FORM 10-K/A-2
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1997
Commission file number: 0-22340
PALOMAR MEDICAL TECHNOLOGIES, INC
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(Exact name of registrant as specified in its charter)
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Delaware 04-3128178
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
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45 Hartwell Avenue, Lexington, Massachusetts 02173
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(Address of principal executive offices)
(781) 676-7300
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(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
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
Check if there is no disclosure of delinquent filers in response to
Item 405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
As of March 20, 1998, 59,553,243 shares of Common Stock were
outstanding. The aggregate market value of the voting shares (based upon the
closing price reported by Nasdaq on March 20, 1998) of Palomar Medical
Technologies, Inc., held by nonaffiliates was $66,009,188. For purposes of this
disclosure, shares of Common Stock held by entities who own 5% or more of the
outstanding Common Stock, as reported in Amendment No. 3 to a Schedule 13G filed
on March 10, 1998, and shares of Common Stock held by each officer and director
have been excluded in that such persons may be deemed to be "affiliates" as that
term is defined under the Rules and Regulations of the Securities Exchange Act
of 1934. This determination of affiliate status is not necessarily conclusive.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive proxy statement to be filed prior to April
30, 1998, pursuant to Regulation 14A of the Securities Exchange Act of 1934 are
incorporated by reference into Part III of this Form 10-K
Transitional Small Business Disclosure Format: Yes No X
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PALOMAR MEDICAL TECHNOLOGIES, INC.
INDEX
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS P. 1
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS P. 4
ITEM 8. FINANCIAL STATEMENTS P. F-1
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PART II
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ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is currently traded on the National
Association of Securities Dealers Automated Quotation System (NASDAQ) under the
symbol PMTI. The following table sets forth the high and low bid prices quoted
on NASDAQ for the Common Stock for the periods indicated. Such quotations
reflect inter-dealer prices, without retail markup, markdown or commission and
do not necessarily represent actual transactions.
Fiscal Year Ended
December 31, 1996
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High Low
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Quarter Ended March 31, 1996 13 1/8 5
Quarter Ended June 30, 1996 16 3/8 8 7/8
Quarter Ended September 30, 1996 14 5/8 7 7/8
Quarter Ended December 31, 1996 9 1/8 5 7/8
Fiscal Year Ended
December 31, 1997
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High Low
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Quarter Ended March 31, 1997 9 1/4 5 7/16
Quarter Ended June 30, 1997 5 3/4 2 3/8
Quarter Ended September 30, 1997 4 7/16 1 15/16
Quarter Ended December 31, 1997 2 31/32 25/32
As of March 20, 1998, the Company had 751 holders of record of common
stock. This does not include holdings in street or nominee names.
The Company has not paid dividends to its common stockholders since its
inception and does not plan to pay dividends to its common stockholders in the
foreseeable future. The Company intends to retain any earnings to finance the
operations of the Company.
PRIVATE PLACEMENTS OF COMMON STOCK
Pursuant to Section 4(2) of the Act, on December 29, 1997, the Company
sold 700,000 shares of Nexar Technologies, Inc. ("Nexar") common stock and
300,000 shares of the Company's common stock for an aggregate of $1,750,000 to
Clearwater Fund IV, LLC.
Pursuant to Section 4(2) of the Act, on February 20, 1998 the Company
sold 2,000,000 shares, 1,500,000 shares, 1,100,000 shares, 1,000,000 shares,
250,000 shares and 1,350,000 shares of the Company's common stock to the
Travelers Insurance Company, AIM Overseas Ltd., TJJ Corporation, PAR Investment
Partners L.P., Pequot Scout Fund L.P., and other individual investors,
respectively, for an aggregate of $7,200,000. In addition, for every share
purchased the investor received a warrant to purchase the Company's common stock
for $3 per share. These warrants expire five years from the closing date and are
exercisable beginning six months after the closing date.
CONVERTIBLE DEBENTURES
Pursuant to Section 4(2) of the Act, the Company sold a total of
$1,000,000 5% Convertible Debentures on January 13, 1997 to High Risk
Opportunities Hub Fund Ltd. The debentures, due January 13, 2002, are
convertible into
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shares of common stock at a conversion price equal to 85% of the average closing
bid price of the Company's common stock price during the ten trading days
preceding the date of conversion, provided that in any thirty day period the
holder of these debentures may convert no more than 33% (or 34% in the last
thirty day period available for conversion) of the debentures.
Pursuant to Section 4(2) of the Act, the Company sold a total of
$5,500,000 5% Convertible Debentures on March 10, 1997 to 16 domestic and
overseas entities and individuals. The debentures, due March 10, 2002, are
convertible into shares of common stock at a conversion price equal to 100% of
the Average Stock Price through June 7, 1997 and 90% of the Average Stock Price
thereafter, provided that between June 8, 1997 and October 5, 1997 the holders
of these debentures may convert no more than one-third of the debentures. The
Average Stock Price for the debentures is the lesser of i) the average of the
closing bid of the Company's common stock during the five trading days preceding
each conversion; or ii) the average of the closing bid of the Company's common
stock during the ten trading days preceding each conversion.
Pursuant to Section 4(2) of the Act, the Company sold a total of
$500,000 6% Convertible Debentures on March 13, 1997 to Soginvest Bank. The
debentures, due March 13, 2002, are convertible into shares of common stock at a
conversion price of $11.00, provided that in any thirty day period after June
11, 1997 the holder of these debentures may convert no more than 33% (or 34% in
the last thirty day period available for conversion) of the debentures.
Pursuant to Section 4(2) of the Act, the Company sold a total of
$7,000,000 6%, 7% and 8% Convertible Debentures on September 30, 1997 to JNC
Opportunity Fund Ltd., Diversified Strategies Fund, L.P. and Southbrook
International Investment Ltd. The coupon is payable in kind upon conversion at
6% from September 30, 1997 through March 28, 1998, 7% from March 29 through June
26, 1998 and 8% thereafter. The debentures, due September 30, 2002, are
convertible into shares of common stock at a conversion price equal to the
average of the closing bid price of the Company's common stock during the ten
trading days preceding each conversion, provided that in any thirty day period
from the closing date to April 27, 1998 the holder of these debentures may
convert no more than 33% (or 34% in the last thirty day period available for
conversion) of the debentures. In addition, the holder of the debentures were
issued 413,109 shares of the Company's common stock in lieu of a discount. (See
Note 6 to Financial Statements.)
Pursuant to Section 4(2) of the Act, the Company sold a $2,000,000
convertible debenture on March 27, 1998 to an individual. The debenture is due
the earlier of May 26, 1998 or one day following the sale of Dynaco or any other
Palomar assets outside the normal course of business or any other financing
where the use of proceeds to pay back debt is not prohibited. If the debenture
is not repaid by the maturity date, the debenture becomes convertible at market
value at the option of the debentureholder, as defined. If the note is not paid
by the maturity date and/or June 23, 1998, penalties of $100,000 and $125,000,
payable in the Company's common stock, will be owed on May 26, 1998 and June 23,
1998, respectively, if the note has not been repaid by those dates. Interest on
this debenture is in the form of a warrant to purchase 125,000 shares of common
stock for $.01 per share exercisable over five years.
PREFERRED STOCK
Pursuant to Section 4(2) of the Act, the Company sold 16,000 shares of
Series H Convertible Preferred Stock to RGC International Investors, LDC,
Proprietary Convertible Investment Group, Inc. (an affiliate of Credit Suisse
First Boston Corp.), CC Investments, LDC and Southbrook International
Investments, Ltd. in three separate tranches for an aggregate of $16,000,000.
The first tranche consisted of 6,000 shares sold on March 31, 1997, the second
tranche of 7,000 shares sold on May 5, 1997 and the third tranche of 3,000
shares sold on May 23, 1997. The premium for all tranches is payable at 6% from
March 31, 1997 through September 26, 1997, 7% from September 27, 1997 through
December 25, 1997 and 8% thereafter. The Series H Preferred Stock is convertible
at a conversion price equal to 100% of the Average Stock Price from March 31,
1997 through September 26, 1997, 90% of the Average Stock Price from September
27, 1997 through December 25, 1997, and 85% of the Average Stock Price
thereafter. The Average Stock Price is the average closing bid price of the
Company's common stock price during the ten trading days preceding the date of
conversion, provided that in any thirty day period from the closing date to
October 26, 1997 the holders may convert no more than 33% (or 34% in the last
thirty day period available for conversion) of the Preferred Stock. (See Note
7(b) to Financial Statements.)
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CONVERSIONS OF PREFERRED STOCK AND DEBENTURES
During the year ended December 31, 1997, the following securities were
converted by the accredited investor unaffiliated third-party holders for the
number of shares of common stock indicated:
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TYPE OF SECURITY NUMBER OF SHARES NUMBER OF SHARES
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COMMON STOCK ISSUED
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Preferred Series E 2,128 332,859
Preferred Stock Series G 7,316 602,824
Preferred Stock Series H 8,310 5,204,158
Debenture 4.5% Due 7/3/03 N/A 914,028
Debenture 5% Due 12/31/01 & 1/13/02 N/A 2,074,992
Debenture 5% Due 3/10/02 N/A 2,794,677
Debenture 4.5% Due 10/17/01 N/A 1,381,264
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The Company received no proceeds in connection with any of these
conversions.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
(A) OVERVIEW
In the third and fourth quarter of 1997, the Board of Directors
authorized management to focus the Company on its core laser products and
services business principally related to cosmetic hair removal and to proceed
with a restructuring plan to reorganize the Company and divest its electronic
subsidiaries, Dynaco, Dynamem, Inc. ("Dynamem"), Comtel Electronics, Inc.
("Comtel") and Nexar (the "Electronic Subsidiaries"), and other noncore
businesses.
Pursuant to Accounting Principles Board Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions," the consolidated financial statements of the Company have been
reclassified to reflect the dispositions of the Electronic Subsidiaries.
Accordingly, the revenues, cost and expenses, assets and liabilities and cash
flows of the Electronics Subsidiaries have been reported as discontinued
operations in these consolidated financial statements. (See Note 2 to Financial
Statements.)
As part of the Company's overall restructuring efforts implemented in
the fourth quarter of 1997, the Company made the strategic decision to focus its
operations principally on its cosmetic hair removal products. Accordingly, the
Company also divested its wholly-owned subsidiary Tissue Technologies, Inc.
("Tissue Technologies") due in part to a significant decline in revenues for
Tissue Technologies' Tru-Pulse(R) CO2 skin resurfacing laser caused by an
overall decline in the worldwide CO2 skin resurfacing laser market. This
restructuring also included a reduction in the Company's work force and closing
of the Company's manufacturing facility in Hull, England due to underutilized
plant capacity. The Company has simplified its organization and now conducts
business in only two locations, Lexington, Massachusetts and Pleasanton,
California. Prior to this restructuring, the Company conducted business in over
a dozen different locations. (See Item 1. "Introduction.")
(B) RESULTS
(i) Year Ended December 31, 1997, Compared to Year Ended December
31, 1996
Revenues from continuing operations for the year ended December 31,
1997, were $20,994,546 as compared to $17,606,871 for the year ended December
31, 1996. The 19.2% increase mainly was due to additional sales volume of
approximately $11.3 million associated with the EpiLaser(R) laser system and
service revenue and RD-1200(TM) ruby laser manufactured by the Company. The
Company obtained FDA clearance to market and sell the EpiLaser(R) laser system
for hair removal in the United States in March 1997. This increase in revenues
was offset by a decline of approximately $7.9 million in sales volume for the
Company's Tru-Pulse(R) CO2 laser product. The Company believes that overall
revenues from its medical products will increase in 1998 due to its improved
manufacturing process, growing market demand for its EpiLaser(R) laser system
and recently FDA cleared LightSheer(TM) laser system and an improved
distribution network as a result of the Company's exclusive distribution
arrangement with Coherent. (See "Risk Factors - Dependence on New Relationship
With Coherent.")
Gross margin for the year ended December 31, 1997 was $938,583 (4.5% of
revenues) versus $3,437,400 (19.5% of revenues) for the year ended December 31,
1996. The decline in gross margin percentage was caused mainly by lower margins
attained on the Company's EpiLaser(R) laser system due to manufacturing and
production inefficiencies in the initial manufacturing stage of this product as
well as underabsorbed overhead costs incurred during the fourth quarter of 1997
as the Company transitioned to its exclusive distribution arrangement with
Coherent. The decline in gross margin dollars was due principally to a reduction
in revenues related to the Company's Tru-Pulse(R) CO2 laser product. The
Company's overall strategy was to first demonstrate and prove the overall
efficacy of its proprietary cosmetic hair removal technology licensed from MGH
and gain early entrance to the market. This resulted in higher than anticipated
costs of materials and manufacturing techniques. As a result of this strategy,
the Company believes that during 1997 it demonstrated to the medical community
the efficacy of its technology and its long term benefits and advantages. The
Company believes that its gross margins will improve throughout 1998 as the
Company introduces its successor hair removal laser products in the first and
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second quarter. The Company expects to obtain manufacturing efficiencies and
volume production related to these successor laser products. In addition, the
Company anticipates an increase in revenues due to an improved distribution
network related to its arrangement with Coherent. (See "Risk Factors -
Dependence on New Products; Dependence on New Relationship with Coherent.")
Research and development costs increased to $11,990,332 (57.1% of
revenues) for the year ended December 31, 1997, from $6,297,477 (35.8% of
revenues) for the year ended December 31, 1996. This 90.4% increase in research
and development reflects the Company's strategic decision to accelerate its
research and development efforts during 1997 to develop and obtain FDA clearance
for its successor hair removal and other cosmetic products using the Company's
proprietary cooling technology licensed from MGH. The Company also continued to
concentrate on the development of additional products for other medical laser
applications. Although as part of its agreement with Coherent, the Company has
committed to certain minimum research and development spending levels,
management believes that research and development expenditures in the aggregate
and as a percentage of revenues will substantially decrease over the next year
as the Company introduces to the market its successor hair removal products.
(See Item 1. "Description of Business Research and Development.")
Selling and marketing expenses increased to $6,959,750 (33.2% of
revenues) for the year ended December 31, 1997, from $5,076,941 (28.8% of
revenues) for the year ended December 31, 1996. This 37.1% increase reflected
the Company's effort to expand its marketing and distribution for the Company's
EpiLaser(R) laser system. The Company anticipates that its aggregate selling and
marketing expenses will increase as revenues increase due to the costs
associated with its distribution 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. The amounts received by
Coherent (as a percentage of the Company's net revenues) are greater than the
Company's selling and marketing expenses when it performed these functions
internally. (See "Risk Factors - Dependence on New Relationship With Coherent.")
General and administrative expenses increased to $15,332,241 (73.0% of
revenues) for the year ended December 31, 1997, from $9,752,922 (55.4% of
revenues) for the year ended December 31, 1996. This 57.2% increase was the
result of additional administrative resources required at the Company's now
closed corporate offices and subsidiaries to oversee the growth of the Company's
medical products and service businesses, the initial public offering of common
stock of Nexar, and divestiture efforts substantially completed during 1997,
totaling approximately $500,000. Additional general and administrative costs
were also incurred at Palomar Medical Products, Inc., CTI and Palomar
Technologies, Ltd. totaling approximately $1,400,000, $2,300,000 and $1,000,000,
respectively. The majority of these general and administrative expenditures
incurred by the subsidiaries were for employee and infrastructure expenses to
manage the transition from a development stage company to the commercialization
stage. The Company anticipates that general and administrative expenses will
decrease in the aggregate amount and as a percentage of revenues in 1998 as a
result of the third quarter restructuring effort.
Business development and financing costs decreased to $2,060,852 (9.8%
of revenues) for the year ended December 31, 1997, from $2,879,603 (16.4% of
revenues) for the year ended December 31, 1996. This 28.4% decrease is
attributable to the Company's restructuring efforts to focus on its core medical
product and service businesses. The Company anticipates that business
development expense will decrease substantially in 1998 as a result of the
restructuring.
Restructuring and asset write-off costs totaling $12,983,000 were
incurred for the year ended December 31, 1997. These charges reflect
restructuring and asset write-off costs for certain operating and nonoperating
assets that the Company believes were not fully realizable for both the
Company's medical business and other nonmedical investments. Included in this
charge is a $2.7 million charge for severance costs associated with
consolidating the selling, general and administrative functions, including the
closing of certain facilities.
Settlement and litigation costs totaled $3,199,000 for the year ended
December 31, 1997, an increase from $880,000 for the year ended December 31,
1996. These costs are attributable to a lawsuit brought by an investment bank
and other claims made against the Company. In this suit, the investment bank
alleged that the Company breached a contract in which the bank was to provide
certain investment banking services in return for certain compensation. This
case was settled on August 18, 1997 for $1.875 million.
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Interest expense from continuing operations increased to $6,993,898 for
the year ended December 31, 1997, from $271,619 for the year ended December 31,
1996. This amount for 1997 includes $5.4 million of noncash interest expense
related to the value ascribed to the discount features of the convertible
debentures issued by the Company.
Interest income decreased to $456,945 for the year ended December 31,
1997, from $1,355,488 for the year ended December 31, 1996. This decrease is
primarily the result of a reduction in interest received due to a decrease in
other loans and investments and a decrease in the Company's average cash
position during 1997.
Loss from discontinued operations was $29,508,755 for the year ended
December 31, 1997 as compared with a loss of $20,895,534 for the year ended
December 31, 1996. The Company also reported a gain of $2,073,943 on the
disposition of its discontinued operations. This amount includes a gain of
$6,221,689 related to the disposition of 1,960,736 shares of Nexar common stock
which was offset by losses incurred and accrued of $4,148,000 on the disposition
of Dynaco and its wholly owned subsidiaries. The Company completed the
disposition of Comtel and Dynamem on December 9, 1997. The Company anticipates
that the disposition of Dynaco and the remainder of its Nexar stock will be
completed by the fourth quarter of 1998.
(ii) Year Ended December 31, 1996, Compared to Year Ended December
31, 1995
For the year ended December 31, 1996, the Company had revenues from
continuing operations of $17,606,871 as compared to $5,610,280 for the year
ended December 31, 1995. The 214% increase in revenues from 1995 to 1996 is
principally attributable to $10.1 million of revenues generated from sales of
Tissue Technologies' Tru-Pulse(R) CO2 skin resurfacing laser in 1996 as compared
to only $114,000 of revenues generated from the Tru-Pulse(R) laser for the year
ended December 31, 1995. The Company began commercial shipment of the
Tru-Pulse(R) laser in the fourth quarter of 1995. Furthermore, revenues
increased approximately $2.3 million for the year ended December 31, 1996 as a
result of the Company's introduction and initial shipments of its EpiLaser(R)
laser system during the third and fourth quarters of 1996.
Gross margin for the year ended December 31, 1996 was $3,437,400 (19.5%
of revenues) versus $2,145,808 (38.2% of revenues) for the year ended December
31, 1995. This decrease in gross profit was due to the novation of the Company's
research and development contract with the U.S. Army in anticipation of the
commercialization of its medical products. (See Item 1. "Description of Business
- - Products Under Development; Dye Laser.") The gross profit percent also
decreased due to underutilization of increased production capacity in
preparation for the anticipated increase in demand for the EpiLaser(R) laser
system in fiscal 1997. A portion of this decrease in gross margins was offset by
an increase in gross margins attributed to the introduction of the Tru-Pulse(R)
laser to the commercial marketplace in the first quarter of 1996.
Research and development costs increased to $6,297,477 (35.8% of
revenues) for the year ended December 31, 1996, from $3,964,920 (70.7% of
revenues) for the year ended December 31, 1995. This 58.8% increase in research
and development reflects the Company's focused efforts during 1996 to obtain FDA
clearance for hair removal using the EpiLaser(R) laser system. The Company
received FDA clearance to market its EpiLaser(R) laser system for hair removal
in March 1997. The Company also continued to concentrate on the development of
additional products for medical and cosmetic laser applications. (See Item 1.
"Description of Business - Research and Development.")
Selling and marketing expenses increased to $5,076,941 (28.8% of
revenues) for the year ended December 31, 1996, from $2,768,541 (49.3% of
revenues) for the year ended December 31, 1995. This 83.4% increase reflects the
Company's effort to expand its marketing and distribution to support its new
internally developed EpiLaser(R) and Tru-Pulse(R) laser product lines.
General and administrative expenses increased to $9,752,922 (55.4% of
revenues) for the year ended December 31, 1996, from $2,141,798 (38.2% of
revenues) for the year ended December 31, 1995. This 355.4% increase is
primarily due to acquisition efforts during 1996 and the transformation of the
Company from the development stage to commercialization combined with the
increased administrative resources required at the Company's now closed
corporate offices and subsidiaries to oversee the growth of the Company's
business. The Company expanded its general and administrative support staff to
accommodate the forecasted growth in the fourth quarter of 1996 and in 1997.
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Business development and financing costs increased to $2,879,603 (16.4%
of revenues) for the year ended December 31, 1996, from $1,409,303 (25.1% of
revenues) for the year ended December 31, 1995. This 104.3% increase was
attributable to the Company's continuing acquisitions and financing activities.
Restructuring and asset write-off costs of $3.06 million were incurred
for the year ended December 31, 1996. These charges reflect restructuring and
asset write-off costs for certain operating and nonoperating assets that the
Company believes were not fully realizable for both the Company's medical
business and other nonmedical investments.
Settlement and litigation costs totaled $880,000 for the year ended
December 31, 1996 up from $700,000 for the year ended December 31, 1995. The
$700,000 of settlement and litigation costs incurred during 1995 resulted from
the pledge of 2,860,000 shares of the Company's common stock as collateral for a
$5,000,000 debt financing that was canceled before it was consummated; the
Company was required to pay $700,000 to a third party in order to secure the
return of these common shares. The $880,000 of settlement and litigation costs
incurred during 1996 was associated with the lawsuit filed by the investment
bank. In this suit, the investment bank alleged that the Company breached a
contract with it in which the bank was to provide certain investment banking
services in return for certain compensation. The Company settled this lawsuit on
August 18, 1997 for $1.875 million.
Interest expense from continuing operations decreased to $271,619 for
the year ended December 31, 1996, from $766,079 for the year ended December 31,
1995. This decrease was principally attributable to the Company's increased use
of preferred stock financing in 1996.
Interest income increased to $1,355,488 for the year ended December 31,
1996, from $912,019 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 as of December 31, 1996.
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 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.
Other income totaled $591,853 for the year ended December 31, 1996 as
compared to $102,305 for the year ended December 31, 1995. Included in other
income for the year ended December 31, 1996 is a foreign currency exchange gain
of $446,596.
Loss from discontinued operations was $20,895,534 for the year ended
December 31, 1996 as compared with a loss of $4,231,326 for the year ended
December 31, 1995. The Company also reported a gain on disposition of $3,380,000
on the disposition of 400,000 shares of Nexar common stock that was consummated
during the fourth quarter of 1996.
(C) LIQUIDITY AND CAPITAL RESOURCES
During 1996, the Company reorganized its operations, and as such became
a holding company with no significant operations or assets other than its
investments in operating subsidiaries and strategic investments. The Company
depends upon dividends, cash advances and/or other cash payments from its
subsidiaries to meet its cash flow requirements. To date, the Company's
operating subsidiaries have required cash advances from the Company to fund
their operations.
In order to meet these cash flow requirements and fund operating losses
at the Company's subsidiaries, the Company has generated $16.7 million, $15.0
million and $5.6 million in net proceeds from the issuance of convertible
debentures, the sale of its preferred stock, and the private placement of
Palomar-owned Nexar common stock, respectively, during the year ended December
31, 1997. The Company may be required to raise additional funds to meet future
cash flow requirements for the Company's subsidiaries. As of December 31, 1997,
the Company had approximately $4,453,000 million in cash, cash equivalents and
trading securities.
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The Company's net loss for the year ended December 31, 1997 included
the following noncash items: $2.2 million of depreciation and amortization
expense; $5.4 million of additional interest expense relating to the
amortization of the discounts on the convertible debentures and $13.0 million in
restructuring and asset write-off costs.
The Company anticipates that capital expenditures in the normal course
of manufacturing operations and administrative requirements related thereto for
1998 will total approximately $2 million. The Company will finance these
expenditures with cash on hand and equipment leasing lines or the Company will
seek to raise additional funds. If necessary, the Company can reduce these
expenditures. There can be no assurance that the Company will be able to raise
the necessary funds.
The Company has entered into a Loan Agreement with Coherent, pursuant
to which Coherent has agreed to loan the Company money to help finance the
Company's working capital requirements, which loans are collateralized by the
Company's accounts receivable where Coherent has acted as the Company's sales
agent. (See "Risk Factors - Dependence on New Relationship With Coherent.")
The Company has marketable securities for two of its investments in
publicly traded companies whose market value was $17.2 million as of December
31, 1997. The sale of some of these securities may be subject to volume
limitations. As part of the Company's ongoing strategic financing plan, the
Company is evaluating sale of these securities in an effort to raise funds for
ongoing operations.
As of December 31, 1997, accounts receivable totaled approximately
$2,249,000. This amount is net of our allowance for doubtful accounts of
approximately $746,000. During 1997, revenue increased $11.3 million primarily
due to the introduction of the Company's EpiLaser(R) hair removal system. The
Company allowance for doubtful accounts as of December 1997 is primarily
required for sales of the EpiLaser(R) hair removal system to customers whose
accounts receivable balance was potentially uncollectible at year end.
During 1997, the Company funded its CTI service business in the amount
of $5,097,000. The Company is in the process of evaluating its strategic
business plan related to the cosmetic laser service business in an effort to
ascertain the risks and benefits of investing additional resources in this
business. If the Company believes that additional investments in CTI contribute
toward its overall goal of maximizing shareholder value, then the Company may
continue to make substantial additional investments in CTI.
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 million. As of December 31,
1997, the amount of accounts receivable sold that remained uncollected totaled
$2.1 million net of related reserves and fees, as defined in the agreement. This
amount is included in the net assets of discontinued operations in the
accompanying balance sheet as of December 31, 1997. The interest rate on such
outstanding amounts is the bank's prime rate 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. The Company guarantees
borrowings under this loan agreement.
In connection with the disposition of Comtel, the Company assumed a
note issued by Comtel to a loan association that totals $3,233,000. This note
bears interest at the loan association's prime rate plus 2.25% and is payable in
24 monthly installments of principal and interest totaling approximately
$150,000, beginning in March 1998. This note is secured by a pledge of 3,250,000
shares of the Company's common stock. In addition, the Company has also
guaranteed up to an additional maximum amount of $2,500,000 under a line of
credit extended by this 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 that the Company is obligated to honor
this guarantee. The stockholders of BTC have collateralized this guarantee by
the Company with certain assets personally owned by the stockholders.
The Company's strategic plan is to continue to fund research and
development for its medical products. This research and development effort
entails extensive clinical trials leading up to FDA submissions. 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
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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. (See Item 1. "Description of Business - Research and Development.")
The Company has had significant losses to date and expects these losses
to continue through 1998. Therefore, the Company must continue to secure
additional financing to continue to complete its research and development
activities, commercialize its current and proposed medical products and
services, and fund ongoing operations for the next twelve months. 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, including strategic partnerships, additional bank
financing, private debt and equity financing, sale of assets, including the
Company's marketable securities consisting of Nexar and The American Materials &
Technology Corporation ("AMTK"), and other sources. Based on its historical
ability to raise funds as necessary and ongoing preliminary discussions with
potential financing sources, the Company believes that it will be successful in
obtaining additional financing in order to fund current operations in the near
future. Although the Company believes that 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. (See "Risk Factors Substantial
Continuing Losses; Doubt About Ability to Continue as a Going Concern.")
Subsequent to December 31, 1997, the Company entered into a financing
agreement with a Series G Preferred shareholder to sell this investor 500,000
shares of Nexar common stock for $2,000,000. Under the terms of this agreement,
the Company has guaranteed a $2,000,000 aggregate value to be realized by this
entity. To the extent this amount is not realized by this investor, the Company
will repay any deficiency two years from the date of closing. In connection with
this financing, the Company also agreed to certain amendments of the Series G
Preferred Stock, as defined in the agreement.
In February 1998, the Company sold 7,200,000 shares of its common stock
to a group of investors for $7,200,000. In addition, the Company also issued
warrants to the investors to purchase 7,200,000 shares of common stock at an
exercise price of $3.00 per share.
On March 27, 1998, the Company borrowed $2,000,000. This bridge loan is
payable the earlier of May 26, 1998 or (i) one day following the sale of Dynaco
(ii) the sale of any other Palomar assets in a transaction outside the normal
course of business or (iii) any financing where the use of proceeds to pay back
debt is not prohibited. The Company issued 125,000 warrants to the lender to
purchase 125,000 shares of common stock at an exercise price of $.01 per share
in lieu of interest.
(D) RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 129, DISCLOSURE OF
INFORMATION ABOUT CAPITAL STRUCTURE. In June 1997, FASB issued SFAS No. 130,
REPORTING COMPREHENSIVE INCOME and SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 129, 130 and 131 are effective
for fiscal years beginning after December 15, 1997. The Company believes that
the adoption of these new accounting standards will not have a material impact
on the Company's financial statements.
(E) YEAR 2000
The Company utilizes software and related technologies throughout its
businesses that will be affected by the date change in the year 2000. An
internal study was completed to determine the full scope and related costs to
insure that the Company's systems continue to meet its internal needs and those
of its customers. Anticipated spending for this modification will be expensed as
incurred and is not expected to have a significant impact on the Company's
ongoing results of operations.
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STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT
In addition to the other information in this Annual Report on Form 10-K
the following cautionary statements should be considered carefully in evaluating
the Company and its business. Statements contained in this Form 10-K that are
not historical facts (including, without limitation, statements concerning
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 defined by (i) the Private Securities Litigation Reform Act of
1995 (the "Reform Act") and (ii) 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.
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
cautionary statements below are being made pursuant to the provisions of the
Reform Act and with the intention of obtaining the benefits of safe harbor
provisions of the Reform Act.
RISK FACTORS
SUBSTANTIAL CONTINUING LOSSES; DOUBT ABOUT ABILITY TO CONTINUE AS A
GOING CONCERN. The Company incurred a net loss from continuing operations of
$58,369,079 for the year ended December 31, 1997. The Company expects to incur
losses for the near term and through the third quarter of 1998. However, there
can be no assurance that the Company will achieve profitable operations or that
profitable operations will be sustained if achieved. At December 31, 1997, the
Company's accumulated deficit and working capital deficit was $6,183,687 and
$9,138,915, respectively. The Company's Star, PMP and CTI subsidiaries each have
had a history of losses. There can be no assurance that these companies will
achieve profitable operations or that profitable operations will be sustained if
achieved. As a result, 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 doubts about the Company's ability to continue as a going
concern. The Company must continue to secure additional financing to complete
its research and development activities, commercialize its current and proposed
cosmetic laser products, and fund ongoing operations. The Company anticipates
that it will require substantial additional financing during the next
twelve-month period. The Company believes that the cash generated to date from
its financing activities, continued sale of assets and the Company's ability to
raise cash in future financing activities will be sufficient to satisfy its
working capital requirements through the next twelve-month period. The Company
bases its belief that it has the ability to raise cash in future financings on
its demonstrated historical ability to raise money and its ongoing preliminary
discussions with financing sources. However, there can be no assurance that this
assumption will prove to be accurate or that events in the future will not
require the Company to obtain additional financing sooner than presently
anticipated. The Company may also determine, depending upon the opportunities
available to it, to seek additional debt or equity financing to fund the costs
of acquisitions or expansion. To the extent that the Company finances an
acquisition with a combination of cash and equity securities, any such issuance
of equity securities could result in dilution to the interests of the Company's
shareholders. Additionally, to the extent that the Company incurs indebtedness
to fund increased levels of accounts receivable or to finance the acquisition of
capital equipment or issues debt securities in connection with any acquisition,
the Company will be subject to risks associated with incurring substantial
additional indebtedness, including the risks that interest rates may fluctuate
and cash flow may be insufficient to pay principal and interest on any such
indebtedness. The Company continues to investigate several financing
alternatives, including strategic partnerships, additional bank financing,
private, debt and equity financing and other sources, including the liquidation
of its marketable securities (Nexar and AMTK). While the Company regularly
reviews potential funding sources in relation to its ongoing and proposed
projects, there can be no assurance that the current levels of funding or
additional funding will be available, or if available will be on terms
satisfactory to the Company. Failure to obtain additional financing could have a
material adverse effect on the Company, including requiring it to significantly
curtail its operations. (See "Management's Discussion and Analysis of Financial
Condition and Results of Operations," Item 1. "Description of Business -
Financing of Operations and Increase in Outstanding Shares," and Notes 1, 6 and
7 to Financial Statements.)
DEPENDENCE ON NEW RELATIONSHIP WITH COHERENT. The Company has entered
into a Sales Agency, Development and License Agreement with Coherent (the
"Agreement") pursuant to which Coherent serves as exclusive distributor for the
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Company's laser based hair removal systems. As a result, the Company no longer
has its own sales force. Coherent receives a marketing and sales commission,
based on the end-user price, for each Palomar laser it sells. There can be no
assurance that Coherent will be successful in distributing the Company's hair
removal lasers or that it will give sufficient priority to marketing the
Company's products. In addition, Coherent may develop, market and manufacture
its own lasers that incorporate the Company's proprietary technology and compete
with the Company's lasers, in which case it must pay the Company a royalty on
such sales. If Coherent proves unable to sell Palomar's hair removal lasers in
the volume anticipated, it could have a material adverse effect on the Company's
business, financial condition and results of operations. Pursuant to the
Agreement, if Palomar is unable (as defined) or unwilling to manufacture the
cosmetic laser products to be distributed by Coherent, then Palomar will license
to Coherent the technology necessary to make such products. The initial term of
the Agreement is for three years, commencing on November 17, 1997. At the end of
each year, the Agreement automatically renews for another year, unless either
party provides written notice of its nonrenewal 30 days prior to the renewal
date. In the Agreement, the Company has agreed to upgrade all its EpiLaser(R)
laser systems sold prior to the date of the Agreement. The unanticipated loss of
Coherent as a distributor, any significant reduction in orders from Coherent,
the introduction by Coherent of competitive products, and unanticipated costly
product upgrades would have a material adverse effect on the Company's business,
financial condition and results of operations. (See Notes 3(i) and 12(e) to
Financial Statements.)
DEPENDENCE ON NEW PRODUCTS. The Company expects that a significant
portion of future revenue will continue to be derived from sales of newly
introduced products. The Company must continue to make significant investments
in research and development in order to continue to develop new products,
enhance existing products and achieve market acceptance for such products.
However, there can be no assurance that development stage products will be
successfully completed or, if developed, will achieve significant customer
acceptance. If the Company were unable to successfully define, develop and
introduce competitive new products, and enhance its existing products, its
future results of operations would be adversely affected. Development and
manufacturing schedules for technology products are difficult to predict, and
there can be no assurance that the Company will achieve timely initial customer
shipments of new products. The timely availability of these products in volume
and their acceptance by customers are important to the future success of the
Company. Delays, whether due to manufacturing delays, lack of market acceptance,
delays in regulatory approval, or otherwise, could have a material adverse
effect on the company's results of operations. From time to time, the Company or
its competitors may announce new products, capabilities or technologies that
have the potential to replace or shorten life cycles of the Company's existing
products. No assurance can be given that announcements of currently planned or
other new products will not cause customers to defer purchasing existing Company
products. To the extent that new products are not developed in a timely manner,
do not achieve customer acceptance or do not generate higher sales prices and
margins than existing products, the Company's business, financial condition and
results of operations could be materially adversely affected.
DEPENDENCE ON DEVELOPING MARKET; PRODUCT CONCENTRATION. The market for
laser hair removal is new and rapidly evolving. The Company currently derives
substantially all of its revenues from its laser hair removal products and
expects that revenues from these products will continue to account for
substantially all of its revenues in the foreseeable future. Broad market
acceptance of laser hair removal and, in particular, the Company's EpiLaser(R)
and LightSheer(TM) laser hair removal systems is critical to the Company's
future success.
NEXAR. As of March 20, 1998, the Company owned approximately 31% of the
voting capital stock of Nexar. In order to successfully execute its business
plan, the Company is to a certain degree dependent on the success of Nexar and
Nexar's ability to fund its operations and achieve profitability in the near
term. The Company intends to reduce its ownership of Nexar over time as the
Company continues to focus on its core cosmetic laser business. (See Note 2 to
Financial Statements.)
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
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.
LIMITED OPERATING HISTORY. 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
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products industry. 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. (See Item 1. "Description of Business.")
NEW VENTURES. The Company's CTI subsidiary has entered into agreements
with healthcare providers to provide cosmetic 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," and
Item 1. "Description of Business - Cosmetic Laser Services.")
INVESTMENTS IN UNRELATED BUSINESSES. The Company has investments in
marketable securities (consisting principally of Nexar and AMTK common stock).
The Company's basis for financial reporting in these investments totals
approximately $5.1 million. The Company's current market value of these
investments totals approximately $14.0 million. 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, and the
ultimate disposition of these investments could result in a loss to the Company.
(See "Management's Discussion and Analysis of Financial Condition and Results of
Operations," and Notes 2 and 3(b) and (c) to Financial Statements.)
HIGHLY COMPETITIVE INDUSTRIES. 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
cosmetic laser 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 electrolysis and waxing,
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," and Item 1. "Description of
Business - Cosmetic Laser Services.")
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 products sold
by the Company, changes in regulations affecting the cosmetic laser products
industry, changes in the Company's operating expenses, personnel changes and
general economic conditions.
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. 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 Company's common stock.
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 Company's common stock.
GOVERNMENT REGULATION. The Company's laser product business segment is
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
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from obtaining, or could affect the timing of, future regulatory approvals. (See
Item 1. "Description of Business - Impact of Medical Device Regulations.")
All laser medical 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 of 1976, as amended (the "FDA Act"),
pursuant to which the FDA regulates the clinical testing, manufacture, labeling,
sale, distribution and promotion of medical devices. Before a new device can be
introduced into the market, the manufacturer must obtain market clearance
through either the 510(k) premarket notification process or the lengthier
premarket approval ("PMA") application process. Compliance with this process is
expensive and time-consuming. Three of the Company's lasers have received
clearance from the FDA through the 510(k) process for certain dermatological
applications: the Q-switched RD-1200(TM) ruby laser for tattoo removal, the
StarLight(TM) diode laser for hair and leg vein removal and the EpiLaser(R) hair
removal laser. 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 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. 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. The Company's business, financial condition and
operations are, and will continue to be, critically dependent upon timely
receipt of FDA clearance for its current and proposed cosmetic laser products.
Delays or failure to obtain such approval would have a material adverse effect
on the Company.
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 may require
postmarket testing and surveillance programs to monitor a product's effects. 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 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 Quality Systems
Regulations ("QSR"). QSR impose certain procedural and documentation
requirements upon the Company relevant to its manufacturing, testing and quality
control activities. Noncompliance with applicable FDA regulations, including
QSR, can result in, among other things, fines, injunctions, civil penalties,
recall or seizure of products, total or partial suspension of production,
failure of the government to grant premarket clearance or premarket approval for
devices, withdrawal of marketing approvals and criminal prosecution. The FDA
also has the authority to request repair, replacement or refund of the cost of
any medical device manufactured or distributed by the Company. The Company
believes that it is currently in compliance with these regulations.
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. Additional approvals may be required in other countries.
The Company's EpiLaser(R) laser system has received the CE Mark pursuant to the
European Medical Device Directive which allows that laser to be sold in all
countries that recognize the CE Mark, including the countries that comprise the
European Community. The Company has not yet sought international approval for
its diode laser for use in cosmetic surgery and dermatology, because it has not
yet begun to ship this laser overseas.
UNCERTAINTY OF MARKET ACCEPTANCE. The Company continually develops new
products intended for use in the cosmetic laser market. 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 the marketplace will accept
applications or uses for the Company's current and proposed products or that any
of the Company's current or proposed products will be able to compete
effectively. (See Item 1. "Description of Business - Competition.")
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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 research
agreements with recognized research hospitals and clinical laboratories. At
present, the Company's principal research partner is the Wellman Labs at MGH.
The Company provides research funding, laser technology and optics know-how in
return for licensing agreements with respect to specific medical applications
and patents. 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. The Company's
success will be highly dependent upon the results of the research, and there can
be no assurance that such 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. (See Item 1. "Description
of Business - Research and Development" and Note 8 to Financial Statements.)
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. (See Item 1. "Description of Business.")
PATENTS/POSSIBLE PATENT INFRINGEMENTS. 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. (See Item 1. "Description of
Business - Patents and Licenses.")
The laser industry is characterized by frequent litigation regarding
patent and other intellectual property rights. Because patent applications are
maintained in secrecy in the United States until such patents are issued and are
maintained in secrecy for a period of time outside the United States, the
Company can conduct only limited searches to determine whether its technology
infringes any patents or patent applications. Any claims for patent infringement
could be time-consuming, result in costly litigation, diversion of technical and
management personnel, cause shipment delays, require the Company to develop
noninfringing technology or to enter into royalty or licensing agreements.
Although patent and intellectual property disputes in the laser industry have
often been settled through licensing or similar arrangements, costs associated
with such arrangements may be substantial and often require the payment of
ongoing royalties, which could have a negative impact on gross margins. There
can be no assurance that necessary licenses would be available to the Company on
satisfactory terms, or that the Company could redesign its products or processes
to avoid infringement, if necessary. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses
could prevent the Company from manufacturing and selling some of its products.
This could have a material adverse effect on the Company's business, results of
operations and financial condition. Conversely, costly and time consuming
litigation may be necessary to enforce patents issued to the Company, to protect
trade secrets or know-how owned by the Company or to determine the
enforceability, scope and validity of the proprietary rights of others.
The Company is aware of patents relating to laser technologies used in
certain applications. The Company intends to pursue such laser technologies in
the future; hence, if the patents relating to those technologies are valid and
enforceable, they
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may be infringed by the Company. After consulting with outside counsel to the
Company, the Company believes that it is not infringing currently on patents
held by others; however, were the issue ever to be litigated, a court could
reach a different opinion. 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 nonexclusive, 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. One of the Company's competitors has filed suit against the Company
alleging patent infringement, among other things. No assurance can be given that
other 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 would
be costly and could have a material adverse effect on the Company's business,
even if the Company were to prevail. (See Item 3. "Legal Proceedings.")
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.
RISKS ASSOCIATED WITH PENDING LITIGATION. The Company and its
subsidiaries are involved in disputes with third parties. Such disputes have
resulted in litigation with such parties and, although the Company is a
plaintiff in several matters, the Company is subject to claims and counterclaims
for damages and has incurred, and likely will continue to incur, legal expenses
in connection with such matters. There can be no assurance that such litigation
will result in favorable outcomes for the Company. An adverse result in either
the MEHL patent litigation or the action relating to the Swiss Franc Debentures
(both described in detail in Item 3) could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
is unable to determine the total expense or possible loss, if any, that may
ultimately be incurred in the resolution of these proceedings. These matters may
result in diversion of management time and effort from the operations of the
business. (See Item 3. "Legal Proceedings" and Note 12(d) to Financial
Statements.)
NEED FOR ADDITIONAL QUALIFIED PERSONNEL. The Company's ability to
develop, manufacture and market all of its products, and to attain a competitive
position within the laser products industry, 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.
ISSUANCE OF PREFERRED STOCK AND DEBENTURES COULD AFFECT RIGHTS OF
COMMON SHAREHOLDERS. The Company is authorized to issue up to five 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. In July 1996, the Company issued 9,675 units
in a convertible debenture financing. Each unit consisted 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. In February 1997, the Company
redeemed 300 units for an aggregate price of $195,044. In November 1997, the
remaining 9,375 units were converted into 914,028 shares of common stock. (See
Item 3. "Legal Proceedings.") In October 1996, the Company issued $5,000,000 in
4.5% Convertible Subordinated Promissory Notes. As of March 20, 1998, $5,000,000
principal amount was converted into 1,442,073 shares of common stock. In
December 1996 and January 1997, the Company issued a total of $6,000,000 in 5%
Convertible Debentures. As of March 20, 1998, $5,533,356 principal amount was
converted into 3,707,292 shares of common stock. In March 1997, the Company
issued $5,500,000 in 5% Convertible Debentures. As of March 20, 1998, $5,500,000
principal amount was converted into 4,355,735 shares of common stock. In March
1997, the Company issued $500,000 in 6% Convertible Debentures. In September
1997, the Company issued $7,000,000 in 6%, 7% and 8% Convertible Debentures. The
holders were issued 413,109 shares upon issuance in lieu of a discount. In
addition, as of March 20, 1998, $160,000 principal amount was converted into
103,021 shares of common stock. The Company also redeemed $2,000,000 principal
amount for $2,196,667. In July 1996, the Company issued 6,000 shares of Series F
Convertible Preferred Stock at a price of $1,000 per share. In September 1996,
the Company issued 10,000 shares of Series G Convertible Preferred Stock at a
price of $1,000 per share. As of March 20, 1998, 7,316 shares of the Series G
Convertible Preferred Stock were converted into 602,824 shares of common stock,
956,388 shares of common stock of Nexar and $47,731 in cash dividends. In March
1997, the Company issued
15
<PAGE>
6,000 shares of Series H Convertible Preferred Stock at a price of $1,000 per
share. In May 1997, the Company issued 10,000 shares of Series H Convertible
Preferred Stock at a price of $1,000 per share. As of March 20, 1998, 11,100
shares of the Series H Convertible Preferred Stock were converted into 8,289,013
shares of common stock. In addition, 2,950 shares of the Series H Convertible
Preferred Stock were redeemed for $3,588,715. The issuance of any such
additional Preferred Stock or Debentures could affect the rights of the holders
of common shares, and could reduce the market price of the common 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 1. "Description of Business," Item 5. "Market
for Common Equity and Related Stockholder Matters," and Notes 6, 7 and 13 to
Financial Statements.)
ISSUANCE OF RESERVED SHARES; REGISTRATION RIGHTS. As of March 20, 1998,
the Company had 59,553,243 shares of common stock outstanding. The Company has
reserved an additional 28,180,020 shares for issuance as follows: (1) 3,707,655
shares for issuance to key employees, officers, directors, consultants and
advisors pursuant to the Company's Stock Option Plans; (2) 166,674 shares for
issuance to employees, officers and directors pursuant to the Company's 401(k)
Plan; (3) 966,014 shares for issuance pursuant to the Company's Employee Stock
Purchase Plan; (4) 9,998,030 shares for issuance upon exercise of three-, four-,
five- and seven year warrants issued to certain lenders, investors, consultants,
directors and officers (a portion of which are subject to certain antidilutive
adjustments); (5) 530,217 shares for issuance upon conversion of $466,644
principal amount of a 5% Convertible Debentures; (6) 45,455 shares for issuance
upon conversion of $500,000 principal amount of 6% Convertible Debentures; (7)
6,396,979 shares for issuance upon conversion of $4,840,000 principal amount of
a 6%, 7% and 8% Convertible Debenture; (8) 600,000 shares for issuance upon
conversion of the 6,000 shares of Series F Convertible Preferred Stock; (9)
3,611,659 shares for issuance upon conversion of the 2,684 shares of Series G
Convertible Preferred Stock; and (10) 2,157,337 shares for issuance upon
conversion of the 1,950 shares of Series H Convertible Preferred Stock. All of
the foregoing reserved shares are, or the Company intends for them shortly to
be, registered with the Securities and Exchange Commission and therefore freely
salable on Nasdaq or elsewhere.
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. 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.
INTERNATIONAL OPERATIONS. Because the Company has minimal experience in
marketing and distributing its products internationally, it engaged Coherent, a
company with particular experience in international markets, to serve as its
distributor in international markets. (See "- Dependence on New Relationship
with Coherent" and Item 1. "Description of Business - Marketing, Distribution
and Service.") Accordingly, the Company's success in international markets will
be substantially dependent upon the skill and expertise of Coherent in marketing
the Company's products. There can be no assurance that Coherent will be able to
successfully market, sell and deliver the Company's 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. (See Item 1. "Financial Information
About Exports by Domestic Operations.")
16
<PAGE>
NEED FOR CONTINUED PRODUCT DEVELOPMENT. Although the Company received
FDA clearance in March and December 1997, respectively, to commercially market
its EpiLaser(R) and diode laser systems for hair removal, the Company is
continuing its development of both products. The Company is continuing to study
both laser systems to optimize performance and treatment parameters. (See Item
1. "Description of Business.")
DEPENDENCE ON SUPPLIERS. The Company relies on outside suppliers for
substantially all of its manufacturing supplies, parts and components. Several
component parts of the Company's cosmetic laser products are manufactured
exclusively by one supplier. There can be no assurance that the Company will be
able to obtain a sufficient supply of such components at commercially reasonable
prices or at all. A shortage of necessary parts and components or the inability
of the Company to obtain such parts and components would have a material adverse
effect on the Company's business, financial condition and results of operations.
(See Item 1. "Description of Business - Production and Sources and Availability
of Materials.")
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 Company's 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 fewer 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 Registrant's Common Equity and Related
Shareholder Matters" and Note 6 to Financial Statements.)
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 nonvested 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,
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.")
YEAR 2000. The Company is aware of the issues associated with the
programming code in existing computer systems as the millennium (year 2000)
approaches. The "year 2000" problem is pervasive and complex, as virtually every
computer operation will be affected in the same way by the rollover of the two
digit year value to 00. The issue is whether computer systems will properly
recognize date sensitive information when the year changes to 2000. Systems that
do not properly recognize such information could generate erroneous data or
cause a system to fail. The Company is at this time utilizing internal resources
to identify, correct or reprogram, and test the systems for year 2000
compliance. However, there can be no assurance that the systems of other
companies on which the Company's systems rely will also be converted in a timely
manner or that any such failure to convert by another company would not have an
adverse effect on the Company's
17
<PAGE>
systems. Management is in the process of assessing the year 2000 compliance
costs; however, based on information to date (excluding the possible impact of
vendor systems), management does not believe that it will have a material effect
on the Company's earnings. (See Note 12(c) to Financial Statements.)
18
<PAGE>
ITEM 8. FINANCIAL STATEMENTS.
PALOMAR MEDICAL TECHNOLOGIES, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Reports of Independent Public Accountants F-2-3
Consolidated Balance Sheets as of December 31, 1996 and 1997 F-4
Consolidated Statements of Operations for the years ended December 31, 1995,
1996 and 1997 F-5
Consolidated Statements of Stockholders' Equity (deficit) for the years ended
December 31, 1995, 1996 and 1997 F-6
Consolidated Statements of Cash Flows for the years ended December 31, 1995,
1996 and 1997 F-9
Notes to Consolidated Financial Statements F-11
</TABLE>
F-1
<PAGE>
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, 1996 and 1997, and the related consolidated statements of
operations, stockholders' equity (deficit) and cash flows for each of the three
years in the period ended December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits. The summarized
financial data for Nexar Technologies, Inc. as of and for the year ended
December 31, 1997 contained in Note 2 are based on the financial statements of
Nexar Technologies, Inc. which were audited by other auditors. Their report has
been furnished to us and our opinion, insofar as it relates to the data in Note
2, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors,
the financial statements referred to above present fairly, in all material
respects, the financial position of Palomar Medical Technologies, Inc. and
subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997 in conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As discussed in Note
1, the Company has suffered recurring losses from operations and has a working
capital deficiency and a stockholders' deficit that raises substantial doubt
about the Company's ability to continue as a going concern. Management's plans
in regard to these matters are also described in Note 1. The accompanying
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
February 6, 1998 (except for
the matters discussed in Note
13, as to which the date is
March 31, 1998)
F-2
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Nexar Technologies, Inc.
Southborough, Massachusetts
We have audited the accompanying consolidated balance sheet of Nexar
Technologies, Inc. and subsidiary as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity (deficit) and cash
flows for the year then ended. These financial statements (which are not shown
separately herein) are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated financial statements of Nexar Technologies, Inc. and
subsidiary as of December 3 1, 1996 and for the periods ended December 31, 1995
and 1996 (not shown separately herein), were audited by other auditors whose
report dated January 24, 1997 (except with respect to the purchased technology
matter discussed in Note 2 as to which the date is February 28, 1997), expressed
an unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements- An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the 1997 financial statements referred to above present fairly,
in all material respects, the financial position of Nexar Technologies, Inc. and
subsidiary as of December 31, 1997 and the results of their operations and their
cash flows for the year then ended in conformity with generally accepted
accounting principles.
BDO SEIDMAN, LLP
February 13, 1998 (except
for Note 10 which is as
of March 20, 1998)
F-3
<PAGE>
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<S> <C> <C>
December 31, December 31,
1996 1997
---------------- ----------------
ASSETS
Current Assets:
Cash and cash equivalents $12,292,406 $3,003,300
Marketable securities 2,893,792 1,449,326
Accounts receivable, net of allowance for doubtful accounts of
approximately $1,129,000 and $746,000, respectively 2,171,086 2,248,680
Inventories 5,205,954 4,711,474
Loans to former officers 948,198 478,343
Notes receivable from related parties for sale of Dynaco subsidiary --- 855,379
Subscription receivable 3,500,000 ---
Other current assets 2,983,209 820,219
---------------- ----------------
Total current assets 29,994,645 13,566,721
---------------- ----------------
Net Assets of Discontinued Operations (Note 2) 22,971,380 5,825,602
---------------- ----------------
Property and Equipment, at Cost, Net 3,827,990 6,455,586
---------------- ----------------
Other Assets:
Cost in excess of net assets acquired, net of accumulated amortization of
approximately $725,000 and $1,280,000, respectively 2,856,616 2,302,348
Deferred financing costs 1,943,420 591,609
Other noncurrent assets 5,938,826 225,706
---------------- ----------------
Total other assets 10,738,862 3,119,663
---------------- ----------------
$67,532,877 $28,967,572
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current Liabilities:
Current portion of long-term debt $497,377 $1,640,465
Accounts payable 3,318,460 4,150,982
Accrued liabilities 10,975,309 16,914,249
---------------- ----------------
Total current liabilities 14,791,146 22,705,696
---------------- ----------------
Long-Term Debt, Net of Current Portion 14,665,140 12,445,563
---------------- ----------------
Commitments and Contingencies (Notes 2, 6 and 10)
Stockholders' Equity (Deficit):
Preferred stock, $.01 par value-
Authorized - 5,000,000 shares
Issued and outstanding -
18,151 shares and 16,397 shares
at December 31, 1996 and December 31, 1997, respectively
(Liquidation preference of $17,714,474 as of December 31, 1997) 182 164
Common stock, $.01 par value-
Authorized - 100,000,000 shares
Issued - 30,596,812 shares and 45,792,585 shares
at December 31, 1996 and December 31, 1997, respectively 305,968 457,926
Additional paid-in capital 104,900,551 147,356,579
Accumulated deficit (64,971,200) (152,359,497)
Unrealized loss on marketable securities (342,500) ---
Subscriptions receivable from related party (604,653) ---
Less: Treasury stock - (200,000 shares and 345,000 shares at cost, respectively) (1,211,757) (1,638,859)
---------------- ----------------
Total stockholders' equity (deficit) 38,076,591 (6,183,687)
---------------- ----------------
$67,532,877 $28,967,572
================ ================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F-4
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<S> <C> <C> <C>
Years Ended December 31,
1995 1996 1997
---------------- -------------- --------------
Revenues $5,610,280 $17,606,871 $20,994,546
Cost of Revenues 3,464,472 14,169,471 20,055,963
---------------- -------------- --------------
Gross profit 2,145,808 3,437,400 938,583
---------------- -------------- --------------
Operating Expenses
Research and development 3,964,920 6,297,477 11,990,332
Sales and marketing 2,768,541 5,076,941 6,959,750
General and administrative 2,141,798 9,752,922 15,332,241
Business development 1,409,303 2,879,603 2,060,852
Restructuring and asset write-off (Note 4) -- 1,660,808 3,325,000
Settlement and litigation costs 700,000 880,000 3,199,000
---------------- -------------- --------------
Total operating expenses 10,984,562 26,547,751 42,867,175
---------------- -------------- --------------
Loss from operations (8,838,754) (23,110,351) (41,928,592)
Interest Expense (766,079) (271,619) (6,993,898)
Interest Income 912,019 1,355,488 456,945
Net Gain (Loss) on Trading Securities 201,067 2,033,371 (52,272)
Asset Write-off (Note 4) -- (1,397,000) (9,658,000)
Other Income (Expense) 102,305 591,853 (193,262)
---------------- -------------- --------------
Net Loss from Continuing Operations (8,389,442) (20,798,258) (58,369,079)
---------------- -------------- --------------
Loss from Discontinued Operations (Note 2):
Loss from operations (4,231,326) (20,895,534) (29,508,755)
Gain on dispositions, net -- 3,830,000 2,073,943
---------------- -------------- --------------
Net Loss from Discontinued Operations (4,231,326) (17,065,534) (27,434,812)
---------------- -------------- --------------
Net Loss $(12,620,768) $(37,863,792) $(85,803,891)
================ ============== ==============
Basic and Diluted Net Loss Per Common Share:
Continuing operations $(0.60) $(0.84) $(1.79)
Discontinued operations (0.30) (0.65) (0.78)
---------------- -------------- --------------
Total Loss Per Common Share $(0.90) $(1.49) $(2.57)
================ ============== ==============
Weighted Average Number of
Common Shares Outstanding 14,164,901 26,166,538 35,105,272
================ ============== ==============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F-5
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<S> <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 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 -- -- -- -- -- --
payable -- -- 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
technology -- -- -- -- -- --
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>
<S> <C> <C> <C> <C> <C>
Unrealized Total
Additional Loss on Stockholders'
Paid-in Accumulated Marketable Subscriptions Equity
Capital Deficit Securities Receivable (Deficit)
------------------------------------------------------------------
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.
F-6
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(Continued)
<TABLE>
<S> <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>
<S> <C> <C> <C> <C> <C>
Total
Additional Unrealized Subscriptions Stockholders'
Paid-in Accumulated Loss on Receivable Equity
Capital Deficit Marketable Securities (Deficit)
---------------------------------------------------------------------
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.
F-7
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
(Continued)
<TABLE>
<S> <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, 1996 18,151 182 30,596,812 $305,968 (200,000) (1,211,757)
Sale of common stock pursuant to warrants,
options and Employee Stock Purchase Plan -- -- 815,101 8,151 -- --
Reduction in subscriptions receivable -- -- -- -- -- --
Sale of preferred stock, net of issuance cost
of approximately $1,000,000 16,000 160 -- -- -- --
Issuance of common stock for 1996 employer 401(k)
matching contribution -- -- 87,441 874 -- --
Conversion and redemption of preferred stock (17,754) (178) 6,139,841 61,399 -- --
Conversion of convertible debentures and issuance
of common stock to an investor -- -- 7,464,961 74,650 -- --
Issuance of common stock for investment banking,
merger and acquisition and consulting services -- -- 20,000 200 -- --
Value ascribed to the discount feature of
convertible debentures issued -- -- 413,109 4,131 -- --
Unrealized gain on marketable securities -- -- -- -- -- --
Preferred stock dividends -- -- -- -- -- --
Guaranteed value of common stock associated
with Dermascan Acquisition -- -- -- -- -- --
Issuance of common stock for technology -- -- 255,320 2,553 -- --
Purchase of stock for treasury -- -- -- -- (145,000) (427,102)
Gain related to the issuance of common
stock by Nexar Technologies, Inc. -- -- -- -- -- --
Value ascribed to warrant to purchase
common stock issued to Coherent, Inc. -- -- -- -- -- --
Net loss -- -- -- -- -- --
----------------------------------------------------------------------------
Balance, December 31, 1997 16,397 $164 45,792,585 $457,926 (345,000) (1,638,859)
============================================================================
</TABLE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Unrealized Total
Additional (Loss) Gain Stockholders'
Paid-in Accumulated on Marketable Subscriptions Equity
Capital Deficit Securities Receivable (Deficit)
----------------------------------------------------------------------------
Balance, December 31, 1996 104,900,551 $(64,971,200) (342,500) $(604,653) $38,076,591
Sale of common stock pursuant to warrants,
options and Employee Stock Purchase Plan 1,606,083 -- -- -- 1,614,234
Reduction in subscriptions receivable -- -- -- 604,653 604,653
Sale of preferred stock, net of issuance
cost of approximately $1,000,000 14,999,840 -- -- -- 15,000,000
Issuance of common stock for 1996 employer
401(k) matching contribution 317,280 -- -- -- 318,154
Conversion and redemption of preferred stock (3,926,317) -- -- -- (3,865,096)
Conversion of convertible debentures and
issuance of common stock to an investor 16,935,713 -- -- -- 17,010,363
Issuance of common stock for investment
banking, merger and acquisition
and consulting services 52,925 -- -- -- 53,125
Value ascribed to the discount feature of
convertible debentures issued 3,750,812 -- -- -- 3,754,943
Unrealized gain on marketable securities -- -- 342,500 -- 342,500
Preferred stock dividends -- (1,584,406) -- -- (1,584,406)
Guaranteed value of common stock associated
with Dermascan Acquisition (216,562) -- -- -- (216,562)
Issuance of common stock for technology 1,146,388 -- -- -- 1,148,941
Purchase of stock for treasury -- -- -- -- (427,102)
Gain related to the issuance of common stock
by Nexar Technologies, Inc. 7,409,866 -- -- -- 7,409,866
Value ascribed to warrant to purchase common
stock issued to Coherent, Inc. 380,000 -- -- -- 380,000
Net loss -- (85,803,891) -- -- (85,803,891)
-----------------------------------------------------------------------------
Balance, December 31, 1997 147,356,579 $(152,359,497) $-- $-- $(6,183,687)
=============================================================================
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F-8
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C> <C>
Years Ended December 31,
1995 1996 1997
-------------- ------------- ------------
Cash Flows from Operating Activities
Net loss $(12,620,768) $(37,863,792) $(85,803,891)
Less: Net Loss from Discontinued Operations (4,231,326) (17,065,534) (27,434,812)
------------- ------------- ------------
Net Loss from Continuing Operations (8,389,442) (20,798,258) (58,369,079)
------------- ------------- ------------
Adjustments to reconcile net loss from continuing
operations to net cash
used in operating activities-
Depreciation and amortization 1,006,055 2,343,013 2,246,412
Restructuring and asset write-off costs -- 3,057,808 12,983,000
Write-off of in-process research and development -- 57,212 --
Write-off of intangible assets -- 631,702 --
Loss on sale of wholly owned subsidiary -- -- 165,845
Write-off of deferred financing costs associated with
redemption of convertible debentures -- 201,500 27,554
Valuation allowances for notes and investments -- -- 1,035,912
Accrued interest receivable on note
and subscription receivable -- (568,917) --
Foreign currency exchange gain -- (446,596) (651,970)
Noncash interest expense related to debt 220,280 163,680 5,473,077
Noncash compensation related to common stock
and warrants 95,370 836,982 205,238
Realized gain on marketable securities -- (835,197) (577,969)
Unrealized (gain) loss on marketable securities (133,568) (1,198,174) 669,293
Changes in assets and liabilities, net of effects
from business combinations
Purchases of marketable trading securities (615,842) (10,355,055) (152,938)
Sale of marketable trading securities and
interest received on marketable trading
securities 50,000 10,244,044 2,234,436
Accounts receivable (734,080) (82,025) (1,809,371)
Inventories (614,364) (4,661,443) (3,390,396)
Other current assets and loans to officers (407,575) (1,514,858) (1,005,781)
Accounts payable 1,046,192 1,243,161 1,378,637
Accrued liabilites 2,141,429 4,762,781 6,494,790
------------- ------------- -------------
Net cash used in operating activities (6,335,545) (16,918,640) (33,043,310)
------------- ------------- -------------
Cash Flows from Investing Activities
Cash acquired from purchase of Spectrum Medical 75,087 -- --
Technologies, Inc.
Purchases of property and equipment (649,642) (3,180,112) (5,777,446)
Increase in other assets (828,569) (1,176,527) (95,830)
Loans to related parties (3,861,375) (7,338,625) (1,250,000)
Loans to nonrelated parties -- (2,236,531) --
Payments received on loans to related parties -- 9,322,284 941,288
Guaranteed value associated with --rmascan Acquisition -- -- (216,562)
Investment in nonmarketable securities (500,000) (2,077,054) (1,057,631)
Increase in organizational costs (500,000) -- --
------------- ------------- -------------
Net cash used in investing activities (6,264,499) (6,686,565) (7,456,181)
------------- ------------- -------------
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F-9
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<S> <C> <C> <C>
Years Ended December 31,
1995 1996 1997
Cash Flows from Financing Activities ---------- ---------- ----------
Proceeds from issuance of convertible debentures 4,150,000 14,169,441 16,715,169
Proceeds from notes payable 1,280,000 -- 3,500,000
Deferred financing costs incurred related to
convertible debentures (182,000) (1,365,217) --
Redemption of convertible debentures (1,048,967) (930,000) (196,000)
Payments of notes payable and capital lease
obligations (1,291,350) (260,224) (4,856,479)
Proceeds from issuance of common stock 9,631,148 13,715,287 1,462,121
Issuance of preferred stock 19,385,963 30,823,147 15,000,000
Purchase of treasury stock (1,211,757) -- (427,102)
Payment of contingent note payable -- (500,000) --
Redemption of preferred stock, including accrued
dividends of $71,223 -- (3,194,375) --
Payments received on subscriptions receivable -- 2,009,592 --
Deferred costs -- (932,661) --
------------ ------------ ------------
Net cash provided by financing
activities 30,713,037 53,534,990 31,197,709
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 18,112,993 29,929,785 (9,301,782)
Net cash (used in) provided by discontinued operations (8,677,687) (30,073,633) 12,676
Cash and cash equivalents, beginning of year 3,000,948 12,436,254 12,292,406
------------ ------------ ------------
Cash and cash equivalents, end of year $12,436,254 $12,292,406 $3,003,300
============ ============ ============
Supplemental Disclosure of Cash Flow Information
Cash paid for interest $125,702 $280,659 $534,037
=========== =========== ============
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 $17,010,363
=========== =========== ============
Subscriptions received in connection with warrant
exercises
notes payable $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 $414,904
=========== =========== ============
Exchange of preferred stock for investment in a
discontinued operation $-- $-- ($4,280,000)
=========== =========== ============
Issuance of common stock for purchase of technology
related to a discontinued operation $-- $-- $1,148,941
=========== =========== ============
Investment banking and consulting fees for services
related to the issuance of common stock and
convertible debentures $120,000 $709,224 $53,125
=========== =========== ============
Issuance of common stock for 1995 and 1996 employer 401(k)
matching contribution $-- $160,598 $318,154
=========== =========== ============
Issuance of common stock for minority interest
in Star Medical subsidiary $-- $1,749,723 $--
=========== =========== ============
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) $-- $--
============ =========== ============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
F-10
<PAGE>
PALOMAR MEDICAL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND OPERATIONS
Palomar Medical Technologies, Inc. and subsidiaries ("Palomar" or the
"Company") are engaged in the commercial sale and development of cosmetic and
medical laser systems and services. During the year ended December 31, 1997, the
Company formed and began execution of a plan to dispose of its electronics
segment (see Note 2).
Some of the Company's medical laser products are in various stages of
development, and as such, the 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 the Company's 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 potential sources in order to fund its operations over the next
twelve months. The Company has financed current operations, expansion of its
core business and outside short-term financial investments primarily through the
private sale of debt and equity securities of the Company. The Company raised a
total of approximately $30,713,000, $53,535,000 and $31,198,000 in such
financings during the years ended December 31, 1995, 1996 and 1997,
respectively. The Company believes that it will require additional financing
during the next twelve-month period to continue to fund operations and growth.
The Company may raise additional funds through private sales of the Company's
debt or equity securities and sales of its investment in Nexar Technologies,
Inc. ("Nexar") (see below). Sales of securities to private investors are
generally 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.
(2) DISCONTINUED OPERATIONS
During the fourth quarter of 1997, the Company's Board of Directors
approved a plan to dispose of the electronics business segment. The electronics
segment consists of the manufacture and sale of personal computers, high-density
flexible electronics circuitry and memory modules.
Included in the electronics business segment is Nexar. Nexar is an
early-stage company that manufactures, markets and sells personal computers with
a unique circuit board that enables end users to upgrade and replace the
microprocessor, memory and hard drive components. On April 14, 1997, Nexar
completed an initial public offering of 2,500,000 shares at $9.00 per share, for
net proceeds of approximately $19,593,000. The Company recorded an increase in
stockholders' equity of $7,409,866, in accordance with Staff Accounting Bulletin
("SAB") No. 51 as a result of Nexar's initial public offering. The Company's
accounting policy for gains arising under SAB No. 51 is to recognize these gains
in its statement of operations to the extent that such gains are realizable at
the date of each transaction.
As of the effective date of Nexar's initial public offering, the Company
beneficially owned 6,100,000 shares of Nexar's common stock and 45,684 shares of
Nexar's convertible preferred stock. In April 1997, the Company purchased
300,000 shares of Nexar's newly issued publicly registered common stock for
approximately $2,777,000 from Nexar's underwriter in a private placement
transaction. The convertible preferred stock is convertible into 406,080 shares
of Nexar's common stock. Pursuant to an agreement between the Company and Nexar,
1,200,000 common shares (the Contingent Shares) of the total 6,506,080 common
and common equivalent shares of Nexar owned by the Company were placed in escrow
and are subject to a mandatory repurchase, in whole or part, by Nexar at $0.01
per share (or $12,000) after the 48 month anniversary of the initial public
offering of Nexar's common stock unless these shares are released from escrow.
The Contingent Shares are subject to release to the Company in installments of
400,000 shares each upon the achievement of any
F-11
<PAGE>
three of the four milestones as specified in the agreement between the Company
and Nexar. The milestones are based on Nexar achieving certain revenue and net
income levels as defined in the agreement. On December 10, 1997, the Company
sold these contingent shares for $5,000 to an investor. However, if the investor
sells the escrow shares for a price in excess of $240,000, the excess will be
paid to Palomar.
During the fourth quarter of 1997, the Company reduced its ownership in
Nexar through the sale of common stock to private investors. At December 31,
1997, the Company beneficially owned 3,746,343 shares of Nexar's common stock,
representing approximately a 36% ownership. Subsequent to year-end, the Company
further reduced its ownership through the sale of 500,000 shares to a private
investor for $2,000,000; 400,000 of these shares will be held by a custodian and
released for sale by the investor over the next two years. The Company has
guaranteed the investor a minimum selling price of $5.00 a share. The Company
has deferred the gain on the sale of Nexar stock to the investor and will
recognize gains related to these shares as the investor sells them. The Company
plans to liquidate its remaining position in Nexar within the next year. The
Company has accounted for its investment in Nexar as a Discontinued Operation
using the equity method. During the years ended December 31, 1996 and 1997, the
Company has recognized gains on the disposition of Nexar of $3,830,000 and
$6,221,689, respectively. These amounts are included in "Gain on Dispositions"
in the Consolidated Statements of Operations.
The other entities included in the electronics business segment are
Dynaco Corp. ("Dynaco") and Dynaco's wholly owned subsidiaries Comtel
Electronics, Inc. ("Comtel") and Dynamem, Inc. ("Dynamem"). On December 9, 1997,
the Company entered into a two-phase stock purchase agreement with Biometric
Technologies Corporation ("BTC"). BTC was formed jointly by Dynaco's President
and its Chairman of the Board. The first phase was consummated on December 9,
1997 and consisted of the sale of all of the issued and outstanding common stock
of Comtel and Dynamem in exchange for $3,654,000 payable in two installments.
The first installment is an $850,000 promissory note due February 15, 1998
bearing interest at a rate of prime plus two percent and secured by a Pledge and
Security Agreement. The second installment is a $2.8 million promissory note due
in forty-eight monthly installments, beginning February 1, 1999. The note bears
interest at the prime rate. This promissory note was fully reserved by the
Company during 1997, as its ultimate collectability is uncertain.
As part of phase I, the Company entered into a Loan and Subscription
Agreement with a creditor of Comtel for $3,233,000. This promissory note
represents the settlement of amounts owed the creditor by Comtel and guaranteed
by Palomar. Principal and interest payments will be made over twenty-four months
and interest will accrue at the bank's prime rate plus 2.25%. This promissory
note has been collateralized by 3,250,000 shares of the Company's common stock.
The Company also guarantees $2,500,000 of Comtel's borrowings from this creditor
until October 31, 1998. The stockholders of BTC have personally guaranteed to
the Company payment for any amounts borrowed under this line of credit in excess
of approximately $1,500,000 in the event that the Company is obligated to honor
this guarantee. The Company also restructured all assets and investments related
to a significant customer of Comtel into a $4,000,000 note receivable. This
receivable was fully reserved by the Company during 1997, as its ultimate
collectability is uncertain.
In phase II, which shall occur upon the earlier of BTC's initial public
offering of stock or June 30, 1998, BTC will purchase all of the issued and
outstanding stock of Dynaco. The phase II purchase price is $5,346,000, of which
$2,673,000 will be paid in cash and $2,673,000 will be paid in BTC common stock
of equal value. Alternatively, the Company may elect to have the entire phase II
purchase paid in cash at a value of $3,500,000. If phase II is not completed by
June 30, 1998, the Company will exercise alternative options for disposing of
and /or liquidating Dynaco. BTC also has the option to sell Dynaco to a third
party in which case any proceeds greater than $3,500,000 will be split evenly
between BTC and Palomar. The Company recognized a loss of approximately
$4,148,000 related to the phase I and phase II dispositions. The Company has
estimated Dynaco's 1998 operating loss through June 30, 1998 to be approximately
$850,000. These charges have been netted in "Gain on Disposition" in the
accompanying Consolidated Statement of Operations. The Company guarantees
$3,000,000 of amounts borrowed by Dynaco to a creditor. This guarantee expires
in May 1999.
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 dispositions of the
F-12
<PAGE>
aforementioned subsidiaries that comprise the electronics segment. Accordingly,
the assets and liabilities, revenues and expenses, and cash flows of the
electronics segment have been excluded from the respective captions in the
Consolidated Balance Sheets, Consolidated Statements of Operations and
Consolidated Statements of Cash Flows. The net assets of these entities have
been reported as "Net Assets of Discontinued Operations" in the accompanying
Consolidated Balance Sheets; the net operating losses of these entities have
been reported as "Net Loss from Discontinued Operations" in the accompanying
Consolidated Statements of Operations; the net cash flows of these entities have
been reported as "Net Cash (Used in) Provided by Discontinued Operations" in the
accompanying Consolidated Statements of Cash Flows.
Summarized financial information for the discontinued operations were
as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1996 1997
-------------- --------------
Current Assets $36,153,021 $5,683,694
Total Assets 46,195,699 11,506,145
Current Liabilities 21,524,767 5,375,353
Total Liabilities 23,224,319 5,680,543
-------------- --------------
Net Assets of Discontinued Operations $22,971,380 $5,825,602
============== ==============
Year Ended December 31,
1995 1996 1997
--------------- ---------------- ----------------
Revenues $16,296,224 $52,491,572 $57,663,080
Net Loss from Discontinued Operations ($4,231,326) ($17,065,534) ($27,434,812)
</TABLE>
The assets and liabilities of the discontinued operations as of
December 31, 1997 represent the financial position of Dynaco and the Company's
liability associated with the sale of Nexar's common stock to GFL. The assets
and liabilities of the discontinued operations as of December 31, 1996 represent
the financial position of Dynaco, Comtel and Dynamem, and the Company's
liability associated with the sale of Nexar's common stock to GFL.. The loss
from operations for all of the discontinued operations from the measurement date
October 1, 1997 through the date of disposition for Comtel and Dynamem or
December 31, 1997 for Dynaco total approximately $3,405,000.
The following is the summarized financial information for Nexar:
<TABLE>
<S> <C> <C> <C>
December 31,
1996 1997
------------------------- ------------------------
Current Assets $16,966,851 $17,810,564
Non-Current Assets 2,622,270 2,098,495
Current Liabilities 6,542,296 7,886,594
Non-Current Liabilities 22,817,998 883,613
</TABLE>
<TABLE>
<S> <C> <C> <C>
Period Ended December 31,
1995 1996 1997
----------------- ---------------- -----------------
Net Revenues $619,629 $18,695,364 $33,608,063
Gross Profit 45,018 2,302,881 740,151
Net Loss (2,261,434) (7,510,139) (13,346,380)
</TABLE>
F-13
<PAGE>
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the
application of certain accounting policies described below and elsewhere in the
Notes to Consolidated Financial Statements.
(a) PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements reflect the
consolidated financial position, results of operations and cash flows of the
Company and all wholly owned and majority-owned subsidiaries, including Star
Medical Technologies, Inc., a wholly-owned subsidiary. Nexar, a discontinued
entity, has been accounted for in consolidation under the equity method in
accordance with APB No. 30 as described in Note 2. 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, 1997, the Company has investments in marketable securities totaling
approximately $5,054,000, including amounts totaling $3,604,880 in net assets of
discontinued operations. Included in the amount of $3,604,880 is the Company's
financial reporting basis for 3,746,343 shares of Nexar common stock that the
Company beneficially owns. 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, 1997.
(c) INVESTMENTS
The Company accounts for marketable securities in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, ACCOUNTING FOR
CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES. Under SFAS No. 115,
securities that the Company has the positive intent and ability to hold to
maturity are reported at amortized cost and classified as held-to-maturity.
There were no held-to-maturity securities as of December 31, 1996 and 1997.
Securities purchased to be held for indefinite periods of time and not intended
at the time of purchase to be held until maturity are reported at fair market
value and classified as available-for-sale securities. Unrealized gains and
losses related to available-for-sale securities are included as a separate
component of stockholders' equity. Securities that are bought and held
principally for the purpose of selling them in the near term are reported at
fair market value and classified as trading securities. Realized and unrealized
gains and losses related to trading securities are included in the Consolidated
Statements of Operations. The Company's available-for-sale securities held at
December 31, 1996 consist of the following:
F-14
<PAGE>
<TABLE>
<S> <C> <C>
December 31, 1996
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
Available-for-Sale (long-term):
Equity investments in publicly
traded companies 1,000,000 --- 342,500 657,500
============= ============= ============ ============
</TABLE>
(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, 1996 and 1997, inventories
consist of the following:
<TABLE>
<S> <C> <C> <C>
December 31,
1996 1997
---------------- ----------------
Raw materials $4,076,381 $2,928,350
Work-in-process and finished goods 1,129,573 1,783,124
---------------- ----------------
$5,205,954 $4,711,474
================ ================
</TABLE>
(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:
<TABLE>
<S> <C> <C>
Estimated
Asset Classification Useful Life
------------------------------------ ----------------------
Machinery and equipment 5-8 Years
Furniture and fixtures 5 Years
Leasehold improvements Term of Lease
</TABLE>
At December 31, 1996 and 1997, property and equipment consist of the
following:
<TABLE>
<S> <C> <C> <C>
December 31,
1996 1997
---------------- -----------------
Machinery and equipment $3,177,828 $6,328,442
Furniture and fixtures 1,047,942 1,018,931
Leasehold improvements 407,334 480,453
---------------- -----------------
4,633,104 7,827,826
Less: Accumulated depreciation
and amortization 805,114 1,372,240
---------------- -----------------
$3,827,990 $6,455,586
================ =================
</TABLE>
F-15
<PAGE>
Included in machinery and equipment as of December 31, 1996 and 1997 is
approximately $884,000 and $3,470,000, respectively, of equipment manufactured
by the Company and used in its service business.
(f) COST IN EXCESS OF NET ASSETS ACQUIRED
The costs in excess of net assets for acquired businesses are being
amortized on a straight-line basis over 5 to 7 years. Amortization expense for
the years ended December 31, 1995, 1996 and 1997 amounted to approximately
$189,000, $536,000 and $554,000, respectively, and is included in general and
administrative expenses in the Consolidated Statements of Operations.
The Company accounts for long-lived assets in accordance with SFAS No.
121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND FOR LONG-LIVED
ASSETS TO BE DISPOSED OF. Under SFAS No. 121, the Company is required to assess
the valuation of its long-lived assets, including cost in excess of net assets
acquired, based on the estimated future cash flows to be generated by such
assets (see Note 4). The Company has assessed the realizability of its
long-lived assets as of December 31, 1997 and believes them to be realizable.
(g) DEFERRED FINANCING COSTS
During the years ended December 31, 1996 and 1997, the Company incurred
financing costs related to several issuances of convertible debentures. Deferred
financing costs are amortized by a charge to interest expense over the period
that the debt is outstanding (see Note 6).
(h) REVENUE RECOGNITION
The Company recognizes product revenue upon shipment. There is no right
of return on any sales of the Company's products. Provisions are made at the
time of revenue recognition for any applicable warranty costs expected to be
incurred. Revenues from services, which have not been significant to date, are
recognized as the services are provided. International sales for the years ended
December 31, 1995, 1996 and 1997 were approximately 44%, 22% and 24%,
respectively, of total revenue.
(i) SIGNIFICANT CUSTOMERS
For the year ended December 31, 1997, one customer accounted for 11% of
revenues and 51% of accounts receivable. This customer is the Company's
worldwide distributor of laser systems (see Note 12(e)).
(j) RESEARCH AND DEVELOPMENT EXPENSES
The Company charges research and development expenses to operations as
incurred.
(k) NET LOSS PER COMMON SHARE
In March 1997, the 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 year. Diluted net
loss per share is the same as basic earnings per share because the Company's
potentially dilutive securities, primarily stock options, warrants, redeemable
preferred stock and convertible debentures are antidilutive. The calculation of
the Company's net loss per common share from continuing operations for the years
ended December 31, 1995, 1996 and 1997 are as follows:
F-16
<PAGE>
<TABLE>
<S><C> <C> <C> <C>
December 31,
1995 1996 1997
--------------- --------------- ----------------
Net loss from continuing operations $(8,389,442) $(20,798,258) $(58,369,079)
Preferred stock dividends (124,610) (1,242,751) (1,584,406)
Amortization of value ascribed to preferred
stock conversion discount --- --- (2,823,529)
--------------- --------------- ----------------
Adjusted net loss from continuing operations $(8,514,052) $(22,041,009) $(62,777,014)
=============== =============== ================
Basic and diluted net loss per common share
from continuing operations $(0.60) $(0.84) $(1.79)
=============== =============== ================
Weighted average number of
common shares outstanding 14,164,901 26,166,538 35,105,272
=============== =============== ================
</TABLE>
Net loss from discontinued operations per common share is computed by
dividing the net loss from discontinued operations by the weighted average
number of common shares outstanding for the period.
In 1995, 1996 and 1997, 11,275,200, 17,636,423 and 29,271,031 weighted
average common equivalent shares, respectively, were not included in the diluted
weighted average shares outstanding as they were antidilutive.
(l) CONCENTRATION OF CREDIT RISK
SFAS No. 105, DISCLOSURE OF INFORMATION ABOUT FINANCIAL INSTRUMENTS
WITH OFF-BALANCE-SHEET RISK AND FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF
CREDIT RISK, requires disclosure of any significant off-balance-sheet and credit
risk concentrations. Financial instruments that subject the company to credit
risk consist primarily of cash and trade accounts receivable. The Company places
its cash in highly rated financial institutions. The Company has no significant
off-balance-sheet concentration of credit risk such as foreign exchange
contracts, options contracts or other foreign hedging arrangements. To reduce
its accounts receivable risk, the Company relies on its worldwide distributor to
assess the financial strength of its end customers and, as a consequence,
believes that its accounts receivable credit risk exposure is limited. The
Company maintains an allowance for potential credit losses. The Company's
accounts receivable credit risk is not concentrated within any one geographic
area.
(m) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS,
requires disclosure of an estimate of the fair value of certain financial
instruments. At December 31, 1996 and 1997, financial instruments consisted of
principally convertible debentures and preferred stock financings. The fair
value of financial instruments pursuant to SFAS No. 107 approximated their
carrying values at December 31, 1996 and 1997. Fair values have been determined
through information obtained from market sources and management estimates.
(n) RECLASSIFICATIONS
Certain reclassifications have been made to the 1995 and 1996
consolidated financial statements to conform with the current year's
presentation.
F-17
<PAGE>
(o) RECENTLY ISSUED ACCOUNTING STANDARDS
In February 1997, the FASB issued SFAS No. 129, DISCLOSURE OF
INFORMATION ABOUT CAPITAL STRUCTURE. In June 1997, the FASB issued SFAS No. 130,
REPORTING COMPREHENSIVE INCOME, and SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF
AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 129, 130 and 131 are effective
for fiscal years beginning after December 15, 1997. The Company believes that
the adoption of these new accounting standards will not have a material impact
on the Company's financial statements.
(4) ASSET WRITE-OFF AND RESTRUCTURING
The Company, in accordance with applicable accounting principles,
determined during the third quarter of 1997 that the carrying values of certain
investments and notes receivable for its continuing operations will not be
realizable due to the Company's change in strategy to divest of its investments
in non-core businesses. These investments did not qualify as a discontinued
operation in accordance with APB No. 30. The Company has fully reserved for all
such investments and notes receivable resulting in a charge of approximately
$10,283,000 to continuing operations, which breaks down approximately as
follows:
DESCRIPTION CARRYING AMOUNT
Notes Receivable $2,250,000
Investments in Non-Core Businesses 8,033,000
----------------
$10,283,000
================
The write-offs of the notes receivable and investments related to a
number of strategic investments and loans in non-medical businesses that the
Company made during 1996 and 1997. The notes receivable were principally
mezzanine investments whereby the Company loaned money and, in some cases,
received equity in early stage companies as a condition to making these loans.
The Company also made other equity investments in companies that were strategic
to the Company's business or had the potential to yield a higher than average
financial return. By September 30, 1997, based on a number of factors, including
the Company's change in strategy, the book value of these companies and their
poor financial performance to date, it became apparent to management that there
was significant uncertainty as to the ultimate realizability of these
investments and notes receivable. Accordingly, the Company wrote-off these
investments and notes receivable as of September 30, 1997.
In the third quarter of 1997, the Company recognized a restructuring
charge of $2,700,000 based on the decision to discontinue certain medical
product and service business units and consolidate others. The majority of these
amounts relate to severance benefits for significant reductions in staffing for
all areas of the Company including the elimination of essentially all of the
sales and marketing function as a result of the Coherent transaction (Note
12(e)). Management's plan specifically identified 33 employees who were targeted
for termination almost exclusively in selling, general and administrative
functions. Actual employees terminated as a result of this restructuring totaled
45.
All expenses accounted for as restructuring charges were in accordance
with the criteria set forth in EMERGING TASK FORCE ISSUE 94-3, LIABILITY
RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS AND OTHER COSTS TO EXIT AN
ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A RESTRUCTURING), and are
exclusive of the charges related to discontinued operations, as disclosed in
Note 2. During the three months ended December 31, 1997, the Company paid out
approximately $718,000 of severance resulting in a restructuring liability
balance of approximately $1,982,000 at December 31, 1997. This restructuring
liability will be paid in 1998. As part of this restructuring, the Company
disposed of the following medical businesses:
F-18
<PAGE>
(a) TISSUE TECHNOLOGIES, INC.
On December 16, 1997, the Company sold assets and certain liabilities
of Tissue Technologies, Inc. ("Tissue Technologies"), a manufacturer of a
dermatological laser product for the treatment of wrinkles to a newly formed
medical laser manufacturer. This medical laser manufacturer was formed by former
executives of Tissue Technologies Inc. In exchange, the Company received a
$500,000 note receivable due in monthly installments over the next year,
royalties ranging from 2% to 5% on product revenue over the next ten years, a
15% equity position in the newly formed company and a warrant to purchase 10% of
the common stock of the newly formed company at $.50 per share. This transaction
did not have a material effect on the Company's operations for the year ended
December 31, 1997.
(b) DERMASCAN, INC.
Subsequent to year end, the Company sold Dermascan, an electrology
marketing subsidiary, back to a Dermascan shareholder for $167,000. This amount
was offset against amounts owed to the Dermascan shareholder under an agreement
terminated in connection with the Company's sale of Dermascan. This transaction
did not have a material effect on the Company's operations for the year ended
December 31, 1997.
(c) PALOMAR TECHNOLOGIES, LTD.
On January 1, 1998 the Company sold substantially all of the business
assets and liabilities of Palomar Technologies, Ltd., a foreign manufacturer, to
a publicly traded company. The Company received cash of approximately $200,000
and was relieved of obligations related to the building lease and all employment
agreements. This transaction did not have a material effect on the Company's
operations for the year ended December 31, 1997.
(5) INCOME TAXES
The Company provides for income taxes under the liability method in
accordance with the provisions of SFAS No. 109, ACCOUNTING FOR INCOME TAXES. At
December 31, 1997, the Company had available, subject to review and possible
adjustment by the Internal Revenue Service, a federal net operating loss
carryforward of approximately $85,000,000 to be used to offset future taxable
income, if any. This net operating loss carryforward will begin to expire in
2003. The Internal Revenue Code contains provisions that limit the net operating
loss carryforwards due to changes in ownership, as defined by the Internal
Revenue Code. The Company believes that its net operating loss carryforwards
will be limited due to its reorganization in 1991 and subsequent stock
offerings. The Company has not recorded a deferred tax asset for the net
operating losses, due to uncertainty relating to the Company's ability to
utilize such carryovers.
(6) LONG-TERM DEBT
At December 31, 1996 and 1997, long-term debt consisted of the
following:
<TABLE>
<S> <C> <C>
December 31,
1996 1997
-------------- ---------------
Dollar denominated convertible debentures $7,288,063 $10,683,440
Swiss franc denominated convertible debentures 7,222,846 --
Note payable in connection with guarantee on behalf of discontinued
subsidiary (See Note 2) -- 3,233,000
Other notes payable 651,608 169,588
-------------- ---------------
15,162,517 14,086,028
Less - current maturities (497,377) (1,640,465)
-------------- ---------------
$14,665,140 $12,445,563
============== ===============
</TABLE>
F-19
<PAGE>
(a) CONVERTIBLE DEBENTURES
The following table summarizes the issuance and conversion of the
convertible debentures for the years ended December 31, 1996 and 1997.
<TABLE>
<S><C> <C> <C> <C> <C>
Common
Shares
Outstanding at Issued
Face December 31, Upon
-----------------------------
Series Value 1996 1997 Conversion
---------------------------------------------------- -------------- -------------- ------------- -------------
3% Series due September 30, 1996 $ 750,000 $ -- $ -- 370,189
6% Series due November 21, 1997 2,000,000 -- -- 1,172,132
7% Series due March 31, 2000 1,100,000 -- -- --
7% Series due July 1, 2000 1,200,000 -- -- 401,549
8% Series due October 26, 1997 1,000,000 -- -- 34,615
4.5% Series due October 21, 1999, 2000, 2001 5,000,000 3,761,038 100,000 1,381,264
5% Series due December 31, 2001 5,000,000 3,527,025 923,439 2,074,992
5% Series due January 13, 2002 1,000,000 -- 1,000,000 --
5% Series due March 10, 2002 5,500,000 -- 1,160,001 3,094,677
6% Series due March 13, 2002 500,000 -- 500,000 --
6%, 7% and 8% Series due September 30, 2002 7,000,000 -- 7,000,000 --
4.5% Series denominated in Swiss francs
due July 3, 2003 7,669,442 7,222,846 -- 914,028
-------------- -------------- ------------- -------------
$37,719,442 $14,510,909 $10,683,440 9,443,446
============== ============== ============= =============
</TABLE>
On January 13, 1997, the Company issued $1,000,000 of 5% convertible
debentures due January 13, 2002. The convertible debentures have a conversion
price equal to 85% of the average closing bid price of the Company's common
stock price as defined, provided that in any thirty-day period, the holder of
these debentures may convert no more than 33% (or 34% in the last thirty-day
period available for conversion) of the debentures. The Company has ascribed a
value of $176,471 for the discount conversion feature. This amount is being
amortized over a six month period which represents the period to the earliest
conversion date.
On March 10, 1997, the Company issued $5,500,000 of 5% convertible
debentures due March 10, 2002. The convertible debentures have a conversion
price of 100% of the Company's average stock price, as defined, within the first
90 days and 90% of the average stock price, as defined, thereafter. The Company
has ascribed a value of $611,111 for the 10% conversion discount. This amount is
being amortized over a six month period which represents the period to the
earliest conversion date.
It is the Company's policy to discount convertible debentures based on
the discount conversion price and amortize the discount to operations over the
expected life of the convertible debentures, which in most cases is less than
the term of the debentures. Accordingly, the Company has credited the ascribed
value for the discount features described above to additional paid-in capital.
This amount is being amortized over a six month period which represents the
period to the earliest conversion date.
On March 13, 1997, the Company issued $500,000 of 6% convertible
debentures due March 13, 2002. The convertible debentures have a conversion
price of $11.00. In addition, after 90 days, the debentureholder may convert no
more than one-third of the debenture in any thirty-day period. The Company has
accounted for these debentures at face value.
F-20
<PAGE>
On September 30, 1997, the Company issued $7,000,000 of convertible
debentures due September 30, 2002. The debentures bear interest at a rate of 6%
for the first 179 days, 7% for days 180-269 and 8% thereafter. The
debentureholders were also issued 413,109 shares of common stock related to this
financing. The fair market value of the common stock was $1,050,000 and this
amount is being treated as debt discount and amortized to interest expense. The
convertible debentures have a conversion price of 100% of the Company's average
stock price as defined. In addition, the debentureholder may convert no more
than 33% in any thirty-day period (or 34% of the debentures in the last thirty
day period). The Company also has redemption rights related to this financing.
(See Note 13.) The Company incurred deferred financing costs of $350,000
relating to the issuance of these debentures.
On July 3, 1996, the Company raised approximately $7,669,000 through
the issuance of 9,675 units in a convertible debenture financing. These units
are traded on the Luxembourg Stock Exchange. 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 are convertible by the holder or the Company
commencing October 1, 1996 at a conversion price equal to from 100% to 77.5% of
the applicable conversion price, calculated as defined. The Company ascribed a
value of $1,917,360 to the discount conversion feature of the convertible
debenture. This amount was being amortized to interest expense over the life of
the Swiss franc convertible debenture. During 1997, the Company redeemed 300
units of this convertible debenture financing for $195,044.
On October 16, 1997, the Company brought a declaratory judgment action
in the United States District Court against certain of the Swiss franc
debentureholders. Prior to this suit, those debentureholders had alleged that
the Company was in breach of certain protective covenants and on October 22,
1997, they brought suit based on these claims. On November 13, 1997, the Company
exercised its right to convert 9,375 units into 914,028 shares of common stock
and cash of approximately $36,000. The unamortized discount totaling
approximately $1,784,000 was amortized to interest expense upon conversion. The
Company has accounted for these debentures as converted in the accompanying
financial statements. The ongoing litigation will be accounted for under SFAS
No. 5, ACCOUNTING FOR CONTINGENCIES (see Note 12(d)).
The Company incurred deferred financing costs of approximately
$2,038,000 and $769,000 relating to the issuance of convertible debentures
during the years ended December 31, 1996 and 1997, respectively. These costs
have been reflected as deferred financing costs in the accompanying consolidated
balance sheets and are being amortized to interest expense over the term of the
related convertible debentures. During the years ended December 31, 1995, 1996
and 1997, the Company amortized approximately $71,000, $78,000 and $276,000 to
interest expense, respectively. Any remaining unamortized deferred financing
costs are recorded to additional paid-in capital upon conversion. During the
years ended December 31, 1996 and 1997, the Company amortized approximately
$41,000 and $1,820,000, respectively, of unamortized deferred financing costs to
additional paid-in-capital.
During the years ended December 31, 1995, 1996 and 1997, the Company
recorded approximately $168,000, $77,000 and $5,444,000, respectively, of
interest expense related to the amortization of the discount of convertible
debentures.
(b) FUTURE MATURITIES OF LONG-TERM DEBT
Future maturities of notes payable, capital lease obligations and
convertible debentures reflected at face value as of December 31, 1997 are as
follows:
1998 $ 1,640,465
1999 1,699,740
2000 65,237
2001 1,988,679
2002 8,691,907
=============
$14,086,028
=============
F-21
<PAGE>
(7) STOCKHOLDERS' EQUITY
(a) COMMON STOCK
On February 28, 1997, the Company and Nexar entered into an Asset
Purchase and Settlement agreement with a former executive of Nexar and
Technovation Computer Labs Inc. (Licensor). The Licensor was affiliated with a
former officer of Nexar. Under the terms of this agreement, the Company agreed
to pay this former executive and certain of his affiliates $1,250,000 in cash
and deliver $1,500,000 worth of Palomar's common stock in exchange for all
right, title and interest in to all the technology licensed under Nexar's
license agreement with the Licensor and a patent application related thereto and
a complete release and settlement of all claims between this former executive
and Nexar.
The Company agreed to assign to Nexar all of its rights to and title in
the technology received under the Asset Purchase and Settlement Agreement and
charged to Nexar the cost associated with this claim and the purchase of the
technology. Nexar allocated $1,375,000 of the consideration to settle this claim
and reflected this amount as a litigation expense in its statement of operations
for the year ended December 31, 1996. The remaining consideration totaling
$1,375,000 was allocated to the purchase of technology and is being amortized by
Nexar over the technology's estimated useful life. The allocation of the
purchased technology was based on the value of anticipated royalty payments to
the Licensor over the three years ended December 31, 1999.
During the year ended December 31, 1997, the Company issued 20,000
shares of common stock in connection with advisory services.
On December 31, 1997, in connection with the discontinuation of
Dynaco's operations, the Company entered a Security Agreement-Stock Pledge with
a bank. Pursuant to this agreement, the Company pledged 3,250,000 shares of its
common stock to the bank as security for a guaranty by the Company (Note 2).
These shares are held in escrow, are not entitled to vote and are not considered
outstanding as of December 31, 1997.
(b) PREFERRED STOCK
The Company is authorized to issue up to 5 million shares of preferred
stock, $.01 par value. As of December 31, 1996 and 1997, preferred stock
authorized, issued and outstanding consists of the following:
<TABLE>
<S> <C> <C> <C>
1996 1997
---- ----
Redeemable convertible preferred stock, Series E, $.01 par value per
share 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 per share
Authorized - 6,000 shares
Issued and outstanding - 6,000 shares in 1997, liquidation preference of $6,748,500
at December 31, 1997 60 60
Redeemable convertible preferred stock, Series G, $.01 par value per
share Authorized - 10,000 shares Issued and outstanding - 2,684 shares
in 1997, liquidation preference of $2,934,742
at December 31, 1997 100 27
Redeemable convertible preferred stock, Series H, $.01 par value per
share Authorized - 16,000 shares Issued and outstanding - 7,690 shares
in 1997, liquidation preference of $8,031,232
at December 31, 1997 -- 77
Total preferred stock $ 182 $ 164
====== ======
</TABLE>
F-22
<PAGE>
The Series F redeemable convertible preferred stock ("Series F
Preferred"), together with any accrued but unpaid dividends, may be converted
into common stock at 80% of the average closing bid price for the ten trading
days preceding the conversion date, but in no event less than $3.00 or more than
$16.00. This conversion floor was decreased by the two parties from an original
price of $7.00. The Series F Preferred may be redeemed at the Company's option
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.
The Series G redeemable convertible preferred stock ("Series G
Preferred"), together with any accrued but unpaid dividends, may be converted
into common stock at 85% of the average closing bid price for the five trading
days preceding the conversion date, but in no event less than $.01. On December
31, 1997, the Company and the holder of the remaining 2,684 shares of Series G
Preferred entered into an Exchange Agreement. The conversion floor was decreased
by the two parties from an original floor of $6.00. In addition, beginning on
March 1, 1998, for any thirty-day period, the holder may exchange a limited
amount of the Series G Preferred ("exchangeability amount") and any accrued but
unpaid dividends for common stock at 85% of the average closing bid price for
the five trading days preceding the conversion date ("exchange date"). The
exchangeability amount increases as the exchange rate increases. The
exchangeability amount ranges from 268 shares of preferred stock for an exchange
rate below $2.00 to 1,072 shares of preferred stock for an exchange rate in
excess of $4.00. The Series G Preferred may be redeemed at the Company's option
at any time, with no less than 15 days' and no more than 20 days' notice, at an
amount equal to the sum of (a) the amount of liquidation preference determined
as of the applicable redemption date plus (b) $176.50. Dividends are payable
quarterly at 7% per annum in arrears on January 1, April 1, July 1 and October
1. Dividends not paid on the payment date, whether or not such dividends have
been declared, will bear interest at the rate of 12% per annum until paid.
The conversion price for the Series F and G Preferred is adjustable for
certain dilutive events, as defined. The Series F and G Preferred have a
liquidation preference equal to $1,000 per share of redeemable convertible
preferred stock, plus accrued but unpaid dividends and accrued but unpaid
interest. The Series F and G Preferred stockholders do not have any voting
rights except on matters affecting the Series F and G Preferred.
During the first and second quarters of 1997, the Company issued 16,000
shares of Series H redeemable convertible preferred stock ("Series H Preferred")
for $16,000,000 with attendant financing costs of $1,000,000. The Series H
Preferred accrues dividends at rates varying from 6% to 8% per annum, as
defined. The Series H Preferred, including any accrued but unpaid dividends, may
be converted into common stock at 100% of the average stock price, as defined,
for the first 179 days from the closing date, 90% of the average stock price, as
defined, for the following 90 days and 85% of the average stock price, as
defined, thereafter. The conversion price is adjustable for certain dilutive
events, as defined. The holders are restricted for the first 209 days following
the closing date to converting no more than 33% of the Series H Preferred in any
thirty-day period (or 34% in the last thirty-day period). Under certain
conditions, the Company has the right to redeem the Series H Preferred. The
Company has ascribed a value of $2,823,529 to the discount conversion feature of
the Series H Preferred, which is being amortized as an adjustment to earnings
available to common shareholders over the most favorable conversion period
attainable to the holders (270 days from the date of issuance).
During the year ended December 31, 1997, the following shares of
preferred stock, accrued premium, dividends, interest and other related costs
were converted into shares of common stock as follows:
F-23
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Number of Additional Dollar Amount
Preferred Preferred Dollar Amount of Converted, Including Accrued Number of Common
Stock Shares Preferred Stock Premium, Dividends, Interest Total Dollar Shares Converted
Series Converted Converted and Other Related Costs Amount Converted Into
- ------------ --------------- --------------------- --------------------------------- --------------------- -------------------
E 2,128 $2,128,000 $126,366 $2,254,366 332,859
G 7,316 7,316,000 438,234 7,754,234 602,824
H 8,310 8,310,000 228,411 8,538,411 5,204,158
--------------- --------------------- --------------------------------- --------------------- -------------------
17,754 $17,754,000 $793,011 $18,547,011 6,139,841
</TABLE>
In addition to the 602,824 shares of common stock issued related to the
Series G Preferred conversion, the Company issued to the Series G Preferred
stockholder $47,731 in cash dividends and 956,388 shares of Nexar common stock
valued at $4,671,597. The reduction to stockholder's equity (deficit) as a
result of this transaction was as follows:
Value of Nexar Common Stock $4,671,597
Accrued Interest and Dividend (391,597)
-----------
$4,280,000
===========
(c) STOCK OPTION PLANS AND WARRANTS
(i) STOCK OPTIONS
The Company has several Stock Option Plans (the "Plans") that provide
for the issuance of a maximum of 4,350,000 shares of common stock, which may be
issued as incentive stock options ("ISOs") or nonqualified options. Under the
terms of the Plans, ISOs may not be granted at less than the fair market value
on the date of grant (and in no event less than par value); in addition, ISO
grants to holders of 10% of the combined voting power of all classes of Company
stock must be granted at an exercise price of not less than 110% of the fair
market value at the date of grant. Pursuant to the Plans, options are
exercisable at varying dates, as determined by the Board of Directors, and have
terms not to exceed 10 years (five years for 10% or greater stockholders). The
Board of Directors, at the request of the optionee, may, at its discretion,
convert the optionee's ISOs into nonqualified options at any time prior to the
expiration of such ISOs.
During the year ended December 31, 1997, the Company granted options to
certain Tissue Technologies employees to purchase an aggregate of 60,845 shares
of common stock at an exercise price of $.01 per share in settlement of a stock
option dispute. The employees simultaneously exercised these options. The fair
market value of the common stock issued totals approximately $152,000, which has
been reflected as a charge in the accompanying Consolidated Statements of
Operations.
The Company's Star subsidiary, a wholly owned subsidiary as of December
31, 1997, manufacturer of the Company's diode laser, also has established a
stock option plan that provides for the issuance of both nonqualified options
and ISOs. In the year ended December 31, 1996, Star granted a total of 140,000
options to purchase Star's common stock to officers and employees at exercise
prices ranging from $2.50 to $9.50 per share. In the year ended December 31,
1996, an individual exercised 20,000 shares at $2.50 per share; in addition,
12,000 shares at $6.00 per share were canceled. In the year ended December 31,
1997, Star granted a total of 50,500 options to purchase its common stock to
employees at an exercise price of $19.00 per share. During the year ended
December 31, 1997, no options were exercised or canceled. As of December 31,
1997, options to purchase 255,500 shares of Star common stock at prices ranging
from $2.50 to $19.00 per share are outstanding.
F-24
<PAGE>
The following table summarizes all stock option activity of the Company
for the years ended December 31, 1995, 1996 and 1997:
<TABLE>
<S> <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
Granted 1,747,345 0.01-6.50 2.53
Exercised (214,845) 0.01-3.00 1.62
Canceled (1,206,100) 2.375-10.50 6.23
------------- ---------------- ----------------------
Outstanding, December 31, 1997 2,982,400 $1.50-$8.00 $3.33
============= ================ ======================
Exercisable, December 31, 1997 1,657,565 $2.00-$8.00 $3.48
============= ================ ======================
Available for future issuances under the Plans
as of December 31, 1997 725,255
=============
</TABLE>
The range of exercise prices for options outstanding and options
exercisable at December 31, 1997 is as follows:
<TABLE>
<S> <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
- -------------------- ---------------- ---------------------- ----------------------- -------------- -----------------------
$1.50 - $2.50 2,415,900 3.39 years $2.36 1,257,733 $2.30
$3.00 - $3.50 66,500 1.65 years 3.23 66,500 3.23
$8.00 500,000 3.65 years 8.00 333,332 8.00
---------------- ---------------------- ----------------------- -------------- -----------------------
2,982,400 3.40 years $3.33 1,657,565 $3.48
================ ====================== ======================= ============== =======================
</TABLE>
The Company accounts for its stock-based compensation plans under APB
Opinion No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES. In October 1995, the
FASB issued SFAS No. 123, ACCOUNTING FOR STOCK-BASED Compensation, which is
effective for fiscal years beginning after December 15, 1995. SFAS No. 123
established a fair-value-based method of accounting for stock-based compensation
plans. The Company has adopted the disclosure-only alternative under SFAS No.
123 which requires disclosure of the pro forma effects on earnings per share as
if SFAS No. 123 had been adopted, as well as certain other information. The
Company accounts for equity instruments issued to non-employees in accordance
with EITF 96-18 by valuing the instrument using the black-sholes pricing model,
as prescribed by FAS 123, and recording a charge to operations for their fair
value. The Company has issued options and warrants to purchase common stock to
certain financial intermediaries in connection with various financings at below
the fair market value of the underlying stock. The costs associated with these
issuances are accounted for as a cost of raising capital and netted against the
proceeds from these issuances.
The majority of options cancelled during the years ended December 31,
1995, 1996 and 1997 were the result of employee terminations. During the year
ended December 31, 1997, a total of 1,005,000 options to purchase common stock
were repriced to the current fair market value of the underlying common stock of
$2.50 per share.
F-25
<PAGE>
The Company has computed the pro forma disclosures required under SFAS
No. 123 for all stock options granted to employees of the Company in the years
ended December 31, 1996 and 1997 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 Star subsidiary were
immaterial for the years ended December 31, 1996 and 1997.
The assumptions used to calculate the SFAS No. 123 pro forma disclosure
and the weighted average information for the years ended December 31, 1995, 1996
and 1997 for the Company are as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1995 1996 1997
--------------------- ----------------- -------------------
Risk-free interest rate 6.08% 6.37% 6.09%
Expected dividend yield - - -
Expected lives 3.2 years 4.4 years 3.69 years
Expected volatility 55% 79% 79%
Weighted-average grant date fair value of
Options granted during the period $3.92 $4.57 $2.06
</TABLE>
The weighted fair market value and weighted exercise price of options
granted for the Company in the years ended December 31, 1995, 1996 and 1997 are
as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1995 1996 1997
-------------- ----------------- -----------------
Weighted average exercise price for options:
Whose exercise price exceeded fair market value at
the date of grant $3.00 $10.00 $2.53
Whose exercise price was equal to fair market
value at the date of grant $1.614 $6.875 $-
Weighted Average Fair Market Value for options:
Whose exercise price exceeded fair market value at
the date of grant $2.125 $8.875 $1.87
Whose exercise price was equal to fair market
value at the date of grant $5.265 $6.875 $-
</TABLE>
F-26
<PAGE>
(ii) WARRANTS
The following table summarizes all warrant activity of the Company for
the years ended December 31, 1995, 1996 and 1997:
<TABLE>
<S> <C> <C> <C>
Weighted
Number of Exercise Average
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
Granted 6,527,576 4.88-16.50 8.16
Exercised (3,101,261) 0.01-7.69 2.66
---------------- ---------------- ------------------
Outstanding, December 31, 1996 9,976,239 $0.60-$16.50 $7.02
Granted 2,793,187 2.50-8.875 4.29
Exercised (584,879) 0.60-7.50 2.10
Canceled (2,186,517) 1.00-16.50 6.65
---------------- ---------------- ------------------
Outstanding, December 31, 1997 9,998,030 $2.00-$15.00 $6.65
================ ================ ==================
Exercisable, December 31, 1997 8,233,020 $2.00-$15.00 $7.01
================ ================ ==================
</TABLE>
The majority of warrants cancelled during the year ended December 31,
1997 were the result of employee terminations. During the year ended December
31, 1997, a total of 240,000 warrants to purchase common stock were repriced to
then current fair market values of the underlying common stock ranging from
$2.50 to $4.00 per share.
The range of exercise prices for warrants outstanding and exercisable
at December 31, 1997 is as follows:
<TABLE>
<S> <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
- -------------------- ---------------- ---------------------- ----------------------- -------------- ----------------------
$2.00 - $3.50 2,535,452 3.29 years $2.68 1,970,452 $2.52
$4.00 - $5.25 1,802,420 2.85 years 4.89 1,402,412 4.99
$6.00 - $7.50 3,000,000 3.25 years 6.83 2,399,999 7.03
$7.69 - $15.00 2,660,158 3.25 years 6.83 2,460,157 7.03
---------------- ---------------------- ---------------------- -------------- ----------------------
9,998,030 3.19 years $6.65 8,233,020 $7.01
================ ====================== ====================== ============== ======================
</TABLE>
The Company has computed the pro forma disclosures required under SFAS
No. 123 for all warrants granted in the years ended December 31, 1996 and 1997
using the Black-Scholes option pricing model prescribed by SFAS No. 123.
F-27
<PAGE>
The assumptions used to calculate the SFAS No. 123 pro forma disclosure
and the weighted average information for the years ended December 31, 1995, 1996
and 1997 for the Company are as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1995 1996 1997
---------------- ------------------ ------------------
Risk-free interest rate 6.01% 5.93% 6.13%
Expected dividend yield - - -
Expected lives 4.8 years 5.9 years 4.44 years
Expected volatility 56% 79% 79%
Weighted-average grant date fair value of
warrants granted during the period $1.81 $5.39 $2.17
Weighted-average exercise price of warrants
granted during the period $2.36 $8.16 $4.29
</TABLE>
The weighted average fair-value and weighted average exercise price of
warrants granted by the Company for the years ended December 31, 1995, 1996 and
1997 are as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1995 1996 1997
---------------- --------------- -----------------
Weighted average exercise price for warrants:
Whose exercise price exceeded fair market value at
date of grant $2.72 $11.76 $4.30
Whose exercise price was less than fair market value
at date of grant $3.17 $7.07 $7.50
Whose exercise price was equal to fair market value at
date of grant $1.98 $6.67 $3.25
Weighted average fair market value for warrants:
Whose exercise price exceeded fair market value at
date of grant $2.18 $9.34 $2.09
Whose exercise price was less than fair market value
at date of grant $4.96 $8.82 $8.13
Whose exercise price was equal to fair market value at
date of grant $2.86 $6.67 $3.25
</TABLE>
(iii) PRO FORMA DISCLOSURE
The pro forma effect on the Company of applying SFAS No. 123 for all
options and warrants to purchase common stock would be as follows:
<TABLE>
<S> <C> <C> <C>
December 31,
1995 1996 1997
-------------------- ---------------------- ----------------
Pro forma net loss from continuing operations $(18,499,644) $(48,292,780) $(62,020,782)
Pro forma basic and dilutive net loss per share from
continuing operations $(1.31) $(1.89) $(1.89)
</TABLE>
F-28
<PAGE>
(d) RESERVED SHARES
At December 31, 1997, the Company has reserved shares of its common
stock for the following:
<TABLE>
<S> <C>
Warrants 9,998,030
Stock option plans 3,709,504
Convertible debentures 8,212,815
Preferred stock 8,077,786
Employee Stock Purchase Plan 984,623
Employee 401(k) Plan 166,674
---------------
Total 31,149,432
===============
</TABLE>
From January 1, 1998 through February 6, 1998, 5,473,265 shares of
common stock were issued in connection with the items above.
(e) STOCK PURCHASE PROGRAM
During the year ended December 31, 1997, the Company purchased 145,000
shares of its common stock at an aggregate cost of $427,102 as part of a
treasury stock purchase program approved by its Board of Directors in May of
1997.
(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 85% of the fair market
value of the common stock with a lookback provision of three months. The
Purchase Plan provides for issuance of up to 1,000,000 shares under the Purchase
Plan. During the year ended December 31, 1997, employees purchased 15,377 shares
of the Company's common stock for approximately $40,000 pursuant to the Purchase
Plan.
(8) RESEARCH & PRODUCT DEVELOPMENT AGREEMENTS
During 1995, the Company entered into a multiyear agreement with
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. MGH will provide the
Company with data previously generated by Dr. Anderson and further clinical
research on the ruby laser device at MGH and other sites and remit ownership of
all case report forms and data resulting from the study.
Effective February 14, 1997, the Company amended the 1995 agreement
with MGH. The Company agreed to provide MGH with a grant of $203,757 to perform
research and evaluation in the field of hair removal. The Company immediately
paid $50,090 upon execution of this agreement, and the Company paid a license
fee of $10,000 within thirty days of this amendment. As consideration for this
amended license, the Company is obligated to pay to MGH royalties of up to 5% on
net revenues as defined (See Note 12 (b)). In March 1997, the U.S. Patent Office
issued a patent protecting the laser-based hair removal technology developed by
Dr. Anderson at MGH, for which Palomar is the exclusive worldwide licensee.
F-29
<PAGE>
(9) ACCRUED LIABILITIES
At December 31, 1996 and 1997, accrued liabilities consist of the
following:
<TABLE>
<S> <C> <C>
December 31,
1996 1997
---------------- ---------------
Payroll and consulting costs $2,596,867 $1,535,013
Royalties 843,345 853,808
Settlement costs 1,755,000 1,457,020
Warranty 2,854,401 2,583,677
Deferred revenue 256,912 3,154,395
Restructuring -- 1,981,907
Interest and preferred stock dividends 579,739 1,659,709
Other 2,089,045 3,688,720
---------------- ---------------
Total $10,975,309 $16,914,249
================ ===============
</TABLE>
(10) RELATED PARTY TRANSACTIONS
At December 31, 1996 and 1997, approximately $948,000 and $478,000 of
loans receivable with interest at the rate of 7% per annum were outstanding from
the former CEO and President, respectively. No amounts are currently outstanding
under these loans. During the fourth quarter of 1997, the Company's former CEO
paid back his outstanding loan balance, which totaled approximately $1,029,000
as of September 30, 1997. The former CEO made payments in both cash and
marketable securities. In the first quarter of 1998, the Company's former
President paid back his outstanding loan.
(11) 401(k) PROFIT SHARING PLAN
The Company has a 401(k) profit sharing plan (the "Profit Sharing
Plan") which covers substantially all employees who have attained the age of 18
and are employed at year-end. Employees may contribute up to 15% of their
salary, as defined, subject to restrictions defined by the Internal Revenue
Service. The Company is obligated to make a matching contribution, in the form
of the Company's common stock, of 50% of all employee contributions effective
January 1, 1995. The Company contributions vest over a three-year period.
During 1997, the Company issued 87,441 shares of its common stock to
the Profit Sharing Plan in satisfaction of its $318,154 employer match of the
1996 employee contributions. For the year ended December 31, 1997, the Company
has accrued $250,000 for the 1997 match, which will be made in common stock in
April 1998.
(12) COMMITMENTS AND CONTINGENCIES
(a) OPERATING LEASES
The Company has entered into various operating leases for its corporate
office, research facilities and manufacturing operations. These leases have
monthly rents ranging from approximately $2,000 to $34,000, adjusted annually
for certain other costs such as inflation, taxes and utilities, and expire
through May 31, 2000. The Company guarantees certain subsidiaries' operating
leases.
F-30
<PAGE>
Future minimum payments under the Company's operating leases at
December 31, 1997 are approximately as follows:
December 31,
1998 $683,000
1999 549,000
2000 246,000
-------------
$1,478,000
=============
(b) ROYALTIES
The Company is required to pay a royalty of up to 5% of "net laser
sales," as defined, under a royalty agreement with MGH (see Note 8). For the
years ended December 31, 1995, 1996 and 1997, approximately $167,000, $175,000
and $854,000 of royalty expense, respectively, was incurred under this
agreement. These amounts are included in cost of sales in the accompanying
consolidated statement of operations.
A former employee and previous owner of one of the Company's
subsidiaries is paid a 1% commission on the net sales of certain ruby lasers and
diode lasers, as defined. These commissions will be paid through March 31, 2000
and are to be no less than $450,000. In accordance with the settlement agreement
with this individual, the Company paid advances on commissions totaling
$450,000: $200,000 in 1997 and $250,000 in January 1998. (See Note 10.)
(c) LITIGATION
The Company was a defendant in a lawsuit filed on March 14, 1996 in the
United States District Court for the Southern District of New York by
Commonwealth Associates ("Commonwealth"). In its suit, Commonwealth alleged that
the Company had breached a contract with Commonwealth in which Commonwealth was
to provide certain investment banking services in return for certain
compensation. In January 1997, Commonwealth's motion for summary judgment on its
breach of contract claim was granted, and in April 1997 the District Court
awarded Commonwealth $3,174,070 in damages. That judgment was appealed by
Palomar and on August 18, 1997 the case was settled for $1.875 million. During
the year ended December 31, 1997, the Company incurred $1.875 million in
settlement costs related to the above matter and another $1.324 million related
to several other claims and associated litigation costs.
The Company is involved in litigation regarding an alleged infringement
of a competitor's patent (the "Selvac Patent"). The Company believes that the
Selvac Patent is invalid, void and unenforceable, and that the Company does not
infringe the Selvac Patent. The court has granted Palomar's motion to amend its
complaint previously filed to allege that the Selvac Patent was obtained by
inequitable conduct, and the Company has moved for summary judgment on the
grounds that the Selvac Patent is invalid and was obtained by inequitable
conduct. The Company believes that competitor's claims are wholly without merit.
Nonetheless, an adverse result could have a material adverse effect on the
Company. The Company is not able to estimate a range of any possible loss in
this matter.
On October 16, 1997, the Company brought a declaratory judgment action
in U.S. District Court for the District of Massachusetts against the holders and
the indenture trustee of the Company's 4.5% Subordinated Convertible Debentures
due 2003, denominated in Swiss francs (the "Swiss Franc Debentures"). Just prior
to this suit, certain of the debenture holders (the "Asserting Holders") had
alleged that the Company was in breach of certain protective covenants under the
indenture, and on October 22, 1997 they sued the Company and all of its
principal subsidiaries in the same court; the October 16 and October 22 cases
have been assigned to the same judge, and the dispute between the Asserting
Holders and the Company is proceeding under the October 22 case. The Asserting
Holders claim that the Company has breached certain protective indenture
covenants and that the Asserting Holders are entitled to immediate payment of
their indebtedness under the Swiss Franc Debentures (which amounts to
approximately US$5,087,000 at current exchange rates). As of November 13, 1997,
acting under applicable provisions of the indenture, the Company notified the
holders of the Swiss Franc Debentures that it is causing the conversion of all
of the Swiss Franc Debentures into an aggregate of 914,028 shares of the
Company's common stock. The Company believes that it has not breached any of the
protective covenants under this
F-31
<PAGE>
indenture and that its position in these matters is correct, and intends to
contest the claims of the Asserting Holders vigorously. Nonetheless, an adverse
result could have a material adverse effect on the Company in the range of
$5,087,000 to $7,000,000.
The Company is involved in other legal and administrative proceedings
and claims of various types. While any litigation contains an element of
uncertainty, management, in consultation with the Company's general counsel,
presently believes that the outcome of each such other proceeding or claim which
is pending or known to be threatened, or all of them combined, will not have a
material adverse effect on the Company.
The Company is also aware of a claim alleging that the Company had
previously committed to make an additional capital contribution to Nexar. The
Company believes that this claim is without merit.
(d) DISTRIBUTION AGREEMENT
On November 17, 1997, the Company entered into an exclusive
distribution, sales and service agreement with an established, worldwide laser
company ("the Distributor"). The Distributor has the exclusive right to sell the
EpiLaser(R) and LightSheer(TM) laser systems and future generation products
worldwide. The Company pays the Distributor a per unit commission, adjusted for
certain events as defined. During the year ended 1997, the Company incurred
approximately $800,000 of commission expense to this Distributor. Upon execution
of this agreement, the Distributor made a non-refundable lump sum payment of
$3,500,000 and received a warrant to purchase one million shares of the
Company's common stock at a share price of $5.25. The valuation of the warrant
using the Black-Scholes option pricing model was approximately $380,000. The
value was credited to additional paid-in-capital during the year ended December
31, 1997. The remaining amount of $3,120,000, included in deferred revenue, will
be amortized to revenue over the three year life of the agreement. The Company
believes that the three year term of this agreement properly represents the
period over which it earns revenues. The Company believes that the commissions
paid to this distributor are higher than the industry average and will reduce
the overall profit margin that the Company is able to earn from the sale of its
products during this period.
On January 20, 1998, the Distributor made a loan to the Company of
approximately $2,211,000. This loan is collateralized by the Company's accounts
receivable. Payments against this loan will be made as the Distributor collects
receivables from the end user of the Company's products. Any unpaid principal
will be paid on July 26, 1998 at an interest rate of 1.5% per month or the
highest interest rate permitted by law.
(e) EMPLOYMENT AGREEMENTS
The Company and its subsidiaries have employment agreements with
certain executive officers that provide for annual bonuses to the officers and
expire on various dates through 2001. Each of these agreements provides for 12
months severance upon termination of employment.
(f) CORPORATE GUARANTEES
The Company has issued guarantees for payment of various vendor
liabilities for several electronic subsidiaries that have been accounted for as
discontinued operations (see Note 2). Outstanding guarantees totaled
approximately $7,000,000 as of December 31, 1997.
F-32
<PAGE>
(13) SUBSEQUENT EVENTS
In February 1998, the Company sold 7,200,000 shares of its common stock
to a group of investors for $7,200,000. In addition, the Company also issued
warrants to the investors to purchase 7,200,000 shares of common stock at an
exercise price of $3.00 per share.
Subsequent to year-end the Company redeemed 2,950 shares of Series H
Preferred and paid related dividends and interest for a total of approximately
$3,589,000. The Company also redeemed 6%, 7% and 8% convertible debentures with
a face value of $2,000,000 and related interest for a total of approximately
$2,197,000. On March 30, 1998, in resolution of a dispute regarding the
redemption of certain Series H Preferred shares, the Company agreed with one of
the Series H Preferred stockholders to issue 766,725 shares of common stock for
$914,864 in lieu of redeeming 750 shares of Series H Preferred previously
redeemed.
In the first quarter of 1998, debentureholders converted debentures
with a face value of $3,344,344 into 3,809,922 shares of convertible debentures.
Also in the first quarter of 1998, preferred stockholders converted 268 shares
of Series G Preferred and 3,840 shares of Series H Preferred into 287,908 and
4,103,650 shares of common stock, respectively.
On March 27, 1998, the Company borrowed $2,000,000. This bridge loan is
payable the earlier of May 26, 1998 or (i) one day following the sale of Dynaco
(ii) the sale of any other Palomar assets in a transaction outside the normal
course of business or (iii) any financing where the use of proceeds to pay back
debt is not prohibited. The Company issued 125,000 warrants to the lender to
purchase 125,000 shares of common stock at an exercise price of $.01 per share
in lieu of interest.
F-33
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the
Registrant certifies that it has caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the Town of Lexington in the
Commonwealth of Massachusetts on March 3, 1999.
PALOMAR MEDICAL TECHNOLOGIES, INC.
By: /s/ Louis P. Valente
-----------------------------
Louis P. Valente
Chief Executive Officer and
President
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>
<S> <C> <C> <C>
Name Capacity Date
/s/ Louis P. Valente President, Chief Executive March 3, 1999
---------------------------------
Louis P. Valente Officer and Director
/s/ Joseph P. Caruso Chief Financial Officer and Treasurer March 3, 1999
---------------------------------
Joseph P. Caruso (Principal Financial Officer and
Principal Accounting Officer)
/s/ Nicholas P. Economou Director March 3, 1999
---------------------------------
Nicholas P. Economou
/s/ A. Neil Pappalardo Director March 3, 1999
---------------------------------
A. Neil Pappalardo
/s/ James G. Martin Director March 3, 1998
---------------------------------
James G. Martin
</TABLE>
