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Cautionary statements
Our future revenue may decrease if
we are unable to successfully develop and market new products.
Light
based technology is rapidly changing and improving. In order to be successful, we must
continue to make significant investments in research and development in order to develop
in a timely and cost-effective manner, new products that meet changing market demands,
enhance existing products, and achieve market acceptance for such products. We have in the
past experienced delays in developing and marketing new products and enhancing existing
products. Furthermore, some of our new products under development are based on unproven
technology and/or technology with which we have no previous experience. In addition, the
market for professional hair removal light based devices may already be saturated. At
present, broader market acceptance of light based hair removal is critical to our success
and we intend to continue our goals of bringing light based hair removal devices to the
mass consumer market. We also intend to continue to diversify our product line by
developing cosmetic light based products for uses other than hair and tattoo removal and
treatment of pigmented and vascular lesions. There can be no assurance that we will be
able to successfully implement such strategy in a timely fashion or at all and our failure
to do so could decrease our future revenue.
Our failure to respond to rapid
changes in technology could make our products obsolete and we may be unable to compete
with companies having superior financial, marketing and other resources.
The
light based cosmetic and dermatology industry is highly competitive and companies
frequently introduce new products. We compete in the development, manufacture, marketing,
sales and servicing of light based devices with numerous other companies, some of which
have substantially greater financial, marketing and other resources than us. Our products
also face competition from medical products and cosmetic procedures, such as electrolysis
and waxing, among others. We may not be able to differentiate our products from the
products of our competitors, and customers may not consider our products to be superior to
competing products or procedures, especially if competitive products and procedures are
offered at lower prices. Our competitors may develop products or new technologies that
make our products obsolete or less competitive. If forecasted demand decreases, we could
have excess inventories which may result in a write-off of some or all of our inventory.
We may need to secure additional
financing and without such additional financing we may be unable to fund ongoing
operations or grow the business.
Although
we have generated a profit in recent years, we have a history of losses. We may have to
secure additional financing to complete our research and development activities,
commercialize our current and proposed light based products, and fund ongoing operations.
However, there can be no assurance that such financing will be obtained. We may also
determine, depending upon the opportunities available, to seek additional debt or equity
financing to fund the costs of operations or expansion. Additionally, if we incur
indebtedness to fund increased levels of accounts receivable, finance the acquisition of
capital equipment, or if we issue debt securities in connection with any acquisition we
will be subject to risks associated with incurring substantial additional indebtedness.
Our quarterly operating results are and may continue to be volatile, and that may hurt the
price of our common stock. If our operating results fall below the expectations of
investors or public market analysts, the price of our common stock could decline.
Failure to receive shipments of
critical components could reduce revenues and reduced reliability of critical components
could increase expenses.
We
develop light based systems that incorporate third-party components. Some of these items
are custom made or otherwise not readily available on the market. We purchase some of
these components from small, specialized vendors that are not well capitalized. A
disruption in the delivery of these key components could prevent us from manufacturing
product and result in a decrease in revenue. We depend on an acceptable level of reliability
for purchased components. Reliability below expectations for key components could have an
adverse affect on inventory and inventory reserves.
-21-
Our products are subject to
numerous medical device regulations. Compliance is expensive and time-consuming. Without
necessary clearances, we may be unable to sell products and compete effectively.
All
of our current products are light based devices, which are subject to FDA regulations for
clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new
product or a new use of or claim for an existing product can be marketed in the United
States, we must obtain clearance from the FDA. The types of medical devices that we seek
to market in the U.S. generally must receive either “510(k) clearance” or
“PMA approval” in advance from the U.S. Food and Drug Administration (FDA)
pursuant to the Federal Food, Drug, and Cosmetic Act. The FDA’s 510(k) clearance
process usually takes from four to twelve months, but it can last longer. The process of
obtaining PMA approval is much more costly and uncertain and generally takes from one to
three years or even longer. To date, the FDA has deemed our products eligible for the
510(k) clearance process. We believe that our products in development will receive similar
treatment. However, we cannot be sure that the FDA will not impose the more burdensome PMA
approval process upon one or more of our future products, nor can we be sure that 510(k)
clearance or PMA approval will ever be obtained for any product we propose to market and
our failure to do so could adversely affect our ability to sell our products.
Our
products are subject to similar regulations in many international markets. Complying with
these regulations is necessary for our strategy of expanding the markets for sales of our
products into these countries. Compliance with the regulatory clearance process in any
country is expensive and time consuming. Regulatory clearances may necessitate clinical
testing, limitations on the number of sales and limitations on the type of end user, among
other things. In certain instances, these constraints can delay planned shipment schedules
as design and engineering modifications are made in response to regulatory concerns and
requests. We may not be able to obtain clearances in each country in a timely fashion or
at all, and our failure to do so could adversely affect our ability to sell our products
in those countries.
We have modified some of our
products and sold them under prior 510(k) clearances. The FDA could retroactively decide
the modifications required new 510(k) clearances and require us to cease marketing and/or
recall the modified products.
Any
modification to one of our 510(k) cleared devices that could significantly affect its
safety or effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance. The FDA requires every manufacturer to make this
determination in the first instance, but the FDA can review any such decision. We have
modified some of our marketed devices, but we believe that new 510(k) clearances were not
required. We cannot be certain that the FDA would agree with any of our decisions not to
seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for any
modification, we also may be required to cease marketing and/or recall the modified device
until we obtain a new 510(k) clearance.
We may also be subject to state
regulations. State regulations, and changes to state regulations, may prevent sales to
particular end users which may decrease revenues or prevent growth of revenues.
Our
products may also be subject to state regulations. Federal regulation allows our products
to be sold to and used by licensed practitioners as determined on a state-by-state basis.
As a result, in some states non-physicians may purchase and operate our product. However,
a state could disagree with our decision to sell to a particular type of end user or
change regulations preventing sales to particular types of end users. Thus, state
regulations and changes to state regulations may decrease revenues or prevent growth of
revenues. The purchase and use of our products by non-physicians may result in their
misuse, which could harm our reputation and expose us to costly product liability
litigation.
Achieving complete compliance with
FDA regulations is difficult, and if we fail to comply, we could be subject to FDA
enforcement action.
-22-
We
are subject to inspection and market surveillance by the FDA to determine compliance with
regulatory requirements. The FDA’s regulatory scheme is complex, especially the
Quality System Regulation (“QSR”), which requires manufacturers to follow
elaborate design, testing, control, documentation, and other quality assurance procedures.
This complexity makes complete compliance difficult to achieve. Also, the determination as
to whether a QSR violation has occurred is often subjective. If the FDA finds that we have
failed to comply with the QSR or other applicable requirements, the agency can institute a
wide variety of enforcement actions, including a public warning letter or other stronger
remedies, such as fines, injunctions, and civil penalties, recall or seizure of our
products, operating restrictions, partial suspension, or total shutdown of our production,
refusing our requests for 510(k) clearance or PMA approval of new products, withdrawing
product approvals already granted or criminal prosecution.
Failure to manage our
relationships with third party researchers effectively may limit our access to new
technology, increase the cost of licensing new technology, and divert management attention
from our core business.
We
are dependent upon third-party researchers over whom we do not have absolute control to
satisfactorily conduct and complete research on our behalf. We are also dependent upon
third-party researchers to grant us licensing terms, which may or may not be favorable for
products and technology which they may develop. At present, our principal research partner
is the Wellman Laboratories of Photomedicine at Massachusetts General Hospital. We provide
research funding, light technology and optics know-how in return for licensing rights with
respect to specific dermatologic and cosmetic applications and patents. In return for
certain exclusive license rights, we are subject to due diligence obligations in order to
maintain such exclusivity. Our success will be dependent upon the results of research with
our partners and meeting due diligence obligations. We cannot be sure that third-party
researchers will agree with our interpretation of the terms of our agreements, that we
will meet our due diligence obligations, or that such research agreements will provide us
with marketable products in the future or that any of the products developed under these
agreements will be profitable for us.
Our common stock could be further
diluted by the conversion of outstanding options and warrants.
In
the past, we have issued and still have outstanding convertible securities in the form of
options and warrants. We have and may continue to issue options and warrants as
compensation for services and incentive compensation for our employees, directors and
consultants or others who provide services to us. We have a substantial number of shares
of common stock reserved for issuance upon the conversion and exercise of these
securities. Such a conversion would dilute our stockholders and could adversely affect the
market price of our common stock.
Our proprietary technology has
only limited protections which may not prevent competitors from copying our new
developments. This may impair our ability to compete effectively, and we may expend
significant resources enforcing our intellectual property rights to prevent such copying.
Our
business could be materially and adversely affected if we are not able to adequately
protect our intellectual property rights. We rely on a combination of patent, copyright,
trademark and trade secret laws, licenses and confidentiality agreements to protect our
proprietary rights. We generally enter into non-disclosure agreements with our employees
and third parties with whom we work, including but not limited to consultants and vendors,
to restrict access to, and distribution of, our proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use our technology. Monitoring unauthorized use of our technology is
difficult and we cannot be certain that the steps we have taken will prevent unauthorized
use of our technology, particularly in foreign countries where the laws may not protect
our proprietary rights as fully as in the United States. If competitors are able to use
our technology, our ability to compete effectively could be harmed. Costly and time
consuming lawsuits may be necessary to enforce and defend patents issued or licensed
exclusively to us, to protect our trade secrets and/or know-how or to determine the
enforceability, scope and validity of others’ intellectual property rights. Such
lawsuits may result in patents issued or licensed exclusively to us
-23-
to be found invalid and
unenforceable. Our competitors also may independently develop technologies that are
substantially equivalent or superior to our technology and which do not infringe our
patents.
Claims by others that our products
infringe their patents or other intellectual property rights could prevent us from
manufacturing and selling some of our products or require us to pay royalties or incur
substantial costs from litigation or development of non-infringing technology.
In
recent years, there has been significant litigation in the United States involving patents
and other intellectual property rights. The light based cosmetic and dermatology industry
in particular is characterized by a large number of patents and related litigation
regarding patents and other intellectual property rights. Because our resources are
limited and patent applications are maintained in secrecy for a period of time, we can
conduct only limited searches to determine whether our technology infringes any patents or
patent applications. Any claims for patent infringement, regardless of merit, could be
time-consuming, result in costly litigation and diversion of technical and management
personnel, cause shipment delays, require us to develop non-infringing technology or to
enter into royalty or licensing agreements. Although patent and intellectual property
disputes in the light based industry have often been settled through licensing or similar
arrangements, costs associated with such arrangements may be substantial and often require
the payment of ongoing royalties, which could have a negative impact on gross margins.
There can be no assurance that necessary licenses would be available to us on satisfactory
terms, or that we could redesign our products or processes to avoid infringement, if
necessary. Accordingly, an adverse determination in a judicial or administrative
proceeding or failure to obtain necessary licenses could prevent us from manufacturing and
selling some of our products. This could have a material adverse effect on our business,
results of operations and financial condition.
Our charter documents and Delaware
law may discourage potential takeover attempts.
Our
Second Restated Certificate of Incorporation and our By-laws contain provisions that could
discourage takeover attempts or make more difficult the acquisition of a substantial block
of our common stock. Our By-laws require a stockholder to provide to our Secretary advance
notice of director nominations and business to be brought by such stockholder before any
annual or special meeting of stockholders, as well as certain information regarding such
nomination and/or business, the stockholder and others known to support such proposal and
any material interest they may have in the proposed business. They also provide that a
special meeting of stockholders may be called only by the affirmative vote of a majority
of the board of directors. These provisions could delay any stockholder actions that are
favored by the holders of a majority of our outstanding stock until the next
stockholders’ meeting. In addition, the board of directors is authorized to issue
shares of our common stock and preferred stock that, if issued, could dilute and adversely
affect various rights of the holders of common stock and, in addition, could be used to
discourage an unsolicited attempt to acquire control of us.
We
are also subject to the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which prohibits us from engaging in a “business combination”
with an “interested stockholder” for a period of three years after the date of
the transaction in which the person becomes an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203 may limit
the ability of stockholders to approve a transaction that they may deem to be in their
best interests. These provisions of our Second Restated Certificate of Incorporation,
By-laws and the Delaware General Corporation Law could deter certain takeovers or tender
offers or could delay or prevent certain changes in control or management of us, including
transactions in which stockholders might otherwise receive a premium for their shares over
the then current market price. In April 1999, we adopted a shareholder rights plan
(“Rights Plan”). The Rights Plan is intended to protect shareholders from unfair
or coercive takeover practices. In accordance with the Rights Plan, the Board of Directors
declared a dividend distribution of Series A right for each share of common stock
outstanding until the rights become exercisable.
We may not be able to successfully
collect licensing royalties.
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In
past years and now again following the settlement with Lumenis, material portions of our
revenues consist of royalties from sub-licensing patents licensed to us on an exclusive
basis by Massachusetts General Hospital.
We
have sued Cutera, Inc. (formerly Altus Medical Inc., See Legal Proceedings) for patent
infringement, and we are involved in patent disputes with other third parties. Such other
disputes may also result in litigation. We have incurred, and likely will continue to
incur, legal expenses in connection with such matters. There can be no assurance that such
litigation will result in favorable outcomes for us. Any adverse result in litigation
could weaken the strength of the patents involved, have a material adverse effect on our
business, financial condition and results of operations.
We may be unable to attract and
retain key executives and research and development personnel that we need to succeed.
As
a small company with less than 150 employees, our success depends on the services of key
employees in executive and research and development positions. The loss of the services of
one or more of these employees could have a material adverse effect on our business. Our
future success will depend in large part upon our ability to attract, retain, and motivate
highly skilled employees. We cannot be certain that we will be able to do so.
We face a risk of financial
exposure to product liability claims in the event that the use of our products results in
personal injury.
Our
products are and will continue to be designed and manufactured with numerous safety
features, but it is possible that consumers could be adversely affected by use of one of
our products. Furthermore, in the event that any of our products prove to be defectively
designed and manufactured, we may be required to recall and redesign such products.
Although we have not experienced any material losses due to product liability claims to
date, there can be no assurance that we will not experience such losses in the future. We
maintain general liability insurance and umbrella coverage; however, there can be no
assurance that such coverage will continue to be available on terms acceptable to us or
that such coverage will be adequate for liabilities actually incurred. In the event we are
found liable for damages in excess of the limits of our insurance coverage or if any claim
or product recall results in significant adverse publicity against us, our business,
financial condition and results of operations could be materially and adversely affected.
In addition, although our products have been and will continue to be designed to operate
in a safe manner, and although we attempt to educate customers with respect to the proper
use of our products, misuse of our products by personnel over whom we cannot exert control
may result in the filing of product liability claims or significant adverse publicity
against us.
Disappointing quarterly revenue or
operating results could cause the price of our common stock to fall.
Our
quarterly revenue and operating results are difficult to predict and may swing sharply
from quarter to quarter. If our quarterly revenue or operating results fall
below the expectations of investors or public market analysts, the price of our common
stock could fall substantially. Our quarterly revenue is difficult to forecast for many
reasons, some of which are outside of our control. For example, many factors are related
to market supply and demand, including potential increases in the level and intensity of
price competition between our competitors and us, potential decrease in demand for our
products and possible delays in market acceptance of our new products. Other factors are
related to our customers and include changes in or extensions of our customers’
budgeting and purchasing cycles and changes in the timing of product sales in anticipation
of new product introductions or enhancements by us or our competitors. Factors related to
our operations may also cause quarterly revenue or operating results to fall below
expectations, including absence of significant product backlogs, our effectiveness in our
manufacturing process, unsatisfactory performance of our distribution channels, service
providers, or customer support organizations, and timing of any acquisitions and related
costs.
We face risks associated
with product warranties.
-25-
We
could incur substantial costs as a result of product failures for which we are responsible
under warranty obligations.
Because we derive a significant
amount of our revenue from international sales, we are susceptible to currency
fluctuations, long payment cycles, credit risks and other risks associated with conducting
business overseas.
We
sell a significant amount of our products and services outside the U.S. International
product revenue, consisting of sales from our distributors in Japan, Europe, Australia,
Asia\Pacific Rim and South and Central America and sales shipped directly to international
locations from the United States was 49% of total product revenue for the year ended 2003,
and we expect that international sales will continue to be significant. As a result, a
major part of our revenues and operating results could be adversely affected by risks
associated with international sales. In particular, longer payment cycles common in
foreign markets, credit risk and delays in obtaining necessary import or foreign
regulatory approvals for products may occur. In addition, significant fluctuations in the
exchange rates between the U.S. dollar and foreign currencies could cause us to lower our
prices and thus reduce our profitability, or could cause prospective customers to push out
orders to later dates because of the increased relative cost of our products in the
aftermath of a currency devaluation or currency fluctuation.
Managing our relationship with
Gillette effectively may divert the attention of key technical personnel and management
from the core business. If Gillette ends the relationship our stock price could fall, and
we may be unable to bring a home use hair removal device for women to the market.
On
February 14, 2003, we entered into a Development and License Agreement with Gillette to
complete development and commercialize a home-use, light-based hair removal device for
women. We believe that this represents a unique opportunity to bring light based devices
to the mass market. Under the agreement, significant resources and the attention of key
technical personnel and management will be directed to the development of such a device
even though such device will not likely be commercialized for several years, if ever. In
addition, we cannot be sure that Gillette will agree with our interpretation of the terms
of the agreement, that the agreement will provide us with marketable products in the
future or that we will receive payments for any of the products developed under the
agreement. During the term of the agreement, Gillette has the ability to choose not to
continue and may terminate the agreement. If Gillette terminates the agreement, the price
of our common stock could fall significantly, and we will not receive certain payments. We
may proceed to develop and commercialize the device on our own or with a third party.
However, there can be no assurance that we will be able to successfully implement such a
strategy. In addition, after commercialization of such device, Gillette is to pay us a
percentage of net sales of such device. Certain of these percentages of net sales are only
owed if the device is covered by valid patents. There can be no assurance that valid
patents will cover the device in any or all countries, in which the device will be
manufactured, used or sold. This could have a material adverse effect on our business,
results of operations and financial condition.
Managing our contract with the
Army effectively may divert the attention of key technical personnel and management from
the core business. We may be unable to complete the project within the time period which
may impact our ability to receive future government contracts.
On
February 18, 2004, we announced that we were awarded a $2.5 million research contract by
the Department of the Army to develop a light-based self-treatment device for
Pseudofolliculitis Barbae or PFB. We believe this represents a unique opportunity to
address PFB. Although the project is scheduled to last for nineteen months, there can be
no assurance that we will be able to complete the project within that time period which
may impact our ability to receive future government contracts. Under the agreement,
significant resources and the attention of key technical personnel and management will be
directed to the development of such a device even though such device will not likely be
ready for military use for several years, if ever.
Managing our relationship with
Johnson & Johnson Consumer Companies (“JJCC”) effectively may divert the
attention of key technical personnel and management from the core business. If JJCC
-26-
ends the relationship our stock
price could fall, and we may be unable to develop and commercialize home-use, light-based
devices in the fields of (i) reducing or reshaping body fat including cellulite; (ii)
reducing appearance of skin aging; and (iii) reducing or preventing acne.
On
September 1, 2004, we entered into a Development and License Agreement with Johnson &
Johnson Consumer Companies, Inc. (“JJCC”), a Johnson & Johnson company, to
develop and commercialize home-use, light-based devices in the fields of (i) reducing or
reshaping body fat including cellulite; (ii) reducing appearance of skin aging; and (iii)
reducing or preventing acne. We believe that this represents a unique opportunity to bring
light based devices to the mass market. Under the agreement, significant resources and the
attention of key technical personnel and management will be directed to the development of
such devices even though such devices will not likely be commercialized for several years,
if ever. In addition, we cannot be sure that JJCC will agree with our interpretation of
the terms of the agreement, that the agreement will provide us with marketable products in
the future or that we will receive payments for any of the products developed under the
agreement. During the term of the agreement, JJCC has the ability to choose not to
continue and may terminate the agreement. If JJCC terminates the agreement, the price of
our common stock could fall significantly, and we will not receive certain payments. We
may proceed to develop and commercialize the devices on our own or with a third party.
However, there can be no assurance that we will be able to successfully implement such a
strategy. There can be no assurance that valid patents will cover these devices in
any or all countries, in which the devices will be manufactured, used or sold. This could
have a material adverse effect on our business, results of operations and financial
condition.
Item 3. Quantitative and qualitative disclosures about market risk
Our
primary market risk exposures are in the areas of interest rate risk. Our investment
portfolio of cash equivalents and debt securities is subject to interest rate
fluctuations, but we believe this risk is immaterial because of the short-term nature of
these investments.
Item 4. Controls and
procedures
Our
management has evaluated the effectiveness of our disclosure controls and procedures as of
the end of the period covered by this report. Based upon that evaluation, our Chief
Executive Officer and our Chief Financial Officer concluded that our disclosure controls
and procedures were effective to provide reasonable assurance that we record, process,
summarize and report the information we must disclose in reports that we file or submit
under the Securities Exchange Act of 1934, as amended, within the time periods specified
in the SEC’s rules and forms.
The
effectiveness of a system of disclosure controls and procedures is subject to various
inherent limitations, including cost limitations, judgments used in decision making,
assumptions about the likelihood of future events, the soundness of internal controls, and
the risk of fraud. Because of these limitations, there can be no assurance that any system
of disclosure controls and procedures will be successful in preventing all errors or fraud
or in making all material information known in a timely manner to the appropriate levels
of management.
During
the three months ended September 30, 2004, there were no changes in our internal control
over financial reporting that have affected, or are reasonably likely to affect,
materially our internal control over financial reporting.
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PART II – Other
information
Item 1. Legal proceedings
On
February 15, 2002, Palomar commenced an action for patent infringement in the United
States District Court for the District of Massachusetts against Altus Medical, Inc., now
known as Cutera, Inc., seeking both monetary damages and injunctive relief. The complaint
alleges Cutera’s CoolGlide and CoolGlide Excel laser systems willfully infringe U.S.
patent No. 5,735,844, which is exclusively licensed to Palomar by the Massachusetts
General Hospital. The Massachusetts General Hospital has been added as a plaintiff in this
lawsuit. Cutera answered the complaint denying that its products infringe the asserted
patent and filed a counterclaim seeking a declaratory judgment that the asserted patent is
invalid and not infringed. Palomar and the Massachusetts General Hospital filed a reply
denying the material allegations of the counterclaims. Palomar and the Massachusetts
General Hospital have further alleged that Cutera’s CoolGlide Vantage and CoolGlide
XEO laser systems also willfully infringe the asserted patent. On June 4, 2003, Cutera
amended their answer and asserted a counter claim alleging that the patent is
unenforceable due to inequitable conduct. Palomar and the Massachusetts General Hospital
believe that this claim is without merit and filed a reply denying the material
allegations of this counterclaim. A claim construction hearing (often referred to as a
Markman hearing) was held on June 12, 2003, and on February 27, 2004 the Judge issued her
ruling. Palomar believes the ruling largely embraced Palomar’s position and will have
a considerable impact on the case as it proceeds toward trial. Fact discovery is on-going.
A trial date has not yet been set.(See “Cautionary
Statements”)
Item 2. Changes in
securities, use of proceeds and issuer purchases of securities.
Not
applicable.
Item 3. Defaults upon
senior securities
Not
applicable.
Item 4. Submission of matters to a vote of security holders
Not applicable.
Item 5. Other
information.
Not
Applicable.
Item 6. Exhibits and
reports on Form 8-K
(a)
Exhibits
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