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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-Q
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 For the quarter ended October 2, 1999
Commission file number 0-14742
CANDELA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
Delaware 04-2477008
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER IDENTIFICATION NO.)
OF INCORPORATION OR ORGANIZATION)
530 Boston Post Road, Wayland, Massachusetts 01778
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (508) 358-7400
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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. Yes X No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practical date.
CLASS OUTSTANDING AT NOVEMBER 11, 1999
--------- -------------------------------
Common Stock, $.01 par value 7,255,217
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CANDELA CORPORATION
INDEX
Page(s)
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Part I. Financial Information:
Item 1. Unaudited Condensed Consolidated Balance Sheets
as of October 2, 1999 and July 3, 1999 3
Unaudited Condensed Consolidated Statements of Operations
and Comprehensive Income for the three month periods
ended October 2, 1999 and September 26, 1998 4
Unaudited Condensed Consolidated Statements of Cash
Flows for the three month periods ended October 2, 1999
and September 26, 1998 5
Notes to Unaudited Condensed Consolidated
Financial Statements 6-9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10-13
Cautionary Statements 14-21
Item 3. Quantitative and Qualitative Disclosure
about Market Risk 21
Part II. Other Information:
Item 1. Legal proceedings 22-23
Item 6. Exhibits and Reports on Form 8-K 23
Exhibit 27.1 Financial Data Schedule 25
2
PART I. FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
CANDELA CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)
October 2, July 3,
ASSETS 1999 1999
- --------------------------------------------------------------------------------------------------------------------------
Current assets:
Cash and cash equivalents $ 29,538 $ 10,055
Accounts receivable, net 12,591 12,337
Notes receivable 2,356 2,186
Inventories 6,639 6,927
Other current assets 1,114 928
---------------------------------------------------------------------------------------------------------------------
Total current assets 52,238 32,433
- --------------------------------------------------------------------------------------------------------------------------
Property and equipment, net 2,520 2,626
Deferred tax assets 1,898 1,100
Other assets 276 292
- --------------------------------------------------------------------------------------------------------------------------
Total Assets $ 56,932 $ 36,451
==========================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------------------------------------------------
Current liabilities:
Accounts payable $ 3,843 $ 4,846
Accrued payroll and related expenses 2,016 3,735
Accrued warranty costs 2,481 2,502
Income taxes payable 2,718 3,185
Restructuring reserve 1,394 1,519
Other accrued liabilities 1,478 1,132
Current portion of long-term debt 337 415
Deferred income 2,122 1,913
- --------------------------------------------------------------------------------------------------------------------------
Total current liabilities 16,389 19,247
- --------------------------------------------------------------------------------------------------------------------------
Long-term debt 3,116 3,181
- --------------------------------------------------------------------------------------------------------------------------
Commitments and contingencies - -
- --------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock 73 56
Additional paid-in capital 38,667 18,562
Accumulated deficit (1,132) (3,846)
Accumulated other comprehensive income (181) (749)
- --------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 37,427 14,023
- --------------------------------------------------------------------------------------------------------------------------
Total Liabilities and Stockholders' Equity $ 56,932 $ 36,451
==========================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
3
CANDELA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(in thousands, except per share data)
(unaudited)
For the three months ended
October 2, September 26,
1999 1998
- ------------------------------------------------------------------------------------------------------------------
Revenue:
Lasers and other products $ 13,092 $ 8,022
Product related service 2,083 2,000
Skin care center 865 716
- ------------------------------------------------------------------------------------------------------------------
Total revenue 16,040 10,738
Cost of revenue:
Lasers and other products 5,050 3,801
Product related service 1,280 1,344
Skin care center 569 529
- ------------------------------------------------------------------------------------------------------------------
Total cost of revenue 6,899 5,674
- ------------------------------------------------------------------------------------------------------------------
Gross profit 9,141 5,064
Operating expenses:
Selling, general, and administrative 5,001 3,333
Research and development 981 688
- ------------------------------------------------------------------------------------------------------------------
Total operating expenses 5,982 4,021
- ------------------------------------------------------------------------------------------------------------------
Income from operations 3,159 1,043
Other income (expense):
Interest income 219 11
Interest expense (127) (78)
Other 141 34
- ------------------------------------------------------------------------------------------------------------------
Total other income (expense) 233 (33)
- ------------------------------------------------------------------------------------------------------------------
Income before income taxes 3,392 1,010
Provision for income taxes 678 100
- ------------------------------------------------------------------------------------------------------------------
Net income $ 2,714 $ 910
==================================================================================================================
Basic earnings per share $ 0.40 $ 0.17
Diluted earnings per share $ 0.35 $ 0.16
==================================================================================================================
Weighted average shares outstanding 6,853 5,479
Adjusted weighted average shares outstanding 7,751 5,566
==================================================================================================================
Net income $ 2,714 $ 910
Other comprehensive income net of tax:
Foreign currency translation adjustment 455 326
===================================================================================================================
Comprehensive income $ 3,169 $ 1,236
===================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
4
CANDELA CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the three months ended:
October 2, September 26,
1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 2,714 $ 910
Adjustments to reconcile net income to net cash
provided by (used for) operating activities:
Depreciation and amortization 170 180
Provision for bad debts 200 36
Accretion of debt 24 -
Increase (decrease) in cash from working capital:
Accounts receivable (85) 300
Notes receivable 101 (13)
Inventories 532 190
Other current assets (133) (497)
Other assets (782) (19)
Accounts payable (1,863) (734)
Accrued payroll and related expenses (1,731) 92
Deferred income 149 (102)
Accrued warranty costs (20) 117
Income taxes payable (573) (13)
Accrued restructuring charges (125) (38)
Other accrued liabilities 310 627
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities (1,112) 1,036
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (62) (39)
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (62) (39)
- -----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Principal payments of long-term debt (78) (358)
Principal payments of capital lease obligations (97) (132)
Proceeds from the issuance of common stock 20,121 8
- -----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities 19,946 (482)
- -----------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rates on cash and cash equivalents 711 333
- -----------------------------------------------------------------------------------------------------------------------------------
Net increase in cash and cash equivalents 19,483 848
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of period 10,055 1,615
- -----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 29,538 $ 2,463
===================================================================================================================================
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THE UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS.
5
CANDELA CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements and
notes do not include all of the disclosures made in the Annual Report on
Form 10-K of Candela Corporation (the "Company") for fiscal 1999, which
should be read in conjunction with these financial statements. The
financial information included herein is unaudited, with the exception of
the condensed consolidated balance sheet as of July 3, 1999 which was
derived from the audited consolidated balance sheet dated July 3, 1999.
However, in the opinion of management, the statements include all
necessary adjustments for a fair presentation of the quarterly results and
are prepared and presented in a manner consistent with the Company's
Annual Report on Form 10-K. The results for the three month period ended
October 2, 1999 are not necessarily indicative of the results to be
expected for the full year.
2. INVENTORIES
Inventories consist of the following (in thousands):
OCTOBER 2, 1999 JULY 3, 1999
--------------- ------------
Raw materials $ 1,751 $ 1,643
Work in process 1,158 1,395
Finished goods 3,730 3,889
--------- ---------
$ 6,639 $ 6,927
======== ========
3. DEBT
On October 15, 1998, we issued eight-year, 9.75% subordinated notes to
three investors in the aggregate amount of $3,700,000. The notes become
due in October, 2006, and require quarterly interest payments. In
addition, we issued warrants to purchase 370,000 shares of common stock to
the note holders that have an exercise price of $4.00 per share. The
agreement contains restrictive covenants establishing maximum leverage,
certain minimum ratios, and minimum levels of net income.
We maintain a renewable $3,500,000 revolving line of credit agreement with
a major bank with interest at the bank's prime lending rate. This line of
credit is due to expire on December 1, 1999. No amounts were outstanding
under the line of credit as of October 2, 1999.
4. STOCK OFFERING
We completed a public offering in July, 1999 of 2,430,000 shares of common
stock, of which 1,499,854 shares were sold by Candela and 930,146 shares
were sold by certain selling shareholders. $19,805,573 was received in
cash after underwriting discounts on completion of the offering. We
incurred $585,000 of additional costs in conjunction with the offering, of
which $411,796 was paid in the current fiscal year.
5. EARNINGS PER SHARE
Basic earnings per share is computed by dividing net income by the
weighted average number of shares of common stock outstanding for the
period and, if there are dilutive securities, diluted earnings per share
is computed by including common stock equivalents outstanding for the
period in the denominator.
6
CANDELA CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
Common stock equivalents include shares issuable upon the exercise of
stock options or warrants, net of shares assumed to have been purchased
with the proceeds, using the treasury stock method.
FOR THE THREE MONTHS ENDED:
---------------------------
October 2, September 26,
1999 1998
---- ----
NUMERATOR
Net income $ 2,714 $ 910
======= =======
DENOMINATOR
BASIC EARNINGS PER SHARE
Weighted average shares
outstanding 6,853 5,479
-------- --------
Earnings per share $ 0.40 $ 0.17
======== ========
DILUTED EARNINGS PER SHARE
Weighted average shares
outstanding 6,853 5,479
Effect of dilutive securities:
Stock options 551 87
Stock warrants 347 -
-------- ----------
Adjusted weighted average
shares outstanding 7,751 5,566
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Earnings per share $ 0.35 $ 0.16
======== ===========
During the quarter ended October 2, 1999, there were 1,500 options with an
expiration date of March 29, 2000 to purchase shares of common stock that
were excluded from the calculation of diluted earning per share because
the options' exercise price was greater than the average market price of
the common stock. All warrants to purchase shares of common stock were
included in the computation of diluted EPS. During the first quarter of
fiscal 1999, there were 294,434 options to purchase shares of common stock
and warrants to purchase 281,983 shares of common stock that were not
included in calculation of diluted earnings per share because the options'
exercise price were greater than the average market price of the common
stock.
6. RESTRUCTURING CHARGES
During the quarter ended December 27, 1997, we recorded restructuring
charges of $2,609,000 resulting from management's decision to close the
skin care center located in Scottsdale, Arizona. The following table
reflects the restructuring charges incurred in the most recent quarter:
7
CANDELA CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
LEASEHOLD
IMPROVEMENTS CAPITALIZED
PAYROLL AND AND FIXED FACILITY START UP
SEVERANCE ASSETS COSTS COSTS TOTAL
--------- ------ ----- ----- -----
Balance at July 3, 1999 $ 210 $ 797 $ 512 $ 0 $ 1,519
Cash Charges (19) (55) (74)
Non-Cash Charges (51) (51)
----------------- ------------------- ----------------- ------------------ ---------------
Balance at October 2, 1999 $ 191 $ 746 $ 457 $ 0 $ 1,394
================= =================== ================= ================== ===============
6. INCOME TAXES
The provision for income taxes results from a combination of activities
including both the domestic and foreign subsidiaries of the Company. The
provision for income taxes for the three months ended October 2, 1999,
reflects a reduction of the valuation allowance against the deferred tax
asset in the amount of $798,000 and includes tax provisions calculated in
Japan and Spain at a rate in excess of the U.S. statutory tax rate. We had
deferred tax assets of $4,214,000 at the beginning of the current fiscal
year. A valuation allowance had then been provided against the deferred
tax asset in the amount of $3,114,000 leaving a net deferred tax asset of
$1,100,000. The valuation allowance has been reduced by $798,000 in the
current quarter effectively increasing the net deferred tax asset to
$1,898,000. The effective tax rate for the year is expected to be
approximately 20% due to anticipated reductions in the valuation
allowance.
7. SEGMENT INFORMATION
We operate principally in two industry segments; the design, manufacture,
sale, and service of medical devices and related equipment, and the
performance of services in the skin care/healthy spa industry.
LINE OF BUSINESS DATA For the three months ended:
October 2, 1999 September 26, 1999
--------------- ------------------
REVENUE:
Product Sales and Service $15,175 $10,022
Skin Care/Health Spa Services 865 716
------- ---------
Total Revenue $16,040 $10,738
======= =======
OPERATING INCOME (LOSS):
Product Sales and Service $ 3,335 $1,329
Skin Care/Health Spa Services (176) (286)
------- ---------
Total Operating Income (Loss) $ 3,159 $1,043
======= ======
As of As of
October 2, 1999 July 3, 1999
--------------- ------------
TOTAL ASSETS: (NET INTERCOMPANY ACCOUNTS)
Product Sales and Service $ 54,753 $34,250
Skin Care/Health Spa Services 2,179 2,201
------- ---------
Total Assets $ 56,932 $36,451
======== =======
8
CANDELA CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(CONTINUED)
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board "FASB" issued
Statement of Financial Accounting Standards No. 133 ("SFAS 133")
"Accounting for Derivative Instruments and Hedging Activities." SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts
(collectively referred to as "derivatives"), and for hedging activities.
SFAS 133 requires companies to recognize all derivatives as either assets
or liabilities, with the instruments measured at fair value. The
accounting for changes in fair value, gains or losses, depends on the
intended use of the derivative and its resulting designation. Originally,
the statement had been effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. In June 1999, the FASB issued Statement of
Financial Accounting Standards No. 137 ("SFAS 137"), "Accounting for
Derivative Instruments and Hedging Activities", which postponed the
adoption of SFAS 133 until fiscal years beginning after June 15, 2000. As
such, we plan to implement SFAS 133 for its fiscal year 2001.
The derivative instruments and hedging activities entered into by Candela
includes foreign currency forward contracts to protect against currency
fluctuation for amounts due between itself and its foreign subsidiaries.
At October 2, 1999, we held foreign currency forward contracts with
notional value totaling approximately $3,221,000 compared to forward
contracts with a value of $1,369,000 held at September 26, 1998. The
present contracts have maturity dates prior to January 24, 2000. The
carrying and net fair value of these contracts at October 2, 1999, was $0
and ($264,000), respectively, compared to $0 and ($32,000) respectively,
at September 26, 1998.
9
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
We research, develop, manufacture, market and service lasers used to perform
aesthetic and cosmetic procedures. We sell our lasers principally to medical
practitioners. We market our products directly and through a network of
distributors to end users. Our traditional customer base includes plastic and
cosmetic surgeons and dermatologists. More recently we have expanded our sales
to a broader group of practitioners consisting of general practitioners and
certain specialists including obstetricians, gynecologists and general and
vascular surgeons. We derive our revenue from: the sales of lasers and other
products; the provision of product-related services; and the operations of our
remaining skin care center. Approximately half of our revenue in recent periods
has come from international sales.
RESULTS OF OPERATIONS
REVENUE. Revenue source by geography is reflected in the following table:
(unaudited) OCTOBER 2, 1999 SEPTEMBER 26, 1998 CHANGE
--------------- ------------------ -----------------
$ % $ % $ %
-------------------------------------------------------------------------------
US revenue $ 8,182,000 51% $ 5,260,000 49% $ 2,922,000 56%
Foreign revenue 7,858,000 49% 5,478,000 51% 2,380,000 43%
--------------------------------------------------------------------------------
Total revenue $ 16,040,000 100% $10,738,000 100% $ 5,302,000 49%
US sales were impacted by increases both in sales to distributors and sales
through our direct sales force. The increase in foreign revenue is attributable
to increased sales in both Europe and the Asian Pacific region, including sales
by our Neu-Isenberg, Germany and Osaka, Japan sales offices, both of which were
not operational in the first quarter of fiscal 1999.
Revenue source by type is reflected in the following table:
(unaudited) OCTOBER 2, 1999 SEPTEMBER 26, 1998 CHANGE
--------------- ------------------ ----------------
$ % $ % $ %
-------------------------------------------------------------------------------
Lasers and other
products $ 13,092,000 82% $ 8,022,000 75% $ 5,070,000 63%
Product related
service 2,083,000 13% 2,000,000 19% 83,000 4%
Skin care centers 865,000 5% 716,000 6% 149,000 21%
----------------------------------------------------------------------------------------
Total revenue $ 16,040,000 100% $10,738,000 100% $ 5,302,000 49%
The increase in laser product revenue resulted from a substantial increase in
our GentleLASE product line, including the initial shipments of our enhanced
GentleLASE PLUS. We also experienced increased revenue in our ScleroPLUS and
AlexLAZR product lines. Skin care center revenue increased as a result of
increased marketing and promotion.
10
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
GROSS PROFIT. Gross profit was $9,141,000, or 57% of revenues for the three
month period ended October 2, 1999, compared to gross profit of $5,064,000, or
47% for the same period one year earlier. The increase in gross profit, over the
same period a year earlier, is the result of increased sales of higher margin
laser systems and higher absorption of fixed portions of manufacturing overhead
due to our higher sales volume.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative
expenses increased from $3,333,000 in the three month period ended September 26,
1998, to $5,001,000 for the three month period ending October 2, 1999. This
increase is primarily a result of the increased marketing and sales staff,
including costs for our German and Osaka, Japan sales offices which were not
operational in the same period a year earlier. Selling, general and
administrative expenses were 31% of revenues for the both of the first quarters
of fiscal year 1999 and 2000.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development spending increased
43% to $981,000 for the three months ended October 2, 1999, compared to $688,000
for the same period one year earlier. This increase reflects our efforts to
develop products and product improvements designed to enhance, augment, and
expand our existing product lines.
RESTRUCTURING CHARGE. During the quarter ended December 27, 1997, a
restructuring charge was recorded and a reserve established in the amount of
$2,609,000 resulting from management's decision to close the skin care center
located in Scottsdale, Arizona. During the three months ended October 2, 1999, a
total of $125,000 was charged against this reserve, representing costs
associated with the Scottsdale facility. Candela continues to pursue a sublease
of the Scottsdale facility, but if this effort is not successful, we could incur
additional costs in excess of our existing reserve. Management believes that the
reserve established to date will be sufficiently adequate so that no additional
material charges will need to be recognized for at least the next 18 months.
OPERATING INCOME. Operating income increased 203% to $3,159,000 for the three
months ended October 2, 1999, compared to $1,043,000 for the same period one
year earlier. Operating income increased to 20% of revenue compared to 10% for
the same period a year ago.
OTHER INCOME/EXPENSE. Net other income and expense was $233,000 in income for
the three months ended October 2, 1999, in comparison to expenses of $33,000 for
the same period a year earlier. This increase was primarily caused by increased
interest income resulting from a higher level of cash during the period and
exchange gains realized in our foreign subsidiaries.
INCOME TAXES. The provision for income taxes results from a combination of
activities of both our domestic and foreign subsidiaries. The provision for
income taxes for the three months ended October 2, 1999, reflects a reduction of
the valuation allowance against our deferred tax asset in the amount of $798,000
and includes tax provisions calculated in Japan and Spain at a rate in excess of
the U.S. statutory tax rate. We had deferred tax assets of $4,214,000 at the
beginning of the current fiscal year. A valuation allowance had been provided
against the deferred tax asset in the amount of $3,114,000 leaving a net
deferred tax asset of $1,100,000 at July 3, 1999. The valuation allowance has
been reduced by $798,000 in the current quarter effectively increasing the net
deferred tax asset to $1,898,000 at October 2, 1999. The effective tax rate for
the year is expected to be approximately 20%.
11
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
LIQUIDITY AND CAPITAL RESOURCES
Cash used for operating activities amounted to $1,112,000 for the three months
ended October 2, 1999, in comparison to cash provided by operating activities of
$1,036,000 for the same period a year earlier. The decrease reflects an increase
due to improved profitability in the quarter offset by a reduction in accounts
payable as well as increased payments for income taxes and accrued payroll. Cash
used for investing activities totaled $62,000 for the three months ended October
2, 1999 compared to cash used for investing activities of $39,000 for the same
period in the prior year. Cash provided by financing activities amounted to
$19,946,000 in comparison to cash used for financing activities of $482,000 for
the same period a year earlier. This reflects proceeds from the issuance of
common stock amounting to $20,121,000 primarily resulting from our July, 1999
stock offering.
Cash and cash equivalents at October 2, 1999, increased by $19,483,000 to
$29,538,000 from $10,055,000 at July 3, 1999, due principally to cash received
in our stock offering completed in July, 1999.
We completed a public offering in July, 1999 of 2,430,000 shares of common
stock, of which 1,499,854 shares were sold by Candela and 930,146 shares were
sold by certain selling shareholders. $19,805,573 was received in cash after
underwriting discounts on completion of the offering. We incurred $585,000 of
additional costs in conjunction with the offering, of which $411,796 was paid in
the current fiscal year.
We issued eight-year, 9.75% subordinated notes in the amount of $3,700,000 in
October, 1998. The notes become due in October, 2006, and require quarterly
interest payments. In addition, we issued warrants to purchase 370,000 shares of
common stock to the note holders that have an exercise price of $4.00 per share.
The relative fair value of the debt was recorded as $2,864,000. The relative
fair value of the warrants was $836,000 and was recorded as a component of
Additional Paid-In Capital. The debt will be accreted to face value using the
interest method over the eight-year life of the notes resulting in interest
expense of $836,000 over the eight-year period in addition to the 9.75% face
interest. A total of $89,000 has been accreted to the notes through October 2,
1999 resulting in a long term liability balance of $2,953,000 at quarter end.
We also maintain a $3,500,000 line of credit with a major bank which expires
December 1, 1999. The line of credit bears interest at the bank's prime lending
rate and is collateralized by total domestic accounts receivable, inventories,
and a pledge of subsidiary stock. At October 2, 1999, we had no borrowings
outstanding on this line of credit.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board "FASB" issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133") "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133 establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
"derivatives"), and for hedging activities. SFAS 133 requires companies to
recognize all derivatives as either assets or liabilities, with the instruments
measured at fair value. The accounting for changes in fair value, gains or
losses, depends on the intended use of the derivative and its resulting
designation. Originally, the statement had been effective for all fiscal
quarters of fiscal years beginning after June 15, 1999. In June 1999, the FASB
issued Statement of Financial Accounting Standards No. 137 ("SFAS 137"),
"Accounting for Derivative Instruments and Hedging Activities", which postponed
the adoption of SFAS 133 until fiscal years beginning after June 15, 2000. As
such, the Company plans to implement SFAS 133 for its fiscal year 2001.
12
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
YEAR 2000 READINESS DISCLOSURE STATEMENT
We have assessed our operations, from information and financial systems to each
aspect of our manufacturing processes, including non-information systems and
products, in order to reduce the risk of operational disruption and potential
litigation due to the Year 2000 issue. We have completed approximately 95% of
the implementation and testing of the necessary upgrades to our financial and
information systems and expect to finish our upgrades prior to the end of
November 1999. Our Year 2000 assessment identified no need for upgrades to our
products and non-information systems. To date, we have primarily used our
internal resources to assess our Year 2000 readiness. We have currently incurred
less than $10,000 of incremental costs relating to Year 2000 readiness and
believe that we will incur less than $10,000 of additional incremental costs in
the foreseeable future. We have questioned representatives of Litton Airtron
Synoptics, our sole supplier for Alexandrite rods, and PSS, a major distributor,
and have reviewed publicly available disclosures relating to PSS. Litton has
indicated that their business systems are Year 2000 compliant. Based on this
review, we are not aware of any information to indicate that Litton or PSS will
experience substantial Year 2000 problems. In addition, we have conducted an
informal survey of our other suppliers, significant customers, and business
partners. While responses to this survey indicate that many of our suppliers and
customers are Year 2000 compliant, we have not yet received sufficient
information from all parties about their Year 2000 preparedness to assess the
effectiveness of their efforts. Moreover, in most cases, we are not in a
position to verify the accuracy or completeness of the information we receive
from third parties.
If third parties with whom we interact have Year 2000 problems that are not
remedied, we could experience problems including the following:
- in the case of vendors, disruption of important services upon which we
depend, such as telecommunications and electrical power;
- in the case of customers, temporary reduction in their purchasing
activities as they implement upgraded systems;
- in the case of third-party data providers, receipt of inaccurate or
out-of-date information that would impair our ability to perform
critical data functions; and
- in the case of banks and other lenders, disruption of capital flows,
potentially resulting in liquidity stress.
While we believe that Year 2000 disruptions will not materially hurt our
business, in the worst case scenario our systems, or those of our suppliers and
customers, may not function properly after December 31, 1999. This could result
in delays in operations which would significantly harm our financial condition
and operating results. In some international markets in which we do business,
the level of awareness and remediation efforts relating to the Year 2000 issue
may be less advanced than in the U.S. We are in the process of formulating a
contingency plan to address the failure of our most important organizational
systems, which we expect to be substantially complete by November 1999. We
anticipate that our contingency plan will focus on identifying additional
suppliers that can be utilized in the event of a Year 2000 disruption.
13
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
CAUTIONARY STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements
including, without limitation, statements concerning the future of the
industry, product development, business strategy (including the possibility
of future acquisitions), anticipated operational and capital expenditure
levels, continued acceptance and growth of our products, and dependence on
significant customers and suppliers. This Quarterly Report on Form 10-Q
contains forward-looking statements that we have made based on our current
expectations, estimates and projections about our industry, operations, and
prospects, not historical facts. We have made these forward-looking
statements pursuant to the provisions of the Private Securities Litigation
Reform Act of 1995. These statements can be identified by the use of
forward-looking terminology such as "may," "will," "believe," "expect,"
"anticipate," "estimate," "continue" or other similar words. These statements
discuss future expectations, and may contain projections of results of
operations or of financial condition or state other forward-looking
information. When considering forward-looking statements, you should keep in
mind the cautionary statements in this Quarterly Report on Form 10-Q. The
cautionary statements noted below and other factors noted throughout this
Quarterly Report on Form 10-Q could cause our actual results to differ
significantly from those contained in any forward looking statement. We may
not update or publicly release the results of these forward-looking
statements to reflect events or circumstances after the date hereof.
OUR DEPENDENCE ON GENTLELASE-REGISTERED TRADEMARK- INCREASES OUR
SUSCEPTIBILITY TO COMPETITIVE CHANGES IN THE MARKETPLACE.
We introduced our GentleLASE-Registered Trademark- in March 1998.
GentleLASE-Registered Trademark-'s sales have grown rapidly and accounted for
more than half of our total revenue in fiscal 1999 and in the first quarter
of fiscal 2000. Heavy dependence on GentleLASE-Registered Trademark- sales
increases our susceptibility to changes in the marketplace, such as
competitors reducing prices or adding new features to their products, or
customers ordering fewer of our products. Such changes in the marketplace
could hurt our financial results.
OUR RIGHT TO SUBLICENSE THE DCD TECHNOLOGY TO OTHERS COULD BE TERMINATED IF WE
DO NOT PREVAIL IN AN ARBITRATION ON OUR CLAIM THAT THE REGENTS' REFUSAL TO GRANT
OUR REQUEST TO EXTEND OUR EXCLUSIVE RIGHT TO SUBLICENSE THE DCD TECHNOLOGY WAS
UNREASONABLE. OUR EXCLUSIVE RIGHTS TO THE DCD TECHNOLOGY COULD BE LOST IF A
COURT CHALLENGE BY NEW STAR LASERS INC. AND ITS SUBSIDIARY LASER AESTHETICS INC.
TO THE UNDERLYING PATENT IS SUCCESSFUL. IN ADDITION, WE COULD LOSE OUR RIGHTS TO
THE DCD TECHNOLOGY ALTOGETHER IF WE DO NOT PREVAIL IN AN ARBITRATION ON OUR
CLAIM THAT WE HAVE FULLY COMPLIED WITH THE AMENDED LICENSE AGREEMENT'S
PROVISIONS GOVERNING OUR SUBLICENSING EFFORTS AND OUR ROYALTY OBLIGATIONS TO THE
REGENTS. WE COULD ALSO BE REQUIRED TO PAY SUBSTANTIALLY HIGHER FUTURE AND
HISTORIC ROYALTIES TO THE REGENTS IF WE DO NOT PREVAIL IN THE ARBITRATION.
We developed our Dynamic Cooling Device ("DCD"), which is used to selectively
cool a patient's epidermal layers during cosmetic laser treatments, under an
exclusive license to patent rights owned by the Regents of the University of
California ("Regents"). The DCD is a component of our biggest-selling laser,
the GentleLASE-Registered Trademark-, and is also currently sold as an
attachment to our other principal laser, the ScleroPLUS-TM-. We believe the
efficacy of the DCD has been a key element in the recent growth in sales of
our laser devices. In October 1998, we entered into an amendment of the
license agreement, which provided us with an exclusive right under the
Regents' patent to make, use, and sell the dynamic cooling technology in all
fields of use. However, this amendment also imposed on us an obligation to
negotiate in good faith and make commercially reasonable efforts to conclude
sublicensing agreements with interested third parties, subject to certain
stipulated minimum terms and conditions. If we fail to negotiate in good
faith or do not enter into sublicenses with interested third parties within
the required time periods, the Regents may then grant license rights to such
third parties directly, provided that Candela will receive 50% of all
revenues received under such licenses.
14
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
The amendment, however, also provides that we may request an extension of
time to consummate sublicenses and that the Regents shall not unreasonably
deny such an extension. To date, Candela has corresponded with seven
prospective sublicensees of the DCD technology who were identified by the
Regents as potentially interested in obtaining a sublicense for that
technology. Of these seven entities, two expressed an interest in pursuing
sublicensing discussions. Candela provided term sheets for a sublicense to
each of them. One of these entities, Laser Aesthetics, Inc., and its parent
corporation, New Star Lasers, Inc., responded by commencing litigation
seeking, among other things, to invalidate the Regents' patent under which
the DCD was developed. The other entity has not responded to the term sheet.
Candela has sent additional correspondence to the other entities who were
identified by the Regents reminding them that Candela remains willing to open
negotiations with them for the sublicensing of DCD technology, but has not
received any further response. We have requested that, in light of our
efforts to negotiate sublicenses with entities brought to our attention by
the Regents, the Regents agree to extend the time periods set forth by the
license amendment. The Regents have denied that request. The amended license
agreement further requires that we remit royalties to the Regents at a rate
of six percent based on net sales of "Patent Products." By letter dated
September 17, 1999, the Regents notified us that we were purportedly in
default under the license agreement, as amended. The notice of default states
that it is based on our alleged failure to make royalty payments deemed by
the Regents to be due; our alleged failure to engage in good faith
negotiations with third parties expressing an interest in sublicensing the
DCD technology; and our alleged failure to provide a draft license agreement
to those third parties expressing an interest in sublicensing the DCD
technology. The Regents' default notice gave us sixty days to cure the
alleged default on the payment of royalties and until October 9, 1999 to
satisfy our sublicensing obligations. We responded in writing to the Regents'
notice of default, informing the Regents that we are in full compliance with
the terms of the license, as amended. In addition, we noted that we had
requested an extension of the time to negotiate sublicenses and that the
Regents had unreasonably withheld the extension. On September 28, 1999, we
filed a Demand for Arbitration with the American Arbitration Association in
which we sought, among other things, a declaration that we are not in default
of any of our obligations and that the period in which we may exclusively
attempt to consummate sublicenses be extended for at least six months from
the date of the final award in the arbitration. On October 27, 1999, the
Regents issued another notice by which it purported to terminate our right to
sublicense the DCD technology. This notice is also the subject of the AAA
arbitration. On November 9, 1999, the arbitrator issued an interim order of
protection prohibiting the Regents from issuing a notice of termination or
licensing the DCD technology to any third party until ten days after the
award of judgment in the arbitration. The arbitration hearing is currently
scheduled for late January 2000. We believe that an adverse outcome of the
arbitration with the Regents could have a material adverse effect on our
operations and financial condition, including losing our rights to the DCD
technology and/or being required to pay substantially higher future and
historical royalty payments to the Regents for the use of DCD technology.
While no such sublicenses or further licenses have been granted by us or the
Regents to date, principal competitors of ours, or new entrants into the
medical laser industry, may successfully conclude licensing arrangements
providing them with access to the dynamic cooling technology. Also on October
27, 1999, the Regents sent us another notice of default arising out of its
claim that we have refused to indemnify the Regents in connection with the
New Star litigation. The notice gives us sixty days to cure the alleged
default. We intend to contest this notice of default. Should we not cure the
alleged default or not be successful in challenging the alleged default,
there could be a material adverse effect on our operations and financial
condition, including losing our rights to the DCD technology.
BECAUSE WE DERIVE APPROXIMATELY HALF OF OUR REVENUE FROM INTERNATIONAL SALES,
INCLUDING APPROXIMATELY ONE-THIRD OF OUR REVENUE FROM JAPAN AND THE
ASIA-PACIFIC MARKETPLACE IN THE FISCAL YEAR ENDED JULY 3, 1999 AND THE
QUARTER ENDED OCTOBER 2, 1999, WE ARE SUSCEPTIBLE TO CURRENCY FLUCTUATIONS,
NEGATIVE ECONOMIC CHANGES TAKING PLACE IN JAPAN AND THE ASIA-PACIFIC
MARKETPLACE, AND OTHER RISKS ASSOCIATED WITH CONDUCTING BUSINESS OVERSEAS.
15
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
We sell a significant portion of our products and services outside the U.S.
and Canada. International sales, consisting of sales from our subsidiaries in
Germany, Spain, and Japan, and sales shipped directly to international
locations from the U.S., accounted for 52% and 53% of our revenue for fiscal
years 1999 and 1998, respectively, and accounted for 49% for the quarter
ended October 2, 1999. We expect that international sales will continue to be
significant. As a result, a major part of our revenues and operating results
could be adversely affected by risks associated with international sales. In
particular, significant fluctuations in the exchange rates between the U.S.
dollar and foreign currencies could cause us to lower our prices and thus
reduce our profitability, or could cause prospective customers to push out
orders because of the increased relative cost of our products in the
aftermath of a currency devaluation or currency fluctuation. For example, in
our fiscal year ended June 27, 1998, we experienced an 8% decline in product
sales to Japanese customers as a result of the erosion of the Japanese Yen
compared to the U.S. dollar during this period. Other risks associated with
international sales which we have faced in the past include:
- longer payment cycles common in foreign markets;
- failure to obtain or significant delays in obtaining necessary import
or foreign regulatory approvals for our products;
- difficulties in staffing and managing our foreign operations.
THE FAILURE TO OBTAIN ALEXANDRITE RODS FOR THE GENTLELASE-REGISTERED
TRADEMARK- AND ALEXLAZR-TM-FROM OUR SOLE SUPPLIER WOULD IMPAIR OUR ABILITY TO
MANUFACTURE AND SELL GENTLELASE-REGISTERED TRADEMARK-, WHICH ACCOUNTED FOR
MORE THAN HALF OF OUR REVENUE IN THE FISCAL YEAR ENDED JULY 3, 1999 AND IN
THE QUARTER ENDED OCTOBER 2, 1999.
We use Alexandrite rods to manufacture the GentleLASE-Registered Trademark-
and the ALEXlazr-TM-, which account for a significant portion of our total
revenues. We depend exclusively on Litton Airtron Synoptics to supply these
rods, for which no alternative supplier meeting our quality standards exists.
We cannot be certain that Litton will be able to meet our future requirements
at current prices or at all. To date, we have been able to obtain adequate
supplies of Alexandrite rods in a timely manner, but any extended
interruption in our supplies could hurt our results.
DISAPPOINTING QUARTERLY REVENUE OR OPERATING RESULTS COULD CAUSE THE PRICE OF
OUR COMMON STOCK TO FALL.
Our quarterly revenue and operating results are difficult to predict and may
swing sharply from quarter to quarter. Historically, our first fiscal quarter
has had the least amount of revenue in any quarter of our fiscal year. The
results of the first quarter are directly impacted by the seasonality of the
purchasing cycle. In the last three fiscal years, first quarter revenue has
been below the previous quarter's revenue in the range of 12.6% to 38.1%.
If our quarterly revenue or operating results fall below the expectations of
investors or public market analysts, the price of our common stock could fall
substantially. Our quarterly revenue is difficult to forecast for many
reasons, some of which are outside of our control, including the following:
Market Supply and Demand
- potential increases in the level and intensity of price competition
between us and our competitors;
16
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- potential decrease in demand for our products; and
- possible delays in market acceptance of our new products.
Customer Behavior
- changes in or extensions of our customers' budgeting and purchasing
cycles; and
- changes in the timing of product sales in anticipation of new product
introductions or enhancements by us or our competitors.
Company Operations
- absence of significant product backlogs;
- our effectiveness in our manufacturing process;
- unsatisfactory performance of our distribution channels, service
providers, or customer support organizations; and
- timing of any acquisitions and related costs.
THE COST OF CLOSING OUR SKIN CARE CENTERS MAY BE HIGHER THAN MANAGEMENT HAS
ESTIMATED TO DATE, AND HIGHER ACTUAL COSTS WOULD NEGATIVELY IMPACT OUR
OPERATING RESULTS.
We have renewed our commitment to expand and diversify our core cosmetic and
surgical laser equipment business. As part of this refocus, we decided to
reduce our focus on our efforts to own and operate centers which would offer
cosmetic laser treatments utilizing our equipment, along with providing other
cosmetic services traditionally offered by high-end spas. Although we are
actively seeking buyers for the two skin care centers we opened which are
located in Scottsdale, Arizona, and Boston, Massachusetts, we cannot be
certain that a sale or sublease of either facility will be completed on
favorable terms or at all. We have established a reserve to accrue for the
anticipated costs of terminating the Scottsdale facility, but we can't be
sure that such a reserve will be adequate. To date, we have not established a
reserve in connection with the Boston facility, which we are continuing to
operate as a spa without providing cosmetic laser services.
OUR FAILURE TO EXPAND OUR SALES FORCE AND DISTRIBUTION CHANNELS WOULD INHIBIT
OUR ABILITY TO GROW.
We sell our products primarily through our direct sales force and we support
our customers with our internal technical and customer support staff. To
achieve significant revenue growth in the future we must recruit and train
sufficient technical, customer, and direct sales personnel. We have in the
past and may in the future experience difficulty in recruiting qualified
sales, technical, and support personnel. We also rely on our network of
distributors and our relationship with PSS for sales of our products. Our
inability to rapidly and effectively expand our direct sales force and our
technical and support staff or our failure to maintain effective distribution
relationships with PSS and other distributors could hurt our business.
17
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
OUR FAILURE TO RESPOND TO RAPID CHANGES IN TECHNOLOGY AND INTENSE COMPETITION IN
THE LASER INDUSTRY COULD MAKE OUR LASERS OBSOLETE.
The aesthetic and cosmetic laser equipment industry is subject to rapid and
substantial technological development and product innovations. To be
successful, we must be responsive to new developments in laser technology and
new applications of existing technology. Our financial condition and
operating results could be hurt if our products fail to compete favorably in
response to such technological developments, or we are not agile in
responding to competitors' new product introductions or product price
reductions. In addition, we compete against numerous companies offering
products similar to ours, some of which have greater financial, marketing,
and technical resources than we do. We cannot be sure that we will be able to
compete successfully with these companies and our failure to do so could hurt
our business, financial condition, and results of operations.
LIKE OTHER COMPANIES IN OUR INDUSTRY, WE ARE SUBJECT TO A REGULATORY REVIEW
PROCESS AND OUR FAILURE TO RECEIVE NECESSARY GOVERNMENT CLEARANCES OR APPROVALS
COULD AFFECT OUR ABILITY TO SELL OUR PRODUCTS AND REMAIN COMPETITIVE.
The types of medical devices that we seek to market in the U.S. generally
must receive either "510(k) clearance" or "PMA approval" in advance from the
U.S. Food and Drug Administration (FDA) pursuant to the Federal Food, Drug,
and Cosmetic Act. The FDA's 510(k) clearance process usually takes from four
to twelve months, but it can last longer. The process of obtaining PMA
approval is much more costly and uncertain and generally takes from one to
three years or even longer. To date, the FDA has deemed our products eligible
for the 510(k) clearance process. We believe that most of our products in
development will receive similar treatment. However, we cannot be sure that
the FDA will not impose the more burdensome PMA approval process upon one or
more of our future products, nor can we be sure that 510(k) clearance or PMA
approval will ever be obtained for any product we propose to market.
Many foreign countries in which we market or may market our products have
regulatory bodies and restrictions similar to those of the FDA. Particularly,
for example, we are awaiting Ministry of Health approval in Japan for the
sale of ScleroPLUS-TM-. We cannot be certain that we will be able to obtain
(or continue to obtain) any such government approvals or successfully comply
with any such foreign regulations in a timely and cost-effective manner, if
at all, and our failure to do so could adversely affect our ability to sell
our products.
WE HAVE MODIFIED SOME OF OUR PRODUCTS WITHOUT FDA CLEARANCE. THE FDA COULD
RETROACTIVELY DECIDE THE MODIFICATIONS WERE IMPROPER AND REQUIRE US TO CEASE
MARKETING AND/OR RECALL THE MODIFIED PRODUCTS.
Any modification to one of our 510(k) cleared devices that could
significantly affect its safety or effectiveness, or that would constitute a
major change in its intended use, requires a new 510(k) clearance. The FDA
requires every manufacturer to make this determination in the first instance,
but the FDA can review any such decision. We have modified some of our
marketed devices, but we believe that new 510(k) clearances are not required.
We cannot be certain that the FDA would agree with any of our decisions not
to seek 510(k) clearance. If the FDA requires us to seek 510(k) clearance for
any modification, we also may be required to cease marketing and/or recall
the modified device until we obtain a new 510(k) clearance.
ACHIEVING COMPLETE COMPLIANCE WITH FDA REGULATIONS IS DIFFICULT, AND IF WE FAIL
TO COMPLY, WE COULD BE SUBJECT TO FDA ENFORCEMENT ACTION.
18
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
We are subject to inspection and market surveillance by the FDA to determine
compliance with regulatory requirements. The FDA's regulatory scheme is
complex, especially the Quality System Regulation, which requires
manufacturers to follow elaborate design, testing, control, documentation,
and other quality assurance procedures. This complexity makes complete
compliance difficult to achieve. Also, the determination as to whether a QSR
violation has occurred is often subjective. If the FDA finds that we have
failed to comply with the QSR or other applicable requirements, the agency
can institute a wide variety of enforcement actions, including a public
warning letter or other stronger remedies, such as:
- fines, injunctions, and civil penalties against us;
- recall or seizure of our products;
- operating restrictions, partial suspension, or total shutdown of our
production;
- refusing our requests for 510(k) clearance or PMA approval of new
products;
- withdrawing product approvals already granted; and
- criminal prosecution.
UNANTICIPATED CHANGES IN DOMESTIC AND FOREIGN GOVERNMENTAL REGULATION AFFECTING
OUR INDUSTRY COULD ADVERSELY AFFECT OUR ABILITY TO REMAIN COMPETITIVE AND
PROFITABLE.
A host of regulatory requirements apply to the manufacture and commercial
distribution of our devices after the FDA and foreign governments have cleared
them for marketing. Unanticipated changes in existing regulatory requirements or
adoption of new requirements could hurt our business, results of operations, and
financial condition.
WE MAY INCUR UNEXPECTED COSTS TO COMPLY WITH OTHER GOVERNMENT REGULATIONS.
We also must comply with numerous laws relating to such matters as safe working
conditions, manufacturing practices, environmental protection, fire hazard
control, and hazardous substance disposal. We may incur significant costs to
comply with such laws and regulations in the future and we cannot be sure that
such laws or regulations will not hurt our business, results of operations, and
financial condition.
CLAIMS BY OTHERS THAT OUR PRODUCTS INFRINGE THEIR PATENTS OR OTHER INTELLECTUAL
PROPERTY RIGHTS COULD PREVENT US FROM MANUFACTURING AND SELLING SOME OF OUR
PRODUCTS OR REQUIRE US TO INCUR SUBSTANTIAL COSTS FROM LITIGATION OR DEVELOPMENT
OF NON-INFRINGING TECHNOLOGY.
Our industry has been characterized by frequent litigation regarding patent and
other intellectual property rights. Patent applications are maintained in
secrecy in the U.S. until such patents are issued and are maintained in secrecy
for a period of time outside the U.S. Accordingly, we can conduct only limited
searches to determine whether our technology infringes any patents or patent
applications of others. Any claims of patent infringement would be
time-consuming and could:
- result in costly litigation;
- divert our technical and management personnel;
19
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
- cause product shipment delays;
- require us to develop non-infringing technology; or
- require us to enter into royalty or licensing agreements.
One such litigation matter is currently pending, New Star Lasers, Inc.'s action
to invalidate the patent under which the DCD was developed, and others could
occur at any time.
Although patent and intellectual property disputes in the laser industry have
often been settled through licensing or similar arrangements, costs
associated with such arrangements may be substantial and often require the
payment of ongoing royalties, which could hurt our gross margins. In
addition, we cannot be sure that the necessary licenses would be available to
us on satisfactory terms, or that we could redesign our products or processes
to avoid infringement, if necessary. Accordingly, an adverse determination in
a judicial or administrative proceeding, or the failure to obtain necessary
licenses, could prevent us from manufacturing and selling some of our
products, which could hurt our business, results of operations, and financial
condition. On the other hand, we may have to start costly and time consuming
litigation in order to enforce our patents, to protect trade secrets, and
know-how owned by us or to determine the enforceability, scope, and validity
of the proprietary rights of others. We have received correspondence on
behalf of Palomar Medical Technologies informing us that Palomar is the
exclusive licensee to certain Unites States patents and offering to grant us
a nonexclusive license to such patents. We have determined that two of the
patents are unrelated to our products. We continue to study the other two
patents to determine whether they have any application to our products, and
if so, the value of non-exclusive rights to such patents. In addition, we are
exploring various licensing arrangements with Palomar.
WE COULD INCUR SUBSTANTIAL COSTS AS A RESULT OF PRODUCT LIABILITY CLAIMS.
There are various risks of physical injury to the patient when using our lasers
for aesthetic and cosmetic treatments. Injuries often result in product
liability or other claims being brought against the practitioner utilizing the
device and us. The costs and management time we would have to spend in defending
or settling any such claims, or the payment of any award in connection with such
claims, could hurt our business, results of operations, and financial condition.
Although we maintain product liability insurance, we cannot be certain that our
policy will provide sufficient coverage for any claim or claims that may arise,
or that we will be able to maintain such insurance coverage on favorable
economic terms.
WE MAY BE UNABLE TO ATTRACT AND RETAIN MANAGEMENT AND OTHER PERSONNEL WE NEED TO
SUCCEED.
The loss of any of our senior management or other key research, development,
sales, and marketing personnel, particularly if lost to competitors, could hurt
our future operating results. Our future success will depend in large part upon
our ability to attract, retain, and motivate highly skilled employees. We cannot
be certain that we will attract, retain, and motivate sufficient numbers of such
personnel.
OUR FAILURE TO MANAGE FUTURE ACQUISITIONS AND JOINT VENTURES EFFECTIVELY MAY
DIVERT MANAGEMENT ATTENTION FROM OUR CORE BUSINESS AND CAUSE US TO INCUR
ADDITIONAL DEBT, LIABILITIES OR COSTS.
20
CANDELA CORPORATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (CONTINUED)
We may acquire businesses, products, and technologies that complement or expand
our business. We may also consider joint ventures and other collaborative
projects. We may not be able to:
- identify appropriate acquisition or joint venture candidates;
- successfully negotiate, finance, or integrate any businesses,
products, or
technologies that we acquire; or
- successfully manage any joint ventures or collaborations.
Furthermore, the integration of any acquisition or joint venture may divert
management time and resources. If we fail to manage these acquisitions or joint
ventures effectively we may incur debts or other liabilities or costs which
could harm our operating results or financial condition. While we from time to
time evaluate potential acquisitions of businesses, products, and technologies,
consider joint ventures and other collaborative projects, and anticipate
continuing to make these evaluations, we have no present understandings,
commitments, or agreements with respect to any acquisitions or joint ventures.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At October 2, 1999 the Company held foreign currency forward contracts with
notional value totaling approximately $3,221,000 compared to forward contracts
with a value of $1,369,000 held at September 26, 1998. The present contracts
have maturity dates prior to January 24, 2000. The carrying and net fair value
of these contracts at October 2, 1999, was $0 and ($264,000), respectively,
compared to $0 and ($32,000) respectively, at September 26, 1998.
21
CANDELA CORPORATION
PART II OTHER INFORMATION
ITEM 1 -- LEGAL PROCEEDINGS
On March 5, 1999, New Star Lasers, Inc. and its subsidiary Laser Aesthetics,
Inc. filed a complaint in the U.S. District Court for the Eastern District of
California against The Regents of the University of California (the "Regents"),
the Beckman Laser Institute and Medical Clinic ("Beckman") and Candela. In the
complaint, New Star Lasers sought a declaration that its technology does not
infringe the Regents' patent pertaining to dynamic cooling technology to which
we are a licensee, or in the alternative that the patent is invalid and not
infringed by the plaintiff's technology. The complaint also included various
tort claims against us and contract-related claims against the Regents and
Beckman. The complaint asserted that we interfered with the licensing of the
dynamic cooling technology to the plaintiffs. The complaint sought unspecified
general, special, punitive and exemplary damages plus costs and attorneys' fees
against Candela as well as the "disgorgement" of any benefit received by Candela
as a result of the alleged receipt of any of New Star Lasers' trade secrets from
Beckman and the Regents. We intend to defend this matter vigorously. Both
Candela and the Regents moved to dismiss the complaint. On August 27, 1999, the
court granted in part both Candela's and the Regents' motion, but gave New Star
Lasers permission to file an amended complaint. On October 25, 1999, New Star
Lasers filed a second amended complaint, to which we filed an answer denying New
Star's material allegations and raising several affirmative defenses. We believe
that an adverse outcome of New Star Lasers' tort claims against Candela will not
have a material adverse effect on our operations and financial condition.
However, if New Star Lasers were to obtain a declaration that the Regents'
patent under which the DCD was developed is invalid or unenforceable, Candela's
rights to the DCD technology pursuant to the license agreement could no longer
be exclusive, which could aversely impact our operations and financial
condition. The Regents have requested that we indemnify them in connection with
this litigation pursuant to the license agreement between the Regents and
Candela. We have rejected this request.
By letter dated September 17, 1999, The Regents purported to give Candela notice
of alleged default under the parties' exclusive license agreement, as amended
("the Agreement") on the grounds (1) that Candela has failed to make necessary
royalty payments to The Regents pursuant to the Agreement; and (2) that Candela
has not complied with its sublicensing obligations under the Agreement. The
Regents informed Candela that it has sixty days in which to cure the alleged
defaults. Candela maintains and has informed The Regents that it is in full
compliance with each of the terms of the Agreement, including with respect to
its royalty payments to The Regents and its sublicensing efforts. On September
28, 1999, we commenced an arbitration before the American Arbitration
Association ("AAA") against the Regents in which we seek a declaration that we
are not in default of any of our obligations under the Agreement. On October 27,
1999, the Regents issued another notice by which it purported to terminate our
right to sublicense the DCD technology. This notice is also the subject of the
AAA arbitration. On November 9, 1999, the arbitrator issued an interim order of
protection prohibiting the Regents from issuing a notice of termination or
licensing the DCD technology to any third party until ten days after the award
of judgment in the arbitration. The arbitration hearing is currently scheduled
for late January or early February 2000. We believe that an adverse outcome of
the arbitration with The Regents could have a material adverse effect on our
operations and financial condition, including losing our rights to the DCD
technology and/or being required to pay substantially higher future and
historical royalty payments to the Regents for the use of DCD technology. Also
on October 27, 1999, The Regents sent us another notice of default arising out
of its claim that we have refused to indemnify The Regents in connection with
the New Star litigation. The notice gives us sixty days to cure the alleged
default. We intend to contest this notice of default. Should we not cure the
alleged default or not be successful in challenging the alleged default, there
could be a material adverse effect on our operations and financial condition,
including losing our rights to the DCD technology.
22
CANDELA CORPORATION
PART II, ITEM 1 - LEGAL PROCEEDINGS (CONTINUED)
From time to time, the Company is a party to various legal proceedings
incidental to its business. The Company believes that none of such other
presently pending legal proceedings will have a material adverse effect upon
its financial position, results of operation, or liquidity.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27.1, Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the quarter ended
October 2, 1999.
23
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.
CANDELA CORPORATION
Registrant
Date: November 15, 1999 /s/ Gerard E. Puorro
----------------- ---------------------------------------
Gerard E. Puorro
(President and Chief Executive Officer)
Date: November 15, 1999 /s/ F. Paul Broyer
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F. Paul Broyer
(Senior Vice President of Finance and
Administration,
Chief Financial Officer and Treasurer)
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