Description
Palomar Medical Technologies Inc. 10% Owner PARTNERS LP BROADWOOD bought 26,455 shares on 8-02-2012 at $ 7.88
BUSINESS OVERVIEW
Business Strategy
Early in 2009, we responded to the challenging economic times by taking actions to reduce our cost structure to be more in line with current sales levels in all areas of the Company, including reductions in headcount and operating cost. We maintained this cost structure in 2010 and 2011. Early in 2012, we again took actions to reduce our cost structure to bring our research and development spend closer to industry averages. We have built a diversified business model that does not rely solely on high-priced capital equipment sales. These are volatile economic times, but we believe that we have the resources needed to navigate through them and continue as an industry leader.
With our strong focus on both the professional and consumer markets, we believe we will emerge as a stronger company when the economy recovers to continue capitalizing on the market for improving personal appearance. Our strategy is three-fold: growth of our professional product segment, driving our technology into the consumer markets, and enforcing our intellectual property rights.
Growth of Professional Product Segment.
Innovative Products . We grow our professional product segment by investing significant resources in research and development to allow us to continually introduce innovative products. For example, in 2009, we completed the full launch of the Aspire body sculpting system and SlimLipo handpiece. The SlimLipo handpiece was our first minimally invasive product and provides laser-assisted lipolysis during liposuction procedures. In 2010, we launched the Artisan Aesthetic System, a complete facial rejuvenation system. In 2011, we launched the Palomar Icon Aesthetic System, the next generation aesthetic system with high peak powers, state of the art cooling, built in calibration, and an intuitive user interface. We also began selling two third party manufactured products: (i) the Acleara™ Acne Clearing System with continuous-cooling, advanced vacuum suction and filtered broadband light technology and (ii) the Adivive™ Fat Transfer System, an all-in-one, integrated system that uses a unique filtering mechanism and high G-force centrifugation to yield a higher quality of adipose tissue for re-injection. Our strategy is to sell these new products at attractive price points to expand our customer base and cross sell our full line of laser and light-based aesthetic systems. In February 2012, we launched the Skintel™ Melanin Reader which provides an additional element of treatment confidence by determining the average melanin density of skin, in a quantitative manner, prior to treatment with the Icon System. We believe that these new systems provide our sales force with the right product offerings for the current economic environment. We intend to continue to lead the industry in offering platforms that allow practitioners to grow their practice by adding new platforms and handpieces for additional applications and by moving to higher power, more sophisticated systems. We will also consider selling additional third party products that we believe will supplement our product offering. This strategy is designed to allow us to leverage our installed customer base.
Expanding Practitioner Base . We believe that our professional product segment has further growth potential through sales to non-traditional practitioners. In addition to our traditional base of plastic surgeons and dermatologists, we intend to continue to market and sell to other practitioners including general and family practitioners, gynecologists, surgeons, physicians offering cosmetic treatments in medi-spa facilities and others.
Increasing International Presence . We are expanding our international presence in order to create additional opportunities for us. In 2007, we opened an office in Amsterdam, The Netherlands, which oversees our sales and marketing efforts in Europe, the Middle East, and Africa and provides certain servicing of our products in these regions. In 2008, we opened an office near Sydney, Australia, which is responsible for the sales and marketing of our products in Australia and New Zealand as well as certain servicing of our products for those countries. In 2010, we opened an office in Tokyo, Japan, which is responsible for the sales and marketing and certain servicing of our products in Japan. In 2011, we opened an office in Hamburg, Germany, which is responsible for the sales and marketing of our products in Germany and Austria and certain servicing of our products for those countries, and we opened an office in Madrid, Spain, which is responsible for the sales and marketing of our products in Spain and Portugal and certain servicing of our products for those countries. We will continue to work with our current distributors and seek new distributors to improve our international sales and marketing efforts.
Driving Our Technology into Consumer Markets. We direct significant resources toward driving our technology into the consumer markets with our own independent research capabilities, and, in the past, through funding provided by Johnson & Johnson, P&G, and Gillette. At the end of 2010, we independently launched the PaloVia ® Skin Renewing Laser ® -- the first FDA-cleared, at-home laser clinically proven to reduce fine lines and wrinkles around the eyes. The PaloVia laser received OTC clearance from the FDA in 2009 and was developed in part with funding from Johnson & Johnson. This undertaking required and will continue to require us to make a significant investment in inventory, to establish and grow a manufacturing line for consumer products, and expand our sales and marketing support for the business. In addition, we face significant competition, including from companies which are much larger and better funded than us. Currently the PaloVia laser is the only product of its kind on the market in the United States but another company, namely Philips Electronics, sells a similar product outside the United States and is seeking FDA clearance to sell that product in the United States. Though competition is expected to be strong, we believe the PaloVia Laser offers advantages to consumers over competing products, including, for example, laser versus light emitting diode technology and delivery of a user-independent consistent pattern of energy. We seek to gain valuable knowledge of the consumer market and collect feedback from the retail channels and our consumers.
Expanding Consumer Base. We believe that our consumer product segment has significant growth potential through increased consumer awareness and acceptance. We continue to take steps to increase both of these factors, including search engine optimization and marketing, online advertising, and social marketing.
Increasing International Presence. We are actively exploring international distribution opportunities outside the United States for the PaloVia laser both with regional distributors and large international partners.
Intellectual Property Enforcement . We have a portfolio of patents in a number of areas. In the light-based hair removal area, we have granted licenses to certain of our hair removal patents to a number of companies. Several of these companies have become licensees following our enforcement of our patents against them. We will continue to enforce these hair removal patents. In addition, in November 2008, together with MGH and Reliant Technologies, Inc. (now Solta Medical, Inc. (“Solta”)), we announced the formation of a Fractional Technology Open Patent Program (“F-TOPP”) to offer licenses in the professional field to six key patent families in the fractional space. Our efforts to license the F-TOPP patent families have not yet been successful.
We will continue to review various strategies with additional parties, including granting additional licenses and further litigation, if necessary, to protect our intellectual property rights. (For more information about our patent litigation, see “Item 3. Legal Proceedings” and Note 6 to our consolidated financial statements included in this annual report on Form 10-K.)
Products
Principal Products
We research, develop, manufacture, market, sell and service light-based products used to perform procedures addressing medical and cosmetic concerns. We offer a comprehensive range of products based on proprietary technologies that address various cosmetic issues, including:
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hair removal;
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body sculpting, including laser-assisted liposuction;
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removal of vascular lesions such as rosacea, spider veins, port wine stains and hemangiomas;
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wrinkle reduction;
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removal of leg veins;
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removal of benign pigmented lesions such as age and sun spots, freckles and melasma;
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tattoo removal;
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acne treatment;
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skin resurfacing;
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treatment of red pigmentation in hypertrophic and keloid scars;
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treatment of verrucae, skin tags, seborrheic keratosis;
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skin tightening through soft tissue coagulation;
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removal of scars, including acne scars, stretch marks and warts; and
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soft tissue coagulation.
Professional Products
Lux Platform. With increasing market acceptance of light-based treatments for new applications, we recognized the need for a cost effective platform that could expand with the needs of our customers by providing various detachable handpieces. In 2001, we announced the first product with the Lux Platform: the EsteLux ® Pulsed Light System. In the ensuing years, we introduced the MediLux™ Pulsed Light System, the StarLux ® 300 Pulsed Light and Laser System, and the StarLux ® 500 Pulsed Light and Laser System. Each system upgrade included major advances in technology and offered significant benefits to our customers. We also introduced many new handpieces through the years, including various laser handpieces, both fractional and non-fractional and both ablative and non-ablative, various intense pulsed light (IPL) handpieces, and infrared handpieces.
Customers can invest in their first Lux system with one or more handpieces, then purchase additional handpieces as their practices grow and upgrade into a more powerful Lux system when ready. The Lux platform enables us to custom tailor products to fit almost any professional medical office or spa location and provide customers with the comfort that the system is able to grow with their practice.
In addition to being cost effective and upgradeable, the Lux platform includes many technological advances. For example, the platform includes our Smooth Pulse technology, a safe and comfortable treatment that spreads power evenly over the entire pulse of light and provides optimal wavelengths for faster results in fewer treatments. By contrast, many competitive systems deliver a power spike at the beginning of each pulse which can cause injury at the most effective wavelengths. The Smooth Pulse technology extends the life of the light source. We sell replacement handpieces to existing customers providing us with a recurring revenue stream.
The Lux pulsed-light handpieces combine the latest technology with simple, streamlined engineering that is both effective and economical. Long pulse widths and AccuSpectrum™ filtering are designed to provide increased safety and efficacy. Efficacy is further improved through our Photon Recycling process which increases the effective fluence by capturing light scattered out of the skin during treatments and redirecting it back into the treatment target. Offering one of the largest spot sizes in the market and high repetition rates allows for fast coverage, which is especially important when removing hair from large areas such as legs and backs. A back or a pair of legs can be treated with a LuxR or LuxY handpiece in approximately thirty minutes, and a smaller area, such as the underarms, in even less time. The system’s simple operation opens its applications to a wider band of worldwide users.
EsteLux. During 2001, we received FDA clearance to market and sell the Palomar EsteLux™ Pulsed Light System. In 2002 and 2003, we offered six handpieces for the EsteLux system: LuxY, LuxG, LuxR, LuxRs, LuxB and LuxV. These handpieces emit pulses of intense light to reduce future acne breakouts and treat, among other conditions, unwanted hair, solar lentigo (sunspots), rosacea, actinic bronzing, spider veins, birthmarks and telangiectasias. The LuxY handpiece is used for hair removal for large body areas and for pigmented lesion treatments. The LuxG handpiece delivers the RejuveLux™ process - photofacial treatments that remove pigmented and vascular lesions to improve skin tone and texture. The LuxR handpiece can be used to remove hair on all skin types, from the fairest to the darkest, including deep tans. Likewise, the LuxRs handpiece can be used to remove hair on all skin types, but offers concentrated power in each pulse resulting in permanent hair reduction in fewer treatments. The LuxB handpiece provides effective treatment of lighter pigmented lesions on fair skin as well as leg and spider veins, and the LuxV handpiece treats pigmented lesions and mild to moderate acne. With these complimentary handpieces, the Lux Platform is one of the most affordable and multifaceted systems in the market.
MediLux. In March 2003, we launched the Palomar MediLux™ Pulsed Light System with the six handpieces also available on the EsteLux. The MediLux provides increased power, a faster repetition rate and a snap-on connector making it easier to switch among handpieces and provide treatments tailored to each individual being treated.
StarLux 300. In February 2004, we launched the StarLux ® 300 Laser and Pulsed Light System. The StarLux has a single power supply capable of operating both lasers and lamps. The StarLux 300 includes increased power, active contact cooling and a full color touch screen for easy operation. The StarLux 300 operates five of the EsteLux / MediLux handpieces, namely the LuxY, LuxG, LuxR, LuxRs, and LuxV. In addition, the increased power of the StarLux 300 allows for the operation of a long pulse Nd:YAG laser handpiece, the Lux1064™. In January 2005, the Lux1064 laser handpiece received FDA clearance for a variety of applications, including removal of pigmented and vascular lesions such as visible leg veins. The Lux1064 is a high-power laser handpiece featuring Smooth Pulse technology and Active Contact Cooling while also providing multiple spot sizes.
Our Active Contact Cooling technology sends a chilled water supply through the StarLux 300 handpieces, thus cooling the skin before, during, and after treatment. This feature is designed to enhance safety and comfort during treatment. The StarLux 300’s high-powered treatments deliver long-lasting and, in some cases, permanent results. The StarLux 300 full-color screen allows easy finger-touch operation and instant handpiece recognition while providing constant feedback on operating parameters.
In 2005, we introduced a new infrared handpiece, the LuxIR™, for deep tissue heating for relief of muscle and joint pain. In 2006, we received FDA clearance for the LuxIR handpiece for soft tissue coagulation and began marketing the LuxIR for skin tightening through soft tissue coagulation.
In 2006, we introduced the Lux1540™ Fractional Laser handpiece for soft tissue coagulation. In 2007, we received FDA clearance for the Lux1540 for non-ablative skin resurfacing. The Lux1540 delivers light in an array of high precision microbeams which create narrow, deep columns of tissue coagulation that penetrate well below the epidermis and into the dermis, while sparing the tissue surrounding the columns from damage.
In February 2007, we introduced the LuxYs™ Pulsed Light handpiece for permanent reduction of lighter, finer hair.
StarLux 500. In February 2007, we launched the StarLux ® 500 Laser and Pulsed Light System. The StarLux 500 provides 70% more power and increased functionality and speed of treatment as compared to the StarLux 300. The StarLux 500 operates all the handpieces available for the StarLux 300 System as well as the LuxDeepIR™ handpiece. The LuxDeepIR Fractional handpiece is an upgrade of the LuxIR Fractional handpiece and includes advanced cooling, contact sensors and longer pulse duration for improved safety and efficacy. In addition, in December 2007, we launched the Lux2940™ Fractional handpiece for ablative skin resurfacing, and in February 2008, we announced the launch of the Lux1440™ Fractional handpiece for faster non-ablative skin resurfacing. In early 2009, we also announced the launch of the XD Optic for the Lux1540 and Lux1440. The XD Optic provides compression technology for extra depth of treatment which is helpful when treating difficult acne and surgical scars. We completed the full launch of the XD Optic in 2010. In November 2009, we introduced the Groove Optic for the Lux2940 which creates a unique, grooved injury pattern on the skin that increases ablative tissue coverage while preserving the benefits of the fractional approach. Also in 2009, we introduced the LuxMaxG, which provides enhanced power for closure of more difficult facial vessels. We completed the full launch of the LuxMaxG in 2010.
CEO BACKGROUND
JOSEPH P. CARUSO. Mr. Caruso has been one of our directors since October 2001. On March 9, 2012, our board appointed him to serve as Chairman of the Board of Directors. Since May 2002, Mr. Caruso has served as our Chief Executive Officer and President and is responsible for all aspects of operational controls. Mr. Caruso served as our President and Chief Operating Officer from 2000 to May 2002. From 1992 until 2000, Mr. Caruso served as our Vice President and Chief Financial Officer. From 1981 to 1992, Mr. Caruso was a chief financial officer for a private manufacturing company and a manager with an international public accounting firm. We believe Mr. Caruso’s qualifications to sit on our board of directors include his 20 years of experience at the Company, including as our President for the past 12 years. Mr. Caruso’s extensive knowledge of the Company and the light-based aesthetic industry provides our board with a detailed understanding of our operations and is invaluable to our board’s discussions of our current and future needs.
JEANNE COHANE. Ms. Cohane has been one of our directors since June 7, 2000. Ms. Cohane retired in 2002 from Nantucket Imports, a retail consulting company, where she served as President. Ms. Cohane served as the Managing Director of Crabtree & Evelyn’s private label company from 1995 to 1997; from 1991 to 1995 she served as an officer and Vice President of Crabtree & Evelyn Retail Stores; and from 1988 to 1991 Ms. Cohane served as Director of U.S. Retail Stores. Crabtree & Evelyn, an international company, is well known and respected for its beauty products and consumer based market approach. Ms. Cohane was President and sole owner of JRC Imports from 1982 to 1988, which owned and operated retail stores on the east coast of the United States. We believe Ms. Cohane’s qualifications to sit on our board of directors include her 18 years of experience in strategic planning, business development and product expansion, and her leadership and management of all areas of operations in the cosmetic industry, which provide Ms. Cohane with an excellent perspective of what consumers look for in cosmetic procedures and products. Ms. Cohane’s experience provides her with exceptional insights into our challenges and opportunities.
DAMIAN N. DELL’ANNO. Mr. Dell’Anno was elected to our board on March 13, 2012. Mr. Dell’Anno has served as a Principal and Founder of Next Step Healthcare, LLC, which provides advisory, consulting and valuation expertise to investors in the senior housing and living sector, since 2007. Prior to co-founding Next Step Healthcare, Mr. Dell’Anno served as Chief Executive Officer and President of Genoa Healthcare, LLC from 2008 to 2009. From 2007 to 2008, Mr. Dell’Anno served as Senior Executive Vice President and Chief Operating Officer of Formation Capital, LLC. Mr. Dell’Anno joined Harborside Healthcare, Inc. in 1989 as Director of Acquisitions and Due Diligence and was promoted to Chief Operating Officer in 1994, President in 2000, and served as Chief Executive Officer and Chairman of the Board from 2005 to 2007. Before joining Harborside, from 1987 to 1989, Mr. Dell’Anno served as Director of Budget and Reimbursement for the Mediplex Group, Inc., and prior to that he held several other positions in the healthcare services sector. Mr. Dell’Anno was a member of the Board of Directors of Alliance For Quality Nursing Home Care from 2005 to 2007 and the Massachusetts, Connecticut, and Ohio Nursing Home associations from 1990 to 2007. Mr. Dell’Anno became a member and Chairman of the Board of Directors of Millennium Pharmacy Systems, Inc. in 2007. Mr. Dell’Anno has a B.S.B.A. in accounting from Suffolk University. We believe Mr. Dell’Anno’s qualifications to sit on our board of directors include his extensive experience in new business development and redesigning business processes as well as his experience leading and managing public companies and forming strategic alliances. We believe Mr. Dell’Anno’s experience in the healthcare industry will provide important insights in future board discussions.
NICHOLAS P. ECONOMOU. Dr. Economou has been one of our directors since November 13, 1997. Dr. Economou has served as the president and chief executive officer of PointSpectrum LLC since October 2010. From January 2009 through September 2010, Dr. Economou was the president of Carl Zeiss SMT, Inc., the North American operation of Carl Zeiss SMT AG, and was also a director of Carl Zeiss SMT, Inc. Dr. Economou is also a director of private companies Laser Light Engines, Inc., LumArray, Inc., and Xradia, Inc. He co-founded ALIS Corporation, a developer and manufacturer of analytical equipment for the semiconductor, nanotechnology, life sciences and materials industries. ALIS Corporation was acquired by Carl Zeiss SMT in July 2006 and continues as a wholly owned subsidiary of Carl Zeiss SMT. Dr. Economou was the chief executive officer of ALIS Corporation from July 2006 to January 2009, president of ALIS Corporation from January 2009 through September 2010 and served as executive chairman of the board from March 2005 to July 2006. Before founding ALIS, Dr. Economou was chief executive officer of Confluent Photonics Corporation, a manufacturer of photonic subsystems. Previously, Dr. Economou was chief operating officer of AXSUN Technologies, a manufacturer of photonic subsystems. Prior to AXSUN, he was chief operating officer of FEI Company (FEIC), a manufacturer of production and analytical equipment for the semiconductor and data storage industries. Prior to FEIC, he was chairman, president and chief executive officer of Micrion Corporation (MICN), which merged with FEIC in August 1999. Dr. Economou received his B.A. in physics from Dartmouth College and his M.A. and Ph.D. in physics from Harvard University. We believe Dr. Economou’s qualifications to sit on our board of directors include his extensive experience in leading complex technology enterprises, as well as his executive leadership and management experience. Dr. Economou’s experiences in life sciences, research, and global affairs add significant value to board discussions.
JAMES G. MARTIN. Dr. Martin has been one of our directors since June 2, 1997. He currently serves as a director and chairman of the corporate governance committee for Family Dollar Stores, Inc., a publicly held corporation of a chain of more than 6,800 small box, everyday, low priced retail stores. From July of 2008 until November of 2011, he was Senior Advisor of McGuireWoods Consulting, and until October 2011, he served as director and chairman of the executive committee of DesignLine, Inc., a privately held corporation which builds transit buses, primarily hybrid buses. From 1996 through 2010, he served as a director and member of the audit committee of N.C. Capital Management Trust, an investment company providing fixed income securities for local governments. From 1995 through March 2008, he served as Vice President of Carolinas HealthCare System, where he was also Chairman of the Research Development Board of Carolinas Medical Center from 1993 until 2000. From 1985 until 1993, Dr. Martin was the Governor of North Carolina. Prior to that position, he served as a United States Congressman from North Carolina from 1973 through 1984. From 1960 until 1972, Dr. Martin was an Associate Professor of Chemistry at Davidson College. Dr. Martin has a B.S. in chemistry from Davidson College and a Ph.D. in chemistry from Princeton University. We believe Dr. Martin’s qualifications to serve on our board of directors include his expertise in corporate strategy development and organizational acumen. In addition, Dr. Martin’s experience as both a Governor and United States Congressman provides our board with a unique perspective and contacts. Mr. Martin also brings excellent leadership skills to his role of chairman of our Compensation Committee.
A. NEIL PAPPALARDO. Mr. Pappalardo has been one of our directors since June 2, 1997. In 1969, Mr. Pappalardo founded Medical Information Technology, Inc., a provider of software systems to hospitals in the United States, Canada and the United Kingdom with over 3,500 employees. He has served as the Chairman and Chief Executive Officer of Medical Information Technology since its inception. Mr. Pappalardo serves on the MIT Corporation, the executive committee and is chairman of the audit committee as well as various other operational and academic committees. Mr. Pappalardo received his B.S. in electrical engineering from MIT. We believe Mr. Pappalardo’s qualifications to sit on our board of directors include his extensive experience with public and financial accounting matters. Mr. Pappalardo is extremely conscientious and diligent in keeping our board of directors abreast of current audit issues and collaborating with our independent auditors and senior management team regarding the financial position of the Company. His leadership skills and experience with his own company, Medical Information Technology, enables him to be an effective board member and chairman of our Audit Committee.
LOUIS P. VALENTE. Mr. Valente has served as one of our directors since February 1, 1997. Mr. Valente served as our Executive Chairman from May 2002 until March 9, 2012. On March 9, 2012, Mr. Valente entered into a Senior Strategic Advisor Agreement with the Company under which Mr. Valente will provide the Company strategic advisory services in various areas, including mergers and acquisitions, new business development and other strategic initiatives. He served as our Chief Executive Officer from May 1997 to May 2002 and as Chairman of the Board from September 1997 to March 2012. From 1968 to 1995, Mr. Valente held numerous positions at PerkinElmer, Inc. (formerly EG&G, Inc.), a provider of drug discovery, research and clinical screening products, services and technologies for the life science industry and products for aerospace, chemical, environmental, medical, photography, security and other global arenas. In 1968, he began his career at EG&G, Inc. as an Assistant Controller and held executive positions, including Corporate Treasurer, before becoming Senior Vice President of EG&G, Inc., presiding over and negotiating acquisitions, mergers and investments. Mr. Valente serves as a director and member of the audit committee of Medical Information Technology, Inc. and MKS Instruments, Inc., both of which are publicly held companies. Mr. Valente is also a member of the compensation committee of MKS Instruments, Inc. Mr. Valente is a Certified Public Accountant and a graduate of Bentley University. We believe Mr. Valente’s qualifications to sit on our board of directors include his 15 years of experience at the Company, including five years as our Chief Executive Officer and 10 years as our Executive Chairman. In addition, his experience at EG&G provides our board with a perspective of someone with experience with all facets of a global enterprise, including financial and accounting issues. His accomplishments working in the life science industry and other high technology enterprises and his experience with executive management are of significant benefit to our board and our company.
MANAGEMENT DISCUSSION FROM LATEST 10K
Overview
We are a global medical device company engaged in research, development, manufacturing and distribution of proprietary light-based systems for medical and cosmetic treatments. Since our inception, we have been able to develop a differentiated product mix of light-based systems for various treatments through our research and development as well as with our partnerships throughout the world. We are continually developing and testing new indications to further the advancement in light-based treatments.
Our corporate headquarters and United States operations are located in Burlington, Massachusetts, where we conduct our manufacturing, warehousing, research and development, regulatory, sales, customer service, marketing and administrative activities. In the United States, Australia, Canada, Japan, Germany, and Spain, we market, sell, and service our products primarily through our direct sales force and customer service employees. In the rest of the world, sales are generally made through our worldwide distribution network in over 70 countries.
Financial Information
Consolidated revenues in 2011 were $103.4 million, up 62% from revenues of $63.7 million in 2010. Consolidated revenues for 2011 include $29.8 million in royalty revenues as a result of the settlement of the Candela/Syneron litigation. We had operating income of $10.7 million and net income of $7.4 million, or $0.39 per diluted share, in 2011. These results compared with operating loss of $9.2 million and net loss of $8.8 million, or $0.47 per share, in 2010.
Critical accounting policies
Management’s discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which are prepared in accordance with accounting principles that are generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, related disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. We continually evaluate our estimates and judgments, the most critical of which are those related to revenue recognition, available for sale and marketable securities valuation, accounts receivable valuation, inventory valuation, warranty provision, stock-based compensation, fair value measurements, income tax valuation, and contingencies. We base our estimates and judgments on historical experience and other factors that we believe to be reasonable under the circumstances. Materially different results can occur as circumstances change and additional information becomes known.
Revenue Recognition. We recognize revenue in accordance with Securities and Exchange Commission (“SEC”) guidance on revenue recognition. The SEC’s guidance requires that four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) is based on management’s judgments regarding the fixed nature of the fee charged for services rendered and products delivered and the collectability of those fees. Should changes in conditions cause management to determine that these criteria are not met for certain future transactions, revenue recognized for any reporting period could be adversely affected. We generally recognize product revenues upon shipment. If a product sale does not meet all of the above criteria, the revenue from the sale is deferred until all criteria are met. Provisions are made at the time of revenue recognition for any estimated return and applicable warranty costs expected to be incurred.
In our consumer products business, customer returns are recorded on an actual basis throughout the year and also include an estimate at the end of each reporting period for future customer returns related to sales recorded prior to the end of the period. We generally estimate customer returns based upon the time lag that historically occurs between the date of the sale and the date of the return, while also factoring in any new business conditions that might impact the historical analysis, such as a new consumer product introduction. We believe that our procedures for estimating such return amounts are reasonable.
Periodically, we sell products together with a product upgrade option that requires that the customer pay an upgrade fee at the time of exercise, has no refund provisions and includes an expiration date on the upgrade option. In accordance with Accounting Standards Update No. 2009-13, Multiple-Delivery Revenue Arrangements (ASU 2009-13) , we defer the estimated selling price ascribed to the upgrade option until the expiration of the upgrade option or the exercise of the upgrade option and shipment of the product upgrade.
Revenues from the sale of service contracts is deferred and recognized on a straight-line basis over the life of the service contract. Revenues from services administered by us that are not covered by a service contract are recognized as the services are provided. In certain instances, we sell products together with service contracts. We recognize revenue on such multiple-element arrangements in accordance with ASU 2009-13, based on the estimated selling price of each element. In accordance with ASU 2009-13, we use vendor-specific objective evidence or VSOE, if available, to determine the selling price of each element. If VSOE is not available, we use third-party evidence, or TPE to determine the selling price. If TPE is not available, we use our best estimate to develop the estimated selling price.
We generally recognize royalty revenue from licensees upon receipt of cash payments since the royalty amounts are not determinable at the end of each quarter. Licensees are obligated to make payments to us between 30 and 45 days after the end of each quarter. If at the end of a quarter royalty revenue from licensees are determinable, we record royalty revenue during the period earned. Periodically, as we sign on new licensees, we recognize back-owed royalties in the period in which it is determinable and earned. We have the right under our license agreements to engage independent auditors to review the royalty calculations. The amounts owed as a result of these audits may be higher or lower than previously recognized.
We have other revenues which consist of quarterly technology transfer payments (“TTP Quarterly Payment” as defined in the License Agreement with Proctor & Gamble). TTP Quarterly Payments are being 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. On December 9, 2010, we announced an amendment to the License Agreement with P&G and Gillette. The amendment provides additional funding from each company to meet the common goal of a successful product launch. The amendment does not change the scope of P&G's non-exclusive license to Palomar's broad patent portfolio as well as its non-exclusive license to the extensive technology developed by Palomar prior to February 28, 2008 for home-use, light-based hair removal devices for women. Under the amended License Agreement, the parties agreed to reduce pre-commercial launch calendar quarterly payments from $1.25 million to $1.0 million for the calendar quarter ending December 31, 2010 and thereafter to $2.0 million per year for an agreed period, after which the payments return to $1.25 million per calendar quarter if no product has been launched. P&G will apply the savings, together with agreed minimum overall program funding, to accelerating product readiness and commercialization while Palomar will be paid an increased percentage of sales after commercial launch. The payments under the amended license agreement are being recognized ratably through the expected launch term.
In the past, we have had funded product development revenue from development agreements with Johnson & Johnson and P&G/Gillette. For both Johnson & Johnson and Gillette, we have received payments in accordance with the work plans that were developed with each of Johnson & Johnson and Gillette. Revenue was recognized under the contracts as costs were incurred and services were rendered. Any amounts received in advance of costs incurred and services rendered were recorded as deferred revenue. Payments were not refundable if the development was not successful.
Marketable Securities and Other Investments. Marketable securities, which primarily consist of auction-rate preferred securities and auction-rate municipal securities are classified as “marketable securities” under Debt and Equity Securities Topic of the FASB Accounting Standards Codification and are recorded at fair market value. Any unrealized gains and losses, net of income tax effects, would be computed on the basis of specific identification and reported as a component of accumulated other comprehensive income (loss) in stockholders’ equity. We evaluate unrealized losses to determine if the loss is other-than-temporary. If the loss is other-than-temporary, it is separated into two amounts, one amount representing a credit loss and the other representing an impairment due to all other factors. The amount representing a credit loss is recorded in earnings, while the remaining impairment is recorded as a component of accumulated other comprehensive income (loss), as we do not have the intent to sell the impaired investments, nor do we believe that it is more likely than not that we will be required to sell these investments before the recovery of their cost basis. We determined that the fair value of our auction-rate securities (“ARS”) was temporarily impaired as of December 31, 2011 and 2010.
In addition to the auction-rate preferred securities and auction-rate municipal securities discussed above, our other investments primarily consisted of corporate bonds, U.S. agency bonds, and U.S. Treasuries and were classified as held-to-maturity securities. These other investments are recorded at amortized cost. The amortized cost of these investments approximates fair market value.
Accounts Receivable Reserves. Allowances for doubtful accounts are based on estimates of losses related to customer receivable balances. In establishing the appropriate provisions for customer receivable balances, we make assumptions with respect to their future collectability. Our assumptions are based on an individual assessment of a customer’s credit quality as well as subjective factors and trends, including the aging of receivable balances. Generally, these individual credit assessments occur prior to the inception of the credit exposure and at regular reviews during the life of the exposure and consider (a) a customer’s ability to meet and sustain their financial commitments; (b) a customer’s current and projected financial condition; (c) the positive or negative effects of the current and projected industry outlook; and (d) the economy in general. Once we consider all of these factors, a determination is made as to the probability of default. An appropriate provision is made, which takes into account the severity of the likely loss on the outstanding receivable balance based on our experience in collecting these amounts. Our level of reserves for our customer accounts receivable fluctuates depending upon all of the factors mentioned above. We provide an additional reserve for doubtful accounts based on the aging of our accounts receivable balances, historical experiences of write-offs, and defaults.
Inventory Reserves. As a designer and manufacturer, we may be exposed to a number of economic and industry factors that could result in portions of our inventory becoming either obsolete or in excess of anticipated usage. These factors include, but are not limited to, technological changes in our markets, our ability to meet changing customer requirements, competitive pressures in products and prices, reliability and replacement of and the availability of key components from our suppliers. Our policy is to establish inventory reserves when conditions exist that suggest that our inventory may be in excess of anticipated demand or is obsolete based upon our assumptions about future demand for our products and market conditions. Included in our inventory are demonstration products that are used by our sales organization. We account for such products as we do with any other finished goods item in our inventory in accordance with the review of our entire inventory. We regularly evaluate our ability to realize the value of our inventory based on a combination of factors including the following: historical usage rates, forecasted sales or usage, product end of life dates, estimated current and future market values, and new product introductions. Assumptions used in determining our estimates of future product demand may prove to be incorrect, in which case the provision required for excess and obsolete inventory would have to be adjusted in the future. If inventory is determined to be overvalued, we would be required to recognize such as cost of goods sold at the time of such determination. Although we perform a detailed review of our forecasts of future product demand, any significant unanticipated changes in demand could have a significant impact on the value of our inventory and our reported operating results. Additionally, purchasing requirements and alternative usage avenues are explored within these processes to mitigate inventory exposure. When recorded, our reserves are intended to reduce the carrying value of our inventory to its net realizable value.
Warranty Provision. We typically offer a one year warranty for our base professional and consumer products. We provide for the estimated cost of product warranties at the time product revenue is recognized. Factors that affect our warranty reserves include the number of units sold, historical and anticipated rates of warranty repairs and the cost per repair. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our component suppliers, our estimated warranty obligation is affected by ongoing product failure rates, specific product class failures outside of our baseline experience, material usage and service delivery costs incurred in correcting a product failure. If actual product failure rates, material usage or service delivery costs differ from our estimates, revisions to the estimated warranty liability would be required. Assumptions and historical warranty experience are evaluated to determine the appropriateness of such assumptions. We assess the adequacy of the warranty provision and we may adjust this provision if necessary.
Stock-Based Compensation. We recognize stock-based compensation expense in accordance with FASB Codification Topic regarding Stock Compensation. This guidance requires share-based payments to employees, including grants of employee stock options, restricted stock awards, restricted stock units, and stock-settled stock appreciation rights (SARs) to be recognized in the statement of operations based on their fair values at the date of grant.
We use the Black-Scholes option pricing model to estimate the fair value of stock option and SAR grants. Key input assumptions used to estimate the fair value of stock options and SARs include the exercise price of the award, the expected option term, the expected volatility of our stock over the option or SAR’s expected term, the risk-free interest rate over the option or SAR’s expected term and our expected annual dividend yield. Expected volatilities are based on historical volatilities of our common stock; the expected life represents the weighted average period of time that options or SARs granted are expected to be outstanding giving consideration to vesting schedules and our historical exercise patterns; and the risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option or SAR. Our assumed dividend yield of zero is based on the fact that we have never paid cash dividends and currently have no intention to pay cash dividends.
If factors change and we employ different assumptions for estimating stock-based compensation expense in future periods, or if we decide to use a different valuation model, the stock-based compensation expense we recognize in future periods may differ significantly from what we have recorded in the current period and could materially affect our income from operations, net income, and earnings per share. It may also result in a lack of comparability with other companies that use different models, methods, and assumptions. The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. These characteristics are not present in our stock option and SAR grants. Existing valuation models, including the Black-Scholes model, may not provide reliable measures of the fair values of our stock-based compensation. Consequently, there is a risk that our estimates of the fair values of our stock-based compensation awards on the grant dates may bear little resemblance to the actual values realized upon the exercise, expiration, early termination or forfeiture of those stock-based payments in the future. Certain stock-based payments, such as employee stock options and SARs, may expire with little or no intrinsic value compared to the fair values originally estimated on the grant date and reported in our financial statements. Alternatively, the value realized from these instruments may be significantly higher than the fair values originally estimated on the grant date and reported in our financial statements.
Fair Value Measurements. The performance of fair value measurements is an integral part of the preparation of financial statements in accordance with generally accepted accounting principles. Fair value is defined as the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction between market participants to sell or transfer such an asset or liability. Selection of the appropriate valuation technique, as well as determination of assumptions, risks and estimates used by market participants in pricing the asset or liability requires significant judgment. Although we believe that the inputs used in our valuation techniques are reasonable, a change in one or more of the inputs could result in an increase or decrease in the fair value of certain assets and certain liabilities and could have an impact on both our consolidated balance sheets and consolidated statements of operations.
To value our auction-rate securities, we determined the present value of the auction-rate securities at the balance sheet date by discounting the estimated future cash flows based on a fair value rate of interest and an expected time horizon to liquidity. As the secondary market for these investments is not currently very active or liquid, their valuation required management’s judgment.
Income taxes. Under FASB Accounting Standards Codification Topic regarding Income Taxes, we can only recognize a deferred tax asset for future benefit of our tax loss, temporary differences and tax credit carry forwards to the extent that it is more likely than not that these assets will be realized. Since 2008, we incurred operating losses in foreign jurisdictions. We believe that it is more likely than not that the associated tax asset will not be utilized. Therefore, we have established a full valuation allowance in 2010 and 2011 on this deferred tax asset.
In 2011 and 2010, we recorded a valuation allowance against our U.S. deferred tax assets. In evaluating the ability to recover these deferred tax assets, we considered all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies. As a result of the resolution of the patent infringement lawsuits against Syneron, Inc., Syneron Medical Ltd., and Candela Corporation, we generated profits in the U.S. in 2011 which were partially offset by U.S. net operating loss carryforwards. In assessing the need for a valuation allowance, we looked to our historic losses and our future profitability. We do not believe it is more likely than not that the net deferred tax assets will be realized.
In addition to the tax assets described above, we have deferred tax assets totaling approximately $18.5 million, related to excess tax deductions from the exercise of employee stock options. Recognition of these assets would occur upon utilization of these deferred tax assets to reduce taxes payable and would result in a credit to additional paid-in capital within stockholders’ equity. For 2011, 2010, and 2009, the impact to paid-in capital resulting from the exercise and expiration of employee stock options was $3.2 million, $0.2 million, and $0.4 million, respectively.
In evaluating the potential exposure associated with the various tax filing positions, we accrue charges for possible exposures. Based on the annual evaluations of tax positions, we believe we have appropriately filed our tax returns and accrued for possible exposures. To the extent we were to prevail in matters for which accruals have been established or be required to pay amounts in excess of reserves, our effective tax rate in a given financial period might be materially impacted.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
We are a global leader in laser and other light-based systems for aesthetic treatments. Since our inception, we have been able to develop a differentiated product mix of light-based systems for various treatments through our research and development as well as with our partnerships throughout the world. We are continually developing and testing new indications to further the advancement in light-based treatments.
Our corporate headquarters and United States operations are located in Burlington, Massachusetts, where we conduct our manufacturing, warehousing, research and development, regulatory, sales, customer service, marketing and administrative activities. In the United States, Australia, Canada, Japan, Germany, and Spain, we market, sell, and service our products primarily through our direct sales force and customer service employees. In the rest of the world, sales are generally made through our worldwide distribution network in over 70 countries.
Results of operations
Revenues for the quarter ended March 31, 2012 were $19.0 million, a 5 percent increase over the $18.2 million reported in the first quarter of 2011. Excluding the $1.1 million back-owed royalty payment recognized in the first quarter of 2011, revenues for the quarter ended March 31, 2012, were 11 percent greater than in the same quarter in 2011. We believe that the use of this non-GAAP revenues disclosure enhances our ability to conduct period-to-period analyses of our results. Professional product revenues for the quarter ended March 31, 2012 were $11.9 million, an increase of 13 percent over the first quarter of 2011. Professional product gross margins were 59% in both the first quarter of 2012 and 2011. Consumer product revenues were $1.0 million for the quarter ended March 31, 2012. A majority of the 2011 consumer product revenues were deferred until the fourth quarter of 2011. Consumer product revenues gross margin was 15% in the first quarter of 2012. Loss before taxes for the quarter ended March 31, 2012 was $2.2 million. Loss before taxes for the quarter ended March 31, 2011 was $1.9 million, which included $0.7 million positive effect from the receipt of a $1.1 million back-owed royalty payment. Net loss for the quarter ended March 31, 2012 was $2.3 million, or $0.12 per share, as compared to a net loss for the quarter ended March 31, 2011 of $1.9 million, or $0.10 per share. As of March 31, 2012, the balance sheet continues to be strong with $100.1 million in cash, cash equivalents, short-term investments, and marketable securities and other investments with no borrowings.
Royalty revenues . Royalty revenues decreased for the three months ended March 31, 2012 by 44% as compared to the corresponding period in the prior year. The decrease is mainly attributed to lower on-going royalty payments from our licensees and a $1.1 million back-owed royalty payment received in the first quarter of 2011.
Other revenues. During the three months ended March 31, 2012, other revenues remained consistent as compared to the corresponding period in the prior year. For the three months ended March 31, 2012 and 2011, other revenues consisted of the recognition of $0.6 million related to payments received under an amendment to our license agreement (“License Agreement”) with P&G which was signed in the fourth quarter of 2010. The payments under the amended License Agreement are being recognized ratably through the expected launch term.
Cost of professional product revenues . For the three months ended March 31, 2012 and 2011, the cost of professional product revenues increased in absolute dollars, but remained consistent as a percentage of professional product revenues at 41% in both 2012 and 2011. The increase in absolute dollars was attributable to higher product revenues. Our cost of professional product revenues consists primarily of material, labor and manufacturing overhead expenses. Cost of professional product revenues also includes royalties incurred on certain products sold, warranty expenses, as well as payroll and payroll-related expenses, including stock-based compensation, and quality control.
Cost of consumer product revenues. The cost of consumer product revenues relates to the PaloVia ® Skin Renewing Laser ® . For the three months ended March 31, 2012, cost of consumer product revenues was $0.8 million, or 85% of consumer product revenues. Since we were selling the PaloVia laser through retail channels with which we had no history and were unable to estimate the customer return rates and the expected warranty accrual needed on sales of our consumer product, we deferred all consumer product revenues from the PaloVia laser until the fourth quarter of 2011. During the fourth quarter of 2011, we determined that we had sufficient history to be able to estimate our customer return rates and the expected warranty accrual needed on sales of our consumer product. In the fourth quarter of 2011, we recognized $3.5 million of consumer product revenues related to the PaloVia laser and the related expenses.
Cost of service revenues . For the three months ended March 31, 2012 and 2011, the cost of service revenues decreased in absolute dollars and as a percentage of service revenues to 44% in 2012 from 47% in 2011. The decrease is due to shipping expenses, offset by an increase in labor costs as headcount has grown to be in line with our growing product base and the opening of our new offices in Germany and Spain during 2011.
Cost of royalty revenues . The cost of royalty revenues were 40% of royalty revenues at the end of each period and decreased for the three months ended March 31, 2012 by 44% as compared to the corresponding period in the prior year. The decrease is mainly attributed to lower on-going royalty payments from our licensees and a $1.1 million back-owed royalty payment in the first quarter of 2011.
Research and development expense . Research and development expense decreased by $0.3 million, or 8%, for the three months ended March 31, 2012 over the corresponding period in 2011. The decrease in research and development expense was due to reorganizing these departments while maintaining our continued commitment to introducing new products and enhancing our current family of products through our continued substantial investment in research and development.
Research and development expenses relating to our Professional Product segment decreased by 9% for the three months ended March 31, 2012, as compared to the corresponding period in 2011. Research expenses relating to our Professional Product segment include internal research and development projects relating to the introduction of new professional products and enhancements to our current line of professional products. Research and development expense relating to our Consumer Product segment decreased by 12% for the three months ended March 31, 2012, as compared to the corresponding period in 2011. This decrease in research and development expense related to our Consumer Product segment includes decreases in materials and consultants, offset by increases in payroll and payroll related and clinical expenses related directly to our consumer products as compared to 2011.
For the three months ended March 31, 2012 and 2011, research and development expense included $0.2 million and $0.5 million, respectively, of stock-based compensation expense.
Selling and marketing expense . Selling and marketing expense increased by $1.1 million, or 20%, for the three months ended March 31, 2012 over the corresponding period in 2011. Selling and marketing expenses relating to our Professional Product segment increased by 16% in the three months ended March 31, 2012 as compared to corresponding period in 2011. The increase was primarily driven by increases of $0.7 million from our foreign subsidiaries in Germany and Spain that we established in 2011. Selling and marketing expenses related to our Consumer Product segment increased by 68% in the three months ended March 31, 2012 as compared to corresponding period in 2011. The increase was primarily driven by increases of $0.2 million in direct marketing expenses.
For the three months ended March 31, 2012 and 2011, selling and marketing expense included $0.2 million and $0.3 million, respectively, of stock-based compensation expense.
General and administrative expense . General and administrative expense decreased by $0.3 million, or 10%, for the three months ended March 31, 2012 over the corresponding period in 2011. The decrease in general and administrative expense was driven by lower legal expenses and stock-based compensation expense, partially offset by higher payroll and payroll related expenses.
For the three months ended March 31, 2012 and 2011, general and administrative expense included $0.1 million and $0.2 million, respectively, of stock-based compensation expense.
Interest income . Interest income for the three months ended March 31, 2012 decreased by 21% as compared to the corresponding periods in 2011 primarily due to lower interest rates, offset by a higher average cash and cash equivalents, short-term investments, and marketable securities and other investments balance during the three months ended March 31, 2012 as compared to the corresponding period in 2011.
Other income. Other income for the three months ended March 31, 2012 and 2011 includes the foreign exchange gain resulting from transactions in currencies other than the U.S. dollar.
Provision for income taxes . Our effective tax rate for the three months ended March 31, 2012 and 2011 was 3% and 2%, respectively. Our 2012 and 2011 effective tax rates are primarily related to minimum state income taxes as the Company was in an operating loss in both periods. We continue to maintain a full valuation allowance in all jurisdictions and have available net operating losses in foreign jurisdictions to offset future income in those jurisdictions.
At March 31, 2012, we held $1.0 million in auction-rate securities (“ARS”) all of which were preferred municipal securities. The ARS we invest in are high quality securities, none of which are mortgage-backed. Beginning in February 2008, 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 classified these investments as non-current as of March 31, 2012 and 2011. During the three months ended March 31, 2012 and 2011, we sold $0 and $0.2 million of our ARS at par, respectively.
We have determined that the fair value of our ARS was temporarily impaired as of March 31, 2012 and 2011. For the three months ended March 31, 2012 and 2011, we marked to market our ARS and recorded an unrealized loss of $23,000 and unrealized gain of $21,000, respectively, net of taxes in accumulated other comprehensive (loss) income in stockholder’s equity to reflect the temporary impairment of our ARS. The recovery of these investments is based upon market factors which are not within our control. As of March 31, 2012, we do not intend to sell the ARS and it is not more likely than not that we will be required to sell the ARS before recovery of their amortized cost bases, which may be at maturity.
Cash used in operating activities increased for the period ended March 31, 2012 as compared to the corresponding period in 2011. This increase primarily reflects the effects of a larger net loss, lower stock-based compensation expense, and greater working capital requirements in 2012 than in 2011. Cash from (used in) investing activities increased during the period ended March 31, 2012 as compared to the corresponding period in 2011. These amounts primarily reflect less cash used for purchases of property and equipment (including construction in progress) and purchases of and proceeds from the sale of short-term investments and marketable securities. Cash (used in) from financing activities increased for period ended March 31, 2012 as compared to the corresponding period in 2011. This change was primarily due to a decrease in the proceeds from the exercise of stock options.
We anticipate that capital expenditures for 2012 will total approximately $1.0 million consisting primarily of information technology equipment, furniture and fixtures, software, and machinery. We expect to finance these expenditures with cash on hand.
On August 13, 2007, our board of directors approved a stock repurchase program under which our management is authorized to repurchase up to one million shares of our common stock. At March 31, 2012, 675,500 shares of common stock had been repurchased under this program, leaving 324,500 remaining to be repurchased, if desired. The timing and actual number of shares purchased will depend on a variety of factors such as price, corporate and regulatory requirements, alternative investment opportunities and other market conditions. Stock repurchases under this program, if any, will be made using our cash resources, and may be commenced or suspended at any time or from time to time at management’s discretion without prior notice. During the three months ended March 31, 2012, we did not purchase any of our common stock through the stock repurchase program.
Off-balance sheet arrangements
We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as variable interest or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2012, we were not involved in any unconsolidated transactions.
Contractual obligations
We are a party to three patent license agreements with MGH under which we are obligated to pay royalties to MGH for sales of certain products as well as a percentage of royalties received from third parties. Royalty expense for the three months ended March 31, 2012, totaled approximately $0.7 million. For more information, please see the Amended and Restated License Agreement (MGH Case Nos. 783, 912, 2100), the License Agreement (MGH Case No. 2057) and the License Agreement (MGH Case No. 1316) filed as Exhibits 10.1, 10.2, and 10.3 to our Current Report on Form 8-K filed on March 20, 2008.
CONF CALL
Kerry McAnistan
Good morning and welcome to the Palomar Medical Technologies third quarter 2010 conference call. Before we start this morning's call there are a couple of items we would like to cover. These conference calls are recorded live and you may access the webcast replay at Palomar’s website, www.palomarmedical.com, through Thursday, November 4th.
Various remarks that we’ll make about future expectations, plans and prospects for the company constitute forward-looking statements, the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Form 10-K for the year ended December 31, 2009 and the company's Quarterly Reports on Form 10-Q, which are on file with the SEC and available through Palomar's website.
The information in this conference call related to projections or other forward-looking statements may be relied upon subject to the previous Safe Harbor statement as of the date of this call. The information in this conference call is the property of Palomar and should not be reproduced, recorded or otherwise published without the expressed prior written consent of the company.
Joining us this morning are Dan Valente, Chairman; Joe Caruso, President and Chief Executive Officer; and Paul Weiner, Chief Financial Officer.
I would now like to turn the call over to Dan.
Dan Valente
Thanks Kelly and thank you all for tuning into the conference call. We’ve met our financial and operating goals again for the third quarter. As you know, Palomar will be entering a new and exciting phase in achieving the company’s direct-to-consumer commercialization goals. We are very excited about our plans to introduce our first home product in 2011. Now let’s hear from Joe Caruso, Palomar, CEO.
Joe Caruso
Thank you, Dan. Although the economy remains weak, we are seeing signs of improvement in our business. There has been a decrease in physician components and an increase in lead generation and demos. We are yet to see any substantial change in the availability of credit to our customers. Fortunately, Palomar’s products are very well positioned for these challenging times. Even in this environment, our products make economic sense to our customers due to their high return on investment profile and the flexibility of our platform.
We also continue to add technology in product configurations that fits in today’s economy. Our sales force has the ability to match our technology to fit not only the clinical needs of our customers, but their financial constraints as well. This quarter was the fourth consecutive quarter of product sales growth, quarter-over-quarter. We also increased our product revenues 23% this quarter as compare to the same period last year. This is the largest such increase in more than three years.
There are also benefits from a diversified business model that includes a significant portion of our revenues being derived from multiple sources. 31% of our revenues during the third quarter were generated from sources other than one-time capital equipment sales.
Our distribution expansion initiative is moving along according to plan. The office we opened in Japan last quarter is working out well. We have hired direct sales and marketing staff, as well as set up people with peer capability with service technicians. This office will not only service the Japanese market, but help support our efforts in other Asian countries. Our business outside North America continues to strength. It now accounts for 38% of our overall product and service revenue.
This quarter we were able to achieve better gross margins than last year. Average selling prices remained stable for our products and we were happy with our product mix. Paul will give us more details during his comments in just a few minutes on the financial results for the quarter.
We continue to focus on executing our diversified strategy by addressing the professional light-based aesthetic market today, working for driving our technology directly to the consumer markets and capitalizing on the value of our extensive client portfolio. We continue to invest in more in research and into developments than our competitors as we position the company for future growth.
Earlier this year we launched a new platform system called Addison. It is positioned to penetrate the ever-growing skin rejuvenation market. It combines the best of our non-ablative and ablative fractional laser technologies with photofacial IPL technology. This combination of technologies can be used to provide milder treatments, plutonium texture up to the more aggressive fractional ablated laser treatments for wrinkles.
Physicians are able to have the multiple tools they need for an overall best-in-class treatment protocol, depending on individual age, skin conditions, potential down time and financial constraints at even more attractive price points. We continue to monitor the economic environment and adjust if necessary. Our intent is to balance our short-term operating goals with our long-term opportunities as we invest in research.
Year-to-date the core competency in the light-based aesthetic devices and we intend on maintaining it as we navigate through this tough economic period. We also plan on investing in new markets prior to the economic turnaround to be best positioned for the next growth period. Although these challenging times could be with us for a while, we firmly believe that the long term outlook for light-based aesthetic devices remains a great opportunity.
We have made significant progress over the past few years with our long-term goal of taking our technology directly to the consumers. We have FDA over-the-counter clearance for the first at-home laser for periorbital wrinkle treatment. We announced that we will take the first step towards commercializing our consumer product probably next year. So this is a big challenge. We are excited about this initial launch. With our in house manufacturing expertise, additional manufacturing space in our new facility and FDA clearance, we plan to launch our consumer products on a limited basis through specific channels within the next few months.
Manufacturing is in process and we are building finished goods for our product launch. Our first target is into the specialty retail market. The specialty retail market includes potentially selling through television shopping programs, specialty retail outlets, the Internet and physicians. We will first build a basic business in those channels before expanding to the boarder markets.
We are very pleased with the final branding and product position. Having full control over the initial introduction of our consumer products will enable us to build a core expertise seamlessly in market. This is a great opportunity for us as we build the business and fill these in channels.
Our entry into the consumer markets is one of our core strategic initiatives. We understand that entering the consumer market is not going to be easy in the short-term. However, we believe our efforts will be worthwhile in the long run, as the consumer markets can substantially increase our business and increases the value of our technology and brands.
We firmly believe that in the near future, light-based aesthetic treatments at home will be the standard. Palomar will be well positioned to exploit this new opportunity because of the investments we are making today.
We continue to execute our intellectual property enforcement strategy. To date, we have received approximately $88 million in royalty payments from this portfolio. The U.S. Patent Office issued reexamination certificate for our hair removal patents confirming the validity of the claims in those patents. We believe we are in a stronger position now than prior to that reexamination. We expected to go to trial against Candela by the end of 2011.
In the short-term, our business, like many others is being affected by the overall economy. We are starting to see some positive economic signs. Over the years we have successfully built our business and accumulated the assets needed for our company’s growth. We are expanding our product portfolio in the commercial markets and remain focused on investing in the long-term for research and development and we will continue to strengthen our intellectual property position.
We are working on penetrating the very large consumer products market with our first product in the very near term. We believe we are one of the best-positioned companies in our states for the next economic growth period.
Now, Paul will give us some more detail on financial performance for the quarter.
Paul Weiner
Thank you, Joe. Revenues for the quarter were $15.8 million as compared to $14.5 million for the same quarter last year, an 8% increase. Products and service revenues for the quarter were $13 million as compared to $11.2 million for the same quarter last year, a 16% increase and product revenues excluding service were $9.3 million as compared to $7.5 million, a 23% increase.
52% of products and service revenues were in North America and 48% were outside North America. This compares to the year ago quarter of 62% of products and service revenues in North America and 37% outside North America. Royalty revenues increased $1.5 million from $1.3. This increase is a good indicator that the industry has significantly strengthened since last year.
Other revenues include the $1.25 million quarterly payment from P&G related to the non-exclusive license to Palomar’s technology and patent portfolio in female consumer light-based hair removal. Products and service gross margin was 60% this quarter as compared to 57% in the same quarter last year.
As a percentage of worldwide products and service revenues, products and service gross margin was positively affected by higher product revenues, which resulted in higher overhead absorption. This growth in gross margin was offset by an increase in products and service revenues outside North America, but international sales are at lower distributor transfer prices as compared to end customer prices in North America. Average selling prices remain stable.
Research and development expense for the quarter was $3.5 million as compared to $3.2 million for the same quarter last year. Research and development as a percentage of total revenue remain constant at 22% this quarter, as compared to the same quarter last year. We continue to invest in the research and development of both our professional and consumer platforms, in an amount that is significantly higher than the industry average. This should allow us to remain the technology leader over both the short and long-term.
Selling and marketing expense for the quarter was $4.7 million as compared to $4.1 million for the same quarter last year. Selling and marketing as a percentage of total revenue was 30% this quarter, as compared to 28% for the same quarter last year.
General and administrative expense for the quarter was $4.3 million as compared to $2.5 million for the same quarter last year. General and administrative expense as a percentage of total revenues was 27% this quarter, as compared to 17% for the same quarter last year.
We incurred additional cost over last year of $1.4 million in patent litigation expense. G&A expense this quarter included $1.5 million in patent litigation products as compared to only $100,000 for the same quarter last year. The estimated patent litigation products are between $1 million and $1.5 million in the fourth quarter.
We also incurred additional costs over last year of $2.1 million in consumer commercialization spending. The estimated additional cost over last year related to commercialization of consumer products are between $1 million and $1.5 million in the fourth quarter.
Loss before taxes in this quarter was $2 million as compared to a loss before taxes of $176,000 in the same quarter last year. Net loss this quarter was $2 million or $0.11 per share, as compared to a net loss of $297,000 or $0.02 per share for the same quarter last year. This quarter’s loss over last year’s includes the additional $1.4 million in patent litigation expense and the $2.1 million in consumer commercialization spending.
The balance sheet is solid, with cash, cash equivalents, short-term investments and marketable securities of $102 million and no borrowings. We have been successful in maintaining our low accounts receivable days outstanding of 35.
We are now ready to take your questions. Operator.
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Fund Letters
