FORM 10-Q/A-1
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For quarterly period ended September 30, 1998
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.
(Exact name of issuer as specified in its charter)
<TABLE>
<S> <C>
Delaware 04-3128178
- -------------------------------------------------------------- ---------------------------------------
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
</TABLE>
45 Hartwell Avenue, Lexington, Massachusetts 02421
--------------------------------------------------
(Address of principal executive offices)
(781) 676-7300
-----------------------------------------------
(Issuer's telephone number, including area code)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such
shorter period that the registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days. Yes X No
As of October 30, 1998, 70,402,163 shares of Common Stock, $.01 par
value per share, were outstanding.
Transitional Small Business Disclosure Format (check one): Yes No X
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Page 1 of 21
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PALOMAR MEDICAL TECHNOLOGIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
information. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. The results of operations for the interim periods shown in
this report are not necessarily indicative of expected results for any future
interim period or for the entire fiscal year. Palomar Medical Technologies, Inc.
and its subsidiaries (the "Company" or "Palomar") believes that the quarterly
information presented includes all adjustments (consisting of normal, recurring
adjustments) necessary for a fair presentation in accordance with generally
accepted accounting principles. The accompanying financial statements and notes
should be read in conjunction with the Company's Form 10-K, as of and for the
year ended December 31, 1997.
Some of the Company's medical laser products are in various stages of
development; the success of future operations is hence 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 the
Company's products, obtaining regulatory approval, the need to maintain
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 is currently in negotiations with its
distributor, Coherent, Inc. ("Coherent"), regarding the sale of the Company's
Star Medical Technologies, Inc. ("Star") subsidiary, which manufactures the
Company's LightSheer(TM) diode laser hair removal and leg vein treatment system.
(See Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations.") If this subsidiary is sold, the successful introduction
and marketing of new products will become more critical to the Company's
long-term success.
The Company has incurred significant losses since inception. The
Company has historically financed current operations and expansion of its
business primarily through the private sale of debt and equity securities of the
Company. The Company may require additional financing throughout the year to
continue to fund operations, working capital and growth. The Company may, from
time to time, be required to raise funds through additional private sales of the
Company's debt or equity securities. Securities are sold to private investors at
market or 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 its securities for resale to the public at some
future time.
2. INVENTORIES
Inventories are stated at lower of cost (first-in, first-out) or
market. Work in process and finished goods inventories consist of material,
labor and manufacturing overhead and consist of the following:
<TABLE>
<S> <C> <C> <C>
December 31, September 30,
1997 1998
---------------- ----------------
Raw materials $2,928,350 $1,320,712
Work-in-process and finished goods 1,783,124 2,796,714
---------------- ----------------
$4,711,474 $4,117,425
================ ================
</TABLE>
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3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<S> <C> <C> <C>
December 31, September 30,
1997 1998
---------------- ---------------
Machinery and equipment $6,328,442 $6,070,637
Furniture and fixtures 1,018,931 1,001,155
Leasehold improvements 480,453 445,613
---------------- ---------------
7,827,826 7,517,405
Less: Accumulated depreciation
and amortization 1,372,240 3,999,689
---------------- ---------------
$6,455,586 $3,517,716
================ ===============
</TABLE>
4. NET LOSS PER COMMON SHARE
In March 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, Earnings per Share. This statement establishes standards for
computing and presenting earnings per share and applies to entities with
publicly traded common stock or potential common stock. This statement is
effective for fiscal years ending after December 15, 1997. Basic net loss per
share was determined by dividing net income by the weighted average shares of
common stock outstanding during the period. Diluted net loss per share is the
same as basic net loss per share because the Company's potentially dilutive
securities, primarily stock options, warrants, redeemable preferred stock and
convertible debentures, are antidilutive.
The Company's net loss per common share from continuing operations for
the three and nine months ended September 30, 1997 and 1998 is as follows:
<TABLE>
<S> <C> <C> <C> <C>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
---------------- -------------- ---------------- ---------------
Net (loss) income from continuing
operations $(22,039,259) $539,883 $(43,521,015) $(10,267,252)
Amortization of value ascribed to
preferred stock conversion discount (941,176) -- (1,882,352) --
Preferred stock dividends (500,754) (195,000) (1,227,978) (1,341,435)
---------------- -------------- ---------------- ---------------
Adjusted net (loss) income $(23,418,189) $344,883 $(46,631,345) $(11,608,687)
================ ============== ================ ===============
Basic and diluted net (loss) income
per common share from
continuing operations $(0.68) $0.01 $(1.43) $(0.19)
================ ============== ================ ===============
Weighted average number of
common shares outstanding 34,498,657 67,248,694 32,758,019 60,880,311
================ ============== ================ ===============
</TABLE>
As of September 30, 1997 and 1998, 22,833,270 and 29,394,921 weighted
average common equivalent shares, respectively, were not included in the diluted
weighted average shares outstanding as they were antidilutive.
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5. NOTES PAYABLE
Notes payable consist of the following:
<TABLE>
<S> <C> <C>
December 31, September 30,
1997 1998
---------------- ---------------
Convertible debentures $10,683,440 $2,500,000
Note payable issued in connection with guaranty on behalf of discontinued subsidiary 3,233,000 2,290,042
Short-term notes payable to Coherent, Inc. --- 4,000,000
Advance from Coherent, Inc. --- 148,986
Other notes payable 169,588 ---
---------------- ---------------
14,086,028 8,939,028
Less - current maturities (1,640,465) (5,765,486)
--------------- ---------------
$12,445,563 $3,173,542
================ ===============
</TABLE>
(a) Convertible Debentures
During the first quarter of 1998, the Company converted: the remaining
$100,000 of its 4.5% convertible debentures due October 21, 1999, 2000 and 2001
into 60,809 shares of the Company's common stock; the remaining $3,084,344 of
its 5% convertible debentures due December 31, 2001, January 13, 2002 and March
10, 2002 into 3,646,092 shares of the Company's common stock; and $160,000 of
its 6%, 7% and 8% convertible debentures due September 30, 2002 into 103,021
shares of the Company's common stock. Accrued interest totaling $158,685 was
included in the above conversions. The Company amortized deferred financing
costs totaling $245,878 to additional paid-in capital related to these
conversions.
During the second quarter of 1998, the Company converted $2,840,000 of
6%, 7% and 8% convertible debentures due September 30, 2002 into 2,702,519
shares of the Company's common stock. Accrued interest totaling $107,999 was
included in the above conversions. The Company amortized deferred financing
costs totaling $128,156 to additional paid-in capital related to this
conversion.
During the first quarter of 1998, the Company redeemed $2,000,000,
including interest and premium, of 6%, 7% and 8% convertible debentures due
September 30, 2002 for $2,196,667. Deferred financing cost totaling $95,000 was
charged to interest expense upon this redemption.
(b) Short-Term Notes Payable
On May 22 and June 22, 1998, the Company borrowed $3,000,000 and
$1,000,000, respectively, from the Company's worldwide distributor, Coherent.
These notes accrue interest at 8.5% per annum. The notes are secured by all of
the inventory owned by the Company's Star subsidiary.
Under the terms of the Loan Agreement between Coherent and the Company,
the Company agreed to enter into good faith negotiations with Coherent regarding
the sale of Star for a price of no less than $42 million, on terms to be agreed
upon between the Company and Coherent. The negotiations are ongoing, and
Coherent and the Company have announced that, if the parties are able to reach a
definitive agreement, the sale price for Star is expected to be in the range of
$60 to $65 million, payable in cash. However, at this time, the parties have not
agreed to all of the terms of the transaction. Because a number of significant
issues regarding the terms of the transaction remain unresolved, there can be no
assurance that the parties will reach agreement. Due to the uncertain nature of
transaction negotiations, the likelihood that an agreement will be reached is
indeterminable. If an agreement is reached, consummation of the transaction
would be subject to the approval of the stockholders of Palomar, as well as
certain regulatory approvals and other standard closing conditions. In the event
that the parties are unable to agree on the terms and conditions for the sale of
Star, the $4,000,000 of funds borrowed by the Company from Coherent are due 90
days from the termination of negotiations regarding the proposed sale.
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(c) Advance from Coherent
Coherent advanced funds to the Company during 1998. The advances are
secured by specific accounts receivable outstanding at the time of the advance.
Payments against this advance are made as Coherent collects receivables from the
end users of the Company's products.
(d) Revolving Line of Credit
On September 23, 1998 the Company received a commitment letter from a bank for a
$10,000,000 revolving line of credit. The commitment letter provides, among
other things, that:
- The line of credit will mature on March 31, 2000;
- The line of credit will bear interest at the bank's prime rate
(8.00% at September 30, 1998);
- Borrowings will be limited to 80% of domestic accounts receivable
under 90 days from invoice; and
- A director of the Company will personally guaranty borrowings
under the line of credit.
6. STOCKHOLDERS' DEFICIT
(a) Issuance of Common Stock
During 1998 the Company sold 10,200,000 shares of common stock to a
group of investors for $10,200,000. In addition, the Company issued callable
warrants to the investors to purchase 10,200,000 shares of common stock at an
exercise price of $3.00 per share. The callable warrants are not exercisable for
the first six months after issuance and, thereafter, are callable by the Company
if the closing price of the Company's common stock equals or exceeds $5.00 for
ten consecutive trading days. Under the terms of this private placement, the
Company is obligated to pay the investors a fee of 5% per annum (payable
quarterly) of the dollar value invested in the Company as long as the investors
continue to hold their common stock in their name. Through September 30, 1998,
the Company has paid $190,000 related to this fee. The Company paid a 5%
commission of $360,000 related to this issuance which has been netted against
the proceeds through a reduction in additional paid-in capital.
(b) Convertible Preferred Stock
During the first quarter of 1998, the Company converted 268 shares of
Series G Preferred Stock and accrued dividends and interest of $30,255 into
283,507 shares of the Company's common stock. Also, during the first quarter of
1998, the Company converted 3,840 shares of its Series H Preferred Stock and
accrued dividends of $359,807 into 4,103,650 shares of the Company's common
stock.
During the first quarter of 1998, the Company redeemed 2,200 shares of
Series H Preferred Stock including related accrued dividends and premiums for
$2,673,850.
During the second quarter of 1998, the Company converted 536 shares of
Series G Preferred Stock and accrued dividends and interest of $66,485 into
616,378 shares of the Company's common stock. During the second quarter of 1998,
the Company converted 84 shares of Series H Preferred Stock and accrued
dividends of $24,112 into 85,000 shares of the Company's common stock.
During the second quarter of 1998, the Company redeemed 866 shares of
Series H Preferred Stock including related accrued dividends and premiums for
$1,118,039. During the second quarter of 1998, the Company converted 84 shares
of Series H Preferred Stock and accrued dividends of $24,112 into 85,000 shares
of the Company's common stock.
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During the third quarter of 1998, the Company converted 804 shares of
Series G Preferred Stock and accrued dividends and interest of $117,451 into
1,181,410 shares of the Company's common stock.
During the third quarter of 1998, the Company redeemed 250 shares of
Series H Preferred Stock including related accrued dividends and premiums for
$328,784.
(c) Options to Purchase Common Stock
During the nine months ended September 30, 1998, the Company cancelled
options to purchase 2,892,400 shares of the Company's common stock at exercise
prices ranging from $1.50 to $8.00 per share. In addition, the Company granted
2,234,900 options at above market prices. No options were exercised during the
nine months ended September 30, 1998.
(d) Warrants to Purchase Common Stock
During the nine months ended September 30, 1998, the Company cancelled
warrants to purchase 2,508,452 shares of the Company's common stock at exercise
prices ranging from $2.25 to $6.75 per share and issued warrants to purchase
12,385,000 shares of the Company's common stock at exercise prices ranging from
$.01 to $3.25 per share. During the nine months ended September 30, 1998, a
warrant for 125,000 shares was exercised for $1,250.
This warrant was held by an investor.
(e) Reserved Shares
As of September 30, 1998, the Company had reserved shares of its common
stock for the following:
<TABLE>
<S> <C> <C>
September 30,
1998
---------------
Convertible debentures 3,739,915
Stock option plans 6,707,655
Warrants 19,749,578
Employee 401(k) plan 554,787
Employee stock purchase plan 439,272
Convertible preferred stock 3,950,631
Common stock reserved in
connection with guarantee of note
payable on behalf of discontinued
subsidiary 3,250,000
---------------
Total 38,391,838
===============
</TABLE>
7. DISCONTINUED OPERATIONS
During the fourth quarter of 1997, the Company's Board of Directors
approved a plan to dispose of the Company's electronics business segment. During
the second quarter of 1998, the Company sold all of the issued and outstanding
common stock of its wholly owned subsidiary Dynaco Corp. ("Dynaco") for net
proceeds of approximately $2,381,000. Due to the delay in the sale of Dynaco,
the Company recognized a loss from discontinued operations of approximately
$1,091,000 for the nine months ended September 30, 1998. This represents the
amount in excess of the losses accrued for at December 31, 1997 related to the
operations of Dynaco through the date of disposition. The Company recorded a
charge to discontinued operations of $1,525,000 due to management's decision to
write down the carrying value of its investment in Nexar Technologies, Inc.
("Nexar") during the nine months ended September 30, 1998. For the three months
ended September 30, 1998 there was no effect from discontinued operations.
Pursuant to Accounting Principles Board ("APB") Opinion No. 30,
Reporting the Results of Operations Reporting the Effects of Disposal of a
Segment of a Business and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions, the consolidated financial statements of the Company
have been reclassified to reflect the disposition of the electronics segment.
Accordingly, the assets and liabilities, revenues and expenses, and
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cash flows of the electronics segment have been excluded from the respective
captions in the Consolidated Condensed Balance Sheets, Consolidated Statements
of Operations and Consolidated Statements of Cash Flows. The net assets /
liabilities of these entities have been reported as "Net Assets / Liabilities of
Discontinued Operations" in the accompanying Consolidated Condensed Balance
Sheets; the net operating losses of these entities have been reported as "Net
Loss from Discontinued Operations" in the accompanying Consolidated Statements
of Operations; the net cash flows of these entities have been reported as "Net
Cash (Used In) Provided by Discontinued Operations" in the accompanying
Consolidated Statements of Cash Flows.
Summarized financial information for the discontinued operations were
as follows:
<TABLE>
<S> <C> <C> <C> <C> <C>
Three Months Ended September 30, Nine Months Ended September 30,
1997 1998 1997 1998
------------------ ---------------- ---------------- ----------------------
Revenues $12,460,000 -- $47,507,978 $5,745,750
Net Loss from Discontinued
Operations $(14,950,310) -- $(23,646,687) $(2,624,180)
</TABLE>
8. RESTRUCTURING
In the third quarter of 1997, the Company recognized a restructuring
charge of $2,700,000 based on the decision to discontinue and/or downsize
certain medical product and service business units and consolidate others. The
majority of these amounts related to severance benefits. All expenses accounted
for as restructuring charges were in accordance with the criteria set forth in
Emerging Task Force Issue 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (Including Certain
Costs Incurred in a Restructuring), and are exclusive of the charges related to
discontinued operations. During the nine months ended September 30, 1998, the
Company paid out approximately $1,365,000 of severance, leaving a restructuring
liability of approximately $617,000 at September 30, 1998. This remaining
restructuring liability is principally associated with severance and equipment
due to the Company's former Medical Director.
9. NET LIABILITIES OF DISCONTINUED OPERATIONS
On December 31, 1997 the Company entered into an Exchange Agreement and
sold 500,000 share of Nexar's common stock to GFL Advantage Fund Limited ("GFL")
for $2,000,000. Under the terms of the Exchange Agreement Palomar guaranteed GFL
a minimum selling price of $5.00 a share with respect to 400,000 shares of
Nexar's common stock over a two year time period. The Company is obligated to
pay GFL on January 1, 2000 the difference between $5.00 and the price at which
GFL sells the shares of common stock. As of September 30, 1998, the deferred
gain related to this transaction totaled $1,687,079 and represents the total
amount due to GFL after GFL sold their 400,000 common shares of Nexar stock.
As of November 13, 1998, the Company owns 2,000,000 shares of Nexar's
common stock and 45,684 shares of Nexar Convertible Preferred Stock convertible
into 406,080 shares of Nexar's common stock. The Company estimates that it owns
approximately 18.99% of Nexar. The Company has been actively trying to sell the
remaining shares of Nexar common stock; however, the Company may not be
successful since Nexar filed in the United States Bankruptcy Court a petition
for reorganization under Chapter 11 of title 11 of the United States Code on
December 17, 1998. Furthermore, Nexar has been delisted from The Nasdaq Stock
Market due to Nexar's failure to satisfy Nasdaq listing requirements.
[This space intentionally left blank.]
7
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
REVENUE AND GROSS MARGIN: Three Months Ended September 30, 1998, Compared to
Three Months Ended September 30, 1997
For the three months ended September 30, 1998, the Company had revenues
of $13.8 million as compared to $5.8 million for the three months ended
September 30, 1997. The increase in the Company's revenue of $8.0 million or
136% from the quarter ended September 30, 1997 was mainly due to additional
sales volume of $13.0 million associated with the introduction of the
LightSheer(TM) diode laser hair removal and leg vein treatment system combined
with a decrease in revenue of approximately $5.0 million in other cosmetic
product revenue principally related to the Company's EpiLaser(R) ruby laser hair
removal system. The Company obtained FDA clearance to market and sell its
LightSheer(TM) laser for hair removal and leg vein treatment in the United
States at the end of 1997. The decrease in sales volume associated with the
Company's EpiLaser(R) laser was due to the Company's focus on bringing the
LightSheer(TM) laser to market while developing a new generation of ruby hair
removal laser. Using its core ruby laser technology, originally developed for
tattoo and pigmented lesion removal, Palomar developed its long pulse
EpiLaser(R) ruby laser that is specifically configured to allow the appropriate
wavelength, energy level and pulse duration to be absorbed effectively by the
hair follicle without being absorbed by the surrounding tissue. That, combined
with Company's patented cooling handpiece, allows safe and effective hair
removal. Palomar's new generation long pulse ruby laser is expected both to
permit more rapid treatment of large areas of the body such as the back, chest,
abdomen, legs and arms and to be manufactured at a higher gross margin than the
Company's current EpiLaser(R) laser. In July 1998 the Company obtained FDA
clearance to market and sell its EpiLaser(R) laser in the United States for
"permanent hair reduction."
The Company is in negotiations with its distributor, Coherent, Inc.
("Coherent") regarding the sale of the Company's Star Medical Technologies, Inc.
("Star") subsidiary. This subsidiary manufactures the Company's LightSheer(TM)
diode laser. The parties have announced that, if the transaction is consummated,
the sale price for Star is expected to be in the range of $60 to $65 million,
payable in cash. However, at this time, the parties have not agreed to all of
the terms of the transaction. Because a number of significant issues regarding
the terms of the transaction remain unresolved, there can be no assurance that
the parties will reach agreement. Due to the uncertain nature of transaction
negotiations, the likelihood that an agreement will be reached is
indeterminable. If an agreement is reached, consummation of the transaction
would be subject to the approval of the stockholders of Palomar, as well as
certain regulatory approvals and other standard closing conditions. If the
transaction is consummated, revenue would decline significantly in the near term
and the successful introduction and marketing of new products will become more
critical to the Company's long-term success.
Gross margin for the three months ended September 30, 1998 was
approximately $8.1 million (59% of revenues) versus $918,000 (16% of revenues)
for the three months ended September 30, 1997. The increase in gross margin
dollars and gross margin percentage was caused by the introduction of the
LightSheer(TM) laser. This new laser system has a significantly higher gross
margin than the Company's EpiLaser(R) laser.
OPERATING AND OTHER EXPENSES: Three Months Ended September 30, 1998, Compared to
Three Months Ended September 30, 1997
Research and development costs were $1.5 million for the three months
ended September 30, 1998 and $2.9 million for the three months ended September
30, 1997. Research and development expenses as a percent of revenue totaled 11%
for the three months ended September 30, 1998 and 50% for the three months ended
September 30, 1997. The decline in spending is primarily the result of the
Company receiving FDA clearance for the LightSheer(TM) diode laser system at the
end of 1997. The continued spending on research and development reflects the
Company's commitment to research and development for medical devices and
delivery systems for cosmetic laser applications and other medical applications
using a variety of lasers, while continuing dermatology research utilizing the
Company's ruby and diode lasers. Among the Company's research and development
goals in hair removal is to design systems permitting more rapid treatment of
large areas, and to produce systems with high gross margins. Management believes
that research and development expenditures will remain constant over the next
year as the Company continues product development and clinical trials for
additional applications for its lasers and delivery systems in the cosmetic and
dermatological markets.
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Selling and marketing expenses increased to $4.4 million (32% of
revenues) for the three months ended September 30, 1998, from approximately $1.7
million (29% of revenues) for the three months ended September 30, 1997. The
increase in selling and marketing expenses is attributable to the costs
associated with the Company's exclusive distribution arrangement with Coherent
which increase in direct proportion to sales volume under the terms of the
Company's Sales Agency Agreement with Coherent, because Coherent receives a
commission for each of the Company's products that it sells, to compensate it
for its selling and marketing efforts.
General and administrative expenses decreased to $1.8 million (13% of
revenues) for the three months ended September 30, 1998, compared to $3.6
million (62% of revenues) for the three months ended September 30, 1997. This
decrease is attributable to the Company's successful restructuring and
consolidation of administrative functions in the third and fourth quarters of
1997. In previous years, the Company focused management time and allocated
resources to developing businesses outside of the medical and cosmetic laser
industry and financing those businesses. Beginning in the fourth quarter of
1997, the Company focused its efforts on its core business. The Company
anticipates general and administrative expense will continue to decrease in the
future as the benefits of the third and fourth quarter 1997 restructuring are
realized.
Restructuring and asset write-off costs were approximately $3.3 million
for the three months ended September 30, 1997. This non-recurring charge
reflects the write-off costs for certain operating assets that the Company
believes were not fully realizable. Included in this charge is a $2.7 million
reserve for severance costs associated with consolidating the selling, general
and administrative functions, including the closing of certain facilities.
Asset write-off costs of $9.7 million were incurred in the three months
ended September 30, 1997. This one time charge reflects asset write-off costs
for notes and investments whose value had been permanently impaired.
Interest expense decreased to $184,000 for the three months ended
September 30, 1998, from $728,000 for the three months ended September 30, 1997.
This 75% decrease is primarily the result of a decrease in convertible debenture
financings and the Company's increased use of conventional financing. Also,
operations did not require as much financing in 1998 as compared to 1997.
Other (expense) income was income of approximately $396,000 for the
three months ended September 30, 1998. This amount was principally related to a
realized net gain from the Company's trading securities. The Company incurred
other expenses of approximately $375,000 for the three months ended September
30, 1997. This amount reflects unrealized losses from the Company's trading
securities.
The Company had no loss from discontinued operations for the three
months ended September 30, 1998 due to the fact that it has substantially
completed the divestiture of its discontinued operations in the second quarter
of 1998. This compares to losses of $15 million from discontinued operations for
the three months ended September 30, 1997. (See Note 7 of Notes to Consolidated
Financial Statements.)
REVENUE AND GROSS MARGIN: Nine Months Ended September 30, 1998, Compared to Nine
Months Ended September 30, 1997
For the nine months ended September 30, 1998, the Company had revenues
of $30 million as compared to $15.7 million for the nine months ended September
30, 1997. The increase in the Company's revenue of $14.3 million or 91% from the
nine months ended September 30, 1997 was mainly due to additional sales volume
of $22 million associated with the introduction of the LightSheer(TM) diode
laser combined with a decrease in revenue of approximately $7.7 million in other
cosmetic product revenue. The Company obtained FDA clearance to market and sell
its LightSheer(TM) laser for hair removal and leg vein treatment in the United
States at the end of 1997. The decrease in sales volume associated with the
Company's EpiLaser(R) ruby laser was due to the Company's focus on bringing the
LightSheer(TM) laser to market while further developing a new generation of ruby
hair removal laser. Using its core ruby laser technology, originally developed
for tattoo and pigmented lesion removal, Palomar developed its long pulse
EpiLaser(R) ruby laser that is specifically configured to allow the appropriate
wavelength, energy level and pulse duration to be absorbed effectively by the
hair follicle without being absorbed by the surrounding tissue. That, combined
with Company's patented cooling handpiece, allows safe and effective hair
removal. Palomar's new generation long pulse ruby laser is expected both to
permit more rapid treatment of large areas of the body such as the back, chest,
abdomen, legs and arms and to be manufactured at a higher gross margin
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than the Company's current EpiLaser(R) laser. In July 1998 the Company obtained
FDA clearance to market and sell its EpiLaser(R) laser in the United States for
"permanent hair reduction."
The Company is in negotiations with Coherent regarding the sale of the
Company's Star subsidiary, which manufactures the Company's LightSheer(TM) diode
laser. The parties have announced that, if the transaction is consummated, the
sale price for Star is expected to be in the range of $60 to $65 million,
payable in cash. However, at this time, the parties have not agreed to all of
the terms of the transaction. Because a number of significant issues regarding
the terms of the transaction remain unresolved, there can be no assurance that
the parties will reach agreement. Due to the uncertain nature of transaction
negotiations, the likelihood that an agreement will be reached is
indeterminable. If an agreement is reached, consummation of the transaction
would be subject to the approval of the stockholders of Palomar, as well as
certain regulatory approvals and other standard closing conditions. If this
transaction is consummated, revenues would decline significantly in the near
term and the successful introduction and marketing of new products will become
more critical to the Company's long-term success.
Gross margin for the nine months ended September 30, 1998 was
approximately $13.1 million (44% of revenues) versus $1.3 million (8% of
revenues) for the nine months ended September 30, 1997. The increase in gross
margin and gross margin percentage was caused by the introduction of the
LightSheer(TM) diode laser system. This new laser system has a significantly
higher gross margin than the Company's EpiLaser(R) laser.
OPERATING AND OTHER EXPENSES: Nine Months Ended September 30, 1998, Compared to
Nine Months Ended September 30,
1997
Research and development costs were $5.7 million for the nine months
ended September 30, 1998 and $7.8 million for September 30, 1997. Research and
development expenses as a percent of revenue totaled 19% for the nine months
ended September 30, 1998 and 50% for the nine months ended September 30, 1997.
The decline in spending is primarily the result of the Company receiving FDA
approval for the LightSheer(TM) laser at the end of 1997. The continued spending
on research and development reflects the Company's commitment to research and
development for medical devices and delivery systems for cosmetic laser
applications and other medical applications using a variety of lasers, while
continuing dermatology research utilizing the Company's ruby and diode lasers.
Among the Company's research and development goals in hair removal is to design
systems permitting more rapid treatment of large areas, and to produce systems
with high gross margins. Management believes that research and development
expenditures will remain constant over the next year as the Company continues
product development and clinical trials for additional applications for its
lasers and delivery systems in the cosmetic and dermatological markets.
Selling and marketing expenses increased to $10.5 million (35% of
revenues) for the nine months ended September 30, 1998, from approximately $4.3
million (27% of revenues) for the nine months ended September 30, 1997. The
increase in selling and marketing expenses is attributable to the costs
associated with the Company's distribution agreement with Coherent which
increase in direct proportion to sales volume under the terms of the Company's
Sales Agency Agreement with Coherent, because Coherent receives a commission for
each of the Company's products that it sells, to compensate it for its selling
and marketing efforts.
General and administrative expenses decreased to $7.0 million (23% of
revenues) for the nine months ended September 30, 1998, as compared to $13.3
million (85% of revenues) for the nine months ended September 30, 1997. This
decrease is attributable to the Company's successful restructuring and
consolidation of administrative functions in the third and fourth quarters of
1997. In previous years, the Company used management's time and allocated
resources to developing businesses outside of the medical and cosmetic laser
industry and financing the non-core businesses. Beginning in the fourth quarter
of 1997, the Company focused its efforts on its core business. The Company
anticipates general and administrative expense will continue to decrease in the
future as the benefits of the third and fourth quarter 1997 restructuring are
realized.
For the nine months ended September 30, 1998, the Company did not incur
settlement expenses. Settlement costs of $3.2 million were incurred in the nine
months ended September 30, 1997. These charges consisted mainly of a legal
accrual related to a legal settlement with an investment bank.
Restructuring and asset write-off costs were approximately $3.3 million
for the nine months ended September 30, 1997. This non-recurring charge reflects
the write-off costs for certain operating assets that the
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Company believes were not fully realizable. Included in this charge is a $2.7
million reserve for severance coasts associated with consolidating the selling,
general and administrative functions, including the closing of certain
facilities.
Interest expense decreased to $1.0 million for the nine months ended
September 30, 1998, from $3.3 million for the nine months ended September 30,
1997. This 69% decrease is primarily the result of a decrease in convertible
debenture financings and the Company's increased use of conventional financing.
Also, operations did not require as much financing in 1998 as compared to 1997.
Asset write-off costs of $9.7 million were incurred in the nine months
ended September 30, 1997. This non-recurring charge reflects asset write-off
costs for notes and investments whose value had been permanently impaired.
Other (expense) income was approximately $751,000 of income for the
nine months ended September 30, 1998. This amount primarily consists of realized
gains from the Company's trading securities.
The loss from discontinued operations for the nine months ended
September 30, 1998 was $2.6 million compared to a loss of $23.6 million for the
nine months ended September 30, 1997. The loss from discontinued operations in
1998 was due to a delay in the disposition of Dynaco resulting in operating
expenses of approximately $1.1 million above the estimated operating expenses
accrued for at December 31, 1997. A loss on disposition of discontinued entities
for the nine months ended September 30, 1998 of $1.5 million was incurred. The
majority of this charge relates to management's decision to write-off the
carrying value of its investment in Nexar.
Liquidity and Capital Resources
As of September 30, 1998, the Company had $2.7 million in cash, cash
equivalents and trading securities. During the nine months ended September 30,
1998 the Company generated $9.9 million and $3.1 million in net proceeds from
the issuance of common stock and short-term notes payable, respectively. The
Company's net cash used in operating activities for the nine months ended
September 30, 1998 was approximately $9.4 million.
The Company's net loss for the nine months ended September 30, 1998
included approximately $2.2 million of non-cash depreciation and amortization
expense.
As of September 30 1998, the Company's accounts receivable total
approximately $5,901,000. This amount is principally related to accounts
receivable due from the sale of Star's LightSheer(TM) diode laser. The Company
began shipping this product in the first quarter of 1998.
The Company anticipates that capital expenditures for the remaining
three months of 1998 will total approximately $250,000. The Company will finance
these expenditures with cash on hand, the line of bank credit and equipment
leasing lines. However, there can be no assurance that the Company will be able
to obtain the necessary financing.
On September 23, 1998, the Company received a commitment letter from a
bank for a $10,000,000 revolving line of credit. The commitment letter provides,
among other things, that:
- The line of credit will mature on March 31, 2000;
- The line of credit will bear interest at the bank's prime rate (8.00%
at September 30, 1998);
- Borrowings will be limited to 80% of domestic accounts receivable
under 90 days from invoice; and
- A director of the Company will personally guaranty borrowings under
the line of credit.
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The Company has also considered and expects to continue to consider
intellectual property licensing agreements, the sale of intellectual property
rights that the Company does not intend to exploit, the sale of operating
subsidiaries, and mergers, acquisitions, or other transactions to provide
additional financing to fund future products and research and development.
The Company is in negotiations with Coherent regarding the sale of the
Company's Star subsidiary, which manufactures the Company's LightSheer(TM) diode
laser system. The parties have announced that, if the transaction is
consummated, the sale price for Star is expected to be in the range of $60 to
$65 million, payable in cash. However, at this time, the parties have not agreed
to all of the terms of the transaction. Because a number of significant issues
regarding the terms of the transaction remain unresolved, there can be no
assurance that the parties will reach agreement. Due to the uncertain nature of
transaction negotiations, the likelihood that an agreement will be reached is
indeterminable. If an agreement is reached, consummation of the transaction
would be subject to the approval of the stockholders of Palomar, as well as
certain regulatory approvals and other standard closing conditions.
The Company's strategic plan is to continue to fund research and
development for its medical and cosmetic laser products. This research and
development effort entails extensive clinical trials. These activities are an
important part of the Company's business plan. Due to the nature of clinical
trials and research and development activities, it is not possible to predict
with any certainty the timetable for completion of these research activities or
the total amount of funding required to commercialize products developed as a
result of such research and development. The rate of research and the number of
research projects underway are dependent to some extent upon external funding.
While the Company is regularly reviewing potential funding sources in relation
to these ongoing and proposed research projects, there can be no assurance that
the current levels of funding or additional funding will be available, or, if
available, on terms satisfactory to the Company.
The Company will consider a number of alternatives with respect to its
future products, including manufacturing them itself and selling them directly
and/or through distributors or selling the product line and/or technology to
others. The Company will in each case choose the alternative which it believes
best maximizes profitability and long-term shareholder value.
In connection with the disposition of Comtel, Inc. ("Comtel"), a former
wholly-owned subsidiary in the electronics segment, the Company guaranteed
$2,500,000 of a $3,300,000 line of credit extended by a loan association to
Biometric Technologies Corp. ("BTC"), the buyer of Comtel. The stockholders of
BTC have personally guaranteed to the Company payment for any amounts borrowed
under this line of credit in excess of approximately $1,500,000 in the event the
Company is obligated to honor this guaranty. The amount BTC has outstanding
under the line of credit at September 30, 1998 was approximately $2,633,000.
The Company has historically incurred significant losses. While the
Company achieved profitable operations for the three months ended September 30,
1998, there can be no assurance that this will continue. Therefore, the Company
may need to continue to secure additional financing to complete its research and
development activities, commercialize its current and proposed medical products
and services, and fund ongoing operations. There can be no assurance that events
in the future will not require the Company to seek additional financing. The
Company continues to investigate several financing alternatives, including the
sale of intellectual property rights that the Company does not intend to
exploit, the sale of operating subsidiaries, strategic partnerships, and
mergers, acquisitions, or other transactions. Based on its historical ability to
raise funds as necessary and ongoing discussions with potential financing
sources, the Company believes that it will be successful in obtaining additional
financing, if required, in order to fund future operations. Although the Company
believes it will be successful in obtaining additional financing, there can be
no assurance that any such financing will be available on terms satisfactory to
the Company. The report of the Company's independent public accountants in
connection with the Company's Consolidated Balance Sheets at December 31, 1997
and 1996, and the related Consolidated Statements of Operations, Stockholders'
Equity (Deficit) and Cash Flows for the three years ended December 31, 1997
includes an explanatory paragraph stating that the Company's recurring losses,
working capital deficiency and stockholders' deficit raises substantial doubt
about the Company's ability to continue as a going concern.
Material Uncertainties
Year 2000 Issues
During 1998, the Company has been actively engaged in addressing Year
2000 (Y2K) issues, which result from the use of two-digit, rather than
four-digit, year dates in software, a practice which could cause date-sensitive
systems to malfunction or fail because they may not recognize or process date
information correctly.
State of Readiness: To manage its Y2K program, the Company has divided its
efforts into four program areas:
- Information Technology (computer hardware, and software)
- Physical Plant (manufacturing equipment and facilities)
- Products (including product development)
- Extended Enterprise (suppliers and customers)
For each of these program areas, the Company is using a four-step
approach:
- Ownership (creating awareness, assigning tasks)
- Inventory (listing items to be assessed for Y2K readiness)
- Assessment (prioritizing the inventoried items, assessing their Y2K
readiness, planning corrective actions, developing initial contingency
plans)
- Corrective Action Deployment (implementing corrective actions,
verifying implementation, finalizing and executing contingency plans)
At September 30, 1998, the Ownership, Inventory and Assessment steps
were essentially complete for all program areas. The Company expects to complete
Corrective Action Deployment by June 1999.
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Costs to Address Y2K Issues: The Company's estimated aggregate costs for its Y2K
activities from 1998 through 2000 are expected to be less than $100,000. To date
the Company has spent approximately $10,000.
Risks of Y2K Issues and Contingency Plans: The Company continues to assess the
Year 2000 issues relating to its physical plant, products and suppliers. The
Company intends to develop a contingency planning process to mitigate worst-case
business disruptions such as delays in product delivery, which could potentially
result from events such as supply chain disruptions. The Company expects its
contingency plans to be complete by June 1999.
Sale of Star
Although Palomar and Coherent have announced that they are in
negotiations regarding the sale of the Company's Star subsidiary, the parties
have not agreed to all the terms of the transaction. Because a number of
significant issues regarding the terms of the transaction remain unresolved,
there can be no assurance that the parties will reach agreement. Due to the
uncertain nature of transaction negotiations, the likelihood that an agreement
will be reached is indeterminable. If an agreement is reached, consummation of
the transaction would be subject to the approval of the stockholders of Palomar,
as well as certain regulatory approvals and other standard closing conditions.
Nasdaq Stock Market Listing
By letter dated October 13, 1998, the Nasdaq Stock Market ("Nasdaq")
brought to the Company's attention Nasdaq's concern regarding the continued
listing of the Company's common stock on the Nasdaq SmallCap Market, based on
the fact that the Company's common stock had failed to maintain a closing bid
price greater or equal to $1.00 over the previous thirty consecutive trade
dates. Nasdaq informed the Company that it has ninety calendar days (until the
close of business on January 13, 1998) in which to regain compliance with
Nasdaq's $1.00 minimum bid price requirement. Although the Company's common
stock may be subject to delisting on January 13, 1998, the Company may stay the
delisting by requesting a hearing before such time. If the Company has not
regained compliance with the minimum bid price requirement by January 13, 1998,
the Company intends to appeal a potential delisting to Nasdaq's Listing and
Hearing Review Committee and anticipates that delisting of the Company's common
stock may be stayed during the pendency of such appeal. There can be no
assurance, however, that the Company will be able to maintain Nasdaq listing for
the Company's common stock (whether as a result of failure to meet the minimum
bid price requirement, the market value requirement or other requirements
imposed by Nasdaq). The Company's management anticipates that the absence of the
Nasdaq listing for the Company's common stock would have an adverse effect on
the market for, and potentially the market price of, the Company's common stock.
If the Company's common stock is delisted from Nasdaq, the Company expects that
brokers would continue to make a market in the Company's common stock on the OTC
Bulletin Board.
Factors That May Affect Future Results
From time to time, information provided by the Company or statements
made by its employees may contain "forward-looking" information, as that term is
defined in the Private Securities Litigation Reform Act of 1995 (the "Reform
Act"). This report may also contain statements that are deemed to be
forward-looking information under the Reform Act, including, without limitation,
statements relating to sale of the Company's Star subsidiary; products under
development;, maintenance of Nasdaq listing for the Company's common stock;
financial projections; gross margin, distribution and product improvements;
growing market demand; additional financings; increases in revenues; and
research and development, selling and marketing, general and administrative and
capital expenditures. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. The Company
undertakes no obligation to release publicly the results of any revisions to
these forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events. The Company cautions investors that there can be no
assurance that actual results or business conditions will not differ materially
from those projected or suggested in such forward-looking statements as a result
of various factors, including but not limited to the risk factors identified in
the Company's Annual Report on Form 10-K for the year ended December 31, 1997,
which cautionary statements are 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.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On March 7, 1997, Selvac Acquisition Corp. ("Selvac"), a subsidiary of
Mehl Biophile International, Inc. ("Mehl"), filed a complaint for injunctive
relief and damages for patent infringement and for unfair competition in the
United States District Court for the District of New Jersey against the Company,
two of its subsidiaries and a New Jersey dermatologist. Selvac's complaint
alleged that the Company's EpiLaser(R) ruby laser hair removal system infringed
a patent licensed to Selvac (the "Selvac Patent") and that the Company unfairly
competed by promoting the EpiLaser(R) ruby laser hair removal system for hair
removal before it had received FDA approval for that specific application. On
May 18, 1998 the court granted the Company's motion for partial summary judgment
on the ground that the Selvac patent is invalid because prior art anticipated
it. The court has since denied Selvac's motion for reconsideration of the
summary judgment ruling. On September 25, 1998, the court denied Selvac's motion
for reconsideration of its prior order dismissing so much of Selvac's unfair
competition claim as relied on interpreting the Food, Drug and Cosmetics Act or
FDA regulations, and dismissed without prejudice the state law remainder of
Selvac's unfair competition claim. On October 26, 1998, Selvac filed its notice
of appeal to the Court of Appeals for the Federal Circuit.
On October 16, 1997, the Company brought a declaratory judgment action
in United States District Court for the District of Massachusetts against the
holders and the indenture trustee of the Company's 4.5% Subordinated Convertible
Debentures due 2003, denominated in Swiss francs (the "Swiss Franc Debentures").
The defendants in this action are Banque SCS Alliance SA, Arbuthnot Fund
Managers, Ltd., Banca Commerciale Lugano, Privatinvest Bank AG (these four
defendants being referred to collectively as the "Asserting Holders"), CUF
Finance S.A., Fibi Bank (Schweiz) AG, Teawood Nominees, Ltd., JS Gadd & CIE, SA,
Swedbank (Luxembourg) SA, Christiana Bank Luxembourg SA, (now known as Credit
Agricole Indosuez), Landatina Financiera SA and American Stock Transfer & Trust
Co., as trustee ("Trustee"). Just prior to this suit, the Asserting Holders had
alleged that the Company is in breach of certain protective covenants under the
indenture. The Company believes that it is not in default under any protective
covenants, and the Company's action seeks a declaration from the Court to that
effect. All payments on the Swiss Franc Debentures were current to the time of
suit. On October 22, 1997, the Asserting Holders sued the Company and all of its
principal subsidiaries in the same court; the October 16th and October 22nd
cases have been assigned to the same judge, and the dispute between the
Asserting Holders and the Company is proceeding under the October 22nd case. The
Asserting Holders claim that the Company has breached certain protective
indenture covenants and that the Asserting Holders are entitled to immediate
payment of their indebtedness under the Swiss Franc Debentures (which amounts to
about US$5,000,000 at recent exchange rates). As of November 13, 1997, acting
under applicable provisions of the indenture, the Company notified the holders
of the Swiss Franc Debentures that it is causing the conversion of all of the
Swiss Franc Debentures into an aggregate of 914,028 shares of the Company's
common stock. Palomar filed a motion for summary judgment, asserting that its
conversion of the debentures into Palomar common stock deprives the plaintiffs
of standing to bring a claim. That motion has been denied without prejudice, and
the court also denied the plaintiffs' motion for summary judgment. By mutual
agreement, the Asserting Holders and the Company requested that the case be
removed from the Court's October 1998 trial calendar. The parties have discussed
ways to resolve their dispute, but there can be no assurance that all the
debentureholders, including the Asserting Holders, and Palomar will complete a
proposed settlement. If the case is returned to the trial calendar, the Company
expects vigorously to contest the claims of the Asserting Holders, as the
Company believes its position in the lawsuit is correct, and that the debt
cannot properly be accelerated.
Item 2. Changes in Securities
On July 22, 1998, the Company sold 1,800,000 shares and 1,200,000
shares of the Company's common stock to Rockside Foundation and Mark T. Smith,
respectively, for an aggregate amount of $3,000,000. In addition, for every
share purchased the investor received a warrant to purchase one share of the
Company's common stock for $3.00 per share. These warrants expire five years
from the closing date and are exercisable beginning six months after the closing
date. This sale was made in reliance on Section 4(2) of the Securities Act. The
sale was made without general solicitation or advertising. Each purchaser was a
sophisticated investor with access to all relevant information necessary to
evaluate the investment in the Company, and each purchaser represented to the
Company that the shares and warrants were being acquired for investment.
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SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
Registrant certifies that it has caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the Town of Lexington in the
Commonwealth of Massachusetts on February 12, 1999.
PALOMAR MEDICAL TECHNOLOGIES, INC.
(Registrant)
DATE: February 12, 1999 By: /s/ Louis P. Valente
--------------------
Louis P. Valente
Chief Executive Officer
(Principal Executive Officer)
DATE: February 12, 1999 /s/ Joseph P. Caruso
--------------------
Joseph P. Caruso
Chief Financial Officer and
Treasurer
(Principal Financial Officer
and Principal Accounting
Officer)
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