UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT -TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____ TO ____
COMMISSION FILE NUMBER 000-32045
DIOMED HOLDINGS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 84-1480636
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
1 DUNDEE PARK
ANDOVER, MA 01810
(Address of principal executive offices) (Zip Code)
(978) 475-7771
(Registrant's telephone number)
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED
TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING
THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS
REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING
REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO __
AS OF NOVEMBER 11, 2005, THERE WERE 19,423,728 SHARES OF COMMON STOCK, PAR VALUE
$0.001, OUTSTANDING.
DIOMED HOLDINGS, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-QSB
FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2005
TABLE OF CONTENTS
Page
Item Number Number
- ----------- ------
Part I - Financial Information
1 Condensed Consolidated Balance Sheets - F-1
September 30, 2005 (unaudited) and December 31, 2004
Unaudited Condensed Consolidated Statements of Operations - F-2
Three Months and Nine Months Ended September 30, 2005 and 2004
Unaudited Consolidated Statements of Cash Flows - F-3
Nine Months Ended September 30, 2005 and 2004
Notes to Consolidated Financial Statements (unaudited) F-4
2 Management's Discussion and Analysis of Operations 1
3 Controls and Procedures 11
Part II - Other Information 11
1 Legal Proceedings 11
2 Unregistered Sales of Equity Securities and Use of Proceeds 12
6 Reports on Form 8-K 13
Signatures 14
Diomed Holdings, Inc.
Condensed Consolidated Balance Sheets
As of September 30, 2005 (unaudited) and December 31, 2004
Assets September 30, 2005 December 31, 2004
------------------ -----------------
Current assets:
Cash and cash equivalents $14,800,507 $14,436,053
Short term investments 1,768,908 --
Accounts receivable, net 2,667,086 2,074,393
Inventories 3,102,225 2,204,385
Note Receivable 500,000 --
Prepaid expenses and other current assets 543,548 348,586
----------- -----------
Total current assets 23,382,274 19,063,417
Property, plant and equipment, net 1,032,307 901,569
Intangible assets, net 4,428,938 4,482,091
Other assets 319,053 896,320
----------- -----------
Total assets $29,162,572 $25,343,397
=========== ===========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 3,809,985 $ 2,092,562
Accrued expenses and other 2,216,109 1,894,908
Bank line of credit 193,329 --
Current portion of deferred revenue 228,030 148,402
EVLT(R) technology payable ($500,000 face value, net
of $14,610 debt discount at September 30, 2005 and
$1,000,000 face value, net of $66,733 debt discount at
December 31, 2004 485,390 933,267
Warrant liability 1,861,328 --
----------- -----------
Total current liabilities 8,794,171 5,069,139
----------- -----------
Deferred revenue, net of current portion, and other 162,680 211,347
Convertible debt ($3,712,000 face value, net of
$1,177,803 debt discount at September 30, 2005
and $7,000,000 face value, net of $2,183,151 debt
discount at December 31, 2004) 2,534,197 4,816,849
EVLT(R) technology payable ( $250,000 face value,
net of $4,902 debt discount at December 31, 2004),
net of current portion -- 245,098
----------- -----------
2,696,877 5,273,294
Total liabilities 11,491,048 10,342,433
----------- -----------
Convertible preferred stock, par value $0.001,
20,000,000 shares authorized, 4,000,000 shares
issued and outstanding 7,755,000 --
----------- -----------
Stockholders' equity 9,916,524 15,000,964
----------- -----------
Total liabilities and stockholders' equity $29,162,572 $25,343,397
=========== ===========
The accompanying notes are an integral part of these
consolidated financial statements.
F-1
Diomed Holdings, Inc.
Unaudited Condensed Consolidated Statements of Operations
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2004 2005 2004
------------ ------------ ------------ ------------
Revenues $ 4,582,840 $ 3,276,464 $ 13,488,120 $ 9,408,769
Cost of revenues 2,511,536 1,959,384 7,325,127 5,822,032
------------ ------------ ------------ ------------
Gross profit 2,071,304 1,317,080 6,162,993 3,586,737
------------ ------------ ------------ ------------
Operating expenses:
Research and development 403,498 453,578 1,150,712 1,123,181
Selling and marketing 2,080,723 1,708,391 6,693,660 4,865,889
General and administrative 1,811,921 1,712,727 5,475,535 4,521,375
------------ ------------ ------------ ------------
Total operating expenses 4,296,142 3,874,696 13,319,907 10,510,445
------------ ------------ ------------ ------------
Loss from operations (2,224,838) (2,557,616) (7,156,914) (6,923,708)
------------ ------------ ------------ ------------
Interest expense, non-cash 98,904 -- 1,502,760 --
Interest expense, net, cash-based 35,405 15,433 187,773 37,194
------------ ------------ ------------ ------------
Total interest expense 134,309 15,433 1,690,533 37,194
------------ ------------ ------------ ------------
Net loss $ (2,359,147) $ (2,573,049) $ (8,847,447) $ (6,960,902)
============ ============ ============ ============
Less: Preferred stock dividends (762,656) -- (762,656) --
------------ ------------ ------------ ------------
Net loss applicable to common
stockholders $ (3,121,803) $ (2,573,049) $ (9,610,103) $ (6,960,902)
============ ============ ============ ============
Basic and diluted net loss per share $ (0.16) $ (0.18) $ (0.50) $ (0.50)
============ ============ ============ ============
Basic and diluted weighted average
common shares outstanding 19,423,728 14,606,422 19,143,276 14,041,892
============ ============ ============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
DIOMED HOLDINGS, INC.
Unaudited Consolidated Statements of Cash Flows
Nine Months Ended September 30,
2005 2004
------------ ------------
Cash flows from operating activities:
Net loss $ (8,847,447) $ (6,960,902)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 688,545 712,989
Amortization of EVLT(R) discount 57,025 85,529
Fair value of stock options for services 35,440 62,231
Non-cash interest expense 1,502,760 --
Changes in operating assets and liabilities:
Accounts receivable (592,694) (690,865)
Inventories (897,840) (404,224)
Prepaid expenses and other current assets (194,963) (277,211)
Deposits 175,277 (206,567)
Accounts payable 952,423 1,037,844
Accrued expenses and deferred revenue 392,330 (240,780)
------------ ------------
Net cash used in operating activities (6,729,144) (6,881,956)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (406,048) (331,349)
Note receivable - Luminetx (500,000) --
Purchase of short term investments (1,749,323) --
------------ ------------
Net cash used in investing activities (2,655,371) (331,349)
------------ ------------
Cash flows from financing activities:
Payments on promissory notes -- (936,000)
Net proceeds/(payments) on bank borrowings 193,329 (261,676)
Payments on EVLT(R) purchase obligation (750,000) (750,000)
Proceeds from the exercise of warrants 404,903 --
Net proceeds from equity financing -- 2,723,620
Proceeds from preferred stock financing 10,000,000 --
Payments on capital lease obligations (40,168) (33,378)
------------ ------------
Net cash provided by financing activities 9,808,064 742,566
------------ ------------
Effect of exchange rate changes (59,095) (102,775)
------------ ------------
Net increase (decrease) in cash and cash equivalents 364,454 (6,573,514)
Cash and cash equivalents, beginning of period 14,436,053 13,398,075
------------ ------------
Cash and cash equivalents, end of period $ 14,800,507 $ 6,824,561
============ ============
Supplemental disclosure of cash flow information:
Cash paid for interest $ 228,647 $ 20,053
============ ============
Fair value of warrants exchanged for distribution rights $ 332,630 $ --
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(1) OPERATIONS
Diomed Holdings, Inc. ("Diomed" or "the Company") develops and commercializes
minimally invasive medical procedures that employ its laser technologies and
associated disposable products. Using its proprietary technology, including its
exclusive rights to U.S. Patent No. 6,398,777, the Company currently focuses on
endovenous laser treatment (EVLT(R)) of varicose veins. The Company also
develops and markets lasers and disposable products for photodynamic therapy
(PDT) cancer procedures and products for other clinical applications, including
dental and general surgical procedures.
In developing and marketing its clinical solutions, the Company uses proprietary
technology and aims to secure strong commercial advantages over competitors by
gaining governmental approvals in advance of others, by developing and offering
innovative practice enhancement programs including physician training and
promotional materials, and by obtaining exclusive commercial arrangements. To
optimize revenues, Diomed focuses on clinical procedures that generate revenues
from both capital equipment and disposable products, such as procedure kits and
optical fibers.
Diomed's high power semiconductor diode lasers combine clinical efficacy,
operational efficiency and cost effectiveness in a versatile, compact,
lightweight, easy-to-use and easy-to-maintain system. Along with lasers and
single-use procedure kits for EVLT(R), the Company provides its customers with
state of the art physician training and practice development support. The
EVLT(R) procedure and the Company's related products were cleared by the United
States FDA in January of 2002.
(2) BASIS OF PRESENTATION
In the opinion of management, these unaudited consolidated financial statements
contain all adjustments considered normal and recurring and necessary for their
fair presentation. Interim results are not necessarily indicative of results to
be expected for the year. These interim financial statements have been prepared
in accordance with the instructions for Form 10-QSB, and therefore, do not
include all information and footnotes necessary for a complete presentation of
operations, financial position, and cash flows of the Company in conformity with
accounting principles generally accepted in the United States. The Company filed
with the Securities and Exchange Commission its 2004 annual report on Form
10-KSB on March 30, 2005, which included audited consolidated financial
statements for the year ended December 31, 2004 and information and footnotes
necessary for such presentation. These unaudited consolidated financial
statements should be read in conjunction with the audited consolidated financial
statements and the notes thereto included in our annual report on Form 10-KSB
for the year ended December 31, 2004.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Our Annual Report on Form 10-KSB for the year ended December 31, 2004 includes a
comprehensive summary of the significant accounting policies and methods used in
the preparation of our consolidated financial statements. The application of
these policies has a significant impact on our reported results. In addition,
the application of some of these policies depends on management's judgment, with
financial reporting results relying on estimations and assumptions about the
effect of matters that are inherently uncertain. For all of these policies,
management cautions that future events rarely develop exactly as forecast and
the best estimates routinely require adjustment.
Short-term Investments
Marketable debt and equity securities with original maturities greater than
three months are classified as short-term investments. Investments designated as
short-term consist of U.S. agency discount notes and corporate bonds, are
classified as available-for-sale, and are reported at fair value using the
specific identification method. Unrealized gains and losses, net of related tax
effects are reflected in other comprehensive income (loss) until realized.
Interest Expense and Other Financing Costs
The Company has issued options and warrants to non-employees from time to time
as payment for services. In all of these cases, the Company applies the
principles of SFAS No. 123 "Accounting for Stock-based Compensation" to value
these awards, which inherently include a number of estimates and assumptions
including stock price volatility factors. In addition to interest expense, the
Company records financing and certain offering costs associated with its capital
raising efforts in its statements of operations. These include amortization of
debt issue costs such as cash, warrants and other securities issued to finders
and placement agents, and amortization of debt discount created by in-the-money
conversion features on convertible debt accounted for in accordance with
Emerging Issues Task Force ("EITF") Issue 98-5, "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios," and Issue 00-27, "Application of Issue 98-5 to Certain
Convertible Instruments," by other securities issued in connection with debt as
a result of allocating the proceeds amongst the securities in accordance with
Accounting Principles Board ("APB") Opinion No. 14, "Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants", based on their relative fair
values. The Company based the estimates and assumptions on the best information
available at the time of valuation, however, changes in these estimates and
assumptions could have a material effect on the valuation of the underlying
instruments.
F-4
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(a) RECLASSIFICATIONS
Certain reclassifications have been made in the prior year consolidated
financial statements to conform to the current year's presentation.
(b) INVENTORIES
Inventories are valued at the lower of cost (first-in, first-out) or market.
Work-in-progress and finished goods consist of materials, labor and
manufacturing overhead. Inventories consist of the following:
September 30, December 31,
2005 2004
---------- ----------
Raw Materials $1,549,171 $ 838,390
Work-in-Process 810,300 502,905
Finished Goods 742,754 863,090
---------- ----------
$3,102,225 $2,204,385
========== ==========
(c) ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for its employee stock-based compensation plans under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees utilizing the intrinsic value method. Accordingly, compensation cost
for stock options issued to employees is measured as the excess, if any, of the
market price over the exercise price of the Company's stock at the date of the
fixed grant. Statement of Financial Accounting Standards ("SFAS") No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS No. 148, establishes
a fair value-based method of accounting for stock-based compensation plans. The
Company has adopted the disclosure-only alternative under SFAS No. 123, with
respect to its employee stock compensation plan, which requires disclosure of
the proforma effects on net loss and loss per share as if SFAS No. 123 had been
adopted as well as certain other information.
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
2005 2004 2005 2004
------------ ------------ ------------ ------------
Net loss applicable to common
stockholders as reported: $ (3,121,803) $ (2,573,049) $ (9,610,103) $ (6,960,902)
Deduct: total stock-based
employee compensation
expense determined under
the fair value-based
method for all awards,
net of tax (426,732) (107,317) (1,255,352) (596,573)
------------ ------------ ------------ ------------
Proforma net loss $ (3,548,535) $ (2,680,366) $(10,865,455) $ (7,557,475)
============ ============ ============ ============
Loss per share:
Basic and diluted - as reported $ (0.16) $ (0.18) $ (0.50) $ (0.50)
============ ============ ============ ============
Basic and diluted - proforma $ (0.18) $ (0.18) $ (0.57) $ (0.54)
============ ============ ============ ============
F-5
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(d) COMPREHENSIVE INCOME
SFAS No. 130, Reporting Comprehensive Income, requires disclosure of all
components of comprehensive income (loss). Comprehensive income is defined as
the change in stockholders' equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner sources.
Comprehensive net loss for all periods presented is as follows:
Three Months Nine Months
Ended Ended
September 30, September 30,
------------------------------ ------------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Net loss $(2,359,147) $(2,573,049) $(8,847,447) $(6,960,902)
Unrealized holding gain (loss)
on marketable securities, net of
related tax effects 1,768 -- (331) --
Foreign currency translation adjustment 140,636 (7,173) (42,836) (94,041)
----------- ----------- ----------- -----------
Comprehensive loss $(2,216,743) $(2,580,222) $(8,890,614) $(7,054,943)
=========== =========== =========== ===========
(e) MARKETABLE SECURITIES
U.S. Agency Notes and Corporate Bonds, are classified as "available-for-sale
securities" and reported at fair value, with unrealized gains and losses
excluded from operations and reported as a component of accumulated other
comprehensive income (loss), net of the related tax effects, in stockholders'
equity.
Marketable securities, at September 30, 2005, all of which mature within one
year, consist of the following:
Amortized Cost Fair Value
---------- ----------
Available-for-sale securities
U.S. Agency Notes $1,270,380 $1,270,113
Corporate Bonds 498,859 498,795
---------- ----------
$1,769,239 $1,768,908
========== ==========
Gross unrealized gain for the three months ended September 30, 2005 totaled
$1,768 and the gross unrealized loss for the nine months ended September 30,
2005 totaled $331.
F-6
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(f) NET LOSS PER SHARE
Net loss per share is computed based on the guidance of SFAS No. 128, Earnings
per Share. SFAS No. 128 requires companies to report both basic loss per share,
which is based on the weighted average number of common shares outstanding, and
diluted loss per share, which is based on the weighted average number of common
shares outstanding and the dilutive potential common shares outstanding using
the treasury stock method. The calculation of net loss applicable to common
stockholders for the three month and nine month periods ended September 30, 2005
includes $763,000 in non-cash dividends accreted on preferred stock as a result
of the beneficial conversion feature and the fair value adjustment to present
preferred stock at its exchangeable value related to the September 30, 2005
Private Placement.
As a result of the losses incurred by the Company for the three and nine month
periods ended September 30, 2005 and 2004, respectively, all potential common
shares were antidilutive and were excluded from the diluted net loss per share
calculations. The following table summarizes securities outstanding as of each
of the periods, which were not included in the calculation of diluted net loss
per share since their inclusion would be antidilutive.
Three Months Ended September 30, Three Months Ended September 30,
--------- --------- --------- ---------
2005 2004 2005 2004
--------- --------- --------- ---------
Common stock options 1,711,225 1,017,006 1,711,225 1,017,006
========= ========= ========= =========
Common stock warrants 5,198,452 882,625 5,198,452 882,625
========= ========= ========= =========
Convertible debt 1,620,961 -- 1,620,961 --
========= ========= ========= =========
Preferred stock 4,000,000 -- 4,000,000 --
========= ========= ========= =========
(4) LINE OF CREDIT ARRANGEMENTS
Diomed, Ltd., the Company's United Kingdom-based subsidiary, utilizes an
overdraft facility as well as an accounts receivable line of credit with
Barclays Bank, limited to the lesser of (GBP)100,000 ($177,000 at September 30,
2005), or 80% of eligible accounts receivable. The credit line bears interest at
a rate of 3% above Barclays base rate of 4.5% at September 30, 2005, and
borrowings are due upon collection of receivables from customers. As security
for the line of credit, Barclays Bank has a lien on all of the assets of Diomed
Ltd., excluding certain intellectual property. As of September 30, 2005 and
2004, there was approximately $193,329 and $0, respectively outstanding under
these credit facilities.
F-7
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(5) STOCK OPTIONS
(a) In November 2003, the Company's stockholders approved the 2003 Omnibus Plan,
under which the Company reserved 1,600,000 shares of common stock for future
issuance. In May 2005, the Company's stockholders approved an increase of
1,500,000 reserved shares providing for a total of 3,100,000 shares of common
stock reserved for future issuance. The 2003 Omnibus Plan provides for grants or
awards of stock options, restricted stock awards, restricted stock units,
performance grants, stock awards, and stock appreciation rights. Only present
and future employees and outside directors and consultants are eligible to
receive incentive awards under the 2003 Omnibus Plan.
The exercise price and vesting are determined by the Board of Directors at the
date of grant. Options generally vest over two to four years, and expire 10
years after the date of grant. Incentive stock options under the Plans are
granted at not less than fair market value per share of Common Stock on the date
of grant, or 110% of fair market value for any stockholder who holds more than
10% of the total combined voting power of all classes of stock of the Company.
As of September 30, 2005, 1,526,818 options and other incentive stock awards
were available for future grants under the 2003 Omnibus Plan. In addition, 2,542
options were available under the 2001 Plan as of September 30, 2005.
A summary of stock option activity for the 2003 Omnibus Plan, the 2001 Plan and
the 1998 Plan is as follows:
Range of Exercise Weighted Average
Price Number of Shares Exercise Price
--------------------------------------------------------
Outstanding, December 31, 2004 $2.00 - $205.75 1,076,318 $ 8.12
Granted 2.24 - 4.30 680,738 4.13
Forfeited 2.85 - 205.75 (45,831) 13.10
--------------------------------------------------------
Outstanding, September 30, 2005 $2.00 - $205.75 1,711,225 $ 6.05
========================================================
Exercisable, September 30, 2005 $2.00 - $205.75 799,955 $ 7.89
========================================================
F-8
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
The following table summarizes currently outstanding and exercisable options as
of September 30, 2005.
OUTSTANDING EXERCISABLE
-------------------------------- --------------------------
Weighted Average Weighted Average
Exercise Price Shares Remaining Life* Exercise Price Shares Exercise Price
- -------------- ------------- ------------- ------------ -------------------------
$ 2.00 - $11.50 1,679,861 8.61 $ 4.61 770,666 $ 4.91
26.00 - 50.00 18,256 6.07 35.32 16,231 35.84
56.25 - 88.50 814 5.67 61.40 764 61.74
100.00 - 164.00 11,974 2.32 152.20 11,974 152.20
$201.25 - $205.75 320 1.08 205.75 320 205.75
------------ --------- --------- ---------
1,711,225 $ 6.05 799,955 $ 7.89
============ ========= =========================
* Weighted average remaining contractual life (in years).
(b) A summary of warrant activity is as follows:
Weighted Average
Range of Exercise Weighted Average Remaining Contractual
Price Number of Shares Exercise Price Life (In Years)
-------------------------------------------------------------------------
Outstanding, December 31, 2004 $0.025 - $87.50 2,991,263 $ 2.18 4.82
Granted 2.50 - 2.90 2,400,000 2.60 4.96
Exercised 2.10 (192,811) 2.10 --
-------------------------------------------------------------------------
Outstanding, September 30, 2005 $0.025 - $87.50 5,198,452 $ 2.38 4.31
=========================================================================
Exercisable, September 30, 2005 $0.025 - $87.50 5,198,452 $ 2.38 4.31
=========================================================================
F-9
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(6) DISTRIBUTION AGREEMENT WITH LUMINETX CORPORATION
On August 5, 2005, the Company entered into a distribution agreement with
Luminetx Corporation ("Luminetx"), pursuant to which Luminetx appointed Diomed
as a distributor and granted Diomed an exclusive right to distribute and sell
Luminetx' patented biomedical imaging system known as the VeinViewer(TM) Imaging
System. The agreement is for an initial term of three years following the
initial date that Luminetx delivers the VeinViewer(TM) product to Diomed, which
is expected to occur on or before January 31, 2006. The specific market covered
by this agreement includes those physicians who perform sclerotherapy,
phlebectomies or varicose vein treatments, initially in the United States and
the United Kingdom, with additional territories to be negotiated as
VeinViewer(TM) receives regulatory clearance in other countries, on terms to be
agreed. The Company loaned $500,000 to Luminetx on August 5, 2005, and the
Company will invest an additional $500,000 in Luminetx when Luminetx delivers to
the Company a minimum number of VeinViewer(TM) systems, as specified in the
distribution agreement. The note matures on August 5, 2006, bears interest at 5%
per annum and is convertible into Luminetx's common or preferred stock if
Luminetx completes an arms-length stock financing with a minimum of $3,000,000
raised or upon a change of control of Luminetx.
The Company also issued warrants to purchase up to 600,000 shares of our common
stock. The warrants have an exercise price of $2.90 per share, become
exercisable when the underlying shares are listed with the American Stock
Exchange and cease to be exercisable on the earlier of five years from full
vesting, August 5, 2011 and the date of termination of the Distribution
Agreement. The warrant is exercisable as to 50% of the underlying shares, with
the remainder becoming exercisable when Luminetx has both (A) produced at least
100 units of the system and (B) Diomed shall have accepted delivery of at least
25 units of the system.
In accordance with Emerging Issues Task Force Number 96-18 "Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services", the fair value of the distribution
rights of $332,630 is being amortized over the 3 year period of the distribution
agreement commencing on the date that distribution agreement was executed,
August 5, 2005. The Company recorded the fair value of the warrants using the
Black-Scholes model
The Company converted the $500,000 loan to Luminetx into 250,000 shares of
Luminetx preferred stock, convertible into common stock on a share-for-share
basis, and warrants to purchase 50,000 shares of Luminetx common stock at $2.00
per share, exercisable for five years, as part of an $11 million private
placement financing that Luminetx announced on November 4, 2005. The Company
will invest the remaining $500,000 of the loan commitment to Luminetx for
preferred stock and warrants on the same terms. When Luminetx delivers to the
Company a minimum number of Vein Viewer (TM) Systems, as specified in the
distribution agreement.
(7) SEPTEMBER 30, 2005 PRIVATE PLACEMENT FINANCING AND WARRANT LIABILITY
On September 30, 2005 the Company completed a private placement which resulted
in gross proceeds of $10 million. In connection with this private placement, the
Company sold 4,000,000 shares of preferred stock at a price of $2.50 per share
and issued warrants to purchase up to 1,600,000 shares of common stock. The
warrants have a term of 5 years and an exercise price equal to $2.50. The
Investors may exchange shares of Preferred Stock for shares of Common Stock.
Each share of Preferred Stock may be exchanged for that number of shares of
Common Stock that equals the issue price of the Preferred Stock ($2.50) divided
by an exchange rate, initially set at $2.50 and subject to reduction in the case
of dilutive issuances.
Under the terms of the private placement, the Company has agreed to file a Form
SB-2 registration statement with the Commission covering the shares of Common
Stock that are issuable upon exchange under the Share Exchange Agreement and the
Common Stock that is issuable upon exercise of the Warrants. The Company agreed
to file the registration statement within 45 days of the date of the
Registration Rights Agreement, which the Company has complied with, having filed
a registration statement on November 9, 2005. The Company agreed to use its best
efforts to cause the registration statement to be declared effective within 120
days of the closing date of the purchase and sale of the Preferred Stock and the
Warrants. If the Company fails to comply, the Company will have to pay
liquidated damages of 3% per month of the aggregated purchase price paid by
investors for the Preferred Stock.
In accordance with Emerging Issues Task Force (EITF) number 00-27, "Application
of Issue No. 98-5 to Certain Convertible Instruments", (EITF 00-27) the Company
allocated the proceeds received in the financing between the preferred stock and
the warrants based on their relative fair values. Then the Company compared the
proceeds allocated to the preferred stock to the fair value of the common stock
that would be received upon conversion to determine if a beneficial conversion
feature existed. The Company determined that a beneficial
F-10
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
conversion feature of $381,328 existed and, in accordance with EITF 00-27,
amortized that amount immediately to the value of the preferred stock, as the
preferred stock is immediately convertible. Further, as the fair value was less
than the conversion value, the Company recorded $381,328 as an increase to the
carrying value with an offset to additional paid-in capital. In accordance with
EITF 98-5 this combined adjustment of $762,656 is analogous to a dividend and
recognized as a return to the shareholders and has been included in Preferred
Stock Dividends in the Company's calculation of Net Loss Applicable to Common
Stockholders and Basic and Diluted Net Loss Per Share.
The Company further reduced the carrying value of the preferred stock by
$765,000 for specific incremental costs directly attributable to the transaction
including; investment banking, legal and professional fees.
EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company's Own Stock" (EITF 00-19) requires
freestanding contracts that are settled in a Company's own stock, including
common stock warrants, to be designated as an equity instrument, assets or
liability. Under the provisions of EITF 00-19, a contract designated as an asset
or liability must be carried at fair value until the contract meets the
requirements for classification as equity, until the contract is exercised or
until the contract expires.
According to the terms of the transaction, the Company is subject to certain
liquidated damages under the Registration Rights agreement if the Company cannot
obtain and maintain effectiveness of a registration statement. Since the
liquidated damages had no contractual maximum, the Company determined that the
liquidated damages were onerous and thus, could result in net-cash settlement of
the transaction in accordance with EITF 00-19. The Company valued the warrants
using the Black-Scholes model. The Company recorded a warrant liability of
$1,861,328 based on the relative fair value in accordance with EITF 00-27.
Because the warrants are classified as a liability, any changes in fair value
will be recorded as non-cash interest expense in the Statements of Operations
until the warrants are exercised, terminated or expired.
As the preferred stock includes stated dividend rates that increase over time,
from a rate considered below market, the Company will amortize an incremental
amount which together with the stated rate for the period results in a constant
dividend rate in accordance with Securities Exchange Commission Staff Accounting
Bulletin Topic 5Q. The Company determined that the present value of the
incremental dividends of $1,371,429 will be amortized over the period preceding
the perpetual dividend rate using an effective interest rate of 16.5%. The
Company will increase the carrying value of the preferred stock with an offset
to Additional Paid-in Capital periodically and reduce the carrying value when
paid. These dividends will be included in Preferred Stock Dividends in the
Company's calculation of Net Loss Applicable to Common Stockholders and Basic
and Diluted Net Loss Per Share.
In addition to the warrants we issued to the investors, we also issued warrants
to purchase up to 200,000 shares of common stock to the three holders of our
convertible debentures we issued in October 2004, as an inducement to, and in
consideration for, the debenture holders' waiver of certain negative covenants
that would have been violated by the financing had the debenture holders not
waived. These warrants were valued using the Black-Scholes model. As a result,
the Company recorded an additional debt discount to the September 28, 2004
convertible debentures of $256,969 which will be amortized to non cash interest
expense over the remaining term of the Notes.
The holders of the warrants may exercise their warrants by paying the Company
cash equal to the exercise price of the warrants, $2.50, or by means of a
"cashless exercise" instead of paying cash to the Company upon exercise, in
which case the holder shall be entitled to receive a certificate for the number
of warrant shares equal to the quotient obtained by dividing [(A-B) (X)] by (A),
where;
(A) = the VWAP (as defined in the Warrant Agreement) on the Trading of
exercise;
(B) = the then current Exercise Price of the warrant, and
(X) = the number of warrant shares issuable upon exercise of the warrant
by means of a cash exercise rather than a cashless exercise
Because of this cashless exercise feature, the Company may not receive any
proceeds from the exercise of warrants (although the Company will issue a net
number of shares that is less than the total of 1,800,000 face amount of the
warrants).
F-11
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(8) SEGMENT REPORTING
Operating segments are identified as components of an enterprise about which
separate discrete financial information is available for evaluation by the chief
operating decision maker, or decision making group, in making decisions on how
to allocate resources and assess performance. The Company's chief decision
making group, as defined under SFAS No. 131, is the Executive Management
Committee.
The Company's reportable segments are determined by product type: laser systems
and fibers, accessories and service. The Executive Management Committee
evaluates segment performance based on revenue. Accordingly, all expenses are
considered corporate level activities and are not allocated to segments. Also,
the Executive Management Committee does not assign assets to its segments.
This table presents revenues by reportable segment:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
2005 2004 2005 2004
----------- ----------- ----------- -----------
Laser systems $ 2,193,635 $ 1,878,281 $ 6,762,513 $ 5,537,152
Fibers, accessories,
and service 2,389,205 1,398,183 6,725,607 3,871,617
----------- ----------- ----------- -----------
Total $ 4,582,840 $ 3,276,464 $13,488,120 $ 9,408,769
=========== =========== =========== ===========
The following table represents percentage of revenues and long-lived assets by
geographic destination:
% of Revenue Long-lived Assets
Nine Months Ended September 30, ---------------------------
---------------------------- September 30, December 31,
2005 2004 2005 2004
---------- ---------- ---------- ----------
United States 75% 64% $5,456,575 $5,769,521
Asia/Pacific 14% 25% -- --
Europe 8% 11% 323,723 510,459
Other 3% 0% -- --
---------- ---------- ---------- ----------
Total 100% 100% $5,780,298 $6,279,980
========== ========== ========== ==========
F-12
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2005
(UNAUDITED)
(9) COMMITMENTS AND CONTINGENCIES
On July 21, 2005, a lawsuit was filed against the Company in the United States
District Court for the Northern District of California by VNUS Medical
Technologies, Inc., alleging infringement of U.S. patents Nos. 6,258,084,
6,638,273, 6,752,803, and 6,769,433. The complaint was served on the Company on
July 27, 2005. On September 15, 2005, the Company filed an answer denying the
allegations of infringement, and counterclaiming against VNUS for a declaration
that none of the patents are infringed and that they are all invalid. On October
12, 2005, VNUS served an amended complaint adding two additional parties,
AngioDynamics, Inc. and Vascular Solutions, Inc., as defendants. On October 31,
2005, the Company filed an answer to the First Amended Complaint, again denying
the allegations of infringement, and counterclaiming against VNUS for a
declaration that none of the patents are infringed, that they are all invalid,
and that two of VNUS's patents are unenforceable for inequitable conduct. An
initial scheduling conference for the case has been set for December 2, 2005.
The Company intends to continue defending this case.
During 2004, the Company filed lawsuits in the United States Federal District
Court for the District of Massachusetts against four competitors seeking
injunctive relief and damages for infringement of the Company's U.S. Patent
Number 6,398,777 covering the endovascular laser treatment of varicose veins
which the Company uses in its EVLT(R) product line. If the Company's EVLT(R)
patent is judicially determined to be invalid, the Company will not prevail in
the infringement actions and will not be able to exclude third parties from
using the Company's EVLT(R) technology. As a result, the EVLT(R) patent may be
determined to be impaired and the Company's EVLT(R) revenue stream may be
adversely affected.
Insofar as legal proceedings other than patent litigation are concerned, from
time to time the Company is the defendant in legal and administrative
proceedings and claims of various types. Although any such litigation contains
an element of uncertainty, management, in consultation with the Company's
general counsel, presently believes that the outcome of such proceedings or
claims which are pending or known to be threatened, or all of them combined,
will not have a material adverse effect on the Company.
(10) SUBSEQUENT EVENTS
The Company converted the $500,000 loan to Luminetx into 250,000 shares of
Luminetx preferred stock, convertible into common stock on a share-for-share
basis, and warrants to purchase 50,000 shares of Luminetx common stock at $2.00
per share, exercisable for five years, as part of an $11 million private
placement financing that Luminetx announced on November 4, 2005. The Company
will invest the remaining $500,000 of the loan commitment to Luminetx for
preferred stock and warrants on the same terms, when Luminetx delivers to the
Company a minimum number of VeinViewer(TM) systems, as specified in the
distribution agreement.
F-13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS
In this Quarterly Report, the terms "Company" and "Diomed Holdings" both refer
to Diomed Holdings, Inc. The term "Diomed" refers to the Company's principal
subsidiary, Diomed, Inc. and its consolidated subsidiaries. We use the terms
"we,", "our" and "us" when we do not need to distinguish among these entities or
their predecessors, or when any distinction is clear from the context.
This section contains forward-looking statements, which involve known and
unknown risks and uncertainties. These statements relate to our future plans,
objectives, expectations and intentions. These statements may be identified by
the use of words such as "may," "will," "should," "potential," "expects,"
"anticipates," "intends," "plans," "believes" and similar expressions. These
statements are based on our current beliefs, expectations and assumptions and
are subject to a number of risks and uncertainties. Our actual results could
differ materially from those discussed in these statements. Our 2004 Annual
Report on Form 10-KSB (the "Annual Report") contains a discussion of certain of
the risks and uncertainties that affect our business. We refer you to the "Risk
Factors" on pages 22 through 37 of the Annual Report for a discussion of certain
risks, including those relating to our business as a medical device company
without a significant operating record and with operating losses, our risks
relating to the commercialization of our current and future products and
applications, and risks relating to our common stock and its market value.
In view of our relatively limited operating history, we have limited experience
forecasting our revenues and operating costs. Therefore, we believe that
period-to-period comparisons of financial results are not necessarily meaningful
and should not be relied upon as an indication of future performance. To date,
the Company has incurred substantial costs to create or acquire our products. As
of September 30, 2005, we had an accumulated deficit of approximately $78
million including $17.5 million in non-cash interest expense. We may continue to
incur operating losses due to spending on research and development programs,
clinical trials, regulatory activities, and sales, marketing and administrative
activities. This spending may not correspond with any meaningful increases in
revenues in the near term, if at all. As such, these costs may result in losses
until such time as the Company generates sufficient revenue to offset such
costs.
The following discussion should be read in conjunction with the Consolidated
Financial Statements and Notes set forth above in this Quarterly Report and in
the Annual Report.
(1) OVERVIEW
We develop and commercialize minimally invasive medical procedures that employ
our laser technologies and associated disposable products. Using our proprietary
technology, including our exclusive rights to U.S. Patent No. 6,398,777, we
currently focus on endovenous laser treatment (EVLT(R)) of varicose veins. We
also develop and market lasers and disposable products for photodynamic therapy
(PDT) cancer procedures and products for other clinical applications, including
dental and general surgical procedures. We carry on our business primarily
through our wholly-owned subsidiaries, Diomed, Inc. and Diomed, Ltd.
In developing and marketing our clinical solutions, we use proprietary
technology and aim to secure strong commercial advantages over competitors by
obtaining exclusive commercial arrangements, gaining governmental approvals in
advance of others and developing and offering innovative practice enhancement
programs, including physician training and promotional materials. To optimize
revenues, we focus on clinical procedures that generate revenues from both
capital equipment and disposable products, such as procedure kits and optical
fibers.
Our high power semiconductor diode lasers combine clinical efficacy, operational
efficiency and cost effectiveness in a versatile, compact, lightweight,
easy-to-use and easy-to-maintain system. Along with lasers and single-use
procedure kits for EVLT(R), we provide our customers with state-of-the-art
physician training and practice development support.
In 2001, we pioneered the commercialization of endovenous laser treatment
(EVLT(R)), an innovative minimally invasive laser procedure for the treatment of
varicose veins caused by greater saphenous vein reflux. In September 2001, we
were the first company to receive the CE mark of the European Economic Union for
approval for endovenous laser treatment with respect to marketing EVLT(R) in
Europe. In January 2002, we were the first company to receive FDA clearance for
endovenous laser treatment of the greater saphenous vein. In December 2004, we
received FDA clearance to expand the application of EVLT(R) to other superficial
veins in the lower extremities.
1
EVLT(R) was our primary source of revenue in the three months and nine-months
ended September 30, 2005, and will continue to be a primary source of revenue
for the remainder of 2005. We believe that EVLT(R) will achieve a high level of
commercial acceptance due to its relative short recovery period, immediate
return to the patient's normal routine barring vigorous physical activities,
reduced pain and minimal scarring and reduced costs compared to other treatments
for varicose veins. We developed our EVLT(R) product line as a complete clinical
solution and marketing model, including a laser, disposable kit, clinical
training, customized marketing programs plus other complimentary products that
support our basic EVLT(R) strategy, to assist office-based and hospital-based
physicians in responding to the growing demand for treatment of varicose veins
in a minimally invasive manner. We have also published a health insurance
reimbursement guide to assist physicians in the reimbursement submission
process. We believe that these attributes, in addition to EVLT(R)'s superior
clinical trial results, favorable peer reviews and comparatively larger and
longer follow-up data reports provide EVLT(R) with a competitive advantage over
competing traditional and minimally invasive varicose vein treatment products.
We expect that as the number of EVLT(R) procedures increases, so will our sales
of associated disposable items. We believe that the U.S. represents the single
largest market for EVLT(R). We target our sales and marketing efforts at
hospitals, private physician practices and clinics and focus on specialists in
vascular surgery, interventional-radiology, general surgery, phlebology,
interventional cardiology, gynecology and dermatology.
We primarily utilize a direct sales force to market our products in the United
States and a network of more than 30 distributors to market our products abroad.
In June 2005, we entered into an exclusive distribution agreement with
Colorado-based Med1 Online, Inc., a leading online distributor of capital
medical equipment in the United States. Under the terms of the three-year
renewable distribution agreement, Med1Online acquired exclusive distribution
rights to market our EVLT(R) product line to the OB/GYN and plastic surgery
physician market segments in the United States. We currently employ 18 EVLT(R)
sales representatives, two regional sales managers and four clinical
specialists, including one training manager, in support of our field sales
efforts. These clinical specialists assist in physician training and post-sales
support, freeing our sales representatives to focus on new sales opportunities.
We plan to fill two open sales territories and plan to add three sales
development personnel to focus on VeinViewer(TM) sales.
We have developed and maintain a website - www.EVLT.com - to assist both
patients and physicians. EVLT.com provides patients with education about
treatment options and benefits of EVLT(R) and provides physicians with education
about the EVLT(R) procedure. At www.EVLT.com, patients can also locate the
nearest physician performing EVLT(R) by inputting their city and state. We also
maintain a corporate website - www.diomedinc.com - to provide information about
us and our physician support iniatives, among other things.
We currently focus on the development and growth of EVLT(R) sales both
domestically and internationally. We also plan to expand our product offerings
to include VeinViewer(TM) to physicians performing sclerotherapy, phlebectomies
or varicose vein treatments, in North American and the United Kingdom under our
exclusive distribution agreement with Luminetx. We also support the development
and approval of applications for PDT products and the development of
enhancements to our products in order to further improve their quality,
effectiveness and manufacturability. Our management team focuses on developing
and marketing solutions that address serious medical problems that present
significant market opportunities. Our determinations are based upon the number
of procedures that may be conducted in a market and projections of the
associated revenue. Currently, EVLT(R) applications fall within this guideline,
and we believe that photodynamic therapy may have the potential to do so as well
at some time in the future. However, EVLT(R), and not PDT, is the emphasis of
our current business plan.
2
(2) RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2004
REVENUE
Diomed delivered revenue for the three months ended September 30, 2005 of
$4,583,000, increasing approximately $1,306,000, or 40%, from $3,276,000 for the
three months ended September 30, 2004. Revenue from the EVLT(R) product line
increased 56% over the three months ended September 30, 2004, including North
America EVLT(R) growth of 82%, demonstrating the continued and growing
acceptance of EVLT(R) by the medical community and patients alike.
For the three months ended September 30, 2005, approximately $2,194,000, or 48%,
of our total revenue was derived from laser sales, as compared to approximately
$1,878,000, or 57%, in the three months ended September 30, 2004. In the three
months ended September 30, 2005, approximately $2,389,000, or 52%, of our total
revenues were derived from sales of disposable fibers and kits, accessories and
service, as compared to approximately $1,398,000, or 43%, in the same period in
2004. We expect the proportion of revenue derived from disposables to increase
as we establish a larger base of installed lasers and the number of EVLT(R)
procedures performed grows.
The increase in revenue is attributable primarily to:
- increased penetration of EVLT(R) in the market for treating varicose
veins by minimally invasive means,
- the compounding impact of the recurring revenue stream from
disposable product sales to both new and existing customers,
- the impact of new sales management and development of our sales
team, and
- the impact of increased acceptance of the EVLT(R) procedure by the
medical community and expanded reimbursement coverage by health care
insurers, including the establishment of reimbursement codes for
EVLT(R) by the American Medical Association and the Center for
Medicare and Medicaid Services, effective January 1, 2005.
Revenues for the period ended September 30, 2005 were negatively impacted by
Hurricanes Katrina and Rita, which we believe resulted in the deferral of three
to five EVLT(R) laser sales (representing revenues of between approximately
$100,000 to $150,000) in the affected regions. We expect that we will complete
these sales in future periods.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the three months ended September 30, 2005 was $2,512,000,
increasing approximately $552,000, or 28%, from $1,959,000 for the three months
ended September 30, 2004. The increase in cost of revenue in 2005 was driven by
the corresponding increase in the number of lasers and disposable products sold,
offset, on a percentage of sales basis, by the leverage of fixed manufacturing
costs across a greater number of units, and improved material costs. Cost of
revenue, as a percentage of sales, decreased from 60% to 55% on a year-to-year
basis.
Gross profit for the three months ended September 30, 2005 was $2,071,000,
increasing approximately $754,000 from $1,317,000 from the three months ended
September 30, 2004. On a percent-of-sales-basis, the gross margin increased from
40% to 45%. The increase in gross profit in the third quarter of 2005 was driven
by fixed cost leverage of the incremental sales volume as well as improvements
in material costs. The Company believes that in the future, gross profit as a
percentage of sales may reach 60%, assuming increases in sales volume that may
occur after completion of the `777 patent litigation.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES for the three months ended September 30, 2005
were $404,000, a decrease of $50,000, or 11%, from the three months ended
September 30, 2004. R&D expenditures are expected to remain at this level as we
continue to drive product functionality, cost improvements, and other
enhancements.
3
SELLING AND MARKETING EXPENSES for the three months ended September 30, 2005
were $2,081,000, an increase of $372,000, or 22%, over 2004, but decreased
$225,000 or 10% from the second quarter of 2005. The increase from the three
months ended September 30, 2004 was driven by higher sales commissions of
$112,000 resulting from the increased sales volume, and increased sales and
marketing expenditures in support of the sales efforts to drive the growing
commercialization of EVLT(R). Sales and marketing expenditures are expected to
increase with corresponding increases in revenue to support the continued
commercialization of EVLT(R).
GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended September 30,
2005 were $1,812,000, an increase of $99,000, or 6%, from the same period in
2004, but decreased $281,000 or 13% from the second quarter of 2005. The
increase from the three months ended September 30, 2004 was primarily
attributable to incremental legal fees of $224,000, which totaled $718,000 for
the quarter, as well as Sarbanes-Oxley compliance costs of $106,000, offset by
other administrative costs savings. Legal expenses included $676,000 for the
continuing cost of patent litigation commenced during 2004 against four
competitors and the theft of trade secrets litigation initiated in the fourth
quarter of 2003. We expect general and administrative costs to decrease to a
more normalized run rate in the fourth quarter after the discovery phase of the
`777 patent litigation is completed.
LOSS FROM OPERATIONS
Loss from operations for the three months ended September 30, 2005 was
$2,225,000, a decrease of approximately $333,000 from the three months ended
September 30, 2004, as incremental gross profit from an increased revenue base
offset the increase in legal costs related to our patent litigation.
NET LOSS
Net loss for the three months ended September 30, 2005 was $2,359,000 compared
to $2,573,000 for the third quarter of 2004. As a result of the relevant
accounting for the preferred stock and warrants issued in the private placement
financing completed on September 30, 2005, on an ongoing basis, the Company has
valued the 1,800,000 warrants using the Black-Scholes model and any subsequent
changes in the fair value will be included as Non-Cash Interest Expense for as
long as the warrants are outstanding.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
Net loss applicable to common stockholders was $3,122,000, or $0.16 per share,
for the three months ended September 30, 2005 compared to $2,573,000, or $0.18
per share, for the three months ended September 30, 2004. For the three months
ended September 30, 2005, net loss applicable to common stockholders includes
non-cash charges of $763,000 in dividends accreted on preferred stock as a
result of a beneficial conversion feature and the fair value adjustment to
present preferred stock at its exchangeable value related to the September 30,
2005 Private Placement. The Company will pay cash dividends to the holders of
the preferred stock on an ongoing basis at 6% for the first 18 months, 10% for
months 19 to 24, and 15% thereafter for as long as the preferred stock is
outstanding. In addition, because the dividend percentage is considered below
market for accounting purposes, the Company will record an incremental non-cash
dividend as an increase to the carrying value of the preferred stock to reflect
an effective interest rate of 16.5%.
NINE MONTHS ENDED SEPTEMBER 30, 2005 COMPARED TO THE NINE MONTHS ENDED
SEPTEMBER 30, 2004
REVENUE
Diomed delivered revenue for the nine months ended September 30, 2005 of
$13,488,000, increasing approximately $4,079,000, or 43%, from $9,409,000 for
the nine months ended September 30, 2004. Revenue from the EVLT(R) product line
increased 69% over the nine months ended September 30, 2004. North America
EVLT(R) sales increased 87% including 96% growth in procedure products revenue.
For the nine months ended September 30, 2005, approximately $6,763,000, or 50%,
of our total revenue was derived from laser sales, as compared to approximately
$5,537,000, or 59%, in the nine months ended September 30, 2004. In the nine
months ended September 30, 2005, approximately $6,726,000, or 50%, of our total
revenues were derived from sales of disposable fibers and kits, accessories and
service, as compared to approximately $3,872,000, or 41%, in the nine months
ended September 30, 2004. We expect the proportion of revenue derived from
disposables to increase as we establish a larger base of installed lasers and
the number of EVLT(R) procedures performed grows.
The increase in revenue is attributable primarily to:
- increased penetration of EVLT(R) in the market for treating varicose
veins by minimally invasive means,
- the compounding impact of the recurring revenue stream from
disposable product sales to both new and existing customers,
4
- the impact of new sales management and development of our sales
team, and
- the impact of increased acceptance of the EVLT(R) procedure by the
medical community and expanded reimbursement coverage by health care
insurers, including the establishment of reimbursement codes for
EVLT(R) by the American Medical Association and the Center for
Medicare and Medicaid Services, effective January 1, 2005.
Revenues for the period ended September 30, 2005 were negatively impacted by
Hurricanes Katrina and Rita, which we believe resulted in the deferral of three
to five EVLT(R) laser sales (representing revenues of between approximately
$100,000 to $150,000) in the affected regions. We expect that we will complete
these sales in future periods.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the nine months ended September 30, 2005 was $7,325,000,
increasing approximately $1,503,000, or 26%, from $5,822,000 for the same period
in 2004. The increase in cost of revenue in 2005 was driven by the corresponding
increase in the number of lasers and disposable products sold, offset, on a
percentage of sales basis, by the leverage of fixed manufacturing costs across a
greater number of units and improved materials costs. Cost of revenue, as a
percentage of sales, decreased from 62% to 54% on a year-to-year basis.
Gross profit for the nine months ended September 30, 2005 was $6,163,000,
increasing approximately $2,576,000 from $3,587,000 for the same period in 2004.
On a percent-of-sales-basis, the gross margin increased from 38% to 46%. The
increase in gross profit was driven by fixed cost leverage of the incremental
sales volume as well as improvements in material costs. The Company believes
that in the future gross profit as a percentage of sales may reach 60%, assuming
increases in sales volume that may occur after completion of the `777 patent
litigation.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES for the nine months ended September 30, 2005
were $1,151,000, an increase of $28,000, or 2%, from the same period in 2004.
R&D expenditures are expected to remain at this level as we continue to drive
product functionality, cost improvements, and other enhancements.
SELLING AND MARKETING EXPENSES for the nine months ended September 30, 2005 were
$6,694,000, an increase of $1,828,000, or 38%, over 2004. The increase was
driven by a significant expansion in the size of the sales force, higher sales
commissions of $300,000 resulting from the increased sales volume, and increased
sales and marketing expenditures in support of the sales efforts to drive the
growing commercialization of EVLT(R).
GENERAL AND ADMINISTRATIVE EXPENSES for the nine months ended September 30, 2005
were $5,476,000, an increase of $954,000, or 21%, from the same period in 2004.
The increase was primarily attributable to incremental legal fees of $635,000,
as well as Sarbanes-Oxley compliance of $182,000 and other administrative costs.
Legal expenses included the continuing cost of patent litigation against four
competitors commenced during 2004.
LOSS FROM OPERATIONS
Loss from operations for the nine months ended September 30, 2005 was
$7,157,000, an increase of approximately $233,000 from the same period in 2004,
as incremental gross profit from an increased revenue base was primarily offset
by increased legal costs related to our patent litigation.
INTEREST EXPENSE, NET
Interest expense for the nine months ended September 30, 2005 was $1,691,000,
compared to $37,000 for the same period in 2004. Interest expense in the nine
months ended September 30, 2005 included non-cash charges totaling $1,503,000
related to the amortization and acceleration of the debt discount related to the
first quarter 2005 conversion of $3,288,000 in debt issued in the September 28,
2004 equity and debt financing. As a result of the relevant accounting for the
preferred stock and warrants issued in the private placement financing completed
on September 30, 2005, on an ongoing basis, the Company has valued the 1,800,000
warrants using the Black-Scholes model and any subsequent changes in the fair
value will be included as Non-Cash Interest Expense for as long as the warrants
are outstanding.
5
NET LOSS
Net loss for the nine months ended September 30, 2005 was $8,847,000 compared to
$6,961,000 for the same period 2004. The expansion of Diomed's sales and
marketing efforts during the year drove incremental revenue, which was offset by
the increased legal costs and $1,503,000 in non-cash interest expense arising
from the amortization and acceleration of debt discount from the conversion of
$3,288,000 in debt in the first quarter 2005.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
Net loss applicable to common stockholders was $9,610,000, or $0.50 per share,
compared to $6,961,000 million, or $0.50 per share, for the same period 2004.
For the nine month period ended September 30, 2005, net loss applicable to
common stockholders includes non-cash charges of $763,000 in dividends accreted
on preferred stock as a result of a beneficial conversion feature and the fair
value adjustment to present preferred stock at its exchangeable value related to
the September 30, 2005 Private Placement. The Company will pay cash dividends to
the holders of the preferred stock on an ongoing basis at 6% for the first 18
months, 10% for months 19 to 24, and 15% thereafter for as long as the preferred
stock is outstanding. In addition, because the dividend percentage is considered
below market for accounting purposes, the Company will record an incremental
non-cash dividend as an increase to the carrying value of the preferred stock to
reflect an effective interest rate of 16.5%.
(3) LIQUIDITY, CAPITAL RESOURCES AND CAPITAL TRANSACTIONS
CASH POSITION AND CASH FLOW
The Company has financed its operations primarily through private placements of
common stock and preferred stock, and private placements of convertible notes
and short-term notes and credit arrangements. The Company had cash and short
term investment balances of approximately $16,569,000 and $14,436,000 at
September 30, 2005 and December 31, 2004, respectively.
CASH USED IN OPERATIONS
Cash used in operations for the nine months ended September 30, 2005 was
$6,729,000. The cash used in operations reflects the net loss of $8,847,000,
reduced by the non-cash interest expense of $1,503,000, and working capital
changes including, $300,000 in 2004 incentive compensation payments which are
not expected to recur during the year.
CASH USED IN INVESTING
Cash used in investing activities for the nine months ended September 30, 2005
was approximately $2,655,000, including; purchases of available for sale
securities of $1,749,000, promissory note to Luminetx of $500,000, and computer
and demonstration equipment.
CASH PROVIDED BY FINANCING
Cash provided by financing activities for the nine months ended September 30,
2005 was $9,808,000. This includes; $10 million raised in the September 30, 2005
private placement, $405,000 received from the exercise of warrants we issued in
the 2004 equity and debt financing, and $193,000 in bank borrowings, offset by
$750,000 in payments related the current maturities of the EVLT(R) technology
acquisition obligation.
PRIVATE PLACEMENT FINANCING COMPLETED SEPTEMBER 30, 2005
On September 30, 2005, we entered into and completed a financing transaction
pursuant to which we issued and sold 4,000,000 shares of preferred stock at a
purchase price of $2.50 per share. We also issued to the investors warrants to
purchase an aggregate of 1,600,000 shares of common stock, at an exercise price
of $2.50 per share (subject to antidilution adjustments). In addition to the
warrants we issued to the investors, we also issued warrants to purchase up to
200,000 shares of common stock to the three holders of our convertible
debentures we issued in October 2004, as an inducement to, and in consideration
for, the debenture holders' waiver of certain negative covenants that would have
been violated by the financing had the debenture holders not waived them.
6
We received aggregate gross proceeds of $10 million from the sale of these
shares (approximately $9,500,000 net of financing costs, excluding legal fees or
registration expenses). We are using the proceeds of the September 2005
financing for general working capital purposes. We agreed with the investors
that we would not use these proceeds to (i) increase director or executive
compensation without prior board approval, (ii) pay dividends (except on the
preferred stock), (iii) purchase debt or equity securities, (iv) make
investments not directly related to our current business or (v) repay debt
(other than trade payables in the ordinary course of our business).
The following summarizes the principal terms of the transaction:
Preferred Stock
We entered into a share exchange agreement with the investors who purchased
preferred stock, pursuant to which the investors may exchange shares of
preferred stock for shares of common stock. Each share of preferred stock may be
exchanged for that number of shares of common stock that equals the issue price
of the preferred stock ($2.50) divided by an exchange rate, initially set at
$2.50 and subject to reduction in the case of dilutive issuances.
The antidilution adjustment provides that if we sell common stock (or the right
to acquire common stock) for a price lower than the then-current exchange rate,
the exchange rate will be reduced to the amount paid for the shares of common
stock, subject to a floor of $2.17, unless the stockholders of the company
approve the elimination of the floor price. We agreed to propose to our
stockholders that the floor price be eliminated. If the stockholders approve
this proposal and we make a dilutive issuance, then the exchange rate for the
preferred stock may be decreased, first to the floor price, then to the weighted
average price of the securities issued after giving effect to the dilutive
issuance.
We agreed to pay liquidated damages to the investors if we fail to comply with
an investor's request to exchange preferred stock for common stock, if the
registration statement covering the common stock underlying the preferred stock
and the warrants is not declared effective by the Commission within 120 days of
the September 30, 2005 closing date (or, after being declared effective by the
Commission, is unavailable to the investors for the resale of their common
stock) or if the common stock is suspended from trading or is not listed on an
exchange. The liquidated damages will be equal to 3% per month of the aggregate
purchase price paid by investors for the preferred stock.
We agreed to seek the registration of the common stock underlying the preferred
stock and the warrants with the Commission. We undertook to file a registration
statement for such registration within 45 days of completion of the financing,
which we have complied with, having filed a registration statement on November
9, 2005, and agreed that if the Commission does not declare this registration
statement effective within 120 days of completion of the financing, we will pay
liquidated damages to the investors. The liquidated damages will be equal to 3%
per month of the aggregate purchase price paid by investors for the preferred
stock.
If certain redemption events set forth in the exchange agreement occur, the
investors have the right to redeem their shares of preferred stock for cash at a
20% redemption premium over the issue price. These events include those events
entitling the investors to receive liquidated damages if not remedied during
applicable cure periods, and in addition the failure to remove restrictive
legends upon an investor's request when permitted under applicable law, our
announcement that we intend not to issue common stock in exchange for preferred
stock, bankruptcy events, a default under indebtedness of the Company or one of
our material agreements or a concentration of ownership of the Company's capital
stock of 35% which continues for 30 days. After five years, we also have the
right to redeem the preferred stock at a 20% premium over the issue price.
The holders of outstanding shares of preferred stock are entitled to cumulative
annual dividends at the rate of: (i) 6%, for the first 18 months following the
initial sale of preferred stock, (ii) 10% from the 19th through the 24th month
following the initial sale and (iii) 15% after the 24th month following the
initial sale. The dividends shall accrue from day-to-day on each share of
preferred stock, whether or not earned or declared, and shall accrue until paid.
We may pay the dividends with either cash or, if certain conditions are met,
shares of common stock, valued at the volume weighted average price for the
ten-day period immediately prior to the dividend payment date. The dividends
will not accrue on any days where the volume weighted average price of the
common stock for the 30 prior trading days equals or exceeds $6.25. For either
the payment of dividends in the form of common stock or the suspension of the
dividend accrual, the shares of common stock for which the preferred stock may
be exchanged (in the case of suspension of dividends) or which may be issued as
dividends (in the case of payment of dividends in the form of common stock) are
subject to an effective registration statement, the
7
shares of common stock for which the preferred stock may be exchanged and the
common stock underlying warrants is authorized and reserved for issuance and
listed on a trading market, none of the events giving rise to an investor's
right to redeem the preferred stock under the exchange agreement shall have
occurred and not been cured and we do not owe the investors more than $15,000,
in the aggregate, under the transaction documents for the private placement
financing.
Each holder of preferred stock is entitled to one vote per share of issued and
outstanding preferred stock owned by such holder on the record date for the
determination of stockholders entitled to vote, and the holders of the preferred
stock and the common stock shall vote together as a single class (except where
the Delaware General Corporation Law provides that a separate vote of the
holders of preferred stock is required for approval of certain matters, in which
case a majority of the shares of preferred stock outstanding shall be required
for approval).
The preferred stock is preferred over the common stock, and any class or series
of capital stock that our board of directors may create in the future, as to the
assets of the Company available for distribution to the stockholders in the
event of the liquidation, dissolution or winding up of the Company, the sale of
all or substantially all of the assets of the Company or the merger or
consolidation of the Company with another entity that results in either the
existing stockholders of the Company having less than 50% of the outstanding
voting securities of the successor company in the merger or combination
transaction or the members of the board of directors of the Company constituting
50% or less than the members of the board of directors of the successor company
in the merger. Upon the occurrence of one of the transactions listed above, the
holders of preferred stock are to receive, before any distribution or payment is
made to any holders of common stock, the greater of: (i) $3.00 per share of
preferred stock, plus all accrued and unpaid dividends thereon, and (ii) such
amount per share of preferred stock that would have been payable had each share
of preferred stock been tendered in exchange for common stock immediately prior
to the transaction.
Warrants
The warrants are exercisable for five years from the date of listing of the
underlying shares of common stock with the AMEX at an exercise price of $2.50
per share, subject to reduction in the case of dilutive issuances. The
antidilution adjustment provides that if we sell common stock (or the rights to
acquire common stock) for a price lower than the then-current exercise price,
the exercise price will be reduced to the amount paid for the shares of common
stock we issued at such lower price, subject to a floor of $2.12, unless the
stockholders of the Company approve the elimination of the floor price. We
agreed to propose to our stockholders that the floor price be eliminated. If the
stockholders approve this proposal and we make a dilutive issuance, then the
exercise price of the warrants may be decreased, first to the floor price, then
to the weighted average price of the securities issued after giving effect to
the dilutive issuance. If the exercise price of the warrants is so adjusted,
then there will concurrently be an adjustment to the number of shares for which
the warrant will be exercisable, by dividing the product of the former exercise
price multiplied by the number of shares underlying the warrant by the adjusted
exercise price.
The holders of the warrants may exercise their warrants by means of a "cashless
exercise" instead of paying cash to us upon exercise, in which case the holder
shall be entitled to receive a certificate for the number of warrant shares
equal to the quotient obtained by dividing [(A-B)(X)] by (A), where;
(A) = the VWAP (as defined in the Warrant Agreement) on the Trading of
exercise;
(B) = the then current Exercise Price of the warrant, and
(X) = the number of warrant shares issuable upon exercise of the warrant
by means of a cash exercise rather than a cashless exercise
Because of this cashless exercise feature, we may not receive any proceeds from
the exercise of warrants (although we will issue a net number of shares that is
less than the total of 1,800,000 face amount of the warrants). Assuming,
however, that all of the warrants are exercised for cash at our exercise price
of $2.50 per share, then we will receive a total of $4,500,000 for the exercise
of the warrants, and we will issue 1,800,000 shares of common stock. We will use
the proceeds of the exercise of warrants for our general working capital
purposes.
8
Limitations on Ownership
The terms of the preferred stock and the warrants that we issued in the
September 30, 2005 financing limit the ability of any investor to exchange
preferred stock (and for the Company to issue shares of common stock as
dividends) and/or exercise warrants to the extent that the shares of common
stock so issued would exceed 4.99% (or, in the case of certain investors who
already owned over 4.99% of our common stock prior to the financing, 9.99%) of
the shares of common stock outstanding, unless this limitation is waived in
advance by the investor.
PARTICIPATION BY RELATED PARTIES IN THE SEPTEMBER 30, 2005 PRIVATE PLACEMENT
FINANCING
Among the investors in the financing transaction that we completed on September
30, 2005 are ProMed Partners, L.P., ProMed Partners II, L.P., ProMed Offshore
Fund, Ltd. and ProMed Offshore Fund II, L.P. Prior to the September 30, 2005
financing, these entities collectively beneficially owned excess of 5% of our
outstanding common stock. These entities collectively invested a total of $2
million in our September 30, 2005 financing transaction, and accordingly, we
issued an aggregate of 800,000 shares of preferred stock and warrants to
purchase up to 320,000 shares of common stock to these entities. The ProMed
entities participated in the September 30, 2005 financing transaction on
identical terms as the other investors in that financing.
One of our private placement agents in the September 30, 2005 financing, Musket
Research Associates, Inc., is a related party to the ProMed entities.
Specifically, Mr. David Musket is the president of Musket Research Associates
and he also has investment and voting control over the shares of our common
stock beneficially owned by the ProMed entities. With the prior approval of our
board of directors, we entered into a written placement agency agreement with
Musket Research Associates. Pursuant to that agreement, Musket Research
Associates raised $7 million in gross proceeds in the September 30, 2005
financing (including the $2 million invested by the ProMed entities), and we
paid Musket Research Associates commissions of $350,000 for its services in
connection with the September 30, 2005 financing. The rate of commission paid to
Musket Research Associates is the same rate as that we paid to our other private
placement agent in the September 30, 2005 financing, Roth Capital Partners, LLC,
which is not a related party. Roth Capital raised $3 million in gross proceeds
and accordingly we paid $150,000 in placement agent fees to Roth Capital. Our
board of directors determined that our agreement with Musket Research to be on
fair terms, as if it had been negotiated at arms-length with an unrelated party.
Among the holders of convertible debentures we issued in October 2004 to
investors who participated in a financing that we entered into on September 28,
2004 is Omicron Master Trust. As a result of the securities it acquired in that
transaction, Omicron became the beneficial holder of in excess of 5% of our
common stock. The terms of the debentures we issued to Omicron and the two other
debt investors in the 2004 private placement include negative covenants that
were implicated by the proposed financing that we ultimately completed on
September 30, 2005. As an inducement to, and in consideration for, the waiver of
these negative covenants, we issued common stock purchase warrants to Omicron
and the other debenture holders for the purchase of 200,000 shares of common
stock, on a pro rata basis, according to the principal amount of debentures
held. Of these, we issued 119,181 warrants to Omicron. Our board of directors
determined that the issuance of these warrants was fair consideration for the
waiver of rights by the debenture holders as if the same had been negotiated at
arms-length with unrelated parties.
BANK LINES OF CREDIT
Diomed, Ltd., the Company's United Kingdom-based subsidiary, utilizes an
overdraft facility as well as an accounts receivable line of credit with
Barclays Bank, limited to the lesser of (GBP)100,000 ($177,000 at September 30,
2005), or 80% of eligible accounts receivable. The credit line bears interest at
a rate of 3% above Barclays' base rate of 4.5% at September 30, 2005 and
borrowings are due upon collection of receivables from customers. As security
for the line of credit, Barclays Bank has a lien on all of the assets of Diomed
Ltd., excluding certain intellectual property. As of September 30, 2005 and
2004, there was approximately $193,000 and $0, respectively outstanding under
these credit facilities.
9
COMMITMENT FOR LUMINETX INVESTMENT
On August 5, 2005, we entered into a distribution agreement with Luminetx,
pursuant to which Luminetx appointed us a distributor and granted us the
exclusive right to distribute and sell Luminetx' patented biomedical imaging
system known as the VeinViewer(TM) Imaging System for physicians who perform
sclerotherapy, phlebectomies or varicose vein treatments, initially in the
United States and the United Kingdom, with additional territories to be
negotiated as VeinViewer(TM) receives regulatory clearance in other countries,
on terms to be agreed. We loaned $500,000 to Luminetx on August 5, 2005 and will
invest the remaining $500,000 in Luminetx when it delivers to us a minimum
number of VeinViewer(TM) systems, as specified in our distribution agreement. We
converted our $500,000 loan to Luminetx into 250,000 shares of Luminetx
preferred stock, convertible into common stock on a share-for-share basis, and
warrants to purchase 50,000 shares of Luminetx common stock at $2.00 per share,
exercisable for five years, as part of an $11 million private placement
financing that Luminetx announced on November 4, 2005. We will invest the
remaining $500,000 of our loan commitment to Luminetx for preferred stock and
warrants on the same terms. We intend to fund the investment in Luminetx out of
our working capital resources.
(4) CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of the Company's financial condition, results of
operations, and cash flows are based on the Company's consolidated financial
statements. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate these estimates, including those
related to bad debts, inventory valuation and obsolescence, intangible assets,
income taxes, warranty obligations, contingencies and litigation. We base our
estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
Equity Transactions
In many of our financing transactions, the Company has issued warrants.
Additionally, the Company issues options and warrants to non-employees from time
to time as payment for services. In all of these cases, the Company applies the
principles of SFAS No. 123 "Accounting for Stock-based Compensation" to value
these awards, which inherently include a number of estimates and assumptions
including stock price volatility factors. In addition to interest expense, the
Company records financing and certain offering costs associated with its capital
raising efforts in its statements of operations. These include amortization of
debt issue costs such as cash, warrants and other securities issued to finders
and placement agents, and amortization of debt discount created by in-the-money
conversion features on convertible debt accounted for in accordance with
Emerging Issues Task Force ("EITF") Issue 98-5, "Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios," and Issue 00-27, "Application of Issue 98-5 to Certain
Convertible Instruments," by other securities issued in connection with debt as
a result of allocating the proceeds amongst the securities in accordance with
Accounting Principles Board ("APB") Opinion No. 14, "Accounting for Convertible
Debt and Debt Issued with Stock Purchase Warrants", based on their relative fair
values. The Company has based its estimates and assumptions on the best
information available at the time of valuation, however, changes in these
estimates and assumptions could have a material effect on the valuation of the
underlying instruments.
(5) RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB revised SFAS No. 123, Share Based Payment, or SFAS
No. 123R. SFAS No. 123R supersedes APB Opinion No. 25, Accounting for Stock
Issued to Employees, and amends Statement No. 95, Statement of Cash Flows. Under
SFAS No. 123R, companies must calculate and record in the income statement the
cost of equity instruments, such as stock options, awarded to employees for
services received. The cost of the equity instruments is to be measured based on
the fair value of the instruments on the date they are granted and is required
to be recognized over the period during which the employees are required to
provide services in exchange for the equity instruments. SFAS No. 123R has been
deferred and is now effective for the Company in the first fiscal year beginning
after December 15, 2005.
The adoption of SFAS No. 123R is expected to have a significant impact on the
Company's financial statements. The impact of adopting SFAS No. 123R cannot be
accurately estimated at this time, as it will depend on the market value and the
amount of share-based awards granted in future periods.
In March 2005, the SEC issued Staff Accounting Bulletin ("SAB") No. 107 ("SAB
107"). SAB 107 provides guidance for the implementation of SFAS 123R with
respect to valuation techniques, expected volatility and expected term for
valuing employee stock options among other matters. The provisions of SAB 107
will be effective for the Company at the time the Company adopts SFAS 123R.
10
ITEM 3. CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures.
The Company's principal executive officer and its principal financial officer
have carried out an evaluation of the effectiveness of our disclosure controls
and procedures (as defined in Rules 13a -15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of September 30, 2005 and have concluded
that, as of such date, the Company's disclosure controls and procedures in place
are operating effectively to ensure material information and other information
requiring disclosure is identified and communicated on a timely basis.
(b) Changes in internal control over financial reporting.
During the period covered by this report, there have been no significant changes
in our internal control over financial reporting that have materially affected
or are reasonably likely to materially affect our internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Misappropriation Litigation vs. Vascular Solutions
On December 12, 2003, we filed a lawsuit in the United States District Court for
the District of Massachusetts seeking injunctive and other relief against
Vascular Solutions, Inc. and one of its executives. We allege, among other
things, that Vascular Solutions and the executive misappropriated our trade
secrets and then improperly used that information to develop and market laser
accessory products. We also seek to redress what we allege to be the willful and
deceptive manner in which Vascular Solutions has been marketing its laser
accessory products by, among other things:
- infringing our registered EVLT(R) mark, including by Vascular Solutions'
use of the mark "ELT;"
- marketing Vascular Solutions' products in a way designed to confuse
consumers as to the source and origin of its products;
- making false and defamatory statements about us and our products;
- tortiously interfering with our existing and prospective customer
relationships; and
- tortiously interfering with agreements previously entered into by the
executive and us that prohibit the executive from disclosing our
confidential information to Vascular Solutions or any other third party.
On June 16, 2004, Vascular Solutions and the other the defendant answered the
complaint, and filed a counterclaim for invalidity of the EVLT(R) trademark. On
July 13, 2005 the Court heard oral arguments on Vascular Solutions' motion for
summary judgment on all claims. Vascular Solutions conceded that it would
stipulate to desist from any further use of the mark ELT, which Diomed alleged
infringes Diomed's federally-registered EVLT(R) trademark. Vascular Solutions
further stipulated that it would desist from any further dissemination of the
defamatory statements alleged in Diomed's complaint.
'777 Patent Litigation
On March 4, 2004, we filed a second lawsuit against Vascular Solutions in the
United States District Court for the District of Massachusetts seeking
injunctive relief and damages for infringement of our U.S. Patent Number
6,398,777 (the "'777 patent") covering the endovascular laser treatment of
varicose veins which we use in our EVLT(R) product line, the exclusive rights to
which we acquired on September 3, 2003.
On April 28, 2004, Vascular Solutions answered the complaint and filed a
counterclaim for declaratory judgment that the '777 patent is invalid and not
infringed. Vascular Solutions amended its answer and counterclaims to further
allege patent unenforceability. In addition, Vascular Solutions moved to
bifurcate the damages and willful infringement aspects of this case. We opposed
this motion and on June 28, 2005 the court denied Vascular Solutions' motion.
We are now completing the discovery phase of this litigation. For purposes of
efficiency, this case has been consolidated with another case for pretrial
purposes as discussed below.
11
On January 6, 2004, we filed a lawsuit in the United States District Court for
the District of Massachusetts against AngioDynamics, Inc. seeking injunctive
relief and damages for infringement of the '777 patent. AngioDynamics has
generally denied our allegations and has sought a declaratory judgment of
invalidity of the '777 patent. AngioDynamics has also added certain
counterclaims against us, including antitrust violations, patent misuse and
other allegations, all arising from our obtaining and seeking to enforce the
'777 patent. The court has bifurcated the case, so that those counterclaims will
not be litigated until we resolve our patent infringement claims against
AngioDynamics. At the parties' joint request, however, our patent cases
involving AngioDynamics and Vascular Solutions have been consolidated by the
court for pretrial purposes. We are now completing the discovery phase of this
litigation.
On April 12, 2005, the Court issued a claim construction ruling, which
interprets certain claim language in the '777 patent. We believe that the
evidence we have developed to date in the course of these lawsuits if admitted
and fully credited will show that AngioDynamics and Vascular Solutions are
infringing our patent as it has now been interpreted by the Court.
On April 2, 2004, we filed a lawsuit in the United States District Court for the
District of Massachusetts against Total Vein Solutions, LLC, seeking injunctive
relief and damages for infringement of the '777 patent covering the endovascular
laser treatment of varicose veins which we use in our EVLT(R) product line. On
May 21, 2004, Total Vein Solutions answered the complaint, generally denying our
allegations and counterclaiming for declaratory judgment of non-infringement and
invalidity of the EVLT(R) patent. We are in the discovery phase of this
litigation.
On October 14, 2004, we filed a lawsuit in the United States Federal District
Court for the District of Massachusetts against New Star Lasers, Inc., d/b/a
Cooltouch, Inc., seeking injunctive relief and damages for infringement of the
'777 patent covering the endovascular laser treatment of varicose veins which we
use in our EVLT(R) product line. On December 3, 2004, CoolTouch answered the
complaint, generally denying our allegations and counterclaiming for declaratory
judgment of non-infringement and invalidity of the EVLT(R) patent. We are now
proceeding with the discovery phase of this litigation.
VNUS Technologies Litigation
On July 21, 2005, a lawsuit was filed against us in the United States District
Court for the Northern District of California by VNUS Medical Technologies,
Inc., alleging infringement of U.S. patents Nos. 6,258,084, 6,638,273,
6,752,803, and 6,769,433. The complaint was served on us on July 27, 2005. On
September 15, 2005, we filed an answer denying the allegations of infringement,
and counterclaiming against VNUS for a declaration that none of the patents are
infringed and that they are all invalid. On October 12, 2005, VNUS served an
amended complaint adding two additional parties, AngioDynamics, Inc. and
Vascular Solutions, Inc., as defendants. On October 31, 2005, we filed an answer
to the First Amended Complaint, again denying the allegations of infringement,
and counterclaiming against VNUS for a declaration that none of the patents are
infringed, that they are all invalid, and that two of VNUS' patents are
unenforceable for inequitable conduct. An initial scheduling conference for the
case has been set for December 2, 2005. We intend to continue defending this
case.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
Please see Item 6 for reference to Current Reports on Form 8-K that we filed
with respect to the two transactions wherein we made unregistered sales of
equity securities during the fiscal quarter ended September 30, 2005.
12
ITEM 6. REPORTS ON FORM 8-K
31.1 Certification by the Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
31.2 Certification by the Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002
32.1 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
32.2 Certification of Principal Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K.
During the fiscal quarter ended September 30, 2005, we filed with the Securities
and Exchange Commission Current Reports on Form 8-K as follows:
On August 11, 2005, we filed a Current Report on Form 8-K disclosing that we
entered into a distribution agreement with Luminetx Corporation pursuant to
which Luminetx appointed us as a distributor and granted us an exclusive right
to distribute and sell Luminetx' patented biomedical imaging system known as the
VeinViewerTM Imaging System to physicians performing sclerotherapy,
phlebectomies or varicose vein treatments, in the United States and the United
Kingdom. In connection with this distribution agreement, we issued to Luminetx
warrants to purchase up to 600,000 shares of common stock.
Additionally, on October 4, 2005, we filed a Current Report on Form 8-K
disclosing that that on September 30, 2005, we entered into definitive
agreements for the sale and issuance of shares of the Company's preferred stock,
par value $0.001 per share and warrants to purchase the Company's common stock,
par value $0.001 per share to certain accredited investors in a private
placement financing transaction, and that on that same day, we completed the
sale of 4 million shares of preferred stock and warrants to purchase up to 1.6
million shares of common stock to the investors, and received gross proceeds of
$10 million. In connection with this financing transaction, we issued warrants
to purchase up to an additional 200,000 shares of common stock to the holders of
convertible debentures that we issued in October 2004 as an inducement to and in
consideration for a waiver by these debenture holders of a negative covenant
that would have been implicated by the September 30, 2005 financing, absent that
waiver.
On October 28, 2005, the Company filed a Current Report of Form 8-K disclosing
additional information discussed on its Third Quarter 2005 Conference Call, held
on October 27, 2005. The Company estimated that the recent hurricanes had a
financial impact of between $100,000 and $150,000, representing three to five
laser sales that were not completed due to the storms. The Company discussed the
launch of a new laser platform, DELTA, at a list price between 37,900 and
$39,900 per DELTA D-15 laser (depending on configuration) as compared to $33,900
for the Company's current D-15 laser, and that manufacturing efficiencies are
expected to provide higher margins for DELTA lasers than the existing laser
line. The Company stated that the VeinViewer(TM) would be offered at a list
price of $17,500.
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SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.
DIOMED HOLDINGS, INC.
(REGISTRANT)
By: /s/ JAMES A. WYLIE, JR.
----------------------------------------
Name: James A. Wylie, Jr.
Title: President and Chief Executive Officer,
Director
Date: November 14, 2005
By: /s/ DAVID B. SWANK
----------------------------------------
Name: David B. Swank
Title: Chief Financial Officer, Director
Date: November 14, 2005
14