<PAGE>
U.S. Securities and Exchange Commission
Washington, D.C. 20549
Form 10-QSB
[ X ] QUARTERLY REPORT SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1998
-----------------
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
EXCHANGE ACT
Commission File Number 0-21537
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PACIFIC BIOMETRICS, INC.
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(Exact name of small business issuer specified in its charter)
Delaware 93-1211114
- --------------------------------------------------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
25651 Atlantic Ocean Drive, Suite A-1, Lake Forest, CA 92630
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(Address of principal executive offices)
949-455-9724
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(Issuer's telephone number)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months, and (2) has been
subject to such filing requirements for the past 90 days. Yes ( X ) No ( )
As of February 10, 1999, shares of common stock outstanding of the issuer were
3,709,671.
Transitional Small Business Disclosure Format (check one) Yes ( ) No ( X )
1
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PACIFIC BIOMETRICS, INC.
INDEX TO FORM 10-QSB
PART I - FINANCIAL INFORMATION
Page
----
ITEM 1 - FINANCIAL STATEMENTS
Consolidated Balance Sheet...................................................3
Consolidated Statements of Operations........................................4
Condensed Consolidated Statements of Cash Flows..............................6
Notes to Consolidated Financial Statements...................................8
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.........................................................12
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS..................................................19
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS..........................19
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES....................................19
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS...................................................19
ITEM 5 - OTHER INFORMATION..................................................19
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K...................................19
2
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
CONSOLIDATED BALANCE SHEET
December 31, 1998
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 368,131
Accounts receivable, net of allowance for doubtful
accounts of $24,035 235,928
Inventory 210,354
Prepaid expense and other 188,236
-----------
Total current assets 1,002,649
Property and equipment, net 591,303
Other assets:
Technology license, net 2,225,739
Prepaid financing costs 53,906
Restricted cash 100,000
Deposit and other 14,000
-----------
Total assets $ 3,987,597
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable to related parties $ 253,664
Accounts payable 332,532
Accrued liabilities 377,775
Deferred compensation 159,979
Advances from customers 44,330
Technology licenses payable 2,244,040
Capital lease obligations 270,300
-----------
Total current liabilities 3,682,620
-----------
Capital lease obligations - long term portion 220,671
-----------
Total long term liabilities 220,671
-----------
Stockholders' equity:
Preferred stock, $0.01 par value, 5,000,000 shares
authorized, 1,550,000 shares issued and outstanding 15,500
Common stock, $0.01 par value, 30,000,000 shares
authorized, 3,709,671 shares issued and outstanding 37,097
Additional paid-in capital Common Stock 13,638,869
Additional paid-in capital Preferred Stock 5,062,654
Deficit accumulated during the development stage (18,669,814)
-----------
Total stockholders' equity 84,306
-----------
Total liabilities and stockholders' equity $ 3,987,597
===========
The accompanying notes are an integral part of these consolidated
financial statements.
3
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Month Periods Ended December 31, 1998 and 1997
(unaudited)
Three Month Period
Ended December 31
-------------------------
1998 1997
---------- ----------
Revenues $ 329,274 $ 871,290
---------- ----------
Operating expenses:
Laboratory expense and cost of goods sold 267,109 732,635
Research and product development 242,921 549,806
Selling, general and administrative 534,523 522,501
Amortization of intangible assets 200,452 15,625
---------- ----------
Total operating expenses 1,245,005 1,820,567
---------- ----------
Operating loss (915,731) (949,277)
---------- ----------
Other income (expense):
Interest expense (66,095) (15,690)
Interest income 10,716 18,051
Grant and other income 4,112 5,861
---------- ----------
(51,267) 8,222
---------- ----------
Net loss $ (966,998) $ (941,055)
========== ==========
Basic and diluted loss per share $ (0.28) $ (0.25)
========== ==========
Number of shares used in per-share calculation 3,709,671 3,706,424
========== ==========
The accompanying notes are an integral part of these consolidated
financial statements.
4
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Six Month Periods Ended December 31, 1998 and 1997
and For the Period from Inception (December 1992) to December 31, 1998
(unaudited)
<TABLE>
<CAPTION>
Six Month Period For the Period
Ended December 31 from Inception
--------------------------- (December 1992) to
1998 1997 December 31, 1998
----------- ----------- ------------------
<S> <C> <C> <C>
Revenues $ 636,228 $ 1,509,637 $ 8,170,471
----------- ----------- ------------
Operating expenses:
Laboratory expense and cost of goods sold 584,057 1,127,315 6,257,417
Research and product development 752,762 1,012,040 5,391,427
Selling, general and administrative 1,113,912 962,286 7,256,462
Purchased in-process research and development 0 0 6,373,884
Amortization of intangible assets 400,904 31,250 1,423,926
----------- ----------- ------------
Total operating expenses 2,851,635 3,132,891 26,703,116
----------- ----------- ------------
Operating loss (2,215,407) (1,623,254) (18,532,645)
----------- ----------- ------------
Other income (expense):
Interest expense (135,954) (29,164) (529,735)
Interest income 22,916 81,457 314,380
Grant and other income 5,078 6,025 78,186
----------- ----------- ------------
(107,960) 58,318 (137,169)
----------- ----------- ------------
Net loss $(2,323,367) $(1,564,936) $(18,669,814)
=========== =========== ============
Basic and diluted loss per share $ (0.66) $ (0.42) $ (11.32)
=========== =========== ============
Number of shares used in per-share calculation 3,709,671 3,705,973 1,837,260
=========== =========== ============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
5
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Month Periods Ended December 31, 1998 and 1997
(unaudited)
Three Month Period
Ended December 31
-------------------------
1998 1997
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Cash used by operations $(498,524) (404,099)
Cash used in investing activities 0 (819,779)
Cash used by financing activities (76,041) (79,035)
----------- -----------
Decrease in cash and cash equivalents (574,565) (1,302,913)
Cash and cash equivalents:
Beginning of period 942,696 2,916,695
----------- -----------
End of period $ 368,131 1,613,782
=========== ===========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
6
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Month Periods Ended December 31, 1998 and 1997
and For the Period from Inception (December 1992) to December 31, 1998
(unaudited)
<TABLE>
<CAPTION>
Six Month Period For the Period
Ended December 31 from Inception
---------------------------- (December 1992) to
1998 1997 December 31, 1998
----------- ----------- -----------------
<S> <C> <C> <C>
Cash used by operations $(1,616,500) $(1,260,647) $(9,133,388)
Cash (used) provided in investing activities (35,493) 101,805 (261,055)
Cash (used) provided by financing activities (223,932) (475,379) 9,762,574
----------- ----------- -----------
Increase (Decrease) in cash and cash equivalents (1,875,925) (1,634,221) 368,131
Cash and cash equivalents:
Beginning of period 2,244,056 2,916,695 0
----------- ----------- -----------
End of period $ 368,131 $ 1,282,474 $ 368,131
=========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
7
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PACIFIC BIOMETRICS, INC.
(a company in the development stage)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
Pacific Biometrics, Inc. (the "Company" or "PBI") was incorporated in Delaware
in May 1996 in connection with the June 1996 acquisitions of BioQuant, Inc.
("BioQuant"), a Michigan corporation, and Pacific Biometrics, Inc. ("PBI-WA"), a
Washington corporation, whereby both became wholly-owned subsidiaries of the
Company.
The unaudited financial statements of the Company presented herein have been
prepared pursuant to the rules of the Securities and Exchange Commission for
quarterly reports on Form 10-QSB and do not include all of the information and
footnote disclosures required by generally accepted accounting principles. These
statements should be read in conjunction with the financial statements and notes
thereto for the year ended June 30, 1998 included in the Company's Annual Report
on Form 10-KSB. In the opinion of management, the financial statements include
all adjustments (consisting solely of normal, recurring adjustments) necessary
for a fair presentation of results for these interim periods.
Revenues are primarily from the laboratory business. The Company's
Osteopatch(TM) product is currently being prepared to launch in Europe, all
other potential products are in research and development, and no significant
revenues have been generated to date from products or potential products based
on Sweatpatch(TM) or SalivaSac(R) technology. Consequently, the Company is a
development stage enterprise.
2. Summary of Significant Accounting Policies
Technology
The Company has an exclusive worldwide license for the use of a transdermal
sweat collection device from Sudormed, Inc. ("Sudormed") for all applications of
such skin patch technology, except for those relating to alcohol and drugs of
abuse. In exchange for such license rights, the Company agreed to pay Sudormed
approximately $3 million over a twenty-month period, of which approximately
$928,000 has been paid through December 31, 1998. Such remaining payments
include a lump-sum payment of $1.6 million. The Company has renegotiated with
Sudormed to defer the due date on the $1.6 million and $360,000 in other
payments until March 31, 1999 (see Note 3). The license from Sudormed is still
fully in effect as of the date of this report, however, the Company risks
defaulting on the Sudormed license if it is unable to pay or renegotiate such
payments. The Company also owns a fully paid license to the assay technology
used with the Osteopatch(TM) product. The SalivaSac(R) is a proprietary patented
product of the Company.
8
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Risks and Uncertainties
The Company's products require approvals from the U.S. Food and Drug
Administration (FDA) and may require approval from international regulatory
agencies prior to commercialization. There can be no assurance that the
Company's products will receive any of the required approvals. If the Company
does not receive such approvals, such actions would have a material adverse
effect on the Company.
The Company's financial position also creates risks and uncertainties as
discussed below in Note 3 and puts the Company at risk of defaulting under the
Sudormed license.
3. Going Concern
The Company has experienced recurring losses from operations and cash flow
shortages, and has deficiencies in working capital and stockholders' equity.
Also, the Company has significant amounts of debt maturing on March 31, 1999.
These matters raise substantial doubt about the Company's ability to continue as
a going concern. Management's plans in regard to these matters are described
below. The consolidated financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
In view of the matters described in the preceding paragraph, recoverability of a
major portion of the recorded asset amounts shown in the accompanying balance
sheet is dependent upon continued operations of the Company, which in turn is
dependent upon the Company's ability to meet its financing requirements on a
continuing basis.
Management has taken the following steps to revise its operating and financial
requirements, which it believes are necessary to provide the Company with the
ability to continue in existence. These steps include significant reductions in
expenses and staffing, delay of research and development projects, renegotiation
of certain contractual commitments and engagement of firms to raise capital.
The Company does not anticipate that the Company's current cash and cash
equivalents and short-term investments, together with projected revenues from
operations and financing arrangements, will be sufficient to satisfy its
operating expense requirements beyond mid-March 1999. The Company is actively
working to raise additional funds through bridge financing, equity sales, debt
arrangements and product licensing agreements to cover current year liquidity
requirements. Failure to do so will have a material adverse effect on the
Company and its ability to continue to operate as currently contemplated (See
Management's Discussion and Analysis of Financial Condition and Results of
Operations).
9
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4. Earnings Per Share
As the Company had a net loss from continuing operations for the period ended
December 31, 1998, and 1997 and for the period from inception to December 31,
1998, basic and diluted net loss per share are the same.
Net loss applicable to common stockholders includes $62,000 and $124,000 in
cumulative dividends on the convertible preferred stock for the three and six
month periods ended December 31, 1998. The Company has not yet paid the
quarterly dividend due on January 1, 1999. The Company intends to make this
payment once additional funding has been arranged. The imputed dividends shown
in the Period from Inception are non-cash, one-time charges based on the
immediate conversion feature.
Basic and diluted net loss per common share for the Period from Inception and
the six month periods ended December 31, 1998 and 1997 were calculated as
follows:
<TABLE>
<CAPTION>
Six Month Six Month For the Period
Period Ended Period Ended from Inception
12/31/1998 12/31/1997 to 12/31/1998
----------------------------------------------------
<S> <C> <C> <C>
Net Loss $ (2,323,367) $ (1,564,936) $(18,669,814)
Preferred Stock cumulative dividend (124,000) 0 (194,093)
Imputed dividend on Preferred
Stock issued 0 0 (1,937,500)
------------ ------------ ------------
Net Loss applicable to
Common stockholders $ (2,447,367) $ (1,564,936) $(20,801,407)
============ ============ ============
Basic and diluted net loss per share $ (0.66) $ (0.42) $ (11.32)
============ ============ ============
Weighted average shares
outstanding 3,709,671 3,705,973 1,837,260
============ ============ ============
</TABLE>
5. Commitments and Contingencies
Technology and Manufacturing Agreements
The Company has also entered into a supply agreement with Sudormed (Note 2) that
requires certain minimum purchases to retain the exclusive use of the licensed
technology. As of December 31, 1998, all minimum purchase requirements had been
met. The Company is obligated to purchase 400,000 additional units by June 30,
1999 and each year thereafter. Failure to make the necessary purchases by the
Company or renegotiate the supply agreement could result in the technology
license becoming non-exclusive.
10
<PAGE>
Legal Proceedings
On September 24, 1997, the Company received from the former manufacturer of
SPINPRO(R) a demand for arbitration in connection with alleged breaches of the
contract relating to the manufacture of SPINPRO(R). The former manufacturer is
seeking damages of approximately $515,000. The Company does not believe that the
claims have any merit and believes that the ultimate outcome of this proceeding
will not have a material impact on the Company. The Company is contesting such
claims and has filed counterclaims against the former manufacturer. At this
time, an arbitration hearing has not been scheduled.
The Company has also filed for arbitration against a former vendor relating to
SPINPRO(R), seeking damages for alleged breach of contract with respect to the
manufacture of molds for SPINPRO(R) parts. Arbitration for this case has been
scheduled for July of 1999.
11
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the preceding consolidated financial statements and notes in this Form 10-QSB
and in conjunction with the financial statements and notes thereto for the year
ended June 30, 1998 included in the Company's Annual Report on Form 10-KSB.
Overview
PBI was incorporated in Delaware in May 1996 in connection with the acquisition
of BioQuant and PBI-WA. On June 28, 1996, the Company completed the mergers
whereby BioQuant and PBI-WA became wholly owned subsidiaries of the Company.
The mission of PBI is to develop and commercialize non-invasive technologies for
use in medical diagnostics and laboratory services to improve the detection and
management of chronic diseases. The Company has developed two patented platform
technologies that permit the use of sweat and saliva as diagnostic fluids. Such
platform technologies are based on fifteen issued U.S. patents and two pending
U.S. patents with respect to the Company's SweatPatch (TM) and SalivaSac(R).
Expenses consist, and are expected to continue to consist, primarily of
operating expenses necessary to continue the commercial laboratory operation
(the Company's only significant current source of revenue), research and
development costs for products under development, administration expenses and
payment of license and royalty fees to maintain the Company's intellectual
property rights.
As of December 31, 1998, the Company had an accumulated deficit since inception
of $18,669,814 which included one-time non-cash charges of $6.8 million incurred
prior to fiscal 1997.
Results of Operations:
Comparison of the three and six month periods ended December 31, 1998 and 1997:
- --------------------------------------------------------------------------------
Rounded to Nearest Three Six Comments on increase or decrease from
Thousand Dollars Months Months Fiscal 1998 to Fiscal 1999
- --------------------------------------------------------------------------------
Revenues:
Ended 12/31/98 $329 $636 Revenues for both quarters is almost
Ended 12/31/97 $871 $1,510 entirely comprised of laboratory service
$ variance ($542) ($873) revenue. Revenues were higher for the
% variance -62% -58% quarter ended 12/97 due to work
performed on a large contract that was
not replaced.
12
<PAGE>
Results of Operations (continued):
Comparison of the three and six month periods ended December 31, 1998 and 1997:
- --------------------------------------------------------------------------------
Rounded to Nearest Three Six Comments on increase or decrease from
Thousand Dollars Months Months Fiscal 1998 to Fiscal 1999
- --------------------------------------------------------------------------------
Laboratory expenses and cost of sales:
Ended 12/31/98 $267 $584 The decrease is related directly to the
Ended 12/31/97 $733 $1,127 decline in revenues, partially offset by
$ variance ($466) ($543) additions to capital equipment and
% variance -64% -48% relocation into a new facility.
Research and product development:
Ended 12/31/98 $243 $753 The decrease in the three-month periods
Ended 12/31/97 $550 $1,012 is due to curtailment of most R&D
$ variance ($307) ($259) programs. The lower costs in the
% variance -56% -26% six-month periods are partially offset
by the accrual of severance costs.
Selling, general and administration expenses:
Ended 12/31/98 $535 $1,114 The increase in expenses results
Ended 12/31/97 $523 $962 primarily from increased sales efforts
$ variance $12 $152 for laboratory operations and higher
% variance 2% 16% legal and auditing costs.
Amortization of intangible assets:
Ended 12/31/98 $200 $401 The increase is due to the inclusion of
Ended 12/31/97 $16 $31 non-cash amortization of the Sudormed
$ variance $185 $370 license.
% variance 1183% 1183%
Total other income (expense):
Ended 12/31/98 ($51) ($108) The additional net expense is due to
Ended 12/31/97 $8 $58 both the inclusion of imputed interest
$ variance ($59) ($166) on the Sudormed license obligation and
% variance -724% -285% on a decline in interest income.
Net loss:
Ended 12/31/98 ($967) ($2,323) Decreased revenue and new amortization
Ended 12/31/97 ($941) ($1,565) in the three-month periods is partially
$ variance ($26) ($758) offset by the decreases in R&D. The
% variance -3% -48% decrease in revenue and increase in
amortization exceeded the lower R&D for
the six-month periods.
13
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Liquidity and Capital Resources:
Prior Financing Activities
The Registration Statement pertaining to the initial public offering ("IPO") of
the Company's securities was declared effective by the Securities and Exchange
Commission on October 29, 1996. Gross proceeds from the public offering were
approximately $8.1 million. The Company has used the net proceeds from the
offering (approximately $6.3 million) for product development activities
relating to the Osteopatch(TM), for funding the growth of its central reference
laboratory operations, for research on SalivaSac(R) potential products, working
capital, and approximately $1.2 million to repay debt.
On February 20, 1998, the Company consummated the sale of 925,000 shares of
Series A Convertible Preferred Stock (the "Preferred Stock") with an
institutional investor for an aggregate purchase price of $1,850,000. In
addition, the Company granted such institutional investor an option (the
"Option") to purchase up to 625,000 shares of Preferred Stock until May 20, 1998
for an exercise price of $1,250,000. The Option was exercised in full during May
1998. The Company has not yet paid the quarterly dividend due on January 1, 1999
which continues to accrue until paid. The Company intends to make this payment
once additional funding has been arranged.
Operations
As of December 31, 1998 the Company had cash and cash equivalents of $368,000.
In addition, the Company's current liabilities exceeded its current assets.
During the quarter ended December 31, 1998, the Company's cash and cash
equivalents declined by approximately $575,000 from the prior quarter. This
represents a significant reduction from the average cash usage of over $1
million per quarter for the past four quarters prior to September 30, 1998.
The Company has implemented cost reduction programs that will permit existing
cash reserves to meet operating expense requirements through mid-March 1999.
These programs include: reducing staffing from 50 employees in May 1998 to 26
employees since October 1998, deferral of approximately $160,000 in
compensation, and suspension of current research and development activities
except for a 70-subject clinical trial focused on developing data to support the
use of the Company's SalivaSac(R) as a glucose screening device. The Company has
negotiated deferral of certain real estate lease and capital lease payments. In
addition, the Company has renegotiated the Sudormed license agreement to defer
the $1.6 million obligation and certain other payments of approximately $360,000
until March 31, 1999. Based on existing resources, the Company will be unable to
make such payments (see "Future Operations" below).
14
<PAGE>
In December 1997, the Company entered into the ActiMed Agreement, which provides
the Company with exclusive worldwide rights to ActiMed's patented analyte
detection technology in the field of saliva glucose testing. In conjunction with
the ActiMed Agreement, the Company has entered into a development program with
ActiMed, which the Company will fund on a mutually agreed budget by ActiMed and
the Company, and will pay ActiMed a royalty based on future sales of products
developed under this arrangement that use ActiMed's thin film and dye
technology. As part of the Company's cost reduction programs the Company has
temporarily ceased funding ActiMed's portion of the development program. ActiMed
has canceled the ActiMed Agreement as of February 18, 1999. The Company plans to
continue this development project once additional funding has been
arranged,however, there can be no assurance that the Company will be able to
resurect this relationship, in which case the Company would have to establish a
similar relationship with another Company, which in turn would delay development
of the Company's saliva glucose products during the period in which the Company
sought a replacement for ActiMed's technology.
Products and Services
On September 8, 1998 the Company announced it is seeking development partners
for new applications and marketing partners for existing products and products
under development utilizing its proprietary non-invasive collection
technologies, the SweatPatch(TM) and the SalivaSac(R). Several firms with
resources much greater than the Company's have expressed interest in the
Company's technology but at this time no formal agreements are pending.
On September 8, 1998 the Company also announced that Segix Italia S. p. A.
("Segix") exercised its option to enter into an exclusive ten year license,
supply and distribution agreement with the Company for the distribution of the
Osteopatch(TM) system in Italy. This agreement was finalized after the
successful market and technical evaluation of the Osteopatch(TM) system in Italy
during the past year. This agreement will permit Segix to launch the
Osteopatch(TM) system in Italy. If the Company were to lose its rights under the
Sudormed license agreement (see "Future Operations" below), Sudormed would have
the option (if Segix agrees) to continue to license to Segix directly.
However, Segix (or Sudormed as licensor) in order to use the Osteopatch(TM)
would still require the Company's Pyridinoline and/or Deoxypyridinoline Assay
Kit, which is covered by a fully paid exclusive license with Metra Biosystems,
Inc. Development of a separate assay would take considerable time and expense.
Segix placed their first significant order of approximately $124,000 in January
of 1999 and is planning a launch of the product in the first calendar quarter of
1999.
On September 14, 1998 the Company announced that BSI, Inc., the North American
Division of BSI, the world's leading registrar of quality management systems,
awarded the Osteopatch(TM) an Annex 5 CE marking certificate under the European
Medical Device
15
<PAGE>
Directive. The CE marking of the Osteopatch(TM) product allows the Company to
commercially distribute the Osteopatch(TM) system throughout the European common
market.
In February 1998 the Company completed the initial clinical trials for the
Osteopatch(TM), for the collection and analysis of bone resorption, an indicator
of fracture risk, and filed a 510(k) premarket notification with the U.S. Food
and Drug Administration (FDA). While the Company was encouraged by the results
of the clinical trials, the FDA will require additional information before this
product can be approved as a collection and analytical device for bone
resorption markers. The Company has been and expects to continue to work with
the FDA to determine which additional studies and information will be required
to support the approval process. Given the novelty of sweat as a diagnostic
fluid today, the Company believes this product application is establishing a
precedent for future applications of the SweatPatch(TM) technology and therefore
will require a more detailed review on the part of the FDA than originally
anticipated.
The additional studies required for resubmission to the FDA will not begin until
after appropriate funding has been raised by the Company and the clinical trial
design has been reviewed with the FDA. The Company estimates that completion of
such studies and resubmission will cost approximately $2.4 million. Once the
Company commences these trials, it is expected it will take at least nine to
twelve months before the Company can resubmit its application to the FDA. Based
on current capital requirements, without an immediate infusion of capital, the
Company will not be able to commence such trials. Further, even if commenced,
there can be no assurance that the Company will have sufficient resources to
complete such trials or that the FDA will not require further studies so as to
delay the Company's application, or that the FDA will ultimately approve the
Company's product.
Future Operations
If the Company is unable to renegotiate the scheduled March 31, 1999 payment of
$1.6 million or raise equity funding adequate to pay or finance the obligation,
it is at risk of losing the Sudormed license rights to the patch technology
(SweatPatch(TM)). Loss of such license would result in the abandonment of the
Osteopatch(TM) product and all research and development efforts relating to the
SweatPatch(TM) technology.
The Company is working to raise approximately $5 million in debt or equity. This
would permit the Company to maintain the Sudormed license and continue with the
Company's plans to develop non-invasive diagnostic products using both the
SweatPatch(TM) and SalivaSac(R) technologies and build the laboratory service
business. If the Company is unsuccessful in these efforts, the Company will
likely lose the SweatPatch(TM) license and will focus its efforts on the
laboratory service business and SalivaSac(R) licensing opportunities to fund its
operations.
16
<PAGE>
If the Company loses the Sudormed license and is absolved of its related payment
obligations, current liabilities would exceed current assets. Laboratory service
revenues would have to be increased and/or expenses would have to be reduced in
order to achieve self-sufficiency without additional funding. Therefore, without
additional outside funding the Company will not be able to meet its operating
expense requirements beyond mid-March 1999.
The Company is actively working to raise the funds mentioned above and
additional funds to cover longer-term requirements for product research and
development and laboratory operations.
In August 1998, the Company announced that it had retained R&R Capital Group to
assist in raising capital. The Company has terminated its relationship with R&R
Capital Group and is currently working with other groups to raise capital. There
can be no assurance that such external sources of funding will be available or
be available on terms acceptable to the Company, in which event, the Company
will be required to delay, scale back or eliminate its research and development
programs, including but not limited to the development of the Osteopatch(TM) and
other products involving the SweatPatch(TM) and the SalivaSac(R) technologies.
Alternatively, the Company may obtain funds through entering into arrangements
with collaborative partners or others that may require the Company to relinquish
rights, which may be substantial, to certain of its technologies or potential
products that the Company would not otherwise relinquish. Outside funding, if
available, will probably involve substantial dilution to existing stockholders
or changes in stockholder rights in order to raise the necessary additional
funds.
The Company has advised Nasdaq that for the period ended September 30, 1998, the
Company has fallen below the $2,000,000 in net tangible assets (total assets
minus total liabilities and goodwill) maintenance criteria for continued listing
of the Company's securities on the Nasdaq SmallCap Market. The Company also
received notice from Nasdaq that it is not in compliance with the $1.00 minimum
bid requirement with respect to its common stock and is not in compliance with
the two market maker requirements for the Company's publicly held warrants. The
Company has a hearing scheduled on February 26, 1999 with Nasdaq to present a
plan for regaining compliance with Nasdaq listing requirements and request
continued listing of the Company's warrants and common stock.
In the event of Nasdaq's delisting the Company's securities, trading, if any, in
the Company's securities may then continue to be conducted on the OTC Electronic
Bulletin Board or in the non-Nasdaq over-the-counter market. As a result, an
investor may find it more difficult to purchase, sell, or to obtain accurate
quotations as to the market value of the Company's securities and it could
become more difficult for the Company to raise capital.
17
<PAGE>
Future Operations - Year 2000
As a supplier of laboratory services, readiness for the Year 2000 is critical to
our customers. The Company's Year 2000 Compliance Team is working to ensure that
all our systems are compliant in advance of the turn of the century. We have
been addressing Year 2000 compliance since the latter part of calander year
1997.
Our basic systems: hardware platform and network operating system are compliant
as per their manufacturers. Our accounting system is warrantied by the
manufacturer as compliant. Our database engine for our Laboratory Information
System (LIS) and Proficiency Testing (PT) System is compliant per its
manufacturer.
Our LIS and PT application software has been analyzed by our programmers and we
have found no compliance issues. For added assurance, end-user functional
testing is in progress. This is being performed on a mirror duplicate system
that can be advanced to the year 2000 and beyond. The main cost involved in our
Year 2000 compliance is the time and effort of our programming and support
staff.
We are in the midst of the final part of our plan which includes obtaining Year
2000 compliance status from our vendors (reagent suppliers, instrument
manufacturers, shipping companies, etc.) and developing contingency plans in the
event any problems arise (i.e. alternate suppliers/shippers).
In summary, the Company has audited its internal systems, finding no significant
compliance issues. We are presently addressing the problem of a potential
"ripple effect", that is, how Year 2000 problems with external systems/suppliers
may affect us and our ability to deliver our services.
While the Company believes its planning efforts are adequate to address its year
2000 concerns, there can be no assurance that the systems and products of other
companies on which the Company's operations rely and interact with will be
compliant and will not have a material adverse effect on the Company's results
of operations.
18
<PAGE>
PART II - OTHER INFORMATION
ITEM 1 - Legal Proceedings
The Company is not a party to any material legal proceedings. However, on
September 24, 1997 the Company received from the former manufacturer of
SPINPRO(R) a demand for arbitration in connection with alleged breaches of the
contract relating to the manufacture of SPINPRO(R). The former manufacturer is
seeking damages of approximately $515,000. The Company does not believe that the
claims have any merit and believes that the ultimate outcome of this proceeding
will not have a material impact on the Company. The Company is contesting such
claims and has filed counterclaims against the former manufacturer. At this
time, an arbitration hearing has not been scheduled.
The Company has also filed for arbitration against a former vendor relating to
SPINPRO(R), seeking damages for alleged breach of contract with respect to the
manufacture of molds for SPINPRO(R) parts. Arbitration for this case has been
scheduled for July of 1999.
ITEM 2 - Changes in Securities and Use of Proceeds - Not Applicable.
ITEM 3 - Defaults upon Senior Securities - Not Applicable.
ITEM 4 - Submission of Matters to a Vote of Security Holders - Not Applicable.
ITEM 5 - Other Information - Not Applicable.
ITEM 6 - Exhibits and Reports on Form 8-K
(a) (27.1) Financial Data Schedule.
(b) On December 23, 1998, the Company filed a Current Report on Form 8-K
with respect to the notification from Nasdaq of its intention to
delist the Company's Common Stock and the Company's request for a
hearing relating thereto.
19
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Dated: February 17, 1999
\s\ Paul G. Kanan President and Chief Executive
- ----------------------------------- Officer
Paul G. Kanan
\s\ Peter B. Ludlum Vice President and Chief Financial
- ----------------------------------- Officer (Principal Financial and
Peter B. Ludlum Accounting Officer)
20
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