SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
Annual Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended July 3, 1999 Commission file number 0-14742
CANDELA CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 04-2477008
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
530 BOSTON POST ROAD, WAYLAND, MASSACHUSETTS 01778
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (508) 358-7400
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Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value
Common Stock Purchase Warrants
(Title of Class)
Indicate by a 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 by a check mark if the disclosure of delinquent filers, pursuant to
Item 405 of Regulation S-K, is not contained herein and will not be contained in
the definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. [ ]
As of September 23, 1999, 7,248,503 shares of the registrant's Common Stock,
$.01 par value, were issued and outstanding. The aggregate market value of the
registrant's voting stock, held by non-affiliates of the registrant as of
September 23, 1999, based upon the closing price of such stock on The NASDAQ
Stock Market on that date, was approximately $61,422,000.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant intends to file a Definitive Proxy Statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended July 3, 1999.
Portions of such Proxy Statement are incorporated by reference in Part III of
this report.
PART I
ITEM 1. BUSINESS
We develop, manufacture, market, and service lasers for a broad variety of
aesthetic and cosmetic procedures including:
- hair removal;
- non-invasive treatment of varicose veins and other benign vascular
lesions;
- removal of benign pigmented lesions such as age spots and tattoos;
- treatment of scars and stretch marks; and
- skin resurfacing.
Since our founding nearly 30 years ago, we have continuously developed and
enhanced applications of laser technology. In the mid-1980's we began developing
laser technology for medical applications, and since that time have shipped
approximately 3,000 lasers to 40 countries. Since the early 1990's we have
focused our organizational resources on developing laser technology for use
solely in the aesthetic and cosmetic laser industry. Our introduction of new
dermatology/plastic surgery laser systems during the mid-1990's allowed us to
expand rapidly in this area. Today, all of our products are for aesthetic and
cosmetic applications, and we offer one of the broadest product lines in the
aesthetic and cosmetic laser industry. Our current products, all of which are
marketed in the U.S. and internationally, include the following:
- GentleLASE(R), for performing hair removal and treating leg veins;
- ScleroPLUS(TM), for treating vascular lesions;
- ALEXlazr(TM) and YAGlazr(TM), for treating pigmented lesions and
tattoos; and
- SkinPLUS 2J(TM) system, for resurfacing and treating fine facial veins.
The aesthetic and cosmetic laser industry appears to be entering an era of
broader based growth. The most important factors contributing to this growth are
changing practitioner economics, positive demographic trends with America's baby
boomer population and its higher discretionary income, and the introduction of
more effective and affordable products offering a broader range of treatments.
The challenging managed care medical reimbursement environment has resulted in
many practitioners seeking to offer more procedures on a direct pay basis. In
addition, the aesthetic and cosmetic laser industry has only recently developed
technology that successfully addresses hair removal, which is the largest
cosmetic application to date.
Aesthetic and cosmetic laser vendors, who are able to develop lasers that are
more affordable, fast, small, and easy to use, will be well positioned to take
advantage of the industry's growth. We believe that we have the technological
expertise, product offerings, and necessary infrastructure to execute our
business strategy and to capitalize on this market opportunity, as evidenced by
the successful introduction of our newest laser, the GentleLASE(R).
INDUSTRY OVERVIEW
Medical lasers use the unique characteristics of laser light to achieve precise
and efficacious therapeutic effects, often in a non-invasive manner. The precise
color, concentration, and controllability of different types of laser light
provide for the delivery of a wide range of specialized treatments. First
introduced in the 1960's, the use of lasers for medical applications grew
rapidly in the 1990's as technical advances made medical lasers more
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effective and reliable. Medical lasers today are used for numerous types of
procedures falling into four broad categories: ophthalmic surgery, aesthetic
and cosmetic procedures, general surgery, and dental procedures. Candela
competes solely within the growing market for lasers performing aesthetic and
cosmetic procedures including:
- removal of unwanted facial hair;
- removal of hair from legs, back, and other body areas;
- treatment of varicose, spider, and other veins;
- treatment of birthmarks;
- removal of wrinkles, scars, and stretch marks; and
- removal of pigmented lesions and tattoos.
Lasers produce intense bursts of highly-focused light to treat skin tissues. A
laser's wavelength (color), energy level, spot size and pulse width (exposure
time) are optimized for the specific treatment. Hair removal and the treatment
of various leg vein malformations require the deepest laser penetration for
successful treatment while scars, stretch marks, and red birth marks (port wine
stains and hemangiomas) require less laser penetration. Pigmented lesions such
as sunspots, liverspots and tattoos are typically surface conditions that
require the least amount of penetration. Different conditions may require the
use of different types of lasers, and an active aesthetic and cosmetic practice
addressing a broad range of laser procedures requires multiple lasers.
In the pioneering years of the cosmetic and aesthetic laser industry from the
late 1980's to the mid 1990's, the market for laser procedures was focused on
vascular conditions such as port wine stains and hemangiomas and the development
of treatments for pigmented lesions, such as tattoos. Equipment available in
this period tended to be expensive, slow, and bulky. In addition, laser
applications addressed the needs of relatively small patient populations, served
by a narrow group of specialists.
In the last half of the 1990's, the development of computer driven beam delivery
systems called scanners increased the interest of a growing number of physicians
by providing procedures to new, larger market segments, such as wrinkle removal.
During this period, the complexity and cost of equipment from many vendors still
inhibited sales. However, clinical experience was broadening, leading to better
development efforts for new applications, which are now resulting in the next
generation of aesthetic and cosmetic lasers.
The aesthetic and cosmetic laser industry appears to be entering an era of
broader based growth. The major factors converging to drive this growth are:
- the economics of practitioners in a tough medical reimbursement
environment;
- the rising discretionary income of aging baby boomers; and
- the development of technology that allows for new, effective procedures
for conditions that have large patient populations.
Aesthetic and cosmetic laser vendors, who are able to deliver lasers that are
cost effective, reliable, and easy to use, will be well positioned to take
advantage of such broader-based industry growth.
Managed care and reimbursement restrictions in the U.S. and similar constraints,
such as socialized medicine, outside the U.S., are motivating practitioners to
emphasize aesthetic and cosmetic procedures that are delivered on a private,
fee-for-service basis. While cosmetic procedures were once the domain of plastic
surgeons and dermatologists, reimbursement reductions coupled with the reliable
revenue stream from private-pay procedures have piqued the interest of other
specialties, including general practice physicians.
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Key technical developments required for the broader cosmetic laser markets
relate to ease-of-use, speed, lower costs, safety, and effective elimination of
undesirable side effects. These factors are critical for broader segments of
practitioners who wish to build aesthetic and cosmetic laser practices. These
factors are also important for minimizing the disruption of a patient's normal
routine and for building demand for procedures addressing very large patient
populations.
BUSINESS STRATEGY
Candela believes that a convergence of price and performance is occurring in the
aesthetic and cosmetic laser industry, driving the expansion of the market. We
believe we have the necessary infrastructure in place to capitalize on this
expansion. Candela's objective is to establish itself as the leading provider of
aesthetic and cosmetic lasers by using its proprietary technology and expertise
in light and tissue interaction, as well as by developing market-oriented
products that utilize related technologies. Our business strategy is focused on
the following goals:
- reduce product costs;
- increase penetration of our traditional customer base;
- expand sales beyond our traditional customer base;
- expand our domestic marketing and distribution channels;
- expand our international marketing and distribution channels;
- continue investing in research and development; and
- broaden additional applications for our Dynamic Cooling Device ("DCD").
REDUCE PRODUCT COSTS. We apply bottom-up engineering, focusing on each component
to improve the performance of each device while reducing its size, complexity,
and cost. We believe our approach leads to lasers with fewer parts and greater
manufacturing efficiency, resulting in lower production costs which enables us
to offer more reliable products at more affordable prices.
INCREASE PENETRATION OF OUR TRADITIONAL CUSTOMER BASE. Our traditional customer
base consists of dermatologists and plastic and cosmetic surgeons. We believe
that the affordability of our products will enable us to penetrate further into
the dermatologist and plastic and cosmetic surgeon markets. We have conducted
surveys that indicate that only approximately one-third of the 17,000
dermatologists and plastic and cosmetic surgeons in the U.S. presently have
lasers. We believe that affordability has been a major obstacle preventing the
remaining practitioners from purchasing a laser. As competition for patients
among practitioners increases, those practitioners with aesthetic and cosmetic
lasers will be able to differentiate themselves
EXPAND SALES BEYOND OUR TRADITIONAL CUSTOMER BASE. We seek collaborative
relationships that expand upon our traditional customer base, such as our recent
relationship with Physicians Sales & Services ("PSS"). We believe those
specialist practitioners outside our traditional customer base are a market with
a large growth potential. In December 1998, we entered into a three year
distribution arrangement with PSS that gives PSS the exclusive right to
distribute the GentleLASE(R) and ScleroPLUS(TM) to specific office-based
specialists. The agreement with PSS specifies that our products will be the
exclusive aesthetic and cosmetic lasers sold by PSS. In addition, we have begun
an innovative leasing program to target electrologists in the U.S. as potential
customers of the GentleLASE(R) for hair removal.
EXPAND OUR DOMESTIC MARKETING AND DISTRIBUTION CHANNELS. The U.S. presently
represents almost 50% of our sales and is the largest single geographic market
for our products. We have increased the size of our U.S. direct sales force to
better address the needs of our traditional core markets.
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EXPAND OUR INTERNATIONAL MARKETING AND DISTRIBUTION CHANNELS. Outside of the
U.S. we continue to strengthen our long-standing positions in Europe and Japan
and are seeking to expand our markets in Asia and Latin America. We currently
have direct sales offices in Madrid, Frankfurt, and Tokyo and are anticipating
opening an additional sales office in Hong Kong. An office was opened in Osaka,
Japan on June 1, 1999. Over the past year we increased the number and improved
the quality of our international independent distributor channel. We currently
utilize 34 independent distributors in 46 countries.
CONTINUE INVESTING IN R&D. We believe that investment in research and
development is necessary to remain a leader in the aesthetic and cosmetic laser
market. Our research and development approach is to develop high-quality,
reliable, and affordable products that continue to address existing markets and
allow us to enter into and expand new markets. Our research and development
staff works closely with our marketing and operations groups to ensure our goals
are met. Our strategy has been to drive technology that is market applicable and
addresses voids in the marketplace. To that end, Candela will continue to apply
technologies to reduce the size and complexity of its technology and products,
increase the speed and ease with which therapeutic applications can be
delivered, improve its ability to build and deliver lasers at affordable prices,
and address expanding therapeutic applications and markets. Candela has numerous
research and development arrangements with leading hospitals and medical
laboratories in the U.S.
BROADEN ADDITIONAL APPLICATIONS FOR OUR DYNAMIC COOLING DEVICE ("DCD").
Recently, the aesthetic and cosmetic laser market has begun to recognize the
importance of effective cooling delivery systems for laser treatment, especially
in such large market segments as hair removal and treatment of leg veins.
Currently, DCD is an integral component of our GentleLASE(R) and is sold as an
attachment to our ScleroPLUS(TM). We intend to broaden the incorporation of DCD
into all of our lasers and believe by doing so we can address major new market
opportunities.
THE MARKET FOR AESTHETIC AND COSMETIC LASERS
Our traditional customer base for aesthetic and cosmetic lasers consists of
dermatologists and plastic and cosmetic surgeons. In addition, other
practitioner groups are emerging as potential customers, including general
practitioners, obstetricians, gynecologists, and general and vascular surgeons.
In the U.S., according to the American Medical Association and various
societies, there are approximately 10,000 dermatologists, and 7,000 plastic and
cosmetic surgeons. Practitioners in other specialties that are beginning to buy
aesthetic and cosmetic lasers include 70,000 general and family practitioners,
35,000 obstetricians and gynecologists, and 28,000 general and vascular
surgeons. In addition, the aesthetic and cosmetic laser market includes
non-medical practitioners, notably electrologists, of which there are an
estimated 6,000 in the U.S.
The end markets for cosmetic laser procedures encompass broad and growing
patient groups, including aging "baby boomers" as well as younger age groups.
According to the U.S. Census Bureau, at the end of 1998 the number of "baby
boomers" in the 35 to 54 age range was approximately 80 million, representing
more than 29% of the total U.S. population. This large population group
generally has a high level of disposable income and has exhibited a strong
demand for aesthetic and cosmetic procedures. We believe that as the cost of
treatments decreases and the popularity of laser cosmetic procedures such as
hair removal increases, the target market for these procedures will expand
beyond the baby boomers to include a broad range of women and men aged 17 to 65.
Demographic factors similar to the U.S. underlie the growth of the aesthetic and
cosmetic laser market outside of the U.S.
HAIR REMOVAL. We believe that the great majority of the 108 million women over
the age of 16 in the U.S. employ one or more techniques for temporary hair
removal from various parts of the body. Also, a growing number of men are
removing hair by means other than their daily shaving routine. A number of
techniques are used to pull hair from the follicle including waxing,
depilatories, and tweezing. In the waxing process, a lotion, generally
beeswax-based, is spread on the area to be treated and is then rapidly peeled
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off, pulling out the entrapped hairs. Depilatories employ rotating spring coils
or slotted rubber rolls to trap and pull out the hairs. Tweezing involves
removing individual hairs with a pair of tweezers. Pulling hair from the
follicle produces temporary results, but is often painful and may cause skin
irritation. Depilatory creams, which contain chemicals to dissolve hair,
frequently leave a temporary unpleasant odor and may also cause skin irritation.
Shaving is the most widely used method of hair removal, especially for legs and
underarms, but produces the shortest-term results. Hair bleaches do not remove
hair, but instead lighten the color of hair so that it is less visible. A
principal drawback of all of these methods is that they require frequent
treatment.
Before the advent of laser hair removal, electrolysis was the only method
available for the long-term removal of body hair. Electrolysis is a process in
which an electrologist inserts a needle directly into a hair follicle and
activates an electric current in the needle, which disables the hair follicle.
The tiny blood vessels in each hair follicle are heated and coagulated,
presumably cutting off the blood supply to the hair matrix, or are destroyed by
chemical action depending upon modality used. The success rate for electrolysis
is variable depending upon the skill of the electrologist and always requires a
series of treatments. Electrolysis is time-consuming, expensive and sometimes
painful. There is also some risk of skin blemishes and a rising concern relating
to needle infection. Because electrolysis requires that each hair follicle be
treated separately and can only treat visible hair follicles, the treatment of
an area as small as an upper lip may require numerous visits at an aggregate
cost of up to $1,000. The American Electrology Association estimates that
approximately one million people per year undergo electrology procedures.
Although we believe the large majority of all electrolysis treatments are for
facial hair, the neck, breasts and bikini line are also treated. Because hair
follicles are disabled one at a time, electrolysis is rarely used to remove hair
from large areas such as the back, chest, abdomen, and legs. We believe lasers
enable the practitioner to address a potentially larger market than electrolysis
by treating a larger area of the body more quickly and with better results.
We believe the market for laser-based hair removal is in its early stages and
that this market will grow as the customer compares laser treatments to other
hair removal methods that are currently available. The benefits include:
- significant longer term cosmetic improvement;
- treatment of larger areas in each treatment session;
- less discomfort during and immediately after procedures;
- reduced procedure time and number of treatments;
- reduced risk of scarring and infection;
- non-invasive procedures; and
- no risk of cross-contamination.
VASCULAR LESIONS. Benign vascular lesions are generally enlarged and
proliferating blood vessels that appear on the surface of the skin as splotches,
dots, bulges, and spider shapes in a variety of colors ranging from red to
purple. Different types of benign vascular lesions include the following:
- varicose veins, which are large veins greater than 1mm in diameter and
often bulge above the skin surface;
- leg telangiectasias, which are smaller spider veins up to 1mm in
diameter in size appearing as single strands;
- facial and truncal telangiectasias, which are spider veins and other
dilated veins that appear on the face and other parts of the body;
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- port wine stains, which are vascular birthmarks characterized by a red
or purple discoloration of the skin;
- hemangiomas, which are protuberances that consist of dilated vessels,
which often appear on newborns within one month of birth; and
- stretch marks and scars.
Varicose leg veins typically result when damaged valves cause blood to stagnate
rather than be pumped back to the heart, causing the vein walls to stretch and
bulge. Varicose veins affect a significant portion of the U.S. adult population
and increase in prevalence with age. To date, treatment for varicose veins has
been predominantly performed on women. Other benign vascular lesions include
port wine stains, hemangiomas, and facial and truncal telangiectasias or spider
veins. It is estimated that in 1997 there were approximately 661,000 procedures
performed in the U.S. to remove vascular lesions and the number of procedures is
expected to increase to an estimated 2.6 million in 2002.
PIGMENTED LESIONS/TATTOOS: Benign pigmented lesions can be both epidermal and
dermal, natural or man-made (tattoos), and can constitute a significant cosmetic
problem to those who have them.
SKIN RESURFACING: A significant percentage of the population suffers from
wrinkles or older looking skin as a result of the normal aging process, which is
often exacerbated by the effects of sun damage and smoking. This is the primary
group of candidates for skin resurfacing procedures. While there are a variety
of techniques used for smoothing skin including botox and collagen injections,
chemical peels and dermabrasion, laser technology has become an accepted
alternative for efficacious treatment of moderate and deep wrinkles. Developed
in the mid 1990's, laser skin resurfacing experienced explosive growth fueled by
improved technology and patient acceptance of the procedure. Recent advances
enabling lasers to treat other body parts and different skin types effectively
have further expanded the market. These advances in laser technology continue to
improve efficiency and reduce patient recovery time. Estimates based on aging
population demographics indicate continuous growth in the number of procedures
on an annual basis.
CANDELA'S PRODUCTS
We develop, manufacture, market, and service lasers used to perform procedures
addressing patients' aesthetic and cosmetic concerns. We offer a comprehensive
range of products based on proprietary technologies. Our products focus on the
major aesthetic and cosmetic laser applications including:
- hair removal;
- non-invasive treatment of varicose veins and other benign vascular
lesions;
- removal of benign pigmented lesions such as age spots and tattoos;
- treatment of scars and stretch marks; and
- skin resurfacing.
Intense light technology forms the basis for most of our products. Our patented
technology uses thermal energy generated by an intense pulsed laser light source
to selectively eliminate unwanted skin blemishes without damaging the
surrounding healthy tissue, and to remove facial or other unwanted hair
throughout the body. Candela's objective is to establish itself as the leading
provider of aesthetic and cosmetic lasers by continually striving to develop
smaller, faster, and less expensive devices. Candela has been a pioneer in the
laser industry. From the start, our mission has been to lead the way in the
development of innovative laser products. Significant innovations include:
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- a laser system to treat vascular lesions with minimal skin injury;
- a vascular lesion treatment laser approved for use on children;
- an Er/YAG resurfacing laser with a microprocessor-driven scanner; and
- a hair removal laser with integrated DCD.
GENTLELASE(R). The GentleLASE(R), integrated with DCD, is a high-energy,
long-pulse solid-state laser that generates laser light in the near infrared
wavelength range. It is used for both hair removal and the treatment of large
(1mm or larger) leg veins. The technology incorporated in the GentleLASE(R) uses
high energy directed through an Alexandrite rod, which achieves selective
heating while keeping the temperature of the skin below its damage threshold.
The longer Alexandrite laser wavelength enables GentleLASE(R) to penetrate skin
surfaces deeper than traditional Ruby lasers, and the large spot size (15mm)
allows the practitioner to treat a larger area more quickly.
The DCD is integrated into the design of GentleLASE(R) and delivers a short
burst of cryogen coolant onto targeted areas of the skin undergoing treatment.
DCD selectively cools only the top layer of the skin, while leaving the targeted
underlying hair follicle, vein or other structure at normal temperature. As a
result, higher levels of laser energy can be delivered during treatment, while
minimizing thermal injury, pain, and the inconvenience associated with
anesthetics. The design of the hand-held DCD enables the practitioner to clearly
see the area being treated, and the combined efficiency of GentleLASE(R) and DCD
reduces the risks of over treatment, which can result in white spots on the
skin, or under treatment which can result in brown spots.
GentleLASE(R) was initially cleared for marketing by the FDA in December 1997
for treating facial veins and vascular lesions and we commenced sales in March
1998. Candela began selling GentleLASE(R) for hair removal in the U.S. in July
1998, when it received FDA marketing clearance for hair removal. In August 1998,
we were issued a CE Mark on GentleLASE(R), clearing it for sale in 15 European
countries.
We introduced a enhanced version of the GentleLASE(R), the GentleLASE PLUS(R),
on September 22, 1999. The GentleLASE PLUS(R) features a larger spot size for
faster treatment times, an elliptical spot option for improved alignment when
treating large leg veins, and a foot pedal for greater physician convenience in
operating the system.
Hair removal typically requires three to five treatments to achieve efficacious
results due to the growth cycle of hair follicles. A typical treatment can range
from approximately $200 for an upper lip and chin procedure to as much as $1,000
per treatment for the back or chest.
SCLEROPLUS(TM). The ScleroPLUS(TM) is a versatile laser combining multiple
wavelengths and long pulse duration for the treatment of a broad range of benign
vascular lesions and is typically sold with a DCD attachment. ScleroPLUS(TM)
provides treatment of facial spider veins, port wine stains, leg telangiectasia,
hemangiomas, poikiloderma, rosacea, scars, warts, stretch marks, vulvodynia, and
other vascular abnormalities in adults, children and infants. The practitioner
selects the wavelength and energy density that are most appropriate for each
patient, delivering a longer or shorter pulse duration to treat veins and
lesions of different sizes, shapes, locations, and depth. Most treatments of
vascular lesions cost between $300 and $800 depending on the length of and type
of procedure. The combination of ScleroPLUS(TM) and GentleLASE(R) offers the
capability to treat a majority of leg veins in patients seeking treatment. A
predecessor product to ScleroPLUS(TM), the SPTL-1b, is currently marketed in
Japan, pending Ministry of Health approval of ScleroPLUS(TM). The ScleroPLUS(TM)
was initially cleared for marketing by the FDA in the U.S. in 1995.
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ALEXLAZR(TM) AND YAGLAZR(TM). We offer two types of lasers to address removal of
a broad range of pigmented lesions and most tattoos.
The ALEXlazr(TM) is a short-pulsed solid-state laser, which emits near-infrared
light for the non-invasive removal of tattoo pigments and pigmented lesions such
as freckles and Nevus of Ota, a bluish colored, non-vascular, pigmented lesion,
generally found among persons of Asian descent. The ALEXlazr(TM) was cleared by
the FDA for marketing for these uses in the U.S. in 1994. The ALEXlazr(TM) has a
fiber optic delivery system that produces an even beam distribution without hot
spots. Its wavelength maximizes beam penetration, providing positive results
with deeper pigments and is effective in the removal of most tattoo pigments
except red.
The YAGlazr(TM) is a short-pulsed Nd/YAG laser, which is able to emit both near
infrared and green light, for the non-invasive removal of red tattoos and the
treatment of brown benign pigmented lesions, such as age spots and sunspots. The
YAGlazr(TM) was cleared for marketing by the FDA for these uses in the U.S. in
1994. The YAGlazr(TM) has variable pulse repetition frequency to optimize
treatment time, and dual wavelengths that broaden treatment options, allowing
for removal of tattoos which have red pigments as well as tattoos in darker skin
types.
SKINPLUS SYSTEM WITH OPTIONAL SKINSCAN. The SkinPLUS system provides skin
resurfacing of the face, hands, neck and eye areas with an Er/YAG laser, an
erbium laser which emits a mid-infrared light, and the treatment of fine facial
veins with an optional KTP/532, Nd/YAG laser. The characteristic shallow
penetration of the Er/YAG energy into the skin allows precise removal of tissue
without heating adjacent tissue and also permits the treatment of delicate skin
on neck and hands, as well as darker pigmented skin. Healing time following a
SkinPLUS treatment is relatively rapid so that patients can return to their
daily routines quickly. The SkinPLUS system was approved for marketing by the
FDA in the U.S. in 1996.
The SkinScan Computerized Pattern Scanner is an optional add-on device for the
SkinPLUS system that enables the user to have a high degree of flexibility and
precision when performing skin resurfacing procedures. The SkinScan was cleared
for marketing by the FDA in the U.S. in 1996.
DYNAMIC COOLING DEVICE. Currently, DCD is integrated into GentleLASE(R), as
described above, and is offered as an attachment to the ScleroPLUS(TM). In
addition, owners of earlier models of the Sclero product line can purchase DCD
separately as an accessory.
SKINTONIC. The Skintonic is a massage device for body and face manufactured by
CFK Concepts of Valence, France. The system utilizes a variety of massage heads
and varying vacuum pressure to deeply massage and stimulate local blood
circulation, which helps patients look and feel better. Current regulatory
claims restrict promotion for cellulite reduction. However, we are working to
obtain additional marketing claims for promotion in the first half of fiscal
2000.
MARKETING, SALES, AND DISTRIBUTION
We pursue a global marketing, sales and distribution strategy which is centrally
managed out of our Wayland, Massachusetts headquarters. Separate regional
managers for the Americas, Europe and the Middle East, and Asia ensure that the
differing needs of each region are identified and satisfied. International sales
are an important contributor to our revenue. During our 1999 fiscal year, the
U.S. and Canada comprised 48% of our revenue, Japan and the Far East 31%, Europe
20%, and the rest of the world 1%.
We have stepped up our marketing efforts to increase both brand and specific
product awareness. Expenditures on marketing our products and services in
fiscal 1999 were approximately $4.6 million, an increase of approximately 63%
over fiscal 1998. Most of this increase was used to support the growth of our
sales force and new promotional activities. Our traditional marketing has
concentrated on practitioners through trade shows, trade journals and
workshops. Recently, we have increased our marketing directly to consumers
including practice enhancement programs for practitioners, regional consumer
print advertising and other media aimed at the consumer. In addition, we have
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allocated resources to support our new distribution relationship with PSS. We
intend to increase resources dedicated to marketing to further expand support
of PSS and ancillary markets as well as developing greater brand awareness by
both the practitioner and the consumer.
We sell our products through our direct sales force and a network of independent
distributors. The particular mix of direct sales and distributors varies by
region. Generally, our distributors enter into a two to three year exclusive
agreement during which they typically agree not to sell our competitors'
products. Our sales strategy is to choose the most productive and practicable
distribution channel within each of our geographic markets.
We sell products in the U.S. primarily through our direct sales force to our
traditional customer base of dermatologists and plastic and cosmetic surgeons.
In addition, several independent distributors enhance our coverage of this
traditional customer base. In order to expand outside our traditional customer
base in the U.S., we entered into a three-year distribution arrangement with PSS
in December 1998 that gives PSS the exclusive right to distribute the
GentleLASE(R) and ScleroPLUS(TM) to specific office-based specialists. PSS is a
division of PSS World Medical, Inc., and is the largest distributor of medical
supplies, equipment, and pharmaceuticals to office-based physicians in the U.S.
Through its nationwide sales force of 700 representatives, PSS offers the
GentleLASE(R) and ScleroPLUS(TM) to approximately 100,000 family practice and
general practice physicians, ob/gyn specialists and general and vascular
surgeons. The agreement with PSS specifies that our products will be the only
aesthetic and cosmetic lasers sold by PSS.
Outside the U.S. we sell our products in Western Europe, Japan, Central and
South America, including Brazil, the Middle East, and the Pacific Rim through
direct sales offices and distribution relationships. We have 24 employees in our
direct sales offices in Madrid, Frankfurt, Tokyo, and Osaka. We plan to open an
additional direct sales office in Hong Kong. We have established distribution
relationships throughout Europe, Japan, Africa, Central and South America,
including Brazil, and the Middle East. Outside the U.S. we currently utilize 34
distributors in 46 countries.
The following chart shows data relating to Candela's international activities
during each of the last two fiscal years by geographic region. Revenue generated
from regions other than the U.S. and Canada includes sales from Candela's
German, Spanish, and Japanese subsidiaries, as well as sales shipped directly to
international locations from the U.S. Candela does not record or report, either
internally or externally, operating profit or assets in the same manner it
aggregates revenues.
YEAR ENDED
---------------------------------
July 3, 1999 June 27, 1998
----------------- ---------------
REVENUE:
(in 000's)
United States and Canada ............................... $ 28,185 $ 17,248
Japan and Far East ..................................... 18,175 11,267
Europe ................................................. 11,837 8,232
United States shipments to other regions of the world... 391 278
SERVICE AND SUPPORT
We believe that quick and effective delivery of service is important to our
customers. We strive to respond to service calls within 24 hours and to complete
the call within 48 hours to minimize practitioner disruption. Our principal
service center and parts depot is located at our Wayland, Massachusetts
headquarters. Parts depots are also located at our sales offices in Japan,
Spain, and Germany. Independent distributors maintain parts depots and service
representatives adequate to cover their installed systems and have
10
primary responsibility to service such systems. In addition, we have service
representatives in each of our markets worldwide.
Product maintenance and repair following the warranty period provides an
additional recurring source of revenue. Customers may elect to purchase an
extended warranty or to purchase service on a time-and-materials basis. Our
extended warranties vary by the type of system and the level of service desired
by the customer and are typically for a 12 to 24 month period after the initial
warranty period expires. Initial warranties on all laser products cover parts
and service for twelve months.
Candela emphasizes education and support of its customers. Our recommended
preventive maintenance, coupled with continuing technical education for service
representatives, helps to ensure product reliability. After a sale, the system
is installed and supported by a Candela qualified service engineer. After
installation of a system at the customer's location, a nurse clinician provides
the practitioner with training and clinical support.
MANUFACTURING
We design, manufacture, assemble, and test our branded products other than the
SkinPLUS system at our Wayland, Massachusetts facility. Ensuring adequate and
flexible production capacity, continuous cost reduction, and superior product
quality are top priorities of our manufacturing organization. We achieve our
goals by:
- working closely with the research and development organization,
including significant early involvement in product design;
- continually improving our just-in-time manufacturing and inventory
processes; and
- effectively managing a limited number of the most qualified suppliers.
In March 1999, our facility was awarded ISO 9001 certification and EN 46001
registration. ISO 9001 certification provides guidelines for the quality of
company systems associated with the design, manufacturing, installation, and
servicing of company products. EN 46001 standards are European quality
requirements specifically relating to the design of medical devices.
Our products are manufactured with standard components and subassemblies
supplied by subcontractors to our specifications. We purchase certain components
and subassemblies from a limited number of suppliers; or in the case of the
Alexandrite rods used in our GentleLASE(R) and ALEXlazr(TM) products, a sole
supplier.
If our suppliers are unable to meet our requirements on a timely basis, our
production could be interrupted until we obtain an alternative source of supply.
To date, we have not experienced significant delays in obtaining dyes, optical
and electro-optical components, electronic components, and raw materials for our
products.
RESEARCH AND DEVELOPMENT
We believe that our advanced research and engineering activities are crucial to
maintaining and enhancing our business, and we are currently conducting research
on a number of applications. We believe that our in-house research and
development staff has demonstrated its ability to develop innovative new
products that meet evolving market needs. Our core competencies include:
- applied laser physics and technology;
- new imaging methods;
- tissue optics;
11
- photochemistry; and
- laser-tissue interaction.
As we discover new technologies or applications with commercial potential, we
assemble a team to develop the new product or application in cooperation with
leading physicians and medical and research institutions. In most instances, we
must receive FDA clearance before marketing new products or applications.
Our research and development team works with our operations group to design our
products for ease of manufacturing and assembly and with our marketing group to
respond to market opportunities. We believe that this interaction between
functional groups facilitates the introduction of new products with the right
balance of features, performance, quality, and cost. To date our research and
development effort has relied primarily on internal development building on our
core technologies, rather than through acquisition.
In addition, Candela conducts joint research with physicians affiliated with
various medical and research institutions. One example of technology developed
through joint research is our DCD which was developed in conjunction with the
Beckman Laser Institute at the University of California, Irvine. We anticipate
continuing joint research and licensing arrangements with medical research
institutions.
As of July 3, 1999, our research and development staff consisted of 31 people,
six of whom have advanced degrees including three Ph.Ds. The core members of our
research and development team have been with us for an average of ten years. The
significant continuity of the research and development staff has been a major
factor in enabling Candela to expand. We believe our research and development
staff is one of the most experienced teams in the industry.
CUSTOMERS
We currently sell our products primarily to physicians. The majority of our
sales in the U.S. are financed through leasing companies. Although our sales are
not dependent on any single customer or distributor, our sales to PSS have
increased and we expect sales to PSS to continue to represent a significant
portion of sales. Our customers are located in more than 40 countries. We have
recently begun an innovative program to target the estimated 6,000
electrologists in the U.S. as potential customers for GentleLASE(R) for hair
removal, positioning GentleLASE(R) as an adjunct to traditional electrolysis
methods.
COMPETITION
Competition in the aesthetic and cosmetic laser industry is intense and
technological developments are expected to continue at a rapid pace. Although
there are over 20 manufacturers of aesthetic and cosmetic lasers, we believe
that only Candela and a few others offer a broad range of products able to
address multiple applications. Unlike Candela, few, if any, of our competitors
focus exclusively on the cosmetic and aesthetic laser market. We believe that
our principal competitors are currently Coherent and ESC Medical Systems. We
compete on the basis of proprietary technology, product features, performance,
service, price, and reputation. Some of our competitors have greater financial,
marketing, and technical resources than we do. In addition, some competitors
have developed, and others may attempt to develop, products with applications
similar to ours.
We believe that many factors will affect our competitive position in the future,
including our ability to:
- develop and manufacture new products that meet the needs of our markets;
- respond to competitive developments and technological changes;
12
- manufacture our products at lower cost;
- retain a highly qualified research and engineering staff; and
- provide sales and service to a worldwide customer base.
PROPRIETARY RIGHTS
We own several U.S. and foreign patents and have four U.S. and one foreign
patent applications pending to protect our rights in certain technical aspects
of our hair removal, benign vascular lesion, pigmented lesion, and other laser
systems. The expiration dates for our issued U.S. patents range from December 8,
2006 to February 5, 2017.
In addition to our portfolio of patents issued and pending, we license patented
technology from third parties. We use DCD under an exclusive license agreement
to patent rights owned by the Regents of the University of California. In
October 1998, we entered into an amendment of the license agreement which now
gives us 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
imposes an obligation to negotiate sublicensing agreements with third parties,
subject to certain minimum terms and conditions. If we do not enter into
sublicenses with such third parties within certain time periods, the Regents may
then grant license rights to them directly, provided that Candela will receive
50% of all revenues received under such licenses. To date, no such sublicenses
or further licenses have been granted by us or the Regents. 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 in the license amendment. The Regents have denied that request. We will
contest any sublicense the Regents grant for the DCD technology on the grounds
that the Regents' refusal to agree to our request to extend the time periods set
forth in the license amendment was unreasonable. By letter dated September 10,
1999, the Regents notified us that we were in default under the license
agreement, as amended. The notice of default states that it is based on our
alleged failure to make all 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
gives us sixty days to cure the alleged default.
We have 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. We believe that the Regents' notice of default is without merit and
we have challenged the Regents' determination that we are in default.
We rely primarily on a combination of patent, copyright, and trademark laws to
establish and protect our proprietary rights. We also rely on trade secret laws,
confidentiality procedures, and licensing arrangements to establish and protect
our technology rights. In addition, we seek to protect our proprietary rights by
using confidentiality agreements with employees, consultants, advisors, and
others. We cannot be certain that these agreements will adequately protect our
proprietary rights in the event of any unauthorized use or disclosure, that our
employees, consultants, advisors, or others will maintain the confidentiality of
such proprietary information, or that our competitors will not otherwise learn
about or independently develop such proprietary information.
Despite our efforts to protect our intellectual property, unauthorized third
parties may attempt to copy aspects of our products, to violate our patents, or
to obtain and use our proprietary information. In addition, the laws of some
foreign countries do not protect our intellectual property to the same extent as
do the laws of the U.S. The loss of any material trademark, trade name, trade
secret, or copyright could hurt our business, results of operations, and
financial condition.
13
We believe that our products do not infringe the rights of third parties.
However, we cannot be certain that third parties will not assert infringement
claims against us in the future or that any such assertion will not result in
costly litigation or require us to obtain a license to third party intellectual
property. In addition, we cannot be certain that such licenses will be available
on reasonable terms or at all, which could hurt our business, results of
operations, and financial condition. We have received correspondence on behalf
of Palomar Medical Technologies informing us that Palomar is the exclusive
licensee to certain United States patents and offering to grant us a
nonexclusive license to such patents. We have determined that two of the Palomar
patents are unrelated to our products, and 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.
GOVERNMENT REGULATION
FDA'S PREMARKET CLEARANCE AND APPROVAL REQUIREMENTS. Unless an exemption
applies, each medical device that we wish to market in the U.S. must receive
either "510(k) clearance" or "PMA approval" in advance from the U.S. Food and
Drug Administration 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,
lengthy, and uncertain and generally takes from one to three years or even
longer. We cannot be sure that 510(k) clearance or PMA approval will ever be
obtained for any product we propose to market.
The FDA decides whether a device must undergo either the 510(k) clearance or PMA
approval process based upon statutory criteria. These criteria include the level
of risk that the agency perceives is associated with the device and a
determination whether the product is a type of device that is similar to devices
that are already legally marketed. Devices deemed to pose relatively less risk
are placed in either class I or II, which requires the manufacturer to submit a
pre-market notification requesting 510(k) clearance, unless an exemption
applies. The pre-market notification must demonstrate that the proposed device
is "substantially equivalent" in intended use and in safety and effectiveness to
a legally marketed "predicate device" that is either in class I, class II, or is
a "pre-amendment" class III device (i.e., one that was in commercial
distribution before May 28, 1976) for which the FDA has not yet decided to
require PMA approval.
After a device receives 510(k) clearance, any modification 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 each manufacturer to make this determination in the first instance, but
the FDA can review any such decision. If the FDA disagrees with a manufacturer's
decision not to seek a new 510(k) clearance, the agency may retroactively
require the manufacturer to submit a pre-market notification requiring 510(k)
clearance. The FDA also can require the manufacturer to cease marketing and/or
recall the modified device until 510(k) clearance is obtained. We have modified
some of our 510(k) cleared devices, but have determined that, in our view, 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.
Devices deemed by the FDA to pose the greatest risk such as life-sustaining,
life-supporting, or implantable devices, or deemed not substantially equivalent
to a legally marketed predicate device, are placed in class III. Such devices
are required to undergo the PMA approval process in which the manufacturer must
prove the safety and effectiveness of the device to the FDA's satisfaction. A
PMA application must provide extensive pre-clinical and clinical trial data and
also information about the device and its components regarding, among other
things, manufacturing, labeling, and promotion. After approval of a PMA, a new
PMA or PMA supplement is required in the event of a modification to the device,
its labeling, or its manufacturing process.
14
A clinical trial may be required in support of a 510(k) submission or PMA
application. Such trials generally require an Investigational Device Exemption
("IDE") application approved in advance by the FDA for a limited number of
patients, unless the product is deemed a nonsignificant risk device eligible for
more abbreviated IDE requirements. The IDE application must be supported by
appropriate data, such as animal and laboratory testing results. Clinical trials
may begin if the IDE application is approved by the FDA and the appropriate
institutional review boards at the clinical trial sites.
To date, the FDA has deemed our products to be class II devices eligible for the
510(k) clearance process. We believe that most of our products in development
will receive similar treatment. However, we cannot be certain that FDA will not
deem one or more of our future products to be a class III device and impose the
more burdensome PMA approval process.
PERVASIVE AND CONTINUING FDA REGULATION. A host of regulatory requirements apply
to marketed devices such as our laser products, including labeling regulations,
the Quality System Regulation (which requires manufacturers to follow elaborate
design, testing, control, documentation, and other quality assurance
procedures), the Medical Device Reporting regulation (which requires that
manufacturers report to the FDA certain types of adverse events involving their
products), and the FDA's general prohibition against promoting products for
unapproved or "off label" uses. Class II devices such as ours also can have
special controls such as performance standards, post-market surveillance,
patient registries, and FDA guidelines that do not apply to class I devices.
Unanticipated changes in existing regulatory requirements or adoption of new
requirements could hurt our business, financial condition, and results of
operations.
We are subject to inspection and market surveillance by the FDA for compliance
with regulatory requirements. If the FDA finds that we have failed to comply
with applicable requirements, the agency can institute a wide variety of
enforcement actions. The FDA sometimes issues a public warning letter, but also
may pursue more drastic remedies, such as refusing our requests for 510(k)
clearance or PMA approval of new products, withdrawing product approvals already
granted to us, requiring us to recall products, or asking a court to require us
to pay civil penalties or criminal fines, adhere to operating restrictions, or
close down our operations. Ultimately, criminal prosecution is available to FDA
as punishment for egregious offenses. Any FDA enforcement action against us
could hurt our business, financial condition, and results of operation.
OTHER U.S. REGULATION. We also must comply with numerous federal, state, and
local laws relating to such matters as safe working conditions, manufacturing
practices, environmental protection, fire hazard control, and hazardous
substance disposal. We cannot be sure that we will not be required to incur
significant costs to comply with such laws and regulations in the future or that
such laws or regulations will not hurt our business, financial condition, and
results of operations.
FOREIGN REGULATION. International sales are subject to foreign government
regulation, the requirements of which vary substantially from country to
country. The time required to obtain approval by a foreign country may be longer
or shorter than that required for FDA approval, and the requirements may differ.
Companies are now required to obtain the CE Mark prior to sale of certain
medical devices within the EU. During this process, the sponsor must demonstrate
compliance with ISO manufacturing and quality requirements. In addition, Candela
is currently awaiting Ministry of Health approval in Japan to market the
ScleroPLUS(TM) and in June, 1999, received Ministry of Health approval in Brazil
to market GentleLASE(R), ScleroPLUS(TM), and ALEXlazr(TM).
Candela and its products may also be subject to other federal, state, local, or
foreign regulations relating to health and safety, environmental matters,
quality assurance, and the like. Candela's compliance with laws that regulate
the discharge of materials into the environment or otherwise relate to the
protection of the environment does not have a material effect on its ongoing
operations. Candela has not made any material expenditures for environmental
control facilities.
15
PRODUCT LIABILITY AND WARRANTIES
Our products are generally covered by a one year warranty. We set aside a
reserve based on anticipated warranty claims. We believe such reserves to be
adequate, but in the event of a major product problem or recall, such reserves
may be inadequate to cover all costs, and such an event could have a material
adverse effect on our business, financial condition, and results of operations.
Our business involves the inherent risk of product liability claims. We maintain
appropriate product liability insurance with respect to its products with a
coverage limit of $13 million in the aggregate. We cannot be certain that with
respect to our current or future products, such insurance coverage will continue
to be available on terms acceptable to us or that such coverage will be adequate
for liabilities that may actually be incurred.
THE SKIN CARE CENTERS
In June 1996, we began an effort to own and operate skin care centers offering
cosmetic laser treatments utilizing our equipment along with other cosmetic
services traditionally offered by high-end spas. We pursued this strategy by
purchasing an operating spa in Boston in 1996. In March 1997, we opened a new
facility in Scottsdale, Arizona, with no pre-existing customer base. We
subsequently decided to reduce our focus on our skin care center efforts. We
closed our Scottsdale, Arizona facility in the quarter ended December 27, 1997,
and in January of 1999 ceased to offer aesthetic laser procedures at our Boston
skin care center, although we continue to offer health and beauty services from
this location. We are actively seeking buyers to assume the leases and purchase
the assets of both the Scottsdale and Boston facilities.
EMPLOYEES
As of July 3, 1999, we employed 285 people in the following areas of our
organization:
- 31 in research, development, and engineering;
- 43 in manufacturing and quality assurance;
- 22 in service positions;
- 33 in sales and marketing;
- 19 in finance and administrative positions;
- 108 in our clinic and health spa subsidiary, including both full and
part-time employees; and
- 29 in our international sales and service subsidiaries.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130 Reporting Comprehensive Income ("SFAS
130") which establishes standards for reporting and displaying comprehensive
income and its components (revenue, expenses, gains, and losses) in a full set
of general purpose financial statements. Components of comprehensive income are
net income and all other non-owner changes in equity such as the change in
cumulative translation adjustment. The Company presents such information in its
statement of operations.
Also in June 1997, the FASB issued Statement of Financial Accounting Standard
No. 131 ("SFAS 131"), "Disclosure about Segments of an Enterprise and Related
16
Information." Based on the management approach to segment reporting, SFAS No.
131 establishes requirements to report selected segment information quarterly
and to report entity-wide disclosures about products and services, major
customers, and the countries in which the entity holds material assets and
reports material revenue. The Company has adopted SFAS No. 131 for its fiscal
year ending July 3, 1999. The adoption of FAS 131 did not affect results of
operations or financial position, but did affect the footnote disclosure of
segment information.
In June 1999, the FASB issued Statement of Financial Accounting Standard No. 137
("SFAS 137"), "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FAS Statement 133," which postponed the
adoption date of SFAS No. 133. As such, the Company is not required to adopt the
statement until fiscal 2001. Had the Company implemented SFAS 133 for the
current reporting period, there would have been no material effect on our
statement of operations and current assets and current liabilities would have
increased equally by $5.2 million to reflect foreign currency forward contracts
held by the Company.
EXECUTIVE OFFICERS
The current executive officers of the Company are as follows:
NAME AGE POSITION
Gerard E. Puorro 52 President, Chief Executive Officer and
Director
F. Paul Broyer 50 Senior Vice President of Finance and
Administration, Chief Financial Officer,
and Treasurer
James C. Hsia, Ph.D. 53 Senior Vice President, Research
William D. Spies 49 Senior Vice President of Marketing, Sales
and Service
Jay D. Caplan 37 Vice President, Operations
Timothy P. Costello 39 Vice President, Worldwide Marketing
William B. Kelley 44 Vice President, North American and Latin
American Sales
William McGrail 38 Vice President of Development Engineering
Toshiro Mori 47 Vice President, President of Candela KK
Robert J. Wilber 41 Vice President, Worldwide Service and
Manager of European Sales
Executive officers of the Company are elected by the Board of Directors on an
annual basis and serve until their successors are duly elected and qualified,
subject to earlier removal by the Board of Directors. There are no family
relationships among any of the executive officers or directors of the Company.
Mr. Puorro was appointed a Director of the Company in September 1991. Mr. Puorro
has been President and Chief Executive Officer of the Company since April 1993.
From April 1989 until April 1993, he was Senior Vice President and Chief
Financial Officer of the Company. He was elected Chief Operating Officer in
December 1992. Prior to joining the Company, and since 1982, he was Vice
President and Controller at Massachusetts Computer Corporation. Mr. Puorro
became acting Chief Executive Officer of Candela Skin Care Centers, Inc. in June
1997.
17
Mr. Broyer was appointed Senior Vice President of Finance and Administration,
Chief Financial Officer, and Treasurer in July 1998. Mr. Broyer joined the
Company in October 1996 as Vice President and Chief Financial Officer. Prior to
joining the Company, Mr. Broyer held the position of Vice President Finance at
Integrated Genetics from 1994 to 1996. From 1987 until 1994, Mr. Broyer was
Corporate Controller for Laserdata, Inc. and held earlier positions with Avatar
Technologies and Data General Corporation.
Dr. Hsia has been Senior Vice President, Research, of the Company since July
1991. He has been with the Company since October 1985, and was previously Vice
President, Research and Development. Prior to joining the Company, and since
1982, he was Vice President, Research and Development at Laser Science, Inc.
Mr. Spies joined Candela in July 1998, as Senior Vice President of Marketing,
Sales, and Service. Prior to joining the Company, and since 1996, Mr. Spies held
the position of Director, Business Development with the Cordis medical device
unit of Johnson & Johnson. From 1988 to 1996 Mr. Spies held the positions of
Executive Vice President/General Merchandise Manager, and Vice President Sales
and Marketing with Seiko Optical Products. Previously, Mr. Spies held a position
with Corning, Inc.
Mr. Caplan was appointed Vice President, Operations in February 1997, after
serving as Vice President, Manufacturing since December 1995. He has been with
the Company since September 1988 and was previously Senior Director, Corporate
Planning/ Business Development. From 1988 to 1993, Mr. Caplan held the positions
of Product Director, International Controller, Manager, Financial Planning and
Analysis, and Planning Associate. Prior to joining the Company, Mr. Caplan held
positions at Xerox Corporation and the United States Air Force.
Mr. Timothy Costello joined Candela in December 1998 as Vice President,
Worldwide Marketing. Prior to joining Candela, and since 1996, Mr. Costello held
the position of Vice President, Marketing with ESC Medical Systems, Inc. From
1989 until 1996, Mr. Costello held a number of product and marketing manager
positions at Mentor Corporation.
Mr. Kelley was named Vice President of North American and Latin American Sales
in July 1998. Mr. Kelley was previously Vice President, North American Sales and
Service, from April 1993 through June 1998. From January 1993 until April 1993
he was Vice President, Domestic Sales. He has been with the Company since 1987
and previously held the positions of National Sales Manager and Eastern Regional
Sales Manager. Prior to joining the Company, Mr. Kelley held a number of sales
and sales management positions in the medical industry.
Mr. McGrail was named Vice President of Development Engineering in July 1998.
Previously, Mr. McGrail served in the position of Director of Engineering since
August 1994. From 1987 to 1992, he held the positions of Senior Software
Engineer and Software Design Engineer. Prior to joining Candela, Mr. McGrail was
employed with Raytheon Corporation.
Mr. Mori was named Vice President, President of Candela K.K. in July 1998, after
serving as President and Representative Director of Candela K.K. since September
1996. Previously, Mr. Mori held the positions of Director of Candela K.K. from
September 1992 to September 1996, and General Manager from September 1989 to
September 1992. From 1976 to 1989, he was employed by Sansui Electric Co. Ltd.
in Tokyo.
Mr. Wilber was appointed Vice President, Worldwide Service in August 1997, after
serving as Director of Worldwide Service since October 1993. He has been with
the Company since September of 1989 and was previously a Finance Group Director.
From 1989 to 1992 Mr. Wilber held the positions of International Accounting
Manager, Customer Service Manager, and Director of Financial Planning and
Analysis. Prior to joining the Company, Mr. Wilber held positions at Sony
Corporation of America, Massachusetts Computer Corporation, and National
Semiconductor/Data Terminal Systems.
18
ITEM 2. PROPERTIES
The Company leases a facility totaling approximately 35,000 square feet for its
operations in Wayland, Massachusetts, which is located approximately 20 miles
west of Boston. The lease on this facility was amended in April 1998 to extend
the expiration date to March 2003. Management of the Company believes that its
current facilities are suitable and adequate for its near-term needs.
The Company's subsidiary, Candela Skin Care Centers, Inc, currently leases the
following facilities:
1) Candela Skin Care Center of Scottsdale, Inc., 7,555 square feet located at
6939 E. Main Street, Scottsdale, AZ. The lease on this facility is for a period
of ten years, expiring on June 30, 2006, with a provision for two five-year
extensions; and
2) Candela Skin Care Center of Boston, Inc., 20,728 square feet located at 28
Arlington Street, Boston, MA. The lease on this facility is for a period of 15
years, and commenced on June 1, 1994.
ITEM 3. 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 is seeking 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 includes various
tort claims against us and contract-related claims against the Regents and
Beckman. The complaint asserts that we interfered with the licensing of the
dynamic cooling technology to the plaintiffs. The complaint seeks 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 and have
filed a motion to dismiss the case on jurisdictional grounds. In August 1999,
the Court granted our motion and dismissed the patent claims, but gave the
plaintiffs additional time to amend their complaint. 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 not valid or enforceable, our rights to the DCD technology
would no longer be exclusive. This outcome could adversely 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.
From time to time, we are a party to various legal proceedings incidental to our
business. We believe that none of the other presently pending legal proceedings
will have a material adverse effect upon our financial position, results of
operations, or liquidity.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders during the fourth quarter
of the fiscal year covered by this report.
19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock trades on The NASDAQ Stock Market under the symbol
"CLZR."
At September 23, 1999, there were 423 holders of record of the Company's common
stock and the closing sales price of the Company's common stock was $11.625.
The following table sets forth quarterly high and low closing sales prices of
the common stock for the indicated fiscal periods:
High Low
---- ---
FISCAL 1998
First Quarter.................................. $ 6.000 $ 4.250
Second Quarter................................. 7.125 4.250
Third Quarter.................................. 5.500 3.250
Fourth Quarter................................. 4.313 2.813
FISCAL 1999
First Quarter.................................. $ 4.750 $ 2.688
Second Quarter................................. 6.031 3.000
Third Quarter.................................. 10.000 5.625
Fourth Quarter................................. 20.438 8.125
DIVIDEND POLICY
The Company has never paid a cash dividend and has no present intention to pay
cash dividends in the foreseeable future. The Board of Directors currently
intends to retain any future earnings for use in the Company's business.
20
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The table set forth below contains certain consolidated financial data for each
of the last five fiscal years of the Company. This data should be read in
conjunction with the detailed information, financial statements and related
notes, as well as Management's Discussion and Analysis of Financial Condition
and Results of Operations included elsewhere herein.
(IN THOUSANDS, EXCEPT PER SHARE DATA) For the Year Ended
------------------------------------------------------------------
JULY 3, JUNE 27, JUNE 28, JUNE 29, JULY 1,
CONSOLIDATED STATEMENT OF OPERATIONS DATA: 1999 1998 1997 1996 1995
----------------------------------------- ---- ---- ---- ---- ----
REVENUE:
Lasers and other products.................... $46,708 $25,917 $25,601 $20,403 $18,017
Product related service...................... 8,801 8,405 7,660 7,861 8,450
Skin care centers............................ 3,079 2,703 2,244 2,149 1,777
--------- --------- --------- --------- ---------
Total revenue........................... 58,588 37,025 35,505 30,413 28,244
COST OF REVENUE:
Lasers and other products.................... 18,623 11,272 11,195 9,159 7,952
Product related service...................... 5,715 6,954 5,563 6,560 6,976
Skin care centers............................ 2,125 2,481 1,892 1,114 940
--------- --------- --------- --------- ---------
Total cost of revenue................... 26,463 20,707 18,650 16,833 15,868
GROSS PROFIT:
Lasers and other products.................... 28,085 14,645 14,406 11,244 10,065
Product related service...................... 3,086 1,451 2,097 1,301 1,474
Skin care centers............................ 954 222 352 1,035 837
--------- --------- --------- --------- ---------
Total cost of revenue................... 32,125 16,318 16,855 13,580 12,376
OPERATING EXPENSES:
Selling, general & administrative............ 17,891 15,271 13,680 9,873 10,246
Research and development expense............. 3,998 2,399 2,488 1,818 3,733
Restructuring charges (1).................... 0 2,609 0 0 0
--------- --------- --------- --------- ---------
Total operating expenses................ 21,889 20,279 16,168 11,691 13,979
--------- --------- --------- --------- ---------
Income (loss) from operations.................. 10,236 (3,961) 687 1,889 (1,603)
OTHER INCOME (EXPENSE):
Interest income.............................. 115 42 84 93 70
Interest expense............................. (492) (235) (107) (49) (47)
Other expense................................ (3) (123) (26) (207) 544
--------- --------- --------- --------- ---------
Total other income (expense)............ (380) (316) (49) (163) 567
--------- --------- --------- --------- ---------
INCOME (LOSS) BEFORE INCOME TAXES.............. 9,856 (4,277) 638 1,726 (1,036)
Provision for income taxes..................... 2,365 175 400 481 500
--------- --------- --------- --------- ---------
NET INCOME (LOSS).............................. $ 7,491 $(4,452) $ 238 $ 1,245 $ (1,536)
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Basic earnings(loss)per share.................. $ 1.36 $ (.81) $ .04 $ .23 $ (.29)
Diluted earnings(loss)per share................ $ 1.22 $ (.81) $ .04 $ .22 $ (.29)
Weighted average shares outstanding............ 5,500 5,479 5,398 5,321 5,288
Adjusted weighted average shares outstanding... 6,119 5,479 5,673 5,652 5,288
Pro-forma
Unaudited
July 3, July 3, June 27, June 28, June 29, July 1,
CONSOLIDATED BALANCE SHEET DATA: 1999(2) 1999 1998 1997 1996 1995
- -------------------------------- ---- ---- ---- ---- ---- ----
Cash and cash equivalents.................... $29,993 $10,055 $ 1,615 $ 2,674 $ 3,041 $ 2,565
Working capital.............................. 32,951 13,186 2,639 7,032 8,608 8,033
Total assets................................. 56,216 36,451 22,604 24,837 19,334 16,832
Long-term debt............................... 3,181 3,181 887 1,519 557 476
Total stockholders' equity................... 33,787 14,023 5,395 10,246 9,965 9,086
Total liabilities and stockholders' equity... 56,216 36,451 22,604 24,837 19,334 16,832
(1) During the quarter ended December 27, 1997, a restructuring charge was
recorded and a reserve established in the amount of $2.6 million
resulting from the closure of the skin care center
located in Scottsdale, Arizona.
(2) Reflects proceeds of secondary offering completed on July 22, 1999.
(unaudited)
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
ALL STATEMENTS, TREND ANALYSIS AND OTHER INFORMATION CONTAINED IN THE FOLLOWING
DISCUSSION RELATIVE TO MARKETS FOR OUR PRODUCTS AND TRENDS IN REVENUE, GROSS
MARGINS AND ANTICIPATED EXPENSE LEVELS, AS WELL AS OTHER STATEMENTS INCLUDING
WORDS SUCH AS "ANTICIPATE", "BELIEVE", "PLAN", "ESTIMATE", "EXPECT", AND
"INTEND" AND OTHER SIMILAR EXPRESSIONS CONSTITUTE FORWARD-LOOKING STATEMENTS.
THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO BUSINESS AND ECONOMIC RISKS AND
UNCERTAINTIES, AND OUR ACTUAL RESULTS OF OPERATIONS MAY DIFFER MATERIALLY FROM
THOSE CONTAINED IN THE FORWARD-LOOKING STATEMENTS. FACTORS THAT COULD CAUSE OR
CONTRIBUTE TO SUCH DIFFERENCES INCLUDE, BUT ARE NOT LIMITED TO THOSE DISCUSSED
IN "CAUTIONARY STATEMENTS" AS WELL AS OTHER RISKS AND UNCERTAINTIES REFERENCED
IN THIS PROSPECTUS.
OVERVIEW
We research, develop, manufacture, market, and service lasers used to perform
aesthetic and cosmetic procedures. We sell our lasers principally to medical
practitioners. Candela markets its 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. Over 50% of our revenue in fiscal 1999 came from
international sales.
We derive our revenue from:
- the sale of lasers and other products;
- the provision of product related services; and
- the operations of our remaining skin care center.
Domestic and international product sales are generated principally through our
direct sales force based in the U.S. and three international offices. Prior to
fiscal 1999, a relatively small portion of our sales have come through our
network of independent distributors. In December 1998, we entered into an
exclusive distributorship arrangement with Physician Sales and Service (PSS)
whose 700 representatives target general practice physicians and certain
specialists in the U.S. Sales to distributors for the year ended July 3, 1999,
increased as a result of this arrangement.
Since we began marketing the GentleLASE(R) in 1998, sales of this product have
accounted for an increasing percentage of our total revenue. For our fiscal year
ended July 3, 1999, sales of GentleLASE(R) and its accessories accounted for 53%
of our total revenue. We typically assemble products in our Wayland,
Massachusetts, facility in the quarter in which they are shipped, and backlog
has not been significant. We experience some seasonal reduction of our product
sales in the quarter ending in September due to the summer holiday schedule of
physicians and their patients.
All product shipments include a 12-month parts and service warranty. The
anticipated cost associated with the warranty coverage is accrued at the time of
shipment and amortized over the warranty period as a cost of sales charged to
service revenue. Costs associated with product installation are also recognized
as costs of product-related service revenue. Both such anticipated and actual
costs have no associated revenue and therefore reduce the gross profit from
product related service revenue.
Product related service revenue consists of revenue from maintenance and repair
services and the sale of spare parts and consumables. We derive revenue from
extended warranty contracts, which are typically for a 12 to 24 month period. In
addition, we provide on- site service worldwide on a time-and-materials basis
directly or through our distributors.
22
In June 1996, we began an effort to own and operate skin care centers offering
cosmetic laser treatments utilizing our equipment, along with providing other
cosmetic services traditionally offered by high-end spas. We pursued this
strategy by purchasing an existing spa in Boston in 1996. In March 1997, we
opened a new skin care center in Scottsdale, Arizona, with no pre-existing
client base. We subsequently decided to reduce our focus on our skin care center
efforts and to renew our commitment to our core aesthetic and cosmetic laser
business. In the quarter ending December 27, 1997, we closed our Scottsdale
facility because it had failed to generate any material revenue from its
inception, recorded a restructuring charge, and established a reserve in the
amount of $2.6 million which represented the anticipated cost associated with
this closure. In January 1999, we ceased to offer aesthetic laser procedures at
our Boston skin care center because the rate of performance was insufficient to
justify the associated costs, but we continue to provide personal care and
health and beauty services from this location. We are actively seeking buyers to
assume the leases and purchase the assets of both the Scottsdale and Boston
facilities.
International revenue, consisting of sales from our subsidiaries in Germany,
Spain, and Japan, and sales shipped directly to international locations from the
U.S., during the fiscal years ended July 3, 1999, and June 27, 1998, represented
52% and 53% of total sales, respectively.
Our fiscal year consists of the 52 or 53 week period ending on the Saturday
closest to June 30 of each year. The years ended July 3, 1999, June 27, 1998,
and June 28, 1997, contained 53, 52 and 52 weeks, respectively.
RESULTS OF OPERATIONS
The following tables set forth selected financial data for the periods
indicated, expressed as percentages.
FOR THE YEAR ENDED
JULY 3, JUNE 27, JUNE 28,
1999 1998 1997
---- ---- ----
REVENUE MIX:
(PERCENTAGE OF TOTAL REVENUE)
Lasers and other products 79.7% 70.0% 72.1%
Product related service 15.0 22.7 21.6
Skin care centers 5.3 7.3 6.3
----- ----- -----
Total 100.0% 100.0% 100.0%
OPERATING RATIOS:
GROSS PROFIT
(PERCENTAGE OF EACH REVENUE CATEGORY)
Lasers and other products 60.1% 56.5% 56.3%
Product related service 35.1 17.3 27.4
Skin care centers 31.0 8.2 15.6
----- ----- -----
Total 54.8 44.1 47.5
OPERATING EXPENSE
(PERCENTAGE OF TOTAL REVENUE)
Selling, general and administrative 30.5% 41.2% 38.5%
Research and development 6.8 6.5 7.1
Restructuring charge 0.0 7.1 0.0
----- ----- -----
Total 37.3 54.8 45.6
----- ----- -----
Income (loss) from operations 17.5 (10.7) 1.9
Other income (expense) (0.6) (0.9) (0.1)
----- ----- -----
Net income (loss) before income taxes 16.9 (11.6) 1.8
Provision for income taxes 4.0 0.4 1.1
----- ----- -----
Net income (loss) 12.8% (12.0)% 0.7%
----- ----- -----
----- ----- -----
23
FISCAL YEAR ENDED JULY 3, 1999 COMPARED TO FISCAL YEAR ENDED JUNE 27, 1998
REVENUE. Total revenue increased 58% to $58.6 million in fiscal 1999 from $37.0
million in fiscal 1998. International product revenue, consisting of sales from
our subsidiaries in Germany, Spain, and Japan, and sales shipped directly to
international locations from the U.S., was 52% of total revenue for fiscal 1999
compared to 53% for the same period in 1998. Laser and product revenue increased
80% to $46.7 million in fiscal 1999 from $25.9 million in fiscal 1998. This was
due mainly to a significant increase in the volume of both domestic and
international shipments of the GentleLASE(R), which we began shipping in March
1998. Product-related service revenue increased 5% to $8.8 million in fiscal
1999 from $8.4 million in fiscal 1998. This increase was attributable to
shipments of consumables used with the GentleLASE(R) and Sclero products. Skin
care center revenue increased 14% to $3.1 million in 1999 compared to $2.7
million in 1998, due to increased marketing and promotional activities for our
Boston Spa.
GROSS PROFIT. Gross profit increased to $32.1 million or 55% of revenue in
fiscal 1999 from $16.3 million or 44% of revenue in fiscal 1998 as a result of
increased sales of higher margin GentleLASE(R) and higher absorption of fixed
portions of manufacturing overhead. Gross profit on lasers and other products
increased to $28.0 million or 60% in fiscal 1999 compared to $14.6 million or
57% in fiscal 1998. Gross profit for service revenue in fiscal 1999 increased to
$3.1 million or 35% of revenue compared to $1.5 million or 17% of revenue for
fiscal 1998. Skin care center gross profit for the year ended July 3, 1999 was
positively impacted, in comparison to 1998, by the closure of the Scottsdale
facility in the second quarter of fiscal 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative
expense increased 17% to $17.9 million in fiscal 1999, from $15.3 million in
fiscal 1998. This reflects increased staffing levels in the sales and marketing
departments incurred to support revenue growth, partially offset by savings
realized from operating one skin care center rather than two during the first
six months of the fiscal year. Also affecting selling, general and
administrative expense for fiscal 1999 was an expense of approximately $1.3
million for the payment of management bonuses which are tied to pre-tax profits
derived from product and service revenue. In fiscal 1998, the management bonus
accrued amounted to approximately $325,000. In relation to revenue, selling,
general and administrative expenses was 31% of revenue in fiscal 1999 compared
to 41% for fiscal 1998.
RESEARCH AND DEVELOPMENT EXPENSE. Research and development spending for fiscal
1999 increased 67% to $4.0 million, from $2.4 million for fiscal 1998. The
increase in research and development expense reflects efforts to develop
products and product improvements designed to enhance, augment, and expand
existing product lines. Research and development expense also includes
approximately $481,000 of management bonuses, which are tied to pre-tax profits.
RESTRUCTURING CHARGE. During the quarter ended December 27, 1997, a
restructuring charge was recorded and a reserve established in the amount of
$2.6 million resulting from the closure of the skin care center located in
Scottsdale, Arizona. During fiscal 1999, a total of $476,000 was charged against
this reserve, representing costs associated with the closure of the Scottsdale
facility leaving a reserve balance of $1.5 million. 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 recorded for at least the
next 18 months.
OPERATING INCOME. Income from operations for the year ended July 3, 1999,
increased by $14.2 million, from a loss of $4.0 million in fiscal 1998 to a
profit of $10.2 million, in fiscal 1999. The improved performance was a result
of both increased revenue from product sales and reduced expenses in connection
with operations of the skin care centers.
24
OTHER INCOME/EXPENSE. For the fiscal year ended July 3, 1999, total other
expense was $380,000 in comparison to $316,000 for the same period a year
earlier. The increase resulted from an increase in interest expenses from the
debt issued in October, 1998, partially offset by a decrease in exchange losses
from our foreign operations and an increase in interest income resulting from
higher cash balances.
INCOME TAXES. The provision for income taxes results from a combination of
activities of both the domestic and foreign subsidiaries. The provision for
income taxes for the year ended July 3, 1999, reflects the utilization of the
domestic net operating loss and tax credit carryforwards and tax provisions
calculated in Japan and Spain at a rate in excess of the U.S. statutory tax
rate. We had a net operating loss carryforward of approximately $2.2 million and
tax credit carryforwards of approximately $1.6 million at June 28, 1998, the
beginning of the current fiscal year. Based on current year operating results,
we utilized all of the federal net operating loss carryforwards and the federal
tax credit carryforwards. We also released $1.1 million of the valuation
allowance against our deferred tax asset in fiscal 1999. The effective tax rate
for fiscal 1999 is approximately 24%.
During the second quarter of fiscal 1999, Candela believed that it was more
likely than not that a portion of the deferred tax asset would be utilized
during 1999. Therefore, the Company, in accordance with the Statement of
Financial Accounting Standard No. 109 "Accounting for Income Taxes", decreased
its valuation allowance for the portion related to the utilization of the net
operating loss and tax credit carryforwards against current year taxable income,
resulting in a decrease to its effective rate.
FISCAL YEAR ENDED JUNE 27, 1998 COMPARED TO FISCAL YEAR ENDED JUNE 28, 1997
REVENUE. Total revenue for fiscal 1998 increased 4% over fiscal 1997 to $37.0
million from $35.5 million. International revenue, as a percentage of total
revenue, represented 53% of revenue in fiscal 1998 compared to 52% in fiscal
1997. Laser and product revenue increased slightly to $25.9 million for fiscal
1998 compared to $25.6 million for fiscal 1997. Increased shipments of
GentleLASE(R) were partially offset by an 8% sales decline in our Japanese
subsidiary as a result of the erosion of the Japanese Yen compared to the U.S.
dollar during this period. Product related service revenue increased 10% in
fiscal 1998 over fiscal 1997 to $8.4 million from $7.7 million. This increase
was primarily the result of increased service in our Spanish subsidiary. Skin
care center revenue for fiscal 1998 increased 20% over fiscal 1997 to $2.7
million from $2.2 million primarily as a result of operating two skin care
centers in fiscal 1998 compared to fiscal 1997 when only the Boston skin care
center was operating.
GROSS PROFIT. Gross profit decreased to $16.3 million or 44% of total revenue in
fiscal 1998 from $16.9 million or 47% of total revenue in fiscal 1997. This
decline was primarily due to the negative effect of currency devaluation on
Japanese sales and a decrease in gross margins from the skin care centers
resulting from increased medical procedure costs. Gross profit from product
revenue for fiscal 1998 was $14.6 million, basically unchanged from $14.4
million for fiscal 1997. Gross profit from product related service revenue
decreased to $1.5 million or 17% in fiscal 1998 compared to $2.1 million or 27%
in fiscal 1997. This decline in product related service gross profit is
attributable to warranty expenses associated with the initial shipments of the
GentleLASE(R) which were estimated to be higher than our historical experience.
Skin care center gross profit declined to $223,000, or 8.2% of total revenue,
from $351,000, or 16% of total revenue, due to the higher operating costs and
minimal revenue associated with the Scottsdale facility.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE. Selling, general and administrative
expense increased 12% to $15.3 million in fiscal 1998 from $13.7 million in
fiscal 1997, as a result of charges incurred in the second quarter for legal and
consulting fees and taking a full reserve for potentially uncollectible accounts
and notes receivable from a domestic distributor. Selling, general and
administrative expense was 41% of total revenue in fiscal 1998 compared to 39%
in fiscal 1997.
25
RESEARCH AND DEVELOPMENT EXPENSE. Research and development spending for fiscal
1998 decreased 4% to $2.4 million in fiscal 1998 from $2.5 million in fiscal
1997.
RESTRUCTURING CHARGE. During the quarter ended December 27, 1997, a
restructuring charge was recorded and a reserve established in the amount of
$2.6 million resulting from the closure of our skin care center located in
Scottsdale, Arizona. Charges against the reserve for fiscal 1998 totaled
$614,000, leaving a reserve balance of $2.0 million.
OPERATING INCOME (LOSS). We experienced an operating loss in fiscal 1998 of $4.0
million compared to an operating profit of $687,000 in fiscal 1997. This decline
was a result of the restructuring charge, higher selling, general and
administrative expenses, and declining margins from product related service
revenue and the skin care centers.
OTHER INCOME AND EXPENSE. For fiscal 1998, other income and expense reflected
$316,000 in expense in comparison to $49,000 in expense for fiscal 1997.
Interest income decreased in fiscal 1998 as a result of a decrease in average
cash balances, while interest expense increased in fiscal 1998 as a result of
the increased level of debt and lease financing. Other expenses in fiscal 1998
included an increase in expense from foreign currency transactions.
INCOME TAXES. The provision for income taxes in fiscal 1998 was established due
to taxable income from our subsidiaries in Spain and Japan.
LIQUIDITY AND CAPITAL RESOURCES
Cash provided by operating activities amounted to $8.8 million for fiscal 1999
compared to cash used for operating activities of $1.9 million in fiscal 1998,
reflecting increased operating profit. Cash used in investing activities totaled
$161,000 for 1999 compared to $293,000 for the same period a year earlier. Cash
provided by financing activities amounted to $15,000 in 1999 in comparison to
$1.4 million for 1998. We issued $3.7 million eight-year, 9.75% subordinated
term notes with warrants in October 1998 and used the proceeds of this financing
in part to pay the balance of $2.7 million on our line of credit. We borrowed
$1.7 million on our line of credit during the same period a year ago.
Cash and cash equivalents at July 3,1999, increased by $8.4 million to $10.1
million from $1.6 million at June 27, 1998, due primarily to higher cash
receipts resulting from increased shipments of GentleLASE(R).
On October 15, 1998, we issued eight-year, 9.75% subordinated term notes to
three investors in the aggregate amount of $3.7 million. 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 ascribed to
the warrants is $836,000 and has been recorded as a component of Additional
Paid-In Capital in Stockholders Equity. The relative fair value of the debt was
recorded as $2,864,000. The debt will be accreted to face value using the
interest method over eight years, which will result in interest expense of
$836,000 over the eight-year period in addition to the 9.75% face interest.
We also maintain a $3.5 million 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 July 3, 1999 we had no borrowings
outstanding on this line of credit.
Our Japanese subsidiary borrowed funds to be used for payment of equipment
purchases made from the U.S. parent. At July 3, 1999, this liability was
$69,000, based upon year-end exchange rates. Our remaining short-term and
long-term debt is comprised of capital lease obligations in the amount of
$310,000 and $252,000, respectively, at July 3, 1999, compared to $362,000 and
$828,000, respectively, at June 27, 1998.
26
Subsequent to the end of fiscal 1999, we completed a public offering in July
1999, for 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. We
received approximately $19.2 million in net proceeds from the sale of our
shares. Accordingly, on a pro forma basis, had the offering occurred on July 3,
1999, we would have had approximately $30 million in cash at year-end.
We believe that cash balances will be sufficient to meet anticipated cash
requirements through the first quarter of fiscal 2001. However, we cannot be
sure that we will not require additional capital beyond the amounts currently
forecasted by us, nor that any such required additional capital will be
available on reasonable terms, if at all, at such time as required.
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
October 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.
Candela has questioned representatives of Litton Airtron Synoptics, our sole
supplier for Alexandrite rods, and PSS, a major distributor, and has reviewed
publicly available disclosures relating to PSS. Litton has indicated that their
business systems are Year 2000 compliant. Based on this review, Candela is not
aware of any information indicating 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
27
systems, which we expect to be substantially complete by October 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.
CAUTIONARY STATEMENTS
This Annual Report on Form 10-K 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 Annual Report on Form 10-K 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 Annual Report on Form
10-K. The cautionary statements noted below and other factors noted throughout
this Annual Report on Form 10-K 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(R) INCREASES OUR SUSCEPTIBILITY TO COMPETITIVE
CHANGES IN THE MARKETPLACe.
We introduced our GentleLASE(R) in March 1998. GentleLASE(R)'s sales have grown
rapidly and accounted for more than half of our total revenue in fiscal 1999.
Heavy dependence on GentleLASE(R) 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 EXCLUSIVE RIGHTS TO THE DCD TECHNOLOGY COULD BECOME NON-EXCLUSIVE BECAUSE
OUR AMENDED LICENSE AGREEMENT REQUIRES US TO MAKE COMMERCIALLY REASONABLE
EFFORTS TO CONCLUDE SUBLICENSE AGREEMENTS WITH THIRD PARTIES, OR WE COULD LOSE
OUR RIGHTS TO THE DCD TECHNOLOGY ALTOGETHER IF A COURT CHALLENGE TO THE
UNDERLYING PATENT IS SUCCESSFUL.
Due to the terms of an amended license agreement entered into in October 1998,
Candela could lose its exclusive rights to our Dynamic Cooling Device (DCD), or
the patent under which the DCD was developed could be invalidated as a result of
pending litigation. We developed our DCD, which is used to selectively cool the
subject's outermost layer of skin during cosmetic laser treatments, under an
exclusive license to patent rights owned by the Regents of the University of
California. The DCD is an integral component of our biggest-selling device, the
GentleLASE(R), and is also currently sold as an attachment to our other
principal laser device, 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 imposes on us an obligation to negotiate in good faith and make
commercially reasonable efforts to conclude sublicensing agreements with third
parties, subject to certain stipulated minimum terms and conditions. If we fail
to negotiate in good faith or enter into sublicenses with third parties within
certain 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. By letter dated September 10, 1999, the
28
Regents notified us that we were in default under the license agreement, as
amended. The notice of default states that it is based on our alleged failure to
make all 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 gives us sixty days to cure the
alleged default. We have 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. We believe that the Regents' notice of default is without
merit and will challenge any effort by the Regents to terminate the license. If
the Regents successfully terminate our DCD license, we will lose our rights to
the DCD technology. In addition, our financial condition will be adversely
affected if the Regents prevail on their claim that we have not made all
required royalty payments.
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. We will contest any sublicense
the Regents grant for the DCD technology on the grounds that the Regents'
refusal to agree to our request to extend the time periods set forth in the
license amendment was unreasonable.
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. While our agreement with the
Regents provides that we would receive 50% from all such licenses, the loss of
exclusivity to this technology could hurt our financial results. In addition,
while we believe the litigation commenced by New Star Lasers, Inc. challenging
the validity of the Regents' patent rights is without merit, we can't be certain
that the Regents' patent rights will not be reduced or invalidated, which could
also hurt our business and financial results.
BECAUSE WE DERIVE MORE THAN HALF OF OUR REVENUE FROM INTERNATIONAL SALES,
INCLUDING APPROXIMATELY ONE-THIRD OF OUR REVENUE FROM JAPAN AND THE ASIA-PACIFIC
MARKETPLACE IN FISCAL 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.
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 we expect that they 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:
29
- 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(R) AND ALEXLAZR(TM)
FROM OUR SOLE SUPPLIER WOULD IMPAIR OUR ABILITY TO MANUFACTURE AND SELL
GENTLELASE(R), WHICH ACCOUNTED FOR MORE THAN HALF OF OUR REVENUE IN THE FISCAL
YEAR ENDED JULY 3, 1999.
We use Alexandrite rods to manufacture the GentleLASE(R) 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;
- 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.
30
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.
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.
31
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.
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.
32
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;
- 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 patent. We have determined
that two of the Palomar patents are unrelated to our products, and 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.
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
33
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.
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 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
At July 3, 1999, the Company held foreign currency forward contracts with
notional values totaling approximately $5,307,086 (631,844,877 Japanese Yen)
compared to $1,386,000 (183,687,568 Japanese Yen) at June 27, 1998. These
contracts have maturities prior to October 29, 1999. The carrying and net fair
value of these contracts at July 3, 1999, was $0 and $86,090, respectively,
compared to $0 and $127,000, respectively, at June 27, 1998.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Financial statements and supplementary data are included herein and are indexed
under item 14 (a) (1)-(2).
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning directors of the Company required under this item in
incorporated herein by reference to the Company's definitive proxy statement
pursuant to Regulation 14A to be filed with the Commission not later than 120
days after the close of the Company's fiscal year ended July 3, 1999 under the
headings "Election of Directors" and "Section 16(a) Reporting Delinquencies."
The information concerning executive officers of the Company are set forth under
the caption "Executive Officers" in Item 1 of this Form 10-K is incorporated
herein by reference to the Company's definitive proxy statement pursuant to
Regulation 14A, to be filed with the Commission not later than 120 days after
the close of the company's fiscal year ended July 3, 1999 under the heading
"Section 16(a) Reporting Delinquencies."
ITEM 11. EXECUTIVE COMPENSATION
The information required under this item is incorporated herein by reference to
the Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission nor later than 120 days after the close of the Company's
fiscal year ended July 3, 1999, under the heading "Compensation and Other
Information Concerning Directors and Officers."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required under this item is incorporated herein by reference to
the Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission not later than 120 days after the close of the Company's
fiscal year ended July 3, 1999, under the heading "Security Ownership of Certain
Beneficial Owners and Management."
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information, if any, required under this item is incorporated herein by
reference to the Company's definitive proxy statement pursuant to Regulation
14A, to be filed with the Commission within 120 days after the close of the
Company's fiscal year ended July 3, 1999, under the heading "Certain
Transactions."
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following items are filed as part of this report:
(1) CONSOLIDATED FINANCIAL STATEMENTS:
Report of Independent Accountants F-1
Consolidated Balance Sheets - July 3, 1999 and June 27, 1998 F-2
Consolidated Statements of Operations - Years ended July 3, 1999, June
27, 1998, and June 28, 1997 F-3
Consolidated Statements of Stockholders' Equity - Years Ended July 3,
1999, June 27, 1998, and June 28, 1997 F-4
Consolidated Statements of Cash Flows - Years Ended July 3, 1999, June
27, 1998, and June 28, 1997 F-5
Notes to Consolidated Financial Statements F-6
(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULES:
Schedule II - Valuation and Qualifying Accounts F-20
35
The report of the registrant's independent accountants with respect to the
above-listed financial statements and financial statement schedule appears on
page F-1 of this report.
All other financial statements and schedules not listed have been omitted since
the required information is included in the consolidated financial statements or
the notes thereto, or is not applicable, material, or required.
(3) EXHIBITS: Except as otherwise noted, the following documents are
incorporated by reference from the Company's Registration Statement on Form
S-1 (File Number 333-78339):
3.1 Certificate of Incorporation, as amended
3.2 (FN9) By-laws of the Company, as amended and restated
3.3 (FN1) Agreement of Merger between Candela Corporation, Inc., a Massachusetts
corporation, and Candela Laser Corporation, a Delaware corporation.
4.1 (FN6) Form of Rights Agreement dated as of September 4, 1992, between the
Company and The First National Bank of Boston, as Rights Agent,
which includes as Exhibit A thereto the Form of Rights Certificate
10.1 (FN1) 1985 Incentive Stock Option Plan
10.2 (FN2) 1987 Stock Option Plan
10.2.1 (FN2) 1989 Stock Plan
10.2.2 (FN3) 1990 Employee Stock Purchase Plan
10.2.3 (FN3) 1990 Non-Employee Director Stock Option Plan
10.2.4 (FN7) 1993 Non-Employee Director Stock Option Plan
10.2.5 (FN13) 1998 Stock Plan
10.3 (FN7) Lease for premises at 526 Boston Post Road, Wayland, Massachusetts
10.4 (FN7) Lease for premises at 530 Boston Post Road, Wayland, Massachusetts
10.5 (FN7) Patent License Agreement between the Company and Patlex Corporation
effective as of July 1, 1988
10.6 (FN4) License Agreement among the Company, Technomed International, Inc. and Technomed
International S.A. dated as of December 20, 1990
10.7 (FN5) License Agreement between the Company and Pillco Limited Partnership
effective as of October 1, 1991
10.8 (FN8) Distribution Agreement between the Company and Cryogenic Technology
Limited, dated October 15, 1993
10.9 (FN10) Asset Purchase Agreement between the Company and Derma-Laser, Limited and
Derma-Lase, Inc. dated June 23, 1994.
10.10 (FN13) Letter Agreement between the Company and Fleet Bank dated February 13,
1997
10.10.1 (FN13) Amendment to Letter Agreement between the Company and Fleet Bank dated
December 15, 1998.
10.11* (FN11) Exclusive Distribution Agreement dated as of December 21, 1999, by and
among the Company and Physicians Sales and Service.
10.12* (FN11) Exclusive License Agreement dated as of February 13,1995 and amended
October 15, 1998, by and among the Company and the Regents of the
University of California.
10.13 (FN12) Note and Warrant Purchase Agreement, dated as of October 15, 1998 by and
among the Company, Massachusetts Capital Resource Company, William D. Witter
and Michael D. Witter.
10.13.1 (FN12) Form of Note delivered to the Company in the aggregate principal amount
of $3,700,000 to Massachusetts Capital Resource Company, William D. Witter
and Michael D. Witter.
10.13.2 (FN12) Form of Common Stock Purchase Warrant to purchase an aggregate of
370,000 shares of the Company's Common Stock delivered to Massachusetts
Capital Resource Company, William D. Witter and Michael D. Witter.
21.1 (FN11) Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP (Independent Accountants)
27.1 Financial Data Schedule
- Confidential treatment as to certain portions has been requested pursuant to
Rule 24b-2.
(FN1) Previously filed as an exhibit to Registration Statement No. 33-54448B
and incorporated herein by reference.
(FN2) Previously filed as an exhibit to the Company's Amended and Restated
Annual Report on Form 10-K for the fiscal year ended June 30, 1988, and
incorporated herein by reference.
(FN3) Previously filed as an exhibit to the Company's Annual Report on
Form 10-K for the fiscal year ended June 30, 1990, and incorporated herein
by reference.
(FN4) Previously filed as an exhibit to Form 10-Q for the quarter ended
December 29, 1990, and incorporated herein by reference.
(FN5) Previously filed as an exhibit to Form 10-Q for the quarter ended
September 28, 1991, and incorporated herein by reference.
(FN6) Previously filed as an exhibit to Form 8-K, dated
September 8, 1992, and incorporated herein by reference.
36
(FN7) Previously filed as an exhibit to the Company's Annual Report on
Form 10-K for the fiscal year ended July 3, 1993, and incorporated
herein by reference.
(FN8) Previously filed as an exhibit to Form 10-Q for the quarter ended
January 1, 1994, and incorporated herein by reference.
(FN9) Previously filed as an exhibit to Form 10-Q for the quarter ended April
2, 1994, and incorporated herein by reference.
(FN10) Previously filed as an exhibit to the Company's Annual Report on
Form 10-K for the fiscal year ended July 2, 1994, and incorporated herein
by reference.
(FN11) Previously filed as an exhibit to Form 10-Q for the quarter ended March
27, 1999 and incorporated herein for reference.
(FN12) Previously filed as an exhibit to the Company's Amended and Restated
Annual Report on Form 10-K for the fiscal year ended June 27, 1998, and
incorporated herein by reference.
(FN13) Previously filed as an exhibit to Registration Statement No. 333-78339
and incorporated herein by reference.
(b) Reports on Form 8-K. No reports on Form 8-K were filed by
the Company during the fourth quarter of the fiscal year
ended July 3, 1999.
(c) The Company hereby files, as part of this Form 10-K, the
exhibits listed in Item 14(a)(3) above.
37
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on September 29, 1999.
CANDELA CORPORATION
By: /s/ Gerard E. Puorro
---------------------
Gerard E. Puorro, President,
Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Gerard E. Puorro President, Chief Executive September 29, 1999
------------------------- Officer, and Director
Gerard E. Puorro (Principal Executive Officer)
/s/ F. Paul Broyer Senior Vice President of September 29, 1999
------------------------- Finance and Administration,
F. Paul Broyer Treasurer and Chief Financial
Officer
/s/ Kenneth D. Roberts Chairman of the Board September 29, 1999
------------------------- of Directors
Kenneth D. Roberts
/s/ Richard J. Cleveland Director September 29, 1999
-------------------------
Richard J. Cleveland
/s/ Theodore G. Johnson Director September 29, 1999
-------------------------
Theodore G. Johnson
/s/ Nancy Nager Director September 29, 1999
-------------------------
Nancy Nager
/s/ Douglas W. Scott Director September 29, 1999
-------------------------
Douglas W. Scott
38
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Candela Corporation:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 35 present fairly, in all material
respects, the financial position of Candela Corporation and its Subsidiaries
at July 3, 1999 and June 27, 1998 and the results of their operations and
their cash flows for each of the three years in the period ended July 3, 1999
in conformity with generally accepted accounting principles. In addition, in
our opinion, the financial statement schedule listed in the index appearing
under Item 14(a)(2) on page 35 present fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements. These financial statements and financial
statement schedule are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based
on our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/PRICEWATERHOUSECOOPERS LLP
Boston, Massachusetts
August 23, 1999
F-1
CANDELA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JULY 3, 1999 AND JUNE 27, 1998
(DOLLARS IN THOUSANDS)
Pro-forma
1999* 1999 1998
(unaudited)
---------- -------- --------
ASSETS
Current assets:
Cash and cash equivalents (Note 1) $ 29,993 $ 10,055 $ 1,615
Accounts receivable (net of allowance of $998 and
$1,038 in 1999 and 1998, respectively)(Notes 1 & 6) 12,337 12,337 8,419
Notes receivable 2,186 2,186 1,486
Inventories (Notes 1 & 3) 6,927 6,927 7,241
Other current assets 755 928 200
---------- ---------- -----------
Total current assets 52,198 32,433 18,961
Property and equipment, net (Note 4) 2,626 2,626 3,120
Deferred tax assets (Note 7) 1,100 1,100 -
Other assets 292 292 523
---------- ---------- -----------
Total assets $ 56,216 $ 36,451 $ 22,604
---------- ---------- -----------
---------- ---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 4,846 $ 4,846 $ 4,292
Accrued payroll and related expenses 3,735 3,735 1,319
Accrued warranty costs 2,502 2,502 2,012
Income taxes payable 3,185 3,185 335
Restructuring reserve (Note 12) 1,519 1,519 1,995
Other accrued liabilities 1,132 1,132 957
Lines of credit and short-term notes(Note 6) - - 3,052
Current portion of long-term debt (Note 6) 415 415 597
Deferred income (Note 5) 1,913 1,913 1,763
---------- ---------- -----------
Total current liabilities 19,247 19,247 16,322
Long-term debt (Note 6) 3,181 3,181 887
Commitments and contingencies(Note 6) -- -- --
Stockholders' equity (Note 8):
Common stock, $.01 par value: 30,000,000
shares authorized; 7,163,994, 5,564,998 and
5,479,020 shares issued and outstanding
in pro-forma 1999, 1999 and 1998, respectively 72 56 55
Additional paid-in capital 38,311 18,562 17,407
Accumulated deficit (3,846) (3,846) (11,337)
Accumulated other comprehensive income (749) (749) (730)
---------- ---------- -----------
Total stockholders' equity 33,787 14,023 5,395
---------- ---------- -----------
Total liabilities and stockholders' equity $ 56,216 $ 36,451 $ 22,604
---------- ---------- -----------
---------- ---------- -----------
*Reflects proceeds of secondary offering completed on July 22, 1999. (see
Note 1)
The accompanying notes are an integral part of the consolidated financial
statements.
F-2
CANDELA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED JULY 3, 1999, JUNE 27, 1998,
AND JUNE 28, 1997 (IN THOUSANDS, EXCEPT PER
SHARE DATA)
1999 1998 1997
---------- -------- --------
Revenue:
Lasers and other products $46,708 $25,917 $25,601
Product related service 8,801 8,405 7,660
Skin care centers 3,079 2,703 2,244
---------- -------- --------
Total revenue 58,588 37,025 35,505
Cost of sales:
Lasers and other products 18,623 11,272 11,195
Product related service 5,715 6,954 5,563
Skin care centers 2,125 2,481 1,892
---------- -------- --------
Total cost of sales 26,463 20,707 18,650
---------- -------- --------
Gross profit 32,125 16,318 16,855
Operating expenses:
Research and development 3,998 2,399 2,488
Selling, general and administrative 17,891 15,271 13,680
Restructuring charge 0 2,609 0
---------- -------- --------
Total operating expenses 21,889 20,279 16,168
---------- -------- --------
Income (loss) from operations 10,236 (3,961) 687
Other income (expense)
Interest income 115 42 84
Interest expense (492) (235) (107)
Other expense (3) (123) (26)
---------- -------- --------
Total other expense (380) (316) (49)
---------- -------- --------
Income (loss) before income taxes 9,856 (4,277) 638
Provision for income taxes 2,365 175 400
---------- -------- --------
Net income (loss) $ 7,491 $(4,452) $ 238
---------- -------- --------
---------- -------- --------
Basic earnings (loss) per share $ 1.36 $(0.81) $ 0.04
Diluted earnings (loss) per share $ 1.22 $(0.81) $ 0.04
---------- -------- --------
---------- -------- --------
Weighted average shares outstanding 5,500 5,479 5,398
Adjusted weighted average shares
outstanding 6,119 5,479 5,673
---------- -------- --------
---------- -------- --------
Net income (loss) $ 7,491 $(4,452) $ 238
Other comprehensive income (loss)net of tax:
Foreign currency translation adjustment (14) (607) (42)
---------- -------- --------
Comprehensive income (loss) $ 7,477 $(5,059) $ 196
---------- -------- --------
---------- -------- --------
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
CANDELA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED JULY 3, 1999, JUNE 27, 1998, AND JUNE 28, 1997
(IN THOUSANDS)
Accumulated
Additional Other
Paid-in Accumulated Comprehensive
Common Stock Capital Deficit Income
------------ ------- ----------- ------
Shares Amount Total
------ ------ -----
- --------------------------------------------------------------------------------------------------------------------------
BALANCE JUNE 29, 1996 5,385 $53 $17,069 $(7,123) $(34) $9,965
Sale of common stock
under stock plans 35 1 154 155
Net income 238 238
Currency translation
adjustment (112) (112)
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE JUNE 28, 1997 5,420 54 17,223 (6,885) (146) 10,246
Sale of common stock
under stock plans 59 1 184 185
Net loss (4,452) (4,452)
Currency translation
ADJUSTMENT (584) (584)
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE JUNE 27, 1998 5,479 55 17,407 (11,337) (730) 5,395
Sale of common stock
under stock plans 84 1 309 310
Exercise of stock
warrants 2 0 10 10
Issuance of stock
warrants 836 836
Net income 7,491 7,491
Currency translation
ADJUSTMENT (19) (19)
- ---------------------------------------------------------------------------------------------------------------------------
BALANCE JULY 3, 1999 5,565 $56 $18,562 $(3,846) $(749) $14,023
- ---------------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
CANDELA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED JULY 3, 1999, JUNE 27, 1998, AND JUNE 28, 1997
(IN THOUSANDS)
1999 1998 1997
---- ---- ----
Cash flows from operating activities:
Net income (loss) $ 7,491 $(4,452) $ 238
Adjustments to reconcile net income (loss)
to net cash provided by (used for)
operating activities:
Depreciation and amortization 751 815 666
Provision for bad debts 268 844 36
Provision for restructuring charges - 2,609 -
Accretion of interest on debt discount 66 - -
Increase(decrease) in cash from working capital:
Accounts receivable (3,905) (950) (2,628)
Notes receivable (488) (434) 620
Inventories 362 (810) (1,216)
Other current assets (762) 314 (188)
Other assets (1,114) 664 (529)
Accounts payable 361 (1,046) 2,945
Accrued payroll and related expenses 2,415 491 88
Deferred income 78 (241) 145
Accrued warranty costs 488 683 445
Income taxes payable 2,849 (154) 181
Restructuring reserve (289) (501) -
Other accrued liabilities 213 303 (395)
--------- --------- ---------
Net cash provided by (used for) operating
activities 8,784 (1,865) 408
Cash flows from investing activities:
Proceeds from sale of assets 363 24 50
Purchases of property and equipment (524) (317) (1,867)
--------- --------- ---------
Net cash used for investing activities (161) (293) (1,817)
Cash flows from financing activities:
Net borrowings from (repayments of) lines
of credit (2,700) 1,700 1,000
Proceeds from issuance of debt and stock
warrants 3,700 396 655
Principal payments on debt (668) (441) (422)
Payments of capital lease obligations (638) (390) (258)
Proceeds from issuance of common stock 321 184 155
--------- --------- ---------
Net cash provided by financing activities 15 1,449 1,130
Effect of exchange rate changes on
cash and cash equivalents (198) (350) (88)
--------- --------- ---------
Net increase (decrease) in cash and
cash equivalents 8,440 (1,059) (367)
Cash and cash equivalents at beginning
of period 1,615 2,674 3,041
--------- --------- ---------
Cash and cash equivalents at end of period $10,055 $ 1,615 $ 2,674
--------- --------- ---------
--------- --------- ---------
Cash paid during the year for:
Interest $ 366 $ 235 $ 107
Income taxes $ 615 $ 356 $ 492
Non cash activity:
Capital lease financing $ 42 $ 84 $ 1,011
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
The Company researches, develops, manufactures, markets, and services lasers and
other devices used to perform aesthetic and cosmetic procedures.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of Candela
Corporation and its wholly-owned subsidiaries. All intercompany accounts and
transactions have been eliminated.
The Company's fiscal year ends on the Saturday nearest June 30. The years ended
July 3, 1999, June 27, 1998, and June 28, 1997 contain 53, 52 and 52 weeks,
respectively.
USE OF ESTIMATES
The presentation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. It is the belief
of the Company's management that all necessary adjustments have been made for an
accurate presentation of results. Actual results could differ from those
estimates and impact future results of operations and cash flows.
PRO FORMA BALANCE SHEET (UNAUDITED)
In order to reflect the Company's stock offering on July 22, 1999, of 1,499,854
shares of Common Stock at $14 per share, an unaudited pro forma balance sheet is
included with the July 3, 1999, and June 27, 1998, balance sheets. This
presentation discloses the pro forma effects of this financing as if it had
occurred on July 3, 1999.
Cash would have increased by the proceeds, $19,429,056, net of issuance costs of
$376,517. Cash would have increased an additional $509,101 from the exercise of
stock purchase warrants by certain selling shareholders in conjunction with the
public offering. Other current assets would have decreased by $173,483 in
prepaid issuance costs, which would be offset to additional paid in capital.
Common stock would have increased by $15,990 to reflect the par value of the
additional shares that would have been outstanding. Additional paid-in capital
would have increased by $19,748,683 reflecting the proceeds received net of
issuance costs and amounts allocated to the par value of the common stock.
CASH AND CASH EQUIVALENTS
The Company classifies investments purchased with a maturity at the date of
acquisition of three months or less as cash equivalents. These are valued at
cash plus accrued interest which approximates market value. At July 3, 1999,
and June 27, 1998, substantially all cash equivalents were invested in
F-6
overnight Repurchase Agreements, U.S. Treasury Bills with a major bank, or
commercial paper issued by a major bank. The Company had letters of credit
outstanding at July 3, 1999, amounting to $331,000 with expiration dates
varying between August 15, and September 30, 1999.
FINANCIAL INSTRUMENTS
The Company operates internationally, with sales offices, customers, and vendors
in several countries outside of the United States. The Company may reduce its
exposure to fluctuations in foreign exchange rates by creating offsetting
positions through the use of foreign currency forward contracts, a type of
derivative financial instrument. Foreign currency exposures are accounted for on
an accrual basis. The Company does not use derivative financial instruments for
trading or speculative purposes, nor is the Company a party to leveraged
derivatives.
At July 3, 1999, the Company held foreign currency forward contracts with
notional values totaling approximately $5,307,086 (631,844,877 Japanese Yen)
compared to $1,386,000 (183,687,568 Japanese Yen) at June 27, 1998. These
contracts have maturities prior to October 29, 1999. The carrying and net fair
value of these contracts at July 3, 1999, was $0 and $86,090, respectively,
compared to $0 and $127,000, respectively, at June 27, 1998. The net fair value
is computed by subtracting the value of the contracts using the year end
exchange rate (the notional value) from the value of the forward contracts
computed at the contracted exchange rates.
ACCOUNTS RECEIVABLE AND NOTES RECEIVABLE
The Company's trade accounts receivables and notes receivables are primarily
from sales to end users and distributors servicing the dermatology market, and
reflect a broad domestic and international customer base. The Company does not
require collateral and has not historically experienced significant credit
losses related to receivables from individual customers or groups of customers
in any particular industry or geographic area.
INVENTORY
Inventory is stated at the lower of cost (first-in, first-out method) or market,
using a standard costing system.
PROPERTY AND EQUIPMENT
Purchased property and equipment is recorded at cost. Property and equipment
purchased under capital lease arrangements is recorded at the lesser of cost or
the present value of the minimum lease payments required during the lease
period. Laser systems used for testing are capitalized at cost. Significant
improvements are capitalized; maintenance and repairs are charged to expense as
incurred. Upon sale or retirement of property and equipment, the costs and
accumulated depreciation are removed from the accounts and any resulting gain or
loss is included in income from operations. Depreciation and amortization are
provided using the straight-line method over the estimated useful lives as
follows:
F-7
Number of Years
----------------
Leasehold improvements and assets under capital lease 2 to 13
Office furniture and other equipment 3 to 5
Laser systems 3
REVENUE RECOGNITION
PRODUCT SALES - Revenue from product sales, except sales to certain
distributors, is recognized at the time of shipment. Shipments made to
distributors, for which payment to the Company is dependent on resale of the
system, are not recognized as revenue unless the distributor demonstrates that
the system is sold.
GRANTS - Revenue from U.S. government contracts is granted under the Small
Business Innovation Research program. Government contracts limit reimbursement
to 100% of allowable direct costs and a negotiated rate for indirect costs. The
revenue is recognized as reimbursable costs are incurred.
SERVICE - Revenue from the sale of service contracts is deferred and recognized
on a straight-line basis over the contract period. Revenue from service
administered by CSCC is recognized as the services are provided. Amounts
received from the sale of gift certificates by CSCC are deferred and recognized
as revenue when the services are provided.
ADVERTISING COSTS
Advertising costs are expensed as incurred.
RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred.
FOREIGN CURRENCY TRANSLATION
The activity of the Company's foreign subsidiaries are translated into U.S.
dollars in accordance with Statement of Financial Accounting Standards (SFAS)
No. 52, "Foreign Currency Translation". Assets and liabilities are translated
into U.S. dollars at current exchange rates, while income and expense items are
translated at average rates of exchange prevailing during the year. Exchange
gains and losses arising from translation of the Japanese and Spanish subsidiary
balance sheets are accumulated as a separate component of stockholders' equity.
Net exchange losses resulting from foreign currency transactions amounted to
$20,000, $138,000 and $60,000 for fiscal 1999, 1998, and 1997, respectively, and
are included in other expense.
PRODUCT WARRANTY COSTS
The length of the Company's warranty on end user sales of medical devices is
generally one year on parts and labor. Distributor sales generally include a
parts warranty only. Estimated future costs for initial product warranties are
provided for at the time of sale.
F-8
EARNINGS (LOSS) PER SHARE
FOR THE YEARS ENDED
-----------------------------------
(numbers in thousands, except
per share amounts) JULY 3, JUNE 27, JUNE 28,
1999 1998 1997
------- -------- --------
NUMERATOR
Net income (loss) $ 7,491 $ (4,452) $ 238
-------- --------- --------
-------- --------- --------
DENOMINATOR
BASIC EARNINGS PER SHARE
Weighted average shares outstanding 5,500 5,479 5,398
-------- --------- --------
Basic earnings (loss) per share $ 1.36 $ (0.81) $ 0.04
-------- --------- --------
-------- --------- --------
DILUTED EARNINGS PER SHARE
Weighted average shares outstanding 5,500 5,479 5,398
Effect of dilutive warrants 211 0 0
Effect of dilutive options 408 0 275
-------- --------- --------
Adjusted weighted average shares
outstanding 6,119 5,479 5,673
-------- --------- --------
Diluted earnings (loss) per share $ 1.22 $ (0.81) $ 0.04
-------- --------- --------
-------- --------- --------
During the years ended July 3, 1999, June 27, 1998, and June 28, 1997, options
and warrants to purchase 4,589, 202,914 and 65,297 shares of common stock,
respectively, were not included in the computation of diluted earnings(loss) per
share because they would have had an anti-dilutive effect.
DIVIDENDS
The Company currently intends to retain future earnings for use in its business
and, therefore, does not expect to pay dividends in the foreseeable future.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The company has elected the disclosure-only alternative permitted under SFAS
123, "Accounting for Stock-Based Compensation" ("SFAS 123"). The Company has
disclosed herein pro forma net income and pro forma earnings per share in the
footnotes using the fair value based method for fiscal 1999, 1998, and 1997.
NEW ACCOUNTING PRONOUNCEMENTS
Effective June 28, 1998, The Company adopted SFAS 130, "Reporting Comprehensive
Income", which establishes standards for reporting and displaying comprehensive
income and its components in a set of financial statements. Components of
comprehensive income are net income and all other non-owner changes in equity
such as the change in the cumulative translation adjustment. The Company
presents such information in its statement of operations.
In fiscal 1999, the Company adopted SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS 131 supersedes SFAS 14, "Financial
Reporting for Segments of a Business Enterprise", and replaces the "industry
segment" approach with "management" approach. The management approach designates
the internal organization that is used by management for making operating
decisions and assessing performance as the source of the Company's reportable
segments. SFAS 131 also requires disclosures about products and services,
geographic areas, and major customers. The adoption of SFAS 131 did not affect
F-9
results of operations or financial position, but did affect the disclosure of
segment information. (See note 8)
In June 1999, the FASB issued Statement of Financial Accounting Standard No. 137
("SFAS 137"), "Accounting for Derivative Instruments and Hedging Activities -
Deferral of the Effective Date of FAS Statement 133," which postponed the
adoption date of SFAS No. 133. As such, the Company is not required to adopt the
statement until fiscal 2001. Had the Company implemented SFAS 133 for the
current reporting period, there would have been no material effect on
operational results.
UNCERTAINTIES
The Company is subject to risks common to companies in the aesthetic laser
industry, including (i) the Company's ability to successfully complete
preclinical and clinical development and obtain timely regulatory approval and
adequate patent and other proprietary rights protection of its products and
services, (ii) the content and timing of decisions made by the FDA and other
agencies regarding the procedures for which the Company's products may be
approved, (iii) the ability of the Company to manufacture adequate supplies of
its products for development and commercialization activities, (iv) the accuracy
of the Company's estimates of the size and characteristics of markets to be
addressed by the Company's products and services, (v) market acceptance of the
Company's product and services, (vi) the Company's ability to obtain
reimbursement for its products from third-party payers, where appropriate, and
(vii) the accuracy of the Company's information concerning the products and
resources of competitors and potential competitors.
2. INVENTORIES
Inventories consist of the following (in thousands):
July 3, June 27,
1999 1998
---- ----
Raw materials $1,643 $3,110
Work in process 1,395 1,062
Finished goods 3,889 3,069
------ ------
$6,927 $7,241
------ ------
------ ------
3. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
July 3, June 27,
1999 1998
---- ----
Leasehold improvements $2,173 $2,033
Office furniture 791 819
Laser systems 482 483
Computers and other equipment 4,265 4,544
------ ------
7,711 7,879
Less accumulated depreciation and amortization 5,085 4,759
------ ------
Property and equipment, net $2,626 $3,120
------ ------
------ ------
Depreciation expense was approximately $751,000, $684,000, and $616,000 for
fiscal 1999, 1998, and 1997, respectively.
F-10
Assets under capital lease obligations of $487,000 and $1,648,000 are included
in property and equipment at July 3, 1999 and June 27, 1998, respectively.
Accumulated depreciation on these assets was $413,000 and $818,000 at July 3,
1999 and June 27, 1998, respectively.
4. DEFERRED INCOME
Deferred income consists of the following (in thousands):
July 3, June 27,
1999 1998
---- ----
Service contract revenue $ 941 $1,026
Gift certificate revenue 510 343
Other deferred sales revenue 462 394
------ ------
$1,913 $1,763
------ ------
------ ------
5. DEBT AND LEASE OBLIGATIONS
DEBT
On October 15, 1998, the Company issued eight-year, 9.75%, subordinated term
notes to three investors in the aggregate amount of $3.7 million. The notes
become due in October, 2006, and require quarterly interest payments. In
addition, the Company issued warrants to purchase 370,000 shares of common
stock to the note holders which have an exercise price of $4.00 per share and
are exercisable through October, 2006. The relative fair value ascribed to
the warrants of $836,000 (measured as of the date of issuance) was estimated
using a Black-Scholes model assuming a 4.5% risk free rate of return, and
eight-year life of the warrant, a 72% volatility factor for an eight-year
period and no dividend rate. The relative fair value of the warrants has been
recorded as a component of Additional Paid-In Capital. The relative fair
value of the debt was recorded as $2,864,000. In addition to the 9.75% stated
interest rate, interest expense of an additional $836,000 will be accreted to
debt using the interest method over the eight-year life of the debt to bring
the value of that debt to its $3.7 million face value. The Company is
required to make mandatory quarterly principle payments of $185,000, along
with any unpaid interest, beginning on January 31, 2002. The Note Agreement
also contains clauses that prohibit the Company from redeeming the notes
earlier than November 1, 2001, except in certain circumstances. The Company
is also subject to an early redemption premium amounting to 10% if paid in the
first year following November 1, 2001. This premium decreases by 2% per year
for the next two years following November 1, 2001 and allows for the Company
to redeem the notes without penalty after November 1, 2004.
On October 22, 1998, $2.7 million of the note proceeds was used to retire the
full amount then outstanding on the Company's line of credit. In December 1998,
this line of credit was renewed to expire on December 1, 1999, bearing interest
at the bank's prime lending rate and collateralized by domestic accounts
receivable, inventories, and a pledge of subsidiary stock. At July 3, 1999,
there were no borrowings outstanding on this line of credit and no amounts were
drawn from the line during the period.
F-11
LINE OF CREDIT
The Company also maintains a renewable $3,500,000 revolving 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. The line of credit is
collateralized by all tangible and intangible assets, international accounts
receivable covered by credit insurance, and the pledge of stock of CSCC. The
agreement contains restrictive covenants establishing maximum leverage, certain
minimum ratios, and minimum levels of net income. No amounts were outstanding
under the line of credit as of July 3, 1999.
SHORT-TERM DEBT
In June 1998, the Company obtained a term bank loan denominated in 50,000,000
Japanese Yen($355,467), collateralized by a customer note receivable, bearing
interest at 1.825% per annum with payment of interest in advance. The amount due
at June 27, 1998, was $352,000, converted at the year-end exchange rate. The
principal became due and was paid in August 1998.
LONG-TERM DEBT
The Company's long-term debt consists of the following (dollars in thousands):
JULY 3, JUNE 27,
1999 1998
-------- --------
Unsecured term bank loan denominated in 75,000,000 Japanese yen; interest
at 1.745% per annum; quarterly payments of principal and interest through
September 1999 69 294
Obligations under capital leases with options to purchase equipment;
interest from 5.8% to 12.31% per annum; payments of principal and
interest through March 2001 598 1,190
Subordinated notes, eight-year term, 9.75% interest rate, quarterly
interest payments due through December 31, 2006 2,929 0
------ -----
3,596 1,484
Less current portion 415 597
------ -----
Total long-term debt $3,181 $ 887
------ -----
------ -----
LEASE COMMITMENTS
The Company leases several facilities and automobiles under noncancellable lease
arrangements. The facility leases may be adjusted for increases in maintenance
and insurance costs above specified levels. In addition, certain facility leases
contain escalation provisions based on certain specified criteria, and one lease
calls for the payment of additional rent based on a percentage of gross revenues
above a base gross sales level for that particular location. These operating
leases expire in various years through 2009. These leases may be renewed for
periods ranging from one to five years.
Future minimum lease payments under noncancellable operating leases with initial
terms of one year or more consisted of the following at July 3, 1999:
F-12
(in thousands) 2000 $ 686
2001 668
2002 587
2003 412
2004 210
Thereafter 688
------
Total minimum 1ease payments $3,251
------
------
Total rent expense was approximately $769,000, $848,000, and $772,000 for fiscal
1999, 1998, and 1997, respectively.
The Company had additions to capital lease obligations of approximately $42,000,
$84,000, and $1,240,000 in fiscal 1999, 1998, and 1997 respectively, for the
acquisition of certain equipment. These obligations are collateralized by the
related equipment.
Cash paid for interest, including interest on capital lease obligations, totaled
approximately $366,000, $235,000, and $107,000 for fiscal 1999, 1998, and 1997,
respectively.
As of July 3, 1999, the Company's approximate minimum payment requirements under
debt and capital lease obligations are as follows (in thousands):
Fiscal
------
2000 776
2001 634
2002 751
2003 1,038
2004 965
Thereafter 2,098
------
Total minimum payments 6,262
Less interest 1,896
------
Present value of minimum payments 4,366
Less current portion 415
------
Long-term obligations $3,951
-------
-------
6. STOCKHOLDERS' EQUITY
STOCK PLANS
1985, 1987, 1989 AND 1998 CANDELA CORPORATION STOCK OPTION PLANS
The 1985, 1987, 1989 and 1998 Stock Option Plans (the "Plans") provide for the
granting of incentive stock options to employees for the purchase of common
stock at an exercise price not less than the fair market value of the stock on
the date of grant. The 1987, 1989 and 1998 Stock Option Plans also provide for
the granting of non-qualified stock options.
Options granted under the 1985, 1987 and 1989 Stock Option Plans generally
become exercisable ratably over two or four years from the date of grant and
expire ten years from the date of the grant. The maximum number of shares for
which options may be granted under the 1989 Plan is 1,000,000 shares. The
Board of Directors terminated the granting of options under the 1985 and
F-13
1987 plans. On April 28, 1998, the Board of Directors approved the repricing
of certain outstanding stock options priced at $8.75 and $8.125. The exercise
price of these options was amended to $3.25, the fair market value of the
stock on that date.
Options granted under the 1998 Stock Option Plan become exercisable on the date
of grant or in installments, as specified by a Committee established by the
Board of Directors, and expire ten years from the date of the grant. The maximum
number of shares for which options may be granted under the 1998 Plan is 500,000
shares.
1996 CANDELA SKIN CARE CENTER INC. STOCK OPTION PLAN
During fiscal year 1996, CSCC adopted the 1996 Incentive and Non-Statutory Stock
Option Plan under which options may be granted enabling the purchase, at a price
not less than the fair market value, of the common stock on the date of grant
for incentive stock options and at a price of not less than the par value of the
common stock for non-qualified stock options. Options granted under this plan
become exercisable at different rates over one to four years from the date of
grant and expire ten years from the date of grant. All such options were issued
with an exercise price equal to the fair market value of the subsidiary's common
stock on the date of grant. During fiscal year 1998, the Board of Directors of
Candela Corporation approved the conversion of all outstanding CSCC stock
options to Candela Corporation stock options. CSCC options were converted at the
rate of 0.21053 Candela Corporation options for each CSCC option. At the time of
the conversion, there were options for 193,000 shares outstanding which
converted to options for 40,634 Candela Corporation shares at $4.75 per share,
the fair market value of Candela Corporation stock on the date of the
conversion. As of July 3, 1999, and June 27, 1998, there were no options to
purchase shares of the subsidiary's common stock outstanding compared to 188,000
at June 28, 1997.
1990 AND 1993 CANDELA CORPORATION NON-EMPLOYEE DIRECTOR STOCK OPTION PLANS
The 1990 and 1993 Non-Employee Director Stock Option Plans provide for the
issuance of options for the purchase of up to 60,000 and 80,000 shares of common
stock, respectively. Under these plans, each director who is neither an employee
nor an officer receives a one-time grant of an option to purchase 10,000 shares
of common stock at an exercise price equal to the fair market value of the
common stock on the date of grant. Under the 1990 and 1993 Plans, options become
exercisable in equal amounts over a period of four and two years, respectively.
Shares under these Plans expire four and ten years, respectively, after the date
of grant and are nontransferable.
The following is a summary of stock option activity under these Plans:
F-14
WEIGHTED AVERAGE
NUMBER OF EXERCISE PRICE
SHARES OPTION PRICE PER SHARE
------ ------------ ---------
Balance at June 29, 1996 658,103 $ 4.1300
Granted 296,500 $4.88 -$8.63 $ 6.9343
Exercised (22,591) $2.00 -$7.25 $ 3.0484
Canceled (70,755) $2.00 -$9.875 $ 6.8645
--------
Balance at June 28, 1997 861,257 $ 4.8800
Granted 243,867 $3.25 -$4.75 $ 4.1028
Exercised (43,891) $2.75 -$3.375 $ 3.1202
Canceled (269,973) $2.75 -$9.875 $ 7.0516
---------
Balance at June 27, 1998 791,260 $ 3.7200
Granted 381,000 $3.438 -$8.438 $ 5.4799
Exercised (63,293) $2.000 -$7.500 $ 3.6528
Canceled (126,562) $3.1875-$7.750 $ 4.1965
---------
Balance at July 3, 1999 982,405 $ 4.5705
---------
---------
Options available for grant at July 3,1999 408,000
--------
--------
The following table summarizes information about stock options under the Option
Plans outstanding at July 3, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------------------------------- -------------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
RANGE OF NUMBER REMAINING AVERAGE NUMBER AVERAGE
EXERCISE OUTSTANDING AT CONTRACTUAL EXERCISE AS OF EXERCISE
PRICES JULY 3, 1999 LIFE (YEARS) PRICE JULY 3, 1999 PRICE
-------- --------------- ----------------- -------- ------------ -----------
$1.50 -$ 3.1875 204,939 4.36 $ 2.8154 204,939 $ 2.8154
$3.25 -$ 3.4375 199,175 5.75 $ 3.3230 163,050 $ 3.3341
$3.4375-$ 4.6880 226,625 8.78 $ 4.0039 58,500 $ 4.2871
$4.7500-$ 7.0000 286,416 8.62 $ 6.3160 146,770 $ 5.8039
$7.5000-$14.5000 65,250 8.16 $ 8.1832 11,750 $ 8.3936
------- -------
$1.50 -$14.5000 982,405 7.16 $ 4.5705 585,009 $ 3.9690
------- -------
------- -------
The Company applies Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees", and related interpretations in accounting for
its option plans. Accordingly, no compensation expense has been recognized
for options granted to employees and directors of the Company. Had compensation
expense for the Company's stock option plans and employee stock purchase plan
been determined based on the fair value at the grant date for awards under these
plans consistent with the methodology prescribed under SFAS No. 123, the
Company's net income and net income per share would have been reduced by
$479,000, or $.08 per share in 1999, $45,000.00 or $.01 per share in 1998, and
$416,000 or $.08 per share in 1997. The weighted average fair value of the
options granted under the stock option plans 1999, 1998 and 1997, calculated
using the Black-Scholes pricing model, was $3.24, $2.49 and $4.93 per share,
respectively. The weighted average fair value of shares issued under the
employee stock purchase plan for 1999, calculated using the Black-
F-15
Scholes pricing model, was $1.38 per share for 1999. The following assumptions
were used in the Black-Scholes pricing model for options granted in 1999, 1998,
and 1997, respectively:
1999 1998 1997
--------- ------- --------
risk-free interest rate 4.84% 5.95% 5.93%
estimated volatility 77% 83% 85%
an expected life for stock options 3.8 years 6 years 6 years
an expected life for stock purchase plan 6 months 6months 6 months
expected dividends none none none
The effects of applying SFAS No. 123 in this pro-forma disclosure are not
indicative of the pro-forma effect on net income in future years because SFAS
No. 123 does not take into consideration pro-forma expenses related to options
granted prior to 1996.
1990 CANDELA CORPORATION EMPLOYEE STOCK PURCHASE PLAN
The 1990 Employee Stock Purchase Plan provides for the sale of up to 500,000
shares of common stock to eligible employees. The shares are issuable at the
lesser of 85% of the average market price on the first or last day of semiannual
periods. Substantially all full-time employees are eligible to participate in
the plan.
The following is a summary of shares issued under this plan:
RANGE OF
SHARES PRICE PER SHARE
------ ---------------
1997 11,483 $5.00
1998 15,216 $2.50 - $3.75
1999 21,201 $2.50 - $5.00
RESERVED SHARES
The Company has reserved 2,783,051 shares of common stock for issuance under its
stock plans.
CANDELA CORPORATION COMMON STOCK WARRANTS
In connection with a litigation settlement in January 1991, the Company
authorized warrants to purchase 300,000 shares of common stock in March 1992.
The exercise price for the warrants is $6.875 per share, the fair market value
of the Company's common stock on the date of the settlement. These warrants will
expire in November 2000. There were 282,182 warrants issued in December 1992. A
total of 1,683 warrants have been exercised; 1,484 in fiscal 1999 and 199 in
fiscal 1997. No warrants were exercised during fiscal 1998. There were 280,499
warrants outstanding at July 3, 1999. (See also Note 5)
The Company also issued warrants to purchase 370,000 shares of common stock to
the note holders of the Company's $3.7 million debt issuance in October, 1998.
The warrants have an exercise price of $4.00 per share and are exercisable
through October, 2006. The relative fair value ascribed to the warrants of
$836,000 (measured as of the date of issuance) was estimated using a
Black-Scholes model assuming a 4.5% risk free rate of return, and eight-year
life of the warrant, a 72% volatility factor for an eight-year period and no
dividend rate. No warrants were exercised during fiscal 1999.
F-16
CANDELA CORPORATION STOCKHOLDER RIGHTS PLAN
On September 4, 1992, the Company adopted a Stockholder Rights Plan under which
it declared a dividend of one common stock purchase Right for each share of the
Company's common stock outstanding on September 22, 1992. The Rights are not
currently exercisable, but would become exercisable if certain triggering events
occur, such as the initiation of certain tender offers for the Company's common
stock. If such an event occurs, each Right would initially entitle shareholders
to purchase one share of the Company's common stock at an exercise price of $48
per share, subject to adjustment. In the event that the Rights are exercised
after further triggering events, each Right would entitle holders to purchase,
for the exercise price then in effect, shares of the Company's common stock (or
other property, under certain circumstances) having a value of twice the
exercise price.
Such Rights do not extend to any shareholders whose action triggered the Rights.
The Company can in certain circumstances redeem the Rights at $.005 per Right.
The Rights expire on September 22, 2002, unless redeemed earlier by the Company.
7. INCOME TAXES
The components of income before income taxes and the related provision for
income taxes consists of the following periods (in thousands):
FOR YEARS ENDED
------------------------------------------
JULY 3, JUNE 27, JUNE 28,
1999 1998 1997
---------- ---------- ---------
Income (loss) before income taxes:
Domestic $ 8,063 $(4,686) $ (46)
Foreign 1,793 409 684
------- -------- --------
$ 9,856 $(4,277) $ 638
------- -------- --------
------- -------- --------
Provision for income taxes:
Current provision:
Federal $ 1,890 $ - $ -
State 635 26 19
Foreign 940 149 381
---------- ---------- ---------
Total current provision for income taxes $ 3,465 $ 175 $ 400
Deferred provision:
Federal (1,100) - -
------- -------- --------
Total provision for income taxes 2,365 175 400
------- -------- --------
------- -------- --------
F-17
The components of the Company's deferred tax assets consist of the
following at July 3, 1999 and June 27, 1998 (in thousands):
FOR YEARS ENDED
---------------------------
JULY 3, JUNE 27,
1999 1998
-------- --------
Federal and state net operating loss carryforwards $ 108 $ 607
Federal and state tax credit carryforwards 315 1,816
Inventory valuation reserves 1,022 787
Warranty reserve 1,001 771
Deferred revenue 368 352
Intercompany profit - 265
Bad debt reserve 360 393
Restructuring reserve 608 798
Pre-opening expense 260 349
Other 172 89
------ ------
Gross deferred tax asset 4,214 6,227
Valuation allowance (3,114) (6,227)
------ ------
Net deferred tax assets $1,100 $ 0
------ ------
------ ------
A reconciliation from the federal statutory tax rate to the effective tax
rate is as follows:
FOR YEARS ENDED
------------------------------------------
JULY 3, JUNE 27, JUNE 28,
1999 1998 1997
------- -------- --------
Statutory rate 34% 34% 34%
State taxes 4 -- 3
Differences between foreign and
U.S. tax rates 3 -- 21
Utilization of deferred tax assets (14) -- --
Unbenefitted losses (6) (35) (2)
Other 3 (3) 7
------- -------- --------
Effective tax rate 24% (4)% 63%
------- -------- --------
------- -------- --------
Income taxes paid were $615,000, $356,000, and $492,000 in fiscal 1999, 1998,
and 1997, respectively.
As of June 27, 1998 the Company had approximately $6.2 million of valuation
allowance relating to a deferred tax asset resulting principally from U.S.
tax losses, investment tax credits, and timing differences relating to U.S.
assets and liabilities. Income tax expense for the year ended July 3, 1999,
has been reduced by approximately $3.1 million through a reduction in the
valuation allowance. As of July 3, 1999, the Company has valuation allowances
of approximately $3.1 million of the deferred tax asset resulting principally
from timing differences relating to U.S. assets and liabilities. Income tax
expense for the year ended July 3, 1999, has been reduced by approximately
$3.1 million through a reduction in the valuation allowance. In accounting
for the deferred tax asset, the Company has relied on historic data to
determine the necessity of providing a valuation allowance for this asset.
The historic information available for the periods reflected in the balance
sheets herein indicated that a partial reserve is required based principally
on the historic volatility of earnings.
Accordingly, at July 3, 1999, based upon the history of US tax losses,
volatility of historical earnings, and an inability to project future taxable
income from U.S. operations, under the requirements of Statements of
Financial Accounting Standard ("SFAS") No. 109, "Accounting for Income
Taxes," Candela believed it more likely than not that the deferred tax asset
would be partially utilized.
F-18
8. SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION
The Company operates 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/health spa industry.
GEOGRAPHIC DATA
Geographic information for fiscal 1999, 1998, and 1997 is as follows (in
thousands):
1999 1998 1997
---- ---- ----
Revenue:
United States $ 39,403 $ 24,943 $ 25,185
Intercompany 14,374 8,342 6,303
--------- --------- ---------
53,777 33,285 31,488
Europe 6,059 3,333 818
Japan 13,126 8,749 9,502
--------- --------- ---------
72,962 45,367 41,808
Elimination (14,374) (8,342) (6,303)
--------- --------- ---------
Consolidated total $ 58,588 $ 37,025 $ 35,505
--------- --------- ---------
--------- --------- ---------
Operating income(loss):
United States $ 9,381 $ (4,315) $ (12)
Europe 404 364 86
Japan 1,411 174 616
Elimination (960) (184) (3)
--------- --------- ---------
Consolidated total $ 10,236 $ (3,961) $ 687
--------- --------- ---------
--------- --------- ---------
Geographic identification of assets:
United States $ 43,706 $ 28,911 $ 27,139
Europe 3,781 2,575 852
Japan 9,961 4,372 5,901
Elimination (20,997) (13,254) (9,055)
--------- --------- ---------
Consolidated total $ 36,451 $ 22,604 $ 24,837
--------- --------- ---------
--------- --------- ---------
LINE OF BUSINESS DATA
Revenue:
Product sales and service $ 55,509 $ 34,322 $ 33,261
Skin care/health spa services 3,079 2,703 2,244
--------- --------- ---------
Total Revenue $ 58,588 $ 37,025 $ 35,505
--------- --------- ---------
--------- --------- ---------
Operating income(loss):
Product sales and service $ 11,321 $ 1,550 $ 4,073
Skin care/health spa services (1,085) (5,511) (3,386)
--------- --------- ---------
Total operating income(loss) $ 10,236 $ (3,961) $ 687
--------- --------- ---------
--------- --------- ---------
Depreciation and Amortization:
Product sales and service $ 520 $ 308 $ 281
Skin care/health spa services 221 507 385
--------- --------- ---------
Total Depreciation and Amortization $ 741 $ 815 $ 666
--------- --------- ---------
--------- --------- ---------
Capital Expenditures:
Product sales and service $ 566 $ 241 $ 243
Skin care/health spa services 0 160 1,624
--------- --------- ---------
Total Capital Expenditures $ 566 $ 401 $ 1,867
--------- --------- ---------
--------- --------- ---------
Total Assets: (net of intercompany accounts)
Product sales and service $ 34,250 $ 19,455 $ 20,661
Skin care/health spa services 2,201 3,149 4,176
--------- --------- ---------
Total Assets $ 36,451 $ 22,604 $ 24,837
--------- --------- ---------
--------- --------- ---------
F-19
United States revenue includes export sales to unaffiliated companies located
principally in Western Europe, the Middle East, and in the Asia-Pacific
region, which approximated $11,218,000, $7,695,000, and $8,188,000 for fiscal
1999, 1998, and 1997, respectively. Three customers accounted individually
for more than 5% of total gross receivables at July 3, 1999. Two of the
customers were foreign distributors who accounted for 7.8% and 9.6% of gross
receivables at July 3, 1999, in comparison to 3.6% and 11.7% of total gross
receivables at June 27, 1998. One US distributor accounted for 16.6% of gross
receivables at July 3, 1999. This distributor had no outstanding receivables
at June 27, 1998.
9. EMPLOYEE BENEFIT PLANS
The Company offers a savings plan which allows eligible U.S. employees to make
tax-deferred contributions, a portion of which are matched by the Company.
Company contributions vest ratably with three years of employment and amounted
to $102,000, $58,000, and $84,000 in fiscal 1999, 1998, and 1997, respectively.
10. RESTRUCTURING COSTS AND OTHER CHARGES
During the second quarter ended December 27, 1997, the Company recorded a
restructuring charge against income in the amount of $2,609,000. This
charge represents the anticipated costs associated with closing the
Scottsdale, Arizona, LaserSpa(TM), including costs of maintaining the
facility, reserve for leasehold improvements and fixed assets (carrying
value before reserve of $1,123,000), and a reserve against loss upon
liquidation of the equipment at the site. Charges against the reserve for
the years ended July 3, 1999 and June 27, 1998 total $476,000 and $614,000,
respectively, leaving a reserve balance of $1,519,000 at July 3, 1999.
LEASEHOLD
IMPROVEMENTS
PAYROLL AND AND FIXED FACILITY CAPITALIZED
SEVERANCE ASSETS COSTS START UP COSTS TOTAL
----------- ------------ --------- --------------- ---------
BalancKe at December 27, 1997 $ 419 $ 1,123 $ 887 $ 180 $ 2,609
Cash Charges (134) - (161) - (295)
Non-Cash Charges - (139) - (180) (319)
-------- -------- ------- -------- --------
Balance at June 27, 1998 285 984 726 - 1,995
Cash Charges (75) - (214) - (289)
Non-Cash Charges - (187) - - (187)
-------- -------- ------- -------- --------
Balance at July 3, 1999 210 797 512 - 1,519
-------- -------- ------- -------- --------
-------- -------- ------- -------- --------
As of July 3, 1999, the payroll and severance costs will be paid through
December 2003 and the facility lease expires in 2006.
11. 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 is seeking 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
F-20
infringed by the plaintiff's technology. The complaint also includes various
tort claims against us and contract-related claims against the Regents and
Beckman. The complaint asserts that we interfered with the licensing of the
dynamic cooling technology to the plaintiffs. The complaint seeks 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. The Company intends to defend this
matter vigorously and have filed a motion to dismiss the case on
jurisdictional grounds. In August 1999, the Court granted our motion and
dismissed the patent claims, but gave the plaintiffs additional time to amend
their complaint. 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 not valid or enforceable, our rights to the DCD technology would
no longer be exclusive. This outcome could adversely 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.
From time to time, the Company is a party to various legal proceedings
incidental to our business. The Company believes that none of the other
presently pending legal proceedings will have a material adverse effect upon our
financial position, results of operations, or liquidity.
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
QUARTER
1999 FIRST SECOND THIRD FOURTH
------------------------------------------------------------------------------
Revenues $ 10,738 $ 13,299 $ 15,844 $ 18,707
Gross Profit 5,064 6,800 9,024 11,237
Net Income(Loss) 910 1,393 1,907 3,281
Earnings(Loss) per common share
Basic $ 0.17 $ 0.25 $ 0.35 $ 0.59
Diluted $ 0.16 $ 0.24 $ 0.31 $ 0.50
QUARTER
1998 FIRST SECOND THIRD FOURTH
------------------------------------------------------------------------------
Revenues $ 7,822 $ 8,522 $ 8,617 $ 12,063
Gross Profit 3,320 3,698 3,843 5,455
Restructuring charge - 2,609 - -
Net Income(Loss) (851) (4,441) (194) 1,034
Earnings(Loss) per common share
Basic $ (0.16) $ (0.82) $ (0.04) $ 0.19
Diluted $ (0.16) $ (0.82) $ (0.04) $ 0.18
F-21
SCHEDULE II
CANDELA CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED JULY 3, 1999, JUNE 27, 1998, AND JUNE 28, 1997
COLUMN A COLUMN B COLUMN C COLUMN D
Balance at Additions Deductions Balance at
Beginning Charged to from End of
Description of Period Income Reserves Period
-------------------------------------------------------------------------------------------------------------------
Reserves deducted from assets to which they apply (in thousands):
Allowance for doubtful accounts:
Year ended July 3, 1999 $1,038 $ 268 $308 $ 998
------ ------ ---- ------
------ ------ ---- ------
Year ended June 27, 1998 $ 197 $ 866 $ 25 $1,038
------ ------ ---- ------
------ ------ ---- ------
Year ended June 28, 1997 $ 305 $ 42 $150 $ 197
------ ------ ---- ------
------ ------ ---- ------
Restructuring reserve:
Year ended July 3, 1999 $1,995 $ 0 $476 $1,519
------ ------ ---- ------
------ ------ ---- ------
Year ended June 27, 1998 $ 0 $2,609 $614 $1,995
------ ------ ---- ------
------ ------ ---- ------
F-22
EXHIBIT INDEX
Page
----
21 Subsidiaries of the Company 40
23 Consent of PricewaterhouseCoopers LLP,
Independent Accountants 41