Failure to receive shipments of
critical components could reduce revenues and reduced reliability of critical components
could increase expenses.
We develop light-based systems that incorporate third-party components and we purchase
some of these components from small, specialized vendors that are not well capitalized. We
do not have long-term contracts with some of these third parties for the supply of parts.
A disruption in the delivery of these key components, or our inability to obtain
substitute components or subassemblies from alternate sources at acceptable prices in a
timely manner, or our inability to obtain assembly or testing services could prevent us
from manufacturing products and result in a decrease in revenue. We depend on an
acceptable level of reliability for purchased components. Reliability below
expectations for key components could have an adverse affect on inventory and inventory
reserves. Any extended interruption in our supplies of third-party components could
materially harm our business.
29
We forecast sales to determine
requirements for components and materials used in our products and if our forecasts are
incorrect, we may experience either delays in shipments or increased inventory costs.
To
manage our manufacturing operations with our suppliers, we forecast anticipated product
orders and material requirements to predict our inventory needs and enter into purchase
orders on the basis of these requirements. Our limited historical experience may not
provide us with enough data to accurately predict future demand. If our business expands,
our demand for components and materials would increase and our suppliers may be unable to
meet our demand. If we overestimate our component and material requirements, we will have
excess inventories, which would increase our expenses. If we underestimate our component
and material requirements, we may have inadequate inventories, which could interrupt,
delay, or prevent delivery of our products to our customers.
Our proprietary technology has
only limited protections which may not prevent competitors from copying our new
developments. This may impair our ability to compete effectively. We may
expend significant resources enforcing our intellectual property rights to prevent such
copying, and our intellectual property could be determined to be not infringed, invalid or
unenforceable.
Our
business could be materially and adversely affected if we are not able to adequately
protect our intellectual property rights. We rely on a combination of patent, copyright,
trademark and trade secret laws, licenses and confidentiality agreements to protect our
proprietary rights. We own and license a variety of patents and patent applications in the
United States and corresponding patents and patent applications in many foreign
jurisdictions. Our pending and future patent applications may not issue as patents or, if
issued, may not issue in a form that will be advantageous to us. Even if issued, patents
may be challenged, narrowed, invalidated or circumvented, which could limit our ability to
stop competitors from marketing similar products or limit the length of term of patent
protection we may have for our products. Changes in either patent laws or in
interpretations of patent laws in the United States and other countries may diminish the
value of our intellectual property or narrow the scope of our patent protection.
We
have granted certain patent licenses to several competitors, and in return for those
license grants, we receive a significant ongoing royalty revenue stream. A few of
these competitors entered into license agreements only after we sued them for patent
infringement. We are currently enforcing these patents against Candela Corporation
and intend to enforce against other competitors in the future. We do not know how
successful we will be in asserting our patents against Candela or other suspected
infringers. Whether or not we are successful in the pending lawsuit, litigation
consumes substantial amounts of our financial resources and diverts managements
attention away from our core business. Public announcements concerning this litigation
that are unfavorable to us may in the future result in significant declines in our stock
price. An adverse ruling or judgment in this matter could result in a loss of our
significant ongoing royalty revenue stream and could also have a material adverse effect
on license agreements with other companies both of which could have a material adverse
effect on our business and results of operation and cause our stock price to decline
significantly. (For more information about our patent litigation, see Part II, Item
1 Legal Proceedings.)
In
addition to patented technology, we rely upon unpatented proprietary technology, processes
and know-how. We generally enter into agreements with our employees and third parties with
whom we work, including but not limited to consultants and vendors, to restrict access to,
and distribution of, our proprietary information and define our intellectual property
ownership rights. Despite our efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use our technology, proprietary
information and know-how and we may not have adequate remedies for any such breach.
Monitoring unauthorized use of our technology is difficult and we cannot be certain that
the steps we have taken will prevent unauthorized use of our technology, particularly in
foreign countries where the laws may not protect our proprietary rights as fully as in the
United States. If competitors are able to use our technology, our ability to compete
effectively could be harmed and the value of our technology and products could be
adversely affected. Costly and time consuming lawsuits may be necessary to enforce
and defend patents issued or licensed exclusively to us, to protect our trade secrets
and/or know-how or to determine the enforceability, scope and validity of others
intellectual property rights. Such lawsuits may result in patents issued or licensed
exclusively to us to be found invalid and unenforceable. In addition, our trade
secrets may otherwise become known or our competitors also may independently develop
technologies that are substantially equivalent or superior to our technology and which do
not infringe our patents.
30
Claims by others that our products
infringe their patents or other intellectual property rights could prevent us from
manufacturing and selling some of our products or require us to pay royalties or incur
substantial costs from litigation or development of non-infringing technology.
In recent years, there has been significant litigation in the United States involving
patents and other intellectual property rights. The light-based cosmetic and
dermatology industry in particular is characterized by a large number of patents and
related litigation regarding patents and other intellectual property rights. Because our
resources are limited and patent applications are maintained in secrecy for a period of
time, we can conduct only limited searches to determine whether our technology infringes
any patents or patent applications. Any claims for patent infringement, regardless of
merit, could be time-consuming, result in costly litigation and diversion of technical and
management personnel, cause shipment delays, require us to develop non-infringing
technology or to enter into royalty or licensing agreements. Uncertainties resulting from
the initiation and continuation of patent litigation or other proceedings could have a
material adverse effect on our ability to compete in the marketplace. Although patent and
intellectual property disputes in the light-based industry have often been settled through
licensing or similar arrangements, costs associated with such arrangements may be
substantial and often require the payment of ongoing royalties, which could have a
negative impact on gross margins. There can be no assurance that necessary licenses would
be available to us on satisfactory terms, or that we could redesign our products or
processes to avoid infringement, if necessary. Accordingly, an adverse determination in a
judicial or administrative proceeding or failure to obtain necessary licenses could
prevent us from manufacturing and selling some of our products. This could have a material
adverse effect on our business, results of operations and financial condition.
Candela
Corporation has filed two patent infringement lawsuits against us. (For more information
about our patent litigation, see Part II, Item 1 Legal Proceedings.) Litigation with
Candela is expected to be expensive and protracted, and our intellectual property position
may be weakened as a result of an adverse ruling or judgment. Whether or not we are
successful in the pending lawsuits, litigation consumes substantial amounts of our
financial resources and diverts managements attention away from our core business.
Public announcements concerning this litigation that are unfavorable to us may in the
future result in significant declines in our stock price. An adverse ruling or judgment in
this matter could cause our stock price to decline significantly.
We may not be able to
successfully collect licensing royalties.
Material portions of our revenues consist of royalties from sub-licensing patents licensed
to us on an exclusive basis by Massachusetts General Hospital. If we are unable to collect
our licensing royalties, our revenues will decline.
Quarterly revenue or operating
results could cause the price of our common stock to fall.
Our quarterly revenue and operating results are difficult to predict and may swing sharply
from quarter to quarter. If our quarterly revenue or operating results fall
below the expectations of investors or public market analysts, the price of our common
stock could fall substantially. Our quarterly revenue is difficult to forecast for many
reasons, some of which are outside of our control. For example, many factors are
related to market supply and demand, including potential increases in the level and
intensity of price competition between our competitors and us, potential decrease in
demand for our products and possible delays in market acceptance of our new
products. Other factors are related to our customers and include changes in or
extensions of our customers budgeting and purchasing cycles and changes in the
timing of product sales in anticipation of new product introductions or enhancements by us
or our competitors. Factors related to our operations may also cause quarterly
revenue or operating results to fall below expectations, including our effectiveness in
our manufacturing process, unsatisfactory performance of our distribution channels,
service providers, or customer support organizations, and timing of any acquisitions and
related costs.
31
Managing our relationships with
Johnson & Johnson Consumer Companies, Inc. and future development partners may divert
the attention of key technical personnel and management from the core
business. If, pursuant to rights in their respective agreements with us, any
of these parties should end their relationship with us, our stock price could fall, and we
may be unable to bring home-use devices to the market.
We
believe that our relationship with Johnson & Johnson Consumer Companies, Inc.
represents a unique opportunity to bring light-based devices to the mass market.
Significant resources and the attention of key technical personnel and management have
been and may continue to be directed to the development and commercialization of such
devices even though such devices will not likely be commercialized for several years, if
ever. In addition, we cannot be sure that these parties will agree with our
interpretation of the terms of the agreements, that the agreements will provide us with
marketable products in the future or that we will receive payments for any of the products
developed under the agreements. During the term of the agreement, Johnson &
Johnson has the ability to choose not to continue and may terminate the agreement.
If Johnson & Johnson should terminate their agreement with us, we will not receive
certain payments, and the price of our common stock could fall significantly. In that
event, we may proceed to develop and commercialize the devices on our own or with a
third party. However, there can be no assurance that we will be able to successfully
implement such a strategy. In addition, after commercialization of such devices,
Johnson & Johnson is to pay us a percentage of net sales of such devices. Certain of
these percentages of net sales are only owed if the devices are covered by valid
patents. There can be no assurance that valid patents will cover the devices in any
or all countries, in which the devices will be manufactured, used or sold. This
could have a material adverse effect on our business, results of operations and financial
condition.
The expense and potential
unavailability of liability insurance coverage for our customers could adversely affect
our ability to sell our products and our financial condition.
Some
of our customers and prospective customers have had difficulty in procuring or maintaining
liability insurance to cover their operation and use of our products. Medical malpractice
carriers are withdrawing coverage in some states or substantially increasing premiums. If
this trend continues or worsens, our customers may discontinue using our products, and
potential customers may elect not to purchase laser and other light-based products.
The reduced availability of
consumer financing could have a material adverse effect on our results of operations.
Prior
to selling to a new customer, we require proof of financing. Availability of financing is
dependent on the lending practices of financial institutions, financial markets,
governmental policies, and economic conditions, all of which are largely beyond our
control. The reduced availability of financing from third party lenders for our customers
could affect our sales volume and have a material adverse effect on our results of
operations.
We may be unable to attract and
retain key executives and research and development personnel that we need to succeed.
As a small company with approximately 250 employees, our success depends on the services
of key employees in executive and research and development positions. The loss of the
services of one or more of these employees could have a material adverse effect on our
business. Our future success will depend in large part upon our ability to attract,
retain, and motivate highly skilled employees. We cannot be certain that we will be able
to do so.
32
Product liability suits could be
brought against us due to a defective design, material or workmanship or due to misuse of
our products. These lawsuits could be expensive and time consuming and result in
substantial damages to us and increases in our insurance rates.
If
our products are defectively designed, manufactured or labeled, contain defective
components or are misused, we may become subject to substantial and costly litigation by
our customers or their patients or clients. Furthermore, in the event that any of our
products prove to be defectively designed and manufactured, we may be required to recall
and redesign such products. Misusing our products or failing to adhere to operating
guidelines for our products can cause severe burns or other damage to the eyes, skin or
other tissue. We are routinely involved in claims related to the use of our products.
Product liability claims could divert managements attention from our core business,
be expensive to defend and result in sizable damage awards against us. Our current
insurance coverage may not be sufficient to cover these claims. Moreover, in the future,
we may not be able to obtain insurance in amount or scope sufficient to provide us with
adequate coverage against potential liabilities. Any product liability claims brought
against us, with or without merit, could increase our product liability insurance rates or
prevent us from securing continuing coverage, could harm our reputation in the industry
and reduce product sales. We would need to pay any product losses in excess of our
insurance coverage out of cash reserves, harming our financial condition and adversely
affecting our operating results.
We face risks associated with
product warranties.
We
could incur substantial costs as a result of product failures for which we are responsible
under warranty obligations.
Because we derive a significant
amount of our revenue from international sales, we are susceptible to currency
fluctuations, long payment cycles, credit risks and other risks associated with conducting
business overseas.
We sell a significant amount of our products and services outside the U.S.
International product revenue, consisting of sales from our distributors in Japan, Europe,
Australia, AsiaPacific Rim and South and Central America and sales shipped directly to
international locations from the United States, and we expect that international sales
will continue to be significant. As a result, a major part of our revenues and
operating results could be adversely affected by risks associated with international
sales, including but not limited to political and economic instability and difficulties in
managing our foreign operations. In particular, longer payment cycles common in
foreign markets, credit risk and delays in obtaining necessary import or foreign
certification or regulatory approvals for products may occur. In addition,
significant fluctuations in the exchange rates between the U.S. dollar and foreign
currencies could cause us to lower our prices and thus reduce our profitability, or could
cause prospective customers to push out orders to later dates because of the increased
relative cost of our products in the aftermath of a currency devaluation or currency
fluctuation.
We may not be able to sustain or
increase profitability and we may seek additional financing to grow the business.
Although we have generated a profit in recent years, we incurred a loss this quarter and
have a history of losses. We may not be able to sustain or increase profitability on a
quarterly or annual basis due to many factors including lower demand for our products by practitioners, including practitioners postponing their buying decisions due to
the weakening economy or other factors. If our operating results fall below the
expectations of investors or public market analysts, the price of our common stock could
decline.
We
may determine, depending upon the opportunities available, to seek additional debt or
equity financing to fund the costs of expansion. Additionally, if we incur
indebtedness to fund increased levels of accounts receivable, finance the acquisition of
capital equipment, or if we issue debt securities in connection with any acquisition we
will be subject to risks associated with incurring substantial additional indebtedness.
33
The liquidity and market value of our
investments may decrease.
As
of March 31, 2008, we held approximately $21.9 million of auction-rate securities.
Recently, there have been disruptions in the market for auction-rate securities related to
liquidity which has caused substantially all auctions to fail. All of our securities held
as of March 31, 2008 failed in its last auction. We will not be able to access our
investments in ARS until future auctions are successful, ARS are called for redemption by
the issuers, or until we sell the securities in a secondary market, which currently is not
active. In the event that we are unable to sell the underlying securities at or above our
carrying value, these securities may not provide us a liquid source of cash in the future.
At March 31, 2008, due to the uncertainty and illiquidity in this market, we have
classified our auction-rate securities as non-current assets and have recorded an
unrealized loss of $341,000 in accumulated other comprehensive (loss) income, net of
taxes in stockholder's equity. The recovery of these investments is based upon market factors which are not within our control.
We will continue to evaluate whether the impairment is temporary.
Our common stock could be further
diluted by the conversion of outstanding options and warrants.
In
the past, we have issued and still have outstanding convertible securities in the form of
options and warrants. We may continue to issue options, warrants and other equity
rights as compensation for services and incentive compensation for our employees,
directors and consultants or others who provide services to us. We have a substantial
number of shares of common stock reserved for issuance upon the conversion and exercise of
these securities. Such a conversion would dilute our stockholders and could adversely
affect the market price of our common stock.
Our charter documents, Delaware
law and our shareholder rights plan may discourage potential takeover attempts.
Our Second Restated Certificate of Incorporation and our By-laws contain provisions that
could discourage takeover attempts or make more difficult the acquisition of a substantial
block of our common stock. Our By-laws require a stockholder to provide to our Secretary
advance notice of director nominations and business to be brought by such stockholder
before any annual or special meeting of stockholders, as well as certain information
regarding such nomination and/or business, the stockholder and others known to support
such proposal and any material interest they may have in the proposed business. They also
provide that a special meeting of stockholders may be called only by the affirmative vote
of a majority of the board of directors. These provisions could delay any stockholder
actions that are favored by the holders of a majority of our outstanding stock until the
next stockholders meeting. In addition, the board of directors is authorized to
issue shares of our common stock and preferred stock that, if issued, could dilute and
adversely affect various rights of the holders of common stock and, in addition, could be
used to discourage an unsolicited attempt to acquire control of us.
We
are also subject to the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which prohibits us 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 becomes an interested stockholder, unless the business
combination is approved in a prescribed manner. The application of Section 203 may limit
the ability of stockholders to approve a transaction that they may deem to be in their
best interests. These provisions of our Second Restated Certificate of Incorporation,
By-laws and the Delaware General Corporation Law could deter certain takeovers or tender
offers or could delay or prevent certain changes in control or our management, including
transactions in which stockholders might otherwise receive a premium for their shares over
the then current market price.
In
April 1999, we adopted a shareholder rights plan or poison pill. This is
intended to protect shareholders from unfair or coercive takeover practices.
Any acquisitions that we make
could disrupt our business and harm our financial condition.
From
time to time, we evaluate potential strategic acquisitions of complementary businesses,
products or technologies, as well as consider joint ventures and other collaborative
projects. We may not be able to identify appropriate acquisition candidates or strategic
partners, or successfully negotiate, finance or integrate any businesses, products or
technologies that we acquire. Any acquisition we pursue could diminish our cash available
to us for other uses or be dilutive to our stockholders, and could divert
managements time and resources from our core operations.
34
Our stock price may be
volatile.
Our
common stock price may be volatile. The stock market in general has experienced extreme
volatility that has often been unrelated to the operating performance of particular
companies. The market price for our common stock may be influenced by many factors,
including:
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