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FORM 10-K
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For fiscal year ended December 31, 1997
Commission file number: 0-22340
[OBJECT OMITTED]
PALOMAR MEDICAL TECHNOLOGIES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 04-3128178
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
45 Hartwell Avenue, Lexington, Massachusetts 02173
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(Address of principal executive offices)
(781) 676-7300
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(Issuer's telephone number, including area code)
Securities registered pursuant to Section 12 (b) of the Act:
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Name of each exchange on
Title of each class which registered
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Not Applicable Not Applicable
Securities registered pursuant to Section 12 (g) of the Act:
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Common Stock, $.01 par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s)), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
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Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-K contained in this form, and no disclosure will be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [ ]
As of March 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 X No
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PART I
ITEM 1. BUSINESS.
(a) INTRODUCTION
Palomar Medical Technologies, Inc. (the "Company" or "Palomar" or the
"Registrant") was organized in 1987 to design, manufacture and market lasers,
delivery systems and related disposable products for use in medical procedures.
In December 1992 the Company went public. Subsequently, the Company pursued an
aggressive acquisition program, acquiring companies in its core laser business
as well as others, principally in the electronics industry, in order to spread
risk and bolster operating assets, among other reasons. By the beginning of
1997, the Company had more than a dozen subsidiaries. At the same time, having
obtained FDA clearance to market its EpiLaser(R) hair removal laser system in
March 1997, the Company was well positioned to focus on what it believes is the
most promising product in its core laser business. Hence, under the direction of
a new Board and management, the Company undertook an ambitious program in 1997
of exiting all non-core businesses and investments and focusing only on those
businesses which it believes hold the greatest promise for maximizing
stockholder value. Currently, the Company has four subsidiaries, one of which,
Dynaco Corp. ("Dynaco"), the only remaining electronics subsidiary, the Company
anticipates exiting in 1998. (See Report on Form 8-K filed December 23, 1997 and
incorporated herein by reference.) The remaining three subsidiaries are Palomar
Medical Products, Inc. ("PMP"), in Lexington, Massachusetts, where the Company's
ruby hair removal laser system is manufactured, Star Medical Technologies, Inc.
("Star") in Pleasanton, California, where the Company's diode hair and leg vein
removal laser is manufactured, and Cosmetic Technology International, Inc.
("CTI"), also headquartered in Lexington, Massachusetts, which provides cosmetic
laser services.
(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company conducts business in one industry segment, medical products
and services. In 1997, the Company began a program of divesting all of its
noncore electronics subsidiaries. The Company expects to complete this program
in 1998. (See Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview" and Note 2 to Financial
Statements.)
(c) DESCRIPTION OF BUSINESS
(i) PRINCIPAL PRODUCTS AND SERVICES
Lasers for Hair Removal
The word "laser" is the acronym for "light amplification by stimulated
emission of radiation." The emitted radiation oscillates within an optical
resonator and is amplified by an active medium, resulting in a monochromatic
beam of light, which is narrow, highly coherent and thus can be focused to a
small spot with a high degree of precision. In recent years, scientists and
clinicians have developed a concept called tissue optics to describe how the
unique properties of the laser can be used to treat human tissue selectively and
more precisely. By careful selection of laser parameters, such as wavelength
(color), energy and pulse width (exposure time), and with a detailed
understanding of the physical and optical properties of the target tissue, the
clinician can selectively treat the target tissue while minimizing or
eliminating damage to surrounding tissue. The concept of color selectivity has
been useful in developing a number of successful dermatological applications.
The patented hair removal technology utilized by Palomar targets the pigment in
a hair follicle and was developed by Dr. R. Rox Anderson at Massachusetts
General Hospital ("MGH"). Pigment, called melanin, is found in the upper layer
of the skin and in the hair shaft and hair follicle deeper below the surface of
the skin. With the appropriate selection of wavelength (color), energy and pulse
width to allow for the preferential absorption of laser energy by the melanin
present in the hair, there is negligible absorption by the surrounding tissue.
Energy from ruby lasers is particularly well absorbed by melanin and absorption
by other cells and tissue is particularly low. Palomar uses a patented and
proprietary contact cooling technology to protect the upper layer of the skin
while the ruby or diode laser light is targeting and destroying the follicle
deeper within the skin tissue. In addition, Palomar's patented contact cooling
handpiece enables the laser light to penetrate to the correct depth while at the
same time limiting the amount of discomfort associated with the procedure. This
method of hair removal using the cooling handpiece allows for selective
destruction of the target follicle
1
without harming the surrounding skin or surface of the skin. The laser light is
pulsed at a rapid rate covering approximately one-eighth square inch at each
pulse. This treatment method allows for a large area of treatment over a
relatively short period of time.
Using its core ruby laser technology, originally developed for tattoo
removal and pigmented lesions, Palomar developed a long pulse ruby laser, the
EpiLaser(R) laser system, that is specifically configured to allow the
appropriate wavelength, energy level and pulse duration to be absorbed
effectively by the hair follicle without being absorbed by the surrounding
tissue. That, combined with the patented ChillTip(TM) cooling handpiece, allows
for safe and effective hair removal.
In an effort to find a way to allow the laser light to pass through top
skin layers and be deeply absorbed in the hair follicle below, a contact cooling
handpiece was developed by MGH and licensed to Palomar on an exclusive
world-wide perpetual basis. This unique cooling handpiece is key to the success
and safety of Palomar's laser hair removal systems, as it permits laser
applications of higher power with better targeting and greater safety. The cold
sapphire tip protects the epidermis while allowing the laser light to
efficiently destroy the target follicles. The Company believes its unique
delivery system enables the user to address a potentially larger market than
electrolysis currently does by offering to treat large areas of the body such as
back, chest, abdomen, legs, arms and other areas. (See "Research and
Development.")
In March 1997, Palomar was the first company to receive FDA clearance
to sell and market a ruby laser in the U.S. for hair removal. In December 1997
and January 1998 respectively, Palomar was also the first company to receive FDA
clearance for a diode laser for hair removal and for leg vein treatment, the
Company's LightSheer(TM) diode laser system.
During 1998, Palomar may upgrade its ruby laser system to include a
fiber delivery system, a higher energy head and a new handpiece. Palomar will
continue to make improvements to the ruby laser systems including higher energy
(for even more effective hair reduction), colder cooling and user selectable
pulse widths (for more comfort and safety with darker skin), and faster pulse
rate (for faster hair removal).
Throughout 1997, the Company's Star subsidiary continued work on the
Company's latest hair removal system, the LightSheer(TM) diode laser. This
revolutionary device incorporates state-of-the-art laser diode technology into a
2,000 watt system that the Company feels will be the ideal complement to the
current ruby laser technology for hair removal. The LightSheer(TM) diode laser
weighs approximately one-eighth the weight of the EpiLaser(R) laser system, can
complete a treatment more rapidly than the ruby laser, and plugs into any wall
outlet. Clinical results after 18 months of testing show comparable results to
the EpiLaser(R) laser system for most hair and skin types. The new system uses
Palomar's exclusive patented contact cooling technology to provide greater
efficacy while maintaining epidermal safety.
The Hair Removal Market
The market for laser-based hair removal is in its early stages and is
rapidly growing. The final size of that market cannot yet be determined;
however, the Company believes that the current electrolysis market is a good
model. Last year, more than one million women in the United States underwent
treatment using electrolysis, spending on average more than $1,000 each,
representing a market of approximately $1 billion annually. In addition, surveys
indicate as many as 15% of men would also like to remove unwanted hair
especially from back and chest areas. Electrolysis is a commonly used method for
the long-term removal of body hair. Other methods of hair removal include
waxing, depilatories, tweezing, depilatory creams and shaving, all resulting in
only short-term hair removal. (See Item 7. "Risk Factors - Dependence on
Developing Market; Product Concentration.")
Electrolysis is a process in which an electrologist inserts a needle
directly into a hair follicle and activates an electric current in the needle,
which disables the hair follicle. The tiny blood vessels in each hair follicle
are heated and coagulated, presumably cutting off the blood supply to the hair
matrix, or are destroyed by chemical action depending upon modality used. The
success rate for electrolysis is variable depending upon the skill of the
electrologist and always requires a series of treatments. Electrolysis is
time-consuming, expensive and sometimes painful. There is also some risk of skin
blemishes and a rising concern relating to needle infection. Since electrolysis
only treats one hair follicle at a time and can only treat visible hair
follicles, the treatment of an area as small as an upper lip may require
numerous visits at an aggregate cost of up to $1,000. Although 70% of all
electrolysis treatments are for facial hair, the neck, breasts and bikini line
are also
2
treated. Because hair follicles are disabled one at a time, electrolysis is
rarely used to remove hair from large areas such as the back, chest, abdomen and
legs.
Market surveys report that more than 70% of women in the United States
employ one or more techniques for temporary hair removal from various parts of
the body. Pulling hair from the follicle produces the longest-term temporary
results, but is painful and may cause skin irritation. A number of techniques
are used to pull hair from the follicle including waxing, depilatories and
tweezing. In the waxing process, a lotion, generally beeswax-based, is spread on
the area to be treated and allowed to harden, thereby trapping the hairs. The
hardened film is then rapidly peeled off, pulling out the entrapped hairs.
Depilatories employ rotating spring coils or slotted rubber rolls to trap and
pull out the hairs. Tweezing involves removing individual hairs with a pair of
tweezers. Depilatory creams, which contain chemicals to separate hair from the
follicle, frequently leave a temporary, unpleasant odor and may also cause skin
irritation. Shaving is the most widely used method of hair removal, especially
for legs and underarms, but produces the shortest-term results. Hair bleaches do
not remove hair, but instead lighten the color of hair so that it is less
visible. A principle drawback of all of these methods is that they require
frequent treatment.
Studies using Palomar's laser hair removal process demonstrated
significant permanent reduction of hair following treatment with the EpiLaser(R)
laser system. The first treatment causes a portion of the hair (typically the
hair in the growth mode) to be reduced in size, color and/or quantity (based on
studies followed for up to three years) and causes significant growth delay
(three to six months) of most of the rest of the hair. Since the partial
re-growth tends to occur in synchrony, the follow-up treatment is often more
effective than the first treatment. An FDA submission seeking to allow Palomar
to claim permanent reduction of hair from treatments with its EpiLaser(R) laser
system was filed in January of 1998. Benefits of Palomar's laser hair removal
process include: significant long term cosmetic improvement, treatment of larger
areas in each treatment session, relatively painless procedure, reduced risk of
scarring, non-invasive procedure, no risk of cross-contamination, and higher
success rates than with previous methods.
Marketing, Distribution and Service
Pursuant to an agreement executed in November 1997, Coherent, Inc.
("Coherent") is the exclusive distributor for Palomar's hair removal lasers. If
Coherent fails to meet certain minimums sales quotas specified in its agreement
with Palomar, it loses its exclusive distribution rights. Coherent is the
largest medical laser company in the world, with over 200 sales persons
worldwide. Under its agreement with Palomar, Coherent is responsible for sales,
marketing, service, training and education. Coherent has over 50 service
representatives in the US, and over 100 worldwide. (See Item 7. "Risk Factors -
Dependence on New Relationship with Coherent" and Note 12(e) to Financial
Statements.)
Laser for Tattoo and Pigmented Lesion Removal
The Company also sells a Q-switched ruby laser for tattoo removal and
treating pigmented lesions, the RD-1200(TM). In 1997, RD-1200(TM) sales
constituted approximately 10% of the Company's sales, and were primarily
overseas, in Japan, Korea and other parts of the world. Palomar sells and
services the RD-1200(TM) through distributors internationally. In the United
States, Palomar has provided service through its own service organization, but
expects to arrange for third party service beginning in the middle of 1998.
The RD-1200(TM) Q-switched ruby laser has been on the market for nearly
nine years. Competition in the medical device industry is intense and technology
developments have continued at a rapid pace over the past decade. While the
RD-1200(TM) Q-switched ruby laser is still recognized as the "gold standard" for
performance in this market, there are less expensive products now available for
this purpose. Palomar expects sales of this product to continue in 1998 at a low
volume to foreign countries where the advantages of ruby laser for treatment of
pigmented lesions is especially important.
Cosmetic Laser Services
An additional avenue that the Company has explored for its laser
technology is the service business conducted through its CTI subsidiary, which
was incorporated in 1996 for that purpose. During 1997, CTI established a number
of test sites to explore business models.
3
In early 1997, CTI entered into a binding letter of intent with
Columbia/HCA, one of the world's largest owners and operators of medical
facilities, to establish revenue-sharing cosmetic laser service sites in
existing Columbia/HCA facilities. To date, three such sites have been
established. CTI provides each of its sites with a turnkey package of laser and
medical device technology, equipment, training and service, operations
personnel, strategic advertising and marketing programs, patient financial
credit programs and management assistance. To date, ten CTI revenue-sharing
sites in addition to the Columbia/HCA sites are open and under development.
During 1997, CTI generated revenues of approximately $1,000,000 and incurred
operating expenses of approximately $4,500,000.
(ii) PRODUCTS UNDER DEVELOPMENT
Burn Diagnosis Laser System
In 1994, the Company's Star subsidiary was awarded a $60,000 Phase I
Small Business Innovation Research Grant ("SBIR") entitled "High Energy Diode
Laser for Burn Diagnosis" by the U.S. Air Force, Phillips Laboratory. In 1994,
Star obtained an exclusive, worldwide license to a patent relating to the
measurement of burn depth in skin from the Office of Technology Affairs at MGH.
In 1995, Star was granted a $743,000 follow-on Phase II SBIR contract by
Phillips Laboratory for the research and development of the burn diagnostic
system. During the fiscal years ended December 31, 1997, 1996 and 1995, Star
recognized $149,251, $281,991 and $307,000 of government contract revenue,
respectively. In 1996, Star began initial clinical testing of the burn diagnosis
system at the Shriner Burn Center in Boston, Massachusetts and at the Augusta
Medical Center in Augusta, Georgia. The system is designed to illuminate the
wound site with near infrared light from a diode laser and to image the blood
flow using a fluorescence dye as an aid to the doctor in determining the extent
of blood flow within the dermis to more accurately diagnose the degree of a burn
and to enable physicians to improve treatment of burn patients. To date the
system has been tested on a small number of burn patients and has demonstrated
the ability to detect the absence or presence of blood flow deep in the dermis.
The system has also been used clinically to determine blood flow surrounding
skin ulcers and in surgical flaps, again, on a very limited number of patients.
Clinical testing continues at the Augusta Medical Center. The Company expects
that it may take several years before a commercial blood flow diagnostic product
is available.
Laser Tonsillectomy
In June 1994, the Company signed an agreement with the Otolaryngology
Research Center for Advanced Endoscopic Applications at New England Medical
Center, Boston, Massachusetts (the "NEMC Agreement"), to provide a research
grant and to sponsor investigations and development of laser applications,
advanced delivery systems and disposable products in the area of dye and diode
laser applications in otolaryngology and related specialties. Under the NEMC
Agreement, the Company provided a total of $150,000 in funding and $50,000 in
the form of laser hardware. The parties have reached an understanding that the
Company will obtain ownership rights or the right of first refusal to exclusive
worldwide licenses to sell and market any inventions developed with the grant
funding. In August 1994, the NEMC Agreement was amended to support animal
testing with one of the Company's diode lasers in connection with performing
tonsillectomies. In the year ended December 31, 1997, the Company provided
$54,000 in funding. The animal studies were completed successfully in 1997. The
Company intends to fund human clinical studies in this area over the next twelve
month period. The Company expects that it may take several years before a
commercial product for tonsillectomy is available.
Dye Laser
During 1995, the Company entered into a two year cost plus fixed fee
contract with the U.S. Army for the investigation of compact, wavelength
diverse, high efficiency solid-state dye lasers. In 1997, the Company, which
does not anticipate this research will result in a commercial product within the
next few years, concluded with the U.S. Army a Novation Agreement which novates
this contract to Physical Sciences, Inc. ("PSI"). Upon completion of the
contract, PSI has agreed to offer the Company a right of first refusal for a
commercial license to sell, manufacture or otherwise dispose of solid-state dye
laser technology as developed by PSI under the contract for use in medical
products.
4
Laser Thrombolysis
In 1993, the Company entered into an agreement with the Edwards LIS
Division of Baxter (the "Baxter Agreement") regarding an integrated system
utilizing lasers and catheters for the removal of blood clots. Under the Baxter
Agreement, Baxter licensed its proprietary technology to the Company, and the
Company cross-licensed its laser thrombolysis technology to Baxter. The Company
also granted to Baxter a license to sell and market products incorporating such
technology. Baxter agreed to transfer its interest in the agreement to Advanced
Cardiovascular Systems, Inc. ("ACS"), a division of Eli Lilly, as part of a
purchase by Eli Lilly of the Baxter LIS division. Eli Lilly subsequently sold
ACS to Guidant Corp.
In January 1997, Palomar became an equity partner in the formation of a
new company, LaTIS, Inc., created to use Palomar's laser thrombolysis technology
to develop a pulsed-dye laser system for treating strokes. All licenses relating
to this technology have been transferred to LaTIS. With the formation of this
new venture, laser thrombolysis is no longer part of Palomar's strategic agenda,
although the Company can still derive some benefits from its research due to its
equity participation.
(iii) PRODUCTION AND SOURCES AND AVAILABILITY OF MATERIALS
Palomar's manufacturing and research and development operations are
located in two locations, Lexington, Massachusetts and Pleasanton, California.
The ruby laser system is manufactured in Massachusetts and the diode laser
system is manufactured in California. Manufacturing consists of the assembly and
testing of components purchased from outside suppliers and contract
manufacturers. Palomar maintains control of and manufactures key components
in-house. The entire fully assembled system is subjected to a rigorous set of
tests prior to shipment to the customer or distributors.
Palomar depends and will depend upon a number of outside suppliers for
components used in its manufacturing process. Most of Palomar's components and
raw materials are available from a number of qualified suppliers. Two critical
components that are available through only one qualified supplier each are ruby
rods for the ruby lasers and diode bars for the diode lasers. To date, the
Company has not experienced, nor does it expect to experience, any significant
delays in obtaining component parts or raw materials. Palomar has expanded its
manufacturing capabilities to satisfy projected demand. Palomar has the approval
for the CE Mark for the EpiLaser(R) laser system, and is working towards
completion of ISO 9001 registrations for both facilities. (See "Risk Factors -
Dependence on Suppliers.")
(iv) PATENTS AND LICENSES
Certain processes by which the Company is able to produce its products
are largely proprietary. The Company believes that patent protection of its
technology and products that result from the Company's research and development
efforts is important to the possible commercialization of the Company's
technology. The Company continually attempts to protect its proprietary
technology by obtaining patent application protection and relying on trade
secret laws and non-disclosure and confidentiality agreements with its employees
and persons that have access to its proprietary technology.
To date, the Company and its subsidiaries have filed eleven patent
applications related to its laser products with the United States Patent and
Trademark Office in order to protect its current technology. This includes two
applications that are continuations of previous applications. To date, two of
these patents have been issued. Additionally, the Company extends many of its
domestic filings into foreign applications. To date, four foreign applications
have been filed, and no foreign patents have been issued. The Company intends to
aggressively pursue any person or company that offers products that the Company
believes infringe on one or more of its patents or on patents licensed
exclusively to the Company.
The Company believes it owns, or has the right to use, the basic
patents covering its products. However, each year there are hundreds of patents
granted worldwide related to lasers and their applications. In the past, the
Company has been able to obtain patent licenses for patents related to its
products on commercially reasonable terms. The failure to obtain a key patent
license from a third party could cause the Company to incur liabilities for
patent infringement and, in the extreme case, to discontinue the manufacturing
of products that infringe upon the patent. Management believes that none of the
Company's current products infringe upon a valid claim of any patents owned by
third parties, where the failure to license the patent would have a material and
adverse effect on the Company's financial position or results of operations.
5
In March 1997, one of Palomar's competitors, Selvac Acquisitions Corp.
("Selvac"), filed a complaint alleging, among other things, that the EpiLaser(R)
laser system infringes a patent held by Selvac.
Another company has recently informally notified the Company's
distributor that it believes that the Company's contact cooling method as used
in connection with the Company's diode laser for vascular lesions infringes a
patent owned by that company. The Company is evaluating this contention. Based
upon the Company's review to date, it does not appear that this patent should be
successfully assertable against the Company.
Other than the two matters described above, the Company has not been
notified that it is currently infringing on any patents nor has it been the
subject of any patent infringement action. Defense of a claim of infringement is
costly and could have a material adverse effect on the Company's business, even
if the Company were to prevail. (See Item 3. "Legal Proceedings" and Item 7.
"Risk Factors - Patents/Possible Patent Infringements.")
The Company also entered into a four year agreement with MGH whereby
MGH agreed to conduct clinical trials on a laser treatment for hair
removal/reduction invented by Dr. R. Rox Anderson, Wellman Laboratories of
Photomedicine, MGH. As part of the agreement, MGH provided the Company with
prior data already generated by Dr. Anderson with respect to the ruby laser
device at MGH. This information was the basis for the Company's application
filed with the FDA for approval of the Company's EpiLaser(R) laser system for
treating unwanted hair. The Company is obligated to fund the clinical research
in the aggregate amount of approximately $917,000 over the term of its contract
with MGH. Effective February 14, 1997, the Company amended the 1995 agreement
with MGH. Under the terms of this amendment, the Company agreed to provide MGH
with a grant of $203,757 to perform research and evaluation in the field of hair
removal. During 1997, the Company incurred approximately $1,100,000 under its
clinical research agreement with MGH and other clinical studies.
In August 1995, the Company entered into a worldwide exclusive
agreement with MGH to license (with the right to sublicense) U.S. Patent No.
5,595,568 ("Permanent Hair Removal Using Optical Pulses") as well as any other
patents arising out of the Palomar-funded clinical trials. As consideration for
this license, the Company is obligated to pay MGH royalties of 5% of net
revenues on products covered by valid patents licensed to the Company
exclusively; 2.5% of net revenues on products covered by valid patents licensed
to the Company non-exclusively; no less than 2.5% of net revenues for products
sold for hair removal as well as other uses, and a royalty to be negotiated on
services or commercial dispositions (other than sales) involving products
covered by valid patents licensed to the Company.
On February 24, 1993, the principals of the Company's Star subsidiary
applied for a patent. This application was subsequently transferred to Star in
connection with the technology underlying the use of a high-powered diode laser
for the treatment of psoriasis and other derma vascular malformation. The patent
was issued on June 18, 1996. Star has applied for additional patents regarding
the design and use of high-powered diode lasers. On June 22, 1995, the New
England Medical Center ("NEMC") filed a patent application for Coagulation Laser
Tonsillectomy; which application was issued as a patent on May 28, 1996. The
Company has exclusive rights to the NEMC patent. MGH has filed a number of
patents surrounding technology involving laser hair removal. The first patent
was issued on January 21, 1997, and a continuation-in-part of this patent was
issued on April 7, 1998. The Company has licensed this laser hair removal
technology from MGH in accordance with a certain license and research agreement
as previously discussed.
(v) SEASONAL INFLUENCES
There is no significant seasonal influence on the Company's sales.
(vi) FINANCING OF OPERATIONS AND INCREASE IN OUTSTANDING SHARES
The Company has financed current operations and past expansion of its
core business with short-term financial borrowings and investments through the
private sale of debt and equity securities of the Company. The Company raised a
total of $31,197,709 and $53,534,990 in such financings during the years ended
December 31, 1997, and December 31, 1996, respectively. The Company anticipates
that it will require substantial additional financing during the next twelve
month period. The Company may from time to time be required to raise additional
funds through additional private sales of the Company's debt or equity
securities. Sales of securities to private investors have been sold at a
discount to the current
6
or future public market for similar securities. It has been the Company's
experience that private investors require that the Company make its best effort
to register their securities for resale to the public at some future time. There
can be no assurance that the Company will be successful in raising additional
capital on favorable terms. (See Notes 1, 6, 7 and 13 to Financial Statements,
Item 5. "Market for Common Equity and Related Stockholder Matters," and Item 7.
"Risk Factors - Substantial Continuing Losses; Doubt About Ability to Continue
as a Going Concern.")
As a result of financing activities, business developments, mergers and
acquisitions, issuance of incentive stock options and warrants to purchase
common stock to attract and retain key employees, the Company's issued and
outstanding shares of common stock have increased to 45,792,585 at December 31,
1997. The Company also had additional reserved but unissued shares of common
stock of 31,149,432 shares at December 31, 1997. The Company's issued and
outstanding shares of common stock increased subsequent to December 31, 1997 to
59,553,243 shares with additional reserved but unissued shares of common stock
of 28,180,020 shares as of March 20, 1998. A substantial number of the Company's
reserved shares are registered and could be resold into the public market. (See
Item 7. "Risk Factors - Issuance of Reserved Shares; Registration Rights;
Issuance of Preferred Stock and Debenture Could Affect Rights of Common
Stockholders; and Significant Outstanding Indebtedness; - Subordination of
Debentures.")
There are no special inventory requirements or credit terms extended to
customers that would have a material adverse effect on the Company's working
capital.
(vii) DEPENDENCY ON A SINGLE CUSTOMER
Sales pursuant to the Company's Sales Agency, Development and License
Agreement with Coherent accounted for approximately 11% of the Company's total
revenues in fiscal 1997. (See - Marketing, Distribution and Service, "Risk
Factors - Dependence on New Relationship with Coherent" and Notes 3(i) and 12(e)
to Financial Statements.)
(viii) BACKLOG
The Company's backlog of firm orders for its continuing operations at
December 31, 1997, and December 31, 1996, was approximately $2.5 million and
$2.2 million, respectively. The backlog as of year-end has already been filled
in 1998. As of March 31, 1998, the Company's backlog of firm orders related to
its laser hair removal systems was approximately $7,000,000.
(ix) GOVERNMENT CONTRACTS
Not applicable.
(x) COMPETITION
The markets in which the Company is engaged are subject to keen
competition and rapid technological change. Four other companies, ThermoLase
Corporation, Laser Industries, Ltd., MEHL/Biophile International and Cynosure,
Inc. have received market clearance from the FDA for laser hair removal and
another company, ESC Medical Systems Limited, has received FDA clearance to
market a laser-like system using filtered intense light to remove hair. The
Company expects that other hair removal devices will be developed and/or
introduced in 1998, making laser hair removal the most competitive application
within the cosmetic laser marketplace. The Company also expects that there will
be further consolidation of companies within the laser hair removal industry via
acquisitions, partnering arrangements or joint ventures; ESC Medical Systems
Limited recently completed the acquisition of Laser Industries. The Company's
products will also compete with other hair removal products and methods. The
Company competes primarily on the basis of technology, product performance,
price, quality, reliability, distribution and customer service and support. To
remain competitive, the Company will be required to continue to develop new
products, periodically enhance its existing products and compete effectively in
the areas described above. (See Item 7. "Risk Factors - Dependence on New
Products; Highly Competitive Industries.")
In the cosmetic laser services industry, the Company's CTI subsidiary
competes not only with other laser companies which also either revenue-share
with physicians and/or operate their own centers, but also with healthcare
providers. CTI's services will also compete for business with other aesthetic
service providers such as electrologists, beauty
7
salons, spas, and aestheticians, among others. Product efficacy, location,
marketing, a wide offering of laser procedures, price and customer service are
all important competitive factors. (See Item 7. "Risk Factors - New Ventures.")
(xi) RESEARCH AND DEVELOPMENT
During fiscal 1997, fiscal 1996, and fiscal 1995, the Company incurred
approximately $11,990,332, $6,297,477 and $3,964,920, respectively, of
internally sponsored research and development programs. Due to the intense
competition and rapid technological changes in the laser industry, the Company
believes that it must continue to improve and refine its existing products and
services, and develop new applications for its technology.
Wellman Laboratories ("Wellman Labs"), the world's largest biomedical
laser research facility and part of the MGH Laser Center located in Boston,
Massachusetts, was created to oversee and speed the flow of biomedical laser
research from the laboratory to patient care. Funded in part by a grant from the
Department of Energy, the MGH Laser Center brings together two strengths of MGH:
its clinical departments and the Wellman Labs. The MGH Laser Center works
together with industry, academia and the Department of Energy Laboratories to
access information and technology across a broad spectrum of laser and medical
capabilities. The principals at Wellman Labs study the fundamental photophysical
and photochemical properties and processes of biomolecules excited by
ultraviolet, visible and near infrared radiation. Engineers, laser physicists
and physicians familiar with all aspects of biomolecules, cells and tissue in
vitro staff the labs. The scientists work side by side with the clinicians to
understand the basic principles involved in the complex interactions of light
and tissue. In 1994, the Company began a number of studies for the treatment of
certain dermatological conditions using its diode laser at Wellman Labs. In
1995, those studies were expanded to include the Company's ruby lasers for
cosmetic procedures. In 1997, those studies were again expanded to include the
Company's diode lasers for cosmetic purposes. Wellman Labs and the Company are
currently evaluating the data associated with these treatments. The Company
works closely with Dr. R. Rox Anderson, the Research Director of the MGH Laser
Center and Associate Professor of Dermatology at Harvard Medical School, who is
a recognized expert in laser tissue interaction and the inventor of a number of
laser procedures in use today. Dr. Anderson has authored over 60 papers in
peer-reviewed publications relating to the use of lasers in dermatology, is the
recipient of numerous awards in the field of laser medicine and serves as a
member of the Blue Ribbon Government Liaison Committee of the American Society
for Laser Medicine and Surgery. Dr. Anderson holds ten U.S. patents and has
pending applications for an additional eleven. The Company feels that these
types of relationships are critical in developing effective products for
widespread use in the market on a timely basis, and that this method of
conducting research and development provides a higher level of technical and
clinical expertise than it could provide on its own and in a more cost-efficient
manner.
PMP's Vice President of Research and Development, Gregory Altshuler, is
the former Director of the Laser Center of the St. Petersburg (Russia) Institute
of Fine Mechanics and Optics (the "St. Petersburg Laser Center)" and the Company
continues to work closely with the St. Petersburg Laser Center, contracting out
research and development tasks to them on a project basis. Palomar owns all
inventions, developments and patents which result from the work performed at the
St. Petersburg Laser Institute and funded by Palomar. In 1997, the Company spent
approximately $100,000 on research and development conducted at the St.
Petersburg Laser Institute. Dr. Altshuler holds approximately 50 patents in
Russia in the field of lasers and the application of lasers in medicine, and has
authored approximately 130 papers relating to laser physics, engineering and
medicine.
While MGH focuses on the biological aspects of laser hair removal, Dr.
Altshuler's in-house research and development team focuses on the physical
aspects. Approximately 40 employees of the Company and its subsidiaries were
engaged full time in research and development activities at December 31, 1997.
Pursuant to the Sales Agency, Development and License Agreement that
the Company entered into with Coherent in November 1997, the Company has
committed to spend the following amounts on research and development over the
next three years: at least $5,000,000 in 1998, at least 10% of its 1998 gross
revenues (minus commissions to Coherent) from cosmetic laser products ("Product
Revenues") in 1999, and at least 10% of its 1999 Product Revenues in 2000.
(See Item 7. "Risk Factors - Dependence on Third Party Researchers" and
Note 8 to Financial Statements.)
8
(xii) ENVIRONMENTAL PROTECTION REGULATIONS
The Company believes that compliance with federal, state and local
environmental regulations will not have a material adverse effect on its capital
expenditures, earnings or competitive position.
(xiii) IMPACT OF MEDICAL DEVICE REGULATIONS
The Company's products are subject to regulation and control by the Center
for Devices and Radiological Health, a branch of the Food and Drug
Administration (FDA) within the Department of Health and Human Services. The FDA
medical device regulations require either an Investigational Device Exemption,
Pre-Market Approval or 510(K) clearance before new products can be marketed to,
or utilized by, the physician. The Company's products are subject to similar
regulations in its major international markets. Complying with these regulations
is necessary for the Company's strategy of expanding the markets for and sales
of its products into these countries. These approvals may necessitate clinical
testing, limitations on the number of sales and controls of end user purchase
price, among other things. In certain instances, these constraints can delay
planned shipment schedules as design and engineering modifications are made in
response to regulatory concerns and requests. The Company's competitors are
subject to the same regulations. (See Item 7. "Risk Factors - Government
Regulation.")
(xiv) NUMBER OF EMPLOYEES
As of December 31, 1997, the Company and its PMP, CTI and Star
subsidiaries employed 165 people, two independent contractors and three
temporary employees. In addition, as of December 31, 1997, the Company's Dynaco
subsidiary employed 187 people.
The Company's ability to develop, manufacture and market its products
and to establish and maintain a competitive position in the industry will
depend, in large part, upon its ability to attract and retain qualified
technical, marketing and managerial personnel. The Company believes that its
relations with its employees are good. None of the Company's employees are
represented by a union. (See Item 7. "Risk Factors - Need for Additional
Qualified Personnel.")
(d) FINANCIAL INFORMATION ABOUT EXPORTS BY DOMESTIC OPERATIONS
Aggregate export sales for the Company's continuing operations were
approximately $2,468,000 for 1995, $3,935,000 for 1996 and $4,978,000 for 1997.
The 1995 export sales consisted primarily of the RD-1200(TM) tattoo removal
laser, the 1996 export sales of a combination of both the RD-1200(TM) and the
EpiLaser(R) laser system, and the 1997 export sales primarily of the EpiLaser(R)
laser system. (See Note 3(h) to Financial Statements.)
ITEM 2. PROPERTIES.
The Company and its PMP and CTI subsidiaries occupy approximately
25,000 square feet of office, manufacturing and research space in Lexington,
Massachusetts under a lease expiring in May 2000. The Company's Star subsidiary
occupies approximately 15,000 square feet of office, manufacturing and research
space under a lease expiring in April 1999 in Pleasanton, California. The
Company believes that these facilities are in good condition and are suitable
and adequate for its current operations. (See Note 12(a) to Financial
Statements.)
ITEM 3. LEGAL PROCEEDINGS.
On October 7, 1996 the Company filed a declaratory judgment action in
the United States District Court for the District of Massachusetts against
MEHL/Biophile ("MEHL") seeking (i) a declaration that MEHL is without right or
authority to threaten or maintain suit against the Company or its customers for
alleged infringement of the patent held by MEHL's subsidiary Selvac Acquisitions
Corp. (the "Selvac Patent"), that the Selvac Patent is invalid, void and
unenforceable, and that the Company does not infringe the Selvac patent; (ii) a
preliminary and permanent injunction enjoining MEHL from threatening the Company
or its customers with infringement litigation or infringement; and (iii) an
award to the Company of damages suffered in connection with MEHL's conduct. On
March 7, 1997, Selvac filed a complaint for injunctive relief and damages for
patent infringement and for unfair competition in the United States District
Court for the District of New Jersey against the Company, two of its
9
subsidiaries and a New Jersey dermatologist. Selvac's complaint alleges that the
Company's EpiLaser(R) laser system infringes the Selvac Patent and that the
Company unfairly competed by promoting the EpiLaser(R) laser system for hair
removal before it had received FDA approval for that specific application. The
Company and Selvac agreed to dismiss the Massachusetts litigation without
prejudice. The Company has brought in the New Jersey action its claims that the
Selvac patent is invalid, that the Company has not infringed the Selvac patent,
that MEHL should be enjoined from making further assertions concerning
infringement and unfair competition, and that the Company should be awarded
attorney fees and other appropriate relief. Thus both the Company's and MEHL's
claims will be presented on the merits in New Jersey. The court has granted the
Company's motion to dismiss Selvac's federal unfair competition claim so far as
it depends on the Company's supposed violations of FDA rules. The court has also
granted the Company's motion to amend its complaint to allege that Selvac's
patent was obtained by inequitable conduct. The Company has moved for summary
judgment on the grounds that the Selvac patent is invalid and was obtained by
inequitable conduct. Discovery in the case has been stayed by court order
pending a ruling on the Company's dispositive motion. The Company believes that
MEHL's claims are without merit.
On October 16, 1997, the Company brought a declaratory judgment action
in United States District Court for the District of Massachusetts against the
holders and the indenture trustee of the Company's 4.5% Subordinated Convertible
Debentures due 2003, denominated in Swiss francs (the "Swiss Franc Debentures").
The defendants in this action are Banque SCS Alliance SA, Arbuthnot Fund
Managers, Ltd., Banca Commerciale Lugano, Privatinvest Bank AG (these four
defendants being referred to collectively as the "Asserting Holders"), CUF
Finance S.A., Fibi Bank (Schweiz) AG, Teawood Nominees, Ltd., JS Gadd & CIE, SA,
Swedbank (Luxembourg) SA, Christiana Bank Luxembourg SA, (now known as Credit
Agricole Indosuez), Landatina Financiera SA and American Stock Transfer & Trust
Co., as trustee ("Trustee"). Just prior to this suit, the Asserting Holders had
alleged that the Company is in breach of certain protective covenants under the
indenture. The Company believes that it is not in default under any protective
covenants, and the Company's action seeks a declaration from the Court to that
effect. All payments on the Swiss Franc Debentures were current to the time of
suit. On October 22, 1997, the Asserting Holders sued the Company and all of its
principal subsidiaries in the same court; the October 16th and October 22nd
cases have been assigned to the same judge, and the dispute between the
Asserting Holders and the Company is proceeding under the October 22nd case. The
Asserting Holders claim that the Company has breached certain protective
indenture covenants and that the Asserting Holders are entitled to immediate
payment of their indebtedness under the Swiss Franc Debentures (which amounts to
approximately US$5,087,000 at current exchange rates). The Asserting Holders
sought a temporary restraining order attaching bank accounts and barring the
Company from transferring any interest in securities of its subsidiaries. The
Court denied this motion, and the Asserting Holders withdrew a preliminary
injunction motion concerning essentially the same issues. 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 court thereafter denied without prejudice the
Company's motion to dismiss the complaint on the ground the Asserting Holders
had failed to proceed through the Trustee, as required, and denied without
prejudice the Company's motion for summary judgment as to its conversion. The
Asserting Holders' summary judgment motion, arguing that an event of default has
occurred as a matter of law, is under advisement. The court has schedule a
time-limited evidentiary hearing, further to clarify the legal and factual
issues. If there remain disputed issues after that hearing, the case will be
tried before a factfinder. The Company believes that its position in these
matters is correct and intends to contest the claims of the Asserting Holders
vigorously. (See Note 6(a) to Financial Statements.)
On August 27, 1997, Pamela Siegman, as Trustee for the Pamela Siegman
Trust, filed an action in the Court of Chancery of the State of Delaware in and
for New Castle County against the Company and each of its current directors and
two former directors. Siegman, purportedly on behalf of similarly situated
shareholders, claimed disclosure errors and omissions in the Company's annual
meeting proxy statement, and sought a declaration that the Company's preferred
stock is void because of a purported deficiency in the Company's Certificate of
Incorporation. On March 9, 1998, the Court of Chancery ruled against Siegman on
all of her claims (she had abandoned some of her claims prior to the Court's
ruling). The Company does not know whether Siegman will appeal the ruling, as
the court's final order has not of this date been entered.
(See "Risk Factors - Risks Associated with Pending Litigation" and Note
12(d) to Financial Statements.)
10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's common stock is currently traded on the National
Association of Securities Dealers Automated Quotation System (NASDAQ) under the
symbol PMTI. The following table sets forth the high and low bid prices quoted
on NASDAQ for the Common Stock for the periods indicated. Such quotations
reflect inter-dealer prices, without retail markup, markdown or commission and
do not necessarily represent actual transactions.
Fiscal Year Ended
December 31, 1996
-----------------
High Low
-----------------
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
-----------------
High Low
-----------------
Quarter Ended March 31, 1997 9 1/4 5 7/16
Quarter Ended June 30, 1997 5 3/4 2 3/8
Quarter Ended September 30, 1997 4 7/16 1 15/16
Quarter Ended December 31, 1997 2 31/32 25/32
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 shares of
12
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.)
13
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected consolidated financial and
other information (in thousands except per share data) on a consolidated
historical basis for the Company and its subsidiaries as of and for each of the
fiscal years in the five year period ended December 31, 1997. Pursuant to
Accounting Principles Board Opinion ("APB") No. 30, Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions, the
consolidated financial statements of the Company have been reclassified to
reflect the dispositions of its subsidiaries that comprise the electronics
segment. (See Note 2 to Consolidated Financial Statements.) (Note that in 1994
the Company changed its fiscal year end from March 31 to December 31.) This
table should be read in conjunction with the Consolidated Financial Statements
of the Company and the Notes thereto included elsewhere in this Annual Report on
Form 10-K.
14
Year ended Nine months ended Year ended
March 31, December 31, December 31,
------------------------ ------------------ ---------------------------------------------
Income Statement Data 1994 1994 1995 1996 1997
------------------------ ------------------ ------------ ------------- ----------------
Revenues $10 $40 $5,610 $17,607 $20,995
Cost of Revenues -- 18 3,464 14,169 20,056
----------------------- ------------------ ------------ ------------- ----------------
Gross profit 10 22 2,146 3,438 939
----------------------- ------------------ ------------ ------------- ----------------
Operating Expenses
Research and development 1,911 2,939 3,965 6,297 11,990
Sales and marketing -- -- 2,769 5,077 6,960
General and administrative 1,630 1,561 2,142 9,753 15,332
Business development -- 1,240 1,409 2,880 2,061
Restructuring and Asset -- -- -- 1,661 3,325
Write-off
Settlement and Litigation -- -- 700 880 3,199
Costs
----------------------- ------------------ ------------ ------------- ----------------
Total operating expenses 3,541 5,740 10,985 26,548 42,867
----------------------- ------------------ ------------ ------------- ----------------
Loss from operations (3,531) (5,718) (8,839) (23,110) (41,928)
Interest Expense (33) (76) (766) (271) (6,994)
Interest Income 53 38 912 1,355 456
Net Gain on Trading Securities -- -- 201 2,033 (52)
Asset Write-off -- -- -- (1,397) (9,658)
Other Income (Expense) 82 67 102 592 (193)
----------------------- ------------------ ------------ ------------- ----------------
Net Loss from Continuing
Operations (3,429) (5,689) (8,390) (20,798) (58,369)
----------------------- ------------------ ------------ ------------- ----------------
Loss from Discontinued Operations:
Loss from Operations (634) (3) (4,231) (20,896) (29,509)
Gain on Dispositions, net -- -- -- 3,830 2,074
----------------------- ------------------ ------------ ------------- ----------------
Net Loss from Discontinued
Operations (634) (3) (4,231) (17,066) (27,435)
----------------------- ------------------ ------------ ------------- ----------------
Net Loss $(4,063) $(5,692) $(12,621) $(37,864) $(85,804)
======================= ================== ============ ============= ================
Basic and Diluted Net Loss
Per Common Share:
Continuing Operations $(0.85) $(0.84) $(0.60) $(0.84) $(1.79)
Discontinued Operations (0.15) 0.00 (0.30) (0.65) (0.78)
----------------------- ------------------- ------------ ------------- ----------------
Total Loss Per Common Share $(1.00) $(0.84) $(0.90) $(1.49) $(2.57)
======================= =================== ============ ============= ================
Weighted Average Number of
Common Shares Outstanding 4,053 6,759 14,165 26,167 35,105
======================= =================== ============ ============= ================
Balance Sheet Data:
Working Capital 279 2,491 12,998 15,203 (9,139)
Total Assets 2,581 6,551 33,656 67,533 28,968
Long-term obligations 37 2,322 1,765 14,665 12,446
Stockholders' Equity (Deficit) 1,466 2,794 25,289 38,077 (6,184)
15
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
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
16
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. (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,
combined with the transformation of the Company from the development stage to
product 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.
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.
17
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
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.
18
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
As of December 31, 1997, the Company had approximately $4,453,000
million in cash, cash equivalents and trading securities. During the year ended
December 31, 1997, the Company 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.
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.")
19
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.
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 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.")
20
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.
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
21
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
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
22
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 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.")
23
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 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 pro