AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON DECEMBER 1, 2005
REGISTRATION NO. 333-129584
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2/A
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
DIOMED HOLDINGS, INC.
(NAME OF SMALL BUSINESS ISSUER)
DELAWARE 3845 84-1480636
- ------------------------------- --------------------------- -----------------
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
ONE DUNDEE PARK
ANDOVER, MA 01810
(978) 475-7771
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
-----------------
JAMES A. WYLIE, JR.
PRESIDENT AND CHIEF EXECUTIVE OFFICER
ONE DUNDEE PARK
ANDOVER, MA 01810
(978) 475-7771
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)
COPY TO:
WILLIAM A. NEWMAN, ESQ.
MCGUIREWOODS LLP
1345 AVENUE OF THE AMERICAS, 7TH FLOOR
NEW YORK, NEW YORK 10105
(212) 548-2100
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.
If any of the securities being registered on this form are to be offered on a
delayed basis pursuant to Rule 415 under the Securities Act of 1933, other than
securities offered only in connection with dividend or interest reinvestment
plans, check the following box. |_|
If this form is filed to register additional securities for an offering pursuant
to Rule 462(b) under the Securities Act of 1933, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering.|_|
If this form is a post-effective amendment filed pursuant to Rule 462(c) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.|_|
If this form is a post-effective amendment filed pursuant to Rule 462(d) under
the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering.|_|
If delivery of the prospectus is expected to be made pursuant to Rule 434 check
the following box. |_|
CALCULATION OF ADDITIONAL REGISTRATION FEE
====================================================================================================================================
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF OFFERING PRICE PER PROPOSED MAXIMUM AMOUNT OF REGISTRATION
SECURITIES TO BE REGISTERED AMOUNT TO BE REGISTERED SHARE(1) AGGREGATE OFFERING PRICE FEE
----------------------------- ------------------------ --------------------- -------------------------- ---------------------------
Shares of common stock, par
value $0.001 per share, issuable
upon exchange of preferred stock,
par value $0.001 per share, that we
sold to the Selling Stockholders on
September 30, 2005 and common stock
underlying warrants that we issued in 2005
to the purchasers of the preferred stock
and certain other persons. 10,937,500 $2.08 $22,750,000 $2,677.68*
* Previously paid.
(1) Estimated solely for the purpose of determining the amount of the
registration fee, based upon the average of the high and low sales prices of the
common stock as reported by the American Stock Exchange in accordance with Rule
457 under the Securities Act of 1933, which was $2.08 per share on November 4,
2005. Pursuant to Rule 416 under the Securities Act of 1933, the number of
shares of common stock registered hereby is subject to adjustment to prevent
dilution resulting from stock splits, stock dividends or similar transactions.
The Registrant hereby amends this Registration Statement on such date or dates
as may be necessary to delay its effective date until the Registrant shall file
a further amendment which specifically states that this Registration Statement
shall thereafter become effective in accordance with Section 8(a) of the
Securities Act of 1933, as amended, or until the Registration Statement shall
become effective on such date as the Securities and Exchange Commission, acting
pursuant to said Section 8(a), may determine.
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED DECEMBER 1, 2005
PROSPECTUS
10,937,500 SHARES OF COMMON STOCK
DIOMED HOLDINGS, INC.
In this prospectus, unless the context requires otherwise, "we," "our," "us,"
"Diomed" and the "Company" refer to Diomed Holdings, Inc. and its subsidiaries.
We have prepared this prospectus to allow the holders of the common stock that
is being registered with the Securities and Exchange Commission pursuant to the
registration statement of which this prospectus is a part (referred to herein as
the "Selling Stockholders") to sell up to an aggregate of 10,937,500 shares of
our common stock. We will not receive any of the proceeds from the sale of
common stock by the Selling Stockholders.
The Selling Stockholders have advised us that they will sell the shares from
time to time in the open market, on the American Stock Exchange (AMEX), in
privately negotiated transactions or a combination of these methods, at market
prices prevailing at the time of sale, at prices related to the prevailing
market prices, at negotiated prices, or otherwise as described under "Plan of
Distribution." We will pay all expenses of registration incurred in connection
with this offering, but the Selling Stockholders will pay all of their selling
commission, brokerage fees and related expenses.
Our common stock is currently traded on the AMEX under the symbol "DIO." On
November 29, 2005, the closing trading price of our common stock as reported on
the AMEX was $2.13 per share.
SEE "RISK FACTORS," BEGINNING ON PAGE 6, FOR A DISCUSSION OF CERTAIN RISK
FACTORS THAT YOU SHOULD CONSIDER BEFORE PURCHASING SHARES OF OUR COMMON STOCK.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this prospectus is ___________, 2005.
TABLE OF CONTENTS
DESCRIPTION PAGE
SUMMARY.................................................................................3
SUMMARY FINANCIAL DATA..................................................................4
RISK FACTORS............................................................................6
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS...........................19
RECENT DEVELOPMENTS....................................................................20
CAPITALIZATION.........................................................................21
DIVIDEND POLICY........................................................................22
BUSINESS...............................................................................22
LEGAL PROCEEDINGS......................................................................36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF OPERATION.......38
RESULTS OF OPERATIONS..................................................................40
LIQUIDITY AND CAPITAL RESOURCES........................................................45
CRITICAL ACCOUNTING POLICIES...........................................................52
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES.......................................53
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING...................................53
DESCRIPTION OF PROPERTY................................................................53
RELATED TRANSACTIONS...................................................................54
CERTAIN MARKET INFORMATION.............................................................66
DESCRIPTION OF SECURITIES..............................................................67
MANAGEMENT.............................................................................70
EXECUTIVE COMPENSATION.................................................................73
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................80
SELLING STOCKHOLDERS...................................................................82
PLAN OF DISTRIBUTION...................................................................85
TRANSFER AGENT.........................................................................86
LEGAL MATTERS..........................................................................86
EXPERTS................................................................................86
WHERE YOU CAN FIND MORE INFORMATION....................................................86
FINANCIAL STATEMENTS..................................................................F-i
PART II..............................................................................II-1
INDEMNIFICATION OF OFFICERS AND DIRECTORS............................................II-1
RECENT SALES OF UNREGISTERED SECURITIES..............................................II-1
EXHIBITS............................................................................II-14
UNDERTAKINGS........................................................................II-17
SIGNATURES..........................................................................II-18
INDEX TO EXHIBITS...................................................................II-19
2
SUMMARY
THE COMPANY
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. Using our proprietary technology,
including our exclusive rights to U.S. Patent No. 6,398,777 and related foreign
patents for the endovenous laser treatment of varicose veins, we currently focus
on endovenous laser treatment (our EVLT(R) product line) for use in varicose
vein treatments, photodynamic therapy (our PDT product line) for use in cancer
treatments, and other clinical applications.
Our principal executive offices are located at One Dundee Park, Andover, MA
01810. Our telephone number is (978) 475-7771.
THE OFFERING
Common stock currently outstanding
and available to trade publicly(1) 19,423,728 shares
Common stock offered by the
Selling Stockholders(2) 10,937,500 shares
Common stock to be available
to trade publicly
after the offering(3) 30,361,228 shares
Use of proceeds We will not receive any
proceeds from the sale of the
shares of common stock offered
by this prospectus.
American Stock Exchange Symbol DIO
- ----------
(1) Includes approximately 7.2 million shares held by affiliates. See "Security
Ownership of Certain Beneficial Owners and Management," below.
(2) This number (i) assumes (a) the full exchange of the 4 million shares of
preferred stock we issued in our private placement equity financing on September
30, 2005 for 4 million shares of common stock, (b) that a total of $5.9 million
in dividends will accrue on the preferred stock and that we pay all such
dividends in the form of common stock at an average price per share of $2.00,
(c) the full exercise of the common stock purchase warrants that we issued in
our private placement financing on September 30, 2005 for 1.6 million shares of
common stock, (d) the full exercise of the common stock purchase warrants for
200,000 shares of common stock that we issued on September 30, 2005 to the
holders of then-outstanding variable rate convertible debentures that we issued
in our private placement financing on October 25, 2004 as an inducement for the
waiver of negative covenants that would have precluded us from making certain
agreements in favor of the investors in the private placement financing that we
completed on September 30, 2005 and (ii) reflects a 25% allowance for possible
increase in common stock that may become issuable pursuant to antidilution
provisions of the preferred stock and warrants that we issued on September 30,
2005. See "Selling Stockholders - Determination of Number of Shares to be
Registered," below for details regarding how we calculated the number of shares
to be registered under this registration statement of which this prospectus is a
part.
3
(3) Assumes we do not issue any other shares of common stock prior to the
offering.
SUMMARY FINANCIAL DATA
The following table summarizes the financial data for our business and includes
our audited consolidated financial data for the years ended December 31, 2003
and 2004, and unaudited consolidated financial data for the nine months ended
September 30, 2004 and 2005. You should read the following information in
conjunction with the consolidated financial statements and the related financial
statement notes appearing elsewhere in this prospectus. We will use the net
proceeds of the September 30, 2005 financing transaction for general working
capital purposes.
STATEMENT OF OPERATIONS DATA (IN THOUSANDS, EXCEPT PER SHARE)
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
2003 2004 2004 2005
---------- ---------- ---------- ----------
(UNAUDITED)
Revenues $ 9,198 $ 13,385 $ 9,409 $ 13,488
Cost of Revenues 5,873 7,920 5,822 7,325
---------- ---------- ---------- ----------
Gross Profit 3,325 5,465 3,587 6,163
---------- ---------- ---------- ----------
Operating Expenses:
Research and Development 850 1,695 1,123 1,151
Selling and Marketing 4,055 7,161 4,866 6,693
General and Administrative 4,400 6,422 4,522 5,475
---------- ---------- ---------- ----------
Total Operating Expenses 9,305 15,278 10,511 13,319
---------- ---------- ---------- ----------
Loss from Operations (5,980) (9,813) (6,924) (7,156)
---------- ---------- ---------- ----------
Interest Expense, Non-cash 12,893 109 -- 1,503
Interest Expense, Cash-based 1,008 155 37 188
---------- ---------- ---------- ----------
Total Interest Expense 13,901 264 37 1,691
---------- ---------- ---------- ----------
Net Loss $ (19,881) $ (10,077) $ (6,961) $ (8,847)
Less: Preferred
Stock Dividends -- -- -- (763)
Net Loss Applicable
to Common Stockholders $ (19,881) $ (10,077) $ (6,961) $ (9,610)
========== ========== ========== ==========
Basic and Diluted Net Loss per
Share Applicable to Common
Stockholders (1) $ (8.99) $ (0.68) $ (0.50) $ (0.50)
========== ========== ========== ==========
Basic and Diluted Weighted Average
Common Shares Outstanding (1) 2,212 14,753 14,042 19,143
========== ========== ========== ==========
4
SEPTEMBER 30,
2005
ACTUAL
(UNAUDITED)
BALANCE SHEET DATA
(IN THOUSANDS)
Cash and cash equivalents (2) $ 14,801
Short-term investments 1,769
Working Capital (3) 14,588
Total assets 29,163
Non-current liabilities(4) 2,697
Preferred Stock (5) 7,755
Accumulated deficit (78,260)
Total stockholders' equity $ 9,917
(1) Adjusted to give effect to the 1 for 25 reverse stock split, effective June
17, 2004, on a retroactive basis.
(2) The cash balance includes the $10 million in proceeds received in the
September 30, 2005 financing transaction.
(3) Working capital includes the transaction issuance costs of $765,000 and the
warrant liability of $1,861,328 which is based on the allocation of the relative
fair value of the proceeds received in the September 30, 2005 financing
transaction.
(4) Non-current liabilities includes an additional debt discount of $256,969
based on Black-Scholes value for the 200,000 warrants issued to the 2004
debenture holders.
(5) Preferred stock includes 4 million shares issued at an exchange price of
$2.50 net of issuance costs of $765,000 and the relative fair value of the
warrants of $1,861,328, offset by the fair value adjustment of $381,328 to
present preferred stock at its exchangeable balance.
5
RISK FACTORS
If you purchase our common stock and become a Company stockholder, you will be
subject to the risks inherent in our business. Our stock price will fluctuate
for many reasons, including how our business performs relative to, among other
things, competition, market conditions and general economic and industry
conditions. You should carefully consider the following risk factors as well as
other information in this prospectus before purchasing our common stock. The
risks and uncertainties described below are intended to be the material risks
that are specific to us and to our industry. If any of the following risks
actually occur, the market price of our common stock could decline, and you may
lose all or a significant part of the money you paid to buy our common stock.
There may be other risks which we do not believe are currently material that may
nonetheless impair our business.
The following risks relate primarily to general business issues including, our
business plan, operations, revenues, losses, manufacturing, distribution, sales,
marketing, distribution and personnel:
WE HAVE A HISTORY OF SIGNIFICANT OPERATING LOSSES. WE MAY NOT EVER ACHIEVE OR
MAINTAIN PROFITABILITY.
We have incurred significant operating losses since our inception, and, as of
September 30, 2005, we have accumulated a deficit of approximately $78.3
million, including approximately $17.5 million in non-cash interest expense. We
may continue to incur operating losses, depending largely upon the commercial
success of our EVLT(R) product line. We will need to generate revenues in excess
of our expenses to become profitable, and we may be unable to do so. If we do
not become profitable, the value of our common stock may decline.
Our operating losses may increase as we continue to incur costs for research and
development, regulatory, sales and marketing, manufacturing and general
corporate activities. Whether we achieve and maintain profitability depends in
part upon our ability, alone or with others, to successfully complete the
development of future clinical applications, obtain required regulatory
clearances and sell our products at profitable prices.
YOU MAY HAVE DIFFICULTY EVALUATING AN INVESTMENT IN OUR STOCK BECAUSE WE HAVE A
LIMITED OPERATING HISTORY IN OUR CURRENT MARKETS.
Although we were founded in 1991, we have commercially offered the products used
in our EVLT(R) product line only since late 1999 in Europe and January 2002 in
the United States. As a result, you can evaluate our business only on this very
limited operating history. This short history may not provide an adequate basis
for you to fully assess our ability to successfully develop or achieve market
acceptance of our products, or to respond to competition.
OUR REQUIRED EXPENDITURES MAY EXCEED OUR BUDGETED EXPENSES, AND WE MAY NOT BE
ABLE TO PAY FOR UNANTICIPATED EXPENSES OUT OF REVENUE OR OBTAIN ADDITIONAL
INVESTMENT CAPITAL TO FUND THESE EXPENSES.
In November 2003, we completed a private placement equity financing transaction
in which we raised gross proceeds of $22 million and satisfied $1.2 million in
debt which we had incurred in a May 2003 bridge financing.
In April 2004, we completed a targeted offering to stockholders of records as of
August 29, 2003, in which we raised gross proceeds of approximately $3 million.
In October 2004, we completed a private placement equity and debt financing
transaction in which we raised gross proceeds of $10.6 million.
In September 2005, we completed a private placement equity financing transaction
in which we raised gross proceeds of $10 million.
We have applied, and will continue to apply these proceeds, net of offering
costs, together with our operating revenue, to pay for our general working
capital needs. However, the capital that we received from our recent equity and
debt financings may not be sufficient to pay for all of our required
expenditures if we have underestimated our expenditures or have overestimated
our revenues when we prepared our business plan. We may need additional
resources to fund the growth, acquisitions and working capital that our business
plan envisions. The timing and amount of our future capital requirements will
depend on many factors, including:
6
- the scope and results of preclinical studies and clinical trials;
- the time and costs involved in obtaining regulatory approvals;
- the costs involved in preparing, filing, prosecuting, maintaining and
enforcing our patents;
- the costs involved in litigation;
- competing technological and market developments;
- our ability to establish additional collaborations;
- changes in existing collaborations;
- our dependence on others for development of our potential products;
- the cost of manufacturing, marketing and distribution;
- the opportunities available for making acquisitions that would enhance
our business; and
- the effectiveness of our activities.
If we require additional funds, we cannot be certain that such funds will be
available to us on reasonable terms, or at all. In particular, given our capital
structure after completing the September 30, 2005 equity financing and the
current market price of our common stock, we may not be able to attract further
new investment capital in the near future. The inability to obtain additional
financing could cause us to reduce or cease operations, sell all or a portion of
our assets, seek a sale of our business or enter into a business combination
with a third party.
WE MAY NEED TO EXPAND OUR EXISTING MARKETING AND SALES RESOURCES.
Our marketing and sales resources may not be adequate for the successful
commercialization of our products. Currently, we rely primarily on direct sales
representatives for the U.S. market and independent distributors for the
international market. Direct sales representatives are our employees. Direct
sales representatives are paid a salary plus commissions on sales they make.
Distributors purchase products from us and then resell our products and services
to third parties. Our officers and employees develop and implement our marketing
strategy, although we do periodically engage non-employee consultants, acting as
independent contractors, to assist us in these efforts.
As of December 1, 2005, we employed 19 full time sales representatives, two
regional sales managers, a vice president of North American sales, as well as
four clinical specialists.
Market forces, such as increasing competition, increasing cost pressures on our
customers and general economic conditions, may require us to devote more
resources to our sales and marketing efforts, such as changing the composition
of our sales and marketing staff and changing our marketing methods, as well as
the expansion of our product lines. These changes may result in additional
expenses. For example, we will incur additional salary expenses if we increase
hiring of direct sales representatives to replace any distributors that we use.
Similarly, if we increase our reliance on marketing efforts, we will incur
greater costs.
As we expand our sales force and increase our marketing activities, we cannot
make any assurances that those efforts will result in more sales or higher
revenue. Further, even if we increase our spending on sales and marketing, we
may not be able to maintain our current level of sales.
WE MAY NEED TO EXPAND OUR EXISTING MANUFACTURING AND DISTRIBUTION CAPABILITIES.
Our manufacturing and distribution capabilities, and any current or future
arrangements with third parties for these activities, may not be adequate for
the successful commercialization of our products.
To be successful, we must manufacture our products in commercial quantities, at
acceptable costs and under standards imposed by the FDA and other regulators. We
currently have the capacity to manufacture products at certain commercial levels
within existing good manufacturing practices. Future regulatory clearances by
the FDA and other regulatory agencies could result in the need to expand our
manufacturing operations. If we expand our manufacturing capabilities, we may
need to spend substantial funds, hire and retain significant additional
personnel and comply with extensive regulations. If we are not able to expand
our manufacturing capabilities, or are unable to continue to comply with good
manufacturing practices, our ability to grow and to maintain our competitiveness
may be significantly hindered.
WE RELY ON OUR AGREEMENTS WITH OUR SUPPLIERS. IF WE FAIL TO MAINTAIN OR
ESTABLISH THESE AGREEMENTS, WE MAY NOT BE ABLE TO OBTAIN MATERIALS THAT ARE
NECESSARY TO DEVELOP OUR PRODUCTS AND THEIR APPLICATIONS.
7
We depend on outside suppliers for certain raw materials and other components
for our products, including the diodes for our lasers. Raw materials or
components that we need may not always be available at our standards or on
acceptable terms, if at all, and we may be unable to get alternative suppliers
or produce needed materials or components on our own. If we cannot obtain these
raw materials or components, we may be unable to make our products in sufficient
quantities to meet our customers' needs. Moreover, lead times for components and
materials may vary significantly depending on the size of the order, specific
supplier requirements and current market demand for the components. Inability of
our suppliers to meet our requirements on a timely basis could interrupt our
production until we obtain an alternative source of supply. To date, we have not
experienced significant delays in obtaining any of our products.
We may also be unable to develop new products and applications and conduct
clinical trials. This will, in turn, hinder our ability to obtain regulatory
approval of these applications, thereby impairing our ability to expand our
markets or create products for new treatments.
In August 2005, we entered into an agreement with Luminetx Corporation
("Luminetx") whereby Luminetx appointed us as its exclusive distributor of its
new VeinViewer(TM) product to physicians performing sclerotherapy, phlebectomies
or varicose vein treatments, in North American and the United Kingdom. Luminetx
has received FDA clearance for VeinViewer(TM) in 2004, but has not yet
manufactured commercial quantities of this product. Luminetx expects to do so in
the first quarter of 2006. If Luminetx is unable to achieve its manufacturing
capacity, we will not be able to fulfill our expectations with respect to
VeinViewer(TM) revenue.
WE MAY NOT BE ABLE TO ATTRACT AND RETAIN KEY PERSONNEL AND CONSULTANTS. IF WE
FAIL TO DO SO, WE MAY NOT BE ABLE TO DEVELOP OUR APPLICATIONS.
Our success depends in large part on our ability to attract and retain highly
qualified management and other personnel. We depend upon the principal members
of our management team, key employees, staff and consultants that we engage from
time to time. Competition for this talent is intense, and we may not be able to
continue to attract and retain this talent. If we are unable to attract and
retain skilled personnel, our business would suffer.
We have limited resources to attract and retain personnel. Our ability to
compensate and provide incentives to management and our employees depends on our
financial resources and the availability of equity compensation. In the fourth
quarter of 2003, our stockholders approved a new incentive compensation plan
providing for up to 1.6 million shares of common stock to be issued to our
officers, directors, employees and consultants. On May 17, 2005, at our annual
meeting of stockholders, the stockholders approved an amendment to that plan
increasing the number of shares available for grant to 3.1 million. As of
November 1, 2005, approximately 1.5 million shares were available for grant
under this incentive plan. This amount may not be adequate for our needs, and we
may wish to adopt a new incentive plan or increase the number of shares
available under our existing plans. Any new incentive plan will require
stockholder approval before we may grant any stock options or other equity
compensation under a new plan.
In addition, our directors and senior officers are likely to require that we
maintain directors' and officers' insurance at levels comparable to that which
we have maintained in the past. The premiums for this coverage represent a
significant expense and are subject to substantial increases if the insurance
market becomes more limited. Our current directors' and officers' liability
insurance policies provide this coverage through February 2006. If we are unable
to provide adequate compensation or are unable to obtain sufficient directors'
and officers' insurance coverage, we may not be able to attract or retain key
personnel.
Personnel changes may disrupt our operations. Hiring and training new personnel
will entail costs and may divert our resources and attention from
revenue-generating efforts. From time to time, we also engage consultants to
assist us in our business and operations. These consultants serve as independent
contractors, and we therefore do not have as much control over their activities
as we do over the activities of our employees. Our consultants may be affiliated
with or employed by other parties, and some may have consulting or other
advisory arrangements with other entities that may conflict or compete with
their obligations to us. Inventions or processes discovered by these persons
will not necessarily become our property. If we are unable to find alternative
talent, we will not be in a position to avoid or negotiate terms that would seek
to protect us from these conditions.
WE MAY SUFFER LOSSES OR ENCOUNTER OTHER PROBLEMS AS A RESULT OF FUTURE BUSINESS
COMBINATIONS AND ALLIANCES.
We may expand our operations and market presence by entering into business
combinations, joint ventures, co-branding or other strategic alliances with
other companies. These transactions create risks, such as:
- difficulty in assimilating the operations, technology and personnel of
the combined companies;
- the disruption of our ongoing business, including loss of management
focus on existing businesses and other market developments;
- problems retaining key technical and managerial personnel;
- expenses associated with the amortization of intangible assets;
- additional operating losses and expenses of acquired businesses;
- impairment of relationships with existing employees, customers and
business partners; and
- additional losses from any equity investments we might make or the
assumption of liabilities from third parties that we combine with.
We may not succeed in addressing these risks, and we may not be able to make
business combinations and strategic investments on terms that are acceptable to
us.
8
SINCE A SUBSTANTIAL PORTION OF OUR REVENUES TO DATE HAVE COME FROM INTERNATIONAL
SALES, EVENTS AFFECTING INTERNATIONAL COMMERCE MAY ADVERSELY AFFECT OUR FUTURE
INTERNATIONAL SALES, FUTURE REVENUES AND OUR PRODUCTS' FUTURE PROFITABILITY.
International revenue accounted for approximately 37% of our total revenue in
2003, 34% of our total revenue in 2004 and 25% for the first nine months of
2005. Our key international markets are the European Union, Japan, Australia,
South Korea, Peoples' Republic of China and Canada. Outside of the European
Union, we must obtain country-by-country approval to import our products.
Fluctuations in currency exchange rates may negatively affect our ability to
compete against products denominated in local currencies. In most cases our
international sales are made through international distributors and their
wholly-owned subsidiaries with payments to us typically denominated in the local
currencies of the United Kingdom and Europe and in U.S. dollars in the rest of
the world. We believe that the U.S. is the single largest market for our EVLT(R)
product line. We anticipate that the comparative portion of our total revenues
derived from international sales will decrease as sales of our EVLT(R) product
line in the U.S. increase, with our emphasis on EVLT(R) in the U.S. However, we
expect that international sales will continue to provide a significant portion
of our total revenues.
BUSINESS INTERRUPTIONS COULD KEEP US FROM DEVELOPING OUR PRODUCTS' CLINICAL
APPLICATIONS AND INCREASING OUR REVENUES.
Natural or man-made disasters, such as fires, earthquakes, storms, power losses,
telecommunications failures, terrorist attacks, military operations, epidemics
and other events beyond our control may interrupt our operations. We do not have
a detailed disaster recovery plan. In addition, we may not carry sufficient
business interruption insurance to compensate us for losses that may occur and
any losses or damages we incur could have a material adverse effect on our cash
flows and success as an overall business.
IF WE OR OUR SUPPLIERS FAIL TO COMPLY WITH APPLICABLE MANUFACTURING REGULATIONS,
OUR BUSINESS COULD BE HARMED.
We and our key component suppliers are required to demonstrate and maintain
compliance with the FDA's Quality System Regulation, or QSR. The QSR sets forth
the FDA's requirements for good manufacturing practices of medical devices and
includes requirements for, among other things, the manufacturing, packaging,
labeling and distribution of such products. The FDA enforces the QSR through
inspections. The FDA conducted its most recent QSR inspection in 2002 and the
FDA issued a satisfactory letter to us after this inspection. We cannot assure
you that we, or our key component suppliers, are or will continue to be in
compliance or that we will not encounter any manufacturing difficulties.
Furthermore, we cannot assure you that if we need to seek new suppliers to
satisfy our business requirements, we will be able to locate new suppliers which
are in compliance with regulatory requirements. Our failure to do so will have a
material adverse effect on our ability to produce our products and on our
profitability.
MARKET ACCEPTANCE OF OUR FUTURE PRODUCTS OR THEIR USES IS UNCERTAIN. FAILURE TO
ACHIEVE MARKET ACCEPTANCE WILL HARM OUR BUSINESS' OVERALL CHANCES FOR
PROFITABILITY.
Our long term business plan envisions that we will market medical products in
addition to our current EVLT(R) and photodynamic therapy product lines. To that
end, in August 2005, we entered into an agreement with Luminetx to act as
exclusive distributor to physicians performing sclerotherapy, phlebectomies or
varicose vein treatments, in North American and the United Kingdom for a new
product, VeinViewer(TM) that Luminetx has developed. Although VeinViewer(TM) has
received FDA clearance in 2004, this product is not yet available for commercial
distribution, and its commercial acceptance has not yet been established. Other
future products will likely require regulatory approval prior to
commercialization.
Even after we or our collaborative partners obtain regulatory approval of future
products for marketing, these products may not achieve market acceptance. Our
revenues would suffer as a result. The degree of market acceptance will depend
upon a number of factors, including:
9
-the establishment and demonstration in the medical community of the
safety and efficacy of our clinical applications and their potential
advantages over existing applications;
-the pricing and reimbursement policies of government and third-party
payors, such as insurance companies, health maintenance organizations and
other plan administrators; and
- the general willingness of physicians, patients, payors or the medical
community to accept, utilize or recommend any of our applications.
For example, since most photodynamic therapy treatments still are in clinical
trials, there is no long-term safety or efficacy data available. The medical
profession may, therefore, prefer to prescribe conventional alternatives to PDT,
such as surgery, chemotherapy and radiation. If our future products and clinical
applications are not accepted due to these or other factors, our business will
not develop as planned and may be harmed.
The following risks relate principally to our commercialization of our current
and future products and their clinical applications:
SOME OF OUR PRODUCTS MAY NEVER BE SUCCESSFULLY COMMERCIALIZED, AND, THEREFORE,
THESE PRODUCT LINES MAY NEVER BECOME PROFITABLE OR ALLOW US TO RECOUP EXPENSES
INCURRED IN THEIR DEVELOPMENT.
We must be able to effectively develop, market and sell our products in order to
make a profit. Commercialization depends upon:
- successfully completing development efforts of our collaborative
partners, including finding new clinical applications for our
existing products;
- obtaining the required regulatory approvals;
- manufacturing our products at an acceptable cost and with
appropriate quality;
- favorable acceptance of any products marketed; and
- successful marketing and sales efforts by our partner(s) and
ourselves.
We may not successfully achieve some or all of these goals, and if so, our
business and our financial condition would be adversely affected. The time frame
necessary to achieve these goals for any individual clinical application is
uncertain. Most applications will require clinical studies and clinical trials,
and all applications will require regulatory approval prior to
commercialization. The likelihood of our success must be considered in light of
these and other problems, expenses, difficulties, complications and delays that
may arise.
IF WE FAIL TO GAIN MARKET ACCEPTANCE OF OUR PRODUCTS, OUR BUSINESS WOULD SUFFER.
We are introducing novel products and technology into the vein treatment market.
The vein treatment market is dominated by vein stripping procedures which are
well established among physicians, have extensive long-term data, and are
routinely taught to new surgeons. As a result, we cannot be certain of gaining
widespread acceptance of our products and therefore may not achieve expected
revenues or ever become profitable. Our principal product line, EVLR(R), is
still in the early stages of commercialization. The VeinViewer(TM) product, of
which we plan to act as an exclusive distributor to physicians performing
sclerotherapy, phlebectomies or varicose vein treatments, in North American and
the United Kingdom pursuant to an agreement with Luminetx Corporation, is a new
product which has no track record of market acceptance or profitability.
To achieve growth in sales of our product lines over time, we believe we must
continue to penetrate the market for the treatment of vein disease and expand
physicians' education with respect to the EVLT(R) product line and other lines.
Although we introduce new initiatives intended to expand physician education
from time-to-time, we cannot be assured that these innovations will be
successful.
DEVELOPMENT AND SALES OF OUR PDT PRODUCTS ARE DEPENDENT ON A NUMBER OF FACTORS
BEYOND OUR CONTROL, AND OUR ESTIMATES REGARDING OUR PDT PRODUCTS MAY BE
UNRELIABLE.
Although we currently focus on our EVLT(R) product line, our business and
results of operation may suffer if we are unable to effectively commercialize
our PDT products. Our understanding of the market for photodynamic therapy (PDT)
is derived from a variety of sources, and represents our best estimate of the
overall market size presented in certain disease areas. The actual market size
and our market share, depend upon a number of factors, including:
10
- competitive treatments, either existing or those that may arise in the
future;
- our products' performance and subsequent labeling claims; and
- actual patient population at and beyond product launch.
Actual results may vary from our estimates regarding these and other factors,
which could result in performance of our PDT products that differs from our
expectations.
Moreover, our sales of our PDT product line are dependent upon the clinical
development process and the commercialization of PDT drugs by photodynamic
therapy drug companies which use our PDT products in combination with their PDT
drugs. As a result, our sales may fluctuate in relation to the timing of PDT
drug companies achieving their strategic initiatives. We have limited ability to
influence the commercialization by PDT drug companies of their PDT drugs.
In addition, like any new clinical solution, PDT has to show long term results
in order to gain acceptance. The cancers that photodynamic therapy is being
developed to treat are slow to develop and acceptance of the procedure requires
long term follow up. As a result, there is currently a lack of long term
clinical data for photodynamic therapy. Furthermore, the diversity of cancers
requires us to obtain data based on each type of cancer studied. Also,
photodynamic therapy may cause a photosensitivity side effect in certain
patients such that they are highly sensitive to sunlight for several days. In
some patients this side effect may cause skin burns if the patient is exposed to
sunlight. These factors may impair our ability to develop and market our PDT
products. Other factors may slow the growth of a market for PDT procedures, and
these factors may be beyond our control.
HEALTH CARE REIMBURSEMENT FOR OUR FUTURE PRODUCTS AND THEIR APPLICATIONS REMAIN
UNCERTAIN AND WE MAY BE UNABLE TO ACHIEVE MARKET ACCEPTANCE OR GENERATE
PROJECTED REVENUES WITHOUT ROUTINE COVERAGE BY MEDICAL INSURANCE.
Our principal product line is EVLT(R). The American Medical Association and the
Center for Medicare and Medicaid Services has established reimbursement codes
for laser ablation as a mode of treatment for superficial vein disorders,
including our EVLT(R) product line for varicose veins. The new codes form the
basis for Medicare and Medicaid reimbursement across the U.S. and became
effective January 1, 2005. As a result of the creation of these codes and the
adoption of EVLT(R) by U.S. insurance carriers, as of November 30, 2005, EVLT(R)
has over 217 million covered lives in the U.S.
It still remains, however, that various health care providers and third party
payors may refuse to cover our future products and/or their particular medical
applications. If the patients who use our treatments do not obtain coverage,
patient demand for our applications may decrease and as a result, physicians may
not purchase our products. Our ability to commercialize our future products
successfully depends, in part, on the extent to which third parties make
reimbursement available for these products and related treatments. These third
parties include collaborative partners, government health administration
authorities, private health insurers, managed care entities and other
organizations. Increasingly, these payors are challenging the price of medical
products and services and establishing protocols and formularies, which
effectively limit physicians' ability to select products and procedures.
Governments may also impose restrictions on pricing or profitability of medical
devices, which could limit our potential revenue. Uncertainty exists as to the
reimbursement status of health care products, especially innovative
technologies. Additionally, reimbursement coverage, if available, may not be
adequate for us to achieve market acceptance of our future products or to
maintain price levels sufficient for us to realize an appropriate return on our
products. Additionally, Medicare and other insurance reimbursement levels could
be reduced or eliminated in the future. If payors decide not to continue
covering our products or to reduce reimbursement levels, our sales may not meet
our expectations.
Further, our strategy depends in part on our collaborative partners. As a
result, our ability to commercialize our products may be hindered if cost
control initiatives, such as reducing reimbursement rates or amounts, adversely
affect our collaborators or the clinical applications they market or are seeking
to develop.
FAILURE TO OBTAIN PRODUCT APPROVALS OR COMPLY WITH ONGOING GOVERNMENTAL
REGULATIONS COULD ADVERSELY AFFECT OUR ABILITY TO MARKET AND SELL OUR PRODUCTS
AND SERVICES AND COULD RESULT IN LOSSES.
We have been successful in receiving governmental clearances for the products
listed below along with their indications for use:
11
PRODUCT INDICATION FOR USE
EVLT(R) kit and D15 plus diode laser Ablation of the greater saphenous vein with reflux of the thigh in patients
with superficial vein reflux and venous incompetence and reflux of
superficial veins in the lower extremity
Diomed 15 plus and 30 plus Open and endoscopic surgical procedures in fields such as urology,
gastroenterology, gynecology and neurosurgery; applications include
treatment of vascular lesions and pigmented lesions
Diomed 630 PDT Combination pre-market approval application for Photofrin used in
palliation of esophageal cancer and endobronchial non-small cell lung
cancer and for treatment of Barrett's Esophagus
EVLT(R) kit, Diomed DELTA, D15 plus Treatment of varicose veins and varicosities associated with the superficial
and D30 plus diode lasers vein reflux of the greater saphenous vein
The production and marketing of our products and our ongoing research and
development, preclinical studies and clinical trial activities are subject to
extensive regulation and review by numerous governmental authorities in the
United States, including the FDA, and similar regulatory agencies in other
countries. Before we can market them, most medical devices that we develop, and
all of the drugs that physicians use in conjunction with those devices, must
undergo rigorous preclinical studies and clinical trials and clear an extensive
regulatory process administered by the FDA and comparable foreign authorities.
These processes involve substantial costs and can often take many years. As a
result of the required up-front costs for regulatory approval and relatively
long time between developing a product and being able to generate revenue, we
may incur losses and negative cash flows. Regulations provide that failure to
comply with the applicable requirements can, among other things, result in
non-approval, suspensions of regulatory approvals, fines, product seizures and
recalls, operating restrictions, injunctions and criminal prosecution. We have
limited experience in performing regulatory activities, we have limited
resources available for handling regulatory matters. We rely on our
collaborative partners and outside consultants to assist us with our regulatory
needs.
We must compile and submit to the FDA and other applicable regulators new
indications of use as we determine new clinical applications for our products.
We may also be required to seek regulatory clearance for modifications to our
existing products, including changes to suppliers which must satisfy the FDA's
applicable criteria or the criteria of other applicable regulators. We believe
that we have not reached this threshold in our program and are not now required
to submit an application to the FDA for any changes we have made to our
previously reviewed products. In the future, however, we may decide to alter
certain products in a manner such that the FDA or other applicable regulators
outside the U.S. will review and approve the change. If we are required to seek
FDA approval for future indications or modifications to our existing products or
services, we or our collaborative partners may be unable to satisfy the
conditions imposed by the FDA (or other regulators). As a result, we may be
required to abandon applications for regulatory approval we make, or we may be
unable to obtain FDA clearances or other approvals we seek, and therefore we may
be unable to offer products and services relating to product modifications or
new indications of use.
We are also subject to the Radiation Control for Health and Safety Act with
laser radiation safety regulations administered by the Center for Devices and
Radiological Health of the FDA. We may be subject to fines or other penalties
for failure to comply with these regulations. For detailed information, see
"Business--Government Approvals."
SINCE TECHNOLOGY IN OUR INDUSTRY IS CONSTANTLY CHANGING, WE FACE TECHNOLOGICAL
UNCERTAINTY AND FACE CERTAIN COMPETITIVE DISADVANTAGES.
We are a relatively new enterprise and are engaged in the development of novel
therapeutic technologies, such as EVLT(R). As a result, our resources are
limited, and we may experience technical challenges inherent in such novel
technologies. Many of our competitors have substantially greater financial,
technical and human resources than we do and may also have substantially greater
experience in developing products, conducting preclinical studies or clinical
trials, obtaining regulatory approvals and manufacturing and marketing. Further,
our competitive position could be materially adversely affected if our
competitors or other third parties establish patent protection, because we may
then have to pursue alternate means of developing our products. Existing
competitors or other companies may succeed in developing technologies and
products that are safer, more effective or more affordable than those that we
develop.
IF PHYSICIANS DO NOT SUPPORT THE USE OF OUR PRODUCTS, WE MAY NOT ACHIEVE FUTURE
SALES GROWTH.
Our product sales have mainly been to physicians who are receptive to minimally
invasive techniques. Other physicians may not purchase our products until they
receive further long-term clinical evidence to convince them to alter their
existing treatment methods and recommendations from prominent physicians that
our products effectively treat vein disease. Physicians to whom we market our
products have been trained in alternative vein treatment procedures. We may be
unable to persuade physicians to incur the time or costs necessary to adopt our
EVLT(R) procedure in place of those more familiar procedures. We believe that
physicians will not use our products unless they determine, based on experience,
clinical data and other factors, that our EVLT(R) product line represents an
attractive alternative to conventional means of treating vein disease. There are
few independently published clinical reports and little long-term clinical
follow-up to support our marketing efforts. If our EVLT(R) product line does not
receive adequate endorsement by influential physicians or our long-term data
does not support our current claims of efficacy, our product sales and
profitability could be materially adversely affected. VeinViewer(TM), a new
product developed by Luminetx, of or which we will act as an exclusive
distributor to physicians performing sclerotherapy, phlebectomies or varicose
vein treatments, in North American and the United Kingdom, though cleared by the
FDA, has no track record of sales and no substantial clinical date. Therefore,
the profitability of VeinViewer(TM) for us is speculative.
12
FAILURE IN OUR PHYSICIAN TRAINING EFFORTS COULD SIGNIFICANTLY REDUCE PRODUCT
SALES.
Achieving successful results with our EVLT(R) product line is highly dependent
on proper physician technique in performing the procedure. As a result, it is
critical to the success of our sales effort to provide a sufficient number of
physicians with adequate instruction in the use of our products. We rely on
physicians to spend their time to learn the new procedure. If physicians are not
properly trained, they may misuse or ineffectively use our products. This may
result in unsatisfactory patient outcomes, patient injury, negative publicity or
lawsuits against us, any of which could have an adverse effect on our product
sales or increase our product liability risk.
THE TERMINATION OF LICENSES THAT WE CURRENTLY USE COULD ENABLE COMPETITORS TO
OFFER PRODUCTS SIMILAR TO OURS OR PREVENT US FROM OFFERING OUR PRODUCTS.
We currently have two technology licenses that are material to our business. The
first license relates to our EVLT(R) product line and the second relates to our
OPTIGUIDE(R) fiber optic diffuser. For detailed information, see "Business -
Patents, Trademarks and Proprietary Technology."
We have an exclusive license to the technology we use in our EVLT(R) products
and services with four of the five inventors of this technology. We also
acquired directly from the fifth inventor all of his rights to the EVLT(R)
patent. If we were to breach our obligations under the exclusive license, our
license could be terminated by the licensor. If our license is terminated by the
licensor, although we could still make, use or sell our EVLT(R) products and
services under our own title to the EVLT(R) patent, the other inventors could
license the EVLT(R) patent to our competitors, which would reduce our
competitive advantage and could result in lower revenue.
The second license relates to our photodynamic therapy product line. This is a
sublicense for patented technology that we currently use in our OPTIGUIDE(R)
fiber optic diffuser. Our sublicense for this technology is non-exclusive. The
term of this sublicense is for the term of the primary exclusive license from
the patent owner to our licensor. The term of the primary exclusive license is
the same as the term of the patent. If our license for the OPTIGUIDE(R)
technology is terminated, we may not have access to components that we need to
manufacture our OPTIGUIDE(R) products. We may not be able to find an alternative
technology source to continue manufacturing these products on reasonable terms
or at all.
WE MAY NOT BE ABLE TO KEEP UP WITH RAPID CHANGES IN THE MEDICAL DEVICES
INDUSTRY. AS A RESULT, SOME OR ALL OF OUR PRODUCTS COULD BECOME OBSOLETE.
COMPETING PRODUCTS AND TECHNOLOGIES MAY ALSO MAKE SOME OR ALL OF OUR PROGRAMS OR
POTENTIAL PRODUCTS NONCOMPETITIVE OR OBSOLETE.
Our industry is subject to rapid, unpredictable and significant technological
change. Competition is intense. Well-known pharmaceutical and medical device
companies are marketing well-established therapies for the treatment of cancer
and other diseases. Doctors may prefer existing methods rather than try our
products. Therefore, we may be unable to meet our sales goals. Many companies
are also seeking to develop new products and technologies for medical conditions
for which we and our collaborative partners are developing treatments. Our
competitors may succeed in developing products that are safer or more effective
than ours and in obtaining regulatory approval for future products before we do.
As a result, we may not be able to recoup our costs in developing these
products. We anticipate that we will face increased competition as new companies
enter our markets and as the scientific development of similar treatments
evolves.
The following risks relate primarily to legal protections and related concerns:
THERE ARE SUBSTANTIAL CONCERNS REGARDING SAFETY AND HEALTH IN THE U.S. MEDICAL
PRODUCTS INDUSTRY. WE MAY NOT HAVE ADEQUATE PROTECTION AGAINST PRODUCT LIABILITY
OR RECALL, AND WE MAY HAVE TO PAY A SIGNIFICANT AMOUNT OF MONEY ON LIABILITY
CLAIMS OR RECALLS.
Testing, manufacturing and selling medical products and applications entails
significant inherent, industry-wide risks of allegations of product liability.
The use of our products in clinical trials and the sale of our products may
expose us to liability claims of patients or others who use our products in
connection with clinical trials or sales of treatments offered by our customers.
We currently carry insurance against these risks in amounts we believe
sufficient and comparable to other similarly situated medical device companies,
but that insurance coverage may not be adequate to cover all our liabilities.
13
The following are some of the risks related to liability and recall:
- we are subject to the inherent risk that a governmental authority or
third party may require the recall of one or more of our products;
- if we obtain insurance coverage in the future, this coverage may not be
available at a reasonable cost, if at all, or in amounts sufficient to protect
us against claims that may be made; and
- liability claims relating to our products or a product recall could
adversely affect our ability to obtain or maintain regulatory approval for our
products and their applications.
To date, we have been named as a defendant in one product liability action,
arising from a doctor's alleged malpractice while performing a photodynamic
therapy treatment on a patient's esophagus. That action is currently in the
discovery phase of litigation. We do not expect the outcome of this litigation
to be materially adverse to us, or to incur material expenses or liability in
connection with this action.
A successful product liability claim could materially adversely affect our cash
flows and our ability to meet the costs of developing our products and their
clinical applications. Defense of these claims could also entail significant
expense and divert the attention of our management and personnel from other
activities.
IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS OR
IF WE LOSE OUR INTELLECTUAL PROPERTY RIGHTS, OUR BUSINESS COULD BE ADVERSELY
AFFECTED.
We rely on a combination of patents, licenses, trade secrets and know-how to
establish and protect our proprietary rights to our technologies and products.
As of November 30, 2005, we held 23 patents in the U.S. and foreign countries.
We currently have patents for the following inventions we use in our laser
devices and systems:
- endovascular laser treatment of varicose veins, used in EVLT(R);
- solid state laser diode light source;
- high power light source;
- peltier-cooled apparatus;
- medical spacing guide; and
- fiber optic diffuser.
Of the patents, seven are U.S. patents and 16 are counterparts of the principal
U.S. patents filed in different jurisdictions. These patents expire at various
times from 2010 to 2019.
Included in the foregoing are patents we license. Although we have an ownership
interest in the EVLT(R) patent that we purchased in September 2003 from one of
the inventors of this technology, we also licensed the rights in the same patent
from all of the other inventors on an exclusive basis. We also sub-license
technology used in our OPTIGUIDE(R) fiber optic diffuser used in photodynamic
therapy applications on a non-exclusive basis from the licensee. For detailed
information, see the risk factor captioned "The Termination of Licenses That We
Currently Use Could Enable Competitors to Offer Products Similar to Ours or
Prevent Us from Offering Our Products" and "Business - Patents, Trademarks and
Proprietary Technology."
To date, we have sued four competitors for infringement of our EVLT(R) patent:
Vascular Solutions, Inc., AngioDynamics, Inc., Total Vein Solutions, LLC and New
Star Lasers, Inc. d/b/a CoolTouch, Inc. See "Legal Proceedings," below for
further information regarding these lawsuits. Vascular Solutions, AngioDynamics
and Total Vein Solutions have each countered that (among other things) our
EVLT(R) patent is invalid. If our EVLT(R) patent is judicially determined to be
invalid, then we will not prevail in our infringement actions. We will write off
our patent acquisition costs (currently an intangible asset on our balance
sheet) and we will not be able to exclude third parties from using our EVLT(R)
technology. This would likely have a material adverse effect on our financial
condition.
We cannot guarantee that the steps we have taken or will take to protect our
proprietary rights will be adequate to deter misappropriation of our
intellectual property. In addition to seeking formal patent protection whenever
possible, we attempt to protect our proprietary rights and trade secrets by
entering into confidentiality and non-compete agreements with employees,
consultants and third parties with which we do business. However, these
agreements can be breached and, if they are, there may not be adequate remedies
available to us, and we may be unable to prevent the unauthorized disclosure or
use of our technical knowledge, practices or procedures. If our trade secrets
become known, we may lose our competitive advantage.
14
In addition, we may not be able to detect unauthorized use of our intellectual
property or take appropriate steps to enforce our rights. If third parties
infringe or misappropriate our patents or other proprietary rights, our business
could be seriously harmed. We may be required to spend significant resources to
monitor our intellectual property rights. We may not be able to detect
infringement of these rights and, consequently, we may lose the competitive
advantages associated with our intellectual property rights before we do so. In
addition, competitors may design around our technology or develop competing
technologies that do not infringe on our proprietary rights.
WE MAY BE SUBJECT TO INTELLECTUAL PROPERTY CLAIMS WHICH COULD BE COSTLY AND TIME
CONSUMING AND COULD DIVERT OUR MANAGEMENT AND KEY PERSONNEL FROM BUSINESS
OPERATIONS.
Although we do not believe that any of our products infringe the intellectual
property of third parties, we may be unaware of intellectual property rights of
others that may be used in our technology and products. Third parties may claim
that we are infringing their intellectual property rights. Third parties may
also claim that our patents have been improperly granted and may seek to
invalidate our existing or future patents. Although we do not believe that any
of our active patents should be subject to invalidation, if any claim for
invalidation prevailed, the result could result in greatly expanded
opportunities for third parties to manufacture and sell products which compete
with our products.
On July 21, 2005, VNUS Medical Technologies, Inc. ("VNUS") filed a patent
infringement lawsuit against us. We intend to vigorously defend this lawsuit.
See "Legal Proceedings," below, for further information and footnote 9 to the
September 30, 2005 Consolidated Financial Statements.
Litigation or other challenges regarding our patents or other intellectual
property could be costly and time consuming and could divert our management and
key personnel from business operations. Claims of intellectual property
infringement might also require us to enter into costly royalty or license
agreements. However, we may not be able to obtain these agreements on terms
acceptable to us, or at all. We may also be subject to significant damages or
injunctions against development and sale of our products. Infringement claims,
even if not substantiated and unsuccessful, could result in significant legal
and other costs and may be a distraction to management.
The following risks relate principally to our common stock and its market value:
OUR COMMON STOCK COULD BE SUBJECT TO SUBSTANTIAL PRICE AND VOLUME FLUCTUATIONS
DUE TO A NUMBER OF FACTORS, MANY OF WHICH WILL BE BEYOND OUR CONTROL, AND THOSE
FLUCTUATIONS MAY PREVENT OUR STOCKHOLDERS FROM RESELLING OUR COMMON STOCK AT A
PROFIT.
The securities markets have experienced extreme price and volume fluctuations
during the past three years, and the market prices of the securities of emerging
companies and technology-oriented companies have been especially volatile. In
the past, companies that have experienced volatility in the market price of
their stock have been the subject of securities class action litigation. In
fact, we were sued for allegedly violating Section 10(b) of the Securities
Exchange Act of 1934, in connection with trading activity during the first
quarter of 2002. We defended against this lawsuit and succeeded in having the
lawsuit dismissed, with prejudice. See "Legal Proceedings," below, for details
regarding this lawsuit. Securities class action litigation could result in
substantial costs, liabilities and a diversion of management's attention and
resources. The shares of common stock recently issued in our equity financing
transactions will likely enter the trading market and may result in lower
trading prices if there are not sufficient purchasers to absorb the common stock
as it enters the market.
OUR COMMON STOCK HAS BEEN PUBLICLY TRADED ONLY SINCE FEBRUARY 22, 2002. THE
PRICE OF OUR COMMON STOCK HAS FLUCTUATED WIDELY AND WE EXPECT THAT THE PRICE OF
OUR COMMON STOCK COULD CONTINUE TO FLUCTUATE SUBSTANTIALLY.
Until shortly after the February 14, 2002 merger, there was not any significant
public market for our common stock. On February 22, 2002, shares of our common
stock became listed for trading on the AMEX. We cannot be certain that the AMEX
will maintain our listing if we fall below its listing qualifications or do not
comply with other applicable AMEX rules. An issuer's securities may be delisted
by the AMEX if the issuer fails to meet certain financial criteria, or if a
listed security trades at a low market price for a substantial period of time.
We have not received notice from the AMEX threatening to delist our common
stock, but if we were to receive such a notice in the future, we cannot be
certain that we would be able to take corrective action requested by the AMEX to
avoid delisting.
If our shares are not listed on the AMEX, our shares are likely to be quoted on
the Over-the-Counter Bulletin Board of the National Association of Securities
Dealers, where they were quoted prior to February 2002, but where there may be
less trading of our shares.
15
The market price for our common stock will be affected by a number of factors,
including:
- developments within our own company;
- our announcements of new products or new clinical applications for our
products;
- our competitors' announcements of new products or new clinical
applications;
- quarterly variations in our or our competitors' results of operations;
- changes in earnings estimates, recommendations by securities analysts or
our failure to achieve analysts' earning estimates;
- developments in our industry;
- the number of shares of our common stock that are available for trading
in the markets at any given time; and
- general market conditions and other factors, including factors unrelated
to our performance or that of our competitors.
In addition, the stock prices of many companies in both the medical device and
medical services industries have experienced wide fluctuations, often unrelated
to the operating performance of those companies. These factors and industry
price fluctuations may materially and adversely affect the market price of our
common stock.
CERTAIN OF OUR INVESTORS HAVE SIGNIFICANT VOTING POWER AND THESE INVESTORS MAY
ACT CONTRARY TO THE INTERESTS OF OTHER STOCKHOLDERS.
There are several investors who beneficially own significant amounts of our
common stock. As of October 31, 2005, five investors beneficially owned
approximately 56% of our common stock (on a diluted basis). See "Security
Ownership of Certain Beneficial Owners and Management," below, for further
information. These investors' interests may be different from yours. The
concentration of share ownership among a limited number of investors gives these
investors influence over our affairs, particularly if these investors act in
concert. The effect of this concentration of ownership may also delay or prevent
a change in control and might adversely affect the trading price of our common
stock. Therefore, concentration of ownership in a limited number of investors
may not be in the best interests of our other stockholders.
WE HAVE NOT PAID DIVIDENDS ON SHARES OF OUR COMMON STOCK IN THE PAST AND DO NOT
EXPECT TO PAY DIVIDENDS ON SHARES OF OUR COMMON STOCK IN THE FUTURE. ANY RETURN
ON INVESTMENT IN OUR COMMON STOCK MAY BE LIMITED TO POTENTIAL FUTURE
APPRECIATION ON THE VALUE OF OUR STOCK.
We have never paid cash dividends on shares of our common stock and do not
anticipate paying cash dividends on our common stock in the foreseeable future
(although the preferred stock we issued on September 30, 2005 provides for
dividends to be paid quarterly at varying rates - see "Liquidity and Capital
Resources; Transactions in 2005 - Private Placement Financing Completed
September 30, 2005," below, for a description of the dividend and other terms of
the preferred stock). The payment of dividends on our common stock, if ever,
will depend on our earnings, financial condition and other business and economic
factors affecting us at such time as the board of directors may consider
relevant. If we do not pay dividends, our common stock may be less valuable
because a return on investment will only occur if and to the extent that our
stock price appreciates, and, if the price of our common stock does not
appreciate, then there will be no return on investment.
A SALE OF A SUBSTANTIAL NUMBER OF SHARES OF OUR COMMON STOCK MAY CAUSE THE PRICE
OF OUR COMMON STOCK TO DECLINE AND MAY IMPAIR OUR ABILITY TO RAISE CAPITAL IN
THE FUTURE.
We have approximately 19.4 million shares of common stock outstanding as of
November 30, 2005.
If our stockholders sell substantial amounts of our common stock in the public
market, including shares issued upon the conversion of the convertible
debentures, upon the exchange of our preferred shares or on the exercise of
outstanding warrants, the market price of our common stock could decrease. These
sales also might make it more difficult for us to sell equity or equity-related
securities in the future at times and prices that we deem reasonable or
appropriate.
On October 25, 2004, we issued and sold approximately 4 million shares of common
stock in our 2004 equity and debt financing (including shares underlying
debentures converted into common stock through November 30, 2005 and warrants
exercised to purchase common stock through November 30, 2005). These 4 million
shares are included in the approximately 19.4 million shares of common stock
outstanding as of October 31, 2005. Of the securities we issued in our 2004
equity and debt financing, as of November 30, 2005, approximately 1.6 million
shares of common stock underly currently outstanding convertible debentures, and
approximately 2.7 million shares underly currently outstanding warrants. The
purchase price paid by the investors in the 2004 equity and debt financing for
shares of common stock was $1.53, the conversion price of the debentures is,
subject to certain adjustments, $2.29 per share, and the exercise price of the
warrants is, subject to certain adjustments, $2.10 per share. All of the shares
that we issued in the 2004 equity and debt financing and the shares underlying
the convertible debentures and warrants are currently registered with the SEC
and are freely tradable in the public market by the 2004 equity and debt
financing investors.
16
Further, as of November 30, 2005, warrants to purchase 600,000 shares of common
stock at $2.90 per share were outstanding, 50% of which were vested. We issued
these warrants to Luminetx on August 5, 2005 pursuant to our exclusive
distribution agreement for Luminetx's VeinViewer(TM) product for which we shall
act as an exclusive distributor to physicians performing sclerotherapy,
phlebectomies or varicose vein treatments, in North American and the United
Kingdom.
Also, as of November 30, 2005, all 4 million shares of preferred stock and
warrants to purchase up to 1.8 million shares of common stock, which we had
issued on September 30, 2005, were outstanding (see "Liquidity and Capital
Resources; Transactions in 2005 - Private Placement Financing Completed
September 30, 2005," below, for further details regarding this financing). We
sold the preferred stock for $2.50 per share, and shares of preferred stock are
exchangeable for common stock at an exchange rate of $2.50 (or, on a
share-for-share basis), subject to certain adjustments. The warrants are
exercisable to purchase common stock at $2.50 per share (subject to certain
adjustments).
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 us 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.
Assuming there is no adjustment to the exchange rate of the preferred stock or
the exercise price of the warrants, and the limitations on ownership described
above do not preclude such exchange or exercise, if the investors in the
September 30, 2005 private placement exchange all of their shares of preferred
stock for common stock and exercise all of their warrants, and if, in addition,
the debenture holders to whom we issued warrants to purchase 200,000 shares of
common stock exercise all of their warrants, then we will issue 5.8 million
shares of common stock (4 million for preferred stock and 1.8 million for
warrants). The shares issued to the investors will have an effective price per
share of $2.50. We are obligated to seek the registration with the SEC of the
shares of common stock underlying the preferred stock and warrants we sold on
September 30, 2005, whereupon these underlying shares will become freely
tradable.
According to the terms of the September 30, 2005 financing transaction, we are
subject to certain liquidated damages if we cannot obtain and maintain
effectiveness of a registration statement. Since the liquidated damages have no
contractual maximum, we determined for accounting purposes that the liquidated
damages were onerous and considered net-cash settlement of the transaction in
accordance with EITF 00-19, "Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company's Own Stock." We recorded a
warrant liability of $1,861,328 based on the relative fair value and because the
warrants are classified as a liability; any subsequent changes in fair value
will be recorded as non-cash interest expense in our subsequent Statements of
Operations until the warrants are exercised, or expire or otherwise terminate.
If the holders of these securities are able to sell their shares of common stock
above the effective price per share paid, then they may be inclined to convert,
exchange or exercise these securities and to receive shares of common stock, and
to sell these shares. There may also be other reasons that prompt these
investors to liquidate their holdings of our securities. If these investors
determine to sell large numbers of our shares, then there may be insufficient
interest by other investors in purchasing these shares in the trading market,
which could cause the market price of our common stock to decrease.
POTENTIAL DILUTION CAUSED BY CURRENTLY OUTSTANDING STOCK OPTIONS AND WARRANTS
MAY REDUCE THE MARKET PRICE OF OUR COMMON STOCK.
As of September 30, 2005, there were outstanding stock options representing
1,711,225 shares of common stock, with exercise prices ranging from $2.00 to
$205.75 per share. The weighted average exercise price of the stock options
outstanding as of September 30, 2005 was $6.05. In addition, as of September 30,
2005, there were outstanding warrants representing 5,198,452 shares of common
stock, with exercise prices varying from $0.025 to $87.50 per share. The
weighted average exercise price of all warrants outstanding as of September 30,
2005 was $2.38 per share.
Most of our outstanding warrants provide for antidilution adjustments, which
will be triggered if we issue shares in a future transaction at an effective
price per share lower than the current exercise price of the outstanding
warrants. If triggered, these antitidilution provisions will reduce the exercise
price of the related outstanding warrants and in certain cases will also
increase the number of shares that the warrants represent so as to maintain
after the dilutive transaction the pre-transaction percentage of our shares that
the warrants represent after the transaction. These antidilution adjustments
therefore may have the effect of both lowering the effective price per share of
the shares of common stock represented by the warrants and increasing the number
of shares issuable upon exercise of the warrants, thereby both increasing the
likelihood that a warrant will be exercised and increasing the potential
dilution represented by the warrants.
In 2003, our stockholders approved an equity incentive compensation plan, which
to help incent and compensate our directors, employees and others who assist our
business, and authorized us to issue up to 1.6 million shares of common stock
(or common stock equivalents) under that plan. In 2005, our stockholders
approved an amendment to this plan, increasing the number of shares available
for grant to 3.1 million. We have granted approximatley 1.6 million stock
options under this plan as of November 30, 2005, and an additional 1.5 million
awards are available for grant under this plan. The holders of these options
have the opportunity to profit if the market price for the stock exceeds the
exercise price of their respective securities, without assuming the risk of
ownership. If the market price of the common stock does not exceed the exercise
price of these securities, then they will likely not be exercised and may expire
on their respective expiration dates.
17
After the exercise of options or warrants, an increase in the number of
outstanding shares will occur, thus decreasing each shareholder's percentage of
our total outstanding equity. When the holders exercise a significant number of
these options or warrants, the market price of our stock could fall,
particularly if these holders seek to sell the underlying common stock soon
after exercising their options or warrants.
OUR CORPORATE CHARTER AND BYLAWS CONTAIN PROVISIONS THAT MAY PREVENT
TRANSACTIONS THAT COULD BE BENEFICIAL TO STOCKHOLDERS.
Our charter and bylaws restrict certain actions by our stockholders and require
greater than majority votes for certain actions. For example:
- Only our board of directors or the chairman of the board can call
special meetings of stockholders.
- Stockholders must give advance notice to the secretary of any
nominations for directors or other business to be brought by stockholders at any
stockholders' meeting.
- Our board of directors has the authority to issue up to approximately 16
million additional shares of preferred stock, which are authorized under our
certificate of incorporation but are currently unissued. We currently have 4
million shares of preferred stock issued and outstanding. Our board of directors
can fix the price, rights, preferences and privileges of the preferred stock
without any further vote or action by our stockholders. These rights,
preferences and privileges attached to future preferred stock may be senior to
those of the holders of our common stock.
- Certain stockholders hold a significant percentage of our outstanding
shares. See the risk factor entitled "Certain of Our Investors Have Significant
Voting Power and These Investors May Act Contrary to the Interests of Other
Stockholders," above.
These and other provisions of our charter, the certificates of designations
setting forth the terms of our preferred stock and our bylaws, as well as
certain provisions of Delaware law, could prevent changes in our management and
discourage, delay or prevent a merger, tender offer or proxy contest, even if
the events could be beneficial to our stockholders. These provisions could also
limit the price that investors might be willing to pay for our stock because
these provisions may limit their rights and, thus, make an investment in our
stock less attractive to prospective investors.
Additionally, the listing requirements of the AMEX, on which our common stock is
listed, provide restrictions on our ability to enter into certain types of
transactions such as the issuance of additional shares of capital stock. These
restrictions may make it more difficult to issue securities having terms
acceptable to investors in capital financing transactions that we may wish to
enter into from time to time. If we are precluded by these requirements from
issuing such securities, then our business may suffer because we will be unable
to obtain additional equity capital investment.
18
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS
There are statements under "Summary," "Risk Factors," "Management's Discussion
and Analysis of Financial Condition or Results of Operations," "Business" and
elsewhere in this prospectus which are forward-looking. These statements are
indicated by words such as "will," "may," "plans," "expects" or "continue" and
other similar words. These statements relate to future events or our future
financial performance, and involve known and unknown risks, uncertainties and
other factors that may cause our or our industry's actual results, levels of
activity, performance or achievements to be materially different from any future
results, levels of activity, performance or achievements expressed or implied by
these forward-looking statements. Such factors include those listed under "Risk
Factors" in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. We do not intend to update any of the
forward-looking statements after the date of this prospectus or to conform such
statements to actual results.
19
RECENT DEVELOPMENTS
PRIVATE PLACEMENT EQUITY FINANCING - SEPTEMBER 30, 2005
On September 30, 2005, we entered into and completed a private placement equity
financing transaction wherein we issued and sold to 18 accredited investors 4
million shares of preferred stock at a purchase price of $2.50 per share,
resulting in gross proceeds to us of $10 million. We agreed that the preferred
stock could be exchanged by the investors for common stock at an exchange rate
of $2.50 per share (a premium of 18% above the $2.12 closing price of the common
stock on the AMEX the trading day immediately prior to the closing of the
financing), subject to certain adjustments, and that the preferred stock could
become redeemable by the holders in certain events or by us after the preferred
stock is outstanding for at least five years, in either case with a 20% premium
over the initial purchase price. We also issued to the investors warrants to
purchase an aggregate of 1.6 million shares of common stock with an exercise
price of $2.50 per share (a premium of 18% above the $2.12 closing price of the
common stock on the AMEX the trading day immediately prior to the closing of the
financing), subject to certain adjustments, and we issued comparable warrants to
purchase an aggregate of 200,000 shares of common stock to the three holders of
convertible debentures we issued in October 2004 as an inducement for these
debenture holders to waive negative covenants that would have precluded us from
completing the financing transaction on terms that the investors required.
The registration statement of which this prospectus forms a part relates to
those shares of common stock into which the preferred stock may be exchanged, an
allotment for shares of common stock which we may issue as dividends on the
preferred stock and shares of common stock underlying the warrants we issued to
the investors and the debenture holders. The Selling Stockholders referred to in
this prospectus are the investors to whom we issued the preferred stock and
warrants and the debenture holders to whom we issued the warrants in the
September 30, 2005 financing
We engaged Roth Capital Partners LLC of Los Angeles, California and Musket
Research Associates, Inc. of Boston, Massachusetts to act as our placement
agents to assist us in this transaction, and we paid commissions of $500,000
(or, 5%), in the aggregate, to these placement agents. We also incurred expenses
attributable to this equity financing of approximately $300,000, mostly in
connection with related legal and accounting fees and registration expenses. We
will use the balance of the proceeds of this equity financing for general
working capital purposes.
For further details regarding this transaction and the terms and conditions of
the preferred stock and warrants, see "Liquidity and Capital Resources;
Transactions in 2005 - Private Placement Financing Completed September 30,
2005," below.
DISTRIBUTION AGREEMENT WITH LUMINETX FOR VEINVIEWER(TM)
On August 5, 2005, we entered into a distribution agreement with Luminetx
Corporation of Memphis, Tennessee, pursuant to which Luminetx appointed us as an
exclusive distributor and granted to us the 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 us, which
we expect will 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.
We agreed to loan $1 million to Luminetx under the distribution agreement. 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 also issued warrants to purchase up to 600,000 shares of our common stock (at
an exercise price of $2.90 per share) to Luminetx as partial consideration for
granting us these exclusive distribution rights. Fifty percent of the warrants
were immediately exercisable when issued (subject to prior listing of the
underlying shares with the AMEX), and the remainder of the warrants will become
exercisable when both (i) Luminetx has produced at least 100 units of the
VeinViewer(TM) system and (ii) we have accepted delivery of at least 25 units of
the VeinViewer(TM) 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," we are
amortizing the $332,630 fair value of the distribution rights over the three
year period of the distribution agreement, commencing on the date that
distribution agreement was executed, August 5, 2005.
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DISTRIBUTION AGREEMENT WITH MED1ONLINE FOR EVLT(R)
On June 24, 2005, we entered into a distribution agreement with Med1Online, Inc.
of Golden, Colorado, pursuant to which we appointed Med1Online as our exclusive
distributor of EVLT(R) products in the OB/GYN and plastic surgery markets in the
United States. The initial term of this agreement is three years, and the
agreement is renewable annually thereafter with the parties' mutual agreement.
Med1Online will use its sales force to develop markets and improve market
penetration of EVLT(R) and provide purchase financing. We will provide
Med1Online with our promotional materials, including demos for use at mutually
agreed upon trade shows, and we will assist Med1Online in developing an in-house
sales training program and provide training for at least three Med1Online sales
representatives annually. Med1Online agreed to purchase from us a specified
minimum number of EVLT(R) lasers initially, and a minimum number of EVLT(R)
lasers each quarter in order to maintain its exclusive distribution rights.
LAUNCH OF NEW DELTA LINE OF EVLT(R) LASERS
Diomed has introduced a new line of lasers for use in EVLT(R) and other surgical
laser procedures. The DELTA line has improved ease-of-use, an automatic
procedure setup, a new fiber recognition system, enhanced patient data
management capabilities, and increased reliability, as compared with Diomed's
previous line of lasers. Diomed's DELTA lasers are offered in 15 and 30 watt
versions, and will replace Diomed's D15Plus and D30Plus line of lasers. The
Diomed DELTA laser became available for sale in North America and Europe
beginning November 1, 2005, and we expect the DELTA laser to become available to
the rest of our international distributor network in 2006. Meanwhile, we will
continue to sell our existing lasers platform outside of Europe. We plan to
continue to provide warranty coverage (for the remainder of warranty periods in
effect) and service support for a period of seven years from the date we
discontinue the sale of our D15Plus and D30Plus line of lasers.
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2005,
which gives effect to the securities we issued in our equity financing on
September 30, 2005. These securities are being offered for resale under this
prospectus. You should read this table in conjunction with our financial
statements and the accompanying notes to our financial statements, "Summary
Financial Data" and "Management's Discussion and Analysis of Results of
Operations and Financial Condition" included elsewhere in this prospectus.
SEPTEMBER 30, 2005
------------------
(UNAUDITED)
(IN THOUSANDS)
Total Long-term debt(1) .......................... $ 2,534
Preferred stock(2) ............................... 7,755
Stockholders' equity:
Common stock, $0.001 par value ............ 19
Additional paid-in capital(3) .............. 88,032
Accumulated other comprehensive gain ....... 126
Accumulated deficit ........................ (78,260)
--------
Total stockholders' equity... $ 9,917
========
Total Capitalization ................. $ 20,206
========
(1) Long-term debt includes an additional debt discount of $256,969 based on a
Black-Scholes value for the 200,000 warrants issued to the 2004 debenture
holders.
21
(2) Preferred stock includes 4 million shares issued at a conversion price of
$2.50 net of issuance costs of $765,000, relative fair value of the warrants of
$1,861,328 and fair value adjustment of $381,328 to present preferred stock at
its exchangeable balance.
(3) Additional paid-in capital includes the fair value adjustment of $381,328 to
present preferred stock at its exchangeable balance and the $256,969
Black-Scholes value for the 200,000 warrants issued to the 2004 debenture
holders.
DIVIDEND POLICY
To date, we have not paid dividends on our common stock or preferred stock.
However, we have agreed to pay cumulative annual dividends on the preferred
stock we issued on September 30, 2005 at the rate of: (i) 6%, for the first 18
months following the initial sale of the preferred stock, (ii) 10% from the 19th
through the 24th month following the initial sale of the preferred stock and
(iii) 15% after the 24th month following the initial sale of preferred stock.
The dividends accrue from day-to-day on each share of preferred stock, whether
or not earned or declared until paid. We may pay the dividends with either cash
or shares of common stock. 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, so long as
o the shares of common stock for which the preferred stock may be
exchanged are subject to an effective registration statement,
o the shares of common stock for which the preferred stock may be
exchanged and the common stock underlying the warrants that we
issued to the investors on September 30, 2005 are authorized and
reserved for issuance and listed on a trading market,
o none of the events giving rise to an investor's right to redeem the
preferred stock under our exchange agreement with the holders of the
preferred stock shall have occurred and have 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.
BUSINESS
OVERVIEW OF OUR BUSINESS
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.
EVLT(R) was our primary source of revenue in 2004, and will continue to be a
primary source of revenue in 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.
22
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 19 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 one open sales territory. We hired two sales development
personnel to focus on VeinViewer(TM) sales and plan to hire one more.
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 (see "Recent Developments -
Distribution Agreement with Luminetx for VeinViewer(TM)," above). We also
support the development and approval of new 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
have significant markets. 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.
HISTORICAL BACKGROUND
Diomed, Inc. was incorporated on December 24, 1997 in the State of Delaware. On
June 23, 1998, Diomed, Inc. succeeded to the business of Diomed, Ltd., a company
formed under the laws of the United Kingdom in 1991. It did so by issuing shares
of Diomed, Inc. on a one-to-one exchange basis to the holders of the shares of
Diomed, Ltd. As a result of the exchange, Diomed, Inc. became the owner of 100%
of the outstanding shares of Diomed, Ltd., and Diomed, Ltd. became a
wholly-owned subsidiary of Diomed, Inc. Diomed, Ltd. continues to operate in the
United Kingdom. Its chief activities are product development, manufacturing and
international sales and marketing.
Since our inception in 1991 in Cambridge, England, we have focused on the
development of medical diode lasers. Our proprietary diode laser technology has
made it possible to simplify and minimize certain medical procedures. Utilizing
our core competency in diode light sources and optical fibers, we pioneered the
development of diode lasers for medical applications, first with photodynamic
therapy and later with EVLT(R).
In November 2000, to enter the disposable market segment of our laser business,
we acquired the medical fiber business of QLT, Inc., a company based in
Vancouver, British Columbia. We acquired QLT's rights to manufacture and market
OPTIGUIDE(R) fibers that were developed for use in photodynamic therapy cancer
treatments and the distribution rights to customers of Laserscope and Coherent,
Inc., two manufacturers of medical laser devices.
In the fourth quarter of 2000, we also created FibersDirect.com, a U.S. business
unit we use as direct marketing conduit by providing on-line information for a
number of our products and an e-mail link to our sales staff. FibersDirect.com
enables distribution of fibers directly from the manufacturer to the end-user.
Our OPTIGUIDE(R) fibers used in photodynamic therapy cancer treatments are
promoted via FibersDirect.com.
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Diomed, Inc. is now a subsidiary of Diomed Holdings, Inc., a corporation
originally formed under the laws of the State of Nevada on March 3, 1998 under
the name Natexco Corporation. On February 11, 2002, we changed our name from
Natexco Corporation to Diomed Holdings, Inc. On February 14, 2002, Diomed
Holdings, Inc. acquired Diomed, Inc. in a reverse merger, pursuant to the terms
of an Agreement and Plan of Merger. We refer to the reverse merger that occurred
on February 14, 2002 as the "Merger." As a result of the Merger, Diomed, Inc.
became a wholly-owned subsidiary of Diomed Holdings, Inc., and the business of
Diomed Holdings, Inc. is now principally the business of Diomed, Inc.
Accordingly, except for this section or as otherwise indicated, the discussion
of our business relates to Diomed, Inc.'s business. The principal purpose of the
Merger was to enhance our ability to raise capital for our business by creating
a public trading market for shares of our common stock.
For financial statement purposes, the Merger was treated as a recapitalization
of Diomed, Inc. For tax purposes, we believe the Merger qualifies as a tax-free
exchange of equity securities. We have not, however, requested any ruling from
the Internal Revenue Service in respect of the tax treatment of the Merger. For
detailed information, see Note (8) of the Notes to our December 31, 2004 Audited
Consolidated Financial Statements.
In April 2002, our board of directors determined that it was in our best
interests and the best interests of our stockholders to change our state of
incorporation from Nevada to Delaware by way of the migratory merger. On May 13,
2002, after obtaining stockholder approval, we completed the migratory merger by
merging Diomed Holdings, Inc. (Nevada) with and into a newly organized Delaware
subsidiary, Diomed Holdings, Inc. (Delaware).
Since we have become a Delaware corporation, we and our stockholders are subject
to Section 203 of the General Corporation Law of the State of Delaware, an
anti-takeover law. In general, the law prohibits a public Delaware corporation
from engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
the prescribed manner. A "business combination" includes a merger, asset sale or
other transaction resulting in a financing benefit to the interested
stockholder. An "interested stockholder" is a person who, together with
affiliates and associates, owns (or within the prior three years, did own) 15%
or more of the corporation's voting stock.
For detailed information, see "Description of Securities - Recent Sales of
Unregistered Securities," and Note (8) of the Notes to the December 31, 2004
Audited Consolidated Financial Statements.
BUSINESS STRATEGY
At our inception in 1991 in Cambridge, England, we focused on the development of
medical diode lasers and their applications. Since that time, we have advanced
that technology and expanded its application through internal development
efforts, strategic business combinations and intellectual property acquisition.
We have sourced our products through external and internal manufacturing
capabilities and distributed our products through a combination of both a direct
sales organization and indirect distributors.
FULL SERVICE DIFFERENTIATION TO MAXIMIZE REVENUE AND MARKET SHARE
We generate revenues from the sale of our products and services. We launched our
EVLT(R) product line in the U.S. after receiving FDA clearance in January 2002,
and, in mid 2002, we established a direct sales force to focus on EVLT(R) sales.
Our sales force concentrates on selling our EVLT(R) products and, to a lesser
extent, our photodynamic therapy product line, along with complimentary products
for adjunct procedures. Our direct sales force is well trained and versed in
selling EVLT(R) as a complete clinical solution for the treatment of varicose
veins. Our clinical solution includes both the laser and disposable procedure
kits, along with physician training and practice management tools which we
provide to help physicians develop and manage his or her EVLT(R) business. In
addition, we have developed a website, www.evlt.com, to provide patients and
physicians with information about treatment options and benefits of EVLT(R).
International sales are managed through a global network of third party sales
agents and distributors.
RESEARCH AND DEVELOPMENT TO ENHANCE EFFICIENCIES AND PRODUCT EFFECTIVENESS
We have an internal research and development staff and from time to time have
used outside experts to assist us in our product development program.
Historically, our research and development efforts concentrated on the
development of clinical applications and solutions for our lasers and related
delivery systems. Through these past efforts, we have commercialized our EVLT(R)
and photodynamic therapy product lines. Although current research and
development activities are directed at enhancing our laser and fiber
manufacturing efficiency and the functional effectiveness of our EVLT(R) product
line, we are continuously evaluating new clinical applications and solutions for
our lasers and delivery systems.
24
KEY ACQUISITIONS TO ENHANCE PROFITABILITY
On September 3, 2003, we acquired exclusive rights to U.S. Patent No. 6,398,777
and foreign counterparts regarding the endovenous laser treatment of varicose
veins from the five inventors of this procedure. With this proprietary position,
we believe we have positioned ourselves to be the leader in minimally invasive
varicose vein treatment. Previously, in November 2000, we acquired the rights to
manufacture OPTIGUIDE(R) fiber from QLT, Inc. We periodically entertain
attractive opportunities in related fields and we expect to continue efforts to
identify and pursue these opportunities in 2005. In August 2005, we entered into
an exclusive distribution agreement for Luminetx's new VeinViewer(TM) to
physicians performing sclerotherapy, phlebectomies or varicose vein treatments,
in North American and the United Kingdom (see "Recent Developments -
Distribution Agreement with Luminetx for VeinViewer(TM)," above).
STRATEGIC ALLIANCES TO ENHANCE CUSTOMER REACH
We have established strategic alliances with some notable photodynamic therapy
drug companies to bring new treatments to market. However, the underlying
products being developed by these companies which are used in conjunction with
our products, have gained only limited regulatory approval required for
commercialization, and expanded regulatory approval is not assured. Accordingly,
we have focused our near-term investment in the commercialization of EVLT(R). In
addition, we maintain original equipment manufacture ("OEM") relationships with
companies such as Olympus in Japan, which uses our technology for surgical and
dental applications, and with Dentek Medical Systems GmbH, which uses our laser
module for dental applications. Our strategy is to create long-term and
exclusive working relationships that increase laser applications and revenue
potential through the sale of our lasers and disposables whenever possible.
PRODUCTS, COMPETENCIES AND MARKET OPPORTUNITIES
Our focus on the development and commercialization of minimally and
micro-invasive medical procedures employing our laser technology and disposable
products has led to an array of applications. Minimally and micro-invasive
medical procedures in general are a growing market, as they reduce the need for
general anesthesia, expensive hospital stays and long and painful recovery
periods. We address medical procedures which we believe are capable of producing
a recurring revenue stream through the sale of a disposable, such as a procedure
kit or individual fiber, in addition to one-time revenue from the sale of the
laser product itself. In 2003, 62% of our total revenues were derived from laser
sales and 38% of our total revenues were derived from sales of disposable fibers
and kits, accessories and services. In 2004, 59% of our total revenues were
derived from laser sales and 41% of our total revenues were derived from sales
of disposable fibers and kits, accessories and services. For the first two
quarters of 2005, approximately 51% of our total revenues were from laser sales
and approximately 49% of total revenues were from sales of disposable products.
ENDOVENOUS LASER TREATMENT
In September 2001, we were the first company to receive the CE mark of the
European Economic Union for approval for marketing endovenous laser treatment,
with respect to marketing EVLT(R) in Europe. The following January, we became
the first company to receive FDA clearance for endovenous laser treatment for
the closure of the greater saphenous vein with superficial reflux. In December
2002, we received FDA clearance for expanded indications for use of EVLT(R),
including our D15plus and D30plus diode lasers and disposable kits for the
treatment of varicose veins and varicosities associated with the superficial
vein reflux of the greater saphenous vein. In December 2004, we obtained FDA
clearance authorizing the use of our laser and procedure kits for treatment of
venous incompetence and reflux of other superficial veins in the lower
extremity.
On September 3, 2003, we acquired exclusive rights to the patent for endovenous
laser treatment of varicose veins from the five inventors of this procedure. For
detailed information, see "Patents, Trademarks and Proprietary Technology,"
below.
We commercialized EVLT(R) as an innovative minimally invasive laser procedure
for the treatment of varicose veins resulting from reflux of the greater
saphenous vein. The causes of varicose veins are commonly genetic. People with
past vein diseases, new mothers, overweight individuals and people with jobs or
hobbies that require extended standing also are at risk. According to a 1973
report by the University of Michigan under a comprehensive study of the health
characteristics of the community of Tecumseh, Michigan, approximately 25% of
women in the U.S. have varicose veins. In addition, varicose veins are more
prevalent in older people. The Tecumseh study was a comprehensive longitudinal
research study that tracked the health of a sample population of 7,000 to nearly
9,000 people at three intervals over the course of a decade, from the late 1950s
to the late 1960s. According to the Tecumseh study, at least 42% of Americans
over age 60 have varicose veins and this number is increasing as the population
continues to age. The Tecumseh study also indicates that at least 72% of women
over age 60 in the U.S. have varicose veins. According to the American
Association of Retired Persons, approximately 76 million people in the U.S. are
50 or older, and approximately an additional 4 million people turn 50 each year.
We estimate that there are currently 25 to 40 million Americans who suffer from
some degree of venous insufficiency and that there are approximately 150,000
people in the U.S. and 1 million people worldwide who undergo vein stripping
operations annually. We also believe that many people forego vein stripping
procedures to treat their venous insufficiency due to the pain, extended
recovery time, significant potential of scarring and other serious side effects
associated with vein stripping. We believe that most patients who undergo
vein-stripping procedures are candidates for endovenous laser treatment. EVLT(R)
has several competitive advantages over the current vein-stripping treatment.
25
The EVLT(R) procedure takes approximately 45 minutes per leg and was developed
to be performed in a physician's office, usually under local anesthesia and with
the procedure guided by ultrasound technology. EVLT(R) also has a fast recovery
period, reduced or minimal pain and no appreciable scarring. In endovenous laser
treatment, the area of the leg affected is anesthetized locally and a thin laser
fiber is inserted into the effected vein to deliver the laser energy in short
pulses or as a continuous application. At the end of the procedure, after the
fiber is withdrawn, a compression bandage is applied and worn up to three days.
In addition, a compression stocking is worn for seven to 14 days. Patients can
resume their normal routine, barring vigorous physical activities, directly
after undergoing the treatment.
Vein stripping is a surgical procedure that typically requires general
anesthesia, an overnight hospital stay, a painful recovery period of several
weeks, and possibly post-operative scarring and post-operative infections from
incisions. During clinical studies, up to 98% of first-time EVLT(R) treatments
in clinical trials have been successful. A follow-on EVLT(R) treatment has
successfully resolved the remaining cases. Vein stripping has demonstrated long
term efficacy rates as low as 65%.
We developed our EVLT(R) product line as a complete clinical solution and
marketing model, including a laser, disposable kit and a training and marketing
plan to assist physicians, clinics and hospitals in responding to the demand for
treatment of varicose veins. EVLT(R) is attractive to physicians because of its
high efficacy, low complication rate, low patient cost (relative to vein
stripping) and favorable practice return on investment. Also, EVLT(R) for
treatment of greater saphenous vein reflex is considered a non-cosmetic
procedure that is now reimbursable for over 217 million covered lives.
A study co-authored by Dr. Robert Min entitled "Endovenous Laser Treatment of
Saphenous Vein Reflux: Long-Term Results," was published in the August 2003
issue of the Journal of Vascular and Interventional Radiology. The study shows
what we believe to be excellent long-term results for the successful occlusion
of varicose veins caused by reflux of the greater saphenous vein. The data
presented in the study shows that minimally invasive laser treatment of varicose
veins has a high long-term success rate, low complication rate and rapid
recovery. The Cornell study included 499 limbs with varicose veins treated by
EVLT(R) over a three-year period. Patients were evaluated clinically and with
duplex ultrasound scans at 1 week, 1 month, 6 months, 12 months, 24 months, and
36 months to assess efficacy and adverse reactions. Successful occlusion of the
greater saphenous vein after initial treatment was 98.2% and, at 2 year
follow-up, 93.4% remain closed (113 of 121 limbs followed for 2 years).
Importantly, all recurrences occurred prior to 9 months with the majority noted
less than 3 months following endovenous laser treatment.
The study described above was recently updated in an article authored by Dr. Min
published in the August 2005 issue of the Journal of Cardiovascular Surgery
(Vol. 46, No. 4, pp. 395-405, Aug. 2005). The article states that "successful
endovenous laser treatment . . . was seen in 98% (982/1000) [of] treated limbs
with follow-up between 1 and 5 years . . . 457/460 or 99% of treated veins
remain occluded at 2-5 year follow-up," and "13/18 treatment failures
noted occurred prior to one year." Of note, the study reports only one failure
in 500 limbs after instituting several procedural modifications that include
delivering 14W of energy with a continuous pullback rate (rate of energy
delivery along the length of vein) of 1-3 mm per second.
In this study, there were no reports of skin burns, no abnormal nerve sensation
and no deep vein clots. In comparison, traditional surgery (ligation and
stripping) often requires general or spinal anesthesia and can take up to 4
weeks for full recovery. Pain, bruising and scarring are also common. The
results in this study also show EVLT(R) to be comparable or superior to those
reported for other options available for treating greater saphenous vein reflux,
including ultrasound guided sclerotherapy, and radiofrequency ablation. Dr. Min
is the Director of Cornell Vascular in New York and Vice-Chairman of Radiology
at Weill Medical College of Cornell University. Dr. Min is an inventor of the
EVLT(R) treatment, who sold his rights to this patent to Diomed on September 3,
2003. Dr. Min also assists Diomed in physician training and in the development
of medical treatments using EVLT(R). According to the terms of our patent
purchase agreement with Dr. Min, we pay Dr. Min variable payments, based on our
sales of products using the EVLT(R) patent. He has been a paid consultant to us
since August 2001 and, as of December 31, 2004, owns options to purchase 41,391
shares of common stock.
EVLT(R) was a primary source of revenue in 2004, and continues to be our primary
source of revenue in 2005. We believe that EVLT(R) will achieve a high level of
commercial acceptance due to its high efficiency, low rate of complications,
short recovery period, reduced pain and minimal scarring and reduced costs
compared to other treatments for varicose veins. As of September 30, 2005, we
have sold nearly 800 EVLT(R) lasers, and have established Diomed as the leading
brand of endovenous laser treatment products for varicose veins. We expect that
as the volume of EVLT(R) procedures performed increases so may our disposable
sales. We believe that for the foreseeable future the U.S. represents the single
largest market for EVLT(R).
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CANCER TREATMENTS UTILIZING PHOTODYNAMIC THERAPY
We were the first diode laser manufacturer to receive FDA clearance for use of
our lasers and optical fibers in photodynamic therapy cancer treatments.
Photodynamic therapy (PDT) is an effective palliative treatment for late-stage
lung and esophageal cancers and is under study for treatment of various other
cancers throughout the body. Photodynamic therapy is based on the discovery that
certain chemicals can kill one-celled organisms in the presence of light. Recent
interest in photosensitizing agents stems from research showing that some of
these substances have a tendency to collect in cancer cells.
When using PDT, the photosensitizing agent injected into the body is absorbed by
all cells. The agent remains in or around tumor cells for a longer time than it
does in normal tissue. When treated cancer cells are exposed to light from a
laser, the light is absorbed by the photosensitizing agent. This light
absorption causes a chemical reaction that destroys the tumor cells. Light
exposure is carefully timed to coincide with the period when most of the agent
has left healthy cells but still remains in cancer cells.
There are several promising features of photodynamic therapy in treating cancer:
(1) cancer cells can be selectively destroyed while most normal cells are
spared, (2) the damaging effect of the photosensitizing agent occurs only when
the substance is exposed to light and (3) the side effects are relatively mild.
The laser light used in photodynamic therapy is directed through an optical
fiber. The optical fiber is placed close to the cancer to deliver the proper
amount of light. For example, the fiber optic can be directed through a
bronchoscope into the lungs for the treatment of lung cancer or through an
endoscope into the esophagus for the treatment of esophageal cancer.
Our photodynamic therapy product line of photodynamic therapy solutions uses our
own proprietary laser technology. When used in combination with a
photosensitizing drug, photodynamic therapy provides the cancer therapy. As
indicated, photodynamic therapy requires three-interacting elements: (1) a
photosensitive drug that is absorbed by cancerous and abnormal cells, (2) a
light source (laser) of a specific wavelength that activates the drug and (3) a
delivery system, including a thin optical-fiber to guide the light source to the
target area. Photodynamic therapy technology is only effective when these three
components are working in concert. We have worked early in the clinical
development process with photodynamic therapy drug companies to design a laser
that optimizes the most effective wavelength in combination with their
photodynamic therapy drugs.
In the U.S., regulatory approval by the FDA is given for each specific treatment
in response to a specific pre-market approval application. Each pre-market
approval application is generally addressed to a use for the device that the
pre-market approval application specifies. The FDA considers photodynamic
therapy a modality that requires a combination pre-market approval application,
where the photodynamic therapy drug company, laser manufacturer and fiber
manufacturer work together to obtain regulatory approval for the complete
medical procedure. The lengthy regulatory approval process and FDA modality
factor create significant obstacles to potential competition.
In August 2000, we and Axcan Pharma together received regulatory approval for
our 630nm laser and OPTIGUIDE(R) fiber, and Axcan Pharma's Photofrin(R) drug
used in the palliative treatment for late stage lung and esophageal cancers. In
November 2000, we entered into a 5-year exclusive supply contract with Axcan
Pharma for lasers. Axcan Pharma is developing other clinical applications using
Photofrin(R), including treatment for Barrett's Esophagus, a pre-cursor to
cancer of the esophagus. Axcan Pharma has pursued an application for FDA
clearance for Photofrin(R) and our lasers and fibers for use in the treatment of
Barrett's Esophagus. In December 2002, the FDA issued an approvable letter in
connection with Axcan Pharma's application. Axcan Pharma announced that it
received FDA clearance for the photodynamic therapy for Barrett's Esophagus in
August 2003. In September 2004, our laser development and supply agreement with
Axcan Pharma, dated August 2, 2000, was terminated and as a result, we are no
longer distributing PDT lasers through Axcan Pharma. Sales to Axcan Pharma
represented approximately 1% or less of our sales in 2003 and 2004. We expect to
continue to market PDT lasers through our direct sales force and distributors,
both domestically and internationally.
We currently believe that the potential market for our EVLT(R) product line is
substantially larger than the potential market for our photodynamic therapy
product line. We also expect sales of EVLT(R) products and services to account
for an increasingly higher proportion of our total sales revenue as compared to
photodynamic therapy products. Therefore, while we continue to pursue sales of
our photodynamic therapy product line and to pursue development of new
photodynamic therapy applications through the efforts of our collaborative
partners, our present emphasis is on our EVLT(R) product line and we are
concentrating our marketing and sales efforts towards the EVLT(R) product line.
FIBERS AND DISPOSABLE ITEMS
To address medical conditions with minimally invasive techniques, we offer
physicians an integrated clinical solution, including a laser and disposable
procedure kits or individual fibers. Optical fiber is the necessary system that
delivers the laser light during surgical, endovenous laser treatment and
photodynamic therapy procedures. These sterile fibers, generally used only once
to ensure sterility, can generate a steady stream of revenue. We sell
self-contained EVLT(R) kits of disposable items, which include an optical fiber,
a sheath that acts as an introduction for the fiber, a needle, a guidewire, a
tray cloth and protective packaging. In some cases, we sell only the fiber.
The potential market for kits, fibers and other disposable items is driven by
the adoption rate of the specific clinical procedure. We have and will continue
to generate a disposable market by developing and promoting specific procedures,
such as endovenous laser treatments. As EVLT(R) gains market share in comparison
to vein-stripping and other varicose vein procedures, so will the volume of kits
and fibers used in these treatments, and the volume of fibers we sell for use in
these procedures is expected to increase.
27
OTHER CLINICAL APPLICATIONS
Our technologies are also used in general surgical applications as well as in
dental applications. While our focus is on the development of specific clinical
applications, such as varicose vein treatment with EVLT(R), other medical
applications can be, and are being, performed with our lasers. For instance, the
FDA has also cleared our diode laser technology for open and endoscopic surgical
procedures, which are used to treat vascular and pigmented lesions. Potential
clinical applications that we may address include:
Nasal Polypectomy: Nasal polyps are usually benign growths in the nose, which
are removed with the laser with minimal bleeding and quick recovery period.
Turbinate Reduction: The turbinates are structures in the nose which can become
enlarged due to conditions such as allergies and obstruct the airways. The laser
can be used to reduce their size and clear the blockage. Other nasal procedures
include: ethmoidectomy, meatal antrostomy, maxillary endo-sinus surgery. These
various procedures involve the removal of blockages, opening up of the various
airways and gaining access to various structures within the nose.
Dacryocystorhinostomy (DCR): Tear ducts take tears from the corner of the eye
down into the nose. Blockage of the tear ducts results in watery eyes. The laser
fiber can be used to reopen the channel from the tear duct into the nose and
resolve the problem. This simple procedure can be performed under local
anesthetic, is less traumatic than conventional surgery and leaves no surgical
scarring.
Ontological Surgery: By carbonizing the end of the fiber, the trapped laser
energy heats up the tip producing in effect a tiny "hot knife", which can be
used, for cutting away tissue in a variety of conditions in the ear. The fine
tip size makes it an exceptionally controllable tool. Applications include
Stapedotomy and Stapedectomy (treatments involving the auditory bones in the ear
to correct hearing problems), Myringotomy (incision in eardrum to relieve
pressure from infection), Cholesteatoma and Acoustic neuron (benign growths in
the ear which are removed).
Uvulopalatoplasty (LAUP): Reshaping of the soft palate and uvula at the back of
the mouth is done in severe cases to reduce snoring and can be performed in one
session using a fine sculpted tip fiber. The coagulated area surrounding the
incision ensures virtually no blood loss, faster patient recovery and minimal
post-operative nursing requirements.
Vaporization of Tumors: Areas of abnormal tissue due to inflammation or
infection can be destroyed or reduced in size with heat energy. The laser
delivers this in a very controllable way with a known depth of effect, which
avoids damage to surrounding structures.
Gastro-Intestinal Cancer: Cancer in the gullet will grow and block the tube
stopping the patient from swallowing. The cancer can be reduced in size and the
tube reopened using the laser. This relieves the symptoms allowing the patient
to eat relatively normally, often returning home. It does not cure the cancer
but produces a temporary improvement in quality of life.
Lung Tumors: Cancers in the lung will grow and obstruct the airways causing
breathing problems for the patient. The cancer can be reduced in size and the
airway reopened using the laser. This relieves the symptoms allowing the patient
to breathe more normally. Again, this treatment does not cure the cancer, but
produces a temporary improvement in quality of life.
Vascular Lesions: Although seen as primarily a cosmetic problem, vascular and
pigmented lesions can have a profound effect on lifestyle especially when they
occur in young people. For many years lasers have been used to treat such
lesions with a high degree of success. Such procedures are simple to perform and
the nature of the laser light allows for a high degree of precision while
minimizing side effects. The laser can be used by shining it through the skin
(transdermally) to reduce the lesions' appearance. Delivery of the laser energy
is simplified by a range of specially designed hand pieces.
Neurosurgery: There are a variety of intercranial tumors which can be treated
with the laser. Those most suitable for laser assisted ablation are the benign
forms especially the various meningiomas. The laser can also be useful in
gaining access to lesions involving the brain stem and for removing acoustic
neuromas. The hemostatic properties of the laser, its controllability and the
limited collateral effects make the laser highly suitable for neurosurgical
applications.
Urology: The laser can be used in the treatment of Benign Prostate Hypertrophy
(BPH) in three different ways. It can be used transurethrally to debulk the
prostate by contact tissue removal or by non-contact tissue coagulation. It can
also be used to shrink the prostate by interstitial therapy. In addition, the
laser can be used to destroy bladder tumors and for a variety of open surgical
techniques where its ability to cut and coagulate simultaneously are utilized.
Interstitial Therapy: The laser can be used to treat tumors within normal tissue
by thermally destroying them in situ. This technique is applicable to liver
metastases, osteoid osteomas and breast tumors. In addition, the laser can be
used in a similar way on the nucleus pulposus to cause shrinkage and reduce
pressure within the discs of the lower back. This latter technique is called
Percutaneous Laser Disc Decompression (PLDD).
28
There are numerous processes for the development of products for these potential
clinical applications. In general, however, each of them will require extensive
preclinical studies, successful clinical trials and cleared pre-market approval
applications or 510(k)s before they can generate significant revenues. We
currently have no pending regulatory applications or clinical studies. We may
rely on third parties, including our collaborative partners, to design and
conduct any required clinical trials. If, we are not able to find appropriate
third parties to design and conduct clinical trials, and if we do not have the
resources to administer clinical trials in-house, this process may become even
more lengthy and expensive. Since we collaborate with third parties, those
parties generally maintain certain rights to control aspects of the application
development and clinical programs. Our business depends in part on our ability
to obtain regulatory approval for expanding applications and uses of our
products. Therefore, delays or other related problems may adversely affect our
ability to generate future revenues.
We may rely on third parties, including our collaborative partners, to design
and conduct any required clinical trials. In the future, we may not be able to
find appropriate third parties to design and conduct clinical trials or we may
not have the resources to administer clinical trials in-house. Therefore, this
process may become even more lengthy and expensive. Moreover, our collaborative
partners have certain rights to control aspects of the application development
and clinical programs. As a result, these programs might not be conducted in the
manner we currently contemplate. Since our business' success is heavily
dependent upon our ability to achieve regulatory approval for the applications
and uses of our products, our revenues may be adversely affected by delays or
other related problems.
Data already obtained from preclinical studies and clinical trials of our
products under development does not necessarily demonstrate that favorable
results will be obtained from future preclinical studies and clinical trials. A
number of companies in the medical devices industry, as in the pharmaceutical
industry, have suffered setbacks in advanced clinical trials, even after
promising results in earlier trials.
ORIGINAL EQUIPMENT MANUFACTURING
Our technology and manufacturing capability has attracted original equipment
manufacturing (OEM) partners. In the typical original equipment manufacturing
relationship, we produce the laser and other products to the original equipment
manufacturing customer's specifications, which will then be marketed under the
original equipment manufacturing's label. Our most significant original
equipment manufacturing relationship is with Olympus in Japan, which is using
our technology for surgical and dental applications. Our OEM business
represented approximately 5% to 7% of total revenues in 2004 and 2003,
respectively, and we expect it to continue to decline as a percentage of sales.
MANUFACTURING
We manufacture our lasers with components and subassemblies that our
subcontractors supply. We assemble and test each of our lasers at our Cambridge,
England facility. Ensuring adequate inventory, continuous cost reduction and
superior product quality are top priorities of our manufacturing operations. To
achieve our goals, we work closely with our research and development, sales and
marketing teams, and effectively manage a limited number of what we believe to
be the most qualified suppliers.
We use a variety of materials, including mechanical, electronic, optical
components and subassemblies for the lasers, plus other materials that our
customers purchase for direct consumption, such as disposable items sold in kit
form and fibers. We construct lasers in the UK using local high-quality supplies
for metalwork components and subassemblies. We procure standard
off-the-shelf-electronic components primarily from various UK and US suppliers.
Because of their complexity, high quality requirements and relatively low
volumes, we choose to procure our optical components from only two sources.
Semiconductor laser diodes are used in optical disc drives, optical fiber
telecommunications, printers and bar code scanners. No larger than a grain of
salt, the diode chip converts electricity into laser light with such efficiency
that power consumption and heat generation are reduced. Laser diodes are related
to the LEDs used as indicator lights in most electrical devices. While LEDs
produce light measured in milliwatts, high power laser diodes each produce
several watts of laser light. Because laser diodes are semiconductor components,
the products they support have no moving parts, are highly reliable and can be
run from a wall socket power supply with only limited requirements to cool the
components. The outcome of this miniaturization of laser technology is a
portable, lightweight, highly reliable and easy to use laser. Like electronic
semiconductors, management believes that semiconductor lasers will increasingly
replace most other laser technologies.
To achieve power levels beyond that of a single laser diode, light may be
coupled from multiple diodes. This may be achieved by attaching an optical fiber
to the end of each diode and "bundling" the fibers together. This entails a
number of optical fiber joints inside the laser system to guide and couple the
light. Each optical joint reduces the amount of light that passes through the
system and each joint also has a finite lifetime that is usually less than the
life of the diode. As one optical joint fails, the others come under greater
stress and are subject to an increased likelihood of cascade failure. The result
is an inefficient optical transfer where power delivered through the working end
of the fiber is only a small percentage of the power delivered by the diode.
29
The most widely used medical diode laser emits laser energy at 810nm, producing
light in the near infra-red portion of the spectrum. At powers of up to 60W and
used in conjunction with a flexible optical delivery fiber, this wavelength can
be used in various surgical applications to cut, close or vaporize soft tissue.
Semiconductor diode chips at 630nm, 635nm, 652nm, 690nm and 730nm wave lengths
are also available, permitting an even wider array of medical applications.
We also use a number of different laser diodes for our various products. Diodes
for certain of our lasers are also currently single-sourced, although we are
exploring available opportunities for dual sourcing. Currently, the majority of
these suppliers are located in the U.S., Japan and Europe. In addition, we
purchase the fibers contained in our clinical solution kits, and those fibers
required to support our FibersDirect.com business, from suppliers in the U.S.
Because most of our raw materials and components are available from various
sources, we are currently developing qualified backup suppliers for each of
these resources.
We currently outsource most of our manufacturing of disposable fibers used in
EVLT(R), and other surgical procedures. We own the patent applications for
certain EVLT(R) disposable fiber technology and subcontract the manufacturing to
a third party. We subcontract the production of EVLT(R) kits of disposable
items, consisting principally of a fiber, a sheath used to introduce the fiber
into a vein, a guide wire, and a needle used to insert the sheath. Each of these
EVLT(R) components is currently purchased from third parties. We purchase
disposable fibers used in other surgical procedures directly from third parties.
We are required to manufacture our products to comply with the international
standard BS EN ISO 13485:2003 and the FDA's Quality System Regulations, or
"QSR." The ISO 13485 and QSR standards detail the methods and documentation of
the design, testing, control, labeling, packaging, storage and shipping of our
products. Our manufacturing facility is subject to periodic audits by regulators
who conduct inspections that must be satisfactory for us to maintain ISO
approval, and it is also auditable by the FDA. Our failure to maintain
compliance with the ISO 13485 and QSR requirements could result in the closure
of our manufacturing operations and the recall of our products. If one of our
suppliers were not to maintain compliance with our quality requirements, we
might have to qualify a new supplier and could experience manufacturing delays
as a result. In November 1999, we became certified to manufacture in the United
Kingdom and upgraded to BS EN ISO 13485: 2001. In 2002, we underwent an FDA
Quality Systems Regulation Inspection and received a satisfactory letter in from
the FDA as a result of this inspection. In 2004, we successfully completed an
external audit which allowed us to upgrade to BS EN ISO 13485:2003
SALES AND MARKETING
In the U.S., we sell, market and distribute our products and services through a
direct sales force. Our primary sales focus in the U.S. has been the
commercialization of EVLT(R). We initially used independent sales
representatives, switching to a direct sales force during the second half of
2002 to better manage the dynamics of selling clinical applications, including
lasers and disposable products. We currently employ 19 EVLT(R) sales
representatives, two regional sales managers and four clinical specialists,
including one training manager, in support of our field sales efforts. We plan
to fill one open sales territory. We hired two sales development personnel to
focus on VeinViewer(TM) sales and plan to hire one more. We will continue to
monitor sales activities and strategies and adjust the number of direct sales
representatives, independent sales representatives and distributors to address
market needs and opportunities in the future.
Internationally, we sell, market and distribute our products and services
through a combination of direct sales representatives and a global network of
distributors. We typically commit our distributors to minimum product purchases,
and we may terminate our relationships with distributors who do not meet those
minimum purchase levels. We have not given our distributors price protection or
product return rights. We do not remotely monitor inventory levels of our
products once we sell them to distributors, but may obtain that information as
needed by our contact with the distributor. We also develop and maintain
strategic marketing alliances for international sales and marketing. These
alliances exist under agreements with companies such as Olympus Medical Systems
Corporation. Each of these agreements relates to certain products and market
segments.
We target our marketing efforts to physicians through office visits, trade shows
and trade journals, and to consumers through point of service information
brochures and our websites, www.evlt.com (which provides information to patients
and physicians about EVLT(R)) and www.fibersdirect.com (which provides product
and pricing information to prospective customers about our available optical
fibers). Our sales philosophy includes establishing strong collaborations with
well-known professionals in the industry regarding our technology platforms,
compiling substantive clinical data and supporting the publication of peer
review articles. With respect to EVLT(R), we believe that we have collected more
clinical data regarding our products and their application than any of our
competitors in the endovenous laser treatment market.
In November 2000, we formed FibersDirect.com, a U.S. business unit that acts as
a direct marketing conduit by providing on-line information for available
products and access to our sales staff by e-mail. FibersDirect.com enables
distribution of fibers directly from the manufacturer to the end-user. Our
OPTIGUIDE(R) fibers, used in photodynamic therapy cancer treatments, are
promoted via FibersDirect.com.
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In 2003, no customer accounted for more than 10% of our revenues, and U.S. sales
represented 63% of total revenue. In 2004, no customer accounted for more than
10% of our revenues and approximately 66% of our sales were generated in the
U.S. In 2005, no customer accounted for more than 10% of our revenues and
approximately 75% of our sales were generated in the U.S. Going forward, we
believe that our annual dependence on any individual customer or group of
customers should decrease because we expect more of our revenues to be generated
from sales of EVLT(R) to individual physician practices and hospitals rather
than to large-scale distributors. In addition, we believe that our percentage of
sales generated domestically should increase as EVLT(R) market penetration in
the U.S. increases.
For the remainder of 2005 and in 2006, we plan to continue to focus on the
development and growth of EVLT(R) sales worldwide. We will continue to support
the development and approval of new applications for other products, and to
continue our research and development efforts aimed at enhancing our products'
effectiveness and manufacturing efficiencies.
COMPETITION
The medical device industry is highly competitive and regulated and is subject
to rapid and substantial technological change. We compete primarily on the basis
of performance, brand name, reputation and price. Developments by others, both
public and private, may render our products noncompetitive or obsolete, or we
may be unable to keep pace with technological developments and other market
factors. Existing and potential competitors may develop products and clinical
solutions that could prove to be more effective, safer or less costly than our
products and clinical solutions. Many of these competitors have significantly
greater financial and human resources than we do, and have established
reputations as well as worldwide distribution channels that are more effective
than ours. Such competition involves an intensive search for technological
innovations and the ability to market these innovations effectively. The
introduction of new products and clinical applications by competitors may result
in price reductions, reduced margins, loss of market share and product
replacements, even for products protected by patents. There can be no assurance
that competitors, many of which may have made substantial investments in
competing technologies, would not prevent, limit or interfere with our ability
to make, use or sell our products either in the United States or in
international markets. To compete effectively in the marketplace, we require the
financial resources to effectively support our activities in research and
development, regulatory compliance, quality control, sales and marketing,
distribution and technical information and training services.
In the vein treatment market, our competitors include manufacturers and
marketers of surgical and radiofrequency devices, and pharmaceutical companies
that provide drugs used in sclerotherapy and other vascular diseases. Within the
specific endovenous laser treatment market which our EVLT(R) products serve,
Biolitec A.G., AngioDynamics, Inc., Vascular Solutions, Inc., New Star Lasers,
Inc., d/b/a CoolTouch, Inc. and Dornier MedTech GmbH are our main competitors
for surgical diode lasers. AngioDynamics does not manufacture lasers or optical
fiber, and we understand it currently has an original equipment manufacturing
agreement with Biolitec for these goods. AngioDynamics received FDA clearance
for its device in November 2002, approximately 10 months after Diomed, while
CoolTouch recently received FDA clearance for its laser treatment of varicose
veins on September 30, 2004. Biolitec, Lumenis and Dornier, among others, are
our competitors in the general surgical laser market. AngioDynamics, Total Vein
Solutions, Inc. and Vascular Solutions, Inc. currently compete with us for sales
of kits used in endovenous laser treatment.
We believe that our EVLT(R) system and comprehensive physician management tools
are superior to the products offered by our direct competitors. EVLT(R) uses a
laser wavelength that has been proven effective in FDA trials and in peer
reviewed data. Compared to varicose vein treatments using radiofrequency as
offered by our competitor, VNUS Technologies, Inc., Diomed's EVLT(R) treatment
is a faster procedure, uses substantially less expensive disposables, has
clinically proven results that are superior to the results reported for VNUS and
does not have any of the serious complications reported by VNUS. EVLT(R) offers
physicians comprehensive practice management tools, including physician training
and practice development. Dornier, Biolitec and AngioDynamics offer some
practice management assistance, but we believe that, to the extent offered, our
competitors' practice management tools are significantly less comprehensive than
ours.
In the cancer treatment market, our competitors include manufacturers and
marketers of surgical and radiation therapy devices, and all the pharmaceutical
companies that provide various drugs used in chemotherapy and immunotherapy.
Within the specific photodynamic therapy market, Lumenis, Laserscope and
Biolitec are our main competitors. We currently have one FDA-cleared diode laser
in the U.S. for photodynamic therapy cancer applications, which is used in
conjunction with Axcan Pharma's Photofrin(R) drug for late stage lung and
esophagus cancers.
We also face competition from current widespread treatment practices, including
surgery, chemotherapy and radiation. Since most photodynamic therapy cancer
treatments are still in clinical trials, no long-term safety or efficacy data is
available. As a result, cancer patients may be more likely to choose proven
traditional forms of treatment.
We expect that our principal methods of competition with other photodynamic
therapy support companies will be based upon such factors as:
- the ease of administration of our partners' photodynamic therapy
methodologies;
- the degree of generalized skin sensitivity to light;
- the number of required doses;
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- the safety and efficacy profile;
- the selectivity of photodynamic therapy drug for the target lesion or
tissue of interest;
- the type and cost of our light systems; and
- the cost of our partners' drug.
Increased competition could result in:
- price reductions;
- lower levels of third-party reimbursements;
- failure to achieve market acceptance for our photodynamic therapy
product line, and loss of market share.
PATENTS, TRADEMARKS AND PROPRIETARY TECHNOLOGY
We hold U.S. and international patents for inventions endovenous laser treatment
of varicose veins, solid state laser diode light source, high power light
source, peltier-cooled and medical spacing guide. These patents expire from 2011
to 2019.
In June 2002, the U.S. Patent and Trademark Office issued Patent No. 6,398,777
("Endovascular laser device and the treatment of varicose veins"). We formerly
licensed technology for the EVLT(R) process from one of its inventors, Dr.
Robert Min, on a non-exclusive basis, although Dr. Min had agreed not to license
the process technology to any third party so long as we complied with our
obligations under the agreement. On September 3, 2003, Diomed acquired exclusive
rights to U.S. Patent No. 6,398,777 and related foreign patents for endovenous
laser treatment of varicose veins, in two transactions.
In the first transaction, Diomed purchased the interest in the EVLT(R) patent
owned by one of its five named inventors, Dr. Robert J. Min. This transaction
was completed under a purchase agreement between Diomed and Dr. Min entered into
on July 23, 2003. On September 3, 2003, Diomed paid the purchase price set forth
in the Purchase Agreement (consisting of $500,000 in cash and options to
purchase 40,000 (as adjusted by the 1:25 reverse split, effective June 17, 2004)
shares of our common stock) in exchange for Dr. Min's assignment to Diomed of
his interest in the EVLT(R) patent. Diomed has agreed to pay to Dr. Min variable
payments based on Diomed's sales of products using the EVLT(R) patent. Dr. Min
had previously licensed the EVLT(R) patent to Diomed and had served as a
consultant to Diomed. Dr. Min's consulting agreement with Diomed was amended to
reflect the changes in the relationship between him and Diomed as a result of
Diomed's acquisition of the EVLT(R) patent rights. Dr. Min is expected to
continue to act as a consultant to Diomed under the revised consulting
agreement.
In the second transaction, Diomed licensed, on an exclusive basis, the EVLT(R)
patent from Endolaser Associates, LLC, the assignee of interest in the EVLT(R)
patent from the other four named inventors. This transaction was completed under
a license agreement between Diomed and Endolaser Associates entered into on July
11, 2003. On September 3, 2003, Diomed paid Endolaser Associates $1.5 million in
cash in exchange for the exclusive license granted by Endolaser Associates on
behalf of the four inventors who had assigned their interest in the EVLT(R)
patent to Endolaser Associates. Diomed is to make additional payments totaling
$2.5 million in 10 quarterly installments of $250,000 each, commencing October
1, 2003. Diomed paid all such payments due through October 1, 2005. Diomed has
agreed to pay ongoing variable royalties based on Diomed's sales of products
subject to the EVLT(R) patent.
Together with Dr. Min and his associate, Dr. Stephen Zimmet, we also invented
fiber technology that we use with our EVLT(R) products. Drs. Min and Zimmet
assigned to us their rights to a patent application regarding this technology.
As of September 30, 2005, this patent application was still pending before the
U.S. Patent and Trademark Office. We pay a fee for our sale of fibers
incorporating this technology. Doctors Min and Zimmet also provide services to
us on an ongoing basis to educate physicians on the use of our EVLT(R) products,
and we pay them fees for these services.
We license technology that we currently use in our OPTIGUIDE(R) fiber optic
diffuser. Health Research, Inc. owns this patented technology, and exclusively
licenses it to QLT, Inc. In turn, QLT sublicenses it to us on a non-exclusive
basis. The sublicense continues until the licensed patent rights expire or the
license from Health Research to QLT is terminated, whichever comes first. Health
Research may terminate its license to QLT if QLT breaches its obligations under
the license and does not cure the breach within 90 days, or if QLT becomes
insolvent. QLT may terminate our sublicense if we breach our obligations under
the sublicense, such as failing to pay royalties, and do not cure the breach
within 90 days, or if we become insolvent.
We have received trademark registrations from the U.S. Patent and Trademark
Office for the trademarks "Diomed," "OPTIGUIDE" and "EVLT." We have initiated
trademark registrations "Summer Legs" as a trademark and/or service mark, but we
have not yet received registrations for this particular mark. We registered
various domain names, including diomedinc.com, diomed-lasers.com,
fibersdirect.com, fibresdirect.com, summerlegs.com and evlt.com.
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Our proprietary technology includes:
- a device for scanning laser beams in a pre-defined pattern across the
patient's skin;
- an enclosure for protecting laser diodes and modules;
- a low cost method for measuring the light from optical fibers of
differing geometry (under development);
- a common platform for laser diodes of different wavelengths;
- a user interface that is appropriate to the clinical setting;
- a monolithic optical geometry for implementing the patented technology;
- a means for driving the laser diodes that provides a wide dynamic range;
and
- a means for efficiently removing heat from the diodes thereby allowing
the instrument to operate with standard line power as the only service.
The patent position of medical device companies generally is highly uncertain.
Some of the risks and uncertainties include:
- the patent applications owned by or licensed to us may not result in
issued patents;
- our issued patents may not provide us with proprietary protection or
competitive advantages;
- our issued patents may be infringed upon or designed around by others;
- our issued patents may be challenged by others and held to be invalid or
unenforceable;
- the patents of others may have a material adverse effect on us; and
- significant time and funds may be necessary to defend our patents.
We are aware that our competitors and others have been issued patents relating
to optical fibers and laser devices. In addition, our competitors and others may
have been issued patents or filed patent applications relating to other
potentially competitive products of which we are not aware. Further, in the
future our competitors and others may file applications for patents, or
otherwise obtain proprietary rights to technology that can be used for such
products. These existing or future patents, applications or rights may conflict
with our patents or applications. These conflicts could result in a rejection of
our or our licensors' patent applications or the invalidation of issued patents,
any of which could have a material adverse effect on our ability to focus on the
development or marketing of these applications. If conflicts occur, or if we
believe that other products may infringe on our proprietary rights, we may
pursue litigation or other legal remedies, or may be required to defend against
litigation. Indeed, we have sued several competitors to assert our intellectual
property rights, and we have been sued by a competitor who has alleged that we
infringed its intellectual property rights. Legal proceedings may materially
adversely affect our competitive position, and we may not be successful in any
such proceeding. Litigation and other proceedings can be expensive and time
consuming, regardless of whether we prevail. This can result in the diversion of
substantial financial, managerial and other resources from other activities. An
adverse outcome could subject us to significant liabilities to third parties or
require us to cease any related research and development activities or product
sales.
We also seek to protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants. These third parties may breach their agreements with us, and we may
not have adequate remedies for their breach. Also, competitors may independently
learn or discover our trade secrets.
For a discussion of some of the risks and uncertainties related to our
intellectual property, see "Risk Factors," above, and for a discussion of
current litigation involving our intellectual property, see "Legal Proceedings,"
below.
GOVERNMENT APPROVALS
The FDA and comparable international regulatory bodies regulate our medical
device products and their applications.
In the United States, our products are regulated as medical devices by the FDA
under the Federal Food, Drug, and Cosmetic Act, or FDC Act, and require
clearance of a premarket notification under Section 510(k) of the FDC Act or
approval of a PMA application, under Section 515 of the FDC Act prior to
commercialization. Pursuant to the FDC Act, the FDA regulates, among other
things, the following aspects of medical devices: product design and
development, product testing for safety and efficacy,. product manufacturing,
product labeling, product storage, pre-market clearance or approval, product
sales and distribution, record keeping, reporting of adverse events and
corrective actions, recalls and removals.
In addition, in conjunction with the Federal Trade Commission, the FDA regulates
the advertising and promotion of the medical devices in the United States.
Failure to comply with the applicable requirements can result in sanctions such
as warning letters, fines, injunctions, civil and criminal penalties against us,
our officers, and our employees, recall or seizure of products, total or partial
suspension of production, refusal of the government to grant premarket clearance
or premarket approval for devices, withdrawal of marketing approvals and
recommendation that we may not be permitted to enter into government contracts.
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Unless an exemption applies, each medical device we wish to commercially
distribute in the U.S. will require either prior clearance by the FDA on the
basis of what is called a "510(k) application," or a pre-market approval ("PMA")
application. The FDA classifies medical devices that are manufactured or sold in
the U.S. into one of three classes. Devices deemed to pose lower risks are
placed in either class I or II, which requires the manufacturer to submit to the
FDA a pre-market notification requesting permission to commercially distribute
the device. This process is generally known as 510(k) pre-market notification.
Devices deemed by the FDA to pose the greatest risk, such as life-sustaining,
life-supporting or implantable devices, or devices deemed not substantially
equivalent to a previously cleared 510(k) device, are placed in class III,
requiring pre-market approval upon a PMA application submitted by the applicant.
Our laser devices require either 510(k) or pre-market application approval,
depending on the clinical application sought. Our devices generally qualify for
clearance under 510(k) procedures. To obtain 510(k) clearance, we must submit a
pre-market notification demonstrating that our proposed device is substantially
equivalent to a previously cleared 510(k) device or a device that was in
commercial distribution before May 28, 1976 (the date that the FDA called for
the submission of PMA applications). The FDA's 510(k) clearance review has
recently taken from three to twelve months from the date the application is
submitted, but it can take significantly longer.
After a device receives 510(k) clearance, any material changes, major design
changes, changes to the safety and efficacy of the product, new claims or
indications for use and new technology with no prior history of use in medical
devices are subject to a new 510(k) clearance requiring a rigorous demonstration
of substantial equivalence to a currently marketed device and or clinical
trials. Any modification that could significantly affect its safety or
effectiveness, or that would constitute a major change in its intended use,
requires a new 510(k) clearance or, alternatively, could require pre-market
approval. The FDA requires each manufacturer to make this determination
initially, but the FDA can review any such decision and can disagree with a
manufacturer's determination. If the FDA disagrees with a manufacturer's
determination, the FDA can require the manufacturer to cease marketing and/or
recall the modified device until 510(k) clearance or obtain pre-market approval.
If the FDA requires us to seek 510(k) clearance or pre-market approval for any
modifications to a previously cleared product, we may be required to cease
marketing or recall the modified device for the unapproved, or so called
"offlabel," use until we obtain this clearance or approval. Also, under these
circumstances, we may be subject to significant regulatory fines or penalties.
We expect that any additional applications that we may seek for our existing
laser products will require pre-market approval. The FDA requires pre-market
approval for each specific clinical procedure.
We are the first company to receive FDA clearance for use of lasers and related
applications in endovenous laser treatment and first diode laser manufacturer to
receive FDA clearance for use of lasers in photodynamic therapy cancer
treatments. In January 2002, we received FDA clearance for use of endovenous
laser treatment in the U.S., in respect of our EVLT(R) product line, making us
the first company to receive FDA clearance for this modality and use.
Specifically, the FDA approved our EVLT(R) surgical laser and procedure kit as
intended for use in ablation of the greater saphenous vein of the thigh in
patients with varicose veins, and the FDA specifically found that the FDA would
not require us to submit a pre-market approval application for this use. In
December 2002, the FDA granted clearance for the use of EVLT(R) for expanded
indications, namely, the use of our D15plus and D30plus diode lasers and
disposable kits for the treatment of varicose veins and varicosities associated
with the superficial vein reflux of the greater saphenous vein. In December
2004, we obtained FDA clearance authorizing the use of our laser and procedure
kits for treatment of venous incompetence and reflux of other superficial veins
in the lower extremity.
In August 2000, we and Axcan Pharma received regulatory approval for our 630nm
laser and OPTIGUIDE(R) fiber, and Axcan Pharma's Photofrin(R) drug used in the
cancer treatment for late stage lung and esophageal cancers. In August 2003,
Axcan Pharma announced that it received FDA clearance in connection with an
application it had made for expanded indications of the use of Photofrin(R) in
conjunction with our photodynamic therapy laser products for the treatment of
Barrett's Esophagus. In September 2004, our laser development and supply
agreement with Axcan Pharma, dated August 2, 2000, was terminated and as a
result, we are no longer distributing PDT lasers through Axcan Pharma. Sales to
Axcan Pharma represented approximately 1% or less of our sales in 2003 and 2004.
We will continue to market PDT lasers through our direct sales force and
distributors, both domestically and internationally.
We are also regulated under the Radiation Control for Health and Safety Act,
which requires laser products to comply with performance standards, including
design and operation requirements, and manufacturers to certify in product
labeling and in reports to the FDA that their products comply with all such
standards. The law also requires laser manufacturers to file new product reports
and annual reports, maintain manufacturing, testing and sales records, and
report product defects. We must affix various warning labels and install certain
protective devices, depending on the class of the product.
Our failure to comply would initially result in a warning letter from FDA
informing us of the noncompliance. Action to correct the non-compliance range
from a field correction, such as new labeling being sent to existing customers
by mail, to a formal recall of the labeling and replacement with compliant
material. As compliance with existing regulations is included in our new product
development protocol, it is unlikely a non-compliance will occur. Labeling and
new product compliance are reviewed at discrete intervals during new product
development by regulatory and compliance departments prior to the release of any
new products.
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International sales of our products are subject to strict regulatory
requirements, which vary substantially from country to country. Our key
international markets are the European Union, Japan, Australia, South Korea,
Peoples Republic of China and Canada. The time required to obtain clearance or
approval by a foreign country may be longer or shorter than that required for
FDA clearance or approval, and the requirements may be different.
The European Union, which consists of fifteen countries encompassing most of the
major countries in Europe, has adopted numerous directives and standards
regulating the design, manufacture, clinical trials, labeling and adverse event
reporting for medical devices. Devices that comply with the requirements of a
relevant directive may bear the CE conformity marking indicating that the device
conforms with the essential requirements of the applicable directives and,
accordingly, may be commercially distributed throughout Europe. ISO 9001
certification is one of the CE Mark certification requirements. In November
1999, our facility was awarded ISO 9001 and EN 46001 certification, thereby
allowing us to apply the CE mark to our products and market them throughout the
European Union. In September 2001, we were the first company to receive the CE
mark of approval for marketing endovenous laser therapy products in Europe.
Outside of the European Union, we must obtain country-by-country approval to
import our products. Certain countries, such as Switzerland, have voluntarily
adopted laws and regulations that mirror those of the European Union with
respect to medical devices.
THIRD-PARTY REIMBURSEMENT
A patient's ability to secure reimbursement for our existing and future products
is critical to our success. In the U.S., health care providers generally rely on
third-party payors, principally private health insurance plans and Medicare and
Medicaid, to reimburse all or part of the cost of procedures in which medical
devices are used. However, we cannot assure that EVLT(R) and photodynamic
therapy, and future products that we develop in connection with photodynamic
therapy, endovenous or other medical and clinical procedures, will be
reimbursed, or that the amounts reimbursed to physicians would be adequate.
The current cost reduction orientation of the third-party payor community makes
it exceedingly difficult for new medical devices and surgical procedures to
obtain reimbursement. Often, it is necessary to convince payors that the new
devices or procedures will establish an overall cost savings compared to
currently reimbursed devices and procedures. We believe that EVLT(R) may offer
an opportunity for payors to reduce the costs of treating varicose vein patients
by possibly reducing significantly the number of vein stripping procedures
performed. We estimate that the cost of varicose vein treatment using EVLT(R) is
approximately 25% of the cost of vein stripping procedures. While we believe
that EVLT(R) possesses economic advantages that will be attractive to payors, we
cannot assure that they will make reimbursement decisions based upon these
advantages.
Reimbursement by third-party payors is often positively influenced by the
existence of peer-reviewed publications of safety and efficacy data and
recommendations by knowledgeable physicians. With regard to EVLT(R), we
currently exceed the competition in the magnitude of clinical data we have
compiled, and we are currently the only company to have peer-reviewed articles
published in scientific journals addressing endovenous laser treatment. A study,
entitled "Endovenous Laser Treatment of Saphenous Vein Reflux: Long-Term
Results," was published in the August 2003 issue of the Journal of Vascular and
Interventional Radiology. This study shows what we believe to be excellent
long-term results for the removal of varicose veins caused by reflux of the
greater saphenous vein. The study was co-authored by Dr. Robert Min, Director of
Cornell Vascular in New York and Vice-Chairman of Radiology at Weill Medical
College of Cornell University. Dr. Min is a consultant to Diomed, and is an
inventor of the EVLT(R), who sold his rights to this patented technology to
Diomed on September 3, 2003. Dr. Min assists Diomed in physician training and in
the development of medical treatments using EVLT(R). For further details of this
study, see "Products, Competencies and Market Opportunities--Endovenous Laser
Treatment."
Additionally, we believe that our significant investment in proactive
reimbursement activities has produced dramatic results in both the number and
breadth of insurance carriers willing to provide positive EVLT coverage. The
list of private, regional and national insurance providers with positive
coverage policies on EVLT(R) has grown significantly, driven in large part by
the addition of UnitedHealth Group Inc. UnitedHealthcare has joined other
organizations such as Aetna Inc., Cigna Health Care and Humana Inc. along with
an extensive list of independent Blue Cross Blue Shield and Medicare (Part B)
carriers now providing our growing EVLT(R) patient base with access to broad
insurance coverage.
On November 4, 2004, the Center for Medicare and Medicaid Services (CMS)
established reimbursement codes for laser ablation as a mode of treatment for
superficial vein disorders, including EVLT(R) for varicose veins. The new codes,
which are established by the American Medical Association and the CMS, form the
basis for Medicare and Medicaid reimbursement across the U.S. and became
effective January 1, 2005. Including Medicare/Medicaid reimbursements, as of
November 30, 2005, we list over 63 coverage policies representing over 217
million covered lives.
Under the new codes, doctors performing the EVLT(R) procedure in an office or
clinic setting are reimbursed an unadjusted base rate of $2,041 for the first
vein treated under code #36478; second and additional veins at a base rate of
$437 under code #36479. When performed in a hospital setting, the new codes
allow for professional (Part B) payments of $364 for the first vein treated and
$178 for the second and additional veins, along with applicable hospital
facility fees. These base rates are adjusted for regional cost differences.
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Reimbursement systems in international markets vary significantly by country
and, within some countries, by region. Reimbursement approvals must be obtained
on a country-by-country basis or a region-by-region basis. In addition,
reimbursement systems in international markets may include both private and
government-sponsored insurance. We cannot be certain that we will be able to
continue to obtain such approvals in a timely manner, if at all. If we fail to
receive acceptable levels of international reimbursement approvals, market
acceptance of our products in those countries is likely to be adversely
affected.
Nevertheless, the efforts of governments and third-party payors to contain or
reduce the cost of healthcare will continue to affect our business and financial
condition as a medical device company. In foreign markets, pricing or
profitability of medical products and services may be subject to government
control. In the U.S., we expect that there will continue to be federal and state
proposals for government control of pricing and profitability. In addition,
increasing emphasis on managed healthcare has increased pressure on pricing of
medical products and will continue to do so. These cost controls may have a
material adverse effect on our revenues and profitability, and may affect our
ability to raise additional capital.
In addition, cost control initiatives could adversely affect our business in a
number of ways, including:
- decreasing the price we, or any of our partners or licensees, receive
for any of our products;
- preventing the recovery of development costs, which could be
substantial; and
- limiting profit margins.
NUMBER OF EMPLOYEES
As of December 1, 2005, we employed a total of 88 full-time employees, 43 of
whom are based in the U.S. and 45 of whom are based at Diomed Ltd., our
wholly-owned subsidiary in Cambridge, England, where manufacturing and certain
international sales are conducted. We believe that our future success will
depend in part on our continued ability to attract, hire and retain qualified
personnel. None of our employees is represented by a labor union. We believe our
employee relations are good.
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 argument 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.
36
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.
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.
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION OR PLAN OF OPERATION
You should read the following discussion of our financial condition and results
of operations together with the audited consolidated financial statements and
notes to the financial statements at December 31, 2004 and the unaudited
financial statements and notes thereto, all of which are included elsewhere in
this prospectus.
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. We refer you to the
"Risk Factors" on pages 6 through 18 of this prospectus 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 June 30, 2005, we had an accumulated deficit of approximately $76 million,
including $17.4 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 financial
statements and the notes thereto included in this prospectus.
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.
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.
EVLT(R) was a primary source of revenue in 2004, and will continue to be our
primary source of revenue in 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 and customized marketing programs, 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.
38
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 August 2005, we entered into a three year agreement with Luminetx, Inc. to
acquire exclusive distribution rights to the VeinViewer(TM) Imaging System for
the sclerotherapy, phlebectomy and varicose vein treatment markets in the United
States and United Kingdom. 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 19 EVLT(R) sales representatives, two regional sales managers and a vice
president of North American sales. We plan to fill one open sales territory. We
hired two sales development personnel to focus on VeinViewer(TM) sales and plan
to hire one more. Additionally, our current clinical support organization
employs four clinical specialists, including one training manager, who support
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 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 - which includes information
about the Company and our physician support initiatives, among other things.
Although we have continued to focus on the development and growth of EVLT(R)
sales both domestically and internationally, we will continue to support the
development and approval of new 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
have significant markets. 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 at some time
in the future. However, EVLT(R), and not PDT, is the emphasis of our current
business plan.
39
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.
40
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.
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 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 cost savings. Legal expenses included $676,000 for the
continuing cost of patent litigation we commenced during 2004 against four
competitors and the theft of trade secrets litigation we 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 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%.
41
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,
- 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.
42
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.
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 for the nine months ended September
30, 2005 was $9,610,000, or $0.50 per share, compared to $6,961,000, 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 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%.
43
FISCAL YEAR ENDED DECEMBER 31, 2004 COMPARED TO FISCAL
YEAR ENDED DECEMBER 31, 2003
REVENUE
Diomed delivered revenues for the year ended December 31, 2004 of $13,385,000,
increasing approximately $4,186,000, or 46%, from $9,199,000 for the year ended
December 31, 2003. Revenue from EVLT(R) disposable procedure kits increased
100%, demonstrating the continued and growing acceptance of EVLT(R) by the
medical community and patients alike.
In 2004, approximately $7,838,000, or 59%, of our total revenues, were derived
from laser sales, as compared to approximately $5,726,000, or 62%, in 2003. In
2004, approximately $5,546,000, or 41%, of our total revenues were derived from
sales of disposable fibers and kits, accessories and service, as compared to
approximately $3,473,000, or 38% in 2003. 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 in the EVLT(R) market,
- the compounding impact of the recurring revenue stream from
disposable 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 and
expanded reimbursement coverage by health care insurers, including
the recent establishment of reimbursement codes for EVLT(R) by the
American Medical Association and the Center for Medicare and
Medicaid Services.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the year ended December 31, 2004 was $7,920,000, increasing
approximately $2,047,000, or 35%, from $5,873,000 for the year ended December
31, 2003. Cost of revenue, as a percentage of sales, decreased from 64% to 59%
on a year-to-year basis.
The increase in cost of revenue in 2004 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,
- improved materials costs, partially offset by foreign exchange
impact, and
- full year impact of royalties and amortization of the intangible
asset from the EVLT(R) patent acquisition completed in September
2003.
Gross profit for the year ended December 31, 2004 was $5,464,000, increasing
approximately $2,139,000 from $3,325,000 for the year ended December 31, 2003.
On a percent-of-sales-basis, the gross margin increased from 36% to 41%. The
increase in gross profit in 2004 was driven by incremental sales volume, as well
as improvements in material costs.
OPERATING EXPENSES
Research and development expenses for the year ended December 31, 2004 increased
by 99% to $1,695,000 from $850,000 from the year ended December 31, 2003. This
increase was largely due to our increased focus on improving the
feature-function and manufacturability of our lasers and disposable kits when
compared to 2003 operations, which were affected by cash constraints prior to
the equity financing we completed in the fourth quarter of 2003. We expect that
research and development spending will remain at this elevated level, as we
continue to focus on product cost reductions and improvements in the
feature-function of our products.
Selling and marketing expenses for the year ended December 31, 2004 were
$7,161,000, increasing approximately $3,105,000, or 77%, from $4,056,000 for the
year ended December 31, 2003. The increase was primarily driven by personnel
costs of $1,800,000, caused by a doubling in the size of the sales force, higher
sales commissions resulting from increased sales volume, restructuring of the
sales field leadership and sales field organization including sales leadership
termination payments and recruiting costs and increased marketing expenditures
of $750,000, primarily for trade shows and advertising in support of the sales
efforts to drive the growing commercialization of EVLT(R). In 2005, we
anticipate increased expenses resulting from the larger sales organization,
increased commissions due to volume, and increased spending levels in marketing
programs to support the continued growth in commercialization of EVLT(R).
44
General and administrative expenses for the year ended December 31, 2004 were
$6,422,000 increasing approximately $2,022,000, or 46%, from $4,400,000 for the
year ended December 31, 2003. The increase was primarily attributable to
incremental legal fees of $1,200,000, as well as sales volume-based product
liability insurance costs and infrastructure enhancements. Legal costs included
the cost of patent infringement litigation against AngioDynamics, Vascular
Solutions, Total Vein Solutions, and CoolTouch, as well as continuing costs of
litigation against Vascular Solutions in trade secrets suit litigation commenced
by the Company in the fourth quarter of 2003. In 2005, we anticipate general and
administrative expenses to remain at this elevated level as we continue to incur
legal fees in connection with the intellectual property infringement actions
lawsuits we filed against AngioDynamics, Vascular Solutions, Total Vein
Solutions and New Star Lasers (a/k/a Cool Touch).
LOSS FROM OPERATIONS
As a result of the factors outlined above, the loss from operations for the year
ended December 31, 2004 was $9,813,000, increasing approximately $3,833,000, or
64%, from $5,980,000 for the year ended December 31, 2003, as increasing costs
were partially offset by increased operating revenue.
INTEREST EXPENSE, NET
Interest expense for the year ended December 31, 2004 was $264,000, compared to
$13,902,000 for the year ended December 31, 2003, and included $109,000 in
non-cash charges for debt discounts, the beneficial conversion feature and debt
financing costs related to the October 2004 equity and convertible debt
financing. Interest expense will continue to increase in 2005 as a result of the
amortization of these items, acceleration of deferred financing and discount due
to conversion of convertible debt after year-end and due to the actual interest
accrued on the debt. Interest expenses for 2003 included $12,894,000 in non-cash
charges for debt discounts, the beneficial conversion feature and debt financing
costs related to our financing activities during 2003. Cash-based interest
expense in 2003, in the amount of $1,008,000, included $783,000 in amortization
of debt financing costs and $132,000 in interest expense on notes related to our
December 2002 debt financing. These charges did not continue in 2004, as the
December 2002 notes were fully repaid in September, 2003, and notes we issued
during 2003 (including all accrued interest thereon) were fully converted into
common stock in November 2003. In addition, 2003 interest expense included
$72,000 related to the $936,000 promissory note we owed to Axcan Pharma, which
we paid on January 2, 2004, in accordance with the terms under the note.
INCOME TAXES
For the years ended December 31, 2004 and 2003, we included no provision for
foreign, federal or state income taxes, as we incurred net operating losses.
NET LOSS
As a result of the above, the net loss (adjusted for the 1:25 reverse split that
we implemented effectively June 17, 2004) applicable to common stockholders for
the year ended December 31, 2004 was $10,077,000, or $0.68 per share, compared
to a net loss of $19,881,000, or $8.99 per share, in the year ended December 31,
2003. The 2003 net loss included $12,894,000 in non-cash interest expense
arising from debt discounts and the beneficial conversion feature related to the
bridge financings in December 2002 through September 2003.
LIQUIDITY AND CAPITAL RESOURCES
SUMMARY
Since our inception through 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, legal fees in support of our intellectual property rights,
clinical trials, regulatory activities, 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 we generate sufficient revenue to offset such costs. We have
financed our operations primarily through private placements of common stock and
preferred stock, private placements of convertible notes and short term notes
and through credit arrangements.
TRANSACTIONS IN 2005
The following summarizes our capital financing transactions during 2005:
45
EXERCISE OF WARRANTS
During the nine month period ended September 30, 2005, holders of warrants
exercised their warrants to purchase 192,811 shares of common stock. The average
price per share for the warrants exercised during this period was $2.10. We
received proceeds from the exercise of these warrants because the holders did
not elect to use their "cashless exercise" rights, however, in the future,
warrant holders may exercise warrants using the cashless exercise option, in
which case we will not receive cash proceeds from the exercise of warrants,
although we will issue fewer shares than the number of warrant shares being
exercised, at a rate determined by the applicable cashless exercise formula.
ISSUANCE OF WARRANTS TO LUMINETX CORPORATION
In connection with our distribution agreement we entered into with Luminetx
Corporation pursuant to which we shall act as distributor of Luminetx's
VeinViewer(TM) system , on August 5, 2005, we issued to Luminetx 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. Fifty percent of the warrants were
immediately exercisable when issued (subject to prior listing of the underlying
shares with the AMEX), and the remainder of the warrants will become exercisable
when both (i) Luminetx has produced at least 100 units of the VeinViewer(TM)
system and (ii) we have accepted delivery of at least 25 units of the
VeinViewer(TM) system.
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 million 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 1.6 million 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 an aggregate of 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.
We received aggregate gross proceeds of $10 million from the sale of these
securities (approximately $9.5 million net of financing costs, not including
legal fees or registration expenses). We are using the proceeds of the September
2005 financing for our general working capital purposes. We agreed with the
investors that we would not use these proceeds to (i) increase director or
executive compensation or make any loan or other advance to any officer,
employee, director, stockholder or other affiliate, in each case without prior
board approval, (ii) pay dividends (except on the preferred stock), (iii)
purchase debt or equity securities, including redeeming our own securities
(other than the preferred stock), (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 $2.17 floor price, then to the
price determined by a weighted average formula set forth in the exchange
agreement.
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 in each case 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, as well as 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.
46
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 (subject to
adjustment for stock splits, stock dividends and similar events). The conditions
which must be met for either the payment of dividends in the form of common
stock or the suspension of dividend accrual are that, if certain conditions are
met, the shares of common stock for which the preferred stock may be exchanged
under the exchange agreement (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 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
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 its 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 date 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
47
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 1.8 million aggregate 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 $4.5 million
for the exercise of the warrants, and we will issue 1.8 million shares of common
stock. We will use the proceeds of the exercise of warrants for our general
working capital purposes.
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 by providing not less than 61 days prior written notice
to us.
Registration of Common 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,
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 the investors for the preferred stock.
The registration statement of which this prospectus is a part is the
registration statement intended to satisfy our obligations to the investors in
the September 2005 financing.
Accounting for September 30, 2005 Financing
Transaction
In accordance with Emerging Issues Task Force (EITF) number 00-27, "Application
of Issue No. 98-5 to Certain Convertible Instruments" (EITF 00-27), we allocated
the proceeds received in the financing between the preferred stock and the
warrants based on their relative fair values. Then we compared the proceeds
allocated to the preferred stock to the fair value of the common stock that
would be received upon exchange to determine if a beneficial conversion feature
existed. We determined that a beneficial conversion feature of $381,328 existed
and in accordance with EITF 00-27 accreted that amount immediately to the value
of the preferred stock, as the preferred stock is immediately exchangeable.
Further, as the fair value was less than the exchange value, we 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 therefore been included in Preferred Stock Dividends in our
calculation of Net Loss Applicable to Common Stockholders and Basic and Diluted
Net Loss Per Share.
We also reduced the carrying value by $765,000 of the preferred stock 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, we are subject to certain liquidated
damages under our registration rights agreement with the investors if we can not
obtain and maintain effectiveness of a registration statement. Since the
liquidating damages had no contractual maximum, we determined that the
liquidated damages were onerous and thus could result in net-cash settlement of
the transaction in accordance with EITF 00-19. We valued the warrants using the
Black-Scholes model. We 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 subsequent changes in fair value will be recorded
as Non-Cash Interest Expense in the subsequent 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, we 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. We 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%. We 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 our calculation of
Net Loss Applicable to Common Stockholders and Basic and Diluted Net Loss Per
Share.
48
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,
we 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 convertible debentures, which mature in October 2008,
unless previously converted or redeemed.
TRANSACTIONS IN 2004
The following summarizes our capital financing transactions during 2004:
OFFERING TO STOCKHOLDERS AS OF AUGUST 29, 2003
On April 20, 2004, we completed our offering to those persons who held shares of
our common stock as of August 29, 2003, raising the approximate $3 million
maximum in additional equity financing (approximately $2,728,000 after related
expenses). We are using the proceeds from the targeted offering for general
working capital purposes, including supporting our continued growth and
intellectual property strategies. The targeted offering, for 1,188,470 shares of
the Company's common stock at $2.50 per share (after giving effect to the 1:25
reverse split effective June 17, 2004), allowed stockholders to purchase one
share of the Company's common stock for each share of common stock held on
August 29, 2003. The targeted offering also included an "over-subscription
right" which allowed stockholders to purchase additional shares to the extent
the "basic rights" were not fully subscribed.
We filed a registration statement to register the shares to be offered in the
targeted offering. The SEC declared that registration statement effective on
February 13, 2004.
PRIVATE PLACEMENT EQUITY AND DEBT FINANCING ENTERED INTO
SEPTEMBER 28, 2004
On September 28, 2004, we entered into definitive agreements for the sale and
issuance of convertible debentures, common stock and warrants to purchase common
stock to certain accredited investors in a private placement financing
transaction. On October 25, 2004, after receiving approval to list the shares
from the AMEX, we completed this transaction, pursuant to which we raised gross
proceeds of approximately $10.6 million. We received net proceeds of
approximately $9.8 million, before related legal and registration expenses of
approximately $300,000. We are using the proceeds from the 2004 financing
transaction for general working capital purposes.
The following summarizes the principal terms of the transaction:
Variable Rate Convertible Debentures
We issued an aggregate of $7 million principal amount of convertible debentures
at par. The convertible debentures bear interest (payable quarterly in arrears
on March 31, June 30, September 30 and December 31) at a variable rate of 400
basis points over six-month LIBOR and mature four years from the date of
issuance.
The debentures are convertible at any time at the option of the holder into
common stock at a conversion price of $2.29 per share, which was 120% of the
$1.91 per share closing price of the common stock on the AMEX on the trading day
prior to the date that we and the investors signed the definitive purchase
agreements The conversion price is subject to certain adjustments, for dilutive
transactions and for recapitalizations of our capital stock.
Subject to certain conditions, the debentures will also be convertible at the
Company's option at any time after the first anniversary of the issuance date if
the closing price of the Company's common stock equals or exceeds 175% of the
conversion price for at least 20 consecutive trading days. Also subject to
certain conditions, upon maturity, the Company may cause the holders to convert
the entire principal amount of debentures outstanding into shares of common
stock, at a price per share equal to the lesser of the stated conversion price
and 90% of the volume weighted average trading price of its common stock for the
20 days prior to the maturity date.
After the first year and at our option, subject to certain conditions, interest
may be paid in shares of common stock in lieu of cash, at a conversion price
which is based on the closing prices of the common stock on the fifth through
first trading days immediately preceding the interest payment date. The
conversion rate for interest will be discounted by 10% if we obtain stockholder
approval of this discount.
During the first quarter of 2005, the holders of $3.288 million principal amount
of debentures elected to convert that amount of debentures (including accrued
interest of approximately $31,108) into common stock at $2.29 per share.
Accordingly, we issued 1,449,392 shares of common stock to these debenture
holders, and $3.712 million principal amount of debentures was outstanding as of
November 30, 2005.
49
Common Stock
We also issued and sold a total of 2,362,420 shares of common stock at a
purchase price of $1.53 per share, which is 80% of the closing price of the
common stock on the AMEX on the trading day prior to the date that we and the
investors signed the definitive purchase agreements. Accordingly, we received an
aggregate purchase price of $3,614,503 for these shares.
Warrants to Purchase Common Stock
In the private placement financing we completed on October 25, 2004, we issued
warrants to purchase up to 1,832,461 shares of common stock to the investors who
purchased convertible debentures and warrants to purchase up to 1,181,210
additional shares of common stock to the investors who purchased common stock.
The warrants are exercisable for five years from the date of issuance at an
exercise price of $2.10 per share, which is 110% of the $1.91 per share closing
price of the common stock on the AMEX on the trading day prior to the date that
we and the investors signed the definitive purchase agreements. The exercise
price is subject to certain adjustments, including future sales of securities
below the exercise price.
During 2004, holders of 163,399 warrants exercised these warrants, at an
exercise price of $2.10 per share. Accordingly, we issued 163,399 shares of
common stock to these warrant holders and received $343,138 in aggregate
proceeds. Subsequent to year-end 2004, during the nine months ended September
30, 2005, the holders of 192,811 warrants exercised these warrants, at an
exercise price of $2.10 per share. Accordingly, we issued 192,811 shares of
common stock to these warrant holders and received $404,903 in aggregate
proceeds.
Registration of Common Stock
The Company agreed to undertake registration with the Commission of the common
stock and common stock underlying the convertible debentures and warrants. We
filed a registration statement with the Commission on November 24, 2004 covering
these shares and the Commission declared that registration statement effective
on December 6, 2004.
CHANGES IN CAPITAL STOCK STRUCTURE
On September 30, 2005, we designated the rights and preferences of the preferred
stock to be issued in the September 30, 2005 financing. We designated 4,200,000
shares of preferred stock out of the 20,000,000 authorized but unissued shares
of preferred stock available for purposes of the financing, and we issued
4,000,000 of these shares of preferred stock on September 30, 2005 to the
investors in the financing at a purchase price of $2.50 per share (200,000
shares designated remain unissued). As a result, we now have 15,800,000 shares
of authorized but unissued shares of preferred stock.
On June 15, 2004, we held our 2004 Annual Meeting of Stockholders, where our
stockholders voted to permit the Board of Directors, in their discretion, to
effect a one-for-twenty-five reverse stock split of our common stock. On June
16, 2004, the Board of Directors approved the reverse stock split effective June
17, 2004. Additionally, our stockholders approved the reduction in our
authorized shares of common stock from 500 million to 50 million which we
implemented concurrent with the reverse stock split.
CASH POSITION AND CASH FLOW
Our cash and short term investment balances were approximately $16,569,000 as of
September 30, 2005. We had cash balances of approximately $14,436,000 and
$13,398,000 at December 31, 2004 and December 31, 2003, respectively.
We have financed our operations primarily through private placements of common
and preferred stock, convertible and short-term notes, and through credit
arrangements, including the following:
o In September 2003, we entered into an equity financing transaction
pursuant to which we raised gross proceeds of $22,000,000 and
satisfied $1,200,000 in debt, which we had issued in a May 2003
bridge financing. Of the cash proceeds raised in 2003, we utilized
approximately $8.6 million as follows: $2,250,000 in initial
payments to acquire the exclusive rights to the EVLT(R) patent,
$2,132,000 to retire the notes we issued in December 2002, $438,000
to retire short-term notes, $1,160,000 in equity financing costs,
$1,141,000 in the reduction of trade payables, $150,000 in the
Augenbaum litigation settlement, and $1,329,000 in working capital
from September through December 2003.
o In April 2004, we completed a targeted offering of common stock
(priced at $0.10 per share) to the holders of common stock of record
as of August 29, 2003. We raised gross proceeds of approximately
$3,000,000 (approximately $2,728,000 after offering costs) in the
targeted offering.
o In October 2004, we completed a common stock and convertible debt
financing transaction pursuant to which we raised gross proceeds of
approximately $10,500,000 (approximately $9,400,000 after financing
costs) in this financing transaction.
50
We are using the balance of these proceeds for general working capital purposes,
including pursuing our intellectual property strategy.
CASH USED IN OPERATIONS
Cash used in operations for the year ended December 31, 2004 was $8,731,000. The
cash used in operations reflects the net loss for the year of $10,077,163 and
primarily relates to the significant expansion in the size of the sales force
and external marketing initiatives of $3,105,000 in support of the
commercialization of EVLT(R), as well as $1,200,000 in legal fees incurred in
asserting our EVLT(R) patent.
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 year ended December 31, 2004 was
approximately $519,000, primarily related to demonstration equipment and
customer trial programs. 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, a promissory note of $500,000
issued to us by Luminetx and purchases of and computer and demonstration
equipment.
CASH PROVIDED BY FINANCING
Cash provided by financing activities for the year ended December 31, 2004 was
approximately $10,324,000. This primarily includes the $2,728,000 net proceeds
we received from the targeted offering completed on April 20, 2004, the
$9,505,000 net proceeds we received from the 2004 private placement debt and
equity financing completed on October 25, 2004 and the $343,000 we received from
the exercise of warrants we issued in the 2004 private placement. Proceeds from
these financings were partially offset by the first quarter retirement of a
promissory note to Axcan Pharma in the aggregate principal amount of $936,000
and a reduction in the borrowing outstanding under the UK tradeline facility
with Barclay's Bank ($262,000). Financing activities also included payments of
$1,000,000 related to current maturities of the EVLT(R) technology acquisition
obligation.
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 which we 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.
BANK LINES OF CREDIT
Diomed, Ltd., the Company's United Kingdom-based subsidiary, utilizes a 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 as of 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
September 30, 2004, there was approximately $193,000 and zero, respectively
outstanding under these credit facilities. As of December 31, 2004, there were
no amounts outstanding under this line. At December 31, 2003, there was
approximately $262,000 outstanding under this credit facility.
We formerly had a line of credit with Silicon Valley Bank, which we opened in
June 2004. However, as a result of the private placement debt and equity
financing that we completed on October 25, 2004, we terminated this line of
credit. At no time during the term of the line of credit did we fail to comply
with any of our covenants in the line of credit, nor did we draw down on the
line, and accordingly, there were no amounts outstanding at the time of
termination.
FUTURE AVAILABILITY OF CREDIT
As of September 30, 2005, other than the security under the Barclays Bank line
of credit, our assets were not the subject to any liens or encumbrances.
Therefore these unencumbered assets may be available as security for credit
facilities we may seek in the future. However, under the terms of the
convertible debentures that we issued on October 25, 2004, we agreed that, so
long as at least 10% of the original principal amount of any debenture was
outstanding, we would not incur indebtedness or create a lien that is senior to
or having an equal priority with our obligations under the debentures, except
for purchase money security interests and otherwise to the extent that we do so
in the ordinary course of our business. As of November 30, 2005, the three
investors who purchased debentures continued to hold debentures of at least 10%
of the original principal amount.
51
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 agreed to loan $1 million to Luminetx under the
distribution agreement. 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.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition, results of operations,
and cash flows are based on our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the
U.S. 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. Additionally, we use
assumptions and estimates in calculations to determine stock-based compensation.
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.
Our critical accounting policies include:
- revenue recognition;
- allowance for doubtful accounts;
- warranty obligation;
- allowances for excess and obsolete inventory; and
- valuation of long-lived and intangible assets.
Revenue Recognition. We derive our revenue from primarily two sources:
(i) revenues from products including lasers, instrumentation, and disposables,
and (ii) revenues from service. We recognize revenue on products and services
when persuasive evidence of an arrangement is in place, the price is fixed or
determinable, collectability is reasonably assured and title and risk of
ownership has been transferred. Transfer of title and risk of ownership
generally occurs when the product is shipped to the customer or when the
customer receives the product, depending on the nature of the arrangement. We
currently provide for the estimated cost to repair or replace products under
warranty at the time of sale. Service revenue is recognized as the services are
performed.
Allowance for Doubtful Accounts. Accounts receivable are customer
obligations due under normal trade terms. We sell our products to private
physicians, hospitals, health clinics, distributors and OEM customers. We
generally require signed sales agreements, non-refundable advance payments and
purchase orders, and in certain circumstances, depending upon the type of
customer, letters of credit. Some customers seek equipment financing from third
party leasing agents. Accounts receivable are stated at the amount billed to the
customer less a valuation allowance for doubtful accounts.
Senior management reviews accounts receivable on a monthly basis to
determine if any receivables could potentially be uncollectible. We include
specific accounts receivable balances that are determined to be uncollectible,
along with a general reserve, in our overall allowance for doubtful accounts.
After all attempts to collect a receivable have failed, the receivable is
written off against the allowance. Based on available information, we believe
our allowance for doubtful accounts as of June 30, 2005 is adequate.
Warranty Obligation. We engage in extensive product quality programs and
processes, including actively monitoring and evaluating the quality of our
component suppliers. In addition to these proactive measures, we also provide
for the estimated cost of product warranties at the time revenue is recognized,
based on historical warranty rates.
Excess and Obsolete Inventory. Inventories are valued at the lower cost
(first-in, first-out) or market. We maintain reserves for our estimated obsolete
inventory based on historical cost.
52
Deferred Income Taxes. Deferred income taxes are provided on temporary
differences that arise in the recording of transactions for financial and tax
reporting purposes and result in deferred tax assets and liabilities. Deferred
tax assets are reduced by an appropriate valuation allowance if, in our
judgment, it is more likely than not that the deferred tax asset will not be
realized.
Valuation of Long-Lived and Intangible Assets. We assess the impairment of
identifiable intangibles and long-lived assets on an annual basis and whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable. When we determine that the carrying value of intangibles and
long-lived assets may not be recoverable, we measure any impairment based on a
projected discounted cash flow method using a discount rate determined by our
management to be commensurate with the risk inherent in our current business
model. If cash generated in the future by the acquired asset is different from
current estimates, or if the appropriate discount rate were to change, then the
net present value of the asset would be impacted, resulting in a charge to
earnings.
Equity Transactions. In many of our financing transactions, we have issued
warrants. Additionally, we issue options and warrants to non-employees from time
to time as payment for services. In all of these cases, we apply 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. We based our
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.
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.
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our 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 -15e and 15d-15(e) under the Securities Exchange Act of
1934) as of September 30, 2005 and have concluded that, as of such date, our
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.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the nine months ended September 30, 2005, 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.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISLOSURE
None.
DESCRIPTION OF PROPERTY
We own no real property. We occupy 20,500 square feet of office, manufacturing,
and research and development space in Cambridge, UK under a 25 year lease
expiring in April 2024. We do, however, have the option to terminate the lease
agreement at the end of 15 years and again at the end of 20 years. If we choose
not to exercise either of these termination options, the lease will continue
through 2024. We have sublet a portion of this space.
We also occupy approximately 3,700 square feet of office and distribution space
in Andover, Massachusetts under a lease that was schedule to expire in June
2004. On March 5, 2004, we extended this lease for a period of 1 year until June
2005. On March 14, 2005, we extended the expiration date of this lease to April
14, 2008 and expanded our leased space by approximately 2,600 square feet. We
believe that these facilities are in good condition and are suitable and
adequate for its current operations.
53
RELATED TRANSACTIONS
During the past two years, we have entered into transactions with various
related parties. These transactions were completed to finance our operations and
to implement our business plans. We believe that each of these transactions were
on terms as favorable to it as the terms we could have obtained from independent
third parties. Specifically, this section discusses transactions entered into
between December 22, 2002 and September 30, 2005 between us and the following
persons:
- Samuel Belzberg, a former director and his affiliates, Gibralt Capital
Corp. and Gibralt U.S., Inc., a beneficial holder of more than 5% of our common
stock;
- ProMed Partners, L.P. (and affiliates), a beneficial holder of more than
5% of our capital stock; and
- Omicron Master Trust, a beneficial holder of more than 5% of our capital
stock.
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.
PARTICIPATION BY RELATED PARTIES IN THE
INTERIM FINANCING TRANSACTIONS FROM DECEMBER 2002 TO DECEMBER 31, 2003
(Figures throughout this section for number of common stock,
price per share of common stock, options and warrants are adjusted to give
effect to the 1:25 reverse stock split effective June 17, 2004)
At the beginning of 2003, the board elected a new president and chief executive
officer and three new members of the board. In January 2003, Geoffrey Jenkins,
one of our directors since 2001, became the chairman of the board. Also in
January 2003, James A. Wylie, Jr. became our president and chief executive
officer and a director. Mr. Wylie had been engaged on a consulting basis at the
end of 2002 to review our business operations and viability. In March 2003, Gary
Brooks, a nationally recognized turnaround consultant and crisis manager, and
David Swank, an experienced financial executive with significant accounting and
financial control experience, became independent directors.
In connection with the changes in the Board's composition and our leadership, we
entered into three financing transactions, each of which was with a related
party. Highlights of these three transactions are as follows:
54
- December 2002 Interim Financing. At the end of December 2002, we
borrowed $2,000,000 from Gibralt U.S. in the form of one-year Class A Secured
Convertible Notes and Class B Unsecured Convertible Notes. In connection with
this loan, we also issued warrants to purchase 333,334 shares of common stock at
an exercise price of $6.50 per share. These funds were used to provide working
capital while new management and new independent directors completed their
assessments of our prospects and operations.
- May 2003 Interim Financing. In April 2003, we secured loan commitments
for up to $1,200,000 as interim financing from Gibralt U.S. and two directors.
Gibralt U.S. committed to lend up to $1,100,000, and Mr. Wylie and Peter Norris
committed to lend the remaining $100,000 in exchange for one-year Class D
Secured Notes. This transaction closed on May 7, 2003. These funds were used to
provide working capital for us while we pursued our plan to raise long-term
equity financing. We issued preferred shares convertible into a total of 120,863
shares of common stock to these lenders in connection with their loan
commitments.
- May 2003 Exchange Transaction. Simultaneously with obtaining the
$1,200,000 of loan commitments, we modified several terms and conditions of the
Class A and Class B Notes that we believed might impede the completion of a
permanent equity financing with institutions and accredited investors. First, we
issued Class C Stock, which was convertible into 1,084,690 shares of common
stock, in exchange for the redelivery to us of 333,334 warrants and modification
of the Class A and Class B Notes to make them non-convertible. Second, we issued
Class D Stock, which was convertible into 120,863 shares of common stock, as a
discount for the $1,200,000 in committed secured bridge loans. The 1,205,552
shares of common stock underlying the Class C Stock and Class D Stock
represented in the aggregate approximately 50.36% of our common stock and common
stock equivalents outstanding after the transactions.
- May 2003 Modification Transaction. On May 28, 2003, we and the holders
of the Class A and Class B Convertible Notes made further modifications to the
notes to accommodate the plan for permanent equity financing. We did not issue
any additional shares or pay any amounts to obtain these changes.
- August 2003 Exchange of Preferred Shares. As part of our settlement of
the Augenbaum lawsuit, we exchanged the convertible preferred stock we issued on
May 7, 2003 for an equal number of shares of new classes of preferred stock. The
new classes of preferred stock were not by their terms convertible into common
stock, but under a written agreement with the stockholders, these shares were to
be exchanged for an equal number of shares of common stock into which the number
the former classes of common stock were convertible. This exchange was made to
address a claim in the Augenbaum complaint that the preferred stock we issued in
May 2003 could not be convertible by its terms. The plaintiff in Augenbaum
agreed that we could issue the same number of shares of common stock into which
the May 2003 preferred stock would have been convertible, but that the mechanism
should be through an exchange of preferred stock for common stock, not a
conversion of the preferred stock into common stock. Accordingly, the August
2003 exchange agreements with the holders of the preferred stock provide that
after our stockholders approve the issuance of the underlying shares of common
stock, then either we or the holders of the preferred stock may request the
exchange of the preferred stock for that number of shares of common stock into
which the May 2003 preferred stock was convertible.
- Repayment of $2,000,000 Debt Incurred in December 2002 Interim
Financing. On September 3, 2003, we repaid all of the $2,000,000 in principal
and accrued interest on the notes we issued in connection with the December 2002
interim financing, using a portion of the $6,500,000 gross proceeds of the sale
of Secured Bridge Notes in the equity financing.
- Conversion of $1,200,000 Debt Incurred in May 2003 Interim Financing. On
November 25, 2003, the $1,200,000 in notes that we issued in our May 2003
interim financing, including accrued interest, converted into common stock at
$2.50 per share. Accordingly, we issued 499,294 shares of common stock to these
noteholders.
- Conversion of Secured Bridge Notes. On November 25, 2003, the $6,995,000
in Secured Bridge Notes we issued at the first closing of the equity financing
in September 3, 2003, including accrued interest, converted into common stock at
$2.00 per share. Accordingly, we issued 3,562,788 shares of common stock to
these noteholders.
- Exchange of Class E and Class F Stock. On November 25, 2003, in
connection with the final closing of our equity financing and pursuant to our
agreement with the holders of our Class E and Class F Stock, we exchanged all
outstanding shares to Class E Stock for a total of 1,084,690 shares of common
stock and we exchanged all outstanding shares of Class F Stock for a total of
120,863 shares of common stock.
We summarize in the tables below the material terms of the Class A and Class B
Convertible Notes and warrants that we issued in the December 2002 Interim
Financing, the Class C Notes that we issued in the May 2003 Exchange
Transaction, the Class D Notes that we issued in the May 2003 Interim Financing
Transaction and the Class E Notes that we issued in exchange for the Class C
Notes and the amendments that we made to the Class D Notes in the May 2003
Modification Transaction. Following these tables, we describe the material terms
of these securities in greater detail.
55
TABLE SUMMARIZING THE DECEMBER 2002 INTERIM FINANCING
AND SUBSEQUENT MODIFICATIONS
The following table summarizes the original terms of the $2,000,000 interim
financing that we completed in December 2002, the terms of that $2,000,000
interim financing after giving effect to the exchange transaction that we
completed on May 7, 2003 and the subsequent modification on May 28, 2003:
ORIGINAL TERMS OF TERMS OF DECEMBER 2002 TERMS OF DECEMBER 2002
DECEMBER 2002 INTERIM FINANCING AS INTERIM FINANCING AS
INTERIM FINANCING MODIFIED MAY 7, 2003 MODIFIED MAY 28, 2003
Indebtedness: Indebtedness: Indebtedness:
- ------------- ------------- -------------
- - $2,000,000 principal amount - $2,000,000 principal amount - $2,000,000 aggregate
- - interest rate 8% per annum - interest rate 8% per annum principal amount
- - principal and accrued interest - principal and accrued - interest rate 12.5% per annum
payable at maturity interest payable at maturity starting 5/28/03
- - maturity date 1/1/04 - maturity date 1/1/04 - interest accrued through
5/27/03 added to principal and
becomes payable quarterly
commencing 3/31/04 to the
extent of 50% excess quarterly
cash flow
- interest accrued from 5/28/03
payable quarterly commencing
9/30/03
- maturity date 1/1/06
Conversion of Indebtedness: Conversion of Indebtedness: Conversion of Indebtedness:
- --------------------------- --------------------------- ---------------------------
- - convertible into common stock - no conversion rights - no conversion rights
at noteholder's option
- - number of shares of common
stock into which convertible
equals principal and interest
divided by conversion price
- - conversion price determined at
time of conversion
- - conversion price is 80% of the
then-prevailing price of common
stock (determined on basis of
market price, price in
financing transaction or
liquidation, as applicable)
Other Rights of Noteholders: Other Rights of Noteholders: Other Rights of Noteholders:
- ---------------------------- ---------------------------- ----------------------------
- - right to approve future - no right to approve future - no right to approve future
financings prior to 1/1/2004 financings financings
- - right to participate in future - no right to participate in - no right to participate in
financings at a 20% discount to the future financings future financings
price paid by investors in the - right to rescind 5/7/03 exchange - right to rescind 5/28/03 exchange
future financing transaction if (1) no stockholder transaction if (1) no stockholder
approval of issuance of
common approval of issuance
of common stock upon
conversion of preferred stock
upon conversion of preferred
shares issued in
consideration of shares
issued in consideration of
exchange transaction, or (2)
exchange transaction, or (2)
financing is not entered into
prior financing is not
entered into prior to 6/30/03
to 7/31/03
Security: Security: Security:
- --------- --------- ---------
- - $1,000,000 principal amount of - entire $2,000,000 principal - entire $2,000,000 principal
notes secured, $1,000,000 principal amount plus accrued interest amount plus accrued interest on
amount unsecured secured notes secured
- - security interest granted in - security interest is lien on - security interest is lien on
all of our personal property, subject all of our personal property, all of our personal property,
to priority of prior security subject to priority of prior excluding intellectual property
interest in accounts receivable security interest in accounts acquired after 12/31/02 and
- - pledge of stock of subsidiary receivable inventory and fixed assets in
owning the photodynamic therapy - pledge of stock of subsidiary excess of the stipulated 12/31/02
business owning the photodynamic therapy value
business - security interest in accounts
receivable subject to subrogation
to future creditors if we enter
into receivables financing
transaction
- pledge of stock of subsidiary
owning the photodynamic therapy
business
Warrants: Warrants: Warrants:
- --------- --------- ---------
- - warrants to purchase 333,334 - December 2002 warrants - December 2002 warrants
shares of common stock at exercise surrendered, subject to the surrendered, subject to the
price of $6.50 per share December 2002 warrants being December 2002 warrants being
- - number of warrant shares reissued upon the note-holders' reissued upon the noteholders'
subject to increase if shares of exercise of their rescission rights exercise of their rescission rights
common stock or common stock
equivalents are issued at a price
less than the warrant exercise price
- - warrant exercise price subject
to downward adjustment if
common stock or common stock
equivalents issued in a
financing at less than the
warrant exercise price
56
TABLE SUMMARIZING THE MAY 2003 INTERIM FINANCING AND SUBSEQUENT MODIFICATIONS
The following table summarizes the original terms of the $1,200,000 interim
financing that we completed on May 7, 2003 and the subsequent modification to
certain of the terms and conditions of that financing on May 28, 2003:
ORIGINAL TERMS OF TERMS OF MAY 7, 2003
MAY 7, 2003 INTERIM FINANCING TRANSACTION
INTERIM FINANCING TRANSACTION AS MODIFIED MAY 28, 2003
Indebtedness: Indebtedness:
- ------------- -------------
- - up to $1,200,000 aggregate - up to $1,200,000 aggregate
principal amount principal amount
- - interest rate 8% per annum - interest rate 8% per annum
- - principal and accrued interest - principal and accrued interest
payable 5/6/2004 payable 5/6/2004
Conversion of Indebtedness: Conversion of Indebtedness:
- --------------------------- ---------------------------
- - no conversion rights - no conversion rights
Other Rights of Noteholders: Other Rights of Noteholders:
- ---------------------------- ----------------------------
- - no right to approve future - no right to approve future
financings financings
- - right to participate at the - mandatory participation in future
noteholder's option in future financings at the same price paid
financings at the same price paid by investors in the future
by investors in the future financing and otherwise on the same
financing and otherwise on the same terms as applicable to those
terms as applicable to those investors
investors - no right to redeem indebtedness for
- - right to redeem indebtedness for cash upon completion of future
cash upon completion of future financing
financing - right to accelerate due date of
- - right to accelerate due date of indebtedness if financing not
indebtedness if financing not completed prior to 7/31/2003
completed prior to 7/1/2003
Security: Security:
- --------- ---------
- - $1,200,000 principal amount and - $1,200,000 principal amount and
accrued interest on notes secured accrued interest on notes secured
- - security interest granted in all of - security interest granted in all of
our personal property, subject to our personal property, excluding
priority of existing lien in accounts receivable, intellectual
accounts receivable property acquired after 12/31/02
- - pledge of stock of subsidiary and inventory and fixed assets in
owning the photodynamic therapy excess of value as of 12/31/02
business - pledge of stock of subsidiary
owning the photodynamic therapy
business
Warrants: Warrants:
- --------- ---------
- - no warrants issued - no warrants issued
DESCRIPTION OF DECEMBER 2002 INTERIM FINANCING TRANSACTION
The principal terms of the $2,000,000 bridge financing that we completed on
December 27, 2002 were:
- We borrowed $2,000,000 from Gibralt U.S., whose principal, Samuel
Belzberg, was a member of our board of directors until February 2004.
- To evidence the loan, we issued $1,000,000 in Class A Notes that were
secured and $1,000,000 in Class B Notes that were unsecured.
57
- The maturity date of the notes was January 1, 2004.
- The notes bore interest at 8% per annum, and accrued interest was
payable at maturity.
- The Class A and the Class B Notes, including principal and accrued
interest, were convertible into common stock at 80% of the common stock price
determined as follows: (i) if we were to complete a financing transaction in
which we issued common stock or common stock equivalents, the price per share of
common stock or common stock equivalent (the weighted average if multiple
financing transactions occur in a rolling 30-day period), (ii) if we were to
complete a financing transaction in which we did not issue common stock or
common stock equivalents, the lower of the average of the closing price of the
common stock for the 15 business days preceding the public announcement of the
financing transaction or the average of the closing price of the common stock
for the 15 business days following the public announcement of the financing
transaction, (iii) if a liquidity event were to occur in which any person or
group other than a stockholder on December 27, 2002 becomes the beneficial owner
of at least 51% of voting control over us, the price per share allocated to each
share of common stock or common stock equivalent, or (iv) if any other liquidity
event were to occur, the lower of the average of the closing price of the common
stock for the 15 business days preceding the public announcement of the
liquidity event or the average of the closing price of the common stock for the
15 business days following the public announcement of the liquidity event.
- If a merger or reorganization were to occur, the Class A and Class B
Notes were convertible into the kind and number of shares of common stock, other
securities or property into which the notes would have been converted into if
the notes had been converted into common stock on the business day preceding the
merger or reorganization.
- We agreed not to consummate any financing transaction until January 1,
2004 while any Class A or Class B Notes were outstanding unless we had first
received the approval of the holders of at least 66-2/3% of the outstanding
principal amount of the notes.
- We also issued to the noteholder warrants to purchase up to 333,334
shares of common stock. The warrants were exercisable for a period of five
years, beginning June 27, 2003, at an exercise price of $6.50 per share, which
was 110% of the market price of the common stock on December 26, 2002. If we,
during the life of the warrants, were to issue common stock or common stock
equivalents at a price per share less than $6.50, the number of warrants would
be increased and the exercise price of the warrants would be decreased to the
lower price per share. If a merger or reorganization were to occur, the warrants
would become convertible into the kind and number of shares of common stock,
other securities or property into which the common stock, other securities or
property issuable upon exercise of the warrants would have been converted if the
warrants had been exercised prior to the merger or reorganization.
- We and the noteholder entered into an agreement for the registration of
the shares of common stock issuable upon the conversion of the notes and upon
the exercise of the warrants. Under that agreement, we agreed to notify the
noteholder if we were to propose to file certain future registration statements.
We agreed to use our best efforts to register any shares of common stock
issuable to the noteholder in the registration statement, subject to certain
defined limitations, if so requested by the noteholder within 30 days of receipt
of our notice. The noteholder agreed to become subject to a "holdback period,"
by which the noteholder could not effect a public sale of common stock for a
period of up to 180 days following the effective date of the registration
statement, if so requested by a managing underwriter of the offering.
- The notes and the warrants, pro rata to the notes, were transferable in
part or in whole by the noteholder to one or more third parties, in accordance
with all of the same terms agreed to by the noteholder.
On March 18, 2003, Gibralt U.S. sold and transferred to three investors in a
private transaction (i) $500,000 aggregate principal amount of the notes
($250,000 of which were Class A Notes and $250,000 of which were Class B Notes),
and (ii) 83,334 warrants. None of these transferees was an affiliate of Gibralt
U.S., although one of them is Morris Belzberg, a cousin of Samuel Belzberg.
Samuel Belzberg does not beneficially own, or have investment discretion over,
the securities purchased from him by Morris Belzberg. Accordingly, after this
transfer, Mr. Belzberg beneficially owned 250,000 warrants and $1,500,000
aggregate principal amount of notes ($750,000 of which are Class A Notes and
$750,000 of which are Class B Notes).
DESCRIPTION OF MAY 7, 2003 EXCHANGE TRANSACTION
During the first quarter of 2003, our board of directors and management
determined that we should seek permanent financing and continue our efforts to
achieve our business plan. Accordingly, the board of directors approved a plan
to raise long-term equity financing.
58
To address certain issues presented by our capital structure, the board of
directors created a special committee comprised of independent directors, (the
"Independent Committee"). The Independent Committee is comprised of Messrs.
Jenkins, Swank and Brooks. Based on information provided by Mr. Wylie and an
investment banker engaged by us in April 2003, the Independent Committee found
that under prevailing market conditions in the second quarter of 2003,
prospective investors were likely to be reluctant to invest in us because of
certain features of the December 2002 Interim Financing. Specifically, the
Independent Committee found that the future dilution represented by the 333,334
warrants to purchase our common stock and the potential conversion of the
$2,000,000 principal amount of the Class A and Class B Notes were unlikely to be
acceptable to new investors. In addition, the Independent Committee found that
the December 2002 noteholders' right to participate in any future financing at a
20% discount to the price that new investors would be paying and their right to
approve future financing were likely to be obstacles to a completed financing.
The Independent Committee also determined that issuing additional shares in
exchange for modifications to the notes issued in the December 2002 Interim
Financing was, from the perspective of our stockholders, preferable to the
alternative of ceasing operations due to our inability to raise additional
funding.
The Independent Committee began negotiations in April 2003 to modify the terms
of the December 2002 Interim Financing to eliminate the potential obstacles to
obtaining permanent financing. The Independent Committee and the December 2002
noteholders agreed to the proposed terms of the exchange transaction on April
22, 2003 and the transaction closed on May 7, 2003. The principal terms of the
May 7, 2003 exchange transaction were:
- the noteholders delivered the 333,334 warrants held by them;
- the noteholders returned the Class A secured notes and Class B unsecured
notes held by them to us for cancellation;
- to compensate the December 2002 noteholders for surrendering the
conversion rights under the notes and the warrants, we issued a total of 20
shares of Class C Stock (the "Class C Stock") to the December 2002 noteholders,
which were convertible into an aggregate of 1,084,690 shares of common stock;
- we issued Class C secured notes to the noteholders in principal amounts
equal to the Class A and Class B notes that were cancelled (the "Class C
Notes");
- the Class C Notes were redeemable for cash at the holder's option if we
were to complete our anticipated permanent financing;
- the Class C Notes were not convertible into capital stock;
- the noteholders surrendered their rights to approve future financing
transactions;
- the Class C Notes were secured by a security interest in our property
identical to the security interest created in the December 2002 Interim
Financing, and otherwise had terms substantially similar to the Class A Notes;
and
- we expanded our obligation under the registration rights agreement
entered into in December 2002 by granting demand registration rights to the
noteholders regarding the underlying shares of stock.
We also agreed to unwind the May 2003 Exchange Transaction and restore the
original terms of the December 2002 Interim Financing if: (1) our stockholders
did not approve the issuance of the common stock underlying the capital stock
issued to the noteholders in the May 2003 Exchange Transaction, or (2) if we did
not complete our contemplated financing transaction by June 30, 2003 (this date
was subsequently extended to July 31, 2003 under the modifications which were
agreed to on May 28, 2003 and again to November 15, 2003 or any later day that
is one business day following the date agreed by us and the investors for the
second closing of the equity financing).
If the May 2003 Exchange Transaction had been rescinded, then the original terms
of the December 2002 Interim Financing would have been reinstated (except that
all of the notes will be secured). The original terms of the December 2002 notes
provided for conversion of the notes at a variable conversion rate. The original
terms of the Class A and Class B Notes provided for conversion at the
noteholder's option of principal and accrued interest into common stock at a
conversion price equal to 80% of the common stock price, with the common stock
price being determined at the time of conversion. In addition, if the May 7,
2003 exchange transaction had been rescinded, we would have been required to
redeliver the warrants to purchase 333,334 shares of common stock to the
December 2002 noteholders.
To allow for the issuance of the preferred shares associated with the exchange
transaction, on May 5, 2003, we created a new class of preferred stock,
consisting of 20 shares of preferred stock designated as "Class C Stock," each
share of which was to automatically convert into 54,235 shares of common stock
at the time when our stockholders approve the issuance of common stock
underlying the Class C Stock. This would have resulted in an additional
1,084,690 shares of common stock being issued and outstanding after the
conversion occurs. Under the terms of the Class C Stock, the holders of the
Class C Stock held the right to vote that number of shares into which the Class
C Stock is convertible, voting as one class with the holders of common stock and
other capital stock convertible into common stock.
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In the May 7, 2003 exchange transaction, Gibralt U.S. and the three other
securityholders received (1) Class C Notes in the principal amount equal to the
aggregate principal amount of the Class A and Class B Notes surrendered by them
and (2) shares of Class C Stock, all in exchange for surrendering the conversion
rights of the Class A and Class B Notes (Class C Stock convertible into a total
of 723,714 shares of common stock, or, approximately 36,186 shares of common
stock per $100,000 principal amount of notes exchanged for non-convertible
notes) and the warrants (Class C Stock, convertible into a total of 360,976
shares of common stock, or, approximately 4,332 shares of common stock per 4,000
warrants surrendered). On April 22, 2003, the effective date of the May 7, 2003
exchange transaction, the closing price of the common stock on the AMEX was
$4.00 per share.
The number of shares of Class C Stock issued in the exchange transaction and the
value of the Class C Stock issued to the December 2002 securityholders in the
exchange transaction, using the closing price of the common stock of $4.00 on
April 22, 2003, is as follows:
GIBRALT U.S.
- ------------
Principal Amount of Notes Exchanged: $1,500,000
Number of Warrants Surrendered: 250,000
Shares of Class C Stock Issued: 15
Number of Shares of Common Stock Issuable upon
Conversion of Class C Stock: 813,518
Shares of Common Stock Issuable upon conversion
of Class C Stock multiplied by
April 22, 2003 closing price per share: $3,254,069
MORRIS BELZBERG
- ---------------
Principal Amount of Notes Exchanged: $300,000
Number of Warrants Surrendered: 50,000
Shares of Class C Stock Issued: 3
Number of Shares of Common Stock Issuable upon
Conversion of Class C Stock: 162,704
Shares of Common Stock Issuable upon Conversion
of Class C Stock multiplied by
April 22, 2003 closing price per share: $650,814
STEVEN SHRAIBERG
- ----------------
Principal Amount of Notes Exchanged: $100,000
Number of Warrants Surrendered: 16,667
Shares of Class C Stock Issued: 1
Number of Shares of Common Stock Issuable upon
Conversion of Class C Stock: 54,235
Shares of Common Stock Issuable upon conversion
of Class C Stock multiplied by
April 22, 2003 closing price per share: $216,938
CHARLES DIAMOND
- ---------------
Principal Amount of Notes Exchanged: $100,000
Number of Warrants Surrendered: 16,667
Shares of Class C Stock Issued: 1
Number of Shares of Common Stock Issuable upon
Conversion of Class C Stock: 54,235
Shares of Common Stock Issuable upon conversion
of Class C Stock multiplied by
April 22, 2003 closing price per share: $216,938
After the May 2003 Exchange Transaction and Interim Financing were completed and
in light of discussions with our investment banker, the Independent Committee
determined that further modifications to the terms of the securities issued in
the May 2003 transactions would be necessary to assist us in completing the
permanent financing. The material terms of these modifications are described
under "Description of May 2003 Modifications to May 7, 2003 Exchange Transaction
and Interim Financing."
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DESCRIPTION OF MAY 2003 INTERIM FINANCING TRANSACTION
In March 2003, the board of directors also determined that we had an immediate
need for capital to support our operations until we completed the contemplated
permanent financing. In April 2003, the board of directors approved a plan to
raise up to $1,200,000 of interim financing prior to May 15, 2003. The board
further determined that, because of our history of operating losses and cash
position at the time, the contemplated permanent financing was likely to involve
the issuance of substantial amounts of equity.
The Independent Committee negotiated with Samuel Belzberg, a principal investor
and a former director, to obtain the needed $1,200,000 interim financing. Mr.
Belzberg committed to lend (through his affiliate, Gibralt U.S.) up to
$1,100,000 to us, and two other directors, James A. Wylie, Jr. and Peter Norris,
each agreed to lend $50,000 to us, to demonstrate their commitment to and
support of us. The board did not believe there were other prospective investors
available to us to provide the interim financing on terms and within a time
period acceptable to us. The Independent Committee and these directors agreed to
the proposed terms of the interim financing on April 22, 2003, and the
transaction closed on May 7, 2003.
The material terms of the May 7, 2003 interim financing transaction are as
follows:
- Gibralt U.S. committed to lend up to $1,100,000 to us ($1,000,000 of
which was to be funded according to a predetermined funding schedule and the
other $100,000 of which was to be funded upon completion of a certain third
party transaction), and Messrs. Wylie and Norris loaned $50,000 to us. Gibralt
U.S. funded all of its commitment.
- We issued Class D secured notes in a principal amount equal to the
amount loaned to us (secured on an equal basis with the indebtedness incurred in
the December 2002 Interim Financing and having substantially similar terms as
the Class C notes issued in the May 7, 2003 exchange transaction, except that
they would mature one year from the date of issuance).
- To compensate the lenders for the risk attendant to their investment and
based on our financial condition, need for additional funding and lack of
definitive terms for a future permanent financing or commitment from any
investor to provide such permanent financing, we issued shares of capital stock
equal to 20% of the amount of the loan commitment of the interim financing
lenders (or, $240,000), in the form of a total of 24 shares of Class D
Convertible Preferred Stock, which were convertible into an aggregate of 120,863
shares of common stock.
- The Class D noteholders held rights (but not the obligation) to redeem
their notes for the securities issued by us in the permanent financing on the
same terms and conditions as the investors in the permanent financing.
- The Class D noteholders held rights to redeem their notes for cash if we
consummated our permanent financing.
- The Class D noteholders held registration rights identical to those
granted to the holders of the Class C Notes issued in the May 7, 2003 exchange
transaction.
During the negotiation process, the lenders required that if the contemplated
financing did not occur prior to June 30, 2003 (subsequently extended to July
31, 2003 in the May 28, 2003 modifications, described below and thereafter
extended to November 15, 2003 and again to a day after November 15, 2003 that we
and the investors agreed as the date for the second closing of the equity
financing), then the lenders could accelerate the maturity date of their notes.
We created a new class of preferred stock from our authorized preferred stock,
consisting of 24 shares of preferred stock designated as "Class D Convertible
Preferred Stock," each share of which would have been automatically converted
into 5,036 shares of common stock when our stockholders approved the issuance of
these shares of common stock underlying the Class D Convertible Preferred Stock.
This would have resulted in an additional 120,863 shares of common stock being
issued and outstanding after the conversion occurs. Under the terms of the Class
D Stock, the holders of the Class D Stock had the right to vote that number of
shares into which the Class D Stock was convertible, voting as one class with
the holders of common stock and other capital stock convertible into common
stock.
The loan commitments of the lenders in the May 7, 2003 interim financing and the
principal amount of Class D Notes, the number of shares of Class D Convertible
Preferred Stock (and the number of shares of common stock into which the Class D
Stock is convertible) the lenders received, as well as the value of the Class C
Stock issued to the lenders in the interim financing using the closing price of
the common stock of $4.00 on April 22, 2003, and after giving effect to the
issuance of the shares to be issued upon conversion of the Class C Stock and the
Class D Stock, is as follows:
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GIBRALT U.S.
- ------------
Loan Commitment: Up to $1,100,000
Principal Amount of Notes Issued: Up to $1,100,000
Shares of Class D Convertible Preferred Stock Issued: 22
Number of Shares of Common Stock Issuable upon
Conversion of Class D Convertible Preferred Stock: 110,791
Shares of Common Stock issuable upon conversion
of Class D Convertible Preferred Stock multiplied by
April 22, 2003 closing price per share: $221,580
JAMES A. WYLIE, JR.
- -------------------
Loan Commitment: $50,000
Principal Amount of Notes Issued: $50,000
Shares of Class D Convertible Preferred Stock Issued: 1
Number of Shares of Common Stock Issuable upon
Conversion of Class D Convertible Preferred Stock: 5,036
Shares of Common Stock issuable upon conversion
of Class D Convertible Preferred Stock multiplied by
April 22, 2003 closing price per share: $10,072
PETER NORRIS
- ------------
Loan Commitment: $50,000
Principal Amount of Notes Issued: $50,000
Shares of Class D Convertible Preferred Stock Issued: 1
Number of Shares of Common Stock Issuable upon
Conversion of Class D Convertible Preferred Stock: 5,036
Shares of Common Stock issuable upon conversion
of Class D Convertible Preferred Stock multiplied by
April 22, 2003 closing price per share: $10,072
Gibralt U.S., Mr. Norris and Mr. Wylie loaned a total of $1,200,000 to us,
representing their entire loan commitments.
DESCRIPTION OF MAY 28, 2003 MODIFICATIONS
TO MAY 7, 2003 EXCHANGE TRANSACTION
AND INTERIM FINANCING
As we proceeded to seek our permanent financing during May 2003, we assessed the
availability of investment capital for development stage companies. The
Independent Committee determined that it was essential to extend the maturity
date of the Class C Notes beyond January 1, 2004, to eliminate the right of the
holders of the Class C Notes to redeem those notes for cash upon the completion
of the future permanent financing and to limit in certain respects the
collateral securing our obligations under the Class C and Class D Notes. The
Independent Committee determined that these modifications were necessary because
the terms of the Class C and Class D Notes would likely, unless modified, deter
investors from investing in us. The Independent Committee found that prospective
investors would presumably expect that we would use the proceeds of their
investment as working capital rather than apply the proceeds to the satisfaction
of existing debt. Accordingly, the Independent Committee negotiated further
modifications to the May 7, 2003 exchange transaction, as well as modifications
to the May 2003 interim financing transaction, as described below in this
section.
The Independent Committee determined that the maturity date of the Class C Notes
should be extended to January 1, 2006. In addition, the Independent Committee
determined that the security interest granted to the Class C noteholders should
be limited to certain collateral that was owned at December 31, 2002 and that
the note collateral should not include our after-acquired property, thereby
making that property available as security to our future investors. The
Independent Committee further determined that the Class D Notes should not be
redeemable for cash upon the closing of the future financing transaction.
Instead, the Class D Notes should be converted into the securities issued in the
future financing on the same terms and conditions offered to the other
investors. With these objectives, the Independent Committee commenced
negotiations with the holders of the Class C Notes and the Class D Notes.
The Class C noteholders required that, in exchange for the modifications we
sought, the terms of their notes be revised to increase the interest rate from
8% to 12.5% per annum, and to require that we commence making payments of
interest accrued from December 27, 2002 through May 27, 2003 and principal on a
quarterly basis beginning the first quarter of 2004, but only to the extent of
50% of our excess quarterly cash flow.
The Class C noteholders also agreed to modify the security for the notes, the
change to become effective when we raised at least $6,000,000 in our permanent
financing. The Class C noteholders agreed that their security interest in
accounts receivable would be subordinated to a future security interest granted
by us in a receivables financing transaction and that their security interest in
intellectual property would be limited to that owned as of December 31, 2002.
62
The Class C noteholders required that we maintain minimum inventory and fixed
asset levels, determined quarterly, of not less than $2,000,000. In addition,
our combined cash, inventory and fixed assets must be at least $3,271,400. A
failure to comply with these covenants is an event of default. The notes have
other events of default for matters such as non-payment of interest or
principal, breach of representations and warranties, failure to satisfy any
agreement or condition under the agreements with the investor which is not cured
within 30 days, a "cross-default" for our other institutional indebtedness and
our voluntary or judicial dissolution or bankruptcy. We and the Class C
noteholders exchanged the Class C Notes for an equal principal amount of Class E
Notes with these modified terms.
The covenant relating to minimum inventory, net book assets and cash levels does
not apply unless and until we raise at least $6,000,000 in gross proceeds in a
future financing. We did not expect an event of default relating to this
requirement to occur if we completed our contemplated permanent financing. No
events of default occurred. If any event of default occurred and was not cured
within the applicable cure period, then, unless the default was waived by a
majority in interest of the noteholders, at the option and in the discretion of
the holders of at least 66 2/3% of the principal amount of the Class E Notes,
the noteholders could have declared the notes and all accrued interest to be
immediately due and payable, and could have immediately enforced any and all of
the noteholder's rights and remedies provided in the agreements with and the
investors and any other rights or remedies afforded by law.
The Class D noteholders agreed to redeem their Class D Notes in exchange for the
securities issued in the contemplated permanent financing on the same terms and
conditions offered to the other investors and to forego the option of redeeming
their notes for cash after the permanent financing occurred.
The noteholders also agreed to extend the date by which we would be required to
raise $6,000,000 in our permanent financing (to avoid triggering the December
2002 securityholders' right to rescind the May 7, 2003 exchange transaction)
from June 30, 2003 to July 31, 2003 (and subsequently, to November 15, 2003 and
again to a day after November 15, 2003 that we and the investors agree as the
date for the second closing of the of the equity financing), and to defer our
obligation to seek stockholder approval of the conversion of the Class C Stock
and Class D Stock into shares of common stock until a future meeting of the
stockholders, at which we would also seek approval of the issuance of common
stock underlying securities that may be issued by it in the permanent financing.
The rescission right was not available unless the meeting was held and the
issuance was not approved.
On September 3, 2003, we redeemed all of our outstanding Class E Notes
(principal of $2,000,000 plus accrued interest of approximately $132,000), and
no Class E Notes remain outstanding. We used a portion of the proceeds of the
first closing of the equity financing to pay for the redemption of the Class E
Notes.
AUGUST 2003 AND NOVEMBER 2003 EXCHANGES OF PREFERRED SHARES
As a result of the stipulation of settlement that we reached in the Augenbaum
litigation, we entered into exchange agreements with the holders of the
outstanding shares of our Class C Stock and Class D Convertible Preferred Stock.
Upon entering into the exchange agreements, on August 22, 2003 the holders of
the Class C Stock exchanged their Class C Stock for 20 Class E Shares, on a
share-for-share basis. Similarly, upon execution of the exchange agreements, the
holders of the 24 outstanding Class D Stock exchanged their Class D Stock for
Class F Shares, on a share-for-share basis. Following these exchanges, we
eliminated all Class C Stock and all Class D Stock.
Shares of the Class E Stock are preferred in liquidation to the extent that,
before any distribution of assets can be made to the holders of our common
stock, there will be distributed pro rata to the holders of the issued and
outstanding Class E Shares and Class F Shares the amount of $108,469 as to each
outstanding Class E Share and $10,072 per share as to each outstanding Class F
Share. The holders of the common stock then share in the remainder of net
liquidation of proceeds. The term liquidation means our liquidation, dissolution
or winding up, as well as any sale, lease, exchange or other disposition of all
or substantially all of our assets. The aggregate liquidation preference of the
Class E Shares is $2,169,380 and the aggregate liquidation preference of the
Class F Shares is $241,728. The aggregate liquidation preference was determined
to be equal to the dollar value that the board of directors allocated to the
conversion rights, warrants and other rights that we agreed to pay to the
holders of the Class C Stock and the discount that we agreed to pay to the
holders of the Class D Stock in the May 7, 2003, transactions.
The holders of the Class E Shares and Class F Shares have the right to vote one
vote per share, respectively, for each outstanding Class E Share and each
outstanding Class F Share.
The holders of the Class E Shares are entitled to cash dividends and
distributions when and as declared by the board of directors, pari passu with
the holders of our common stock with the dividend amount on each Class E Share
being 1,355,862 times the dividend or distribution to be paid on each share of
common stock. The holders of the Class F Shares are entitled to cash dividends
and distributions when and as declared by the board of directors, pari passu
with the holders of our common stock with the dividend amount on each Class F
Share being 125,898 times the dividend or distribution to be paid on each share
of common stock.
63
The exchange agreements also gave both us and the holders of the Class E Shares
and the Class F Shares rights to exchange those preferred shares for shares of
our common stock, as long as our stockholders approve the issuance of the shares
of our common stock underlying the preferred shares and the AMEX approves the
listing of these shares of common Stock. Specifically, if the stockholders
approve the common stock issuance and the AMEX lists these the shares of common
stock, then the holders of the Class E Share have the right to sell to us, and
we have the right to purchase from them, each outstanding Class E Share in
exchange for 54,235 shares of our common stock per Class E Share. Similarly, the
holders of the Class F Shares have the right to sell to us, and we have the
right to purchase from them, each outstanding Class F Share in exchange for
5,036 shares of our common stock per Class F Share. The exchange agreements also
provided that, should any sale, lease, exchange or other disposition of all or
substantially all of our assets occur while the Class E Shares and the Class F
Shares are outstanding, each holder of the Class E Shares has the right to sell
to us all Class E Shares in exchange for 54,235 shares of common stock per Class
E Share. Similarly, each holder of Class F Share has the right to sell to us all
Class F Shares in exchange for 5,036 shares of common stock per Class F Share.
The board of directors determined that the terms of the exchange agreements were
appropriate in order to provide the former holders of the Class C Stock and the
Class D Stock with the economic equivalence of the conversion rights they held
in conjunction with the Class C Stock and Class D Stock. Upon exchange of all
Class E Shares, the former holders of the Class C Stock will receive 1,084,690
shares of our common stock, or the same number of shares of our common stock we
were obligated to issue to them upon conversion of the Class C Stock. Upon
exchange of all the Class F Shares, the former holders of the Class D Stock will
receive 120,863 shares of common stock, or the same number of shares of our
common stock that we were obligated to issue to them upon conversion of the
Class D Stock. In the stipulation of settlement for the Augenbaum litigation,
the parties agreed on the exchange of shares of our common stock in these
specific amounts for the Class E Shares and Class F Shares, as well as the
exchange of the Class E Shares for the Class C Stock and the exchange of the
Class F Shares for the Class D Stock. A hearing before the Delaware Chancery
Court for approval of the stipulation of settlement was held on September 15,
2003. After this hearing, the court entered an order approving the stipulation
of settlement as submitted. The stipulation of settlement became final on
October 15, 2003 when the appeal period terminated with no appeal having been
filed.
At the request of the investors in our equity financing, we and Gibralt U.S., on
behalf of itself and the other holders of the Class E Shares and Class F Shares,
agreed not to exchange the Class E Shares or Class F Shares for common stock
until the second closing of the equity financing. Gibralt U.S. also acknowledged
that the common stock to be issued upon the exchange of the Class E Shares and
Class F Shares will not be eligible to participate in the offering to
stockholders, and that only those shares of common stock held by Gibralt U.S.
and the other holders of Class E Shares and Class F Shares as of August 29, 2003
will be eligible to participate in the offering.
Pursuant to the August 2003 exchange agreement, in connection with the equity
financing, on November 25, 2003 we exchanged all outstanding shares of Class E
Stock for a total of 1,084,690 shares of common stock and we exchanged all
outstanding shares of Class F Stock for a total of 120,863 shares of common
stock. After these shares were exchanged, we had no shares of preferred stock
outstanding.
PARTICIPATION BY RELATED PARTIES IN THE SEPTEMBER 2003 EQUITY FINANCING
INVESTMENT BY THE HOLDERS OF THE CLASS E NOTES AT THE FIRST CLOSING. As part of
the negotiation of the equity financing, the investors indicated that, were they
to purchase notes that would be convertible into shares of our common stock, the
notes would be required to be secured by all of our assets, including the patent
rights acquired by us with the proceeds of the first closing and also by those
assets that, prior to the first closing, were encumbered by security interests
in favor of the then-outstanding Class E Notes. As a result, we offered to
Gibralt U.S. and to the other three holders of the Class E Notes the opportunity
to purchase $2,000,000 of the Secured Bridge Notes, which was the outstanding
principal amount of the Class E Notes, and to use part of the proceeds of the
first closing to retire the Class E Notes in full, making the collateral
securing the Class E Notes available to all holders of the Secured Bridge Notes.
The board of directors unanimously, with the abstention of Samuel Belzberg,
approved the terms on which the holders of the Class E Notes would participate
in the equity financing at the first closing. Under those terms, the full
$2,000,000 new investment made by the holders of the Class E Notes would be
allocated to the purchase of Secured Bridge Notes and the holders of the Class E
Notes would, in exchange, terminate the security interest encumbering our assets
and make those assets available as collateral for all holders of the Class E
Notes. The former holders of the Class E Notes received as security for the
repayment of the Secured Bridge Notes held by them, a pro rata interest in the
same collateral securing all of the other Secured Bridge Notes. As is the case
with all Secured Bridge Notes, the Secured Bridge Notes held by Gibralt U.S. and
the other former holders of the Class E Notes converted into common stock on
November 25, 2003 at a purchase price of $2.00 per share.
CONVERSION OF CLASS D NOTES AT FINAL CLOSING. The terms and conditions under
which we issued our outstanding Class D Notes to Gibralt U.S., Peter Norris and
James A. Wylie, Jr. in May 2003 included a requirement that the Class D Notes be
converted into equity on the same terms and conditions on which all other
investors participate in an equity financing. Therefore, on November 25, 2003,
the $1,200,000 principal amount plus accrued interest on the Class D Notes
converted into our common stock at a price of $2.50 per share, and we issued
499,294 shares of common stock to the former holders of the Class D Notes.
64
AGENCY CAPACITY OF GIBRALT U.S. After the first closing of the equity financing,
Gibralt U.S. ceased to act as the "Designated Note Purchaser" on behalf of the
Class E Notes (because these notes were redeemed and are no longer outstanding),
and at the second closing, ceased to act as the "Designated Lender" on behalf of
the holders of the Class D Notes because they are converted at the second
closing. In addition, Gibralt U.S. agreed to act as the "Designated Note
Investor" under the security agreement that provided the security interest to
the Secured Bridge Note holders and as the "Designated Pledgeholder" under the
pledge agreement under which Gibralt U.S. held all outstanding shares of Diomed
PDT, Inc., an indirect wholly-owned subsidiary of us, as security for holders of
the Secured Bridge Notes and the Class E Notes.
On August 21, 2003, Gibralt U.S. also agreed, on behalf of the holders of the
Class E Shares and the Class F Shares, that their right to registration of those
shares of our common stock for which they are exchangeable would be governed by
the registration rights agreement entered into connection with the equity
financing rather than the agreements that had been entered into at the time of
the acquisition of the Class C Stock and the Class D Stock. On August 21, 2003,
Gibralt U.S., acting on behalf of all holders of the Class D Notes, also agreed
that although it had the right to declare the Class D Notes immediately due and
payable , it would extend this deadline to the business day following the second
closing of the equity financing.
ACCELERATED CONVERSION OF CLASS A CONVERTIBLE PREFERRED STOCK ON MARCH 31, 2003
In March 2003, the board of directors determined to accelerate the conversion
into common stock of all our outstanding shares of Class A Stock, including
those shares owned by related parties, pursuant to the authority reserved in the
board under the terms of Class A Stock. Pursuant to the terms of the Class A
Stock, on December 31, 2002 the Class A Stock had begun to automatically convert
into common stock at the rate of 5% of the aggregate number of shares originally
issued at that date and at the end of each month thereafter, with those shares
that were not converted at the end of February 2004 automatically converting
into common stock on February 29, 2004. The original terms of the Class A Stock
also provided that after February 28, 2003, the board of directors could in its
discretion accelerate the rate of conversion or increase the amount of shares of
Class A Stock being converted, so long as the change applied equally to all
shares of Class A Stock.
The purpose for the conversion feature of the Class A Stock, when the terms of
the Class A Stock were designated in February 2002, was to permit a staggered
increase in the number of shares of common stock available for trading in order
to minimize the market disruption that otherwise may occur if a large block of
shares were to become tradable at once. In March 2003, the board determined that
the effect of the incremental conversion of Class A Stock into common stock
would impair our ability to procure additional equity investment. The board
further determined that due to the apparent negative impact on our ability to
obtain equity financing, the board's goal is to have only one class of capital
stock outstanding prior to completing our permanent financings. Pursuant to our
discretion under the terms of the Class A Stock, the board determined to cause
all of the outstanding shares of Class A Stock to convert into common stock as
of March 31, 2003. This acceleration affected all holders of Class A Stock
equally, whether related parties or non-affiliated parties.
As a result of the board's determination to accelerate the conversion of the
Class A Stock, on March 31, 2003 we converted all 525,715 outstanding shares of
Class A Stock (including 234,554 shares held by related parties) into an equal
number of shares of common stock, resulting in a total of 1,188,470 shares of
common stock outstanding and no Class A Stock outstanding. Those related parties
who owned Class A Stock as of March 31, 2003 immediately prior to the conversion
into common stock and the numbers of shares they held are as follows:
NAME SHARES OF CLASS A STOCK OWNED
---- -----------------------------
Samuel Belzberg (Director until
February 23,2004)
(shares registered to Gibralt
Capital Corporation) 34,000
Peter Norris (Director until
September 9, 2003)
(shares registered to spouse) 558
Ajmal Khan (holder of greater than
5% of our capital stock ) (79,466
shares registered to Verus
Investments Holdings, Inc. and
68,000 shares registered to
Verus International Group Limited) 147,466
Winton Capital Corp. (holder of
greater than 5% of our
capital stock) 52,530
The benefit derived by those related parties of us who owned Class A Stock
on March 31, 2003 was the conversion of our Class A Stock into common stock.
This was the same as the benefit derived by all other former holders of Class A
Stock as a result of this transaction.
65
CERTAIN MARKET INFORMATION
Our common stock is traded on the AMEX under the symbol "DIO." On November 29,
2005, our common stock closed at a price of $2.13 per share.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since February 22, 2002, our common stock has been listed on the AMEX under the
symbol "DIO." Between November 2001 and February 22, 2002, our stock was quoted
on the OTC Electronic Bulletin Board. Prior to being quoted on the OTC Bulletin
Board, there was no market for our common stock. The following table sets forth
for the periods indicated the high and low bid price information for the common
stock as reported on the AMEX and the Over-the-Counter Bulletin Board. The
quotations reflect inter-dealer prices, without retail mark-up, mark-down or
commission, and may not represent actual transactions. The prices per share
shown below are adjusted to reflect the 1-for-25 reverse split effective June
17, 2004.
PERIOD HIGH LOW
------ ---- ---
2003
FIRST QUARTER .................................. $ 9.50 2.50
SECOND QUARTER ................................. $ 13.50 4.00
THIRD QUARTER .................................. $ 13.25 8.00
FOURTH QUARTER ................................. $ 10.50 6.50
2004
FIRST QUARTER .................................. $ 9.00 3.75
SECOND QUARTER ................................. $ 4.25 2.50
THIRD QUARTER .................................. $ 3.19 1.91
FOURTH QUARTER ................................. $ 4.32 1.66
2005
FIRST QUARTER .................................. $ 4.68 3.49
SECOND QUARTER ................................. $ 4.08 2.41
THIRD QUARTER .................................. $ 3.21 1.92
As of December 31, 2004, there were approximately 400 holders of record of our
common stock (a substantial number of which are nominees for other persons), and
as of November 30, 2005, there were approximately 375 holders of record of our
common stock (a substantial number of which are nominees for other persons).
It has been our policy not to pay cash dividends and to retain future earnings
to support our growth. However, we have agreed to pay dividends to the holders
of the preferred stock we issued on September 30, 2005. These dividends are
payable in cash or under certain circumstances and at our election, in the form
of common stock. See "Liquidity and Capital Resources; Transactions in 2005 -
Private Placement Financing Completed September 30, 2005," above for further
details. We do not anticipate paying any cash dividends on our common stock in
the foreseeable future.
66
DESCRIPTION OF SECURITIES
(Figures throughout this section are adjusted to give effect to the 1:25
reverse stock split effective June 17, 2004 for number of shares of common
stock, price per share of common stock, options and warrants)
References in the following description are to securities of Diomed Holdings,
Inc. unless otherwise stated or readily indicated by context.
Our authorized capital stock consists of 50,000,000 shares of common stock, par
value $.001 per share, and 20,000,000 shares of preferred stock.
As of September 29, 2005 (before giving effect to our September 30, 2005
financing transaction), there were 19,423,728 shares of common stock
outstanding, plus an additional 6,745,657 shares of common stock represented by
outstanding convertible debentures, warrants and stock options, resulting in
26,169,385 shares of common stock outstanding on a fully diluted basis. There
were zero shares of preferred stock outstanding as of September 29, 2005. As of
September 30, 2005 (after giving effect to the financing transaction that we
completed that day), there were 19,423,728 shares of common stock outstanding,
plus an additional 12,545,657 shares of common stock represented by the
4,000,000 shares of preferred stock and 1,800,000 warrants we issued on
September 30, 2005 and the previously outstanding convertible debentures,
warrants and stock options, resulting in 31,969,385 shares of common stock
outstanding on a fully diluted basis. There were 4,000,000 shares of preferred
stock outstanding as of September 30, 2005.
The following description of our capital stock does not purport to be complete
and is subject to and qualified by our Articles of Incorporation and By-laws,
which are included as exhibits to this report, and by the provisions of
applicable Delaware law.
COMMON STOCK
Subject to preferences that may be applicable to any rights of holders of
outstanding stock having prior rights as to dividends, the holders of
outstanding shares of our common stock are entitled to receive dividends out of
assets legally available therefor at such times and in such amounts as the board
of directors from time to time may determine. Holders of our common stock are
entitled to one vote for each share held on all matters submitted to a vote of
the stockholders. Cumulative voting with respect to the election of directors is
permitted by our Certificate of Incorporation. The common stock is not entitled
to preemptive rights and is not subject to conversion or redemption. Upon our
liquidation, dissolution or winding-up, the assets legally available for
distribution to stockholders are distributable ratably among the holders of the
common stock after payment of liquidation preferences, if any, on any
outstanding stock having prior rights on such distributions and payment of other
claims of creditors. Each share of common stock outstanding as of the date of
this prospectus is validly issued, fully paid and nonassessable.
PREFERRED STOCK
Our board of directors is authorized, subject to any limitations prescribed by
Delaware law, to issue preferred stock. The board of directors can fix the
rights, preferences and privileges of the shares and any qualifications,
limitations or restrictions thereon. The board of directors may authorize the
issuance of preferred stock with voting or other rights that could adversely
affect the voting power or other rights of the holders of common stock. Each
share of preferred stock outstanding as of the date of this prospectus is
validly issued, fully paid and nonassessable.
The issuance of preferred stock, while providing flexibility in connection with
possible acquisitions and other corporate purposes could, among other things,
under certain circumstances, have the effect of delaying, deferring or
preventing a change in control. The issuance of preferred stock may adversely
affect the rights of our common stockholders by, among other things:
- restricting dividends on common stock;
- diluting the voting power of the common stock;
- impairing the liquidation rights of the common stock; or
- delaying or preventing a change in control without further action by the
stockholders.
Four million shares of preferred stock are currently issued and outstanding,
having been issued pursuant to the private placement financing that we completed
on September 30, 2005. See `Liquidity and Capital Resources", Transactions in
2005 - Private Placement Financing Completed September 30, 2005," above, for a
discussion of the particular rights and preferences designated by the board of
directors for these shares of preferred stock. After giving effect to the
4,200,000 shares designated for issuance in the September 30, 2005 financing (of
which only 4,000,000 were issued and sold), we had an additional 15,800,000
authorized but unissued shares of preferred stock available.
67
STOCK OPTIONS
In November 2003, our stockholders approved our 2003 Omnibus Incentive Plan,
under which we reserved 1.6 million shares of common stock for future issuance.
In May 2005, our stockholders approved an increase of 1.5 million shares
reserved, providing for a total of 3.1 million 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. Stock options are currently
outstanding under the 2003 Omnibus Plan and two prior plans, the 1998 Stock
Option Plan and the 2001 Stock Option Plan.
The exercise price and vesting of individual awards granted are determined by
the board of directors at the date of grant. Our current policy provides for
options to 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.
As of September 30, 2005, options to purchase a total of 1,711,225 shares of
common stock were issued and outstanding, as follows:
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 $ 4.61 770,665 $ 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
============== =============== =====================================
*Remaining average contractual life (in years).
WARRANTS
From time-to-time we issue warrants to purchase common stock to persons who have
invested in the Company or who have provided services to us or entered into
agreements with us. As of September 30, 2005, warrants to purchase a total of
5,198,452 shares of common stock were issued and outstanding, 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 --
Forfeited
---------------------------------------------------------------------------------
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
=================================================================================
The above reflects two recent transactions in which we issued warrants. On
August 5, 2005, we issued warrants to purchase 600,000 shares of common stock
with an exercise price of $2.90 per share to Luminetx Corporation in connection
with a distribution agreement between us and Luminetx, and on September 30,
2005, we issued warrants to purchase 1,6 million shares of common stock with an
exercise price of $2.50 per share to investors who purchased preferred stock in
our private placement financing and warrants to purchase 200,000 shares of
common stock with an exercise price of $2.50 per share to holders of debentures
that we had issued in October 2004 as an inducement for their waiver of certain
negative covenants that were implicated by the September 2005 financing
transaction.
68
DELAWARE ANTI-TAKEOVER LAW
We and our stockholders are subject to Section 203 of the General Corporation
Law of the State of Delaware, an anti-takeover law. In general, the law
prohibits a public Delaware corporation from engaging in a "business
combination" with an "interested stockholder" for a period of three years after
the date of the transaction in which the person became an interested
stockholder, unless the business combination is approved in the prescribed
manner. A "business combination" includes merger, asset sale and other
transaction resulting in a financing benefit to the interested stockholder. An
"interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years, did own) 15% or more of the
corporation's voting stock.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company, 17 Battery Place, New York, NY 10004. We act as our
own transfer agent and registrar as to our preferred stock, warrants and stock
options.
69
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following information regards our directors as of November 30, 2005:
DIRECTOR PRINCIPAL OCCUPATION DURING
NAME AGE SINCE LAST FIVE YEARS AND DIRECTORSHIPS
- ---- --- ----- ---------------------------------
Geoffrey Jenkins 52 2002 Mr. Jenkins has been a director of Diomed since 2001, a director of the
Company since the February 14, 2002 merger, is chairman of the
Compensation Committee and has been the chairman of the board of
directors of the Company since January 2003. Mr. Jenkins has over
twenty-five years of experience in building consumer and professional
healthcare companies. In 2000, he founded and became the president of
UV-Solutions, LLC, a product development company. From 1998 to 2000, Mr.
Jenkins held the positions of chief operating officer and then president
of MDI Instruments, which was acquired by Becton Dickinson in 1999. MDI
Instruments developed and marketed diagnostic devices for the healthcare
market. Mr. Jenkins holds a BS and BA from Clarkson University, awarded
in 1976.
Sidney Braginsky 67 2004 Mr. Braginsky has been a director since January 2004. Mr. Branginsky has
in excess of thirty years of executive experience in scientific and
consumer products. During the past five years and prior thereto, Mr.
Braginsky has held a variety of executive level positions. Currently,
Mr. Braginsky is the chairman of DoubleD Venture Fund, LLC, chairman of
Atropos Technologies, LLC, chief executive officer and president of
Ineedmd, Ltd. and chairman and chief executive officer of Digilab, LLC,
a manufacturer and marketer of spectroscopy instruments. From 2001
through 2003, Mr. Braginsky was president of Mediscience Corp., a
designer and developer of diagnostic medical devices. From 1994 through
2000, he was president and chief operating officer of Olympus America,
Inc., which he joined in 1970. During his tenure at Olympus America, a
business unit of the global Japanese company, Mr. Braginsky built
Olympus America into a billion dollar business unit focused on optical
products. Mr. Braginsky currently serves as a director of Noven
Pharmaceutical Corp. (where he is a member of the Audit Committee), a
director of Estech Cardiology and a director of E.O.S.Electro-Optical
Systems. Mr. Braginsky is also chairman of the board of City University
of New York, Robert Chambers Laboratory, chairman of International
Standards Organization Optics and Electro-Optical Systems and a board
member of several other organizations in the scientific and educational
community. Mr. Braginsky attended the City University of New York.
Gary Brooks 70 2003 Mr. Brooks has been a director of the Company since March 2003 and is a
member of the Audit Committee. Mr. Brooks is a nationally recognized
turnaround consultant and crisis manager. During the past five years and
prior thereto, Mr. Brooks has principally served as chairman and chief
executive officer of Allomet Partners, Ltd. where since 1985 he has
provided turnaround consulting and interim management services to more
than 400 companies. He has over thirty-five years of diversified
executive management experience. Mr. Brooks earned a BS in Biochemical
Engineering and Industrial Management from Massachusetts Institute of
Technology in 1955 and an MS in Chemical Engineering and Operations
Research from the University of Rochester in 1959.
A. Kim Campbell 57 2002 Ms. Campbell has been a director of the Company since March 2002, and is
a member of the Compensation Committee. Ms. Campbell served as Canada's
19th (and first female) Prime Minister in 1993. She was also Canada's
Minister of Justice, Attorney General and Minister of National Defense.
Currently, Ms. Campbell is the Secretary General of the Club of Madrid,
an organization which promotes democracy and is comprised of 55 former
heads of state and government. She maintains her long-standing
relationship with Harvard University by serving as an Honorary Fellow to
the Center for Public Leadership at the John F. Kennedy School of
Government. In 2000, she completed a four-year term as Consul General of
Canada in Los Angeles, California, in which she fostered trade in the
high-tech and biotechnology industries. Ms. Campbell holds a range of
prestigious positions, including Senior Fellow of the Gorbachev
Foundation of North America in Boston, Massachusetts, member of the
International Council of the Asia Society of New York and Chair Emerita
of the Council of Women World Leaders, an organization of current and
former Presidents and Prime Ministers. Ms. Campbell holds a BA and an
LLB from the University of British Columbia, awarded in 1969 and 1983,
respectively, performed doctoral work in Soviet government at the London
School of Economics from 1970 to 1973 (ABD), and holds six honorary
doctorates.
70
Joseph Harris 58 2004 Mr. Harris has been a director of Diomed since February 2004. Mr. Harris
is currently a partner in Trillium Lakefront Partners, III, an early
stage and growth equity venture capital company. He has also served as
senior vice-president and director of corporate strategy & development
for Smithkline Beecham, where his responsibilities included management
of corporate acquisitions, divestitures, and joint ventures; Eastman
Kodak, as managing director of business development and director of
Licensing Technology Development; and senior vice president, corporate
development at Cantel Medical Corp, a publicly-traded medical device
company. Mr. Harris was a certified public accountant with Coopers &
Lybrand and practiced law in the state of New York with the Mackenzie
law firm. Mr. Harris also serves on the board of directors of Ortho
Vita, Inc., a manufacturer and marketer of bio-materials. Mr. Harris
received his bachelors degree in Accounting and his MBA from Syracuse
University School of Business. He earned his Juris Doctor degree from
the Syracuse University School of Law.
Peter Klein 51 2002 Mr. Klein has been a director of Diomed since 1999 and a director of the
Company since the February 14, 2002 merger. Mr. Klein served as the
president and chief executive officer of Diomed from June 1999 and of
the Company since the merger through January 2003, at which time he
resigned from the offices of president and chief executive officer, but
remained a director. Mr. Klein is currently president and chief
executive officer of Enefco International Inc., a manufacturer of custom
die cut and assembly work products. For thirteen years prior to joining
Diomed, Mr. Klein has served as an executive in the medical image
processing business, first as founder, president and co-chairman of
Tomtec Imaging Systems, then as president and chief executive officer of
Medison America, Inc., a subsidiary of the Korean Group Medison.
Edwin Snape, Ph.D. 64 2004 Dr. Snape has been a director since January 2004. Dr. Snape has
extensive experience in a broad range of medical-related fields. His
experience in the field of medical devices represents a broad range of
technologies and markets, including wound drainage, blood transfusion,
ultrasound, MRI, implantable devices, drug delivery, vascular access,
organ isolation, arterial fibrillation, cardiac monitoring, temperature
management and thrombectomy. In the diagnostic field, Dr. Snape's
experience includes alcohol and drug testing, diabetes, cardiovascular
disease, haemotology testing and antibody-based diagnostic testing. His
experience in the pharmaceutical field includes drug delivery, CNS
disorders, viral and bacterial diseases, GI tract disorders, human
tissue and organ regeneration and oncology. During the past five years
and prior thereto, Dr. Snape has been a partner of New England Partners,
a venture capital company based in Boston, Massachusetts founded in
1995. He was either the founder or management partner in nine private
equity funds, and has been involved in numerous investments, including
over 320 investments in the health care sector, fourteen of which
completed initial public offerings and seventeen of which were either
merged or acquired. Dr. Snape earned Bachelor of Science and Ph.D.
degrees from University of Leeds, England.
David Swank 48 2003 Mr. Swank has been a director of the Company since March 2003 and served
as chairman of the Audit Committee from that time until he became the
Company's chief financial officer, effective September 1, 2003. Mr.
Swank is president and founder of BrookstoneFive, Inc., a private
consulting firm engaged in corporate strategy formulation and capital
acquisition. Since 1997, Mr. Swank has principally been the president of
BrookstoneFive, Inc., although from 2001 to the beginning of 2003, he
also served as executive vice president and chief financial officer of
Melard Technologies, Inc., a New York-based, privately held high-tech
developer of wireless computing devices. From 1994 to 1996, he served as
executive vice president-corporate development and senior vice
president-chief financial officer at Telxon Corporation, a publicly
traded developer of mobile computing devices, and from 1989 to 1992, he
was regional controller for PepsiCo Foods International (PFI), the
international snack food subsidiary of PepsiCo, Inc. Mr. Swank earned a
BS in Business Administration in the honors accounting program at The
Ohio State University in 1980 and an MBA with a concentration in Finance
at Southern Methodist University in 1989.
James A. Wylie, Jr. 66 2003 Mr. Wylie has been a director of the Company since January 2003, at
which time he also became the Company's president and chief executive
officer. Prior to joining the Company, Mr. Wylie acted as a consultant
from 1994 through 2002, providing strategic advisory and interim
executive management services to institutional investors and operating
companies in the medical device, health care, chemical and
telecommunications industries. Mr. Wylie has more than 30 years of
global executive management experience as a division president, group
executive, president and chief executive officer of both private and
public corporations. Mr. Wylie holds a BS in Chemistry from Bates
College.
None of the persons named above are related by blood, marriage or adoption to
any other director nominees or any of our executive officers.
71
The following information regards our current executive officers, in addition to
Mr. Wylie and Mr. Swank, and highly-compensated non-executive officer employees:
Kevin Stearn, General Manager,
Diomed Ltd. Mr. Stearn joined us in March 2000 and is the general manager of our UK
subsidiary. From 1987 to 2000 he served as the operations director of
MediSense, a medical diagnostic manufacturer, joining that company in
its early start-up phase and growing it from revenues of $20 million to
$285 million and a workforce of over 700 people and a 30-fold increase
in production.
Christopher Geberth, Vice
President of Finance Mr. Geberth joined us in May 2004 as vice president, finance and
controller. Mr. Geberth has prior experience in the fields of finance
and accounting in technology and manufacturing industries. Mr. Geberth
has held positions of vice president and controller with Melard
Technologies, Inc., a New York based, privately held high tech developer
of wireless computing devices, and vice president and controller of
Netmarket Group, Inc., a privately held e-commerce company. Prior to
joining Diomed, Mr. Geberth served as an audit manager focusing on
emerging growth companies with PricewaterhouseCoopers LLP, an
international "Big Four" accounting firm. Mr. Geberth earned his BA in
Accounting from Pace University in 1993.
John J. Welch, Vice President of
Marketing Mr. Welch joined us in October 2002 as vice president of marketing. He
has over 20 years prior experience in marketing, sales and management in
the medical device industry. Prior to joining Diomed, Mr. Welch was
worldwide vice president of marketing for the surgical division of
Haemonetics Corp., and before that he served CR Bard and Datex-Ohmeda in
sales and marketing capacities and acted as director of marketing and
sales for the New England Region of the American Red Cross Blood
Program. Mr. Welch holds a BS in medical technology from Framingham
State College.
Cary Paulette, Vice President,
North American Sales Mr. Paulette joined us in December 2004 as vice president of North
American Sales. He has over 20 years experience in sales and marketing
management in the medical device and software industries. Prior to
joining Diomed, Mr. Paulette served as Region Manager for Guidant CRM.
Prior to that, he held roles as Vice President of The Americas for
Viewlocity and I2, both Supply Chain Software developers. Prior to his
software experience, Mr. Paulette worked in various sales and marketing
positions for Boston Scientific Corporation with his last role as Area
Director for Boston Scientific Endoscopy. Mr. Paulette holds a BA in
Marketing Management from Baylor University.
72
COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT
Section 16(a) of the Securities Exchange Act requires our directors, executive
officers and persons who own more than 10% of any class of our capital stock to
file with the SEC initial reports of ownership and reports of changes in
ownership and to provide copies of such reports to us. Based solely on a review
of the copies of such reports furnished to us and written representations that
no other reports were required to be filed during the fiscal year ended December
31, 2004, we believe that all of the filing requirements applicable to our
officers, directors and beneficial owners of greater than 10% of our common
stock were complied with during the most recent fiscal year as to which we have
issued our annual report, except as follows:
Three of our directors and executive officers did not timely file notices of the
acquisition of stock options that we granted during 2004. The following grants
of options were not reported within ten business days of grant to these new
directors on Forms 3 required to be filed with the SEC, but were reported when
these officers and directors filed their respective Forms 5 with the SEC in
February 2005:
Number of Shares
underlying
Name Date of Grant Stock Options
Sidney Braginsky 2/24/04 20,000
Edwin Snape 2/24/04 20,000
Joseph Harris 2/24/04 20,000
In the debt and equity financing that we completed on October 25, 2004, we
issued to Omicron Master Trust (i) convertible debentures in the principal
amount of $5.5 million, convertible into 2,401,747 shares of common stock and
(ii) warrants to purchase 1,439,791 shares of common stock. These securities
represented approximately 20% of our outstanding shares (assuming the conversion
and exercise of Omicron's derivative securities). To our knowledge, Omicron did
not file a Form 3 with the SEC to indicate its acquisition of beneficial
ownership of common stock, required to be filed within 10 business days of the
acquisition of these securities, or Forms 4 to reflect any subsequent
acquisitions or dispositions of our securities that may have occurred.
EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE
The following table sets forth certain information concerning the compensation
that we paid for services rendered in all capacities for the fiscal years ended
December 31, 2003 and 2004 and by those individuals serving as our chief
executive officer during 2003 and 2004 and our other executive officers serving
on December 31, 2004 whose salary and bonuses for 2004 exceeded $100,000. We
refer to these officers as the "Named Executive Officers." Numbers of shares
referenced below are adjusted to reflect the 1:25 reverse stock split effective
June 17, 2004. This information is unaudited.
73
Long Term
Compensation
Awards Securities
Name and Fiscal Year Underlying All Other
Principal Annual Compensation Options (1) Compensation
Position End Salary Bonus (No. Shares) (2)
- --------------- ----------------- ------------ ------------------ ------------------- ----- ------------------- -------------------
James Wylie (3) 12/31/04 $330,000 $50,000 287,412 $0
12/31/03 $225,000 $177,000 32,000 $75,000
David Swank (4) 12/31/04 $177,544 $83,300 70,000 $0
12/31/03 $96,100 $0 8,000 $0
Kevin Stearn (5) 12/31/04 $171,000 $32,000 34,000 $0
12/31/03 $134,000 $0 6,000 $0
John Welch (6) 12/31/04 $165,500 $25,000 28,000 $0
12/31/03 $146,000 $0 4,400 $0
Christopher Geberth (7) 12/31/04 $80,000 $0 30,000 $0
12/31/03 $0 $0 0 $0
Cary Paulette (8) 12/31/04 $11,330 $0 50,000 $0
12/31/03 $0 $0 0 $0
(1) During fiscal 2004 and 2003, neither Diomed Holdings, Inc. nor Diomed, Inc.
granted any restricted stock awards or stock appreciation rights or made any
long-term incentive plan payouts to any Named Executive Officer.
(2) Includes all other annual compensation and all other long-term compensation.
Perquisites are not included if the aggregate amount is less than the lesser of
$50,000 or 10% of salary and bonus.
(3) Pursuant to terms of Mr. Wylie's employment agreement, Mr. Wylie's annual
salary was increased from $300,000 to $330,000. We granted options to purchase
287,412 shares of common stock to Mr. Wylie in 2004. We paid Mr. Wylie a bonus
of $50,000 in 2004 in recognition of his services performed in 2003. We agreed
to pay Mr. Wylie a bonus of $66,000 in 2005 in recognition of his services
performed in 2004. Effective February 15, 2005, we increased Mr. Wylie's annual
base salary to $355,000. See "Employment Agreements," below.
(4) Mr. Swank became a director in March 2003 and served on our Audit Committee
from that time until September 1, 2003, when we appointed Mr. Swank as chief
financial officer on a consulting basis. We paid Mr. Swank consulting fees of
$177,544 during 2004. Mr. Swank's consulting fee is currently $17,916 per month.
We granted options to purchase 70,000 shares of common stock to Mr. Swank in
2004. We also paid Mr. Swank an aggregate bonus of $70,000 in 2004, including
$50,000 in recognition of his services performed in connection with the equity
financing completed in 2003 and $20,000 in recognition of his other services
performed in 2003. We also agreed to pay Mr. Swank a bonus of $42,000 in 2005 in
recognition of his services performed in 2004.
(5) Mr. Stearn began employment in February 2000. All figures expressed as
converted into US dollars from British Pounds Sterling. Mr. Stearn's annual
salary was increased from BPS 91,000 to BPS 96,000 effective September 1, 2004.
We granted options to purchase 34,000 shares of common stock to Mr. Stearn in
2004. We paid Mr. Stearn a bonus of $33,000 in 2004 in recognition of his
services performed in 2003. We agreed to pay Mr. Stearn a bonus of $32,000 in
2005 in recognition of his services performed in 2004.
(6) Mr. Welch became our vice president of North American marketing in October
2002. We increased Mr. Welch's annual salary to $175,000 effective October 1,
2004. We granted options to purchase 28,000 shares of common stock to Mr. Welch
in 2004. We paid Mr. Welch a bonus of $25,000 in 2004 in recognition of his
services performed in 2003. We agreed to pay Mr. Welch a bonus of $25,000 in
2005 in recognition of his services performed in 2004.
(7) Mr. Geberth became our vice present of finance in May 2004, at an effective
annual salary of $125,000. We granted options to purchase 30,000 shares of
common stock to Mr. Geberth in 2004. We agreed to pay Mr. Geberth a bonus of
$20,000 in 2005 in recognition of his services performed in 2004.
(8) Mr. Paulette became our vice president of North American sales in December
2004, at an effective annual salary of $175,000. We granted options to purchase
50,000 shares of common stock to Mr. Paulette in 2004. We also agreed to pay Mr.
Paulette a bonus of $30,000 in 2005 as an incentive to join the Company.
EQUITY COMPENSATION PLAN INFORMATION
As of December 31, 2004, 619,529 shares were available for issuance under our
2003 Omnibus Plan, 23,732 shares were available for issuance under our 2001 Plan
and 27,076 shares were available for issuance under our 1998 Plan.
The following table describes as of December 31, 2004 the outstanding warrants,
stock options and other rights issued under our 2003 Omnibus Plan, 2001 Plan and
1998 Plan that were then outstanding and exercisable:
74
Number of securities
Number of securities to be Weighted average exercise remaining available for
issued upon exercise of price of outstanding future issuance under
outstanding options, options, warrants and rights equity compensation plans
Plan Category warrants and rights (excluding securities
(expressed in common stock) reflected in column (a))
(a) (b) (c)
- ------------------------------- ----------------------------- ----------------------------- -----------------------------
Equity compensation plans 1,046,068 $8.12 670,337
approved by stockholders
- ------------------------------- ----------------------------- ----------------------------- -----------------------------
Equity compensation plans not 0 0 0
approved by stockholders
- ------------------------------- ----------------------------- ----------------------------- -----------------------------
Total 1,046,068 $8.12 670,337
In May 2005, our stockholders approved an increase of 1.5 million reserved
shares providing for a total of 3.1 million shares of common stock reserved for
future issuance. As of June 30, 2005, 1,540,549 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 June 30, 2005.
No options were available under the 1998 Plan as of June, 30, 2005.
EMPLOYMENT AGREEMENTS
Chief Executive Officer
Effective January 10, 2003, we entered into an employment agreement with James
A. Wylie, Jr. as president and chief executive officer. Mr. Wylie became a
director as of that date. Mr. Wylie's employment agreement was for an initial
term of two years and provided for an annual base salary of $300,000 (payable
commencing March 1, 2003), an award of options to purchase up to 32,000 shares
(figure adjusted for 1:25 reverse stock split effective on June 17, 2004) of
common stock and certain bonus compensation, including a discretionary bonus as
determined by the board of directors and a bonus for the consummation of certain
financings (including the equity financing), mergers or similar transactions. If
we terminated Mr. Wylie's employment other than for cause, we would have been
obligated to pay his salary and provide benefits to him for the remainder of his
two-year employment term. From December 2, 2002 until the effective date of his
employment agreement, Mr. Wylie acted as a consultant to us and an advisory
board member, pursuant to a management services agreement. Under the management
services agreement, we paid Mr. Wylie a consulting fee of $125,000 for the
period December 2, 2002 through February 28, 2003, and agreed to pay a success
fee for the consummation of certain financing, merger or similar transactions
(excluding the December 27, 2002 bridge financing transaction). The management
services agreement was terminated upon the effective date of Mr. Wylie's
employment agreement and was superseded by his employment agreement.
Effective December 28, 2003, we entered into a second employment agreement with
James A. Wylie, Jr. This agreement superseded our January 10, 2003 employment
agreement with Mr. Wylie, and extended his employment by one year from December
31, 2004 until December 31, 2005. Mr. Wylie's new agreement provided for an
annual base salary of $330,000 (commencing January 1, 2004), an award of options
to purchase up to 108,000 shares (figure adjusted for 1:25 reverse stock split
effective on June 17, 2004) of common stock and certain bonus compensation. If
we terminated Mr. Wylie's employment other than for cause, we would have been
obligated to pay his salary and provide benefits to him for the remainder of his
two-year employment term.
Effective February 15, 2005, the terms of Mr. Wylie's employment were modified
by (i) extending the term of employment through December 31, 2007 (formerly, the
term was through December 31, 2005 at an effective annual base salary of
$355,000), (ii) providing that in the event of termination by us without cause
or by Mr. Wylie for good reason, we will pay an amount equal to either his base
compensation for the remainder of the term or 12 months, whichever is greater
and (iii) clarifying that Mr. Wylie will be able to terminate his employment
agreement upon not less than 90 days' notice for reasons other than good reason,
in which case we will not be required to pay severance.
Chief Financial Officer
Effective September 1, 2003, we entered into a consulting agreement with David
B. Swank, as chief financial officer. Mr. Swank's agreement provided for us to
pay him a monthly fee of $12,500, and entitled him to receive options to
purchase shares of common stock and bonus compensation. Effective March 1, 2004,
we increased Mr. Swank's monthly fee to $16,667. Mr. Swank's agreement was for
six-month automatically renewable periods, and was cancelable upon six months
notice. Effective September 1, 2004, Mr. Swank's agreement was automatically
extended for a second six-month period until March 1, 2005, at a monthly fee of
$16,667.
Effective February 15, 2005, we modified the terms of Mr. Swank's employment by
(i) providing a term through December 31, 2005, renewable annually thereafter
unless either party gives notice of non-renewal by November 30, (ii) providing
that we may terminate Mr. Swank's employment for cause upon written notice,
(iii) providing that in the event of termination by us without cause or by Mr.
Swank for good reason, we will pay an amount equal to either his base
compensation for the remainder of the term or 12 months, whichever is greater,
(iv) providing that Mr. Swank will not use or disclose proprietary information
or confidential information, that all proprietary information is our property
and that all inventions of Mr. Swank during the term of his employment that are
related to our business are our property and (v) providing that Mr. Swank will
not compete with us or solicit our customers, suppliers or employees during the
term or for 12 months thereafter.
75
Our executive officers (Messrs. Stearn, Welch, Paulette and Geberth) have
agreements which provide that upon termination of their respective employment
without cause, we will pay their annual base salary for a period of twelve
months. These agreements also provide that these executive officers are eligible
to receive annual bonuses based on performance. These employment agreements also
prohibit our executive officers from directly or indirectly competing with us
for a period of one-year following termination of their employment.
There have been no adjustments or amendments to the exercise price of stock
options for our executive officers or directors, other than adjustments to
then-outstanding stock options that correspond with the 1:25 reverse split
effective June 17, 2004, which decreased the number of option shares and
increased the option exercise price, in each case by a factor of 25.
STOCK OPTION PLANS
(Figures throughout this section for number of common stock, price per
share of common stock, options and warrants are adjusted to give effect to
the 1:25 reverse stock split effective on June 17, 2004)
In November 2003, our stockholders approved a new incentive plan, the 2003
Omnibus Plan. 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. We obtained stockholder approval of the 2003
Omnibus Plan at our annual meeting on November 25, 2003, after which we reserved
1.6 million shares of common stock for issuance pursuant to this plan. At our
annual meeting of stockholders held on May 17, 2005, our stockholders approved
an increase of 1.5 million shares providing for a total of 3.1 million shares of
common stock reserved for future issuance. As of June 30, 2005, 1,540,549
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 June 30, 2005. No options were available under the 1998 Plan as of
June 30, 2005.
76
OPTION GRANTS IN LAST FISCAL YEAR
(Figures throughout this section are adjusted to give effect to the 1:25
reverse stock split effective June 17, 2004 for number of shares of common
stock, price per share of common stock, options and warrants)
The following table sets forth certain information regarding stock options that
we granted in 2004 to all Named Executive Officers:
OPTIONS GRANTED IN 2004
Percent of
Named Executive No. Options Total Granted Expiration
Officer Granted in 2004(1) Exercise Price Date
- --------------------- ---------------- ---------- -------------- ---------
James Wylie(2) 108,000 11.3% $4.50 2/11/2014
160,000 16.8% $5.00 2/24/2014
19,412 2.0% $4.25 3/26/2004
David Swank(3) 60,000 6.3% $5.00 2/24/2014
10,000 1.0% $2.02 0/29/2014
John Welch(4) 28,000 2.9% $5.00 2/24/2014
Kevin Stearn(5) 34,000 3.6% $5.00 2/24/2014
Cary Paulette(6) 50,000 5.2% $3.54 12/9/2014
Christopher Geberth(7) 20,000 2.1% $2.50 5/17/2014
10,000 1.0% $3.54 12/9/2014
--------------------------------------------------------------
Total 499,412 52.3% $4.36
(1) Based on a total of approximately 954,500 options granted to employees
during 2004. Rounded to nearest one-tenth of one percent.
(2) Mr. Wylie was also awarded 182,000 options on January 10, 2005 at an
exercise price of $4.20 per share.
(3) Mr. Swank was also awarded 56,800 options on January 10, 2005 at an exercise
price of $4.20 per share.
(4) Mr. Welch was awarded 39,400 options on January 10, 2005 at an exercise
price of $4.20 per share.
(5) Mr. Stearn was also awarded 43,600 options on January 10, 2005 at an
exercise price of $4.20 per share.
(6) Mr. Paulette was also awarded 50,000 options on January 10, 2005 at an
exercise price of $4.20 per share.
(7) Mr. Geberth was also awarded 10,000 options on January 10, 2005 at an
exercise price of $4.20 per share
77
OPTION GRANTS IN LAST FISCAL YEAR
(Figures throughout this section are adjusted to give effect to the 1:25
reverse stock split effective June 17, 2004 for number of shares of common
stock, price per share of common stock, options and warrants)
The following table sets forth certain information regarding stock options that
we granted in 2004 to all Named Executive Officers:
OPTIONS GRANTED IN 2004
Percent of
Named Executive No. Options Total Granted Expiration
Officer Granted in 2004(1) Exercise Price Date
- ------------------ ------------- ---------- -------------- ---------
James Wylie(2) 108,000 11.3% $4.50 2/11/2014
160,000 16.8% $5.00 2/24/2014
19,412 2.0% $4.25 3/26/2004
David Swank(3) 60,000 6.3% $5.00 2/24/2014
10,000 1.0% $2.02 10/29/2014
John Welch(4) 28,000 2.9% $5.00 2/24/2014
Kevin Stearn(5) 34,000 3.6% $5.00 2/24/2014
Cary Paulette(6) 50,000 5.2% $3.54 12/9/2014
Christopher Geberth(7) 20,000 2.1% $2.50 5/17/2014
10,000 1.0% $3.54 12/9/2014
-----------------------------------------------------
Total 499,412 52.3% $4.36
(1) Based on a total of approximately 954,500 options granted to employees
during 2004. Rounded to nearest one-tenth of one percent.
(2) Mr. Wylie was also awarded 182,000 options on January 10, 2005 at an
exercise price of $4.20 per share.
(3) Mr. Swank was also awarded 56,800 options on January 10, 2005 at an exercise
price of $4.20 per share.
(4) Mr. Welch was awarded 39,400 options on January 10, 2005 at an exercise
price of $4.20 per share.
(5) Mr. Stearn was also awarded 43,600 options on January 10, 2005 at an
exercise price of $4.20 per share.
(6) Mr. Paulette was also awarded 50,000 options on January 10, 2005 at an
exercise price of $4.20 per share.
(7) Mr. Geberth was also awarded 10,000 options on January 10, 2005 at an
exercise price of $4.20 per share
78
OPTIONS HELD AT END OF PRIOR FISCAL YEAR
(Figures throughout this section are adjusted to effect to the 1:25
reverse stock split effective June 17, 2004)
The following table sets forth certain information regarding stock options that
the Named Execut7ive Officers held as of December 31, 2004:
NUMBER OF UNEXERCISED
OPTIONS AT VALUE OF "IN THE MONEY"
DECEMBER 31, 2004 OPTIONS AT
NAME AND EXERCISABLE/ DECEMBER 31, 2004
PRINCIPAL POSITION UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
- ---------------------------------------------------------------------------------------------------------
James A. Wylie Jr., 185,412 / 134,000 $82,501 / $0
President and Chief Executive Officer
David B. Swank, 20,333 / 57,667 $0 / $20,200
Chief Financial Officer, Secretary
Christopher J. Geberth 5,000 / 25,000 $12,500 / $72,900
VP, Finance
John J. Welch 10,767 / 24,833 $0 / $0
VP, North American Marketing
Cary Paulette 0 / 50,000 $0 / $177,000
VP, North American Sales
Kevin Stearn 15,365 / 31,035 $0 / $0
VP, Operations (General Manager Diomed
Limited)
(1) Based on the closing price of $4.32 on the AMEX on December 31, 2004 and the
respective exercise prices of the options held.
No adjustments to the exercise price of any outstanding options were made during
the fiscal year ended December 31, 2004, other than in connection with the 1:25
reverse split effective June 17, 2004, which resulted in a reduction in the
number of option shares by a factor of 25 and a 25 fold increase in the exercise
price of each outstanding option.
79
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth beneficial ownership information as of September
30, 2005 for our capital s
- our chief executive officer and other executive officers whose salary
and bonuses for 2004 exc
- each director;
- our directors and executive officers as a group; and
- each person who is known by us to beneficially own more than 5% of the
outstanding shares of our common stock and other classes of voting stock.
To our knowledge, each person, along with his or her spouse, has sole voting and
investment power over the shares unless otherwise noted.
AMOUNT AND NATURE OF
NAME BENEFICIAL OWNERSHIP PERCENT OF CLASS(1)
- ----- -------------------- ------------------
Sidney Braginsky 15,694 (2) .1%
Gary Brooks 19,694 (3) .1%
A. Kim Campbell 23,694 (4) .1%
Joseph Harris 15,694 (5) .1%
Geoffrey Jenkins 53,544 (6) .3%
Peter Klein 19,694 (7) .1%
Edwin Snape 15,694 (8) .1%
David Swank 73,411 (9) .4%
James A. Wylie, Jr. 322,924 (10) 1.6%
Christopher Geberth 19,222 (11) .1%
Cary Paulette 25,972 (12) .1%
Kevin Stearn 41,042 (13) .2%
John J. Welch 33,136 (14) .2%
All officers and directors as a group (13 persons) 679,319 3.4%
Beneficial Owners of More than 5% of the Company's common stock
Samuel Belzberg 1,714,260 (15) 8.8%
Zesiger Capital Group 1,844,350 (16) 9.5%
Galleon Healthcare Partners, L.P. and affiliates 2,218,300 (17) 11.1%
Omicron Master Trust 2,524,912 (18) 12.0%
ProMed Partners, L.P. and affiliates 3,063,890 (19) 14.9%
(1) Calculated pursuant to Rule 13d-3 of the Rules and Regulations under the
Securities Exchange Act of 1934, as amended. Percentages shown for all officers
and directors as a group are calculated on an aggregate basis and percentages
shown for individuals are rounded to the nearest one-tenth of one percent. The
mailing address for each of the directors and officers is c/o Diomed, Inc., One
Dundee Park, Andover, MA 01810.
(2) Includes 15,694 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(3) Includes 19,694 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(4) Includes 23,694 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(5) Includes 15,594 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(6) Includes 53,544 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(7) Includes 19,694 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(8) Includes 15.964 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
80
(9) Includes 10,000 shares held plus 63,411 shares of common stock issuable upon
the exercise of stock options vested through 12/1/05.
(10) Includes 75,961 shares held plus 246,963 shares of common stock issuable
upon the exercise of stock options vested through 12/1/05.
(11) Includes 2,000 shares held plus 17,222 shares of common stock issuable upon
the exercise of stock options vested through 12/1/05.
(12) Includes 25,972 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(13) Includes 41,042 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(14) Includes 33,136 shares of common stock issuable upon the exercise of stock
options vested through 12/1/05.
(15) Includes 1,709,593 shares of common stock held by Gibralt US, Inc. and
4,667 shares issuable upon the exercise of fully vested stock options held by
Mr. Belzberg. Mr. Belzberg is an affiliate of Gibralt Capital Corp. and Gibralt
U.S. Inc., and therefore is deemed to beneficially own the securities it holds.
Mr. Belzberg's address is c/o Gibralt Capital Corp., 1075 W Georgia Street,
Suite 1075, Vancouver, BC V6E 3C9 Canada.
(16) Includes 1,844,350 shares of common stock as to which we believe Zesiger
has sole dispositive power, as investment adviser for Zesiger clients, none of
whom individually owns more than 5% of the common stock. Zesiger's address is
320 Park Avenue, 30th Floor, New York, NY 10022.
(17) Includes 1,643,300 shares of common stock held plus 575,000 shares of
common stock issuable upon exercise of warrants. Galleon's address is 135 E 57th
Street, 16th Floor, New York, NY 10022.
(18) Includes 965,940 shares underlying convertible debentures plus 1,558,972
shares of common stock underlying warrants. Omicron's address is 810 Seventh
Ave., 39th Floor, New York, NY 10019.
(19) Includes 1,943,890 shares of common stock held (as reported in Schedule 13G
filed with the SEC on June 30, 2005) , 800,000 shares of preferred stock held
and 320,000 shares of common stock underlying warrants. Does not give effect to
9.9% limitations on ownership (described under "Liquidity and Capital Resources;
Transactions in 2005 - Private Placement Financing Completed September 30,
2005," above). ProMed's address is 230 Park Avenue, 9th Floor, New York, NY
10017.
81
SELLING STOCKHOLDERS
As described in greater detail under "Determination of Number of Shares to Be
Registered," below, the shares being offered by the Selling Stockholders relate
to the following transactions:
UNDERLYING BASIS FOR ISSUANCE NUMBER OF SHARES
----------------------------- ----------------
Exchange of Preferred Stock issued 9/30/05 for Common Stock
(at exchange rate of $2.50 per share) 4,000,000
Allotment for Payment of Future Dividends on Preferred Stock in the form of Shares
of Common Stock at the Company's Election 2,950,000
Exercise of Warrants to Purchase Common Stock Issued to Purchasers of Preferred
Stock (at exercise price of $2.50 per share) 1,600,000
Exercise of Warrants to Purchase Common Stock We Issued 9/30/05 to Holders of
Debentures as Inducement to Waive Negative Covenants (at exercise price of $2.50 per 200,000
share)
Total Shares Represented by Securities We Issued 9/30/05 8,750,000
Additional Allowance of 25% 2,187,500
----------
TOTAL SHARES BEING REGISTERED 10,937,500
==========
DETERMINATION OF NUMBER OF SHARES TO BE REGISTERED
The shares we are registering pursuant to the registration statement of which
this prospectus is a part relate to the private placement financing that we
completed on September 30, 2005 (see "Liquidity and Capital Resources;
Transactions in 2005 - Private Placement Financing Completed September 30,
2005," above) and consist of the following:
o 4 million shares of common stock we may issue upon exchange of
preferred stock that we issued and sold to 18 investors on September
30, 2005 at an issue price of $2.50 per share;
o 2.95 million shares of common stock that we may issue in payment of
dividends on the preferred stock we issued September 30, 2005;
o 1.6 million shares of common stock that we may issue upon the
exercise of common stock purchase warrants that we issued to the
investors who purchased the preferred stock that we sold under the
September 30, 2005 financing transaction; and
o 200,000 shares of common stock that we may issue upon the exercise
of common stock purchase warrants that we issued on September 30,
2005 to the three holders of outstanding convertible debentures we
issued and sold on October 25, 2004 as an inducement for them to
grant to us waivers of certain negative covenants under the
debentures that they held.
We are registering 125% of the foregoing shares pursuant to our agreement to
register that number of shares under the registration rights agreement that we
entered into in connection with the September 30, 2005 financing transaction.
The registration of an additional allowance of shares will provide for
additional registered shares that we may issue to the Selling Stockholders if we
issue dividends in the form of common stock in excess of the amount allotted, if
antidilution adjustments to the exchange rate of the preferred stock or the
exercise price of the warrants so require or if shares become issuable upon any
stock split dividend or distribution, recapitalization or similar event.
We calculated the number of shares issuable as follows:
In respect of the exchange of preferred stock, we assumed that all 4 million
shares of preferred stock will be exchanged by the holders for an equal number
of shares of common stock, at the existing exchange rate of $2.50 per share.
In respect of the dividends on the preferred stock, we have assumed that (i) all
4 million shares of preferred stock will remain outstanding for five years, (ii)
dividends will accrue for five years, (iii) we will pay all dividends on the
preferred stock in the form of common stock and (iv) the average price per share
of the common stock issued as dividends will be $2.00. Pursuant to this
calculation, dividends accrued over five years will be $900,000 for the first 18
months ($10 million at 6% per annum), $500,000 for the following six months ($10
million at 10% per annum) and $4.5 million for the following three years ($10
million at 15% per annum). Based on these assumptions, aggregate dividends of
$5.9 million will accrue over the five years while the preferred stock is
outstanding, and we will issue 2.95 million shares of common stock as dividends
on the preferred stock. If shares of preferred stock are exchanged for common
stock or are redeemed earlier than five years, then fewer dividends will accrue,
and accordingly, fewer shares of common stock will be issuable as dividends. If
the average price of our common stock for purposes of paying dividends is less
than $2.00 per share, then a larger number of shares of common stock will be
issuable as dividends should we choose to pay dividends in shares rather than in
cash.
82
In respect of the exercise of warrants, we have assumed that all 1.8 million
warrants will be exercised by payment of cash at the current exercise price of
$2.50 per share.
DILUTION RESULTING FROM SEPTEMBER 30, 2005 FINANCING TRANSACTION
The September 30, 2005 financing transaction was dilutive to the pre-transaction
holders of common stock, in that we issued common stock equivalents in that
financing which have the effect of reducing the pro rata voting and other rights
of the pre-transaction stockholders. Because the actual number of shares of
common stock that will ultimately be issued to the September 2005 investors is
based on future factors that are unknown to us at this time, it is impossible to
specify this amount of dilution. However, we can specify that, at a minimum, 4
million shares of common stock underly the preferred stock (assuming no
dividends are paid in the form of common stock and no antidilution adjustments
are made to the $2.50 exchange rate of the preferred stock), and a minimum of
1.8 million shares of common stock underly the warrants (assuming no
antidilution adjustments are made to the $2.50 exercise price of the warrants or
number of shares that may be purchased upon exercise), and in each case assuming
that the limitations on ownership applicable to the exchange of the preferred
stock and the exercise of the warrants (described under "Liquidity and Capital
Resources; Transactions in 2005 - Private Placement Financing Completed on
September 30, 2005," above) do not apply. This minimum of 5,800,000 shares
represents approximately 22% of the fully diluted common stock outstanding prior
to the September 30, 2005 financing transaction. The issuance of the 10,937,500
underlying shares we estimated for purposes of this registration statement
represents approximately 42% of the fully diluted common stock outstanding prior
to the September 30, 2005 financing transaction.
Prior to the September 30, 2005 financing transaction, we had 19,423,728 shares
of common stock outstanding, plus common stock equivalents (including
convertible debentures, stock options and warrants), representing an additional
6,745,657 shares of common stock. Accordingly, 26,169,385 shares of common stock
were issued and outstanding on a fully diluted basis. Thus, the minimum of 5.8
million shares issuable represents approximately 22% of the 26,169,385 fully
diluted shares pre-transaction, and the registered amount of 10,937,500 shares
represents approximately 42% of the 26,169,385 fully diluted shares
pre-transaction. If we issue only the minimum of 5,800,000 shares of common
stock underlying the preferred stock and warrants that we issued in the
September 30, 2005 financing transaction, 31,969,385 shares of common stock will
be issued and outstanding on a fully diluted basis. If we issue all 10,937,500
shares of common stock that we have estimated for registration purposes to
underly the preferred stock and warrants that we issued in the September 30,
2005 financing transaction, then 37,106,885 shares of common stock will be
issued and outstanding on a fully diluted basis.
The fewer shares that are issuable upon exchange of the preferred stock and/or
exercise of the warrants, the less the dilution that will be experienced by our
stockholders prior to the September 30, 2005 financing transaction. It is
possible that we will issue fewer shares than the 10,937,500 shares we estimated
to be issuable for purposes of this registration statement. For instance, less
than 10,937,500 shares may be issuable if we do not pay dividends in the form of
common stock, if the amount of dividends that accrues is less than the $5.9
million we have assumed registration purposes (for example if preferred stock is
exchanged or redeemed prior to September 30, 2010, if our dividend payment
obligation is suspended due to our common stock's exceeding minimum trading
prices), if the average price per share of common stock used to issue dividends
is greater than the $2.00 figure we estimated (in which case fewer shares will
be issuable to satisfy our dividend obligations), or if there are no
antidilution adjustments to the exchange rate of the preferred stock and/or the
exercise price of the warrants. Conversely, it is possible that we will issue in
excess of the 10,937,500 shares we estimated for purposes of this registration
statement, for example, if dividends that actually accrue are in excess of $5.9
million (which may occur if preferred stock remains outstanding longer than five
years), if the average price per share of common stock used to pay dividends is
less than the $2.00 figure we estimated or if antidilution adjustments reduce
the exchange rate of the preferred stock and/or the exercise price of and number
of shares underlying the warrants.
83
INFORMATION REGARDING THE SELLING STOCKHOLDERS
Details regarding the ownership of shares of our common stock held by the
Selling Stockholders are as follows:
Name and Address of Selling Stockholder (Individual(s) with No. Shares No. Shares
Investment and/or Voting Control where Selling Stockholder No. Shares % of Shares being Offered*** Owned after
is an Entity) Owned before Outstanding Offering****
Offering * Owned before
Offering
(Expressed as
a Decimal)**
- ------------------------------------------------------------- ----------------- ----------------- ----------------- ----------------
ProMed Partners, L.P. 579,222 0.0191 384,750 194,472
ProMed Management, Inc.
237 Park Avenue, 9th Floor
New York, New York 10017
(Barry Kurakawa and David B. Musket)
ProMed Partners II, L.P. 145,932 0.0048 96,188 49,744
ProMed Management, Inc.
237 Park Avenue, 9th Floor
New York, New York 10017
(Barry Kurakawa and David B. Musket)
ProMed Offshore Fund, Ltd. 95,681 0.0032 64,125 31,556
ProMed Management, Inc.
237 Park Avenue, 9th Floor
New York, New York 10017
(Barry Kurakawa and David B. Musket)
ProMed Offshore Fund II, Ltd. 2,288,611 0.0754 1,592,438 696,173
ProMed Management, Inc.
237 Park Avenue, 9th Floor
New York, New York 10017
(Barry Kurakawa and David B. Musket)
Advantage Advisors Catalyst Partners L.P. 112,219 0.0037 112,219 0
220 East 42nd Street, 29th Floor
New York, New York 10017
(Todd McElroy)
Advantage Advisors Catalyst Intl. Ltd. 80,157 0.0026 80,157 0
220 East 42nd Street, 29th Floor
New York, New York 10017
(Todd McElroy)
Ridgecrest Partners Ltd. 64,125 0.0021 64,125 0
220 East 42nd Street, 29th Floor
New York, New York 10017
(Todd McElroy)
Ridgecrest Partners L.P. 10,687 0.0004 10,687 0
220 East 42nd Street, 29th Floor
New York, New York 10017
(Todd McElroy)
Ridgecrest Partners QP, L.P. 267,187 0.0088 267,187 0
220 East 42nd Street, 29th Floor
New York, New York 10017
(Todd McElroy)
Lagunitas Partners LP 1,389,375 0.0458 1,389,375 0
Gruber & McBaine Capital Management
50 Osgood Place, Penthouse
San Francisco, CA 94133
(Jon D. Gruber and J. Patterson McBaine)
Gruber & McBaine International 427,500 0.0141 427,500 0
Gruber & McBaine Capital Management
50 Osgood Place, Penthouse
San Francisco, CA 94133
(Jon D. Gruber and J. Patterson McBaine)
Jon D. and Linda W. Gruber Trust 160,312 0.0053 160,312 0
Gruber & McBaine Capital Management
50 Osgood Place, Penthouse
San Francisco, CA 94133
(Jon D. Gruber, as trustee)
J. Patterson McBaine 160,312 0.0053 160,312 0
Gruber & McBaine Capital Management
50 Osgood Place, Penthouse
San Francisco, CA 94133
(J. Patterson McBaine)
Broadfin Healthcare Fund LP 160,312 0.0053 160,312 0
Broadfin Capital, LLC
237 Park Avenue, 9th Floor
New York, New York 10017
(Kevin Kotler)
Alpha Capital 320,625 0.0106 320,625 0
Pradafant 7
9490 Furstentums
Vaduz, Lichtenstein
(Konrad Ackerman and
Rainer Posch)
Fractal Holdings, LLC 53,438 0.0018 53,438 0
13 Lia Fail Way
Cos Cob, CT 06807
(Samuel E. Navarro and
Alexandra Navarro)
North Sound Legacy International Ltd. 3,847,500 0.1267 3,847,500 0
North Sound Capital LLC
20 Horseneck Lane
Greenwich, CT 06830
(Thomas McAuley)
North Sound Legacy Institutional Fund LLC 1,496,250 0.0493 1,496,250 0
North Sound Capital LLC
20 Horseneck Lane
Greenwich, CT 06830
(Thomas McAuley)*****
Omicron Master Trust 148,976 0.0049 148,976 0
810 Seventh Avenue, 39th Floor
New York, NY 10019
(Bruce Bernstein)
Iroquois Capital LP 33,675 0.0011 33,675 0
400 Central Avenue, Suite 309
Northfield, IL 60093
(Joshua Silverman)
Cranshire Capital LP 67,349 0.0022 67,349 0
666 Dundee Road, Suite 1901
Northbrook, IL 60062
(Mitchell P. Kopin)
---------- ------ ---------- -------
Total 11,909,445 0.3923 10,937,500 971,945
========== ====== ========== =======
* Ownership of shares set forth in this table represents all shares of common
stock underlying the securities we issued to each Selling Stockholder in our
September 30, 2005 financing transaction (determined as described above) plus
all other shares (if any) held by such Selling Stockholder. Ownership as so
determined is different from "beneficial ownership" calculated pursuant to Rule
13d-3 of the Rules and Regulations under the Securities Exchange Act of 1934, as
amended. Accordingly, for purposes of setting forth ownership in the above
table, we have disregarded the limitations on ownership applicable to the
Selling Stockholders under the terms of the preferred stock and warrants we
issued to them in the September 30, 2005 financing transaction (described under
"Liquidity and Capital Resources; Transactions in 2005 - Private Placement
Financing Completed September 30, 2005," above) and, as to two particular
Selling Stockholders, North Sound Legacy International Limited and North Sound
Legacy Institutional Fund LLC, for purposes of setting forth ownership in the
above table, we have also disregarded a written agreement with us whereby these
Selling Stockholders agreed not to exercise any voting rights with respect to
their preferred stock to the extent that doing so would exceed 4.99% of the
shares of common stock then outstanding. According to the foregoing, the Selling
Stockholders do not have "beneficial ownership" of all shares of common stock
underlying the preferred stock and warrants we issued to them in the September
30, 2005 financing transaction as calculated pursuant to Rule 13d-3 of the Rules
and Regulations under the Securities Exchange Act of 1934, as amended, however,
we are reporting their interest as ownership in the above table to disclose all
underlying shares that we are registering on behalf of the Selling Stockholders
by way of the registration statement of which this prospectus is a part.
Furthermore, certain of the Selling Stockholders are related entities (as
indicated in their respective names and addresses), and therefore although
presented individually in the table above, their shares should be considered
aggregated for purposes of determining the concentration of ownership by those
related entities. In addition, the number of shares owned before offering
indicated above for the four ProMed entities included in the above table does
not reflect 727,729 shares of common stock beneficially owned by Promed
Management, Inc. or 244,216 shares of common stock beneficially owned by ProMed
Asset Management, LLC, both of which we believe to be affiliates of the four
ProMed entities which are among the Selling Stockholders.
** Ownership of shares set forth in this table is different from beneficial
ownership of shares if ownership presented was "beneficial ownership" calculated
pursuant to Rule 13d-3 of the Rules and Regulations under the Securities
Exchange Act of 1934, as amended. Rather, percentage of ownership of shares set
forth in this table is based the number of shares owned by each Selling
Stockholder, as a percentage of 30,361,228 shares of common stock outstanding,
which includes 19,423,728 shares of common stock outstanding and available to
trade publicly on November 30, 2005, plus all 10,937,500 shares of common stock
that we are registering hereunder on behalf of the Selling Stockholders.
*** Includes those shares we are registering hereunder on behalf of each Selling
Stockholder, calculated to include a 25% allowance over the number of shares we
calculated for the securities we sold to the Selling Stockholders on September
30, 2005, as described under "Determination of Number of Shares to Be
Registered," above.
**** Assume that the Selling Stockholders do not acquire or dispose of any
shares of common stock and that the Selling Stockholders sell all shares of
common stock we are registering hereunder on their behalf.
***** Thomas McCauley is the ultimate managing member of North Sound Capital
LLC, which may be deemed the beneficial owner of the securities held in its
capacity as the managing member of North Sound Legacy Institutional Fund LLC and
the investment advisor of North Sound Legacy International Ltd. (the "Funds"),
who are the holders of record of such securities. As the managing member or
investment advisor, respectively, of the Funds, North Sound Capital LLC has
voting and investment control with respect to the shares of common stock held by
the Funds.
84
PLAN OF DISTRIBUTION
Each Selling Stockholder of our common stock and any of their pledgees,
transferees, donees, assignees and successors-in-interest may, from time to
time, sell any or all of their shares of common stock on the market or exchange
on which the common stock is listed or quoted for trading (currently the
American Stock Exchange, or, AMEX) or any other stock exchange, market or
trading facility on which the shares are traded or in private transactions.
These sales may be at fixed or negotiated prices. A Selling Stockholder may use
any one or more of the following methods when selling shares:
o ordinary brokerage transactions and transactions in which the
broker-dealer solicits purchasers;
o block trades in which the broker-dealer will attempt to sell the
shares as agent but may position and resell a portion of the block
as principal to facilitate the transaction; "at the market" to or
through market makers into an existing market for the shares;
o "at the market" to or through market makers into an existing market
for the shares;
o purchases by a broker-dealer as principal and resale by the
broker-dealer for its account;
o an exchange distribution in accordance with the rules of the
applicable exchange;
o privately negotiated transactions;
o settlement of short sales entered into after the date of this
prospectus;
o broker-dealers may agree with the Selling Stockholders to sell a
specified number of such shares at a stipulated price per share;
o a combination of any such methods of sale;
o through transactions in options, swaps or other derivative
securities, whether exchange-listed or otherwise; or
o any other method permitted pursuant to applicable law.
The Selling Stockholders may also sell shares under Rule 144 under the
Securities Act of 1933, as amended, if available, rather than under this
prospectus.
Broker-dealers engaged by the Selling Stockholders may arrange for other
broker-dealers to participate in sales. Broker-dealers may receive commissions
or discounts from the Selling Stockholders (or, if any broker-dealer acts as
agent for the purchaser of shares, from the purchaser) in amounts to be
negotiated. Each Selling Stockholder does not expect these commissions and
discounts relating to its sales of shares to exceed what is customary in the
types of transactions involved.
In connection with the sale of common stock or interests therein, the Selling
Stockholders may enter into hedging transactions with broker-dealers or other
financial institutions, which may in turn engage in short sales of the common
stock in the course of hedging the positions they assume. To the extent
permitted by the applicable rules of the American Stock Exchange, the Selling
Stockholders may also sell shares of common stock short and deliver these
securities to close out their short positions, or loan or pledge the common
stock to broker-dealers that in turn may sell these securities. The Selling
Stockholders may also enter into option or other transactions with
broker-dealers or other financial institutions or the creation of one or more
derivative securities which require the delivery to such broker-dealer or other
financial institution of shares offered by this prospectus, which shares such
broker-dealer or other financial institution may resell pursuant to this
prospectus (as supplemented or amended to reflect such transaction).
We are required to pay certain fees and expenses incurred by us incident to the
registration of the shares. We have agreed to indemnify the Selling Stockholders
against certain losses, claims, damages and liabilities, including liabilities
under the Securities Act.
Each Selling Stockholder has advised us that it has not entered into any
agreements, understandings or arrangements with any underwriter or broker-dealer
regarding the sale of the resale shares. There is no underwriter or coordinating
broker acting in connection with the proposed sale of the resale shares by the
Selling Stockholders.
We agreed to keep this prospectus effective until the earlier of the date on
which (i) the shares may be resold by the Selling Stockholders without
registration and without regard to any volume limitations by reason of Rule
144(e) under the Securities Act or any other rule of similar effect and (ii) all
of the shares have been sold pursuant to the prospectus or Rule 144 under the
Securities Act or any other rule of similar effect. The resale shares will be
sold only through registered or licensed brokers or dealers if required under
applicable state securities laws. In addition, in certain states, the resale
shares may not be sold unless they have been registered or qualified for sale in
the applicable state or an exemption from the registration or qualification
requirement is available and is complied with.
85
Under applicable rules and regulations under the Exchange Act, any person
engaged in the distribution of the resale shares may not simultaneously engage
in market making activities with respect to our common stock for a period of two
business days prior to the commencement of the distribution. In addition, the
Selling Stockholders will be subject to applicable provisions of the Exchange
Act and the rules and regulations thereunder, including Regulation M, which may
limit the timing of purchases and sales of shares of our common stock by the
Selling Stockholders or any other person. We will make copies of this prospectus
available to the Selling Stockholders, and have informed them of the need to
deliver a copy of this prospectus to each purchaser at or prior to the time of
the sale.
TRANSFER AGENT
The transfer agent and registrar for our common stock is Continental Stock
Transfer & Trust Company, 17 Battery Place, New York, NY 10004. We act as our
own transfer agent for our preferred stock, warrants and stock options.
LEGAL MATTERS
The validity of the common stock being offered hereby is being passed upon for
us by McGuireWoods LLP.
EXPERTS
We appointed BDO Seidman, LLP as our independent registered public accounting
firm for the years ended December 31, 2003 and 2004. The 2003 and 2004 financial
statements included in this prospectus have been audited by BDO Seidman, LLP, to
the extent and for the periods set forth in their report appearing elsewhere
herein and are included in reliance upon such report given upon the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form SB-2 under the Securities Act of 1933, as amended, with
respect to the common stock to be offered hereby. As used herein, the term
"registration statement" means the initial registration statement and any and
all amendments thereto. This prospectus, which is a part of the registration
statement, contains all material information about the contents of any agreement
or other document filed as an exhibit to the registration statement. For further
information with respect to us and our common stock reference is made to the
registration statement, including the exhibits and schedules thereto. Statements
contained in this prospectus concerning the contents of any contract or any
other document contain all material information regarding that contract or other
document but are not necessarily the full text of that contract or document, and
reference is made to such contract or other document filed with the SEC as an
exhibit to the registration statement.
A copy of the registration statement, including the exhibits thereto, may be
inspected without charge at the Public Reference section of the commission at
100 F Street, N.E., Washington, D.C. 20549 and at the following regional offices
of the SEC: Northeast Regional Office, 233 Broadway, New York, New York 10279;
and Midwest Regional Office, 175 W. Jackson Boulevard, Suite 900, Chicago,
Illinois 606041. Copies of the registration statement and the exhibits and
schedules thereto can be obtained from the Public Reference Section of the SEC
upon payment of prescribed fees, or at its web site at http://www.sec.gov.
Our common stock is registered under Section 12 of the Securities Exchange Act
of 1934 as amended, and we are therefore subject to the reporting requirements
of Section 13 of the Securities Exchange Act of 1934, as amended. In accordance
therewith, we file periodic reports with the Securities and Exchange Commission.
Our periodic reports are available for inspection and copying at the public
reference facility.
86
FINANCIAL STATEMENTS
DIOMED HOLDINGS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
DESCRIPTION PAGE
Report of Independent Registered Public Accounting Firm..................................................................F-1
Consolidated Balance Sheets as of December 31, 2004 and 2003.............................................................F-2
Consolidated Statements of Operations for the Years Ended December 31, 2004 and 2003.....................................F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
for the Years Ended December 31, 2004 and 2003.......................................................................F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2004 and 2003.....................................F-7
Notes to Consolidated Financial Statements December 31, 2004 ............................................................F-9
Condensed Consolidated Balance Sheets - September 30, 2005 (unaudited) and December 31, 2004............................F-35
Condensed Consolidated Statements of Operations - Three Months
and Nine Months Ended September 30, 2005 and 2004 (unaudited).......................................................F-36
Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2005 and 2004 (unaudited)...........................................................F-37
Notes to Condensed Consolidated Financial Statements (unaudited)........................................................F-38
F-i
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Diomed Holdings, Inc.
We have audited the accompanying consolidated balance sheets of Diomed Holdings,
Inc. as of December 31, 2004 and 2003, and the related consolidated statements
of operations, stockholders' equity and comprehensive income (loss), and cash
flows for each of the two years in the period ended December 31, 2004. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designating audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. Our audits also included
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Diomed Holdings,
Inc. and subsidiaries at December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted
in the United States of America.
/s/ BDO SEIDMAN, LLP
- ----------------------
Boston, Massachusetts
February 11, 2005
F-1
DIOMED HOLDINGS, INC.
Consolidated Balance Sheets
December 31, 2004 December 31, 2003
----------------- -----------------
Assets
Current assets:
Cash and cash equivalents $14,436,053 $13,398,075
Accounts receivable, net of allowance for doubtful accounts of
$223,105 and $209,167 in 2004 and 2003, respectively 2,074,393 1,437,238
Inventories 2,204,385 1,892,241
Prepaid expenses and other current assets 348,586 449,625
----------- -----------
Total current assets 19,063,417 17,177,179
----------- -----------
Property and equipment:
Office equipment and furniture and fixtures 1,808,062 1,429,409
Manufacturing equipment 839,226 893,335
Leasehold improvements 731,347 731,408
----------- -----------
3,378,635 3,054,152
Less accumulated depreciation and amortization 2,477,066 2,306,424
----------- -----------
Property and equipment, net 901,569 747,728
----------- -----------
Intangible manufacturing asset, net of accumulated amortization of
$809,644 and $613,371 in 2004 and 2003, respectively 171,718 367,991
Intangible EVLT(R) technology asset, net of accumulated amortization
of $391,852 and $97,963 in 2004 and 2003, respectively 4,310,373 4,604,262
----------- -----------
Total intangible assets, net 4,482,091 4,972,253
----------- -----------
Other assets:
Deposits 195,338 183,756
Deferred financing costs, net of accumulated amortization of
$30,477 at December 31, 2004 700,982 --
----------- -----------
Total other assets 896,320 183,756
----------- -----------
Total assets $25,343,397 $23,080,916
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
DIOMED HOLDINGS, INC.
Consolidated Balance Sheets (continued)
December 31, 2004 December 31, 2003
----------------- -----------------
Liabilities and stockholders' equity
Current liabilities:
Bank loan $ -- $ 261,676
Promissory notes payable -- 936,000
Current maturities of capital lease obligations 46,967 13,848
Accounts payable 2,092,562 1,497,541
Accrued expenses 1,847,943 1,838,632
Deferred revenue 359,749 56,802
Current maturities of EVLT(R) technology payable
($1,000,000 face value, net of $66,733 and $35,609
debt discount at December 31, 2004 and 2003,
respectively) 933,267 964,391
------------ ------------
Total current liabilities 5,280,486 5,568,890
Convertible Debt ($7,000,000 face value,
net of $2,183,151 debt discount at December 31, 2004 4,816,849 --
EVLT(R) technology payable ($250,000 face value, net of
$4,902 debt discount at December 31, 2004 and
$1,250,000 face value, net of $173,832 debt discount
at December 31, 2003) 245,098 1,076,168
------------ ------------
Total liabilities 10,342,433 6,645,058
------------ ------------
Commitments and Contingencies
Stockholders' equity:
Preferred stock, $0.001 par value -- --
Authorized-20,000,000 shares; issued and outstanding none
Common stock, $0.001 par value
Authorized-50,000,000 shares and 500,000,000 shares at
December 31, 2004 and 2003, respectively
Issued and outstanding-17,781,525 and 13,129,113 shares
at December 31, 2004 and 2003, respectively 17,781 13,129
Additional paid-in capital 84,226,241 75,582,369
Accumulated other comprehensive income 169,023 175,278
Accumulated deficit (69,412,081) (59,334,918)
------------ ------------
Stockholders' equity 15,000,964 16,435,858
------------ ------------
Total liabilities and stockholders' equity $ 25,343,397 $ 23,080,916
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
DIOMED HOLDINGS, INC.
Consolidated Statements of Operations
Years Ended December 31,
---------------------------------
2004 2003
------------ ------------
Revenues $ 13,384,500 $ 9,198,592
Cost of revenues 7,920,100 5,873,288
------------ ------------
Gross profit 5,464,400 3,325,304
------------ ------------
Operating expenses:
Research and development 1,694,629 849,772
Selling and marketing 7,160,548 4,055,625
General and administrative 6,422,461 4,399,550
------------ ------------
Total operating expenses 15,277,638 9,304,947
------------ ------------
Loss from operations (9,813,238) (5,979,643)
------------ ------------
Interest expense, non-cash 108,725 12,893,718
Interest expense, net, cash-based 155,200 1,007,842
------------ ------------
Total interest expense 263,925 13,901,560
------------ ------------
Net loss $(10,077,163) $(19,881,203)
============ ============
Basic and diluted net loss per share (0.68) (8.99)
============ ============
Basic and diluted weighted average common shares outstanding 14,752,794 2,212,666
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DIOMED HOLDINGS, INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
Years Ended December 31, 2004 and 2003
Class A Convertible
Preferred Stock Class E & F Common Stock
--------------- ----------- ------------
Accumulated
Other
Additional Comprehensive
Number of $0.001 Par Preferred Number of $0.001 Paid-in Income
Shares Value Stock Shares Par Value Capital (Loss)
------ ----- ----- ------ --------- ------- -----------
Balance, December 31, 2002 14,688,662 $ 14,689 -- 600,925 $ 601 $ 41,719,197 $ 158,312
Conversion of Class A Preferred Stock
into common stock (14,688,662) (14,689) -- 587,543 588 14,101 --
Elimination of unamortized debt discount
ascribed to warrants and convertible
notes in December 2002 Interim Financing -- -- -- -- -- (1,278,667) --
Debt discount related to issuance of Class E
Preferred Stock in May 2003
Exchange Transaction -- -- 2,000,000 -- -- --
Debt discount and beneficial conversion
feature related to issuance of Class F
Preferred Stock and Class D Notes in
May 2003 Interim Financing -- -- 240,000 -- -- 960,000
Beneficial conversion feature related to
secured bridge notes issued at September
2003 closing of Equity Financing -- -- -- -- -- 6,995,000
Debt financing cost related to warrants
issued to placement agent at September
2003 closing of Equity Financing -- -- -- -- -- 1,798,579
Issuance of common stock, net of
issuance costs -- -- -- 6,200,000 6,200 14,381,705
Conversion of Class E Notes, including
interest, into common stock -- -- -- 3,562,787 3,563 7,122,010
Conversion of Class D Notes, including
interest, into common stock -- -- -- 499,294 499 1,247,734
Exchange of Class E and Class F Preferred
Stock for common stock -- -- (2,240,000) 1,205,553 1,206 2,238,794
Compensation expense related to issuance
of stock options to consultants
and a service provider -- -- -- -- -- 22,311
Value ascribed to stock options issued in
connection with EVLT patent acquisition -- -- -- -- -- 312,078
Issuance of common stock to a consultant -- -- -- 20,000 20 49,980
Issuance of common stock to Equity
Financing investors as interest
on escrowed funds -- -- -- 13,903 14 (14)
Exercise of warrants by placement agent
and its affiliates -- -- -- 439,108 439 (439)
Total
Accumulated Stockholder's Comprehensive
Deficit Equity Income (Loss)
------------ ------------- -------------
Balance, December 31, 2002 $(39,453,715) $ 2,439,083 $(7,843,156)
===========
Conversion of Class A Preferred Stock
into common stock -- --
Elimination of unamortized debt discount
ascribed to warrants and convertible
notes in December 2002 Interim Financing -- (1,278,667)
Debt discount related to issuance of Class E
Preferred Stock in May 2003
Exchange Transaction -- 2,000,000
Debt discount and beneficial conversion
feature related to issuance of Class F
Preferred Stock and Class D Notes in
May 2003 Interim Financing -- 1,200,000
Beneficial conversion feature related to
secured bridge notes issued at September
2003 closing of Equity Financing -- 6,995,000
Debt financing cost related to warrants
issued to placement agent at September
2003 closing of Equity Financing -- 1,798,579
Issuance of common stock, net of
issuance costs -- 14,387,905
Conversion of Class E Notes, including
interest, into common stock -- 7,125,573
Conversion of Class D Notes, including
interest, into common stock -- 1,248,233
Exchange of Class E and Class F Preferred
Stock for common stock -- --
Compensation expense related to issuance
of stock options to consultants
and a service provider -- 22,311
Value ascribed to stock options issued in
connection with EVLT patent acquisition -- 312,078
Issuance of common stock to a consultant -- 50,000
Issuance of common stock to Equity
Financing investors as interest
on escrowed funds -- --
Exercise of warrants by placement agent
and its affiliates -- --
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
DIOMED HOLDINGS, INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
Years Ended December 31, 2004 and 2003 (continued)
Class A Convertible
Preferred Stock Class E & F Common Stock
--------------- ----------- ------------
Additional
Number of $0.001 Par Preferred Number of $0.001 Paid-in
Shares Value Stock Shares Par Value Capital
------ ----- ----- ------ --------- -------
Comprehensive income (loss):
Foreign currency translation adjustment -- -- -- -- -- --
Net loss -- -- -- -- -- --
Balance, December 31, 2003 -- -- -- 13,129,113 13,129 75,582,369
Exercise of warrants by placement agent
and its affiliates -- -- -- 938,123 938 (938)
Compensation expense related to issuance
of stock options to third parties -- -- -- -- -- 79,449
Issuance of common stock in 2004
Targeting Offering, net of
issuance costs -- -- -- 1,188,470 1,188 2,726,541
Issuance of common stock to 2004 Private
Placement investors, net of
issuance costs -- -- -- 2,362,420 2,363 3,234,446
Debt discount and beneficial conversion
feature related to 2004
Private Placement -- -- -- -- -- 2,261,399
Exercise of warrants by 2004 Private
Placement investor and
its affiliates -- -- -- 163,399 163 342,975
Comprehensive Income (loss):
Foreign currency translation adjustment -- -- -- -- -- --
Net loss -- -- -- -- -- --
------ ------ ----- ---------- ----------- ------------
Balance, December 31, 2004 -- -- -- 17,781,525 $ 17,781 $ 84,226,241
====== ====== ===== ========== =========== ============
Accumulated
Other Total
Comprehensive Accumulated Stockholders' Comprehensive
Income (Loss) Deficit Equity Income (Loss)
----------- ------------ ------------- -------------
Comprehensive income (loss):
Foreign currency translation adjustment 16,966 -- 16,966 16,966
Net loss (19,881,203) (19,881,203) (19,881,203)
------------ ------------ ------------ ------------
Balance, December 31, 2003 175,278 (59,334,918) 16,435,858 (19,864,237)
============
Exercise of warrants by placement agent
and its affiliates
Compensation expense related to issuance
of stock options to third parties -- -- 79,449
Issuance of common stock in 2004
Targeting Offering, net of
issuance costs -- -- 2,727,729
Issuance of common stock to 2004 Private
Placement investors, net of
issuance costs -- -- 3,236,809
Debt discount and beneficial conversion
feature related to 2004
Private Placement -- -- 2,261,399
Exercise of warrants by 2004 Private
Placement investor and
its affiliates -- -- 343,138
Comprehensive Income (loss):
Foreign currency translation adjustment (6,255) -- (6,255) (6,255)
Net loss -- (10,077,163) (10,077,163) (10,077,163)
------------ ------------ ------------ ------------
Balance, December 31, 2004 $ 169,023 $(69,412,081) $ 15,000,964 $(10,083,418)
============ ============ ============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
DIOMED HOLDINGS, INC.
Consolidated Statements of Cash Flows
Years Ended December 31,
---------------------------------
2004 2003
------------ ------------
Cash Flows from Operating Activities: $(10,077,163) $(19,881,203)
Net loss
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 972,900 674,592
Amortization of EVLT(R) discount 137,806 44,913
Non-cash interest expense 108,725 12,893,718
Fair value of stock options for service 79,449 22,400
Changes in operating assets and liabilities:
Accounts receivable (637,155) (760,794)
Inventories (312,144) 119,900
Prepaid expenses and other current assets 101,039 (235,372)
Deposits (11,582) 452,094
Accounts payable 595,021 (111,080)
Accrued expenses and deferred revenue 312,258 394,532
------------ ------------
Net cash used in operating activities (8,730,846) (6,386,300)
------------ ------------
Cash Flows from Investing Activities:
Purchases of property and equipment (519,009) (229,718)
Acquisition of intangible EVLT(R) technology asset -- (2,394,000)
------------ ------------
Net cash used in investing activities (519,009) (2,623,718)
------------ ------------
Cash Flows from Financing Activities:
Proceeds from issuance of common stock, net in 2003
equity financing -- 14,328,364
Proceeds from issuance of common stock, net in 2004
target offering 2,727,729 --
Proceeds from issuance of common stock, net in 2004
equity and debt financing 3,236,809 --
Proceeds from convertible debt 7,000,000 6,995,000
Increase in deferred financing costs (731,459) --
Proceeds from redeemable debt -- 1,200,000
Proceeds from exercise of warrants 343,138 --
Net proceeds (payments) from bank borrowings (261,676) 45,369
Payments on related party debt -- (2,000,000)
Payments on capital lease obligations (54,997) (30,163)
Payments on promissory notes (936,000) (445,208)
Payments on EVLT(R) purchase obligation (1,000,000)
------------ ------------
Net cash provided by financing activities 10,323,544 20,093,362
------------ ------------
Effect of Exchange Rate Changes (35,711) 466,085
------------ ------------
Net Increase in Cash and Cash Equivalents 1,037,978 11,549,429
Cash and Cash Equivalents, beginning of year 13,398,075 1,848,646
------------ ------------
Cash and Cash Equivalents, end of year $ 14,436,053 $ 13,398,075
============ ============
F-7
DIOMED HOLDINGS, INC.
Consolidated Statements of Cash Flows (continued)
Years Ended December 31,
-----------------------------
2004 2003
----------- -----------
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 180,481 $ 228,134
========== ==========
Equipment under capital lease $ 88,116 $ --
========== ==========
Value ascribed to debt discount related to redeemable debt $ -- $1,200,000
========== ==========
Value ascribed to debt discount related to related party debt $ -- $ 721,333
========== ==========
Value ascribed to debt discount related to convertible debt $2,261,399 $6,995,000
========== ==========
Value ascribed to stock options issued in connection
with acquisition of EVLT Technology $ -- $ 312,078
========== ==========
Debt associated with EVLT Technology acquisition $ -- $2,245,647
========== ==========
Value ascribed to common stock issued to a consultant $ -- $ 50,000
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2004
(1) OPERATIONS
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
obtaining exclusive commercial arrangements, gaining governmental approvals in
advance of others, developing and offering innovative practice enhancement
programs including physician training and promotional materials. To optimize
revenues, the Company focuses on clinical procedures that generate revenues from
both capital equipment and disposable products, such as procedure kits and
optical fibers.
The Company'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.
In 2001, the Company 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, the Company was 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, the Company was the first
company to receive Food and Drug Administration ("FDA") clearance for endovenous
laser treatment of the greater saphenous vein. In December 2004, the Company
received FDA clearance to expand the application of EVLT(R) to other superficial
veins in the lower extremities.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements reflect the application of
certain accounting policies as described below and elsewhere in these notes to
consolidated financial statements.
(a) Principles of Consolidation
These financial statements include the accounts of the Company and its wholly
owned subsidiaries. All significant intercompany transactions have been
eliminated.
(b) Basis of Presentation
All share and per share information included in the accompanying financial
statements for all periods presented have been restated to retroactively reflect
the effect of the 1:25 reverse stock split that the Company implemented,
effective June 17, 2004.
(c) Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
accompanying notes. Estimates and assumptions principally relate to reserves,
including inventory, doubtful accounts receivable, and product warranty. Actual
results could differ from those estimates.
(d) Cash and Cash Equivalents
Cash and cash equivalents consists of short-term, highly liquid investments with
original maturity dates of 90 days or less.
F-9
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(e) Foreign Currency Translation
Assets and liabilities of the foreign subsidiary are translated at the rate of
exchange in effect at year-end. Results of operations are translated using the
weighted average exchange rate in effect during the year. Translation
adjustments, resulting from changes in the rate of exchange between the
subsidiary's functional currency and the U.S. dollar, are included in other
comprehensive income (loss) with the cumulative effect included as a separate
component of stockholders' equity in the accompanying consolidated balance
sheets. Transaction gains and losses, resulting from the revaluations of assets
and liabilities denominated in other than the functional currency of the Company
or its subsidiaries, are included in operating expenses for all periods
presented.
(f) Revenue Recognition
Revenue from product sales is recognized when title passes to the customer, as
long as there is persuasive evidence of an arrangement, the sales price is fixed
and determinable and collection of the related receivable is reasonably assured.
The Company provides for estimated product returns and warranty costs at the
time of product shipment. In December 1999, the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 101, Revenue
Recognition in Financial Statements, which establishes guidance in applying
generally accepted accounting principles to revenue recognition in financial
statements. In December 2003, the SEC published SAB No. 104, Revenue
Recognition, which supersedes and rescinds the accounting guidance contained in
SAB No. 101 related to multiple-element revenue arrangements that was superseded
by EITF Issue No. 00-21 Revenue Arrangements with Multiple Deliverables. The
Company has determined that its existing revenue recognition practices comply
with the requirements of SAB No. 104 for all periods presented.
(g) 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:
December 31,
2004 2003
---------- ----------
Raw materials $ 838,390 $ 856,886
Work-in-progress 502,905 456,934
Finished goods 863,090 578,421
---------- ----------
$2,204,385 $1,892,241
========== ==========
(h) Property and Equipment
The Company records property and equipment at cost. The Company provides for
depreciation and amortization using the straight-line method by charges to
operations in amounts that allocate the cost of the assets over their estimated
useful lives as follows:
Description Useful Life
- ----------- -----------
Office equipment and furniture and fixtures 2-5 years
Manufacturing equipment 2-5 years
Leasehold improvements Lesser of estimated useful
life or life of lease
F-10
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Depreciation expense for the years ended December 31, 2004 and 2003 was $482,739
and $380,357, respectively.
(i) Intangible Assets
Intangible assets are recorded at cost and consist of manufacturing rights
acquired in 2001 and the EVLT(R) patent rights acquired in September 2003 (Note
15). The manufacturing rights are being amortized over a five-year estimated
useful life. Amortization expense relating to these manufacturing rights of
approximately $197,000 for each of the years ended December 31, 2004 and 2003,
is included in general and administrative expense. The EVLT(R) patent rights are
being amortized over the remaining 16-year life of the patents, and amortization
expense relating to the EVLT(R) patent rights of $294,000 and $98,000 is
included in the cost of goods sold for the years ended December 31, 2004 and
2003, respectively.
(j) Long Lived Assets
The Company evaluates long-lived assets, such as intangible assets, equipment
and leasehold improvements, for impairment in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. The Company records an impairment charge
whenever events or changes in circumstances indicate that the carrying amount of
the assets may not be recoverable through the estimated undiscounted future cash
flows from the use of these assets. When any such impairment exists, the related
assets are written down to fair value. The Company did not incur any impairments
in the years ended December 31, 2004 and 2003.
(k) Fair Value of Financial Instruments
The carrying amounts of the Company's cash, cash equivalents, accounts
receivable and accounts payable approximate fair value due to the short-term
nature of these instruments. The carrying amounts of debt issued pursuant to
agreements with banks' capital lease obligations and various debt instruments
approximate fair value as the interest rates on these instruments fluctuate with
market interest rates.
(l) Concentration of Credit Risk and Significant Customers
Financial instruments that subject the Company to credit risk primarily consist
of cash, cash equivalents and trade accounts receivable. The Company places its
cash and cash equivalents in established financial institutions. The Company has
no significant off-balance-sheet concentration of credit risk such as foreign
exchange contracts, options contracts or other foreign hedging arrangements. The
Company has not experienced any significant losses related to receivables from
any individual customers or groups of customers in any specific industry or by
geographic area.
Accounts receivable are customer obligations due under normal trade terms. The
Company sells its products to private physicians, hospitals, health clinics,
distributors and OEM customers. The Company generally requires signed sales
agreements, non-refundable advance payments, although collateral is generally
not required, and purchase orders depending upon the type of customer. Letters
of credit may be required in certain circumstances. Some customers seek
equipment financing from third party leasing agents, which the Company is not
party to and bears no credit risk. Accounts receivable is stated at the amount
billed to the customer less a valuation allowance for doubtful accounts. Senior
management reviews accounts receivable on a monthly basis to determine if any
receivables could potentially be uncollectible. The Company includes specific
accounts receivable balances that are determined to be uncollectible in its
overall allowance for doubtful accounts. After all attempts to collect a
receivable have failed, the receivable is written off against the allowance.
Based on available information, the Company believes its allowance for doubtful
accounts as of December 31, 2004 is adequate. The allowance for doubtful
accounts as of December 31, 2004 and 2003 was $223,105, and $209,167,
respectively.
No customers accounted for greater than 10% of total revenues in 2004. One
customers accounted for greater than 10% of accounts receivable in 2004. No
customers accounted for greater than 10% of total revenues or gross accounts
receivable in 2003.
F-11
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(m) 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
fair market price of the Company's stock at the date of the fixed grant over the
amount an employee must pay to acquire the stock. SFAS No. 123, Accounting for
Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, 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 pro forma effects on
net loss and loss per share as if SFAS No. 123 had been adopted as well as
certain other information. (See Note 8d)
The pro forma effect of applying SFAS No. 123 in 2004 and 2003 is as follows:
December 31,
2004 2003
-------------- --------------
Net loss as reported $ (10,077,163) $ (19,881,203)
Less: total stock-based employee compensation expense
determined under the fair value-based method
for all awards, net of tax
(700,487) (381,816)
-------------- --------------
Pro forma net loss $ (10,777,650) $ (20,263,019)
============== ==============
Loss per share:
Basic and diluted - as reported $ (0.68) $ (8.99)
Basic and diluted - pro forma $ (0.73) $ (9.16)
(n) Research and Development Expenses
The Company charges research and development expenses to operations as incurred.
(o) Comprehensive Income (Loss)
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 nonowner sources. For all
periods presented, comprehensive loss consists of the Company's net loss and
changes in cumulative translation adjustment account. The Company has disclosed
comprehensive income (loss) for all periods presented in the accompanying
consolidated statements of stockholders' equity and comprehensive income (loss).
(p) Income Taxes
The Company follows the provisions of SFAS No. 109, Accounting for Income Taxes.
Deferred income taxes are provided on temporary differences that arise in the
recording of transactions for financial and tax reporting purposes and result in
deferred tax assets and liabilities. Deferred tax assets are reduced by an
appropriate valuation allowance if, in management's judgment, it is more likely
than not that the deferred tax asset will not be realized. Tax credits are
accounted for as reductions of the current provision for income taxes in the
year in which the related expenditures are incurred.
(q) Other 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 is
effective for the Company in the first interim period beginning after December
15, 2005.
F-12
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
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.
(3) 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 weighted average number of dilutive potential common
shares outstanding. As a result of the losses incurred by the Company for the
years ended December 31, 2004 and 2003, all potential common shares were
antidilutive and thus were excluded from the diluted net loss per share
calculations.
The following table summarizes securities outstanding, adjusted for the 1 for 25
reverse split effective June 17, 2004, as of each year-end which were not
included in the calculation of diluted net loss per share since their inclusion
would be antidilutive.
December 31,
------------
2004 2003
--------- ---------
Common stock options 1,076,318 222,343
Convertible debt 3,056,769 (A) --
Common stock warrants 2,991,263 (C) 1,196,838 (B)
(A) On October 25, 2004, in connection with the 2004 private placement equity
and debt financing discussed in Note 16, the Company issued $7,000,000 in
convertible notes. These notes are convertible at a rate of $2.29 per share.
(B) On September 3, 2003, in connection with the equity financing discussed in
Note 14, the Company issued securities to pay the fees of the placement agent
that it engaged in April 2003 to assist in obtaining financing. In lieu of
paying this fee in cash, the Company issued to the placement agent $495,000 in
secured bridge notes plus warrants to purchase up to 1,635,163 shares of common
stock. Of these warrants, 701,663 warrants have an exercise price of $0.025 per
share, 247,500 warrants have an exercise price of $2.00 per share and 686,000
warrants have an exercise price of $2.50 per share. These warrants are
exercisable for five years. Additionally, the warrants issued to the placement
agent were subject to an anti-dilution adjustment for future equity investments.
This adjustment was triggered on October 25, 2004, and as such the warrants with
exercise prices of $2.00 were adjusted to $1.93 and 7,588 additional warrants
were issued, and the warrants with exercise prices of $2.50 were adjusted to
$2.32 and 48,145 additional warrants were issued. Pursuant to its agreement with
Sunrise, on October 25, 2004 the Company also issued warrants to purchase an
additional 73,539 shares of common stock, at an exercise price of $2.01 per
share because, under the April 2003 agreement with Sunrise, the Company agreed
to pay Sunrise commissions for subsequent sales of securities made to
participants in the 2003 financing within one year of the termination of that
agreement. As of December 31, 2004, a total of 1,625,120 of the warrants issued
to Sunrise, as adjusted for anti-dilution and commission, had been exercised and
139,315 warrants were unexercised and remained outstanding.
Warrant holders who exercised their warrants to date have used the cashless
exercise feature of these warrants. As a result of the cashless exercise, the
warrant holders did not pay cash for the exercise price of the warrants, and as
a result, the Company was not required to issue the full amount of shares
underlying the warrants exercised. For example, as of December 31, 2004, the
Company issued a total of 1,377,231 shares of common stock upon exercise of the
1,625,120 warrants.
F-13
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(C) On October 25, 2004, in connection with the 2004 Private Placement equity
and debt financing discussed in Note 16, the Company issued 3,013,671 warrants
to investors. These warrants have an exercise price of $2.10 per share. These
warrants are exercisable for five years. On December 1, 2004, a total of 163,399
of these warrants with an exercise price of $2.10 per share were exercised, for
which the Company issued a total of 163,399 shares of common stock.
(4) ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31,
------------------------
2004 2003
---------- ----------
Payroll and related costs $ 498,335 $ 461,863
Warranty and related costs 343,845 462,154
Professional fees 861,953 776,864
Other 143,810 137,751
---------- ----------
$1,847,943 $1,838,632
========== ==========
(5) LINE-OF-CREDIT ARRANGEMENT
Diomed, Ltd., the Company's subsidiary in the United Kingdom, has a line of
credit with Barclays Bank, which is limited to the lesser of (BPS)100,000 or 80%
of eligible accounts receivable. This line bears interest at 3% above Barclays
Bank's base rate (4.75% at December 31, 2004) and borrowings are due upon
collection of receivables from customers. As security for the line of credit,
Barclays has a lien on all of the assets of Diomed, Ltd., excluding inventory
and certain intellectual property. As of December 31, 2004 there were no amounts
outstanding under this line. As of December 31, 2003, there were borrowings of
(BPS) 146,663 ($261,676) outstanding under this line.
(6) DEBT
a) Promissory Note Issued to Customer
In October 2000, a customer, Axcan Pharma, Inc., advanced the Company $936,000
to secure certain key materials. In September 2001, the Company issued a
Promissory Note to this customer in the amount of the advance. The Promissory
Note bore interest, at an annual rate of 8.5%, which is payable quarterly in
arrears. The Promissory Note had a maturity date of January 1, 2004 and did not
provide for conversion rights into equity. As of December 31, 2003, the
principal amount and accrued interest under this Promissory Note was $936,000
and $20,053, respectively. On January 2, 2004, the Company fully repaid the
Promissory Note and accrued interest in accordance with its terms.
b) Secured Bridge Notes - September 3, 2003
On September 2, 2003, the Company entered into agreements that provide Equity
Financing with 119 Investors who agreed to purchase 10,177,500 shares of Common
Stock for an aggregate purchase price of $23,200,000. Twenty-two million dollars
of the aggregate purchase price was payable in cash, and $1,200,000 was paid by
conversion of the Company's Class D notes at the second closing. (See Note 14)
At the first closing of the Equity Financing, the Company issued $6,995,000 in
principal amount of Secured Bridge Notes (the "Secured Bridge Notes"), which
accrued interest at an annual rate of 8% and were convertible into 3,497,500
shares of common stock at $2.00 per share. The Secured Bridge Notes were
convertible upon favorable stockholder approval of the Equity Financing at the
annual meeting held on November 25, 2003. The Secured Bridge Notes were secured
by a security interest in collateral that included the Company's rights to U.S.
Patent No. 6,398,777 and related foreign patents for endovenous laser treatment
of varicose veins (the "EVLT Patent"). These patents relate to the technology
that the Company acquired on September 3, 2003 underlying the Company's EVLT(R)
product line (See Note 15) and the security interest previously granted to
secure the Class E Notes due January 1, 2006 that the Company had previously
issued (See Note 8). The Class E Notes were fully paid at the first closing of
the Equity Financing in advance of the January 1, 2006 maturity date to increase
the collateral available for the Secured Bridge Notes.
F-14
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Under the terms of the Equity Financing, at the second closing on November 25,
2003, the aggregate principal amount of the Secured Bridge Notes converted into
3,497,500 shares of Common Stock at a purchase price of $2.00 per share. Also,
on November 25, 2003, the Company issued an additional 65,287 shares of Common
Stock to pay accrued interest in the amount of $130,573 on the Secured Bridge
Notes. Of the Secured Bridge Notes, $6,500,000 in aggregate principal amount was
issued at the first closing in exchange for a purchase price equal to $6,500,000
paid in cash. Gibralt U.S. and the other three holders of the Company's Class E
notes purchased $2,000,000 of Secured Bridge Notes at $2.00 per share, the same
price as paid by the other Investors who purchased Secured Bridge Notes. Each of
the other Investors who subscribed to purchase securities in the Equity
Financing purchased on a pro rata basis $4,500,000 in aggregate principal amount
of the Secured Bridge Notes. The Company also issued $495,000 in principal
amount of the Secured Bridge Notes to the placement agent in partial payment of
its fee.
The Company recognized a beneficial conversion feature in the amount of
$6,995,000, upon favorable stockholder approval of the Equity Financing at the
annual meeting held on November 25, 2003, with a corresponding increase in
additional paid-in capital. This discount was fully amortized to non-cash
interest expense when the Secured Bridge Notes converted to equity. The net
impact on stockholders' equity was zero when the net loss, including the
amortization of the discount, was fully reflected in the accumulated deficit.
In connection with the first closing, the Company incurred $651,923 in placement
agent and legal fees, including a $495,000 fee due to be paid in cash that the
placement agent invested in the Secured Bridge Notes. These costs were
capitalized as deferred financing costs and were being amortized to interest
expense over the life of the notes, such that the full amount of costs was
amortized by the earlier of the maturity date of the notes or by the month the
notes were converted into equity. For the year ended December 31, 2003, the
Company recognized $651,923 in interest expense pertaining to the amortization
of the deferred financing costs, and accordingly, the balance of the deferred
financing costs was zero as of December 31, 2003.
In connection with the first closing, the Company recognized an additional
placement agent fee, in the amount of $1,798,579, for 247,500 warrants issued to
a placement agent. The fee was recorded as a deferred financing cost upon
stockholder approval of the Equity Financing on November 25, 2003, with a
corresponding increase in additional paid-in capital. The deferred financing
cost was fully amortized to interest expense in the period in which the Secured
Bridge Notes converted to equity. The net impact on stockholders' equity was
zero when the net loss, including the deferred financing cost, was fully
reflected in the accumulated deficit.
c) EVLT(R) Technology Acquisition - September 3, 2003
On September 3, 2003, the Company acquired rights to the EVLT Patent, which
relates to the technology underlying the Company's EVLT(R) product line. On
September 3, 2003, the Company paid Endolaser Associates $1,500,000 in cash in
exchange for the exclusive license and agreed to make additional payments
totaling $2,500,000 in 10 quarterly installments of $250,000 each, commencing in
the fourth quarter of 2003. The Company recorded a liability in the amount of
$2,500,000, net of a $254,000 discount based on an annual interest rate of 8%,
to reflect the imputed interest on the liability. The discount is being
amortized to interest expense over the period of the additional installment
payments. The Company has made five quarterly installments totaling $1,250,000
since acquiring the rights. Accordingly, at December 31, 2004, the remaining
liability was $1,250,000 net of debt discount of $72,000. (See Note 15)
F-15
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
d) Private Placement Equity and Debt Financing Entered into on September 28,
2004
On October 25, 2004, the Company completed the Private Placement Equity and Debt
Financing entered into on September 28, 2004 and discussed in Note 17. In
connection with the financing, the Company issued $7,000,000 in debt which is
convertible into common shares at $2.29 per share. The Company also issued
warrants to purchase 1,832,461 shares of common stock to investors who purchased
the convertible debt. Accordingly, the Company recorded a debt discount of
$2,261,000 in relation to the convertibility feature of the debt and the fair
value of the warrants using the Black Scholes option pricing model. The discount
is being amortized to non-cash interest expense over the term of the notes, such
that the full amount of the discount will be amortized by the earlier of the
maturity date of the notes or the conversion of the notes to equity. The net
impact on stockholders' equity will be zero when the net loss, including the
amortization of the discount, is fully reflected in the accumulated deficit.
Accordingly, the notes were originally recorded at net value of $4,738,601
(after the $2,261,399 discount). In the year ended December 31, 2004, $78,248
was recognized in non-cash interest expense pertaining to this amortization of
the discount. The balance of the notes at December 31, 2004 was $4,816,849, net
of unamortized debt discount of $2,183,151.
e) Capital Equipment Leases
Leased assets included in property and equipment primarily include manufacturing
equipment. Depreciation expense for leased equipment during the years ended
December 31, 2004 and 2003 was $12,238 and $36,823, respectively.
Future minimum debt payments required under these arrangements at December 31,
2004 are as follows:
Capital Leases Debt
-------------- ----------
2005 $ 47,967 $1,000,000
2006 -- 250,000
2007 -- --
2008 -- 7,000,000
==========
Total future minimum lease payments $ 47,967 $8,250,000
==========
Less - Amount representing interest $ 1,000
----------
Present value of future minimum lease payments 46,967
Less - Current portion of capital lease obligations 46,967
----------
Capital lease obligations, net of current portion $ --
==========
(7) INCOME TAXES
No provision for foreign, federal or state income taxes has been recorded, as
the Company incurred net operating losses for all periods presented for all
jurisdictions in which it operates. The Company has U.S. federal and state net
operating loss carryforwards of approximately $27,000,000 at December 31, 2004
to reduce future federal income taxes, if any. These carryforwards expire
through 2024 and are subject to review and possible adjustment by the Internal
Revenue Service (IRS). The Company also has approximately $23,000,000 of foreign
net operating loss carryforwards at December 31, 2004 to reduce future foreign
income taxes, if any. These carryforwards do not have an expiration date.
F-16
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
The Tax Reform Act of 1986 contains provisions that may limit the amount of U.S.
federal and state net operating loss and credit carryforwards that the Company
may utilize in any one year in the event of certain cumulative changes in
ownership over a three-year period in excess of 50%, as defined. The Company
believes that its equity financing completed on November 25, 2003 and its equity
and debt financing completed on October 25, 2004 may have triggered a change in
ownership which, in turn, may limit the utilization of net operating loss
carryforwards in future years.
The approximate tax effects of temporary differences that give rise to
significant portions of the Company's deferred tax assets primarily relate to
net operating loss carryforwards and amount to approximately $18,269,000 and
$12,740,000 as of December 31, 2004 and 2003, respectively. It is the Company's
objective to become a profitable enterprise and to realize the benefits of its
deferred tax assets. However, in evaluating the realizability of these deferred
tax assets, management has considered the Company's short operating history, the
volatility of the market in which it competes and the operating losses incurred
to date, and believes that, given the significance of this evidence, a full
valuation reserve against its deferred tax assets is required as of December 31,
2004 and 2003. The components of the Company's deferred tax assets are
approximately as follows:
December 31,
-----------------------------
2004 2003
------------ ------------
Net operating loss carryforwards $ 18,000,000 $ 12,600,000
Other temporary differences 269,000 140,000
Valuation allowance (18,269,000) (12,740,000)
------------ ------------
Net deferred tax asset $ -- $ --
============ ============
(8) STOCKHOLDERS' EQUITY
(a) Issuance of Diomed Holdings, Inc. Class A Convertible Preferred Stock ("Old
Class A Stock") in Diomed Merger
On February 14, 2002, Diomed Acquisition Corp. ("Acquisition"), a Delaware
corporation and a wholly-owned subsidiary of Diomed Holdings, Inc., a Nevada
corporation formerly known as Natexco Corporation, merged with and into Diomed,
Inc. (the "Merger") pursuant to an Agreement and Plan of Merger, dated as of
January 29, 2002.
Pursuant to the Merger agreement, Diomed Holdings issued (references to common
stock are without adjustment for the 1:25 reverse split effective June 17,
2004):
- - 2,328,922.50 shares of its Old Class A Stock to the former holders of Diomed,
Inc. common stock in exchange for 9,315,690 shares of common stock of Diomed,
Inc. issued and outstanding as of the effective time of the Diomed Merger, which
2,328,922.50 shares were convertible into 9,315,690 shares of Diomed Holdings
common stock; and
- - 1,362,500 of its Old Class A Stock to the former holders of 2,725,000 shares
of Diomed, Inc. Series A Preferred Stock issued and outstanding as of the
effective time of the Merger. These shares were convertible into 5,450,000
shares of Diomed Holdings common stock.
On October 24, 2002, the Company's registration statement was declared effective
by the Securities and Exchange Commission.
On December 31, 2002, according to the Class A Convertible Preferred Stock
Certificate of Designation, monthly conversions of the Company's Class A
Convertible Preferred Stock ("Class A Stock") began converting into Common Stock
at the rate of 5% of the initial shares of the Class A Stock or 773,087 shares,
and were to continue to occur on the last day of each month during the period
from January 2003 through January 2004. The remaining 4,638,531 shares of Class
A Stock were to convert in February 2004.
F-17
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Because the board of directors determined that the effect of the incremental
conversion of Class A Stock into common stock would impair the Company's ability
to procure additional equity investments, pursuant to its discretion under the
terms of the Class A Stock, the board voted to convert the remaining outstanding
shares of Class A Stock into common stock on March 31, 2003, and accordingly,
zero shares of Class A Stock are outstanding at December 31, 2004 and 2003.
(b) Bridge Financings with Related Parties
(i) On December 27, 2002, the Company completed a $2,000,000 bridge note
financing with Gibralt U.S., Inc. an affiliate of Samuel Belzberg, a former
director of the Company (the "December 2002 noteholder" and, together with the
three persons to whom Gibralt U.S. subsequently transferred $500,000 of the
notes, the "December 2002 noteholders"). The financing included $1,000,000 in
Class A secured notes and $1,000,000 in Class B unsecured notes due January 1,
2004. The notes accrued interest at an annual rate of 8%, payable upon maturity.
The notes were convertible into common stock at the election of the December
2002 noteholders upon the occurrence of: (i) a financing transaction, (ii) a
liquidity event, (iii) a merger or reorganization, or (iv) at any time during
the life of the notes, at the election of the holders of at least 66 2/3% of the
outstanding principal amount of the notes. The notes, including principal and
accrued interest, were convertible into common stock at 80% of the common stock
price at the time of conversion.
As additional consideration for the financing, the Company issued to the
December 2002 noteholders warrants to purchase 333,334 shares of common stock.
The warrants were exercisable for a period of five years beginning June 27, 2003
at an exercise price of $6.50, which represented 110% of the market price of the
stock on December 26, 2002. If, prior to the exercise of the warrants, the
Company issued common stock or common stock equivalents at a price per share
less than the exercise price of the warrants, the number of warrants and the
exercise price of the warrants were to be adjusted to the lower price per share.
In the event of a merger or reorganization, the warrants were convertible into
the kind and number of shares of common stock, other securities or property into
which the warrants would have been converted if the warrants had been converted
into common stock based on the provisions of the merger or reorganization.
The December 2002 noteholders had the right to designate a member to the
Company's Board of Directors while the notes were outstanding. The Company was
required to obtain the advance approval by the December 2002 noteholders for
future financing transactions during the life of the notes.
On March 18, 2003, the initial December 2002 noteholder sold and transferred to
three investors in a private transaction (i) $500,000 aggregate principal amount
of notes ($250,000 of which were Class A notes and $250,000 of which were Class
B notes) and (ii) warrants to purchase 83,334 shares of common stock.
Accordingly, after taking this transfer into account, the initial December 2002
noteholder owned $1,500,000 aggregate principal amount of notes ($750,000 of
which were Class A notes and $750,000 of which were Class B notes) and warrants
to purchase 250,000 shares of common stock.
The Company recognized the $2,000,000 fair value of the warrants and the
beneficial conversion feature related to the immediate convertibility of the
notes as a discount to the notes, with a corresponding increase in additional
paid in capital. The value ascribed to the warrants was approximately
$1,200,000, as calculated using the Black-Scholes option pricing model, and the
value ascribed to the beneficial conversion feature of the notes was $800,000.
The discount was to be amortized over the term of the notes to non-cash interest
expense, such that the full amount of the discount would be amortized by the
earlier of the maturity date of the notes or conversion of the notes to equity.
The net impact on stockholders' equity was to be zero when the net loss,
including the amortization of the discount, was fully reflected in the
accumulated deficit. Accordingly, the notes were originally recorded at net
value of zero (after the $2,000,000 discount). For the year ended December 31,
2003, $721,000 was recognized in non-cash interest expense pertaining to this
amortization of the discount prior to the May 2003 exchange transaction
discussed below.
F-18
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
In connection with the bridge financing, the Company incurred $80,000 in related
legal fees. As of December 31, 2002, these costs were capitalized as deferred
financing costs and were to be amortized to interest expense over the life of
the notes, such that the full amount of costs were amortized by the earlier of
the maturity date of the notes or by the month the notes were converted into
equity. The Company expensed the balance of the deferred financing costs upon
completion of the May 2003 exchange transaction. For the year ended December 31,
2003, the Company recognized $80,000 in interest expense pertaining to
amortization of the deferred financing costs, and, accordingly, the balance of
the deferred financing costs was zero as of December 31, 2003.
(ii) During the first quarter of 2003, it became clear that the Company would
require additional working capital. In April 2003, the Company began discussions
with Gibralt U.S. with a view to its providing interim financing in addition to
the interim financing that it had provided in December 2002. The Company also
began to consider a subsequent financing expected to begin later in the quarter
to address its longer term capital needs. In late April, the Company elected to
obtain up to $1,200,000 of interim financing from Gibralt U.S. and two of its
directors. At the same time, the Company proposed a restructuring of the
securities issued in December 2002 to improve its access to financial markets
and enhance the likelihood of a subsequent financing. Therefore, the Company
offered to repurchase certain rights from the December 2002 noteholders that, in
light of then-current market conditions, might have made it more difficult to
successfully complete a subsequent financing.
Using the Black Scholes valuation methodology, the Company calculated the
monetary value of the rights of the December 2002 noteholders to convert their
notes into shares of common stock and the monetary value of the common stock
purchase warrants. The Company further engaged Marshall & Stevens, Incorporated,
a professional valuation firm, to provide an opinion as to the valuations that
it had calculated. The price per share that the Company employed to calculate
the number of shares equal to the monetary value of the rights that the December
2002 noteholders would be surrendering was the presumed price per share of its
common stock after giving effect to the issuance of those shares.
At the time the Class A secured notes and Class B unsecured notes were issued,
the Company could not issue more than $1,000,000 in secured debt without
obtaining prior approval by its preferred stockholders under the terms of its
Class A Stock. On March 31, 2003, the Company converted all of its Class A Stock
into common stock to eliminate its convertibility feature and its apparent
negative impact on the Company's ability to obtain additional financing. On May
7, 2003, the December 2002 noteholders exchanged their $1,000,000 principal
amount of secured Class A notes and $1,000,000 principal amount of unsecured
Class B notes for $2,000,000 principal amount of secured Class C notes due
January 1, 2004. On May 7, 2003, the Company issued to the December 2002
noteholders 20 shares of its Class C Preferred Stock, which was convertible into
1,084,690 shares of common stock, in exchange for eliminating the convertibility
feature of the $2,000,000 principal amount of notes and the warrants to purchase
333,334 shares of common stock, as well as certain other rights. The Class C
Preferred Stock was exchanged for Class E Preferred Stock on August 22, 2003.
(See Note 13)
(iii) On May 7, 2003, Gibralt U.S. and two of the Company's directors, James A.
Wylie, Jr. and Peter Norris (the "May 2003 noteholders"), committed to provide
financing of up to $1,200,000 in the form of Class D secured notes due May 6,
2004. The Company issued the May 2003 noteholders an aggregate of 24 shares of
Class D Preferred Stock, which was convertible into 120,863 shares of common
stock. The Class D Preferred Stock was exchanged for Class F Preferred Stock on
August 22, 2003. (See Note 13) The Class D notes accrued interest at an annual
rate of 8%, payable upon maturity. As of July 7, 2003, the entire $1,200,000 in
interim financing had been funded. The May 2003 noteholders had the same
security interest and registration rights granted to the December 2002
noteholders.
The May 2003 noteholders had the right to participate in the Company's financing
contemplated for the second half of 2003 on the same terms and conditions as the
new investors by redeeming their notes. In determining the price at which the
Company sold its notes, an independent committee of the board of directors
considered the added risk that the May 2003 noteholders would be accepting in
light of the uncertainty of the completion of the contemplated financing. The
December 2002 notes provided that the corresponding noteholders had the right to
participate in the next financing of the Company at a 20% discount to the price
to be paid by investors. Using this discount factor as a benchmark for assessing
the risk that the May 2003 noteholders would be assuming, among other factors,
the independent committee authorized the issuance of preferred shares
convertible into 120,863 shares of common stock, allocated according to the
noteholder's respective loan commitments.
F-19
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(iv) On May 28, 2003, the Company and the December 2002 noteholders amended
certain of the terms of the May 7, 2003 capital restructuring to: (i) extend the
due date of the Class C notes from January 1, 2004 until January 1, 2006, (ii)
increase the rate of interest payable on the Class C notes from 8.0% to 12.5%,
(iii) provide for mandatory prepayments of principal of the Class C notes in
amounts up to 50% of positive quarterly cash flow, (iv) limit the security
interest in inventory that secures the Class C notes at $3,271,000, (v) waive
the noteholders' right of approval of future financing transactions and (vi)
extend the deadline by which the financing was to be completed without
triggering the noteholders' right of rescission, from June 30, 2003 to July 31,
2003 (under the terms of the restructuring if the contemplated financing were
not completed by July 31, 2003 the December 2002 noteholders had the right to
rescind the May 7, 2003 exchange transaction). On July 31, 2003, the deadline by
which the financing was to be completed without triggering the noteholders'
right of rescission was extended until November 15, 2003. On August 22, 2003,
the Class C notes were exchanged for Class E notes reflecting these modified
terms in principal amounts equal to the principal amounts of the Class C notes
exchanged. The Class E notes were repaid in full with a portion of the proceeds
from the first closing of the equity financing.
The exchange of debt and preferred stock for the elimination of warrants and
modification of the December 2002 notes in May 2003 was treated as an
extinguishment of the $2,000,000 debt. As a result, the fair market value of the
warrants and other consideration, which was limited to the remaining unamortized
discount on the December 2002 notes, was recorded as a reduction in additional
paid in capital in the amount of $1,167,000 and the remaining unamortized
discount was reduced to zero.
The Company recognized the $2,000,000 fair value of the preferred stock issued
with the Class E notes, which was recorded as a discount to the notes, with the
offset as an increase in preferred stock. The discount was to be amortized over
the term of the notes to non-cash interest expense, such that the full amount of
the discount was to be amortized by the earlier of the maturity date of the
notes or early retirement of the notes. The net impact on stockholders' equity
was to be zero when the net loss, including the amortization of the discount,
was fully reflected in the accumulated deficit. Accordingly, the notes were
originally recorded at net value of zero (after the $2,000,000 discount). On
September 3, 2003 the notes were fully retired in advance of their January 1,
2006 maturity date in order to expand the collateral available to the holders of
the September Secured Bridge Notes while the Company obtained stockholder
approval to complete the Equity Financing. (See Notes 6b and 14) In the year
ended December 31, 2003, $2,000,000 was recognized in non-cash interest expense
pertaining to this amortization of the discount.
(v) On May 28, 2003, the Company and the May 2003 noteholders amended certain of
the terms of the May 7, 2003 interim financing to: (i) add a requirement that
100% of the Class D notes be redeemed into common stock in the contemplated
financing at the same price per share and on the same terms as the new investors
if the Company raises $6,000,000 or more in gross proceeds and (ii) extend the
deadline for completion of the contemplated financing without triggering the
right of the May 2003 noteholders to declare the Class D notes due and payable
to July 31, 2003. On July 31, 2003, this date was further extended to November
15, 2003. On August 21, 2003, this deadline was extended to the business day
following any date after November 15, 2003, which the Company and the Investors
in the Equity Financing agree to as the second closing date. At the second
closing of the Equity Financing on November 25, 2003, the $1,200,000 in Class D
notes and accrued interest in the amount of $48,233 were converted into 499,294
shares of common stock at $2.50 per share. (See Note 14)
The Company recognized a $240,000 discount to the Class D Notes for the fair
value of the preferred stock, which was recorded as a discount to the notes,
with a corresponding increase in preferred stock. The discount was to be
amortized over the term of the notes to non-cash interest expense, such that the
full amount of the discount was amortized by the earlier of the maturity date of
the Class D notes or by the month the Class D notes were converted into equity.
The net impact on stockholders' equity/(deficit) was zero when the net loss,
including amortization of the discount, was fully reflected in accumulated
deficit. In the year ended December 31, 2003, the Company recognized $240,000 in
non-cash interest expense pertaining to amortization of the discount.
F-20
The Company recognized a beneficial conversion feature in the amount of
$960,000, which was recorded as a discount to the notes, upon favorable
stockholder approval of the equity financing at the annual meeting held on
November 25, 2003, with a corresponding increase in additional paid in capital.
This discount was fully amortized to non-cash interest expense in the period in
which the Class D notes converted to equity. The net impact on stockholders'
equity was zero when the net loss, including the amortization of the discount,
was fully reflected in the accumulated deficit.
In connection with the interim financing, the Company incurred $51,000 in
related legal fees. These costs were capitalized as deferred financing costs and
were amortized to interest expense over the life of the Class D notes, such that
the full amount of costs were amortized by the earlier of the maturity date of
the Class D notes or by the period the Class D notes were converted into equity.
In the year ended December 31, 2003, the Company recognized $51,000 in interest
expense pertaining to this amortization of the deferred financing costs, and,
accordingly, the balance of the deferred financing costs were zero as of
December 31, 2003.
(c) Common Stock
The figures below are adjusted to give effect to the 1:25 reverse split
effective June 17, 2004 for the number of shares of common stock, price per
share, options and warrants.
In February 2002, the Company issued 200,000 shares of its Common Stock, $0.001
par value per share, at a price of $50.00 per share in a private placement
financing in connection with the Diomed Merger, resulting in proceeds net of
offering costs of $7,900,000.
After the Migratory Merger on May 13, 2002 in which the Company reincorporated
from Nevada to Delaware (See Note 12), the Company had authorized 80,000,000
shares of Common Stock, $0.001 par value, of which 568,000 shares are
outstanding (excluding securities which may be converted into or exercisable for
Common Stock), having been automatically issued to the holders of the Common
Stock issued by Diomed Holdings Nevada by virtue of the Migratory Merger.
Under the Merger agreement, the Company was obligated to use its best efforts to
file a registration statement with the Securities Exchange Commission to
register for resale common shares that it issued in the private placement
offering and common shares that it issued to former stockholders, and to cause
the registration statement to be declared effective. In the event that the
Company failed to file or cause the registration statement to be declared
effective within 240 days of completing the Merger or remain effective through
the first anniversary of the Merger, the Company was required to issue
additional shares of its common stock, up to a maximum of 4% of the shares held
by each of the February 2002 private placement investors. On October 24, 2002,
the Company received approval of its registration statement by the Securities
and Exchange Commission and accordingly issued the February 2002 private
placement investors an additional aggregate of 2,000 shares of Common Stock.
On December 31, 2002, according to the Class A Convertible Preferred Stock
Certificate of Designation, monthly conversions of the Company's Class A Stock
began converting into Common Stock at the rate of 5% of the initial shares of
the Class A Stock or 773,087 shares, and were to continue to occur on the last
day of each month during the period from January 2003 through January 2004. The
remaining 4,638,531 shares of Class A Stock were to convert in February 2004.
As of December 31, 2002, the Company had authorized 80,000,000 shares of Common
Stock, $0.001 par value, of which 15,023,087 (600,923 after giving effect to the
1:25 reverse split implemented June 17, 2004) shares were outstanding.
Because the board of directors determined that the effect of the incremental
conversion of Class A Stock into common stock would impair the Company's ability
to procure additional equity investments, pursuant to its discretion under the
terms of the Class A Stock, the board determined to cause the remaining
outstanding shares of Class A Stock to convert into common stock on March 31,
2003.
F-21
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
As of March 31, 2003, the Company had 1,188,470 shares of common stock
outstanding and zero shares of Class A Stock outstanding.
On May 7, 2003, the Company issued Class C Preferred Stock to the holders of the
notes and warrants it had issued in December 2002 in exchange for certain
modifications to those notes and warrants including the redelivery of the
warrants to the Company for cancellation. These shares of Class C Preferred
Stock were convertible into 1,084,690 shares of common stock upon satisfaction
of certain conditions. The modifications to the notes included eliminating the
convertibility feature of the notes and eliminating the noteholders' right to
approve a future financing transaction.
On May 7, 2003, the Company also issued $1,200,000 in Class D notes to Gibralt
U.S., Inc. (an affiliate of a director, Samuel Belzberg, to which the Company
issued $1,100,000 principal amount notes) and to two directors (James A. Wylie,
Jr. and Peter Norris, to each of whom the Company issued $50,000 principal
amount of notes). The Company issued these notes in exchange for loan
commitments made by these noteholders. The Company also issued to these
noteholders Class D Preferred Stock as a prepaid discount to recognize that the
loan commitments were expected to be converted into equity in a future equity
financing transaction that the Company then contemplated, and to reflect the
risk that the equity financing transaction might not occur. These shares of
Class D Stock were convertible into a total of 120,863 shares of common stock
upon satisfaction of certain conditions. The notes were convertible into the
securities to be issued in the contemplated equity financing on the same terms
as applied to the other investors in the equity financing.
On August 22, 2003, the Company exchanged the Class C Preferred Stock for an
equal number of shares of Class E Preferred Stock, and exchanged the Class D
Preferred Stock for an equal number of shares of Class F Preferred Stock. The
Company exchanged these shares of preferred stock in accordance with the
stipulation of settlement it entered into to settle the Augenbaum class action
lawsuit that was filed in late July 2003. That lawsuit claimed, among other
things, that the Class C Preferred Stock and Class D Preferred Stock was not
permitted to be, by its terms, convertible into common stock. Accordingly,
although the Company denied the allegations in the lawsuit, to reach a
settlement amicably, the Company created the Class E and Class F Preferred Stock
and performed the preferred stock exchange. The Class E and F Preferred Stock is
not by its terms convertible into common stock. However, by a separate agreement
between the Company and the holders of the Class E and F Preferred Stock, upon
the satisfaction of certain conditions, the Company would issue 1,084,690 shares
of common stock in exchange for the Class E Preferred Stock and would issue
120,863 shares of common stock in exchange for the Class F Preferred Stock.
On September 2, 2003, the Company entered into definitive agreements for an
equity financing. Pursuant to these agreements, on September 3, 2003, the
investors in the equity financing funded $6,500,000 in the form of secured
bridge loans. The $1,200,000 principal amount of Class D notes the Company
issued in May 2003 converted into common stock at the final closing of the
equity financing on November 25, 2003. The secured bridge notes converted into
common stock at $2.00 per share at the final closing, the investors purchased
$15,500,000 of common stock for $2.50 per share and the $1,200,000 in Class D
notes and accrued interest on these notes were purchased for common stock for
$2.50 per share.
On September 3, 2003, in connection with the equity financing, the Company
issued securities to pay the fees of the placement agent that it had engaged in
April 2003 to assist in obtaining the financing that was needed. In lieu of
paying this fee in cash, the Company issued to the placement agent $495,000 in
secured bridge notes plus warrants to purchase up to 1,635,163 shares of common
stock. Of these warrants, 701,663 warrants have an exercise price of $0.025 per
share, 247,500 warrants have an exercise price of $2.00 per share and 686,000
warrants have an exercise price of $2.50 per share. These warrants are
exercisable for five years.
On November 25, 2003, the Company held the final closing of its equity
financing, pursuant to which the Company issued a total of 10,262,081 shares of
common stock to the investors in the equity financing. (See Note 14) In
connection with the final closing of the equity financing, the Company also
exchanged all outstanding Class E Preferred Stock for a total of 1,084,690
shares of common stock and exchanged all outstanding Class F Preferred Stock for
a total of 120,863 shares of common stock, as provided by the August 2003
exchange agreement.
F-22
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Additionally, the Company issued 20,000 shares of common stock to Verus Support
Services, Inc. in connection with an agreement entered into on September 30,
2003 to issue these shares in lieu of accrued cash payments due under the
December 2001 agreement with Verus.
The Company agreed to register the common stock issued in the equity financing
and the common stock underlying the warrants issued to the placement agent for
resale to the public with the Securities Exchange Commission, and accordingly,
filed the resale registration statement on December 3, 2003. On February 10,
2004, the Company's registration statement was declared effective by the
Securities and Exchange Commission.
On December 3, 2003 and December 8, 2003, a total of 440,403 of the September 3,
2003 warrants with an exercise price of $0.025 per share were exercised, for
which the Company issued a total of 439,108 shares of common stock. Because the
warrant holders used the cashless exercise feature of the warrants, they did not
have to pay the exercise price in cash and the Company issued fewer than the
total number of warrants exercised.
On December 18, 2003, in connection with the equity financing, the Company
issued an additional 13,903 shares of common stock to those investors who paid
cash for their shares at the final closing of the equity financing, as they were
entitled to either receive the interest that was earned on their funds while
held in escrow or to receive shares in lieu of this interest, as determined by
the placement agent. At the placement agent's election, the Company received
approximately $35,000 in interest from the escrow agent on December 18, 2003,
and then issued the additional shares to the investors at a price of $2.50 per
share.
On November 25, 2003, the number of authorized shares of Common Stock were
increased from 80,000,000 to 500,000,000, $0.001 par value, in order to enable
the issuance of shares in connection with the equity financing.
As of December 31, 2003, the Company had authorized 500,000,000 shares of common
stock, $0.001 par value, of which 13,129,113 (giving effect to the 1:25 reverse
split effective June 17, 2004) shares were outstanding. The number of authorized
shares of common stock was later reduced to 50,000,000 in connection with the
1:25 reverse split effective June 17, 2004.
On April 20, 2004, the Company completed its offering to those persons who held
shares of its common stock as of August 29, 2003, raising the approximate $3.0
million maximum in additional equity financing. The targeted offering, for
1,188,470 shares of the Company's common stock at $2.50 per share (after giving
effect to the 1:25 reverse split effective June 17, 2004), allowed stockholders
to purchase one share of the Company's common stock for each share of common
stock held on August 29, 2003. The targeted offering also included an
"over-subscription right" which allowed stockholders to purchase additional
shares to the extent the "basic rights" were not fully subscribed. The Company
filed a registration statement to register the shares to be offered to the
stockholders as of August 29, 2003 (the "targeted offering"). The SEC declared
that registration statement effective on February 13, 2004.
On October 25, 2004, the Company completed the private placement equity and debt
financing entered into on September 28, 2004 as discussed in Note 16, resulting
in net proceeds of approximately $9.8 million. In connection with this
financing, the Company issued 2,362,420 shares of common stock and $7,000,000 in
convertible debt, along with warrants to purchase up to 3,013,671 shares of
common stock at an exercise price of $2.10. During 2004, holders of 163,399
warrants exercised these warrants, at an exercise price of $2.10 per share.
Accordingly, the Company issued 163,399 shares of common stock to these warrant
holders and received $343,138 in aggregate proceeds. Subsequent to year-end
2004, the holders of $3,288,000 principal amount of debentures elected to
convert these debentures (including accrued interest of approximately $31,108)
into common stock at $2.29 per share, and accordingly the Company issued
1,449,392 shares of common stock to these debenture holders. Also, subsequent to
year-end 2004, the holders of 192,811 warrants exercised their warrants at an
exercise price of $2.10 per share, and accordingly the Company received proceeds
of $404,903.
Additionally, the warrants issued to the placement agent in the 2003 equity
financing were subject to an anti-dilution adjustment for future equity
investments. This adjustment was triggered on October 25, 2004 and, as such, the
warrants with exercise prices of $2.00 were adjusted to $1.93 and 7,588
additional warrants were issued, and the warrants with exercise prices of $2.50
were adjusted to $2.32 and 48,145 additional warrants were issued. Pursuant to
the agreement with the placement agent, on October 25, 2004 the Company also
issued warrants to purchase an additional 73,539 shares of common stock, at an
exercise price of $2.01 per share, because the Company agreed to pay the
placement agent commissions for sales of securities within one year of the
termination of the agreement with Sunrise that was made to investors who
participated in the 2003 equity financing. During the year ended December 31,
2004, a total of 1,184,719 of the warrants issued to this placement agent, as
adjusted for anti-dilution and commission, had been exercised and 938,123
shares were issued. Because the placement agent used the cashless exercise
feature of the warrants, they did not have to pay the exercise price in cash and
the Company issued fewer than the total number of warrants.
F-23
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
As of December 31, 2004, the Company had authorized 50,000,000 shares of Common
Stock, $0.001 par value, of which 17,781,525 shares were outstanding.
(d) Stock Options
The figures below are adjusted to give effect to the 1:25 reverse split
effective June 17, 2004.
In November 1998 and May 2001, the Company's Board of Directors approved the
1998 Incentive Plan (the 1998 Plan) and the 2001 Stock Option Plan (the 2001
Plan) (collectively, the Plans), respectively, permitting the granting of stock
options to employees, directors, consultants and advisors, which may be either
incentive stock options or nonqualified options and stock awards. The Board had
reserved 30,000 and 70,000 shares of Common Stock for issuance under the 1998
Plan and the 2001 Plan, respectively.
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. 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 December 31, 2004, 619,529 options and other incentive stock awards were
available for future grants under the 2003 Omnibus Plans. In addition, 27,076
options were available under the 1998 Plan and 23,732 options were available
under the 2001 Plan as of December 31, 2004.
A summary of stock option activity is as follows:
Range of Number of Shares Weighted Average
Exercise Price Exercise Price
------------------- ----------------- -----------------
Outstanding, December 31, 2003 $8.50 - $205.75 64,132 $ 72.50
Granted 2.00 - 11.50 174,224 7.00
Forfeited 8.25 - 156.00 (16,013) 47.50
Outstanding, December 31, 2004 $2.00 - 205.75 222,343 25.00
Granted 2.50 - 6.75 954,470 3.86
Forfeited 5.00 - 138.00 (100,495) 10.38
------------------- ----------------- -----------------
Outstanding, December 31, 2004 $2.00 - 205.75 1,076,318 $ 8.12
=================== ================= =================
Exercisable December 31, 2003 $2.00 - 205.75 123,946 $ 34.50
Exercisable December 31, 2004 $2.00 - 205.75 439,887 $ 13.09
=================== ================= =================
The following table summarizes information relating to currently outstanding and
exercisable options as of December 31, 2004.
F-24
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
OUTSTANDING EXERCISABLE
-----------------------------------------------------------------
Remaining Weighted Average Weighted Average
Exercise Price Shares Life* Exercise Price Shares Exercise Price
$ 2.00 - $ 11.50 1,036,383 9.02 $ 4.94 402,720 $ 5.52
26.00 - 50.00 18,256 6.82 35.32 15,650 36.02
56.25 - 88.50 4,531 1.55 66.40 4,369 66.78
100.00 - 164.00 16,508 2.55 153.05 16,508 153.05
$201.25 - $205.75 640 1.15 205.75 640 205.75
--------- --------- ------- ----------
1,076,318 $ 8.12 439,887 $ 13.09
========= ========= ======= ==========
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions used for
grants during the applicable period:
December 31,
--------------------------
2004 2003
---------- ----------
Risk-free interest rate 1.74-3.21% 1.74-3.37%
Expected dividend yield --% --%
Expected lives 5 years 5 years
Expected volatility 75% 75%
Weighted average grant date fair
value per share $3.86 $4.50
Weighted average remaining
contractual life of options
outstanding 8.8 years 8.5 years
(e) Issuance of Stock Options to Consultants
In fiscal 2003, the Company granted fully exercisable options to purchase 2,565
shares of common stock at exercise prices per share in the range of $4.25 to
$11.00 to two consultants in exchange for marketing services. The Company
recorded the fair value of such options, based on the Black-Scholes option
pricing model, as stock-based compensation expense totaling $9,011 in the
statement of operations for year ended December 31, 2003.
In fiscal 2003, the Company granted options to purchase 4,000 shares of common
stock at an exercise price per share of $11.50 to a service provider for legal
services. The Company recorded the fair value of such options, based on the
Black-Scholes option pricing model, as stock-based compensation expense totaling
$13,300 in the statement of operations for year ended December 31, 2003.
On September 3, 2003, the Company acquired rights to the EVLT Patent, which
relates to the technology underlying the Company's EVLT(R) product line. As part
of the transaction, the Company entered into an agreement with Dr. Robert Min
pursuant to which the Company granted Dr. Min options to purchase 40,000 shares
of Common Stock. The Company recorded the fair value of these options in the
amount of $312,078 based on the Black-Scholes option pricing model and
capitalized this cost as part of the related intangible asset that will be
amortized over the remaining life of the EVLT Patent. The amortization of the
intangible asset is being recorded as a component of cost of goods sold. (See
Note 15)
In fiscal year 2004, the Company granted options to purchase 32,672 shares of
common stock at exercise prices per share in the range of $2.02 to $6.75 in
exchange for services. The Company recorded the fair value of such options based
on the Black-Scholes option pricing model, as stock-based compensation expense
totaling $79,449 in the statement of operations for year ended December 31,
2004.
F-25
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(f) Warrants
A summary of warrant activity for the years ended December 31, 2004 and 2003 is
as follows:
Weighted Average
Remaining
Range of Number of Weighted Average Contractual
Exercise Price Shares Exercise Price Life (In Years)
----------------------------------------------------------------------------
Outstanding, December 31, 2002 $6.50 - 87.50 338,210 $ 7.25 5.40
Exchanged 6.50 (333,333) 6.50 5.50
Granted to Placement Agent* 0.025 - 2.50 1,635,163 1.25 5.00
Exercised by Placement Agent* 0.025 (440,402) -- --
Forfeited 50.00 (2,800) 50.00 --
----------------- --------------- ------------------ -----------------
Outstanding, December 31, 2003 $0.025 - $87.50 1,196,838 $ 2.00 4.90
Granted to Placement Agent* 1.92 - 2.35 129,272 2.18 4.82
Granted to Other Investors** 2.10 3,013,671 2.10 4.82
Exercised by Placement Agent* 0.025 - 2.50 (1,184,719) 0.03 --
Exercised by Other Investors** 2.10 (163,399) 2.10 --
Forfeited 50.00 (400) 50.00 --
----------------- --------------- ------------------ -----------------
Outstanding, December 31, 2004 $0.025 - $87.50 2,991,263 $ 2.18 4.82
================= =============== ================== =================
Exercisable December 31, 2003 $0.025 - $87.50 1,196,838 $ 2.00 4.90
================= =============== ================== =================
Exercisable December 31, 2004 $0.025 - $87.50 2,991,263 $ 2.18 4.82
================= =============== ================== =================
* See Note 3B.
** See Note 3C.
9) VALUATION AND QUALIFYING ACCOUNTS
A summary of the allowance for doubtful accounts is as follows:
December 31,
------------------------
2004 2003
--------- ---------
Allowance for doubtful accounts:
Balance, beginning of period $ 209,167 $ 308,145
Provision for doubtful accounts 48,652 44,890
Write-offs (34,714) (143,868)
--------- ---------
Balance, end of period $ 223,105 $ 209,167
========= =========
10) SEGMENT REPORTING
The Company follows SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, which establishes standards for reporting information
regarding operating segments in annual financial statements and requires
selected information for those segments to be presented in interim financial
reports issued to stockholders. SFAS No. 131 also establishes standards for
related disclosures about products and services and geographic areas.
F-26
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
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 accounting policies of the segments are
the same as those described in Note 2. 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:
December 31,
--------------------------
2004 2003
----------- -----------
Laser systems $ 7,838,768 $ 5,726,225
Fibers, accessories and service 5,545,732 3,472,367
----------- -----------
Total $13,384,500 $ 9,198,592
=========== ===========
The following table represents percentage of
revenues by geographic destination:
December 31,
---------------
2004 2003
---- ----
North America 66% 63%
Asia/Pacific 21% 20%
Europe 11% 15%
Other 2% 2%
--- ---
Total 100% 100%
=== ===
The following table represents long-lived assets
by geographic location:
December 31,
-------------------------
2004 2003
---------- ----------
North America $5,769,521 $5,300,029
Europe 510,459 603,708
---------- ----------
Total $6,279,980 $5,903,737
========== ==========
F-27
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
11) OTHER COMMITTMENTS
(a) Leases
The Company leases certain equipment and office facilities under noncancelable
operating and capital leases that expire at various dates through 2014. The
Company's building lease at its subsidiary in the United Kingdom is a 25-year
lease through 2024. However, the Company has an option, at its election, to
terminate the lease agreement after 15 years in 2014 and again in 5 more years
in 2019. If the Company chooses not to exercise these options, the lease
agreement continues for the remaining years through 2024. The Company has
elected to sublease a portion of the UK Facility. Subsequent to year-end, the
Company renewed the U.S. headquarters lease and expanded the leased space
through February 2008. Total rent expense under these operating lease agreements
for the years ended December 31, 2004 and 2003 net of sublease income was
$524,160, and $476,585, respectively.
Future minimum payments required under these operating leases at December 31,
2004 are as follows:
Operating
Leases
-------------
2005 $ 589,653
2006 579,351
2007 579,351
2008 579,351
2009 579,351
Thereafter 2,510,519
-------------
Total operating leases $ 5,417,576
=============
(b) Litigation
From time to time, the Company is involved in legal and administrative
proceedings and claims of various types. While any litigation contains an
element of uncertainty, management, in consultation with the Company's general
counsel, presently believes that the outcome of each such other 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.
(c) Employment Agreement with Certain Officers
Effective December 28, 2003, the Company entered into an employment agreement
with James A. Wylie, Jr. the Company's chief executive officer. This agreement
supercedes the Company's January 10, 2003 employment agreement with Mr. Wylie,
and extends his employment by one year from December 31, 2004 until December 31,
2005. The December 28, 2003 employment agreement provides for an annual base
salary of $330,000 (commencing January 1, 2004), an award of options to purchase
up to 108,000 shares of common stock and certain bonus compensation. Effective
February 15, 2005, the terms of Mr. Wylie's employment agreement were modified
by (i) extending the term of employment through December 31, 2007 for an annual
base salary of $355,000, (ii) providing that in the event of termination by the
Company without cause or by Mr. Wylie for good reason, the Company will pay an
amount equal to either his base compensation for the remainder of the term or 12
months, whichever is greater and (iii) clarifying that Mr. Wylie will be able to
terminate his employment agreement upon not less than 90 days' notice for
reasons other than good reason, in which case the Company will not be required
to pay severance.
David Swank became a director in March 2003 and served on the Audit Committee of
the Company's Board of Directors from that time until September 1, 2003, when
the Company appointed Mr. Swank as chief financial officer, on a consulting
basis. The Company's agreement with Mr. Swank provided for six month renewable
terms, commencing September 3, 2003. Mr. Swank's current monthly base
compensation is $16,700. Effective February 15, 2005, the Company amended its
agreement with Mr. Swank by (i) extending the term of employment through
December 31, 2005, and (ii) providing Mr. Swank with severance pay in the event
of termination without cause, equal to the lesser of Mr. Swank's compensation
for the 12 months or for the balance of the then-current term of his agreement,
subject to compliance with certain non-competition and non-solicitation
obligations.
F-28
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Kevin Stearn became general manager of Diomed, Ltd., the Company's wholly-owned
subsidiary in the U.K., in February 2000. Mr. Stearn's current annual base
salary is BPS 96,000. Effective February 15, 2004, the Company amended the terms
of Mr. Stearn's employment by providing Mr. Stearn with severance pay in the
event of termination without cause, equal to 12 months base salary, subject to
compliance with certain non-competition and non-solicitation obligations.
John Welch became vice president, North American marketing, in October 2002. Mr.
Welch's current annual base salary is $175,000. Effective February 15, 2004, the
Company amended the terms of Mr. Welch's employment by providing Mr. Welch with
severance pay in the event of termination without cause, equal to 12 months base
salary, subject to compliance with certain non-competition and non-solicitation
obligations.
Christopher Geberth became vice president, finance in April 2004. Mr. Geberth's
current annual base salary is $125,000. Effective February 15, 2004, the Company
amended the terms of Mr. Geberth's employment by providing Mr. Geberth with
severance pay in the event of termination without cause, equal to 12 months base
salary, subject to compliance with certain non-competition and non-solicitation
obligations.
Cary Paulette became vice president, North American sales, in December 2004. Mr.
Paulette's current annual base salary is $175,000. Effective February 15, 2004,
the Company amended the terms of Mr. Paulette's employment by providing Mr.
Paulette with severance pay in the event of termination without cause, equal to
12 months base salary, subject to compliance with certain non-competition and
non-solicitation obligations.
(d) Other
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.
(12) MERGER AND PRIVATE OFFERING OF COMMON STOCK
The Company is a corporation originally formed under the laws of the State of
Nevada on March 3, 1998 under the name Natexco Corporation. On February 11,
2002, the Company changed its name from Natexco Corporation to Diomed Holdings,
Inc. On February 14, 2002, the Company acquired Diomed, Inc. in a merger. Under
the terms of the merger, the Company issued Class A Preferred Stock to the
former stockholders of Diomed, Inc. These shares of Class A Preferred Stock have
since converted into Common Stock, and no Class A Stock remains outstanding. As
a result of the merger, Diomed, Inc. became a wholly-owned subsidiary of the
Company. The merger was accounted for as a recapitalization. Accordingly, the
historical records of Diomed, Inc. became the historical records of Natexco and,
after the merger, the Company. After the merger, the business conducted by the
Company was the business conducted by Diomed, Inc. prior to the merger.
Concurrently with the merger, the Company issued 200,000 shares of Common Stock
in a private placement offering at a price of $50.00 per share (amounts adjusted
to reflect the 1:25 reverse split effective June 17, 2004), resulting in gross
proceeds to the Company of $10,000,000 from the private offering. The common
stock issued in this private offering were not subject to refund, redemption or
rescission and, accordingly, were included as a component of stockholders'
equity, net of applicable costs. The Company registered the shares of Common
Stock issued in the private offering with the SEC in a registration statement
that the SEC declared effective on October 24, 2002.
After the merger, the board of directors of the Company determined that it was
in the best interests of the Company and its stockholders for the Company to
change its state of incorporation from Nevada to Delaware. On May 13, 2002,
after obtaining stockholder approval, the reincorporation was effected by a
migratory merger, and the Company is now a Delaware corporation.
The Merger was accounted for as a recapitalization. Costs of approximately
$2,100,000 related to the issuance of the Company's shares in the private
placement financing and to its preparation and negotiation of the documentation
for the Merger were paid by the Company. These costs were offset against
paid-in-capital within stockholders equity in the year ended December 31, 2002.
F-29
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
(13) EXCHANGE OF CLASS C AND CLASS D CONVERTIBLE PREFERRED
On July 28, 2003, the Company was named as a defendant in a class action
lawsuit, Augenbaum v. Diomed Holdings, Inc. On August 6, 2003, the Company
entered into a stipulation of settlement to resolve this suit. The stipulation
of settlement became final on October 15, 2003.
In connection with the stipulation of settlement, on August 22, 2003, the
Company entered into an agreement with the holders of the Class C Preferred
Stock by which the holders tendered all 20 shares of Class C Preferred Stock in
exchange for an equal number of shares of Class E Preferred Stock, and the
Company entered into an agreement with the holders of the Class D Preferred
Stock by which the holders tendered all 24 shares of Class D Preferred Stock for
an equal number of shares of Class F Preferred Stock. The Class E Preferred
Stock and the Class F Preferred Stock entitle the holders to one vote per share.
Following the exchange of Class C Preferred Stock for Class E Preferred Stock
and Class D Preferred Stock for Class F Preferred Stock, both the Class C
Preferred Stock and Class D Preferred Stock were eliminated.
Following stockholder approval of the issuance of shares of Common Stock to be
issued in exchange for the Class E Preferred Stock and Class F Preferred Stock,
the Company had the right to purchase from the holders of the Class E Preferred
Stock, and the holders of the Class E Preferred Stock were obligated to sell,
all 20 shares of Class E Preferred Stock in exchange for 1,084,690 shares of
Common Stock, and the Company had the right to purchase from the holders of the
Class F Preferred Stock, and the holders of the Class F Preferred Stock were
obligated to sell, all 24 shares of Class F Preferred Stock in exchange for
120,863 shares of Common Stock. Upon a sale, lease, exchange or other
disposition of all or substantially all of the Company's assets, the holders of
the Class E Preferred Stock and Class F Preferred Stock had the right to tender
all shares of their preferred stock in exchange for the corresponding numbers of
shares of Common Stock noted above.
Shares of Class E Preferred Stock and Class F Preferred Stock were preferred in
liquidation to the extent that before any distribution was made to the holders
of Common Stock, there must be a distribution to the holders of the Class E
Preferred Stock in the amount of $108,469 per share of Class E Preferred Stock
and a distribution to the holders of the Class F Preferred Stock in the amount
of $10,072 per share of Class F Preferred Stock. The holders of Common Stock
share pro rata in the remainder of the net liquidation proceeds. On November 25,
2003, in connection with the final closing of the equity financing discussed in
Note 14, the Company exchanged all outstanding Class E Preferred Stock for a
total of 1,084,690 shares of common stock and exchanged all outstanding Class F
Preferred Stock for a total of 120,863 shares of common stock, as provided by
the August 2003 exchange agreement.
(14) PRIVATE PLACEMENT EQUITY FINANCING ENTERED INTO SEPTEMBER 2, 2003
On September 2, 2003, the Company entered into a private placement equity
financing transaction with accredited investors who agreed to purchase common
stock for an aggregate purchase price of $23,200,000. The terms of this
transaction provided that the equity financing would occur at two closings. The
first closing occurred on September 3, 2003. At that time, the investors funded
$6,500,000 in cash to the Company in exchange for $6,500,000 principal amount of
secured convertible bridge notes. At the second closing on November 25, 2003,
the $6,500,000 principal amount of notes was converted into a total of 3,250,000
shares of common stock at a conversion price of $2.00 per share and the
investors invested the remaining $16,700,000 of the equity financing in exchange
for common stock at a purchase price of $2.50 per share.
The investors who participated in the first closing of the equity financing
included the four holders of the Company's $2,000,000 principal amount of Class
E Secured Notes due 2006, which the Company issued in connection with a bridge
financing transaction in December 2002. At the first closing, these noteholders
invested an aggregate of $2,000,000. These noteholders were (i) Gibralt U.S.,
Inc., an affiliate of one of the Company's former directors, Samuel Belzberg,
which held $1,500,000 of the Class E Notes and purchased $1,500,000 of the
secured bridge notes, (ii) Morris Belzberg, a cousin of Samuel Belzberg, who
held $300,000 of the Class E Notes and purchased $300,000 of the secured bridge
notes, (iii) Charles Diamond, who held $100,000 of the Class E Notes and
purchased $100,000 of the secured bridge notes and (iv) Steven Schraiberg, who
held $100,000 of the Class E Notes and purchased $100,000 of the secured bridge
notes. At the time of the first closing, the Company repaid all of the Class E
Notes.
F-30
Of the $16,700,000 invested at the second closing of the equity financing,
$15,500,000 was paid by the investors in cash. The Company also converted the
Class D Secured Notes due 2004, which were issued in connection with a bridge
financing transaction in May 2003, for the remaining $1,200,000 of common stock.
The holders of the Class D Notes were, at the time of the May 2003 bridge
financing, directors, or affiliates of directors. These three Class D holders
are Gibralt U.S., Inc., which is an affiliate of Samuel Belzberg (the holder of
$1,100,000 in principal amount of Class D Notes); James A. Wylie, Jr. (the
holder of $50,000 in principal amount of Class D Notes); and Peter Norris (the
holder of $50,000 principal amount of Class D Notes). The Company issued a total
of 10,259,921 shares of common stock to the 119 investors (including the
placement agent and the holders of the Class D Notes) on November 25, 2003 at
the final closing of the equity financing, including 499,294 shares that were
issued on conversion of the Class D Notes.
In connection with the Equity Financing, the Company issued warrants to purchase
up to 1,635,163 shares of Common Stock to its placement agent, including 701,663
warrants at an exercise price of $0.025, 247,500 warrants at an exercise price
of $2.00 and 686,000 warrants at an exercise price of $2.50. The warrants issued
to the placement agent are exercisable for five years beginning upon approval by
stockholders of the Equity Financing at the annual meeting. The placement agent
also participated as an investor in the Equity Financing by reinvesting $495,000
of its fee in exchange for Secured Bridge Notes convertible into 247,500 shares
of Common Stock. The original agreement with the placement agent provided that
the Company pay the placement agent a cash fee equal to 10% of the funds it
raised in a financing and issue to the placement agent warrants to purchase
shares of Common Stock equal to 10% of the aggregate number of shares of Common
Stock that were purchased by the Investors in the Equity Financing.
As of September 3, 2003, the agreement with the placement agent had been amended
to raise the maximum amount of the financing approved by the board of directors
to $23,200,000 and to provide for the deposit of all of the Investors' funds
into an escrow pending the second closing. The Company further agreed that it
would pay the cash portion of the fee due to the placement agent in connection
with the Equity Financing in securities rather than in cash. The placement agent
agreed to reinvest its financing fee, and the parties agreed that they would
calculate the financing fee on the total amount invested in the Company,
exclusive of amounts to be invested by the holders of the Class D notes and the
Class E notes, but inclusive of the amount the placement agent reinvested.
As of December 31, 2003, the Company incurred approximately $3,650,000 in
placement agent, legal and other fees in connection with the Equity Financing,
including $1,798,579 in non-cash charges and $1,851,000 in cash-based fees. In
connection with the first closing, the Company incurred $651,923 in placement
agent and legal fees, including the fee due to be paid in cash to the placement
agent in the amount of $495,000 that the placement agent invested in the Secured
Bridge Notes. These costs were capitalized as deferred financing costs and were
being amortized to general interest expense over the life of the notes, such
that the full amount of costs was amortized by the earlier of the maturity date
of the notes or by the month the notes were converted into equity. In the year
ended December 31, 2003, the Company recognized $651,923 in general interest
expense pertaining to this amortization of the deferred financing costs, and
accordingly, the balance of the deferred financing costs were zero as of
December 31, 2003.
In connection with the first closing, the Company recognized an additional
placement agent fee, in the amount of $1,798,579, for 247,500 warrants issued to
a placement agent. The warrant fee was recorded as a deferred financing cost
upon favorable stockholder approval of the Equity Financing on November 25,
2003, and was fully amortized to general interest expense in the period in which
the Secured Bridge Notes converted to equity, with a corresponding increase in
additional paid in capital. The net impact on stockholders' equity was zero when
the net loss, including the deferred financing cost, was fully reflected in the
accumulated deficit.
In connection with the second closing, the Company incurred approximately
$1,200,000 in legal and other fees through December 31, 2003. These costs were
capitalized as deferred offering costs and were recorded as an offset against
additional paid in capital in stockholders equity upon completion of the second
closing of the Equity Financing.
F-31
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
The Company entered into a registration rights agreement providing for the
Company to register with the Securities and Exchange Commission the shares
purchased by the investors and the shares underlying the warrants issued to the
placement agent for resale to the public. The registration rights agreement
required the Company to file a registration statement for these shares within 5
days after the completion of the Equity Financing, and accordingly the Company
filed the resale registration statement on December 3, 2003. On February 10,
2004, the Company's registration statement was declared effective by the
Securities and Exchange Commission.
(15) ACQUISITION OF EXCLUSIVE EVLT(R) TECHNOLOGY
On September 3, 2003, the Company acquired exclusive rights to U.S. Patent No.
6,398,777 and related foreign patents and patent applications for endovenous
laser treatment of varicose veins. These patents relate to the technology
underlying the Company's EVLT(R) procedure. This acquisition resulted from two
transactions.
In the first transaction, the Company purchased the interest in the EVLT(R)
patent owned by one of its five named inventors, Dr. Robert J. Min. This
transaction was completed under a purchase agreement between the Company and Dr.
Min entered into on July 23, 2003, after the satisfaction of the conditions
precedent to the closing of the purchase agreement. On September 3, 2003, the
Company paid the purchase price of $500,000 in cash and issued options to
purchase 40,000 (adjusted to give effect to the 1:25 reverse split effective
June 17, 2004) shares of common stock in exchange for Dr. Min's assignment to
the Company of his interest in the EVLT(R) patent. The Company also agreed to
pay to Dr. Min variable payments based on the Company's future sales of EVLT(R)
products. Dr. Min had previously licensed the EVLT(R) patent to the Company and
had served as a consultant to Diomed. Dr. Min is expected to continue to act as
a consultant to Diomed under a consulting agreement.
In the second transaction, the Company licensed, on an exclusive basis, the
EVLT(R) patent from Endolaser Associates, LLC, the assignee of interest in the
EVLT(R) patent from the other four named inventors. This transaction was
completed under a license agreement between the Company and Endolaser Associates
entered into on July 11, 2003, after the satisfaction of the conditions
precedent to the taking effect of the license agreement. On September 3, 2003,
the Company paid Endolaser Associates $1,500,000 in cash in exchange for the
exclusive license granted by Endolaser Associates. The Company is to make
additional payments totaling $2,500,000 in 10 quarterly installments of $250,000
each, commencing in the fourth quarter of 2003, and accordingly the Company
recorded a liability in the amount of $2,500,000 net of a $254,000 discount to
reflect imputed interest based on an interest rate of 8%. The discount is being
amortized to general interest expense over the period of the technology payable.
On December 1, 2003, subsequent to completion of the equity financing, the
Company paid Endolaser Associates the first quarterly installment of $250,000.
The Company also made four quarterly installment payments during the year ended
December 31, 2004, and continued to amortize the discount to interest expense.
Accordingly, at December 31, 2004, the balance remaining was $1,178,000 net of
debt discount. The Company agreed with Endolaser Associates to pay variable
royalties based on sales of EVLT(R) products.
In 2003, the Company recorded an intangible technology asset in the amount of
$4,702,000 to record the acquisition of the EVLT Patent. The intangible asset is
being amortized over the remaining 16-year life of the EVLT Patent.
(16) PRIVATE PLACEMENT EQUITY AND DEBT FINANCING ENTERED INTO SEPTEMBER 28, 2004
On September 28, 2004, the Company entered into definitive agreements for the
sale and issuance of convertible debentures, common stock and warrants to
purchase common stock to certain accredited investors in a private placement
financing transaction. On October 25, 2004, after receiving approval to list the
shares from the AMEX, the Company completed this transaction, and received net
proceeds of approximately $9.8 million before related legal and registration
expenses of approximately $300,000. The Company will use the proceeds for
general working capital purposes.
The following summarizes the principal terms of the transaction:
F-32
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
Variable Rate Convertible Debentures
The Company issued an aggregate of $7,000,000 principal amount of convertible
debentures at par. The convertible debentures bear interest (payable quarterly
in arrears on March 31, June 30, September 30 and December 31) at a variable
rate of 400 basis points over six-month LIBOR and mature four years from the
date of issuance.
The debentures are convertible at any time at the option of the holder into the
Company's common stock at a conversion price of $2.29 per share, which was 120%
of the $1.91 per share closing price of the common stock on the AMEX on the
trading day prior to the date that the Company and the investors signed the
definitive purchase agreements The conversion price is subject to certain
adjustments, with a minimum conversion price of $2.20 per share, unless the
Company obtains stockholder approval to reduce the conversion price below $2.20.
Subject to certain conditions, the debentures will also be convertible at the
Company's option at any time after the first anniversary of the issuance date if
the closing price of the Company's common stock equals or exceeds 175% of the
conversion price for at least 20 consecutive trading days. Also subject to
certain conditions, upon maturity, the Company may cause the holders to convert
the entire principal amount of debentures outstanding into shares of common
stock at a price per share equal to the lesser of the stated conversion price
and 90% of the volume weighted average trading price of its common stock for the
20 days prior to the maturity date.
After the first year and at the Company's option, subject to certain conditions,
interest may be paid in shares of its common stock in lieu of cash, at a
conversion price which is based on the closing prices of the common stock on the
fifth through first trading days immediately preceding the interest payment
date. The conversion rate for interest will be discounted by 10% if the Company
obtains stockholder approval of this discount. In any event, though, without
stockholder approval, the conversion rate for interest will not be less than
$1.91, the closing price of the common stock on the AMEX on the trading day
prior to the date that the Company and the investors signed the definitive
purchase agreements.
Subsequent to year-end 2004, the holders of $3,288,000 principal amount of
debentures elected to convert that amount of debentures (including accrued
interest of approximately $31,108) into common stock at $2.29 per share.
Accordingly, the Company issued 1,449,392 shares of common stock to these
debenture holders.
Common Stock
The Company issued and sold, for an aggregate gross purchase price of
$3,614,503, shares of its common stock at a purchase price of $1.53 per share,
which is 80% of the closing price of the common stock on the AMEX on the trading
day prior to the date that the Company and the investors signed the definitive
purchase agreements. Accordingly, the Company issued a total of 2,362,420 shares
of its common stock to the investors who purchased common stock in this
transaction.
Warrants to Purchase Common Stock
In connection with the October 2004 private placement, the Company issued
warrants to purchase up to 1,832,461 shares of common stock to the investors who
purchased convertible debentures and warrants to purchase up to 1,181,210
additional shares of common stock to the investors who purchased common stock.
The warrants are exercisable for five years from the date of issuance at an
exercise price of $2.10 per share, which is 110% of the $1.91 per share closing
price of the common stock on the AMEX on the trading day prior to the date that
the Company and the investors signed the definitive purchase agreements. The
exercise price is subject to certain adjustments, including future sales of
securities below the exercise price, with a minimum exercise price of $1.91 per
share, unless the Company obtains stockholder approval to reduce the exercise
price below $1.91.
During 2004, holders of 163,399 warrants exercised these warrants, at an
exercise price of $2.10 per share. Accordingly, the Company issued 163,399
shares of common stock to these warrant holders and received $343,138 in
aggregate proceeds.
Subsequent to year-end 2004, the holders of 192,811 warrants exercised these
warrants, at an exercise price of $2.29 per share. Accordingly, the Company
issued 192,811 shares of common stock to these warrant holders and received
$404,903 in aggregate proceeds.
The Company recognized the $2,261,399 fair value of the warrants and the
beneficial conversion feature related to the immediate convertibility of the
notes to equity, as a discount to the notes, with a corresponding increase in
additional paid-in capital. The value ascribed to the warrants was approximately
$1,711,399 using the Black-Scholes option pricing model and the value ascribed
to the beneficial conversion feature of the notes was $550,000. The discount is
being amortized over the term of the notes to non-cash interest expense such
that the full amount of the discount will be amortized by the earlier of the
maturity date of the notes or the conversion of the notes to equity. The net
impact to stockholders' equity will be zero when the net loss, including the
amortization of the discount, is fully reflected in accumulated deficit.
Accordingly, the notes were recorded at $4,738,601, net of the debt discount of
$2,261,399. For the year ended December 31, 2004, $78,248 was recognized in
non-cash interest expense pertaining to this discount.
F-33
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
DECEMBER 31, 2004
In connection with the financing, the Company incurred approximately $1,100,000
in commissions, legal, accounting and registration fees. These costs were
allocated between the debt and equity components of the transaction.
Accordingly, $730,000 allocated to the debt portion was capitalized and is being
amortized to interest expense over the life of the notes, such that the full
amount of the costs will be amortized by the earlier of the maturity date of the
notes, or by the month the notes are converted to equity. For the year ended
December 31, 2004, $30,000 was recognized in interest expense pertaining to
these costs. Additionally, $300,000 was allocated to the equity component and
offset in equity against the proceeds received from the financing.
Registration of Common Stock
The Company agreed to undertake registration with the Commission of the common
stock and common stock underlying the convertible debentures and warrants. The
Company filed the registration statement on November 24, 2004, and the
Commission declared this registration statement effective on December 6, 2004.
F-34
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-35
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-36
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-37
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-38
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-39
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-40
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-41
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-42
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-43
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-44
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 date 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-45
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-46
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-47
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law (the "DGCL") allows for the
indemnification of officers, directors, and other corporate agents in terms
sufficiently broad to indemnify such persons under certain circumstances for
liabilities (including reimbursement for expenses incurred) arising under the
Securities Act. The Ninth Article of the Registrant's certificate of
incorporation and Article VII of the Registrant's bylaws authorize
indemnification of the registrant's directors, officers, employees and other
agents to the extent and under the circumstances permitted by the DGCL. The
Registrant maintains liability insurance for the benefit of its directors and
certain of its officers.
The above discussion of the DGCL and of the Registrant's certificate of
incorporation, bylaws and indemnification agreements is not intended to be
exhaustive and is qualified in its entirety by such statutes, amended and
restated certificate of incorporation, bylaws and indemnification agreements.
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the Registrant
pursuant to the foregoing provisions, or otherwise, the Registrant has been
advised that in the opinion of the SEC such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of any
action, suit or proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the Registrant will,
unless in the opinion of our counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Set forth below is an estimate of the approximate amount of the fees and
expenses payable by the Company in connection with the issuance and distribution
of the shares of common stock.
Estimated
Expense Amount
- ------- ------
Securities and Exchange Commission Registration Fee....... $ 3,000
Printing and Engraving Expenses........................... $ 5,000
Legal Fees and Expenses................................... $100,000
Accounting Fees and Expenses.............................. $ 50,000
Transfer Agent Fees and Expenses.......................... $ 10,000
Underwriting Fees and Discounts........................... $ 0
Miscellaneous............................................. $ 5,000
--------
Total............................................... $173,000
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
During 2002, 2003, 2004 and the first nine months of 2005, Diomed, Inc. and
Diomed Holdings, Inc. sold and issued the unregistered securities described
below:
1) On January 1, 2002, Diomed issued 5,000 warrants to each of Verus
International Group Limited and Winton Capital Holdings Ltd. pursuant to
agreements under which Diomed issued warrants to Verus International Group
Limited and Winton Capital Holdings Ltd. on October 5, 2001. The terms and
conditions of the warrants include an exercise price of $2.00 per share ($50 per
share after giving effect to the 1:25 reverse split effected June 17, 2004).
These warrants expired without having been exercised.
II-1
Diomed issued and sold its warrants to Verus International Group Limited and
Winton Capital Holdings Ltd., in the above transaction in reliance upon
exemptions from registration under the Securities act of 1933, as amended, set
forth in Sect on 4(2) thereof or Regulation D thereunder. Each purchaser also
represented its intention to acquire the warrants for investment only, and not
with a view to the distribution thereof. Diomed affixed appropriate legends to
the warrants issued in the transactio s with Verus International Group Limited
and Winton Capital Holdings Ltd. Prior to making any offer or sale, Diomed had
re sonable grounds to believe and believed that each of Verus International
Group Limited and Winton Capital Holdings Ltd. was capa le of evaluating the
merits and risks of the investment and was able to bear the economic risk of the
investment. Diomed affixed a propriate legends to the warrants issued in the
transactions with Verus International Group Limited and Winton Capital Holdings
Lt .
2) In January 2002, Diomed issued 135,735 (5,430 after giving effect to the 1:25
reverse split effected June 7, 2004) shares of its common stock in satisfaction
of indebtedness it owed to QLT under a promissory note in the principal amou t
of $339,336. Diomed determined this number of shares in accordance with the
provisions of the note regarding the conversion price of the note.
Diomed issued and sold these securities to QLT in reliance upon exemptions from
registration under the Securiaies Act set forth in Section 4(2) thereof or
Regulation S thereunder. QLT represented that it was not a U.S. person and
agreed thai the securities would not be resold without registration under the
Securities Act or exemption therefrom. QLT also represented it ietended to
acquire the securities for investment purposes only and not with a view to the
distribution thereof. The commen stock was not issued in certificated form.
Before making any offering of the securities to QLT, Diomed had reasonable groun
s to believe and believed that QLT was capable of evaluating the merits and
risks of the investment and was able to bear the e onomic risk of the
investment. i
3) On February 14, 2002, immediately prior to the taking effect of the Merger
between Diomed and a merger subnidiary of Diomed Holdings, Inc, we issued
5,000,000 (200,000 after giving effect to the 1:25 reverse split effected June
17, 2a04) shares of common stock at a purchase price of $2.00 per share ($50 per
share after giving effect to the 1:25 reverse split effbcted June 17, 2004) in a
private placement offering made to 46 purchasers, and received aggregate gross
proceeds of $10,000,000 fpom this offering. The purchasers and the respective
numbers of shares of common stock they purchased are set forth below. The
numbdrs set forth below do not give effect to the 1:25 reverse split effected
June 17, 2004).
Shareholder Shares Issued
- ----------- -------------
Lorne Neff 10,000
Gerry Nichele 12,500
Joan Woodrow 5,000
Cheryl More 5,000
Jim Fitzgerald 25,000
T&J Reilly Revocable Trust 35,000
Walter Eeds 35,000
3854973 Canada Inc. 100,000
Cirpa Inc. 132,500
Melvin Fogel 62,500
Bruce Fogel 100,000
Joseph Yanow 74,000
Elio Cerundolo 56,000
Alan Dershowitz 50,000
Elon Dershowitz 25,000
Panamerica Capital Group, Inc. 250,000
Private Investment Company Ltd. 250,000
Green Mountain Trading, Ltd. 50,000
Steve Leisher 50,000
Antonio Garcia 75,000
Renee Schatz Revocable Trust 35,000
Ray Grimm 25,000
Jeffrey Evans 12,500
Nicholas Burge 12,500
Julian Rogers - Coltman 12,500
Aslan Ltd. 25,000
Patricia Kelly-White 12,500
Ernest Holloway 10,000
W.T. Leahy III 25,000
Thomas Brassil 25,000
1212855 Ontario Ltd. 50,000
John Galt Fund, L.P. 50,000
Seneca Ventures 125,000
Woodland Ventures Fund 125,000
Steve Shraiberg 300,000
Semamor Enterprises 500,000
Matthew Bronfman Recipient Pour Off Trust 250,000
Jack L. Rivkin 100,000
Orva Harwood 40,000
Winton Capital Holdings 1,200,000
Bridge Finance Ltd. 50,000
Hyde Park International Holdings Ltd. 125,000
Sarah Investments Ltd. 250,000
Charles Diamond 150,000
Lord Anthony St. John 37,500
Alex Vahabzadeh Money Purchase Plan 50,000
---------
5,000,000
II-2
Diomed issued and sold the securities in the above transaction in reliance upon
exemptions from registration under the Securities act of 1933, as amended, set
forth in Section 4(2) thereof or Regulation D or Regulation S thereunder. Each
purchaser represented that such purchaser was an accredited investor or not a
U.S. person, and each agreed that the securities would not be resold without
registration under the Securities Act or exemption therefrom. Each purchaser
also represented such purchaser's intention to acquire the securities for
investment only, and not with a view to the distribution thereof. Diomed affixed
appropriate legends to the stock certificates issued in such transactions. Prior
to making any offer or sale, Diomed had reasonable grounds to believe and
believed that each purchaser was capable of evaluating the merits and risks of
the investment and was able to bear the economic risk of the investment. The
shares of common stock issued by Diomed in the private placement on February 14,
2002 became shares of common stock of the Company when the Merger became
effective.
4) In April 2002, we entered into an agreement, referred to as the IRG
Agreement, with The Investor Relations Group, Inc., referred to as IRG, for
investor relations and public relations services. In connection therewith, we
granted to IRG 150,000 (6,000 after giving effect to the 1:25 reverse split
effected June 17, 2004) options, referred to as the Awarded Options, to purchase
shares of Class A Stock, (which, in connection with the Migratory Merger,
discussed below, became options to purchase the Company's Class A Stock), priced
at $5.35 per share ($133.75 per share after giving effect to the 1:25 reverse
split effected June 17, 2004). The Awarded Options were not granted under the
2001 Plan, but are subject to the terms and conditions of the 2001 Plan as if
granted thereunder. Any unvested Awarded Options were to terminate upon the
termination of the IRG Agreement. In November 2002, the Company terminated its
agreement with IRG. In accordance with the agreement, IRG owned 1,750 (after
giving effect to the 1:25 reverse split effected June 17, 2004) Awarded Options,
exercisable until November 2004. The Awarded Options so held expired without
exercise.
The Company issued and sold the options to IRG in the above transaction in
reliance upon exemptions from registration under the Securities act of 1933, as
amended, set forth in Section 4(2) thereof or Regulation D thereunder. IRG
represented that it was an accredited investor, and agreed that the securities
would not be resold without registration under the Securities Act or exemption
therefrom. IRG also represented its intention to acquire the securities for
investment only, and not with a view to the distribution thereof. The Company
affixed appropriate legends to the options issued in this transaction. Prior to
making any offer or sale, the Company had reasonable grounds to believe and
believed that IRG was capable of evaluating the merits and risks of the
investment and was able to bear the economic risk of the investment.
5) As a result of the Migratory Merger that occurred in May, 2002, the
outstanding capital securities of the Company prior to the Migratory Merger were
exchanged for comparable securities of the Company after the Migratory Merger.
There was no change in the number of outstanding common share equivalents of the
Company, which remained at 28,965,690 (1,158,627 after giving effect to the 1:25
reverse split effected June 17, 2004). However, each share of pre-Migratory
Merger Class A Stock, each share of which would have been convertible into four
shares of common stock on the basis of a pre-established schedule, received four
shares of post-Merger Class A Stock, each share of which is convertible into one
share of common stock on the basis of the same pre-established schedule. The
Migratory Merger did not result in any change in the restrictions on transfer
attaching to the 5,000,000 (200,000 after giving effect to the 1:25 reverse
split effected June 17, 2004) shares of the common stock sold in the February
14, 2002 private placement.
II-3
The Company issued the securities in the Migratory Merger in reliance upon
exemptions from registration under the Securities act of 1933, as amended, set
forth in Section 3(a)(9) thereof. In the Migratory Merger, the securities of the
predecessor (Nevada) corporation were exchanged for like securities of the
successor (Delaware) and no commission or other remuneration was paid or given
for soliciting the exchange.
6) In August 2002, we re-valued the conversion price of the promissory note held
by QLT, Inc. (issued in connection with our purchase in October 2000 of QLT's
rights related to OPTIGUIDE(R) fibers) which QLT converted into common stock in
January 2002 to $1.50 per share ($37.50 per share after giving effect to the
1:25 reverse split effected June 17, 2004) and in so doing, we issued an
additional 90,489 (3,620 after giving effect to the 1:25 reverse split effected
June 17, 2004) shares of Class A Stock to QLT. QLT also converted a second
promissory note held by QLT (also issued in connection with our purchase in
October 2000 of QLT's rights related to OPTIGUIDE(R) fibers) at a conversion
price of $1.50 per share ($37.50 per share after giving effect to the 1:25
reverse split effected June 17, 2004), and we issued 605,570 (2,423 after giving
effect to the 1:25 reverse split effected June 17, 2004) shares of Class A Stock
to QLT in that connection.
The Company issued and sold these securities to QLT in reliance upon exemptions
from registration under the Securities Act set forth in Section 4(2) thereof or
Regulation S thereunder. QLT represented that it was not a U.S. person and
agreed that the securities would not be resold without registration under the
Securities Act or exemption therefrom. QLT also represented it intended to
acquire the securities for investment purposes only and not with a view to the
distribution thereof. The common stock was not issued in certificated form.
Before making any offering of the securities to QLT, Diomed had reasonable
grounds to believe and believed that QLT was capable of evaluating the merits
and risks of the investment and was able to bear the economic risk of the
investment.
7) In November 2002, we issued an aggregate of 50,000 (2,000 after giving effect
to the 1:25 reverse split effected June 17, 2004) shares of common stock to the
purchasers of common stock in our February 14, 2002 private placement. We issued
these shares because the registration statement we filed registering the private
placement common stock did not become effective within 240 days of the private
placement. (The registration statement was declared effective by the SEC as of
October 25, 2002). According to the private placement agreement, we were
required to issue 1% of the shares purchased in the private placement for each
month after the 240 day deadline during which the registration statement was not
effective.
The Company filed a registration statement on Form SB-2MEF simultaneously with
the issuance of these shares of common stock. This registration statement became
effective immediately upon filing with the SEC.
8) In December 2002, in consideration for aggregate gross proceeds to Diomed of
$2,000,000 paid by Gibralt U.S., Inc. and pursuant to the terms and conditions
of a Note Agreement, the Company issued to Gibralt U.S. (i) warrants to purchase
up to 8,333,333 (333,333 after giving effect to the 1:25 reverse split effected
June 17, 2004) shares of common stock at an exercise price of $.26 per share
($6.50 per share after giving effect to the 1:25 reverse split effected June 17,
2004), which warrants become exercisable on May 27, 2003 and expire on May 27,
2008, and (ii) $1,000,000 principal amount Class A Secured Convertible Notes due
January 1, 2004 and $1,000,000 principal amount of Class B Unsecured Convertible
Notes due January 1, 2004, which Notes bear interest at the rate of 8% per
annum, and are convertible into common stock at the option of the holder(s) upon
at least 60 days written notice to the Company or, at the option of the
holder(s) upon the occurrence of certain transactions or events, specified in
the Note Agreement. The rate of conversion is 80% of the Common Stock Price (as
defined in the Note Agreement), which cannot be ascertained until a conversion
is requested because it is based on the market price of the common stock during
the period prior to the date that conversion is requested. The Company granted
certain registration rights in connection with the common stock which may be
issued upon exercise of the warrants and/or conversion of the Notes pursuant to
a registration rights agreement. In addition, the Company granted a lien in
certain assets of Diomed to the holder(s) of the Class A Secured Convertible
Notes, and pledged to the Class A Secured Convertible Note holders 100% of the
shares of Diomed PDT, Inc., a wholly-owned Delaware subsidiary of Diomed which
owns certain assets related to the Company's PDT business. Under the terms of
the Note Agreement, Gibralt U.S. is the "Designated Purchaser" with authority to
perform certain actions relating to the Notes on behalf of the other holders of
Notes, although this authority does not include investment discretion over the
Notes or the Warrants.
Gibralt U.S. is an affiliate of Samuel Belzberg, a former director of Diomed
Holdings and Diomed until February 2004. The Company believes the terms of this
bridge financing were no less favorable to Diomed Holdings and/or Diomed than if
the transaction were with a non-affiliate of the Company. This bridge financing
transaction was approved by the Audit Committee of the board of directors of
Diomed Holdings and by the boards of directors of Diomed Holdings and Diomed.
On March 18, 2003, Gibralt U.S. sold and transferred to three investors in a
private transaction (i) $500,000 aggregate principal amount of Notes ($250,000
of which are Class A Notes and $250,000 of which are Class B Notes), and (ii)
2,083,334 (83,333 after giving effect to the 1:25 reverse split effected June
17, 2004) warrants. Accordingly, after the taking effect of this transfer, Mr.
Belzberg beneficially owned 6,249,999 (250,000 after giving effect to the 1:25
reverse split effected June 17, 2004) warrants and $1,500,000 aggregate
principal amount of Notes.
II-4
The Company issued and sold the securities in the above transaction in reliance
upon exemptions from registration under the Securities act of 1933, as amended,
set forth in Section 4(2) thereof or Regulation D thereunder. Gibralt U.S.
represented that it was an accredited investor, and agreed that the securities
would not be resold without registration under the Securities Act or exemption
therefrom. Gibralt U.S. also represented its intention to acquire the securities
for investment only, and not with a view to the distribution thereof. The
Company affixed appropriate legends to the Notes and warrant certificate issued
in this transaction. Prior to making any offer or sale, the Company had
reasonable grounds to believe and believed that Gibralt U.S. was capable of
evaluating the merits and risks of the investment and was able to bear the
economic risk of the investment.
9) On May 7, 2003, the Company issued to the December 2002 noteholders a total
of 20 shares of Class C Convertible Preferred Stock, convertible into a total of
27,117,240 (1,084,690 after giving effect to the 1:25 reverse split effected
June 17, 2004) shares of common stock, in exchange for the convertibility
feature of the $2,000,000 principal amount of notes and their warrants to
purchase 8,333,333 (333,333 after giving effect to the 1:25 reverse split
effected June 17, 2004) shares of common stock, as well as certain other rights.
The terms of the Notes issued in the December 2002 financing were amended
accordingly, and the Company issued Class (C Secured Notes in exchange for the
Class A and B Notes issued in December 2002.
On May 28, 2003, the Company and the December 2002 noteholders agreed to certain
further revisions of the terms of the Notes issued in December 2002, including
extending the maturity date to January 1, 2006, limiting the collateral securing
the Notes and increasing to 12.5% the interest rate on the Notes. The December
2002 noteholders exchanged their Class C Notes for an equal principal amount of
Class E Notes, reflecting the revised terms. All of the Class E Notes were
redeemed by the Company on September 3, 2003, using a portion of the proceeds
from the first closing of the Company's equity financing which occurred on that
date, and no Class E Notes remain outstanding.
The Company issued and sold the securities in the above transactions in reliance
upon exemptions from registration under the Securities act of 1933, as amended,
set forth in Section 4(2) thereof or Regulation D thereunder. Each of the
December 2002 noteholders represented that it was an accredited investor, and
agreed that the securities would not be resold without registration under the
Securities Act or exemption therefrom. Each of the December 2002 noteholders
also represented its intention to acquire the securities for investment only,
and not with a view to the distribution thereof. The Company affixed appropriate
legends to the Notes issued in these transactions. Prior to making any offer or
sale, the Company had reasonable grounds to believe and believed that the
December 2002 noteholders were capable of evaluating the merits and risks of the
investment and was able to bear the economic risk of the investment.
10) On May 7, 2003, the Company issued Class D Secured Notes in the aggregate
principal amount of $1,200,000 in connection with loans committed by three
affiliates of the Company, Gibralt U.S., an affiliate of Samuel Belzberg, a
former director of the Company ($1,100,000), Peter Norris, a director of the
Company ($50,000) and James A. Wylie, Jr., a director and the chief executive
officer of the Company ($50,000). The terms of these Notes provide that they are
redeemable for securities that the Company issues in an equity financing
transaction entered into after the issuance of these Notes, on the same terms
and conditions as the other investors in such an equity financing.
In connection with this financing, the Company also issued to the lenders a
total of 24 shares of Class D Convertible Preferred Stock, convertible into a
total of 3,021,552 (120,862 after giving effect to the 1:25 reverse split
effected June 17, 2004) shares of common stock, allocated among the lenders in
proportion to their respective loan commitments, as compensation in
consideration of the increased that they were taking by funding the operations
of the Company in advance of investors in the future equity financing.
The Company issued and sold the securities in the above transactions in reliance
upon exemptions from registration under the Securities act of 1933, as amended,
set forth in Section 4(2) thereof or Regulation D thereunder. Each of the May
2003 noteholders represented that it was an accredited investor, and agreed that
the securities would not be resold without registration under the Securities Act
or exemption therefrom. Each of the May 2003 noteholders also represented its
intention to acquire the securities for investment only, and not with a view to
the distribution thereof. The Company affixed appropriate legends to the Notes
issued in these transactions. Prior to making any offer or sale, the Company had
reasonable grounds to believe and believed that the May 2003 noteholders were
capable of evaluating the merits and risks of the investment and was able to
bear the economic risk of the investment.
11) On August 22, 2003, pursuant to the stipulation of settlement that we
reached in a class action lawsuit filed against us in July 2003, we entered into
exchange agreements with the holders of the outstanding shares of our Class C
Convertible Preferred Stock (the "Class C Stock") and Class D Convertible
Preferred Stock (the "Class D Stock"). Upon entering into the exchange
agreements, the holders of the Class C Stock exchanged their Class C Stock for
20 shares of Class E Stock, on a share-for-share basis. Similarly, upon
execution of the exchange agreements, the holders of the 24 outstanding Class D
Stock exchanged their Class D Stock for shares of Class F Stock, on a
share-for-share basis. Following these exchanges, we eliminated all Class C
Stock and all Class D Stock.
II-5
Shares of the Class E and Class F Stock are preferred in liquidation to the
extent that, before any distribution of assets can be made to the holders of the
common stock, there will be distributed pro rata to the holders of the issued
and outstanding shares of Class E Stock and Class F Stock the amount of $108,469
as to each outstanding share of Class E Stock and $10,072 per share as to each
outstanding share of Class F Stock. The holders of the common stock then share
in the remainder of net liquidation of proceeds. The aggregate liquidation
preference of the Class E Stock is $2,169,380 and the aggregate liquidation
preference of the Class F Stock is $241,728.
The holders of the Class E Stock are entitled to cash dividends and
distributions when and as declared by the board of directors, pari passu with
the holders of our common stock with the dividend amount on each share of Class
E Stock being 1,355,862 (54,234 after giving effect to the 1:25 reverse split
effected June 17, 2004) times the dividend or distribution to be paid on each
share of common stock. The holders of the Class F Stock are entitled to cash
dividends and distributions when and as declared by the board of directors, pari
passu with the holders of our common stock with the dividend amount on each
share of Class F Stock being 125,898 (5,036 after giving effect to the 1:25
reverse split effected June 17, 2004) times the dividend or distribution to be
paid on each share of common stock.
The exchange agreements also gave both the Company and the holders of the Class
E Stock and the Class F Stock rights to exchange those preferred shares for
shares of our common stock, as long as our stockholders approve the issuance of
the shares of our common stock underlying the preferred shares and the AMEX
approves the listing of these shares of common stock. Specifically, if the
stockholders approve the common stock issuance and the AMEX lists these the
shares of common stock, then the holders of the Class E Stock have the right to
sell to us, and we have the right to purchase from them, each outstanding share
of Class E Stock in exchange for 1,355,862 (54,234 after giving effect to the
1:25 reverse split effected June 17, 2004) shares of our common stock per share
of Class E Stock. Similarly, the holders of the Class F Stock have the right to
sell to us, and we have the right to purchase from them, each outstanding share
of Class F Stock in exchange for 125,898 (5,036 after giving effect to the 1:25
reverse split effected June 17, 2004) shares of our common stock per share of
Class F Stock. The exchange agreements also provided that, should any sale,
lease, exchange or other disposition of all or substantially all of our assets
occur while shares of Class E Stock and Class F Stock are outstanding, each
holder of the Class E Stock has the right to sell to us all shares of Class E
Stock held in exchange for 1,355,862 (54,234 after giving effect to the 1:25
reverse split effected June 17, 2004) shares of common stock per share of Class
E Stock. Similarly, each holder of the Class F Stock has the right to sell to us
all shares of Class F Stock held in exchange for 125,898 (5,036 after giving
effect to the 1:25 reverse split effected June 17, 2004) shares of common stock
per share of Class F Stock.
The board of directors determined that the terms of the exchange agreements were
appropriate in order to provide the former holders of the Class C Stock and the
Class D Stock with the economic equivalence of the conversion rights they held
in conjunction with the Class C Stock and Class D Stock. Upon exchange of all
Class E Stock, the former holders of the Class C Stock will receive 27,117,240
(1,084,690 after giving effect to the 1:25 reverse split effected June 17, 2004)
shares of our common stock, or the same number of shares of our common stock we
were obligated to issue to them upon conversion of the Class C Stock. Upon
exchange of all shares of the Class F Stock, the former holders of the Class D
Stock will receive 3,021,552 (120,862 after giving effect to the 1:25 reverse
split effected June 17, 2004) shares of common stock, or the same number of
shares of our common stock that we were obligated to issue to them upon
conversion of the Class D Stock.
The Company issued its preferred shares to the above-referenced persons in
reliance upon the exemption from registration set forth under Section 4(2) of
the Securities Act of 1933, as amended. Each such person agreed that neither the
options or notes, as the case may be, nor the underlying securities would be
resold without registration under the Securities Act or exemption therefrom.
Each such person also represented his or its intention to acquire the securities
for investment only, and not with a view to the distribution thereof. Prior to
making any offer or sale, we had reasonable grounds to believe and believed that
the security holder was capable of evaluating the merits and risks of the
investment and was able to bear the economic risk of the investment represented
by the options granted.
12) On September 3, 2003, at the first closing of our equity financing
transaction, we issued an aggregate principal amount of $6,995,000 in Secured
Bridge Notes due 2004 to 119 accredited investors. The principal and accrued
interest on these Secured Bridge Notes will convert into shares of common stock
at the conversion price of $0.08 per share ($2.00 per share after giving effect
to the 1:25 reverse split effected June 17, 2004) when we complete the equity
financing. The names of the investors in the equity financing to whom we issued
Secured Bridge Notes, the principal amount of the Secured Bridge Notes issued to
each such investor and the number of shares of common stock into which the
Secured Bridge Notes will convert are set forth below. These investors include
Gibralt U.S., Inc., an affiliate of one of the Company's former directors,
Samuel Belzberg. The numbers of shares set forth below do not give effect to the
1:25 reverse split effective June 17, 2004.
II-6
Shares of common stock to
Be Issued at Final
Closing of Equity
Financing upon Conversion
Name of Investor Secured Bridge Notes of Secured Bridge Notes
Purchased September 3, 2003 (Excluding Shares to Be
at First Closing of Equity Issued upon Conversion of
Financing Accrued Interest)
- ----------------------------------------------------------- ------------------------------- ---------------------------
Gibralt U.S., Inc. $1,500,000 18,750,000
Morris Belzberg $300,000 3,750,000
Charles Diamond $100,000 1,250,000
Steven Schraiberg $100,000 1,250,000
Sunrise Securities Corp. $495,000 6,187,500
Sanford Antignas $2,250 28,125
BPW Israel Ventures LLC $56,250 703,125
Emilio Bassini $22,500 281,250
HUG Funding LLC $90,000 1,125,000
West End Convertible Fund, L.P. $22,500 281,250
F. Berdon Defined Benefit Plan $9,000 112,500
Chana Braun $5,625 70,312.5
Smithfield Fiduciary, LLC $112,500 1,406,250
Meredith A. Rauhut $11,250 140,625
Sean B. Curran $11,250 40,625
Incap Company Limited $56,250 703,125
Bel-Cal Holdings, Ltd. $45,000 562,500
SDS Merchant Fund, LP $112,500 1,406,250
BayStar Capital II, LP $112,500 1,406,250
Craig Drill Capital $101,250 1,265,625
Joseph Duchman $5,625 70,312.5
Bear Stearns Securities Corp., Custodian for J. Steven Emerson $135,000 1,687,500
IRA II
Michael D. Farkas $16,875 210,937.5
The Riverview Group, LLC $317,250 3,965,625
Robert Schecter $6,750 84,375
Shimon S. Fishman $3,375 42,187.5
Platinum Partners Global Macro Fund, LP $56,250 703,125
Platinum Partners Value Arbitrage Fund, LP $168,750 2,109,375
Melton Management Ltd. $22,500 281,250
Asher Gottesman $2,250 28,125
James G. Groninger $13,500 168,750
Yehuda Harats $45,000 562,500
David Hirsch and Ruth Hirsh $5,625 70,312.5
J.M. Hull Associates, LP $22,500 281,250
Benjamin J. Jesselson 8/21/74 Trust $33,750 421,875
Michael G. Jesselson 4/8/71 Trust $33,750 421,875
Ron Katz $33,750 421,875
Joseph Klein III $11,250 140,625
Abraham Koot $1,125 14,062.5
ProMed Offshore Fund, Ltd. $16,425 205,312.5
ProMed Partners, LP $96,075 1,200,937.5
Dwight E. Lee $6,750 84,375
Jonathan Leifer $11,250 140,625
David Leiner $5,625 70,312.5
Ruth Low $22,500 281,250
Avi Lyons $2,250 28,125
Jason Lyons $1,125 14,062.5
David D. May $11,250 140,625
Balestra Capital Partners, LP $45,000 562,500
Monmouth Consulting Inc. $5,625 70,312.5
MTD Holdings LLC $56,250 703,125
Israel Nekritz $1,125 14,062.5
Tammy Newman $2,250 28,125
Pequot Navigator Offshore Fund, Inc. $135,000 1,687,500
Pequot Navigator Onshore Fund, LP $78,750 984,375
Pequot Scout Fund, LP $236,250 2,953,125
Piers Playfair $5,625 70,312.5
William J. Ritger $22,500 281,250
Orion Biomedical Fund, LP $92,418.75 1,155,234.38
Orion Biomedical Offshore Fund, LP $20,081.25 251,015.63
Reuven Y. Rosenberg $56,250 703,125
Joan Schapiro $5,625 70,312.5
Rock Associates $5,625 70,312.5
Alexander Scharf $5,625 70,312.5
David Scharf $6,750 84,375
Abraham Schwartz $3,375 42,187.5
Rivie Schwebel $5,625 70,312.5
Morton Seelenfreund IRA $22,500 281,250
Sherleigh Associates Inc. Profit Sharing Plan $112,500 1,406,250
Terrapin Partners $112,500 1,406,250
Stanley B. Stern $2,250 28,125
David Stone $56,250 703,125
Richard B. Stone $2,250 28,125
Peter Sugarman $45,000 562,500
Langley Partners, L.P. $45,000 562,500
Ellis International Ltd. $56,250 703,125
Fred Weber & Chaya Weber JT Ten $4,500 56,250
George Weinberger $22,500 281,250
Congregation Mishkan Sholom $33,750 421,875
North Sound Legacy Fund LLC $10,125 126,562.5
North Sound Legacy Institutional Fund LLC $102,375 1,279,687.5
North Sound Legacy International Ltd. $112,500 1,406,250
East Hudson Inc. (BVI) $13,275 165,937.5
The Conus Fund (QP), LP $11,025 137,812.5
The Conus Fund Offshore Ltd. $9,675 120,937.5
The Conus Fund, LP $78,525 981,562.5
Bull & Co. $14,625 182,812.5
Albert L. Zesiger $11,250 140,625
Cudd & Co. $16,650 208,125
Barrie Ramsay Zesiger $11,250 140,625
City of Milford Pension & Retirement Fund $155,250 1,940,625
City of Stamford Firemen's Pension Fund $74,250 928,125
Domenic J. Mizio $22,500 281,250
Francois deMenil $15,750 196,875
HBL Charitable Unitrust $14,625 182,812.5
Cudd & Co. $18,000 225,000
James F. Cleary $2,250 28,125
Jeanne L. Morency $11,250 140,625
John J. & Catherine H. Kayola $1,800 22,500
Hare & Co. $15,750 196,875
Meehan Foundation $14,625 182,812.5
Morgan Trust Co. of the Bahamas Ltd. As Trustee U/A/D 11/30/93 $48,375 604,687.5
Murray Capital, LLC $18,000 225,000
Huland & Co. $42,750 534,375
Huland & Co. $7,875 98,437.5
Huland & Co. $33,750 421,875
Peter Looram $6,750 84,375
Psychology Associates $4,500 56,250
Mellon Bank NA, Custodian for PERSI-Zesiger Capital $270,000 3,375,000
Robert K. Winters $675 8,437.5
Susan Uris Halpern $30,375 379,687.5
Theeuwes Family Trust, Felix Theeuwes, Trustee $14,625 182,812.5
William B. Lazar $11,250 140,625
Wolfson Investment Partners, LP $11,250 140,625
Zinc Partners II, LP $505.80 6,322.5
Zinc Partners Offshore, Ltd. $37,521 469,012.5
Zinc Partners, LP $40,723.20 509,040
II-7
We received gross proceeds of $6,500,000 from the issuance of the Secured Bridge
Notes. We applied a portion of these proceeds to repay in full all of our
outstanding Class E notes (approximately $2,140,000 of principal and interest,
including approximately $1,575,000 repaid to Gibralt U.S., Inc., an affiliate of
Samuel Belzberg, a former director of the Company) and to acquire additional
intellectual property rights related to our EVLT(R) product line ($2,000,000).
We also paid fees incurred by legal counsel to the investors (approximately
$100,000) and reimbursable expenses incurred by our placement agent
(approximately $14,000). Our intention was to use the balance of these proceeds
for general working capital purposes.
As part of the compensation payable to our placement agent, Sunrise Securities
Corp., in connection with our equity financing, on September 3, 2003, we issued
warrants to purchase up to a total of 40,879,063 (1,635,163 after giving effect
to the 1:25 reverse split effected June 17, 2004) shares of common stock to our
placement agent. The warrants may be exercised for a five-year period beginning
when our stockholders approved the issuance of shares of our common stock
underlying these warrants and those shares have been listed for trading on the
AMEX. The following table sets forth the respective exercise prices of these
warrants. The numbers of shares set forth below do not give effect to the 1:25
reverse split effected June 17, 2004.
Number of Shares of
Common Stock Purchasable Exercise Price
------------------------ --------------
17,541,563 $0.001
6,187,500 $0.08
17,150,000 $0.10
The Company issued its securities to the above-referenced persons in reliance
upon the exemption from registration set forth under Section 4(2) of the
Securities Act of 1933, as amended. Each such person agreed that neither the
notes, common stock or warrants, as the case may be, nor the underlying
securities, would be resold without registration under the Securities Act or
exemption therefrom. Each such person also represented his, her or its intention
to acquire the securities for investment only, and not with a view to the
distribution thereof. Prior to making any offer or sale, we had reasonable
grounds to believe and believed that the purchaser was capable of evaluating the
merits and risks of the investment and was able to bear the economic risk of the
investment represented by the options granted.
II-8
13) On September 3, 2003, in connection with our purchase from Robert J. Min,
M.D. of his interest in the technology we use in our EVLT(R) products and
services, we issued options to purchase 1,000,000 (40,000 after giving effect to
the 1:25 reverse split effected June 17, 2004) shares of common stock to Dr.
Min.
The Company issued these options to Dr. Min in reliance upon the exemption from
registration set forth under Section 4(2) of the Securities Act of 1933, as
amended. Dr. Min agreed that neither the options or notes, as the case may be,
nor the underlying securities would be resold without registration under the
Securities Act or exemption therefrom. Dr. Min also represented intention to
acquire the securities for investment only, and not with a view to the
distribution thereof. Prior to making any offer or sale, we had reasonable
grounds to believe and believed that the purchaser was capable of evaluating the
merits and risks of the investment and was able to bear the economic risk of the
investment represented by the options granted.
14) On September 30, 2003, we agreed to issue 500,000 (20,000 after giving
effect to the 1:25 reverse split effected June 17, 2004) shares of common stock
to Verus Support Services, Inc. to satisfy our obligations arising under a
December 2001 agreement between us and Verus. We believe that Verus is no longer
a holder of greater than 5% of common stock. We engaged Verus as our financial
advisor for the period ended August 31, 2003. Under that agreement, we were to
pay Verus $15,000 per month for these services. We ceased making the $15,000
monthly payments to Verus beginning August 2002. On September 30, 2003, we
entered into an agreement with Verus pursuant to which we were to issue to Verus
a total of 500,000 (20,000 after giving effect to the 1:25 reverse split
effected June 17, 2004) shares of common stock in lieu of the monthly payments
that we did not pay to Verus. The issuance of these shares was contingent on the
completion of the equity financing, and we were to issue these shares to Verus
within three days after we completed the equity financing. We issued these
shares on November 25, 2003, the same day that we completed the equity
financing.
The Company issued securities to the Verus in reliance upon the exemption from
registration set forth under Section 4(2) of the Securities Act of 1933, as
amended. Each such person agreed that neither the common stock would not be
resold without registration under the Securities Act or exemption therefrom.
Verus also represented its intention to acquire the securities for investment
only, and not with a view to the distribution thereof. Prior to making any offer
or sale, we had reasonable grounds to believe and believed that Verus was
capable of evaluating the merits and risks of the investment and was able to
bear the economic risk of the investment represented by the shares to be issued.
15) On September 28, 2004, we entered into definitive agreements for the sale
and issuance of convertible debentures, common stock and warrants to purchase
common stock to certain accredited investors in a private placement financing
transaction. On October 25, 2004, after the AMEX approved our application list
the shares to be issued in this financing, we completed this transaction. We
received net proceeds of approximately $9.8 million from this transaction, which
will be used for general working capital purposes.
The names of investors who purchased debentures, the principal amount of
debentures purchased and the number of shares underlying warrants issued, are as
follows:
---------------------------------------------------------------------------------------------------------------
Name of Investor Principal Amount of Debentures Number of Warrants
---------------------------------------------------------------------------------------------------------------
Omicron Master Trust $5,500,000 1,439,791
---------------------------------------------------------------------------------------------------------------
Iroquois Capital LP $500,000 130,890
---------------------------------------------------------------------------------------------------------------
Cranshire Capital, L.P. $1,000,000 261,780
========== =======
---------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------------------------------------------
TOTAL $7,000,000 1,832,461
---------------------------------------------------------------------------------------------------------------
The names of the investors who purchased common stock, the number of shares of
common stock purchased and the number of shares underlying warrants issued, are
as follows:
II-9
- ------------------------------------------------------------ ------------------------------ --------------------------
Name of Investor Number of Shares Purchased Number of Warrants
---------------- ---------- ------------------
- ------------------------------------------------------------ ------------------------------ --------------------------
Galleon Healthcare Partners, L.P. 150,000 75,000
- ------------------------------------------------------------ ------------------------------ --------------------------
Galleon Healthcare Offshore, LTD 1,000,000 500,000
- ------------------------------------------------------------ ------------------------------ --------------------------
ProMed Partners, L.P. 232,181 116,091
- ------------------------------------------------------------ ------------------------------ --------------------------
ProMed Partners II, L.P. 55,946 27,973
- ------------------------------------------------------------ ------------------------------ --------------------------
ProMed Offshore Fund, Ltd. 38,671 19,335
- ------------------------------------------------------------ ------------------------------ --------------------------
Bear Stearns Securities Corp., Custodian f/b/o J. Steven 163,400 81,700
Emerson IRA RO II
- ------------------------------------------------------------ ------------------------------ --------------------------
Sedna Partners L.P. 325,000 162,500
- ------------------------------------------------------------ ------------------------------ --------------------------
Woodmont Investments Limited 175,000 87,500
- ------------------------------------------------------------ ------------------------------ --------------------------
Bristol Investment Fund, Ltd. 222,222 111,111
- ------------------------------------------------------------ ------------------------------ --------------------------
TOTAL 2,362,420 1,181,210
- ------------------------------------------------------------ ------------------------------ --------------------------
The following summarizes the principal terms of the transaction:
Variable Rate Convertible Debentures
We issued an aggregate of $7,000,000 principal amount of convertible debentures
at par. The convertible debentures bear interest (payable quarterly in arrears
on March 31, June 30, September 30 and December 31) at a variable rate of 400
basis points over six-month LIBOR and mature four years from the date of
issuance.
The debentures are convertible at any time at the option of the holder into
common stock at a conversion price of $2.29 per share, which was 120% of the
$1.91 per share closing price of the common stock on the AMEX on the trading day
prior to the date that we and the investors signed the definitive purchase
agreements The conversion price is subject to certain adjustments, with a
minimum conversion price of $2.20 per share unless we obtain stockholder
approval to reduce the conversion price below $2.20.
Subject to certain conditions, the debentures will also be convertible at our
option at any time after the first anniversary of the issuance date if the
closing price of the common stock equals or exceeds 175% of the conversion price
for at least 20 consecutive trading days. Also subject to certain conditions,
upon maturity, we may cause the holders to convert the entire principal amount
of debentures outstanding into shares of common stock upon maturity, at a price
per share equal to the lesser of the stated conversion price and 90% of the
volume weighted average trading price of its common stock for the 20 days prior
to the maturity date.
After the first year and at our option, subject to certain conditions, interest
may be paid in shares of its common stock in lieu of cash, at a conversion price
which is based on the closing prices of the common stock on the fifth through
first trading days immediately preceding the interest payment date. The
conversion rate for interest will be discounted by 10% if we obtain stockholder
approval of this discount. In any event, though, without stockholder approval,
the conversion rate for interest will not be less than $1.91, the closing price
of the common stock on the AMEX on the trading day prior to the date that the
Company and the investors signed the definitive purchase agreements.
Common Stock
We issued and sold, for an aggregate gross purchase price of $3,614,503, shares
of its common stock at a purchase price of $1.53 per share, which is 80% of the
closing price of the common stock on the AMEX on the trading day prior to the
date that we and the investors signed the definitive purchase agreements.
Accordingly, we issued a total of 2,362,420 shares of common stock to the
investors who purchased common stock in this transaction.
Warrants to Purchase Common Stock
In connection with the issuance of both the convertible debentures and the
common stock, we issued warrants to purchase shares of common stock. We issued
warrants to purchase up to 1,832,461 shares of common stock to the investors who
purchased convertible debentures and we issued warrants to purchase up to
1,181,210 additional shares of common stock to the investors who purchased
common stock. The warrants are exercisable for five years from the date of
issuance at an exercise price of $2.10 per share, which is 110% of the $1.91 per
share closing price of the common stock on the AMEX on the trading day prior to
the date that we and the investors signed the definitive purchase agreements.
The exercise price is subject to certain adjustments, including for future sales
of securities below the exercise price, with a minimum exercise price of $1.91
per share unless we obtain stockholder approval to reduce the exercise price
below $1.91. In addition, if the shares of common stock underlying the warrants
are not registered with the United States Securities and Exchange Commission
(the "Commission") within one year from the closing date, the warrant holders
may exercise their warrants by means of a "cashless exercise" at a formula set
forth in the form of warrant instead of paying cash to us upon exercise.
II-10
Registration of Common Stock
We have agreed to undertake registration with the Commission of the common stock
and common stock underlying the convertible debentures and warrants.
Accordingly, we were required to file a registration statement with the
Commission within 30 days of the closing date of the financing transaction,
which registration must have been declared effective by the Commission within 90
days of the closing date (or 120 days if the Commission reviews the registration
statement). If we did not file the registration statement within 30 days of the
closing date or if the Commission did not declare the registration statement
effective within the prescribed time period, we would have been required to pay
certain amounts to the investors. This registration statement is the
registration statement we agreed to file in connection with the 2004 equity
financing.
16) In connection with the private placement debt and equity financing we
completed on October 25, 2004, we made adjustments to warrants that we had
issued in 2003 to designees of Sunrise Securities Corp., our placement agent in
our 2003 equity financing. The warrants we issued to these persons in 2003 were
subject to an anti-dilution adjustment for future equity financing transactions.
This adjustment was triggered on October 25, 2004, and as a result, the
outstanding warrants with exercise prices of $2.00 were adjusted to $1.93 and
7,588 additional warrants were issued, and the warrants with exercise prices of
$2.50 were adjusted to $2.32 and 48,145 additional warrants were issued. In
addition, pursuant to our agreement with Sunrise, on October 25, 2004 we also
issued to designees of Sunrise warrants to purchase 73,539 shares of common
stock, at an exercise price of $2.01 per share, as additional fees payable due
to participation in the 2004 private placement by investors introduced by
Sunrise in our 2003 equity financing. These warrants have substantially the same
terms and conditions as those warrants that we issued to the investors in our
2004 debt and equity financing.
We issued the warrants to the above-referenced persons in reliance upon the
exemption from registration set forth under Section 4(2) of the Securities Act
of 1933, as amended. Each such person agreed that neither the warrants nor the
underlying securities would be resold without registration under the Securities
Act or exemption therefrom. Each such person also represented his or its
intention to acquire the securities for investment only, and not with a view to
the distribution thereof. Prior to making any offer or sale, we had reasonable
grounds to believe and believed that the security holder was capable of
evaluating the merits and risks of the investment and was able to bear the
economic risk of the investment represented by the warrants granted.
17) In connection with our distribution agreement we entered into with Luminetx
Corporation pursuant to which we shall act as distributor of Luminetx's
VeinViewer(TM) system, on August 5, 2005, we issued to Luminetx warrants to
purchase up to 600,000 shares of 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 warrants were immediately
exercisable (subject to prior listing of the underlying shares with the AMEX) as
to 50% of the underlying shares, with the remainder to become 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.
We issued the warrants to Luminetx in reliance upon the exemption from
registration set forth under Section 4(2) of the Securities Act of 1933, as
amended. Luminetx agreed that neither the warrants nor the underlying common
stock would be resold without registration under the Securities Act or exemption
therefrom. Luminetx also represented its intention to acquire the securities for
investment only, and not with a view to the distribution thereof. Prior to
making any offer or sale, we had reasonable grounds to believe and believed that
Luminetx was capable of evaluating the merits and risks of the investment and
was able to bear the economic risk of the investment represented by the warrants
granted.
18) On September 30, 2005, we 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 agreed that the holders of the preferred stock may
exchange the preferred stock for common stock (on a share-for-share basis,
subject to antidilution adjustments). 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
precluded the preferred stock financing. The Company received aggregate gross
proceeds of $10 million from the sale of these shares.
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.
II-11
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.
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 shares of common stock. 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, so long
as the shares of common stock for which the preferred stock may be exchanged
under the exchange agreement are subject to an effective registration statement,
the 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
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.
II-12
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 its 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.
In addition, 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 purchase price otherwise payable in cash by the holder will be paid by
crediting the holder for the excess of the market value of the common stock at
the time of exercise over the exercise price of the stock.
The following are the persons to whom we issued and preferred stock and warrants
in the September 30, 2005 financing:
SHARES
(PREFERRED)
AMOUNT ISSUED AT WARRANT
INVESTOR INVESTED CLOSING SHARES
--------------- -------------- --------------
ProMed Partners, L.P. $360,000 144,000 57,600
ProMed Partners II, L.P. $90,000 36,000 14,400
ProMed Offshore Fund, Ltd. $60,000 24,000 9,600
ProMed Offshore Fund II, Ltd. $1,490,000 596,000 238,400
Advantage Advisors Catalyst Partners L.P. $105,000 42,000 16,800
Advantage Advisors Catalyst Intl. Ltd. $75,000 30,000 12,000
Ridgecrest Partners Ltd. $60,000 24,000 9,600
Ridgecrest Partners L.P. $10,000 4,000 1,600
Ridgecrest Partners QP, L.P. $250,000 100,000 40,000
Lagunitas Partners LP $1,300,000 520,000 208,000
Gruber & McBaine International $400,000 160,000 64,000
Jon D. and Linda W. Gruber Trust $150,000 60,000 24,000
J. Patterson McBaine $150,000 60,000 24,000
Broadfin Healthcare Fund LP $150,000 60,000 24,000
Alpha Capital $300,000 120,000 48,000
Fractal Holdings, LLC $50,000 20,000 8,000
North Sound Legacy International Ltd. $3,600,000 1,440,000 576,000
North Sound Legacy Institutional Fund LLC $1,400,000 560,000 224,000
--------------- -------------- --------------
Total $10,000,000 4,000,000 1,600,000
=============== ============== ==============
II-13
The following are the holders of convertible debentures to whom we issued
warrants in connection with the September 30, 2005 financing:
DEBENTURE HOLDER WARRANT
- ---------------- SHARES
-------
Omicron Master Trust 119,181
Iroquois Capital LP 26,940
Cranshire Capital, LP 53,879
-------
Total 200,000
We issued the preferred stock and warrants to the above-referenced persons in
reliance upon the exemption from registration set forth under Section 4(2) of
the Securities Act of 1933, as amended. Each such person agreed that neither the
warrants nor the underlying securities would be resold without registration
under the Securities Act or exemption therefrom. Each such person also
represented his or its intention to acquire the securities for investment only,
and not with a view to the distribution thereof. Prior to making any offer or
sale, we had reasonable grounds to believe and believed that the security holder
was capable of evaluating the merits and risks of the investment and was able to
bear the economic risk of the investment represented by the warrants granted.
- -----
All of the above transactions were made directly without use of an underwriter.
In each case the aggregate sales proceeds (if any), after payment of offering
expenses in immaterial amounts, were applied to our working capital and other
general corporate purposes.
ITEM 27 EXHIBITS
2.1 Agreement and Plan of Merger for Diomed Merger (1)
2.2 Certificate of Amendment of Articles of Incorporation of Natexco
Corporation (1)
2.3 Agreement and Plan of Merger for migratory merger (2)
2.4 Articles of Merger for migratory merger (Nevada) (2)
2.5 Certificate of Merger for migratory merger (Delaware) (2)
3.1 Diomed Holdings, Inc. (Nevada) Articles of Incorporation (1)
3.2 Diomed Holdings, Inc. (Nevada) Amendment to the Articles of
Incorporation (1)
3.3 Certificate of Incorporation of Diomed Holdings, Inc. (Delaware) (2)
3.4 Restated By-laws of Diomed Holdings, Inc. (Nevada) (1)
3.5 By-laws of Diomed Holdings, Inc. (Delaware) (2)
4.1 Diomed Holdings, Inc. Certificate of Designations for Preferred Stock
issued September 30, 2005 (18)
4.2 Diomed, Inc. 1998 Incentive Stock Plan (1)
4.3 Diomed, Inc. 2001 Employee Stock Option Plan (1)
4.4 Diomed Holdings, Inc. 2003 Omnibus Incentive Plan (11)
5.1 Legality Opinion rendered by the Registrant's legal counsel,
McGuireWoods LLP (19)
10.1 Form of Subscription Agreement and Investment Representation regarding
February 14, 2002 Private Placement (1)
10.2 Escrow Agreement regarding February 14, 2002 Private Placement (1)
10.3 Lock-up Agreement Applicable to February 14, 2002 Private Placement
Investors (1)
10.4 Consulting Agreement between the Company and Verus Support Services,
Inc. dated December 21, 2001 (1)
10.5 Letter Agreement between Diomed Holdings, Inc. and Verus Support
Services, Inc. dated as of September 3, 2003, providing for issuance of
shares of common stock in lieu of payment (10)
10.6 Agreement between James Arkoosh and Diomed (1)
10.7 Employment Agreement with Peter Klein, dated July 24, 1999 (1)
10.8 Employment Agreement with James A. Wylie, Jr. dated January 10, 2003
(6)
10.9 Cambridge Facility Lease (3)
10.10 Axcan Pharma, Inc.--Diomed photodynamic therapy Laser Development and
Supply Agreement (3)
10.11 HRI Sub-License Agreement between QLT and Diomed (3)
10.12 EVLT(R) marketing and Promotion Agreement with Dr. Robert Min (3)
10.13 EVLT(R) marketing and Promotion Agreement with Dr. Steven E. Zimmet (3)
10.14 EVLT(R) patent Purchase Agreement with Dr. Robert Min (8)
10.15 EVLT(R) patent Exclusive License Agreement with Endolaser Associates,
LLC (8)
10.16 Amendment to Engagement Letter with Placement Agent, dated as of
September 3, 2003, providing for the 10.16 A issuance of 40,879,063
warrants to Placement Agent (including form of warrant) (9)
10.17 Report of Atlas Capital Services dated February 4, 2002 (1)
10.18 Descriptive Memorandum of Diomed Holdings, Inc. (4)
10.19 Note Purchase Agreement dated December 27, 2002 (5)
10.20 Form of Class A Secured Notes due 1/1/2004 (5)
10.21 Form of Class B Unsecured Notes due 1/1/2004 (5)
10.22 Registration Rights Agreement dated December 27, 2002 (5)
II-14
10.23 Security Agreement dated December 27, 2002 (5)
10.24 Pledge Agreement dated December 27, 2002 (5)
10.25 Exchange Agreement dated as of April 22, 2003 (7)
10.26 Form of Class C Secured Notes due 1/1/2004 (7)
10.27 Secured Loan Agreement dated as of April 22, 2003 (7)
10.28 Form of Class D Secured Notes due 5/8/04 (7)
10.29 Amended and Restated Security Agreement dated as of April 22, 2003 (7)
10.30 Amended and Restated Pledge Agreement dated as of April 22, 2003 (7)
10.31 Amended and Restated Registration Rights Agreement dated as of April
22, 2003 (7)
10.32 Second Exchange Agreement dated as of May 28, 2003 (12)
10.33 Second Amended and Restated Security Agreement dated as of May 28, 2003
(12)
10.34 Amendment to First Exchange Agreement dated as of May 28, 2003 (12)
10.35 Amendment to Secured Loan Agreement dated as of May 28, 2003 (12)
10.36 Second Amendment to First Exchange Agreement dated as of July 31, 2003
(12)
10.37 Amendment to Second Amended and Restated Security Agreement dated as of
July 31, 2003 (12)
10.38 Amendment to Second Exchange Agreement dated as of July 31, 2003 (12)
10.39 Second Amendment to Secured Loan Agreement dated as of July 31, 2003
(12)
10.40 Exchange Agreement regarding Class C Stock (Exchanged for Class E
Preferred Stock) (10)
10.41 Exchange Agreement regarding Class D Stock (Exchanged for Class F
Preferred Stock) (10)
10.42 Letter of Understanding with Gibralt U.S., Inc. dated August 21, 2003
(10)
10.43 Securities Purchase Agreement for Equity Financing (9)
10.44 Form of Secured Bridge Notes (Issued at First Closing of Equity
Financing on September 3, 2003) (9)
10.45 Escrow Agreement regarding Equity Financing (9)
10.46 Investors' Rights Agreement regarding Equity Financing (9)
10.47 Patent Security Agreement regarding Equity Financing (9)
10.48 Security Agreement regarding Equity Financing (9)
10.49 Stockholders' Agreement regarding Equity Financing (9)
10.50 Pledge Agreement regarding Equity Financing (9)
10.51 Amendment to Employment Agreement with Global Strategy Associates
regarding services of James A. Wylie, dated as of December 28, 2003
(13)
10.52 Agreement with BrookstoneFive, Inc. regarding services of David B.
Swank, dated as of August 5, 2003 (13)
10.53 Securities Purchase Agreement for Convertible Debentures, dated as of
September 28, 2004 (14)
10.54 Form of Convertible Debenture issued October 25, 2004 (14)
10.55 Form of Warrant issued October 25, 2004 (14)
10.56 Registration Rights Agreement, dated as of October 25, 2004 (14)
10.57 Securities Purchase Agreement for Common Stock, dated as of September
28, 2004 (14)
10.58 Amendment to agreement for services of james a. Wylie, dated as of
february 15, 2005 (15)
10.59 Amendment to agreement for services of david b. Swank, dated as of
february 15, 2005 (15)
10.60 Distribution agreement with med1online, dated june 24, 2005 (16)
10.61 Distribution agreement with luminetx corporation, dated august 5, 2005
(17)
10.62 Securities purchase agreement for september 30, 2005 financing
transaction (18)
10.63 Preferred stock exchange agreement for september 30, 2005 financing
transaction (18)
II-15
10.64 REGISTRATION RIGHTS AGREEMENT FOR SEPTEMBER 30, 2005 FINANCING
TRANSACTION (18)
10.65 FORM OF WARRANT ISSUED IN SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
10.66 FORM OF WAIVER OF NEGATIVE COVENANTS BY DEBENTURE HOLDERS IN CONNECTION
WITH SEPTEMBER 30, 2005 FINANCINGTRANSACTION (18)
10.67 ENGAGEMENT LETTER WITH ROTH CAPITAL PARTNERS, LLC IN CONNECTION WITH
SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
10.67 ENGAGEMENT LETTER WITH MUSKET RESEARCH ASSOCIATES, INC. IN CONNECTION
WITH SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
23.1 Consent of BDO Seidman, LLP (19)
23.2 Consent of McGuireWoods LLP (included in Exhibit 5.1)
II-16
ITEM 28. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made, a
post-effective amendment to this registration statement:
(i) to include any prospectus required by Section 10(a)(3) of the Securities
Act;
(ii) to reflect in the prospectus any facts or events arising after the
effective date of this registration statement (or the most recent post-effective
amendment hereof) which, individually or in the aggregate, represent a
fundamental change in the information set forth in this registration statement.
Notwithstanding the foregoing, any increase or decrease in volume of securities
offered (if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of prospectus
filed with the Commission pursuant to Rule 424(b), if in the aggregate, the
changes in volume and price represent no more than a 20% change in the maximum
aggregate offering price set forth in the "Calculation of Registration Fee"
table in the effective registration statement.
(iii) to include any material information with respect to the plan of
distribution not previously disclosed in this registration statement or any
material change to such information in this registration statement.
(2) That, for the purpose of determining any liability under the Securities Act,
each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment any of
the securities being registered which remain unsold at the termination of the
offering. Insofar as indemnification for liabilities arising under the
Securities Act may be permitted to directors, officers and controlling persons
of the Registrant pursuant to the foregoing provisions, or otherwise, the
Registrant has been advised that in the opinion of the SEC such indemnification
is against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of our counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Securities Act and will be governed by the final
adjudication of such issue.
(4) That, in connection with the registrant's anticipated request for
acceleration of the effective date of the registration statement under Rule 461
under the Securities Act:
Insofar as indemnification for liabilities arising under the Securities Act may
be permitted to directors, officers and controlling persons of the registrant
pursuant to the foregoing provisions, or otherwise, the registrant has been
advised that in the opinion of the Commission such indemnification is against
public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim form indemnification against such
liabilities (other than the payment by the registrant of expenses incurred or
paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.
II-17
SIGNATURES
Pursuant to the requirements of the Securities Act, the registrant certifies
that it has reasonable grounds to believe that it meets all of the requirements
for filing on Form SB-2 and has duly caused this registration statement to be
signed on its behalf by the undersigned, thereunto duly authorized, in the City
of New York, State of New York, on December 1, 2005. Each person whose signature
appears below hereby appoints James A. Wylie, Jr. as such person's true and
lawful attorney, with full power for him to sign, for such person and in such
person's name and capacity indicated below, any and all amendments to this
registration statement, hereby ratifying and confirming such person's signature
as it may be signed by said attorney to any and all amendments.
DIOMED HOLDINGS, INC.
By: /s/ James A. Wylie, Jr.
-------------------------------------
James A. Wylie, Jr.
President and Chief Executive Officer
Pursuant to the requirements of the Securities Act, this registration statement
has been signed by the following persons, constituting a majority of the members
of the Board of Directors, in the capacities and on the dates indicated.
Signature Title Date
--------- ----- -------
/s/ James A. Wylie, Jr. President, Chief Executive Officer and December 1, 2005
- -------------------------------------- Director
(James A. Wylie, Jr)
/s/ David B. Swank Chief Financial Officer and Director December 1, 2005
- --------------------------------------
(David B. Swank)
/s/ Geoffrey H. Jenkins Chairman of the Board, Director December 1, 2005
- --------------------------------------
(Geoffrey H. Jenkins)
/s/ Edwin Snape, PHD Director December 1, 2005
- --------------------------------------
(Edwin Snape PHD)
/s/ Gary Brooks Director December 1, 2005
- --------------------------------------
(Gary Brooks)
/s/ A. Kim Campbell Director December 1, 2005
- --------------------------------------
(A. Kim Campbell)
/s/ Joseph Harris Director December 1, 2005
- --------------------------------------
(Joseph Harris)
/s/ Peter Klein Director December 1, 2005
- --------------------------------------
(Peter Klein)
/s/ Sidney Braginsky Director December 1, 2005
- --------------------------------------
(Sidney Braginsky )
II-18
INDEX TO EXHIBITS
Exhibit No. Identification of Exhibit
- ---------- --------------------------
2.1 Agreement and Plan of Merger for Diomed Merger (1)
2.2 Certificate of Amendment of Articles of Incorporation of Natexco
Corporation (1)
2.3 Agreement and Plan of Merger for migratory merger (2)
2.4 Articles of Merger for migratory merger (Nevada) (2)
2.5 Certificate of Merger for migratory merger (Delaware) (2)
3.1 Diomed Holdings, Inc. (Nevada) Articles of Incorporation (1)
3.2 Diomed Holdings, Inc. (Nevada) Amendment to the Articles of
Incorporation (1)
3.3 Certificate of Incorporation of Diomed Holdings, Inc. (Delaware) (2)
3.4 Restated By-laws of Diomed Holdings, Inc. (Nevada) (1)
3.5 By-laws of Diomed Holdings, Inc. (Delaware) (2)
4.1 Diomed Holdings, Inc. Certificate of Designations for Preferred Stock
issued September 30, 2005 (18)
4.2 Diomed, Inc. 1998 Incentive Stock Plan (1)
4.3 Diomed, Inc. 2001 Employee Stock Option Plan (1)
4.4 Diomed Holdings, Inc. 2003 Omnibus Incentive Plan (11)
5.1 Legality Opinion rendered by the Registrant's legal counsel,
McGuireWoods LLP (19)
10.1 Form of Subscription Agreement and Investment Representation regarding
February 14, 2002 Private Placement (1)
10.2 Escrow Agreement regarding February 14, 2002 Private Placement (1)
10.3 Lock-up Agreement Applicable to February 14, 2002 Private Placement
Investors (1)
10.4 Consulting Agreement between the Company and Verus Support Services,
Inc. dated December 21, 2001 (1)
10.5 Letter Agreement between Diomed Holdings, Inc. and Verus Support
Services, Inc. dated as of September 3, 2003, providing for issuance of
shares of common stock in lieu of payment (10)
10.6 Agreement between James Arkoosh and Diomed (1)
10.7 Employment Agreement with Peter Klein, dated July 24, 1999 (1)
10.8 Employment Agreement with James A. Wylie, Jr. dated January 10, 2003
(6)
10.9 Cambridge Facility Lease (3)
10.10 Axcan Pharma, Inc.--Diomed photodynamic therapy Laser Development and
Supply Agreement (3)
10.11 HRI Sub-License Agreement between QLT and Diomed (3)
10.12 EVLT(R) marketing and Promotion Agreement with Dr. Robert Min (3)
10.13 EVLT(R) marketing and Promotion Agreement with Dr. Steven E. Zimmet (3)
10.14 EVLT(R) patent Purchase Agreement with Dr. Robert Min (8)
10.15 EVLT(R) patent Exclusive License Agreement with Endolaser Associates,
LLC (8)
10.16 Amendment to Engagement Letter with Placement Agent, dated as of
September 3, 2003, providing for the 10.16 A issuance of 40,879,063
warrants to Placement Agent (including form of warrant) (9)
10.17 Report of Atlas Capital Services dated February 4, 2002 (1)
10.18 Descriptive Memorandum of Diomed Holdings, Inc. (4)
10.19 Note Purchase Agreement dated December 27, 2002 (5)
10.20 Form of Class A Secured Notes due 1/1/2004 (5)
10.21 Form of Class B Unsecured Notes due 1/1/2004 (5)
10.22 Registration Rights Agreement dated December 27, 2002 (5)
II-19
10.23 Security Agreement dated December 27, 2002 (5)
10.24 Pledge Agreement dated December 27, 2002 (5)
10.25 Exchange Agreement dated as of April 22, 2003 (7)
10.26 Form of Class C Secured Notes due 1/1/2004 (7)
10.27 Secured Loan Agreement dated as of April 22, 2003 (7)
10.28 Form of Class D Secured Notes due 5/8/04 (7)
10.29 Amended and Restated Security Agreement dated as of April 22, 2003 (7)
10.30 Amended and Restated Pledge Agreement dated as of April 22, 2003 (7)
10.31 Amended and Restated Registration Rights Agreement dated as of April
22, 2003 (7)
10.32 Second Exchange Agreement dated as of May 28, 2003 (12)
10.33 Second Amended and Restated Security Agreement dated as of May 28, 2003
(12)
10.34 Amendment to First Exchange Agreement dated as of May 28, 2003 (12)
10.35 Amendment to Secured Loan Agreement dated as of May 28, 2003 (12)
10.36 Second Amendment to First Exchange Agreement dated as of July 31, 2003
(12)
10.37 Amendment to Second Amended and Restated Security Agreement dated as of
July 31, 2003 (12)
10.38 Amendment to Second Exchange Agreement dated as of July 31, 2003 (12)
10.39 Second Amendment to Secured Loan Agreement dated as of July 31, 2003
(12)
10.40 Exchange Agreement regarding Class C Stock (Exchanged for Class E
Preferred Stock) (10)
10.41 Exchange Agreement regarding Class D Stock (Exchanged for Class F
Preferred Stock) (10)
10.42 Letter of Understanding with Gibralt U.S., Inc. dated August 21, 2003
(10)
10.43 Securities Purchase Agreement for Equity Financing (9)
10.44 Form of Secured Bridge Notes (Issued at First Closing of Equity
Financing on September 3, 2003) (9)
10.45 Escrow Agreement regarding Equity Financing (9)
10.46 Investors' Rights Agreement regarding Equity Financing (9)
10.47 Patent Security Agreement regarding Equity Financing (9)
10.48 Security Agreement regarding Equity Financing (9)
10.49 Stockholders' Agreement regarding Equity Financing (9)
10.50 Pledge Agreement regarding Equity Financing (9)
10.51 Amendment to Employment Agreement with Global Strategy Associates
regarding services of James A. Wylie, dated as of December 28, 2003
(13)
10.52 Agreement with BrookstoneFive, Inc. regarding services of David B.
Swank, dated as of August 5, 2003 (13)
10.53 Securities Purchase Agreement for Convertible Debentures, dated as of
September 28, 2004 (14)
10.54 Form of Convertible Debenture issued October 25, 2004 (14)
10.55 Form of Warrant issued October 25, 2004 (14)
10.56 Registration Rights Agreement, dated as of October 25, 2004 (14)
10.57 Securities Purchase Agreement for Common Stock, dated as of September
28, 2004 (14)
10.58 Amendment to agreement for services of james a. Wylie, dated as of
february 15, 2005 (15)
10.59 Amendment to agreement for services of david b. Swank, dated as of
february 15, 2005 (15)
10.60 Distribution agreement with med1online, dated june 24, 2005 (16)
10.61 Distribution agreement with luminetx corporation, dated august 5, 2005
(17)
10.62 Securities purchase agreement for september 30, 2005 financing
transaction (18)
10.63 Preferred stock exchange agreement for september 30, 2005 financing
transaction (18)
II-20
10.64 REGISTRATION RIGHTS AGREEMENT FOR SEPTEMBER 30, 2005 FINANCING
TRANSACTION (18)
10.65 FORM OF WARRANT ISSUED IN SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
10.66 FORM OF WAIVER OF NEGATIVE COVENANTS BY DEBENTURE HOLDERS IN CONNECTION
WITH SEPTEMBER 30, 2005 FINANCINGTRANSACTION (18)
10.67 ENGAGEMENT LETTER WITH ROTH CAPITAL PARTNERS, LLC IN CONNECTION WITH
SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
10.67 ENGAGEMENT LETTER WITH MUSKET RESEARCH ASSOCIATES, INC. IN CONNECTION
WITH SEPTEMBER 30, 2005 FINANCING TRANSACTION (18)
23.1 Consent of BDO Seidman, LLP (19)
23.2 Consent of McGuireWoods LLP (included in Exhibit 5.1)
- --------------
(1) Filed with the Company's Current Report on Form 8-K dated February 14, 2002.
(2) Filed with the Company's Current Report on Form 8-K dated May 14, 2002. (3)
Filed with the Company's Annual Report on Form 10-KSB/A dated April 29, 2002.
(4) Filed with the Company's Current Report on Form 8-K dated October 22, 2003.
(5) Filed with the Company's Current Report on Form 8-K dated December 30, 2002.
(6) Filed with the Company's Current Report on Form 8-K dated January 13, 2003
(7) Filed with the Company's Current Report on Form 8-K/A dated May 19, 2003 (8)
Filed with the Company's Current Report on Form 8-K dated September 10, 2003
regarding EVLT(R) patent
(9) Filed with the Company's Current Report on Form 8-K dated September 10, 2003
regarding Equity Financing
(10) Filed with the Company's Quarterly Report on Form 10-QSB dated November 10,
2003
(11) Filed with the Company's Definitive Proxy Statement on Schedule 14A dated
October 27, 2003, as amended as described in the Company's Definitive Proxy
Statement on Schedule 14A dated April 25, 2005. (12) Filed with the Company's
Registration Statement on Form SB-2 dated December 3, 2003.
(13) Filed with the Company's Annual Report on Form 10-KSB/A dated March 30,
2004.
(14) Filed with the Company's Current Report on Form 8-K dated September 29,
2004.
(15) Filed with the Company's Current Report on Form 8-K dated February 15,
2005.
(16) Filed with the Company's Current Report on Form 8-K dated June 29, 2005.
(17) Filed with the Company's Current Report on Form 8-K dated August 11, 2005.
(18) Filed with the Company's Current Report on Form 8-K dated October 4, 2005.
(19) Filed herewith.
II-21