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FORM 10-K
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1998
Commission file number: 0-22340
[OBJECT OMITTED]
PALOMAR MEDICAL TECHNOLOGIES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 04-3128178
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
45 Hartwell Avenue, Lexington, Massachusetts 02173
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(Address of principal executive offices)
(781) 676-7300
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(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
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Name of each exchange on
Title of each class which registered
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Not Applicable Not Applicable
Securities registered pursuant to Section 12 (g) of the Act:
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Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s)), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
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Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-K contained in this form, and no disclosure will 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. [ ]
As of March 2, 1999, 72,145,509 shares of Common Stock were outstanding.
The aggregate market value of the voting shares (based upon the closing price
reported by Nasdaq on March 20, 1998) of Palomar Medical Technologies, Inc.,
held by nonaffiliates was $$43,549,606. For purposes of this disclosure, shares
of Common Stock held by entities who own 5% or more of the outstanding Common
Stock, as reported in Amendment No. 4 to a Schedule 13G filed on January 22,
1999 and Amendment No. 3 to a Schedule 13D filed on February 16, 1999, and
shares of common stock held by each officer and director have been excluded in
that such persons may be deemed to be "affiliates" as that term is defined under
the Rules and Regulations of the Securities Exchange Act of 1934. This
determination of affiliate status is not necessarily conclusive.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement to be filed prior to April 30,
1998, pursuant to Regulation 14A of the Securities Exchange Act of 1934 are
incorporated by reference into Part III of this Form 10-K
Transitional Small Business Disclosure Format: Yes X No
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INDEX
Item Page No.
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PART I.........................................................................................................1
Item 1. Business.........................................................................................1
(a) Introduction.....................................................................................1
(b) Financial Information About Industry Segments....................................................1
(c) Description of Business..........................................................................1
(d) Financial Information About Exports by Domestic Operations......................................10
Item 2. Properties......................................................................................10
Item 3. Legal Proceedings...............................................................................10
Item 4. Submission of Matters to a Vote of Security Holders.............................................11
PART II.......................................................................................................12
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...........................12
Item 6. Selected Financial Data.........................................................................14
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...........15
(a) Overview........................................................................................15
(b) Results.........................................................................................15
(c) Liquidity and Capital Resources......................................................................19
(d) Year 2000 Issues.....................................................................................21
(e) Nasdaq Stock Market Listing..........................................................................21
(f) Recently Issued Accounting Standard..................................................................22
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.....................................22
Statement Under the Private Securities Litigation Reform Act.............................................22
Risk Factors.............................................................................................23
Item 8. Financial Statements............................................................................27
Reports of Independent Public Accountants............................................................28
Consolidated Balance Sheets as of December 31, 1997 and 1998.........................................30
Consolidated Statements of Operations for the years ended December 31, 1996, 1997 and 1998...........31
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended
December 31, 1996, 1997 and 1998................................................................32
Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1997 and 1998...........35
Notes to Consolidated Financial Statements...........................................................37
Item 9. Changes and Disagreements with Accountants on Accounting and Financial Disclosures..............63
PART III .....................................................................................................64
Item 10. Directors and Executive Officers of the Registrant.............................................64
Item 11. Executive Compensation.........................................................................64
Item 12. Security Ownership of Certain Beneficial Owners and Management.................................64
Item 13. Certain Relationships and Related Transactions.................................................64
PART IV.......................................................................................................65
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K................................65
(a) Index to Consolidated Financial Statements and Schedules........................................65
(b) Reports on Form 8-K.............................................................................65
(c) Exhibits........................................................................................66
SIGNATURES....................................................................................................73
ii
PART I
Item 1. Business.
(a) Introduction
Palomar Medical Technologies, Inc. (the "Company," "Palomar," or "we")
was organized in 1987 to design, manufacture and market lasers, delivery systems
and related disposable products for use in medical procedures. In December 1992
the Company went public. Subsequently, the Company pursued an aggressive
acquisition program, acquiring companies in its core laser business as well as
others, principally in the electronics industry, in order to spread risk and
bolster operating assets, among other reasons. By the beginning of 1997, the
Company had more than a dozen subsidiaries. At the same time, having obtained
FDA clearance to market its EpiLaser(R) hair removal laser system in March 1997,
the Company was well positioned to focus on what it believed was at that time
the most promising product in its core laser business. Hence, under the
direction of a new Board and management, the Company undertook an ambitious
program in 1997, completed in May of 1998, of exiting all non-core businesses
and investments and focusing only on those businesses which it believes hold the
greatest promise for maximizing stockholder value. The Company's exclusive focus
is now the use of lasers in dermatology and cosmetic procedures, with an
emphasis on laser hair removal and research and development relating to that and
other cosmetic laser products. Currently, the Company has three operating
subsidiaries, Palomar Medical Products, Inc. ("PMP"), Esthetica Partners, Inc.
("Esthetica") (formerly Cosmetic Technology International, Inc.) and Star
Medical Technologies, Inc. ("Star"). PMP, located at the Company's headquarters
in Lexington, Massachusetts, oversees the manufacture and sale of the Company's
two ruby hair removal laser system currently on the market. Esthetica, also
based in Lexington, Massachusetts, places the Company's lasers in clinical and
cosmetic settings and shares in a portion of the revenue generated thereby.
Star, based in Pleasanton, California, manufactures the LightSheer(TM) diode
hair removal laser. Palomar has entered into an agreement with Coherent, Inc.
("Coherent') to sell Star to Coherent. The agreement is subject to stockholder
approval and standard closing conditions. (On March 12, 1999, Palomar filed a
proxy statement with the Securities and Exchange Commission that details the
Star Sale.) A Special Meeting of Palomar's stockholders has been scheduled for
April 21, 1999. If the Star sale is approved at that meeting by the holders of a
majority of the shares of Palomar's outstanding common stock, then the sale will
be completed shortly after the meeting date. (See Item 7., "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Overview.")
(b) Financial Information About Industry Segments
The Company conducts business in one industry segment, medical products
and services. In 1998 the Company completed the program, begun in 1997, of
divesting all of its non-core electronics subsidiaries. (See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Overview" and Note 2 to Financial Statements.)
(c) Description of Business
(i) Principal Products and Services
Lasers for Hair Removal
The Technology
The word "laser" is the acronym for "light amplification by stimulated
emission of radiation." The emitted radiation oscillates within an optical
resonator and is amplified by an active medium, resulting in a monochromatic
beam of light, which is narrow, highly coherent and thus can be focused to a
small spot with a high degree of precision. In recent years, scientists and
clinicians have developed a concept called tissue optics to describe how the
unique properties of the laser can be used to treat human tissue selectively and
more precisely. By careful selection of laser parameters, such as wavelength
(color), energy and pulse width (exposure time), and with a detailed
understanding of the physical and optical properties of the target tissue, the
clinician can selectively treat the target tissue while minimizing or
eliminating damage to surrounding tissue. The concept of color selectivity has
been useful in developing a number of successful dermatological applications.
The patented hair removal technology licensed exclusively to Palomar targets the
pigment in a hair follicle and was developed at Massachusetts General Hospital
("MGH"), Palomar's research partner. Pigment, called melanin, is found in the
upper layer of the skin and in the hair shaft and hair follicle deeper below the
surface of the skin. With the appropriate
1
selection of wavelength (color), energy and pulse width to allow for the
preferential absorption of laser energy by the melanin present in the hair,
there is negligible absorption by the surrounding tissue. Energy from ruby
lasers is particularly well absorbed by melanin and absorption by other cells
and tissue is particularly low. Palomar uses a patented and proprietary contact
cooling technology to protect the upper layer of the skin while the laser light
is targeting and destroying the follicle deeper within the skin tissue. In
addition, Palomar's patented contact-cooling handpiece enables the laser light
to penetrate to the correct depth while at the same time limiting the amount of
discomfort associated with the procedure. This method of hair removal using the
cooling handpiece allows for selective destruction of the target follicle
without harming the surrounding skin or surface of the skin. The laser light is
pulsed at a rapid rate covering approximately one square inch at each pulse.
This treatment method allows for a large area of treatment over a relatively
short period of time.
In an effort to find a way to allow the laser light to pass through top
skin layers and be deeply absorbed in the hair follicle below, a contact cooling
handpiece was developed by MGH and the underlying patents licensed to Palomar on
an exclusive world-wide perpetual basis. This unique cooling handpiece is key to
the success and safety of Palomar's laser hair removal systems, as it permits
laser applications of higher power with better targeting and greater safety. The
cold sapphire tip protects the epidermis while allowing the laser light to
efficiently destroy the target follicles.
The Products
Using its core ruby laser technology, originally developed for tattoo
removal and pigmented lesions, Palomar developed a long pulse ruby laser, the
EpiLaser(R) laser system, that is specifically configured to allow the
appropriate wavelength, energy level and pulse duration to be absorbed
effectively by the hair follicle without being absorbed by the surrounding
tissue. That, combined with the patented cooling handpiece, allows for safe and
effective hair removal. In March 1997, Palomar was the first company to receive
FDA clearance to sell and market a ruby laser (the EpiLaser(R) system) in the
U.S. for hair removal.
In December 1997 and January 1998 respectively, Palomar was also the
first company to receive FDA clearance for a diode laser for hair removal and
for leg vein treatment, the LightSheer(TM) diode laser system manufactured by
Star. The LightSheer(TM) diode laser also incorporates the patented
contact-cooling system licensed exclusively to Palomar. Star's high-powered
diode system is a compact, solid-state laser that is significantly smaller than
most current systems, and relatively easy to install and service. The
LightSheer(TM) is the only high-power pulsed diode laser hair removal system
available on the market today.
Palomar recently introduced its second generation ruby laser, the
Palomar E2000(TM), a product which the Company anticipates will be superior to
hair removal lasers currently available in a number of respects, including speed
and efficacy. The Palomar E2000(TM) has already received FDA clearance for hair
removal.
Studies using Palomar's laser hair removal process demonstrated
significant permanent reduction of hair following treatment with the EpiLaser(R)
ruby laser. The first treatment causes a portion of the hair (typically the hair
in the growth mode) to be reduced in size, color and/or quantity (based on
studies followed for up to three years) and causes significant growth delay
(three to six months) of most of the rest of the hair. Since the partial
re-growth tends to occur in synchrony, the follow-up treatment is often more
effective than the first treatment. The EpiLaser(R) and the Palomar E2000(TM)
are the only hair removal lasers on the market that have been cleared by the FDA
for "permanent hair reduction" labeling.
The Hair Removal Market
The market for laser-based hair removal is in its early stages. Palomar
believes that this market remains a growing one. Benefits of Palomar's laser
hair removal process, as compared to other hair removal methods currently
available, include significant long term cosmetic improvement, treatment of
larger areas in each treatment session, relatively painless procedure, reduced
risk of scarring, non-invasive procedure, no risk of cross-contamination, and
higher success rates than with previous methods.
Market surveys report that the great majority of women in the United
States employ one or more techniques for temporary hair removal from various
parts of the body. Pulling hair from the follicle produces temporary results,
but is painful and may cause skin irritation. A number of techniques are used to
pull hair from the follicle including waxing, depilatories and tweezing. In the
waxing process, a lotion, generally beeswax-based, is spread on the area to be
treated and
2
allowed to harden, thereby trapping the hairs. The hardened film is then rapidly
peeled off, pulling out the entrapped hairs. Depilatories employ rotating spring
coils or slotted rubber rolls to trap and pull out the hairs. Tweezing involves
removing individual hairs with a pair of tweezers. Depilatory creams, which
contain chemicals to dissolve hair, frequently leave a temporary, unpleasant
odor and may also cause skin irritation. Shaving is the most widely used method
of hair removal, especially for legs and underarms, but produces the
shortest-term results. Hair bleaches do not remove hair, but instead lighten the
color of hair so that it is less visible. A principle drawback of all of these
methods is that they require frequent treatment.
Before the advent of laser hair removal, electrolysis was the only
method available for the long-term removal of body hair. Electrolysis is a
process in which an electrologist inserts a needle directly into a hair follicle
and activates an electric current in the needle, which disables the hair
follicle. The tiny blood vessels in each hair follicle are heated and
coagulated, presumably cutting off the blood supply to the hair matrix, or are
destroyed by chemical action depending upon modality used. The success rate for
electrolysis is variable depending upon the skill of the electrologist and
always requires a series of treatments. Electrolysis is time-consuming,
expensive and sometimes painful. There is also some risk of skin blemishes and a
rising concern relating to needle infection. Since electrolysis only treats one
hair follicle at a time and can only treat visible hair follicles, the treatment
of an area as small as an upper lip may require numerous visits at an aggregate
cost of up to $1,000. Although 70% of all electrolysis treatments are for facial
hair, the neck, breasts and bikini line are also treated. Because hair follicles
are disabled one at a time, electrolysis is rarely used to remove hair from
large areas such as the back, chest, abdomen and legs. The Company believes its
unique delivery system enables the user to address a potentially larger market
than electrolysis currently does by offering to treat large areas of the body
such as back, chest, abdomen, legs, arms and other areas.
Marketing, Distribution and Service
Pursuant to an agreement executed in November 1997, Coherent acts as
the exclusive distributor for Palomar's hair removal lasers. Under its agreement
with Palomar, Coherent is responsible for sales, marketing, service, training
and education. However, Coherent and Palomar agreed that, beginning January 1,
1999, Palomar would take over all service for Palomar's ruby hair removal
lasers. Coherent has over 200 sales persons worldwide, and 50 service
representatives in the US and over 100 worldwide. If Star is sold to Coherent,
Coherent will continue to act as a distributor of Palomar's products, but on a
non-exclusive basis. If the Star sale is not completed, Coherent will remain as
the Company's exclusive distributor through November 2001, pursuant to the terms
of the Sales Agency Agreement between the parties. In December, 1998, Palomar
signed a letter of intent with Continuum Biomedical, Inc., a medical division of
the scientific laser-based company Continuum Electro-Optics (which is in turn a
wholly-owned subsidiary of Hoya Corp. of Japan), to distribute Palomar's
products (other than Star's LightSheer(TM) laser) on a non-exclusive basis. The
Company intends to tailor distribution methods to different geographic regions
and may include a combination of exclusive and non-exclusive distributors,
independent representatives or direct salespeople. In exchange for a payment of
$2,740 per day from January 20, 1999 until the closing of the Star sale,
Coherent has agreed to waive its exclusive distribution rights under the
Company's Sales Agency Agreement with Coherent, so that Palomar may begin to
sell the Palomar E2000(TM) immediately through other channels, including
Continuum Biomedical, without the necessity of paying commissions to Coherent or
waiting for the Sales Agency Agreement to terminate upon the closing of the Star
sale.
Laser for Tattoo and Pigmented Lesion Removal
The Company also sells a Q-switched ruby laser for tattoo removal and
treating pigmented lesions, the RD-1200(TM). The RD-1200(TM) has been on the
market for ten years. In 1998, RD-1200(TM) sales constituted less than 5% of the
Company's sales, and were primarily overseas, in Japan, Korea and other parts of
the world. Intense competition in the medical device industry and market
saturation for this type of laser have reduced RD-1200(TM) sales over the last
five years. In addition, there are less expensive products now available for
this purpose. Palomar expects sales of this product to continue in 1999 at a low
volume to foreign countries where the advantages of ruby laser for treatment of
pigmented lesions is especially important. Palomar sells and services the
RD-1200(TM) through distributors internationally. In the United States, Palomar
provides service through its own service organization.
3
Cosmetic Laser Services
An additional avenue that the Company has explored for its laser
technology is the service business conducted through its Esthetica subsidiary,
which was incorporated in 1996 (under the name Cosmetic Technology
International, Inc.) for that purpose. During 1997 and 1998, Esthetica
established a number of test sites to explore business models. Esthetica
provides each of its sites with a turnkey package of laser and medical device
technology, equipment, training and service, strategic advertising and marketing
programs, and management assistance. To date, ten Esthetica revenue-sharing
sites are open and under development.
(ii) Products Under Development
Other Cosmetic Applications
Palomar aims to address dermatology and cosmetic procedure markets
other than hair removal, and its research and development is not limited to hair
removal. (See "Research and Development.")
Palomar will consider a number of alternatives with respect to its
future products, including manufacturing them itself and selling them directly
and/or through distributors or (as in the case of Star) selling the product line
and/or technology to others. Palomar will choose in each case the alternative
which it believes best maximizes long-term stockholder value.
Non-Cosmetic Applications Developed at Star
The only non-cosmetic products under development are all being
developed out of Palomar's Star subsidiary, and these projects would transfer to
Coherent upon the sale of Star. One of the products under development at Star is
a diode laser for burn diagnosis. The system is designed to illuminate the wound
site with near infrared light from a diode laser and to image the blood flow
using a fluorescence dye as an aid to the doctor in determining the extent of
blood flow within the dermis to more accurately diagnose the degree of a burn
and to enable physicians to improve treatment of burn patients. In 1994, Star
obtained an exclusive, worldwide license to a patent relating to the measurement
of burn depth in skin from the Office of Technology Affairs at MGH. In 1996,
Star began initial clinical testing of the burn diagnosis system at the Shriner
Burn Center in Boston, Massachusetts and at the Augusta Medical Center in
Augusta, Georgia. To date the system has been tested on a small number of burn
patients and has demonstrated the ability to detect the absence or presence of
blood flow deep in the dermis. The system has also been used clinically to
determine blood flow surrounding skin ulcers and in surgical flaps, again, on a
very limited number of patients. Clinical testing continues at the Augusta
Medical Center.
Non-Cosmetic Applications Developed at Palomar
Another area of non-cosmetic laser product development being conducted
by Palomar is laser tonsillectomy. In June 1994, Palomar signed an agreement
with the Otolaryngology Research Center for Advanced Endoscopic Applications at
New England Medical Center, Boston, Massachusetts (the "NEMC Agreement"), to
provide a research grant and to sponsor investigations and development of laser
applications, advanced delivery systems and disposable products in the area of
dye and diode laser applications in otolaryngology and related specialties.
Under the NEMC Agreement, the Company provided a total of $150,000 in funding
and $50,000 in the form of laser hardware. Palomar will obtain ownership rights
or the right of first refusal to exclusive worldwide licenses to sell and market
any inventions developed with the grant funding. In August 1994, the NEMC
Agreement was amended to support animal testing with one of Star's diode lasers
in connection with performing tonsillectomies. The animal studies were completed
successfully in 1997.
Palomar expects that it may take several years before commercial
products are available as a result of any of the above-described non-cosmetic
product development efforts.
4
Dye Laser
During 1995, the Company entered into a two-year cost plus fixed fee
contract with the U.S. Army for the investigation of compact, wavelength
diverse, high efficiency solid-state dye lasers. In 1997, the Company, which
does not anticipate this research will result in a commercial product within the
next few years, concluded with the U.S. Army a Novation Agreement which novates
this contract to Physical Sciences, Inc. ("PSI"). Upon completion of the
contract, PSI has agreed to offer the Company a right of first refusal for a
commercial license to sell, manufacture or otherwise dispose of solid-state dye
laser technology as developed by PSI under the contract for use in medical
products.
Laser Thrombolysis
In 1993, the Company entered into an agreement with the Edwards LIS
Division of Baxter regarding an integrated system utilizing lasers and catheters
for the removal of blood clots. Under this agreement, Baxter licensed its
proprietary technology to the Company, and the Company cross-licensed its laser
thrombolysis technology to Baxter. The Company also granted to Baxter a license
to sell and market products incorporating such technology. Baxter agreed to
transfer its interest in the agreement to Advanced Cardiovascular Systems, Inc.
("ACS"), a division of Eli Lilly, as part of a purchase by Eli Lilly of the
Baxter LIS division. Eli Lilly subsequently sold ACS to Guidant Corp. In January
1997, Palomar became an equity partner in the formation of a new company, LaTIS,
Inc., created to use Palomar's laser thrombolysis technology to develop a
pulsed-dye laser system for treating strokes. All licenses relating to this
technology have been transferred to LaTIS. Palomar owns approximately 10% of
LaTIS. With the formation of this new venture, laser thrombolysis is no longer
part of Palomar's strategic agenda, although the Company can still derive some
benefits from its research due to its equity participation. The results of
LaTIS' operations and financial position have been immaterial to Palomar to
date.
(iii) Production and Sources and Availability of Materials
Palomar's manufacturing operations are currently located in both
Lexington, Massachusetts and Pleasanton, California. The ruby laser systems are
manufactured in Massachusetts and the diode laser system is manufactured in
California. If Star is sold to Coherent, Palomar will no longer have facilities
in California. Manufacturing consists of the assembly and testing of components
purchased from outside suppliers and contract manufacturers. Palomar maintains
control of and manufactures key components in-house. The entire fully assembled
system is subjected to a rigorous set of tests prior to shipment to the customer
or distributors.
Palomar depends and will depend upon a number of outside suppliers for
components used in its manufacturing process. Most of Palomar's components and
raw materials are available from a number of qualified suppliers. Two critical
components that are available through only one qualified supplier each are ruby
rods for the ruby lasers and diode bars for the diode lasers. To date, the
Company has not experienced, nor does it expect to experience, any significant
delays in obtaining component parts or raw materials. Palomar has expanded its
manufacturing capabilities to satisfy projected demand. Palomar has the approval
for the CE Mark for the EpiLaser(R) laser system, and is working towards
completion of ISO 9001 registrations for both facilities.
(iv) Patents and Licenses
Certain products of the Company and methods for the use of such
products are largely proprietary. The Company believes that patent protection of
its technology and products that result from the Company's research and
development efforts is important to the possible commercialization of the
Company's technology. The Company continually attempts to protect its
proprietary technology by obtaining patent protection and relying on trade
secret laws and non-disclosure and confidentiality agreements with its employees
and persons that have access to its proprietary technology.
To date, the Company and its subsidiaries have filed thirteen patent
applications related to its laser products with the United States Patent and
Trademark Office in order to protect its current technology. This includes two
applications that are continuations of previous applications. To date, four of
these patents have been issued. Additionally, the Company extends many of its
domestic filings into foreign applications. To date, ten foreign applications
have been filed, and no foreign patents have been issued. The Company intends to
aggressively pursue any person or company that offers products that the Company
believes infringe on one or more of its patents or on patents licensed
exclusively to the Company.
5
The Company believes it owns, or has the right to use, the basic
patents covering its products. However, each year there are many patents granted
worldwide related to lasers and their applications. In the past, the Company has
been able to obtain patent licenses for patents related to its products on
commercially reasonable terms. The failure to obtain a key patent license from a
third party could cause the Company to incur liabilities for patent infringement
and, in the extreme case, to discontinue manufacturing products that infringe
upon the patent. Management believes that none of the Company's current products
infringe upon a valid claim of any patents owned by third parties, where the
failure to license the patent would have a material and adverse effect on the
Company's financial position or results of operations.
In March 1997, one of Palomar's competitors, Selvac Acquisitions Corp.
("Selvac"), filed a complaint alleging, among other things, that the EpiLaser(R)
laser system infringes a patent held by Selvac. Palomar successfully argued that
the Selvac patent was invalid, and now Selvac has appealed that ruling. See Item
3. "Legal Proceedings.")
Other than the matter described above, the Company has not been
notified that it is currently infringing on any patents nor has it been the
subject of any patent infringement action. Defense of a claim of infringement is
costly and could have a material adverse effect on the Company's business, even
if the Company were to prevail. (See Item 3. "Legal Proceedings" and Item 7.
"Risk Factors - Patents/Possible Patent Infringements.")
In August 1995, the Company entered into an agreement with MGH whereby
MGH agreed to conduct clinical trials on a laser treatment for hair
removal/reduction developed at MGH's Wellman Laboratories of Photomedicine. As
part of the agreement, MGH provided the Company with prior data already
generated at MGH with respect to the ruby laser device. This information was the
basis for the Company's application filed with the FDA for approval of the
Company's EpiLaser(R) laser system for treating unwanted hair. Effective
February 14, 1997, the Company amended the 1995 agreement with MGH. Under the
terms of this amendment, the Company agreed to provide MGH with a grant of
approximately $204,000 to perform research and evaluation in the field of hair
removal. During 1998, the Company incurred approximately $517,000 under its
clinical research agreement with MGH and other clinical studies. The Company
expects to incur approximately $350,000 of clinical research with MGH during
1999. The Company is also in the process of negotiating another amendment to
both extend the term and expand the scope of the clinical trial agreement with
MGH.
MGH has filed a number of patents surrounding technology involving
laser hair removal. The first patent was issued on January 21, 1997, and a
continuation-in-part of this patent was issued on April 7, 1998. MGH licenses
these patents exclusively to Palomar. Palomar, in turn, has the right to
sublicense these patents to others. Palomar also has the right to exclusively
license any other patents arising out of MGH's Palomar-funded clinical trials.
As consideration for this license, the Company is obligated to pay MGH royalties
of 5% of net revenues on laser hair removal products covered by valid patents
licensed to the Company exclusively; 2.5% of net revenues on products covered by
valid patents licensed to the Company non-exclusively; no less than 2.5% of net
revenues for products sold for hair removal as well as other uses, and a royalty
to be negotiated on services or commercial dispositions (other than sales)
involving products covered by valid patents licensed to the Company.
Star owns four patents, two relating to the use of a high-powered diode
laser for the treatment of psoriasis and subsurface blood vessels, one related
to the design and use of high-powered diode lasers, and one related to laser
diode array packaging. Under a patent license agreement which will take effect
only if and when Star is sold to Coherent (the "Patent License Agreement"),
Palomar will sublicense to Coherent the two MGH hair removal patents discussed
above for a royalty of 7.5% of the net sales price of all licensed products.
Licensed products means products manufactured by Coherent or Star which infringe
one or more claims of either of the two MGH hair removal patents. Assuming it
purchases Star, then, Coherent will have to pay Palomar a 7.5% royalty on all
LightSheer(TM) diode lasers that are sold by Coherent. Palomar, in turn, will
pay a portion of this royalty income back to MGH.
The Patent License Agreement further provides that, if it is sold to
Coherent, Star will grant to Palomar a royalty-free license on its two patents
relating to treatment of subsurface blood vessels, in the following limited
respect: Palomar may sublicense these patents only to other companies in
connection with their manufacture and sale of so-called "dual use devices," that
is, lasers that perform both hair removal and the treatment of subsurface blood
vessels (for example, leg veins). If Palomar does enter into such sublicensing
agreements, it will not have to pay any royalty amounts back to Coherent.
However, for a period of two years from the closing of the Star sale, Palomar
may not offer to sublicense the two subsurface blood vessel patents for
semiconductor lasers that operate in a continuous wave mode or in a
quasi-continuous wave mode
6
that deliver more than 5 joules in any 50 millisecond period ("Competitive
Products"). After the two year period, Palomar may sublicense dual use devices
that constitute Competitive Products, but then it must pay a royalty back to
Coherent.
The Patent License Agreement also provides that Star will grant to
Palomar a royalty-free license to Star's high-fluence diode laser patent for
uses other than Competitive Products. Once again, Palomar may license this
patent in connection with Competitive Products at the end of the two year
period, but only if it pays a royalty back to Coherent.
All licenses granted under the Patent License Agreement are granted for
the life of the respective patents. The Patent License Agreement also includes a
so-called "most favored licensee" provision, which means that, should either
party grant to a third party a license to any of these patents on more favorable
royalty terms than those established in the Patent License Agreement, then the
other party can immediately obtain that same lower royalty going forward
(assuming that all of the other material terms of the license agreement with the
third party are essentially like those in the Patent License Agreement).
(v) Seasonal Influences
There is no significant seasonal influence on the Company's sales.
(vi) Financing of Operations and Increase in Outstanding Shares
If Star is sold to Coherent, Palomar will receive net proceeds of
approximately $49 million in cash. In addition, as part of the sale of Star,
Coherent has agreed to pay the Company an ongoing 7.5% sublicensing royalty on
future sales of its hair removal lasers. (See "Patents and Licenses.") There can
be no assurance that the sale of Star to Coherent will be completed and that
events in the future will not require the Company to seek additional financing.
The sale must be approved by a majority of the Company's shares outstanding, and
is also subject to standard closing conditions. Financing of the Company's
future operating plan is now to a great extent dependant on completing the sale.
If the sale of Star is not completed the Company will require additional
financing during 1999 and there can be no assurance that any such financing will
be available on terms satisfactory to the Company. Based on its historical
ability to raise funds as necessary and ongoing discussions with potential
financing sources, the Company believes that it will be successful in obtaining
additional financing, if required, in order to fund future operations.
To enhance stockholder value and increase revenues, Palomar will also
consider licensing its intellectual property (in particular, the patents
licensed exclusively to Palomar by MGH under which the Company practices its
proprietary method of skin cooling and hair removal), selling intellectual
property rights that the Company does not intend to exploit, and mergers,
acquisitions or other transactions.
The Company has financed current operations and past expansion of its
core business with short-term financial borrowings and investments through the
private sale of debt and equity securities of the Company. Net cash provided by
financing activities totaled approximately $7,050,000 and $31,198,000 for the
years ended December 31, 1998, and December 31, 1997, respectively. If Star is
not sold, the Company may from time to time be required to raise additional
funds through additional private sales of the Company's debt or equity
securities. Sales of securities to private investors have been sold at a
discount to the current or future public market for similar securities. It has
been the Company's experience that private investors require that the Company
make its best effort to register their securities for resale to the public at
some future time. There can be no assurance that the Company would be successful
in raising additional capital on favorable terms. (See Notes 1, 6, and 7 to
Financial Statements, Item 5. "Market for Common Equity and Related Stockholder
Matters," and Item 7. "Risk Factors")
The Company has a $10,000,000 revolving line of credit from a bank.
This revolving line of credit matures on March 31, 2000 and bears interest at
the bank's prime rate (7.75% at December 31, 1998). Borrowings are limited to
80% of domestic accounts receivable under 90 days from invoice. A director of
the Company has personally guaranteed borrowings under the line of credit. As of
March 20, 1999, $725,000 was available under that line of credit. Substantially
all of Star's account receivables provide the borrowing base under this line of
credit.
As a result of financing activities, business developments, mergers and
acquisitions, issuance of incentive stock options and warrants to purchase
common stock to attract and retain key employees, the Company's issued and
outstanding
7
shares of common stock have increased to 70,179,027 at December 31, 1998. The
Company also had additional reserved but unissued shares of common stock of
33,807,020 shares at December 31, 1998. As of March 18, 1999, the Company's
issued and outstanding shares of common stock increased to 72,145,509 shares,
and reserved but unissued shares of common stock stood at 31,268,118 shares. A
substantial number of the Company's reserved shares are registered and could be
resold into the public market. (See Item 7. "Risk Factors.")
There are no special inventory requirements or credit terms extended to
customers that would have a material adverse effect on the Company's working
capital.
(vii) Dependency on a Single Customer
Sales pursuant to the Company's Sales Agency, Development and License
Agreement with Coherent accounted for approximately 89% of the Company's total
revenues in fiscal 1998. (See - "Marketing, Distribution and Service," Item 7.
"Risk Factors" and Notes 3(i) and 12(d) to Financial Statements.) If Star is not
sold to Coherent, then this Sales Agency Agreement will remain in effect until
November 17, 2001. Otherwise, the Sales Agency Agreement will terminate upon the
closing of the sale of Star.
(viii) Backlog
The Company's backlog of firm orders for its continuing operations at
December 31, 1998, and December 31, 1997, was approximately $3.4 million and
$2.5 million, respectively. This backlog consists almost entirely of orders for
Star's LightSheer(TM) diode laser. The Company has filled $2.1 million of this
year-end backlog in 1999. As of March 20, 1999, the Company's backlog of firm
orders related to Star's LightSheer(TM) was approximately $4.4 million, and, to
the Palomar E2000(TM), approximately $750,000.
(ix) Government Contracts
Not applicable.
(x) Competition
The markets in which the Company is engaged are subject to keen
competition and rapid technological change. Nine other companies, ThermoLase
Corporation; Candela, Inc.; Medical Laser Technologies Ltd. (Aesculap-Medtec);
Light Age, Inc.; Dornier Surgical Products, Inc.; Continuum Biomedical, Inc.;
Polytec PI, Inc. (Lambda Photometics); Leisegang Medical, Inc. and Cynosure,
Inc. have received market clearance from the FDA for laser hair removal and
another company, ESC Medical Systems Limited, has received FDA clearance to
market a laser-like system using filtered intense light to remove hair. The
Company expects that other hair removal devices will be developed and/or
introduced in 1999, making laser hair removal a competitive application within
the cosmetic laser marketplace. The Company also expects that there may be
further consolidation of companies within the laser hair removal industry via
acquisitions, partnering arrangements or joint ventures. The Company's products
will also compete with other hair removal products and methods. The Company
competes primarily on the basis of technology, product performance, price,
quality, reliability, distribution and customer service and support. To remain
competitive, the Company will be required to continue to develop new products,
periodically enhance its existing products and compete effectively in the areas
described above.
In the cosmetic laser services industry, the Company's Esthetica
subsidiary competes not only with other laser companies which also either
revenue-share with physicians and/or operate their own centers, but also with
healthcare providers. Esthetica's services will also compete for business with
other aesthetic service providers such as electrologists, beauty salons, spas,
and aestheticians, among others. Product efficacy, location, marketing, a wide
offering of laser procedures, price and customer service are all important
competitive factors. (See Item 7. "Risk Factors.")
(xi) Research and Development
Among Palomar's research and development goals in the field of laser
hair removal are to design systems that (1) permit more rapid treatment of large
areas, (2) have high gross margins, and (3) are lower cost, thus addressing
broader markets. Further, Palomar aims to address dermatology and cosmetic
procedure markets other than hair.
8
During fiscal 1998, fiscal 1997, and fiscal 1996, the Company incurred
approximately $7,029,000 $11,990,000 and $6,297,000, respectively, of internally
sponsored research and development programs. Due to the intense competition and
rapid technological changes in the laser industry, the Company believes that it
must continue to improve and refine its existing products and services, and
develop new applications for its technology.
Wellman Laboratories, the world's largest biomedical laser research
facility and part of the MGH Laser Center located in Boston, Massachusetts, was
created to oversee and speed the flow of biomedical laser research from the
laboratory to patient care. Funded in part by a grant from the Department of
Energy, the MGH Laser Center brings together two strengths of MGH: its clinical
departments and the Wellman Labs. The MGH Laser Center works together with
industry, academia and the Department of Energy Laboratories to access
information and technology across a broad spectrum of laser and medical
capabilities. The principals at Wellman Labs study the fundamental photophysical
and photochemical properties and processes of biomolecules excited by
ultraviolet, visible and near infrared radiation. Engineers, laser physicists
and physicians familiar with all aspects of biomolecules, cells and tissue in
vitro staff the labs. The scientists work side by side with the clinicians to
understand the basic principles involved in the complex interactions of light
and tissue. In 1994, the Company began a number of studies for the treatment of
certain dermatological conditions using its diode laser at Wellman Labs. In
1995, those studies were expanded to include the Company's ruby lasers for
cosmetic procedures. In 1997, those studies were again expanded to include the
Company's diode lasers for cosmetic purposes. Wellman Labs and the Company are
currently evaluating the data associated with these treatments. The Company
works closely with Dr. R. Rox Anderson, the Research Director of the MGH Laser
Center and Associate Professor of Dermatology at Harvard Medical School, who is
a recognized expert in laser tissue interaction and the inventor of a number of
laser procedures in use today. Dr. Anderson has authored over 60 papers in
peer-reviewed publications relating to the use of lasers in dermatology, is the
recipient of numerous awards in the field of laser medicine and serves as a
member of the Blue Ribbon Government Liaison Committee of the American Society
for Laser Medicine and Surgery. Dr. Anderson holds 23 U.S. patents and has
pending applications for an additional eleven. The Company feels that these
types of relationships are critical in developing effective products for
widespread use in the market on a timely basis, and that this method of
conducting research and development provides a higher level of technical and
clinical expertise than it could provide on its own and in a more cost-efficient
manner.
PMP's Vice President of Research and Development, Gregory Altshuler, is
the former Director of the Laser Center of the St. Petersburg (Russia) Institute
of Fine Mechanics and Optics (the "St. Petersburg Laser Center)" and the Company
continues to work closely with the St. Petersburg Laser Center, contracting its
research and development tasks to them on a project basis. In 1998, the Company
spent approximately $178,000 on research and development conducted at the St.
Petersburg Laser Institute. Dr. Altshuler holds approximately 50 patents in
Russia in the field of lasers and the application of lasers in medicine, and has
authored approximately 130 papers relating to laser physics, engineering and
medicine.
While MGH focuses on the biological aspects of laser hair removal, Dr.
Altshuler's in-house research and development team focuses on the physical
aspects. Approximately 43 employees of the Company and its subsidiaries were
engaged full time in research and development activities at December 31, 1998.
Twenty-three of these employees work at Star and will no longer work for Palomar
if Star is sold.
Under the Sales Agency, Development and License Agreement that the
Company entered into with Coherent in November 1997, the Company committed to
spend the following amounts on research and development over the next three
years: at least $5,000,000 in 1998, at least 10% of its 1998 gross revenues
(minus commissions to Coherent) from cosmetic laser products ("Product
Revenues") in 1999, and at least 10% of its 1999 Product Revenues in 2000.
Although the Company expects to continue to devote substantial resources to
research and development regardless of whether the sale of Star to Coherent is
consummated, this specific commitment will terminate upon the sale.
(See Item 7. "Risk Factors" and Note 8 to Financial Statements.)
9
(xii) Environmental Protection Regulations
The Company believes that compliance with federal, state and local
environmental regulations will not have a material adverse effect on its capital
expenditures, earnings or competitive position.
(xiii) Impact of Medical Device Regulations
The Company's products are subject to regulation and control by the
Center for Devices and Radiological Health, a branch of the Food and Drug
Administration (FDA) within the Department of Health and Human Services. The FDA
medical device regulations require either an Investigational Device Exemption,
Pre-Market Approval or 510(K) clearance before new products can be marketed to,
or utilized by, the physician. The Company's products are subject to similar
regulations in its major international markets. Complying with these regulations
is necessary for the Company's strategy of expanding the markets for and sales
of its products into these countries. These approvals may necessitate clinical
testing, limitations on the number of sales and controls of end user purchase
price, 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. The Company's competitors are
subject to the same regulations. (See Item 7. "Risk Factors.")
(xiv) Number of Employees
As of December 31, 1998, the Company and its PMP, Esthetica and Star
subsidiaries employed 164 people, 3 independent contractors and 14 temporary
employees. Of these employees, 71 are with Star and would not remain with the
Company following the sale of Star.
The Company's ability to develop, manufacture and market its products
and to establish and maintain a competitive position in the industry will
depend, in large part, upon its ability to attract and retain qualified
technical, marketing and managerial personnel. The Company believes that its
relations with its employees are good. None of the Company's employees are
represented by a union. (See Item 7. "Risk Factors.")
(d) Financial Information About Exports by Domestic Operations
Aggregate export sales for the Company's continuing operations were
approximately $3,870,000 for 1996, $5,030,000 for 1997 and $17,360,000 for 1998.
The 1996 export sales consisted primarily of the RD-1200(TM) tattoo removal
laser and the EpiLaser(R) laser system, the 1997 export sales consisted
primarily of the EpiLaser(R) laser system, and the 1998 export sales consisted
primarily of the LightSheer(TM). (See Notes 3(i) and 13 to Financial
Statements.)
Item 2. Properties.
The Company occupies approximately 25,000 square feet of office,
manufacturing and research space in Lexington, Massachusetts under a lease
expiring in May 2000. The Company's Star subsidiary occupies approximately
25,000 square feet of office, manufacturing and research space in Pleasanton,
California under two leases expiring in April 1999 and March 2001. Upon the sale
of Star to Coherent, Coherent will assume these leases for Star's operations.
The Company believes that these facilities are in good condition and are
suitable and adequate for its current operations, assuming it does not sell
Star. However, if the Star sale is completed, the Company expects that it will
require additional office, manufacturing and research space for its existing
operations.
Item 3. Legal Proceedings.
On March 7, 1997, Selvac Acquisition Corp. ("Selvac"), a subsidiary of
Mehl Biophile International, Inc. ("Mehl"), filed a complaint for injunctive
relief and damages for patent infringement and for unfair competition in the
United States District Court for the District of New Jersey against the Company,
two of its subsidiaries and a New Jersey dermatologist. Selvac's complaint
alleged that the Company's EpiLaser(R) ruby laser hair removal system infringed
a patent licensed to Selvac (the "Selvac Patent") and that the Company unfairly
competed by promoting the EpiLaser(R) ruby laser hair removal system for hair
removal before it had received FDA approval for that specific application. On
May 18, 1998 the court granted the Company's motion for partial summary judgment
on the ground that the Selvac patent is invalid because prior art anticipated
it. The court has since denied Selvac's motion for reconsideration of the
summary judgment ruling.
10
On September 25, 1998, the court denied Selvac's motion for reconsideration of
its prior order dismissing so much of Selvac's unfair competition claim as
relied on interpreting the Food, Drug and Cosmetics Act or FDA regulations, and
dismissed without prejudice the state law remainder of Selvac's unfair
competition claim. On October 26, 1998, Selvac filed its notice of appeal to the
Court of Appeals for the Federal Circuit. Selvac subsequently filed its opening
brief on appeal; the Company filed its opposition. Selvac will likely file a
reply brief in April 1999. The Company is unable to express an opinion as to the
likely outcome of Selvac's appeal.
On October 16, 1997, the Company brought a declaratory judgment action
in U.S. District Court for the District of Massachusetts against the holders and
the indenture trustee of the Company's 4.5% Subordinated Convertible Debentures
due 2003, denominated in Swiss francs (the "Swiss Franc Debentures"). The
defendants in this action are Banque SCS Alliance SA, Arbuthnot Fund Managers,
Ltd., Banca Commerciale Lugano, Privatinvest Bank AG (these four defendants
being referred to collectively as the "Asserting Holders"), CUF Finance S.A.,
Fibi Bank (Schweiz) AG, Teawood Nominees, Ltd., JS Gadd & CIE SA, Swedbank
(Luxembourg) SA, Christiana Bank Luxembourg SA (now know as Credit Agricole
Indosuez), Landatina Financiera SA and American Stock Transfer & Trust Co., as
trustee ("Trustee"). Just prior to this suit, the Asserting Holders had alleged
that the Company was in breach of certain protective covenants under the
indenture, and on October 22, 1997 they sued the Company and all of its
principal subsidiaries in the same court; the October 16 and October 22 cases
have been assigned to the same judge, and the dispute between the Asserting
Holders and the Company is proceeding under the October 22 case. The Asserting
Holders claim that the Company has breached certain protective indenture
covenants and that the Asserting Holders are entitled to immediate payment of
their indebtedness under the Swiss Franc Debentures (which amounts to
approximately US$5,600,000 at December 31, 1998 exchange rates). As of November
13, 1997, acting under applicable provisions of the indenture, the Company
notified the holders of the Swiss Franc Debentures that it is causing the
conversion of all of the Swiss Franc Debentures into an aggregate of 914,028
shares of the Company's common stock. Palomar filed a motion for summary
judgment, asserting that its conversion of the debentures into Palomar common
stock deprives the plaintiffs of standing to bring a claim. That motion has been
denied without prejudice, and the court also denied the plaintiffs' motion for
summary judgment. By mutual agreement, the Asserting Holders and the Company
requested that the case be removed from the Court's October 1998 trial calendar.
The parties have discussed ways to resolve their dispute, including the
restructuring of the debentures (so that Palomar would withdraw its forced
conversion and repay on a modified schedule the original debt, with a
substantial prepayment of principal). But there can be no absolute assurance
that all of the debentureholders, including the Asserting Holders, and the
Company will complete the proposed settlement. If the case is returned to the
trial calendar, the Company expects to vigorously contest the claims of the
Asserting Holders, as the Company believes its position in the lawsuit is
correct, and that the debt cannot properly be accelerated. The court has given
the parties until April 30, 1999 to complete their agreement.
On March 11, 1999, the United States District Court for the Southern
District of New York granted plaintiffs leave to amend their complaint in the
action styled VARLJEN V. H.J. MEYERS, INC., ET. AL. to join the Company, Steven
Georgiev and Joseph Caruso as defendants. On March 17, 1999, the Second Amended
Class Action Complaint ("Complaint") in Varljen was served upon the Company and
Caruso. The Complaint alleges that the Company, Georgiev and Caruso violated the
federal securities laws in various public disclosures that the Company made
directly and indirectly during the period from February 1, 1996 to March 26,
1997. In particular, the Complaint alleges that Palomar, Georgiev and Caruso
misrepresented the Company's financial results and future prospects through
their direct disclosure and through disclosures made by securities analysts and
other third parties. The case is in its earliest stages, and the Company cannot
predict its outcome.
The Company is also aware of a claim alleging that the Company had
previously committed to make an additional capital contribution to Nexar. The
Company believes that this claim is without merit.
The Company is involved in other legal and administrative proceedings
and claims of various types. While any litigation contains an element of
uncertainty, management, in consultation with the Company's general counsel, at
present believes that the outcome of each such other proceeding or claim which
is pending or known to be threatened, or all of them combined, will not have a
material adverse effect on the Company.
(See "Risk Factor.")
Item 4. Submission of Matters to a Vote of Security Holders.
Not applicable.
11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's common stock is currently traded on the National
Association of Securities Dealers Automated Quotation System (Nasdaq) under the
symbol PMTI. The following table sets forth the high and low bid prices quoted
on Nasdaq for the Common Stock for the periods indicated. Such quotations
reflect inter-dealer prices, without retail markup, markdown or commission and
do not necessarily represent actual transactions.
Fiscal Year Ended
December 31, 1997
-----------------
High Low
---- ---
Quarter Ended March 31, 1997 9 1/4 5 7/16
Quarter Ended June 30, 1997 5 3/4 2 3/8
Quarter Ended September 30, 1997 4 7/16 1 15/16
Quarter Ended December 31, 1997 2 31/32 25/32
Fiscal Year Ended
December 31, 1998
-----------------
High Low
---- ---
Quarter Ended March 31, 1998 2 11/32 5/8
Quarter Ended June 30, 1998 1 9/16 31/32
Quarter Ended September 30, 1998 1 7/32 3/4
Quarter Ended December 31, 1998 1 1/8 19/32
As of March 2, 1999, the Company had 939 holders of record of common
stock. This does not include holdings in street or nominee names.
The Company has not paid dividends to its common stockholders since its
inception and does not plan to pay dividends to its common stockholders in the
foreseeable future. The Company intends to retain any earnings to finance the
operations of the Company.
Private Placements of Common Stock
Pursuant to Section 4(2) of the Act, on February 20, 1998 the Company
sold 2,000,000 shares, 1,500,000 shares, 1,100,000 shares, 1,000,000 shares,
250,000 shares and 1,350,000 shares of the Company's common stock to the
Travelers Insurance Company, AIM Overseas Ltd., TJJ Corporation, PAR Investment
Partners L.P., Pequot Scout Fund L.P., and other third party unaffiliated
individual investors, respectively, for an aggregate of $7,200,000. In addition,
for every share purchased the investor received a warrant to purchase one share
of the Company's common stock for $3 per share. These warrants expire five years
from the closing date and are exercisable beginning six months after the closing
date.
Pursuant to Section 4(2) of the Act, on July 24, 1998 the Company sold
1,800,000 shares and 1,200,000 shares of the Company's common stock to the
Rockside Foundation and Mark T. Smith, respectively, for an aggregate of
$3,000,000. In addition, for every share purchased the investors received a
warrant to purchase one share of the Company's common stock for $3 per share.
These warrants expire five years from the closing date and are exercisable
beginning six months after the closing date.
Each of these sales was made without general solicitation or
advertising. Each purchaser was a sophisticated investor with access to all
relevant information necessary to evaluate the investment in the Company, and
each purchaser represented to the Company that the securities were being
acquired for investment.
12
Convertible Debentures
Pursuant to Section 4(2) of the Act, the Company sold a $2,000,000
convertible debenture on March 27, 1998 to Hechtor Wiltshire, an individual
unaffiliated third party investor. The debenture was due the earlier of May 26,
1998 or one day following the sale of Dynaco or any other Palomar assets outside
the normal course of business or any other financing where the use of proceeds
to pay back debt was not prohibited. If the debenture was not repaid by the
maturity date, the debenture would become convertible at market value at the
option of the debentureholder, as defined. Interest on this debenture was in the
form of a warrant to purchase 125,000 shares of common stock for $.01 per share
exercisable over five years. The Company repaid $1,250,000 and $750,000 of this
$2,000,000 convertible debenture on April 8, 1998 and May 27, 1998,
respectively. The warrant to purchase 125,000 shares of common stock for $.01
per share was exercised by the individual on May 18, 1998.
This sales was made without general solicitation or advertising. The
purchaser was a sophisticated investor with access to all relevant information
necessary to evaluate the investment in the Company, and represented to the
Company that the securities were being acquired for investment.
Conversions of Preferred Stock and Debentures
During the year ended December 31, 1998, the following securities were
converted by the accredited investor unaffiliated third-party holders for the
number of shares of common stock indicated:
Number of Shares
Type of Security Number of Shares Common Stock Issued
---------------- ---------------- -------------------
Preferred Stock Series G 1,941 2,703,032
Preferred Stock Series H 3,947 4,188,650
Debenture 5% Due December 31, 2001 N/A 1,160,999
Debenture 5% Due January 13, 2002 N/A 924,029
Debenture 5% Due March 10, 2002 N/A 1,561,064
Debenture 4.5% Due October 21, 1999, 2000, 2001 N/A 60,809
Debenture 6%,7%,8% Due September 30, 2002 N/A 3,328,761
The Company received no proceeds in connection with any of these
conversions.
13
Item 6. Selected Financial Data.
The following table sets forth selected consolidated financial and other
information (in thousands except per share data) on a consolidated historical
basis for the Company and its subsidiaries as of and for each of the fiscal
years in the five year period ended December 31, 1998. Pursuant to Accounting
Principles Board Opinion ("APB") No. 30, Reporting the Results of Operations -
Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary,
Unusual and Infrequently Occurring Events and Transactions, the consolidated
financial statements of the Company have been reclassified to reflect the
dispositions of its subsidiaries that comprise the electronics segment. (See
Note 2 to Consolidated Financial Statements.) (Note that in 1994 the Company
changed its fiscal year end from March 31 to December 31.) This table should be
read in conjunction with the Consolidated Financial Statements of the Company
and the Notes thereto included elsewhere in this Annual Report on Form 10-K.
Selected Financial Data
(in thousands, except per share data)
Nine months
ended Year ended
December 31, December 31,
-----------------------------------------------------------------------------
Statement of Operations Data 1994 1995 1996 1997 1998
-------------- ------------ ------------ ------------ ------------
Revenues $ 40 $ 5,610 $ 17,607 $ 20,995 $ 44,514
Gross Profit (Loss) 22 2,146 3,437 939 21,463
Operating Expenses 5,740 10,985 26,548 42,867 30,897
Loss from Operations (5,718) (8,839) (23,110) (41,929) (9,434)
Net Loss from Continuing Operations (5,689) (8,390) (20,798) (58,369) (9,967)
Net Loss from Discontinued Operations (3) (4,231) (17,066) (27,435) (2,624)
Net Loss (5,692) (12,621) (37,864) (85,804) (12,591)
Basic and Diluted Net Loss Per Common Share:
Continuing Operations $ (0.84) $ (0.60) $ (0.84) $ (1.79) $ (0.18)
Discontinued Operations - (0.30) (0.65) (0.78) (0.04)
-------------- ------------ ------------ ------------ ------------
Total Loss Per Common Share $ (0.84) $ (0.90) $ (1.49) $ (2.57) $ (0.22)
Weighted Average Number of
Common Shares Outstanding
6,759 14,165 26,167 35,105 62,869
============== ============ ============ ============ ============
Balance Sheet Data:
Working Capital $ 2,491 $ 12,998 $ 15,203 $ (7,269) $ (6,004)
Total Assets 6,551 33,656 67,533 28,968 23,526
Long-term debt 2,322 1,765 14,665 12,446 3,150
Stockholders' Equity (Deficit) 2,794 25,289 38,077 (6,184) (6,463)
14
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
(a) Overview
On December 7, 1998, the Company entered into an Agreement and Plan of
Reorganization (the "Agreement") with Coherent, Inc. ("Coherent") to sell all of
the issued and outstanding common stock of Star Medical Technologies, Inc.
("Star"), its 99.96% majority-owned subsidiary, to Coherent for $65 million in
cash. The Company currently owns substantially all of the issued and outstanding
common shares of Star. However, options that have been granted to Palomar and
employees of Star to purchase shares of Star's common stock remain outstanding.
When all of the outstanding options under Star's Stock Option Plan have been
exercised, the Company will own 82.46% of Star's common stock and the employees
will collectively own 17.54% at the time of the sale of Star. Therefore, the
Company anticipates that it will receive net proceeds from this sale of
approximately $46 million after taxes (see Note 7 to the Consolidated Financial
Statements). Under the terms of the Agreement, the Company will also receive an
ongoing royalty of 7.5% from Coherent on the sale of any products by Coherent
that employ certain patented technology related to laser hair removal currently
licensed by the Company on an exclusive basis from Massachusetts General
Hospital ("MGH") (see Note 12(b) to the Consolidated Financial Statements). The
sale is subject to stockholder approval, as well as customary closing
conditions.
If this transaction is consummated, revenues would decline
significantly in the near term and the successful introduction and marketing of
new products will become more critical to the Company's long-term success. A
significant portion of the Company's current revenue base will need to be
replaced with future revenues from the Company's other laser products, including
the Palomar E2000TM hair removal laser introduced in February of 1999 and other
products currently in development. For the year ended December 31, 1998, gross
revenues associated with Star's LightSheer(TM) diode laser comprised 80% of the
Company's total revenues. There can be no assurance that the Palomar E2000TM or
the Company's future products will achieve market acceptance or generate
sufficient margins. Broad market acceptance of laser hair removal is critical to
the Company's success. The Company recognizes the need and intends to broaden
its product line by developing cosmetic laser products other than hair removal
lasers.
In the third and fourth quarters of 1997, the Board of Directors
authorized management to focus the Company on its core laser products and
services business, principally related to laser hair removal, and to proceed
with a restructuring plan to reorganize the Company and divest its electronic
subsidiaries, Dynaco Corp. ("Dynaco"), Dynamem, Inc. ("Dynamem"), Comtel
Electronics, Inc. ("Comtel") and Nexar Technologies, Inc. ("Nexar")
(collectively, the "Electronic Subsidiaries"), and other non-core businesses.
Pursuant to Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," the consolidated financial statements of the Company have been
reclassified to reflect the dispositions of the Electronic Subsidiaries.
Accordingly, the revenues, cost and expenses, assets and liabilities and cash
flows of the Electronics Subsidiaries have been reported as discontinued
operations in these consolidated financial statements (see Note 2 to
Consolidated Financial Statements).
The Company has simplified its organization and now conducts business
in only two locations, Lexington, Massachusetts and Pleasanton, California.
Prior to this restructuring, the Company conducted business in over a dozen
different locations.
(b) Results
(i) REVENUES AND GROSS MARGIN: Year Ended December 31, 1998,
Compared to Year Ended December 31, 1997
For the year ended December 31, 1998, the Company's revenues increased
to $44.5 million as compared to $21.0 million for the year ended December 31,
1997. The increase in the Company's revenue of $23.5 million or 112% from the
year ended December 31, 1997 was mainly due to additional sales volume of $35.6
million associated with the introduction of the LightSheer(TM) diode laser,
partially offset by a decrease in revenue of approximately $12.1 million in
other cosmetic laser product revenue. The Company obtained FDA clearance to
market and sell its LightSheer(TM) laser for hair removal and leg vein treatment
in the United States at the end of 1997. The decrease in sales volume associated
with other cosmetic laser
15
product revenue was principally due to declining sales of the Company's
EpiLaser(R) ruby laser. The Company focused on bringing the LightSheer(TM) laser
to market while further developing a new generation of ruby hair removal lasers
during 1998. Using its core ruby laser technology, originally developed for
tattoo and pigmented lesion removal, Palomar developed its long pulse
EpiLaser(R) ruby laser that is specifically configured to allow the appropriate
wavelength, energy level and pulse duration to be absorbed effectively by the
hair follicle without being absorbed by the surrounding tissue. That, combined
with Company's patented cooling handpiece, allows safe and effective hair
removal. Palomar expects its new generation long pulse ruby laser, the Palomar
E2000TM, to permit more rapid treatment of large areas of the body. In July
1998, the Company obtained FDA clearance to market and sell its EpiLaser(R)
laser system in the United States for "permanent hair reduction." In March of
1999, the Company also obtained FDA clearance to market and sell its Palomar
E2000TM laser system in the United States for "permanent hair reduction."
Gross margin for the year ended December 31, 1998 was approximately
$21.5 million (48% of revenues) compared to $939,000 (4% of revenues) for the
year ended December 31, 1997. The increase in gross margin and gross margin
percentage was due to sales of the LightSheer(TM) diode laser system. This new
laser system has a significantly higher gross margin than the Company's
EpiLaser(R) laser and other cosmetic products. The Company anticipates that if
the sale of Star is consummated, its gross margin percentage from the sale of
Palomar E2000TM will decrease compared to the current gross margin from the sale
of its LightSheer(TM) product unless and until the Palomar E2000TM achieves
volume production and manufacturing efficiencies.
(ii) OPERATING AND OTHER EXPENSES: Year Ended December 31, 1998,
Compared to Year Ended December 31, 1997
Research and development costs decreased to $7.0 million for the year
ended December 31, 1998 from $12.0 million for the year ended December 31, 1997.
Research and development expenses as a percentage of revenue totaled 16% for the
year ended December 31, 1998 and 57% for the year ended December 31, 1997. The
decline in spending is primarily the result of the Company's receipt of FDA
approval for the LightSheer(TM) laser at the end of 1997. The continued spending
on research and development reflects the Company's commitment to research and
development for medical devices and delivery systems for cosmetic laser
applications and other medical applications using a variety of lasers, while
continuing dermatology research utilizing the Company's ruby and diode lasers.
Among the Company's research and development goals in hair removal is to design
systems permitting more rapid treatment of large areas, and to produce systems
with high gross margins. Management believes that research and development
expenditures will remain constant over the next year as the Company continues
product development and clinical trials for additional applications for its
lasers and delivery systems in the cosmetic and dermatological markets.
Selling and marketing expenses increased to $15.1 million (34% of
revenues) for the year ended December 31, 1998, from approximately $7.0 million
(33% of revenues) for the year ended December 31, 1997. The increase in selling
and marketing expenses is attributable to the costs associated with the
Company's distribution agreement with Coherent, which increase in direct
proportion to sales volume (see Note 12(d) to the Consolidated Financial
Statements) because Coherent receives a commission for each of the Company's
products that it sells to compensate it for its selling and marketing efforts.
The amounts received by Coherent (as a percentage of the Company's net revenues)
are greater than the Company's selling and marketing expenses when it performed
these functions internally during 1997. The Company anticipates that its selling
and marketing expenses will decrease as a percentage of revenue after the
completion of the sale of Star to Coherent as the Company begins to sell the
Palomar E2000TM through other sales channels, including distribution through
Continuum Biomedical, a distributor of medical products. The Company also will
consider establishing its own direct sales force to compliment these sales
channels. The Company anticipates that its selling and marketing costs incurred
through other sales channels and its own direct sales force will be less than
the commissions currently earned by Coherent as a percentage of the Company's
net revenues.
General and administrative expenses decreased to $8.9 million (20% of
revenues) for the year ended December 31, 1998, as compared to $15.3 million
(73% of revenues) for the year end ended December 31, 1997. This decrease is
attributable to the Company's restructuring and consolidation of administrative
functions in the third and fourth quarters of 1997, including a reduction in
costs attributable to Palomar Technologies, Ltd., Esthetica, Inc. (formerly
Cosmetic Technology International, Inc.), Palomar Medical Products, Inc. and
corporate costs totaling $1.0 million, $2.4 million, $1.9 million and $2.0
million, respectively. This reduction was offset by an increase of $900,000 for
general and administrative expenses incurred at the Company's Star subsidiary to
support its successful introduction of its LightSheer(TM) laser. In previous
16
years, the Company used management's time and allocated resources to developing
businesses outside of the medical and cosmetic laser industry and financing the
non-core businesses. Beginning in the fourth quarter of 1997, the Company
focused its efforts on its core business. The Company anticipates general and
administrative expense will continue to stabilize in the future and after the
sale of Star as the Company focuses on its core operations in the cosmetic laser
business.
The Company incurred no business development and financing costs during
the year ended December 31, 1998 as compared to $2.1 million (10% of revenues)
for the year ended December 31, 1997. This decrease is attributable to the
Company's restructuring efforts to focus on its core medical business.
Restructuring and asset write-off costs were approximately $13.0
million for the year ended December 31, 1997. These charges reflect
restructuring and asset write-off costs for certain operating and non-operating
assets that the Company believes were not fully realizable for both the
Company's medical business and other non-medical investments. Included in this
charge is a $2.7 million reserve for severance costs associated with
consolidating selling, general and administrative functions, including the
closing of certain facilities. Through December 31, 1998, the Company paid out
$2.3 million of severance costs and has a remaining liability of $279,000
related to two individuals that will be paid out in 1999, resulting in actual
restructuring costs incurred of $2.6 million. Accordingly, the Company reversed
the balance of this restructuring accrual of approximately $131,000 in its
consolidated statement of operations during the fourth quarter of fiscal 1998
(see Note 4 to Consolidated Financial Statements).
For the year ended December 31, 1998, the Company did not incur
settlement expenses. Settlement costs of $3.2 million were incurred in the year
ended December 31, 1997. These charges consisted mainly of a legal accrual
related to a legal settlement with an investment bank.
Interest expense decreased to $1.3 million for the year ended December
31, 1998, from $7.0 million for the year ended December 31, 1997. The amount for
1997 includes $5.5 million of non-cash interest expense related to the value
ascribed to the discount features of the convertible debentures issued by the
Company during 1996 and 1997. This 82% decrease is primarily the result of a
decrease in convertible debenture financings and the Company's increased use of
conventional financing. Also, operations did not require as much financing in
1998 as compared to 1997.
Interest income decreased to $33,000 for the year ended December 31,
1998, from approximately $457,000 for the year ended December 31, 1997. This
decrease is primarily the result of a reduction in interest received due to a
decrease in other loans and investments and a decrease in the Company's average
cash position during 1998.
Net gain on trading securities represents a realized gain of
approximately $703,000 for the year ended December 31, 1998 related to the
Company's investment in a publicly traded company that was sold during 1998. The
Company does not have any marketable trading securities as of December 31, 1998.
The loss from discontinued operations for the year ended December 31,
1998 was $2.6 million compared to a loss of $27.4 million for the year ended
December 31, 1997. The loss from discontinued operations in 1998 was due to a
delay in the disposition of Dynaco resulting in operating expenses of
approximately $1.1 million above the estimated operating expenses accrued at
December 31, 1997. A loss on disposition of discontinued entities for the year
ended December 31, 1998 of $1.5 million was incurred. The majority of this
charge relates the write-off of the Company's carrying value of its investment
in Nexar during the second quarter of 1998.
(iii) REVENUES AND GROSS MARGIN Year Ended December 31, 1997,
Compared to Year Ended December 31, 1996
Revenues from continuing operations for the year ended December 31,
1997 were $21.0 million as compared to $17.6 million for the year ended December
31, 1996. The 19.2% increase mainly was due to additional sales volume of
approximately $11.3 million associated with the EpiLaser(R) hair removal laser
system and service revenue and with the RD-1200(TM) tattoo removal and pigmented
lesion treatment laser manufactured by the Company. The Company obtained FDA
clearance to market and sell the EpiLaser(R) laser system for hair removal in
the United States in March 1997. This increase in revenues was offset by a
decline of approximately $7.9 million in sales volume for the Company's
Tru-Pulse(R) CO2 laser product.
17
Gross margin for the year ended December 31, 1997 was $939,000 (4% of
revenues) compared to $3.4 million (20% of revenues) for the year ended December
31, 1996. The decline in gross margin percentage was caused mainly by lower
margins attained on the Company's EpiLaser(R) laser system due to manufacturing
and production inefficiencies in the initial manufacturing stage of this product
as well as under-absorbed overhead costs incurred during the fourth quarter of
1997 as the Company transitioned to its exclusive distribution arrangement with
Coherent. The decline in gross margin dollars was due principally to a reduction
in revenues related to the Company's Tru-Pulse(R) CO2 laser product. The
Company's overall strategy was to first demonstrate and prove the overall
efficacy of its proprietary cosmetic hair removal technology licensed from MGH
and gain early entrance to the market. This resulted in higher than anticipated
costs of materials and manufacturing techniques. As a result of this strategy,
the Company believes that during 1997 it demonstrated to the medical community
the efficacy of its technology and its long-term benefits and advantages which
led to the successful introduction and sales of its LightSheer(TM) laser in
1998.
(iv) OPERATING AND OTHER EXPENSES: Year Ended December 31, 1997,
Compared to Year Ended December 31, 1996
Research and development costs increased to $12.0 million (57% of
revenues) for the year ended December 31, 1997, from $6.3 million (36% of
revenues) for the year ended December 31, 1996. This 90% increase in research
and development reflects the Company's strategic decision to accelerate its
research and development efforts during 1997 to develop and obtain FDA clearance
for its successor hair removal and other cosmetic products using the Company's
proprietary cooling technology licensed from MGH. The Company also continued to
concentrate on the development of additional products for other medical laser
applications.
Selling and marketing expenses increased to $7.0 million (33% of
revenues) for the year ended December 31, 1997, from $5.1 million (29% of
revenues) for the year ended December 31, 1996. This 37% increase reflected the
Company's effort to expand its marketing and distribution for the Company's
EpiLaser(R) laser system.
General and administrative expenses increased to $15.3 million (73% of
revenues) for the year ended December 31, 1997, from $9.8 million (55% of
revenues) for the year ended December 31, 1996. This 57% increase was the result
of additional administrative resources required at the Company's now closed
separate corporate offices and subsidiaries to oversee the growth of the
Company's medical products and service businesses, the initial public offering
of common stock of Nexar, and divestiture efforts substantially completed during
1997, totaling approximately $500,000. Additional general and administrative
costs were also incurred at Palomar Medical Products, Inc., Esthetica and
Palomar Technologies, Ltd. totaling approximately $1.7 million, $2.3 million and
$1.0 million, respectively. The majority of these general and administrative
expenditures incurred by the subsidiaries were for employee and infrastructure
expenses to manage the transition from a development stage company to the
commercialization stage.
Business development and financing costs decreased to $2.1 million (10%
of revenues) for the year ended December 31, 1997, from $2.9 million (16% of
revenues) for the year ended December 31, 1996. This 28% decrease is
attributable to the Company's restructuring efforts to focus on its core medical
product and service businesses.
Restructuring and asset write-off costs totaling $13.0 million were
incurred for the year ended December 31, 1997 as compared to $1.7 million for
the year ended December 31, 1996. These charges reflect restructuring and asset
write-off costs for certain operating and non-operating assets that the Company
believes were not fully realizable for both the Company's medical business and
other non-medical investments. Included in this charge for 1997 is a $2.7
million charge for severance costs associated with consolidating the selling,
general and administrative functions, including the closing of certain
facilities. Through December 31, 1998, the Company paid out $2.3 million of
severance costs and has a remaining liability of $279,000 to two individuals
that will be paid out in 1999 resulting in total restructuring costs incurred of
$2.6 million. Accordingly, the Company reversed the balance of this
restructuring accrual of approximately $131,000 in its consolidated statement of
operations during the fourth quarter of fiscal 1998 (see Note 4 to Consolidated
Financial Statements).
Settlement and litigation costs increased to $3.2 million for the year
ended December 31, 1997 from $880,000 for the year ended December 31, 1996.
These costs are primarily attributable to a lawsuit brought by an investment
bank. In
18
this suit, the investment bank alleged that the Company breached a contract in
which the bank was to provide certain investment banking services in return for
certain compensation. This case was settled on August 18, 1997 for $1.9 million.
Interest expense from continuing operations increased to $7.0 million
for the year ended December 31, 1997, from $272,000 for the year ended December
31, 1996. This amount for 1997 includes $5.5 million of non-cash interest
expense related to the value ascribed to the discount features of the
convertible debentures issued by the Company.
Interest income decreased to $457,000 for the year ended December 31,
1997, from $1.4 million for the year ended December 31, 1996. This decrease is
primarily the result of a reduction in interest received due to a decrease in
other loans and investments and a decrease in the Company's average cash
position during 1997.
Loss from discontinued operations was $27.4 million for the year ended
December 31, 1997 as compared with a loss of $17.1 million for the year ended
December 31, 1996. The Company also reported a gain of $2.1 million on the
disposition of its discontinued operations. This amount includes a gain of $6.2
million related to the disposition of 1,960,736 shares of Nexar common stock
which was offset by losses incurred and accrued of $4.1 million on the
disposition of Dynaco and its wholly owned subsidiaries. The Company completed
the disposition of Comtel and Dynamem on December 9, 1997. The disposition of
Dynaco was completed in May of 1998 (see Note 2 to the Consolidated Financial
Statements).
(c) Liquidity and Capital Resources
The Company is a holding company with no significant operations or
assets other than its investments in operating subsidiaries and strategic
investments. The Company depends upon dividends, cash advances and/or other cash
payments from its subsidiaries to meet its cash flow requirements. To date, the
Company's operating subsidiaries have required cash advances from the Company to
fund their operations.
On December 7, 1998, the Company entered into a Agreement and Plan of
Reorganization (the "Agreement") with Coherent to sell all of the issued and
outstanding common stock of Star, its 99.96% majority-owned subsidiary, to
Coherent. The Company currently owns substantially all of the issued and
outstanding common shares of Star. However, options outstanding granted to
Palomar and employees of Star to purchase shares of Star's common stock remain
outstanding. When all of the outstanding options under Star's Stock Option Plan
have been exercised, the Company will own 82.46% of Star's common stock and the
employees will collectively own 17.54%. See Note 7 to the Financial Statements.
Under the terms of the Agreement, the selling price of Star is $65 million. In
addition, the Company will receive an ongoing royalty of 7.5% from Coherent on
the sale of any products by Coherent that use certain patents currently licensed
by the Company on an exclusive basis from Massachusetts General Hospital. See
Note 12(b) to the Financial Statements. This sale is subject to the approval of
the stockholders of Palomar. The Company anticipates that it will receive net
proceeds of approximately $49 million for the sale. The Company intends to use
these funds to support its ongoing operations and research and development
activities.
As of December 31, 1998, the Company had $1.9 million in cash and cash
equivalents. In order to meet its cash flow requirements and fund operating
losses at its subsidiaries, the Company generated $9.8 million and $3.0 million
in net proceeds from the issuance of common stock and short-term notes payable,
respectively, during the year ended December 31, 1998. The Company's net cash
used in operating activities for the year end ended December 31, 1998 was
approximately $11.1 million which includes approximately $2.1 million of net
cash generated from Star's operating activities. The Company's net loss for the
year ended December 31, 1998 included approximately $2.7 million of non-cash
depreciation and amortization expense.
As of December 31, 1998, the Company's accounts receivable totaled $9.9
million as compared to $2.2 million as of December 31, 1997. The amount at
December 31, 1998 is principally related to accounts receivable from the sale of
Star's LightSheer(TM) diode laser. The Company began shipping this product in
the first quarter of 1998. The increase in this balance from 1997 is related to
the sale of Star's LightSheer(TM) diode laser product. The Company's allowance
for doubtful accounts totaled approximately $364,000 as of December 31, 1998,
compared to $746,000 as of December 31, 1997. This reduction was principally due
to a decrease in the allowance for doubtful accounts for write-offs during 1998
of certain accounts receivable related to the sales of the Company's EpiLaser(R)
laser systems sold in 1997 totaling approximately $565,000, and an increase in
the allowance for doubtful accounts for the Company sale of its LightSheer(TM)
diode laser products during 1998.
19
As of December 31, 1998 accounts payable totaled approximately $6.6
million as compared to $4.2 million as of December 31, 1997. This increase of
$2.4 million is principally due to the additional purchases of inventory and
additional plant cost for the manufacturing of the Company's LightSheer(TM)
product during the fourth quarter of 1998 and the buildup of inventory for the
anticipated sales of Palomar E2000(TM) laser system.
The Company anticipates that capital expenditures for 1999 will total
approximately $1.0 million, consisting primarily of machinery, equipment and
computers and peripherals. The Company expects to finance these expenditures
with cash on hand, its line of credit and equipment leasing lines. However,
there can be no assurance that the Company will be able to obtain the necessary
financing.
The Company has a $10,000,000 revolving line of credit from a bank.
This revolving line of credit matures on March 31, 2000 and bears interest at
the bank's prime rate (7.75% at December 31, 1998). Borrowings are limited to
80% of domestic accounts receivable under 90 days from invoice. A director of
the Company has personally guaranteed borrowings under the line of credit. As of
March 20, 1999, approximately $725,000 was available under this line of credit.
The Company entered into a Loan Agreement with Coherent, pursuant to
which Coherent agreed to loan the Company money to help finance the Company's
working capital requirements. These loans are collateralized by Star's
inventory. As of December 31, 1998, the total amount outstanding under this loan
agreement was $4.0 million (see Note 6 to the Consolidated Financial
Statements).
In connection with the disposition of Comtel, a former wholly-owned
subsidiary in the electronics segment, the Company guaranteed $2.5 million of a
$3.3 million line of credit extended by a loan association to Biometric
Technologies Corp. ("BTC"), the buyer of Comtel. The stockholders of BTC have
personally guaranteed to the Company payment for any amounts borrowed under this
line of credit in excess of approximately $1.5 million in the event the Company
is obligated to honor this guaranty. The amount BTC has outstanding under the
line of credit at December 31, 1998 was approximately $2.1 million.
Regardless of whether the sale of Star to Coherent is consummated, the
Company's strategic plan is to continue to fund research and development for its
medical and cosmetic laser products. The Company expects to expand the scope and
extend the term of its current Clinical Trial Agreement with MGH following the
sale of Star. This research and development effort entails extensive clinical
trials. These activities are an important part of the Company's business plan.
Due to the nature of clinical trials and research and development activities, it
is not possible to predict with any certainty the timetable for completion of
these research activities or the total amount of funding required to
commercialize products developed as a result of such research and development.
The rate of research and the number of research projects underway are dependent
to some extent upon external funding. While the Company is regularly reviewing
potential funding sources in relation to these ongoing and proposed research
projects, there can be no assurance that the current levels of funding or
additional funding will be available, or, if available, on terms satisfactory to
the Company.
The Company will consider a number of alternatives with respect to its
future products, including manufacturing them itself and selling them directly
and/or through distributors or selling the product line and/or technology to
others. The Company will in each case choose the alternative which it believes
best maximizes profitability and long-term shareholder value.
The Company has historically incurred significant losses. While the
Company achieved profitable operations for the three and six months ended
December 31, 1998, primarily related to the operations of Star, there can be no
assurance that this will continue. Therefore, the Company may need to continue
to secure additional financing to complete its research and development
activities, commercialize its current and proposed medical products and
services, and fund ongoing operations.
There can be no assurance that the sale of Star to Coherent will be
completed (resulting in cash proceeds to the Company of $49 million) and that
events in the future will not require the Company to seek additional financing.
The sale must be approved by the Company's stockholders, and is also subject to
regulatory approval and other standard closing conditions. Financing of the
Company's future operating plan is now to a great extent dependant on completing
the sale. If the sale of Star is not completed the Company will require
additional financing during 1999 and there can be no assurance that any such
financing will be available on terms satisfactory to the Company. Based on its
historical ability to raise funds as
20
necessary and ongoing discussions with potential financing sources, the Company
believes that it will be successful in obtaining additional financing, if
required, in order to fund future operations.
The report of the Company's independent public accountants in
connection with the Company's Consolidated Balance Sheets at December 31, 1998
and 1997, and the related Consolidated Statements of Operations, Stockholders'
Equity (Deficit) and Cash Flows for the three years ended December 31, 1998
includes an explanatory paragraph stating that the Company's recurring losses,
working capital deficiency and stockholders' deficit raises substantial doubt
about the Company's ability to continue as a going concern.
(d) Year 2000 Issues
During 1998, the Company has been actively engaged in addressing Year 2000
(Y2K) issues, which result from the use of two-digit, rather than four-digit,
year dates in software, a practice which could cause date-sensitive systems to
malfunction or fail because they may not recognize or process date information
correctly.
State of Readiness:
To manage its Y2K program, the Company has divided its efforts into
four program areas:
o Information Technology (computer hardware and software)
o Physical Plant (manufacturing equipment and facilities)
o Products (including product development)
o Extended Enterprise (suppliers and customers)
For each of these program areas, the Company is using a four-step
approach:
o Ownership (creating awareness, assigning tasks)
o Inventory (listing items to be assessed for Y2K readiness)
o Assessment (prioritizing the inventoried items, assessing
their Y2K readiness, planning corrective actions, developing
initial contingency plans)
o Corrective Action Deployment (implementing corrective actions,
verifying implementation, finalizing and executing contingency
plans)
At December 31, 1998, the Ownership, Inventory and Assessment steps
were essentially complete for all program areas. The Company expects to complete
Corrective Action Deployment by June 1999.
Costs to Address Y2K Issues:
The Company's estimated aggregate costs for its Y2K activities from
1998 through 2000 are expected to be less than $100,000. Through December 31,
1998 the Company has spent approximately $20,000.
Risks of Y2K Issues and Contingency Plans:
The Company continues to assess the Year 2000 issues relating to its
physical plant, products and suppliers. The Company intends to develop a
contingency planning process to mitigate worst-case business disruptions such as
delays in product delivery, which could potentially result from events such as
supply chain disruptions. The Company expects its contingency plans to be
complete by June 1999.
(e) Nasdaq Stock Market Listing
The Company has been notified by the Nasdaq Stock Market ("Nasdaq") that
for continued listing on the Nasdaq SmallCap Market the Company must meet
Nasdaq's minimum bid price requirement of $1.00 per share. Because the
21
Company's stock price fell below $1.00 for a 30 day trading period between
August 28 and October 9, 1998, it is now subject to delisting. The Company met
with representatives of Nasdaq on March 18, 1999 and presented arguments
supporting continued listing. At the hearing, the Company volunteered to delist
from the Nasdaq SmallCap Market on May 18, 1999 if it is not in compliance with
the minimum bid price requirement by that date. The Company expects that it will
be in compliance by that date, as a result of the reverse split and the Star
sale. Nasdaq's decision is still pending. To regain compliance with the minimum
bid price requirement, the Company has asked its stockholders to approve a
reverse split of the Company's common stock. However, the reverse split may not
enable the Company to regain compliance with the minimum bid price requirement
in time to prevent delisting. The Company's management anticipates that the
absence of the Nasdaq listing for the Company's common stock would have an
adverse effect on the market for, and potentially the market price of, the
Company's common stock. The delisting of the common stock would likely reduce
stockholders' ability to buy and sell Company common stock, and the Company's
ability to raise capital. If the Company's common stock is delisted from Nasdaq,
the Company expects that brokers would continue to make a market in the
Company's common stock on the OTC Bulletin Board.
(f) Recently Issued Accounting Standard
In February 1997, Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No.133 Accounting for
Derivative Instruments and Hedging Activities. SFAS No. 133 establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 is effective for fiscal
years beginning after June 15, 1999. The Company believes that the adoption of
this new accounting standard will not have a material impact on the Company's
financial statements.
Item 7A Quantitative And Qualitative Disclosures About Market Risk
(i) Derivative Financial Instruments, Other Financial Instruments,
and Derivative Commodity Instruments.
As of December 31, 1998, the Company did not participate in any
derivative financial instruments or other financial and commodity instruments
for which fair value disclosure would be required under SFAS No. 107. All of the
Company's investments are considered cash equivalents money market accounts that
are carried on the Company's books at amortized cost, which approximates fair
market value. Accordingly, the Company has no quantitative information
concerning the market risk of participating in such investments.
(ii) Primary Market Risk Exposures.
The Company's primary market risk exposures are in the areas of
interest rate risk and foreign currency exchange rate risk. The Company's
investment portfolio of cash equivalents is subject to interest rate
fluctuations, but the Company believes this risk is immaterial due to the
short-term nature of these investments.
The Company's exposure to currency exchange rate fluctuations has been
and is expected to continue to be modest due to the fact it currently sells its
products in United States dollars. The Company does not engage in foreign
currency hedging activities.
Statement Under the Private Securities Litigation Reform Act
In addition to the other information in this Annual Report on Form 10-K
the following cautionary statements should be considered carefully in evaluating
the Company and its business. Statements contained in this Form 10-K that are
not historical facts (including, without limitation, statements concerning the
sale of Star, financing of future operations, and the Company's research
partnership with MGH) and other information provided by the Company and its
employees from time to time may contain certain forward-looking information, as
defined by (i) the Private Securities Litigation Reform Act of 1995 (the "Reform
Act") and (ii) releases by the SEC. The risk factors identified below, among
other factors, could cause actual results to differ materially from those
suggested in such forward-looking statements. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak only as of the
date hereof. The Company undertakes no obligation to release publicly the
results of any revisions to these forward-looking statements that may be made to
reflect
22
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events. The cautionary statements below are being made pursuant to
the provisions of the Reform Act and with the intention of obtaining the
benefits of safe harbor provisions of the Reform Act.
RISK FACTORS
IF WE DO NOT CLOSE THE SALE OF OUR STAR SUBSIDIARY, WE MAY NOT HAVE ENOUGH MONEY
TO FINANCE FUTURE OPERATIONS.
We have recently signed an agreement with Coherent in which Coherent
has agreed to buy our Star subsidiary for $65 million in cash. The sale must be
approved by stockholders holding a majority of the shares of our outstanding
common stock. The sale is also subject to other standard closing conditions. We
may not receive a sufficient number of stockholder votes to approve the
transaction, or the transaction may fail to close for other reasons. Our future
operating plan is now to a great extent dependant on completing the sale, in
that it will provide us with the money necessary to finance our future
operations, including research and product development.
WE MAY BE DELISTED FROM NASDAQ. DELISTING MAY REDUCE YOUR ABILITY TO BUY AND
SELL OUR COMMON STOCK AND OUR ABILITY TO RAISE MONEY.
We have been notified by the Nasdaq Stock Market that for continued
listing on the Nasdaq SmallCap Market we must meet Nasdaq's minimum bid price of
$1.00 per share. Because our stock price fell below $1.00 for a 30 day trading
period between August 28 and October 9, 1998, it is now subject to delisting.
Nasdaq held a hearing on our delisting on March 18, 1999. Nasdaq's decision is
pending. To regain compliance with the minimum bid price requirement, we have
asked our stockholders to approve a one-for-seven reverse split of our common
stock. At the March 18, 1999 hearing, the Company volunteered to delist from the
Nasdaq SmallCap Market on May 18, 1999 if it is not in compliance with the
minimum bid price requirement by that date. We expect that we will be in
compliance by that date as a result of the reverse split and the Star sale.
Nevertheless, the reverse split may not enable us to regain compliance with the
minimum bid price requirement in time to prevent delisting. The delisting of our
common stock would likely reduce stockholders' ability to buy and sell our
common stock and our ability to raise capital. If our common stock is delisted
from the Nasdaq SmallCap Market, it will likely be quoted on the "pink sheets"
maintained by the National Quotation Bureau, Inc. or Nasdaq's OTC Bulletin
Board. These listings can make trading more difficult for stockholders. In
addition, a reverse split itself could hurt the market price of our common
stock.
WE MAY NEED TO SECURE ADDITIONAL FINANCING, AND OUR AUDITORS HAVE EXPRESSED
DOUBT ABOUT OUR ABILITY TO CONTINUE AS A GOING CONCERN.
We have a history of losses. As a result, the report of our independent
public accountants in connection with our Consolidated Balance Sheets as of
December 31, 1998 and 1997, and the related Consolidated Statements of
Operations, Stockholders' Equity (Deficit) and Cash Flows for the three years
ended December 31, 1998 includes an explanatory paragraph stating that our
recurring losses, working capital deficiency and stockholders' deficit raises
substantial doubts about our ability to continue as a going concern. If we do
not sell our Star subsidiary, we may have to secure additional financing to
complete our research and development activities, commercialize our current and
proposed cosmetic laser products, and fund ongoing operations. We may also
determine, depending upon the opportunities available, to seek additional debt
or equity financing to fund the costs of acquisitions or expansion. If we
finance an acquisition with our stock, our issuance of such stock could result
in dilution to the interests of our stockholders. 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. One of those risks is that interest rates
may fluctuate and our cash flow may be insufficient to pay principal and
interest on any such indebtedness.
WE WILL CONTINUE TO BE DEPENDENT ON COHERENT IF WE DO NOT SELL STAR.
Under our sales agency agreement with Coherent, which will remain in
effect until November, 2001 if we do not sell Star to Coherent, Coherent
receives a marketing and sales commission, based on the end-user price, for each
of our lasers that it sells. If Coherent remains as our exclusive distributor
because we do not close the Star sale, Coherent may not be successful in
distributing our lasers or may not give sufficient priority to marketing our
products. In addition, Coherent may develop, market and manufacture its own
lasers that incorporate our proprietary technology and compete with our lasers,
in which case it must
23
pay us a royalty on such sales. Under our agreement, if we are unable or
unwilling to manufacture the cosmetic laser products to be distributed by
Coherent, then we must license to Coherent the technology necessary to make such
products.
OUR FUTURE REVENUE DEPENDS ON OUR DEVELOPING NEW PRODUCTS.
We face rapidly changing technology and continuing improvements in
cosmetic laser technology. 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 new products and enhancing
existing products. If we sell our Star subsidiary, our future revenue will be
entirely dependent on sales of newly introduced products. Although we have
recently introduced a new hair removal laser, it may not achieve market
acceptance or generate sufficient margins. In addition, the market for this type
of hair removal laser may already be saturated. At present, broad market
acceptance of laser hair removal is critical to our success. We need to
diversify our product line by developing cosmetic laser products other than hair
removal lasers.
WE FACE INTENSE COMPETITION FROM COMPANIES WITH SUPERIOR FINANCIAL, MARKETING
AND OTHER RESOURCES.
The laser hair removal industry is highly competitive, and companies
frequently introduce new products. We compete in the development, manufacture,
marketing and servicing of hair removal lasers with numerous other companies,
many of which have substantially greater financial, marketing and other
resources than we do. As a result, some of our competitors are able to sell hair
removal lasers at prices significantly below the prices at which we sell our
hair removal lasers. In addition, if and when we sell Star, our current
distributor, Coherent, one of the largest and best financed laser companies,
will become our competitor, and we will have to find new ways to distribute our
products. Our laser products also face competition from alternative medical
products and 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 medical 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.
OUR QUARTERLY OPERATING RESULTS MAY DECREASE IF WE SELL STAR, AND THAT MAY HURT
THE PRICE OF OUR COMMON STOCK.
Almost all of our revenues in our most recent two quarters were
attributable to sales of the LightSheer(TM) diode laser manufactured by Star. If
we sell Star, our revenues will decline significantly. If our operating results
fall below the expectations of investors or public market analysts, the price of
our common stock could fall dramatically.
OUR LASERS ARE SUBJECT TO NUMEROUS FDA REGULATIONS. COMPLIANCE IS EXPENSIVE AND
TIME-CONSUMING. OUR PRODUCTS MAY NOT BE ABLE TO OBTAIN THE NECESSARY FDA
CLEARANCES BEFORE WE CAN SELL THEM.
All of our products are laser medical devices. Laser medical devices
are subject to FDA regulations regulating clinical testing, manufacture,
labeling, sale, distribution and promotion of medical devices. Before a new
device can be introduced into the market, we must obtain clearance from the FDA.
Compliance with the FDA clearance process is expensive and time-consuming, and
we may not be able to obtain such clearances timely or at all.
WE ARE DEPENDENT ON THIRD PARTY RESEARCHERS.
We are substantially dependent upon third party researchers, over whom
we do not have absolute control, to satisfactorily conduct and complete research
on our behalf and to grant us favorable licensing terms for products which they
may develop. At present, our principal research partner is the Wellman Labs at
Massachusetts General Hospital. We provide research funding, laser technology
and optics know-how in return for licensing agreements with respect to specific
medical applications and patents. Our success will be highly dependent upon the
results of the research. We cannot be sure 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.
24
OUR COMMON STOCK COULD BE FURTHER DILUTED AS THE RESULT OF OUR ISSUING
CONVERTIBLE SECURITIES, WARRANTS AND OPTIONS.
In the past, we have issued convertible securities, such as debentures
and preferred stock, and warrants in order to raise money. We have also issued
options and warrants as compensation for services and incentive compensation for
our employees and directors. We have a substantial number of shares of common
stock reserved for issuance upon the conversion and exercise of these
securities. Our issuing additional convertible securities, options and warrants
could affect the rights of our stockholders, and could reduce the market price
of our common stock.
OUR PROPRIETARY TECHNOLOGY HAS ONLY LIMITED PROTECTIONS.
Our business could be materially and adversely affected if we are not
able to protect adequately our proprietary intellectual property rights. We rely
on a combination of patent, trademark and trade secret laws, license and
confidentiality agreements to protect our proprietary rights. We generally enter
into non-disclosure agreements with our employees and customers and restrict
access to, and distribution of, our proprietary information. Nevertheless, we
may be unable to deter misappropriation of our proprietary information, to
detect unauthorized use and to take appropriate steps to enforce our
intellectual property rights. Our competitors also may independently develop
technologies that are substantially equivalent or superior to our technology.
Although we believe that our services and products do not infringe on the
intellectual property rights of others, we cannot prevent someone else from
asserting a claim against us in the future for violating their intellectual
property rights. In addition, costly and time consuming lawsuits may be
necessary to enforce 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.
The laser industry is characterized by frequent litigation regarding
patent and other intellectual property rights. Because patent applications are
maintained in secrecy in the United States until such patents are issued and are
maintained in secrecy for a period of time outside the United States, we can
conduct only limited searches to determine whether our technology infringes any
patents or patent applications. Any claims for patent infringement could be
time-consuming, result in costly litigation, diversion of technical and
management personnel, cause shipment delays, require us to develop noninfringing
technology or to enter into royalty or licensing agreements. Although patent and
intellectual property disputes in the laser 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.
Certain provisions of our Second Restated Certificate of Incorporation,
our By-laws, and Delaware law could be used by our incumbent management to make
it more difficult for a third party to acquire control of us, even if the change
in control might be beneficial to our stockholders. This could discourage
potential takeover attempts and could adversely affect the market price of our
common stock. In particular, we may issue preferred stock in the future without
stockholder approval, upon terms determined by our board of directors. The
rights of our common stockholders may be adversely affected by the rights of
holders of any preferred stock issued in the future. Our issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporate purposes, could have the effect of making it
more difficult for a third party to acquire, or of discouraging a third party
from acquiring, a majority of our outstanding stock.
25
AS WITH ANY NEW PRODUCTS, THERE IS SUBSTANTIAL RISK THAT THE MARKETPLACE MAY NOT
ACCEPT OR BE RECEPTIVE TO THE POTENTIAL BENEFITS OF OUR PRODUCTS.
Market acceptance of our current and proposed products will depend, in
large part, upon our or any marketing partners to demonstrate to the marketplace
the advantages of our products over other types of products. There can be no
assurance that the marketplace will accept applications or uses for our current
and proposed products or that any of our current or proposed products will be
able to compete effectively.
WE FACE RISKS ASSOCIATED WITH PENDING LITIGATION.
We are involved in disputes with third parties. Such disputes have
resulted in litigation with such parties. 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. An
adverse result in the MEHL patent litigation, the action relating to the Swiss
Franc Debentures, or the Varljen litigation (all described in detail in Item 3)
could have a material adverse effect on our business, financial condition and
results of operations. We are unable to determine the total expense or possible
loss, if any, that may ultimately be incurred in the resolution of these
proceedings. These matters may result in diversion of management time and effort
from the operations of the business.
WE MAY NOT BE ABLE TO RETAIN OUR KEY EXECUTIVES AND RESEARCH AND DEVELOPMENT
PERSONNEL.
As a small company with less than 100 employees (assuming the sale of
Star) 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 us.
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 with numerous safety
features, but it is possible that patients could be adversely affected by use of
one of our products. Further, in the event that any of our products prove to be
defective, 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 in the amount of $1,000,000 per
occurrence and $2,000,000 in the aggregate and maintain umbrella coverage in the
aggregate amount of $25,000,000; 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 medical personnel with respect to the proper use of our
products, misuse of our products by medical personnel over whom we cannot exert
control may result in the filing of product liability claims or significant
adverse publicity against us.
COMPUTER SYSTEMS ON WHICH WE RELY MAY NOT PROPERLY RECOGNIZE DATE SENSITIVE
INFORMATION WHEN THE YEAR CHANGES TO 2000.
Systems that do not properly recognize such information could generate
erroneous data or cause a system to fail. We are at this time utilizing internal
resources to identify, correct or reprogram, and test our systems for year 2000
compliance. However, there can be no assurance that the systems of other
companies on which our systems rely will also be converted in a timely manner or
that any such failure to convert by another company would not have an adverse
effect on our systems. Management is in the process of assessing the year 2000
compliance costs; however, based on information to date (excluding the possible
impact of vendor systems), management does not believe that it will have a
material effect on our earnings.
26
Item 8. Financial Statements
PALOMAR MEDICAL TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Reports of Independent Public Accountants 28
Consolidated Balance Sheets as of December 31, 1997 and 1998 30
Consolidated Statements of Operations for the years ended December 31, 1996,
1997 and 1998 31
Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1996,
1997 and 1998 32
Consolidated Statements of Cash Flows for the years ended December 31, 1996,
1997 and 1998 35
Notes to Consolidated Financial Statements 37
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Palomar Medical Technologies, Inc:
We have audited the accompanying consolidated balance sheets of Palomar
Medical Technologies, Inc. (a Delaware corporation) and subsidiaries as of
December 31, 1997 and 1998, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1998. 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. The summarized
financial data for Nexar Technologies, Inc. as of and for the year ended
December 31, 1997 contained in Note 2 are based on the financial statements of
Nexar Technologies, Inc. which were audited by other auditors. Their report has
been furnished to us and our opinion, insofar as it relates to the data in Note
2, is based solely on the report of the other auditors.
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, based on our audits and the report of other auditors, the
financial statements referred to above present fairly, in all material respects,
the financial position of Palomar Medical Technologies, Inc. and subsidiaries as
of December 31, 1997 and 1998, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1998 in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has suffered recurring losses from operations and has a working
capital deficiency and a stockholders' deficit that raises substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 1. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 11, 1999 (except for the
matter discussed in Note 12(c)
as to which the date is March 17, 1999).
28
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Nexar Technologies, Inc.
Southborough, Massachusetts
We have audited the accompanying consolidated balance sheet of Nexar
Technologies, Inc. and subsidiary as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for the year then ended. These financial statements (which are not shown
separately herein) are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated financial statements of Nexar Technologies, Inc. and
subsidiary as of December 31, 1996 and for the periods ended December 31, 1995
and 1996 (not shown separately herein), were audited by other auditors whose
report dated January 24, 1997 (except with respect to the purchased technology
matter discussed in Note 2 as to which the date is February 28, 1997), expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1997 financial statements referred to above present fairly,
in all material respects, the financial position of Nexar Technologies, Inc. and
subsidiary as of December 31, 1997 and the results of their operations and their
cash flows for the year then ended in conformity with generally accepted
accounting principles.
/s/ BDO Seidman, LLP
----------------------------
BDO Seidman, LLP
February 13, 1998 (except for
Note 10 which is as of
March 20, 1998)
29
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, December 31,
1997 1998
---------------- ----------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $3,003,300 $1,874,718
Marketable securities 1,449,326 -
Accounts receivable, net of allowance for doubtful accounts of
approximately $746,000 and $364,000 in 1997 and 1998, respectively 2,248,680 9,938,121
Inventories 4,711,474 5,416,342
Other current assets 2,153,941 1,056,388
---------------- ----------------
Total current assets 13,566,721 18,285,569
---------------- ----------------
NET ASSETS OF DISCONTINUED OPERATIONS (NOTE 2) 5,825,602 -
---------------- ----------------
PROPERTY AND EQUIPMENT, NET 6,455,586 3,314,087
---------------- ----------------
OTHER ASSETS:
Cost in excess of net assets acquired, net of accumulated amortization of
approximately $1,280,000 and $1,882,000 in 1997 and 1998, respectively 2,302,348 1,699,983
Deferred financing costs 591,609 58,923
Other non-current assets 225,706 167,352
---------------- ----------------
Total other assets 3,119,663 1,926,258
---------------- ----------------
$28,967,572 $23,525,914
================ ================
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES:
Current portion of long-term debt $1,640,465 $6,290,041
Accounts payable 4,150,982 6,553,745
Accrued liabilities 13,759,854 10,301,624
Current portion of deferred revenue 1,284,395 1,143,796
---------------- ----------------
Total current liabilities 20,835,696 24,289,206
---------------- ----------------
NET LIABILITIES OF DISCONTINUED OPERATIONS - 1,680,171
---------------- ----------------
LONG-TERM DEBT, NET OF CURRENT PORTION 12,445,563 3,150,000
---------------- ----------------
DEFERRED REVENUE, NET OF CURRENT PORTION 1,870,000 870,000
---------------- ----------------
COMMITMENTS AND CONTINGENCIES (NOTE 12)
STOCKHOLDERS' DEFICIT:
Preferred stock, $.01 par value-
Authorized - 5,000,000 shares
Issued and outstanding -
16,397 shares and 6,993 shares
at December 31, 1997 and 1998, respectively
(Liquidation preference of $8,228,082 as of December 31, 1998) 164 69
Common stock, $.01 par value-
Authorized - 120,000,000 shares
Issued - 45,792,585 shares and 70,524,027 shares
at December 31, 1997 and 1998, respectively 457,926 705,240
Additional paid-in capital 147,356,579 160,733,433
Accumulated deficit (152,359,497) (166,263,346)
Less: Treasury stock - (345,000 shares at cost) (1,638,859) (1,638,859)
---------------- ----------------
Total stockholders' deficit (6,183,687) (6,463,463)
---------------- ----------------
$28,967,572 $23,525,914
================ ================
The accompanying notes are an integral part of these consolidated
financial statements.
30
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31,
1996 1997 1998
------------------ ----------------- ----------------
REVENUES $17,606,871 $20,994,546 $44,514,057
COST OF REVENUES 14,169,471 20,055,963 23,050,834
------------------ ----------------- ----------------
Gross profit 3,437,400 938,583 21,463,223
------------------ ----------------- ----------------
OPERATING EXPENSES:
Research and development 6,297,477 11,990,332 7,029,348
Sales and marketing 5,076,941 6,959,750 15,132,595
General and administrative 9,752,922 15,332,241 8,866,530
Business development
and other financing costs 2,879,603 2,060,852 -
Restructuring and asset write-off (Note 4) 1,660,808 3,325,000 (131,310)
Settlement and litigation costs 880,000 3,199,000 -
------------------ ----------------- ----------------
Total operating expenses 26,547,751 42,867,175 30,897,163
------------------ ----------------- ----------------
Loss from operations (23,110,351) (41,928,592) (9,433,940)
INTEREST EXPENSE (271,619) (6,993,898) (1,290,905)
INTEREST INCOME 1,355,488 456,945 33,080
NET GAIN (LOSS) ON TRADING SECURITIES 2,033,371 (52,272) 703,211
ASSET WRITE-OFF (NOTE 4) (1,397,000) (9,658,000) -
OTHER INCOME (EXPENSE) 591,853 (193,262) 21,311
------------------ ----------------- ----------------
NET LOSS FROM CONTINUING OPERATIONS (20,798,258) (58,369,079) (9,967,243)
------------------ ----------------- ----------------
LOSS FROM DISCONTINUED OPERATIONS (NOTE 2):
Loss from operations (20,895,534) (29,508,755) (1,090,885)
Gain (Loss) on dispositions, net 3,830,000 2,073,943 (1,533,295)
------------------ ----------------- ----------------
NET LOSS FROM DISCONTINUED OPERATIONS (17,065,534) (27,434,812) (2,624,180)
------------------ ----------------- ----------------
NET LOSS $ (37,863,792) $ (85,803,891) $(12,591,423)
================== ================= ================
BASIC AND DILUTED NET LOSS PER COMMON SHARE:
Continuing operations $(0.84) $(1.79) $(0.18)
Discontinued operations (0.65) (0.78) (0.04)
------------------ ----------------- ----------------
TOTAL LOSS PER COMMON SHARE $(1.49) $(2.57) $(0.22)
================== ================= ================
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING 26,166,538 35,105,272 62,868,696
================== ================= ================
The accompanying notes are an integral part of these
consolidated financial statements.
31
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock Common Stock Treasury Stock
----------------------------------------------------------------
Number $0.01 Number $0.01 Number
of Shares Par Value of Shares Par Value of Shares Cost
----------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 13,860 $139 20,135,406 $201,353 (200,000) $(1,211,757)
Sale of common stock pursuant to warrants and
options -- -- 2,967,996 29,681 -- --
Sale of common stock -- -- 1,176,205 11,762 -- --
Payments received on subscriptions receivable -- -- -- -- -- --
Issuance of preferred stock, including common stock issued
as a placement fee, net of issuance costs 32,000 320 115,000 1,150 -- --
Issuance of common stock for 1995 employer 401(k)
matching contribution -- -- 45,885 459 -- --
Conversion of preferred stock, including accrued
dividends and interest of $782,602 (25,209) (252) 4,481,518 44,815 -- --
Conversion of convertible debentures -- -- 34,615 346 -- --
Redemption of convertible debentures -- -- -- -- -- --
Value ascribed to convertible debentures -- -- -- -- -- --
Redemption of preferred stock (2,500) (25) -- -- -- --
Exercise of underwriter's warrants -- -- 500,000 5,000 -- --
Exercise of stock options in majority controlled
subsidiary -- -- -- -- -- --
Issuance of common stock for conversion of debentures at
Tissue Technologies, Inc. -- -- 813,431 8,134 -- --
Issuance of common stock for minority interest in
Star Medical subsidiary -- -- 224,054 2,241 -- --
Issuance of common stock in exchange for license
rights -- -- 56,900 569 -- --
Issuance of common stock for acquisition of
Dermascan, Inc. -- -- 35,000 350 -- --
Issuance of common stock for investment banking and merger
and acquisition consulting services -- -- 56,802 568 -- --
Compensation expense related to warrants issued to
non-employees under SFAS No. 123 -- -- -- -- -- --
Return of escrowed shares -- -- (46,000) (460) -- --
Amortization of deferred financing costs -- -- -- -- -- --
Unrealized loss on marketable securities -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss -- -- -- -- -- --
-----------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 18,151 $182 30,596,812 $305,968 (200,000) $(1,211,757)
=================================================================
Additional Unrealized
Paid-in Accumulated (Loss) Gain on Subscriptions
Capital Deficit Marketable Receivable
Securities
------------------------------------------------------------
BALANCE, DECEMBER 31, 1995 $54,152,385 $(25,864,657) $-- $(1,988,709)
Sale of common stock pursuant to warrants and
options 7,569,226 -- -- --
Sale of common stock 6,049,618 -- -- --
Payments received on subscriptions receivable -- -- -- 2,441,556
Issuance of preferred stock, including common stock issued
as a placement fee, net of issuance costs 30,821,677 -- -- --
Issuance of common stock for 1995 employer 401(k)
matching contribution 160,139 -- -- --
Conversion of preferred stock, including accrued
dividends and interest of $782,602 744,124 -- -- --
Conversion of convertible debentures 145,260 -- -- --
Redemption of convertible debentures (41,530) -- -- --
Value ascribed to convertible debentures 2,757,860 -- -- --
Redemption of preferred stock (3,123,127) -- -- --
Exercise of underwriter's warrants 1,057,500 -- -- (1,057,500)
Exercise of stock options in majority controlled
subsidiary 50,000 -- -- --
Issuance of common stock for conversion of debentures at
Tissue Technologies, Inc. 1,019,022 -- -- --
Issuance of common stock for minority interest in
Star Medical subsidiary 1,747,482 -- -- --
Issuance of common stock in exchange for license
rights 369,574 -- -- --
Issuance of common stock for acquisition of
Dermascan, Inc. 489,650 -- -- --
Issuance of common stock for investment banking and merger
and acquisition consulting services 476,156 -- -- --
Compensation expense related to warrants issued to
non-employees under SFAS No. 123 532,758 -- -- --
Return of escrowed shares 460 -- -- --
Amortization of deferred financing costs (77,683) -- -- --
Unrealized loss on marketable securities -- -- (342,500) --
Preferred stock dividends -- (1,242,751) -- --
Net loss -- (37,863,792) -- --
------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 $104,900,551 $(64,971,200) $(342,500) $(604,653)
============================================================
Total
Stockholders
Equity (Deficit)
-------------------
BALANCE, DECEMBER 31, 1995 25,288,754
Sale of common stock pursuant to warrants and
options 7,598,907
Sale of common stock 6,061,380
Payments received on subscriptions receivable 2,441,556
Issuance of preferred stock, including common stock issued
as a placement fee, net of issuance costs 30,823,147
Issuance of common stock for 1995 employer 401(k)
matching contribution 160,598
Conversion of preferred stock, including accrued
dividends and interest of $782,602 788,687
Conversion of convertible debentures 145,606
Redemption of convertible debentures (41,530)
Value ascribed to convertible debentures 2,757,860
Redemption of preferred stock (3,123,152)
Exercise of underwriter's warrants 5,000
Exercise of stock options in majority controlled
subsidiary 50,000
Issuance of common stock for conversion of debentures at
Tissue Technologies, Inc. 1,027,156
Issuance of common stock for minority interest in
Star Medical subsidiary 1,749,723
Issuance of common stock in exchange for license
rights 370,143
Issuance of common stock for acquisition of
Dermascan, Inc. 490,000
Issuance of common stock for investment banking and merger
and acquisition consulting services 476,724
Compensation expense related to warrants issued to
non-employees under SFAS No. 123 532,758
Return of escrowed shares --
Amortization of deferred financing costs (77,683)
Unrealized loss on marketable securities (342,500)
Preferred stock dividends (1,242,751)
Net loss (37,863,792)
------------
BALANCE, DECEMBER 31, 1996 $ 38,076,591
=== ==== ============
The accompanying notes are an integral part of these
consolidated financial statements.
32
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
Preferred Stock Common Stock Treasury Stock
-----------------------------------------------------------------------
Number $0.01 Number $0.01 Number
of Shares Par Value of Shares Par Value of Shares Cost
-----------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 18,151 $182 30,596,812 $305,968 (200,000) $(1,211,757)
Sale of common stock pursuant to warrants,
options and Employee Stock Purchase Plan -- -- 815,101 8,151 -- --
Reduction in subscriptions receivable -- -- -- -- -- --
Sale of preferred stock, net of issuance costs of
approximately $1,000,000 16,000 160 -- -- -- --
Issuance of common stock for 1996 employer 401(k)
matching contribution -- -- 87,441 874 -- --
Conversion and redemption of preferred stock (17,754) (178) 6,139,841 61,399 -- --
Conversion of convertible debentures and issuance
of common stock to an investor -- -- 7,464,961 74,650 -- --
Issuance of common stock for investment banking, merger
and acquisition and consulting services -- -- 20,000 200 -- --
Value ascribed to the discount feature of
convertible debentures issued -- -- 413,109 4,131 -- --
Unrealized gain on marketable securities -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Guaranteed value of common stock associated with
Dermascan acquisition -- -- -- -- -- --
Issuance of common stock for technology -- -- 255,320 2,553 -- --
Purchase of stock for treasury -- -- -- -- (145,000) (427,102)
Gain related to the issuance of common stock by
Nexar Technologies, Inc. -- -- -- -- -- --
Value ascribed to warrant to purchase common
stock issued to Coherent, Inc. -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 16,397 $164 45,792,585 $457,926 (345,000) $(1,638,859)
======================================================================
Additional Unrealized (Loss)
Paid-in Accumulated Gain on Marketable Subscriptions
Capital Deficit Securities Receivable
----------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 $104,900,551 $(64,971,200) $(342,500) $(604,653)
Sale of common stock pursuant to warrants,
options and Employee Stock Purchase Plan 1,606,083 -- -- --
Reduction in subscriptions receivable -- -- -- 604,653
Sale of preferred stock, net of issuance costs of
approximately $1,000,000 14,999,840 -- -- --
Issuance of common stock for 1996 employer 401(k)
matching contribution 317,280 -- -- --
Conversion and redemption of preferred stock (3,926,317) -- -- --
Conversion of convertible debentures and issuance
of common stock to an investor 16,935,713 -- -- --
Issuance of common stock for investment banking, merger
and acquisition and consulting services 52,925 -- -- --
Value ascribed to the discount feature of
convertible debentures issued 3,750,812 -- -- --
Unrealized gain on marketable securities -- -- 342,500 --
Preferred stock dividends -- (1,584,406) -- --
Guaranteed value of common stock associated with
Dermascan acquisition (216,562) -- -- --
Issuance of common stock for technology 1,146,388 -- -- --
Purchase of stock for treasury -- -- -- --
Gain related to the issuance of common stock by
Nexar Technologies, Inc. 7,409,866 -- -- --
Value ascribed to warrant to purchase common
stock issued to Coherent, Inc. 380,000 -- -- --
Net loss -- (85,803,891) -- --
----------------------------------------------------------
BALANCE, DECEMBER 31, 1997 $147,356,579 $(152,359,497) $ -- $ --
==========================================================
Total
Stockholder
Equity (Deficit)
----------------
BALANCE, DECEMBER 31, 1996 $38,076,591
Sale of common stock pursuant to warrants,
options and Employee Stock Purchase Plan 1,614,234
Reduction in subscriptions receivable 604,653
Sale of preferred stock, net of issuance costs of
approximately $1,000,000 15,000,000
Issuance of common stock for 1996 employer 401(k)
matching contribution 318,154
Conversion and redemption of preferred stock (3,865,096)
Conversion of convertible debentures and issuance
of common stock to an investor 17,010,363
Issuance of common stock for investment banking, merger
and acquisition and consulting services 53,125
Value ascribed to the discount feature of
convertible debentures issued 3,754,943
Unrealized gain on marketable securities 342,500
Preferred stock dividends (1,584,406)
Guaranteed value of common stock associated with
Dermascan acquisition (216,562)
Issuance of common stock for technology 1,148,941
Purchase of stock for treasury (427,102)
Gain related to the issuance of common stock by
Nexar Technologies, Inc. 7,409,866
Value ascribed to warrant to purchase common
stock issued to Coherent, Inc. 380,000
Net loss (85,803,891)
------------
BALANCE, DECEMBER 31, 1997 $(6,183,687)
=== ==== ============
The accompanying notes are an integral part of these
consolidated financial statements.
33
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(CONTINUED)
Preferred Stock Common Stock
-----------------------------------------------
Number $0.01 Number
of Shares Par Value of Shares
----------------------------------------------
BALANCE, DECEMBER 31, 1997 16,397 $ 164 45,792,585
Sale of common stock pursuant to warrants, options and Employee
Stock Purchase Plan -- -- 192,211
Issuance of common stock for 1997 employer 401(k) matching contribution -- -- 311,887
Conversion of preferred stock (5,888) (59) 6,891,682
Conversion of convertible debentures -- -- 7,035,662
Issuance of common stock net of investment banking fees -- -- 10,200,000
Redemption of preferred stock (3,516) (36) --
Value ascribed to warrants issued to investment banker -- -- --
Common stock issued for advisory services -- -- 100,000
Costs incurred related to the issuance of common stock -- -- --
Preferred stock dividends and penalties -- -- --
Net loss -- -- --
------------- ------------- -----------
BALANCE, DECEMBER 31, 1998 6,993 $ 69 70,524,027
============= ============= ===========
Common Stock Treasury Stock
----------------------------------------------------
$0.01 Number
Par Value of Shares Cost
----------------------------------------------------
BALANCE, DECEMBER 31, 1997 $ 457,926 (345,000) ($ 1,638,859)
Sale of common stock pursuant to warrants, options and Employee
Stock Purchase Plan 1,923 -- --
Issuance of common stock for 1997 employer 401(k) matching contribution 3,118 --
Conversion of preferred stock 68,917 --
Conversion of convertible debentures 70,356 -- --
Issuance of common stock net of investment banking fees 102,000 -- --
Redemption of preferred stock -- -- --
Value ascribed to warrants issued to investment banker -- -- --
Common stock issued for advisory services 1,000 -- --
Costs incurred related to the issuance of common stock -- -- --
Preferred stock dividends and penalties -- -- --
Net loss -- -- --
------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 $ 705,240 (345,000) ($ 1,638,859)
============= ============= =============
Additional Total
Paid-in Accumulated Stockholders'
Capital Deficit Equity (Deficit)
---------------------------------------------------
BALANCE, DECEMBER 31, 1997 $ 147,356,579 ($152,359,497) ($ 6,183,687)
Sale of common stock pursuant to warrants, options and Employee
Stock Purchase Plan 64,208 -- 66,131
Issuance of common stock for 1997 employer 401(k) matching contribution 251,163 -- 254,281
Conversion of preferred stock 583,310 -- 652,168
Conversion of convertible debentures 6,368,820 -- 6,439,176
Issuance of common stock net of investment banking fees 9,738,000 -- 9,840,000
Redemption of preferred stock (3,615,522) -- (3,615,558)
Value ascribed to warrants issued to investment banker 171,000 -- 171,000
Common stock issued for advisory services 99,000 -- 100,000
Costs incurred related to the issuance of common stock (283,125) -- (283,125)
Preferred stock dividends and penalties -- (1,312,426) (1,312,426)
Net loss -- (12,591,423) (12,591,423)
------------- ------------- -------------
BALANCE, DECEMBER 31, 1998 $ 160,733,433 ($166,263,346) ($ 6,463,463)
============= ============= =============
34
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
1996 1997 1998
--------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss $(37,863,792) $(85,803,891) $(12,591,423)
Less: Net Loss from Discontinued Operations (17,065,534) (27,434,812) (2,624,180)
------------ ------------ ------------
Net Loss from Continuing Operations (20,798,258) (58,369,079) (9,967,243)
------------ ------------ ------------
Adjustments to reconcile net loss from continuing operations to net cash
used in operating activities-
Depreciation and amortization 2,343,013 2,246,412 2,676,651
Restructuring and asset write-off costs 3,057,808 12,983,000 (131,310)
Write-off of in-process research and development 57,212 -- --
Write-off of intangible assets 631,702 -- --
Loss on sale of wholly-owned subsidiary -- 165,845 --
Write-off of deferred financing costs associated with -- -- --
redemption of convertible debentures 201,500 27,554 --
Valuation allowances for notes and investments -- 1,035,912 --
Accrued interest receivable on note -- -- --
and subscription receivable (568,917) -- --
Foreign currency exchange gain (446,596) (651,970) --
Non-cash interest expense related to debt 163,680 5,473,077 63,652
Non-cash compensation related to common stock and warrants 836,982 205,238 171,000
Realized gain on marketable securities (835,197) (577,969) --
Unrealized (gain) loss on marketable securities (1,198,174) 669,293 (703,211)
Changes in assets and liabilities,
Purchases of marketable securities (10,355,055) (152,938) --
Net sale of marketable securities 10,244,044 2,234,436 2,152,537
Accounts receivable (82,025) (1,809,371) (7,689,441)
Inventories (4,661,443) (3,390,396) (704,868)
Other current assets (1,514,858) (1,005,781) 1,097,553
Accounts payable 1,243,161 1,378,637 2,402,763
Accrued liabilities 4,727,008 3,546,543 639,934
Deferred revenue 35,773 2,948,247 (1,140,599)
------------ ------------ ------------
Net cash used in operating activities (16,918,640) (33,043,310) (11,132,582)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property and equipment (3,180,112) (5,777,446) (403,189)
Increase in other assets (1,176,527) (95,830) (19,628)
Loans to related parties (7,338,625) (1,250,000) --
Loans to unrelated parties (2,236,531) -- --
Payments received on loans to related parties 9,322,284 941,288 --
Guaranteed value associated with Dermascan acquisition -- (216,562) --
Net proceeds from notes receivable -- -- --
Investment in nonmarketable securities (2,077,054) (1,057,631) --
------------ ------------ ------------
Net cash used in investing activities (6,686,565) (7,456,181) (422,817)
------------ ------------ ------------
The accompanying notes are an integral part of these
consolidated financial statements
35
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years Ended December 31,
1996 1997 1998
----------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of convertible debentures 14,169,441 16,715,169 --
Proceeds from notes payable -- 3,500,000 --
Deferred financing costs incurred related to convertible debentures (1,365,217) -- --
Redemption of convertible debentures (930,000) (196,000) (2,196,667)
Proceeds from (payments of) notes payable and capital lease obligations (260,224) (4,856,479) 3,010,817
Proceeds from issuance of common stock 13,715,287 1,462,121 9,840,000
Proceeds from exercise of warrants, stock options
and Employee Stock Purchase Plan -- -- 66,131
Issuance of preferred stock 30,823,147 15,000,000 --
Purchase of treasury stock -- (427,102) --
Payment of contingent note payable (500,000) -- --
Cost incurred in connection with the issuance of common stock -- -- (283,125)
Redemption of preferred stock, including accrued dividends of $71,223
and $771,876 in 1996 and 1998, respectively (3,194,375) -- (4,387,434)
Proceeds from line of credit -- -- 1,000,000
Payments received on subscription receivable 2,009,592 -- --
Deferred costs (932,661) -- --
============ ============= ============
Net cash provided by financing activities 53,534,990 31,197,709 7,049,722
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 29,929,785 (9,301,782) (4,505,677)
NET CASH (USED IN) PROVIDED BY DISCONTINUED OPERATIONS (30,073,633) 12,676 3,377,095
CASH AND CASH EQUIVALENTS, BEGINNING OF THE PERIOD 12,436,254 12,292,406 3,003,300
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF THE PERIOD $ 12,292,406 $ 3,003,300 $ 1,874,718
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for interest $ 280,659 $ 534,037 $ 1,094,759
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING AND INVESTING ACTIVITIES:
Conversion of convertible debentures and related accrued
interest, net of financing fees $ 1,172,762 $ 17,010,363 $ 6,439,176
============ ============ ============
Subscription received in connection with warrant
exercises $ 1,057,500 $ -- $ --
============ ============ ============
Conversion of preferred stock $ 788,687 $ 414,904 $ 652,168
============ ============ ============
Issuance of common stock for purchase of technology
related to discontinued operations $ -- $ 1,148,941 $ --
============ ============ ============
Exchange of preferred stock for investment in a
discontinued operation $ -- $ (4,280,000) $ --
============ ============ ============
Investment banking and consulting fees for services related
to the issuance of common stock and convertible debentures $ 709,224 $ 53,125 $ --
============ ============ ============
Issuance of common stock for employer 401(k)
matching contribution $ 160,598 $ 318,154 $ 254,281
============ ============ ============
Issuance of common stock for minority interest
in Star Medical Technologies subsidiary $ 1,749,723 $ -- $ --
============ ============ ============
Issuance of common stock for advisory services performed
in 1997 $ -- $ -- $ 100,000
============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements
36
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND OPERATIONS
Palomar Medical Technologies, Inc. and subsidiaries ("Palomar" or the
"Company") are engaged in the commercial sale and development of cosmetic and
medical laser systems and services. During the year ended December 31, 1997, the
Company formed and began execution of a plan to dispose of its electronics
segment (see Note 2). The Company substantially completed the divestiture
program in May of 1998.
Some of the Company's medical laser products are in various stages of
development; and, accordingly, the success of future operations is subject to a
number of risks similar to those of other companies with products in similar
stages of development. Principal among these risks are the successful
development and marketing of the Company's products, obtaining regulatory
approval, the need to achieve profitable operations, competition from substitute
products and larger companies, the need to obtain adequate financing to fund
future operations and dependence on key individuals.
The Company has incurred significant losses since inception. The
Company continues to seek additional financing from issuances of common stock
and/or other potential sources including the pending sale of its Star Medical
Technologies, Inc. ("Star") to Coherent, Inc. ("Coherent), as discussed below,
in order to fund its operations over the next twelve months. The Company has
financed current operations, expansion of its core business and outside
short-term financial investments primarily through the private sale of debt and
equity securities of the Company. Net cash provided by financing activities
totaled approximately $53,535,000, $31,198,000 and $7,050,000 for the years
ended December 31, 1996, 1997 and 1998, respectively. If the Company does not
complete the sale of Star to Coherent the Company believes that it will require
additional financing during the next twelve-month period to continue to fund
operations and growth. This additional financing could be in the form of sales
of securities to private investors which are generally sold at a discount to the
publicly quoted market price for similar securities. It has been the Company's
experience that private investors require that the Company make its best effort
to register these securities for resale to the public at some future time.
On December 7, 1998, the Company entered into a Agreement and Plan of
Reorganization (the "Agreement") with Coherent to sell all of the issued and
outstanding common stock of Star, its 99.96% majority-owned subsidiary, to
Coherent. The Company currently owns substantially all of the issued and
outstanding common shares of Star. However, options outstanding granted to
Palomar and employees of Star to purchase shares of Star's common stock remain
outstanding. When all of the outstanding options under Star's Stock Option Plan
have been exercised, the Company will own 82.46% of Star's common stock and the
employees will collectively own 17.54%. See Note 7. Under the terms of the
Agreement, the selling price of Star is $65 million. In addition, the Company
will receive an ongoing royalty of 7.5% from Coherent on the sale of any
products by Coherent that use certain patents currently licensed by the Company
on an exclusive basis from Massachusetts General Hospital. See Note 12(b). This
sale is subject to the approval of the stockholders of Palomar.
The Agreement may only be terminated by (i) mutual consent of the
Company, Star and Coherent, or (ii) Coherent, if Palomar's Board of the Company
approves a superior proposal to sell Star to a different party, or (iii) either
party after May 1, 1999. The Company anticipates that this sale will close by
May 1, 1999, so long as the Company obtains stockholder approval.
(2) DISCONTINUED OPERATIONS
During the fourth quarter of 1997, the Company's Board of Directors
approved a plan to dispose of the electronics business segment. The electronics
segment consist of the manufacture and sale of personal computers, high-density
flexible electronics circuitry and memory modules. The Company substantially
completed this plan in May of 1998.
37
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Nexar Technologies, Inc. ("Nexar") was included in the electronics
business segment. Nexar is an early-stage company that manufactures, markets and
sells personal computers. On April 14, 1997, Nexar completed an initial public
offering of 2,500,000 shares at $9.00 per share, for net proceeds of
approximately $19,593,000. The Company recorded an increase in stockholders'
equity of $7,409,866, in accordance with Staff Accounting Bulletin ("SAB") No.
51 as a result of Nexar's initial public offering. The Company's accounting
policy for gains arising under SAB No. 51 is to recognize these gains in its
statement of operations to the extent that such gains are realizable at the date
of each transaction.
During the fourth quarter of 1997, the Company reduced its ownership in
Nexar through the sale of common stock to private investors. At December 31,
1997, the Company beneficially owned 3,746,343 shares of Nexar's common stock,
representing approximately a 36% ownership. As of December 31, 1998 the Company
beneficially owned 2,406,080 shares of Nexar's common stock, representing
approximately a 19% ownership interest and had no other significant obligations
related to Nexar, other than the guaranty to GFL Advantage Fund Limited ("GFL")
discussed below. The Company has been actively trying to sell its remaining
shares of Nexar common stock; however, the Company may not be successful since
Nexar filed in the United States Bankruptcy Court a petition for reorganization
under Chapter 11 of Title 11 of the United States Code on December 17, 1998.
Furthermore, Nexar has been delisted from The Nasdaq Stock Market due to Nexar's
failure to satisfy Nasdaq minimum listing requirements.
The Company has accounted for its investment in Nexar as a discontinued
operation using the equity method. During 1998, the Company recorded a charge to
discontinued operations of $1,524,966 as a result of management's decision to
write-down the carrying value of its investment in Nexar. During the years ended
December 31, 1996 and 1997, the Company recognized gains on the disposition of
shares of Nexar common stock of $3,830,000 and $6,221,689, respectively. These
amounts are included in "Gain (Loss) on Dispositions, net" in the Consolidated
Statements of Operations.
The following is the summarized financial information for Nexar:
December 31,
1996 1997
------------------------- ------------------------
Current Assets $16,966,851 $17,810,564
Non-Current Assets 2,622,270 2,098,495
Current Liabilities 6,542,296 7,886,594
Non-Current Liabilities 22,817,998 883,613
Year Ended December 31,
1996 1997
------------------------- ------------------------
Net Revenues $18,695,364 $33,608,063
Gross Profit 2,302,881 740,151
Net Loss (7,510,139) (13,346,380)
On December 31, 1997 the Company entered into an Exchange Agreement and
sold 500,000 shares of Nexar's common stock to GFL for $2,000,000. Under the
terms of the Exchange Agreement, Palomar guaranteed GFL a minimum selling price
of $5.00 per share with respect to 400,000 shares of Nexar's common stock over a
two-year time period. The Company is obligated to pay GFL on January 1, 2000 the
difference between $5.00 and the price at which GFL sells the shares of Nexar's
common stock. As of December 31, 1998, the deferred liability related to this
transaction totaled $1,680,171 and represents the total amount due to GFL after
GFL sold their 400,000 common shares of Nexar stock.
38
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The other entities that were included in the electronics business
segment are Dynaco Corp. ("Dynaco") and Dynaco's wholly owned subsidiaries
Comtel Electronics, Inc. ("Comtel") and Dynamem, Inc. ("Dynamem"). On December
9, 1997, the Company entered into a two-phase stock purchase agreement with
Biometric Technologies Corporation ("BTC"). BTC was formed jointly by Dynaco's
President and its Chairman of the Board. The first phase was consummated on
December 9, 1997 and consisted of the sale of all of the issued and outstanding
common stock of Comtel and Dynamem in exchange for $3,654,000 payable in two
installments. The first installment was a $850,000 unsecured promissory note
that was due on February 15, 1998. The second installment was a $2.8 million
unsecured promissory note due in forty-eight monthly installments, beginning
February 1, 1999. This promissory note was fully reserved by the Company during
1997, as its ultimate collectibility was believed to be uncertain. BTC did not
make the first installment on February 1, 1998 and on October 7, 1998 the
Company and BTC agreed to reduce the principal balances of the $850,000 note and
the $2.8 million note to a total of $1,000,000. BTC paid $500,000 during 1998
and the balance is due April 5, 1999. The amended note is guaranteed by the
principal shareholders of BTC.
As part of phase I, the Company entered into a Loan and Subscription
Agreement with a creditor of Comtel for $3,233,000. This promissory note
represents the settlement of amounts owed the creditor by Comtel and guaranteed
by Palomar. Principal and interest payments are being made over twenty-four
months, beginning December 31, 1997 and interest will accrue at the bank's prime
rate (7.75% at December 31, 1998) plus 2.25%. This promissory note has been
collateralized by 3,250,000 shares of the Company's common stock that are held
in escrow, are not entitled to vote and are not considered outstanding. The
Company also guaranteed up to $2,500,000 of Comtel's borrowings from this
creditor until November 30, 1999. The stockholders of BTC have personally
guaranteed to the Company payment for any amounts borrowed under this line of
credit in excess of approximately $1,500,000 in the event that the Company is
obligated to honor this guarantee.
In connection with the disposition of Comtel, the Company also
restructured all assets and investments related to a significant customer of
Comtel into a $4,000,000 note receivable. This receivable was fully reserved by
the Company during 1997, as its ultimate collectibility is uncertain. To date,
no amounts have been received under this restructured note receivable from the
customer, nor does the Company anticipate receiving any amounts from this note
receivable in the foreseeable future.
In phase II, BTC agreed to purchase all of the issued and outstanding
stock of Dynaco. The phase II purchase price was $5,346,000, of which $2,673,000
was to be paid in cash and $2,673,000 was to be paid in BTC common stock of
equal value. Alternatively, the Company could have elected to have the entire
phase II purchase paid in cash at a value of $3,500,000. During phase II BTC had
the option of selling Dynaco to a third party if agreed to by the Company and
BTC. Phase II was required to be completed by June 30, 1998. Consistent with the
terms of the agreement with BTC, the Company entered into a Stock Purchase
Agreement with Quick Turn Circuits, Inc. ("QTC") on May 26, 1998 pursuant to
which QTC purchased 100% of the issued and outstanding shares of common stock of
Dynaco for $3,200,000.
As of December 31, 1997, the Company recognized a loss of approximately
$4,148,000 related to the phase I and phase II dispositions. These charges have
been netted in "Gain (Loss) on Dispositions, net" in the accompanying
Consolidated Statements of Operations. As of December 31, 1997, the Company
accrued for the estimate of Dynaco's 1998 operating loss through June 30, 1998
of approximately $850,000. Through the date of disposition of Dynaco, the
Company recognized additional operating losses totaling $1,090,885. During 1998,
the Company recorded a loss on disposition of $8,329 related to the ultimate
sale of Dynaco to QTC.
Pursuant to Accounting Principles Board ("APB") Opinion No. 30, REPORTING
THE RESULTS OF OPERATIONS REPORTING THE EFFECTS OF DISPOSAL OF A SEGMENT OF A
BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY OCCURRING EVENTS AND
TRANSACTIONS, ("APB No. 30") the consolidated financial statements of the
Company have been reclassified to reflect the dispositions of the aforementioned
subsidiaries that comprise the electronics segment.
39
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Accordingly, the assets and liabilities, revenues and expenses, and cash flows
of the electronics segment have been excluded from the respective captions in
the Consolidated Balance Sheets, Consolidated Statements of Operations and
Consolidated Statements of Cash Flows. The net assets (liabilities) of these
entities have been reported as "Net Assets (Liabilities) of Discontinued
Operations" in the accompanying Consolidated Balance Sheets; the net operating
losses of these entities have been reported as "Net Loss from Discontinued
Operations" in the accompanying Consolidated Statements of Operations; the net
cash flows of these entities have been reported as "Net Cash (Used in) Provided
by Discontinued Operations" in the accompanying Consolidated Statements of Cash
Flows.
Summarized financial information for the discontinued operations were as
follows:
December 31,
1997 1998
-------------- --------------
Current Assets $5,683,694 $ -
Total Assets 11,506,145 -
Current Liabilities 5,375,353 -
Total Liabilities 5,680,543 (1,680,171)
-------------- --------------
Net Assets (Liabilities) of Discontinued
Operations $5,825,602 $(1,680,171)
============== ==============
The assets and liabilities of the discontinued operations as of
December 31, 1997 represent the financial position of Dynaco and the Company's
liability associated with the sale of Nexar common stock to GFL. The net
liability as of December 31, 1998 represents the Company's liability associated
with the sale of Nexar common stock to GFL.
Year Ended December 31, Period Ended May 26,
1996 1997 1998
---------------- ---------------- ------------------------
Revenues $52,491,572 $57,663,080 $6,471,701
Net Loss from Discontinued Operations $(17,065,534) $(27,434,812) $(2,624,180)
The loss from operations for all of the discontinued operations from
the measurement date, October 1, 1997, through the date of disposition for
Comtel and Dynamem or December 31, 1997 for Dynaco, total approximately
$3,405,000. Dynaco's loss from operations for the period beginning January 1,
1998 and ending May 26, 1998, the date of disposition, totaled $1,940,885.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the
application of certain accounting policies described below and elsewhere in the
Notes to Consolidated Financial Statements.
(A) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements reflect the
consolidated financial position, results of operations and cash flows of the
Company and all wholly owned and majority-owned subsidiaries including Star, a
99.96% majority owned subsidiary as of December 31, 1998. Nexar, a discontinued
entity, has been accounted for in consolidation under the equity method in
accordance with APB No. 30 as described in Note 2.
40
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
All other investments are accounted for using the cost method as the Company
owns less than 20% of the common stock outstanding for these investments. All
intercompany transactions have been eliminated in consolidation.
(B) MANAGEMENT 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.
(C) INVESTMENTS
The Company accounts for marketable securities in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Under SFAS No. 115,
securities that the Company has the positive intent and ability to hold to
maturity are reported at amortized cost and classified as held-to-maturity.
There were no held-to-maturity securities as of December 31, 1997 and 1998.
Securities purchased to be held for indefinite periods of time and not intended
at the time of purchase to be held until maturity are reported at fair market
value and classified as available-for-sale securities. Unrealized gains and
losses related to available-for-sale securities are included as a separate
component of stockholders' equity. There were no available-for-sale securities
as of December 31, 1997 and 1998. Securities that are bought and held
principally for the purpose of selling them in the near term are reported at
fair market value and classified as trading securities. Realized and unrealized
gains and losses related to trading securities are included in the Consolidated
Statements of Operations. As of December 31, 1997, marketable securities
consisted of American Material & Technologies Corporation, held for trading
purposes. As of December 31, 1998, the Company did not have any investments in
marketable securities.
(D) INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market. Work-in-process and finished goods inventories consist of material,
labor and manufacturing overhead. At December 31, 1997 and 1998, inventories
consist of the following:
December 31,
1997 1998
--------------- ----------------
Raw materials $2,928,350 $2,478,289
Work-in-process 727,284 1,330,822
Finished goods 1,055,840 1,607,231
--------------- ----------------
$4,711,474 $5,416,342
=============== ================
Included in finished goods inventory at December 31, 1998 is
approximately $938,000 of service inventory and finished good test units
currently being evaluated by medical professionals.
41
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(E) DEPRECIATION AND AMORTIZATION
The Company provides for depreciation and amortization on property and
equipment using the straight-line method by charging to operations amounts that
allocate the cost of assets over their estimated useful lives as follows:
Estimated
Asset Classification Useful Life
------------------------------------ ----------------------
Machinery and equipment 3-8 Years
Furniture and fixtures 5 Years
Leasehold improvements Term of Lease
At December 31, 1997 and 1998, property and equipment consist of the
following:
December 31,
1997 1998
---------------- ----------------
Machinery and equipment $6,328,442 $6,022,320
Furniture and fixtures 1,018,931 1,120,450
Leasehold improvements 480,453 567,216
---------------- ----------------
7,827,826 7,709,986
Less: Accumulated depreciation
and amortization 1,372,240 4,395,899
---------------- ----------------
$6,455,586 $3,314,087
================ ================
Included in machinery and equipment as of December 31, 1997 and 1998 is
approximately $3,470,000 and $2,726,000, respectively, of equipment manufactured
by the Company and used in its service business.
(F) COST IN EXCESS OF NET ASSETS ACQUIRED
The costs in excess of net assets for acquired businesses are being
amortized on a straight-line basis over 5 to 7 years. Amortization expense for
the years ended December 31, 1996, 1997, and 1998 amounted to approximately
$536,000, $554,000 and $602,000 respectively, and is included in general and
administrative expenses in the Consolidated Statements of Operations.
The Company accounts for long-lived assets in accordance with SFAS No.
121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF. Under SFAS No. 121, the Company is required to assess
the valuation of its long-lived assets, including cost in excess of net assets
acquired, based on the estimated future cash flows to be generated by such
assets. The Company has assessed the realizability of its long-lived assets as
of December 31, 1998 and believes them to be realizable.
(G) DEFERRED FINANCING COSTS
During the year ended December 31, 1996, the Company incurred financing
costs related to several issuances of convertible debentures. Deferred financing
costs are amortized by a charge to interest expense over the period that the
debt is outstanding (see Note 6).
42
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(H) REVENUE RECOGNITION
The Company recognizes product revenue upon shipment. The Company's
sales of its product do not include any rights of return. Provisions are made at
the time of revenue recognition for any applicable warranty costs expected to be
incurred. Revenues from services, which have not been significant to date, are
recognized as the services are provided.
(I) SIGNIFICANT CUSTOMERS
For the years ended December 31, 1997 and 1998, Coherent acted as the
sales agent for products sold to the Company's customers that represented 11%
and 89% of revenues and 51% and 89% of accounts receivable, respectively.
Coherent is the Company's worldwide distributor of laser systems (see Note
12(d)). International sales (including sales for which Coherent was the sales
agent) for the years ended December 31, 1996, 1997 and 1998 were approximately
22%, 24% and 39% respectively, of total revenue.
(J) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development expenses to operations as
incurred.
(K) NET LOSS PER COMMON SHARE
Basic net loss per share was determined by dividing net loss by the
weighted average shares of common stock outstanding during the year. Diluted net
loss per share is the same as basic loss per share because the Company's
potentially dilutive securities, primarily stock options, warrants, redeemable
preferred stock and convertible debentures are antidilutive. The calculation of
the Company's net loss per common share from continuing operations for the years
ended December 31, 1996, 1997 and 1998 are as follows:
Year Ended December 31,
1996 1997 1998
---------------- --------------- ----------------
Net loss from continuing operations $(20,798,258) $(58,369,079) $(9,967,243)
Preferred stock dividends (1,242,751) (1,584,406) (1,312,426)
Amortization of value ascribed to preferred
stock conversion discount --- (2,823,529) ---
---------------- --------------- ----------------
Adjusted net loss from continuing operations $(22,041,009) $(62,777,014) $(11,279,669)
================ =============== ================
Basic and diluted net loss per common share
from continuing operations $(0.84) $(1.79) $(0.18)
================ =============== ================
Weighted average number of common shares
outstanding 26,166,538 35,105,272 62,868,696
================ =============== ================
Net loss from discontinued operations per common share is computed by
dividing the net loss from discontinued operations by the weighted average
number of common shares outstanding for the period.
In 1996, 1997 and 1998, 16,140,688, 32,358,446 and 28,451,024 weighted
average common equivalent shares, respectively, were not included in the diluted
weighted average shares outstanding, as they were antidilutive.
43
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(L) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS
WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF
CREDIT RISK, requires disclosure of any significant off-balance-sheet and credit
risk concentrations. Financial instruments that subject the Company to credit
risk consist primarily of cash and trade accounts receivable. The Company places
its cash in established financial institutions. The Company has no significant
off-balance-sheet concentration of credit risk such as foreign exchange
contracts, options contracts or other foreign hedging arrangements. To reduce
its accounts receivable risk, the Company relies on its worldwide distributor to
assess the financial strength of its end customers and, as a consequence,
believes that its accounts receivable credit risk exposure is limited. The
Company maintains an allowance for potential credit losses. The Company's
accounts receivable credit risk is not concentrated within any one geographic
area. The Company has not experienced significant losses related to receivables
from any individual customers or groups of customers in any specific industry or
by geographic area. Due to these factors, no additional credit risk beyond
amounts provided for collection losses is believed by management to be inherent
in the Company's accounts receivable.
(M) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS,
requires disclosure of an estimate of the fair value of certain financial
instruments. At December 31, 1997 and 1998, financial instruments consisted
principally of convertible debentures and preferred stock financings. The fair
value of financial instruments pursuant to SFAS No. 107 approximated their
carrying values at December 31, 1997 and 1998. Fair values have been determined
through information obtained from market sources and management estimates.
(N) COMPREHENSIVE INCOME
The Company adopted SFAS No. 130, REPORTING COMPREHENSIVE INCOME,
effective January 1, 1998. SFAS No. 130 establishes standards for reporting and
presentation of comprehensive income/loss and its components in the financial
statements. The components of the Company's comprehensive loss are as follows:
December 31,
1996 1997 1998
---------------- --------------- ----------------
Net loss from continuing operations $(20,798,258) $(58,369,079) $(9,967,243)
Unrealized (loss) gain on marketable securities (342,500) 342,500 ---
---------------- --------------- ----------------
Comprehensive loss from continuing operations $(21,140,758) $(58,026,579) $(9,967,243)
================ =============== ================
(O) RECLASSIFICATIONS
Certain reclassifications have been made to the 1996 and 1997
consolidated financial statements to conform with the current year's
presentation.
44
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(4) ASSET WRITE-OFF AND RESTRUCTURING
The Company, in accordance with applicable accounting principles,
determined during the third quarter of 1997 that certain investments' and notes
receivables' carrying values would not be realizable due to the Company's change
in strategy to divest of its investments in non-core businesses. These
investments did not qualify for discontinued operations in accordance with APB
No. 30. During 1997, the Company fully reserved for all such investments
resulting in a charge of approximately $10,283,000 to continuing operations, as
follows:
Description Carrying Amount
----------- ---------------
Notes Receivable $ 2,250,000
Investments in Non-Core Businesses 8,033,000
-----------
$10,283,000
-----------
-----------
The write-offs of the notes receivable and investment related to a
number of strategic investments and loans in non-medical businesses that the
Company made during 1996 and 1997. The notes receivable were principally
mezzanine investments whereby the Company loaned money and, in some cases,
received equity in early stage companies as a condition to making these loans.
During 1996 and 1997, the Company also made other equity investments in
companies that at the time were believed to be strategic to the Company's
business or had the potential to yield a higher than average financial return.
During 1997, based on a number of factors, including the Company's change in
strategy, the book value of these companies and their poor financial performance
to date, it became apparent to management that there was significant uncertainty
as to the ultimate realizability of these investments and notes receivable.
Accordingly, the Company wrote off these investments and notes receivable in
1997.
In the third quarter of 1997, the Company recognized a restructuring
charge of $2,700,000 based on the decision to discontinue certain medical
product and service business units and consolidate others. The majority of these
amounts relate to severance benefits for significant reductions in staffing for
all areas of the Company, including the elimination of essentially all of the
sales and marketing function as a result of the Coherent transaction (Note
12(d)). Management's plan specifically identified 33 employees who were targeted
for termination almost exclusively in selling, general and administrative
functions. Actual employees terminated as a result of this restructuring totaled
45.
All expenses accounted for as restructuring charges were in accordance
with the criteria set forth in EMERGING TASK FORCE ISSUE 94-3, LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING), and are
exclusive of the charges related to discontinued operations, as disclosed in
Note 2. Through December 31, 1998, the Company paid out $2,289,690 of severance
costs and has a remaining liability of $279,000 to two individuals that will be
paid out in 1999 resulting in total restructuring costs incurred of $2,568,690.
Accordingly, the Company reversed the balance of this restructuring accrual of
$131,310 in its consolidated statement of operations during the fourth quarter
of fiscal 1998.
As part of this restructuring, the Company disposed of the following
medical businesses:
(A) TISSUE TECHNOLOGIES, INC.
On December 16, 1997, the Company sold assets and certain liabilities
of Tissue Technologies, Inc. ("Tissue Technologies"), a manufacturer of a
dermatological laser product for the treatment of wrinkles, to a newly formed
medical laser manufacturer. This medical laser manufacturer was formed by former
executives of Tissue Technologies. In exchange, the Company received a $500,000
note receivable due in monthly installments over the
45
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
next year, royalties ranging from 2% to 5% on product revenue over the next ten
years, a 15% equity position in the newly formed company and a warrant to
purchase 10% of the common stock of the newly formed company at $.50 per share.
The Company placed zero value on the equity position in the newly formed
company.
(B) PALOMAR TECHNOLOGIES, LTD.
On January 1, 1998 the Company sold substantially all of the business
assets and liabilities of Palomar Technologies, Ltd., a foreign manufacturer, to
a publicly-traded company. The Company received cash of approximately $200,000
and was relieved of obligations related to the building lease and all employment
agreements. This transaction did not have a material effect on the Company's
operations for the year ended December 31, 1997.
(5) INCOME TAXES
The Company provides for income taxes under the liability method in
accordance with the provisions of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. At
December 31, 1998, the Company had available, subject to review and possible
adjustment by the Internal Revenue Service, a federal net operating loss
carryforward of approximately $101,000,000 to be used to offset future taxable
income, if any. This net operating loss carryforward will begin to expire in
2003. The Internal Revenue Code contains provisions that limit the net operating
loss carryforwards due to changes in ownership, as defined by the Internal
Revenue Code. The Company believes that its net operating loss carryforwards
will be limited due to its reorganization in 1991 and subsequent stock
offerings. The Company has completed an analysis of its availability to utilize
its operating loss in connection with the anticipated sale of Star to Coherent
(See Note 1). The Company estimates that its has net operating losses of
approximately $75,000,000 that are not subject to limitation under the Internal
Revenue Code. The Company has a net deferred tax asset of approximately
$40,400,000, comprised mainly of the net operating tax carryforwards discussed
above, and the tax effect of certain expenses and reserves not currently
deductible. However, the Company has placed a full valuation allowance against
the deferred tax asset, due to uncertainty relating to the Company's ability to
realize the asset.
(6) LONG-TERM DEBT
At December 31, 1997 and 1998, long-term debt consisted of the
following:
December 31,
1997 1998
--------------- ---------------
Convertible debentures $10,683,440 $2,150,000
Revolving line of credit with a bank -- 1,000,000
Note payable in connection with guarantee on behalf of discontinued
subsidiary (See Note 2) 3,233,000 2,290,041
Short-term notes payable to Coherent -- 4,000,000
Other notes payable 169,588 --
--------------- ---------------
$14,086,028 $9,440,041
Less - current maturities (1,640,465) (6,290,041)
--------------- ---------------
$12,445,563 $3,150,000
=============== ===============
46
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(A) CONVERTIBLE DEBENTURES
The following table summarizes the issuance and conversion of the
convertible debentures for the years ended December 31, 1997 and 1998.
Common Shares
Initial Amount Outstanding Issued Upon
Face December 31, Conversion
----------------------------- --------------------------
Series Value 1997 1998 1997 1998
---------------------------------------------------- -------------- -------------- ------------- ---------------- ----------
4.5% Series due October 21, 1999, 2000, 2001 $5,000,000 $100,000 $-- 1,381,264 60,809
5% Series due December 31, 2001 5,000,000 923,439 -- 2,074,992 1,160,999
5% Series due January 13, 2002 1,000,000 1,000,000 -- -- 924,029
5% Series due March 10, 2002 5,500,000 1,160,001 -- 2,794,677 1,561,064
6% Series due March 13, 2002 500,000 500,000 500,000 -- --
6%, 7% and 8% Series due September 30, 2002 7,000,000 7,000,000 1,650,000 -- 3,328,761
4.5% Series denominated in Swiss francs
due July 3, 2003 7,669,442 -- -- 914,028 --
-------------- -------------- ------------- --------------- ----------
$31,669,442 $10,683,440 $2,150,000 7,164,961 7,035,662
============== ============== ============= =============== ==========
It is the Company's policy to discount convertible debentures based on
the discount conversion price and amortize the discount to operations over the
expected life of the convertible debentures, which in most cases is less than
the term of the debentures. Accordingly, the Company credits the ascribed value
for the discount features described above to additional paid-in capital. This
ascribed amount is amortized over a period to the earliest conversion date,
which is six months for the convertible debentures outstanding in 1997 and 1998.
During 1996 and 1997, the Company recorded approximately $77,000 and
$5,444,000, respectively, of interest expense related to the amortization of the
discount of convertible debentures. There was no amortization of the discount of
convertible debentures in 1998.
On March 13, 1997, the Company issued $500,000 of 6% convertible
debentures due March 13, 2002. The convertible debentures have a conversion
price of $11.00. The debentureholder may convert no more than one-third of the
debenture in any thirty-day period. The Company has accounted for these
debentures at face value.
On September 30, 1997, the Company issued $7,000,000 of convertible
debentures due September 30, 2002. The debentures bear interest at a rate of 6%
for the first 179 days, 7% for days 180-269 and 8% thereafter. The
debentureholders were also issued 413,109 shares of common stock related to this
financing. The fair market value of the common stock was $1,050,000 and this
amount is being treated as debt discount and amortized to interest expense. The
convertible debentures have a conversion price of 100% of the Company's average
stock price, as defined. In addition, the debentureholder may convert no more
than 33% of their debentures in any thirty-day period (or 34% of the debentures
in the last thirty-day period). The Company also has redemption rights related
to this financing. During the year ended December 31, 1998 the Company redeemed
$2,196,667 of these convertible debentures. This amount includes accrued
interest of $196,667.
On July 3, 1996, the Company raised approximately $7,669,000 through
the issuance of 9,675 units in a convertible debenture financing. These units
are traded on the Luxembourg Stock Exchange and consist of a convertible
debenture, due July 3, 2002, denominated in 1,000 Swiss francs and a warrant to
purchase 24 shares of the Company's common stock at $16.50 per share. The
warrants are non-detachable and may be exercised only if the related debentures
are simultaneously converted, redeemed or purchased. Interest on the convertible
debentures accrued at a rate of 4.5% per annum and was payable quarterly in
Swiss francs. The convertible debentures were convertible by the holder, or the
Company, commencing October 1, 1996 at a conversion price equal to from 100%
47
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
to 77.5% of the applicable conversion price, calculated as defined. The Company
ascribed a value of $1,917,360 to the discount conversion feature of the
convertible debenture. This amount was being amortized to interest expense over
the life of the Swiss franc convertible debenture. During 1997, the Company
redeemed 300 units of this convertible debenture financing for $195,044.
On October 16, 1997, the Company brought a declaratory judgment action
in the United States District Court against certain of the Swiss franc
debentureholders. Prior to this suit, those debentureholders had alleged that
the Company was in breach of certain protective covenants and on October 22,
1997, they brought suit based on these claims. On November 13, 1997, the Company
exercised its right to convert 9,375 units into 914,028 shares of common stock
and cash of approximately $36,000. The unamortized discount totaling
approximately $1,784,000 was amortized to interest expense upon conversion. The
Company has accounted for these debentures as converted in the accompanying
financial statements. The ongoing litigation will be accounted for under SFAS
No. 5, ACCOUNTING FOR CONTINGENCIES (see Note 12(c)).
The Company incurred deferred financing costs of approximately
$2,038,000 and $769,000 relating to the issuance of convertible debentures
during the years ended December 31, 1996 and 1997, respectively. These costs are
reflected as deferred financing costs in the accompanying consolidated balance
sheets and are being amortized to interest expense over the term of the related
convertible debentures. During the years ended December 31, 1996, 1997 and 1998,
the Company amortized approximately $78,000, $276,000 and $64,000 to interest
expense, respectively. Any remaining unamortized deferred financing costs are
charged to additional paid-in capital upon conversion. During the years ended
December 31, 1996, 1997 and 1998, the Company charged approximately $41,000,
$1,820,000 and $374,000, respectively, of unamortized deferred financing costs
to additional paid-in-capital.
(B) REVOLVING LINE OF CREDIT WITH A BANK
The Company has a $10,000,000 revolving line of credit with a bank.
This line of credit will mature on March 31, 2000 and bears interest at the
bank's prime rate (7.75% at December 31, 1998). Borrowings under this line of
credit are secured by substantially all assets of the Company and are limited to
80% of qualified accounts receivables. A director of Palomar has guaranteed all
borrowings under this line of credit. In connection with this guarantee the
Company issued this director 200,000 warrants with a three-year term to purchase
the Company's common stock at $1.50 per share. These warrants were valued at
approximately $69,000. This amount is being amortized to interest expense over
the term of the revolving line of credit.
(C) BRIDGE LOAN
On March 27, 1998, the Company borrowed $2,000,000 from an individual.
The Company subsequently repaid this note during 1998. Interest on this note was
in the form of a warrant to purchase 125,000 shares of common stock for $.01 per
share exercisable over five years. This warrant was valued at $171,000 using the
Black-Scholes option pricing model. The Company accounted for this warrant as a
discount to the note through additional paid-in capital and amortized the
discount to interest expense over the period that the note was outstanding.
(D) NOTES PAYABLE TO COHERENT
On May 22 and June 22, 1998, the Company borrowed $3,000,000 and
$1,000,000, respectively, from the Company's worldwide distributor, Coherent.
These notes accrue interest at 8.5% per annum. The notes are secured by all of
the inventory owned by the Company's Star subsidiary.
48
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
Under the terms of the Loan Agreement between Coherent and the Company,
in the event that sale of Star to Coherent is not completed, the $4,000,000 of
funds borrowed by the Company from Coherent are due 90 days from the date of
termination of the Agreement to sell Star to Coherent as discussed in Note (1).
(E) FUTURE MATURITIES OF LONG-TERM DEBT
Future maturities of notes payable and convertible debentures reflected
at face value as of December 31, 1998 are as follows:
1999 $6,290,041
2000 1,000,000
2001 --
2002 2,150,000
-------------
$9,440,041
=============
(7) STOCKHOLDERS' EQUITY
(A) COMMON STOCK
During 1998, the Company sold 10,200,000 shares of common stock to a
group of investors for $10,200,000. In addition, the Company issued callable
warrants with a three-year term to these investors to purchase 10,200,000 shares
of common stock at an exercise price of $3.00 per share. The callable warrants
are not exercisable for the first six months after issuance and thereafter are
callable by the Company if the closing price of the Company's common stock
equals or exceeds $5.00 for ten consecutive trading days. Under the terms of
this private placement, the Company is obligated to pay the investors a fee of
5% per annum (payable quarterly) of the dollar value invested in the Company as
long as the investors continue to hold their common stock in their name at the
Company's transfer agent. During 1998, the Company paid $283,125 related to this
fee. This amount has been charged to additional paid-in capital. The Company
also paid $360,000 for investment banking fees related to the issuance of these
common shares. The Company netted this amount against the proceeds through a
reduction in additional paid-in capital.
On February 28, 1997, the Company and Nexar entered into an Asset
Purchase and Settlement agreement with a former executive of Nexar and
Technovation Computer Labs, Inc. ("Licensor"). The Licensor was affiliated with
a former officer of Nexar. Under the terms of this agreement, the Company agreed
to pay this former executive and certain of his affiliates $1,250,000 in cash
and deliver $1,500,000 worth of Palomar's common stock. In exchange, the Company
and Nexar received the rights to certain technology previously licensed to Nexar
and a complete release and settlement of all claims between this former
executive and Nexar.
The Company assigned to Nexar all of its rights to the technology and
charged Nexar for the cost associated with this claim and the purchase of the
technology. Nexar recorded $1,375,000 of the consideration to settle this claim
as a litigation expense in its statement of operations for the year ended
December 31, 1996. The remaining consideration totaling $1,375,000 was recorded
as purchased technology and was being amortized by Nexar over the technology's
estimated useful life. The allocation of the purchased technology was based on
the value of anticipated royalty payments to the Licensor over the three years
ended December 31, 1999.
49
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(B) PREFERRED STOCK
The Company is authorized to issue up to 5 million shares of preferred
stock, $.01 par value. As of December 31, 1997 and 1998, preferred stock
authorized, issued and outstanding consist of the following:
1997 1998
---- ----
Redeemable convertible preferred stock, Series F, $.01 par value per
share Authorized, issued and outstanding - 6,000 shares
(liquidation preference of $7,072,917 at December 31, 1998) $60 $60
Redeemable convertible preferred stock, Series G, $.01 par value per
share Authorized - 10,000 shares Issued and outstanding - 2,684 shares
and 743 shares in 1997 and 1998, respectively,
(liquidation preference of $874,603 at December 31, 1998) 27 7
Redeemable convertible preferred stock, Series H, $.01 par value per
share Authorized - 16,000 shares Issued and outstanding - 7,690 shares
and 250 shares in 1997 and 1998, respectively,
(liquidation preference of $280,562 at December 31, 1998) 77 2
Total preferred stock $164 $ 69
==== =====
The Series F redeemable convertible preferred stock ("Series F
Preferred"), together with any accrued but unpaid dividends, may be converted
into common stock at 80% of the average closing bid price for the ten trading
days preceding the conversion date, but in no event less than $3.00 or more than
$16.00. This conversion floor was decreased by the two parties from the original
price to $7.00. The Series F Preferred may be redeemed at the Company's option,
with no less than 10 days' and no more than 30 days' notice or when the stock
price exceeds $16.80 per share for sixty consecutive trading days, at an amount
equal to the amount of liquidation preference determined as of the applicable
redemption date. Dividends are payable quarterly at 8% per annum in arrears on
March 31, June 30, September 30 and December 31. Dividends not paid on the
payment date, whether or not such dividends have been declared, will bear
interest at the rate of 10% per annum until paid.
The Series G redeemable convertible preferred stock ("Series G
Preferred"), together with any accrued but unpaid dividends, may be converted
into common stock at 85% of the average closing bid price for the five trading
days preceding the conversion date, but in no event less than $.01. On December
31, 1997, the Company and the holder of the remaining 2,684 shares of Series G
Preferred entered into an Exchange Agreement. The conversion floor was decreased
by the two parties from the original floor to $6.00. In addition, beginning on
March 1, 1998, for any thirty-day period, the holder may exchange a limited
amount of the Series G Preferred ("exchangeability amount") and any accrued but
unpaid dividends for common stock at 85% of the average closing bid price for
the five trading days preceding the conversion date ("exchange date"). The
exchangeability amount increases as the exchange rate increases. The
exchangeability amount ranges from 268 shares of preferred stock for an exchange
rate below $2.00 to 1,072 shares of preferred stock for an exchange rate in
excess of $4.00. The Series G Preferred may be redeemed at the Company's option
at any time, with no less than 15 days' and no more than 20 days' notice, at an
amount equal to the sum of (a) the amount of liquidation preference determined
as of the applicable redemption date plus (b) $176.50. Dividends are payable
quarterly at 7% per annum in arrears on January 1, April 1, July 1 and October
1. Dividends not paid on the payment date, whether or not such dividends have
been declared, will bear interest at the rate of 12% per annum until paid.
The conversion price for the Series F and G Preferred is adjustable for
certain dilutive events, as defined. The Series F and G Preferred have a
liquidation preference equal to $1,000 per share of redeemable convertible
50
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
preferred stock, plus accrued but unpaid dividends and accrued but unpaid
interest. The Series F and G Preferred stockholders do not have any voting
rights except on matters affecting the Series F and G Preferred.
During the first and second quarters of 1997, the Company issued 16,000
shares of Series H redeemable convertible preferred stock ("Series H Preferred")
for $16,000,000 less associated financing costs of $1,000,000. The Series H
Preferred accrues dividends at rates varying from 6% to 8% per annum, as
defined. The Series H Preferred, including any accrued but unpaid dividends, may
be converted into common stock at 100% of the average stock price for the first
179 days from the closing date, 90% of the average stock price, as defined, for
the following 90 days and 85% of the average stock price, as defined,
thereafter. The conversion price is adjustable for certain dilutive events. The
holders are restricted for the first 209 days following the closing date to
converting no more than 33% of the Series H Preferred in any thirty-day period
(or 34% in the last thirty-day period). Under certain conditions, the Company
has the right to redeem the Series H Preferred. The Company has ascribed a value
of $2,823,529 to the discount conversion feature of the Series H Preferred,
which has been amortized as an adjustment to earnings available to common
shareholders over the most favorable conversion period attainable to the holders
(270 days from the date of issuance).
During the year ended December 31, 1997, the following shares of
preferred stock, accrued premium, dividends, interest and other related costs
were converted into shares of common stock as follows:
Number of Additional Dollar Amount
Preferred Preferred Dollar Amount of Converted, Including Accrued Number of Common
Stock Series Shares Preferred Stock Premium, Dividends, Interest Total Dollar Shares Converted
Converted Converted and Other Related Costs Amount Converted Into
- -------------- -------------- --------------------- --------------------------------- --------------------- -------------------
E 2,128 $2,128,000 $126,366 $2,254,366 332,859
G 7,316 7,316,000 438,234 7,754,234 602,824
H 8,310 8,310,000 228,411 8,538,411 5,204,158
- -------------- -------------- --------------------- --------------------------------- --------------------- -------------------
17,754 $17,754,000 $793,011 $18,547,011 6,139,841
In addition to the 602,824 shares of common stock issued related to the
Series G Preferred conversion, the Company issued to the Series G Preferred
stockholder $47,731 in cash dividends and 956,388 shares of Nexar common stock
valued at $4,671,597. The reduction to stockholder's equity (deficit) as a
result of this transaction was as follows:
Value of Nexar Common Stock $4,671,597
Accrued Interest and Dividend (391,597)
-----------
$4,280,000
===========
During the year ended December 31, 1998, the following shares of preferred
stock, accrued premium, dividends, interest and other related costs were
converted into shares of common stock as follows:
Number of Additional Dollar Amount
Preferred Preferred Dollar Amount of Converted, Including Accrued Number of Common
Stock Series Shares Preferred Stock Premium, Dividends, Interest Total Dollar Shares Converted
Converted Converted and Other Related Costs Amount Converted Into
- -------------- -------------- --------------------- --------------------------------- --------------------- -------------------
G 1,941 $1,941,000 $268,245 $2,209,245 2,703,032
H 3,947 3,946,700 383,923 4,330,623 4,188,650
- -------------- -------------- --------------------- --------------------------------- --------------------- -------------------
5,888 $5,887,700 $652,168 $6,539,868 6,891,682
51
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
In addition to the 4,188,650 shares of common stock issued related to
the Series H Preferred conversion, the Company redeemed 3,516 shares of Series H
Preferred for $4,387,434. This amount includes accrued dividends and interest
totaling $771,876.
(C) STOCK OPTION PLANS AND WARRANTS
(I) STOCK OPTIONS
The Company has several Stock Option Plans (the "Plans") that provide
for the issuance of a maximum of 7,350,000 shares of common stock, which may be
issued as incentive stock options ("ISOs") or nonqualified options. Under the
terms of the Plans, ISOs may not be granted at less than the fair market value
on the date of grant (and in no event less than par value); in addition, ISO
grants to holders of 10% of the combined voting power of all classes of Company
stock must be granted at an exercise price of not less than 110% of the fair
market value at the date of grant. Pursuant to the Plans, options are
exercisable at varying dates, as determined by the Board of Directors, and have
terms not to exceed 10 years (five years for 10% or greater stockholders). The
Board of Directors, at its discretion, may convert the optionee's ISOs into
nonqualified options at any time prior to the expiration of such ISOs.
The following table summarizes all stock option activity of the Company
for the years ended December 31, 1996, 1997 and 1998:
Number of Exercise Weighted Average
Shares Price Exercise Price
------------- ---------------- ----------------------
Outstanding, December 31, 1995 1,507,735 $0.40-$3.50 $2.06
Granted 1,520,000 6.00-10.50 7.08
Exercised (366,735) 0.40-3.50 1.28
Canceled (5,000) 3.00 3.00
------------- ---------------- ----------------------
Outstanding, December 31, 1996 2,656,000 $2.00-$10.50 $5.03
Granted 1,747,345 0.01-6.50 2.53
Exercised (214,845) 0.01-3.00 1.62
Canceled (1,206,100) 2.375-10.50 6.23
------------- ---------------- ----------------------
Outstanding, December 31, 1997 2,982,400 $1.50-$8.00 $3.33
Granted 2,294,900 1.50 1.50
Canceled (2,924,400) 1.50-8.125 3.38
------------- ---------------- ----------------------
Outstanding, December 31, 1998 2,352,900 $1.50-$2.50 $1.51
============= ================ ======================
Exercisable, December 31, 1998 1,851,371 $1.50-$2.50 $1.51
============= ================ ======================
Available for future issuances under the Plans
as of December 31, 1998 4,354,755
=============
52
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The exercise prices for options outstanding and options exercisable at
December 31, 1998 are as follows:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------- --------------------------------------
Weighted Average
Range of Options Remaining Weighted Average Options Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- --------------------- ---------------- ---------------------- ----------------------- --------------- ----------------------
$1.50 2,327,900 2.88 years $1.50 1,834,705 $1.50
$2.50 25,000 2.96 years 2.50 16,666 2.50
================ ====================== ======================= =============== ======================
2,352,900 2.88 years $1.51 1,851,371 $1.51
================ ====================== ======================= =============== ======================
The Company accounts for its stock-based compensation plans under APB
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. In October 1995, the
FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED Compensation, which is
effective for fiscal years beginning after December 15, 1995. SFAS No. 123
established a fair-value-based method of accounting for stock-based compensation
plans. The Company has adopted the disclosure-only alternative under SFAS No.
123 which requires disclosure of the pro forma effects on earnings per share as
if SFAS No. 123 had been adopted, as well as certain other information. The
Company accounts for equity instruments issued to non-employees in accordance
with EITF 96-18 by valuing the instrument using the Black-Scholes pricing model,
as prescribed by SFAS No. 123, and recording a charge to operations for their
fair value. The Company has issued options and warrants to purchase common stock
to certain financial intermediaries in connection with various financings at
below the fair market value of the underlying stock. The costs associated with
these issuances are accounted for as a cost of raising capital and netted
against the proceeds from these issuances.
During the year ended December 31, 1997 and 1998, a total of 1,005,000
and 2,184,900 options to purchase common stock were repriced to above the fair
market value of the underlying common stock to $2.50 and $1.50 per share,
respectively. The majority of the remainder of the options canceled during the
years ended December 31, 1996, 1997 and 1998 were the result of employee
terminations.
The Company has computed the pro forma disclosures required under SFAS
No. 123 for all stock options granted to employees of the Company in the years
ended December 31, 1996, 1997 and 1998 using the Black-Scholes option pricing
model prescribed by SFAS No. 123.
The assumptions used to calculate the SFAS No. 123 pro forma disclosure
for the years ended December 31, 1996, 1997 and 1998 for the Company are as
follows:
December 31,
1996 1997 1998
------------------ ------------------ ------------------
Risk-free interest rate 6.37% 6.09% 5.60%
Expected dividend yield - - -
Expected lives 4.4 years 3.69 years 2.94 years
Expected volatility 79% 79% 93%
Grant date fair value of options granted during
the period $4.57 $2.06 $0.64
53
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The weighted average fair-value and weighted average exercise price of
options granted by the Company for the years ended December 31, 1996, 1997 and
1998 are as follows:
December 31,
1996 1997 1998
------------- ----------------- -----------------
Weighted average exercise price for options:
Whose exercise price exceeded fair market value at
the date of grant $10.00 $2.53 $1.50
Whose exercise price was equal to fair value at the
date of grant $6.875 $- $-
Weighted average fair market value for options:
Whose exercise price exceeded fair market value at
the date of grant $8.875 $2.06 $0.64
Whose exercise price was equal to fair market value
at the date of grant $6.875 $- $-
The Company's majority owned Star subsidiary, a manufacturer of the
Company's diode laser, also has established a stock option plan that provides
for the issuance of a maximum of 650,000 shares of common stock, which may be
issued as nonqualified options and ISOs. The following table summarizes the
employee stock option activity for Star:
Weighted
Average
Number of Shares Exercise Price Exercise Price
---------------- -------------- --------------
Outstanding, December 31, 1995 95,000 $2.50 - $5.00 $3.68
Granted 150,000 6.00 - 19.00 6.27
Exercised (20,000) 2.50 2.50
Canceled (10,000) 6.00 6.00
----------------- --------------- -----------------
Outstanding, December 31, 1996 215,000 2.50 - 19.00 5.44
Granted 40,500 19.00 19.00
Canceled (1,917) 19.00 19.00
----------------- --------------- -----------------
Outstanding, December 31, 1997 253,583 $2.50-$19.00 $8.04
Exercised (6,300) 2.50-5.00 4.21
----------------- --------------- -----------------
Outstanding, December 31, 1998 247,283 $2.50-$19.00 $8.13
================= =============== =================
================= =============== =================
Exercisable, December 31, 1998 218,870 $2.50-$19.00 $7.22
================= =============== =================
================= =============== =================
Available for future issuances under the
Plan as of December 31, 1998 24,493
=================
54
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The exercise prices for options outstanding and options exercisable at
December 31, 1998 for Star are as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ------------------------------
Weighted
Average Weighted Weighted
Options Remaining Average Options Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
$2.50 28,000 5.45 years $ 2.50 28,000 $ 2.50
$5.00 40,700 5.43 years 5.00 40,700 5.00
$6.00 120,000 7.13 years 6.00 113,332 6.00
$9.50 10,000 7.63 years 9.50 7,777 9.50
$19.00 48,583 8.20 years 19.00 29,061 19.00
--------------- ---------- -------------- --------------- --------------
247,283 6.89 years $ 8.13 218,870 $ 7.22
=============== ========== ============== =============== ==============
During 1998, Star also issued options to purchase 378,224 shares of
common stock of Star to Palomar at $19.00 per share.
(II) WARRANTS
The following table summarizes all warrant activity of the Company for
the years ended December 31, 1996, 1997 and 1998:
Weighted
Number of Exercise Average
Shares Price Exercise Price
--------------- ----------------- -------------------
Outstanding, December 31, 1995 6,549,924 $0.01-$15.00 $3.82
Granted 6,527,576 4.88-16.50 8.16
Exercised (3,101,261) 0.01-7.69 2.66
--------------- ----------------- -------------------
Outstanding, December 31, 1996 9,976,239 $0.60-$16.50 $7.02
Granted 2,793,187 2.50-8.875 4.29
Exercised (584,879) 0.60-7.50 2.10
Canceled (2,186,517) 1.00-16.50 6.65
--------------- ----------------- -------------------
Outstanding, December 31, 1997 9,998,030 $2.00-$15.00 $6.65
Granted 12,585,000 0.01-3.00 2.75
Exercised (125,000) 0.01 0.01
Canceled (2,878,452) 2.25-6.75 4.13
--------------- ----------------- -------------------
Outstanding, December 31, 1998 19,579,578 $1.50-$15.00 $4.38
=============== ================= ===================
Exercisable, December 31, 1998 19,359,578 $1.50-$15.00 $4.37
=============== ================= ===================
During the years ended December 31, 1997 and 1998, a total of 1,240,000
and 1,300,000 warrants to purchase common stock were repriced to above the then
current fair market values of the underlying common stock. These repriced
exercise prices ranged from $2.50 to $4.00 per share in 1997 and ranged from
$1.50 to $2.00 per share in 1998. The majority of the remainder of the canceled
warrants during the years ended December 31, 1997 and 1998 were the result of
employee terminations. During 1998, the Company also issued warrants for an
aggregate of 250,000 shares of common stock to various parties in connection
with certain financing arrangements.
55
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The Company valued these warrants using the Black-Scholes pricing model, as
prescribed by SFAS No.123, and recorded a charge to operations for their fair
value for approximately $47,000.
The range of exercise prices for warrants outstanding and exercisable
at December 31, 1998 are as follows:
Warrants Outstanding Warrants Exercisable
- ------------------------------------------------------------------------------------- --------------------------------------
Weighted Average
Range of Warrants Remaining Weighted Average Warrants Weighted Average
Exercise Prices Outstanding Contractual Life Exercise Price Exercisable Exercise Price
- --------------------- ---------------- ---------------------- ----------------------- --------------- ----------------------
$1.50 - $2.125 2,739,500 2.44 years $1.71 2,619,500 $1.72
$3.00 - $3.00 10,560,000 4.26 years 3.00 10,560,000 3.00
$3.25 - $9.50 5,102,020 2.07 years 6.45 5,002,020 6.39
$10.38 - $15.00 1,178,058 2.07 years 13.98 1,178,058 13.98
---------------- ---------------------- ----------------------- --------------- ----------------------
19,579,578 3.30 years $4.38 19,359,578 $4.37
================ ====================== ======================= =============== ======================
The Company has computed the pro forma disclosures required under SFAS No.
123 for all warrants granted in the years ended December 31, 1997 and 1998 using
the Black-Scholes option pricing model prescribed by SFAS No. 123.
The weighted-average assumptions used to calculate the SFAS No. 123 pro
forma disclosure for the years ended December 31, 1996, 1997 and 1998 for the
Company are as follows:
December 31,
1996 1997 1998
---------------- ------------------ ------------------
Risk-free interest rate 5.93% 6.13% 5.44%
Expected dividend yield - - -
Expected lives 5.9 years 4.44 years 2.58 years
Expected volatility 79% 79% 93%
Grant date fair value of warrants granted during
the period $5.39 $2.17 $0.76
56
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The weighted average fair value and weighted average exercise price of
warrants granted by the Company for the years ended December 31, 1996, 1997 and
1998 are as follows:
December 31,
1996 1997 1998
----------------- -------------- -----------------
Weighted average exercise price for warrants:
Whose exercise price exceeded fair market value at date
of grant $11.76 $4.30 $2.78
Whose exercise price was less than fair market value at
date of grant $7.07 $7.50 $0.01
Whose exercise price was equal to fair market value at
date of grant $6.67 $3.25 $-
Weighted average fair value for warrants:
Whose exercise price exceeded fair market value at date
of grant $9.34 $1.10 $0.76
Whose exercise price was less than fair market value at
date of grant $8.82 $0.62 $1.24
Whose exercise price was equal to fair market value at
date of grant $6.67 $2.18 $-
(III) PRO FORMA DISCLOSURE
The pro forma effect on the Company of applying SFAS No. 123 for all
options and warrants to purchase common stock of the Company and Star would be
as follows:
December 31,
1996 1997 1998
------------------- ---------------------- -----------------
Pro forma net loss from continuing operations $(48,292,780) $(62,020,782) $(23,169,514)
Pro forma basic and dilutive net loss per share from
continuing operations $(1.89) $(1.89) $(0.39)
(D) RESERVED SHARES
At December 31, 1998, the Company has reserved shares of its common
stock for the following:
Warrants 19,579,578
Stock option plans 6,707,655
Convertible debentures 3,216,694
Preferred stock 3,328,894
Employee stock purchase plan 419,412
Employee 401(k) plan 554,787
---------------
Total 33,807,020
===============
(E) EMPLOYEE STOCK PURCHASE PLAN
In June 1996, the Board of Directors established the Palomar Medical
Technologies, Inc. 1996 Employee Stock Purchase Plan (the "Purchase Plan").
Under the Purchase Plan, all employees, are eligible to purchase the Company's
common stock at an exercise price equal to 85% of the fair market value of the
common stock with a
57
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
lookback provision of three months. The Purchase Plan provides for issuance of
up to 500,000 shares under the Purchase Plan. During the year ended December 31,
1997 and 1998, employees purchased 15,377 and 65,211 shares of the Company's
common stock for approximately $40,000 and $50,000, respectively, pursuant to
the Purchase Plan.
(8) RESEARCH AND PRODUCT DEVELOPMENT AGREEMENTS
During 1995, the Company entered into a multi-year agreement with
Massachusetts General Hospital ("MGH"), whereby MGH agreed to conduct clinical
trials on a laser treatment for hair removal. MGH will provide the Company with
data previously generated by Dr. Anderson and further clinical research on the
ruby laser device at MGH and other sites and remit ownership of all case report
forms and data resulting from the study.
The Company agreed to provide MGH with a grant of $203,757 to perform
research and evaluation in the field of hair removal. The Company immediately
paid $50,090 upon execution of this agreement, and the Company paid a license
fee of $10,000 within thirty days of this amendment. As consideration for this
amended license, the Company is obligated to pay to MGH royalties of up to 5% on
net revenues as defined (See Note 12 (b)). In March 1997, the U.S. Patent Office
issued a patent covering the laser-based hair removal technology developed by at
MGH, for which Palomar is the exclusive worldwide licensee.
(9) ACCRUED LIABILITIES
At December 31, 1997 and 1998, accrued liabilities consist of the
following:
December 31,
1997 1998
---------------- ---------------
Payroll and consulting costs $1,535,013 $1,148,898
Royalties 853,808 1,106,352
Settlement costs 1,457,020 --
Warranty 2,583,677 2,798,836
Restructuring 1,981,907 279,000
Interest and preferred stock dividends 1,659,709 1,550,662
Other 3,688,720 3,417,876
---------------- ---------------
Total $13,759,854 $10,301,624
================ ===============
(10) RELATED PARTY TRANSACTION
At December 31, 1997, approximately $478,000 of loans receivable with
interest at the rate of 7% per annum were outstanding from the Company's former
President. In the first quarter of 1998, the Company's former President paid
back his outstanding loan.
(11) 401(K) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "Profit Sharing
Plan") which covers substantially all employees who have attained the age of 18
and are employed at year-end. Employees may contribute up to 15% of their
salary, as defined, subject to restrictions defined by the Internal Revenue
Service. The Company is obligated to make a matching contribution, in the form
of the Company's common stock, of 50% of all employee contributions effective
January 1, 1995. The Company contributions vest over a three-year period. The
Company has reserved 554,787 shares of its common stock for issuance in
connection with the Profit Sharing Plan.
58
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
During 1997 and 1998, the Company issued 87,441 and 311,887 shares of
its common stock to the Profit Sharing Plan in satisfaction of its $318,154 and
$254,281 employer match for the 1996 and 1997 employee contributions,
respectively. For the year ended December 31, 1998, the Company has accrued
$206,000 for the 1998 match. The Company contributed 227,930 shares of its
common stock for this match in February of 1999.
(12) COMMITMENTS AND CONTINGENCIES
(A) OPERATING LEASES
The Company has entered into various operating leases for its corporate
office, research facilities and manufacturing operations. These leases have
monthly rents ranging from approximately $2,000 to $34,000, adjusted annually
for certain other costs such as inflation, taxes and utilities, and expire
through July 2003. The Company guarantees Star's facility operating lease
Future minimum payments under the Company's operating leases at
December 31, 1998 are approximately as follows:
December 31,
1999 $548,000
2000 264,000
2001 96,000
2002 101,000
2003 60,000
-------------
$1,069,000
=============
(B) ROYALTIES
The Company is required to pay a royalty of up to 5% of "net laser
sales," as defined, under a royalty agreement with MGH (see Note 8). For the
years ended December 31, 1996, 1997 and 1998, approximately $175,000, $854,000
and $1,332,000 of royalty expense, respectively, was incurred under this
agreement. These amounts are included in cost of sales in the accompanying
consolidated statements of operations.
A former employee and previous owner of one of the Company's
subsidiaries is paid a 1% commission on the net sales of certain ruby lasers and
diode lasers, as defined. These commissions will be paid through March 31, 2000
and are to be no less than $450,000. In accordance with the settlement agreement
with this individual, the Company paid advances on commissions totaling
$450,000: $200,000 in 1997 and $250,000 in January 1998.
(C) LITIGATION
The Company was a defendant in a lawsuit filed on March 14, 1996 in the
United States District Court for the Southern District of New York by
Commonwealth Associates ("Commonwealth"). In its suit, Commonwealth alleged that
the Company had breached a contract with Commonwealth in which Commonwealth was
to provide certain investment banking services in return for certain
compensation. In January 1997, Commonwealth's motion for summary judgment on its
breach of contract claim was granted, and in April 1997 the District Court
awarded Commonwealth $3,174,070 in damages. That judgment was appealed by
Palomar and on August 18, 1997 the case was settled for $1.875 million. During
the year ended December 31, 1997, the Company incurred $1.875 million in
settlement costs related to the above matter and another $1.324 million related
to several other claims and associated litigation costs.
On March 7, 1997, Selvac Acquisition Corp. ("Selvac"), a subsidiary of
Mehl Biophile International, Inc. ("Mehl"), filed a complaint for injunctive
relief and damages for patent infringement and for unfair competition in
59
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
the United States District Court for the District of New Jersey against the
Company, two of its subsidiaries and a New Jersey dermatologist. Selvac's
complaint alleged that the Company's EpiLaser(R)- ruby laser hair removal system
infringed a patent licensed to Selvac (the "Selvac Patent") and that the Company
unfairly competed by promoting the EpiLaser(R)- ruby laser hair removal system
for hair removal before it had received FDA approval for that specific
application. On May 18, 1998 the court granted the Company's motion for partial
summary judgment on the ground that the Selvac patent is invalid because prior
art anticipated it. The court has since denied Selvac's motion for
reconsideration of the summary judgment ruling. On September 25, 1998, the court
denied Selvac's motion for reconsideration of its prior order dismissing so much
of Selvac's unfair competition claim as relied on interpreting the Food, Drug
and Cosmetics Act or FDA regulations, and dismissed without prejudice the state
law remainder of Selvac's unfair competition claim. On October 26, 1998, Selvac
filed its notice of appeal to the Court of Appeals for the Federal Circuit.
Selvac subsequently filed its opening brief on appeal; the Company's opposition
was filed in March, 1999. The Company is unable to express an opinion as to the
likely outcome of Selvac's appeal, or as to the range of loss if Selvac
ultimately prevailed at trial.
On October 16, 1997, the Company brought a declaratory judgment action
in U.S. District Court for the District of Massachusetts against the holders and
the indenture trustee of the Company's 4.5% Subordinated Convertible Debentures
due 2003, denominated in Swiss francs (the "Swiss Franc Debentures"). Just prior
to this suit, certain of the debenture holders (the "Asserting Holders") had
alleged that the Company was in breach of certain protective covenants under the
indenture, and on October 22, 1997 they sued the Company and all of its
principal subsidiaries in the same court; the October 16 and October 22 cases
have been assigned to the same judge, and the dispute between the Asserting
Holders and the Company is proceeding under the October 22 case. The Asserting
Holders claim that the Company has breached certain protective indenture
covenants and that the Asserting Holders are entitled to immediate payment of
their indebtedness under the Swiss Franc Debentures (which amounts to
approximately US$5,600,000 at December 31, 1998 exchange rates). As of November
13, 1997, acting under applicable provisions of the indenture, the Company
notified the holders of the Swiss Franc Debentures that it is causing the
conversion of all of the Swiss Franc Debentures into an aggregate of 914,028
shares of the Company's common stock. The Company believes that it has not
breached any of the protective covenants under this indenture and that the debt
cannot properly be accelerated, and intends to contest the claims of the
Asserting Holders vigorously. Nonetheless, an adverse result could have a
material adverse effect on the Company in the range of $5,600,000 to $7,000,000.
By mutual agreement, the Asserting Holders and the Company requested that the
case be removed from the Court's trial calendar. The parties have discussed ways
to resolve their dispute, including the restructuring of the debentures, but
there can be no absolute assurance that all of the debentureholders, including
the Asserting Holders, and the Company will complete a proposed settlement.
On March 17, 1999, the company and a former and current officer were
added as defendants in the class action of VARLJEN V. H.J. MEYERS, INC. ET AL.
pending in the United States District Court of the Southern District of New
York. The Company is unable to estimate any possible outcome or range of loss in
this matter at this time. An adverse result in the VARLJEN action, however,
could have a materially adverse effect upon the financial statements and
operations of the Company.
The Company is also aware of a claim alleging that the Company had
previously committed to make an additional capital contribution to Nexar. The
Company believes that this claim is without merit.
The Company is involved in other legal and administrative proceedings
and claims of various types. While any litigation contains an element of
uncertainty, management, in consultation with the Company's general counsel,
presently believes that the outcome of each such other proceeding or claim which
is pending or known to be threatened, or all of them combined, will not have a
material adverse effect on the Company.
60
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
(D) DISTRIBUTION AGREEMENT
On November 17, 1997, the Company entered into an exclusive
distribution, sales and service agreement with Coherent, an established,
worldwide laser company. Under this agreement, Coherent has the exclusive right
to sell the EpiLaser(R) and LightSheer(TM) laser systems and future generation
products worldwide. The Company pays Coherent a per unit commission, adjusted
for certain events as defined. During 1997 and 1998, the Company incurred
approximately $800,000 and $14,108,000, respectively, of commission expense
related to this agreement which is included in sales and marketing expense in
the accompanying consolidated statement of operations. Upon execution of this
agreement, Coherent made a lump sum payment of $3,500,000 and received a warrant
to purchase one million shares of the Company's common stock at a share price of
$5.25. The valuation of the warrant using the Black-Scholes option pricing model
was approximately $380,000. The value was credited to additional paid-in capital
during the year ended December 31, 1997. The remaining amount of $3,120,000,
included in deferred revenue, is being amortized to revenue over the three year
life of the agreement. If the Company completes its anticipated sale of Star to
Coherent as discussed in Note 1, the current distribution agreement with
Coherent will be terminated and replaced with a one year non-exclusive
distribution agreement that will enable Coherent to sell the Company's
ruby-based laser products. The Company will amortize the deferred revenue
related to Coherent over this one year non-exclusive period.
In exchange for the payment at closing of $2,740 per day from January
20, 1999 until Palomar shareholder approval of the Agreement, Coherent has
agreed to waive its exclusive rights under the distribution agreement to market
and sell our ruby laser products, so that we may begin to sell the Palomar
E2000(TM) immediately through other channels without the obligation of paying a
commission to Coherent or waiting for the distribution agreement to terminate
upon the closing of the sale of Star to Coherent.
(E) EMPLOYMENT AGREEMENTS
The Company and its subsidiaries have employment agreements with
certain executive officers that provide for annual bonuses to the officers and
expire on various dates through 2001. Each of these agreements provides for 12
months severance upon termination of employment.
(13) SEGMENT AND GEOGRAPHIC INFORMATION
The Company has adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED Information in the fiscal year ended December 31, 1998.
SFAS 131 establishes standards for reporting information regarding operating
segments in annual financial statements and requires selected information for
those segments to be presented in interim financial reports issued to
stockholders. SFAS 131 also establishes standards for related disclosures about
products and services and geographic areas. Operating segments are identified as
components of an enterprise about which separate discrete financial information
is available for evaluation by the chief operating decision maker, or decision
making group, in making decisions how to allocate resources and assess
performance. The Company's chief decision-maker, as defined under SFAS 131, is a
combination of the Chief Executive Officer and the Chief Financial Officer. To
date, the Company has viewed its operations and manages its business as
principally one segment, cosmetic laser sales. Associated services are not
significant. As a result, the financial information disclosed herein represents
all of the material financial information related to the Company's principal
operating segment.
Product revenues from international sources were approximately $3.87
million, $5.03 million and $17.36 million in 1996, 1997 and 1998, respectively.
The Company's revenues from international sources were primarily generated from
customers located in Europe, Canada, Latin America and Asia/Pacific. All of the
Company's product sales for the years ended December 31, 1996, 1997 and 1998
were shipped from its facilities located in the United States.
61
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Continued)
The following table represents percentage of product revenue by
geographic region from customers for 1996, 1997 and 1998:
Year ended December 31,
1996 1997 1998
---- ---- ----
United States 78% 76% 61%
Europe 3 6 17
Asia/Pacific 10 6 13
Canada 9 4 3
Latin America -- 8 6
---- ---- ----
Total 100% 100% 100%
==== ==== ====
62
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.
Not applicable.
63
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information concerning directors required under this item is
incorporated herein by reference from the material contained under the heading
"Election of Directors" in the Registrant's definitive proxy statement to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A,
not later than 120 days after the close of the fiscal year. The information
concerning delinquent filers pursuant to Item 405 of Regulation S-K is
incorporated herein by reference from the material contained under the heading
"Section 16(a) Beneficial Ownership Reporting Compliance" in the Registrant's
definitive proxy statement to be filed with the Securities and Exchange
Commission pursuant to Regulation 14A, not later than 120 days after the close
of the fiscal year.
Item 11. Executive Compensation.
The information required under this item is incorporated herein by
reference from the material contained under the heading "Executive Compensation"
in the Registrant's definitive proxy statement to be filed with the Securities
and Exchange Commission pursuant to Regulation 14A, not later than 120 days
after the close of the fiscal year.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required under this item is incorporated herein by
reference from the material contained under the heading "Stock Ownership" in the
Registrant's definitive proxy statement to be filed with the Securities and
Exchange Commission pursuant to Regulation 14A, not later than 120 days after
the close of the fiscal year.
Item 13. Certain Relationships and Related Transactions.
The information required under this item is incorporated herein by
reference from the material contained under the heading "Relationship with
Affiliates" in the Registrant's definitive proxy statement to be filed with the
Securities and Exchange Commission pursuant to Regulation 14A, not later than
120 days after the close of the fiscal year.
64
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Index to Consolidated Financial Statements. Page
----
The following Consolidated Financial Statements of the Company and its
subsidiaries are filed as part of this report on Form 10-K:
Reports of Independent Public Accountants 29
Consolidated Balance Sheets -
December 31, 1998 and December 31, 1997 31
Consolidated Statements of Operations -
Years ended December 31, 1998, December 31, 1997 and December 31, 1996 32
Consolidated Statements of Stockholders' Equity (Deficit) -
Years ended December 31, 1998, December 31, 1997 and December 31, 1996 33
Consolidated Statements of Cash Flows -
Years ended December 31, 1998, December 31, 1997 and December 31, 1996 36
Notes to Consolidated Financial Statements 38
2. Consolidated Financial Statement Schedules
Report of Independent Public Accountants on Schedule II 71
Schedule II - Valuation and Qualifying Accounts 72
Schedules not listed above have been omitted because the
matter or conditions are not present or the information
required to be set forth therein is included in the
Consolidated Financial Statements hereto.
(b) Reports on Form 8-K.
Form 8-K filed June 3, 1998.
Form 8-K filed November 3, 1998.
65
(c) Exhibits.
The following exhibits required to be filed herewith are incorporated
by reference to the filings previously made by the Company where so
indicated below.
Exhibit
No. Title
^^^^2.1 Stock Purchase Agreement Between and Among Biometric Technologies Corp., Palomar Medical
Technologies, Inc. and Dynaco Corp., dated November 17, 1997.
***3.1 Second Restated Certificate of Incorporation, as filed with the
Delaware Secretary of State on January 8, 1999.
##3.2 Bylaws, as amended.
^4.1 Common Stock Certificate.
###4.2 Form of 4.5% Convertible Debenture (denominated in Swiss Francs) due July 3, 2003.
*10.1 Patent License Agreement by and between the Company and Patlex Corporation, effective as of
January 1, 1992.
####10.2 Amended 1991 Stock Option Plan.
####10.3 Amended 1993 Stock Option Plan.
####10.4 Amended 1995 Stock Option Plan.
####10.5 Amended 1996 Stock Option Plan.
####10.6 Amended 1996 Employee Stock Purchase Plan.
**10.7 Form of Stock Option Grant under the 1991, 1993 and 1995 Stock Option Plans.
##10.8 Form of Stock Option Agreement under the 1996 Stock Option Plan.
#10.9 Form of Company Warrant to Purchase Common Stock.
####10.10 Lease for premises at 45 Hartwell Avenue, Lexington, Massachusetts, dated March, 1996.
- --10.11 The Company's 401(k) Plan.
####10.12 Sales Agency, Development and License Agreement between the Company and Coherent, Inc., dated
November 17, 1997. (Portions omitted pursuant to a request for confidential treatment.)
####10.13 Stock Purchase Agreement, dated December 29, 1997.
####10.14 Stock Purchase Agreement, dated December 31, 1997.
####10.15 Exchange Agreement, dated December 31, 1997.
^^10.16 Form of 6%, 7% and 8% Convertible Debentures Due September 30, 2002
66
^^10.17 Form of Registration Rights Agreement, dated September 30, 1997.
####10.18 Form of Securities Purchase Agreement dated September 30, 1997.
^^^10.19 Securities Purchase Agreement dated December 29, 1997.
##10.20 Subscription Agreement between the Company and Soginvest Bank, dated as of March 13, 1997.
##10.21 6% Convertible Debenture due March 13, 2002.
####10.22 Employment Agreement, dated as of January 1, 1997, between the Company and Joseph P. Caruso.
####10.23 Employment Agreement, dated as of May 15, 1997, between the Company and Louis P. Valente.
####10.24 Securities Purchase Agreement between the Company and RGC
International Investors, LDC, dated March 27, 1997.
##10.25 Registration Rights Agreement between the Company and RGC
International Investors, LDC, dated March 27, 1997.
####10.26 Binding Term Sheet between the Company and Hechtor Wiltshire, dated March 27, 1998.
####10.27 Securities Purchase Agreement between the Company and various entities, dated February 20, 1998.
####10.28 Security Agreement - Stock Pledge between the Company and Coast Business Credit, dated December
31, 1997.
####10.29 Secured Promissory Note between the Company and Coast Business Credit, dated December 31, 1997.
####10.30 Continuing Guaranty between the Company and Coast Business Credit, dated December 5, 1996.
####10.31 License Agreement between the Company and Massachusetts General Hospital, dated August 18, 1995.
####10.32 First Amendment to License Agreement between the Company and Massachusetts General Hospital,
dated August 18, 1995.
####10.32 Second Amendment to License Agreement between the Company and Massachusetts General Hospital,
dated August 18, 1995.
- ----10.34 Letter Agreement between Palomar Medical Technologies, Inc. and Coherent, Inc. dated September 10,
1998.
***10.35 Form of Securities Purchase Agreement between the Company, The Rockside Foundation, and Mark T.
Smith dated , 1998
***10.36 Form of Warrant to Purchase Common Stock
@10.37 Second Amended 1996 Employee Stock Purchase Plan.
@10.38 Second Loan Agreement Between Palomar Medical Technologies, Inc. and Coherent, Inc., dated May 7,
1998
@10.39 Loan Agreement between Palomar Medical Technologies, Inc. and Coherent, Inc., dated May 22, 1998
67
@10.40 Fifth Amendment to the Schedule to the Loan and Security Agreement between Palomar Medical
Technologies, Inc. and Coast Business Credit, dated April 29, 1998.
****10.41 Agreement and Plan of Reorganization by and Among Coherent, Inc., Medical Technologies,
Acquisition, Inc., Palomar Medical Technologies, Inc., Star Medical Technologies, Inc., Robert E.
Grove, James Z. Holtz and David C. Mundinger, dated as of December 7,1998.
@@10.42 Form of Warrant to Purchase Common Stock
10.43 Letter Agreement between Palomar Medical Technologies, Inc. and Fleet National Bank, dated
November 16, 1998
10.44 Guaranty Agreement between A. Neil Pappalardo. and Fleet National Bank dated November 16, 1998.
10.45 Security Agreement (Trademarks) between Palomar Medical Technologies, Inc. and Fleet National Bank
dated November 16, 1998.
10.46 Security Agreement (Patents) between Palomar Medical Technologies, Inc. and Fleet National Bank
dated November 16, 1998.
10.47 Promissory Note between Palomar Medical Technologies, Inc. and Fleet National Bank dated November
16, 1998.
10.48 Guaranty Agreement between Star Medical Technologies, Inc. and Fleet National Bank dated November 16,
1998.
10.49 Security Agreement (Patents) between Star Medical Technologies, Inc. and Fleet National Bank dated
November 16, 1998.
10.50 Security Agreement (Trademarks) between Star Medical Technologies, Inc. and Fleet National Bank
dated November 16, 1998.
10.51 Bonus Agreement between Palomar Medical Technologies, Inc. Robert E. Grove, James Z. Holtz and
David C. Mundinger, dated as of December 7, 1998.
10.52 Letter Agreement between Palomar Medical Technologies, Inc. and Coherent, Inc., dated
February 1,1999
21 List of Subsidiaries.
23 Consent of Arthur Andersen LLP.
27 Financial Data Schedule for the Period Ended December 31, 1998.
^ Previously filed as an exhibit to Form 10-KSB/A-4 for the year ended December 31, 1996 filed on
July 11, 1997, and incorporated herein by reference.
^^ Previously filed as an exhibit to Registration Statement No. 333-42129 filed on December 12, 1997,
and incorporated herein by reference.
^^^ Previously filed as an exhibit to Registration Statement No. 333-42129/A-2 filed on January 9,
1998, and incorporated herein by reference.
68
^^^^ Previously filed as an exhibit to Form 8-K filed on December 23, 1997, and incorporated herein by
reference.
* Previously filed as an exhibit to Registration Statement No. 33-47479 filed on April 27, 1992, and
incorporated herein by reference.
** Previously filed as an exhibit to Amendment No. 4 to Form S-1 Registration Statement No. 33-47479
filed on October 5, 1992, and incorporated herein by reference.
*** Previously filed as an exhibit to Registration Statement No. 333-70391 filed on January 11, 1999,
and incorporated herein by reference.
**** Previously filed as an exhibit to the Company's Definitive Proxy
Statement for the period ended December 31, 1998 filed on March
12, 1999, and incorporated herein by reference.
# Previously filed as an exhibit to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1995, and incorporated
herein by reference.
## Previously filed as an exhibit to the Company's Annual Report on
Form 10-KSB for the year ended December 31, 1996, and incorporated
herein by reference.
### Previously filed as an exhibit to Form S-3 Registration Statement No. 333-22725 filed on March 4,
1997 and incorporated herein by reference.
#### Previously filed as an exhibit to the Company's Annual Report on
Form 10-K for the year ended December 31, 1998, and incorporated
herein by reference.
- - Previously filed as an exhibit to the Company's Quarterly Report on Form 10-QSB for the quarter
ended June 30, 1996, and incorporated herein by reference.
- -- Previously filed as an exhibit to Form S-8 Registration Statement No. 33-97710 filed on October 4,
1995, and incorporated herein by reference.
- --- Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997, and incorporated herein by reference.
- ---- Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 1998, and incorporated herein by reference.
& Previously filed as an exhibit to the Company's Quarterly Report
on Form 10-QSB for the quarter ended September 30, 1996, and
incorporated herein by reference.
&& Previously filed as an exhibit to Form S-3 Registration Statement No. 333-18003 filed on December
16, 1996, and incorporated herein by reference.
&&& Previously filed as an exhibit to Form S-3 Registration Statement No. 333-22725 filed on March 4,
1997, and incorporated herein by reference.
&&&& Previously filed as an exhibit to Form S-3 Registration Statement No. 333-28251 filed on May 30,
1997 and incorporated herein by reference.
@ Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998, and incorporated herein by reference
69
@@ Previously filed as an exhibit to Form S-8 Registration Statement No. 333-574031 filed on June 22,
1998 and incorporated herein by reference.
70
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULE II
To Palomar Medical Technologies, Inc.:
We have audited, in accordance with generally accepted auditing
standards, the consolidated financial statements of Palomar Medical
Technologies, Inc. and subsidiaries included in this Form 10-K and have issued
our report thereon dated February 11, 1999. Our audit was made for the purpose
of forming an opinion on the basic financial statements taken as a whole. The
schedule listed in Item 14(2) above is the responsibility of the Company's
management and is presented for purposes of complying with the Securities and
Exchange Commission's rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the audit
of the basic financial statements and, in our opinion, fairly states, in all
material respects, the financial data required to be set forth therein, in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Boston, Massachusetts
February 11, 1999 (except for the
matter discussed in Note 12(c) as
to which the date is March 17, 1999).
71
SCHEDULE II
PALOMAR MEDICAL TECHNOLOGIES, INC.
Valuation and Qualifying Accounts
Balance,
Beginning of Balance, End of
Period Increases Deductions Period
Allowance for Doubtful Deductions:
December 31, 1996 $7,000 $1,122,000 $-- $1,129,000
================= ================= ================ =================
December 31, 1997 $1,129,000 $933,000 $(1,316,000) $746,000
================= ================= ================ =================
================= ================= ================ =================
December 31, 1998 $746,000 $183,000 ($565,000) $364,000
================= ================= ================ =================
Balance,
Beginning of Balance, End of
Period Increases Deductions Period
Restructuring Accrual:
December 31, 1996 $-- $-- $-- $--
================= ================= ================ =================
December 31, 1997 $-- $2,700,000 $(718,000) $1,982,000
================= ================= ================ =================
December 31, 1998 $1,982,000 $-- $(1,703,000) $279,000
================= ================= ================ =================
72
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
Registrant certifies that it has caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the Town of Lexington in the
Commonwealth of Massachusetts on March 30, 1999.
PALOMAR MEDICAL TECHNOLOGIES, INC.
By: /S/ Louis P. Valente
------------------------------
Louis P. Valente
President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this Report
has been signed by the following persons on behalf of the Registrant in the
capacities and on the dates indicated.
Name Capacity Date
---- -------- ----
/s/ Louis P. Valente President, Chief Executive March 30, 1999
- -------------------------------------- Officer and Director
Louis P. Valente
/s/ Joseph P. Caruso Chief Financial Officer and Treasurer March 30, 1999
- -------------------------------------- (Principal Financial Officer and
Joseph P. Caruso Principal Accounting Officer)
/s/ Nicholas P. Economou Director March 30, 1999
- --------------------------------------
Nicholas P. Economou
/s/ A. Neil Pappalardo Director March 30, 1999
- --------------------------------------
A. Neil Pappalardo
/s/ James G. Martin Director March 30, 1999
- --------------------------------------
James G. Martin
73