Note 12 Development and
License Agreement with The Gillette Company and New License Agreement with The Procter
& Gamble Company (and its wholly owned subsidiary The Gillette Company)
Effective
as of February 14, 2003, we entered into a Development and License Agreement (the
Agreement) with Gillette to complete the development and commercialize a
home-use, light-based hair removal device for women. In October 2005, The Procter &
Gamble Company (P&G) (NYSE: PG) completed its acquisition of Gillette.
Under the Agreement, Procter & Gamble, as the acquiring party, assumed all of
Gillettes rights and obligations. The agreement provided for up to $7 million in
support of research and development to be paid by Gillette over approximately 30 months.
Effective as of June 28, 2004, we completed the initial phase of the Agreement and both
parties decided to move onto the next phase. Accompanying this decision, we amended the
Agreement, whereby, Gillette provided $2.1 million in additional development funding to
further technical innovations over a 9-month extension of the development phase, which was
completed on August 31, 2006 (the Development Phase).
75
On
September 29, 2006, in response to a first decision point in the Agreement, Gillette
decided to continue with the project. On December 8, 2006, over-the-counter clearance was
obtained from the United States Food and Drug Administration for the device and, per the
Agreement, Gillette was obligated to make a development completion payment to us of $2.5
million, which was paid on December 26, 2006. The $2.5 million payment was recorded as
revenue over a 12 month period, as we were obligated to perform additional services to
Gillette during that period in consideration for this payment.
Gillette
was to conduct approximately 12 months of commercial assessment tests with respect to the
device. Based on the commercial assessment tests, Gillette was to decide by January 7,
2008 whether or not to continue with the project (the Launch Decision). On
February 21, 2007, we announced an amendment to our agreement with Gillette to include the
development and commercialization of an additional home-use, light-based hair removal
device for women, and we also announced that we had executed an amended and restated joint
development agreement to incorporate other amendments, including several new amendments to
allow for more open collaboration through commercialization. With regard to the additional
home-use, light-based hair removal device for women, we completed certain development
activities in consultation with Gillette during an eleven month program. Gillette provided
us with $1.2 million and an additional $300,000 upon the completion of certain
deliverables which was recognized over an eleven month period as costs were incurred and
services were provided.
On
December 21, 2007, we announced an agreement with Gillette to extend the Launch Decision
until no later than February 29, 2008. During this extension period, we negotiated with
Gillette and its parent company P&G for a new agreement to replace the existing one.
On February 29, 2008, we entered into a License Agreement with P&G under which we
granted a non-exclusive license to certain patents and technology to commercialize
home-use, light-based hair removal devices for women. This License Agreement terminated
and replaced the prior Development and License Agreement.
For
the years ended December 31, 2008, 2007 and 2006, we recognized $216,000, $3.8 million and
$1.1 million, respectively, of funded product development revenues from P&G and
Gillette under the Development and License Agreement and various other agreements. As of
December 31, 2008 and 2007, $0 and $48,000, respectively, of advance payments received
from P&G and Gillette for which services were not yet provided were included in
deferred revenue, under the Development and License Agreement and various other
agreements.
For
the year ended December 31, 2008, we recognized $5.0 million of other revenues from
P&G under the new License Agreement, consisting of four quarterly technology transfer
payments (TTP Quarterly Payment as defined in the License Agreement) of $1.25
million. TTP Quarterly Payments will be made by P&G during the term of the License
Agreement up to and including the quarter in which P&G launches the first Licensed
Product (as defined in the License Agreement). Thereafter, TTP and royalty payments will
be based on product sales as set forth in the License Agreement. TTPs, including the TTP
Quarterly Payments, are non-creditable and non-refundable and there is no right of offset.
As of December 31, 2008, $1.25 million of advance payments received from P&G for which
services were not yet provided were included in deferred revenue, under the new License
Agreement.
For
more information, please see the License Agreement filed as Exhibit 10.1 to our Current
Report on Form 8-K filed March 3, 2008, the Development and License Agreement and
subsequent amendments filed as Exhibit 10.1 to our Current Report on Form 8-K filed on
February 19, 2003, Exhibits 99.1, 99.2, and 99.3 to our Current Report on Form 8-K filed
on June 28, 2004, Exhibit 10.30 to our Annual Report on Form 10-K filed on March 6, 2006,
and Exhibits 10.1 and 10.2 to our Current Report on Form 8-K filed on February 21, 2007.
76
Note 13 Joint
Development and License agreement with Johnson & Johnson Consumer Companies, Inc.
Effective
as of September 1, 2004, we entered into a Joint Development and License Agreement with
Johnson & Johnson Consumer Companies, Inc. to develop and commercialize home-use,
light-based devices in the fields of (i) reducing or reshaping body fat including
cellulite; (ii) reducing appearance of skin aging; and (iii) reducing or preventing acne.
Under the agreement, Johnson & Johnson funds our research and clinical studies during
an initial proof-of-principle phase. At the end of the proof-of-principle phase, Johnson
& Johnson will decide whether or not to continue with one or more of the devices in
one or more of the fields into a development phase. If Johnson & Johnson decides to
continue, Johnson & Johnson will be obligated to fund the development of the selected
devices. If Johnson & Johnson decides not to continue, we may proceed in fields
not selected by Johnson & Johnson to develop and commercialize these and other devices
on our own or with a different party.
At
the end of the development phase, Johnson & Johnson will decide whether or not to
commercialize one or more of the devices in one or more fields. If Johnson & Johnson
decides to commercialize one or more of the devices, Johnson & Johnson will make
payments to us for each selected field. Upon commercial launch of the first device in each
selected field, Johnson & Johnson will make a payment to us, and for all devices sold
for use in each selected field, Johnson & Johnson shall pay us a percentage of sales
of such devices and certain topical compounds. If Johnson & Johnson decides not to
commercialize or fails to launch a device, we may proceed in fields not selected by
Johnson & Johnson to develop and commercialize these and other devices on our own or
with a different party.
On
August 22, 2007, we signed an amendment to our agreement with Johnson & Johnson to
provide for additional development funding for certain development activities. Johnson
& Johnson will provide us with quarterly payments of $448,000 for these development
activities. We will recognize this revenue as costs are incurred and services are
provided.
For
the years ended December 31, 2008, 2007 and 2006, we recognized approximately $2.2
million, $2.5 million and $1.4 million, respectively, of funded product development
revenues from Johnson & Johnson. As of December 31, 2008 and 2007, $726,000 and
$477,000, respectively, of advance payments received from Johnson & Johnson for which
services were not yet provided were included in deferred revenue.
For
more information, please see the Joint Development and License Agreement and amendments
filed as Exhibit 99.1 to our Current Report on Form 8-K filed on September 7, 2004,
Exhibit 10.45 to our Quarterly Report on Form 10-Q filed on May 8, 2007, and Exhibits
10.47 and 10.48 to our Quarterly Report on Form 10-Q filed on November 2, 2007.
Note 14 Research
contract with the United States Department of the Army
In
the first quarter of 2004, we began providing services under a $2.5 million research
contract with the United States Department of the Army to develop a light-based
self-treatment device for Pseudofolliculitis Barbae or PFB. On October 25, 2005, we
announced that we had been awarded additional funding of $888,000 for a total of $3.4
million and a twelve month extension. On September 1, 2006, we were awarded additional
funding of $440,000 for a total of $3.8 million and an additional five month extension
until April 30, 2007. Subsequent to April 30, 2007, the contract was extended on multiple
occasions, the last of which was through March 31, 2008. The contract was a cost plus fee
arrangement whereby we were reimbursed for the expenses incurred in connection with PFB
research plus an 8% fee. Our revenue from the contract is subject to government audit.
For
the years ended December 31, 2008, 2007 and 2006, we recognized $0, $388,000 and $1.3
million of funded product development revenues under this agreement, respectively.
77
Note 15
Settlement of Cutera Litigation
On
June 5, 2006, we announced the resolution of our patent infringement lawsuits against
Cutera, Inc. through the execution of a Settlement Agreement and a Non-Exclusive Patent
License Agreement. Under the License Agreement, we granted Cutera a non-exclusive, royalty
bearing license to U.S. Patent Nos. 5,735,844 and 5,595,568 and all corresponding foreign
patents and patent applications in the professional field, excluding the consumer field.
Cutera admitted that their products infringe these patents and that these patents are
valid and enforceable. In addition, Cutera agreed not to challenge the infringement,
validity and enforceability of these patents in the future. Cutera paid us $22 million as
an estimated payment for royalties on past sales of their laser and lamp-based hair
removal systems beginning with their initial sales in 2000 through March 31, 2006,
interest and reimbursement of our legal costs. Cutera subsequently informed us that they
believed the actual liability for past royalties, interest and legal costs was $19.6
million, versus the actual payment of $22 million. We recorded the difference of $2.4
million as deferred revenue at June 30, 2006 to be applied against future amounts owed.
The final amounts due were subject to an audit by an independent accounting firm which was
completed during the fourth quarter of 2006, resulting in an additional $648,000 of
royalty and interest. Under our license agreement with the Massachusetts General Hospital,
we pay to the Massachusetts General Hospital 40% of all royalty and interest payments from
Cutera. In connection with the settlement, during the three and nine months ended
September 30, 2006, we recorded $13.6 million of royalty revenue and $5.4 million in cost
of royalties. We also recorded, net of amounts owed to the Massachusetts General Hospital,
$3.8 million as a reduction in general and administrative expense and $1.2 million in
interest income. Starting on April 1, 2006, Cutera began paying us a royalty on sales of
its existing and any new light-based hair removal systems later developed.
For
the year ended December 31, 2006 we recognized $14.2 million of back-owed royalty revenues
related to the settlement of the Cutera litigation.
For
more information, please see the Settlement Agreement, the Non-Exclusive Patent License
Agreement, the Consent Judgments and Stipulations of Dismissal filed as Exhibits 99.1,
99.2, 99.3 and 99.4 to our Current Report on Form 8-K filed June 5, 2006.
Note 16
Laserscope Agreement
On
October 18, 2006, we entered into a new Non-Exclusive Patent License Agreement with
Laserscope and terminated the prior license agreement. Under the Patent License Agreement,
we granted Laserscope a non-exclusive, royalty bearing license to U.S. Patent Nos.
5,735,844 and 5,595,568 and all corresponding foreign patents and patent applications in
the professional field, excluding the consumer field. Under the new license agreement,
Laserscope will pay us a royalty on sales of its current light-based hair removal
products, including the Lyra and Gemini Laser Systems and the Solis IPL System, as well as
on sales of new light-based hair removal systems developed in the future.
As
a result of a royalty audit of Laserscopes product sales from January 1, 2001
through June 30, 2006, in the third quarter of 2006, we recognized royalty revenue of $2.2
million for back-owed royalties, cost of royalty revenue of $864,000 and net income of
$1.3 million.
American
Medical Systems Holdings, Inc. acquired Laserscope in July of 2006 and subsequently sold
the assets of Laserscopes aesthetic division to Iridex Corporation, effective in the
first quarter of 2007. As a result, the license agreement between Palomar and Laserscope
has been assigned to Iridex. Iridex has assumed all of Laserscopes rights and
obligations under the license agreement.
For
more information, please see the Non-Exclusive Patent License Agreement filed as Exhibit
99.2 to our Current Report on Form 8-K filed October 26, 2006.
Note 17 Cynosure
Agreement
On
November 7, 2006, we announced the execution of a Non-Exclusive Patent License Agreement
with Cynosure, Inc. Under this Agreement, we granted to Cynosure a non-exclusive, royalty
bearing license to U.S. Patent Nos. 5,735,844 and 5,595,568 and all corresponding foreign
patents and patent applications in the professional field, excluding the consumer field.
In return, Cynosure granted us a non-royalty bearing (fully paid up), non-exclusive
license to eight Cynosure patents and patent applications, including counterparts.
Cynosure also paid us $10 million on November 7, 2006 as a royalty on sales of their laser
and lamp-based hair removal systems made before October 1, 2006, which we recognized
during 2006 as back-owed royalty revenue. Starting on October 1, 2006, Cynosure began
paying us a royalty on sales of existing and any new light-based hair removal systems
later developed.
78
For
more information, please see the Non-Exclusive Patent License Agreement filed as Exhibit
99.2 to our Current Report on Form 8-K filed November 7, 2006.
Note 18 Alma
Agreement
On
April 2, 2007, we announced the resolution of our patent infringement and trade dress
lawsuit against Alma Lasers, Inc. through the execution of a Settlement Agreement, a
Non-Exclusive Patent License Agreement and a Trade Dress Settlement Agreement. Under the
Patent License Agreement, we granted Alma a non-exclusive, royalty bearing license to U.S.
Patent Nos. 5,735,844 and 5,595,568 and all corresponding foreign patents and patent
applications in the professional field, excluding the consumer field. Alma admitted that
their 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. The rights included in the Non-Exclusive Patent License
Agreement, such as Almas agreement not to challenge such infringement, validity, and
enforceability, and various other terms and conditions, do not have any stand alone value
and they have no substance apart from the ongoing royalty. Alma will pay for royalties and
interest due on past sales of their laser and lamp-based hair removal systems beginning
with their initial sales in 2003 and a trade dress fee plus interest on past sales of
their Harmony and Aria systems. The amounts due to us were determined based on an audit by
an independent accounting firm which was completed in the first quarter of 2008. We
recognized royalty revenue as amounts became determinable. Under our license agreement
with the Massachusetts General Hospital, we pay to the Massachusetts General Hospital 40%
of all patent royalty and interest thereof from Alma. 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
the year ended December 31, 2007, we recognized $3.1 million of back-owed royalty
revenues, $894,000 of other revenues for trade dress infringement, and $432,000 of
interest on back-owed royalties. As the result of the completion of the independent audit
during the three months ended March 31, 2008, we recognized $682,000 of back-owed royalty
revenues, $248,000 of other revenues for trade dress infringement, and $87,000 of interest
on back-owed royalties. At December 31, 2008, we had no deferred revenue related to
payments received from Alma.
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 10.1, 10.2, 10.3, 10.4 and 10.5 to our Current Report on Form
8-K filed on April 2, 2007.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
None.
Item 9A. Controls and
Procedures
Evaluation of disclosure
controls and procedures
The
Company carried out an evaluation, as required by Rule 13a-15(b) under the Securities
Exchange Act of 1934, as amended (Exchange Act), under the supervision and with the
participation of the Companys management, including the Companys Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures, as defined in Rule
13a-15(e) of the Exchange Act, as of the end of the period covered by this report (the
Evaluation Date). Based on such evaluation, such officers have concluded that, as of the
Evaluation Date, the Companys disclosure controls and procedures were effective to
provide reasonable assurance that information required to be disclosed by the Company in
reports that it files or submits under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in the Securities and Exchange
Commissions rules and forms and to provide reasonable assurance that such
information is accumulated and communicated to the Companys management, including
the Companys Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure.
79
The
effectiveness of a system of disclosure controls and procedures is subject to various
inherent limitations, including cost limitations, judgments used in decision making,
assumptions about the likelihood of future events, the soundness of internal controls, and
the risk of fraud. Because of these limitations, there can be no assurance that any system
of disclosure controls and procedures will be successful in preventing all errors or fraud
or in making all material information known in a timely manner to the appropriate levels
of management.
Changes in internal
controls
There
have been no changes in our internal control over financial reporting that occurred during
the quarter ended December 31, 2008 that have materially affected or are reasonably
likely to materially affect our internal control over financial reporting.
Managements report
on internal control over financial reporting
Our
management is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rule 13a-15(f) under the Securities Exchange Act of
1934, as amended. Our internal control system was designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting
principles.
Internal
control over financial reporting cannot provide absolute assurance of achieving financial
reporting objectives because of its inherent limitations. Internal control over financial
reporting is a process that involves human diligence and compliance and is subject to
lapses in judgment and breakdowns resulting from human failures. Internal control over
financial reporting also can be circumvented by collusion or improper management override.
Because of such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial reporting.
However, these inherent limitations are known features of the financial reporting process.
Therefore, it is possible to design into the process safeguards to reduce, though not
eliminate, this risk.
In
conducting their evaluation of the effectiveness of our companys internal control
over financial reporting, management used the framework set forth in the report entitled
Internal ControlIntegrated Framework published by the Committee of
Sponsoring Organizations (COSO) of the Treadway Commission. Management has
concluded that the Companys internal control over financial reporting was effective
as of December 31, 2008.
Our
internal controls over financial reporting as of December 31, 2008 have been audited
by Ernst & Young LLP, an independent registered public accounting firm, as stated in
their attestation report which appears on the following page.
80
Report of Independent
Registered Public Accounting Firm
The Board of Directors and
Stockholders of Palomar Medical Technologies, Inc.:
We have audited Palomar Medical
Technologies, Inc.s internal control over financial reporting as of December 31,
2008, based on criteria established in Internal ControlIntegrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO
criteria). Palomar Medical Technologies, Inc.s management is responsible for
maintaining effective internal control over financial reporting, and for its assessment of
the effectiveness of internal control over financial reporting included in the
accompanying managements report on internal control over financial reporting. Our
responsibility is to express an opinion on the companys internal control over
financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control over financial
reporting, assessing the risk that a material weakness exists, testing and evaluating the
design and operating effectiveness of internal control based on the assessed risk, and
performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.
A companys internal control
over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for
external purposes in accordance with generally accepted accounting principles. A
companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the
company; (2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are being made
only in accordance with authorizations of management and directors of the company; and (3)
provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of the companys assets that could have a material
effect on the financial statements.
Because of its inherent limitations,
internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that the degree
of compliance with the policies or procedures may deteriorate.
In our opinion, Palomar Medical
Technologies, Inc. maintained, in all material respects, effective internal control over
financial reporting as of December 31, 2008, based on the COSO criteria.
We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), the
consolidated balance sheets of Palomar Medical Technologies, Inc. and subsidiaries as of
December 31, 2008 and 2007, and the related consolidated statements of operations,
stockholders equity and cash flows for each of the three years in the period ended
December 31, 2008 and our report dated March 4, 2009 expressed an unqualified opinion
thereon.
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