<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 19, 1997
REGISTRATION NO. 333-37441
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM SB-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
MEDICAL SCIENCE SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
TEXAS 8099 94-3123681
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER)
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
4400 MACARTHUR BOULEVARD, SUITE 980
NEWPORT BEACH, CALIFORNIA 92660
(714) 440-9730
(ADDRESS AND TELEPHONE NUMBER OF PRINCIPAL EXECUTIVE OFFICES)
PAUL J. WHITE
PRESIDENT AND CHIEF EXECUTIVE OFFICER
MEDICAL SCIENCE SYSTEMS, INC.
4400 MACARTHUR BOULEVARD, SUITE 980
NEWPORT BEACH, CALIFORNIA 92660
(714) 440-9730
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE OF PROCESS)
THE COMMISSION IS REQUESTED TO SEND COPIES OF ALL COMMUNICATION TO:
CHRISTOPHER A. WILSON, ESQ.
DANIEL J. TANGEMAN, ESQ.
JEFFERS, WILSON, SHAFF & FALK, LLP
18881 VON KARMAN AVENUE, SUITE 1400
IRVINE, CALIFORNIA 92612
(714) 660-7700
WILLIAM M. PRIFTI, ESQ.
LYNNFIELD WOODS OFFICE PARK
220 BROADWAY
SUITE 204
LYNNFIELD, MASSACHUSETTS 01940
(781) 593-4525
APPROXIMATE DATE OF PROPOSED SALE TO THE PUBLIC: As soon as possible after the
effective date.
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
CALCULATION OF REGISTRATION FEE
<TABLE>
<S> <C> <C> <C> <C>
============================================================================================================
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE PER AGGREGATE OFFERING AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED SHARE PRICE(1) REGISTRATION FEE
- ------------------------------------------------------------------------------------------------------------
Common Stock, no par
value..................... 2,600,000 $ 9.00 $23,400,000 $ 7,091
Underwriters' Warrants(2)... 260,000 $ .001 $ 260 $ 0(3)
Common Stock, no par
value(4).................. 260,000 $14.85 $ 3,861,000 $ 1,170
Common Stock, no par
value(5).................. 390,000 $ 9.00 $ 3,510,000 $ 1,064
Total.............. $ 9,325(6)
============================================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee, pursuant
to rule 457(a) and (g) under the Securities Act.
(2) To be sold to the Representatives of the Underwriters.
(3) None pursuant to Rule 457(g).
(4) Issuable upon exercise of the Underwriters' Warrants.
(5) Issuable upon exercise of the Underwriters' option to purchase to cover
over-allotments, if any.
(6) $8,966 has previously been paid.
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.
================================================================================
<PAGE> 2
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE. WE MAY NOT SELL THESE
SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SEC IS
EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT SEEKING AN
OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER OR SALE IS NOT
PERMITTED.
SUBJECT TO COMPLETION, DATED NOVEMBER 19, 1997
Initial Public Offering
Prospectus
[MEDICAL SCIENCE SYSTEMS LOGO]
2,600,000 shares of Common Stock
$8 to $9 per share
Medical Science Systems, Inc.
4400 MacArthur Boulevard
Suite 980
Newport Beach, California 92660
(714) 440-9730
THE OFFERING*
<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----------
<S> <C> <C>
Public Price........... $9.00 $23,400,000
Underwriting
discounts........... $ .72 $ 1,872,000
Proceeds to Company.... $8.28 $21,528,000
</TABLE>
- ---------------
*Assumes a $9 per share offering price.
We develop genetic tests which
indicate whether a person is more
likely to develop or will be more
severely affected by certain common
diseases which are treatable and
preventable. We recently began
marketing our initial test related to
periodontitis (gum disease). Provided
that our clinical trials continue to
produce favorable results, we intend
to commence marketing our other
genetic tests which indicate
susceptibility to osteoporosis (bone
disease), coronary artery disease
(heart disease) and diabetic
retinopathy (blindness associated with
diabetes) in 1998 and 1999.
Proposed Trading Symbol
NASDAQ NATIONAL MARKET(R) -- MSSI
This Investment Involves a High Degree of Risk.
Please Refer to "Risk Factors" Beginning on Page 9.
The Securities and Exchange Commission (SEC) and state securities regulators
have not approved these securities or determined if this prospectus is truthful
or complete. Any representation to the contrary is a criminal offense and should
be reported immediately to the SEC by calling 1-800-SEC-0330.
Nutmeg Securities, Ltd.
Millennium Financial Group, Inc.
<PAGE> 3
[Pictorial Depiction of Biological and Behavioral Risk Factors Contributing to
Disease Progression]
Our website is located at http://www.medscience.com.
This prospectus includes names and marks which we believe to be trademarks or
servicemarks of third parties. We have no ownership interest in any of the
intellectual property indicated by the trademark or servicemark symbols of third
parties referenced in this prospectus.
Upon the effective date of the registration statement, of which this prospectus
is a part, our company will become a reporting company. Thereafter, we intend to
distribute to our shareholders annual reports containing audited financial
statements. We will also make available copies of quarterly reports for the
first three quarters of each fiscal year containing unaudited interim financial
information.
Certain persons who participate in this offering may engage in transactions that
stabilize, maintain or otherwise affect the price of the Shares, including
purchases of the Shares to maintain their market price or purchases to cover
some or all of the Underwriters' short position in the Shares.
<PAGE> 4
MEDICAL SCIENCE SYSTEMS, INC. PROSPECTUS
INTRODUCTION
Please read this prospectus carefully. It describes our company, finances and
products. Federal and state securities laws require that we include in this
prospectus all the important information that investors will need to make an
investment decision.
You should rely only on the information contained in this prospectus to make
your investment decision. We have not authorized anyone to provide you with
information that is different from what is contained in this prospectus.
TABLE OF CONTENTS
<TABLE>
<S> <C>
Summary......................... 1
Risk Factors.................... 9
The Company..................... 17
Use of Proceeds................. 18
Dividend Policy................. 19
Capitalization.................. 19
Dilution........................ 20
Selected Financial Data......... 21
Management's Discussion and
Analysis of Financial
Condition and Results of
Operations................... 22
Business........................ 25
Management...................... 46
Certain Relationships and
Related Party Transactions... 52
Principal Shareholders.......... 53
Description of Securities....... 54
Shares Eligible for Future
Sale......................... 55
Underwriting.................... 57
Legal Matters................... 58
Experts......................... 58
Additional Information.......... 58
Index to Financial Statements... F-1
</TABLE>
<PAGE> 5
MEDICAL SCIENCE SYSTEMS, INC. Summary
ABOUT OUR COMPANY
Our company has developed genetic tests which indicate whether an
individual is genetically more likely to be affected or more
severely affected by certain common diseases which are treatable
and preventable. We have focused on four diseases initially:
periodontitis (gum disease), osteoporosis (bone disease), coronary
artery disease (heart disease) and diabetic retinopathy (blindness
associated with diabetes). We have identified several genetic
markers which, if present in a patient, increase the probability
that such patient will be affected by the disease or that the
disease will be more severe. Moreover, we are the only company that
we know of that has brought to market a test (our periodontal
susceptibility test) that identifies a genetic marker which
indicates a greater susceptibility to a disease which is treatable
and preventable.
Our company's ability to identify genetic markers related to common
diseases is enhanced by a strategic alliance with Sheffield
University. Sheffield University provides us with access to
critical biotechnology research in molecular genetics. This
arrangement helps provide for the development of additional genetic
testing products in the future and reduces our capital costs
relative to biotechnology firms that support large in-house
research programs. See "Competitive Advantages" at page 42.
We have ten (10) patent applications pending, including
applications covering each of our four genetic susceptibility
tests. We have also been issued one patent related to our computer
modeling technology. In June 1997, the United States Patent and
Trademark Office notified us that the patents for our periodontal
and osteoporosis susceptibility tests are expected to issue. While
the issuance of those patents is likely, the Patent and Trademark
Office could disallow the patents at any time prior to the actual
issue date. See "Intellectual Property" at page 40.
MISSION
Our mission is to improve patient care and treatment outcomes by
incorporating genetic information about a patient's susceptibility
to disease into overall risk assessment and treatment planning. We
believe that doctors and dentists will use our genetic
susceptibility tests to assess the risk involved for any particular
patient and to adopt appropriate treatments or therapy, including
preventive measures.
1
<PAGE> 6
Summary (con't)
PRODUCTS AND SERVICES
PERIODONTAL SUSCEPTIBILITY TEST
- Description. Our periodontal susceptibility test is a
genetic test capable of detecting individuals with an
increased susceptibility to developing severe gum
disease (periodontitis). Periodontitis is a
bacterially-induced chronic inflammation that destroys
the collagen fibers and bone that support the
teeth -- ultimately resulting in tooth loss.
- Market. According to industry data, in the United
States alone, an estimated one-third of all adults, or
67 million people, suffer from some form of
periodontitis. Approximately 13 million people seek
professional treatment annually for periodontal
disease, resulting in over 17 million periodontal
procedures and annual expenditures of approximately $6
billion. Because of the great prevalence of
periodontitis, we believe that a substantial portion
of the United States' population receiving dental care
will be our initial target market.
- Launch. On October 3, 1997, we commercially launched
our periodontal susceptibility test at the American
Academy of Periodontology's Annual Meeting in San
Diego, California.
OSTEOPOROSIS SUSCEPTIBILITY TEST
- Description. Our osteoporosis susceptibility test is
a genetic test capable of detecting individuals with
an increased susceptibility to developing
osteoporosis. Osteoporosis is a disease which causes a
decrease in the amount of normal bone, making the
affected individual more susceptible to fractures.
- Market. According to industry data, in the United
States alone, an estimated 28 million people, suffer
from osteoporosis. Post-menopausal osteoporosis,
stemming from the loss of estrogen, affects more than
one-half of all women over 65 years of age and has
been detected in as many as 90% of the women over age
75. Osteoporosis is responsible for a majority of the
1.5 million bone fractures each year and leads to
disabilities costing more than $10 billion in medical,
social and nursing home costs.
- Launch. We have confirmed the results of our initial
trials which demonstrated a relationship between a
certain genetic marker and an individual's likelihood
to develop or be more severely affected
2
<PAGE> 7
Summary (con't)
by osteoporosis. We are currently gathering
information on the clinical utility of our
osteoporosis susceptibility test. Provided that our
clinical trials continue to produce favorable results,
we anticipate commercially launching this test in late
1998. See "Pre-Marketing Trials/Status of
Susceptibility Tests" at pages 35 and 36; "Difficulty
of Developing Genetic Susceptibility Tests" at page
10.
CORONARY ARTERY DISEASE SUSCEPTIBILITY TEST
- Description. Our coronary artery disease
susceptibility test is a genetic test capable of
detecting individuals with an increased susceptibility
to developing coronary artery disease (or "CAD"). CAD
is a condition where the arteries that supply blood to
the heart have become partially obstructed by plaque
accumulation. CAD results in heart attacks due to
damage to the heart muscle when blood supply (and
therefore oxygen) is cut off and heart muscle cells
die. An individual testing positive under our CAD
susceptibility test has between a 2.4 to 5.4 times
greater change of developing coronary artery disease
than the general population.
- Market. More than one in four Americans, or about 60
million, now have some form of cardiovascular disease.
Cardiovascular diseases kill nearly one million
Americans every year. Every year since 1919,
cardiovascular disease has been the number one cause
of death in the United States. Approximately 13.5
million Americans suffer from coronary artery disease,
and approximately half a million Americans die each
year from this disease.
- Launch. We have confirmed the results of our initial
trials which demonstrated a relationship between a
certain genetic marker and an individual's likelihood
to develop or be more severely affected by coronary
artery disease. We are currently gathering information
on the clinical utility of our coronary artery disease
test. Provided that our clinical trials continue to
produce favorable results, we anticipate commercially
launching this test sometime in 1999. See
"Pre-Marketing Trials/Status of Susceptibility Tests"
at pages 35 and 36; "Difficulty of Developing Genetic
Susceptibility Tests" at page 10.
DIABETIC RETINOPATHY SUSCEPTIBILITY TEST
- Description. Our diabetic retinopathy susceptibility
test is a genetic test capable of detecting diabetic
individuals who have an increased susceptibility to
developing sight-threatening retinopathy. Diabetic
retinopathy refers to diabetic complications
3
<PAGE> 8
Summary (con't)
affecting the retina that predictably lead to severe
vision loss or even blindness.
- Market. In the United States there are approximately
16 million people suffering from diabetes. It is
estimated that only one-half of this number have been
diagnosed. Diabetic retinopathy is one of the most
common complications of diabetes. It is the fourth
leading cause of legal blindness in the U.S. and the
leading cause of blindness in people ages 20 to 74.
Each year 15,000 to 39,000 people lose their sight
from diabetic retinopathy.
- Launch. We are currently confirming the results of
our initial trials which demonstrated a relationship
between a certain genetic marker and a diabetic
individual's likelihood to develop diabetic
retinopathy. Upon completion of the confirmatory
trials more information will be gathering regarding
the clinical utility of the diabetic retinopathy test.
Provided that our confirmatory and subsequent clinical
trials produce favorable results, we anticipate
commercially launching this test sometime in 1999. See
"Pre-Marketing Trials/Status of Susceptibility Tests"
at pages 35 and 36; "Difficulty of Developing Genetic
Susceptibility Tests" at page 10.
COST OF PRODUCTS AND SERVICES
We have recently commercially launched our periodontal
susceptibility test and are marketing the test at $210 per test.
Although we cannot be certain, we anticipate that the remainder of
our genetic susceptibility tests will be marketed at a price
between $200 and $250. Final pricing of these other tests will be
determined at the time of commercial launch. We anticipate our
direct cost (exclusive of sales and marketing) on a per test basis
to be between $45-$80 depending primarily upon volume
considerations.
RISKS OF INVESTING
An investment in our company is subject to many risks. We
summarize some of the most serious risks below. A more detailed
list of the risk factors is found under "Risk Factors" at page 9.
You should read and understand all risk factors before making your
decision to invest.
- Uncertainty of Market Acceptance for Genetic
Susceptibility Tests. Consumers may not accept our
current genetic susceptibility tests or others in
development or may accept the tests much later than we
anticipate.
- New Business Venture. Our genetic susceptibility
testing business is relatively new and may be affected
significantly by
4
<PAGE> 9
Summary (con't)
unknown economic and market conditions over which we
have no control.
- History of Operating Losses; Accumulated Deficit;
Uncertainty of Future Profitability. Our company
incurred a net loss of $788,546 in 1996 and
anticipates a net loss of approximately $4.0 million
in 1997. As of September 30, 1997, our accumulated
deficit was approximately $3.91 million. It is
uncertain when we will become profitable.
- Intense Competition. Our company faces intense
competition related to the discovery and use of
disease predisposing genes and genetic markers. Even
after our discovery of the genetic markers, our
competition may find and patent the same markers
before we do or may find other markers for the same
diseases. Additionally, our competitors may have
greater resources enabling them to more effectively
market their discoveries.
- Difficulty of Developing Genetic Susceptibility
Tests. It is uncertain whether we will be successful
in bringing our complete portfolio of tests to market.
Even after identifying a genetic marker, many
additional trials must be run in order to verify and
confirm the test's accuracy and utility. Any delay in
clinical trials or negative clinical results could
slow or prevent our ability to successfully market our
tests.
- Uncertainty of Insurance Reimbursement. It is
uncertain whether insurers and third-party payors will
elect to reimburse patients for the cost of the
genetic susceptibility tests. If insurers or
third-party payors elect not to reimburse patients, it
is uncertain whether individuals will elect to pay
directly for our tests.
- Reliance on Collaborative Partners. We have a
collaborative research relationship, evidenced by an
exclusive worldwide agreement, with the Section of
Molecular Medicine at Sheffield University.
Additionally, we have entered into agreements with
Sheffield University governing each of our individual
tests. If these agreements were terminated, we would
need to enter into additional collaborative
arrangements in order to continue to build a future
pipeline of new products.
- Uncertain Ability to Protect Proprietary
Technology. The patent position of biotechnology
companies generally is highly uncertain and involves
complex legal and factual questions. Although initial
approvals have been granted by the Patent and
Trademark Office with respect to some of our tests,
certain of our patent
5
<PAGE> 10
Summary (con't)
applications may be rejected. Even when patents are
issued, the claims of any issued patents may not
provide meaningful protection for our technology or
products. Others may develop similar products which
test for susceptibility related to the same diseases
yet avoid infringing upon, or conflicting with, our
anticipated patents. In addition, there can be no
assurance that any patents issued to us will not be
challenged, and subsequently narrowed, invalidated or
circumvented.
- Technological Changes Resulting in Product
Obsolescence. It is possible that our competitors
will develop technologies more effective than those
contained or used in our products. Our competitors
could develop new products which make our products
less competitive or obsolete.
- Limited Marketing or Sales Experience. We have
limited experience in developing and commercially
marketing our genetic susceptibility testing services.
6
<PAGE> 11
Summary (con't)
PAST FINANCIAL HISTORY
The following graph depicts our revenues and net income or
loss for each of the last three fiscal years. Our financial results
are described in more detail under "Management's Discussion and
Analysis of Financial Condition and Results of Operations" at page
22. Audited financial statements are included beginning at page
F-1.
[NET INCOME AND REVENUES GRAPH]
7
<PAGE> 12
Medical Science Systems, Inc. Summary (con't)
KEY FACTS
SHARES OFFERED TO THE PUBLIC:
2,600,000 Shares
OVER-ALLOTMENT OPTION:
Up to 390,000 Shares (not included in 2,600,000)
TOTAL SHARES OUTSTANDING PRIOR TO OFFERING:
3,738,007 Shares
TOTAL SHARES OUTSTANDING AFTER OFFERING:
6,338,007 Shares (assuming no exercise of the over-allotment option)
TOTAL SHARES OUTSTANDING AFTER OFFERING AND EXERCISE OF ALL OPTIONS/WARRANTS:
7,755,131 Shares
PRICE PER SHARE TO PUBLIC:
$9.00 per share
TOTAL PROCEEDS RAISED BY OFFERING:
$23,400,000
UNDERWRITERS' FEES:
$1,872,000/8% of the total proceeds plus a 3% non-accountable expense allowance
EXPENSES OF THE OFFERING:
$355,000
NET PROCEEDS:
$20,471,000
USE OF PROCEEDS:
Marketing, sales, customer service and
commercialization expenses; research and
development activities; capital investment; repayment
of bridge loans; and working capital and general
corporate purposes.
UNDERWRITERS' WARRANTS:
Underwriters will receive warrants to purchase 260,000 Shares at an exercise
price of $14.85 exercisable for five (5) years.
AVERAGE PRICE PER SHARE PAID BY CURRENT
SHAREHOLDERS:
$0.59
NET TANGIBLE BOOK VALUE:
$(1,725,016)
NET TANGIBLE BOOK VALUE PER SHARE BEFORE
DILUTION:
$(0.46)
NET TANGIBLE BOOK VALUE PER SHARE AFTER DILUTION:
$2.96
MARKET:
Nasdaq National Market(R) -- MSSI
DIVIDEND POLICY:
No Dividends Expected
UNDERWRITING:
Firm Commitment
8
<PAGE> 13
RISK FACTORS
The shares of Common Stock offered by this Prospectus are speculative and
involve a high degree of risk of loss. Prior to making an investment, you should
carefully read this entire Prospectus and consider the following risk and
speculative factors:
UNCERTAINTY OF MARKET ACCEPTANCE FOR GENETIC SUSCEPTIBILITY TESTS
The commercial success of our genetic susceptibility tests and those that
we may develop will depend upon their acceptance as medically useful and
cost-effective by patients, physicians, dentists, other members of the medical
and dental community and insurers. Broad market acceptance can be achieved only
with substantial education about the benefits and limitations of such tests. We
expect to expend substantial financial resources to effectively promote the
benefits of our genetic susceptibility tests and those that we may develop. We
intend to expend significant resources on educating medical and dental
caregivers, policymakers, patients, insurers and others. It is uncertain whether
current genetic susceptibility tests or others that we may develop will gain
market acceptance on a timely basis. If patients, dentists and physicians do not
accept our tests, or take a longer time to accept than we anticipate, then our
revenues and profit margins may be reduced and may result in losses. See
"Uncertainty of Insurance Reimbursement" at page 10.
NEW BUSINESS VENTURE
The securities being offered by us are subject to the risks inherent in any
new business venture. Although we have operated as a contract research firm
since 1986, we have limited experience and a short history of operations with
respect to marketing and selling susceptibility tests or therapeutics. We have
had only minimal revenues related to the sale of our genetic susceptibility
testing services. With the exception of our periodontal susceptibility test, the
genetic susceptibility tests anticipated to be sold by us have not yet been
finally designed, developed, tested or marketed. Therefore, there can be no
assurance that we will be able to complete these genetic susceptibility tests,
that those tests will be accepted in the marketplace, or that the tests can be
sold at a profit. Our business may also be affected significantly by economic
and market conditions over which we have no control. Consequently, an investment
in our Common Stock is highly speculative. We do not guarantee any return on an
investment in our Common Stock.
HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE
PROFITABILITY
We incurred a net operating loss of $788,546 in fiscal year 1996. We
anticipate a net loss of approximately $4.0 million in 1997. As of September 30,
1997, our accumulated deficit was $3,913,577. Our losses have resulted
principally from expenses incurred in research and development and from selling,
general and administrative expenses. These expenses have exceeded our revenues.
We have yet to generate any significant revenues from the sale of our genetic
susceptibility testing services and there can be no assurance that we will be
able to generate significant revenues in the future. We expect our operating
losses to continue for the near future as our research and development, sales
and marketing activities and operations continue. Our ability to achieve
profitability depends on our ability to develop our sales and marketing capacity
and our ability to successfully market and sell our products and services. It is
uncertain when we will become profitable. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations" at page 22.
INTENSE COMPETITION
Research in the field of disease predisposing genes and genetic markers is
intense and highly competitive. Genetic research is characterized by rapid
technological change. Our competitors in the United States and abroad are
numerous and include, among others, major pharmaceutical and diagnostic
companies, specialized biotechnology firms, universities and other research
institutions (including those receiving funding from the Human Genome Project).
Many of our potential competitors have considerably greater financial,
technical, marketing and other resources than us. These greater resources may
allow our competitors to discover important genes or genetic markers before us.
If we, in conjunction with the Department of Molecular and Genetic Medicine at
the University of Sheffield, U.K., do not discover disease predisposing
9
<PAGE> 14
genes or genetic markers associated with increased disease severity,
characterize their function, develop susceptibility tests and related
information services based on such discoveries, obtain regulatory and other
approvals, if needed, and launch such services or products before competitors,
then our revenues and earnings will be reduced or eliminated. In addition, any
of the susceptibility tests that we may develop, including our periodontal
susceptibility test, could be made obsolete by less expensive or more effective
tests or methods which may be developed in the future. We expect competition to
intensify in our industry as technical advances are made and become more widely
known. See "Uncertain Ability to Protect Proprietary Technology" at page 11,
"Competition" at page 41 and "Intellectual Property" at page 40.
DIFFICULTY OF DEVELOPING GENETIC SUSCEPTIBILITY TESTS
It is uncertain whether we will be successful in developing and bringing to
market our current portfolio or future tests based on the genetic discoveries
made by us and our collaborators. Even when we discover a genetic marker (i.e.,
a genetic variation or polymorphism associated with increased disease incidence
or severity), additional clinical trials need to be conducted to confirm the
initial scientific discovery and to support the scientific discovery's clinical
utility in the marketplace. The results of a clinical trial could delay, reduce
the test's acceptance or cause our company to cancel a program. Such delays,
reduced acceptance or cancellations would reduce revenues and may result in
losses.
UNCERTAINTY OF INSURANCE REIMBURSEMENT
Our ability to successfully commercialize existing genetic susceptibility
tests and others that we may develop depends in part on obtaining adequate
reimbursement for such testing services and related treatments from government
and private health care insurers (including health maintenance organizations)
and other third-party payors. Physicians' and dentists' decisions to recommend
genetic susceptibility tests, as well as patients' elections to pursue testing,
are likely to be heavily influenced by the scope and extent of reimbursement for
such tests by third-party payors. Government and private third-party payors are
increasingly attempting to contain health care costs by limiting both the extent
of coverage and the reimbursement rate for new testing and treatment products
and services. In particular, services which are determined to be investigational
in nature or which are not considered "reasonable and necessary" for diagnosis
or treatment may be denied reimbursement coverage. To date, few insurers or
third-party payors have agreed to reimburse patients for genetic susceptibility
tests. As a result, we initially expect to bill patients directly for the
genetic susceptibility tests.
It remains uncertain whether insurers or third-party payors will elect to
provide full reimbursement coverage for the genetic susceptibility tests in the
near future. If adequate reimbursement coverage is not available from insurers
or third-party payors, it is uncertain whether individuals will elect to
directly pay for the test. If both insurers or third-party payors and
individuals are unwilling to pay for the test, then the number of tests
performed will be significantly decreased. Such a scenario would result in
reduced revenues and possible losses.
RELIANCE ON COLLABORATIVE PARTNERS
In 1994 we entered into a strategic alliance with the Section of Molecular
Medicine at Sheffield University, a world leader in the genetic aspects of
common diseases with an inflammatory component. In 1996 we formalized our
relationship by entering into an exclusive worldwide agreement (the "Master
Agreement"). Under the terms of the Master Agreement, we will undertake the
development and commercialization of any discoveries resulting from the research
of Section of Molecular Medicine at Sheffield University. In exchange, Sheffield
University will receive a share of the resultant net profits, with the
percentage of net profits for us and Sheffield University agreed upon separately
under project agreements related to each test (each a "Project Agreement"). Our
share of the net profits under such Project Agreements ranges from 50% to 67%.
The Master Agreement may be terminated with or without cause by either party
upon six-months notice. Although termination does not affect any existing
Project Agreements, any termination would limit or eliminate our access to
future Sheffield University genetic discoveries that fall outside of the scope
of our existing Project Agreements.
10
<PAGE> 15
The Project Agreements (excluding the agreement covering the periodontal
test which has no fixed termination date) each have a ten-year term, commencing
in September 1996, which is automatically renewed for one-year periods unless
terminated by either party upon a six month's prior notice. The Project
Agreements may be terminated: (i) by mutual agreement, (ii) by either party 30
days after an uncured breach or default by the other party; (iii) by either
party upon certain events of bankruptcy; and (iv) by our company if Professor
Gordon Duff ceases to be an employee of, or head of the Section of Molecular
Medicine at Sheffield University. In the case of mutual agreement to terminate,
or in the case of our terminating a Project Agreement prior to the end of the
ten-year term, net profits would be reallocated by mutual agreement in light of
the continued responsibilities between the parties. However, Sheffield
University's share of the net profits would not be allowed to fall below ten
percent (10%) in such an instance. If the Master Agreement or any of the Project
Agreements were terminated, we would need to enter into additional collaborative
arrangements in order to continue to build a future pipeline of products.
In the future we may, in order to facilitate the sale of our testing
services and/or products, enter into collaborative selling arrangements with one
or more other persons. It is uncertain whether we will be able to negotiate
acceptable collaborative arrangements in the future or that such collaborative
arrangements will be successful. If we are unable to identify collaborative
partners to sell certain of our services and/or products, we may be forced to
develop an internal sales force to market and sell our services and/or products
in markets where we are not intending on developing a direct selling presence.
Such a process would take more time and potentially cost more. As a result, our
revenues and earnings would be reduced. If we do enter into collaborative
selling arrangements, our success will depend upon the efforts of others and may
be beyond our control. Failure of any collaborative selling arrangement could
result in reduced revenues and possible losses.
UNCERTAIN ABILITY TO PROTECT PROPRIETARY TECHNOLOGY
Our success will partly depend on our ability to obtain patent protection,
both in the United States and in other countries, for our products and services.
In addition, our success will also depend upon our ability to preserve our trade
secrets and to operate without infringing the proprietary rights of third
parties.
We have ten (10) patent applications pending, including applications
covering each of our four genetic susceptibility tests. In June 1997, a Notice
of Allowance was issued by the United States Patent and Trademark Office with
respect to the patent applications for both our periodontal and osteoporosis
susceptibility tests. A Notice of Allowance is granted by the Patent and
Trademark Office, if, on examination of the application, the patent application
is found to be allowable. Thereafter a fee for issuing the patent is due within
three months from the date of the Notice of Allowance. When the issue fee is
paid, the patent issues as soon as possible after the date of payment, dependent
upon the backlog of patents at the Patent and Trademark Office. The patent is
then delivered or mailed on the day of its grant, or as soon thereafter as
possible. We paid the issue fee related to the application for the periodontal
susceptibility test on July 18, 1997 and for the osteoporosis susceptibility
test on September 8, 1997. While the issuance of these patents is likely, the
exact date of issuance is not known. It is rather unlikely, but possible, that
the United States Patent Trademark Commissioner could disallow the granting of
our patents at any time prior to the date of issuance. There can be no assurance
that our patent applications will ever be issued as patents or that the claims
of any issued patents will afford meaningful protection for our technology or
products. Further, others may develop similar products which test for
susceptibility related to some diseases yet avoid infringing upon, or
conflicting with, our anticipated patents. In addition, there can be no
assurance that any patents issued to us will not be challenged, and subsequently
narrowed, invalidated or circumvented.
Our testing services and/or products may also conflict with patents which
have been or may be granted to others. As the biotechnology industry expands and
more patents are filed and issued, the risk increases that our products may give
rise to a declaration of interference by the Patent and Trademark Office, or to
claims of patent infringement by other companies, institutions or individuals.
Such entities or persons could bring legal proceedings against us seeking
damages or seeking to enjoin us from testing, manufacturing or marketing our
products. Patent litigation is costly, and even if we prevail, the cost of such
litigation could have an adverse effect on us. If the other parties in any such
actions are successful, in addition to any liability for damages, we could be
required to cease the infringing activity or obtain a license. It is uncertain
whether
11
<PAGE> 16
any license required would be available to us on acceptable terms, if at all.
Failure by us to obtain a license to any technology that we may require to
commercialize our products could have a material adverse effect on our business,
financial condition, results of operations and cash flows. In addition, there is
considerable pressure on academic institutions and other entities to publish
discoveries in the genetic field. Such a publication by an academic institution
or other entity, prior to our filing of a patent application on such discovery,
may compromise our ability to obtain U.S. and foreign patent protection for the
discovery.
We also rely upon unpatented proprietary technologies. We rely on
confidentiality agreements with our employees, consultants and collaborative
partners to protect such proprietary technology. There can be no assurance that
we can adequately protect our rights in such unpatented proprietary
technologies, that others will not independently develop substantially
equivalent proprietary information or techniques, or otherwise gain access to
our proprietary technologies or disclose such technologies. See "Intellectual
Property" at page 40.
The United States Patent and Trademark Office issued new Utility Guidelines
in July 1995 that address the requirements for demonstrating utility,
particularly in inventions relating to human therapeutics. While the guidelines
do not require clinical efficacy data for issuance of patents for human
therapeutics, there can be no assurance that the Patent and Trademark Office's
interpretations of such guidelines, and any chances to such interpretations will
not delay or adversely affect our or our collaborators' ability to obtain patent
protection. The biotechnology patent situation outside the United States is even
more uncertain and is currently undergoing review and revision in many
countries.
TECHNOLOGICAL CHANGES RESULTING IN PRODUCT OBSOLESCENCE
Market acceptance and sales of our testing services could also be adversely
affected by technological change. It is uncertain whether our competitors will
succeed in developing genetic susceptibility tests that circumvent or are more
effective than our technologies or services. Further, it is uncertain whether
such developments would render our or our collaborators' technology or services
less competitive or obsolete. Further, our testing services could be rendered
obsolete as a result of future innovations in the treatment of gum disease,
osteoporosis, coronary artery disease or diabetes retinopathy, which could have
a significant negative impact on our company's ability to market our services
effectively. See "Uncertain Ability to Protect Proprietary Technology" at page
11, "Competition" at page 41 and "Intellectual Property" at page 40.
LIMITED MARKETING OR SALES EXPERIENCE
Our business strategy is to provide genetic susceptibility testing services
aimed at common diseases that are treatable and preventable. The commercial
introduction of the periodontal susceptibility test at the beginning of October
1997 represents our first such effort. In preparation for the launch of the
periodontal susceptibility test, we have devoted substantial human and financial
resources to the establishment and staffing of a customer service support
facility and the building of a sales and marketing infrastructure. However, we
have limited experience in developing and commercially marketing susceptibility
testing services. It is uncertain whether our customer service support
facilities and sales and marketing program will achieve efficient, effective or
successful operations. Failure to successfully market such tests could reduce
our revenues and may result in losses. See "Competition" at page 41 and
"Government Regulation" at pages 12 and 44.
GOVERNMENT REGULATION
The sampling of blood, saliva or cheek scrapings from patients and
subsequent analysis in a clinical laboratory does not, at the present time,
require FDA or regulatory authority approval outside the U.S. for either the
sampling procedure or the analysis itself. The samples are taken in the
healthcare provider's office, using standard materials previously approved as
medical devices, such as sterile lancets and swabs. The testing procedure itself
is performed in one or more registered, certified clinical laboratories under
the auspices of the Clinical Laboratory Improvement Amendments of 1988,
administered by the Health Care Financing Administration. In general, the
federal regulations governing approval of the laboratory facilities
12
<PAGE> 17
and applicable state and local regulations governing the operation of clinical
laboratories apply to the laboratory but not to our company. However, changes in
the scope of the services offered by our company (e.g., establishing an in-house
clinical laboratory) would subject our company to applicable regulations.
Additionally, changes in existing regulations could require advance regulatory
approval of genetic susceptibility tests which may result in a substantial
curtailment or even prohibition of our activities without regulatory approval.
If our tests ever require regulatory approval, the costs of introduction will
increase and marketing and sales may be significantly delayed.
Further, eighteen months ago the FDA proposed to regulate as medical
devices the "active ingredients" (known as "analyte specific reagents" or
"ASRs") of certain tests developed by, or in conjunction with, clinical
laboratories. Currently, a final rule has not been issued. The FDA has
specifically stated that it is not proposing a comprehensive regulatory scheme
over the final tests, but rather the active ingredients (ASRs) provided to the
laboratories that perform them. According to the FDA, any contemplated
additional controls (e.g. submission for Pre-Market Approval applications) over
the tests themselves would likely involve those tests which identify genes
associated with cancer or diseases associated with dementia. If the FDA requires
Pre-Market Approval of our genetic susceptibility test, our company may be
required to conduct pre-clinical studies, obtain an investigational device
exemption to conduct clinical tests, file a Pre-Market Approval application, and
obtain FDA approval. There can be no assurance such approval would be received
on a timely basis, if at all. The failure to receive such approval could require
us to develop alternative testing methods or utilize approved ASRs, which could
result in the delay or stop the use of such tests. Such a delay or termination
could result in reduced revenues or losses.
Although our primary business is to develop genetic susceptibility testing
services, we may also develop or assist others to develop, drugs or other
treatments for the diseases related to our tests. The FDA and comparable
agencies in state and local jurisdictions and in foreign countries impose
substantial requirements upon the manufacturing and marketing of drug products
such as those potentially to be developed by our company or any partner. The
process of obtaining FDA and other required regulatory approvals is lengthy and
expensive. The time required for FDA approvals is uncertain and typically takes
a number of years, depending on the type, complexity and novelty of the product.
We may encounter significant delays or excessive costs in our efforts to secure
necessary approvals or licenses. Because certain of the products likely to
result from our research and development programs involve the application of new
technologies and will be based on new approaches, such products may be subject
to substantial additional review by various governmental regulatory authorities
and as a result, regulatory approvals may be obtained more slowly than for
products using more conventional technologies. There can be no assurance that
FDA approvals will be obtained in a timely manner, if at all. Any delay in
obtaining, or the failure to obtain, such approvals would adversely affect our
ability to generate product or product sales. Even if FDA approvals are
obtained, the marketing and manufacturing of drug products are subject to
continuing FDA and other regulatory review, and later discovery of previously
unknown problems with a product, manufacturer or facility may result in
restrictions on the product or manufacturer, including withdrawal of the product
from the market. Additional governmental regulations may be promulgated which
could delay regulatory approval of our potential products. We cannot predict the
impact of adverse governmental regulation which might arise from future
legislative or administrative action.
We intend to generate product revenues from sales outside of the United
States. Distribution of our testing services or products outside the United
States may be subject to extensive government regulation. These regulations,
including the requirements for approvals or clearance to market, the time
required for regulatory review and the sanctions imposed for violations, vary by
country. It is uncertain whether we will obtain regulatory approvals in such
countries or that we will be required to incur significant costs in obtaining or
maintaining our foreign regulatory approvals. Failure to obtain necessary
regulatory approvals or any other failure to comply with regulatory requirements
could result in reduced revenues and earnings. See "Products and Services" at
page 27 and "Government Regulation" at page 44.
13
<PAGE> 18
PRODUCT LIABILITY EXPOSURE
Our business exposes us to potential liability risks inherent in the
testing and marketing of medical and dental related services or products. It is
uncertain whether liability claims will be asserted against us. We have product
and professional liability insurance which we believe provides coverage for the
testing and commercial introduction of our genetic susceptibility tests. It is
uncertain whether we will be able to maintain such insurance on acceptable
terms. Any insurance obtained may not provide adequate coverage against
potential liabilities. A liability claim, even one without merit, could result
in significant legal defense costs thereby increasing our expenses, lowering our
earnings and even resulting in losses.
DEPENDENCE ON CLINICAL LABORATORY
The clinical laboratory operated by Baylor University currently performs
all of our genetics tests. Our company is not licensed as a clinical laboratory
and cannot perform genetic tests. Although we believe other clinical
laboratories are readily available if we cannot use Baylor University, the loss
of Baylor University may result in delays in the performance of genetic tests or
may increase the costs of performing genetic tests.
ETHICAL, LEGAL AND SOCIAL IMPLICATIONS OF GENETIC SUSCEPTIBILITY TESTING
The prospect of broadly available genetic susceptibility testing has raised
issues which are currently being widely discussed by the medical and scientific
communities, as well as other interested groups and organizations, regarding the
appropriate utilization and the confidentiality of information provided by such
testing. The recent movement towards discovery and commercialization of
susceptibility tests for assessing a person's likelihood of developing a chronic
disease has also focused public and legislative attention on the need to protect
the privacy of genetic assessment medical information. With the progression
towards more comprehensive record keeping by health insurers and managed care
firms, this need has led to a number of legal initiatives. The recently enacted
federal health insurance reform law (Kassebaum-Kennedy of 1996) recognizes the
comparability of information obtained by genetic means to other types of
personal medical information. The law prohibits insurance companies from
refusing health insurance coverage to individuals on the basis of their medical
history, including "genetic information." This legislation also prohibits
employees from discrimination in hiring practices on the same basis. This
legislation indicates a trend to protect the privacy of patients while allowing
them to be screened for conditions which, can be prevented, reduced in severity
or cured. In the most extreme scenario, governmental authorities could, for
social or other purposes, limit the use of genetic testing or prohibit testing
for genetic susceptibility to certain conditions. For these reasons, we could
experience a delay or reduction in test acceptance. Such a delay or reduction
could reduce our revenues or result in losses.
We are taking a proactive stance in the ethical arena. We have engaged Dr.
Philip Reilly, who is both an M.D. (certified specialist in clinical genetics)
and an attorney, to advise us in the area of genetic testing and its ethical,
legal and clinical utility ramifications. Additionally, we are currently
advising doctors who administer our genetic susceptibility tests to take special
efforts to maintain the confidentiality of the test results. Our intent is to
avoid information about test results being disclosed to insurers until issues
regarding insurability have been fully analyzed and acted upon by the
appropriate legislative bodies.
On August 1, 1997, we formed a joint venture named Digisphere, LLC whose
purpose, in part, will be to provide marketing information to those patients who
test positive on one of our tests and who subsequently send in a business reply
card seeking more information. See "Product Development" at page 36. The
confidentiality of patient information is subject to regulation by state law. A
variety of statutes and regulations exist safeguarding privacy and regulating
the disclosure and use of medical information. State constitutions may provide
privacy rights and states may provide private causes of action for violations of
an individual's "expectation of privacy." Tort liability may result from
unauthorized access and breaches of patient confidence. We intend to comply with
state law and regulations governing medical information privacy.
14
<PAGE> 19
DEPENDENCE ON KEY PERSONNEL AND CONSULTANTS
Because of the specialized scientific nature of our business, we are highly
dependent upon our ability to attract and retain qualified management,
scientific and technical personnel. Our company will also be dependent upon the
ability to hire qualified marketing and sales personnel. Competition for
scientific, marketing and sales personnel is intense. Loss of the services of
Mr. White, Dr. Kornman or Dr. Newman could adversely affect our research and
development programs and susceptibility testing service business and could
impede the achievement of our business objectives. We do not maintain key man
life insurance on any of our personnel.
CONTROL BY EXISTING SHAREHOLDERS
Following completion of this offering, our directors, executive officers
and certain of their affiliates, will beneficially own approximately 55.26% of
our outstanding Common Stock. Accordingly, these shareholders, individually and
as a group, may be able to influence the outcome of shareholder votes, including
votes concerning the election of directors, the adoption or amendment of
provisions in our Amended and Restated Articles of Incorporation or Amended and
Restated By-Laws and the approval of certain mergers and other significant
corporate transactions, including a sale of substantially all of our assets.
Such control by existing shareholders could have the effect of delaying,
deferring or preventing a change in control. See "Principal Shareholders" at
page 53.
DILUTION; ABSENCE OF DIVIDENDS
Purchasers in the offering will experience immediate and substantial
dilution in the net tangible book value of the Common Stock from the public
offering price. Additional dilution is likely to occur upon the exercise of any
options or warrants that we have granted. See "Dilution" at page 20. We have
never paid dividends and do not intend to pay any dividends in the foreseeable
future. See "Description of Securities" at page 54.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of Common Stock in the public market following
this offering could lower the market price of the Common Stock. Of the 6,338,007
shares of Common Stock to be outstanding after this offering (assuming no
exercise of outstanding options, warrants or the overallotment option),
2,600,000 shares will be freely tradeable without restriction. Upon expiration
of the lock-up agreements entered into by the officers and directors of our
company, an additional 3,258,053 shares will become eligible for sale one year
from the closing of this offering, subject to the provisions of Rule 144. See
"Shares Eligible for Future Sale" at page 55. Of the remaining 479,954 shares of
Common Stock, 5,000 shares will be eligible for resale under Rule 144 following
this offering. The remaining 474,954 shares will have been held for less than
one year and will become eligible for sale at various dates as the one-year
holding period under Rule 144 is satisfied.
In addition, we intend to file a registration statement on Form S-8 with
respect to the shares of Common Stock issuable upon exercise of options under
the 1996 Equity Incentive Plan (the "Plan"). The Plan authorizes the issuance of
options relating to up to 1,000,000 shares of Common Stock. Currently, there are
800,579 options that have been issued under the Plan which generally vest over
three years. See "1996 Equity Incentive Plan" at page 50. Upon filing of such
registration statement, the holders of such options may, subject to vesting
requirements, exercise and sell their shares immediately without restriction,
except affiliates who are subject to certain volume limitations and manner of
sale requirements of Rule 144. See "Shares Eligible for Future Sale" at page 55.
Holders of 356,545 warrants to purchase shares are entitled to certain
registration rights with respect to such shares. Upon registration, such shares
may be sold in the market without limitation. See "Registration Rights" at page
55. Sales of such shares may decrease the market price for our Common Stock. See
"Underwriting" at page 57.
15
<PAGE> 20
IMPACT UPON FUTURE NET INCOME OR LOSS OF THE COMPANY BY CURRENT ACCOUNTING FOR
DEBT ISSUANCE COSTS
From August 1, 1997 through October 6, 1997, the Company issued Bridge
Loans to investors in the aggregate amount of $1,780,000. In connection with the
issuance of these Bridge Loans, the Company also issued 356,545 warrants to
purchase the Company's Common Stock for $5.50 per share. The Company has
determined that an additional expense of $356,545 needs to be recognized in
connection with the issuance of these warrants. The $356,545 of additional
interest expense is currently being amortized over fourteen months, the terms of
the Bridge Loans. However, upon completion of the initial public offering, the
$1,780,000 Bridge Loans will be repaid and the unamortized amount will be
charged to earnings and will significantly impact the net income or loss of the
Company in the quarter in which the initial public offering is completed.
ARBITRARY OFFERING PRICE OF THE COMMON STOCK; POSSIBLE VOLATILITY OF COMMON
STOCK PRICE
The initial public offering price of the Common Stock has been determined
by negotiations between our company and the Underwriter. The initial public
offering price bears no relationship to earnings, asset values, book value or
any other recognized criteria of value. See "Underwriting" at page 57.
The market prices for securities of emerging health care companies have
been highly volatile. Announcements may have a significant impact on the market
price of the Common Stock. Such announcements may include biological or medical
discoveries, technological innovations or new commercial services by us or our
competitors, developments concerning proprietary rights, including patents and
litigation matters, regulatory developments in both the United States and
foreign countries, public concern as to the safety of new technologies, general
market conditions as well as quarterly fluctuations in our revenues and
financial results and other factors. The stock market has from time to time
experienced extreme price and volume fluctuations which have particularly
affected the market prices for emerging and biotechnology companies and which
have often been unrelated to the operating performance of such companies. These
broad market fluctuations may adversely affect the market price of our Common
Stock. In the past, following periods of volatility in the market price of a
company's stock, securities class action litigation has occurred against the
issuing company. Such litigation could result in substantial costs and a
diversion of management's attention and resources, which could have a material
adverse effect on our revenues and earnings. Any adverse determination in such
litigation could also subject us to significant liabilities.
EFFECT OF PREFERRED STOCK AND DIRECTOR REMOVAL PROVISIONS
Our Board of Directors is authorized to issue up to 5,000,000 shares of
Preferred Stock and to determine the price, rights, preferences and privileges
of those shares without any further vote or action by our shareholders. The
rights of the holders of Common Stock will be subject to, and may be adversely
affected by, the rights of the holders of any shares of Preferred Stock that may
be issued in the future. While we have no present intention to issue shares of
Preferred Stock, such issuance, while providing desirable flexibility in
connection with possible acquisitions and other corporate purposes, could have
the effect of making it more difficult for a third party to acquire a majority
of our outstanding voting stock. In addition, such Preferred Stock may have
other rights, including economic rights, senior to the Common Stock. As a
result, the issuance of Preferred Stock could decrease the market value of the
Common Stock.
Our Amended and Restated Articles of Incorporation provide that members of
the Board of Directors may be removed only for cause upon the affirmative vote
of holders of at least a majority of the shares of our outstanding capital stock
entitled to vote. Certain other provisions of our Amended and Restated Articles
of Incorporation could also have the effect of delaying or preventing changes of
control or in management. Such a delay or preventive effect could adversely
affect the price of our Common Stock.
16
<PAGE> 21
THE COMPANY
Drs. Kenneth S. Kornman and Michael G. Newman founded the Company in 1986
to develop and introduce new methods, tools and technology for dental
practitioners that would better predict treatment outcomes in patients. We
derived our initial revenue primarily from contract research to pharmaceutical
companies and others. In early 1992, we expanded our contract research program
to include both medical and dental research. In 1994, we implemented an internal
product discovery program. We then used profits generated from our contract
research programs to fund our own product research and development.
We originally operated under two separate Texas corporations, known as Oral
Science Systems and Oral Science Technologies. In August 1995, Oral Science
Systems was merged into Oral Science Technologies which changed its corporate
name to Medical Science Systems, Inc. ("MSS"). MSS continued to function as a
Subchapter "S" corporation until September 30, 1996, when it became a "C"
corporation. MSS' principal executive office is located at 4400 MacArthur
Boulevard, Suite 980, Newport Beach, California 92660, and may be reached by
telephone at (714) 440-9730. MSS maintains a website located at
http://www.medscience.com.
17
<PAGE> 22
USE OF PROCEEDS
If all 2,600,000 shares of Common Stock offered by this Prospectus are
sold, we will receive net proceeds of approximately $20,471,000 (assuming the
public offering price is $9.00, and assuming the over-allotment option is not
exercised). If the Underwriters exercise the over-allotment option, our company
would receive an additional $3,123,900. Net proceeds are determined after
deduction of all commissions, discounts and expenses paid to the Underwriters
(estimated to be $2,574,000) and after all expenses of the offering (estimated
to be $355,000).
We intend, in the following order of priority, to use the net proceeds from
this offering to:
<TABLE>
<CAPTION>
PERCENTAGE
AMOUNT NET PROCEEDS
------------ -------------
<S> <C> <C>
Marketing, sales, customer service and commercialization
expenses.................................................. $ 9,850,000 48.12%
-- Expenses for sales and marketing in conjunction with
the market introduction of each susceptibility test.
Such expenses include market research studies,
marketing collateral materials, trade show
participation, public relations, advertising
expenses and sales and marketing personnel.
Research and development activities......................... 3,450,000 16.85%
-- Continuation of clinical trials for genetic
susceptibility tests under development, to provide
clinical utility data, amortization of capitalized
patent expense beginning when each patent issued and
salaries of research and development personnel.
Capital Investments......................................... 300,000 1.46%
-- Expenditures for computer equipment, furniture and
fixtures primarily related to increases in
personnel.
Repayment of Bridge Loans(1)................................ 1,780,000 8.70%
Working capital and general corporate purposes.............. 5,091,000 24.87%
------------ ------
TOTAL............................................. $ 20,471,000 100.00%
============ ======
</TABLE>
- ---------------
(1) The proceeds of the Bridge Loans were applied and utilized in the following
manner: $7,000 (cost of bridge financing, including legal expenses);
$125,000 (initial public offering expenses); $600,000 (operating expenses,
August and September 1997); $300,000 (operating expenses, October 1997); and
$748,000 (remaining on balance as of November 12, 1997).
The amount and timing of working capital expenditures may vary
significantly depending upon numerous factors, including the progress of our
research, discovery and development programs, the timing and costs involved in
obtaining regulatory approvals, the costs involved in filing, prosecuting and
enforcing patent claims, competing technological and market developments,
payments received under collaborative agreements, changes in collaborative
research relationships, the costs associated with potential commercialization of
our products, including the development of marketing and sales capabilities, the
cost and availability of third-party financing for capital expenditures and
administrative and legal expenses.
We believe that our available cash and existing sources of funding,
together with the proceeds of this offering and interest earned thereon, will be
adequate to maintain our current and planned operations for at least the next 18
months.
Until used, we intend to invest the net proceeds of this offering in
interest-bearing, investment-grade securities. While the net proceeds are so
invested, the interest earned by us on such proceeds will be limited by
available market rates. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" at page 22. We intend to invest and use
such proceeds so as not to be considered an "investment company" under the
Investment Company Act of 1940, as amended.
18
<PAGE> 23
DIVIDEND POLICY
Holders of shares of Common Stock are entitled to dividends when, as and if
declared by the Board of Directors, out of funds legally available therefor. We
have not yet paid any dividends and do not expect to do so in the foreseeable
future. We intend to use all retained earnings for working capital and to
finance the anticipated growth and expansion of our business.
CAPITALIZATION
The following table sets forth our capitalization (i) as of September 30,
1997; (ii) on a pro forma basis after giving effect to the issuance of $230,000
in Bridge Loans subsequent to September 30, 1997 as if the issuance of Bridge
Loans occurred on September 30, 1997; and (iii) on a pro forma basis as adjusted
to give effect to the receipt of net proceeds from the sale of 2,600,000 shares
of Common Stock offered hereby after deducting underwriting discounts and
commissions and estimated offering expenses:
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
-----------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Long term debt and obligations under capital leases, less
current portion(1), and Bridge Loans....................... $ 2,169 $ 2,399 $ 619
------- ------- -------
Shareholders' equity:
Preferred Stock, 5,000,000 shares authorized; none issued
and outstanding actual, pro forma or pro forma as
adjusted................................................ -0- -0- -0-
Common Stock, no par value, 10,000,000 shares authorized;
3,738,007 shares issued and outstanding; 3,738,007
shares issued and outstanding pro forma; 6,338,007
shares issued and outstanding pro forma as
adjusted(2)............................................. 2,450 2,450 23,252
Accumulated deficit........................................ (3,914) (3,914) (4,245)
------- ------- -------
Total shareholders' equity.............................. (1,464) (1,464) 19,007
------- ------- -------
Total capitalization.................................. $ 705 $ 935 $19,626
======= ======= =======
</TABLE>
- ---------------
(1) As of September 30, 1997, the current portion of obligations under long term
debt and capital leases was approximately $187,959.
(2) Excludes (i) 356,545 shares of Common Stock subject to Bridge Warrants,
exercisable at $5.50 per share; (ii) 800,579 shares of Common Stock subject
to outstanding options under our 1996 Equity Incentive Plan, exercisable at
$3.70 or $5.00 per share; (iii) 199,421 shares of Common Stock reserved for
issuance pursuant to our 1996 Equity Incentive Plan; (iv) the exercise of
the Underwriters' over-allotment option; and (v) 260,000 shares of Common
Stock subject to Underwriters' Warrants, exercisable at 165% of the initial
public offering price of the Common Stock. See "Description of Securities"
at page 54.
19
<PAGE> 24
DILUTION
As of September 30, 1997, there were 3,738,007 shares of our Common Stock
outstanding, having a negative net tangible book value per share of
approximately $(0.46). Net tangible book value per share represents the amount
of our total tangible assets less our total liabilities, divided by the number
of shares of our Common Stock outstanding.
After giving effect to the sale of the 2,600,000 shares of Common Stock
under this offering at a price of $9.00 per share and the application of the net
proceeds therefrom (but assuming none of the options or warrants are exercised),
there would be a total of 6,338,007 shares of our Common Stock outstanding with
a net tangible book value of approximately $2.96 per share. This would represent
an immediate increase in net tangible book value of $3.42 per share to existing
shareholders and an immediate dilution of $6.04 per share to new investors.
Dilution is determined by subtracting net tangible book value per share after
the offering from the amount paid by new investors per share of Common Stock.
The following table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share............................. $9.00
Net tangible book value per share as of September 30, 1997........ $(0.46)
Increase attributable to new investors............................ 3.42
Adjusted net tangible book value per share after this offering...... 2.96
-----
Dilution per share to new investors................................. $6.04
=====
</TABLE>
The following table summarizes, on a pro forma basis, as of September 30,
1997, the difference between the existing shareholders and the new investors
with respect to the number of shares of Common Stock purchased from our company,
the total consideration paid and the average price per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
--------------------- ----------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing shareholders....... 3,738,007 58.98% $ 2,190,600 8.56% $0.59
New investors............... 2,600,000 41.02 23,400,000 91.44 $9.00
--------- ------ ----------- ------
Total....................... 6,338,007 100.00% $25,590,600 100.00%
========= ====== =========== ======
</TABLE>
The foregoing table assumes (i) no exercise of the Underwriters'
over-allotment option; (ii) no exercise of the 260,000 Underwriters' Warrants;
(iii) no exercise of the 356,545 Bridge Warrants, exercisable at $5.50 per
share; and (iv) no exercise of stock options outstanding after September 30,
1997. As of September 30, 1997, there were options outstanding to purchase a
total of 800,579 shares of Common Stock under our 1996 Equity Incentive Plan, at
a weighted average exercise price of $4.37 per share. To the extent that any of
the shares of Common Stock are issued on exercise of any of these warrants,
options or additional options granted after September 30, 1997, there will be
further dilution to new investors. See "Description of Securities" at page 54.
20
<PAGE> 25
SELECTED FINANCIAL DATA
We are providing the following selected financial data to aid you in your
analysis of this potential investment. This information was derived from: (1)
our 1995 and 1996 historical financial statements; and (2) from our internally
prepared unaudited financial statements for the nine-month periods ended
September 30, 1996 and 1997. Our financial statements as of December 31, 1995
and 1996 with the notes thereto and the related reports of Singer Lewak
Greenbaum & Goldstein LLP, independent public accountants, together with our
internally prepared unaudited financial statements for the nine-month periods
ended September 30, 1996 and 1997 are included elsewhere in this Prospectus. Our
unaudited financial statements, in the opinion of management, include all
adjustments (consisting of normal recurring adjustments) necessary for a fair
presentation of our financial position and results of operations for the
unaudited interim periods. The selected financial data set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" at page 22 and our financial statements and
related notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED
YEAR ENDED YEAR ENDED SEPTEMBER 30, SEPTEMBER 30,
DECEMBER 31, 1996 DECEMBER 31, 1995 1997 1996
----------------- ----------------- ----------------- -----------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS
DATA:
Revenues..................... $ 1,919 $ 1,873 $ 152 $ 1,905
Cost of sales................ 548 368 149 538
--------- --------- --------- ---------
Gross profit (loss).......... 1,371 1,505 3 1,367
Expenses:
Research and development... 958 582 785 682
Selling, general and
administrative.......... 1,163 756 2,164 776
--------- --------- --------- ---------
Total expenses.......... 2,121 1,338 2,949 1,458
--------- --------- --------- ---------
Operating income (loss)...... (750) 167 (2,946) (91)
Other income (expense),
net........................ (33) (14) (96) (6)
Provision for income taxes... (6) (3) -0- -0-
Net income (loss)............ $ (789) $ 150 $ (3,042) $ (97)
========= ========= ========= =========
Earnings (loss) per share.... $ (.18) $ .03 $ (.71) $ .(02)
========= ========= ========= =========
Shares used in computing
earnings (loss) per
share(1)................... 4,288,436 4,288,436 4,288,436 4,288,436
========= ========= ========= =========
</TABLE>
- ---------------
(1) Includes all shares issuable upon the exercise of options and warrants
granted within one year prior to the date of this Prospectus.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
-------------------------------------------------
(UNAUDITED)
(IN THOUSANDS)
PRO FORMA
ACTUAL PRO FORMA(1) AS ADJUSTED(2)
------- -------------- --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................... $ 870 $ 1,100 $ 19,791
Working capital................................... 168 398 19,089
Total assets...................................... 1,437 1,667 20,358
Total shareholders' equity........................ (1,464) (1,464) 19,007
</TABLE>
- ---------------
(1) On a pro forma basis after giving effect to the issuance of $230,000 in
Bridge Loans subsequent to September 30, 1997 as if the issuance of Bridge
Loans occurred on September 30, 1997.
(2) On a pro forma as adjusted basis to give effect to the receipt of net
proceeds from the sale of 2,600,000 shares of Common Stock offered hereby
after deducting underwriting discounts and commissions and estimated
offering expenses.
21
<PAGE> 26
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the Financial Statements and related Notes contained elsewhere in this
Prospectus. This Prospectus contains forward-looking statements which involve
risks and uncertainties. Our actual results may differ significantly from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those discussed in "Risk
Factors" at page 9.
OVERVIEW
Since inception, we have devoted substantially all of our resources to
maintaining our research and development programs and supporting contract
research agreements. To date, we have received limited revenues from the sale of
our periodontal susceptibility test. Revenues received by us have historically
been payments pursuant to contract research agreements. For the fiscal year
ended December 31, 1996, we had a net loss of $789,000 and as of December 31,
1996 had a shareholder deficit of $700,000.
We had two research contracts with Alpharma, Inc. ("Alpharma") for the
clinical investigation of Alpharma's proprietary periodontitis antibiotic
product. These contracts and the payments associated therewith ended in June
1996.
We intend to enter into additional contract research agreements to assist
in the funding of our own internal research projects. There can be no assurance
that we will be able to enter into additional contract research agreements on
terms acceptable to us. We could incur losses for at least the next several
years, primarily due to expansion of our research and development programs,
increasing staffing costs and expansion of our facilities. Additionally, we
expect to incur substantial sales, marketing and other expenses in connection
with launching our genetic susceptibility testing business. We expect that
losses will fluctuate from quarter to quarter and that such fluctuations may be
substantial.
We devoted significant resources during the last fiscal year to the beta
testing and validation of our genetic susceptibility test related to
periodontitis, as well as building our sales and marketing force in preparation
for the commercial launch of the periodontal susceptibility test. Additional
outlays have been expended on the hiring of additional customer service
personnel and the associated increase in use of test materials and commercial
laboratory charges. We also incurred increased development expenses during the
year related to work on developing our genetic susceptibility tests for
osteoporosis, coronary artery disease and diabetic retinopathy. We expect
research and development expenses to continue to increase as personnel and
research and development facilities are expanded.
Selling, general and administrative expenses for the year ended December
31, 1996 increased $407,000 from the year ended December 31, 1995. The increase
was attributable to sales and marketing expenses related to the upcoming launch
of our periodontal susceptibility test and salaries and benefits paid to
existing and newly hired sales and marketing employees. We recently commercially
launched our periodontal susceptibility test on October 3, 1997. Additionally,
we expect that our general and administrative expenses will continue to increase
in support of our research and development efforts and the anticipated growth of
our genetic susceptibility testing business.
RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996.
Revenues for the nine months ended September 30, 1997 decreased by
$1,753,000, from $1,905,000 for the nine months ended September 30, 1996 to
$152,000 for the same period in 1997, due to the decrease in contract research
agreements. In the summer of 1996, we changed our focus from providing
pharmaceutical companies clinical trial and research services pursuant to
contract research agreements to concentrating our resources on developing
genetic susceptibility tests. This change in focus resulted in a significant
decrease in revenue for the nine months ended September 30, 1997 compared to the
same period for 1996. Research and development expenses of $785,000 for the nine
months ended September 30, 1997 were comparable to the
22
<PAGE> 27
$682,000 for the same period in 1996. The research and development expenses are
attributed to development expenses related to work on developing our genetic
susceptibility tests for periodontitis, osteoporosis, coronary artery disease
and diabetic retinopathy. The increase of $103,000 in research and development
is due to our focus on developing genetic susceptibility tests. Selling, general
and administrative expenses increased by $1,388,000 from $776,000 for the nine
months ended September 1996 to $2,164,000 for the same period in 1997. The
increase in 1997 was primarily due to the hiring of additional sales and
marketing personnel and costs related to the pre-commercial launch of our
periodontal susceptibility test.
Interest income for the nine months ended September 30, 1997 decreased by
$6,000 primarily due to decreased funds available for investment. Interest
expense for the nine months ended September 30, 1997, amounted to $99,000, an
increase of $85,000 over the same period in 1996. The increase was due primarily
to an increased working capital line of credit, a long term loan with Bank of
America, the Bridge Loans and the additional interest expense resulting from the
issuance of the Bridge Loan Warrants.
The net loss for the nine months ended September 30, 1996 was $97,000
compared to $3,042,000 for the nine months ended September 30, 1997. The
difference is a result of the increased research and development expenses,
increased selling, general and administrative expenses and the decrease in
research contract revenues.
YEARS ENDED DECEMBER 31, 1996 AND 1995.
Revenues for the year ended December 31, 1996 increased by $46,000.
Research and development expenses increased to $958,000 for the year ended
December 31, 1996 from $582,000 for the year ended December 31, 1995. The
increase in research and development expenses is attributed to development
expenses during the period related to work on developing our genetic
susceptibility tests for periodontitis, osteoporosis, coronary artery disease
and diabetic retinopathy. Selling, general and administrative expenses increased
to $1,163,000 for the year ended December 31, 1996 from $756,000 for the year
ended December 31, 1995. The increase in 1996 was primarily due to the hiring of
additional personnel and costs related to the pre-commercial launch of our
periodontal susceptibility test.
Interest income for the year ended December 31, 1996 increased to $9,000
from $0 for the prior year, due to the increased funds available for investment.
These funds were raised in our private placement of common stock in starting in
November 1996 and through our contract research agreements with various
companies. Interest expense for the year ended December 31,1996, amounting to
$34,000, was due entirely to a working capital line of credit and a long term
loan with Bank of America.
The net income for the year ended December 31, 1995 was $150,000 compared
to a net loss of $789,000 for the year ended December 31, 1996. The difference
is a result of the increase in research and development expense, the increase in
selling, general and administrative expenses and the decrease in research
contract revenues.
LIQUIDITY AND CAPITAL RESOURCES
We have financed our operations from inception through contract research
revenues and more recently through sales of common stock and borrowings. During
1997 we have received $1,882,000 in net proceeds from private placements of our
Common Stock. We raised an additional $1,780,000 through a debt/warrant offering
from August 1, 1997 through October 6, 1997.
We have also, for working capital purposes, entered into term loans with a
bank to effect borrowings originally in the amounts of $500,000 and $250,000. As
of September 30, 1997, our borrowings under the term loans were $483,000 and
$185,000, respectively.
As a result of the private placements of debt and equity securities and the
new loan agreements, our cash and cash equivalents has increased from $56,000 at
December 31, 1996 to $870,000 at September 30, 1997.
During the nine months ended September our Company spent $35,000 on
furniture and equipment and $108,000 on patents.
23
<PAGE> 28
During the nine months ended September 30, 1997 and 1996, and the fiscal
years ended December 31, 1996 and 1995, our cash provided by (used in)
operations used in was $(2,469,000), $(23,000), $(442,000) and $112,000,
respectively. The cash used for operations was primarily to fund research and
development and sales and marketing expenses related to the introduction and
support of our genetic susceptibility tests.
We expect to use a portion of the net proceeds of this offering for
expanding sales and marketing efforts, funding of clinical studies, increasing
production or commercialization capacity, customer service and funding research
and development, the repayment of the investor Bridge Loans, as well as for
working capital and general corporate purposes. A portion of the proceeds may
also be used for investments in or acquisitions of complementary businesses,
products or technologies. See "Use of Proceeds" at page 18.
24
<PAGE> 29
BUSINESS
GENERAL DESCRIPTION
We provide genetic susceptibility testing services for common diseases that
are treatable and preventable. We have focused on four diseases initially:
periodontitis (gum disease), osteoporosis (bone disease), coronary artery
disease (heart disease) and diabetic retinopathy (blindness associated with
diabetes). Our tests identify genetic markers which, if present in a patient,
increase the probability that such patient will be affected by the disease or
that the disease will progress more rapidly and become more severe. Doctors and
dentists will use our genetic susceptibility tests to assess the risk involved
for individual patients and to adopt appropriate treatments or therapy,
including preventive measures. Our genetic tests will allow early determination
of genetic predisposition to these four diseases with the following potential
benefits:
(1) Patients with genetic predisposition to a disease may adopt health
care and lifestyle changes that will delay or prevent onset of the
disease or reduce disease severity;
(2) Early detection of genetic predisposition will allow doctors and
dentists to select the most appropriate (i) preventive strategy
where no disease symptoms are present or (ii) course of treatment
once the patient develops the disease; and
(3) Earlier and better treatment selection will motivate patients and
improve outcomes.
Our tests assist doctors in the development of better preventive treatment
strategies, aid patients in making more informed decisions, and help payers to
target healthcare investments where they make the biggest difference. We believe
that this will contribute to a better quality of life, while directing
healthcare resources to individuals who derive the greatest benefit.
Accordingly, our mission is to improve patient care and treatment outcomes by
incorporating genetic information regarding disease susceptibility into overall
risk assessment and treatment planning.
SCIENTIFIC BACKGROUND
Genetic Testing. For many years it was well accepted that genetics
influenced much of our health and behavior. Scientists frequently noted that
certain diseases "ran in families." The clear genetic influence on disease was
only known, however, for a few uncommon or rare conditions such as Down's
Syndrome or Tay-Sachs Disease. Such conditions involve either a major
abnormality in a chromosome or a genetic defect that is strong enough by itself
to cause a clinical problem. Both types of genetic abnormalities are so powerful
that they are usually evident in childhood.
Some diseases, such as Down's Syndrome, are essentially entirely genetic.
Others are essentially entirely environmental, such as an infected cut. The
purely genetic conditions tend to be rare, or at least uncommon. For example,
the defects in the gene associated with breast cancer are involved in only 5% to
10% of all breast cancers. Accordingly, 90% to 95% of all breast cancers are
caused by some other factor or factors.
Most of the common chronic diseases that cause the greatest debilitation
and cost for adults are diseases in which genetics interact with other factors,
such as lifestyle or environmental challenges to the body. We refer to such
diseases as "multi-factorial" because numerous factors contribute to the disease
(Figure 1). For example, while it has been demonstrated that there is a genetic
influence on the susceptibility to periodontitis, research has also shown that
periodontitis is influenced by factors such as smoking and oral hygiene.
25
<PAGE> 30
FIGURE 1
[CHART DEPICTING BIOLOGICAL AND BEHAVORIAL RISK FACTORS CONTRIBUTING TO DISEASE
PROGRESSION]
Source: Chart developed by Medical Science Systems, Inc. Copyright Medical
Science Systems, Inc.
In multi-factorial diseases the genetic influence is not due to a "genetic
defect" but a normal variation within the population. For example, for a
specific gene, 20% to 30% of the population may have a slight variation in the
genetic code that alters the function of that gene just enough under certain
environmental challenges that a specific disease is accelerated (Figure 1).
Since these variations are multiple forms of the same gene, they are called
genetic polymorphisms or genetic markers.
If the genetic polymorphisms associated with a common disease can be
identified, it is possible to predict those at high risk for disease and alter
the individual's lifestyle or provide early medication to prevent clinical
disease. If the polymorphism can be shown to actually be involved functionally
in accelerating the disease, then that information may be used to develop
innovative new treatments or preventive agents.
For example, it is well established that two proteins, interleukin-1
("IL-1") and tumor necrosis factor ("TNF") play a central role in many chronic
diseases that have inflammatory components. We have discovered specific genetic
variations that influence how much IL-1 and TNF are produced in the body. Our
findings in periodontal disease provide an example of how this works. Normally,
the body produces IL-1 and TNF in responses to a bacterial infection to help
activate the inflammatory and immune responses that will fight the infection.
This happens without producing any longlasting tissue damage. In a person where
a certain genetic variation exists, excessive levels of IL-1 or TNF are
produced. This causes an inflammatory response that may lead to tissue damage.
Our research revealed that individuals with two specific polymorphisms in the
IL-1 genes were predisposed to more severe periodontitis. Our periodontal
susceptibility test determines whether an individual has such a genetic
predisposition.
In general, it may be said that the early detection of a predisposition to
genetic diseases presents the best opportunity for medical intervention. Early
genetic diagnosis may improve the prognosis for a patient through supervision
and early intervention before the clinically detectable disorder occurs.
26
<PAGE> 31
PRODUCTS AND SERVICES
Genetic Susceptibility Test for Periodontal Disease (Patent Pending).
DESCRIPTION OF PERIODONTAL DISEASE TEST. Our first genetic susceptibility
test detects a genetic susceptibility to severe gum disease (periodontitis).
Periodontitis is a bacterially-induced chronic inflammation that destroys the
collagen fibers and bone that surround and support the teeth. Untreated,
periodontitis will eventually result in tooth loss.
Periodontitis results from a complex interplay of bacterial infection with
the patient which can often be modified through behavioral factors. The fact
that periodontal disease is both preventable and treatable makes predicting the
host response (or one's susceptibility to the development of periodontal
disease) "wanted information" for the patient and health care provider.
Periodontists have attempted for years to understand why patients with similar
plaque levels and oral bacterial profiles often show remarkably different
clinical characteristics. It is now possible to integrate genetics into overall
risk assessment so clinicians can identify that subset of patients who are
highly susceptible to rapid disease progression and severe periodontitis. This
discovery allows individual patients to be managed in a more targeted and
proactive way.
FIGURE 2
[BAR GRAPH DEPICTING DIFFERING SUSCEPTIBILITY TO PERIODONTITIS IN ADULTS]
Source: K. Kornman et al., Journal of Clinical Periodontology, January 1997.
27
<PAGE> 32
FIGURE 3
[BAR GRAPH DEPICTING DIFFERING BLEEDING RESPONSE ON PROBING IN ADULTS]
Source: Unpublished data analysis based on data developed under the study
reported by K. Kornman et. al, Journal of Clinical Periodontology,
January 1997.
Our periodontal susceptibility test is the result of a scientific
breakthrough in which an association was discovered between a specific IL-1
genotype and severe periodontal disease (Figure 2). IL-1 is a cytokine or
protein that is known to play a role in inflammation and the expression of
periodontal disease. Patients with this specific genotype have been found to
progress more rapidly towards severe periodontal disease and show increased
bleeding on probing (Figure 3). It has also been determined that cells with this
genotype produce as much as four times more IL-1 in response to the same
bacterial challenge. Since IL-1 in high concentrations is known to be
destructive to tissues, this may explain the more rapid progression of
periodontal disease experienced by patients with this specific IL-1 genotype
when faced with a bacterial challenge. Prevention or therapeutic intervention
aimed at reducing the bacterial challenge should decrease the stimulus for IL-1
production and thereby protect the patient against the potentially destructive
effects of this genotype. It is estimated that approximately 30% of the
population will test positive for this genotype.
We have developed our periodontal susceptibility test and continue to be
governed by a project agreement between our company and Sheffield University.
See "Competitive Advantages" at page 42.
A patent application related to the detection of genetic predisposition to
periodontal disease has been filed and assigned to us from Sheffield University,
Dr. Gordon Duff and Dr. Kenneth Kornman. We have received a Notice of Allowance
from the U.S. Patent and Trademark Office related to the patent's anticipated
issuance.
28
<PAGE> 33
MARKET FOR PERIODONTAL SUSCEPTIBILITY TEST. The American Academy of
Periodontology estimates that:
"$5 billion was spent in 1990 to treat gingivitis and periodontal
disease, more than $10 billion is spent annually for the replacement of
teeth lost to periodontal disease, that 80% of all employed American
adults have some stage of periodontal disease and that periodontal
disease is the primary cause of tooth loss in adults 35 years and
older."
In general, population based studies indicate that gingivitis (that is,
mild gum disease) affects 50% of the adult population. Studies also show that
periodontitis affects between 30% to 35% of U.S. adults and increases with age
after 35. Many of the affected individuals have mild clinical disease, but it
appears that 20% of the adult population have a level of periodontitis which
requires professional treatment.
The early identification of those individuals susceptible to severe
periodontal disease would allow for more aggressive prevention and treatment of
the disease. Early intervention is the key to preventing or stopping the
progression of the disease in order to minimize permanent loss of bone that
supports the teeth. Most periodontal disease is currently diagnosed only after
significant damage has already occurred. The patient is frequently referred to a
specialist if the patient does not respond to conventional cleaning therapy and
continues to experience substantial additional bone loss. The current dilemma is
the inability to differentiate between those patients likely to respond to the
normal conservative approaches such as scaling and root planing, oral hygiene
improvement and more regular dental visits, and those which will likely go
rapidly downhill despite customary therapy. Those who have periodontal disease
and are susceptible to the severe form of periodontitis need more aggressive
care such as more frequent monitoring and periodontal cleanings, earlier
treatment with drugs or even early surgical intervention in severe cases.
Early identification of patients at high risk for periodontitis will allow
general practitioner dentists, as well as periodontists, to better focus
resources and confidently choose the most cost-effective therapy. Moreover, use
of our periodontal susceptibility test will allow payors to better monitor
resource utilization and to better design dental insurance plans.
We commercially launched our periodontal susceptibility test on October 3,
1997.
Genetic Susceptibility Test for Osteoporosis (Patent Pending).
DESCRIPTION OF OSTEOPOROSIS SUSCEPTIBILITY TEST. The second genetic test we
are currently developing is a test for susceptibility to osteoporosis.
Osteoporosis, the most common bone disease, resulting in a decrease in the
amount of normal bone which leaves the affected individual more susceptible to
fractures. We have identified a genetic marker that in clinical trials was
associated with a more severe loss of bone through osteoporosis. The
osteoporosis susceptibility test is a genetic test capable of indicating a
greater susceptibility to severe osteoporosis in postmenopausal women. This
susceptibility appears to involve a more rapid loss of bone as estrogen levels
decrease and menopause occurs.
29
<PAGE> 34
We have completed three clinical trials of the osteoporosis susceptibility
test. The first trial focused on the relationship of the genetic test to
bone-mineral density ("BMD") in post-menopausal women with a history of bone
fractures. All three trials confirmed the association between the specific
genetic marker and the onset of osteoporosis (Figure 4).
FIGURE 4
[BAR GRAPH DEPICTING SUSCEPTIBILITY TO POST - MENOPAUSAL OSTEOPOROSIS]
Source: R. Eastell, G. Russell, G. W. Duff and co-workers, unpublished data on
file, Medical Science Systems, Inc.
Our test provides data that will allow practitioners to practice preventive
medicine. Ideally, all females should be tested for this genetic trait by
adolescence so that they are encouraged to develop healthy lifestyles to attain
peak bone mass prior to the onset of menopause. These lifestyles include
avoiding smoking, increasing the intake of calcium, and participating in regular
weight-bearing exercise. Results of this test will also assist women who are
approaching menopause in deciding whether to start treatment. On introduction
into the marketplace, this test will be targeted at all women in their
mid-thirties, the point in their lives when the estrogen level begins to
decrease. This will enable counseling at a sufficiently early stage in the
process that significant bone loss can be avoided through lifestyle modification
and/or drug/hormone therapy.
A patent application related to the method of testing for genetic
predisposition to osteoporosis has been filed and assigned to Sheffield
University. Sheffield University, has in turn, granted to us an exclusive
worldwide license to utilize the underlying patent. Under the terms of our
Project Agreement with Sheffield University, upon our commercialization of the
osteoporosis susceptibility test, Sheffield University is obligated to assign
the patent to us in its entirety. The U.S. Patent and Trademark Office has
recently issued a Notice of Allowance with respect to the aforementioned patent.
MARKET FOR OSTEOPOROSIS SUSCEPTIBILITY TEST. Twenty-eight million Americans
suffer from osteoporosis, of which 85% are women. Post-menopausal osteoporosis,
stemming from the loss of estrogen, affects more than one-half of all women over
65 years of age and has been detected in as many as 90% of women over age 75.
Osteoporosis is responsible for a majority of the 1.5 million bone fractures
each year, leading to disabilities costing more than $10 billion in medical,
social and nursing home costs. In 1991, one out of three
30
<PAGE> 35
American women were 50 years of age or older. The "baby boomer" generation began
to enter this age group in 1996.
In the past, a diagnosis of osteoporosis was made only after an elderly
individual had suffered a bone fracture. The current definition requires that
the individual has lost enough bone to put them at increased risk for fractures.
Since the strength of bones is largely determined by the mineral density of the
bones, an assessment of bone mineral density is currently the most reliable
method for determining whether one has osteoporosis. The diagnosis may therefore
be made by bone densitometry measurements that allow the calculation of the
density of bone relative to normal individuals. The key problem with this
approach is that it is directed at Those individuals who already have the
disease and have manifested symptoms. Although new therapies reverse some bone
loss, their primary benefit is in retarding future bone loss. Given that little
can be done to reverse damage that has already occurred, it appears that the
best management of osteoporosis will involve early detection and prevention.
By identifying at-risk individuals before symptoms appear, the individual
can be counseled to make appropriate life style changes or institute other
treatments. For example, calcium supplements and exercise have been shown to be
valuable preventive factors if used during a critical early age window. Hormone
replacement therapy has also been used successfully to combat osteoporosis
occurring after menopause. Hormone replacement therapy may be of greatest
benefit if used early in the disease process before major bone loss has
occurred. New treatment alternatives for osteoporosis include a class of drugs
that has recently been approved called bisphosphonates. Didronel(TM), a
bisphosphonate manufactured by Procter and Gamble Pharmaceuticals, is available
in much of Europe. Fosamax(TM), another new bisphosphonate produced by Merck,
has recently received FDA approval and is now marketed in the U.S.
Historically, it has been very difficult to reliably identify those women
who are at greater risk for developing severe osteoporosis. Although various
risk factors are strongly associated with osteoporosis, assessment of risk
factors in patients by means of questionnaires has not been a reliable means of
identifying women with low bone density. New urine or blood tests can detect
special chemical markers when the bone is actively being destroyed. However,
these chemical markers, like the bone density measurements, primarily provide
diagnostic information only after significant amounts of bone have been lost.
Unfortunately, the opportunity for increasing bone density by nutrition or
exercise occurs far before osteoporosis is detectable by such means.
Since our marker is genetic, we may test patients at an early age and
identify their risk. This provides the opportunity for disease prevention in the
form of lifestyle changes early enough to make a difference. This test may also
be valuable in selecting patients for early drug intervention to stop
osteoporosis. Such drugs include earlier supplementation with estrogen or a
preemptive use of a bisphosphonate-class drug such as Fosamax(TM).
We anticipate initiating marketing efforts related to a pre-commercial
phase for the osteoporosis susceptibility test in late 1997. See "Market
Development Strategy for Other Susceptibility Tests" at page 39. The full
commercial launch is anticipated to begin sometime in late 1998.
Genetic Susceptibility Test for Coronary Artery Disease (Patent Pending).
DESCRIPTION OF CAD TEST. The third genetic susceptibility test we are
developing is the coronary artery disease test (the "CAD test"). The CAD test is
a genetic test capable of detecting those individuals with a significantly
higher level of susceptibility to coronary artery disease. When an individual
has one copy of this specific genetic marker (i.e., is heterozygous) there is a
2.4 times greater chance of his developing coronary artery disease than the
general population. An individual who has two copies of the genetic marker
(i.e., is homozygous) has a 5.4 times greater chance of developing coronary
artery disease than the general population. It follows that being homozygous for
this particular genetic marker indicates a greater risk for coronary artery
disease than any other single risk factor (Figure 5).
31
<PAGE> 36
FIGURE 5
THE NEWLY IDENTIFIED GENETIC
POLYMORPHISM IS A STRONG RISK-MARKER
FOR CORONARY ARTERY DISEASE
<TABLE>
<CAPTION>
INCREASED RISK
RISK FACTOR/MARKER FOR CAD
------------------------------------ --------------
<S> <C>
Smoking 1 pack/day 2.4
Sedentary lifestyle 1.9
Severe obesity 3.3
Hypertension 2.1
High cholesterol (>240) 2.4
1 copy of new marker 2.4
2 copies of new marker 5.4
</TABLE>
Source: S. Francis, D. Crossman, G. W. Duff and co-workers. Submitted for
publication, 1997. Data on file at Medical Science Systems, Inc.
The availability of our CAD test will provide practitioners with a means of
truly practicing preventive medicine with respect to coronary artery disease.
The CAD test can be given to all individuals early in life because genetic risk
factors do not change over time. Individuals who test positive for the genotype
can be treated with more aggressive approaches to risk factor reduction. As
these individual age, they can be provided with more regular: (i) monitoring of
cholesterol levels; (ii) blood pressure testing; and (iii) early intervention to
alter the level of blood lipids (i.e., fats). Such an approach allows for truly
preventive medicine through early risk factor reduction and appropriate
monitoring for early detection of any problems.
A patent application related to the method of testing for genetic
predisposition to coronary artery disease has been filed and assigned to the
Sheffield University. Sheffield University, has in turn, granted to us an
exclusive worldwide license to utilize the underlying patent. Under the terms of
our Project Agreement with Sheffield University, upon our commercialization of
the CAD test, Sheffield University is obligated to assign the patent to us in
its entirety.
MARKET FOR CAD TEST. More than one in four Americans, or about 60 million,
have some form of cardiovascular disease. Cardiovascular diseases kill nearly
one million Americans every year -- more than all forms of cancer (about
500,000), accidents (about 85,000), and AIDS (about 38,000) combined. Since
1900, cardiovascular disease has been the number one cause of death in the U.S.
every year except 1918 (when there was a world-wide flu epidemic). If all forms
of cardiovascular disease were eliminated, life expectancy would rise by 7.78
years.
Atherosclerosis (or arteriosclerosis) refers to the progressive blockage of
arteries by plaque accumulation. Atherosclerosis is the principle cause of heart
attack, stroke and gangrene of the extremities. It is responsible for 50% of all
deaths in the U.S., Europe and Japan.
If atherosclerosis occurs in the arteries that supply blood to the heart,
then the disease is often referred to as coronary artery disease ("CAD"). CAD
results in heart attacks (myocardial infarctions) due to damage to the heart
muscle when blood supply (and therefore oxygen) is cut off and heart muscle
cells die. Approximately 13.5 million Americans suffer from coronary artery
disease, and approximately half a million Americans die each year from this
disease.
Although many theories exist, the causes and mechanisms of this build-up
are not completely understood. Because of this lack of understanding,
prediction, diagnosis, and treatment of atherosclerosis has centered on the
development of a set of risk factors that help to identify those individuals who
are most at risk. The primary approach to treatment for atherosclerosis, once
diagnosed, centers on controlling these risk factors.
32
<PAGE> 37
Unfortunately, many of the classic risk factors, such as smoking, high
cholesterol levels, and high blood pressure, only account for about half of the
incidence of CAD. Because CAD is the leading cause of death among people in the
U.S., a tremendous amount of research over the past four decades has been
directed at CAD. Initially, serum lipids (e.g., triglycerides and total
cholesterol) were linked with CAD during the 1940s and 1950s These observations
have been refined to focus on high and low density lipoproteins (i.e., "HDLs"
and "LDLs") as potential factors in the cause of the disease and as potential
markers of the disease.
Preventive treatment, including lifestyle changes and drug therapy, is
directed primarily at reducing the risk factors. Treatment strategies usually
involve coronary artery by-pass surgery or angioplasty (i.e., expansion of the
blood vessel), both of which only treat the result and not the root cause(s) of
the disease. Though an increasingly large number of risk factors have been
identified, they still only account for slightly over half of the cases of
atherosclerosis.
The genetic susceptibility test that we are developing may offer a
potential solution to this dilemma. The CAD test is based on a genetic marker
that is associated with an increased susceptibility to coronary artery disease
that substantially exceeded the increased risk of other commonly associated
factors, such as smoking or high cholesterol.
We anticipate initiating marketing efforts related to a pre-commercial
phase for the CAD test in late 1998. See "Market Development Strategy for Other
Susceptibility Tests" at page 39. The full commercial launch is anticipated to
begin in 1999.
Genetic Susceptibility Test for Retinopathy in Diabetics (Patent Pending).
DESCRIPTION OF THE DIABETIC RETINOPATHY TEST. The fourth genetic
susceptibility test we are developing is a test to determine the susceptibility
to sight-threatening retinopathy in diabetics. This susceptibility involves a
continued and increased risk of losing vision when an individual has been
diagnosed with diabetes. The data from our first clinical trial involving over
500 diabetics is shown below (Figure 6). Of the individuals who did not have the
specific genetic marker (genotype negative), approximately 10% developed
sight-threatening retinopathy. The risk for this group remained low and
relatively constant for many years. For genotype positive individuals, however,
the risk continued to increase dramatically until nearly 50% ultimately
developed sight-threatening diabetic retinopathy.
33
<PAGE> 38
FIGURE 6
[GRAPH DEPICTING SUSCEPTIBILITY TO DIABETIC RETINOPATHY]
Source: P. Richardson, I. Rennie, G. W. Duff and co-workers. Submitted for
publication, 1997. Data on file at Medical Science Systems, Inc.
Sight-threatening diabetic retinopathy refers to diabetic complications
affecting the retina that predictably lead to severe loss of vision. Retinal
disease is one of numerous problems related to diabetes. Retinal disease is
primarily the result of the disruption of small blood vessels in the retina due
to: (i) capillary leakage; and/or (ii) destruction or obstruction of capillaries
causing damage to the tissues of the retina and the uncontrolled growth of new
blood vessels. Such retinal changes are a leading cause of blindness in the
western world.
A patent application related to the method of testing for the genetic
predisposition to retinopathy in patients with diabetes has been filed and
assigned to Sheffield University. Sheffield University, in turn, has granted us
an exclusive, worldwide license to utilize the underlying patent. Under the
terms of our Project Agreement with Sheffield University, upon our
commercialization of the diabetic retinopathy susceptibility test, Sheffield
University is obligated to assign the patent to us in its entirety.
MARKET FOR DIABETIC RETINOPATHY TEST. In the United States there are
approximately 16 million people suffering from diabetes mellitus (or are
diabetic). It is estimated that only half of this number have been diagnosed.
There are two general categories of diabetes mellitus. Type I diabetes, or
insulin-dependent diabetes mellitus, generally appears in patients under 20
years of age and is marked by severe insulin deficiency. Type I diabetes is
generally detected at its onset and requires insulin treatment to control. Type
II diabetes, or non-insulindependent diabetes mellitus, emerges in patients over
20, may remain undetected for years, and is marked by insulin resistance and an
insulin deficiency. Dietary changes may be able to control Type II diabetes,
however, insulin supplements (that is, injections) are often required. Ninety
percent of all diabetics have Type II diabetes.
Patients with either form of diabetes mellitus are at risk of developing
complications such as problems with their nervous system, kidneys, vision and
heart. Studies have shown that the duration of diabetes is
34
<PAGE> 39
associated with the increasing incidence of diabetic complications. Accordingly,
the longer an individual has diabetes, the greater his or her chances of
developing complications. These complications are a major clinical burden in
diabetes, but the origination and development of the disease are not well
understood.
Diabetic retinopathy is one of the most common complications of diabetes.
It is the fourth leading cause of legal blindness in the U.S. and the leading
cause of blindness in people ages 20 to 74. Each year 15,000 to 39,000 people
lose their sight from diabetic retinopathy. Early detection of retinopathy is
critical to the prevention of vision loss. The early stage of this disease is
known as nonproliferative retinopathy. Nonproliferative retinopathy is somewhat
difficult to detect but responds well to treatment. Nonproliferative
retinopathy, if untreated, can deteriorate with a resultant loss of vision.
Although treatment may arrest the condition, it will not restore lost vision.
Proliferative retinopathy is the final state of the disease. At this point,
the disease involves the production or growth of new tissue in and around the
retina. These types of growths can lead to serious vision loss including
blindness. Satisfactory treatment is difficult in advanced proliferative
retinopathy. Surgical procedures used at this stage will themselves result in a
loss of patient vision four percent of the time. Clearly, early treatment of
diabetic retinopathy is desirable.
We have identified a genetic marker that is correlated with an increased
risk of developing diabetic retinopathy in patients who have diabetes. This
correlation seems to indicate an earlier onset of retinopathy in patients who
have diabetes thus putting such individuals at risk of losing their sight at an
earlier age. The availability of such a test would allow practitioners to assess
a patient's risk of losing his or her sight due to diabetes at the time that he
or she is diagnosed with the disease. Preventive treatment would allow doctors
to practice truly preventive medicine, providing a means of identifying
susceptible patients early in the disease process. Enhanced assessment and
monitoring can then be initiated from the start, allowing early detection of
problems and preemptive treatment that will ultimately reduce the incidence of
diabetes related vision loss. This would translate into improvements in patient
quality of life and cost savings.
Confirmatory clinical studies of the diabetic retinopathy susceptibility
test are scheduled for completion in mid-1998. We anticipate initiating
marketing efforts related to a pre-commercial phase for the diabetic retinopathy
susceptibility test sometime in 1998. See "Market Development Strategy for Other
Susceptibility Tests" at page 39. The full commercial launch is anticipated to
begin sometime in 1999.
Testing Procedure. Each of our four genetic susceptibility tests will
require that the following single procedure be utilized. To conduct a genetic
susceptibility test, the doctor will draw a blood sample and submit it to our
customer service department. We will log in the sample and submit sample batches
to the testing laboratory. The laboratory will perform the test following our
specific protocol and inform us of the results. We, in turn, will advise the
doctor of the results, who informs the patient and determines the appropriate
course of action. At the time results are provided to the doctor, our billing
service (which we presently "outsource") will invoice the patient directly for
the test. The doctor will then invoice the patient for his or her professional
services related to administration of the test.
We are currently using Baylor University as our commercial laboratory. We
will continue to use one or more sophisticated, certified, and fully validated
laboratories, such as the Baylor facility, capable of providing consistent and
high quality analysis. Customer service is handled via our toll free "888"
numbers by our own staff who are knowledgeable about our genetic susceptibility
tests, the procedural requirements of the testing system and the related
diseases.
Pre-Marketing Trials/Status of Susceptibility Tests. As an internal
procedural standard, we conduct three categories of clinical trials in
conjunction with our genetic susceptibility tests. The first trial is called a
proof of principle trial, used to prove a laboratory finding. The results of
this trial are utilized to support the initial patent application and therefore
need to be completed before the patent application can be filed. The second
trial is a confirmatory trial. The purpose of the confirmatory trial is to
independently confirm the results of the proof of principle trial. The third
category of trial relates to clinical utility. The clinical utility trial is
conducted to learn what is the most effective utilization of the test in actual
clinical practice. The
35
<PAGE> 40
current trial status and actual and anticipated commercial launch date of each
of our four genetic susceptibility tests is depicted below:
STATUS OF CLINICAL TRIALS AND ACTUAL/ANTICIPATED LAUNCH DATES
RELATED TO MSS' GENETIC SUSCEPTIBILITY TESTS
<TABLE>
<CAPTION>
INITIAL PROOF ACTUAL/ANTICIPATED
(PRIOR TO CONFIRMATORY COMMERCIAL
PATENT FILING) TRIAL CLINICAL UTILITY LAUNCH
-------------- ------------ ---------------- ------------------
<S> <C> <C> <C> <C>
Periodontal Disease................ Completed Completed Completed October 1997
Osteoporosis....................... Completed Completed Underway Late 1998
Coronary Artery Disease............ Completed Completed Underway 1999
Diabetic Retinopathy............... Completed Underway Not Yet Started 1999
</TABLE>
Following confirmatory studies, additional trials are completed on larger
populations to help develop broad scientific evidence supporting the clinical
utility of each of our tests. Such additional trials not only strengthen the
support for each tests' known use (i.e., detecting genetic susceptibility) but
also lead to additional practical uses of the susceptibility tests (e.g., use of
the susceptibility tests to determine a patient's responsiveness to a given
drug).
Product Development. Beyond our current four genetic susceptibility tests,
we have on-going research to continue to identify other genetic markers that
appear to be associated with certain other common diseases. We plan on filing
additional patent applications to cover these discoveries. It is our intent to
bring these discoveries to market in the form of additional genetic
susceptibility tests. We have also come upon certain genetic markers that might
be likely candidates to serve as therapeutic targets -- or in other words, be
susceptible to influence by drug agents. We are considering certain
collaborative long term relationships with pharmaceutical companies as a method
to provide for either the licensing of our discoveries or to assist in the
research and development of future products.
There may be additional applications of either our testing services or the
underlying technology that we use to develop and support our genetic testing
services. We will seek to exploit opportunities to develop such additional
applications in conjunction with other companies so long as our company's focus
remains on genetic susceptibility testing. For example, we have recently granted
a worldwide, nonexclusive, nontransferable license to Digisphere, LLC to market
customized versions of our computer modeling technology to pharmaceutical
companies. Previously, we had only used our computer modeling technology for the
internal development of our genetic testing services. On August 1, 1997,
Digisphere, LLC was formed, representing a joint venture between our company and
Nelson Communications Inc. ("NCI"), one of the largest providers of health care
marketing services to pharmaceutical companies in the United States. See
"Transactions with Directors and Executive Officers" at page 52. Ownership of
Digisphere, LLC is divided approximately equally between our company and NCI.
Digisphere, LLC has a stated term which lasts until August 31, 2000, unless
extended. However, the arrangement may be terminated upon mutual agreement or if
certain performance goals are not met. The primary purpose of the joint venture
is to market our computer modeling technology to pharmaceutical companies as a
tool which provides medical education regarding disease progression. A secondary
purpose of the joint venture is to provide marketing information to those
patients who test positive on one of our tests and who subsequently send in a
business reply card seeking more information. In both aspects of the joint
venture, our company will be acting as the technology/information partner and
NCI will be functioning as the marketing partner. As of September 30, 1997, we
have not received any revenues from this joint venture.
MARKET AND SELLING STRATEGIES
General Strategy. Our strategy is to build a commercial operation based on
the delivery of our genetic susceptibility testing services on a worldwide
basis. Our testing services are aimed at multi-factorial diseases which are
treatable and preventable. Our strategy assumes that genetic tests revealing
susceptibility to preventable diseases will ultimately be highly valued by the
public, by clinicians involved in prevention and
36
<PAGE> 41
treatment planning, by industries involved in clinical trials and by healthcare
payers and administrators who need to direct limited resources where they will
make the biggest difference.
We intend to utilize a sales and marketing approach which will aim to
improve patient care and treatment outcomes by incorporating genetic information
regarding disease susceptibility into overall risk assessment and treatment
planning. We hope to accomplish this through educating doctors, managed care
organizations, industry and the public about the value of targeting healthcare
investments based on an individual's tendency to develop a specific disease. We
will seek to influence attitudes and mindsets through clearly articulating the
benefit for our customers and adopting a missionary sales approach in
partnership with crusaders in the field. Emphasis will be placed on building
strong relationships with key decision-makers and educators who will work with
us to overcome the obstacles and influence the acceptance of genetic testing,
especially testing that reveals wanted information, as part of the medical
standard of care.
Our initial goal will be to establish genetic tests such as our periodontal
susceptibility test into overall risk assessment and treatment planning for
patients. Ultimately, we envision these tests being used more broadly by
healthcare administrators and practitioners as a screening tool to direct
limited resources in a more targeted and proactive way.
Market Strategy for Specific Tests.
MARKET STRATEGY FOR PERIODONTAL SUSCEPTIBILITY TEST. We plan to develop the
worldwide market for our periodontal susceptibility test directly through a
number of centrally-driven tactics and thereby establish an environment in which
locally appropriate, focused selling efforts will be most likely to succeed. The
worldwide market will be segmented according to geography and customer groups,
with appropriate emphasis being given to specific segments as the business
grows. Wherever possible, we will initially sell our periodontal susceptibility
test directly, anticipating that once demand has been created we may elect to
work in partnership with other selling organizations that offer significantly
greater access to the market and/or a better competitive position.
GEOGRAPHIC SEGMENTATION PLAN. Initial emphasis will be placed on sales of
our periodontal susceptibility test in North America. North America represents
at least half of the worldwide opportunity for our periodontal susceptibility
test. We intend to market directly in the U.S. and Canada, focusing on specific
customer segments as outlined below. In a parallel effort, we will also begin to
develop a sales program in Europe, in partnership with local sales organizations
familiar with the periodontal market. Emphasis will be placed on Italy, since
momentum and a customer base have already been established during our
pre-commercial phase. In the meantime, European customers who want access to our
periodontal susceptibility test are being serviced directly out of the U.S. The
same is true for Asia and South America. It is anticipated that partners will be
sought for sales efforts in these regions as well.
CUSTOMER SEGMENTATION PLAN. There are several potential customers for our
periodontal susceptibility test who need to be targeted in a specific order and
with appropriate emphasis over time. Our study of the value-chain involved in
making or influencing a purchasing decision for our periodontal susceptibility
test revealed that some of the key players involved include: specialists
(primarily periodontists), general dentists, hygienists, reimbursement groups
(i.e., insurance companies, managed care organizations, etc.) and, of course,
the individuals (and their families) who are being tested. The degree to which
each of these groups embrace our periodontal susceptibility test will be
influenced by how others in the value-chain view the value of the information.
For example, initial feedback indicates that patients will be strongly
influenced by their doctors. Whereas, generalists may be influenced by how
specialists view the value of the test. Managed care organizations are likely to
be influenced by how attractive the test is to their current or potential
members. The influence diagram for the decision to purchase the test reveals a
high degree of interdependence between all of the groups. For this reason, it is
critical to develop the market in the right order and with the appropriate
selling message for the specific group being targeted. It is important not to
skip a step in the process or believe that, just because resistance to change in
a specific segment may be great, such segment may be ignored. The initial
segmentation plan we have developed will allow us to focus resources on the
group most likely to generate early sales growth, while at the same time
ensuring long-term sustainability and opportunity
37
<PAGE> 42
for growth. In light of the foregoing, we will be targeting four customer
groups: (i) Periodontists/ periodontally-oriented GPs; (ii) General
Practitioners; (iii) Managed Care/Buying Groups; and (iv) Oral Care Companies
with Dental Research Programs.
Periodontist/Periodontally-oriented GPs. During the launch period and early
adoption phase, emphasis will be placed on this segment in both North America
and Europe. From a market development standpoint, we recognize that it is
critical that our periodontal susceptibility test be understood and accepted by
"periodontists" for it to gain broad acceptance in the other segments.
Relationships with opinion leaders and professional organizations are
already well established in this segment. Key opinion leaders have their own
data to present, which can be further supported with educational materials that
we have developed. Speakers will be engaged who can interpret the scientific
message and translate the breakthrough and effectively convey its clinical value
to others. Our goal is to be highly visible at major periodontal meetings
(international, national and "large" regional) the first year, with educational
information on our periodontal susceptibility test either incorporated into the
main program, or as part of an associated continuing education program wherever
possible. Our periodontal susceptibility test was recently featured at the last
general session of the American Academy of Periodontology meeting in October
1997.
From a selling standpoint, periodontists can be reached with a relatively
small organization through attending their major meetings and sending targeted
mail/fax communications. We initially expect periodontists to be our major
source of revenue transitioning to dental general practitioners ("GPs") over the
course of the first year.
We will seek to convince/motivate periodontists, in addition to testing
their own patients, to take the "genetic susceptibility testing/risk assessment
message" to referring GPs, and in some cases, directly to patients to help build
their practices. As such, we see periodontists as important multipliers and an
integral part of the "selling effort." Support materials, such as updated
referral slide shows and general dentist's brochures, patient brochures,
"informatics" and press release packets, are already being provided to help
periodontists to be more effective in this role.
General Practitioners. We intend on developing this segment in a parallel
manner, with emphasis switching from periodontists to GPs as the business grows.
From a market development standpoint, we are working closely with leaders in the
American Dental Association to help them understand the benefits of our
periodontal susceptibility test to GPs, and to motivate then to educate their
membership. Our periodontal susceptibility test is already scheduled to be
presented at the American Dental Association's major fall meeting in Washington,
D.C., where the test will also be included in an exhibit on dental innovations
at the Smithsonian. Emphasis will be placed on translating the clinical value as
it relates to a general practice, with appropriate opinion leaders from their
own "camps" being identified for this purpose. GPs will be the target of mass
mailings and advertising campaigns to increase brand recognition for our
periodontal susceptibility test. In addition, we will seek to use periodontists
as "advocates" to reach their GP referral base. As the need for additional sales
activities within this segment grows, we will evaluate using a "co-marketing"
arrangement with a large GP-oriented sales organization.
Managed Care/Buying Groups. Initially, we expect most genetic tests to be
paid for by the consumer, not insurance companies or other payors. Our
contracted billing service will directly bill the patient who has utilized the
test. We realize, however, that successful commercialization of our products and
services may depend in part upon the availability of reimbursement or funding
from third-party health care payors such as federal and state governmental
agencies, private insurance plans and health maintenance organizations. Thus, In
the longer term, we intend to target this managed care/buying group segment by
building a sales and marketing organization aimed at understanding the value of
genetic testing and risk assessment to large buying groups (including managed
care organizations of all forms and governments in some countries) and "selling"
through negotiating contracts with the decision makers (and gate keepers). This
is clearly the trend in organized healthcare and presents an opportunity for
susceptibility tests such our periodontal susceptibility test. As we grow, this
capability should also generalize to other genetic tests. From a market
development standpoint, we intend to better understand the needs of this
segment, and tailor claim support
38
<PAGE> 43
studies/educational activities to satisfy these needs. Our periodontal
susceptibility test is already scheduled to be featured at the next meeting of
the National Association of Dental Plans.
Oral Care Companies with Dental Research Programs. An additional segment
that we intend to target involves companies with clinical research programs. We
have already sold some of our periodontal susceptibility tests to companies that
are interested in having patients in their clinical studies genotyped. Due to
the clear benefit of including this information in large clinical studies and
our strong preexisting relationships with many of the companies in this segment,
we view this as an opportunity to generate additional sales during the first
year with a limited selling effort. However, there can be no assurance that
future sales will be effected or that such sales will result in net income.
Public Awareness/PR Plan. Initially most of our sales and marketing effort
aimed at the general public will be indirect, primarily in the form of brochures
and other tools that a doctor can use to explain the tests and their value to
patients. We have initiated some public relations activities in order to
increase public awareness of our specific tests and genetic susceptibility
testing more generally through the popular media. For example, with our
periodontal susceptibility test, we have initiated some publications in
cooperation with a professional organization known as the American Association
of Periodontology, which has its own vested interest in increasing public
awareness about the disease and featuring significant discoveries that help
validate the importance of the profession. We will begin to use PR in
coordination with our other selling efforts aimed at each customer segment we
approach. With the commercial introduction of the periodontal susceptibility
test at the American Academy of Periodontology meeting in October 1997, we began
a campaign aimed at reaching the periodontal and general dentists. Ultimately,
we plan on marketing directly to the public in order to create consumer demand
for our tests.
Educational and Promotional Materials. As with any change of behavior
product, we anticipate the sales and promotional effort for our genetic
susceptibility test to be highly education-intensive and are planning to develop
several materials to support this effort. In addition, some promotional
materials will be developed that are primarily aimed at increasing
brand/logo/company recognition and creating a "high tech/ high value" image for
ourselves.
Market Development Strategy for Other Susceptibility Tests. We are also
preparing market development plans to implement the "pre-commercial phase" for
our osteoporosis tests. We intend to implement a similar strategy as is
currently being utilized with our periodontal susceptibility test. We will
initially involve the current academic and research "thought leaders" in the
development and verification of our tests results and clinical utility. We will
then develop a speaker circuit where these thought leaders will begin to convey
the clinical utility and importance of our tests to specialists within each
testing area (e.g., cardiologist for the CAD test). As the thought leaders begin
to reach and influence the specialists we will then begin to target generalists,
who presumably will be or have been influenced by the specialists. At this point
direct marketing can be introduced to complete the progression, resulting in
consumer demand. This segmentation strategy has been proven to be effective with
other medical devices and is already being implemented with respect to our
periodontal susceptibility test.
SELLING METHODS
Direct Sales. We plan to build demand for our susceptibility tests using a
small direct consultative sales organization specializing in genetic testing,
risk assessment and change of behavior. We do not plan on building a large sales
force capability in any specific market; however, when the need for additional
sales force activity increases within a particular segment, we will consider
"co-marketing" or other business arrangements with companies with a large sales
organization in the field. Our direct sales capability will focus on the
profession segment initially, then shift to institutional and large buying group
sales. After a sales partner has been brought on, we will focus on sales partner
support and trade/professional association meetings. We will thereafter continue
to seek to establish corporate partnerships which will produce revenues,
credibility and a market presence for our other services and products.
Professional and Industry Meetings/Trade Associations. Initially, we will
be present and market our products and services at all national and selected
regional associations and meetings where a genetic
39
<PAGE> 44
susceptibility test has applicability to the professionals in attendance. Over
time, we anticipate our partners playing an increasingly important role in the
specific disease markets where our tests are used.
INTELLECTUAL PROPERTY
Our commercial success will be dependent in part on our ability to obtain
patent protection on genes, genetic sequences and/or their relationship to
common diseases, or products or methods based on the association between
particular genes and diseases, discovered by us and Sheffield University. We
have ten patent applications pending, including applications covering each of
our four genetic susceptibility tests. In June 1997, a Notice of Allowance was
issued by the United States Patent and Trademark Office with respect to both our
periodontal and osteoporosis susceptibility tests. A Notice of Allowance is
granted by the Patent and Trademark Office, if, on examination of the
application, the patent application is found to be allowable. Thereafter a fee
for issuing the patent is due within three months from the date of the Notice of
Allowance. When the issue fee is paid, the patent issues as soon as possible
after the date of payment, dependent upon the backlog of patents at the Patent
and Trademark Office. The patent is then delivered or mailed on the day of its
grant, or as soon thereafter as possible. We paid the issue fee related to the
application for the periodontal susceptibility test on July 18, 1997 and for the
osteoporosis susceptibility test on September 8, 1997. While the issuance of
these patents is likely, the exact date of issuance is not known. It is rather
unlikely, but possible, that the United States Patent Trademark Commissioner
could disallow the granting of our patents at any time prior to the date of
issuance. We have filed and will continue to file foreign counterparts of our
U.S. applications within the appropriate time frames. Where we have originally
filed in another country, we plan to file U.S. and other foreign counterparts
within the appropriate time frame. These applications seek to protect these gene
markers and corresponding use of gene markers, and products derived therefrom
and uses therefor. Some of these applications also identify possible biological
functions for the genes and gene fragments based in part on a comparison to
genes or gene fragments included in public databases but do not contain any
laboratory or clinical data with respect to such biological functions.
We own the patent application covering the genetic marker related to our
periodontal susceptibility test. However, with each of the other tests, the
Section of Molecular Medicine at Sheffield University holds the patent
application but has granted us an exclusive worldwide, irrevocable, transferable
license to make, have made, use, offer to sell, license and otherwise transfer
products created under the applicable patents. Sheffield University has retained
the right to carry on internal research related to the underlying patents.
However, under the terms of our Project Agreements with Sheffield University,
upon the commercialization of each test, Sheffield University is obligated to
assign the patent to us in its entirety.
We have filed three patents related to our computer modeling software
technology, two of which are still pending and one of which has issued. We are
continuing to identify and develop applications related to additional genetic
markers. We have also applied for trademark protection for the name of our
periodontal susceptibility test. Our proprietary technology is subject to
numerous risks. See "Uncertain Ability to Protect Proprietary Technology" at
page 11.
ETHICAL, LEGAL AND SOCIAL IMPLICATIONS OF GENETIC SUSCEPTIBILITY TESTING
The prospect of broadly available genetic susceptibility testing has raised
issues which are currently being widely discussed by the medical and scientific
communities, as well as other interested groups and organizations, regarding the
appropriate utilization and the confidentiality of information provided by such
testing. The recent movement towards discovery and commercialization of
susceptibility tests for screening a person's likelihood of developing one or
more chronic conditions has also focused public and legislative attention on the
need to protect the privacy of genetic screening medical information. With the
progression towards more comprehensive record keeping by health insurers and
managed care firms, this need has led to a number of legal initiatives. The
recently enacted federal health insurance reform law (Kassebaum-Kennedy of 1996)
recognizes the comparability of information obtained by genetic means to other
types of personal medical information. The law prohibits insurance companies
from refusing health insurance coverage to individuals on the basis of their
medical history, including "genetic information." This legislation also
prohibits employees from discrimination in hiring practices on the same basis.
This should serve as an example
40
<PAGE> 45
of a trend to protect the privacy of patients, while allowing them to be
screened for conditions which, as medicine progresses, can be prevented, reduced
in severity, or cured. Although the current trend is pro-genetic testing,
governmental authorities could, for social or other purposes, limit the use of
genetic testing or prohibit testing for genetic susceptibility to certain
conditions.
We have attempted to take a proactive stance in the ethical arena. We have
engaged Dr. Philip Reilly, who is both an M.D. (board certified specialist in
clinical genetics) and an attorney to advise us in the area of genetic testing
and its ethical, legal and clinical utility ramifications. Additionally, we are
currently advising doctors who administer our genetic susceptibility tests to
take special efforts to maintain the confidentiality of the test results. Our
intent is to avoid information about test results being disclosed to insurers
until issues regarding insurability have been fully analyzed and acted upon by
the appropriate legislative bodies.
On August 1, 1997, we formed a joint venture named Digisphere, LLC whose
purpose, in part, will be to provide marketing information to those patients who
test positive on one of our tests and who subsequently send in a business reply
card seeking more information. See "Product Development" at page 36. The
confidentiality of patient information is subject to regulation by state law. A
variety of statutes and regulations exist safeguarding privacy and regulating
the disclosure and use of medical information. State constitutions may provide
privacy rights and states may provide private causes of action for violations of
an individual's "expectation of privacy." Tort liability may result from
unauthorized access and breaches of patient confidence. We intend to comply with
state law and regulations governing medical information privacy.
COMPETITION
Although testing for major genetic defects, such as Down's Syndrome, has
been available for years, genetic susceptibility testing for multi-factorial
diseases is a newly emerging growth segment. Despite this segment's relatively
young age, companies other than ours do exist have research programs seeking
disease related genes for therapeutic and susceptibility testing purposes,
including some that involve treatable/ preventable disease. Other companies with
research programs include OncorMed, Inc. ("OncorMed"), Myriad Genetics, Inc.
("Myriad"), Genome Therapeutics Corp. ("GTC") and Sequana Therapeutics, Inc.
("Sequana"). Both GTC and Sequana have announced that they have research
programs focusing on osteoporosis. Myriad has a test for breast cancer and has
announced research programs for osteoporosis and coronary artery disease.
OncorMed, while engaged in the development of genetic susceptibility tests, is
focused solely on cancer.
Additionally, some of our competitors receive data and funding from the
Human Genome Project. The Human Genome Program is a federally funded program
focused on sequencing the human DNA and enriching the sequence data with
information about its biological function. To the extent our competitors receive
data and funding from the Human Genome Project at no cost to them, they may have
a competitive advantage over our company.
Each of the above noted company's involvement with genetic susceptibility
testing, together with large market capitalizations as public companies,
validates this newly emerging market. In the case of newly introduced products
requiring "change of behavior," (such as genetic susceptibility tests) multiple
competitors may accelerate market acceptance and penetration through increasing
awareness. Moreover, two different genetic susceptibility tests for the same
disease may in fact test or measure different components, and thus actually be
complementary when given in parallel as an overall assessment of risk, rather
than being competitive with each other.
Furthermore, with the exception of OncorMed, the primary focus of each of
the above-referenced companies is performing gene-identifying research for
pharmaceutical companies for therapeutic purposes, with genetic susceptibility
testing being a secondary goal. On the other hand, our company's primary
business focus is developing and commercializing genetic susceptibility tests
for common diseases, with only an ancillary drug discovery program. Factors
which further differentiate us from other companies are discussed below in
"Competitive Advantages" at page 42.
41
<PAGE> 46
COMPETITIVE ADVANTAGES
Other companies have entered the market for genetic testing as medical
research has increasingly recognized the advantages provided by early detection
of genetic predisposition. Although many of these competitors have greater
financial and other resources than us (see "Competition" at page 41), we believe
that our company has many competitive advantages, including:
(1) Alliance with The University of Sheffield, U.K. Our efforts in the
genetic discovery and development process are complemented by a strategic
alliance with the Section of Molecular Medicine at The University of
Sheffield, U.K. Sheffield University is one of the world's leaders in
genetic aspects of common diseases with an inflammatory component.
Sheffield University's research is targeted around identifying and
discovering genes and genetic markers which appear to correlate with a
patient's susceptibility to common diseases.
Our relationship with Sheffield University offers another significant
advantage over our competitors in reducing the cost of genetics research.
The gene discovery process uses and generates vast amounts of information.
Such research is time consuming, costly, heavily dependent upon advanced
computer technology and unpredictable. Sheffield University has an
integrated genetics program consisting of approximately 46 M.D. and Ph.D.
scientists and researchers focusing on molecular genetics. Sheffield
University performs gene-identifying research for us, thereby reducing our
costs and allowing us to focus our attention on developing and
commercializing known genetic markers. Many of our competitors' primary
focus and capital is spent on performing gene-identifying research.
In exchange for Sheffield University's providing us with research and
discoveries, the company has agreed to pay Sheffield University a share of
the resultant net profits, with the percentage of net profits for our
company and Sheffield University to be agreed upon separately under project
agreements related to each test (each a "Project Agreement"). Pursuant to
such Project Agreements, our share of the net profits ranges from 50% to
67%. See "Reliance on Collaborative Partners" at page 10. Net profits will
be paid out to Sheffield University only after we have recovered the cost
of goods sold, all marketing and sales costs and all operational costs
related to each of the separate tests.
(2) Identified Genetic Markers. While many of our competitors are
currently seeking to identify diseaserelated genes, we have already
identified four genetic markers that indicate a patient's genetic
predisposition to certain diseases. Additionally, we are continuing to
identify other genetic markers and intend to file patent applications
related to the same.
(3) Focus on Diseases that are Treatable and Preventable. We are one of
the few companies that we know of that is focusing on genetic
susceptibility testing services for diseases that are treatable and
preventable. Most of our competitors have not focused on
treatable/preventable diseases but have instead focused on drug development
with a secondary emphasis on genetic testing. Other companies, such as
Myriad and OncorMed are developing tests for breast cancer for which there
is no known preventive treatment (except mastectomy). The value of this
information is, as a result, often times "unwanted" by the patient. Our
tests, on the other hand, when used in overall risk assessment, provide
doctors and patients with information regarding a patient's risk for
developing a potential future disease. Since the disease is treatable and
preventable, this information is "wanted." Doctors and patients may use
this wanted information to take preventive measures to slow down or avoid
disease progression and develop treatment plans based on a patient's future
risk for disease progression.
(4) Focus on Developing and Commercializing Genetic Susceptibility
Testing Services. Our company's primary business focus is to develop and
commercialize genetic susceptibility testing services. We are committed to
becoming one of the world's leaders in marketing and selling genetic
susceptibility tests. We believe that broad market acceptance of genetic
susceptibility testing, and any particular test, can be achieved only by
educating consumers and professionals about the benefits of genetic testing
and demonstrating how genetic testing can improve patient risk assessment
and treatment. In order to commercialize our own products and prepare the
markets we are entering, we have built and continue to expand a team with
significant experience in the commercialization process and marketing high
42
<PAGE> 47
technology medical and dental products which require a change of behavior.
We have developed a focused marketing and sales strategy for our initial
product that includes segmentation, thought leader development, educational
marketing and consultative selling. See "Market and Selling Strategies" at
page 36.
(5) First to Market with a Genetic Susceptibility Test for a Disease
That is Treatable and Preventable. We are the only company that we know of
that has brought to market a test (our periodontal susceptibility test)
that identifies a genetic marker which indicates a greater susceptibility
to a disease which is treatable and preventable. As a result, we believe
that we are well-positioned to become a market leader in the periodontal
market and potentially in each of the other areas in which we have
developed or are developing tests.
(6) Computer Modeling Technology. We have developed a computer modeling
technology that simulates the biology of specific diseases. These
simulations include basic genetic, cellular and subcellular interactions,
as well as systems-level information about the clinical symptoms involved
in the disease process. They allow a comprehensive integration of
gene-expression data, basic biochemistry, and cell biology such that
disease-associated genetic findings may be linked to the clinical outcomes.
These simulations give us a competitive advantage by allowing us to more
accurately and efficiently:
(i) evaluate the combined effects of genetic markers and other risk
factors in order to establish risk assessment;
(ii) link risk assessment profiles to treatment regimes;
(iii) identify new candidate genes or genetic markers; and
(iv) design clinical trials more effectively.
(7) Integrated Risk Assessment and Treatment Planning Approach to
Multi-Factorial Diseases. While we recognize the importance of our genetic
susceptibility tests, we also acknowledge the reality of other risk factors
contributing to the development of disease. Thus certain diseases are often
referred to as "multi-factorial" given that several factors contribute to
their causation. See "Genetic Testing" at page 25. We have attempted to
take a holistic approach toward analyzing the disease process. Therefore
our risk assessment strategy includes not only the results of our genetic
susceptibility tests, but also other known risk factors. By combining our
test results together with present risk factors we are able to develop a
more accurate risk assessment tool. We then link patient testing criteria
to possible treatment suggestions. We package this data together with our
genetic susceptibility tests to enhance our tests' practical utility to
clinicians actually administering the tests.
(8) Experienced in Structuring Clinical Trials to Evaluate
Discoveries. We have extensive experience in product development, including
designing and conducting clinical trials to evaluate genetic and drug
discoveries. In the past, we provided clinical research services to
pharmaceutical and medical/dental device companies. We have performed
contract research for many of the world's leading health care and
pharmaceutical companies. Some of our representative clients have included:
Proctor & Gamble; Alpharma/Dumex; Implant Innovations, Inc.; W. L. Gore &
Associates; Teledyne WaterPik; and Oral B. Commencing in 1994, our research
team has increasingly focused on the development of our own products. Our
research capability expedites the development process and increases our
knowledge about target diseases. Moreover, we have already successfully
completed our initial proof trials on all four of our genetic
susceptibility test and confirmatory trials on three out of four of these
tests. See "Pre-Marketing Trials/Status of Susceptibility Tests" at pages
35 and 36.
(9) Cost Effective Commercialization Process. Because we are focusing
primarily on genetic susceptibility testing services and intend to develop
at least four genetic susceptibility tests initially, with more tests in
the future, we have designed our current product distribution and customer
service operation in such a way that it can process, perform, track, bill
and collect large volumes of genetic tests with appropriate quality and
customer service support. We have carefully designed our product
distribution and customer service operations to allow for multi-test or
product capabilities. The design and functionality of our product
distribution and customer service operations has been created in such a
43
<PAGE> 48
way as to enable us to easily move from a company currently selling only
one genetic susceptibility test to a company distributing a portfolio of
four or more such tests in multiple markets on a worldwide basis. Further,
our operations have the capability of processing additional tests or
products at even greater volumes with little or no modifications or
increases in capital outlays. Moreover, as each test or product is added
into our distribution stream, the cost per test to us decreases allowing
for increased profitability.
GOVERNMENT REGULATION
The sampling of blood, saliva or cheek scrapings from patients and
subsequent analysis in a clinical laboratory does not, at the present time,
require Federal Drug Administration ("FDA") or regulatory authority approval
inside the U.S. for either the sampling procedure or the analysis itself. The
samples are taken in the healthcare provider's office, using standard materials
previously approved as medical devices, such as sterile lancets and swabs. The
testing procedure itself is performed in one or more registered, certified
clinical laboratories under the auspices of the Clinical Laboratory Improvement
Amendments of 1988, administered by the Health Care Financing Administration.
The federal regulations governing approval of the laboratory facilities and
applicable state and local regulations governing the operation of clinical
laboratories would also apply. Changes in such regulatory schemes could require
advance regulatory approval of genetic susceptibility tests sometime in the
future could have a material adverse effect on our business.
In addition, while our main focus is on genetic susceptibility testing, we
may, in the future, endeavor to partner with pharmaceutical companies in the
area of drug development. Any drug products developed by us or our future
collaborative partners, prior to marketing in the United States, would be
required to undergo an extensive regulatory approval process by the FDA. The
regulatory process, which includes preclinical testing and clinical trials of
each therapeutic product in order to establish its safety and efficacy, can take
many years and requires the expenditure of substantial resources. Data obtained
from preclinical and clinical activities are susceptible to varying
interpretations which could delay, limit or prevent regulatory agency approval.
In addition, delays or rejections may be encountered during the period of
therapeutic development, including delays during the period of review of any
application. Delays in obtaining regulatory approvals could adversely affect the
marketing of any therapeutics developed by us or our collaborative partners,
impose costly procedures upon us and our collaborative partners' activities,
diminish any competitive advantages that we or our collaborative partners may
attain and adversely affect our ability to receive royalties. Once regulatory
approval of a product is granted, such approval may impose limitations on the
indicated uses for which it may be marketed. Further, even if such regulatory
approval is obtained, a marketed product and its manufacturer are subject to
continuing review. The discovery of previously unknown problems with a product
or manufacturer may result in restrictions on such product or manufacturer. Such
restriction could include withdrawal of the product from the market.
FACILITIES
Our company has offices in the following locations: Flagstaff, Arizona; San
Antonio, Texas; and Newport Beach, California. Flagstaff, Arizona is the site of
our global commercial operations, including our marketing, sales and customer
service organization. The San Antonio Research Center is the principal site of
our research and development and employs teams of top medical, dental and
computer scientists. Newport Beach is the site of our corporate headquarters.
Our commercial operations office located at 3100 N. West Street, Bldg. A,
Flagstaff, Arizona, contains 6,000 square feet and is held under a three-year
lease which expires in September 2000. Our research and development office,
located at 100 N.E. Loop 410, San Antonio, Texas, contains 1,961 usable square
feet and is held under a five-year lease that will convert into a month to month
tenancy on December 1, 2000 unless either party gives a prior 30 day notice. Our
corporate headquarters, located at 4400 MacArthur Boulevard, Suite 980, Newport
Beach, California, contains 1,798 usable square feet and is held under a
five-year lease which expires in April of 2001.
We believe that our current facilities are adequate for the foreseeable
future and that alternate facilities are readily available.
44
<PAGE> 49
EMPLOYEES
As of September 30, 1997, we had 27 full-time employees. Most of our
employees are engaged directly in the development and commercialization of our
tests. We believe that the success of our business will depend, in part, on our
ability to attract and retain qualified personnel.
Our employees are not covered by a collective bargaining agreement, and we
consider our relations with our employees to be good.
LEGAL PROCEEDINGS
We are not a party to, nor is our property the subject of, any pending
legal proceeding.
45
<PAGE> 50
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of our company are:
<TABLE>
<CAPTION>
NAME AGE POSITION SINCE
- ------------------------------- --- --------------------------------------------- -----
<S> <C> <C> <C>
Paul J. White, J.D., L.L.M.(1) 41 President, Chief Executive Officer and 1994
Chairman of the Board of Directors
Kenneth S. Kornman, DDS, Ph.D. 50 Chief Scientific Officer and Director 1986
Michael G. Newman, DDS 50 Executive Vice President, Secretary and 1986
Director
U. Spencer Allen, MS, MBA 55 Chief Financial Officer and Treasurer 1997
Jeanne Ambruster 40 Vice President, Global Business Operations 1997
Thomas A. Moore(1,2) 46 Director 1997
Ronald A. La Rosa(1,2,3) 40 Director 1997
</TABLE>
- ---------------
(1) Member of Compensation Committee.
(2) Member of Audit Committee.
(3) Mr. La Rosa will be appointed as a Director following the completion of this
offering.
Directors are elected to serve until the next annual meeting of
shareholders. Directors serve without cash compensation or other remuneration.
See "Principal Shareholders" at page 53.
Officers are elected by the Board of Directors and serve until their
successors are appointed by the Board of Directors. Biographical resumes of each
officer and director are set forth below.
Paul J. White, J.D., L.L.M. Mr. White joined the Company as President in
1994. Prior to joining our company, Mr. White was managing partner of White &
Resnick, Irvine, California, a mid-size law firm servicing emerging companies.
Mr. White was a business and corporate attorney and consultant to emerging
health care companies for 15 years. Mr. White holds a B.A. (History/Political
Science) from State University of New York at Brockport, a J.D. from
Southwestern University and an L.L.M. (Taxation) from the University of San
Diego.
Kenneth S. Kornman, D.D.S., Ph.D. Dr. Kornman is a co-founder, officer and
director of our company and currently serves as Chief Scientific Officer and
Director. Prior to founding our company in 1986, he was a Department Chair and
Professor at The University of Texas Health Science Center at San Antonio. He
has also been a consultant and scientific researcher for many of the major oral
care and pharmaceutical companies. Dr. Kornman currently holds academic
appointments at The University of Texas Health Science Center and Harvard
University. Dr. Kornman holds six patents in the pharmaceutical area, has
published two books and more than 100 articles and abstracts and has lectured
and consulted worldwide on the transfer of technology to clinical practice. Dr.
Kornman holds a B.A. in Economics from Duke University. He obtained a D.D.S.
from Emory University. Dr. Kornman also holds an M.S. (Periodontics) and a Ph.D.
(Microbiology) from the University of Michigan.
Michael G. Newman, D.D.S. Dr. Newman is a co-founder, officer and director
of our company and currently serves as Executive Vice President, Secretary and
Director. Prior to founding the Company in 1986, he was an adjunct Professor and
former Director of the Periodontal Microbiology Laboratory at the University of
California at Los Angeles (UCLA) and was president of the American Academy of
Periodontology. Dr. Newman is currently a member of the American College of
Dentists. Dr. Newman currently holds an academic appointment at UCLA. Dr. Newman
has published more than 200 articles and abstracts and is the co-author of four
books on microbiology, periodontitis and oral infections. Dr. Newman holds a
B.A. and a D.D.S. from the University of California at Los Angeles.
U. Spencer Allen, M.S., M.B.A. Mr. Allen joined the Company as Chief
Financial Officer in January 1997. From September 1996 to January 1997, Mr.
Allen functioned as an independent financial consultant. From August 1995 to
August 1996, Mr. Allen was the Vice President (Finance) and Chief
46
<PAGE> 51
Financial Officer of Promart Industries, Inc., a houseware products
manufacturer. Mr. Allen worked as a self-employed financial consultant from
January 1994 to August 1995. Prior to that time, Mr. Allen functioned as general
manager of Slow Waltz Imports, Inc., a potpourri manufacturer. Mr. Allen holds
B.S. (Engineering Science) from the U.S. Air Force Academy, an M.S. (Electrical
Engineering) from the University of Southern California and an M.B.A. (Finance)
from George Washington University.
Jeanne Ambruster. Ms. Ambruster joined as Vice President, Global Business
Operations in February 1997. Prior to joining our company, Ms. Ambruster served
as Senior Manager of the Medical and Dental Technologies Business Division for
16 years with W.L. Gore & Associates. At W.L. Gore & Associates, she played a
key role in the growth of this division and was the senior business leader
responsible for building the company's dental product business. Ms. Ambruster
holds a B.A. (Biology and Chemistry) from Pitzer College.
Thomas A. Moore. Mr. Moore became a director of our company in 1997. Mr.
Moore is the Chief Executive Officer and President of Nelson Communications
Inc., one of the largest providers of health care marketing services in the
United States. Prior to joining NCI as President in 1996, Mr. Moore was
President of Procter & Gamble's $3 billion worldwide prescription and
over-the-counter health care business and Group Vice President of the Procter &
Gamble Company. He joined Procter & Gamble in 1973 and held positions of
increasing responsibility in the company's cleaning products, beauty care,
Richardson-Vicks and personal care divisions. He is Chairman of the American
Health Foundation -- a nonprofit organization that researched the nutritional
and environmental factors in cancer and other diseases. Mr. Moore holds a B.A.
(History) from Princeton University.
Ronald A. La Rosa, M.B.A. Mr. La Rosa will become a Director upon
completion of this offering. Mr. La Rosa is the President and Chief Executive
Officer of Delta Technical Coatings, Inc. ("Delta"), a privately-owned consumer
product marketing company. Mr. La Rosa has been with Delta for over five years.
Prior to joining Delta, Mr. La Rosa worked for over eleven years with various
subsidiaries of The Mennon Company, a $600 million consumer products company.
Mr. La Rosa's various job capacities included Vice President Finance,
Controller, Director of Controls and Director International Finance. Mr. La Rosa
is a member of both the American Institute of Certified Public Accountants and
the New Jersey Society of Certified Public Accountants. Mr. La Rosa holds a B.S.
(Accounting) and an M.B.A. (Finance) from Fairleigh Dickinson University.
KEY EMPLOYEES
Pamela K. Fink, Ph.D., Executive Director, Biologic Modeling Group. Dr.
Fink has operational responsibility for our company's computer technology
development. Dr. Fink is an expert in knowledge acquisition and simulation of
complex systems. Dr. Fink joined the Company as Executive Director, Biologic
Modeling Group in July 1994. She was formerly with the Southwest Research
Institute for 10 years as a Section Manager and Staff Scientist. Dr. Fink holds
a B.A. (Mathematics and Philosophy of Language) from Eckerd College and an M.A.
and Ph.D. in Computer Science from Duke University.
Debra J. Moore, M.S., Vice President, Product Development. Ms. Moore joined
the Company as the Vice President, Product Development in September 1990. Ms.
Moore has 19 years practical experience in identification and development of new
health care products. Prior to joining us, Ms. Moore spent 13 years at Procter &
Gamble Health Care where she was a Senior Manager in the Oral Care Product
Development and Professional Relations Division. Ms. Moore was a leader in the
research, development, manufacture and FDA approval of such products as Tartar
Control Crest and Peridex, the first prescription drug approved by the FDA for
the treatment of periodontal disease. Ms. Moore holds a B.S. (Chemistry) from
Central Michigan University and an M.S. (Organic Chemistry) from the University
of Wisconsin, Madison.
Evan B. Siegel, M.Phil, Ph.D., Vice President, Regulatory Affairs. Dr.
Siegel joined our company as Vice President of Regulatory Affairs in August
1996. From January 1994 to July 1996, Dr. Siegel was employed by Quintiles,
Inc., a multinational contract research organization, where he held positions as
Director, Regulatory Services, Director, Regulatory Consulting, and Principal
Regulatory Scientist. From November 1991 until February 1994, he held senior
management positions at Astra Pharmaceutical Products,
47
<PAGE> 52
Inc. Previously, Dr. Siegel was Director, OTC Regulatory Affairs at Syntex, USA,
Inc. and Chief of Special Services and Supervising Toxicologist at the
California Food and Drug Branch and a reviewer at the U.S. Food and Drug
Administration. Dr. Siegel holds a B.S. (Physics) from Bucknell University, an
M.S. (Radiological Health), an M.Phil. (Virology) and a Ph.D. (Virology) from
Rutgers University.
Todd D. Snowden, Director of Worldwide Sales. Mr. Snowden joined our
company as Director of Worldwide Sales, in April 1997. From 1986 until joining
us, Mr. Snowden worked in the Regenerative Technologies division at W. L. Gore &
Associates, selling surgical devices and regenerative materials and as a product
manager with responsibility for all aspects of their products. Mr. Snowden holds
a B.S. (Biomedical Engineering) from Catholic University of America.
Nancy Whitley, Director of Market Development & Commercialization. Ms.
Whitley is involved in transitioning products in the development phase into the
marketplace, including leading pre and post-commercial product launches. Ms.
Whitley has been the Director of Market Development & Commercialization for our
company since February 1997. Prior to joining us, Ms. Whitley was a Senior
Manager in the Medical and Dental Technologies Business Division of W. L. Gore &
Associates where she worked for 19 years. Ms. Whitley holds a B.A. (Education)
from Northern Arizona University.
SCIENTIFIC EXPERTS
We have engaged a number of scientific experts to render services. With the
exception of one expert, we either (i) have entered into written agreements with
the expert, each of which provides that we are the sole and exclusive owner of
all proprietary rights to all genetic discoveries and related technology,
whether developed by us or our consultant; or (ii) receive services from the
consultant underneath existing agreements between our company and Sheffield
University. We currently have no written agreement in place with Dr. Bailit.
Some of our scientific experts are engaged on a project basis while others are
kept on a retainer and utilized in accordance with our current needs. Set forth
below is a brief description of each scientific expert's background.
PROFESSOR GORDON W. DUFF, M.A., PH.D., FRCP
Lord Florey Chair and Director of the Division of Molecular and Genetic
Medicine
The University of Sheffield, U.K.
Professor Duff is internationally recognized as a leader and innovator in
the genetic aspects of cytokines and the immuno-inflammatory response. He is a
fellow of the Royal College of Physicians, Edinburgh. Professor Duff holds a
B.A. (Animal Physiology), an M.A. (Physiology) and a B.M., B.Ch., all from the
University of Oxford and a Ph.D. in Medicine from the University of London.
FRANCESCO S. DI GIOVINE, M.D., PH.D.
Head of the Section of Molecular Medicine
in the Department of Molecular and Genetic Medicine
The University of Sheffield, U.K.
Dr. di Giovine is a molecular geneticist managing the Sheffield University
Molecular Medicine research and development laboratory. Dr. di Giovine holds a
M.D. from the University of Florence, Italy and a Ph.D. (Molecular Immunology)
from the University of Edinburgh, U.K.
PROFESSOR GRAHAM RUSSELL, M.B., CH.B, D.M., PH.D
Director of Division of Biochemical and Musculoskeletal Sciences
Professor of Human Metabolism and Clinical Biochemistry
The University of Sheffield, U.K.
Professor Russell is an internationally recognized researcher in the field
of osteoporosis. Professor Russell holds a B.A. (Biochemistry), an M.A.
(Biochemistry) and an M.B., Ch.B. (Pharmacology, Therapeutics and Toxicology)
from Cambridge University. Dr. Russell also holds a Ph.D. (Chemical Pathology)
from Leeds University, as well as a Doctor of Medicine (D.M.) from Oxford
University.
48
<PAGE> 53
PHILIP R. REILLY M.D., J.D.
Eunice Shriver Center
Dr. Reilly is an expert in the area of genetic testing and its ethical,
legal and clinical utility ramifications. Dr. Reilly is a board certified
specialist in clinical genetics and an attorney. Dr. Reilly holds a B.A.
(Government) from Cornell University, a J.D. from Columbia University and a M.D.
from Yale University.
HOWARD L. BAILIT, D.M.D., PH.D.
University of Connecticut Health Center
Dr. Bailit is a former senior vice president of Medical Policies and
Programs for Aetna Health Plans and was responsible for the assessment and
acceptance of new medical technology. Dr. Bailit assists with the assessment of
new product opportunities with understanding of third-party payor issues. Dr.
Bailit holds a D.M.D. from Tufts Dental School, an M.A. (Anthropology) and a
Ph.D. (Anthropology) from Harvard University.
EXECUTIVE COMPENSATION
The following table sets forth total compensation for the year ended
December 31, 1996 for the Chief Executive Officer, and each of the other
executive officers of our company for each of the last three fiscal years (the
"Named Executive Officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
-------------------------------
AWARDS
ANNUAL COMPENSATION --------------------- PAYOUTS
--------------------------------- RESTRICTED SECURITIES -------
OTHER ANNUAL STOCK UNDERLYING LTIP ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION AWARD(S) OPTIONS/ PAYOUTS COMPENSATION
POSITION YEAR ($) ($) ($) ($) SARS (#) ($) ($)
- ------------------------ ---- ------- ----- ------------- ---------- -------- ------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Paul J. White 1996 138,332 -0- -0- -0- -0- -0- -0-
CEO, President 1995 102,226 -0- -0- -0- -0- -0- -0-
1994 60,607 -0- -0- -0- -0- -0- -0-
- ------------------------------------------------------------------------------------------------------------------
Kenneth S. Kornman 1996 154,886 -0- -0- -0- -0- -0- -0-
Chief Scientific
Officer 1995 103,735 -0- 23,797* -0- -0- -0- -0-
1994 217,629 -0- 30,000* -0- -0- -0- -0-
- ------------------------------------------------------------------------------------------------------------------
Michael G. Newman 1996 141,695 -0- -0- -0- -0- -0- -0-
Executive Vice
President 1995 121,536 -0- 23,797* -0- -0- -0- -0-
Secretary 1994 274,146 -0- 30,000* -0- -0- -0- -0-
</TABLE>
- ---------------
* These amounts reflect contributions made to our profit sharing plan.
49
<PAGE> 54
OPTION GRANTS IN LAST FISCAL YEAR
The following table provides information concerning each grant of options
to purchase our Common Stock made during the year ended December 31, 1996 to the
Named Executive Officers:
OPTION/SAR GRANTS IN LAST FISCAL YEAR
(INDIVIDUAL GRANTS)
<TABLE>
<CAPTION>
NUMBER OF SECURITIES PERCENT OF TOTAL
UNDERLYING OPTIONS/SARS
OPTIONS/SARS GRANTED GRANTED TO EMPLOYEES EXERCISE OR BASE EXPIRATION
NAME (#) IN FISCAL YEAR PRICE ($/SH) DATE
- ----------------------------- -------------------- -------------------- ---------------- ----------
<S> <C> <C> <C> <C>
Paul J. White -0-* -0- -0- N/A
Kenneth S. Kornman -0-** -0- -0- N/A
Michael G. Newman -0-*** -0- -0- N/A
</TABLE>
- ---------------
* Does not reflect 25,000 stock options issued in 1997. Does not reflect
20,000 warrants purchased as part of a debt/warrant offering in 1997. See
"Debt/Warrant Offering" at page 52.
** Does not reflect 22,000 stock options issued in 1997. Does not reflect
20,000 warrants purchased as part of a debt/warrant offering in 1997. See
"Debt/Warrant Offering" at page 52.
*** Does not reflect 35,125 stock options issued in 1997. Does not reflect
20,000 warrants purchased as part of a debt/warrant offering in 1997. See
"Debt/Warrant Offering" at page 52.
1996 EQUITY INCENTIVE PLAN
Our 1996 Equity Incentive Plan (the "Plan") was adopted by the Board of
Directors and approved by the shareholders in June 1996. A total of 750,000
shares of Common Stock were originally reserved for issuance under the Plan. The
Plan was later amended by vote of both the Board of Directors and the
shareholders in May 1997 to increase the number of shares of Common Stock
reserved for issuance under the Plan to 1,000,000. The Plan provides for grants
of incentive stock options to employees (including officers and employee
directors), nonstatutory stock options to employees (including officers and
employee directors) and consultants (including non-employee directors), stock
appreciation rights ("SARs"), stock awards and stock bonuses. The Plan allows
for administration by either the Board of Directors or a committee thereunder,
which determines optionees and the terms of options granted, including the
exercise price, number of shares subject to the option and the exercisability
thereof.
The terms of options granted under the Plan generally may not exceed 10
years. The exercise price of options granted under the Plan is determined by the
Board of Directors, but, in the case of an incentive stock option, cannot be
less than 100% of the fair market value of the Common Stock on the date of
grant. The exercise price of all nonstatutory stock options must equal at least
85% of the fair market value of the Common Stock on the date of grant. The
exercise price of any stock option granted to an optionee who owns stock
possessing more than 10% of the voting power of all classes of stock of our
company must equal at least 110% of the fair market value of the Common Stock on
the date of grant. The exercise price may be paid in such consideration as
determined by the Board of Directors or a committee of the Board, including cash
and promissory notes. Options granted under the Plan to employees and
consultants have generally not been immediately exercisable and have vested over
a thirty-six (36) month period (at the rate of 16.66% of the shares subject to
the option at the end of six (6) months and 2.777% at the end of every full
month thereafter). No option may be transferred by the optionee other than by
will or the laws of descent or distribution. An optionee whose relationship with
us or any related corporation ceases for any reason (other than by death or
permanent and total disability) may exercise options in the three (3) month
period following such cessation (unless such options terminate or expire sooner
by their terms) or in such longer period determined by the Board of Directors,
provided a period of five (5) years is not exceeded.
Shares subject to options granted under the Plan which have lapsed or
terminated may again be subject to options granted under the Plan. Furthermore,
the Board of Directors may offer to exchange new options for
50
<PAGE> 55
existing options, with the shares subject to the existing options again becoming
available for grant under the Plan. Upon any merger or consolidation in which we
are not the surviving corporation, all outstanding options shall either be
assumed or substituted by the surviving entity. If the surviving entity
determines not to assume or substitute such options, the options terminate as of
the closing of the merger or consolidation.
As of September 30, 1997, no shares of Common Stock had been issued upon
the exercise of options granted under the Plan, options to purchase 800,579
shares of Common Stock at a weighted average exercise price of $4.37 per share
were outstanding and 199,421 shares remained available for future options
grants. Prior to this offering, no SARs or restricted stock awards had been
given to our employees and consultants. The Plan will terminate in June 2006,
unless terminated sooner by the Board of Directors.
EMPLOYMENT AGREEMENTS
In January 1996, we entered into employment contracts with all three of the
Named Executive Officers. Mr. Paul J. White, the Chief Executive Officer and
President, currently receives an annual base salary of $140,000 a year, which
will increase to $170,000 for 1998. Drs. Kenneth S. Kornman and Michael G.
Newman each currently receive an annual base salary of $135,000, which will
increase to $165,000 for 1998. Each Named Executive Officer's employment
contract has a five year term (beginning in January 1996) which is automatically
renewed for an additional twelve months unless six-months prior written notice
is given by either party. Each of the Named Executive Officers is also receiving
a $600 a month automobile allowance.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
Our company's Amended and Restated Articles of Incorporation eliminates the
liability of directors for monetary damages for an act or omission in the
director's capacity as a director, except for: (i) a breach of a director's duty
of loyalty to our company or our shareholders; (ii) an act or omission not in
good faith that constitutes a breach of duty of that director to our Company or
an act or omission that involves intentional misconduct or a knowing violation
of the law; (iii) a transaction from which a director received an improper
benefit, whether or not the benefit resulted from an action taken within the
scope of the director's office; or (iv) an act or omission for which the
liability of a director is expressly provided for by an applicable statute.
If the Texas Miscellaneous Corporation Laws Act or the Texas Business
Corporation Act is amended to authorize action further eliminating or limiting
the personal liability of directors, then the liability of a director of our
company shall be eliminated or limited to the fullest extent permitted by such
statutes, as so amended. Any amendment, repeal or modification of such provision
shall be prospective only and shall not adversely affect any right or protection
of a director of our company existing at the time of such amendment, repeal or
modification.
Additionally, it is the position of the Securities and Exchange Commission
that indemnification of directors and officers for liabilities arising under the
Securities Act of 1933 is against public policy and unenforceable pursuant to
Section 14 of the Securities Act of 1933.
51
<PAGE> 56
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
We believe that the transactions set forth below were made on terms no less
favorable to us than could have been obtained from unaffiliated third parties.
All future transactions, including loans, between us and our officers,
directors, principal shareholders and their affiliates will be approved by a
majority of the Board of Directors, including a majority of the independent and
disinterested outside directors, and will continue to be on terms no less
favorable to us than could be obtained from unaffiliated third parties.
PRIVATE PLACEMENT OF SECURITIES
Between November 1996 and January 1997, we sold 189,188 shares of our
Common Stock in a private placement at a price of $3.70 per share. Between March
1997 and September 1997, we sold 293,820 shares of our Common Stock in a second
private placement transaction at a price of $5.00 per share. Except for Thomas
Moore, who subsequently became one of our directors, all investors in both such
private placements were unrelated third party investors who purchased in
arms'-length transactions.
DEBT/WARRANT OFFERING
From August 1, 1997 through October 6, 1997, we borrowed an aggregate of
$1,780,000 from a group of lenders evidenced by promissory notes bearing
interest at 10% interest rate and due the earlier of fourteen months from the
date of the notes or the closing date of an initial public offering (the "Bridge
Loans"). As additional consideration for the Bridge Loans, we issued one warrant
for each $5.00 loaned to the Company for a total of 356,545 warrants (the
"Bridge Warrants"). Each Bridge Warrant entitles the holder to purchase one
share of Common Stock at $5.50 per share for a period of five years from the
date of issuance. The following officers and directors subscribed to the Bridge
Loans in the principal amount indicated after their names: Paul J. White
($100,000/20,000 Bridge Warrants); Kenneth S. Kornman ($100,000/20,000 Bridge
Warrants); Michael G. Newman ($100,000/20,000 Bridge Warrants); U. Spencer Allen
($50,000/10,000 Bridge Warrants); Jeanne Ambruster ($50,000/10,000 Bridge
Warrants); and Thomas A. Moore ($75,000/15,000 Bridge Warrants).
TRANSACTIONS WITH DIRECTORS AND EXECUTIVE OFFICERS
Our shareholders have elected Thomas A. Moore to serve as a director. Mr.
Moore is also the CEO and President of Nelson Communications, Inc. ("NCI"). We
have recently formed a joint venture with NCI. The primary purpose of the joint
venture is to market our computer modeling technology to pharmaceutical
companies as a tool which provides medical education regarding disease
progression. A secondary purpose of the joint venture is to provide marketing
information to those patients who test positive on one of our tests and who
subsequently send in a business reply card seeking more information. In both
aspects of the joint venture, our company will be acting as the
technology/information partner and NCI will be functioning as the marketing
partner. See "Product Development" at page 36. We believe that the terms of the
joint venture are at least as favorable to us as would be available from a
company other than NCI in an arm's-length transaction. The disinterested members
of the Board of Directors have unanimously approved the execution of this
agreement.
EMPLOYEE SALARY REDUCTION PLAN
In May 1997, in order to reduce our overhead and as an additional incentive
to our employees, we instituted a voluntary salary reduction plan where our
employees could choose to receive stock options instead of salary. Employees
were offered options to purchase 600 shares of Common Stock for every $1,000
their salary was reduced. Most of our employees participated, including all of
our officers. A total of 267,079 options to purchase Common Stock at an exercise
price of $5.00 or $5.50 per share were issued to employees.
52
<PAGE> 57
PRINCIPAL SHAREHOLDERS
As of September 30, 1997, we have issued 3,738,007 shares of Common Stock
to 72 holders of record. The following table sets forth certain information
regarding the beneficial ownership of shares of our Common Stock as of September
30, 1997 by (i) each of our company's directors and executive officers, (ii)
each person who beneficially owns more than 5% of the outstanding shares of
Common Stock, and (iii) all directors and officers of our company as a group.
Unless otherwise indicated, the shareholders listed below may be reached at 4400
MacArthur Boulevard, Suite 980, Newport Beach, California 92660.
<TABLE>
<CAPTION>
PERCENTAGE BENEFICIALLY OWNED(1)
SHARES ---------------------------------
NAME BENEFICIALLY OWNED BEFORE OFFERING AFTER OFFERING
- ---------------------------------------------------- ------------------ --------------- --------------
<S> <C> <C> <C>
Kenneth S. Kornman(2)............................... 1,131,235 30.26% 17.85%
100 N.E. Loop 410
San Antonio, Texas 78216
Paul J. White(3).................................... 1,121,110 29.99% 17.69%
Michael G. Newman(4)................................ 1,072,110 28.68% 16.92%
U. Spencer Allen(5)................................. 62,783 1.68% *
Jeanne Ambruster(6)................................. 38,999 1.04% *
3100 N. West St., Bldg. A
Flagstaff, Arizona 86004
Thomas A. Moore(7).................................. 75,998 2.03% 1.20%
41 Madison Avenue, Ste. 27
New York, New York 10010
Ronald A. LaRosa(8)................................. -- * *
231 S. Francisco Place
Anaheim Hills, California 92807
All Officers and Directors as a Group (7
persons)(9)....................................... 3,502,235 93.69% 55.26%
</TABLE>
- ---------------
* Less than one percent.
(1) Percentage of ownership for each holder is based on 3,738,007 shares of
Common Stock outstanding on September 30, 1997 together with applicable
options and warrants for such shareholder. Beneficial ownership is
determined in accordance with the rules of the Securities and Exchange
Commission and generally includes shares over which the holder has voting or
investment power, subject to community property laws. Shares of Common Stock
subject to options and warrants that are currently exercisable or
exercisable within 60 days are deemed to be beneficially owned by the person
holding the option or warrants for computing such person's percentage, but
are not treated as outstanding for computing the percentage of any other
person.
(2) Includes 983,333 shares held in Rocklyn, Ltd., a Texas limited partnership
created for the benefit of the Kornman family, including Mr. Kornman.
Includes 27,902 shares issuable pursuant to options exercisable within 60
days of September 30, 1997 and 20,000 shares issuable pursuant to warrants
which are immediately exercisable.
(3) Mr. Paul J. White and Mrs. Suzette White, as trustees of the White Family
Trust, have voting power over 1,022,333 of such shares. The White Family
Trust was established for the benefit of members of the White family,
including Mr. White. Includes 60,000 shares held in irrevocable trusts
created for the benefit of the White's children. Mr. White disclaims
beneficial ownership of such shares. Includes 17,777 shares issuable
pursuant to options exercisable within 60 days of September 30, 1997 and
20,000 shares pursuant to warrants which are immediately exercisable.
(4) Mr. Michael G. Newman and Mrs. Susan L. Newman, as trustees of the Newman
Family Trust, have voting power over 806,556 of such shares. The Newman
Family Trust was created for the benefit of the family of Michael G. Newman
and Mrs. Susan L. Newman. Mr. and Mrs. Newman, as general partners of The
Michael and Susan Newman Family L.P., a Delaware limited partnership, have
voting power over 196,000 shares included therein. Mr. Newman disclaims
beneficial ownership of such shares. Includes
53
<PAGE> 58
14,777 shares issuable pursuant to options exercisable within 60 days of
September 30, 1997 and 20,000 shares issuable pursuant to warrants which are
immediately exercisable.
(5) Includes 52,783 shares issuable pursuant to options which are exercisable
within 60 days of September 30, 1997 and 10,000 shares issuable pursuant to
warrants which are immediately exercisable.
(6) Includes 28,999 shares issuable pursuant to options which are exercisable
within 60 days of September 30, 1997 and 10,000 shares issuable pursuant to
warrants which are immediately exercisable.
(7) Includes 6,944 shares issuable pursuant to options which are exercisable
within 60 days of September 30, 1997 and 15,000 shares issuable pursuant to
warrants which are immediately exercisable.
(8) Mr. LaRosa will be appointed as a Director of our company upon completion of
this offering. Mr. LaRosa currently holds no beneficial interest in our
company.
(9) Includes all shares deposited in trust by the officers and directors of our
company, in which shares such officers and directors disclaim any beneficial
ownership interest.
DESCRIPTION OF SECURITIES
We are authorized to issue up to 10,000,000 shares of no par value Common
Stock and 5,000,000 shares of Preferred Stock. As of September 30, 1997, there
were outstanding 3,738,007 shares of Common Stock held of record by 72 persons.
No shares of Preferred Stock were issued or outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share on all matters
to be voted upon by the shareholders. Holders of Common Stock are entitled to
receive ratably such dividends, if any, as may be declared by the Board of
Directors out of funds legally available therefor. Upon the liquidation,
dissolution, or winding up of our company, the holders of Common Stock are
entitled to share ratably in all of our assets which are legally available for
distribution, after payment of all debts and other liabilities and the
liquidation preference of any outstanding Common Stock. Holders of Common Stock
have no preemptive, subscription, redemption or conversion rights. The
outstanding shares of Common Stock are, and the shares being sold by us in this
offering will be, when issued and delivered, validly issued, fully paid and
nonassessable.
Based upon the number of shares outstanding as of that date, and after
giving effect to the sale of the Common Stock offered hereby, there will be
6,338,007 shares of Common Stock outstanding (assuming no exercise of
outstanding options, warrants or the Underwriters' over-allotment option).
PREFERRED STOCK
Our company is authorized to issue up to 5,000,000 shares of Preferred
Stock. No shares of Preferred Stock are outstanding. The Board has the authority
without any further action by our shareholders to issue any or all of the
authorized shares of Preferred Stock in one or more series and to establish the
rights, preferences, privileges and restrictions thereof, including dividend
rights, conversion rights, voting rights, terms of redemption, liquidation
preferences, sinking fund terms and the number of shares constituting any series
or the designation of such series. The issuance of Preferred Stock could
adversely affect the holders of Common Stock and could have the effect of
delaying, deferring or preventing a change in our control. We have no present
plans to issue any shares of Preferred Stock. See "Effect of Preferred Stock and
Director Removal Provisions" at page 16.
OPTIONS AND WARRANTS
Options. As of September 30, 1997, 800,579 options to purchase our Common
Stock had been issued under our 1996 Equity Incentive Plan. These options vest
over time and have a per share exercise price from $3.70 to $5.00. See "1996
Equity Incentive Plan" at page 50.
Underwriters' Warrants. Upon completion of this offering, we will have
granted to the Underwriters warrants (the "Underwriters' Warrants") to purchase
260,000 shares of Common Stock. The Underwriters' Warrants are exercisable at a
price per share equal to 165% of the initial public offering price for a
four-year
54
<PAGE> 59
period, commencing one year from the effective date of this offering. The
Underwriters' Warrants contain anti-dilution provisions providing for
adjustments of the exercise price and the number of shares underlying the
Underwriters' Warrants upon the occurrence of certain events, including any
recapitalization, reclassification, stock dividend, stock split, stock
combination or similar transaction. The Underwriters' Warrants grant to the
holders thereof certain registration rights which are described below. See
"Registration Rights" at page 55 and "Underwriting" at page 57.
Bridge Warrants. From August 1, 1997 through October 6, 1997, we borrowed
an aggregate of $1,780,000 from a group of lenders evidenced by promissory notes
bearing interest at 10% interest rate and due the earlier of fourteen months
from the date of the notes or the closing date an initial public offering (the
"Bridge Loans"). The Bridge Loans are subordinate to the prior payment in full
of all of our secured obligations currently existing or those created in the
future. As additional consideration for the Bridge Loans, we issued one warrant
for each $5.00 loaned to the Company for a total of 356,545 warrants (the
"Bridge Warrants"). Each Bridge Warrant entitles the holder to purchase one
share of Common Stock at $5.50 per share for a period of five years from the
date of issuance. We can call the Bridge Warrants if the Common Stock is listed
on a national market or Nasdaq system and has had a closing price of at least
$12.00 per share for thirty (30) consecutive trading days.
REGISTRATION RIGHTS
In connection with the Underwriters' Warrants, the holders of the Common
Stock issuable upon exercise of the Underwriters' Warrants have the right to
notice and inclusion in any registration statement filed by us for a period of
six (6) years commencing one year after our initial public offering closes
solely at our expense (but excluding fees and expenses of the holder's counsel
and any underwriting or selling commissions). Additionally, we agreed to allow
one demand registration for a period of four years from the effective date of
the registration statement, upon written demand of holder(s) representing a
majority of the outstanding Underwriters' Warrants, solely at our expense (but
excluding fees and expenses of the holder's counsel and any underwriting or
selling commissions). Additionally, the Bridge Warrant holders are permitted one
(1) S-3 demand registration upon request of holders of fifty percent (50%) of
the outstanding Bridge Warrants.
TRANSFER AGENT AND REGISTRAR
U.S. Stock Transfer Corporation will act as transfer agent and registrar
for our Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, we will have 6,338,007 outstanding shares
of Common Stock (assuming no exercise of outstanding options, warrants or
Underwriters' over-allotment option). Of these shares, the 2,600,000 shares sold
to the public in this offering will be freely tradeable without restrictions or
further registration under the Securities Act, except for any shares purchased
by our "affiliates" within the meaning of the Securities Act, which will be
subject to the resale limitations of Rule 144. The remaining 3,738,007 shares
held by existing shareholders were issued by us in private transactions in
reliance upon one or more exemptions under the Securities Act, are "restricted
securities" as that term is defined in Rule 144 promulgated under the Securities
Act. Such restricted securities may be sold in compliance with such Rule,
pursuant to registration under the Securities Act or pursuant to an exemption
therefrom. Generally, under Rule 144, each person holding restricted securities
for a period of one year may, every three months after such one year holding
period, sell in ordinary brokerage transactions or to market makers an amount of
shares equal to the greater of one percent of our then outstanding Common Stock
or the average weekly trading volume during the four weeks prior to the proposed
sale. In addition, sales under Rule 144 may be made only through unsolicited
"broker's transactions" or to a "market maker" and are subject to various other
conditions. The limitation on the number of shares which may be sold under Rule
144 and the "broker's transaction" requirement do not apply to restricted
securities sold for the account of a person who is not and has not been our
"affiliate" (as that term is defined in the Act) during the three months prior
to the proposed sale and who has beneficially owned the securities for at least
two years.
55
<PAGE> 60
Prior to the offering, there has been no market for the Common Stock, and
no predictions can be made as to the effect, if any, that sales of shares under
Rule 144 or the availability of shares for sale will have on the market prices
prevailing from time to time. Sales of substantial amounts of Common Stock in
the public market following this offering could lower the market price of the
Common Stock. Of the 6,338,007 shares of Common Stock to be outstanding after
this offering (assuming no exercise of outstanding options, warrants or the
overallotment option), 2,600,000 shares will be freely tradeable without
restriction. Upon expiration of the lock-up agreements entered into by the
officers and directors of our company, an additional 3,258,053 shares will
become eligible for sale one year from the close of this offering, subject to
the provisions of Rule 144. Of the remaining 479,954 shares of Common Stock,
5,000 shares will be eligible for resale under Rule 144 following this offering.
The remaining 474,954 shares will have been held for less than one year and will
become eligible for sale at various dates as the one-year holding period under
Rule 144 is satisfied.
In addition, we intend to file a registration statement on Form S-8 with
respect to the shares of Common Stock issuable upon exercise of options under
the 1996 Equity Incentive Plan (the "Plan"). The Plan authorizes the issuance of
options relating to up to 1,000,000 shares of Common Stock. Currently, there are
800,579 options that have been issued under the Plan which generally vest over
three years. See "1996 Equity Incentive Plan" at page 50. Upon filing of such
registration statement, the holders of such options may, subject to vesting
requirements, exercise and sell their shares immediately without restriction,
except affiliates who are subject to certain volume limitations and manner of
sale requirements of Rule 144. Holders of 356,545 warrants to purchase shares
are entitled to certain registration rights with respect to such shares. Upon
registration, such shares may be sold in the market without limitation. See
"Registration Rights" at page 55. Sales of such shares may decrease the market
price for our Common Stock. See "Underwriting" at page 57 and "Arbitrary
Offering Price of the Common Stock; Possible Volatility of Common Stock Price"
at page 16.
56
<PAGE> 61
UNDERWRITING
CERTAIN PERSONS WHO PARTICIPATE IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SHARES, INCLUDING
PURCHASES OF SHARES TO MAINTAIN THEIR MARKET PRICE OR PURCHASES TO COVER SOME OR
ALL OF THE UNDERWRITERS' SHORT POSITION IN THE SHARES.
Subject to the terms and conditions set forth in the underwriting agreement
(the "Underwriting Agreement"), we have agreed to sell to each of the
underwriters named below (the "Underwriters"), and each of the Underwriters, for
whom Nutmeg Securities, Ltd. is acting as representative (the "Representative"),
has severally agreed to purchase, the number of shares of Common Stock set forth
opposite its name below. Under certain circumstances, the commitments of
nondefaulting Underwriters may be increased as set forth in the Agreement Among
Underwriters.
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
------------------------------------------------------------------ ----------
<S> <C>
Nutmeg Securities, Ltd............................................
Millennium Financial Group, Inc...................................
Total........................................................ 2,600,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters thereunder are subject to approval of certain legal matters by
counsel and to various other conditions. The nature of the Underwriters'
obligations is such that they are committed to purchase and pay for all of the
above shares of Common Stock if any are purchased. The Underwriters propose to
offer the shares of Common Stock directly to the public at the public offering
price set forth on the cover page of this Prospectus.
We have granted to the Underwriters a 30-day over-allotment option to
purchase up to 390,000 additional shares of Common Stock at the public offering
price less the underwriting discount. The Underwriters may exercise such option
only to cover over-allotments made in connection with the sale of the shares of
Common Stock offered hereby.
We have also agreed to sell to the Underwriters, for nominal consideration,
warrants (the "Underwriters' Warrants") to purchase the number of shares of our
Common Stock equal to 10% of the total number of shares of Common Stock sold in
this offering at a price per share equal to 165% of the initial public offering
price of the Common Stock. The Underwriters' Warrants will be exercisable for a
period of four years commencing one year from the effective date of this
offering and will contain certain demand and "piggyback" registration rights
with respect to the Common Stock issuable upon the exercise of the Underwriters'
Warrants. The Underwriters' Warrants are not transferable (except to members of
the syndicate and their affiliates). The exercise price and the number of shares
issuable upon exercise may, under certain circumstances, be subject to
adjustment pursuant to antidilution provisions.
We have agreed to allow the Underwriters a commission of eight percent (8%)
of the public offering price of the shares of Common Stock. Additionally, we
will be paying the Underwriters, following the closing of this offering, a
nonaccountable expense allowance equal to three percent (3%) of the aggregate
public offering price of the shares of Common Stock, less any applicable
deposits.
We have further agreed to indemnify the Underwriters against certain
liabilities, losses and expenses, including liabilities under the Securities
Act, or to contribute to payments that the Underwriters may be
57
<PAGE> 62
required to make in respect thereof. We also have agreed to reimburse the
Underwriters for certain out-of-pocket expenses incurred in connection with the
offering.
The Underwriters have advised us that they do not intend to make sales to
discretionary accounts.
Our officers and directors who in the aggregate beneficially own 3,258,053
shares of Common Stock have agreed not to, directly or indirectly, sell, offer,
contract to sell, make any short sale, pledge or otherwise dispose of such
shares for a period of 12 months after the date of the closing of this offering.
In connection with this offering certain underwriters may engage in passive
market making transactions in the shares in accordance with Rule 103 of
Regulation M. Further, the Underwriters' selling group members and their
respective affiliates may engage in transactions that stabilize, maintain or
otherwise affect the market price of our shares. These transactions may include
stabilization transactions permitted by Rule 104 of Regulation M, under which
persons may bid for or purchase shares to stabilize the market price. The
Underwriters may also create a "short position" for their own account by selling
more shares in the offering than they are committed to purchase, and in that
case they may purchase shares in the open market after this offering is
completed to cover all or a part of their short position. The Representative may
also cover all or a portion of their short position, up to 390,000 shares, by
exercising their over-allotment option described above and on the cover of this
prospectus.
LEGAL MATTERS
Certain legal matters with respect to the legality of the issuance of the
Common Stock offered hereby will be passed upon for us by Jeffers, Wilson, Shaff
& Falk, LLP, Irvine, California. Certain legal matters in connection with the
offering will be passed upon for the Underwriters by William M. Prifti, Esq.,
Lynnfield, Massachusetts.
EXPERTS
The audited consolidated financial statements included in this Prospectus
and elsewhere in the Registration Statement have been audited by Singer Lewak
Greenbaum & Goldstein LLP, Los Angeles, California, independent public
accountants, as indicated in their reports with respect thereto, and are
included herein in reliance upon the authority of said firm as experts in giving
said reports.
ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission (the
"Commission") a Registration Statement (the "Registration Statement") under the
Securities Act with respect to the securities offered hereby. This Prospectus
does not contain all of the information set forth in the Registration Statement,
certain parts of which are omitted in accordance with the rules and regulations
of the Commission. For further information with respect to us and this offering,
reference is made to the Registration Statement, including the exhibits and
schedules filed therewith, copies of which may be obtained at prescribed rates
from the Commission at its principal office at 450 Fifth Street N.W.,
Washington, D.C. 20549, and at the following regional offices of the Commission:
75 Park Place, New York 10007, and Northwestern Atrium Center, 500 West Madison
Street, Suite 1400 Chicago, Illinois 60604. In addition, the Commission
maintains a World Wide Web site on the Internet at http://www.sec.gov that
contains reports, proxy and information statements and other documents filed
electronically with the Commission, including the Registration Statement.
Descriptions contained in this Prospectus as to the contents of any agreement or
other documents filed as an exhibit to the Registration Statement are not
necessarily complete and each such description is qualified by reference to such
agreement or document.
We intend to furnish to our shareholders annual reports containing
financial statements audited and reported upon by our independent public
accountants.
58
<PAGE> 63
INDEX TO FINANCIAL STATEMENTS OF MEDICAL SCIENCE SYSTEMS, INC.
<TABLE>
<CAPTION>
PAGE
-----------
<S> <C>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS............................... F-2
FINANCIAL STATEMENTS
Balance Sheets................................................................. F-3
Statements of Operations....................................................... F-4
Statements of Shareholders' Deficit............................................ F-5
Statements of Cash Flows....................................................... F-6
Notes to Financial Statements.................................................. F-7 - F-17
</TABLE>
F-1
<PAGE> 64
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
Medical Science Systems, Inc.
We have audited the accompanying balance sheet of Medical Science Systems,
Inc. as of December 31, 1996 and the related statements of operations,
shareholders' deficit, and cash flows for each of the two years in the period
ended December 31, 1996. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Medical Science Systems,
Inc. as of December 31, 1996, and the results of its operations and its cash
flows, for each of the two years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles.
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
September 26, 1997
F-2
<PAGE> 65
MEDICAL SCIENCE SYSTEMS, INC.
BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND SEPTEMBER 30, 1997 (UNAUDITED)
ASSETS (Note 4)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------- -------------
(UNAUDITED)
<S> <C> <C>
Current assets
Cash and cash equivalents (Note 2).............................. $ 55,966 $ 869,627
Accounts receivable............................................. 12,359 6,365
Inventories..................................................... -- 6,721
Due from shareholder............................................ 6,565 --
Deposits........................................................ -- 17,816
------------ ------------
Total current assets......................................... 74,890 900,529
Furniture and equipment, net (Note 3)............................. 82,877 188,458
Patents........................................................... 154,195 261,475
Deferred offering costs........................................... -- 87,000
------------ ------------
Total assets............................................ $ 311,962 $ 1,437,462
============ ============
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities
Revolving line of credit (Note 4)............................... $ 353,723 $ --
Accounts payable................................................ 219,669 320,922
Accrued expenses................................................ 44,384 202,539
Accrued officer compensation (Note 11).......................... 127,500 --
Deferred rent................................................... 12,703 10,217
Deferred income................................................. -- 10,400
Current portion of long-term debt (Note 4)...................... 44,489 147,648
Current portion of capitalized lease obligations (Note 10)...... 8,408 40,311
------------ ------------
Total current liabilities.................................... 810,876 732,037
Promissory notes (Note 5)......................................... 1,550,000
Long-term debt, less current portion (Note 4)..................... 173,798 524,176
Capitalized lease obligations, less current portion (Note 10)..... 27,036 94,790
------------ ------------
Total liabilities............................................ 1,011,710 2,901,003
------------ ------------
Commitments and contingencies (Note 10)
Shareholders' deficit (Notes 7 and 9) Preferred stock, no par
value 5,000,000 shares authorized none issued and outstanding... -- --
Common stock, no par value 10,000,000 shares authorized;
3,295,539 and 3,738,007 (unaudited) shares issued and
outstanding.................................................. 171,500 2,450,036
Accumulated deficit............................................. (871,248) (3,913,577)
------------ ------------
Total shareholders' deficit.................................. (699,748) (1,463,541)
------------ ------------
Total liabilities and shareholders' deficit............. $ 311,962 $ 1,437,462
============ ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 66
MEDICAL SCIENCE SYSTEMS, INC.
STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
------------------------ --------------------------
1996 1995 1997 1996
---------- ---------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Sales....................................... $1,918,879 $1,872,932 $ 152,476 $ 1,905,380
Cost of sales............................... 547,766 367,520 149,702 538,172
---------- ---------- ----------- -----------
Gross profit................................ 1,371,113 1,505,412 2,774 1,367,208
---------- ---------- ----------- -----------
Expenses
Research and development.................. 958,249 582,595 784,722 681,871
Selling, general, and administrative...... 1,162,768 755,785 2,164,141 776,064
---------- ---------- ----------- -----------
Total expenses......................... 2,121,017 1,338,380 2,948,863 1,457,935
---------- ---------- ----------- -----------
Income (loss) from operations............... (749,904) 167,032 (2,946,089) (90,727)
---------- ---------- ----------- -----------
Other income (expense)
Interest income........................... 8,561 35 2,417 7,918
Interest expense.......................... (34,229) (14,300) (98,657) (13,728)
Loss on disposal of assets................ (6,934) -- -- --
---------- ---------- ----------- -----------
Total other income (expense)........... (32,602) (14,265) (96,240) (5,810)
---------- ---------- ----------- -----------
Income (loss) before provision for income
taxes..................................... (782,506) 152,767 (3,042,329) (96,537)
Provision for income taxes.................. 6,040 2,755 --
---------- ---------- ----------- -----------
Net income (loss)........................... $ (788,546) $ 150,012 $(3,042,329) $ (96,537)
========== ========== =========== ===========
Earnings (loss) per common share............ $ (.18) $ .03 $ (.71) $ (.02)
========== ========== =========== ===========
Weighted average common shares
outstanding............................... 4,288,436 4,288,436 4,288,436 4,288,436
========== ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 67
MEDICAL SCIENCE SYSTEMS, INC.
STATEMENTS OF SHAREHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 (UNAUDITED)
<TABLE>
<CAPTION>
COMMON STOCK
----------------------- ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
--------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Balance, December 31, 1994.................. 3,249,999 $ 3,000 $ (100,714) $ (97,714)
Distribution to shareholders................ (132,000) (132,000)
Net income.................................. 150,012 150,012
--------- ---------- ----------- -----------
Balance, December 31, 1995.................. 3,249,999 3,000 (82,702) (79,702)
Sale of common stock (Note 7)............... 40,540 150,000 150,000
Common stock issued for services rendered... 5,000 18,500 18,500
Net loss.................................... (788,546) (788,546)
--------- ---------- ----------- -----------
Balance, December 31, 1996.................. 3,295,539 171,500 (871,248) (699,748)
Sale of common stock (unaudited) (Note 7)... 148,648 550,000 550,000
Sale of common stock (unaudited) (Note 7)... 293,820 1,469,100 1,469,100
Offering costs (unaudited).................. (136,975) (136,975)
Stock options issued for reduction in salary
(unaudited) (Note 9)...................... 370,943 370,943
Issuance of warrants resulting in additional
interest expense (unaudited) (Note 5)..... 25,468 25,468
Net loss (unaudited)........................ (3,042,329) (3,042,329)
--------- ---------- ----------- -----------
Balance, September 30, 1997 (unaudited)..... 3,738,007 $2,450,036 $(3,913,577) $(1,463,541)
========= ========== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 68
MEDICAL SCIENCE SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED FOR THE NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
--------------------- --------------------------
1996 1995 1997 1996
--------- -------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)................................................ $(788,546) $150,012 $(3,042,329) $ (96,537)
Adjustments to reconcile net income (loss) to net cash provided
by (used in) operating activities
Loss on sale of assets......................................... 6,934 -- -- --
Depreciation and amortization.................................. 27,330 14,118 48,610 20,446
Issuance of common stock for services.......................... 18,500 -- -- 18,500
Issuance of stock options in exchange for a reduction in
salary....................................................... -- -- 370,943 --
Issuance of warrants resulting in additional interest
expense...................................................... -- 25,468
(Increase) decrease in
Accounts receivable............................................ 315,241 (324,376) 5,994 286,746
Inventories.................................................... -- (6,721)
Prepaid expenses............................................... -- 900 -- --
Due from shareholder........................................... (6,565) 394 6,565 (42,000)
Deposits....................................................... -- (17,816)
Increase (decrease) in
Accounts payable............................................... 198,090 (69,143) 101,253 28,779
Accrued expenses............................................... 140,323 (25,497) 158,155 127,377
Accrued officer compensation................................... -- (127,500)
Unearned revenues.............................................. (366,051) 366,051 -- (366,051)
Deferred rent.................................................. 12,703 -- (2,486) --
Deferred income................................................ -- 10,400
--------- --------- ----------- ---------
Net cash provided by (used in) operating activities................ (442,041) 112,459 (2,469,464) (22,740)
--------- --------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of furniture and equipment.............................. (31,942) (35,743) (35,194) (7,268)
Increase in patents.............................................. (128,559) (25,636) (107,601) (37,500)
Proceeds from sale of assets..................................... 13,000 -- -- --
--------- --------- ----------- ---------
Net cash used in investing activities.............................. (147,501) (61,379) (142,795) (44,768)
--------- --------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Sale of common stock............................................. 150,000 -- 1,882,125 --
Issuance of promissory notes..................................... -- 1,550,000
Increase in deferred offering costs.............................. -- -- (87,000) --
Distribution to shareholders..................................... -- (132,000) -- --
Proceeds from note payable....................................... 250,000 -- -- 250,000
Principal payments on long-term debt............................. (31,713) -- (46,463) (21,244)
Borrowings on line of credit, net................................ 209,723 144,000 146,277 105,990
Principal payments on capital lease obligations.................. (5,120) -- (19,019) (4,104)
--------- -------- ----------- -----------
Net cash provided by financing activities.......................... 572,890 12,000 3,425,920 330,642
--------- -------- ----------- -----------
Net increase (decrease) in cash.................................... (16,652) 63,080 813,661 263,134
Cash and cash equivalents, beginning of period..................... 72,618 9,538 55,966 72,618
--------- -------- ----------- -----------
Cash and cash equivalents, end of period........................... $ 55,966 $ 72,618 $ 869,627 $ 335,752
========== ========= ============ ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Interest paid.................................................... $ 29,549 $ 14,300 $ 59,194 $ 13,728
========== ========= ============ ==========
Income taxes paid................................................ $ 6,040 $ 2,755 $ -- $ --
========== ========= ============ ==========
</TABLE>
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
During the year ended December 31, 1996 and the nine months ended September
30, 1997 and 1996, the Company acquired furniture and equipment of $40,564,
$118,676 (unaudited), and $40,564 (unaudited), respectively, under capitalized
lease obligations.
The accompanying notes are an integral part of these financial statements.
F-6
<PAGE> 69
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Line of Business
Medical Science Systems, Inc., a Texas corporation, (the "Company")
originally operated under two separate corporations, known as Oral Science
Systems and Oral Science Technologies. In 1995 Oral Science Systems was merged
into Oral Science Technologies and Oral Science Technologies was renamed Medical
Science Systems, Inc. The merger was accounted for in a manner similar to a
pooling of interest, accordingly, the results of operations for the year ended
December 31, 1995 include Oral Science Systems from January 1, 1995 to the date
of the merger.
The Company is currently developing a line of genetic susceptibility tests
and therapeutic targets for common diseases. As of December 31, 1996, the
Company has commercially introduced one such product and is in various stages of
development for several others. The Company also provides clinical trials and
research services under contract to pharmaceutical companies, and such services
generated substantially all of the Company's revenues for the years ended
December 31, 1996 and 1995.
Interim Financial Information
The unaudited financial information furnished herein reflects all
adjustments, consisting only of normal recurring adjustments, which in the
opinion of management, are necessary to fairly state the Company's financial
position, the results of its operations, and cash flows for the periods present.
The results of operations for the nine months ended September 30, 1997 are not
necessarily indicative of results for the entire fiscal year ending December 31,
1997.
Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements, as well as the reported amounts of revenues and expenses during the
reported periods. Actual results could differ from those estimates.
Fair Value of Financial Instruments
The Company measures its financial assets and liabilities in accordance
with generally accepted accounting principles. For certain of the Company's
financial instruments including cash, accounts receivable, accounts payable,
accrued expenses, and accrued officer compensation, the carrying amounts
approximate fair value due to their short maturities. The amounts shown for line
of credit, long-term debt, and capital lease obligations also approximate fair
value because current interest rates and terms offered to the Company for
similar debt and lease agreements are substantially the same.
F-7
<PAGE> 70
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Furniture and Equipment
Furniture and equipment, including equipment under capital leases, are
stated at cost, less accumulated depreciation and amortization. Depreciation and
amortization are provided using the straight-line method over the estimated
useful lives of three to five years as follows:
<TABLE>
<S> <C>
Computer equipment.................................. 3 years
Furniture and fixtures.............................. 5 years
Computer software................................... 3 years
Equipment under capital leases...................... 3 years
</TABLE>
Betterments, renewals, and extraordinary repairs that extend the life of
the asset are capitalized; other repairs and maintenance charges are expensed as
incurred. The cost and related accumulated depreciation applicable to assets
retired are removed from the accounts, and the gain or loss on disposition is
recognized in the statement of operations.
Patents
The cost of acquiring patents, which consists principally of legal fees, is
being amortized using the straight-line method of their useful lives of ten
years beginning from the time the patents are awarded. The Company was issued a
patent in August 1997 and currently has ten patents pending; accordingly, the
Company had not recognized any amortization related to the ten pending patents
as of September 30, 1997. The Company recognized $321 (unaudited) in
amortization expense for the nine months ended September 30, 1997 related to the
patent issued in August 1997.
Deferred Offering Costs
Amounts paid for costs associated with an anticipated initial public
offering ("IPO") are capitalized and will be recorded as a reduction to common
stock upon the completion of the IPO. In the event that the IPO is not
successful, the deferred offering costs will be charged to expense.
Revenue Recognition
Contract revenues are recognized ratably as services are provided based on
a fixed contract price or on negotiated hourly rates. The Company has no
unbilled accounts receivable under any contracts at December 31, 1996 and
September 30, 1997 (unaudited). Provision for anticipated losses on fixed-price
contracts is made in the period such losses are identified. Revenue from genetic
susceptibility tests is recognized when the tests have been completed and the
results reported to the doctors.
Concentrations of Credit Risk
The Company sells products and provides contract services for customers
primarily in the United States and extends credit based on an evaluation of the
customer's financial condition, generally without requiring collateral. Exposure
to losses on receivables is principally dependent on each customer's financial
condition. The Company monitors its exposure for credit losses and maintains
allowances for anticipated losses.
F-8
<PAGE> 71
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
During the year ended December 31, 1996, the Company did business with
three customers whose sales comprised approximately 99% of revenues. Amounts due
from these customers represented 100% of accounts receivable at December 31,
1996.
During the year ended December 31, 1995, the Company did business with two
customers whose sales comprised approximately 85% of revenues.
During the nine months ended September 30, 1996, the Company did business
with three customers whose sales comprised approximately 100% of revenues.
Research and Development
Research and development costs related to the development of new products
are expensed as incurred.
Income Taxes
Prior to September 30, 1996, the Company had elected to be treated as an
"S" corporation for federal and state tax purposes. Effective September 30,
1996, the Company terminated such election and became taxable as a "C"
corporation. The Company will not realize any future tax benefits of net
operating losses incurred prior to September 30, 1996.
The Company accounts for income taxes under the liability method required
by Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for
Income Taxes." Deferred tax assets and liabilities reflect the expected future
tax consequences of events that have been included in the financial statements
and tax returns. Deferred tax assets and liabilities are determined based upon
the difference between the financial statement and tax bases of assets and
liabilities, using the enacted tax rates in effect for the year in which the
differences are expected to reverse. The Company has not recorded any deferred
tax assets related to operating loss carryforwards generated subsequent to
September 30, 1996 due to the uncertainty of the Company's ability to ultimately
recognize the benefits of such carryforwards.
Net Income (Loss) Per Share
Net income (loss) per share is based on the weighted average number of
common and common equivalent shares outstanding during the period. In connection
with the Company's IPO, common stock issued for consideration below the IPO per
share price (assuming an IPO price of $9.00) during the twelve months before the
filing of the registration statement, plus options and warrants to purchase the
Company's common stock issued for consideration below the IPO per share price
during the same period (using the treasury stock method), have been included in
the calculation of common shares outstanding as if they had been outstanding for
all periods presented.
Cash and Cash Equivalents
For purposes of the statements of cash flows, the Company considers all
highly-liquid investments purchased with original maturities of three months or
less to be cash equivalents.
F-9
<PAGE> 72
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Risks and Uncertainties
Commercial success of genetic susceptibility tests will depend upon their
acceptance as medically useful and cost-effective by patients, physicians,
dentists, other members of the medical and dental community, and third-party
payers. The Company plans to expend substantial financial resources to promote
the benefits of the Company's susceptibility tests. It is uncertain whether
current genetic susceptibility tests or others that the Company may develop will
gain acceptance on a timely basis.
Research in the field of disease predisposing genes and genetic markers is
intense and highly competitive. The Company has many competitors in the United
States and abroad which have considerably greater financial, technical,
marketing, and other resources available. If the Company does not discover
disease predisposing genes or genetic markers and develop susceptibility tests
and launch such services or products before their competitors, then sales and
earnings will be reduced or eliminated.
The Company's ability to successfully commercialize genetic susceptibility
tests depends on obtaining adequate reimbursement for such products and related
treatment from government and private health care insurers and other third-party
payers. Doctors' decisions to recommend genetic susceptibility tests will be
influenced by the scope and reimbursement for such tests by third-party payors.
If both third-party payors and individuals are unwilling to pay for the test,
then the number of tests performed will significantly decrease, therefore
resulting in a reduction of revenues.
The Company entered into an agreement with Sheffield University, whereby
the Company will undertake the development and commercialization of any
discoveries resulting from Sheffield University's research. The agreement may be
terminated with or without cause by either party upon six-months notice. If
Sheffield University terminated the agreement, such termination could make the
discovery and commercial introduction of new products more difficult or
unlikely.
Recently Issued Accounting Pronouncement
The Financial Accounting Standards Board ("FASB") issued SFAS No. 128,
"Earnings Per Share," which is effective for financial statements issued for
periods ending after December 15, 1997, including interim periods. SFAS No. 128
requires public companies to present basic earnings per share and, if
applicable, diluted earnings per share instead of primary and fully-diluted
earnings per share. The Company does not believe that diluted earnings per share
in accordance with SFAS No. 128 will be materially different from the earnings
per share previously reported.
SFAS No. 129, "Disclosure of Information about Capital Structures," issued
by FASB is effective for financial statements ending after December 15, 1997.
The new standard reinstates various securities disclosure requirements
previously in effect under Accounting Principles Board ("APB") Opinion No. 15,
"Computing Earnings per Share," which has been superseded by SFAS No. 128. The
Company does not expect adoption of SFAS No. 129 to have a material effect, if
any, on its financial position or results of operations.
SFAS No. 130, "Reporting Comprehensive Income," issued by FASB is effective
for financial statements with fiscal years beginning after December 15, 1997.
SFAS No. 130 establishes standards for reporting and display of comprehensive
income and its components in a full set of general-purpose financial statements.
The Company does not expect adoption of SFAS No. 130 to have a material effect,
if any, on its financial position or results of operations.
F-10
<PAGE> 73
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 2 -- CASH
The Company maintains cash deposits at several banks. Deposits at each bank
are insured by the Federal Deposit Insurance Corporation up to $100,000. As of
December 31, 1996 and September 30, 1997, uninsured portions of balances held at
these financial institutions totaled $0 and $866,985 (unaudited), respectively.
The Company has not experienced any losses in such accounts and believes it is
not exposed to any significant credit risk on cash and cash equivalents.
NOTE 3 -- FURNITURE AND EQUIPMENT
Furniture and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Computer equipment................................ $113,470 $ 132,542
Furniture and fixtures............................ 9,053 18,626
Computer software................................. 20,531 27,080
Equipment under capitalized leases................ 40,564 159,240
-------- ---------
183,618 337,488
Less accumulated depreciation and amortization.... 100,741 149,030
-------- ---------
Total................................... $ 82,877 $ 188,458
======== =========
</TABLE>
NOTE 4 -- NOTES PAYABLE AND REVOLVING LINE OF CREDIT WITH BANK
In March 1996, the Company entered into a revolving line of credit
agreement with a bank to borrow up to $250,000, and a note payable of $250,000,
for working capital purposes and to repay the outstanding borrowings under
certain promissory notes. In October 1996, the line of credit was increased to
provide for total borrowings of up to $500,000. The line of credit originally
matured in March 1997 and was extended to June 1997 at which time all
outstanding principal was converted into a five-year note payable, payable in
sixty monthly installments of $8,334 (unaudited) plus interest. The line of
credit bore interest at the bank's prime rate plus 1.75% (effectively 10% at
December 31, 1996) which was payable monthly in arrears. At December 31, 1996,
the Company had outstanding borrowings of $353,723 under the revolving line of
credit and at September 30, 1997 had outstanding borrowings of $671,824
(unaudited) under the notes payable.
The $250,000 note payable matures in March 2001 and requires monthly
payments of principal and interest of $5,222. The $250,000 note payable bears
interest at a fixed rate of 9.125% per annum.
Required principal payments under the notes payable are as follows:
<TABLE>
<CAPTION>
YEAR ENDING YEAR ENDING
DECEMBER 31, SEPTEMBER 30,
------------ -------------
(UNAUDITED)
<S> <C> <C>
1997............................................ $ 44,489 $ --
1998............................................ 48,724 147,648
1999............................................ 53,361 154,432
2000............................................ 58,439 157,126
2001............................................ 13,274 129,284
2002............................................ -- 83,334
-------- ---------
218,287 671,824
Less current portion.............................. 44,489 147,648
-------- ---------
Long-term portion............................ $173,798 $ 524,176
======== =========
</TABLE>
F-11
<PAGE> 74
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 4 -- TERM LOAN AND REVOLVING LINE OF CREDIT WITH BANK (CONTINUED)
Both the notes payable and the revolving line of credit are secured by
substantially all of the Company's assets and accounts receivable. In addition,
three of the Company's officers have personally guaranteed the Company's
obligations under the notes payable and the revolving line of credit. The
agreements also include certain covenants which restrict, among other things,
the occurrence of new indebtedness.
NOTE 5 -- PROMISSORY NOTES
In August and September 1997, the Company entered into several subscription
agreements to sell subordinated Promissory Notes ("Notes"). In addition, the
Company granted one warrant to purchase common stock at an exercise price of
$5.50 per share for each $5.00 loaned. The Company issued Notes in the amount of
$1,550,000 and issued 310,545 warrants to purchase the Company's common stock.
The Notes accrue interest at 10% per annum, and all unpaid principal and
interest are due the earlier of 14 months from the date of issuance or the sale
of equity securities which results in gross proceeds in excess of $6,000,000.
The warrants expire the earlier of five years from the date of issuance or upon
the occurrence of the Company's common stock traded on a national or regional
stock exchange and the closing price of the common stock equals or exceeds
$12.00 per share for thirty consecutive trading days. In connection with the
issuance of such warrants, the Company will recognize additional interest
expense of $310,545 over the 14-month term of the Notes with the unamortized
portion at the closing of the Company's IPO being charged to interest expense
immediately.
NOTE 6 -- INCOME TAXES
Prior to September 30, 1996, the Company elected to be taxed as an "S"
corporation for federal and state income tax purposes; the Company's income or
loss for such periods was allocated among its shareholders. Consequently, the
Company has not recorded any tax provision for any period prior to such date.
Effective September 30, 1996, the Company terminated such election and became
taxable as a "C" corporation.
The Company has not recorded a current or deferred provision for federal
income taxes for the period from October 1, 1996 to December 31, 1996 due to
losses incurred during that period. The provision for income taxes represents
the minimum required for state franchise taxes. To reconcile from the federal
statutory tax rate of 34% to the Company's effective tax rate of approximately
1%, the deferred tax asset valuation reserve is deducted. At December 31, 1996,
the Company had net operating loss carryforwards of approximately $590,000 and
$295,000 for federal and state income tax purposes, respectively, expiring in
varying amounts through the year 2012, which are available to offset future
federal and state taxable income. The Company also had a research tax credit of
$14,400 at December 31, 1996 that expires in 2012. The ability of the Company to
utilize the federal and state net operating loss carryforwards may be subject to
annual limitations under certain provisions of the Internal Revenue Code as a
result of the private placements of common stock and issuance of stock options.
F-12
<PAGE> 75
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 6 -- INCOME TAXES (CONTINUED)
Deferred tax assets (liabilities) consisted of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
------------
<S> <C>
Deferred tax assets Net operating loss carryforwards............ $219,900
Research tax credit carryforwards............................. 14,400
Accrual to cash adjustments................................... 82,900
Accrued payroll related costs................................. 71,800
--------
Total deferred tax assets............................. 389,000
Valuation allowance for deferred tax assets..................... 327,300
--------
61,700
Deferred tax liabilities Patents................................ 61,700
--------
Net deferred tax assets............................... $ --
========
</TABLE>
The valuation allowance increased by $276,900 from September 30, 1996 (the
date the Company elected to be taxed as a "C" corporation) to December 31, 1996.
NOTE 7 -- CAPITAL STOCK
Stock Split
In June 1996, the Company's shareholders approved a 1,083.333 for 1 stock
split which was completed in July 1996. All references in the financial
statements to numbers of common shares and per common share amounts have been
restated to reflect the stock split. All disclosures related to sales of common
stock, warrants, employee stock plans, and other common stock transactions for
all periods presented have also been restated to reflect the stock split.
Private Placements of Common Stock
In September 1996, the Company's Board of Directors authorized the private
offering of shares of the Company's common stock at $3.70 per share up to an
aggregate of $5,250,000. For the year ended December 31, 1996 and the nine
months ended September 30, 1997, the Company sold 40,540 and 148,648 (unaudited)
shares, respectively, of its common stock in private placement transactions at a
price of $3.70 per share. The gross proceeds of the sale were approximately
$150,000 and $550,000 (unaudited), respectively.
During the nine months ended September 30, 1997, the Company sold 293,820
(unaudited) shares of the Company's common stock at $5.00 (unaudited) per share
in a private placement. Gross proceeds from the sale were $1,469,100
(unaudited).
NOTE 8 -- EMPLOYEE BENEFIT PLAN
In 1988, the Company adopted a profit sharing plan covering substantially
all of its employees. Under the profit sharing plan, the Company may, at the
discretion of the Board of Directors, contribute a portion of the Company's
current or accumulated earnings. Company contributions, if any, are credited to
participant accounts and are immediately vested. During the years ended December
31, 1996 and 1995 and the nine
F-13
<PAGE> 76
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 8 -- EMPLOYEE BENEFIT PLAN (CONTINUED)
months ended September 30, 1997 (unaudited) and 1996 (unaudited), no
contributions were made to the profit sharing plan.
NOTE 9 -- STOCK OPTION PLAN
In June 1996, the Company's shareholders approved the adoption of the
Medical Science Systems, Inc. 1996 Equity Incentive Plan (the "Plan"). The Plan
provides for the award of nonqualified and incentive stock options, restricted
stock, and stock bonuses to employees, directors, officers, and consultants of
the Company. The Plan provides for the grant of nonqualified and incentive stock
options to all directors, officers, and employees of the Company. A total of
1,000,000 shares of the Company's common stock have been reserved for award
under the amended Plan.
Nonqualified and incentive stock options are granted at exercise prices
equal to the fair market value of the common stock on the date of grant.
One-sixth of the options are generally available for exercise at the end of six
months which the remainder of the grant is exercisable ratably over the next
30-month period provided the optionee remains in service to the Company. The
Company may also awardshare appreciation rights ("SARs") either in tandem with
stock options or independently. At December 31, 1996 and September 30, 1997
(unaudited), no SARs has been awarded under the Plan.
The Company has adopted only the disclosure provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation." It applies Accounting Principles
Bulletin ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and
related Interpretations in accounting for its plans and does not recognize
compensation expense for its stock-based compensation plans other than for
restricted stock and options issued to outside third parties. If the Company had
elected to recognize compensation expense based upon the fair value at the grant
date for awards under this plan consistent with the methodology prescribed by
SFAS 123, the Company's net loss and loss per share would be reduced to the pro
forma amounts indicated below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
------------
<S> <C>
Net loss
As reported................................... $ (788,546)
Pro forma..................................... $ (894,437)
Loss per common share
As reported................................... $ (0.18)
Pro forma..................................... $ (0.21)
</TABLE>
The fair value of these options was estimated at the date of grant using
the Black-Scholes option-pricing model with the following weighted average
assumptions for the years ended December 31, 1996: dividend yields of 0%;
expected volatility of 70%; risk-free interest rates of 6.0%; and expected life
of 3 years. The weighted average fair value of options granted during the year
ended December 31, 1996 was $1.87, and the weighted average exercise price was
$3.70.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the
F-14
<PAGE> 77
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 9 -- STOCK OPTION PLAN (CONTINUED)
Company's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
NUMBER GRANTED PRICE
OF SHARES PER SHARE
--------- ----------------
<S> <C> <C>
Outstanding, December 31, 1995..................... -- $ --
Granted.......................................... 142,500 $ 3.70
Exercised........................................ -- $ --
Canceled......................................... -- $ --
-------
Outstanding, December 31, 1996..................... 142,500 $ 3.70
Granted (unaudited).............................. 658,079 $ 4.52
Exercised (unaudited)............................ -- $ --
Canceled (unaudited)............................. -- $ --
-------
Outstanding, September 30, 1997 (unaudited)........ 800,579 $ 4.37
=======
</TABLE>
The weighted average remaining contractual life of options outstanding
issued under the Plan is ten years at December 31, 1996.
The Plan also provides for the award of restricted stock to eligible
persons. Such awards may be at prices not less than 85% of the fair market value
of the Company's common stock as determined by the Board of Directors. In
addition, stock bonuses may be awarded to certain employees or officers of the
Company at the discretion of the Board of Directors. In September 1996, the
Company's Board of Directors issued a stock bonus of 5,000 shares to a
consultant of the Company. The estimated fair value of such shares at the date
of the award was charged to expense in 1996. As of September 30, 1997, the
Company has not awarded any restricted stock awards.
In May 1997, the Company offered to its employees the opportunity to
receive stock options to acquire shares of the Company's common stock at $5.00
to $5.50 per share in an exchange for a reduction of salary. Employees elected
to reduce their salaries up to 50% for the period from May 1997 to October 1997
in exchange for 600 stock options for each $1,000 of salary reduction. As a
result the Company issued 267,079 stock options in exchange for salary
reductions of $445,132. The Company will record an expense relating to the
issuance of these stock option in the amount of $74,189 per month for each of
the six months from May 1997 to October 1997.
F-15
<PAGE> 78
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 10 -- COMMITMENTS AND CONTINGENCIES
The Company leases its office space under non-cancelable operating leases
expiring through April 2001. The Company also leases certain office furniture
and equipment under capitalized lease obligations. Future minimum rental
commitments under lease agreements with initial or remaining terms of one year
or more at December 31, 1996 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING OPERATING CAPITAL
DECEMBER 31, LEASES LEASES
------------------------------------------------------ -------- -------
<S> <C> <C>
1997................................................ $ 86,316 $11,376
1998................................................ 151,116 11,376
1999................................................ 151,116 11,376
2000................................................ 129,516 8,121
2001................................................ 9,440 891
-------- -------
$527,504 43,140
========
Less amount representing interest..................... 7,696
-------
35,444
Less current portion.................................. 8,408
-------
Long-term portion................................ $27,036
=======
</TABLE>
Included in furniture and equipment are capitalized leased equipment of
$40,564 and $159,240 (unaudited) with accumulated depreciation of $7,615 and
$34,010 (unaudited) at December 31, 1996 and September 30, 1997, respectively.
Rent expense was $59,594 and $30,943 for the years ended December 31, 1996
and 1995, respectively, and $64,247 (unaudited) and $33,472 (unaudited) for the
nine months ended September 30, 1997 and 1996, respectively.
Employment Agreements
The Company entered into employment agreements with certain key employees
of the Company which range from one to five years.
Sheffield University Master Agreement
In July 1996, the Company entered into a ten-year, exclusive agreement with
Sheffield University, whereby the Company will take the lead in the development
and commercialization of any discoveries resulting from Sheffield University's
research. The proceeds distributed to Sheffield University from the sale or
license of products or technologies developed or commercialized under this
agreement will be determined on a case-by-case basis.
Either party may terminate the agreement with no less than six-months
notice.
NOTE 11 -- RELATED PARTIES
During 1996, three officers of the Company agreed to defer a portion of
their salaries totaling $127,500. The Company intends to pay such amounts of
deferred compensation in 1997, and accordingly, they are presented as current
liabilities in the accompanying balance sheet as of December 31, 1996.
F-16
<PAGE> 79
MEDICAL SCIENCE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995 AND
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996 (UNAUDITED)
(THE INFORMATION WITH RESPECT TO THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996 IS UNAUDITED.)
NOTE 11 -- RELATED PARTIES (CONTINUED)
Unaudited
During the nine months ended September 30, 1997, the Company paid the
deferred salaries of $127,500.
NOTE 12 -- SUBSEQUENT EVENTS (UNAUDITED)
From October 1, 1997 through October 6, 1997, the Company entered into
several subscription agreements to sell subordinated Promissory Notes ("Notes").
In addition, the Company granted one warrant to purchase common stock at an
exercise price of $5.50 per share for each $5.00 loaned. The Company issued
Notes in the amount of $230,000 and issued 46,000 warrants to purchase the
Company's common stock. The Notes accrue interest at 10% per annum, and all
unpaid principal and interest are due the earlier of fourteen months from the
date of issuance or the sale of equity securities which results in gross
proceeds in excess of $6,000,000. The warrants expire the earlier of five years
from the date of issuance or upon the occurrence of the Company's common stock
traded on a national or regional stock exchange and the closing price of the
common stock equals or exceeds $12.00 per share for 30 consecutive trading days.
In connection with the issuance of such warrants, the Company will recognize
additional interest expense of $46,000 over the fourteen month term of the Notes
with the unamortized portion at the closing of the Company's IPO being charged
to interest expense immediately.
F-17
<PAGE> 80
======================================================
We have not authorized any dealer, salesperson or any other person to give
any information or to represent anything not contained in this Prospectus. You
must not rely on any unauthorized information. This Prospectus does not offer to
sell or buy any shares in any jurisdiction where it is unlawful. The information
in this Prospectus is current as of November , 1997.
------------------------
TABLE OF CONTENTS
PROSPECTUS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary............................... 1
Risk Factors.......................... 9
The Company........................... 17
Use of Proceeds....................... 18
Dividend Policy....................... 19
Capitalization........................ 19
Dilution.............................. 20
Selected Financial Data............... 21
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 22
Business.............................. 25
Management............................ 46
Certain Relationships and Related
Party Transactions.................. 52
Principal Shareholders................ 53
Description of Securities............. 54
Shares Eligible for Future Sale....... 55
Underwriting.......................... 57
Legal Matters......................... 58
Experts............................... 58
Additional Information................ 58
Index to Financial Statements......... F-1
</TABLE>
UNTIL , 199 , (25 DAYS AFTER THE DATE OF THIS PROSPECTUS) ALL
DEALERS THAT BUY, SELL OR TRADE THESE SECURITIES, WHETHER OR NOT PARTICIPATING
IN THIS OFFERING, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION
TO THE DEALERS' OBLIGATION TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
======================================================
======================================================
2,600,000 SHARES
[MEDICAL SCIENCE LOGO]
COMMON STOCK
------------------------
PROSPECTUS
------------------------
NUTMEG SECURITIES, LTD.
MILLENIUM FINANCIAL GROUP, INC.
======================================================
<PAGE> 81
PART II -- INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 24. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Our company's Amended and Restated Articles of Incorporation eliminates the
liability of directors for monetary damages for an act or omission in the
director's capacity as a director, except for: (1) a breach of a director's duty
of loyalty to our company or our shareholders; (2) an act or omission not in
good faith that constitutes a breach of duty of that director to our company or
an act or omission that involves intentional misconduct or a knowing violation
of the law; (3) a transaction from which a director received an improper
benefit, whether or not the benefit resulted from an action taken within the
scope of the director's office; or (4) an act or omission for which the
liability of a director is expressly provided for by an applicable statute.
If the Texas Miscellaneous Corporation Laws Act or the Texas Business
Corporation Act is amended to authorize action further eliminating or limiting
the personal liability of directors, then the liability of a director of our
company shall be eliminated or limited to the fullest extent permitted by such
statutes, as so amended. Any amendment, repeal or modification of such provision
shall be prospective only and shall not adversely affect any right or protection
of a director of our company existing at the time of such amendment, repeal or
modification.
ITEM 25. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The following table sets forth the expenses in connection with this
Registration Statement. All of such expenses are estimates, other than the
filing fees payable to the Securities and Exchange Commission.
<TABLE>
<S> <C>
Filing Fee -- Securities and Exchange Commission................ $ 9,325.00
Exchange Listing Fee............................................ 35,000.00
Fees and Expenses of Accountants................................ 45,000.00
Fees and Expenses of Counsel.................................... 120,000.00
Printing and Engraving Expenses................................. 75,000.00
Blue Sky Fees and Expenses...................................... 20,000.00
Transfer Agent Fees............................................. 4,000.00
Miscellaneous Expenses.......................................... 46,675.00
------------
Total................................................. $ 355,000.00
============
</TABLE>
ITEM 26. RECENT SALES OF UNREGISTERED SECURITIES
1. Between November 1996 and January 1997, we sold 189,188 shares of our
Common Stock to seven (7) investors in a private placement at a price of $3.70
per share. No commissions or finder's fees were paid.
Within the 12 month period preceding such private placement, the Company
did not make any offer or sales of securities. These securities were issued in
reliance upon the exemption set forth in Rule 504 of Regulation D of the
Securities Act.
2. Between March 1997 and September 1997, we sold 292,060 shares of our
Common Stock to forty-six (46) investors in a second private placement
transaction at a price of $5.00 per share. We issued 1,760 shares of our Common
Stock as a finder's fee with respect to such private placement.
Fewer than 35 purchasers in such offering were unaccredited. Each purchaser
executed subscription agreements representing that such purchaser either alone
or with his representatives had knowledge and experience sufficient to evaluate
the merits and risks of the investment. These securities were issued in reliance
upon the exemption set forth in Rule 506 of Regulation D of the Securities Act.
3. From December 1996 through May 1997, our company has issued a total of
800,579 incentive and non-qualifying stock options to thirty-seven (37)
employees and consultants under our 1996 Equity Incentive Plan. Of the total
issued, 533,500 were issued in exchange for services rendered to our company.
These options generally vest over 36 months and have a per share exercise price
from $3.70 to $5.00. The balance of
II-1
<PAGE> 82
the options (267,079) were issued in May 1997. In order to reduce our overhead
and as an additional incentive to our employees, we instituted a voluntary
salary reduction plan where our employees could choose to receive stock options
instead of salary. Employees were offered options to purchase 600 shares of
Common Stock for every $1,000 their salary was reduced. Most of our employees
participated, including all of our officers. A total of 267,079 options to
purchase Common Stock at an exercise price of $5.00 or $5.50 per share were
issued. These options vested immediately.
The offer of these securities was made solely to directors and employees of
the Company. The offering was made without any public advertisement. These
securities were issued in reliance upon the exemptions set forth in Section 4(2)
of the Securities Act on the basis that they were issued under circumstances not
involving a public offering. It should also be noted that in December 1996, a
permit was issued by the California Department of Corporations qualifying grants
of options or common stock under the company's 1996 Equity Incentive Plan.
4. From August 1, 1997 through October 6, 1997, we borrowed an aggregate of
$1,780,000 from twenty-eight (28) lenders evidenced by promissory notes bearing
interest at 10% interest rate and due the earlier of fourteen months from the
date of the notes or the closing date of an initial public offering (the "Bridge
Loans"). As additional consideration for the Bridge Loans, we issued one warrant
for each $5.00 loaned to the Company for a total of 356,000 warrants (the
"Bridge Warrants"). Each Bridge Warrant entitles the holder to purchase one
share of Common Stock at $5.50 per share for a period of five years from the
date of issuance. An additional 545 Bridge Warrants were issued as a finder's
fee. The following officers and directors subscribed to the Bridge Loans in the
principal amount indicated after their names: Paul J. White ($100,000/20,000
Bridge Warrants); Kenneth S. Kornman ($100,000/20,000 Bridge Warrants); Michael
G. Newman ($100,000/20,000 Bridge Warrants); U. Spencer Allen ($50,000/10,000
Bridge Warrants); Jeanne Ambruster ($50,000/10,000 Bridge Warrants); and Thomas
A. Moore ($75,000/15,000 Bridge Warrants). The other twenty-one investors were
outside private parties. Other than the 545 Bridge Warrants referenced above, no
commissions or finder's fees were paid by the Company.
Fewer than 35 purchasers in such offering were unaccredited. Each purchaser
executed subscription agreements representing that such purchaser either alone
or with his representatives had knowledge and experience sufficient to evaluate
the merits and risks of the investment. These securities were issued in reliance
upon the exemption set forth in Rule 506 of Regulation D of the Securities Act.
ITEM 27. EXHIBITS.
<TABLE>
<S> <C>
1.1 Form of Underwriting Agreement.*
1.2 Form of Agreement Among Underwriters.*
1.3 Form of Selected Dealers Agreement.*
3.1 Amended and Restated Articles of Incorporation.*
3.2 Articles of Amendment to the Amended and Restated Articles of Incorporation.*
3.3 Amended and Restated Bylaws of the Company.*
3.4 Amendment to the Amended and Restated Bylaws.*
4.1 Form of Stock Certificate.*
4.2 Form of Underwriters' Warrant.*
4.3 Form of Subordinated Promissory Note.*
4.4 Form of Security Agreement.*
4.5 Form of Warrant Agreement.*
4.6 Form of Warrant Certificate.*
4.7 $500,000 Term Loan with Bank of America.*
4.8 $250,000 Term Loan with Bank of America.*
4.9 Form of Lock-up Agreement.*
</TABLE>
II-2
<PAGE> 83
<TABLE>
<S> <C>
5.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP.*
10.1 Master Agreement for Technology Evaluation, Sheffield University.*(1)
10.2 Research Support Agreement and Amendments to Various Existing Project
Agreements, Sheffield University.*(1)
10.3 Development and Commercialization Project Agreement (Atherosclerosis including
Coronary Artery Disease), Sheffield University.*(1)
10.4 Development and Commercialization Project Agreement (Eye Disease Among
Diabetics), Sheffield University.*(1)
10.5 Development and Commercialization Project Agreement (Osteoporosis), Sheffield
University.*(1)
10.6 Joint Project Agreement Between Gordon Duff and Medical Science Systems, Inc.
Governing the Periodontal Susceptibility Test.*(1)
10.7 Employment Agreement with Paul J. White.*
10.8 Amendment of Employment Agreement with Paul J. White.*
10.9 Employment Agreement with Kenneth S. Kornman.*
10.10 Amendment of Employment Agreement with Kenneth S. Kornman.*
10.11 Employment Agreement with Michael G. Newman.*
10.12 Amendment of Employment Agreement with Michael G. Newman. *
10.13 Service Agreement Relating to Laboratory Services with Baylor University.*(1)
10.14 Lease Agreement dated March 21, 1996 between Koll Center Newport Number 9 and
Company. *
10.15 Lease Agreement dated March 31, 1997 between Jim Jamison and Richard Henderson
and Company. *
10.16 Lease Agreement dated October 23, 1995 between Diamond Shamrock Leasing, Inc.
and Company. *
10.17 1996 Equity Incentive Plan. *
10.18 Amendment to the 1996 Equity Incentive Plan. *
10.19 Form of Stock Option Agreement. *
10.20 Stock Option Exercise Agreement. *
10.21 Operating Agreement of Disisphase, LLC.*(1)
10.22 Disease Progression Explorer Development and License Agreement.*(1)
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP.
23.2 Consent of Counsel (previously filed under Exhibit 5.1).
24.1 Power of Attorney (included in signature page).
27.1 Financial Data Schedule.*
99.1 Consent of Ronald A. La Rosa to Being Named as a Future Director.*
</TABLE>
- ---------------
* Previously filed.
(1) Confidential treatment has been requested with respect to portions of this
document. Omitted portions have been filed separately with the Securities
and Exchange Commission.
II-3
<PAGE> 84
ITEM 28. UNDERTAKINGS.
The undersigned small business issuer hereby undertakes:
(1) Insofar as indemnification for liabilities arising under the
Securities Act of 1933 (the "Act") may be permitted to directors, officers
and controlling persons of the registrant pursuant to the foregoing
provisions, or otherwise, the registrant has been advised that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in
the successful defense of any action, suit or proceeding) is asserted by
such director, officer or controlling person in connection with the
securities being registered, we will, unless in the opinion of our counsel
the matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
(2) The undersigned registrant hereby undertakes that:
(i) For purposes of determining any liability under the Securities
Act of 1933, the information omitted from the form of prospectus filed
as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the registrant pursuant to
Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed
to be part of this registration statement as of the time it was declared
effective.
(ii) For the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a
form of prospectus shall be deemed to be a new registration statement
relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be the initial bona fide
offering thereof.
II-4
<PAGE> 85
SIGNATURES
In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that is has reasonable grounds to believe that it meets all
of the requirements of filing on Form SB-2 and authorized this registration
statement to be signed on its behalf by the undersigned, in the City of Newport
Beach, State of California, on November 19, 1997.
MEDICAL SCIENCE SYSTEMS, INC.
By: /s/ PAUL J. WHITE
------------------------------------
Paul J. White,
President and Chief Executive
Officer
POWER OF ATTORNEY
We, the undersigned directors and officers of Medical Science Systems, Inc.
do hereby constitute and appoint Paul J. White and U. Spencer Allen, or either
of them, acting individually, our true and lawful attorneys and agents, to do
any and all acts and things in our name and behalf in our capacities as
directors and officers and to execute any and all instruments for us and in our
names in the capacities indicated below, which said attorneys and agents, or any
one of them, may deem necessary or advisable to enable said corporation to
comply with the Securities Act of 1933, as amended, and any rules, regulations,
and requirements of the Securities and Exchange Commission, in connection with
this Registration Statement, including specifically, but without limitation,
power and authority to sign for us or any of us in our names and in the
capacities indicated below, any and all amendments (including post-effective
amendments) hereof; and we do hereby ratify and confirm all that the said
attorneys and agents, or any of them, shall do or cause to be done by virtue
hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement was signed by the following persons in the capacities and
on the dates stated.
<TABLE>
<CAPTION>
NAME TITLE DATE
- --------------------------------------------- -------------------------- ------------------
<S> <C> <C>
/s/ PAUL J. WHITE President, Chief November 19, 1997
- --------------------------------------------- Executive Officer and
Paul J. White Director
/s/ U. SPENCER ALLEN Principal Accounting November 19, 1997
- --------------------------------------------- Officer and Treasurer
U. Spencer Allen
/s/ KENNETH S. KORNMAN Chief Scientific Officer November 19, 1997
- --------------------------------------------- and Director
Kenneth S. Kornman
/s/ MICHAEL G. NEWMAN Executive Vice November 19, 1997
- --------------------------------------------- President, Secretary and
Michael G. Newman Director
/s/ THOMAS A. MOORE Director November 19, 1997
- ---------------------------------------------
Thomas A. Moore
</TABLE>
II-5
<PAGE> 86
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ ------------------------------------------------------------------------------
<S> <C>
1.1 Form of Underwriting Agreement.*
1.2 Form of Agreement Among Underwriters.*
1.3 Form of Selected Dealers Agreement.*
3.1 Amended and Restated Articles of Incorporation.*
3.2 Articles of Amendment to the Amended and Restated Articles of Incorporation.*
3.3 Amended and Restated Bylaws of the Company.*
3.4 Amendment to the Amended and Restated Bylaws.*
4.1 Form of Stock Certificate.*
4.2 Form of Underwriters' Warrant.*
4.3 Form of Subordinated Promissory Note.*
4.4 Form of Security Agreement.*
4.5 Form of Warrant Agreement.*
4.6 Form of Warrant Certificate.*
4.7 $500,000 Term Loan with Bank of America.*
4.8 $250,000 Term Loan with Bank of America.*
4.9 Form of Lock-up Agreement.*
5.1 Opinion of Jeffers, Wilson, Shaff & Falk, LLP.*
10.1 Master Agreement for Technology Evaluation, Sheffield University.*(1)
10.2 Research Support Agreement and Amendments to Various Existing Project
Agreements, Sheffield University.*(1)
10.3 Development and Commercialization Project Agreement (Atherosclerosis including
Coronary Artery Disease), Sheffield University.*(1)
10.4 Development and Commercialization Project Agreement (Eye Disease Among
Diabetics), Sheffield University.*(1)
10.5 Development and Commercialization Project Agreement (Osteoporosis), Sheffield
University.*(1)
10.6 Joint Project Agreement Between Gordon Duff and Medical Science Systems, Inc.
Governing the Periodontal Susceptibility Test.*(1)
10.7 Employment Agreement with Paul J. White.*
10.8 Amendment of Employment Agreement with Paul J. White.*
10.9 Employment Agreement with Kenneth S. Kornman.*
10.10 Amendment of Employment Agreement with Kenneth S. Kornman.*
10.11 Employment Agreement with Michael G. Newman.*
10.12 Amendment of Employment Agreement with Michael G. Newman.*
10.13 Service Agreement Relating to Laboratory Services with Baylor University.*(1)
10.14 Lease Agreement dated March 21, 1996 between Koll Center Newport Number 9 and
Company.*
10.15 Lease Agreement dated March 31, 1997 between Jim Jamison and Richard Henderson
and Company.*
10.16 Lease Agreement dated October 23, 1995 between Diamond Shamrock Leasing, Inc.
and Company.*
10.17 1996 Equity Incentive Plan.*
10.18 Amendment to the 1996 Equity Incentive Plan.*
10.19 Form of Stock Option Agreement.*
10.20 Stock Option Exercise Agreement.*
10.21 Operating Agreement of Digisphere, LLC.*(1)
10.22 Disease Progression Explorer Development and License Agreement.*(1)
23.1 Consent of Singer Lewak Greenbaum & Goldstein LLP.
27.1 Financial Data Schedule.*
99.1 Consent of Ronald A. La Rosa to Being Named as a Future Director.*
</TABLE>
- ---------------
* Previously filed.
(1) Confidential treatment has been requested with respect to portions of this
document. Omitted portions have been filed separately with the Securities
and Exchange Commission.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
We have issued our report dated September 26, 1997, accompanying the financial
statements of Medical Science Systems, Inc. contained in the Registration
Statement and Prospectus. We consent to the use of the aforementioned report in
the Registration Statement and Prospectus, and to the use of our name as it
appears under the caption "Experts."
SINGER LEWAK GREENBAUM & GOLDSTEIN LLP
Los Angeles, California
November 19, 1997
