AS FILED WITH THE SECURITIES AND
EXCHANGE COMMISSION ON JANUARY 30, 2007
REGISTRATION NO. 333-138605
U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
AMENDMENT NO.2
DIOMED HOLDINGS, INC.
(NAME OF SMALL BUSINESS ISSUER)
DELAWARE 3845 84-1480636
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION INDUSTRIAL IDENTIFICATION NO.)
OF INCORPORATION CLASSIFICATION
OR ORGANIZATION) CODE NUMBER)
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. |X|
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
================================================================================
TITLE OF EACH CLASS PROPOSED MAXIMUM PROPOSED MAXIMUM
OF SECURITIES TO BE AMOUNT TO BE OFFER PRICE PER AGGREGATE AMOUNT OF
REGISTERED REGISTERED SHARE (1) OFFERING PRICE REGISTRATION FEE
- ------------------------------------------ -------------- ------------------ ------------------ ------------------
Shares of common stock, par value $0.001 24,774,675 $.97 $23,783,688 $2,571.36
per share, issuable upon (i) exchange of
preferred stock (or Par Warrants which
may be issued in certain instances in
lieu of shares of common stock upon
exchange of preferred stock) sold to the
Selling Stockholders on September 29, 2006, (ii) exercise of warrants to
purchase common stock issued as partial compensation for placement agent
services provided in the September 29, 2006 financing; and (iii) an increased
number of shares of common stock underlying adjustments to the conversion price
of outstanding convertible debentures and to the number of shares of common
stock issuable upon exercise of outstanding warrants to purchase common stock,
in each case as a result of the September 29, 2006 financing.
(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 $.97 per share on November 8,
2006. 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. THESE
SECURITIES MAY NOT BE SOLD 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 JANUARY 30, 2007
PROSPECTUS
24,774,675 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 24,774,675 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
January 26, 2007, the closing trading price of our common stock as reported on
the AMEX was $1.01 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 January 30, 2007.
TABLE OF CONTENTS
DESCRIPTION PAGE
SUMMARY................................................................................................3
SUMMARY FINANCIAL DATA.................................................................................4
RISK FACTORS...........................................................................................6
SPECIAL NOTE OF CAUTION REGARDING FORWARD-LOOKING STATEMENTS..........................................19
CAPITALIZATION........................................................................................19
DIVIDEND POLICY.......................................................................................19
DESCRIPTION OF OUR BUSINESS...........................................................................20
NUMBER OF EMPLOYEES...................................................................................33
LEGAL PROCEEDINGS.....................................................................................33
MANAGEMENT`S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION OR PLAN OF OPERATION......................36
RESULTS OF OPERATIONS.................................................................................36
LIQUIDITY AND CAPITAL RESOURCES.......................................................................39
CRITICAL ACCOUNTING POLICIES..........................................................................56
RECENT ACCOUNTING PRONOUNCEMENTS......................................................................56
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTNG AND FINANCIAL DISCLOSURE...................58
DESCRIPTION OF PROPERTY...............................................................................58
RELATED TRANSACTIONS..................................................................................58
CERTAIN MARKET INFORMATION............................................................................60
DESCRIPTION OF SECURITIES.............................................................................60
MANAGEMENT............................................................................................63
EXECUTIVE COMPENSATION................................................................................66
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................................70
SELLING STOCKHOLDERS..................................................................................72
PLAN OF DISTRIBUTION..................................................................................76
TRANSFER AGENT........................................................................................77
LEGAL MATTERS.........................................................................................77
EXPERTS...............................................................................................78
WHERE YOU CAN FIND MORE INFORMATION...................................................................78
FINANCIAL STATEMENTS.................................................................................F-i
PART II.............................................................................................II-1
INDEMNIFICATION OF OFFICERS AND DIRECTORS...........................................................II-1
OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.........................................................II-1
RECENT SALES OF UNREGISTERED SECURITIES.............................................................II-1
EXHIBITS............................................................................................II-7
UNDERTAKINGS.......................................................................................II-11
SIGNATURES.........................................................................................II-12
INDEX TO EXHIBITS..................................................................................II-13
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 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) 19,448,728 shares
Common stock offered by the
Selling Stockholders(2) 24,774,675 shares
Common stock to be available
to trade publicly
after the offering(3) 44,223,403 shares
Use of proceeds We will not receive any
proceeds from the sale of
the shares of common stock
offered by this prospectus. (4)
American Stock Exchange Symbol DIO
----------
(1) Includes approximately 6.04 million shares of common stock held by
affiliates. See "Security Ownership of Certain Beneficial Owners and
Management," below.
(2) This number (i) assumes (a) the full exchange of all preferred stock we
issued in our private placement equity financing on September 29, 2006 for
17,354,347 shares of common stock, (b) the full exercise of the common stock
purchase warrants that we issued to designees of our co-placement agent in our
private placement financing on September 29, 2006 for 370,000 shares of common
stock, (c) assumes conversion of the portion of the $3.712 million principal
amount of outstanding convertible debentures representing the additional
1,606,865 underlying shares convertible as a result of the conversion price
antidilution reset and (d) assumes exercise of a portion of the warrants
representing the additional 488,528 shares to be received upon exercise as a
result of the exercise price antidilution reset and (ii) reflects a 25%
allowance for possible increase in common stock that may become issuable
pursuant to the terms of the securities. 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) Assumes we do not issue any other shares of common stock prior to the
offering.
(4) Except that, to the extent any warrants for which some of the shares being
registered are exercised for cash, we will receive the exercise price of the
warrants.
3
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, 2004
and 2005, and unaudited consolidated financial data for the nine months ended
September 30, 2005 and 2006. 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 29, 2006 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,
2004 2005 2005 2006
(UNAUDITED)
Revenues $ 13,385 $ 19,049 $ 13,488 $ 15,972
Cost of revenues 7,920 10,113 7,325 8,786
-------- -------- -------- --------
Gross profit 5,465 8,936 6,163 7,186
-------- -------- -------- --------
Operating expenses:
Research and development 1,695 1,537 1,151 1,141
Selling and marketing 7,161 9,392 6,693 8,490
General and administrative 6,422 7,819 5,475 5,865
-------- -------- -------- --------
Total operating expenses 15,278 18,748 13,319 15,495
-------- -------- -------- --------
Loss from operations (9,813) (9,812) (7,156) (8,310)
-------- -------- -------- --------
Other income (expense): (Gain)/loss
on fair adjustment value on warrant
liability -- (157) -- (971)
Interest expense, non-cash 109 1,197 1,503 288
Interest expense, net, and other
(income) 155 586 188 (1)
-------- -------- -------- --------
Total other (income)
expense, net 264 1,626 1,691 (684)
-------- -------- -------- --------
Net loss $(10,077) $(11,438) $ (8,847) $ (7,626)
Less preferred stock
cash dividends -- (150) -- (447)
Less preferred stock
non-cash dividends -- 1,301 (763) (484)
Less beneficial conversion
feature on 2006 preferred
stock -- -- -- (470)
Less deemed dividend on
the exchange of 2005
preferred stock -- -- -- (2,980)
Net loss applicable to
common stockholders $(10,077) $(12,889) $ (9,610) $(12,007)
======== ======== ======== ========
Basic and diluted net loss per
share applicable to common
stockholders $ (0.68) $ (.67) $ (0.50) $ (.62)
======== ======== ======== ========
Basic and diluted weighted average
common shares outstanding (14,753) (19,214) (19,143) (19,448)
======== ======== ======== ========
4
SEPTEMBER 30,
2006
(UNAUDITED)
-------------
BALANCE SHEET DATA
(IN THOUSANDS)
Cash and cash equivalents (1) 12,942
Short-term investments 499
Working capital (2) 13,691
Total assets 27,286
Non-current liabilities (3) 774
Preferred stock (4) 21,239
Aditional paid-in capital (5) 86,507
Accumulated deficit (88,475)
Total stockholders' equity 19,545
(1) The cash balance includes the $9.3 million in net proceeds received in the
September 29, 2006 financing transaction.
(2) Working capital includes the transaction issuance costs of approximately
$276,000 incurred in the September 29, 2006 financing transaction.
(3) Non-current liabilities include the 2004 convertible debt of $3,712,000 net
of discount of $3,049,341. The debt discount reflects an additional $2,255,843
beneficial conversion amount recorded in the third quarter of 2006. The
additional beneficial conversion amount resulted from a contingent conversion
feature that lowered the conversion price upon issuance of the 2006 Preferred
Stock.
4) Preferred stock includes shares issued at an effective exchange price of
$1.15 (i) for new cash investment of $10,010,000; (ii) the reclassification of
the carrying amount of the 2005 preferred stock of $8,248,993 from mezzanine
level equity to permanent equity and (iii) $2,980,439 in exchange for all shares
of 2005 preferred stock outstanding on September 30, 2005, based on the
additional fair value provided to the 2005 preferred stockholders as the
adjusted exchange price of $1.15 was below the original effective exchange price
of $2.50 in accordance with EITF Topic D-42.
5) Additional paid-in capital includes; (i) a decrease for the fair value
adjustment of $2,980,439 recorded as an increase to Preferred Stock; (ii) an
increase of $2,255,843 for the additional debt discount recorded against the
2004 convertible debentures; (iii) an increase of $926,771 for the
reclassification of the warrant liability recorded as part of the 2005 Preferred
Stock Financing; and (iv) a decrease of $950,573 for financing and registration
expenses incurred in connection with the 2006 Preferred Stock Financing.
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 annual report when making investment decisions
concerning 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, 2006, we have accumulated a deficit of approximately $88 million,
including approximately $17.5 million in non-cash interest expense, a $1.1
million gain related to the adjustments of the market value for our warrant
liability and $444,000 in SFAS 123R compensation 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, legal 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.
Our revenues have not been sufficient to fund our operations, and therefore we
have required investor financing to fund our activities. The following
summarizes our recent financing transactions. 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 record 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.
In September 2006, we completed a private placement equity and debt financing
transaction in which we raised gross proceeds of $10.01 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;
- changes in compliance-related costs;
- market acceptance of our products and services, including new
product offerings, such as our Delta laser and VeinViewer(TM);
- additional cash-based compensation due to changes in accounting
rules for stock-based compensation;
- whether holders of outstanding warrants and stock options choose to
exercise these securities;
- whether we convert our outstanding debentures into common stock or
exchange our outstanding preferred stock into common stock; 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 29, 2006 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.
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
the number 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. We may also determine to expand our sales force in order to
compete more effectively.
7
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.
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 any significant delays in shipping our products as a result of
obtaining any of our products from our suppliers.
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. During
the first quarter of 2006, Luminetx began manufacturing the VeinViewer(TM)
through an outsourced contract manufacturer, and the product became available
for distribution in the second quarter of 2006. Luminetx is the sole supplier of
VeinViewer(TM). If Luminetx or its contracted manufacturer are unable to achieve
manufacturing requirements, then we will not be able to fulfill our expectations
with respect to VeinViewer(TM) revenue. Further, if we are unable to sell
certain minimum quantities of VeinViewer(TM) set forth in our distribution
agreement with Luminetx, we may lose our exclusivity.
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
September 30, 2006, approximately 853,725 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.
8
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 2007. 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
resources, we will not be in a position to avoid or negotiate terms that would
seek to protect us from the loss of these resources.
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 with which we combine.
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.
SINCE A CONSIDERABLE PORTION OF OUR REVENUES HAVE COME HISTORICALLY 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, 24% of our total revenue in 2005 and 21%
of our total revenue for the nine months ended September 30, 2006. No country
outside the U.S. represented more than 10% of our revenue in either period. Our
key international markets are the European Union, Latin America/Mexico, 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 comparable 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.
9
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 would 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. Luminetx recently began
manufacturing the VeinViewer(TM) product, and commercial quantities of the
product first became available for commercial distribution during the second
quarter of 2006. Therefore, the commercial acceptance of VeinViewer(TM) 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:
- 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.
10
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.
Vein stripping procedures, which are well established among physicians, have
extensive long-term data, and are routinely taught to new surgeons have
historically dominated. 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, EVLT(R), is still in the
early stages of commercialization. The VeinViewer(TM) product, for which we
recently began 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, is in the initial
stages of commercialization and market acceptance and profitability are not yet
demonstrated.
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:
- 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 of 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 REMAINS
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, 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.
11
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 TO 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:
PRODUCT INDICATION FOR USE
EVLT(R) kit and D15Plus diode laser Ablation of the greater
saphenous vein with reflux
in patients with superficial
vein reflux and venous
incompetence and reflux of
superficial veins in the lower
extremity
Diomed 15Plus and 30Plus 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, D15Plus
and D30Plus diode lasers Treatment of varicose veins and
varicosities associated with the
superficial 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 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.
12
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. 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, for which we will
act as an exclusive distributor to physicians performing sclerotherapy,
phlebectomies or varicose vein treatment, in North American and the United
Kingdom, is in the initial stages of commercialization. Therefore, the
profitability of VeinViewer(TM) for us is speculative.
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, increase our product liability risk and impair our ability to operate as
a going concern.
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.
13
WE MAY NOT BE ABLE TO KEEP PACE WITH RAPID CHANGES IN THE MEDICAL DEVICE
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.
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 have a material adverse effect on 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 September 30, 2006, we held 35 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);
- introducer sheath/optical fiber arrangement for use in endovascular
laser treatment of varicose veins, used in EVLT(R);
14
- methods of using introducer sheath/optical fiber arrangement in the
endovascular treatment of varicose veins;
- laser system incorporating optical fibers;
- solid state laser diode light source;
- high power light source; and
- fiber optic diffuser.
Of the patents, 7 are U.S. patents and 28 are filed in different jurisdictions.
These patents expire at various times from 2010 to 2023.
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. Vascular Solutions, AngioDynamics and
Total Vein Solutions have each countered that (among other things) our EVLT(R)
patent is invalid. In August 2006 the court in the Vascular Solutions and
AngioDynamics case granted summary judgment in our favor on this issue, finding
that our EVLT(R) patent is valid and enforceable. Separately, in January 2006,
concurrently with the grant of our introducer sheath/optical fiber patents,
AngioDynamics commenced a declaratory judgment of invalidity, unenforceability
and non-infringement in connection with these two patents proceeding against us.
In August, 2006, the court granted our motion to dismiss this lawsuit. See
"Legal Proceedings," below for further information regarding these lawsuits.
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.
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 have since been defending ourselves against
this lawsuit vigorously. See "Legal Proceedings," below, for further
information.
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.
15
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. However, we cannot be assured of success if
we are sued by stockholders in the future. 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 American Stock Exchange. We cannot be
certain that the American Stock Exchange will maintain our listing if we fall
below its listing qualifications or do not comply with other applicable American
Stock Exchange rules. An issuer's securities may be delisted by the American
Stock Exchange 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.
On June 1, 2006, we received notice from the American Stock Exchange that we
were not in compliance with a listing standard that requires us to have at least
$4,000,000 of stockholders' equity. This resulted from the accounting treatment
of the preferred stock we issued on September 30, 2005 as mezzanine level and
not as stockholders' equity, due to certain characteristics of the 2005
preferred stock. We submitted a plan for compliance with this listing standard,
which the American Stock Exchange has accepted. As part of our compliance plan,
the shares of preferred stock we issued on September 29, 2006 have
characteristics which qualify it for stockholders' equity, resulting in
stockholders' equity as of September 30, 2006 of approximately $20.2 million,
well in excess of the listing standard at issue. The American Stock Exchange
will continue to monitor our progress under our compliance plan through 2007,
and thereafter we will continue to be required to continue to comply with all
applicable listing standards.
If our shares are not listed on the American Stock Exchange, 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.
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.
16
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 September 30, 2006, five investors beneficially owned
approximately 21.5 million shares of our common stock (on a fully diluted basis)
which represents approximately 44.3% of our outstanding shares (on a fully
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 now cancelled preferred stock we issued on September 30, 2005
provided for dividends to be paid quarterly at varying rates and the preferred
stock we issued on September 29, 2006 provides for dividends to become payable
if certain events occur - see "Liquidity and Capital Resources," 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.
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. We have approximately 19.4 million shares of common stock
outstanding as of December 31, 2006. We are registering approximately 24.8
million additional shares of common stock pursuant to the registration statement
of which this prospectus is a part.
Assuming there is no adjustment to the exchange rate of the preferred stock or
the conversion price of outstanding debentures or exercise price of outstanding
warrants, and assuming the limitations on ownership applicable to certain
investors do not preclude such exchange or exercise, if (i) the investors in the
September 29, 2006 private placement exchange all of their shares of preferred
stock for approximately 17.4 million shares of common stock, (ii) the holders of
the warrants we issued on September 29, 2006 to our placement agent exercise all
of their warrants to purchase 370,000 shares of common stock, (iii) the holders
of $3.712 million principal amount of previously issued debentures opt to
convert their debentures into approximately 3.2 million shares of common stock
and (iv) the holders of previously issued warrants exercise all of their
warrants to purchase approximately 5.6 million shares of common stock, then
these investors may seek to sell the underlying shares of common stock. Because
we are seeking to register the common stock underlying most of the foregoing
securities pursuant to the registration statement of which this prospectus is a
part (in the case of the debentures and previously issued warrants, the
incremental number of shares resulting from antidilution adjustment resulting
from the September 29, 2006 financing transaction above the amount of underlying
shares currently registered), when this registration statement is declared
effective by the Commission, these underlying shares will, upon issuance
following exchange, conversion or exercise, as the case may be, be freely
tradeable in the public market by these investors.
The effective exchange price of the preferred stock, conversion price of the
debentures and exercise price of the warrants issued as placement fees for the
September 29, 2006 financing is $1.15 per share, and the exercise price of most
of the additional warrants is $1.98 per share. 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 able to sell their underlying shares of
common stock at a profit and therefore be inclined to exchange, convert or
exercise these securities and to receive shares of common stock, and to sell
these common 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.
17
POTENTIAL DILUTION CAUSED BY CURRENTLY OUTSTANDING STOCK OPTIONS AND WARRANTS
MAY REDUCE THE MARKET PRICE OF OUR COMMON STOCK.
As of September 30, 2006, there were outstanding stock options representing
approximately 2.4 million shares of common stock, with exercise prices ranging
from 1.02 to 205.75 per share. The weighted average exercise price of the stock
options outstanding as of September 30, 2006, was 4.77. In addition, as of
September 30, 2006, there were outstanding warrants representing approximately
6.0 million shares of common stock, with exercise prices varying from $0.025 to
$2.90 per share. The weighted average exercise price of all warrants outstanding
as of September 30, 2006 was $1.63 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 antidilution 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 approximately 2.3 million stock
options under this plan as of September 30, 2006, and an additional 853,725
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.
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.
- 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 American Stock Exchange, 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.
CAPITALIZATION
The following table sets forth our capitalization as of September 30, 2006,
which includes the securities we issued in our equity financing on September 30,
2006. 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, 2006
------------------
(UNAUDITED)
(IN THOUSANDS)
Total Long-term debt(1)............................................ $ 663
Stockholders' equity:
Common stock, $0.001 par value................................ 19
Preferred stock(2)............................................ 21,239
Additional paid-in capital (3)................................ 86,507
Accumulated other comprehensive gain.......................... 254
Accumulated deficit........................................... (88,475)
Total stockholders` equity................................ 19,545
Total capitalization...................................... $ 20,208
1) Long-term debt includes the 2004 convertible debt of $3,712,000 net of
discount of $3,049,341. The debt discount reflects an additional
$2,255,843 beneficial conversion amount recorded in the Third Quarter of
2006. The additional beneficial conversion amount resulted from a
contingent conversion feature that lowered the conversion price upon
issuance of the 2006 Preferred Stock.
2) Preferred stock includes shares issued at an effective exchange price
of $1.15 (i) for new cash investment of $10,010,000; (ii) the
reclassification of the carrying amount of the 2005 preferred stock
outstanding $8,248,993 from mezzanine level equity to permanent equity and
(ii) $2,980,439 in exchange for all shares of 2005 preferred stock
oustanding on September 30, 2005, based on the additional fair value
provided to the 2005 preferred stockholders as the adjusted exchange price
of $1.15 was below the original effective exchange price of $2.50 in
accordance with EITF Topic D-42.
3) Additional paid-in capital includes; (i) a decrease for the fair value
adjustment of $2,980,439 recorded as an increase to Preferred Stock; (ii)
an increase of $2,255,843 for the additional debt discount recorded
against the 2004 convertible debentures; (iii) an increase of $926,771 for
the reclassification of the warrant liability recorded as part of the 2005
Preferred Stock Financing; and (iv) a decrease of $950,573 for financing
and registration expenses incurred in connection with the 2006 Preferred
Stock Financing.
DIVIDEND POLICY
To date, we have not paid dividends on our common stock. However, we have paid
dividends on the now-cancelled preferred stock we issued on September 30, 2005
at the annual rate of 6%, from the date of issuance through its cancellation on
September 29, 2006, when these shares were exchanged for shares of a new series
of preferred stock we issued on that date. We will not pay any dividends on the
2006 series of preferred stock unless we complete a future financing transaction
involving the issuance of common stock for less than $1.15 per share and certain
other conditions are met. If dividends do become payable on this series of
preferred stock, dividends will begin to accrue at an annual rate of 15% and be
payable quarterly in arrears.
19
DESCRIPTION OF OUR BUSINESS
OVERVIEW
We develop and commercialize minimally invasive medical procedures that employ
our laser technologies and associated disposable products. Using our proprietary
technology, including our exclusive rights to U.S. Patent No. 6,398,777, we
currently focus on endovenous laser treatment (EVLT(R)) of varicose veins. We
also develop and market lasers and disposable products for photodynamic therapy
(PDT) cancer procedures and products for other clinical applications, including
dental and general surgical procedures. We carry on our business primarily
through our wholly-owned subsidiaries, Diomed, Inc. and Diomed, Ltd.
In developing and marketing our clinical solutions, we use proprietary
technology and aim to secure strong commercial advantages over competitors by
obtaining exclusive commercial arrangements, gaining governmental approvals in
advance of others and developing and offering innovative practice enhancement
programs, including physician training and promotional materials. To optimize
revenues, we focus on clinical procedures that generate revenues from both
capital equipment and disposable products, such as procedure kits and optical
fibers.
Our high power semiconductor diode lasers combine clinical efficacy, operational
efficiency and cost effectiveness in a versatile, compact, lightweight,
easy-to-use and easy-to-maintain system. Along with lasers and single-use
procedure kits for EVLT(R), we provide our customers with state-of-the-art
physician training and practice development support.
In 2001, we pioneered the commercialization of endovenous laser treatment
(EVLT(R)), an innovative minimally invasive laser procedure for the treatment of
varicose veins caused by greater saphenous vein reflux. In September 2001, we
were the first company to receive the CE mark of the European Economic Union for
approval for endovenous laser treatment with respect to marketing EVLT(R) in
Europe. In January 2002, we were the first company to receive FDA clearance for
endovenous laser treatment of the greater saphenous vein. In December 2004, we
received FDA clearance to expand the application of EVLT(R) to other superficial
veins in the lower extremities.
EVLT(R) was our primary source of revenue in 2005, and will continue to be a
primary source of revenue in 2006. 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, provide EVLT(R) with a competitive advantage
over competing traditional and minimally invasive varicose vein treatment
products.
We expect that as the number of EVLT(R) procedures increases, so will our sales
of associated disposable items. We believe that the U.S. represents the single
largest market for EVLT(R). We target our sales and marketing efforts at
hospitals, private physician practices and clinics and focus on specialists in
vascular surgery, interventional radiology, general surgery, phlebology,
interventional cardiology, gynecology and dermatology.
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. VeinViewer(TM) became commercially available during
the second quarter of 2006.
We primarily use 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.
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 initiatives, products and program offerings.
20
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. Our management team focuses on
developing and marketing solutions that address serious medical problems that
have significant markets. We also support the development and approval of new
applications, including our PDT product line, and the development of
enhancements to our products in order to further improve their quality,
effectiveness and manufacturability. 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. 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.
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.
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.
21
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. Our research and development expenditures were approximately
$1.7 million in 2004 and $1.5 million in 2005. 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.
KEY ACQUISITIONS TO ENHANCE PROFITABILITY
We periodically evaluate attractive opportunities in related fields and we
expect to continue efforts to identify and pursue these opportunities in the
future. 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. In August 2005, we
entered into an exclusive distribution agreement for the Luminetx VeinViewer(TM)
vascular imaging system to market to physicians performing sclerotherapy,
phlebectomies or varicose vein treatments, in North American and the United
Kingdom.
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
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 disposable products, such as
procedure kits or individual fibers, 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. In
2005, approximately 49% of our total revenues were from laser sales and
approximately 51% of total revenues were from sales of disposable products. For
the first nine months of 2006, approximately 38% of our total revenues were from
laser sales and approximately 62% of total revenues were from sales of
disposable products and VeinViewer(TM).
22
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.
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 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 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.
23
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 Acting Chair of Radiology at Weill Medical College of Cornell University
and the Acting Radiologist-in-Chief of New York Presbyterian Hospital-Weill
Cornell. 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 September 30,
2006, owned options to purchase 41,823 shares of common stock.
EVLT(R) was our primary source of revenue in 2004 and 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, 2006, we had sold over 1,000 EVLT(R) lasers, and we
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).
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.
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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, 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 introducer 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.
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.
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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).
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.
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 its surgical products. Our OEM business represented
approximately 8% and 5% of total revenues in 2005 and 2004, respectively.
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. The priorities of our manufacturing operations include
ensuring adequate inventory, continuous cost reduction and superior product
quality. 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.
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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.
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 are now available in multiple wavelengths, permitting
an even wider array of medical applications.
We also use a number of different laser diodes for our various products. Diodes
for our lasers are multi-sourced. 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 throughout the world. 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. We currently
purchase each of these EVLT(R) components from third parties. We also 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 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
our direct sales force. Our primary sales focus in the U.S. has been the
commercialization of EVLT(R). We initially used independent sales
representatives, and switched 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 a field sales organization
of 30 professionals, who sell EVLT(R) and VeinViewer(TM) technologies and
products. In order to more effectively address competitive sales tactics and
strategies, we are in the process of expanding our field sales organization from
30 to 36 professionals to provide greater focus and responsiveness to the needs
of our rapidly expanding physician base. We will continue to monitor sales
activities and strategies and adjust the number of direct 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.
In North America, we target our marketing efforts to physicians through hospital
and private 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 physician 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.
27
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. 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.
In 2004, no customer accounted for more than 10% of our revenues, and we
generated approximately 64% of our sales in the U.S. In 2005, no customer
accounted for more than 10% of our revenues, and we generated approximately 76%
of our sales in the U.S. Going forward, we believe that any dependence on any
individual customer or group of customers is likely to 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 in the U.S. will
increase as EVLT(R) market penetration in the U.S. increases.
For the remainder of 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 both our products'
effectiveness and our manufacturing efficiencies.
COMPETITION
The medical device industry is highly competitive, regulated and 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. Competition in the industry 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 that 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
fibers, and we understand it currently has an original equipment manufacturing
agreement with Biolitec for these goods. AngioDynamics and Vascular Solutions
received FDA clearance for their respective varicose vein treatment devices on
June 18, 2003, approximately 17 months after Diomed, while CoolTouch 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 and Vascular
Solutions 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
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.
Treating the great saphenous vein (GSV) with liquid or foamed sclerosant (with
and without ultrasound guidance) pre-dates FDA clearance for endovenous thermal
ablation procedures such as radio frequency and laser. However, numerous
published reports and abstracts presented at medical conferences show that
outcomes for sclerotherapy of the GSV do not equal those shown for thermal
ablation. Although some GSV treatment is still done with sclerotherapy, current
accepted standards of care call for thermal ablation for primary reflux of the
GSV followed by sclerotherapy or ambulatory phlebectomy for visible varicosities
and spider veins.
Several newer catheter-based systems for delivering sclerosant to the GSV are
undergoing clinical trials, but none are yet commercially available and
long-term outcomes for these systems are not known. Should these systems become
commercially available, these new products could gain market share currently
held by thermal ablation technologies, including endovenous laser treatment.
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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;
- 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; and
- 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 related to 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 was to make additional payments totaling
$2.5 million in 10 quarterly installments of $250,000 each, commencing October
1, 2003. Diomed paid all of these payments when due and fully satisfied this
obligation when it paid the final installment in January 2006. We 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.
In January 2006, the U.S. Patent and Trademark Office issued to us two
additional patents that we use in connection with EVLT(R), Patent Nos. 6,981,971
and 6,986,766 for our introducer sheath/optical fiber arrangement that may be
used in the endovascular laser treatment of varicose veins. 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.
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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 for "Summer Legs" and "Spotlight" 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.
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. In fact, 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 also 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.
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We also seek to protect our proprietary technology and processes in part by
confidentiality agreements with our collaborative partners, employees and
consultants. However, these third parties may breach their agreements with us,
and we may not have adequate remedies for their breach. Competitors may also
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," below, 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.
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 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 it 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.
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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 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 that 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.
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, Mexico/Latin America, 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 25 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, although 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) offers an
opportunity for payors to reduce the costs of treating varicose vein patients by
reducing 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. Although 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), a number of
physicians have published clinical data and studies addressing endovenous laser
treatment in scientific journals. A recent study, entitled "Endovenous Laser
Ablation of Varicose Veins," was published in the August 2005 issue of the
Journal of Cardiovascular Surgery. 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,
Acting Chair of Radiology at Weill Medical College of Cornell University and
Acting Radiologist-in-Chief at New York Presbyterian Hospital-Weill Cornell. Dr.
Min is a consultant to Diomed, and is an inventor of 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."
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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, subject to annual adjustment. In January 2006, new
codes became effective. Including Medicare/Medicaid reimbursements, as of
September 30, 2006, we list over 67 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 $1,954 for the first
vein treated under code #36478; second and additional veins at a base rate of
$418 under code #36479. When performed in a hospital setting, the new codes
allow for professional (Part B) payments of $348 for the first vein treated and
$170 for the second and additional veins, along with applicable hospital
facility fees. These base rates are adjusted for regional cost differences.
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 31, 2006, we employed a total of 92 full-time employees, 49 of
whom are based in the U.S. and 43 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
'777 Patent Litigation
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 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. AngioDynamics generally denied our allegations and sought a
declaratory judgment of invalidity of the '777 patent. AngioDynamics 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 bifurcated the case, so that those counterclaims will not
be litigated until we resolve our patent infringement claims against
AngioDynamics.
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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 the '777 patent. 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. At the parties' joint
request, however, our patent cases involving AngioDynamics and Vascular
Solutions were consolidated by the court for pretrial purposes. We subsequently
completed the discovery phase of the litigation.
On April 12, 2005, the Court issued a claim construction ruling, which
interpreted 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 been interpreted by the Court.
On December 21, 2005, we moved for summary judgment that the `777 patent is
valid, enforceable, and infringed by both Vascular Solutions and AngioDynamics.
On the same date, AngioDynamics and Vascular Solutions moved for summary
judgment of noninfringement. The Court initially scheduled a hearing on the
parties' respective motions, but that hearing date was cancelled when the judge
originally assigned to the case (Judge Richard Stearns) recused himself due to
his having consulted one of Diomed's expert witnesses for a personal medical
condition. The cases were reassigned to another Judge in the same District
(Nathaniel Gorton).
On August 20, 2006, Judge Gorton issued a favorable ruling on the summary
judgment motions. In particular, Judge Gorton rejected all of the various
challenges raised by the defendants to the validity or enforceability of our
`777 patent, and granted us summary judgment of validity and enforceability of
the patent. Judge Gorton further denied all parties' cross-motions for summary
judgment on infringement, as a result of which the case will proceed to trial as
we had expected. A trial date has been set for March 12, 2007.
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. 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. For the same reasons
discussed above, this case has also been reassigned from Judge Stearns to Judge
Gorton.
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. CoolTouch answered the complaint, generally denying our allegations and
counterclaiming for declaratory judgment of non-infringement and invalidity of
the '777 patent. We are now proceeding with the discovery phase of this
litigation. For the same reasons discussed above, this case has also been
reassigned from Judge Stearns to Judge Gorton.
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. We are
now proceeding with the discovery phase of this litigation, which is scheduled
to continue through mid-2007, with a preliminary trial date in October 2007.
The Court held a claim construction tutorial and a hearing on claim construction
issues on October 30, 2006 and issued a claims construction ruling on November
20, 2006.
We intend to continue to defend against the allegations against us in this case.
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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 alleged, 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 sought to redress what we alleged to be the willful
and deceptive manner in which Vascular Solutions had been marketing its laser
accessory products.
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
infringed 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 our complaint.
On March 3, 2006, the Court referred the parties to nonbinding mediation. At the
mediation on May 24, 2006, the case was settled. The terms of the settlement are
confidential. A joint stipulated dismissal was filed on June 23, 2006, ending
the case.
'971 and '976 Patent Declaratory Judgment Litigation
On January 3, 2006, AngioDynamics filed a lawsuit against us in the U.S.
District Court for the District of Delaware, seeking a declaratory judgment that
the claims of our U.S. Patent Number 6,981,971 (the "'971 Patent"), for an
introducer sheath/optical fiber arrangement that may be used in the endovascular
laser treatment of varicose veins, are invalid, unenforceable and not infringed
by AngioDynamics. The '971 Patent was issued by the U.S. Patent and Trademark
Office on January 3, 2006, the same day AngioDynamics filed the lawsuit. On
January 17, 2006, AngioDynamics filed an Amended Complaint seeking a declaratory
judgment with respect to our U.S. Patent Number 6,986,766 (the "'766 Patent").
The '766 Patent relates to methods of using an introducer sheath/optical fiber
arrangement in the endovascular laser treatment of varicose veins. We filed a
motion to dismiss AngioDynamics' declaratory judgment action in its entirety,
based primarily on lack of declaratory judgment jurisdiction. We also asserted
in our motion to dismiss that the court should dismiss the action in its
discretion, and because AngioDynamics' complaint contained a number of
deficiencies which we believe warranted dismissal. On September 7, 2006, the
Court granted our motion to dismiss the action, denied AngioDynamics' Motion to
Amend the Complaint, and dismissed the Case as we had requested.
35
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, 2005 and the unaudited
financial statements and notes to the financial statements of September 30,
2006, 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 September 30, 2006, we had an accumulated deficit of approximately $88
million, including $17.5 million in non-cash interest expense, a $1.1 million
gain related to the adjustments of the market value for our current liability
and $444,000 in SFAS 123R compensation 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.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THE THREE MONTHS ENDED
SEPTEMBER 30, 2005
REVENUE
We delivered revenue for the three months ended September 30, 2006 of
$5,321,000, increasing approximately $738,000, or 16%, from $4,583,000 for the
same period in 2005. Revenue from the EVLT(R) product line increased 22% over
the same period last year, including growth of 44% in disposable procedure
product revenue, demonstrating the continued and growing acceptance of EVLT(R)
by the medical community and patients alike.
In the three months ended September 30, 2006, approximately $1,980,000, or 37%,
of our total revenue was derived from laser sales, as compared to approximately
$2,194,000, or 48%, in the same period in 2005. In the three months ended
September 30, 2006, approximately $3,341,000, or 63%, of our total revenues were
from sales of disposable fibers and kits, accessories, service and
VeinViewer(TM), as compared to approximately $2,389,000, or 52%, in the same
period in 2005. 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 increased acceptance of the EVLT(R) procedure and
expanded reimbursement coverage by health care insurers.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the three months ended September 30, 2006 was $3,042,000,
increasing approximately $531,000, or 21%, from $2,511,000 for the three months
ended September 30, 2005. The increase in cost of revenue in 2006 was primarily
a result of increased revenues and lower overhead absorption.
Gross profit for the three months ended September 30, 2006 was $2,279,000,
increasing approximately $208,000, or 10% from $2,071,000 from the three months
ended September 30, 2005. The increase in gross profit in 2006 was primarily a
result of incremental sales volume. On a percent-of-sales-basis, the gross
profit of 43% decreased two percentage points compared with the gross margin of
45% in the prior year. The reduction in margin was a result a less favorable
product mix and lower overhead absorption, which offset favorable pricing
variances. We believe that gross profit as a percentage of sales may reach 60%,
or more, assuming increases in sales volume and pricing adjustments that may
occur after successful completion of the '777 patent litigation.
36
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES for the three months ended September 30, 2006
of $423,000, increased by $19,000, or 5%, from the three months ended September
30, 2005. We expect R&D expenditures to remain relatively stable, as we continue
to drive product functionality, cost improvements, and other enhancements.
SELLING AND MARKETING EXPENSES for the three months ended September 30, 2006 of
$2,687,000, increased $606,000, or 29%, over the three months ended September
30, 2005. The increase was driven by an expansion in the size of the sales force
of $289,000, higher sales commissions resulting from the increased sales volume,
and increased sales and marketing expenditures in support of the sales efforts.
We anticipate continued increased expenses resulting from the larger sales
organization and increased commissions due to expected increases in volume.
GENERAL AND ADMINISTRATIVE EXPENSES for the three months ended September 30,
2006 of $1,907,000, increased $95,000, or 5%, from the three months ended
September 30, 2005. The increase was primarily attributable to $67,000 in SFAS
123R stock based compensation costs, in accordance with SFAS 123R incurred in
the three months ended September 30, 2006 as well as $126,000 in other
administration costs, reduced by Sarbanes-Oxley costs of $106,000, as initial
internal control assessment costs incurred in the three-months ended September
30, 2005 did not reoccur in the three months ended September 30, 2006. Total
legal costs during the quarter decreased by $24,000 to $718,000 and included a
reduction in the continuing cost of litigation against our primary laser
competitors, partially offset by an increase in the cost of litigation in the
VNUS Medical Technologies, Inc. ("VNUS") litigation.
We anticipate general and administrative expenses to remain at this level as we
continue to incur legal fees in connection with our intellectual property '777
patent infringement actions lawsuits, some of which we expect to proceed to
trial in early 2007, as well as defense costs pertaining to the patent
infringement action initiated by VNUS.
LOSS FROM OPERATIONS
As a result of the factors outlined above, the loss from operations for the
three months ended September 30, 2006 was $2,738,000, increasing $513,000 from
$2,225,000 for the three months ended September 30, 2005, as the expansion of
our sales and marketing efforts during the quarter drove incremental revenue,
which was offset by an increase in sales and marketing costs.
OTHER (INCOME) EXPENSE, NET
Other expense, net for the three months ended September 30, 2006 was $242,000,
compared to other expense, net of $134,000 for the three months ended September
30, 2005. Other expense, net for the three months ended September 30, 2006
includes $69,000 for the non-cash, non-operating charge, after giving effect to
the change in market value of the warrants issued in the private placement
financing completed on September 30, 2005.
As a result of the financing closed on September 29, 2006, the Company marked to
market the warrant obligation for a final time and reclassified its mezzanine
level preferred stock and warrant liability to permanent equity.
NET LOSS
Net loss for the three months ended September 30, 2006 was $2,979,000 compared
to $2,359,000 for three months ended September 30, 2005. The expansion of our
sales and marketing efforts during the three months ended September 30, 2006
drove incremental revenue, resulting in increased gross margin, increased
commissions, and increases in other sales and marketing costs. Also, included in
the net loss is $126,000 in non-cash charges in accordance with SFAS 123R for
the fair value of stock options issued to employees and directors. This expense
has been allocated between Selling, General and Administrative and Cost of Sales
departmental expenses.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
Net loss applicable to common stockholders for the three months ended September
30, 2006 was $6,746,000, or $0.35 per share, compared to $3,122,000, or $0.16
per share, for the three months ended September 30, 2005. During 2005, we agreed
to pay cash dividends to holders of the 2005 preferred stock. These cash
dividends amounted to $149,000 during the three months ended September 30, 2006.
In addition, because the dividend percentage was considered below market for
accounting purposes, we recorded an incremental non-cash dividend of $167,000 to
reflect an effective interest rate of 16.5%. As a result of the preferred stock
financing closed on September 29, 2006, the 2005 preferred stock was exchanged
for the 2006 preferred stock, which does not accrue dividends unless a future
dilutive financing is completed within certain terms. Therefore, the Company
will cease paying or accreting these dividends on a prospective basis. The 2006
preferred stock does not currently accrue dividends.
37
Upon completion of the 2006 preferred stock financing, the company recorded a
one-time, non-cash, non-operating beneficial conversion feature charge of
$469,938, since the market price of the Company's common stock on September 29,
2006 of $1.20 was above the $1.15 effective conversion price of the immediately
convertible preferred stock. The company also recorded a one-time, non-cash,
non-operating deemed dividend of $3.0 million on the exchange of the 2005
preferred stock for the 2006 preferred stock.
NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER
30, 2005
REVENUE
Diomed delivered revenue for the nine months ended September 30, 2006 of
$15,972,000, increasing approximately $2,484,000, or 18%, from $13,488,000 for
the nine months ended September 30, 2005. Revenue from the EVLT(R) product line
increased 23% over the nine months ended September 30, 2005.
For the nine months ended September 30, 2006, approximately $6,125,000, or 38%,
of our total revenue was derived from laser sales, as compared to approximately
$6,763,000 or 50%, in the nine months ended September 30, 2005. In the nine
months ended September 30, 2006, approximately $9,847,000, or 62%, of our total
revenues were derived from sales of disposable fibers and kits, accessories,
service and VeinViewer(TM), as compared to approximately $6,725,000, or 50%, in
the nine months ended September 30, 2005. 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 increased acceptance of the EVLT(R) procedure and
expanded reimbursement coverage by health care insurers.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the nine months ended September 30, 2006 was $8,786,000,
increasing approximately $1,461,000, or 20%, from $7,325,000 for the same period
in 2005. The increase in cost of revenue in 2006 was driven by the corresponding
increase in the number of disposable products sold. Cost of revenue, as a
percentage of sales of 55% was comparable to cost of revenue on a year-to-year
basis.
Gross profit for the nine months ended September 30, 2006 was $7,186,000,
increasing approximately $1,023,000 from $6,163,000 for the same period in 2005.
On a percent-of-sales-basis, gross profit of 45% was comparable with the gross
margin in the prior year, as fixed cost leverage from incremental sales volume
was offset by unfavorable product mix. We believe that gross profit as a
percentage of sales may reach 60%, or more, assuming increases in sales volume
and pricing adjustments that may occur after successful completion of the `777
patent litigation.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT EXPENSES for the nine months ended September 30, 2006
were $1,140,000, a decrease of $11,000, or 1%, from the same period in 2005. We
expect R&D expenditures to remain relatively stable, as we continue to drive
product functionality, cost improvements, and other enhancements.
SELLING AND MARKETING EXPENSES for the nine months ended September 30, 2006 were
$8,490,000, an increase of $1,797,000, or 27%, over 2005. The increase was
driven by an expansion in the size of the sales force of $1,052,000 and higher
sales commissions resulting from the increased sales volume, and increased sales
and marketing expenditures in support of the sales efforts.
GENERAL AND ADMINISTRATIVE EXPENSES for the nine months ended September 30, 2006
were $5,865,000, an increase of $390,000, or 7%, from the same period in 2005.
The increase was primarily attributable to incremental legal fees of $339,000
and SFAS 123R expenses of $274,000, as we implemented SFAS 123R in the nine
months ended September 30, 2006. These increased costs were offset by decreased
Sarbanes-Oxley costs of $179,000, as initial internal control assessment costs
incurred in the nine-months ended September 30, 2005 did not reoccur in the nine
months ended September 30, 2006. Legal expenses included the continuing cost of
patent litigation against four competitors commenced during 2004, as well as
defense costs pertaining to the patent infringement action initiated by VNUS.
38
LOSS FROM OPERATIONS
Loss from operations for the nine months ended September 30, 2006 was
$8,310,000, an increase of approximately $1,153,000 from the same period in
2005, as incremental gross profit from an increased revenue base was primarily
offset by increased sales and marketing expense and legal costs related to our
patent litigation.
OTHER (INCOME) EXPENSE, NET
Other income for the nine months ended September 30, 2006 was $684,000, compared
to other expense, net of $1,691,000 for the same period in 2005. Other income in
the nine months ended September 30, 2006 includes $971,000 for the non-cash,
non-operating gain, after giving effect to the change in market value of the
warrants issued in the private placement financing completed on September 30,
2005. Other income also includes the non-operating impact of the theft of trade
secrets settlement with Vascular Solutions, Inc.
Interest expense in the nine months ended September 30, 2005 included non-cash
charges totaling $1,404,000 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 financing closed on September 29, 2006, the Company marked to
market the warrant obligation for a final time and reclassified its mezzanine
level preferred stock and warrant liability to permanent equity.
NET LOSS
Net loss for the nine months ended September 30, 2006 was $7,626,000 compared to
$8,847,000 for the same period 2005. The expansion of our sales and marketing
efforts during the year drove incremental revenue, which was offset by the
increased legal costs and supplemented by $971,000 for the non-cash,
non-operating gain on warrant liability, after giving effect to the change in
market value of the warrants issued in the private placement financing completed
on September 30, 2005.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
Net loss applicable to common stockholders was $12,007,000, or $0.62 per share,
compared to $9,610,000, or $0.50 per share, for the same period 2005. During
2005, we agreed to pay cash dividends to holders of the preferred stock. These
cash dividends amounted to $447,000 during the nine months ended September 30,
2006. In addition, because the dividend percentage was considered below market
for accounting purposes, we recorded an incremental non-cash dividend to reflect
an effective interest rate of 16.5%. As a result, in the nine months ended
September 30, 2006, we recorded $484,000 of non-cash preferred stock dividend.
As a result of the preferred stock financing closed on September 29, 2006, the
2005 preferred stock was exchanged for the 2006 preferred stock and the Company
will cease paying and accreting these dividends on a prospective basis. The 2006
preferred stock does not currently accrue dividends.
Upon completion of the 2006 preferred stock financing, the company recorded a
one-time, non-cash, non-operating beneficial conversion feature charge of
$469,938, since the market price of the Company's common stock on September 29,
2006 of $1.20 was above the $1.15 effective conversion price of the immediately
convertible preferred stock. The company also recorded a one-time, non-cash,
non-operating deemed dividend of $3.0 million on the exchange of the 2005
preferred stock for the 2006 preferred stock.
FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 2004
REVENUE
Diomed delivered revenues for the year ended December 31, 2005 of $19,049,000,
increasing approximately $5,664,000, or 42%, from $13,385,000 for the year ended
December 31, 2004. Revenue from EVLT(R) disposable procedure kits increased 83%
in 2005 versus 2004, demonstrating the continued and growing acceptance of
EVLT(R) by the medical community and patients alike.
In 2005, approximately $9,301,000, or 49%, of our total revenues, were derived
from laser sales, as compared to approximately $7,839,000, or 59%, in 2004. In
2005, approximately $9,748,000, or 51%, of our total revenues were derived from
sales of disposable fibers and kits, accessories and service, as compared to
approximately $5,546,000, or 41% 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 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 establishment of reimbursement codes for EVLT(R) by the American
Medical Association and the Center for Medicare and Medicaid
Services, which became effective January 31, 2005.
COST OF REVENUE AND GROSS PROFIT
Cost of revenue for the year ended December 31, 2005 was $10,113,000, increasing
approximately $2,193,000, or 28%, from $7,920,000 for the year ended December
31, 2004. Cost of revenue, as a percentage of sales, decreased from 59% to 53%
on a year-to-year basis. 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.
Gross profit for the year ended December 31, 2005 was $8,936,000, increasing
approximately $3,471,000 from $5,464,000 for the year ended December 31, 2004.
On a percent-of-sales-basis, the gross margin increased from 41% to 47%. The
increase in gross profit in 2005 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, 2005 decreased
by $158,000 or 9%, to $1,537,000 from $1,695,000 in the year ended December 31,
2004, as work on our new Delta laser platform was completed. We expect that
research and development spending will remain at approximately the same level as
2005, as we continue to drive product functionality, cost improvements and other
enhancements.
Selling and marketing expenses for the year ended December 31, 2005 were
$9,392,000, increasing approximately $2,231,000, or 31%, from $7,161,000 for the
year ended December 31, 2004. The increase was driven by a continued expansion
in the size of our sales force of $915,000, primarily related to salaries,
higher sales commissions of $468,000 resulting from increased sales volume and
increased marketing expenditures of $262,000 primarily for trade shows and
practice enhancement to support the sales efforts to drive the growing
commercialization of EVLT(R). In 2006, we anticipate continued increased
expenses resulting from the larger sales organization and increased commissions
due to expected increases in volume.
General and administrative expenses for the year ended December 31, 2005 were
$7,819,000 increasing approximately $1,397,000, or 22%, from $6,422,000 for the
year ended December 31, 2004. The increase was primarily attributable to
incremental legal fees of $1,105,000, which totaled $2,980,000 in 2005, as well
as Sarbanes-Oxley compliance costs of $192,000, including costs for consultants
we retained to document our processes and internal controls. Legal costs
included the cost of '777 patent infringement litigation against four
competitors commenced during 2004, 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 2006, we anticipate general and
administrative expenses to remain at this elevated level as we continue to incur
legal fees in connection with our intellectual property '777 patent infringement
actions lawsuits, some of which we expect to proceed to trial during the third
quarter of 2006, as well as defense costs pertaining to the patent infringement
action initiated by VNUS and the declaratory judgment patent litigation
commenced by AngioDynamics in January 2006.
LOSS FROM OPERATIONS
As a result of the factors outlined above, the loss from operations for the year
ended December 31, 2005 was $9,812,000, decreasing slightly from $9,813,000 for
the year ended December 31, 2004, as incremental gross profit was primarily
offset by increased legal costs related to our patent litigation.
OTHER (INCOME) EXPENSE, NET
Other expense, net for the year ended December 31, 2005 was $1,626,000, compared
to $264,000 for the year ended December 31, 2004. Interest expense of $1,783,000
in the year ended December 31, 2005 included non-cash charges totaling
$1,197,000 related to the amortization and acceleration of the debt discount
related to the conversion of $3,288,000 in debt issued in the September 28, 2004
equity and debt financing interest excuse of $264,000 in the year ended December
31, 2004 included non cash charges of $109,000.
Gain on the fair value of warrant liability for the year ended December 31, 2005
was $158,000, as a result of the mark-to-market for the warrants issued in the
private placement financing completed on September 30, 2005. The Company valued
the 1,800,000 warrants using the Black-Scholes model at December 31, 2005. The
Company will continue to revalue the 1,800,000 warrants in each reporting period
based on the Company's stock price, and any subsequent changes in the fair value
will be included as non-cash and non-operating gains or losses on the fair value
of warrant liability for as long as the warrants are outstanding. These warrants
were not outstanding in 2004 and therefore there was no gain or loss related to
the fair value liability in 2004.
INCOME TAXES
For the years ended December 31, 2005 and 2004, we included no provision for
foreign, federal or state income taxes, as we incurred net operating losses.
NET LOSS
Net loss for the year ended December 31, 2005 was $11,438,000 compared to
$10,077,000 for the year ended December 31, 2004. The expansion of our sales and
marketing efforts during 2005 drove incremental revenue, resulting in increased
gross margin, which was offset by the increased legal costs and $1,623,000 in
non-cash interest expense arising from the amortization and acceleration of debt
discount from the conversion of $3,288,000 in debt in 2005 and a $158,000
non-cash gain for the change in the fair value of the warrant liability entered
into on September 30, 2005.
NET LOSS APPLICABLE TO COMMON STOCKHOLDERS
Net loss applicable to common stockholders for the year ended December 31, 2005
was $12,888,000, or $0.67 per share, compared to $10,077,000, or $0.68 per
share, for the year ended 2004. For the year ended December 31, 2005, net loss
applicable to common stockholders included $1,151,000 in non-cash dividends
accreted on preferred stock as a result of a beneficial conversion feature and a
fair value adjustment to preferred stock. We also agreed to 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, although these 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). These cash dividends amounted to $150,000 during
the fourth quarter of 2005. In addition, because the dividend percentage is
considered below market for accounting purposes, we will continue to 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%. As a result, in
the fourth quarter of 2005, we recorded $149,000 of non-cash preferred stock
dividend.
LIQUIDITY AND CAPITAL RESOURCES
SUMMARY
Since our inception through September 30, 2006, we had an accumulated deficit of
approximately $88 million, including $17.5 million in non-cash interest expense,
a $1.1 million gain related to the adjustments of the market value for our
warrant liability and $443,000 in SFAS 123R compensation 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.
During the first nine months of 2006, we entered into a number of transactions
with provisions which may impact our future liquidity and capital resources,
such as:
- exchange of former series of preferred stock for new series of
preferred stock with different terms, including the elimination of
dividends and the elimination of optional redemption provisions and
liquidated damages that did not represent a reasonable percentage
discount of the fair value of an unregistered share versus a
registered share on our preferred stock which had precluded
inclusion in stockholders' equity;
39
- amendment of authorized capital by increasing number of shares of
authorized common shares from 50 million to 65 million and
eliminating board's authority to issue "blank check" preferred stock
after the September 29, 2006 financing;
- antidilution adjustments to conversion price of outstanding
debentures and exercise price of outstanding warrants;
- investment in Luminetx for VeinViewer(TM); and
- changes to our bank line of credit.
CASH POSITION AND CASH FLOW AS OF SEPTEMBER 30, 2006
The Company has financed its operations primarily through private placements of
common stock and preferred stock, and private placements of convertible notes
and short-term notes and credit arrangements. The Company had cash and
short-term investment balances of approximately $13,440,000 and $13,129,000 at
September 30, 2006 and December 31, 2005, respectively.
CASH USED IN OPERATIONS
Cash used in operations for the nine months ended September 30, 2006 was
$7,958,000. The cash used in operations reflects the net loss of $7,626,000
which includes $2,212,000 in legal fees incurred in asserting our EVLT(R) patent
and $444,000 for stock based compensation. The cash flow impact of the net loss
was offset by changes in working capital balance sheet accounts.
CASH PROVIDED BY INVESTING
Cash provided by investing activities for the nine months ended September 30,
2006 was approximately $2,363,000, including purchases of marketable securities
of $687,000, proceeds from maturities of marketable securities of $3,800,000,
$250,000 paid to Luminetx per our distribution agreement and purchases of
computer and demonstration equipment of $500,000.
CASH PROVIDED BY FINANCING
Cash provided by financing activities for the nine months ended September 30,
2006 was $9,017,000, consisting of $250,000 for the final EVLT(R) technology
acquisition obligation and $447,000 in dividends paid to the September 2005 PIPE
investors, offset by net proceeds of $9,349,000 from the preferred stock
financing closed on September 29, 2006.
CASH POSITION AND CASH FLOW AS OF SEPTEMBER 30, 2005
The Company has financed its operations primarily through private placements of
common stock and preferred stock, and private placements of convertible notes
and short-term notes and credit arrangements. The Company had cash and short
term investment balances of approximately $16,569,000 and $14,436,000 at
September 30, 2005 and December 31, 2004, respectively.
CASH USED IN OPERATIONS
Cash used in operations for the nine months ended September 30, 2005 was
$6,729,000. The cash used in operations reflects the net loss of $8,847,000,
reduced by the non-cash interest expense of $1,503,000, and working capital
changes including, $300,000 in 2004 incentive compensation payments which are
not expected to recur during the year.
CASH USED IN INVESTING
Cash used in investing activities for the nine months ended September 30, 2005
was approximately $2,655,000, including; purchases of available for sale
securities of $1,749,000, promissory note to Luminetx of $500,000, and computer
and demonstration equipment.
CASH PROVIDED BY FINANCING
Cash provided by financing activities for the nine months ended September 30,
2005 was $9,808,000. This includes; $10 million raised in the September 30, 2005
private placement, $405,000 received from the exercise of warrants we issued in
the 2004 equity and debt financing, and $193,000 in bank borrowings, offset by
$750,000 in payments related the current maturities of the EVLT(R) technology
acquisition obligation.
40
CASH POSITION AND CASH FLOW AS OF DECEMBER 31, 2005
Our cash and short term investment balances were approximately $13,129,000 and
$14,436,000 as of December 31, 2005 and December 31, 2004, respectively.
We have financed our operations primarily through private placements of common
and preferred stock, convertible debentures and short-term notes, and through
credit arrangements, including the following:
- In April 2004, we completed a targeted offering of common stock
(priced at $2.50 per share (adjusted to reflect the 1-for-25 reverse
stock split effective June 17, 2004) ) to the holders of common
stock of record as of August 29, 2003, pursuant to which we raised
gross proceeds of approximately $3,000,000 (approximately $2,728,000
after offering costs);
- In October 2004, we completed a common stock and convertible debt
financing transaction, pursuant to which we raised gross proceeds of
approximately $10,600,000 (approximately $9,500,000 after financing
costs); and
- In September 2005, we computed a preferred stock financing
transaction, pursuant to which we raised gross proceeds of
$10,000,000 (approximately $9,250,000 after financing costs).
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, 2005 was $8,857,000. The
cash used in operations reflects the net loss for the year of $11,437,637,
reduced by $1,623,081 for non-cash interest charges related to acceleration and
amortization of debt discounts, and primarily relates to the continued expansion
in the size of our sales force and external marketing initiatives of $1,177,000
in support of the commercialization of EVLT(R), as well as $2,700,000 in legal
fees incurred in asserting our EVLT(R) patent.
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 continued 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 INVESTING
Cash used in investing activities for the year ended December 31, 2005 was
approximately $4,583,000 including purchases of available for sale securities of
$6,800,000, proceeds from maturities of available for sale securities of
$3,107,000, a promissory note of $500,000 issued to us by Luminetx and computer
and demonstration equipment of $576,000. 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 PROVIDED BY FINANCING
Cash provided by financing activities for the year ended December 31, 2005 was
$8,568,000. This includes approximately $9,150,000 raised in the September 30,
2005 private placement, net of costs, $405,000 which we received from the
exercise of warrants we issued in the 2004 equity and debt financing offset by
$1,000,000 in payments related the current maturities of the EVLT(R) technology
acquisition obligation and $150,000 in preferred stock dividends.
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.
BANK LINES OF CREDIT
Diomed, Ltd., the Company's United Kingdom-based subsidiary, utilizes an
overdraft facility as well as an accounts receivable line of credit with
Barclays Bank, limited to the lesser of (GBP)100,000 or 80% of eligible accounts
receivable. We received a waiver to increase the overdraft to 80% of accounts
receivable or $420,519 at September 30, 2006. The credit line bears interest at
a rate of 2.5% above Barclays' base rate (4.75% at September 30, 2006) and
borrowings are due upon collection of receivables from customers. As security
for the line of credit, Barclay's Bank has a lien on all of the assets of Diomed
Ltd., excluding certain intellectual property. As of September 30, 2006, there
was $420,519 outstanding and at December 31, 2005, there was approximately
$53,924 outstanding under this line of credit.
FUTURE AVAILABILITY OF CREDIT
As of December 31, 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 September 30, 2006, two of the three investors who
purchased debentures in 2004 continued to hold debentures of at least 10% of the
original principal amount. Also, under the terms of the September 29, 2006
financing transaction, we agreed that so long as any investor owned at least 25%
of the shares of preferred stock initially purchased, we would not incur
indebtedness (other than ordinary course trade payables and installment loans)
in excess of $1 million (including the Barclays Bank line of credit) without
prior approval of the holders of 65% of the outstanding 2006 preferred stock.
41
The following summarizes our capital financing transactions during 2006:
PRIVATE PLACEMENT EQUITY FINANCING COMPLETED SEPTEMBER 29, 2006
Description of the 2006 Preferred Stock
On September 29, 2006, we issued 1,735.4347 shares of preferred stock, each
share of which has a stated value of $11,500 per share. We issued 870.4348 of
these shares to investors who purchased these shares for cash at a price of
$11,500 per share, and we issued 864.9999 shares to investors who tendered all
3.975 million outstanding shares of preferred stock we issued in 2005 in
exchange for shares of the 2006 preferred stock, all in accordance with the
terms of a Securities Purchase Agreement we entered into with the investors in
July 2006.
Exchange Provisions. At an investor's option, each share of the 2006
preferred stock may be exchanged for shares of the common stock. Subject to
applicable limitations on ownership (described below), each share of the 2006
preferred stock is exchangeable for the number of shares of the common stock
equal to $11,500 divided by the exchange rate. The exchange rate initially is
$1.15 and is subject to certain adjustments, including reduction if we make
certain dilutive issuances of equity securities in the future. The antidilution
adjustment provides that if we sells shares of the common stock (or the rights
to acquire the common stock) for a price lower than the then-current exchange
rate, the exchange rate will be reduced to the weighted average price of the
common stock issued after giving effect to the dilutive issuance.
We also have the right to require the investors to exchange their shares of the
2006 preferred stock if the trading price of the common stock achieves and
remains at a price level of $2.875 per share and certain other conditions are
satisfied. Upon a change of control (as defined), shares of the preferred stock
will automatically be exchanged for the right to receive either (1) the
liquidation preference of the 2006 preferred stock of $13,800 per share or (2)
the consideration which would have become payable in the change of control
transaction to the holders of the preferred stock in respect of the shares of
common stock underlying the preferred stock, whichever is greater. For purposes
of the preferred stock, a "change of control" is defined to include only (i) the
sale by us of all or substantially all of our assets or (ii) a merger,
consolidation or other business combination where either (1) we are not the
surviving entity or (2) either the holders of our capital stock immediately
prior to the transaction have 50% or less of the voting rights of the surviving
entity or own 50% or less of the outstanding voting securities of the surviving
entity immediately following the transaction or the board of directors
immediately prior to the transaction comprise 50% or less of the board of
directors of the surviving entity. A change in ownership of our outstanding
capital stock is excluded from the definition of "change in control."
We did not structure the definition of "change of control" for the purpose of
discouraging a takeover of the Company. Rather, we defined "change of control"
in this manner to ensure that the 2006 preferred stock would not become
redeemable by the holders as a result of an event outside of our control. We
believe that under applicable accounting standards, this, together with the
other terms and conditions of the 2006 preferred stock, enabled us to categorize
the 2006 preferred stock as stockholders' equity on our balance sheet, which in
turn will assist us in complying with the minimum stockholders' equity required
by the AMEX in its continued listing criteria.
Redemption. The investors do not have the right to require us to redeem
their shares of the 2006 preferred stock. We, however, have the right to redeem
the 2006 preferred stock after the fifth anniversary of the completion of the
financing transaction at a price equal to 120% of the issue price, or $13,800
per share.
Dividends. Dividends do not accrue on the 2006 preferred stock unless
and until we complete a transaction in the future that reduces the effective
conversion price of our outstanding convertible debentures below the conversion
price in effect upon the completion of the financing transaction ($1.15), as a
result of the operation of the antidilution rights of the holders of the
debentures, but only if at the time of the future transaction the reduction in
conversion price affects debentures having an aggregate principal amount of at
least $1,000,000. Thereafter, dividends will accrue on the issued and
outstanding shares of the 2006 preferred stock at the rate of 15% per annum and
will be payable quarterly in arrears.
Voting Rights. The holders of 2006 preferred stock will be entitled to
vote on all matters submitted to a vote of our stockholders, together with the
holders of common stock, voting as a single class. The holders of 2006 preferred
stock will vote their shares on the basis of the number of shares of common
stock into which the 2006 preferred stock is then exchangeable (subject to the
applicable limitations on ownership described below). If, under the Delaware
General Corporation Law, the holders of 2006 preferred stock are required to
approve any action by separately voting as a class, the vote of the holders of
at least 65% of the outstanding shares of the 2006 preferred stock will be
required to approve such action.
Liquidation. The 2006 preferred stock shall be preferred over and
senior to the common stock and any other class or series of capital stock
created by the Company. Upon the occurrence of any event causing our liquidation
or any change of control transaction (as defined) by the Company, the holders of
then-outstanding shares of preferred stock will be entitled to receive, from the
proceeds of such event or transaction, before any distribution is made to any
other class or series of capital stock, an amount equal to the greater of (i)
$13,800 per share of the preferred stock or (ii) such amount per share of the
preferred stock as would have been payable had each share been exchanged into
common stock immediately prior to the event or transaction. If there are
sufficient proceeds from the liquidation or change of control transaction (as
defined) remaining after the distribution to the holders of the preferred stock,
the remaining proceeds will be distributed ratably among the holders of the
common stock.
42
Anti-Dilution Adjustments to the Exchange Rate. The exchange rate of
the 2006 preferred stock will be adjusted if we offer or sell any common stock
or common stock equivalent securities at an effective price per share of less
than the exchange rate of the 2006 preferred stock, (initially, $1.15). The
exchange rate will not be adjusted, however, for our issuance of common stock or
common stock equivalent securities exercisable below the exchange rate if such
issuance is limited to: (i) shares of common stock or options issued to
employees, officers, directors or consultants pursuant to an equity plan
approved by the stockholders or (ii) the exchange of exchangeable or convertible
securities already outstanding as of the date of the Securities Purchase
Agreement.
Liquidated Damages. We may be required to pay liquidated damages to the
investors if we fail to timely comply with an investor's request to exchange
shares of the 2006 preferred stock for shares of the common stock or if we do
not timely remove restrictive legends from certificates representing shares of
the common stock when requested by the investor and permitted by applicable law.
The liquidated damages are payable in the amount of 1% per day of the issue
price of the shares of the 2006 preferred stock subject to the investor's
request and are subject to an aggregate cap of 25% of the issue price paid by
the Investor for the 2006 preferred stock (inclusive of any other liquidated
damages payable by we in respect of the 2006 preferred stock). If we fail to
timely issue shares of the common stock upon exchange or remove legends from
shares of the common stock when requested by investors and permitted by
applicable law and the investor purchases other shares of common stock to settle
the sale of shares of common stock that were intended to be settled by shares of
common stock issuable upon exchange of the unlegended shares, then we may also
be required to pay to the investors the difference between the proceeds of sale
of the shares of the common stock sold and the price paid for the other shares
of the common stock purchased for settlement purposes.
In accordance with EITF Number 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," (EITF 00-27), we compared the amount allocated to the
2006 preferred stock of $10,010,000 to the fair value of the common stock that
would be received upon conversion to determine if a beneficial conversion
feature existed. We determined that a beneficial conversion feature of $469,938
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. In accordance with EITF 98-5, this adjustment of $469,938 is
analogous to a dividend and recognized as a return to the shareholders and has
been included in the beneficial conversion feature of 2006 preferred stock in
our calculation of net loss applicable to common stockholders and basic and
diluted net loss per share. We recorded the 2006 preferred stock to permanent
equity in accordance with the terms of EITF Abstracts - Appendix D - Topic D-98:
Classification and Measurement of Redeemable Securities ("Topic D-98").
We also issued 370,000 placement fee warrants to Musket Research Associates,
Inc. ("MRA") and $610,600 in consideration of services to both MRA and Roth
Capital Partners. The placement fee warrants are exercisable for five years from
the date of listing with the AMEX at an exercise price of $1.15 per share,
subject to reduction in the case of dilutive issuances.
In addition, the holders of the placement fee 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 on the Trading Day immediately preceding the date of such
election;
B = the Exercise Price of this warrant, as adjusted; and
X = the number of Warrant Shares issuable upon exercise of this Warrant
in accordance with the terms of this Warrant by means of a cash exercise rather
than a cashless exercise
Where:
"VWAP" means, for any security as of any date, the price determined by the first
of the following clauses that applies: (a) if the common stock is then listed or
quoted on a Trading Market, the daily volume weighted average price of the
common stock for such date on the Trading Market on which the common stock is
then listed or quoted as reported by Bloomberg Financial L.P. (based on a
Trading Day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (b) if the
common stock is not then listed or quoted on a Trading Market and if prices for
the common stock are then quoted on the OTC Bulletin Board, the volume weighted
average price of the common stock for such date on the OTC Bulletin Board; (c)
if the common stock is not then listed or quoted on the OTC Bulletin Board and
if prices for the common stock are then reported in the "Pink Sheets" published
by the National Quotation Bureau Incorporated (or a similar organization or
agency succeeding to its functions of reporting prices), the most recent bid
price per share of the common stock so reported; or (d) in all other cases, the
fair market value of a share of common stock as determined by an independent
appraiser selected in good faith by the holders of the preferred stock and
reasonably acceptable to the Corporation, where "Trading Day" means a day on
which the common stock is traded on a Trading Market, and "Trading Market" means
the following markets or exchanges on which the common stock is listed or quoted
for trading on the date in question: the Nasdaq SmallCap Market, the American
Stock Exchange, the New York Stock Exchange or the Nasdaq National Market.
Description of the Transaction Documents
Securities Purchase Agreement
The following summary sets forth the provisions of the Securities Purchase
Agreement:
On July 27, 2006, we entered into a Securities Purchase Agreement with the
investors, under which we agreed to issue and sell to the investors an aggregate
of 1,735.4347 shares of the 2006 preferred stock. Of this total, we agreed to
sell 870.4348 shares of the 2006 preferred stock for cash at a price per share
of $11,500 per share, which will result in gross proceeds of $10,010,000 to the
Company. We agreed to issue the other 864.9999 shares of the 2006 preferred
stock in exchange for all 3,975,000 currently outstanding shares of the 2005
preferred stock. Each share of the 2006 preferred stock will be exchangeable for
10,000 shares of our common stock. For a discussion of the terms and conditions
on which we and the investors have agreed that the shares of the 2006 preferred
stock may be exchanged, see "Description of the 2006 Preferred Stock," above.
Following the completion of the transactions set forth in the Securities
Purchase Agreement on September 29, 2006, no shares of the 2005 preferred stock
were issued or outstanding, and 1,735.4347 shares of the 2006 preferred stock
were issued and outstanding. The shares of the 2006 preferred stock then issued
and outstanding exchangeable for, in the aggregate, 17,354,347 shares of common
stock.
43
Form of Par Warrant
The Securities Purchase Agreement places limitations on ownership on the
investors of either 4.99% of the total outstanding shares of common stock or
9.99% of the outstanding shares of common stock (depending on the particular
investor). To the extent that exchanging shares of the 2006 preferred stock for
shares of common stock would violate these limitations on ownership of the
common stock, we may issue a common stock purchase warrant (the "Par Warrant"),
exercisable for the number of shares of our common stock which exceeds the
shares that the Investor could have acquired if not for the limitation on
ownership.
The following summarizes the terms of the Par Warrants:
Each Par Warrant will be exercisable for a purchase price of $0.001 per share
for a period of five years from the date the Par Warrant is issued to investor.
The Par Warrants are exercisable by the holder at any time (subject to common
stock ownership limitations) by delivering a Notice of Exercise Form to us in
substantially the form attached to the Par Warrants, provided that the investor
delivers the original Par Warrant to us within three days of sending the Notice
of Exercise to us. No Par Warrant exercise will be accepted by us if such
exercise causes the common stock ownership of the investor exercising the Par
Warrant to exceed the limitation on common stock ownership set forth in the
Securities Purchase Agreement applicable to such investor. We agreed to register
the shares of common stock underlying the Par Warrants on the same registration
statement as the other Securities and upon the terms set forth in the
Registration Rights Agreement.
Upon an investor's exercise of its Par Warrant, we will deliver to the investor
a certificate representing the shares underlying the exercised Par Warrant
within two trading days of the exercise date. If at any time we fail to deliver
the common stock underlying the Par Warrant to an investor upon the investor's
proper exercise of the Par Warrant, we will pay the investor any difference in
market price of such shares of common stock on the date the common stock should
be delivered and the date the common stock is actually delivered to the
investor. Penalties under the Par Warrant are subject to the 25% cap on
liquidated damages set forth in the Securities Purchase Agreement.
The exercise price of the Par Warrants will be adjusted in the event of any
stock dividends, stock splits, distributions of our assets and pro rata
distribution by we of convertible securities or instruments to holders of common
stock. Additionally, in the event we undergo a change of control (as defined),
liquidation, share exchange or other fundamental transaction, the Par Warrant
holder will have the right to receive the stock, cash or other property such
holder would have received had the Par Warrant holder held the number of shares
of common stock for which the Par Warrant is exercisable.
The laws of New York would govern the construction and enforcement of the Par
Warrants.
Registration Rights Agreement
Upon completing the financing transaction on September 29, 2006, we entered into
a registration rights agreement among us and the investors. Pursuant to the
Registration Rights Agreement, we agreed to file (at our expense) a registration
statement on Form SB-2 with the SEC, registering for public resale the
"registrable securities" consisting of the shares of the common stock that are
issuable upon exchange of the shares of 2006 preferred stock issued to investors
in the financing transaction and the shares of common stock that are issuable
upon exercise of the Par Warrants, should any Par Warrants be issued in lieu of
common stock as a result of applicable limitations on ownership. The
registration statement of which this prospectus is a part is the registration
statement we agreed to file under the Registration Rights Agreement.
44
We were required to file the registration statement within 45 days of the
closing of the financing transaction and to use our best efforts to cause the
registration statement to be declared as soon as practicable, but no more than
120 days of the closing of the financing transaction. We agreed to pay
liquidated damages to the investors if we did not file the registration
statement within 45 days of the closing date of the financing transaction, if
the registration statement is not declared effective within 120 days of the
closing date, is not continually effective for any period that exceeds 20
consecutive days or 30 aggregate days during any 12-month period or if the
common stock does not remain listed on an applicable stock exchange after the
effective date of the registration statement. If any of the foregoing occurs, we
may be required to pay each investor liquidated damages for the period from the
date on which such event occurs until the event is cured, at a monthly rate
equal to 3% of the original issue price of the 2006 preferred stock, prorated
for partial months based on the number of days in the month. The liquidated
damages are subject to an aggregate cap of 25% of the issue price paid by the
investors for the shares of the 2006 preferred stock (inclusive of any other
liquidated damages payable by us in respect of the preferred stock).
The initial number of securities included in the registration statement and any
increase in the number of registrable securities included therein shall be
allocated pro rata among the investors based on the number of registrable
securities held by each investor at the time the registration statement is
declared effective by the SEC. If an investor sells or otherwise transfers any
of the investor's securities to one or more of the other investors, each
transferee investor shall be allocated a pro rata portion of the number of
registrable securities included in such registration statement for such
transferor investor at the time of transfer. Any shares of common stock included
in a registration statement that remain allocated to any investor which ceases
to hold any securities covered by the registration statement shall be allocated
to the remaining investors, pro rata, based on the number of registrable
securities covered by the registration statement which are then held by such
investors.
45
We also agreed that if the SEC does not permit the shares of common stock
underlying the Par Warrants to be registered in the same registration statement
as the shares of common stock issuable upon exchange of the 2006 preferred
stock, we shall prepare and file with the SEC, as soon as practicable and in any
event no later than our first issuance of any Par Warrants, an additional resale
registration statement covering the resale of the warrant shares issuable upon
exercise of any and all Par Warrants that we may issue from time to time.
46
We shall bear all fees and expenses incident to the performance of or compliance
with the Registration Rights Agreement, whether or not any registrable
securities are sold pursuant to the registration statement.
The Registration Rights Agreement contains indemnification provisions that
obligate us to indemnify and hold harmless each investor and its directors,
legal counsel and accountants and any underwriter for losses caused by (i) any
untrue statement of material fact or omission of a material fact in the
registration statement or any prospectus included therein, (ii) our violation of
the Securities Act or the Exchange Act, or any rule or regulation thereunder
relating to our acts or omissions in connection with the registration statement.
The laws of New York are expected to govern the construction and enforcement of
the Registration Rights Agreements. The Registration Rights Agreements also
contain other customary terms found in similar agreements, including provisions
concerning registration procedures.
Placement Agent Agreements
We engaged Musket Research Associates, Inc. ("MRA") and Roth Capital Partners,
LLC ("RCP") as our placement agents in connection with the financing
transaction, and we agreed to pay fees to MRA and RCP out of the proceeds of the
financing transaction for their services, as follows:
o MRA. We agreed to pay (i) cash fees equal to 6.0% of the
aggregate cash proceeds received from the MRA Contacts (as
defined in the agreement between us and MRA) and (ii) issue
common stock purchase warrants to designees of MRA exercisable
at the same price per share as paid by the investors in the
financing transaction, exercisable for five years, in that
number equal to 5% of the number of the common stock
equivalent securities actually purchased by MRA Contacts, and
o RCP. We agreed to pay (i) cash fees equal to the greater of
(a) 6% of the amount raised by RCP from Existing RCP investors
and New RCP investors (as defined in the agreement between RCP
and the Company) and (b) $100,000, as long as each of the
Existing RCP investors has either exercised its rights to
receive the benefit of future preferential financing terms or
has waived certain redemption and other rights pursuant to the
waiver attached to the term sheet for the financing, in each
case as to all shares of the 2005 preferred stock purchased by
the Existing RCP investors from us on September 30, 2005, and
(ii) issue Placement Agent Warrants in that number equal to 5%
of the number of the common stock equivalents purchased by New
RCP investors.
Accordingly, upon completion of the financing transaction on September 29, 2006,
we paid an aggregate of $610,600 in cash to MRA and RCP, and issued placement
agent warrants representing 370,000 shares of common stock to designees of MRA
(no Placement Agent Warrants were issued to RCP).
David Musket, a principal of MRA, invested $138,500 from the fees payable to MRA
that MRA would have otherwise paid over to Mr. Musket.
Both MRA and Mr. Musket are affiliates of ProMed Partners, L.P., whose
affiliated parties beneficially owned in excess of five percent of our
outstanding shares of common stock prior to the September 29, 2006 financing
transaction. See "Related Party Transactions," below, for further information.
ANTIDILUTION ADJUSTMENTS TO OUTSTANDING SECURITIES RESULTING FROM SEPTEMBER 29,
2006 FINANCING TRANSACTION
The terms of certain of our previously issued and outstanding securities (the
"Anti-Dilution Securities") provide for adjustments to the effective price
payable for shares of the common stock upon conversion or exercise of those
Anti-Dilution Securities and, in certain cases, for an increase in the number of
underlying shares of common stock, if we complete certain future transactions
and the effective price per share of the common stock or common stock
equivalents that we issue in the future transaction is less than the effective
price per share under the terms of the Anti-Dilution Security. The September 29,
2006 financing transaction was at an effective price per share of common stock
of $1.15, which constituted a dilutive transaction under the terms of the
Anti-Dilution Securities.
Accordingly, when we completed the financing transaction, antidilution
provisions of Anti-Dilution Securities resulted in the following adjustments:
47
o the conversion price of the outstanding convertible debentures we
issued in our October 25, 2004 financing transaction ($3.712 million
principal amount) was reduced from $2.29 per share common stock to
$1.15 per share which, when converted will result in an increase in
the number of shares of common stock to be issued from 1,620,961 to
3,227,826;
o the exercise price of the warrants to purchase common stock we
issued to the investors in our October 25, 2004 financing
transaction (the "2004 Warrants") was reduced from $2.10 to $1.15
per share of the common stock;
o the exercise price of the warrants to purchase common stock we
issued to the investors in our September 30, 2005 financing
transaction (the "2005 Warrants") was reduced from $2.50 to $1.98
per share, and the number of shares of common stock issuable upon
exercise of the 2005 Warrants increased from 1,800,000 to 2,272,000;
and
o the exercise price of certain warrants to purchase shares of the
common stock we issued to designees of our former placement agent,
Sunrise Securities Corp. (the "Sunrise Warrants"), was reduced and
the number of shares of common stock issuable upon exercise of these
Sunrise Warrants increased from 139,315 to 155,843 as follows:
a. the exercise price of certain Sunrise Warrants decreased from
$2.32 to $1.77 per share, and the number of shares of common
stock issuable upon exercise of these Sunrise Warrants
increased from 42,282 to 55,559;
b. the exercise price of certain Sunrise Warrants decreased from
$1.93 to $1.50 per share, and the number of shares of common
stock issuable upon exercise of these Sunrise Warrants
increased from 11,455 to 14,706; and
c. the exercise price of certain Sunrise Warrants decreased from
$2.10 to $1.15 per share (no adjustments impacted the
remaining Sunrise Warrants).
The following table sets forth the numbers of shares of common stock currently
underlying the Anti-Dilution Securities and the numbers of shares that underly
the Anti-Dilution Securities following completion of the September 29, 2006
financing transaction:
----------------------------- --------------------------- ---------------------------- --------------------------
Number of Underlying Number of Underlying Net Increase in
Description of Common Shares Before Shares After Antidilution Underlying Common
Anti-Dilution Security Antidilution Adjustment Adjustment Shares
----------------------------- --------------------------- ---------------------------- --------------------------
Debentures 1,620,961 3,227,826 1,606,865
----------------------------- --------------------------- ---------------------------- --------------------------
2005 Warrants 1,800,000 2,272,000 472,000
----------------------------- --------------------------- ---------------------------- --------------------------
Sunrise Warrants 139,315 155,843 16,528
------------------ ------------------- -------------------
----------------------------- --------------------------- ---------------------------- --------------------------
----------------------------- --------------------------- ---------------------------- --------------------------
TOTAL 3,560,276 5,655,669 2,095,393
================== =================== ===================
----------------------------- --------------------------- ---------------------------- --------------------------
AMENDMENT TO CERTIFICATE OF INCORPORATION APPROVED SEPTEMBER 27, 2006
Prior to the September 29, 2006 financing transaction, our Certificate of
Incorporation authorized us to issue up to 50,000,000 shares of common stock and
20,000,000 shares of preferred stock. In contemplation of the financing
transaction that we completed on September 29, 2006, on September 27, 2006, our
stockholders approved an amendment to our certificate of incorporation to
authorize us to issue up to 1,736 shares of the new series of preferred stock
and to increase the number of shares of our common stock that we are authorized
to issue to 65,000,000 shares.
The amendment to the certificate of incorporation had the effect of canceling
the shares of preferred stock that we issued on September 30, 2005, which the
holders of these shares surrendered to us in exchange for shares of the new 2006
series of preferred stock. The amendment removed the provision of our former
certificate of incorporation that authorized our board to issue preferred shares
with voting and preference rights as assigned by the board. We are now only
authorized to issue only 1,736 shares of our 2006 preferred stock, all but a
fraction of which are now issued and outstanding, and 65,000,000 shares of our
common stock, 19,448,728 of which are now issued and outstanding. The rights,
preferences and privileges relating to the 2006 series of preferred stock are
described at "Description of the 2006 Preferred Stock," above.
The additional shares of common stock authorized by our amended certificate of
incorporation have rights identical to the currently outstanding shares of our
common stock. The future issuance of these shares of common stock will not
affect the rights of the holders of our currently outstanding common stock,
except for effects incidental to increasing the number of shares of our common
stock outstanding, such as dilution of the earnings per share.
Though our board has no other plans to issue the additional shares of common
stock, it desires to have the shares available to enable us to have a limited
number of shares reserved and to provide additional flexibility to use common
stock for business and financial purposes in the future. The additional shares
may be used for various purposes without further stockholder approval, except to
the extent required by applicable rules of the AMEX. These purposes may include
raising capital, establishing strategic relationships with other companies,
expanding our business or product lines through the acquisition of other
businesses or products, and other purposes.
48
We could also use the additional shares of common stock that would become
available for issuance to oppose a hostile takeover attempt or to delay or
prevent changes in control or our management, including transactions in which
the stockholders might otherwise receive a premium for their shares over then
current market prices. Although the number of shares is unlikely to be large
enough to be effective in that regard, it is possible that, without further
stockholder approval, our board could strategically sell shares of common stock
in a private transaction to purchasers who would oppose a takeover or favor the
current board, and the number of shares so issued could result in a vote in
favor of our current board.
TRANSACTIONS IN 2005
The following summarizes our capital financing transactions during 2005:
EXERCISE OF WARRANTS
During the year ended December 31, 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 of
$404,904 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.
ACCELERATION OF STOCK OPTIONS
On December 16, 2005, our board of directors determined to accelerate the
vesting of our unvested stock options previously awarded to our directors,
officers and employees pursuant to our 2003 Omnibus Incentive Plan, 2001 Stock
Option Plan and 1998 Stock Option Plan with an exercise price greater than $4.00
per share. The closing price of our common stock on the American Stock Exchange
on that date was $1.90. As a result of this acceleration, we will recognize no
compensation expense for options to acquire approximately 574,000 shares of
common stock (representing approximately 3% of the common stock outstanding on
December 16, 2005) which would have vested during the fiscal years ended
December 31, 2006 and 2007 had we not accelerated vesting of these options. As a
result of these actions, we eliminated approximately $1,657,000 of future
after-tax compensation expense relating to employee stock options after January
1, 2006.
ISSUANCE OF WARRANTS TO LUMINETX CORPORATION
On August 5, 2005, in connection with our distribution agreement we entered into
with Luminetx Corporation pursuant to which we shall act as distributor of the
Luminetx VeinViewer(TM) system, 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 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 vested and exercisable
when issued (subject to prior listing of the underlying shares with the American
Stock Exchange), and the remainder of the warrants vested and became exercisable
when both (i) Luminetx produced at least 100 units of the VeinViewer(TM) system
and (ii) we accepted delivery of at least 25 units of the VeinViewer(TM) system.
On August 4, 2006, Luminetx notified us that it had achieved the contractual
milestones necessary to effect the remaining fifty percent of the warrants as
required under the distribution agreement, and accordingly, the remaining
300,000 warrants became immediately vested and exercisable on that date.
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 the
preferred stock (approximately $9.5 million net of financing costs, but
excluding 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).
49
The following summarizes the principal terms of the transaction:
Preferred Stock
We entered into a share exchange agreement with the investors who purchased 2005
preferred stock, pursuant to which the investors may exchange shares of
preferred stock for shares of common stock. Each share of preferred stock could
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 provided that if we sold common stock (or the right
to acquire common stock) for a price lower than the then-current exchange rate,
the exchange rate would be reduced to the amount paid for the shares of common
stock, (such as the September 29, 2006 financing transaction) subject to a floor
of $2.17 until the stockholders approved the elimination of the floor price at
our 2006 annual meeting of stockholders. As a result, if we were to make a
dilutive issuance (such as the September 29, 2005 financing transaction), then
the exchange rate for the preferred stock would 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 failed 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 was not declared effective by the Commission within 120 days of
the September 30, 2005 closing date (or, after being declared effective by the
Commission, became unavailable to the investors for the resale of their common
stock). We filed the necessary registration statement on November 9, 2005 and
the SEC declared that registration statement effective on December 1, 2005. We
also agreed to pay liquidated damages to the investors if the common stock was
suspended from trading or is not listed on an exchange. The liquidated damages
in each case were equal to 3% per month of the aggregate purchase price paid by
investors for the preferred stock.
The investors had the right to redeem the 2005 preferred stock for cash at a 20%
redemption premium over the issue price (or, $3.00 per share) if redemption
events set forth in the exchange agreement occurred and were not cured within
the applicable cure period. These events are (i) those registration events,
described above, entitling the investors to receive liquidated damages, (ii) the
failure to remove restrictive legends upon an investor's request when permitted
under applicable law, (iii) the failure to issue common stock upon exchange in
accordance with the exchange agreement, (iv) our announcement that we intend not
to issue common stock in exchange for preferred stock, (v) suspension of the
common stock from trading on a national securities exchange for a defined period
of time, (vi) bankruptcy events, (vii) a default under our indebtedness or one
of our material agreements and (viii) a concentration of ownership of our
capital stock of 35% which continues for thirty days. After five years, we also
had the right to redeem the preferred stock at a 20% premium over the issue
price.
The holders of outstanding shares of preferred stock were 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 daily on each share of preferred stock,
whether or not earned or declared, and shall accrue until paid. We were
permitted to pay the dividends with cash or, if under certain conditions, shares
of common stock, valued at the volume weighted average price for the ten-day
period immediately prior to the dividend payment date. These dividends are
payable at the end of each of our fiscal quarters while preferred stock was
outstanding. The dividends would 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) and certain conditions were met.
Each holder of preferred stock was 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 voted 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 would be required for
approval).
The 2005 preferred stock was preferred over the common stock, and any class or
series of capital stock that our board of directors may have created in the
future, as to the assets 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 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 were 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.
50
Warrants
The warrants were fully vested upon issuance and are exercisable for five years
from the date of listing of the underlying shares of common stock with the
American Stock Exchange (January 6, 2006) 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, initially subject to a floor of $2.12, until the
stockholders approved the elimination of the floor price at our 2006 annual
meeting of stockholders. As a result, if we were to make a dilutive issuance
(such as the September 29, 2005 financing transaction), then the exercise price
of the warrants would 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 (volume weighted average price, as defined in the
warrant agreement) on 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, 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, if any, 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 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 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 SEC. We undertook to file a registration
statement within 45 days of completion of the financing, and agreed that if the
SEC did not declare this registration statement effective within 120 days of
completion of the financing (or if the registration statement ceases to be
effective), we would pay liquidated damages to the investors. We also agreed to
keep the registration statement effective, and that if it is not effective for
20 consecutive trading days or 30 trading days during any 12-month period, we
would pay liquidated damages. The liquidated damages will be equal to 3% per
month of the aggregate purchase price paid by the investors for the preferred
stock. On November 9, 2005, we filed a registration statement to satisfy our
obligations to the investors in the September 2005 financing, and on December 6,
2005, the SEC declared that registration statement effective.
Accounting for September 30, 2005 Financing Transaction
Because the preferred stock includes stated dividend rates that increase over
time, from a rate considered below market, we amortized an incremental amount
which together with the stated rate for the period resulted in a constant
dividend rate in accordance with SEC Staff Accounting Bulletin Topic 5Q. We
determined that the present value of the incremental dividends of $1,371,429
would be amortized over the period preceding the perpetual dividend rate using
an effective interest rate of 16.5%. We increased the carrying value of the
preferred stock with an offset to additional paid-in capital periodically, as we
do not have retained earnings, and reduced 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. At December 31, 2005 we recorded a non-cash dividend of $149,000 for the
affect of the increasing rate dividends. Since the preferred stock may become
redeemable upon the occurrence of a redemption event that is not solely within
the control of the issuer, we recorded the preferred stock outside of permanent
equity on our balance sheet.
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Emerging Issues Task Force (EITF) Number 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 initially recorded and
carried at fair value until the contract meets the requirements for
classification as equity, until the contract is exercised or until the contract
expires. Because the liquidated damages under the registration rights agreement
had no contractual maximum, we determined that the liquidated damages did not
represent a reasonable percentage discount of the fair value of an unregistered
share versus a registered share and thus, could result in net-cash settlement of
the transaction in accordance with EITF 00-19. Because the 1,600,000 warrants
are classified as a liability, any changes in fair value will be recorded as
non-cash gain or loss on the fair value of the warrant liability in the
subsequent statements of operations until the warrants are exercised, terminated
or expired. At December 31, 2005, we recorded a non-cash gain of $157,535 to
revalue the warrants. Accordingly, we valued the warrants using the
Black-Scholes model resulting in a fair value of $2,055,748 recorded as a
warrant liability and we simultaneously recorded $2,055,748 as a discount to the
preferred stock.
In accordance with EITF Number 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," (EITF 00-27), we compared the amount 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. We
determined that a beneficial conversion feature of $575,748 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, we recorded $575,748 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 $1,151,516 is analogous
to a dividend and recognized as a return to the shareholders and has 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 further reduced the carrying value of the preferred stock by $850,000 for
specific incremental costs directly attributable to the transaction including;
investment banking, legal and professional fees.
In addition to the 1,600,000 warrants that we issued to the investors in the
September 2005 financing, in 2005, we also issued warrants to purchase up to
200,000 shares of common stock to the three holders of our convertible
debentures 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, in 2005, 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 debentures.
Impact of 2006 Preferred Stock Financing on September 30, 2005 Financing
As a result of the 2006 preferred stock financing we exchanged the 2005
preferred stock for new 2006 preferred stock. As illustrated in EITF Topic D-42:
The Effect on the Calculation of Earnings per Share for the Redemption or
Induced Conversion of Preferred Stock, ("Topic D-42"), the 2005 preferred
stockholders received additional value as the exchange price was adjusted down
below the original effective exchange price. We compared the excess of the fair
value of the consideration transferred to the holders of the 2005 preferred
stock over the carrying amount of the 2005 preferred stock in our balance sheet
to approximate the return to the 2005 preferred stockholder. For the purposes of
calculating the excess of (1) the fair value of the consideration transferred to
the holders of the 2005 preferred stock over (2) the carrying amount of the 2005
preferred stock in our balance sheet was reduced by the carrying amount of the
2005 preferred stock by the issuance costs of the 2005 preferred stock.
Accordingly, since the value of the 864.999 shares of 2006 preferred stock can
be exchanged for common stock at the ratio of 1 for 10,000 common shares,
multiplied by the market price of common stock on the day of the closing ($1.20)
was $10,379,988; and the carrying value of $8,248,993 less the issuance costs of
$849,444 represents $7,399,549; we recorded the residual fair value of
$2,980,439 as an increase to preferred stock and a decrease to additional
paid-in capital. We also recorded the $2,980,439 as a deemed dividend on the
exchange of the 2005 preferred stock in the calculation of basic and diluted
earnings per share. We reclassified the 2005 preferred stock fair value of
$11,229,432 to permanent equity as a result of the exchange and included it
within the 2006 preferred stock on our balance sheet in accordance with Topic
D-98.
As a result of the exchange and the corresponding implementation of a liquidated
damages cap in an amount that represents a reasonable percentage discount of the
fair value of an unregistered share versus a registered share, the warrants are
no longer required to be accounted for as a liability under EITF 00-19.
Therefore, the warrant liability of $926,771 was marked to market one final time
at September 29, 2006, through a charge to the statement of operations in the
amount of $68,995, and then reclassified to additional paid-in capital.
52
In accordance with the contingent anti-dilution terms of the 2005 preferred
stock warrant agreement, the exercise price and number of warrants originally
issued to the 2005 preferred stockholders were adjusted so that the number of
warrants increased by 472,000 and the exercise price decreased to $1.98.
Increasing rate dividends and cash dividends of the 2005 preferred stock were
eliminated when the 2005 preferred stock was exchanged for the 2006 preferred
stock.
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 American Stock Exchange, we completed this transaction.
We raised gross proceeds of approximately $10.6 million from this financing
transaction. 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 debentures mature on October 25, 2008, or such as earlier date as
the debentures are required or permitted to be repaid as provided in the
debenture, in cash or common stock, subject to the terms and conditions of the
debentures. 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 American Stock Exchange
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 December 6, 2005 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.
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%, but will be subject to a minimum of $1.91
per share unless we obtain stockholder approval of the issuance of shares in
payment of interest at a lower price.
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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
September 30, 2006.
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 was 80% of the closing price of the
common stock on the American Stock Exchange 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 was 110% of the $1.91 per share closing
price of the common stock on the American Stock Exchange 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.
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 (volume weighted average price, as defined in the warrant
agreement) on date immediately preceding 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, 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 shares that would have been issued in an exercise for
cash payment).
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. During the year ended December 31, 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.
Limitations on Ownership
The terms of the preferred stock and the warrants that we issued in the October
2004 financing transaction generally limit the ability of any investor to
convert the debentures or exercise warrants to the extent that the shares of
common stock beneficially owned after issuance of the common stock would exceed
4.99% of the shares of common stock outstanding, and limit our ability to force
the conversion of the debentures or issue shares as payment of interest to the
extent that the shares of common stock beneficially owned after issuance of the
common stock would exceed 9.99% of the shares of common stock outstanding.
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.
Impact of 2006 Preferred Stock Financing on October 25, 2004 Financing
We determined that the conversion and exercise price changes were not
modifications to the terms of their respective agreements, but were executions
of contingent conversion options within those agreements. Under EITF 00-27
"Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF
00-27"), the Task Force reached a consensus that if the terms of a contingent
conversion option do not permit an issuer to compute the number of shares that
the holder would receive if the contingent event occurs and the conversion price
is adjusted, an issuer should wait until the contingent event occurs and then
compute the resulting number of shares that would be received pursuant to the
new conversion price.
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Prior to the transaction, the 2004 debt was convertible into 1,620,961 shares,
and after the 2006 preferred stock financing the 2004 debt is convertible into
3,227,826 shares. The difference of 1,606,865 shares multiplied by the market
price of our common stock on the date of the closing of $1.20 results a new fair
value of $3,631,516. Because the result was in excess of the carrying value of
the debt, we recorded a discount of $2,255,843. This debt discount will be
accreted back to debt over the remaining two years of the 2004 convertible debt
through charges against non-cash interest expense in our statements of
operations.
The exercise price of warrants originally issued to the 2004 debt holders was
adjusted so that the exercise price decreased to $1.15 in accordance with the
original contingent antidilution terms of those 2004 warrants.
CHANGES IN CAPITAL STOCK STRUCTURE
On September 27, 2006, our stockholders approved an amendment to our certificate
of incorporation to (i) increase the number of shares of common stock authorized
for issuance from 50 million to 65 million and (ii) eliminated the "blank check"
preferred stock provisions of our former certificate of incorporation and
authorized us to issue only that number of shares (plus a fraction of a share
for purposes of authorizing a whole number) of common stock, having the
particular rights and preferences as included in the terms of the new series of
2006 preferred stock contemplated by the financing transaction. On September 29,
2006, the holders of all outstanding shares of preferred stock we issued
September 30, 2005 exchanged these shares for shares of the new series of
preferred stock, and we sold additional shares of the new series of preferred
stock to investors for gross cash proceeds of $10.01 million at an effective
price of $1.15 per share of underlying common stock.
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 so designated were never issued). As a result, we had 15,800,000 shares
of authorized but unissued shares of preferred stock until we amended our
certificate of incorporation to create the new series of 2006 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 500,000,000 to 50,000,000 which we
implemented concurrent with the reverse stock split.
55
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 the Luminetx patented biomedical imaging
system known as the VeinViewer(TM) Imaging System for physicians who perform
sclerotherapy, phlebectomies or varicose vein treatments, in the United States
and the United Kingdom.
We and Luminetx anticipate that Luminetx will sell to us a certain minimum
number of VeinViewer(TM) systems that we will distribute to our customers at
specified prices during the term of our distribution agreement. As a condition
to receiving the exclusive rights under the distribution agreement, we agreed
under the distribution agreement to loan $1 million to Luminetx, of which
$500,000 was provided to Luminetx on August 5, 2005 as specified in our
distribution agreement. We later 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. On
August 4, 2006, Luminetx notified us that it had achieved the contractual
milestones necessary to effect the remaining $500,000 investment as required
under the distribution agreement. Under separate agreement entered into on
August 4, 2006, we agreed to fund the $500,000 investment in two equal
installments. We paid the first installment upon execution of the August 4, 2006
agreement and we paid the second and final installment on October 30, 2006.
Effective August 4, 2006, and with the initial installment payment, Luminetx
issued to us 250,000 shares of its preferred stock and 50,000 warrants under the
same terms as the private placement financing announced by Luminetx on November
4, 2005. These shares and warrants were held as collateral by Luminetx until we
funded the remaining $250,000 installment on October 30, 2006.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 2006, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position Number 00-19-2, "Accounting for Registration Payment
Arrangements" ("FSP EITF 00-19-2"). FSP EITF 00-19-2 addresses an issuer's
accounting for registration payment arrangements. FSP EITF 00-19-2 specifies
that the contingent obligation to make future payments or otherwise transfer
consideration under a registration payment arrangement, whether issued as a
separate agreement or included as a provision of a financial instrument or other
agreement, should be separately recognized and measured in accordance with FASB
Statement No. 5, Accounting for Contingencies.
FSP EITF 00-19-2 is effective immediately for registration payment arrangements
and the financial instruments subject to those arrangements that are entered
into or modified subsequent to the date of issuance of FSP EITF 00-19-2
(December 21, 2006).
For registration payment arrangements and financial instruments subject to those
arrangements that were entered into prior to the issuance of FSP EITF 00-19-2,
this guidance shall be effective for financial statements issued for fiscal
years beginning after December 15, 2006, and interim periods within those fiscal
years.
The Company has evaluated FSP EITF 00-19-2 and does not believe that it will
have an impact on its consolidated financial statements but the Company will
evaluate the probability of any contingent payment in each prospective quarter.
CRITICAL ACCOUNTING POLICIES
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
its 2005 Annual Report on Form 10-KSB/A with the Securities and Exchange
Commission on April 13, 2006, which included audited consolidated financial
statements for the year ended December 31, 2005, and included 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/A for the year ended December 31, 2005.
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, short-term investments 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;
- product warranties;
- inventories;
- deferred income taxes;
- valuation of long-lived and intangible assets;
56
- equity transactions;
- short-term investments; and
- stock based compensation.
Revenue Recognition. We derive revenue primarily from two sources: (i) revenue
from products, including lasers, instrumentation and disposables, and (ii)
revenue from services. Service revenue includes fees earned under extended
service contracts and repairs for products that are not under warranty. We
recognize revenue in accordance with SEC Staff Accounting Bulletin No. 104,
"Revenue Recognition" ("SAB No. 104"). SAB No. 104 requires that four basic
criteria must be met before revenues can be recognized: (1) persuasive evidence
of an arrangement exists; (2) title has transferred; (3) the fee is fixed and
determinable and (4) collectibility is reasonably assured.
We use signed quotations and/or customer purchase orders that include all terms
of the arrangement to determine the existence of an arrangement and whether the
fee is fixed or determinable based on the terms of the associated agreement. We
generally ship F.O.B. shipping point and uses shipping documents and third-party
proof of delivery to verify delivery and transfer of title. We assess whether
collection is reasonably assured by considering a number of factors, including
past transaction history with the customer and the creditworthiness of the
customer, as obtained from third party credit references. If we determine that
collection is not reasonably assured, revenue is deferred until collection
becomes reasonably assured, generally upon receipt of payment.
In certain transactions, we sell additional training or extended service
contracts with the sale of the laser. In those situations, we apply the guidance
in EITF 00-21 "Revenue Arrangements with Multiple Deliverables", and divides the
components into separate units of accounting based on their relative fair
values. Revenue from each unit is recognized in accordance with SAB 104.
We defer revenue for extended service contracts related to future periods and
recognizes revenue on a straight-line basis in accordance with FASB Technical
Bulletin No. 90-1, "Accounting for Separately Priced Extended Warranty and
Product Maintenance Contracts." We provide for estimated warranty costs an
original product warranties at the time of sale.
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. In some cases we assist customers in obtaining 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.
Product Warranties. 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 trends in the volume of product returns within the
warranty period and the cost to repair the laser. We maintain reserves for our
estimated obsolete inventory based on historical cost.
Inventories. 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.
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. We account for tax credits as reductions of the current provision for
income taxes in the year in which related expenditures are incurred.
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 in accordance with SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets" ("SFAS 144"). Should an impairment exist,
recoverability of identifiable intangibles and long-lived assets is measured by
comparison of the carrying amount of an asset to future net undiscounted pretax
cash flows expected to be generated by the asset. If these comparisons indicate
that an asset is not recoverable, we will recognize an impairment loss for the
amount by which the carrying value of the asset exceeds the related estimated
fair value. Estimated fair value is 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.
57
Considerable judgment is required to estimate discounted future operating cash
flows. Judgment is also required in determining whether an event has occurred
that may impair the value of identifiable intangible assets. Factors that could
indicate that an impairment may exist include significant underperformance
relative to plan or long-term projections, strategic changes in business
strategy or a significant negative industry or economic trends.
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" and EITF 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services," 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 base 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.
Short Term Investments. We classify marketable securities with original
maturities greater than three months as short-term investments. Investments that
we designate 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. We reflect unrealized gains and
losses, net of related tax effects, in other comprehensive income (loss) until
realized.
Stock Based Compensation.We maintain stock-based incentive plans, under which we
provide stock incentives to employees and directors. We grant options to
employees and directors to purchase common stock at an option price equal to the
market value of the stock at the date of grant. Prior to the effective date of
SFAS 123R, we applied APB 25, and related interpretations, for our stock option
grants. APB 25 provides that the compensation expense relative to our stock
options is measured based on the intrinsic value of the stock option at date of
grant.
Effective the beginning of the first quarter of fiscal year 2006, we adopted the
provisions of SFAS 123R using the modified prospective transition method. Under
this method, prior periods are not restated. We use the Black-Scholes option
pricing model which requires extensive use of accounting judgment and financial
estimates, including estimates of the expected term participants will retain
their vested stock options before exercising them, the estimated volatility of
our common stock price over the expected term, and the number of options that
will be forfeited prior to the completion of their vesting requirements.
Application of alternative assumptions could produce significantly different
estimates of the fair value of stock-based compensation and consequently, the
related amounts recognized in the Consolidated Statements of Operations. The
provisions of SFAS 123R apply to new stock options and stock options
outstanding, but not yet vested, on the date we adopted SFAS 123R. Stock-based
compensation expense was included in applicable departmental expense categories
in the Consolidated Statements of Operations.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
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 the 2014 term years and again at the end of the 2019
term 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 7,400 square feet of office and distribution space in
Andover, Massachusetts under a lease that was scheduled to expire in April 2008.
We believe that these facilities are in good condition and are suitable and
adequate for its current operations.
RELATED PARTY TRANSACTIONS
During the past two years, we have entered into transactions with several
related parties. The 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.
PARTICIPATION BY RELATED PARTIES IN THE SEPTEMBER 29, 2006 PRIVATE PLACEMENT
FINANCING TRANSACTION
Investors in the financing transaction that we completed on September 29, 2006
included each of the investors in our September 30, 2005 financing transaction
(each of which exchanged all of the shares of preferred stock we issued to them
on September 30, 2005 for shares of the new series of preferred stock we issued
on September 29, 2006). These include affiliates of Gruber & McBaine
International and affiliates of ProMed Partners, L.P. In addition, Promed
Partners, L.P., ProMed Offshore Fund, Ltd. and ProMed Offshore Fund II, Ltd.
invested, in the aggregate, an additional $1,506,500 in cash in the September
29, 2006 financing transaction. Prior to this transaction, Gruber & McBaine
entities beneficially owned approximately 6.8% of our outstanding common stock
ProMed entities beneficially owned approximately 10.3% of our outstanding common
stock (without giving effect to the restrictions on ownership contained in the
terms of our securities held by these entities).
58
Also, one of our directors, Ed Snape, is a principal of the general partner of
New England Partners Capital, L.P. ("NEP") and a director of the management
company of Nexus Medical Partners II S.C.A., SICAR ("Nexus"), an affiliate of
NEP. NEP and Nexus each invested $750,000 in the September 29, 2006 financing
transaction. Although he was initially a member of the finance committee of the
board of directors which was charged with evaluating and negotiating the
financing transaction, when he determined that NEP and its affiliates might have
an interest in investing, he immediately recused himself from the committee.
The terms and conditions of the financing transaction were the same for all
investors, including the ProMed entities and Mr. Snape's affiliated entities.
In addition, the ProMed investors and one additional investor in the September
29, 2006 financing transaction, David Musket, have an affiliation with Musket
Research Associates, Inc. ("MRA"), our co-placement agent in the financing.
Specifically, Mr. Musket is the president of MRA and he also has investment
and/or voting control over the securities held by the ProMed entities. MRA also
served as our co-placement agent in the private placement financing transaction
that we completed on September 30, 2005. As stated above, the ProMed entities
invested a total of $1,506,500 in cash in the September 29, 2006 financing
transaction; Mr. Musket invested $138,000, out of funds that MRA would have
otherwise paid to him from the placement agent fees that MRA earned from us. Our
board of directors determined that our placement agency agreement with MRA was
on fair terms, as if it had been negotiated at arms-length with an unrelated
party, and gave us its prior approval of the agreement.
Further, according to our placement agency agreement with MRA, as partial
compensation for services MRA provided to us, we issued to designees of MRA
warrants to purchase a total of 370,000 shares of common stock. MRA designated
five of its representatives and the three ProMed entities which invested in the
financing to receive these warrants. Among the individuals designated by MRA are
Mr. Musket and Barry Kurokawa, whom we believe shares investment and voting
control over our securities held by the ProMed entities. We did not have
discretion or influence over the persons that MRA designated to receive the
370,000 warrants we agreed to issue to MRA, rather, MRA advised us of its
designees shortly before the financing transaction was completed on September
29, 2006.
Finally, each of the holders of those securities that were subject to
antidilution adjustment as a result of the September 29, 2006 financing
transaction was indirectly interested in this transaction. These investors
include (i) the holders of the warrants to purchase 1.8 million shares of common
stock that we issued on September 30, 2005 and (ii) the holders of (a) $3.712
million principal amount of outstanding convertible debentures and (b)
outstanding warrants to purchase common stock that we issued October 25, 2004.
The September 29, 2006 financing transaction did not alter the terms of these
outstanding securities, rather, it triggered the antidilution adjustments that
were included in the original terms of the outstanding securities. This
benefited the holders of these securities by decreasing the conversion price of
debentures and exercise price of the warrants, and by increasing the number of
common shares underlying the 1.8 million warrants issued September 30, 2005. For
no additional consideration, the holders of the outstanding debentures also
waived certain covenants of the debentures which would have otherwise been
violated by the September 29, 2006 financing transaction.
PARTICIPATION BY RELATED PARTIES IN THE SEPTEMBER 30, 2005 PRIVATE PLACEMENT
FINANCING
Investors in the financing transaction that we completed on September 30, 2005
included 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 and conditions as the other investors in that financing.
MRA served as co-placement agent in the September 30, 2005 financing, and as
noted above, MRA is a related party to 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.
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 included
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.
59
CERTAIN MARKET INFORMATION
Our common stock is traded on the AMEX under the symbol "DIO." On January 26,
2007, our common stock closed at a price of $1.01 per share.
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since February 22, 2002, our common stock has been listed on the American Stock
Exchange under the symbol "DIO." Between November 2001 and February 22, 2002,
our stock was quoted on the OTC Electronic Bulletin Board. Prior to being quoted
on the OTC Bulletin Board, there was no market for our common stock. The
following table sets forth for the periods indicated the high and low bid price
information for the common stock as reported on the American Stock Exchange and
the Over-the-Counter Bulletin Board. The quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions.
PERIOD HIGH LOW
------ ------ ------
2006
First Quarter...................$ 2.83 $ 1.94
Second Quarter..................$ 2.45 $ 1.06
Third Quarter...................$ 1.44 $ 1.00
Fourth Quarter..................$ 1.21 $ .76
2005
First Quarter...................$ 4.68 $ 3.49
Second Quarter..................$ 4.08 $ 2.41
Third Quarter...................$ 3.21 $ 1.92
Fourth Quarter..................$ 2.50 $ 1.73
As of December 31, 2006, there were approximately 317 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 earnings to
support our growth. However, we did pay dividends to the holders of the
now-cancelled preferred stock we issued on September 30, 2005, and we have
agreed to pay dividends on the preferred stock we issued on September 29, 2006
if certain events occur. See "Liquidity and Capital Resources," below for
further details. We do not anticipate paying any cash dividends on our common
stock in the foreseeable future.
DESCRIPTION OF SECURITIES
Our authorized capital stock consists of 65,000,000 shares of common stock, par
value $.001 per share, and 1,736 shares of preferred stock.
As of December 31, 2006, there were 19,448,728 shares of common stock
outstanding and 1,735.4347 shares of preferred stock outstanding (which are
exchangeable for common stock on a 1-for-10,000 basis).
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 (such as the
preferred stock we issued on September 29, 2006, should any of those shares be
outstanding at the time of liquidation, dissolution or winding up) and payment
of other claims of creditors. Each share of common stock outstanding as of
December 31, 2006 is validly issued, fully paid and nonassessable.
60
PREFERRED STOCK
Our board of directors is authorized, subject to any limitations prescribed by
Delaware law, to issue preferred stock. In contemplation of the September 29,
2006 financing transaction and following stockholder approval, we amended our
certificate of incorporation to limit the amount of shares and rights of the
preferred stock to essentially that number of shares and those rights to be
enjoyed by the holders of the 2006 series of preferred stock. As of December 31,
2006, 1,735.4347 shares of preferred stock were issued and outstanding, having
been issued pursuant to the private placement financing that we completed on
September 29, 2006. See `Liquidity and Capital Resources", Transactions in 2006
- - Private Placement Financing Completed September 29, 2006," below, for a
discussion of the particular rights and preferences designated by the board of
directors for these shares of preferred stock. Each share of preferred stock
outstanding as of December 31, 2006 is validly issued, fully paid and
nonassessable. Only a fraction of a share of preferred stock is currently
authorized and unissued.
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, as well as a de minimis number of
non-plan options.
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.
On December 16, 2005, the Board of Directors determined to accelerate the
vesting of the Company's unvested stock options with an exercise price greater
than $4.00 per share previously awarded to the directors, officers and employees
pursuant to the Company's 2003 Omnibus Incentive Plan, 2001 Stock Option Plan
and 1998 Stock Option Plan. The closing price of our common stock on the
American Stock Exchange on December 16, 2005 was $1.90. As a result of this
acceleration, the Company will recognize no compensation expense for options to
acquire approximately 574,000 shares of common stock (representing approximately
3% of the shares of our common stock outstanding on December 16, 2005) which
would have vested during the fiscal years ended December 31, 2006 and 2007. As a
result of these actions, we eliminated approximately $1,657,000 of future
after-tax compensation expense relating to employee stock options after January
1, 2006.
As of December 31, 2006, 755,756 options and other incentive stock awards were
available for future grants under the 2003 Omnibus Plan. In addition, 4,542
options were available under the 2001 Plan and 339 were available under the 1998
Plan as of December 31, 2006.
As of December 31, 2006, options to purchase a total of 2,478,376 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
-------------------------- --------- --------------- ---------------- ---------- ----------------
$ 1.02 - $ 2.15 217,482 8.65 $ 1.44 99,611 $ 1.86
2.16 -
2.29 617,369 9.04 2.24 264,840 2.24
2.30 -
4.00 169,250 7.73 3.18 116,335 3.19
4.01 -
4.75 743,931 7.83 4.24 743,931 4.24
4.76 -
5.00 598,800 7.16 5.00 598,800 5.00
5.01 - 11.50 104,091 6.14 8.59 104,091 8.59
11.51 - 49.00 12,256 4.46 31.20 12,256 31.20
49.01 - 87.00 4,700 5.06 51.06 4,700 51.06
87.01 - 164.00 4,113 1.50 114.55 4,113 114.55
164.01 - 205.75 6,384 1.26 174.47 6,384 174.47
--------- ---------------- ---------- ----------------
TOTAL 2,478,376 $ 4.63 1,955,061 $ 5.32
========= ================ ========== ================
61
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 December 31, 2006, warrants to purchase a total of
6,055,303 shares of common stock were issued and outstanding, as follows:
Weighted Average
Range of Number of Shares Weighted Average Remaining Contractual
Exercise Price Exercise Price Life (In Years)
--------------- ---------------- ---------------- ---------------------
Outstanding, December 31, 2005 $0.025 - $2.90 5,196,775 $ 2.35 4.00
Granted to 2005 PIPE Holders* 1.98 472,000 1.98 3.75
Granted to Placement Agent 2003** 1.50 - 1.77 16,528 1.72 1.90
Granted to Placement Agent 2006* 1.15 370,000 1.15 4.75
--------------- ---------------- ---------------- ---------------------
Outstanding, December 31, 2006 $0.025 - $2.90 6,055,303 $ 1.63 3.36
=============== ================ ================ =====================
Exercisable (1), December 31, 2006 $0.025 - $2.90 6,055,303 $ 1.63 3.36
=============== ================ ================ =====================
(1) After giving effect to listing of underlying common stock with the AMEX.
The table above reflects the following transactions:
On September 30, 2005, we issued warrants to purchase 1.6 million shares of
common stock, initially 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. Pursuant to the antidilution
adjustment under the terms of these warrants, as a result of the September 29,
2006 financing transaction, we reduced the exercise price of these warrants to
$1.98 and increased the number of underlying shares of commons stock from
1,800,000 to 2,272,000.
On October 25, 2004, in connection with our equity and debt financing, we issued
3,013,671 warrants to investors. These warrants initially had an exercise price
of $2.10 per share, and were exercisable for five years. During 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. During 2005, a total of 192,811 of these warrants with an exercise price
of $2.10 per share were exercised, for which the Company issued a total of
192,811 shares of common stock. Pursuant to the antidilution adjustment under
the terms of these warrants, as a result of the September 29, 2006 financing
transaction, we reduced the exercise price of these outstanding warrants to
$1.15.
On September 29, 2006, we issued warrants to purchase 370,000 to designees of
our placement agent. We agreed to issue these warrants as part of the fees that
our placement agent earned in connection with the September 29, 2006 financing
transaction. These warrants have an exercise price of $1.15 per share, expire in
five years and include a "cashless exercise" feature.
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. No antidilution
adjustment to these warrants resulted from the September 29, 2006 financing
transaction.
62
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following information regards our directors as of December 31, 2006:
DIRECTOR PRINCIPAL OCCUPATION DURING
NAME AGE SINCE LAST FIVE YEARS AND DIRECTORSHIPS
- ---- --- -------- ---------------------------------
Geoffrey Jenkins 54 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. He has over twenty-five years of experience in building
consumer and professional healthcare companies. Mr. Jenkins is currently Vice
President of W/W Operations for Inverness Medical a leader in rapid diagnostic
tests. 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. Prior to MDI, Mr. Jenkins was
Corp. Vice President of Operations for MediSense which introduced the first
biosensor-based blood glucose test for people with diabetes. Jenkins holds a
BS and BA from Clarkson University, awarded in 1976.
Sidney Braginsky 68 2004 Mr. Braginsky has been a director since January 2004. Mr. Braginsky 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 72 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. Currently, Mr.
Brooks also serves as the Managing Director of the Central Fund of the
Community Development Venture Capital Alliance. The Fund invests in
enterprises that are expected to yield both financial and social returns to
their communities. 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 59 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 70 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 seven honorary
doctorates.
Joseph Harris 60 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.
63
Peter Klein 53 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. 66 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, atrial 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 32 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 49 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's other experience includes Chief
Financial Officer at AVM Systems, Inc., a high-tech developer of Command and
Control Systems, and Audit Manager at Peat, Marwick, Mitchell & Company
(currently KPMG), an international "Big Four" accounting firm. 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. 68 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.
The following information regards our current executive officers, in addition to
Mr. Wylie and Mr. Swank, and highly-compensated non-executive officer employees:
64
William D. Allan,
Managing Director of Diomed. Ltd. Prior to becoming Managing Director of Diomed, Ltd., Mr. Allan
was for the past fifteen years an officer and employee of Smith &
Nephew, in South Africa and the United Kingdom. Most recently,
Mr. Allan was Global Vice- President of Marketing for Smith &
Nephew Wound Management, a position he hold from November 2005 to
October 2007. Prior to serving in this capacity, Mr. Allan was
Global Vice -President for Wound Bed Preparation and Core Brands
at Smith & Nephew from March 2003 to November 2005
Christopher Geberth,
Vice President of Finance, Controller and
Assistant Secretary Mr. Geberth joined us in May 2004 as Vice President, Finance and
Corporate 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 and his CPA in New York State in
1995.
John J. Welch, Vice President of
Marketing Mr. Welch joined us in October 2002 as Vice President of North
American 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 Johnson & Johnson, CR Bard and Datex (now
part of GE Medical) in various sales and marketing capacities.
Mr. Welch was also 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 Diomed in December 2004 as Vice President of
North American Sales. He has over 20 years in sales and
marketing management experience in the medical device and
software industries. Prior to joining Diomed, Mr. Paulette
served as Region Manager for Guidant CRM, managing over 25
million dollars in revenue. Prior to Guidant, he held roles as
Vice President of Sales Operations for Viewlocity and I2, both
Supply Chain Software developers. Prior to his software
experience, Mr. Paulette worked for over 10 years 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.
65
EXECUTIVE COMPENSATION
The following table summarizes all compensation recorded by us in the last
completed fiscal year for our principal executive officer and each other
executive officer serving as such whose annual compensation exceeded $100,000 as
of the end of the last completed fiscal year. Such officers are referred to
herein as our "Named Executive Officers."
Summary Compensation Table
Option Non-Equity Nonqualified
Stock Awards Incentive Deferred All Other
Salary Awards ($)(2) Plan Compensation Compensation
Name and principal position Year ($) (1) Bonus ($) ($) (3) Compensation Earnings ($) ($) Total ($)
- -------------------------------------------------------------------------------------------------------------------------------
James Wylie 2006 367,425 138,828 0 130,910 0 0 19,960(4) 657,123
Chief Executive Officer
David Swank 2006 224,825 70,883 0 48,146 0 0 0 343,854
Chief Financial Officer
Kevin Stearn 2006 157,179 31,350 0 12,475 0 0 0 201,004
Vice President Operations,
Diomed Ltd.
William Allan 2006 32,216 0 0 4,776 0 0 0 36,992
Vice President Operations,
Diomed Ltd.
Christopher Geberth 2006 139,596 31,678 0 39,093 0 0 0 210,367
VP Finance
Cary Paulette 2006 186,000 70,778 0 52,271 0 0 0 309,049
VP North America Sales
John Welch 2006 184,000 39,925 0 16,633 0 0 0 240,558
VP North America Marketing
TOTAL 1,291,241 383,442 0 304,304 0 0 19,960 1,998,947
(1) Salaries are provided for that part of 2006 during which each Named
Executive Officer served as such. Mr. Stearn resigned from the Company effective
September 29, 2006. Mr. Allan commenced employment with the Company on November
1, 2006.
(2) Granted under the terms of our 2003 Omnibus Incentive Plan.
(3) We used the Black-Scholes option pricing model was used to determine the
fair value of all 2006 option grants.
Messrs. Geberth, Paulette, Stearn and Welch were granted stock options on
January 11, 2006, which vest and therefore become exercisable on a pro rata
basis quarterly in arrears over three years from the date of grant, commencing
March 31, 2006, which we valued based on with the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 87.3%
Risk-free Interest Rate (%) 4.32%
Expected Life 5.8 years
Accordingly, the weighted average fair value per option at grant date is $1.66.
62
Mr. Wylie was granted 60,000 stock options on January 11, 2006, which vest and
therefore become exercisable on a pro rata basis quarterly in arrears over two
years from the date of grant, commencing March 31, 2006, which we valued based
on the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 89.3%
Risk-free Interest Rate (%) 4.32%
Expected Life 5.7 years
Accordingly, the weighted average fair value per option at grant date is $1.68.
Mr. Wylie was also granted 50,000 stock options on January 11, 2006, which vest
and therefore become exercisable immediately, as to 50%, with the remainder
vesting on a pro rata basis quarterly in arrears over one year from the date of
grant, commencing March 31, 2006, which we valued based on the following
assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 87.7%
Risk-free Interest Rate (%) 4.32%
Expected Life 5.2 years
Accordingly, the weighted average fair value per option at grant date is $1.61.
Mr. Swank was granted 40,000 stock options on January 11, 2006, which vest and
therefore become exercisable on a pro rata basis quarterly in arrears over three
years from the date of grant, commencing March 31, 2006, which we valued based
on the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 87.3%
Risk-free Interest Rate (%) 4.32%
Expected Life 5.8 years
Accordingly, the weighted average fair value per option at grant date is $1.66.
Mr. Swank was also granted 15,000 stock options on January 6, 2006, which vest
and therefore become exercisable immediately, as to 50%, with the remainder
vesting on a pro rata basis quarterly in arrears over one year from the date of
grant, commencing March 31, 2006, with the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 87.6%
Risk-free Interest Rate (%) 4.33%
Expected Life 5.2 years
Accordingly, the weighted average fair value per option at grant date is $1.48.
Mr. Allan was granted 75,000 stock options on November 1, 2006, which vest and
therefore become exercisable on a pro rata basis quarterly in arrears over three
years from the date of grant, commencing December 31, 2006, which we valued
based on the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 88.56%
Risk-free Interest Rate (%) 4.52%
Expected Life 5.8 years
Accordingly, the weighted average fair value per option at grant date is $0.76.
63
(4) Rent and related expenses for apartment leased by us near our Andover,
Massachusetts headquarters for use by Mr. Wylie when he is in Andover, as Mr.
Wylie's residence is approximately 150 miles from our headquarters.
Outstanding Equity Awards at Fiscal Year End
The following table provides information concerning unexercised options, stock
that has not vested and equity incentive plan awards for each of our Named
Executive Officers as of December 31, 2006.
OPTION AWARDS STOCK AWARDS
- ---------------------------------------------------------------------------------- -----------------------------------------------
Equity
Incentive
Equity Plan
Incentive Awards:
Plan Market or
Equity Awards: Payout
Incentive Number of Value of
Plan Number Unearned Unearned
Number of Awards: of Share Market Shares, Shares,
Number of Securities Number of or Units Value of Units or Units or
Securities Underlying Securities of Stock Shares or Other Other
Underlying Unexercised Underlying Option That Units of Rights Rights
Unexercised Options Unexercised Exercise Option Have Not Stock That That Have That Have
Options (#) (#) Unearned Price Expiration Vested Have Not Not Vested Not Vested
Name Exercisable UnexercisableOptions (#) ($) Date (#) Vested ($) (#) ($)
- -----------------------------------------------------------------------------------------------------------------------------------
James Wylie 16,000 0 0 6.50 01/10/2013 0 0 0 0
108,000 0 0 4.50 02/11/2014 0 0 0 0
160,000 0 0 5.00 02/24/2014 0 0 0 0
19,412 0 0 4.25 03/26/2014 0 0 0 0
23,732 0 0 4.20 01/10/2015 0 0 0 0
16,000 0 0 6.50 01/20/2013 0 0 0 0
27,076 0 0 4.20 01/10/2015 0 0 0 0
50,000 0 0 2.24 01/11/2016 0 0 0 0
30,000 30,000 0 2.24 01/11/2016 0 0 0 0
131,192 0 0 4.20 01/10/2015 0 0 0 0
TOTAL 581,412 30,000 0 0 0 0 0
David Swank 60,000 0 0 5.00 02/24/2014 0 0 0 0
13,334 26,666 0 2.24 01/11/2016 0 0 0 0
6,667 3,333 0 2.02 10/29/2014 0 0 0 0
8,000 0 0 11.50 06/04/2013 0 0 0 0
15,000 0 0 2.06 01/06/2016 0 0 0 0
56,800 0 0 4.20 01/10/2015 0 0 0 0
TOTAL 159,801 29,999 0 0 0 0 0
Kevin Stearn (1) 0 0 0 0 0 0 0
William Allan 6,253 68,747 0 1.02 11/01/2016 0 0 0 0
0 0 0 0
Christopher Geberth 13,334 26,666 0 2.24 01/11/2016 0 0 0 0
6,667 3,332 0 3.54 12/09/2014 0 0 0 0
10,000 0 0 4.20 01/10/2015 0 0 0 0
18,333 1,667 0 2.50 05/17/2014 0 0 0 0
TOTAL 48,334 31,665 0 0 0 0
Cary Paulette 15,000 0 0 4.20 1/10/2015 0 0 0 0
11,668 23,332 0 2.24 1/11/2016 0 0 0 0
33,334 16,666 0 3.54 12/9/2014 0 0 0 0
35,000 0 0 4.20 1/10/2015 0 0 0 0
TOTAL 95,002 39,998 0 0 0 0 0
John Welch 3,600 0 0 7.50 06/02/2013 0 0 0 0
3,200 0 0 8.50 10/01/2012 0 0 0 0
400 0 0 8.75 10/08/2013 0 0 0 0
28,000 0 0 5.00 02/24/2014 0 0 0 0
400 0 0 4.75 05/01/2013 0 0 0 0
10,000 20,000 0 2.24 01/11/2016 0 0 0 0
39,400 0 0 4.20 01/10/2015 0 0 0 0
TOTAL 85,000 20,000 0 0 0 0 0
TOTAL 975,802 220,409 0 0 0 0 0
(1) Mr. Stearn resigned effective September 29, 2006 and as a result his
unvested options were forfeited and he had 90 days to exercise his vested
options. Effective January 3, 2007, Mr. Stearn's vested options were also
forfeited, none having been exercised. Mr. Stearn was succeeded by Mr. Allan,
whose employment began on November 1, 2006.
64
DIRECTOR COMPENSATION
Directors who are also our employees do not receive separate compensation for
their service as directors, although we may award stock options or other
compensation in our discretion. We pay an honorarium to directors who are not
also our employees (described below), and we typically award stock options or
other stock-based compensation in our discretion. The board retains discretion
to award other forms of compensation to directors. We also reimburse
non-employee directors for reasonable out-of-pocket expenses incurred in
attending directors' meetings.
In 2004, we instituted a director honorarium program because we believed it was
appropriate to provide monetary compensation to our outside directors for their
efforts on our behalf and that such a program would assist us in attracting and
retaining qualified persons to act as directors and to serve on committees of
the board. In 2006, these stipends are $1,000 per face-to-face meeting, plus
annual stipends, as follows:
Position Amount per Annum
=============================== ================
Director $12,000
Chairman of Board of Directors $10,000
Audit Committee Chairman $10,000
Audit Committee Member $ 5,000
Compensation Committee Chairman $ 5,000
Compensation Committee Member $ 2,500
Under this program, the Company awarded stipends to non-employee directors in
the aggregate amount of $156,000 during 2006.
65
Director Compensation Table
Fees
Earned
or Option Nonqualified
Paid Stock Awards Non-Equity Deferred All Other
in Cash Awards ($) (2) Incentive Plan Compensation Compensation
Name ($) (1) ($) (3) Compensation Earnings ($) (4) Total ($)
- ------------------------------------------------------------------------------------------------------------------
Geoffrey Jenkins 31,250 0 13,861 0 0 0 45,111
Sidney Braginsky 21,000 0 8,371 0 0 0 29,317
Gary Brooks 21,500 0 8,371 0 0 0 29,817
A. Kim Campbell 17,500 0 8,371 0 0 0 25,817
Joseph Harris 28,750 0 8,371 0 0 0 37,067
Peter Klein 16,000 0 8,371 0 0 0 24,317
Edwin Snape, Ph.D 20,000 0 8,371 0 0 0 28,317
TOTAL 156,000 0 64,763 0 0 0 219,763
(1) Fees earned are provided for that part of 2006 during which each Director
served and received cash, plus cash payment for 2005 fees earned and not paid in
cash until 2006. Each Director earns $12,000 per year, the Chairman of the Board
and the Chairman of the Audit Committee earn an additional $10,000, the members
of the Audit Committee each earn $5,000, the Chairman of the Compensation
Committee earns $5,000, and the members of the Compensation Committee each earn
2,500. Directors are also paid $1,000 per face-to-face meeting and additional
compensation for participating as members of special sub committees, when
necessary.
(2) Granted under the terms of our 2003 Omnibus Incentive Plan. All of the
options awarded to directors during the fiscal year ended December 31, 2006
remained outstanding as of December 31, 2006.
(3) We used the Black-Scholes option pricing model to determine the fair value
of 2006 option grants. The Directors were granted stock options on January 11,
2006, which vest and therefore become exercisable on a pro rata basis quarterly
in arrears over three years from the date of grant, commencing March 31,
2006,which we valued based on the following assumptions:
Dividend Yield (per share) $0.00
Volatility (%) 87.3%
Risk-free Interest Rate (%) 4.32%
Expected Life 5.8 years
Accordingly, the weighted average fair value per option at grant date is $1.66.
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.
66
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.
Effective January 11, 2006, Mr. Wylie's annual salary was increased to $367,425,
and he was awarded 50,000 options.
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. In accordance with this agreement, Mr. Swank's
employment was automatically renewed for the term ending December 31, 2007.
Other Executive Officers
Our other executive officers (Messrs. Allan, 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.
67
Additionally, we agreed to provide to Mr. Allan an annual transportation
allowance of (pound)13,440 (paid in monthly installments), as well as temporary
living expenses and relocation expenses for his transition when he joined our UK
subsidiary, Diomed Ltd., on November 1, 2006.
STOCK OPTION PLANS
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.
EQUITY COMPENSATION PLAN INFORMATION
As of December 31, 2006, 755,756 shares were available for issuance under our
2003 Omnibus Plan, 4,542 shares were available for issuance under our 2001 Plan
and 339 shares were available for issuance under our 1998 Plan.
The following table describes as of December 31, 2006 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:
Number of securities
Number of securities to be Weighted average exercise remaining available for
issued upon exercise of price of outstanding future issuance under
utstanding options, options, warrants and rights equity compensation
warrants and rights (excluding securities) plans
(expressed in common stock) reflected in column (a)
Plan Category (a) (b) (c)
- ----------------------------------------------------------------------------------------------------------------------
Equity compensation plans 2,439,363 $4.11 760,637
approved by stockholders
- ----------------------------------------------------------------------------------------------------------------------
Equity compensation plans not 0 0 0
approved by stockholders
- ----------------------------------------------------------------------------------------------------------------------
TOTAL 2,439,363 $4.11 760,637
CHANGES AND ADJUSTMENTS TO OUTSTANDING INCENTIVE AWARDS DURING PRIOR FISCAL YEAR
No adjustments to the exercise price of any outstanding options were made during
the fiscal year ended December 31, 2006.
68
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth beneficial ownership information as of September
30, 2006 for shares of our capital stock or rights to acquire shares of our
capital stock exercisable within 60 days beneficially owned by:
o our chief executive officer and other executive officers whose
salary and bonuses for 2005 exceeded $100,000 and whose annualized
salary exceeds $100,000;
o each director;
o our directors and executive officers as a group; and
o 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 40,000 (2) 0.2%
Gary Brooks 47,000 (3) 0.23%
A. Kim Campbell 48,000 (4) 0.24%
Joseph Harris 42,000 (5) 0.21%
Geoffrey Jenkins 108,934 (6) 0.56%
Peter Klein 53,100 (7) 0.27%
Edwin Snape 49,000 (8) 0.25%
David Swank 174,801 (9) 0.89%
James A. Wylie, Jr. 747,373 (10) 3.73%
Christopher Geberth 52,335 (11) 0.27%
Cary Paulette 95,002 (12) 0.45%
Kevin Stearn 0 (13) 0%
John J. Welch 85,001 (14) 0.44%
William D. Allan 6,253 (15) .0%
All officers and directors as a group
(14 persons) 1,548,800 7.45%
Beneficial Owners of More than 5% of the Company's Common Stock
Samuel Belzberg 1,714,260 (16) 8.8%
Zesiger Capital Group 1,672,786 (17) 8.6%
Galleon Healthcare Partners, L.P. 1,134,000 (18) 5.8%
and affiliates
ProMed Partners, L.P. and affiliates 14,611,594 (19) 44.1%
Gruber & McBain International 2,426,141 (20) 11.1%
and affiliates
(1) Calculated pursuant to Rule 13d-3 of the Rules and Regulations under the
Exchange Act. 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.
69
(2) Includes 38,750 shares of common stock issuable upon the exercise of stock
options vested through 10/31/06.
(3) Includes 3,000 shares held plus 42,750 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06.
(4) Includes 46,750 shares of common stock issuable upon the exercise of stock
options vested through 10/31/06.
(5) Includes 2,000 shares held plus 38,750 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06.
(6) Includes 6,600 shares held plus 100,251 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06.
(7) Includes 9,100 shares held plus 42,750 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06.
(8) Includes 9,000 shares held plus 38,750 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06. Excludes a total of
1,304,348 shares of common stock underlying preferred stock purchased by New
England Partners Capital, L.P. and Nexus Medical Partners II S.C.A. SICAR in the
September 29, 2006 financing transaction.
(9) Includes 15,000 shares held plus 154,593 shares of common stock issuable
upon the exercise of stock options vested through 10/31/06.
(10) Includes 165,961 shares held plus 566,412 shares of common stock issuable
upon the exercise of stock options vested through 10/31/06.
(11) Includes 4,000 shares held plus 42,502 shares of common stock issuable upon
the exercise of stock options vested through 10/31/06.
(12) Includes 87,919 shares of common stock issuable upon the exercise of stock
options vested through 10/31/06.
(13) Includes 97,501 shares of common stock issuable upon the exercise of stock
options vested through 10/31/06. Mr. Stearn resigned from our employ effective
September 29, 2006. To the extent not previously exercised, these options will
expire on December 30, 2006 as a result of Mr. Stearn's resignation.
(14) Includes 82,501 shares of common stock issuable upon the exercise of stock
options vested through 10/31/06.
(15) Options to purchase 75,000 shares of common stock were granted when Mr.
Allan was hired on November 1, 2006, none of which will be vested through
12/31/06.
(16) 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.
(17) Includes 1,672,786 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 our common stock. Zesiger's address is
320 Park Avenue, 30th Floor, New York, NY 10022. Barrie R. Zesiger, Managing
Director of Zesiger Capital Group, may be deemed to beneficially own our
securities held by Zesiger's clients as a result of his investment and/or voting
power over these securities, although Mr. Zesiger disclaims beneficial ownership
of these securities.
(18) Includes 1,134,000 shares of common stock held. Galleon's address is 135 E
57th Street, 16th Floor, New York, NY 10022. Raj Rajaratnam, as the managing
member of Galleon Advisors, L.L.C., may be deemed the beneficial owner of our
securities held by Galleon as a result of the investment and/or voting control
over our securities that he exercises in that connection. However, Mr.
Rajaratnam disclaims any beneficial ownership of the shares reported herein,
except to the extent of any pecuniary interest therein.
(19) Includes 1,025,401 shares of common stock held, 13,051,282 shares of common
stock underlying preferred stock held and 534,9111 shares of common stock
underlying warrants. Does not give effect to 9.9% limitations on ownership which
restrict the exchange of preferred stock and exercise of warrants. ProMed's
address is 122 E 42nd Street, Suite 2105, New York, NY 10168. Barry Kurakawa and
David Musket are co-investment managers of ProMed Management, Inc., which acts
as investment manager for various other ProMed entities. Messrs. Kurakawa and
Musket may be deemed to have beneficial ownership of our securities held by
ProMed entities by virtue of their position with ProMed Management, Inc. and the
investment and/or voting control that this relationship may confer on them.
(20) Includes 283,100 shares of common stock held, 1,739,131 shares of common
stock underlying preferred stock held and 403,910 shares of common stock
underlying warrants held. Does not give effect to 4.9% limitations on ownership
which restrict the exchange of preferred stock and exercise of warrants. Gruber
& McBain's address is 50 Osgood Place, San Francisco, CA 94133. Jon D. Gruber,
J. Patterson McBain and Eric Swergold may be deemed to have beneficial ownership
of these securities because of shared voting and/or investment power over the
securities held by Lagunitas Partners LP and Gruber & McBain International. Mr.
Gruber and Linda W. Gruber share voting and investment power over the securities
held by the Jon D. Gruber and Linda W. Gruber Trust, and Mr. McBain has voting
and investment power over the securities held by him.
70
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 9/29/06 into Common Stock 17,354,347
-------------------------------------------------------------------------- ---------------------------------
Exercise of Warrants to Purchase Common Stock Issued as Placement Agent
Fees in 9/29/06 Financing 370,000
-------------------------------------------------------------------------- ---------------------------------
Increase in Shares of Common Stock Issuable upon Conversion of
Outstanding Debentures after Giving Effect to Antidilution Adjustment
Triggered by 9/29/06 Financing 1,606,865
-------------------------------------------------------------------------- ---------------------------------
Increase in Shares of Common Stock Issuable upon Exercise of Outstanding
Warrants after Giving Effect to Antidilution Adjustment Triggered by
9/29/06 Financing 488,528
-------------------------------------------------------------------------- ---------------------------------
Total Shares Represented by 9/29/06 Transactions 19,819,740
-------------------------------------------------------------------------- ---------------------------------
Additional Allowance of 25% 4,954,935
----------
-------------------------------------------------------------------------- ---------------------------------
TOTAL SHARES BEING REGISTERED 24,774,675
==========
-------------------------------------------------------------------------- ---------------------------------
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 29, 2006 (see "Liquidity and Capital Resources;
Transactions in 2006 - Private Placement Financing Completed September 29,
2006," above) and consist of the following:
o 1,735.4347 shares of preferred stock, exchangeable for 17,354,347
shares of common stock (including shares of common stock issuable
upon exercise of Par Warrants which may be issued in lieu of common
stock upon exchange of preferred stock);
o 370,000 shares of common stock that we may issue upon the exercise
of common stock purchase warrants that we issued as part of the fees
earned in the September 29, 2006 financing by our placement agent to
the persons designated by the placement agent to receive these
warrants;
o 1,606,865 additional shares of common stock that we may issue upon
the conversion of $3.712 million principal amount of outstanding
debentures (initially issued on October 25, 2004) as a result of the
reduction in the conversion price from $2.29 per share to $1.15 per
share pursuant to the antidilution provisions of these debentures
when triggered by the September 29, 2006 financing; and
o 488,528 additional shares of common stock that we may issue upon the
exercise of various common stock purchase warrants as a result of
the increase in the number of underlying shares pursuant to the
antidilution provisions of these warrants when triggered by the
September 29, 2006 financing.
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 29, 2006 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
antidilution adjustments to the exchange rate of the preferred stock, the
conversion price of the debentures 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 1,735.4347
shares of preferred stock will be exchanged by the holders for 17,354,347 shares
of common stock, at the existing exchange rate of 10,000 shares of common stock
per share of preferred stock. Because future payment of dividends on the
preferred stock is conditioned on the occurrence of certain events, we are not
at this time seeking to register shares that may be issued as payment of
dividends. If dividends become issuable and we seek to pay them by issuance of
common stock, then we may seek to use the 25% allowance to issue these shares in
registered form, to amend the registration statement or to issue shares in
unregistered form. Because the terms of the preferred stock include limitations
on ownership which may preclude an investor from exchanging preferred stock for
common stock, we agreed that to the extent the limitations on ownership would
prevent an investor from exchanging shares of preferred stock directly into
common stock, an investor may exchange shares of preferred stock for a Par
Warrant, exercisable at the par value of $0.001 per share, enabling the investor
to acquire in the future that number of shares of common stock that the investor
would have otherwise acquired directly at the time the preferred stock is
exchanged. We are registering the shares underlying any Par Warrants that we may
issue, but the aggregate number of shares issuable and therefore being
registered hereunder is the same regardless of whether they are shares of common
stock issued directly in exchange for preferred stock or are shares underlying
Par Warrants issued upon exchange of preferred stock.
71
In respect of the exercise of warrants, we assumed that all warrants to purchase
common stock we issued to the designees of our placement agent will be exercised
for cash at the exercise price of $1.15 per share and without application of the
"cashless exercise" feature of these warrants.
In respect of the conversion of outstanding debentures, we assumed that the
entire $3.712 outstanding principal amount of these debentures will be converted
into common stock at the reduced conversion price of $1.15 per share (after the
conversion price was reduced from $2.29 per share to $1.15 per share because the
September 29, 2006 financing constituted a dilutive issuance under the terms of
the debentures, which required this antidilution adjustment). Because future
payment of interest on the debentures in the form of common stock is conditioned
on the occurrence of certain events, we are not at this time seeking to register
shares that may be issued as payment of interest. If interest is sought to be
paid in the form of common stock, we may issue shares in registered form under
the registration previously declared effective by the Commission. If the number
of shares under that registration statement is insufficient, then we may seek to
use the 25% allowance to issue these shares in registered form, to amend the
registration statement or to issue shares in unregistered form.
In respect of the exercise of warrants, we assumed that all warrants to purchase
a total of 2,427,843 shares of common stock (after increasing by 488,528 the
number of underlying shares of common stock per share because the September 29,
2006 financing constituted a dilutive issuance under the terms of the warrants,
which required this antidilution adjustment) will be exercised for cash at the
various exercise prices of these warrants and without application of the
"cashless exercise" feature of these warrants.
DILUTION RESULTING FROM SEPTEMBER 29, 2006 FINANCING TRANSACTION
The September 29, 2006 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. The preferred stock represents 17,354,347
shares of underlying common stock (assuming no dividends are paid in the form of
common stock and no antidilution adjustments are made to the $1.15 effective
exchange rate of the preferred stock), and the warrants issued as compensation
to our placement agent represents 370,000 shares of underlying common stock
(assuming no antidilution adjustments are made to the $1.15 exercise price of
the warrants or number of shares that may be purchased upon exercise of these
warrants). Further, antidilution adjustments to outstanding securities as a
result of the September 29, 2006 financing resulted in an increase of 1,606,865
shares of common stock underlying outstanding convertible debentures and an
increase of 488,528 shares of common stock underlying outstanding warrants.
The following table sets forth information regarding our common stock issued and
outstanding on a fully diluted basis, both before and after giving effect to the
September 29, 2006 financing transaction. When we refer to "a fully diluted
basis," we assume the exchange of all outstanding preferred stock into
underlying shares of common stock, the exercise of all outstanding stock options
and warrants and the conversion of all outstanding convertible debentures.
Before After
Financing Financing
Description of Common Shares Transaction Transaction
---------------------------- ----------- -----------
Shares issued and outstanding 19,448,728 19,448,728
Shares to be issued on conversion of
convertible debentures 1,620,961 3,227,826
Shares to be issued on exchange of 2005
Preferred Stock 3,975,000 --
Shares to be issued on exchange of 2006
Preferred Stock -- 17,354,347
Shares to be issued on exercise of stock
options and non-investor warrants 3,023,787 3,393,787
Shares to be issued on exercise of investor
warrants 4,596,776 5,085,304
---------- ----------
TOTAL 32,665,252 48,509,992
========== ==========
Of the 32,665,252 shares of our common stock that were issued and outstanding on
a fully diluted basis prior to the financing transaction, actual shares of
common stock represented approximately 59.54% of our outstanding shares. Of the
48,509,992 shares of our common stock issued and outstanding on a fully diluted
basis as of the completion of the financing transaction, the 19,448,728 actual
shares of common stock represented approximately 40.0%, a decrease of
approximately 19.5 percentage points as a result of the September 29, 2006
financing transaction. If all 24,774,675 shares we are registering hereunder
(including the 25% allowance) are issued, then the dilutive effect of the
financing transaction will be even greater. Specifically, there will then be
53,464,927 shares of common stock outstanding on a fully diluted basis, and the
19,338,728 actual shares of common stock outstanding prior to the September 29,
2006 financing transaction will only represent approximately 36%, a decrease of
approximately 23.5 percentage points.
72
Conversely, the fewer shares that are issuable upon exchange of the preferred
stock and/or conversion of debentures or exercise of warrants, the less the
dilution that will be experienced by our stockholders prior to the September 29,
2006 financing transaction. It is possible that we will issue fewer shares than
the 24,774,675 shares we estimated to be issuable for purposes of this
registration statement. For instance, less than 24,774,675 shares may be
issuable if all fewer than all shares of preferred stock are exchanged into
common stock, if less than all outstanding debentures are converted into common
stock and we instead repay them in cash or if fewer than all of warrants are
exercised prior to their expiration or if warrants are exercised on a "cashless
exercise" basis (in which case the warrant holder will not pay us the exercise
price in cash but will receive fewer shares upon exercise). Moreover, because
the 25% allowance includes an excess number of shares in the event of
antidilution adjustments to the preferred stock, debentures and warrants, fewer
shares will be issuable if we do not enter into a dilutive issuance and
therefore we trigger no antidilution adjustments to these securities.
INFORMATION REGARDING THE SELLING STOCKHOLDERS
Details regarding the ownership of shares of our common stock held by the
Selling Stockholders are as follows:
SELLING STOCKHOLDERS
Name of Selling Stockholder and
Individual(s) with Beneficial Ownership, Common Shares Beneficially Owned
Common Shares Being Registered Voting and/or Investment Power Prior to
Offering (1) and Offered under This Prospectus
---------------------------------------- -------------------------------- ---------------------------------
"Westfield Group" (a)
Westfield Life Sciences Fund, L.P. 970,491 212,500
Westfield Life Sciences Fund II, L.P. 970,491 1,887,500
Westfield Microcap Fund, L.P. 970,491 75,000
TOTAL 970,491 2,175,000
SDS Capital Group SPC, Ltd. (b) 970,491 3,250,000
"New England/Nexus Group" (c)
New England Partners Capital, L.P. 970,491 815,217
Nexus Medical Partners II SCA SICAR 970,491 815,218
TOTAL 970,491 1,630,435
MCF Navigator Master Fund, Ltd. (d) 325,000 325,000
Camber Capital Fund L.P. (e) 275,000 275,000
Robert S. Martin 275,000 275,000
Oliveira Capital, LLC (f) 275,000 275,000
Alan W. Steinberg, L.P. (g) 275,000 275,000
Valley Forge Investments, Ltd. (h) 275,000 275,000
Cipher 06, LLC (i) 237,500 237,500
Guerilla IRA Partners, L.P. (j) 50,000 50,000
Douglas Schmidt 50,000 50,000
"ProMed Group" (k)
ProMed Partners, L.P. 1,942,927 830,184
ProMed Partners II, L.P. 1,942,927 34,836
ProMed Offshore Fund, Ltd. 1,942,927 120,864
ProMed Offshore Fund II, Ltd. 1,942,927 2,944,582
David Musket 1,942,927 302,250
Barry Kurokawa 1,942,929 76,125
Paul Scharfer 116,382 145,478
Josh Golomb 12,500 12,500
David Bartash 12,500 12,500
TOTAL 2,084,309 4,479,319
"Advantage Related Parties" (l)
Advantage Advisors Catalyst Partners LP 136,436 119,636
Advantage Advisors Catalyst Intl. Ltd. 97,455 85,455
Ridgecrest Partners Ltd. 77,964 68,364
Ridgecrest Partners LP 12,995 11,395
Ridgcrest Partners QP LP 284,850 284,850
TOTAL 609,700 569,700
"Gruber & McBain Related Parties" (m)
Lagunitas Partners LP 970,491 1,481,221
Gruber & McBain International 970,491 455,760
Jon D. and Linda W. Gruber Trust 970,491 170,910
J. Patterson McBain 970,491 170,910
TOTAL 970,491 2,278,801
Broadfin Healthcare Fund LP (n) 194,910 170,910
Alpha Capital (o) 389,821 341,821
Fractal Holdings, LLC (p) 64,970 56,970
"North Sound Related Parties" (q)
North Sound Legacy International Ltd. 970,491 4,112,712
North Sound Legacy Institutional Fund LLC 970,491 1,595,162
TOTAL 970,491 5,707,874
Omicron Master Trust (r) 158,246 39,065
Iroquois Capital (s) 315,594 281,590
Cranshire Capital (t) 626,774 558,766
Rockmore Investment Master Fund Ltd. (u) 379,885 379,885
Portside Growth and Opportunity Fund (v) 817,039 817,039
TOTAL 12,531,203 24,774,675
-----
SELLING STOCKHOLDERS
Name of Selling Stockholder and Percent of Outsanding
Individual(s) with Beneficial Ownership, Common Shares Owned Common Shares
Affiliate of a Voting and/or Investment Power after Offering Owned after
Offering (2) Broker-Dealer
---------------------------------------- ------------------- ------------------------ --------------
"Westfield Group" (a)
Westfield Life Sciences Fund, L.P. 0 0.0000 NO
Westfield Life Sciences Fund II, L.P. 0 0.0000 NO
Westfield Microcap Fund, L.P. 0 0.0000 NO
TOTAL 0 0.0000
SDS Capital Group SPC, Ltd. (b) 0 0.0000 NO
"New England/Nexus Group" (c)
New England Partners Capital, L.P. 0 0.0000 NO
Nexus Medical Partners II SCA SICAR 0 0.0000 NO
TOTAL 0 0.0000
MCF Navigator Master Fund, Ltd. (d) 0 0.0000 YES *
Camber Capital Fund L.P. (e) 0 0.0000 NO
Robert S. Martin 0 0.0000 NO
Oliveira Capital, LLC (f) 0 0.0000 NO
Alan W. Steinberg, L.P. (g) 0 0.0000 NO
Valley Forge Investments, Ltd. (h) 0 0.0000 NO
Cipher 06, LLC (i) 0 0.0000 YES *
Guerilla IRA Partners, L.P. (j) 0 0.0000 NO
Douglas Schmidt 0 0.0000 NO
"ProMed Group" (k)
ProMed Partners, L.P. 1,025,401 0.0506 YES *
ProMed Partners II, L.P. 1,025,401 0.0526 YES *
ProMed Offshore Fund, Ltd. 1,025,401 0.0524 YES *
ProMed Offshore Fund II, Ltd. 1,025,401 0.0458 YES *
David Musket 1,025,401 0.0519 YES *
Barry Kurokawa 1,025,401 0.0525 YES *
Paul Scharfer 18,228 0.0009 YES *
Josh Golomb 0 0.0000 YES *
David Bartash 0 0.0000 YES *
TOTAL 2,050,802 0.0857
"Advantage Related Parties" (l)
Advantage Advisors Catalyst Partners LP 16,800 0.0009 NO
Advantage Advisors Catalyst Intl. Ltd. 12,000 0.0006 NO
Ridgecrest Partners Ltd. 9,600 0.0005 NO
Ridgecrest Partners LP 1,600 0.0001 NO
Ridgcrest Partners QP LP 40,000 0.0020 NO
TOTAL 80,000 0.0040
"Gruber & McBain Related Parties" (m)
Lagunitas Partners LP 491,100 0.0235 NO
Gruber & McBain International 347,100 0.0174 NO
Jon D. and Linda W. Gruber Trust 307,100 0.0157 NO
J. Patterson McBain 307,100 0.0157 NO
TOTAL 1,452,400 0.0668
Broadfin Healthcare Fund LP (n) 24,000 0.0012 NO
Alpha Capital (o) 48,000 0.0024 NO
Fractal Holdings, LLC (p) 8,000 0.0004 NO
"North Sound Related Parties" (q)
North Sound Legacy International Ltd. 576,000 0.0244 NO
North Sound Legacy Institutional Fund LLC 224,000 0.0106 NO
TOTAL 800,000 0.0318
Omicron Master Trust (r) 119,181 0.0061 NO
Iroquois Capital (s) 34,004 0.0017 NO
Cranshire Capital (t) 68,008 0.0034 NO
Rockmore Investment Master Fund Ltd. (u) 0 0.0000 NO
Portside Growth and Opportunity Fund (v) 0 0.0000 YES *
TOTAL 4,684,395 0.1059
-----
73
NOTES TO TABLE OF SELLING STOCKHOLDERS
(1) For purposes of this presentation, ownership of shares constitutes
"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, we have given effect to the limitations
on ownership applicable to the selling stockholders under the terms of the
preferred stock we issued on September 29, 2006 and warrants we issued in the
September 30, 2005 financing transaction (described under "Liquidity and Capital
Resources," above). Ownership figures also 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.
(2) Percentages based on the 19,448,728 shares of common stock issued and
outstanding as of the date of the registration statement of which this
prospectus is a part plus that number of shares issued and sold by this selling
stockholder.
* Although affiliated with a broker-dealer, this selling stockholder has
certified to us that it purchased our securities in the ordinary course of
business and at the time of its purchase of the securities being registered for
sale pursuant to the registration statement of which this prospectus is a part
such selling stockholder had no agreements or understandings, directly or
indirectly, with any person to distribute these securities.
(a) Arthur Bauernfeind is the chairman and chief executive officer of this
selling stockholder and as such may be deemed to have beneficial ownership of
these securities because of his voting and/or investment power over these
securities.
(b) Steve Derby is the director of the selling stockholder and as such may be
deemed to have beneficial ownership of these securities because of his voting
and/or investment power over these securities.
(c) John F. Rousseau, Jr., Edwin Snape, Thomas Hancock, Gregory Zaie, David A.
R. Dullum and Robert J. Hanks may be deemed to have beneficial ownership of
these securities because they share voting and/or investment power over these
securities. Mr. Snape is one of our directors. See "Related Party Transactions,"
above, for further information.
(d) MCF Asset Management, LLC has beneficial ownership of these securities by
virtue of its relationship with the selling stockholder. Gregory S. Curhan,
Stephen H. Leist and John Hiestand, each of whom is an executive officer of MCF
Asset Management, LLC, have beneficial ownership of these securities because
they share voting and/or investment power over these securities. Merriman Curhan
Ford & Co., an NASD member and broker-dealer, is affiliated with MCF Asset
Management, LLC by virtue of common control by their parent company, MCF
Corporation.
(e) Stephen DuBois, the managing member of this selling stockholder, may be
deemed to have beneficial ownership of these securities because of his voting
and/or investment power over these securities.
(f) Steven Oliveira, the sole member of this selling stockholder, may be deemed
to have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(g) Alan W. Steinberg, the general partner of this selling stockholder, may be
deemed to have beneficial ownership of these securities because of his voting
and/or investment power over these securities.
(h) The following persons are directors and alternate directors of Montblanc
(Directors) Ltd., the sole director of the selling stockholder, and therefore
they may be deemed to have voting power and/or investment control over these
securities: Ian Christopher Crosby, Laurence Leslie Hart, Mervyn Brian Ellis,
James Samuel Coclough, Cora Binchy, Aris Solon Tatos, James David Moran, Andre
Rigby Nolan, Ralf Michael Capraro and Paul Edmund Walker Roper.
(i) Michael Liss and Jason T. Adelman, the managing members of Cipher 06 LLC,
have beneficial ownership of these securities because they share voting and/or
investment power over these securities. Messrs. Adelman and Liss are affiliates
of Pali Capital Inc., a registered broker-dealer.
(j) Peter Siris is the Managing Director of this selling stockholder and may be
deemed to beneficially own its shares. Mr. Siris disclaims beneficial ownership
of this selling stockholder's shares.
(k) Barry Kurakawa and David Musket are co-investment managers of ProMed
Management, Inc., which acts as investment manager for the other ProMed entities
named as selling stockholders. David Musket is a principal of Musket Research
Associates, Inc., a registered broker-dealer. Paul Scharfer, Joshua Golomb and
David Bartash are each registered representatives of Musket Research Associates,
Inc. Beneficial ownership of shares underlying antidilution adjustment warrants
previously issued to designees of Sunrise Securities Corp. is attributed to Paul
Scharfer, who was formerly affiliated with Sunrise. By virtue of the percentage
of ownership of our shares held (notwithstanding the limitations on ownership
described in footnote 1), these related entities may be considered our
affiliates. See "Related Party Transactions," above, for further information.
(l) Joshua M. Raffner, principal of this selling stockholder, may be deemed to
have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(m) Jon D. Gruber, J. Patterson McBain and Eric Swergold may be deemed to have
beneficial ownership of these securities because of shared voting and/or
investment power over the securities held by Lagunitas Partners LP and Gruber &
McBain International. Mr. Gruber and Linda W. Gruber share voting and investment
power over the securities held by the Jon D. Gruber and Linda W. Gruber Trust,
and Mr. McBain has voting and investment power over the securities held by him.
By virtue of the percentage of ownership of our shares held (notwithstanding the
limitations on ownership described in footnote 1), these related entities may be
considered our affiliates. See "Related Party Transactions," above, for further
information.
(n) Kevin Kotler, principal of this selling stockholder, may be deemed to have
beneficial ownership of these securities because of his voting and/or investment
power over these securities.
74
(o) Konrad Ackerman, principal of this selling stockholder, may be deemed to
have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(p) Samuel E. Navarro, principal of this selling stockholder, may be deemed to
have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(q) Thomas McCauley, principal of this selling stockholder, may be deemed to
have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(r) Omicron Capital, L.P., a Delaware limited partnership ("Omicron Capital"),
serves as investment manager to Omicron Master Trust, a trust formed under the
laws of Bermuda ("Omicron"), Omicron Capital, Inc., a Delaware corporation
("OCI"), serves as general partner of Omicron Capital, and Winchester Global
Trust Company Limited ("Winchester") serves as the trustee of Omicron. By reason
of such relationships, Omicron Capital and OCI may be deemed to share
dispositive power over the shares of our common stock owned by Omicron, and
Winchester may be deemed to share voting and dispositive power over the shares
of our common stock owned by Omicron. Omicron Capital, OCI and Winchester
disclaim beneficial ownership of such shares of our common stock. As of the date
of the registration statement of which this prospectus is a part, Mr. Olivier H.
Morali, an officer of OCI, and Mr. Bruce T. Bernstein, a consultant to OCI, have
delegated authority from the board of directors of OCI regarding the portfolio
management decisions with respect to the shares of our common stock owned by
Omicron. By reason of such delegated authority, Messrs. Morali and Bernstein may
be deemed to share dispositive power over the shares of our common stock owned
by Omicron. Messrs. Morali and Bernstein disclaim beneficial ownership of such
shares of our common stock and neither of such persons has any legal right to
maintain such delegated authority. No other person has sole or shared voting or
dispositive power with respect to the shares of our common stock being offered
by Omicron, as those terms are used for purposes under Regulation 13D-G of the
Securities Exchange Act of 1934, as amended. Omicron and Winchester are not
"affiliates" of one another, as that term is used for purposes of the Exchange
Act or of any other person named in this prospectus as a selling stockholder. No
person or "group" (as that term is used in Section 13(d) of the Exchange Act or
the SEC's Regulation 13D-G) controls Omicron and Winchester.
(s) Joshua Silverman, principal of this selling stockholder, may be deemed to
have beneficial ownership of these securities because of his voting and/or
investment power over these securities.
(t) Downsview Capital, Inc. is the general partner of Cranshire Capital, L.P.
Mitchell P. Kopin, the president of Downsview Capital, Inc., has sole voting and
investment power over these securities.
(u) Rockmore Capital, LLC ("Rockmore Capital") and Rockmore Partners, LLC
("Rockmore Partners"), each a limited liability company formed under the laws of
the State of Delaware, serve as the investment manager and general partner,
respectively, to Rockmore Investments (US) LP, a Delaware limited partnership,
which invests all of its assets through Rockmore Investment Master Fund Ltd., an
exempted company formed under the laws of Bermuda ("Rockmore Master Fund"). By
reason of such relationships, Rockmore Capital and Rockmore Partners may be
deemed to share dispositive power over the shares of our common stock owned by
Rockmore Master Fund. Rockmore Capital and Rockmore Partners disclaim beneficial
ownership of such shares of our common stock. Rockmore Partners has delegated
authority to Rockmore Capital regarding the portfolio management decisions with
respect to the shares of common stock owned by Rockmore Master Fund and, as of
the date of the registration statement of which this prospectus is a part, Mr.
Bruce T. Bernstein and Mr. Brian Daly, as officers of Rockmore Capital, are
responsible for the portfolio management decisions of the shares of common stock
owned by Rockmore Master Fund. By reason of such authority, Messrs. Bernstein
and Daly may be deemed to share dispositive power over the shares of our common
stock owned by Rockmore Master Fund. Messrs. Bernstein and Daly disclaim
beneficial ownership of such shares of our common stock and neither of such
persons has any legal right to maintain such authority. No other person has sole
or shared voting or dispositive power with respect to the shares of our common
stock as those terms are used for purposes under Regulation 13D-G of the
Securities Exchange Act of 1934, as amended. No person or "group" (as that term
is used in Section 13(d) of the Securities Exchange Act of 1934, as amended, or
the SEC's Regulation 13D-G) controls Rockmore Master Fund.
(v) Ramius Capital Group, L.L.C. ("Ramius Capital") is the investment adviser of
Portside Growth and Opportunity Fund ("Portside") and consequently has voting
control and investment discretion over securities held by Portside. Ramius
Capital disclaims beneficial ownership of the shares held by Portside. Peter A.
Cohen, Morgan B. Stark, Thomas W. Strauss and Jeffrey M. Solomon are the sole
managing members of C4S & Co., L.L.C., the sole managing member of Ramius
Capital. As a result, Messrs. Cohen, Stark, Strauss and Solomon may be
considered beneficial owners of any shares deemed to be beneficially owned by
Ramius Capital. Messrs. Cohen, Stark, Strauss and Solomon disclaim beneficial
ownership of these shares. An affiliate of Ramius Capital Group, L.L.C. is a
NASD member. However, this affiliate will not sell any shares offered by
Portside Growth and Opportunity Fund through the registration statement of which
this prospectus is a part and will receive no compensation whatsoever in
connection with sales of shares by Portside Growth and Opportunity Fund offered
through this prospectus.
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;
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;
75
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.
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.
76
EXPERTS
The financial statements included in the Prospectus have been audited by BDO
Seidman, LLP, an independent registered public accounting firm, 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.
77
TABLE OF CONTENTS
Page
----
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets as of December 31, 2005 and 2004 F-2
Consolidated Statements of Operations for the Years Ended December 31, 2005
and 2004 F-4
Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
for the Years Ended December 31, 2005 and 2004 F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 2005
and 2004 F-7
Notes to Consolidated Financial Statements December 31, 2005 F-9
Condensed Consolidated Balance Sheets - September 30, 2006 (unaudited) and
December 31, 2005 F-35
Condensed Consolidated Statements of Operations - Three Months
and Nine Months Ended September 30, 2006 and 2005 (unaudited) F-36
Condensed Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 2006 and 2005 (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. and subsidiaries as of December 31, 2005 and 2004 and the related
consolidated statements of operations, stockholders' equity and comprehensive
loss, and cash flows for each of the two years in the period ended December 31,
2005. 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 designing 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. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, 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, 2005 and 2004, and the results of their
operations and their cash flows for each of the two years in the period ended
December 31, 2005, in conformity with accounting principles generally accepted
in the United States of America.
/s/ BDO SEIDMAN, LLP
- ----------------------
Boston, Massachusetts
February 9, 2006
F-1
DIOMED HOLDINGS, INC.
Consolidated Balance Sheets
December 31, 2005 December 31, 2004
Assets
Current assets:
Cash and cash equivalents $ 9,562,087 $14,436,053
Short-term investments - available for sale securities 3,566,454 -
Accounts receivable, net of allowance for doubtful accounts of
$102,740 and $223,105 in 2005 and 2004, respectively 2,824,717 2,074,393
Inventories 3,059,886 2,204,385
Prepaid expenses and other current assets 444,453 348,586
----------- -----------
Total current assets 19,457,597 19,063,417
----------- -----------
Property and equipment:
Office equipment and furniture and fixtures 2,256,536 1,808,062
Manufacturing equipment 944,425 839,226
Leasehold improvements 731,347 731,347
----------- -----------
3,932,308 3,378,635
Less accumulated depreciation and amortization 2,760,605 2,477,066
----------- -----------
Property and equipment, net 1,171,703 901,569
----------- -----------
Intangible assets:
Intangible manufacturing asset, net of accumulated amortization
of $981,362 and $809,644 in 2005 and 2004, respectively - 171,718
Luminetx distribution rights, net of accumulated amortization of
$46,199 and $0 in 2005 and 2004, respectively 286,431 -
Intangible EVLT(R) technology asset, net of accumulated
amortization of $685,741 and $391,852 in 2005 and 2004,
respectively 4,016,484 4,310,373
----------- -----------
Total intangible assets, net 4,302,915 4,482,091
----------- -----------
Other assets:
Investment in Luminetx 500,000 -
Deposits 20,060 195,338
Deferred financing costs, net of accumulated amortization of
$456,709 and $30,477 in 2005 and 2004, respectively 274,750 700,982
----------- -----------
Total other assets 794,810 896,320
----------- -----------
Total assets $25,727,025 $25,343,397
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-2
DIOMED HOLDINGS, INC.
Consolidated Balance Sheets (Continued)
December 31, 2005 December 31, 2004
----------------- -----------------
Liabilities, preferred stock and stockholders' equity Current
liabilities:
Accounts payable $ 3,561,786 $ 2,092,562
Accrued expenses 2,298,823 1,847,941
Bank line of credit 53,924 -
Current maturities of capital lease obligations 2,047 46,967
Current portion of deferred revenue 257,889 148,402
Current maturities of EVLT(R) technology payable
($250,000 face value, net of $4,902 debt discount at
December 31, 2005 and $1,000,000 face value, net of
$66,733 debt discount at December 31, 2004) 245,098 933,267
Warrant liability 1,898,213 -
------------ ------------
Total current liabilities 8,317,780 5,069,139
Deferred revenue, net of current portion 144,428 211,347
Capital lease obligation, net of current maturities 4,094 -
Convertible debt ($3,712,000 face value, net of $1,081,727 debt
discount at December 31, 2005 and $7,000,000 face value,
net of $2,183,151 debt discount at December 31, 2004) 2,630,273 4,816,849
EVLT(R) technology payable ($250,000 face value, net of
$4,902 debt discount at December 31, 2004), net of
current maturities - 245,098
------------ ------------
Total liabilities 11,096,575 10,342,433
------------ ------------
Commitments and contingencies
Preferred stock, $0.001 par value
Authorized-20,000,000 shares; issued and outstanding
4,000,000 (Liquidation value $12,150,000
at December 31, 2005) 7,819,658 -
------------ ------------
Stockholders' equity:
Common stock, $0.001 par value
Authorized-50,000,000 shares at December 31, 2005 and 2004
Issued and outstanding-19,423,728 and 17,781,525 shares
at December 31, 2005 and 2004, respectively
19,424 17,781
Additional paid-in capital 87,551,286 84,226,241
Accumulated other comprehensive income 89,800 169,023
Accumulated deficit (80,849,718) (69,412,081)
------------ ------------
Stockholders' equity 6,810,792 15,000,964
------------ ------------
Total liabilities, preferred stock and stockholders' equity $ 25,727,025 $ 25,343,397
============ ============
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,
-------------------------------
2005 2004
-------------- --------------
Revenues $ 19,048,751 $ 13,384,500
Cost of revenues 10,112,951 7,920,100
------------ ------------
Gross profit 8,935,800 5,464,400
------------ ------------
Operating expenses:
Research and development 1,536,522 1,694,629
Selling and marketing 9,391,952 7,160,548
General and administrative 7,819,312 6,422,461
------------ ------------
Total operating expenses 18,747,786 15,277,638
------------ ------------
Loss from operations (9,811,986) (9,813,238)
------------ ------------
Other (income) expense, net:
Gain on the fair value of warrant liability (157,535) -
Interest expense, non-cash 1,196,849 108,725
Interest expense, net, cash-based 586,337 155,200
------------ ------------
Total other expense, net 1,625,651 263,925
------------ ------------
Net loss (11,437,637) (10,077,163)
Less preferred stock cash dividends (150,000) -
Less preferred stock non-cash dividends (1,300,597) -
------------ ------------
Net loss applicable to common stockholders $(12,888,234) $(10,077,163)
============ ============
Basic and diluted net loss per share $ (0.67) $ (0.68)
============ ============
Basic and diluted weighted average common shares outstanding 19,213,965 14,752,794
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
DIOMED HOLDINGS, INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
Years Ended December 31, 2005 and 2004
Common Stock
------------ Accumulated
Additional Other
Number of $0.001 Paid-in Comprehensive Accumulated
Shares Par Value Capital Income (Loss) Deficit
------ --------- ------- ------------- -------
Balance, December 31, 2003 13,129,113 $ 13,129 $ 75,582,369 $ 175,278 $(59,334,918)
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 - - - (6,255) -
Net loss - - - - (10,077,163)
------------ ------------ ------------ ------------ ------------
Balance, December 31, 2004 17,781,525 17,781 84,226,241 169,023 (69,412,081)
------------ ------------ ------------ ------------ ------------
Total
Stockholders' Comprehensive
Equity Loss
------ ----
Balance, December 31, 2003 $ 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)
Net loss (10,077,163) (10,077,163)
------------ ------------
Balance, December 31, 2004 15,000,964 $(10,083,418)
------------ ============
F-5
DIOMED HOLDINGS, INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
Years Ended December 31, 2005 and 2004
(continued)
Common Stock
Additional Other Total
Number of $0.001 Paid-in Comprehensive Accumulated Stockholders'
Shares Par Value Capital Income (Loss) Deficit Equity
Exercise of warrants by
2004 Private Placement
investor and its
affiliates 192,811 194 404,710 - - 404,904
Compensation expense
related to issuance of
stock options to third
parties - - 49,474 - - 49,474
Conversion of debt for
common stock 1,449,392 1,449 3,156,111 - - 3,157,560
Issuance of warrants to
Luminetx for
distribution rights - - 332,630 - - 332,630
Fair value adjustments to
accrete preferred stock
to its exchangeable
value - - (575,748) - - (575,748)
Value ascribed to warrants
issued to 2004 debt
holders in the 2005 PIPE - - 256,969 - - 256,969
Dividends recorded on
preferred stock - - (299,101) - - (299,101)
Change in unrealized gain
(loss) on available for
sale securities - - - 296 - 296
Foreign currency
translation adjustment - - - (79,519) - (79,519)
Net loss - - - - (11,437,637) (11,437,637)
------------ ------------ ------------ ------------ ------------ ------------
Balance, December 31, 2005 19,423,728 $ 19,424 $ 87,551,286 $ 89,800 $(80,849,718) $ 6,810,792
============ ============ ============ ============ ============ ============
Comprehensive
Loss
Exercise of warrants by
2004 Private Placement
investor and its
affiliates
Compensation expense
related to issuance of
stock options to third
parties
Conversion of debt for
common stock
Issuance of warrants to
Luminetx for
distribution rights
Fair value adjustments to
accrete preferred stock
to its exchangeable
value
Value ascribed to warrants
issued to 2004 debt
holders in the 2005 PIP
Dividends recorded on
preferred stock
Change in unrealized gain
(loss) on available for
sale securities 296
Foreign currency
translation adjustment (79,519)
Net loss (11,437,637)
------------
Balance, December 31, 2005 $(11,516,860)
============
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,
-----------------------------
2005 2004
------------ ------------
Cash Flows from Operating Activities: $(11,437,637) $(10,077,163)
Net loss
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 955,389 972,900
Amortization of EVLT(R) discount 66,733 137,806
Non-cash interest expense 1,196,849 108,725
Accretion of discount on marketable securities (142,669) -
Amortization of deferred financing costs 426,232 -
Fair value of stock options for service 49,474 79,449
Gain on fair value of warrant liability (157,535) -
Changes in operating assets and liabilities:
Accounts receivable (750,324) (637,155)
Inventories (855,501) (312,144)
Prepaid expenses and other current assets (95,867) 101,039
Deposits 175,278 (11,582)
Accounts payable 1,219,335 595,021
Accrued expenses and deferred revenue 493,450 312,258
------------ ------------
Net cash used in operating activities (8,856,793) (8,730,846)
------------ ------------
Cash Flows from Investing Activities:
Purchases of property and equipment (575,706) (519,009)
Purchase of available for sale securities (6,707,261) -
Proceeds from maturities of available for sale securities 3,200,000 -
Investment in Luminetx (500,000) -
------------ ------------
Net cash used in investing activities (4,582,967) (519,009)
------------ ------------
Cash Flows from Financing Activities:
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
Proceeds from issuance of preferred stock, net, in 2005 equity
financing 9,150,556 -
Increase in deferred financing costs - (731,459)
Proceeds from exercise of warrants 404,904 343,138
Net proceeds (payments) from bank borrowings 53,924 (261,676)
Payments on promissory note - (936,000)
Payments on capital lease obligations (40,826) (54,997)
Payments on EVLT(R) purchase obligation (1,000,000) (1,000,000)
------------ ------------
Net cash provided by financing activities 8,568,558 10,323,544
------------ ------------
Effect of exchange rate changes (2,764) (35,711)
------------ ------------
Net increase (decrease) in cash and cash equivalents (4,873,966) 1,037,978
Cash and cash equivalents, beginning of year 14,436,053 13,398,075
------------ ------------
Cash and cash equivalents, end of year $ 9,562,087 $ 14,436,053
============ ============
F-7
DIOMED HOLDINGS, INC.
Consolidated Statements of Cash Flows
(continued)
Years Ended December 31,
Supplemental Disclosure of Cash Flow Information: 2005 2004
---------- ----------
Cash paid for interest $ 732,194 $ 180,481
========== ==========
Equipment under capital lease $ - $ 88,116
========== ==========
Value ascribed to warrants issued to purchase distribution rights $ 332,630 $ -
========== ==========
Unrealized gains (losses) on marketable securities $ 296 $ -
========== ==========
Value ascribed to warrants issued in 2005 private placement $2,055,748 $ -
========== ==========
Non-cash increasing rate preferred stock dividend $ 149,101 $ -
========== ==========
Value ascribed to debt discount related to convertible debt $ - $2,261,399
========== ==========
Conversion of debt for common stock $3,157,560 $ -
========== ==========
Fair value adjustment on preferred stock to bring preferred
stock to its immediately exchangeable value $ 575,748 $ -
========== ==========
Accretion of preferred stock dividends $ 150,000 $ -
========== ==========
Value ascribed to debt discount related to convertible debt $ 256,969 $ -
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
F-8
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2005
(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) 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) Principled 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.
F-9
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(d) Reclassifications
Certain reclassifications have been made in the prior year consolidated
financial statements to conform to the current year's presentation.
(e) Cash and Cash Equivalents
Cash and cash equivalents consists of short-term, highly liquid investments with
original maturities of three months or less.
(f) Short Term Investments
Marketable 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.
Marketable securities included in cash and cash equivalents and short term
investments, at December 31, 2005, all of which mature within one year, consist
of the following:
Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ------------ ----------- -----------
Money Market Funds $ 3,815,711 $ 3,815,711 $ - $ -
Commercial Paper 5,852,606 5,852,408 - 198
U.S. Agency Notes 2,096,266 2,096,760 494 -
----------- ----------- ----------- -----------
$11,764,583 $11,764,879 $ 494 $ 198
=========== =========== =========== ===========
As Reported: Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ----------- ----------- -----------
Cash and Cash $ 8,197,698 $ 8,198,426 $ 728 $ -
Equivalents
Marketable Securities 3,566,886 3,566,454 - 432
----------- ----------- ----------- -----------
$11,764,584 $11,764,880 $ 728 $ 432
=========== =========== =========== ===========
Gross unrealized gains (losses) for the year ended December 31, 2005 totaled
$296. The unrealized losses were caused by increasing market interest rates.
Based on the scheduled maturities of these marketable securities and our intent
and ability to hold these securities until maturity, we have concluded that
these unrealized losses are not other-than-temporary. There were no realized
gains or losses in 2005.
(g) 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-10
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(h) 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,
changes in cumulative translation adjustment account and unrealized gains and
losses on available for sale securities. The Company has disclosed comprehensive
income (loss) for all periods presented in the accompanying consolidated
statements of stockholders' equity and comprehensive income (loss).
DECEMBER 31,
2005 2004
------------ ------------
Net loss $(11,437,637) $(10,077,163)
Unrealized holding gain (loss) on marketable securities, net of
related tax effects 296 -
Foreign currency translation adjustment (79,519) (6,255)
------------ ------------
Comprehensive loss $(11,516,860) $(10,083,418)
============ ============
(i) Revenue Recognition
The Company derives revenue primarily from two sources: (i) revenue from
products, including lasers, instrumentation and disposables, and (ii) revenue
from services. Service revenue includes fees earned under extended service
contracts and repairs for products that are not under warranty. The Company
recognizes revenue in accordance with SEC Staff Accounting Bulletin No. 104,
"Revenue Recognition" ("SAB No. 104"). SAB No. 104 requires that four basic
criteria must be met before revenues can be recognized: (1) persuasive evidence
of an arrangement exists; (2) title has transferred; (3) the fee is fixed and
determinable; and (4) collectibility is reasonably assured.
The Company uses signed quotations and/or customer purchase orders that include
all terms of the arrangement to determine the existence of an arrangement and
whether the fee is fixed or determinable based on the terms of the associated
agreement. The Company generally ships F.O.B. shipping point and uses shipping
documents and third-party proof of delivery to verify delivery and transfer of
title. The Company assesses whether collection is reasonably assured by
considering a number of factors, including past transaction history with the
customer and the creditworthiness of the customer, as obtained from third party
credit references. If the Company determines that collection is not reasonably
assured, revenue is deferred until collection becomes reasonably assured,
generally upon receipt of payment.
In certain transactions, the Company sells additional training or extended
service contracts with the sale of the laser. In those situations, the Company
applies the guidance in EITF 00-21 "Revenue Arrangements with Multiple
Deliverables", and divides the components into separate units of accounting
based on their relative fair values. Revenue from each unit is recognized in
accordance with SAB 104.
The Company defers revenue for extended service contracts related to future
periods and recognizes revenue on a straight-line basis in accordance with FASB
Technical Bulletin No. 90-1, "Accounting for Separately Priced Extended Warranty
and Product Maintenance Contracts." The Company provides for estimated warranty
costs an original product warranties at the time of sale.
F-11
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
A rollforward of deferred revenue for the years ended December 31, 2005 and
2004, is as follows
December 31,
2005 2004
--------- ---------
Beginning balance $ 359,749 $ 56,802
Additions 208,294 356,241
Revenue/release (165,726) (53,294)
--------- ---------
Ending balance $ 402,317 $ 359,749
========= =========
(j) Product Warranties
The Company engages in extensive product quality programs and processes,
including actively monitoring and evaluating the quality of component suppliers.
In addition to these proactive measures, the Company also provides for the
estimated cost of product warranties at the time revenue is recognized, based on
historical warranty trends in the volume of product returns within the warranty
period and the cost to repair the laser. The Company maintains reserves for its
estimated obsolete inventory based on historical cost.
Warranty provisions and claims for the years ended December 31, 2005 and 2004,
were as follows
December 31,
2005 2004
--------- ---------
Beginning balance $ 323,622 $ 406,382
Warranty provision 133,379 85,622
Release/estimates (166,589) -
Usage (97,466) (168,382)
--------- ---------
Ending balance $ 192,946 $ 323,622
========= =========
(k) 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,
2005 2004
---------- ----------
Raw materials $1,415,546 $ 838,390
Work-in-progress 674,010 502,905
Finished goods 970,330 863,090
---------- ----------
$3,059,886 $2,204,385
========== ==========
F-12
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(l) 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 3-5 years
Manufacturing equipment 5 years
Leasehold improvements Lesser of estimated useful
life or life of lease
Depreciation expense for the years ended December 31, 2005 and 2004 was $443,583
and $482,739, respectively.
(m) 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
12). The manufacturing rights are being amortized on a straight-line basis over
a five-year estimated useful life. Amortization expense relating to these
manufacturing rights of approximately $172,000 and $197,000 for the years ended
December 31, 2005 and 2004, is included in general and administrative expense.
The EVLT(R) patent rights are being amortized on a straight-line basis over the
remaining 16-year life of the patents, and amortization expense relating to the
EVLT(R) patent rights of $293,889 is included in the cost of goods sold for each
of the years ended December 31, 2005 and 2004.
The Luminetx distribution rights are being amortized on a straight-line basis
over a three-year estimated useful life consistent with the original term of the
distribution agreement entered into on August 5, 2005 (Note 15). Amortization
expense relating to the Luminetx distribution rights of approximately $46,200 is
included in selling and marketing expenses for the year ended December 31, 2005.
Future amortization at December 31, 2005 is as follows:
Amortization
------------
2006 $ 404,766
2007 404,766
2008 358,567
2009 293,889
2010 293,889
Thereafter 2,547,038
----------
Total amortization $4,302,915
==========
(n) 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 discounted future cash
flows from the use of these assets. Considerable judgment is required to
estimate discounted future operating cash flows. Judgment is also required in
determining whether an event has occurred that may impair the value of
identifiable intangible assets. Factors that could indicate that an impairment
may exist include significant underperformance relative to plan or long-term
projections, strategic changes in business strategy or a significant negative
industry or economic trends. 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, 2005 and 2004.
F-13
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(o) 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.
(p) 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" and EITF
96-18, "Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services," to
value these awards, which inherently includes 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 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.
(q) Concentrations
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 also be required in certain circumstances. Some customers seek
equipment financing from third party leasing agents, to 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 as well as
a general reserve 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, 2005 is adequate. The
allowance for doubtful accounts as of December 31, 2005 and 2004 was $102,740,
and $223,105, respectively.
No customers accounted for greater than 10% of total revenues in 2005 or 2004.
One customer accounted for 13% of accounts receivable in 2004.
Suppliers
The Company depends on outside suppliers for certain raw materials and other
components for the Company's products, including the diodes for the Company's
lasers. If the Company cannot obtain these raw materials or components, the
Company may be unable to make products in sufficient quantities to meet the
Company's 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 the
Company's suppliers to meet the requirements on a timely basis could interrupt
production until the Company obtains an alternative source of supply.
F-14
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(r) 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 8b).
The pro forma effect of applying SFAS No. 123 in 2005 and 2004 is as follows:
December 31,
2005 2004
------------ ------------
Net loss applicable to common stockholders as reported $(12,888,234) $(10,077,163)
Less: total stock-based employee compensation expense determined
under the fair value-based method for all awards, net of tax (1,671,514) (700,487)
------------ ------------
Pro forma net loss $(14,559,748) $(10,777,650)
============ ============
Loss per share:
Basic and diluted - as reported $ (0.67) $ (0.68)
Basic and diluted - pro forma $ (0.76) $ (0.73)
(s) Reserach and Development Expenses
The Company charges research and development expenses to operations as incurred.
(t) 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.
(u) Other Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 151, "Inventory Costs--an amendment of ARB No. 43, Chapter 4." SFAS No. 151
clarifies that abnormal amounts of idle facility expense, freight, handling
costs and wasted material should be recognized as current period charges in all
circumstances. Additionally, SFAS No. 151 requires that a facility's fixed
production overhead be charged to inventory based on the normal capacity of the
production facility. As required, the Company adopted SFAS No. 151 on January 1,
2006. The Company does not expect the adoption of SFAS No. 151 to have a
material impact on its consolidated financial statements.
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-15
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 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. It may or may not
approximate the current pro forma expense that the Company reports under SFAS
No. 123R.
On December 16, 2005, the Company's board of directors determined to accelerate
the vesting of the Company's unvested stock options previously awarded to our
directors, officers and employees pursuant to the Company's 2003 Omnibus
Incentive Plan, 2001 Stock Option Plan and 1998 Stock Option Plan with an
exercise price greater than $4.00 per share. The closing price of the Company's
common stock on the American Stock Exchange on that date was $1.90. As a result
of this acceleration, the Company will recognize no compensation expense for
options to acquire approximately 574,000 shares of common stock (representing
approximately 3% of the common stock outstanding on December 16, 2005) which
would have vested during the fiscal years ended December 31, 2006 and 2007 had
the Company not accelerated vesting of these options. As a result of these
actions, the Company eliminated approximately $1,657,000 of future after-tax
compensation expense relating to employee stock options after January 1, 2006.
In December 2004, the FASB issued SFAS No. 153, "Exchange of Nonmonetary
Assets--an amendment of APB Opinion No. 29, Accounting for Nonmonetary
Transactions" ("SFAS No. 153"). SFAS No. 153 is based on the principle that
exchange of nonmonetary assets should be measured based on the fair market value
of the assets exchanged. SFAS No. 153 eliminates the exception of nonmonetary
exchanges of similar productive assets and replaces it with a general exception
for exchanges of nonmonetary assets that do not have commercial substance. SFAS
153 is effective for nonmonetary asset exchanges in fiscal periods beginning
after June 15, 2005. The Company is currently evaluating the provisions of SFAS
No. 153 and does not believe that the adoption of SFAS No. 153 will have a
material impact on its consolidated financial statements.
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.
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections" ("SFAS 154"), which replaces APB Opinion No. 20, Accounting Changes
and SFAS No. 3, "Reporting Accounting Changes in Interim Financial Statements --
An Amendment of APB Opinion No. 28." SFAS 154 provides guidance on the
accounting for and reporting of accounting changes and error corrections. It
establishes retrospective application, or the latest practicable date, as the
required method for reporting a change in accounting principle and the reporting
of a correction of an error. SFAS 154 is effective for accounting changes and
corrections of errors made in fiscal years beginning after December 15, 2005,
and is required to be adopted by the Company in the first fiscal quarter of
2006.
In June 2005, the Emerging Issued Task Force (EITF) issued EITF Issue Number
05-02, "The Meaning of Conventional Convertible Debt Instrument in Issue 00-19"
("EITF 05-02"). The EITF reached the following consensus: that the exception to
the requirements of paragraphs 12-33 of Issue 00-19 for "conventional
convertible debt instruments" should be retained; that instruments that provide
the holder with an option to convert into a fixed number of shares (or
equivalent amount of cash at the discretion of the issuer) for which the ability
to exercise the option is based on the passage of time or a contingent event
should be considered "conventional" for purposes of applying Issue 00-19; and
that convertible preferred stock with a mandatory redemption date may qualify
for the exception included in paragraph 4 of Issue 00-19 if the economic
characteristics indicate that the instrument is more akin to debt than equity.
The consensus in EITF 05-02 will be effective for the Company for new
instruments entered into and instruments modified in periods beginning after
June 29, 2005.
F-16
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
In September 2005, the EITF issued Number 05-08, "Income Tax Consequences of
Issuing Convertible Debt with a Beneficial Conversion Feature" ("EITF 05-08").
EITF 05-08 provides guidance on the income tax consequences of issuing
convertible debt with a beneficial conversion feature. For accounting purposes
the proceeds received from the debt are allocated between the debt and the
beneficial conversion feature based on the guidance in EITF 98-05. However, for
income tax purposes the debt is not allocated, and consequently basis in the
debt instrument differ for book and tax purposes. This difference will be
recorded as a deferred tax liability through a charge to equity, rather than
provision for income taxes or deferred debit. EITF 05-08 is effective in the
first fiscal quarter of 2006, and is required to be applied retrospectively to
all prior periods in which convertible debt with a beneficial conversion feature
as outstanding. Since the Company records a full valuation allowance against its
deferred tax assets, there will be no immediate effect on its balance sheet.
(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, 2005 and 2004, 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,
2005 2004
----------- ----------
Common stock options 1,733,398 1,076,318
Convertible debt 1,620,961 (A) 3,056,769 (A)
Common stock warrants 5,196,775 (B) 2,991,263 (C)
(A) On October 25, 2004, in connection with the 2004 Private Placement Equity
and Debt financing discussed in Note 13, the Company issued $7,000,000 in
convertible notes. These notes are convertible at a rate of $2.29 per
share. During 2005, a total of $3,288,000 including accrued interest of
$31,108, of this debt was converted, for which the Company issued a total
of 1,449,392 shares of common stock.
(B) On September 30, 2005, in connection with the 2005 Private Placement Equity
financing discussed in Note 14, the Company issued 1,800,000 warrants to
investors. These warrants have an exercise price of $2.50 per share. These
warrants are exercisable for five years. On August 5, 2005, in connection
with the investment in Luminetx discussed in Note 15, the Company issued
600,000 warrants. These warrants have an exercise price of $2.90 per share.
These warrants are exercisable for five years.
(C) On October 25, 2004, in connection with the 2004 Private Placement Equity
and Debt financing discussed in Note 13, 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. During 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. During 2005, a total of 192,811 of these warrants with an exercise
price of $2.10 per share were exercised, for which the Company issued a
total of 192,811 shares of common stock.
On September 3, 2003, in connection with the 2003 equity financing, 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, 2005, 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.
F-17
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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, 2005, the Company issued a total of 1,377,231 shares of common
stock upon exercise of the 1,625,120 warrants.
During 2005, 1,677 warrants issued to investors in prior years with
exercise prices of $87.50 expired unexercised.
(4) ACCRUED EXPENSES
Accrued expenses consist of the following:
December 31,
2005 2004
---------- ----------
Payroll and related costs $ 729,711 $ 498,333
Warranty costs 192,946 323,622
Professional fees 1,296,487 882,176
Other 79,679 143,810
---------- ----------
$2,298,823 $1,847,941
========== ==========
(5) LINE-OF-CREDIT ARRANGEMENT
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 ($171,880 at December 31,
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 December 31, 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 December 31, 2005 and
December 31, 2004, there was approximately $53,924 and zero, respectively,
outstanding under these credit facilities.
(6) DEBT
a) 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 nine quarterly installments totaling $2,250,000
since acquiring the rights. Accordingly, at December 31, 2005, the remaining
liability was $245,098 net of debt discount of $4,902. The Company made the
final $250,000 payment in January 2006. (See Note 12)
F-18
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
b) 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 13. 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 debentures mature on
October 25, 2008, or such as earlier date as debentures are required or
permitted to be repaid as provided in the debenture, in cash or common stock,
subject to the terms and conditions of the debenture. 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
approximately $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).
During the first quarter of 2005, 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, we issued 1,449,392 shares of common stock to these debenture
holders, and $3,712,000 principal amount of debentures was outstanding as of
December 31, 2005. As a result of this conversion, a proportion of the discount
was accelerated and amortized to non-cash interest expense in the amount of
approximately $985,000.
As discussed in Note 14, in connection with a 2005 private placement preferred
stock financing, the Company issued warrants to purchase up to 200,000 shares of
common stock to the three holders of these convertible debentures, 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
convertible debentures, which mature in October 2008, unless previously
converted or redeemed. The balance of the notes at December 31, 2005 was
$2,630,273, net of unamortized debt discount of $1,081,727. The balance of the
notes at December 31, 2004 was $4,816,849, net of unamortized debt discount of
$2,183,151. In the years ended December 31, 2005 and December 31, 2004, the
Company recognized $1,196,849 and $78,248, respectively, in non-cash interest
expense pertaining to this amortization of these discounts.
c) 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, 2005 and 2004 was $1,755 and $12,238, respectively.
Future minimum debt payments required under these arrangements at December 31,
2005 are as follows:
Capital Leases Debts
---------- ----------
2006 $ 6,141 $ 250,000
2007 - -
2008 - 3,712,000
---------- ==========
Total future minimum lease payments $ 6,141 $3,962,000
==========
Less - Amount representing interest -
----------
Present value of future minimum lease payments 6,141
Less - Current portion of capital lease obligations 2,047
----------
Capital lease obligations, net of current portion $ 4,094
==========
F-19
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(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 $36,000,000 at December 31, 2005
to reduce future federal income taxes, if any. These carryforwards expire
through 2025 and are subject to review and possible adjustment by the Internal
Revenue Service (IRS). The Company also has approximately $20,000,000 of foreign
net operating loss carryforwards at December 31, 2005 to reduce future foreign
income taxes, if any. These carryforwards do not have an expiration date.
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, its equity
and debt financing completed on October 25, 2004 and its equity financing
completed on September 30, 2005 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 $20,601,000 and
$18,269,000 as of December 31, 2005 and 2004, 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,
2005 and 2004. The components of the Company's deferred tax assets are
approximately as follows:
December 31,
-----------------------------
2005 2004
------------ ------------
Net operating loss carryforwards $ 20,313,000 $ 18,000,000
Other temporary differences 288,000 269,000
Valuation allowance (20,601,000) (18,269,000)
------------ ------------
Net deferred tax asset $ - $ -
============ ============
(8) STOCKHOLDERS' EQUITY
(a) Common Stock
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.
F-20
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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. During 2005, the holders of
$3,288,000 principal amount of debentures elected to convert these debentures
(including accrued interest of $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, during 2005, the holders of 192,811 warrants exercised
their warrants at an exercise price of $2.10 per share, and accordingly the
Company issued 192,811 shares of common stock and 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 were 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 shares than the corresponding total number of warrants
exercised.
(b) Preferred Stock
On September 30, 2005, the Company completed the private placement equity
financing as discussed in Note 17, resulting in net proceeds of approximately
$9.3 million. In connection with this financing, the Company issued 4,000,000
shares of exchangeable preferred stock, along with warrants to purchase up to
1,800,000 shares of common stock at an exercise price of $2.50. Since the
preferred stock may become redeemable upon the occurrence of a redemption event
that is not solely within its control, the Company recorded the preferred stock
outside of permanent equity on its balance sheet. Subsequent to year-end 2005,
the holders of $25,000 face value of preferred elected to exchange these shares
into common stock on a one for one basis, and accordingly the Company issued
25,000 shares of common stock to these holders.
(c) Stock Options
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.
On December 16, 2005, the Board of Directors of the Company determined to
accelerate the vesting of the Company's unvested stock options previously
awarded to the directors, officers and employees of the Company pursuant to the
Company's 2003 Omnibus Incentive Plan, 2001 Stock Option Plan and 1998 Stock
Option Plan with exercise prices which were greater than $4.00 per share. The
closing price of the Company's common stock on the American Stock Exchange on
December 16, 2005 was $1.90. As a result of this acceleration, the Company will
recognize no compensation expense for options to acquire approximately 574,000
shares of common stock (representing approximately 3% of the shares of Company's
common stock outstanding on December 16, 2005) which would have vested during
the fiscal years ended December 31, 2006 and 2007. As a result of these actions,
the Company eliminated approximately $1,657,000 of future after-tax compensation
expense relating to employee stock options after January 1, 2006.
F-21
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
As of December 31, 2005, 1,504,644 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 December 31, 2005. A summary of
stock option activity is as follows (adjusted to give effect to the 1:25 reverse
split effective June 17, 2004:
Range of Number of Weighted Average
Exercise Price Shares Exercise Price
Outstanding, December 31, 2003 $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
Granted 2.03 - 4.30 710,953 4.07
Forfeited 2.85 - 205.75 (53,873) 11.23
Outstanding, December 31, 2005 $2.00 - $205.75 1,733,398 $ 6.01
Exercisable December 31, 2004 $2.00 - $205.75 439,887 $ 13.09
Exercisable December 31, 2005 $2.00 - $205.75 1,623,990 $ 6.21
The following table summarizes information relating to currently outstanding and
exercisable options as of December 31, 2005.
OUTSTANDING EXERCISABLE
Remaining Weighted Average Weighted Average
Exercise Price Shares Life Exercise Price Shares Exercise Price
$2.00 - $4.75 991,343 8.64 $ 3.91 881,935 $ 4.01
5.00 - 11.50 710,691 7.96 5.56 710,691 5.56
26.00 - 50.00 18,256 5.82 35.32 18,256 35.32
56.25 - 88.50 814 5.42 61.40 814 61.40
100.00 - 164.00 11,974 1.99 152.20 11,974 152.20
201.25 - $205.75 320 0.83 205.75 320 205.75
--------- ------ ------- --------- -------
1,733,398 $ 6.01 1,623,990 $ 6.21
========= ======= ========= =======
F-22
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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,
2005 2004
--------- -----------
Risk-free interest rate 3.01-4.39% 1.74-3.21%
Expected dividend yield --% --%
Expected lives 5 years 5 years
Expected volatility 75% 75%
Weighted average grant date fair value
per share $4.07 $3.86
Weighted average remaining contractual
life of options outstanding 8.3 years 8.8 years
(d) Issuance of Stock Options to Consultants
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.
In fiscal year 2005, the Company granted options to purchase 29,760 shares of
common stock at exercise prices per share in the range of $2.03 to $4.03 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 $49,474 in the statement of operations for year ended December 31,
2005.
(e) Warrants
A summary of warrant activity for the years ended December 31, 2005 and 2004 is
as follows:
Weighted Average
Range of Exercise Weighted Average Remaining Contractual
Price Number of Shares Exercise Price Life (In Years)
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 2004 PIPE Holders ** 2.10 3,013,671 2.10 4.82
Exercised by Placement Agent** 0.025 - 2.50 (1,184,719) 0.03 -
Exercised by 2004 PIPE Holders ** 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
Granted to 2005 PIPE Holders* 2.50 1,600,000 2.50 4.75
Granted to 2004 PIPE Holders* 2.50 200,000 2.50 4.75
Granted to Luminetx* 2.90 600,000 2.90 4.60
Exercised by 2004 PIPE Holders** 2.10 (192,811) 2.10 -
Forfeited 87.50 (1,677) 87.50 -
--------------- ---------- --------- ----
Outstanding, December 31, 2005 $0.025 - $2.90 5,196,775 $ 2.35 4.00
=============== ========== ========= ====
Exercisable December 31, 2004 $0.025 - $87.50 2,991,263 $ 2.18 4.82
=============== ========== ========= ====
Exercisable December 31, 2005 $0.025 - $2.90 4,896,775 $ 2.35 4.00
=============== ========== ========= ====
F-23
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
* See Note 3B. ** See Note 3C.
As discussed in Note 14, the value of the 1,600,000 warrants, $2,055,748, issued
in the September 2005 equity financing was classified as a warrant liability in
accordance with EITF 00-19.
9) VALUATION AND QUALIFYING ACCOUNTS
A summary of the allowance for doubtful accounts is as follows:
December 31,
-----------------------
2005 2004
--------- ---------
Allowance for doubtful accounts:
Balance, beginning of period $ 223,105 $ 209,167
Provision for doubtful accounts 3,727 48,652
Write-offs (124,092) (34,714)
--------- ---------
Balance, end of period $ 102,740 $ 223,105
========= =========
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.
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,
--------------------------
2005 2004
----------- -----------
Laser systems $ 9,300,736 $ 7,838,768
Fibers, accessories and service 9,748,015 5,545,732
----------- -----------
Total $19,048,751 $13,384,500
=========== ===========
F-24
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
The following table represents percentage of revenues by geographic destination:
December 31,
-------------
2005 2004
---- ----
United States 76% 64%
Asia/Pacific 12% 21%
Europe 8% 11%
Other 4% 4%
--- ---
Total 100% 100%
=== ===
The following table represents long-lived assets by geographic location:
December 31,
------------------------
2005 2004
---------- ----------
United States $5,930,287 $5,769,521
Europe 339,141 510,459
---------- ----------
Total $6,269,428 $6,279,980
========== ==========
Besides the United States, no individual country represents 10% or more of
revenues or long-lived assets.
11) COMMITMENTS AND CONTINGENCIES
(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. The Company will receive
$119,950 and $96,289 in fiscal years 2006 and 2007 for sublease rental payments
under a non-cancelable sublease agreement at the UK facility. During 2005, 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, 2005 and 2004 was $540,073, and $524,160, net
of sublease income of $127,577 and $111,650, respectively.
Future minimum payments required under these operating leases and related
sublease income at December 31, 2005 are as follows:
Operating Sublease
Leases Income
---------- ----------
2006 $ 632,882 $ 119,950
2007 614,882 96,289
2008 543,512 -
2009 519,722 -
2010 519,722 -
Thereafter 1,732,407 -
---------- ----------
Total operating leases $4,563,127 $ 216,239
========== ==========
F-25
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(b) 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. Effective January 11, 2006, the terms of Mr. Wylie's
employment agreement were modified providing for an annual base salary of
$367,425 (commencing January 1, 2006) and an award of options to purchase up to
50,000 shares of common stock.
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. As of December 31, 2005, Mr. Swank's
current monthly base compensation is $17,917. 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 greater of
Mr. Swank's current 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. In accordance with this
agreement, Mr. Swank's employment was automatically extended for the term ending
December 31, 2006.
Kevin Stearn became general manager of Diomed, Ltd., the Company's wholly-owned
subsidiary in the U.K., in February 2000. As of December 31, 2005, Mr. Stearn's
annual base salary was BPS 101,000. Effective February 15, 2005, 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. As
of December 31, 2005, Mr. Welch's annual base salary was $175,000. Effective
February 15, 2005, 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. As of December
31, 2005, Mr. Geberth's annual base salary was $134,000. Effective February 15,
2005, 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. As
of December 31, 2005, Mr. Paulette's annual base salary was $175,000. Effective
February 15, 2005, 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.
(c) Purchase Commitments
On August 5, 2005, the Company entered into a distribution agreement with
Luminetx, pursuant to which Luminetx appointed the Company as a distributor and
granted the Company the exclusive right to distribute and sell the Luminetx
patented biomedical imaging system known as the VeinViewer(TM) Imaging System to
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. Luminetx agreed to supply the Company
with a certain minimum number of VeinViewer(TM) systems for distribution by the
Company at specified prices during the term of the distribution agreement,
initially three years. As discussed in Note 15, the Company also agreed to 1oan
$1 million to Luminetx under the distribution agreement. The Company loaned
$500,000 to Luminetx on August 5, 2005 and later converted that note to shares
of preferred stock and warrants.
F-26
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
(d) 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, 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' patents are unenforceable for inequitable conduct. The Company is now
proceeding with the discovery phase of this litigation. A claim construction
hearing is scheduled for November of 2006. The Company intends to continue to
defend its position, however, management is unable to predict the outcome of
this lawsuit.
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. The Company is presently
prosecuting these lawsuits, however, management is unable to predict the outcome
of these lawsuits. 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.
(12) 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.
F-27
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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 made nine quarterly installment payments, and continued to amortize
the discount to interest expense. Accordingly, at December 31, 2005, the balance
remaining was $245,098 net of debt discount. The Company also agreed with
Endolaser Associates to pay variable royalties based on sales of EVLT(R)
products. In January 2006, the Company paid the final $250,000 payment.
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.
(13) 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 American Stock Exchange, 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:
Variable Rate Convertible Debentures
The Company issued an aggregate of $7,000,000 principal amount of convertible
debentures at par. The debentures mature on October 25, 2008, or such as earlier
date as the debentures are required or permitted to be repaid as provided in the
debenture, in cash or common stock, subject to the terms and conditions of the
debenture. 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 effective interest rate for the debentures was 9.7%.
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 American Stock
Exchange 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 was to obtain stockholder approval to reduce the conversion price
below $2.20. The Company obtained stockholder approval to eliminate that minimum
conversion price at its 2005 annual meeting, and accordingly, there is no longer
a minimum conversion price in the event of an adjustment to the conversion price
due to a dilutive issuance. The holder's right to convert the debentures is
limited to the extent that such conversion will not result in the debenture
holder's owning more than 4.99% of the shares of common stock outstanding
immediately after giving effect to the conversion.
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.
F-28
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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 American Stock Exchange on
the trading day prior to the date that the Company and the investors signed the
definitive purchase agreements.
During 2005, the holders of $3,288,000 principal amount of debentures elected to
convert that amount of debentures (including accrued interest of $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 American Stock
Exchange 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 American Stock Exchange 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. The Company obtained
stockholder approval to eliminate that minimum exercise price at its 2005 annual
meeting, and accordingly, there is no longer a minimum exercise price in the
event of an adjustment to the exercise price due to a dilutive issuance.
The holders of the warrants may exercise their warrants 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 (volume weighted average price, as defined in the
warrant) on date immediately preceding 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 shares that would have been
issued in an exercise for cash payment). Assuming, however, that all of the
warrants are exercised for cash at an exercise price of $2.10 per share, then
the Company will receive a total of approximately $3.85 million for the exercise
of the warrants, and the Company will issue approximately 2.7 million shares of
common stock.
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.
F-29
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
During the first quarter of 2005, 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, we issued 1,449,392 shares of common stock to these debenture
holders, and $3,712,000 principal amount of debentures was outstanding as of
December 31, 2005. As a result of this conversion, a proportion of the discount
was accelerated and amortized to non-cash interest expense in the amount of
$985,000. In the years ended December 31, 2005 and December 31, 2004, $1,196,849
and $78,248, respectively, were recognized in non-cash interest expense
pertaining to this amortization of the discount.
As discussed in Note 14, on September 30, 2005, the Company issued warrants to
purchase up to 200,000 shares of common stock to the three holders of these
convertible debentures, as an inducement to, and in consideration for, the
debenture holders' waiver of certain negative covenants that would have been
violated by the September 30, 2005 financing had the debenture holders not
waived those covenants. 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 convertible debentures,
which mature in October 2008, unless previously converted or redeemed. The
balance of the debentures at December 31, 2005 was $2,630,273, net of
unamortized debt discount of $1,081,727. The balance of the debentures at
December 31, 2004 was $4,816,849, net of unamortized debt discount of
$2,183,151.
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. Additionally, $300,000
was allocated to the equity component and offset in equity against the proceeds
received from the financing. As a result of the conversion of notes during the
2005, a proportion of the deferred financing costs was accelerated and amortized
to non-cash interest expense in the amount of $308,000. For the years ended
December 31, 2005 and 2004, approximately $426,000 and $30,000, respectively,
were recognized in non-cash interest expense pertaining to these costs.
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. During 2005, 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.
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.
(14) SEPTEMBER 30, 2005 PRIVATE PLACEMENT FINANCING
On September 30, 2005 the Company completed a private placement which resulted
in gross proceeds of $10 million from accredited investors. 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 1,800,000
shares of common stock. The warrants have a term of five years and an exercise
of $2.50 per share. 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.
F-30
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
The antidilution adjustment provides that if the Company sells 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. The Company agreed to
propose to our stockholders that the floor price be eliminated. If the
stockholders approve this proposal and the Company makes 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.
The investors have the right to redeem the preferred stock at a 20% redemption
premium over the issue price, which equals $3.00 per share, if certain
redemption events set forth in the exchange agreement (described below) occur
and are not cured within the applicable cure period. At December 31, 2005, the
redemption value was $12,000,000 plus $150,000 in accrued dividends. These
redemption events are (i) the Company fails to maintain the registration
statement covering the common stock underlying the preferred stock and warrants
for a period of 20 consecutive trading days or 30 days during any 12-month
period, (ii) the failure to remove restrictive legends upon an investor's
request when permitted under applicable law, (iii) the failure to issue common
stock upon exchange in accordance with the exchange agreement, (iv) the
Company's announcement that it intends not to issue common stock in exchange for
preferred stock, (v) suspension of the common stock from trading on a national
securities exchange for a defined period of time, (vi) bankruptcy events, (vii)
a default under indebtedness of the Company or one of its material agreements
and (viii) a concentration of ownership of the Company's capital stock of 35%
which continues for 30 days. After five years from issuance, the Company may at
its option redeem the preferred stock at a 20% redemption 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 daily on each share of preferred stock,
whether or not earned or declared, and shall accrue until paid. The Company 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 the Company does not owe the investors more than $15,000, in the
aggregate, under the transaction documents for the private placement financing.
Because 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 and 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. At December 31, 2005 the Company recorded
an additional non-cash dividend of $149,000 for the affect of the increasing
rate dividends.
F-31
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
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 the Company may create in the future, as to the assets of
the Company available for distribution to the stockholders in the event of (i)
the liquidation, dissolution or winding up of the Company, (ii) the sale of all
or substantially all of the assets of the Company or (iii) 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 described 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 for a liquidation value of $12,000,000 plus $150,000 in
accrued dividends at December 31, 2005.
The warrants are exercisable for five years from the date of listing of the
underlying shares of common stock with the American Stock Exchange (which
occurred on January 6, 2006) at an exercise price of $2.50 per share, subject to
reduction in the case of dilutive issuances. The antidilution adjustment
provides that if the Company sells 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 the
Company 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. The
Company agreed to propose to its stockholders that the floor price be
eliminated. If the stockholders approve this proposal and the Company makes 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 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 (volume weighted average price, as defined in the
warrant agreement) on 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 it will issue a net number of
shares that is less than the total of 1,800,000 warrants). Assuming, however,
that all of the warrants are exercised for cash at an exercise price of $2.50
per share, then the Company will receive a total of $4.5 million for the
exercise of the warrants, and the Company will issue 1,800,000 shares of common
stock.
Emerging Issues Task Force (EITF) Number 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 initially recorded and
carried at fair value until the contract meets the requirements for
classification as equity, until the contract is exercised or until the contract
expires. Accordingly, the Company valued the 1,600,000 warrants using the
Black-Scholes model and simultaneously recorded $2,055,748 as a discount to the
preferred stock. In accordance with EITF Number 00-27, "Application of Issue No.
98-5 to Certain Convertible Instruments," (EITF 00-27), the Company compared the
amount allocated to the preferred stock of $7,944,252 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 conversion
feature of $575,748 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 $575,748 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 $1,151,496 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.
F-32
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
The Company further reduced the carrying value of the preferred stock by
$850,000 for specific incremental costs directly attributable to the transaction
including; investment banking, legal and professional fees.
Under the terms of the September 2005 financing, the Company agreed to file a
resale 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 but in any
event within 120 days of the closing date of the purchase and sale of the
preferred stock and the warrants, which the Company has complied with, having
obtained effectiveness of the registration statement on December 1, 2005. The
Company also agreed to use its best efforts to maintain the effectiveness of the
registration statement until the shares of Common stock underlying the preferred
stock and warrants may be resold by the holder without limitation pursuant to
Rule 144(k) under the Securities Act of 1933, as amended (generally, two years
from the closing date, unless the holder of the common stock is an affiliate of
the Company). If the Company fails to comply with this provision, then the
Company will have to pay liquidated damages of 3% per month of the aggregated
purchase price paid by investors for the preferred stock.
Because the liquidated damages under the Registration Rights Agreement have 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 1,600,000 warrants using the
Black-Scholes model and resulting in a fair value of $2,055,748, which was
recorded as a warrant liability in accordance with EITF 00-19. Because the
warrants are classified as a liability, any changes in fair value will be
recorded as non-cash gain or loss on the fair value of the warrant liability in
the subsequent Statements of Operations until the warrants are exercised,
terminated or expired. The Company recorded a non-cash gain of $157,535 to
revalue the warrants to fair value at December 31, 2005.
In addition to the 1,600,000 warrants that the Company issued to the investors
in the September 2005 financing, in 2005, the Company also issued warrants to
purchase up to 200,000 shares of Common stock to the three holders of our
convertible debentures 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,
in 2005, 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 debentures (Note 13).
(15) 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 in the second quarter of 2006. The 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.
F-33
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2005
Under the original terms of the agreement, the Company agreed to loan Luminetx
$1,000,000. The Company loaned $500,000 to Luminetx on August 5, 2005 and will
invest the remaining $500,000 in Luminetx when it delivers to the Company a
minimum number of VeinViewer(TM) systems, as specified in the distribution
agreement. The Company converted the $500,000 loan for 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.
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 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 exercisable
warrants for 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 determined the
fair value of the warrants using the Black-Scholes model. The fair value of the
remaining warrants for 300,000 shares of common stock will be valued when they
become exercisable.
(16) SUBSEQUENT EVENTS
Subsequent to year-end 2005, the holders of 25,000 shares of preferred stock
purchased in the September 30, 2005 private placement equity financing elected
to exchange these shares into common stock on a one-for-one basis, and
accordingly the Company issued 25,000 shares of common stock to these holders.
F-34
Diomed Holdings, Inc.
Condensed Consolidated Balance Sheets
As of September 30, 2006 (unaudited) and December 31, 2005
September 30, December 31,
2006 2005
------------- ------------
Assets
Current assets:
Cash and cash equivalents $12,941,840 $ 9,562,087
Short term investments 498,595 3,566,454
Accounts receivable, net 2,629,923 2,824,717
Inventories 3,874,721 3,059,886
Prepaid expenses and other current assets 713,820 444,453
----------- -----------
Total current assets 20,658,899 19,457,597
Property, plant and equipment, net 1,272,790 1,171,703
Intangible assets, net 4,125,294 4,302,915
Investment in Luminetx 1,000,000 500,000
Other assets 229,014 294,810
----------- -----------
Total assets $27,285,997 $25,727,025
=========== ===========
Liabilities, preferred stock and stockholders' equity Current liabilities:
Accounts payable $ 4,180,333 $ 3,561,786
Accrued expenses 2,104,597 2,298,823
Current portion of deferred revenue 260,625 257,889
Bank loan 420,519 53,924
Current maturities of capital lease obligations 1,389 2,047
EVLT technology payable (zero face value at September 30,
2006 and $250,000 face value, net of $4,902 debt
discount at December 31, 2005) -- 245,098
Warrant liability -- 1,898,213
----------- -----------
Total current liabilities 6,967,463 8,317,780
Deferred revenue, net of current portion 108,527 144,428
Capital lease obligation, net of current maturities 2,778 4,094
Convertible notes payable ($3,712,000 face value, net of
$3,049,341 debt discount at September 30, 2006 and
$3,712,000 face value, net of $1,081,727 debt
discount at December 31, 2005) 662,659 2,630,273
----------- -----------
Total liabilities 7,741,427 11,096,575
----------- -----------
Commitments and contingencies
Preferred stock -- 7,819,658
----------- -----------
Stockholders' equity 19,544,570 6,810,792
----------- -----------
Total liabilities, preferred stock and stockholders' equity $27,285,997 $25,727,025
=========== ===========
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 and Nine Months Ended September 30, 2006 and 2005
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ------------ -----------
Revenues $ 5,321,080 $ 4,582,840 $ 15,972,476 $13,488,120
Cost of revenues 3,042,223 2,511,536 8,786,487 7,325,127
----------- ----------- ------------ -----------
Gross profit 2,278,857 2,071,304 7,185,989 6,162,993
----------- ----------- ------------ -----------
Operating expenses:
Research and development 422,596 403,498 1,140,170 1,150,712
Selling and marketing 2,687,000 2,080,723 8,490,263 6,693,660
General and administrative 1,906,886 1,811,921 5,865,439 5,475,535
----------- ----------- ------------ -----------
Total operating expenses 5,016,482 4,296,142 15,495,872 13,319,907
----------- ----------- ------------ -----------
Loss from operations (2,737,625) (2,224,838) (8,309,883) (7,156,914)
----------- ----------- ------------ -----------
Other (income) expense:
(Gain)/loss on fair value adjustment on
warrant liability 68,995 -- (971,442) --
Interest expense, non-cash 96,078 98,904 288,229 1,502,760
Interest expense, net, and other (income) 76,480 35,405 (958) 187,773
----------- ----------- ------------ -----------
Total other (income) expense, net 241,553 134,309 (684,171) 1,690,533
----------- ----------- ------------ -----------
Net loss (2,979,178) (2,359,147) (7,625,712) (8,847,447)
Less preferred stock cash dividends (149,063) -- (447,353) --
Less preferred stock non-cash dividends (167,480) (762,656) (483,586) (762,656)
Less beneficial conversion feature on
2006 preferred stock (469,938) -- (469,938) --
Less deemed dividend on the exchange of
2005 preferred stock (2,980,439) -- (2,980,439) --
----------- ----------- ------------ -----------
Net loss applicable to common stockholders $(6,746,098) $(3,121,803) $(12,007,028) $(9,610,103)
=========== =========== ============ ===========
Basic and diluted net loss per share
applicable to common stockholders $ (0.35) $ (0.16) $ (0.62) $ (0.50)
=========== =========== ============ ===========
Basic and diluted weighted average
common shares outstanding 19,448,728 19,423,728 19,447,812 19,143,276
=========== =========== ============ ===========
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,
-------------------------
2006 2005
----------- -----------
Cash Flows from Operating Activities:
Net loss $(7,625,712) $(8,847,447)
Adjustments to reconcile net loss
to net cash used in operating activities:
Depreciation and amortization 690,166 688,545
Amortization of EVLT(R) discount 4,902 57,025
Non-cash interest expense 288,229 1,502,760
Accretion of discount on marketable securities (105,157) --
Amortization of deferred financing costs 72,727 --
Fair value of stock options 443,524 35,440
Gain on fair value adjustment on warrant liability (971,442) --
Changes in operating assets and liabilities:
Accounts receivable 194,794 (592,694)
Inventories (814,835) (897,840)
Prepaid expenses and other current assets (269,367) (194,963)
Deposits (6,931) 175,277
Accounts payable 368,547 952,423
Accrued expenses and deferred revenue (227,391) 392,330
----------- -----------
Net cash used in operating activities (7,957,946) (6,729,144)
----------- -----------
Cash Flows from Investing Activities:
Purchase of property and equipment (500,012) (406,048)
Purchase of available for sale securities (687,099) (1,749,323)
Proceeds from maturities of available for sale
securities 3,800,000 --
Note receivable - Luminetx (500,000)
Investment in Luminetx (250,000) --
----------- -----------
Net cash provided by (used in) investing activities 2,362,889 (2,655,371)
----------- -----------
Cash Flows from Financing Activities:
Net proceeds (payments) on bank borrowings 366,595 193,329
Payments on EVLT(R) purchase obligation (250,000) (750,000)
Proceeds from the exercise of warrants -- 404,903
Dividend payments (447,353) --
Payments on capital lease obligations (1,974) (40,168)
Proceeds from preferred stock financing 9,349,400 10,000,000
----------- -----------
Net cash provided by financing activities 9,016,668 9,808,064
----------- -----------
Effect of Exchange Rate Changes (41,858) (59,095)
----------- -----------
Net Increase in Cash and Cash Equivalents 3,379,753 364,454
Cash and Cash Equivalents, beginning of period 9,562,087 14,436,053
----------- -----------
Cash and Cash Equivalents, end of period $12,941,840 $14,800,507
=========== ===========
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest $ 275,883 $ 228,647
=========== ===========
Non-cash Investing and Financing Activities:
Fair value of warrants exchanged for distribution rights $ 137,403 $ 332,630
=========== ===========
Value ascribed to debt discount related toconvertible debt $ 2,255,843 $ --
=========== ===========
Fair value adjustment on preferred stock to bring preferred
stock to its immediately exchangeable value $ 2,980,439 $ --
=========== ===========
Non-cash note payable for Luminetx investment $ 250,000 $ --
=========== ===========
The accompanying notes are an integral part of
these consolidated financial statements.
F-37
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(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 2005 annual report on Form
10-KSB/A on April 13, 2006, which included audited consolidated financial
statements for the year ended December 31, 2005, and included 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/A for the year ended December 31, 2005.
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Our Annual Report on Form 10-KSB/A for the year ended December 31, 2005 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.
F-38
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(a) 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,
2006 2005
------------- -----------
Raw Materials $1,532,738 $1,415,546
Work-in-Process 767,871 674,010
Finished Goods 1,574,112 970,330
---------- ----------
$3,874,721 $3,059,886
========== ==========
(b) DEFERRED REVENUE
Deferred revenue at September 30, 2006 was as follows:
September 30,
2006
-------------
Beginning balance $ 402,317
Additions 402,245
Revenue/release (435,410)
---------
Ending balance $ 369,152
=========
(c) ACCOUNTING FOR STOCK-BASED COMPENSATION
Effective January 1, 2006, the Company adopted Statement No. 123R, Share-Based
Payment ("SFAS 123R"), which requires companies to measure and recognize
compensation expense for all share-based payment awards made to employees and
directors based on estimated fair values. SFAS 123R is being applied on the
modified prospective basis. Prior to the adoption of SFAS 123R, the Company
accounted for its stock-based compensation plans under the recognition and
measurement principles of Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, as provided by SFAS 123, "Accounting
for Stock Based Compensation" ("SFAS 123") and accordingly, recognized no
compensation expense related to the stock-based plans as stock options granted
to employees and directors were equal to the fair market value of the underlying
stock at the date of grant. In March 2005, the SEC issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to SFAS 123R. The Company has applied the
provisions of SAB 107 in its adoption of SFAS 123R.
Under the modified prospective approach, SFAS 123R applies to new awards and to
awards that were outstanding on January 1, 2006 that are subsequently modified,
repurchased or cancelled. Under the modified prospective approach, compensation
cost recognized includes compensation cost for all share-based payments granted
prior to, but not yet vested on, January 1, 2006, based on the grant-date fair
value estimated in accordance with the provisions of SFAS 123, and compensation
cost for all share-based payments granted subsequent to January 1, 2006, based
on the grant-date fair value estimated in accordance with the provisions of SFAS
123R. Prior periods were not restated to reflect the impact of adopting the new
standard. During the three and nine month periods ended September 30, 2006, the
Company recorded $126,000 and $444,000, respectively, in non-cash charges in
accordance with of SFAS 123R. As of September 30, 2006, there was approximately
$801,000 of total unrecognized compensation cost related to unvested options.
That cost is expected to be recognized over a weighted average period of 1.92
years. The Company plans on obtaining shares to be issued upon exercise of stock
options through authorized common stock. There have been no stock options
exercised during the nine-month period ended September 30, 2006.
F-39
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The following table illustrates the effect on net loss and net loss per share
had the Company accounted for stock-based compensation in accordance with SFAS
123R in fiscal 2005:
Three Months Nine Months
Ended Ended
September 30, September 30,
2005 2005
------------- ------------
Net loss applicable to common
stockholders as reported: $(3,121,803) $ (9,610,103)
Deduct: total stock-based employee compensation;
expense determined under the fair value-based
method for all awards, net of tax (426,732) (1,255,352)
----------- ------------
Proforma net loss applicable to common
stockholders $(3,548,535) $(10,865,455)
=========== ============
Loss per share:
Basic and diluted - as reported $ (0.16) $ (0.50)
=========== ============
The weighted average grant date fair value of options granted during the nine
months ended September 30, 2006 of $1.62 was estimated on the grant date using
the Black-Scholes option-pricing model with the following assumptions: expected
volatility of 86.95%, expected term of 5.68 years, risk-free interest rate of
4.34%, and expected dividend yield of 0%. The weighted average grant date fair
value of options granted during the nine months ended September 30, 2005 of
$2.58 was estimated on the grant date using the Black-Scholes option-pricing
model with the following assumptions: expected volatility of 75%, expected term
of 4.9 years, risk-free interest rate of 3.72%, and expected dividend yield of
0%. Expected volatility is based on a weighted average of the historical
volatility of the Company's stock and peer company volatility. The average
expected life used in 2006 was calculated using the simplified method under SAB
107. The risk-free rate is based on the rate of U.S. Treasury zero-coupon issues
with a remaining term equal to the expected life of option grants. The Company
uses historical data to estimate pre-vesting forfeiture rates.
(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. For all
periods presented, comprehensive loss consists of the Company's net loss,
changes in the cumulative translation adjustment account, and unrealized gains
(loss) on marketable securities. Comprehensive net loss for all periods
presented is as follows:
F-40
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2006 2005 2006 2005
----------- ----------- ----------- -----------
Net loss $(2,979,178) $(2,359,147) $(7,625,712) $(8,847,447)
Unrealized holding gain (loss)
on marketable securities 29 1,768 (202) (331)
Foreign currency translation adjustment 37,559 140,636 164,378 (42,836)
----------- ----------- ----------- -----------
Comprehensive loss $(2,941,590) $(2,216,743) $(7,461,536) $(8,890,614)
=========== =========== =========== ===========
(e) SHORT TERM INVESTMENTS
Marketable 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.
Marketable securities included in cash and cash equivalents and short term
investments at September 30, 2006, all of which mature within one year, consist
of the following:
Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ---------- ---------- ----------
Money Market Funds $1,476,678 $1,476,678 $-- $ --
Commercial Paper 498,501 498,595 -- (94)
---------- ---------- --- ----
$1,975,179 $1,975,273 $-- $(94)
========== ========== === ====
As Reported:
Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ---------- ---------- ----------
Cash and Cash
Equivalents $1,476,678 $1,476,678 $-- $ --
Marketable Securities 498,501 498,595 -- (94)
---------- ---------- --- ----
$1,975,179 $1,975,273 $-- $(94)
========== ========== === ====
Marketable securities included in cash and cash equivalents and short term
investments at December 31, 2005, all of which mature within one year, consist
of the following:
Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ---------- ---------- ----------
Money Market Funds $ 3,815,711 $ 3,815,712 $ -- $ --
Commercial Paper 5,852,606 5,852,408 -- (198)
U.S. Agency Notes 2,096,266 2,096,760 495 --
----------- ----------- ---- -----
$11,764,583 $11,764,880 $495 $(198)
=========== =========== ==== =====
As Reported:
Unrealized Unrealized
Amortized Cost Fair Value Gains Losses
-------------- ---------- ---------- ----------
Cash and Cash
Equivalents $ 8,197,697 $ 8,198,426 $729 $ --
Marketable Securities 3,566,886 3,566,454 -- (432)
----------- ----------- ---- ----
$11,764,583 $11,764,880 $729 $(432)
=========== =========== ==== =====
Net unrealized losses for the nine month period ended September 30, 2006 totaled
$94. The unrealized losses were caused by increasing market interest rates.
Based on the scheduled maturities of these marketable securities and our intent
and ability to hold these securities until maturity, we have concluded that
these unrealized losses are not other-than-temporary.
F-41
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(4) 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 and nine month periods ended September 30, 2006
includes $167,480 and $483,586, respectively, in non-cash preferred stock
dividends accreted for future increasing rate dividends and $149,063 and
$447,353, respectively, of preferred stock cash dividends earned during the
period related to the September 30, 2005 private placement. Upon completion of
the 2006 preferred stock financing, the Company recorded a one-time, non-cash,
non-operating beneficial conversion feature charge of $469,938 as the market
price of the Company's common stock on September 29, 2006 of $1.20 was above the
$1.15 effective conversion price of the immediately convertible preferred stock.
As a result of the 2006 preferred stock financing, the Company exchanged the
2005 preferred stock and recorded a one-time, non-cash, non-operating deemed
dividend of $2,980,439 based on the difference between the fair value of
consideration transferred to the holders of the preferred stock over the
carrying amount, net of original issuance costs.
As a result of the losses incurred by the Company for the three and nine month
periods ended September 30, 2006 and 2005, 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 Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2006 2005 2006 2005
---------- --------- ---------- ---------
Common Stock Options 2,423,787 1,711,225 2,423,787 1,711,225
========== ========= ========== =========
Common Stock Warrants 6,055,303 5,198,452 6,055,303 5,198,452
========== ========= ========== =========
Convertible Debt 3,227,826 1,620,961 3,227,826 1,620,961
========== ========= ========== =========
Preferred Stock 17,354,347 4,000,000 17,354,347 4,000,000
========== ========= ========== =========
(5) 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 or 80% of eligible
accounts receivable. The Company received a waiver to increase the overdraft to
80% of accounts receivable or $420,519 at September 30, 2006. The credit line
bears interest at a rate of 2.5% above Barclays' base rate (4.75% at September
30, 2006) and borrowings are due upon collection of receivables from customers.
As security for the line of credit, Barclay's Bank has a lien on all of the
assets of Diomed, Ltd., excluding certain intellectual property. As of September
30, 2006, there was $420,519 outstanding and at December 31, 2005, there was
approximately $53,924 outstanding under this line of credit.
F-42
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(6) 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 three 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.
The Company plans on settling any exercised employee stock options by issuing
authorized but unissued shares.
As of September 30, 2006, 853,725 options and other incentive stock awards were
available for future grants under the 2003 Omnibus Plan. In addition, 4,542
options were available under the 2001 Plan and 339 options were available under
the 1998 Plan as of September 30, 2006.
A summary of stock option activity for the 2003 Omnibus Plan, the 2001 Plan and
the 1998 Plan is as follows:
Range of Number Weighted Average Weighted Average
Exercise Price of Shares Exercise Price Remaining Life
--------------- --------- ---------------- ----------------
Outstanding, December 31, 2005 $2.00 - $205.75 1,733,398 $6.01
Granted 1.02 - 2.70 722,250 2.21
Forfeited 2.24 - 133.75 (55,168) 8.45
--------------- --------- -----
Outstanding, September 30, 2006 $1.02 - $205.75 2,400,480 $4.77 8.09
=============== ========= ===== ====
Exercisable, September 30, 2006 $1.02 - $205.75 1,880,148 $5.45 7.79
=============== ========= ===== ====
The intrinsic value of options vested at September 30, 2006 was $698. The fair
value of options vested at September 30, 2006 was $455,027. At September 30,
2006, there were 520,332 unvested shares outstanding with a weighted average
grant date fair value of $1.65.
F-43
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The following table summarizes currently outstanding and exercisable options as
of September 30, 2006.
OUTSTANDING EXERCISABLE
---------------------------------------------- ----------------------------
Weighted Average Weighted Average
Exercise Price Shares Remaining Life* Exercise Price Shares Exercise Price
- ---------------- --------- --------------- ---------------- --------- ----------------
$ 1.02 - $2.15 112,565 7.84 $ 1.87 86,440 $ 1.95
2.16 - 2.29 639,143 9.29 2.24 211,184 2.24
2.30 - 4.00 170,417 7.98 3.19 105,836 3.20
4.01 - 4.75 746,211 8.08 4.24 746,211 4.24
4.76 - 5.00 600,200 7.41 5.00 598,533 5.00
5.01 - 11.50 104,491 6.39 8.59 104,491 8.59
11.51 - 49.00 12,256 4.72 31.20 12,256 31.20
49.01 - 87.00 4,700 5.31 51.06 4,700 51.06
87.01 - 164.00 4,113 1.67 114.55 4,113 114.55
164.01 - 205.75 6,384 1.50 174.47 6,384 174.47
--------- ------- --------- -------
2,400,480 $ 4.77 1,880,148 $ 5.45
========= ======= ========= =======
* Weighted average remaining contractual life (in years).
(b) A summary of warrant activity is as follows:
Weighted Average
Range of Number of Weighted Average Remaining Contractual
Exercise Price Shares Exercise Price Life (In Years)
-------------- --------- ---------------- ---------------------
Outstanding, December 31, 2005(i) $0.025 - $2.90 5,196,775 $2.35 4.00
Granted to 2005 PIPE Holders(ii) 1.98 472,000 1.98 4.00
Granted to Placement Agent 2003(iii) 1.50 - 1.77 16,528 1.72 2.16
Granted to Placement Agent 2006(iv) 1.15 370,000 1.15 5.00
-------------- --------- ----- ----
Outstanding, September 30, 2006 $0.025 - $2.90 6,055,303 $1.63 3.61
============== ========= ===== ====
Exercisable, September 30, 2006 $0.025 - $2.90 6,055,303 $1.63 3.61
============== ========= ===== ====
(i) the exercise price of the warrants to purchase shares of the common stock
issued to the investors in the Company's financing transaction completed
October 28, 2004 (the "2004 Warrants") was reduced from $2.10 to $1.15 per
share of the common stock;
(ii) the exercise price of the warrants to purchase shares of the common stock
issued to the investors in the Company's financing transaction completed
September 30, 2005 (the "2005 Warrants") was reduced from $2.50 to $1.98
per share, and the number of shares of the common stock issuable upon
exercise of the 2005 Warrants was increased from 1,800,000 to 2,272,000;
See Footnote 9.
(iii) the exercise price of certain warrants to purchase shares of the common
stock issued to designees of the Company's former placement agent, Sunrise
Securities Corp. (the "Sunrise Warrants"), was reduced and the number of
shares of common stock issuable upon exercise of these Sunrise Warrants
was increased from 139,315 to 155,843 as follows:
- - the exercise price of certain Sunrise Warrants was decreased from $2.32 to
$1.77 per share, and the number of shares of common stock issuable upon
exercise of these Sunrise Warrants was increased from 42,282 to 55,559;
- - the exercise price of certain Sunrise Warrants was decreased from $1.93 to
$1.50 per share, and the number of shares of common stock issuable upon
exercise of these Sunrise Warrants was increased from 11,455 to 14,706;
and
- - the exercise price of certain Sunrise Warrants was decreased from $2.10 to
$1.15 per share (no adjustments impacted the remaining Sunrise Warrants).
(iv) The Company granted the placement agent, Musket Research Associates, Inc.,
370,000 warrants at an exercise price of $1.15 per share of common stock
under the 2006 preferred stock financing.
F-44
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(7) SEGMENT REPORTING
The Company's reportable segments are determined by product type: laser systems;
and fibers, accessories and service. The Board of Directors evaluates segment
performance based on revenue. Accordingly, all expenses are considered corporate
level activities and are not allocated to segments. Also, the Board of Directors
does not assign assets to its segments.
This table presents revenues by reportable segment:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2006 2005 2006 2005
---------- ---------- ----------- -----------
Laser systems $1,980,183 $2,193,635 $ 6,125,422 $ 6,762,513
Fibers, accessories, and service 3,340,897 2,389,205 9,847,054 6,725,607
---------- ---------- ----------- -----------
Total $5,321,080 $4,582,840 $15,972,476 $13,488,120
========== ========== =========== ===========
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,
2006 2005 2006 2005
-------- -------- ------------- ------------
United States 75% 75% $6,226,894 $5,930,287
Asia/Pacific 9% 14% -- --
Europe 12% 8% 400,204 339,141
Other 4% 3% -- --
---- ---- ---------- ----------
Total 100% 100% $6,627,098 $6,269,428
==== ==== ========== ==========
F-45
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
(8) COMMITMENTS AND CONTINGENCIES
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, 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' patents are unenforceable for inequitable conduct.
The Company is now proceeding with the discovery phase of this litigation. A
claim construction hearing was held on October 30, 2006. The court will provide
their ruling on the hearing at a later date. The Company intends to continue to
defend its position, however, management is unable to predict the outcome of
this lawsuit.
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. The Company is presently
prosecuting these lawsuits, however, management is unable to predict the outcome
of these lawsuits.
On August 30, 2006 U.S. District Judge Nathaniel M. Gorton ruled that the '777
patent is valid and enforceable. In granting Diomed's motion for summary
judgment; the court rejected defenses advanced by defendants AngioDynamics and
Vascular Solutions that Diomed's patent was invalid and unenforceable. The court
denied separate motions by each of the parties for summary judgment on the issue
of infringement by the defendants, in effect ruling that Diomed is entitled to
proceed to trial on its claims for an injunction and damages against the
defendants. If the Company does not prevail in the infringement actions and is
not be able to exclude third parties from using the Company's EVLT(R)
technology, 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.
(9) PRIVATE PLACEMENT EQUITY FINANCING COMPLETED SEPTEMBER 29, 2006
On September 29, 2006, the Company issued 1,735.4347 shares of preferred stock,
each share of which has a stated value of $11,500 per share, for gross proceeds
of $10,010,000. The Company issued 870.4348 of these shares to investors who
purchased these shares for cash at a price of $11,500 per share, and the Company
issued 864.9999 shares to investors who tendered their shares of the 3,975,000
outstanding shares of preferred stock the Company issued in 2005 in exchange for
shares of the 2006 preferred stock, all in accordance with the terms of a
Securities Purchase Agreement the Company entered into with the investors in
July 2006.
Exchange Provisions. At an investor's option, each share of the 2006 preferred
stock may be exchanged for shares of the common stock. Subject to applicable
limitations on ownership (described below), each share of the 2006 preferred
stock is exchangeable for the number of shares of the common stock equal to
$11,500 divided by the exchange rate. The exchange rate initially is $1.15 and
is subject to certain adjustments, including reduction if we make certain
dilutive issuances of equity securities in the future. The antidilution
adjustment provides that if the Company sells shares of the common stock (or the
rights to acquire the common stock) for a price lower than the then-current
exchange rate, the exchange rate will be reduced to the weighted average price
of the common stock issued after giving effect to the dilutive issuance.
F-46
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
The Company also has the right to require the investors to exchange their shares
of the 2006 preferred stock if the trading price of the common stock achieves
and remains at a price level of $2.875 per share and certain other conditions
are satisfied. Upon a change of control (as defined), shares of the preferred
stock will automatically be exchanged for the right to receive either (1) the
liquidation preference of the 2006 preferred stock of $13,800 per share or (2)
the consideration which would have become payable in the change of control
transaction to the holders of the preferred stock in respect of the shares of
common stock underlying the preferred stock, whichever is greater. For purposes
of the preferred stock, a "change of control" is defined to include only (i) the
sale by the Company of all or substantially all of our assets or (ii) a merger,
consolidation or other business combination where either (1) the Company is not
the surviving entity or (2) either the holders of the Company's capital stock
immediately prior to the transaction have 50% or less of the voting rights of
the surviving entity or own 50% or less of the outstanding voting securities of
the surviving entity immediately following the transaction or the board of
directors immediately prior to the transaction comprise 50% or less of the board
of directors of the surviving entity. A change in ownership of our outstanding
capital stock is excluded from the definition of "change in control."
Redemption. The investors do not have the right to require the Company to redeem
their shares of the 2006 preferred stock. The Company, however, has the right to
redeem the 2006 preferred stock after the fifth anniversary of the completion of
the financing transaction at a price equal to 120% of the issue price, or
$13,800 per share.
Dividends. Dividends do not accrue on the 2006 preferred stock unless and until
the Company completes a transaction in the future that reduces the effective
conversion price of our outstanding convertible debentures below the conversion
price in effect upon the completion of the financing transaction, $1.15, as a
result of the operation of the anti-dilution rights of the holders of the
debentures, but only if at the time of the future transaction the reduction in
conversion price affects debentures having an aggregate principal amount of at
least $1,000,000. Thereafter, dividends will accrue on the issued and
outstanding shares of the 2006 preferred stock at the rate of 15% per annum and
will be payable quarterly in arrears.
Voting Rights. The holders of 2006 preferred stock will be entitled to vote on
all matters submitted to a vote of the Company's stockholders, together with the
holders of common stock, voting as a single class. The holders of 2006 preferred
stock will vote their shares on the basis of the number of shares of common
stock into which the 2006 preferred stock is then exchangeable (subject to the
applicable limitations on ownership described below). If, under the Delaware
General Corporation Law, the holders of 2006 preferred stock are required to
approve any action by separately voting as a class, the vote of the holders of
at least 65% of the outstanding shares of the 2006 preferred stock will be
required to approve such action.
Liquidation. The 2006 preferred stock shall be preferred over and senior to the
common stock and any other class or series of capital stock created by the
Company. Upon the occurrence of any event causing our liquidation or any change
of control transaction (as defined) by the Company, the holders of
then-outstanding shares of preferred stock will be entitled to receive, from the
proceeds of such event or transaction, before any distribution is made to any
other class or series of capital stock, an amount equal to the greater of (i)
$13,800 per share of the preferred stock or (ii) such amount per share of the
preferred stock as would have been payable had each share been exchanged into
common stock immediately prior to the event or transaction. If there are
sufficient proceeds from the liquidation or change of control transaction (as
defined) remaining after the distribution to the holders of the preferred stock,
the remaining proceeds will be distributed ratably among the holders of the
common stock.
Anti-Dilution Adjustments to the Exchange Rate. The exchange rate of the 2006
preferred stock will be adjusted if the Company offers or sells any common stock
or common stock equivalent securities at an effective price per share of less
than the exchange rate of the 2006 preferred stock, initially, $1.15. The
exchange rate will not be adjusted, however, for the Company's issuance of
common stock or common stock equivalent securities exercisable below the
exchange rate if such issuance is limited to: (i) shares of common stock or
options issued to employees, officers, directors or consultants pursuant to an
equity plan approved by the stockholders or (ii) the exchange of exchangeable or
convertible securities already outstanding as of the date of the Securities
Purchase Agreement.
F-47
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
Liquidated Damages. The Company may be required to pay liquidated damages to the
investors if the Company fails to timely comply with an investor's request to
exchange shares of the 2006 preferred stock for shares of the common stock or if
the Company does not timely remove restrictive legends from certificates
representing shares of the common stock when requested by the investor and
permitted by applicable law. The liquidated damages are payable in the amount of
1% per day of the issue price of the shares of the 2006 preferred stock subject
to the investor's request and are subject to an aggregate cap of 25% of the
issue price paid by the investor for the 2006 preferred stock (inclusive of any
other liquidated damages payable by us in respect of the 2006 preferred stock).
If the Company fails to timely issue shares of the common stock upon exchange or
remove legends from shares of the common stock when requested by investors and
permitted by applicable law and the investor purchases other shares of common
stock to settle the sale of shares of common stock that were intended to be
settled by shares of common stock issuable upon exchange of the unlegended
shares, then the Company may also be required to pay to the investors the
difference between the proceeds of sale of the shares of the common stock sold
and the price paid for the other shares of the common stock purchased for
settlement purposes.
Registration Rights. Upon completing the financing transaction on September 29,
2006, the Company entered into a registration rights agreement among the Company
and the investors. Pursuant to the Registration Rights Agreement, the Company
agreed to file a registration statement on Form SB-2 with the SEC, registering
for public resale the "registrable securities" consisting of the shares of the
common stock that are issuable upon exchange of the shares of 2006 preferred
stock issued to investors in the financing transaction and the shares of common
stock that are issuable upon exercise of the par warrants, as defined under the
Securities Purchase Agreement, should any par warrants be issued in lieu of
common stock as a result of applicable limitations on ownership.
The Company is required to file the registration statement within 45 days of the
closing of the financing transaction, and to use its best efforts to cause the
registration statement to be declared effective as soon as practicable but no
more than 120 days of the closing of the financing transaction. The Company
agreed to pay liquidated damages to the investors if the Company does not file
the registration statement within 45 days of the closing date of the financing
transaction, if the registration statement is not declared effective within 120
days of the closing date, or is not continually effective for any period that
exceeds 20 consecutive days or 30 aggregate days during any 12-month period, or
if the common stock does not remain listed on an applicable stock exchange after
the effective date of the registration statement. If any of the foregoing
occurs, the Company may be required to pay each investor liquidated damages for
the period from the date on which such event occurs until the event is cured, at
a monthly rate equal to 3% of the original issue price of the 2006 preferred
stock, prorated for partial months based on the number of days in the month. The
liquidated damages are subject to an aggregate cap of 25% of the issue price
paid by the investors for the shares of the 2006 preferred stock (inclusive of
any other liquidated damages payable by the Company in respect of the preferred
stock).
In accordance with EITF Number 00-27, "Application of Issue No. 98-5 to Certain
Convertible Instruments," (EITF 00-27), the Company compared the amount
allocated to the preferred stock of $10,010,000 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 conversion
feature of $469,938 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. In accordance with EITF 98-5, this adjustment of
$469,938 is analogous to a dividend and recognized as a return to the
shareholders and has been included in the beneficial conversion feature of 2006
Preferred Stock in the Company's calculation of Net Loss Applicable to Common
stockholders and Basic and Diluted Net Loss per Share. The Company recorded the
2006 preferred stock to permanent equity in accordance with the terms of EITF
Abstracts - Appendix D - Topic D-98: Classification and Measurement of
Redeemable Securities ("Topic D-98").
The Company also issued 370,000 placement fee warrants to Musket Research
Associates, Inc. ("MRA") and $610,600 in cash in consideration of services to
both MRA and Roth Capital Partners. The placement fee warrants are exercisable
for five years from the date of listing with the American Stock Exchange at an
exercise price of $1.15 per share, subject to reduction in the case of dilutive
issuances.
F-48
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
In addition, the holders of the Placement Fee Warrants may exercise their
warrants 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 on the Trading Day immediately preceding the date of such
election;
B = the Exercise Price of this warrant, as adjusted; and
X = the number of Warrant Shares issuable upon exercise of this Warrant in
accordance with the terms of this Warrant by means of a cash exercise rather
than a cashless exercise
Where:
"VWAP" means, for any security as of any date, the price determined by the first
of the following clauses that applices: (a) if the common stock is then listed
or quoted on a Trading Market, the daily volume weighted average price of the
common stock for such date on the Trading Market on which the common stock is
then listed or quoted as reported by Bloomberg Financial L.P. (based on a
Trading Day from 9:30 a.m. Eastern Time to 4:02 p.m. Eastern Time); (b) if the
common stock is not then listed or quoted on a Trading Market and if prices for
the common stock are then quoted on the OTC Bulletin Board, the volume weighted
average price of the common stock for such date on the OTC Bulletin Board; (c)
if the common stock is not then listed or quoted on the OTC Bulletin Board and
if prices for the common stock are then reported in the "Pink Sheets" published
by the National Quotation Bureau Incorporated (or a similar organization or
agency succeeding to its functions of reporting prices), the most recent bid
price per share of the common stock so reported; or (d) in all other cases, the
fair market value of a share of common stock as determined by an independent
appraiser selected in good faith by the holders of the preferred stock and
reasonably acceptable to the Corporation, where "Trading Day" means a day on
which the common stock is traded on a Trading Market, and "Trading Market" means
the following markets or exchanges on which the common stock is listed or quoted
for trading on the date in question: the Nasdaq SmallCap Market, the American
Stock Exchange, the New York Stock Exchange or the Nasdaq National Market.
Effect on 2005 Preferred Stock
As a result of the 2006 preferred stock financing, the Company exchanged the
2005 preferred stock for new 2006 preferred stock. As illustrated in EITF Topic
D-42: The Effect on the Calculation of Earnings per Share for the Redemption or
Induced Conversion of Preferred Stock, ("Topic D-42"), the preferred
stockholders received additional value as the exchange price was adjusted down
below the original effective exchange price. The Company compared the excess of
the fair value of the consideration transferred to the holders of the 2005
preferred stock over the carrying amount of the 2005 preferred stock in the
Company's balance sheet to approximate the return to the 2005 preferred
stockholder. For the purposes of calculating the excess of (1) the fair value of
the consideration transferred to the holders of the 2005 preferred stock over
(2) the carrying amount of the 2005 preferred stock in the registrant's balance
sheet, the carrying amount of the 2005 preferred stock was reduced by the
issuance costs of the 2005 preferred stock.
Accordingly, since the value of the 864.999 shares of 2006 preferred stock can
be exchanged for common stock at the ratio of 1 for 10,000 common shares,
multiplied by the market price of common stock on the day of the closing ($1.20)
was $10,379,988; and the carrying value of $8,248,993 less the issuance costs of
$849,444 represents $7,399,549; the residual fair value of $2,980,439 was
recorded as an increase to preferred stock and a decrease to Additional Paid-in
Capital. The Company also recorded the $2,980,439 as a deemed dividend on the
exchange of the 2005 preferred stock in the calculation of basic and diluted
earnings per share. The 2005 preferred stock fair value of $11,229,432 was
reclassified to permanent equity as a result of the exchange and included within
the 2006 Preferred Stock on the Company's Balance Sheet in accordance with Topic
D-98.
As a result of the exchange and the corresponding implementation of a liquidated
damages cap in an amount that represents a reasonable percentage discount of the
fair value of an unregistered share versus a registered share, the warrants are
no longer required to be accounted for as a liability under EITF 00-19.
Therefore, the warrant liability of $926,771 was marked to market one final time
at September 29, 2006, through a charge to the Statement of Operations in the
amount of $68,995, and then reclassified to Additional Paid-in Capital.
F-49
DIOMED HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006
(UNAUDITED)
In accordance with the contingent anti-dilution terms of the 2005 preferred
stock warrant agreement, the exercise price and number of warrants originally
issued to the 2005 preferred stockholders were adjusted so that the number of
warrants increased by 472,000 and the exercise price decreased to $1.98.
Increasing rate dividends and cash dividends of the 2005 Preferred Stock were
eliminated when the 2005 preferred stock was exchanged for the 2006 preferred
stock.
Effect on 2004 Convertible Debentures
The Company determined that the conversion and exercise price changes were not
modifications to the terms of their respective agreements, but were executions
of contingent conversion options within those agreements. Under EITF 00-27
"Application of Issue No. 98-5 to Certain Convertible Instruments" ("EITF
00-27"), the Task Force reached a consensus that if the terms of a contingent
conversion option do not permit an issuer to compute the number of shares that
the holder would receive if the contingent event occurs and the conversion price
is adjusted, an issuer should wait until the contingent event occurs and then
compute the resulting number of shares that would be received pursuant to the
new conversion price.
Prior to the transaction, the 2004 debt was convertible into 1,620,961 shares,
and after the 2006 Preferred Stock Financing the 2004 debt is convertible into
3,227,826 shares. The difference of 1,606,865 shares multiplied by the market
price of our common stock on the date of the closing of $1.20 results a new fair
value of $3,631,516. Because the result was in excess of the carrying value of
the debt, the Company recorded a discount of $2,255,843. This debt discount will
be accreted back to debt over the remaining two year term of the 2004
convertible debt agreement through charges against non-cash interest expense in
the Company's Statements of Operations.
The exercise price of warrants originally issued to the 2004 debt holders was
adjusted so that the exercise price decreased to $1.15 in accordance with the
original contingent anti-dilution terms of those 2004 debenture agreements.
(10) SUBSEQUENT EVENTS
Commitment for Luminetx Investment
Under separate agreement entered into on August 4, 2006, the Company agreed to
fund the $500,000 investment in two equal installments, one of which was paid
upon execution of the August 4, 2006 agreement, and the other was subsequently
paid on October 30, 2006. Effective August 4, 2006, and with the initial
payment, the Company was issued 250,000 shares of preferred stock and 50,000
warrants under the same terms as the private placement financing announced by
Luminetx on November 4, 2005. These shares and warrants were held as collateral
by Luminetx until the Company funded the remaining $250,000 installment on
October 30, 2006.
F-50
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 certain 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....... $ 2,500
Printing and Engraving Expenses........................... $ 10,000
Legal Fees and Expenses................................... $ 250,000
Accounting Fees and Expenses.............................. $ 50,000
Transfer Agent Fees and Expenses.......................... $ 4,500
Underwriting Fees and Discounts........................... $ 611,000
Miscellaneous............................................. $ 22,000
----------
Total............................................... $ 950,000
Item 26. Recent Sales of Unregistered Securities
1) 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.
II-1
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:
- ------------------------------------------------- ------------------------------ --------------------------
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 163,400 81,700
f/b/o J. Steven 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.
II-2
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 (which we obtained at our 2005 annual meeting of stockholders).
Registration of Common Stock
We agreed to undertake registration with the Securities and Exchange Commission
(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.
2) 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.
3) 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.
4) 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.
II-3
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 could
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, initially subject to a floor of $2.17, unless the stockholders of the
Company approved the elimination of the floor price. We agreed to propose to our
stockholders that the floor price be eliminated, and the stockholders approved
this proposal at our 2006 annual meeting of stockholders. Accordingly, if we
were to make a dilutive issuance (such as the September 29, 2006 financing
transaction), then the exchange rate for the preferred stock would be decreased,
first to the floor price, then to the weighted average price of the securities
issued after giving effect to the dilutive issuance.
The warrants were fully vested upon issuance and are exercisable for five years
from the date of listing of the underlying shares of common stock with the
American Stock Exchange (January 6, 2006) 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, initially subject to a floor of $2.12, until the
stockholders approved the elimination of the floor price at our 2006 annual
meeting of stockholders. As a result, if we were to make a dilutive issuance
(such as the September 29, 2005 financing transaction), then the exercise price
of the warrants would 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 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-4
The following are the holders of convertible debentures to whom we issued
warrants in connection with the September 30, 2005 financing:
Warrant
Debenture Holder 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.
(5) On September 29, 2006, after obtaining stockholder approval and amending our
certificate of incorporation to enable us to issue a new 2006 series of
preferred stock, we completed a private placement equity financing in which we
issued (i) 870.4348 shares of a new 2006 series of preferred stock, each share
having a stated value of $11,500, which is exchangeable at $1.15 per share into
an aggregate of 8,704,348 shares of our common stock and (ii) 864.9999 shares of
the 2006 preferred stock in exchange for all 3,975,000 then-outstanding shares
of preferred stock we issued on September 30, 2005, exchangeable at $1.15 per
share into 8,649,999 shares of common stock.
The following investors purchased shares of 2006 preferred stock for cash in the
September 29, 2006 financing:
No.
Shares 2006 No. Shares Common
Dollar Amount Preferred Stock to Stock underlying
Name of Investor Invested be Purchased 2006 Preferred Stock
- ----------------------------------------------------- ------------------- --------------------- ----------------------
SDS Capital Group SPC, Ltd. 2,990,000 260 2,600,000
Westfield Life Sciences Fund, L.P. 195,500 17 170,000
Westfield Life Sciences Fund II, L.P. 1,736,500 151 1,510,000
Westfield Microcap Fund, L.P. 69,000 6 60,000
ProMed Partners, L.P. 368,000 32 320,000
ProMed Offshore Fund, Ltd. 46,000 4 40,000
ProMed Offshore Fund II, L.P. 1,092,500 95 950,000
New England Partners Capital, L.P. 750,000 65.2174 652,174
Nexus Medical Partners II S.C.A. SICAR 750,000 65.2174 652,174
MCF Navigator Master Fund, Ltd. 299,000 26 260,000
Camber Capital Fund L.P. 253,000 22 220,000
Robert S. Martin 253,000 22 220,000
Oliveira Capital, LLC 253,000 22 220,000
Alan W. Steinberg, L.P. 253,000 22 220,000
Valley Forge Investments Limited 253,000 22 220,000
Cipher 06, LLC 218,500 19 190,000
David B. Musket 138,000 12 120,000
Guerrilla IRA Partners, L.P. 46,000 4 40,000
Douglas Schmidt 46,000 4 40,000
---------- -------- ---------
TOTAL 10,010,000 870.4348 8,704,348
========== ======== =========
II-5
The following investors exchanged their 2005 shares of preferred stock for
shares of 2006 preferred stock in the September 29, 2006 financing:
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
2006 Shares Issuable Common Stock
upon Exchange (Issue underlying 2006
2005 Shares Amount of 2005 Shares Preferred Stock
Cancelled upon Exchanged divided by (at Exchange Rate of
Name of Investor Exchange $11,500) $1.15)
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
ProMed Partners, LP 144,000 31.3043 313,043
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
ProMed Partners II, LP 11,000 2.3913 23,913
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
ProMed Offshore Fund, Ltd 24,000 5.2174 52,174
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
ProMed Offshore Fund II, Ltd 596,000 129.5652 1,295,652
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Advantage Advisors Catalyst Partners LP 42,000 9.1304 91,304
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Advantage Advisors Catalyst Intl. Ltd 30,000 6.5217 65,217
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Ridgecrest Partners Ltd. 24,000 5.2174 52,174
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Ridgecrest Partners L.P. 4,000 .8696 8,696
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Ridgecrest Partners QP, L.P. 100,000 21.7391 217,391
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Lagunitas Partners LP 520,000 113.0435 1,130,435
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Gruber & McBaine International 160,000 34.7826 347,826
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Jon D. and Linda W. Grubert Trust 60,000 13.0435 130,435
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
J. Patterson McBaine 60,000 13.0435 130,435
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Broadfin Healthcare Fund LP 60,000 13.0435 130,435
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Alpha Capital 120,000 26.0870 260,870
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
Fractal Holdings, LLC 20,000 4.3478 43,478
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
North Sound Legacy International Ltd 1,440,000 313.9130 3,139,130
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
North Sound Legacy Institutional Fund LLC 560,000 121.7391 1,217,391
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
TOTAL 3,975,000 864.9999 8,649,999
========= ======== =========
- ------------------------------------------------------ ------------------- ------------------------- -----------------------
We issued the 2006 preferred stock 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
2006 preferred stock nor the underlying common stock 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.
(6) On September 29, 2006, concurrent with the issuance of the 2006 preferred
stock described under (1), above, we adjusted the terms of certain outstanding
securities as required by the antidilution adjustment provisions of those
securities. We reduced the conversion price of the $3.712 million principal
amount of convertible debentures we issued on October 25, 2004 by reducing the
conversion price from $2.29 per share to $1.15 per share, resulting in an
increase in the number of shares of common stock issuable upon conversion of the
principal amount of these debentures from 1,620,961 to 3,227,826. We also
reduced the exercise price of the 2,657,461 outstanding common stock purchase
warrants we issued on October 25, 2004 from $2.10 per share to $1.15 per share.
In addition, we reduced the exercise price of the 1,800,000 outstanding common
stock purchase warrants we issued on September 30, 2005 from $2.50 per share to
$1.98 per share and we increased the number of shares underlying these warrants
to 2,272,000. Further, we reduced the exercise price of 42,282 common stock
purchase warrants we issued on November 25, 2003 from $2.32 per share to $1.77
per share and we increased the number of shares underlying these warrants to
55,559, we reduced the exercise price of 11,455 common stock purchase warrants
we issued on November 25, 2003 from $1.93 per share to $1.50 per share and we
increased the number of shares underlying these warrants to 14,706 and we
reduced the exercise price of 73,539 common stock purchase warrants we issued on
October 25, 2004 from $2.10 per share to $1.15 per share (without adjustment to
the number of shares underlying these warrants).
II-6
The holders of the debentures are those persons to whom we initially issued the
debentures, except that in 2006, one of the original debenture holders, Omicron
Master Trust, transferred its debentures to two other persons, Rockmore
Investment Master Fund Limited (which holds $700,054.36 principal amount of
debentures) and Portside Growth and Opportunity Fund (which owns $1,509,945.64
principal amount of debentures). The holders of the warrants are those persons
to whom we initially issued the warrants, except that in 2006, one of the
original warrant holders, Omicron Master Trust, transferred some of the warrants
it held to another person, Rockmore Investment Master Fund Limited (which owns
456,078 warrants).
We initially issued the debentures 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
debentures or warrants, or the underlying common stock 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.
(7) On September 29, 2006, concurrently with the issuance of the 2006 preferred
stock described under (5), above, we issued 370,000 common stock purchase
warrants, exercisable for five years at an exercise price of $1.15 per share, to
eight persons that our co-placement agent in the 2006 preferred stock financing,
Musket Research Associates, Inc. ("MRA"), designated to receive warrants that
MRA earned as part of its fees for placement agency services MRA provided to us
in the financing.
We issued these warrants to the MRA designees as follows:
- ------------------------------------------------------- ---------------------------------------------
Name of Warrant Holder Number of underlying Common Shares
- ------------------------------------------------------- ---------------------------------------------
David B. Musket 121,800
- ------------------------------------------------------- ---------------------------------------------
Paul Scharfer 101,800
- ------------------------------------------------------- ---------------------------------------------
Barry Kurokawa 60,900
- ------------------------------------------------------- ---------------------------------------------
Josh Golomb 10,000
- ------------------------------------------------------- ---------------------------------------------
David Bartash 10,000
- ------------------------------------------------------- ---------------------------------------------
ProMed Partners, L.P. 16,000
- ------------------------------------------------------- ---------------------------------------------
ProMed Offshore Fund, Ltd. 2,000
- ------------------------------------------------------- ---------------------------------------------
ProMed Offshore Fund II, Ltd. 47,500
- ------------------------------------------------------- ---------------------------------------------
TOTAL 370,000
=======
- ------------------------------------------------------- ---------------------------------------------
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 or warrants nor the
underlying common stock 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
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)
II-7
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)
4.5 Diomed Holdings, Inc. Amendment to Certificate of Incorporation
filed September 27, 2006 (20)
5.1 Legality Opinion rendered by the Registrant's legal counsel,
McGuireWoods LLP (21)
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)
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)
II-8
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)
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 financing transaction (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)
10.68 Securities Purchase Agreement in connection with September 29,
2006 financing transaction (19)
10.69 Form of Registration Rights Agreement in connection with
September 29, 2006 financing transaction (19)
10.70 Form of Par Warrant in connection with September 29, 2006
financing transaction (19)
10.71 Engagement Letter with Roth Capital Partners, LLC in connection
with September 29, 2006 financing transaction (19)
10.67 Engagement Letter with Musket Research Associates, Inc. in
connection with Sepember 29, 2006 financing transaction (19)
23.1 Consent of BDO Seidman, LLP (21)
23.2 Consent of McGuireWoods LLP (included in Exhibit 5.1)
- --------------
II-9
(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 with the Company's Current Report on Form 8-K
dated August 1, 2006. (20) Filed with the Company's Definitive Proxy
Statement on Schedule DEF14A
dated August 25, 2006
(21) Filed herewith.
II-10
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-11
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 January 30, 2007. 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 January 30, 2007
- -------------------------------------- Director
(James A. Wylie, Jr)
/s/ David B. Swank Chief Financial Officer and Director January 30, 2007
- --------------------------------------
(David B. Swank)
/s/ Geoffrey H. Jenkins Chairman of the Board, Director January 30, 2007
- --------------------------------------
(Geoffrey H. Jenkins)
/s/ Sidney Braginsky Director January 30, 2007
- --------------------------------------
(Sidney Braginzky)
/s/ Gary Brooks Director January 30, 2007
- --------------------------------------
(Gary Brooks)
/s/ A. Kim Campbell Director January 30, 2007
- --------------------------------------
(A. Kim Campbell)
/s/ Joseph Harris Director January 30, 2007
- --------------------------------------
(Joseph Harris)
/s/ Peter Klein Director January 30, 2007
- --------------------------------------
(Peter Klein)
/s/ Edwin Snape Director January 30, 2007
- --------------------------------------
(Edwin Snape)
II-12
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)
4.5 Diomed Holdings, Inc. Amendment to Certificate of Incorporation
filed September 27, 2006 (20)
5.1 Legality Opinion rendered by the Registrant's legal counsel,
McGuireWoods LLP (21)
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)
10.23 Security Agreement dated December 27, 2002 (5)
II-13
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)
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)
II-14
10.66 Form of Waiver of Negative Covenants by Debenture Holders in
connection with September 30, 2005 financing transaction (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)
10.68 Securities Purchase Agreement in connection with September 29,
2006 financing transaction (19)
10.69 Form of Registration Rights Agreement in connection with
September 29, 2006 financing transaction
(19)
10.70 Form of Par Warrant in connection with September 29, 2006
financing transaction (19)
10.71 Engagement Letter with Roth Capital Partners, LLC in connection
with September 29, 2006 financing transaction (19)
10.67 Engagement Letter with Musket Research Associates, Inc. in
connection with Sepember 29, 2006 financing transaction (19)
23.1 Consent of BDO Seidman, LLP (21)
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 with the Company's Current Report on Form 8-K
dated August 1, 2006. (20) Filed with the Company's Definitive Proxy
Statement on Schedule DEF14A
dated August 25, 2006
(21) Filed herewith.
II-15