Item 3. Quantitative and qualitative disclosures about market risk
Our
primary market risk exposures are in the areas of interest rate risk, liquidity risk, and
foreign currency exchange risk.
Our
investment portfolio of cash equivalents, corporate preferred securities, and municipal
debt securities is subject to interest rate fluctuations, but we believe this risk is
immaterial because of the historically short-term nature of these investments. At June 30,
2008, we held $9.0 million in auction-rate securities (ARS). The ARS we typically invest
in are high quality, AAA-rated securities, none of which are mortgage-backed. At December
31, 2007, because of the short-term nature of our investment in these securities, they
were classified as available-for-sale and included in short-term investments on our
consolidated balance sheets. Subsequent to December 31, 2007, our securities failed at
auction due to a decline in liquidity in the ARS and other capital markets. 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 sold in a secondary market which is not currently
active. As our investments in ARS currently lack short-term
liquidity, we have reclassified some of these investments as non-current as of June 30,
2008. Investments classified as current at June 30, 2008 were sold at full value in July
2008. In the six months ended June 30, 2008, we have sold $33.8 million of the ARS held at
December 31, 2007. The recovery of the remaining $9.3 million ARS held is based upon
market factors which are not within our control.
Our
international subsidiary in The Netherlands conducts business in both local and foreign
currencies and therefore, we are exposed to foreign currency exchange risk resulting from
fluctuations in foreign currencies. This risk could adversely impact our results and
financial condition. We believe our current exposure to fluctuations in foreign currency
exchange rates is immaterial. We have not entered into any foreign currency exchange and
option contracts to reduce our exposure to foreign currency exchange risk and the
corresponding variability in operating results as a result of fluctuations in foreign
currency exchange rates.
Item 4. Controls and
procedures
Under
the direction of the principal executive officer and principal financial officer, the
Company has evaluated the effectiveness of its disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of June 30, 2008. Based on that
evaluation, the Company has concluded that its disclosure controls and procedures were
effective.
The
Companys management, including the CEO and CFO, does not expect that the
Companys disclosure controls or internal controls over financial reporting will
prevent all errors and all fraud. A control system, no matter how well designed and
operated, can provide only reasonable, not absolute, assurance that the control
systems objectives will be met. Further, the design of a control system must reflect
the fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, within the Company have been detected. These inherent
limitations include the realities that judgments in decision making can be faulty and that
individual acts of some persons, by collusion of two or more people, or by management
override of the controls. The design of any system of controls is based in part on certain
assumptions about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Because of the
inherent limitations in a cost-effective control system, misstatements due to error or
fraud may occur and not be detected.
There
were no significant changes in the Companys internal controls over financial
reporting or in other factors that could significantly affect these controls during the
quarter ended June 30, 2008, including any corrective actions with regard to significant
deficiencies and material weaknesses.
27
PART II Other
information
Item
1. Legal proceedings
Alma Lasers Litigation
On
July 7, 2006, we commenced an action for patent infringement against Alma Lasers, Inc. in
the United States District Court for the District of Massachusetts seeking both monetary
damages and injunctive relief. The complaint alleged Almas Harmony, Soprano and
Sonata Systems which use pulsed light and laser technology for hair removal willfully
infringe U.S. Patent Nos. 5,595,568 & 5,735,844, which are exclusively licensed to us
by the Massachusetts General Hospital. On July 27, 2006, we filed an amended complaint
including an additional claim against Alma for unfair competition due to infringement by
Almas Harmony System of the distinctive trade dress of our products, including the
unique, distinctive, and immediately recognizable design of our EsteLux, MediLux and
StarLux Systems.
On
April 2, 2007, we announced the resolution of our lawsuit against Alma Laser, Inc. through
the execution of a Non-Exclusive Patent License Agreement, a Trade Dress Settlement
Agreement, and a Settlement Agreement. Under the Patent License Agreement, we granted Alma
a non-exclusive, royalty bearing license to U.S. Patent Nos. 5,595,568 & 5,735,844
& corresponding foreign patents and applications in the professional field, excluding
the consumer field. Alma admitted that its products infringe these patents and that these
patents are valid and enforceable. In addition, Alma agreed not to challenge the
infringement, validity and enforceability of these patents in the future. Alma paid us an
estimated payment for royalties due on past sales of their laser and lamp-based hair
removal systems beginning with their initial sales in 2003 through the date of settlement,
plus interest and reimbursement of our legal costs. Alma also paid us an estimated payment
for trade dress fees on past sales of their Harmony and Aria Systems and interest, and
Alma agreed to change and has changed the trade dress of the Harmony and Aria systems. The
final amounts due to us were the subject of an audit by an independent accounting firm
completed in the first quarter of 2008. Starting on March 30, 2007, Alma began paying us a
royalty on sales of its existing and any new light-based hair removal systems later
developed.
For
more information, please see the Settlement Agreement, the Non-Exclusive Patent License
Agreement, the Trade Dress Settlement Agreement, the Consent Judgments and Stipulations of
Dismissal filed as exhibits to our Current Report on Form 8-K filed April 2, 2007.
Candela Corporation,
Massachusetts Litigation
On
August 9, 2006, we commenced an action for patent infringement against Candela Corporation
in the United States District Court for the District of Massachusetts seeking both
monetary damages and injunctive relief. The complaint alleges Candelas GentleYAG and
GentleLASE systems, which use laser technology for hair removal willfully, infringe U.S.
patent No. 5,735,844, which is exclusively licensed to us by the Massachusetts General
Hospital. Candela answered the complaint denying that its products infringe valid claims
of the asserted patents and filing a counterclaim seeking a declaratory judgment that the
asserted patent and U.S. patent No. 5,595,568 are invalid and not infringed. We filed a
reply denying the material allegations of the counterclaims.
We
filed an amended complaint on February 16, 2007 to add the Massachusetts General Hospital
as a plaintiff. In addition, we further alleged that Candelas GentleMAX system
willfully infringes U.S. Patent No. 5,735,844 and that Candelas Light Station system
willfully infringes both U.S. Patent Nos. 5,735,844 and 5,595,568. On February 16, 2007,
Candela filed an amended answer to our complaint adding allegations of inequitable
conduct, double patenting and violation of Massachusetts General Laws Chapter 93A. On
February 28, 2007, we filed a response to Candelas amended complaint pointing out
many weaknesses in Candelas allegations. A claim construction hearing, sometimes
called a Markman Hearing, was held August 2, 2007, and we received what we
consider to be a favorable Markman ruling on November 9, 2007. No trial date has yet been
set.
28
On
August 10, 2006, Candela Corporation commenced an action for patent infringement against
us in the United States District Court for the District of Massachusetts seeking both
monetary damages and injunctive relief. The complaint alleged that our StarLux System with
the LuxV handpiece willfully infringes U.S. Patent No. 6,743,222 which is directed to acne
treatment, that our QYAG5 System willfully infringes U.S. Patent No. 5,312,395 which is
directed to treatment of pigmented lesions, and that our StarLux System with the LuxG
handpiece willfully infringes U.S. Patent No. 6,659,999 which is directed to wrinkle
treatment. On October 25, 2006, Candela filed an amended complaint which did not include
U.S. Patent No. 6,659,999. Consequently, Candela no longer alleges in this lawsuit that
the StarLux System with LuxG handpiece infringes its patents. With regard to the two
remaining patents, Candela is seeking to enjoin us from selling these products in the
United States if we are found to infringe the patents, and to obtain compensatory and
treble damages, reasonable costs and attorneys fees, and other relief as the court
deems just and proper. On October 30, 2006 we answered the complaint denying that our
products infringe the asserted patents and filing counterclaims seeking declaratory
judgments that the asserted patents are invalid and not infringed. In addition, with
regard to U.S. Patent No. 5,312,395, we filed a counterclaim of inequitable conduct.
In
February 2008, we filed a request for reexamination and then an amended request for
reexamination of Candelas 222 patent with the United States Patent and
Trademark Office (PTO). In our request, we argued that Candelas
222 patent is unpatentable over our own United States Patent No. 6,605,080 alone or
in combination with other prior art. About the same time, we filed a motion to stay all
proceedings in this action related to the 222 patent pending resolution of the
amended request for reexamination of the 222 patent. In March 2008, the PTO granted
our request for reexamination of the 222 patent. On June 11, 2008, the Court ordered
the parties to report back to the Court after the PTO makes its decision in the
reexamination of the 222 patent, after which a claim construction hearing, or a
Markman Hearing, will be scheduled for both the 222 and 395 patents. On
June 12, 2008, the parties informed the Court that the total time the reexamination will
remain pending is not known. No trial date has yet been set. We are defending the action
vigorously and believe that we have meritorious defenses of non-infringement, invalidity
and inequitable conduct. However, litigation is unpredictable and we may not prevail in
successfully defending or asserting our position. If we do not prevail, we may be ordered
to pay substantial damages for past sales and an ongoing royalty for future sales of
products found to infringe in the United States. We could also be ordered to stop selling
any products in the United States that are found to infringe.
Candela Corporation,
Texas Litigation
On
December 19, 2006, Candela Corporation commenced an action for patent infringement against
us in the United States District Court for the Eastern District of Texas, seeking both
monetary damages and injunctive relief. The complaint alleges that our StarLux System with
the LuxY handpiece willfully infringes U.S. Patent No. 6,659,999 and that our StarLux
System with the Lux1540 handpiece willfully infringes related U.S. Patent Nos. 5,810,801
and 6,120,497. The three asserted patents are directed to wrinkle treatment. Candela is
seeking to enjoin us from selling these products in the United States if found to infringe
the patents, and to obtain compensatory and treble damages, reasonable costs and
attorneys fees, and other relief as the court deems just and proper. On January 10,
2007, we answered the complaint denying that our products infringe the asserted patents
and filing counterclaims seeking declaratory judgments that the asserted patents are
invalid and not infringed. On April 6, 2007, Candela filed their infringement contentions
which modified their complaint to accuse the Lux1540, Lux1540-Z, LuxIR, LuxDeepIR, LuxB,
LuxG and LuxY handpieces for use with the StarLux, StarLux 500, MediLux and EsteLux
Systems of infringing the three asserted patents. On July 13, 2007, we filed an amended
answer to Candelas first amended complaint including counterclaim of inequitable
conduct, and on March 21, 2008, we filed a second amended answer to Candelas second
amended complaint including a further counterclaim of inequitable conduct and a
counterclaim of bad faith filing and prosecution of this lawsuit. We are defending the
action vigorously and believe that we have meritorious defenses of non-infringement,
invalidity, and unenforceability. However, litigation is unpredictable and we may not
prevail in successfully defending or asserting our position. If we do not prevail, we may
be ordered to pay substantial damages for past sales and an ongoing royalty for future
sales of products found to infringe in the United States. We could also be ordered to stop
selling any products that are found to infringe in the United States. A claim construction hearing, sometimes called a Markman Hearing, was held November 13, 2007, and we
received what we consider to be a favorable Markman ruling on August 6, 2008. On June 23,
2008, we filed two motions for summary judgment and Candela then filed oppositions to
those motions. The Judge has not yet ruled on those motions for summary judgment. The
trial is scheduled to begin September 29, 2008.
29
Item
1A. Risk Factors
This
report contains forward-looking statements that involve risks and uncertainties, such as
statements of our objectives, expectations and intentions. The cautionary statements made
in this report should be read as applicable to all forward-looking statements wherever
they appear in this report. Our actual results could differ materially from those
discussed herein. Factors that could cause or contribute to such differences include those
discussed below, as well as those discussed elsewhere in this report.
If we do not continue to develop
and commercialize new products and identify new markets for our products and technology,
we may not remain competitive, and our revenues and operating results could suffer.
The
aesthetic light-based (both lasers and lamps) treatment system industry is subject to
continuous technological development and product innovation. If we do not continue to be
innovative in the development of new products and applications, our competitive position
will likely deteriorate as other companies successfully design and commercialize new
products and applications. We compete in the development, manufacture, marketing, sales
and servicing of light-based devices with numerous other companies, some of which have
substantially greater direct worldwide sales capabilities. Our products also face
competition from medical products, prescription drugs and cosmetic procedures, such as
electrolysis and waxing.
Our products are subject to
numerous medical device regulations. Compliance is expensive and time-consuming. Without
necessary clearances, we may be unable to sell products and compete effectively.
All
of our current products are light-based devices, which are subject to FDA regulations for
clinical testing, manufacturing, labeling, sale, distribution and promotion. Before a new
product or a new use of or claim for an existing product can be marketed in the United
States, we must obtain clearance from the FDA. In the event that we do not obtain FDA
clearances, our ability to market products in the United States and revenue derived
therefrom may be adversely affected. The types of medical devices that we seek to
market in the U.S. generally must receive either 510(k) clearance or PMA
approval in advance from the FDA pursuant to the Federal Food, Drug, and Cosmetic
Act. The FDAs 510(k) clearance process can be expensive and usually takes from three
to twelve months, but it can last longer. The process of obtaining PMA approval is much
more costly and uncertain and generally takes from one to three years or even longer from
the time the pre-market approval application is submitted to the FDA until an approval is
obtained.
In
order to obtain pre-market approval and, in some cases, a 510(k) clearance, a product
sponsor must conduct well controlled clinical trials designed to test the safety and
effectiveness of the product. Conducting clinical trials generally entails a long,
expensive and uncertain process that is subject to delays and failure at any stage. The
data obtained from clinical trials may be inadequate to support approval or clearance of a
submission. In addition, the occurrence of unexpected findings in connection with clinical
trials may prevent or delay obtaining approval or clearance. If we conduct clinical
trials, they may be delayed or halted, or be inadequate to support approval or clearance,
for numerous reasons, including:
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