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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period endedMarch 31, 2006
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 0-18053
LASERSCOPE
(Exact name of registrant as specified in its charter)
CALIFORNIA | 77-0049527 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) |
3070 Orchard Drive
San Jose, California
95134
(Address of principal executive offices and zip code)
San Jose, California
95134
(Address of principal executive offices and zip code)
(408) 943-0636
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
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 reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesþ | Noo |
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filerþ Accelerated filero Non-accelerated filero
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yeso | Noþ |
The number of shares of Registrant’s common stock issued and outstanding as of April 30, 2006 was 22,380,731
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EXHIBIT 31.1 | ||||||||
EXHIBIT 31.2 | ||||||||
EXHIBIT 32.1 | ||||||||
EXHIBIT 32.2 |
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PART I. FINANCIAL INFORMATION.
Item 1. Financial Statements.
Laserscope
Condensed Consolidated Balance Sheets
(in thousands)
(unaudited)
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 33,234 | $ | 30,653 | ||||
Accounts receivable, net of allowance for doubtful accounts of $814 and $416, respectively | 23,972 | 25,138 | ||||||
Inventories | 27,595 | 27,058 | ||||||
Deferred tax assets | 14,954 | 16,285 | ||||||
Other current assets | 3,507 | 2,886 | ||||||
Total current assets | 103,262 | 102,020 | ||||||
Property and equipment, net | 10,919 | 8,663 | ||||||
Goodwill | 655 | 655 | ||||||
Other assets | 405 | 432 | ||||||
Total assets | $ | 115,241 | $ | 111,770 | ||||
Liabilities and Shareholders’ Equity | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 7,617 | $ | 7,961 | ||||
Accrued compensation | 4,341 | 4,273 | ||||||
Warranty | 3,004 | 2,947 | ||||||
Other accrued liabilities | 6,846 | 6,691 | ||||||
Deferred revenue | 4,376 | 5,082 | ||||||
Capital leases, current portion | 19 | 19 | ||||||
Total current liabilities | 26,203 | 26,973 | ||||||
Long-term liabilities: | ||||||||
Obligations under capital leases | 4 | 9 | ||||||
Total long-term liabilities | 4 | 9 | ||||||
Contingencies (see note 7) | ||||||||
Shareholders’ equity: | ||||||||
Common stock | 86,341 | 84,957 | ||||||
Retained earnings | 3,078 | 287 | ||||||
Accumulated other comprehensive loss | (385 | ) | (456 | ) | ||||
Total shareholders’ equity | 89,034 | 84,788 | ||||||
Total liabilities and shareholders’ equity | $ | 115,241 | $ | 111,770 | ||||
The accompanying notes are an integral part of these condensed consolidated interim financial statements.
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Laserscope
Condensed Consolidated Statements of Income
(in thousands, except per share amounts)
(Unaudited)
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Net revenues | $ | 32,009 | $ | 28,177 | ||||
Cost of sales (1) | 12,499 | 10,577 | ||||||
Gross margin | 19,510 | 17,600 | ||||||
Operating expenses: | ||||||||
Research and development (1) | 2,949 | 1,585 | ||||||
Selling, general and administrative (1) | 11,835 | 9,878 | ||||||
Total operating expenses | 14,784 | 11,463 | ||||||
Operating income | 4,726 | 6,137 | ||||||
Interest income and other, net | 144 | 79 | ||||||
Income before income taxes | 4,870 | 6,216 | ||||||
Provision for income taxes (1) | 2,079 | 1,253 | ||||||
Net income | $ | 2,791 | $ | 4,963 | ||||
Net income per share | ||||||||
Basic | $ | 0.13 | $ | 0.23 | ||||
Diluted | $ | 0.12 | $ | 0.22 | ||||
Shares used for net income per share | ||||||||
Basic | 22,327 | 22,009 | ||||||
Diluted | 22,823 | 22,986 | ||||||
(1) | Includes the following amounts related to share-based compensation expense of stock options and employee stock purchases |
Cost of sales | $ | 100 | $ | — | ||||
Research and development | 110 | — | ||||||
Selling, general and administrative | 386 | — | ||||||
Benefit for income taxes | (124 | ) | — | |||||
Total | $ | 472 | $ | — | ||||
The accompanying notes are an integral part of these condensed consolidated interim financial statements.
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Laserscope
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 2,791 | $ | 4,963 | ||||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Depreciation and amortization | 545 | 364 | ||||||
Provision for doubtful accounts | 399 | 89 | ||||||
Excess tax benefits from share-based compensation | (420 | ) | — | |||||
Tax benefit from employee stock options | 492 | — | ||||||
Share-based compensation expense of stock options and employee stock purchases | 596 | — | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | 809 | (2,079 | ) | |||||
Inventories | (477 | ) | (3,464 | ) | ||||
Deferred tax assets | 1,331 | — | ||||||
Prepayments and other current assets | (600 | ) | (85 | ) | ||||
Accounts payable | (361 | ) | 3,169 | |||||
Accrued compensation | 59 | (402 | ) | |||||
Warranty | 57 | 68 | ||||||
Deferred revenue | (712 | ) | 2,170 | |||||
Other accrued liabilities | 110 | 465 | ||||||
Net cash provided by operating activities | 4,619 | 5,258 | ||||||
Cash flows from investing activities: | ||||||||
Acquisition of property and equipment | (2,771 | ) | (694 | ) | ||||
Acquisition of intangibles and licenses | — | (15 | ) | |||||
Net cash used in investing activities | (2,771 | ) | (709 | ) | ||||
Cash flows from financing activities: | ||||||||
Payments on obligations under capital leases | (5 | ) | (5 | ) | ||||
Proceeds from the sale of common stock under stock option plans | 295 | 1,488 | ||||||
Excess tax benefits from share-based compensation | 420 | — | ||||||
Proceeds from warrants exercised | — | 15 | ||||||
Net cash provided by financing activities | 710 | 1,498 | ||||||
Effect of exchange rate changes on cash and cash equivalents | 23 | (31 | ) | |||||
Net increase in cash and cash equivalents | 2,581 | 6,016 | ||||||
Cash and cash equivalents, beginning of period | 30,653 | 15,954 | ||||||
Cash and cash equivalents, end of period | $ | 33,234 | $ | 21,970 | ||||
The accompanying notes are an integral part of these condensed consolidated interim financial statements.
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Laserscope
Notes to Unaudited Condensed Consolidated Financial Statements
1. Basis of presentation
The accompanying unaudited condensed consolidated financial statements include Laserscope and its wholly owned subsidiaries (the “Company,” “management,” “we,” “us,” “our”). All intercompany transactions and balances have been eliminated. While the financial information in this report is unaudited, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to state fairly the financial position and results of operations as of and for the periods indicated have been recorded. We recommend that these consolidated financial statements be read in conjunction with the consolidated financial statements and notes for the year ended December 31, 2005 included in the Company’s annual report on Form 10-K for the year ended December 31, 2005. The December 31, 2005 balance sheet data has been derived from the audited financial statements at that date but does not include all disclosures required by accounting principles generally accepted in the United States of America. The results of operations for the three months period ended March 31, 2006 are not necessarily indicative of the results expected for the full year or any other interim period.
Certain prior period balances have been reclassified to conform to the current financial statement presentation.
2. Stock Benefit Plans and Share Based Compensation
Stock Plans
1994 Stock Option Plan
During 1994, we adopted a stock option plan under which the Board of Directors may grant incentive stock options to purchase shares of common stock to employees at a price not less than the fair value of the shares as of the date of grant. The Board of Directors may also grant non-statutory stock options to employees and consultants, including directors who serve as employees or consultants, at not less than 85% of the fair market value of the shares as of the date of grant. Options issued pursuant to the 1994 plan vest and become exercisable over periods of up to four years and expire five years after the date of grant.
The 1994 Stock Option Plan expired by its term with respect to future grants in 2004.
1999 Retention Stock Option Plan
During 1999, we adopted a stock option plan under which the Board of Directors may grant non-statutory options to purchase shares of common stock to non-officer employees at a price not less than the fair value of the shares as of the date of grant. Options issued pursuant to the 1999 plan vest and become exercisable over periods of up to four years and expire five to ten years after the date of grant.
We have reserved 698,000 shares of common stock of which there were 10,319 shares available for issuance pursuant to our 1999 Retention Stock Option Plan as of March 31, 2006.
2004 Stock Option Plan
During 2004, we adopted a stock option plan under which the Board of Directors may grant incentive stock options to purchase shares of common stock to employees at a price not less than the fair value of the shares as of the date of grant. The Board of Directors may also grant non-statutory stock options to employees and consultants, including directors who serve as employees or consultants, at not less than 85% of the fair market value of the shares as of the date of grant. Options issued pursuant to the 2004 plan vest and become exercisable over periods of up to four years and expire five to ten years after the date of grant.
We have reserved 850,000 shares of common stock of which there were 21,260 shares available for issuance pursuant to our 2004 stock option plan as of March 31, 2006.
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Directors’ Stock Option Plans
We have reserved an aggregate of 840,000 shares of our common stock for issuance pursuant to our 1999 and 1995 Directors’ Stock Option Plans. Under these plans, non-employee directors have been granted options to purchase shares of our common stock exercisable at the fair market value of such shares on the respective grant dates. Options issued pursuant to these plans vest and become exercisable over three years from the respective original date of issuance with respect to each optionee who remains a director and expire five to ten years after the date of grant. Upon the adoption of the 1999 Directors’ Stock Option Plan, the 1995 Directors’ Stock Option Plan expired with respect to future grants. There were 240,000 shares available for issuance pursuant to the 1999 Directors’ Stock Option Plan at March 31, 2006.
1999 Employee Stock Purchase Plan
During 1999, we adopted our 1999 Employee Stock Purchase Plan under which qualified employees can purchase up to a specified maximum amount of our common stock through payroll deductions at 85% of its fair market value. The 1999 Employee Stock Purchase Plan replaced the 1989 Employee Stock Purchase Plan which expired in July 1999. We have reserved 750,000 shares of common stock for issuance pursuant to its 1999 Employee Stock Purchase Plan.
General Option Information
The activities under all our stock option plans are summarized as follows:
Options | Weighted Average | |||||||
Outstanding | Exercise Price | |||||||
Balance, January 1, 2004 | 2,593,357 | $ | 3.63 | |||||
Granted | 337,250 | $ | 24.49 | |||||
Exercised | (1,407,038 | ) | $ | 2.09 | ||||
Expired | (66,076 | ) | $ | 14.78 | ||||
Balance, December 31, 2004 | 1,457,493 | $ | 9.44 | |||||
Granted | 579,400 | $ | 29.12 | |||||
Exercised | (277,773 | ) | $ | 5.68 | ||||
Expired | (83,467 | ) | $ | 17.17 | ||||
Balance, December 31, 2005 | 1,675,653 | $ | 16.48 | |||||
Granted | 51,400 | $ | 20.89 | |||||
Exercised | (73,581 | ) | $ | 4.01 | ||||
Expired | (12,213 | ) | $ | 15.49 | ||||
Balance, March 31, 2006 | 1,641,259 | $ | 17.18 | |||||
The following table displays a summary of relevant ranges of exercise prices for options outstanding and options exercisable for our stock option plans at March 31, 2006:
Options Outstanding | Options Exercisable | |||||||||||||||||||
Weighted | ||||||||||||||||||||
Average | Weighted | Weighted | ||||||||||||||||||
Remaining | Average | Average | ||||||||||||||||||
Number | Contractual | Exercise | Number | Exercise | ||||||||||||||||
Range of Exercise Prices | Outstanding | Life (Years) | Price | Exercisable | Price | |||||||||||||||
$1.03-$1.63 | 166,389 | 2.17 | $ | 1.58 | 166,389 | $ | 1.58 | |||||||||||||
$1.65-$4.19 | 168,113 | 3.02 | $ | 3.73 | 154,031 | $ | 3.74 | |||||||||||||
$4.52-$5.25 | 224,901 | 1.60 | $ | 4.98 | 168,206 | $ | 5.02 | |||||||||||||
$7.53-$7.53 | 1,434 | 2.24 | $ | 7.53 | 775 | $ | 7.53 | |||||||||||||
$9.91-$9.91 | 171,054 | 2.39 | $ | 9.91 | 99,223 | $ | 9.91 | |||||||||||||
$14.33-$21.33 | 228,817 | 8.38 | $ | 20.70 | 66,243 | $ | 20.49 | |||||||||||||
$23.10-$23.10 | 164,500 | 9.73 | $ | 23.10 | 1,747 | $ | 23.10 | |||||||||||||
$24.42-$30.01 | 271,651 | 8.23 | $ | 28.93 | 271,651 | $ | 28.93 | |||||||||||||
$30.85-$31.25 | 100,900 | 8.69 | $ | 31.14 | 100,900 | $ | 31.14 | |||||||||||||
$34.40-$34.40 | 143,500 | 9.19 | $ | 34.40 | 143,500 | $ | 34.40 | |||||||||||||
$1.03-$34.40 | 1,641,259 | 5.85 | $ | 17.18 | 1,172,665 | $ | 17.06 | |||||||||||||
At March 31, 2006 aggregate pre-tax intrinsic value of options outstanding and exercisable was $14.4 million and $11.5 million, respectively. Aggregate pre-tax intrinsic value represents the difference between our closing stock price on the last trading day of the
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fiscal period, which was $23.65 as of March 31, 2006, and the exercise price multiplied by the number of options outstanding or exercisable. Total pre-tax intrinsic value of options exercised was $1.4 million and $1.9 million for the three month periods ended March 31, 2006 and March 31, 2005, respectively. The tax benefit realized for the tax deductions from awards exercised for the three month period ended March 31, 2006 was $0.5 million. We issue new shares upon the exercise of stock options.
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment, or SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including stock options and employee stock purchases related to the Employee Stock Purchase Plan based on fair values. Our financial statements as of and for the first quarter of fiscal year 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method we used in adopting SFAS 123(R), our financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Share-based compensation expense recognized in our Condensed Consolidated Statement of Income during the first quarter of fiscal year 2006 include compensation expense for share-based payment awards granted prior to, but not yet vested as of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), we elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for our pro forma information required under SFAS 123, Share-based compensation expense related to stock options and employee stock purchases was $0.6 million, before taxes on earnings, for the first quarter of fiscal year 2006. During the first quarter of fiscal year 2005 there was no share-based compensation expense related to stock options or employee stock purchases recognized under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, or APB 25.
Upon adoption of SFAS 123(R), we elected to value our share-based payment awards granted beginning in fiscal year 2006 using the Black-Scholes option-pricing model, or the Black-Scholes model, which we previously used for the pro forma information required under SFAS 123. The determination of fair value of share-based payment awards on the date of grant using the Black-Scholes model is affected by our stock price as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and our expected stock price volatility over the term of the awards.
The fair value of options granted and the option component of the Employee Stock Purchase Plan shares were estimated at the date of grant using the Black-Scholes option pricing model. The assumptions used to value the option grants and purchase rights are stated as follows:
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Expected life of options (in years) | 3.91 | 4.26 | ||||||
Expected life of ESPP rights (in years) | 0.50 | 0.50 | ||||||
Volatility for options | 66 | % | 79 | % | ||||
Volatility for ESPP rights | 63 | % | 82 | % | ||||
Risk free interest rate for options | 4.73 | % | 3.87 | % | ||||
Risk free interest rate for ESPP rights | 4.47 | % | 2.68 | % | ||||
Dividend yield | 0.0 | % | 0.0 | % |
The weighted average fair value per share of options granted under our stock option plans during the three months ended March 31, 2006 and 2005, was $11.17 and $18.49, respectively. The weighted average fair value per share of options granted under our employee stock purchase plan during the three months ended March 31, 2006 and 2005, was $7.42 and $8.32, respectively.
The expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding. The expected term is based on the observed and expected time to post-vesting exercise of options by our employees. Upon adoption of SFAS 123(R), we used historical volatility in deriving the expected volatility assumption as allowed under SFAS 123(R) and SAB 107. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our stock options. The dividend yield assumption of zero is based on our history and expectation of dividend payouts.
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As share-based compensation expense recognized in the Condensed Consolidated Statement of Income for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on our historical experience. In our pro forma information required under SFAS 123 for the periods prior to January 1, 2006, we accounted for forfeitures as they occurred. If factors change and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period.
At March 31, 2006, total unrecognized compensation expense related to stock options granted under all our Employee Stock Plans totaled $4.5 million. This unrecognized compensation expense is expected to be recognized over the remaining vesting period of each grant up to the next 48 months.
The following table illustrates the effect on net income after taxes and net income per common share as if we had applied the fair value recognition provisions of SFAS No. 123 to share based compensation during the three month period ended March 31, 2005 (in thousands, except per share amounts):
Three months | ||||||||
ended | ||||||||
March 31, 2005 | ||||||||
Net Income | As Reported | $ | 4,963 | |||||
Deduct: | ||||||||
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | (632 | ) | ||||||
Net Income | Pro Forma | $ | 4,331 | |||||
Basic Earnings Per Share | As Reported | $ | 0.23 | |||||
Pro Forma | 0.20 | |||||||
Diluted Earnings Per Share | As Reported | $ | 0.22 | |||||
Pro Forma | 0.19 |
3. Inventories
Inventories were comprised of the following (in thousands):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Sub-assemblies and purchased parts | $ | 13,067 | $ | 12,785 | ||||
Work-in-process | 8,769 | 7,963 | ||||||
Finished goods | 5,759 | 6,310 | ||||||
$ | 27,595 | $ | 27,058 | |||||
4. Warranty
We have a direct field service organization that provides service for products. We generally provide a twelve month warranty on laser systems. After the warranty period, maintenance and support is provided on a service contract basis or on an individual call basis. Our warranties and premium service contracts provide for a “99.0% Uptime Guarantee” on laser systems. Under provisions of this guarantee, at the request of the customer, we extend the terms of the related warranty or service contract if specified system uptime levels are not maintained.
We currently provide for the estimated cost to repair or replace products under warranty at the time of sale. The cost estimate is based on warranty costs experienced in the prior 12 months, and the outstanding warranty liability is revalued on a quarterly basis.
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Changes in product warranty obligations for the periods ended March 31, 2006 and 2005 are as follows (in thousands):
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Balance at beginning of period | $ | 2,947 | $ | 2,536 | ||||
Add: Expense for products sold | 860 | 753 | ||||||
Expense to extend pre-existing warranties | 101 | 31 | ||||||
Less: Cost of warranty service provided | (904 | ) | (715 | ) | ||||
Balance at end of period | $ | 3,004 | $ | 2,605 | ||||
5. Net income per share
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by giving effect to all dilutive potential common shares, including options and warrants. A reconciliation of the numerator and denominator used in the calculation of historical basic and diluted net income per share follows (in thousands, except per share amounts):
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Numerator: | ||||||||
Net income used in computing basic and diluted net income per share | $ | 2,791 | $ | 4,963 | ||||
Denominator: | ||||||||
Weighted average number of common shares outstanding used in computing basic net income per share | 22,327 | 22,009 | ||||||
Add: Dilutive potential common shares used in computing dilutive net income per share | 496 | 977 | ||||||
Total weighted average number of shares used in computing diluted net income per share | 22,823 | 22,986 | ||||||
Net income per share | ||||||||
Basic | $ | 0.13 | $ | 0.23 | ||||
Diluted | $ | 0.12 | $ | 0.22 |
We exclude options from the computation of diluted weighted average shares outstanding if the assumed proceeds, including the sum of (a) the exercise price of the options; (b) the amount of compensation cost attributed to future periods and not yet recognized and (c) the amount of tax benefit, are greater than the average market price of the shares because the inclusion of these options would be antidilutive to earnings per share. Options to purchase 857,395 and 87,400 shares with a weighted average exercise price of $27.41 and $31.22 for the three month periods ended March 31, 2006 and 2005, respectively, were excluded from the computation of diluted net income per share.
6. Comprehensive income
Total comprehensive income during the periods ended March 31, 2006 and 2005 consisted of ( in thousands):
Three months ended | ||||||||
March 31, | ||||||||
2006 | 2005 | |||||||
Net income | $ | 2,791 | $ | 4,963 | ||||
Translation adjustments | 71 | (118 | ) | |||||
Comprehensive income | $ | 2,862 | $ | 4,845 | ||||
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7. Contingencies
During the quarter ended March 31, 2006, there were no material developments with respect to legal matters except as follows.
Palomar Medical Technologies, Inc. (“Palomar”) has informed Laserscope that it disputes the method used by us for calculating the royalty to be paid on the Lyra laser system pursuant to the Patent License Agreement between Laserscope and Palomar (the “License Agreement”). Palomar also disputes our application of the License Agreement to the Gemini laser system, including our calculation of royalties due on the Gemini laser system under the License Agreement. In the third quarter of 2005, Palomar exercised its right under the License Agreement to engage an independent auditor to conduct a review of our royalty calculations and payments under the License Agreement. In November 2005, the independent auditors issued a report identifying several potential alternative interpretations of the application of the License Agreement that indicate a potential liability of up to $3.7 million. We disagree with each of these potential alternative interpretations and believe that we have been correctly calculating and paying the royalties owed to Palomar under the License Agreement. Accordingly, we have not accrued for a settlement. We intend to vigorously defend our position while we continue to negotiate with Palomar. If our dispute with Palomar is resolved in a manner contrary to our position, we could be required to record additional expenses which could have a material adverse impact on our financial statements.
On November 8, 2005, we received notice from a customer of our GreenLight products alleging that we have violated certain terms of a specific treatment parameters/outcomes program agreement with it. Such party has taken no further action. We believe that we have complied with our obligations under the agreement. If this matter is resolved in a manner unfavorable to the company, it could have a material adverse impact on our financial statements.
We are involved in various legal proceedings and other disputes that arise in the normal course of business. These other matters include product liability actions, contract disputes and other matters. Based on currently available information, we believe we have meritorious defenses to these actions and that resolution of these cases is not likely to have a material adverse effect on our business, financial position, cash flows or future results of operations.
8. Indemnifications
In the ordinary course of business, we enter into contractual arrangements under which we may agree to indemnify the third party to such arrangement from any losses incurred relating to the services they perform on behalf of us or for losses arising from certain events as defined within the particular contract, which may include, for example, patents, litigation or claims relating to past performance. Such indemnification obligations may not be subject to maximum loss clauses. Historically, payments made related to these indemnifications have been immaterial.
We have entered into indemnification agreements with our directors and officers that may require us to indemnify our directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of a culpable nature; to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified; and to make good faith determination whether or not it is practicable for us to obtain directors’ and officers’ insurance. We currently have directors’ and officers’ insurance.
9. Income Tax Provision
Our effective income tax rate in the first quarter of 2006 was 43% as compared to 20% in the first quarter of 2005. As a result of net operating loss and tax credit carryforwards, our effective tax rate for 2005 was 7.5%. Valuation allowances for our deferred tax assets were released in 2005. Without the benefit of net operating loss and tax credit carryforwards to reduce income tax expense in 2006, our book income tax expense increased substantially to reflect the full U.S. federal and state income tax rates (approximately 40.5% combined). In addition, ISO compensation recorded in accordance with SFAS 123(R) represents non-cash expense which is non-deductible for income tax purposes and, therefore, increased the income tax rate by an additional 2.5% in the first quarter of 2006.
10. Intangibles and Other Assets
In June 2005, we acquired certain intellectual property assets related to the Solis intense pulsed light aesthetic treatment device, including among other things the rights to certain patent applications, copyrights, trademarks, designs, trade secrets and licenses to certain other intellectual property (collectively, the “Solis Assets”) from New Star Lasers, Inc., which had been the OEM manufacturer of the Solis product prior to such asset purchase. We acquired the Solis Assets for $250,000 in cash and the OEM agreement between New Star Lasers, Inc. and us was superseded by a supply agreement pursuant to which New Star Lasers, Inc. is to sell certain component parts of the Solis product to us.
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11. Subsequent Event
On April 30, 2006, we acquired all of the outstanding shares of InnovaQuartz, Inc. for approximately $7.5 million in cash, the assumption of $1.1 million in debt and future cash payments contingent on the financial performance of InnovaQuartz, Inc. over approximately three years. The contingent cash payments include payment of up to $3.5 million for achievement of specified financial performance goals plus additional payments based on achievement in excess of such financial performance goals over three years. The purchase price will be allocated to the tangible and intangible assets acquired and liabilities assumed based on their respective fair values at the acquisition date.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
INTRODUCTORY STATEMENT
Some of the statements in this Quarterly Report on Form 10-Q, including but not limited to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this document are forward-looking statements within the meaning of the Private Securities Litigation Act of 1995. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from those expressed or implied by any forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “could,” “would,” “should,” “expect,” “plan,” “anticipate,” “intend,” “believe,” “estimate,” “predict,” “potential” or “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. We refer you to the factors described under the heading “Risk Factors” in this Quarterly Report on Form 10-Q as well as to our Annual Report on Form 10-K for the year ended December 31, 2005 under the heading “Risk Factors.” Readers are cautioned not to place undue reliance on forward-looking statements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of those statements. We are under no duty to publicly release any revision to the forward-looking statements after the date of this document.
Overview.
We are a leading provider of medical laser and other light-based systems for surgical and aesthetic applications. Founded in 1982, we are a pioneer developer of innovative technologies with over 8,500 lasers installed worldwide in doctors’ offices, out-patient surgical centers and hospitals. Our product portfolio consists of lasers and other light-based systems and related energy delivery devices for medical applications.
We primarily serve the needs of two medical specialties: urology and aesthetic surgery. Our GreenLight PV® laser system, offers a treatment for a urological disorder called benign prostatic hyperplasia (“BPH”), an enlargement of the prostate gland experienced by most men after the age of fifty. For aesthetic applications, we offer a full line of products used to perform a wide variety of treatments including the removal of leg and facial veins, unwanted hair, pseudo-folliculitis and wrinkles.
In the United States, we distribute our urology products to hospitals, outpatient surgical centers and physician offices through our own direct sales force. Our urology customers also include various physician partnerships and certain medical technology rental companies that mobilize the GreenLight PV laser system in order to rent it to health care providers on a per use or shared use basis, increasing the availability of a single GreenLight PV laser system for multiple sites. We distribute our aesthetic products through a combination of our direct sales force and our non-exclusive U.S. distribution partner Henry Schein. Until November 9, 2005, we also distributed our aesthetic products through the McKesson Corporation Medical Group (“McKesson”) pursuant to a distribution agreement, that was made non-exclusive in April 2005 and terminated effective as of November 9, 2005. On July 29, 2005, we entered into a non-exclusive distribution agreement with Henry Schein (the “HSI Agreement”), pursuant to which Henry Schein, a distributor of healthcare products and services to office-based practitioners in the North American and European markets, will distribute our aesthetic product line to physicians and physician practices within the United States. We intend to distribute our aesthetic product line through Henry Schein on a non-exclusive basis for the foreseeable future. The Henry Schein distribution relationship has replaced the McKesson distribution relationship as our principal U.S. distribution network for our aesthetic product line.
Sales of our aesthetic products through McKesson and Henry Schein, Inc. as a percentage of total revenues for the respective periods during 2005 and 2006, were as follows:
Three months ended | ||||||||
March 31, 2006 | March 31, 2005 | |||||||
McKesson Corp | — | 12 | % | |||||
Henry Schein | 4 | % | — |
As of March 31, 2006, neither McKesson or Henry Schein accounted for greater than 10% of our total accounts receivable.
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We anticipate that the percentage of aesthetic sales through Henry Schein, Inc. will increase in future periods. However, we are still engaged in the transitional phase of our distribution relationship with Henry Schein, Inc which involves significant training and coordination activities which are necessary to achieve an effective distribution partnership. Although to date we have made substantial progress in effecting this transition, there can be no assurance that our new relationship with Henry Schein will generate revenues equal to or greater than those previously generated through our relationship with McKesson.
In the United Kingdom and France, we distribute our products to hospitals, outpatient surgical centers and physician offices through our own direct sales force. Elsewhere, we sell our products through regional distributor networks throughout Europe, the Middle East, Latin America, Asia and the Pacific Rim. We are both ISO 13485 and CE certified.
For the three month period ended March 31, 2006, our revenues increased compared to the corresponding period in 2005 primarily as a result of growth in sales of our GreenLight PV fiber optic delivery devices and aesthetic lasers and instrumentation. GreenLight PV fiber optic delivery devices are presented in our results of operations under the heading disposable supplies. Our reported revenue for the quarter ended March 31, 2006 was $32.0 million, a 14% increase as compared to total revenues of $28.1 million in the same period in 2005. Our net income in the first quarter of 2006 was $2.8 million, or $0.12 per diluted share. We expect revenues from our urology products, fueled by sales of our GreenLight line of products, will continue to grow at a faster rate than revenue from our aesthetic products for the remainder of 2006. We anticipate that revenue and net income will be larger in the second half of 2006 due to new products we anticipate to bring to market as a result of internal research and development and strategic activities.
Intense competition in the market for light-based cosmetic treatment devices, which is characterized by low barriers to entry and marginal technological differentiation among product offerings, continued to create pressure on sales of our aesthetic products. We will focus on the key features of our product offerings affecting the value proposition to the customer, in particular the speed and comfort of light-based aesthetic treatments, to address this challenge. There can be no assurance that our existing products and any future products will be competitive in an increasingly difficult market for light-based cosmetic treatment devices.
Sales of GreenLight PV delivery devices used for the Photoselective Vaporization of the Prostate (“PVP”) procedure grew in the three month period ended March 31, 2006 both domestically and internationally over the same period of the prior year and we expect continued growth in 2006. Our priority in the urology market is to have the PVP procedure, using the GreenLight laser system, replace the TURP procedure as the worldwide standard for the surgical treatment of BPH. Demonstrating and maintaining the clinical effectiveness and safety of the PVP procedure using our product is essential to achieving this goal. As a result, we continued to make significant investments in sales, marketing and professional education and training in the first three months of 2006, and intend to continue to do so for the remainder of 2006. Our efforts to increase adoption of PVP using our product in the United States, Europe and the Asia-Pacific region will be especially important to our continued success. The international market for PVP, which we believe to be substantially larger than the U.S. market, offers great promise but also a greater variety of challenges and uncertainties than our domestic market, which are discussed in greater detail in Part II – Item 1A. “Risk Factors”. We expect sales of our urology products in international markets to grow at a rate as fast or faster than domestic sales of our urology products, although there can be no assurance that such growth will occur.
Obtaining satisfactory heath care reimbursement rates for the PVP procedure using the GreenLight laser system from government and private insurers continues to be a critical factor for our success in the United States and in international markets. The 2006 national Medicare reimbursement rate for PVP performed in a hospital outpatient department is approximately $2,500, a reduction from $3,750 which was in effect from April 1, 2004 to December 31, 2005. The $2,500 reimbursement is by Medicare to hospitals for all prostate laser procedures described by CPT codes 52647 and 52648. Physicians receive a separate payment of approximately $600 for their services when they perform a PVP procedure in a hospital outpatient department.
Physicians’ professional services are paid by CPT code under the Medicare Physician Fee Schedule. The fee schedule contains different reimbursement rates depending on whether a physician performs a service in his/her office (also known as the non-facility rate) or at a facility that is paid separately (i.e., the hospital outpatient department). A change in the CPT code descriptors for CPT codes 52647 and 52648 became effective January 2006. Under the new descriptions, PVP is more appropriately described by 52648. Prior to the change, 52647 was used most frequently to describe PVP. Historically, CPT code 52648 was not assigned non-facility practice expense relative value units (RVUs). Consequently, despite the fact that physicians have been performing PVP in a well-equipped office setting, there would no longer have been a mechanism to reimburse physicians for the overhead costs of performing PVP in the non-facility setting. CMS published a technical revision to the 2006 Medicare physician fee schedule to address this situation. CPT code 52648 was assigned non-facility RVUs. Thus, the total national 2006 reimbursement rate for a PVP procedure performed in the office is approximately $3,100.
We will continue to work diligently to obtain satisfactory health care reimbursement in our key domestic and international markets.
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Our sensitivity to public and private payer reimbursement rates makes us subject to a variety of risks and uncertainties, which are discussed in greater detail in Part II – Item 1A. “Risk Factors” section.
Critical Accounting Policies and Estimates
We follow accounting principles generally accepted in the United States (“GAAP”) in preparing our financial statements. As part of this work, we must make many estimates and judgments about future events. These affect the value of the assets and liabilities, contingent assets and liabilities, and revenues and expenses reported in our financial statements. We believe these estimates and judgments are reasonable and we make them in accordance with policies based on information available at the time. However, actual results could differ from our estimates and could require us to record adjustments to expenses or revenues material to our financial position and results of operations in future periods. We believe our most critical accounting policies, estimates and judgments include the following:
• | revenue recognition; | ||
• | share-based compensation expense; | ||
• | allowance for doubtful accounts; | ||
• | warranty obligation; | ||
• | excess and obsolete inventory; | ||
• | legal contingencies; and | ||
• | income tax |
Revenue Recognition
Our revenue is primarily comprised of the following: sale and rental of laser equipment and instrumentation, GreenLight PV delivery devices, and service and parts revenue. We recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”). Under this standard the following four criteria must be met in order to recognize revenue:
1) | Persuasive evidence of an arrangement exists; | ||
2) | Delivery has occurred or services have been rendered; | ||
3) | Our selling price is fixed or determinable; and | ||
4) | Collectibility is reasonably assured |
The four revenue recognition criteria and other revenue related accounting pronouncements are applied to our sales as described in the following paragraphs.
We recognize revenues from the sale of GreenLight PV delivery devices when we ship the delivery device. We recognize revenue upon shipment of the GreenLight PV delivery devices as we have no continuing obligations subsequent to shipment. We do not accept returns of GreenLight PV delivery devices. The payment for a GreenLight PV delivery device becomes due upon shipment and is not dependent on actual PVP procedures performed and our customers do not notify us of their GreenLight PV delivery device usage.
In international regions outside of the United Kingdom and France, we utilize distributors to market and sell our products. We recognize revenues upon shipment for sales through these independent, third party distributors as we have no continuing obligations subsequent to shipment. Generally, our distributors are responsible for all marketing, sales, installation, training and warranty labor coverage for our products. Our standard terms and conditions do not provide price protection or stock rotation rights to any of our distributors. In addition, our distributor agreements do not allow the distributor to return or exchange products and the distributor is obligated to pay us for the sale regardless of whether the distributor is able to resell the product.
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Certain sales of lasers have post-sale obligations of installation and advanced training. These obligations are fulfilled after product shipment, and in these cases, we recognize revenue in accordance with the multiple element accounting guidance set forth in Emerging Issues Task Force No. 00-21, “Revenue Arrangements with Multiple Deliverables”. When we have objective and reliable evidence of fair value of the undelivered elements we defer revenue attributable to the post-shipment obligations and recognize such revenue when the obligation is fulfilled. Otherwise we defer all revenue until all elements are delivered.
Historically, we have allowed the return of a small number of lasers, and as of December 31, 2005 we have recorded an allowance to cover such laser returns as a direct reduction to revenues. In addition, we are usually willing to accept returns of small-dollar accessories if the customer ordered the wrong part or quantity. The return of small-dollar accessories has an insignificant impact on revenue. We are able to make reasonable estimates of future returns based upon historical return rates and therefore we recognize revenue on all products as they are shipped, provided that Staff Accounting Bulletin No. 104, “Revenue Recognition” criteria have been met. Returns have an insignificant impact on revenue as historical return rates have been low.
We provide incentives to customers that are accounted for under EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products)”. Customers are not required to provide documentation that would allow us to reasonably estimate the fair value of the benefit received and we do not receive an identifiable benefit in exchange for the consideration. Accordingly, the incentives are recorded as a reduction of revenue.
We occasionally provide consideration (in the form of cash or free products) to customers in exchange for performing training. Such consideration is treated as a sales and marketing expense and not as a reduction of revenue, because we receive an identifiable benefit and we can reasonably estimate the fair value of that benefit, based upon external market rates for similar training and physicians’ services.
Service revenues are related to the provision of repair and maintenance services under various types of arrangements. For customers who purchase fixed price service contracts, we recognize service revenue on a straight-line basis over the term of the contract. Payments received in advance of services performed, normally for purchases of service contracts by our customers for a specified period, are initially recorded as deferred revenue. For customers without service contracts, we recognize service revenue when we provide service. We record spare parts revenue upon shipment of the parts.
For all types of revenue we assess the credit worthiness of all customers in connection with their purchases. We only recognize revenue when collectibility is reasonably assured.
Share-based Compensation Expenses
On January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004),Share-Based Payment, or SFAS 123(R), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, including stock options, employee stock purchases related to the Employee Stock Purchase Plan based on fair values. Our financial statements as of and for the first quarter of fiscal year 2006 reflect the impact of SFAS 123(R). In accordance with the modified prospective transition method we used in adopting SFAS 123(R), our financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of the portion of share-based payment awards that is ultimately expected to vest. Share-based compensation expense recognized in our Condensed Consolidated Statement of Income during the first quarter of fiscal year 2006 include compensation expense for share-based payment awards granted prior to, but not yet vested as of, December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123 and compensation expense for the share-based payment awards granted subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), we elected to attribute the value of share-based compensation to expense using the straight-line method, which was previously used for our pro forma information required under SFAS 123. Share-based compensation expense related to stock options and employee stock purchases was $0.6 million, before taxes on earnings for the first quarter of fiscal year 2006. During the first quarter of fiscal year 2005, there was no share-based compensation expense related to stock options or employee stock purchases recognized under the intrinsic value method in accordance with Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees, or APB 25.
Upon adoption of SFAS 123(R), we elected to value our share-based payment awards granted beginning in fiscal year 2006 using the Black-Scholes option-pricing model, or the Black-Scholes model, which we previously used for the pro forma information required under SFAS 123. The determination of fair value of share-based payment awards on the date of grant using the Black-Scholes model is affected by our stock price as well as the input of other subjective assumptions. These assumptions include, but are not limited to, the expected term of stock options and our expected stock price volatility over the term of the awards.
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The expected term of stock options represents the weighted-average period the stock options are expected to remain outstanding. The expected term is based on the observed and expected time to post-vesting exercise of options by our employees. Upon adoption of SFAS 123(R), we used historical volatility in deriving the expected volatility assumption as allowed under SFAS 123(R) and SAB 107. The risk-free interest rate assumption is based upon observed interest rates appropriate for the term of our stock options. The dividend yield assumption of zero is based on our history and expectation of dividend payouts.
As share-based compensation expense recognized in the Condensed Consolidated Statement of Income for the first quarter of fiscal 2006 is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based on our historical experience. In our pro forma information required under SFAS 123 for the periods prior to January 1, 2006, we accounted for forfeitures as they occurred. If factors change and we employ different assumptions in the application of SFAS 123(R) in future periods, the compensation expense that we record under SFAS 123(R) may differ significantly from what we have recorded in the current period.
As of March 31, 2006, there was $4.5 million of total unrecognized compensation expense related to stock options granted under all our Employee Stock Plans. This unrecognized compensation expense is expected to be recognized over the remaining vesting period of each grant up to the next 48 months.
Allowance for Doubtful Accounts
We assess the credit worthiness of our customers prior to making a sale in order to mitigate the risk of loss from customers not paying us. However, to account for the possibility that a customer may not pay us, we maintain an allowance for doubtful accounts. We estimate losses based on the overall business climate, our accounts receivable aging profile, and an analysis of the circumstances associated with specific accounts which are past due. Despite the significant amount of analysis used to compute the required allowance, if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. As of March 31, 2006 and December 31, 2005 our allowance for doubtful accounts totaled approximately $814,000 and $416,000, respectively.
Warranty Obligation
We provide for the estimated cost of product warranties at the time revenue is recognized. We estimate the cost of our future warranty obligation based on actual material usage and service delivery costs experienced in correcting product warranty failures over the preceding twelve months. However, should actual product failure rates, material usage or service delivery costs differ from historical experience, increases in warranty expense could be required. Warranty reserves as of March 31, 2006 and December 31, 2005 were $3.0 million and $2.9 million, respectively.
Excess and Obsolete Inventory
We maintain reserves for our estimated obsolete or unmarketable inventory. Inventory reserves are recorded when conditions indicate that the selling price may be less than cost due to factors such as estimates about future demand, reductions in selling prices, physical deterioration, usage and obsolescence. The reserves are equal to the difference between the cost of inventory and the estimated market value. Once established, the original cost of the inventory less the related inventory reserve represents the new cost basis of such products. Reversal of these reserves is recognized only when the related inventory has been scrapped or sold. If actual market conditions are less favorable than those projected by management, additional inventory writedowns may be required and gross margin could be adversely impacted. As of March 31, 2006 and December 31, 2005, our reserves were $1.5 million and $1.6 million, respectively.
Legal Contingencies
At the end of each accounting period, we review all outstanding legal matters. If we believe it is probable that we will incur a loss as a result of the resolution of a legal matter and we can reasonably estimate the amount of the loss, we accrue our best estimate of the potential loss. New developments in legal matters can cause changes in previous estimates and result in significant changes in loss accruals. If current legal matters are resolved in a manner unfavorable to us, it could have a material adverse impact on our financial results.
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Income Tax
We are subject to income taxes in both the United States and foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. We establish reserves for tax-related uncertainties based on our estimate of the possibility that certain positions will be challenged and may not be sustained upon audit by tax authorities. We adjust these reserves in light of changing facts and circumstances, such as the completion of audits or the expiration of statutes of limitations. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.
We must assess whether it is “more likely than not” that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. Due to the amount of Net Operating Losses available for income tax purposes through 2004, we had a full valuation allowance against our deferred tax assets. In 2005 we concluded that it is more likely than not that we will have sufficient future taxable income in the United States to utilize our deferred tax assets and accordingly eliminated our valuation allowances against these deferred tax assets.
Results of Operations.
The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes included in Part I — Item 1 of this Quarterly Report and the audited consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005 and the accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following table contains selected income statement information, which serves as the basis of the discussion of the Company’s results of operations for the three months ended March 31, 2006 and 2005 (in thousands, except percentages):
Three months ended | ||||||||||||||||||||
March 31, 2006 | March 31, 2005 | % | ||||||||||||||||||
Amount | %(a) | Amount | %(a) | Change | ||||||||||||||||
Revenues from sales of: | ||||||||||||||||||||
Lasers and instrumentation | $ | 14,761 | 46 | % | 13,802 | 49 | % | 7 | % | |||||||||||
Disposable supplies | 14,672 | 46 | % | 12,438 | 44 | % | 18 | % | ||||||||||||
Service | 2,576 | 8 | % | 1,937 | 7 | % | 33 | % | ||||||||||||
Total net revenues | $ | 32,009 | 100 | % | 28,177 | 100 | % | 14 | % | |||||||||||
Gross margin | 19,510 | 61 | % | 17,600 | 62 | % | 11 | % | ||||||||||||
Operating expenses: | ||||||||||||||||||||
Research and development | 2,949 | 9 | % | 1,585 | 6 | % | 86 | % | ||||||||||||
Selling, general and administrative | 11,835 | 37 | % | 9,878 | 35 | % | 20 | % | ||||||||||||
Operating income | $ | 4,726 | 15 | % | $ | 6,137 | 22 | % | (23 | %) |
(a) | expressed as a percentage of total net revenues. |
Lasers and instrumentation
Revenues from the sales of lasers and instrumentation increased 7% during the three month period ended March 31, 2006 compared to the same period in 2005. The increase is due primarily to increased aesthetic laser revenues of $1.4 million offset by a slight reduction in revenues from the sale of GreenLight PV laser systems. We believe the increase in aesthetic laser revenues was driven by our steady progress with the transition to Henry Schein and higher average per unit selling prices. Additionally, we experienced a slowdown in our aesthetic business in the first quarter of 2005, contributing to the large percentage increase in aesthetic revenues in the first quarter of 2006 as compared to the first quarter of 2005.
We expect to see higher sales of our laser systems and instrumentation during 2006 as we expect demand for the procedures which use our laser systems to continue to grow. We expect this growth to be heavily weighted toward the second half of 2006 as revenues from our new product pipeline and expanded sales network take effect.
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Disposable Supplies
Revenues from the sales of disposable supplies increased 18% to $14.7 million compared to $12.4 million in the first quarter of 2005. This increased revenue was driven primarily by an increase in shipments of GreenLight PV fiber optic delivery devices which totaled approximately 21,000 units in the first quarter of 2006, up from approximately 16,000 units in the comparable period of 2005. We believe these increases were driven by the growing world wide body of clinical data that demonstrates the clinical efficacy, high safety profile, and cost effectiveness of the PVP procedure. During the fourth quarter of 2005, we introduced a new pricing program for the GreenLight PV delivery device in the United States, reducing the retail sales price of our GreenLight PV delivery devices from $875 to $795. We expect revenues from the sales of GreenLight PV delivery devices to continue to increase worldwide in 2006 based on the following factors:
• | Further increases in demand for the PVP procedure; | ||
• | Growth in the worldwide PVP market; and | ||
• | Increased positive clinical data on the benefits of the PVP procedure. |
In addition, we expect our new line of fiber optic delivery devices for the intracorporeal treatment of kidney, bladder and urinary stones using Holmium laser energy which are manufactured by our recently acquired subsidiary InnovaQuartz to contribute to our revenue growth in 2006.
Service
Service revenues increased 33% to $2.6 million compared to $1.9 million in the period ended March 31, 2005. The increase was due primarily to a greater number of service contracts sold to service our growing installed base of lasers. We generally provide a twelve month warranty on our laser systems. After the warranty period, maintenance and support is provided on a service contract basis or on a time and material basis. We recognize revenues on service over the period of the service contract or when time and material services are performed. Increases in future service revenues depends on increases to the installed base of lasers, as well as the acceptance of our service contracts by our customers.
Gross margin
Gross margin as a percentage of revenues was 61% in the first quarter of 2006, a decrease of one percentage point compared to the same period in 2005. Higher average unit prices for aesthetic laser and instrumentation sales relative to the first quarter of 2005 were offset by higher international GreenLight PV fiber optic delivery devices and system sales as a percentage of total revenues. Sales to international customers are generally at lower prices than in the United States as they are sold through distributors, resulting in lower gross profit margins. During the fourth quarter of 2005, we introduced a new pricing program for the GreenLight PV delivery device in the United States, reducing the retail sales price of our GreenLight PV delivery devices from $875 to $795, resulting in lower gross profit margins in the first quarter of 2006 compared to the same period in 2005. Our gross profit margin will vary as our sales mix changes. Increases in sales of our GreenLight fiber optic delivery devices will generally raise our overall gross profit margin, whereas sales of products through distributors in international markets will tend to decrease our overall gross profit margin.
Research and development
Research and development expenses increased 86% in the first quarter of 2006 compared to the same period in 2005. The increase in research and development expenses resulted primarily from accelerated new product development and clinical activities focused on the near and medium term development of multiple new products and clinical applications in urology and aesthetics. We expect research and development expenses to increase between 50-60% in 2006 as we continue funding of key new product development programs, enhancements to existing products, new clinical applications, and clinical trials and evaluations necessary for regulatory approval to market new products. Research and development spending during 2006 is expected to be in the range of 8% to 9% of total revenues.
Selling, general and administrative
Selling, general and administrative (“S,G&A”) expenses increased by approximately 20% to $11.8 million, or 37% of revenues in the first quarter of 2006, compared to $9.9 million, or 35% of revenues in the first quarter of 2005. The increase in SG&A expenses resulted primarily from higher sales, marketing, business development and administrative expenses to support our current and future growth initiatives and increased sales activities in the United States and international markets. SG&A expenses included approximately $0.4 million of share based compensation expense related to stock options and employee stock purchases in the three months ended March 31, 2006.
We expect our S,G&A expenses to increase in 2006 as domestic and international initiatives in sales and marketing are executed, but not exceed the rate of increase in our revenues. S,G&A expenses are expected to be approximately 35% of revenues during 2006.
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Provision for Income Taxes
Our effective income tax rate in the first quarter of 2006 was 43% as compared to 20% in the first quarter of 2005. As a result of net operating loss and tax credit carryforwards, our effective tax rate for 2005 was 7.5%. Valuation allowances for our deferred tax assets were released in 2005. Without the benefit of net operating loss and tax credit carryforwards to reduce income tax expense in 2006, our book income tax expense increased substantially to reflect the full U.S. federal and state income tax rates (approximately 40.5% combined). In addition, ISO compensation recorded in accordance with SFAS 123(R) represents non-cash expense which is non-deductible for income tax purposes and, therefore, increased the income tax rate by an additional 2.5% in the first quarter of 2006. We expect an income tax rate of approximately 43% in 2006.
Liquidity and Capital Resources.
The following table contains selected balance sheet information that serves as the basis of the discussion of the Company’s liquidity and capital resources at March 31, 2006 and for the three months then ended (in thousands):
March 31, | December 31, | |||||||
2006 | 2005 | |||||||
Cash and cash equivalents | $ | 33,234 | $ | 30,653 | ||||
Total assets | $ | 115,241 | $ | 111,770 | ||||
Total liabilities | $ | 26,207 | $ | 26,982 | ||||
Working capital | $ | 77,059 | $ | 75,047 |
Our cash and cash equivalents consist principally of money market funds. Cash and cash equivalents were $33.2 million at March 31, 2006, an increase of $2.6 million compared with December 31, 2005.
Cash and cash equivalents were impacted principally by:
• | Positive cash flow from operating activities of $4.6 million; | ||
• | Proceeds from issuance of common stock related to employee participation in employee stock programs generating $0.3 million; and | ||
• | Capital expenditures of $2.8 million primarily for facility expansion and implementation of a new enterprise resource planning system. |
Operating activities generated $4.6 million in cash for the three months ended March 31, 2006 down from $5.3 million provided in the three months ended March 31, 2005. In the first quarter of 2006 we:
• | Generated $4.4 million of cash from net income plus non-cash related expenses; | ||
• | Used cash of $0.5 million to increase inventory levels, primarily for the laser systems and delivery devices; and | ||
• | Decreased accounts payable by $0.4 million due to payments on various fiscal year end expenses. |
Net cash used in investing activities was $2.8 million for the three months ended March 31, 2006 up from $0.7 million net cash used in the three months ended March 31, 2005. The principal changes in cash used in investing activities in the first quarter of 2006 were due to acquisition of property and equipment.
Cash provided by financing activities was $0.7 million in the three months ended March 31, 2006 down from $1.5 million cash provided for the three months ended March 31, 2005. The principal factor that contributed to the cash provided by financing activities was cash received from the issuance of stock under employee stock programs.
We have in place an asset based line of credit which provides up to $5.0 million in borrowings. The line of credit expires September 2006. Credit is extended based on our eligible accounts receivable and inventory. At March 31, 2006, we had approximately $5.0 million in borrowing capacity and no borrowings outstanding. Our assets collateralize the line of credit which bears an interest rate equivalent to the bank’s prime rate plus 2.0%. Borrowings against the line of credit are paid down as we collect our accounts receivable. Provisions of the bank loan agreement prohibit the payment of dividends on non-preferred stock, or the redemption, retirement, repurchase or other acquisition of our stock. The agreement further requires we maintain a minimum tangible net worth. As of March 31, 2006, we were in compliance with all covenants and had no outstanding borrowings under the line of credit facility.
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We anticipate that future changes in cash and working capital will be dependent on a number of factors including:
• | our ability to effectively manage inventory and accounts receivable; | ||
• | our ability to anticipate and adapt to the changes in our industry such as new and alternative medical procedures; | ||
• | our level of profitability; | ||
• | our determination to acquire or invest in products and businesses complementary to ours; and | ||
• | the market price for our common stock as it affects the exercise of stock options and sale of common stock under stock plans. |
We have historically financed acquisitions using our existing cash resources. While we believe our existing cash resources, including our bank line of credit, will be sufficient to fund our operating needs for the next twelve months, additional financing may be required for our currently envisioned long-term needs. The table above does not reflect the payment of approximately $7.5 million to the stockholders of InnovaQuartz, Inc. on April 30, 2006 or the assumption or repayment of approximately $1.1M in debt in connection with such acquisition.
There can be no assurance that any additional financing will be available on terms acceptable to us, or at all. In addition, future equity financings could result in dilution to our shareholders, and future debt financings could result in certain financial and operational restrictions.
Off-Balance Sheet Arrangements.
We do not have any transactions with unconsolidated entities or financial partnerships, or other off-balance sheet arrangements.
Contractual Obligations.
We did not enter into any material contractual obligations during the quarter ended March 31, 2006.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to a variety of risks, including changes in interest rates affecting the return on its investments, outstanding debt balances and foreign currency fluctuations. In the normal course of business, the Company employs established policies and procedures to manage its exposure to fluctuations in interest rates and foreign currency values.
Interest Rate Risk.
Our exposure to market rate risk for changes in interest rates relates primarily to our cash and cash equivalents. In the three months ended March 31, 2006 and 2005, we did not use derivative financial instruments. We invest our excess cash in money market funds. Our debt financings have generally consisted of convertible debentures and bank loans requiring either fixed or variable rate interest payments. Investments in and borrowings under both fixed-rate and floating-rate interest-earning instruments carry a degree of interest rate risk. On the investment side, fixed-rate securities may have their fair market value adversely affected due to a rise in interest rates, while floating-rate securities may produce less income than expected if interest rates fall. In addition, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to sell securities that have declined in market value due to changes in interest rates.
On the debt side, borrowings that require fixed-rate interest payments require greater than current market rate interest payments if interest rates fall, while floating rate borrowings may require greater interest payments if interest rates rise. Additionally, our future interest expense may be greater than expected due to changes in interest rates.
Foreign Currency Risk.
Our international revenues were 36% and 28% of total revenues in the quarters ended March 31, 2006 and 2005. Our international sales are made through international distributors and wholly owned subsidiaries with payments to the Company typically denominated in the local currencies of the United Kingdom and France, and in United States dollars in the rest of the world. Our expenses are typically denominated in local currencies. Our international business is subject to risks typical of an international business, including, but not limited to, differing economic conditions, changes in political climate, differing tax structures, other regulations and
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restrictions, and foreign exchange rate volatility. Accordingly, our future results could be materially adversely affected by changes in these or other factors. We do not engage in hedging transactions.
Item 4. Controls and Procedures.
(a) Evaluation of disclosure controls and procedures.
Our chief executive officer and our chief financial officer, after evaluating the effectiveness of the Company’s “disclosure controls and procedures” as defined in the Securities Exchange Act of 1934, as amended (the “Exchange Act”), Rules 13a-15(e) or 15d-15(e) as of the end of the period covered by this report (the “Evaluation Date”), have concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective based on the evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 13d-15.
(b) Changes in internal controls.
No change in the Company’s internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the Company’s first fiscal quarter has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Limitations on Effectiveness of Disclosure Controls.We intend to review and evaluate the design and effectiveness of our disclosure controls and procedures on an ongoing basis and to correct any material deficiencies that we may discover. Our goal is to ensure that our senior management has timely access to material information that could affect our business. While we believe the present design of our disclosure controls and procedures is effective to achieve our goal, future events affecting our business may cause us to modify our disclosure controls and procedures. The effectiveness of controls cannot be absolute because the cost to design and implement a control to identify errors or mitigate the risk of errors occurring should not outweigh the potential loss caused by errors that would likely be detected by the control. Moreover, we believe that disclosure controls and procedures cannot be guaranteed to be 100% effective all of the time. Accordingly, a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Palomar Medical Technologies, Inc. (“Palomar”) has informed us that it disputes the method used by us for calculating the royalty to be paid on the Lyra laser system pursuant to the Patent License Agreement between Laserscope and Palomar (the “License Agreement”). Palomar also disputes our application of the License Agreement to the Gemini laser system, including our calculation of royalties due on the Gemini laser system under the License Agreement. In the third quarter of 2005, Palomar exercised its right under the License Agreement to engage an independent auditor to conduct a review of our royalty calculations and payments under the License Agreement. In November the independent auditors issued a report identifying several potential alternative interpretations of the application of the License Agreement that indicate a potential liability of up to $3.7 million. We disagree with each of these potential alternative interpretations and believe that we have been correctly calculating and paying the royalties owed to Palomar under the License Agreement. Accordingly, we have not accrued for a settlement. We intend to vigorously defend our position while we continue to negotiate with Palomar. If our dispute with Palomar is resolved in a manner contrary to our position, we could be required to record additional expenses which could have a material adverse impact on our financial statements.
On November 8, 2005, we received notice from a customer of our GreenLight products alleging that we have violated certain terms of a specific treatment parameters/outcomes program agreement with it. Such party has taken no further action. We believe that we have complied with our obligations under the agreement. If this matter is resolved in a manner unfavorable to the company, it could have a material adverse impact on our financial statements.
Item 1A. Risk Factors
There are no material changes to the Risk Factors described under the title “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005 other than the addition of the Risk Factor below entitled “Our acquisition of InnovaQuartz, Inc may not provide us the expected benefits and could disrupt our business and harm our financial condition”.
RISK FACTORS
In determining whether to invest in our common stock, you should carefully consider the information below in addition to all other information provided to you in this Report, including the information incorporated by reference in this Report. The statements under this caption are intended to serve as cautionary statements within the meaning of the Private Securities Litigation Reform Act of 1995. The following information is not intended to limit in any way the characterization of other statements or information under other captions as cautionary statements for such purpose.
Demand for our products in the United States and internationally is highly dependent on the ability of physicians, hospitals and other health care facilities to obtain satisfactory reimbursement rates for our products and services performed with our products from private and governmental third-party payers as well as direct payments from consumers. If satisfactory reimbursement rates are not maintained, demand for our products would decline and our business and financial results and cash flows would suffer.
A substantial portion of our laser sales are for aesthetic procedures that generally are not covered or reimbursed by government or commercial health insurance. The general absence of insurance coverage for these cosmetic procedures may restrict the development of this market as growth in procedures performed with our aesthetic products largely depends on consumers’ willingness to pay out-of-pocket for these treatments.
Market acceptance of our products internationally may depend in part upon the availability of reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government sponsored health care and private insurance. We may not obtain international reimbursement approvals in a timely manner, if at all. Our failure to receive international reimbursement approvals may negatively impact market acceptance of our products in the international markets in which those approvals are sought.
Increasing the use of our GreenLight laser system to perform the Photoselective Vaporization of the Prostate (“PVP”) procedure could be hindered by the ongoing efforts of major third-party payers for health care in the United States (such as Medicare, Medicaid, private healthcare insurance and managed care plans) and in our key international markets such as the European Union and the Asia-Pacific region to contain healthcare costs through stricter coverage criteria, price regulation, and lower payments for all items, including health care services, disposable medical products and medical capital equipment.
The current Facility Fee reimbursement for PVP in the United States has been reduced and could be reduced further, eliminated or utilized by a competitor.
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Demand in the United States for our GreenLight laser system and disposable fiber optic delivery devices is highly dependent on the reimbursement for the PVP procedure when it is performed in the hospital outpatient setting. The rate set by Medicare is particularly influential on demand because Medicare is the largest single payer for PVP procedures and because many commercial payers use Medicare payments as a benchmark for their reimbursement rates. The national reimbursement rate for the PVP procedure was reduced to a new rate of approximately $2,500 for 2006. This amount represents a decrease of $1,250 from the temporary reimbursement amount of $3,750 per procedure previously in effect since April 2004, but is higher than the $1,850 paid per procedure prior to April 2004.
Medicare pays for hospital outpatient services on a rate-per-service basis that varies according to the ambulatory payment classification (APC) group to which the service is assigned. Services within a particular APC are supposed to be like in clinical character and resource utilization. Medicare uses the median cost to establish a payment amount for the services grouped with a single APC. The hospital outpatient payment rate includes the national payment amount that is made up of the Medicare payment and the beneficiary co-payment to the facility. Special payments are made under the hospital outpatient payment system for new technology items in one of two ways. The first is through a temporary add-on payment or “transitional pass-through payments.” This applies to certain drugs, devices and biologics. The second is through a temporary assignment to a New Technology APC. New services, not specific items, generally are handled through this method. Assignment to a New Technology APC is time limited. Medicare has the discretion to reassign a New Technology service to a standard clinical APC when it feels it has sufficient data to understand the costs incurred by hospitals to provide the service.
The APC code applicable to the PVP procedure has varied since its launch. We submitted a New Technology Application to the Centers for Medicare and Medicaid Services (“CMS”) in September 2003, and was notified by Medicare several months afterwards that the application was approved. As a result, PVP was assigned temporary HCPCS code C9713 and was assigned to New Technology APC 1525, effective April 1, 2004. The national average payment rate for APC 1525 is $3,750. In July 2005, CMS published its proposed rule regarding the 2006 Outpatient Prospective Payment System (“OPPS”) for outpatient hospital facility reimbursement. In this rule, CMS proposed to transfer PVP to a standard clinical Ambulatory Payment Classification (“APC”) code beginning in 2006. CMS recently finalized this proposal based on the agency’s belief that although it had less than a full-year of hospital claims data for PVP, it had a sufficient number of claims upon which to establish the median cost for performing the procedure billed under code C9713, and, therefore, a median cost could be established. As of January 1, 2006, PVP was assigned to APC 0429, which includes all prostate laser procedures described by CPT codes 52647 and 52648. The 2006 national reimbursement rate for APC 0429 is approximately $2,500.
Physician Fee Schedule reimbursement for PVP in the United States remains uncertain.
Demand in the U.S. for our GreenLight laser system and disposable fiber optic delivery devices is also highly dependent on the reimbursement rates physicians are paid to perform a PVP procedure. In particular, Medicare payments to physicians for the PVP procedure are of critical importance as Medicare is the largest single payer for PVP procedures and its reimbursement rates are used as a benchmark by many commercial payers.
Medicare pays for physician services under a uniform, national fee schedule based on relative value units (“RVUs”) that reflect the physician work and overhead costs associated with furnishing a particular item or service. Medicare assigns different RVUs for a single procedure depending on whether the service is performed in the physician’s office or a facility such as a hospital outpatient department or ambulatory surgery center. The non-facility payment rate is higher and is meant to reflect the fact that physicians incur greater overhead costs when they perform a procedure in their office.
Prior to January 2006, physicians generally used CPT code 52647 to describe to payers that they performed a PVP procedure. A change in the CPT code descriptors for CPT codes 52647 and 52648 became effective January 2006. Under the new descriptions, PVP is more appropriately described by 52648. Prior to the change, 52647 was used most frequently to describe PVP. Historically, CPT code 52648 was not assigned non-facility practice expense relative value units (RVUs). Consequently, despite the fact that physicians have been performing PVP in a well-equipped office setting, there would no longer have been a mechanism to reimburse physicians for the overhead costs of performing PVP in the non- facility setting. CMS published a technical revision to the 2006 Medicare physician fee schedule to address this situation. CPT code 52648 was assigned non-facility RVUs. Thus, the total national 2006 reimbursement rate for a PVP procedure performed in the office is approximately $3,100.
There is the chance that at some time in the future PVP may be assigned a payment level that does not pay physicians at a rate they feel adequately reflects the time, effort and resource costs associated with the procedure. If physicians were paid at a rate for the PVP
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procedure they felt was inadequate, such underpayments would discourage physicians from performing the PVP procedure. Similarly, should Medicare underpay PVP relative to other procedures it will negatively influence physician adoption of the PVP procedure, which would reduce demand for our products and harm our financial performance. CMS reimbursement decisions regarding the physician Fee Schedule for PVP in any site of service remain uncertain and could result in maintenance of the current reimbursement structure or a decrease in reimbursement rates which could adversely affect PVP procedural volume and sales of our products.
PVP physician reimbursement is typically lower, on a per-procedure basis, compared to other BPH therapies.
The current national average rate of reimbursement paid by Medicare to physicians for performing the PVP procedure on a per-procedure basis is, in some cases, substantially lower than the reimbursement rate paid for performing certain other minimally invasive BPH therapies on a per-procedure basis. While we believe that this disparity results in physicians and hospitals not being reimbursed at a rate commensurate with the necessary resources and work required to do the PVP procedure in all sites of service currently being used by physicians, there can be no assurance that CMS will adjust reimbursement rates to address this disparity. Further, there can be no assurance that physician reimbursement for these other therapies will not be maintained at current levels or raised relative to reimbursement for PVP or that the physician reimbursement for PVP will be maintained at current levels or increased relative to other BPH therapies. The adoption rate of the PVP procedure in the United States is highly dependent upon hospital and physician economics. A substantial reduction in payments to facilities and/or a continuation of the disparity which currently exists between the physician reimbursement for certain other BPH therapies and that for PVP could cause a reduction in the adoption of PVP by hospitals and physicians, which would reduce demand for our products and harm our business.
If we are not able to protect our intellectual property adequately, we will lose a critical competitive advantage, which will reduce our revenues, profits and cash flows.
Our patents, copyrights, trademarks, trade secrets and other intellectual property are critical to our success. We hold several patents issued in the United States, generally covering surgical laser systems, delivery devices, calibration inserts and the laser resonator. We have also licensed certain technologies from others.
We cannot assure that any patents or licenses that we hold or that may be issued as a result of our patent applications will provide any competitive advantages for our products. Nor can we assure that any of the patents that we now hold or may hold in the future will not be successfully challenged, invalidated or circumvented in the future. In addition, we cannot assure that competitors, many of which have substantial resources and have made substantial investments in competing technologies, will not seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, issue, use and sell our products.
Furthermore, we cannot be certain that the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States. We have not attempted to secure patent protection in foreign countries, and the laws of some foreign countries may not adequately protect our intellectual property as well as the laws of the United States. As we increase our international presence, we expect that it will become more difficult to monitor the development of competing technologies that may infringe on our rights as well as unauthorized use of our technologies.
We believe that we own or have the right to use the basic patents covering our products. However, the laser industry is characterized by a very large number of patents, some of which appear to overlap with other issued patents. As a result, there is a significant amount of uncertainty in the industry regarding patent protection and infringement. Because patent applications are maintained in secrecy in the United States until such patents are issued and are maintained in secrecy for a period of time outside the United States, we can conduct only limited searches to determine whether our technology infringes any patents or patent applications of others.
If we are unable to protect the integrity, safety and proper use of our disposable fiber optic delivery device used with the GreenLight laser system, it could result in negative patient outcomes and reduce our disposable delivery device recurring revenue stream.
Ensuring the integrity, safety and proper use of the GreenLight PV disposable fiber optical delivery device, also known as the ADDStat fiber optic delivery device, and referred to elsewhere in this Report as the “delivery device”, used with the GreenLight PV laser system is crucial to achieving optimal patient outcomes from the PVP procedure. With this is mind, we manufacture the GreenLight PV delivery device using high quality materials and exacting production standards. We inspect each unit carefully to check that it conforms to our specifications and use diligent efforts to ensure that the delivery device is used appropriately in
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connection with the GreenLight PV laser system. However, if a third party were to produce and distribute a counterfeit version of the GreenLight PV delivery device or an inferior substitute delivery device to our customers, use of inferior materials, poor design, shoddy construction or improper handling or use of such products could result in severe adverse patient events. While we are constantly making diligent efforts to promote positive clinical outcomes by protecting the safety, integrity and proper use of our products, particularly the GreenLight PV delivery device, one or more third party manufacturers may produce counterfeit or inferior quality delivery devices that our customers may, knowingly or unknowingly, purchase for use with the GreenLight PV laser system. In addition, it is possible that our customers may seek to violate our prohibition on reuse of delivery devices (or reuse inferior substitute delivery devices) on unwitting patients, reducing the efficacy of the procedure and exposing such patients to the risk of blood-borne pathogens. Use of such third party delivery devices or misuse of our genuine GreenLight PV delivery devices could result in adverse clinical outcomes, potentially reducing demand for PVP and decreasing demand for our products. Although we use a variety of methods to protect patients from inferior delivery devices and the reuse of our GreenLight PV delivery devices, including legal and regulatory safeguards, system enabling, patient education and safety packaging among other measures, there can be no assurance that such methods will be effective at avoiding the introduction of such counterfeit or substitute delivery devices into the market. Moreover, use of counterfeit or substitute disposable delivery devices for use with the GreenLight PV laser system or unauthorized reuse of delivery devices, would displace sales of our GreenLight PV disposable delivery devices reducing our recurring disposable delivery device revenue stream and harming our business.
We participate in competitive markets with companies that have significantly greater financial, technical, research and development, manufacturing and marketing resources and/or who produce standard, entrenched medical technologies.
We compete in the non-ophthalmic surgical segment of the worldwide medical laser market. In this market, lasers are used in hospital operating rooms, outpatient surgery centers and individual physician offices for a wide variety of procedures. This market is highly competitive. Our competitors are numerous and include some of the world’s largest organizations as well as smaller, highly specialized firms. Our ability to compete effectively depends on such factors as:
• | market acceptance of our products; | ||
• | product performance; | ||
• | price; | ||
• | satisfactory reimbursement of the PVP procedure by public and private third party payers; | ||
• | customer support; | ||
• | the success and timing of new product development; and | ||
• | continued development of successful distribution channels. |
Some of our current and prospective competitors have or may have significantly greater financial, technical, research and development, manufacturing and marketing resources than we have. To compete effectively, we will need to continue to expand our product offerings, periodically enhance our existing products and continue to enhance our distribution.
Certain surgical laser manufacturers have targeted their efforts on narrow segments of the market, such as angioplasty, orthopedics, and lithotripsy. Their products may compete for the same capital equipment and disposable device funds as our products, and accordingly, these manufacturers may be considered our competitors. Generally, surgical laser manufacturers such as us compete with standard surgical methods and other medical technologies and treatment modalities. Several of these manufacturers and their distribution partners offer products for the treatment of BPH using similar technologies to ours and engage in aggressive marketing campaigns, pricing, and promotional efforts targeted at our products and customers. We cannot assure that we can compete effectively against such competitors. In addition, we cannot assure that these or other companies will not succeed in developing technologies, products or treatments that are more effective than ours or that would render our technology or products obsolete or non-competitive.
If we are unable to effectively manage our growth, our business may be harmed.
Our future success depends on our ability to successfully manage our growth. Our ability to manage our business successfully in a rapidly evolving and extremely competitive market requires an effective planning and management process. Our rates of growth in
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recent years have been high. Should our business continue to grow and demand for our products continue to increase at similar rates, it will increase the strain on our personnel in all aspects of our business.
Our historical growth and international expansion, have placed, and are expected to continue to place, a significant strain on our managerial, operational and financial resources as well as our financial and management controls, reporting systems and procedures. Although some new controls, systems and procedures have been implemented, our future growth, if any, will depend on our ability to continue to implement and improve operational, financial and management information and control systems on a timely basis, together with maintaining effective cost controls. Our inability to manage any future growth effectively would be harmful to our revenues and profitability.
Our dependence on certain single-source suppliers and certain other third parties could adversely impact our ability to manufacture lasers.
Certain of the components used in our laser products, including certain optical components, are purchased from single sources. While we believe that most of these components are available from alternate sources, an interruption of these or other supplies could adversely affect our ability to manufacture lasers.
Problems associated with international business operations could affect our ability to sell our products.
As our international business has grown, we have become increasingly subject to the risks arising from the unique and potentially adverse factors in the countries in which we operate. Our international revenues were 36% of total revenues in the three months ended March 31, 2006 and 28% in the same period of 2005. Our international sales are made through international distributors and wholly-owned subsidiaries with payments to us typically denominated in the local currencies of the United Kingdom and France, and in United States Dollars in the rest of the world. We intend to continue our operations outside of the United States and potentially to enter additional international markets. We anticipate that sales to customers located outside North America will increase and will continue to represent a significant portion of our total revenues in future periods. These activities, require significant management attention and financial resources and further subject us to the risks of operating internationally. These risks include, but are not limited to:
• | changes in regulatory requirements; | ||
• | delays resulting from difficulty in obtaining export licenses for certain technology; | ||
• | customs, tariffs and other barriers and restrictions; and | ||
• | the burdens of complying with a variety of foreign laws. |
We are also subject to general geopolitical risks in connection with our international operations, such as:
• | differing economic conditions; | ||
• | changes in political climate; | ||
• | differing tax structures; and | ||
• | changes in diplomatic and trade relationships and war. |
In addition, fluctuations in currency exchange rates may negatively affect our ability to compete in terms of price against products denominated in local currencies.
Accordingly, if these risks actually materialize, our international operations may be adversely affected and sales to international customers, as well as those domestic customers that use foreign fabrication plants, may decrease
Our business has significant risks of product liability claims, which could drain our resources and exceed our limited insurance coverage.
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Our business has significant risks of product liability claims. We have experienced product liability claims from time to time, which we believe are ordinary for our business. While we cannot predict or determine the outcome of the actions brought against us, we believe that these actions will not ultimately have a material adverse impact on our financial position, results of operations, and future cash flows.
At present, we maintain product liability insurance on a “claims made” basis with coverage commensurate with our business and product lines. We cannot assure that such insurance coverage will be available to us in the future at a reasonable cost, if at all, nor can we assure that other claims will not be brought against us in excess of our insurance coverage.
Our products are subject to government regulation, and we cannot assure that all necessary regulatory approvals, including approvals for new products or product improvements, will be granted on a timely basis, if at all, and that we won’t be subject to product recalls or warnings and other regulatory actions and penalties that could materially affect our operating results.
Government regulation in the United States and other countries is a significant factor in the development, manufacturing and marketing of many of our products.
Our products are regulated in the United States by the Food and Drug Administration under the Federal Food, Drug and Cosmetic Act (the “FDC Act”) and the Radiation Control for Health and Safety Act. The FDC Act provides two basic review procedures for medical devices. Certain products qualify for a Section 510(k) (“510(k)”) procedure under which the manufacturer gives the FDA pre-market notification of the manufacturer’s intention to commence marketing the product. The manufacturer must, among other things, establish that the product to be marketed is “substantially equivalent” to a previously marketed product. In some cases, the manufacturer may be required to include clinical data gathered under an investigational device exemption (“IDE”) granted by the FDA allowing human clinical studies.
There can be no assurance that the FDA will grant marketing clearance for our future products on a timely basis, or at all.
If the product does not qualify for the 510(k) procedure, the manufacturer must file a pre-market approval application (“PMA”) based on testing intended to demonstrate that the product is both safe and effective. The PMA requires more extensive clinical testing than the 510(k) procedure and generally involves a significantly longer FDA review process. Approval of a PMA allowing commercial sale of a product requires pre-clinical laboratory and animal tests and human clinical studies conducted under an IDE establishing safety and effectiveness. Generally, because of the amount of information required, the 510(k) procedure takes less time than the PMA procedure.
In addition, we are subject to review, periodic inspection and marketing surveillance by the FDA to determine our compliance with regulatory requirements for any product for which we obtain marketing approval. Following approval, our manufacturing processes, subsequent clinical data and promotional activities are subject to ongoing regulatory obligations. If the FDA finds that we have failed to comply with these requirements or later discovers previously unknown problems with our products, including unanticipated adverse events of unanticipated severity or frequency, manufacture or manufacturing processes or failure to comply with regulatory requirements, it can institute a wide variety of enforcement actions, ranging from a public warning letter to more severe sanctions, including:
• | fines, injunctions and civil penalties; | ||
• | recall or seizure of our products; | ||
• | restrictions on our products or manufacturing processes, including operating restrictions, partial suspension or total shutdown of production; | ||
• | denial of requests for 510(k) clearances or PMAs of product candidates; | ||
• | withdrawal of 510(k) clearances or PMAs already granted; | ||
• | disgorgement of profits; and | ||
• | criminal prosecution. |
Any of these enforcement actions could affect our ability to commercially distribute our products in the United States and may also harm our ability to conduct the clinical trials necessary to support the marketing, clearance or approval of these products and could materially and adversely affect our business.
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To date, all of our products (except for the 800 and 600 Series Dye Module) have been marketed through the 510(k) procedure. Future products, however, may require clearance through the PMA procedure. There can be no assurance that such marketing clearances can be obtained on a timely basis, or at all. Delays in receiving such clearances could have a significant adverse impact on our ability to compete in our industry. The FDA may also require post-market testing and surveillance programs to monitor certain products.
Certain other countries require medical device manufacturers to obtain clearances for products prior to marketing the products in those countries. The requirements vary widely from country to country and are subject to change. Obtaining necessary regulatory approvals in key international markets and retaining such regulatory licenses is essential to international expansion of our business, which is an important strategic objective.
We are also required to register with the FDA and state agencies, such as the Food and Drug Branch of the California Department of Health Services (“CDHS”), as a medical device manufacturer. We are inspected routinely by these agencies to determine our compliance with the FDA’s current “Quality Systems Regulations”. Those regulations impose certain procedural and documentation requirements upon medical device manufacturers concerning manufacturing, testing and quality control activities. If these inspections determine violations of applicable regulations, the continued marketing of any products manufactured by us may be adversely affected.
In addition, our laser products are covered by a performance standard for laser products set forth in FDA regulations. The laser performance standard imposes certain specific record-keeping, reporting, product testing, and product labeling requirements on laser manufacturers. These requirements also include affixing warning labels to laser systems, as well as incorporating certain safety features in the design of laser products.
Complying with applicable governmental regulations and obtaining necessary clearances or approvals can be time consuming and expensive. There can be no assurance that regulatory review will not involve delays or other actions adversely affecting the marketing and sale of our products in the United States and internationally. We also cannot predict the extent or impact of future legislation or regulations in the United States and abroad.
We are also subject to regulation under federal and state laws regarding, among other things, occupational safety, the use and handling of hazardous materials and protection of the environment. While we believe that we are in material compliance with these requirements, noncompliance with any such requirements could have a material adverse effect on our business.
The regulatory approval process outside the United States varies depending on foreign regulatory requirements and may limit our ability to develop, manufacture and sell our products internationally.
To market any of our products outside of the United States, we and our collaborative partners, including certain of our distributors, are subject to numerous and varying foreign regulatory requirements, implemented by foreign health authorities, governing the design and conduct of human clinical trials and marketing approval for diagnostic products. As an example, we are seeking regulatory approval to market the GreenLight laser system for the treatment of BPH in Japan, which we hope will be received before the end of 2007. However, there can be no assurance that this approval will be obtained within this time frame or at all. The approval procedure varies among countries and can involve additional testing, and the time required to obtain approval may differ from that required to obtain FDA approval. The foreign regulatory approval process includes all of the risks associated with obtaining FDA approval set forth above, and approval by the FDA does not ensure approval by the health authorities of any other country, nor does the approval by foreign health authorities ensure approval by the FDA.
If our dispute with Palomar is resolved in a manner contrary to our position, we could be required to record additional expenses which could have a material adverse impact on our financial results.
Palomar Medical Technologies, Inc. (“Palomar”) has informed us that it disputes the method used by us for calculating the royalty to be paid on the Lyra laser system pursuant to the Patent License Agreement between Laserscope and Palomar (the “License Agreement”). Palomar also disputes our application of the License Agreement to the Gemini laser system, including our calculation of royalties due on the Gemini laser system under the License Agreement. In the third quarter of 2005, Palomar exercised its right under the License Agreement to engage an independent auditor to conduct a review of our royalty calculations and payments under the License Agreement. The independent auditors have issued a report identifying several potential alternative interpretations of the application of the License Agreement that indicate a potential liability of up to $3.7 million. We disagree with each of these potential alternative interpretations and believe that we have been correctly calculating and paying the royalties owed to Palomar under the
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License Agreement. Although we intend to vigorously defend our position while we seek to negotiate a resolution of the dispute with Palomar, we may be unable to reach a mutually agreeable resolution of the dispute. Additionally, we have not accrued for a settlement of the dispute. If our dispute with Palomar is resolved in a manner contrary to our position, we could be required to litigate the dispute incurring significant expenses and risk an unfavorable judgment, to record additional expenses and/or to pay a material amount to settle the dispute, which could have a material adverse impact on our financial statements.
As we have limited working capital, we may need additional capital that may not be available to us and, if raised, may dilute our shareholders’ ownership interest in us.
We may need to raise additional funds to develop or enhance our technologies, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies.
As of March 31, 2006, our total assets were $115.2 million and our total liabilities were $26.2 million. As of the same date, our working capital was $77.1 million and our cash and cash equivalents totaled $33.2 million. Current and anticipated demand for our products as well as procurement and production affect our need for capital. Changes in these or other factors could have a material impact on capital requirements and may require us to raise additional capital.
In the three months ended March 31, 2006, the only capital raised was through shares issued through the exercise of stock options under our Incentive Stock Option Plans. In 2005 the only other capital raised was through the exercise of warrants, which resulted in the issuance of 10,000 shares and shares issued through our Employee Stock Purchase Plan.
We anticipate that future changes in cash and working capital will be dependent on a number of factors including:
• | Our ability to manage effectively non-cash assets such as inventory and accounts receivable; | ||
• | Our ability to anticipate and adapt to the changes in our industry such as new and alternative medical procedures; | ||
• | Our level of profitability; and | ||
• | Our determination to acquire or invest in products and businesses complementary to ours. |
We have historically financed acquisitions using our existing cash resources. While we believe our existing cash resources, including our bank line of credit, will be sufficient to fund our operating needs for the next twelve months, additional financing will may be required for our currently envisioned long term needs.
Additional financing may not be available on terms that are acceptable to us. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our shareholders would be reduced and these securities might have rights, preferences and privileges senior to those of our current shareholders. If adequate funds are not available on acceptable terms, our ability to fund our expansion, take advantage of unanticipated opportunities, develop or enhance our products or services, or otherwise respond to competitive pressures would be significantly limited.
We may have difficulty sustaining profitability and may experience additional losses in the future.
Although we recorded net income of $2.8 million and $5.0 million for the three months ended March 31, 2006 and 2005, prior to 2002 we had prolonged periods of consecutive quarterly net losses. In order to maintain and improve our profitability, we will need to continue to generate new sales while controlling our costs. However, any failure to do so could harm our profitability and negatively affect the market price of our stock.
We may be unable to respond to the rapid technological changes that often affect the markets in which we compete.
If we fail to rapidly develop, manufacture and market technologically innovative products at acceptable costs, our operating results will suffer.
We operate in an industry that is subject to rapid technological change. Our ability to remain competitive and future operating results will depend upon, among other things, our ability to anticipate and respond rapidly to such change by developing, manufacturing and marketing technologically innovative products in sufficient quantities at acceptable costs to meet such demand. As we introduce new
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products this may cause some of our existing products to become obsolete, which may result in the write-off of inventory. However, without new products and enhancements, our existing products will likely become obsolete due to technological advances by other companies, which could result in the write-off of inventory as well as diminished revenues. Therefore, we intend to continue to invest significant amounts in research and development.
Our expenditures for research and development were $2.9 million for the three months ended March 31, 2006 and $1.6 million in the same period of 2005. We anticipate that our ability to compete will require significant research and development expenditures with a continuing flow of innovative, high-quality products. We cannot assure that we will be successful in designing, manufacturing or selling enhanced or new products in a timely manner. Nor can we assure that a competitor could not introduce a new or enhanced product or technology that could have an adverse effect on our competitive position.
Our current research and development programs are directed toward the development of new laser systems and delivery devices. We cannot assure that these markets will develop as anticipated or that our product development efforts will prove successful. Nor can we assure that such new products, if developed and introduced, will be accepted by the market.
We may become a party to a patent infringement and other intellectual property related actions or disputes, which could result in significant royalty or other payments or in injunctions that can prevent the sale of our products.
Our industry has been characterized by frequent allegations of patent infringement and or other intellectual property related activity including demands for licenses and litigation. Our competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. In addition, we do not know whether our competitors will apply for and obtain patents that will prevent, limit or interfere with our ability to make, use, sell or import our products. Although we may seek to resolve any potential future claims or actions, we may not be able to do so on reasonable terms, or at all. If, following a successful third-party action for infringement, we cannot obtain a license or redesign our products, we may have to stop manufacturing and marketing our products, and our business would suffer as a result.
We may become involved in litigation not only as a result of alleged infringement of a third party’s intellectual property rights but also to protect our own intellectual property. We have and may hereafter become involved in litigation to protect the trademark rights associated with our company name or the names of our products. If we have to change the name of our products, we may experience a loss in goodwill associated with customer confusion and a loss of sales.
Infringement and other intellectual property related claims, with or without merit, can be expensive and time-consuming to litigate, and could divert management’s attention from our core business. We do not know whether necessary licenses would be available to us on satisfactory terms, or whether we could redesign our products or processes to avoid infringement. If we lose this kind of litigation, a court could require us to pay substantial damages, and prohibit us from using technologies essential to our products, either of which would have a material adverse effect on our business, results of operations and financial condition.
Our acquisition of InnovaQuartz, Inc. may not provide us the expected benefits and could disrupt our business and harm our financial condition.
On April 30, 2006, we acquired all of the outstanding shares of InnovaQuartz, Inc for approximately $7.5 million in cash, the assumption of $1.1 million in debt and future cash payments contingent on the financial performance of InnovaQuartz over approximately three years. Since 2002, InnovaQuartz has been a reliable, high quality supplier of a key component of Laserscope’s GreenLight PV fiber optic delivery device. We acquired InnovaQuartz for several important reasons including, among others, the addition of a new fiber optic product line for the intracorporeal treatment of kidney, bladder, and other urinary stones, to realize an immediate reduction in the cost of goods of our single use products, to utilize InnovaQuartz’s manufacturing and design capabilities to contribute further reductions in the costs of our fiber optic disposable products in the future, and to deploy InnovaQuartz’s research and development expertise, focus in specialty assemblies and components and rapid proto-typing capability to support our efforts to develop new and lower cost fiber optic medical devices. However, the InnovaQuartz acquisition may not provide us some or all of these expected benefits. InnovaQuartz is highly dependent on several large customers and if we are unable to maintain those relationships, it would impede our ability to generate expected revenues and profits from the sale of InnovaQuartz’s products. In addition, the successful operation of InnovaQuartz is dependent on certain key employees. The integration of InnovaQuartz may prove to be more difficult than expected, and we may be unsuccessful in maintaining and developing relations with the company’s employees, customers and business partners. Further, InnovaQuartz may not contribute to desired contributions in R&D and if the integration of and continuing management of InnovaQuartz is not successful it could disrupt our supply of a key component of our GreenLight PV delivery device. Moreover, the additional resources required to integrate and manage InnovaQuartz could disrupt our business and harm our financial condition, results of operations and cash flows. The InnovaQuartz acquisition may result in unforeseen operating difficulties and expenditures which may consume significant management and other company resources. As a result of such difficulties and expenditures, these costs may outweigh the value we realize from the InnovaQuartz acquisition.
Any future acquisitions or divestitures we make may not provide us the expected benefits and could disrupt our business and harm our financial condition.
Any acquisitions we make may not provide us the expected benefits and could disrupt our business and harm our financial condition, results of operations and cash flows. We have acquired businesses and technologies in the past such as the acquisition of InnovaQuartz, Inc. in Phoenix, Arizona, and we may continue to acquire businesses or technologies that we believe are a strategic fit with our business. Any future acquisitions may result in unforeseen operating difficulties and expenditures and may absorb significant management attention that would otherwise be available for ongoing development of our business. In addition, the integration of acquisition targets may prove to be more difficult than expected, and we may be unsuccessful in maintaining and developing relations with the employees, customers and business partners and other acquisition targets. Since we will not be able to accurately predict these difficulties and expenditures, it is possible that these costs may outweigh the value we realize from a future acquisition. Future acquisitions could result in issuances of equity securities that would reduce our shareholders’ ownership interest, the incurrence of debt, contingent liabilities, stock based compensation or expenses related to the valuation of goodwill or other intangible assets and the incurrence of large, immediate write-offs.
We may be unable to attract and retain key personnel who are critical to the success of our business.
Our future success also depends on our ability to attract and retain engineers and other highly skilled personnel and senior managers. In addition, in order to meet our planned growth we must increase our sales force, both domestic and international, with qualified employees and personnel. Hiring qualified technical, sales and management personnel is difficult due to a limited number of qualified
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professionals and competition in our industry for these types of personnel. We have in the past experienced delays and difficulties in recruiting and retaining qualified technical and sales personnel and believe that at times our personnel are recruited aggressively by our competitors and start-up companies. Our employees are “at will” and may leave our employment at any time. As a result, we may experience significant employee turnover. Failure to attract and retain personnel, particularly sales and technical personnel would make it difficult for us to develop and market our technologies.
In addition, our business and operations are substantially dependent on the performance of our key personnel, including Eric Reuter, our President and Chief Executive Officer, Derek Bertocci, Vice President Finance and Chief Financial Officer, Bob Mathews, Group Vice President, Operations and Product Development, and Robert Mann, Group Vice President, Global Surgical Sales and Marketing. We do not have formal employment agreements with Messrs. Reuter, Bertocci, Mathews and Mann and do not maintain “key person” life insurance policies on their lives. If such individuals were to leave or become unable to perform services for our company, our business could be severely harmed.
Our quarterly operating results may fluctuate significantly and any failure to meet financial expectations for any fiscal quarter may cause our stock price to decline.
A number of factors affect our quarterly financial results including the timing of shipments and orders. Our laser products are relatively expensive pieces of medical capital equipment and the precise shipment date of specific units can have a marked effect on our results of operations on a quarterly basis. Additionally, our fiber optic disposable delivery devices are relatively complex assemblies requiring components that can have long lead times. Failure of suppliers to provide materials in a timely manner or other disruptions in the continuous production of these fiber optics components could have a substantially marked effect on our results of operations on a quarterly basis. Any delay in product shipments near the end of a quarter could cause our quarterly results to fall short of anticipated levels. Furthermore, to the extent we receive orders near the end of a quarter, we may not be able to fulfill the order during the balance of that same quarter. Moreover, we typically receive a disproportionate percentage of orders toward the end of each quarter. To the extent that we do not receive anticipated orders or orders are delayed beyond the end of the applicable quarter, our results may be adversely affected and may be unpredictable from quarter to quarter. In addition, because a significant portion of our revenues in each quarter result from orders received in that quarter, we base our production, inventory and operating expenditure levels on anticipated revenue levels. Thus, if sales do not occur when expected, expenditure levels could be disproportionately high and operating results for that quarter and potentially future quarters, would be adversely affected. We cannot assure that we will accomplish revenue growth or profitability on a quarterly or annual basis. Nor can we assure that revenue growth or profitability will not fluctuate significantly from quarter to quarter.
If we are unable to expand and maintain our relationship with our U.S. distribution partner, Henry Schein on favorable contractual terms, our business may be harmed.
In July 2005, we entered into a non-exclusive distribution agreement with Henry Schein (the “HSI Agreement”), pursuant to which Henry Schein, a provider of healthcare products and services to office-based practitioners in the North American and European markets, will distribute our aesthetic product line to physicians and physician practices within the United States. The HSI Agreement is terminable by either party upon 90 days notice. The Henry Schein distribution relationship is intended to replace our distribution relationship with McKesson, which terminated effective November 9, 2005. McKesson had been our exclusive U.S. distribution partner for aesthetic products for nearly four years until April 2005, when our relationship with McKesson was made non-exclusive. On August 9, we received a notice from McKesson that it intended to terminate the McKesson Agreement effective in November 2005. Following the amendment of our distribution agreement with McKesson to make it non-exclusive and prior to termination of the distribution relationship with McKesson, we experienced a significant decline in sales of our aesthetic products through McKesson. Sales of our aesthetic products through the Henry Schein relationship failed to offset the decline in revenues through McKesson in the 2005. A national distribution relationship that extends our reach is important to our success because the potential customer base for our aesthetic product line includes physicians from a variety of specialties including among others, dermatologists, plastic surgeons, primary care and OB/GYN physicians. During the term of our distribution relationship with McKesson, sales to McKesson accounted for a substantial portion of our revenues. For the year ended December 31, 2005, sales through McKesson accounted for approximately 6% of our total revenues and at December 31, 2005. Although we expect revenue generated through Henry Schein to increase significantly as this new distribution relationship is fully implemented, there can there be no assurance that our distribution relationship with Henry Schein will adequately replace our relationship with McKesson and we may be unable to generate sufficient revenues on a timely basis or at all. If we are unable to effect a timely and effective transition to the new distribution relationship and maintain a favorable relationship with Henry Schein and/or another major U.S. distribution partner or if Henry Schein or any such other U.S. distribution partner encounters financial difficulties, it could have a material adverse effect on our business, financial condition, results of operations, and future cash flows.
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If we are unable to effect a swift transition and rapidly establish a strong working relationship with our U.S. distribution partner, Henry Schein, we may be unable to achieve growth in sales of our aesthetic product line in a timely manner or at all.
The Henry Schein distribution relationship has replaced the McKesson distribution relationship as our principal U.S. distribution network for our aesthetic product line, but as of yet has not replaced the revenues previously generated through McKesson. During the three months ended March 31, 2005, sales to McKesson accounted for approximately 12% of our total revenues. In the three months ended March 31, 2006, revenues generated through Henry Schein failed to offset the decline in revenues through McKesson in the comparable period of 2005. Establishing a strong U.S. distribution partner for our aesthetic products is important to our future success in the near future and beyond. The initial phase of our distribution relationship with Henry Schein involves significant training and coordination activities which are necessary to achieve a successful distribution partnership. Although to date we have made substantial progress in effecting this transition, unless we are able to accelerate this process and expand our relationship rapidly we will be unable to generate revenues sufficient to replace those previously generated through our relationship with McKesson.
If our products contain defects that harm our customers’ patients, it would damage our reputation, subject us to potential legal liability and cause us to lose customers and revenue.
Laser systems and fiber optic delivery devices are inherently complex in design and manufacturing. Laser systems require ongoing regular maintenance. The manufacture of our lasers, laser products, disposable delivery devices, and systems involve highly complex and precise processes. As a result of the technical complexity of our products, changes in our or our suppliers’ manufacturing processes or the inadvertent use of defective materials by us or our suppliers could result in a material adverse effect on our ability to achieve acceptable manufacturing yields and product reliability. To the extent that we do not achieve such yields or product reliability, this could have a material affect on our business, financial position, and results of operations.
Our customers may discover defects in our products after the products have been fully deployed and operated under peak stress conditions. In addition, some of our products are combined with products from other vendors, which may contain defects. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:
• | loss of customers; | ||
• | increased costs of product, returns and warranty expenses; | ||
• | damage to our brand reputation; | ||
• | failure to attract new customers or achieve market acceptance; | ||
• | action by regulatory authorities; | ||
• | diversion of development and engineering resources; and | ||
• | legal actions by our customers. |
The occurrence of any one or more of the foregoing factors could seriously harm our business, financial condition and results of operations.
Our financial results and stock price are affected by a number of factors which are beyond our control.
A number of factors affect our financial results and stock price including, but not limited to:
• | product mix; | ||
• | competitive pricing pressures; | ||
• | material costs; |
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• | revenue and expenses related to new products and enhancements to existing products; | ||
• | delays in customer purchases in anticipation of new products or product enhancements by us or our competitors; and | ||
• | the risk of loss or interruption to our operations or increased costs due to earthquakes, the availability of power and energy supplies and other events beyond our control . |
The market price of our common stock has historically been subject to significant fluctuations. These fluctuations may be due to factors specific to us, such as:
• | quarterly fluctuations in our financial results; | ||
• | changes in analysts’ estimates of future results; | ||
• | changes in investors’ perceptions of our products; | ||
• | announcement of new or enhanced products by us or our competitors; | ||
• | announcements relating to acquisitions and strategic transactions by us or our competitors; | ||
• | general conditions in the medical equipment industry; and | ||
• | general conditions in the financial markets. |
The stock market has from time to time experienced extreme price and volume fluctuations, particularly among stocks of high technology companies, which, on occasion, have been unrelated to the operating performance of particular companies. Factors not directly related to our performance, such as negative industry reports or disappointing earnings announcements by publicly traded competitors, may have an adverse impact on the market price of our common stock.
As of March 31, 2006, we had 22,370,270 shares of outstanding common stock. The sale of a substantial number of shares of common stock or the perception that such sales could occur, could adversely affect prevailing market prices for our common stock.
Our financial results and stock price are highly dependent upon successful pricing and sales of our main product line, the GreenLight laser system and related fiber optic delivery device, which increases our vulnerability to a variety of factors outside of our direct control.
Our financial results are highly dependent on successful pricing and sales of the GreenLight PV laser system and related fiber optic delivery device. Pricing and sales may be affected by a myriad of factors including public and private payer reimbursement domestically and internationally, products and services offered by competitors with greater financial resources than us who may engage in aggressive marketing and pricing strategies, new technologies that deliver superior results to PVP or comparable results at commensurate or lower costs, our ability to maintain or reduce the costs of materials and components used to produce the GreenLight products, among other factors beyond our direct control. Any of these or other factors could compel us to make significant reductions in our pricing or other changes in our sales strategy, which could adversely affect our financial performance and future prospects.
We are a party to legal proceedings arising in the ordinary course of business.
We are party to a number of legal proceedings arising in the ordinary course of business. While it is not feasible to predict or determine the outcome of the actions brought against us, we believe that the ultimate resolution of these claims will not ultimately have a material adverse effect on our financial position, results of operations, or future cash flows.
We typically assume warranty obligations in connection with the sales of our products, which could cause a significant drain on our resources if our products perform poorly.
We have a direct field service organization that provides service for our products. We generally provide a twelve month warranty on our laser systems. After the warranty period, maintenance and support is provided on a service contract basis or on an individual call basis. Our warranties and premium service contracts provide for a “99.0% Uptime Guarantee” on our laser systems. Under provisions of this guarantee, at the request of the customer, we extend the term of the related warranty or service contract if specified system
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uptime levels are not maintained. Although the number of warranties extended under this program are currently not material, we can not assure that the number of warranties will not become significant in the future if our products perform poorly, which could cause a significant drain on our resources.
Natural catastrophic events, such as earthquakes, hurricanes or terrorist attacks may reduce our revenues and harm our business.
Our corporate headquarters, including our research and development operations, our manufacturing facilities, and our principal sales, marketing and service offices, are located in the Silicon Valley area of Northern California, a region known for seismic activity. A significant natural disaster, such as an earthquake or a flood, could have a material adverse impact on our business, operating results, and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition.
In addition, as our business has grown, we have become increasingly subject to the risks arising from adverse changes in domestic and global economic conditions, natural and man-made disasters. Disruptions in large areas of the United States due to natural disasters and subsequent relief efforts, as seen with the hurricanes that struck the southern United States in the summer and fall of 2005, could have a material adverse effect on our business, operating results, and financial condition. The effects of war or acts of terrorism could likewise have a material adverse effect on our business, operating results, and financial condition. The terrorist attacks in New York, Pennsylvania and Washington, D.C. on September 11, 2001 disrupted commerce throughout the world and intensified the uncertainty of the United States and other economies. The continued threat of terrorism and heightened security and military action in response to this threat, or any future acts of terrorism, may cause further disruptions to these economies and create further uncertainties. To the extent that such disruptions or uncertainties result in delays or cancellations of customer orders, or the manufacture or shipment of our products, our business, operating results, financial condition and cash flows could be materially and adversely affected.
No Dividends.
We have never paid cash dividends on our common stock and do not anticipate paying cash dividends on the common stock in the foreseeable future. The payment of dividends on the common stock will depend on our earnings, financial condition and other business and economic factors affecting us at such time as the Board of Directors may consider relevant.
The exercise of outstanding options and warrants granted under our stock option plans and other options and warrants may result in dilution of our shareholders equity interests.
Shareholders may experience dilution in the net tangible book value of their investment upon the exercise of outstanding options and warrants granted under our stock option plans and other options and warrants.
Other Risks.
Other risks are detailed from time to time in our press releases and other public disclosure filings with the United States Securities and Exchange Commission (“SEC”), copies of which are available upon request from us.
Item 5. Other Information
On December 15, 2005, the Company announced that Robert Pearson, a member of the Board of Directors of the Company and the Chairman of its Audit Committee, stated his intention to resign from the Board effective upon the filing of the Company’s Annual Report on Form 10-K for the year ended December 31, 2005. Mr. Pearson has since determined that he will serve as a member of the Company’s Board of Directors and as the Chairman of its Audit Committee until the Company’s 2006 Annual Meeting. Mr. Pearson has decided to leave the Board for personal reasons. The Company plans to fill the vacancy created by Mr. Pearson’s departure.
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Item 6. Exhibits
(a)Exhibits filed herewith (numbered in accordance with Item 601 of Regulation S-K):
Exhibit | ||
Number | Description | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Principal Executive Officer pursuant to 18 U.S.C Section 1350. | |
32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
LASERSCOPE Registrant | ||||
/s/ Derek Bertocci | ||||
Derek Bertocci | ||||
Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer) | ||||
Date: May 10, 2006
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Exhibit Index
Exhibit | ||
Number | Description | |
31.1 | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of Principal Executive Officer pursuant to 18 U.S.C Section 1350. | |
32.2 | Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350. |