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FORM 10-KSB/A-1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1996
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 0-22340
PALOMAR MEDICAL TECHNOLOGIES, INC.
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(Exact name of small business issuer as specified in its charter)
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Delaware 04-3128178
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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66 Cherry Hill Drive, Beverly, MA 01915
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(Address of principal executive offices)
(508) 921-9300
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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-B 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-KSB
or any amendment to this Form 10-KSB. [ ]
The issuer's revenues for its fiscal year ended December 31, 1996 were
$70,098,443.
As of March 20, 1997, 30,945,824 shares of Common Stock, $.01 par value per
share, and 16,000 shares of Preferred Stock $.01 par value per share were
outstanding. The aggregate market value, held by non-affiliates, of shares of
the Common Stock, based upon the average of the bid and ask prices for such
stock on that date was approximately $195,345,514.
Transitional Small Business Disclosure Format: Yes No X
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DOCUMENTS INCORPORATED BY REFERENCE
Documents Form 10-KSB Reference
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Proxy Statement for the Annual Meeting of Shareholders Part III
to be held June 18, 1997
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PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL
Palomar Medical Technologies, Inc., a Delaware corporation, (the "Company"
or "Palomar") was organized in 1987 to design, manufacture and market lasers,
delivery systems and related disposable products for use in cosmetic and medical
procedures. The Company currently operates in two business segments: medical
products and services and electronic products. In the medical products segment,
the Company manufactures and markets U.S. Food and Drug Administration ("FDA")
approved ruby and CO2 lasers for hair removal, skin resurfacing and wrinkle
treatment, among other things. The Company has and continues to develop ruby,
pulse dye and diode medical lasers for use in clinical trials and is engaged in
the research and development of additional laser products. The Company has
expanded its efforts in the cosmetic laser area through a series of product
development activities, acquisitions and strategic alliances that target patient
self-pay procedures performed in doctors' offices and clinics. Principal among
these are the development of the EpiLaserTM, a ruby laser system for removing
unwanted hair. The laser hair removal, skin resurfacing and wrinkle treatment
products are significant to the Company's strategic plan and are discussed in
further detail below. The Company has entered into a number of research
agreements with recognized research hospitals and clinical laboratories. The
Company provides research funding, laser technology and optics expertise in
return for licensing agreements to specific medical applications and patents as
more fully described below. See "Patents and Licenses." Management believes 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.
In February 1997, Palomar Medical Products, Inc. ("Palomar Medical
Products") was formed with the purpose of consolidating the management and
operations of the medical products companies. In January 1997, the Company named
an outside party as the President and CEO of Palomar Medical Products to oversee
and manage the operations. Included in the Medical Products Group are the
following companies; Spectrum Medical Technologies, Inc., Tissue Technologies,
Inc., Star Medical Technologies, Inc., Dermascan, Inc. and Palomar Technologies,
Ltd. (see "Formation of Palomar Technologies, Ltd."). Included as part of the
medical business segment but excluded from the Medical Products Group is a newly
formed, wholly owned subsidiary of the Company, Cosmetic Technology
International, Inc., which intends to establish a worldwide network of cosmetic
and dermatological laser sites with medical service partners (see "Formation of
Cosmetic Technology International, Inc.").
In September 1995, the Company established Palomar Electronics Corporation
as a wholly-owned subsidiary of Palomar Medical Technologies, Inc. as part of a
plan to separate the electronics and computer segments of the business from the
medical laser segments of the business.
In the electronic products segment, the Company's Nexar Technologies, Inc.
subsidiary manufactures, markets and sells personal computers with a unique
circuit board design that enables end users to easily upgrade and replace the
microprocessor, memory and hard drive components, which management believes will
decrease the level of technical obsolescence associated with most desktop
personal computers in the market. Dynaco Corp. manufactures high density,
flexible electronic circuitry for use in industrial, military and medical
devices and is also introducing a number of proprietary products targeted to
service the personal computer industry, including high density memory modules.
These new proprietary computer memory modules double the memory capacity of
traditional memory modules using the same interface. Comtel Electronics is a
contract manufacturer which provides turnkey manufacturing and test services of
electronic assemblies.
THE COMPANY'S STRATEGIC PLAN
The Company's near-term strategy is to increase its focus on the medical
segment portion of the business. The company believes that it can spin out
companies in the non-core electronics segment in the form of publicly traded
companies. The Company believes that with the attainment of FDA clearance for
marketing and sales of its lasers for the treatment of hair removal, skin
resurfacing, and wrinkle treatment, the medical segment of its business is
positioned for success. The Company will continue to develop, acquire or license
technologies that can be integrated into its current and proposed products in
the medical business segment. Through its Cosmetic Technology International Inc.
subsidiary, the Company will also focus on the services segment of the business.
The Company intends to address very large
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markets incorporating its core technology with proprietary products and services
and structure its operations to strive to be the low-cost producer and provider
of these products and services. The Company intends to seek agreements or
arrangements with other medical products and high technology companies in order
to acquire technical and financial assistance in the research and development of
such products and in the extensive experimentation and testing required to
obtain regulatory approvals in the United States and elsewhere. The Company will
continue to seek marketing and distribution agreements with established
companies to enable it to market some of its products quickly and more
efficiently and will also utilize and enhance a direct sales force.
The Company has already begun to spin out Companies in its electronics
segment. Management is currently evaluating various alternatives and methods for
Dynaco Corp. and its subsidiaries, as well as CD Titles, Inc. Although the
Company cannot guarantee successful completion of these publicly traded
spinouts, the intention is to complete these transactions during 1997. In
addition, the Company's subsidiary Nexar Technologies, Inc. (See "Formation of
Nexar Technologies, Inc.") is in the process of completing its proposed initial
public offering. Management anticipates that this initial public offering will
be completed by mid-April 1997. However, the Company can in no way guarantee nor
ensure successful completion of the initial public offering.
The Company believes that the expansion and success of its business is
significantly influenced by key employees at its operating subsidiaries. The
Company has and intends to continue to create incentive programs that allow
management as well as key members of senior management of the Company at these
operating subsidiaries to participate in the success of these operating
subsidiaries by participating in the equity of each subsidiary or profit sharing
plans.
The Company also makes early stage investments in core technologies and
companies that management feels are strategic to the Company's business or will
yield a higher than average financial return to support the Company's core
business. Some of these investments are with companies that are related to some
of the directors and officers of the Company. See "Related Party Investments and
Transactions."
RECENT FINANCING OF OPERATIONS AND INVESTMENTS
The Company has financed current operations and expansion of its core
business with short-term financial borrowings and investments through the
private sale of debt and equity securities of the Company. The Company raised a
total of $56,112,391 and $31,083,892 in such financings during the years ended
December 31, 1996, and December 31, 1995, respectively. The Company anticipates
that it will require substantial additional financing during the next
twelve-month period. 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 are 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. The Company increased its authorized shares on July 19, 1996
from 40,000,000 shares of common stock to 100,000,000 shares of common stock.
There can be no assurance that the Company will be successful in raising
additional capital on favorable terms. See Notes 5 and 15 in the "Notes to
Consolidated Financial Statements."
INCREASE IN OUTSTANDING SHARES
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 shares of common stock have increased to 30,596,812 at December 31,
1996. The Company also had additional reserved but unissued shares of common
stock of 20,467,819 shares at December 31, 1996. The Company's issued and
outstanding shares of common stock increased subsequent to December 31, 1996 to
30,996,283 shares with additional reserved but unissued shares of common stock
of 20,061,274 shares as of February 21, 1997. A substantial number of the
Company's reserved shares are registered and could be resold into the public
market.
RELATED PARTY INVESTMENTS AND TRANSACTIONS
The Company has entered into a number of transactions with related parties.
To date, the Company has an aggregate of $5,076,751 of notes receivable and
investments with related parties. Included in the aggregate amount are loans to
certain officers, directors and key employees of $995,331; notes receivable to
related parties of $464,153; a loan of
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$1,100,000 to a public company of which a former director is the director and
chief financial officer; an unsecured note of $604,653 to the Company's
underwriter; and trading securities of $1,912,614 in a publicly traded company
in which the chief executive officer is an approximately 13% owner. See Note 11
in the "Notes to Consolidated Financial Statements."
MEDICAL PRODUCTS SEGMENT
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BUSINESS DEVELOPMENTS
ACQUISITION OF STAR MEDICAL TECHNOLOGIES, INC.
On July 1, 1993, the Company acquired 80% of the common stock of Star
Medical Technologies, Inc. ("Star"), a development stage company formed on April
1, 1993. Star develops medical and commercial products using high power laser
diodes. To date, Star has developed a number of medical diode laser prototypes
under clinical investigation. The acquisition price was $600,000 in cash and
five-year nonqualified stock options granted to certain officers of Star to
purchase up to an aggregate of 100,000 shares of the Company's common stock at
an exercise price of $1.78 (50% of the fair market value of the Company's common
stock on July 1, 1993). In addition, during 1994, the Company acquired an
additional 5% of the common stock of Star for cash payments of $970,000.
In April 1996, the Company purchased the remaining 15% of the outstanding
common stock of Star from its founders, bringing its ownership to 100%, in
exchange for 217,943 shares of Palomar's common stock valued at $7.85 per share.
This agreement restricts for a period of two years the sale of the Company's
common stock issued in connection with this agreement. The purchase price has
been recorded as additional goodwill and is being amortized over a period of
five years. In connection with this agreement the original founders of Star have
agreed to rescind all royalties due to them under a Rights Agreement dated July
1, 1993. To date, revenue from the Star subsidiary has not been significant.
ACQUISITION OF SPECTRUM MEDICAL TECHNOLOGIES, INC.
On April 5, 1995, the Company acquired all of the outstanding common stock
of Spectrum Medical Technologies, Inc. ("Spectrum"). The purchase price
consisted of $300,000 in cash, a $700,000 two-year promissory note, 364,178
shares of the Company's common stock with an aggregate fair market value of
$1,000,000, acquisition costs of $161,138 and assumed liabilities totaling
$1,128,139. In addition, the purchase price consists of a 20% contingency
payment, payable in the Company's common stock, based upon the future earnings
performance of Spectrum over a three to five-year period. Spectrum develops,
manufactures, sells and services ruby lasers throughout the world for
dermatological applications.
FORMATION OF SPECTRUM FINANCIAL SERVICES LLC
On June 30, 1995, Spectrum Financial Services LLC ("SFS"), a financial
services leasing company and a minority- owned subsidiary of the Company, was
formed. As of December 31, 1996 and 1995, the Company had funded the minority
subsidiary with cash in the amount of $1,680,919 and $856,300 respectively. SFS
arranges for financing of medical products sold by the Company. In addition,
during 1996 as part of its business strategy, the Company aligned itself with
Copelco Capital, one of the world's largest and most established leasing
companies, to become the exclusive label leasing company for the Company's
complete line of cosmetic lasers.
LICENSE AND RESEARCH AGREEMENT WITH MASSACHUSETTS GENERAL HOSPITAL FOR LASER
HAIR REMOVAL
In August 1995, the Company entered into an exclusive, worldwide, perpetual
license for certain technology that applies to a patented method of delivering
laser energy to treat unwanted hair. The Company also entered into a four-year
agreement with the Massachusetts General Hospital ("MGH"), whereby MGH agreed to
conduct clinical trials on a laser treatment for hair removal/reduction invented
by Dr. R. Rox Anderson, Wellman Laboratories of Photomedicine, MGH. As part of
the agreement, MGH provided the Company with prior data already generated by Dr.
Anderson with respect to the ruby laser device at MGH. This information was the
basis for an application filed on December 8, 1995 with the FDA for approval of
the Company's EpiLaser(TM) for treating unwanted hair. The Company is obligated
to fund the clinical research in the aggregate amount of approximately $917,000
over the term of the contract. On August 18, 1995, the Company also entered into
a worldwide exclusive license agreement with MGH. Upon completion of a valid
product or service, or new uses (not related solely to hair removal) based on
the findings of the clinical studies, the Company shall be given the first
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right of refusal to negotiate an exclusive or non-exclusive license agreement.
As consideration for this license, the Company is obligated to pay MGH royalties
of 5.5% of net revenue from product/services covered by valid patents licensed
to the Company exclusively; 2.5% of net revenues of products/services covered by
valid patents licensed to the Company non-exclusively; 1.5% of net revenues of
products developed and exploited, not covered above and no less than 3% on the
sale of any other laser using other technology as defined for the use of hair
removal.
ACQUISITION OF TISSUE TECHNOLOGIES, INC.
On May 3, 1996 the Company acquired 100% of Tissue Technologies, Inc.
("Tissue Technologies"), an Albuquerque, New Mexico based manufacturer of
dermatology laser products, in exchange for 3,200,000 shares of the Company's
common stock. The Company has accounted for this acquisition as a
pooling-of-interest in accordance with Accounting Principles Board Opinion
No.16. Tissue Technologies is engaged in the manufacture, marketing and sales of
C02 laser systems used in skin resurfacing and treatment of wrinkles.
ACQUISITION OF DERMASCAN, INC.
On July 18, 1996 the Company purchased 80 shares of common stock (80% of
total issued and outstanding capital stock) of Dermascan, Inc. ("Dermascan")
from a Dermascan stockholder in exchange for 35,000 shares of common stock of
the Company. The Company included these 35,000 shares in a registration
statement that became effective February 28, 1997. In addition, the Company has
agreed to pay the Dermascan stockholder an amount equal to the difference
between $14.00 and $7.8125, the closing bid price on February 28, 1997. The
agreement also includes a put right by the remaining 20% stockholder of
Dermascan, which provides that, at any time after three years from the date of
the agreement, the Company will be required to purchase the stockholders' 20%
interest for $130,000 in cash. In connection with the agreement, the Company
entered into a five year employment agreement with the President of Dermascan
which guarantees annual payments of up to $125,000. Dermascan's operations prior
to acquisition were not material. The Company has recorded the acquisition at
the guaranteed stock price of $490,000 in total. Dermascan markets and sells
electrology equipment and supplies to the electrology market. To date, the
operations of Dermascan have not been significant.
FORMATION OF PALOMAR TECHNOLOGIES, LTD.
On November 13, 1996, the Company formed Palomar Technologies, Ltd. located
in Hull, England. This company was formed to establish a European resource to
manufacture, sell and service laser products throughout Europe and provide a
low-cost sourcing alternative for specialty components. Operations have not yet
begun and will not begin until mid-1997. Through February 28, 1997, the Company
has funded this subsidiary with $1,592,180 for the purchase and lease of its
manufacturing facilities and the hiring of certain key employees.
FORMATION OF PALOMAR MEDICAL PRODUCTS, INC.
On February 18, 1997, the Company formed Palomar Medical Products, Inc. for
the purpose of consolidating the management and operations of the medical
products companies. Included in the Medical Products Group are the following
companies: Spectrum, Tissue, Star Medical, Dermascan and Palomar Technologies,
Ltd.
MEDICAL SERVICES SEGMENT
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FORMATION OF COSMETIC TECHNOLOGY INTERNATIONAL, INC.
On December 20, 1996, Cosmetic Technology International, Inc. ("CTI") was
formed as a 100%-owned subsidiary of the Company. As of December 31, 1996 the
Company had funded CTI with cash of approximately $650,000. CTI is a services
company which intends to establish a worldwide network of cosmetic
dermatological laser and medical device sites with medical services partners
(both fixed and mobile) in key geographic locations. Each site will be provided
a turnkey package of laser and medical device technology, equipment, training
and service, operations personnel, strategic advertising and marketing programs,
patient financial credit programs and management assistance. In early 1997, a
binding letter of intent was completed with Columbia/HCA, a $20 billion company
and one of the world's largest owners and operators of medical facilities, to
establish revenue sharing sites throughout the country in existing Columbia/HCA
facilities. During 1996 the operations of CTI were not significant.
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MEDICAL PRODUCTS AND LASERS IN MEDICINE
EPILASER PRODUCT FOR LASER HAIR REMOVAL
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 dermatologic
applications. With the appropriate selection of energy and pulse width to allow
for the preferential absorption by the melanin present in the target area or by
the hemoglobin in blood there is negligible absorption by the surrounding
tissue. This concept of tissue optics applies to all of the medical laser
products under development by the Company.
Spectrum has developed a long pulse ruby laser, using its core ruby laser
technology developed for tattoo removal and pigmented lesions, that is
specifically configured to allow the appropriate wavelength, energy level and
pulse duration to effectively be absorbed by the hair follicle without being
absorbed by the surrounding tissue. In March 1997 Spectrum received FDA
clearance to sell and market the EpiLaser in the U.S. for hair removal. In July
1996 the Company received clearance from the FDA to sell and market the EpiLaser
for a wide range of dermatological applications, not including hair removal.
During April of 1996, clearance was given to market the laser-based hair removal
system in Canada. This method of hair removal allows for selective destruction
of the target follicle without harming the surrounding skin. The laser operates
in the 20-25 J energy range, delivering fluences in the range of 10-50J/cm2 in a
3-ms pulse. The beam delivering system produces a round beam with a nearly
flat-top energy distribution, thereby avoiding local hot spots. The hair-removal
technology utilized by Palomar targets the pigment in a hair follicle and was
developed by Dr. Rox Anderson at MGH. The laser incorporates a proprietary
handpiece delivery system that enables the laser light to penetrate to the
correct depth while at the same time limiting the amount of discomfort
associated with the procedure. The laser light is pulsed at a rapid rate
covering approximately one half square inch at each pulse. This treatment method
allows for a large area of treatment over a 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
handpiece applicator was developed by MGH and licensed to Spectrum on an
exclusive world-wide perpetual basis. This unique delivery device is the key to
the success and selectivity of the ruby based laser hair removal system. The
Company believes this 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. See "License and Research Agreement with Massachusetts General Hospital
for Laser Hair Removal".
THE HAIR-REMOVAL MARKET
The market for laser-based hair removal is in its early stages and, as
such, market segment information is only now being formulated. However,
management believes that the current electrolysis market is a good model. Last
year, more than one million women in the United States underwent treatment using
electrolysis, spending on average more than $1,000 each, representing a market
of approximately $1 billion annually. In addition, surveys indicate as many as
15% of men would also like to remove unwanted hair especially from back and
chest areas. Electrolysis is the only proven commercially available method for
the long-term removal of body hair. Other methods of hair removal include
waxing, depilators, tweezing, depilatory creams and shaving, all resulting in
only short-term hair removal.
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.
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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.
Market surveys report that more than 70% 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 the longest term temporary
results, but is painful and may cause skin irritation. A number of techniques
are used to pull hair from the follicle including waxing, depilators and
tweezing. In the waxing process, a lotion, generally beeswax-based, is spread on
the area to be treated and allowed to harden, thereby trapping the hairs. The
hardened film is then rapidly peeled off, pulling out the entrapped hairs.
Depilators 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 separate hair from the
follicle, 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.
Preliminary studies using Spectrum's laser hair removal process
demonstrated significant prolonged hair growth delay ranging from six to nine
months to in excess of two years in some cases. In some cases, the hair is
permanently removed following treatment with the EpiLaser. Potential benefits of
laser hair removal include: treatment of larger areas in each treatment session,
relatively painless procedure, reduced risk of scarring, non-invasive procedure,
carries no risk of cross-contamination, and higher success rates than with
previous methods.
COMPETITION
Currently, there are three other companies (ThermoLase (Division of Thermo
Electron Corp.), Laser Industries, Ltd. and MEHL/Biophile International) that
have FDA clearance for a laser-based hair removal system in the United States.
ThermoLase, a publicly traded company, received clearance from the FDA in April
1995 to commercially market services using its laser-based hair removal system.
The ThermoLase system uses a low-energy, dermatology laser in combination with a
carbon based lotion that absorbs the laser's energy to disable hair follicles.
ThermoLase opened up spas in California, Texas, Florida and Colorado. ThermoLase
is also opening or plans to open additional spas, including in suburban Detroit,
Michigan; Greenwich, Connecticut; Manhasset, New York; Minneapolis, Minnesota;
and Palm Beach, Florida. As part of its commercialization strategy, ThermoLase
plans to establish a network of ThermoLase-owned centers in major metropolitan
areas in the U.S., third-party licensees in selected smaller U.S. markets and
joint ventures in foreign markets. Laser Industries, Ltd., received FDA
clearance in March 1997 to market its EpiTouchTM ruby laser for hair removal.
The EpiTouchTM will be sold in the U.S. through Sharplan 2000, Inc., a joint
venture of Laser Industries, Ltd. and MEHL/Biophile International Corp.
MEHL/Biophile's wholly owned subsidiary, Selvec Acquisitions Corp., received FDA
clearance in March 1997 to market its SLS CHROMOS 694 (R) long pulse ruby laser
hair removal system.
Several other companies have also indicated interest in developing and/or
introducing hair removal devices in 1997, making laser hair removal the most
competitive application within the cosmetic laser marketplace.
As more companies complete development of cosmetic/medical laser products
and/or receive FDA clearance it is expected that there will be a consolidation
of companies within the industry via acquisitions, partnering arrangements or
joint ventures. In February 1997, ESC Medical Systems announced a definitive
stock swap agreement under which it would acquire Luxar Corporation, a privately
held manufacturer of surgical lasers.
MARKETING, DISTRIBUTION AND SERVICE FOR THE EPILASER
Spectrum sells and markets the EpiLaser through an established network of
distributors in the U.S. and worldwide and will also enhance and develop a
direct sales force during 1997. Management feels that this combination allows
for a level of coverage that is more than adequate to service all its major
market segments. As part of Spectrum's marketing efforts, the sales force
provides the doctors a level of local market support including in-office
marketing brochures, advertising copy and clinical data in a marketing kit that
the doctor uses to educate the doctors' patient base. Using this marketing
approach, Spectrum is able to establish long term relationships with its
customers providing Spectrum with an installed base of customers. This base of
customers is an important factor in introducing new products to the market.
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Spectrum provides for service in the U.S. through its own service organization
with regional representation. Spectrum's international sales are serviced by its
distributor network. All service technicians are trained by Spectrum. Spectrum's
recommended preventive maintenance schedule provided by these trained technical
representatives provides for a high level of product reliability.
MANUFACTURING AND SUPPLIERS FOR THE EPILASER
Spectrum's manufacturing operations consist of the assembly and testing of
components purchased from outside suppliers and contract manufacturers. Spectrum
maintains control 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.
Spectrum depends and will depend upon a number of outside suppliers for
components used in its manufacturing process. Most of Spectrum's components and
raw materials are available from a number of qualified suppliers. One critical
component that is available through only one supplier is ruby rods. To date, the
Company has not experienced, nor does it expect to experience, any significant
delays in obtaining component parts or raw materials. Spectrum has expanded its
manufacturing capabilities in the United States to satisfy projected demand and
allow for manufacturing capacity for additional products. Spectrum is pursuing
both CE mark and ISO 9001 Registrations to meet international standards needed
to pursue European markets.
TRU-PULSE(R) C02 LASER FOR SKIN RESURFACING AND TREATMENT OF WRINKLES
Tissue Technologies manufactures and sells the Tru-Pulse Laser. In late
1995, Tissue Technologies received FDA clearance to sell and market its
Tru-Pulse laser in the U.S. for skin resurfacing. To date, Tissue Technologies
has shipped approximately 250 laser systems to dermatologists and other medical
specialists worldwide. In October of 1996 Tissue Technologies received both CE
Mark and ISO 9001 registrations, meeting the international standards that allow
products to be sold and shipped primarily to European countries. On February 18,
1997, Tissue Technologies received additional clearance from the FDA to sell and
market its Tru-Pulse Laser for the treatment of wrinkles, scar revision and burn
debridement.
The Tru-Pulse laser offers skin ablation as a means of reducing wrinkles.
The laser uses certain patented C02 technology designed especially for skin
ablation. The Tru-Pulse operates at 10,000 watts of peak power delivering 500
millijoules per pulse in a 65 microsecond pulse. The Tru-Pulse has the ability
to deliver the required amount of energy in a relatively short pulse as compared
to competitors' systems. The Tru-Pulse also has a unique beam profile. Most C02
lasers have a gaussion beam with a central hot spot. In contrast, the Tru-Pulse
has a non-gaussion beam with power evenly distributed throughout its cross
section. Clinical data suggests that the combination of these unique C02 laser
properties may account for the shorter healing time and reduced erythema
reported by doctors who use the Tru-Pulse.
The Tru-Pulse is currently being sold through distributors in the United
States as well as internationally. Tissue Technologies utilizes the same
distributors as Spectrum Medical and is in the process of enhancing/utilizing a
joint direct sales force within the Palomar Medical Products Group. The system
is also sold to dermatologists, plastic surgeons and other medical specialists
directly.
MANUFACTURING AND SUPPLIERS FOR TRU-PULSE LASER
Tissue Technologies' manufacturing operations consist of the assembly and
testing of components purchased from outside suppliers and contract
manufacturers. Tissue Technologies depends upon a number of outside suppliers
for components used in its assembly process. To date Tissue Technologies has not
experienced any significant delays or other difficulties in obtaining parts or
components. The Tissue Technology CO2 technology is based on recent technology
advances and as such is yet to be optimized. Currently, the most critical
component is manufactured by one supplier that has experienced problems in tube
reliability. The Company is currently seeking other alternative tube suppliers
as well as considering manufacturing and producing the CO2 tubes themselves, and
believes that this reliability issue will be rectified during 1997.
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COMPETITION FOR TISSUE'S TRU-PULSE LASER
Currently, there are three main competitors to the Tru-Pulse Laser: Laser
Industries (Sharplan), Coherent, Inc. and Luxar (recently acquired by ESC
Medical Systems.) Laser Industries and Coherent, combined, account for
approximately 50% of the world market. The estimated U.S. patient services
market for skin resurfacing and treatment of wrinkles is $500-plus million. The
annual worlwide cosmetic skin resurfacing product laser market is estimated to
be approximately $115 million. These numbers are expected to increase as "baby
boomers" age into their 50's. Coherent had been pricing its UltraPulse System at
the high end of the market with a high power laser that lists for $120,000, but
recently introduced new models which are priced from $75,000 to $90,000. Tissue
Technologies, Sharplan and Luxar average list price is $40,000 - $70,000.
RUBY LASER FOR TATTOO REMOVAL
In April 1995, the Company acquired all of the outstanding common stock of
Spectrum. This acquisition provided the Company with an operating subsidiary
concentrating on sales and marketing to the cosmetic laser market including
dermatologists and plastic surgeons. The majority of Spectrum's sales in the
past have been Q-Switched Ruby Lasers for tattoo removal and treating pigmented
lesions, but in 1996 more than half of Spectrum's sales were from the newly
developed EpiLaser. The EpiLaser will clearly be the focus in 1997, but the
RD-1200 ruby laser for tattoo removal will continue to be marketed and sold as
it is already approved for sale in the U.S., Japan and in certain other parts of
the world. The basic ruby laser technology includes core laser technology that
the Company believes is applicable to other lasers for additional applications.
Spectrum sells and markets the RD-1200 through an established network of
distributors and direct sales force in the U.S. and through distributors
worldwide. Spectrum provides for service in the U.S. through its own service
organization with regional representation. Spectrum's international sales are
serviced by its distributor network.
COMPETITION FOR SPECTRUM'S RUBY LASER FOR TATTOO REMOVAL
Competition in the medical device industry is intense and technology
developments are expected to continue at the rapid pace experienced over the
past few decades. Spectrum relies on proprietary technology, performance,
product features, price, reputation in the marketplace and its installed base as
leverage to keep its competitive edge in the marketplace. Spectrum competes with
other manufacturers, some with similar technology and others with competing
technology. Some of these competitive companies have greater financial,
marketing and technical resources than that of Spectrum. The Company anticipates
competition for its tattoo removal laser will continue.
FUTURE PRODUCTS
RELATIONSHIP WITH WELLMAN LABORATORIES
Wellman Laboratories ("Wellman Labs"), 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 Laser Center brings together two strengths of MGH: its
clinical departments and 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. The labs are staffed by engineers, laser
physicists and physicians familiar with all aspects of biomolecules, cells, and
tissue IN VITRO. 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
dermatologic conditions using its diode laser at Wellman Labs. In 1995, these
studies were expanded to include the Company's ruby lasers for cosmetic
procedures. The data associated with these treatments is currently being
evaluated by Wellman Labs and the Company. The Company works closely with Dr. R.
Rox Anderson, a recognized expert in laser tissue interaction and the inventor
of a number of laser procedures in use today. The Company feels that these types
of relationships are critical in developing effective products for widespread
use in the market on a timely basis.
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DIODE LASER PRODUCT DEVELOPMENT
BURN DIAGNOSIS SYSTEM - U.S. AIR FORCE CONTRACT
In March 1994, the Company's Star subsidiary was notified that their
proposal entitled "High Energy Diode Laser for Burn Diagnosis," submitted to the
Phillips Laboratory Kirkland Air Force Base, New Mexico under DOD Solicitation
94.1 Topic AF94-110, had been selected for funding. The initial contract, a
phase I Small Business Innovation Research Grant ("SBIR") for approximately
$60,000, was completed.
On June 21, 1994, Star was granted an exclusive worldwide license for the
measurement of the Burn Depth in Skin from the Office of Technology Affairs at
MGH.
In March 1995, Star was granted a follow-on phase II SBIR contract with the
U.S. Air Force, Phillips Laboratory, for the research and development of the
burn diagnosis system. The aggregate contract value is approximately $743,000
over a two-year performance period. During the fiscal years ended December 31,
1996 and 1995, the Company recognized $281,991 and $307,000 of government
contract revenue, respectively.
In January 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 in November 1996. The system is designed to
illuminate the burn site with near infrared light from a diode laser and to
image the blood flow using fluorescence from an FDA cleared dye as an aid to the
doctor in determining the burn depth. The treatment of the burn differs greatly
depending on the degree of burn. This technique has been licensed by MGH
exclusively to Star. To date the system has been tested on five burn victims and
has demonstrated the ability to detect the absence or presence of blood flow
deep in the dermis. The Company expects that it may take several years before a
commercial product for the measurement of burn depth is available.
LASER TONSILLECTOMY RESEARCH AGREEMENT WITH THE NEW ENGLAND MEDICAL CENTER
("NEMC")
In June 1994, the Company signed an agreement (the "NEMC Agreement") with
the Otolaryngology Research Center for Advanced Endoscopic Applications at New
England Medical Center, Boston, Massachusetts, 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. As defined under the
NEMC Agreement, the Company will provide a total of $150,000 over a one-year
period, of which $50,000 has been paid in the form of laser hardware and an
additional $100,000 has been incurred through December 31, 1995. The parties
have reached an understanding that the Company 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 the Company's diode
lasers in connection with performing tonsillectomies. The Company has provided
funding of $54,813 and $36,534 for the years ended December 31, 1995 and 1996
respectively. The Company intends to fund human clinical studies in this area
over the next twelve-month period. The Company expects that it may take several
years before a commercial product for tonsillectomy is available.
DYE LASER PRODUCT DEVELOPMENT
SOLID-STATE DYE LASER SYSTEM DEVELOPMENT
In response to an increasing demand within the medical community for
reliability, compactness and lower cost, the Company has completed preliminary
work on the development of a solid-state laser that the Company believes will be
substantially smaller in size, less expensive and easier to maintain than the
current medical pulsed dye lasers. By using a solid-state lasing medium in place
of fluid, the need for pumps, plumbing, valves, filters and fluid reservoirs
found in a liquid dye laser can be eliminated. In addition, since solid-state
lasers do not require regular dye and filter changes and have fewer moving
parts, they may prove to be more reliable. Research has indicated the
feasibility of a solid-state laser device and the Company has developed a
working prototype. The development of the Company's solid-state laser is in the
very preliminary stages, however, and the Company does not anticipate the
inclusion of this technology into its products within the next few years.
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U.S. ARMY CONTRACT
During 1995, the Company entered into a two-year cost plus fixed fee
contract with the U.S. Army. The contract provides for the Company to
investigate Compact, Wavelength Diverse, High Efficiency Solid-State Dye Lasers
and is valued at $3,555,223. Revenue on the contract is recognized as costs are
incurred. During the fiscal years ended December 31, 1995, and December 31, 1996
the Company recognized $1,305,542 and $190,694, respectively, of government
contract revenue. The Company does not anticipate this research will result in a
commercial product within the next few years. The Company has submitted to the
U.S. Army a draft Novation Agreement in which it seeks to have this contract
novated to Physical Sciences, Inc. ("PSI"). If the contract is novated to 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.
THROMBOLYSIS AGREEMENT
On September 10, 1993, the Company entered into the Baxter Agreement with
the Edwards LIS Division of Baxter. Under the Baxter Agreement, the two
companies intend to develop, market, and sell an integrated system utilizing
lasers and catheters for the removal of blood clots. Baxter is responsible for
sales and marketing of the product after FDA clearance and the Company is
responsible for the development and manufacture of the product. Following FDA
clearance the Company will receive 80% of the net sales for laser equipment and
50% of the net sales for catheter and disposable components. Prior to FDA
clearance, the Company will receive 100% of the revenue received from the laser
and the catheter. Under the Baxter Agreement, Baxter licensed its proprietary
technology to the Company, and the Company cross-licensed its 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 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 stroke. With the formation of
this new venture, Laser Thrombolysis is no longer part of Palomar's strategic
agenda, although the Company can still derive the benefits from its research by
potentially being the laser supplier for this large market.
PATENTS AND LICENSES
On February 24, 1993, the principals of the Company's Star subsidiary
applied for a patent. This application was subsequently transferred to Star in
connection with the technology underlying the use of a high powered diode laser
for the treatment of psoriasis and other derma vascular malformation. The patent
was issued on June 18, 1996. On June 22, 1995, the NEMC filed a patent for
Coagulation Laser Tonsillectomy. The patent was issued on May 28, 1996. Star has
applied for additional patents regarding the design and use of high powered
diode lasers. The Company has exclusive rights to the NEMC patent. MGH has filed
a number of patents surrounding technology involving laser hair removal. The
first patent was issued on January 21, 1997. The Company has licensed this laser
hair removal technology from MGH in accordance with a certain license and
research agreement as previously discussed.
The Company intends to pursue certain applications of laser technologies,
and is aware of patents relating to laser technologies used in those
applications. If those patents are valid and enforceable, they may be infringed
by the Company. If the Company's current or proposed products are, in the
opinion of patent counsel, infringing on any of these patents, the Company
intends to seek non-exclusive, royalty-bearing licenses to such patents.
The Company has obtained opinions of counsel that the Company is not
infringing on patents held by others; however, these opinions have not been
challenged in court.
In March 1997, Selvac Acquisitions Corp. ("Selvac") filed a complaint
in the United States District Court for the District of New Jersey alleging,
among other things, that the EpiLaser infringes a patent held by Selvac. The
Company filed an action against Selvac's parent MEHL/Biophile in the United
States District Court for the District of Massachusetts in October 1996 seeking,
among other things, a declaration that the Company does not infringe Selvac's
patent and that Selvac's patent is invalid, void and unenforceable. See "Item 3.
Legal Proceedings." Other than the Selvac action, the Company has not been
notified that it is currently infringing on any patents nor has it been the
subject of any patent
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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.
The United States Patent and Trademark Office has granted certain patents
covering basic laser technology to Dr. Gordon Gould, an individual not
affiliated with the Company. In October 1988, Dymed, the Company's predecessor,
entered into a License Agreement with Patlex Corporation ("Patlex") whereby
Dymed was granted a worldwide non-exclusive license to several laser related
patents developed by Dr. Gould and assigned to Patlex ("Dymed Agreement"). In
exchange for payment of royalties, Patlex granted to Dymed the right to
manufacture lasers using its patented technologies until the expiration of its
patents and agreed not to sue the Company or any of its customers for
infringement of the licensed patents. In January 1992, the Company entered into
a new Patent License Agreement with Patlex (the "Patlex Agreement") that
superseded the Dymed Agreement. Under the terms of the Patlex Agreement, the
Company is required to pay, during the term of the applicable licenses (which
are for the life of the patents covered), royalties of 5% of the "net selling
price" (as defined therein) of lasers which are manufactured, used or sold by
the Company, and incorporate Patlex's patent rights. These patents expire on
various dates through May 4, 2005. During the years ended December 31, 1996 and
1995, the Company recorded $167,000 and $620,000, respectively, of royalty
expense relating to this agreement.
GOVERNMENT REGULATION
All medical devices are subject to FDA regulation under the Medical Device
Amendments of the United States Food, Drug and Cosmetics Act (the "FDA Act").
The Company's business, financial condition and operations are critically
dependent upon timely receipt of FDA regulatory clearances.
FDA CLEARANCE STATUS FOR COSMETIC LASER PRODUCTS
The FDA clearance process in dermatology may be accomplished through a
pre-market approval ("PMA") or under Section 510(k) of the FDA Act. Based upon
discussions with several experts familiar with the FDA clearance process,
management believes that the appropriate FDA clearance process for most
dermatology laser systems is via the 510(k) process which historically has
required less clearance time than the PMA clearance process. The Company is
subject to FDA regulation governing the use and marketing of medical devices.
In December 1995, the Company filed an application for clearance with the
FDA to commercially market the EpiLaser system pursuant to the FDA's 510(k)
process. The data submitted in the filing was based on clinical information
obtained at Wellman Laboratories under the direction of Dr. R. Rox Anderson. The
purpose of the data was to illustrate the safety and effectiveness of using a
ruby laser for removing unwanted hair. In March 1997 the Company received FDA
clearance to sell and market the EpiLaser in the U.S. for hair removal. In July
1996 the Company received clearance from the FDA to sell and market the EpiLaser
for a wide range of dermatological applications, not including hair removal. The
Company's other FDA cleared lasers include the Tru-Pulse for skin resurfacing
and treatment of wrinkles and the RD-1200(TM) Q-switched ruby laser for
treatment of age spots and tattoos. In the event the Company changes laser
specifications of its lasers, it may be required to obtain FDA clearance
pursuant to a new 510(k) application.
OTHER GOVERNMENT APPROVALS FOR MEDICAL PRODUCTS
In order to be sold outside the United States, the Company's products are
subject to FDA permit requirements that are conditioned upon clearance by the
importing country's appropriate regulatory authorities. Many countries also
require that imported products comply with their own or international electrical
and safety standards. In November 1992, the Company obtained approval certifying
compliance with certain international electrical and safety regulations
applicable to its pulsed dye laser. Additional approvals may be required in
other countries. The Company has yet to apply for international approval for its
diode laser for use in cosmetics and dermatology. In October 1996, Tissue
Technologies received both CE Mark and ISO 9001 registrations, meeting
international standards that allow the Tru-Pulse laser to be sold and marketed
in certain European countries. Another significant certification the Company
will pursue will be Shonin, which allows sales and marketing of the Company's
lasers in Japan.
The Company is subject to the laser radiation safety regulations of the
FDA Act administered by the National Center for Devices and Radiological Health
("CDRH") of the FDA. These regulations require a laser manufacturer to file new
product and annual reports, to maintain quality control, product testing and
sales records, to distribute appropriate operation
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manuals, to incorporate certain design and operating features in lasers sold to
end-users and to certify and label each laser sold to end-users as one of four
classes of lasers (based on the level of radiation from the laser). In addition,
various warning labels must be affixed to the product and certain protective
devices must be installed, depending upon the class of product. Under the FDA
Act, the Company is also required to register with the FDA as a medical device
manufacturer and is subject to inspection on a routine basis by the FDA for
compliance with Good Manufacturing Practice ("GMP") regulations. The GMP
regulations impose certain procedural and documentation requirements upon the
Company relevant to its manufacturing, testing and quality control activities.
The CDRH is empowered to seek fines and other remedies for violations of these
regulatory requirements. The Company believes that it is currently in compliance
with these regulations.
ELECTRONIC PRODUCTS SEGMENT
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BUSINESS DEVELOPMENTS
ACQUISITION OF DYNACO CORPORATION
On February 9, 1994, the Company acquired substantially all of the assets
and business of Dynaco Corp. ("Dynaco"), Tempe, AZ, for $1,300,000 in cash and
the assumption of approximately $6 million in liabilities. At the time of the
acquisition, Dynaco had been operating under Chapter 11 of the U.S. Bankruptcy
Code. Dynaco now operates as a wholly-owned subsidiary of the Company and is a
manufacturer of high density flexible electronic circuitry with commercial and
government applications. The flexible circuit technology utilized by Dynaco
offers advantages over traditional circuit board technology in applications
where space constraints and performance specifications demand compact packaging
and a high level of reliability. Dynaco has developed a number of unique
products using the flexcircuit core technology that it plans to market over the
next twelve months.
FORMATION OF NEXAR TECHNOLOGIES, INC.
On March 7, 1995, the Company formed Nexar Technologies, Inc. ("Nexar), a
wholly-owned subsidiary. Nexar is an early stage company which manufactures,
markets, and sells personal computers with a unique circuit board design that
enables end users to upgrade and replace the microprocessor, memory and hard
drive components. Nexar markets its products using various proprietary brand
names through multiple channels of distribution, including the wholesale, retail
and direct response channels. Revenue recognized during 1996 was $18,695,364.
On December 20, 1996, Nexar filed a registration statement with the SEC
relating to an initial public offering of 2,500,000 shares of its common stock
for its own account, as well as shares held by Nexar shareholders. The estimated
price per share of the proposed offering is $9.00 to $11.00. Following the
offering, Palomar will beneficially own approximately 67% of Nexar's common
stock subject to a contingent repurchase right of the Company at a nominal price
per share in the event that Nexar does not achieve certain performance
milestones set forth in an agreement between Nexar and Palomar, and shares of
Nexar common stock which Palomar may acquire upon conversion of shares of Nexar
Convertible Preferred Stock. The Company anticipates that the offering will be
completed by mid-April 1997. However, the Company can in no way guarantee nor
ensure successful completion of the initial public offering.
FORMATION OF DYNAMEM, INC.
On September 29, 1995, Dynaco formed a new company called Dynamem, Inc.
("Dynamem") with an outside party who is a joint owner of the patent underlying
certain FRAMM technology (a technology utilized to package two rigid-flex
printed circuit boards in the same slot arrangement that customarily houses a
single board). The joint owner became an employee of the new subsidiary,
Dynamem. Dynamem issued 80% of its authorized and outstanding capital stock to
Dynaco and the remaining 20% to the joint owner. The joint owner granted Dynamem
a non-exclusive license to manufacture, use, sell and sublicense the patented
FRAMM technology in exchange for certain royalty payments. The royalties are
guaranteed by Dynaco. Dynaco and the joint owner also entered into a
stockholders' agreement which grants the joint owner the right, upon the earlier
of December 29, 2000 or the termination of his employment with Dynamem, to
require Dynaco to purchase a total of 75% of the securities owned by the joint
owner in Dynamem. In addition, if the Company purchases the joint owner's
shares, the joint owner may elect to receive between 35% and 100% of the
purchase price in the form of common stock of the Company.
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LICENSE AGREEMENT WITH TECHNOVATION COMPUTER LAB, INC.
Nexar's current PCs are shipped with motherboards based on technology
licensed from Technovation Computer Lab, Inc. ("Technovation"), a Nevada
corporation which, to the best of the Company's knowledge, is owned by Babar I.
Hamirani, a former executive officer of Nexar whose employment was terminated on
November 29, 1996. The Company has agreed to acquire all such technology and a
patent application related thereto, and settle all claims between Mr. Hamirani
and Nexar, no later than the closing of Nexar's initial public offering pursuant
to the Asset Purchase and Settlement Agreement by and among Mr. Hamirani,
Technovation, Nexar and the Company dated as of February 28, 1997 (the "Asset
Purchase and Settlement Agreement"). Pursuant to the Asset Purchase and
Settlement Agreement and a separate asset purchase agreement between the Company
and Nexar, the Company will first acquire the subject technology and then convey
such technology to Nexar.
FORMATION OF PALOMAR ELECTRONICS CORPORATION
On September 15, 1995, the Company formed Palomar Electronics Corporation
("PEC"), a wholly-owned subsidiary, as part of a reorganization to separate the
electronics and computer operations of the Company's business from the laser
segments of its business. On September 29, 1995, as part of this reorganization,
the Company contributed all of its outstanding capital stock of Dynaco and Nexar
to PEC in exchange for all of the outstanding common stock of PEC.
ACQUISITION OF CD TITLES, INC.
On July 13, 1995, CD Titles, Inc. ("CD Titles") was incorporated with the
Company owning substantially all of CD Titles' common stock. Certain minority
stockholders of CD Titles loaned CD Titles a total of $600,000. On July 31,
1995, CD Titles purchased certain assets and assumed certain liabilities of
CDRP, Inc. The purchase price consisted of $625,000 in cash and a $600,000 note
due September 30, 1995, which was guaranteed by the Company. The notes to
minority stockholders and CDRP, Inc. were repaid in December 1995 with 386,144
shares of the Company's common stock. CD Titles is a CD ROM publishing company
which distributes various materials on CD ROM through personal computer
wholesale channels in the United States.
ACQUISITION OF COMTEL ELECTRONICS, INC.
During 1996, Dynaco acquired 80.32% of Comtel Electronics, Inc. ("Comtel")
by converting a $100,000 note receivable into equity of Comtel and paying
$27,500 in cash. Effective December 31, 1996, as part of a recapitalization of
Comtel, Dynaco exchanged $2,200,000 in intercompany receivables from Comtel
issued by Comtel to fund its operations for an additional 16.98% ownership in
Comtel, resulting in Dynaco owning 97.3% of Comtel. The remaining 2.7% ownership
is held by two individuals. This acquisition has been accounted for as a
purchase in accordance with Accounting Principles Board (APB) Opinion No. 16.
Accordingly, the Company has allocated the purchase price based on the fair
market value of assets acquired and liabilities assumed. The results of Comtel
have been included with those of the Company since March 20, 1996.
Comtel has entered into a five-year agreement with New Media, Inc. ("New
Media") whereby New Media subcontracted to Comtel all of its manufacturing and
assembly business over the contract term. On April 5, 1996, Palomar invested
$2,690,000 in New Media Series E Preferred Stock and common stock and loaned New
Media an additional $1,000,000. Palomar also received a warrant to purchase
200,000 shares of common stock in New Media at $1.20 per share. Palomar has
accounted for this investment under the cost method.
On February 14, 1997 Palomar invested an additional $1,200,000 and
converted its $1,000,000 note plus accrued interest totaling $76,931 into New
Media Series F Preferred Stock. In addition, Palomar also entered into a
settlement agreement together with Lucent Technologies and New Media whereby
Palomar agreed to purchase 33,000 LapTalk(TM) speaker/microphone products from
Lucent Technologies and New Media for $1,200,000, which was paid March 1997.
During the twelve months ended December 31, 1996 Comtel had sales to New
Media of $15,664,967. At December 31, 1996, $4,896,632 of accounts receivable
was due from New Media, of which $2,475,929 was collected through March 20,
1997.
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GENERAL
Through its wholly-owned subsidiary Nexar, PEC is marketing and
manufacturing a new family of personal computers that incorporates user-oriented
printed circuit boards and computer chassis designs that allow an end-user to
conveniently alter or upgrade the computer's processor, memory and hard drive
capacity, thereby reducing the rate of obsolescence in the rapidly changing and
technology-driven arena of personal computers. Nexar offers PCs to its resellers
without the CPU, RAM, cache and hard drive pre-installed, allowing them to
configure the PC with their customers' choice of components. Unlike other
upgradeable or modular computers, Nexar PCs are not based on a proprietary
architecture. Industry standard components can be used. The customer, not the
manufacturer's technicians, is in control of enhancements to the system. The
removable hard drive is a feature that is particularly desirable where security
is an issue or when a user wants portable data to go. It also makes possible the
use of multiple operating systems on a single PC. See "Formation of Nexar
Corporation".
PEC, through its wholly-owned subsidiary Dynaco, designs, develops and
manufactures interconnect products, principally flexible circuits, for
electronic systems. Dynaco currently designs flexible interconnect solutions for
complex military and commercial applications where high reliability, precision
tolerances and multilayer packaging are important. Dynaco's traditional
customers serve diverse markets, including the defense, aerospace, electronics
and telecommunications industries. Dynaco has recently developed two new,
lower-cost flexible circuit products which it believes will enable it to develop
more cost-effective interconnect solutions for commercial applications. Comtel,
which is a majority owned subsidiary of Dynaco, is a contract manufacturer that
specializes in thin core and high density surface mount assemblies for the
computer and telecommunication industries. Dynaco, through its majority-owned
subsidiary Dynamem, has developed, and plans to manufacture and market to the
personal computer industry, foldable rigid assembly memory modules which it
believes will have between 50% and 100% more memory capacity than currently
available memory modules.
PERSONAL COMPUTER INDUSTRY BACKGROUND
In 1991, there were over 100 vendors competing in the personal computer
marketplace with intense competition in both price and product specification.
Nexar believes that, over the past five years, the personal computer industry
has become oversaturated with manufacturers of varying degrees of financial
stability and marketing expertise. Since 1995, many personal computer
manufacturers have exited the industry for a variety of reasons, and many more
have reported significant losses.
Nexar believes that aggressive channel expansion played an important role
in the demise of many second and third tier personal computer manufacturers.
Since 1995, many first tier manufacturers have expanded their channels of
distribution to include national distributors, mass merchants, computer
superstores, office superstores, end-user direct sellers and wholesale buying
clubs. Prior to 1992, these channels were almost exclusively the domain of the
second and third tier manufacturers. The channel expansion of the top tier
manufacturers reduced the available retail shelf space for second and third tier
manufactures through these once alternative channels. Consequently, second and
third tier suppliers, which compete primarily on the basis of price and
availability, are facing ever-increasing competition.
NEXAR STRATEGY
The Nexar strategy is to provide products that benefit wholesalers and
resellers by reducing their commitment to inventory with specific unit
configuration and permitting them to satisfy customers with systems easily
configured to their needs, and that benefit end-users by permitting them to
upgrade components from time to time without incurring the expense of a new
system.
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LEVERAGE NEXAR'S XPA(TM) (CROSS-PROCESSOR ARCHITECTURE) TECHNOLOGY.
Nexar develops, manufactures and markets high-performance,
competitively-priced desktop personal computers (PCs) based on patent-pending
technologies. Unlike conventional PCs, Nexar systems permit an end user to
easily upgrade or switch important components of the PC to accommodate emerging
and future technologies resulting in a significant extension of the computer's
useful life. Nexar sells a high-performance system which is typically shipped to
resellers without the key system defining components (microprocessor, memory and
hard drive), but which is otherwise fully configured. This approach:
Enables the end-user, whether corporate or individual, to buy a system
configured exactly to that customer's technical and budgetary
requirements and, later, to easily upgrade the PC's key components
with industry-standard products;
Enables Nexar's channel resellers to reduce their exposure to
inventory depreciation caused by rapid advances in technology and
frequent price reductions of the key system components, which
typically account for more than 50% of the cost of a PC;
Enables Nexar's resellers to compete with direct marketers, such as
Dell Computer and Gateway 2000, because a Nexar PC provides resellers
with the ability to promptly deliver a custom-configured, high
performance PC at a competitive price;
Enables Nexar to maintain profit margins unaffected by the forecasting
risks borne by conventional PC manufacturers who operate within a
several-month-long cycle from component procurement to assembly to
date-of-sale, all conducted in an environment of rapid technological
advances and frequent price reductions.
Nexar's current PCs are based on an industry standard, open architecture
design, co-engineered by HCL Hewlett Packard LTD., which allows the central
processing unit (CPU), random access memory (RAM), and cashe memory to be
replaced by end-users without technical assistance and without opening the
entire chassis. Nexar's current model accepts Intel Corporation's Pentium and
compatible CPUs, including the recently released Pentium processor with MMX
multimedia extension technology. Nexar PCs also include, as a standard feature,
a removable hard drive, permitting its replacement and the further advantages of
increased data portability and security, and the use of multiple operating
systems in a single PC. The Nexar PC is configured with the following
components: system chassis with removable side panels, custom designed
motherboard, power supply, video controller, input/output controller, floppy
disk drive, caddy for removable hard disk, keyboard, mouse, and hardware
manuals. Nexar occasionally includes additional components, including the key
system defining components (CPU, memory and hard drive) and peripherals such as
monitors and modems at the customer's request. Nexar PCs sold by resellers fully
configured have list prices generally ranging from $1,200 to $2,500, depending
upon the components included.
Nexar's objective is to become the industry leader in designing and
marketing PCs with technology that enables resellers and end-users, in an easy
and cost-effective manner, to upgrade and transition the CPU and the other key
system defining components in accordance with the known and anticipated roadmaps
of various makers of fundamental and leading-edge PC technology. Accordingly,
Nexar has developed and will soon market a new generation of PCs featuring the
Company's patent-pending Cross-Processor ArchitectureTM (Nexar XPATM ) in which
any one of the several state-of-the-art CPUs can be initially included or later
installed, including Intel's Pentium or Pentium Pro and Compatible CPU's. The
Nexar XPATM technology will also accommodate microprocessors based on other
technologies, such as the Alpha CPU made by Digital Equipment Corporation or the
PowerPC processor offered jointly by IBM, Motorola, and Apple Computer.
ENGAGE IN PRIVATE LABELING.
Nexar believes that as personal computer users become increasingly computer
literate, they will tend to shift away from branded products and towards private
label products. Nexar anticipates that contemporary technology and design,
upgradability, value, reliability and system flexibility will continue to be
essential requirements, but the method of presentation and product distribution
will adapt to satisfy the requirements of resellers and users alike. A primary
component of Nexar's overall channel strategy is to bypass the OEM and provide
custom, private label systems directly to major channel resellers. Nexar
believes that there will be a proliferation of private label personal computers
by channel resellers, and that
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private label branding will become an increasingly standard practice in various
reseller channels. Nexar intends to be one of the first manufacturers to
capitalize upon this opportunity.
EXPLOIT SPECIALIZED GOVERNMENT MARKETS.
Nexar believes that, in addition to the other advantages of Nexar PCs and
the increased security and other benefits of the removable hard disk drive
described herein, the Nexar PC is particularly appealing to many government
buyers because the time required for ordering entirely new systems is often
prohibitive under government regulations, while component parts can be more
timely requisitioned, thereby allowing a government office to more easily remain
technologically current. In 1996, Nexar recognized approximately 66% of its
total year revenue from Government Technology Services, Inc. (GTSI), a leading
supplier of desktop systems to the U.S. government.
COMPETITION
The desktop PC industry is intensely competitive and may become more so as
the result of, among other things, the introduction of new competitors
(including large multi-national, diversified companies) and possibly weakening
demand. Nexar currently competes in the desktop PC market principally with Acer,
Apple Computer, Compaq Computer, Dell Computer, Gateway 2000, Hewlet-Packard,
IBM and Packard Bell NEC. In addition, Nexar plans to compete in the network
server market by late 1997 with established companies such as ALR, Compaq, Dell,
Hewlett-Packard and IBM. All of these companies have stronger brand recognition,
significantly greater financial, marketing, manufacturing, technological and
distribution resources, broader product lines and larger installed customer
bases than Nexar. Principal competitive factors include product features,
product performance, quality and reliability, the ability to deliver product to
customers in a timely fashion, customer service and support, marketing and
distribution capabilities and price. The ability of Nexar to compete
successfully will depend on factors within and outside its control, including
the acceptance of its Nexar XPA(TM) system and general market and economic
conditions.
MANUFACTURING AND SUPPLIERS
Nexar's manufacturing process requires a high volume of quality components
that are procured from third party suppliers. Most of these components are
generally available from multiple sources; however, Nexar relies on two outside
contractors to manufacture motherboards used in PCs and plans to rely on a sole
outside contractor to manufacture the motherboards to be used in its planned
server product. In addition, Nexar relies on a single supplier to produce its
customized chassis and has several other single supplier relationships for less
critical components. In some cases, alternative sources of supply are not
readily available for some of Nexar's single sourced components. Nexar
occasionally experiences delays in receiving certain components, which can and
has caused delays in shipment of products.
ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS
Although Nexar conducts certain manufacturing operations, those operations
consist primarily of product assembly and do not involve the use of material
quantities of hazardous or other regulated substances. Nexar believes that it
has substantially complied with existing environmental laws and regulations, but
has not conducted any environmental studies of its operations to determine
whether contamination has occurred at its facilities. Nexar's computer products
are subject to certain FCC guidelines. Nexar believes they are in compliance
with these FCC guidelines.
INTELLECTUAL PROPERTY
Nexar has rights to two pending patent applications covering the essential
technology which enables the easy installation, removal and replacement of key
components in the Nexar PC. Nexar filed a patent application in late 1996
covering its proprietary Nexar XPATM technology, which is expected to be used in
Nexar's PCs by mid-1997. Also Nexar has agreed to acquire, no later than the
closing of its initial public offering, a patent application originally filed in
March 1995 together with the related technology which is currently included in
Nexar's PCs under an exclusive license agreement.
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DYNACO CORP. BUSINESS INTRODUCTION
DYNACO CORP. ("DYNACO")
Dynaco is a leading U.S. supplier of high-density, multilayer, flexible
printed circuit products for original equipment manufacturers ("OEMs"),
value-added resellers and contract manufacturers of sophisticated electronics
equipment. Specifically, Dynaco designs, develops and manufactures products that
provide electrical connections between components in electronic systems.
Dynaco's interconnect solutions use 3-dimensional packaging techniques to
enhance space utilization and increase signal speed via thin, multilayer
substrates. Dynaco's principal products are flexible circuits and rigid-flex
circuits. Dynaco's flexible circuits are flexible, multilayer printed circuit
boards that can be bent or folded to fit into spaces too small or too oddly
shaped for traditional rigid printed circuit boards. Dynaco's rigid-flex
circuits consist of one or more rigid, multilayer printed circuit boards
combined with flexible circuitry. The multiple layers of circuitry in Dynaco's
products increase reliability and reduce the overall size of its interconnect
systems by reducing the number of circuit boards, connectors and wires. Dynaco
also manufactures specialty interconnect cable harnesses that are sold with
Dynaco's traditional flexible circuit products and that are sold independently.
Dynaco currently designs flexible interconnect solutions for complex
military and commercial applications where high reliability, precision
tolerances and multilayer packaging are important. Dynaco's traditional
customers serve diverse markets, including defense, aerospace, electronics,
telecommunications, global positioning systems navigation, medical electronics,
interactive displays and semiconductor wafer fabrication equipment. For example,
Dynaco's products have been used in guidance systems for the Tomahawk and AMRAAM
missiles, and Dynaco has developed applications for lasers, night vision
systems, digital imaging and engine monitoring controls.
FLEXIBLE INTERCONNECT SUBSTRATE INDUSTRY BACKGROUND
Generally, interconnect substrates are printed circuits, consisting of
copper traces (circuitry) and an insulating (dielectric) base, that provide
electrical connections between electronic components such as microprocessors,
resistor networks and capacitors. Interconnect substrates include rigid printed
circuit boards, ceramic hybrid circuits and flexible circuits. Each type of
substrate has specific performance and price ratios which affect usage and
demand in the marketplace.
Dynaco believes that its multilayer flexible circuits offer the following
advantages over rigid printed circuit boards and ceramic substrates for
sophisticated, compact electronic equipment:
Flexible circuits are thinner and better able to conform to smaller
volumes and unusual container shapes;
Flexible circuits allow 3-dimensional interconnect packaging
techniques;
Flexible circuits are lighter and more space-efficient because they
eliminate the need for connectors and wires;
Film-based flexible substrates cost significantly less per
input/output connection than ceramic-based interconnect systems; and
The use of multiple layers can provide significant performance
enhancements over single-sided and double-sided interconnect packages.
The 3-dimensional packaging and flexure characteristics of multilayer
flexible circuits and multilayer rigid-flex circuits have made them the fastest
growing segment of the U.S. printed circuit market. According to a May 1996
report by TechSearch International, Inc., a technology licensing and consulting
firm, the world market for flexible printed circuits in 1995 was approximately
$1.8 billion to $2.0 billion, of which the U.S. market was approximately $550
million, an increase of nearly 18% from $470 million in 1994. Japanese
manufacturers and their affiliated offshore operations had approximately 60%
share of the world market. According to Flexible Circuits Engineering, an
industry publication, sales of flexible circuits in North America have grown
from $300 million in 1985 to an estimated $650 million in 1995. The publication
points out that the market has grown erratically, growing principally in the
periods from 1985 through 1987 and from 1993 through the present. According to
Flexible Circuits Engineering, the first growth phase reflected a short-lived
increase in the use of flexible circuits in missiles, "black boxes" and other
defense-related products shortly before the end of
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the Cold War, and the current growth phase reflects the increased use of
flexible circuits in commercial markets, including the personal computer,
automotive, consumer and instrument markets. As a result of these market trends,
Dynaco believes there is a significant market opportunity for manufacturers that
can timely deliver complex multilayer flexible and rigid-flex circuits to
leading suppliers of electronic equipment.
DYNACO STRATEGY
Dynaco's objective is to be the preferred supplier of multilayer flexible
circuits and rigid-flex circuits in the electronics industry and to expand its
business to include high density memory modules. Dynaco's strategy is to
capitalize on its significant investment in flexible circuit technology, modern
facilities and multilayer packaging expertise in order to participate in the
growth of the worldwide electronics market. In order to achieve its objective
and benefit from the trends in the industry, Dynaco's strategy includes the
following:
MAINTAIN AND IMPROVE THE COMPANY'S MARKET POSITION IN THE DEFENSE/AEROSPACE
MARKETS
Dynaco seeks to capitalize on a growing trend among electronics
manufacturers in the defense and aerospace markets to reduce the number of
suppliers with which they do business and to increase their out-sourcing of
higher level assemblies. Dynaco is currently a preferred supplier with leading
prime contractors such as Hughes Aircraft Company, Lockheed Martin Corporation,
Loral Corporation, McDonnell Douglas Corporation and Raytheon Company. A
preferred supplier is one of a select number of suppliers whose products and
facilities have been determined by the customer to meet certain performance and
quality specifications. Because customers frequently contact only preferred
suppliers for particular products, Dynaco intends to obtain and maintain the
status of preferred supplier with its current and prospective customers.
In January 1997, Raytheon announced a tentative agreement to purchased the
defense operations of Texas Instruments, Inc. and GM Hughes Electronics Corp.
for $2.95 billion and $9.5 billion respectively. These three companies combined
accounted for approximately one third of Dynaco's 1996 revenue. It is too early
to determine how this proposed consolidation will affect Dynaco.
Another market trend is the growth occurring in defense electronics due to
electronic upgrades, re-packaging for lower cost, and the commercialization of
defense hardware. Dynaco is currently developing new flat-panel displays,
night-vision systems, digital electronic upgrades, global positioning system
navigation products and enhanced communication systems that use flexible
circuits as the principal electronic interconnect. Dynaco also plans to utilize
its packaging expertise to convert wire bundles and cable harnesses into
flexible circuits to reduce weight, space and cost. Dynaco has designed and
currently expects to convert at least five wire and cable electronic
interconnect systems.
COMMERCIALIZE THE DYNAFLEX PRODUCTS
Dynaco believes that the demand for smaller electronic products will
increasingly cause commercial designers to consider high-density multilayer
flexible packaging. Historically, Dynaco's flexible circuit products have been
too costly to make most commercial applications feasible. Dynaco has recently
developed, and in June, 1995, submitted patent applications for, Dynaflex-D
(Dynamic) and Dynaflex-S (Static), two new flexible circuit products that
utilize less expensive, commercial-grade substrates. Dynaco believes that these
proposed products will permit it to expand into commercial markets. Dynaco
believes that its proposed Dynaflex-D and Dynaflex-S products will ultimately be
used in commercial applications such as automotive engine monitoring controls,
disk drives, personal computers, workstations, and cellular communication
systems.
EXPLOIT MANUFACTURING AND MARKETING CAPABILITIES
Dynaco believes there are few domestic or foreign high-volume
multilayer flexible and rigid-flex circuit manufacturers with comparable
expertise and know-how. As the manufacture of multilayer flexible circuits for
commercial applications proliferates, Dynaco intends to license its
manufacturing and marketing expertise to high volume, highly capitalized printed
circuit board manufacturers throughout the world. Dynaco recently signed a
license agreement with Wong Circuits International, a Hong Kong corporation, to
manufacture certain flexible circuit products in Hong Kong and China. In
addition, the Company is currently conducting negotiations with other
manufacturers in the United States and
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Europe. By working with these manufacturers, Dynaco hopes to expand the customer
base for its flexible circuits technology.
ACQUIRE, DEVELOP AND MARKET FLEXIBLE CIRCUIT PRODUCTS
Dynaco through its Dynamem subsidiary and internal research and
development, intends to produce and market additional flexible circuit products.
Dynaco has recently obtained certain rights to the patented FRAMM technology.
See "Acquisition of Dynamem."
COMTEL ELECTRONICS, INC. BUSINESS INTRODUCTION
COMTEL ELECTRONICS, INC. ("COMTEL")
Comtel, which was acquired in 1996, is an electronic and
electro-mechanical, contract manufacturer. Comtel's business is to provide a
lower cost alternative (outsourcing) to OEM in-house, or captive manufacturing.
Comtel's primary product is turnkey, build-to-print (versus its own design)
circuit card assemblies. These circuit card assemblies range in complexity from
very high volume, relatively simple (few components) assemblies in support of
the consumer electronics industry, to very complex, full "black and white box"
builds for high technology industry.
CONTRACT MANUFACTURING INDUSTRY BACKGROUND
Contract electronics manufacturers (CEMs) are playing an even more
important role in the electronics market. The world market for contract
manufacturing services exceeded $30 billion in 1996, and industry analysts
recently estimated the U.S. contract manufacturing market will grow from $11
billion in 1994 to over $36 billion by the year 2001, a compound average annual
growth rate of 20%. Based on industry data, the Company believes that OEMs are
increasingly relying upon independent manufacturers of complex, electronic
interconnect products, such as Comtel, rather than on internal captive
production. Factors which Comtel believes will lead OEMs to utilize contract
manufacturers include:
LIMITED RESOURCES USED ON CORE COMPETENCIES: In recent years the
electronics industry has experienced greater levels of competition and
technical changes forcing OEMs to focus their resources on critical product
activities. By offering comprehensive turnkey manufacturing services, CEMs
afford OEMs the resources to focus on core activities such as product
development, marketing and product distribution.
IMPROVED PURCHASING POWER AND MATERIAL MANAGEMENT: OEMs are faced with
increasing difficulties planning, procuring and managing their inventories
efficiently due to frequent design changes, short product life-cycles,
component price fluctuations, and the need to achieve economies of scale in
material procurement. By using the CEMs' combined purchasing power and
required expertise in inventory management, OEMs can reduce capital
required for production and inventory.
REDUCED CAPITAL INVESTMENT: As electronic products become more
technologically advanced, including the transition from through-hole to
surface mount assembly, the manufacturing operation has become more
sophisticated and automated, requiring a greater level of capital
investment in equipment. By outsourcing, OEMs can reduce their overall
capital equipment investment, maintain access to the latest advanced
manufacturing technology, and enjoy the lower costs associated with higher
capacity utilization experienced by CEMs.
DESIGN/PACKAGING EXPERTISE: The customer benefits from the ever
accumulating design and packaging capabilities of CEMs. For example, Comtel
works on hundreds of different designs each year and certain packaging
solutions can be applied to a multitude of new applications. OEMs are
motivated to work with a CEM in order to gain access to this process
expertise and manufacturing know-how.
Comtel Electronics believes they can exploit this market with the latest
manufacturing capabilities in surface mount assembly and thin core PC card
assembly.
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COMTEL STRATEGY
Comtel is a CEM who provides turnkey manufacturing and test services of
electronic assemblies. Comtel specializes in thin core and high density surface
mount assemblies. Comtel's services consist of design, procurement,
manufacturing and test.
DESIGN: Working closely with customers and the substrate manufacturer,
Comtel designs a specific packaging configuration to satisfy the customer's
requirements for reliability and lowest cost of ownership. In selection of
substrate materials, Comtel advises its customers with respect to issues
such as size, power consumption and package configuration.
PROCUREMENT: Early involvement in the design process allows Comtel to
assist in the selection of suppliers and components to enhance time to
market, manufacturability and logistical support of volume ramp-ups. As
part of the procurement process, Comtel offers its customers material
planning and procurement, inventory management, and material handling
services. From time to time, material suppliers must allocate components
among their customers in response to supply shortages. By assuming
responsibility for procurement, Comtel and the Company may be required to
bear the risks of price fluctuations and availability. However, in certain
cases, Comtel can pool its purchasing power and leverage its position as a
manufacturing partner to receive more favorable pricing and volume
allocations.
ASSEMBLY: Substrate assembly involves the exact placement and
soldering of a wide size range of electronic components. Comtel's current
assembly techniques range from manual assembly of through-hole connectors
to highly automated screen printing and placement of miniaturized SMT
components. SMT is a method of affixing electronic components, including
integrated circuits, onto the surface of a substrate. Components mounted in
SMT assemblies can be of relatively small size due to the use of fine
lead-to-lead spacing (called "pitch") which currently can be as small as 12
Mils. Comtel's SMT assembly process has become increasingly complex because
of these smaller dimensions and tight tolerances, and accordingly requires
the use of expensive automated assembly and test equipment.
TEST: Using sophisticated in-circuit and functional test systems,
Comtel tests complex assemblies in order to determine whether the
electronic assembly is performing to customer satisfactions. Comtel's
current and planned investment in manufacturing defect analyzer testers
enables customers to specify a wide range of test options.
DYNAMEM, INC. BUSINESS INTRODUCTION
DYNAMEM, INC. ("DYNAMEM")
Dynamem spent most of 1996 developing the 64MB, 128MB, and 256MB FRAMM high
density memory modules. These memory modules are currently being technically
evaluated by a number of potential OEM users. A memory module usually consists
of various configurations of memory chips or other memory devices mounted on a
printed circuit board inserted into a slot on a computer's motherboard. Memory
modules currently in use include single in-line memory modules ("SIMMs") and
double in-line memory modules ("DIMMs"), both of which utilize rigid printed
circuit boards. Industry standards limit the number of memory chips that can be
mounted on a rigid printed circuit board within a given length and height.
Consequently, a traditional memory module that has reached the maximum length
and height has also reached maximum memory capacity. Dynamem believes its
proposed memory modules will overcome this limitation of memory capacity by
utilizing the FRAMM technology to fit two rigid printed circuit boards in the
same slot arrangement that customarily houses SIMMs and DIMMs. Dynaco's proposed
memory modules will mount thin, small outline package memory chips onto two
rigid printed circuit boards, connected by flexible circuits, that are folded
for insertion into the motherboard.
HIGH-DENSITY MEMORY MODULES
A memory module usually consists of various configurations of memory
devices or chips mounted on a printed circuit board inserted into a slot on a
computer's motherboard. Dynamem's memory modules consists of two rigid printed
circuit boards connected by flexible circuits that are folded for insertion. In
recent years, the overall size of computers, especially that of portable
computers, has shrunk while the newest program applications, such as Windows 95,
continue to use increasing amount of random-access memory ("RAM"). Meanwhile,
computer manufacturers are shipping an increasing number of systems with limited
RAM in order to maintain price competitiveness. As a result, end-users who
desire to run
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the latest applications must add memory modules or buy new systems with greater
memory capacity. Dynaco believes that these trends will favor manufacturers of
high density memory modules as requirements for RAM increase from 16MB to 32MB,
64MB, 128MB and beyond.
DYNAMEM STRATEGY
Dynaco has introduced high density memory modules based on the patented
FRAMM technology. These memory modules overcome the current limitation on memory
capacity by utilizing the FRAMM technology to fit two rigid printed circuit
boards in the same slot arrangement that customarily houses SIMMs and DIMMs.
Dynaco's memory modules will mount thin, small outline package memory chips onto
two rigid printed circuit boards, connected by flexible circuits, that are
folded for insertion into the motherboard. This combination produces a module
that is no wider or taller than conventional rigid boards but that offers four
substrate surface areas, twice the area offered by rigid boards. Dynaco believes
that FRAMM represents a novel and innovative packaging approach which will have
between 50% and 100% more memory capacity than currently available memory
modules.
This is in comparison to a traditional memory module that consists of
various configurations of memory chips or other memory devices mounted on a
printed circuit board inserted into a slot on a computer's motherboard. Industry
standards limit the number of memory chips that can be mounted on a rigid
printed circuit board within a given length and height. Consequently, a
traditional memory module that has reached the maximum length and height has
also reached maximum memory capacity. Dynaco is designing a full memory product
line around the FRAMM technology. Initial products are planned for
IBM-compatible personal, portable, laptop and notebook computers, Apple
Computer's Macintosh computers and Sun Microsystems' workstations. Dynaco also
plans to design custom modules for certain special needs and is investigating
other applications.
SALES AND DISTRIBUTION
Dynaco markets its products through a direct sales force and through a
network of four independent sales representatives and distributors specializing
in electronics equipment. Dynaco principally targets large OEM corporations and
government prime contractors. These and other customers often employ competitive
bidding techniques with respect to large, multi-year contracts, for which Dynaco
competes with other qualified suppliers of flexible circuits.
Comtel presently utilizes a combination of direct factory and independent
manufacturers representatives sales personnel and is moving towards complete
direct selling. Comtel relocated its manufacturing facility in November 1996 to
a much larger (65,000 square feet) facility to increase its capacity to fulfill
the expected increase in demand.
Dynaco's Dynamem subsidiary markets its FRAMM products through both a
separate sales organization and through Nexar. Dynaco believes that this
approach will enable the Dynamem sales force to develop specific industry
contacts and a focused knowledge base of the high-density memory market.
Dynaco has generally utilized selected sources to obtain volume discounts.
CUSTOMERS
DYNACO
Dynaco's traditional customers include OEMs, prime contractors and contract
manufacturers of defense and aerospace electronics, telecommunications
equipment, navigational systems and medical products. Dynaco's new Dynaflex
products have attracted prototype orders from customers in the automotive,
computer and data storage markets.
For the year ended December 31, 1996, sales to Hughes, Raytheon, and
Lockheed Martin accounted for approximately 20%, 10% and 5%, respectively, of
Dynaco's net sales. For the year ended December 31, 1995, sales to Raytheon ,
Hughes Electronics and Loral accounted for 15%, 9% and 6%, respectively, of
Dynaco's net sales. Sales to Dynaco's top 10 customers accounted for
approximately 55% of Dynaco's net sales for the year ended December 31, 1996.
Approximately 100 other customers accounted for the remainder of Dynaco's net
sales for the year ended December 31, 1996.
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COMTEL
Comtel entered into a five year agreement New Media, whereby New Media
subcontracted to Comtel all of its manufacturing and assembly business over the
contract term. Comtel recognized approximately $17.1 million of total revenue of
which 91% was from New Media. Comtel's intention in 1997 is to increase and
diversify its overall revenue base and reduce the percentage of New Media
concentration. The Company has received orders in 1997 from customers such as
MCI, MGE UPS Systems and others, thereby reducing the New Media customer
concentration. However, the Company cannot ensure that the New Media
concentration will significantly decrease in 1997.
COMPETITION
The flexible circuit industry is characterized by intense competition.
Dynaco and its competitors have developed various technologies to serve niche
packaging requirements. Dynaco has focused its development efforts on more
complex multilayer circuit technology rather than single sided or double sided
circuit technology. Among others, Dynaco's competitors include Packard-Hughes
Interconnect Co., Parlex Corporation and Teledyne, Inc. Dynaco believes it
competes principally on the basis of design, quality, price and customer
service. Some of Dynaco's competitors include larger companies that have
substantially greater managerial, financial, technical and marketing resources
than Dynaco.
Other flexible circuit companies such as Adflex Solutions, Inc., Sheldahl,
Inc., MFlex and Smartflex primarily market single sided and double sided circuit
technology. Although Dynaco does not currently compete with such companies with
respect to those products, Dynaco believes that the customers of these companies
have begun to demand multilayer flexible circuits and that such companies will
become competitors in the near future.
The contract manufacturing market is estimated to be $30 billion plus
worldwide made up of many competitors. Comtel primarily competes with smaller
sized regional competitors. The same is true for Dynamem which competes in a $20
plus billion computer memory market.
ENVIRONMENTAL CONTROLS AND GOVERNMENT CERTIFICATIONS
The manufacture of substrate interconnect products involves numerous
chemical solvents and other solid, chemical and hazardous wastes and materials.
Dynaco incurs approximately $200,000 per year in waste treatment costs. Dynaco
is subject to a variety of environmental laws relating to the generation,
storage, handling, use, emission, discharge and disposal of these substances.
Dynaco believes that it operates its facilities in substantial compliance with
existing environmental laws and regulations. In June 1989 and April 1994, Dynaco
conducted environmental studies of its Tempe, Arizona substrate manufacturing
facility and did not discover any contamination requiring remediation.
Certain sales of flexcircuits are subject to certain military and
government certifications. Dynaco maintains military certifications for
Mil-P-50884, Mil-P-55110, Mil-I-45208 and Mil-Std. 2000, and various subsets of
such certifications. In January 1996, Dynaco obtained ISO 9001 certification.
Dynaco is further subject to various federal, state and local regulations
regarding environmental protection and hazardous substance controls. Management
believes that its Dynaco operations are in compliance with governmental
environmental regulations.
MANUFACTURING AND SUPPLIERS
Dynaco relies upon a number of outside suppliers for all of its
manufacturing supplies, parts and components and, to date, has not experienced
any significant delays in obtaining parts and components. Although most of the
supplies, parts and components are available from multiple sources, Dynaco has
generally utilized selected sources to obtain volume discounts. Pyralux(R), a
substrate material used in substantially all of the products sold by Dynaco in
1994, is available only from DuPont. In addition, certain customers issue, from
time to time, narrow product specifications that can be fulfilled only by a
single component available from a single source. Because such specifications
vary from product to product, Dynaco is unable to anticipate its future needs
for such components and therefore cannot make advance arrangements for the
supply of such components. Dynaco believes that it will continue to be able to
obtain most of the required components and parts from a number of different
suppliers. Dynaco may subcontract production of certain subsystems, such as heat
exchangers, power
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supplies and electronic control modules, in order to minimize production
overhead and to avoid rapid fluctuations in capacity utilization as the demand
for Dynaco's product changes.
PATENTS IN THE ELECTRONIC BUSINESS SEGMENT
The Company's Nexar subsidiary has filed a patent for the construction
method facilitating replacement of CPU memory and other modules in a personal
computer. This technology allows the end user a simple, quick and easy platform
for upgrading the most volatile components in a personal computer.
The Company, through its Dynaco subsidiary has filed a patent for flexible
circuit boards and method for their manufacture. This technology covers a unique
method of manufacturing, using proprietary materials that enable the
manufacturer to be cost competitive with rigid board manufacturers. Dynaco is
awaiting first office action from the U.S. Patent Office. As part of the
formation of Dynamem discussed previously, Dynamem became joint owner of an
issued patent surrounding technology that uses two rigid printed circuit boards
attached by flex circuitry that can be folded with low profile memory chips
attached to be inserted into the motherboard of a computer. This design, while
no larger than conventional rigid board designs, doubles the capacity of
conventional memory modules.
RESEARCH AND DEVELOPMENT
For the fiscal year ended December 31, 1996, and December 31, 1995, the
Company incurred $7,977,085 and $4,419,487, respectively, in product research
and development costs. Due to the intense competition and rapid technological
changes in the medical device and electronic industry, the Company believes that
it must continue to improve and refine its existing products and services, and
develop new applications for its technology. The Company also intends to obtain
additional technology and expand its product line through strategic
partnerships, joint ventures, licensing and acquisitions.
EMPLOYEES
As of December 31, 1996 the Company and its subsidiaries had 522 full-time
employees and 64 temporary employees. When necessary, the Company also relies on
consultants with particular expertise for specific research and consulting
assignments. 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.
ITEM 2. DESCRIPTION OF PROPERTY
The Company currently leases approximately 11,500 square feet of research
and development and office space in Beverly, Massachusetts under a seven year
lease, expiring in June 2000, for laser research and as corporate headquarters.
The Company's Dynaco subsidiary leases approximately 55,000 square feet in
Tempe, Arizona under a lease from a partnership consisting of Dynaco's Chief
Executive Officer and Chief Operating Officer which expires in July 1997. The
Company's Comtel subsidiary leases 65,000 square feet in Tustin, California,
which is used as a manufacturing facility under a lease that expires in August
2002. The Company's Star subsidiary leases an office and research facility of
approximately 6,200 square feet in Pleasanton, California for diode laser
research and manufacturing under a lease expiring in April 1999. The Company's
Spectrum subsidiary leases an office, manufacturing and research facility of
approximately 25,000 square feet in Lexington, Massachusetts under a lease
expiring in June 2000. The Company's Tissue Technologies subsidiary leases an
office and manufacturing facility of 17,000 square feet in Albuquerque, New
Mexico under a lease expiring in October 1999. The Company's Nexar subsidiary
leases an office and telemarketing facility of approximately 7,000 square feet
in Westboro, Massachusetts under a lease expiring in August 1998, and a
manufacturing facility of approximately 100,000 square feet in Haywood,
California under a lease expiring in August 2001. The Company's Palomar
Technologies, Ltd. subsidiary owns an office and leases a manufacturing facility
in Hull, England. In the opinion of management, the properties leased by the
Company and its subsidiaries are currently suitable and adequate for their
intended purposes.
<PAGE>
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ITEM 3. LEGAL PROCEEDINGS
On October 7, 1996 the Company filed a declaratory judgment action against
MEHL/Biophile ("MEHL") seeking (i) a declaration that MEHL is without right or
authority to threaten or maintain suit against the Company or its customers for
alleged infringement of the patent held by MEHL's subsidiary Selvac Acquisitions
Corp. ("Selvac" and the "Selvac Patent"), that the Selvac Patent is invalid,
void and unenforceable, and that the Company does not infringe the Selvac
patent; (ii) a preliminary and permanent injunction enjoining MEHL from
threatening the Company or its customers with infringement litigation or
infringement; and (iii) an award to the Company of damages suffered in
connection with MEHL's conduct. On March 7, 1997, Selvac filed a complaint for
injunctive relief and damages for patent infringement and for unfair competition
against the Company, its Spectrum Medical Technologies and Spectrum Financial
Services subsidiaries, and a New Jersey dermatologist, in the United States
District Court for the District of New Jersey. Selvac's complaint alleges that
the Company's EpiLaser infringes the Selvac Patent and that the Company unfairly
competed by promoting the EpiLaser or hair removal before it had received FDA
approval for that specific application. The Company intends to assert defenses
vigorously which it believes to be meritorious. Both suits are in their infancy,
and, as of March 17, 1997, discovery has not yet commenced in either action. The
extent of exposure of the Company cannot be determined at this time.
The Company is a defendant in a lawsuit filed by Commonwealth Associates
("Commonwealth") on March 14, 1996. In its suit, Commonwealth alleges that the
Company 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. A trial on Commonwealth's damages is scheduled for
April 14, 1997. Commonwealth has alleged that it suffered up to $3,381,250 in
damages on its breach of contract claim, exclusive of interest. The Company
intends to appeal the matter after damages have been determined, and believes
its grounds for appeal are meritorious.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS
The Company's Annual Meeting of Stockholders was held on November 14, 1996.
Holders of record of the Company's common stock at the close of business on
October 7, 1996 were entitled to vote at the meeting. On that date, the Company
had 28,409,007 shares of its common stock outstanding. Each stockholder was
entitled to one vote per share on all matters voted on at the meeting. A
majority of the outstanding shares constituted a quorum at the meeting.
Abstentions and broker non-votes were counted for purposes of determining the
presence or absence of a quorum for the transaction of business. Abstentions
were counted in tabulations of the votes cast on proposals presented to
stockholders, whereas broker non-votes were not counted for purposes of
determining whether a proposal had been approved. At the Annual Meeting, the
stockholders elected four (4) Directors.
The tabulation of votes with respect to the election of such Directors is as
follows:
Total Votes Total Votes
For Withheld
Steven Georgiev 25,014,274 348,728
Michael H. Smotrich 25,014,274 348,728
Joseph E. Levangie 25,014,274 348,728
Buster Glossen 25,014,274 348,728
The stockholders also ratified and approved the selection of Arthur
Andersen, LLP as the Company's independent auditor for the 1996 fiscal year by a
vote of 25,106,794 shares in favor, 155,717 shares against and 100,491 shares
abstaining.
<PAGE>
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PART II
ITEM 5. MARKET FOR 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 mark-up, mark-down or commission and do not necessarily
represent actual transactions.
Fiscal Year Ended
December 31, 1995
-------------------
High Low
-------------------
Quarter Ended March 31, 1995 3 5/8 2 1/2
Quarter Ended June 30, 1995 2 5/8 1 15/16
Quarter Ended Sept. 30, 1995 6 11/16 1 7/8
Quarter Ended Dec. 31, 1995 7 1/8 4 7/16
Fiscal Year Ended
December 31, 1996
-------------------
High Low
-------------------
Quarter Ended March 31, 1996 13 1/8 5
Quarter Ended June 30, 1996 16 3/8 9 1/8
Quarter Ended Sept. 30, 1996 14 5/8 7 7/8
Quarter Ended Dec. 31, 1996 9 1/8 6
As of March 24, 1997, the Company had 600 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
growth of the Company.
PRIVATE PLACEMENT OF COMMON STOCK
Pursuant to Regulation S under the Act, the Company sold 365,533 shares of
common stock and 182,765 warrants to purchase common stock to a total of 23
overseas individuals and corporations on February 1, 1996 for an aggregate
purchase price of $1,783,800. The warrants were issued at a price of $5.00 per
share, are immediately exercisable and expire on February 1, 1999.
Pursuant to Regulation D and Section 4(2) of the Act, the Company sold a
total of 165,810 shares of common stock on March 29, 1996 for an aggregate
purchase price of $1,364,842. 114,810 shares of common stock were sold to Arista
High-Tech Growth Fund, Ltd. for an aggregate purchase price of $936,442; 45,000
shares of common stock were sold to Histon Financial Services, Inc. for an
aggregate purchase price of $378,000 and 6,000 shares of common stock were sold
to Berkshire International Finance, Inc. Pension Plan for an aggregate purchase
price of $50,400.
Pursuant to Regulation D and Section 4(2) of the Act, the Company sold a
total of 44,862 shares of common stock on April 15, 1996 to Egger & Co. for an
aggregate purchase price of $416,250.
Pursuant to Section 4(2) of the Act, the Company sold 600,000 shares of
common stock on December 27, 1996 to Finmanagment, Inc. for an aggregate
purchase price of $3,150,000. In addition to the common stock, Finmanagment
received 420,000 net warrants to purchase common stock at $7.50 per share,
300,000 net warrants to purchase common stock at $9.50 per share and 180,000 net
warrants to purchase common stock at $11.50 per share. The net warrants are
subject to a cashless exercise for common stock in which the number of shares of
common stock issuable upon such cashless exercise
<PAGE>
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shall be determined by multiplying (1) the difference between (a) the closing
bid price of the common stock on the day prior to the date exercised, as
reported by NASDAQ, and (b) the exercise price, by (2) the number of net warrant
shares; divided by the closing bid price of the common stock on the day prior to
the date exercised. The net warrants are exercisable immediately and expire on
February 28, 1997.
CONVERTIBLE DEBENTURES
Pursuant to Regulation S of the Act, the Company sold 9,675 units of
convertible debentures to a total of 11 overseas individuals on July 3, 1996 for
an aggregate purchase price of $7,669,441. Each unit consists of a convertible
debenture due July 3, 2003 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 immediately exercisable and expire on June 27, 2003.
Pursuant to Section 4(2) of the Act, the Company sold a total of $5,000,000
4.5% Convertible Debentures on October 17, 1996 to Cameron Capital Ltd. and Wood
Gundy London Limited. The debentures, due October 17, 2001, may be converted at
any time after 75 days from issuance at the option of the holder into shares of
the Company's common stock at a price equal to 85% of the average trailing five
day bid price from the date of conversion.
Pursuant to Section 4(2) of the Act, the Company sold a total of $6,000,000
5% Convertible Debentures as follows: $3,000,000 to High Risk Opportunities Hub
Fund Ltd. on December 31, 1996; $2,000,000 to Berckeley Investment Group, Ltd.
on December 31, 1996; and $1,000,000 to High Risk Opportunities Hub Fund Ltd. on
January 13, 1997. The debentures, due December 31, 2001, December 31, 2001 and
January 13, 2002, respectively, are convertible into shares of common stock at a
conversion price equal to 85% of the average trailing 10 day bid price from the
date of conversion, provided that in any 30 day period the holder of these
debentures may convert no more than 33% (or 34% in the last 30 day period
available for conversion) of the debentures.
PREFERRED STOCK
Pursuant to Section 4(2) of the Act, the Company sold 6,000 shares of
Series D Convertible Preferred Stock on February 14, 1996 to the Travelers
Insurance Company for an aggregate purchase price of $6,000,000. All of the
Series D Convertible Preferred Stock was converted into 1,116,918 shares of
common stock (including accrued dividends of $342,092 and accrued interest of
$9,183) as of December 31, 1996. In connection with the issuance of Series D
Convertible Preferred Stock the Company issued 600,000 warrants to purchase
common stock at a price of $7.50 per share, and 200,000 warrants to purchase
common stock at a price of $8.00 per share, both of which expire on February 14,
2001 and are immediately exercisable.
Pursuant to Section 4(2) of the Act, the Company sold 10,000 shares of
Series E Convertible Preferred Stock on April 17, 1996 to GFL Advantage Fund
Limited for an aggregate purchase price of $10,000,000. All of the Series E
Preferred Stock was converted into 1,381,506 shares of common stock (including
accrued dividends of $326,174 and accrued interest of $7,536) as of January 28,
1997. In connection with the issuance of Series E Convertible Preferred Stock,
the Company issued 304,259 warrants to purchase common stock at a price of $15
per share, which expire on April 17, 2001 and are immediately exercisable.
Pursuant to Section 4(2) of the Act, the Company sold 6,000 shares of
Series F Convertible Preferred Stock on July 12, 1996 to the Travelers Insurance
Company for an aggregate purchase price of $10,000,000. The Series F Convertible
<PAGE>
-27-
Preferred Stock, together with any accrued but unpaid dividends, may be
converted into common stock at 80% of the daily average closing price of the
common stock on the ten trading days preceding such conversion, but in no event
less than $7.00 or more than $16.00. Series F Preferred stock may be redeemed at
any time, with no less than 10 days and no more than 30 days notice or when the
stock price exceeds $16.50 per share, at an amount equal to the amount of
liquidation preference determined as of the applicable redemption date. In
connection with the issuance of Series F Convertible Preferred Stock, the
Company issued 500,000 warrants to purchase common stock at a price of $11 per
share, which expire on July 12, 2001 and are immediately exercisable.
Pursuant to Section 4(2) of the Act, the Company sold 10,000 shares of
Series G Convertible Preferred Stock to Genesee Fund Limited on September 26,
1996 for an aggregate purchase price of $10,000,000. Genesee Fund Limited
subsequently transferred 5,000 of its shares of Series G Convertible Preferred
Stock to GFL Advantage Fund and the remaining 5,000 shares to GFL Performance
Fund. The Series G Convertible Preferred Stock, together with any accrued but
unpaid dividends, may be converted into common stock at 85% of the average
closing bid price for the three trading days immediately preceding the
conversion date, but in no event at less than $6.00 or more than $11.50 for the
5,000 shares of Series G Convertible Preferred Stock held by GFL Advantage Fund
and no less than $6.00 or more than $8.00 for the 5,000 shares of Series G
Convertible Preferred Stock held by GFL Performance Fund. The warrants are
immediately exercisable and expire on December 31, 2001. Series G Convertible
Preferred Stock may be redeemed at any time, with no less than 10 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. In connection with the issuance of Series G Convertible Preferred
Stock, the Company issued 323,799 warrants to purchase common stock at a price
of $12 per share, which expire on September 27, 2001, and 50,000 warrants to
purchase common stock at a price of $6.5625 per share, which expire on December
31, 2001 and are immediately exercisable.
STOCKHOLDER SERVICES
Stockholders of the Company who desire information about the Company are
invited to contact John Ingoldsby, Director of Investor Relations, Palomar
Medical Technologies, Inc., 66 Cherry Hill Drive, Beverly, Massachusetts 01915,
508-921-9300, e-mail at [email protected]. A mailing list is maintained to
enable stockholders whose stock is held in street name, and other interested
individuals, to receive quarterly reports, annual reports and press releases as
quickly as possible. (Quarterly reports and press releases are also available
through the Internet at the Company's home page on the World Wide Web
(http://www.palmed.com)).
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
YEAR ENDED DECEMBER 31, 1996, COMPARED TO YEAR ENDED DECEMBER 31, 1995
For the year ended December 31, 1996, the Company had revenues of
$70,098,443 as compared to $21,906,504 for the year ended December 31, 1995. The
220% increase in revenues from 1995 to 1996 is primarily the result of
acquisitions, additional product lines and the transition of certain
subsidiaries from the development stage to commercialization in both the medical
and electronic business segments. Net revenues by the Company's business
segments are as follows:
Year ended
December 31,
------------------------------------
1995 1996
------------- ------------
Medical $ 5,610,280 $ 17,824,158
Electronic 16,296,224 52,274,285
------------- ------------
Total $ 21,906,504 $ 70,098,443
============ ============
The increase in revenues for the Company's medical segment was principally
attributable to $10.1 million of revenues generated from the Company's Tissue
Technologies subsidiary during the year ended December 31, 1996 as compared to
only $114,000 for the year ended December 31, 1995. Tissue Technologies began
commercial shipment of its product in the fourth quarter of 1995. Approximately
$6.1 million of medical revenues were generated by the Company's Spectrum
subsidiary during the year ended December 31, 1996, as compared to approximately
$3.8 million of revenues for the year ended December 31, 1995. This increase in
revenues at Spectrum was due to the introduction and initial shipments
<PAGE>
-28-
of its EpiLaser during the third and fourth quarters of 1996. The Company
expects its revenue from the medical segment to continue to increase as the
Company further penetrates the domestic and international medical markets with
its Tru-Pulse CO2 laser for treatment of wrinkles and skin resurfacing and
begins marketing and shipping its EpiLaser for hair removal which was approved
by the FDA in March of 1997.
The increase in revenues for the Company's electronics segment was
attributable to approximately $18.6 million of revenues generated from the
Company's Nexar subsidiary which introduced its proprietary upgradeable PC in
April of 1996, as compared to only approximately $620,000 of revenues generated
from the sale of non-proprietary PCs during the year ended December 31, 1995.
The remaining increase in 1996 in the electronics segment was principally due to
$17.1 million of sales by Dynaco's Comtel subsidiary acquired in the first
quarter of 1996. The Company believes that the revenue in the electronic segment
will continue to increase as Nexar further expands its production capabilities,
marketing and distribution efforts and as Comtel expands its contract
manufacturing operations. However, the Company intends to divest a portion of
its interest in companies in the electronics segment, and such increase in
revenue may not be reflected in the consolidated results of the Company to the
extent it is successful in its divesture.
Gross margin for the year ended December 31, 1996 was $6,920,888 (9.9% of
revenues) versus $4,714,034 (21.5% of revenues) for the year ended December 31,
1995. Gross margin by the Company's business segments are as follows:
Year ended
December 31,
-----------------------------------
1995 1996
-----------------------------------
Medical $ 2,145,808 $ 3,437,399
Electronic 2,568,226 3,483,489
----------- -----------
Total $ 4,714,034 $ 6,920,888
=========== ===========
The increase in gross profit dollars was a result of the additional
revenues generated from new products introduced during the year ended December
31,1996 as discussed above. In the medical segment the principal reason for the
decrease in the gross profit percent was the phase-out of the Company's research
and development contract with the U.S. Army in anticipation of the
commercialization of its medical products. The gross profit percent also
decreased due to underutilization of increased production capacity at Spectrum
in preparation for the anticipated increase in demand of its EpiLaser in fiscal
1997. A portion of this decrease in gross margins was offset by an increase in
gross margins attributed to the acquisition of Tissue Technologies, which
introduced its Tru-Pulse CO2 laser to the commercial marketplace in the first
quarter of 1996.
In the electronic segment, the principal reason for the decrease in the
gross profit percent was a decrease in yields at Dynaco due to an increase in
production costs attributable to a change in Dynaco's product mix and an
inventory valuation write-off of $643,000 at Dynaco's Comtel subsidiary offset
by an increase in the gross margin as a result of Nexar's introduction and
initial volume shipments of its proprietary upgradeable PC in 1996.
Research and development costs increased to $7,977,085 (11% of revenues)
for the year ended December 31, 1996, from $4,419,487 (20% of revenues) for the
year ended December 31, 1995. This 80.5% increase in research and development
reflects the Company's continuing commitment to research and development for
both its medical and electronic business segments. In the Company's medical
segment the Company focused its efforts during 1996 to obtain FDA clearance for
hair removal using the EpiLaser. The Company received FDA clearance for hair
removal in March of 1997. The Company also continued to concentrate on the
development of additional products for medical laser applications. In the
electronics segment, the Company's Nexar subsidiary continues to enhance and
further develop its current proprietary upgradeable PC product in order to stay
competitive in a rapidly changing high technology industry. In addition, Dynaco
began funding a new process engineering and materials development program, and
has filed several patents. Management believes that research and development
expenditures will increase over the next few years as the Company continues
clinical trials of its medical products and develops additional applications for
its lasers and delivery systems. However, management anticipates that research
and development expenditures as a percentage of revenue will decrease as its
revenues increase with commercialization of its products.
General and Administrative expenses increased to $21,569,054 (31% of
revenues) for the year ended December 31, 1996, from $7,879,694 (36% of
revenues) for the year ended December 31, 1995. This 173.7% increase is
primarily due to
<PAGE>
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acquisitions and the transition of certain subsidiaries from the development
stage to commercialization combined with the increased administrative resources
required at the Company's corporate offices to oversee the growth of the
Company's medical and electronic business segments. In the medical segment, the
Company acquired Tissue Technologies and expanded its general and administrative
support staff at Spectrum to accommodate the forecasted growth in the fourth
quarter of 1996 and in 1997. In the electronics segment, the Company's Dynaco
subsidiary acquired Comtel and formed Dynamem. Additionally, the Company's Nexar
subsidiary has expanded its executive, administrative and finance staffs to
support Nexar's growing operations. The Company has continued to increase its
support staffs in anticipation of several new product introductions in 1996. All
the Company's subsidiaries maintain their own general and administrative support
staffs. The increase in general and administrative expenses is also due to
write-downs and valuation allowances totaling approximately $3,100,000 related
to accounts receivable, intangibles and the accrual of severance costs.
Selling and Marketing expenses increased to $11,420,943 (16% of revenues)
for the year ended December 31, 1996, from $2,768,541 (13% of revenues) for the
year ended December 31, 1995. This 312.5% increase reflects the Company's effort
to increase its marketing and distribution as a result of its new product lines
developed internally within the medical segment. This increase is attributable
to the Company's Spectrum subsidiary and the acquisition of Tissue Technologies,
both increasing its sales and marketing expenditures to coincide with the
addition of two new product lines. In the electronics segment, this increase
reflects the change in focus of the Company's Nexar subsidiary from product
development to selling and marketing its proprietary upgradeable PC. During 1996
Nexar began its efforts to increase its selling, marketing and distribution
which resulted in additional costs of $4.8 million in 1996 as compared to $0.6
million in 1995.
Business Development and Financing Costs increased to $2,879,603 (4% of
revenues) for the year ended December 31, 1996, from $1,409,303 (6% of revenues)
for the year ended December 31, 1995. This 104.3% increase is attributable to
the Company's continuing acquisitions and financing activities. The Company
anticipates that it will continue to expend funds to raise additional sources of
financing and to focus its efforts to acquire other technologies to broaden its
scope of product applications and services in both the medical and electronic
business segments.
Settlement and litigation costs increased to $2,255,000 for the year ended
December 31, 1996 from $700,000 for the year ended December 31, 1995. This
increase is a result of a settlement of potential claims with a former executive
of Nexar for approximately $1,400,000 and under which Nexar is purchasing
previously-licensed core technology and eliminated future royalty payments on
the use of Nexar's core technology, a settlement of approximately $525,000 in
connection with a suit brought against the Company and the chief executive
officer of Nexar upon Nexar's organization, and other claims against the
Company, combined with the associated legal costs.
Merger expenses totaled $443,780 for the year ended December 31, 1996 and
are comprised of professional fees associated with the merger of Tissue
Technologies and the Company.
Interest expense increased to $1,443,564 for the year ended December 31,
1996, from $1,374,199 for the year ended December 31, 1995. This 5% increase is
primarily the result of the issuance of acquisition debt in April 1995 to
purchase Spectrum, and the issuance of the 4.5% Swiss Franc convertible
debentures in July 1996.
Interest income increased to $1,586,620 for the year ended December 31,
1996, from $913,050 for the year ended December 31, 1995. This increase is
primarily the result of interest received from subscriptions receivable and
other loans and investments made as a result of the Company's improved cash
position.
Net gain on trading securities represents realized and unrealized trading
gains and losses of $2,033,371 for the year ended December 31, 1996. Included in
this amount is an unrealized gain totaling approximately $1,547,000 related to
the Company's investment in a publicly traded company in which the Company's
chief executive officer owns approximately 13% and a realized gain totaling
approximately $827,000 related to the Company's investment in another publicly
traded company offset by various unrealized losses aggregating approximately
$340,000. The Company had a net realized trading gain of $201,067 for the year
ended December 31, 1995. It is the Company's intention to continue to invest in
trading securities, which may result in additional realized and unrealized
trading gains or losses in the future
Gain on the sale of stock of a subsidiary stock represents a gain of
$3,830,000 related to the private placement sale by the Company of 400,000 Nexar
common shares. See Note 10 of the Notes to the Consolidated Financial
Statements.
<PAGE>
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Other income and expense totaled $4,245,642 of expense for the year ended
December 31, 1996 as compared to $102,305 income for the year ended December 31,
1995. Significant amounts included in this amount for 1996 is a charge to
operations of $3,690,000 related to the Company's New Media investment and
additional reserves totaling $1,306,038 required for other loans to joint
ventures. Offsetting these losses is a foreign currency exchange gain of
$446,596. See Note 9 of the Notes to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 1996, the Company had $19,066,523 in cash, cash
equivalents and trading securities. During the year ended December 31, 1996, the
Company generated the following net cash proceeds from its financing and
investing activities to fund operations, acquisitions and the development of its
products:
YEAR ENDED
DECEMBER 31, 1996
-----------------
Sale of common stock $ 6,061,380
Sale of preferred stock 30,823,147
Issuance of convertible debentures 14,169,441
Sale of Stock of a subsidiary 2,000,000
Exercise of stock options and warrants 7,653,907
---------------
Total $60,707,875
---------------
The Company's net loss for the year ended December 31, 1996, included the
following noncash items: $3,916,221 of depreciation and amortization expense;
$70,130 of interest expense relating to the amortization of the discounts on the
convertible debentures; and $741,982 related to common stock and warrants issued
to non-employees and consultants of which approximately $532,758 results from
the issuance of warrants for services in accordance with SFAS No. 123.
The Company anticipates that capital expenditures for 1997 will total
approximately $16 million, with nearly 60% of this amount funding lasers needed
for CTI laser centers. The Company intends to finance the majority of the CTI
expenditures under equipment leasing arrangements with various financing
institutions. However, there can be no assurance that the Company will be able
to obtain the necessary financing.
Dynaco has a three-year revolving credit and security agreement with a
financial institution. The agreement provides for the revolving sale of
acceptable accounts receivable, as defined in the agreement, with recourse at
85% of face value, up to a maximum commitment of $3,000,000. As of December 31,
1996, the amount of accounts receivable sold that remained uncollected totaled
$1,787,057 net of related reserves and fees, as defined in the agreement. This
amount is classified as a revolving line of credit in the accompanying
consolidated balance sheet as of December 31, 1996. The interest rate on such
outstanding amounts is the bank's prime rate (8.25% at December 31, 1996) plus
1.5%, and interest is payable monthly in arrears. The financing is
collateralized by the purchased accounts receivable and substantially all of
Dynaco's assets. Borrowings under this line are guaranteed by the Company.
On December 5, 1996, Comtel entered into a loan agreement with a loan
association which provided for borrowings up to $4,500,000 in the form of
revolving receivable and inventory loans. Borrowings under the loan agreement
are limited by a borrowing base calculation on eligible accounts receivable and
inventory, and are collateralized by accounts receivable, inventory and certain
other assets. Borrowings bear interest at the lender's prime rate plus 2.25% and
amounted to $2,770,375 as of December 31, 1996. The loan agreement terminates on
November 30, 1998. Borrowings under this loan agreement are guaranteed by the
Company.
Some of the Company's medical products businesses are still in the
development stage, with significant research and development costs and
regulatory constraints that currently limit sales of its medical products. 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
<PAGE>
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assurance that the current levels of funding or additional funding will be
available, or, if available, on terms satisfactory to the Company.
The Company also makes early stage investments in core technologies and
companies that management feels are strategic to the Company's business or will
yield a higher than average financial return to support the Company's core
business. Some of these investments are with companies that are related to some
of the directors and officers of the Company. In addition, the Company has made
loans to various affiliated parties. See "Related Party Transactions". At
December 31, 1996, the Company had $1,564,153 of such related party investments
and loans.
The Company has had significant losses to date and expects these losses to
continue for the near future. Therefore, the Company must continue to secure
additional financing to complete its research and development activities,
commercialize its current and proposed medical products segment, spin-off its
electronic products segment, execute its acquisition business plan and fund
ongoing operations. The Company believes that the cash generated to date from
its financing activities and amounts available under its credit agreement will
be sufficient to satisfy its working capital requirements through at least the
next twelve months. However, there can be no assurance that events in the future
will not require the Company to seek additional financing sooner. The Company
continues to investigate several financing alternatives, strategic partnerships,
additional bank financing, private debt and equity financing and other sources.
The Company believes that it has adequate cash reserves or will be successful in
obtaining additional financing in order to fund current operations in the near
future.
FACTORS THAT MAY AFFECT FUTURE RESULTS
In addition to the other information in this Annual Report on Form 10-KSB
the following cautionary statements should be considered carefully in evaluating
the Company and its business. Statements contained in this Form 10-KSB that are
not historical facts (including, without limitation, statements concerning
anticipated operational and capital expense levels and such expense levels
relative to the Company's total revenues) and other information provided by the
Company and its employees from time to time may contain certain
"forward-looking" information, as that term is defined by (i) the Private
Securities Litigation Reform Act of 1995 (the "Reform Act") and (ii) in releases
by the SEC. The factors identified in the cautionary statements below, among
other factors, could cause actual results to differ materially from those
suggested in such forward-looking statements. 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.
SUBSTANTIAL AND CONTINUING LOSSES. The Company and certain of its
subsidiaries have a history of losses, and the Company expects its losses to
continue. The Company must secure additional financing to complete its research
and development activities, commercialize its current and proposed medical
products, spin-off its non-medical business, execute its acquisition business
plan and fund ongoing operations. To the extent that the Company is not able to
successfully execute its plan to spin-off its non-medical business, the Company
may be required either to fund or to shut down those operations, potentially
incurring substantial losses.
LIMITED OPERATING HISTORY; RECENT ACQUISITIONS. Many of the Company's
subsidiaries have limited operating histories and are in the development stage,
and the Company is subject to all of the risks inherent in the establishment of
a new business enterprise. The likelihood of success of the Company must be
considered in light of the problems, expenses, difficulties, complications and
delays frequently encountered in connection with the establishment of a new
business and development of new technologies in the cosmetic laser products and
electronic products industries. These include, but are not limited to,
government regulation, competition, the need to expand manufacturing
capabilities and market expertise, and setbacks in production, product
development, market acceptance and sales and marketing. The Company's prospects
could be significantly affected by its ability to subsequently manage and
integrate the operations of several distinct businesses with diverse products,
services and customer bases in order to achieve cost efficiencies. There can be
no assurance that the Company will be able to successfully manage and integrate
the operations of newly acquired businesses into its operations or that the
failure to do so will not increase the costs inherent in the establishment of
new business enterprises.
HOLDING COMPANY STRUCTURE. The Company has no significant operations other
than those incidental to its ownership of the capital stock of its subsidiaries.
As a holding company, the Company is dependent on dividends or other
intercompany transfers of funds from its subsidiaries to meet the Company's debt
service and other obligations. Claims of creditors of the
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Company's subsidiaries, including trade creditors, will generally have priority
as to the assets of such subsidiaries over the claims of the Company and the
holders of the Company's indebtedness.
RISKS ASSOCIATED WITH ACQUISITIONS. In the normal course of business, the
Company evaluates potential acquisitions of businesses, products and
technologies that would complement or expand the Company's business. Promising
acquisitions are difficult to identify and complete for a number of reasons,
including competition among prospective buyers and the need for regulatory
approvals. Acquisitions may result in the incurrence of additional debt, the
write-off of in-process research and development or technology acquisition and
development costs and the amortization of expenses related to goodwill and other
intangible assets, any of which could have a material adverse effect on the
Company's business, financial condition, results of operations and cash flow.
Acquisitions involve numerous additional risks, including difficulties in the
assimilation of the operations, services, products and personnel of the acquired
company, the diversion of management's attention from other business concerns,
entering markets in which the Company has little or no direct prior experience
and the potential loss of key employees of the acquired company. In order to
finance acquisitions, it may be necessary for the Company to raise additional
funds through public or private financings. Any equity or debt financing, if
available at all, may be on terms which are not favorable to the Company and, in
the case of equity financing, may result in dilution to the Company's
stockholders.
NEW VENTURES. The Company's CTI subsidiary has entered into agreements with
medical service partners to provide cosmetic dermatological laser services at
laser treatment centers, and plans to enter into more such agreements in the
future. While the Company believes these new partnerships are strategically
important, there are substantial uncertainties associated with the development
of new products, technologies and services for evolving markets. The success of
these ventures will be determined not only by the Company's efforts, but also by
those of its partners. Initial timetables for the development and introduction
of new technologies, products or services may not be achieved, and
price/performance targets may not prove feasible. External factors, such as the
development of competitive alternatives or government regulation, may cause new
markets to evolve in unanticipated directions. (See "Highly Competitive
Industries.")
INVESTMENTS IN UNRELATED BUSINESSES. The Company has investments in
marketable and non-marketable securities and loans to related and unrelated
parties. The amount that the Company may ultimately realize from these
investments could differ materially from the value of these investments recorded
in the Company's financial statements.
MANAGEMENT OF GROWTH. In light of management's views of the potential for
future growth, the Company has adopted an aggressive growth plan that includes
substantial investments in its sales, marketing, production and distribution
organizations, the creation of new research and development programs and
increased funding of existing programs, and investments in corporate
infrastructure that will be required to support significant growth. This plan
carries with it a number of risks, including a higher level of operating
expenses, the difficulty of attracting and assimilating a large number of new
employees, and the complexities associated with managing a larger and faster
growing organization. Depending on the extent of future growth, the Company may
experience a significant strain on its management, operational, manufacturing
and financial resources. The failure of the Company's management team to
effectively manage growth, should it continue to occur, could have a material
adverse effect on the Company's financial condition and results of operations
HIGHLY COMPETITIVE INDUSTRIES. The cosmetic laser and electronics
industries are characterized by intense competition. The cosmetic laser industry
is highly competitive and is characterized by the frequent introduction of new
products. The Company competes in the development, manufacture, marketing and
servicing of laser technology products with numerous other companies, certain of
which have substantially greater financial, marketing and other resources than
the Company. In addition, the Company's cosmetic laser products face competition
from alternative medical products and procedures, such as dermabrasion, chemical
peels, pharmaceutical treatment, electrolysis, waxing and surgery, among others.
There can be no assurance that the Company will be able to differentiate its
products from the products of its competitors or that the marketplace will
consider the Company's products to be superior to competing products or medical
procedures. There can be no assurance that competitors will not develop products
or that new technologies will not be developed that render the Company's
products obsolete or less competitive. See "Technological Obsolescence." In
addition, in entering areas of business in which it has little or no experience,
such as the opening of laser treatment centers, the Company may not be able to
compete successfully with competitors that are more established in such areas.
See "New Ventures."
FLUCTUATIONS IN QUARTERLY PERFORMANCE. The Company's results of operations
have fluctuated substantially and can be expected to continue to vary
significantly. The Company's quarterly operating results depend on a number of
factors, including the timing of the introduction or acceptance of new products
offered by the Company or its competitors, changes in the mix of
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products sold by the Company, changes in regulations affecting the cosmetic
laser products or electronics industry, changes in the Company's operating
expenses, personnel changes and general economic conditions.
The Company's stock price, like that of other technology companies, is
subject to significant volatility. If revenues or earnings in any quarter fail
to meet the investment community's expectations, there could be an immediate
impact on the price of the Shares. The price of the Shares may also be affected
by broader market trends unrelated to the Company's performance. (See
"Volatility of Share Price.")
VOLATILITY OF SHARE PRICE. Factors such as announcements of developments
related to the Company's business, announcements by competitors, quarterly
fluctuations in the Company's financial results and other factors have caused
the price of the Company's stock to fluctuate, in some cases substantially, and
could continue to do so in the future. In addition, the stock market has
experienced extreme price and volume fluctuations that have particularly
affected the market price for many technology companies and that have often been
unrelated to the operating performance of these companies. These broad market
fluctuations may adversely affect the market price of the Shares. The trading
prices of many technology companies' stocks are at or near their historical
highs, and reflect price/earnings ratios substantially above historical norms.
There can be no assurance that the trading price of the Shares will remain at or
near its current level.
GOVERNMENT REGULATION. The Company's laser product business segment and, to
a lesser degree, its electronics business segment are subject to regulation in
the United States and abroad. Failure to comply with applicable regulatory
requirements can result in fines, denial or suspension of approvals, seizures or
recall of products, operating restrictions and criminal prosecutions, any or all
of which could have a material adverse effect on the Company. Furthermore,
changes in existing regulations or adoption of new regulations could prevent the
Company from obtaining, or could affect the timing of, future regulatory
approvals.
LASER PRODUCT SEGMENT. All laser product devices, including those sold by
the Company, are subject to regulation by the FDA under the Medical Device
Amendments of the United States Food, Drug and Cosmetics Act (the "FDA Act").
The Company's business, financial condition and operations are critically
dependent upon timely receipt of FDA regulatory clearance.
FDA CLEARANCE STATUS FOR COSMETIC LASER PRODUCTS. Three of the
Company's lasers have received clearance from the FDA for certain
dermatological applications: the Q-pulse ruby laser, the Tru-Pulse laser
and the EpiLaser system.
The Company is also investigating other applications in dermatology for its
laser systems. It will be required to obtain FDA clearance before commercially
marketing any other application. The Company believes that it will be able to
seek such clearance under the 510(k) application process; however, no assurance
can be given that the FDA will not require the Company to follow the more
extensive and time-consuming Pre-Market Approval ("PMA") process. FDA review of
a 510(k) application currently averages about seven to twelve months and
requires limited clinical data based on "substantial equivalence" to a product
marketed prior to 1976, while a PMA review can last for several years and
require substantially more clinical data.
The FDA also imposes various requirements on manufacturers and sellers of
products under its jurisdiction, such as labeling, good manufacturing practices,
record keeping and reporting requirements. The FDA also may require post-market
testing and surveillance programs to monitor a product's effects. There can be
no assurance that the appropriate clearances from the FDA will be granted, that
the process to obtain such clearances will not be excessively expensive or
lengthy or that the Company will have sufficient funds to pursue such
clearances.
No assurance can be given that FDA clearance will be obtained for the
Company's current or proposed laser products on a timely basis, if at all. The
laser products segment of the Company's business, is, and will continue to be,
critically dependent upon FDA clearance of its current and proposed cosmetic
laser products. Delays or failure to obtain such clearance would have a material
adverse effect on the Company.
OTHER GOVERNMENT CLEARANCES FOR LASER PRODUCTS; GOOD MANUFACTURING
PRACTICES. In order to be sold outside the United States, the Company's products
are subject to FDA permit requirements that are conditioned upon clearance by
the importing country's appropriate regulatory authorities. Many countries also
require that imported products comply with their own or international electrical
and safety standards. In November 1992, the Company obtained approval certifying
compliance with certain international electrical and safety regulations
applicable to its pulsed dye laser. Additional approvals may be
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required in other countries. The Company has yet to apply for international
approval for its diode laser for use in cosmetic surgery and dermatology.
The Company is subject to the laser radiation safety regulations of the FDA
Act administered by the National Center for Devices and Radiological Health
("CDRH") of the FDA. These regulations require a laser manufacturer to file new
product and annual reports, to maintain quality control, product testing and
sales records, to distribute appropriate operation manuals, to incorporate
certain design and operating features in lasers sold to end-users and to certify
and label each laser sold to end-users as one of four classes of lasers (based
on the level of radiation from the laser). In addition, various warning labels
must be affixed on the product and certain protective devices must be installed
depending upon the class of product. Under the FDA Act, the Company is also
required to register with the FDA as a medical device manufacturer and is
subject to inspection on a routine basis by the FDA for compliance with Good
Manufacturing Practice ("GMP") regulations. The GMP regulations impose certain
procedural and documentation requirements upon the Company relevant to its
manufacturing, testing and quality control activities. The CDRH is empowered to
seek fines and other remedies for violations of these regulatory requirements.
The Company believes that it is currently in compliance with these regulations.
ELECTRONIC SEGMENT. A significant percentage of the total sales of the
flexible circuit board component business of the Company, which presently
accounts for a significant amount of the sales of the Company, are the result of
either a subcontract or a direct contract for government programs funded by the
U.S. military. Generally, government contracts and subcontracts are terminable
at the convenience of the government. Cutbacks in military spending for certain
programs or lack of military spending in general could have a material adverse
effect on the Company. There can be no assurance that termination of contracts,
cessation of purchase orders, or a failure to appropriate funds will not occur
in the future. Any termination, cessation, or failure to appropriate funds with
respect to contracts or subcontracts having a significant dollar value would
have a material adverse effect on the Company's business, financial condition
and results of operation. The unpredictable nature of the government procurement
process also may contribute to fluctuations in the Company's quarterly
performance. (See "Fluctuations in Quarterly Performance.")
UNCERTAINTY OF MARKET ACCEPTANCE. The Company continually develops new
products intended for use in the cosmetic laser products segment and the
electronic products segment. As with any new products, there is substantial risk
that the marketplace may not accept or be receptive to the potential benefits of
such products. Market acceptance of the Company's current and proposed products
will depend, in large part, upon the ability of the Company or any marketing
partners to demonstrate to the marketplace the advantages of the Company's
products over other types of products. There can be no assurance that
applications or uses for the Company's current and proposed products will be
accepted by the marketplace or that any of the Company's current or proposed
products will be able to compete effectively.
UNCERTAINTY OF HEALTHCARE REIMBURSEMENT AND REFORM. The healthcare industry
is subject to changing political, economic and regulatory influences that may
affect the procurement practices and operations of healthcare industry
participants. During the past several years, state and federal government
regulation of reimbursement rates and capital expenditures in the United States
healthcare industry has increased. Lawmakers continue to propose programs to
reform the United States healthcare system, which may contain programs to
increase governmental involvement in healthcare, lower Medicare and Medicaid
reimbursement rates or otherwise change the operating environment for the
Company's customers. Healthcare industry participants may react to these
proposals by curtailing or deferring investments, including investments in the
Company's products.
DEPENDENCE ON THIRD PARTY RESEARCHERS. The Company is substantially
dependent upon third party researchers and others, over which the Company will
not have absolute control, to satisfactorily conduct and complete research on
behalf of the Company and to grant to the Company favorable licensing terms for
products which may be developed. The Company has entered into a number of
research agreements with recognized research hospitals and clinical
laboratories. These research institutions include the Oregon Medical Laser
Center at the Heart Institute of St. Vincent Hospital and Medical Center in
Portland, Oregon, the Wellman Labs at MGH and the Otolaryngology Research Center
for Advanced Endoscopic Applications at NEMC, Boston, Massachusetts. The Company
provides research funding, laser technology and optics know-how in return for
licensing agreements with respect to specific medical applications and patents.
The Company's success will be highly dependent upon the results of the research,
and there can be no assurance that these research agreements will provide the
Company with marketable products in the future or that any of the products
developed under these agreements will be profitable for the Company.
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TECHNOLOGICAL OBSOLESCENCE. The markets for the Company's products are
characterized by rapid and significant technological change, evolving industry
standards and frequent new product introductions and enhancements. Many of the
Company's products and products under development are technologically
innovative, and require significant planning, design, development and testing at
the technological, product and manufacturing process levels. These activities
require significant capital commitments and investment by the Company. The
Company's failure to develop products in a timely manner in response to changes
in the industry, whether for financial, technological or other reasons, will
have a material adverse effect on the Company's business, financial condition
and results of operations.
Development by others of new or improved products, processes or
technologies may make the Company's products or proposed products obsolete or
less competitive. The Company will be required to devote continued efforts and
financial resources to enhancement of its existing products and development of
new products. There can be no assurance that the Company will have the financial
resources or the technological capability necessary to carry out such product
enhancement and development. Nor can there be any assurance that any of the
products currently being developed by the Company, or those to be developed in
the future, will be technologically feasible or accepted by the marketplace,
that any such development will be completed in any particular time frame, or
that the Company's products or proprietary technologies will not become
uncompetitive or obsolete.
LACK OF PATENT PROTECTION. The Company currently holds several patents and
intends to pursue various additional avenues that it deems appropriate to
protect its technology. There can be no assurance, however, that the Company
will file any additional patent applications or that any patent applications
that have been, or may be, filed will result in issued patents, or that any
patent, patent application, know-how, license or cross-license will afford any
protection or benefit to the Company.
The cosmetic laser device market has been characterized by substantial
litigation regarding patent and other intellectual property rights. One of the
company's competitors has filed suit against the Company alleging patent
infringement, among other things. See "Item 3. Legal Proceedings." In both the
cosmetic laser products and the electronic products segments, litigation, which
could result in substantial cost to and diversion of effort by the Company, may
be necessary to protect trade secrets or know-how owned by or licensed to the
Company or to determine the enforceability, scope and validity of the
proprietary rights of others. Adverse determination in litigation or
interference proceedings could subject the Company to significant liabilities to
third parties, require the Company to seek licenses from third parties and could
prevent the Company from manufacturing and selling its products, all of which
could have a material adverse effect on the Company's business, financial
condition and results of operations.
POSSIBLE PATENT INFRINGEMENTS. In the medical products segment, the Company
is aware of patents relating to laser technologies used in certain applications
that the Company intends to pursue, which, if valid and enforceable, may be
infringed by the Company. The Company has obtained opinions of counsel that the
Company is not infringing currently on patents held by others; however, the
validity of such opinions have not yet been judicially determined. If the
Company's current or proposed products are, in the opinion of patent counsel,
infringing on any of these patents, the Company intends to seek non-exclusive,
royalty-bearing licenses to such patents but there can be no assurance that any
such license would be available on favorable terms, if at all. In the electronic
products segment, 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. No assurance can be given that infringement claims will not be made or
that the Company would prevail in any legal action with respect thereto. 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.
DEPENDENCE ON PROPRIETARY RIGHTS. The Company relies on trade secrets and
proprietary know-how which it seeks to protect, in part, by confidentiality
agreements with its collaborators, employees and consultants. There can be no
assurance that these agreements will not be breached, that the Company would
have adequate remedies for any breach, or that the Company's trade secrets will
not otherwise become known or be independently developed by competitors.
NEED FOR ADDITIONAL QUALIFIED PERSONNEL/DEPENDENCE ON KEY PERSONNEL. The
Company's ability to develop, manufacture and market all of its products, and to
attain a competitive position within the laser products and electronics
industries, will depend, in large part, on its ability to attract and retain
qualified personnel. Competition for qualified personnel in these industries is
intense and the Company will be required to compete for such personnel with
companies which may have greater financial and other resources; there can be no
assurance that the Company will be successful in attracting, assimilating and
retaining the personnel it requires to grow and operate profitably. The
Company's inability to attract and retain such personnel could have a material
adverse effect upon its business. (See "Management of Growth.")
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The Company's future success depends to a significant extent on its
executive officers and certain technical, managerial and marketing personnel.
The loss of the services of any of these individuals or group of individuals
could have a material adverse effect on the Company's business, financial
condition and results of operations.
The Company is dependent on various sales representatives and distributors
to market and sell its medical products. The Company is in the process of
expanding its direct sales force to ensure that it satisfactorily monitors and
controls the expected growth of its medical product sales.
ISSUANCE OF PREFERRED STOCK AND DEBENTURES COULD AFFECT RIGHTS OF COMMON
SHAREHOLDERS. The Company is authorized to issue up to 5 million shares of
Preferred Stock, $.01 par value. The Preferred Stock may be issued in one or
more series, the terms of which may be determined at the time of issuance by the
Board of Directors, without further action by shareholders, and may include
voting rights (including the right to vote as a series on particular matters),
preferences as to dividends and liquidation, conversion and redemption rights
and sinking fund provisions. The issuance of any such additional Preferred Stock
or Debentures could affect the rights of the holders of Shares, and could reduce
the market price of the Shares. In particular, specific rights granted to future
holders of Preferred Stock or Debentures could be used to restrict the Company's
ability to merge with or sell its assets to a third party, thereby preserving
control of the Company by the existing control group. See "Item 5. Market for
Common Equity and Related Stockholder Matters."
PRODUCT LIABILITY EXPOSURE. Cosmetic laser product companies face an
inherent business risk of financial exposure to product liability claims in the
event that the use of their products results in personal injury. The Company's
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 the
Company's products or that deaths could occur. Further, in the event that any of
the Company's products prove to be defective, the Company may be required to
recall and redesign such products. Although the Company has not experienced any
material losses due to product liability claims to date, there can be no
assurance that it will not experience such losses in the future. The Company
maintains general liability insurance in the amount of $1,000,000 per occurrence
and $2,000,000 in the aggregate and maintains 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 the Company or that such
coverage will be adequate for liabilities actually incurred. In the event the
Company is found liable for damages in excess of the limits of its insurance
coverage, or if any claim or product recall results in significant adverse
publicity against the Company, the Company's business, financial condition and
results of operations could be materially and adversely affected. In addition,
although the Company's products have been and will continue to be designed to
operate in a safe manner, and although the Company attempts to educate medical
personnel with respect to the proper use of its products, misuse of the
Company's products by medical personnel over whom the Company cannot exert
control may result in the filing of product liability claims or significant
adverse publicity against the Company.
RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS. As part of its business
strategy, the Company intends to seek opportunities to expand its product and
service offerings into international markets. In marketing its products and
services internationally, the Company will likely face new competitors. There
can be no assurance that the Company will be successful in marketing or
distributing products and services in these markets or that its international
revenue will be adequate to offset the expense of establishing and maintaining
international operations. The Company's international business may be adversely
affected by changing economic conditions in foreign countries. The majority of
the Company's sales are currently denominated in U.S. dollars, but there can be
no assurance that a significantly higher level of future sales will not be
denominated in foreign currencies. To the extent the Company makes sales
denominated in currencies other than U.S. dollars, gains and losses on the
conversion of those sales to U.S. dollars may contribute to fluctuations in the
Company's business, financial condition and results of operations. In addition,
fluctuations in exchange rates could affect demand for the Company's products
and services. Conducting an international business inherently involves a number
of other difficulties and risks, such as export restrictions, export controls
relating to technology, compliance with existing and changing regulatory
requirements, tariffs and other trade barriers, difficulties in staffing and
managing international operations, longer payment cycles, problems in collecting
accounts receivable, political instability, seasonal reductions in business
activity in Europe and certain other parts of the world during the summer
months, and potentially adverse tax consequences. There can be no assurance that
one or more of these factors will not have a material adverse effect on any
international operations established by the Company and, consequently, on the
Company's business, financial condition and results of operations.
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The Company plans to expand its business into international markets and has
set up a manufacturing and distribution center in Hull, England. To date, the
Company has minimal experience in marketing and distributing its products
internationally and plans to establish alliances with sales representative
organizations and resellers with particular experience in international markets.
Accordingly, the Company's success in international markets will be
substantially dependent upon the skill and expertise of such international
participants in marketing the Company's products. There can be no assurance that
the Company will be able to successfully market, sell and deliver its products
in these markets. In addition, there are certain risks inherent in doing
business in international markets, such as unexpected changes in regulatory
requirements, export restrictions, tariffs and other trade barriers,
difficulties in staffing and managing foreign operations, management's lack of
international expertise, political instability and fluctuations in currency
exchange rates and potentially adverse tax consequences, which could adversely
impact the success of the Company's international operations. There can be no
assurance that one or more of such factors will not have a material adverse
effect on the Company's future international operations and, consequently, on
the Company's business, financial condition or operating results.
HAZARDOUS SUBSTANCE AND ENVIRONMENTAL CONCERNS. The manufacture of
substrate interconnect products involves numerous chemical solvents and other
solid, chemical and hazardous wastes and materials. Dynaco is subject to a
variety of environmental laws relating to the generation, storage, handling,
use, emission, discharge and disposal of these substances and potentially
significant risks of statutory and common law liability for environmental damage
and personal injury. The Company, and in certain circumstances, its officers,
directors and employees, may be subject to claims arising from the Company's
manufacturing activities, including the improper release, spillage, misuse or
mishandling of hazardous or non-hazardous substances or material. The Company
may be strictly liable for damages, regardless of whether it exercised due care
and complied with all relevant laws and regulations. The Company does not
currently maintain environmental impairment insurance. There can be no assurance
that the Company will not face claims resulting in substantial liability for
which the Company is uninsured or that hazardous substances are not or will not
be present at the Company's facilities. Failure to comply with proper hazardous
substance handling procedures or violation of environmental laws and regulations
would have a material adverse effect on the Company.
SIGNIFICANT OUTSTANDING INDEBTEDNESS; SUBORDINATION OF DEBENTURES. The
Company has incurred substantial indebtedness in relation to its equity capital
and will be subject to all of the risks associated with substantial leverage,
including the risk that available cash may not be adequate to make required
payments to the holders of the Debentures. The Company's ability to satisfy its
obligations under the Debentures from cash flow will be dependent upon the
Company's future performance and will be subject to financial, business and
other factors affecting the operation of the Company, many of which may be
beyond the Company's control. In the event the Company does not have sufficient
cash resources to satisfy quarterly interest or other repayment obligations to
the holders of the Debentures, the Company will be in default under the
Debentures, which would have a material adverse effect on the Company. To the
extent that the Company is required to use cash resources to satisfy interest
payments to the holders of the Debentures, it will have less resources available
for other purposes. Inability of the Company to repay the Debentures upon
maturity would have a material adverse effect on the Company, which could result
in a reduction of the price of the Company's Shares.
The Debentures will be unsecured and subordinate in right of payment to all
Senior Indebtedness of the Company. The Debentures do not restrict the Company's
ability to incur additional Senior Indebtedness and most other indebtedness. The
terms of Senior Indebtedness now existing or incurred in the future could affect
the Company's ability to make payments of principal and/or interest to the
holders of Debentures. See "Item 5. Market for Common Equity and Related
Stockholder Matters."
POTENTIAL EFFECT OF ANTI-TAKEOVER PROVISIONS. The Company is subject to
the anti-takeover provisions of Section 203 of the Delaware General Corporation
Law, which prohibit the Company from engaging in a "business combination" with
an "interested stockholder" for a period of three years after the date of the
transaction in which the person becomes an interested stockholder, unless the
business combination is approved in a prescribed manner. The application of
Section 203 could have the effect of delaying or preventing a change of control
of the Company. The Company's stock option grants generally provide for an
exercise of some or all of the optioned stock, including non-vested shares, upon
a change of control or similar event. The Board of Directors has authority to
issue up to 5,000,000 shares of Preferred Stock and to fix the rights,
preference, privileges and restrictions, including voting rights, of these
shares without any further vote or action by the stockholders. The rights of the
holders of the Common Stock will be subject to, and may be adversely affected
by, the rights of the holders of any Preferred Stock that may be issued in the
future. The 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 a
majority of the outstanding voting stock of the Company, thereby delaying,
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deferring or preventing a change in control of the Company. Furthermore, such
Preferred Stock may have other rights, including economic rights senior to the
Common Stock, and, as a result, the issuance of such Preferred Stock could have
a material adverse effect on the market value of the Common Stock. (See
"Issuance of Preferred Stock and Debentures Could Affect Rights of Common
Shareholders.")
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F-1
ITEM 7. FINANCIAL STATEMENTS
PALOMAR MEDICAL TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Public Accountants F-2
Consolidated Balance Sheets as of December 31, 1995 and 1996 F-3
Consolidated Statements of Operations for the years ended
December 31, 1995 and 1996 F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1995 and 1996 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1995 and 1996 F-7
Notes to Consolidated Financial Statements F-10
<PAGE>
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Palomar Medical Technologies, Inc. and Subsidiaries:
We have audited the accompanying consolidated balance sheets of Palomar
Medical Technologies, Inc. (a Delaware corporation) and subsidiaries, as of
December 31, 1995 and 1996, and the related consolidated statements of
operations, stockholders' equity and cash flows for the years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Palomar Medical
Technologies, Inc. and subsidiaries as of December 31, 1995 and 1996, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Boston, Massachusetts,
March 7, 1997 (Except with respect
to the matter discussed
in Note 15(a) as to which
the date is March 31, 1997)
<PAGE>
F-3
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<C> <C> <C>
December 31, December 31,
1995 1996
ASSETS
Current Assets:
Cash and cash equivalents $17,138,178 $16,172,731
Marketable securities 749,410 2,893,792
Accounts receivable, net of allowance for doubtful accounts of 4,737,766 18,308,077
approximately $445,000 and $3,113,000, respectively
Inventories 3,649,884 18,790,484
Loans to officers 948,198 995,331
Notes receivable related parties 3,161,375 464,153
Other notes receivable --- 899,937
Other current assets 352,130 7,623,161
----------- ----------
Total current assets 30,736,941 66,147,666
----------- ----------
Property and Equipment, at Cost, Net 3,165,015 8,404,605
Other Assets:
Cost in excess of net assets acquired, net of accumulated 3,729,508 5,024,299
amortization of approximately $673,000 and $1,480,000,
respectively
Intangible assets, net of accumulated amortization of approximately 1,597,745 2,286,058
and $1,025,000, respectively
Deferred costs 809,120 2,895,803
Long-term investments 500,000 3,179,554
Loan to related party 700,000 1,100,000
Other assets 631,831 1,719,211
----------- -----------
Total other assets 7,968,204 16,204,925
----------- -----------
$41,870,160 $90,757,196
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Revolving lines of credit $1,296,462 $4,558,052
Current portion of long-term debt 2,574,265 2,783,683
Contingent note payable 500,000 ---
Accounts payable 4,246,950 14,304,285
Accrued expenses 4,633,557 14,669,893
------------ ----------
Total current liabilities 13,251,234 36,315,913
------------ ----------
Long-Term Debt, Net of Current Portion 3,330,172 16,204,692
------------ ----------
Minority Interest in Subsidiary --- 160,000
------------ ----------
Commitments and Contingencies (Note 13)
Stockholders' Equity:
Preferred stock, $.01 par value- 139 182
Authorized - 5,000,000 shares
Issued and outstanding -
13,860 shares and 18,151 shares
at December 31, 1995 and 1996
(Liquidation preference of $18,645,956 as of December 31,
1996)
Common stock, $.01 par value- 201,353 305,968
Authorized - 100,000,000 shares
Issued and outstanding - 20,135,406 shares
and 30,596,812 shares at December 31, 1995 and 1996
Additional paid-in capital 54,152,385 104,900,551
Accumulated deficit (25,864,657) (64,971,200)
Unrealized loss on marketable securities --- (342,500)
Subscriptions receivable from related party (1,988,709) (604,653)
Less: Treasury Stock (200,000 shares at cost) (1,211,757) (1,211,757)
------------ ------------
Total stockholders' equity 25,288,754 38,076,591
------------ ------------
$41,870,160 $90,757,196
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
F-4
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Year ended December 31,
1995 1996
----------- ------------
Revenues $21,906,504 $70,098,443
Cost of revenues 17,192,470 63,177,555
----------- ------------
Gross profit 4,714,034 6,920,888
----------- ------------
Operating Expenses
Research and development 4,419,487 7,977,085
Sales and marketing 2,768,541 11,420,943
General and administrative 7,879,694 21,569,054
Business development
and other financing costs 1,409,303 2,879,603
Settlement and Litigation Costs 700,000 2,255,000
Merger expenses -- 443,780
----------- ------------
Total operating expenses 17,177,025 46,545,465
----------- ------------
Loss from operations (12,462,991) (39,624,577)
Interest Expense (1,374,199) (1,443,564)
Interest Income 913,050 1,586,620
Net Gain on Trading Securities 201,067 2,033,371
Gain On Sale of Stock of a Subsidiary -- 3,830,000
Other Income (Expense) 102,305 (4,245,642)
----------- ------------
Net loss $(12,620,768) $(37,863,792)
============ =============
Net Loss Per Common Share $(0.89) $(1.49)
============ =============
Weighted Average Number of
Common Shares Outstanding 14,164,901 26,166,538
============ =============
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
F-5
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<C> <C> <C> <C> <C> <C> <C>
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, 1994 -- $-- 9,464,963 $94,649 -- $--
Sale of common stock pursuant to warrants and options -- -- 2,925,093 29,251 -- --
Sale of common stock -- -- 1,622,245 16,223 -- --
Payments received on subscriptions receivable -- -- -- -- -- --
Issuance of preferred stock, including common stock issued as
as a placement fee, net of issuance costs 21,295 213 300,000 3,000 -- --
Purchase of treasury stock -- -- -- -- (200,000) (1,211,757)
Issuance of common stock in lieu of payment of notes payab -- -- 632,144 6,321 -- --
Repayment of convertible debentures -- -- -- -- -- --
Conversion of convertible debentures -- -- 1,943,870 19,438 -- --
Value ascribed to convertible debentures -- -- -- -- -- --
Value ascribed to warrant in exchange for license technolo -- -- -- -- -- --
Issuance of common stock for technology -- -- 739,546 7,395 -- --
Conversion of preferred stock (7,435) (74) 1,775,691 17,757 -- --
Exercise of underwriter's warrants -- -- 200,000 2,000 -- --
Issuance of common stock for Spectrum Medical Tech., Inc. -- -- 364,178 3,642 -- --
Issuance of common stock for investment banking and merger
and acquisition consulting services -- -- 167,676 1,677 -- --
Amortization of deferred financing costs -- -- -- -- -- --
Compensation expense related to warrants issued to
consultants and investment bankers -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Net loss -- -- -- -- -- --
--------------------------------------------------------------
Balance, December 31, 1995 13,860 $139 20,135,406 $201,353 (200,000) $(1,211,757)
===============================================================
</TABLE>
<TABLE>
<C> <C> <C> <C> <C> <C>
Additional Unrealized Total
Paid-in Accumulated Loss On Subscription Stockholders
Capital Deficit Marketable Receivable Equity
Securities
Balance, December 31, 1994 $15,773,109 $(13,119,279) $-- $-- $2,748,479
Sale of common stock pursuant to
warrants and options 7,588,888 -- -- (4,633,975) 2,984,164
Sale of common stock 2,935,921 -- -- -- 2,952,144
Payments received on subscriptions receivable -- -- -- 3,694,840 3,694,840
Issuance of preferred stock,
including common stock issued as
as a placement fee, net of issuance costs 19,382,750 -- -- -- 19,385,963
Purchase of treasury stock -- -- -- -- (1,211,757)
Issuance of common stock in lieu of
payment of notes payable 1,873,611 -- -- -- 1,879,932
Repayment of convertible debentures (321,533) -- -- -- (321,533)
Conversion of convertible debentures 3,071,302 -- -- -- 3,090,740
Value ascribed to convertible debentures 899,813 -- -- -- 899,813
Value ascribed to warrant in exchange
for license technology 100,000 -- -- -- 100,000
Issuance of common stock for technology 292,605 -- -- -- 300,000
Conversion of preferred stock 68,377 -- -- -- 86,060
Exercise of underwriter's warrants 1,049,574 -- -- (1,049,574) 2,000
Issuance of common stock for
Spectrum Medical Tech., Inc. 996,358 -- -- -- 1,000,000
Issuance of common stock for
investment banking and merger
and acquisition consulting services 416,823 -- -- -- 418,500
Amortization of deferred financing costs (70,583) -- -- -- (70,583)
Compensation expense related to
warrants issued to
consultants and investment bankers 95,370 -- -- -- 95,370
Preferred stock dividends -- (124,610) -- -- (124,610)
Net loss -- (12,620,768) -- -- (12,620,768)
------------------------------------------------------------------------
Balance, December 31, 1995 $54,152,385 $(25,864,657) $-- $(1,988,709) $25,288,754
========================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
<PAGE>
F-6
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(continued)
<TABLE>
<C> <C> <C> <C> <C> <C> <C>
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)
======================================================================
</TABLE>
<TABLE>
<C> <C> <C> <C> <C> <C>
Additional Unrealize Total
Paid-in Accumulated Loss on Subscriptions Stockholders'
Capital Deficit Marketable Receivable Equity
Securities
----------------------------------------------------------------------
Balance, December 31, 1995 $54,152,385 $(25,864,657) $-- $(1,988,709) $25,288,754
Sale of common stock pursuant to warrants
and options 7,569,226 -- -- -- 7,598,907
Sale of common stock 6,049,618 -- -- -- 6,061,380
Payments received on subscriptions receivable -- -- -- 2,441,556 2,441,556
Issuance of preferred stock, including common
stock issued as a placement fee, net
of issuance costs 30,821,677 -- -- -- 30,823,147
Issuance of common stock for 1995 employer 401(k)
matching contribution 160,139 -- -- -- 160,598
Conversion of preferred stock, including accrued
dividends and interest of $782,602 744,124 -- -- -- 788,687
Conversion of convertible debentures 145,260 -- -- -- 145,606
Redemption of convertible debentures (41,530) -- -- -- (41,530)
Value ascribed to convertible debentures 2,757,860 -- -- -- 2,757,860
Redemption of preferred stock (3,123,127) -- -- -- (3,123,152)
Exercise of underwriter's warrants 1,057,500 -- -- (1,057,500) 5,000
Exercise of stock options in majority
controlled subsidiary 50,000 -- -- -- 50,000
Issuance of common stock for conversion
of debentures at Tissue Technologies, Inc. 1,019,022 -- -- -- 1,027,156
Issuance of common stock for minority interest
in Star Medical subsidiary 1,747,482 -- -- -- 1,749,723
Issuance of common stock in exchange for
license rights 369,574 -- -- -- 370,143
Issuance of common stock for acquisition
of Dermascan, Inc. 489,650 -- -- -- 490,000
Issuance of common stock for investment
banking and merger and acquisition
consulting services 476,156 -- -- -- 476,724
Compensation expense related to warrants
issued to non-employees under SFAS No. 123 532,758 -- -- -- 532,758
Return of escrowed shares 460 -- -- -- --
Amortization of deferred financing costs (77,683) -- -- -- (77,683)
Unrealized loss on marketable securities -- -- (342,500) -- (342,500)
Preferred stock dividends -- (1,242,751) -- -- (1,242,751)
Net loss -- (37,863,792) -- -- (37,863,792)
-------------------------------------------------------------------------
Balance, December 31, 1996 $104,900,551 $(64,971,200) $(342,500) $(604,653) $38,076,591
=========================================================================
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
F-7
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<C> <C> <C>
Year ended December 31,
1995 1996
------------- -------------
Cash Flows from Operating Activities
Net loss $(12,620,768) $(37,863,792)
Adjustments to reconcile net loss to net cash
used in operating activities-
Depreciation and amortization 1,825,673 3,916,221
Settlement and litigation costs 700,000 2,255,000
Gain on sale of stock of a subsidiary -- (3,830,000)
Write-off of in-process research and development -- 57,212
Write-off of intangible assets -- 631,702
Write-off of deferred financing costs associated with
redemption of convertible debentures -- 201,500
Valuation allowances for notes and investments -- 4,996,038
Minority interest in loss of subsidiary (102,305) --
Accrued interest receivable on note
and subscription receivable -- (568,917)
Foreign currency exchange gain -- (446,596)
Noncash interest expense related to debt 220,280 163,680
Noncash compensation related to common stock and warrant 95,370 836,982
Realized gain on marketable securities -- (835,197)
Unrealized gain on marketable securities (133,568) (1,198,174)
Changes in assets and liabilities, net of effects
from business combinations;
Purchases of marketable securities (615,842) (10,355,055)
Sale of marketable securities and
interest received on marketable securities 50,000 10,244,044
Accounts receivable, net (1,479,532) (13,806,643)
Inventories (1,419,030) (14,975,426)
Other current assets and loans to officers (658,012) (1,809,381)
Accounts payable 1,770,100 9,902,024
Accrued expenses 2,159,702 6,251,560
------------ -------------
Net cash used in operating activities (10,207,932) (46,233,218)
------------ -------------
Cash Flows from Investing Activities
Cash paid for purchase of Comtel Electronics, Inc., net of -- (146,586)
Cash acquired from purchase of Spectrum Medical
Technologies, Inc., and CD Titles, Inc. 101,207 --
Cash paid for purchase of Inter-connecting Products, Inc. (397,199) --
Proceeds from sale of subsidiary stock -- 2,000,000
Purchases of property and equipment (1,147,945) (5,142,128)
Increase in intangible assets -- (410,647)
Increase in other assets (695,673) (1,125,333)
Loans to related parties (3,861,375) (7,338,625)
Loans to non-related parties -- (2,236,531)
Payments received on loans to related parties -- 9,322,284
Investment in nonmarketable securities (500,000) (5,767,054)
Increase in organizational costs (500,000) --
------------ -------------
Net cash used in investing activities (7,000,985) (10,844,620)
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
F-8
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
<TABLE>
<C> <C> <C>
Year ended December 31,
1995 1996
--------- ----------
Cash Flows from Financing Activities
Proceeds from issuance of convertible debentures 4,150,000 14,169,441
Proceeds from notes payable 2,630,000 --
Deferred financing costs incurred related to
convertible debemtures (182,000) (1,365,217)
Redemption of convertible debentures (1,048,967) (930,000)
Payments of notes payable and capital lease obligations (1,653,957) (944,413)
Net (payments) proceeds from revolving lines of credit (616,538) 3,261,590
Proceeds from sale of common stock 2,952,144 6,061,380
Exercise of warrants 6,194,955 7,111,684
Issuance of preferred stock 19,385,963 30,823,147
Purchase of treasury stock (1,211,757) --
Payment of contingent note payable -- (500,000)
Redemption of preferred stock, including accrued dividends -- (3,194,375)
Payments received on subscriptions receivable -- 2,009,592
Deferred costs -- (932,661)
Proceeds from exercise of stock options 484,049 542,223
----------- ----------
Net cash provided by financing activities 31,083,892 56,112,391
----------- ----------
Net increase (decrease) in cash and cash equivalents 13,874,975 (965,447)
Cash and cash equivalents, beginning of year 3,263,203 17,138,178
----------- ----------
Cash and cash equivalents, end of year $17,138,178 $16,172,731
=========== ===========
Supplemental Disclosure of Cash Flow Information
Cash paid for interest $542,294 $599,011
=========== ===========
Supplemental Disclosure of Noncash Financing and Investing Activities:
Conversion of convertible debentures and related accrued
interest, net of financing fees $3,190,740 $1,172,762
=========== ===========
Subscriptions received in connection with warrant
exercises $1,988,709 $1,057,500
=========== ===========
Issuance of common stock in lieu of payment of
notes payable $1,879,932 $--
=========== ===========
Conversion of preferred stock $86,060 $788,687
=========== ===========
Property acquired under capital leases $196,321 $1,135,189
=========== ===========
Issuance of common stock in exchange for license rights $300,000 $370,143
=========== ===========
Purchase of technology $--- $1,375,000
=========== ===========
Investment banking and consulting fees for services
related to the issuance of common stock and
convertible debentures $120,000 $709,224
=========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
<PAGE>
F-9
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
<TABLE>
<C> <C> <C>
Year ended December 31,
1995 1996
--------- -----------
Supplemental Disclosure of Noncash Financing and Investing Activities
Value ascribed to warrants in exchange for
license technology $100,000 $--
========= ===========
Issuance of common stock for 1995 employer 401(k)
matching contribution $-- $160,598
========= ===========
Issuance of common stock for minority interest
in Star Medical subsidiary $-- $1,749,723
========= ===========
Acquisition of Comtel Electronics, Inc.
Liabilities assumed $-- $(258,144)
Fair value of assets acquired -- 72,661
Cash paid, net of cash acquired -- (146,586)
--------- -----------
Cost In Excess of Net Assets Acquired $-- $(332,069)
========= ===========
Acquisition of Dermascan, Inc.
Liabilities assumed $-- $(39,980)
Fair value of assets acquired -- 28,126
Fair value of common stock issued -- (490,000)
--------- -----------
Cost In Excess of Net Assets Acquired $-- $(501,854)
========= ===========
Acquisition of Spectrum Medical Technologies, Inc.
Liabilities assumed $(1,128,139) $--
Fair value of assets acquired 1,456,920 --
Fair value of 364,178 shares of common stock issued (1,000,000) --
Promissory note issued (700,000) --
Cash paid (300,000) --
Acquisition costs incurred (161,138)
------------ -----------
Cost in Excess of Net Assets Acquired $(1,832,357) $--
============ ===========
Acquisition of CD Titles, Inc.
Liabilities assumed $(1,271,345) $--
Fair value of assets acquired 1,271,345 --
------------ -----------
Cost In Excess of Net Assets Acquired $-- $--
============ ===========
Acquisition of Inter-connecting Products, Inc.
Liabilities assumed $(201,761) $--
Fair value of assets acquired 598,960 --
Cash Paid (397,199) --
------------ -----------
Cost In Excess of Net Assets Acquired $-- $--
============ ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
<PAGE>
F-10
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") is engaged in two business segments: medical device products and
services and electronic products and services. The medical device products
segment consists of the commercial sales and development of cosmetic and medical
laser systems and services. The electronics products segment consists of the
manufacture and sale of personal computers, high density flexible electronics
circuitry and memory modules.
The Company also makes early stage investments in core technologies and
companies that management feels are strategic to the Company's business or will
yield a higher than average financial return to support the Company's core
business. Some of these investments are with companies associated with some of
the directors and officers of the Company (See Note 11).
Some of the Company's medical laser and electronic products are in various
stages of development, and, as such, success of future operations is subject to
a number of risks similar to those of other companies in similar stages of
development. Principal among these risks are the successful development and
marketing of its products, proper 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 prospective sources in order to fund future operations. 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. The Company raised a total of $56,112,391 and
$31,083,892 in such financings during the years ended December 31, 1996 and
1995, respectively. The Company anticipates that it will require additional
financing during the next twelve-month period to continue to fund operations and
growth. 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 are sold at a discount to the 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 these
securities for resale to the public at some future time.
MEDICAL SEGMENT BUSINESS DEVELOPMENTS
STAR MEDICAL TECHNOLOGIES, INC.
On April 22, 1996, the Company purchased the remaining 14.5% of the
outstanding common stock of Star Medical Technologies, Inc. ("Star") which it
did not already own in exchange for 224,054 shares of Palomar's common stock
valued between $6 and $8 per share. This agreement restricts, for a period of
two years, the sale of the Company's common stock issued in connection with this
agreement. The purchase price has been recorded as additional goodwill and is
being amortized over a period of five years. In connection with this agreement
the original founders of Star have agreed to rescind all royalties due to them
under a Rights Agreement dated July 1, 1993. To date, revenues from Star have
not been significant.
SPECTRUM MEDICAL TECHNOLOGIES, INC.
On April 5, 1995, the Company acquired all of the outstanding common
stock of Spectrum Medical Technologies, Inc. ("Spectrum"). The purchase price
consisted of $300,000 in cash, a $700,000 two-year promissory note, 364,178
shares of the Company's common stock with an aggregate fair market value of
$1,000,000, acquisition costs of $161,138 and assumed liabilities totaling
$1,128,139. In addition, the purchase price includes a 20% contingency payment,
payable in the Company's common stock, based upon the future earnings
performance of Spectrum over a three to five-year period, which will be recorded
as additional goodwill if earned. Spectrum develops, manufactures, sells and
services ruby lasers
<PAGE>
F-11
throughout the world for dermatological applications including the recently
(March 1997) FDA approved EpiLaser. The acquisition has been accounted for as a
purchase in accordance with Accounting Principles Board ("APB") Opinion No. 16.
SPECTRUM FINANCIAL SERVICES LLC
On June 30, 1995, the Company formed Spectrum Financial Services LLC
("SFS"), a Limited Liability Company. SFS provides financial leasing services
for medical and electronic manufacturers both related and unrelated to the
Company. The Company has majority control over the operating activities of this
entity. Accordingly, the Company has consolidated the results of operations and
financial position of SFS since the date of formation. To date, the operations
of SFS have not been a significant.
TISSUE TECHNOLOGIES, INC.
On May 3, 1996, the Company acquired 100% of Tissue Technologies, Inc.
("Tissue Technologies"), a manufacturer of a dermatology laser product for the
treatment of wrinkles, in exchange for 3,200,000 shares of the Company's common
stock. The Company has accounted for this acquisition as a pooling-of-interest
in accordance with APB No. 16. Tissue Technologies is engaged in the
manufacturing, marketing and sales of the Tru-Pulse C02 laser system used in
skin resurfacing and treatment of wrinkles.
DERMASCAN, INC.
On July 18, 1996 the Company purchased 80 shares of common stock (80% of
total issued and outstanding capital stock) of Dermascan, Inc. ("Dermascan")
from a Dermascan stockholder in exchange for 35,000 shares of the Company's
common stock. The Company included these 35,000 shares in a registration
statement that became effective February 28, 1997. In addition, the Company
agreed to pay the Dermascan stockholder an amount equal to the difference
between $14.00 and the $7.8125, the closing bid price on February 28, 1997. The
Company has recorded the acquisition at a price of $490,000 in total. Dermascan
markets and sells electrology equipment and supplies to the electrology market.
To date, the operations of Dermascan have not been significant.
PALOMAR TECHNOLOGIES, LTD.
On November 13, 1996, the Company formed Palomar Technologies, Ltd. located
in Hull, England. The purpose of the formation of this company was to establish
a European entity to manufacture, sell and service laser products throughout
Europe and provide a low-cost sourcing alternative for specialty components.
Operations are expected to begin in mid-1997. Through March 7, 1997, the Company
has funded this subsidiary with approximately $1,600,000 for the purchase of
office building and lease of its manufacturing facilities and the hiring of
certain key employees, and is committed to fund this subsidiary an additional $1
million. Subsequent to year end, Palomar Technologies Ltd. entered into
employment agreements with several individuals and issued stock options to
purchase up to 49% of the outstanding common shares of Palomar Technologies Ltd.
Under the terms of the employment agreements, the optionholders have the right
to require the Company to purchase all or a portion of these common shares
exercised pursuant to such stock option at a purchase price based on an earnings
formula as defined.
COSMETIC TECHNOLOGY INTERNATIONAL, INC.
On December 20, 1996, the Company formed Cosmetic Technology International,
Inc. ("CTI"). CTI is a service company which intends to establish a worldwide
network of cosmetic, dermatological laser and medical device sites with medical
service partners (both fixed and mobile) in key geographic locations. Each site
will be provided a turnkey package of laser and medical device technology,
equipment and services. To date, the operations of CTI have not been
significant.
<PAGE>
F-12
ELECTRONICS SEGMENT BUSINESS DEVELOPMENTS
NEXAR TECHNOLOGIES, INC.
On March 7, 1995, the Company formed Nexar Technologies, Inc. ("Nexar").
Nexar is an early-stage company that manufactures, markets and sells personal
computers with a unique circuit board design that will enable end users to
upgrade and replace the microprocessor, memory and hard drive components. Nexar
markets its products using various proprietary brand names through multiple
channels of distribution, including the wholesale, retail and direct response
channels.
On December 20, 1996, Nexar filed a registration statement on Form S-1 with
the SEC in connection with an initial public offering of 2,500,000 shares of its
common stock for its own account, as well as shares held by Nexar shareholders.
The estimated price per share range of the proposed offering is $11.00 to
$13.00. Following the offering, Palomar will beneficially own approximately 67%
of the common stock subject to a contingent repurchase right of Nexar at a
nominal price per share in the event that Nexar achieves certain performance
milestones set forth in an agreement between Nexar and Palomar, and shares of
Nexar common stock which Palomar may acquire upon conversion of shares of Nexar
convertible preferred stock. The Company anticipates that the offering will
close in early April 1997. Upon completion of the offering, Nexar will repay the
Company approximately $8,200,000 from the net proceeds received from this
offering. However, the Company can in no way guarantee, nor ensure, successful
completion of the initial public offering.
In December 1996 the Company sold 400,000 shares of Nexar common stock for
$4,000,000, of which $2,000,000 was collected prior to year end and $2,000,000
is in other current assets in the consolidated balance sheet. One of the
purchasers of 200,000 shares is a shareholder of the Company. The Company
recognized a gain on this sale of $3,830,000 in the consolidated statement of
operations. Subsequent to year end, the Company sold an additional 200,000
shares of Nexar common stock for $2,000,000 to another Company shareholder. The
subsequent to year end sale of Nexar common stock includes an option
arrangement, whereby the purchaser has the option to exchange the shares of
Nexar common stock, as defined, for $2,000,000 of the Company's common stock
based on a discounted value as defined, if an option exercise event occurs,
based on the value of the Company's stock on the exchange date. The option
exercise terminates upon the completion of Nexar's initial public offering.
CD TITLES, INC.
On July 13, 1995, CD Titles, Inc. ("CD Titles") was incorporated. The
Company owns substantially all of CD Titles' outstanding common stock. During
July 1995, certain minority stockholders of CD Titles loaned CD Titles a total
of $600,000. On July 31, 1995, CD Titles purchased certain assets and assumed
certain liabilities of CD Titles totaling $1,271,345. The purchase price
consisted of $625,000 in cash and a $600,000 note payable due September 30,
1995, which was guaranteed by the Company. CD Titles is a CD ROM publishing
company that distributes various materials on CD ROM through personal computer
wholesale channels in the United States. The acquisition has been accounted for
as a purchase in accordance with the APB No. 16.
CD Titles defaulted on its loans to the minority stockholders, and on
October 30, 1995 the Company negotiated a settlement with the minority
stockholders by agreeing to issue 257,144 shares of the Company's common stock
in lieu of the then outstanding principal and accrued interest (approximately
$794,000 at October 30, 1995). The common stock was issued at a 35% discount of
the closing bid price of the stock on October 30, 1995. The discount represented
the Company's cost of acquiring capital and was consistent with discounts
offered in similar financings during 1995.
In addition to the settlement of the minority stockholders' notes, the
Company entered into a settlement agreement with the former stockholders.
Pursuant to the settlement agreement, the Company registered 175,000 shares of
its authorized, but unissued common stock (the "pledged shares") which were then
issued to the former shareholders of CD Titles for resale. As part of the
agreement, the former shareholders of CD Titles would sell only the amount of
pledged shares to receive proceeds equal to the outstanding principal and
accrued interest on the note payable, which totaled $628,531, due on September
30, 1995, as part of the acquisition of CD Titles. In 1996, the former
shareholders of CD Titles returned 46,000 of the pledged shares, which
represents the unused portion. The Company has retired the returned shares.
<PAGE>
F-13
DYNAMEM, INC.
On September 28, 1995, Dynaco Corp. ("Dynaco") formed Dynamem Corporation
("Dynamem") (a Delaware Corporation) and contributed $8,000 for a majority (80%)
ownership in this subsidiary. The remaining 20% ownership is owned by the
president of Dynamem (the "Joint Owner"). Dynamem was formed to manufacture and
distribute a patented, high-density memory packaging technology. The Joint Owner
granted Dynamem a non-exclusive license to manufacture, use, sell and sublicense
certain patented FRAMM technology in exchange for certain royalty payments. The
royalities are guaranteed by Dynaco. Dynaco and the Joint Owner also entered
into a stockholders' agreement which grants the Joint Owner the right, upon the
earlier of December 29, 2000, or the termination of his employment with Dynamem,
to require Dynaco to purchase a total of 75% of the securities owned by the
Joint Owner in Dynamem. In addition, if the Company purchases the Joint Owner's
shares, the Joint Owner may elect to receive between 35% and 100% of the
purchase price in the form of common stock of the Company.
PALOMAR ELECTRONICS CORPORATION
On September 15, 1995, the Company formed Palomar Electronics Corporation
("PEC"), as part of a reorganization to separate the electronics and computer
operations of the Company's business from the medical laser segments of its
business. On September 29, 1995, as part of this reorganization, the Company
contributed all of its outstanding capital stock of Dynaco and Nexar, together
with certain intercompany indebtedness, to PEC in exchange for 4,500,000 shares
of common stock of PEC. On December 21, 1995, PEC issued 10% bridge notes
payable to certain investors for an aggregate consideration of $1,350,000 (see
Note 4). In connection with these notes, PEC issued to the noteholders warrants
to purchase up to 240,000 shares of its common stock. During the year ended
December 31, 1995, the Company started, but did not complete, an initial public
offering of PEC and incurred costs of approximately $438,000. This amount is
included in business development and other financing costs in the accompanying
consolidated statement of operations for the year ended December 31, 1995.
COMTEL ELECTRONICS, INC.
During 1996, Dynaco acquired 80.23% ownership Comtel Electronics, Inc.
("Comtel") by converting a $100,000 note receivable into equity of Comtel and
paying $27,500 in cash. Effective December 31, 1996, as part of a
recapitalization of Comtel, Dynaco exchanged $2,200,000 in intercompany
receivables due from Comtel and used by Comtel to fund its operations for an
additional 11.98% ownership in Comtel. This transaction resulted in Dynaco
owning 97.3% of Comtel. The remaining 2.7% ownership is held by two individuals.
The acquisition has been accounted for as a purchase in accordance with APB No.
16. Accordingly, the Company has allocated the purchase price based on the fair
market value of assets acquired and liabilities assumed. The results of Comtel
have been included with those of the Company since March 20, 1996.
PRO FORMA INFORMATION
The results of operations related to Spectrum have been included with those
of the Company since April 5, 1995.
The results of operations related to CD Titles, Inc./CDRP have been
included with those of the Company since July 31, 1995.
The results of operations related to Comtel have been included with those
of the Company since March 20, 1996.
The results of operations related to Dermascan have been included with
those of the Company since July 18, 1996
<PAGE>
F-14
Unaudited pro forma operating results for the Company, assuming the
acquisitions of Spectrum and Comtel had been made as of January 1, 1995, are as
follows (operations of CD Titles and Dermascan prior to acquisition were
insignificant):
Year Ended
1995 1996
----------- -----------
Revenue $31,051,600 $70,483,048
Net loss (16,827,709) (37,901,990)
Net loss per common share $(1.20) $(1.49)
Separate and combined results of the Company and Tissue Technologies
preceding the merger were as follows:
Tissue Palomar Combined
------------ ----------- -------------
Four Months Ended
May 3, 1996
(unaudited)
Net Revenues $3,093,804 $10,255,380 $13,349,184
Net Loss $(1,731,775) $(8,259,386) $ (9,991,161)
Year Ended
December 31, 1995
Net Revenues $114,425 $21,792,079 $21,906,504
Net Loss $(1,969,793) $(10,650,975) $(12,620,768)
(2) 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. 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. As of
December 31, 1996, the Company also has investments in marketable and
nonmarketable securities and loans to related parties totaling $8,632,830. The
amount that the Company may ultimately realize from these investments could
differ materially from the value of these investments recorded in the
accompanying consolidated financial statements as of December 31, 1996.
(c) INVESTMENTS
The fair values for the Company's marketable securities are based on
quoted market prices. The fair values of nonmarketable equity securities which
totaled $2,400,000 at December 31, 1996 represent equity investments in early
stage technology companies, and are based on the financial information provided
by these ventures. The Company periodically performs a financial analysis to
evaluate whether a permanent impairment has occurred. The amount that the
Company
<PAGE>
F-15
realizes from these investments may differ significantly from the amounts
recorded in the accompanying consolidated financial statements.
The Company accounts for marketable securities in accordance with 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 are classified as
held-to-maturity. There were no held-to-maturity securities as of December 31,
1995 and 1996. Securities purchased to be held for indefinite periods of time
and not intended at the time of purchase to be held until maturity are
classified as available-for-sale securities. Unrealized gains and losses
relating to available-for-sale securities are included as a separate component
of stockholders' equity. Securities that are bought and held principally for the
purpose of selling them in the near term are classified as trading securities.
Realized and unrealized gains and losses relating to trading securities are
included in the accompanying consolidated statements of operations. The Company
has deemed its portfolios at December 31, 1995 and 1996 to consist of
available-for-sale and trading securities summarized as follows:
December 31, 1995
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Costs Gain Loss Value
----------- ------------ ------------- -------------
Trading Securities:
Investments in publicly
traded companies $615,842 $137,170 $3,602 $749,410
============ ============ ============= =============
December 31, 1996
------------------------------------------------------
Trading Securities:
Investments in publicly
traded companies $1,695,618 $1,537,614 $339,440 $2,893,792
Available-for-Sale (long-term):
Investments in publicly
traded companies 1,000,000 --- 342,500 657,500
------------ ------------ ------------- -------------
$2,695,618 $1,537,614 $681,940 $3,551,292
============ ============ ============= =============
(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, 1995 and 1996, inventories
consist of the following:
December 31,
1995 1996
---------------- ----------------
Raw materials $1,949,288 $13,266,204
Work-in-process and finished goods 1,700,596 5,524,280
---------------- ----------------
$3,649,884 $18,790,484
================ ================
<PAGE>
F-16
(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
------------------------------------ ----------------------
Equipment under capital leases Term of Lease
Machinery and Equipment 5-8 Years
Furniture and Fixtures 5 Years
Leasehold improvements Term of Lease
Property and Equipment consist of the following:
December 31,
1995 1996
---------------- -----------------
Equipment under capital leases $1,214,950 $2,261,339
Machinery and equipment 1,992,157 5,429,764
Furniture and fixtures 806,252 1,926,948
Leasehold improvements 308,158 1,160,814
---------------- -----------------
4,321,517 10,778,865
Less: Accumulated depreciation
and amortization 1,156,502 2,374,260
---------------- -----------------
$3,165,015 $8,404,605
================ =================
(f) COST IN EXCESS OF NET ASSETS ACQUIRED AND INTANGIBLE ASSETS
The costs in excess of net assets acquired for Dynaco, Spectrum, Star and
Comtel are being amortized on a straight-line basis over periods ranging from 5
to 10 years, and are as follows:
December 31,
1995 1996
---------------- ----------------
Dynaco $2,570,318 $2,570,318
Spectrum 1,832,357 1,832,357
Star --- 1,749,722
Comtel --- 352,220
---------------- ----------------
4,402,675 6,504,617
Less: accumulated amortization 673,167 1,480,318
================ ================
$3,729,508 $5,024,299
================ ================
Amortization expense for the years ended December 31, 1995, and 1996,
amounted to approximately $445,000 and $807,000, respectively, and is included
in general and administrative expenses in the accompanying consolidated
statements of operations.
The Financial Accounting Standards Board issued Statement of Financial
Accounting Standards ("SFAS") No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF, in March 1995.
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 had
write-offs totaling
<PAGE>
F-17
approximately $1,032,000 associated with the realizability of certain licenses
and goodwill. This amount is included in general and administrative expenses in
the accompanying consolidated statement of operations for the year ended
December 31, 1996.
Other intangibles include the cost of licenses and technologies acquired
through the purchase of product rights and licenses during 1995 and 1996. These
intangibles are being amortized over a period of five years. Amortization
expense for the years ended December 31, 1995 and 1996 were approximately
$149,000 and $876,000 respectively, and is recorded in general and
administrative expenses in the accompanying consolidated statements of
operations.
On February 28, 1995, Tissue Technologies entered into a license agreement
to license a patent on a low pressure discharge apparatus (a key instrument in
Tissue Technologies' product) with a corporation. As consideration for entering
into the agreement, the corporation received $50,000 in cash and a warrant to
purchase 160,000 shares of common stock at a price of $.01 per share. Tissue
Technologies ascribed a value to the warrant of $100,000. The former majority
stockholder and officer of Tissue Technologies also assigned his right to
license the technology to Tissue Technologies, on an exclusive basis, and
exchanged his note payable of $100,000 for 600,000 shares of Tissue
Technologies' common stock, which was subsequently exchanged in the merger
discussed in Note 1. Tissue Technologies has capitalized $450,000 which
represents the cash paid plus the value ascribed to the equity consideration
given in exchange for the license.
As part of the formation and organization of PEC and Nexar, the Company
agreed to settle a complaint brought against the Company and the chief executive
officer of Nexar. As part of the settlement, the Company was required to pay
$525,000 and agreed to issue warrants to purchase 108,000 shares of the
Company's common stock at $5.00 per share. The Company has fully expensed this
amount in 1996 which is included in settlement and litigation costs in the
accompanying consolidated statement of operations.
(g) DEFERRED COSTS
Deferred costs consisted of the following at December 31, 1995 and 1996:
December 31,
1995 1996
--------------- --------------
Prepaid Investment banking fees $290,816 $ ---
Deferred initial public offering costs --- 952,383
Deferred financing costs, net 518,304 1,943,420
=============== ==============
$809,120 $2,895,803
=============== ==============
On August 19, 1994, the Company entered into an investment services
agreement whereby an investment banker would provide merger and acquisition
consulting services over a two-year period ending August 1996. The Company
expensed approximately $436,000 and $291,000 of these prepaid fees during the
years ended December 31, 1995 and 1996, respectively.
As of December 31, 1996, the Company has incurred costs of approximately
$952,383 in connection with the proposed initial public offering of Nexar's
common stock. These costs have been deferred as of December 31, 1996 and upon
the consummation of the proposed initial public offering the deferred offering
costs will be charged to stockholder's equity as reduction of the gross
proceeds.
During the years ended December 31, 1995 and 1996, the Company incurred
financing costs related to several issuances of convertible debentures (see Note
4). Deferred financing costs related to convertible debentures totalled $238,333
and $1,943,420 at December 31, 1995 and 1996, respectively.
<PAGE>
F-18
(h) REVENUE RECOGNITION
The Company recognizes product revenue upon shipment. Design and tooling
revenue is recognized upon customer acceptance. Occasionally, revenue is
recognized by the Company's Dynaco subsidiary upon completion of a phase of the
order when contractually accepted by the customer. Provisions are made at the
time of revenue recognition for any applicable warranty costs expected to be
incurred.
Nexar recognizes product revenue upon shipment. Nexar has established
programs which, under specified conditions, provide price protection and or
enable customers to return products. The effects of these programs are estimated
and current period revenue and cost of revenue are reduced accordingly. This is
standard industry practice, and no other contingencies exist relating to these
programs. Provisions are made at the time of sale for any applicable warranty
costs expected to be incurred.
During the year ended December 31, 1996, Nexar recognized revenue totaling
approximately $2,500,000 for products whose title passed to a significant
customer (see Note 2(i)) and such customer instructed the Company to hold the
product at its manufacturing facility on the customer's behalf. Subsequent to
December 31, 1996, all of this product had been shipped to this customer.
Included in accounts receivable at December 31, 1996 is approximately $160,000
due from this customer related to this transaction. The Company has recognized
this revenue in accordance with the SEC Accounting and Auditing Enforcement
Release No. 108.
(i) SIGNIFICANT CUSTOMERS
For the year ended December 31, 1995 one customer accounted for 10.3% of
revenues and 11.2% of accounts receivable. For the year ended December 31, 1996
one customer accounted for 22.3% of revenues and 26.7% of accounts receivable.
The two largest customers in 1996 accounted for 39.9% of revenue and represented
49.9% of the December 31, 1996 accounts receivable balance of which
approximately $5,056,000 was collected subsequent to year end. Accounts
receivable included $4,896,632 from a customer of Comtel's in which the Company
has approximately 14% equity ownership as of December 31, 1996. (See Note 11.)
(j) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development expenses to operations as
incurred.
(k) NET LOSS PER COMMON SHARE
For the years ended December 31, 1995 and 1996 the net loss per common
share has been computed by dividing net loss, as adjusted for preferred stock
dividends, by the weighted average number of shares of common stock outstanding
during the period. Common stock equivalents are not considered as outstanding,
as the result would be antidilutive.
The net loss was adjusted by the aggregate amount of dividends totaling
$124,610 and $1,242,751 on the Company's preferred stock during the years ended
December 31, 1995 and 1996, respectively. In March of 1997, SFAS No.128 EARNINGS
PER SHARE was issued which established new standards for calculating and
presenting earnings per share. The Company will be required to adopt this new
standard in the 1997 consolidated financial statements. In accordance with this
new standard, basic and diluted loss per share for 1995 and 1996 would be
$(0.89) and $(1.49).
(l) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS WITH
OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATION OF CREDIT
RISK, requires disclosures 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 highly rated financial institutions. The Company also has convertible
debentures denominated in Swiss francs of $7,222,846 at December 31, 1996 (see
Note 4(c)). The Company currently does not have a
<PAGE>
F-19
foreign currency hedging arrangement and plans to hedge this amount in 1997. The
Company has no other 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 routinely
assesses the financial strength of its 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 within any geographic area. The Company has issued
notes and made investments to various related parties totaling $5,076,751as of
December 31, 1996 (see Note 11). Included in this amount are unsecured loans of
$604,653 to and for the benefit of a director of the Company's underwriter. As
of December 31, 1996, the Company also made strategic equity investments
totaling $2,587,500 in four technology companies. Subsequent to year-end, the
Company loaned money to, prepaid fees for, purchased inventory on behalf of and
made investments in certain related entities totaling $3,060,000.
(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.
The fair value of financial instruments pursuant to SFAS No. 107 approximated
their carrying values at December 31, 1995 and 1996. Fair values have been
determined through information obtained from market sources and management
estimates.
(n) RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 consolidated financial
statements to conform with the current year's presentation.
(3) 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, 1996, the Company had available, subject to review and possible
adjustment by the Internal Revenue Service, a federal net operating loss
carryforward of approximately $45,917,000 to be used to offset future taxable
income, if any. This net operating loss carryforward will begin to expire in
2002. 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 not recorded a deferred tax asset for the net
operating losses, due to uncertainty relating to the Company's ability to
utilize such carryovers. In connection with Nexar's proposed initial public
offering it is contemplated that the Company's ownership of Nexar will fall
below 80%. Accordingly, $6,375,000 of net operating losses generated by Nexar as
of December 31, 1996 will not be available for to Company to utilize in future
periods.
<PAGE>
F-20
(4) LONG-TERM DEBT
(a) NOTES PAYABLE
<TABLE>
<C> <C> <C> <C>
December 31,
1995 1996
-------------- ---------------
Dollar denominated convertible debentures $ 819,359 $7,288,063
Swiss franc denominated convertible debentures -- 7,222,846
7% Note payable 244,782 244,782
7.4% to 21% Capital lease obligations, maturities ranging from August 1997 to
May 2001 1,393,612 2,290,847
Present value of notes payable, discounted at 8%, maturities ranging from
February 1996 to February 1998 468,012 337,606
Note payable in connection with the Spectrum acquisition, interest at the prime
rate (8.25% at Dec. 31, 1996) plus 1%, due April 1997 500,000 150,000
Bridge notes payable, interest at 10% until March 1996, then prime (8.25% at
December 31, 1996) plus 2% 1,350,000 1,200,000
8% Convertible debentures 950,000 --
Other notes payable 178,672 254,231
-------------- ---------------
5,904,437 18,988,375
Less - current maturities 2,574,265 2,783,683
-------------- ---------------
$3,330,172 $16,204,692
============== ===============
</TABLE>
On December 21, 1995, PEC issued $1,350,000 face value bridge notes
payable. The notes will be due 18 months after their inception or 10 days
following the closing of a public offering of PEC. Payment of principal and
accrued interest is guaranteed by the Company. In connection with the bridge
financing, PEC issued to the noteholders at nominal value warrants to purchase
up to 240,000 shares of PEC's common stock at $1.20 per share. In 1996 the
Company paid back one bridge noteholder a principal amount of $120,000 plus
accrued interest. As of December 31, 1995, the Company had $950,000 of
convertible debentures that were issued by the Company's subsidiary Tissue
Technologies. These notes were converted into 813,431 shares of the Company's
common stock on May 3, 1996 in connection with the merger of Tissue Technologies
with Palomar.
(b) DOLLAR DENOMINATED CONVERTIBLE DEBENTURES
During the years ended December 31, 1995 and 1996, the Company issued
several series of convertible debentures. The interest on certain of these
convertible debentures is forgiven if the debentures are converted before
specified dates; otherwise, interest is payable on their respective due dates.
During 1995 and 1996, approximately $152,000 and $10,500, respectively, of
accrued interest was forgiven and is included in additional paid-in capital. The
convertible debentures outstanding on December 31, 1996 have a conversion price
which represents a discount of 15% of the Company's common stock at the time of
conversion. It has been the Company's policy to discount those convertible
debentures using an assumed implicit rate ranging from 12% to 15% as a result of
the discount conversion feature of the convertible debentures. The Company
believes that the intent of the debentureholders is to convert the debentures
into common stock at their discounted conversion price. Accordingly, the Company
has credited this ascribed value to additional paid-in-capital, and this amount
is being amortized to interest expense over the terms of the convertible
debentures. During the years ended December 31, 1995 and 1996, the Company
recorded $168,393 and $76,721, respectively, of additional interest expense
relating to the amortization of the discounts relating to the convertible
debentures.
In addition, the Company has incurred financing costs of $380,000 and
$1,055,400 during the years ended December 31, 1995 and 1996, respectively,
relating to these debentures. Given the debentureholders' intent to convert,
these costs have been reflected in deferred costs in the accompanying
consolidated balance sheet as of December 31, 1995 and
<PAGE>
F-21
1996, and are amortized to additional paid-in capital over the term of the
related convertible debentures. Any remaining unamortized deferred financing
costs are also recorded to additional paid-in-capital upon conversion of the
debentures. During the years ended December 31, 1995 and 1996, the Company
amortized deferred financing costs of $70,583 and $77,683 to additional paid-in
capital, respectively. Also, as a result of the conversions of certain
convertible debentures during 1995 and 1996, the Company amortized another
$253,158 and $40,658, respectively, to additional paid-in capital.
The following table summarizes the issuance and conversion of the
convertible debentures for the years ended December 31, 1995 and 1996.
<TABLE>
<C> <C> <C> <C> <C> <C>
Value Common
Ascribed to Shares
Additional Outstanding at Issued
Face Paid-In December 31, Upon
---------------------------
Series Value Capital 1995 1996 Conversion
----------------------------------------------- ------------- ------------- ------------- ------------ -------------
3% Series due September 30, 1996 $ 750,000 $ 150,000 $ -- $ -- 370,189
6% Series due November 21, 1997 2,000,000 400,000 -- -- 1,172,132
7% Series due March 31, 2000 1,100,000 350,000 -- -- --
7% Series due July 1, 2000 1,200,000 350,000 -- -- 401,549
8% Series due October 26, 1997 1,000,000 199,813 819,359 -- 34,615
4.5% Series due October 21, 1999, 2000, 2001 5,000,000 1,284,705 -- 3,761,038 --
5% Series due December 31, 2001 5,000,000 1,472,975 -- 3,527,025 --
------------- ------------- ------------- ------------ -------------
$16,050,000 $4,207,493 $819,359 $7,288,063 1,978,485
============= ============= ============= ============ =============
</TABLE>
During the years ended December 31, 1995 and 1996, all of the 7%
convertible debentures due on March 31, 2000 and $775,000 face value of the 8%
convertible debentures, respectively, were redeemed by the Company together with
accrued interest. Accordingly, $321,533 and $41,530 for the years ended December
31 1995 and 1996, respectively, representing the unamortized amount previously
credited to additional paid-in capital for the ascribed value of the discount,
was reversed.
During 1995, the debentureholders converted the 3%, 6% and 7% series
convertible debenture due September 30, 1996, November 21, 1997, and July 1,
2000, respectively. During 1996, the debentureholders converted $225,000 in face
value of the 8% convertible debentures. Upon their conversion, in 1995 and 1996
these convertible debentures totaled $2,964,209 and $191,139 with related
accrued interest of $126,531 and $10,500, respectively, on the dates of
conversion.
In connection with the 6% convertible debentures, each holder is entitled
to receive one warrant to purchase common stock of the Company (expiring no
later than three years from the date of conversion) for every five shares of
common stock of the Company issued, at 150% of the market price, as defined, at
the time of conversion. As a result, the Company issued 242,655 warrants to
purchase common shares of the Company during 1995 at stock prices ranging from
$3.09 to $3.75. These warrants expire through July 28, 1998.
(c) SWISS FRANC DENOMINATED CONVERTIBLE DEBENTURES
On July 3, 1996, the Company raised $7,669,442 through the issuance of
9,675 units in convertible debenture financing. These units are traded on the
Luxembourg Stock Exchange. Each unit consists of a convertible debenture
denominated in 1,000 Swiss Francs and a warrant to purchase 24 shares of the
Company's common stock at $16.50 per share and is due July 3, 2003. 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 accrues at a rate of 4.5% per annum and is payable quarterly in Swiss
Francs. The convertible debentures may be converted by the holder or the Company
commencing October 1, 1996 at a conversion price equal to 100% to 77.5% of the
price per share of the Company's common stock, calculated as defined. This
conversion price decreases from the third anniversary to the seventh
<PAGE>
F-22
anniversary of the convertible debentures but in no event is less than $12.00
per share. Because of this decreasing conversion feature and the non-detachable
nature of the debentures, the Company believes that the intent of the
debentureholder is to hold the debenture through the life of the debt and no
discount has been ascribed to this debt. In addition, the Company has the option
to redeem these debentures after the third anniversary of the issuance. The
Company is required to set up a mandatory sinking fund beginning on July 3, 2000
through July 3, 2003, for 25% of the aggregate principal amount of the
convertible debentures. The debenture is payable in Swiss Francs and the Company
adjusts the debt based on fluctuations in the exchange rate. The translated
value of these convertible debentures as of December 31, 1996 was $7,222,846 and
the difference of $446,596 was recognized as a foreign exchange gain and
included in other income (see Note 9) in the consolidated statement of
operations for the year ended December 31, 1996. The Company incurred financing
costs of $982,365 relating to these debentures and is amortizing this asset over
the life of the debentures.
(d) FUTURE MATURITIES OF LONG-TERM DEBT OBLIGATIONS
Future maturities of notes payable, capital lease obligations and
convertible debentures reflected at face value as of December 31, 1996 are as
follows:
1997 $ 2,783,683
1998 1,359,208
1999 1,881,242
2000 1,732,169
2001 6,721,163
Thereafter 7,222,846
=============
$21,700,311
=============
(5) STOCKHOLDERS' EQUITY
(a) COMMON STOCK OUTSTANDING
During 1995, the Company pledged 2,860,000 shares of its common stock as
collateral for an anticipated $5,000,000 debt financing with Whetstone Ventures
Corporation, Inc. ("Whetstone"). The Company received only $400,000 from
Whetstone, and the debt financing was canceled before being consummated. On
March 13, 1996, the Company filed a complaint against the third party to whom
Whetstone had pledged the shares, demanding return of the shares and obtained a
restraining order prohibiting transfer of the shares. On March 22, 1996, the
third party agreed to return the shares in exchange for the $400,000 previously
received by the Company and an additional $700,000. The Company charged the
additional $700,000 to settlement and litigation cost during the year ended
December 31, 1995. Accordingly, the Company did not consider these shares as
outstanding in the accompanying consolidated financial statements as of December
31, 1995.
On February 1, 1996, the Company issued 365,533 shares of common stock and
warrants to purchase 182,765 shares of common stock at $5.00 per share in a
private placement for net proceeds of $1,530,776. Under the terms of the private
placement agreement, the Company can only use the proceeds to finance the
development and premarketing activities of certain products.
<PAGE>
F-23
(b) PREFERRED STOCK
The Company is authorized to issue up to 5 million shares of preferred
stock, $.01 par value.
As of December 31, 1995 and 1996, preferred stock authorized, issued and
outstanding consists of the following:
<TABLE>
<C> <C> <C> <C>
Par Value
December 31,
----------------------
1995 1996
---- ----
Redeemable convertible preferred stock, Series I Class A, $.01 par value
Authorized - 7,000 shares
Issued and outstanding - 1,960 shares in 1995, liquidation preference of $1,989,500 $ 20 --
Redeemable convertible preferred stock, Series II Class A, $.01 par value
Authorized - 9,000 shares
Issued and outstanding - 4,400 shares in 1995, liquidation preference of $4,456,415 44 --
Redeemable convertible preferred stock, Series A, $.01 par value
Authorized - 2,500 shares
Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329 25 --
Redeemable convertible preferred stock, Series B, $.01 par value
Authorized - 2,500 shares
Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329 25 --
Redeemable convertible preferred stock, Series C, $.01 par value
Authorized - 2,500 shares
Issued and outstanding - 2,500 shares in 1995, liquidation preference of $2,512,329 25 --
Redeemable convertible preferred stock, Series E, $.01 par value
Authorized - 10,000 shares
Issued and outstanding - 2,151 shares in 1996, liquidation preference of $2,235,615 -- 22
Redeemable convertible preferred stock, Series F, $.01 par value
Authorized - 6,000 shares
Issued and outstanding - 6,000 shares in 1996, liquidation preference of $6,229,333 -- 60
Redeemable convertible preferred stock, Series G, $.01 par value
Authorized - 10,000 shares
Issued and outstanding - 10,000 shares in 1996, liquidation preference of $10,181,008 -- 100
Total preferred stock $139 $182
==== ====
</TABLE>
During 1996, all of the outstanding Series I and II preferred shares
(including accrued dividends of $110,689) were converted into 1,527,242 shares
of the Company's common stock. In addition, all of the 5,000 shares of Series A
and B redeemable convertible preferred stock (including dividends of $125,625)
were converted into 788,711 shares of the Company's common stock. The Company
also redeemed all the 2,500 shares of Series C convertible redeemable preferred
stock (including accrued dividends of $71,223) on March 20, 1996 for $3,194,375.
In February 1996, the Company issued 6,000 shares of Series D redeemable
convertible preferred stock, all of which were converted into 1,116,918 shares
of common stock (including accrued dividends of $342,092) as of December 31,
1996. In April 1996, the Company issued 10,000 shares of Series E redeemable
preferred stock, 7,849 shares of which were converted into 1,048,647 shares of
common stock (including accrued dividends of $204,196) as of December 31, 1996,
and the remaining were converted after year end as discussed in Note 15.
In July 1996, the Company issued 6,000 shares of Series F redeemable
convertible preferred stock at a price of $1,000 per share. The Series F
redeemable convertible preferred stock, together with any accrued but unpaid
dividends, may be converted into shares at 80% of the daily average closing
price of the shares on the ten trading days preceding such conversion,
<PAGE>
F-24
but in no event less than $7.00 or more than $16.00. The Series F redeemable
convertible preferred stock may be redeemed as defined, 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.
On September 26, 1996, the Company issued 10,000 shares of Series G
redeemable convertible preferred stock at a price of $1,000 per share to two
investors. The Series G redeemable convertible preferred stock, together with
any accrued but unpaid dividends, may be converted into common stock at 85% of
the average closing bid price for the three trading days immediately preceding
the conversion date, but in no event at less than $6.00 or more than $11.50 for
5,000 shares of Series G redeemable convertible preferred stock or $8.00 for the
other 5,000 shares of Series G redeemable convertible preferred stock. The
Series G redeemable convertible preferred stock may be redeemed 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 Series F and G redeemable convertible preferred
stock is adjustable for certain dilutive events, as defined. The Series F and G
redeemable convertible preferred stock have a liquidation preference equal to
$1,000 per share of redeemable convertible preferred stock, plus accrued but
unpaid dividends, and accrued but unpaid interest. The Series F and G redeemable
convertible preferred stockholders do not have any voting rights except on
matters effecting the Series F and G redeemable convertible preferred stock. The
Company has registered 2,100,000 shares of common stock underlying the
conversion of the Series F and G redeemable convertible preferred stock into
common shares.
(c) STOCK OPTION PLANS AND WARRANTS
(i) STOCK OPTIONS
The Company has 1991, 1993, 1995 and 1996 Stock Option Plans (the "Plans")
that provide for the issuance of a maximum of 350,000, 500,000, 1,000,000 and
2,500,000 shares of common stock, respectively, 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), provided that 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 the
request of the optionee, may, in its discretion, convert the optionee's ISOs
into nonqualified options at any time prior to the expiration of such ISOs.
During 1995, Tissue Technologies granted options to purchase 224,235 shares
of the Company's common stock at prices ranging from $0.40 to $0.81 per share.
These options were not granted pursuant to the above mentioned plans. These
options were exercised on May 3, 1996 in connection with the Company's merger
with Tissue Technologies as discussed in Note 1.
<PAGE>
F-25
The following table summarizes all stock option activity for the Company:
<TABLE>
<C> <C> <C> <C>
Number of Exercise Weighted Average
Shares Price Exercise Price
------------- ---------------- ----------------------
Outstanding, December 31, 1994 1,047,500 $1.00-3.50 $2.25
Granted 820,235 0.40-3.00 1.75
Exercised (285,000) 1.00-3.50 1.76
Canceled (75,000) 2.375 2.375
------------- ---------------- ----------------------
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
============= ================ ======================
Exercisable as of December 31, 1996 1,600,998 $2.00-$10.50 $3.79
============= ================ ======================
Available for future issuances under the plans
as of December 31, 1996 1,266,500
=============
</TABLE>
The range of exercise prices for options outstanding and options
exercisable at December 31, 1996 are as follows:
<TABLE>
<C> <C> <C> <C> <C> <C> <C> <C>
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
- -------------------- ---------------- ---------------------- ----------------------- -------------- -----------------------
$2.00-$3.50 1,136,000 3.04 $2.29 1,136,000 $2.29
6.00-10.50 1,520,000 4.75 7.08 464,998 7.46
================ ---------------------- ----------------------- ============== =======================
2,656,000 4.01 $5.03 1,600,998 $3.79
================ ====================== ======================= ============== =======================
</TABLE>
In August 1995, Nexar established its 1995 Stock Option Plan (the "Nexar
Plan"), which provides for the issuance of a maximum of 4,800,000 shares of
common stock, which may be issued as incentive stock options (ISOs) or
nonqualified stock options. Subsequent to December 31, 1996, the Nexar Board of
Directors increased the number of shares issuable under the Nexar Plan to
5,300,000.
On January 30, 1996 and July 19, 1996 Nexar granted options to purchase
3,234,480 and 83,000 respective shares of Nexar's common stock at an exercise
price of $0.0025 and $4.25 per share. The price per share was based on the fair
market value of Nexar's Common Stock as determined by the Board of Directors of
Nexar on the date of grant.
Nexar has also agreed to issue, upon consummation of Nexar's initial public
offering, options to purchase 50,000 and 50,000 shares of Nexar's common stock
at 85% and 50% of the initial public offering price, respectively. Upon the
granting of these options, the Company will record deferred compensation expense
for the difference between the exercise price and the price of the initial
public offering, if any. In addition, the Board of Directors of Nexar approved
the issuance of stock options to purchase 1,050,000 shares of Nexar's common
stock at the initial public offering price upon the effectiveness of Nexar's
proposed initial public offering price to certain employees, directors and
officers of the Company and Nexar. These stock options will vest over periods
ranging from four to five years, except for stock options to purchase 800,000
shares of Nexar's common stock, which may vest earlier, upon the achievement of
certain revenue, net income and stock price milestones, as defined, through
December 31, 2000.
<PAGE>
F-26
In December 1996, the Director Plan was adopted by the Board of Directors
of Nexar. The Director Plan will become effective upon the closing of the
proposed initial public offering. Under the terms of the Director Plan, initial
options (the "Initial Options") to purchase 15,000 shares of common stock will
be granted to each person who becomes a non-employee director of Nexar after the
closing date of the proposed initial public offering and who is not otherwise
affiliated with Nexar, effective as of the date of election to the Board of
Directors. The Initial Options will vest in equal annual installments over three
years after the date of grant. In addition, each non-employee director will
receive annually options to purchase 10,000 shares (the "Annual Options") on the
date of each annual meeting of Nexar's stockholders held after the closing of
Nexar's initial public offering. The Annual Options will vest one year from the
date of grant. A total of 100,000 shares of common stock may be issued upon the
exercise of stock options granted under the Director Plan. Unless sooner
terminated pursuant to its terms, the Director Plan will terminate in December
2006.
Subsequent to December 31, 1996, the Board of Directors of Nexar authorized
amendments to employment agreements accelerating the vesting of certain options
to purchase 451,950 shares of Nexar's common stock upon the closing of Nexar's
initial public offering contemplated herein. In addition, the Board of Directors
of Nexar approved amendments to employment agreements accelerating the vesting
of options to purchase 903,900 shares of Nexar's common stock to vest one year
from the closing of Nexar's initial public offering contemplated.
The following table summarizes stock option activity for Nexar:
<TABLE>
<C> <C> <C>
Number of Exercise
Shares Price
------------------------ -----------------
Inception, March 7, 1995 - $
-
Granted 20,640 .001
------------------------ -----------------
Outstanding, December 31, 1995 20,640 .001
Granted 3,396,840 .0025-10.00
Canceled (361,560) .0025
------------------------ -----------------
Outstanding, December 31, 1996 3,055,920 $.001-$10.00
======================== =================
Exercisable as of December 31, 1996 1,063,973 $.001-$.0025
======================== =================
</TABLE>
Star also has established a stock option plan which provides for the
issuance of both nonqualified and ISOs. As of December 31, 1994, Star granted a
total of 97,000 options to purchase Star's common stock to officers and
employees ranging from $2.50 to $6.00 per share. In the fiscal year ending
December 31, 1996, Star granted a total of 140,000 options to purchase Star's
common stock to officers and employees ranging from $2.50 to $9.50 per share. In
the fiscal year ending December 31, 1996, 20,000 shares at $2.50 per share were
exercised by an individual; in addition, 12,000 shares at $6.00 per share were
canceled. As of December 31, 1996, 205,000 ranging from $2.50 to $9.50 per share
are outstanding, of these, 105,000 are exercisable.
PEC has also established a stock option plan, which provides for the
issuance of both nonqualified and incentive stock options. On December 1, 1995,
PEC granted stock options to purchase 1,590,000 shares of PEC common stock for
$.30 per share, the fair value of PEC's common stock, as determined by PEC's
Board of Directors. Of the total stock options granted, 1,230,000 vested
immediately, and the balance vest over a four-year period. In 1996, options to
purchase 870,000 shares of PEC common stock were canceled. No additional stock
options were granted by PEC during 1996.
Comtel has established a stock option plan which provides for the issuance
of both nonqualified and incentive stock options. During 1996, Comtel issued
423,675 options to purchase Comtel common stock for $.55 per share, the fair
market value as determined by Comtel's Board of Directors.
CTI has established a stock option plan which provides for the issuance of
both nonqualified and inventive stock options. During 1996, CTI issued 1,750
options to purchase CTI common stock for $.01 per share, the fair market value
at the date of grant as determined by CTI's Board of Directors.
<PAGE>
F-27
The Company accounts for its stock-based compensation plans under APB
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. In October 1995, the
Financial Accounting Standards Board 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 has computed the pro forma disclosures required under SFAS No.
123 for all stock options and warrants granted to employees of the Company and
its Nexar subsidiary in fiscal years ending December 31, 1995 and 1996 using the
Black Scholes option pricing model prescribed by SFAS No. 123. The pro forma
disclosure for the Company's results of operations related to stock option plans
at its Dynaco, Star, PEC, Comtel and CTI subsidiaries were immaterial for the
years ended December 31, 1995 and 1996.
The assumptions used to calculate the SFAS 123 pro forma disclosure and the
weighted average information for the fiscal years ending December 31, 1995 and
1996 for Palomar are as follows:
<TABLE>
<C> <C> <C>
1995 1996
------------------------ -----------------------
Risk-free interest rate 6.08% 6.37%
Expected dividend yield - -
Expected lives 3.2 years 4.4 years
Expected volatility 55% 79%
Weighted-average grant date fair value of
options granted during the period $3.92 $4.57
</TABLE>
The weighted fair-value and weighted exercise price of options granted for
the Company in fiscal years ending December 31, 1995 and 1996 are as follows:
<TABLE>
<C> <C> <C>
1995 1996
-------------------- -------------------
Weighted Average Exercise Price for options:
whose exercise price exceeded fair market value at the $3.00 $10.00
date of grant
whose exercise price was equal to fair market value at $1.614 $6.875
the date of grant
Weighted Average Fair Market Value for options:
whose exercise price exceeded fair market value at the $2.125 $8.875
date of grant
whose exercise price was equal to fair market value at $5.265 $6.875
the date of grant
</TABLE>
<PAGE>
F-28
The assumptions used to calculate the SFAS No. 123 pro forma disclosure and
the weighted average information for the fiscal years ending December 31, 1995
and 1996 for Nexar are as follows:
<TABLE>
<C> <C> <C>
1995 1996
------------------------ -----------------------
Risk-free interest rate 6.11% 5.87%
Expected dividend yield - -
Expected lives 4.5 years 4.5 years
Expected volatility 51% 51%
Weighted-average grant date fair value of
options granted during the period $0.001 $0.28
Weighted-average exercise price of options granted
during the period $0.001 $0.45
Weighted-average remaining contractual life of
options outstanding 4.58 years 4.13 years
Weighted-average exercise price of 5,733 and
1,063,973 options exercisable at December
31, 1995 and 1996, respectively. $0.001 $0.0025
</TABLE>
(ii) WARRANTS
In connection with the Company's initial public offering, the Company
issued 2,442,621 warrants to purchase one share of common stock per warrant as
adjusted in certain antidilution provisions in the warrant agreement. In January
1995, the Company announced its intention to redeem the warrants. Through
February 10, 1995, the date the warrant call ended, certain warrantholders
exercised such warrants to purchase a total of 1,852,012 shares of common stock.
The remaining unexercised warrants to purchase 590,609 shares were redeemed by
the Company for $29,530. As a result of these warrant exercises, the Company
received cash proceeds totaling $1,286,931 and received demand promissory notes
in the total principal amount of $4,633,975 with interest at 7.75% per annum. In
September 1995, $3,694,840 of the notes were repaid.
The remaining balance of $939,135 from the demand promissory note discussed
above relates to warrants exercised by a director of the Company's underwriter.
In addition, on May 12, 1995, this director exercised warrants to purchase a
total of 200,000 shares of the Company's common stock. The Company received
another demand promissory note in the principal amount of $1,049,574 with
interest at 7.75% per annum. These promissory notes are unsecured and there are
no restrictions on transfer or sale of the shares of common stock received in
connection with the exercise of these warrants. In 1996, the Company loaned this
underwriter $1,057,500 in connection with the exercise of warrants for a total
of 500,000 shares of the Company's common stock. In 1996, the underwriter paid
off loans totaling $2,509,591 in connection with the exercise of stock warrants.
Of this amount $2,009,591 was paid in cash and $500,000 was paid through
investment banking services in connection with the 5% convertible debentures
issued on December 31, 1996.
In the years ending December 31, 1995 and 1996, the Company issued to
certain investment bankers, consultants (including related parties to the
Company - see Note 11), directors, noteholders and officers, warrants to
purchase common stock. In 1995, the Company issued warrants totaling 82,500 at
an exercise price of $1.25 to certain investment bankers. The warrants to
purchase 82,500 shares were issued below the fair market value of the Company's
common stock at the date of grant. Accordingly, the Company charged $95,370 to
business development and other financing costs in the accompanying consolidated
statement of operations for the year ended December 31, 1995.
The Company issued 182,765 warrants during 1996 in connection with the
private placement of common stock for a total Black Scholes value of $599,465;
these amounts are exclusive of 900,000 shares of net warrants issued in
connection with the sale of 600,000 shares of common stock to Finmanagement on
December 27, 1996. The Company issued 232,200 warrants during 1996 in connection
with convertible debentures for a total Black Scholes value of $2,468,286. The
Company issued 1,978,058 warrants during 1996 in connection with preferred stock
for a total Black Scholes value of
<PAGE>
F-29
$13,325,477. The Company issued 36,553 warrants during 1996 in investment
banking fees in connection with financings for a total Black Scholes value of
$119,894. The Company has not reflected the value attributable to these warrants
in the consolidated statement of stockholders' equity due to the fact that the
issuance of these warrants were directly associated with the issuance of
convertible debentures, common and preferred stock and the Company believes it
is the intent of the debenture holders to convert their debentures into common
stock on a short-term basis. Accordingly, the value of those warrants would both
increase and decrease additional paid-in capital.
In January 1995, the Company issued a warrant to purchase 160,000 shares of
the Company's common stock at $0.01 per share in connection with a license
agreement. See Note 2(f). This warrant was exercised on May 3, 1996 in
connection with the Company's merger with Tissue Technologies, as discussed in
Note 1.
From January 1, 1997 through March 7, 1997, certain warrantholders
exercised warrants to purchase 155,532 shares of common stock at a price of
$2.25 per share. The total proceeds received by the Company were $349,947.
The following table summarizes all warrant activity for the Company:
<TABLE>
<C> <C> <C> <C>
Average
Number of Exercise Weighted
Shares Price Exercise Price
---------------- ---------------- ------------------
Outstanding, December 31, 1994 4,554,862 $0.60 - $15.00 $5.39
Granted 4,835,155 0.01 - 7.50 2.36
Exercised (2,840,093) 0.60 - 5.00 3.86
---------------- ---------------- ------------------
Outstanding, December 31, 1995 6,549,924 0.01 - 15.00 3.82
================ ================ ==================
Exercisable as of December 31, 1995 6,549,924 0.60 - 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
================ ================ ==================
Exercisable, December 31, 1996 8,161,237 $0.60 - $16.50 $5.80
================ ================ ==================
</TABLE>
The range of exercise prices for warrants outstanding and exercisable at
December 31, 1996 are as follows:
<TABLE>
<C> <C> <C> <C> <C> <C> <C>
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
- -------------------- ---------------- ---------------------- ----------------------- -------------- ----------------------
$0.60-$1.00 98,660 .39 $ .67 98,660 $ .67
2.00-4.88 2,343,579 2.43 2.30 2,343,579 2.30
5.00-7.69 4,773,742 4.58 6.57 3,375,407 4.80
8.00-16.50 2,760,258 4.45 12.03 2,343,591 10.68
================ ====================== ======================= ============== ======================
9,976,239 4.00 $ 7.02 8,161,237 $ 5.80
================ ====================== ======================= ============== ======================
</TABLE>
The Company has computed the pro forma disclosures required under SFAS No.
123 for all warrants granted in fiscal years ending December 31, 1995 and 1996
using the Black Scholes option pricing model prescribed by SFAS No. 123.
<PAGE>
F-30
The assumptions used to calculate the SFAS No. 123 pro forma disclosure and
the weighted average information for the fiscal years ending December 31, 1995
and 1996 for the Company are as follows:
<TABLE>
<C> <C> <C>
1995 1996
------------------------ -----------------------
Risk-free interest rate 6.01% 5.93%
Expected dividend yield - -
Expected lives 4.8 years 5.9 years
Expected volatility 56% 80%
Weighted-average grant date fair value of
warrants granted during the period $1.81 $5.39
Weighted-average exercise price of warrants
granted during the period $2.36 $8.16
</TABLE>
The weighted fair-value and weighted exercise price of warrants granted for
the Company in fiscal years ending December 31, 1995 and 1996 are as follows:
<TABLE>
<C> <C> <C>
1995 1996
-------------------- -------------------
Weighted Average Exercise Price for warrants:
whose exercise price exceeded fair market value at $2.72 $11.76
date of grant
whose exercise price was less than fair market value 3.17 7.07
at date of grant
whose exercise price was equal to fair market value at 1.98 6.67
date of grant
Weighted Average Fair Market Value for warrants:
whose exercise price exceeded fair market value at 2.18 9.34
date of grant
whose exercise price was less than fair market value 4.96 8.82
at date of grant
whose exercise price was equal to fair market value at $2.86 $6.67
date of grant
</TABLE>
During 1996, the Company issued 300,000 warrants to purchase common stock
at $7.69 per share to three non-employees who provided consulting services.
These warrants vest over a period of two to three years. The Company valued
these warrants in accordance with SFAS No. 123 at $1,598,298 to be amortized
over the vesting period. The Company recorded $266,375 of this amount as
business development and other financing costs in the accompanying consolidated
statement of operations and $266,383 as capitalized deferred Nexar initial
public offering costs in 1996 in the accompanying consolidated balance sheet.
(iii) PRO FORMA DISCLOSURE
The pro forma effect of applying SFAS No. 123 for all options and warrants
to purchase common stock for the Company and its Nexar subsidiary would be as
follows:
Year Ended December 31,
1995 1996
------------------------- -----------------------
Pro forma net loss $(22,730,970) $(65,358,314)
Pro forma net loss per share $(1.60) $(2.50)
<PAGE>
F-31
(d) RESERVED SHARES
At December 31, 1996, the Company has reserved shares of its common stock
for the following:
Warrants 9,976,239
Stock option plans 3,922,500
Convertible debentures 2,617,800
Preferred stock 2,697,165
Employee Stock Purchase Plan 1,000,000
Employee 401(k) Plan 254,115
---------------
Total 20,467,819
===============
From January 1, 1997 through March 7, 1997 740,826 shares of common stock
were issued in connection with certain of the items above.
(e) COMMON STOCK ISSUED IN LIEU OF PAYMENT
In August 1995, the Company issued to an officer of Dynaco a total of
200,000 shares of common stock in lieu of two demand promissory notes totaling
$355,000 (see Note 11).
In connection with the organization and purchase of CD Titles and CDRP,
Inc. (see Note 1), certain related parties of the officers of the Company and
Dynaco loaned CD Titles $300,000. On October 27, 1995, the Company agreed to
issue common stock at a 35% discount to these individual noteholders, (as well
as the remaining noteholders in CD Titles), in lieu of payment on the related
promissory notes. The related parties received 128,572 shares of the Company's
common stock in satisfaction of the notes payable and accrued interest totaling
approximately $397,000. In 1996 the Company issued 56,900 shares of common stock
to purchase the license rights to product line on behalf of CD Titles.
During the year ended December 31, 1995, the Company issued 167,676 shares
of its common stock for investment banking, merger and acquisition services,
with a fair market value of $421,500. The Company included $398,250 of this
amount in deferred costs, as the shares were issued in connection with the
convertible debenture financings and other prepaid investment banking services
(See Note 2(g)). The remaining amount was expensed to and included in business
development and other financing costs in the accompanying consolidated statement
of operations. In 1996, the Company issued 36,802 shares of common stock for
investment banking services in connection with the sale of common stock and the
issuance of convertible debentures for a value of $209,224. The Company issued
20,000 shares of common stock for acquisition services of $267,500 relating to
the Tissue Technologies acquisition and recognized this expense in the
accompanying consolidated statement of operations.
(f) 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, as defined, are eligible to purchase the
Company's common stock at an exercise price equal to 95% of the fair market
value of the common stock. The Purchase Plan provides for up to 1,000,000 shares
for issuance under the Purchase Plan. As of December 31, 1996, rights to
purchase 580 shares were outstanding.
(6) RESEARCH & PRODUCT DEVELOPMENT AGREEMENTS
The Company has an agreement with the New England Medical Center ("NEMC")
and Dr. Stanley M. Shapshay to provide a research grant and to sponsor
investigations and development of laser applications, advanced delivery systems
and
<PAGE>
F-32
disposable products in the agreed-upon medical applications. The Company also
agreed to provide a total of $150,000 over a one-year period, of which $50,000
was paid in the form of laser hardware. The parties have reached an
understanding that the Company will obtain ownership rights or the right of
first refusal to exclusive worldwide licenses to sell and market any products
developed with the grant funding. In August 1994, this agreement was amended to
support animal testing with one of the Company's diode lasers in connection with
performing tonsillectomies. The Company recorded approximately $95,000 and
$37,000 of research and development expenses for the years ended December 31,
1995 and 1996 related to this agreement.
The Company entered into a multiyear agreement with Massachusetts General
Hospital ("MGH") effective August 18, 1995, whereby MGH agreed to conduct
clinical trials on a laser treatment for hair removal/reduction invented by Dr.
R. Rox Anderson, Wellman Laboratories of Photomedicine, MGH. MGH will provide
the Company with data previously generated by Dr. Anderson, 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 is
obligated to fund the clinical research obligation of $917,000 and pay a license
fee of $250,000 over the term of the contract, until completion of the studies
which is anticipated to be two years from the effective date unless amended or
terminated. During 1995, the Company expensed approximately $177,000
representing the cost of research and development and capitalized approximately
$50,000 as a license fee, which is being amortized over five years. In 1996, the
Company paid the remaining $200,000 for the license fee and in early 1997 made
payments of $54,417 per the terms of the agreement. The Company has agreed to
enter into a worldwide exclusive license agreement with MGH upon completion of a
valid product or service, or new uses (not related solely to hair removal) based
on the findings of the clinical studies.
Effective February 14,1997, the Company amended the August 18, 1995
agreement with MGH. The Company agrees 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 shall
pay 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 5.5% of net revenues of products/services covered by valid patent
licensed to the Company exclusively; 2.5% of net revenues of products/services
covered by valid patent licensed to the Company nonexclusively; 1.5% of net
revenues of products developed and exploited, not covered above and no less than
3% on the sale of any other laser using other technology as defined for the use
of hair removal. In March of 1997 the U.S. Patent Office issued a patent
protecting the laser-based hair removal technology developed by Dr. Rox Anderson
at MGH, for which Palomar is the exclusive worldwide licensee. The Company
incurred $175,000 of royalties under this license in 1996.
On March 11, 1996 the Company entered in an agreement with Dr. R.G.
Geronemus, M.D., P.C ("Geronemus") a New York State professional corporation, to
conduct clinical studies using the ruby laser for hair removal with longer pulse
duration than in previous studies. The studies will be performed on
approximately 70 patients. The total contract is for $178,750, of which $44,688
was recorded as research expense for the year ended December 31, 1996.
<PAGE>
F-33
(7) SEGMENT INFORMATION
The Company has two operating business groups, medical products and
electronics products. All of the operations of Dynaco, Nexar, CD Titles, PEC and
their subsidiaries are reported below as the Electronics Products Group. All
other operations are focused in the areas of cosmetology and dermatology, which
are included in the Medical Products Group. Information with respect to industry
segments is set forth as follows:
<TABLE>
<C> <C> <C> <C> <C>
As of and for the year ended December 31, 1995
Electronic Medical
Products Products Total
----------------------------------------------------------
Revenues $16,296,224 $5,610,280 $21,906,504
Loss from Operations (3,668,083) (8,794,908) (12,462,991)
Identifiable Assets 17,048,106 24,822,054 41,870,160
Depreciation and Amortization 881,530 944,143 1,825,673
Capital Expenditures $540,725 $908,062 $1,448,787
As of and for the year ended December 31, 1996
Electronic Medical
Products Products Total
----------------------------------------------------------
Revenues $52,274,285 $17,824,158 $70,098,443
Loss from Operations (17,189,563) (22,435,014) (39,624,577)
Identifiable Assets 43,501,440 47,255,756 90,757,196
Depreciation and Amortization 1,243,666 2,672,555 3,916,221
Capital Expenditures $3,066,056 $3,257,632 $6,323,688
</TABLE>
(8) ACCRUED EXPENSES
Accrued expenses consist of the following:
<TABLE>
<C> <C> <C>
December 31, December 31,
1995 1996
---------------- ---------------
Payroll and consulting costs $852,793 $3,456,311
Professional fees 914,935 961,815
Settlement costs 700,000 1,755,000
Warranty 295,962 2,854,401
Other 1,869,867 5,642,365
---------------- ---------------
Total $4,633,557 $14,669,892
================ ===============
</TABLE>
(9) OTHER INCOME (EXPENSE)
Other Income (Expense) consist of the following:
<TABLE>
<C> <C> <C>
December 31, December 31,
1995 1996
---------------- ----------------
Foreign Currency Gain $ -- $ 446,596
Write-down of notes and
investments -- (4,996,038)
Other 102,305 303,800
================ ================
Total $102,305 $(4,245,642)
================ ================
</TABLE>
<PAGE>
F-34
(10) REVOLVING LINES OF CREDIT
On May 31, 1995, Dynaco entered into a three year revolving credit and
security agreement with a financial institution, which provides for the
revolving sale of acceptable trade accounts receivable with recourse at 85% of
face value, up to a maximum commitment of $3 million. The outstanding balance
under the line bears interest at the lender's prime rate (8.25% as of December
31, 1996) plus 1.5%, payable monthly, and amounted to $1,296,462 and $1,787,057
as of December 31, 1995 and 1996, respectively. Borrowings under this line are
collateralized by the purchased receivables and substantially all of Dynaco's
assets and are guaranteed by the Company.
On December 5, 1996, Comtel entered into a loan agreement with a loan
association which provided for borrowings up to $4,500,000 in the form of
revolving receivable and inventory loans. Borrowings under the loan agreement
are limited by a borrowing base calculation on eligible accounts receivable and
inventory, and are collateralized by accounts receivable, inventory, and certain
other assets. Borrowings bear interest at the lender's prime rate plus 2.25% and
amounted to $2,770,375 as of December 31, 1996. The loan agreement terminates on
November 30, 1998.
(11) RELATED PARTY TRANSACTIONS
Included in current assets at December 31, 1995 and 1996 are $4,109,573 and
$1,459,484 of notes receivable from various officers and related entities and
investments in related entities. Also included in trading securities at December
31, 1996 is a $1,912,614 investment in a related entity. It is reasonably
possible that the Company's estimate that it will collect these receivables or
realize its investment within one year will change in the near term.
Dynaco leases its Tempe, Arizona, facility from a partnership consisting of
the Chief Executive Officer and Chief Operating Officer of Dynaco. The Company
also has certain capital leases which are personally guaranteed by an officer.
The Board of Directors have established a corporate loan policy under which
loans may be granted to certain officers/stockholders/directors of the Company
for amounts up to an aggregate of $800,000. All of such loans must be
collateralized by certain stockholdings of these individuals, as defined. At
December 31, 1995 and 1996, $383,198 and $578,680, respectively, with interest
at the rate of 7% per annum, was outstanding to certain
officers/stockholders/directors under the corporate loan policy.
At December 31, 1996, the Company had loans receivable of $134,000 and
$151,363 from two officers of Dynaco, which are evidenced by promissory notes
due upon demand, respectively, with interest at the rate of 8% and the prime
rate per annum, respectively. The $151,363 loan receivable is collateralized
with a certain amount of vested stock options in the Company owned by the
officer with a market price in excess of the exercise price. At December 31,
1996, the Company had an additional loan receivable for $75,000 from an officer
of Dynaco, which is evidenced by a demand promissory note and bears interest at
7%. The total accrued interest relating to all of the Company loans to officers
of the Company and Dynaco was $56,288 as of December 31, 1996.
At December 31, 1995, the Company had notes receivable for $3,150,000 from
an affiliated company. The Company's chairman and CEO personally owns
approximately 13% of the affiliated company as of December 31, 1996. The notes
receivable were repaid during 1996, upon the affiliated company's successful
completion of an initial public offering. In connection with the notes the
Company received 173,874 shares of common stock and two warrants to purchase
289,790 shares of common stock at $1.29 from the affiliated company. The Company
fully exercised these warrants and at December 31, 1996 still owned 463,664
shares. The shares are registered and the Company plans to sell these shares in
1997. The Company recognized an unrealized gain of $1,537,614 in the
accompanying consolidated statement of operations in connection with these
shares. The Company also has a demand note of $500,000 from a manufacturer that
is collateralized by a portion of the Chairman's common stock in this affiliated
company.
A former director of Palomar is also a director of a publicly traded
company. The Company loaned $1,700,000 during 1996 to this publicly traded
company, of which $500,000 was paid back as of December 31, 1996. The remaining
<PAGE>
F-35
balance outstanding of $1,200,000 is a note receivable which is collateralized
by a security agreement for manufacturing equipment owned by the publicly traded
company. The note is also convertible to common stock at the discretion of the
Company at a conversion price of $1.00 per share, subject to adjustment as
defined. The Company also has three warrants to purchase a total of 300,000
shares of common stock at a price of $1.13.
On September 30, 1996 the Company purchased two limited liability
partnership units for $500,000 in a full service investment banking and
securities brokerage firm. A director of the partnership is a former director of
the Company and a current director of Nexar.
The Company has a $500,000 equity investment in a privately held technology
company. A director of the Company's underwriter, H.J. Meyers, is also a
director of the investee company. In addition, at December 31, 1996, the Company
had unsecured notes receivable from this director totaling $1,059,548, of which
$604,653 was in connection with the exercise of stock warrants (see Note 5). In
1996 the Company loaned $500,000 to an affiliate of the underwriter. This amount
was paid back in full as of year end. Subsequent to year end, the Company made a
deposit of $450,000 towards the purchase of a publicly traded affiliate of the
underwriter and prepaid the underwriter $200,000 relating to future investment
banking services. Both the deposit and the prepayment are refundable upon
demand. Also subsequent to year end, the Company loaned $500,000 to the
underwriter which has been paid back in full.
During the year ended December 31, 1996 the Company made a $1,000,000
equity investment in a publicly traded technology company. In connection with
this investment, a director of Palomar joined the Board of Directors of this
publicly traded company. In 1996, the Company loaned $5,800,000and paid
$109,000in consulting fees to a company owned by this director. This loan has
been paid back as of December 31, 1996.
During the year ended December 31, 1996 the Company purchased 2,325,581
shares of Series E preferred stock and 1,000,000 shares of common stock for
$2,690,000 in the privately held former parent of Comtel. The Company also
loaned the privately held company $1,000,000 in the form of a subordinated note
and sold 500,000 shares of the privately held company's common stock to
employees of the company for non-recourse promissory notes totaling $345,000.
Both the notes and the investments were written off by the Company at year end,
as the Company believes there has been an impairment in the net realizable value
of this investment. The privately held company was a significant customer as
disclosed in Note 2(i). Subsequent to year end, the Company invested an
additional $1,200,000 and converted the $1,000,000 subordinated note into
764,665 shares of Series F preferred stock. The Company also purchased $960,000
of inventory and is committed to purchase an additional $240,000 of inventory
from a major supplier on behalf of the privately held company. The Company has
entered into an agreement to resell this inventory back to this privately held
company in 1997 at an estimated loss of $210,000.
On October 11, 1996 the Company paid $500,000 to a privately held medical
and cosmetic services company. An officer of CTI is a director of the privately
held company. In return the Company received 500,000 shares of common stock and
a promissory note for $499,500 due on October 11, 1997 accruing interest at 8%
per annum. Subsequent to year end, the Company paid $250,000 for 100,000 shares
of common stock and a promissory note of $249,900 accruing interest at 12% per
annum and was due February 28, 1997. For every thirty day period this note goes
unpaid, the Company will receive 50,000 shares of the privately held company's
common stock, to a maximum of 250,000 shares. The privately held company intends
to file an initial public offering in 1997 and will register the Company's
shares subsequent to the filing.
During the year ended December 31, 1996, the Company granted to its
officers and directors warrants to purchase 1,700,000 shares of the Company's
common stock, at prices ranging from $6.00 - $8.00, and expiring five years from
the date of grant. These warrants were issued at the fair market value on the
date of grant. In addition, the Company issued to these individuals options to
purchase 500,000 shares of the Company's common stock, at a price of $8.00 and
expiring five years from the date of grant.
<PAGE>
F-36
(12) 401(K) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "Plan") which covers
substantially all employees who have satisfied a six-month service requirement,
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.
On March 25, 1996, the Company issued 45,885 shares of its common stock to
the Plan in satisfaction of its $160,595 employer match of the 1995 employee
contributions. For the year ended December 31, 1996 the Company has accrued
$225,000 for the 1996 match which will be made in common stock in April 1997.
(13) 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 $49,000, adjusted annually
for certain other costs such as inflation, taxes and utilities and expire
through August 2002. The Company also leases certain automobiles under operating
leases expiring through January 2000. The Company guarantees certain
subsidiaries' operating leases.
Future minimum payments under all leases at December 31, 1996 are approximately
as follows:
December 31,
1997 $2,151,000
1998 1,983,000
1999 1,692,000
2000 1,350,000
2001 940,000
Thereafter 1,002,000
-------------
$9,118,000
=============
Rental expense related to all operating leases was approximately $695,000
and $1,383,000 for years ended December 31, 1995 and 1996, respectively.
(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 6). For the years ended
December 31, 1995 and 1996, approximately $167,000 and $620,000 was incurred
under this agreement.
As discussed in Note 2(f), Tissue Technologies has a license agreement to
license a patent on a low pressure discharge apparatus. Under the terms of this
license, Tissue Technologies is required to pay a 3% royalty on net sales of
product as defined. During 1996, the Company incurred approximately $301,000
under this license agreement.
In connection with the formation of Dynamem, the Company entered into a
license agreement with the 20% minority shareholder of Dynamem to license a
patent on a foldable electronic assembly module on an exclusive basis. The
license agreement gives Dynamem the right to manufacture, sell and use the
foldable electronic assembly module for a royalty, payable to the minority
shareholder of Dynamem, equal to 2% of net sales proceeds, as defined in the
license
<PAGE>
F-37
agreement. The license agreement expires upon expiration of the patent, and
royalties are guaranteed by Dynaco. For the years ended December 31, 1995 and
1996, amounts incurred under this agreement were immaterial.
On August 1, 1995, Nexar entered into a license agreement with Technovation
Computer Lab Inc. (the "licensor"). The licensor is controlled by one current
and one former officer of Nexar. The license agreement gives Nexar the right to
manufacture, sell and use a system designed by the licensor which allows
external replacement of certain component parts. In exchange for these rights,
Nexar will pay a royalty on each unit sold, as defined. The term of the
agreement is for five years (three years on an exclusive basis), renewable for
an additional five-year period at the option of Nexar. For the period from
inception of Nexar (March 7, 1995) to December 31, 1995 and for the year ended
December 31, 1996, royalties charged to operations were immaterial. Subsequent
to December 31, 1996, the Company and the Licensor entered into an Asset
Purchase and Settlement Agreement, see Note 15(b).
(c) CONSULTING AGREEMENTS
The Company has entered into various consulting agreements with a former
treasurer and director of the Company. During the years ended December 31, 1995
and 1996, the Company incurred an aggregate of $124,300 and $258,891,
respectively, in consulting expenses relating to these agreements. On January 1,
1997, a new three year consulting agreement was executed which replaced the
existing two year agreement. From January 1, 1997 to December 31, 1997 the
Company shall pay the consultant at a rate of $15,000 per month for performance
of services, which rate shall be increased by 10% per annum therafter for the
term of the agreement. This agreement can be terminated by the Company upon
twelve months written notice to the former director and upon other circumstances
as defined.
On August 1, 1995, the Company entered into a consulting agreement with an
individual pursuant to which the individual provides certain business
development and consulting services for a monthly fee of $10,000 which expired
on July 31, 1996. During the year ended December 31, 1995, the Company incurred
an aggregate of $50,000 in consulting expenses relating to this agreement, of
which $10,000 remained unpaid at December 31, 1995. In addition, the Company
issued warrants to purchase 1,500,000 common shares of the Company's common
stock at $2.25, the fair market value on the date of issuance. These warrants
were fully vested on July 31, 1996. On August 1, 1996, the consulting agreement
was renewed for a period of one year for a monthly fee of $10,000. During 1996,
$120,000 of consulting finances were incurred relating to this agreement.
On January 1, 1996, the Company entered into a consulting agreement with a
strategic investment banking and financial services company. Under the terms of
this agreement, the Company is required to pay $5,000 monthly. In addition, on
February 7, 1996, the Company granted two individuals, who are employees of this
investment banking and financial services company, 150,000 warrants to purchase
shares of common stock at $7.69, the fair market value on the date of issuance.
These stock options vest based on milestones defined in the agreement. The
company incurred expenses of $143,830 for consulting services received during
the year ended December 31, 1996.
On February 7, 1996, the Company entered into a consulting agreement
whereby the consultant would provide investment banking services for one year to
the Company in exchange for a warrant to purchase 150,000 shares of the
Company's common stock at $7.69.
(d) GOVERNMENT CONTRACTS
The Company, like other companies doing business with the U.S. government,
is subject to routine audit and, in certain circumstances, inquiry, review or
investigation by U.S. government agencies for its compliance with government
procurement policies and practices. Based on government procurement regulations,
under certain circumstances, a contractor violating or not complying with
procurement regulations can be subject to legal or administrative proceedings,
including fines and penalties, as well as be suspensed or debarred from
contracting with the government. The Company's policy has been, and continues to
be, to conduct its activities in compliance with all applicable rules and
regulations.
<PAGE>
F-38
(e) CONTINGENCIES
On December 19, 1996 the Company signed a price quotation with a vascular
laser manufacturer for the purchase of up to 120 vascular lasers. The price
quotation requires the Company to place a deposit of $1,200,000 for the purchase
of 120 vascular lasers. After a minimum of 40 units are purchased at a per unit
average price of $147,250, the remaining down-payment will be refunded if no
additional purchases are made. The Company also paid $400,000 for tooling and
other costs to ensure the vascular laser is manufactured with the Palomar name.
The Company plans to use this vascular laser in the CTI sites in order to
provide a full suite of lasers.
On October 17, 1996 the Company entered into an option purchase agreement
with Enviro-Invest Oy ("Enviro"), a privately held Finnish company with
technology related to the detection of nuclear and chemical compounds. Under the
option purchase agreement the Company has the right to acquire all of the issued
and outstanding shares of Enviro at any time through October 1, 1997. The
purchase price is $400,000 in cash, a range of $3,750,000 to $5,250,000 in the
Company's common stock based on certain milestones, and other contingent cash
payments not to exceed $325,000. The purchase agreement also calls for the
Company to fund Enviro with a $400,000 loan. As of December 31, 1996 the Company
has paid $300,000 and has recognized a liability for the remaining $100,000,
payable on March 31, 1997. The Company intends to exercise the purchase option
in 1997 and has accounted for the $400,000 loan as a long term investment.
Enviro has a distribution agreement with Sensor Applications Inc.
("Sensor"), a Delaware corporation. On November 14, 1996 the Company entered
into a option purchase agreement with Sensor. The purchase agreement calls for
the Company to pay $150,000 in cash and issue 150,000 shares of Palomar stock
for all the issued and outstanding shares of Sensor and extends to November 1,
1997. The purchase agreement calls for the Company to make payments of $200,000,
payable in four installments for consulting services. During the year ended
December 31, 1996, the Company incurred $50,000 related to these consulting
services. The Company is also committed to make payments to Sensor of $15,000 a
month to cover 50% of monthly operating expenses which the Company has expenses
as incurred. The Company intends to exercise this purchase agreement in
conjunction with the option for Enviro.
(f) LETTERS OF CREDIT
Dynaco has a three irrevocable letters of credit outstanding totaling
$295,000 with a bank to secure payment to a vendor.
(g) CORPORATE GUARANTEES
The Company has issued guarantees for payment of various vendor liabilities
for several subsidiaries. Outstanding guarantees totaled approximately $975,000
as of December 31, 1996.
(h) LITIGATION
The Company is a defendant in a lawsuit filed by a former consultant to the
Company on March 14, 1996. In the suit, the former consultant alleges that the
Company breached a contract with the consultant in which the consultant was to
provide certain investment banking services in return for certain compensation.
In January 1997, this consultant's motion for summary judgment on a breach of
contract claim was granted. The consultant has alleged that he suffered up to
$3,381,250 in damages on a breach of contract claim, exclusive of interest. The
Company has not accrued for the full cost of the alleged damages and intends to
vigorously defend this action and appeal this matter after damages have been
determined. The Company believes its grounds for appeal are meritorious.
The Company is also involved in legal and administrative proceedings and
claims of various types, including a patent infringement and unfair competition
claim by a competitor of the Company. While any litigation contains an element
of uncertainty, management, based upon the opinion of the Company's general
counsel, presently believes that the outcome of each such proceeding or claim
which is pending or known to be threatened (including the actions described
above), or all of them combined, will not have a material adverse effect on the
Company.
<PAGE>
F-39
(14) 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 provide for 12 months
severance upon termination of employment. One of the officers at the Company's
Spectrum subsidiary receives a bonus equal to .75% of Spectrum's net sales, as
defined.
Dynamem entered into an employment agreement on September 29, 1995, with
its minority shareholder to serve as President and director of Dynamem for a
period of five years. At the end of five years from the date of employment, the
minority shareholder will have the option to sell 75% of his outstanding shares
of Dynamem to PEC at a price equal to 10 times the average net income of Dynamem
for the preceding 48-month period. A portion (35%) of the payment will be made
in the Company's common stock, with the balance to be paid in cash. The minority
shareholder also has the option to increase the percentage of the payment to be
paid in common shares of the Company. Dynaco has also guaranteed the
compensation due its President under this agreement. The Company is accounting
for the option related to the restricted stock in the subsidiary in accordance
with Financial Accounting Standard Board Interpretation No. 28, ACCOUNTING FOR
STOCK APPRECIATION RIGHTS AND OTHER VARIABLE STOCK OPTION OR AWARD PLANS.
Accordingly, compensation is measured annually based on the increase in value of
the subsidiary. Total compensation has been insignificant to date. In the event
of a public offering of Dynamem, the minority shareholder/officer has certain
registration rights as defined in the employment agreement.
Nexar has an employment agreement with its Chief Executive Officer (CEO)
expiring in March 2002, unless extended. The agreement provides for annual
salary and bonus for the CEO and a commission of $2.00 per computer sold by
Nexar. Upon termination of employment with Nexar, the CEO will be entitled to
amounts ranging from $1,000,000 to $3,000,000 in cash, three to five years
salary, bonus and participation in Nexar's benefit plans, immediate vesting of
unvested stock options and an income tax "gross up" for all the above items in
the event of a change of control. This termination payment is guaranteed by the
Company for as long as the Company owns greater than 50% of Nexar.
Nexar also has an employment agreement with another executive officer
expiring in March 2002, unless extended. The agreement provides for annual
salary and bonus for the officer and a commission of $2.00 per unit sold by
Nexar. Upon termination of employment with Nexar, the officer will be entitled
to up to $750,000 in cash, one year of salary, bonus and participation in
Nexar's benefit plans, immediate vesting of unvested stock options and an income
tax "gross up" for all the above items in the event of a change of control. This
termination payment is guaranteed by the Company for as long as the Company owns
greater than 50% of Nexar.
(15) SUBSEQUENT EVENTS
(a) EQUITY AND FINANCING TRANSACTIONS
On January 13, 1997 the Company raised $1,000,000 through the issuance of
5% series convertible debentures due January 13, 2002. The Company incurred
financing costs of $100,000 relating to investment banking services. The
financing costs were offset against a note receivable from a director of the
investment bank. This debenture has been accounted for similar to the other
dollar denominated convertible debentures as discussed in Note 4(b).
Subsequent to year-end, all of the outstanding shares of Series E preferred
stock (including accrued dividends of $121,978) were converted into 332,859
shares of the Company's common stock. In addition, as of February 28, 1997, 680
shares of Series G convertible preferred stock (including accrued dividends of
$19,833) were converted into 102,508 shares of the Company's common stock.
On February 28, 1997, the Company redeemed 300 units of the outstanding
Swiss franc denominated convertible debentures for $196,000.
<PAGE>
F-40
Subsequent to year end, the Company raised an additional $12,000,000 to
help sustain 1997 operations. The Company raised $6,000,000 through the
issuance of Series H redeemable convertible preferred stock. The Company raised
$5,500,000 through the issuance of 5% convertible debentures and $500,000
through the issuance of 6% convertible debentures. The Company will account for
these financings similar to the 1996 preferred stock and convertible debenture
issuances as discussed in Notes 5 and 4, respectively.
(b) LEGAL SETTLEMENTS
In 1996, a former executive officer of Nexar threatened to file a lawsuit
or seek arbitration proceedings against Nexar regarding Nexar's termination of
his employment and Nexar's license agreement with the Licensor.
On February 28, 1997, Nexar entered into an Asset Purchase and Settlement
Agreement with this former executive and the Licensor. Under the terms of this
agreement, the Company has agreed to pay this former executive and certain of
his affiliates $1,250,000 in cash and deliver $1,500,000 worth of the Company's
common stock in exchange for all right, title and interest in and to all the
technology licensed under Nexar's license agreement with the Licensor and a
patent application thereto and a complete release and settlement of all claims
between this former executive and Nexar. The Company will first acquire the
subject technology and then convey such technology to Nexar. Accordingly, the
Company paid $75,000 upon execution of this agreement. The Company will issue
its common shares and remit $475,000 to this former executive on the earlier of
April 30, 1997 or the closing of the initial public offering of Nexar. The
$700,000 balance of the cash consideration will be held in escrow, subject to
release to the former executive and/or Licensor in the absence of a breach of a
representation, warranty or covenant within one year after closing.
The Company has agreed to assign to Nexar all of its rights and title in
the technology to be received under the Asset Purchase and Settlement Agreement
immediately upon the receipt thereof, and has charged to Nexar the cost
associated with this claim and the purchase of the technology. Nexar has
allocated $1,375,000 of the consideration to settle this claim and the Company
has reflected this amount in settlement and litigation costs in its accompanying
statement of operations for the year ended December 31, 1996. The remaining
consideration totaling $1,375,000 has been allocated to the purchase of the
technology as of December 31, 1996 and will be amortized 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.
On March 14, 1997, CTI entered into an agreement with a medical service
company in settlement of CTI's claims of breach of the contract. The settlement
calls for the medical service company to reimburse CTI for all expenses
incurred, not to exceed $900,000, and an additional lump sum payment of
$400,000. In addition, the medical service company is required to purchase
lasers from CTI under certain circumstances. The medical service company also is
not to compete with CTI, as defined, for a period of six months.
(c) COMMITMENTS AND CONTINGENCIES
Subsequent to year end, the Company entered into an exclusive relationship
with a private label leasing company. CTI then entered into a master lease
agreement with this private label leasing company. This master lease agreement
is guaranteed by the Company.
<PAGE>
-40-
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There has been no change in the Company's accountants during the Company's
two most recent fiscal years, nor were there any disagreements on any matter of
accounting principle or practice of financial statement disclosure which would
be required to be reported on a Form 8-K.
<PAGE>
-41-
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE
WITH SECTION 16(A) OF THE EXCHANGE ACT.
See the sections entitled "Election of Directors" and "Executive Officers"
appearing in the Company's Proxy Statement in connection with its Annual Meeting
of Shareholders to be held on June 18, 1997, which section is incorporated
herein by reference.
ITEM 10. EXECUTIVE COMPENSATION.
See the section entitled "Executive Compensation and Other Information
Concerning Officers and Directors" appearing in the Company's Proxy Statement in
connection with its Annual Meeting of Shareholders to be held on June 18, 1997,
which section is incorporated herein by reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
See the section entitled "Security Ownership of Certain Beneficial Owners
and Management" appearing in the Company's Proxy Statement in connection with
its Annual Meeting of Shareholders to be held on June 18, 1997, which section is
incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
See the section entitled "Certain Transactions" appearing in the Company's
Proxy Statement in connection with its Annual Meeting of Shareholders to be held
on June 18, 1997, which section is incorporated herein by reference.
<PAGE>
-42-
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) 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.
<TABLE>
<C> <C>
Exhibit
No. Title
*****2.1 Stock Purchase Agreement, dated July 1, 1993, by and between the Company and Star Medical Technologies,
Inc.
+++2.2 Agreement, dated December 30, 1993, by and between the Company, Dynaco Corporation and Dynaco West
Corporation.
+++2.3 First Amendment to Purchase and Sale Agreement, by and between the Company, Dynaco Corporation and
Dynaco West Corporation, dated January 24, 1994.
- -2.4 Purchase and Sale Agreement dated March 14, 1995, by and
between the Company and SPMT Acquisition Corp., Spectrum
Medical Technologies, Inc., Sanford R. Lane and CSF
Investments Ltd.
- --2.5 Purchase and Sale Agreement dated June 5, 1995, by and between Dynaco Acquisition Corporation and
Inter-Connecting Products, Inc.
&&&&2.6 Agreement and Plan of Reorganization dated March 9, 1996 by and among the Company, TTI Acquisition
Corp., Tissue Technologies, Inc. and Mario Barton
&&&&2.7 Amendment to the Merger Agreement dated April 29, 1996 by and among the Company, TTI Acquisition Corp.,
Tissue Technologies, Inc. and Mario Barton.
&&&&2.8 Letter from the Company to Tissue Technologies, Inc. waiving the Company's right to receive
indemnification under Section 6 of the Merger Agreement in certain circumstances.
&&&&2.9 Plan of Merger dated May 3, 1996 by and between the Company, TTI Acquisition Corp. and Tissue
Technologies, Inc.
&&&&2.10 List of exhibits and schedules omitted from the Tissue Technologies, Inc. Merger Agreement.
(The Company hereby undertakes and agrees to furnish copies of the exhibits and schedules set forth in
exhibit 2f above to the Commission upon its request.)
###2.11 Stock Purchase Agreement dated March 19, 1996, by and between Dynaco Acquisition Corp., Comtel
Electronics, Inc., Mikel C. Green, Peter Rogal and Palomar Electronics Corp.
###2.12 Agreement for Purchase of Stock dated July 12, 1996, by and between the Company, Eleanor Roberts Weisman
and Wallace Roberts.
- ----3.1 Restated Certificate of Incorporation, as amended.
&&3.2 Certificate of Amendment to Certificate of Incorporation, as filed with the Delaware Secretary of State
on December 16, 1996.
<PAGE>
-43-
&3.3 Certificate of Designation of Series G Convertible Preferred
Stock as filed with the Delaware Secretary of State on
September 26, 1996.
3.4 Certificate of Designation of Series H Convertible Preferred
Stock as filed with the Delaware Secretary of State
on March 26, 1997.
*3.5 Bylaws, as amended.
***4.1 Form of Common Stock Certificate.
*10.1 Patent License Agreement by and between the Company and Patlex Corporation, effective as of January 1,
1992.
**10.2 1991 Stock Option Plan, as amended.
#10.3 1993 Stock Option Plan.
####10.4 1995 Stock Option Plan.
- ----10.5 1996 Stock Option Plan
- ----10.6 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 66 Cherry Hill Drive, Beverly, Massachusetts,
dated May 25, 1993.
- ---10.11 The Company's 401(k) Plan.
&10.12 Securities Purchase Agreement between the Company and The Travelers Insurance Company dated July 12,
1996.
&10.13 Warrant to purchase Common Stock of the Company, dated July 12, 1996.
&10.14 Subscription Agreement between the Company and Genesee Fund Limited, dated September 26, 1996.
&10.15 Registration Rights Agreement between the Company and Genesee Fund Limited, dated September 26, 1996.
&10.16 Warrant to purchase Common Stock of the Company, dated September 27, 1996.
&10.17 Warrant Agreement between the Company and American Stock Transfer & Trust Co. as warrant agent, dated
June 24, 1996.
&10.18 Palomar Medical Technologies, Inc. and American Stock Transfer & Trust Company as trustee, Indenture
dated as of June 24, 1996, SF 25,000,000, 4.5% Convertible Subordinated Debentures due 2003.
&&&10.19 Form of Offshore Securities Subscription Agreement, dated July 3, 1996.
&&&10.20 Palomar Medical Technologies, Inc. and American Stock Transfer & Trust Company as trustee, Indenture
dated as of June 24, 1996, SF 25,000,000 4.5% Convertible Subordinated Debentures due 2003.
&&&10.21 Warrant Agreement between the Company and American Stock Transfer & Trust Company as warrant agent,
dated June 24, 1996.
<PAGE>
-44-
&&&10.22 Form of Registration Rights Agreement, dated July 3, 1996.
&&&10.23 Form of Debenture, dated July 3 1996.
&&&10.24 Form of Warrant, dated July 3, 1996.
&&&10.25 Berckeley Subscription Agreement, dated December 31, 1996 and Amendment thereto dated January 10, 1997.
&&&10.26 Berckeley Debenture, dated December 31, 1996.
&&&10.27 High Risk Opportunities Hub Fund, Ltd. Subscription Agreement, dated January 14, 1997.
&&&10.28 High Risk Opportunities Hub Fund, Ltd. Debenture, dated January 13, 1997.
###10.29 Securities Purchase Agreement between Palomar Electronics Corporation and Clearwater Fund IV, LLC, dated
December 31, 1996.
###10.30 Securities Purchase Agreement between Palomar Electronics Corporation, the Company and The Travelers
Insurance Company, dated as of December 18, 1996.
###10.31 Securities Purchase Agreement between Palomar Electronics Corporation and GFL Advantage Fund Limited
dated December 31, 1996.
###10.32 Option Agreement between the Company and GFL Advantage Fund Limited dated December 31, 1996.
###10.33 Common Stock Purchase Warrant dated December 31, 1996.
###10.34 Form of Net Warrant to Purchase Common Stock.
###10.35 Subscription Agreement between the Company and Finmanagement, Inc. dated December 27, 1996.
###10.36 Subscription Agreement dated as of April 12, 1996, between the Company and GFL Advantage Fund Limited.
###10.37 Registration Rights Agreement dated as of April 17, 1996 by and between the Company and GFL Advantage
Fund Limited.
###10.38 Warrant dated as of April 16, 1996.
###10.39 Form of Warrant to Purchase Common Stock dated February 1, 1996.
###10.40 Form of Offshore Stock Subscription Agreement dated February 1, 1996.
###10.41 Form of Subscription Agreement dated as of March 10, 1997.
###10.42 Form Registration Rights Agreement dated as of March 10, 1997.
###10.43 Form of 5% Convertible Debenture due March 10, 2002.
###10.44 Subscription Agreement between the Company and Soginvest Bank dated as of March 13, 1997.
###10.45 6% Convertible Debenture due March 13, 2002.
<PAGE>
-45-
###10.46 Asset Purchase and Settlement Agreement by and among the Company, Nexar Technologies, Inc., Technovation
Computer Labs, Inc. and Babar I. Hamirani, dated February 28, 1997.
###10.47 List of exhibits omitted from the Asset Purchase and Settlement Agreement.
(The Company hereby undertakes and agrees to furnish copies of
the exhibits and schedules set forth in exhibit 10(dddd) above
to the Commission upon its request.)
###10.48 Employment Agreement dated as of January 1, 1997, between the Company and Steven Georgiev.
###10.49 Employment Agreement dated as of January 1, 1997, between the Company and Michael H. Smotrich.
###10.50 Employment Agreement dated as of January 1, 1997, between the Company and Joseph P. Caruso.
###10.51 Employment Agreement dated as of January 1, 1997, between the Company and Anthony Fiorillo.
###10.52 Securities and Purchase Agreement between the Company and RGC International Investors, LDC,
dated March 27, 1997
###10.53 Registration Rights Agreement between the Company and RGC International Investors, LDC,
dated March 27, 1997
###23 Consent of Arthur Andersen LLP.
* Previously filed as an exhibit to Registration Statement No. 33-47479 filed on April 27, 1992, and
incorporated herein by reference.
** Previously filed as and exhibit to Amendment No. 4 to Form S-1 Registration Statement No. 33-47479 filed
on October 5, 1992.
*** Previously filed as an exhibit to Amendment No. 8 Registration Statement on Form S-1, No. 33-37379,
filed on December 17, 1992.
**** Previously filed as an exhibit to the Company's Annual Report on Form 10-KSB date March 31, 1993, and
incorporated herein by reference.
***** Previously filed as an exhibit to the Current Report on Form 8-K date July 1, 1993, and incorporated
herein by reference.
# Previously filed as an exhibit to the Company's Annual Report
on Form 10-KSB for the year ended March 31, 1994, 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 the Current Report on Form 8-k dated April 20, 1995, 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, 1995, 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-QSB for the quarter ended
June 30, 1996, 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.
<PAGE>
-46
&&& 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 Current Report on Form 8-K dated May 16, 1996, and incorporated
herein by reference
+ Previously filed as an exhibit to the Current Report on Form 8-K dated September 10, 1993, and
incorporated herein by reference.
++ Previously filed as an exhibit to the Current Report on Form 8-K dated February 7, 1994, and
incorporated herein by reference.
+++ Previously filed as an exhibit to the Current Report on Form 8-K dated February 9, 1994, and
incorporated herein by reference.
++++ Previously filed as an exhibit to the Current Report on Form 8-K dated February 14, 1994, and
incorporated herein by reference.
</TABLE>
(b) REPORTS ON FORM 8-K
None
<PAGE>
-47-
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 Beverly in the
Commonwealth of Massachusetts on March 30, 1997.
PALOMAR MEDICAL TECHNOLOGIES, INC.
By: /s/ Stevem Georgiev
------------------------------
Steven Georgiev
Chairman of the Board of Directors
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.
<TABLE>
<C> <C> <C>
Name Capacity Date
/s/ Steven Georgiev President, Chief Executive April __, 1997
---------------------------------
Steven Georgiev Officer and Chairman of the Board
/s/ Dr. Michael H. Smotrich President, Chief Operating Officer, April __, 1997
---------------------------------
Dr. Michael H. Smotrich Secretary and Director
/s/ Joseph P. Caruso Chief Financial Officer and Treasurer April __, 1997
---------------------------------
Joseph P. Caruso ( Principal Financial Officer and
Principal Accounting Officer)
/s/ Buster C. Glosson Director April __, 1997
---------------------------------
Buster C. Glosson
/s/ Louis P. Valente Director April __, 1997
---------------------------------
Louis P. Valente
/s/ John M. Deutch Director April __, 1997
---------------------------------
John M. Deutch
</TABLE>
-1-
EXHIBIT A
TO
SECURITIES PURCHASE
AGREEMENT
CERTIFICATE OF DESIGNATIONS,
PREFERENCES AND RIGHTS
OF
SERIES H CONVERTIBLE PREFERRED STOCK
OF
PALOMAR MEDICAL TECHNOLOGIES, INC.
Pursuant to Section 151 of the
Delaware General Corporation Law
Palomar Medical Technologies, a corporation organized and existing under
the laws of the State of Delaware (the "CORPORATION"), hereby certifies that the
following resolutions were adopted by the Board of Directors of the Corporation
pursuant to authority of the Board of Directors as required by Section 151 of
the Delaware General Corporation Law.
RESOLVED, that pursuant to the authority granted to and vested in the
Board of Directors of this Corporation (the "BOARD OF DIRECTORS" or the "BOARD")
in accordance with the provisions of its Certificate of Incorporation, the Board
of Directors hereby authorizes a series of the Corporation's previously
authorized Preferred Stock, par value $.01 per share (the "PREFERRED STOCK"),
and hereby states the designation and number of shares, and fixes the relative
rights, preferences, privileges, powers and restrictions thereof as follows:
Series H Convertible Preferred Stock:
I. DESIGNATION AND AMOUNT
The designation of this series, which consists of 20,000 shares of
Preferred Stock, is the Series H Convertible Preferred Stock (the "SERIES H
PREFERRED STOCK") and the face amount shall be One Thousand U.S. Dollars
($1,000.00) per share (the "FACE AMOUNT").
II. NO DIVIDENDS
The Series H Preferred Stock will bear no dividends, and the holders of
the Series H
<PAGE>
-2-
Preferred Stock shall not be entitled to receive dividends on the Series H
Preferred Stock.
III. CERTAIN DEFINITIONS
For purposes of this Certificate of Designations, the following terms
shall have the following meanings:
A. "CLOSING BID PRICE" means, for any security as of any date, the
closing bid price of such security on the principal securities exchange or
trading market where such security is listed or traded as reported by Bloomberg
Financial Markets or a comparable reporting service of national reputation
selected by the Corporation and reasonably acceptable to holders of a majority
of the then outstanding shares of Series H Preferred Stock if Bloomberg
Financial Markets is not then reporting closing bid prices of such security
(collectively, "BLOOMBERG"), or if the foregoing does not apply, the last
reported sale price of such security in the over-the-counter market on the
electronic bulletin board for such security as reported by Bloomberg, or, if no
sale price is reported for such security by Bloomberg, the average of the bid
prices of any market makers for such security as reported in the "pink sheets"
by the National Quotation Bureau, Inc. If the Closing Bid Price cannot be
calculated for such security on such date on any of the foregoing bases, the
Closing Bid Price of such security on such date shall be the fair market value
as reasonably determined by an investment banking firm selected by the
Corporation and reasonably acceptable to holders of a majority of the then
outstanding shares of Series H Preferred Stock, with the costs of such appraisal
to be borne by the Corporation.
B. "CLOSING DATE" means the Closing Date under that certain Securities
Purchase Agreement dated March 27, 1997 by and among the Corporation and the
initial purchasers of the Series H Preferred Stock (the "SECURITIES PURCHASE
AGREEMENT").
C. "CONVERSION DATE" means, for any Optional Conversion, the date
specified in the notice of conversion in the form attached hereto (the "NOTICE
OF CONVERSION"), so long as the copy of the Notice of Conversion is faxed (or
delivered by other means resulting in notice) to the Corporation before
Midnight, New York City time, on the Conversion Date indicated in the Notice of
Conversion. If the Notice of Conversion is not so delivered before such time,
then the Conversion Date shall be the date the holder delivers the Notice of
Conversion to the Corporation. The Conversion Date for the Required Conversion
at Maturity shall be the Maturity Date (as such terms are defined in Paragraph D
of Article IV).
D. "CONVERSION PERCENTAGE" shall have the following meaning and shall be
subject to adjustment as provided herein:
If the Conversion Date is: Then the Conversion Percentage is:
On or prior to the 179th day 100%
after the Closing Date
<PAGE>
-3-
On or after the 180th and on or prior 90%
to the 269th day after the Closing Date
On or after the 270th day after 85%
the Closing Date
E. "CONVERSION PRICE" means, (i) with respect to any Conversion Date
occurring prior to the 210th day after the Closing Date, the Variable Conversion
Price and (ii) with respect to any Conversion Date occurring on or after the
210th day after the Closing Date, the lower of the Conversion Price Ceiling and
the Variable Conversion Price, each in effect as of such date and subject to
adjustment as provided herein.
F. "CONVERSION PRICE CEILING" means the average of the Closing Bid
Prices for the Common Stock for the twenty (20) consecutive trading days ending
on the trading day immediately preceding the 210th day after the Closing Date
(subject to equitable adjustment for any stock splits, stock dividends,
reclassifications or similar events during such twenty (20) trading day period),
and shall be subject to adjustment as provided herein.
G. "CONVERSION PRICE FLOOR" means (i) on or prior to that date which is
two hundred ten (210) days after the Closing Date, $6.00, and (ii) after that
date which is two hundred ten (210) days after the Closing Date, the lower of
(a) $6.00 and (b) the product of (.65) and the Conversion Price Ceiling, and
shall be subject to adjustment as provided herein.
H. "N" means the sum of (a) the number of days from, but excluding, the
date of issuance of such share of Series H Preferred Stock, through and
including the earlier of (i) the Conversion Date for such share of Series H
Preferred Stock and (ii) such date (if any) that the average of the Closing Bid
Prices for the Common Stock for ten (10) consecutive trading days is greater
than one hundred and seventy five percent (175%) of the initial Conversion Price
Ceiling determined under Paragraph F of this Article III (subject to equitable
adjustment for any of the events described in Article XI.A) plus (b) the number
of days not included in clause (a) of this Paragraph H (if any) during the
period beginning on, but excluding, the date such share of Series H Preferred
Stock was required to be (but was not) redeemed by the Corporation pursuant to
Article VIII.B and the subsequent Conversion Date for such share of Series H
Preferred Stock.
I. "PREMIUM" means an amount equal to: (i) (.06)x(N/365)x(1,000) for the
period beginning on the Closing Date and ending on that date which is 179 days
after the Closing Date, (ii) (.07)x(N/365)x(1,000) for the period beginning on
the 180th day after the Closing Date and ending on that date which is 269 days
after the Closing Date, and (iii) (.08)x(N/365)x(1,000) for the period beginning
on the 270th day after the Closing Date and thereafter.
I. "VARIABLE CONVERSION PRICE" means, as of any date of determination,
the amount obtained by multiplying the Conversion Percentage then in effect by
the average of the Closing
<PAGE>
-4-
Bid Prices for the Common Stock for ten (10) consecutive trading days ending on
the trading day immediately preceding such date of determination (subject to
equitable adjustments for any stock splits, stock dividends, reclassifications
or similar events during such ten (10) trading day period), and shall be subject
to adjustment as provided herein.
IV. CONVERSION
A. Conversion at the Option of the Holder. Subject to the limitations on
conversions contained in Paragraph C of this Article IV, each holder of shares
of Series H Preferred Stock may, at any time and from time to time, convert (an
"OPTIONAL CONVERSION") each of its shares of Series H Preferred Stock into a
number of fully paid and nonassessable shares of Common Stock determined in
accordance with the following formula:
1,000 + THE PREMIUM
CONVERSION PRICE
B. Mechanics of Conversion. In order to convert Series H Preferred Stock
into shares of Common Stock, a holder shall: (x) deliver (by facsimile or
otherwise) a copy of the fully executed Notice of Conversion to the Corporation
and (y) surrender or cause to be surrendered the original certificates
representing the Series H Preferred Stock being converted (the "PREFERRED STOCK
CERTIFICATES"), duly endorsed, along with a copy of the Notice of Conversion as
soon as practicable thereafter to the Corporation. At the request of a holder
and upon receipt by the Corporation of a facsimile copy of a Notice of
Conversion from a holder, the Corporation shall immediately send, via facsimile,
a confirmation to such holder stating that the Notice of Conversion has been
received, the date upon which the Corporation expects to deliver the Common
Stock issuable upon such conversion and the name and telephone number of a
contact person at the Corporation regarding the conversion. The Corporation
shall not be obligated to issue shares of Common Stock issuable upon such
conversion unless either the Preferred Stock Certificates are delivered to the
Corporation as provided above, or the holder notifies the Corporation that such
certificates have been lost, stolen or destroyed (subject to the requirements of
Article XIV.B).
(i) Delivery of Common Stock Upon Conversion. The Corporation
shall, within one business day after the later of (a) the second
business day following the Conversion Date in the case of DWAC
deliveries and the third business day following the Conversion date in
all other cases and (b) the date of such surrender (or, in the case of
lost, stolen or destroyed certificates, the date on which indemnity
pursuant to Article XIV.B is provided) (the "DELIVERY PERIOD"), and
provided the holder has surrendered Preferred Stock Certificates, issue
and deliver to or upon the order of the holder (x) that number of shares
of Common Stock issuable upon conversion of such shares of Series H
Preferred Stock being converted and (y) a certificate representing the
number of shares of Series H Preferred Stock not being converted, if
any.
(ii) Taxes. The Corporation shall pay any and all taxes which
may be
<PAGE>
-5-
imposed upon it with respect to the issuance and delivery of the shares
of Common Stock upon the conversion of the Series H Preferred Stock.
(iii) No Fractional Shares. If any conversion of Series H
Preferred Stock would result in the issuance of either a fractional
share of Common Stock, such fractional share shall be disregarded and
the number of shares of Common Stock issuable upon conversion of the
Series H Preferred Stock shall be the closest whole number of shares.
(iv) Status as Stockholder. Upon submission of a Notice of
Conversion by a holder of Series H Preferred Stock, the shares covered
thereby shall be deemed converted into shares of Common Stock as of the
Conversion Date and the holder's rights as a holder of such converted
shares of Series H Preferred Stock shall cease and terminate, excepting
only the right to receive certificates for such shares of Common Stock
and to any remedies provided herein or otherwise available at law or in
equity to such holder because of a failure by the Corporation to comply
with the terms of this Certificate of Designations (including its right
to regain its status as a Series H Preferred Stockholder pursuant to
Article VI.E).
(v) Conversion Disputes. In the case of any dispute with respect
to a conversion, the Corporation shall promptly issue such number of
shares of Common Stock as are not disputed in accordance with
subparagraph (i) above. If such dispute involves the calculation of the
Conversion Price, the Corporation shall submit the disputed calculations
to its outside accountant via facsimile within two (2) business days of
receipt of the Notice of Conversion. The accountant shall audit the
calculations and notify the Corporation and the holder of the results no
later than two (2) business days from the date it receives the disputed
calculations. The accountant's calculation shall be deemed conclusive,
absent manifest error. The Corporation shall then issue the appropriate
number of shares of Common Stock in accordance with subparagraph (i)
above.
C. Limitations on Conversions. (i) Except in a Required Conversion at
Maturity, in no event shall a holder of shares of Series H Preferred Stock be
entitled to receive shares of Common Stock to the extent that the sum of (a) the
number of shares of Common Stock beneficially owned by the holder and its
affiliates (exclusive of shares issuable upon conversion of the unconverted
portion of the shares of Series H Preferred Stock or the unexercised or
unconverted portion of any other securities of the Corporation subject to a
limitation on conversion or exercise analogous to the limitations contained
herein) and (b) the number of shares of Common Stock issuable upon the
conversion of the shares of Series H Preferred Stock with respect to which the
determination of this subparagraph is being made, would result in beneficial
ownership by the holder and its affiliates of more than 4.9% of the outstanding
shares of Common Stock. For purposes of this subparagraph, beneficial ownership
shall be determined in accordance with Section 13(d) of the Securities Exchange
Act of 1934, as amended, and Regulation 13 D-G thereunder, except as otherwise
provided in clause (i) above. The Corporation shall be entitled to rely, and
shall be fully protected in relying, on any statement or representation made by
a holder of Series H Preferred Stock to the Corporation in connection
-6-
with a particular conversion without any obligation on the part of the
Corporation to make any inquiry or investigation or to examine its records or
the records of any transfer agent for the Common Stock. The restriction
contained in this Paragraph C shall not be altered, amended, deleted or changed
in any manner whatsoever unless the holders of a majority of the Common Stock
and each holder of Series H Preferred Stock shall approve such alteration,
amendment, deletion or change.
(ii) Except as otherwise provided in Article XIII, during any
thirty (30) day period beginning on the Closing Date and ending on the
earlier of (a) that date which is two hundred and nine (209) days after
the Closing Date and (b) that date (if any) that the Corporation
delivers an Optional Redemption Notice (as defined below) to the holders
of Series H Preferred Stock pursuant to Article VIII.B, no holder of
Series H Preferred Stock may convert in excess of thirty-three percent
(33%) of the shares of Series H Preferred Stock initially purchased by
such Holder; provided, however, if such holder has already converted
sixty-six percent (66%) of the shares of Series H Preferred Stock so
purchased, such holder may convert the remaining thirty-four percent
(34%) of the shares so purchased in the next succeeding thirty day
period or thereafter.
D. Required Conversion at Maturity. Provided all shares of Common Stock
issuable upon conversion of all outstanding shares of Series H Preferred Stock
are then (i) authorized and reserved for issuance, (ii) registered under the
Securities Act of 1933, as amended (the "SECURITIES ACT") for resale by the
holders of such shares of Series H Preferred Stock and (iii) eligible to be
traded on either the NASDAQ, the New York Stock Exchange or the American Stock
Exchange, each share of Series H Preferred Stock issued and outstanding on March
27, 2002 (the "MATURITY DATE") (and any accrued and unpaid Conversion Default
Payments), automatically shall be converted into shares of Common Stock on such
date in accordance with the conversion formulas set forth in Paragraph A of this
Article IV (the "REQUIRED CONVERSION AT MATURITY"). If a Required Conversion at
Maturity occurs, the Corporation and the holders of Series H Preferred Stock
shall follow the applicable conversion procedures set forth in Paragraph B of
this Article IV; PROVIDED, HOWEVER, that the holders of Series H Preferred Stock
are not required to deliver a Notice of Conversion to the Corporation.
V. RESERVATION OF SHARES OF COMMON STOCK
A. Reserved Amount. Upon adoption of this Certificate of Designations by
the Corporation's Board of Directors, the Corporation shall have reserved
4,500,000 authorized but unissued shares of Common Stock for issuance upon
conversion of the Series H Preferred Stock and thereafter the number of
authorized but unissued shares of Common Stock so reserved (the "RESERVED
AMOUNT") shall at all times be sufficient to provide for the conversion of the
Series H Preferred Stock outstanding at the then current Conversion Price. The
Reserved Amount shall be allocated to the holders of Series H Preferred Stock as
provided in Article XIV.D.
B. Increases to Reserved Amount. If the Reserved Amount for any three
(3)
-7-
consecutive trading days (the last of such three (3) trading days being the
"AUTHORIZATION TRIGGER DATE") shall (i) during the period beginning on the
Closing Date and ending on that date which is one hundred fifty (150) days after
the Closing Date be less than 100% of the number of shares of Common Stock
issuable upon conversion of the Series H Preferred Stock on such trading days,
or (ii) on or after that date which is one hundred fifty one (151) days after
the Closing Date, be less than 135% of the number of shares of Common Stock
issuable upon conversion of the Series H Preferred Stock on such trading days,
the Corporation shall immediately notify the holders of Series H Preferred Stock
of such occurrence and shall take immediate action (including seeking
shareholder approval to authorize the issuance of additional shares of Common
Stock) to increase the Reserved Amount to 150% of the number of shares of Common
Stock into which the Series H Preferred Stock are then convertible. In the event
the Corporation fails to so increase the Reserved Amount within ninety (90) days
after an Authorization Trigger Date, each holder of Series H Preferred Stock
shall thereafter have the option, exercisable in whole or in part at any time
and from time to time by delivery of a Redemption Notice (as defined in Article
VIII.D) to the Corporation, to require the Corporation to purchase for cash, at
an amount per share equal to the Redemption Amount (as defined in Article
VIII.C), a portion of the holder's Series H Preferred Stock such that, after
giving effect to such purchase, the holder's allocated portion of the Reserved
Amount exceeds 135% of the total number of shares of Common Stock issuable to
such holder upon conversion of its Series H Preferred Stock. If the Corporation
fails to redeem any of such shares within five (5) business days after its
receipt of a Redemption Notice, then such holder shall be entitled to the
remedies provided in Article VIII.D.
VI. FAILURE TO SATISFY CONVERSIONS
A. Conversion Default Payments. If, at any time, (x) a holder of shares
of Series H Preferred Stock submits a Notice of Conversion and the Corporation
fails for any reason (other than because such issuance would exceed such
holder's allocated portion of the Reserved Amount, for which failure the holders
shall have the remedies set forth in Article V) to deliver, on or prior to the
fourth business day following the expiration of the Delivery Period for such
conversion, the shares of Common Stock to which such holder is entitled upon
such conversion, or (y) the Corporation provides notice to any holder of Series
H Preferred Stock at any time of its intention not to issue shares of Common
Stock upon exercise by any holder of its conversion rights in accordance with
the terms of this Certificate of Designations other than because such issuance
would exceed such holder's allocated portion of the Reserved Amount (each of (x)
and (y) being a "CONVERSION DEFAULT"), then the Corporation shall pay to the
affected holder, in the case of a Conversion Default described in clause (x)
above, and to all holders, in the case of a Conversion Default described in
clause (y) above, payments for the first ten (10) business days following the
expiration of the Delivery Period, in the case of a Conversion Default described
in clause (x), and for the first ten (10) business days of any other Conversion
Default, an amount equal to $1,000 per day. In the event any Conversion Default
continues beyond such ten (10) business day period, the Corporation shall pay to
the holder an additional amount equal to:
-8-
(.24) x (D/365) x (the Default Amount)
where:
"D" means the number of days after the expiration of the ten (10)
business day period described above through and including the Default Cure Date;
"DEFAULT AMOUNT" means (i) the total Face Amount of all shares of Series
H Preferred Stock held by such holder plus (ii) the total Premium as of the
first day of the Conversion Default on all shares of Series H Preferred Stock
included in clause (i) of this definition; and
"DEFAULT CURE DATE" means (i) with respect to a Conversion Default
described in clause (x) of its definition, the date the Corporation effects the
conversion of the full number of shares of Series H Preferred Stock and (ii)
with respect to a Conversion Default described in clause (y) of its definition,
the date the Corporation begins to honor all conversions of Series H Preferred
Stock in accordance with Article IV.A.
The payments to which a holder shall be entitled pursuant to this
Paragraph A are referred to herein as "CONVERSION DEFAULT PAYMENTS." A holder
may elect to receive accrued Conversion Default Payments in cash or to convert
all or any portion of such accrued Conversion Default Payments, at any time,
into Common Stock at the Conversion Price in effect at the time of such
conversion. In the event a holder elects to receive any Conversion Default
Payments in cash, it shall so notify the Corporation in writing. Such payment
shall be made in accordance with and be subject to the provisions of Article
XIV.F. In the event a holder elects to convert all or any portion of the
Conversion Default Payments, the holder shall indicate on a Notice of Conversion
such portion of the Conversion Default Payments which such holder elects to so
convert and such conversion shall otherwise be effected in accordance with the
provisions of Article IV.
B. Adjustment to Conversion Price. If a holder has not received
certificates for all shares of Common Stock prior to the tenth (10th) business
day after the expiration of the Delivery Period with respect to a conversion of
Series H Preferred Stock for any reason (other than because such issuance would
exceed such holder's allocated portion of the Reserved Amount, for which failure
the holders shall have the remedies set forth in Article V), then the Conversion
Price in respect of any shares of Series H Preferred Stock held by such holder
shall thereafter be the lesser of (i) the Conversion Price on the Conversion
Date specified in the Notice of Conversion which resulted in the Conversion
Default and (ii) the lowest Conversion Price in effect during the period
beginning on, and including, such Conversion Date through and including the day
such shares of Common Stock are delivered to the holder and (iii) the Conversion
Price (calculated in accordance with Article III.E) on the Conversion Date
specified in the Notice of Conversion for such share of Series H Preferred
Stock. If there shall occur a Conversion Default of the type described in clause
(y) of Article VI.A, then the Conversion Price with respect to any conversion
thereafter shall be the lower of (x) the lowest Conversion Price in effect
-9-
at any time during the period beginning on, and following, the date of the
occurrence of such Conversion Default through and including the Default Cure
Date and (y) the Conversion Price (calculated in accordance with Article III.E)
on the Conversion Date specified in the Notice of Conversion for such share of
Series H Preferred Stock.. The Conversion Price shall thereafter be subject to
further adjustment for any events described in Article XI.
C. Buy-In Cure. If (i) the Corporation fails for any reason to deliver
during the Delivery Period shares of Common Stock to a holder upon a conversion
of shares of Series H Preferred Stock having a Conversion Date on or prior to a
date upon which the Corporation has notified the applicable holder in writing
that the Corporation is unable to honor conversions and (ii) after the
applicable Delivery Period with respect to such conversion, such holder
purchases (in an open market transaction or otherwise) shares of Common Stock to
deliver in satisfaction of a sale by such holder of the shares of Common Stock
which such holder anticipated receiving upon such conversion (a "BUY-IN"), the
Corporation shall pay such holder (in addition to any other remedies available
to the holder) the amount by which (x) such holder's total purchase price
(including brokerage commissions, if any) for the shares of Common Stock so
purchased exceeds (y) the total Face Amount (plus the accrued Premium thereon)
of the portion of the Series H Preferred Stock resulting in the Buy-In. For
example, if a holder purchases shares of Common Stock having a total purchase
price of $11,000 to cover a Buy-In with respect to an attempted conversion of
Series H Preferred Stock having a total Face Amount and accrued Premium of
$10,000, the Corporation will be required to pay the holder $1,000. A holder
shall provide the Corporation written notification indicating any amounts
payable to such holder pursuant to this Paragraph C. The Corporation shall make
any payments required pursuant to this Paragraph C in accordance with and
subject to the provisions of Article XIV.F.
D. Redemption Right. If the Corporation fails, and such failure
continues uncured for five (5) business days after the Corporation has been
notified thereof in writing by the holder, for any reason (other than because
such issuance would exceed such holder's allocated portion of the Reserved
Amount, for which failure the holders shall have the remedies set forth in
Article V) to issue shares of Common Stock within ten (10) business days after
the expiration of the Delivery Period with respect to any conversion of Series H
Preferred Stock, then the holder may elect at any time and from time to time
prior to the Default Cure Date for such Conversion Default, by delivery of a
Redemption Notice (as defined in Article VIII.D) to the Corporation, to have all
or any portion of such holder's outstanding shares of Series H Preferred Stock
purchased by the Corporation for cash, at an amount per share equal to the
Redemption Amount (as defined in Article VIII.C). If the Corporation fails to
redeem any of such shares within five (5) business days after its receipt of a
Redemption Notice, then such holder shall be entitled to the remedies provided
in Article VIII.D.
E. Retention of Rights as Series H Preferred Stockholder. If a holder
has not received certificates for all shares of Common Stock prior to the tenth
(10th) business day after the expiration of the Delivery Period with respect to
a conversion of Series H Preferred Stock for any reason, then the Corporation
shall, as soon as practicable, return such unconverted shares of
-10-
Series H Preferred Stock to the holder and (unless the holder otherwise elects
to retain its status as a holder of Common Stock) the holder shall regain the
rights of a holder of Series H Preferred Stock with respect to such shares. In
all cases, the holder shall retain all of its rights and remedies (including,
without limitation, (i) the right to receive Conversion Default Payments
pursuant to Paragraph A above to the extent required thereby for such Conversion
Default and any subsequent Conversion Default and (ii) the right to have the
Conversion Price with respect to subsequent conversions determined in accordance
with Paragraph B above) for the Corporation's failure to convert Series H
Preferred Stock.
VII. [INTENTIONALLY OMITTED]
VIII. REDEMPTION DUE TO CERTAIN EVENTS
A. Redemption by Holder. In the event (each of the events described in
clauses (i)-(v) below after expiration of the applicable cure period (if any)
being a "REDEMPTION EVENT"):
(i) the Common Stock (including all of the shares of Common
Stock issuable upon conversion of the Series H Preferred Stock) is
suspended from trading on any of, or is not listed or designated for
quotation (and authorized) for trading on at least one of, the New York
Stock Exchange, the American Stock Exchange, the NASDAQ National Market
or the NASDAQ Small Cap Market ("NASDAQ") for an aggregate of ten (10)
trading days in any nine (9) month period,
(ii) the Registration Statement required to be filed by the
Corporation pursuant to Section 2(a) of the Registration Rights
Agreement, dated as of March 27, 1997, by and among the Corporation and
the other signatories thereto (the "REGISTRATION RIGHTS AGREEMENT"), has
not been declared effective by the 180th day following the Closing Date
or such Registration Statement, after being declared effective, cannot
be utilized by the holders of Series H Preferred Stock for the resale of
all of their Registrable Securities (as defined in the Registration
Rights Agreement) for an aggregate of more than thirty (30) days in any
consecutive twelve month period,
(iii) the Corporation fails, and any such failure continues
uncured for five (5) business days after the Corporation has been
notified thereof in writing by the holder, to remove any restrictive
legend on any certificate or any shares of Common Stock issued to the
holders of Series H Preferred Stock upon conversion of the Series H
Preferred Stock as and when required by this Certificate of
Designations, the Securities Purchase Agreement or the Registration
Rights Agreement,
(iv) the Corporation provides notice to any holder of Series H
Preferred Stock, including by way of public announcement, at any time,
of its intention not to issue shares of Common Stock to any holder of
Series H Preferred Stock upon conversion in accordance with the terms of
this Certificate of Designations (other than due to the circumstances
contemplated
<PAGE>
-11-
by Article V, for which the holders shall have the remedies set forth in
such Article), or
(v) the Corporation shall:
(a) sell, convey or dispose of all or substantially all
of its assets;
(b) merge, consolidate or engage in any other business
combination with any other entity (other than a merger,
consolidation or business combination in which the holders of
the Corporation's voting securities immediately preceding such
merger, consolidation or business combination own, on a pro rata
basis, at least 50% of the surviving entity's voting
securities); or
(c) have fifty percent (50%) or more of the voting power
of its capital stock owned beneficially by one person, entity or
"group" (as such term is used under Section 13(d) of the
Securities Exchange Act of 1934, as amended),
then, upon the occurrence of any such Redemption Event, each holder of
shares of Series H Preferred Stock shall thereafter have the option,
exercisable in whole or in part at any time and from time to time by
delivery of a Redemption Notice (as defined in Paragraph D below) to the
Corporation while such Redemption Event continues, to require the
Corporation to purchase for cash any or all of the then outstanding
shares of Series H Preferred Stock held by such holder for an amount per
share equal to the Redemption Amount (as defined in Paragraph C below)
in effect at the time of the redemption hereunder. For the avoidance of
doubt, the occurrence of any event described in clauses (i), (ii), (iv)
or (v) above shall immediately constitute a Redemption Event and there
shall be no cure period.
B. Redemption by Corporation.
(i) If at any time after that date which is two (2) years after
the Closing Date, the average of the Closing Bid Prices for the Common
Stock for ten (10) consecutive trading days is greater than the
Conversion Price Ceiling multiplied by 1.5 (subject to equitable
adjustments for stock splits, stock dividends, reclassifications or
similar events during such ten (10) trading day period), then the
Corporation shall have the right to redeem up to fifty percent (50%) of
the Series H Preferred Stock for a price per share equal to the Optional
Redemption Amount (as defined below). If at any time after the Closing
Date the average of the Closing Bid Prices for the Common Stock for ten
(10) consecutive trading days is greater than the Conversion Price
Ceiling multiplied by 2.0 (subject to equitable adjustments for stock
splits, stock dividends, reclassifications or similar events during such
ten (10) trading day period) then the Corporation shall have the right
to redeem (such right, collectively with the Corporation's redemption
rights pursuant to the immediately preceding sentence, shall be referred
to as "REDEMPTION AT CORPORATION'S ELECTION") any or all of the Series H
Preferred Stock for an amount equal to the Optional redemption Amount. A
Redemption at Corporation's Election shall
<PAGE>
-12-
be exercisable by the Corporation in its sole discretion by delivery of
an Optional Redemption Notice (as defined below). Holders of Series H
Preferred Stock may convert all or any part of their shares of Series H
Preferred Stock into Common Stock by delivering a Notice of Conversion
to the Corporation at any time prior to that date which is ten (10) days
after receipt of an Optional Redemption Notice. The "OPTIONAL REDEMPTION
Amount" with respect to each share of Preferred Stock means (a) for
redemptions pursuant to the first sentence of this subparagraph (i), an
amount equal to:
(1,000 + P) x 1.5
CCP
and (b) for redemptions pursuant to the second sentence of this
subparagraph (I), an amount equal to:
(1,000 + P) x 2.0
CCP
where:
"P" means the accrued Premium on such share of Series H
Preferred Stock through the date of redemption; and
"CCP" means the Conversion Price Ceiling on the date of the
redemption.
(ii) The Corporation shall effect each redemption under this
Section VIII.B by giving at least ten (10) trading days but not more
than twenty (20) trading days (subject to extension as set forth below)
prior written notice (the "OPTIONAL REDEMPTION NOTICE") of the date
which such redemption is to become effective (the "EFFECTIVE DATE OF
REDEMPTION") and the Optional Redemption Amount to (a) the holders of
Series H Preferred Stock selected for redemption at the address and
facsimile number of such holder appearing in the Corporation's register
for the Series H Preferred Stock and (b) the transfer agent for the
Common Stock, which Optional Redemption Notice shall be deemed to have
been delivered on the business day after the Corporation's fax (with a
copy sent by overnight courier) of such notice to the holders of Series
H Preferred Stock.
(iii) The Optional Redemption Amount shall be paid to the holder
of the Series H Preferred Stock being redeemed within three (3) business
days of the Effective Date of Redemption; PROVIDED, HOWEVER, that the
Corporation shall not be obligated to deliver any portion of the
Optional Redemption Amount until either the certificates evidencing the
Series H Preferred Stock being redeemed are delivered to the office of
the Corporation, or the holder notifies the Corporation that such
certificates have been lost, stolen or destroyed and delivers the
documentation in accordance with Article XIV.B hereof. Notwithstanding
anything herein to the contrary, in the event that the certificates
evidencing the Series H Preferred Stock redeemed are
<PAGE>
-13-
not delivered to the Corporation prior to the 3rd business day following
the Effective Date of Redemption, the redemption of the Series H
Preferred Stock pursuant to this Article VIII.B shall still be deemed
effective as of the Effective Date of Redemption and the Optional
Redemption Price shall be paid to the holder of Series H Preferred Stock
redeemed within five (5) business days of the date the certificates
evidencing the Series H Preferred Stock redeemed are actually delivered
to the Corporation.
(iv) Notwithstanding the provisions of Article IV hereof, if the
Conversion Price on the date a holder delivers a Conversion Notice is
less than or equal to the Conversion Price Floor then in effect, the
Corporation may, at its option, elect to redeem the shares of Series H
Preferred Stock which are the subject of such Conversion Notice at a
price per share equal to the Floor Redemption Amount (as defined below)
in lieu of converting such shares to Common Stock. Each holder of Series
H Preferred Stock shall have the right, by sending a written request to
the Corporation, to require the Corporation to provide advance written
notice to such holder stating whether the Corporation will elect to
exercise its redemption rights pursuant to this paragraph (iv). The
Corporation shall have five (5) business days from receipt of such
request to reply in writing to such holder. In the event Corporation
either fails to so reply or replies that it will not elect to exercise
such redemption rights, the Corporation shall forfeit its rights to
redeem shares of Series H Preferred Stock pursuant to this paragraph
(iv) during the thirty (30) day period immediately following the
expiration of the Corporation's reply period or receipt of such election
not to redeem, as the case may be. In the event the Corporation notifies
a holder of its intention to redeem shares of Series H Preferred Stock
pursuant to this paragraph (v) and such holder delivers a Conversion
Notice at any time during which the Corporation has redemption rights
pursuant to this paragraph (iv) and the Corporation, prior to the date
of such Conversion Notice, has not provided such holder with written
notice that it no longer intends to exercise its redemption rights
pursuant to this paragraph (iv), the Corporation shall, no later than
thirty (30) days from the date of such Conversion Notice, pay to such
holder the Floor Redemption Amount for each share of series H Preferred
which is covered by such Conversion Notice. The Floor Redemption Amount
per share means an amount equal to:
(1000+P) x (RAP)
where:
"P" means the accrued Premium on such share of Series H
Preferred Stock through the date of redemption.
"RAP" means:
If the Redemption occurs: RAP
On or prior to the 209th
day after the Closing Date 110%
<PAGE>
-14-
On or after the 210th and on or prior
to the 299th day after the Closing Date 112%
On or after the 300th and on or prior
to the 394th day after the Closing Date 115%
On or after the 395th day
after the Closing Date 120%
(v) If the Corporation fails to pay, when due and owing, any
Optional Redemption Amount or Floor Redemption Amount, then the holder
of Series H Preferred Stock entitled to receive such Optional Redemption
Amount or Floor Redemption Amount, as the case may be, shall have the
right, at any time and from time to time, to require the Corporation,
upon written notice, to immediately convert (in accordance with the
terms of paragraph A of Article IV) any or all of the shares of Series H
Preferred Stock which are the subject of such redemption, into shares of
Common Stock at the lowest Conversion Price in effect during the period
beginning on the date the Corporation elected to redeem such shares of
Series H Preferred Stock and ending on the earlier of the date the
Corporation effects such redemption and the twentieth trading day
following either the Conversion Date which gave rise to the right of
redemption (in the case of a redemption pursuant to subparagraph (iv) of
this Paragraph B) or the Effective Date of Redemption (in the case of a
Redemption at Corporation's Election), as the case may be. In addition,
if the Corporation fails to pay a Floor Redemption Amount, when due and
owing, the Corporation shall thereafter forfeit its rights this
Paragraph B to effect any redemption with respect to any or all issued
and outstanding shares of Series H Preferred Stock, and in the case of a
failure to pay all or any portion of an Optional Redemption Amount,
shall pay the holder entitled to such Optional Redemption Amount an
amount equal to:
ORA
____ x (ORF-LCBP)
OCP
where:
"ORA" means the amount of the Optional Redemption Amount which
the Corporation failed to so pay;
"OCP" means the Conversion Price in effect on the Effective Date
of Redemption;
"ORF" means (i) with respect to any redemption pursuant to the
first sentence of Article VIII.B (I), the product obtained by
multiplying 1.5 by the Conversion Price Ceiling and (ii) with respect to
any redemption pursuant to the second sentence of Article VIII.B(ii),
the product
<PAGE>
-15-
obtained by multiplying 2.0 by the Conversion Price Ceiling; and
"LCBP" means the lowest Closing Big Price of the Corporation's
Common Stock during the Twenty (20) trading day period beginning on the
Effective Date of redemption.
C. Definition of Redemption Amount. The "REDEMPTION AMOUNT" with respect
to a share of Series H Preferred Stock means an amount equal to:
1,000 + P
X M
---------
C P
where:
"P" means the accrued Premium on such share of Series H
Preferred Stock through the date of redemption;
"CP" means the Conversion Price in effect on the date of the
Redemption Notice; and
"M" means the highest Closing Bid Price of the Corporation's
Common Stock during the period beginning on the date of the Redemption
Notice and ending on the date of the redemption.
D. Redemption Defaults. If the Corporation fails to pay any holder the
Redemption Amount with respect to any share of Series H Preferred Stock within
five (5) business days of its receipt of a notice requiring such redemption (a
"REDEMPTION NOTICE"), then the holder of Series H Preferred Stock delivering
such Redemption Notice (i) shall be entitled to interest on the Redemption
Amount at a per annum rate equal to the lower of twenty-four percent (24%) and
the highest rate permitted by applicable law from the date of the Redemption
Notice until the date of redemption hereunder, and (ii) shall have the right, at
any time and from time to time, to require the Corporation, upon written notice,
to immediately convert (in accordance with the terms of Paragraph A of Article
IV) all or any portion of the Redemption Amount, plus interest as aforesaid,
into shares of Common Stock at the lowest Conversion Price in effect during the
period beginning on the date of the Redemption Notice and ending on the
Conversion Date with respect to the conversion of such Redemption Amount. In the
event the Corporation is not able to redeem all of the shares of Series H
Preferred Stock subject to Redemption Notices, the Corporation shall redeem
shares of Series H Preferred Stock from each holder pro rata, based on the total
number of shares of Series H Preferred Stock included by such holder in the
Redemption Notice relative to the total number of shares of Series H Preferred
Stock in all of the Redemption Notices.
IX. RANK
<PAGE>
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All shares of the Series H Preferred Stock shall rank (i) prior to the
Corporation's common stock, par value $.01 per share (the "COMMON STOCK"); (ii)
pari passu with any class or series of capital stock of the Corporation now
outstanding or hereafter created other than the Common Stock or classes or
series of capital stock of the Corporation specifically ranking, by their terms,
junior to the Series H Preferred Stock (the "PARI PASSU SECURITIES"); and (iii)
junior to any class or series of capital stock of the Corporation hereafter
created (with the consent of the holders of Series H Preferred Stock obtained in
accordance with Article XIII hereof) specifically ranking, by its terms, senior
to the Series H Preferred Stock (the "SENIOR SECURITIES"), in each case as to
distribution of assets upon liquidation, dissolution or winding up of the
Corporation, whether voluntary or involuntary.
X. LIQUIDATION PREFERENCE
A. If the Corporation shall commence a voluntary case under the U.S.
Federal bankruptcy laws or any other applicable bankruptcy, insolvency or
similar law, or consent to the entry of an order for relief in an involuntary
case under any law or to the appointment of a receiver, liquidator, assignee,
custodian, trustee, sequestrator (or other similar official) of the Corporation
or of any substantial part of its property, or make an assignment for the
benefit of its creditors, or admit in writing its inability to pay its debts
generally as they become due, or if a decree or order for relief in respect of
the Corporation shall be entered by a court having jurisdiction in the premises
in an involuntary case under the U.S. Federal bankruptcy laws or any other
applicable bankruptcy, insolvency or similar law resulting in the appointment of
a receiver, liquidator, assignee, custodian, trustee, sequestrator (or other
similar official) of the Corporation or of any substantial part of its property,
or ordering the winding up or liquidation of its affairs, and any such decree or
order shall be unstayed and in effect for a period of sixty (60) consecutive
days and, on account of any such event, the Corporation shall liquidate,
dissolve or wind up, or if the Corporation shall otherwise liquidate, dissolve
or wind up (a "LIQUIDATION EVENT"), no distribution shall be made to the holders
of any shares of capital stock of the Corporation (other than Senior Securities)
upon liquidation, dissolution or winding up unless prior thereto the holders of
shares of Series H Preferred Stock shall have received the Liquidation
Preference with respect to each share. If, upon the occurrence of a Liquidation
Event, the assets and funds available for distribution among the holders of the
Series H Preferred Stock and holders of Pari Passu Securities shall be
insufficient to permit the payment to such holders of the preferential amounts
payable thereon, then the entire assets and funds of the Corporation legally
available for distribution to the Series H Preferred Stock and the Pari Passu
Securities shall be distributed ratably among such shares in proportion to the
ratio that the Liquidation Preference payable on each such share bears to the
aggregate Liquidation Preference payable on all such shares. After payment in
full of the Liquidation Preference of the shares of the Series H Preferred Stock
and the Pari Passu Securities, the holders of such shares shall not be entitled
to any further participation in any distribution of assets by the Corporation.
B. The purchase or redemption by the Corporation of stock of any class,
in any manner permitted by law, shall not, for the purposes hereof, be regarded
as a liquidation,
<PAGE>
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dissolution or winding up of the Corporation. Neither the consolidation or
merger of the Corporation with or into any other entity nor the sale or transfer
by the Corporation of less than substantially all of its assets shall, for the
purposes hereof, be deemed to be a liquidation, dissolution or winding up of the
Corporation.
C. The "LIQUIDATION PREFERENCE" with respect to a share of Series H
Preferred Stock means an amount equal to the Face Amount thereof plus the
Premium thereon through the date of final distribution. The Liquidation
Preference with respect to any Pari Passu Securities shall be as set forth in
the Certificate of Designations filed in respect thereof.
XI. ADJUSTMENTS TO THE CONVERSION PRICE
The Conversion Price shall be subject to adjustment from time to time as
follows:
A. Stock Splits, Stock Dividends, Etc. If at any time on or after a
determination of the Conversion Price Ceiling or Conversion Price Floor, the
number of outstanding shares of Common Stock is increased by a stock split,
stock dividend, combination, reclassification or other similar event, the
Conversion Price Ceiling and Conversion Price Floor shall be proportionately
reduced, or if the number of outstanding shares of Common Stock is decreased by
a reverse stock split, combination or reclassification of shares, or other
similar event at anytime on or after the determination of the Conversion Price
Ceiling or Conversion Price Floor, the Conversion Price Ceiling and Conversion
Price Floor shall be proportionately increased. In such event, the Corporation
shall notify the transfer agent for the Common Stock of such change on or before
the effective date thereof.
B. Adjustment Due to Major Announcement. In the event the Corporation
(i) makes a public announcement that it intends to consolidate or merge with any
other entity (other than a merger in which the Corporation is the surviving or
continuing entity and its capital stock is unchanged) or to sell or transfer all
or substantially all of the assets of the Corporation or (ii) any person, group
or entity (including the Corporation) publicly announces a tender offer to
purchase 50% or more of the Corporation's Common Stock (the date of the
announcement referred to in clause (i) or (ii) of this Paragraph B is
hereinafter referred to as the "ANNOUNCEMENT DATE"), then the Conversion Price
shall, effective upon the Announcement Date and continuing through the
Abandonment Date (as defined below), be equal to the Conversion Price which
would have been applicable for an Optional Conversion occurring on the
Announcement Date. From and after the Abandonment Date, the Conversion Price
shall be determined as set forth in Article III.F "ABANDONMENT DATE" means with
respect to any proposed transaction or tender offer for which a public
announcement as contemplated by this Paragraph B has been made, the date upon
which the Corporation (in the case of clause (i) above) or the person, group or
entity (in the case of clause (ii) above) publicly announces the termination or
abandonment of the proposed transaction or tender offer which caused this
Paragraph B to become operative.
C. Adjustment Due to Merger, Consolidation, Etc. If, at any time when
any Series H
<PAGE>
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Preferred Stock is issued and outstanding, there shall be (i) any
reclassification or change of the outstanding shares of Common Stock (other than
a change in par value, or from par value to no par value, or from no par value
to par value, or as a result of a subdivision or combination), (ii) any
consolidation or merger of the Corporation with any other entity (other than a
merger in which the Corporation is the surviving or continuing entity and its
capital stock is unchanged), (iii) any sale or transfer of all or substantially
all of the assets of the Corporation or (iv) any share exchange pursuant to
which all of the outstanding shares of Common Stock are converted into other
securities or property, then the holders of Series H Preferred Stock shall
thereafter have the right to receive upon conversion, in lieu of the shares of
Common Stock immediately theretofore issuable (without giving effect to any
limitations upon conversion imposed by Article IV.C), such shares of stock,
securities and/or other property as may be issued or payable with respect to or
in exchange for the number of shares of Common Stock immediately theretofore
issuable upon conversion (without giving effect to any limitations upon
conversion imposed by Article IV.C) had such merger, consolidation, exchange of
shares, recapitalization, reorganization or other similar event not taken place,
and in any such case, appropriate provisions shall be made with respect to the
rights and interests of the holders of the Series H Preferred Stock to the end
that the provisions hereof (including, without limitation, provisions for
adjustment of the Conversion Price and of the number of shares of Common Stock
issuable upon conversion of the Series H Preferred Stock) shall thereafter be
applicable, as nearly as may be practicable in relation to any shares of stock
or securities thereafter deliverable upon the conversion thereof. The
Corporation shall not effect any transaction described in this Paragraph C
unless (i) each holder of Series H Preferred Stock has received written notice
of such transaction at least thirty (30) days prior thereto, but in no event
later than ten (10) days prior to the record date for the determination of
shareholders entitled to vote with respect thereto, and (ii) the resulting
successor or acquiring entity (if not the Corporation) assumes by written
instrument the obligations of this Paragraph C. The above provisions shall apply
regardless of whether or not there would have been a sufficient number of shares
of Common Stock authorized and available for issuance upon conversion of the
shares of Series H Preferred Stock outstanding as of the date of such
transaction, and shall similarly apply to successive reclassifications,
consolidations, mergers, sales, transfers or share exchanges.
D. Adjustment Due to Distribution. If the Corporation shall declare or
make any distribution of its assets (or rights to acquire its assets) to holders
of Common Stock as a partial liquidating dividend, by way of return of capital
or otherwise (including any dividend or distribution to the Corporation's
shareholders in cash or shares (or rights to acquire shares) of capital stock of
a subsidiary (I.E. a spin-off)) (a "Distribution"), then the holders of Series H
Preferred Stock shall be entitled, upon any conversion of shares of Series H
Preferred Stock after the date of record for determining shareholders entitled
to such Distribution, to receive the amount of such assets which would have been
payable to the holder with respect to the shares of Common Stock issuable upon
such conversion (without giving effect to any limitations upon conversion
imposed by Article IV.C) had such holder been the holder of such shares of
Common Stock on the record date for the determination of shareholders entitled
to such Distribution.
<PAGE>
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E. [Intentionally Omitted]
F. Purchase Rights. If at any time when any Series H Preferred Stock is
issued and outstanding, the Corporation issues any Convertible Securities or
rights to purchase stock, warrants, securities or other property (the "PURCHASE
RIGHTS") pro rata to the record holders of any class of Common Stock, then the
holders of Series H Preferred Stock will be entitled to acquire, upon the terms
applicable to such Purchase Rights, the aggregate Purchase Rights which such
holder could have acquired if such holder had held the number of shares of
Common Stock acquirable upon complete conversion of the Series H Preferred Stock
(without giving effect to any limitations upon conversion imposed by Article
IV.C) immediately before the date on which a record is taken for the grant,
issuance or sale of such Purchase Rights, or, if no such record is taken, the
date as of which the record holders of Common Stock are to be determined for the
grant, issue or sale of such Purchase Rights.
G. Notice of Adjustments. Upon the occurrence of each adjustment or
readjustment of the Conversion Price pursuant to this Article XI, the
Corporation, at its expense, shall promptly compute such adjustment or
readjustment and prepare and furnish to each holder of Series H Preferred Stock
a certificate setting forth such adjustment or readjustment and showing in
detail the facts upon which such adjustment or readjustment is based. The
Corporation shall, upon the written request at any time of any holder of Series
H Preferred Stock, furnish to such holder a like certificate setting forth (i)
such adjustment or readjustment, (ii) the Conversion Price at the time in effect
and (iii) the number of shares of Common Stock and the amount, if any, of other
securities or property which at the time would be received upon conversion of a
share of Series H Preferred Stock.
XII. VOTING RIGHTS
The holders of the Series H Preferred Stock have no voting power
whatsoever, except as otherwise provided by the Delaware General Corporation Law
(the "GENERAL CORPORATE LAW"), in this Article XII and in Article XIII below.
Notwithstanding the above, the Corporation shall provide each holder of
Series H Preferred Stock, at its request, with copies of proxy materials and
other information sent to shareholders. If the Corporation takes a record of its
shareholders for the purpose of determining shareholders entitled to (a) receive
payment of any dividend or other distribution, any right to subscribe for,
purchase or otherwise acquire (including by way of merger, consolidation or
recapitalization) any share of any class or any other securities or property, or
to receive any other right, or (b) to vote in connection with any proposed sale,
lease or conveyance of all or substantially all of the assets of the
Corporation, or any proposed merger, consolidation, liquidation, dissolution or
winding up of the Corporation, the Corporation shall mail a notice to each
holder, at least twenty (20) days prior to the record date specified therein (or
thirty (30) days prior to the consummation of the transaction or event,
whichever is earlier, but in no event earlier than public announcement of such
proposed transaction), of the date on which any such
<PAGE>
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record is to be taken for the purpose of such vote, dividend, distribution,
right or other event, and a brief statement regarding the amount and character
of such vote, dividend, distribution, right or other event to the extent known
at such time.
To the extent that under the General Corporate Law the vote of the
holders of the Series H Preferred Stock, voting separately as a class or series,
as applicable, is required to authorize a given action of the Corporation, the
affirmative vote or consent of the holders of at least a majority of the shares
of the Series H Preferred Stock represented at a duly held meeting at which a
quorum is present or by written consent of a majority of the shares of Series H
Preferred Stock (except as otherwise may be required under the General Corporate
Law) shall constitute the approval of such action by the class. To the extent
that under the General Corporate Law holders of the Series H Preferred Stock are
entitled to vote on a matter with holders of Common Stock, voting together as
one class, each share of Series H Preferred Stock shall be entitled to a number
of votes equal to the number of shares of Common Stock into which it is then
convertible (without giving effect to any limitations upon conversion imposed by
Article IV.C) using the record date for the taking of such vote of shareholders
as the date as of which the Conversion Price is calculated. Holders of the
Series H Preferred Stock shall be entitled to notice of (and copies of proxy
materials and other information sent to shareholders) all shareholder meetings
or written consents with respect to which they would be entitled to vote, which
notice would be provided pursuant to the Corporation's by-laws and the General
Corporate Law.
XIII. PROTECTION PROVISIONS
So long as any shares of Series H Preferred Stock are outstanding, the
Corporation shall not, without first obtaining the approval (by vote or written
consent, as provided by the General Corporate Law) of the holders of at least a
majority of the then outstanding shares of Series H Preferred Stock:
(a) alter or change the rights, preferences or privileges of the
Series H Preferred Stock;
(b) alter or change the rights, preferences or privileges of any
capital stock of the Corporation so as to affect adversely the Series H
Preferred Stock;
(c) create any new class or series of capital stock having a
preference over the Series H Preferred Stock as to distribution of
assets upon liquidation, dissolution or winding up of the Corporation
(as previously defined in Article IX hereof, "SENIOR SECURITIES");
(d) increase the authorized number of shares of Series H
Preferred Stock;
(e) issue any shares of Series H Preferred Stock other than
<PAGE>
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pursuant to the Securities Purchase Agreement; or
(f) redeem, or declare or pay any cash dividend or distribution
on, any capital stock of the Corporation ranking junior to the Series H
Preferred Stock as to distribution of assets upon liquidation,
dissolution or winding up of the Corporation (including the Common
Stock).
If holders of at least a majority of the then outstanding shares of Series H
Preferred Stock agree to allow the Corporation to alter or change the rights,
preferences or privileges of the shares of Series H Preferred Stock pursuant to
subsection (a) above, then the Corporation shall deliver notice of such approved
change to the holders of the Series H Preferred Stock that did not agree to such
alteration or change (the "DISSENTING Holders") and the Dissenting Holders shall
have the right, for a period of thirty (30) days, to convert all of their shares
of Series H Preferred Stock pursuant to the terms of this Certificate of
Designations as they existed prior to such alteration or change or to continue
to hold their shares of Series H Preferred Stock.
XIV. MISCELLANEOUS
A. Cancellation of Series H Preferred Stock. If any shares of Series H
Preferred Stock are converted pursuant to Article IV, the shares so converted
shall be canceled, shall return to the status of authorized, but unissued
preferred stock of no designated series, and shall not be issuable by the
Corporation as Series H Preferred Stock.
B. Lost or Stolen Certificates. Upon receipt by the Corporation of (i)
evidence of the loss, theft, destruction or mutilation of any Preferred Stock
Certificate(s) and (ii) (y) in the case of loss, theft or destruction, of
indemnity reasonably satisfactory to the Corporation, or (z) in the case of
mutilation, upon surrender and cancellation of the Preferred Stock
Certificate(s), the Corporation shall execute and deliver new Preferred Stock
Certificate(s) of like tenor and date. However, the Corporation shall not be
obligated to reissue such lost or stolen Preferred Stock Certificate(s) if the
holder contemporaneously requests the Corporation to convert such Series H
Preferred Stock.
C. [Intentionally Omitted]
D. Allocations of Reserved Amount. The Reserved Amount and each increase
to the Reserved Amount shall be allocated pro rata among the holders of Series H
Preferred Stock based on the number of shares of Series H Preferred Stock held
by each holder at the time of the establishment of or increase in the Reserved
Amount, as the case may be. In the event a holder shall sell or otherwise
transfer any of such holder's shares of Series H Preferred Stock, each
transferee shall be allocated a pro rata portion of such transferor's Reserved
Amount. Any portion of the Reserved Amount which remains allocated to any person
or entity which does not hold any Series H Preferred Stock shall be allocated to
the remaining holders of shares of Series H Preferred Stock, pro rata based on
the number of shares of Series H Preferred Stock then held by such holders.
<PAGE>
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E. Statements of Available Shares. So long as any shares of Series H
Preferred Stock are outstanding, the Corporation shall deliver to each holder a
written report notifying the holders of any occurrence which prohibits the
Corporation from issuing Common Stock upon any conversion. In addition, the
Corporation shall provide, within ten (10) days after delivery to the
Corporation of a written request by any holder, any of the following information
as of the date of such request: (i) the total number of shares of Series H
Preferred Stock outstanding, (ii) the total number of shares of Common Stock
issued upon all prior conversions of Series H Preferred Stock, (iii) the total
number of shares of Common Stock which are reserved for issuance upon conversion
of the Series H Preferred Stock, (iv) the total number of shares of Common Stock
which may thereafter be issued by the Corporation upon conversion of the Series
H Preferred Stock before the Corporation would exceed the Reserved Amount.
F. Payment of Cash; Defaults. Whenever the Corporation is required to
make any cash payment to a holder under this Certificate of Designations (as a
Conversion Default Payment, upon redemption or otherwise), such cash payment
shall be made to the holder within five (5) business days after delivery by such
holder of a notice specifying that the holder elects to receive such payment in
cash and the method (E.G., by check, wire transfer) in which such payment should
be made. If such payment is not delivered within such five (5) business day
period, such holder shall thereafter be entitled to interest on the unpaid
amount at a per annum rate equal to the lower of twenty-four percent (24%) and
the highest rate permitted by applicable law until such amount is paid in full
to the holder.
G. Remedies Cumulative. The remedies provided in this Certificate of
Designations shall be cumulative and in addition to all other remedies available
under this Certificate of Designations, at law or in equity (including a decree
of specific performance and/or other injunctive relief), and nothing herein
shall limit a holder's right to pursue actual damages for any failure by the
Corporation to comply with the terms of this Certificate of Designations. The
Corporation acknowledges that a breach by it of its obligations hereunder will
cause irreparable harm to the holders of Series H Preferred Stock and that the
remedy at law for any such breach may be inadequate. The Corporation therefore
agrees, in the event of any such breach or threatened breach, the holders of
Series H Preferred Stock shall be entitled, in addition to all other available
remedies, to an injunction restraining any breach, without the necessity of
showing economic loss and without any bond or other security being required.
[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
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IN WITNESS WHEREOF, this Certificate of Designations is executed on
behalf of the Corporation this 26th day of March, 1997.
PALOMAR MEDICAL TECHNOLOGIES, INC.
By: /s/
--------------------------------
Sarah Burgess Reed
Assistant Secretary
<PAGE>
NOTICE OF CONVERSION
(To be Executed by the Registered Holder
in order to Convert the Series H Preferred Stock)
The undersigned hereby irrevocably elects to convert ____________ shares of
Series H Preferred Stock (the "CONVERSION"), represented by stock certificate
No(s). ___________ (the "PREFERRED STOCK CERTIFICATES") into shares of common
stock ("COMMON STOCK") of Palomar Medical Technologies, Inc. (the "CORPORATION")
according to the conditions of the Certificate of Designations, Preferences and
Rights of Series H Convertible Preferred Stock (the "CERTIFICATE OF
DESIGNATIONS"), as of the date written below. If securities are to be issued in
the name of a person other than the undersigned, the undersigned will pay all
transfer taxes payable with respect thereto and is delivering herewith such
certificates. No fee will be charged to the holder for any conversion, except
for transfer taxes, if any. A copy of each Preferred Stock Certificate is
attached hereto (or evidence of loss, theft or destruction thereof).
The undersigned represents and warrants that all offers and sales by the
undersigned of the securities issuable to the undersigned upon conversion of the
Series H Preferred Stock shall be made pursuant to registration of the Common
Stock under the Securities Act of 1933, as amended (the "ACT"), or pursuant to
an exemption from registration under the Act.
Date of Conversion:
-------------------------
Applicable Conversion Price:
-------------------------
Amount of Conversion Default Payments
to be Converted, if any:
------------------------------
Number of Shares of
Common Stock to be Issued:
----------------------------
By:
---------------------------------
Name:
Title:
(Must be _____ exactly as _____ appears on the Preferred
Stock Certificate)
Name:
--------------------------------
Address:
--------------------------------
Social Security or
Federal Tax I.D. Number:
-------------
* The Corporation is not required to issue shares of Common Stock until the
original Preferred Stock Certificate(s) (or evidence of loss, theft or
destruction thereof) to be converted are received by the Corporation. The
Corporation shall issue and deliver shares of Common Stock to an overnight
courier not later than the business day following the later of (a) the second
business day following the Conversion Date in the case of DWAC deliveries and
the third business day following the Conversion Date in all other cases and (b)
receipt of the original Preferred Stock Certificate(s) (or evidence of loss,
theft or destruction thereof) to be converted, and shall make payments pursuant
to the Certificate of Designations for the number of business days that such
issuance and delivery is late.
