphH1WykdION8soaA== 0000891618-98-001572.txt : 19980407 0000891618-98-001572.hdr.sgml : 19980407 ACCESSION NUMBER: 0000891618-98-001572 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980406 SROS: NONE 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: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-10428 FILM NUMBER: 98588350 BUSINESS ADDRESS: STREET 1: 47265 FREMONT BLVD 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-K405 1 FORM 10-K405 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, 1997. 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. 0-17816 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) 47265 FREMONT BOULEVARD, 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. [X] The aggregate market value of the Registrant's Common Stock held by non-affiliates of the Registrant was approximately $197,512,748 as of March 26, 1998 based upon the price on the over-the-counter market for that date. There were 33,265,305 shares of the Registrant's Common Stock issued and outstanding on March 26, 1998. DOCUMENTS INCORPORATED BY REFERENCE Portions of the definitive proxy statement to be filed prior to April 30, 1998, 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. 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. 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 laser corneal shaping product, known as Laser Thermal Keratoplasty (the "LTK system") for the treatment of refractive error of the eye, such as hyperopia and presbyopia. The LTK system is based on patented technology acquired in the Company's acquisitions of in-process technology from Laser Biotech, Inc. and Emmetropix Corporation in 1992. (See "Products -- LTK system" in this Section.) The Company has incurred substantial losses in the past six years, which have seriously depleted its working capital. Sales of its existing ophthalmic products at current levels will not be sufficient to sustain the continued development and regulatory licensing of the LTK system. The Company has been able to raise additional working capital for all aspects of its business through the private placement of its Common Stock and convertible notes with warrants. These private placements raised $15,296,000 in 1994, 1995 and 1996 in new equity for the Company and $3,700,000 in the form of promissory notes with warrants in 1997 (the "1997 Notes Placement"). The Company recently completed a private placement of promissory notes with warrants in January 1998 that raised $9,300,000, net of offering costs (the "1998 Note Offering" ). If the Company is unable to obtain additional working capital, it may be forced to substantially curtail its activities and could, under certain circumstances, be forced to eliminate or suspend operations. There can be no assurance that additional funds can be raised on terms acceptable to the Company, if at all. PRODUCTS LTK system In April 1992, the Company acquired Laser Biotech, Inc., a California corporation ("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 (farsightedness) and presbyopia (loss of near vision) without removing corneal tissue. The procedure employs a laser to shrink, selectively, the collagen in the cornea, changing the curvature of the cornea and thereby changing the refractive power of the eye. By comparison, excimer laser systems for corneal reshaping developed by Summit Technologies, Inc. ("Summit") and VISX, Inc. ("VISX") remove parts of the cornea to achieve changes in refraction. Laser Biotech conducted pre-clinical studies to gain preliminary information on the efficacy and safety of the product, which resulted in positive indications that the LTK system could be applied successfully and safely to correct certain refractive error. In May 1992, the Company acquired substantially all of the in-process technology of Emmetropix Corporation, a Texas corporation ("Emmetropix"), including an assignment of certain patent applications and related technology from an Emmetropix shareholder which the Company believes will be useful in further developing the LTK system. The Company received an Investigational Device Exemption ("IDE") from the United States Food and Drug Administration ("FDA") to begin Phase I clinical trials of the LTK system on human subjects in the 1 3 first quarter of 1992. Phase I trials commenced in June 1992 using a prototype LTK system designed and developed by the Company. The Company completed Phase I of the clinical work for the LTK system and filed its results with the FDA in June 1993. In September 1993, the Company received clearance to begin Phase IIa clinical trials for the treatment of hyperopia and these clinical trials have commenced. The trials were conducted at the Doheny Eye Institute at the University of Southern California and Baylor University and completed in November 1994. In February 1995, the Company filed its request with the FDA to commence Phase IIb clinical trials. In a March 1995 letter, the FDA cited various deficiencies in the Company's February letter and requested additional information. In December 1995, the Company submitted the requested additional information. In January 1996, the FDA responded to the Company's submittal by requesting current follow-up data on all Phase IIa patients. In March 1996, the Company provided the current follow-up data on all Phase IIa patients. On September 5, 1996, the FDA authorized the Company to treat an additional 100 subjects at five United States locations in a continuation of Phase IIa clinical trials using a treatment algorithm developed by the Company in the course of the initial Phase IIa clinical trials and in the course of studies conducted by ophthalmologists in Mexico, Germany, Belgium, Italy and Canada. On March 31, 1997, the Company added three new investigators to its Phase IIa clinical study for hyperopia. On July 18, 1997, the Company received FDA approval to treat the fellow eye of patients who had one eye treated as part of the clinical trial for hyperopia six months after the first eye was treated. On August 7, 1997, the Company received approval from the FDA to treat an additional 100 patients as part of its Phase IIa clinical trial for hyperopia, bringing the total patients approved for treatment to 228. On October 8, 1997, the Company received FDA approval to re-treat patients in its clinical study. To date, no patients have been re-treated. On November 19, 1997, the Company completed enrollment in its Phase IIa clinical trial for hyperopia and also received FDA approval to begin Phase III of its clinical trial for hyperopia with an additional 200 patients to be treated by the existing eight clinical sites and up to seven additional clinical sites. On February 24, 1998, the Company announced that it had received FDA 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 March 24, 1998, the Company announced that it had received FDA approval for a new clinical study to treat patients with the LTK system who were overcorrected after receiving treatment for myopia (nearsightedness) from other companies' excimer laser systems. (See "Government Regulation" and "Patents and Licenses" in this Section and "Management's Discussion and Analysis of Financial Condition and Results of Operations".) In addition, clinical trials were initiated outside the United States in early 1993 and are ongoing. The Company has obtained FDA export clearance to market the LTK system in 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. Following regulatory approvals, the Company commenced marketing the LTK system overseas, primarily in Europe, for the treatment of hyperopia and astigmatism in December 1993. On September 25, 1997, the Company received approval to treat 60 patients at four sites for the condition known as presbyopia. Presbyopia is the age-related loss of near vision. The Company's clinical trial will employ a technique known as monovision to treat presbyopia. A patient with monovision utilizes one eye primarily for distance vision and the other eye primarily for reading, or near vision. The LTK system incorporates the Sun 1000, a modified gLase 210 system, as described below, as the laser source, into a delivery system that is built into a standard slit-lamp to perform the LTK procedure. A slit-lamp is a binocular microscope used regularly by ophthalmologists to examine an eye binocularly under high magnification. The LTK system delivers eight simultaneous laser beams disposed in a circle of varying diameter. This system allows for easy alignment on the patient's eye and the delivery of a less than two-second exposure for the treatment. To date, international sales of the LTK system have been limited. Revenue in the United States cannot reasonably be expected before the second half of 1999, at the earliest. There can be no assurance the FDA will approve the pre-market approval application ("PMA") which summarizes the results of continued clinical trials, or that the Company will successfully develop or market the LTK system. 2 4 Ophthalmic Laser System for Glaucoma In 1990, the Company developed the gLase 210 ophthalmic system (the "gLase 210 system"), a holmium laser system designed to perform a filtering procedure for the treatment of glaucoma. Conventional filtering procedures, whereby a permanent drainage duct is created to relieve the pressure in the eye, is a difficult surgical procedure and is currently being performed only by a limited number of glaucoma specialists. The gLase 210 system emits radiation at a wavelength that is highly absorbed by water and, therefore, by all tissues in the body because water is the main constituent of all body tissues. The goal of a filtering procedure is to relieve the pressure inside the eye by making a small hole in the sclera, the strong wall of the eye. The pulsed nature of the holmium laser combined with the wavelength provide an effective and efficient way of creating a hole in the sclera with minimal disturbance to surrounding tissues. The laser beam is brought to the target inside the eye with a 200-micron fiber built into a special probe that emits the laser beam at a right angle to the fiber axis. The design characteristics and the unique delivery device of the gLase 210 system enable the ophthalmologist to perform this procedure on an outpatient basis, thus avoiding the use of an operating room and the hospitalization sometimes required with traditional filtering surgery. Foreign sales of the gLase 210 system commenced on a limited basis during the second quarter of 1990; domestic sales commenced in December 1990 when the Company received FDA clearance to begin commercial sale of the product line in the United States for the filtering procedure. The gLase 210 system is not currently marketed actively in the United States or internationally. Sales of the gLase 210 system have been limited and have never represented more than 11% of the Company's revenues in any year. 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 state and 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. No clinical testing of the Company's products on humans may be undertaken without first obtaining an IDE from the FDA. To date, sales of the LTK system in the United States for clinical testing on humans have been pursuant to approved IDEs. There are two principal methods by which FDA-regulated products may be marketed in the United States. One method is an FDA premarket notification filing under Section 510(k) of the Food, Drug and Cosmetics Act. Applicants under the 510(k) procedure must demonstrate the device for which clearance is sought is substantially equivalent to devices on the market before May 1976. The review period for a 510(k) application is 90 days from the date of filing the application. Applications filed pursuant to 510(k) are often subject to questions and requests for clarification that often extend the review period beyond 90 days. Marketing of the product must be deferred until written clearance is received from the FDA. In some instances, an IDE is required for clinical trials for a 510(k) notification. The alternate method, when Section 510(k) is not available, is to obtain a PMA from the FDA. 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 more complex and time consuming than the 510(k) application. The 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 FDA also imposes various requirements on manufacturers and sellers of products under its jurisdiction, such as labeling, manufacturing practices, record keeping and reporting requirements. The FDA 3 5 also may require postmarket testing and surveillance programs to monitor a product's effects. All of the Company's products will require filing of an IDE, and a 510(k) application or PMA. There can be no assurance that the appropriate approvals from the FDA will be granted for the Company's products, the process to obtain such approvals will not be excessively expensive or lengthy or 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 Radiation Control for Health and Safety Act administered by the FDA which requires laser manufacturers: (i) to file new product and annual reports; (ii) to maintain quality control, product testing and sales records; (iii) to incorporate certain design and operating features in lasers sold to end-users; and (iv) to certify and label each laser sold to an end-user as belonging to one of four classes, based on the level of radiation from the laser that is accessible to users. Various warning labels must be affixed and certain protective devices installed, depending on the class of the product. The Center for Devices and Radiological Health is empowered to seek fines and other remedies for violations of the regulatory requirements. Foreign sales of the Company's ophthalmic laser systems are subject in each case to clearance by the FDA for export to the recipient country. Regulatory requirements vary widely among the countries, from electrical approvals to clinical applications similar to the PMA filed with the FDA for sales in the United States. There can be no assurance that the Company will be successful in obtaining such approvals for its products in the future. MARKETING AND SALES The Company's strategy is to market its products through established medical equipment distributors overseas. In the United States, the Company sells its products through a small direct sales force. In 1990, the Company completed development and obtained regulatory clearance to market the gLase 210 system for sclerostomy. A modified gLase 210 system is used together with the LTK device to produce the LTK system to treat hyperopia. The Company has established relationships with distributors in Great Britain, Canada, France, Mexico, South Africa and Central and South America for sale of its ophthalmic systems. 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 ophthalmic market for the gLase 210 system has been impacted by reimbursement pricing pressures, the continued need for publication of long term follow-up data, and increased educational requirements on the part of the practitioner regarding follow-up requirements and patient monitoring. The establishment of a successful distributor network requires providing the distributors with sales instruments (brochures, clinical data, research papers, educational videos, etc.). Such marketing efforts are expected to include presentations at conventions and trade shows, customer training by Company personnel and sponsorship of teaching seminars, clinical presentations, and research by others. The Company also hires additional marketing and sales consultants from time to time to assist in the introduction of its products. There can be no assurance the Company can effectively market its existing and planned new products. ENGINEERING AND DEVELOPMENT The Company's success will depend substantially upon its ability to develop, produce and market innovative new products. For the years ended December 31, 1997, 1996 and 1995, the Company expended $964,000, $1,326,000 and $1,218,000, respectively, on engineering and development, relating to dental and ophthalmic lasers, and MicroPrep (an air abrasive cavity preparation system for dentistry), as well as research on a variety of medical and dental applications. 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 4 6 sale of the Company's dental business and assets in June 1997, to an unaffiliated party, the Company no longer expends any of its funds on the engineering and development of dental laser or other dental products. Clinical testing and sale of the Company's products are subject to obtaining applicable regulatory approvals, of which there can be no assurance. The Company's research and development activities are conducted in-house as well as by outside sources, including consultants and universities. The laser industry is characterized by extensive research and rapid technological change. Development by others of new or improved products, processes or technologies may make product development by the Company obsolete or less competitive. The Company will be required to devote continuing efforts and funds to further developments and enhancements for its existing products and for its research and development of new technologies and products. There can be no assurance the Company will be able to successfully adapt its operations to evolving markets and technologies and fund the development of new medical products to achieve possible technological advantages. PRODUCTION The Company manufactures its ophthalmic lasers from parts, components and subassemblies obtained from a number of unaffiliated suppliers, and the Company designs the software incorporated into a microprocessor purchased from an unaffiliated third party. Prototype production and all manufacturing, assembly and testing activities take place at its Fremont, California facility. Although all the parts and components used by the Company are available from multiple sources, several are currently being purchased from only one source to obtain volume discounts. Lack of availability of certain components could require minor redesign of the products resulting in production delays. 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. POTENTIAL LIABILITY The testing and use of human healthcare products entail an inherent risk of physical injury to patients and resultant product liability or malpractice litigation. While the Company has obtained product liability coverage in the amount of $5,000,000 with an umbrella policy for an additional $5,000,000, such coverage is limited, and there can be no assurance that such coverage will be sufficient to protect it from all risks to which it may be subject. Those costs of defending a product liability or malpractice action could have a material adverse impact on the Company, even if the Company were to ultimately prevail. PATENTS AND LICENSES In the acquisition of Laser Biotech, the Company acquired a United States patent and pending United States and foreign patent applications previously licensed to Laser Biotech by Dr. Bruce Sand, its founder. The issued patent covers a method for using a laser to shrink collagen in the human body, with specific reference to the cornea. Since the acquisition, two more patents filed by Dr. Sand have been allowed, and have been assigned to the Company. In the Emmetropix acquisition, the Company acquired three United States patent applications as well as foreign patent applications previously licensed to Emmetropix, which the Company believes will be useful in 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 has been granted 23 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 2007 and are currently pledged as collateral for the 1997 Notes Placement. 5 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 (farsightedness) can achieve vision correction with eyeglasses, contact lenses and possibly with other technologies and surgical techniques currently under development, such as corneal implants, lens replacement 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, although it is not currently approved to treat hyperopia in the United States or Japan, other than in limited clinical trials. In the United States, VISX and Summit are the leading manufacturers of excimer refractive surgical systems. While the Company believes the LTK system offers several distinct advantages over the use of excimer lasers for treating hyperopia, including ease of use and decreased invasiveness, both VISX and Summit have significantly greater financial resources than the Company and have received FDA approval for their respective excimer laser products for treating myopia (nearsightedness) and astigmatism. In addition, certain of the Company's competitors, including Summit, have developed LTK devices for the treatment of hyperopia. 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. Although neither the VISX and Summit excimer laser products nor the Summit LTK devices are currently approved for treating hyperopia in the United States, and Summit discontinued its clinical trials for treating hyperopia with its holmium laser system in 1996, any alternative treatment offered by VISX or Summit may have a competitive advantage because of the name recognition being created by the current promotion of excimer laser products for correcting myopia using lasers and the fact that VISX and Summit have been able to establish a 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 1997, approximately 38% of the Company's revenues were international as compared to approximately 47% in 1996 and 69% in 1995. BACKLOG On December 31, 1997, the Company had a backlog of approximately $1,000, all of which the Company expects to ship to its customers in 1998. 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 in the United States. The Company's laser products include microprocessors and software that perform self-checks upon startup 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. 6 8 To date, actual costs incurred related to warranty work have been minimal. In the case of sales by distributors, all product service will be provided by such distributor. EMPLOYEES At December 31, 1997, the Company had 23 full-time employees (including its executive officers); ten in manufacturing, two in engineering and development, five in marketing, sales and regulatory, and six in administration. In addition, the Company has retained a number of consultants to assist with its product development and regulatory activities during 1997 and beyond. The Company is primarily dependent upon its engineering and development employees and consultants for the development and improvement of existing and proposed products. The Company's future success will depend in a large part upon its ability to attract and retain highly qualified scientific and management personnel, and its ability to continue to train and retain highly skilled technical and marketing personnel. None of the Company's employees are represented by a labor organization. The Company maintains various benefit plans and experiences 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. History of Losses; Profitability Uncertain; Cash Flow Deficits Since 1992, the Company has incurred substantial losses, which have depleted its working capital and reduced its stockholders' equity. In addition, the Company's business will continue to be a significant consumer of cash, as the revenues from its business are not expected to be sufficient to cover its operating costs, unless and until FDA approval is obtained to permit domestic sale of the LTK system, which approval is not expected until the second-half of 1999, at the earliest. The negative cash flows for the Company have been funded during 1996 and 1997 by the sale of additional equity and convertible debt with warrants. At December 31, 1997, cash and cash equivalents for the Company were approximately $1,958,000, and at February 28, 1998, after consummation of the 1998 Note Offering (approximate net proceeds of $9,300,000), cash and cash equivalents of the Company was approximately $10,500,000. The Company anticipates that it will be required to raise additional working capital to fund its activities for late 1999 and beyond. Any additional equity or debt offerings may be dilutive to the Company's stockholders. No assurance can be given that additional financing will be available, or if available, that it will be available on terms favorable to the Company and its stockholders. If funds are not 7 9 available to satisfy the Company's short-term and long-term operating requirements, the Company may be required to limit or suspend its operations in their entirety or, under certain circumstances, be forced to seek protection from creditors. (See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Consolidated Financial Statements attached hereto.) Continuing Losses Expected The Company expects to report operating losses during 1998 and beyond. The losses will come primarily from the expenses of the FDA approval process and underlying clinical studies related to the LTK system. The Company will not have any domestic revenues from this product line unless and until FDA approval is obtained. International revenues are not expected to be sufficient to cover the cost of the approval process. Regulatory Matters -- FDA Approval of LTK System The Company's activities are subject to extensive regulation by the FDA and similar health authorities in certain foreign countries. The LTK system is regulated as a Class III medical device by the FDA under the Food, Drug & Cosmetic Act. Class III medical devices require a PMA by the FDA prior to commercial sale in the United States. The PMA process (and underlying clinical studies) is lengthy, the outcome is difficult to predict and requires substantial commitments of the Company's financial resources and management's time and effort. Delays in obtaining or failure to obtain required regulatory approvals or clearances in the United States and other countries would postpone or prevent the marketing of the LTK system and other devices and would impair the Company's ability to generate funds from operations, which in turn would have a material adverse effect on the Company's business, financial condition and results of operations. There can be no assurance that the Company will be able to obtain in a timely manner, if at all, the required PMA in the United States for intended uses of the LTK system, or for any other devices which the Company may seek approvals or clearances. Any products manufactured or distributed by the Company will be subject to pervasive and continuing regulation by the FDA. In addition, the introduction of the Company's products in foreign countries may require obtaining 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 Japan. There can be no assurance that the Company will be able to obtain regulatory clearances for its products in the United States or foreign markets. Uncertain Market Acceptance of the LTK System Although the Company has another ophthalmic laser product, the gLase 210, the Company has and intends to concentrate its efforts primarily on the development of the LTK system and will be dependent upon the successful development of that system to generate increased revenues. The LTK system has not yet been introduced commercially in the United States, and there can be no assurance that if approved by the FDA, such system will be accepted by either the ophthalmic community or the general population as an alternative to existing methods of treating refractive vision disorders. Many ophthalmologists may have already invested significant time and resources in developing expertise in other corrective ophthalmic techniques. Acceptance of the LTK system may be affected adversely by its costs, concerns related to its safety and efficacy, the general resistance to use of laser products on the eye, the effectiveness of alternative methods of correcting refractive vision disorders, the lack of long-term follow-up data and 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. The Company's failure to achieve broad market acceptance of the LTK system will have a material adverse effect on the Company's business, financial condition and results of operations. 8 10 Safety and Efficacy Concerns; Lack of Long-Term Follow-Up The Company has developed limited clinical data to date on the safety and efficacy of the LTK system in correcting hyperopia (farsightedness), and related long-term safety and efficacy data. The FDA has not yet determined whether the LTK system will prove to be safe or effective for the predictable and reliable treatment of hyperopia (farsightedness) or other common vision problems. Potential complications and side effects from the use of the LTK system include mild foreign body sensation, temporary increased light sensitivity, modest fluctuations in refractive capabilities during healing, unintended over or under-corrections, regression of effect and induced astigmatism. There can be no assurance that long-term safety and efficacy data when collected will be consistent with the clinical trial results previously obtained or will demonstrate that the LTK system can be used safely and successfully to treat hyperopia (farsightedness) in a broad segment of the population on a long-term basis. Loss of Dental Revenues Prior to the sale of the dental assets in June 1997, the Company's revenues were substantially derived from the sale of its dental laser and air abrasive products. These sales represented 98% and 69% of the Company's revenues in 1996 and 1997, respectively. By selling the dental assets, the Company lost a significant source of continued revenue, although the dental assets made a negative contribution to the Company's financial results. Patent Concerns Although the Company believes it holds dominant United States process patents for the use of holmium lasers in non-destructive cornea shaping, process and apparatus patents relating to shaping the cornea with holmium lasers have been issued to others. An apparatus patent, generally, is a patent on a machine or device. A process patent is a patent on an act or a method, and includes a new use of a known process, machine, manufacture, composition of matter or material. Because patent applications are maintained in secrecy in the United States until such patents are issued, and are maintained in secrecy for a period of time outside the United States, the Company can conduct only limited searches to determine whether its technology infringes any patent or patent applications. Any claims for patent infringement could be time-consuming, result in costly litigation, divert technical and management personnel or require the Company to develop non-infringing technology or to enter into royalty or licensing agreements. The Company believes it is 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 the Company's holmium laser corneal shaping systems or use of such systems to perform LTK or other procedures. There can be no assurance that the Company will not be subject to one or more claims for patent infringement, that the Company would prevail in any such action or that its patents will afford protection against competitors with similar technology. In the event the LTK system is adjudged to infringe a patent in a particular market, the Company and its customers may be enjoined from making, selling and using such system or be required to obtain a royalty-bearing license, if available, on acceptable terms. Alternatively, in the event a license is not offered or available, the Company might be required to redesign those aspects of the LTK system held to infringe so as to avoid infringement. Any redesign could delay reintroduction of the Company's products into certain markets, or may be so significant as to be impractical. If redesign efforts were impractical, the Company could be prevented from manufacturing and selling the infringing products, which would have a material adverse effect on the Company's business, financial condition and results of operations. In addition, the Company has attempted to negotiate with the University of Miami to reach agreement regarding the non-exclusive use of a component of the delivery system used in the LTK system which was jointly developed by the Company and the University. The Company believes that it will be able to make reasonable arrangements with the University. If, however, the Company is unable to conclude negotiations with the University successfully, the Company may have no rights in the delivery system presently configured 9 11 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. Volatility of Stock Price The market price of the Company's Common Stock may be affected by quarterly fluctuations in the Company's operating results, announcements by the Company or its competitors of technological innovations or new product introductions and other factors. If revenue or earnings in any quarter fail to meet expectations of the investment community, there could be an immediate impact on the Company's stock price. In addition, the stock market has from time to time experienced extreme price and volume fluctuations, particularly among stocks of high technology companies, which on occasion have been unrelated to the operating performance of particular companies. Factors not directly related to the Company's performance, such as negative industry reports or disappointing earnings announcements by publicly traded competitors, may have an adverse impact on the market price of the Company's Common Stock. Year 2000 Compliance The Company is aware of the issues associated with the programming code in existing computer systems as the millennium (year 2000) approaches. The "year 2000" problem is pervasive and complex, as virtually every computer operation will be affected in the same way by the rollover of the two digit year value to 00. The issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company is utilizing both internal and external resources to identify, correct or reprogram, and test the systems for year 2000 compliance. It is anticipated that all reprogramming efforts will be completed by December 31, 1998, allowing adequate time for testing. This process includes getting confirmations from the Company's primary vendors that plans are being developed or are already in place to address processing of transactions in the year 2000. However, there can be no assurance that the systems of other companies on which the Company's systems rely will also be converted in a timely manner, or that any such failure to convert by another company would not have an adverse effect on the Company's systems. Management is in the process of completing its assessment of the year 2000 compliance costs; however, based on information to date (excluding the possible impact of vendor systems), management does not believe that it will have a material effect on the Company's earnings. ITEM 2. FACILITIES The Company leases 10,400 square feet for all its business activities including executive offices as well as engineering and development, manufacturing, assembly and testing activities in Fremont, California for approximately $12,300 per month, including expenses. The lease expires in January 2001. The Company is currently in lease negotiations for larger space in the Fremont area. ITEM 3. LEGAL PROCEEDINGS Not Applicable ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS Not Applicable 10 12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Market Information As of December 31, 1997, there were 673 holders of record of the Company's Common Stock. Price information for the Company's Common Stock may be obtained from the OTC Bulletin Board. 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 for the periods indicated. PRICES FOR COMMON STOCK
QUARTER ENDED HIGH LOW ------------- ----- ----- March 31, 1996.............................................. $2.88 $1.09 June 30, 1996............................................... $2.31 $1.06 September 30, 1996.......................................... $2.00 $0.88 December 31, 1996........................................... $2.13 $0.81 March 31, 1997.............................................. $1.75 $0.75 June 30, 1997............................................... $1.44 $0.88 September 30, 1997.......................................... $3.94 $1.00 December 31, 1997........................................... $5.13 $3.13
- --------------- (1) Bid and ask prices are quoted on 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. On March 26, 1998, the closing price of the Company's Common Stock as reported on the OTC Bulletin Board was $5.9375 per share. The over-the-counter market quotations provided herein may reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions. 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 The Company did not sell any unregistered securities during the fourth quarter of 1997. The Company has approximately 75 warrant holders of record for its warrants as of March 26, 1998. 11 13 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, 1993, 1994, 1995, 1996 and 1997.
YEAR ENDED DECEMBER 31, --------------------------------------------------- 1993 1994 1995 1996 1997 ------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Net revenues............................. $11,860 $ 7,578 $ 5,294 $ 5,654 $ 2,839 Gross profit............................. 5,009 1,340 1,637 1,638 293 Operating costs and expenses............. 11,461 8,257 5,824 7,658 7,368 Loss from operations..................... (6,452) (6,917) (4,187) (6,020) (7,075) Gain on sale of dental assets............ -- -- -- -- 1,740 Interest income(expense), net............ (232) 7 57 52 (1,283) Net loss................................. (6,624) (6,910) (4,130) (5,968) (6,618) Net loss per share, basic and diluted.... (0.74) (0.68) (0.28) (0.23) (0.23) Shares used in calculation of basic and diluted net loss per share............. 8,955 10,129 14,935 26,414 28,550 Total assets............................. 5,511 3,822 6,689 3,741 2,949 Long term obligations.................... 18 -- -- -- 945 Total stockholders' equity............... 2,708 1,357 4,745 1,272 849 Working capital.......................... 1,965 1,101 4,541 1,073 1,382
(See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for information regarding the Company's disposition of dental business and assets.) 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. Prior to June 26, 1997, the Company developed, manufactured and marketed lasers and air abrasion cavity preparation systems for use in dentistry. 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, with two installments due in June 2000 and 2001, respectively (the "Lares Note"). Collection is not reasonably assured due to subordination of the Lares Note to Lares' bank and the Company intends to recognize proceeds from the sale and interest on the Lares Note as cash is received. The gain on sale of the Dental Assets is comprised as follows:
IN THOUSANDS ------------ Cash proceeds from sale of 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 has incurred substantial losses in the past six years which have seriously depleted its working capital. Sales of its existing ophthalmic products at current levels will not be sufficient to sustain the continued development and regulatory licensing of the LTK system. The Company has been able to raise additional working capital for all aspects of its business through the private placement of its common stock and convertible notes with warrants. These private placements raised $15,296,000 in 1994, 1995 and 1996 in new equity for the Company and $3,700,000 from the 1997 Notes Placement. The Company recently completed 12 14 the 1998 Note Offering that raised $9,300,000, net of offering costs. If the Company is unable to obtain additional working capital, it may be forced to substantially curtail its activities and could, under certain circumstances, be forced to eliminate or suspend operations. The following table sets forth certain operations data as a percentage of net revenue for the periods indicated:
YEAR ENDED DECEMBER 31, ------------------------- 1997 1996 1995 ------ ------ ----- Net Revenues................................................ 100% 100% 100% Cost of revenues............................................ 90 71 69 ---- ---- --- Gross profits............................................... 10 29 31 Other costs and expenses: Engineering and development............................... 33 24 23 Sales, marketing and regulatory........................... 96 64 43 General and Administration................................ 130 48 44 ---- ---- --- Total other costs and expenses.............................. 259 135 110 Loss from operations........................................ (249) (106) (79) Gain on sale of Dental Assets............................... 61 -- -- Interest income(expense), net............................... (45) 1 1 ---- ---- --- Net Loss.................................................... (233)% (105)% (78)% ==== ==== ===
REVENUES The Company's revenues have historically been comprised primarily of sales related to its dental products (69% in 1997, 98% in 1996 and 76% in 1995). Revenues of $2,839,000 in 1997 reflect sales of its ophthalmic and dental products through June 26, 1997 and ophthalmic products only during the second half of 1997 due to the sale of the Company's dental business effective June 26, 1997. Revenues decreased from $5,654,000 in 1996, approximately a 50% reduction, due to the effective elimination of any revenue from dental products in the second half of 1997 as a result of the sale of the dental business. Revenues of $5,654,000 in 1996 represented an increase of approximately 7% from 1995 revenues, attributable to a slight increase in sales of the Company's dental products. GROSS PROFITS Gross profit margins were 10%, 29% and 31% in 1997, 1996 and 1995, respectively. The major factors contributing to the significant reduction in gross profit margins in 1997 from the 1996 levels include lower revenues of the Company's products, under-utilization of manufacturing capacity due to decreased product shipments and increased reserves for excess and obsolete inventory. Under-utilization of manufacturing capacity is expected to continue to adversely affect gross profit margins in 1998. The 1996 decrease in gross profit margin when compared to 1995 was attributed to an increase in the percentage of sales through distributors and a decrease in sales of the LTK system which carried a higher gross margin than the Company's dental products. ENGINEERING AND DEVELOPMENT Engineering and development expenses were $964,000, $1,326,000 and $1,218,000 for the years ended 1997, 1996, and 1995, respectively. Engineering and development expenses decreased to $964,000 in 1997, an approximately 27% reduction from the 1996 level of expense, principally due to the effect of the sale of the dental business and subsequent elimination of the engineering and development expenses relating to the dental business subsequent to the sale. 13 15 The increase in engineering and development expenses for 1996 from 1995 of approximately 9% was attributed to development costs associated with a new dental product launched in the first calendar quarter of 1997. SALES, MARKETING AND REGULATORY Sales, marketing and regulatory expenses were $2,718,000, $3,632,000 and $2,277,000 for the years ended 1997, 1996, and 1995, respectively. The reduction in sales, marketing and regulatory expenses in 1997 from 1996 of approximately 25% was attributable to the elimination of such expenses after the sale of the dental business in June 1997, offset by an increase in regulatory expenses associated with the Company's clinical studies for hyperopia and presbyopia as compared to 1996. In addition, the Company added personnel to its ophthalmic sales and marketing organization during the second half of 1997 in support of its international sales and international and domestic marketing activities. The increase in sales, marketing and regulatory expenses of approximately 60% in 1996 from 1995 was attributed to the launch expenses for the MicroPrep in the first quarter of 1996 and the expenses associated with the expansion of the Phase IIa clinical study for the LTK system and the FDA review of the Company's PMA submitted for use of its dental lasers for hard tissue applications. The Company currently markets its ophthalmic lasers through an indirect sales organization. Distribution for all products internationally is handled through distributors. The Company will not be able to market its LTK system in the United States until the FDA approves the product for sale in the United States. The Company is unable to predict when, if at all, the FDA will approve the LTK system for sale in the United States. GENERAL AND ADMINISTRATIVE General and administrative expenses were $3,686,000, $2,700,000 and $2,329,000 for the years ended 1997, 1996, and 1995, respectively. The increase in general and administrative expenses for 1997 from 1996 of approximately 37% was primarily due to expenses associated with severance pay for certain officers, nonstatutory option expenses and an increase in investor relations expenses. The increase in general and administrative expenses of approximately 16% in 1996 from 1995 was attributed to costs associated with the Company's proposed acquisition of EyeSys Technologies, which was not consummated, and the expenses associated with the hiring of a new management team for the Company's ophthalmic business. 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 (EXPENSE), NET Interest income was $98,000, $65,000 and $69,000 for the years ended 1997, 1996 and 1995, respectively. The increase in interest income between 1997 and 1996 was due to higher average balances in the Company's interest bearing accounts. Interest expense was $1,381,000, $13,000 and $12,000 for the years ended 1997, 1996 and 1995, respectively. The increase in interest expense for 1997 was due to the interest accrued on the notes issued by the Company in connection with the 1997 Notes Placement (the "1997 Notes"), at the rate of 5% according to the terms of the 1997 Notes, non-cash interest expense accrued for the fair value of the warrants and the conversion features of such notes, as well as placement costs that were partially amortized as additional interest expense. 14 16 INCOME TAXES At December 31, 1997, 1996 and 1995, all deferred tax assets computed in accordance with Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" have been fully offset by a valuation allowance. As of December 31, 1997, the Company had federal net operating loss carry-forwards of approximately $30,000,000. The ownership provisions of the Internal Revenue Code of 1986 would limit the utilization of the carry-forwards should there be a substantial change in the Company's ownership. NET LOSSES The Company reported losses of $6,618,000, $5,968,000 and $4,130,000 in 1997, 1996, and 1995, respectively. The net loss in 1997 was due principally to the low level of revenue, excess manufacturing capacity and inventory, the Company's continuing clinical trials for hyperopia and presbyopia, expenses associated with the Company's issuance of convertible debt with warrants and certain non-statutory stock options, and the Company's need to maintain its basic corporate infrastructure, partially offset by the gain from the sale of the Company's dental business in June 1997. Although total operating expenses were reduced by 4% from 1996, the reduction was not sufficient to return the Company to profitability in 1997. The net loss in 1996 was due primarily to increased selling, marketing and product development expenses associated with the attempt to grow the dental and ophthalmic businesses, compounded by the continued low level of revenue and excess manufacturing capacity. Total operating expenses increased 31% from 1995 while gross profit was essentially the same in both years. This increase in operating expenses accounts for essentially all of the $1,800,000 increase in net loss in 1996 from 1995. The net loss in 1995 was due principally to the continued low level of sales, excess manufacturing capacity and the Company's need to maintain the basic sales, marketing, regulatory and corporate infrastructure. The Company expects to report net losses during 1998 and beyond. The losses will come primarily from the expenses of the FDA approval process and underlying clinical studies related to the LTK system and the expenses associated with maintaining the Company's basic corporate infrastructure. The Company will not have any material domestic revenues from this product line unless and until FDA approval is obtained. The Company's international revenues are not projected to be sufficient to cover the expenses of maintaining the basic corporate infrastructure and the Company's costs of the continuing clinical trials for hyperopia and presbyopia. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1997, the Company had $1,958,000 in cash and cash equivalents. The Company's operating activities used $6,774,000 in cash during 1997. A substantial portion of the 1997 loss was funded by the $3,600,000 of net proceeds received from the sale of its dental business in June 1997 and proceeds of $3,700,000 from the 1997 Notes. Working capital amounted to $1,073,000 at December 31, 1996 and increased to $1,382,000 at December 31, 1997. Working capital, including the proceeds from the 1997 Notes Placement and the sale of the Dental Assets, was used to fund the Company's 1997 operating loss and to reduce accounts payable. During 1997, the Company used $201,000 in investing activities for the purchase of fixed assets and generated $3,449,000 from the sale of the Dental Assets. Net cash provided from financing activities was $4,837,000 during 1997 and was primarily comprised of the issuance of the Company's Common Stock and the issuance of the 1997 Notes. The 1997 Notes Placement was completed in March 1997 and consisted of convertible promissory notes with warrants. The promissory notes held by domestic purchasers convert at a rate of $0.875 per share and the promissory notes held by international purchasers convert at a rate of $1.00 per share. The warrants associated 15 17 with the 1997 Notes Placement would convert into 2,538,328 shares of Common Stock and have an exercise price of $1.00 per share. The Company's current operations continue to be cash flow negative, further straining the Company's working capital resources. The level of current product sales is not sufficient to provide enough cash to support the ongoing development and regulatory approval of the LTK system, as well as maintain the Company's basic corporate infrastructure. In January 1998, the Company completed the 1998 Note Offering. The Company believes it has sufficient working capital to continue its existing operations through 1998 and into 1999. In order to continue its current level of operations beyond 1999 and have sufficient funds to launch the LTK system in the United States, it will be necessary for the Company to obtain additional working capital resources, whether from debt or equity sources. If the Company is unable to obtain additional working capital resources from the placement of debt or equity instruments or the sale of some of its assets, it may be necessary for the Company to curtail or suspend operations in their entirety. YEAR 2000 COMPLIANCE The Company is aware of the issues associated with the programming code in existing computer systems as the millennium (year 2000) approaches. The "year 2000" problem is pervasive and complex, as virtually every computer operation will be affected in the same way by the rollover of the two digit year value to 00. The issue is whether computer systems will properly recognize date sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company is utilizing both internal and external resources to identify, correct or reprogram, and test the systems for year 2000 compliance. It is anticipated that all reprogramming efforts will be completed by December 31, 1998, allowing adequate time for testing. This process includes getting confirmations from the Company's primary vendors that plans are being developed or are already in place to address processing of transactions in the year 2000. However, there can be no assurance that the systems of other companies on which the Company's systems rely will also be converted in a timely manner, or that any such failure to convert by another company would not have an adverse effect on the Company's systems. Management is in the process of completing its assessment of the year 2000 compliance costs; however, based on information to date (excluding the possible impact of vendor systems), management does not believe that it will have a material effect on the Company's earnings. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company does not engage in any hedge transactions or derivative financial instruments. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated balance sheets at December 31, 1997 and 1996, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years ended December 31, 1997, 1996 and 1995 and the notes thereto appear beginning at page 22. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On December 9, 1997, the Company dismissed Ernst & Young LLP ("E&Y") as its independent accounting firm. E&Y's report on the financial statements for the past two years did not contain an adverse opinion or a disclaimer of opinion, however, the report was modified to include an explanatory paragraph with respect to the Company's ability to continue as a going concern. During the Company's two most recent fiscal years and the subsequent interim period preceding such dismissal, there were no disagreements with E&Y on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure. The decision to change accountants was recommended and approved by the Audit Committee of the Company's Board of Directors. On December 10, 1997, the Company engaged Coopers & Lybrand L.L.P. ("C&L") as the new independent accountant to audit the Company's financial statements. During the Company's two most recent fiscal years and the subsequent interim period prior to engaging C&L, the Company had not consulted C&L 16 18 regarding either: (i) the application of accounting principles to a specified transaction, either completed or proposed; or the type of audit opinion that might be rendered on the Company's financial statements, and no written report was provided to the Company and no oral advice was provided that C&L concluded was an important factor considered by the Company in reaching a decision as to the accounting, auditing or financial reporting issue; or (ii) any matter that was either the subject of a disagreement (as defined in paragraph 304(a)(1)(iv) of Regulation S-K) or a reportable event (as described in paragraph 304(a)(1)(v) of Regulation S-K). PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding the Company's directors will be set forth under the caption "Election of Directors -- Nominees/Continuing Directors," and information regarding the Company's executive officers will be set forth under the caption "Executive Compensation -- Executive Officers" in the Company's proxy statement for use in connection with the 1998 Annual Meeting of Stockholders (the "Proxy Statement"), and is incorporated herein by reference. The Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. ITEM 11. EXECUTIVE COMPENSATION The section entitled "Executive Compensation" in the 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 Owners and Management" in the Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The section entitled "Certain Relationships and Related Transactions" in the Proxy Statement is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8K (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 Coopers & Lybrand L.L.P., Independent Accountants........................................ 20 Report of Ernst & Young LLP, former Independent Auditors........................................... 21 Consolidated Balance Sheets -- December 31, 1997 and 1996............................................... 22 Consolidated Statements of Operations*............... 23 Consolidated Statement of Stockholders' Equity*...... 24 Consolidated Statements of Cash Flows*............... 25 Notes to Consolidated Financial Statements........... 26 - --------------- *For the years ended December 31, 1997, 1996 and 1995
17 19 2. FINANCIAL STATEMENT SCHEDULES The following financial statement schedules are filed as part of this report: Schedule II -- Valuation and Qualifying Accounts........................................ 36
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 DESCRIPTION ------- ----------- 2.1 Asset Purchase Agreement dated as of March 26, 1997, by and between the Company and Lares Research, a California corporation(6) 3.1 Certificate of Incorporation, as amended(1) 3.2 Bylaws(1) 4.1 Form of 5% Convertible Notes due 1999(7) 4.2 Form of Security Agreement relating to 5% Convertible Notes due 1999(7) 4.3 Form of Registration Rights Agreement(7) 4.4 Form of Warrant issued to Pennsylvania Merchant Group(4) 4.5 Form of Rights Agreement, dated as of October 24, 1997, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(8) 4.6 Form of 12% Subordinated Pay-In-Kind Note Due 2001(9) 4.7 Form of Registration Rights Agreement(9) 10.1 Lease Agreement with Bayside Spinnaker Partners III, as lessor, for the lease of facilities at 47265 Fremont Boulevard, Fremont, California, dated January 23, 1998 10.2 Patent License Agreement between the Company and Patlex Corporation dated January 1, 1990(3) 10.3 Agreement between the Company and the University of Miami, Department of Ophthalmology, dated October 28, 1991(2) 10.4 Joint Development and Exclusive Manufacturing Agreement dated April 17, 1993 between the Company and Danville Engineering, Inc.(1) 10.5 Settlement Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.6 License Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.7 Settlement Agreement between the Company and American Dental Technologies, dated July 30, 1996(6) *10.8 Form of Indemnification Agreement between the Company and each of its officers and directors(3) *10.9 1988 Stock Option Plan, as amended(5) *10.10 Employment Agreement, entered into between the Company and Joseph W. Shaffer, dated April 5, 1989(5) 10.11 Form of U.S. Note and Warrant Purchase Agreement relating to the Regulation D private placement of 5% convertible notes due 1999 and warrants in February and March 1997(7) 10.12 Form of Offshore Note and Warrant Purchase Agreement relating to the Regulation S private placement of 5% convertible notes due 1999 and warrants in March 1997(7) *10.13 Form of Change of Control Agreement by and between the Company and its President and Chief Executive Officer(8)
18 20
EXHIBIT DESCRIPTION ------- ----------- *10.14 Form of Change of Control Agreement by and between the Company and its executive officers (other than the President and Chief Executive Officer)(8) *10.15 Form of Indemnification Agreement by and between the Company and its executive officers(8) 10.16 Form of U.S. Note and Warrant Purchase Agreement related to the Regulation D private placement of 12% Convertible Subordinated Pay-In-Kind Notes Due 2001 and accompanying Warrants in January 1998(9) 21.1 Subsidiaries of the Company 22 Power of Attorney (included on the signature pages to this Form 10-K) 23.1 Consent of Coopers & Lybrand L.L.P., Independent Accountants 23.2 Consent of Ernst & Young LLP, Former Independent Auditors 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, 1994 (File No. 0-17816) (2) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-17816) (3) Incorporated by reference from the registrant's Registration Statement on Form S-1, as amended (File No. 33-36768) (4) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-17816) (5) Incorporated by reference from the registrant's Registration Statement on Form S-18, as amended (File No. 33-27029-LA) (6) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 1-10428) (7) Incorporated by reference from the registrant's Current Report on Form 8-K dated March 12, 1997 (File No. 0-17816) (8) Incorporated by reference from the registrant's Current Report on Form 8-K dated October 24, 1997 (File No. 0-17816) (9) Incorporated by reference from the registrant's Current Report on Form 8-K dated January 26, 1998 (File No. 0-17816) REPORTS ON FORM 8-K The Company filed a Current Report on Form 8-K dated October 24, 1997, to report its adoption of a stockholder's right plan and the adoption of change of control and indemnification agreements for each of the Company's executive officers. The Company also filed a Current Report on Form 8-K dated December 9, 1997, to report a change in its certifying accountant from Ernst & Young LLP to Coopers & Lybrand L.L.P. 19 21 REPORT OF COOPERS & LYBRAND L.L.P., INDEPENDENT ACCOUNTANTS The Board of Directors and Stockholders Sunrise Technologies International, Inc.: We have audited the accompanying consolidated balance sheet of Sunrise Technologies International, Inc. as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for the year then ended. We have also audited the financial statement schedule listed in Item 14(a) of this Form 10-K for the year ended December 31, 1997. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audit. The consolidated financial statements of Sunrise Technologies International, Inc. for the years ended December 31, 1996 and 1995, were audited by other auditors, whose report, dated March 10, 1997, included an explanatory paragraph that described the Company's ability to continue as a going concern. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunrise Technologies International, Inc. and its subsidiaries as of December 31, 1997, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. COOPERS & LYBRAND L.L.P. San Jose, California March 6, 1998 20 22 REPORT OF ERNST & YOUNG LLP, FORMER INDEPENDENT AUDITORS The Board of Directors and Stockholders Sunrise Technologies International, Inc. We have audited the accompanying consolidated balance sheets of Sunrise Technologies International, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the two years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sunrise Technologies International, Inc. at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. The accompanying consolidated financial statements have been prepared assuming that Sunrise Technologies International, Inc. will continue as a going concern. The Company has incurred recurring operating losses which condition raises substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that may result from the outcome of this uncertainty. ERNST & YOUNG LLP San Jose, California March 10, 1997 21 23 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ---------------------- 1997 1996 -------- -------- (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS Current assets: Cash and cash equivalents................................. $ 1,958 $ 647 Accounts receivable, net of allowance of $85 and $140 in 1997 and 1996.......................................... 312 472 Inventories, net.......................................... 127 2,135 Prepaid and other expenses................................ 140 288 -------- -------- Total current assets........................................ 2,537 3,542 Property and equipment, net................................. 204 199 Other non-current assets.................................... 208 -- -------- -------- Total assets........................................... $ 2,949 $ 3,741 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term debt......................... $ 31 $ -- Accounts payable.......................................... 284 1,586 Accrued payroll and related expenses...................... 221 209 Accrued warranty.......................................... 25 199 Other accrued expenses.................................... 594 475 -------- -------- Total current liabilities................................... 1,155 2,469 Long term debt, net of current portion...................... 945 -- -------- -------- Total liabilities...................................... 2,100 2,469 -------- -------- Commitments and contingencies (Note 3) Stockholders' equity: Preferred stock, $0.001 par value; 2,000,000 shares authorized, none issued or outstanding................. -- -- Common stock, $0.001 par value; 40,000,000 shares authorized, 32,307,990 and 27,868,613 shares issued and outstanding at December 31, 1997 and 1996, respectively........................................... 32 28 Additional paid-in-capital................................ 38,151 31,688 Deferred compensation..................................... (272) -- Accumulated deficit....................................... (37,062) (30,444) -------- -------- Total stockholders' equity............................. 849 1,272 -------- -------- Total liabilities and stockholders' equity........ $ 2,949 $ 3,741 ======== ========
See accompanying notes. 22 24 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, ------------------------------------------ 1997 1996 1995 ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Net revenues.............................................. $ 2,839 $ 5,654 $ 5,294 Cost of revenues.......................................... 2,546 4,016 3,657 ------- ------- ------- Gross profit.............................................. 293 1,638 1,637 ------- ------- ------- Other costs and expenses: Engineering and development............................. 964 1,326 1,218 Sales, marketing and regulatory......................... 2,718 3,632 2,277 General and administrative.............................. 3,686 2,700 2,329 ------- ------- ------- Total other costs and expenses....................... 7,368 7,658 5,824 ------- ------- ------- Loss from operations...................................... (7,075) (6,020) (4,187) Gain on sale of dental assets............................. 1,740 -- -- Interest income (expense), net............................ (1,283) 52 57 ------- ------- ------- Net loss.................................................. $(6,618) $(5,968) $(4,130) ======= ======= ======= Net loss per share, basic and diluted..................... $ (0.23) $ (0.23) $ (0.28) ======= ======= ======= Shares used in calculation of basic and diluted net loss per share............................................... 28,550 26,414 14,935 ======= ======= =======
See accompanying notes. 23 25 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
COMMON STOCK ADDITIONAL TOTAL ------------------- PAID-IN DEFERRED ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL COMPENSATION TREASURY STOCK DEFICIT EQUITY ---------- ------ ---------- ------------ -------------- ----------- ------------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Balance at December 31, 1994..... 10,459,286 $10 $22,312 $ -- $(619) $(20,346) $ 1,357 Sale of common stock, net of offering costs.............. 15,100,000 15 7,528 -- -- -- 7,543 Cancellation of treasury stock....................... (275,000) -- (619) -- 619 -- -- Other.......................... (4,570) -- (25) -- -- -- (25) Net loss....................... -- -- -- -- -- (4,130) (4,130) ---------- --- ------- ----- ----- -------- ------- Balance at December 31, 1995..... 25,279,716 25 29,196 -- -- (24,476) 4,745 Sale of common stock, net of offering costs.............. 2,333,412 3 2,242 -- -- -- 2,245 Exercise of warrants and options..................... 243,252 -- 243 -- -- -- 243 Other.......................... 12,233 -- 7 -- -- -- 7 Net loss....................... -- -- -- -- -- (5,968) (5,968) ---------- --- ------- ----- ----- -------- ------- Balance at December 31, 1996..... 27,868,613 28 31,688 -- -- (30,444) 1,272 Issuance of warrants and beneficial conversion features in association 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 Sale of shares under Employee Stock Purchase Plan......... 18,367 -- 15 -- -- -- 15 Deferred compensation related to stock option grants...... -- -- 659 (659) -- -- -- Amortization of deferred compensation................ -- -- -- 387 -- -- 387 Net Loss....................... -- -- -- -- -- (6,618) (6,618) ---------- --- ------- ----- ----- -------- ------- Balance at December 31, 1997..... 32,307,990 $32 $38,151 $(272) $ -- $(37,062) $ 849 ========== === ======= ===== ===== ======== =======
See accompanying notes. 24 26 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ----------------------------- 1997 1996 1995 ------- ------- ------- (IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES Net loss.................................................... $(6,618) $(5,968) $(4,130) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization............................... 77 438 102 Amortization of deferred compensation....................... 387 -- -- Amortization of debt issuance costs......................... 150 -- -- Warrant accretion and beneficial conversion features associated with 1997 Notes................................ 1,066 -- -- Issuance of common stock for services....................... 371 -- -- Provision for doubtful accounts............................. 176 115 25 Provision for obsolete inventory............................ 397 -- -- Gain on sale of dental assets............................... (1,740) -- -- Changes in assets and liabilities: Accounts receivable....................................... (16) 461 (303) Inventories............................................... 233 (837) 289 Other current assets...................................... 148 (31) 25 Accounts payable.......................................... (1,302) 489 (278) Other accrued liabilities................................. (258) 36 (225) Other long-term liabilities............................... 155 -- -- ------- ------- ------- Total adjustments...................................... (156) 671 (365) ------- ------- ------- Net cash used in operating activities..................... (6,774) (5,297) (4,495) ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment.......................... (201) (65) (50) Proceeds from sale of dental assets, net of costs........... 3,449 -- -- ------- ------- ------- Net cash provided by (used in) investing activities....... 3,248 (65) (50) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Payment on capital lease obligations........................ (5) -- (18) Proceeds from issuance of capital lease obligation.......... 103 -- -- Issuance of common stock, net of offering costs............. 996 2,495 7,518 Issuance of 1997 Notes...................................... 4,101 -- -- Capitalization of debt issuance costs....................... (358) -- -- ------- ------- ------- Net cash provided by financing activities................... 4,837 2,495 7,500 ------- ------- ------- Net increase (decrease) in cash and equivalents............. 1,311 (2,867) 2,955 Cash and cash equivalents at beginning of year.............. 647 3,514 559 ------- ------- ------- Cash and cash equivalents at end of year.................... $ 1,958 $ 647 $ 3,514 ======= ======= =======
See accompanying notes. 25 27 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization and Nature of Business Sunrise Technologies International, Inc. (the "Company") develops, manufactures and markets laser systems and other products for applications in ophthalmology. The Company was organized as a California corporation in March 1987 and was reincorporated in Delaware in June 1993 as Sunrise Technologies International, Inc. The Company continues to do business under the name Sunrise Technologies, Inc. Basis of Presentation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries after elimination of all intercompany balances and transactions. The Company has incurred significant losses for the last several years and at December 31, 1997 has an accumulated deficit of $37,062,000. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. The Company's long term ability to continue as a going concern is dependent upon returning to profitable operations. Management's plans include increasing sales through increased direct sales and marketing efforts on existing products and pursuing timely regulatory approval for certain products under development. Management also recognized the need for infusion of cash during the fiscal year 1998 and in January 1998, the Company completed a $9,300,000 private placement of convertible notes with warrants, net of offering costs. There can be no assurance that additional funds can be raised on terms acceptable to the Company, if at all. Industry Segment and Concentration of Risks The Company, which operates in a single industry segment, designs, manufactures, markets and services medical laser systems. The Company sells its products to customers in the field of ophthalmology globally. The 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. 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 U.S. Treasury and U.S. Agency obligations. One of the more significant risks potentially affecting the Company's operating results is the fact that a substantial portion of the Company's net revenues in each quarter generally result from shipments during the latter part of the quarter. Because the Company establishes its operating expense levels based on expected revenue, if anticipated shipments in any quarter do not occur as expected, gross profits may be adversely affected. For these and other reasons, the Company may not learn of shortfalls in revenues, margins or other financial results until late in a quarter. Any such shortfall could have an immediate and material adverse effect on the Company's operating results. The Company's activities are subject to extensive regulation by the FDA and similar health authorities in certain foreign countries. The LTK system is regulated as a Class III medical device by the FDA under the Food, Drug & Cosmetic Act. Class III medical devices require a PMA by the FDA prior to commercial sale in the United States. The 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 26 28 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) assurance that the Company will be able to obtain in a timely manner, if at all, the required PMA in the United States for intended uses of the LTK system, or for any other devices which the Company may seek approvals or clearances. Any products manufactured or distributed by the Company will be subject to pervasive and continuing regulation by the FDA. In addition, the introduction of the Company's products in foreign countries may require obtaining 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 Japan. There can be no assurance that the Company will be able to obtain regulatory clearances for its products in the United States or foreign markets. The Company's international business is an important contributor to the Company's net revenues and gross profits. Substantially all of the Company's international sales are denominated in the U.S. dollar and an increase in the value of the U.S. dollar relative to foreign currencies could make products sold internationally less competitive. The Company does not have any overseas offices. The Company has developed only limited clinical data to date on the safety and efficacy of the LTK system in correcting hyperopia (farsightedness), and related long-term safety and efficacy data. The FDA has not yet determined whether the LTK system will prove to be safe or effective for the predictable and reliable treatment of hyperopia or other common vision problems. There can be no assurance that long-term safety and efficacy data when collected will be consistent with the clinical trial results previously obtained or will demonstrate that the LTK system can be used safely and successfully to treat hyperopia in a broad segment of the population on a long-term basis. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents Cash and cash equivalents consist of cash on deposit with the Company's bank and highly liquid investments with a maturity from the date of purchase of 90 days or less. As of December 31, 1997 and 1996, 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. Inventories at December 31, consist of:
1997 1996 ----- ------ (IN THOUSANDS) Raw materials.............................................. $ 416 $1,468 Work-in-process............................................ 167 299 Finished goods............................................. 190 718 ----- ------ 773 2,485 Less reserves.............................................. (646) (350) ----- ------ Inventory, net............................................. $ 127 $2,135 ===== ======
27 29 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Most components used in the Company's laser systems are purchased from outside sources. The Company has at least two suppliers for all of its components used to manufacture its laser systems. Property and Equipment Property and equipment is stated at cost and depreciated using the straight-line method for financial reporting over estimated useful lives of two to five years. Assets under capitalized leases are amortized over the shorter of the term of the lease or their useful lives, and such amortization is included with depreciation expense. Property and equipment at December 31, consists of:
1997 1996 ----- ------ (IN THOUSANDS) Machinery and equipment.................................... $ 257 $1,644 Computer Equipment......................................... 231 611 Furniture and fixtures..................................... 27 207 Leasehold improvements..................................... 0 392 ----- ------ 515 2,854 Less accumulated depreciation and amortization............. (311) (2,655) ----- ------ Property and equipment, net................................ $ 204 $ 199 ===== ======
Other Non-Current Assets Other non-current assets are comprised principally of note placement costs and are being amortized over the life of the notes issued in the 1997 Notes Placement (the "1997 Notes") (two years). The amortization of the note placement costs into interest expense for 1997, 1996 and 1995 was $149,000, $0 and $0, respectively. Net Loss Per Share Effective December 31, 1997, the Company adopted Financial Accounting Standards Board No. 128 "Earnings Per Share" (EPS) and accordingly all prior periods have been restated. Basic EPS is computed as net income (loss) divided by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur from common shares issuable through stock options, warrants and other convertible securities. Common equivalent shares are excluded from the computation of net loss per share if their effect is anti-dilutive. 28 30 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following is a reconciliation of the numerator (net loss) and denominator (number of shares) used in the basic and diluted EPS calculation:
YEAR ENDED DECEMBER 31 -------------------------------------- 1997 1996 1995 ---------- ---------- ---------- (IN THOUSANDS, EXCEPT PER SHARE DATA) BASIC EPS: Net loss...................................... $(6,618) $(5,968) $(4,130) Average Common Shares Outstanding............. 28,550 26,414 14,935 ------- ------- ------- Basic EPS..................................... $ (0.23) $ (0.23) $ (0.28) ======= ======= ======= DILUTED EPS: Net loss...................................... $(6,618) $(5,968) $(4,130) Average Common Shares Outstanding............. 28,550 26,414 14,935 Convertible Notes............................. -- -- -- Warrants...................................... -- -- -- Stock options................................. -- -- -- Total Shares.................................. 28,550 26,414 14,935 ------- ------- ------- Diluted EPS................................... $ (0.23) $ (0.23) $ (0.28) ======= ======= =======
7,303,537 shares in 1997, 989,637 shares in 1996 and 739,446 shares in 1995 were excluded from the shares used to calculate diluted EPS as their effect is anti-dilutive. Revenue Recognition Revenues are recognized at time of shipment. A provision for the estimated future cost of warranty is made at the time a sale is recorded. Research and Development Research and development expenditures are charged to operations as incurred. Segment Information The Company had export sales by region as follows:
1997 1996 1995 ------ ------ ------ (IN THOUSANDS) Europe........................................... $ 152 $1,036 $1,948 Pacific Rim...................................... 409 1,602 1,192 Canada........................................... 180 -- 248 Other............................................ 324 -- 282 ------ ------ ------ Total.................................. $1,065 $2,638 $3,670 ====== ====== ======
Fair Value of Financial Instruments Carrying amounts of certain of the Company's financial instruments including cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities approximate fair value due to their short maturities. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of its debt obligations approximates fair value. Reclassifications: Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. 29 31 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 2. TAXES ON INCOME The Company uses the liability method to calculate deferred income taxes. The realization of deferred tax assets is based on historical tax positions and expectations about future taxable income. The Company's effective tax rate differs from the statutory federal income tax rate as shown in the following schedule:
1997 1996 1995 ----- ----- ----- Statutory Rate........................... (34)% (34)% (34)% NOL's not benefited which have been reserved............................... 34 % 34 % 34 % ----- ----- ----- 0 % 0 % 0 % ===== ===== =====
Temporary differences and carryforwards which give rise to a significant portion of deferred tax assets and liabilities for 1997 and 1996 are as follows:
1997 1996 -------- -------- (IN THOUSANDS) Deferred tax assets: Net operating loss carryforwards..................... $ 11,100 $ 9,000 Research credits (expire 2005-2009).................. 700 600 Other................................................ 500 600 -------- -------- Total deferred tax asset............................... 12,300 10,200 Valuation allowance for deferred tax assets............ (12,300) (10,200) -------- -------- Net deferred tax assets................................ $ -- $ -- ======== ========
As of December 31, 1997, the Company had federal and state net operating loss carryforwards of approximately $30,000,000 and $11,000,000, respectively. The change in the Company's valuation allowance from 1996 to 1997 was an increase of $2,100,000. The net operating loss and credit carryforwards will expire at various dates through 2012 if not utilized. The ownership change provisions of the Internal Revenue Code of 1986 and similar state provisions would limit utilization of the carryforwards should there be a substantial change in the Company's ownership. The annual limitation may result in the expiration of net operating losses and credits before utilization. 3. COMMITMENTS AND CONTINGENCIES Leases The Company leases certain of its facilities and equipment under a noncancellable operating lease. Rent expense was $233,000, $290,000 and $281,000 in 1997, 1996 and 1995, respectively. 30 32 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following is a schedule by year of future minimum lease payments at December 31, 1997:
OPERATING LEASES -------------- (IN THOUSANDS) Year ending December 31, 1998...................................................... $147 1999...................................................... 155 2000...................................................... 162 2001...................................................... 14 ---- Total minimum payments required............................. $478 ====
Contingencies During 1997, the Company settled all of its outstanding disputes with American Dental Technologies, Inc. and with Danville Engineering, Inc. The settlement called for certain payments to be made by the Company to American Dental Technologies, Inc. upon the sale of the dental assets of the Company. The Company made such payments during 1997 and believes it has no further obligation to pay American Dental Technologies, Inc. 4. LONG-TERM DEBT Long-term debt consists primarily of the 1997 Notes and associated discounts on those notes. In March 1997, the Company completed a private placement of convertible notes with warrants raising gross proceeds of $4,101,000. 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 with expiration dates of February and March 2002. In addition, the notes were convertible into 4,615,143 shares of common stock and the warrants attached to the notes were convertible into 2,307,572 shares of common stock with an exercise price of $1.00 per share and expiration dates of February and March 2002. As of December 31, 1997, certain of the notes were converted into 2,902,573 shares of common stock and certain warrants were converted into 702,857 shares of common stock. As of December 31, 1997, there remained warrants outstanding convertible into 1,835,471 common stock, including the placement agent warrants, and 1,712,570 shares convertible from the notes. The 1997 Notes consist of $1,499,000 in principal at December 31, 1997, bear interest at 5% per annum, and are due and payable in February and March of 1999. The 1997 Notes are collateralized by a lien against the Company's ophthalmic patents and have no significant performance covenants. The Company also leases certain equipment under noncancellable capital leases. The cost of equipment under capital leases was $103,000 and accumulated amortization was $8,500 at December 31, 1997. As of December 31, 1997, the Company's long-term debt consisted of $1,499,000 of the 1997 Notes, net a discount related to the warrants of $772,000, interest of $155,000 on the 1997 Notes and capital lease obligations of $94,000. Future payments of $32,000, $1,686,000 and $30,000 are due in fiscal years 1998, 1999 and 2000, respectively. Warrants The Company has granted the note holders participating in the 1997 Notes Placement warrants to purchase 2,538,328 shares of common stock. The warrants are exercisable at a purchase price of $1.00 per share and expire in February and March 2002. The warrants issued had a fair value of approximately $1.25 per warrant, at the time of issuance. The fair value of these warrants has been reflected as additional consideration 31 33 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) for the 1997 Notes, recorded as a discount on the debt and accreted as interest expense to be amortized over the life of the 1997 Notes. 5. STOCKHOLDERS' EQUITY Common Stock In February 1994, the Company completed a private placement of 1,250,000 shares of common stock. In connection with the private placement, the placement agent received warrants to purchase 62,500 shares of common stock. The exercise price for the warrants is $6.00 per share and the warrants expire February 1999. In June 1995, the Company completed a private placement of 2,100,000 shares of common stock. In September 1995, the Company completed a private placement of 13,000,000 shares of common stock. In connection with the private placement, the placement agent received a warrant to purchase 675,000 shares of common stock. The exercise price for these warrants was $0.55 and they were exercised in full during 1997. In September 1996, the Company completed a private placement of 2,334,420 shares of common stock. In connection with the private placement, the placement agent received warrants to purchase 116,721 shares of common stock with an exercise price of $1.0625 per share and an expiration date of August 2001. 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 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 and an expiration date of February and March 2002. As of December 31, 1997, certain of the notes were converted into 2,902,573 shares and certain warrants were converted into 702,857 shares of common stock. As of December 31, 1997, there remained warrants outstanding convertible into 1,835,471 common shares, including the placement agent warrants, and 1,712,570 shares convertible from the notes. As of December 31, 1997, there were warrants outstanding to purchase 2,290,692 shares of common stock. In January 1998, the Company completed a private placement of convertible notes with warrants. The notes are convertible into 3,116,666 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. Stock Option Plans In 1988, the Company adopted the 1988 Stock Option Plan (the "1988 Plan") under which employees, directors and consultants may be granted incentive or nonstatutory stock options. Under the 1988 Plan, incentive stock options must be granted at an exercise price of not less than the fair market value of the common stock at the date of grant, except that options granted to stockholders owning greater than 10 percent of the total voting power of all classes of stock of the Company must have an exercise price of not less than 110 percent of the fair market value at the date of grant. Nonstatutory options must be at least 85 percent of fair market value at the date of grant. Options granted generally provide that 25 percent of the shares subject thereto become exercisable one year after the date of grant and 1/36 of the remaining shares subject to the option become exercisable each month thereafter. The 1988 Plan expires in November 1998. In 1997, the Company adopted the 1997 Stock Option Plan (the "1997 Plan") under which employees, directors and consultants may be granted incentive or nonstatutory stock options. Under the 1997 Plan, incentive stock options must be granted at an exercise price of not less than the fair market value of the common stock at the date of grant, except that options granted to stockholders owning greater than 10 percent 32 34 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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. The fair value of each option grant is estimated at the date of grant using the Black-Scholes pricing model with the following weighted average assumptions for grants in 1997 and 1996:
1997 1996 ----- ----- Risk-free interest rate.......................... 6.15% 5.70% Expected life.................................... 4.8years 4.8years Volatility....................................... 95.5% 95.5% Dividend yield................................... -- --
A summary of the Company's option activity as of December 31, 1997, 1996, and 1995 and changes during the year ending on those dates are as follows:
SHARES OUTSTANDING OPTION AVAILABLE ---------------------------- WEIGHTED AVERAGE FOR GRANT SHARES SHARE PRICE EXERCISE PRICE ---------- ----------- -------------- ---------------- BALANCE -- 12/31/1994 346,770 1,183,858 $0.85 - $4.375 $2.032 Reserved 1,550,000 Granted (605,000) 605,000 $ 0.91 - $2.50 $1.290 Cancelled 336,194 (336,194) $1.50 - $4.375 $2.776 Exercised -- (20,000) $ 4.375 $4.375 ---------- ----------- -------------- ------ BALANCE -- 12/31/1995 1,627,964 1,432,664 $ 0.91 - $2.50 $1.064 Reserved -- Granted (1,711,000) 1,711,000 $ 1.03 - $2.87 $ 1.10 Cancelled 379,974 (379,974) $ 0.91 - $1.00 $ 0.99 Exercised -- (251,252) $ 1.00 - $1.25 $ 1.02 ---------- ----------- -------------- ------ BALANCE -- 12/31/1996 296,938 2,512,438 $ 0.91 - $2.87 $ 1.09 Reserved 3,000,000 Granted (2,954,300) 2,954,300 $ 1.00 - $4.44 $ 2.69 Cancelled 854,620 (854,620) $ 0.75 - $2.87 $ 1.18 Exercised -- (251,663) $ 0.75 - $1.06 $ 1.01 ---------- ----------- -------------- ------ BALANCE -- 12/31/1997 1,197,258 4,360,455 $ 1.00 - $4.44 $ 2.16
As of December 31, 1997 and 1996, vested options to purchase 1,476,112 and 680,248 shares, respectively, were exercisable. The weighted average fair value of those options granted in 1997, 1996 and 1995 was $2.08, $0.74 and $0.89, respectively. 33 35 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The following table summarizes information about fixed stock options outstanding at December 31, 1997:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------- ------------------------------------- WEIGHTED WEIGHTED AVERAGE AVERAGE REMAINING WEIGHTED REMAINING WEIGHTED CONTRACTUAL AVERAGE CONTRACTUAL AVERAGE NUMBER LIFE EXERCISE NUMBER LIFE EXERCISE OUTSTANDING (YEARS) PRICE EXERCISABLE (YEARS) PRICE ----------- ------------ -------- ----------- ------------ -------- $0.75 - $1.75.......... 2,788,155 6.8 $1.15 1,404,816 6.5 $1.05 $2.76 - $3.75.......... 8,000 8.3 $2.87 7,664 8.3 $2.87 $3.76 - $4.75.......... 1,564,300 9.7 $3.97 63,632 9.6 $3.89 --------- --- ----- --------- --- ----- 4,360,455 7.9 $2.16 1,476,112 6.6 $1.18 ========= === ===== ========= === =====
Employee Stock Purchase Plan During 1992, the 1992 Employee Stock Purchase Plan (the "Purchase Plan") was adopted by the Board of Directors. As of December 31, 1997, a total of 200,000 shares of common stock have been reserved for issuance under the Purchase Plan. The Purchase Plan provides for eligible employees to purchase common stock at a price equal to 85% of the fair market value at certain specified dates. Purchases are limited to 10 percent of each employee's compensation. There were 59,023 and 40,656 shares issued under the plan as of December 31, 1997 and 1996, respectively. Fair value for the purchase rights issued under the Purchase Plan is determined under the Black-Scholes valuation model using the following assumptions for 1997, 1996 and 1995:
1997 1996 1995 -------- -------- -------- Risk-free Interest Rates................ 6.15% 5.70% 5.60% Expected Life........................... 6 months 6 months 6 months Volatility.............................. 95.5% 95.5% 95.5% Dividend Yield.......................... -- -- --
The weighted average fair market value of those purchase rights granted in 1997 and 1996 was $0.76 and $0.96, respectively. The Company has adopted the disclosure-only provisions of the Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-based Compensation." Had compensation cost for the Stock Plans been determined based on the fair market value at the grant date for awards in 1997, 1996 and 1995 consistent with the provisions of SFAS No. 123, the Company's net loss and net loss per share for the years ended December 31, 1997, 1996 and 1995 would have been increased as follows: (amounts in thousands except per share data)
1997 1996 1995 ------- ------- ------- Net loss -- as reported..................... $(6,618) $(5,968) $(4,130) Net loss -- pro forma....................... $(7,322) $(6,390) $(4,220) Net loss per share -- as reported........... $ (0.23) $ (0.23) $ (0.28) Net loss per share -- proforma.............. $ (0.26) $ (0.24) $ (0.28)
6. 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, with two installments due in three and four years, respectively (the "Lares Note"). Although the Company anticipates collecting interest and principal on the Lares Note, collection is not 34 36 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) reasonably assured due to the subordination of the Lares Note to Lares' bank and the Company intends to recognize proceeds from the sale and interest on the note as cash is received. The gain on sale of the Dental Assets is comprised as follows:
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. On a pro-forma basis, the Company had the following revenues and earnings from the dental business during the first half of 1997, 1996 and 1995, including the gain on sale of the Dental Assets of $1,740,000 in 1997:
1997 1996 1995 -------------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) Revenues from dental business....................... $1,968 $ 5,514 $ 4,008 Loss from dental business........................... $ (11) $(2,504) $(3,488)
7. SUPPLEMENTAL STATEMENT OF CASH FLOWS INFORMATION
1997 1996 1995 ---- ---- ---- (IN THOUSANDS) CASH PAID DURING THE YEAR FOR: Interest............................................. $ 13 $ 5 $-- Income taxes......................................... $ 6 $ 9 $--
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
1997 1996 1995 ---- ---- ---- (IN THOUSANDS) Acquisition of equipment pursuant to capital lease obligations......................................... $103 -- $ 8 Conversion of notes payable to common stock........... 2,602
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 to 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 $20,000, $24,000 and $7,000 in 1997, 1996, and 1995, respectively. 9. SUBSEQUENT EVENTS In January 1998, the Company completed a $9,300,000 private placement of convertible notes (convertible into the Company's common stock) with warrants, net of offering costs. The promissory notes are convertible at any time, at the option of the holder. The notes bear an interest rate of 12%, payable-in-kind semi-annually (additional convertible notes), and convert at a price of $3.00 per share. There were warrants to purchase 1,870,000 shares of the Company's common stock issued as part of this private placement with an exercise price of $3.00 per share and an expiration date of January 2003. The notes have a maturity date of January 2001 and the Company has an option to extend the notes for an additional two years for additional warrant consideration. 35 37 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND END OF PERIOD EXPENSES DEDUCTIONS OTHER OF PERIOD ---------- ---------- ---------- ----- ---------- (IN THOUSANDS) Year ended December 31, 1995 Reserves and allowances deducted from assets accounts: Allowance for uncollectible accounts........................... $ 450 $ 25 $(450) $-- $ 25 Allowance for inventory............... $ 513 $ 250 $(295) $-- $ 468 Year ended December 31, 1996 Reserves and allowances deducted from assets accounts: Allowance for uncollectible accounts........................... $ 25 $ 115 $ -- $-- $ 140 Allowance for inventory............... $ 468 $ -- $(118) $-- $ 350 Year ended December 31, 1997 Reserves and allowances deducted from assets accounts: Allowance for uncollectible accounts........................... $ 140 $ 176 $(232) $-- $ 84 Allowance for inventory............... $ 350 $ 397 $(100) $-- $ 647 Allowance for uncollectible notes receivable......................... -- $1,500 -- -- $1,500
36 38 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 6th day of April, 1998. SUNRISE TECHNOLOGIES INTERNATIONAL, INC. By: /s/ 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 Timothy A. Marcotte, 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 Chief Executive April 6, 1998 - --------------------------------------------------- Officer C. Russell Trenary, III /s/ TIMOTHY A. MARCOTTE Vice President, Finance and Chief April 6, 1998 - --------------------------------------------------- Financial Officer (Principal Timothy A. Marcotte Financial and Accounting Officer) and Director /s/ JOSEPH D. KOENIG Director and Chairman of the Board April 6, 1998 - --------------------------------------------------- Joseph D. Koenig /s/ R. DALE BOWERMAN Director April 6, 1998 - --------------------------------------------------- R. Dale Bowerman /s/ MICHAEL S. MCFARLAND, M.D. Director April 6, 1998 - --------------------------------------------------- Michael S. McFarland, M.D.
37 39 EXHIBIT INDEX
EXHIBIT DESCRIPTION ------- ----------- 2.1 Asset Purchase Agreement dated as of March 26, 1997, by and between the Company and Lares Research, a California corporation(6) 3.1 Certificate of Incorporation, as amended(1) 3.2 Bylaws(1) 4.1 Form of 5% Convertible Notes due 1999(7) 4.2 Form of Security Agreement relating to 5% Convertible Notes due 1999(7) 4.3 Form of Registration Rights Agreement(7) 4.4 Form of Warrant issued to Pennsylvania Merchant Group(4) 4.5 Form of Rights Agreement, dated as of October 24, 1997, between the Company and ChaseMellon Shareholder Services, L.L.C., as rights agent(8) 4.6 Form of 12% Subordinated Pay-In-Kind Note Due 2001(9) 4.7 Form of Registration Rights Agreement(9) 10.1 Lease Agreement with Bayside Spinnaker Partners III, as lessor, for the lease of facilities at 47265 Fremont Boulevard, Fremont, California, dated January 23, 1998 10.2 Patent License Agreement between the Company and Patlex Corporation dated January 1, 1990(3) 10.3 Agreement between the Company and the University of Miami, Department of Ophthalmology, dated October 28, 1991(2) 10.4 Joint Development and Exclusive Manufacturing Agreement dated April 17, 1993 between the Company and Danville Engineering, Inc.(1) 10.5 Settlement Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.6 License Agreement between the Company and American Dental Laser, Inc., dated February 4, 1993 (confidential treatment has previously been granted for portions of this exhibit)(4) 10.7 Settlement Agreement between the Company and American Dental Technologies, dated July 30, 1996(6) *10.8 Form of Indemnification Agreement between the Company and each of its officers and directors(3) *10.9 1988 Stock Option Plan, as amended(5) *10.10 Employment Agreement, entered into between the Company and Joseph W. Shaffer, dated April 5, 1989(5) 10.11 Form of U.S. Note and Warrant Purchase Agreement relating to the Regulation D private placement of 5% convertible notes due 1999 and warrants in February and March 1997(7) 10.12 Form of Offshore Note and Warrant Purchase Agreement relating to the Regulation S private placement of 5% convertible notes due 1999 and warrants in March 1997(7) 10.13 Form of Change of Control Agreement by and between the Company and its President and Chief Executive Officer(8) *10.14 Form of Change of Control Agreement by and between the Company and its executive officers (other than the President and Chief Executive Officer)(8)
38 40
EXHIBIT DESCRIPTION ------- ----------- *10.15 Form of Indemnification Agreement by and between the Company and its executive officers(8) 10.16 Form of U.S. Note and Warrant Purchase Agreement related to the Regulation D private placement of 12% Convertible Subordinated Pay-In-Kind Notes Due 2001 and accompanying Warrants in January 1998(9) 21.1 Subsidiaries of the Company 22 Power of Attorney (included on the signature pages to this Form 10-K) 23.1 Consent of Coopers & Lybrand L.L.P., Independent Accountants 23.2 Consent of Ernst & Young LLP, Former Independent Auditors 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, 1994 (File No. 0-17816) (2) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 0-17816) (3) Incorporated by reference from the registrant's Registration Statement on Form S1, as amended (File No. 33-36768) (4) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 0-17816) (5) Incorporated by reference from the registrant's Registration Statement on Form S18, as amended (File No. 33-27029-LA) (6) Incorporated by reference from the registrant's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 1-10428) (7) Incorporated by reference from the registrant's Current Report on Form 8-K dated March 12, 1997 (File No. 0-17816) (8) Incorporated by reference from the registrant's Current Report on Form 8-K dated October 24, 1997 (File No. 0-17816) (9) Incorporated by reference from the registrant's Current Report on Form 8-K dated January 26, 1998 (File No. 0-17816) 39 EX-10.1 2 LEASE AGREEMENT WITH BAYSIDE SPINNAKER PARTNERSIII 1 EXHIBIT 10.1 [California Net Lease] LEASE AGREEMENT THIS LEASE AGREEMENT is made this ______________day of _____________________, ______________, between SCI Limited Partnership-I, a Delaware Limited Partnership ("Landlord"), and the Tenant named below. TENANT: Sunrise Technologies International, Inc., a Delaware Corporation TENANT'S REPRESENTATIVE, Tim Marcotte ADDRESS, AND PHONE NO.: 47265 Fremont Boulevard Fremont, CA 94538 (510) 623-9001 PREMISES: That portion of the Building, containing approximately 10,400 rentable square feet, as determined by Landlord and commonly known as 47265 Fremont Boulevard, Fremont, CA as shown on Exhibit A. PROJECT: Bayside Commons BUILDING: Shoreline Business Center Building #7 (14507) TENANT'S PROPORTIONATE SHARE OF PROJECT: 13.77% TENANT'S PROPORTIONATE SHARE 30.23% OF BUILDING: LEASE TERM: Beginning on the Commencement Date and ending on the last day of the 36th full calendar month thereafter. COMMENCEMENT DATE: February 1, 1998 INITIAL MONTHLY BASE RENT: Ten Thousand Four Hundred $10,400 INITIAL ESTIMATED MONTHLY 1. Utilities: ($46) Operating Expense Payments: estimates only and subject 2. Common Area Charges: $429 to adjustment to actual costs and expenses 3. Taxes: $1,414 according to the provisions of this Lease) 4. Insurance: $35 INITIAL ESTIMATED MONTHLY OPERATING EXPENSE PAYMENTS: $1,924 INITIAL MONTHLY BASE RENT AND OPERATING EXPENSE PAYMENTS: $12,324 SECURITY DEPOSIT: $11,440 ($18,200 IS CURRENTLY ON ACCOUNT WITH LESSOR. $6,760 SHALL BE REFUNDED UPON COMMENCEMENT OF THIS LEASE RENEWAL). BROKER: N/A ADDENDA: Addendum I and II, Exhibit A, B and C
1. GRANTING CLAUS. In consideration of the obligation of Tenant to pay rent as herein provided and in consideration of the other terms, covenants, and conditions hereof, Landlord leases to Tenant, and Tenant takes from Landlord, the Premises, to have and to hold for the Lease Term, subject to the terms, covenants and conditions of this Lease. 2. ACCEPTANCE OF PREMISES. Tenant shall accept the Premises in its condition as of the Commencement Date, subject to all applicable laws, ordinances, regulations, covenants and restrictions. Landlord has made no representation or warranty as to the suitability of the Premises for the conduct of Tenant's business, and Tenant waives any implied warranty that the Premises are suitable for Tenant's intended purposes. Except as provided in Paragraph 10, in no event shall Landlord have any obligation for any defects in the Premises or any limitation on its use. The taking of possession of the Premises shall be conclusive evidence that Tenant accepts the Premises and that the Premises were in good condition at the time possession was taken except for items that are Landlord's responsibility under Paragraph 10 and any punchlist items agreed to in writing by Landlord and Tenant. 3. USE. The Premises shall be used only for the purpose of receiving, storing, shipping and selling (but limited to wholesale sales) products, materials and merchandise made and/or distributed by Tenant and for such other lawful purposes as may be incidental thereto; provided, however, with Landlord's prior written consent, Tenant may also use the Premises for light manufacturing AND R&D. Tenant shall not conduct or give -2- 2 notice of any auction, liquidation, or going out of business sale on the Premises. Tenant will use the Premises in a careful, safe and proper manner and will not commit waste, overload the floor or structure of the Premises or subject the Premises to use that would damage the Premises. Tenant shall not permit any objectionable or unpleasant odors, smoke, dust, gas, noise, or vibrations to emanate from the Premises, or take any other action that would constitute a nuisance or would disturb, unreasonably interfere with, or endanger Landlord or any tenants of the Project. Outside storage, including without limitation, storage of trucks and other vehicles, is prohibited without Landlord's prior written consent. Tenant, at its sole expense, shall use and occupy the Premises in compliance with all laws, including, without limitation, the Americans With Disabilities Act, orders, judgments, ordinances, regulations, codes, directives, permits, licenses, covenants and restrictions now or hereafter applicable to the Premises (collectively, "Legal Requirements"). The Premises shall not be used as a place of public accommodation under the Americans With Disabilities Act or similar state statutes or local ordinances or any regulations promulgated thereunder, all as may be amended from time to time. Tenant shall, at its expense, make any alterations or modifications, within or without the Premises, that are required by Legal Requirements related to Tenant's use or occupation of the Premises. Tenant will not use or permit the Premises to be used for any purpose or in any manner that would void Tenant's or Landlord's insurance, increase the insurance risk, or cause the disallowance of any sprinkler credits. If any increase in the cost of any insurance on the Premises or the Project is caused by Tenant's use or occupation of the Premises, or because Tenant vacates the Premises, then Tenant shall pay the amount of such increase to Landlord. Any occupation of the Premises by Tenant prior to the Commencement Date shall be subject to all obligations of Tenant under this Lease SUBJECT TO EXISTING LEASE TAKING PRECEDENCE. 4. BASE RENT. Tenant shall pay Base Rent in the amount set forth above. The first month's Base Rent, the Security Deposit, and the first monthly installment of estimated Operating Expenses (as hereafter defined) shall be due and payable, ON THE LEASE COMMENCEMENT DATE and Tenant promises to pay to Landlord in advance, without demand, deduction or set-off, monthly installments of Base Rent on or before the first day of each calendar month succeeding the Commencement Date. Payments of Base Rent for any fractional calendar month shall be prorated. All payments required to be made by Tenant to Landlord hereunder shall be payable at such address as Landlord may specify from time to time by written notice delivered in accordance herewith. The obligation of Tenant to pay Base Rent and other sums to Landlord and the obligations of Landlord under this Lease are independent obligations. Tenant shall have no right at any time to abate, reduce, or set-off any rent due hereunder except as may be expressly provided in this Lease. Tenant waives and releases all statutory liens and offset rights as to rent. If Tenant is delinquent in any monthly installment of Base Rent or of estimated Operating Expenses for more than 5 days, Tenant shall pay to Landlord on demand a late charge equal to 5 percent of such delinquent sum. The provision for such late charge shall be in addition to all of Landlord's other rights and remedies hereunder or at law and shall not be construed as a penalty. 5. SECURITY DEPOSIT. The Security Deposit shall be held by Landlord as security for the performance of Tenant's obligations under this Lease. The Security Deposit is not an advance rental deposit or a measure of Landlord's damages in case of Tenant's default. Upon each occurrence of an Event of Default (hereinafter defined), Landlord may use all or part of the Security Deposit to pay delinquent payments due under this Lease, and the cost of any damage, injury, expense or liability caused by such Event of Default, without prejudice to any other remedy provided herein or provided by law. Tenant shall pay Landlord on demand the amount that will restore the Security Deposit to its original amount. Landlord's obligation respecting the Security Deposit is that of a debtor, not a trustee; no interest shall accrue thereon. The Security Deposit shall be the property of Landlord, but shall be paid to Tenant when Tenant's obligations under this Lease have been completely fulfilled. Landlord shall be released from any obligation with respect to the Security Deposit upon transfer of this Lease and the Premises to a person or entity assuming Landlord's obligations under this Paragraph 5. 6. OPERATING EXPENSE PAYMENTS. During each month of the Lease Term, on the same date that Base Rent is due, Tenant shall pay Landlord an amount equal to 1/12 of the annual cost, as estimated by Landlord from time to time, of Tenant's Proportionate Share (hereinafter defined) of Operating Expenses for the Project. Payments thereof for any fractional calendar month shall be prorated. The term "Operating Expenses" means all costs and expenses incurred by Landlord with respect to the ownership, maintenance, and operation of the Project including, but not limited to costs of: Taxes (hereinafter defined) and fees payable to tax consultants and attorneys for consultation and contesting taxes; insurance; utilities; maintenance, repair and replacement of all portions of the Project, including without limitation, paving and parking areas, roads, roofs, alleys, and driveways, mowing, landscaping, exterior painting, utility lines, heating, ventilation and air conditioning systems, lighting, electrical systems and other mechanical and building systems; amounts paid to contractors and subcontractors for work or services performed in connection with any of the foregoing; charges or assessments of any association to which the Project is subject; property management fees payable to a property manager, including any affiliate of Landlord, or if there is no property manager, an administration fee of 15 percent of Operating Expenses payable to Landlord; security services, if any; trash collection, sweeping and removal; and additions or alterations made by Landlord to the Project or the Building in order to comply with Legal Requirements (other than those expressly required herein to be made by Tenant) or that are appropriate to the continued operation of the Project or the Building as a bulk warehouse facility in the market area, provided that the cost of additions or alterations that are required to be capitalized for federal income tax purposes shall be amortized on a straight line basis over a period equal to the lesser of the useful life thereof for federal income tax purposes or 10 years. Operating Expenses do not include costs, or expenses, depreciation or amortization for capital repairs and capital replacements required to be made by Landlord under Paragraph 10 of this Lease, debt service under mortgages or ground rent under ground leases, costs of restoration to the extent of net insurance proceeds received by Landlord with respect -2- 3 thereto, leasing commissions, or the costs of renovating space for tenants. If Tenant's total payments of Operating Expenses for any year are less than Tenant's Proportionate Share of actual Operating Expenses for such year, then Tenant shall pay the difference to Landlord within 30 days after demand, and if more, then Landlord shall retain such excess and credit it against Tenant's next payments. For purposes of calculating Tenant's Proportionate Share of Operating Expenses, a year shall mean a calendar year except the first year, which shall begin on the Commencement Date, and the last year, which shall end on the expiration of this Lease. With respect to Operating Expenses which Landlord allocates to the entire Project, Tenant's "Proportionate Share" shall be the percentage set forth on the first page of this Lease as Tenant's Proportionate Share of the Project as reasonably adjusted by Landlord in the future for changes in the physical size of the Premises or the Project; and, with respect to Operating Expenses which Landlord allocates only to the Building, Tenant's "Proportionate Share" shall be the percentage set forth on the first page of this Lease as Tenant's Proportionate Share of the Building as reasonably adjusted by Landlord in the future for changes in the physical size of the Premises or the Building. Landlord may equitably increase Tenant's Proportionate Share for any item of expense or cost reimbursable by Tenant that relates to a repair, replacement, or service that benefits only the Premises or only a portion of the Project or Building that includes the Premises or that varies with occupancy or use OF THE TENANT. The estimated Operating Expenses for the Premises set forth on the first page of this Lease are only estimates, and Landlord makes no guaranty or warranty that such estimates will be accurate. 7. UTILITIES. Tenant shall pay for all water, gas, electricity, heat, light, power, telephone, sewer, sprinkler services, refuse and trash collection, and other utilities and services used on the Premises, all maintenance charges for utilities, and any storm sewer charges or other similar charges for utilities imposed by any governmental entity or utility provider, together with any taxes, penalties, surcharges or the like pertaining to Tenant's use of the Premises. Landlord may cause at Tenant's expense any utilities to be separately metered or charged directly to Tenant by the provider. Tenant shall pay its share of all charges for jointly metered utilities based upon consumption, as reasonably determined by Landlord. No interruption or failure of utilities shall result in the termination of this Lease or the abatement of rent. Tenant agrees to limit use of water and sewer for normal restroom use AND CAFETERIA. 8. TAXES. Landlord shall pay all taxes, assessments and governmental charges (collectively referred to as "Taxes") that accrue against the Project during the Lease Term, which shall be included as part of the Operating Expenses charged to Tenant. Landlord may contest by appropriate legal proceedings the amount, validity, or application of any Taxes or liens thereof. All capital levies or other taxes assessed or imposed on Landlord upon the rents payable to Landlord under this Lease and any franchise tax, any excise, transaction, sales or privilege tax, assessment, levy or charge measured by or based, in whole or in part, upon such rents from the Premises and/or the Project or any portion thereof shall be paid by Tenant to Landlord monthly in estimated installments or upon demand, at the option of Landlord, as additional rent; provided, however, in no event shall Tenant be liable for any net income taxes imposed on Landlord unless such net income taxes are in substitution for any Taxes payable hereunder. If any such tax or excise is levied or assessed directly against Tenant, then Tenant shall be responsible for and shall pay the same at such times and in such manner as the taxing authority shall require. Tenant shall be liable for all taxes levied or assessed against any personal property or fixtures placed in the Premises, whether levied or assessed against Landlord or Tenant. 9. INSURANCE. Landlord shall maintain all risk property insurance covering the full replacement cost of the Building. Landlord may, but is not obligated to, maintain such other insurance and additional coverages as it may deem necessary, including, but not limited to, commercial liability insurance and rent loss insurance. All such insurance shall be included as part of the Operating Expenses charged to Tenant. The Project or Building may be included in a blanket policy (in which case the cost of such insurance allocable to the Project or Building will be determined by Landlord based upon the insurer's cost calculations). Tenant shall also reimburse Landlord for any increased premiums or additional insurance which Landlord reasonably deems necessary as a result of Tenant's use of the Premises. Tenant, at its expense, shall maintain during the Lease Term: all risk property insurance covering the full replacement cost of all property and improvements installed or placed in the Premises by Tenant at Tenant's expense; worker's compensation insurance with no less than the minimum limits required by law; employer's liability insurance with such limits as required by law; and commercial liability insurance, with a minimum limit of $1,000,000 per occurrence and a minimum umbrella limit of $1,000,000, for a total minimum combined general liability and umbrella limit of $2,000,000 (together with such additional umbrella coverage as Landlord may reasonably require) for property damage, personal injuries, or deaths of persons occurring in or about the Premises. Landlord may from time to time require reasonable increases in any such limits. The commercial liability policies shall name Landlord as an additional insured, insure on an occurrence and not a claims-made basis, be issued by insurance companies which are reasonably acceptable to Landlord, not be cancelable unless 30 days' prior written notice shall have been given to Landlord, contain a hostile fire endorsement and a contractual liability endorsement and provide primary coverage to Landlord (any policy issued to Landlord providing duplicate or similar coverage shall be deemed excess over Tenant's policies). Such policies or certificates thereof shall be delivered to Landlord by Tenant upon commencement of the Lease Term and upon each renewal of said insurance. The all risk property insurance obtained by Landlord and Tenant shall include a waiver of subrogation by the insurers and all rights based upon an assignment from its insured, against Landlord or Tenant, -3- 4 their officers, directors, employees, managers, agents, invitees and contractors, in connection with any loss or damage thereby insured against. Neither party nor its officers, directors, employees, managers, agents, invitees or contractors shall be liable to the other for loss or damage caused by any risk coverable by all risk property insurance, and each party waives any claims against the other party, and its officers, directors, employees, managers, agents, invitees and contractors for such loss or damage. The failure of a party to insure its property shall not void this waiver. Landlord and its agents, employees and contractors shall not be liable for, and Tenant hereby waives all claims against such parties for, business interruption and losses occasioned thereby sustained by Tenant or any person claiming through Tenant resulting from any accident or occurrence in or upon the Premises or the Project from any cause whatsoever, including without limitation, damage caused in whole or in part, directly or indirectly, by the negligence of Landlord or its agents, employees or contractors. 10. LANDLORD'S REPAIRS. Landlord shall maintain, at its expense, the structural soundness of the roof, foundation, and exterior walls of the Building in good repair, reasonable wear and tear and uninsured losses and damages caused by Tenant, its agents and contractors excluded. The term "walls" as used in this Paragraph 10 shall not include windows, glass or plate glass, doors or overhead doors, special store fronts, dock bumpers, dock plates or levelers, or office entries. Tenant shall promptly give Landlord written notice of any repair required by Landlord pursuant to this Paragraph 10, after which Landlord shall have a reasonable opportunity to repair. 11. TENANT'S REPAIRS. Landlord, at Tenant's expense as provided in Paragraph 6, shall maintain in good repair and condition the parking areas and other common areas of the Building, including, but not limited to driveways, alleys, landscape and grounds surrounding the Premises. Subject to Landlord's obligation in Paragraph 10 and subject to Paragraphs 9 and 15, Tenant, at its expense, shall repair, replace and maintain in good condition all portions of the Premises and all areas, improvements and systems exclusively serving the Premises including, without limitation, dock and loading areas, truck doors, plumbing, water, and sewer lines up to points of common connection, fire sprinklers and fire protection systems, entries, doors, ceilings and roof membrane, windows, interior walls, and the interior side of demising walls, and heating, ventilation and air conditioning systems. Such repair and replacements include capital expenditures and repairs whose benefits may extend beyond the Term. Heating, ventilation and air conditioning systems and other mechanical and building systems serving the Premises shall be maintained at Tenant's expense pursuant to maintenance service contracts entered into by Tenant or, at Landlord's election, by Landlord. The scope of services and contractors under such maintenance contracts shall be reasonably approved by Landlord. At Landlord's request, Tenant shall enter into a joint maintenance agreement with any railroad that services the Premises. If Tenant fails to perform any repair or replacement for which it is responsible, Landlord may perform such work and be reimbursed by Tenant within 10 days after demand therefor. Subject to Paragraphs 9 and 15, Tenant shall bear the full cost of any repair or replacement to any part of the Building or Project that results from damage caused by Tenant, its agents, contractors, or invitees and any repair that benefits only the Premises. 12. TENANT-MADE ALTERATIONS AND TRADE FIXTURES. Any alterations, additions, or improvements made by or on behalf of Tenant to the Premises ("Tenant-Made Alterations") shall be subject to Landlord's prior written consent. Tenant shall cause, at its expense, all Tenant-Made Alterations to comply with insurance requirements and with Legal Requirements and shall construct at its expense any alteration or modification required by Legal Requirements as a result of any Tenant-Made Alterations. All Tenant-Made Alterations shall be constructed in a good and workmanlike manner by contractors reasonably acceptable to Landlord and only good grades of materials shall be used. All plans and specifications for any Tenant-Made Alterations shall be submitted to Landlord for its approval. Landlord may monitor construction of the Tenant-Made Alterations. Tenant shall reimburse Landlord for its costs in reviewing plans and specifications and in monitoring construction. Landlord's right to review plans and specifications and to monitor construction shall be solely for its own benefit, and Landlord shall have no duty to see that such plans and specifications or construction comply with applicable laws, codes, rules and regulations. Tenant shall provide Landlord with the identities and mailing addresses of all persons performing work or supplying materials, prior to beginning such construction, and Landlord may post on and about the Premises notices of non-responsibility pursuant to applicable law. Tenant shall furnish security or make other arrangements satisfactory to Landlord to assure payment for the completion of all work free and clear of liens and shall provide certificates of insurance for worker's compensation and other coverage in amounts and from an insurance company satisfactory to Landlord protecting Landlord against liability for personal injury or property damage during construction. Upon completion of any Tenant- Made Alterations, Tenant shall deliver to Landlord sworn statements setting forth the names of all contractors and subcontractors who did work on the Tenant-Made Alterations and final lien waivers from all such contractors and subcontractors. Upon surrender of the Premises, all Tenant-Made Alterations and any leasehold improvements constructed by Landlord or Tenant shall remain on the Premises as Landlord's property, except to the extent Landlord requires removal at Tenant's expense of any such items or Landlord and Tenant have otherwise agreed in writing in connection with Landlord's consent to any Tenant-Made Alterations. Tenant shall repair any damage caused by such removal. Tenant, at its own cost and expense and without Landlord's prior approval, may erect such shelves, bins, machinery and trade fixtures (collectively "Trade Fixtures") in the ordinary course of its business provided that such items do not alter the basic character of the Premises, do not overload or damage the Premises, and may be removed without injury to the Premises, and the construction, erection, and installation thereof complies with all Legal Requirements and with Landlord's requirements set forth above. Tenant shall remove its Trade Fixtures and shall repair any damage caused by such removal. -4- 5 13. SIGNS. Tenant shall not make any changes to the exterior of the Premises, install any exterior lights, decorations, balloons, flags, pennants, banners, or painting, or erect or install any signs, windows or door lettering, placards, decorations, or advertising media of any type which can be viewed from the exterior of the Premises, without Landlord's prior written consent. Upon surrender or vacation of the Premises, Tenant shall have removed all signs and repair, paint, and/or replace the building facia surface to which its signs are attached. Tenant shall obtain all applicable governmental permits and approvals for sign and exterior treatments. All signs, decorations, advertising media, blinds, draperies and other window treatment or bars or other security installations visible from outside the Premises shall be subject to Landlord's approval and conform in all respects to Landlord's requirements. 14. PARKING. Tenant shall be entitled to park in common with other tenants of the Project in those areas designated for nonreserved parking. Landlord may allocate parking spaces among Tenant and other tenants in the Project if Landlord determines that such parking facilities are becoming crowded. Landlord shall not be responsible for enforcing Tenant's parking rights against any third parties. 15. RESTORATION. If at any time during the Lease Term the Premises are damaged by a fire or other casualty, Landlord shall notify Tenant within 60 days after such damage as to the amount of time Landlord reasonably estimates it will take to restore the Premises. If the restoration time is estimated to exceed 6 months, either Landlord or Tenant may elect to terminate this Lease upon notice to the other party given no later than 30 days after Landlord's notice. If neither party elects to terminate this Lease or if Landlord estimates that restoration will take 6 months or less, then, subject to receipt of sufficient insurance proceeds, Landlord shall promptly restore the Premises excluding the improvements installed by Tenant or by Landlord and paid by Tenant, subject to delays arising from the collection of insurance proceeds or from Force Majeure events. Tenant at Tenant's expense shall promptly perform, subject to delays arising from the collection of insurance proceeds, or from Force Majeure events, all repairs or restoration not required to be done by Landlord and shall promptly re-enter the Premises and commence doing business in accordance with this Lease. Notwithstanding the foregoing, either party may terminate this Lease if the Premises are damaged during the last year of the Lease Term and Landlord reasonably estimates that it will take more than one month to repair such damage. Tenant shall pay to Landlord with respect to any damage to the Premises the amount of the commercially reasonable deductible under Landlord's insurance policy (currently $10,000) within 10 days after presentment of Landlord's invoice. If the damage involves the premises of other tenants, Tenant shall pay the portion of the deductible that the cost of the restoration of the Premises bears to the total cost of restoration, as determined by Landlord. Base Rent and Operating Expenses shall be abated for the period of repair and restoration in the proportion which the area of the Premises, if any, which is not usable by Tenant bears to the total area of the Premises. Such abatement shall be the sole remedy of Tenant, and except as provided herein, Tenant waives any right to terminate the Lease by reason of damage or casualty loss. 16. CONDEMNATION. If any part of the Premises or the Project should be taken for any public or quasi-public use under governmental law, ordinance, or regulation, or by right of eminent domain, or by private purchase in lieu thereof (a "Taking" or "Taken"), and the Taking would prevent or materially interfere with Tenant's use of the Premises or in Landlord's judgment would materially interfere with or impair its ownership or operation of the Project, then upon written notice by Landlord this Lease shall terminate and Base Rent shall be apportioned as of said date. If part of the Premises shall be Taken, and this Lease is not terminated as provided above, the Base Rent payable hereunder during the unexpired Lease Term shall be reduced to such extent as may be fair and reasonable under the circumstances. In the event of any such Taking, Landlord shall be entitled to receive the entire price or award from any such Taking without any payment to Tenant, and Tenant hereby assigns to Landlord Tenant's interest, if any, in such award. Tenant shall have the right, to the extent that same shall not diminish Landlord's award, to make a separate claim against the condemning authority (but not Landlord) for such compensation as may be separately awarded or recoverable by Tenant for moving expenses and damage to Tenant's Trade Fixtures, if a separate award for such items is made to Tenant. 17. ASSIGNMENT AND SUBLETTING. Without Landlord's prior written consent, which Landlord shall not unreasonably withhold, Tenant shall not assign this Lease or sublease the Premises or any part thereof or mortgage, pledge, or hypothecate its leasehold interest or grant any concession or license within the Premises and any attempt to do any of the foregoing shall be void and of no effect. For purposes of this paragraph, a transfer of the ownership interests controlling Tenant shall be deemed an assignment of this Lease unless such ownership interests are publicly traded. Notwithstanding the above, Tenant may assign or sublet the Premises, or any part thereof, to any entity controlling Tenant, controlled by Tenant or under common control with Tenant (a "Tenant Affiliate"), without the prior written consent of Landlord. Tenant shall reimburse Landlord for all of Landlord's reasonable out-of-pocket expenses in connection with any assignment or sublease. Upon Landlord's receipt of Tenant's written notice of a desire to assign or sublet the Premises, or any part thereof (other than to a Tenant Affiliate), Landlord may, by giving written notice to Tenant within 30 days after receipt of Tenant's notice, terminate this Lease with respect to the space described in Tenant's notice, as of the date specified in Tenant's notice for the commencement of the proposed assignment or sublease. If Landlord so terminates the Lease, Landlord may enter into a lease directly with the proposed sublessee or assignee. Tenant may withdraw its notice to sublease or assign by notifying Landlord within 10 days after Landlord has given Tenant notice of such termination, in which case the Lease shall not terminate but shall continue. It shall be reasonable for the Landlord to withhold its consent to any assignment or sublease in any of the following instances: (i) an Event of Default has occurred and is continuing that would not be cured -5- 6 upon the proposed sublease or assignment; (ii) the assignee or sublessee does not have a net worth calculated according to generally accepted accounting principles at least equal to the greater of the net worth of Tenant immediately prior to such assignment or sublease or the net worth of the Tenant at the time it executed the Lease; (iii) the intended use of the Premises by the assignee or sublessee is not reasonably satisfactory to Landlord; (iv) the intended use of the Premises by the assignee or sublessee would materially increase the pedestrian or vehicular traffic to the Premises or the Project; (v) occupancy of the Premises by the assignee or sublessee would, in Landlord's opinion, violate an agreement binding upon Landlord or the Project with regard to the identity of tenants, usage in the Project, or similar matters; (vi) the identity or business reputation of the assignee or sublessee will, in the good faith judgment of Landlord, tend to damage the goodwill or reputation of the Project; (vii) the assignment or sublet is to another tenant in the Project and is at rates which are below those charged by Landlord for comparable space in the Project; (viii) in the case of a sublease, the subtenant has not acknowledged that the Lease controls over any inconsistent provision in the sublease; (ix) the proposed assignee or sublessee is a governmental agency; or (x) there is vacant space in the Premises suitable for lease to the proposed sublessee or assignee. Tenant and Landlord acknowledge that each of the foregoing criteria are reasonable as of the date of execution of this Lease. The foregoing criteria shall not exclude any other reasonable basis for Landlord to refuse its consent to such assignment or sublease. Any approved assignment or sublease shall be expressly subject to the terms and conditions of this Lease. Tenant shall provide to Landlord all information concerning the assignee or sublessee as Landlord may request. Notwithstanding any assignment or subletting, Tenant and any guarantor or surety of Tenant's obligations under this Lease shall at all times remain fully responsible and liable for the payment of the rent and for compliance with all of Tenant's other obligations under this Lease (regardless of whether Landlord's approval has been obtained for any such assignments or sublettings). In the event that the rent due and payable by a sublessee or assignee (or a combination of the rental payable under such sublease or assignment plus any bonus or other consideration therefor or incident thereto) exceeds the rental payable under this Lease, then Tenant shall be bound and obligated to pay Landlord as additional rent hereunder 50% such excess rental and other excess consideration within 10 days following receipt thereof by Tenant. If this Lease be assigned or if the Premises be subleased (whether in whole or in part) or in the event of the mortgage, pledge, or hypothecation of Tenant's leasehold interest or grant of any concession or license within the Premises or if the Premises be occupied in whole or in part by anyone other than Tenant, then upon a default by Tenant hereunder Landlord may collect rent from the assignee, sublessee, mortgagee, pledgee, party to whom the leasehold interest was hypothecated, concessionee or licensee or other occupant and, except to the extent set forth in the preceding paragraph, apply the amount collected to the next rent payable hereunder; and all such rentals collected by Tenant shall be held in trust for Landlord and immediately forwarded to Landlord. No such transaction or collection of rent or application thereof by Landlord, however, shall be deemed a waiver of these provisions or a release of Tenant from the further performance by Tenant of its covenants, duties, or obligations hereunder. 18. INDEMNIFICATION. Except for the negligence of Landlord, its agents, employees or contractors, and to the extent permitted by law, Tenant agrees to indemnify, defend and hold harmless Landlord, and Landlord's agents, employees and contractors, from and against any and all losses, liabilities, damages, costs and expenses (including attorneys' fees) resulting from claims by third parties for injuries to any person and damage to or theft or misappropriation or loss of property occurring in or about the Project and arising from the use and occupancy of the Premises or from any activity, work, or thing done, permitted or suffered by Tenant in or about the Premises or due to any other act or omission of Tenant, its subtenants, assignees, invitees, employees, contractors and agents. The furnishing of insurance required hereunder shall not be deemed to limit Tenant's obligations under this Paragraph 18. 19. INSPECTION AND ACCESS. Landlord and its agents, representatives, and contractors may enter the Premises at any reasonable time to inspect the Premises and to make such repairs as may be required or permitted pursuant to this Lease and for any other business purpose WITH 24 HOUR PRIOR NOTICE EXCEPT IN CASES OF EMERGENCY. Landlord and Landlord's representatives may enter the Premises during business hours for the purpose of showing the Premises to prospective purchasers and, during the last year of the Lease Term, to prospective tenants. Landlord may erect a suitable sign on the Premises stating the Premises are available to let or that the Project is available for sale. Landlord may grant easements, make public dedications, designate common areas and create restrictions on or about the Premises, provided that no such easement, dedication, designation or restriction materially interferes with Tenant's use or occupancy of the Premises. At Landlord's request, Tenant shall execute such instruments as may be necessary for such easements, dedications or restrictions. 20. QUIET ENJOYMENT. If Tenant shall perform all of the covenants and agreements herein required to be performed by Tenant, Tenant shall, subject to the terms of this Lease, at all times during the Lease Term, have peaceful and quiet enjoyment of the Premises against any person claiming by, through or under Landlord. 21. SURRENDER. Upon termination of the Lease Term or earlier termination of Tenant's right of possession, Tenant shall surrender the Premises to Landlord in the same condition as received, broom clean, ordinary wear and tear and casualty loss and condemnation covered by Paragraphs 15 and 16 excepted. Any Trade Fixtures, Tenant-Made Alterations and property not so removed by Tenant as permitted or required herein shall be deemed abandoned and may be stored, removed, and disposed of by Landlord at Tenant's -6- 7 expense, and Tenant waives all claims against Landlord for any damages resulting from Landlord's retention and disposition of such property. All obligations of Tenant hereunder not fully performed as of the termination of the Lease Term shall survive the termination of the Lease Term, including without limitation, indemnity obligations, payment obligations with respect to Operating Expenses and obligations concerning the condition and repair of the Premises. 22. HOLDING OVER. If Tenant retains possession of the Premises after the termination of the Lease Term, unless otherwise agreed in writing, such possession shall be subject to immediate termination by Landlord at any time, and all of the other terms and provisions of this Lease (excluding any expansion or renewal option or other similar right or option) shall be applicable during such holdover period, except that Tenant shall pay Landlord from time to time, upon demand, as Base Rent for the holdover period, an amount equal to 150% the Base Rent in effect on the termination date, computed on a monthly basis for each month or part thereof during such holding over. All other payments shall continue under the terms of this Lease. In addition, Tenant shall be liable for all damages incurred by Landlord as a result of such holding over. No holding over by Tenant, whether with or without consent of Landlord, shall operate to extend this Lease except as otherwise expressly provided, and this Paragraph 22 shall not be construed as consent for Tenant to retain possession of the Premises. 23. EVENTS OF DEFAULT. Each of the following events shall be an event of default ("Event of Default") by Tenant under this Lease: (i) Tenant shall fail to pay any installment of Base Rent or any other payment required herein when due, and such failure shall continue for a period of 5 days from the date such payment was due. (ii) Tenant or any guarantor or surety of Tenant's obligations hereunder shall (A) make a general assignment for the benefit of creditors; (B) commence any case, proceeding or other action seeking to have an order for relief entered on its behalf as a debtor or to adjudicate it a bankrupt or insolvent, or seeking reorganization, arrangement, adjustment, liquidation, dissolution or composition of it or its debts or seeking appointment of a receiver, trustee, custodian or other similar official for it or for all or of any substantial part of its property (collectively a "proceeding for relief"); (C) become the subject of any proceeding for relief which is not dismissed within 60 days of its filing or entry; or (D) die or suffer a legal disability (if Tenant, guarantor, or surety is an individual) or be dissolved or otherwise fail to maintain its legal existence (if Tenant, guarantor or surety is a corporation, partnership or other entity). (iii) Any insurance required to be maintained by Tenant pursuant to this Lease shall be cancelled or terminated or shall expire or shall be reduced or materially changed, except, in each case, as permitted in this Lease. (iv) Tenant shall not occupy or shall vacate the Premises or shall fail to continuously operate its business at the Premises for the permitted use set forth herein, whether or not Tenant is in monetary or other default under this Lease. (SEE ADDENDUM II) (v) Tenant shall attempt or there shall occur any assignment, subleasing or other transfer of Tenant's interest in or with respect to this Lease except as otherwise permitted in this Lease. (vi) Tenant shall fail to discharge any lien placed upon the Premises in violation of this Lease within 30 days after any such lien or encumbrance is filed against the Premises THAT RESULTS FROM TENANTS ACTIVITIES. (vii) Tenant shall fail to comply with any provision of this Lease other than those specifically referred to in this Paragraph 23, and except as otherwise expressly provided herein, such default shall continue for more than 30 days after Landlord shall have given Tenant written notice of such default. 24. LANDLORD'S REMEDIES. Upon each occurrence of an Event of Default and so long as such Event of Default shall be continuing, Landlord may at any time thereafter at its election: terminate this Lease or Tenant's right of possession (but Tenant shall remain liable as hereinafter provided), and/or pursue any other remedies at law or in equity. Upon the termination of this Lease or termination of Tenant's right of possession, it shall be lawful for Landlord, without formal demand or notice of any kind, to re-enter the Premises by summary dispossession proceedings or any other action or proceeding authorized by law and to remove Tenant and all persons and property therefrom. If Landlord re-enters the Premises, Landlord shall have the right to keep in place and use, or remove and store, all of the furniture, fixtures and equipment at the Premises. Except as otherwise provided in the next paragraph, if Tenant breaches this Lease and abandons the Premises prior to the end of the term hereof, or if Tenant's right to possession is terminated by Landlord because of an Event of Default by Tenant under this Lease, this Lease shall terminate. Upon such termination, Landlord may recover from Tenant the following, as provided in Section 1951.2 of the Civil Code of California: (i) the worth at the time of award of the unpaid Base Rent and other charges under this Lease that had been earned at the time of termination; (ii) the worth at the time of award of the amount by which the reasonable value of the -7- 8 unpaid Base Rent and other charges under this Lease which would have been earned after termination until the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; (iii) the worth at the time of award by which the reasonable value of the unpaid Base Rent and other charges under this Lease for the balance of the term of this Lease after the time of award exceeds the amount of such rental loss that Tenant proves could have been reasonably avoided; and (iv) any other amount necessary to compensate Landlord for all the detriment proximately caused by Tenant's failure to perform its obligations under this Lease or that in the ordinary course of things would be likely to result therefrom. As used herein, the following terms are defined: (a) The "worth at the time of award" of the amounts referred to in Sections (i) and (ii) is computed by allowing interest at the lesser of 18 percent per annum or the maximum lawful rate. The "worth at the time of award" of the amount referred to in Section (iii) is computed by discounting such amount at the discount rate of the Federal Reserve Bank of San Francisco at the time of award plus one percent; (b) The "time of award" as used in clauses (i), (ii), and (iii) above is the date on which judgment is entered by a court of competent jurisdiction; (c) The "reasonable value" of the amount referred to in clause (ii) above is computed by determining the mathematical product of (1) the "reasonable annual rental value" (as defined herein) and (2) the number of years, including fractional parts thereof, between the date of termination and the time of award. The "reasonable value" of the amount referred to in clause (iii) is computed by determining the mathematical product of (1) the annual Base Rent and other charges under this Lease and (2) the number of years including fractional parts thereof remaining in the balance of the term of this Lease after the time of award. Even though Tenant has breached this Lease and abandoned the Premises, this Lease shall continue in effect for so long as Landlord does not terminate Tenant's right to possession, and Landlord may enforce all its rights and remedies under this Lease, including the right to recover rent as it becomes due. This remedy is intended to be the remedy described in California Civil Code Section 1951.4, and the following provision from such Civil Code Section is hereby repeated: "The Lessor has the remedy described in California Civil Code Section 1951.4 (lessor may continue lease in effect after lessee's breach and abandonment and recover rent as it becomes due, if lessee has right to sublet or assign, subject only to reasonable limitations)." Any such payments due Landlord shall be made upon demand therefor from time to time and Tenant agrees that Landlord may file suit to recover any sums falling due from time to time. Notwithstanding any such reletting without termination, Landlord may at any time thereafter elect in writing to terminate this Lease for such previous breach. Exercise by Landlord of any one or more remedies hereunder granted or otherwise available shall not be deemed to be an acceptance of surrender of the Premises and/or a termination of this Lease by Landlord, whether by agreement or by operation of law, it being understood that such surrender and/or termination can be effected only by the written agreement of Landlord and Tenant. Any law, usage, or custom to the contrary notwithstanding, Landlord shall have the right at all times to enforce the provisions of this Lease in strict accordance with the terms hereof; and the failure of Landlord at any time to enforce its rights under this Lease strictly in accordance with same shall not be construed as having created a custom in any way or manner contrary to the specific terms, provisions, and covenants of this Lease or as having modified the same. Tenant and Landlord further agree that forbearance or waiver by Landlord to enforce its rights pursuant to this Lease or at law or in equity, shall not be a waiver of Landlord's right to enforce one or more of its rights in connection with any subsequent default. A receipt by Landlord of rent or other payment with knowledge of the breach of any covenant hereof shall not be deemed a waiver of such breach, and no waiver by Landlord of any provision of this Lease shall be deemed to have been made unless expressed in writing and signed by Landlord. To the greatest extent permitted by law, Tenant waives the service of notice of Landlord's intention to r enter as provided for in any statute, or to institute legal proceedings to that end, and also waives all right of redemption in case Tenant shall be dispossessed by a judgment or by warrant of any court or judge. The terms "enter," "re-enter," "entry" or "re-entry," as used in this Lease, are not restricted to their technical legal meanings. Any reletting of the Premises shall be on such terms and conditions as Landlord in its sole discretion may determine (including without limitation a term different than the remaining Lease Term, rental concessions, alterations and repair of the Premises, lease of less than the entire Premises to any tenant and leasing any or all other portions of the Project before reletting the Premises). Landlord shall not be liable, nor shall Tenant's obligations hereunder be diminished, because of Landlord's failure to relet the Premises or collect rent due in respect of such reletting. 25 TENANT'S REMEDIES/LIMITATION OF LIABILITY. Landlord shall not be in default hereunder unless Landlord fails to perform any of its obligations hereunder within 30 days after written notice from Tenant specifying such failure (unless such performance will, due to the nature of the obligation, require a period of time in excess of 30 days, then after such period of time as is reasonably necessary). All obligations of Landlord hereunder shall be construed as covenants, not conditions; and, except as may be otherwise expressly provided in this Lease, Tenant may not terminate this Lease for breach of Landlord's obligations hereunder. All obligations of Landlord under this Lease will be binding upon Landlord only during the period of its ownership of the Premises and not thereafter. The term "Landlord" in this Lease shall mean only the owner, for the time being of the Premises, and in the event of the transfer by such owner of its interest in the Premises, such owner shall thereupon be released and discharged from all obligations of Landlord thereafter accruing, but such obligations shall be binding during the Lease Term upon each new owner for the duration of such owner's ownership. Any liability of Landlord under this Lease shall be limited solely to its interest in the Project, and in no event shall any personal liability be asserted against Landlord in connection with this Lease nor shall any recourse be had to any other property or assets of Landlord. 26 WAIVER OF JURY TRIAL. TENANT AND LANDLORD WAIVE ANY RIGHT TO TRIAL BY JURY OR TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE, BETWEEN LANDLORD AND TENANT ARISING OUT OF THIS -8- 9 LEASE OR ANY OTHER INSTRUMENT, DOCUMENT, OR AGREEMENT EXECUTED OR DELIVERED IN CONNECTION HEREWITH OR THE TRANSACTIONS RELATED HERETO. 27 SUBORDINATION. This Lease and Tenant's interest and rights hereunder are and shall be subject and subordinate at all times to the lien of any first mortgage, now existing or hereafter created on or against the Project or the Premises, and all amendments, restatements, renewals, modifications, consolidations, refinancing, assignments and extensions thereof, without the necessity of any further instrument or act on the part of Tenant. Tenant agrees, at the election of the holder of any such mortgage, to attorn to any such holder. Tenant agrees upon demand to execute, acknowledge and deliver such instruments, confirming such subordination and such instruments of attornment as shall be requested by any such holder. Tenant hereby appoints Landlord attorney in fact for Tenant irrevocably (such power of attorney being coupled with an interest) to execute, acknowledge and deliver any such instrument and instruments for and in the name of the Tenant and to cause any such instrument to be recorded. Notwithstanding the foregoing, any such holder may at any time subordinate its mortgage to this Lease, without Tenant's consent, by notice in writing to Tenant, and thereupon this Lease shall be deemed prior to such mortgage without regard to their respective dates of execution, delivery or recording and in that event such holder shall have the same rights with respect to this Lease as though this Lease had been executed prior to the execution, delivery and recording of such mortgage and had been assigned to such holder. The term "mortgage" whenever used in this Lease shall be deemed to include deeds of trust, security assignments and any other encumbrances, and any reference to the "holder" of a mortgage shall be deemed to include the beneficiary under a deed of trust. 28 MECHANIC'S LIENS. Tenant has no express or implied authority to create or place any lien or encumbrance of any kind upon, or in any manner to bind the interest of Landlord or Tenant in, the Premises or to charge the rentals payable hereunder for any claim in favor of any person dealing with Tenant, including those who may furnish materials or perform labor for any construction or repairs. Tenant covenants and agrees that it will pay or cause to be paid all sums legally due and payable by it on account of any labor performed or materials furnished in connection with any work performed on the Premises and that it will save and hold Landlord harmless from all loss, cost or expense based on or arising out of asserted claims or liens against the leasehold estate or against the interest of Landlord in the Premises or under this Lease. Tenant shall give Landlord immediate written notice of the placing of any lien or encumbrance against the Premises and cause such lien or encumbrance to be discharged within 30 days of the filing or recording thereof; provided, however, Tenant may contest such liens or encumbrances as long as such contest prevents foreclosure of the lien or encumbrance and Tenant causes such lien or encumbrance to be bonded or insured over in a manner satisfactory to Landlord within such 30 day period. 29 ESTOPPEL CERTIFICATES. Tenant agrees, from time to time, within 10 days after request of Landlord, to execute and deliver to Landlord, or Landlord's designee, any estoppel certificate requested by Landlord, stating that this Lease is in full force and effect, the date to which rent has been paid, that Landlord is not in default hereunder (or specifying in detail the nature of Landlord's default), the termination date of this Lease and such other matters pertaining to this Lease as may be requested by Landlord. Tenant's obligation to furnish each estoppel certificate in a timely fashion is a material inducement for Landlord's execution of this Lease. No cure or grace period provided in this Lease shall apply to Tenant's obligations to timely deliver an estoppel certificate. 30 ENVIRONMENTAL REQUIREMENTS. Except for Hazardous Material contained in products used by Tenant in de minimis quantities for ordinary cleaning and office purposes, Tenant shall not permit or cause any party to bring any Hazardous Material upon the Premises or transport, store, use, generate, manufacture or release any Hazardous Material in or about the Premises without Landlord's prior written consent. Tenant, at its sole cost and expense, shall operate its business in the Premises in strict compliance with all Environmental Requirements and shall remediate in manner satisfactory to Landlord any Hazardous Materials released on or from the Project by Tenant, its agents, employees, contractors, subtenants or invitees. Tenant shall complete and certify to disclosure statements as requested by Landlord from time to time relating to Tenant's transportation, storage, use, generation, manufacture, or release of Hazardous Materials on the Premises. The term "Environmental Requirements" means all applicable present and future statutes, regulations, ordinances, rules, codes, judgments, orders or other similar enactments of any governmental authority or agency regulating or relating to health, safety, or environmental conditions on, under, or about the Premises or the environment, including without limitation, the following: the Comprehensive Environmental Response, Compensation and Liability Act; the Resource Conservation and Recovery Act; and all state and local counterparts thereto, and any regulations or policies promulgated or issued thereunder. The term "Hazardous Materials" means and includes any substance, material, waste, pollutant, or contaminant listed or defined as hazardous or toxic, under any Environmental Requirements, asbestos and petroleum, including crude oil or any fraction thereof, natural gas, or synthetic gas usable for fuel (or mixtures of natural gas and such synthetic gas). As defined in Environmental Requirements, Tenant is and shall be deemed to be the "operator" of Tenant's "facility" and the "owner" of all Hazardous Materials brought on the Premises by Tenant, its agents, employees, contractors or invitees, and the wastes, by-products, or residues generated, resulting, or produced therefrom. Tenant shall indemnify, defend, and hold Landlord harmless from and against any and all losses (including, without limitation, diminution in value of the Premises or the Project and loss of rental income from the Project), claims, demands, actions, suits, damages (including, without limitation, punitive damages), expenses -9- 10 (including, without limitation, remediation, removal, repair, corrective action, or cleanup expenses), and costs (including, without limitation, actual attorneys' fees, consultant fees or expert fees and including, without limitation, removal or management of any asbestos brought into the Premises or disturbed in breach of the requirements of this Paragraph 30, regardless of whether such removal or management is required by law) which are brought or recoverable against, or suffered or incurred by Landlord as a result of any release of Hazardous Materials for which Tenant is obligated to remediate as provided above or any other breach of the requirements under this Paragraph 30 by Tenant, its agents, employees, contractors, subtenants, assignees or invitees, regardless of whether Tenant had knowledge of such noncompliance. The obligations of Tenant under this Paragraph 30 shall survive any termination of this Lease. Landlord shall have access to, and a right to perform inspections and tests of, the Premises to determine Tenant's compliance with Environmental Requirements, its obligations under this Paragraph 30, or the environmental condition of the Premises. Access shall be granted to Landlord upon Landlord's PRIOR notice to Tenant and at such times so as to minimize, so far as may be reasonable under the circumstances, any disturbance to Tenant's operations. Such inspections and tests shall be conducted at Landlord's expense, unless such inspections or tests reveal that Tenant has not complied with any Environmental Requirement, in which case Tenant shall reimburse Landlord for the reasonable cost of such inspection and tests. Landlord's receipt of or satisfaction with any environmental assessment in no way waives any rights that Landlord holds against Tenant. 31 RULES AND REGULATIONS. Tenant shall, at all times during the Lease Term and any extension thereof, comply with all reasonable rules and regulations at any time or from time to time established by Landlord covering use of the Premises and the Project. The current rules and regulations are attached hereto. In the event of any conflict between said rules and regulations and other provisions of this Lease, the other terms and provisions of this Lease shall control. Landlord shall not have any liability or obligation for the breach of any rules or regulations by other tenants in the Project. 32 SECURITY SERVICE. Tenant acknowledges and agrees that, while Landlord may patrol the Project, Landlord is not providing any security services with respect to the Premises and that Landlord shall not be liable to Tenant for, and Tenant waives any claim against Landlord with respect to, any loss by theft or any other damage suffered or incurred by Tenant in connection with any unauthorized entry into the Premises or any other breach of security with respect to the Premises. 33 FORCE MAJEURE. Landlord shall not be held responsible for delays in the performance of its obligations hereunder when caused by strikes, lockouts, labor disputes, acts of God, inability to obtain labor or materials or reasonable substitutes therefor, governmental restrictions, governmental regulations, governmental controls, delay in issuance of permits, enemy or hostile governmental action, civil commotion, fire or other casualty, and other causes beyond the reasonable control of Landlord ("Force Majeure"). 34 ENTIRE AGREEMENT. This Lease constitutes the complete agreement of Landlord and Tenant with respect to the subject matter hereof. No representations, inducements, promises or agreements, oral or written, have been made by Landlord or Tenant, or anyone acting on behalf of Landlord or Tenant, which are not contained herein, and any prior agreements, promises, negotiations, or representations are superseded by this Lease. This Lease may not be amended except by an instrument in writing signed by both parties hereto. 35 SEVERABILITY. If any clause or provision of this Lease is illegal, invalid or unenforceable under present or future laws, then and in that event, it is the intention of the parties hereto that the remainder of this Lease shall not be affected thereby. It is also the intention of the parties to this Lease that in lieu of each clause or provision of this Lease that is illegal, invalid or unenforceable, there be added, as a part of this Lease, a clause or provision as similar in terms to such illegal, invalid or unenforceable clause or provision as may be possible and be legal, valid and enforceable. 36 BROKERS. Tenant represents and warrants that it has dealt with no broker, agent or other person in connection with this transaction and that no broker, agent or other person brought about this transaction, other than the broker, if any, set forth on the first page of this Lease, and Tenant agrees to indemnify and hold Landlord harmless from and against any claims by any other broker, agent or other person claiming a commission or other form of compensation by virtue of having dealt with Tenant with regard to this leasing transaction. 37 MISCELLANEOUS. (a) Any payments or charges due from Tenant to Landlord hereunder shall be considered rent for all purposes of this Lease. (b) If and when included within the term "Tenant," as used in this instrument, there is more than one person, firm or corporation, each shall be jointly and severally liable for the obligations of Tenant. (c) All notices required or permitted to be given under this Lease shall be in writing and shall be sent by registered or certified mail, return receipt requested, or by a reputable national overnight courier service, postage prepaid, or by hand delivery addressed to the parties at their addresses below, and with a copy sent to Landlord at 14100 East 35th Place, Aurora, Colorado 80011. Either party may by notice given aforesaid change its address for all subsequent notices. Except where otherwise expressly provided to the contrary, notice shall be deemed given upon delivery. -10- 11 (d) Except as otherwise expressly provided in this Lease or as otherwise required by law, Landlord retains the absolute right to withhold any consent or approval. (e) At Landlord's request from time to time Tenant shall furnish Landlord with true and complete copies of its most recent annual and quarterly financial statements prepared by Tenant or Tenant's accountants and any other financial information or summaries that Tenant typically provides to its lenders or shareholders. (f) Neither this Lease nor a memorandum of lease shall be filed by or on behalf of Tenant in any public record. Landlord may prepare and file, and upon request by Landlord Tenant will execute, a memorandum of lease. (g) The normal rule of construction to the effect that any ambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Lease or any exhibits or amendments hereto. (h) The submission by Landlord to Tenant of this Lease shall have no binding force or effect, shall not constitute an option for the leasing of the Premises, nor confer any right or impose any obligations upon either party until execution of this Lease by both parties. (i) Words of any gender used in this Lease shall be held and construed to include any other gender, and words in the singular number shall be held to include the plural, unless the context otherwise requires. The captions inserted in this Lease are for convenience only and in no way define, limit or otherwise describe the scope or intent of this Lease, or any provision hereof, or in any way affect the interpretation of this Lease. (j) Any amount not paid by Tenant within 5 days after its due date in accordance with the terms of this Lease shall bear interest from such due date until paid in full at the lesser of the highest rate permitted by applicable law or 15 percent per year. It is expressly the intent of Landlord and Tenant at all times to comply with applicable law governing the maximum rate or amount of any interest payable on or in connection with this Lease. If applicable law is ever judicially interpreted so as to render usurious any interest called for under this Lease, or contracted for, charged, taken , reserved, or received with respect to this Lease, then it is Landlord's and Tenant's express intent that all excess amounts theretofore collected by Landlord be credited on the applicable obligation (or, if the obligation has been or would thereby be paid in full, refunded to Tenant), and the provisions of this Lease immediately shall be deemed reformed and the amounts thereafter collectible hereunder reduced, without the necessity of the execution of any new document, so as to comply with the applicable law, but so as to permit the recovery of the fullest amount otherwise called for hereunder. (k) Construction and interpretation of this Lease shall be governed by the laws of the state in which the Project is located, excluding any principles of conflicts of laws. (l) Time is of the essence as to the performance of Tenant's obligations under this Lease. (m) All exhibits and addenda attached hereto are hereby incorporated into this Lease and made a part hereof. In the event of any conflict between such exhibits or addenda and the terms of this Lease, such exhibits or addenda shall control. 39 LIMITATION OF LIABILITY OF TRUSTEES, SHAREHOLDERS, AND OFFICERS OF SECURITY CAPITAL INDUSTRIAL TRUST. Any obligation or liability whatsoever of Security Capital Industrial Trust, a Maryland real estate investment trust, which may arise at any time under this Lease or any obligation or liability which may be incurred by it pursuant to any other instrument, transaction, or undertaking contemplated hereby shall not be personally binding upon, nor shall resort for the enforcement thereof be had to the property of, its trustees, directors, shareholders, officers, employees or agents, regardless of whether such obligation or liability is in the nature of contract, tort, or otherwise. IN WITNESS WHEREOF, Landlord and Tenant have executed this Lease as of the day and year first above written. -11- 12 TENANT: LANDLORD: Sunrise Technologies International, Inc., a SCI Limited Partnership-I, a Delaware Corporation Delaware Limited Partnership By: Security Capital Industrial Trust, a Maryland Real Estate Investment Trust, General Partner By: By: ------------------------------- ------------------------------- Title: Ned K. Anderson ---------------------------- Title: Senior Vice President Address: Address: 47265 Fremont Boulevard 47775 Fremont Boulevard Fremont, CA 94538 Fremont, CA 94538
-12- 13 Rules and Regulations 1 The sidewalk, entries, and driveways of the Project shall not be obstructed by Tenant, or its agents, or used by them for any purpose other than ingress and egress to and from the Premises. 2. Tenant shall not place any objects, including antennas, outdoor furniture, etc., in the parking areas, landscaped areas or other areas outside of its Premises, or on the roof of the Project. 3. Except for seeing-eye dogs, no animals shall be allowed in the offices, halls, or corridors in the Project. 4. Tenant shall not disturb the occupants of the Project or adjoining buildings by the use of any radio or musical instrument or by the making of loud or improper noises. 5. If Tenant desires telegraphic, telephonic or other electric connections in the Premises, Landlord or its agent will direct the electrician as to where and how the wires may be introduced; and, without such direction, no boring or cutting of wires will be permitted. Any such installation or connection shall be made at Tenant's expense. 6. Tenant shall not install or operate any steam or gas engine or boiler, or other mechanical apparatus in the Premises, except as specifically approved in the Lease. The use of oil, gas or inflammable liquids for heating, lighting or any other purpose is expressly prohibited. Explosives or other articles deemed extra hazardous shall not be brought into the Project. 7. Parking any type of recreational vehicles is specifically prohibited on or about the Project. Except for the overnight parking of operative vehicles, no vehicle of any type shall be stored in the parking areas at any time. In the event that a vehicle is disabled, it shall be removed within 48 hours. There shall be no "For Sale" or other advertising signs on or about any parked vehicle. All vehicles shall be parked in the designated parking areas in conformity with all signs and other markings. All parking will be open parking, and no reserved parking, numbering or lettering of individual spaces will be permitted except as specified by Landlord. 8. Tenant shall maintain the Premises free from rodents, insects and other pests. 9. Landlord reserves the right to exclude or expel from the Project any person who, in the judgment of Landlord, is intoxicated or under the influence of liquor or drugs or who shall in any manner do any act in violation of the Rules and Regulations of the Project. 10 Tenant shall not cause any unnecessary labor by reason of Tenant's carelessness or indifference in the preservation of good order and cleanliness. Landlord shall not be responsible to Tenant for any loss of property on the Premises, however occurring, or for any damage done to the effects of Tenant by the janitors or any other employee or person. 11 Tenant shall give Landlord prompt notice of any defects in the water, lawn sprinkler, sewage, gas pipes, electrical lights and fixtures, heating apparatus, or any other service equipment affecting the Premises. 12 Tenant shall not permit storage outside the Premises, including without limitation, outside storage of trucks and other vehicles, or dumping of waste or refuse or permit any harmful materials to be placed in any drainage system or sanitary system in or about the Premises. 13 All moveable trash receptacles provided by the trash disposal firm for the Premises must be kept in the trash enclosure areas, if any, provided for that purpose. 14 No auction, public or private, will be permitted on the Premises or the Project. 15 No awnings shall be placed over the windows in the Premises except with the prior written consent of Landlord. 16 The Premises shall not be used for lodging, sleeping or cooking or for any immoral or illegal purposes or for any purpose other than that specified in the Lease. No gaming devices shall be operated in the Premises. 17 Tenant shall ascertain from Landlord the maximum amount of electrical current which can safely be used in the Premises, taking into account the capacity of the electrical wiring in the Project and the Premises and the needs of other tenants, and shall not use more than such safe capacity. Landlord's consent to the installation of electric equipment shall not relieve Tenant from the obligation not to use more electricity than such safe capacity. 18 Tenant assumes full responsibility for protecting the Premises from theft, robbery and pilferage. 19 Tenant shall not install or operate on the Premises any machinery or mechanical devices of a nature not directly related to Tenant's ordinary use of the Premises and shall keep all such machinery free of vibration, noise and air waves which may be transmitted beyond the Premises. -13- 14 HVAC Maintenance/Service Contract Requirements A service contract with a Landlord approved HVAC contractor must become effective within thirty (30) days of occupancy and service visits should be performed on a quarterly basis. The following are the approved HVAC contractors: Thermoscape 510/445-0700 Phoenix Heating and Air Conditioning 408/487-0390 Cal-Air Conditioning 408/947-0155 We suggest that you send the following list to one of the above HVAC contractors to be assured that these items are included in the maintenance contract: 1. Adjust belt tension; 2. Lubricate all moving parts, as necessary; 3. Inspect and adjust all temperature and safety controls; 4. Check refrigeration system for leaks and operation; 5. Check refrigeration system for moisture; 6. Inspect compressor oil level and crank case heaters; 7. Check head pressure, suction pressure and oil pressure; 8. Inspect air filters and replace when necessary; 9. Check space conditions; 10. Check condensate drains and drain pans and clean, if necessary; 11. Inspect and adjust all valves; 12. Check and adjust dampers; 13. Run machine through complete cycle. Note: A certificate must be provided for our files not later than thirty (30) days after mutual execution hereof. Failure to provide such certificate or perform said services, when required, shall constitute material default of this lease. -14- 15 ADDENDUM I BASE RENT ADJUSTMENTS ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED _______________________, BETWEEN SCI Limited Partnership-I and Sunrise Technologies International, Inc. Base Rent shall equal the following amounts for the respective periods set forth below:
Period Monthly Base Rent ------ ----------------- 02/01/98 - 01/31/99 $10,400 02/01/99 - 01/31/00 $10,920 01/01/00 - 01/31/01 $11,440
-15- 16 ADDENDUM II VACATION OF PREMISES ATTACHED TO AND A PART OF THE LEASE AGREEMENT DATED ________________, BETWEEN SCI Limited Partnership-I and Sunrise Technologies International, Inc. Tenant's vacating of the Premises shall not constitute an Event of Default if, prior to vacating the Premises, Tenant has made arrangements reasonably acceptable to Landlord to (a) insure that Tenant's insurance for the Premises will not be voided or cancelled with respect to the Premises as a result of such vacancy, (b) insure that the Premises are secured and not subject to vandalism, and (c) insure that the Premises will be properly maintained after such vacation. Tenant shall inspect the Premises at least once each month and report monthly in writing to Landlord on the condition of the Premises. -16- 17 EXHIBIT C SIGN CRITERIA BAYSIDE COMMONS WINDOW SIGNS IDENTIFICATION: Each Tenant will be allowed one window sign placed either to the left or to the right of the entrance door, whichever provides the best visibility. Company names, logos or symbols will be allowed in this area - color and size to be determined by the Tenant. all other copy in this area except for logos or symbols will be white pressure sensitive letters. Copy should start at 5' from grade working down to no more than 3 1/2' from grade. sign layout including copy, sizes and color must be approved by the building management. One security decal only may be applied to the front door glass in the lower corner if the Tenant so desires. All exterior alarm bells are to be mounted to the rear of the building only. DIRCTORY SIGN IDENTIFICATION: A monument directory sign has been provided for each building. If only one tenant occupies an entire building, that Tenant shall be allowed to utilize the entire directory sign area for its sensitive vinyl letters in the Handel Gothic style with a letter height suitable for the area allowed, and a logo may be used. Layout is to be approved by building management. If two Tenants occupy a building, signs shall consist of 4: Handel Gothic, Spar-Cal Forest Green pressure sensitive vinyl letters condensed to 60.4%. Directory signs shall list the street number and the company names only, no slogans or symbols allowed. If three Tenants occupy a building, signs shall consist of 4: Handel Gothic, Spar-Cal dark Forest Green sensitive vinyl letters condensed to 60.4%. Directory signs shall list the street number and the company names only, no slogans or symbols allowed. REAR LOADING SIGNS: Each Tenant will be allowed to identify its rear door for shipping and receiving purposes. the company name shall be placed on a 36" x 24" aluminum panel adjacent to the rear doors. Copy shall consist of 3" vinyl capital letters only in the Spar-Cal Forest Green Handel Gothic style. Company names and logos only are allowed. MANAGEMENT RESERVES THE RIGHT TO DENY ANY COPY IT CONSIDERS UNSUITABLE. LAYOUT IS TO BE APPROVED BY BUILDING MANAGEMENT. THE COST OF ALL LETTERING AND LOGOS WILL BE THE RESPONSIBILITY OF THE TENANT. NO OTHER SIGNS ARE ALLOWED IN THE WINDOWS OR DOORS. -17- EX-21.1 3 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21.1 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. EXHIBIT 21.1 SUBSIDIARIES OF THE REGISTRANT Laser Biotech, Inc. (a California corporation) Sunrise Acquisition Corporation (a Delaware corporation) Sunrise Technologies, Ltd. (a Barbados corporation) EX-23.1 4 CONSENT OF COOPERS & LYBRAND L.L.P. 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Sunrise Technologies International, Inc. on Form S-8 (File No. 33-82314, 33-53466 and 33-53448) of our report dated March 6, 1998 on our audit of the consolidated financial statements and financial statement schedule of Sunrise Technologies International, Inc., as of December 31, 1997, and for the year then ended, which report is included in this Annual Report on Form 10-K. San Jose, California April 6, 1998 EX-23.2 5 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23.2 SUNRISE TECHNOLOGIES INTERNATIONAL, INC. CONSENT OF ERNST & YOUNG LLP, FORMER INDEPENDENT AUDITORS We consent to the incorporation by reference in Registration Statement (Form S-8, No. 33-82314) and Registration Statement (Form S-8, No. 33-53466) pertaining to the 1988 Stock Option Plan and in the Registration Statement (Form S-8, No. 33-53448) pertaining to the 1992 Employee Stock Purchase Plan of Sunrise Technologies International, Inc. of our report dated March 10, 1997 with respect to the consolidated financial statements and schedule of Sunrise Technologies International, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1996. /s/ ERNST & YOUNG LLP. April 6, 1998 EX-27 6 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 1,958,000 0 312,000 85,000 127,000 2,537,000 515,000 311,000 2,949,000 1,155,000 0 0 0 32,000 817,000 2,949,000 2,839,000 2,839,000 2,546,000 2,546,000 7,368,000 0 1,376,000 (6,618,000) 0 (6,618,000) 0 0 0 (6,618,000) (.23) (.23)
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