-----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, AfAlTAkYI/7oDtkvc03wf02XVPKw4ISp64nd4GD/QqeubPI8n+C0hWLvcJo+u5Z7 sHyE26txx8bc0uNDqlWcMQ== 0001019687-99-000837.txt : 19991230 0001019687-99-000837.hdr.sgml : 19991230 ACCESSION NUMBER: 0001019687-99-000837 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991229 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LASER POWER CORP/FA CENTRAL INDEX KEY: 0000874019 STANDARD INDUSTRIAL CLASSIFICATION: OPTICAL INSTRUMENTS & LENSES [3827] IRS NUMBER: 953423358 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22625 FILM NUMBER: 99782453 BUSINESS ADDRESS: STREET 1: 12777 HIGH BLUFF DR CITY: SAN DIEGO STATE: CA ZIP: 92130 BUSINESS PHONE: 6197550700 MAIL ADDRESS: STREET 1: 12777 HIGH BLUFF DRIVE CITY: SAN DIEGO STATE: CA ZIP: 92130 10-K 1 LASER POWER CORPORATION ================================================================================ UNITED STATES 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 SEPTEMBER 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO _______________ COMMISSION FILE NUMBER 000-22625 LASER POWER CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-3423358 (STATE OR OTHER JURISDICTION OF (IRS EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 12777 HIGH BLUFF DRIVE 92130 SAN DIEGO, CALIFORNIA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (858) 755-0700 ---------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001 PAR VALUE (TITLE OF EACH 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 and 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 approximate aggregate market value of the Common Stock held by non-affiliates of the Registrant, based upon the last sale price of the Common Stock reported on the NASDAQ National Market System was $12,895,473 as of December 1, 1999.* The number of shares of Common Stock outstanding was 8,629,987 as of December 1, 1999. DOCUMENTS INCORPORATED BY REFERENCE (TO THE EXTENT INDICATED HEREIN) Registrant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission (the "Commission") in connection with the 2000 Annual Meeting of Stockholders to be held on or about March 3, 2000 (the "2000 Annual Meeting") is incorporated herein by reference into Part III of this Report. Certain exhibits filed with the Registrant's Registration Statement on Form SB-2 (Registration No. 333-24421), as amended, and the Registrant's Registration Statement on Form S-4 (No. 333-43415), as amended, are incorporated herein by reference into Part IV of this Report. - ------------ * Excludes 3,421,798 shares of Common Stock held by directors and officers and certain stockholders whose beneficial ownership exceeds ten percent of the shares outstanding on December 1, 1999. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of the management or policies of the Registrant, or that such person is controlled by or under common control with the Registrant. ================================================================================ This Annual Report on Form 10-K contains certain forward-looking statements, and the actual results for Laser Power Corporation ("Laser Power" or the "Company") may differ materially from those discussed here. Additional information concerning factors that could cause such a difference can be found in this Annual Report on Form 10-K in Part I, Item 1 under the caption "Certain Risk Factors Related to the Company's Business" and elsewhere throughout this Annual Report. PART I ITEM 1. BUSINESS Laser Power designs, manufactures and markets high performance optics for industrial, medical and military applications. The Company also provides thin film design and coating services to industrial and military customers. The Company's laser optics products are sold to laser system OEMs and end users as original and replacement components in high power CO2 and other lasers. The Company's infrared optics products are sold primarily to the U.S. government and its prime contractors for use in night vision and thermal imaging and guidance systems. The Company's laser optics customers use high power CO2 lasers in a variety of industrial processing applications, such as sheet metal cutting, automobile body welding, surface hardening for engine components and scribing and drilling delicate ceramic circuits. The Company also sells high performance laser optics to medical equipment OEMs for lower power CO2 lasers used in certain therapeutic and cosmetic procedures, including surgery and skin wrinkle removal. In addition, the Company has developed very low absorption thin film coatings for laser optics for various government programs. The Company's infrared optics products are primarily windows, window assemblies and domes. Windows and window assemblies are utilized in thermal imaging systems that provide night vision, target acquisition and designation and low altitude navigation capabilities. These systems are installed in various platforms, including ground vehicles, helicopters and fixed-wing aircraft. Domes are utilized as a protective cover and infrared filter for various infrared guided missiles. Missile sizes range from small, man-portable designs to larger designs mounted on ground vehicles, helicopters and fixed-wing aircraft. The Company's core competencies in the manufacture of laser optics and infrared optics lie in its surface finishing processes and thin film coatings, and in the growth of a key material used in most of its infrared windows. The Company believes that its expertise in these areas provides it with a significant competitive advantage. RESTRUCTURING PLAN In August 1999 the Board of Directors approved a strategic restructuring plan intended to permit the Company to focus on its core business of the manufacture and sale of high performance laser and infrared optics and thin film coatings. As part of the restructuring plan, the Board approved the disposition of the Company's microlaser manufacturing business and the phase-out of contract research activities not related to the core optics business. The impact of the plan to dispose or phase-out these operations is reported as discontinued operations in the Consolidated Financial Statements for all periods presented. On December 16, 1999, the Company concluded a transaction for the sale of certain of its microlaser operations to Melles Griot, Inc., a unit of Barlow Scientific Group Ltd. In exchange for the sale of essentially all of the assets related to the visible microlaser product line, the Company received an initial payment of approximately $2.0 million. An additional payment will be made in January 2000, such that the sum of the two payments will approximate the aggregate net book value of the transferred assets. In addition, the agreement provides for royalty payments on sales of certain laser products, from October 1, 2000 until September 30, 2003. The maximum amount of royalty payments is approximately $2.7 million. Royalty payments will be reported as income from discontinued operations in the period in which they are earned. The assets of the Company's inactive 1550nm microlaser product line and the related contract research operations which will be phased out are stated at their estimated realizable value on the Consolidated Balance Sheet at September 30, 1999. The Company is actively seeking one or more buyers for these assets. 2 INDUSTRY AND MARKET OVERVIEW INDUSTRIAL AND MEDICAL LASER TECHNOLOGY The use of lasers in industrial and medical applications continues to grow and to expand into new areas. High power CO2 lasers are widely used in industrial applications, such as welding automobile bodies, scribing delicate ceramic circuits and sheet metal cutting. CO2 lasers offer greater quality, speed, flexibility and automation than conventional cutting and welding technologies. Lower power CO2 lasers are used in various medical procedures, including surgical, dermatology and ophthalmology applications. Surgical laser procedures reduce blood loss and post-operative pain compared to other procedures. The precision optics which collect, form, reflect and transmit the laser beam are crucial to a laser's function. In gas lasers, the lasing medium is encased in a tube with optics at either end. These internal optics may direct the beam from one tube to another, may turn the beam back on itself to further energize the lasing medium or may allow part of the beam to exit the tube while turning the rest of the beam back on itself. In addition to the internal optics, a number of external optics may be used to deliver the beam for its intended application. These external optics may include mirrors, beam splitters, focusing lenses and other special function optics INFRARED SENSOR TECHNOLOGY Infrared sensors are used in a variety of military and aerospace applications. Fielded systems range from small, personal use devices such as range finders and night vision goggles to sophisticated airborne and space-based imaging and targeting systems. As sensor and signal processing technologies evolve, infrared-based technology is expected to gain wider acceptance for commercial applications. Infrared optics are critical to the performance of infrared sensor systems. The typical infrared sensor system utilizes an optic, which acts as a window to the environment external to the sensor package, such as a flat window or a dome, and one or more internal optics. External thin film coatings and surfaces of windows and domes degrade through exposure to the outside environment, and where practical, these optics are periodically refurbished or replaced. Refurbishment and replacement of damaged windows represents an important component of the Company's infrared optics business. LARGE APERTURE OPTICS The market for thin film design and coating services for large aperture optics is expected to increase due to increased U.S. government funding for development of ground, airborne and space based defensive laser weapon systems. Although the number of fielded systems is likely to be small, design and process research before and after fielding of these systems is expected to be a sustainable market. High performance thin film coating technology is an enabling technology for extremely high-energy laser systems. For example, space based systems and ground based systems with space based optical components might not be feasible without light weight optics which are dependent on very low absorption thin film coatings. PRODUCTS AND SERVICES LASER OPTICS PRODUCTS The Company produces optics, including total reflectors, output couplers, beam splitters and lenses, for use in high power industrial, medical, scientific and military lasers. The Company's expertise in the area of surface finishing and, in particular, thin film coatings, is critical to producing high performance laser optics. In general, the performance of an optic is primarily dependent on the quality of the thin film coating. Thin film coatings include various reflective coatings for mirrors and transmissive and partially transmissive coatings for lenses, beam splitters and output couplers. The Company believes that the high quality of its thin film coatings and its commitment to customer service enhance its reputation as a supplier of high power and technically advanced laser optics. 3 CO2 LASER OPTICS. Reliable operation of high power CO2 lasers requires high quality, low absorption optics. The Company supplies substantially all types of optics used in CO2 lasers and laser systems. Such optics fall broadly into two categories: transmissive and reflective optics. Zinc selenide is the substrate material of choice for high power CO2 laser transmissive optics such as lenses, output couplers and beam splitters because of its low absorption of laser energy. Generally, zinc selenide optics with low absorption thin film coatings are able to handle up to three kilowatts of power. As laser power increases to the multi-kilowatt range, reflective optics replace transmissive optics in certain applications. Reflective optics (such as folding mirrors, phase shifting mirrors, beam bending mirrors and focusing mirrors) utilize a highly reflective substrate, such as copper or silicon. Silicon optics are fabricated by conventional polishing processes, while copper optics are usually fabricated by single-point diamond turning, a process which involves cutting by gem quality diamonds to create a mirror finish. The Company is a leader in the use of single-point diamond turning methods to produce both standard optics and those with complicated surfaces such as aspheres, parabolas and hyperbolas, which are used with higher power CO2 lasers. The Company's fabrication and thin film coating technologies have earned Laser Power a reputation as a leading manufacturer of laser optics. The Company supplies optics to high power CO2 laser and laser system manufacturers and to the aftermarket as replacement parts. Because CO2 laser optics wear or become contaminated, every new laser installed increases the market for replacement optics. In order to meet this growing aftermarket demand, the Company provides same day shipment of critical replacement optics for most high power CO2 lasers. OTHER LASER OPTICS. In addition to CO2 laser optics, the Company provides optics for a variety of industrial and military lasers operating at different wavelengths. MILITARY PRODUCTS AND SERVICES. The Company has developed thin film coatings for a variety of optics utilized in ongoing U.S. government programs. The Company has developed very low absorption thin film coatings for uncooled optics, which are critical to a space-based laser for defense against long range ballistic missiles. The Company has also developed thin film coatings for use in ground based and airborne laser defense systems for use against shorter-range missiles. The technology used to produce coatings for optics for these lasers is derived from technology used by the Company for CO2 laser optics. The Company believes that participation in these military programs fosters continued improvement in its optics technology for commercial applications. During fiscal year 2000, the Company expects to complete construction of a large aperture optic thin film coating facility. When complete, the facility will enable the Company to provide coating services for optics over 80 inches in diameter. The U.S. government has funded construction of the facility. INFRARED OPTICS PRODUCTS The Company produces optics for use in infrared systems for night vision imaging and navigation applications, principally for use by the U.S. government. These products include monolithic and segmented windows and window assemblies, focusing optics and missile domes. In addition, the Company provides thin film design and coating services to customers for military and commercial infrared applications. Performance of infrared optics is highly dependent on the durability and optical performance of the thin film coatings applied to the polished surfaces of the optics. The Company believes that the high quality of its thin film coatings, along with its in-house capability for growth of germanium substrates and expertise in high-speed fabrication and polishing provide it with significant competitive advantages. 4 GERMANIUM WINDOWS. The substrate material utilized in optics for a significant number of infrared systems is germanium. Depending upon the operating environment, germanium windows may be heated through a metallic grid applied to the surface of the optic. Windows manufactured by the Company are utilized in a variety of platforms including the M1 tank and Bradley fighting vehicle, the AH-64 Apache helicopter, and B-52 and tactical fixed-wing aircraft. Applications include electronic viewing, night vision, target acquisition and designation, and low altitude navigation and targeting. The Company supplies optics during production phases of sensor programs, and provides post-production repair, refurbishment and replacement services. The Company believes it is the principal supplier of heated germanium windows for infrared systems utilized by the U.S. government. OTHER WINDOWS. The Company also supplies windows fabricated from materials other than germanium, such as silicon and zinc sulfide. These products are manufactured utilizing the same fabrication and thin film coating processes as are germanium windows. Typically, these products are sold in substantially lower volumes than germanium windows. MISSILE DOMES. The Company manufactures domes for the U.S. Army's Javelin missile (a shoulder launched infrared guided anti-tank missile), and is currently in the development or pre-production phase of other U.S. government missile programs. Missile domes are mounted on the tip of infrared guided missiles as a protective cover for the underlying sensor system. These optics are designed to optimize the performance of the sensor system while accommodating the size and weight limitations of the missile. The resultant dome shape is difficult to fabricate in a cost-effective manner utilizing conventional fabrication techniques. The Company has developed and automated high-speed fabrication and polishing processes, which it believes, have enabled it to become a leading supplier of missile domes. STRATEGY The Company's strategy is to expand its current precision optics business through internal growth and industry consolidation, and to expand into related markets where its technologies and its knowledge of laser and laser system technologies and applications provide it with a competitive advantage. Key aspects of the Company's strategy include: CONTINUE TO GROW HIGH PERFORMANCE CO2 LASER OPTICS BUSINESS The Company's core competencies in the design and manufacture of high performance laser optics, including its polishing and diamond turning processes and thin film coatings, have made Laser Power one of the leading suppliers of such components, especially for high power CO2 lasers. The Company's strategy is to continually improve quality and customer service while lowering production costs. The Company believes it is well positioned to meet more stringent requirements for optics used in higher power CO2 lasers because of its proprietary and state-of-the-art technologies. EXPAND MARKETS FOR HIGH PERFORMANCE OPTICS PRODUCTS The Company believes that its technologies have applications in markets not currently served by the Company. The Company plans to use its technology base developed for CO2 laser optics and crystal polishing and thin film coating to produce certain optics for neodymium-YAG lasers and visible lasers. The Company also plans to enter other non- CO2 infrared markets using CO2 coatings. INCREASE MARGINS ON OPTICS PRODUCTS The Company has a multifaceted strategy to reduce costs and increase margins on its optics products. To reduce costs, the Company is consolidating its laser and infrared optics operations and is increasing the use of automation which will reduce labor costs and improve yields on certain manufacturing processes. To increase margins, the Company plans to intensify its sales efforts on higher margin products and to serve high performance, high margin niches in such markets as the emerging high power neodymium-YAG laser market. SUPPLEMENT PRODUCT DEVELOPMENT ACTIVITIES THROUGH CONTRACT FUNDING The Company will opportunistically secure research contracts that will enhance and advance its products under development. 5 EXPAND CAPABILITIES THROUGH STRATEGIC ALLIANCES AND ACQUISITIONS Through alliances with other companies, Laser Power has enhanced its high performance laser optics technologies and broadened its research activities. The Company will continue to identify and, if possible, acquire technologies or other companies that complement its current technologies. SALES AND MARKETING As of December 1, 1999, Laser Power employed 19 persons in continuing operations in sales and marketing at sales offices in the United States and Belgium. The Company promotes its products to OEM and end user customers through a multi-faceted program which includes trade journal advertising, catalog distribution, direct mail promotion, field sales presentations, technical seminars, trade show exhibits and direct telemarketing. The Company sells its products through its direct sales force in the United States and Belgium and through its distributors in the rest of the world. RESEARCH AND DEVELOPMENT The Company believes that its future success depends in large part on its ability to continue to enhance its existing products and manufacturing processes and to develop new products and processes. As of December 1, 1999, the Company had 14 employees in continuing operations performing research and development in the United States and Belgium. The Company spent $2.4 million during fiscal year 1999 on research and development. The sources of such funds included contracts with customers as well as internal Company funds. The Company continuously develops proprietary manufacturing processes for optics fabrication and polishing to lower costs and provide a more flexible manufacturing environment. In addition, the Company continues to improve thin film designs and processes under programs funded by the Company and certain of its customers. The successful completion of process and product development activities and the implementation of process changes or transition to manufacture and sale of any resultant products is dependent on a number of factors. These factors include availability of capital for investment in process improvements, determination of demand and appropriate product design, length of development period, development of appropriate manufacturing processes, product performance and sales and marketing. There can be no assurance that development of process improvements or new products will be successfully completed, or that new products developed by the Company will be commercially available or achieve market acceptance. See "Certain Risk Factors Related to the Company's Business." MANUFACTURING The Company manufactures high performance optics and provides sophisticated thin film design and coating services. Some materials are available only from single suppliers. The Company manufactures optics at its Temecula, California and Mexico facilities. Thorium fluoride, zinc selenide, zinc sulfide and germanium are important to the manufacture of optics. The Company purchases all of its thorium fluoride for use in its low absorption thin film coating processes from Cerac Incorporated ("Cerac"), which the Company believes is the sole source for high quality thorium fluoride. Any interruption or cessation of supply by Cerac would have a material adverse effect on the Company's business, financial condition and results of operations. In the case of zinc selenide and zinc sulfide, critical raw materials in a significant percentage of the Company's optics products, the Company currently relies principally on one supplier, the Advanced Materials unit of Rohm and Hass Company. To date, the Company has not experienced any material difficulties in the quantity or the quality of the zinc selenide and zinc sulfide delivered. If any such problem arises in the future, the Company would have to seek an alternate supplier. However, there can be no assurance that the Company would be able to secure sufficient inventory of zinc selenide and zinc sulfide to produce sufficient product to meet its customers' needs. A transition to alternate arrangements would involve additional costs and delays in production. 6 Germanium is mined as a byproduct of zinc mining. Germanium and refined germanium are available through a limited number of suppliers worldwide. Because of its status as a byproduct, availability of germanium is linked to the effects of supply and demand for zinc. Germanium also has other uses such as in solar panels used in space vehicles and satellites and in certain radar systems. Changes in demand for and supply of germanium have resulted in significant fluctuations in price in the past. While the Company attempts to structure its contracts to protect it from the effects of price increases, there can be no assurance that future price increases will not materially affect the profitability of the Company's products which utilize germanium. The manufacture of optics is capital intensive. Future manufacturing capacity requirements may require substantial investment in equipment and facilities. See "Certain Risk Factors Related to the Company's Business." PATENTS AND PROPRIETARY RIGHTS In general, the Company's optics products do not use design technology, which is patentable. The Company has filed a patent application for a thin film design, which it believes, provides a significant competitive advantage in certain high power CO2 laser applications. However, there can be no assurance that a patent will be issued. The Company has developed certain of its proprietary technology pursuant to development contracts, including contracts with federal government agencies. Under standard provisions in government contracts, the government may retain certain rights in technology developed under such contracts. The Company's strategy is to continue to develop a significant portion of its proprietary technology pursuant to funding received from development contracts. There can be no assurance that the Company will be able to continue to obtain funding for the development of its proprietary technology, or that, if received, the Company will obtain rights to such technology sufficient to permit the Company to develop and market new products or to prevent third parties from using such technology to compete with the Company. In addition to patent protection, Laser Power also relies on copyright protection, trade secrets, know-how, continuing technological innovation and licensing opportunities to expand and bolster its competitive position. In an effort to maintain the confidentiality and ownership of trade secrets and proprietary information, the Company requires employees, consultants and certain collaborators to execute confidentiality and invention assignment agreements upon commencement of a relationship with the Company. These agreements are intended to enable the Company to protect its proprietary information by controlling the disclosure and use of technology to which it has rights and provide for ownership by the Company of proprietary technology developed at the Company or with the Company's resources. There can be no assurance, however, that these agreements will provide meaningful protection for the Company's trade secrets or other confidential information in the event of unauthorized use or disclosure of such information or that adequate remedies would exist in the event of such unauthorized use or disclosure. The loss or exposure of trade secrets possessed by Laser Power could have a material adverse effect on the Company's business, financial condition and results of operations. The Company's academic collaborators have certain rights to publish data and information in which the Company has rights. There is considerable pressure on academic institutions to publish discoveries in the high technology and physics fields. There can be no assurance that such publication would not adversely affect the Company's ability to obtain patent protection for certain technologies in which it may have a commercial interest. COMPETITION The industries in which the Company sells its products are highly competitive. Laser Power's competitive position depends upon a number of factors, including the price and performance of its products, the level of customer service, the quality of its manufacturing processes, the compatibility of its products with existing laser and infrared systems and Laser Power's ability to participate in the growth of emerging technologies. In the laser optics market, Laser Power primarily competes with II-VI, Inc. ("II-VI"), Coherent, Inc. ("Coherent") and Sumitomo Electric Industries, Ltd. II-VI produces its own supply of zinc selenide. The Company uses zinc selenide as the substrate for 40% to 50% of the CO2 laser optics sold by the Company and purchases this raw material from the Advanced Materials unit of Rohm and Haas Corporation. In the infrared optics market, the Company primarily competes with in-house optical fabrication and thin film coating capabilities of major prime contractors, such as Raytheon Corporation. 7 ENVIRONMENTAL, HEALTH AND SAFETY MATTERS The Company uses or generates certain hazardous substances in its research and manufacturing facilities. The Company believes that its handling and disposal of such substances is in material compliance with applicable local, state and federal environmental, safety and health regulations at each operating location. The Company invests substantially in proper protective equipment, process controls and specialized training to minimize risks to employees, surrounding communities and the environment due to the presence and handling of such hazardous substances. The Company conducts monthly workplace monitoring regarding such substances. When exposure problems or potential problems have been indicated, corrective actions have been implemented and re-occurrence has been minimal or non-existent. The Company does not carry environmental impairment insurance. The Company uses a low-level radioactive material called thorium fluoride to manufacture low absorption thin film coatings. The use, storage and disposal of this material is governed by the State of California which last inspected and licensed the Company's facilities and procedures in February 1996. All thorium fluoride-bearing by-products are collected and disposed of at an appropriately licensed facility. The generation, use, collection, storage and disposal of all other hazardous by-products resulting from the Company's manufacturing of its products and research and development of new products, such as suspended solids containing heavy metals or airborne particulates, are believed by the Company to be in material compliance with local, state and federal regulations. The Company believes that it possesses all of the permits and licenses required for operation. Although the Company is not aware of any material environmental, safety and health problems in its properties or processes, there can be no assurance that problems will not develop in the future which would have a material adverse effect on the Company. BACKLOG With the exception of contracts with the U.S. government and its prime contractors, most customer orders for optics are from stock or for deliveries within one to two months. Backlog of optics was $13.0 million at September 30, 1999, consisting primarily of backlog for infrared optics. Backlog of research contracts fluctuates based on the timing of contract awards and was $700,000 at September 30, 1999. EMPLOYEES As of December 1, 1999, in continuing operations the Company had 207 full time and 3 part time employees in the United States and 37 full time employees in its foreign subsidiaries, and 27 full time employees in discontinued operations in the United States. Of the Company's employees in continuing operations, in the United States 14 were engaged in marketing, sales and related customer-support services, 12 in research and development and 184 in operations, administration and finance. None of the Company's employees is represented by a labor union or covered by a collective bargaining agreement. The Company has not experienced any work stoppages and considers its relations with its employees to be good. EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company are as follows:
NAME AGE POSITION - --------------------------------------------------- --- ------------------------------------------------- Dick Sharman....................................... 65 Chief Executive Officer and Director Paul P. Wickman.................................... 50 Senior Vice President and Chief Financial Officer Douglas H. Tanimoto, Ph.D.......................... 59 President, Research Division and Director
8 DICK SHARMAN has served as Chief Executive Officer of the Company since December 1998 and as a director of the Company since February 1998. Mr. Sharman has served as Chairman of the Board, President and Chief Executive Officer of EMI from 1993 until February 1998 and as Chairman of the Board of its wholly owned subsidiary, Exotic Materials, Inc., from 1988 until February 1998. From 1988 until June 1996, and again from June 1997 until November 1997, Mr. Sharman served as President and Chief Executive Officer of Exotic. Mr. Sharman received an A.A. in Electronics from Orange Coast College. PAUL P. WICKMAN has served as Senior Vice President and Chief Financial Officer of the Company since September 1992. From 1982 to 1992, he served as Group Vice President, Finance, and Controller of The Titan Corporation, a diversified high technology company. Mr. Wickman received a B.S. in Accounting from San Diego State University and is a Certified Public Accountant. DOUGLAS H. TANIMOTO, PH.D. has served as President of the Research Division since 1988 and has served as a director of the Company since 1984. Dr. Tanimoto intends to retire on or before the 2000 Annual Meeting. CERTAIN RISK FACTORS RELATED TO THE COMPANY'S BUSINESS In addition to those risks identified elsewhere in this Annual Report on Form 10-K, the Company's business and results of operations are subject to other risks, including the following risk factors: POSSIBLE CHANGE OF CONTROL In September 1999, II-VI Inc., one of the Company's principal competitors, publicly announced its willingness to buy the outstanding capital stock of the Company. The Company's Board of Directors, which had previously been told privately of such proposal, rejected the public proposal on the grounds that the proposal did not adequately reflect the value of the Company. The Board of Directors also re-affirmed its commitment to maximizing stockholder value. The Board subsequently retained the services of Cruttenden Roth & Company as its financial advisor and directed Cruttenden Roth to evaluate the proposal by II-VI and to advise the Board on the proposal and other strategic alternatives that may be available to the Company. The Board continues to evaluate such alternatives. II-VI, which as of December 1, 1999 owns approximately 14.6% of the outstanding voting stock of the Company, has informed the Company that it intends to propose its own slate of directors for election at the Company's next annual meeting of stockholders. If a majority of directors elected at the next annual meeting are nominees of II-VI, II-VI will be able to control the Company through the newly elected Board of Directors. A II-VI-controlled Board of Directors could then cause the Company to be sold to II-VI on terms and at a price that may not maximize stockholder value. There can be no assurance that the nominees for election to the Board of Directors proposed by the current Board will be elected directors at the next annual meeting or that if control of the Company passes to a II-VI-controlled Board, the Company will be sold on terms consistent with those published in II-VI's proposal. In addition, due to the time spent and effort expended by the Company's management in addressing the proposal by II-VI and considering strategic alternatives, the Company's officers have had less time and effort to conduct the business of the Company. Other employees of the Company have expressed some concern over the possible change in control of the Company and how it may effect their personal employment situations. There can be no assurance that such factors will not have a material adverse effect on the Company's business, financial condition or results of operations. HISTORY OF OPERATING LOSSES AND ACCUMULATED DEFICIT The Company has incurred operating losses in the past and, at September 30, 1999, had an accumulated deficit of $9.6 million. The development, sales, marketing and support of new products will require continued substantial expenditures for the foreseeable future, which could result in additional operating losses. The Company has funded a substantial portion of its product development efforts through development contracts. Any failure by the Company to maintain its external funding sources could result in increased operating losses. There can be no assurance that the Company will maintain its external funding sources or be profitable in the future or that present capital and any funds provided by operations will be sufficient to fund the Company's future capital requirements. 9 COMPETITION In each of the markets that the Company serves, the Company faces competition from established companies, many of which have substantially greater financial, engineering, research, development, manufacturing, sales, marketing, service and support resources, including greater name recognition, a larger installed base of products and long-standing customer relationships. In addition, some of the Company's competitors are customers of the Company, which might have the ability to perform or obtain the capability to perform projects, which are presently being performed for them by the Company. There can be no assurance that the Company will be able to maintain the Company's existing contracts or obtain additional contracts for projects at favorable rates, that the Company will be able to make the technological advances necessary to maintain its competitive position or that its new products will receive market acceptance. In addition, there can be no assurance that technological changes or development efforts by the Company's competitors will not render the Company's products or technologies obsolete or uncompetitive. DEPENDENCE ON NEW PRODUCTS AND PROCESSES To meet its strategic objectives, the Company must continue to develop, manufacture and market new products, develop new processes and improve its existing processes. As a result, the Company expects to continue to make investments in research and development and to consider from time to time the strategic acquisition of businesses, products, or technologies complementary to the Company's business. The success of the Company in developing, introducing and selling new and enhanced products depends upon a variety of factors, including product selection, timely and efficient completion of product design and development, timely and efficient implementation of manufacturing and assembly processes, effective sales and marketing and product performance in the field. There can be no assurance that the Company will be able to develop and introduce new products or enhancements to its existing products and processes in a manner that satisfies customer needs or achieves market acceptance. The failure to do so would have a material adverse effect on the Company's business, financial condition and results of operations. FUTURE CAPITAL REQUIREMENTS Although the Company believes that its existing cash balances and available lines of credit will be sufficient to meet its capital requirements for at least the next 12 months, the Company may seek additional equity or debt financing to compete effectively in the markets it serves. The timing and amount of the Company's capital requirements cannot be precisely determined at this time and will depend on a number of factors, including the demand for the Company's products and products under development. There can be no assurance that such additional financing will be available when needed, or, if available, will be on terms satisfactory to the Company. If additional funds are raised by issuing equity securities, further dilution to the then existing stockholders will result. FLUCTUATION IN QUARTERLY PERFORMANCE The Company has experienced and expects to continue to experience significant fluctuations in its quarterly results. The Company may incur significant losses in the future due to product design, development, manufacturing and marketing expenditures. If significant variations were to occur between forecasts and actual orders, the Company may not be able to reduce its expenses proportionately and in a timely manner, and operating results could be adversely affected. In addition, the Company's ability to fill orders in a timely and responsive manner is dependent upon maintaining adequate manufacturing capacity and significant inventories of raw material and finished optics for replacement orders. The Company has experienced capacity constraints in the past which have resulted in delays in order fulfillment and reduced gross margins. Future delays in order fulfillment could lead to declines in product sales. If product sales or prices were to decline substantially, inventory writedowns could occur. Price reductions or increases in material costs could also have an adverse effect on the Company's business, financial condition and results of operations. 10 EXPOSURE TO GOVERNMENT MARKETS Product sales to customers in the defense industry accounted for 54% of product sales from continuing operations in the fiscal year ended September 30, 1999. These customers in turn generally contract with a governmental entity, typically the U.S. government. In addition, essentially all of the Company's contract research and development revenues were derived from contracts with customers in the defense industry. Many times, governmental programs are subject to funding approval and can be modified or terminated with no warning upon the determination of a legislative or administrative body. The loss or failure to obtain certain contracts could have a material adverse effect on the Company's business, financial condition and operating results. In addition, the loss of a major government customer or any significant reduction or delay in orders by such customer, could have a material adverse effect on the Company's business, financial condition and operating results. EXPOSURE TO MAJOR CUSTOMER Approximately 31% of the Company's sales from continuing operations in the fiscal year ended September 30, 1999, were derived from net sales to Lockheed Martin Corporation. The loss of this major customer, or any significant reduction or delay in orders by such customer, would have a material adverse effect on the Company's business, financial condition and operating results. RISKS ASSOCIATED WITH INTERNATIONAL SALES International sales accounted for approximately 25% of the Company's total revenues from continuing operations in the fiscal year ended ended September 30, 1999 and the Company expects that international sales will continue to account for a substantial portion of total revenues. The Company may continue to expand its operations outside of the United States and to enter additional international markets, both of which will require significant management attention and financial resources. International sales are subject to inherent risks, including unexpected changes in regulatory requirements, tariffs and other trade barriers, political and economic instability in foreign markets, difficulties in staffing and management and integration of foreign operations, longer payment cycles, greater difficulty in accounts receivable collection, currency fluctuations and potentially adverse tax consequences. Since substantially all of the Company's foreign sales are denominated in U.S. dollars, the Company's products may also become less price competitive in countries in which local currencies decline in value relative to the U.S. dollar. The Company's business and operating results may also be materially and adversely affected by lower sales levels, which typically occur during the summer months and the calendar year end in Europe and certain other overseas markets. The sales of many of the Company's OEM customers are dependent on international sales, which increases the Company's exposure to the risks associated with international sales. ENVIRONMENTAL, HEALTH AND SAFETY CONCERNS The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use and disposal of hazardous materials used by the Company in connection with the manufacture of optics. Both the governmental regulations and the costs associated with complying with such regulations are subject to change in the future. There can be no assurance that any such change will not have a material adverse effect on the Company's business, financial condition and results of operations. The Company makes investments in protective equipment, and continually reviews and monitors process controls, manufacturing procedures and training to minimize the risks to employees, surrounding communities and the environment due to the presence and handling of such hazardous materials. The failure to properly handle such materials could lead to harmful exposure to employees or to the improper discharge of hazardous materials. Since the Company does not carry environmental impairment insurance, such a failure could result in a material adverse effect on the Company's business, financial condition and results of operations. VOLATILITY OF STOCK PRICE Until 1997, there had been no public market for the Common Stock, and there can be no assurance that an active public market for the Common Stock will develop or be sustained. The trading price of the Common Stock could be subject to significant fluctuations in response to variations in quarterly operating results, the gain or loss of significant orders, changes in earning estimates by analysts, announcements of technological innovations or new products by the Company or its competitors, general conditions in the optics and laser industries and other events or factors. In addition, the stock market in general has experienced extreme price and volume fluctuations that have affected the market price for many companies in industries similar or related to that of the Company and that have been unrelated to the operating performance of those companies. These market fluctuations may materially and adversely affect the market price of the Common Stock. 11 ITEM 2. PROPERTIES The Company leases a facility of approximately 44,000 square feet in San Diego, California, which is used for its headquarters and for certain of its discontinued operations. This facility is leased through December 31, 2001 and may be purchased pursuant to an option that may be exercised at the expiration of the lease with a purchase price equal to the prevailing market value of the property. As of December 1, 1999 approximately 73% of this facility has been subleased to unrelated parties under terms which provide for rental periods expiring concurrently with the Company's master lease, and at rates which in the aggregate are less than the total cost to the Company. The estimated loss was expensed in the fiscal year ended September 30, 1998. The Company also leases a facility in Temecula, California of approximately 60,000 square feet under a lease agreement that provides for an initial term expiring in June 2007. In addition to the initial lease term, the lease provides for two additional five-year terms that are exercisable at the Company's option. The Company has an option to purchase the Temecula facility at its fair market value at the time the option is exercised. The Company also leases facilities in Tijuana, Mexico and Gent, Belgium, consisting of approximately 4,600 and 3,900 square feet, respectively. The lease on the Mexico facility expires in September 2000, and the lease on the Belgium facility expires in December 2000. The Company believes that its leased properties are adequately covered by insurance. The Company believes that its facilities are adequate for its current and projected needs and that additional space will be available as needed. ITEM 3. LEGAL PROCEEDINGS In October 1999, the Company and certain directors of the Company were sued by Kathy and George Roelofsen, Jonathan Bryrum, and Cheryl Roelofsen, in the Delaware Chancery Court (ROELOFSEN ET AL. VS. KLIMASEWSKI ET AL, Del. Ch. C.A. No. 17450NC). The complaint, which purports to be a class action, asserts claims for purported breaches of fiduciary duty in connection with the Company's rejection of an acquisition proposal by II-VI. The Company and a number of the individual defendants have moved to dismiss the complaint. The Company believes that the claims are without merit and intends to defend itself vigorously. However, there can be no assurance that the Company will prevail in these proceedings or that an outcome unfavorable to the Company in these proceedings will not materially adversely affect the Company's business, financial condition or results of operations. The Company had previously entered into indemnification contracts with each of its officers and directors, including the directors who were named defendants in the complaint. As a result, the Company is paying the expenses of the directors in defending themselves in this matter subject to reimbursement under its insurance policies. Subject to certain limited exceptions, the Company will reimburse the directors for any monetary damages assessed against the individual directors that are not covered by the Company's insurance policies. In addition, the conduct of litigation can be time-consuming and costly. There can be no assurance that these factors will not materially adversely affect the Company's business, financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the quarter ended September 30, 1999. 12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS (a) The Company's Common Stock was first traded on June 19, 1997 on the Nasdaq National Market under the symbol LPWR. The following table sets forth, for the periods indicated, the high and low sales prices per share of the Common Stock as reported on the Nasdaq National Market:
HIGH LOW FISCAL YEAR ENDED AUGUST 31, 1997 ---- --- Fourth Quarter (beginning June 19, 1997).......................................... 7 3/8 5 1/2 FISCAL YEAR ENDED SEPTEMBER 30, 1998 First Quarter..................................................................... 9 3/4 5 3/8 Second Quarter.................................................................... 8 7/8 4 5/16 Third Quarter..................................................................... 5 5/32 3 1/8 Fourth Quarter.................................................................... 4 1/2 1 1/8 FISCAL YEAR ENDED SEPTEMBER 30, 1999 First Quarter..................................................................... 2 5/8 1 Second Quarter.................................................................... 1 17/32 1/2 Third Quarter..................................................................... 1 1/16 17/32 Fourth Quarter.................................................................... 3 1/8 3/4
The Company had approximately 309 stockholders of record of its Common Stock as of September 30, 1999. This number does not reflect the number of beneficial holders of the Company's Common Stock, which the Company believes to be in excess of 800 holders. The Company has never paid any cash dividends on its Common Stock and does not anticipate paying cash dividends in the foreseeable future. The Company's credit agreements restrict the payment of cash dividends. (b) On June 18, 1997, the Company's Form SB-2 registration statement (File no. 333-24421) was declared effective by the Securities and Exchange Commission. The registration statement, as amended, covered the offering of 1,650,000 shares of the Company's Common Stock, $.001 par value. The offering commenced on June 19, 1997 and the sale to the public of 1,650,000 shares of Common Stock at $5.50 per share was completed on June 24, 1997 for an aggregate price of $9,075,000. The registration statement covered an additional 247,500 shares of Common Stock that the underwriters had the option to purchase solely to cover over-allotments. The managing underwriters for the offering were Cruttenden Roth Incorporated and L.H. Friend, Weinress, Frankson & Presson, Inc. On August 6, 1997, the underwriters exercised their option to purchase all 247,500 additional shares of Common Stock. A total of 1,897,500 shares of Common Stock were sold in the offering at an aggregate price of $10,436,250. All of the shares sold in the offering were sold by the Company. Expenses incurred by the Company through September 30, 1999 in connection with the issuance and distribution of Common Stock in the offering included underwriting discounts, commissions and allowances of $965,353 and other expenses of $1,365,566. Total offering expenses of $2,330,919 resulted in net offering proceeds to the Company of $8,105,331. No expenses were paid to directors, officers or affiliates of the Company or 10% owners of any class of equity securities of the Company. 13 ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and the Notes thereto included elsewhere in this Annual Report on Form 10-K.
YEAR ENDED AUGUST 31, YEAR ENDED SEPTEMBER 30,(2) ------------------------------------ --------------------------- 1995 1996 1997 1998 1999 --------- --------- ---------- --------- --------- CONSOLIDATED STATEMENTS OF OPERATIONS DATA: Revenues: Product sales.............. $ 19,136 $ 25,764 $ 29,118 $ 30,035 $ 31,278 Contract research and development.............. 460 179 622 81 2,732 --------- --------- ---------- --------- --------- Total revenues......... 19,596 25,943 29,740 30,116 34,010 Cost of revenues: Product sales.............. 13,466 17,356 19,373 22,177 23,059 Contract research and development.............. 270 117 418 239 1,820 --------- --------- ---------- --------- --------- Total cost of revenues. 13,736 17,473 19,791 22,416 24,879 Gross profit: Product sales................. 5,670 8,408 9,745 7,858 8,219 Contract research and development 190 62 204 (158) 912 --------- --------- ---------- --------- --------- Total gross profit..... 5,860 8,470 9,949 7,700 9,131 Income (loss) from continuing operations.................. 94 1,761 2,780 (3,862) 1,639 Loss from discontinued operations.................. (1,931) (1,708) (505) (3,169) (3,126) Net income (loss) before extraordinary items......... $ (1,837) $ 54 $ 2,275 $ (7,032) $ (1,487) Net income (loss)............. $ (1,837) $ 173 $ 2,275 $ (7,032) $ (1,487) Diluted earnings (loss) per share(1)................ $ (.38) $ .03 $ .32 $ (.85) $ (.18) Average common shares outstanding - Diluted(1).... 4,790 6,573 7,196 8,263 8,454
AUGUST 31, SEPTEMBER 30, ---------------------------------- --------------------- 1995 1996 1997 1998 1999 --------- -------- --------- --------- --------- CONSOLIDATED BALANCE SHEETS DATA: Cash and cash equivalents.................. $ 834 $ 1,508 $ 8,253 $ 2,412 $ 860 Working capital............................ 4,819 6,647 15,202 5,304 5,928 Total assets............................... 14,224 17,159 28,119 24,618 21,908 Long-term debt, net of current portion.................. 2,922 2,640 3,230 287 3,083 Subordinated convertible debentures........ 1,660 1,660 1,660 1,660 1,660 Total stockholders' equity................. 5,809 7,922 17,682 11,233 9,925 - ------------
(1) See Note 1 of Notes to Consolidated Financial Statements for a description of the computation of net income (loss) per share and the number of shares used in the per share calculation. (2) See the Notes to Consolidated Financial Statements regarding the change in fiscal year end and the results of operations for the one-month ended September 30, 1997. 14 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion contains forward-looking statements that involve risks and uncertainties. Laser Power's actual results could differ materially from those discussed here. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the sections entitled "Certain Risk Factors Related to the Company's Business" as well as those discussed elsewhere in this Form 10-K. RESULTS OF OPERATIONS FISCAL YEAR ENDED SEPTEMBER 30, 1999 COMPARED TO THE FISCAL YEAR ENDED SEPTEMBER 30, 1998 REVENUES For the fiscal year ended September 30, 1999, product sales were $31.3 million compared to $30.0 million for fiscal 1998, an increase of $1.3 million or 4%. Contract research and development revenues were $2.7 million for fiscal 1999 compared to $81,000 for fiscal 1998, an increase of $2.6 million. The increase in product sales was due primarily to increased shipments of infrared optics on long-term production contracts, partially offset by reduced shipments of laser optics. Laser optics orders decreased due to delivery delays resulting from relocation of the laser optic product line to the Company's Temecula, California facility, and increased competition. The increase in contract research and development revenues was due to a significant subcontract to design and construct a large aperture optic thin film coating facility at the Temecula location, for which there were no revenues in fiscal 1998. The Company's ability to increase product sales for fiscal 2000 is dependent on successful consolidation of optics operations, increased manufacturing capacity for anticipated customer requirements for infrared optics, and recovery of laser optics market share. Contract research and development revenues are expected to decrease due to a shift in focus from facility construction to thin film coating process development. GROSS PROFIT Gross profit on product sales was $8.2 million in fiscal 1999 compared to $7.9 million in fiscal 1999, an increase of $300,000 or 4%. Gross profit on research and development revenues was $912,000 in fiscal 1999 compared to a gross loss of $158,000 in fiscal 1998. Gross margin on product sales was 26% in fiscal 1999 and fiscal 1998. Increased gross margins due to a product mix shift to infrared optics was offset by the negative impact on gross margin of laser optic manufacturing inefficiencies related to the relocation to Temecula. Gross margin on contract research and development revenues was 33% in fiscal 1999. Losses on fixed price contracts experienced in fiscal 1998 did not recur in fiscal 1999. INTERNAL RESEARCH AND DEVELOPMENT EXPENSE Internal research and development expense was $620,000 in fiscal 1999 compared to $870,000 in fiscal 1998, a decrease of $250,000 or 29%. The decrease was due to a change in focus in development activities from new product development to process improvement, which is primarily accounted for in cost of sales. As a percentage of sales, the Company does not expect internal research and development expense to increase significantly in the near term. In the long term, increases and decreases as a percentage of sales are less predictable and depend on a number of factors, including the Company's ability to obtain contract funding for development of key technologies. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense was $6.5 million in fiscal 1999 and fiscal 1998. A reduction in corporate administrative expense was offset by an increase in operating unit selling and administrative expenses. The Company anticipates that these expenses will continue to increase to enable the sales and marketing activities and information systems infrastructure necessary to support the Company's long-term growth objectives. However, as a percentage of sales, these expenses are expected to remain constant or increase moderately. 15 INTEREST EXPENSE Net interest expense was $342,000 in fiscal 1999 compared to $187,000 in fiscal 1998, an increase of $155,000 or 83%. The increase was due primarily to higher average borrowings during fiscal 1999 resulting from capital and other expenditures related to consolidation of optics operations and use of cash to fund discontinued operations. Future increase or decrease in interest expense will depend in part on the time required to dispose of discontinued operations and the timing of proceeds from disposal. INCOME TAXES Income taxes were $11,000 in fiscal 1999 compared to $249,000 in fiscal 1998, a decrease of $238,000 or 96%. The tax provision in 1998 was due to taxable income of EMI for the period prior to the merger of EMI and the Company. The Company has substantial federal and state tax operating loss carryforwards available for future periods. The availability of these carryforwards may be limited by the application of rules relating to a change in control as a result of the merger with EMI and the completion of the Company's initial public offering of Common Stock in August 1997. FISCAL YEAR ENDED SEPTEMBER 30, 1998 COMPARED TO FISCAL YEAR ENDED AUGUST 31, 1997 REVENUES For the fiscal year ended September 30, 1998, product sales were $30.0 million compared to $29.1 million for fiscal 1997, an increase of $.9 million or 3%. Contract research and development revenues were $81,000 for fiscal 1998 compared to $623,000 for fiscal 1997, a decrease of $542,000 or 87%. The increase in product sales was due primarily to shipments of infrared optics on long-term production contracts. The decrease in contract research and development revenues was primarily due to a reduction in commercial laser and optics technology development contracts. GROSS PROFIT Gross profit on product sales was $7.9 million in fiscal 1998 compared to $9.7 million in fiscal 1997, a decrease of $1.8 million or 19%. Gross loss on research and development revenues was $158,000 in fiscal 1998 compared to a gross profit of $204,000 in fiscal 1997, a decrease of $.4 million. Gross margin on product sales was 26% in fiscal 1998 compared to 33% in fiscal 1997. The decrease in gross margin was primarily due to manufacturing inefficiencies and reduced selling prices in the laser optics product line. A gross loss was experienced on contract research and development revenues in fiscal 1998 due to costs incurred to complete a fixed price development contract. INTERNAL RESEARCH AND DEVELOPMENT EXPENSE Internal research and development expense was $870,000 in fiscal 1998 and $916,000 in fiscal 1997. SELLING, GENERAL AND ADMINISTRATIVE EXPENSE Selling, general and administrative expense was $6.5 million in fiscal 1998 compared to $5.8 million in fiscal 1997, an increase of $.7 million or 12%. The increase was due to the increased expense of being a publicly held company after the Company's IPO in June 1997. INTEREST EXPENSE Net interest expense was $187,000 in fiscal 1998 compared to $254,000 in fiscal 1997, a decrease of $68,000 or 27%. The decrease was due primarily to income from investment of the net proceeds of the Company's initial public offering, partially offset by increased borrowings for capital investments. 16 INCOME TAXES Income taxes were $249,000 in fiscal 1998 compared to $185,000 in fiscal 1997, an increase of $64,000 or 35%. The increase was due to increased taxable income of EMI prior to its merger with the Company. The Company's effective tax rate in fiscal 1997 was reduced substantially by the utilization of federal and state tax net operating loss carryforwards. LIQUIDITY AND CAPITAL RESOURCES The Company completed its initial public offering in August 1997, raising approximately $8.1 million, net of offering costs. Prior to the public offering, the Company satisfied its liquidity requirements primarily from cash generated from operating activities and the net proceeds of private sales of preferred and common stock and, to a lesser extent, from issuance of subordinated debentures and capital equipment leasing and bank debt. In November 1999, the Company entered into a credit agreement with a unit of Wells Fargo Bank. The new credit agreement provides for a $4 million working capital line of credit, subject to a borrowing base, and a $1.95 million term loan to be amortized over 5 years. The Company utilized the proceeds of the term loan and an initial draw on the working capital line to retire its debt to Wells Fargo Bank under a prior credit agreement. The new credit agreement also provides for a capital equipment financing facility, and for a reduction in interest rates in the event that the net proceeds of the sale of its discontinued operations exceeds $2,000,000. The credit agreement expires in November 2002. The amount due under the working capital line is classified as long-term debt in the Consolidated Balance Sheet at September 30, 1999, and is secured by substantially all of the assets of the Company. Cash provided by operating activities of continuing operations was $2.7 million in fiscal 1999 compared to cash used of $454,000 in fiscal 1998 and cash provided of $2.8 million in 1997. The primary reasons for the use of cash in 1998 were expenses related to the merger with EMI and subsequent integration activities, and the restriction of $1 million in cash in connection with renewal of a bank credit agreement. The Company's new credit agreement does not provide for a restriction on cash. Cash used in investing activities of continuing operations was $2.2 million in fiscal 1999 compared to $2.9 million and $3.0 million in fiscal 1998 and 1997, respectively. The decrease in 1999 is due to reduced requirements for plant expansion and process automation investments. The Company expects capital equipment investment to be lower in the near term. Cash used in financing activities of continuing operations was $391,000 in fiscal 1999 compared to cash provided of $1.9 million and $8.6 million for fiscal 1998 and 1997, respectively. Cash usage in 1999 was primarily the net reduction of debt. For fiscal 1998, the primary sources of financing were bank borrowings and exercise of stock options. For fiscal 1997, the primary source of financing was the public offering. The Company had $1.7 million outstanding on its line of credit under its new credit agreement at December 1, 1999. The Company believes that its current cash balance together with other sources of liquidity will satisfy its cash requirements for at least the next twelve months. YEAR 2000 Many older computer software programs refer to years in terms of their last two digits only. Such programs may interpret the year 2000 to mean the year 1900 instead. If not corrected, these programs could cause date-related transaction failures. This problem is often referred to as the "Year 2000" issue. The Company recognizes the need to ensure that the Year 2000 issue will not impact its operations. The Company does not believe that it has an exposure to the Year 2000 issue with respect to its own products. As of December 1, 1999, the Company has determined that all of its 215 critical systems are Year 2000 ready. The Company also has contacted critical suppliers and customers to determine the status of their Year 2000 readiness programs. The Company has requested that each critical supplier and customer provide information with respect to their efforts to address the Year 2000 issue. Based primarily on reliance on representations and certifications provided by these vendors and customers, the Company has not identified any material customer or vendor exposure to the Y2K issue. 17 To date, the Company's expenditures on such corrective actions and surveys have not been material and the Company does not expect to incur material costs in the future related to addressing the Year 2000 issue. The Company does not have the financial resources to maintain higher than normal levels of inventory and to take other actions to insulate itself from disruption to its suppliers and customers caused by their failure to achieve Year 2000 compliance. Although the Company does not believe that it has an exposure to the Year 2000 issue with respect to its own products, there can be no assurance that failure of software upgrades and fixes provided to it by third parties for microprocessor software which supports critical operations, or that failure of its critical suppliers and customers to adequately address the Year 2000 issue in a timely fashion, will not result in a material adverse effect on the Company's business, financial condition or operating results. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures pursuant to item 7A. are not material and are therefore not required. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data of the Company required by this item are filed as exhibits hereto, are listed under Item 14(a)(1) and (2), and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item with respect to directors of the Company is incorporated by reference to Registrant's Definitive Proxy Statement to be filed with the Commission in connection with the 2000 Annual Meeting (the "Proxy Statement") under the headings "Nominees" and "Directors." The information required by this section with respect to Executive Officers is set forth under Part I, Item 1, "Business--Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is incorporated by reference to the Proxy Statement under the heading "Executive Compensation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this item is incorporated by reference to the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated by reference to the Proxy Statement under the heading "Certain Transactions." 18 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Index to Consolidated Financial Statements: The consolidated financial statements required by this item are submitted in a separate section beginning on page 21 of this Annual Report on Form 10-K. Report of Ernst & Young LLP, Independent Auditors................................... 22 Consolidated Balance Sheets at September 30, 1999 and September 30, 1998............ 23 Consolidated Statements of Operations for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....................................... 24 Consolidated Statements of Stockholders' Equity for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....................................... 25 Consolidated Statements of Cash Flows for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....................................... 26 Notes to Consolidated Financial Statements.......................................... 27
(2) All schedules have been omitted because they are not applicable or required, or the information required to be set forth therein is included in the Financial Statements or notes thereto. (b) The Registrant filed no reports on Form 8-K during the fourth quarter of the fiscal year ended September 30, 1999. (c) Exhibits EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - -------- ------ ----------- (7) 2.1 Asset Purchase Agreement dated December 16, 1999 between Registrant and Melles Griot, Inc. (1) 3.1 Registrant's Amended and Restated Certificate of Incorporation (6) 3.2 Registrant's Amended and Restated Bylaws (1) 4.1 Reference is made to Exhibits 3.1 and 3.2 (1) 4.2 Form of Common Stock Certificate of Registrant (6) 4.3 Rights Agreement dated as of October 15, 1999 between Laser Power Corporation and American Securities Transfer & Trust, Inc. (6) 4.4 Registrant's Certificate of Designation of Series A Junior Participating Preferred Stock (6) 4.5 Form of Rights Certificate (1) 10.1 Form of Indemnity Agreement entered into between Registrant and its directors and executive officers (1)(3) 10.2 Registrant's Second Amended and Restated 1981 Stock Option Plan (the "1981 Plan") (1) 10.3 Incentive Stock Option Agreement Under Registrant's 1981 Plan (1)(3) 10.4 Registrant's 1993 Stock Option Plan (the "1993 Plan") (1) 10.5 Form of Incentive Stock Option Agreement under the 1993 Plan (1) 10.6 Form of Nonstatutory Stock Option Agreement under the 1993 Plan (1)(3) 10.7 Registrant's 1997 Equity Incentive Plan (the "1997 Plan") (1) 10.8 Form of Incentive Stock Option Agreement under the 1997 Plan (1) 10.9 Form of Nonstatutory Stock Option Agreement under the 1997 Plan (1)(3) 10.10 Registrant's Employee Stock Purchase Plan (1) 10.11 Form of Warrant issued by Registrant in favor of certain directors of Registrant and attached schedule 19 EXHIBIT EXHIBIT FOOTNOTE NUMBER DESCRIPTION - -------- ------ ----------- (1)(2) 10.12 Cooperative Development and License Agreement between Proxima Corporation and Registrant dated January 11, 1994 (1) 10.13 Registration Rights Agreement between Registrant, Union Miniere Inc. and Proxima Corporation dated June 9, 1997 (1)(2) 10.14 Assignment Agreement between Registrant and ATx Telecom Systems, Inc. dated September 30, 1996 (1)(3) 10.15 Form of Employment Agreement and attached schedule (1) 10.16 Lease dated August 30, 1984 between the Registrant and Highlands Park Partnership and amendments thereto (4) 10.17 Building Lease dated October 25, 1991, as amended, between Exotic Materials, Inc. and Reisung Enterprises, Inc. (4)(3) 10.18 Employment Agreement between Exotic Materials, Inc. and Dick Sharman dated December 5, 1997. (4)(3) 10.19 Employment Agreement between Exotic Materials, Inc. and Robert N. Haro dated December 5, 1997. (5) 10.20 Credit Agreement dated February 1, 1999 between the Company and Wells Fargo Bank and related promissory notes 10.21 Credit Agreement dated November 24, 1999 between the Company and Wells Fargo Business Credit and related promissory notes (1) 21.1 Subsidiaries of the Registrant 23.1 Consent of Ernst & Young LLP, Independent Auditors 24.1 Power of Attorney. Reference is made to page 39 27.1 Financial Data Schedule - ------------ (1) Filed as an exhibit to the Registrant's Registration Statement on Form SB-2 (No. 333-24421) or amendments thereto and incorporated herein by reference. (2) Certain confidential portions deleted pursuant to Order Granting Application Under the Securities Act of 1933, as amended, and Rule 406 thereunder respecting Confidential Treatment dated June 12, 1997. (3) Indicates management or compensatory plan or arrangement required to be identified pursuant to item 14(a)(3). (4) Filed as an exhibit to Registrant's Registration Statement on Form S-4 (No. 333-43415) or amendments thereto and incorporated herein by reference. (5) Filed as an exhibit to Registrant's quarterly report on Form 10-Q for the quarter ending March 28, 1999 and incorporated herein by reference. (6) Filed as an exhibit to Registrant's current report on Form 8-K on October 19, 1999 and incorporated herein by reference. (7) The attachments listed in the index to the Asset Purchase Agreement were omitted pursuant to Item 601(b)(2) of Regulation S-K. Registrant hereby undertakes to furnish supplementally a copy of any omitted attachment to the Commission upon request. 20 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Ernst & Young LLP, Independent Auditors....................................... 22 Consolidated Balance Sheets at September 30, 1999 and September 30, 1998................ 23 Consolidated Statements of Operations for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....... 24 Consolidated Statements of Stockholders' Equity for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....... 25 Consolidated Statements of Cash Flows for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997....... 26 Notes to Consolidated Financial Statements.............................................. 27
21 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders Laser Power Corporation We have audited the accompanying consolidated balance sheets of Laser Power Corporation at September 30, 1999 and September 30, 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Laser Power Corporation at September 30, 1999 and September 30, 1998, and the consolidated results of its operations and its cash flows for the years ended September 30, 1999, September 30, 1998 and August 31, 1997 and the one month ended September 30, 1997, in conformity with generally accepted accounting principles. /s/ Ernst & Young, LLP ERNST & YOUNG LLP San Diego, California December 4, 1999 22 LASER POWER CORPORATION CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, SEPTEMBER 30, 1999 1998 ------------ ------------ ASSETS Current assets: Cash and cash equivalents........................................... $ 859,927 $ 2,412,327 Restricted cash..................................................... - 1,000,000 Accounts receivable, net............................................ 4,488,460 4,760,828 Inventories, net.................................................... 6,499,710 6,134,525 Other current assets................................................ 329,709 521,254 Net current assets of discontinued operations....................... 570,027 880,610 ------------ ------------ Total current assets............................................ 12,747,833 15,709,544 Property and equipment, net............................................. 7,094,233 6,096,847 Intangibles and other assets, net....................................... 418,907 442,354 Net non-current assets of discontinued operations....................... 1,647,208 2,369,468 ------------ ------------ Total assets.................................................... $21,908,181 $24,618,213 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................................... $ 2,023,763 $ 1,939,636 Accrued compensation and related expenses........................... 1,529,649 1,106,641 Other current liabilities........................................... 1,732,680 2,931,470 Allowance for operating losses of discontinued operations........... 450,000 - Current portion of long-term debt................................... 1,083,778 4,427,811 ------------ ------------ Total current liabilities....................................... 6,819,870 10,405,558 Long-term liabilities................................................... 420,120 1,032,472 Long-term debt.......................................................... 3,082,809 286,838 Subordinated convertible debentures..................................... 1,660,000 1,660,000 Stockholders' equity: Common stock, par value $.001: Authorized -- 15,000,000 shares Issued and outstanding 8,579,987 shares in 1999, and 8,398,455 shares in 1998................................................ 8,580 8,398 Additional paid-in capital.......................................... 19,573,531 19,416,298 Accumulated deficit................................................. (9,638,986) (8,152,304) Accumulated other comprehensive loss................................ (17,743) (39,047) ------------ ------------ Total stockholders' equity.......................................... 9,925,382 11,233,345 ------------ ------------ Total liabilities and stockholders' equity...................... $21,908,181 $24,618,213 ============ ============ See accompanying notes.
23 LASER POWER CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
ONE MONTH YEAR ENDED YEAR ENDED ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, AUGUST 31, 1999 1998 1997 1997 -------------- -------------- -------------- -------------- Revenues: Product sales.............................. $ 31,278,196 $ 30,034,601 $ 2,531,442 $ 29,117,915 Contract research and development.......... 2,731,981 81,274 36,240 622,514 -------------- -------------- -------------- -------------- Total revenues.......................... 34,010,177 30,115,875 2,567,682 29,740,429 Costs and expenses: Cost of product sales...................... 23,059,310 22,176,606 1,517,015 19,372,937 Contract research and development.......... 1,820,026 239,402 36,488 418,076 Internal research and development......... 619,752 869,518 48,561 915,926 Selling, general and administrative........ 6,519,791 6,479,216 725,298 5,814,390 Merger and integration..................... - 3,778,000 - - -------------- -------------- -------------- -------------- Total costs and expenses................. 32,018,879 33,542,742 2,327,362 26,521,329 -------------- -------------- -------------- -------------- Income (loss) from operations................. 1,991,298 (3,426,867) 240,320 3,219,100 Interest expense, net...................... 341,798 186,893 5,962 254,077 -------------- -------------- -------------- -------------- Income (loss) before income taxes............. 1,649,500 (3,613,760) 234,358 2,965,023 Income taxes............................... 10,547 248,642 129,800 184,758 -------------- -------------- -------------- -------------- Income (loss) continuing operations........... 1,638,953 (3,862,402) 104,558 2,780,265 Loss from discontinued operations............. (2,475,635) (3,169,210) (178,116) (505,049) Loss on disposal, including estimated loss during disposal period of $450,000... (650,000) - - - -------------- -------------- -------------- -------------- Net income (loss)............................. $ (1,486,682) $ (7,031,612) $ (73,558) $ 2,275,216 ============== ============== ============== ============== Basic earnings (loss) per share: Income (loss) from continuing operations.... $ .19 $ (.47) $ .01 $ .50 Loss from discontinued operations........... (.37) (.38) (.02) (.09) -------------- -------------- -------------- -------------- Net income (loss)......................... $ (.18) $ (.85) $ (.01) $ .41 ============== ============== ============== ============== Diluted earnings (loss) per share: Income (loss) from continuing operations.... $ .19 $ (.47) $ .01 $ .39 Loss from discontinued operations........... (.37) (.38) (.02) (.07) -------------- -------------- -------------- -------------- Net income (loss)......................... $ (.18) $ (.85) $ (.01) $ .32 ============== ============== ============== ============== Average common shares outstanding: Basic....................................... 8,454,000 8,263,000 8,099,000 5,592,000 ============== ============== ============== ============== Diluted..................................... 8,454,000 8,263,000 8,099,000 7,196,000 ============== ============== ============== ==============
See accompanying notes. 24 LASER POWER CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 1999, SEPTEMBER 30, 1998 AND AUGUST 31, 1997 AND ONE MONTH ENDED SEPTEMBER 30, 1997
Convertible Accumulated Preferred Stock Common Stock Additional Other ---------------------- ---------------------- Paid-In Accumulated Comprehensive Shares Amount Shares Amount Capital Deficit Income/(Loss) Total ----------- ---------- ----------- ---------- ------------- ------------- ----------- ------------ Balance at August 31, 1996....... 1,610,891 $ 201,361 5,049,259 $ 5,049 $ 10,290,004 $ (3,093,617) $ 123,222 $ 7,526,019 Issuance of common stock...... - - 95,373 95 117,405 - - 117,500 Issuance of common stock in initial public offering...... - - 1,897,500 1,898 8,121,868 - - 8,123,766 Conversion of preferred stock........................ (1,610,891) (201,361) 1,193,252 1,193 200,168 - - - Repurchase of common stock..... - - (161,642) (161) (186,672) - - (186,833) Comprehensive income (loss): Net income.................. - - - - - 2,275,216 - 2,275,216 Foreign currency translation adjustment..... - - - - - - (173,798) (173,798) Comprehensive income..... - - - - - - 2,101,418 ----------- ---------- ----------- ---------- ------------- ------------- ----------- ------------ Balance at August 31, 1997....... - - 8,073,742 8,074 18,542,773 (818,401) (50,576) 17,681,870 Transition period (Note 1)..... - - - - (13,216) (302,291) 13,385 (302,122) ----------- ---------- ----------- ---------- ------------- ------------- ----------- ------------ Balance at September 30, 1997.... - - 8,073,742 8,074 18,529,557 (1,120,692) (37,191) 17,379,748 Issuance of common stock for exercised options......... - - 291,142 291 718,213 - - 718,504 Employee stock purchase plan................. - - 33,571 33 111,528 - - 111,561 Issuance of warrants for services - - - - 57,000 - - 57,000 Comprehensive loss: Net loss..................... - - - - - (7,031,612) - (7,031,612) Foreign currency translation adjustment...... - - - - - - (1,856) (1,856) Comprehensive loss....... - - - - - - - (7,033,468) ----------- ---------- ----------- ---------- ------------- ------------- ----------- ------------ Balance at September 30, 1998.... - - 8,398,455 8,398 19,416,298 (8,152,304) (39,047) 11,233,345 Employee stock purchase plan................. - - 181,532 182 157,233 - - 157,415 Comprehensive income (loss): Net loss..................... - - - - - (1,486,682) - (1,486,682) Foreign currency translation adjustment...... - - - - - - 21,304 21,304 Comprehensive loss....... - - - - - - - (1,465,378) ----------- ---------- ----------- ---------- ------------- ------------- ----------- ------------ Balance at September 30, 1999.... - $ - 8,579,987 $ 8,580 $ 19,573,531 $ (9,638,986) $ (17,743) $ 9,925,382 =========== ========== =========== ========== ============= ============= =========== ============
See accompanying notes. 25 LASER POWER CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
ONE MONTH YEAR ENDED SEPTEMBER 30, ENDED YEAR ENDED ------------------------------- SEPTEMBER 30, AUGUST 31, 1999 1998 1997 1997 ------------- ------------- ------------- ------------- OPERATING ACTIVITIES Income (loss) from continuing operations.................... $ 1,638,953 $ (3,862,402) $ 104,558 $ 2,780,265 Adjustment to income (loss) to account for overlapping periods (Note 1).............................. - - (228,733) - Adjustments to reconcile income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization........................... 1,276,779 1,582,785 93,038 1,053,211 Loss on disposal of property and equipment and impairment of long-lived assets........................ - 1,250,505 - - Long-term liabilities................................... (612,352) 803,548 (5,871) (70,452) Warrants issued for services............................ - 57,000 - - Changes in operating assets and liabilities: Restricted cash....................................... 1,000,000 (1,000,000) - - Accounts receivable................................... 272,368 408,122 355,289 (613,503) Inventories........................................... (365,185) (637,568) (181,632) (1,061,258) Other current assets.................................. 191,545 (13,595) (41,439) (153,761) Accounts payable...................................... 84,127 (471,499) 77,104 418,245 Accrued compensation and related expenses............. 423,008 (403,841) 47,006 414,404 Other current liabilities............................. (1,198,790) 1,832,686 30,778 56,285 ------------- ------------- ------------- ------------- Net cash provided by (used in) operating activities of continuing operations.................................. 2,710,453 (454,259) 250,098 2,823,436 Net cash used in operating activities of discontinued operations..................... (1,871,621) (4,055,785) (77,935) (599,317) ------------- ------------- ------------- ------------- Net cash provided by (used in) operating activities........ 838,832 (4,510,044) 172,163 2,224,119 INVESTING ACTIVITIES Additions to property and equipment......................... (2,226,006) (2,852,776) (92,341) (3,144,787) Changes in intangibles and other assets..................... (3,408) (7,202) 500 4,923 ------------- ------------- ------------- ------------- Net cash used in investing activities of continuing operations.................................. (2,229,414) (2,859,978) (91,841) (3,139,864) Net cash provided by (used in) investing activities of discontinued operations................................ 228,829 (316,097) (89,411) (417,797) ------------- ------------- ------------- ------------- Net cash used in investing activities....................... (2,000,585) (3,176,075) (181,252) (3,557,661) FINANCING ACTIVITIES Proceeds from borrowings.................................... 1,349,097 3,504,476 - 1,354,835 Payments on borrowings...................................... (1,897,159) (2,435,446) (30,845) (801,623) Net proceeds from issuance of stock in conjunction with initial public offering.............................. - - - 8,123,766 Net proceeds from issuance and repurchase of stock.......... 157,415 830,065 (13,216) (69,333) ------------- ------------- ------------- ------------- Net cash provided by (used in) financing activities of continuing operations.................................. (390,647) 1,899,095 (44,061) 8,607,645 ------------- ------------- ------------- ------------- Net increase (decrease) in cash and cash equivalents........ (1,552,400) (5,787,024) (53,150) 7,274,103 Cash and cash equivalents at beginning of the period........ 2,412,327 8,199,351 8,252,501 978,398 ------------- ------------- ------------- ------------- Cash and cash equivalents at end of the period.............. $ 859,927 $ 2,412,327 $ 8,199,351 $ 8,252,501 ============= ============= ============= ============= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest.................... $ 574,000 $ 619,000 $ 17,000 $ 548,000 ============= ============= ============= ============= Cash paid during period for income taxes.................... $ 9,000 $ 241,000 $ - $ 48,000 ============= ============= ============= =============
See accompanying notes. 26 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1999 1. BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS AND BASIS OF PRESENTATION Laser Power Corporation ("Laser Power" or the "Company") designs, manufactures and markets high performance optics for industrial, medical and military applications. The Company's laser optics products are sold to laser system OEMs and end users as original and replacement components in high power CO2 and other lasers. The Company's infrared optics products are sold to various government agencies and to prime contractors of these agencies, and are used primarily in infrared imaging systems. The company also provides thin film design and coating services for industrial and military applications. The accompanying consolidated financial statements present the financial position, results of operations and cash flows of Laser Power Corporation (the "Company") and its subsidiaries, EMI Acquisition Corp. ("EMI"), Laser Power Optics de Mexico S.A. de C.V. ("Laser Power Mexico") and Laser Power Europe N.V. ("LPE"). EMI operates through its subsidiary Exotic Materials, Inc. (doing business as Exotic Electro-Optics - "Exotic"). Exotic manufactures infrared optic products principally for the aerospace and defense markets in the United States. LPE operates primarily as the European sales and distribution center for the Company. Laser Power Mexico performs a portion of the laser optic manufacturing and does not sell products to unaffiliated customers. All significant inter-company accounts and transactions have been eliminated in consolidation. DISCONTINUED OPERATIONS During fiscal 1999, the Company's Board of Directors adopted a plan to sell its microlaser operations and to phase out certain contract research operations. Operations to be sold or phased out are reported as discontinued operations. The Company expects to conclude a transaction for the sale of a majority of the assets of discontinued operations by December 31, 1999. The results of discontinued operations were as follows:
YEAR ENDED YEAR ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30, AUGUST 31, 1999 1998 1997 ------------ ------------ ------------ Revenues: Product sales....................... $ 2,217,204 $ 1,034,830 $ 277,796 Contract research and development... 1,821,431 3,411,997 5,533,280 ------------ ------------ ------------ Total revenues.................. 4,038,635 4,446,827 5,811,076 Costs and expenses: Cost of product sales............... 2,117,178 1,189,054 705,013 Contract research and development... 1,466,620 3,088,957 4,431,107 Internal research and development... 1,319,457 1,930,230 461,250 Selling, general and administrative. 1,392,489 1,288,307 556,313 ----------- ---------- ---------- Total costs and expenses........ 6,295,744 7,496,548 6,153,683 ----------- --------- ---------- Loss from operations................... (2,257,109) (3,049,721) (342,607) Interest expense, net............... 218,526 119,489 162,442 ------------ ------------ ------------ Income (loss) before income taxes...... (2,475,635) (3,169,210) (505,049) Income taxes........................ - - - ------------ ------------ ------------ Net loss from discontinued operations.. (2,475,635) (3,169,210) (505,049) Loss on disposal, including estimated loss during disposal period of $450,000 (650,000) - - ------------ ------------ ------------ Net loss............................... $(3,125,635) $(3,169,210) $ (505,049) ============ ============ ============
Corporate overhead expenses, historically allocated and charged to discontinued operations, were reversed and allocated back to continuing operations because those expenses were not considered to be directly attributable to discontinued operations. Expenses allocated back to continuing operations totaled $219,000, $119,000 and $162,000 in fiscal 1999, 1998 and 1997, respectively. 27 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) Interest expense attributable to discontinued operations includes an allocation of interest on general corporate credit facilities. Interest is allocated to discontinued operations based on the expected reduction in interest expense that should occur upon the sale of any of the discontinued operations and the use of proceeds from such sale to repay debt, and is representative of projected future interest expense. The Company believes this approach is substantially the same as if the buyer assumed this debt. Assets and liabilities of discontinued operations have been reflected in the consolidated balance sheets as current or non-current assets based on the original classification of the accounts, except that current liabilities are netted against current assets and non-current liabilities are netted against non-current assets. Net non-current assets also reflect a valuation allowance of $200,000 to recognize the estimated loss on disposal. The summary of assets and liabilities of discontinued operations are presented in the "Selected Balance Sheet Detail" footnote. The accrual for the estimated pre-tax losses to be incurred during the expected disposal period of $450,000 is presented separately in the accompanying consolidated balance sheet for fiscal 1999. Such amount excludes corporate overhead and interest allocation. CHANGE IN FISCAL YEAR The Company changed its fiscal year end from August 31 to September 30 effective for the fiscal year ended September 30, 1998. ACQUISITION OF EMI In February 1998, the Company merged with EMI. The Company issued 2,021,178 shares of its common stock based on a 1.8511 ratio of exchange. The Company has accounted for the merger as a pooling-of-interests; accordingly, the consolidated financial statements for the periods prior to the merger have been retroactively restated as if the combining companies had been combined for all periods presented. The Company's August 31, 1997 financial statements include the EMI financial statements for the year ended September 30, 1997. The consolidated results of operations of EMI for the three months ended December 31, 1996 were utilized in the 1997 fiscal period. Summarized information for the three months ended December 31, 1996 is as follows (unaudited, in thousands): Total revenues.................................................. $ 3,122 Operating expenses.............................................. $ 2,697 Income before extraordinary item................................ $ 384 The consolidated financial statements for the year ended August 31, 1997 include the year ended September 30, 1997 for EMI. The consolidated financial statements for the one month ended September 30, 1997 include EMI's net income as follows: Laser Power.................................................. $ (302,291) EMI.......................................................... 228,733 ----------- Net loss..................................................... $ (73,558) =========== Total revenues and income (loss) of Laser Power and EMI from continuing operations for the periods preceding the acquisition were as follows (in thousands):
LASER POWER EMI COMBINED ----------- --- -------- Five months ended February 28, 1998 (unaudited): Total revenues............................................ $ 6,969 $ 5,474 $ 12,443 Income (loss) from continuing operations.................. $ (1,225) $ 469 $ (756) Year ended August 31, 1997: Total revenues............................................ $ 17,541 $12,199 $ 29,740 Income from continuing operations......................... $ 1,233 $ 1,521 $ 2,754
28 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) MERGER AND INTEGRATION CHARGE During 1998, the Company recorded a merger and integration charge of approximately $3.8 million related to the Company's merger with EMI and plan to move its laser optics operations from San Diego, California to Temecula, California. This charge included approximately $1.0 million related to an abandonment of a portion of the San Diego facilities lease, $1.3 million related to impairment of long-lived assets, $800,000 for acquisition costs and $700,000 related to severance for 26 employees, including three senior officers. The remaining merger and integration accrual balance at September 30, 1999 amounts to $1.0 million, which is for remaining employee severance and abandonment of a portion of the San Diego facilities lease. REVENUES Product sales are recorded upon shipment. Revenue on long-term (generally spanning more than twelve months) fixed price contracts is recognized utilizing the units-of-delivery method of accounting. Under such method, revenues are recognized as units are shipped. The costs attributable to units shipped are based upon the actual cost of those units. Losses expected to be incurred on long-term contracts in progress are charged to operations when identified. Revenues from research and development contracts are recognized using the percentage-of-completion method based on the ratio of costs incurred to date to total estimated costs. Provisions are made to recognize any anticipated losses on contracts when losses become evident. Total product revenues from continuing operations from government contracts and subcontracts were $16,905,000, $14,491,000, and $12,485,000 in 1999, 1998 and 1997, respectively. Total contract revenues from continuing operations from government contracts and subcontracts were $2,638,000, $8,000, and $401,000 in 1999, 1998 and 1997, respectively. CASH AND CASH EQUIVALENTS AND RESTRICTED CASH Cash and cash equivalents consist of cash and highly liquid investments with maturities of three months or less when purchased. INVENTORIES Inventories are stated at lower of cost (first-in, first-out) or market. Market is based upon estimated net realizable value. DEPRECIATION AND AMORTIZATION Machinery, equipment and office furniture are depreciated over their estimated useful lives (3 to 15 years) on the straight-line method and leasehold improvements are amortized over the useful life of the asset or the lease term, whichever is less. Intangible assets consist primarily of goodwill and patents. Goodwill is amortized over 20 years and patents are amortized over the shorter of the estimated useful life or the legal life. Amortization of patents is initiated when the related technology is ready for commercial release. 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. 29 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) CONCENTRATION OF CREDIT RISK The Company sells its products primarily to industrial and medical equipment companies, and to U.S. government agencies and their prime contractors. Financial instruments that potentially subject the Company to credit risk consist principally of cash equivalents and trade receivables. The Company invests in a variety of financial instruments and limits exposure with any one issuer. The Company performs periodic credit evaluations of its customers and has not experienced significant losses with respect to its accounts receivable. As of September 30, 1999, the carrying value of cash equivalents and trade receivables approximated estimated fair value. IMPAIRMENT OF LONG-LIVED ASSETS The Company records impairment losses on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. ACCOUNTING FOR STOCK-BASED COMPENSATION As permitted by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"), the Company has elected the current intrinsic value-based method and the pro forma effect of using the fair value-based method to account for stock-based compensation in its financial statements. NET INCOME (LOSS) PER SHARE Net income (loss) per share is computed using "Basic EPS" and "Diluted EPS" as required by Statement of Financial Accounting Standards No. 128, Earnings per Share ("SFAS 128"), which supersedes APB Opinion 15. Basic EPS includes no dilution and is based on weighted-average common shares outstanding for the period. Diluted EPS reflects the potential dilution of stock options, convertible preferred stock and warrants to purchase common stock. For loss periods, these common equivalent shares are excluded from the Diluted EPS computation as their effect would be antidilutive. FAIR VALUE OF FINANCIAL INSTRUMENTS Financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities, are carried at cost, which management believes approximate fair value because of the short-term maturity of these instruments. Long term debt bears interest at a variable rate, and therefor is carried at fair value. COMPREHENSIVE INCOME As of January 1, 1998, the Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME. SFAS No. 130 establishes rules for the reporting and display of comprehensive income and its components; the company has disclosed its comprehensive income as a component of its statement of stockholders' equity. SEGMENT REPORTING As of January 1, 1998, the Company adopted SFAS No. 131, DISCLOSURE ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes annual and interim reporting standards for an enterprise's operating segments and related disclosures about its products, services, geographic areas, and major customers. The Company has determined that its continuing operations are only in one segment and has disclosed information related to its discontinued operations elsewhere in these Notes to Consolidated Financial Statements. Accordingly, the adoption of this statement has no impact on the Company's financial statements. 30 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) EFFECT OF NEW ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which will be effective January 1, 2001. This statement establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments imbedded in other contracts, be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement also requires that changes in the derivative's fair value be recognized in earnings unless specific hedge accounting criteria are met. The Company believes the adoption of SFAS No. 133 will not have a material effect on the financial statements. 2. SELECTED BALANCE SHEET DETAILS
SEPTEMBER 30, SEPTEMBER 30, 1999 1998 ------------- ------------- Accounts receivable: Trade..........................................................................$ 4,895,642 $ 5,159,103 Reserves....................................................................... (407,182) (398,275) ------------- ------------- $ 4,488,460 $ 4,760,828 ============= ============= Inventories: Raw materials..................................................................$ 3,404,834 $ 2,231,389 Work in progress............................................................... 3,008,989 3,257,916 Finished goods................................................................. 1,483,003 1,260,040 ------------- ------------- 7,896,826 6,749,345 Reserves....................................................................... (1,397,116) (614,820) ------------- ------------- $ 6,499,710 $ 6,134,525 ============= ============= Property and equipment, at cost: Machinery and equipment........................................................$ 10,647,510 $ 10,541,369 Leasehold improvements......................................................... 2,040,634 683,348 Office furniture and equipment................................................. 497,629 929,481 ------------- ------------- 13,185,773 12,154,198 Less accumulated depreciation and amortization................................. (6,091,540) (6,057,351) ------------- ------------- $ 7,094,233 $ 6,096,847 ============= ============= Intangibles and other assets: Goodwill in foreign subsidiary.................................................$ 549,100 $ 549,100 Other.......................................................................... 365,379 361,967 ------------- ------------- 914,479 911,067 Less accumulated amortization.................................................. (495,572) (468,713) ------------- ------------- $ 418,907 $ 442,354 ============= ============= Net current assets of discontinued operations: Accounts receivable, net......................................................$ 922,586 $ 898,891 Inventories, net.............................................................. 484,739 738,953 Other current assets.......................................................... 24,197 25,842 Accounts payable.............................................................. (306,279) (294,122) Accrued compensation and related expenses..................................... (327,243) (198,436) Other current liabilities..................................................... (227,973) (290,518) ------------- ------------- $ 570,027 $ 880,610 ============= ============= Net non-current assets of discontinued operations: Property and equipment, net...................................................$ 1,452,263 $ 1,991,451 Patents and licenses.......................................................... 394,945 378,017 Reserve for valuation......................................................... (200,000) - ------------- ------------- $ 1,647,208 $ 2,369,468 ============= =============
31 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 3. LONG-TERM DEBT AND OTHER FINANCING AGREEMENTS Long-term debt consists of the following:
SEPTEMBER 30, SEPTEMBER 30, 1999 1998 ------------- ------------- Promissory note...............................................................$ 39,015 $ 57,058 Term note payable to bank..................................................... 2,846,134 2,814,877 Note payable to bank.......................................................... 840,743 - Equipment line of credit from bank............................................ - 1,504,466 Other equipment financing..................................................... 436,115 330,328 Other......................................................................... 4,580 7,920 ------------- ------------ 4,166,587 4,714,649 Less current portion.......................................................... (1,083,778) (4,427,811) ------------- ------------- $ 3,082,809 $ 286,838 ============= ============
In November 1999, the Company entered into a new credit agreement with a unit of Wells Fargo Bank. The credit agreement provides for a revolving line of credit of $4,000,000, subject to a borrowing base limitation, with an annual interest rate of 1.5% above the bank's prime rate. The credit agreement includes a term loan of $1,950,000 amortized over 60 months commencing October 31, 1999 with interest at 1.5% above the bank's prime rate, and a $750,000 equipment financing facility with interest at 2% above the bank's prime rate. The credit agreement expires on October 31, 2002 unless renewed. In connection with the new agreement, the Company paid in full the existing term note payable and note payable with the bank amounting to approximately $3,642,000. The agreement includes a .25% facility fee. The agreement provides for a reduction in the interest rate applied to amounts outstanding under the line of credit and the term loan of 0.5% in the event that the net proceeds from the sale of discontinued operations received prior to June 30, 2000 is at least $2,000,000. All borrowings under the new credit agreement are secured by accounts receivable, inventory, and property and equipment. The agreement contains restrictive covenants, which include limitations on losses, maintenance of minimum tangible net worth, debt equity and cash flow ratios, as well as restrictions on capital and lease expenditures, additional borrowings and payments of dividends. In addition, penalties are due on a declining scale in the event that the Company terminates the agreement prior to the expiration of its term. Other equipment financing agreements are payable in monthly installments of principal and interest through April 2004. Borrowings under these financing agreements are secured by specific equipment, with interest at rates ranging from 9.75% to 12.00% at September 30, 1999. In November 1987, the Company obtained debt and equity financing from Union Miniere ("Union"). The Company issued 483,333 shares of common stock for $1,053,000 cash (net of stock issuance costs of $107,000) and subordinated convertible debentures amounting to $1,340,000. In December 1988, the Company issued an additional $320,000 of subordinated convertible debentures to Union. In March 1997, the maturity date of the debentures was extended to November 2, 2000 and the conversion rate for which the debentures are convertible into common stock was set at $4.625 per share (358,918 shares). The debentures are subordinated to all bank borrowings and interest is payable semi-annually at an annual rate equal to 1% above a bank's prime rate (9.25% at September 30, 1999) subject to a minimum rate of 5 -1/2% and a maximum rate of the lesser of 11.5% or the maximum rate permitted by law. The debentures provide for restrictive covenants similar to those of the bank borrowings. At September 30, 1999, the Company was not in compliance with one of these covenants; however, a waiver has been obtained from Union. 32 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) All subordinated convertible debentures and long-term debt of the Company bear an adjustable interest rate and are carried at the principal value of the liability, which approximates fair value. Principal maturities on the subordinated convertible debentures and long-term debt, for each of the years ending subsequent to September 30, 1999 are as follows: 2000....................................................... $ 1,084,000 2001....................................................... 2,723,000 2002....................................................... 906,000 2003....................................................... 1,087,000 2004....................................................... 27,000 Thereafter................................................. - ------------ $ 5,827,000 ============ 4. INCOME TAXES Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Valuation allowances are established when the realization of deferred tax assets is uncertain. The components of the Company's deferred tax liabilities and assets are as follows:
YEAR ENDED SEPTEMBER 30, ------------------------------------ 1999 1998 ------------ ------------ Deferred tax assets: Tax basis operating loss and credit carryforwards.... $ 4,693,000 $ 4,817,000 Impairment loss...................................... 1,141,000 - Accrued expenses and reserves........................ 1,004,000 - Other................................................ - 518,000 ------------ ------------ Total deferred tax assets.............................. 6,838,000 5,335,000 ------------ ------------ Deferred tax liability: Depreciation......................................... (866,000) (55,000) Intangibles.......................................... (181,000) (243,000) ------------ ------------ Total deferred tax liabilities......................... (1,047,000) (298,000) ------------ ------------ Net deferred tax assets................................ 5,791,000 5,037,000 Valuation allowance.................................... (5,791,000) (5,037,000) ------------ ------------ Net deferred tax accounts.............................. $ - $ - ============ ============
YEAR ENDED SEPTEMBER 30, ------------------------------- YEAR ENDED 1999 1998 AUGUST 31, 1997 ------------- ------------- ------------------ Pretax income (loss): United States............. $ (1,557,457) $ (6,983,277) $ 2,289,323 Foreign................... 81,322 200,307 170,651 ------------- ------------- ------------- $ (1,476,135) $ (6,782,970) $ 2,459,974 ============= ============= ============= Significant components of the provision for income taxes are as follows: YEAR ENDED SEPTEMBER 30, ------------------------------- YEAR ENDED 1999 1998 AUGUST 31, 1997 ------------- ------------- --------------- Current: Federal................... $ - $ 177,000 $ 139,500 Foreign................... - - 12,836 State..................... 10,547 71,642 32,422 ------------- ------------- ------------- Total income tax provision... $ 10,547 $ 248,642 $ 184,758 ============= ============= =============
33 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) A reconciliation of the effective tax rates and the statutory federal income tax rate is as follows:
YEAR ENDED SEPTEMBER 30, --------------------------- YEAR ENDED 1999 1998 AUGUST 31, 1997 ------------- ------------- --------------- Tax at U.S. statutory rate.............. (35.0%) (35.0%) 35.0% State income taxes, net of federal benefit............................... .5% .7% .9% Higher effective income taxes of other countries.............. - - (.5%) Change in valuation allowance........... 35.0% 38.0% (30.0%) Other, net.............................. - - 1.1% ------------- ------------- --------------- 0.5% 3.9% 6.5% ============= ============= ================
At September 30, 1999, the Company has net operating loss carryforwards for federal and California income tax purposes of approximately $11,442,000 and $3,066,000, respectively, which may be applied against future taxable income. The federal carryforwards will begin to expire in 2001 unless previously utilized. The California carryforwards begin to expire in 2000. The Company also has investment tax credit, research and development credit, targeted jobs tax credit, alternative minimum tax credit and California manufacturers investment credit carryforwards at September 30, 1999 aggregating approximately $648,000 These tax credit carryforwards will begin to expire in 2000. Due to the Tax Reform Act of 1986, the Company's ability to use the net operating loss and tax credit carryforwards could be limited in the event of a cumulative change in ownership of more than 50% occurring within a three year period. 5. STOCKHOLDERS' EQUITY COMMON STOCK WARRANTS Periodically, the Company will issue warrants to purchase common stock to outside directors and consultants in lieu of stock options. During the three years ended September 30, 1999, 46,664 warrants at an exercise price of $4.50 per share were issued to outside directors, which are fully exercisable. Warrants to purchase 324,996 shares of common stock at $3.00 to $7.33 per share are outstanding at September 30, 1999 including 185,000 warrants at a price range of $7.15 to $7.33 per share issued to representatives of the underwriters in conjunction with the initial public offering and for periodic advisory services. During 1999, 23,332 warrants were cancelled. The outstanding warrants expire from June 2002 to December 2006. STOCK OPTION PLANS The Company's 1981 Stock Option Plan was approved by the Board of Directors and stockholders in 1981, as amended (the "1981 Plan"). The Company's 1993 Stock Option Plan (the "1993 Plan") was approved by the Board of Directors and stockholders in September 1993. The exercise prices of options granted were not less than fair market value of the stock on the date of grant. The options vest over a five-year period commencing on the date of grant in annual increments of twenty percent and are exercisable for a period of ten years after the date of grant. The Board of Directors has terminated the 1981 and 1993 Plans and no additional shares will be granted thereunder, but outstanding options remain exercisable and continue to vest in accordance with their terms until they terminate. On March 25, 1997, the Company adopted the 1997 Equity Incentive Plan (the "1997 Plan"). The 1997 Plan provides for incentive stock options and stock appreciation rights appurtenant thereto for employees (including officers and employee directors), and nonstatutory stock options, stock appreciation rights appurtenant thereto, stock bonuses and rights to purchase restricted stock for employees (including officers and employee directors) and non-employee directors and consultants. The 1997 Plan is administered by the Board of Directors, or a Committee appointed by the Board, which determines the option awards to be granted, including exercise prices, number of shares subject to the awards and the exercisability thereof, provided that such terms comply with the provisions of the plan. 34 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The term of stock options granted under the 1997 Plan may not exceed 10 years. The exercise price of options granted under the 1997 Plan is determined by the Board of Directors, but in the case of an incentive stock option, cannot be less than 100% of the fair market value of the common stock on the date of grant and in the case of a non- statutory stock option, cannot be less than 85% of the fair market value of the common stock on the date of grant. Options granted under the plans vest at the rate specified in the option agreement. The Board has authorized and reserved an aggregate of 1,000,000 shares of common stock for issuance under the Plan. On December 5, 1998 the Company repriced to $3.00 per share, which price was above the closing market price per share on the date of the repricing, 267,329 options that had original exercise prices ranging from $3.50 to $7.00 per share. The following table summarizes stock option and warrant activity:
WEIGHTED AVERAGE EXERCISE NUMBER OF PRICE PER PRICE PER SHARES SHARE SHARE ----------- ----------- --------- Outstanding at August 31, 1996................................ 1,278,497 $ .22-4.50 $ 3.40 Granted..................................................... 666,776 1.05-3.00 5.02 Exercised................................................... - - - Canceled.................................................... (35,329) 3.00-4.50 3.37 ----------- ----------- --------- Outstanding at August 31, 1997................................ 1,909,944 .22-7.15 3.97 Granted..................................................... 502,000 3.25-7.33 4.39 Exercised................................................... (243,880) .22-3.00 2.67 Canceled.................................................... (275,524) 1.22-6.50 4.50 ----------- ----------- --------- Outstanding at September 30, 1998............................. 1,892,540 .56-7.33 4.17 Granted..................................................... 180,250 .75-2.00 1.65 Canceled.................................................... (261,537) 1.55-4.94 3.03 ----------- ----------- --------- Outstanding at September 30, 1999............................. 1,811,253 $.56-7.33 $ 3.61 =========== =========== =========
At September 30, 1999, the weighted-average exercise price of outstanding stock options and warrants is $3.18 and $5.56, respectively, and 1,351,026 options and warrants are exercisable. Adjusted pro forma information regarding net income (loss) is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using the Black-Scholes method for option pricing with the following weighted-average assumptions: volatility of 0.559; risk-free interest rate range from 5.4% to 6.2%; dividend yield of 0%; and a weighted average expected life of the options of 6 years. The Company's pro forma information is as follows:
YEAR ENDED ---------------------------------------------- SEPTEMBER 30, SEPTEMBER 30, AUGUST 31, 1999 1998 1997 ------------- ------------- ------------- Adjusted pro forma net income (loss)................ $ (2,109,000) $ (7,683,000) $ 2,025,000 Adjusted pro forma diluted net income (loss) per share.................................. $ (.25) $ (.92) $ .28
35 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) EMPLOYEE STOCK PURCHASE PLAN On March 25, 1997 the Company adopted the Employee Stock Purchase Plan (the "Purchase Plan") covering an aggregate of 250,000 shares of common stock. The Purchase Plan is intended to qualify as an employee stock purchase plan within the meaning of Section 423 of the IRS Code. Under the Purchase Plan, the Board has authorized participation by eligible employees, including officers, in periodic offerings following the commencement of the Purchase Plan. The initial offering under the Purchase Plan commenced on the closing of the Company's initial public offering and terminated on February 28, 1998. Sequential six-month offerings have occurred since that date. The Purchase Plan permits the purchase of shares of common stock at the end of each offering period at 85% of the lesser of the price of the common stock on the first day of the offering period and the last day of the offering period. During 1999, 181,532 shares were issued to employees under this Plan at an average price of $.87 per share. The Company does not have sufficient shares reserved to satisfy the expected requirement for the offering period ending February 29, 2000. The Board of Directors has authorized an increase in the number of shares reserved for issuance under the Purchase Plan of 100,000 shares, subject to stockholder approval at the next annual meeting of stockholders. In the event the increase in shares authorized is not approved, or approval occurs after the end of the offering period, the Company will allocate shares to the participants. The Purchase Plan would then become inactive until such time as stockholders approve an increase in shares reserved for issuance. Effective October 15, 1999, the Company designated 150,000 shares of Preferred Stock as Series A Junior Participating Preferred Stock and declared a dividend of one preferred share purchase right (a "Right") for each outstanding share of common stock. Each Right entitles a Stockholder to purchase one one-hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of $10.00, subject to adjustment. The Rights are only exercisable when a person or group of affiliated or associated persons (an Acquiring Person) acquires or obtains the right to acquire 15% or more of the Company's outstanding Common Stock or announces a tender or exchange offer that would result in an Acquiring Person beneficially owning more than 15% or more of the Company's outstanding shares. In the event any person becomes an Acquiring Person, each holder of a Right, other than Rights beneficially owned by the Acquiring Person, will thereafter have the right to receive on exercise that number of shares of common stock of the Company, or, in certain business combinations, of the acquiring company, having a market value of two times the exercise price of the Right. The Rights expire on October 15, 2009 unless extended prior thereto by the Board, or earlier redeemed or exchanged by the Company. SHARES RESERVED FOR FUTURE ISSUANCE The following shares of common stock are reserved for future issuance at September 30, 1999: Subordinated convertible debentures...................... 358,918 Stock options: Granted and outstanding................................ 1,486,257 Reserved for future grants............................. 543,852 Warrants................................................. 324,996 Stock Purchase Plan...................................... 34,897 ----------- 2,748,920 =========== 36 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 6. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share (in thousands):
YEAR ENDED --------------------------------------------- SEPTEMBER 30, SEPTEMBER 30, AUGUST 31, 1999 1998 1997 ------------ ------------ ------------ Numerator: Numerator for basic and diluted earnings per share -- income (loss) available to common stockholders......... $ (1,487) $ (7,032) $ 2,275 ============ ============ ============ Denominator: Denominator for basic earnings per share -- weighted-average shares................................ 8,454 8,263 5,592 Effect of dilutive securities: Stock options and warrants............................ - - 634 Convertible preferred stock........................... - - 970 ------------ ------------ ------------ Dilutive potential common shares......................... - - 1,604 Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions............................................ 8,454 8,263 7,196 ============ ============ ============ Basic earnings per share................................... $ (.18) $ (.85) $ .41 ============ ============ ============ Diluted earnings per share................................. $ (.18) $ (.85) $ .32 ============ ============ ============
7. COMMITMENTS AND CONTINGENCIES LEASE COMMITMENTS The Company leases its operating, office and other facilities as well as certain vehicles and equipment under non-cancellable operating leases. The operating and office facilities leases contain escalation clauses and options for renewal and extend through June 2007. Future minimum rental payments (excluding common area maintenance charges) required under the operating leases for each of the remaining fiscal years ending subsequent to September 30, 1999 are as follows: 2000.............................................. $ 857,000 2001.............................................. 632,000 2002.............................................. 452,000 2003.............................................. 391,000 2004.............................................. 357,000 Thereafter........................................ 977,000 ----------- $ 3,666,000 =========== Rent expense was $1,191,000, $1,528,000, and $1,063,000 for the years ended September 30, 1999, September 3, 1997 and August 31, 1997, respectively. 8. GEOGRAPHIC INFORMATION The Company designs, manufactures and markets high performance optics for industrial, processing, medical, aerospace and defense markets. Export sales from U.S. continuing operations to unaffiliated customers located principally in Europe and the Asia Pacific region amounted to 13%, 30%, and 33% of total revenue in 1999, 1998 and 1997, respectively. Information with respect to the Company's continuing operations by significant geographic area is set forth below. Transfers between geographic areas have been shown at the agreed upon transfer price. All transactions denominated in foreign currency have been translated at the average exchange rates during the period. 37 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) The identifiable assets located in the United States include assets located in Mexico, which are not considered significant.
YEAR ENDED SEPTEMBER 30, 1999 ------------------------------------------------------------------- UNITED CONSOLIDATED STATES EUROPE ELIMINATIONS TOTAL --------------- --------------- --------------- --------------- Sales to unaffiliated customers......................... $ 29,270,046 $ 4,740,131 $ - $ 34,010,177 Transfers between geographic areas...................... 2,037,483 - (2,037,483) - --------------- --------------- --------------- --------------- Total revenue........................................... $ 31,307,529 $ 4,740,131 $ (2,037,483) $ 34,010,177 =============== =============== =============== =============== Income (loss) before income taxes....................... $ 1,586,605 $ 81,322 $ (18,427) $ 1,649,500 =============== =============== =============== =============== Identifiable assets..................................... $ 26,556,347 $ 2,146,119 $ (6,794,285) $ 21,908,181 =============== =============== =============== =============== YEAR ENDED SEPTEMBER 30, 1998 ------------------------------------------------------------------- UNITED CONSOLIDATED STATES EUROPE ELIMINATIONS TOTAL --------------- --------------- --------------- --------------- Sales to unaffiliated customers......................... $ 25,759,723 $ 4,356,152 $ - $ 30,115,875 Transfers between geographic areas..................... 2,192,342 - (2,192,342) - --------------- --------------- --------------- --------------- Total revenue........................................... $ 27,952,065 $ 4,356,152 $ (2,192,342) $ 30,115,875 =============== =============== =============== =============== Income (loss) before income taxes....................... $ (3,762,730) $ 200,307 $ (51,337) $ (3,613,760) =============== =============== =============== =============== Identifiable assets..................................... $ 23,965,886 $ 2,387,980 $ (1,735,653) $ 24,618,213 =============== =============== =============== =============== YEAR ENDED AUGUST 31, 1997 ------------------------------------------------------------------- UNITED CONSOLIDATED STATES EUROPE ELIMINATIONS TOTAL --------------- --------------- --------------- --------------- Sales to unaffiliated customers......................... $ 26,020,906 $ 3,719,523 $ - $ 29,740,429 Transfers between geographic areas...................... 1,391,125 - (1,391,125) - --------------- --------------- --------------- --------------- Total revenue........................................... $27,412,031 $ 3,719,523 $ (1,391,125) $ 29,740,429 =============== =============== =============== =============== Income before income taxes.............................. $ 2,780,753 $ 170,651 $ 13,619 $ 2,965,023 =============== =============== =============== =============== Identifiable assets..................................... $ 27,763,976 $ 2,009,946 $ (1,655,280) $28,118,642 =============== =============== =============== ===============
9. EMPLOYEE BENEFIT PLAN The Company has a defined contribution plan (the "Plan") covering substantially all employees that have been employed for at least 90 days and meet certain age requirements. Employees may contribute up to 16% of their compensation per year (subject to a maximum limit by federal tax law). The Company is obligated to make matching contributions equal to 50% of the employee's contribution up to a maximum of 6% of the employee's compensation. At the discretion of the Board of Directors, the Company may make additional contributions. Prior to its merger with the Company, EMI had a defined contribution plan with contributions based on a profit-sharing formula. Subsequent to the merger, the EMI plan was terminated and participant balances rolled over into the Company's plan. The Company's contributions charged to continuing operations, which include contributions to the EMI plan prior to its termination, were $197,000, $381,000 and $275,000 for the years ended September 30, 1999, September 30, 1998 and August 31, 1997, respectively. 10. SUBSEQUENT EVENT In October 1999, the Company and certain directors of the Company were sued by a group of shareholders. The complaint asserts claims as a class action for purported breaches of fiduciary duty in connection with the Company's rejection of an acquisition proposal. The Company and a number of the individual defendants have moved to dismiss, and no briefing schedule has been set for the motion. No trial date has been scheduled. Management believes such claims are without merit and intends to vigorously defend its position if required. 38 LASER POWER CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) 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 San Diego, County of San Diego, State of California, on the 29th day of December, 1999. LASER POWER CORPORATION By /s/ PAUL P. WICKMAN -------------------------------------- Paul P. Wickman, Jr. SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Dick Sharman and Paul P. Wickman, Jr., or any of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connections therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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/ DICK SHARMAN Chief Executive Officer and Director December 29, 1999 - ---------------------------------------- (Principal Executive Officer) Dick Sharman /s/ PAUL P. WICKMAN Senior Vice President and Chief Financial Officer December 29, 1999 - ---------------------------------------- (Principal Financial and Accounting Officer) Paul P. Wickman, Jr. /s/ ROBERT G. KLIMASEWSKI Chairman of the Board December 29, 1999 - ---------------------------------------- Robert G. Klimasewski /s/ DOUGLAS H. TANIMOTO Director December 29, 1999 - ---------------------------------------- Douglas H. Tanimoto, Ph.D. /s/ WILLIAM G. FREDRICK Director December 29, 1999 - ---------------------------------------- William G. Fredrick /s/ JOHN C. STISKA Director December 29, 1999 - ---------------------------------------- John C. Stiska /s/ ROBERT P. PERKINS Director December 29, 1999 - ---------------------------------------- Robert P. Perkins
39 EX-2.1 2 ASSET PURCHASE AGREEMENT - MELLES GRIOT, INC. ASSET PURCHASE AGREEMENT BY AND BETWEEN MELLES GRIOT, INC. AND LASER POWER CORPORATION December 16, 1999 TABLE OF CONTENTS Page ARTICLE I DEFINITIONS..............................................1 Section 1.1 Definitions..............................................1 ARTICLE II SALE AND PURCHASE OF THE ASSETS..........................7 Section 2.1 Sale and Purchase of the Assets..........................7 Section 2.2 Assumption of Liabilities................................7 Section 2.3 Liabilities Not Assumed..................................8 Section 2.4 Purchase Price...........................................9 Section 2.5 Instruments of Conveyance and Transfer..................10 Section 2.6 Transfer of Permits.....................................11 Section 2.7 Further Assurances......................................11 Section 2.8 Diligence in Pursuing Sales of Products.................12 ARTICLE III CLOSING.................................................12 Section 3.1 Closing.................................................12 Section 3.2 Deliveries at Closing...................................12 ARTICLE IV REPRESENTATIONS AND WARRANTIES OF SELLER................13 Section 4.1 Corporate Existence.....................................13 Section 4.2 Seller's Authority Relative to this Agreement...........13 Section 4.3 Title to Properties, Etc................................13 Section 4.4 Equipment...............................................14 Section 4.5 Inventory...............................................14 Section 4.6 Customers...............................................14 Section 4.7 Suppliers...............................................14 Section 4.8 Customers and Suppliers.................................14 Section 4.9 Accounts Receivable.....................................14 Section 4.10 Intellectual Property...................................14 Section 4.11 Material Contracts......................................15 Section 4.12 Absence of Certain Changes..............................16 Section 4.13 Tax Matters.............................................17 Section 4.14 No Default; Compliance with Laws........................18 Section 4.15 Litigation..............................................18 Section 4.16 Product Liability.......................................18 Section 4.17 Insurance...............................................18 Section 4.18 Licenses, Permits, Etc..................................18 Section 4.19 Interest in Competitors, Suppliers, Customers, etc......19 Section 4.20 Questionable Payments...................................19 Section 4.21 Year 2000 Compliance....................................19 Section 4.22 At-Will Employees.......................................19 i Section 4.23 No Brokers..............................................19 ARTICLE V REPRESENTATIONS AND WARRANTIES OF BUYER.................19 Section 5.1 Corporate Existence.....................................19 Section 5.2 Buyer's Authority Relative to this Agreement............19 Section 5.3 Absence of Litigation...................................20 Section 5.4 No Further Approval.....................................20 ARTICLE VI OTHER MATTERS...........................................20 Section 6.1 Retention Bonus Payments................................20 Section 6.2 American Laser Accounts Receivable......................20 Section 6.3 Balancing Payment.......................................21 ARTICLE VII COVENANTS OF SELLER.....................................21 Section 7.1 Conduct of Business.....................................21 Section 7.2 Access to Information...................................21 Section 7.3 Preservation of Business Organization...................22 Section 7.4 Trade Secrets...........................................22 Section 7.5 Consents of Third Parties...............................22 Section 7.6 Collection of Receivables...............................22 Section 7.7 Supply Contracts........................................22 Section 7.8 Royalties...............................................22 Section 7.10 Acknowledgments by Seller...............................23 Section 7.11 Confidential Information................................23 Section 7.12 Noncompetition Agreement of Seller......................24 ARTICLE VIII CONDITIONS TO OBLIGATIONS OF BUYER......................25 Section 8.1 Seller's Representations and Warranties True at Closing.25 Section 8.2 Approval by Counsel.....................................26 Section 8.3 Opinion of Counsel for Seller...........................26 Section 8.4 No Damage or Destruction................................26 Section 8.5 Absence of Restraint....................................26 Section 8.6 Approvals...............................................26 Section 8.7 Employment Agreements...................................26 ARTICLE IX CONDITIONS TO OBLIGATIONS OF SELLER.....................27 Section 9.1 Buyer's Representations and Warranties True at Closing..27 Section 9.2 Approval by Counsel.....................................27 Section 9.3 Opinion of Buyer's Counsel..............................27 ARTICLE X NATURE OF STATEMENTS; SURVIVAL..........................27 ii ARTICLE XI INDEMNITY..............................................28 Section 11.1 Indemnity by Seller....................................28 Section 11.2 Indemnity by Buyer.....................................28 Section 11.3 Third Party Claims.....................................28 Section 11.4 Indemnity Limits.......................................29 Section 11.5 Right of Set-Off.......................................30 ARTICLE XII DISPUTE RESOLUTION.....................................30 Section 12.1 Arbitration............................................30 Section 12.2 Jurisdiction...........................................31 Section 12.3 .......................................................31 ARTICLE XIII TERMINATION............................................31 Section 13.1 Termination............................................31 ARTICLE XIV MISCELLANEOUS..........................................32 Section 14.1 Notices................................................32 Section 14.2 Governing Law..........................................33 Section 14.3 Section Headings.......................................33 Section 14.4 Entire Agreement.......................................33 Section 14.5 Severability...........................................33 Section 14.6 Assignment; Successors and Assigns.....................33 Section 14.7 Amendment..............................................34 Section 14.8 Waiver.................................................34 Section 14.9 Counterparts...........................................34 Section 14.10 Buyer's Remedies for Seller's Breach of Confidentiality and Noncompetition.....................................34 Section 14.11 Buyer's Right to Specific Performance..................34 Section 14.12 Bulk Sales.............................................34 Section 14.13 Fees and Expenses......................................35 Section 14.14 Prorations and Transfer Taxes..........................35 Section 14.15 Sales Tax..............................................35 Section 14.16 Announcements..........................................35 iii SCHEDULES AND EXHIBITS - ---------------------- Schedule 1.1(a) Products Schedule 2.1(a) Equipment Schedule 2.1(b) Inventory Schedule 2.1(c) Intellectual Property Schedule 2.1(d) Accounts Receivable Schedule 2.1(e) Acquired Contracts Schedule 2.1(i) Permits Schedule 4.3 Permitted Liens Schedule 4.6 Customers of the Business Schedule 4.7 Suppliers of the Business Schedule 4.8 Adverse Changes in Customer and Supplier Relationships Schedule 4.10(a) Licenses and Other Agreements in Respect of Intellectual Property Listed at Schedule 2.1(c) Schedule 4.10(a)(1) Intellectual Property Infringements Schedule 4.10(b) Related Party Ownership of Patents and Inventions Schedule 4.10(c) New Developments with Respect to Business or Products Schedule 4.11(a) Material Contracts Schedule 4.11(b) Non-Assignable Contracts Schedule 4.12 Absence of Certain Changes Schedule 4.12(b) Absence of Certain Employee Compensation Changes Schedule 4.14 No Default; Compliance with Laws Schedule 4.15(a) Litigation Schedule 4.15(b) Continuing Orders Schedule 4.16(a) Seller's Standard Warranties Schedule 4.16(b) Product Liability Claims Not Covered by Insurance Schedule 4.17 Insurance Schedule 4.18 Licenses, Permits, Etc. Schedule 4.19 Interest in Competitors, Suppliers, Customers, etc. Schedule 5.6 No Inducement Employees Schedule 6.1 Employees of the Business Schedule 7.13 Release of Certain Liens Schedule 8.7 Key Employees Exhibit A Interim Balance Sheet Exhibit B Bill of Sale Exhibit C Assignment (Acquired Contracts and Accounts Receivable) Exhibit D Assignment (Intellectual Property) Exhibit D-1 Assignment (Registered Patents) Exhibit F Seller's Opinion of Counsel Exhibit G Buyer's Opinion of Counsel iv ASSET PURCHASE AGREEMENT THIS ASSET PURCHASE AGREEMENT (this "Agreement") dated as of December 16, 1999, is made and entered into by and between Melles Griot, Inc., a Nevada corporation ("Buyer"), and Laser Power Corporation, a Delaware corporation ("Seller"). RECITALS WHEREAS, the parties hereto desire that Seller sell and Buyer purchase certain operating assets (including fixed assets, inventory, accounts receivable and intellectual property) of Seller used in and associated with the business of Seller's Microcavity Laser Division, excluding the 1550 nm laser product line, (the "BUSINESS"), all in accordance with and subject to the terms and provisions of this Agreement; and WHEREAS, the parties hereto desire to set forth certain representations, warranties and covenants made by each to the other as an inducement to the execution, delivery and performance of this Agreement. NOW, THEREFORE, expressly incorporating the foregoing Recitals as part of the consideration hereof and in further consideration of the premises and of the mutual representations, warranties, covenants and agreements contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I DEFINITIONS Section 1.1 DEFINITIONS. The following terms, as used herein, have the following meanings: "ACCOUNTS RECEIVABLE" shall mean the accounts receivable of Seller relating to the Business and remaining unpaid at the Closing Date as set forth on the attached Schedule 2.1(d). "ACQUIRED CONTRACTS" shall have the meaning ascribed to it in Section 2.1(e) hereof. "ACQUIRED RECORDS" shall mean copies of all Records relating to the Business or the Assets. "ADJUSTMENT FUND" shall have the meaning ascribed to it in Section 2.4(a)(i) hereof. "ADVANCED ROYALTY PAYMENT" shall have the meaning ascribed to it in Section 2.4(b)(i) hereof. "AFFILIATE" shall mean, with respect to any Person, any Person directly or indirectly controlling, controlled by, or under common control with such other Person. 1 "ASSETS" shall have the meaning ascribed to it in Section 2.1 hereof. "ASSUMED LIABILITIES" shall have the meaning ascribed to it in Section 2.2 hereof. "BENEFIT PLAN" means any plan, program, trust, contract, policy or arrangement which is sponsored by Seller or to which Seller contributes, and that provides any pension, retirement, profit sharing, bonus, deferred or incentive compensation, life, health, post-retirement, medical, disability, accident, stock option, stock purchase, stock appreciation, severance payments, fringe benefits, vacation pay, holiday pay, sick pay or similar benefit to employees of the Business, whether or not such plan, program, trust, contract, policy or arrangement is an "employee benefit plan" within the meaning of Section 3(3) of ERISA. "BUSINESS" shall have the meaning ascribed to it in the first Recital to this Agreement. "BUYER" shall have the meaning ascribed to it in the first paragraph of this Agreement. "CASH PAYMENT" shall have the meaning ascribed to it is Section 2.4 hereof. "CLOSING" shall have the meaning ascribed to it in Section 3.1 hereof. "CLOSING BALANCE SHEET" shall have the meaning ascribed to it in Section 2.4(a)(ii). "CLOSING DATE" shall have the meaning ascribed to it in Section 3.1 hereof. "CODE" shall mean the Internal Revenue Code of 1986, as amended. "CONFIDENTIAL INFORMATION" shall have the meaning ascribed to it in Section 7.11 hereof. "CONTRACT" shall mean any agreement, contract, obligation, promise, or undertaking (whether written or oral and whether express or implied) that is legally binding. "DAMAGES" shall have the meaning ascribed to it in Section 11.1 hereof. "EMPLOYEES" shall mean employees of the Business as of the date of this Agreement. "EQUIPMENT" shall mean the machinery, equipment, computers, hardware, computer software, furniture, fixtures, vehicles, tools, dies, supplies, and other tangible personal property set forth on the attached Schedule 2.1(a). "GAAP" shall mean generally accepted United States accounting principles, applied on a basis consistent with the basis on which the Seller's Audited Consolidated Financial Statements for the years ending August 31, 1997 and September 30, 1998 were prepared. 2 "GOVERNMENTAL AUTHORIZATION" shall mean any approval, consent, license, permit, waiver, or other authorization issued, granted, given, or otherwise made available by or under the authority of any Governmental Body or pursuant to any Legal Requirement. "GOVERNMENTAL BODY" shall mean any (i) nation, state, county, city, district, or other jurisdiction of any nature; (ii) federal, state, local, municipal, foreign or other government; (iii) governmental or quasi-governmental authority of any nature (including any governmental agency, branch, department, official, or entity and any court or other tribunal); or (iv) multi-national organization or body; exercising, or entitled to exercise, any administrative, executive, judicial, legislative, police, regulatory, or taxing authority or power of any nature. "INTELLECTUAL PROPERTY" shall mean any patents, patent applications, licenses, and Trademarks set forth on Schedule 2.1(c), as well as all patents, patent applications, licenses, industrial design registrations, utility models, mask works, mask work registrations, copyrights, copyright registrations, applications for copyright registration, Trademarks, trade names, trade secrets, processes, designs, formulas, rights to technology, inventions, licenses, computer software, all product know-how, including engineering drawings, engineering notebooks, specifications, designs, manufacturing procedures and documentation, schematics, blueprints, files, records, notes or computer disks, tapes or other storage media associated therewith, owned by Seller, licensed to Seller, used or held for use in connection with the design, manufacture, fabrication or production of any of the Products, owned by Seller, licensed to Seller, used or held for use in connection with the Business, and approvals owned, applied for, held or licensed to or by Seller, related to or in connection with the Business or the Products. "INTERIM BALANCE SHEET" shall mean the unaudited balance sheet of the Assets, dated as of October 31, 1999, attached hereto as Exhibit A. "INTERIM NET VALUE OF PURCHASED ASSETS" shall mean the net value of purchased assets set forth on the Interim Balance Sheet. "INVENTORY" shall mean the inventories of raw materials, work-in-process and finished Products held for sale, and general stores, spare parts and other items relating to the Products set forth on the attached Schedule 2.1(b), including, without limitation, Seller's rights in and to raw materials previously ordered and currently in transit to the Business, but excluding any finished products shipped to customers on or before the Closing Date. "IRS" shall mean the United States Internal Revenue Service or any successor agency, and, to the extent relevant, the United States Department of the Treasury. "KEY EMPLOYEES" shall have the meaning ascribed to it in Section 8.8. "KNOWLEDGE" Seller will be deemed to have "Knowledge" of a particular fact or other matter if Dick Sharman, Paul Wickman, Dean Hodges, or David Hargis: (a) is actually aware of such fact or other matter; or 3 (b) could be expected to discover or otherwise become aware of such fact or other matter in the course of conducting a reasonably comprehensive investigation concerning the existence of such fact or other matter. "LEGAL ACTION" shall have the meaning ascribed to it in Section 11.3(b) hereof. "LEGAL REQUIREMENT" shall mean any federal, state, local, municipal, foreign, international, multinational, or other administrative order, constitution, law, ordinance, principle of common law, regulation, statute, or treaty. "LIENS" shall mean any liabilities, security interests, claims, charges, conditions, equitable interests, liens, options, mortgages, pledges, title defects, conditional sales or other title retention agreements, obligations, commitments or other encumbrances of any nature whatsoever. "MONTHLY ROYALTY AMOUNTS" shall have the meaning ascribed to it in Section 2.4(b)(ii). "NET VALUE OF PURCHASED ASSETS" shall mean that portion of the Purchase Price which is set forth on the Closing Balance Sheet, as adjusted by the parties in accordance with Section 2.4(a) of this Agreement. "OCCUPATIONAL SAFETY AND HEALTH LAW" shall mean any Legal Requirement designed to provide safe and healthful working conditions and to reduce occupational safety and health hazards, and any program, whether governmental or private (including those promulgated or sponsored by industry associations and insurance companies), designed to provide safe and healthful working conditions. "ORDER" shall mean any award, decision, injunction, judgment, order, ruling, subpoena, or verdict entered, issued, made, or rendered by any court, administrative agency, or other Governmental Body or by any arbitrator. "ORDINARY COURSE OF BUSINESS" shall mean an action taken by a Person will be deemed to have been taken in the "Ordinary Course of Business" only if: (a) such action is consistent with the past practices of such Person and is taken in the ordinary course of the normal day-to-day operations of such Person; (b) such action is not required to be authorized by the board of directors of such Person (or by any Person or group of Persons exercising similar authority); and (c) such action is similar in nature and magnitude to actions customarily taken, without any authorization by the board of directors (or by any Person or group of Persons exercising similar authority), in the ordinary course of the normal day-to-day operations of other Persons that are in the same line of business as such Person. 4 "ORGANIZATIONAL DOCUMENTS" shall mean (a) the articles or certificate of incorporation and the bylaws of a corporation; (b) any charter or similar document adopted or filed in connection with the creation, formation, or organization of a Person; and (c) any amendment to any of the foregoing. "PERMITS" shall mean the licenses, permits, approvals and authorizations of any Governmental Body which are necessary to the conduct of the Business and which are transferable, set forth on the attached Schedule 2.1(i). "PERMITTED LIENS" shall mean, (i) liens for taxes not yet due and payable or being contested in good faith by appropriate proceedings and for which an adequate reserve has been set aside; (ii) inchoate liens of materialmen and suppliers and other like liens which have not yet been asserted and which are incurred in the ordinary course of business securing obligations that are not overdue; and (iii) those Liens set forth on Schedule 4.3 hereto. "PERSON" shall mean any individual, corporation (including any non-profit corporation), general or limited partnership, limited liability company, joint venture, estate, trust, association, organization, labor union, other legal or commercial entity or Governmental Body. "PROCEEDING" shall mean any action, arbitration, audit, hearing, investigation, litigation, or suit (whether civil, criminal, administrative, investigative, or informal) commenced, brought, conducted, or heard by or before, or otherwise involving, any Governmental Body or arbitrator. "PRODUCTS" shall mean the products listed or described on the attached Schedule 1.1(a). "PURCHASE PRICE" shall have the meaning ascribed to it in Section 2.4 hereof. "REASONABLE BEST EFFORTS" shall mean the reasonable efforts that a prudent Person desirous of achieving a result would use in similar circumstances to achieve such result as expeditiously as possible. "RECORDS" shall mean books, files, and records including any accounting reports, data processing or computer reports and information used therewith, and vendor lists, customer lists, mailing lists, personnel records, copies of business records, computer disks, computer tapes or other storage media, operating data, property records, production data, royalty statements, manufacturing and quality control records and other data and databases. "RETAINED LIABILITIES" shall have the meaning ascribed to it in Section 2.3 hereof. "ROYALTY PERIOD" shall have the meaning ascribed to it in Section 2.4(b)(ii). "SELLER" shall have the meaning ascribed to it in the first paragraph of this Agreement. "SYSTEMS" shall have the meaning ascribed to it in Section 4.21 hereof. 5 "TAX" shall mean any tax (including any income tax, capital gains tax, value added tax, sales tax, property tax, gift tax, or estate tax), levy, assessment, tariff, duty (including any customs duty), deficiency, or other fee, and any related charge or amount (including any fine, penalty, interest, or addition to tax), imposed, assessed, or collected by or under the authority of any Governmental Body or payable pursuant to any tax-sharing agreement or any other Contract relating to the sharing or payment of any such tax, levy, assessment, tariff, duty, deficiency, or fee. "TAX RETURN" shall mean any return (including any information return), report, statement, schedule, notice, form, or other document or information filed with or submitted to, or required to be filed with or submitted to, any Governmental Body in connection with the determination, assessment, collection, or payment of any Tax or in connection with the administration, implementation, or enforcement of or compliance with any Legal Requirement relating to any Tax. "THREATENED" shall mean a claim, Proceeding, dispute, action, or other matter will be deemed to have been "Threatened" if any demand or statement has been made (orally if made to Dick Sharman, Paul Wickman, Dean Hodges, or David Hargis, or in writing) or any notice has been given (orally if made to Dick Sharman, Paul Wickman, Dean Hodges, or David Hargis, or in writing), or if Seller has Knowledge of any other event or circumstances that would lead a prudent Person to conclude that such a claim, Proceeding, dispute, action, or other matter is likely to be asserted, commenced, taken, or otherwise pursued in the future. "TERRITORY" shall have the meaning ascribed to it in Section 7.10(c) hereof. "TRADEMARKS" shall mean trademarks and service marks, including the goodwill associated therewith, trademark and service mark registrations, and applications for trademark and service mark registrations. "YEAR 2000 COMPLIANT" shall have the meaning ascribed to it in Section 4.21 hereof. 6 ARTICLE II SALE AND PURCHASE OF THE ASSETS Section 2.1 SALE AND PURCHASE OF THE ASSETS. Seller, at the Closing, will sell, convey, transfer or assign and deliver to Buyer, free and clear of all Liens, except Permitted Liens and Buyer will purchase from Seller, all Seller's right, title and interest in and to the Assets (as hereinafter defined). As used herein, "ASSETS" shall mean the following assets: (a) the Equipment; (b) the Inventory; (c) the Intellectual Property; (d) the Accounts Receivable; (e) all rights under any contracts listed in Schedule 2.1(e) ("ACQUIRED CONTRACTS"), except to the extent related to Retained Liabilities; (f) all rights, claims, commitments and warranties relating to the Business, and all other rights relating to the Assets; (g) all prepaid expenses and deposits of the Business having an ongoing value to Buyer for use in the Business; (h) the Acquired Records; (i) the Permits; and (j) all sales literature, catalogues, art work, promotional literature and other selling material associated with, used or employed by Seller in connection with the Business (the "SALES LITERATURE"). Section 2.2 ASSUMPTION OF LIABILITIES. (a) Subject to the terms and conditions of this Agreement, and in further consideration for the transfer and delivery of the Assets to the Buyer, and in reliance on the representations and warranties of Seller herein contained, Buyer, from and after the Closing Date, shall: (i) assume and agree to observe, perform and fulfill the terms and conditions of the Acquired Contracts transferred pursuant to Section 2.1 hereof; provided, however, that there shall exist no default or condition that, with notice or the passage of time, or both, might constitute a default with respect to such agreements, and no default will exist upon assignment of any such agreement to Buyer; and 7 (ii) assume and agree to pay and discharge all debts, liabilities and obligations arising out of the Buyer's conduct of the Business and the ownership of the Assets (except as provided in Section 2.2(a)(i) above) of any kind, character or description, whether accrued, absolute, contingent or otherwise including any and all Product warranty obligations for repairs to Products (the "Product Repair Claims") that arise before or after the Closing Date, or any obligations under any of the Permits that arise after the Closing Date. (b) The obligations and liabilities which are required to be assumed by the Buyer under this Section 2.2 are herein referred to as the "ASSUMED LIABILITIES." The undertakings of the Buyer referred to in this Section 2.2 shall not in any way limit the Buyer's right of recourse for any breach of the covenants, representations or warranties of the Seller contained in this Agreement. Nothing contained in this Agreement shall be deemed or construed to foreclose the Buyer from contesting in good faith the duties and liabilities to third parties which are assumed by the Buyer pursuant to this Agreement. Section 2.3 LIABILITIES NOT ASSUMED. Except as specifically provided in this Agreement (including, without limitation, the terms of Section 2.2 hereof), regardless of when asserted or claimed, Buyer shall not assume or be bound by and Seller shall retain and shall be solely responsible for all obligations and liabilities of Seller and the Business (all such liabilities and obligations being herein referred to as the "RETAINED LIABILITIES") including, but not limited to: (a) any and all liabilities and obligations, whether civil or criminal in nature, arising out of, relating to or involving the Business and existing before the Closing or any violation by Seller of any term or provision of any Legal Requirements, except for warranty obligations provided for in Section 2.2(a)(ii) hereof; (b) any and all obligations or liabilities relating to the Business, the existence of which constitutes a breach of Seller's representations or warranties under this Agreement; (c) any and all product liability of Seller (whether or not asserted on or before or after the Closing Date, but excluding the Product Repair Claims) in connection with the Business or the Products manufactured, sold or serviced prior to the Closing Date by Seller or Seller's agents or produced by any third party and sold or serviced by Seller or Seller's agents prior to the Closing Date; (d) any and all Proceeding(s) arising from the conduct of the Business before the Closing, including any liability arising from any environmental condition either existing before the Closing or arising from the conduct of the Business before the Closing; (e) any income tax liability of Seller and any penalties and interest related thereto; (f) any debt or liability for borrowed funds; 8 (g) any liability arising out of or related to the sponsorship of, the responsibility for, contributions to, or any liability in connection with any Benefit Plan maintained or contributed to by Seller; without limiting the foregoing, Seller shall be liable for any continuation coverage (including any penalties, excise taxes or interest resulting from the failure to provide continuation coverage) required by law due to qualifying events which occur on or before the Closing Date; (h) any obligation or liability of Seller or arising from the Seller's conduct of the Business before the Closing which is not specifically assumed by the Buyer pursuant to Section 2.2 hereof; (i) any obligation or liability for increased Worker's Compensation premiums relating to the period prior to Closing. Section 2.4 PURCHASE PRICE. Subject to the terms and conditions of this Agreement, in reliance upon the representations and warranties of Seller contained herein, and in consideration of the transfer of the Assets described in Section 2.1 as herein provided, on the Closing Date, Buyer agrees to purchase the Assets for an aggregate purchase price (the "PURCHASE PRICE") equal to: (i) the Net Value of Purchased Assets (the "CASH PAYMENT"), plus (ii) royalty payments as required by Section 2.4(b) hereof. (a) CASH PAYMENT. (i) An amount equal to ninety percent (90%) of the Interim Net Value of Purchased Assets shall be paid to Seller by wire transfer at Closing. An amount equal to ten percent (10%) of the Interim Net Value of Purchased Assets shall be held by Buyer pending agreement of the parties on the Closing Balance Sheet (the "ADJUSTMENT FUND"). (ii) Within ten (10) days following the Closing, Seller shall provide Buyer with a balance sheet reflecting the Net Value of Purchased Assets as of the Closing Date ("CLOSING BALANCE SHEET"). Buyer shall have fifteen (15) days to review the Closing Balance Sheet and to provide Seller with any proposed adjustments to the Closing Balance Sheet. Seller shall then have five (5) days thereafter to accept or reject such proposed adjustments. (iii) Upon agreement of the parties on the Closing Balance Sheet, and any adjustments thereto pursuant to Section 2.4(a)(ii) above, the Adjustment Fund shall be distributed as follows: (1) If the Net Value of Purchased Assets is equal to the Interim Net Value of Purchased Assets, then the Adjustment Fund shall be paid to Seller immediately by wire transfer; (2) If the Net Value of Purchased Assets is greater than the Interim Net Value of Purchased Assets, then the Adjustment Fund, plus the difference between the Net Value of Purchased Assets and the Interim Net Value of Purchased Assets, shall be paid to Seller immediately by wire transfer; or 9 (3) If the Net Value of Purchased Assets is less than the Interim Net Value of Purchased Assets, then the difference between the Net Value of Purchased Assets and the Interim Net Value of Purchased Assets shall be subtracted from the Adjustment Fund and the balance of the Adjustment Fund, if any, paid to Seller immediately by wire transfer. In the event that the Adjustment Fund is reduced below $0, then the Seller shall immediately repay to Buyer any negative balance by wire transfer. (iv) In the event the parties cannot agree within fifteen (15) days of Seller's receipt of Buyer's proposed adjustments to the Closing Balance Sheet, then the parties agree to submit the matter to arbitration pursuant to Section 12 of this Agreement. (b) ROYALTY PAYMENT (i) ADVANCED ROYALTY PAYMENT. Buyer shall pay a portion of the royalty payment ("ADVANCED ROYALTY PAYMENT") on November 1, 2000, in the amount of US $920,000. (ii) ADDITIONAL ROYALTY PAYMENTS. During the period October 1, 2000 through September 30, 2003 (the "ROYALTY PERIOD"), royalties of nine and two tenths percent (9.2 %) of the Net Sales Proceeds of the sales of microcavity laser products invoiced by Buyer in a given month shall accrue, PROVIDED, HOWEVER, that the sales price of microcavity laser products invoiced to Affiliates of Buyer during the Royalty Period shall be increased by twelve percent (12%) for purposes of this royalty calculation ("ROYALTY AMOUNTS") and shall be paid to Seller, in arrears, in monthly installments by wire transfer to an account designated by Seller ("MONTHLY ROYALTY AMOUNTS"). Notwithstanding anything contained herein to the contrary, no Monthly Royalty Amounts shall be made until the full amount of the Advanced Royalty Payment has been fully offset by the Royalty Amounts, and PROVIDED FURTHER, that in no event shall the sum of the Advanced Royalty Payment, and the Monthly Royalty Amounts exceed US$2,668,000. For purposes of this Agreement, "Net Sales Proceeds" shall mean, with respect to any microcavity laser products sold by Buyer, the gross amount billed or invoiced by Buyer to a third party for sales of such products, less the following items, as allocable to such sales: (i) trade discounts, credits or allowances, (ii) credits or allowances additionally granted upon returns, rejections or recalls (except where any such recall arises out of Buyer's or its Affiliate's gross negligence, willful misconduct or fraud), (iii) freight, shipping and insurance charges, (iv) taxes, duties or other governmental tariffs (other than income taxes), and (v) government mandated rebates, if any. Section 2.5 INSTRUMENTS OF CONVEYANCE AND TRANSFER. (a) At the Closing, as contemplated hereby, Seller will execute, acknowledge and deliver to Buyer: (i) duly executed bills of sale substantially in the forms attached hereto as Exhibit B transferring the Equipment, Inventory and certain of the other Assets; 10 (ii) a duly executed assignment in the form attached hereto as Exhibit C transferring the Acquired Contracts and Accounts Receivable, together with such Uniform Commercial Code financing statements as may be required in connection with the transfer of the Accounts Receivable; (iii) duly executed instruments of assignment, transfer or license in the forms attached hereto as Exhibit D, transferring the Intellectual Property; (iv) all Sales Literature and true and complete copies of all Records; and (v) such other documents, instruments, certificates and writings, in form and substance satisfactory to Buyer's counsel, for the conveyance, sale, transfer and assignment of the Assets as shall be required to effectively vest in Buyer good and marketable title to the Assets free and clear of all Liens except Permitted Liens and Seller shall take all such steps as may be required to put the Buyer in actual possession and operating control of the Assets as contemplated hereby. (b) To the extent that the assignment of any lease, license, Contract, commitment or right shall require the consent of any other party thereto, this Agreement shall not constitute an agreement to assign the same if an attempted assignment would constitute a breach thereof; and to the extent that the transfer of any Permit shall require the consent of the Governmental Body which issued such Permit, this Agreement shall not constitute an agreement to transfer any such Permit if an attempted transfer would invalidate such Permit. Other than with respect to the Intellectual Property, if any lease, license, Contract, commitment, right, Permit or other asset or property which is part of the Assets cannot, in the opinion of the Buyer's counsel, be transferred effectively to the Buyer without the consent of a third party, the Seller shall thereafter be obligated to use its Reasonable Best Efforts to assure the Buyer of the benefits of such lease, license, Contract, commitment, right, Permit, or other asset or property. Section 2.6 TRANSFER OF PERMITS. The Seller and the Buyer shall, before and after the Closing, take all reasonable action as may be necessary or appropriate, in the opinion of the Buyer, to transfer to the Buyer all of the Permits set forth on Schedule 2.1(i), to the end that the Buyer shall be substituted for the Seller as the approved party under such Permits. Section 2.7 FURTHER ASSURANCES. The Seller shall, at the Closing and at any time and from time to time at the Buyer's request and without further consideration, execute, acknowledge and deliver such further instruments of conveyance, sale, transfer, assignment and confirmation in addition to those delivered pursuant to Section 3.2, and shall take such other action as Buyer may reasonably request to more effectively (i) convey, sell, transfer and assign to and vest in Buyer any of the Assets, (ii) confirm the title of Buyer thereto, (iii) deliver the Assets to Buyer, (iv) assist Buyer in exercising rights with respect thereto, and (v) put Buyer in actual possession and operating control of any of the Assets. Section 2.8 DILIGENCE IN PURSUING SALES OF PRODUCTS. Buyer shall use Reasonable Best Efforts to market and sell the microcavity laser products during the Royalty Period at prices competitive in the microcavity laser market. 11 ARTICLE III CLOSING Section 3.1 CLOSING. The closing of the transactions contemplated by this Agreement (referred to herein as the "CLOSING") shall take place at the offices of Cooley Godward LLP, 4365 Executive Drive, Suite 1100, San Diego, California 92121-2128 at [______] [__].m. on December ___, 1999, or such other place, time and date to which the parties may agree. The date of the Closing is referred to herein as the "CLOSING DATE." Failure to consummate the transactions contemplated hereby on the Closing Date shall not result in a termination of this Agreement or relieve any party hereto of any obligation hereunder. Section 3.2 DELIVERIES AT CLOSING. (a) At the Closing, Buyer shall deliver the following to Seller: (i) ninety percent (90%) of the Interim Net Value of Purchased Assets as provided for in Section 2.4(a)(i); (ii) the opinion of counsel, agreements, documents, and certificates required in Article 9 of the Agreement; (iii) certified copies of the resolutions duly adopted by the Board of Directors of Buyer constituting all necessary corporate authorization for the consummation by Buyer of the transactions contemplated hereby; and (iv) certificates of incumbency for all relevant officers and directors of Buyer executing this Agreement and any other documents pursuant to this Agreement. (b) At the Closing, Seller shall deliver the following to Buyer: (i) such documents, instruments, certificates and writings required to be delivered by Seller pursuant to Section 2.5; (ii) the opinion of counsel, agreements, documents and certificates required by Article 8 of this Agreement; (iii) certified copies of the resolutions duly adopted by the Board of Directors of Seller constituting all necessary corporate authorization for the consummation by Seller of the transactions contemplated hereby; (iv) certificates of incumbency for all relevant officers and directors of Seller executing this Agreement and any other documents pursuant to this Agreement; and 12 (v) such consents or other documents executed by Seller and such third parties as may, in Buyer's opinion, be required to effectively vest in Buyer good and marketable title to the Intellectual Property; and (vi) such additional documents, instruments, certificates and writings as Buyer may reasonably request to effect the transactions contemplated hereby. ARTICLE IV REPRESENTATIONS AND WARRANTIES OF SELLER Seller represents and warrants to Buyer as follows: Section 4.1 CORPORATE EXISTENCE Seller is a corporation duly organized, validly existing and in good standing under the laws of the State of Delaware and is duly authorized, qualified and licensed under all applicable laws, regulations, ordinances and orders of public authorities to carry on its business in the places and in the manner as now being conducted, except where the failure to be so qualified or licensed would not reasonably be expected to have a material adverse effect on the Seller or the Business. Section 4.2 SELLER'S AUTHORITY RELATIVE TO THIS AGREEMENT. Seller has full corporate power and authority to execute, deliver and perform this Agreement, and the transactions contemplated hereby. The execution, delivery and performance by Seller of this Agreement and the consummation and performance of the transactions contemplated hereby have been duly authorized and approved and no further corporate action is necessary on the part of Seller to make this Agreement, and the transactions contemplated hereby, valid and binding upon Seller in accordance with their terms. Neither the execution, delivery nor performance of this Agreement nor the consummation and performance of the transactions contemplated hereby by Seller will conflict with any provision of the Organizational Documents of Seller, or result in a violation or breach of any term or provision or constitute a default or accelerate the performance required under any Lien or other Material Contract to which Seller is a party or by which it or any of the Assets is bound, or violate any Order applicable to Seller. Section 4.3 TITLE TO PROPERTIES, ETC. Seller has good and marketable title to, and is in possession of, all the Assets, free and clear of all Liens except for liens to be removed prior to Closing and Permitted Liens as set forth on Schedule 4.3 attached hereto. Seller has the right to transfer, sell, convey and assign the Assets without the consent of any other party; and the instruments of transfer, sale, conveyance and assignment to be executed and delivered by Seller to Buyer at the Closing will be valid and binding obligations of Seller and sufficient to transfer, sell, convey and assign to Buyer all right, title and interest of Seller, in and to the Assets. Section 4.4 EQUIPMENT. Schedule 2.1(a) attached hereto sets forth an accurate description of all items of Equipment, including the book value of the items listed thereon. The Equipment being transferred as a portion of the Assets is in good operating condition, is in a state of reasonable maintenance and repair, ordinary wear and tear excepted, and is fit for the ordinary purposes for which such Equipment is used. All of the Equipment conforms in all material respects to all applicable laws. 13 Section 4.5 INVENTORY. Schedule 2.1(b) attached hereto sets forth an accurate description of all Inventory of Seller as of October 31, 1999, including the book value of the items listed thereon. The Inventory consists of items of raw materials and work in process as indicated, and are of good and standard quality, fit for their intended purpose and, in the case of goods covered by a customer or distributor purchase order, of specifications and in quantities corresponding to the customer orders to which they relate. Any of the Inventory that is obsolete, excessive, slow-moving or unsaleable is valued in accordance with GAAP in the books and records of Seller. The values at which the Inventory is carried on Seller's books and records reflect Seller's normal valuation policy as consistently applied. Section 4.6 CUSTOMERS. Schedule 4.6 sets forth a complete and accurate list of all of the customers of the Business during the period beginning December 1, 1998 and ending on the date of this Agreement. Section 4.7 SUPPLIERS. Schedule 4.7 sets forth a complete and accurate list of all of the suppliers of the Business during the period beginning December 1, 1998 and ending on the date of this Agreement. Section 4.8 CUSTOMERS AND SUPPLIERS. There have been no material adverse changes in the relationships between Seller and Seller's customers and suppliers of the Business since December 1, 1998 through the date of this Agreement. Except as and to the extent set forth on Schedule 4.8, Seller has not been provided with any notice that any significant supplier or customer of the Business intends to cease doing business with Seller. Section 4.9 ACCOUNTS RECEIVABLE. The accounts receivable related to the Business owed to Seller as of October 31, 1999 are listed on the attached Schedule 2.1(d). To Seller's Knowledge, all such accounts receivable are collectible in the amounts shown on Schedule 2.1(d). Section 4.10 INTELLECTUAL PROPERTY. The attached Schedule 2.1(c) sets forth a list of all Intellectual Property, together with a summary description and full information in respect of the filing, registration, issuance or status thereof. No Intellectual Property will be adversely affected by the transactions contemplated hereby. Except as set forth on attached Schedule 4.10(a), no licenses, sublicenses, covenants, Contracts, agreements or legally enforceable commitments have been granted or entered into by Seller in respect of such Intellectual Property. Except as set forth on attached Schedule 4.10(a)(1), Seller has no Knowledge of: (i) any infringement or claimed infringement by Seller or its customers of any patent rights, copyrights, trademarks, service marks, trade names, trade secrets, mask work rights or other intellectual property rights of others, (ii) any infringement of rights in and to the Intellectual Property, or of any pending, existing or Threatened Proceedings relating to the Intellectual Property, or (iii) any Threatened or contemplated cancellation or revocation of any Contract granting to the Seller any copyright, or patent or trademark, license or other Intellectual Property right. Except as set forth on attached Schedule 4.10(b), to Seller's Knowledge, no present or past parent or Affiliate, director, officer, employee, stockholder, or consultant of Seller: (i) owns, directly or indirectly, in whole or in part, any 14 interest in and to any Intellectual Property or inventions or patents, or copyrights or applications therefor which Seller is presently using in connection with the Business or related to the Business or Products, or (ii) has made any invention not assigned to Seller which is necessary or desirable for the operation of the Business. Except as set forth on Schedule 4.10(c), as of the date hereof, the Seller has no Knowledge of any new developments with respect to the Business or the Products which are commercially available or any new or improved materials, products, processes, methods or services useful in connection with the Business or the Products which are commercially available and which may adversely affect the sales, properties, Assets, liabilities or condition (financial or otherwise) of the Business. Section 4.11 MATERIAL CONTRACTS. (a) Schedule 4.11(a) is a list of certain material contracts, agreements and other documents to which the Seller is a party or by which it, or the Assets, is bound in connection with the Business and which may involve payments or receipts in excess of $25,000 (the "Material Contracts"). Except for contracts, agreements and other documents listed on Schedule 4.11(a), the Seller is not a party in connection with the Business, nor are any of the Assets in any way bound or obligated by any written or oral: (i) Contracts, agreements or commitments in respect of the sale of products or services, including any existing written warranties given by Seller in connection with the sale of products of the Business that are in force at Closing Date, or for the future purchase of raw materials, supplies, equipment, or other products or utilities; (ii) sales agency or distributorship agreements or franchise agreements, or any legally enforceable commitments or obligations with respect thereto; (iii) collective bargaining agreements, union agreements, employment contracts, consulting agreements or any agreements providing for the services of an independent contractor; (iv) profit-sharing, pension, stock option, severance pay, retirement, bonus, deferred compensation, group life and health insurance or other employee benefit plans, agreements, arrangements or commitments, whether or not legally binding, applicable to any employee employed by Seller in connection with the Business; (v) loan or credit agreements, indentures, guarantees (other than an endorsement made for collection), mortgages, pledges, conditional sales or other title retention agreements, or any equipment financing obligations, leases or lease-purchase agreements; or (vi) Contracts, agreements or legally enforceable commitments, other than those of the types covered by paragraphs (a) through (e) above and as otherwise listed on Schedule 4.11(a), which might materially affect the sales, properties, Assets, liabilities or condition (financial or otherwise) of the Business. 15 (b) A true and complete copy of each Contract, agreement or other document (or, in the case of oral commitments, a description of the material terms thereof) which is listed on Schedule 4.11(a), including all amendments, supplements and modifications thereto, has heretofore been furnished to Buyer. Each such Contract, agreement or other document is in full force and effect and is the binding obligation of the parties thereto. No event or condition has occurred or exists, or, is alleged by any of the other parties to such Contracts, agreements or other documents to have occurred or existed which constitutes, or as a result of the consummation of the transactions contemplated hereby or with the lapse of time or giving of notice or both might constitute a material default or a basis for acceleration of any obligation, force majeure, or other claim of excusable delay or non-performance thereunder or in respect thereof, whether on the part of Seller or any other party. Except as noted on Schedule 4.11(b), each such Contract, agreement or other document may be assigned or otherwise transferred pursuant to this Agreement without consent of any third party. Section 4.12 ABSENCE OF CERTAIN CHANGES. Except as disclosed on Schedule 4.12, since June 30, 1999, the Seller has not: (a) experienced any material adverse change in the Business, or in the prospects or conditions (financial or otherwise) of the Business; (b) (i) except for customary raises granted its Employees in accordance with its past practices, increased or agreed to increase the rate of compensation payable or to become payable by it to any of its Employees, or (ii) made, directly or indirectly, any accrual or arrangement for or payment of bonuses or special compensation of any kind or any severance or termination pay to any present or former Employees other than as described on Schedule 4.12(b) hereto, or (iii) adopted any new, or made any increase in any existing, profit sharing, bonus, deferred compensation, savings, insurance, group life, health insurance, pension, retirement or other employee benefit plan, payment or arrangement made to, for or with any of such Employees; (c) changed accounting methods or practices followed by Seller as it relates to the Business or changed depreciation or amortization policies or rates heretofore adopted in connection with the Assets; (d) borrowed or agreed to borrow any funds or incurred, or become subject to, any obligations or liability (absolute or contingent, whether or not outstanding at present) which materially and adversely affects the Business or any of the Assets except: (i) current liabilities (other than for borrowed money or the deferred purchase price of any assets) incurred in the Ordinary Course of Business and obligations under agreements entered into in the Ordinary Course of Business; and (ii) obligations or liabilities entered into or incurred in connection with the execution of this Agreement; (e) experienced any actual or Threatened employment dispute, demand for recognition, strike, walkout, lockout, slowdown, labor grievance or arbitration, unfair labor practice charge or complaint, labor organizational activity or requests by Employees for union representation, charge of discrimination or unfair employment practice, or any other occurrence, event or condition of any similar character affecting the Employees, directly or indirectly, which may have a material adverse effect on the condition, continued operation or prospects of the Business or on the Assets; 16 (f) granted any powers of attorney or comparable delegations of authority outstanding in connection with the Business which may be binding on Seller; (g) suffered any damage, destruction, loss, waiver of rights or other decreases in the value of any of the Assets of whatever form, whether or not covered by insurance, which individually or in the aggregate is material; (h) canceled or agreed to cancel any debt or claims or entered or agreed to enter into any Contract, agreement or arrangement granting any preferential rights to purchase any of the Assets or requiring the consent of any party to the transfer or assignment of any of the Assets of the Business; (i) learned of any planned or proposed Legal Requirement which has or would have a material and adverse effect on the continued operation, Assets, business condition (financial or otherwise) or prospects of the Business; (j) amended or terminated, or agreed to amend, terminate or permit any termination of, any Contract, agreement or license to which Seller is a party and which affects the Business, if such amendment or termination is or would have a material and adverse effect on the Buyer or the Business, is not at arm's length or is other than in Ordinary Course of Business; or (k) amended, terminated, allowed to lapse or failed to renew any Permit, if such amendment, termination, lapse or failure to renew is or would be material or has or would have an adverse effect on Buyer or the Business. Section 4.13 TAX MATTERS. All foreign, federal, state, county, local and any other Tax, including, without limitation, income taxes, corporate franchise taxes, payroll taxes, sales taxes and ad valorem taxes, due and payable by Seller with respect to the Business on or before the date of this Agreement have been paid and the Seller has filed all Tax Returns and reports required to be filed by it. Section 4.14 NO DEFAULT; COMPLIANCE WITH LAWS. Except as listed on Schedule 4.14: (a) there has been no default in any respect in any material obligation to be performed by Seller under any Material Contract, nor has Seller waived any material right under any such Material Contract; and (b) the Seller has complied in all material respects with all applicable Legal Requirements, including, without limitation, those imposing taxes, in every applicable jurisdiction, in respect of the ownership of the Assets used in connection with the Business and the conduct of the Business. 17 Section 4.15 LITIGATION. Except as set forth on Schedule 4.15(a), there are no Proceedings pending, Threatened or affecting the Seller in connection with the Business or the Assets, including, but not limited to, any such action (a) involving or concerning product liability of any Products designed, produced, manufactured, sold or serviced by the Seller prior to the Closing Date or (b) which question the validity or legality of the transactions contemplated hereby. Seller is not, in connection with the Business, subject to any continuing Order, applicable to it or to the Business or the Assets, and is not, in violation of or in default with respect to any Order, except as set forth on Schedule 4.15(b). Section 4.16 PRODUCT LIABILITY. Seller has not given or made any warranties to third parties with respect to any Products, except for Seller's standard warranties and OEM warranties, true copies of which are attached as Schedule 4.16(a), warranties imposed by the provisions of the applicable commercial codes or for which it is indemnified by third parties. Except as set forth on Schedule 4.16(b), to Seller's Knowledge there is no state of Seller's affairs, nor has any event occurred which may form the basis of any present claim against the Seller in connection with the Business not fully covered by insurance for product liability. Section 4.17 INSURANCE. Schedule 4.17 is a schedule setting forth a list and brief description of all policies of insurance held by the Seller in connection with the Business, copies of which policies have been heretofore furnished to the Buyer. Such policies are (i) in full force and effect, (ii) underwritten by financially sound and reputable insurers, (iii) sufficient for all applicable requirements of law and (iv) in amount, and against such risks, as are generally maintained for comparable businesses and properties in the locality where such business and properties are located. Section 4.18 LICENSES, PERMITS, ETC. Schedule 4.18 is a schedule describing all licenses, product and establishment registrations, franchises, Permits, easements, certificates, consents, rights and privileges necessary to the conduct of the Business, all of which have been obtained by Seller and are valid and in full force. Copies of all such items have heretofore been furnished to the Buyer. Section 4.19 INTEREST IN COMPETITORS, SUPPLIERS, CUSTOMERS, ETC. To Seller's Knowledge, no officer or director of Seller or any spouse or child of any such officer or director, as applicable, has any ownership interest in any competitor, supplier or customer of Seller in connection with the Business, or any property (tangible or intangible) used in the operation of the Business, except as disclosed on Schedule 4.19. Section 4.20 QUESTIONABLE PAYMENTS. To Seller's Knowledge, neither the Seller nor any Employee, agent, or representative as applicable, of Seller has made, directly or indirectly, in connection with the Business, any bribes, kickbacks, illegal payments, political contributions with corporate funds, payments from corporate funds not recorded on the books and records of Seller, payments from corporate funds which were falsely recorded on the books and records of the Seller, payments from corporate funds to governmental officials for improper purposes or illegal payments from corporate funds to obtain or retain business either within the United States or abroad. 18 Section 4.21 YEAR 2000 COMPLIANCE. All computers, hardware, computer software, databases and embedded control systems used by the Seller, to the extent that they constitute part of the Assets (collectively, the "SYSTEMS") are Year 2000 Compliant. As used herein, the term "YEAR 2000 COMPLIANT" means that the Systems (i) accurately process date and time data (including calculating, comparing, and sequencing) from, into and between the twentieth and twenty-first centuries, the years 1999 and 2000, and leap year calculations and (ii) operate accurately with other software and hardware that use standard date format (4 digits) for representation of the year. Section 4.22 AT-WILL EMPLOYEES. It is Seller's published policy that all Employees of the Business are employed "at will". Section 4.23 NO BROKERS. No broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement arising out of any action taken by Seller. ARTICLE V REPRESENTATIONS AND WARRANTIES OF BUYER Buyer represents and warrants to Seller as follows: Section 5.1 CORPORATE EXISTENCE. Buyer is a corporation duly organized, validly existing and in good standing under the laws of the State of Nevada. Buyer is duly qualified to do business and in good standing as a foreign corporation in California. Section 5.2 BUYER'S AUTHORITY RELATIVE TO THIS AGREEMENT. Buyer has full corporate power and authority to execute, deliver and perform this Agreement and the transactions contemplated hereby. The execution, delivery and performance by Buyer of this Agreement and the consummation and performance of the transactions contemplated hereby have been duly authorized and approved and no further corporate action is necessary on the part of Buyer to make this Agreement, and the transactions contemplated hereby, valid and binding upon Buyer in accordance with their terms. Neither the execution, delivery nor performance of this Agreement and consummation and performance of the transactions contemplated hereby by Buyer will conflict with any provision of the Organizational Documents of Buyer, or result in a violation or breach of any term or provision or constitute a default or accelerate the performance required under any Lien or other Contract or agreement to which Buyer is a party or by which it or any of its assets and properties is bound, or violate any Order applicable to Buyer. Section 5.3 ABSENCE OF LITIGATION. There are no claims, actions, suits, proceedings or investigations pending or, to the knowledge of any director or officer of Buyer, threatened against or affecting the ability or right of Buyer to execute and deliver this Agreement or to consummate and perform the transactions contemplated hereby. Section 5.4 NO FURTHER APPROVAL. No approval, authorization, order, license, permit, franchise or consent of, or registration, declaration or filing with, any governmental authority or other person is required in connection with the execution, delivery and performance by Buyer of this Agreement and the consummation of the transactions contemplated hereby. 19 Section 5.5 NO BROKERS. No broker, finder or investment banker is entitled to any brokerage, finder's or other fee or commission in connection with the transactions contemplated by this Agreement arising out of any action taken by Buyer. Section 5.6 NO INDUCEMENT. For a period of three (3) years after the Closing, Buyer will not, directly or indirectly, either for itself, its subsidiary, an Affiliate, or any other Person, induce or attempt to induce any employee of the Seller identified on Schedule 5.6 to leave the employ of the Seller. ARTICLE VI OTHER MATTERS Section 6.1 RETENTION BONUS PAYMENTS. Buyer shall reserve for certain employees set forth on Schedule 6.1: (i) US $80,000, plus (ii) in the event that the Royalty Amounts exceed $920,000, then eight tenths of one percent (.8%) of the Net Sales Proceeds during the Royalty Period shall be distributed to such employees (to the extent that such employee is an employee of Buyer at the time such funds are to be distributed) in the form of a bonus. In no event shall such bonus amounts exceed US $232,000. Section 6.2 AMERICAN LASER ACCOUNTS RECEIVABLE. For each microcavity laser that Buyer ships to American Laser Corporation, Buyer shall remit to Seller the value of one microcavity laser. In the event American Laser pays to Buyer any amounts unrelated to or independent from the shipment of microcavity lasers, Buyer shall remit to Seller all of such payment. Notwithstanding the foregoing, Buyer's obligation to remit such payments to Seller shall cease at such time as all such remittances shall equal $98,910.00 (the "Remittance Cap"). Section 6.3 BALANCING PAYMENT. From the Closing Date until December 24, 1999, Buyer shall pay to the Seller the value of the gross margin on sales of the Products shipped during such period, less any commissions or other payments to a third party relative to theses shipments. Seller shall pay Buyer $4,000 per day for each business day between the Closing Date and December 24, 1999. This provision shall apply only to sales of the Products which are included on the unshipped order backlog of the Seller as of the Closing Date. 20 ARTICLE VII COVENANTS OF SELLER Seller covenants with the Buyer that: Section 7.1 CONDUCT OF BUSINESS. From the date of this Agreement to the Closing Date, Seller will operate the Business only in the Ordinary Course, and, in particular, without the prior written consent of Buyer, Seller, in connection with the Business, will not: (a) commit any act or permit the occurrence of any event or the existence of any condition of the type described in Section 4.12 in connection with the Business or the Assets; (b) enter into any Contract, agreement, commitment or undertaking in connection with the Business or the Assets involving payments or receipts of more than US $25,000, other than Contracts or commitments made pursuant to this Agreement; (c) cancel or permit any insurance maintained in connection with the Business or the Assets to lapse or terminate, unless reviewed or replaced by like coverage; (d) be in material default under any Contract, agreement, commitment or undertaking of any kind relating to the Business or the Assets; (e) violate or fail to comply with all laws applicable to the Assets or the Business; (f) fail to maintain and repair the Assets in accordance with good standards of maintenance and as required in any leases or other agreements pertaining thereto; or Section 7.2 ACCESS TO INFORMATION. From and after the date of this Agreement, the Seller will give to Buyer and its representatives, full and free access to all the properties, Records, contracts, and commitments of the Business so that Buyer may have full opportunity to make such investigation as it shall desire to make of the affairs of the Business. Without limiting the foregoing, Seller shall cooperate with and give Buyer full access to such information and Records as Buyer may deem necessary to facilitate the review of the Closing Balance Sheet by Buyer. Any such investigation shall not affect the representations and warranties of the Seller contained in this Agreement. Section 7.3 PRESERVATION OF BUSINESS ORGANIZATION. Seller will use its Reasonable Best Efforts to preserve the business organization of the Business from the date of this Agreement to and including the Closing Date, and to preserve for Buyer Seller's good relations with all licensors, suppliers, customers and others having business relations with Seller in connection with the Business. Section 7.4 TRADE SECRETS. From and after the Closing Date, Seller will not use or divulge to any competitor or unauthorized person, any Confidential Information, and will use its Reasonable Best Efforts to insure that its employees and agents do not use or divulge, any Confidential Information, trade secrets, processes, formulae or know-how relating to the Business. 21 Section 7.5 CONSENTS OF THIRD PARTIES. Seller will use all reasonable and proper efforts to obtain, where required, the consents of all third parties, including assisting Buyer in obtaining all Governmental Authorizations related to the Business or Assets which require such consents. Section 7.6 COLLECTION OF RECEIVABLES. Subject to Section 6.2, hereof, after the Closing Date, Seller hereby authorizes Buyer to collect all receivables and other items transferred to Buyer hereunder, and to endorse with the name of Seller any checks or other instruments received on account of any such receivable or other item. The Seller agrees that it will transfer or cause to be transferred to Buyer any cash or other property that it may receive after the Closing Date in respect of such receivables or other items. The Seller will on and after the Closing Date, cooperate with Buyer in endeavoring to effect the collection of all receivables and the pursuit of all other Proceedings involving the Business based on Contracts, arrangements or acts of the Seller which were in effect or occurred on or prior to the Closing Date and related to the Business. Section 7.7 SUPPLY CONTRACTS. As may be requested by Buyer, Seller hereby agrees that it shall maintain any and all Contracts or agreements with suppliers or vendors listed on Schedule 2.1(e) or other such Contracts or arrangements which Seller is unable, for whatever reason, to transfer or assign to Buyer. Seller shall for the duration of any such Contract, agreement or arrangement, pass through the benefits of same to Buyer at Seller's cost of the goods or services provided thereunder. Buyer shall pay Seller for such goods or services in accordance with the terms of Seller's invoice for same. Section 7.8 ROYALTIES. With respect to the license agreements set forth on Schedule 4.18 Seller has paid or shall pay prior to the Closing Date any royalties or other similar obligations associated with the Business due and payable on or before the Closing Date. Section 7.9 INSURANCE. Seller shall maintain valid policies of insurance as set forth in Section 4.17 hereof which will be outstanding and duly in force on the Closing Date. Section 7.10 ACKNOWLEDGMENTS BY SELLER. Seller acknowledges that: (a) Seller has occupied a position of trust and confidence in connection to the Business prior to the date hereof and has become familiar with the following, any and all of which constitute confidential information of the Business, (collectively the "CONFIDENTIAL INFORMATION"): (i) any and all trade secrets concerning the business and affairs of the Business, the Products, product specifications, data, know-how, formulae, compositions, processes, designs, sketches, photographs, graphs, drawings, samples, inventions and ideas, past, current and planned research and development, current and planned manufacturing and distribution methods and processes, customer lists, current and anticipated customer requirements, price lists, market studies, business plans, computer software and programs (including object code and source code), computer software and database technologies, systems, structures and architectures (and related processes, formulae, compositions, improvements, devices, know-how, inventions, discoveries, concepts, ideas, designs, methods and information of the Business and any other information, however documented, of the Business that is a trade secret within the meaning of California Uniform Trade Secrets Act, Section 3426, et seq. of the California Civil Code; (ii) any and all information concerning the business and affairs of the Business (which 22 includes historical financial statements, financial projections and budgets, historical and projected sales, capital spending budgets and plans, the names and backgrounds of key personnel, personnel training and techniques and materials) however documented; and (iii) any and all notes, analysis, compilations, studies, summaries, and other material prepared by or for the Business containing or based, in whole or in part, on any information included in the foregoing; (b) the business of the Business is international in scope; (c) its products and services are marketed worldwide (the "TERRITORY"); (d) Buyer has required that Seller make the covenants set forth in Section 7 of this Agreement as a condition to the Buyer's purchase of the Assets owned by Seller; (e) the provisions of Section 7 of this Agreement are reasonable and necessary to protect and preserve the Business; and (f) the Business would be irreparably damaged if Seller were to breach the covenants set forth in Section 7 of this Agreement. Section 7.11 CONFIDENTIAL INFORMATION. (a) Seller acknowledges and agrees that all Confidential Information known or obtained by Seller, whether before or after the date hereof, is the property of the Business. Therefore, Seller agrees that Seller will not, at any time, disclose and will use its Reasonable Best Efforts to prevent any of its employees from disclosing to any unauthorized Person or use for its own account (other than with respect to internal research or development of products unrelated to the Business or to the Products) or for the benefit of any third party any Confidential Information, which Seller has in its possession, whether in memory, in writing or other physical form, without Buyer's written consent, unless and to the extent that the Confidential Information is or becomes generally known to and available for use by the public other than as a result of Seller's fault or the fault of any other Person bound by a duty of confidentiality to Buyer or the Business. Seller agrees to deliver to Buyer at the time of execution of this Agreement, and at any other time Buyer may request, all documents, memoranda, notes, plans, records, reports, and other documentation, models, components, devices, or computer software, whether embodied in a disk or in other form (and all copies of all of the foregoing), relating to the businesses, operations, or affairs of the Business and any other Confidential Information that Seller may then possess or have under its control. (b) If, for any reason, the Closing of the transactions contemplated by this Agreement fails to occur, each party shall maintain as confidential all non-public information of the other received or learned by it in the course of negotiations, due diligence and other actions undertaken in the course of entering into and performing this Agreement, and Buyer shall return all such information delivered by Seller to Seller. 23 Section 7.12 NONCOMPETITION AGREEMENT OF SELLER. As an inducement for Buyer to enter into this Agreement and as additional consideration for the consideration to be paid to Seller hereunder, (a) Seller agrees that: (i) for a period of three (3) years after the Closing, Seller will not, directly or indirectly, or individually or in partnership or jointly in conjunction with any Person, as a principal, agent or shareholder, or in any manner whatsoever engage or invest in, own, manage, operate, finance, control, or participate in the ownership, management, operation, financing, or control of, be associated with, or in any manner connected with, lend Seller's name or any similar name to, lend Seller's credit to, or render services or advice to, any business whose products or activities compete in whole or in part with the products or activities of the Business anywhere within the Territory, other than with respect to laser optics coating products; provided, however, that Seller may purchase or otherwise acquire up to (but not more than) five percent of any class of securities of any enterprise (but without otherwise participating in the activities of such enterprise) if such securities are listed on any national or regional securities exchange or have been registered under Section 12(g) of the Securities Exchange Act of 1934. Seller agrees that this covenant is reasonable with respect to its duration, geographical area, and scope; (ii) for a period of three (3) years after the Closing, Seller will not, directly or indirectly, either for itself, its subsidiary, an Affiliate, or any other Person, (i) induce or attempt to induce any employee of the Buyer in connection with the Business to leave the employ of the Buyer; (ii) in any way interfere with the relationship between the Buyer and any employee of the Buyer in connection with the Business; (iii) employ, or otherwise engage as an employee, independent contractor, or otherwise, any employee of the Buyer in connection with the Business; or (iv) induce or attempt to induce any customer, supplier, licensee, or business relation of the Buyer in connection with the Business to cease doing business with the Buyer, or in any way interfere with the relationship between any customer, supplier, licensee, or business relation of the Buyer in connection with the Business; and (iii) for a period of three (3) years after the Closing, Seller will not, directly or indirectly, either for itself, its subsidiary, an Affiliate, or any other Person, solicit the business of any Person known to Seller to be a customer of the Business, whether or not Seller, or any of Seller's shareholders, directors, officers, employees or agents, had personal contact with such Person, with respect to products or activities which compete in whole or in part with the products or activities of the Business, other than for the 1550 nm microlaser product line which is not part of the Business. (b) In the event of a breach by Seller of any covenant set forth in Subsection 7.12(a) hereof, the term of such covenant will be extended by the period of the duration of such breach. Seller will not, at any time during or after the three (3) year period, disparage Buyer or the Business, or any of their shareholders, directors, officers, employees, or agents. (c) It is the understanding and agreement of the parties that the covenants not to compete contained in this Section 7.12, as to duration, scope and geographical area are necessary to protect the rights of Buyer in and to the Assets. In the event that the provisions of this Section 7.12 should ever be deemed to exceed the duration, scope or geographic limitations permitted by applicable laws, then such provisions shall be reformed to the maximum duration, scope or geographic limitations permitted by applicable law. 24 (d) In the event that Seller is acquired by, merged with or into or sells all or substantially all of its assets to a competitor or an affiliate of a competitor of Buyer, then the term of the covenants set forth in Section 7.12 hereof, shall expire as of the date of the closing of such acquisition, merger, or sale. Section 7.13 RELEASE OF CERTAIN LIENS. The parties agree that the liens set forth on the attached Schedule 7.13 will not be released prior to Closing. Seller hereby agrees to effect a release of the Assets from the liens set forth on Schedule 7.13 on or before sixty (60) days after Closing. ARTICLE VIII CONDITIONS TO OBLIGATIONS OF BUYER The obligations of Buyer hereunder shall be, at the option of Buyer, subject to the satisfaction of the following conditions: Section 8.1 SELLER'S REPRESENTATIONS AND WARRANTIES TRUE AT CLOSING. Buyer shall not have discovered any material error, misstatement or omission in the representations and warranties made by Seller in Article 4 hereof; the representations and warranties made by Seller herein shall be deemed to have been made again at and as of the time of Closing and shall then be true in all material respects, except to the extent that such representations and warranties shall have been made as of a specified date; Seller shall have performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it at or prior to the Closing; and Buyer shall have received a certificate of the President of Seller to the effect set forth in this Section 8.1. Section 8.2 APPROVAL BY COUNSEL. All actions, proceedings, instruments and documents required to carry out the transactions contemplated by this Agreement or incidental thereto and all other related legal matters shall have been approved by Fulbright & Jaworski L.L.P., counsel for Buyer, and such counsel shall have been furnished with such certified copies of actions and proceedings and other such instruments and documents as it shall have reasonably requested. Section 8.3 OPINION OF COUNSEL FOR SELLER. Buyer shall have received the legal opinion of Cooley Godward LLP, Counsel for Seller, within five (5) business days of the Closing Date and dated the Closing Date, in the form of Exhibit F attached hereto. Section 8.4 NO DAMAGE OR DESTRUCTION. Prior to the Closing there shall not have occurred any casualty to any Equipment or Inventory owned or used by the Seller as a result of which the monetary amount of damage or destruction aggregates more than $250,000 and such loss shall not be substantially covered by valid, existing insurance underwritten by responsible insurers. Additionally, there shall not have been any changes in the business, properties or operations of the Business or of the Assets since the date hereof and continuing as of the Closing Date which would have a material adverse effect on the value of the Business or the Assets. 25 Section 8.5 ABSENCE OF RESTRAINT. No Order to restrain, enjoin or otherwise prevent the consummation of this Agreement or any transactions in connection herewith shall have been entered and, on the Closing Date, there shall not be any pending or Threatened Proceeding with a view to seeking to restrain or prohibit consummation of the transactions contemplated hereby or in which divestiture, rescission or significant damages are sought in connection with the transactions contemplated hereby, and no investigation by any foreign or domestic Governmental Body shall be pending or Threatened which might result in any such Proceeding. Section 8.6 APPROVALS. All consents and authorizations by third parties and all Governmental Authorizations in form and substance reasonably satisfactory to Buyer, the granting or making of which are necessary for the consummation of the transactions contemplated hereby or for the prevention of the termination of any right, privilege, lease, license, Contract, Permit or agreement of Seller relating to the Business or any material loss or disadvantage to Buyer upon the consummation of the transactions contemplated hereby shall have been obtained or made. Section 8.7 EMPLOYMENT AGREEMENTS. Buyer shall have received executed employment agreements in the form of Exhibit E from the individuals listed on Schedule 8.8 (the "Key Employees"). ARTICLE IX CONDITIONS TO OBLIGATIONS OF SELLER The obligations of Seller hereunder shall be, at the option of Seller, subject to the satisfaction of the following conditions: Section 9.1 BUYER'S REPRESENTATIONS AND WARRANTIES TRUE AT CLOSING. There shall have been no material error, misstatement or omission in the representations and warranties made by Buyer in Article 5 hereof; the representations and warranties made by Buyer herein shall be deemed to have been made again at and as of the time of Closing and shall then be true in all material respects, except to the extent that such representations and warranties shall have been made at and as of a specific date; Buyer shall have performed and complied with all agreements and conditions required by this Agreement to be performed or complied with by it at or prior to the Closing; and Seller shall have received a certificate, dated the Closing Date, of a senior officer of Buyer to the effect set forth in this Section 9.1. Section 9.2 APPROVAL BY COUNSEL. All actions, proceedings, instruments and documents required to carry out the transactions contemplated by this Agreement or incidental thereto and all other related legal matters shall have been approved by counsel for Seller and such counsel shall have been furnished with such certified copies of actions and proceedings of Buyer and other such instruments and documents as they shall have reasonably requested. 26 Section 9.3 OPINION OF BUYER'S COUNSEL. The Seller shall have received an opinion of Fulbright & Jaworski, L.L.P., counsel for the Buyer, dated the Closing Date, substantially in the form of Exhibit G attached hereto. ARTICLE X NATURE OF STATEMENTS; SURVIVAL Except as otherwise set forth in Article 7 of this Agreement, all covenants, representations and warranties made by Seller hereunder or pursuant hereto or in connection with the transactions contemplated hereby (except such covenants, agreements, representations and warranties relating to the Intellectual Property which shall survive until December 16, 2002) shall survive until December 16, 2000, regardless of any investigation at any time made by or on behalf of Buyer, or of any information Buyer may have in respect thereto. Except as otherwise set forth in this Agreement, all covenants, agreements, representations and warranties made by Buyer hereunder or pursuant hereto or in connection with the transactions contemplated hereby shall survive until December 16, 2000, regardless of any investigation at any time made by or on behalf of Seller, or of any information Seller may have in respect thereto. ARTICLE XI INDEMNITY Section 11.1 INDEMNITY BY SELLER. Subject to the limitations set out in Section 11.4 hereof, Seller covenants and agrees to indemnify and save and hold Buyer and its representatives, affiliates, shareholders, officers and directors, harmless, at all times after the Closing Date, from and against any loss, liability, claim, damage (including incidental and consequential damages), expense (including costs of investigation and defense and reasonable attorneys' fees), or diminution of value, whether on or involving a third party claim (collectively, "DAMAGES") arising out of or resulting from: (a) any Retained Liabilities; (b) any breach of any representation, warranty, or covenant made by Seller in connection with the transactions contemplated hereby. Section 11.2 INDEMNITY BY BUYER. In addition to Buyer's indemnity obligations under Section 2.3 hereof, Buyer covenants and agrees to indemnify and hold Seller, its directors, officers, employees and agents, harmless, at all times after the Closing Date, from and against any damages arising or resulting from: (a) any breach of any representation, warranty, covenant or agreement made by Buyer in connection with the transactions contemplated hereby, including any inaccuracy in any written representation, list, schedule, certificate or other agreement, instrument or document furnished or to be furnished to Seller pursuant to the terms of this Agreement, or delivered in contemplation of, or in connection with the transactions contemplated hereby; 27 (b) product safety or liability claims (including, without limitation, any based on a failure to warn), or claims in respect of any personal injury or damage to the property of others, or any Occupational Safety, Health or Welfare Law arising from or relating to acts, omissions, events or conditions of or relating to the Business occurring after the Closing Date or any claim otherwise arising out of the Business after the Closing Date; (c) the Assumed Liabilities. Section 11.3 THIRD PARTY CLAIMS. The obligations and liabilities of the parties under this Article 11 with respect to claims resulting from the assertion of liability by third parties (including governmental penalties, fines and assessments) shall be subject to the following terms and conditions: (a) NOTICE. The indemnified party shall give prompt written notice to the indemnifying party of any assertion of liability by a third party which might give rise to a claim by the indemnified party against the indemnifying party based on the indemnity agreements contained in Section 11. Such notice shall comply with the provisions of Section 14. (b) DEFENSE. In the event any action, suit or proceeding (a "LEGAL ACTION") is brought against an indemnified party, with respect to which the indemnifying party may have liability under an indemnity agreement contained herein, the Legal Action shall, upon the written agreement of the indemnifying party that it is obligated to indemnify under such indemnity agreement, be defended by the indemnifying party and such defense shall include all proceedings on appeal or for review which counsel for the defendant shall deem appropriate. The indemnified party shall have the right to be represented by counsel and accountants, at its own expense, and shall be kept fully informed as to such Legal Action at all stages thereof whether or not it is represented by its own counsel. Until the indemnifying party shall have so assumed the defense of any Legal Action, or if the indemnified party shall have reasonably concluded that there are likely to be defenses available to the indemnified party that are different from or in addition to those available to the indemnifying party (in which case the indemnifying party shall not be entitled to assume the defense of such Legal Action but shall have the right to be represented by counsel and accountants, at its own expense, and shall be kept fully informed as to such Legal Action at all stages thereof whether or not represented by its own counsel), all legal or other expenses reasonably incurred by the indemnified party shall be borne by the indemnifying party. The indemnifying party shall make available to the indemnified party and its attorneys and accountants all books and records of the indemnifying party relating to such Legal Action and the parties hereto agree to render to each other such assistance as they may reasonably require of each other in order to facilitate the proper and adequate defense of any such Legal Action. (c) SETTLEMENT OF CLAIMS. The indemnifying party shall not make any settlement of any claim without the written consent of the indemnified party, which consent shall not be unreasonably withheld. Without limiting the generality of the foregoing, it shall not be deemed unreasonable to withhold consent to a settlement involving injunctive or other equitable relief against the indemnified party or its assets, employees or business. 28 (d) Buyer and Seller agree that it, as applicable, shall promptly pay to any indemnified party it is obligated to indemnify hereunder in cash the amount of any damages to which such indemnified party may become entitled by reason of the provisions of this Agreement. Section 11.4 INDEMNITY LIMITS. The parties agree that no claims may be made by Buyer under the indemnification provisions set forth in this Agreement to the extent that the aggregate of all indemnity claims made by Buyer (as indemnified party) as of the date of such claim exceeds the sum of the Cash Payment and the Advanced Royalty Payment or to the extent that the aggregate of all such indemnity claims does not exceed US $100,000. In addition, Seller shall not be liable for the first $100,000 in Damages that would otherwise be included in claims made under the indemnification provisions in this Agreement. Seller shall not be liable for Damages that would otherwise be included in claims made under the indemnification provisions of this Agreement in any amount exceeding the sum of the Cash Payment and the Advanced Royalty Payment. Section 11.5 RIGHT OF SET-OFF. Upon notice to the Seller specifying the basis for such set-off, Buyer may set-off any amount to which it may be entitled pursuant to this Agreement against any payments due Seller under this Agreement and/or may give notice of a claim in such amount under the indemnification provisions hereof. The exercise of such right of set-off by the Buyer in good faith, whether or not ultimately determined to be justified, will not constitute an event of default under this Agreement. Neither the exercise of nor the failure to exercise such right of set-off or to give notice of a claim under the indemnification provisions hereof will constitute an election of remedies or limit the Buyer in any manner in the enforcement of any other remedies which may be available to it. ARTICLE XII DISPUTE RESOLUTION Section 12.1 ARBITRATION. (a) All disputes under this Agreement shall be settled by binding arbitration at San Diego County, California, before a single arbitrator pursuant to the Commercial Arbitration Rules of the American Arbitration Association (the "RULES"). Any party may commence arbitration at any time by giving written notice to the other party that such dispute has been referred to arbitration under this Agreement. The arbitrator shall be selected by the joint agreement of the parties, but, if they do not so agree, within twenty (20) days following the notice referred to above, then the selection shall be made pursuant to the Rules from the panel of arbitrators maintained by such Association. The parties shall be entitled to conduct discovery in connection with the dispute in accordance with the Federal Rules of Civil Procedure. (b) Within ten (10) days following the appointment of the arbitrator each party shall furnish the arbitrator with a statement of the matters in dispute. The arbitrator shall commence hearing the matter within twenty (20) days of receiving such statement and shall complete the arbitration and file his written decision within sixty (60) days following his appointment. The costs of arbitration, including the arbitrator's fees and the fees and costs of counsel shall be allocated by the arbitrator in his decision. If the arbitrator determines that the dispute and arbitration, or either is not the result of good faith on the part of any party, then the arbitrator may make an additional award to the party aggrieved for such sum as the arbitrator may in his or her discretion determine is a reasonable damage figure. 29 (c) The award of the arbitrator shall be binding and conclusive upon the parties and may be entered in any state or federal court within San Diego County, California. There shall be no right of appeal from the award of the arbitrator. The arbitrator may award attorneys fees and costs in accordance with Section 12.3 below. (d) To the extent that arbitration may not be legally permitted hereunder, then any party to any dispute under this Agreement may commence a civil action in accordance with Section 12.2, below. (e) Nothing in this Agreement shall prevent the parties from settling any dispute by mutual agreement or mutually agreed mediation. Section 12.2 JURISDICTION. (a) The parties hereby irremovably submit to the exclusive jurisdiction of the state and federal courts located in San Diego County, California for the purpose of any action or proceeding arising out of or relating to this Agreement. The parties irrevocably agree that all claims in such action or proceeding may be heard and determined only in such courts. To the extent permitted by law each of the parties hereby waives and hereby agrees not to assert by way of motion as a defense or otherwise in any such action or proceeding that it is not personally subject to the jurisdiction of such courts, that the action or proceeding is brought in an inconvenient forum or that the venue of the action or proceeding is improper; PROVIDED, HOWEVER, that nothing herein shall prevent any party hereto from removing any case hereunder brought in a state court to the United States District Court in San Diego County, California. The parties further agree that a final judgment in any action or proceeding hereunder shall be conclusive and may be enforced in any other jurisdiction by suit on the judgment or in any other manner provided by law. (b) Each of the parties irrevocably consents to the service of the summons and complaint and any other process in such action or proceeding relating to this Agreement on behalf of itself or its property by any means permitted by California law and addressed to such party at the address set forth in Section 14.1 hereof. Section 12.3 If any legal action or arbitration or other proceeding is brought by any party with respect to this Agreement or because of an alleged dispute, breach, default or misrepresentation in connection with any other provisions of this Agreement, then the court or arbitrator shall award the successful or prevailing party, in addition to any other relief to which it may be entitled, reasonable attorneys' fees and other costs incurred in that action or proceeding, including fees and costs incurred on appeal and in collecting any judgment or award, as equitably determined by the court or the arbitrator, and the court or arbitrator shall so provide in its judgment or award. 30 ARTICLE XIII TERMINATION Section 13.1 TERMINATION. This Agreement may be terminated by: (a) the mutual written consent of the parties hereto; (b) Buyer, if a material default shall be made by Seller in the observance or in the due and timely performance by Seller of any of the covenants of Seller herein contained, or if there shall have been a material breach by Seller of any of the warranties and representations of Seller herein contained, or if the conditions of this Agreement to be complied with or performed by Seller at or before the Closing Date shall not have been complied with or performed at the time required for such compliance or performance and such noncompliance or nonperformance shall not have been waived by Buyer; (c) Seller, if a material default shall be made by Buyer in the observance or in the due and timely performance by Buyer of any covenants of Buyer herein contained, or if there shall have been a material breach by Buyer of any of the warranties and representations of Buyer herein contained, or if the conditions of this Agreement to be complied with or performed by Buyer at or before the Closing Date shall not have been complied with or performed at the time required for such compliance or performance and such noncompliance and nonperformance shall not have been waived by Seller; or (d) either Buyer or Seller if the Closing has not occurred (other than through the failure of any party seeking to terminate this Agreement to comply fully with its obligations under this Agreement) on or before January 10, 2000, or such later date to which the parties may agree. ARTICLE XIV MISCELLANEOUS Section 14.1 NOTICES. Except as otherwise provided herein, all notices, requests, demands and other communications required or permitted to be given hereunder shall be in writing and shall be transmitted by telegram, telecopy or personal delivery and shall be confirmed by first-class, postage prepaid, registered or certified mail. All such communications shall be deemed received when sent. All such communications shall be addressed, as applicable, to a party at his or its address as shown below: 31 (a) If to Buyer to: Melles Griot, Inc. 2051 Palomar Airport Road, Suite 200 Carlsbad, CA 92009 Facsimile: (760) 804-0198 Attention: Michael J. Dorich With a copy to: Fulbright & Jaworski L.L.P. 801 Pennsylvania Avenue, N.W. Washington, D.C. 20004-2615 Telecopy: (202) 662-4643 Attention: Steven B. Pfeiffer (b) If to Seller to: Laser Power Corporation 12777 High Bluff Drive San Diego, CA 92130-2016 Facsimile: (619) 269-0956 Attention: With a copy to: Cooley Godward LLP 4365 Executive Drive, Suite 1100 San Diego, CA 92121-2128 Facsimile: (619) 453-3555 Attention: D. Bradley Peck or to such other address as it may by written notice, received by the other party, have designated as its address for such purpose. Section 14.2 GOVERNING LAW. This Agreement shall be governed by the laws of California and of the United States of America, as applicable, in all respects, including matters of construction, enforcement and performance, without giving effect to the principles of conflicts of law thereof. Section 14.3 SECTION HEADINGS. The section headings and underlining contained herein are for purposes of convenience only and shall not be deemed to constitute a part of this Agreement or to affect the meaning or interpretation of this Agreement in any way. Section 14.4 ENTIRE AGREEMENT. This Agreement, including the Exhibits, and Schedules hereto, set forth the entire agreement and understanding of the parties with respect to the transactions contemplated hereby, and supersede all prior agreements, arrangements and understandings related to the subject matter hereof. The Schedules to this Agreement, which have been provided by Seller are an integral part of this Agreement and are incorporated herein by reference. 32 Section 14.5 SEVERABILITY. If any provision of this Agreement is or becomes or is deemed invalid, illegal or unenforceable in any jurisdiction, such provision shall be deemed amended to conform to applicable laws so as to be valid and enforceable or, if it cannot be amended without materially altering the intention of the parties, it shall be stricken and the remainder of this Agreement shall remain in full force and effect. Section 14.6 ASSIGNMENT; SUCCESSORS AND ASSIGNS. None of the parties hereto may assign this Agreement or its rights hereunder, whether in whole or in part, without the prior written consent of the other parties hereto; provided, however, that either party may assign this Agreement and its rights and obligations hereunder to any person by which it is acquired, with which or into which it is merged, or to which it sells all or substantially all of its assets. This Agreement shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and assigns, heirs and representatives, as applicable. Section 14.7 AMENDMENT. This Agreement may not be released, discharged, amended or modified in any manner except by an instrument in writing signed by the parties or their duly authorized officers or agents. Section 14.8 WAIVER. No waiver of any right under this Agreement shall be deemed effective unless contained in writing signed by the party charged with such waiver, and no waiver of any right arising from any breach or failure to perform shall be deemed to be a waiver of any future such right or any other right arising under this Agreement. Section 14.9 COUNTERPARTS. This Agreement may be executed simultaneously in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. Section 14.10 BUYER'S REMEDIES FOR SELLER'S BREACH OF CONFIDENTIALITY AND NONCOMPETITION. If Seller breaches the covenants set forth in Section 7 of this Agreement, Buyer will be entitled, in addition to any right to damages and any other rights it may have, to obtain injunctive or other equitable relief to restrain any breach or threatened breach or otherwise to specifically enforce the provisions of Section 7 of this Agreement, it being agreed that money damages alone would be inadequate to compensate the Buyer and would be an inadequate remedy for such breach. Nothing herein shall be construed as prohibiting Buyer from pursuing any other remedies available to it at law or in equity including recovery of damages. Section 14.11 BUYER'S RIGHT TO SPECIFIC PERFORMANCE. The parties hereto recognize that the Business is uniquely suited to Buyer's business requirements and that it may be impossible to determine the amount of damages which would result to Buyer from Seller's refusal to complete the sale of the Business as required under the provisions of this Agreement. Seller therefore agrees that in the event of the failure of Seller to complete the sale of the Business in accordance with the provisions of this Agreement after the conditions precedent to Seller's obligations to close have been fulfilled or waived, that Buyer will 33 be entitled to enforce specific performance of this Agreement against Seller. Seller and Buyer hereby consent to the right of Buyer to obtain a Decree of Specific Performance against Seller in any court having jurisdiction over this matter. Nothing herein shall be construed, however, as prohibiting Buyer from pursuing any other available remedy at law or in equity for such breach including recovery of damages. Section 14.12 BULK SALES. Seller agrees to indemnify Buyer from and against any loss, cost or expense (including expenses for investigations, reasonable costs of employee time used in investigation and defense, and attorneys' fees and expenses) arising out of the failure to comply with the laws of the State of California as set forth in Division 6 of the California Commercial Code and any similar law of any other jurisdiction which may be applicable to the transactions set forth in this Agreement. Section 14.13 FEES AND EXPENSES. (a) Buyer agrees to pay all costs associated with or arising out of moving the Assets. (b) Each of Buyer and Seller shall pay its own expenses incurred in connection with the preparation, negotiation, execution, delivery and consummation of this Agreement and the transactions contemplated hereby. Section 14.14 PRORATIONS AND TRANSFER TAXES. Personal property taxes, utilities and other terms not included in the Assumed Liabilities shall be adjusted ratably as of the Closing Date. All applicable state, federal and local transfer taxes payable in connection with the transactions contemplated hereby shall be paid by Seller. Section 14.15 SALES TAX. Buyer shall pay, when due, all state and local sales taxes due upon the sale of the Assets and shall hold Seller harmless from and indemnify Seller against any liability thereon. Section 14.16 ANNOUNCEMENTS. Except for announcements or filings required by law, or securities regulation, each party shall promptly advise and cooperate with the other prior to issuing any press release or other information to the press or any third party with respect to this Agreement or the transactions contemplated by this Agreement. In this regard, each party shall provide to the other, prior to release, copies of all proposed public releases with respect to the transactions and shall use its Reasonable Best Efforts to accommodate the reasonable comments of the other party with respect to the text of any such release. 34 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. MELLES GRIOT, INC. By: /s/ Michael J. Dorich Name: Michael J. Dorich Title: COO LASER POWER CORPORATION By: /s/ Paul P. Wickman Name: Paul P. Wickman Title: CFO 35 EX-10.21 3 CREDIT AND SECURITY AGREEMENT CREDIT AND SECURITY AGREEMENT Dated as of November 24, 1999 LASER POWER CORPORATION, a Delaware corporation ("LPC") and EXOTIC MATERIALS, INC., a California corporation ("EMI") (collectively, jointly and severally the "Borrower"), and WELLS FARGO CREDIT, INC., a Minnesota corporation (the "Lender"), hereby agree as follows: ARTICLE I Definitions ----------- SECTION 1.1 DEFINITIONS. For all purposes of this Agreement, except as otherwise expressly provided or unless the context otherwise requires: (a) the terms defined in this Article have the meanings assigned to them in this Article, and include the plural as well as the singular; and (b) all accounting terms not otherwise defined herein have the meanings assigned to them in accordance with GAAP. "Accounts" means all of the Borrower's accounts, as such term is defined in the UCC, including without limitation the aggregate unpaid obligations of customers and other account debtors to the Borrower arising out of the sale or lease of goods or rendition of services by the Borrower on an open account or deferred payment basis. "Advance" means a Revolving Advance, a Term Advance or a Capital Expenditures Advance. "Affiliate" or "Affiliates" means EMI Acquisition Corp., Laser Power Europe (fka Radius Engineering, NV) and Laser Power Optics de Mexico, S.A. de C.V. and any other Person controlled by, controlling or under common control with the Borrower, including (without limitation) any Subsidiary of the Borrower. For purposes of this definition, "control," when used with respect to any specified Person, means the power to direct the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise. "Agreement" means this Credit and Security Agreement, as amended, supplemented or restated from time to time. "Availability" means the positive difference, if any, between (i) the Borrowing Base and (ii) the outstanding principal balance of the Revolving Note. "Banking Day" means a day other than a Saturday, Sunday or other day on which banks are generally not open for business in Phoenix, Arizona. 1 "Book Net Worth" means the aggregate of the common and preferred stockholders' equity in the Borrower, determined in accordance with GAAP. "Borrowing Base" means, at any time the lesser of: (a) the Maximum Line; or (b) subject to change from time to time in the Lender's sole discretion, the sum of: (i) the lesser of (A) 85% of Eligible Accounts or (B) $4,000,000.00, plus (ii) the lesser of (A) 50% of Eligible Inventory or (B) $2,000,000.00. "Capital Expenditures" for a period means any expenditure of money for the lease, purchase or other acquisition of any capital asset, or for the lease of any other asset whether payable currently or in the future. "Capital Expenditures Advance" has the meaning specified in Section 2.2(b). "Capital Expenditures Floating Rate" means an annual rate equal to the sum of the Prime Rate plus two percent (2.0%), which annual rate shall change when and as the Prime Rate changes, provided however, if but only if, (i) there is not a then existing Event of Default or Default Period and (ii) LPC sells its microlaser division (the "Transaction") for a sales price which is not less than $4,000,000.00 which includes a cash payment at closing of not less than $2,000,000.00, then the Capital Expenditures Floating Rate shall be reduced to an annual rate equal to the sum of the Prime Rate plus one and one-half percent (1.5%) which rate shall change when and as the Prime Rate changes, said reduction to be effective, if at all, on the later of (x) the closing of the Transaction, or (y) March 31, 2000. "Capital Expenditures Note" means the Borrower's promissory note, payable to the order of the Lender in substantially the form of Exhibit B-2 hereto and any note or notes issued in substitution therefore, as the same may hereafter be amended, supplemented or restated from time to time. "Collateral" means all of the Borrower's Equipment, General Intangibles, Inventory, Receivables, Investment Property, all sums on deposit in any Lender Account, and any items in any Lockbox; together with (i) all substitutions and replacements for and products of any of the foregoing; (ii) proceeds of any and all of the foregoing; (iii) in the case of all tangible goods, all accessions; (iv) all accessories, attachments, parts, equipment and repairs now or hereafter attached or affixed to or used in connection with any tangible goods; and (v) all warehouse receipts, bills of lading and other documents of title now or hereafter covering such goods. Notwithstanding the foregoing, the grant of a security interest as provided herein shall not extend to, and the term "Collateral" shall not include, any general intangibles of Borrower (whether owned or held as licensee or lessee, or otherwise), to the 2 extent that (i) such general intangibles are not assignable or capable of being encumbered as a matter of law or under the terms of the license, lease or other agreement applicable thereto (but solely to the extent that any such restriction shall be enforceable under applicable law), without the consent of the licensor or lessor thereof or other applicable party thereto; (ii) such consent has not been obtained, and (iii) such license, lease or other Agreement is otherwise permitted by the terms of this Agreement. "Commitment" means the Lender's commitment to make Advances to or for the Borrower's account pursuant to Article II. "Credit Facility" means the credit facility being made available to the Borrower by the Lender pursuant to Article II. "Current Maturities of Long Term Debt" as of a given date means the amount of the Borrower's long-term debt and capitalized leases which became due during the applicable period ending on the designated date. "Debt" of any Person means all items of indebtedness or liability which in accordance with GAAP would be included in determining total liabilities as shown on the liabilities side of a balance sheet of that Person as at the date as of which Debt is to be determined. For purposes of determining a Person's aggregate Debt at any time, "Debt" shall also include the aggregate payments required to be made by such Person at any time under any lease that is considered a capitalized lease under GAAP. "Debt Service Coverage Ratio" means the ratio of (i) the sum of (A) Funds from Operations and (B) Interest Expense MINUS (C) unfinanced Capital Expenditures to (ii) the sum of (A) Current Maturities of Long Term Debt actually paid during the period and (B) Interest Expense. "Default" means an event that, with giving of notice or passage of time or both, would constitute an Event of Default. "Default Period" means any period of time beginning on the day on which an Event of Default has occurred and ending on the date the Lender notifies the Borrower in writing that such Event of Default has been cured or waived. "Default Rate" means, with respect to the Revolving Advances, an annual rate equal to three percent (3%) over the Revolving Floating Rate, which rate shall change when and as the Revolving Floating Rate changes, with respect to the Term Advance, an annual rate equal to three percent (3%) over the Term Floating Rate, which rate shall change when and as the Term Floating Rate changes, and with respect to the Capital Expenditure Advances, an annual rate equal to three percent (3%) over the Capital Expenditure Floating Rate, which rate shall change when and as the Capital Expenditures Floating Rate changes. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "Eligible Accounts" means all unpaid Accounts, net of any credits, except the following shall not in any event be deemed Eligible Accounts: 3 (i) That portion of Accounts unpaid 90 days or more after the invoice date; (ii) That portion of Accounts that is disputed or subject to a claim of offset or a contra account; (iii) That portion of Accounts not yet earned by the final delivery of goods or rendition of services, as applicable, by the Borrower to the customer; (iv) Accounts owed by any unit of government, whether foreign or domestic (provided, however, that there shall be included in Eligible Accounts that portion of Accounts owed by such units of government for which the Borrower has provided evidence satisfactory to the Lender that (A) the Lender has a first priority perfected security interest and (B) such Accounts may be enforced by the Lender directly against such unit of government under all applicable laws); (v) Accounts owed by an account debtor located outside the United States which are not (A) backed by a bank letter of credit naming the Lender as beneficiary or assigned to the Lender, in the Lender's possession and acceptable to the Lender in all respects, in its sole discretion, (B) covered by a foreign receivables insurance policy acceptable to the Lender in its sole discretion; (vi) Accounts owed by an account debtor that is insolvent, the subject of bankruptcy proceedings or has gone out of business; (vii) Accounts owed by a shareholder, Subsidiary, Affiliate, officer or employee of the Borrower; (viii) Accounts not subject to a duly perfected security interest in the Lender's favor or which are subject to any lien, security interest or claim in favor of any Person other than the Lender including without limitation any payment or performance bond; (ix) That portion of Accounts that has been restructured, extended, amended or modified; (x) That portion of Accounts that constitutes advertising, finance charges, service charges or sales or excise taxes; (xi) Accounts owed by an account debtor, regardless of whether otherwise eligible, if 20% or more of the total amount due under Accounts from such debtor is ineligible under clauses (i), (ii)or (ix) above; (xii) Accounts owed by an account debtor (other than Lockheed Martin Technical Operations Company) regardless of whether otherwise eligible, in excess of 15% of total Accounts; (xiii) Accounts owed by Lockheed Martin Technical Operations Company, regardless of whether otherwise eligible, in excess of 35% of total Accounts; and 4 (xiv) Accounts, or portions thereof, otherwise deemed ineligible by the Lender in its sole discretion. "Eligible Inventory" means all Inventory of the Borrower, at the lower of cost or market value as determined in accordance with GAAP; provided, however, that the following shall not in any event be deemed Eligible Inventory: (i) Inventory that is: in-transit; located at any warehouse, job site or other premises not approved by the Lender in writing; located outside of the states, or localities, as applicable, in which the Lender has filed financing statements to perfect a first priority security interest in such Inventory; covered by any negotiable or non-negotiable warehouse receipt, bill of lading or other document of title; on consignment from any Person; on consignment to any Person or subject to any bailment unless such consignee or bailee has executed an agreement with the Lender; (ii) Parts or sample Inventory; (iii) Work-in-process Inventory; (iv) Inventory that is damaged, obsolete, slow moving or not currently saleable in the normal course of the Borrower's operations; (v) Inventory that the Borrower has returned, has attempted to return, is in the process of returning or intends to return to the vendor thereof; (vi) Inventory that is in-transit; (vii) Inventory manufactured by the Borrower pursuant to a license unless the applicable licensor has agreed in writing to permit the Lender to exercise its rights and remedies against such Inventory; (viii) Inventory that is subject to a security interest in favor of any Person other than the Lender; (ix) Consigned supplies and packaging Inventory; and (x) Inventory otherwise deemed ineligible by the Lender in its sole discretion. "Environmental Laws" has the meaning specified in Section 5.12. "Equipment" means all of the Borrower's equipment, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all present and future machinery, vehicles, furniture, fixtures, manufacturing equipment, shop equipment, office and recordkeeping equipment, parts, tools, supplies, and including specifically (without limitation) the goods described in any equipment schedule or list herewith or hereafter furnished to the Lender by the Borrower. 5 "Event of Default" has the meaning specified in Section 8.1. "Funding Date" has the meaning given in Section 2.1. "Funds From Operations" for a given period means the sum of (i) Net Income, (ii) depreciation and amortization, (iii) deferred income taxes, and (iv) other non-cash items, each as determined for such period in accordance with GAAP. "GAAP" means generally accepted accounting principles, applied on a basis consistent with the accounting practices applied in the financial statements described in Section 5.5, except for any change in accounting practices to the extent that, due to a promulgation of the Financial Accounting Standards Board changing or implementing any new accounting standard, the Borrower either (i) is required to implement such change, or (ii) for future periods will be required to and for the current period may in accordance with generally accepted accounting principles implement such change, for its financial statements to be in conformity with generally accepted accounting principles (any such change is herein referred to as a "Required GAAP Change"), provided that (1) the Borrower shall fully disclose in such financial statements any such Required GAAP Change and the effects of the Required GAAP Change on the Borrower's income, retained earnings or other accounts, as applicable, and (2) the Borrower's financial covenants set forth in Sections 6.12 through 6.15 and 7.10 shall be adjusted as necessary to reflect the effects of such Required GAAP Change. "General Intangibles" means all of the Borrower's general intangibles, as such term is defined in the UCC, whether now owned or hereafter acquired, including (without limitation) all present and future patents, patent applications, copyrights, trademarks, trade names, trade secrets, customer or supplier lists and contracts, manuals, operating instructions, permits, franchises, the right to use the Borrower's name, and the goodwill of the Borrower's business. "Hazardous Substance" has the meaning given in Section 5.12. "Interest Expense" means, for a fiscal year-to-date period, the Borrower's total gross interest expense during such period (excluding interest income), and shall in any event include, without limitation, (i) interest expensed (whether or not paid) on all Debt, (ii) the amortization of debt discounts, (iii) the amortization of all fees payable in connection with the incurrence of Debt to the extent included in interest expense, and (iv) the portion of any capitalized lease obligation allocable to interest expense. "Inventory" means all of the Borrower's inventory, as such term is defined in the UCC, whether now owned or hereafter acquired, whether consisting of whole goods, spare parts or components, supplies or materials, whether acquired, held or furnished for sale, for lease or under service contracts or for manufacture or processing, and wherever located. "Investment Property" means all of the Borrower's investment property, as such term is defined in the UCC, whether now owned or hereafter acquired, including but not limited to all securities, security entitlements, securities accounts, commodity contracts, commodity accounts, stocks, bonds, mutual fund shares, money market shares and U.S. Government securities. 6 "Lender Account" has the meaning given in the Lockbox and Collection Account Agreement. "Loan Documents" means this Agreement, the Notes and the Security Documents. "Lockbox" has the meaning given in the Lockbox and Collection Account Agreement. "Lockbox and Collection Account Agreement" means the Lockbox and Collection Account Agreement by and among the Borrower, Wells Fargo Bank, N.A., Regulus West LLC and, the Lender, of even date herewith. "Maturity Date" means October 31, 2002. "Maximum Line" means $4,000,000.00 unless said amount is reduced pursuant to Section 2.8, in which event it means the amount to which said amount is reduced. "Minimum Interest Charge" has the meaning given in Section 2.4(c). "Net Income" means fiscal year-to-date after-tax net income from continuing operations as determined in accordance with GAAP. "Net Loss" means fiscal year-to-date after tax net loss from continuing operations as determined in accordance with GAAP. "Note" means the Revolving Note, the Term Note, or the Capital Expenditures Note and "Notes" means the Revolving Note, the Term Note and the Capital Expenditures Note. "Obligations" means the Notes and each and every other debt, liability and obligation of every type and description which the Borrower may now or at any time hereafter owe to the Lender, whether such debt, liability or obligation now exists or is hereafter created or incurred, whether it arises in a transaction involving the Lender alone or in a transaction involving other creditors of the Borrower, and whether it is direct or indirect, due or to become due, absolute or contingent, primary or secondary, liquidated or unliquidated, or sole, joint, several or joint and several, and including specifically, but not limited to, all indebtedness of the Borrower arising under this Agreement, the Notes or any other loan or credit agreement or guaranty between the Borrower and the Lender, whether now in effect or hereafter entered into. "Permitted Lien" has the meaning given in Section 7.1. 7 "Person" means any individual, corporation, partnership, joint venture, limited liability company, association, joint-stock company, trust, unincorporated organization or government or any agency or political subdivision thereof. "Plan" means an employee benefit plan or other plan maintained for the Borrower's employees and covered by Title IV of ERISA. "Premises" means all premises where the Borrower conducts its business and has any rights of possession, including (without limitation) the premises legally described in Exhibit D attached hereto. "Prime Rate" means the rate of interest publicly announced from time to time by Wells Fargo Bank, N.A. as its "prime rate" or, if such bank ceases to announce a rate so designated, any similar successor rate designated by the Lender. "Receivables" means each and every right of the Borrower to the payment of money, whether such right to payment now exists or hereafter arises, whether such right to payment arises out of a sale, lease or other disposition of goods or other property, out of a rendering of services, out of a loan, out of the overpayment of taxes or other liabilities, or otherwise arises under any contract or agreement, whether such right to payment is created, generated or earned by the Borrower or by some other person who subsequently transfers such person's interest to the Borrower, whether such right to payment is or is not already earned by performance, and howsoever such right to payment may be evidenced, together with all other rights and interests (including all liens and security interests) which the Borrower may at any time have by law or agreement against any account debtor or other obligor obligated to make any such payment or against any property of such account debtor or other obligor; all including but not limited to all present and future accounts, contract rights, loans and obligations receivable, chattel papers, bonds, notes and other debt instruments, tax refunds and rights to payment in the nature of general intangibles. "Reportable Event" shall have the meaning assigned to that term in Title IV of ERISA. "Revolving Advance" has the meaning given in Section 2.1. "Revolving Floating Rate" means an annual rate equal to the sum of the Prime Rate plus one and one-half percent (1.5%), which annual rate shall change when and as the Prime Rate changes, provided however, if but only if, (i) there is not a then existing Event of Default or Default Period and (ii) LPC closes the Transaction for a sales price which is not less than $4,000,000.00 which includes a cash payment at closing of not less than $2,000,000.00, then the Revolving Floating Rate shall be reduced to an annual rate equal to the sum of the Prime Rate plus one percent (1%) which annual rate shall change when and as the Prime Rate changes, said reduction to be effective, if at all, on the later of (x) the closing of the Transaction, or (y) March 31, 2000. "Revolving Note" means the Borrower's revolving promissory note, payable to the order of the Lender in substantially the form of Exhibit A hereto and any note or notes issued in substitution therefor, as the same may hereafter be amended, supplemented or restated from time to time. 8 "Security Documents" means this Agreement, the Lockbox and Collection Account Agreement, and any other document delivered to the Lender from time to time to secure the Obligations, as the same may hereafter be amended, supplemented or restated from time to time. "Security Interest" has the meaning given in Section 3.1. "Subordination Agreement" means the Debenture Subordination Agreement of even date herewith, executed by Union Miniere in the Lender's favor and acknowledged by the Borrower, and any other subordination agreement accepted by the Lender from time to time, as the same may hereafter be amended, supplemented or restated from time to time. "Subsidiary" means any corporation of which more than 50% of the outstanding shares of capital stock having general voting power under ordinary circumstances to elect a majority of the board of directors of such corporation, irrespective of whether or not at the time stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency, is at the time directly or indirectly owned by the Borrower, by the Borrower and one or more other Subsidiaries, or by one or more other Subsidiaries. "Term Advance" has the meaning specified in Section 2.2(a). "Term Floating Rate" means an annual rate equal to the sum of the Prime Rate plus one and one-half percent (1.5%), which annual rate shall change when and as the Prime Rate changes, provided however, if but only if, (i) there is not a then existing Event of Default or Default Period and (ii) LPC closes the Transaction for a sales price which is not less than $4,000,000.00 which includes a cash payment at closing of not less than $2,000,000.00, then the Term Floating Rate shall be reduced to an annual rate equal to the sum of the Prime Rate plus one percent (1%) which annual rate shall change when and as the Prime Rate changes, said reduction to be effective, if at all, on the later of (x) the closing of the Transaction, or (y) March 31, 2000. "Term Note" means the Borrower's promissory note, payable to the order of the Lender in substantially the form of Exhibit B-1 hereto and any note or notes issued in substitution therefor, as the same may hereafter be amended, supplemented or restated from time to time. "Termination Date" means the earliest of (i) the Maturity Date, (ii) the date the Borrower terminates the Credit Facility, or (iii) the date the Lender demands payment of the Obligations after an Event of Default pursuant to Section 8.2. "UCC" means the Uniform Commercial Code as in effect from time to time in the state designated in Section 9.14 as the state whose laws shall govern this Agreement, or in any other state whose laws are held to govern this Agreement or any portion hereof. 9 "Wells Fargo Bank N.A." means Wells Fargo Bank, National Association. SECTION 1.2 CROSS REFERENCES. All references in this Agreement to Articles, Sections and subsections, shall be to Articles, Sections and subsections of this Agreement unless otherwise explicitly specified. ARTICLE II Amount and Terms of the Credit Facility --------------------------------------- SECTION 2.1 REVOLVING ADVANCES. The Lender agrees, on the terms and subject to the conditions herein set forth, to make advances to the Borrower from time to time from the date all of the conditions set forth in Section 4.1 are satisfied (the "Funding Date") to the Termination Date, on the terms and subject to the conditions herein set forth (the "Revolving Advances"). The Lender shall have no obligation to make a Revolving Advance if, after giving effect to such requested Revolving Advance, the sum of the outstanding and unpaid Revolving Advances would exceed the Borrowing Base. The Borrower's obligation to pay the Revolving Advances shall be evidenced by the Revolving Note and shall be secured by the Collateral as provided in Article III. Within the limits set forth in this Section 2.1, the Borrower may borrow, prepay pursuant to Section 2.8 and reborrow. The Borrower agrees to comply with the following procedures in requesting Revolving Advances under this Section 2.1: (a) The Borrower shall make each request for a Revolving Advance to the Lender before 11:00 a.m. (Arizona time) of the day of the requested Revolving Advance. Requests may be made in writing or by telephone, specifying the date of the requested Revolving Advance and the amount thereof. Each request shall be by (i) any officer of the Borrower; or (ii) any person designated as the Borrower's agent by any officer of the Borrower in a writing delivered to the Lender; or (iii) any person whom the Lender reasonably believes to be an officer of the Borrower or such a designated agent. (b) Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall disburse the proceeds of the requested Revolving Advance by crediting the same to the Borrower's demand deposit account maintained with Wells Fargo Bank, N.A. unless the Lender and the Borrower shall agree in writing to another manner of disbursement. Upon the Lender's request, the Borrower shall promptly confirm each telephonic request for an Advance by executing and delivering an appropriate confirmation certificate to the Lender. The Borrower shall repay all Advances even if the Lender does not receive such confirmation and even if the person requesting an Advance was not in fact authorized to do so. Any request for an Advance, whether written or telephonic, shall be deemed to be a representation by the Borrower that the conditions set forth in Section 4.2 have been satisfied as of the time of the request. SECTION 2.2 TERM ADVANCES/CAPITAL EXPENDITURES ADVANCES. (a) TERM ADVANCE. The Lender agrees, on the terms and subject to the conditions herein set forth, to make a one time non-revolving advance to the Borrower on the Funding Date (the "Term Advance"). The Lender shall have no obligation to make the Term Advance under this Section 2.2 if the Term Advance would exceed the lesser of (i) $1,950,000.00, (ii) 100% of the appraised auction sale value of Borrower's equipment in which Lender has a perfected first priority security interest (the "Equipment Collateral") or (iii) 80% of the orderly liquidation value of the Equipment Collateral. The Borrower's obligation 10 to pay the Term Advance shall be evidenced by the Term Note and shall be secured by the Collateral as provided in Article III. Upon fulfillment of the applicable conditions set forth in Article IV, the Lender shall deposit the proceeds of the Term Advance by crediting the same to the Borrower's demand deposit account specified in Section 2.1(b) unless the Lender and the Borrower shall agree in writing to another manner of disbursement. (b) CAPITAL EXPENDITURES ADVANCES. The Lender agrees, on the terms and subject to the conditions herein set forth, to make advances to the Borrower from time to time from the Funding Date to the Termination Date (the "Capital Expenditures Advances"). The Lender shall have no obligation to make a Capital Expenditures Advance under this Section 2.2 if all of the conditions contained in Section 4.2 and 4.3 below have not been satisfied. The Borrower's obligation to pay the Capital Expenditures Advance shall be evidenced by the Capital Expenditures Note and shall be secured by the Collateral as provided in Article III. The Borrower agrees to comply with the following procedures in requested Capital Expenditures Advances: (i) The Borrower shall make each request for a Capital Expenditures Advance to the Lender before 11:00 a.m. (Phoenix time) three (3) Banking Days before the day of the requested Capital Expenditures Advance. The request may be made in writing or by telephone, specifying the date of the Capital Expenditures Advance and the amount thereof. (ii) Each Capital Expenditures Advance shall be in a minimum amount of $100,000.00. (iii) Each request shall be by an individual authorized pursuant to Section 2.1(a). Upon fulfillment of the applicable conditions set forth in Article IV, the Lender, at its option, either shall deposit the proceeds of the Capital Expenditures Advance by crediting the same to the Borrower's demand deposit account specified in Section 2.1(b), or pay the proceeds of the requested Capital Expenditures Advance directly to the applicable vendor, unless the Lender and the Borrower shall agree in writing to another manner of disbursement. Upon the Lender's request, the Borrower shall promptly confirm each telephonic request for a Capital Expenditures Advance by executing and delivering an appropriate confirmation certificate to the Lender. The Borrower shall be obligated to repay all Capital Expenditures Advances notwithstanding the Lender's failure to receive such confirmation and notwithstanding the fact that the person requesting the same was not in fact authorized to do so. Any request for a Capital Expenditures Advance, whether written or telephonic, shall be deemed to be a representation by the Borrower that the conditions set forth in Section 4.2 and 4.3 have been satisfied as of the time of the request. SECTION 2.3 PAYMENT OF THE NOTES. (a) PAYMENT OF TERM NOTE. The outstanding principal balance of the Term Note shall be due and payable as follows: 11 (i) Beginning on October 31, 1999, and on the last day of each month thereafter, in equal monthly installments of an amount sufficient to fully amortize the principal balance of the Term Note over an assumed term of sixty (60) months; provided, however, that if Borrower shall make any prepayment on the Term Note as a result of the Transaction, then beginning on the last day of the calendar month during which such prepayment was made and on the last day of each month thereafter, the monthly installments of principal on the Term Note shall be made in a revised amount, which amount shall be sufficient to fully amortize the remaining principal balance of the Term Note following such prepayment over an assumed term of 60 months from the date of such prepayment; and (ii) On the Termination Date, the entire unpaid principal balance of the Term Note, and all unpaid interest accrued thereon, shall in any event be due and payable. (b) PAYMENT OF CAPITAL EXPENDITURES NOTE. The outstanding principal balance of the Capital Expenditures Note shall be due and payable as follows: (i) Beginning on the earlier of (i) September 30, 2000, or (ii) the last day of the month in which the Capital Expenditure Advances have been fully disbursed, and on the last day of each month thereafter, in equal monthly installments of an amount sufficient to fully amortize the principal balance of the Capital Expenditures Note over an assumed term of sixty (60) months (the "Assumed Maturity Date"). If the Lender makes Capital Expenditures Advances after the initial Capital Expenditures Advance, the amount of each installment will be increased so that the remaining payments would fully amortize the outstanding principal balance of the Capital Expenditures Note in equal amounts by the Assumed Maturity Date; and (ii) On the Termination Date, the entire unpaid principal balance of the Capital Expenditures Note, and all unpaid interest accrued thereon, shall in any event be due and payable. SECTION 2.4 INTEREST; MINIMUM INTEREST CHARGE; DEFAULT INTEREST; PARTICIPATIONS; USURY. Interest accruing on the Notes shall be due and payable in arrears on the first day of each month. (a) REVOLVING NOTE. Except as set forth in Sections 2.4(d), and 2.4(g), the outstanding principal balance of the Revolving Note shall bear interest at the Revolving Floating Rate. (b) TERM NOTE. Except as set forth in Sections 2.4(d) and 2.4(g), the outstanding principal balance of the Term Note shall bear interest at the Term Floating Rate. (c) CAPITAL EXPENDITURES NOTE. Except as set forth in Sections 2.4(d) and 2.4(g), the outstanding principal balance of the Capital Expenditures Note shall bear interest at the Capital Expenditures Floating Rate. (d) MINIMUM INTEREST CHARGE. Notwithstanding the interest payable pursuant to Section 2.4(a) (b) and (c), the Borrower shall pay to the Lender interest of not less than $20,000.00 per calendar month (which amount shall be automatically reduced to $12,500.00 on the earlier of (i) the last day of the month in which the Transaction closes or (ii) June 30, 2000) (the "Minimum Interest Charge") during the term of this Agreement, and the Borrower shall pay any deficiency between the Minimum Interest Charge and the amount of interest otherwise calculated under Sections 2.4(a)(b) and (c) on the date and in the manner provided in Section 2.6. 12 (e) DEFAULT INTEREST RATE. At any time during any Default Period, in the Lender's sole discretion and without waiving any of its other rights and remedies, the principal of the Advances outstanding from time to time shall bear interest at the Default Rate, effective for any periods designated by the Lender from time to time during that Default Period. (f) PARTICIPATIONS. If any Person shall acquire a participation in the Advances under this Agreement, the Borrower shall be obligated to the Lender to pay the full amount of all interest calculated under, along with all other fees, charges and other amounts due under this Agreement, regardless if such Person elects to accept interest with respect to its participation at a lower rate than the Revolving Floating Rate or the Term Floating Rate, or otherwise elects to accept less than its pro rata share of such fees, charges and other amounts due under this Agreement. (g) USURY. In any event no rate change shall be put into effect which would result in a rate greater than the highest rate permitted by law. Notwithstanding anything to the contrary contained in any Loan Document, all agreements which either now are or which shall become agreements between the Borrower and the Lender are hereby limited so that in no contingency or event whatsoever shall the total liability for payments in the nature of interest, additional interest and other charges exceed the applicable limits imposed by any applicable usury laws. If any payments in the nature of interest, additional interest and other charges made under any Loan Document are held to be in excess of the limits imposed by any applicable usury laws, it is agreed that any such amount held to be in excess shall be considered payment of principal hereunder, and the indebtedness evidenced hereby shall be reduced by such amount so that the total liability for payments in the nature of interest, additional interest and other charges shall not exceed the applicable limits imposed by any applicable usury laws, in compliance with the desires of the Borrower and the Lender. This provision shall never be superseded or waived and shall control every other provision of the Loan Documents and all agreements between the Borrower and the Lender, or their successors and assigns. (h) SAVINGS CLAUSE. The Borrower agrees that the interest rate contracted for includes the interest rate set forth herein plus any other charges or fees set forth herein and costs and expenses incident to this transaction paid by the Borrower to the extent that some are deemed interest under applicable law. SECTION 2.5 FEES. (a) ORIGINATION FEE. The Borrower hereby agrees to pay the Lender a fully earned and non-refundable origination fee of $25,000.00, due and payable upon the execution of this Agreement. (b) UNUSED LINE FEE. For the purposes of this Section 2.5(b), "Unused Amount" means the Maximum Line reduced by outstanding Revolving Advances. The Borrower agrees to pay to the Lender an unused line fee at the rate of one quarter of one percent (0.25%) per annum on the average daily Unused Amount from the date of this Agreement to and including the Termination Date, due and payable monthly in arrears on the first day of the month and on the Termination Date. 13 (c) AUDIT FEES. The Borrower hereby agrees to pay the Lender, on demand, audit fees in connection with any audits or inspections conducted by the Lender of any Collateral or the Borrower's operations or business at the rates established from time to time by the Lender as its audit fees (which fees are currently $75.00 per hour per auditor), together with all actual out-of-pocket costs and expenses incurred in conducting any such audit or inspection. SECTION 2.6 COMPUTATION OF INTEREST AND FEES; WHEN INTEREST DUE AND PAYABLE. Interest accruing on the outstanding principal balance of the Advances and fees hereunder outstanding from time to time shall be computed on the basis of actual number of days elapsed in a year of 360 days. Interest shall be payable in arrears on the first day of each month and on the Termination Date. SECTION 2.7 CAPITAL ADEQUACY. If any Related Lender determines at any time that its Return has been reduced as a result of any Rule Change, such Related Lender may require the Borrower to pay it the amount necessary to restore its Return to what it would have been had there been no Rule Change upon not less than fifteen (15) days' written notice to the Borrower not less than 180 days after the effective date of the Applicable Rule Change. For purposes of this Section 2.7: (a) "Capital Adequacy Rule" means any law, rule, regulation, guideline, directive, requirement or request regarding capital adequacy, or the interpretation or administration thereof by any governmental or regulatory authority, central bank or comparable agency, whether or not having the force of law, that applies to any Related Lender. Such rules include rules requiring financial institutions to maintain total capital in amounts based upon percentages of outstanding loans, binding loan commitments and letters of credit. (b) "Return", for any period, means the return as determined by such Related Lender on the Advances based upon its total capital requirements and a reasonable attribution formula that takes account of the Capital Adequacy Rules then in effect. Return may be calculated for each calendar quarter and for the shorter period between the end of a calendar quarter and the date of termination in whole of this Agreement. (c) "Rule Change" means any change in any Capital Adequacy Rule occurring after the date of this Agreement, but the term does not include any changes in applicable requirements that at the Closing Date are scheduled to take place under the existing Capital Adequacy Rules or any increases in the capital that any Related Lender is required to maintain to the extent that the increases are required due to a regulatory authority's assessment of the financial condition of such Related Lender. (d) "Related Lender" includes (but is not limited to) the Lender, any parent corporation of the Lender and any assignee of any interest of the Lender hereunder and any participant in the loans made hereunder. 14 Certificates of any Related Lender sent to the Borrower from time to time claiming compensation under this Section 2.7, stating the reason therefor and setting forth in reasonable detail the calculation of the additional amount or amounts to be paid to the Related Lender hereunder to restore its Return shall be conclusive absent manifest error. In determining such amounts, the Related Lender may use any reasonable averaging and attribution methods. SECTION 2.8 VOLUNTARY PREPAYMENT; REDUCTION OF THE MAXIMUM LINE; TERMINATION OF THE CREDIT FACILITY BY THE BORROWER. The Borrower may prepay (other than in accordance with Section 2.3) the Term Advance and the Capital Expenditures Advances in whole at any time or from time to time in part without penalty. Except as otherwise provided herein, the Borrower may prepay the Revolving Advances in whole at any time or from time to time in part. The Borrower may terminate the Credit Facility or reduce the Maximum Line at any time if it (i) gives the Lender at least 20 days' prior written notice and (ii) pays the Lender the termination or line reduction fees in accordance with Section 2.9. Any prepayment of the Term Advance or the Capital Expenditures Advances (other than in accordance with Section 2.3) or reduction in the Maximum Line must be in an amount not less than $100,000.00 or an integral multiple thereof. If the Borrower reduces the Maximum Line to zero, all Obligations shall be immediately due and payable. Any partial prepayments of the Term Note and the Capital Expenditures Note (other than in accordance with Section 2.3) shall be applied to principal payments due and owing in inverse order of their maturities. Upon termination of the Credit Facility and payment and performance of all Obligations, the Lender shall release or terminate the Security Interest and the Security Documents to which the Borrower is entitled by law. SECTION 2.9 TERMINATION, LINE REDUCTION AND PREPAYMENT FEES; WAIVER OF TERMINATION, PREPAYMENT AND LINE REDUCTION FEES. (a) TERMINATION AND LINE REDUCTION FEES. If the Credit Facility is terminated for any reason as of a date other than the Maturity Date, or the Borrower reduces the Maximum Line, the Borrower shall pay to the Lender a fee in an amount equal to a percentage of the Maximum Line (or the reduction, as the case may be) as follows: (i) three percent (3.0%) if the termination or reduction occurs on or before the first anniversary of the Funding Date; (ii) one percent (1.0%) if the termination or reduction occurs after the first anniversary of the Funding Date but on or before the second anniversary of the Funding Date; and (iii) three-quarters of one percent (0.75%) if the termination or reduction occurs after the second anniversary of the Funding Date. (b) WAIVER OF TERMINATION AND LINE REDUCTION FEES. The Borrower will not be required to pay the termination or line reduction fees otherwise due under this Section 2.9 if such termination or line reduction is made because of refinancing by an affiliate of the Lender. In addition, the Borrower may reduce the Maximum Line at any time prior to the first anniversary of the Funding Date by an amount not to exceed $1,000,000.00 without being required to pay the line reduction fees otherwise due under this Section 2.9, if but only if, the line reduction results from the closing of the Transaction. SECTION 2.10 MANDATORY PREPAYMENT. (a) Without notice or demand, if the outstanding principal balance of the Revolving Advances shall at any time exceed the Borrowing Base, the Borrower shall immediately prepay the Revolving Advances to the extent necessary to eliminate such excess. Any payment received by the Lender under 15 this Section 2.10 or under Section 2.8 may be applied to the Obligations, in such order and in such amounts as the Lender, in its discretion, may from time to time determine; provided that any prepayment under Section 2.8 which the Borrower designates as a partial prepayment of the Term Note or the Capital Expenditures Note shall be applied to principal installments of the Term Note or the Capital Expenditures Note, as applicable, in inverse order of maturity. For each day or portion thereof that the Revolving Advances shall exceed the Borrowing Base, the Borrower shall pay to the Lender an overadvance charge (which charge shall be in addition to and not in lieu of any other interest, fees, or charges payable by Borrower hereunder) in the amount of $100.00; provided, however, that if such day occurs during a Default Period, the overadvance charge for such day shall be $200.00. (b) In the event that the Transaction has not closed on or before the first anniversary of the Funding Date, the Lender in its sole discretion may elect to require that the Capital Expenditures Advances be prepaid such that after such prepayment, the outstanding principal balance of the Capital Expenditures Note shall not exceed 80% of the orderly liquidation value of the Equipment purchased with the proceeds of the Capital Expenditures Advances. SECTION 2.11 PAYMENT. All payments to the Lender shall be made in immediately available funds and shall be applied to the Obligations one Banking Day after receipt by the Lender. The Lender may hold all payments not constituting immediately available funds for three (3) additional days before applying them to the Obligations. Notwithstanding anything in Section 2.1, the Borrower hereby authorizes the Lender, in its discretion at any time or from time to time without the Borrower's request and even if the conditions set forth in Section 4.2 would not be satisfied, to make a Revolving Advance in an amount equal to the portion of the Obligations from time to time due and payable. SECTION 2.12 PAYMENT ON NON-BANKING DAYS. Whenever any payment to be made hereunder shall be stated to be due on a day which is not a Banking Day, such payment may be made on the next succeeding Banking Day, and such extension of time shall in such case be included in the computation of interest on the Advances or the fees hereunder, as the case may be. SECTION 2.13 USE OF PROCEEDS. The Borrower shall use the proceeds of the Revolving Advances and the Terms Advance to (i) repay all indebtedness owed to Wells Fargo Bank, N.A., (ii) to pay all accounts payable sixty days or more past invoice date and (iii) for ordinary working capital purposes. The Borrower shall use the proceeds of the Capital Expenditures Advances for Capital Expenditures. SECTION 2.14 LIABILITY RECORDS. The Lender may maintain from time to time, at its discretion, liability records as to the Obligations. All entries made on any such record shall be presumed correct until the Borrower establishes the contrary. Upon the Lender's demand, the Borrower will admit and certify in writing the exact principal balance of the Obligations that the Borrower then asserts to be outstanding. Any billing statement or accounting rendered by the Lender shall be conclusive and fully binding on the Borrower unless the Borrower gives the Lender specific written notice of exception within 60 days after receipt. 16 ARTICLE III Security Interest; Occupancy; Setoff ------------------------------------ SECTION 3.1 GRANT OF SECURITY INTEREST. Each of LPC and EMI hereby pledges, assigns and grants to the Lender a security interest (collectively referred to as the "Security Interest") in the Collateral, as security for the payment and performance of the Obligations. SECTION 3.2 NOTIFICATION OF ACCOUNT DEBTORS AND OTHER OBLIGORS. The Lender may at any time (upon an Event of Default) notify any account debtor or other person obligated to pay the amount due that such right to payment has been assigned or transferred to the Lender for security and shall be paid directly to the Lender. The Borrower will join in giving such notice if the Lender so requests. At any time after the Borrower or the Lender gives such notice to an account debtor or other obligor, the Lender may, but need not, in the Lender's name or in the Borrower's name, (a) demand, sue for, collect or receive any money or property at any time payable or receivable on account of, or securing, any such right to payment, or grant any extension to, make any compromise or settlement with or otherwise agree to waive, modify, amend or change the obligations (including collateral obligations) of any such account debtor or other obligor; and (b) as the Borrower's agent and attorney-in-fact, notify the United States Postal Service to change the address for delivery of the Borrower's mail to any address designated by the Lender, otherwise intercept the Borrower's mail, and receive, open and dispose of the Borrower's mail, applying all Collateral as permitted under this Agreement and holding all other mail for the Borrower's account or forwarding such mail to the Borrower's last known address. SECTION 3.3 ASSIGNMENT OF INSURANCE. As additional security for the payment and performance of the Obligations, the Borrower hereby assigns to the Lender any and all monies (including, without limitation, proceeds of insurance and refunds of unearned premiums) due or to become due under, and all other rights of the Borrower with respect to, any and all policies of insurance now or at any time hereafter covering the Collateral or any evidence thereof or any business records or valuable papers pertaining thereto, and the Borrower hereby directs the issuer of any such policy to pay all such monies directly to the Lender. At any time, whether or not a Default Period then exists, the Lender may (but need not), in the Lender's name or in the Borrower's name, execute and deliver proof of claim, receive all such monies, endorse checks and other instruments representing payment of such monies, and adjust, litigate, compromise or release any claim against the issuer of any such policy. SECTION 3.4 OCCUPANCY. (a) The Borrower hereby irrevocably grants to the Lender the right to take possession of the Premises at any time during a Default Period. (b) The Lender may use the Premises only to hold, process, manufacture, sell, use, store, liquidate, realize upon or otherwise dispose of goods that are Collateral and for other purposes that the Lender may in good faith deem to be related or incidental purposes. (c) The Lender's right to hold the Premises shall cease and terminate upon the earlier of (i) payment in full and discharge of all Obligations and termination of the Commitment, and (ii) final sale or disposition of all goods constituting Collateral and delivery of all such goods to purchasers. 17 (d) The Lender shall not be obligated to pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises; provided, however, that if the Lender does pay or account for any rent or other compensation for the possession, occupancy or use of any of the Premises, the Borrower shall reimburse the Lender promptly for the full amount thereof. In addition, the Borrower will pay, or reimburse the Lender for, all taxes, fees, duties, imposts, charges and expenses at any time incurred by or imposed upon the Lender by reason of the execution, delivery, existence, recordation, performance or enforcement of this Agreement or the provisions of this Section 3.4. SECTION 3.5 LICENSE. The Borrower hereby grants to the Lender a non-exclusive, worldwide and royalty-free license to use or otherwise exploit all trademarks, franchises, trade names, copyrights and patents of the Borrower for the purpose of selling, leasing or otherwise disposing of any or all Collateral during any Default Period. SECTION 3.6 FINANCING STATEMENT. A carbon, photographic or other reproduction of this Agreement or of any financing statements signed by the Borrower is sufficient as a financing statement and may be filed as a financing statement in any state to perfect the security interests granted hereby. For this purpose, the following information is set forth: Name and address of LPC: Laser Power Corporation 12777 High Bluff Drive San Diego, CA 92130 Federal Tax Identification No. 95-3423358 Name and address of EMI: Exotic Materials, Inc. 36570 Briggs Road Murrieta, CA 92563-2347 Federal Tax Identification No. 95-2120954 Name and address of Secured Party: Wells Fargo Credit, Inc. 100 West Washington Street, 7th Floor MAC S4101-076 Phoenix, AZ 85003 Federal Tax Identification No. 41-1237652 18 SECTION 3.7 SETOFF. The Borrower agrees that the Lender may at any time or from time to time, at its sole discretion and without demand and without notice to anyone, setoff any liability owed to the Borrower by the Lender, whether or not due, against any Obligation, whether or not due. In addition, each other Person holding a participating interest in any Obligations shall have the right to appropriate or setoff any deposit or other liability then owed by such Person to the Borrower, whether or not due, and apply the same to the payment of said participating interest, as fully as if such Person had lent directly to the Borrower the amount of such participating interest. ARTICLE IV Conditions of Lending --------------------- SECTION 4.1 CONDITIONS PRECEDENT TO THE INITIAL REVOLVING ADVANCE, TERM ADVANCE AND THE CAPITAL EXPENDITURES ADVANCES. The Lender's obligation to make the initial Revolving Advance, Term Advance and the Capital Expenditures Advance hereunder shall be subject to the conditions precedent that (i) that after giving effect to the initial Revolving Advance, there is not less than $750,000.00 in excess Availability and (ii) the Lender shall have received all of the following, each in form and substance satisfactory to the Lender: (a) This Agreement, properly executed by the Borrower. (b) The Notes, properly executed by the Borrower. (c) A true and correct copy of any and all leases pursuant to which the Borrower is leasing the Premises, together with a landlord's disclaimer and consent with respect to each such lease. (d) A true and correct copy of any and all mortgages pursuant to which the Borrower has mortgaged the Premises, together with a mortgagee's disclaimer and consent with respect to each such mortgage. (e) A true and correct copy of any and all agreements pursuant to which the Borrower's property is in the possession of any Person other than the Borrower, together with, in the case of any goods held by such Person for resale, (i) a consignee's acknowledgment and waiver of liens, (ii) UCC financing statements sufficient to protect the Borrower's and the Lender's interests in such goods, and (iii) UCC searches showing that no other secured party has filed a financing statement against such Person and covering property similar to the Borrower's other than the Borrower, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrower and the Lender sufficient to protect the Borrower's and the Lender's interests in the Borrower's goods from any claim by such secured party. (f) An acknowledgment and waiver of liens from each warehouse in which the Borrower is storing Inventory. (g) A true and correct copy of any and all agreements pursuant to which the Borrower's property is in the possession of any Person other than the Borrower, together with, (i) an acknowledgment and waiver of liens from each subcontractor who has possession of the Borrower's goods from time to time, (ii) UCC financing statements sufficient to protect the Borrower's and the Lender's interests in such goods, and (iii) UCC searches showing that no other secured 19 party has filed a financing statement covering such Person's property other than the Borrower, or if there exists any such secured party, evidence that each such secured party has received notice from the Borrower and the Lender sufficient to protect the Borrower's and the Lender's interests in the Borrower's goods from any claim by such secured party. (h) The Lockbox and Collection Account Agreement, properly executed by the Borrower and all other parties thereto. (i) The Subordination Agreement, properly executed by Union Miniere and acknowledged by the Borrower. (j) Current searches of appropriate filing offices showing that (i) no state or federal tax liens have been filed and remain in effect against either LPC or EMI, (ii) no financing statements or assignments of patents, trademarks or copyrights have been filed and remain in effect against either LPC or EMI except those financing statements and assignments of patents, trademarks or copyrights relating to Permitted Liens or to liens held by Persons who have agreed in writing that upon receipt of proceeds of the Advances, they will deliver UCC releases and/or terminations and releases of such assignments of patents, trademarks or copyrights satisfactory to the Lender, and (iii) the Lender has duly filed all financing statements necessary to perfect the Security Interest, to the extent the Security Interest is capable of being perfected by filing. (k) A certificate of the Secretary or Assistant Secretary of each of LPC and EMI certifying as to (i) the resolutions of the each of their directors and, if required, shareholders, authorizing the execution, delivery and performance of the Loan Documents, (ii) their articles of incorporation and bylaws, and (iii) the signatures of each of their officers or agents authorized to execute and deliver the Loan Documents and other instruments, agreements and certificates, including Advance requests, on their behalf. (l) A current certificate issued by the Secretary of State of Delaware and California, certifying that LPC and EMI are in compliance with all applicable organizational requirements of the State of Delaware and California, as applicable. (m) Evidence that each of LPC and EMI are duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. (n) A certificate of an officer of each of LPC and EMI confirming, in his corporate capacity, the representations and warranties set forth in Article V. (o) An opinion of counsel to each of LPC and EMI, addressed to the Lender. (p) Certificates of the insurance required hereunder, with all hazard insurance containing a lender's loss payable endorsement in the Lender's favor and with all liability insurance naming the Lender as an additional insured. 20 (q) Payment of the fees and commissions due through the date of the initial Advance under Section 2.5 and expenses incurred by the Lender through such date and required to be paid by the Borrower under Section 9.7, including all legal expenses incurred through the date of this Agreement. (r) Such other documents as the Lender in its sole discretion may require. SECTION 4.2 CONDITIONS PRECEDENT TO ALL ADVANCES. The Lender's obligation to make each Advance shall be subject to the further conditions precedent that on such date: (a) the representations and warranties contained in Article V are correct on and as of the date of such Advance as though made on and as of such date, except to the extent that such representations and warranties relate solely to an earlier date; and (b) no event has occurred and is continuing, or would result from such Advance which constitutes a Default or an Event of Default. SECTION 4.3 CONDITIONS PRECEDENT TO THE CAPITAL EXPENDITURES ADVANCES. The Obligation of the Lender to make the Capital Expenditures Advances shall be subject to the further conditions precedent that: (a) There have been not more than three Capital Expenditures Advances. (b) Each request for a disbursement of the Capital Expenditures Advance is an amount of not more than 75% of the "Hard" invoice cost of the equipment which is the subject of the applicable Capital Expenditure. "Hard" invoice costs shall in no event be deemed to include costs associated with installation, taxes and freight charges. (c) Each request for a disbursement of the Capital Expenditures Advance is accompanied by all applicable invoices. ARTICLE V Representations and Warranties ------------------------------ The Borrower represents and warrants to the Lender as follows: SECTION 5.1 CORPORATE EXISTENCE AND POWER; NAME; CHIEF EXECUTIVE OFFICE; INVENTORY AND EQUIPMENT LOCATIONS; TAX IDENTIFICATION NUMBER. LPC is a corporation, duly organized, validly existing and in good standing under the laws of the State of Delaware and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. EMI is a corporation, duly organized, validly existing and in good standing under the laws of the State of California and is duly licensed or qualified to transact business in all jurisdictions where the character of the property owned or leased or the nature of the business transacted by it makes such licensing or qualification necessary. Each of LPC and EMI has all requisite power and authority, corporate or otherwise, to 21 conduct its business, to own its properties and to execute and deliver, and to perform all of its obligations under, the Loan Documents. During their existence, each of LPC and EMI has done business solely under the names set forth in Schedule 5.1 hereto. LPC's and EMI's respective chief executive office and principal place of business is located at the address set forth in Schedule 5.1 hereto, and all of their records relating to their businesses or the Collateral are kept at said locations. All Inventory and Equipment is located at that location or at one of the other locations set forth in Schedule 5.1 hereto. Each of LPC and EMI's tax identification number is correctly set forth in Section 3.6 hereto. SECTION 5.2 AUTHORIZATION OF BORROWING; NO CONFLICT AS TO LAW OR AGREEMENTS. The execution, delivery and performance by LPC and EMI of the Loan Documents and the borrowings from time to time hereunder have been duly authorized by all necessary corporate action and do not and will not (i) require any consent or approval of their stockholders; (ii) require any authorization, consent or approval by, or registration, declaration or filing with, or notice to, any governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, or any third party, except such authorization, consent, approval, registration, declaration, filing or notice as has been obtained, accomplished or given prior to the date hereof; (iii) violate any provision of any law, rule or regulation (including, without limitation, Regulation X of the Board of Governors of the Federal Reserve System) or of any order, writ, injunction or decree presently in effect having applicability to them or of their articles of incorporation or bylaws; (iv) result in a breach of or constitute a default under any indenture or loan or credit agreement or any other material agreement, lease or instrument to which either of them is a party or by which it or its properties may be bound or affected; or (v) result in, or require, the creation or imposition of any mortgage, deed of trust, pledge, lien, security interest or other charge or encumbrance of any nature (other than the Security Interest) upon or with respect to any of the properties now owned or hereafter acquired by the Borrower. SECTION 5.3 LEGAL AGREEMENTS. This Agreement constitutes and, upon due execution by LPC and EMI, the other Loan Documents will constitute the legal, valid and binding obligations of each of them, enforceable against the Borrower in accordance with their respective terms except as enforceability is limited by bankruptcy, insolvency, reorganization, moratorium or other laws relating to or affecting generally the enforcement of creditors' rights and except to the extent that availability of specific performance or injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. SECTION 5.4 SUBSIDIARIES. Except as set forth in Schedule 5.4 hereto, LPC and EMI have no Subsidiaries. SECTION 5.5 FINANCIAL CONDITION; NO ADVERSE CHANGE. LPC has heretofore furnished to the Lender its audited financial statements for its fiscal year ended September 30, 1998, and its unaudited financial statements for the fiscal year-to-date period ended August 29, 1999 and those statements fairly present LPC's financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with generally accepted accounting principles. Since the date of the most recent financial statements, there has been no material adverse change in LPC's business, properties or condition (financial or otherwise). EMI has heretofore furnished to the Lender its audited financial statements for its fiscal year ended September 30, 1998 and its unaudited financial statements for the fiscal year-to-date period ended August 29, 1999 and those statements fairly present 22 EMI's financial condition on the dates thereof and the results of its operations and cash flows for the periods then ended and were prepared in accordance with generally accepted accounting principles. Since the date of the most recent financial statements, there has been no material adverse change in EMI's business, properties or condition (financial or otherwise). SECTION 5.6 LITIGATION. To the knowledge of Borrower, there are no actions, suits or proceedings pending or, to the Borrower's knowledge, threatened against or affecting either LPC or EMI or any of their Affiliates or their properties or any of their Affiliates before any court or governmental department, commission, board, bureau, agency or instrumentality, domestic or foreign, which, if determined adversely to them, would have a material adverse effect on the financial condition, properties or operations of either of them or any of their Affiliates. SECTION 5.7 REGULATION U. LPC and EMI are not engaged in the business of extending credit for the purpose of purchasing or carrying margin stock (within the meaning of Regulation U of the Board of Governors of the Federal Reserve System), and no part of the proceeds of any Advance will be used to purchase or carry any margin stock or to extend credit to others for the purpose of purchasing or carrying any margin stock. SECTION 5.8 TAXES. LPC and EMI and their Affiliates have paid or caused to be paid to the proper authorities when due all federal, state and local taxes required to be withheld by each of them or to the extent that any such taxes are being contested in good faith and adequate reserves have been established therefor in accordance with GAAP. LPC and EMI and their Affiliates have filed all federal, state and local tax returns which to the knowledge of the officers of LPC and EMI or any Affiliate, as the case may be, are required to be filed, and LPC and EMI and their Affiliates have paid or caused to be paid to the respective taxing authorities all taxes as shown on said returns or on any assessment received by any of them to the extent such taxes have become due. SECTION 5.9 TITLES AND LIENS. LPC and EMI have good and absolute title to all Collateral described in the collateral reports provided to the Lender and all other Collateral, properties and assets reflected in the latest financial statements referred to in Section 5.5 and all proceeds thereof, free and clear of all mortgages, security interests, liens and encumbrances, except for Permitted Liens and liens for current taxes are not yet due. No financing statement naming the Borrower as debtor is on file in any office except to perfect only Permitted Liens. SECTION 5.10 PLANS. Except as disclosed to the Lender in writing prior to the date hereof, neither LPC nor EMI nor any of their Affiliates maintain or has maintained any Plan. Neither LPC nor EMI nor any Affiliate has received any notice or has any knowledge to the effect that it is not in full compliance with any of the requirements of ERISA. No Reportable Event or other fact or circumstance which may have an adverse effect on the Plan's tax qualified status exists in connection with any Plan. Neither LPC nor EMI nor any of their Affiliates have: (a) Any accumulated funding deficiency within the meaning of ERISA; or (b) Any liability or knows of any fact or circumstances which could result in any liability to the Pension Benefit Guaranty Corporation, the Internal Revenue Service, the Department of Labor or any participant in connection with any Plan (other than accrued benefits which or which may become payable to participants or beneficiaries of any such Plan). 23 SECTION 5.11 DEFAULT. LPC and EMI are in compliance with all provisions of all agreements, instruments, decrees and orders to which it is a party or by which it or its property is bound or affected, the breach or default of which could have a material adverse effect on their financial condition, properties or operations. SECTION 5.12 ENVIRONMENTAL MATTERS. (a) DEFINITIONS. As used in this Agreement, the following terms shall have the following meanings: (i) "Environmental Law" means any federal, state, local or other governmental statute, regulation, law or ordinance dealing with the protection of human health and the environment. (ii) "Hazardous Substances" means pollutants, contaminants, hazardous substances, hazardous wastes, petroleum and fractions thereof, and all other chemicals, wastes, substances and materials listed in, regulated by or identified in any Environmental Law. (b) To the Borrower's best knowledge, there are not present in, on or under the Premises any Hazardous Substances in such form or quantity as to create any liability or obligation for either the Borrower or the Lender under common law of any jurisdiction or under any Environmental Law, and no Hazardous Substances have ever been stored, buried, spilled, leaked, discharged, emitted or released in, on or under the Premises in such a way as to create any such liability. (c) To the Borrower's best knowledge, the Borrower has not disposed of Hazardous Substances in such a manner as to create any liability under any Environmental Law. (d) To the Borrower's best knowledge, there are not and there never have been any requests, claims, notices, investigations, demands, administrative proceedings, hearings or litigation, relating in any way to the Premises or the Borrower, alleging liability under, violation of, or noncompliance with any Environmental Law or any license, permit or other authorization issued pursuant thereto. To the Borrower's best knowledge, no such matter is threatened or impending. (e) To the Borrower's best knowledge, the Borrower's businesses are and have in the past always been conducted in accordance with all Environmental Laws and all licenses, permits and other authorizations required pursuant to any Environmental Law and necessary for the lawful and efficient operation of such businesses are in the Borrower's possession and are in full force and effect. No permit required under any Environmental Law is scheduled to expire within 12 months and to the Borrower's best knowledge there is no threat that any such permit will be withdrawn, terminated, limited or materially changed. 24 (f) To the Borrower's best knowledge, the Premises are not and never have been listed on the National Priorities List, the Comprehensive Environmental Response, Compensation and Liability Information System or any similar federal, state or local list, schedule, log, inventory or database. (g) The Borrower has delivered to Lender all environmental assessments, audits, reports, permits, licenses and other documents known to the Borrower describing or relating in any way to the Premises or Borrower's businesses. SECTION 5.13 SUBMISSIONS TO LENDER. All financial and other information provided to the Lender by or on behalf of the Borrower in connection with the Borrower's request for the credit facilities contemplated hereby is true and correct in all material respects and, as to projections, valuations or proforma financial statements, present a good faith opinion as to such projections, valuations and proforma condition and results. SECTION 5.14 FINANCING STATEMENTS. LPC and EMI have provided to the Lender signed financing statements sufficient when filed to perfect the Security Interest and the other security interests created by the Security Documents to the extent that such security interest can be perfected by filing of financial statements. When such financing statements are filed in the offices noted therein, the Lender will have a valid and perfected security interest in all Collateral and all other collateral described in the Security Documents which is capable of being perfected by filing financing statements. None of the Collateral or other collateral covered by the Security Documents is or will become a fixture on real estate, unless a sufficient fixture filing is in effect with respect thereto. SECTION 5.15 RIGHTS TO PAYMENT. Each right to payment and each instrument, document, chattel paper and other agreement constituting or evidencing Collateral or other collateral covered by the Security Documents is (or, in the case of all future Collateral or such other collateral, will be when arising or issued) the valid, genuine and legally enforceable obligation, subject to no defense, setoff or counterclaim, of the account debtor or other obligor named therein or in the Borrower's records pertaining thereto as being obligated to pay such obligation except as enforceability is limited by bankruptcy, insolvency, reorganization, moratorium or other laws relating to or affecting generally the enforcement of creditor's rights and except to the extent that availability of specific performance or injunctive relief is subject to the discretion of the court before which any proceeding therefor may be brought. SECTION 5.16 FINANCIAL SOLVENCY. Both before and after giving effect to the transactions contemplated in the Loan Documents, neither LPC nor EMI nor any of their Affiliates: (a) was or will be insolvent, as that term is used and defined in Section 101(32) of the United States Bankruptcy Code and Section 2 of the Uniform Fraudulent Transfer Act; (b) has unreasonably small capital or is engaged or about to engage in a business or a transaction for which any remaining assets of the Borrower or such Affiliate are unreasonably small; 25 (c) by executing, delivering or performing its obligations under the Loan Documents or other documents to which it is a party or by taking any action with respect thereto, intends to, nor believes that it will, incur debts beyond its ability to pay them as they mature; (d) by executing, delivering or performing its obligations under the Loan Documents or other documents to which it is a party or by taking any action with respect thereto, intends to hinder, delay or defraud either its present or future creditors; and (e) at this time contemplates filing a petition in bankruptcy or for an arrangement or reorganization or similar proceeding under any law any jurisdiction, nor, to the best knowledge of the Borrower, is the subject of any actual, pending or threatened bankruptcy, insolvency or similar proceedings under any law of any jurisdiction. ARTICLE VI Borrower's Affirmative Covenants -------------------------------- So long as the Obligations shall remain unpaid, or the Credit Facility shall remain outstanding, the Borrower will comply with the following requirements, unless the Lender shall otherwise consent in writing: SECTION 6.1 REPORTING REQUIREMENTS. The Borrower will deliver, or cause to be delivered, to the Lender each of the following, which shall be in form and detail acceptable to the Lender: (a) as soon as available, and in any event within 90 days after the end of each fiscal year of each of LPC and EMI, their consolidated and consolidating audited financial statements with the unqualified opinion of independent certified public accountants selected by the Borrower and reasonably acceptable to the Lender, which annual financial statements shall include the Borrower's balance sheet as at the end of such fiscal year and the related statements of the Borrower's income, retained earnings and cash flows for the fiscal year then ended, prepared, if the Lender so requests, on a consolidating and consolidated basis to include any Affiliates, all in reasonable detail and prepared in accordance with GAAP, together with (i) copies of all management letters prepared by such accountants; (ii) a report signed by such accountants stating that in making the investigations necessary for said opinion they obtained no knowledge, except as specifically stated, of any Default or Event of Default hereunder and all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the requirements set forth in Sections 6.12 through 6.15, and 7.10; and (iii) a certificate of the Borrower's chief financial officer stating that such financial statements have been prepared in accordance with GAAP and whether or not such officer has knowledge of the occurrence of any Default or Event of Default hereunder and, if so, stating in reasonable detail the facts with respect thereto; (b) as soon as available and in any event within 20 days after the end of each month, a consolidated and consolidating unaudited/internal balance sheet and statements of income and retained earnings of LPC and EMI as at the end of and for such month and for the year to date period then ended, prepared, if the Lender so requests, on a consolidating and consolidated basis to include any Affiliates, in reasonable detail and stating in comparative form 26 the figures for the corresponding date and periods in the previous year, all prepared in accordance with GAAP, subject to year-end audit adjustments; and accompanied by a certificate of the Borrower's chief financial officer, substantially in the form of Exhibit C hereto stating (i) that such financial statements have been prepared in accordance with GAAP, subject to year-end audit adjustments, (ii) whether or not such officer has knowledge of the occurrence of any Default or Event of Default hereunder not theretofore reported and remedied and, if so, stating in reasonable detail the facts with respect thereto, and (iii) all relevant facts in reasonable detail to evidence, and the computations as to, whether or not the Borrower is in compliance with the requirements set forth in Sections 6.12 through 6.15, and 7.10; (c) within 15 days after the end of each month or more frequently if the Lender so requires, agings of LPC's and EMI's accounts receivable and accounts payable, an inventory certification report, and a calculation of their Accounts, Eligible Accounts, Inventory and Eligible Inventory as at the end of such month or shorter time period; (d) at least 30 days before the beginning of each fiscal year of LPC and EMI, the projected consolidated and consolidating balance sheets and income statements for each month of such year, each in reasonable detail, representing the Borrower's good faith projections and certified by LPC's and EMI's chief financial officers as being the most accurate projections available and identical to the projections used by the Borrower for internal planning purposes, together with such supporting schedules and information as the Lender may in its discretion require; (e) immediately after the commencement thereof, notice in writing of all litigation and of all proceedings before any governmental or regulatory agency affecting either LPC or EMI of the type described in Section 5.12 or which seek a monetary recovery against either LPC or EMI in excess of $100,000.00; (f) as promptly as practicable (but in any event not later than five business days) after an officer of either LPC or EMI obtains knowledge of the occurrence of any breach, default or event of default under any Security Document or any event which constitutes a Default or Event of Default hereunder, notice of such occurrence, together with a detailed statement by a responsible officer of either LPC or EMI of the steps being taken by the Borrower to cure the effect of such breach, default or event; (g) as soon as possible and in any event within 30 days after either LPC or EMI knows or has reason to know that any Reportable Event with respect to any Plan has occurred, the statement of LPC's and EMI's chief financial officers setting forth details as to such Reportable Event and the action which the Borrower proposes to take with respect thereto, together with a copy of the notice of such Reportable Event to the Pension Benefit Guaranty Corporation; (h) as soon as possible, and in any event within 10 days after the Borrower fails to make any quarterly contribution required with respect to any Plan under Section 412(m) of the Internal Revenue Code of 1986, as amended, the statement of the Borrower's chief financial officer setting forth details as to such failure and the action which the Borrower proposes to take with respect thereto, together with a copy of any notice of such failure required to be provided to the Pension Benefit Guaranty Corporation; 27 (i) promptly upon knowledge thereof, notice of (i) any disputes or claims by either LPC's or EMI's customers; (ii) credit memos; (iii) any goods returned to or recovered by either of them; and (iv) any change in the persons constituting either of their key officers and key directors; (j) promptly upon knowledge thereof, notice of any loss of or material damage to any Collateral or other collateral covered by the Security Documents or of any substantial adverse change in any Collateral or such other collateral or the prospect of payment thereof; (k) promptly upon their distribution, copies of all financial statements, reports and proxy statements which either LPC or EMI shall have sent to its stockholders; (l) promptly after the sending or filing thereof, copies of all regular and periodic reports (including without limitation 10Q and 10K Reports) which either LPC or EMI shall file with the Securities and Exchange Commission or any national securities exchange; (m) promptly upon knowledge thereof, notice of LPC's or EMI's violation of any law, rule or regulation, the non-compliance with which could materially and adversely affect LPC's or EMI's business or its financial condition; and (n) from time to time, with reasonable promptness, any and all receivables schedules, collection reports, deposit records, equipment schedules, copies of invoices to account debtors, shipment documents and delivery receipts for goods sold, and such other material, reports, records or information as the Lender may request. SECTION 6.2 BOOKS AND RECORDS; INSPECTION AND EXAMINATION. LPC and EMI will keep accurate books of record and account for itself pertaining to the Collateral and pertaining to their business and financial condition and such other matters as the Lender may from time to time request in which true and complete entries will be made in accordance with GAAP and, upon the Lender's request, will permit any officer, employee, attorney or accountant for the Lender to audit, review, make extracts from or copy any and all corporate and financial books and records of LPC and EMI at all times during ordinary business hours, to send and discuss with account debtors and other obligors requests for verification of amounts owed to LPC and EMI, and to discuss their affairs with any of their directors, officers, employees or agents. LPC and EMI will permit the Lender, or their employees, accountants, attorneys or agents, to examine and inspect any Collateral, other collateral covered by the Security Documents or any other property of LPC and EMI at any time during ordinary business hours. SECTION 6.3 ACCOUNT VERIFICATION. The Lender may at any time and from time to time send or require LPC and EMI to send requests for verification of accounts or notices of assignment to account debtors and other obligors. The Lender may also at any time and from time to time telephone account debtors and other obligors to verify accounts. 28 SECTION 6.4 COMPLIANCE WITH LAWS. (a) LPC and EMI will (i) comply with the requirements of applicable laws and regulations, the non-compliance with which would materially and adversely affect its business or its financial condition and (ii) use and keep the Collateral, and require that others use and keep the Collateral, only for lawful purposes, without violation of any federal, state or local law, statute or ordinance. (b) Without limiting the foregoing undertakings, each of LPC and EMI specifically agrees that they will comply with all applicable Environmental Laws and obtain and comply with all permits, licenses and similar approvals required by any Environmental Laws, and will not generate, use, transport, treat, store or dispose of any Hazardous Substances in such a manner as to create any liability or obligation under the common law of any jurisdiction or any Environmental Law. SECTION 6.5 PAYMENT OF TAXES AND OTHER CLAIMS. Each of LPC and EMI will pay or discharge, when due, (a) all taxes, assessments and governmental charges levied or imposed upon it or upon its income or profits, upon any properties belonging to it (including, without limitation, the Collateral) or upon or against the creation, perfection or continuance of the Security Interest, prior to the date on which penalties attach thereto, (b) all federal, state and local taxes required to be withheld by it, and (c) all lawful claims for labor, materials and supplies which, if unpaid, might by law become a lien or charge upon any properties of them; provided, that LPC and EMI shall not be required to pay any such tax, assessment, charge or claim whose amount, applicability or validity is being contested in good faith by appropriate proceedings and for which proper reserves have been made. SECTION 6.6 MAINTENANCE OF PROPERTIES. (a) LPC and EMI will keep and maintain the Collateral, the other collateral covered by the Security Documents and all of its other properties necessary or useful in its business in good condition, repair and working order (normal wear and tear excepted) and will from time to time replace or repair any worn, defective or broken parts; provided, however, that nothing in this Section 6.6 shall prevent LPC and EMI from discontinuing the operation and maintenance of any of its properties if such discontinuance is, in the Lender's judgment, desirable in the conduct of their business and not disadvantageous in any material respect to the Lender. (b) LPC and EMI will use commercially reasonable efforts to defend the Collateral against all claims or demands of all persons (other than the Lender) claiming the Collateral or any interest therein. (c) LPC and EMI will keep all Collateral and other collateral covered by the Security Documents free and clear of all security interests, liens and encumbrances except Permitted Liens. 29 SECTION 6.7 INSURANCE. LPC and EMI will obtain and at all times maintain insurance with insurers believed by the Borrower to be responsible and reputable, in such amounts and against such risks as may from time to time be required by the Lender, but in all events in such amounts and against such risks as is usually carried by companies engaged in similar business and owning similar properties in the same general areas in which LPC and EMI operates. Without limiting the generality of the foregoing, LPC and EMI will at all times maintain business interruption insurance including coverage for force majeure and keep all tangible Collateral insured against risks of fire (including so-called extended coverage), theft, collision (for Collateral consisting of motor vehicles) and such other risks and in such amounts as the Lender may reasonably request, with any loss payable to the Lender to the extent of its interest, and all policies of such insurance shall contain a lender's loss payable endorsement for the Lender's benefit acceptable to the Lender. All policies of liability insurance required hereunder shall name the Lender as an additional insured. SECTION 6.8 PRESERVATION OF EXISTENCE/SECURITIES AND EXCHANGE COMMISSION. Each of LPC and EMI will preserve and maintain its existence and all of its rights, privileges and franchises necessary or desirable in the normal conduct of its business and shall conduct its business in an orderly, efficient and regular manner. Each of LPC and EMI shall at all times remain in good standing with the Securities and Exchange Commission. SECTION 6.9 DELIVERY OF INSTRUMENTS, ETC. Upon request by the Lender, LPC and EMI will promptly deliver to the Lender in pledge all instruments, documents and chattel papers constituting Collateral, duly endorsed or assigned by LPC and EMI. SECTION 6.10 LENDER ACCOUNT. (a) If, notwithstanding the instructions to debtors to make payments to the Lockbox, LPC and EMI receives any payments on Receivables, they shall deposit such payments into the Lender Account. Until so deposited, LPC and EMI shall hold all such payments in trust for and as the property of the Lender and shall not commingle such payments with any of its other funds or property. (b) Amounts deposited in the Lender Account shall not bear interest and shall not be subject to withdrawal by either LPC or EMI, except after full payment and discharge of all Obligations. (c) All deposits in the Lender Account shall constitute proceeds of Collateral and shall not constitute payment of the Obligations. The Lender from time to time at its discretion may, after allowing one (1) collection day for Wells Fargo Bank, N.A. and one (1) Banking Day for Lender, apply deposited funds in the Lender Account to the payment of the Obligations, in any order or manner of application satisfactory to the Lender, by transferring such funds to the Lender's general account. (d) All items deposited in the Lender Account shall be subject to final payment. If any such item is returned uncollected, LPC and EMI will immediately pay the Lender, or, for items deposited in the Lender Account, the bank maintaining such account, the amount of that item, or such bank at its discretion may charge any uncollected item to the Borrower's commercial account or other account. LPC and EMI shall be liable as an endorser on all items deposited in the Lender Account, whether or not in fact endorsed by the Borrower. 30 SECTION 6.11 PERFORMANCE BY THE LENDER. If either LPC or EMI at any time fails to perform or observe any of the foregoing covenants contained in this Article VI or elsewhere herein, and if such failure shall continue for a period of ten calendar days after the Lender gives either of them written notice thereof (or in the case of the agreements contained in Sections 6.5, 6.7 and 6.10, immediately upon the occurrence of such failure, without notice or lapse of time), the Lender may, but need not, perform or observe such covenant on behalf and in the name, place and stead of LPC and EMI (or, at the Lender's option, in the Lender's name) and may, but need not, take any and all other actions which the Lender may reasonably deem necessary to cure or correct such failure (including, without limitation, the payment of taxes, the satisfaction of security interests, liens or encumbrances, the performance of obligations owed to account debtors or other obligors, the procurement and maintenance of insurance, the execution of assignments, security agreements and financing statements, and the endorsement of instruments); and LPC and EMI shall thereupon pay to the Lender on demand the amount of all monies expended and all costs and expenses (including reasonable attorneys' fees and legal expenses) incurred by the Lender in connection with or as a result of the performance or observance of such agreements or the taking of such action by the Lender, together with interest thereon from the date expended or incurred at the Revolving Floating Rate. To facilitate the Lender's performance or observance of such covenants of LPC and EMI, LPC and EMI hereby irrevocably appoint the Lender, or the Lender's delegate, acting alone, as their attorney in fact (which appointment is coupled with an interest) with the right (but not the duty) from time to time to create, prepare, complete, execute, deliver, endorse or file in the name and on behalf of LPC and EMI any and all instruments, documents, assignments, security agreements, financing statements, applications for insurance and other agreements and writings required to be obtained, executed, delivered or endorsed by LPC and EMI under this Section 6.11. SECTION 6.12 DEBT SERVICE COVERAGE RATIO. The Borrower covenants that LPC and EMI shall, commencing on the fiscal quarter ending December 31, 1999, and continuing on the last day of each fiscal quarter thereafter, maintain an aggregate average minimum Debt Service Coverage Ratio (based upon the period from the immediately preceding fiscal year end through the reporting date ) of not less than the ratios set forth below: ------------------------------------- -------------------------------- Quarter Ending Requirement -------------- ----------- ------------------------------------- -------------------------------- December 31 of each year 1.00 to 1.00 ------------------------------------- -------------------------------- March 31 of each year 1.05 to 1.00 ------------------------------------- -------------------------------- June 30 of each year 1.15 to 1.00 ------------------------------------- -------------------------------- September 30 of each year 1.25 to 1.00 ------------------------------------- -------------------------------- SECTION 6.13 NET WORTH. The Borrower covenants that, as of September 30, 1999, LPC and EMI had an aggregate Book Net Worth of $9,888,000.00. The Borrower covenants that commencing with the fiscal quarter ending December 31, 1999, and continuing each fiscal quarter thereafter, Borrower's aggregate Book Net Worth as of the end of each fiscal quarter end shall increase by (or in the event a decrease is allowed, decrease by not more than) the amounts set forth below as measured from the immediately preceding fiscal year end. 31 ---------------------------------------- ------------------------------- Quarter Ending Net Worth Increase -------------- ------------------ (Decrease) ---------- ---------------------------------------- ------------------------------- December 31, 1999 (100,000.00) ---------------------------------------- ------------------------------- March 31 of each year $100,000.00 ---------------------------------------- ------------------------------- June 30 of each year $300,000.00 ---------------------------------------- ------------------------------- September 30 of each year $500,000.00 ---------------------------------------- ------------------------------- December 31, 2000 and each December 31 thereafter $0.00 ---------------------------------------- ------------------------------- SECTION 6.14 NET INCOME. The Borrower covenants that beginning with the fiscal quarter ending December 31, 1999, and continuing for each fiscal quarter thereafter, LPC and EMI shall achieve an aggregate consolidated Net Income of not less than (or in the event a Net Loss is permitted, a Net Loss of not more than) the amounts set forth below, as measured from the immediately preceding fiscal year end: ---------------------------------------- ------------------------------- Quarter Ending Net Income Increase -------------- ------------------- (Decrease) ---------- ---------------------------------------- ------------------------------- September 30, 1999 ($1,500,000.00) ---------------------------------------- ------------------------------- December 31, 1999 (100,000.00) ---------------------------------------- ------------------------------- March 31 of each year $100,000.00 ---------------------------------------- ------------------------------- June 30 of each year $300,000.00 ---------------------------------------- ------------------------------- September 30, 2000 and each September 30 thereafter $500,000.00 ---------------------------------------- ------------------------------- December 31, 2000 and each December 31 thereafter $0.00 ---------------------------------------- ------------------------------- SECTION 6.15 STOP LOSS. The Borrower covenants that beginning with the month of October, 1999 and continuing for each month thereafter, LPC and EMI shall not achieve an aggregate consolidated Net Loss in excess of $100,000.00 in any one month. ARTICLE VII Negative Covenants ------------------ So long as the Obligations shall remain unpaid, or the Credit Facility shall remain outstanding, the Borrower agrees that, without the Lender's prior written consent: SECTION 7.1 LIENS. Neither LPC nor EMI will create, incur or suffer to exist any mortgage, deed of trust, pledge, lien, security interest, assignment or transfer upon or of any of its assets, now owned or hereafter acquired, to secure any indebtedness; EXCLUDING, HOWEVER, from the operation of the foregoing, the following (collectively, "Permitted Liens"): (a) in the case of any of their property which is not Collateral or other collateral described in the Security Documents, covenants, restrictions, rights, easements and minor irregularities in title which do not materially interfere with the Borrower's business or operations as presently conducted; (b) mortgages, deeds of trust, pledges, liens, security interests and assignments in existence on the date hereof and listed in Schedule 7.1 hereto, securing indebtedness for borrowed money permitted under Section 7.2; 32 (c) the Security Interest and liens and security interests created by the Security Documents; (d) purchase money security interests relating to the acquisition of machinery and equipment of the Borrower not exceeding the lesser of cost or fair market value thereof and so long as no Default Period is then in existence and none would exist immediately after such acquisition; and (e) landlords', mortgagees' and lessors' liens in respect of rent not in default, to the extent landlord/mortgagee waivers shall have been delivered to the Lender or liens in respect of pledges or deposits under worker's compensation, unemployment insurance, social security laws, or similar legislation (other than ERISA) or mechanics', laborers' and materialmens' and similar liens, if the obligation secured by such liens are not then delinquent. SECTION 7.2 INDEBTEDNESS. Neither LPC nor EMI will incur, create, assume or permit to exist any indebtedness or liability on account of deposits or advances or any indebtedness for borrowed money or letters of credit issued on the Borrower's behalf, or any other indebtedness or liability evidenced by notes, bonds, debentures or similar obligations, except: (a) indebtedness arising hereunder; (b) indebtedness of the Borrower in existence on the date hereof and listed in Schedule 7.2 hereto; (c) indebtedness relating to liens permitted in accordance with Section 7.1; (d) indebtedness in respect of current liabilities, other than for borrowed money, of the Borrower incurred in the ordinary course of business and of a type and magnitude consistent with past practices; and (e) that subordinated indebtedness set forth in the Subordination Agreement. SECTION 7.3 GUARANTIES. Neither LPC nor EMI will assume, guarantee, endorse or otherwise become directly or contingently liable in connection with any obligations of any other Person, except: (a) the endorsement of negotiable instruments by the Borrower for deposit or collection or similar transactions in the ordinary course of business; (b) guaranties, endorsements and other direct or contingent liabilities in connection with the obligations of other Persons, in existence on the date hereof and listed in Schedule 7.2 hereto; and (c) investments permitted by Section 7.4. 33 SECTION 7.4 INVESTMENTS AND SUBSIDIARIES. (a) Neither LPC nor EMI will purchase or hold beneficially any stock or other securities or evidences of indebtedness of, make or permit to exist any loans or advances to, or make any investment or acquire any interest whatsoever in, any other Person, including specifically but without limitation any partnership or joint venture, except: (i) investments in direct obligations of the United States of America or any agency or instrumentality thereof whose obligations constitute full faith and credit obligations of the United States of America having a maturity of one year or less, commercial paper issued by U.S. corporations rated "A-1" or "A-2" by Standard & Poors Corporation or "P-1" or "P-2" by Moody's Investors Service or certificates of deposit or bankers' acceptances having a maturity of one year or less issued by members of the Federal Reserve System having deposits in excess of $100,000,000 (which certificates of deposit or bankers' acceptances are fully insured by the Federal Deposit Insurance Corporation); (ii) travel advances or loans to the Borrower's officers and employees not exceeding at any one time an aggregate of $50,000.00; and (iii) advances in the form of progress payments, prepaid rent not exceeding three months or security deposits; and (iv) subject to Lender's prior written consent, investments pursuant to or arising under currency arrangements or interest rate agreements entered into in the ordinary course of Borrower's business. (b) Neither LPC nor EMI will create or permit to exist any Subsidiary, other than the Subsidiar(y)(ies) in existence on the date hereof and listed in Schedule 5.4. SECTION 7.5 DIVIDENDS. Neither LPC nor EMI will declare or pay any dividends (other than dividends payable solely in stock of LPC or EMI, as applicable) on any class of its stock or make any payment on account of the purchase, redemption or other retirement of any shares of such stock or make any distribution in respect thereof, either directly or indirectly. SECTION 7.6 SALE OR TRANSFER OF ASSETS; SUSPENSION OF BUSINESS OPERATIONS. Except for the Transaction, neither LPC nor EMI will sell, lease, assign, transfer or otherwise dispose of (i) the stock of any Subsidiary, (ii) all or a substantial part of its assets, or (iii) any Collateral or any interest therein (whether in one transaction or in a series of transactions) to any other Person other than the sale of Inventory in the ordinary course of business and will not liquidate, dissolve or suspend business operations. The Borrower will not in any manner transfer any property without prior or present receipt of full and adequate consideration. SECTION 7.7 CONSOLIDATION AND MERGER; ASSET ACQUISITIONS. Neither LPC nor EMI will consolidate with or merge into any Person, or permit any other Person to merge into it, or acquire (in a transaction analogous in purpose or effect to a consolidation or merger) all or substantially all the assets of any other Person. 34 SECTION 7.8 SALE AND LEASEBACK. Neither LPC nor EMI will enter into any arrangement, directly or indirectly, with any other Person whereby either of them shall sell or transfer any real or personal property, whether now owned or hereafter acquired, and then or thereafter rent or lease as lessee such property or any part thereof or any other property which the Borrower intends to use for substantially the same purpose or purposes as the property being sold or transferred. SECTION 7.9 RESTRICTIONS ON NATURE OF BUSINESS. Neither LPC nor EMI will engage in any line of business materially different from that presently engaged in by the Borrower and will not purchase, lease or otherwise acquire assets not related to its business. SECTION 7.10 CAPITAL EXPENDITURES. LPC and EMI will not, in the aggregate, incur or contract to incur Capital Expenditures of more than $1,500,000.00 in the aggregate during any fiscal year. In addition, LPC and EMI will not, in the aggregate, incur or contract to incur unfinanced Capital Expenditures of more than $1,000,000.00 during any fiscal year. SECTION 7.11 ACCOUNTING. Neither LPC nor EMI will adopt any material change in accounting principles other than as required by GAAP. Neither LPC nor EMI will adopt, permit or consent to any change in its fiscal year. SECTION 7.12 DISCOUNTS, ETC. Neither LPC nor EMI will, after notice from the Lender, grant, other than in the ordinary course of business, any discount, credit or allowance to any customer of either of them or accept any return of goods sold, or at any time (whether before or after notice from the Lender) modify, amend, subordinate, cancel or terminate the obligation of any account debtor or other obligor of either of them. SECTION 7.13 DEFINED BENEFIT PENSION PLANS. Neither LPC nor EMI will adopt, create, assume or become a party to any defined benefit pension plan, unless disclosed to the Lender pursuant to Section 5.10. SECTION 7.14 OTHER DEFAULTS. Neither LPC nor EMI will permit any breach, default or event of default (subject to any applicable cure periods) to occur under any note, loan agreement, indenture, lease, mortgage, contract for deed, security agreement or other contractual obligation binding upon them. SECTION 7.15 PLACE OF BUSINESS; NAME. Neither LPC nor EMI will, without 60 days prior written notice to Lender, transfer its chief executive office or principal place of business, or move, relocate, close or sell any business location. Neither LPC nor EMI will, without 60 days prior written notice to Lender, permit any tangible Collateral or any records pertaining to the Collateral to be located in any state or area in which, in the event of such location, a financing statement covering such Collateral would be required to be, but has not in fact been, filed in order to perfect the Security Interest. Neither LPC nor EMI will, without 60 days prior written notice to Lender, change its name. SECTION 7.16 ORGANIZATIONAL DOCUMENTS; S CORPORATION STATUS. Neither LPC nor EMI will amend its certificate of incorporation, articles of incorporation or bylaws. The Borrower will not become an S Corporation within the meaning of the Internal Revenue Code of 1986, as amended. 35 SECTION 7.17 SALARIES. Neither LPC nor EMI will pay excessive or unreasonable salaries, bonuses, commissions, consultant fees or other compensation; or increase the salary, bonus, commissions, consultant fees or other compensation of the directors, officers and consultants, and any member of their families in the aggregate, by more than 25% in any one year, either individually or for all such persons in the aggregate, or pay any such increase from any source other than profits earned in the year of payment. SECTION 7.18 CHANGE IN OWNERSHIP. Neither LPC nor EMI will issue or sell any stock. ARTICLE VIII Events of Default, Rights and Remedies -------------------------------------- SECTION 8.1 EVENTS OF DEFAULT. "Event of Default", wherever used herein, means any one of the following events: (a) Default in the payment of the Obligations when they become due and payable; (b) Default in the payment of any fees, commissions, costs or expenses required to be paid by the Borrower under this Agreement; (c) Default in the performance, or breach, of any covenant or agreement of the Borrower contained in this Agreement; (d) Either of LPC or EMI shall be or become insolvent, or admit in writing its inability to pay its debts as they mature, or make an assignment for the benefit of creditors; or either of LPC or EMI shall apply for or consent to the appointment of any receiver, trustee, or similar officer for it or for all or any substantial part of its property; or such receiver, trustee or similar officer shall be appointed without the application or consent of the Borrower; or either of LPC or EMI shall institute (by petition, application, answer, consent or otherwise) any bankruptcy, insolvency, reorganization, arrangement, readjustment of debt, dissolution, liquidation or similar proceeding relating to it under the laws of any jurisdiction; or any such proceeding shall be instituted (by petition, application or otherwise) against either of LPC or EMI; or any judgment, writ, warrant of attachment or execution or similar process shall be issued or levied against a substantial part of the property of either of LPC or EMI; (e) A petition shall be filed by or against either of LPC or EMI under the United States Bankruptcy Code naming either of LPC or EMI as debtor; (f) Any representation or warranty made by either of LPC or EMI in this Agreement, or by either of LPC or EMI (or any of their officers) in any agreement, certificate, instrument or financial statement or other statement contemplated by or made or delivered pursuant to or in connection with this Agreement or any such guaranty shall prove to have been incorrect in any material respect when deemed to be effective; 36 (g) The rendering against either of LPC or EMI of a final judgment, decree or order for the payment of money in excess of $50,000.00 and the continuance of such judgment, decree or order unsatisfied and in effect for any period of 30 consecutive days without a stay of execution; (h) A default under any bond, debenture, note or other evidence of indebtedness of either LPC or EMI owed to any Person other than the Lender, or under any indenture or other instrument under which any such evidence of indebtedness has been issued or by which it is governed, or under any lease of any of the Premises, and the expiration of the applicable period of grace, if any, specified in such evidence of indebtedness, indenture, other instrument or lease; (i) Any Reportable Event, which the Lender determines in good faith might constitute grounds for the termination of any Plan or for the appointment by the appropriate United States District Court of a trustee to administer any Plan, shall have occurred and be continuing 30 days after written notice to such effect shall have been given to the Borrower by the Lender; or a trustee shall have been appointed by an appropriate United States District Court to administer any Plan; or the Pension Benefit Guaranty Corporation shall have instituted proceedings to terminate any Plan or to appoint a trustee to administer any Plan; or the Borrower shall have filed for a distress termination of any Plan under Title IV of ERISA; or the Borrower shall have failed to make any quarterly contribution required with respect to any Plan under Section 412(m) of the Internal Revenue Code of 1986, as amended, which the Lender determines in good faith may by itself, or in combination with any such failures that the Lender may determine are likely to occur in the future, result in the imposition of a lien on the Borrower's assets in favor of the Plan; (j) An event of default shall occur under any Security Document or under any other security agreement, mortgage, deed of trust, assignment or other instrument or agreement securing any obligations of the Borrower hereunder or under any Note; (k) Either of LPC or EMI shall liquidate, dissolve, terminate or suspend its business operations or otherwise fail to operate its business in the ordinary course, or sell all or substantially all of its assets, without the Lender's prior written consent; (l) Either of LPC or EMI shall fail to pay, withhold, collect or remit any tax or tax deficiency when assessed or due (other than any tax deficiency which is being contested in good faith and by proper proceedings and for which it shall have set aside on its books adequate reserves therefor) or notice of any state or federal tax liens shall be filed or issued; (m) Default in the payment of any amount owed by either of LPC or EMI to the Lender other than any indebtedness arising hereunder; (n) Either of LPC or EMI shall take or participate in any action which would be prohibited under the provisions of any Subordination Agreement or make any payment on the Subordinated Indebtedness (as defined in the Subordination Agreement) that any Person was not entitled to receive under the provisions of the Subordination Agreement; 37 (o) Any event or circumstance with respect to either of LPC or EMI shall occur such that the Lender shall believe in good faith that the prospect of payment of all or any part of the Obligations or the performance by either of LPC or EMI under the Loan Documents is impaired or any material adverse change in the business or financial condition of either of LPC or EMI shall occur. (p) Any breach, default or event of default by or attributable to any Affiliate under any agreement between such Affiliate and the Lender. SECTION 8.2 RIGHTS AND REMEDIES. During any Default Period, the Lender may exercise any or all of the following rights and remedies: (a) the Lender may, by notice to the Borrower, declare the Commitment to be terminated, whereupon the same shall forthwith terminate; (b) the Lender may, by notice to the Borrower, declare the Obligations to be forthwith due and payable, whereupon all Obligations shall become and be forthwith due and payable, without presentment, notice of dishonor, protest or further notice of any kind, all of which each of LPC and EMI hereby expressly waives; (c) the Lender may, without notice to the Borrower and without further action, apply any and all money owing by the Lender to the Borrower to the payment of the Obligations; (d) the Lender may exercise and enforce any and all rights and remedies available upon default to a secured party under the UCC, including, without limitation, the right to take possession of Collateral, or any evidence thereof, proceeding without judicial process or by judicial process (without a prior hearing or notice thereof, which the Borrower hereby expressly waives) and the right to sell, lease or otherwise dispose of any or all of the Collateral, and, in connection therewith, each of LPC and EMI will on demand assemble the Collateral and make it available to the Lender at a place to be designated by the Lender which is reasonably convenient to both parties; (e) the Lender may exercise and enforce its rights and remedies under the Loan Documents; and (f) the Lender may exercise any other rights and remedies available to it by law or agreement. Notwithstanding the foregoing, upon the occurrence of an Event of Default described in subsections (d) or (e) of Section 8.1, the Obligations shall be immediately due and payable automatically without presentment, demand, protest or notice of any kind. SECTION 8.3 CERTAIN NOTICES. If notice to the Borrower of any intended disposition of Collateral or any other intended action is required by law in a particular instance, such notice shall be deemed commercially reasonable if given (in the manner specified in Section 9.3) at least ten calendar days before the date of intended disposition or other action. 38 ARTICLE IX Miscellaneous ------------- SECTION 9.1 NO WAIVER; CUMULATIVE REMEDIES. No failure or delay by the Lender in exercising any right, power or remedy under the Loan Documents shall operate as a waiver thereof; nor shall any single or partial exercise of any such right, power or remedy preclude any other or further exercise thereof or the exercise of any other right, power or remedy under the Loan Documents. The remedies provided in the Loan Documents are cumulative and not exclusive of any remedies provided by law. SECTION 9.2 AMENDMENTS, ETC. No amendment, modification, termination or waiver of any provision of any Loan Document or consent to any departure by the Borrower therefrom or any release of a Security Interest shall be effective unless the same shall be in writing and signed by the Lender, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given. No notice to or demand on the Borrower in any case shall entitle either LPC or EMI to any other or further notice or demand in similar or other circumstances. SECTION 9.3 ADDRESSES FOR NOTICES, ETC. Except as otherwise expressly provided herein, all notices, requests, demands and other communications provided for under the Loan Documents shall be in writing and shall be (a) personally delivered, (b) sent by first class United States mail, (c) sent by overnight courier of national reputation, or (d) transmitted by telecopy, in each case addressed or telecopied to the party to whom notice is being given at its address or telecopier number as set forth below: If to the Borrower: Laser Power Corporation 12777 High Bluff Drive San Diego, CA 92130 Telecopier: 619/259-0956 Attention: Paul Wickman Exotic Materials, Inc. 36570 Briggs Road Murrieta, CA 92563-2347 Telecopier: 909/926-9026 Attention: Gary Mineo If to the Lender: Wells Fargo Credit, Inc. 100 West Washington Street, 7th Floor MAC S4101-076 Phoenix, AZ 85003 Telecopier: 602/378-6215 Attention: Jill Fedoruk 39 or, as to each party, at such other address or telecopier number as may hereafter be designated by such party in a written notice to the other party complying as to delivery with the terms of this Section. All such notices, requests, demands and other communications shall be deemed to have been given on (a) the date received if personally delivered, (b) when deposited in the mail if delivered by mail, (c) the date sent if sent by overnight courier, or (d) the date of transmission if delivered by telecopy, except that notices or requests to the Lender pursuant to any of the provisions of Article II shall not be effective until received by the Lender. Any notice given to LPC shall be deemed to have also been given to EMI. Any notice given to EMI shall be deemed to have also been given to LPC. Any notice given to Lender on behalf of LPC shall be deemed to have also been given on behalf of EMI. Any notice given to Lender on behalf of EMI shall be deemed to have also been given on behalf of LPC. SECTION 9.4 FURTHER DOCUMENTS. Each of LPC and EMI will from time to time execute and deliver or endorse any and all instruments, documents, conveyances, assignments, security agreements, financing statements and other agreements and writings that the Lender may reasonably request in order to secure, protect, perfect or enforce the Security Interest or the Lender's rights under the Loan Documents (but any failure to request or assure that the Borrower executes, delivers or endorses any such item shall not affect or impair the validity, sufficiency or enforceability of the Loan Documents and the Security Interest, regardless of whether any such item was or was not executed, delivered or endorsed in a similar context or on a prior occasion). SECTION 9.5 COLLATERAL. This Agreement does not contemplate a sale of accounts, contract rights or chattel paper, and, as provided by law, the Borrower is entitled to any surplus and shall remain liable for any deficiency. The Lender's duty of care with respect to Collateral in its possession (as imposed by law) shall be deemed fulfilled if it exercises reasonable care in physically keeping such Collateral, or in the case of Collateral in the custody or possession of a bailee or other third person, exercises reasonable care in the selection of the bailee or other third person, and the Lender need not otherwise preserve, protect, insure or care for any Collateral. The Lender shall not be obligated to preserve any rights the Borrower may have against prior parties, to realize on the Collateral at all or in any particular manner or order or to apply any cash proceeds of the Collateral in any particular order of application. SECTION 9.6 COSTS AND EXPENSES. Each of LPC and EMI jointly and severally agree to pay on demand all costs and expenses, including (without limitation) attorneys' fees, incurred by the Lender in connection with the Obligations, this Agreement, the Loan Documents, and any other document or agreement related hereto or thereto, and the transactions contemplated hereby, including without limitation all such costs, expenses and fees incurred in connection with the negotiation, preparation, execution, amendment, administration, performance, collection and enforcement of the Obligations and all such documents and agreements and the creation, perfection, protection, satisfaction, foreclosure or enforcement of the Security Interest. SECTION 9.7 INDEMNITY. In addition to the payment of expenses pursuant to Section 9.6 each of LPC and EMI, jointly and severally agree to indemnify, defend and hold harmless the Lender, and any of its participants, parent corporations, subsidiary corporations, affiliated corporations, successor corporations, and all present and future officers, directors, employees, attorneys and agents of the foregoing (the "Indemnitees") from and against any of the following (collectively, "Indemnified Liabilities"); provided that the 40 Borrower shall not have any obligation to any Indemnitee hereunder with respect to the Indemnified Liabilities caused by or resulting from the willful misconduct or gross negligence of such Indemnitee or the breach by such Indemnitee of this Agreement or any other Loan Document: (i) any and all transfer taxes, documentary taxes, assessments or charges made by any governmental authority by reason of the execution and delivery of the Loan Documents or the making of the Advances; (ii) any claims, loss or damage to which any Indemnitee may be subjected if any representation or warranty contained in Section 5.12 proves to be incorrect in any respect or as a result of any violation of the covenant contained in Section 6.4(b); and (iii) any and all other liabilities, losses, damages, penalties, judgments, suits, claims, costs and expenses of any kind or nature whatsoever (including, without limitation, the reasonable fees and disbursements of counsel) in connection with the foregoing and any other investigative, administrative or judicial proceedings, whether or not such Indemnitee shall be designated a party thereto, which may be imposed on, incurred by or asserted against any such Indemnitee, in any manner related to or arising out of or in connection with the making of the Advances and the Loan Documents or the use or intended use of the proceeds of the Advances. If any investigative, judicial or administrative proceeding arising from any of the foregoing is brought against any Indemnitee, upon such Indemnitee's request, the Borrower, or counsel designated by the Borrower and satisfactory to the Indemnitee, will resist and defend such action, suit or proceeding to the extent and in the manner directed by the Indemnitee, at the Borrower's sole costs and expense. Each Indemnitee will use its best efforts to cooperate in the defense of any such action, suit or proceeding. If the foregoing undertaking to indemnify, defend and hold harmless may be held to be unenforceable because it violates any law or public policy, the Borrower shall nevertheless make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The Borrower's obligation under this Section 9.7 shall survive the termination of this Agreement and the discharge of the Borrower's other obligations hereunder. SECTION 9.8 PARTICIPANTS. The Lender and its participants, if any, are not partners or joint venturers, and the Lender shall not have any liability or responsibility for any obligation, act or omission of any of its participants. All rights and powers specifically conferred upon the Lender may be transferred or delegated to any of the Lender's participants, successors or assigns. SECTION 9.9 EXECUTION IN COUNTERPARTS. This Agreement and other Loan Documents may be executed in any number of counterparts, each of which when so executed and delivered shall be deemed to be an original and all of which counterparts, taken together, shall constitute but one and the same instrument. SECTION 9.10 BINDING EFFECT; ASSIGNMENT; COMPLETE AGREEMENT; EXCHANGING INFORMATION. The Loan Documents shall be binding upon and inure to the benefit of the Borrower and the Lender and their respective successors and assigns, except that the Borrower shall not have the right to assign its rights thereunder or any interest therein without the Lender's prior written consent. 41 This Agreement, together with the Loan Documents, comprises the complete and integrated agreement of the parties on the subject matter hereof and supersedes all prior agreements, written or oral, on the subject matter hereof. Without limiting the Lender's right to share information regarding the Borrower and its Affiliates with the Lender's participants, accountants, lawyers and other advisors, the Lender, Norwest Corporation, and all direct and indirect subsidiaries of Norwest Corporation, may exchange any and all information they may have in their possession regarding the Borrower and its Affiliates, and the Borrower waives any right of confidentiality it may have with respect to such exchange of such information. SECTION 9.11 SEVERABILITY OF PROVISIONS. Any provision of this Agreement which is prohibited or unenforceable shall be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof. SECTION 9.12 HEADINGS. Article and Section headings in this Agreement are included herein for convenience of reference only and shall not constitute a part of this Agreement for any other purpose. SECTION 9.13 GOVERNING LAW; JURISDICTION, VENUE; WAIVER OF JURY TRIAL. The Loan Documents shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of Arizona. This Agreement shall be governed by and construed in accordance with the substantive laws (other than conflict laws) of the State of Arizona. The parties hereto hereby (i) consents to the personal jurisdiction of the state and federal courts located in the State of Arizona in connection with any controversy related to this Agreement; (ii) waives any argument that venue in any such forum is not convenient, (iii) agrees that any litigation initiated by the Lender or the Borrower in connection with this Agreement or the other Loan Documents shall be venued in either the District Court of Maricopa County, Arizona, or the United States District Court, District of Arizona; and (iv) agrees that a final judgment in any such suit, action or proceeding shall be conclusive and may be enforced in other jurisdictions by suit on the judgment or in any other manner provided by law. THE PARTIES WAIVE ANY RIGHT TO TRIAL BY JURY IN ANY ACTION OR PROCEEDING BASED ON OR PERTAINING TO THIS AGREEMENT. IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers thereunto duly authorized as of the date first above written. WELLS FARGO CREDIT, INC., a Minnesota corporation By /s/ Jill Fedoruk --------------------------------------- Its Officer -------------------------------- 42 LASER POWER CORPORATION, a Delaware corporation By /s/ Paul P. Wickmam -------------------------------------- Its CFO ---------------------------------- EXOTIC MATERIALS, INC., a California corporation By /s/ Paul P. Wickmam -------------------------------------- Its Treasurer ---------------------------------- 43 Table of Exhibits and Schedules Exhibit A Form of Revolving Note Exhibit B-1 Form of Term Note Exhibit B-2 Form of Capital Expenditures Note Exhibit C Compliance Certificate Exhibit D Premises ------------------- Schedule 5.1 Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral Schedule 5.4 Subsidiaries Schedule 7.1 Permitted Liens Schedule 7.2 Permitted Indebtedness and Guaranties 44 Exhibit A to Credit and Security Agreement REVOLVING NOTE $4,000,000.00 Phoenix, Arizona __________, 1999 For value received, the undersigned, LASER POWER CORPORATION, a Delaware corporation and EXOTIC MATERIALS, INC., a California corporation (collectively, jointly and severally, the "Borrower"), hereby promise to pay on the Termination Date under the Credit Agreement (defined below), to the order of WELLS FARGO CREDIT, INC., a Minnesota corporation (the "Lender"), at its main office in Phoenix, Arizona, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Four Million Dollars ($4,000,000.00) or, if less, the aggregate unpaid principal amount of all Revolving Advances made by the Lender to the Borrower under the Credit Agreement (defined below) together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Note is fully paid at the rate from time to time in effect under the Credit and Security Agreement of even date herewith (as the same may hereafter be amended, supplemented or restated from time to time, the "Credit Agreement") by and between the Lender and the Borrower. The principal hereof and interest accruing thereon shall be due and payable as provided in the Credit Agreement. This Note may be prepaid only in accordance with the Credit Agreement. This Note is issued pursuant, and is subject, to the Credit Agreement, which provides, among other things, for acceleration hereof. This Note is the Revolving Note referred to in the Credit Agreement. This Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements. The Borrower hereby agrees to pay all costs of collection, including attorneys' fees and legal expenses in the event this Note is not paid when due, whether or not legal proceedings are commenced. Presentment or other demand for payment, notice of dishonor and protest are expressly waived. LASER POWER CORPORATION, a Delaware corporation By _______________________________________ Its _____________________________________ A-1 EXOTIC MATERIALS, INC., a California corporation By _______________________________________ Its _____________________________________ A-2 Exhibit B-1 to Credit and Security Agreement TERM NOTE $1,950,000.00 Phoenix, Arizona __________, 1999 For value received, the undersigned, LASER POWER CORPORATION, a Delaware corporation, and EXOTIC MATERIALS, INC., a California corporation (collectively, jointly and severally the "Borrower"), hereby promise to pay on the Termination Date under the Credit Agreement (defined below), to the order of WELLS FARGO CREDIT, INC., a Minnesota corporation (the "Lender"), at its main office in Phoenix, Arizona, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of One Million Nine Hundred Fifty Thousand Dollars ($1,950,000.00) or, if less, the aggregate unpaid principal amount of all Term Advance made by the Lender to the Borrower under the Credit Agreement (defined below) together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Note is fully paid at the rate from time to time in effect under the Credit and Security Agreement of even date herewith (as the same may hereafter be amended, supplemented or restated from time to time, the "Credit Agreement") by and between the Lender and the Borrower. The principal hereof and interest accruing thereon shall be due and payable as provided in the Credit Agreement. This Note may be prepaid only in accordance with the Credit Agreement. This Note is issued pursuant, and is subject, to the Credit Agreement, which provides, among other things, for acceleration hereof. This Note is the Term Note referred to in the Credit Agreement. This Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements. The Borrower hereby agrees to pay all costs of collection, including attorneys' fees and legal expenses in the event this Note is not paid when due, whether or not legal proceedings are commenced. Presentment or other demand for payment, notice of dishonor and protest are expressly waived. LASER POWER CORPORATION, a Delaware corporation By ______________________________________ Its __________________________________ B-1-1 EXOTIC MATERIALS, INC., a California corporation By ______________________________________ Its __________________________________ B-1-1 Exhibit B-2 to Credit and Security Agreement CAPITAL EXPENDITURES NOTE $750,000.00 Phoenix, Arizona __________, 1999 For value received, the undersigned, LASER POWER CORPORATION, a Delaware corporation, and EXOTIC MATERIALS, INC., a California corporation (collectively, jointly and severally the "Borrower"), hereby promise to pay on the Termination Date under the Credit Agreement (defined below), to the order of WELLS FARGO CREDIT, INC., a Minnesota corporation (the "Lender"), at its main office in Phoenix, Arizona, or at any other place designated at any time by the holder hereof, in lawful money of the United States of America and in immediately available funds, the principal sum of Seven Hundred Fifty Thousand Dollars ($750,000.00) or, if less, the aggregate unpaid principal amount of all Term Advance made by the Lender to the Borrower under the Credit Agreement (defined below) together with interest on the principal amount hereunder remaining unpaid from time to time, computed on the basis of the actual number of days elapsed and a 360-day year, from the date hereof until this Note is fully paid at the rate from time to time in effect under the Credit and Security Agreement of even date herewith (as the same may hereafter be amended, supplemented or restated from time to time, the "Credit Agreement") by and between the Lender and the Borrower. The principal hereof and interest accruing thereon shall be due and payable as provided in the Credit Agreement. This Note may be prepaid only in accordance with the Credit Agreement. This Note is issued pursuant, and is subject, to the Credit Agreement, which provides, among other things, for acceleration hereof. This Note is the Capital Expenditures Note referred to in the Credit Agreement. This Note is secured, among other things, pursuant to the Credit Agreement and the Security Documents as therein defined, and may now or hereafter be secured by one or more other security agreements, mortgages, deeds of trust, assignments or other instruments or agreements. The Borrower hereby agrees to pay all costs of collection, including attorneys' fees and legal expenses in the event this Note is not paid when due, whether or not legal proceedings are commenced. Presentment or other demand for payment, notice of dishonor and protest are expressly waived. LASER POWER CORPORATION, a Delaware corporation By ____________________________________ Its ________________________________ B-2-1 EXOTIC MATERIALS, INC., a California corporation By ____________________________________ Its ________________________________ B-2-1 Exhibit C to Credit and Security Agreement COMPLIANCE CERTIFICATE ---------------------- To: _________________________________ Wells Fargo Credit, Inc. Date: __________________, ______ Subject: Laser Power Corporation, and Exotic Materials, Inc. Financial Statements In accordance with our Credit and Security Agreement dated as of ____________, ____ (the "Credit Agreement"), attached are the financial statements of Laser Power Corporation, and Exotic Materials, Inc. (collectively the "Borrower") as of and for ________________, _____ (the "Reporting Date") and the year-to-date period then ended (the "Current Financials"). All terms used in this certificate have the meanings given in the Credit Agreement. I certify that the Current Financials have been prepared in accordance with GAAP, subject to year-end audit adjustments, and fairly present the Borrower's financial condition and the results of its operations as of the date thereof. EVENTS OF DEFAULT. (Check one): ------------------ |_| The undersigned does not have knowledge of the occurrence of a Default or Event of Default under the Credit Agreement. |_| The undersigned has knowledge of the occurrence of a Default or Event of Default under the Credit Agreement and attached hereto is a statement of the facts with respect to thereto. I hereby certify to the Lender as follows: |_| The Reporting Date does not mark the end of one of the Borrower's fiscal quarters, hence I am completing only paragraph __ below. |_| The Reporting Date marks the end of one of the Borrower's fiscal quarters, hence I am completing all paragraphs below except paragraph __. |_| The Reporting Date marks the end of the Borrower's fiscal year, hence I am completing all paragraphs below. FINANCIAL COVENANTS. I further hereby certify that the Borrower is in compliance with the covenants set forth in Sections 6.12 through 6.15, 7.10 and 7.17 of the Agreement, except as indicated below. The calculations made to determine compliance are as follows: Covenant 6.12 Debt Service Coverage Ratio ------------------------------- ---------------------- ---------------- Quarter Ending Requirement Actual ------------------------------- ---------------------- ---------------- December 31 of each year 1.00 to 1.00 ------------------------------- ---------------------- ---------------- March 31 of each year 1.05 to 1.00 ------------------------------- ---------------------- ---------------- June 30 of each year 1.15 to 1.00 ------------------------------- ---------------------- ---------------- September 30 of each year 1.25 to 1.00 ------------------------------- ---------------------- ---------------- Covenant 6.13 Book Net Worth ----------------------------- ---------------------------- ---------------- Quarter Ending Requirement Actual ----------------------------- ---------------------------- ---------------- September 30, 1999 $9,888,000.00 ----------------------------- ---------------------------- ---------------- December 31, 1999 An amount equal to the Borrower's Book Net Worth on the immediately preceding fiscal year end MINUS $100,000.00 ----------------------------- ---------------------------- ---------------- March 31 of each year An amount equal to the Borrower's Book Net Worth on the immediately preceding fiscal year end PLUS $100,000.00 ----------------------------- ---------------------------- ---------------- June 30 of each year An amount equal to the Borrower's Book Net Worth on the immediately preceding fiscal year end PLUS $300,000.00 ----------------------------- ---------------------------- ---------------- September 30 of An amount equal to the each year Borrower's Book Net Worth on the immediately preceding fiscal year end PLUS $500,000.00 ----------------------------- ---------------------------- ---------------- December 31, 2000 An amount equal to the and each Borrower's Book Net December 31 Worth on the thereafter immediately preceding fiscal year end ----------------------------- ---------------------------- ---------------- Covenant 6.14 Net Income/Net Loss ----------------------------- ---------------------------- ---------------- Quarter Ending Requirement Actual ----------------------------- ---------------------------- ---------------- September 30, 1999 ($1,500,000.00) as measured from the immediately preceding fiscal year end ----------------------------- ---------------------------- ---------------- December 31, 1999 ($100,000.00) as measured from the immediately preceding fiscal year end ----------------------------- ---------------------------- ---------------- Each March 31 ($100,000.00) as measured from the immediately preceding fiscal year end ----------------------------- ---------------------------- ---------------- Each June 30 $300,000.00 as measured from the immediately preceding fiscal year end ----------------------------- ---------------------------- ---------------- September 30, 2000 $500,000.00 as measured and each from the immediately September 30 preceding fiscal year end thereafter ----------------------------- ---------------------------- ---------------- December 31, 2000 $0.00 as measured from and each the immediately December 31 preceding fiscal year end thereafter ----------------------------- ---------------------------- ---------------- Covenant 6.15 Stop Loss ----------------------------- ---------------------------- ---------------- Month Ending Maximum Loss Actual ----------------------------- ---------------------------- ---------------- Each month $100,000.00 ----------------------------- ---------------------------- ---------------- Covenant 7.10 Capital Expenditures ------------------------- ----------------------- ------------------------- MAXIMUM ALLOWABLE UNFINANCED CAPITAL ACTUAL UNFINANCED FISCAL YEAR EXPENDITURE CAPITAL EXPENDITURES ------------------------- ----------------------- ------------------------- Each Fiscal Year $1,000,000.00 ------------------------- ----------------------- ------------------------- ------------------------- ----------------------- ------------------------- MAXIMUM ALLOWABLE ACTUAL CAPITAL FISCAL YEAR CAPITAL EXPENDITURES EXPENDITURES ------------------------- ----------------------- ------------------------- Each Fiscal Year $1,500,000.00 ------------------------- ----------------------- ------------------------- As of the Reporting Date, the Borrower ____ is ____ is not in compliance with Section 7.17 of the Credit Agreement concerning salary increases not to exceed 25% per annum in the aggregate. OFFICERS PERCENTAGE INCREASE -------- ------------------- ____________________________ _____________________________ ____________________________ _____________________________ ____________________________ _____________________________ (To be completed within 30 days of any salary increase) Attached hereto are all relevant facts in reasonable detail to evidence, and the computations of the financial covenants referred to above. LASER POWER CORPORATION, a Delaware corporation By _____________________________________ Its _________________________________ EXOTIC MATERIALS, INC., a California corporation By _____________________________________ Its _________________________________ Exhibit D to Credit and Security Agreement PREMISES -------- The Premises referred to in the Credit and Security Agreement are legally described as follows: LASER POWER CORPORATION - ----------------------- Highlands Plaza Legal Description LOT 15 OF EMPLOYMENT CENTER DEVELOPMENT UNIT NO. 2A, IN THE CITY OF SAN DIEGO, COUNTY OF SAN DIEGO, STATE OF CALIFORNIA, ACCORDING TO MAP THEREOF NO. 10394, FILED IN THE OFFICE OF THE COUNTY RECORDER OF SAN DIEGO COUNTY, ON MAY 26, 1982. EXCEPT THEREFROM THE FOLLOWING: All Oil, Asphaltum, Petroleum, Natural Gas and other Hydrocarbons and other valuable mineral substances and products, and all other minerals, whether or not of the same character hereinbefore generally described, in or under said land and lying and being at a vertical depth of 500 or more feet below the present natural surface of the ground, but without right of entry on the surface or within a vertical depth of 500 feet below the present natural surface of the ground. PARCEL #304 101 01 00 08227 EXOTIC MATERIALS, INC. - ---------------------- Highlands Plaza Legal Description That certain real property situated in the County of Riverside, State of California, more particularly described as: Parcels 8, 9 and 10 of Parcel Map No. 23199, on file in Book 170, Pages 73 through 76, inclusive of Parcel Maps, Records of Riverside County, California Schedule 5.1 to Credit and Security Agreement Trade Names, Chief Executive Office, Principal Place of Business, and Locations of Collateral TRADE NAMES ----------- Laser Power Corporation Laser Power Micro Laser(s) Laser Power Research Laser Power Optics Exotic Electro-Optics CHIEF EXECUTIVE OFFICE/PRINCIPAL PLACE OF BUSINESS -------------------------------------------------- Laser Power Corporation 12777 High Bluff Drive San Diego, CA 92130 Exotic Materials, Inc. 36570 Briggs Road Murrieta, CA 92563-2347 OTHER INVENTORY AND EQUIPMENT LOCATIONS --------------------------------------- Laser Power Corporation 12777 High Bluff Drive San Diego, CA 92130 Exotic Materials, Inc. 36570 Briggs Road Murrieta, CA 92563-2347 Schedule 5.4 to Credit and Security Agreement SUBSIDIARIES ------------ EMI Acquisition Corporation Laser Power Europe Laser Optics de Mexico, S.A. de C.V. Schedule 7.1 to Credit and Security Agreement PERMITTED LIENS ---------------
Creditor Collateral Jurisdiction Filing Date Filing No. -------- ---------- ------------ ----------- ---------- Imperial Equipment CA at 0800 04/23/96 9611560973 Business Credit, Inc. Safeco Credit Voicemail System CA at 0800 09/27/95 9527260755 Co., Inc. Scripps Bank Equipment CA at 0800 09/16/93 93189562 Continuation 04/22/98 93113c0177 ATX Telecom Patents CA at 1616 11/25/96 9633160864 Systems, Inc. The CIT Group/ Equipment CA at 1545 12/13/96 96348c0358 Equipment Financing, Inc. The CIT Group/ Equipment CA at 1533 02/24/97 9705660157 Equipment Financing, Inc. Mitsui Vendor Equipment CA at 0800 Amended 08/16/96 9623360091 Leasing, Inc. 06/25/97 97177c0301
Schedule 7.2 to Credit and Security Agreement PERMITTED INDEBTEDNESS AND GUARANTIES -------------------------------------
Indebtedness ------------ Creditor Principal Maturity Monthly Collateral -------- --------- -------- ------- ---------- Amount Date Payment ------ ---- ------- Scripps Bank Equipment as listed in recorded financing statement Safeco Credit Co., One (1) 8 Port 45 Hour Inc. Voice Mail Imperial Business $1,671.48 Equipment as listed in Credit, Inc. recorded financing statement Rights under Agreement ATX Telecom between the Board of Systems, Inc. Trustees of the Leland Stanford Junior University & Asa ___ Corporation Mitsui Vendor Equipment as listed in Leasing, Inc. recorded financing statement The CIT Equipment as listed in Group/Equipment recorded financing Financing, Inc. statement The CIT Equipment as listed in Group/Equipment recorded financing Financing, Inc. statement
Guaranties ---------- Primary Obligor Amount and Description of Beneficiary of Guaranty --------------- ------------------------- ----------------------- Obligation Guaranteed --------------------- None EX-23.1 4 CONSENT OF ERNST & YOUNG LLP Exhibit 23.1 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8) pertaining to the 1981 Stock Option Plan, the 1993 Stock Option Plan, the 1997 Equity Incentive Plan, the Employee Stock Purchase Plan, the Warrants to purchase common stock, and the Options to purchase common stock of Laser Power Corporation of our report dated December 4, 1999 with respect to the consolidated financial statements of Laser Power Corporation included in its Annual Report on Form 10-K for the year ended September 30, 1999. /s/ Ernst & Young LLP ERNST & YOUNG LLP San Diego, California December 21, 1999 EX-27 5 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE REGISTRANT'S CONSOLIDATED FINANCIAL STATEMENTS AS OF SEPTEMBER 30, 1999 AND FOR THE TWELVE MONTHS ENDED SEPTEMBER 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH CONSOLIDATED FINANCIAL STATEMENTS. 1000 YEAR SEP-30-1999 OCT-01-1998 SEP-30-1999 860 0 4,895 (407) 6,500 12,748 13,186 (6,092) 21,908 6,820 1,660 0 0 9 (18) 21,908 31,278 34,010 23,059 24,879 7,140 0 342 1,649 10 1,639 (3,126) 0 0 (1,487) (.18) (.18)
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