Item 3. Quantitative
and qualitative disclosures about market risk
Market
risk is the potential loss arising from adverse changes in market rates and prices, such
as foreign currency exchange rates, interest rates and a decline in the stock market. The
current turbulence in the U.S. and global financial markets has caused a decline in stock
values across all industries. We are exposed to market risks related to changes in
interest rates and foreign currency exchange rates.
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 March
31, 2009, we held $4.4 million in auction-rate securities (ARS). The ARS we invest in are
high quality 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. As our investments in ARS currently lack
short-term liquidity, we have reclassified these investments as non-current as of March
31, 2009. In the three months ended March 31, 2009, we did not sell any of the ARS held at
December 31, 2008. The recovery of the remaining $4.4 million ARS held is based upon
market factors which are not within our control.
24
Our
international subsidiaries in The Netherlands and Australia conduct 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 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 March 31, 2009. 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 March 31, 2009, including any corrective actions with regard to significant
deficiencies and material weaknesses.
PART II Other
information
Item
1. Legal proceedings
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.
25
On
November 17, 2008, the Judge stayed the lawsuit pending the outcome of reexamination
procedures requested by a third party on both U.S. Patent Nos. 5,735,844 and 5,595,568 in
the United States Patent and Trademark Office. Consequently, this lawsuit against Candela
will be delayed until the reexaminations are complete. On December 9, 2008, Candela also
filed requests for re-examination of both patents. Generally, a reexamination proceeding
is one which re-opens patent prosecution to ensure that the claims in an issued patent are
valid over prior art references. Requests for reexamination of patents are common and
granted by the Patent Office 92% of the time. The granting of a request for reexamination
does not indicate that the claims of the patents will be cancelled or altered in any way.
We will vigorously respond to the reexamination, including by citing all prior art which
Candela and others have relied upon in their contentions that the patents are not valid.
We believe that at the end of the process, it should be clear, as we and many of our
licensees have already concluded, that the patent claims are valid. However, the patent
office could disagree with us and find some or all of the claims invalid over prior art or
we may need to modify the claims as part of the reexamination process. In either event, it
is possible that Candelas products would no longer infringe the claims that result
from the reexamination process and this lawsuit would be terminated. In addition, the
products of our current licensees may no longer infringe the claims that result from the
reexamination process in which case the licensees would stop paying us royalties. While we
intend to vigorously respond to the reexamination procedures,
each reexamination is inherently uncertain and unpredictable as
to its ultimate outcome. An adverse outcome would materially hurt our
business, financial condition, results of operations and cash flows.
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 (i.e., 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.
26
Alma Lasers, Inc.,
Delaware Litigation
On
September 11, 2008, Alma Lasers, Inc. filed a complaint requesting a declaratory judgment
that our fractional patent, U.S. Patent No. 6,997,923, is not infringed by Almas
products and is invalid over prior art. Alma served this lawsuit on us on November 6,
2008, and on November 21, 2008, we filed an answer which denied Almas allegations
that the patent is invalid and not infringed. We also filed a counterclaim accusing
Almas Pixel C0
2
Omnifit Fractional C0
2
Handpiece and Pixel
C0
2
Fractional C0
2
Skin Resurfacing System of infringing the
patent. On December 16, 2008, upon the request of both parties, a mediation conference was
scheduled for June 30, 2009 before Magistrate Judge Mary Pat Thynge. On December 18, 2008,
upon the request of both parties, the Judge presiding over the lawsuit, stayed the lawsuit
and later closed the lawsuit pending the outcome of the mediation.
Syneron, Inc.,
Massachusetts Litigation
On
November 14, 2008, we commenced an action for patent infringement against Syneron, Inc. in
the United States District Court for the District of Massachusetts seeking both monetary
damages and injunctive relief. The complaint alleges Synerons eLight, eMax, eLaser,
Aurora DS, Polaris DS, Comet and Galaxy Systems, which use light-based technology for hair
removal, willfully infringe U.S. Patent Nos. 5,595,568 and 5,735,844, which are
exclusively licensed to us by the Massachusetts General Hospital. In March 2009, we served
Syneron with this suit. On April 30, 2009, the parties filed a stipulation to stay the
lawsuit pending the outcome of the re-examination of U.S. Patent Nos. 5,595,568 and
5,735,844.
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 risk factors 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.
Recent disruptions in the global economy, the financial markets, and currency markets, as well as
government responses to these disruptions, have adversely impacted our business and results of
operations.
Recent distress in the financial markets has had an adverse impact on the availability of credit and
liquidity resources. Certain preferred lessors are exiting from our industry or declaring bankruptcy.
Prior to selling to a new customer, we require proof of financing. Many of our customers or potential
customers are facing issues gaining access to sufficient credit, which is resulting in an impairment of
their ability to make timely payments to us or to get financing at all. Lack of availability of
consumer credit, a decrease in consumer confidence, and the general economic downturn is adversely
impacting the market in which we operate. These factors are causing some customers to postpone buying
decisions until economic conditions improve. As a result of recent fluctuations in currency markets and
the strong dollar relative to many other major currencies, our products priced in United States dollars
have been more expensive relative to products of our foreign competitors, which has resulted in lower
sales. In addition, the non-dollar denominated earnings of our foreign operations has been lower when
reported by us in US dollars. A slowdown in economic activity caused by the recession has reduced
worldwide demand for our products.
Our new Aspire System with
SlimLipo handpiece requires the use of consumable treatment tips and fiber delivery
assemblies. In the future, we may derive substantial revenue from sales of those
consumable components. These products were recently introduced and could fail to generate
significant revenue or achieve market acceptance.
In
April 2008, we launched the Aspire body sculpting system and SlimLipo handpiece. Shipments
began in the third quarter of 2008. The SlimLipo handpiece is our first minimally invasive
product and provides laser-assisted lipolysis. The SlimLipo
handpiece requires the use of consumable, single-use treatment tips and a limited-use
fiber delivery assembly. In the future, we could receive substantial revenue from sales of
the Aspire system with SlimLipo handpiece as well as the consumable components. Our future
success will depend on a number of factors, including our ability to increase and maintain
sales of the Aspire system with SlimLipo handpiece as well as the consumable components.
Several competing systems also require the use of consumable components, while others do
not or their consumable components allow for more usage before needing to be replaced.
Competing against such systems may be more difficult.
27
If third parties are able to
supply our customers with consumable treatment tips and fiber delivery assemblies for the
Aspire system with SlimLipo handpiece, our business could be adversely impacted.
To
ensure the proper operation of our products, our consumable treatment tips and fiber
delivery assemblies are protected by an encryption technology that is designed to
authenticate that the tips are supplied by us or by a supplier authorized by us. It is
possible that a third party may be able to find methods of circumventing our encryption
technology and other technological requirements which ensure that only authorized tips are
used with the Aspire system with SlimLipo handpiece. If a third party is able to supply
consumable treatment tips and fibers to our customers, this could lead to a reduction in
the safety or efficacy of treatments performed with the Aspire system and SlimLipo
handpiece as we cannot control the quality or operation of such third party products. This
could lead to an increase in product liability lawsuits, damage the Aspire brand, and
result in loss of confidence in our products. In addition, such third party supply of
consumable treatment tips and fibers to our customers could result in a reduction in the
rate of sales and price of consumable treatment tips and fiber delivery assemblies.
We have limited experience
manufacturing the Aspire system, SlimLipo handpiece and consumable treatment tips and
fiber laser assemblies in commercial quantities, which could adversely impact our
business.
We
began manufacturing our Aspire system, SlimLipo handpiece and consumable treatment tips
and fiber delivery assemblies during the second half of 2008. Because we have only limited
experience in manufacturing in commercial quantities, we may encounter unforeseen
situations that would result in delays or shortfalls. We face significant challenges and
risk in manufacturing the Aspire laser system, SlimLipo handpiece and consumable treatment
tips and fibers, including that production processes may have to change to accommodate any
significant future expansion of our manufacturing operations and growth; key components
are currently provided by a single supplier or limited number of suppliers, and we do not
maintain large inventory levels of these components; and we have limited experience
manufacturing the Aspire system, SlimLipo handpiece and consumable treatment tips and
fiber delivery assemblies in compliance with FDAs Quality System Regulation. If we
are unable to keep up with or generate demand for the Aspire system, SlimLipo handpiece
and consumable components, our revenue could be impaired, market acceptance for the Aspire
system, SlimLipo handpiece and consumable components could be adversely affected and our
customers might instead purchase competitors products.
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 treatments and products, prescription drugs and cosmetic topicals
and 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.
28
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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